##### Table of Contents



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 March 31, 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
of Incorporation or Organization) |  | (I.R.S. Employer Identification No.)

|                                         |  |  |           
|---------------------------------------- |  |  | ----------
|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 MARCH 31, 2003
|                                |  |  |  |                                 
|                                |  |  |  |                                 
|Common
Par value $.01 per share |  |  |  | 21,286,039                      





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TABLE OF CONTENTS



|                                                       |                                                                                               |                                                                  |  |  |  |  |  | 
|------------------------------------------------------ | --------------------------------------------------------------------------------------------- | ---------------------------------------------------------------- |  |  |  |  |  | 
|                                                       | ITEM 1. FINANCIAL STATEMENTS                                                                 
|                                                       |                                                                                               | CONDENSED CONSOLIDATED BALANCE SHEETS                           
|                                                       |                                                                                               | CONDENSED CONSOLIDATED STATEMENTS OF INCOME                     
|                                                       |                                                                                               | CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS                 
|                                                       |                                                                                               | NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
|                                                       | 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                                            
|CERTIFICATION OF PRESIDENT AND CHIEF EXECUTIVE OFFICER
|Exhibit Index                                         
|EX-99.1                                               
|EX-99.2                                               



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##### Table of Contents



THREE-FIVE SYSTEMS, INC.
QUARTERLY REPORT ON FORM 10-Q
FOR QUARTER ENDED MARCH 31, 2003
TABLE OF CONTENTS

|               |  |                                                                                                          |    |     
|-------------- |  | -------------------------------------------------------------------------------------------------------- | -- | ----
|               |  |                                                                                                          |    | Page
|               |  |                                                                                                          |    |     
|PART I         |  |                                                                                                         
|ITEM 1.        |  | FINANCIAL STATEMENTS:                                                                                    |    |     
|               |  | Condensed Consolidated Balance Sheets -
December 31, 2002 and March 31, 2003 (unaudited)                 |    | 1   
|               |  | Condensed Consolidated Statements of Income (unaudited) -
Three Months Ended March 31, 2002 and 2003     |    | 2   
|               |  | Condensed Consolidated Statements of Cash Flows (unaudited) -
Three Months Ended March 31, 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                    |    | 9   
|ITEM 3.        |  | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK                                               |    | 17  
|ITEM 4.        |  | CONTROLS AND PROCEDURES                                                                                  |    | 17  
|PART II        |  |                                                                                                         
|ITEM 5.        |  | OTHER INFORMATION                                                                                        |    | 18  
|ITEM 6.        |  | EXHIBITS AND REPORTS ON FORM 8-K                                                                         |    | 18  
|SIGNATURES     |  |                                                                                                          | 18
|CERTIFICATIONS |  |                                                                                                          | 19





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##### Table of Contents






ITEM 1.           FINANCIAL STATEMENTS




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

|                                     |                                      |                            |         |              |         |           |         |             |         | 
|------------------------------------ | ------------------------------------ | -------------------------- | ------- | ------------ | ------- | --------- | ------- | ----------- | ------- | 
|                                     |                                      |                            |         | DECEMBER 31, |         | MARCH 31,
|                                     |                                      |                            |         | 2002         |         | 2003     
|                                     |                                      |                            |         |              |         |          
|                                     |                                      |                            |         |              |         |           |         | (unaudited)
|ASSETS                               |                                      |                            |         |              |         |           |         |            
|Current Assets:                      |                                      |                            |         |              |         |           |         |            
|                                     | Cash and cash equivalents            |                            | $       | 18,389       |         |           | $       | 19,901      |        
|                                     | Short-term investments               |                            |         | 62,178       |         |           |         | 54,493      |        
|                                     | Accounts receivable, net             |                            |         | 16,970       |         |           |         | 17,172      |        
|                                     | Inventories                          |                            |         | 19,876       |         |           |         | 27,675      |        
|                                     | Taxes receivable                     |                            |         | 561          |         |           |         | 653         |        
|                                     | Deferred tax asset                   |                            |         | 3,561        |         |           |         | 3,570       |        
|                                     | Assets held for sale                 |                            |         | 841          |         |           |         |            |        
|                                     | Other current assets                 |                            |         | 2,507        |         |           |         | 2,179       |        
|                                     |                                      |                            |         |              |         |           |         |            
|                                     |                                      | Total current assets       |         |              | 124,883 |           |         |             | 125,643 | 
|Property, plant and equipment, net   |                                      |                            | 31,563  |              |         |           | 33,058  |            
|Intangibles, net                     |                                      |                            | 14,919  |              |         |           | 18,088  |            
|Goodwill                             |                                      |                            | 34,901  |              |         |           | 34,094  |            
|Long-term deferred tax asset         |                                      |                            | 9,642   |              |         |           | 12,693  |            
|Other Investments                    |                                      |                            | 6,331   |              |         |           | 6,331   |            
|Other Assets, net                    |                                      |                            | 455     |              |         |           | 676     |            
|                                     |                                      |                            |         |              |         |           |         |            
|                                     |                                      | $                          | 222,694 |              |         | $         | 230,583 |            
|                                     |                                      |                            |         |              |         |           |         |            
|LIABILITIES AND STOCKHOLDERS EQUITY |                                      |                            |         |              |         |           |         |            
|Current Liabilities:                 |                                      |                            |         |              |         |           |         |            
|                                     | Accounts payable                     |                            | $       | 8,760        |         |           | $       | 16,819      |        
|                                     | Accrued liabilities                  |                            |         | 5,166        |         |           |         | 4,560       |        
|                                     | Deferred revenue                     |                            |         | 358          |         |           |         | 679         |        
|                                     | Term loans                           |                            |         | 2,714        |         |           |         | 6,895       |        
|                                     |                                      |                            |         |              |         |           |         |            
|                                     |                                      | Total current liabilities  |         |              | 16,998  |           |         |             | 28,953  | 
|                                     |                                      |                            |         |              |         |           |         |            
|Long-term Debt                       |                                      |                            | 20      |              |         |           | 1,460   |            
|                                     |                                      |                            |         |              |         |           |         |            
|Other Long-term Liabilities          |                                      |                            | 8       |              |         |           | 6       |            
|                                     |                                      |                            |         |              |         |           |         |            
|Commitments and Contingencies        |                                      |                            |         |              |         |           |         |            
|Stockholders Equity:                |                                      |                            |         |              |         |           |         |            
|                                     | Common stock                         |                            |         | 219          |         |           |         | 219         |        
|                                     | Additional paid-in capital           |                            |         | 200,763      |         |           |         | 200,763     |        
|                                     | Retained earnings                    |                            |         | 13,695       |         |           |         | 8,220       |        
|                                     | Stock subscription note receivable   |                            |         | (174         | )       |           |         | (177        | )      
|                                     | Accumulated other comprehensive loss |                            |         | (332         | )       |           |         | (358        | )      
|                                     | Less  treasury stock, at cost       |                            |         | (8,503       | )       |           |         | (8,503      | )      
|                                     |                                      |                            |         |              |         |           |         |            
|                                     |                                      | Total stockholders equity |         |              | 205,668 |           |         |             | 200,164 | 
|                                     |                                      |                            |         |              |         |           |         |            
|                                     |                                      | $                          | 222,694 |              |         | $         | 230,583 |            
|                                     |                                      |                            |         |              |         |           |         |            

