##### Table of Contents



SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549
___________________

FORM 10-K

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 1999

Commission file number 1-4373
____________________

|                                                      
|------------------------------------------------------
|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)

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

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

|                                       |  |                        
|-------------------------------------- |  | -----------------------
|Common Stock, par value $.01 per share |  | New York Stock Exchange
|                                       |  |                        

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

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

The aggregate market value of Common Stock held by nonaffiliates of the
registrant (11,812,823 shares) based on the closing price of the registrants
Common Stock as reported on the New York Stock Exchange on
March 10, 2000, was
$722,058,806. For purposes of this computation, all officers, directors, and
10% beneficial owners of the registrant are deemed to be affiliates. Such
determination should not be deemed to be an admission that such officers,
directors, or 10% beneficial owners are, in fact, affiliates of the registrant.

As of March 10, 2000,
there were outstanding 12,638,971 shares of the
registrants Common Stock, par value $.01 per share.

Documents Incorporated by Reference

Portions of the registrants definitive Proxy Statement for the 2000
Annual Meeting of Shareholders are incorporated by reference into Part III of
this Form 10-K.





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THREE-FIVE SYSTEMS, INC.

ANNUAL REPORT ON FORM 10-K

FOR THE YEAR ENDED DECEMBER 31, 1999

TABLE OF CONTENTS



|                                                                                                                                               |                                                                                               |  |  |  |  |  |  | 
|---------------------------------------------------------------------------------------------------------------------------------------------- | --------------------------------------------------------------------------------------------- |  |  |  |  |  |  | 
|PART I                                                                                                                                        
|                                                                                                                                               | ITEM 1. BUSINESS                                                                             
|                                                                                                                                               | ITEM 2. PROPERTIES                                                                           
|                                                                                                                                               | ITEM 3. LEGAL PROCEEDINGS                                                                    
|                                                                                                                                               | ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS                                  
|PART II                                                                                                                                       
|                                                                                                                                               | ITEM 5. MARKET FOR REGISTRANTS COMMON EQUITY AND RELATED STOCKHOLDER MATTERS                
|                                                                                                                                               | ITEM 6. SELECTED FINANCIAL DATA                                                              
|                                                                                                                                               | ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
|                                                                                                                                               | ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK                          
|                                                                                                                                               | ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA                                          
|                                                                                                                                               | ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE 
|PART III                                                                                                                                      
|                                                                                                                                               | ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS                                                    
|                                                                                                                                               | ITEM 11. EXECUTIVE COMPENSATION                                                              
|                                                                                                                                               | ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT                      
|                                                                                                                                               | ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS                                      
|PART IV                                                                                                                                       
|                                                                                                                                               | ITEM 14. EXHIBITS AND REPORTS ON FORM 8-K                                                    
|SIGNATURES                                                                                                                                    
|Report of Independent Public Accountants                                                                                                      
|Consolidated Balance Sheets as of December 31, 1998 and 1999                                                                                  
|Consolidated Statements of Income for the years ended December 31, 1997, 1998 and 1999                                                        
|Consolidated Statements of Stockholders' Equity
             for the years ended December 31, 1997, 1998, and 1999                            
|Consolidated Statements of Cash Flows for the years ended December 31, 1997, 1998, and 1999                                                   
|Notes to Consolidated Financial Statements                                                                                                    
|Report of Independent Public Accountants                                                                                                      
|Schedule II
                 Valuation and Qualifying Accounts and Reserves
              for the years ended December 31, 1997, 1998 and 1999



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THREE-FIVE SYSTEMS, INC.

ANNUAL REPORT ON FORM 10-K

FOR THE YEAR ENDED DECEMBER 31, 1999

TABLE OF CONTENTS

|                                                                                                  |  |  |     |          |  |      |  | 
|------------------------------------------------------------------------------------------------- |  |  | --- | -------- |  | ---- |  | 
|                                                                                                  |  |  |     |          |  | Page
|                                                                                                  |  |  |     |          |  |     
|                                                                                                  |  |  |     | PART I  
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|ITEM 1. BUSINESS                                                                                  |  |  | 1   |         
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|ITEM 2. PROPERTIES                                                                                |  |  | 24  |         
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|ITEM 3. LEGAL PROCEEDINGS                                                                         |  |  | 24  |         
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|ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS                                       |  |  | 24  |         
|                                                                                                 
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|                                                                                                 
|                                                                                                 
|                                                                                                  |  |  |     | PART II 
|                                                                                                 
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|                                                                                                 
|ITEM 5. MARKET FOR
REGISTRANTS COMMON EQUITY AND RELATED     STOCKHOLDER MATTERS                 |  |  | 25  |         
|                                                                                                 
|                                                                                                 
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|                                                                                                 
|ITEM 6. SELECTED FINANCIAL DATA                                                                   |  |  | 26  |         
|                                                                                                 
|                                                                                                 
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|                                                                                                 
|ITEM 7. MANAGEMENTS
DISCUSSION AND ANALYSIS OF FINANCIAL     CONDITION AND RESULTS OF OPERATIONS |  |  | 27  |         
|                                                                                                 
|                                                                                                 
|                                                                                                 
|                                                                                                 
|ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK                               |  |  | 34  |         
|                                                                                                 
|                                                                                                 
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|ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA                                               |  |  | 35  |         
|                                                                                                 
|                                                                                                 
|                                                                                                 
|                                                                                                 
|ITEM 9. CHANGES IN AND
DISAGREEMENTS WITH ACCOUNTANTS ON     ACCOUNTING AND FINANCIAL DISCLOSURE  |  |  | 35  |         
|                                                                                                 
|                                                                                                 
|                                                                                                 
|                                                                                                 
|                                                                                                  |  |  |     | PART III
|                                                                                                 
|                                                                                                 
|                                                                                                 
|                                                                                                 
|ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT                                       |  |  | 35  |         
|                                                                                                 
|                                                                                                 
|                                                                                                 
|                                                                                                 
|ITEM 11. EXECUTIVE COMPENSATION                                                                   |  |  | 35  |         
|                                                                                                 
|                                                                                                 
|                                                                                                 
|                                                                                                 
|ITEM 12. SECURITY OWNERSHIP OF
CERTAIN BENEFICIAL OWNERS AND     MANAGEMENT                       |  |  | 35  |         
|                                                                                                 
|                                                                                                 
|                                                                                                 
|                                                                                                 
|ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS                                           |  |  | 35  |         
|                                                                                                 
|                                                                                                 
|                                                                                                 
|                                                                                                 
|                                                                                                  |  |  |     | PART IV 
|                                                                                                 
|                                                                                                 
|                                                                                                 
|                                                                                                 
|ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K                         |  |  | 36  |         
|                                                                                                 
|                                                                                                 
|                                                                                                 
|                                                                                                 
|SIGNATURES                                                                                        |  |  | 38  |         
|                                                                                                 
|                                                                                                 
|                                                                                                 
|                                                                                                 
|INDEX TO CONSOLIDATED FINANCIAL STATEMENTS                                                        |  |  | F-1 |         



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Statement Regarding Forward-Looking Statements

The statements contained in this Report on Form 10-K 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 2000 and
thereafter; 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. Among the factors that could cause actual
results to differ materially are the factors discussed in Item 1, Business -
Special Considerations.

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PART I







ITEM 1. BUSINESS

Introduction

We design and manufacture display modules for use in the end products of
original equipment manufacturers, or OEMs. We currently specialize in custom
liquid crystal display, or LCD, components and technology. We collaborate
closely with our customers in providing our design and manufacturing services.
Our LCD modules are used in mobile handsets and other wireless communication
devices as well as in office automation equipment, industrial controls, medical
equipment, and instrumentation. In addition to our traditional LCD module
business, we are pursuing the commercialization of our liquid crystal on
silicon, or LCoS, microdisplays following substantial research and
development over the past two years. We market our services in North America,
Europe, and Asia through a direct technical sales force. Motorola is our
largest customer.

Industry Overview

Liquid Crystal Displays

Prior to the introduction of LCDs in the 1970s, most commonly used
displays and indicators had substantial limitations as to their use, especially
in terms of size, life, and power consumption. LCDs were developed in response
to these limitations, especially the demand for greater information content and
less power consumption than was possible using light emitting diode, or LED,
technology. LCDs, sometimes called flat panel displays, provide
high-information content displays at competitive prices. LCDs now appear in
products throughout the communications, office automation, industrial, medical,
and commercial electronics industries. LCDs are one of the fastest growing of
the established display industry segments, primarily because of their
widespread application in mobile communications devices, a fast-growing segment
of the electronics industry.

An LCD modifies light that passes through or is reflected by it, rather
than emitting light like an LED. An LCD generally consists of a layer of
liquid crystalline material suspended between two glass plates. The liquid
crystals align themselves in a predictable manner when stimulated electrically.
The alignment produces a visual representation of the desired information.
LCDs can display information in black and white or in a wide range of color
combinations. LCD displays consist of a matrix of dots, called pixels, which
are arranged in rows and columns that can be selectively energized to form
letters or pictures. A principal advantage of LCDs over other display
technologies, such as LEDs, is the ability to include thousands or even
millions of pixels in a single display, which allows for greater information
content.

There are two types of LCDs, active matrix and passive matrix. Active
matrix LCD displays are relatively complex devices that require manufacturing
operations involving very large capital investments. Active matrix LCD
displays are used in larger, high-information content applications, such as
laptop computers. Passive matrix LCD displays are less complex and less
expensive to manufacture. Passive matrix LCD displays are used in such
applications as mobile handsets, pagers, office equipment, data collection
terminals, point of sale equipment, medical devices, transportation
instrumentation, and industrial instruments and controls.

The Custom Passive LCD Market

Stanford Resources estimated that the worldwide market for passive LCD
display modules was approximately $2.8 billion in 1998. This market includes
displays used in mobile handsets and other wireless communication devices as
well as in office automation equipment, industrial controls, medical equipment,
and instrumentation, but excludes displays for use in low-end consumer
products, such as watches and calculators, according to Stanford Resources. Of
the $2.8 billion market, $1.4 billion represented LCD displays used in mobile handset
applications. Mobile handsets are the largest and fastest growing market for
LCD modules. According to Gartner Groups Dataquest, the worldwide market for
mobile wireless handsets has grown from 18.7 million units produced in 1993 to
283 million units in 1999. This represents a compound annual growth rate well
in excess of 50%. Industry sources project that mobile handset production will
exceed 400 million units in

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2000. Additional fast growing markets for LCD
display modules include pagers, personal digital assistants, or PDAs, and palm
top computers.

The increasing complexity and functionality of handheld products, such as
wireless computing devices, require OEMs to increase the visual performance and
information content of the displays incorporated into their products. At the
same time, the market continues to demand that OEMs incorporate displays with
reduced power requirements and lower costs. Custom passive LCDs address these
requirements for high performance, increased information content, low power,
and low cost.

OEMs also seek ways to differentiate their products from the products of
their competitors. Custom-designed display modules provide OEMs a
cost-effective means to achieve this differentiation. In designing its
product, an OEM must determine whether to use standard off-the-shelf display
modules, to design its own custom display modules for production by a custom
display manufacturer, or to enter into arrangements with a third party for
custom display design and production. In making a decision to engage third
parties for custom design and production, OEMs recognize that standard
off-the-shelf displays make it more difficult to differentiate their products
from those of their competitors. In considering whether to design their own
display modules, OEMs often recognize that their greatest strengths consist of
consumer brand name recognition, market research and product development
expertise, and highly developed sales and distribution channels. Advanced
design and manufacturing processes require increasing investments for research
and development, personnel, and equipment. Competitive market conditions
require a shorter period of time from product conception to delivery, product
differentiation, improved product user friendliness, and continually enhanced
product performance and reduced product cost during the life cycle of the
product. As a result of these factors and increasingly sophisticated and
complex technology, it has become more difficult for even the leading OEMs to
maintain the necessary technology, expertise, personnel, and equipment to
design and produce internally all of the various components necessary for their
products. As a result, there has been a trend toward outsourcing the design
and production of components such as display modules.

In addition to design and production, OEMs have increased their use of
third-party suppliers to add additional components to their products. This
permits the integration of more of the manufacturing steps into fewer
locations. This trend toward integration and outsourcing decreases the number
of suppliers necessary to produce a final product and results in lower costs.

The Emerging Microdisplay Market

Market trends demand high-information, power-efficient displays with
increasing functionality and smaller sizes at relatively low costs.
Microdisplays based on liquid crystal on silicon technology provide a response
to those demands.

Liquid crystal on silicon microdisplays are a form of LCD in which liquid
crystalline material is suspended between a glass plate and a silicon backplane
rather than between two glass plates. The silicon backplane, essentially an
integrated circuit, provides drive signals for each pixel element of the
display as well as logic functions, such as serial to parallel conversion and
data storage. Because silicon integrated circuits, a highly developed
technology, form the basis of these displays, liquid crystal on silicon
technology permits a very high-information, high-performance display in a small
size and at a relatively low cost.

Microdisplays are no larger than a thumbnail, but contain all of the
information appearing on a high-resolution personal computer screen. The tiny
image on a microdisplay can be projected onto a screen or other surface for
individual or group viewing or used in a portable application that is viewed
through a magnifying device similar to a viewfinder. Various types of
projector applications represent the most common current use of microdisplays.
Projectors can cast the information on a distant large screen, as in front
projectors, or shine the image through a translucent screen, as in rear
projectors. Potential near-term microdisplay applications include use in
office projection equipment, high-definition televisions, and computer
monitors. Potential longer-term applications include use in wireless access to
the Internet through mobile handsets, pagers, and PDAs as well as in wearable
computing equipment using head-mounted displays, which allow hands-free access
to large amounts of information.

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A well-developed front projector market currently exists. These products
are typically referred to as audio-visual projectors and are generally fixed or
portable products used in business applications. Most front projectors
currently use transmissive polysilicon microdisplay technology. Reflective
liquid crystal on silicon technology, however, is expected to provide more
information at a lower cost.

Emerging market segments are beginning to develop for large,
cost-effective, higher-resolution computer monitors and television screens.
Current display technologies for computer monitors and high-definition
televisions encounter serious barriers related to cost, resolution, and
dimensions when used for high-resolution large screens. Many companies are
considering the incorporation of microdisplays into large, high-resolution
screens to enable affordable display solutions.

Significant development efforts are currently being directed to portable
microdisplays as a potential method for delivering high-information content at
low cost and with low power consumption in mobile, hand-held communications
devices. It is widely assumed that converged voice and data communications
devices have the potential to become a new class of products in mobile
communications, probably integrated with PDA functions, such as phonebooks and
calendars. In concept, the functions of the telephone, e-mail, pagers, PDAs,
and the Internet are expected to become integrated. Delivery of
high-information content over the Internet on a small, direct-view display,
however, presents difficult technological challenges. Portable microdisplays
used with a viewfinder offer a potential solution because they can deliver as
much information as a computer monitor in a very small, lightweight, and
power-efficient package.

The portable microdisplay market is just beginning to develop. Market
potential currently is uncertain and is limited by such factors as the
availability of sufficient wireless communications bandwidth, the uncertainty
of customer acceptance, and the possibility of alternative technologies.
Nevertheless, many major vendors of mobile handsets, pagers, and PDAs have
prototype programs underway to develop new converged mobile communications
products with large information content at low cost, and many of these vendors
are beginning to assess portable microdisplays for use in these products.

The Three-Five Approach

We seek to provide our customers with high-performance, information-rich,
low-power consumption displays that have competitive advantages in terms of
size, cost, and product differentiation. To accomplish this goal, our research
and development activities focus on technological developments intended to meet
the current and future requirements of our customers. We add value for our
customers through our ability to integrate the design and production process,
which reduces the time between product conception and market introduction. Our
emphasis on customization and technological leadership has positioned us to
develop new custom product solutions for our customers as they seek displays
with more information content at lower cost.

Our custom product solutions provide OEMs with the following benefits:



| |  |  | access to specialized design and manufacturing technology and expertise;                                                                      
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | accelerated design process and reduced design and
manufacturing costs through the use of our specialized personnel,
equipment, and facilities;
|
| |  |  | reduced reliance on multiple suppliers for components and
integration of their production processes; and                                      
|
| |  |  | the ability to concentrate their own resources on the design,
production, and distribution of their core products.                            

By eliminating the duplication and overlap of investment and resources, we
and our OEM customers are able to work together and grow at a faster rate than
would otherwise be possible. We concentrate on the development of our display
technologies and their applications to products, while our customers devote
time and resources on market development for these products.

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Our historical target market consists of high-end monochrome passive
matrix LCD display modules of 1/4 VGA (320 x 240 pixels) or less resolution,
primarily those having smaller than three-inch diagonal screen sizes. We do
not address low-end LCD display markets, such as watches and calculators. Our
target market for LCoSmicrodisplays consists of displays of SVGA (800 x 600
pixels) or higher resolution.

Strategy

Our strategy is to enhance our position as a major, worldwide supplier of
custom-designed and manufactured displays for application in various
high-growth segments of the electronics industry. Key elements of our strategy
include the following:

Target Leading Customers in High-Growth Industries

We identify industries that we believe have the greatest long-term
potential for growth. We recognize that our growth and development is closely
aligned with the growth and development of the industries we serve. Current
targeted industries include mobile handsets and other wireless communications,
data collection, office automation, medical equipment, and industrial controls.

Within an industry, we target leading companies that we believe would
benefit from our design and manufacturing services. Targeted customers
typically are Fortune 1000 manufacturing companies whose products require
display devices. Our sales and engineering staffs then attempt to demonstrate
the benefits that the potential customer would derive by outsourcing to us the
design and production of display devices required in their products.

Once we establish a relationship with a new customer, we endeavor to
develop new programs for other product groups within the customers business.
For this reason, we specifically target customers with multiple divisions or
product lines.

Expand Customer Base

We intend to intensify our efforts to diversify our customer base. We
also plan to target specialized markets that have substantial volume
requirements. We will continue to seek opportunities in growing and emerging
markets, both in the United States and internationally.

Establish Close Relationships with Customers

We seek to establish strong and long-lasting customer relationships
through our fundamental business practice, which we refer to as customer
partnering. Customer partnering involves aligning our prospects with those of
our customers and seeking to make our engineering and
production staffs seamless extensions of the product design and production
departments of our customers. This includes our engineers spending a
significant portion of their time assisting customers with their own research
and development efforts at their facilities. In addition, our customers
engineers spend a significant amount of time conducting research and
development in our facilities.

We stress product solutions for our customers products. We view each
customers new product as our own and take pride in creating and implementing
innovative engineering solutions that differentiate the customers product from
competitive products. In connection with this philosophy, we have positioned
ourselves to provide a rapid response to our customers and their worldwide
operations.

To achieve our customer partnering goal, we emphasize corporate cultures,
customs, and communications that complement those of our customers. A thorough
understanding of our customers products and business goals enables us to
anticipate customer needs and to develop new design and production solutions
for their products.

We continually attempt to enhance the competitive position of our
customers by providing them with innovative, distinctive, and high-quality
display devices on a timely and cost-effective basis. To do so, we work

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continually to improve our productivity, lower our costs, and speed the
delivery of our product solutions. We endeavor to streamline the entire design
through delivery process by maintaining an ongoing engineering and
manufacturing improvement effort.

We continue to provide customer support after product design has been
completed and production has been commenced. Through such follow-on activity,
we conduct quality enhancement and cost-reduction efforts to maintain the
competitiveness of our customers products.

Provide Advanced Custom Design and Manufacturing Services

We seek to design, prototype, and manufacture, on a timely and
cost-effective basis, a wide range of innovative, distinctive, and high-quality
display devices for operational control and information display functions
required in the end products of OEMs. Our design processes utilize advanced
computer-aided design software to provide custom solutions for customers
products in time frames and on cost bases that we believe are substantially
shorter and lower-priced than industry norms.

We utilize flexible manufacturing systems that can accommodate low-volume
product runs in Arizona and high-volume, price-sensitive runs in Manila and
Beijing. Our LCD facility in Arizona allows us to supply a majority of our LCD
requirements. Production in Manila and Beijing, with advanced, efficient, and
highly automated manufacturing processes utilizing state-of-the-art
manufacturing and test equipment, provides us with low-cost, high-volume
production capacity. We anticipate that our ability to design, prototype, and
manufacture product solutions will be enhanced by the expansion of our
engineering personnel, our increased design capacity, and our ability to meet
our LCD requirements. We continue to increase our production personnel and add
sophisticated manufacturing equipment to meet expanding capacity requirements.
We will continue to explore the most advanced and cost-efficient production
methods for each product solution.

Leverage Research, Development, and Engineering

We continually strive to develop and acquire new technologies that provide
practical solutions for our customers. We conduct an active research and
development program that



| |  |  | continually improves our products and creates new products,                               
| | - |  | ------------------------------------------------------------------------------------------
|
| |  |  | increases our efficiency,                                                                 
|
| |  |  | reduces our costs,                                                                        
|
| |  |  | improves the speed, efficiency, and performance of our design and manufacturing processes,
|
| |  |  | develops new design and manufacturing processes and techniques,                           
|
| |  |  | enhances the quality, cost-effectiveness, and value of our services, and                  
|
| |  |  | utilizes new technological developments.                                                  

We plan to expand our research and development efforts through increased
expenditures and the hiring of additional personnel to meet the expectations of
our customers and to satisfy our goal to design and produce the most advanced
product solutions on a timely and cost-effective basis. We currently are
exploring the development and expansion of existing LCD technologies as well as
new technologies, such as active addressing, sunlight readable LCDs, color
LCDs, plastic LCDs, bi-stable LCDs, graphics and color graphics, organic and
polymer light emitting displays, and pixel-related display technologies. New
technologies also include our LCoSmicrodisplays, which address the increased
demands for high-information displays in a small size and at a relatively low
cost.

Products and Services

We currently engage in the design and manufacture of LCD display modules
and the development and commercialization of manufacturing technologies for use
in various products of OEMs.

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LCD Display Modules and Services

We currently emphasize custom designed LCD display modules. A
manufacturer of a complete system or product requiring a specific type of
visual display, such as a mobile handset, medical instrument, business machine,
or hand-held data collection device, represents a typical buyer for a custom
LCD display module. For each custom display module, we work directly with our
customer to develop and produce the original design and to manufacture the
display module in accordance with the customers specifications. At a minimum,
each module includes an LCD, a custom LCD driver, and a flexible connector. We
also provide value-added services by assembling additional components onto the
module, such as keypads, microphones, speakers, light guides, and optics. In
1999, LCD custom display modules accounted for approximately 95.0% of our net
sales.

We have developed a sophisticated design process to meet the specific
needs of our customers applications. Each design project normally involves a
cross-functional team of our engineers who are assigned to a customer program.
The team consults with the customers engineers throughout the design,
prototype development, and manufacturing process. We continue to supply
value-added engineering support after the design solution has been developed
and integrated into the manufacturing process in an ongoing effort to provide
customers with product performance enhancements and cost-reduction
opportunities.

The difficulties in developing a custom LCD module include unclear
customer expectations, evolving customer requirements, and changing customer
end-product specifications. These factors result in lengthy lead times for
market introduction of customers products. To overcome the traditional
obstacles involved in custom design and development, we have developed the four
phase program development process described below. We combine our program
development process with our philosophy of being a seamless extension of our
customer. This results in a very flexible, responsive, accurate, and fast
development cycle that enables our customers to introduce their products into
the market rapidly. Our program development process consists of the following
phases:



| |  |  | Feasibility and concept phase.We work closely with our
customer to understand its requirements. Customer input varies from
rough sketches to detailed specifications. Experienced LCD module
design engineers work to develop conceptual solutions to customer
requirements that include both design and cost parameters.                                                               
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | Prototype phase.We conduct a design review with the
customer; complete at our Arizona facility a proposed design,
including the electrical, mechanical, and optical features of the
LCD display module; and deliver a prototype to the customer.                                                                                                                                        
|
| |  |  | Pilot phase.We perform a thorough design review with our
customer, involving an analysis of performance, cost, and volume
production considerations. A successful pilot phase results in the
completion of any design changes, the ordering of the tooling
required for production, and the delivery of manufacturing samples.
We generally conduct the pilot phase primarily in Manila.
|
| |  |  | High-volume production phase.We complete any required
changes in the manufacturing process, receive necessary tooling, and
commence high-volume production. The production takes place either
in Manila or Beijing.                                                                                                                                                                     

We also design and produce standard or off-the-shelf devices, which
involve designs that are adaptable to various uses with little or no
modification. Standard devices encompass a wide variety of display devices
having varied applications. Standard display devices include solid state
lamps, multi-digit numerical displays, integrated displays, and bar graph
displays. In 1999, our standard devices accounted for less than 3% of our net
sales and consisted of non-LCD devices.

New Proprietary LCDs

We are pursuing two new technology initiatives for our LCD module
business. First, we have patented a new type of sunlight readable LCD display
that we call Liquid Crystal intense Display, or LCiD. This lower
information content device provides a multi-colored, emissive-looking display
at passive LCD prices. We also have

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created a higher information content
display with numerous gray shades but at the price of a more typical LCD. This
new product is called Liquid Crystal active Drive, or LCaD®. This technology
is based, in part, on technology we license from Motif, Inc. and additional
proprietary technology that we have developed.

LCiDdisplay devices include a display from as little as one line by five
character dot matrix to as large as four line by 20 character dot matrix, all
available in a variety of colors. We began production shipments of LCiD in the
fourth quarter of 1999. We expect that LCiDdisplays will be used primarily in
lower information content applications requiring high contrast, desired color,
and ease of readability from full sunlight to complete darkness. Typical
applications for standard LCiDdisplay devices include automotive
instrumentation, appliances, hand-held instrumentation devices, vending
equipment, stereo equipment, embedded computing equipment, remote sensing
equipment, outdoor monitor equipment, and industrial controls.

LCaDdisplay devices would typically have 1/4 VGA (320 x 240 pixels)
resolution. The LCaDdisplay would consist of a complete display system
incorporating an LCD panel, lighting, memory, an LCD controller, and interface
electronics. While we have not begun production shipments of these devices,
target applications for the LCaDdisplay would include medical and industrial
instrumentation, test equipment, point-of-sale terminals, mapping and hand-held
global positioning system devices, stereo equipment, and embedded computing
equipment.

LCoS Microdisplays

The display market demands continually greater information content at
reduced prices. In response to these demands, we are pursuing the
commercialization of our liquid crystal on silicon, or LCoS, microdisplays
following two years of extensive research and development activities. Our
LCoStechnology provides very high-information content in a small size and
at an expected relatively low cost. The information presented by these
displays is magnified for view, generally either in a projector or in a
viewfinder. We believe that the inherent capability of our LCoStechnology
provides a cost-effective solution to increased information demands.

Our current plan for the development of our LCoSmicrodisplay business is
to respond in an efficient manner to industry developments and changes, to
develop a dedicated organization infrastructure, and to develop or lead the
market to a common LCoSmodule platform. To meet our business objective of
becoming the leading supplier of microdisplay visual systems, we must rapidly
commercialize LCoSmicrodisplay technology on a cost-effective basis. This
requires us to focus on common LCoSmodule platforms that provide economies of
scale, rapid time to market, and broad market penetration. Specifically, our
strategy calls for a business preparation phase and a business growth phase.
We are currently in the preparation phase in which we are emphasizing research,
development, and licensing opportunities to expand our technology portfolio,
design engineering of LCoSproducts for a significant number of OEMs, and
management to establish an organization infrastructure. The business growth
phase calls for resources to be deployed primarily in high-volume
manufacturing, marketing, sales, and business development.

We are developing a broad range of LCoSmicrodisplay products to offer
customers. The table below sets forth various resolutions with pixel count, or
the number of color dots on a screen, and potential uses for our LCoS
microdisplays. We currently have multiple LCoSsolutions, which we have
prototyped for customer evaluation. We are focussing on products with the
capability to produce all of the following resolutions:

|           |  |             |           |              |  |                                                                                                  
|---------- |  | ----------- | --------- | ------------ |  | -------------------------------------------------------------------------------------------------
|Resolution |  | Pixel Count |           | Applications
|           |  |             |           |             
|SVGA       |  |             | 480,000   |              |  | Hand-held devices such as PDAs or mobile handsets and
head mounted displays or wearable computers
|          
|          
|          
|          
|XGA        |  |             | 780,000   |              |  | Portable audio-visual projectors                                                                 
|          
|          
|          
|          
|SXGA       |  |             | 1,300,000 |              |  | Portable audio-visual projectors, rear-projection monitors                                       
|          
|          
|          
|          
|HDTV       |  |             | 2,000,000 |              |  | High-definition television                                                                       

We believe that the initial markets for our LCoSmicrodisplay products
will be in front projectors, monitors, and high-definition television sets.
Currently, the front projector, rear projection, and high-definition

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television
markets are being served by active matrix polysilicon microdisplays and DMD
microdisplays. Polysilicon microdisplays are manufactured by several large
Japanese companies. These products are incapable of producing cost-effective
resolutions above XGA without the further expense of adding special optics and
are generally more expensive than anticipated costs for LCoSmicrodisplays.
DMD microdisplays are a proprietary product of Texas Instruments. Although
DMDs have no inherent resolution limitations, they are relatively expensive to
manufacture, especially at higher resolutions. The expected relatively low
cost for LCoSmicrodisplays makes them more suitable for competitive consumer
marketplaces, such as portable business projectors, monitors, and
high-definition televisions.

