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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
   Form 10-K x
    
    ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)OF THE SECURITIES EXCHANGE ACT OF 1934
 For the fiscal year ended December 31, 2003 Commission File Number 000-50289   Brillian Corporation 
 (Exact Name of Registrant as Specified in Its Charter)
 Delaware
    
    05-0567906(State or Other Jurisdiction of Incorporation or Organization)
    
    (I.R.S. Employer Identification No.)
 1600 N. Desert Drive
Tempe, Arizona 85281
(602) 389-8888  (Address including zip code, and telephone number,
including area code, of principal executive offices)
 Securities registered
pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Exchange Act: Common Stock, par value $.001 per share 
 (Title of Class)
 Preferred Stock Purchase Rights 
 (Title of Class)
 Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes x No o 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. o Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act).
Yes o No x The aggregate market value of Common Stock held by nonaffiliates of the
registrant (3,978,613 shares) based on the last reported sale price of the registrants
Common Stock on the Nasdaq National Market on September 16, 2003,
which was the first business day on which the Common Stock was publicly traded,
was $38,791,477. 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 23, 2004, there were outstanding 5,392,717 shares of the
registrants Common Stock, par value $.001 per share. Documents Incorporated by Reference Portions of the registrants definitive Proxy Statement for the 2004
Annual Meeting of Stockholders are incorporated by reference into Part III of
this Form 10-K.




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BRILLIAN CORPORATION ANNUAL REPORT ON FORM 10-K
For the Fiscal Year Ended December 31, 2003 TABLE OF CONTENTS PagePART IITEM 1.
    
    BUSINESS
    
    
    1ITEM 2.
    
    PROPERTIES
    
    
    25ITEM 3.
    
    LEGAL PROCEEDINGS
    
    
    26ITEM 4.
    
    SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
    
    
    26PART IIITEM 5.
    
    MARKET FOR THE
REGISTRANTS COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
    
    
    27ITEM 6.
    
    SELECTED FINANCIAL DATA
    
    
    28ITEM 7.
    
    MANAGEMENTS
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
    
    
    29ITEM 7A.
    
    QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
    
    
    38ITEM 8.
    
    FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
    
    
    39ITEM 9.
    
    CHANGES
IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE
    
    
    39ITEM 9A.
    
    CONTROLS AND PROCEDURES
    
    
    39PART IIIITEM 10.
    
    DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
    
    
    39ITEM 11.
    
    EXECUTIVE COMPENSATION
    
    
    39ITEM 12.
    

SECURITY
OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND RELATED STOCKHOLDER
MATTERS
    
    
    39ITEM 13.
    
    CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
    
    
    39ITEM 14.
    
    PRINCIPAL ACCOUNTANT FEES AND SERVICES
    
    
    39PART IVITEM 15.
    
    EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
    
    
    39SIGNATURES
    
    
    
    
    41INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
    
    
    F-1EX-23.1EX-31.1EX-31.2EX-32.1EX-32.2
  Statement Regarding Forward-Looking Information 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 2004 and
thereafter; technological innovations; future products or product development;
our product development strategies; beliefs regarding product and technology
performance; potential acquisitions or strategic alliances; the success of
particular product or marketing programs; 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 under Item 1, Business  Risk Factors. i




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PART I 
 Item 1. Business Introduction We design and develop large-screen, rear-projection, high-definition
televisions, or HDTVs, utilizing our proprietary liquid crystal on silicon, or
LCoS®, microdisplay technology. We market our HDTVs for sale under the brand
names of retailers, including consumer electronics retailers, consumer retail
stores, personal computer manufacturers, and high-end audio/video
manufacturers. We have established a virtual manufacturing model utilizing
third-party contract manufacturers to produce our HDTVs, which incorporate the
LCoS microdisplays that we manufacture. We also offer a broad line of LCoS
microdisplay products and subsystems that original equipment manufacturers, or
OEMs, can integrate into proprietary HDTV products, home theater projectors,
and near-to-eye applications, such as head-mounted monocular or binocular
headsets and viewers, for industrial, medical, military, commercial, and
consumer applications. Microdisplays address the technological demands of the HDTV, home theater,
and near-to-eye markets. Microdisplays are thumbnail-sized displays that
create high-resolution images, including full motion video and computer screen
content. The tiny image on a microdisplay is projected onto a screen or other
surface for individual or group viewing or is viewed through a magnifying
device similar to a viewfinder in portable applications. Rear-projection
televisions shine a magnified image from a microdisplay onto the back of a
translucent screen for viewing; home theater projectors cast the image produced
by a microdisplay on a distant screen; and near-to-eye microdisplay devices
produce an image that can be viewed through a magnifying headset or viewer. Liquid crystal on silicon microdisplays contain a liquid crystalline
material suspended between a glass plate and a silicon backplane. Because
integrated circuits form the basis of these displays, liquid crystal on silicon
technology permits a very high-resolution, high-performance display. We
believe that liquid crystal on silicon microdisplays, particularly our Gen II
LCoS microdisplays, provide a superior alternative to existing technologies in
the HDTV market. We believe our Gen II LCoS technology provides significant
advantages in terms of resolution, brightness, contrast ratio, lifetime, and
cost, particularly in larger screen sizes. Given these advanced capabilities,
our HDTVs compete in the premium segment of the large-screen HDTV market. The worldwide conversion of media content from analog to digital is a
primary growth driver in the television market. This conversion is being
mandated in the United States, Europe, and Asia. For example, the U.S.
Congress has set a target date of December 31, 2006 for all television
transmissions to be digital. Additionally, the U.S. Federal Communications
Commission requires that all televisions with screen sizes of 36 inches or
larger contain an over-the-air digital tuner by July 1, 2005. CEA Market
Research projects that 4.3 million digital televisions were sold in 2003 and
11.9 million will be sold in 2006. The increasing amounts of digital
programming broadcast in high definition is driving growth in the HDTV market,
including large-screen HDTVs based on microdisplay technologies. The
large-screen HDTV market based on microdisplay technologies is expected to grow
92% from 2003 to 2006, with an estimated 3.8 million units to be sold in 2006
according to iSuppli/Stanford Resources. We are currently focusing a majority
of our resources on penetrating the premium segment of this market. We also believe that our LCoS microdisplays provide the best commercially
available solution for high-resolution, color, near-to-eye applications. While
the current market for near-to-eye displays is focused on medical, industrial,
and military applications, we believe the consumer market will be the largest
unit volume microdisplay market. Anticipated initial consumer market
applications include head-mounted display products for video games, portable
DVD viewers, and secondary monitors for privately viewing notebook computers.
We believe the substantial current user base in these consumer markets
represents a large market opportunity for our products. Until September 2003, we operated as a division of Three-Five Systems,
Inc., or TFS. In anticipation of our spin-off to the stockholders of TFS, TFS
organized us as a wholly owned subsidiary. In connection with the spin-off,
TFS transferred to us its entire LCoS microdisplay business, including all
related manufacturing and business assets, personnel, and intellectual
property. TFS also provided initial cash funding to us in the amount of $20.9
million. The spin-off was completed on September 15, 2003 as a special
dividend to the stockholders of TFS.




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We maintain our principal executive offices at 1600 North Desert Drive,
Tempe, Arizona 85281. Our telephone number is (602) 389-8888. Our website is located at www.brilliancorp.com. The information contained
on our website does not constitute part of this prospectus. Through our
website, we make available free of charge our annual reports on Form 10-K, our
proxy statements, our quarterly reports on Form 10-Q, our current reports on
Form 8-K, and amendments to those reports filed or furnished pursuant to
Section 13(a) or 15(d) under the Securities Exchange Act. These reports are
available as soon as reasonably practicable after we electronically file those
materials with the Securities and Exchange Commission. We also post on our
website the charters of our Audit, Compensation, and Nominations and Corporate
Governance Committees; our Corporate Governance Guidelines, our Code of
Conduct, our Code of Ethics for the CEO and Senior Financial Officers, and any
amendments or waivers thereto; and any other corporate governance materials
contemplated by SEC or Nasdaq regulations. The documents are also available in
print by contacting our corporate secretary at our executive offices. Industry Factors Industry Background Microdisplays address the technological demands of the HDTV, home theater,
and near-to-eye markets. Microdisplays are thumbnail-sized displays that
create high-resolution images, including full motion video and computer screen
content. The tiny image on a microdisplay is projected onto a screen or other
surface for individual or group viewing or is viewed through a magnifying
device similar to a viewfinder in portable applications. Rear-projection
televisions shine a magnified image from a microdisplay onto the back of a
translucent screen for viewing; home theater projectors cast the image produced
by a microdisplay on a distant screen; and near-to-eye microdisplay devices
produce an image that can be viewed through a magnifying headset or viewer. Rear-Projection Televisions The worldwide conversion of media content from analog to digital is a
primary growth driver in the television market. This conversion is being
mandated in the United States, Europe, and Asia. For example, the U.S.
Congress has set a target date of December 31, 2006 for all television
transmissions to be digital. Additionally, the U.S. Federal Communications
Commission requires that all televisions with screen sizes of 36 inches or
larger contain an over-the-air digital tuner by July 1, 2005. CEA Market
Research projects that 4.3 million digital televisions were sold in 2003 and
11.9 million will be sold in 2006. The increasing amounts of digital
programming broadcast in high definition is driving growth in the HDTV market,
including large-screen HDTVs based on microdisplay technologies. The
large-screen HDTV market based on microdisplay technologies is expected to grow
92% from 2003 to 2006, with an estimated 3.8 million units to be sold in 2006
according to iSuppli/Stanford Resources. We are currently focusing a majority
of our resources on penetrating the premium segment of this market. Within the home electronics market, there is a continuing trend toward
larger and higher-resolution video screens for home entertainment systems.
Picture quality, including high resolution, high contrast ratio, and a high
pixel fill factor, continues to gain importance in the HDTV market. We believe
consumers are willing to spend more for higher quality entertainment in their
homes to support their diverse television, video, Internet, and other digital
entertainment needs. We believe that microdisplays will become a primary
avenue for delivering large-screen HDTVs. Currently, the large-screen, rear-projection HDTV market is being served
primarily by incumbent cathode ray tube, or CRT, technology as well as by
emerging digital micromirror device, or DMD, and high-temperature polysilicon
technologies. A CRT is an electronic display device that utilizes three
projection devices to create a full motion, full color image. We believe
projection CRTs present resolution, size, weight, cost, and performance issues.
DMDs are a proprietary product of Texas Instruments, which calls this
technology DLP. DLPs, which are silicon based, are reflective devices
containing an array of individually movable micromirrors, one for each pixel.
DLPs are relatively expensive to manufacture, especially for larger devices
with higher resolutions, and the manufacturing facilities involve major capital
investments. We believe DLPs have image quality issues, particularly related
to contrast ratio, unwanted video artifacts, and color distortion.
High-temperature polysilicon microdisplays use a transmissive technology and
are available from only two large Japanese companies. High-temperature
polysilicon 2




