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SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549




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FORM 10-Q

Quarterly Report Pursuant To Section 13 or 15(d) of
The Securities Exchange Act Of 1934


For the Quarter Ended September 30, 2003

Commission file number 1-4373



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THREE-FIVE SYSTEMS, INC.




(Exact Name of Registrant as Specified in Its Charter)


|                                  |  |                                     
|--------------------------------- |  | ------------------------------------
|Delaware                          |  | 86-0654102                          
|                                  |  |                                     
|(State or Other Jurisdiction      |  | (I.R.S. Employer Identification No.)
|of Incorporation or Organization) |  |                                     

|                                         |  |  |            | 
|---------------------------------------- |  |  | ---------- | 
|1600 North Desert Drive, Tempe, Arizona  |  |  | 85281      | 
|                                        
|(Address of Principal Executive Offices) |  |  | (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 by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
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 OCTOBER 31, 2003
|                                |  |                                   
|Common
Par value $.01 per share |  |                                    | 21,319,618 | 





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TABLE OF CONTENTS



|              |                                                                                               |                                                      |  |  |  |  |  | 
|------------- | --------------------------------------------------------------------------------------------- | ---------------------------------------------------- |  |  |  |  |  | 
|PART I       
|              | ITEM 1. FINANCIAL STATEMENTS                                                                 
|              |                                                                                               | CONDENSED CONSOLIDATED BALANCE SHEETS               
|              |                                                                                               | CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS     
|              |                                                                                               | CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS     
|              |                                                                                               | 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 DISCLOSURES ABOUT MARKET RISK                           
|              | ITEM 4. CONTROLS AND PROCEDURES                                                              
|PART II      
|              | ITEM 5. OTHER INFORMATION                                                                    
|              | ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K                                                     
|              | SIGNATURES                                                                                   
|EXHIBIT INDEX
|EX-31.1      
|EX-31.2      
|EX-32.1      
|EX-32.2      



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##### Table of Contents



THREE-FIVE SYSTEMS, INC.QUARTERLY REPORT ON FORM 10-QFOR QUARTER ENDED SEPTEMBER 30, 2003TABLE OF CONTENTS

|           |  |                                                                                       |  |                                                                                                                              |    |      |   | 
|---------- |  | ------------------------------------------------------------------------------------- |  | ---------------------------------------------------------------------------------------------------------------------------- | -- | ---- | - | 
|           |  |                                                                                       |  |                                                                                                                              |    | Page
|           |  |                                                                                       |  |                                                                                                                              |    |     
|           |  |                                                                                       |  | PART I                                                                                                                       |    |      |   | 
|ITEM 1.    |  | FINANCIAL STATEMENTS:                                                                 |  |                                                                                                                              |    |     
|           |  |                                                                                       |  | Condensed Consolidated Balance Sheets -
December 31, 2002 and September 30, 2003 (unaudited)                                 |    |      | 1 | 
|           |  |                                                                                       |  | Condensed Consolidated Statements of Operations (unaudited) -
Three Months and Nine Months Ended September 30, 2002 and 2003 |    |      | 2 | 
|           |  |                                                                                       |  | Condensed Consolidated Statements of Cash Flows (unaudited) -
Nine Months Ended September 30, 2002 and 2003                  |    |      | 3 | 
|           |  |                                                                                       |  | Notes to Condensed Consolidated Financial Statements                                                                         |    |      | 4 | 
|ITEM 2.    |  | MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS |  |                                                                                                                              | 10 |     
|ITEM 3.    |  | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK                            |  |                                                                                                                              | 19 |     
|ITEM 4.    |  | CONTROLS AND PROCEDURES                                                               |  |                                                                                                                              | 19 |     
|           |  |                                                                                       |  | PART II                                                                                                                      |    |      |   | 
|ITEM 5.    |  | OTHER INFORMATION                                                                     |  |                                                                                                                              | 19 |     
|ITEM 6.    |  | EXHIBITS AND REPORTS ON FORM 8-K                                                      |  |                                                                                                                              | 19 |     
|SIGNATURES |  |                                                                                       |  |                                                                                                                              | 20 |     





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ITEM 1. FINANCIAL STATEMENTS

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

|                                             |                                                |                            |         |              |         |               |         |             |         | 
|-------------------------------------------- | ---------------------------------------------- | -------------------------- | ------- | ------------ | ------- | ------------- | ------- | ----------- | ------- | 
|                                             |                                                |                            |         | DECEMBER 31, |         | SEPTEMBER 30,
|                                             |                                                |                            |         | 2002         |         | 2003         
|                                             |                                                |                            |         |             
|                                             |                                                |                            |         |              |         |               |         | (unaudited)
|                                             |                                                |                            |         |             
|ASSETS                                       |                                                |                            |         |              |         |               |         |            
|Current Assets:                              |                                                |                            |         |              |         |               |         |            
|                                             | Cash and cash equivalents                      |                            | $       | 18,389       |         |               | $       | 15,325      |        
|                                             | Short-term investments                         |                            |         | 62,178       |         |               |         | 13,540      |        
|                                             | Accounts receivable, net                       |                            |         | 16,606       |         |               |         | 26,303      |        
|                                             | Inventories                                    |                            |         | 17,292       |         |               |         | 25,331      |        
|                                             | Taxes receivable                               |                            |         | 561          |         |               |         | 657         |        
|                                             | Deferred tax asset                             |                            |         | 2,357        |         |               |         | 130         |        
|                                             | Assets held for sale                           |                            |         | 841          |         |               |         |            |        
|                                             | Other current assets                           |                            |         | 2,204        |         |               |         | 2,457       |        
|                                             | Short-term assets of discontinued operations   |                            |         | 4,455        |         |               |         |            |        
|                                             |                                                |                            |         |              |         |               |         |             |        
|                                             |                                                | Total current assets       |         |              | 124,883 |               |         |             | 83,743  | 
|                                             |                                                |                            |         |              |         |               |         |             |        
|Property, Plant and Equipment, net           |                                                |                            | 23,345  |              |         |               | 35,007  |            
|Intangibles, net                             |                                                |                            | 5,292   |              |         |               | 8,074   |            
|Goodwill                                     |                                                |                            | 34,901  |              |         |               | 34,614  |            
|Long-term Deferred Tax Asset                 |                                                |                            | 10,764  |              |         |               |        |            
|Other Assets, net                            |                                                |                            | 455     |              |         |               | 669     |            
|Long-term Assets of Discontinued Operations  |                                                |                            | 23,054  |              |         |               |        |            
|                                             |                                                |                            |         |              |         |               |         |             |        
|Total Assets                                 |                                                | $                          | 222,694 |              |         | $             | 162,107 |            
|                                             |                                                |                            |         |              |         |               |         |             |        
|LIABILITIES AND STOCKHOLDERS EQUITY         |                                                |                            |         |              |         |               |         |            
|Current Liabilities:                         |                                                |                            |         |              |         |               |         |            
|                                             | Accounts payable                               |                            | $       | 8,244        |         |               | $       | 19,083      |        
|                                             | Accrued liabilities                            |                            |         | 4,491        |         |               |         | 4,915       |        
|                                             | Deferred revenue                               |                            |         | 23           |         |               |         | 128         |        
|                                             | Current portion of term loans                  |                            |         | 2,714        |         |               |         | 4,260       |        
|                                             | Current portion of capital leases              |                            |         |             |         |               |         | 2,334       |        
|                                             | Current liabilities of discontinued operations |                            |         | 1,526        |         |               |         |            |        
|                                             |                                                |                            |         |              |         |               |         |             |        
|                                             |                                                | Total current liabilities  |         |              | 16,998  |               |         |             | 30,720  | 
|                                             |                                                |                            |         |              |         |               |         |             |        
|Long-term Debt                               |                                                |                            | 20      |              |         |               | 1,441   |            
|                                             |                                                |                            |         |              |         |               |         |             |        
|Capital Leases                               |                                                |                            |        |              |         |               | 7,148   |            
|                                             |                                                |                            |         |              |         |               |         |             |        
|Other Long-term Liabilities                  |                                                |                            | 8       |              |         |               |        |            
|                                             |                                                |                            |         |              |         |               |         |            
|Commitments and Contingencies (Note J)      
|Minority Interest in Consolidated Subsidiary |                                                |                            |        |              |         |               | 2,499   |            
|                                             |                                                |                            |         |              |         |               |         |             |        
|Stockholders Equity:                        |                                                |                            |         |              |         |               |         |            
|                                             | Common stock                                   |                            |         | 219          |         |               |         | 220         |        
|                                             | Additional paid-in capital                     |                            |         | 200,763      |         |               |         | 200,921     |        
|                                             | Retained earnings                              |                            |         | 13,695       |         |               |         | (71,682     | )      
|                                             | Stock subscription note receivable             |                            |         | (174         | )       |               |         | (183        | )      
|                                             | Accumulated other comprehensive loss           |                            |         | (332         | )       |               |         | (474        | )      
|                                             | Less  treasury stock, at cost                 |                            |         | (8,503       | )       |               |         | (8,503      | )      
|                                             |                                                |                            |         |              |         |               |         |             |        
|                                             |                                                | Total stockholders equity |         |              | 205,668 |               |         |             | 120,299 | 
|                                             |                                                |                            |         |              |         |               |         |             |        
|Total Liabilities and Stockholders Equity   |                                                | $                          | 222,694 |              |         | $             | 162,107 |            
|                                             |                                                |                            |         |              |         |               |         |             |        