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

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

|                                                     |                                                    |                |        |                    |        |      |        |        |        |  
|---------------------------------------------------- | -------------------------------------------------- | -------------- | ------ | ------------------ | ------ | ---- | ------ | ------ | ------ | -
|                                                     |                                                    |                |        | THREE MONTHS ENDED
|                                                     |                                                    |                |        | MARCH 31,         
|                                                     |                                                    |                |        |                   
|                                                     |                                                    |                |        | 2002               |        | 2003
|                                                     |                                                    |                |        |                    |        |     
|Net Sales                                            |                                                    | $              | 23,110 |                    |        | $    | 25,695 |       
|                                                     |                                                    |                |        |                    |        |      |        |       
|Costs and Expenses:                                  |                                                    |                |        |                    |        |      |        |       
|                                                     | Cost of sales                                      |                |        | 22,902             |        |      |        | 25,913 |       
|                                                     | Selling, general, and administrative               |                |        | 3,125              |        |      |        | 4,344  |       
|                                                     | Research, development, and engineering             |                |        | 4,818              |        |      |        | 3,800  |       
|                                                     | Gain on sale of assets                             |                |        |                   |        |      |        | (13    | )     
|                                                     | Amortization of customer lists/distribution rights |                |        |                   |        |      |        | 511    |       
|                                                     |                                                    |                |        |                    |        |      |        |       
|                                                     |                                                    |                | 30,845 |                    |        |      | 34,555 |       
|                                                     |                                                    |                |        |                    |        |      |        |       
|                                                     |                                                    | Operating loss |        |                    | (7,735 | )    |        |        | (8,860 | )
|                                                     |                                                    |                |        |                    |        |      |        |       
|Other Income:                                        |                                                    |                |        |                    |        |      |        |       
|                                                     | Interest, net                                      |                |        | 1,062              |        |      |        | 296    |       
|                                                     | Other, net                                         |                |        | 136                |        |      |        | 9      |       
|                                                     |                                                    |                |        |                    |        |      |        |       
|                                                     |                                                    |                | 1,198  |                    |        |      | 305    |       
|                                                     |                                                    |                |        |                    |        |      |        |       
|Minority Interest in Loss of Consolidated Subsidiary |                                                    |                | 105    |                    |        |      |       |       
|                                                     |                                                    |                |        |                    |        |      |        |       
|Loss before Income Taxes                             |                                                    |                | (6,432 | )                  |        |      | (8,555 | )     
|                                                     | Benefit from income taxes                          |                |        | (2,122             | )      |      |        | (3,080 | )     
|                                                     |                                                    |                |        |                    |        |      |        |       
|Net Loss                                             |                                                    | $              | (4,310 | )                  |        | $    | (5,475 | )     
|                                                     |                                                    |                |        |                    |        |      |        |       
|Loss per Common Share:                               |                                                    |                |        |                    |        |      |        |       
|                                                     | Basic and Diluted                                  |                | $      | (0.20              | )      |      | $      | (0.26  | )     
|                                                     |                                                    |                |        |                    |        |      |        |       
|Weighted Average Number of Common Shares:            |                                                    |                |        |                    |        |      |        |       
|                                                     | Basic and Diluted                                  |                |        | 21,508             |        |      |        | 21,286 |       
|                                                     |                                                    |                |        |                    |        |      |        |       

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)

|                                                     |                                                                             |                                                                 |                                                     |         |                    |         |        |        |        |     |  
|---------------------------------------------------- | --------------------------------------------------------------------------- | --------------------------------------------------------------- | --------------------------------------------------- | ------- | ------------------ | ------- | ------ | ------ | ------ | --- | -
|                                                     |                                                                             |                                                                 |                                                     |         | THREE MONTHS ENDED
|                                                     |                                                                             |                                                                 |                                                     |         | MARCH 31,         
|                                                     |                                                                             |                                                                 |                                                     |         |                   
|                                                     |                                                                             |                                                                 |                                                     |         | 2002               |         | 2003  
|                                                     |                                                                             |                                                                 |                                                     |         |                    |         |       
|Cash Flows from Operating Activities:                |                                                                             |                                                                 |                                                     |         |                    |         |        |       
|                                                     | Net loss                                                                    |                                                                 | $                                                   | (4,310  | )                  |         | $      | (5,475 | )     
|                                                     | Adjustments to reconcile net loss to net cash
used in operating activities: |                                                                 |                                                     |         |                    |         |        |        |       
|                                                     |                                                                             | Depreciation and amortization                                   |                                                     |         | 1,740              |         |        |        | 2,473  |    
|                                                     |                                                                             | Minority interest in consolidated subsidiary                    |                                                     |         | (105               | )       |        |        |       |    
|                                                     |                                                                             | Deferred revenue                                                |                                                     |         |                   |         |        |        | 321    |    
|                                                     |                                                                             | Provision for accounts receivable valuation reserves            |                                                     |         | 183                |         |        |        | 22     |    
|                                                     |                                                                             | Gain on disposal of assets                                      |                                                     |         |                   |         |        |        | (13    | )  
|                                                     |                                                                             | Benefit from deferred taxes, net                                |                                                     |         | (2,277             | )       |        |        | (3,051 | )  
|                                                     |                                                                             | Interest on notes payable                                       |                                                     |         |                   |         |        |        | 17     |    
|                                                     |                                                                             | Interest on officer loan                                        |                                                     |         | (3                 | )       |        |        | (3     | )  
|                                                     | Changes in assets and liabilities:                                          |                                                                 |                                                     |         |                    |         |        |        |       
|                                                     |                                                                             | (Increase) decrease in accounts receivable                      |                                                     |         | 3,995              |         |        |        | (225   | )  
|                                                     |                                                                             | (Increase) decrease in inventories                              |                                                     |         | 1,288              |         |        |        | (1,545 | )  
|                                                     |                                                                             | Decrease in other assets                                        |                                                     |         | 707                |         |        |        | 644    |    
|                                                     |                                                                             | Increase (decrease) in accounts payable and accrued
liabilities |                                                     |         | (6,594             | )       |        |        | 7,449  |    
|                                                     |                                                                             | Decrease in taxes payable/receivable                            |                                                     |         | (260               | )       |        |        | (91    | )  
|                                                     |                                                                             |                                                                 |                                                     |         |                    |         |        |       
|                                                     |                                                                             |                                                                 | Net cash provided by (used in) operating activities |         |                    | (5,636  | )      |        |        | 523 |  
|                                                     |                                                                             |                                                                 |                                                     |         |                    |         |        |       
|Cash Flows from Investing Activities:                |                                                                             |                                                                 |                                                     |         |                    |         |        |       
|                                                     | Purchases of property, plant, and equipment                                 |                                                                 |                                                     | (1,547  | )                  |         |        | (240   | )     
|                                                     | Proceeds from sale of asset                                                 |                                                                 |                                                     |        |                    |         |        | 325    |       
|                                                     | Purchase of intangibles                                                     |                                                                 |                                                     | (3,283  | )                  |         |        | (232   | )     
|                                                     | Purchase of investments                                                     |                                                                 |                                                     | (25,808 | )                  |         |        | (5,263 | )     
|                                                     | Proceeds from maturities/sales of investments                               |                                                                 |                                                     | 19,783  |                    |         |        | 12,922 |       
|                                                     | Licenses and acquisitions                                                   |                                                                 |                                                     |        |                    |         |        | (6,524 | )     
|                                                     |                                                                             |                                                                 |                                                     |         |                    |         |        |       
|                                                     |                                                                             |                                                                 | Net cash provided by (used in) investing activities |         |                    | (10,855 | )      |        |        | 988 |  
|                                                     |                                                                             |                                                                 |                                                     |         |                    |         |        |       
|Cash Flows from Financing Activities:                |                                                                             |                                                                 |                                                     |         |                    |         |        |       
|                                                     | Payments on notes payable to bank                                           |                                                                 |                                                     |        |                    |         |        | (1     | )     
|                                                     | Stock options exercised                                                     |                                                                 |                                                     | 50      |                    |         |        |       |       
|                                                     |                                                                             |                                                                 |                                                     |         |                    |         |        |       
|                                                     |                                                                             |                                                                 | Net cash provided by (used in) financing activities |         |                    | 50      |        |        |        | (1  | )
|                                                     |                                                                             |                                                                 |                                                     |         |                    |         |        |       
|                                                     | Effect of exchange rate changes on cash and cash equivalents                |                                                                 |                                                     | 16      |                    |         |        | 2      |       
|                                                     |                                                                             |                                                                 |                                                     |         |                    |         |        |       
|Net increase (decrease) in cash and cash equivalents |                                                                             |                                                                 | (16,425                                             | )       |                    |         | 1,512  |       
|Cash and cash equivalents, beginning of period       |                                                                             |                                                                 | 37,003                                              |         |                    |         | 18,389 |       
|                                                     |                                                                             |                                                                 |                                                     |         |                    |         |        |       
|Cash and cash equivalents, end of period             |                                                                             | $                                                               | 20,578                                              |         |                    | $       | 19,901 |       
|                                                     |                                                                             |                                                                 |                                                     |         |                    |         |        |       