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microdisplays require special optics and are large and expensive. We
believe the transmissive nature of high-temperature polysilicon suffers from a
low pixel fill factor, which produces an undesirable screen door effect on the
image. The large-screen HDTV market is also being served by flat panel plasma
technology. Plasma screens tend to be expensive to manufacture, especially in
larger screen sizes, and experience screen burn-in and pixel longevity issues.
Thin film transistor liquid crystal displays, or TFT LCDs, may also be used in
the large-screen HDTV market. TFT LCDs, however, are expensive to manufacture
in larger screen sizes and exhibit a very pronounced screen door effect in
larger screen sizes. Motorola recently announced carbon nanotube technology
designed to enable manufacturers to design large flat panel displays that
exceed the image quality characteristics of plasma and TFT LCDs at lower costs.
Motorola states that it is in discussions with electronics manufacturers in
Europe and Asia to license the technology for commercialization. At this time,
we cannot assess the performance of that technology or the effect, if any, it
will have on the large-screen HDTV market. Finally, liquid crystal on silicon microdisplays also are used in the
large-screen HDTV market. Our proprietary Gen II LCoS products have a high
contrast ratio and high pixel fill factor, and we believe that they provide
superior performance to the liquid crystal on silicon technologies produced by
our competitors. Near-to-Eye Applications The near-to-eye market for microdisplays consists of an established
electronic viewfinder market and an emerging high-resolution viewer market. In
the emerging high-resolution near-to-eye markets, professional applications in
the industrial, medical, and military markets have been the first to develop.
These markets demand superior image quality and high resolution for image,
video, and multimedia applications. Wearable computing, endoscopic surgery,
augmented reality systems, and riflescope applications are examples of product
categories in this segment. Examples of products emerging in professional and
commercial applications include wearable products for enterprise network
access, head-mounted displays for night vision systems, and viewers for test
and measurement systems. As prices for high-resolution near-to-eye
microdisplays decline, we expect professional and commercial applications to
broaden. We believe the consumer market will be the largest unit volume near-to-eye
microdisplay market. Consumers in this market demand high-information content
and power-efficient displays with increasing functionality and smaller sizes.
Anticipated initial applications include head-mounted display products for
video games, portable DVD viewers, and secondary monitors for privately viewing
notebook computers. Head-mounted microdisplays provide features that are
unavailable in current video game products. These features include head
tracking and stereo and 3-D vision, which we believe provide superior game
immersion and realism. Products currently offered in the head-mounted video
game market have low resolution and have experienced limited market success.
By contrast, we believe liquid crystal on silicon microdisplays offer high
resolution and a much improved video game experience. Direct-view displays currently are the primary means of viewing content in
portable devices. Delivery of high-information content through a small,
direct-view display in a portable device, however, presents difficult
technological challenges and human interface issues. As portable products
become smaller, their direct-view displays also become smaller, limiting the
information content and visual experience offered. Small direct-view displays
can offer limited types of data, often involve cumbersome navigation, and
usually present information only in black and white. Larger direct-view
displays that can present more information and full-screen content, color, and
motion consume battery power quickly, do not offer superior image quality, and
are relatively costly. We believe the only available microdisplay technologies targeting portable
near-to-eye applications are high-temperature polysilicon and other
transmissive silicon technologies, organic light emitting diode, or OLED, on
silicon, and liquid crystal on silicon. An OLED is an electronic device that
emits bright light upon the application of an electrical current. We believe
that high-temperature polysilicon and other transmissive silicon technologies
have been unable to deliver resolutions at or above SVGA with acceptable video
performance or image quality. Due to their organic nature, OLED based
microdisplays suffer from short lifetimes and need to use color filters, which
results in a pixelated image. We believe that our LCoS microdisplays provide
the best commercially available solution for high-resolution, color,
near-to-eye applications. 3




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Strategy Our goal is to become a leader in the premium segment of the large-screen
HDTV market as well as to become a leading supplier of microdisplays to OEMs
for both projection and near-to-eye applications. Key elements of our strategy
include the following: Develop and Leverage Key Customer Relationships in the HDTV Market We seek to develop key customer relationships with leading companies in
the HDTV market. We are currently targeting private label retail opportunities
with consumer electronics retailers, consumer retail stores, personal computer
manufacturers, and high-end audio/video manufacturers. Our strategy also
provides our audio/video manufacturer customers with the opportunity to bundle
their electronics with our HDTVs into an integrated entertainment system. This
bundling of the electronics with the HDTV provides increased sales
opportunities for our audio/video manufacturer customers and simplifies the
purchase decision for the ultimate consumer. We believe our strategy of
targeting multiple sales channels will enable us to increase sales at a faster
pace, expand our customer base, and achieve efficiencies of scale.
Additionally, we believe that this strategy will allow us to leverage the brand
names and marketing resources of our key customers in order to drive increased
sales of our products. Leverage Our Virtual Manufacturing Model We plan to utilize third-party contract manufacturers and assemblers to
produce our HDTVs, which incorporate the LCoS microdisplays we manufacture.
This strategy results in a scalable business model; enables us to concentrate

on our core competencies of research and development, technological advances,
and product design; and reduces our capital expenses. We expect our virtual
manufacturing strategy to allow us to maintain a variable cost model, in which
we will not pay many of our manufacturing costs until our HDTVs have been
shipped and billed to our customers. Advance Our Technological Leadership In the HDTV market, we plan to utilize our technological expertise to
advance our industry-leading position in terms of picture quality through
increased resolution, higher contrast ratios, and greater pixel fill factors.
In the near-to-eye market, we plan to utilize our extensive intellectual
property portfolio and technological expertise to provide competitive
advantages and extend the functionality of our products. We intend to continue
to develop our technology to increase the performance of our near-to-eye
products while reducing their size, weight, cost, and power consumption. Pursue Additional Strategic Relationships We intend to enter into additional strategic relationships with leading
companies serving our target markets in order to extend our technology and
enhance our business and competitive position. In the HDTV market, we seek
contract manufacturers, component suppliers, and designers that further our
goal of providing a superior product while advancing our competitive position.
In the microdisplay markets for OEMs, we seek strategic relationships to
enhance our ability to offer value-added microdisplay products, address new
markets, gain market share, and maintain technological leadership. Capitalize on Our LCoS Manufacturing Expertise and Increase Our Manufacturing
Efficiencies We seek to emphasize our extensive manufacturing expertise with respect to
our LCoS microdisplays. We utilize our advanced manufacturing line at our
Tempe facility with its experienced manufacturing team to produce our LCoS
microdisplays. We seek to increase our manufacturing efficiencies, yields, and
quality to reduce the cost and speed the delivery of our LCoS microdisplays.
We stress manufacturing processes and seek to leverage our participation in
both the HDTV and near-to-eye markets. 4




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Provide Value-Added Customer Service for OEMs We plan to foster strong and long-lasting customer relationships by
providing OEM customers with the most advanced microdisplays for their
products. We offer a range of microdisplay products designed to satisfy
varying OEM customer needs in the most efficient manner. We attempt to enhance
the competitive position of our OEM customers by providing them with
high-quality microdisplay products on a timely and cost-effective basis that
enable them to increase the functionality, reduce the size, lower the cost, and
enhance the user experience of their own products. To do so, we work to
improve our productivity, to reduce costs, and to speed the delivery of our
microdisplay products. We also devote considerable effort to support our OEM
customers after the purchase of our microdisplay products. Products Large-Screen, High-Definition Televisions Our initial HDTV product is an HDTV monitor with a screen size of 65
inches. This television is designed to compete in the premium segment of the
large-screen HDTV market. This product has a contrast ratio in excess of
2000:1 and has a 16:9 aspect ratio. It has a resolution of 720p (also known as
HDTV1) utilizing our BR768 microdisplay. We are currently developing HDTVs that will integrate an ATSC television
tuner with our initial HDTV monitor product and anticipate initial shipments of
this product to occur during the first quarter of 2005. We also have under
development an integrated television product with a resolution of 1080i (also
known as HDTV2) and anticipate initial shipments of this product to occur
during the first quarter of 2005. We are also currently evaluating, and
anticipate developing, new platforms with different screen sizes or
modifications in overall dimensions, from our initial HDTV product. We expect
to introduce a product incorporating these changes as early as the first
quarter of 2005. Microdisplay Product Line We offer a broad line of LCoS microdisplay products and subsystems that
OEMs can integrate into proprietary HDTV products, home theater projectors, and
near-to-eye applications. Our microdisplay products include a line of LCoS
display imagers and associated application specific integrated circuits, or
ASICs, that provide driver, controller, and converter functions that operate
the imager. An ASIC is a semiconductor designed for a specific application.
Our imager products have resolutions and sizes designed for specific market
segment applications. The following table sets forth certain information
regarding our currently available imagers and our BR1920 imager currently in
development. Model Number
    
    Resolution
    
    ApplicationsBR768
    
    HDTV1 (720p)
    
    Rear-projection HDTVBR1920
    
    HDTV2 (1080i)
and
WUXGA
(1900 x 1200)
    
    Rear-projection HDTV and other
high-performance video applicationsBR1280
    
    SXGA
(1280 x 1024)
    
    Specialty rear-projection monitors,
front projectors, and photo printersZ86D-3
    
    SVGA
(800 x 600)
    
    Near-to-eye
 We have provided prototypes of our BR1920 imager to potential customers
for evaluation. Our product line also includes optical modules for near-to-eye
applications. Optical modules include illumination, prisms, color separators
and combiners, and lenses to provide complete display products. Our offerings
also include development kits, schematic plans, and specifications, or
reference designs, in order to accelerate time to market for our OEM customers. 5