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

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

|                                                     |                                                    |                |        |                     |        |                     |         |        |         |      |        |        |         |   |         |         |         |  
|---------------------------------------------------- | -------------------------------------------------- | -------------- | ------ | ------------------- | ------ | ------------------- | ------- | ------ | ------- | ---- | ------ | ------ | ------- | - | ------- | ------- | ------- | -
|                                                     |                                                    |                |        | Three Months        |        | Nine Months        
|                                                     |                                                    |                |        | Ended September 30, |        | Ended September 30,
|                                                     |                                                    |                |        |                     |        |                    
|                                                     |                                                    |                |        | 2002                |        | 2003                |         | 2002   |         | 2003
|                                                     |                                                    |                |        |                     |        |                     |         |        |         |     
|Net Sales                                            |                                                    | $              | 18,239 |                     |        | $                   | 41,778  |        |         | $    | 64,987 |        |         | $ | 113,094 |        
|                                                     |                                                    |                |        |                     |        |                     |         |        |         |      |        |        |         |   |         |        
|Costs and Expenses:                                  |                                                    |                |        |                     |        |                     |         |        |         |      |        |        |         |   |         |        
|                                                     | Cost of sales                                      |                |        | 17,023              |        |                     |         | 42,050 |         |      |        | 59,599 |         |   |         | 111,297 |        
|                                                     | Selling, general, and administrative               |                |        | 2,431               |        |                     |         | 4,941  |         |      |        | 7,866  |         |   |         | 12,753  |        
|                                                     | Research, development, and engineering             |                |        | 1,208               |        |                     |         | 1,285  |         |      |        | 3,791  |         |   |         | 3,939   |        
|                                                     | Loss (gain) on sale of assets                      |                |        |                    |        |                     |         | (15    | )       |      |        | 4,545  |         |   |         | (20     | )      
|                                                     | Amortization of customer lists/distribution rights |                |        |                    |        |                     |         | 510    |         |      |        |       |         |   |         | 1,532   |        
|                                                     |                                                    |                |        |                     |        |                     |         |        |         |      |        |        |         |   |         |        
|                                                     |                                                    |                | 20,662 |                     |        |                     | 48,771  |        |         |      | 75,801 |        |         |   | 129,501 |        
|                                                     |                                                    |                |        |                     |        |                     |         |        |         |      |        |        |         |   |         |        
|                                                     |                                                    | Operating loss |        |                     | (2,423 | )                   |         |        | (6,993  | )    |        |        | (10,814 | ) |         |         | (16,407 | )
|                                                     |                                                    |                |        |                     |        |                     |         |        |         |      |        |        |         |   |         |        
|Other Income (Expense):                              |                                                    |                |        |                     |        |                     |         |        |         |      |        |        |         |   |         |        
|                                                     | Interest, net                                      |                |        | 716                 |        |                     |         | (475   | )       |      |        | 2,722  |         |   |         | 19      |        
|                                                     | Other, net                                         |                |        | 39                  |        |                     |         | 24     |         |      |        | 125    |         |   |         | (13     | )      
|                                                     |                                                    |                |        |                     |        |                     |         |        |         |      |        |        |         |   |         |        
|                                                     |                                                    |                | 755    |                     |        |                     | (451    | )      |         |      | 2,847  |        |         |   | 6       |        
|Minority Interest in Loss of Consolidated Subsidiary |                                                    |                |       |                     |        |                     | 71      |        |         |      | 84     |        |         |   | 28      |        
|                                                     |                                                    |                |        |                     |        |                     |         |        |         |      |        |        |         |   |         |        
|Loss before Income Taxes                             |                                                    |                | (1,668 | )                   |        |                     | (7,373  | )      |         |      | (7,883 | )      |         |   | (16,373 | )      
|                                                     | Provision for (benefit from) income taxes          |                |        | (913                | )      |                     |         | 17,576 |         |      |        | (3,194 | )       |   |         | 14,306  |        
|                                                     |                                                    |                |        |                     |        |                     |         |        |         |      |        |        |         |   |         |        
|Loss from Continuing Operations                      |                                                    |                | (755   | )                   |        |                     | (24,949 | )      |         |      | (4,689 | )      |         |   | (30,679 | )      
|Loss from Discontinued Operations, net of taxes      |                                                    |                | (2,625 | )                   |        |                     | (5,931  | )      |         |      | (9,641 | )      |         |   | (10,552 | )      
|                                                     |                                                    |                |        |                     |        |                     |         |        |         |      |        |        |         |   |         |        
|                                                     |                                                    | Net Loss       |        | $                   | (3,380 | )                   |         | $      | (30,880 | )    |        | $      | (14,330 | ) |         | $       | (41,231 | )
|                                                     |                                                    |                |        |                     |        |                     |         |        |         |      |        |        |         |   |         |        
|Loss per Common Share  Basic and Diluted:           |                                                    |                |        |                     |        |                     |         |        |         |      |        |        |         |   |         |        
|Loss from Continuing Operations                      |                                                    | $              | (0.04  | )                   |        |                     | (1.17   | )      |         |      | (0.22  | )      |         |   | (1.44   | )      
|Loss from Discontinued Operations                    |                                                    |                | (0.12  | )                   |        |                     | (0.28   | )      |         |      | (0.45  | )      |         |   | (0.50   | )      
|                                                     |                                                    |                |        |                     |        |                     |         |        |         |      |        |        |         |   |         |        
|                                                     |                                                    | Net Loss       |        | $                   | (0.16  | )                   |         | $      | (1.45   | )    |        | $      | (0.67   | ) |         | $       | (1.94   | )
|                                                     |                                                    |                |        |                     |        |                     |         |        |         |      |        |        |         |   |         |        
|Weighted Average Number of Common Shares:            |                                                    |                |        |                     |        |                     |         |        |         |      |        |        |         |   |         |        
|                                                     | Basic and diluted                                  |                |        | 21,518              |        |                     |         | 21,305 |         |      |        | 21,515 |         |   |         | 21,295  |        
|                                                     |                                                    |                |        |                     |        |                     |         |        |         |      |        |        |         |   |         |        

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

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

|                                                                  |                                                                                           |                                                                 |                                                     |         |                   |       |         |         |         |        |  
|----------------------------------------------------------------- | ----------------------------------------------------------------------------------------- | --------------------------------------------------------------- | --------------------------------------------------- | ------- | ----------------- | ----- | ------- | ------- | ------- | ------ | -
|                                                                  |                                                                                           |                                                                 |                                                     |         | Nine Months Ended
|                                                                  |                                                                                           |                                                                 |                                                     |         | September 30,    
|                                                                  |                                                                                           |                                                                 |                                                     |         |                  
|                                                                  |                                                                                           |                                                                 |                                                     |         | 2002              |       | 2003   
|                                                                  |                                                                                           |                                                                 |                                                     |         |                   |       |        
|Cash Flows from Operating Activities:                             |                                                                                           |                                                                 |                                                     |         |                   |       |         |        
|                                                                  | Net loss                                                                                  |                                                                 | $                                                   | (14,330 | )                 |       | $       | (41,231 | )      
|                                                                  |                                                                                           | Less loss  discontinued operations                             |                                                     |         | (9,641            | )     |         |         | (10,552 | )     
|                                                                  |                                                                                           |                                                                 |                                                     |         |                   |       |         |         |        
|                                                                  |                                                                                           | Loss  continuing operations                                    |                                                     |         | (4,689            | )     |         |         | (30,679 | )     
|                                                                  | Adjustments to reconcile net loss to net cash
(used in) provided by operating activities: |                                                                 |                                                     |         |                   |       |         |         |        
|                                                                  |                                                                                           | Depreciation and amortization                                   |                                                     |         | 2,791             |       |         |         | 5,514   |       
|                                                                  |                                                                                           | Stock compensation                                              |                                                     |         | 92                |       |         |         | 50      |       
|                                                                  |                                                                                           | Minority interest in consolidated subsidiary                    |                                                     |         | (84               | )     |         |         | (28     | )     
|                                                                  |                                                                                           | Deferred revenue                                                |                                                     |         |                  |       |         |         | 105     |       
|                                                                  |                                                                                           | Provision for accounts receivable valuation reserves            |                                                     |         | 124               |       |         |         | 21      |       
|                                                                  |                                                                                           | Loss (gain) on disposal of assets                               |                                                     |         | 4,545             |       |         |         | (20     | )     
|                                                                  |                                                                                           | Provision for (benefit from) deferred taxes, net                |                                                     |         | (7,039            | )     |         |         | 12,991  |       
|                                                                  |                                                                                           | Interest on notes payable                                       |                                                     |         |                  |       |         |         | 96      |       
|                                                                  |                                                                                           | Interest on officer loan                                        |                                                     |         | (8                | )     |         |         | (9      | )     
|                                                                  | Changes in assets and liabilities:                                                        |                                                                 |                                                     |         |                   |       |         |         |        
|                                                                  |                                                                                           | (Increase) decrease in accounts receivable                      |                                                     |         | 6,232             |       |         |         | (9,997  | )     
|                                                                  |                                                                                           | Decrease in inventories                                         |                                                     |         | 3,482             |       |         |         | 2,353   |       
|                                                                  |                                                                                           | Decrease in other assets                                        |                                                     |         | 869               |       |         |         | 124     |       
|                                                                  |                                                                                           | Increase (decrease) in accounts payable and accrued liabilities |                                                     |         | (5,504            | )     |         |         | 9,794   |       
|                                                                  |                                                                                           | Increase (decrease) in taxes payable/receivable                 |                                                     |         | 4,096             |       |         |         | (96     | )     
|                                                                  |                                                                                           |                                                                 |                                                     |         |                   |       |         |         |        
|                                                                  |                                                                                           |                                                                 | Net cash (used in) provided by operating activities |         |                   | 4,907 |         |         |         | (9,781 | )
|                                                                  |                                                                                           |                                                                 |                                                     |         |                   |       |         |         |        
|Cash Flows from Investing Activities:                             |                                                                                           |                                                                 |                                                     |         |                   |       |         |        
|                                                                  | Purchases of property, plant, and equipment                                               |                                                                 |                                                     | (895    | )                 |       |         | (2,131  | )      
|                                                                  | Proceeds from sale of assets                                                              |                                                                 |                                                     | 1,100   |                   |       |         | 606     |        
|                                                                  | Purchase of intangibles                                                                   |                                                                 |                                                     | (581    | )                 |       |         | (433    | )      
|                                                                  | Purchase of short-term investments                                                        |                                                                 |                                                     | (95,884 | )                 |       |         | (13,262 | )      
|                                                                  | Proceeds from maturities/sales of short-term investments                                  |                                                                 |                                                     | 113,874 |                   |       |         | 61,838  |        
|                                                                  | Licenses and acquisitions                                                                 |                                                                 |                                                     | (11,950 | )                 |       |         | (9,680  | )      
|                                                                  |                                                                                           |                                                                 |                                                     |         |                   |       |         |         |        
|                                                                  |                                                                                           |                                                                 | Net cash provided by investing activities           |         |                   | 5,664 |         |         |         | 36,938 |  
|                                                                  |                                                                                           |                                                                 |                                                     |         |                   |       |         |         |        
|Cash Flows from Financing Activities:                             |                                                                                           |                                                                 |                                                     |         |                   |       |         |        
|                                                                  | Payments on notes payable                                                                 |                                                                 |                                                     |        |                   |       |         | (2,734  | )      
|                                                                  | Stock options exercised                                                                   |                                                                 |                                                     | 202     |                   |       |         | 109     |        
|                                                                  | Payments on capital leases                                                                |                                                                 |                                                     |        |                   |       |         | (1,135  | )      
|                                                                  | (Distribution to) receipt from minority interest                                          |                                                                 |                                                     | (239    | )                 |       |         | 2,527   |        
|                                                                  | Purchase of treasury stock                                                                |                                                                 |                                                     | (634    | )                 |       |         |        |        
|                                                                  |                                                                                           |                                                                 |                                                     |         |                   |       |         |         |        
|                                                                  |                                                                                           |                                                                 | Net cash used in financing activities               |         |                   | (671  | )       |         |         | (1,233 | )
|                                                                  |                                                                                           |                                                                 |                                                     |         |                   |       |         |         |        
|                                                                  | Effect of exchange rate changes on cash and cash equivalents                              |                                                                 |                                                     | (62     | )                 |       |         | (80     | )      
|                                                                  |                                                                                           |                                                                 |                                                     |         |                   |       |         |        
|Net increase in cash and cash equivalents  continuing operations |                                                                                           |                                                                 | 9,838                                               |         |                   |       | 25,844  |        
|Net cash used in and contributed to discontinued operations       |                                                                                           |                                                                 | (21,224                                             | )       |                   |       | (28,908 | )      
|                                                                  |                                                                                           |                                                                 |                                                     |         |                   |       |         |        
|Net decrease in cash and cash equivalents                         |                                                                                           |                                                                 | (11,386                                             | )       |                   |       | (3,064  | )      
|Cash and cash equivalents, beginning of period                    |                                                                                           |                                                                 | 37,003                                              |         |                   |       | 18,389  |        
|                                                                  |                                                                                           |                                                                 |                                                     |         |                   |       |         |        
|Cash and cash equivalents, end of period                          |                                                                                           | $                                                               | 25,617                                              |         |                   | $     | 15,325  |        
|                                                                  |                                                                                           |                                                                 |                                                     |         |                   |       |         |        
|Noncash Investing and Financing Activities:                       |                                                                                           |                                                                 |                                                     |         |                   |       |         |        
|                                                                  | Note payable due on purchase of DI distribution rights                                    |                                                                 | $                                                   |        |                   |       | $       | 2,882   |        
|                                                                  | Note payable due on purchase of Microtune inventory and equipment                         |                                                                 |                                                     |        |                   |       |         | 2,723   |        
|                                                                  | Capital lease due on purchase of Unico equipment                                          |                                                                 |                                                     |        |                   |       |         | 9,375   |        
|                                                                  | Capital leases due on purchase of ETMA equipment                                          |                                                                 |                                                     |        |                   |       |         | 1,242   |        