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

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| |                                                                                                           
| | ----------------------------------------------------------------------------------------------------------
| | 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 three-month period ended March 31, 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.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|------ |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|      
|       |  | We announced in March 2003 that our board of directors has approved a
decision to spin-off our Microdisplay division into a newly created and
separately traded public company. We expect that the proposed spin-off
will allow each company to focus its attention and financial resources on
its target markets. In addition, each company will be able to more
aggressively pursue its distinct business model and better meet the needs
of its customers. The transaction is also expected to provide each
independent company with greater strategic and financial flexibility to
support growth opportunities in the future. Under the proposed spin-off,
we will first transfer our entire LCoS microdisplay business, including
all related manufacturing and business assets, personnel, and
intellectual property, to a newly created subsidiary. Included in the
transfer will be established manufacturing infrastructure, such as
quality, logistics, planning, and procurement systems. We then expect to
capitalize the new subsidiary with approximately $20 to $25 million in
cash, an amount that we believe will be sufficient to enable the spun-off
company to achieve its business objectives. We will then distribute 100%
of the subsidiarys common stock pro rata as a dividend to our
stockholders. We have filed a ruling request with the Internal Revenue
Service to qualify the spin-off as a nontaxable transaction. In
addition, we expect to file a Form 10 with the Securities and Exchange
Commission within the next 60 days providing detailed information
regarding the proposed spin-off. No stockholder vote will be required to
effect the spin-off, and no consideration will be required to be paid by
our stockholders in order to receive the stock of the newly spun-off
company.
|      
|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-month periods ended March 31, 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 March 31, 2002 and March
31, 2003, the effect of 430,871 and 8,638 shares, respectively, 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 pursuant to SFAS No. 128  Earnings per Sharefor
the three months ended March 31, 2002 and March 31, 2003.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         

|         |                                |                                    |        |                                       |       |      |        |        |       |  
|-------- | ------------------------------ | ---------------------------------- | ------ | ------------------------------------- | ----- | ---- | ------ | ------ | ----- | -
|         |                                |                                    |        | Three Months Ended March 31,         
|         |                                |                                    |        |                                      
|         |                                |                                    |        | 2002                                  |       | 2003
|         |                                |                                    |        |                                       |       |     
|         |                                |                                    |        | (in thousands, except per share data)
|Net loss |                                | $                                  | (4,310 | )                                     |       | $    | (5,475 | )     
|         |                                |                                    |        |                                       |       |      |        |       
|         | Weighted average common shares |                                    |        | 21,508                                |       |      |        | 21,286 |      
|         |                                |                                    |        |                                       |       |      |        |       
|         |                                | Basic and diluted per share amount |        |                                       | (0.20 | )    |        |        | (0.26 | )
|         |                                |                                    |        |                                       |       |      |        |       

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

|                |  |                |        |           |  |   |        | 
|--------------- |  | -------------- | ------ | --------- |  | - | ------ | 
|                |  | December 31,   |        | March 31,
|                |  | 2002           |        | 2003     
|                |  |                |        |          
|                |  | (in thousands)
|Raw materials   |  | $              | 13,428 |           |  | $ | 20,830 | 
|Work-in-process |  |                | 2,913  |           |  |   | 2,280  | 
|Finished goods  |  |                | 3,535  |           |  |   | 4,565  | 
|                |  |                |        |           |  |   |        | 
|                |  | $              | 19,876 |           |  | $ | 27,675 | 
|                |  |                |        |           |  |   |        | 



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

|                              |  |                |         |           |  |   |         |  
|----------------------------- |  | -------------- | ------- | --------- |  | - | ------- | -
|                              |  | December       |         | March 31,
|                              |  | 31, 2002       |         | 2003     
|                              |  |                |         |          
|                              |  | (in thousands)
|Building and improvements     |  | $              | 16,476  |           |  | $ | 16,476  |  
|Furniture and equipment       |  |                | 47,806  |           |  |   | 50,713  |  
|                              |  |                |         |           |  |   |         |  
|                              |  |                | 64,282  |           |  |   | 67,189  |  
|Less accumulated depreciation |  |                | (32,719 | )         |  |   | (34,131 | )
|                              |  |                |         |           |  |   |         |  
|                              |  | $              | 31,563  |           |  | $ | 33,058  |  
|                              |  |                |         |           |  |   |         |  



|Note E |  | Intangibles:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|------ |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|      
|       |  | Intangibles consist of mask works, patents, licenses, customer lists,
distribution rights, and other intangible assets. Intangibles are
recorded at cost and amortized using the straight-line method over the
estimated useful lives of the respective assets, which range from two to
five years. Our policy is to commence amortization of intangibles when
their related benefits begin to be realized. In January 2003, $3.9
million was recorded as distribution rights for the business license
agreement with Data International, or DI, as described in Note K.
|      
|       |  | Intangible assets consist of the following at March 31, 2003:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           

|                             |                                     |   |             |       |              |   |        |        |   |   |        |       | 
|---------------------------- | ----------------------------------- | - | ----------- | ----- | ------------ | - | ------ | ------ | - | - | ------ | ----- | 
|                             |                                     |   | Acquisition |       | Accumulated  |   | Book  
|                             |                                     |   | Value       |       | Amortization |   | Value 
|                             |                                     |   |             |       |              |   |       
|Amortized Intangible Assets: |                                     |   |             |       |              |   |        |        |   |   |        |      
|                             | Mask works                          |   | $           | 6,311 |              |   | $      | (1,931 | ) |   | $      | 4,380 | 
|                             | Patents and other intangible assets |   |             | 3,594 |              |   |        | (21    | ) |   |        | 3,573 | 
|                             | Customer lists                      |   |             | 5,000 |              |   |        | (572   | ) |   |        | 4,428 | 
|                             | Distribution rights                 |   |             | 3,882 |              |   |        | (194   | ) |   |        | 3,688 | 
|                             | Licenses                            |   |             | 2,954 |              |   |        | (935   | ) |   |        | 2,019 | 
|                             |                                     |   |             |       |              |   |        |        |   |   |        |      
|                             |                                     | $ | 21,741      |       |              | $ | (3,653 | )      |   | $ | 18,088 |      
|                             |                                     |   |             |       |              |   |        |        |   |   |        |      



| |  | Intangible asset amortization expense for the three months ended March
31, 2002 was $423,000 as compared to $945,000 for the three months ended
March 31, 2003. Estimated annual amortization expense through 2007
related to intangible assets reported as of March 31, 2003 is as follows
(in thousands):
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Fiscal Year
    