We believe another market for LCoSmicrodisplay products will be converged
wireless products requiring high-information content displays for e-mail and
access to the Internet. Use of an LCoSmicrodisplay in a viewfinder
application would enable a person to carry a portable device capable of
delivering the same SVGA resolution as on the persons desktop or laptop
computer. This has the potential to allow portable access to the Internet and
critical information, such as calendars, maps, e-mail, and documentation, in a
handheld product. The high resolution of the device would avoid scrolling or
time-consuming text conversions in accessing the World Wide Web for needed
information.

We plan to offer a range of LCoSproduct solutions with different levels
of integration from individual light valves to fully integrated displays. By
adopting a modular approach to configuring and selling our LCoS microdisplays,
we will have the opportunity to price our products on a value-added basis and
to rapidly introduce new LCoS products. We will have undertaken extensive
development efforts before the first sale of LCoS products, and we expect to
incur substantial losses in the microdisplay business until the volume
production of LCoS microdisplays. We currently expect initial production to
commence in late 2000.

Sales and Marketing

We approach sales and marketing on three levels: engineer to engineer,
salesperson to procurement, and factory to factory. Our approach is to treat
an existing program as a marketing platform for the next program. Our
engineering, marketing, and sales groups provide ongoing services to our
customers throughout the life of product programs. These services include
implementing continuous improvement tools related to both the products cost
and technical performance. This service function allows us to market future
sales within our customer base.

We market our services primarily in North America, Asia, and Europe
through a direct technical sales force resident in those areas. A staff of
in-house, Arizona-based engineering personnel directs and aids all sales
personnel. We have 15 sales personnel worldwide.

Our sales to customers in Europe represented approximately 35.2% of net
sales in 1998 and approximately 46.7% of net sales in 1999. Our sales to
customers in Asia represented approximately 12.1% of net sales in 1998 and
approximately 35.3% of net sales in 1999.

Recently, we signed an exclusive distributorship agreement with Mitsui
Co., Ltd. of Tokyo, Japan. Under this agreement, Mitsui will market and sell
our LCiD, LCaD,and LCoSproducts to customers in Japan.

Customers

Our strategy involves concentrating our efforts on providing design and
production services to leading companies in five primary industries: mobile
handsets and other wireless communications, data collection, office automation,
medical equipment, and industrial controls. As a result, we generally derive
our net sales from services provided to a limited number of customers.

Our largest customer is Motorola. Sales to Motorola accounted for
approximately 86.1% of our net sales in 1999, 63.6% of our net sales in 1998,
and 34.6% of our net sales in 1997. Hewlett-Packard accounted for 32.0% of our
net sales in 1997. No customer other than Motorola accounted for more than
10.0% of our net sales in 1998 or 1999. Sales to Motorola currently are made
through multiple national and international buyers, and products are

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delivered
to diverse geographical regions throughout the world including Asia, North
America, and Europe. Substantially all of our net sales to Motorola have been
for mobile handset applications, and we are currently in design or manufacture
on at least 15 programs. Motorola has an LCD module allocation process in
which it designates key LCD module vendors, including us, and communicates to
each vendor the anticipated annual range of purchases. Although the allocation
process does not provide a guarantee of business to us, it provides an
indication that purchases by Motorola during 2000 could exceed 1999 levels.
See Item 1, Business  Special Considerations  Motorola accounts for a
significant portion of our sales.

Backlog

As of December 31, 1999, we had a backlog of orders of approximately $46.3
million. The backlog of orders as of December 31, 1998 was approximately $23.3
million. Our backlog consists of product orders for which confirmed purchase
orders have been received and which are scheduled for shipment within 12
months. Most orders are subject to rescheduling or cancellation by the
customer
with limited penalties. Because of the possibility of customer changes in
delivery schedules or cancellations and potential delays in product shipments,
our backlog as of a particular date may not be indicative of net sales for any
succeeding period.

Manufacturing Services, Facilities, and Quality Control

Manufacturing Services

We have organized our manufacturing geographically to optimize the
combination of technology and labor factors. This organization enables us to
compete solely on the basis of cost, if necessary, with suppliers of similar
products and services throughout the world. Our advanced manufacturing
techniques include surface mount technologies, chip-on-board, chip-on-flex,
chip-on-glass, flip-chip, tape automated bonding, and sophisticated testing
systems throughout these processes.

We seek to increase our value to our customers by providing responsive,
flexible, total manufacturing services. To date, our manufacturing services
have been concentrated on the manufacture of LCDs and assembly of display
modules that we have designed. We provide extended manufacturing services
beyond these core services, however, if the customer requires them. Extended
services may include adding additional components, such as keypads,
microphones, speakers, light guides, and optics, or the turnkey manufacture of
a complete assembly.

Manufacturing Facilities

We currently conduct manufacturing operations in Arizona; Manila, the
Philippines; and Beijing, China. The Arizona facility houses a Class 1000
clean room and LCD fabrication and prototyping operation. We utilize this
facility primarily to conduct LCD research and development, to produce
prototype and pre-production runs of devices for customer approval, to conduct
full production runs of low-volume devices, and to develop advanced
manufacturing processes that can be applied in Manila and Beijing during
full-scale production. In addition, the facility has the largest fully
automated LCD production capacity in North America. This highly automated line
enables us to eliminate substantially our dependence on foreign suppliers of
LCDs. Facility personnel include a team of experts ranging from LCD research
scientists to specialized engineers with backgrounds in electronics, mechanics,
chemistry, physics, and manufacturing. We maintain a wide variety of
state-of-the-art testing and quality control equipment at the facility.

We conduct high-volume display module manufacturing in Manila and Beijing.
In Manila, we are a party to a sub-assembly agreement with Technology
Electronic Assembly and Management Pacific Corporation, or TEAM, under which
TEAM supplies direct manufacturing services at a facility that TEAM owns and
that is located on land TEAM leases from the Philippine government. We also
are party to a lease agreement with TEAM under which TEAM leases space to us
with respect to the manufacturing operations services that TEAM performs under
the sub-assembly agreement. At the leased facility, TEAM manufactures,
assembles, and tests devices that we design pursuant to procedures set forth in
the sub-assembly agreement in accordance with our specifications. Under the
sub-assembly agreement, TEAM supplies only the direct labor and certain
incidental services required to manufacture our products. We own the
manufacturing, assembling, and testing equipment,

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including automated die
attach and wire bond equipment with automatic pattern recognition features for
die and wire placement for LED die, as well as the processes and documentation
that TEAM uses at the Manila facility. We pay TEAM for the direct
manufacturing personnel based upon a negotiated available hourly rate. We
employ all professional personnel, including an operations manager, with a
support staff consisting of manufacturing supervisors; manufacturing, quality,
and process engineers; and logistics and administrative personnel at the Manila
facility.

Our sub-assembly and lease agreements with TEAM extend through December
31, 2000, and each is renewable from year to year thereafter. The sub-assembly
agreement requires us to
maintain minimum production levels. The termination of the lease
agreement or sub-assembly agreement or the inability of TEAM to fulfill its
requirements under the sub-assembly agreement would require us to acquire
additional manufacturing facilities or to contract for additional manufacturing
services. The Philippines has been subject to volcanic eruptions, typhoons,
and substantial civil disturbances, including attempted military coups against
the government. Although we have not experienced any material interruption of
operations to date, these circumstances could affect our ability to obtain
products pursuant to the sub-assembly agreement. Our inability to obtain
products under the sub-assembly agreement, even for a relatively short period,
would have a material adverse effect on our operations and profitability.

Our Beijing facility is a high-volume display module manufacturing
facility similar to our current facility in Manila. We initially leased a
facility in Beijing on a temporary basis, and we commenced manufacturing at
this facility in the third quarter of 1998. We completed the construction of
our permanent facility in Beijing in July 1999, and all production in the
fourth quarter of 1999 occurred in that new facility. We employ all of the
direct and indirect manufacturing employees at the facility, including
technicians, supervisors, and engineers.

Quality Control

We recognize the need to maintain a strong reputation for quality as a
means of retaining existing customers and securing additional orders from them
as well as attracting new customers. We have an extensive quality control
program and maintain at each of our facilities quality systems and processes
that meet or exceed the demanding standards set by many leading OEMs in
targeted industries. We base our quality control program upon statistical
process control, which advocates continual quantitative measurements of crucial
parameters and uses those measurements in a closed-loop feedback system to
control the manufacturing process. We perform product life testing to help
ensure long-term product reliability. We analyze results of product life tests
and take actions to refine the manufacturing process or enhance the product
design.

Increased global competition has led to increased customer expectations
with respect to price, delivery, and quality. Customers often evaluate price
in the quotation process and evaluate delivery and quality only after receiving
the product. Therefore, many customers preview a companys quality by viewing
the quality systems employed. We have received ISO 9002 and QS 9000
certification of our Manila manufacturing facility. ISO and QS are quality
standards established by international organizations that attempt to ensure
that the processes used in development and production remain consistent. This
is accomplished through documentation maintenance, training, and management
review of the processes used. Although achieving an ISO 9002 or QS 9000
certification does not assure that we will obtain future business, it is a
factor that enables our customers to recognize that our production processes
meet these established, global standards of performance.

Components and Raw Materials

Components and raw materials constitute a substantial portion of our
product costs. The principal components and raw materials we use in producing
our displays consist of LCD glass, application specific integrated circuits, or
ASICs, circuit boards, molded plastic parts, lead frames, and packaging
materials. Our procurement strategy is to secure alternative sources of
supplies for the majority of these materials. Many of these, however, must be
obtained from foreign suppliers, which subjects us to the risks inherent in
obtaining materials from foreign sources, including supply interruptions and
currency fluctuations. Our ability to produce a majority of our own LCD
requirements in our Arizona facility, however, has substantially reduced our
dependence on foreign suppliers. With one exception, our other suppliers
generally are meeting our requirements, and we believe our strategic supplier

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alliances have further strengthened our relations with offshore suppliers. We
experienced material shortages of ASICs in 1999 as a result of the increased
worldwide demand for
cellular handsets. These shortages prevented us from meeting customer
demand for certain of our products in 1999. Similar shortages in the future
could have a material adverse effect on our business.

Research, Development, and Engineering

We conduct an active and ongoing research, development, and engineering
program that focuses on advancing technology, developing improved design and
manufacturing processes, and improving the overall quality of the products and
services that we provide. Our goal is to provide our customers with new
solutions that address their needs. Research and development personnel
concentrate on LCD technology, especially on improving the performance of
current products and expanding the technology to serve new markets. We also
conduct research and development in manufacturing processes, including those
associated with efficient, high-volume production and electronic packaging.

With the availability of our high-volume LCD manufacturing line in
Arizona, we are focusing our research and development efforts on new display
technologies. We expect that these advanced display technologies will enable
us to provide our customers with differentiating products or products that
provide higher information content. These new technologies include active
addressing, sunlight readable LCDs, color LCDs, plastic LCDs, bi-stable LCDs,
graphics and color graphics, organic and polymer light emitting displays, and
pixel-related display technologies. These products may be available for use in
custom devices or in standard devices. We have undertaken a significant
research and development program and made substantial investments with respect
to the development of our LCoS microdisplays for potential use in projectors,
monitors, high-definition televisions and portable applications. We expect
that the majority of our available research and development personnel hours
will be dedicated to LCoS microdisplays in 2000.

In October 1999, we signed a letter agreement with Tecdis S.p.A., a
European-based LCD company, to form an ASIC design center in Chatillon, Italy.
The ASIC design center will be known as Dora and will focus on the design of
ASICs necessary to drive the LCDs we and Tecdis design for our respective
customers. Recently, STMicroelectronics announced its participation in Dora
and its agreement to manufacture the ASICs designed by Dora.

Intellectual Property

We rely on a variety of intellectual property methods including patents,
trade secrets, trademarks, confidentiality agreements, licensing agreements,
and other forms of contractual provisions to protect our intellectual property.
Although our existing core business does not depend on any intellectual
property protection, we are manufacturing more advanced display products in
which there are intellectual property issues. For example, our LCiDtechnology
is patented. We have also filed for patents on our LCaDtechnology and have
signed a license agreement with Motif to license the technology that forms the
basis of LCaD. The license applies to all Motif patents relating to its active
addressing chips and system. The term of the license extends from June 1997
until the expiration of the Motif patents. We have also applied for numerous
other process and product patents, all related to display technologies. There
can be no assurance that any of these patents will be issued to us.

We have also taken several steps to both protect and advance our LCoS
microdisplay technology.



| |  |  | We filed several patents relating to our LCoS microdisplay
technology. These patents cover the areas of product design and
manufacturing process technology.                                                                                                                                                                                                                                                                                                                                                           
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | In July 1999, we purchased the assets, including all
production and test equipment, specialized laboratory equipment, and
supporting design documentation and software, of the former Light
Valve business unit of National Semiconductor. We also hired
several key scientists of that business unit and acquired an
exclusive, paid-up, royalty free
license on all of the patents and intellectual property related to
that business unit. This license covers all intellectual property
relating to the processing,

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| |   |  | packaging, and testing of light valves and
the integrated circuits necessary to manufacture and sell both light
valves and light engines.                                                                                                                                                                                                                                                                                                                                                                                                                            
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | In August 1999, we licensed the microdisplay technology of
S-Vision Corporation, a former microdisplay competitor that recently
ceased operations. Under this agreement, we acquired an
irrevocable, royalty free, fully paid-up, worldwide license to the
intellectual property associated with S-Visions digital backplane
and optical systems, which provides us rights to manufacture certain
microdisplay products and patented optical engines. In addition,
S-Vision assigned to us a patent relating to the design and
manufacture of microdisplay products.

Competition

We believe that Hosiden, Hyundai, Optrex, PCI, Philips, Samsung,
Seiko-Epson, Seiko Instruments, and Sharp constitute the principal competitors
for our passive LCD devices. Most of these competitors are large companies
that have greater financial, technical, marketing, manufacturing, vertical
integration, and personnel resources than we do. Our sales, profitability, and
success depend substantially upon our ability to compete with other providers
of display modules. We cannot provide assurance that we will continue to be
able to compete successfully with these organizations.

We currently compete principally on the basis of the technical innovation,
engineering service, and performance of our display modules, including their
ease of use and reliability, as well as on their cost, timely design, and
manufacturing and delivery schedules. Our competitive position could be
adversely affected if one or more of our customers, particularly Motorola,
determines to design and manufacture their display modules internally or
secures them from other parties. Other large companies are currently pursuing
microdisplay solutions. Texas Instruments has developed a product that
competes with our LCoS technology, and IBM and JVC are producing a similar
liquid crystal on silicon display based on their own technology. Numerous
other established and start-up companies are also pursuing similar and related
technologies that may compete with our LCoS technology.

Environmental Regulations

Our operations create a small amount of hazardous waste, including various
epoxies, gases, inks, solvents, and other wastes. The amount of hazardous
waste we produce may increase in the future depending on changes in our
operations. The general issue of the disposal of hazardous waste has received
increasing focus from federal, state, local, and international governments and
agencies and has been subject to increasing regulation.

Employees

As of December 31, 1999, we employed a total of 2,114 persons, of whom
1,166 were employed through third-party contracts. Of our direct employees,
192 were full-time and 14 were temporary employees at our principal U.S.
facility in Arizona and U.S. sales offices; 247 were employees at our
manufacturing facility in Manila; 487 were employees at our manufacturing
facility in Beijing; and 8 were employees at our Three-Five Systems Limited
subsidiary in Swindon, England. We consider our relationship with our
employees to be good, and none of our employees currently are represented by a
union in collective bargaining with us.

TEAM provides the personnel engaged in the direct assembly of our devices
in Manila under the sub-assembly agreement between us and TEAM. As of December
31, 1999, 1,166 persons performed direct labor operations at the Manila
facility through the sub-assembly agreement with TEAM.

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Executive Officers of the Registrant

The following table sets forth certain information regarding our executive officers:

|                    |  |     |    |               |  |                                                                                                                           
|------------------- |  | --- | -- | ------------- |  | --------------------------------------------------------------------------------------------------------------------------
|Name                |  | Age |    | Position Held
|                    |  |     |    |              
|Jack L. Saltich     |  |     | 56 |               |  | President, Chief Executive Officer, and Director                                                                          
|                   
|                   
|                   
|                   
|Jeffrey D. Buchanan |  |     | 44 |               |  | Executive Vice President  Finance, Administration,
and Legal; Chief Financial Officer; Secretary;
Treasurer; and Director
|                   
|                   
|                   
|                   
|Carl E. Derrington  |  |     | 49 |               |  | Vice President, Chief Manufacturing Officer                                                                               
|                   
|                   
|                   
|                   
|Robert L. Melcher   |  |     | 60 |               |  | Chief Technology Officer                                                                                                  
|                   
|                   
|                   
|                   
|Robert T. Berube    |  |     | 61 |               |  | Principal Accounting Officer and Corporate Controller                                                                     

Jack L. Saltichhas served as a director and the President and Chief
Executive Officer of our company since July 1999. Mr. Saltich served as Vice
President of Advanced Micro Devices from May 1993 until July 1999; as Executive
Vice President of Applied Micro Circuits Corp. from January 1991 until March
1993; and as Vice President of VLSI from July 1988 until January 1991. Mr.
Saltich held a variety of executive positions for Motorola from July 1971 until
June 1988. These positions included serving as an Engineering Manager from May
1974 until January 1980, an Operation Manager from January 1980 until May 1982,
a Vice President and Director of the Bipolar Technology Center from May 1982
until June 1986, and a Vice President and Director of the Advanced Product
Research and Development Laboratory from June 1986 until June 1988.

Jeffrey D. Buchananhas served as a director and Executive Vice President
- Finance, Administration, and Legal of our company since June 1998; as Chief
Financial Officer and Treasurer since June 1996; and as Secretary since May
1996. Mr. Buchanan served as our Vice President  Finance, Administration, and
Legal from June 1996 until July 1998 and as our Vice President  Legal and
Administration from May 1996 to June 1996. Mr. Buchanan served from June 1986
until May 1996 as a business lawyer with OConnor, Cavanagh, Anderson,
Killingsworth & Beshears. Mr. Buchanan was associated with the international
law firm of Davis Wright Tremaine from 1984 to 1986, and he was a senior staff
person at Deloitte & Touche from 1982 to 1984.

Carl E. Derringtonhas been our Chief Manufacturing Officer since May
1999. Dr. Derrington joined our company in 1986 as a Director of Research and
Development. Since that time, Dr. Derrington has served as a Plant Manager
from January 1986 until September 1987, a Director of Engineering from
September 1987 until August 1989, a Director of Manufacturing from August 1989
until April 1996, and a Director of Manufacturing Engineering from April 1996
until April 1999.

Robert L. Melcherhas been our Chief Technology Officer since October
1999. Prior to joining our company, Dr. Melcher was employed at IBM in a
variety of management positions since 1970. He served as the Program Leader
for Projection Displays from 1993 to 1999 and immediately prior to that he was
Director of the Physical Sciences Department from 1990 to 1993.

Robert T. Berubehas been our Principal Accounting Officer since July 1998
and has served as our Corporate Controller since July 1990. Mr. Berube served
as Chief Financial Officer of Electronic Research Associate, Inc., a
manufacturing company, from July 1977 until April 1990.

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SPECIAL CONSIDERATIONS

You should carefully consider the following factors, in addition to those
discussed elsewhere in this Report, in evaluating our company and our business.

Motorola accounts for a significant portion of our sales.

Our business depends to a significant extent on Motorolas success in the
mobile handset business, particularly in the various major mobile handset
programs in which we participate. Any material delay, cancellation, or
reduction of orders from Motorola could have a material adverse effect on our
business.

Motorola has been our largest customer during each of the last five years.
Sales to Motorola accounted for approximately 86.1% of our net sales in 1999,
63.6% in 1998, 34.6% in 1997, 65.1% in 1996 and 80.5% in 1995. Throughout this
period, substantially all of our sales to Motorola were for mobile handset
applications.

We anticipate that sales to Motorola in 2000 will exceed 1999 levels and
that the percentage of our net sales attributable to Motorola will stay in the
current range in 2000 as a result of increased worldwide demand for mobile
handsets.

A decline in sales to Motorola could occur at any time. For example, an
unexpected reduction in Motorola mobile handset programs reduced our net sales
to Motorola from $73.7 million in 1995 to $39.5 million in 1996 and $29.2
million in 1997. Since Motorola has no long-term contractual commitments to
purchase any of our products, we could experience similar declines in our net
sales in the future.

We are subject to lengthy development periods and product acceptance cycles.

We sell our display modules to OEMs, which then incorporate them into the
products they sell. OEMs make the determination during their product
development programs whether to incorporate our display modules or pursue other
alternatives. This requires us to make significant investments of time and
capital in the custom design of display modules well before our customers
introduce their products incorporating these displays and before we can be sure
that we will generate any significant sales to our customers or even recover
our investment. During a customers entire product development process, we
face the risk that our display will fail to meet our customers technical,
performance, or cost requirements or will be replaced by a competitive product
or alternative technological solution. Even if we complete our design process
in a manner satisfactory to our customer, the customer may delay or terminate
its product development efforts. The occurrence of any of these events would
adversely affect our operating results.

We do not have long-term purchase commitments from our customers.

Our customers, including Motorola, generally do not provide us with firm,
long-term volume purchase commitments. Although we have begun to enter into
more manufacturing contracts with our customers, these contracts clarify order
lead times, inventory risk allocation, and similar matters rather than provide
firm, long-term volume purchase commitments. As a result, customers can cancel
purchase commitments or reduce or delay orders at any time. The cancellation,
delay, or reduction of customer commitments could result in our holding excess
and obsolete inventory or having unabsorbed manufacturing overhead. The large
percentage of our sales to customers in the electronics industry, which is
subject to severe competitive pressures, rapid technological change, and
product obsolescence, increases our inventory and overhead risks.

Our operating results have been materially and adversely affected in the
past as a result of the failure to obtain anticipated orders and deferrals or
cancellations of purchase commitments because of
changes in customer requirements. For example, we made two announcements
in 1998 that sales would not meet our expectations because of delays in
customer programs.

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We depend on the market acceptance of the products of our customers.

We do not sell any products to end users.  Instead, we design and
manufacture various product solutions that our customers incorporate into their
products. As a result, our success depends almost entirely upon the widespread
market acceptance of our customers products. Any significant slowdown in the
demand for our customers products would adversely affect our business.

Because our success depends on the widespread market acceptance of our
customers products, we must identify industries that have significant growth
potential and establish relationships with OEMs in those industries. Our
failure to identify potential growth opportunities or establish relationships
with OEMs in those industries would adversely affect our business.

Our dependence on the success of the products of our customers exposes us
to a variety of risks, including the following:



| |  |  | our ability to provide significant design and manufacturing
services for customers on a timely and cost-effective basis;                    
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | our success in maintaining customer satisfaction with our
design and manufacturing services;                                                
|
| |  |  | our ability to match our design and manufacturing capacity
with customer demand and to maintain satisfactory delivery
schedules;            
|
| |  |  | customer order patterns, changes in order mix, and the level
and timing of orders placed by customers that we can complete in a
quarter; and
|
| |  |  | the cyclical nature of the industries and markets we serve.                                                                                 

Our failure to address these risks may cause our sales to decline.

We face intense competition.

We serve intensely competitive industries that are characterized by price
erosion, rapid technological change, and competition from major domestic and
international companies. This intense competition could result in pricing
pressures, lower sales, reduced margins, and lower market share. Many of our
competitors have greater market recognition, larger customer bases, and
substantially greater financial, technical, marketing, distribution, and other
resources than we possess. As a result, they may be able to introduce new
products and respond to customer requirements more quickly than we can.

Our competitive position could suffer if one or more of our customers
decide to design and manufacture their own display modules, to use standard
devices, to contract with our competitors, or to use alternative technologies.
In addition, our customers typically develop a second source, even for displays
we design for them. These second source suppliers may win an increasing share
of a program, particularly as it grows and matures, by competing primarily on
price rather than on design capability.

Our ability to compete successfully depends on a number of factors, both
within and outside our control. These factors include the following:



| |  |  | our success in designing and manufacturing new product
solutions, including those implementing new technologies;                           
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | our ability to address the needs of customers;                                                                                             
|
| |  |  | the quality, performance, reliability, features, ease of use,
pricing, and diversity of our product solutions;                             
|
| |  |  | foreign currency fluctuations, which may cause a foreign
competitors products to be priced significantly lower than our
product solutions;

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| |  |  | the quality of our customer services;                                                     
| | - |  | ------------------------------------------------------------------------------------------
|
| |  |  | our efficiency of production;                                                             
|
| |  |  | the rate at which customers incorporate our product solutions into their own products; and
|
| |  |  | product or technology introductions by our competitors.                                   

Shortages of components and materials may delay or reduce our sales and increase our costs.

Our inability to obtain sufficient quantities of components and other
materials necessary to produce our displays could result in reduced or delayed
sales or lost orders. Any delay in or loss of sales could adversely impact our
operating results. We obtain many of the materials we use in the manufacture
of our displays from a limited number of foreign suppliers, particularly
suppliers located in Asia, and we do not have long-term supply contracts with
any of them. As a result, we are subject to economic instability and currency
fluctuations in these Asian countries as well as to increased costs, supply
interruptions, and difficulties in obtaining materials. Our customers also may
encounter difficulties or increased costs in obtaining from others the
materials necessary to produce their products into which our product solutions
are incorporated.

Materials and components for some of our major programs from time to time
have been subject to allocation because of shortages of these materials and
components. During 1998, we occasionally delayed sales of our LCD modules as a
result of the unavailability of LCD polarizers and IC drivers, or ASICs.
During 1999, we experienced difficulties obtaining our requirements for ASICs
as a result of a worldwide shortage. These shortages resulted in lost sales
opportunities. Similar shortages in the future could have a material adverse
effect on our business.

We must maintain satisfactory manufacturing yields and capacity.

Our inability to maintain high levels of productivity or satisfactory
delivery schedules at our manufacturing facilities in Manila, Beijing, or
Arizona would adversely affect our operating results. The design and
manufacture of LCDs and display modules are highly complex processes that are
sensitive to a wide variety of factors, including the level of contaminants in
the manufacturing environment, impurities in the materials used, and the
performance of personnel and equipment. As is typical in the industry, at
times we have experienced lower than anticipated manufacturing yields and
lengthening of delivery schedules. We may encounter lower manufacturing yields
and longer delivery schedules as we continue to ramp up our high-volume LCD
line to greater production levels and begin to manufacture LCoSmicrodisplays.
In addition, the complexity of manufacturing processes will increase along with
increases in the sophistication of display modules.

Our emerging microdisplay business may not be successful.

Our emerging microdisplay business, from which we expect to derive
substantial revenue, faces many uncertainties. If we fail to successfully
address these uncertainties, and our microdisplay business is not successful,
our sales may not grow at the rate we anticipate.

Manufacturing an LCoSmicrodisplay involves a significantly different
procedure than manufacturing a typical liquid crystal display. Although we
added additional equipment to our Arizona LCD manufacturing line in 1998 to
enhance our ability to manufacture LCoSmicrodisplays, the manufacture of
microdisplays will require us to overcome numerous challenges, including the
following:



| |  |  | the use of a new material, silicon;                                                          
| | - |  | ---------------------------------------------------------------------------------------------
|
| |  |  | the modification of equipment and processes to accommodate the miniature size of the product;
|
| |  |  | the implementation of new manufacturing techniques;                                          
|
| |  |  | the incorporation of new handling procedures;                                                
|
| |  |  | the maintenance of cleaner manufacturing environments; and                                   

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| |  |  | the ability to master tighter tolerances in the manufacturing process.
| | - |  | ----------------------------------------------------------------------

We could experience significant problems in commencing volume production
of LCoSmicrodisplays. These problems could result in the delay of the full
implementation of high-volume LCoSmicrodisplay production. In addition, lower
than expected manufacturing yields could significantly and adversely affect us
because of the relatively high cost of the silicon backplanes used in LCoS
microdisplays.