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
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)



|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 our
opinion, 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 nine-month period ended September 30, 2003 are not
necessarily indicative of the operating results that may be expected for
the entire year ending December 31, 2003. These financial statements
should be read in conjunction with our December 31, 2002 financial
statements and the accompanying notes thereto.                                                                                                    
|------ |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|      
|       |  | On September 1, 2003, we transferred all of the net assets of our
microdisplay division, plus approximately $20.9 million in cash, into a
newly created Delaware corporation called Brillian Corporation (Brillian).
Brillian had $44.1 million of net assets on the spin-off date. On
September 15, 2003, we spun off Brillian by distributing all of the
outstanding common stock of Brillian to our stockholders on a pro rata
basis, with each stockholder of Three-Five Systems, Inc. (TFS) receiving
one share of Brillian common stock for each four shares of TFS common
stock held. Brillian is now traded on the Nasdaq National Market under the
symbol BRLC. For more information on the reason for the spin-off, as
well as the description of business and risks associated with the
spin-off, please refer to the Form 10 and the related amendments and
associated documents filed with the Securities and Exchange Commission by
Brillian. The microdisplay business that we transferred to Brillian is
now reported in these consolidated financial statements as Discontinued
Operations.
|      
|       |  | Net loss from discontinued operations was $10.6 million for the first nine
months of 2003 and $9.6 million for the first nine months of 2002. Sales
from discontinued operations were $1.6 million and $794,000 for the first
nine months of 2003 and 2002, respectively. The major classes of
discontinued assets and liabilities included in the Consolidated Balance
Sheet as of December 31, 2002 and the day of spin-off are as follows (in
thousands):                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  

|             |                                          |                                                |   |              |        |               |   |        |        | 
|------------ | ---------------------------------------- | ---------------------------------------------- | - | ------------ | ------ | ------------- | - | ------ | ------ | 
|             |                                          |                                                |   | December 31, |        | September 15,
|             |                                          |                                                |   | 2002         |        | 2003         
|             |                                          |                                                |   |              |        |              
|Assets:      |                                          |                                                |   |              |        |               |   |       
|             | Cash                                     |                                                | $ |             |        |               | $ | 20,443 |       
|             | Accounts Receivable                      |                                                |   | 364          |        |               |   | 473    |       
|             | Inventories                              |                                                |   | 2,584        |        |               |   | 2,937  |       
|             | Other current assets                     |                                                |   | 1,507        |        |               |   | 961    |       
|             | Property, plant and equipment, net       |                                                |   | 8,218        |        |               |   | 6,884  |       
|             | Intangibles, net                         |                                                |   | 9,627        |        |               |   | 8,894  |       
|             | Other long-term assets                   |                                                |   | 5,209        |        |               |   | 4,730  |       
|             |                                          |                                                |   |              |        |               |   |        |       
|             |                                          | Total assets from discontinued operations      |   | $            | 27,509 |               |   | $      | 45,322 | 
|             |                                          |                                                |   |              |        |               |   |        |       
|Liabilities: |                                          |                                                |   |              |        |               |   |       
|             | Accounts payable and accrued liabilities |                                                | $ | 1,191        |        |               | $ | 1,063  |       
|             | Deferred revenue                         |                                                |   | 335          |        |               |   | 112    |       
|             |                                          |                                                |   |              |        |               |   |        |       
|             |                                          | Total liabilities from discontinued operations |   | $            | 1,526  |               |   | $      | 1,175  | 
|             |                                          |                                                |   |              |        |               |   |        |       



|Note B |  | Basic loss per common share is computed by dividing net loss by the
weighted average number of shares of common stock outstanding during the
three- and nine-month periods ended September 30, 2002 and 2003. Diluted
loss per common share is determined assuming that outstanding dilutive
options and warrants were exercised at the beginning of the period or at
the time of issuance, if later. For the three months ended September 30,
2002 and September 30, 2003, the effect of 298,991 and 304,525 shares,
respectively, and for the nine months ended September 30, 2002 and
September 30, 2003, the effect of 61,772 and 78,398 shares, respectively,
as determined using the treasury stock method, were excluded from the
calculation of loss per share, as their effect would have been
antidilutive and decreased the loss per share. Set forth below are the
disclosures required
|------ |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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| |  | pursuant to SFAS No. 128  Earnings per Sharefor the three months and
nine months ended September 30, 2002 and September 30, 2003.
| |  | ----------------------------------------------------------------------------------------------------------------------------------

|                      |                                |                        |        |                                       |       |                   |         |        |       |      |         |        |       |   |         |        |       |  
|--------------------- | ------------------------------ | ---------------------- | ------ | ------------------------------------- | ----- | ----------------- | ------- | ------ | ----- | ---- | ------- | ------ | ----- | - | ------- | ------ | ----- | -
|                      |                                |                        |        | Three Months Ended                    |       | Nine Months Ended
|                      |                                |                        |        | September 30,                         |       | September 30,    
|                      |                                |                        |        |                                       |       |                  
|                      |                                |                        |        | 2002                                  |       | 2003              |         | 2002   |       | 2003
|                      |                                |                        |        |                                       |       |                   |         |        |       |     
|                      |                                |                        |        | (in thousands, except per share data)
|Basic loss per share: |                                |                        |        |                                       |       |                   |         |        |       |      |         |        |       |   |         |       
|Net loss              |                                | $                      | (3,380 | )                                     |       | $                 | (30,880 | )      |       | $    | (14,330 | )      |       | $ | (41,231 | )     
|                      |                                |                        |        |                                       |       |                   |         |        |       |      |         |        |       |   |         |       
|                      | Weighted average common shares |                        |        | 21,518                                |       |                   |         | 21,305 |       |      |         | 21,515 |       |   |         | 21,295 |      
|                      |                                |                        |        |                                       |       |                   |         |        |       |      |         |        |       |   |         |       
|                      |                                | Basic per share amount |        | $                                     | (0.16 | )                 |         | $      | (1.45 | )    |         | $      | (0.67 | ) |         | $      | (1.94 | )
|                      |                                |                        |        |                                       |       |                   |         |        |       |      |         |        |       |   |         |       



|Note C |  | Inventories consisted of the following (in thousands):
|------ |  | ------------------------------------------------------

|                |  |              |        |               |  |   |        | 
|--------------- |  | ------------ | ------ | ------------- |  | - | ------ | 
|                |  | December 31, |        | September 30,
|                |  | 2002         |        | 2003         
|                |  |              |        |              
|Raw materials   |  | $            | 10,915 |               |  | $ | 16,039 | 
|Work-in-process |  |              | 2,868  |               |  |   | 5,869  | 
|Finished goods  |  |              | 3,509  |               |  |   | 3,423  | 
|                |  |              |        |               |  |   |        | 
|                |  | $            | 17,292 |               |  | $ | 25,331 | 
|                |  |              |        |               |  |   |        | 



|Note D |  | Property, plant, and equipment consisted of the following (in thousands)
at:
|------ |  | ----------------------------------------------------------------------------

|                              |  |              |         |               |  |   |         |  
|----------------------------- |  | ------------ | ------- | ------------- |  | - | ------- | -
|                              |  | December 31, |         | September 30,
|                              |  | 2002         |         | 2003         
|                              |  |              |         |              
|Land and building             |  | $            | 16,476  |               |  | $ | 16,496  |  
|Furniture and equipment       |  |              | 32,472  |               |  |   | 45,336  |  
|                              |  |              |         |               |  |   |         |  
|                              |  |              | 48,948  |               |  |   | 61,832  |  
|Less accumulated depreciation |  |              | (25,603 | )             |  |   | (26,825 | )
|                              |  |              |         |               |  |   |         |  
|                              |  | $            | 23,345  |               |  | $ | 35,007  |  
|                              |  |              |         |               |  |   |         |  



|Note E |  | Intangibles:                                                                                                                                                                                                                                                                                                                                                                 
|------ |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|      
|       |  | Intangibles consist of mask works, trademarks, customer lists, and
distribution rights. Intangibles are recorded at cost and amortized using
the straight-line method over the estimated useful lives of the respective
assets, which range from three to five years. Our policy is to commence
amortization of intangibles when their related benefits begin to be
realized.
|      
|       |  | Intangible assets consisted of the following (in thousands) at September
30, 2003:                                                                                                                                                                                                                                                                                           

|                             |                     |   |             |       |              |   |        |        |   |   |       |       | 
|---------------------------- | ------------------- | - | ----------- | ----- | ------------ | - | ------ | ------ | - | - | ----- | ----- | 
|                             |                     |   | Acquisition |       | Accumulated  |   | Book  
|                             |                     |   | Value       |       | Amortization |   | Value 
|                             |                     |   |             |       |              |   |       
|Amortized Intangible Assets: |                     |   |             |       |              |   |        |        |   |   |       |      
|                             | Mask works          |   | $           | 972   |              |   | $      |       |   |   | $     | 972   | 
|                             | Trademarks          |   |             | 8     |              |   |        |       |   |   |       | 8     | 
|                             | Customer lists      |   |             | 5,000 |              |   |        | (1,206 | ) |   |       | 3,794 | 
|                             | Distribution rights |   |             | 3,882 |              |   |        | (582   | ) |   |       | 3,300 | 
|                             |                     |   |             |       |              |   |        |        |   |   |       |      
|                             |                     | $ | 9,862       |       |              | $ | (1,788 | )      |   | $ | 8,074 |      
|                             |                     |   |             |       |              |   |        |        |   |   |       |      



| |  | Intangible asset amortization expense for the nine months ended September
30, 2002 was $50,000 compared to $1.5 million for the nine months ended
September 30, 2003. Estimated annual amortization expense through 2007
related to intangible assets (in thousands) reported as of September 30,
2003 is as follows:
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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|            |  |        |       | 
|----------- |  | ------ | ----- | 
|Fiscal Year |  | Amount
|            |  |       
|2003        |  | $      | 2,043 | 
|2004        |  |        | 2,368 | 
|2005        |  |        | 2,368 | 
|2006        |  |        | 1,702 | 
|2007        |  |        | 1,378 | 



|Note F |  | Goodwill:                                                                                                                                                                                                                                                                               
|------ |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|      
|       |  | Goodwill decreased $287,000 due to a reduction of $607,000 from purchase
accounting adjustments to the ETMA acquisition, the addition of $315,000
of capitalized costs related to the Unico acquisition, and the addition of
$5,000 of capitalized costs related to the AVT acquisition.
|      
|       |  | Changes in goodwill from December 31, 2002 to September 30, 2003 (in
thousands) were as follows:                                                                                                                                                                                        