    Amount2003
    
    $
    4,0592004
    
    
    4,6612005
    
    
    4,6912006
    
    
    3,4742007
    
    
    2,085


5



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|Note F |  | Goodwill:                                                                                                                                             
|------ |  | ------------------------------------------------------------------------------------------------------------------------------------------------------
|      
|       |  | Goodwill decreased $807,000 due to a fair value adjustment made on the
inventory purchased in the ETMA acquisition, which closed in mid-December
2002.
|      
|       |  | Changes in Goodwill from December 31, 2002 to March 31, 2003 (in
thousands):                                                                          

|                             |  |     |        |              |  |       |   |  |  |   |        |  
|---------------------------- |  | --- | ------ | ------------ |  | ----- | - |  |  | - | ------ | -
|                             |  | ISD |        | Microdisplay |  | Total
|                             |  |     |        |              |  |      
|Balance at December 31, 2002 |  | $   | 34,901 |              |  | $     |  |  |  | $ | 34,901 |  
|Change                       |  |     | (807   | )            |  |       |  |  |  |   | (807   | )
|                             |  |     |        |              |  |       |   |  |  |   |        |  
|Balance at March 31, 2003    |  | $   | 34,094 |              |  | $     |  |  |  | $ | 34,094 |  
|                             |  |     |        |              |  |       |   |  |  |   |        |  



|Note G |  | Segment Information:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|------ |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|      
|       |  | We monitor and evaluate the financial performance of our operations by
our two product lines (operating segments): Integrated Systems and
Displays (ISD) and Microdisplay. In the ISD segment, we offer
engineering, manufacturing, and display solutions. Historically, we
focused on display products. Late in 2002, however, we expanded the
value-added manufacturing services we provide in the ISD division through
our acquisition of ETMA Corporation. As a result of that acquisition, we
now provide printed circuit board assembly, or PCBA, and box build
capabilities to customers, 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.
|      
|       |  | In our second business segment, referred to as the Microdisplay division,
we offer a range of LCoS® product solutions with different levels of
integration from individual imagers to optical light engines. The
initial target markets for our LCoS microdisplay products are large
screen televisions, front projectors, and near-to-eye or personal display
system applications.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|      
|       |  | The accounting policies of the operating segments are the same as those
described in our Form 10-K for the year ended December 31, 2002 in Note
2, Summary of Significant Accounting Policies. Non-specific operating
segment expenses were allocated based upon estimated usage. Interest
income was split between the ISD and the Microdisplay segments. The
worldwide average tax rate was used for both segments. The following
includes financial information (in thousands) for our two operating
segments:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       

|                                  |  |     |        |              |  |       |        |   |  |   |        |  
|--------------------------------- |  | --- | ------ | ------------ |  | ----- | ------ | - |  | - | ------ | -
|                                  |  | ISD |        | Microdisplay |  | Total
|                                  |  |     |        |              |  |      
|Three months ended
March 31, 2002 |  |     |        |              |  |       |        |   |  |   |        |  
|Net sales                         |  | $   | 22,884 |              |  | $     | 226    |   |  | $ | 23,110 |  
|Other income                      |  |     | 598    |              |  |       | 600    |   |  |   | 1,198  |  
|Benefit from income taxes         |  |     | (227   | )            |  |       | (1,895 | ) |  |   | (2,122 | )
|Net loss                          |  |     | (463   | )            |  |       | (3,847 | ) |  |   | (4,310 | )
|Goodwill                          |  |     |       |              |  |       |       |   |  |   |       |  

|                                  |  |     |        |              |  |       |        |   |  |   |        |  
|--------------------------------- |  | --- | ------ | ------------ |  | ----- | ------ | - |  | - | ------ | -
|                                  |  | ISD |        | Microdisplay |  | Total
|                                  |  |     |        |              |  |      
|Three months ended
March 31, 2003 |  |     |        |              |  |       |        |   |  |   |        |  
|Net sales                         |  | $   | 25,324 |              |  | $     | 371    |   |  | $ | 25,695 |  
|Other income                      |  |     | 204    |              |  |       | 101    |   |  |   | 305    |  
|Benefit from income taxes         |  |     | (1,440 | )            |  |       | (1,640 | ) |  |   | (3,080 | )
|Net loss                          |  |     | (2,558 | )            |  |       | (2,917 | ) |  |   | (5,475 | )
|Goodwill                          |  |     | 34,094 |              |  |       |       |   |  |   | 34,094 |  

6



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| |  | 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   |        |       |  |         |       | Other |  |   |        | 
|                                  |  | America |        | China |  | Foreign |       | Total
|                                  |  |         |        |       |  |         |       |      
|Three months ended
March 31, 2002 |  |         |        |       |  |         |       |       |  |   |        |  |  |   |        | 
|Net sales                         |  | $       | 2,504  |       |  |         | 9,737 |       |  | $ | 10,869 |  |  | $ | 23,110 | 
|Three months ended
March 31, 2003 |  |         |        |       |  |         |       |       |  |   |        |  |  |   |        | 
|Net sales                         |  | $       | 15,981 |       |  | $       | 4,684 |       |  | $ | 5,030  |  |  | $ | 25,695 | 



|Note H |  | Comprehensive loss for the periods was as follows:
|------ |  | --------------------------------------------------

|                            |                                                      |   |                    |      |      |   |        |     |  
|--------------------------- | ---------------------------------------------------- | - | ------------------ | ---- | ---- | - | ------ | --- | -
|                            |                                                      |   | Three Months Ended
|                            |                                                      |   | March 31,         
|                            |                                                      |   |                   
|                            |                                                      |   | 2002               |      | 2003
|                            |                                                      |   |                    |      |     
|                            |                                                      |   | (in thousands)    
|Net sales                   |                                                      | $ | (4,310             | )    |      | $ | (5,475 | )  
|Other comprehensive income: |                                                      |   |                    |      |      |   |        |    
|                            | Foreign currency translation adjustment              |   |                    | 16   |      |   |        | (9  | )
|                            | Unrealized loss on investment securities, net of tax |   |                    | (297 | )    |   |        | (17 | )
|                            |                                                      |   |                    |      |      |   |        |    
|Comprehensive loss          |                                                      | $ | (4,591             | )    |      | $ | (5,501 | )  
|                            |                                                      |   |                    |      |      |   |        |    



|Note I |  | Debt:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|------ |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|      
|       |  | In May 2002, we renegotiated our credit facility with Comerica Bank.
That credit facility is a $15.0 million unsecured revolving line of
credit that matures in July 2003. No borrowings were outstanding under
that credit facility on March 31, 2003. Advances under the facility may
be made as prime rate advances, which accrue interest payable monthly at
the banks prime lending rate, or as LIBOR rate advances, which bear
interest at 150 basis points in excess of the LIBOR base rate. As of
March 31, 2003, our Beijing subsidiary had an outstanding $2.7 million
term loan due April 30, 2003 to the Bank of China, which was secured by a
$3.0 million stand-by letter of credit issued by Comerica Bank.
|      
|       |  | 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 is payable within
the next six months.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|      
|Note J |  | Commitments and Contingencies:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|      
|       |  | In February 2002, we guaranteed up to $500,000 of the debt of a start-up
company, VoiceViewer Technology, Inc., a private company developing
microdisplay products. As of March 31, 2003, the outstanding balance on
the debt is $406,000. This loan guarantee had a five year term and
matures in January 2007. At this time, no liability has been recognized
by us. This loan is currently two months in arrears. We will be required to pay this guarantee to the lender if the
start-up company defaults on its debt obligations.                                                                                                                                                                                     
|      
|       |  | 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                                                                                                                                                                                                                                                                                                                                                                                                              