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Projection Applications Our microdisplay product line addresses the needs of several projection
markets: the OEM rear-projection HDTV market with screen sizes of greater than
50 inches and the front-projection home theater market. Additionally, we serve
several smaller projection markets, including photo printers and digital
cinema. For projection applications, we offer products with SXGA and HDTV1
resolution and are developing products with HDTV2 resolution. Near-to-Eye Applications We produce products to serve the near-to-eye market, including SVGA
imagers, display modules, and reference designs. Our display modules allow OEM
customers to focus on end-product design and packaging, because they can use
our full-color SVGA resolution microdisplay as a drop-in assembly. Our near-to-eye products typically are mounted in a headset, and provide
image magnification. The magnified image appears to the user with the clarity,
size, and resolution of a computer monitor. These products also are compact,
lightweight, and highly energy efficient. With high resolution and small size,
we believe LCoS microdisplays offer unique advantages for these wearable and
portable products. Products based on LCoS microdisplays have long lifetimes,
can be made lightweight with low power requirements, and display sharp, bright
images. Our LCoS microdisplays also withstand wide ambient temperature ranges,
a feature that is important for industrial and portable applications. In
addition, our associated ASICs enable fast rendering of images, an important
attribute for viewing full-motion video. To date, our near-to-eye product sales have been concentrated in specific
industrial, medical, and military applications. Product shipments have
included LCoS microdisplays for monocular and binocular head-mounted displays,
video telescopes, surgical microscopes, and riflescopes. We are developing
microdisplays for use in headsets for video games. These microdisplay headset
products are designed to provide users with an enhanced video game experience
by allowing greater immersion into the game. We also are pursuing the
development of microdisplay-based monocular or binocular displays for use in
various high-information content portable electronic devices, such as portable
DVD viewers, mobile handsets, PDAs, and wireless Internet appliances. Sales and Marketing We are marketing our HDTVs to various retailers for sale to their
customers under their brand names. These retailers include consumer
electronics retailers, consumer retail stores, personal computer manufacturers,
and high-end audio/video manufacturers. Our sales and marketing strategy is
designed to enable consumer electronics retailers and consumer retail stores to
address the premium portion of the HDTV market. Our strategy with personal
computer OEMs is intended to enable those companies to capitalize on the
continued convergence of computers and home entertainment. Finally, our
strategy with high-end audio/video manufacturers is designed to enable those
manufacturers to bundle their electronics with our HDTVs into an integrated
entertainment system. We initially plan to sell our HDTV products in the
United States. We expect to capitalize on opportunities in the Asian market
through strategic alliances and in the European market either directly or
through strategic alliances. We market our LCoS microdisplays to OEMs through a direct technical sales
force. A staff of in-house engineering personnel directs and aids all sales
personnel. Our approach is to become a critical partner to our OEM customers
rather than simply a component supplier by playing an integral role in the
design and development of their products. Potential customers welcome our
technological expertise and broad industry relationships because they do not
always have the core competencies and relationships necessary to develop and
commercialize products incorporating microdisplays. Sales in Asia and Europe represented approximately 44% of our net sales in
2003, approximately 33% of our net sales in 2002, and approximately 11% of our
net sales in 2001. 6




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Customers Our initial HDTV product is targeted at the premium segment of the
large-screen HDTV market. This premium market segment generally consists of
screen sizes greater than 50 inches and retail prices greater than $6,000. The
typical consumer in this segment generally will be features driven and desire
the best picture available. OEM products that have been announced to date for near-to-eye applications include the following:  
    
    video game, personal video player, and medical head-mounted devices from IO Display Systems;
    
    a night vision headset by Trivisio;
    
    a headset for wearable computers designed by Shimadzu and
currently offered in Hitachi and Xybernaut products;
    
    a viewer for a medical microscope by Zeiss;
    
    a viewer for a video telescope by Betacom; and
    
    a riflescope viewer by Brashear. We also have announced design relationships with Accupix, Baranti, and
Visual Interaction. OEM customers in the projection market include SEOS, Kaiser Electronics,
and Liebold Systems. SEOS introduced a specialty rear-projection monitor for
flight simulators with a 15000:1 contrast ratio. Kaiser Electronics has
announced the use of our microdisplays in their Joint Strike Force fighter and
commercial aviation cockpit displays. Liebold Systems utilizes our
microdisplays in their consumer photo printers. For the year ended December 31, 2003, sales to TQ Systems, Inc., Eastman
Kodak, and Brashear accounted for approximately 14%, 14%, and 12%,
respectively, of our revenue. For the year ended December 31, 2002, sales to
Brashear accounted for approximately 23% of our revenue and sales to Kodak
accounted for approximately 14% of our revenue. No other customer accounted
for more than 10% of our revenue during those periods. Sales to Kodak resulted
from our providing advanced product development services for microdisplay
imagers under a $500,000 contract extending through December 31, 2004. Sales
to Brashear resulted from providing advanced development services for
microdisplay imagers under a $599,000 contract that extended through November
30, 2003 and the sale of microdisplays and ASIC products on a purchase order
basis. We anticipate that our initial HDTV sales will be to a limited number
of customers. Our engineering, sales, and marketing professionals are actively involved
with an OEM customer during all phases of prototype design, production, and
product marketing by providing technical and marketing assistance. In most
cases, our technical staff works with each OEM customer in the development
stage to identify potential improvements to the design of the customers
product in parallel with the customers effort. We help our OEM customers
incorporate our microdisplays into their products, thereby reducing the time
required to bring their products to market. This assistance helps customers
accelerate their design process and achieve cost effective and manufacturable
designs, as well as facilitating a smooth transition into high-volume
production. Manufacturing We utilize an advanced manufacturing line in our Tempe facility to
manufacture and test our LCoS microdisplay imagers. Costs incurred by us and
TFS through December 31, 2003 to construct, furnish, and equip the facility
were approximately $24.5 million. The manufacturing facility is fully equipped
in all areas of manufacturing, including front-end, back-end, packaging, and
test. The front-end processes are conducted in side-by-side Class 100 and
Class 1000 clean rooms. Back-end manufacturing, packaging, and test procedures
are all conducted in a Class 1000 clean room. We have an extensive quality control program and maintain quality systems
and processes that meet or exceed the demanding standards set by many leading
OEMs in our targeted industries. We have received ISO 9001 7




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certification of our manufacturing facility and corporate headquarters in
Tempe, Arizona. 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. We employ a virtual manufacturing model through third-party relationships
for our HDTV products. After production and testing, we ship our LCoS imagers
to our light engine manufacturer, which combines our LCoS imagers with a lamp
and an optical core or prism set to complete the light engine. Separately, one
of our contractors assembles a printed circuit board, or PCB, which contains
the necessary electronics and color management systems. The light engine, the
PCB, a screen, a case, and other necessary components are then shipped to our
assembler for final assembly into an HDTV. We believe our virtual manufacturing strategy provides a scalable business
model; enables us to concentrate on our core competencies of research and
development, technological advances, and product design; and reduces our
capital expenditures. In addition, we expect this strategy to significantly
reduce our inventory costs because we will not pay many of our manufacturing
costs until we have actually shipped our HDTVs to our customers and billed
those customers for those products. We do not have long-term agreements with any of our contract manufacturers
or assemblers that guarantee production capacity, prices, lead times, or
delivery schedules. The strategy of relying on those parties exposes us to
vulnerability owing to our dependence on a few contract manufacturers or
assemblers. We may establish relationships with other contract manufacturers
or assemblers in order to reduce our dependence on any one source of supply. Suppliers In our HDTV products, we manufacture and supply the LCoS microdisplay,
which utilizes a silicon backplane manufactured for us by SMIC. We then
contract for the assembly of the following components: a light engine from OCLI
(a subsidiary of JDS Uniphase) designed by ADO, which consists of a lamp from
OSRAM, an optical core or prism set, a projection lens, and our LCoS
microdisplays; a printed circuit board assembled by TFS containing a video
processing integrated circuit from Pixelworks; a screen from Toppan; and a case
designed by IDEO. The remote control is manufactured for us by SMK. Components and raw materials constitute a substantial portion of our LCoS
microdisplay costs. The principal components and raw materials we use in
producing our LCoS microdisplays consist of specialized glass, silicon wafers,
ASICs, liquid crystal, and packaging materials. We attempt to procure components and other raw materials only when a
purchase order or forecast is received from an OEM customer. Our procurement
strategy is to secure alternative sources of supplies for the majority of these
materials. Many of these materials, however, must be obtained from a sole or
limited number of foreign suppliers, which subjects us to the risks inherent in
obtaining materials from foreign sources, including supply interruptions and
currency fluctuations. We have no short-, medium-, or long-term contracts with
any of our suppliers. We purchase all of our components and raw materials on a
purchase-order basis. Our suppliers generally are meeting our requirements,
and we believe our strategic supplier alliances have further strengthened our
relations with offshore suppliers. Research and Development Our research and development programs focus on advancing technology,
developing design and manufacturing processes, and expanding our technology to
serve new markets. We have assembled an experienced research and development
team by hiring personnel formerly employed by various of the pioneers in the
microdisplay industry. In the HDTV product line, we are also researching
system component and design platforms. Our research and development activities
include the following:  
    
    Silicon backplane design to reduce size and cost, increase
resolution and performance, decrease power consumption, and
integrate driver functionality. 8




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
    
    Projection optics, color science, and display
characterization to optimize the link between the science of LCoS
and the end-user experience.
    
    ASIC design to combine and enhance functionality, reduce
cost, and improve HDTV picture quality.
    
    Basic research and development to characterize, test, and
incorporate new liquid crystal solutions, silicon substrates, and
glass. Our engineers and scientists continue to investigate
alternative combinations of materials to improve picture quality,
cost, and manufacturability.
    
    Printed circuit board design.
    
    LCoS package and test development programs. Research and development expenses were $7.4 million, $8.4 million, and
$5.3 million for the years ended December 31, 2003, 2002, and 2001,
respectively. 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 and advance our
intellectual property. We have developed and patented a full suite of
intellectual property for the microdisplay market. We hold patents in various
technological arenas, including display technologies, optical system
illumination technologies, and display drive electronics, and we own fully
functioning reference designs. In total, we hold 69 issued U.S. patents and
have 68 U.S. patents pending. Of these U.S. patents, seven have been issued as
patents in at least one foreign jurisdiction, and 40 more are pending abroad.
Our patents are system and design patents relating to the production of our
imagers, ASICs, optical modules, and light engines and extend from the year
2012 to the year 2023. The patents enhance our ability to protect our unique
technical developments. We currently have trademarked two brand names. The LCoS trademark
describes the technology that makes up the microdisplay. The Brillian
trademark describes the microdisplay product itself. Both of these trademarks
have recognition in the display community and are being promoted and used by us
to gain product awareness. Competition Our HDTVs will encounter competition from a number of the worlds most
recognized consumer electronics companies, such as JVC, Panasonic, Philips,
Samsung, Sharp, Sony, Thompson, and Toshiba. Other companies, such as Dell,
Hewlett-Packard, Gateway, and ViewSonic, could directly or indirectly compete
with our HDTVs. All of these companies have greater market recognition, larger
customer bases, and substantially greater financial, technical, marketing,
distribution, and other resources than we possess, which afford them
competitive advantages over us. For microdisplays used in third-party televisions, we believe that Texas
Instruments, JVC, Hitachi, Aurora Systems, SpatiaLight, Epson, and Sony
constitute our principal competitors. Intel has also announced its intention
to begin manufacturing liquid crystal on silicon microdisplays. Texas
Instruments has developed a digital micromirror device, which is referred to as
DLP, that competes with our LCoS technology. JVC, Hitachi, eLCoS, UMO,
Phillips, Aurora, and SpatiaLight are developing or producing liquid crystal on
silicon microdisplays that compete with our LCoS microdisplays based on their
own technology. The market participation of these companies is expected to
spur the market penetration of liquid crystal on silicon microdisplays. We
believe that our proprietary Gen II LCoS products provide superior performance
to the liquid crystal on silicon technologies produced by our competitors. We believe that eMagin, Epson, and Sony constitute our principal
competitors for microdisplays used in near-to-eye products. eMagin
manufactures a product using OLEDs, while Epson and Sony manufacture
transmissive high-temperature polysilicon microdisplays, which is a type of
microdisplay that can be used in some of the same applications as liquid
crystal on silicon microdisplays. Numerous other established and start-up
companies are also pursuing similar and related technologies that may compete
with our LCoS technology. 9