|                              |  |       |        |  
|----------------------------- |  | ----- | ------ | -
|                              |  | Total
|                              |  |      
|Balance at December 31, 2002  |  | $     | 34,901 |  
|Change                        |  |       | (287   | )
|                              |  |       |        |  
|Balance at September 30, 2003 |  | $     | 34,614 |  
|                              |  |       |        |  



|Note G |  | Segment Information:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|------ |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|      
|       |  | We offer advanced design and manufacturing services and display products
to original equipment manufacturers, commonly referred to as OEMs.
Historically, we have focused on display-oriented products, although we
have always performed extended manufacturing in conjunction with the
display module. In the past ten months, we expanded the value-added
manufacturing services we provide through several acquisitions. As a
result, we now provide printed circuit board assembly, or PCBA, radio
frequency, or RF, module assembly, new product introduction, or NPI, box
build, and order fulfillment, even in products that do not need displays.
In products that do include displays, we specialize in custom and standard
display solutions utilizing various display technologies, including liquid
crystal displays, or LCDs, organic light emitting diodes, or OLEDs, and
cathode ray tubes, or CRTs. The products we manufacture for OEMs are of
varying sizes and have varying levels of integration.
|      
|       |  | As a result of the spin-off of our microdisplay division into Brillian, we
now report only one operating segment, although we also track net sales by
geographic location. Net sales by geographic area are determined based
upon the location of the end customer. The following includes net sales
(in thousands) for our geographic areas:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         

|                                      |  |         |        |      |  |        |        |       |  |   |        |  |  |   |         | 
|------------------------------------- |  | ------- | ------ | ---- |  | ------ | ------ | ----- |  | - | ------ |  |  | - | ------- | 
|                                      |  | North   |        |      |  |        |        |       |  |   |        |  |  |  
|                                      |  | America |        | Asia |  | Europe |        | Total
|                                      |  |         |        |      |  |        |        |      
|Three months ended September 30, 2002 |  |         |        |      |  |        |        |       |  |   |        |  |  |   |         | 
|Net sales                             |  | $       | 1,439  |      |  | $      | 10,875 |       |  | $ | 5,925  |  |  | $ | 18,239  | 
|Three months ended September 30, 2003 |  |         |        |      |  |        |        |       |  |   |        |  |  |   |         | 
|Net sales                             |  | $       | 24,877 |      |  | $      | 6,518  |       |  | $ | 10,383 |  |  | $ | 41,778  | 
|Nine months ended September 30, 2002  |  |         |        |      |  |        |        |       |  |   |        |  |  |   |         | 
|Net sales                             |  | $       | 5,355  |      |  | $      | 40,721 |       |  | $ | 18,911 |  |  | $ | 64,987  | 
|Nine months ended September 30, 2003  |  |         |        |      |  |        |        |       |  |   |        |  |  |   |         | 
|Net sales                             |  | $       | 64,665 |      |  | $      | 23,963 |       |  | $ | 24,466 |  |  | $ | 113,094 | 

6



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|Note H |  | Comprehensive loss (in thousands) for the periods was as follows:
|------ |  | -----------------------------------------------------------------

|                                   |                                                  |   |                    |      |                   |   |         |     |      |   |         |      |   |   |         |     |  
|---------------------------------- | ------------------------------------------------ | - | ------------------ | ---- | ----------------- | - | ------- | --- | ---- | - | ------- | ---- | - | - | ------- | --- | -
|                                   |                                                  |   | Three Months Ended |      | Nine Months Ended
|                                   |                                                  |   | September 30,      |      | September 30,    
|                                   |                                                  |   |                    |      |                  
|                                   |                                                  |   | 2002               |      | 2003              |   | 2002    |     | 2003
|                                   |                                                  |   |                    |      |                   |   |         |     |     
|Net loss                           |                                                  | $ | (3,380             | )    |                   | $ | (30,880 | )   |      | $ | (14,330 | )    |   | $ | (41,231 | )  
|Other comprehensive income (loss): |                                                  |   |                    |      |                   |   |         |     |      |   |         |      |   |   |         |    
|                                   | Foreign currency translation
adjustment          |   |                    | (114 | )                 |   |         | (74 | )    |   |         | (62  | ) |   |         | (80 | )
|                                   | Unrealized gain (loss) on
securities, net of tax |   |                    | 58   |                   |   |         | (16 | )    |   |         | (150 | ) |   |         | (62 | )
|                                   |                                                  |   |                    |      |                   |   |         |     |      |   |         |      |   |   |         |    
|Comprehensive loss                 |                                                  | $ | (3,436             | )    |                   | $ | (30,970 | )   |      | $ | (14,542 | )    |   | $ | (41,373 | )  
|                                   |                                                  |   |                    |      |                   |   |         |     |      |   |         |      |   |   |         |    



|Note I |  | Debt:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|------ |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|      
|       |  | In the third quarter, our Beijing facility paid off its $2.7 million term
loan to the Bank of China. We currently have no credit facility
outstanding in the United Sates. We expect to close on a $10 million line
of credit in the fourth quarter, although we do not expect to need that
facility in the near future.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|      
|       |  | In January 2003, we signed a note payable of $2.9 million to Data
International that is payable over the next two years. In March 2003, we
signed a note payable of $2.7 million to Microtune that was due in
September 2003. In October 2003, we paid off approximately $300,000 of
that note and entered into an agreement to cancel the remaining $2.4
million balance on that note in exchange for the return of inventory to
Microtune. In May 2003, our 60% owned Penang subsidiary entered into a
capital lease of $12.0 million, which includes interest, with Unico that
is payable at the rate of $3.0 million per year over the next four years.
The principal balance on that capital lease was $8.6 million as of
September 30, 2003. In September 2003, we had $869,000 remaining on
capital leases relating to equipment in Seattle.                                                                                                                                  
|      
|Note J |  | Commitments and Contingencies:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|      
|       |  | In February 2002, we guaranteed up to $500,000 of the debt of a private
start-up company, VoiceViewer Technology, Inc., which is developing
microdisplay products. This guarantee was assumed by Brillian Corporation
in the spin-off. We have not yet been released from our obligation on the
guarantee, so if Brillian becomes required to pay on the guarantee and is
unable to satisfy its obligation, then we are secondarily liable and will
be required to pay this guarantee to the lender. As of September 30, 2003,
the outstanding balance on the debt was $390,000. This loan guarantee has
a five-year term and matures in January 2007.                                                                                                                                                                                                                                                                                                                               
|      
|       |  | We are also involved in certain administrative proceedings arising in the
normal course of business. In our opinion, the ultimate settlement of
these administrative proceedings will not materially impact our financial
position or results of operations.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|      
|Note K |  | Licenses and Acquisitions:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|      
|       |  | In January 2003, we signed licensing and manufacturing agreements with
Data International Co., Ltd. of Taiwan. Under those agreements, we became
the exclusive channel in the Americas for standard and custom LCD products
manufactured by Data International. We also have the right to sell those
products through our worldwide channels. The agreements provide us with
access to a full suite of standard display products that round out our
existing standard product portfolio. In conjunction with the agreement,
we established a sales office in Orlando and hired sales and applications
engineering personnel from a distributor that had previously supported
Data Internationals products. The cost of the license was $3.9 million,
of which $1.0 million was paid upon signing and the remaining $2.9 million
is due as a note payable over the next two years. The unpaid $2.9 million
is subject to reduction if certain revenue and margin targets are not met.
|      
|       |  | In March 2003, we signed an agreement with Microtune, Inc. under which we
agreed to manufacture, assemble, and test Microtunes radio frequency, or
RF, tuner modules and wireless module products in our manufacturing
facility in Manila, the Philippines. As part of the agreement, Microtune
sold to us certain of its own equipment and inventory for $8.2 million, of
which $2.7 million was a note payable due in September 2003, and
contracted with us to provide 100% of Microtunes current demand for fully
assembled RF                                                                                                                                                                                                                                                                                                                                                                                                                                                 

7



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|       |  | subsystems. We also hired approximately 500 Microtune employees in Manila
and are in the process of transferring those employees to our nearby
manufacturing facility. After qualifications are complete for our
facility, Microtune plans to close its Manila manufacturing facility. In
October 2003, we paid off approximately $300,000 of the $2.7 million note
payable to Microtune and entered into an agreement to cancel the remaining
$2.4 million balance on that note in exchange for the return of inventory
to Microtune.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|------ |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|      
|       |  | In April 2003, we acquired the business and certain assets of Unico
Technology Bhd., a privately held Malaysian company located in Penang.
Unico was an electronic manufacturer for OEM customers in the computer,
computer peripheral, and communications industries. The Unico business was
acquired by TFS Electronic Manufacturing Services Sdn. Bhd., or
TFS-Malaysia, a joint venture owned 60% by an overseas TFS subsidiary and
40% by Unico Holdings Bhd., the former parent of Unico. Unico Holdings is
the investment arm of the Chinese Chamber of Commerce of Malaysia. Our
share of the initial cost of capitalizing TFS-Malaysia was $3.8 million
and Unico Holdings share was $2.5 million, most of which will be used for
working capital. TFS-Malaysia purchased $4.1 million in inventory from
Unico, of which $2.7 million was paid at the time of the purchase and
$600,000 was subsequently paid. The balance of $800,000 is included in
accounts payable and accrued liabilities. No advance payment was required
for the acquisition of the property, plant, and equipment of Unico, all of
which is leased from the seller. The equipment lease from the seller is
accounted for as a capital lease of $12.0 million, which includes
interest, that is payable by TFS-Malaysia at the rate of $3.0 million per
year over the next four years. The principal balance on that capital
lease was $8.6 million as of September 30, 2003.
|      
|Note L |  | Stock Compensation:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|      
|       |  | Pursuant to the provisions of SFAS No. 123, Accounting for Stock-Based
Compensation, we account for options granted to our employees pursuant to
Accounting Principles Board Opinion (APB) No. 25, Accounting for Stock
Issued to Employees, under which no compensation cost has been recognized.
However, we have computed compensation cost, for pro forma disclosure
purposes, based on the fair value of all options awarded on the date of
grant, utilizing the Black-Scholes option pricing method with the
following weighted assumptions: risk-free interest rates of 4.08% for the
three and nine months ended September 30, 2002, and 2.46% for the three
and nine months ended September 30, 2003; expected dividend yields of zero
for all scenarios; expected lives of 6.1 years for all scenarios; and
expected volatility (a measure of the amount by which a price has
fluctuated or is expected to fluctuate during a period) of 74.2% for all
scenarios. The compensation costs for the three and nine months ended
September 2002 are tax effected and the compensation costs for the three
and nine months ended September 2003 are not tax effected. Had
compensation cost for these plans been determined consistent with SFAS No.
123, our net loss and loss per share would have been as follows (in
thousands, except per share data):                                                                                              