7



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|       |  | through our world-wide channels. The agreements provide us with access to
a full suite of standard display products that round out our existing
standard product portfolio.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|------ |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|      
|       |  | 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 on 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.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|      
|       |  | We also have signed an agreement with Microtune, Inc. under which we will
manufacture, assemble, and test Microtunes radio frequency (RF) tuner
modules and wireless module products in our existing manufacturing
facility in Manila, the Philippines. The alliance combines Microtunes
radio frequency (RF) product design and development expertise with our
high-volume offshore manufacturing and extended design and manufacturing
services to produce cost-optimized, quality-driven RF module subsystems.                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|      
|       |  | As part of the agreement, Microtune sold the equipment and inventory of
its Philippines manufacturing facility to us and contracted with us to
provide 100% of Microtunes current demand for fully-assembled RF
subsystems. The purchase price of $8.2 million includes $2.8 million in
equipment and $5.4 million of inventory. Upon signing the agreement, we
paid $2.0 million to Microtune and $3.5 million to an escrow account,
which will be released to Microtune upon release of any liens currently
on the equipment. The remaining $2.7 million is due from us on a note
payable to Microtune within the next six months.                                                                                                                                                                                                                                                                                                                                                       
|      
|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 4.931% and
2.780%; expected dividend yields of zero; expected lives of 6.1 and 6.1
years; and expected volatility (a measure of the amount by which a price
has fluctuated or is expected to fluctuate during a period) of 73.9% and
74.4%, respectively. Had compensation cost for these plans been
determined consistent with SFAS No. 123, our net income and earnings per
share would have been as follows:

|                                      |                                                                                                                             |  |                        |        |      |  |   |        |  
|------------------------------------- | --------------------------------------------------------------------------------------------------------------------------- |  | ---------------------- | ------ | ---- |  | - | ------ | -
|                                      |                                                                                                                             |  | Quarters Ended        
|                                      |                                                                                                                             |  | March 31,             
|                                      |                                                                                                                             |  |                       
|                                      |                                                                                                                             |  | 2002                   |        | 2003
|                                      |                                                                                                                             |  |                        |        |     
|                                      |                                                                                                                             |  | (in thousands,        
|                                      |                                                                                                                             |  | except per share data)
|Net loss:                             |                                                                                                                             |  |                        |        |      |  |   |       
|                                      | As reported                                                                                                                 |  | $                      | (4,310 | )    |  | $ | (5,475 | )
|                                      | Total stock-based compensation
expenses determined under fair
value based method for all
awards, net of related tax
affects |  |                        | (1,024 | )    |  |   | (764   | )
|                                      |                                                                                                                             |  |                        |        |      |  |   |       
|                                      | Pro forma net loss                                                                                                          |  | $                      | (5,334 | )    |  | $ | (6,239 | )
|                                      |                                                                                                                             |  |                        |        |      |  |   |       
|Basic and diluted net loss per share: |                                                                                                                             |  |                        |        |      |  |   |       
|                                      | As reported                                                                                                                 |  | $                      | (0.20  | )    |  | $ | (0.26  | )
|                                      | Pro forma                                                                                                                   |  |                        | (0.25  | )    |  |   | (0.29  | )



|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

8



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|       |  | stock-based employee compensation and the effect of the method used on
reported results. We have adopted the disclosure requirements of SFAS
No. 148.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|------ |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|      
|       |  | 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 have 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.                                                                                                                                                                                                                         
|      
|Note N |  | Subsequent Events                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|      
|       |  | In April 2003, after the close of the first quarter, 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, server, 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
subsidiary of ours 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 under $5 million, most of which will be used for working
capital. No advance payment was required for the acquisition of the
property, plant and equipment of Unico, all of which will be leased from
the seller. The equipment lease from the seller will be accounted for as
a capital lease with $3 million owed by TFS-Malaysia each year for four
years.






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

FORWARD-LOOKING STATEMENTS AND FACTORS THAT MAY AFFECT RESULTS

The statements contained in this report on Form 10-Q that are not purely
historical are forward-looking statements within the meaning of applicable
securities laws. Forward-looking statements include statements regarding our
expectations, anticipation, intentions, beliefs, or strategies
regarding the future. Forward-looking statements also include statements
regarding revenue, margins, expenses, and earnings analysis for fiscal 2003 and
thereafter; the proposed spin-off of our Microdisplay division, technological
innovations; future products or product development; our product development
strategies; potential acquisitions or strategic alliances; the success of
particular product or marketing programs; the amounts of revenue generated as a
result of sales to significant customers; and liquidity and anticipated cash
needs and availability. All forward-looking statements included in this report
are based on information available to us as of the filing date of this report,
and we assume no obligation to update any such forward-looking statements. Our
actual results could differ materially from the forward-looking statements.

Overview

We offer advanced design and manufacturing services to original equipment
manufacturers, commonly referred to as OEMs. We have two business divisions,
each reportable as a segment. The first segment is referred to as the
Integrated Systems and Displays, or ISD, division. In that division, we offer
engineering, manufacturing, and display solutions. Historically, we focused on
display products. Late in 2002, however, we expanded the value-added
manufacturing services we provide in the ISD division through our acquisition
of ETMA Corporation, described below. As a result of that acquisition, we now
provide printed circuit board assembly, or PCBA, and box build capabilities to
customers, 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.

9



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In our second business segment, referred to as the Microdisplay
division, we offer a range of LCoS® product solutions with different levels of
integration from individual imagers to optical light engines. The initial
target markets for our LCoS microdisplay products are large screen televisions,
front projectors, and near-to-eye or personal display system applications.

Substantially all of our sales are in our ISD division. In the past
several years, we derived our revenue principally from major OEMs, with more
than 75% of our net sales in 2000, 2001, and 2002 from the mobile handset
market. As a result of the acquisition of ETMA, the organic growth we are
experiencing in other market segments, and the expected reduction in Motorola
business, we expect our revenue from the monochrome, commodity handset market
to drop to below 20% of our net sales in 2003. When we win a custom program,
our customers occasionally pay a portion of our nonrecurring engineering
expenses to defray the costs of custom design, as well as all or a portion of
the costs of nonrecurring tooling for custom or specialized components. The
typical design program life cycle of a custom-designed product is three to
fifteen months and includes technical design, prototyping, pilot manufacturing,
and high-volume manufacturing. The cycle is shorter in products where no
display is involved and where the OEM customer has already completed the
design.

Until 2001, our strategy in our display business was to seek large-volume
programs from major OEMs, typically 100,000 units per year or higher. In 2002,
we re-focused our strategy on lower-volume programs with potentially higher
gross margins. We re-focused our strategy because some OEMs with high-volume
programs began to expect to purchase display modules for less than industry
costs. Early in 2003, we licensed the standard product line of Data
International. The standard products of Data International that we sell will
fit into the strategy of lower-volume programs. The selling price of our
products sold in the ISD division now range from between $3 and $4,300 per
unit.

We experienced substantial growth from 1993 through 1995, primarily as a
result of sales to OEMs in the wireless communications industry, which grew
substantially during that period. During that period, our primary customer in
the wireless communications industry was Motorola. We experienced substantial
growth in 1999 and 2000, but our sales substantially declined in 2001 as a
result of the world-wide economic slowdown. Motorola and its subcontractors
accounted for 63.6% of our sales in 1998, 86.1% in 1999, 86.9% in 2000, 85.4%
in 2001, and 76.9% in 2002. As a result of our change in strategy regarding
high-volume display programs, discussed above, none of our design wins in 2001
and 2002 have been with the handset group at Motorola. Consequently, we expect
total Motorola business to decline sharply in 2003. In the third quarter of
2002, Motorola was 77.7% of our business. In the fourth quarter of 2002,
Motorola was 54.6% of our business. In the first quarter of 2003, Motorola was
21.4% of our business. For all of 2003, we expect Motorola to account for less
than 10% of our revenue.