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Positive factors in our competitive position result from our broad liquid
crystal on silicon capabilities, mature technologies, and high-volume LCoS
microdisplay manufacturing capabilities. A number of our competitors, however,
are large multinational companies that have greater market recognition and

substantially greater financial, technical, marketing, distribution, and other
resources than we possess and that afford them competitive advantages. Technology Purchases and Strategic Investments In August 1997, we entered into a strategic alliance with National
Semiconductor Corporation for the development of LCoS microdisplay products
and, in July 1999, we purchased certain assets and licensed silicon
technologies from National Semiconductor relating to LCoS microdisplays. In
August 1999, we licensed the technology of S-Vision Corporation, a former
microdisplay competitor that had recently ceased operations. In the second
quarter of 2002, we purchased all of the intellectual property of Inviso, a
privately held company with numerous patents and proprietary technology related
to microdisplay development that had recently ceased operations. In January 2002, we hired seven key technical persons formerly employed by
Zight Corporation, a private company focused on microdisplays for personal
display system applications. At that time, Zight had ceased operations. We
then purchased certain fixed assets of Zight at a liquidators auction for
approximately $600,000. Following that auction, we then negotiated with the
representatives of the defunct Zight Corporation to purchase its intellectual
property for approximately $2.0 million. In March 2001, we invested $1.25 million in Silicon Bandwidth, Inc., a
privately held company providing unique semiconductor and optoelectronic
interconnect solutions based upon multiple, patented, proprietary technologies.
We have worked closely with Silicon Bandwidth to design unique,
cost-effective, reconfigurable packaging platforms for LCoS microdisplays. In July 2002, we invested $5.0 million in ColorLink, Inc., a worldwide
leader in the development and manufacture of color management technologies for
microdisplays. ColorLinks products consist of color management components and
system architectures that are critical for digital projection systems that use
high-resolution microdisplays. Those projection systems include color
monitors, high-definition televisions, and multimedia projectors. This
investment furthers our efforts to accelerate as much as possible the
establishment of the necessary infrastructure for LCoS microdisplays. Government Regulation Our operations are subject to certain federal, state, and local regulatory
requirements relating to environmental, waste management, health, and safety
matters. There can be no assurance that material costs and liabilities will
not arise from complying with these or from new, modified, or more stringent
requirements. In addition, our past, current, or future operations may give
rise to claims of exposure by employees or the public or to other claims or
liabilities relating to environmental, waste management, or health and safety
concerns. Our microdisplay manufacturing 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. Backlog As of December 31, 2003, we had a backlog of orders of approximately
$111,000. The backlog of orders as of December 31, 2002, was approximately
$554,000. Our backlog consists of orders for which purchase orders have been
received and which are scheduled for shipment within six months. Most orders
are subject to rescheduling or cancellation with limited penalties. Because of
the possibility of customer changes in product shipments, our backlog as of a
particular date may not be indicative of sales for any succeeding period. 10




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Employees At December 31, 2003, we employed a total of 88 persons. We consider our
relationship with our employees to be good, and none of our employees are
represented by a union in collective bargaining with us. Competition for qualified personnel in our industry is very competitive,
particularly for engineering and other technical personnel. Our success
depends in part on our continued ability to attract, hire, and retain qualified
personnel. Executive Officers The following table sets forth certain information regarding our executive
officers and key employees: Name
    
    Age
    
    PositionVincent F. Sollitto, Jr
    
    
    56
    
    
    President, Chief Executive Officer, and DirectorRobert L. Melcher
    
    
    64
    
    
    Chief Technology OfficerWayne A. Pratt
    
    
    42
    
    
    Vice President, Chief Financial Officer,
Secretary, and TreasurerHope S. Frank
    
    
    44
    
    
    Vice President of Marketing and CommunicationsRajan N. Kapur
    
    
    51
    
    
    Vice President of DevelopmentHenning C. Stauss
    
    
    47
    
    
    Vice President of ManufacturingRainer L. Kuhn
    
    
    43
    
    
    Senior Director of Sales and Marketing
 Vincent
F. Sollitto, Jr. has been our President and Chief Executive
Officer and a director of our company since June 2003. Mr. Sollitto served as
President and Chief Executive Officer of Photon Dynamics, Inc., a provider of
yield management solutions for flat panel displays, from June 1996 until
January 2003. From August 1993 to June 1996, Mr. Sollitto served as the
General Manager of Business Unit Operations for Fujitsu Microelectronics Inc.,
a semiconductor and electronics company. From April 1991 to August 1993, Mr.
Sollitto served as the Executive Vice President of Technical Operations at
Supercomputer Systems, Incorporated. Prior to joining Supercomputer Systems,
Incorporated, Mr. Sollitto spent 21 years in various management positions at
International Business Machines Corporation, including Director of Technology
and Process. Mr. Sollitto serves as a director of Applied Films Corporation, a
thin film deposition equipment company, and Ultratech Stepper, Inc., a
photolithography equipment company, each of which is a public company. Robert L. Melcherhas been our Chief Technology Officer since our
formation. Dr. Melcher served as the Chief Technology Officer of TFS from
October 1999 until our spin-off from TFS. Prior to joining TFS, 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 as Director
of the Physical Sciences Department from 1990 to 1993. Wayne A. Pratthas been our Vice President, Chief Financial Officer,
Secretary, and Treasurer since our formation. Mr. Pratt served as Senior Vice
President and Chief Financial Officer of Limelight Networks, LLC, a provider of
outsourced e-business infrastructure and IP delivery services, from April 2002
until joining our company in April 2003. Mr. Pratt was Senior Vice President
and Chief Financial Officer of Axient Communications, Inc., a venture
capital-backed telecommunications company, from February 2000 until January
2001; Senior Vice President-Operations of Verde Capital Partners, LLC, a
venture capital firm, from November 1999 until January 2000; Senior Vice
President and Chief Financial Officer for Frontier Global Center, Inc., a web
hosting company, from March 1998 until November 1999; Senior Vice President and
Chief Financial Officer for Global Center, Inc., a web hosting company, from
January 1997 until its acquisition by Frontier Global Center, Inc. in February
1998; and Vice President and Chief Financial Officer of Primenet Services for
the Internet, Inc., a nationwide ISP, from December 1995 until its acquisition
by Global Center, Inc. in January 1997. Mr. Pratt was Director of Financial
Reporting for Swift Transportation Co., Inc., a national publicly owned
trucking company, from August 1994 until December 1995. From July 1986 until
August 1994, Mr. Pratt held various positions with KPMG LLP, most recently as a
Senior Manager. In July 2001, Axient Communications, Inc. filed a voluntary
petition for protection from creditors under Chapter 11 of the U.S. Bankruptcy
Code. 11




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Hope S. Frankhas been our Vice President of Marketing and Communications
since January 2004. Prior to joining our company, Ms. Frank served as Vice
President of Communications for Photon Dynamics, Inc. from January 2002 until
March 2003. Prior to joining Photon Dynamics, Ms. Frank served as President of
Strategy 10X from January 2000 until January 2002. Prior to Strategy 10X, Ms.
Frank served as President of Frank Harrison Perez Corporation from 1998 until
December 2000. Rajan N. Kapurhas been our Vice President of Development since November
2003. Prior to that, from our formation until November 2003, Dr. Kapur served
as our Senior Director of Personal Display Systems. Dr. Kapur served as Senior
Director of TFS from January 2002 until our spin-off from TFS. Prior to
joining TFS, Dr. Kapur served as Vice President - Engineering for Zight
Corporation from February 2000 to November 2001 with principal responsibilities
for developing display backplanes, interface ASICs, evaluation kits, and
reference designs for binocular and monocular applications. Dr. Kapur served
as Director of Engineering for Cirrus Logic with which he was employed from
August 1985 to March 1998. He was a member of the Technical Staff of AT&T Bell
Labs from March 1982 to July 1985. Henning C. Stausshas been our Vice President of Manufacturing since
November 2003. Prior to that, from our formation until November 2003, Mr.
Strauss served as our Senior Director of Operations. Mr. Stauss served as
Senior Director  LCoS Operations of TFS from January 2001 until our spin-off
from TFS, where he led the LCoS Manufacturing and Process Engineering
departments and created the wafer scale manufacturing line by using well-known
semiconductor manufacturing equipment and blending them with LCD processes for
making LCoS devices. Mr. Stauss joined TFS as Director of LCD Manufacturing in
August 1997. Prior to joining TFS, Mr. Stauss was leading the product
development and pilot production of Optrex in Germany, a major manufacturer of
LCDs for automotive and telecommunication applications. Rainer L. Kuhnhas been our Senior Director of Sales and Marketing since
our formation. Mr. Kuhn served as the Senior Director of Sales and Marketing
of TFS from February 2003 until our spin-off from TFS and as Senior Director of
Sales  Personal Display Systems from January 2002 until February 2003. Prior
to joining TFS, Mr. Kuhn was Director of Marketing, Product Management, and
Business Development for Zight Corporation from February 1998 to November 2001.
Mr. Kuhn held various management positions with Lexmark International from
March 1997 to February 1998 and various marketing and sales positions with
Siemens Corp. from June 1987 to March 1997. There are no family relationships among any of our directors, officers, or
key employees. We consider Mr. Sollitto, Dr. Melcher, and Mr. Pratt to be our
executive officers and the other individuals to be key employees. 12