|                                      |                                                                                                                             |  |   |                    |   |                   |   |         |   |      |   |         |   |  |   |         |   | 
|------------------------------------- | --------------------------------------------------------------------------------------------------------------------------- |  | - | ------------------ | - | ----------------- | - | ------- | - | ---- | - | ------- | - |  | - | ------- | - | 
|                                      |                                                                                                                             |  |   | Three Months Ended |   | Nine Months Ended
|                                      |                                                                                                                             |  |   | September 30,      |   | September 30,    
|                                      |                                                                                                                             |  |   |                    |   |                  
|                                      |                                                                                                                             |  |   | 2002               |   | 2003              |   | 2002    |   | 2003
|                                      |                                                                                                                             |  |   |                    |   |                   |   |         |   |     
|Net loss:                             |                                                                                                                             |  |   |                    |   |                   |   |         |   |      |   |         |   |  |   |        
|                                      | As reported                                                                                                                 |  | $ | (3,380             | ) |                   | $ | (30,880 | ) |      | $ | (14,330 | ) |  | $ | (41,231 | )
|                                      | Total stock-based compensation
expenses determined under fair
value based method for all
awards, net of related tax
effects |  |   | (937               | ) |                   |   | (1,892  | ) |      |   | (3,107  | ) |  |   | (3,586  | )
|                                      |                                                                                                                             |  |   |                    |   |                   |   |         |   |      |   |         |   |  |   |        
|                                      | Pro forma net loss                                                                                                          |  | $ | (4,317             | ) |                   | $ | (32,772 | ) |      | $ | (17,437 | ) |  | $ | (44,817 | )
|                                      |                                                                                                                             |  |   |                    |   |                   |   |         |   |      |   |         |   |  |   |        
|Basic and diluted net loss per share: |                                                                                                                             |  |   |                    |   |                   |   |         |   |      |   |         |   |  |   |        
|                                      | As reported                                                                                                                 |  | $ | (0.16              | ) |                   | $ | (1.45   | ) |      | $ | (0.67   | ) |  | $ | (1.94   | )
|                                      | Pro forma                                                                                                                   |  |   | (0.20              | ) |                   |   | (1.54   | ) |      |   | (0.81   | ) |  |   | (2.11   | )



|Note M |  | Recently Issued Accounting Standards:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|------ |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|      
|       |  | In December 2002, the FASB issued SFAS No. 148, Accounting for
Stock-Based Compensation -Transition and Disclosure. This Statement
amends SFAS No. 123 to provide alternative methods of transition for a
voluntary change to the fair value method of accounting for stock-based
employee compensation. In addition, this Statement amends the disclosure
requirements of SFAS No. 123 to require prominent disclosures in both
annual and interim financial statements about the method of accounting for
stock-based employee

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| |  | compensation and the effect of the method used on reported results. We
have adopted the disclosure requirements of SFAS No. 148 and there was no
material impact on our financial statements.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  | In November 2002, the FASB issued FASB Interpretation No. 45 (FIN 45),
Guarantors Accounting and Disclosure Requirements for Guarantees,
Including Indirect Guarantees of Indebtedness of Others. This
Interpretation addresses the disclosures to be made by a guarantor in its
financial statements and its obligations under guarantees. The
Interpretation also clarifies the requirements related to the recognition
of a liability by the guarantor at the inception of a guarantee. Per the
Interpretation, initial recognition of a liability shall be applied only
on a prospective basis to guarantees issued or modified after December 31,
2002. We adopted the requirements of FIN 45 as of January 1, 2003, and
there was no material impact on our financial position or results of
operations.                                                                                                                                                                                                                                                                                 
|
| |  | In January 2003, the Emerging Issues Task Force (EITF) issued EITF
00-21, Accounting for Revenue Arrangements with Multiple Deliverables.
EITF 00-21 addresses the issues of how to determine whether an arrangement
involving multiple deliverables contains more than one unit of accounting
and how arrangement consideration should be measured and allocated to the
separate units of accounting in the arrangement. EITF 00-21 does not
change otherwise applicable revenue recognition criteria. EITF 00-21 is
effective for revenue arrangements entered into in fiscal periods
beginning after June 15, 2003. The application of EITF 00-21 did not have
a material effect on our financial statements.                                                                                                                                                                                                                                                                                                                                                                                
|
| |  | In November 2002, the FASB issued FASB Interpretation No. 46 (FIN 46),
Consolidation of Variable Interest Entities, which clarifies the
application of Accounting Research Bulletin No. 52, Consolidated
Financial Statements, relating to consolidation of certain entities. FIN
46 will require identification of our participation in variable interest
entities (VIEs), which are defined as entities with a level of invested
equity that is not sufficient to fund future activities to permit it to
operate on a standalone basis. For entities identified as a VIE, FIN 46
sets forth a model to evaluate potential consolidation based on an
assessment of which party of the VIE, if any, bears a majority of the
exposure to its expected losses or stands to gain from a majority of its
expected returns. The interpretation is effective after January 31, 2003
for any VIE created after that date and is effective July 1, 2003 for VIEs
created before February 1, 2003. We do not believe the adoption of FIN 46
will have a material effect on our financial statements.
|
| |  | In May 2003, the FASB issued SFAS No. 150, Accounting for Certain
Financial Instruments with Characteristics of Both Liabilities and Equity
(SFAS No. 150). SFAS No. 150 requires the classification of certain
financial instruments, previously classified within the equity section of
the balance sheet, to be included in liabilities. SFAS No. 150 is
effective for financial instruments entered into or modified after May 31,
2003 and June 15, 2003 for all other instruments. The application of SFAS
No. 150 did not have a material effect on our financial statements.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            

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| |  | ITEM 2. | MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
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| |  | printed circuit board assembly, in-circuit and functional testing, systems
integration and box build, complete supply chain management, and turnkey
packaging and fulfillment services. The purchase price of the acquisition was
$38.1 million, which we paid entirely in cash. In September 2003, we had
$869,000 remaining on capital leases relating to equipment in Seattle.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
| |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  | In January 2003, we signed licensing and manufacturing agreements with
Data International Co., Ltd. of Taiwan. Under those agreements, we became the
exclusive channel in the Americas for standard and custom LCD products
manufactured by Data International. We also have the right to sell those
products through our worldwide channels. The agreements provide us with access
to a full suite of standard display products that round out our existing
standard product portfolio. In conjunction with the agreement, we established a
sales office in Orlando and hired sales and applications engineering personnel
from a distributor that had previously supported Data Internationals products.
The cost of the license is anticipated to be $3.9 million, of which $1.0
million was paid upon signing and $2.9 million will be due over the next two
years. The unpaid $2.9 million is subject to reduction if certain revenue and
margin targets are not met.                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|
| |  | In March 2003, we signed an agreement with Microtune, Inc. in which we
agreed to manufacture, assemble, and test Microtunes radio frequency, or RF,
tuner modules and wireless module products in our manufacturing facility in
Manila, the Philippines. As part of the agreement, Microtune sold to us certain
of its own equipment and inventory for $8.2 million, of which $2.7 million was
a note payable due in September 2003, and contracted with us to provide 100% of
Microtunes current demand for fully assembled RF subsystems. We also hired
approximately 500 Microtune employees in Manila, and are in the process of
transferring those employees to our nearby manufacturing facility. After
qualifications are complete for our facility, Microtune plans to close its
Manila manufacturing facility. In October 2003, we paid off approximately
$300,000 of the $2.7 million note payable to Microtune and entered into an
agreement to cancel the remaining $2.4 million balance on that note in exchange
for the return of inventory to Microtune.                                                                                                                                                                                                                                                                                                                                                     
|
| |  | In April 2003, we acquired the business and certain assets of Unico
Technology Bhd., a privately held Malaysian company located in Penang. Unico
was an electronic manufacturer for OEM customers in the computer, computer
peripheral, and communications industries. The Unico business was acquired by
TFS Electronic Manufacturing Services Sdn. Bhd., or TFS-Malaysia, a joint
venture owned 60% by an overseas TFS subsidiary and 40% by Unico Holdings Bhd.,
the former parent of Unico. Unico Holdings is the investment arm of the Chinese
Chamber of Commerce of Malaysia. Our share of the initial cost of capitalizing
TFS-Malaysia was $3.8 million and Unico Holdings share was $2.5 million, most
of which will be used for working capital. TFS-Malaysia purchased $4.1 million
in inventory from Unico, of which $2.7 million was paid at the time of the
purchase and $600,000 was subsequently paid. The balance of $800,000 is
included in accounts payable. No advance payment was required for the
acquisition of the property, plant, and equipment of Unico, all of which is
leased from the seller. The equipment lease from the seller is accounted for as
a capital lease of $12.0 million, which includes interest, that is payable by
TFS-Malaysia at the rate of $3.0 million per year over the next four years.
The principal balance on that lease was $8.6 million as of September 30, 2003.
|
| |  | Our revenue is derived principally from manufacturing services and display
products. Several factors impact our gross margins, including manufacturing
efficiencies, product mix, product differentiation, product uniqueness,
inventory management, and volume pricing. We have United States factories in
the Seattle and Boston areas. We also have factories in the Philippines,
Malaysia, and China. In Seattle and in Malaysia, we provide engineering
support, automated printed circuit board assembly, in-circuit and functional
testing, systems integration and box build, complete supply chain management,
and turnkey packaging and fulfillment services. In Boston, we provide
aftermarket customization of CRT and LCD monitors. In the Philippines and
China, we assemble displays into modules and are adding some of the
manufacturing services offered in Seattle and Malaysia. We also assemble RF
tuners in the Philippines.                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|
| |  | Prior to 2001, we used our own front-end LCD production line in the
Phoenix area for the manufacture of more technologically complex and custom
high-volume LCDs. We also purchased LCDs from third parties to provide us an
alternate source and to ensure available capacity. In order to take advantage
of lower labor costs, we traditionally shipped LCDs to our facilities in the
Philippines and China for assembly into modules.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|
| |  | During 2001, we decided to shut down our front-end LCD manufacturing line.
We now purchase all of our LCDs from third parties. Thus, no LCD manufacturing
is done in the United States. During 2002, we signed a Cooperative Agreement
with a Chinese company under which we agreed to sell the equipment used in our
front-end                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               

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| |  | LCD line and establish a supply agreement. Under the terms of the
Cooperative Agreement, in exchange for our front-end LCD line, we will receive
a total of $3.0 million in cash, favorable LCD glass pricing, and flexible yet
assured manufacturing capacity from this strategic partner. In the second
quarter of 2002, as a result of signing the Cooperative Agreement, we realized
a charge of $4.5 million for the write-down on the LCD equipment sold to the
Chinese company. This charge was reported as a separate line item in operating
expense. In connection with the Cooperative Agreement, we received $2.1
million in 2002, all of which was applied against the $3.0 million sales price
and recorded as a reduction in the carrying value of the LCD equipment held for
sale. The sale of the equipment is now complete, and we received another
$300,000 payment in the first quarter and $200,000 in the third quarter of
2003. No payments were received in the second quarter. An additional $400,000
is due to us upon installation of the line, and we expect full payment in the
first quarter of 2004.
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  | 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 through a sales force that consists of both direct technical
sales persons and a representative network. As a result, there is no material
cost of distribution in our selling, general, and administrative expense.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|
| |  | Research, development, and engineering expense consists principally of
salaries and benefits to design engineers and other technical personnel,
related facility costs, process development costs, and various expenses for
projects, including new product development. We do very little pure research
work. Most of this expense relates to the design costs associated with custom
display programs and the development of standard display products.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|
| |  | Discontinued Operations                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|
| |  | On September 1, 2003, we transferred all of the net assets of our
microdisplay division, plus approximately $20.9 million in cash, into a newly
created Delaware corporation called Brillian Corporation (Brillian). Brillian
had $44.1 million of net assets on the spin-off date. On September 15, 2003,
we spun off Brillian by distributing all of the outstanding common stock of
Brillian to our stockholders on a pro rata basis, with each stockholder of
Three-Five Systems, Inc. (TFS) receiving one share of Brillian common stock for
each four shares of TFS common stock held. Brillian is now traded on the Nasdaq
National Market under the symbol BRLC. For more information on the reason
for the spin-off, as well as the description of business and risks associated
with the spin-off, please refer to the Form 10 and the related amendments and
associated documents filed with the Securities and Exchange Commission by
Brillian. The microdisplay business that we transferred to Brillian is now
reported in our consolidated financial statements as Discontinued Operations.                      
|
| |  | Critical Accounting Policies and Estimates                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|
| |  | Our discussion and analysis of our financial condition and results of
operations are based upon our financial statements, which have been prepared in
accordance with generally accepted accounting principles (GAAP) in the United
States. During preparation of these financial statements, we are required to
make estimates and judgments that affect the reported amounts of assets,
liabilities, revenue, and expenses, and related disclosure of contingent assets
and liabilities. On an on-going basis, we evaluate our estimates and judgments,
including those related to sales returns, pricing concessions, bad debts,
inventories, fixed assets, intangible assets, income taxes, pensions, and
contingencies. We base our estimates on historical experience and on various
other assumptions that we believe are reasonable under the circumstances. The
results form the basis for making judgments about the carrying values of assets
and liabilities that are not readily apparent from other sources. Actual
results may differ from these estimates under different assumptions or
conditions.              
|
| |  | We believe the following critical accounting policies affect our more
significant judgments and estimates used in the preparation of our financial
statements.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|
| |  | We recognize revenue from product sales when persuasive evidence of a sale
exists; that is, a product is shipped under an agreement with a customer; risk
of loss and title have passed to the customer; the fee is fixed or
determinable; and collection of the resulting receivable is reasonably assured.
Sales allowances are estimated based upon historical experience of sales
returns.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|
| |  | Design and engineering services consist of engineering services necessary
to conform our displays to a customer or potential customers product or
device, as well as contract research and development arrangements, under                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       