Various target markets for our microdisplays, including projectors,
monitors, high-definition televisions, and portable microdisplays, are
uncertain, may be slow to develop, or could utilize competing technologies.
Many manufacturers have well-established positions in the projector and monitor
markets. As a result, we must provide these manufacturers with lower cost,
comparable performance microdisplays for their products. High-definition
television has only recently become available to consumers, and widespread
market acceptance is uncertain. Penetrating this market will require us to
offer lower cost alternatives to existing technology. In addition, the
commercial success of the portable microdisplay market is uncertain. Gaining
acceptance in this market may prove difficult because of the radically
different approach of microdisplays to the presentation of information. The
failure of any of these target markets to develop as we expect, or our failure
to penetrate these markets, will impede our anticipated sales growth. Even if
our technology successfully meets our price and performance goals, our
customers may not achieve commercial success in selling their products that
incorporate our microdisplay technology.

Our business depends on new products and technologies.

We operate in rapidly changing industries. Technological advances, the
introduction of new products, and new design and manufacturing techniques could
adversely affect our business unless we are able to adapt to the changing
conditions. As a result, we will be required to expend substantial funds for
and commit significant resources to



| |  |  | continue research and development activities on existing and potential product solutions;
| | - |  | -----------------------------------------------------------------------------------------
|
| |  |  | engage additional engineering and other technical personnel; and                         
|
| |  |  | purchase advanced design, production, and test equipment.                                

Our future operating results will depend to a significant extent on our
ability to continue to provide new product solutions that compare favorably on
the basis of time to introduction, cost, and performance with the design and
manufacturing capabilities of OEMs and competitive third-party suppliers. Our
success in attracting new customers and developing new business depends on
various factors, including the following:



| |  |  | utilization of advances in technology;                                   
| | - |  | -------------------------------------------------------------------------
|
| |  |  | innovative development of new solutions for customer products;           
|
| |  |  | efficient and cost-effective services; and                               
|
| |  |  | timely completion of the design and manufacture of new product solutions.

Our efforts to develop new technologies may not result in commercial success.

Our research and development efforts with respect to new technologies may
not result in customer or widespread market acceptance. Some or all of those
technologies may not successfully make the transition from the research and
development lab to cost-effective production as a result of technology
problems, competitive cost issues, yield problems, and other factors. Even
when we successfully complete a research and development effort with respect to
a particular technology, our customers may determine not to introduce or may
terminate products utilizing the technology for a variety of reasons, including
the following:



| |  |  | difficulties with other suppliers of components for the products;
| | - |  | -----------------------------------------------------------------
|
| |  |  | superior technologies developed by our competitors;              
|
| |  |  | price considerations;                                            

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| |  |  | lack of anticipated or actual market demand for the products; and
| | - |  | -----------------------------------------------------------------
|
| |  |  | unfavorable comparisons with products introduced by others.      

The nature of our business requires us to make capital expenditures and
investments for new technologies. For example, our capital expenditures,
including tooling and licenses, for LCoSmicrodisplays, currently our largest
research and development effort, have been over $7.0 million to date. To
facilitate the development of our LCoSmicrodisplay products, we also made an
equity investment of $3.3 million in Inviso, Inc., formerly Siliscape, Inc.,
during 1998 and purchased assets and technology of the former Light Valve
business unit of National Semiconductor Corporation for approximately $3.6
million during 1999. We may be required to make similar investments and
acquisitions in the future to maintain or enhance our ability to offer
technological solutions.

Significant expenditures relating to one or more new technologies,
especially LCoSmicrodisplays, that ultimately prove to be unsuccessful for any
reason could have a material adverse effect on us. In addition, any
investments or acquisitions, such as Inviso and the assets and technology of
the former Light Valve business unit, made to enhance our technologies may
prove to be unsuccessful.

We face risks associated with international operations.

Our manufacturing operations in Manila, Beijing, and Arizona and our sales
and distribution operations in Europe create a number of logistical and
communications challenges. These international operations also expose us to
various economic, political, and other risks, including the following:



| |  |  | management of a multi-national organization;                                                             
| | - |  | ---------------------------------------------------------------------------------------------------------
|
| |  |  | compliance with local laws and regulatory requirements as
well as changes in those laws and requirements;
|
| |  |  | employment and severance issues;                                                                         
|
| |  |  | overlap of tax issues;                                                                                   
|
| |  |  | tariffs and duties;                                                                                      
|
| |  |  | possible employee turnover or labor unrest;                                                              
|
| |  |  | lack of developed infrastructure;                                                                        
|
| |  |  | the burdens and costs of compliance with a variety of foreign laws; and                                  
|
| |  |  | political or economic instability in certain parts of the world.                                         

Changes in policies by the United States or foreign governments resulting
in, among other things, increased duties, higher taxation, currency conversion
limitations, restrictions on the transfer or repatriation of funds, limitations
on imports or exports, or the expropriation of private
enterprises also could have a material adverse effect on us. Any actions
by our host countries to reverse policies that encourage foreign investment or
foreign trade also could adversely affect our operating results. In addition,
U.S. trade policies, such as most favored nation status and trade preferences
for certain Asian nations, could affect the attractiveness of our services to
our U.S. customers.

We depend on our manufacturing operations in the Philippines.

Any disruption or termination of our manufacturing operations in Manila or
air transportation with the Philippines, even for a relatively short period of
time, would adversely affect our operations. The Philippines have been subject
to volcanic eruptions, typhoons, and substantial civil disturbances, including
attempted military coups against the government, since we commenced operations
at the facility in 1986. We have made cumulative capital investments in the
Philippines amounting to approximately $14.3 million through December 31, 1999.
We believe that our manufacturing operations in Manila constitute one of our
most important resources and that it would be

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difficult to replace the
low-cost, high-performance facility or the highly trained production staff in
the event of the disruption or termination of our manufacturing operations in
Manila.

Our operations in Manila also depend on the business and financial
condition of the third-party subcontractor that owns the manufacturing
facility, which is located on land the subcontractor leases from the Philippine
government. The subcontractor operates the facility utilizing equipment,
processes, and documentation that we own and supervisory personnel that we
employ. The subcontractor provides us with direct production personnel and
leases space to us. The subcontractor also utilizes additional space in the
facility to produce products for other entities unrelated to us. The failure
of the subcontractor to fulfill its obligations to us would adversely affect
our operating results. Our agreements with the subcontractor extend through
December 31, 2000 and are renewable from year to year thereafter, but may be
terminated by the subcontractor or us upon 180 days written notice.

Our new operations in China are unproven.

We commenced manufacturing operations in Beijing, China, during 1998 in a
leased temporary facility. During 1999, we completed the construction of a
permanent, high-volume LCD module manufacturing facility in Beijing, which is
similar to our Manila facility. We have made cumulative capital investments in
China amounting to approximately $10.9 million through December 31, 1999. Our
operations and assets are subject to significant political, economic, legal,
and other uncertainties in China. The Chinese government recently has been
pursuing economic reform policies, including the encouragement of foreign trade
and investment and greater economic decentralization. The Chinese government,
however, may not continue to pursue these policies, may not successfully pursue
these policies, or may significantly alter these policies from time to time.
China currently does not have a comprehensive and highly developed system of
laws, particularly with respect to foreign investment activities and foreign
trade. Enforcement of existing and future laws and contracts is uncertain, and
implementation and interpretation of laws may be inconsistent. As the Chinese
legal system develops, the passage of new laws, changes in existing laws, and
the preemption of local regulations by national laws may adversely affect us.
We also could be adversely affected by a number of other factors, including the
following:



| |  |  | the imposition of austerity measures intended to reduce
inflation;                                                                                                       
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | inadequate development or maintenance of infrastructure,
including the unavailability of adequate power and water supplies,
transportation, raw materials, and parts; and
|
| |  |  | a deterioration of the general political, economic, or social
environment in China.                                                                                      

In November 1999, the United States and China signed an agreement that
will lift trade barriers between the two countries and that advances Chinas
efforts to join the World Trade
Organization. Special interest groups have raised objections to these
efforts and we cannot be certain whether or to what extent trade relations with
China will continue to improve. Any developments that adversely affect trade
relations between the United States and China in the future could adversely
affect us by increasing the cost to U.S. customers of products manufactured by
us in China.

We face risks associated with international trade and currency exchange.

Political and economic conditions abroad may adversely affect the foreign
manufacture and sale of our displays. Protectionist trade legislation in
either the United States or foreign countries, such as a change in the current
tariff structures, export or import compliance laws, or other trade policies,
could adversely affect our ability to manufacture or sell displays in foreign
markets and to purchase materials or equipment from foreign suppliers.

While we transact business predominantly in U.S. dollars and bill and
collect most of our sales in U.S. dollars, we collect a portion of our revenue
in non-U.S. currencies, such as the Chinese renminbi. In the future, customers
increasingly may make payments in non-U.S. currencies, such as the newly
created Euro. In addition, we account for a portion of our costs, such as
payroll, rent, and indirect operating costs, in non-U.S. currencies, including
Philippine pesos, British pounds sterling, and Chinese renminbi.

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Fluctuations in foreign currency exchange rates could affect our cost of
goods and operating margins and could result in exchange losses. In addition,
currency devaluation can result in a loss to us if we hold deposits of that
currency. The Philippine peso suffered a major devaluation in late 1997, and
the Chinese renminbi has experienced significant devaluation against most major
currencies over the last five years. Hedging foreign currencies can be
difficult, especially if the currency is not freely traded. We cannot predict
the impact of future exchange rate fluctuations on our operating results.

The risks described above are particularly important since international
sales represented approximately 82.0% of our net sales in 1999 and
approximately 47.3% of our net sales in 1998. Sales in foreign markets,
primarily Europe and China, to OEMs based in the United States accounted for
almost all of our international sales in both of these periods. In the future,
we expect sales to OEMs based in Europe and China to increase.

Variability of customer requirements may adversely affect our operating results.

Custom manufacturers for OEMs must provide increasingly rapid product
turnaround and respond to ever-shorter lead times. A variety of conditions,
both specific to individual customers and generally affecting the demand for
their products, may cause customers to cancel, reduce, or delay orders.
Cancellations, reductions, or delays by a significant customer or by a group of
customers could adversely affect our business. On occasion, customers require
rapid increases in production, which can strain our resources and reduce our
margins. Although we have increased our manufacturing capacity, we may lack
sufficient capacity at any given time to meet our customers demands if their
demands exceed anticipated levels.

Our operating results have significant fluctuations.

In addition to the variability resulting from the short-term nature of our
customers commitments, other factors contribute to significant periodic and
seasonal quarterly fluctuations in our results of operations. These factors
include the following:



| |  |  | the timing of orders;                                                                      
| | - |  | -------------------------------------------------------------------------------------------
|
| |  |  | the volume of orders relative to our capacity;                                             
|
| |  |  | product introductions and market acceptance of new products or new generations of products;
|
| |  |  | evolution in the life cycles of customers products;                                       
|
| |  |  | timing of expenditures in anticipation of future orders;                                   
|
| |  |  | effectiveness in managing manufacturing processes;                                         
|
| |  |  | changes in cost and availability of labor and components;                                  
|
| |  |  | product mix;                                                                               
|
| |  |  | pricing and availability of competitive products and services; and                         
|
| |  |  | changes or anticipated changes in economic conditions.                                     

Accordingly, you should not rely on the results of any past periods as an
indication of our future performance. It is likely that in some future period,
our operating results may be below expectations of public market analysts or
investors. If this occurs, our stock price may drop.

We must effectively utilize our Arizona facility.

The effective utilization of our Arizona facility and its high-volume LCD
manufacturing line is critical to our success. We utilize the high-volume line
to produce a majority of our own requirements for LCDs.

The successful utilization of the LCD manufacturing line requires us to
(1) produce LCDs on a timely and cost-effective basis at quality levels at
least equal to product available from independent suppliers and (2) utilize the
LCDs we produce in devices we design and manufacture in a manner satisfactory
to our customers. We experienced

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some delays in fully implementing our LCD
manufacturing operations in 1996. We could experience problems or delays in
the future in conducting our LCD manufacturing operations. Any problems with
our LCD manufacturing operations could result in the lengthening of our
delivery schedules, reductions in the quality or performance of our design and
manufacturing services, and reduced customer satisfaction. These problems also
could require us to purchase our LCD requirements from third parties and could
delay our ability to recover our substantial expenditures in constructing and
equipping the high-volume LCD manufacturing line.

We must effectively manage our growth.

The failure to manage our growth effectively could adversely affect our
operations. We have increased the number of our manufacturing and design
programs and plan to expand further the number and diversity of our programs in
the future. Our ability to manage our planned growth effectively will require
us to



| |  |  | enhance our operational, financial, and management systems;                                                                                                
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | expand our facilities and equipment; and                                                                                                                   
|
| |  |  | successfully hire, train, and motivate additional employees,
including the technical personnel necessary to operate our new
production facility in Beijing.

The expansion and diversification of our product and customer base may
result in increases in our overhead and selling expenses. We also may be
required to increase staffing and other expenses as well as our expenditures on
capital equipment and leasehold improvements in order to meet the anticipated
demand of our customers. For example, prior to the receipt of orders, we
substantially increased our manufacturing capacity in 1998 by starting up
manufacturing operations in Beijing. Customers, however, generally do not
commit to firm production schedules for more than a short time in advance. Any
increase in expenditures in anticipation of future orders that do not
materialize would
adversely affect our profitability. Customers also may require rapid
increases in design and production services that place an excessive short-term
burden on our resources.

We depend on key personnel.

Our development and operations depend substantially on the efforts and
abilities of our senior management and technical personnel. The appointment of
a new chief executive officer and a new chief technology officer during 1999
required the integration of management personnel, the realignment of management
duties, and the confirmation of strategic initiatives.

The competition for qualified management and technical personnel is
intense. The loss of services of one or more of our key employees or the
inability to add key personnel, including those required for our LCD
manufacturing facility, could have a material adverse effect on us. Although
we maintain non-competition and nondisclosure covenants with certain key
personnel, we do not have any fixed-term agreements with, or key person life
insurance covering, any officer or employee.

We must protect our intellectual property, and others could infringe on or misappropriate our rights.

We believe that our continued success depends in part on protecting our
proprietary technology. Third parties could claim that we are infringing their
patents or other intellectual property rights. In the event that a third party
alleges that we are infringing its rights, we may not be able to obtain
licenses on commercially reasonable terms from the third party, if at all, or
the third party may commence litigation against us. The failure to obtain
necessary licenses or other rights or the institution of litigation arising out
of such claims could materially and adversely affect us.

We rely on a combination of patent, trade secret, and trademark laws,
confidentiality procedures, and contractual provisions to protect our
intellectual property. We seek to protect certain of our technology under
trade secret laws, which afford only limited protection. We face risks
associated with our intellectual property, including the following:

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| |  |  | pending patent applications may not be issued;                                                                                                     
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | intellectual property laws may not protect our intellectual property rights;                                                                       
|
| |  |  | third parties may challenge, invalidate, or circumvent any patent issued to us;                                                                    
|
| |  |  | rights granted under patents issued to us may not provide competitive advantages to us;                                                            
|
| |  |  | unauthorized parties may attempt to obtain and use
information that we regard as proprietary despite our efforts to
protect our proprietary rights;
|
| |  |  | others may independently develop similar technology or design
around any patents issued to us; and                                                 
|
| |  |  | effective protection of intellectual property rights may be
limited or unavailable in some foreign countries, such as China, in
which we operate.  

We may not be able to obtain effective trademark, service mark, copyright,
and trade secret protection in every country in which we sell our products. We
may find it necessary to take legal action in the future to enforce or protect
our intellectual property rights or to defend against claims of infringement.
Litigation can be very expensive and can distract our managements time and
attention, which could adversely affect our business. In addition, we may not
be able to obtain a favorable outcome in any intellectual property litigation.

The market price of our common stock may be volatile.

The market price of our common stock has been extremely volatile. Our
stock price increased dramatically during the three-year period ended December
31, 1994, but declined significantly during 1995 and 1996. The stock price
increased again during 1997, but declined significantly in 1998. Our stock
price again increased significantly during 1999. The trading price of our
common stock in the future could continue to be subject to wide fluctuations in
response to various factors, including the following:



| |  |  | quarterly variations in our operating results;                                                                    
| | - |  | ------------------------------------------------------------------------------------------------------------------
|
| |  |  | actual or anticipated announcements of technical innovations
or new product developments by us or our competitors;
|
| |  |  | changes in analysts estimates of our financial performance;                                                      
|
| |  |  | general conditions in the electronics industry; and                                                               
|
| |  |  | worldwide economic and financial conditions.                                                                      

In addition, the stock market has experienced extreme price and volume
fluctuations that have particularly affected the market prices for many
high-technology companies and that often have been unrelated to the operating
performance of these companies. These broad market fluctuations and other
factors may adversely affect the market price of our common stock.

The electronics industry is cyclical.

The electronics industry has experienced significant economic downturns at
various times, characterized by diminished product demand, accelerated erosion
of average selling prices, and production over-capacity. In addition, the
electronics industry is cyclical in nature. We have sought to reduce our
exposure to industry downturns and cyclicality by providing design and
production services for leading companies in rapidly expanding segments of the
electronics industry. We may, however, experience substantial period-to-period
fluctuations in future operating results because of general industry conditions
or events occurring in the general economy.

We must finance the growth of our business and the development of new products.

To remain competitive, we must continue to make significant investments in
research and development, equipment, and facilities. As a result of the
increase in fixed costs and operating expenses related to these capital

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expenditures, our failure to increase sufficiently our net sales to offset
these increased costs would adversely affect our operating results.

From time to time, we may seek additional equity or debt financing to
provide for the capital expenditures required to maintain or expand our design
and production facilities and equipment. We cannot predict the timing or
amount of any such capital requirements at this time. If such financing is not
available on satisfactory terms, we may be unable to expand our business or to
develop new business at the rate desired and our operating results may suffer.
Debt financing increases expenses and must be repaid regardless of operating
results. Equity financing could result in additional dilution to existing
stockholders.

We are subject to environmental regulations.

Our operations result in the creation of small amounts of hazardous waste,
including various epoxies, gases, inks, solvents, and other wastes. Any
failure by us to control the use, or adequately restrict the discharge, of
hazardous substances could subject us to future liabilities. We are subject to
federal, state, and local governmental regulations related to the use, storage,
discharge, and disposal of toxic, volatile, or otherwise hazardous chemicals
used in our design and manufacturing processes. The amount of hazardous waste
produced by us may increase in the future depending on changes in our
operations. Our failure to comply with present or future environmental
regulations could result in the
imposition of fines, suspension of production, or a cessation of
operations. Compliance with these regulations could require us to acquire
costly equipment or to incur other significant expenses.

Change in control provisions may adversely affect existing stockholders.

Our restated certificate of incorporation and the Delaware General
Corporation Law contain provisions that may have the effect of making more
difficult or delaying attempts by others to obtain control of our company, even
when these attempts may be in the best interests of stockholders. Our restated
certificate also authorizes the board of directors, without stockholder
approval, to issue one or more series of preferred stock, which could have
voting and conversion rights that adversely affect or dilute the voting power
of the holders of common stock. Delaware law also imposes conditions on
certain business combination transactions with interested stockholders.

Sales of large numbers of shares could adversely affect the price of our common stock.

All of our outstanding shares are freely tradeable without restriction or
further registration. Affiliates must sell all shares they own in compliance
with the volume and other requirements of Rule 144, except for the holding
period requirements. Sales of substantial amounts of common stock by our
stockholders, or even the potential for such sales, may have a depressive
effect on the market price of our common stock and could impair our ability to
raise capital through the sale of our equity securities.

We do not pay cash dividends.

We have never paid any cash dividends on our common stock and do not
anticipate that we will pay cash dividends in the foreseeable future. Instead,
we intend to apply earnings to the expansion and development of our business.

Our operating results could differ materially from the forward-looking statements contained in this Report.

Certain statements and information contained in this Report regarding
matters that are not historical facts are forward-looking statements, as such
term is defined under applicable securities laws. These include statements
concerning our future, proposed, and anticipated activities; certain trends
with respect to our revenue, operating results, capital resources, and
liquidity; and certain trends with respect to the markets in which we compete
or the electronics industry in general. Forward-looking statements, by their
very nature, include risks and uncertainties, many of which are beyond our
control. Accordingly, actual results may differ, perhaps materially, from
those expressed in or implied by such forward-looking statements. Factors that
could cause actual results to differ materially include those discussed under
this Item 1, Business  Special Considerations.

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ITEM 2. PROPERTIES

We own and occupy a 97,000 square foot facility in Tempe, Arizona, which
houses our U.S.-based manufacturing operations; our research, development,
engineering, design, and corporate functions; and the largest fully automated
LCD glass manufacturing operations in North America. We entered into a ground
lease for this facility that extends through March 31, 2069, subject to renewal
and purchase options as well as early termination provisions. Costs to
construct, furnish, and equip the Tempe facility were approximately $24.0
million.

We lease approximately 3,500 square feet of office and warehouse space in
Swindon, United Kingdom, where we maintain our European administrative offices
and a distribution warehouse.

We lease approximately 60,000 square feet of manufacturing space in
Manila, the Philippines. Approximately 40,000 square feet is subject to a
lease that expires on December 31, 2000 and is renewable from year to year
thereafter, but may be terminated upon 180 days written notice. The
remaining 20,000 square feet is subject to a lease that expires on March
31, 2000. We currently are in the process of renewing that lease and expect to
finalize the renewal prior to the expiration of that lease.

We own and occupy a 46,000 square foot facility in Beijing, China,
including 29,000 square feet of manufacturing space. We constructed this
facility on property that we have purchased on a long-term land use contract.
Costs to construct, furnish, and equip the Beijing facility were approximately
$10.9 million.







ITEM 3. LEGAL PROCEEDINGS

There are no legal proceedings to which we are a party or to which any of
our properties are subject, other than routine litigation incident to our
business that is covered by insurance or an indemnity or that we do not expect
to have a material adverse effect on our company. It is possible, however,
that we could incur claims for which we are not insured or that exceed the
amount of our insurance coverage.







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

Not applicable.

24



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##### Table of Contents









PART II







ITEM 5. MARKET FOR REGISTRANTS COMMON EQUITY
AND RELATED STOCKHOLDER
                MATTERS

Our common stock has been listed on the New York Stock Exchange under the
symbol TFS since December 29, 1994. The following table sets forth the
quarterly high and low closing prices of our common stock as reported on the
New York Stock Exchange for the periods indicated, adjusted to reflect the
four-for-three split of our common stock effected as a stock dividend in
December 1999.

|      |                |  |      |          |     |  |   |          | 
|----- | -------------- |  | ---- | -------- | --- |  | - | -------- | 
|      |                |  | High |          | Low
|      |                |  |      |          |    
|1997:
|     
|     
|     
|     
|      | First Quarter  |  | $    | 12 3/32  |     |  | $ | 9 3/16   | 
|     
|     
|     
|     
|      | Second Quarter |  |      | 11 13/16 |     |  |   | 8 23/32  | 
|     
|     
|     
|     
|      | Third Quarter  |  |      | 19 7/8   |     |  |   | 10 7/8   | 
|     
|     
|     
|     
|      | Fourth Quarter |  |      | 19 7/8   |     |  |   | 12 3/8   | 
|     
|     
|     
|     
|1998:
|     
|     
|     
|     
|      | First Quarter  |  | $    | 17 19/64 |     |  | $ | 13 5/16  | 
|     
|     
|     
|     
|      | Second Quarter |  |      | 15 9/32  |     |  |   | 11 5/32  | 
|     
|     
|     
|     
|      | Third Quarter  |  |      | 13 41/64 |     |  |   | 5 19/64  | 
|     
|     
|     
|     
|      | Fourth Quarter |  |      | 10 13/32 |     |  |   | 4 7/8    | 
|     
|     
|     
|     
|1999:
|     
|     
|     
|     
|      | First Quarter  |  | $    | 12       |     |  | $ | 6 15/32  | 
|     
|     
|     
|     
|      | Second Quarter |  |      | 10 23/64 |     |  |   | 6 3/64   | 
|     
|     
|     
|     
|      | Third Quarter  |  |      | 16 19/32 |     |  |   | 10 17/64 | 
|     
|     
|     
|     
|      | Fourth Quarter |  |      | 41       |     |  |   | 16 11/16 | 

As of March 10, 2000, there were approximately 808 holders of record of our
common stock. The closing sale price of our common stock on the New York Stock
Exchange on March 10, 2000 was $61.125 per share.

Our policy is to retain earnings to provide funds for the operation and
expansion of our business. We have not paid cash dividends on our common stock
and do not anticipate that we will do so in the foreseeable future.
Furthermore, our $25.0 million 1998 credit facility with Imperial Bank and the
National Bank of Canada did not permit us to pay dividends without the consent
of the lenders. In January 2000, we entered into a new credit facility with
Imperial Bank to replace the 1998 credit facility, and that new facility also
does not permit us to pay dividends without the consent of Imperial Bank. The
payment of dividends in the future will depend on our growth, profitability,
financial condition, and other factors that our board of directors may deem
relevant.