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RISK FACTORS You should carefully consider the following risk factors, in addition to
those discussed elsewhere in this report, in evaluating our company and our
business. Risks Related to Our Business We have never achieved profitability on a quarterly or annual basis. We have never achieved profitability on a quarterly or annual basis. We
incurred net losses of $18.7 million in 2003, $23.2 million in 2002, and $22.3
million in 2001. We cannot assure you that we will ever achieve or maintain
profitability. We have not secured any retailers to sell our HDTVs, and we do not have
long-term purchase commitments from OEM customers for our home theater or
near-to-eye microdisplay products. We have not secured any retailers to sell our HDTVs. The inability to
secure retailers to sell our HDTVs would substantially impede our revenue
growth and require us to write off substantial investments that we have made in
this aspect of our business. We anticipate that our initial HDTV sales will be
to a limited number of customers. As a result, we will face the risks inherent
in relying on a concentration of customers. Any material delay, cancellation,
or reduction of orders by one of these customers would adversely affect our
operating results. Our OEM customers generally do not provide us with firm, long-term volume
purchase commitments. In addition, the worldwide adverse economic slowdown
commencing in 2001 has led to radically shortened lead times on purchase
orders. Although we sometimes enter into manufacturing contracts with our OEM
customers, these contracts typically clarify order lead times, inventory risk
allocation, and similar matters rather than provide firm, long-term volume
purchase commitments. As a result, OEM customers generally can cancel purchase
commitments or reduce or delay orders at any time. The cancellation, delay, or
reduction of OEM customer commitments could result in reduced revenue and in
our holding excess and obsolete inventory and having unabsorbed manufacturing
capacity. The large percentage of our OEM 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. In addition, we make significant decisions, including production
schedules, component procurement commitments, facility requirements, personnel
needs, and other resource requirements, based on our estimates of OEM customer
requirements. The short-term nature of our OEM customers commitments and the
possibility of rapid changes in demand for their products reduce our ability to
estimate accurately the future requirements of those customers. Our operating
results may be materially and adversely affected as a result of the failure to
obtain anticipated orders and deferrals or cancellations of purchase
commitments because of changes in OEM customer requirements. Because many of
our costs and operating expenses are relatively fixed, a reduction in OEM
customer demand can harm our gross margins and operating results. On occasion, OEM customers may require rapid increases in production,
which can stress our resources and reduce operating margins. Although we have
had a net increase in our manufacturing capacity over the past few years, we
may not have sufficient capacity at any given time to meet all of our
customers demands or to meet the requirements of a specific project. We face intense competition. Our HDTVs will encounter competition from a number of the worlds most
recognized consumer electronics companies, such as JVC, Panasonic, Philips,
Samsung, Sharp, Sony, Thompson, and Toshiba. All of these companies have
greater market recognition, larger customer bases, and substantially greater
financial, technical, marketing, distribution, and other resources than we
possess, which afford them competitive advantages over us. Intel has also
announced its intention to begin manufacturing liquid crystal on silicon
microdisplays. Other companies, such as Dell, Hewlett-Packard, Gateway, and
ViewSonic, could directly or indirectly compete with our HDTVs. 13




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In addition to the high-definition television market, we serve intensely
competitive industries that are characterized by price erosion, rapid
technological change, and competition from major domestic and international
companies. Our competitive position in these markets could suffer if one or
more of our OEM customers decide to design and manufacture their own
microdisplays, to use microdisplay products that we do not offer, to utilize
competitive products, or to use alternative technologies that we may not offer.
In addition, our OEM customers sometimes develop a second source, even for
microdisplays we supply to 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 performance. 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 developing and producing new products;
    
    our ability to address the needs of our retailer and OEM customers;
    
    the pricing, quality, performance, reliability, features, ease of use, and diversity of our products;
    
    the quality of our customer service;
    
    our efficiency of production;
    
    the rate at which customers incorporate our products into their own products;
    
    product or technology introductions by our competitors; and
    
    foreign currency devaluations, especially in Asian
currencies, such as the Japanese yen, the Korean won, and the
Taiwanese dollar, which may cause a foreign competitors products to
be priced significantly lower than our products. Competing technologies could reduce the demand for our products. We are also subject to competition from competing technologies, such as
CRT, high-temperature polysilicon, plasma, thin film transistor liquid crystal
displays, or TFT LCDs, and digital micromirror technologies, as well as other
emerging technologies or technologies that may be introduced in the future.
For example, Motorola recently announced carbon nanotube technology that is
intended to enable manufacturers to design large flat panel displays that
exceed the image quality characteristics of plasma and LCD screens at a lower
cost. The success of competing technologies could substantially reduce the
demand for our products. We rely on contract manufacturers and assemblers for a portion of our HDTV
production requirements, and any interruptions of these arrangements could
disrupt our ability to fill customer orders. We outsource to various contract manufacturers and assemblers the
production requirements for our HDTVs. The loss of our relationships with our
contract manufacturers or assemblers or their inability to conduct their
manufacturing and assembly services for us as anticipated in terms of cost,
quality, and timeliness could adversely affect our ability to fill retailer
customer orders in accordance with required delivery, quality, and performance
requirements. If this were to occur, the resulting decline in revenue and
revenue potential would harm our business. Securing new contract manufacturers
and assemblers is time-consuming and might result in unforeseen manufacturing
and operations problems. Our contract manufacturers and assemblers must maintain satisfactory delivery
schedules and their inability to do so could increase our costs, disrupt our
supply chain, and result in our inability to deliver our HDTV products, which
would adversely affect our results of operations. Our contract manufacturers and assemblers must maintain high levels of
productivity and satisfactory delivery schedules. We do not have long-term
arrangements with any of our contract manufacturers or assemblers that
guarantee production capacity, prices, lead times, or delivery schedules. Our
contract manufacturers and 14




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assemblers serve many other customers, a number of which have greater
production requirements than we do. As a result, our contract manufacturers
and assemblers could determine to prioritize production capacity for other
customers or reduce or eliminate services for us on short notice. Longer
delivery schedules may be encountered in commencing volume production of our
HDTVs. Any such problems could result in our inability to deliver our HDTV
products in a timely manner and adversely affect our operating results. Shortages of components and materials may delay or reduce our sales and
increase our costs. Our inability or the inability of our contract manufacturers and
assemblers to obtain sufficient quantities of components and other materials
necessary for the production of our products could result in delayed sales or
lost orders, increased inventory, and underutilized manufacturing capacity.
Many of the materials used in the production of our HDTV and microdisplay
products are available only from a limited number of foreign suppliers,
including our light engines from OCLI (a subsidiary of JDS Uniphase), our video
processing integrated circuits from Pixelworks, and our screens from Toppan.
As a result, we are subject to increased costs, supply interruptions, and
difficulties in obtaining materials. Our OEM customers also may encounter
difficulties or increased costs in obtaining from others the materials
necessary to produce their products into which our products are incorporated. We depend on Shanghai-based Semiconductor Manufacturing International
Corporation, or SMIC, for the fabrication of silicon wafers and ASICs for our
HDTV microdisplay products. We depend on Taiwan-based United Microelectronics
Corporation, or UMC, for the fabrication of silicon wafers and ASICs for our
near-to-eye microdisplay products. We do not have a long-term contract with
SMIC or UMC. As a result, neither is obligated to supply us with silicon
wafers or ASICs for any specific period, in any specific quantity, or at any
specific price, except as provided in purchase orders from time to time. The
termination of our arrangements with SMIC or UMC or their inability or
unwillingness to provide us with the necessary amount or quality of silicon
wafers or ASICs on a timely basis would adversely affect our ability to
manufacture and ship our microdisplay products until alternative sources of
supply could be arranged. We cannot assure you that we would be able to secure
alternative arrangements. Materials and components for some of our major programs may not be
available in sufficient quantities to satisfy our needs because of shortages of
these materials and components. Any supply interruption or shortages may
result in lost sales opportunities. We do not sell any products to end users and depend on the market acceptance of
the products of our customers. We do not sell any products to end users. Instead, we design and develop
HDTVs for sale by retailers under their own brand names and we sell
microdisplay products that our OEM customers incorporate into their products.
As a result, our success depends on the ability of our retailer customers to
sell our HDTVs and the widespread market acceptance of our OEM 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 secure successful retailers for our HDTV products
and establish relationships for our microdisplay products with OEMs in
industries that have significant growth potential. Our failure to secure
retailers to sell our HDTVs or to establish relationships with OEMs in those
high-growth markets would reduce our revenue potential. Our dependence on the success of the products of our retailer and OEM
customers exposes us to a variety of risks, including the following:  
    
    our ability to supply products for customers on a timely and cost-effective basis;
    
    our success in maintaining customer satisfaction with our products;
    
    our ability to match our manufacturing capacity with customer
demand and to maintain satisfactory delivery schedules; 15




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
    
    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 adversely affect our results of
operations. We are subject to lengthy development periods and product acceptance cycles. We sell our microdisplay products to OEMs, which then incorporate them
into the products they sell. OEMs make the determination during their product
development programs whether to incorporate our microdisplay products or pursue
other alternatives. This may require us to make significant investments of
time and capital well before our OEM customers introduce their products
incorporating our products and before we can be sure that we will generate any
significant sales to our OEM customers or even recover our investment. During an OEM customers entire product development process, we face the
risk that our products will fail to meet our OEM customers technical,
performance, or cost requirements or will be replaced by a competing product or
alternative technology. Even if we offer products that are satisfactory to an
OEM customer, the customer may delay or terminate its product development
efforts. The occurrence of any of these events would adversely affect our
revenue. The lengthy development period also means that it is difficult to
immediately replace an unexpected loss of existing business. Our Arizona facility and its high-volume LCoS microdisplay manufacturing line
are critical to our success. Our Arizona facility and its high-volume LCoS microdisplay manufacturing
line are critical to our success. We currently produce all of our LCoS
microdisplays on this dedicated line. This facility also houses our principal
research, development, engineering, design, and managerial operations. Any
event that causes a disruption of the operation of this facility for even a
relatively short period of time would adversely affect our ability to produce
our LCoS microdisplays and to provide technical and manufacturing support for
our customers. We experienced lower than expected manufacturing yields in commencing volume
production of LCoS microdisplays, and we must achieve satisfactory
manufacturing yields. The design and manufacture of microdisplays are new and 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 a result of these
factors, we have experienced lower than expected manufacturing yields in
producing LCoS microdisplays. These issues could continue, and we may continue
to encounter lower than desired manufacturing yields as we manufacture LCoS
microdisplays in higher volumes, which could result in the delay of the ramp-up
to high-volume LCoS manufacturing production. Continued lower than expected
manufacturing yields could significantly and adversely affect our operating
margins. Although we added additional equipment to our Arizona manufacturing
facility in the last two years for manufacturing LCoS microdisplays, the
high-volume manufacture of LCoS microdisplays will require us to overcome
numerous challenges, including the following:  
    
    the availability of a sufficient quantity of quality materials,
    
    the implementation of new manufacturing techniques,
    
    the incorporation of new handling procedures,
    
    the maintenance of clean manufacturing environments, and
    
    the ability to master precise tolerances in the manufacturing process. In addition, the complexity of manufacturing processes will increase along
with increases in the sophistication of microdisplays. Any problems with our
manufacturing operations could result in the lengthening of 16