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| |  | which we research the application of new technologies or manufacturing
processes and develop new products for third parties. We recognize revenue
related to design and engineering services and contract research and
development arrangements depending on the relevant contractual terms. For time
and materials arrangements, revenue is based on a fee per hour basis and is
recognized as services are provided. Under fixed-price contracts, revenue is
recognized as milestones are met. If no milestones exist, we use percentage of
completion to recognize revenue.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  | We write down our inventory for estimated obsolescence or unmarketable
inventory. We write down our inventory to estimated market value based upon
assumptions about future demand and market conditions. If actual market
conditions are less favorable than those projected by us, additional inventory
write-downs may be required.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|
| |  | Pursuant to Financial Accounting Standards Board (FASB) Statement of
Financial Accounting Standards (SFAS) No. 109, Accounting for Income Taxes,
income taxes are recorded based on current year amounts payable or refundable,
as well as the consequences of events that give rise to deferred tax assets and
liabilities. We base our estimate of current and deferred taxes on the tax
laws and rates that are currently in effect in the appropriate jurisdiction.
Changes in tax laws or rates may affect the current amounts payable or
refundable as well as the amount of deferred tax assets or liabilities.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|
| |  | At the end of the second quarter, we had $19.1 million of net deferred tax
assets resulting primarily from net operating loss and tax credit
carryforwards. SFAS No. 109 requires that a valuation allowance be established
when it is more likely than not that all or a portion of a deferred tax asset
will not be realized. In determining whether a valuation allowance is
required, we must take into account all positive and negative evidence with
regard to the utilization of a deferred tax asset, including our past earnings
history, market conditions, management forecasts of future profitability, the
character and jurisdiction of such earnings, unsettled circumstances that, if
unfavorably resolved, would adversely affect utilization of a deferred tax
asset, carryback and carryforward periods, and tax strategies that could
potentially enhance the likelihood of realization of a deferred tax asset. SFAS
No. 109 further states that it is difficult to conclude that a valuation
allowance is not needed when there is negative evidence such as cumulative
losses in recent years. Therefore, despite the fact that a major portion of the
losses came from our spun-off microdisplay division, the expectation of
reporting a loss in the fourth quarter from our continuing operations means
that we will have three years of cumulative losses. Those cumulative losses
weigh heavily in the overall required assessment and outweigh our forecasted
future profitability and expectation that we will be able to utilize all of our
net operating loss carryforwards. As a result, in this quarter we recorded a
charge to establish a full valuation allowance against our deferred tax asset.
We expect to continue to record a full valuation allowance on future tax
benefits until we return to profitability. During the third quarter, our tax
expense was $17.6 million, as a result of our full valuation allowance.
|
| |  | Long-term assets, such as property, plant, and equipment, intangibles,
goodwill, and other investments, are originally recorded at cost. On an
on-going basis, we assess these assets to determine if their current recorded
value is impaired. When assessing these assets, we consider projected future
cash flows to determine if impairment is applicable. These cash flows are
evaluated for objectivity by using weighted probability techniques and also
comparisons of past performance against projections. Assets may also be
evaluated by identifying independent market values of assets that we believe to
be comparable. If we believe that an assets value was impaired, we would write
down the carrying value of the identified asset and charge the impairment as an
expense in the period in which the determination was made.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|
| |  | Results of Operations                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|
| |  | Three months ended September 30, 2003 compared to three months ended
September 30, 2002                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|
| |  | Net Sales.Net sales increased 129.7% to $41.8 million in the third
quarter of 2003 from $18.2 million in the third quarter of 2002. The increase
in revenue was a result of the acquisition of additional manufacturing
businesses in Seattle and Malaysia, the addition of our Microtune business, the
addition of our monitor business in Boston, the addition of our standard
display product business licensed from Data International, increased sales of
color display modules to European handset manufacturers, and increased sales to
display-oriented manufacturing customers other than Motorola. Our sales to
Motorola declined, both in dollars and as a percentage of our revenue. Motorola
accounted for 2.0% of our revenue in the third quarter of 2003 compared to
79.2% in the third quarter of 2002. We had two customers that each exceeded
more than 10% of our revenue in the third quarter of 2003. One of those
customers is in the computer peripherals business and accounted for 25.3% of
our revenue, and the other customer is a European handset manufacturing company
and accounted for 15.9% of our revenue. Geographically, 59.5% of our sales were
in                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             

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| |  | the United States; 15.6% of our sales were in Asia; and 24.9% of our sales were
in Europe. Our recent trend has been to have increased sales in the United
States, primarily as a result of the acquired businesses in the United States
but also because of increased display-oriented manufacturing business. Sales
in Europe increased primarily as a result of the increased sales of color LCD
modules to a European handset manufacturing company. Asia sales have declined
because of the reduced sales to Motorola, most of which was sold into China.
Not including Motorola, however, sales in Asia have increased. Most of our
Asian sales are to United States based, multinational companies with factories
located in Asia.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  | Cost of Sales.Cost of sales increased to 100.7% of net sales in the
third quarter of 2003 from 93.3% in the third quarter of 2002. Our gross margin
is equal to the difference between our revenue and our cost of sales.
Consequently, our company-wide gross margin in the third quarter was a negative
$272,000, or a negative 0.7% of net sales. For products manufactured in
Seattle, Boston, and Malaysia, our gross margin was higher than this aggregate
gross margin. For products manufactured in Beijing and Manila, the gross
margins were lower than the aggregate gross margin for three reasons. First,
the unit volume of our sales in Beijing was lower because of the reduced sales
to Motorola and because the replacement sales to other customers have lower
volumes but higher selling prices. These reduced manufacturing volumes
resulted in under-absorption of our fixed manufacturing costs. Second, in
Manila the gross margins on our color display products were negative because of
introductory pricing on new products and because we have not obtained expected
pricing reductions for color panels that we purchase. Third, we are still in
the process of ramping up our RF module manufacturing in Manila and moving
those processes from Microtunes factory into ours. As a result, those
products are currently selling at below breakeven during this ramp-up phase.
|
| |  | Selling, General, and Administrative Expense.Selling, general, and
administrative expense increased 104.2% in absolute dollars to $4.9 million in
the third quarter of 2003 from $2.4 million in the third quarter of 2002. As a
percentage of net sales, however, SG&A expense decreased to 11.7% of net sales
in the third quarter of 2003 from 13.2% of net sales in the third quarter of
2002. This change in SG&A expense occurred primarily because of four items:
(1) the additional SG&A costs associated with the acquired EMS business in
Seattle of $816,000, (2) the additional SG&A costs associated with the acquired
EMS business in Malaysia of $429,000, (3) increased sales expenses of $498,000
as a result of increased display sales, and (4) the recording of expenses of
approximately $450,000 associated with arbitration in a claim we are pursuing
against J.D. Edwards.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|
| |  | Research, Development, and Engineering Expense.Research, development,
and engineering expense increased 8.3% to $1.3 million in the third quarter of
2003 from $1.2 million in the third quarter of 2002. Research, development, and
engineering expense decreased as a percentage of net sales, declining to 3.1%
of net sales in the third quarter of 2003 from 6.6% of net sales in the third
quarter of 2002. The increase in the third quarter of 2003 was due to expenses
related to the Malaysian design engineering, which was acquired in April 2003.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|
| |  | Loss (Gain) on Sale of Assets.During the third quarter of 2003, we
incurred a gain of $15,000 for the sale of certain assets compared to no loss
or gain in the third quarter of 2002.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|
| |  | Amortization of Customer Lists and Distribution Rights.During the third
quarter of 2003, we had $510,000 of amortization relating to customer lists and
distribution rights compared to no amortization expense of these items for the
third quarter of 2002. The amortization in 2003 relates to the acquisitions of
AVT and ETMA and to the license agreement with Data International, all
described above in Overview. The amortizable asset associated with AVT is
$3.0 million and is being amortized over five years. The amortizable asset
associated with ETMA is $2.0 million and is being amortized over three years.
The amortizable asset associated with Data International is $3.9 million and is
being amortized over five years.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|
| |  | Other Income (Expense), Net.Other expense was $451,000 in the third
quarter of 2003 compared to other income of $755,000 in the third quarter of
2002. The primary difference is that interest income decreased because of
decreased cash and investment balances and because the interest rate earned on
investments was lower in the third quarter of 2003 than in the third quarter of
2002. The interest expense is primarily associated with the capital leases for
our equipment in Malaysia and Seattle.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|
| |  | Minority Interest. We own 60% of the business in Malaysia. Since that
business had a loss in the third quarter, we recorded a benefit of $71,000 to
account for the losses allocated to the minority interest holder compared to no
benefit in the third quarter of 2002.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    