During the past several years, we have experienced seasonal quarterly
fluctuations in our net sales as our OEM customers developed retail products
with shorter product life cycles and phased out older programs early in the
year following holiday sales. Therefore, as compared with the fourth quarter
of a calendar year, sales are usually lower in the following quarter. Although
we experienced that pattern of first quarter softness this quarter in all
market segments, our total revenue did not decline because of the incremental
revenue from the ETMA acquisition that occurred in December 2002.

In all of our businesses, we recognize revenue related to product
shipments when persuasive evidence of an arrangement exists, delivery of the
product or service has occurred, the fee is fixed or determinable, and
collectability is probable. These conditions are met at the time we either
ship products to customers or when they are received by the customer, depending
on when title and risk of loss transfers to the customer. We recognize revenue
related to nonrecurring engineering and nonrecurring tooling after service has
been rendered. This can be determined based upon completion of agreed upon
milestones or deliverables.

Several factors impact our gross margins, including manufacturing
efficiencies, product mix, product differentiation, product uniqueness,
inventory management, and volume pricing.

In the past, we used our own front-end LCD production line in Tempe,
Arizona for the manufacture of more technologically complex and custom
high-volume LCDs. We also purchased LCDs from third parties to
10Table of Contents

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 Manila, the Philippines, or Beijing, China, for assembly into
modules.

During 2001, we decided to shut down our front-end manufacturing LCD line.
We now purchase all of our LCDs from third parties. During 2002, we signed a
Cooperative Agreement with a Chinese company under which we agreed to sell the
equipment used in our front-end 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 to be 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 of 2003. An
additional $600,000 is due to us upon installation of the line, and we expect
payment in 2003.

In Tempe, Arizona, we continue to manufacture all of our LCoS
microdisplays on our high-volume liquid crystal on silicon manufacturing line.
In addition, we do all testing and assembly into LCoS modules in Tempe.

In Redmond, Washington, 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 Marlboro, Massachusetts, we provide aftermarket customization of CRT
and LCD monitors.

In Manila, we assemble displays into modules. In the second quarter of
2003, we will also begin to perform additional manufacturing services, such as
assembly of RF tuners. We conduct all of our operations in Manila at our own
factory where we employ our own employees. The facility is located in a special
Philippines economic zone (PEZA), which allows us to take advantage of certain
tax benefits.

In Beijing, we also assemble displays into modules. We conduct our
display module operations in Beijing through our wholly owned foreign
subsidiary at a facility we own. We also employ all of our own employees in
Beijing.

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. In
addition, we incur substantial marketing and administrative expenses in
connection with our LCoS microdisplay business.

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

Since 1997, we have been working on the development of LCoS microdisplays.
In 1997, we entered into a strategic alliance with National Semiconductor
Corporation for the development of LCoS microdisplay products. Under that
alliance, National Semiconductor focused on the silicon technologies needed for
microdisplays, and we focused on the liquid crystal technologies. In 1999,
National Semiconductor decided to close its microdisplay business unit. In
connection with that closing, in July 1999, we purchased certain assets and
licensed silicon technologies from National Semiconductor relating to LCoS
microdisplays. We paid approximately $3.0 million in cash and issued warrants
to purchase 140,000 shares of our common stock in the transaction, which valued
the transaction at approximately $3.6 million. No additional payments are
required under the licenses. We also hired several key technical employees of
National Semiconductor to assist in the implementation of the acquired
technologies.
11Table of Contents

In April 1998, we entered into a strategic relationship with Inviso, Inc.,
a privately held company with numerous patents and proprietary technology
related to microdisplay development. We acquired a minority equity interest in
Inviso for approximately $3.3 million. In March 2000, we acquired an
additional interest in Inviso for $500,000, raising our total minority equity
interest to $3.8 million. As part of this strategic relationship, we provided
proprietary manufacturing capabilities and liquid crystal expertise, and Inviso
provided patented and proprietary technologies and components for the joint
development of microdisplay products. In the second quarter of 2001, we wrote
off our investment of $3.8 million in Inviso because we determined that our
investment was impaired, as that term is defined under generally accepted
accounting principles. Subsequent to our write-off, Inviso was unable to raise
funds to operate its business and ceased operations. In the second quarter of
2002, we purchased all of the intellectual property of Inviso for $780,000.

In 2001, we invested $1.25 million in Silicon Bandwidth, Inc., a privately
held company providing unique semiconductor and optoelectronic interconnect
solutions based upon multiple, patented, proprietary technologies. We are
working closely with Silicon Bandwidth to design unique, cost-effective,
reconfigurable packaging platforms for LCoS microdisplays.

In January 2002, we hired seven key technical persons formerly employed by
Zight Corporation, a private company focused on microdisplays for personal
display system applications. At that time, Zight had ceased operations. We then
purchased certain assets of Zight at a liquidators auction for approximately
$600,000. Following that auction, we then negotiated with the representatives
of the defunct Zight Corporation to purchase its intellectual property for
approximately $2.0 million.

In July 2002, we invested $5.0 million in ColorLink, Inc. ColorLink has a
leading position worldwide in the development and manufacture of color
management technologies for LCoS microdisplays. ColorLinks products consist
of color management components and system architectures that are critical for
digital projection systems that use high-resolution microdisplays. Those
projection systems include color monitors, high-definition televisions, and
multi-media projectors. This investment furthers our efforts to accelerate as
much as possible the establishment of the necessary infrastructure for LCoS
microdisplays. An additional $81,000 was recorded as investment in ColorLink
during the third quarter of 2002 for legal and due diligence expenses.

In September 2002, we purchased the assets and ongoing business of AVT, a
privately held company that specializes in the design and integration of
complex, high-resolution display systems. AVT designs and provides customized
and ruggedized flat panel, touchscreen, and rackmount systems for original
equipment manufacturers including General Electric, Westinghouse, Gillette, and
the U.S. military. AVT sources its display components from a variety of
companies including Sony, Sharp, NEC, LG, and Samsung. The purchase price of
the acquisition was $12.0 million, which we paid entirely in cash.

In December 2002, we purchased the stock of ETMA Corporation, a privately
held company that is an electronic manufacturer for OEM customers in the
automotive, computer/server, medical monitoring, and Internet security
industries. ETMA offers the manufacturing capabilities of six surface mount
manufacturing lines, including one dedicated to new product introduction and
prototyping activity. ETMA provides 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. The purchase price of the acquisition was $38.1 million,
which we paid entirely in cash.

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 have
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 the $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.
12Table of Contents

In March, we signed an agreement with Microtune, Inc. in which we agreed
to manufacture, assemble, and test Microtunes radio frequency (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 and contracted with us to provide
100% of Microtunes current demand for fully-assembled RF subsystems. We also
hired 450 to 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 April 2003, after the close of the first quarter, 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, server, 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 subsidiary of ours 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 under $5 million, most of which
will be used for working capital. No advance payment was required for the
acquisition of the property, plant and equipment of Unico, all of which will be
leased from the seller. The equipment lease from the seller will be accounted
for as a capital lease with $3 million owed by TFS-Malaysia each year for four
years.