25



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##### Table of Contents









ITEM 6. SELECTED FINANCIAL DATA

The selected historical financial data presented below are derived from
our consolidated financial statements, which have been audited by Arthur
Andersen LLP, independent public accountants. The selected financial data
should be read in conjunction with Item 7, Managements Discussion and
Analysis of Financial Condition and Results of Operations and the Consolidated
Financial Statements and the Notes thereto included elsewhere in this Report.
All share amounts and per share data have been adjusted to reflect the
four-for-three split of our common stock effected as a stock dividend in
December 1999.

|                                                                   |                                        |         |        |                                       |        |      |        |        |        |      |        |        |        |   |        |        |        |   |         |         |        | 
|------------------------------------------------------------------ | -------------------------------------- | ------- | ------ | ------------------------------------- | ------ | ---- | ------ | ------ | ------ | ---- | ------ | ------ | ------ | - | ------ | ------ | ------ | - | ------- | ------- | ------ | 
|                                                                   |                                        |         |        | Years Ended December 31,             
|                                                                   |                                        |         |        |                                      
|                                                                   |                                        |         |        | 1995                                  |        | 1996 |        | 1997   |        | 1998 |        | 1999  
|                                                                   |                                        |         |        |                                       |        |      |        |        |        |      |        |       
|                                                                   |                                        |         |        | (in thousands, except per share data)
|Consolidated Statement of Operations Data:                        
|                                                                  
|                                                                  
|                                                                  
|                                                                  
|Net sales                                                          |                                        | $       | 91,585 |                                       |        | $    | 60,713 |        |        | $    | 84,642 |        |        | $ | 95,047 |        |        | $ | 147,408 |        
|                                                                   |                                        |         |        |                                       |        |      |        |        |        |      |        |        |        |   |        |        |        |   |         |        
|Costs and expenses:                                               
|                                                                  
|                                                                  
|                                                                  
|                                                                  
|                                                                   | Cost of sales                          |         |        | 70,481                                |        |      |        | 58,321 |        |      |        | 64,760 |        |   |        | 76,149 |        |   |         | 117,583 |       
|                                                                  
|                                                                  
|                                                                  
|                                                                  
|                                                                   | Selling, general, and administrative   |         |        | 5,386                                 |        |      |        | 5,351  |        |      |        | 6,557  |        |   |        | 7,334  |        |   |         | 11,170  |       
|                                                                  
|                                                                  
|                                                                  
|                                                                  
|                                                                   | Research, development, and engineering |         |        | 2,396                                 |        |      |        | 4,065  |        |      |        | 5,106  |        |   |        | 7,159  |        |   |         | 8,745   |       
|                                                                   |                                        |         |        |                                       |        |      |        |        |        |      |        |        |        |   |        |        |        |   |         |        
|                                                                   |                                        |         | 78,263 |                                       |        |      | 67,737 |        |        |      | 76,423 |        |        |   | 90,642 |        |        |   | 137,498 |        
|                                                                   |                                        |         |        |                                       |        |      |        |        |        |      |        |        |        |   |        |        |        |   |         |        
|Operating income (loss)                                            |                                        |         | 13,322 |                                       |        |      | (7,024 | )      |        |      | 8,219  |        |        |   | 4,405  |        |        |   | 9,910   |        
|                                                                  
|                                                                  
|                                                                  
|                                                                  
|Other income (expense), net                                        |                                        |         | 643    |                                       |        |      | 273    |        |        |      | 358    |        |        |   | (42    | )      |        |   | (18     | )      
|                                                                   |                                        |         |        |                                       |        |      |        |        |        |      |        |        |        |   |        |        |        |   |         |        
|Income (loss) before provision for
(benefit from) income     taxes |                                        |         | 13,965 |                                       |        |      | (6,751 | )      |        |      | 8,577  |        |        |   | 4,363  |        |        |   | 9,892   |        
|                                                                  
|                                                                  
|                                                                  
|                                                                  
|Provision for (benefit from) income taxes                          |                                        |         | 5,548  |                                       |        |      | (2,920 | )      |        |      | 3,334  |        |        |   | 1,773  |        |        |   | 2,968   |        
|                                                                   |                                        |         |        |                                       |        |      |        |        |        |      |        |        |        |   |        |        |        |   |         |        
|Net income (loss)                                                  |                                        | $       | 8,417  |                                       |        | $    | (3,831 | )      |        | $    | 5,243  |        |        | $ | 2,590  |        |        | $ | 6,924   |        
|                                                                   |                                        |         |        |                                       |        |      |        |        |        |      |        |        |        |   |        |        |        |   |         |        
|Earnings (loss) per common share:                                 
|                                                                  
|                                                                  
|                                                                  
|                                                                  
|                                                                   |                                        | Basic   |        | $                                     | 0.82   |      |        | $      | (0.37  | )    |        | $      | 0.50   |   |        | $      | 0.25   |   |         | $       | 0.67   | 
|                                                                   |                                        |         |        |                                       |        |      |        |        |        |      |        |        |        |   |        |        |        |   |         |        
|                                                                   |                                        | Diluted |        | $                                     | 0.78   |      |        | $      | (0.37  | )    |        | $      | 0.49   |   |        | $      | 0.25   |   |         | $       | 0.65   | 
|                                                                   |                                        |         |        |                                       |        |      |        |        |        |      |        |        |        |   |        |        |        |   |         |        
|Weighted average number of common shares:                         
|                                                                  
|                                                                  
|                                                                  
|                                                                  
|                                                                   |                                        | Basic   |        |                                       | 10,288 |      |        |        | 10,357 |      |        |        | 10,472 |   |        |        | 10,185 |   |         |         | 10,375 | 
|                                                                   |                                        |         |        |                                       |        |      |        |        |        |      |        |        |        |   |        |        |        |   |         |        
|                                                                   |                                        | Diluted |        |                                       | 10,779 |      |        |        | 10,357 |      |        |        | 10,787 |   |        |        | 10,403 |   |         |         | 10,670 | 
|                                                                   |                                        |         |        |                                       |        |      |        |        |        |      |        |        |        |   |        |        |        |   |         |        
|Consolidated Balance Sheet Data:                                  
|                                                                  
|                                                                  
|                                                                  
|                                                                  
|(at end of year):                                                 
|                                                                  
|                                                                  
|                                                                  
|                                                                  
|Working capital                                                    |                                        | $       | 22,400 |                                       |        | $    | 21,513 |        |        | $    | 29,113 |        |        | $ | 24,825 |        |        | $ | 60,853  |        
|                                                                  
|                                                                  
|                                                                  
|                                                                  
|Total assets                                                       |                                        |         | 63,780 |                                       |        |      | 62,569 |        |        |      | 72,835 |        |        |   | 77,904 |        |        |   | 126,930 |        
|                                                                  
|                                                                  
|                                                                  
|                                                                  
|Notes payable to banks and long-term debt                          |                                        |         | 3,000  |                                       |        |      |       |        |        |      |       |        |        |   | 8,095  |        |        |   |        |        
|                                                                  
|                                                                  
|                                                                  
|                                                                  
|Stockholders equity                                               |                                        |         | 55,224 |                                       |        |      | 51,184 |        |        |      | 56,525 |        |        |   | 51,096 |        |        |   | 101,220 |        

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

Overview

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

We currently sell substantially all of our LCD modules to major OEMs.
When we win a design program, our customer typically pays all or a portion of
our nonrecurring engineering expenses to defray the costs of custom design, as
well as the costs of nonrecurring tooling for custom components. The typical
program life cycle of a custom-designed LCD module is three to twelve months
and includes technical design, prototyping, pilot manufacturing, and
high-volume manufacturing. We typically seek large volume programs from major
OEMs. The minimum production quantity for an LCD module typically approximates
100,000 units per year, although the production rate for some programs has been
as high as 100,000 units per week. The selling price of our LCD modules
usually ranges between $5 and $20 per unit. We recognize revenue upon product
shipment.

We experienced substantial growth from 1993 through 1995, primarily as a
result of sales to OEMs in the wireless communications industry, which grew
substantially during that period. During that period, our primary customer was
Motorola. In 1996, our net sales declined, primarily as a result of the
phase-out by Motorola of a significant family of programs. In 1997, our net
sales returned to pre-1996 levels primarily as a result of several new programs
and customers, including Hewlett-Packard. Motorola accounted for 65.1% of our
net sales in 1996, 34.6% in 1997, and 63.6% in 1998. In 1999, net sales to
Motorola increased at a rate faster than net sales to our other customers and
represented 86.1%of our net sales. Hewlett-Packard accounted for 32.0% of our
net sales in 1997, and less than 10.0% in 1998 and 1999. This percentage
decrease occurred as several older Hewlett-Packard programs matured and ended.
In addition, new programs launched by Hewlett-Packard in 1998 either did not
require our LCD modules or required less complex, lower cost modules.

During the past several years, we have experienced seasonal quarterly
fluctuations in our net sales as our OEM customers developed retail products
with shorter product life cycles and phased out older programs early in the
year following holiday sales. As a result, sales usually peak in the fourth
quarter of a calendar year and are lower in the following quarter.

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

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

Historically, we have conducted most of our manufacturing operations at
our facility in Manila. At that facility, we assemble LCDs into modules and
perform certain back-end LCD processing operations. We conduct our operations
in Manila under an agreement with a third-party subcontract manufacturer.
Under this agreement, the subcontractor supplies direct labor and incidental
services required to manufacture our products. We also

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##### Table of Contents



lease our manufacturing
facility from the subcontractor. All indirect manufacturing employees,
primarily technicians, supervisors, and engineers, are our employees.

In early 1998, we decided to open a similar display module manufacturing
facility in Beijing. Within six months, we located a temporary manufacturing
facility, equipped the facility, trained our personnel, qualified the facility
for customers, and qualified products manufactured at the facility. As we
began manufacturing operations in Beijing in the second and third quarters of
1998, however, we incurred costs in advance of the receipt of significant
sales. These incremental Beijing-based expenses were reflected in our cost of
sales. We began manufacturing in volume in Beijing in the fourth quarter of
1998.

We commenced construction of our permanent Beijing facility in late 1998.
This facility was substantially completed in early July 1999, and we began
production in the new manufacturing facility late in the third quarter of 1999.
All production in Beijing during the fourth quarter of 1999 was done out of
our new permanent facility. We own our Beijing facility through a wholly owned
foreign subsidiary.

Selling, general, and administrative expense consists principally of
administrative and selling costs, salaries, commissions, and benefits to
personnel and related facility costs. We make substantially all of our sales
directly to OEMs, and our sales force consists of a small number of direct
technical sales persons. As a result, there is no material cost of
distribution in our selling, general, and administrative expense. Selling,
general, and administrative expense has increased as we have expanded our
business and increased our diversification efforts. In addition, we have
recently incurred substantial marketing and administrative expenses in
connection with our LCoSmicrodisplay business.

Research, development, and engineering expense consists principally of
salaries and benefits to scientists, design engineers, and other technical
personnel, related facility costs, process development costs, and various
expenses for projects, including new product development. Research,
development, and engineering expense continues to increase as we develop new
display products and technologies, especially LCoSmicrodisplays, while we
continue with our in-house process development efforts related to the
high-volume LCD manufacturing line located in Arizona.

Since 1997, we have been working on the development of LCoSmicrodisplays.
In 1997, we entered into a strategic alliance with National Semiconductor
Corporation for the development of LCoSmicrodisplay products. Under that
alliance, National focused on the silicon technologies needed for
microdisplays, and we focused on the liquid crystal technologies. In 1999,
National decided to close its microdisplay business unit. In connection with
that closing, in July 1999, we purchased certain assets and licensed silicon
technologies from National relating to LCoSmicrodisplays. We paid
approximately $3.0 million in cash and issued warrants to purchase 93,333
shares of our common stock in the transaction, which was valued at
approximately $3.6 million. No additional payments are required under the
licenses. We also hired several key technical employees of National to assist
in the implementation of the acquired technologies.

In April 1998, we entered into a strategic relationship with Inviso, Inc.,
formerly Siliscape, 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. As part of
this strategic relationship, we provide proprietary manufacturing capabilities
and liquid crystal expertise, and Inviso provides patented and proprietary
technologies and components for the joint development of microdisplay products.

In August 1999, we licensed the microdisplay technology of S-Vision
Corporation, which had recently ceased operations. This license is an
irrevocable, royalty free, fully paid-up, worldwide license to manufacture and
package certain microdisplay products and patented optical engines.

In October 1999, we signed a letter agreement with Tecdis S.p.A., a
European-based LCD company, to form an ASIC design center in Chatillon, Italy.
The ASIC design center will be known as Dora and will focus on the design of
ASICs necessary to drive the LCDs we and Tecdis design for our respective
customers. Recently, STMicroelectronics announced its participation in Dora
and its agreement to manufacture the ASICs designed by Dora.

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##### Table of Contents



These acquisitions, investments, and licenses will result in increased
research, development, and engineering expenses as we expand our LCoS
microdisplay development efforts in preparation for the commercial introduction
of LCoSmicrodisplay products. We are also considering licensing other
technologies from other companies that could be optimized on our LCD
manufacturing line as well as entering into further alliances. We expect to
continue to devote substantial resources to research and development,
especially on our LCoSmicrodisplay technology and related products. As a
result, the actual dollar amount of our research, development, and engineering
expenses will continue to increase.

Results of Operations

The following table sets forth, for the periods indicated, the percentage
of net sales of certain items in our Consolidated Financial Statements.

|                                         |                                        |  |                          |      |      |  |       |      |  |  |       |      | 
|---------------------------------------- | -------------------------------------- |  | ------------------------ | ---- | ---- |  | ----- | ---- |  |  | ----- | ---- | 
|                                         |                                        |  | Years Ended December 31,
|                                         |                                        |  |                         
|                                         |                                        |  | 1997                     |      | 1998 |  | 1999 
|                                         |                                        |  |                          |      |      |  |      
|Net sales                                |                                        |  | 100.0                    | %    |      |  | 100.0 | %    |  |  | 100.0 | %   
|                                         |                                        |  |                          |      |      |  |       |      |  |  |       |     
|Costs and expenses:                     
|                                        
|                                        
|                                        
|                                        
|                                         | Cost of sales                          |  |                          | 76.5 |      |  |       | 80.1 |  |  |       | 79.8 | 
|                                        
|                                        
|                                        
|                                        
|                                         | Selling, general, and administrative   |  |                          | 7.8  |      |  |       | 7.7  |  |  |       | 7.6  | 
|                                        
|                                        
|                                        
|                                        
|                                         | Research, development, and engineering |  |                          | 6.0  |      |  |       | 7.6  |  |  |       | 5.9  | 
|                                         |                                        |  |                          |      |      |  |       |      |  |  |       |     
|                                         |                                        |  | 90.3                     |      |      |  | 95.4  |      |  |  | 93.3  |     
|                                         |                                        |  |                          |      |      |  |       |      |  |  |       |     
|Operating income                         |                                        |  | 9.7                      |      |      |  | 4.6   |      |  |  | 6.7   |     
|                                        
|                                        
|                                        
|                                        
|Other income (expense), net              |                                        |  | 0.4                      |      |      |  |      |      |  |  |      |     
|                                         |                                        |  |                          |      |      |  |       |      |  |  |       |     
|Income before provision for income taxes |                                        |  | 10.1                     |      |      |  | 4.6   |      |  |  | 6.7   |     
|                                        
|                                        
|                                        
|                                        
|Provision for income taxes               |                                        |  | 3.9                      |      |      |  | 1.9   |      |  |  | 2.0   |     
|                                         |                                        |  |                          |      |      |  |       |      |  |  |       |     
|Net income                               |                                        |  | 6.2                      | %    |      |  | 2.7   | %    |  |  | 4.7   | %   
|                                         |                                        |  |                          |      |      |  |       |      |  |  |       |     

Year ended December 31, 1999 compared to year ended December 31, 1998

Net Sales.Net sales increased 55.2% to $147.4 million in the year ended
December 31, 1999 from $95.0 million in the year ended December 31, 1998. This
increase was the result of several new programs, primarily for Motorola. We
have experienced a seasonality to our sales, primarily as a result of our LCD
modules being used in mobile handsets, the majority of which are sold in the
third and fourth quarter of a year. In 1999, we recorded 63.0% of our net
sales in the third and fourth quarters. Net sales in the fourth quarter of
1999 were 117.2% greater than net sales in the first quarter of 1999.

Cost of Sales.Cost of sales decreased to 79.8% of net sales in the year
ended December 31, 1999 from 80.1% in the year ended December 31, 1998. This
percentage decrease resulted primarily from increased operating efficiencies as
a result of a significant increase in production volume. Most of those
operating efficiencies occurred in the fourth quarter of 1999. In addition, our
permanent China manufacturing facility was operational during the entire fourth
quarter, and in that new
facility we experienced better yields and absorption than when we operated
in our temporary China facility.

Selling, General, and Administrative Expense.Selling, general, and
administrative expense increased 53.4% to $11.2 million in the year ended
December 31, 1999 from $7.3 million in the year ended December 31, 1998.
Selling, general, and administrative expense was 7.6% of net sales in the year
ended December 31, 1999 compared to 7.7% in the year ended December 31, 1998.
The increase in selling, general, and administrative expense reflected the
continued expansion of our business. In particular, we incurred approximately
$2.2 million of marketing and administrative expenditures relating to our LCoS
microdisplay business in 1999 compared to approximately $300,000 in 1998.

Research, Development, and Engineering Expense.Research, development,
and engineering expense increased 20.8% to $8.7 million in the year ended
December 31, 1999 from $7.2 million in the year ended December 31, 1998.
Research, development, and engineering expense was 5.9% of net sales in the
year ended

29



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##### Table of Contents



December 31, 1999 compared to 7.6% in the year ended December 31,
1998. Although research, development, and engineering expense associated with
in-process developments on the LCD line decreased in 1999, research,
development, and engineering expense overall increased as the result of the
development of new display products and technologies. For example, LCoS
microdisplays accounted for approximately $4.4 million of research,
development, and engineering expense in 1999 compared to approximately $2.4
million in 1998.

Other Income (Expense), Net.Other expense in the year ended December 31,
1999 was $18,000 compared to other expense of $42,000 in the year ended
December 31, 1998. We had sharply higher interest income in the fourth quarter
of 1999 as the result of increased cash balances and a tax refund. That
interest income offset interest expense we had in the first three quarters of
1999 as a result of additional borrowing incurred in connection with our stock
repurchase program and increased borrowings on our working capital line of
credit. All credit lines were paid off and cash balances increased as a result
of our equity offering in the third quarter of 1999.

Provision for Income Taxes.We recorded a provision for income taxes of
$3.0 million in the year ended December 31, 1999 compared to a provision for
income taxes of $1.8 million in the year ended December 31, 1998. This change
resulted primarily from higher pre-tax income in 1999 compared to the same
period in 1998. In addition, we recorded tax benefits in the first and fourth
quarters of 1999 relating to a state income tax refund. Generally, the tax
rate was also lower in 1999 as a result of higher net income in China (which is
a low tax rate jurisdiction) versus a net loss in China in 1998. In 2000, we
expect our overall tax rate to be approximately 36.0%.

Net Income.Net income increased 165% to $6.9 million, or $0.65 per
diluted share, in the year ended December 31, 1999 from $2.6 million, or $0.25
per diluted share, in the year ended December 31, 1998. Excluding LCoS
microdisplay related expenses, our net income was approximately $11.4 million,
or $1.07 per diluted share.

Year ended December 31, 1998 compared to year ended December 31, 1997

Net Sales.Net sales increased 12.3% to $95.0 million in 1998 from $84.6
million in 1997. The increase resulted from several new programs in 1998 for a
variety of customers, including Motorola. In 1998, we recorded 56.7% of our
net sales in the third and fourth quarters. Net sales in the fourth quarter of
1998 were almost 58.6% greater than in the first quarter of 1998.

Cost of Sales.Cost of sales increased to 80.1% of net sales in 1998 from
76.5% in 1997. The corresponding decrease in our gross margin was primarily
the result of manufacturing variances occurring as a result of the start-up of
our new manufacturing facility in Beijing, unfavorable manufacturing yields
experienced in connection with the start of several new programs, and
increased pricing pressure from customers and competitors, partially as a
result of the Asian economic crisis.

Selling, General, and Administrative Expense.Selling, general, and
administrative expense increased 10.6% to $7.3 million in 1998 from $6.6
million in 1997. Selling, general, and administrative expense was 7.7% of net
sales in 1998 compared to 7.8% in 1997. Selling, general, and administrative
expense increased in absolute terms as a result of increased selling expenses
and the addition of administrative personnel. As a result of increased net
sales in 1998, however, selling, general, and administrative expense declined
slightly as a percent of net sales.

Research, Development, and Engineering Expense.Research, development,
and engineering expense increased 41.2% to $7.2 million in 1998 from $5.1
million in 1997. Research, development, and engineering expense was 7.6% of
net sales in 1998 compared to 6.0% in 1997. In 1998, we continued to expand
and intensify our research and development efforts on proprietary display
products as well as ongoing LCD manufacturing process improvements, including
increased use of the LCD manufacturing line in our Arizona facility as a
resource for development of these new products.

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Other Income (Expense), Net.Other expense was $42,000 in 1998 compared
to other income of $358,000 in 1997. Net interest income in 1998 was $75,000,
down from $548,000 in 1997. The decrease in net interest income was the result
of investing lower average cash balances during the year as well as increased
interest expense as a result of increased debt. This decline in net interest
income was partially offset by reduced foreign exchange losses.

Provision for Income Taxes.We recorded a provision for income taxes of
$1.8 million in 1998 compared to $3.3 million in 1997. Our overall tax rate
was 40.6% in 1998 compared to 38.9% in 1997. The increased tax rate resulted
primarily from losses in Beijing for which we did not receive a tax benefit
proportionate to our tax rate elsewhere in the world.

Net Income.Net income decreased 50.0% to $2.6 million, or $0.25 per
diluted share, in 1998 compared to $5.2 million, or $0.49 per diluted share, in
1997.

Quarterly Results of Operations

The following table presents unaudited consolidated statement of
operations data for each of the eight quarters in the period ended December 31,
1999, as well as such data expressed as a percentage of net sales. We believe
that all necessary adjustments have been included to present fairly the
quarterly information when read in conjunction with the Consolidated Financial
Statements. The operating results for any quarter are not necessarily
indicative of the results for any subsequent quarter.

|                                                                  |                                           |   |                |        |         |   |          |        |         |   |         |        |         |   |          |        |         |   |        |        |  |   |        |        |  |   |        |        |  |   |        |        | 
|----------------------------------------------------------------- | ----------------------------------------- | - | -------------- | ------ | ------- | - | -------- | ------ | ------- | - | ------- | ------ | ------- | - | -------- | ------ | ------- | - | ------ | ------ |  | - | ------ | ------ |  | - | ------ | ------ |  | - | ------ | ------ | 
|                                                                  |                                           |   | Quarters Ended
|                                                                  |                                           |   |               
|                                                                  |                                           |   | (in thousands)
|                                                                  |                                           |   | 1998           |        | 1999   
|                                                                  |                                           |   |                |        |        
|                                                                  |                                           |   | Mar. 31        |        | June 30 |   | Sept. 30 |        | Dec. 31 |   | Mar. 31 |        | June 30 |   | Sept. 30 |        | Dec. 31
|                                                                  |                                           |   |                |        |         |   |          |        |         |   |         |        |         |   |          |        |        
|Net sales                                                         |                                           | $ | 18,479         |        |         | $ | 22,682   |        |         | $ | 24,572  |        |         | $ | 29,314   |        |         | $ | 23,044 |        |  | $ | 31,600 |        |  | $ | 42,723 |        |  | $ | 50,041 |       
|                                                                 
|                                                                 
|                                                                 
|                                                                 
|Cost and expenses:                                               
|                                                                 
|                                                                 
|                                                                 
|                                                                 
|                                                                  | Cost of sales                             |   |                | 13,687 |         |   |          | 17,095 |         |   |         | 22,243 |         |   |          | 23,124 |         |   |        | 20,191 |  |   |        | 25,103 |  |   |        | 33,882 |  |   |        | 38,407 | 
|                                                                 
|                                                                 
|                                                                 
|                                                                 
|                                                                  | Selling, general, and
   administrative   |   |                | 1,619  |         |   |          | 1,815  |         |   |         | 1,721  |         |   |          | 2,179  |         |   |        | 2,449  |  |   |        | 2,493  |  |   |        | 2,741  |  |   |        | 3,487  | 
|                                                                 
|                                                                 
|                                                                 
|                                                                 
|                                                                  | Research, development, and
   engineering |   |                | 1,689  |         |   |          | 1,904  |         |   |         | 1,250  |         |   |          | 2,316  |         |   |        | 1,821  |  |   |        | 2,008  |  |   |        | 2,427  |  |   |        | 2,489  | 
|                                                                  |                                           |   |                |        |         |   |          |        |         |   |         |        |         |   |          |        |         |   |        |        |  |   |        |        |  |   |        |        |  |   |        |       
|                                                                  |                                           |   | 16,995         |        |         |   | 20,814   |        |         |   | 25,214  |        |         |   | 27,619   |        |         |   | 24,461 |        |  |   | 29,604 |        |  |   | 39,050 |        |  |   | 44,383 |       
|                                                                  |                                           |   |                |        |         |   |          |        |         |   |         |        |         |   |          |        |         |   |        |        |  |   |        |        |  |   |        |        |  |   |        |       
|Operating income (loss)                                           |                                           |   | 1,484          |        |         |   | 1,868    |        |         |   | (642    | )      |         |   | 1,695    |        |         |   | (1,417 | )      |  |   | 1,996  |        |  |   | 3,673  |        |  |   | 5,658  |       
|                                                                 
|                                                                 
|                                                                 
|                                                                 
|Other income (expense), net                                       |                                           |   | 175            |        |         |   | 124      |        |         |   | (52     | )      |         |   | (289     | )      |         |   | (185   | )      |  |   | (214   | )      |  |   | (160   | )      |  |   | 541    |       
|                                                                  |                                           |   |                |        |         |   |          |        |         |   |         |        |         |   |          |        |         |   |        |        |  |   |        |        |  |   |        |        |  |   |        |       
|Income (loss) before
provision for
   (benefit from) income taxes |                                           |   | 1,659          |        |         |   | 1,992    |        |         |   | (694    | )      |         |   | 1,406    |        |         |   | (1,602 | )      |  |   | 1,782  |        |  |   | 3,513  |        |  |   | 6,199  |       
|                                                                 
|                                                                 
|                                                                 
|                                                                 
|Provision for (benefit
from)
   income taxes                      |                                           |   | 664            |        |         |   | 869      |        |         |   | (291    | )      |         |   | 531      |        |         |   | (960   | )      |  |   | 742    |        |  |   | 1,476  |        |  |   | 1,710  |       
|                                                                  |                                           |   |                |        |         |   |          |        |         |   |         |        |         |   |          |        |         |   |        |        |  |   |        |        |  |   |        |        |  |   |        |       
|Net income (loss)                                                 |                                           | $ | 995            |        |         | $ | 1,123    |        |         | $ | (403    | )      |         | $ | 875      |        |         | $ | (642   | )      |  | $ | 1,040  |        |  | $ | 2,037  |        |  | $ | 4,489  |       
|                                                                  |                                           |   |                |        |         |   |          |        |         |   |         |        |         |   |          |        |         |   |        |        |  |   |        |        |  |   |        |        |  |   |        |       

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|                                                                   |                                           |  |                         |      |         |  |          |      |         |  |         |      |         |  |          |      |         |  |       |      |  |  |       |      |  |  |       |      |  |  |       |      | 
|------------------------------------------------------------------ | ----------------------------------------- |  | ----------------------- | ---- | ------- |  | -------- | ---- | ------- |  | ------- | ---- | ------- |  | -------- | ---- | ------- |  | ----- | ---- |  |  | ----- | ---- |  |  | ----- | ---- |  |  | ----- | ---- | 
|                                                                   |                                           |  | Percentage of Net Sales
|                                                                   |                                           |  | Quarters Ended         
|                                                                   |                                           |  |                        
|                                                                   |                                           |  | 1998                    |      | 1999   
|                                                                   |                                           |  |                         |      |        
|                                                                   |                                           |  | Mar. 31                 |      | June 30 |  | Sept. 30 |      | Dec. 31 |  | Mar. 31 |      | June 30 |  | Sept. 30 |      | Dec. 31
|                                                                   |                                           |  |                         |      |         |  |          |      |         |  |         |      |         |  |          |      |        
|Net sales                                                          |                                           |  | 100.0                   | %    |         |  | 100.0    | %    |         |  | 100.0   | %    |         |  | 100.0    | %    |         |  | 100.0 | %    |  |  | 100.0 | %    |  |  | 100.0 | %    |  |  | 100.0 | %   
|                                                                  
|                                                                  
|                                                                  
|                                                                  
|Cost and expenses:                                                
|                                                                  
|                                                                  
|                                                                  
|                                                                  
|                                                                   | Cost of sales                             |  |                         | 74.1 |         |  |          | 75.4 |         |  |         | 90.5 |         |  |          | 78.9 |         |  |       | 87.6 |  |  |       | 79.4 |  |  |       | 79.3 |  |  |       | 76.8 | 
|                                                                  
|                                                                  
|                                                                  
|                                                                  
|                                                                   | Selling, general, and
administrative      |  |                         | 8.8  |         |  |          | 8.0  |         |  |         | 7.0  |         |  |          | 7.4  |         |  |       | 10.6 |  |  |       | 7.9  |  |  |       | 6.4  |  |  |       | 6.9  | 
|                                                                  
|                                                                  
|                                                                  
|                                                                  
|                                                                   | Research, development, and
   engineering |  |                         | 9.1  |         |  |          | 8.4  |         |  |         | 5.1  |         |  |          | 7.9  |         |  |       | 7.9  |  |  |       | 6.4  |  |  |       | 5.7  |  |  |       | 5.0  | 
|                                                                   |                                           |  |                         |      |         |  |          |      |         |  |         |      |         |  |          |      |         |  |       |      |  |  |       |      |  |  |       |      |  |  |       |     
|                                                                   |                                           |  | 92.0                    |      |         |  | 91.8     |      |         |  | 102.6   |      |         |  | 94.2     |      |         |  | 106.1 |      |  |  | 93.7  |      |  |  | 91.4  |      |  |  | 88.7  |     
|                                                                  
|                                                                  
|                                                                  
|                                                                  
|Operating income (loss)                                            |                                           |  | 8.0                     |      |         |  | 8.2      |      |         |  | (2.6    | )    |         |  | 5.8      |      |         |  | (6.1  | )    |  |  | 6.3   |      |  |  | 8.6   |      |  |  | 11.3  |     
|                                                                  
|                                                                  
|                                                                  
|                                                                  
|Other income (expense), net                                        |                                           |  | 1.0                     |      |         |  | 0.6      |      |         |  | (0.2    | )    |         |  | (1.0     | )    |         |  | (0.9  | )    |  |  | (0.7  | )    |  |  | (0.4  | )    |  |  | 1.1   |     
|                                                                   |                                           |  |                         |      |         |  |          |      |         |  |         |      |         |  |          |      |         |  |       |      |  |  |       |      |  |  |       |      |  |  |       |     
|Income (loss) before
provision for

   (benefit
from) income taxes |                                           |  | 9.0                     |      |         |  | 8.8      |      |         |  | (2.8    | )    |         |  | 4.8      |      |         |  | (7.0  | )    |  |  | 5.6   |      |  |  | 8.2   |      |  |  | 12.4  |     
|                                                                  
|                                                                  
|                                                                  
|                                                                  
|Provision for (benefit
from) income
   taxes                       |                                           |  | 3.6                     |      |         |  | 3.8      |      |         |  | (1.2    | )    |         |  | 1.8      |      |         |  | (4.2  | )    |  |  | 2.3   |      |  |  | 3.4   |      |  |  | 3.4   |     
|                                                                   |                                           |  |                         |      |         |  |          |      |         |  |         |      |         |  |          |      |         |  |       |      |  |  |       |      |  |  |       |      |  |  |       |     
|Net income (loss)                                                  |                                           |  | 5.4                     | %    |         |  | 5.0      | %    |         |  | (1.6    | )%   |         |  | 3.0      | %    |         |  | (2.8  | )%   |  |  | 3.3   | %    |  |  | 4.8   | %    |  |  | 9.0   | %   
|                                                                   |                                           |  |                         |      |         |  |          |      |         |  |         |      |         |  |          |      |         |  |       |      |  |  |       |      |  |  |       |      |  |  |       |     

Historically, we have experienced seasonal fluctuations in our net sales.
OEM customers that purchase our products for incorporation into retail
products, such as mobile handsets, typically increase their purchases during
the year-end holiday period and phase out old programs early in the year
following holiday sales. As a result, net sales typically peak in the fourth
quarter and reach a seasonal low point in the first quarter.