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our delivery schedules, reductions in the quality or performance of our
design and manufacturing services, and reduced customer satisfaction. Various target markets for our LCoS microdisplays are uncertain, may be slow to
develop, or could use competing technologies. Various target markets for our LCoS microdisplays, including HDTVs, home
theaters, and near-to-eye microdisplays, are uncertain, may be slow to develop,
or could utilize competing technologies, especially high-temperature
polysilicon and digital micromirror devices. Many manufacturers have
well-established positions in these markets. HDTV has only recently become
available to consumers, and widespread market acceptance is uncertain.
Penetrating this market will require us to offer an improved value, higher
performance proposition to existing technology. In addition, the commercial
success of the near-to-eye microdisplay market is uncertain. Gaining
acceptance in these markets may prove difficult because of the radically
different approach of microdisplays to the presentation of information. We
must provide customers with lower cost, higher performance microdisplays for
their products in these markets. The failure of any of our target markets to
develop, or our failure to penetrate these markets, would impede our sales
growth. Even if our products successfully meet our price and performance
goals, our retailer customers may not achieve success in selling our HDTVs and
our OEM customers may not achieve commercial success in selling their products
that incorporate our microdisplay products. 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 the following:  
    
    continuing research and development activities on existing and potential products;
    
    engaging additional engineering and other technical personnel;
    
    purchasing advanced design, production, and test equipment;
    
    maintaining and enhancing our technological capabilities; and
    
    expanding our manufacturing capacity. We may be unable to recover any expenditures we make relating to one or more
new technologies that ultimately prove to be unsuccessful for any reason. In
addition, any investments or acquisitions made to enhance our technologies may
prove to be unsuccessful. Our future operating results will depend to a significant extent on our
ability to provide new products that compare favorably on the basis of time to
introduction, cost, and performance with the products of competitive
third-party suppliers and technologies. Our success in attracting new
customers and developing new business depends on various factors, including the
following:  
    
    the acceptance of our technology;
    
    utilization of advances in technology;
    
    innovative development of new microdisplay products for customer products; and
    
    efficient, timely, and cost-effective manufacture of microdisplay products. Our products may not achieve commercial success or widespread market
acceptance. A key element of our current business involves the ongoing
commercialization of our LCoS microdisplay technology. Our products may not
achieve customer or widespread market acceptance. Some or all of our products 17




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may not achieve commercial success as a result of technological problems,
competitive cost issues, yield problems, and other factors. Even when we
successfully introduce a new product designed for OEM customers, our OEM
customers may determine not to introduce or may terminate products utilizing
our products 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,  lack of anticipated or actual market demand for the products, and  unfavorable comparisons with products introduced by others. Our products are complex and may require modifications to resolve undetected
errors or unforeseen failures, which could lead to an increase in our costs, a
loss of customers, or a delay in market acceptance of our products. Our products are complex and may contain undetected errors or experience
unforeseen failures when first introduced or as new versions are released.
These errors could cause us to incur significant re-engineering costs, divert
the attention of our engineering personnel from product development efforts,
and cause significant customer relations and business reputation problems. If
we deliver products with defects, our credibility and the market acceptance and
sales of our products could be harmed. Defects could also lead to liability
for defective products as a result of lawsuits against us or against our
customers. We also may agree to indemnify our customers in some circumstances
against liability from defects in our products. A successful product liability
claim could require us to make significant damage payments. We must protect our intellectual property and could be subject to infringement
claims by others. We believe that our success depends in part on protecting our proprietary
technology. 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 aspects of our technology
under trade secret laws, which afford only limited protection. We face risks
associated with our intellectual property, including the following:  
    
    intellectual property laws may not protect our intellectual property rights;
    
    third parties may challenge, invalidate, or circumvent any patents issued to us;
    
    rights granted under patents issued to us may not provide competitive advantages to us;
    
    pending patent applications may not be issued;
    
    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 in which we
operate. We may not be able to obtain effective patent, 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 and such action may be unsuccessful. 18




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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. 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 nature of our business requires us to make significant capital expenditures
and investments. The nature of our business requires us to make significant capital
expenditures and investments. For example, the capital acquisition cost of our
assets, including intangibles such as tooling, licenses, and patents, was $27.1
million through December 31, 2003. To facilitate the development of our LCoS
microdisplay products, we also made an equity investment of $3.8 million in
Inviso, Inc., which we had to write off in 2001 as a result of the closing of
those operations. In 2002, we purchased all of the technology of Inviso for
$780,000 after Inviso ceased operations. In addition, we purchased assets and
technology of the former Light Valve business unit of National Semiconductor
Corporation for approximately $3.6 million during 1999. In early 2002, we
purchased certain fixed assets of Zight Corporation at a liquidators auction
for approximately $600,000. Following that auction, we then negotiated with
the representatives of the defunct Zight Corporation to purchase its
intellectual property for approximately $2.0 million. We also invested $1.3
million in an advanced packaging company, Silicon Bandwidth, Inc., during 2001
and $5.1 million in ColorLink, Inc., a private company providing color
management systems for LCoS microdisplay light engines, during 2002. We may be
required to make similar investments and capital expenditures in the future to
maintain or enhance our ability to offer technologically advanced products. 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
expenditures, our failure to increase sufficiently our net sales to offset
these increased costs would adversely affect our operating results. Rapid
sales increases would also require substantial increases in working capital. 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 or to finance working capital
requirements. 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
have agreed with TFS not to issue common stock if such issuance could result in
the imposition of a tax under Section 355(e) of the Internal Revenue Code
unless we receive an opinion of counsel that Section 355(e) would not apply to
such issuance because it was not part of a plan at the time of the spin-off. If we choose to manufacture or sell in the European and Asian markets, we may
encounter challenges. Any efforts to manufacture or sell in the European and Asian markets may
create a number of challenges. We and our contract manufacturers and
assemblers purchase certain materials from international sources, and in the
future we may decide to move certain manufacturing functions to, or establish
additional manufacturing functions in, international locations. Purchasing,
manufacturing, and selling products internationally exposes us to various
economic, political, and other risks, including the following:  
    
    management of a multinational organization;
    
    the burdens and costs of compliance with local laws and
regulatory requirements as well as changes in those laws and
requirements;
    
    imposition of restrictions on currency conversion or the transfer of funds;
    
    transportation delays or interruptions and other effects of less developed infrastructures;
    
    foreign exchange rate fluctuations; 19




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
    
    employment and severance issues, including possible employee turnover or labor unrest;
    
    overlap of tax issues;
    
    tariffs and duties;
    
    lack of developed infrastructure; and
    
    political or economic instability in certain parts of the world. Political and economic conditions abroad may adversely affect our foreign
relationships. 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 microdisplays in foreign markets and to purchase
materials or equipment from foreign suppliers. 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. 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 products to our U.S. customers. While we transact business predominantly in U.S. dollars and bill and
collect most of our sales in U.S. dollars, we occasionally collect a portion of
our revenue in non-U.S. currencies. In the future, customers may make payments
in non-U.S. currencies. 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. 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 cyclical nature of the consumer electronics industry may cause substantial
period-to-period fluctuations in our operating results. The consumer electronics industry has experienced significant economic
downturns at various times, characterized by diminished product demand,
accelerated erosion of average selling prices, intense competition, and
production over-capacity. In addition, the consumer electronics industry is
cyclical in nature. We may experience substantial period-to-period
fluctuations in operating results, at least in part because of general industry
conditions or events occurring in the general economy. Our operating results may have significant periodic and seasonal fluctuations. In addition to the variability resulting from the short-term nature of our
customers commitments, other factors may contribute to significant periodic
and seasonal quarterly fluctuations in our results of operations. These
factors include the following:  
    
    the timing and volume of orders relative to our capacity;
    
    product introductions or enhancements and market acceptance
of product introductions and enhancements by us, our OEM customers,
and competitors;
    
    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; 20




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
    
    product mix;
    
    pricing and availability of competitive products; 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 decline. We must effectively manage our growth. The failure to manage our growth effectively could adversely affect our
operations. 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
production facility in Tempe, Arizona. We incur increased costs as a result of being a public company. As a public company, we incur significant legal, accounting, and other
expenses that we did not incur as a division of TFS. In addition, the
Sarbanes-Oxley Act of 2002, as well as new rules subsequently implemented by
the Securities and Exchange Commission and Nasdaq, have required changes in
corporate governance practices of public companies. We expect these new rules
and regulations to increase our legal and financial compliance costs and to
make some activities more time-consuming and costly. In addition, we incur
additional costs associated with our public company reporting requirements. We
also expect these new rules and regulations to make it more difficult and more
expensive for us to obtain director and officer liability insurance and we may
be required to accept reduced policy limits and coverage or incur substantially
higher costs to obtain the same or similar coverage. As a result, it may be
more difficult for us to attract and retain qualified persons to serve on our
board of directors or as executive officers. We are currently evaluating and
monitoring developments with respect to these new rules, and we cannot predict
or estimate the amount of additional costs we may incur or the timing of such
costs. We depend on key personnel. Our development and operations depend substantially on the efforts and
abilities of our senior management and technical personnel. The competition
for qualified management and technical personnel is intense. Although we have
not experienced problems of recruiting and maintaining qualified personnel to
date, we have limited experience in personnel recruitment or retention as an
independent company. The loss of services of one or more of our key employees
or the inability to add key personnel 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. Potential strategic alliances may not achieve their objectives. We have entered into various strategic alliances, and we plan to enter
into other similar types of alliances in the future. Among other matters, we
will explore strategic alliances designed to do the following:  
    
    enhance or complement our technology or work in conjunction with our technology;
    
    increase our manufacturing capacity;
    