We announced in March 2003 that our board of directors has approved a
decision to spin-off our Microdisplay division into a newly created and
separately traded public company. We expect that the proposed spin-off will
allow each company to focus its attention and financial resources on its target
markets. In addition, each company will be able to more aggressively pursue
its distinct business model and better meet the needs of its customers. The
transaction is also expected to provide each independent company with greater
strategic and financial flexibility to support growth opportunities in the
future. Under the proposed spin-off, we will first transfer our entire LCoS
microdisplay business, including all related manufacturing and business assets,
personnel, and intellectual property, to a newly created subsidiary. Included
in the transfer will be established manufacturing infrastructure, such as
quality, logistics, planning, and procurement systems. We then expect to
capitalize the new subsidiary with approximately $20 to $25 million in cash, an
amount that we believe will be sufficient to enable the spun-off company to
achieve its business objectives. We will then distribute 100% of the
subsidiarys common stock pro rata as a dividend to our stockholders. We have
filed a ruling request with the Internal Revenue Service to qualify the
spin-off as a nontaxable transaction. In addition, we expect to file a Form 10
with the Securities and Exchange Commission within the next 60 days providing
detailed information regarding the proposed spin-off. No stockholder vote will
be required to effect the spin-off, and no consideration will be required to be
paid by our stockholders in order to receive the stock of the newly spun-off
company.

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, investments, 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 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 or pricing
concessions. We recognize revenue related to engineering and tooling services
13Table of Contents

after service has been rendered, which is determined based upon completion of
agreed upon milestones or deliverables.

We recognize revenue from long-term research and development contracts
over the contractual period under the percentage-of-completion method of
accounting. Under the percentage-of-completion method of accounting, sales and
gross profit are recognized as work is performed based on the relationship
between actual costs incurred and total estimated costs at completion. Sales
and gross profit are adjusted prospectively for revision in estimated total
contract costs and contract values. Provisions for anticipated losses on
long-term contracts are recorded in full when such losses become evident.

We maintain an allowance for doubtful accounts for estimated losses
resulting from the inability of our customers to make required payments. We
determine the adequacy of this allowance by regularly evaluating individual
customer receivables and considering a customers financial condition, credit
history, and current economic conditions. If the financial condition of our
customers were to deteriorate, additional allowances could be required.

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.

We currently have $16.3 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.
Changes in valuation allowances from period to period are included in our tax
provision in the period of change. In determining whether a valuation
allowance is required, we take into account all evidence with regard to the
utilization of a deferred tax asset including our past earnings history,
expected future earnings, 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. We believe that the net deferred tax assets of $16.3
million will be realized based primarily on our projected future earnings and
scheduling of our deferred tax liabilities. However, the amount of the
deferred tax assets actually realized could differ if we have little or no
future earnings.

Long-term assets, such as long-term investments, 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 management believes to be comparable. If we were to 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 March 31, 2003 compared to three months ended March 31,
2002

Net Sales.Net sales increased 11.3% to $25.7 million in the first
quarter of 2003 from $23.1 million in the first quarter of 2002. Increased
shipments to customers in the medical, computing, and industrial markets, as
well as increased LCD standard product sales, all contributed to higher revenue
in the first quarter of 2003. For the first time in more than a decade, no
customer exceeded more than 25% of our revenue. Motorola was 21.4% of our
14Table of Contents

revenue. We had two other customers that each exceeded more than 10% of our
revenue, but neither of those customers exceeded 20% of our revenue.

Cost of Sales.Cost of sales increased to 100.8% of net sales in the
first quarter of 2003 from 99.1% in the first quarter of 2002. The increase
occurred primarily because of reduced volumes at our Manila and Beijing
facilities as a result of Motorolas older high-volume handset programs
reaching end-of-life. In addition, all factories generally had seasonally
reduced volumes. The reduced manufacturing volumes resulted in under-absorption
of our fixed manufacturing costs and increased cost of sales.

Selling, General, and Administrative Expense.Selling, general, and
administrative expense increased 38.7% to $4.3 million in the first quarter of
2003 from $3.1 million in the first quarter of 2002. SG&A expense was 16.9% of
net sales in the first quarter of 2003 compared to 13.5% in the first quarter
of 2002. This increase in operating expenses occurred primarily because of two
items: (1) the assumption of operating costs associated with the acquired ETMA
business, and (2) the recording of expenses associated with the planned
spin-off of our Microdisplay division, which were approximately $464,000.

Research, Development, and Engineering Expense.Research, development,
and engineering expense decreased 20.8% to $3.8 million in the first quarter of
2003 from $4.8 million in the first quarter of 2002. Research, development and
engineering expense was 14.8% of net sales in the first quarter of 2003
compared to 20.8% in the first quarter of 2002. The decrease in the first
quarter of 2003 was due to cost reduction efforts and lower head count in our
Microdisplay division in comparison to the first quarter of 2002.

Other Income, Net.Other income was $305,000 in the first quarter of 2003
compared to $1.2 million in the first quarter of 2002. The primary difference
was a result of decreased interest income because of decreased cash and
investment balances. In addition, the interest rate earned on investments was
lower in the first quarter of 2003 than in the first quarter of 2002.

Benefit from Income Taxes.We recorded a benefit from income taxes of
$3.1 million in the first quarter of 2003 compared to a benefit from income
taxes of $2.1 million for the first quarter of 2002. The tax rate used to
calculate the benefit was 36.0% for the first quarter of 2003 compared to 33.0%
for the first quarter of 2002. The increased tax benefit rate was a result of a
higher estimated annual loss in higher tax rate jurisdictions and because of
the allocation of our loss between various countries.

Net Loss.Net loss was $5.5 million, or $0.26 per diluted share, in the
first quarter of 2003 compared to a net loss of $4.3 million, or $0.20 per
diluted share, in the first quarter of 2002. The increase in losses resulted
from higher operating expenses related to acquisitions, the spin-off, and lower
margins related to reduced manufacturing volumes.

As previously noted, we plan to spin off our Microdisplay division as a
separate public company in mid-2003. The net loss for the Microdisplay division
in the first quarter of 2003 was $2.9 million. This net loss was primarily the
result of low volume sales coupled with continuing development efforts for our
Brillian® liquid crystal on silicon (LCoS®) microdisplay product line. In
addition, we incurred one-time accounting, legal, and banking expenses related
to the spin-off.

The net loss for the ISD division in the first quarter of 2003 was $2.6
million. This net loss resulted from reduced manufacturing volumes in our
offshore factories due to seasonality, as well as the ramp down of end-of-life
handset programs for our largest historical customer, Motorola. This reduced
volume resulted in under-absorption of costs at those facilities.