There is significant pricing pressure in higher volume programs in the
wireless communications and office automation industries. In addition,
high-volume programs that generally have lower gross margins began to represent
a larger percentage of net sales in the second half of 1998, thereby reducing
gross margin. In the third quarter of 1998, we also started several new
programs and incurred substantial start-up costs on those new programs. In
addition, excess inventory purchases occurred in the second quarter of 1998,
slowing purchases in the third quarter of 1998 and greatly reducing material
overhead absorption in that quarter. In the first quarter of 1999, we had an
unfavorable product mix, shipping principally lower margin products. In
addition, reduced manufacturing yields and under-absorption of fixed overhead
contributed to lower margins. In the second half of 1999, higher volumes in
our manufacturing facilities produced increased operating efficiencies,
resulting in better margins.

We started new manufacturing operations in Beijing in 1998 in a temporary
manufacturing facility. Our gross margins in the second and third quarters of
1998 were adversely affected by start-up costs associated with these
operations, which were incurred in advance of the receipt of significant sales.
We moved into our permanent facility in the third quarter of 1999 and, as a
result, operating efficiencies increased in China in the fourth quarter of
1999.

In 1999, we continued to expand and intensify our research and development
efforts on proprietary display products, such as LCoSmicrodisplays. Other
expense increased in the last half of 1998 and the first half of 1999 as our
cash balances declined and we increased our borrowings. All borrowings were
paid off and cash balances increased as a result of our equity offering in the
third quarter of 1999. As a result, we had sharply higher interest income in
the fourth quarter of 1999.

Liquidity and Capital Resources

At December 31, 1999, we had cash and cash equivalents of $45.4 million
compared to cash and cash equivalents of $4.9 million at December 31, 1998.

In 1999, we had $18.4 million in net cash flow from operations compared to
nearly flat net cash flow from operations during 1998. Cash flow from
operations improved during 1999 primarily as a result of increased net income
and depreciation expense. Our depreciation expense was $5.9 million for 1999
as compared with $4.7

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million for 1998. This increase relates to increased
starts on our LCD line and increased capital equipment as a result of our China
operations. The high-volume LCD line is depreciated on a units of production
method based on units started. The increased operational cash flow in 1999 was
also the result of inventory turns increasing from 7.3 to 9.5 in 1999 and
account receivable DSOs (Day Sales Outstanding) decreasing throughout the year,
ending at 52 days on December 31, 1999.

Our working capital was $60.9 million at December 31, 1999, up from $24.8
million at December 31, 1998. Our current ratio at December 31, 1999 was
3.8-to-1 compared to 2.5-to-1 at December 31, 1998. The increase in our
working capital and current ratio occurred primarily because of our equity
offering in the third quarter of 1999, in which we sold 3.1 million shares of
common stock for approximately $45.0 million, and because of our strong
operating cash flow in the fourth quarter of 1999. Including our cash, cash
equivalents, and available credit facilities, we had approximately $70.7
million in readily available funds at December 31, 1999 compared to $22.2
million at December 31, 1998.

In November 1998, we entered into a $25.0 million secured credit facility
with Imperial Bank and the National Bank of Canada. The credit facility
consisted of a $15.0 million revolving line of credit, which was available for
general corporate purposes, and a $10.0 million term loan facility, which
provided available funds to repurchase our common stock. At December 31, 1999,
no borrowings were outstanding under that credit facility as a result of our
repayment of all outstanding amounts. In January 2000, we entered into a new
credit facility with Imperial Bank to replace the 1998 credit facility. The
new credit facility is a $25.0 million unsecured revolving line of credit that
matures in January 2001. Mellon Bank is a participating lender on that new
credit facility. No borrowings are outstanding under that new credit facility.
Advances under the new facility may be made as prime rate advances, which
accrue interest payable monthly at the banks prime lending rate, or as LIBOR
rate advances, which bear interest at 150 basis points in excess of the LIBOR
base rate. Our Three-Five Systems Limited subsidiary has established an
annually renewable credit facility with a United Kingdom bank in order to fund
its working capital requirements. The credit facility, which expires July 15,
2000, provides $350,000 of borrowing capacity secured by accounts receivable of
Three-Five Systems Limited. No borrowings are outstanding under this facility.

Capital expenditures during 1999 were approximately $12.5 million. These
capital expenditures consisted of $5.6 million for equipment and construction
costs relating to our manufacturing facility in Beijing; $1.8 million for
manufacturing and office equipment for our operations in Manila and Arizona;
and $5.1 million for LCoSmicrodisplays, including our purchase of assets and
licenses from National Semiconductor and S-Vision. The assets and licensed
silicon technologies from National Semiconductor relating to LCoSmicrodisplays
were acquired for approximately $3.0 million in cash and warrants to purchase
93,333 shares of our common stock. Substantially all of the purchase price was
allocated to depreciable assets, tooling and mask rights, and amortizable
licenses.

Capital expenditures during 1998 were approximately $8.1 million. These
capital expenditures consisted primarily of manufacturing and office equipment
for our operations in Manila and Arizona and laboratory equipment for research
and development. In addition, we spent $5.3 million for equipment and
construction in 1998 related to our Beijing operations. In 1998 and 1999, we
cumulatively expended approximately $10.9 million in Beijing for manufacturing,
equipment, building construction, and land costs.

We believe that our existing balances of cash and cash equivalents,
anticipated cash flows from operations and available and anticipated credit
lines will provide adequate sources to fund our
operations and planned expenditures through 2000. We may have to expand
our loan commitments or pursue alternate methods of financing or raise capital,
however, should we encounter additional cash requirements. For example,
accounts receivable and inventory could rise faster than anticipated if revenue
levels increase more than currently anticipated. In addition, we will continue
to seek other alliances or acquisitions and additional relationships with
regard to the strategic development of various new technologies, especially
LCoSmicrodisplays, that may also require us to make additional capital
investments. We cannot provide assurance that adequate additional loan
commitments or alternative methods of financing will be available or, if
available, that they will be on terms acceptable to us.

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Effects of Inflation and Foreign Currency Exchange Fluctuations

The results of our operations for the periods discussed have not been
significantly affected by inflation or foreign currency fluctuations. We
generally sell our products and services and negotiate purchase orders with our
foreign suppliers in U.S. dollars. However, we have certain foreign currency
exchange exposure as a result of our manufacturing operations in the
Philippines and China. The sub-assembly agreement relating to our operations
in Manila is based on a fixed conversion rate, exposing us to exchange rate
fluctuations with the Philippine peso. We have not incurred any material
exchange gains or losses to date. There has been some minor benefit as a
result of the peso devaluation, although we are now required to pay
approximately one-third of any peso devaluation gain to our lessor and direct
labor subcontractor in Manila.

In China, we have accounts receivable and cash deposits in the local
currency. Although the Chinese currency currently is stable, its value in
relation to the U.S. dollar is determined by the Chinese government. There has
been general speculation since late 1998 that China may devalue its currency.
Devaluation of the Chinese currency could result in translation adjustments to
our balance sheet as well as reportable losses depending on our monetary
balances and outstanding indebtedness at the time of devaluation. The
government of China historically has made it difficult to convert its local
currency into foreign currencies. Although from time to time we may enter into
hedging transactions in order to minimize our exposure to currency rate
fluctuations, the Chinese currency is not freely traded and thus is difficult
to hedge. In addition, the government of China has recently imposed
restrictions on Chinese currency loans to foreign-operated entities in China.
Based on the foregoing, we cannot provide assurance that fluctuations and
currency exchange rates in the future will not have an adverse effect on our
business.

Year 2000 Compliance

We are heavily dependent upon complex computer software and systems for
our operations. Many existing computer programs and systems use only two
digits to identify a year in the date field. These programs and systems were
designed and developed without considering the impact of the recent change in
the century.

We created a multi-functional Year 2000 task force to resolve any
non-compliant Year 2000 systems or processes. This task force completed the
upgrading of computer software and hardware manufacturing equipment during
1999. As of the date of this Report, we have not experienced any material
disruption to our operations as a result of any failure of any of our systems
to function properly as of January 1, 2000. We also have not experienced any
Year 2000 failures related to any of our significant vendors or suppliers.

Year 2000 compliance has many elements and potential consequences, some of
which may not be foreseeable or may be realized in future periods. In
addition, unforeseen circumstances may arise, and we may not in the future
identify equipment or systems that are not Year 2000 compliant.







ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Derivative Financial Instruments, Other Financial Instruments, and Derivative Commodity Instruments

At December 31, 1999, we did not participate in any derivative financial
instruments, or other financial and commodity instruments for which fair value
disclosure would be required under Statement of Financial Accounting Standards
No. 107. We hold no investment securities that would require disclosure of
market risk.

Primary Market Risk Exposures

Our primary market risk exposures are in the areas of interest rate risk
and foreign currency exchange rate risk. In 1999, we incurred interest on
loans made under a revolving line of credit at interest rates under a variable
interest rate of LIBOR (6.13% at December 31, 1999) plus 237.5 basis points.
At December 31, 1999, no borrowings were outstanding under this line of credit.
In January 2000 we replaced the line of credit with a new unsecured credit
facility with an interest rate of LIBOR plus 150 basis points. Although most of
our business outside the United States is conducted in U.S. dollar denominated
transactions, certain sales in China are in

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renminbi. In addition, we operate
high-volume manufacturing facilities in Manila, the Philippines and Beijing,
China, and a sales and distribution facility in the United Kingdom. Some of
the expenses of these foreign operations are denominated in the Philippine
peso, Chinese renminbi, and British pound sterling, respectively. These
expenses include local salaries and wages, utilities, and some operating
supplies. As a result of these sales and expenses, we do have accounts
receivable and cash deposits in local currencies. We believe, however, that the
operating expenses currently incurred in foreign currencies other than the
Chinese renminbi are immaterial, and therefore any associated market risk is
unlikely to have a material adverse effect on our business, results of
operations, or financial condition. Although the Chinese currency currently is
stable, its value in relation to the U.S. dollar is determined by the Chinese
government. There is general speculation that China may devalue its currency.
Devaluation of the Chinese currency could result in translation adjustments to
our balance sheet as well as reportable losses depending on our monetary
balances and outstanding indebtedness at the time of devaluation. The
government of China historically has made it difficult to convert its local
currency into foreign currencies. Although we from time to time may enter into
hedging transactions in order to minimize our exposure to currency rate
fluctuations, the Chinese currency is not freely traded and thus is difficult
to hedge. In addition, the government of China has recently imposed
restrictions on Chinese currency loans to foreign-operated entities in China.
Based on the foregoing, we cannot provide assurance that fluctuations and
currency exchange rates in the future will not have an adverse effect on our
operations.







ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

Reference is made to the financial statements, the report thereon, the
notes thereto, and the supplementary data commencing at page F-1 of this
Report, which financial statements, report, notes, and data are incorporated
herein by reference.







ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
                FINANCIAL DISCLOSURE

Not applicable.







PART III







ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS

The information required by this Item relating to our directors is
incorporated by reference to the definitive Proxy Statement to be filed
pursuant to Regulation 14A of the Exchange Act for our
2000 Annual Meeting of Stockholders. The information required by this
Item relating to our executive officers is included in Item 1, Business -
Executive Officers of this Report.







ITEM 11. EXECUTIVE COMPENSATION

The information required by this Item is incorporated herein by reference
to the definitive Proxy Statement to be filed pursuant to Regulation 14A of the
Exchange Act for our 2000 Annual Meeting of Stockholders.







ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

The information required by this Item is incorporated herein by reference
to the definitive Proxy Statement to be filed pursuant to Regulation 14A of the
Exchange Act for our 2000 Annual Meeting of Stockholders.







ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

Not applicable.

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##### Table of Contents









PART IV







ITEM 14. EXHIBITS AND REPORTS ON FORM 8-K

(a) Financial Statements and Financial Statement Schedule



| |                                                                                                     
| | ----------------------------------------------------------------------------------------------------
| | (1) Financial Statements are listed in the Index to Financial
Statements on page F-1 of this Report.
|
| | (2) Financial Statement Schedule:                                                                   

Schedule II Valuation and Qualifying Accounts and Reserves is set forth on
page S-1 of this Report.

Other schedules are omitted because they are not applicable, not required,
or because required information is included in the consolidated financial
statements or notes thereto.

(b) Reports on Form 8-K

Not applicable.

(c) Exhibits

|        |  |                                                                                                                                                                      
|------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit
|Number  |  | Exhibits                                                                                                                                                             
|        |  |                                                                                                                                                                      
|2       |  | Amended and Restated Agreement and Plan or Reorganization(1)                                                                                                         
|       
|       
|       
|       
|3(a)    |  | Restated Certificate of Incorporation of the Company(2)                                                                                                              
|       
|       
|       
|       
|3(b)    |  | Amended and Restated Bylaws of the Company(3)                                                                                                                        
|       
|       
|       
|       
|4       |  | Form of Certificate of Common Stock(3)                                                                                                                               
|       
|       
|       
|       
|10(a)   |  | 1990 Incentive Stock Option Plan(1)                                                                                                                                  
|       
|       
|       
|       
|10(c)   |  | Line of Credit Agreement between Three-Five Systems Limited and Barclays Bank, PLC(1)                                                                                
|       
|       
|       
|       
|10(d)   |  | Sub-Assembly Agreement between Three-Five Systems, Inc. and TEAM Pacific Corporation
dated February 22, 1995(4)                                                      
|       
|       
|       
|       
|10(g)   |  | Form of Three-Five Systems, Inc. Distributor Franchise Agreement(5)                                                                                                  
|       
|       
|       
|       
|10(j)   |  | 1993 Stock Option Plan(5)                                                                                                                                            
|       
|       
|       
|       
|10(k)   |  | 1994 Automatic Stock Option Plan(6)                                                                                                                                  
|       
|       
|       
|       
|10(l)   |  | Lease Agreement between Technology Electronic Assembly and Management (T.E.A.M.)
Pacific Corporation and Three-Five Systems Pacific, Inc.(7)                         
|       
|       
|       
|       
|10(m)   |  | Lease Agreement between Regent Apparel Corporation and Three-Five Systems Pacific,
Inc.(7)                                                                           
|       
|       
|       
|       
|10(o)   |  | Lease dated April 1, 1994, between Papago Park Center, Inc. and Three-Five Systems,
Inc.(8)                                                                          
|       
|       
|       
|       
|10(t)   |  | Credit Agreement dated May 23, 1997 between Three-Five Systems, Inc. and Imperial
Bank(9)                                                                            
|       
|       
|       
|       
|10(u)   |  | Addendum No. 1 to Sub-Assembly Agreement between Three-Five Systems, Inc. and TEAM
Pacific Corporation dated March 12, 1997(9)                                       
|       
|       
|       
|       
|10(v)   |  | 1997 Employee Stock Option Agreement(9)                                                                                                                              
|       
|       
|       
|       
|10(w)   |  | Amended and Restated Three-Five Systems, Inc. 1998 Stock Option Plan, amended as of
January 28, 1999, as approved by the Companys stockholders on April 22, 1999(10)
|       
|       
|       
|       
|10(x)   |  | 1998 Directors Stock Plan(9)                                                                                                                                        
|       
|       
|       
|       
|10(y)   |  | Addendum No. 2 to Sub-Assembly Agreement between Three-Five Systems, Inc. and TEAM
Pacific Corporation dated January 1, 1998(9)                                      
|       
|       
|       
|       
|10(z)   |  | 401(k) Profit Sharing Plan(11)                                                                                                                                       
|       
|       
|       
|       
|10(aa)  |  | Credit Agreement dated November 5, 1998, by and among Three-Five Systems, Inc., its
subsidiaries, the Banks named therein, and Imperial Bank Arizona, as Agent.(12)  
|       
|       
|       
|       
|10(bb)  |  | Security Agreement dated November 5, 1998, by Three-Five Systems, Inc. in favor of
Imperial Bank Arizona, as Agent.(12)                                              
|       
|       
|       
|       
|21      |  | List of Subsidiaries(3)                                                                                                                                              
|       
|       
|       
|       
|23      |  | Consent of Arthur Andersen LLP                                                                                                                                       
|       
|       
|       
|       
|27      |  | Financial Data Schedule                                                                                                                                              

36



---



##### Table of Contents





|(1)  |  | Incorporated by reference to the Registration Statement on Form S-4 of TF
Consolidation, Inc. (Registration No. 33-33944) as filed March 27, 1990
and declared effective March 27, 1990.                                       
|---- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|    
|(2)  |  | Incorporated by reference to the Registrants Form 10-QSB for the quarter
ended March 31, 1994, as filed with the Commission on or about May 12,
1994.                                                                         
|    
|(3)  |  | Incorporated by reference to the Registration Statement on Form S-3
(Registration No. 333-84083) as filed on July 30, 1999, as amended by Form
S-3/A filed on August 26, 1999, and declared effective September 27, 1999.      
|    
|(4)  |  | Incorporated by reference to the Registrants Form 10-KSB for the fiscal
year ended December 31, 1994 filed with the Commission on March 22, 1995,
as amended by Form 10-KSB/A as filed with the Commission on April 28,
1995. 
|    
|(5)  |  | Incorporated by reference to the Registration Statement on Form S-1
(Registration No. 33-74788) as filed on February 3, 1994, and declared
effective March 15, 1994.                                                           
|    
|(6)  |  | Incorporated by reference to the Registration Statement on Form S-8
(Registration No. 33-88706) as filed on January 24, 1995.                                                                                                  
|    
|(7)  |  | Incorporated by reference to the Registrants Form 10-K for the fiscal
year ended December 31, 1995, as filed with the Commission on March 13,
1996.                                                                           
|    
|(8)  |  | Incorporated by reference to the Registrants Form 10-K for the fiscal
year ended December 31, 1996, as filed with the Commission on March 14,
1997.                                                                           
|    
|(9)  |  | Incorporated by reference to the Registrants Form 10-K for the fiscal
year ended December 31, 1997, as filed with the Commission on March 13,
1998, and as amended by Form 10-K/A filed with the Commission on March 23,
1998.
|    
|(10) |  | Incorporated by reference to the Registration Statement on Form S-8
(Registration No. 333-87875) as filed on September 27, 1999.                                                                                               
|    
|(11) |  | Incorporated by reference to the Registration Statement on Form S-8
(Registration No. 333-57933) as filed on June 26, 1998.                                                                                                    
|    
|(12) |  | Incorporated by reference to the Registrants Form 10-K for the fiscal
year ended December 31, 1998, as filed with the Commission on March 15,
1999.                                                                           

37



---



##### Table of Contents









SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registration has duly caused this report to be signed
on its behalf by the undersigned, thereunto duly authorized.

|                       |  |  |  |  |  |                                                                              
|---------------------- |  |  |  |  |  | -----------------------------------------------------------------------------
|                       |  |  |  |  |  | THREE-FIVE SYSTEMS, INC.                                                     
|                      
|Date:   March 13, 2000 |  |  |  |  |  | By: /s/ Jack L. Saltich
Jack L. Saltich
President and Chief Executive Officer

Pursuant to the requirements of the Securities Exchange Act of 1934, this
Report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.

|                                            |  |                                                                                                                                                          |  |               
|------------------------------------------- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------- |  | --------------
|Name                                        |  | Title                                                                                                                                                    |  | Date          
|                                            |  |                                                                                                                                                          |  |               
|/s/ Jack L. Saltich
Jack L. Saltich         |  | President, Chief Executive Officer
(Principal Executive Officer), and Director                                                                           |  | March 13, 2000
|                                           
|/s/ Jeffrey D. Buchanan
Jeffrey D. Buchanan |  | Executive Vice President - Finance,
Administration, and Legal; Chief Financial
Officer; Secretary; Treasurer (Principal
Financial Officer), and Director |  | March 13, 2000
|                                           
|/s/ Robert T. Berube
Robert T. Berube       |  | Corporate Controller (Principal Accounting
Officer)                                                                                                      |  | March 13, 2000
|                                           
|/s/ David C. Malmberg
David C. Malmberg     |  | Director                                                                                                                                                 |  | March 13, 2000
|                                           
|/s/ Gary R. Long
Gary R. Long               |  | Director                                                                                                                                                 |  | March 13, 2000
|                                           
|/s/ Kenneth M. Julien
Kenneth M. Julien     |  | Director                                                                                                                                                 |  | March 13, 2000
|                                           
|/s/ Thomas A. Werner
Thomas A. Werner       |  | Director                                                                                                                                                 |  | March 13, 2000
|                                           
|/s/ David P. Chavoustie
David P. Chavoustie |  | Director                                                                                                                                                 |  | March 13, 2000

38



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##### Table of Contents



THREE-FIVE SYSTEMS, INC. AND SUBSIDIARIES

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

|                                                                                                                       |  |      |     | 
|---------------------------------------------------------------------------------------------------------------------- |  | ---- | --- | 
|                                                                                                                       |  | Page
|                                                                                                                       |  |     
|Report of Independent Public Accountants                                                                               |  |      | F-2 | 
|                                                                                                                      
|Consolidated Balance Sheets as of
December 31, 1998 and 1999                                                           |  |      | F-3 | 
|                                                                                                                      
|                                                                                                                      
|                                                                                                                      
|                                                                                                                      
|                                                                                                                      
|Consolidated Statements of Income for the years ended
December 31, 1997,     1998, and 1999.                           |  |      | F-4 | 
|                                                                                                                      
|Consolidated Statements of Stockholders Equity for the
years ended     December 31, 1997, 1998, and 1999.             |  |      | F-5 | 
|                                                                                                                      
|Consolidated Statements of Cash Flows for the years ended
December 31,     1997, 1998, and 1999.                       |  |      | F-6 | 
|                                                                                                                      
|Notes to Consolidated Financial Statements                                                                             |  |      | F-7 | 
|                                                                                                                      
|Report of Independent Public Accountants                                                                               |  |      | S-1 | 
|                                                                                                                      
|Schedule II  Valuation and Qualifying Accounts and Reserves
for the years     ended December 31, 1997, 1998 and 1999. |  |      | S-2 | 

F-1



---



##### Table of Contents









REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS

To Three-Five Systems, Inc.:

We have audited the accompanying consolidated balance sheets of THREE-FIVE
SYSTEMS, INC. (a Delaware corporation) and subsidiaries (the Company) as of
December 31, 1998 and 1999, and the related consolidated statements of income,
stockholders equity and cash flows for each of the three years in the period
ended December 31, 1999. These financial statements are the responsibility of
the Companys management. Our responsibility is to express an opinion on these
financial statements based on our audits.

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

In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of the Company as of December
31, 1998 and 1999, and the results of its operations and its cash flows for
each of the three years in the period ended December 31, 1999, in conformity
with accounting principles generally accepted in the United States.



| | /S/ ARTHUR ANDERSEN LLP
| | -----------------------

Phoenix, Arizona,
  January 21, 2000.

F-2



---



##### Table of Contents



THREE-FIVE SYSTEMS, INC. AND SUBSIDIARIES







CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)

|                                                    |                                                                                                                                                                                                                                |                            |        |        |              |        |        |        |         |         | 
|--------------------------------------------------- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ | -------------------------- | ------ | ------ | ------------ | ------ | ------ | ------ | ------- | ------- | 
|                                                    |                                                                                                                                                                                                                                |                            |        |        | December 31,
|                                                    |                                                                                                                                                                                                                                |                            |        |        |             
|                                                    |                                                                                                                                                                                                                                |                            |        |        | 1998         |        | 1999  
|                                                    |                                                                                                                                                                                                                                |                            |        |        |              |        |       
|ASSETS                                             
|                                                   
|                                                   
|                                                   
|                                                   
|Current Assets:                                    
|                                                   
|                                                   
|                                                   
|                                                   
|                                                    | Cash and cash equivalents                                                                                                                                                                                                      |                            | $      | 4,946  |              |        | $      | 45,363 |        
|                                                   
|                                                   
|                                                   
|                                                   
|                                                    | Accounts receivable, net                                                                                                                                                                                                       |                            |        | 18,601 |              |        |        | 20,886 |        
|                                                   
|                                                   
|                                                   
|                                                   
|                                                    | Inventories                                                                                                                                                                                                                    |                            |        | 12,493 |              |        |        | 12,344 |        
|                                                   
|                                                   
|                                                   
|                                                   
|                                                    | Deferred tax asset                                                                                                                                                                                                             |                            |        | 2,680  |              |        |        | 3,231  |        
|                                                   
|                                                   
|                                                   
|                                                   
|                                                    | Other current assets                                                                                                                                                                                                           |                            |        | 2,313  |              |        |        | 1,047  |        
|                                                    |                                                                                                                                                                                                                                |                            |        |        |              |        |        |        |        
|                                                    |                                                                                                                                                                                                                                | Total current assets       |        |        | 41,033       |        |        |        | 82,871  |        
|                                                   
|                                                   
|                                                   
|                                                   
|Property, Plant and Equipment, net                  |                                                                                                                                                                                                                                |                            | 33,314 |        |              |        | 40,546 |       
|                                                   
|                                                   
|                                                   
|                                                   
|Other Assets, net                                   |                                                                                                                                                                                                                                |                            | 3,557  |        |              |        | 3,513  |       
|                                                    |                                                                                                                                                                                                                                |                            |        |        |              |        |        |        |        
|                                                    |                                                                                                                                                                                                                                |                            |        |        | $            | 77,904 |        |        | $       | 126,930 | 
|                                                    |                                                                                                                                                                                                                                |                            |        |        |              |        |        |        |        
|LIABILITIES AND STOCKHOLDERS EQUITY               
|                                                   
|                                                   
|                                                   
|                                                   
|Current Liabilities:                               
|                                                   
|                                                   
|                                                   
|                                                   
|                                                    | Accounts payable                                                                                                                                                                                                               |                            | $      | 10,649 |              |        | $      | 13,450 |        
|                                                   
|                                                   
|                                                   
|                                                   
|                                                    | Accrued liabilities                                                                                                                                                                                                            |                            |        | 4,673  |              |        |        | 7,526  |        
|                                                   
|                                                   
|                                                   
|                                                   
|                                                    | Current taxes payable                                                                                                                                                                                                          |                            |        | 235    |              |        |        | 1,042  |        
|                                                   
|                                                   
|                                                   
|                                                   
|                                                    | Current portion of long-term debt                                                                                                                                                                                              |                            |        | 651    |              |        |        |       |        
|                                                    |                                                                                                                                                                                                                                |                            |        |        |              |        |        |        |        
|                                                    |                                                                                                                                                                                                                                | Total current liabilities  |        |        | 16,208       |        |        |        | 22,018  |        
|                                                    |                                                                                                                                                                                                                                |                            |        |        |              |        |        |        |        
|Long-term Debt                                      |                                                                                                                                                                                                                                |                            | 7,444  |        |              |        |       |       
|                                                    |                                                                                                                                                                                                                                |                            |        |        |              |        |        |        |        
|Deferred Tax Liability                              |                                                                                                                                                                                                                                |                            | 3,156  |        |              |        | 3,692  |       
|                                                    |                                                                                                                                                                                                                                |                            |        |        |              |        |        |        |         |         | 
|Commitments and
Contingencies
Stockholders Equity:
|                                                   
|                                                   
|                                                   
|                                                   
|                                                    | Preferred stock, $.01 par value; 1,000,000 shares
authorized, no     shares issued or outstanding                                                                                                                              |                            |        |       |              |        |        |       |        
|                                                   
|                                                   
|                                                   
|                                                   
|                                                    | Common stock, $.01 par value; 15,000,000 shares
authorized,
  10,633,201 shares issued, 9,340,143
shares outstanding at 
  December 31, 1998;
12,572,758 shares issued, 12,572,365 
  shares outstanding at December 31, 1999. |                            |        | 106    |              |        |        | 126    |        
|                                                   
|                                                   
|                                                   
|                                                   
|                                                    | Additional paid-in capital                                                                                                                                                                                                     |                            |        | 32,484 |              |        |        | 67,388 |        
|                                                   
|                                                   
|                                                   
|                                                   
|                                                    | Retained earnings                                                                                                                                                                                                              |                            |        | 26,823 |              |        |        | 33,702 |        
|                                                   
|                                                   
|                                                   
|                                                   
|                                                    | Cumulative translation adjustment                                                                                                                                                                                              |                            |        | 8      |              |        |        | 7      |        
|                                                   
|                                                   
|                                                   
|                                                   
|                                                    | Less  Treasury stock, at cost, (1,293,058) shares
at     December 31, 1998 and (393) shares at December
31, 1999.                                                                                                             |                            |        | (8,325 | )            |        |        | (3     | )      
|                                                    |                                                                                                                                                                                                                                |                            |        |        |              |        |        |        |         |         | 
|                                                    |                                                                                                                                                                                                                                | Total stockholders equity |        |        | 51,096       |        |        |        | 101,220 |        
|                                                    |                                                                                                                                                                                                                                |                            |        |        |              |        |        |        |         |         | 
|                                                    |                                                                                                                                                                                                                                |                            |        |        | $            | 77,904 |        |        | $       | 126,930 | 
|                                                    |                                                                                                                                                                                                                                |                            |        |        |              |        |        |        |        