    provide necessary know-how, components, or supplies; and
    
    develop, introduce, or distribute products utilizing our technology. 21




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Any strategic alliances may not achieve their strategic objectives, and
parties to our strategic alliances may not perform as contemplated. Any acquisitions that we undertake could be difficult to integrate, disrupt our
business, dilute stockholder value, and harm our operating results. We plan to review opportunities to buy other businesses or technologies
that would complement our current products, expand the breadth of our markets,
enhance our technical capabilities, or otherwise offer growth opportunities.
While we have no current agreements or active negotiations underway, we may buy
businesses, products, or technologies in the future. If we make any future
acquisitions, we could issue stock that would dilute existing stockholders
percentage ownership, incur substantial debt, or assume contingent liabilities.
We have agreed with TFS not to issue common stock in an acquisition
transaction if such issuance could result in the imposition of a tax under
Section 355(e) of the Internal Revenue Code unless we receive an opinion of
counsel that Section 355(e) would not apply to such issuance because it was not
part of a plan at the time of the spin-off. Our experience in acquiring other businesses and technologies is limited.
Potential acquisitions also involve numerous risks, including the following:   problems integrating the purchased operations, technologies, products, or services with our own;  unanticipated costs associated with the acquisition;  diversion of managements attention from our core businesses;  adverse effects on existing business relationships with suppliers and customers;  risks associated with entering markets in which we have no or limited prior experience; and  potential loss of key employees and customers of purchased organizations. Our acquisition strategy entails reviewing and potentially reorganizing
acquired business operations, corporate infrastructure and systems, and
financial controls. Unforeseen expenses, difficulties, and delays frequently
encountered in connection with rapid expansion through acquisitions could
inhibit our growth and negatively impact our profitability. We may be unable
to identify suitable acquisition candidates or to complete the acquisitions of
candidates that we identify. Increased competition for acquisition candidates
may increase purchase prices for acquisitions to levels beyond our financial
capability or to levels that would not result in the returns required by our
acquisition criteria. In addition, we may encounter difficulties in
integrating the operations of acquired businesses with our own operations or
managing acquired businesses profitably without substantial costs, delays, or
other operational or financial problems. We are subject to governmental regulations. Like all businesses, our operations are subject to certain federal, state,
and local regulatory requirements relating to environmental, waste management,
health, and safety matters. We could become subject to liabilities as a result
of a failure to comply with applicable laws and incur substantial costs from
complying with existing, new, modified, or more stringent requirements. In
addition, our past, current, or future operations may give rise to claims of
exposure by employees or the public or to other claims or liabilities relating
to environmental, waste management, or health and safety concerns. Risks Related to Our Recent Spin-Off We have a limited operating history as a public company, and our business has
relied on TFS for various financial, managerial, and administrative services. We have a limited operating history as an independent company. Our
business historically relied on TFS for various financial, managerial, and
administrative services and was able to benefit from the earnings, assets, and
cash flows of TFS other businesses. TFS is no longer obligated to provide
assistance or services to us, except as 22




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described in the Master Separation and Distribution Agreement, the
Transition Services Agreement, and the other agreements entered into between
the companies. Our historical financial information may not be representative of our results
as a separate company, as we previously operated as a division of TFS. The historical financial information included in this report may not be
representative of our results of operations, financial position, and cash flows
had we operated as a separate, stand-alone entity rather than as a division of
TFS during the periods prior to September 15, 2003 or of our results of
operations, financial position, and cash flows in the future. This results
from the following:  
    
    in preparing this information, we have made adjustments and
allocations because TFS did not account for us as, and we were not
operated as, a stand-alone business for all periods prior to the
spin-off; and
    
    the information prior to the spin-off does not reflect many
changes in our funding and operations as a result of our spin-off
from TFS. We cannot assure you that the adjustments and allocations we have made in
preparing our historical financial statements appropriately reflect our
operations during those periods as if we had in fact operated as a stand-alone
entity. We could incur significant tax liability if the contribution or the spin-off
from TFS does not qualify for tax-free treatment. TFS received a private letter ruling from the IRS to the effect that,
among other things, the spin-off was tax free to TFS and the TFS stockholders
under Section 355 of the Internal Revenue Code, except to the extent that cash
was received in lieu of fractional shares. The private letter ruling, while
generally binding upon the IRS, was based upon factual representations and
assumptions and commitments on our behalf with respect to future operations
made in the ruling request. The IRS could modify or revoke the private letter
ruling retroactively if the factual representations and assumptions in the
request were materially incomplete or untrue, the facts upon which the private
letter ruling was based were materially different from the facts at the time of
the spin-off, or if we do not meet certain commitments made. If the spin-off failed to qualify under Section 355 of the Internal
Revenue Code, corporate tax would be payable by the consolidated group of which
TFS is the common parent based upon the difference between the aggregate fair
market value of the assets of our business and the adjusted tax bases of such
business to TFS prior to the spin-off. The corporate level tax would be
payable by TFS. We have agreed, however, to indemnify TFS for this and certain
other tax liabilities if they result from actions taken by us or from the
spin-off. In addition, under the Internal Revenue Codes consolidated return
regulations, each member of the TFS consolidated group, including our company,
will be severally liable for these tax liabilities. If we are required to
indemnify TFS for these liabilities or otherwise are found liable to the IRS
for these liabilities, the resulting obligation could materially and adversely
affect our financial condition. The agreements governing our relationship with TFS following the spin-off were
negotiated while we were a subsidiary of TFS and, as a result, we cannot assure
you that the agreements are on terms favorable to us. The agreements governing our relationship with TFS following the spin-off
were negotiated in a parent-subsidiary context and were negotiated in the
overall context of our separation from TFS. At the time of these negotiations,
certain of our officers were employees of TFS. We cannot assure you that these
agreements were the result of arms-length negotiations. Especially as it
relates to the Transition Services Agreement and the Real Property Sublease
Agreement, we cannot assure you that these agreements are on terms comparable
to those which might have been obtained from unaffiliated third parties.
Additionally, upon the expiration of these agreements, we may not be able to
replace the services and support that TFS provides under these agreements in a
timely manner or on terms and conditions, including costs, as favorable as
those we receive from TFS. While TFS is contractually obligated to provide us with certain
transitional services, we cannot assure you that these services will be
sustained at the same level as when we were part of TFS or that we will obtain
the same 23




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benefits. In addition, as we build our own infrastructure during the term
of those agreements, we will incur additional costs for duplicated
administrative services. We will not be able to rely on TFS to fund future capital requirements and,
therefore, we may not be able to provide for our capital needs. In the past, our capital needs were satisfied by TFS. However, TFS no
longer provides any funds to finance our working capital or other cash
requirements and does not guarantee our financial or other obligations. The
$20.9 million cash funding that TFS provided us in connection with the spin-off
may not be adequate for us to fund our planned operations and expenditures
beyond 2004. It will be necessary for us to reduce substantially our operating
losses (through either increased sales, reduced expenses, or both) or to raise
additional funds. We cannot assure you that we will be able to increase our
sales or raise necessary funds on terms satisfactory to us. We believe that our capital requirements will vary greatly from quarter to
quarter, depending on, among other things, capital expenditures, fluctuations
in our operating results, and financing activities. To increase our financial
resources, we may be required to raise additional capital through a public
offering or private placement of equity with strategic or other investors or
through debt financing in the future. Future equity financings would dilute
the relative percentage ownership of the then existing holders of our common
stock and may be limited by our agreements with TFS, particularly the Tax
Sharing Agreement. Future debt financings could involve restrictive covenants
that limit our ability to take certain actions, such as pay dividends, incur
additional indebtedness, or create liens. We may not be able to obtain
financing on terms as favorable as those historically enjoyed by TFS. For a
more complete discussion of our capital resources, see Managements Discussion
and Analysis of Financial Condition and Results of Operations  Liquidity and
Capital Resources. Risks Related to Securities Markets The market price for our common stock may be volatile, and many factors could
cause the market price of our common stock to rise and fall. Many factors could cause the market price of our common stock to rise and
fall, including the following:  
    
    variations in our quarterly results;
    
    announcements of technological innovations by us or by our competitors;
    
    introductions of new products or new pricing policies by us or by our competitors;
    
    acquisitions or strategic alliances by us or by our competitors;
    
    recruitment or departure of key personnel;
    
    the gain or loss of significant orders;
    
    the gain or loss of significant customers;
    
    changes in the estimates of our operating performance or
changes in recommendations by any securities analysts that follow
our stock; and
    
    market conditions in our industry, the industries of our
customers, and the economy as a whole. In addition, stocks of technology companies have experienced extreme price
and volume fluctuations that often have been unrelated or disproportionate to
these companies operating performance. Public announcements by technology
companies concerning, among other things, their performance, accounting
practices, or legal problems could cause the market price of our common stock
to decline regardless of our actual operating performance. 24




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Substantial sales of our common stock, or the perception that such sales might
occur, could depress the market price of our common stock. Substantially all of the shares of our common stock are eligible for
immediate resale in the public market. Any sales of substantial amounts of our
common stock in the public market, or the perception that such sales might
occur, could depress the market price of our common stock. We have agreed to restrictions and adopted policies in connection with the
spin-off that could have possible anti-takeover effects. We have agreed to certain restrictions on our future actions to assure
that the spin-off is tax-free, including restrictions with respect to an
acquisition of shares of our common stock by an unrelated party. If we fail to
abide by these restrictions, and, as a result, the spin-off fails to qualify as
a tax-free reorganization, we will be obligated to indemnify TFS for any
resulting tax liability. These restrictions and the potential tax liability
that could arise from an acquisition of shares of our common stock, together
with our related indemnification obligations, could have the effect of
delaying, deferring, or preventing a change in control of our company. Provisions in our certificate of incorporation, our bylaws, and Delaware law
could make it more difficult for a third party to acquire us, discourage a
takeover, and adversely affect existing stockholders. Our 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. These include
provisions limiting the stockholders powers to remove directors or take action
by written consent instead of at a stockholders meeting. Our certificate of
incorporation also authorizes our 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. We have also adopted a stockholder rights plan intended to encourage
anyone seeking to acquire our company to negotiate with our board of directors
prior to attempting a takeover. While the plan was designed to guard against
coercive or unfair tactics to gain control of our company, the plan may have
the effect of making more difficult or delaying any attempts by others to
obtain control of our company. These provisions and others that could be adopted in the future could
deter unsolicited takeovers or delay or prevent changes in our control or
management, including transactions in which stockholders might otherwise
receive a premium for their shares over then current market prices. These
provisions may also limit the ability of stockholders to approve transactions
that they may deem to be in their best interests. 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 any earnings to the expansion and development of our
business. 
 Item 2. Properties We occupy approximately 42,500 square feet in a facility in Tempe,
Arizona, which houses our manufacturing operations and research, development,
engineering, design, and corporate functions. We sublease this facility from
TFS under an agreement that extends through August 31, 2005, subject to
automatic one-year renewals cancellable by either TFS or us upon written notice
delivered at least six months prior to such renewal. TFS occupies office space
in a separate part of the Tempe facility, and we share certain common areas of
the facility with TFS. We lease approximately 7,000 square feet of space in Boulder, Colorado. 25




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Item 3. Legal Proceedings We are not currently involved in any legal proceedings that we believe
would have a material adverse effect on our business or financial condition. 
 Item 4. Submission of Matters to a Vote of Security Holders Not applicable. 26