Liquidity and Capital Resources

At March 31, 2003, we had cash, cash equivalents, and liquid investments
of $74.4 million compared to cash, cash equivalents, and liquid investments of
$80.6 million at December 31, 2002. This decrease was primarily due to our
net loss, our acquisition of Microtune inventory and equipment, and our
purchase of the license of Data Internationals distribution rights.
15Table of ContentsIn the quarter ended March 31, 2003, we had $523,000 in net cash flow from
operations compared to $5.6 million in net cash outflow from operations in the
quarter ended March 31, 2002. This net cash flow in the first quarter of 2003
was primarily due to our net loss being offset by our increased accounts
payable. Inventory turns decreased from 5.7 in the first quarter of 2002 to
5.6 in the first quarter of 2003, and accounts receivable DSOs (day sales
outstanding) decreased to 61 days in the first quarter of 2003 from 70 days in
the first quarter of 2002. The calculation of inventory turns is based on the
last 12 months and thus does not take into consideration the inventory relating
to our ETMA acquisition or the inventory purchased from Microtune at the end of
the quarter. Depreciation and amortization expense increased to $2.5 million
for the first quarter of 2003 compared to $1.7 million for the first quarter of
2002. This increase related primarily to increased amortization of
intangibles.Our working capital was $96.7 million at March 31, 2003 and $107.9 million
at December 31, 2002. Our current ratio was 4.3-to-1 at March 31, 2003
compared to 7.3-to-1 at December 31, 2002. Our current ratio decreased
primarily as a result of increased accounts payable, increased current portion
of our note payable, and decreased cash and cash equivalents.In May 2002, we renegotiated our credit facility with Comerica Bank. That
credit facility is a $15.0 million unsecured revolving line of credit that
matures in July 2003. No borrowings were outstanding under that credit facility
on March 31, 2003. Advances under the facility may be made as prime rate
advances, which accrue interest payable monthly at the banks prime lending
rate, or as LIBOR rate advances, which bear interest at 150 basis points in
excess of the LIBOR base rate. In May 2002, our Beijing subsidiary renewed its
credit facility with the Bank of China. As of March 31, 2003, our Beijing
subsidiary had an outstanding $2.7 million term loan due April 30, 2003 to the
Bank of China, which was secured by a $3.0 million standby letter of credit
issued by Comerica Bank.Capital expenditures during the first quarter of 2003 were approximately
$12.6 million. This includes $3.9 million for the standard product license from
Data International and $8.2 million for the acquisition of RF manufacturing
equipment and inventory from Microtune in connection with the transfer of its
manufacturing operations to us. $5.6 million of the $12.6 million is funded by
note payables of which $2.9 million is due from us on a note payable to Data
International and $2.7 million is due from us on a note payable to Microtune.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
|                                   |  |           |        |           |  |                        |        |           |  |         
|Term Loan                          |  | $         | 2,733  |           |  | $                      | 2,714  |           |  | $        | 15    |  |  | $       | 4     |  |  | $ |      | 
|Notes Payable                      |  |           | 5,622  |           |  |                        | 4,181  |           |  |          | 1,441 |  |  |         |      |  |  |   |      | 
|Operating Leases                   |  |           | 22,139 |           |  |                        | 3,643  |           |  |          | 5,380 |  |  |         | 3,289 |  |  |   | 9,827 | 
|                                   |  |           |        |           |  |                        |        |           |  |          |       |  |  |         |       |  |  |   |       | 
|Total Contractual Cash Obligations |  | $         | 30,494 |           |  | $                      | 10,538 |           |  | $        | 6,836 |  |  | $       | 3,293 |  |  | $ | 9,827 | 
|                                   |  |           |        |           |  |                        |        |           |  |          |       |  |  |         |       |  |  |   |       | 

|                             |  |           |     |           |  |                                            |    |           |  |          |     |  |  |         |     |  |  |  |   | 
|---------------------------- |  | --------- | --- | --------- |  | ------------------------------------------ | -- | --------- |  | -------- | --- |  |  | ------- | --- |  |  |  | - | 
|                             |  |           |     |           |  | Amount of Commitment Expiration Per Period
|                             |  |           |     |           |  |                                           
|                             |  | Total     |     |           |  |                                            |    |           |  |          |     |  |  |         |     |  |  | 
|Other Commercial Commitments |  | Amounts   |     | Less than |  |                                            |    |           |  |          |     |  |  | 6 Years
|(in thousands)               |  | Committed |     | 1 Year    |  | 1-3 Years                                  |    | 4-5 Years |  | and Over
|                             |  |           |     |           |  |                                            |    |           |  |         
|Guarantee                    |  | $         | 406 |           |  | $                                          | 93 |           |  | $        | 208 |  |  | $       | 105 |  |  |  |  | 

The term loan includes a $2.7 million loan from the Bank of China and it
includes an interest-free vehicle financing of $27,000.

The operating leases include a lease for our factory in Manila and our
ground lease in Tempe, Arizona. We have a note payable with Microtune for $2.7
million due within six months and a note payable with Data International for
$2.9 million due over a period of two years. The guarantee relates to our
guarantee in connection with a Small Business Administration loan to
VoiceViewer Technology, Inc., a private company developing microdisplay
products. This loan is currently two months in arrears. A $3.0 million standby letter of credit issued by Comerica has not
been included in the

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Other Commercial Commitments table because it only exists to secure the term
loan obligation of $2.7 million, which is already included in the table for
Contractual Obligations.

We believe that our existing balances of cash, cash equivalents, and
investments will provide adequate sources to fund our operations and planned
expenditures through 2003 and 2004, as well as to meet our contractual
obligations. Specifically, we have over $74.4 million in cash, cash
equivalents, and short-term investments. Our capital expenditures for 2003 are
expected to be less than $10.0 million, and we expect operating cash outflow to
consume only a small portion of our cash reserves. We continue to seek other
alliances or acquisitions and additional relationships with regard to the
strategic development of both business segments that may also require us to
make additional capital investments. New acquisitions or alliances may result
in our needing to expand our loan commitments, or 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 adopted
the disclosure requirement of SFAS No. 148.

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 have reviewed the requirements of FIN 45
as of January 1, 2003, and there was no material impact on our financial
position or results of operations.




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 a date within 90 days prior to the date of filing of this report,
our 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. Subsequent to the date of their
evaluation, there have not been any significant changes in our internal
controls or in other factors that could significantly affect these controls,
including any corrective action with regard to significant deficiencies and
material weaknesses.

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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



| | 99.1 |  | 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
| | ---- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| | 99.2 |  | 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



| | 1) |  | Report on Form 8-K dated March 17, 2003, furnishing an Item 9
FD disclosure
| | -- |  | ---------------------------------------------------------------------------
|
| | 2) |  | Report on Form 8-K dated March 17, 2003, furnishing an Item 9
FD disclosure
|
| | 3) |  | Report on Form 8-K dated March 17, 2003, furnishing an Item 9
FD disclosure
|
| | 4) |  | Report on Form 8-K dated March 28, 2003, furnishing an Item 9
FD 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: |  | April 30, 2003 |  | By:                      | /s/ Jeffrey D. Buchanan                                              
|      |  |                |  |                          |                                                                      
|      |  |                |  |                          | Jeffrey D. Buchanan
Chief Financial Officer, Secretary, and
Treasurer

18



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##### Table of Contents






CERTIFICATION OF PRESIDENT AND CHIEF EXECUTIVE OFFICER

I, Jack L. Saltich, certify that:



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



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



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



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



|6. |  | The registrants other certifying officer and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and
material weaknesses.
|-- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|      |  |                |  |                                                      
|----- |  | -------------- |  | -----------------------------------------------------
|Date: |  | April 30, 2003 |  |                                                      
|      |  |                |  | /s/ Jack L. Saltich                                  
|      |  |                |  |                                                      
|      |  |                |  | Jack L. Saltich
President and Chief Executive Officer

19



---



##### Table of Contents



CERTIFICATION OF CHIEF FINANCIAL OFFICER

I, Jeffrey D. Buchanan, certify that:



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



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



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



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



|6. |  | The registrants other certifying officer and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and
material weaknesses.
|-- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|      |  |                |  |                                                                      
|----- |  | -------------- |  | ---------------------------------------------------------------------
|Date: |  | April 30, 2003 |  |                                                                      
|      |  |                |  | /s/ Jeffrey D. Buchanan                                              
|      |  |                |  |                                                                      
|      |  |                |  | Jeffrey D. Buchanan
Chief Financial Officer, Secretary, and Treasurer

20



---



##### Table of Contents






Exhibit Index

| |  |  |      |  |  |                                                                                                                                                                 
| |  |  | ---- |  |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  |  | 99.1 |  |  | 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
| |  |  |      |  |  |                                                                                                                                                                 
| |  |  | 99.2 |  |  | 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