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

F-3



---



##### Table of Contents



THREE-FIVE SYSTEMS, INC. AND SUBSIDIARIES







CONSOLIDATED STATEMENTS OF INCOME
(in thousands, except share and per share data)

|                                          |                                       |   |        |            |                          |   |        |            |        |   |         |            |         |   | 
|----------------------------------------- | ------------------------------------- | - | ------ | ---------- | ------------------------ | - | ------ | ---------- | ------ | - | ------- | ---------- | ------- | - | 
|                                          |                                       |   |        |            | Years Ended December 31,
|                                          |                                       |   |        |            |                         
|                                          |                                       |   |        |            | 1997                     |   | 1998   |            | 1999  
|                                          |                                       |   |        |            |                          |   |        |            |       
|Net Sales                                 |                                       | $ | 84,642 |            |                          | $ | 95,047 |            |        | $ | 147,408 |           
|                                          |                                       |   |        |            |                          |   |        |            |        |   |         |            |         |  
|                                         
|                                         
|                                         
|                                         
|Costs and Expenses:                      
|                                         
|                                         
|                                         
|                                         
|                                          | Cost of sales                         |   |        | 64,760     |                          |   |        | 76,149     |        |   |         | 117,583    |        
|                                         
|                                         
|                                         
|                                         
|                                          | Selling, general and administrative   |   |        | 6,557      |                          |   |        | 7,334      |        |   |         | 11,170     |        
|                                         
|                                         
|                                         
|                                         
|                                          | Research, development and engineering |   |        | 5,106      |                          |   |        | 7,159      |        |   |         | 8,745      |        
|                                          |                                       |   |        |            |                          |   |        |            |        |   |         |            |         |  
|                                          |                                       |   |        |            | 76,423                   |   |        |            | 90,642 |   |         |            | 137,498 |  
|                                          |                                       |   |        |            |                          |   |        |            |        |   |         |            |         |  
|Operating income                          |                                       |   | 8,219  |            |                          |   | 4,405  |            |        |   | 9,910   |           
|                                          |                                       |   |        |            |                          |   |        |            |        |   |         |            |         |  
|Other Income (Expense):                  
|                                         
|                                         
|                                         
|                                         
|                                          | Interest, net                         |   |        | 548        |                          |   |        | 75         |        |   |         | 51         |        
|                                         
|                                         
|                                         
|                                         
|                                          | Other, net                            |   |        | (190       | )                        |   |        | (117       | )      |   |         | (69        | )      
|                                          |                                       |   |        |            |                          |   |        |            |        |   |         |            |         |  
|                                          |                                       |   |        |            | 358                      |   |        |            | (42    | ) |         |            | (18     | )
|                                          |                                       |   |        |            |                          |   |        |            |        |   |         |            |         |  
|Income before provision for income taxes  |                                       |   | 8,577  |            |                          |   | 4,363  |            |        |   | 9,892   |           
|                                         
|                                         
|                                         
|                                         
|                                          | Provision for income taxes            |   |        | 3,334      |                          |   |        | 1,773      |        |   |         | 2,968      |        
|                                          |                                       |   |        |            |                          |   |        |            |        |   |         |            |         |  
|Net income                                |                                       | $ | 5,243  |            |                          | $ | 2,590  |            |        | $ | 6,924   |           
|                                          |                                       |   |        |            |                          |   |        |            |        |   |         |           
|Earnings Per Common Share:               
|                                         
|                                         
|                                         
|                                         
|                                          | Basic                                 |   | $      | 0.50       |                          |   | $      | 0.25       |        |   | $       | 0.67       |        
|                                          |                                       |   |        |            |                          |   |        |            |        |   |         |           
|                                         
|                                         
|                                         
|                                         
|                                          |                                       |   |       
|                                         
|                                         
|                                         
|                                         
|                                          | Diluted                               |   | $      | 0.49       |                          |   | $      | 0.25       |        |   | $       | 0.65       |        
|                                          |                                       |   |        |            |                          |   |        |            |        |   |         |           
|                                         
|                                         
|                                         
|                                         
|                                          |                                       |   |       
|                                         
|                                         
|                                         
|                                         
|Weighted Average Number of Common Shares:
|                                         
|                                         
|                                         
|                                         
|                                          | Basic                                 |   |        | 10,472,071 |                          |   |        | 10,184,841 |        |   |         | 10,375,414 |        
|                                          |                                       |   |        |            |                          |   |        |            |        |   |         |            |         |  
|                                          | Diluted                               |   |        | 10,786,633 |                          |   |        | 10,402,721 |        |   |         | 10,670,033 |        
|                                          |                                       |   |        |            |                          |   |        |            |        |   |         |            |         |  

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

F-4



---



##### Table of Contents



THREE-FIVE SYSTEMS, INC. AND SUBSIDIARIES







CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY
For the Years Ended December 31, 1997, 1998, and 1999
(in thousands, except share data)

|                                                                 |                      |  |              |   |            |   |         |   |          |   |            |   |             |   |          |   |          |   |         |   |       |   |        |   |  |   |         |   |  |   |       |       | 
|---------------------------------------------------------------- | -------------------- |  | ------------ | - | ---------- | - | ------- | - | -------- | - | ---------- | - | ----------- | - | -------- | - | -------- | - | ------- | - | ----- | - | ------ | - |  | - | ------- | - |  | - | ----- | ----- | 
|                                                                 |                      |  | Common Stock |   |            |   |         |   |          |   |            |   |             |   |          |   |          |   |         |   | Total
|                                                                 |                      |  |              |   | Additional |   |         |   |          |   | Cumulative |   |             |   |          |   | Stock-   |   | Compre-
|                                                                 |                      |  | Shares       |   |            |   |         |   | Paid-in  |   | Retained   |   | Translation |   | Treasury |   | Holders' |   | hensive
|                                                                 |                      |  | Issued       |   | Amount     |   | Capital |   | Earnings |   | Adjustment |   | Stock       |   | Equity   |   | Income  
|                                                                 |                      |  |              |   |            |   |         |   |          |   |            |   |             |   |          |   |         
|Balance,  December 31,    1996                                   |                      |  | 10,373,105   |   |            | $ | 104     |   |          | $ | 32,329     |   |             | $ | 18,990   |   |          | $ | 14      |   |       | $ | (253   | ) |  | $ | 51,184  |  
|                                                                
|                                                                
|                                                                
|                                                                
|Net income                                                       |                      |  |             |   |            |   |        |   |          |   |           |   |             |   | 5,243    |   |          |   |        |   |       |   |       |   |  |   | 5,243   |   |  | $ | 5,243 |      
|                                                                
|                                                                
|                                                                
|                                                                
|Other comprehensive
   income                                   
|                                                                
|                                                                
|                                                                
|                                                                
|Foreign
currency
            translation
            adjustments |                      |  |             |   |            |   |        |   |          |   |           |   |             |   |         |   |          |   | 6       |   |       |   |       |   |  |   | 6       |   |  |   | 6     |      
|                                                                 |                      |  |              |   |            |   |         |   |          |   |            |   |             |   |          |   |          |   |         |   |       |   |        |   |  |   |         |   |  |   |       |      
|                                                                 | Comprehensive income |  |              |  |            |   |         |  |          |   |            |  |             |   |          |  |          |   |         |  |       |   |        |  |  |   |         |  |  |   | $     | 5,249 | 
|                                                                 |                      |  |              |   |            |   |         |   |          |   |            |   |             |   |          |   |          |   |         |   |       |   |        |   |  |   |         |   |  |   |       |      
|Stock options exercised                                          |                      |  | 197,592      |   |            |   | 1       |   |          |   | 50         |   |             |   |         |   |          |   |        |   |       |   |       |   |  |   | 51      |  
|                                                                
|                                                                
|                                                                
|                                                                
|Early disposition of    incentive
stock options                  |                      |  |             |   |            |   |        |   |          |   | 41         |   |             |   |         |   |          |   |        |   |       |   |       |   |  |   | 41      |  
|                                                                 |                      |  |              |   |            |   |         |   |          |   |            |   |             |   |          |   |          |   |         |   |       |   |        |   |  |   |         |   |  |   |       |      
|Balance, December 31,    1997.                                   |                      |  | 10,570,697   |   |            |   | 105     |   |          |   | 32,420     |   |             |   | 24,233   |   |          |   | 20      |   |       |   | (253   | ) |  |   | 56,525  |  
|                                                                
|                                                                
|                                                                
|                                                                
|Net income                                                       |                      |  |             |   |            |   |        |   |          |   |           |   |             |   | 2,590    |   |          |   |        |   |       |   |       |   |  |   | 2,590   |   |  | $ | 2,590 |      
|                                                                
|                                                                
|                                                                
|                                                                
|Other comprehensive    income                                   
|                                                                
|                                                                
|                                                                
|                                                                
|Foreign
currency
            translation
            adjustments |                      |  |             |   |            |   |        |   |          |   |           |   |             |   |         |   |          |   | (12     | ) |       |   |       |   |  |   | (12     | ) |  |   | (12   | )    
|                                                                 |                      |  |              |   |            |   |         |   |          |   |            |   |             |   |          |   |          |   |         |   |       |   |        |   |  |   |         |   |  |   |       |      
|                                                                 | Comprehensive income |  |              |  |            |   |         |  |          |   |            |  |             |   |          |  |          |   |         |  |       |   |        |  |  |   |         |  |  |   | $     | 2,578 | 
|                                                                 |                      |  |              |   |            |   |         |   |          |   |            |   |             |   |          |   |          |   |         |   |       |   |        |   |  |   |         |   |  |   |       |      
|Stock options exercised                                          |                      |  | 62,504       |   |            |   | 1       |   |          |   | 64         |   |             |   |         |   |          |   |        |   |       |   |       |   |  |   | 65      |  
|                                                                
|                                                                
|                                                                
|                                                                
|Purchase of treasury stock                                       |                      |  |             |   |            |   |        |   |          |   |           |   |             |   |         |   |          |   |        |   |       |   | (8,072 | ) |  |   | (8,072  | )
|                                                                 |                      |  |              |   |            |   |         |   |          |   |            |   |             |   |          |   |          |   |         |   |       |   |        |   |  |   |         |   |  |   |       |      
|Balance, December 31,    1998.                                   |                      |  | 10,633,201   |   |            |   | 106     |   |          |   | 32,484     |   |             |   | 26,823   |   |          |   | 8       |   |       |   | (8,325 | ) |  |   | 51,096  |  
|                                                                
|                                                                
|                                                                
|                                                                
|Net income                                                       |                      |  |             |   |            |   |        |   |          |   |           |   |             |   | 6,924    |   |          |   |        |   |       |   |       |   |  |   | 6,924   |   |  | $ | 6,924 |      
|                                                                
|                                                                
|                                                                
|                                                                
|Other comprehensive    income                                   
|                                                                
|                                                                
|                                                                
|                                                                
|Foreign
currency
            translation
            adjustments |                      |  |             |   |            |   |        |   |          |   |           |   |             |   |         |   |          |   | (1      | ) |       |   |       |   |  |   | (1      | ) |  |   | (1    | )    
|                                                                 |                      |  |              |   |            |   |         |   |          |   |            |   |             |   |          |   |          |   |         |   |       |   |        |   |  |   |         |   |  |   |       |      
|                                                                 | Comprehensive income |  |              |  |            |   |         |  |          |   |            |  |             |   |          |  |          |   |         |  |       |   |        |  |  |   |         |  |  |   | $     | 6,923 | 
|                                                                 |                      |  |              |   |            |   |         |   |          |   |            |   |             |   |          |   |          |   |         |   |       |   |        |   |  |   |         |   |  |   |       |      
|Stock options exercised                                          |                      |  | 100,433      |   |            |   | 1       |   |          |   | 184        |   |             |   |         |   |          |   |        |   |       |   | 41     |   |  |   | 226     |  
|                                                                
|                                                                
|                                                                
|                                                                
|Warrants issued                                                  |                      |  |             |   |            |   |        |   |          |   | 555        |   |             |   |         |   |          |   |        |   |       |   |       |   |  |   | 555     |  
|                                                                
|                                                                
|                                                                
|                                                                
|Early disposition of    incentive
stock options                  |                      |  |             |   |            |   |        |   |          |   | 30         |   |             |   |         |   |          |   |        |   |       |   |       |   |  |   | 30      |  
|                                                                
|                                                                
|                                                                
|                                                                
|Sale of common stock, net    of
offering expenses of    $3,007.  |                      |  | 1,839,124    |   |            |   | 19      |   |          |   | 34,135     |   |             |   | (45      | ) |          |   |        |   |       |   | 8,281  |   |  |   | 42,390  |  
|                                                                 |                      |  |              |   |            |   |         |   |          |   |            |   |             |   |          |   |          |   |         |   |       |   |        |   |  |   |         |   |  |   |       |      
|Balance, December 31,    1999.                                   |                      |  | 12,572,758   |   |            | $ | 126     |   |          | $ | 67,388     |   |             | $ | 33,702   |   |          | $ | 7       |   |       | $ | (3     | ) |  | $ | 101,220 |  
|                                                                 |                      |  |              |   |            |   |         |   |          |   |            |   |             |   |          |   |          |   |         |   |       |   |        |   |  |   |         |   |  |   |       |      

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

F-5



---



##### Table of Contents



THREE-FIVE SYSTEMS, INC. AND SUBSIDIARIES







CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)

|                                                                                           |                                                                     |                                                              |                                                     |       |              |        |         |       |        |         |         |       |        |         |  
|------------------------------------------------------------------------------------------ | ------------------------------------------------------------------- | ------------------------------------------------------------ | --------------------------------------------------- | ----- | ------------ | ------ | ------- | ----- | ------ | ------- | ------- | ----- | ------ | ------- | -
|                                                                                           |                                                                     |                                                              |                                                     |       | Years Ended 
|                                                                                           |                                                                     |                                                              |                                                     |       | December 31,
|                                                                                           |                                                                     |                                                              |                                                     |       |             
|                                                                                           |                                                                     |                                                              |                                                     |       | 1997         |        | 1998    |       | 1999  
|                                                                                           |                                                                     |                                                              |                                                     |       |              |        |         |       |       
|CASH FLOWS FROM OPERATING ACTIVITIES:                                                     
|                                                                                          
|                                                                                          
|                                                                                          
|                                                                                          
|Net income                                                                                 |                                                                     | $                                                            | 5,243                                               |       |              | $      | 2,590   |       |        | $       | 6,924   |      
|                                                                                          
|                                                                                          
|                                                                                          
|                                                                                          
|Adjustments to reconcile net income to net cash
provided by (used in) operating activities |                                                                     |                                                              |                                                     |       |              |        |         |       |        |         |         |      
|                                                                                          
|                                                                                          
|                                                                                          
|                                                                                          
|                                                                                           | Depreciation and amortization                                       |                                                              |                                                     | 4,135 |              |        |         | 4,693 |        |         |         | 5,898 |       
|                                                                                          
|                                                                                          
|                                                                                          
|                                                                                          
|                                                                                           | Provision for (reduction of) accounts receivable valuation reserves |                                                              |                                                     | (69   | )            |        |         | (64   | )      |         |         | 234   |       
|                                                                                          
|                                                                                          
|                                                                                          
|                                                                                          
|                                                                                           | Loss on disposal of assets                                          |                                                              |                                                     | 2     |              |        |         |      |        |         |         |      |       
|                                                                                          
|                                                                                          
|                                                                                          
|                                                                                          
|                                                                                           | Changes in assets and
liabilities:                                  |                                                              |                                                     |       |              |        |         |       |        |         |         |       |       
|                                                                                          
|                                                                                          
|                                                                                          
|                                                                                          
|                                                                                           |                                                                     | (Increase) decrease in accounts receivable                   |                                                     |       | (5,641       | )      |         |       | (5,997 | )       |         |       | (2,519 | )      
|                                                                                          
|                                                                                          
|                                                                                          
|                                                                                          
|                                                                                           |                                                                     | (Increase) decrease in inventories                           |                                                     |       | (3,649       | )      |         |       | (4,238 | )       |         |       | 149    |        
|                                                                                          
|                                                                                          
|                                                                                          
|                                                                                          
|                                                                                           |                                                                     | (Increase) decrease in other assets                          |                                                     |       | 505          |        |         |       | (1,425 | )       |         |       | 1,271  |        
|                                                                                          
|                                                                                          
|                                                                                          
|                                                                                          
|                                                                                           |                                                                     | Increase in accounts payable and accrued liabilities         |                                                     |       | 4,778        |        |         |       | 1,730  |         |         |       | 5,654  |        
|                                                                                          
|                                                                                          
|                                                                                          
|                                                                                          
|                                                                                           |                                                                     | Increase (decrease) in taxes payable and deferred taxes, net |                                                     |       | 1,461        |        |         |       | 2,649  |         |         |       | 823    |        
|                                                                                           |                                                                     |                                                              |                                                     |       |              |        |         |       |        |         |         |      
|                                                                                           |                                                                     |                                                              | Net cash provided by (used in) operating activities |       |              | 6,765  |         |       |        | (62     | )       |       |        | 18,434  |  
|                                                                                           |                                                                     |                                                              |                                                     |       |              |        |         |       |        |         |         |      
|CASH FLOWS FROM INVESTING ACTIVITIES:                                                     
|                                                                                          
|                                                                                          
|                                                                                          
|                                                                                          
|Purchase of property, plant and equipment                                                  |                                                                     |                                                              | (3,050                                              | )     |              |        | (8,119  | )     |        |         | (12,537 | )    
|                                                                                          
|                                                                                          
|                                                                                          
|                                                                                          
|Proceeds from sale of property, plant and equipment                                        |                                                                     |                                                              | 19                                                  |       |              |        |        |       |        |         |        |      
|                                                                                          
|                                                                                          
|                                                                                          
|                                                                                          
|Investment in inViso, Inc.                                                                 |                                                                     |                                                              |                                                    |       |              |        | (3,320  | )     |        |         |        |      
|                                                                                           |                                                                     |                                                              |                                                     |       |              |        |         |       |        |         |         |      
|                                                                                           |                                                                     |                                                              | Net cash used in investing activities               |       |              | (3,031 | )       |       |        | (11,439 | )       |       |        | (12,537 | )
|                                                                                           |                                                                     |                                                              |                                                     |       |              |        |         |       |        |         |         |      
|CASH FLOWS FROM FINANCING ACTIVITIES:                                                     
|                                                                                          
|                                                                                          
|                                                                                          
|                                                                                          
|Net proceeds from (payments on) notes payable to banks                                     |                                                                     |                                                              |                                                    |       |              |        | 8,095   |       |        |         | (8,095  | )    
|                                                                                          
|                                                                                          
|                                                                                          
|                                                                                          
|Stock options exercised                                                                    |                                                                     |                                                              | 51                                                  |       |              |        | 65      |       |        |         | 226     |      
|                                                                                          
|                                                                                          
|                                                                                          
|                                                                                          
|Purchase of treasury stock                                                                 |                                                                     |                                                              |                                                    |       |              |        | (8,072  | )     |        |         |        |      
|                                                                                          
|                                                                                          
|                                                                                          
|                                                                                          
|Net proceeds from equity offering                                                          |                                                                     |                                                              |                                                    |       |              |        |        |       |        |         | 42,390  |      
|                                                                                           |                                                                     |                                                              |                                                     |       |              |        |         |       |        |         |         |      
|                                                                                           |                                                                     |                                                              | Net cash provided by financing activities           |       |              | 51     |         |       |        | 88      |         |       |        | 34,521  |  
|                                                                                           |                                                                     |                                                              |                                                     |       |              |        |         |       |        |         |         |      
|Effect of exchange rate changes on cash and cash equivalents                               |                                                                     |                                                              | 6                                                   |       |              |        | (12     | )     |        |         | (1      | )    
|                                                                                           |                                                                     |                                                              |                                                     |       |              |        |         |       |        |         |         |      
|NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS                                       |                                                                     |                                                              | 3,791                                               |       |              |        | (11,425 | )     |        |         | 40,417  |      
|                                                                                          
|                                                                                          
|                                                                                          
|                                                                                          
|CASH AND CASH EQUIVALENTS, beginning of year                                               |                                                                     |                                                              | 12,580                                              |       |              |        | 16,371  |       |        |         | 4,946   |      
|                                                                                           |                                                                     |                                                              |                                                     |       |              |        |         |       |        |         |         |      
|CASH AND CASH EQUIVALENTS, end of year                                                     |                                                                     | $                                                            | 16,371                                              |       |              | $      | 4,946   |       |        | $       | 45,363  |      
|                                                                                           |                                                                     |                                                              |                                                     |       |              |        |         |       |        |         |         |       |        |         |  
|SUPPLEMENTAL CASH FLOW INFORMATION:                                                       
|                                                                                          
|                                                                                          
|                                                                                          
|                                                                                          
|Interest paid                                                                              |                                                                     | $                                                            | 4                                                   |       |              | $      | 364     |       |        | $       | 914     |      
|                                                                                           |                                                                     |                                                              |                                                     |       |              |        |         |       |        |         |         |       |        |         |  
|Income taxes paid, net of refunds                                                          |                                                                     | $                                                            | 1,973                                               |       |              | $      | 992     |       |        | $       | 2,209   |      
|                                                                                           |                                                                     |                                                              |                                                     |       |              |        |         |       |        |         |         |       |        |         |  
|SUPPLEMENTAL DISCLOSURE OF NON-CASH INVESTING AND FINANCING
ACTIVITIES:                   
|                                                                                          
|                                                                                          
|                                                                                          
|                                                                                          
|Value of warrants granted                                                                  |                                                                     | $                                                            |                                                    |       |              | $      |        |       |        | $       | 555     |      
|                                                                                           |                                                                     |                                                              |                                                     |       |              |        |         |       |        |         |         |       |        |         |  

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

F-6



---



##### Table of Contents



THREE-FIVE SYSTEMS, INC. AND SUBSIDIARIES







NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1997, 1998 and 1999

(1) Organization and Operations:

Three-Five Systems, Inc. and subsidiaries (the Company) offers advanced
design and manufacturing services to a wide range of original equipment
manufacturers (OEMs). Most of the Companys sales consist of custom display
modules developed in close collaboration with its customers. Devices designed
and manufactured by the Company find application in communication devices as
well as in office, industrial, medical and commercial electronics products. The
Company currently specializes in liquid crystal display (LCD) components and
technology in providing its design and manufacturing services for its
customers. The Company markets its services primarily in North America, Europe,
and Asia through direct technical sales persons and, to a much lesser extent,
through an independent sales and distribution network.

The Company currently conducts manufacturing operations in Tempe, Arizona;
Manila, the Philippines; and Beijing, China. The Company believes that the
Arizona facility has the largest fully automated LCD glass production capacity
in North America. High-volume LCD module manufacturing is done in Manila, the
Philippines and Beijing, China. In Manila, a third-party subcontractor operates
the facility under a sub-assembly agreement with the Company utilizing
equipment, processes, and documentation owned by the Company. The sub-assembly
agreement has a current term extending through December 31, 2000, and from year
to year thereafter, but may be terminated by either party upon 180 days written
notice. The termination of or the inability of the Company to obtain products
pursuant to the sub-assembly agreement, even for a relatively short period,
would have a material adverse effect on the operations and profitability of the
Company. The Company commenced manufacturing operations in China during 1998.
The China facility is a high-volume LCD module manufacturing facility similar
to the Companys facility in Manila. The Company initially leased a facility in
Beijing on a temporary basis, which expired in mid-1999, and the Company
commenced manufacturing operations in that temporary facility in the second
quarter of 1998. In July 1999, the Company completed construction of its own
facility in Beijing and commenced manufacturing operations in the new facility
in September of 1999.

The Companys strategy involves concentrating its efforts on providing
design and production services to leading companies in a limited number of
fast-growing industries. The Company has been undertaking substantial efforts
to diversify its business, broaden its customer base, and expand its markets.
The Companys historical major customer accounted for approximately 35%, 64%,
and 86% of the Companys net sales in 1997, 1998, and 1999, respectively. This
increased percentage occurred as a result of increased sales to that customer
as well as decreased sales to other customers. The Companys other significant
customer accounted for 32% of the Companys net sales during 1997 and less than
10% of the Companys net sales during both 1998 and 1999. A significant
decrease in orders for the Companys products from the Companys historical
major customer or a decline in the cellular telephone industry would result in
a material adverse impact on the Companys results of operations and financial
position.

The significant amount of sales to a few customers results in certain
concentrations of credit risk for the Company. The Companys accounts
receivable balance, including the accounts receivable of the Companys largest
customers, is comprised of customers, primarily in the cellular telephone,
computer hardware, and other electronic products industries. These customers
are located primarily in the United States, Asia and Europe.

(2) Summary of Significant Accounting Policies:

Principles of Consolidation and Preparation of Financial Statements

The consolidated financial statements include the accounts of the Company
and its wholly owned subsidiaries. All material intercompany transactions have
been eliminated.

F-7



---



##### Table of Contents



Three-Five Systems Limited (Limited), a wholly owned subsidiary of the
Company, is incorporated in the United Kingdom. Limited sells and distributes
the Companys products to customers on the European continent.

Three-Five Systems Pacific, Inc. (Pacific), a wholly owned Philippines
corporation, procures supplies primarily from Philippine vendors. Pacific also
manages and assists production personnel of the third-party subcontractor that
operates the facility in the Philippines.

During the first quarter of 1998, the Company formed a wholly owned
subsidiary in China, Three-Five Systems (Beijing) Co., Ltd. (Beijing). Beijing
manufactures and sells the Companys products to customers primarily located in
Asia.

The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.

Fair Value of Financial Instruments

The estimated fair value of financial instruments has been determined by
the Company using available market information and valuation methodologies.
Considerable judgment is required in estimating fair values. Accordingly, the
estimates may not be indicative of amounts that would be realized in a current
market exchange. The carrying values of cash, accounts receivable, and accounts
payable approximate fair value due to the short maturities of these
instruments. In addition, at December 31, 1998, the carrying amount on the
outstanding revolving line of credit facility is estimated to approximate fair
value as the actual interest rate is consistent with rates estimated to be
currently available for debt with similar terms and remaining maturities.

Cash Equivalents

For purposes of the statements of cash flows, all highly liquid
investments with a maturity of three months or less at the time of purchase are
considered to be cash equivalents. Cash equivalents consist of investments in
commercial paper, marketable debt securities, money market mutual funds, and
United States government agencies obligations. A portion of the Companys
funds held in money market mutual funds are invested in repurchase agreements.
These repurchase agreements are collateralized by U.S. Treasury and Government
obligations. Cash equivalents were $1,992,000 and $42,962,000 at December 31,
1998 and 1999, respectively.

Inventories

Inventories are stated at the lower of cost (first-in, first-out) or net
realizable value. Write-downs are established against Company-owned
inventories for excess, slow-moving, and obsolete items and for items where the
net realizable value is less than cost. The write-downs totaled $1,125,000 and
$3,028,000 at December 31, 1998 and 1999, respectively.