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| |  | Provision for (Benefit from) Income Taxes.We recorded a provision for
income taxes of $17.6 million in the third quarter of 2003 compared to a
benefit from income taxes of $913,000 for the third quarter of 2002. In 2003,
we recorded a charge to establish a full valuation allowance against our
deferred tax asset, which consists primarily of net operating loss
carryforwards, or NOLs. We expect to continue to record a full valuation
allowance on future tax benefits until we return to sustained profitability,
which means we will have an effective tax rate of nearly zero until we either
utilize our NOLs against our future income or reverse the valuation allowance
and bring the tax asset back onto the books.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  | Net Loss.We had a net loss of $30.9 million, or $1.45 per diluted share,
in the third quarter of 2003 compared to a net loss of $3.4 million, or $0.16
per diluted share, in the third quarter of 2002. The net loss in the third
quarter of 2003 includes $5.9 million, or $0.28 per share, from discontinued
operations relating to our former microdisplay business, which was spun off as
a separate public company as of September 15, 2003, as Brillian Corporation,
described above in Discontinued Operations. The net loss in the third
quarter of 2002 included $2.6 million, or $0.12 per share, from Brillian
discontinued operations.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|
| |  | Nine months ended September 30, 2003 compared to nine months ended
September 30, 2002                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|
| |  | Net Sales.Net sales increased 74.0% to $113.1 million in the first nine
months of 2003 from $65.0 million in the first nine months of 2002. The
increase in revenue was a result of the acquisition of additional manufacturing
businesses in Seattle and Malaysia, the addition of our Microtune business, the
addition of our monitor business in Boston, the addition of our standard
product display business licensed from Data International, increased sales of
color display modules to European handset manufacturing company, and increased
sales to display-oriented manufacturing customers other than Motorola. Our
sales to Motorola declined, both in dollars and as a percentage of our revenue.
Motorola was 11.2% of our revenue in the first nine months of 2003 compared to
85.5% in the first nine months of 2002. We had two other customers that each
exceeded more than 10% of our revenue in the first nine months of 2003. One
customer is in the computer peripherals business and one is a European handset
manufacturing company, and they accounted for 22.1% and 11.3% of our revenue,
respectively. Geographically, in the first nine months of 2003, 57.2% of our
sales were in the United States, 21.2% of our sales were in Asia, and 21.6% of
our sales were in Europe. Our recent trend has been to have increased sales in
the United States and Europe. Our increased sales in the United States are
primarily a result of several recently acquired businesses but also because of
increased display-oriented manufacturing business. Our increased sales in
Europe are primarily as a result of the increased sales of color LCD modules to
a European handset manufacturing company. Asia sales have declined because of
the reduced sales to Motorola, most of which was sold into China. Not including
Motorola, however, the trend has been that our sales in Asia are increasing.
Most of our Asian sales are to United States based, multinational companies
with factories located in Asia.
|
| |  | Cost of Sales.Cost of sales increased to 98.4% of net sales in the first
nine months of 2003 from 91.7% in the first nine months of 2002. Our gross
margin is equal to the difference between our revenue and our cost of sales.
Consequently, our company-wide gross margin in the first nine months was $1.8
million, or 1.6% of net sales. For products manufactured in Seattle, Boston,
and Malaysia, our gross margin was higher than this aggregate gross margin. For
products manufactured in Beijing and Manila, the gross margins were lower than
the aggregate gross margin for three reasons. First, the unit volume of our
sales in Beijing and Manila was lower because of the reduced sales to Motorola
and because the replacement sales to other customers have lower volumes but
higher selling prices. These reduced manufacturing volumes resulted in
under-absorption of our fixed manufacturing costs and increased cost of sales.
Second, in Manila the gross margins on our color display products were negative
because of introductory pricing on new products and because we have not
obtained expected pricing reductions of color panels. Third, we are still in
the process of ramping up our RF module manufacturing in Manila and moving
those processes from Microtunes factory to ours. As a result, those products
are currently selling at below breakeven during this ramp-up phase.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|
| |  | Selling, General, and Administrative Expense.Selling, general, and
administrative expense increased 62.0% in absolute dollars to $12.8 million in
the first nine months of 2003 from $7.9 million in the first nine months of
2002. As a percentage of net sales, however, SG&A expense decreased from 12.2%
of net sales in the first nine months of 2002 to 11.3% of net sales in the
first nine months of 2003. This change in SG&A expense occurred primarily
because of four items: (1) the additional SG&A costs associated with the
acquired EMS business in Seattle of $2.4 million, (2) the additional SG&A costs
associated with the acquired EMS business in Malaysia of $953,000, (3)
increased sales expenses as a result of increased display sales of $1.0
million, and (4) the recording of expenses of approximately $700,000 associated
with arbitration in a claim we are pursuing against J.D. Edwards.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                

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| |  | Research, Development, and Engineering Expense.Research, development,
and engineering expense increased 2.6% to $3.9 million in the first nine months
of 2003 from $3.8 million in the first nine months of 2002. Research,
development and engineering expense decreased as a percentage of net sales,
declining to 3.4% of net sales in the first nine months of 2003 from 5.8% of
net sales in the first nine months of 2002. The increase in the first nine
months of 2003 was primarily due to the facilities costs associated with the
design engineering.                                                                                                                                                                                                                                                                   
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  | Loss (Gain) on Sale of Assets.During the first nine months of 2003, we
realized a gain of $20,000 for the sale of certain assets compared to a loss of
$4.5 million in the first nine months of 2002. The loss in the first nine
months of 2002 is related to the sale of our front-end manufacturing LCD
equipment, described above in Overview.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|
| |  | Amortization of Customer Lists and Distribution Rights.During the first
nine months of 2003, we had $1.5 million of amortization relating to customer
lists and distribution rights compared to no amortization expense for the first
nine months of 2002. The amortization in 2003 relates to the acquisitions of
AVT and ETMA and to the license agreement with Data International, all
described above in Overview. The amortizable asset associated with AVT is
$3.0 million and is being amortized over five years. The amortizable asset
associated with ETMA is $2.0 million and is being amortized over three years.
The amortizable asset associated with Data International is $3.9 million and is
being amortized over five years.                                                                                    
|
| |  | Other Income (Expense), Net.Other income was $6,000 in the first nine
months of 2003 compared to $2.8 million in the first nine months of 2002. The
primary difference is that interest income decreased because of decreased cash
and investment balances and because the interest rate earned on investments was
lower in the first nine months of 2003 than in the first nine months of 2002.
The interest expense is primarily associated with the capital leases for our
equipment in Malaysia and Seattle.                                                                                                                                                                                                                                                                                                                   
|
| |  | Minority Interest.We own 60% of the business in Malaysia. Since that
business had losses in the first nine months, we recorded a benefit of $28,000
to account for the losses allocated to the minority interest holder compared to
a benefit of $84,000 in the first nine months of 2002 relating to the
winding-up of another investment with a different minority partner.                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|
| |  | Provision for (Benefit from) Income Taxes.We recorded a provision for
income taxes of $14.3 million in the first nine months of 2003 compared to a
benefit for income taxes of $3.2 million for the first nine months of 2002. We
recorded a charge in 2003 to establish a valuation allowance against our
deferred tax asset, which consists primarily of net operating loss
carryforwards, or NOLs.                                                                                                                                                                                                                                                                                                                                                                                                                              
|
| |  | Net Loss.We had a net loss of $41.2 million, or $1.94 per diluted share,
in the first nine months of 2003 compared to a net loss of $14.3 million, or
$0.67 per diluted share, in the first nine months of 2002. The net loss in the
first nine months of 2003 includes $10.6 million, or $0.50 per share, from
discontinued operations relating to our former microdisplay business. As
previously noted, our microdisplay division was spun off as a separate public
company as of September 15, 2003, as Brillian Corporation, described above in
Discontinued Operations. The net loss for the Brillian discontinued
operations in the first nine months of 2002 was $9.6 million, or $0.45 per
share.                                                                                                                       
|
| |  | Liquidity and Capital Resources                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|
| |  | At September 30, 2003, we had cash, cash equivalents, and liquid
investments of $28.9 million compared to cash, cash equivalents, and liquid
investments of $80.6 million at December 31, 2002. This decrease is due to
our cash outflow from operations of $9.8 million, cash used in acquisitions and
for capital expenditures of $11.8 million, and debt and capital lease
repayments of $3.9 million. In addition, our Brillian discontinued operations
consumed $28.9 million in cash in 2003, including the cash distributed in the
spin-off.                                                                                                                                                                                                                                                                                
|
| |  | Inventory turns were 5.9 in the third quarter of 2003 compared to 7.9 in
the third quarter of 2002, and accounts receivable DSOs (day sales outstanding)
were 58 days in the third quarter of 2003 compared to 68 days in the third
quarter of 2002. The decrease in turns was largely attributable to the
inventory purchased in connection with the Microtune and Unico transactions.
The calculation of inventory turns and DSOs is based on comparing average
balances for the quarter in question against annualized sales data for the same
quarter. Depreciation and amortization expense increased to $2.0 million for
the third quarter of 2003 compared to $1.0 million for the third quarter of
2002. This increase related to increased amortization of intangibles from
acquisitions, which was $510,000 for the third

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| |  | quarter of 2003 compared to $50,000 for the third quarter of 2002, and
increased depreciation of equipment related to acquisitions.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  | In the quarter ended September 30, 2003, we had $4.8 million in net cash
outflow from operations compared to $6.9 million in net cash inflow from
operations in the quarter ended September 30, 2002. This net cash outflow in
the third quarter of 2003 was due to our loss from continuing operations,
combined with approximately $700,000 in working capital requirements. The
increased working capital requirements were primarily a result of decreased
inventory and accounts receivable balances, both of which were partially offset
by a higher accounts payable balance.                                                                                                                                                                                                                                                     
|
| |  | In the nine months ended September 30, 2003, we had $9.8 million net cash
outflow from operations compared to $4.9 million in net cash inflow from
operations in the nine months ended September 30, 2002. Depreciation and
amortization expense increased to $5.5 million in the nine months ended
September 30, 2003 from $2.8 million in the nine months ended September 30,
2002. This increase related primarily to increased amortization of intangibles
for acquisitions, which was $1.5 million for the first nine months of 2003
compared to $50,000 for the first nine months of 2002, and increased
depreciation of equipment related to acquisitions.                                                                                                                                                                        
|
| |  | Our working capital was $53.0 million at September 30, 2003 and $107.9
million at December 31, 2002. Our current ratio was 2.7-to-1 at September 30,
2003 compared to 7.3-to-1 at December 31, 2002. Our working capital and
current ratio have decreased primarily as a result of the reduction of our cash
balances. We had an increase in debt related to a note owing to Microtune for
inventory, a note owing to Data International for license fees, and the current
portion of our capital lease obligation to Unico for equipment in Malaysia.
Subsequent to the end of the third quarter of 2003, we paid off approximately
$300,000 of the $2.7 million note payable to Microtune and entered into an
agreement to cancel the remaining $2.4 million balance on that note in exchange
for the return of inventory to Microtune.
|
| |  | We currently have no credit facility outstanding in the United States. We
expect to close on a $10 million line of credit in the fourth quarter, although
we do not expect to need that facility in the near future. In September 2003,
we paid off our unsecured $2.7 million term loan to the Bank of China.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|
| |  | The following tables list our contractual obligations and commercial
commitments:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        

|                                   |  |           |        |           |  |                        |        |           |  |          |        |  |  |         |       |  |  |   |       | 
|---------------------------------- |  | --------- | ------ | --------- |  | ---------------------- | ------ | --------- |  | -------- | ------ |  |  | ------- | ----- |  |  | - | ----- | 
|                                   |  |           |        |           |  | Payments due by Period
|                                   |  | Total     |        |          
|Contractual Obligations            |  | Amounts   |        | Less than |  |                        |        |           |  |          |        |  |  | 6 Years
|(in thousands)                     |  | Committed |        | 1 Year    |  | 1-3 Years              |        | 4-5 Years |  | and Over
|                                   |  |           |        |           |  |                        |        |           |  |         
|Notes Payable                      |  |           | 5,701  |           |  |                        | 4,260  |           |  |          | 1,441  |  |  |         |      |  |  |   |      | 
|Operating Leases                   |  |           | 21,547 |           |  |                        | 3,893  |           |  |          | 5,616  |  |  |         | 2,835 |  |  |   | 9,203 | 
|Capital Leases                     |  |           | 9,482  |           |  |                        | 2,334  |           |  |          | 5,398  |  |  |         | 1,750 |  |  |   |      | 
|                                   |  |           |        |           |  |                        |        |           |  |          |        |  |  |         |       |  |  |   |       | 
|Total Contractual Cash Obligations |  | $         | 36,730 |           |  | $                      | 10,487 |           |  | $        | 12,455 |  |  | $       | 4,585 |  |  | $ | 9,203 | 
|                                   |  |           |        |           |  |                        |        |           |  |          |        |  |  |         |       |  |  |   |       | 