Inventories consist of the following at (in thousands):

|                |  |              |        |      |  |   |        | 
|--------------- |  | ------------ | ------ | ---- |  | - | ------ | 
|                |  | December 31,
|                |  |             
|                |  | 1998         |        | 1999
|                |  |              |        |     
|Raw materials   |  | $            | 9,367  |      |  | $ | 9,554  | 
|               
|               
|               
|               
|Work-in-process |  |              | 1,459  |      |  |   | 1,336  | 
|               
|               
|               
|               
|Finished goods  |  |              | 1,667  |      |  |   | 1,454  | 
|                |  |              |        |      |  |   |        | 
|                |  | $            | 12,493 |      |  | $ | 12,344 | 
|                |  |              |        |      |  |   |        | 

F-8



---



##### Table of Contents



Property, Plant and Equipment

Property, plant and equipment is recorded at cost and generally is
depreciated using the straight-line method over the estimated useful lives of
the respective assets, which range from 3 to 39 years. Depreciation expense
totaled $4,094, $4,653 and $5,860 for the years ended December 31, 1997, 1998
and 1999, respectively. During 1996, the Company placed into service a
high-volume LCD manufacturing line in its Tempe, Arizona manufacturing
facility. The Company is depreciating the LCD manufacturing line using the
units of production method. Depreciation expense recorded using this method may
be subject to significant fluctuation from year to year resulting from changes
in actual production levels and ongoing analysis of the capacity of the
equipment. Property, plant and equipment consist of the following at (in
thousands):

|                              |  |              |         |      |  |   |         |  
|----------------------------- |  | ------------ | ------- | ---- |  | - | ------- | -
|                              |  | December 31,
|                              |  |             
|                              |  | 1998         |         | 1999
|                              |  |              |         |     
|Building and improvements     |  | $            | 13,031  |      |  | $ | 16,411  |  
|                             
|                             
|                             
|                             
|Furniture and equipment       |  |              | 37,324  |      |  |   | 47,036  |  
|                              |  |              |         |      |  |   |         |  
|                              |  |              | 50,355  |      |  |   | 63,447  |  
|                             
|                             
|                             
|                             
|Less accumulated depreciation |  |              | (17,041 | )    |  |   | (22,901 | )
|                              |  |              |         |      |  |   |         |  
|                              |  | $            | 33,314  |      |  | $ | 40,546  |  
|                              |  |              |         |      |  |   |         |  

The Company utilizes a significant portion of the high-volume LCD
manufacturing line facility to produce a substantial portion of its own
requirements for LCDs. The successful utilization of the LCD manufacturing line
requires the Company to (i) produce LCDs on a timely and cost-effective basis
at quality levels at least equal to product available from independent
suppliers and (ii) utilize the LCDs it produces in devices it designs and
manufactures in a manner satisfactory to its customers. Although management
believes that the manufacturing facility will be successfully utilized, no
assurance can be given that the Company will not experience problems or delays
in conducting its LCD manufacturing operations. Such problems could require the
Company to continue to purchase its LCD requirements from third parties and
result in the inability of the Company to recover its investment in the LCD
manufacturing facility.

During 1996, the Company entered into a transaction, in which it conveyed
its Tempe, Arizona facility and certain improvements to the City of Tempe as
consideration for a rent-free 75-year lease. The Company has the option to
repurchase the facility for $1,000 after ten years; therefore, the lease is
accounted for as a capital lease.

Accrued Liabilities

Accrued liabilities include accrued compensation of approximately $975,000
and $3,788,000 at December 31, 1998 and 1999, respectively.

Income Taxes

Statement of Financial Accounting Standards (SFAS) No. 109, Accounting for
Income Taxes,requires the use of an asset and liability approach in accounting
for income taxes. Deferred tax assets and liabilities are recorded based on the
differences between the financial statement and tax
bases of assets and liabilities and the tax rates in effect when these
differences are expected to reverse.

Foreign Currency Translation

Financial information relating to the Companys foreign subsidiaries is
reported in accordance with SFAS No. 52, Foreign Currency Translation. The
functional currency of Pacific is the same as the local currency. The gain or
loss resulting from the translation of Pacifics financial statements has been
included as a separate component of stockholders equity. Non-U.S. assets and
liabilities are translated into U.S. dollars using the year-end exchange rates.
Revenues and expenses are translated at average rates during the year.

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The functional currency of Beijing and Limited is the U.S. dollar.
Beijing, however, maintains its books and records in the Renminbi. Therefore,
the Company utilizes the remeasurement method of foreign currency translation
when Beijing is consolidated. Any resulting remeasurement gain or loss is
reported in the Companys consolidated statements of operations.

The net foreign currency transaction loss in 1997, 1998, and 1999 was
$183,000, $177,000, and $49,000, respectively, and has been included in other
expenses in the accompanying statements of income.

Revenue Recognition

The Company recognizes revenue upon shipment. The Company provides
reserves for uncollectible accounts receivable. These reserves totaled $431,000
and $650,000 at December 31, 1998 and 1999, respectively. The Company performs
ongoing credit evaluations of all of its customers and considers various
factors in establishing its allowance for doubtful accounts.

Research, Development and Engineering

Research, development and engineering costs are expensed as incurred. The
Company currently is spending research, development and engineering dollars on
several new technologies that it plans to introduce in the future. There is a
risk that some or all of those technologies may not successfully make the
transition from the research, development and engineering lab to cost-effective
manufacturable products.

Earnings Per Share

During 1997, the Company adopted SFAS No. 128, Earnings per Share.
Pursuant to SFAS No. 128, basic earnings per common share are computed by
dividing net income by the weighted average number of shares of common stock
outstanding during the year. Diluted earnings per common share are determined
assuming that outstanding options and warrants were exercised at the beginning
of each year or at the time of issuance, if later. Set forth below are the
disclosures required pursuant to SFAS No. 128:

|                                        |                                                   |                          |       |                                       |      |      |       |        |      |   |       |        |      | 
|--------------------------------------- | ------------------------------------------------- | ------------------------ | ----- | ------------------------------------- | ---- | ---- | ----- | ------ | ---- | - | ----- | ------ | ---- | 
|                                        |                                                   |                          |       | Years Ended                          
|                                        |                                                   |                          |       | December 31,                         
|                                        |                                                   |                          |       |                                      
|                                        |                                                   |                          |       | 1997                                  |      | 1998 |       | 1999  
|                                        |                                                   |                          |       |                                       |      |      |       |       
|                                        |                                                   |                          |       | (in thousands, except per share data)
|Basic earnings per share:              
|                                       
|                                       
|                                       
|                                       
|Income available to common stockholders |                                                   | $                        | 5,243 |                                       |      | $    | 2,590 |        |      | $ | 6,924 |       
|                                        |                                                   |                          |       |                                       |      |      |       |        |      |   |       |       
|                                        | Weighted average common shares                    |                          |       | 10,472                                |      |      |       | 10,185 |      |   |       | 10,375 |     
|                                        |                                                   |                          |       |                                       |      |      |       |        |      |   |       |       
|                                        |                                                   | Basic per share amount   |       | $                                     | 0.50 |      |       | $      | 0.25 |   |       | $      | 0.67 | 
|                                        |                                                   |                          |       |                                       |      |      |       |        |      |   |       |       
|Diluted earnings per share:            
|                                       
|                                       
|                                       
|                                       
|Income available to common stockholders |                                                   | $                        | 5,243 |                                       |      | $    | 2,590 |        |      | $ | 6,924 |       
|                                        |                                                   |                          |       |                                       |      |      |       |        |      |   |       |       
|                                        | Weighted average common shares                    |                          |       | 10,472                                |      |      |       | 10,185 |      |   |       | 10,375 |     
|                                       
|                                       
|                                       
|                                       
|                                        | Options and warrants assumed exercised            |                          |       | 315                                   |      |      |       | 218    |      |   |       | 295    |     
|                                        |                                                   |                          |       |                                       |      |      |       |        |      |   |       |       
|                                        | Total common shares plus common
stock equivalents |                          |       | 10,787                                |      |      |       | 10,403 |      |   |       | 10,670 |     
|                                        |                                                   |                          |       |                                       |      |      |       |        |      |   |       |       
|                                        |                                                   | Diluted per share amount |       | $                                     | 0.49 |      |       | $      | 0.25 |   |       | $      | 0.65 | 
|                                        |                                                   |                          |       |                                       |      |      |       |        |      |   |       |       

Recently Issued Accounting Standards

In 1998, the Company adopted SFAS No. 130, Reporting Comprehensive Income,
which requires companies to report all changes in equity during a period,
except those resulting from investment by owners and distribution

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to owners, in
a financial statement for the period in which they are recognized. The Company
has chosen to disclose comprehensive income, which encompasses net income and
foreign currency translation adjustments, in the Consolidated Statement of
Stockholders Equity. Prior years have been restated to conform to the SFAS No.
130 requirements.

In 1998, the Company also adopted SFAS No. 131, Disclosures about Segments
of an Enterprise and Related Information. The new rules establish revised
standards for public companies relating to the reporting of financial and
descriptive information about their operating segments in financial statements.
The Company adopted SFAS No. 131 and all of the required disclosures. (See Note
8.)

In June 1998, the Financial Accounting Standards Board (FASB) issued SFAS
No. 133, Accounting for Derivative Instruments and Hedging Activities,which
requires that an entity recognize all derivatives as either assets or
liabilities in the statement of financial position and measure those
instruments at fair value. The issuance of SFAS No. 137, Accounting for
Derivative Instruments and Hedging Activities  Deferral of the Effective Date
of FASB Statement No. 133,delayed the required effective date of SFAS No. 133
to all fiscal years beginning after June 15, 2000. The Company will be
required to adopt SFAS No. 133 during the year ending December 31, 2001.
Management does not believe that the adoption of SFAS No. 133 will have a
material impact on its results of operations or financial position.

(3) Long-Term Debt:

Long-term debt consists of the following at (in thousands):

|                                                                                                                                                                                                                                                                                                |  |   |              |       |      |   |   |   | 
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | - | ------------ | ----- | ---- | - | - | - | 
|                                                                                                                                                                                                                                                                                                |  |   | December 31,
|                                                                                                                                                                                                                                                                                                |  |   |             
|                                                                                                                                                                                                                                                                                                |  |   | 1998         |       | 1999
|                                                                                                                                                                                                                                                                                                |  |   |              |       |     
|$15.0 million revolving line of credit, interest due monthly
at the banks prime
    rate (8.5% at December 31, 1999)
or at the LIBOR base rate (6.13% at
    December 31,
1999) plus 1.75%, unpaid balance due May 22,
2000, secured
    by all assets of the Company other
than real property |  | $ |             |       |      | $ |  |  
|                                                                                                                                                                                                                                                                                               
|                                                                                                                                                                                                                                                                                               
|                                                                                                                                                                                                                                                                                               
|                                                                                                                                                                                                                                                                                               
|$10.0 million revolving line of credit/term loan,
interest due monthly at the
    banks prime rate or at
the LIBOR base rate plus 2.375%, unpaid balance
    due August 5, 2004, secured by all assets of the Company
Other than
    real property                                             |  |   | 8,095        |       |      |   |  |  
|                                                                                                                                                                                                                                                                                               
|                                                                                                                                                                                                                                                                                               
|                                                                                                                                                                                                                                                                                               
|                                                                                                                                                                                                                                                                                               
|$350,000 United Kingdom credit facility, interest due
quarterly at the banks
    base rate plus 2%, unpaid
balance due July 15, 2000, secured by
    Limiteds accounts receivable                                                                                                             |  |   |             |       |      |   |  |  
|                                                                                                                                                                                                                                                                                                |  |   |              |       |      |   |   |   | 
|                                                                                                                                                                                                                                                                                                |  |   |              | 8,095 |      |   |   |  | 
|                                                                                                                                                                                                                                                                                               
|                                                                                                                                                                                                                                                                                               
|                                                                                                                                                                                                                                                                                               
|                                                                                                                                                                                                                                                                                               
|Less current maturities                                                                                                                                                                                                                                                                         |  |   | (651         | )     |      |   |  |  
|                                                                                                                                                                                                                                                                                                |  |   |              |       |      |   |   |   | 
|                                                                                                                                                                                                                                                                                                |  |   | $            | 7,444 |      |   | $ |  | 
|                                                                                                                                                                                                                                                                                                |  |   |              |       |      |   |   |   | 

In November 1998, the Company entered into a commitment from Imperial Bank
and the National Bank of Canada for a $25.0 million credit facility. This
credit facility consists of (i) a $15.0 million revolving line of credit for
general corporate needs, and (ii) a $10.0 million term loan, which provided
available funds to repurchase a portion of the Companys common stock. The
Company must apply all proceeds from the sale of any treasury stock to the
outstanding principal balance of the term loan. On January 21, 2000, the
Company entered into a new $25.0 million unsecured revolving line of credit
with Imperial Bank, which matures on January 19, 2001. This line of credit
bears interest at the banks prime rate, or at the LIBOR base rate plus 1.5%,
and is payable monthly. The new revolving line of credit contains restrictive
covenants that include, among other things, restrictions on the declaration or
payment of dividends and the sale or transfer of assets. The new revolving
line of credit facility also requires the Company to maintain a specified net
worth, as defined, to maintain a required debt to equity ratio, and to maintain
certain other financial ratios.

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The credit facility contains restrictive covenants that include, among
other things, restrictions on the declaration or payment of dividends and the
amount of capital expenditures. The credit facility also requires the Company
to maintain a specified net worth, as defined, to maintain required debt to
equity ratio, and to maintain certain other financial ratios.

(4) Stockholders Equity:

On November 8, 1999, the Board of Directors approved a four-for-three
stock split, effective in the form of a 33 percent stock dividend. The stock
split was paid on December 17, 1999, to stockholders of record at the close of
business on December 3, 1999. This stock split has been given retroactive
recognition for all periods presented in the accompanying consolidated
financial statements.

In July 1999, the Company purchased certain assets and licensed silicon
technologies from National Semiconductor relating to liquid crystal on silicon
(LCoS(TM))microdisplays for approximately $3.0 million in cash and warrants,
with a fair market value of $555,000 as determined by the Black-Scholes method,
to purchase 93,333 shares of common stock at a price of $12.70 per share, which
was the closing price of the Companys common stock at the grant date. The
warrants become exercisable on July 12, 2000 and expire on July 12, 2002.

In September 1999, the Company issued 2,666,817 shares of common stock at
$14.531 per share (the Offering). The Offering consisted of 3,066,667 shares
of common stock comprised of 2,666,817 newly issued Company shares and 399,850
shares from an existing shareholder. In October 1999, the Company issued
460,000 shares of common stock at $14.531 per share to cover over-allotments
pertaining to the Offering.

(5) Benefit Plans:

The Company has five stock option plans, the 1990 Stock Option Plan (1990
Plan), the 1993 Stock Option Plan (1993 Plan), the 1994 Non-Employee Directors
Stock Option Plan (1994 Plan), the 1997 Stock Option Plan (1997 Plan), and 1998
Stock Option Plan (1998 Plan).

1990 Stock Option Plan

Under the 1990 Plan, there were options issued but unexercised to purchase
135,518 shares as of December 31, 1999. In conjunction with stockholder
approval of the 1993 Plan, the Board terminated the 1990 Plan with respect to
unissued options to purchase 113,939 shares of common stock, which remained and
were unissued as of the date the 1993 Plan was adopted. The exercise prices of
options
are determined by the plan administrator, but may not be less than 100% (110%
if the option is granted to a stockholder who at the time the option is granted
owns stock representing more than 10% of the total combined voting power of all
classes of stock of the Company). The 1990 Plan will remain in force through
May 1, 2000.

The expiration date, maximum number of shares purchasable, and the other
provisions of the options granted under the 1990 Plan were established at the
time of grant. Options were granted for terms of up to ten years and become
exercisable in whole or in one or more installments at such times as were
determined by the Board of Directors upon grant of the options.

1993 Stock Option Plan

The 1993 Plan provides for the granting of options to purchase up to
513,939 shares of the Companys common stock (which includes 113,939 shares
previously reserved for issuance under the Companys 1990 Plan), the direct
granting of common stock (stock awards), the granting of stock appreciation
rights (SARs) and the granting of other cash awards (cash awards; stock awards,
SARs, and cash awards are collectively referred to herein as Awards). Under the
1993 Plan, options and Awards may be issued to key personnel and others
providing valuable services to the Company. The options issued may be
incentive stock options or nonqualified stock options. If any option or SAR
terminates or expires without having been exercised in full, stock not issued
under such option or SAR will again be available for grant pursuant to the 1993
Plan. There were options

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##### Table of Contents



outstanding to acquire 480,686 shares of the Companys
common stock under the 1993 Plan at December 31, 1999.

To the extent that granted options are incentive stock options, the terms
and conditions of those options must be consistent with the qualification
requirement set forth in the Internal Revenue Code of 1986 (the Code). The
expiration date, maximum number of shares purchasable, and the other provisions
of the options will be established at the time of grant. Options may be granted
for terms of up to ten years and become exercisable in whole or in one or more
installments at such time as may be determined by the plan administrator upon
grant of the options. The exercise prices of options are determined by the plan
administrator, but may not be less than 100% (110% if the option is an
incentive stock option granted to a stockholder who at the time the option is
granted owns stock representing more than 10% of the total combined voting
power of all classes of stock of the Company) of the fair market value of the
common stock at the time of the grant. The 1993 Plan will remain in force until
February 24, 2003.

1994 Non-Employee Directors Stock Option Plan

During 1999, the Board of Directors amended the 1994 Plan to decrease the
number of available shares for issuance from 133,334 shares to 66,667 shares.

The 1994 Plan provides for the automatic grant of stock options to
non-employee directors to purchase up to 66,667 shares of the Companys common
stock. Under the 1994 Plan, options to acquire 500 shares of common stock will
be automatically granted to each non-employee director at the meeting of the
Board of Directors held immediately after each annual meeting of stockholders,
with such options to vest in a series of 12 equal and successive monthly
installments commencing one month after the annual automatic grant date. In
addition, each non-employee director serving on the Board of Directors on the
date the 1994 Plan was approved by the Companys stockholders received an
automatic grant of options to acquire 1,000 shares of common stock and each
subsequent newly elected non-employee member of the Board of Directors receives
an automatic grant of options to acquire 1,000 shares of common stock on the
date of their first appointment or election to the Board of Directors. Those
options become exercisable and vest in a series of three equal and successive
annual installments, with the first such installment becoming exercisable
immediately after the directors second successive election to the Board of
Directors (the First Vesting Date), the second installment becoming exercisable
10 months after the First Vesting Date, and the third installment becoming
exercisable 22 months after the First Vesting Date (provided that the director
has not ceased serving as a director prior to a vesting date). A non-employee
member of the Board of Directors is not eligible to receive the 500 share
automatic option grant if that option grant date is within 30 days of such
non-employee member receiving the 1,000 share automatic option grant. The
exercise price per share of common stock subject to options granted under the
1994 Plan will be equal to 100% of the fair market value of the Companys
common stock on the date such options are granted. There were outstanding
options to acquire 12,672 shares of the Companys common stock under the 1994
Plan at December 31, 1999.

1997 Stock Option Plan

The 1997 Plan provides for the granting of nonqualified options to
purchase up to 133,334 shares of the Companys common stock. Under the 1997
Plan, options may be issued to key personnel and others providing valuable
services to the Company. The options issued will be nonqualified stock options
and shall not be incentive stock options as defined in Section 422 of the Code.
Any option that expires or terminates without having been exercised in full
will again be available for grant pursuant to the 1997 Plan. There were options
outstanding to acquire 132,692 shares of the Companys common stock under the
1997 Plan at December 31, 1999.

The expiration date, maximum number of shares purchasable, and the other
provisions of the options will be established at the time of grant. Options may
be granted for terms of up to ten years and become exercisable in whole or in
one or more installments at such time as may be determined by the plan
administrator upon grant of the options. The exercise prices of the options are
determined by the plan administrator, but may not be less than

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##### Table of Contents



100% of the fair
market value of the common stock at the time of the grant. The 1997 Plan will
remain in force until May 12, 2007.

1998 Stock Option Plan

During 1999, the stockholders approved an amendment to the 1998 Plan to
increase the number of shares of the Companys common stock that may be issued
from 400,000 shares to 733,334 shares.

The 1998 Plan provides for the granting of incentive stock options and/or
nonqualified options. Under the 1998 Plan, options may be issued to key
personnel and others providing valuable services to the Company. The options
issued will be incentive stock options or nonqualified stock options as defined
in Section 422 of the Code. Any option that expires or terminates without
having been exercised in full will again be available for grant pursuant to the
1998 Plan. There were options outstanding to acquire 395,338 shares of the
Companys common stock under the 1998 Plan at December 31, 1999.

The expiration date, maximum number of shares purchasable, and the other
provisions of the options will be established at the time of grant. Options may
be granted for terms of up to ten years and become exercisable in whole or in
one or more installments at such time as may be determined by the plan
administrator upon grant of the options. The exercise prices of the options are
determined by the plan administrator, but may not be less than 100% of the fair
market value of the common stock at the time of the grant (110% if the option
is an incentive stock option granted to a stockholder who at the time the
option is granted owns stock representing more than 10% of the total combined
voting power of all classes of stock of the Company). The 1998 Plan will remain
in force until January 28, 2008.

Tax benefits from early disposition of common stock by optionees with
incentive stock options are credited to additional paid-in capital.

A summary of the status of the Companys five stock option plans at
December 31, 1997, 1998, and 1999 and changes during the years then ended, are
presented in the table and narrative below:

|                                                   |  |  |          |   |       |   |          |  |       |  |          |   |          |   |       |  |  |  |           |   |  |   |       |  | 
|-------------------------------------------------- |  |  | -------- | - | ----- | - | -------- |  | ----- |  | -------- | - | -------- | - | ----- |  |  |  | --------- | - |  | - | ----- |  | 
|                                                   |  |  | 1997     |   | 1998  |   | 1999    
|                                                   |  |  |          |   |       |   |         
|                                                   |  |  |          |   |       |   | Weighted |  |       |  |          |   | Weighted |   |       |  |  |  | Weighted 
|                                                   |  |  |          |   |       |   | Average  |  |       |  |          |   | Average  |   |       |  |  |  | Average  
|                                                   |  |  |          |   |       |   | Exercise |  |       |  |          |   | Exercise |   |       |  |  |  | Exercise 
|                                                   |  |  | Options  |   | Price |   | Options  |  | Price |  | Options  |   | Price   
|                                                   |  |  |          |   |       |   |          |  |       |  |          |   |         
|Outstanding at beginning
of year                   |  |  | 735,747  |   |       | $ | 5.19     |  |       |  | 740,009  |   |          | $ | 8.31  |  |  |  | 933,137   |   |  | $ | 9.15  | 
|                                                  
|                                                  
|                                                  
|                                                  
|Granted                                            |  |  | 272,681  |   |       |   | 11.08    |  |       |  | 446,459  |   |          |   | 10.40 |  |  |  | 679,963   |   |  |   | 12.78 | 
|                                                  
|                                                  
|                                                  
|                                                  
|Exercised                                          |  |  | (216,410 | ) |       |   | .97      |  |       |  | (62,697  | ) |          |   | .81   |  |  |  | (104,980  | ) |  |   | 2.91  | 
|                                                  
|                                                  
|                                                  
|                                                  
|Expired                                            |  |  | (52,009  | ) |       |   | 9.17     |  |       |  | (190,634 | ) |          |   | 11.58 |  |  |  | (351,214  | ) |  |   | 9.84  | 
|                                                   |  |  |          |   |       |   |          |  |       |  |          |   |          |   |       |  |  |  |           |  
|Outstanding at end of year                         |  |  | 740,009  |   |       | $ | 8.31     |  |       |  | 933,137  |   |          | $ | 9.15  |  |  |  | 1,156,906 |   |  | $ | 11.64 | 
|                                                   |  |  |          |   |       |   |          |  |       |  |          |   |          |   |       |  |  |  |           |  
|Exercisable at end of year                         |  |  | 220,140  |   |       |   |          |  |       |  | 303,373  |   |          |   |       |  |  |  | 298,452   |  
|                                                   |  |  |          |   |       |   |          |  |       |  |          |   |          |   |       |  |  |  |           |   | 
|Weighted average fair value of
options     granted |  |  |          |   |       | $ | 8.27     |  |       |  |          |   |          | $ | 7.69  |  |  |  |           |   |  | $ | 9.81  | 
|                                                   |  |  |          |   |       |   |          |  |       |  |          |   |          |   |       |  |  |  |           |   |  |   |      

The weighted average fair value of options granted for the years ended
1997, 1998 and 1999 were $11.08, $10.40 and $12.78, respectively.

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The following table summarizes information about stock options outstanding
at December 31, 1999:

|                    |  |                     |           |             |  |          |     |              |  |          |       |  |  |  |         |  |  |   |       | 
|------------------- |  | ------------------- | --------- | ----------- |  | -------- | --- | ------------ |  | -------- | ----- |  |  |  | ------- |  |  | - | ----- | 
|Options Outstanding |  | Options Exercisable
|                    |  |                    
|                    |  | Number              |           | Weighted    |  |          |     |              |  | Number  
|                    |  | Outstanding         |           | Average     |  | Weighted |     | Exercisable  |  | Weighted
|Range of            |  | at                  |           | Remaining   |  | Average  |     | at           |  | Average 
|Exercise            |  | December 31,        |           | Contractual |  | Exercise |     | December 31, |  | Exercise
|Prices              |  | 1999                |           | Life        |  | Price    |     | 1999         |  | Price   
|                    |  |                     |           |             |  |          |     |              |  |         
|$0.18 - $6.75       |  |                     | 36,497    |             |  |          | 6.7 |              |  | $        | 3.95  |  |  |  | 11,161  |  |  | $ | 0.57  | 
|                   
|                   
|                   
|                   
|6.76 - 15.00        |  |                     | 965,733   |             |  |          | 8.0 |              |  |          | 10.71 |  |  |  | 262,622 |  |  |   | 9.86  | 
|                   
|                   
|                   
|                   
|15.01 - 35.00       |  |                     | 154,676   |             |  |          | 9.3 |              |  |          | 19.26 |  |  |  | 24,669  |  |  |   | 16.95 | 
|                    |  |                     |           |             |  |          |     |              |  |          |       |  |  |  |         |  |  |   |       | 
|                    |  |                     | 1,156,906 |             |  |          | 8.1 |              |  | $        | 11.64 |  |  |  | 298,452 |  |  | $ | 10.10 | 
|                    |  |                     |           |             |  |          |     |              |  |          |       |  |  |  |         |  |  |   |       | 

Pursuant to the provisions of SFAS No. 123, Accounting for Stock-Based
Compensation, the Company accounts for transactions with its employees pursuant
to Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to
Employees, under which no compensation cost has been recognized. However, the
Company has computed for pro forma disclosure purposes the value of all options
granted during 1997, 1998 and 1999, using the Black-Scholes option pricing
method with the following weighted assumptions: risk-free interest rates of
5.45%, 4.52%, and 6.34%; expected dividend yields of zero; expected lives of
6.4, 6.6, and 6.2 years; and expected volatility (a measure of the amount by
which a price has fluctuated or is expected to fluctuate during a period) of
60.0%, 61.4%, and 61.9%.. Had compensation cost for these plans been
determined consistent with SFAS No. 123, the Companys net income and earnings
per share would have been as follows:

|                            |             |  |                          |       |      |  |                        |       |  |  |   |       | 
|--------------------------- | ----------- |  | ------------------------ | ----- | ---- |  | ---------------------- | ----- |  |  | - | ----- | 
|                            |             |  | Years Ended December 31,
|                            |             |  |                         
|                            |             |  | 1997                     |       | 1998 |  | 1999                  
|                            |             |  |                          |       |      |  |                       
|                            |             |  |                          |       |      |  | (in thousands,        
|                            |             |  |                          |       |      |  | except per share data)
|Net income:                
|                           
|                           
|                           
|                           
|                            | As reported |  | $                        | 5,243 |      |  | $                      | 2,590 |  |  | $ | 6,924 | 
|                           
|                           
|                           
|                           
|                            | Pro forma   |  |                          | 4,636 |      |  |                        | 1,980 |  |  |   | 5,393 | 
|                           
|                           
|                           
|                           
|Basic earnings per share:  
|                           
|                           
|                           
|                           
|                            | As reported |  | $                        | 0.50  |      |  | $                      | 0.25  |  |  | $ | 0.67  | 
|                           
|                           
|                           
|                           
|                            | Pro forma   |  |                          | 0.44  |      |  |                        | 0.19  |  |  |   | 0.52  | 
|                           
|                           
|                           
|                           
|Diluted earnings per share:
|                           
|                           
|                           
|                           
|                            | As reported |  | $                        | 0.49  |      |  | $                      | 0.25  |  |  | $ | 0.65  | 
|                           
|                           
|                           
|                           
|                            | Pro forma   |  |                          | 0.43  |      |  |                        | 0.19  |  |  |   | 0.51  | 

The pro forma compensation costs reflected in the above table were
$994,000, $1,028,000 and $2,187,000, for the years ended 1997, 1998 and 1999,
respectively.

401(k) Profit Sharing Plan

Effective September 1, 1990, the Company adopted a profit sharing plan
(401(k) Plan) pursuant to Section 
401(k) of the Code. The 401(k) Plan covers
substantially all full-time employees who meet the eligibility requirements and
provides for a discretionary profit sharing contribution by the Company and an
employee elective contribution with a discretionary Company matching provision.
The Company expensed discretionary contributions pursuant to the 401(k) Plan in
the amount of $71,000, $100,000, and $159,000 for the years ended December 31,
1997, 1998, and 1999, respectively.

(6) Income Taxes:

The provision (benefit) for income taxes for the years ended December 31
consists of the following (in thousands):

F-15



---



##### Table of Contents



|                                                                                                    |                            |   |       |       |      |   |       |       |  |   |       |       | 
|--------------------------------------------------------------------------------------------------- | -------------------------- | - | ----- | ----- | ---- | - | ----- | ----- |  | - | ----- | ----- | 
|                                                                                                    |                            |   | 1997  |       | 1998 |   | 1999 
|                                                                                                    |                            |   |       |       |      |   |      
|Current, net of operating loss carryforwards and tax
credits utilized:                             
|                                                                                                   
|                                                                                                   
|                                                                                                   
|                                                                                                   
|Federal, net of tax benefit from early termination of
incentive stock options                       |                            | $ | 356   |       |      | $ | (509  | )     |  | $ | 2,619 |      
|                                                                                                   
|                                                                                                   
|                                                                                                   
|                                                                                                   
|States                                                                                              |                            |   | 97    |       |      |   | (24   | )     |  |   | 210   |      
|                                                                                                   
|                                                                                                   
|                                                                                                   
|                                                                                                   
|Foreign                                                                                             |                            |   | 71    |       |      |   | 237   |       |  |   | 832   |      
|                                                                                                    |                            |   |       |       |      |   |       |       |  |   |       |      
|                                                                                                    |                            |   | 524   |       |      |   | (296  | )     |  |   | 3,661 |      
|                                                                                                   
|                                                                                                   
|                                                                                                   
|                                                                                                   
|Deferred provision (benefit)                                                                        |                            |   | 2,769 |       |      |   | 2,069 |       |  |   | (723  | )    
|                                                                                                   
|                                                                                                   
|                                                                                                   
|                                                                                                   
|Tax benefit from early termination of incentive stock
options, reflected in    stockholders equity |                            |   | 41    |       |      |   |      |       |  |   | 30    |      
|                                                                                                    |                            |   |       |       |      |   |       |       |  |   |       |      
|                                                                                                    | Provision for income taxes |   | $     | 3,334 |      |   | $     | 1,773 |  |   | $     | 2,968 | 
|                                                                                                    |                            |   |       |       |      |   |       |       |  |   |       |      

In accordance with SFAS No. 109, a tax benefit for net operating losses of
approximately $35,000, $-0-, and
$-0-, and tax credits of approximately $-0-,
$-0-, and $115,362 were utilized in 1997, 1998, and 1999, respectively, are
included as a reduction of the current provision for income taxes in the
consolidated statements of income.

The components of deferred taxes at December 31 are as follows (in
thousands):

|                                        |                                              |   |       |       |      |   |       |       | 
|--------------------------------------- | -------------------------------------------- | - | ----- | ----- | ---- | - | ----- | ----- | 
|                                        |                                              |   | 1998  |       | 1999
|                                        |                                              |   |       |       |     
|Net long-term deferred tax liabilities:
|                                       
|                                       
|                                       
|                                       
|                                        | Accelerated tax depreciation                 |   | $     | 3,156 |      |   | $     | 3,229 | 
|                                       
|                                       
|                                       
|                                       
|                                        | Investments in foreign affiliates            |   |       |      |      |   |       | 463   | 
|                                        |                                              |   |       |       |      |   |       |      
|                                        |                                              | $ | 3,156 |       |      | $ | 3,692 |      
|                                        |                                              |   |       |       |      |   |       |       | 
|Net short-term deferred tax assets:    
|                                       
|                                       
|                                       
|                                       
|                                        | Inventory reserve                            |   | $     | 436   |      |   | $     | 1,140 | 
|                                       
|                                       
|                                       
|                                       
|                                        | Uniform capitalization                       |   |       | 1,076 |      |   |       | 692   | 
|                                       
|                                       
|                                       
|                                       
|                                        | Accrued liabilities not currently deductible |   |       | 1,022 |      |   |       | 1,128 | 
|                                       
|                                       
|                                       
|                                       
|                                        | Allowance for doubtful accounts              |   |       | 156   |      |   |       | 233   | 
|                                       
|                                       
|                                       
|                                       
|                                        | Other                                        |   |       | (10   | )    |   |       | 38    | 
|                                        |                                              |   |       |       |      |   |       |      
|                                        |                                              | $ | 2,680 |       |      | $ | 3,231 |      
|                                        |                                              |   |       |       |      |   |       |       | 

A reconciliation of the U.S. federal statutory rate to the Companys
effective tax rate is as follows:

|                                            |  |      |    |      |  |      |    |   |  |  |    |  
|------------------------------------------- |  | ---- | -- | ---- |  | ---- | -- | - |  |  | -- | -
|                                            |  | 1997 |    | 1998 |  | 1999
|                                            |  |      |    |      |  |     
|Statutory federal rate                      |  |      | 34 | %    |  |      | 34 | % |  |  | 34 | %
|                                           
|                                           
|                                           
|                                           
|Effect of state taxes                       |  |      | 5  |      |  |      | 3  |   |  |  | 3  |  
|                                           
|                                           
|                                           
|                                           
|Foreign earnings taxed at different rates   |  |      |   |      |  |      |   |   |  |  | (4 | )
|                                           
|                                           
|                                           
|                                           
|Other, net                                  |  |      |   |      |  |      | 4  |   |  |  | 3  |  
|                                           
|                                           
|                                           
|                                           
|Benefit from prior year state refund claims |  |      |   |      |  |      |   |   |  |  | (6 | )
|                                            |  |      |    |      |  |      |    |   |  |  |    |  
|                                            |  |      | 39 | %    |  |      | 41 | % |  |  | 30 | %
|                                            |  |      |    |      |  |      |    |   |  |  |    |  

The favorable state tax benefit is the result of settled state refund
claims from prior years.

A deferred U.S. tax liability has not been provided on the undistributed
earnings of certain foreign subsidiaries because it is the intent of the
Company to permanently reinvest such earnings. Undistributed earnings of
foreign subsidiaries, which have been or are intended to be permanently
invested in accordance with Accounting Principles Board (APB) No. 23,
Accounting for Income Taxes  Special Areas, aggregated approximately $990,000
at December 31, 1999.

F-16



---



##### Table of Contents



(7) Commitments and Contingencies:

In March 1995, the Company entered into a non-cancelable operating lease
for its primary manufacturing facility in Manila, the Philippines. The lease
has a current term extending through December 31, 2000, and from year-to-year
thereafter, but may be terminated by either party upon 180 days written notice.
In April 1995, the Company entered into a non-cancelable operating lease for an
additional manufacturing facility in Manila, the Philippines. This lease
expires March 31, 2000. The Company has an option to extend the lease for an
additional year at substantially the same rates as the current lease.

Rent expense was approximately $793,000, $917,000, and $763,000, for the
years ended December 31, 1997, 1998, and 1999, respectively.

In April 1994, the Company entered into a ground lease (with purchase
options) on a 5.7 acre site in Tempe, Arizona. Annual lease payments under the
ground lease, which will expire on March 31, 2069, subject to renewal and
purchase options as well as termination provisions, will average approximately
$100,000 over the term of the lease subject to certain escalation provisions. A
design, manufacturing, and corporate headquarters facility containing
approximately 97,000 square feet was completed on the land in 1995 at a cost of
approximately $10.4 million.

The Companys future lease commitments under the non-cancelable operating
leases as of December 31, 1999 are as follows (in thousands):

|           |  |   |       | 
|---------- |  | - | ----- | 
|2000       |  | $ | 466   | 
|          
|          
|          
|          
|2001       |  |   | 160   | 
|          
|          
|          
|          
|2002       |  |   | 144   | 
|          
|          
|          
|          
|2003       |  |   | 100   | 
|          
|          
|          
|          
|Thereafter |  |   | 6,524 | 
|           |  |   |       | 
|           |  | $ | 7,394 | 
|           |  |   |       | 

The Company is involved in certain administrative proceedings arising in
the normal course of business. In the opinion of management, the ultimate
settlement of these administrative proceedings will not materially impact its
financial position or results of operations.

(8) Segment Information:

The Company offers advanced design and manufacturing services to a wide
range of original equipment manufacturers (OEMs). The majority of the Companys
sales are attributed to the LCD product line. The Companys products are
included in end-user devices for the following product categories:
communication devices, office, industrial, medical and commercial electronics.

Management monitors and evaluates the financial performance of the
Companys operations by its four operating segments located throughout the
world. These segments consist of three manufacturing operations, located in the
United States, China, and the Philippines, and a sales and distribution
operation in the United Kingdom.

F-17



---



##### Table of Contents



The following operating segment information includes financial information
(in thousands) for all four of the Companys operating segments. Financial
information for the China operation is presented beginning from the date those
operations commenced, June 1998.

|                                         |  |        |        |         |  |       |        |             |  |              |   |       |  |   |       |  |  |   |         |   |  |   |        | 
|---------------------------------------- |  | ------ | ------ | ------- |  | ----- | ------ | ----------- |  | ------------ | - | ----- |  | - | ----- |  |  | - | ------- | - |  | - | ------ | 
|                                         |  | United |        | United 
|                                         |  | States |        | Kingdom |  | China |        | Philippines |  | Eliminations |   | Total
|                                         |  |        |        |         |  |       |        |             |  |              |   |      
|December 31, 1997                       
|                                        
|                                        
|                                        
|                                        
|Net sales                                |  | $      | 83,023 |         |  | $     | 10,755 |             |  | $            |  |       |  | $ | 3,107 |  |  | $ | (12,243 | ) |  | $ | 84,642 | 
|                                        
|                                        
|                                        
|                                        
|Income before provision
for income taxes |  |        | 7,990  |         |  |       | 436    |             |  |              |  |       |  |   | 104   |  |  |   | 47      |   |  |   | 8,577  | 
|                                        
|                                        
|                                        
|                                        
|Provision for income taxes               |  |        | 3,263  |         |  |       | 32     |             |  |              |  |       |  |   | 39    |  |  |   |        |   |  |   | 3,334  | 
|                                        
|                                        
|                                        
|                                        
|Depreciation                             |  |        | 4,058  |         |  |       | 27     |             |  |              |  |       |  |   | 9     |  |  |   |        |   |  |   | 4,094  | 
|                                        
|                                        
|                                        
|                                        
|Total assets                             |  |        | 68,039 |         |  |       | 4,896  |             |  |              |  |       |  |   | 354   |  |  |   | (454    | ) |  |   | 72,835 | 
|                                        
|                                        
|                                        
|                                        
|Capital expenditures                     |  |        | 3,036  |         |  |       | 14     |             |  |              |  |       |  |   |      |  |  |   |        |   |  |   | 3,050  | 

|                                                |  |        |        |         |  |       |        |             |  |              |        |       |  |   |       |   |  |   |         |   |  |   |        | 
|----------------------------------------------- |  | ------ | ------ | ------- |  | ----- | ------ | ----------- |  | ------------ | ------ | ----- |  | - | ----- | - |  | - | ------- | - |  | - | ------ | 
|                                                |  | United |        | United 
|                                                |  | States |        | Kingdom |  | China |        | Philippines |  | Eliminations |        | Total
|                                                |  |        |        |         |  |       |        |             |  |              |        |      
|December 31, 1998                              
|                                               
|                                               
|                                               
|                                               
|Net sales                                       |  | $      | 92,251 |         |  | $     | 33,438 |             |  | $            | 7,205  |       |  | $ | 3,010 |   |  | $ | (40,857 | ) |  | $ | 95,047 | 
|                                               
|                                               
|                                               
|                                               
|Income (loss) before provision
for income taxes |  |        | 4,643  |         |  |       | 676    |             |  |              | (947   | )     |  |   | (2    | ) |  |   | (7      | ) |  |   | 4,363  | 
|                                               
|                                               
|                                               
|                                               
|Provision for income taxes                      |  |        | 1,537  |         |  |       | 209    |             |  |              |       |       |  |   | 27    |   |  |   |        |   |  |   | 1,773  | 
|                                               
|                                               
|                                               
|                                               
|Depreciation                                    |  |        | 4,408  |         |  |       | 36     |             |  |              | 168    |       |  |   | 41    |   |  |   |        |   |  |   | 4,653  | 
|                                               
|                                               
|                                               
|                                               
|Total assets                                    |  |        | 60,514 |         |  |       | 9,195  |             |  |              | 12,301 |       |  |   | 642   |   |  |   | (4,748  | ) |  |   | 77,904 | 
|                                               
|                                               
|                                               
|                                               
|Capital expenditures                            |  |        | 2,809  |         |  |       | 10     |             |  |              | 5,298  |       |  |   | 2     |   |  |   |        |   |  |   | 8,119  | 

|                                         |  |        |         |         |  |       |        |             |  |              |        |       |  |   |       |  |  |   |         |   |  |   |         | 
|---------------------------------------- |  | ------ | ------- | ------- |  | ----- | ------ | ----------- |  | ------------ | ------ | ----- |  | - | ----- |  |  | - | ------- | - |  | - | ------- | 
|                                         |  | United |         | United 
|                                         |  | States |         | Kingdom |  | China |        | Philippines |  | Eliminations |        | Total
|                                         |  |        |         |         |  |       |        |             |  |              |        |      
|December 31, 1999                       
|                                        
|                                        
|                                        
|                                        
|Net sales                                |  | $      | 134,028 |         |  | $     | 68,798 |             |  | $            | 40,257 |       |  | $ | 3,291 |  |  | $ | (98,966 | ) |  | $ | 147,408 | 
|                                        
|                                        
|                                        
|                                        
|Income before provision for
income taxes |  |        | 6,381   |         |  |       | 1,624  |             |  |              | 2,147  |       |  |   | 65    |  |  |   | (325    | ) |  |   | 9,892   | 
|                                        
|                                        
|                                        
|                                        
|Provision for income taxes               |  |        | 2,140   |         |  |       | 811    |             |  |              |       |       |  |   | 17    |  |  |   |        |   |  |   | 2,968   | 
|                                        
|                                        
|                                        
|                                        
|Depreciation                             |  |        | 4,983   |         |  |       | 21     |             |  |              | 856    |       |  |   |      |  |  |   |        |   |  |   | 5,860   | 
|                                        
|                                        
|                                        
|                                        
|Total assets                             |  |        | 101,562 |         |  |       | 10,421 |             |  |              | 19,235 |       |  |   | 696   |  |  |   | (4,984  | ) |  |   | 126,930 | 
|                                        
|                                        
|                                        
|                                        
|Capital expenditures                     |  |        | 7,459   |         |  |       | 9      |             |  |              | 5,624  |       |  |   |      |  |  |   |        |   |  |   | 13,092  | 

Net sales are generated from the sale of LCD display devices, which are
applied in several different end-use products. Total net sales by these product
categories are as follows (in thousands):

|                                                                 |       |   |                                  |        |      |   |        |        |  |   |         |         | 
|---------------------------------------------------------------- | ----- | - | -------------------------------- | ------ | ---- | - | ------ | ------ |  | - | ------- | ------- | 
|                                                                 |       |   | For the Years Ended December 31,
|                                                                 |       |   |                                 
|                                                                 |       |   | 1997                             |        | 1998 |   | 1999  
|                                                                 |       |   |                                  |        |      |   |       
|Cellular telephones and other wireless communication
    devices |       | $ | 31,415                           |        |      | $ | 62,073 |        |  | $ | 128,634 |        
|                                                                
|                                                                
|                                                                
|                                                                
|Office automation equipment                                      |       |   | 33,528                           |        |      |   | 12,658 |        |  |   | 7,908   |        
|                                                                
|                                                                
|                                                                
|                                                                
|Other                                                            |       |   | 19,699                           |        |      |   | 20,316 |        |  |   | 10,866  |        
|                                                                 |       |   |                                  |        |      |   |        |        |  |   |         |        
|                                                                 | Total |   | $                                | 84,642 |      |   | $      | 95,047 |  |   | $       | 147,408 | 
|                                                                 |       |   |                                  |        |      |   |        |        |  |   |         |        

F-18



---



##### Table of Contents



(9) Selected Quarterly Financial Data (Unaudited)

The following table summarizes the unaudited consolidated quarterly
results of operations as reported for 1998 and 1999 (in thousands, except per
share amounts):

|                                    |         |   |                |      |         |   |         |      |         |   |         |       |         |   |         |      |         |   |        |       |   |   |        |      |  |   |        |      |  |   |        |      | 
|----------------------------------- | ------- | - | -------------- | ---- | ------- | - | ------- | ---- | ------- | - | ------- | ----- | ------- | - | ------- | ---- | ------- | - | ------ | ----- | - | - | ------ | ---- |  | - | ------ | ---- |  | - | ------ | ---- | 
|                                    |         |   | Quarters Ended
|                                    |         |   |               
|                                    |         |   | 1998           |      | 1999   
|                                    |         |   |                |      |        
|                                    |         |   | Mar. 31        |      | June 30 |   | Sep. 30 |      | Dec. 31 |   | Mar. 31 |       | June 30 |   | Sep. 30 |      | Dec. 31
|                                    |         |   |                |      |         |   |         |      |         |   |         |       |         |   |         |      |        
|Net sales                           |         | $ | 18,479         |      |         | $ | 22,682  |      |         | $ | 24,572  |       |         | $ | 29,314  |      |         | $ | 23,044 |       |   | $ | 31,600 |      |  | $ | 42,723 |      |  | $ | 50,041 |     
|                                   
|                                   
|                                   
|                                   
|Gross profit                        |         |   | 4,792          |      |         |   | 5,587   |      |         |   | 2,329   |       |         |   | 6,190   |      |         |   | 2,853  |       |   |   | 6,497  |      |  |   | 8,841  |      |  |   | 11,634 |     
|                                   
|                                   
|                                   
|                                   
|Net income (loss)                   |         |   | 995            |      |         |   | 1,123   |      |         |   | (403    | )     |         |   | 875     |      |         |   | (642   | )     |   |   | 1,040  |      |  |   | 2,037  |      |  |   | 4,489  |     
|                                   
|                                   
|                                   
|                                   
|Earnings (loss)
per   common
share:
|                                   
|                                   
|                                   
|                                   
|                                    | Basic   |   | $              | 0.09 |         |   | $       | 0.11 |         |   | $       | (0.04 | )       |   | $       | 0.09 |         |   | $      | (0.07 | ) |   | $      | 0.11 |  |   | $      | 0.21 |  |   | $      | 0.37 | 
|                                    |         |   |                |      |         |   |         |      |         |   |         |       |         |   |         |      |         |   |        |       |   |   |        |      |  |   |        |      |  |   |        |     
|                                    | Diluted |   |                | 0.09 |         |   |         | 0.10 |         |   |         | (0.04 | )       |   |         | 0.09 |         |   |        | (0.07 | ) |   |        | 0.11 |  |   |        | 0.21 |  |   |        | 0.35 | 
|                                    |         |   |                |      |         |   |         |      |         |   |         |       |         |   |         |      |         |   |        |       |   |   |        |      |  |   |        |      |  |   |        |     

F-19



---



##### Table of Contents









REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS

To Three-Five Systems, Inc.:

We have audited in accordance with auditing standards generally accepted in the
United States, the financial statements included in Three-Five Systems, Inc.
and subsidiaries (the Company) Form 10-K, and have issued our report thereon
dated January 21, 2000. Our audit was made for the purpose of forming an
opinion on those statements taken as a whole. The schedule shown on page S-2
is the responsibility of the Companys management and is presented for the
purposes of complying with the Securities and Exchange Commissions rules and
is not part of the basic financial statements. This schedule has been
subjected to the auditing procedures applied in the audit of the basic
financial statements and, in our opinion, fairly states in all material
respects the financial data required to be set forth therein in relation to the
basic financial statements taken as a whole.



| | /S/ ARTHUR ANDERSEN LLP
| | -----------------------

Phoenix, Arizona,
    January 21, 2000.

S-1



---



##### Table of Contents



THREE-FIVE SYSTEMS, INC. AND SUBSIDIARIES







SCHEDULE II
VALUATION AND QUALIFYING ACCOUNTS AND RESERVES
For the Years Ended December 31, 1997, 1998 and 1999

|                                                                  |                     |  |                     |       |                  |  |                  |        |       |  |        |     |                   |  |  |        |      |  |   |       | 
|----------------------------------------------------------------- | ------------------- |  | ------------------- | ----- | ---------------- |  | ---------------- | ------ | ----- |  | ------ | --- | ----------------- |  |  | ------ | ---- |  | - | ----- | 
|                                                                  |                     |  | Balance at          |       | Charged to Costs |  | Charged to Other |        |       |  |        |     | Balance at End of
|                                                                  |                     |  | beginning of Period |       | and Expenses     |  | Accounts         |        | Other |  | Period
|                                                                  |                     |  |                     |       |                  |  |                  |        |       |  |       
|                                                                  |                     |  | (in thousands)     
|Allowance for doubtful
accounts and sales
returns and allowances: |                     |  |                     |       |                  |  |                  |        |       |  |        |     |                   |  |  |        |      |  |   |      
|                                                                 
|                                                                 
|                                                                 
|                                                                 
|                                                                  | Year ended 12/31/97 |  | $                   | 649   |                  |  |                  | (105   | )     |  |        | 36  | (1)               |  |  |       |      |  | $ | 580   | 
|                                                                 
|                                                                 
|                                                                 
|                                                                 
|                                                                  | Year ended 12/31/98 |  |                     | 580   |                  |  |                  | (24    | )     |  |        | (40 | )(1)              |  |  |       |      |  |   | 516   | 
|                                                                 
|                                                                 
|                                                                 
|                                                                 
|                                                                  | Year ended 12/31/99 |  |                     | 516   |                  |  |                  | 219    |       |  |        | 15  | (1)               |  |  |       |      |  |   | 750   | 
|                                                                 
|                                                                 
|                                                                 
|                                                                 
|Inventory Reserve:                                               
|                                                                 
|                                                                 
|                                                                 
|                                                                 
|                                                                  | Year ended 12/31/97 |  | $                   | 6,782 |                  |  |                  | 1,114  |       |  |        |    |                   |  |  | (3,587 | )(2) |  | $ | 4,309 | 
|                                                                 
|                                                                 
|                                                                 
|                                                                 
|                                                                  | Year ended 12/31/98 |  |                     | 4,309 |                  |  |                  | (1,660 | )     |  |        |    |                   |  |  | (1,524 | )(2) |  |   | 1,125 | 
|                                                                 
|                                                                 
|                                                                 
|                                                                 
|                                                                  | Year ended 12/31/99 |  |                     | 1,125 |                  |  |                  | 4,603  |       |  |        |    |                   |  |  | (2,700 | )(2) |  |   | 3,028 | 



---

|(1) |  | Actual return activity        
|--- |  | ------------------------------
|   
|   
|   
|   
|(2) |  | Obsolete inventory written off

S-2



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##### Table of Contents



EXHIBIT INDEX

|        |  |                                                                                                                                                                      
|------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit
|Number  |  | Exhibits                                                                                                                                                             
|        |  |                                                                                                                                                                      
|2       |  | Amended and Restated Agreement and Plan or Reorganization(1)                                                                                                         
|       
|       
|       
|       
|3(a)    |  | Restated Certificate of Incorporation of the Company(2)                                                                                                              
|       
|       
|       
|       
|3(b)    |  | Amended and Restated Bylaws of the Company(3)                                                                                                                        
|       
|       
|       
|       
|4       |  | Form of Certificate of Common Stock(3)                                                                                                                               
|       
|       
|       
|       
|10(a)   |  | 1990 Incentive Stock Option Plan(1)                                                                                                                                  
|       
|       
|       
|       
|10(c)   |  | Line of Credit Agreement between Three-Five Systems Limited and Barclays Bank, PLC(1)                                                                                
|       
|       
|       
|       
|10(d)   |  | Sub-Assembly Agreement between Three-Five Systems, Inc. and TEAM Pacific Corporation
dated February 22, 1995(4)                                                      
|       
|       
|       
|       
|10(g)   |  | Form of Three-Five Systems, Inc. Distributor Franchise Agreement(5)                                                                                                  
|       
|       
|       
|       
|10(j)   |  | 1993 Stock Option Plan(5)                                                                                                                                            
|       
|       
|       
|       
|10(k)   |  | 1994 Automatic Stock Option Plan(6)                                                                                                                                  
|       
|       
|       
|       
|10(l)   |  | Lease Agreement between Technology Electronic Assembly and Management (T.E.A.M.)
Pacific Corporation and Three-Five Systems Pacific, Inc.(7)                         
|       
|       
|       
|       
|10(m)   |  | Lease Agreement between Regent Apparel Corporation and Three-Five Systems Pacific,
Inc.(7)                                                                           
|       
|       
|       
|       
|10(o)   |  | Lease dated April 1, 1994, between Papago Park Center, Inc. and Three-Five Systems,
Inc.(8)                                                                          
|       
|       
|       
|       
|10(t)   |  | Credit Agreement dated May 23, 1997 between Three-Five Systems, Inc. and Imperial
Bank(9)                                                                            
|       
|       
|       
|       
|10(u)   |  | Addendum No. 1 to Sub-Assembly Agreement between Three-Five Systems, Inc. and TEAM
Pacific Corporation dated March 12, 1997(9)                                       
|       
|       
|       
|       
|10(v)   |  | 1997 Employee Stock Option Agreement(9)                                                                                                                              
|       
|       
|       
|       
|10(w)   |  | Amended and Restated Three-Five Systems, Inc. 1998 Stock Option Plan, amended as of
January 28, 1999, as approved by the Companys stockholders on April 22, 1999(10)
|       
|       
|       
|       
|10(x)   |  | 1998 Directors Stock Plan(9)                                                                                                                                        
|       
|       
|       
|       
|10(y)   |  | Addendum No. 2 to Sub-Assembly Agreement between Three-Five Systems, Inc. and TEAM
Pacific Corporation dated January 1, 1998(9)                                      
|       
|       
|       
|       
|10(z)   |  | 401(k) Profit Sharing Plan(11)                                                                                                                                       
|       
|       
|       
|       
|10(aa)  |  | Credit Agreement dated November 5, 1998, by and among Three-Five Systems, Inc., its
subsidiaries, the Banks named therein, and Imperial Bank Arizona, as Agent.(12)  
|       
|       
|       
|       
|10(bb)  |  | Security Agreement dated November 5, 1998, by Three-Five Systems, Inc. in favor of
Imperial Bank Arizona, as Agent.(12)                                              
|       
|       
|       
|       
|21      |  | List of Subsidiaries(3)                                                                                                                                              
|       
|       
|       
|       
|23      |  | Consent of Arthur Andersen LLP                                                                                                                                       
|       
|       
|       
|       
|27      |  | Financial Data Schedule                                                                                                                                              



---

|(1)  |  | Incorporated by reference to the Registration Statement on Form S-4 of TF
Consolidation, Inc. (Registration No. 33-33944) as filed March 27, 1990
and declared effective March 27, 1990.                                       
|---- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|    
|    
|    
|    
|(2)  |  | Incorporated by reference to the Registrants Form 10-QSB for the quarter
ended March 31, 1994, as filed with the Commission on or about May 12,
1994.                                                                         
|    
|    
|    
|    
|(3)  |  | Incorporated by reference to the Registration Statement on Form S-3
(Registration No. 333-84083) as filed on July 30, 1999, as amended by Form
S-3/A filed on August 26, 1999, and declared effective September 27, 1999.      
|    
|    
|    
|    
|(4)  |  | Incorporated by reference to the Registrants Form 10-KSB for the fiscal
year ended December 31, 1994 filed with the Commission on March 22, 1995,
as amended by Form 10-KSB/A as filed with the Commission on April 28,
1995. 
|    
|    
|    
|    
|(5)  |  | Incorporated by reference to the Registration Statement on Form S-1
(Registration No. 33-74788) as filed on February 3, 1994, and declared
effective March 15, 1994.                                                           
|    
|    
|    
|    
|(6)  |  | Incorporated by reference to the Registration Statement on Form S-8
(Registration No. 33-88706) as filed on January 24, 1995.                                                                                                  
|    
|    
|    
|    
|(7)  |  | Incorporated by reference to the Registrants Form 10-K for the fiscal
year ended December 31, 1995, as filed with the Commission on March 13,
1996.                                                                           
|    
|    
|    
|    
|(8)  |  | Incorporated by reference to the Registrants Form 10-K for the fiscal
year ended December 31, 1996, as filed with the Commission on March 14,
1997.                                                                           
|    
|    
|    
|    
|(9)  |  | Incorporated by reference to the Registrants Form 10-K for the fiscal
year ended December 31, 1997, as filed with the Commission on March 13,
1998, and as amended by Form 10-K/A filed with the Commission on March 23,
1998.
|    
|    
|    
|    
|(10) |  | Incorporated by reference to the Registration Statement on Form S-8
(Registration No. 333-87875) as filed on September 27, 1999.                                                                                               
|    
|    
|    
|    
|(11) |  | Incorporated by reference to the Registration Statement on Form S-8
(Registration No. 333-57933) as filed on June 26, 1998.                                                                                                    
|    
|    
|    
|    
|(12) |  | Incorporated by reference to the Registrants Form 10-K for the fiscal
year ended December 31, 1998, as filed with the Commission on March 15,
1999.