|                             |  |           |     |             |  |                                            |     |           |  |          |     |  |  |         |     |  |  |   |    | 
|---------------------------- |  | --------- | --- | ----------- |  | ------------------------------------------ | --- | --------- |  | -------- | --- |  |  | ------- | --- |  |  | - | -- | 
|                             |  |           |     |             |  | Amount of Commitment Expiration Per Period
|                             |  | Total     |     |            
|Other Commercial Commitments |  | Amounts   |     | Less than 1 |  |                                            |     |           |  |          |     |  |  | 6 Years
|(in thousands)               |  | Committed |     | Year        |  | 1-3 Years                                  |     | 4-5 Years |  | and Over
|                             |  |           |     |             |  |                                            |     |           |  |         
|Guarantee                    |  | $         | 390 |             |  | $                                          | 104 |           |  | $        | 112 |  |  | $       | 120 |  |  | $ | 54 | 



| |  | The operating leases include a lease for our factory in Manila and our
ground lease in Tempe, Arizona. We have a note payable to Microtune for $2.7
million currently due and a note payable to Data International for $2.9 million
due over a period of two years. As previously noted, we paid off approximately
$300,000 of the $2.7 million note payable to Microtune and entered into an
agreement to cancel the remaining $2.4 million balance on that note in exchange
for the return of inventory to Microtune. The capital leases are for our
equipment in Malaysia and Seattle. The guarantee relates to our guarantee in
connection with a Small Business Administration loan to VoiceViewer Technology,
Inc., a private company developing microdisplay products. If the lending
institution were to declare VoiceViewer to be in default under the loan, and if
Brillian Corporation were unable to satisfy its obligation as primary
guarantor, then we would be required to pay the guaranteed amount.
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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| |  | As previously noted, the microdisplay division of our company was spun off
as a separate public company as of September 15, 2003, as Brillian Corporation.
We distributed approximately $20.9 million in cash in connection with the spin
off of Brillian Corporation.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  | We believe that our existing balances of cash, cash equivalents, and
investments will provide adequate sources to fund our operations and planned
expenditures through the remainder of 2003 and all of 2004, as well as to meet
our contractual obligations. Specifically, we have over $28 million in cash,
cash equivalents, and short-term investments. Our capital expenditures for the
remainder of 2003 and 2004 are expected to be less than $5.0 million, and we
expect operating cash outflow in 2004 may consume only a small portion of our
cash reserves, if any. We continue to seek other alliances or acquisitions and
additional relationships. New acquisitions or alliances may result in our
needing to expand our loan commitments, pursue alternate methods of financing,
or raise capital. 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.                                                                                        
|
| |  | Impact of Recently Issued Standards                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|
| |  | In December 2002, the FASB issued SFAS No. 148, Accounting for
Stock-Based Compensation -Transition and Disclosure. This Statement amends
SFAS No. 123 to provide alternative methods of transition for a voluntary
change to the fair value method of accounting for stock-based employee
compensation. In addition, this Statement amends the disclosure requirements
of SFAS No. 123 to require prominent disclosures in both annual and interim
financial statements about the method of accounting for stock-based employee
compensation and the effect of the method used on reported results. We have
adopted the disclosure requirements of SFAS No. 148 and there was no material
impact on our financial statements.                                                                                                                                                                                                                                                                                                                                                                    
|
| |  | In November 2002, the FASB issued FASB Interpretation No. 45 (FIN 45),
Guarantors Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others. This Interpretation addresses
the disclosures to be made by a guarantor in its financial statements and its
obligations under guarantees. The Interpretation also clarifies the
requirements related to the recognition of a liability by the guarantor at the
inception of a guarantee. Per the Interpretation, initial recognition of a
liability shall be applied only on a prospective basis to guarantees issued or
modified after December 31, 2002. We adopted the requirements of FIN 45 as of
January 1, 2003, and there was no material impact on our financial position or
results of operations.                                                                                                                                                                                                                                                                                 
|
| |  | In January 2003, the Emerging Issues Task Force (EITF) issued EITF
00-21, Accounting for Revenue Arrangements with Multiple Deliverables. EITF
00-21 addresses the issues of how to determine whether an arrangement involving
multiple deliverables contains more than one unit of accounting and how
arrangement consideration should be measured and allocated to the separate
units of accounting in the arrangement. EITF 00-21 does not change otherwise
applicable revenue recognition criteria. EITF 00-21 is effective for revenue
arrangements entered into in fiscal periods beginning after June 15, 2003. The
application of EITF 00-21 did not have a material effect on our financial
statements.                                                                                                                                                                                                                                                                                                                                                                                
|
| |  | In November 2002, the FASB issued FASB Interpretation No. 46 (FIN 46),
Consolidation of Variable Interest Entities, which clarifies the application
of Accounting Research Bulletin No. 52, Consolidated Financial Statements,
relating to consolidation of certain entities. FIN 46 will require
identification of our participation in variable interest entities (VIEs),
which are defined as entities with a level of invested equity that is not
sufficient to fund future activities to permit it to operate on a standalone
basis. For entities identified as a VIE, FIN 46 sets forth a model to evaluate
potential consolidation based on an assessment of which party of the VIE, if
any, bears a majority of the exposure to its expected losses or stands to gain
from a majority of its expected returns. The interpretation is effective after
January 31, 2003 for any VIE created after that date and is effective July 1,
2003 for VIEs created before February 1, 2003. We do not believe the adoption
of FIN 46 will have a material effect on our financial statements.
|
| |  | In May 2003, the FASB issued SFAS No. 150, Accounting for Certain
Financial Instruments with Characteristics of Both Liabilities and Equity
(SFAS No. 150). SFAS No. 150 requires the classification of certain
financial instruments, previously classified within the equity section of the
balance sheet, to be included in liabilities. SFAS No. 150 is effective for
financial instruments entered into or modified after May 31, 2003 and June 15,
2003 for all other instruments. The application of SFAS No. 150 did not have a
material effect on our financial statements.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            

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| |  | ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK                                                                    
| |  | --------------------------------------------------------------------------------------------------------------------------------------
|
| |  | There are no material changes in reported market risks since our most
recent filing on Form 10-K for the year ended December 31, 2002.






| |  | ITEM 4. CONTROLS AND PROCEDURES                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  | As of the end of the period covered by this report, our President and
Chief Executive Officer and Chief Financial Officer have reviewed and evaluated
the effectiveness of our disclosure controls and procedures, which included
inquiries made to certain other of our employees. Based on their evaluation,
our Chief Executive Officer and Chief Financial Officer have each concluded
that our disclosure controls and procedures are effective and sufficient to
ensure that we record, process, summarize, and report information required to
be disclosed by us in our periodic reports filed under the Securities Exchange
Act within the time periods specified by the Securities and Exchange
Commissions rules and forms.




PART II






| |  | ITEM 5. OTHER INFORMATION                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  | Our Insider Trading Policy permits our directors, officers, and other key
personnel to establish purchase and sale programs in accordance with Rule
10b5-1 adopted by the Securities and Exchange Commission. The rule permits
employees to adopt written plans at a time before becoming aware of material
nonpublic information and to sell shares according to a plan on a regular basis
(for example, weekly or monthly), regardless of any subsequent nonpublic
information they receive. In our view, Rule 10b5-1 plans are beneficial
because systematic, pre-planned sales that take place over an extended period
should have a less disruptive influence on the price of our stock. We also
believe plans of this type are beneficial because they inform the marketplace
about the nature of the trading activities of our directors and officers. In
the absence of such information, the market could mistakenly attribute
transactions as reflecting a lack of confidence in our company or an indication
of an impending event involving our company. We recognize that our directors
and officers may have reasons totally apart from the company in determining to
effect transactions in our common stock. These reasons could include the
purchase of a home, tax and estate planning, the payment of college tuition,
the establishment of a trust, the balancing of assets, or other personal
reasons. The establishment of any trading plan involving our company requires
the pre-clearance by our Chief Executive Officer or Chief Financial Officer.
An individual adopting a trading plan must comply with all requirements of Rule
10b5-1, including the requirement that the individual not possess any material
nonpublic information regarding our company at the time of the establishment of
the plan. In addition, sales under a trading plan may be made no earlier than
30 days after the plan establishment date.
|
| |  | No officers currently maintain trading plans.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        






| |  | ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
| |  | ----------------------------------------
|
| |  | (a)     Exhibits                        

|     |  |                                                                                                                                                                         
|---- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|31.1 |  | Certification of President and Chief Executive Officer,
pursuant to Rule 13a-14(a) and Rule 15d-14(a), promulgated under the
Securities Exchange Act of 1934, as amended
|     |  |                                                                                                                                                                         
|31.2 |  | Certification of Chief Financial Officer, pursuant to Rule
13a-14(a) and Rule 15d-14(a), promulgated under the Securities
Exchange Act of 1934, as amended              
|     |  |                                                                                                                                                                         
|32.1 |  | Certification of President and Chief Executive Officer pursuant
to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002         
|     |  |                                                                                                                                                                         
|32.2 |  | Certification of Chief Financial Officer pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002                       



| |  | (b)     Reports on Form 8-K
| |  | ---------------------------



| | (i) |  | Report on Form 8-K dated July 24, 2003 furnishing Item 12
Results of Operations and Financial Condition disclosure.
| | --- |  | -------------------------------------------------------------------------------------------------------------------

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| | (ii)  |  | Report on Form 8-K dated September 3, 2003 furnishing Item 9
Regulation FD Disclosure.                                                                                                      
| | ----- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| | (iii) |  | Report on Form 8-K dated September 15, 2003 furnishing Item 2
Acquisition or Disposition of Assets and Item 7 Financial Statements,
Pro Forma Financial Information and Exhibits disclosure.




SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) 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.
|                        |  |                          |  |                                                   
|Date: November 12, 2003 |  | By:                      |  | /s/ Jeffrey D. Buchanan                           
|                        |  |                          |  | Jeffrey D. Buchanan                               
|                        |  |                          |  | Executive Vice President, Chief Financial Officer,
|                        |  |                          |  | Secretary, and Treasurer                          

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EXHIBIT INDEX

|     |  |                                                                                                                                                                         
|---- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|31.1 |  | Certification of President and Chief Executive Officer,
pursuant to Rule 13a-14(a) and Rule 15d-14(a), promulgated under the
Securities Exchange Act of 1934, as amended
|     |  |                                                                                                                                                                         
|31.2 |  | Certification of Chief Financial Officer, pursuant to Rule
13a-14(a) and Rule 15d-14(a), promulgated under the Securities
Exchange Act of 1934, as amended              
|     |  |                                                                                                                                                                         
|32.1 |  | Certification of President and Chief Executive Officer pursuant
to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002         
|     |  |                                                                                                                                                                         
|32.2 |  | Certification of Chief Financial Officer pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002