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PART II 
 Item 5. Market for the Registrants Common Equity and Related Stockholder
Matters Our common stock has been traded on the Nasdaq National Market under the
symbol BRLC since September 16, 2003. The following table sets forth the
high and low sale prices of our common stock for each calendar quarter
indicated as reported on the Nasdaq National Market. High
    
    Low2003Third quarter
    
    $
    10.25
    
    
    $
    8.20Fourth quarter
    
    $
    10.25
    
    
    $
    7.702004First quarter (through March 23, 2004)
    
    $
    12.40
    
    
    $
    7.41
 On March 23, 2004, the last reported sale price of our common stock was
$8.25 per share. On March 23, 2004, there were approximately 525 record
holders and approximately 10,200 beneficial owners of our common stock. 27




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Item 6. Selected Financial Data The following table contains selected financial information and is
supplemented by the more detailed financial statements and notes thereto
included elsewhere in this report. The statement of operations data for the
fiscal years ended December 31, 2003, December 31, 2002, and December 31, 2001
and the balance sheet data as of December 31, 2003 and December 31, 2002 have
been derived from our financial statements, which statements have been audited
by Deloitte & Touche LLP, independent auditors, and are included elsewhere in
this report. The statement of operations data for the fiscal year ended
December 31, 2000 and the balance sheet data as of December 31, 2001 have been
derived from our financial statements, which have been audited by Deloitte &
Touche LLP, independent auditors, and are not included elsewhere in this
report. The statement of operations data for the fiscal year ended December
31, 1999 and the balance sheet data as of December 31, 2000 and December 31,
1999 have been derived from information that has not been audited. The statement of operations data and balance sheet data for periods prior
to our spin-off from TFS on September 15, 2003, have been derived from the
financial statements of the microdisplay business of TFS. The pre-spin-off
financial information is not necessarily indicative of our past performance as
an independent company or our future performance. This information should be
read in conjunction with our financial statements and notes thereto and
Managements Discussion and Analysis of Financial Condition and Results of
Operations appearing elsewhere in this report. Years Ended December 31,2003
    
    2002
    
    2001
    
    2000
    
    1999(in thousands, except per share data)Statement of Operations
Data:Net sales
    
    $
    2,194
    
    
    $
    1,439
    
    
    $
    1,936
    
    
    $
    1,105
    
    
    $
    198Costs and expenses:Cost of sales
    
    
    9,829
    
    
    
    12,869
    
    
    
    12,280
    
    
    
    3,509
    
    
    
    47Selling, general, and
administrative
    
    
    4,890
    
    
    
    3,333
    
    
    
    2,760
    
    
    
    2,047
    
    
    
    2,156Research and development
    
    
    7,367
    
    
    
    8,430
    
    
    
    5,339
    
    
    
    5,023
    
    
    
    5,272Operating loss
    
    
    (19,892
    )
    
    
    (23,193
    )
    
    
    (18,443
    )
    
    
    (9,474
    )
    
    
    (7,277
    )Interest income
    
    
    57
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Loss on investment in
start-up company
    
    
    
    
    
    
    
    
    
    
    (3,820
    )
    
    
    
    
    
    
    Benefit from income taxes
    
    
    1,091
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Net loss
    
    $
    (18,744
    )
    
    $
    (23,193
    )
    
    $
    (22,263
    )
    
    $
    (9,474
    )
    
    $
    (7,277
    )Loss per
share(1)
    
    $
    (3.51
    )
    
    $
    (4.35
    )
    
    $
    (4.18
    )
    
    $
    (1.78
    )
    
    $
    (1.37
    )December 31,2003
    
    2002
    
    2001
    
    2000
    
    1999(in thousands)Balance Sheet Data:Cash and cash equivalents
    
    $
    2,417
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    Short-term investments
    
    
    12,000
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Total assets
    
    
    39,793
    
    
    
    27,535
    
    
    
    18,373
    
    
    
    14,750
    
    
    
    10,651Notes payable to banks,
term loans, and long-term
debt
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Total stockholders equity
    
    
    38,555
    
    
    
    25,919
    
    
    
    15,214
    
    
    
    13,066
    
    
    
    9,649
   (1)
    
    Loss per share for the year ended December 31, 2003 is computed by
dividing net loss by the weighted average number of shares of common
stock outstanding. Loss per share for all prior periods is calculated
based on the number of shares of common stock issued in the spin-off and
assumes that these shares were outstanding for the entire period. 28




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##### Table of Contents



Item 7. Managements Discussion and Analysis of Financial Condition, and
Results of Operations You should read the following discussion and analysis in conjunction with
our financial statements and related notes contained elsewhere in this report.
This discussion contains forward-looking statements that involve risks,
uncertainties, and assumptions. Our actual results may differ materially from
those anticipated in these forward-looking statements as a result of a variety
of factors, including those set forth under Risk Factors and elsewhere in
this report. Overview We design and develop large-screen, rear-projection, high-definition
televisions, or HDTVs, utilizing our proprietary liquid crystal on silicon, or
LCoS®, microdisplay technology. We market our HDTVs for sale under the brand
names of retailers, including consumer electronics retailers, consumer retail
stores, personal computer manufacturers, and high-end audio/video
manufacturers. We have established a virtual manufacturing model utilizing
third-party contract manufacturers to produce our HDTVs, which incorporate the
LCoS microdisplays that we manufacture. We also offer a broad line of LCoS
microdisplay products and subsystems that original equipment manufacturers, or
OEMs, can integrate into proprietary HDTV products, home theater projectors,
and near-to-eye applications, such as head-mounted monocular or binocular
headsets and viewers, for industrial, medical, military, commercial, and
consumer applications. We derive revenue from the sale of our microdisplay products and from
providing design and engineering services. During 2003, we recorded revenue
from product sales of $1.6 million, or 74% of net sales, and revenue from
design and engineering services of $565,000, or 26% of net sales. We have
never been profitable. In 2003, 2002, and 2001, we had net losses of $18.7
million, $23.2 million, and $22.3 million, respectively. We started the development of LCoS microdisplays in 1997 as a division of
Three-Five Systems, Inc., or TFS, as which we operated until our spin-off in
September 2003. In anticipation of our spin-off to the stockholders of TFS,
TFS organized us as a wholly owned subsidiary. In connection with the
spin-off, TFS transferred to us its entire LCoS microdisplay business,
including all related manufacturing and business assets, personnel, and
intellectual property. TFS also provided initial cash funding to us in the
amount of $20.9 million. The spin-off was completed on September 15, 2003 as a
special dividend to the stockholders of TFS. We share occupancy with TFS in a building owned by TFS in Tempe, Arizona.
We manufacture all of our LCoS microdisplays on our high-volume liquid crystal
on silicon manufacturing line in that Tempe facility, where we also maintain
our corporate headquarters. In addition, we conduct all testing and assembly
of LCoS modules and conduct research and development activities in Tempe. We
also operate a facility in Boulder, Colorado. In Boulder, we conduct sales and
marketing activities and research and development activities. Net Sales.Our sales result from both design and engineering services and
product sales. Until early 2002, substantially all of our sales were for use
in projection-based applications. After the purchase of certain assets in
early 2002, however, we became equally focused on the near-to-eye market. In
the fourth quarter of 2003, we announced our intention to develop, manufacture,
and sell a complete HDTV product based on our Gen II LCoS microdisplay. Since
this announcement, most of our efforts have been focused on the design of this
product and the establishment of a supply chain to source the components that
we do not manufacture. We currently anticipate that sales of our HDTVs will
comprise the majority of our total sales in future periods. In addition to manufacturing and selling our own HDTVs, we will continue
to seek selective OEM customers for our projection displays. We typically sell
three displays and associated electronics for products in the projection
market. In the near-to-eye market, we sell either one or two displays and
associated electronics. The displays and electronics are sold together as a
kit. We also sell optical modules in the near-to-eye market. The selling
price of these products range from between $90 and $1,000 per unit. Cost of Sales.Our gross margins are influenced by various factors,
including manufacturing efficiencies, yields, and absorption issues, product
mix, product differentiation, product uniqueness, inventory management, and
volume pricing. The manufacturing-related issues have the most significant
impact on our gross margins. To date, our manufacturing capacity has exceeded
our manufacturing volume, resulting in the inability to fully absorb the 29




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##### Table of Contents



cost of our manufacturing infrastructure. As a result, we expect it will
be difficult to attain significant improvements in yields until we run higher
volumes. Effective as of the spin-off date, certain amounts that previously were
included in research and development expense have been included in cost of
sales. These are costs related to personnel expense, facilities, depreciation,
and amortization surrounding product and process engineering activities after a
product has been released to manufacturing. When we were part of TFS, these
costs were included in research and development expense. These costs are more
appropriately included in cost of sales. For the years ended December 31, 2002
and 2001, $6.2 million and $6.6 million, respectively, have been reclassified
from research and development to cost of sales  products. Selling, General, and Administrative Expense.Selling, general, and
administrative expense consists principally of administrative and selling
costs; salaries, commissions, and benefits to personnel; and related facilities
costs. We make substantially all of our sales directly to OEMs through a very
small sales force that consists primarily of direct technical sales persons.
Therefore, there is no material cost of distribution in our selling, general,
and administrative expense. Research and Development Expense.Research and development expense
consists principally of salaries and benefits to scientists, engineers, and
other technical personnel; related facilities costs; process development costs;
and various expenses for projects, including new product development. Research
and development expense continues to be very high as we continue to develop our
LCoS technology and manufacturing processes, and refine our HDTV products. Critical Accounting Policies and Estimates Our discussion and analysis of our financial condition and results of
operations are based upon our financial statements, which have been prepared in
accordance with generally accepted accounting principles (GAAP) in the United
States. During preparation of these financial statements, we are required to
make estimates and judgments that affect the reported amounts of assets,
liabilities, revenue, and expenses, and related disclosure of contingent assets
and liabilities. On an on-going basis, we evaluate our estimates and
judgments, including those related to bad debts, inventories, investments,
fixed assets, intangible assets, income taxes, and contingencies. We base our
estimates on historical experience and on various other assumptions that we
believe are reasonable under the circumstances. The results form the basis for
making judgments about the carrying values of assets and liabilities that are
not readily apparent from other sources. Actual results may differ from these
estimates under different assumptions or conditions. We believe the following critical accounting policies affect our more
significant judgments and estimates used in the preparation of our financial
statements. We recognize revenue from product sales when persuasive evidence of a sale
exists; that is, a product is shipped under an agreement with a customer, risk
of loss and title has passed to the customer, the fee is fixed and
determinable, and collection of the resulting receivable is reasonably assured.
Sales allowances are estimated based upon historical experience of sales
returns. We recognize revenue related to design and engineering services depending
on the relevant contractual terms. Under fixed-price contracts that contain
project milestones, revenue is recognized as milestones are met. Under
contracts where revenue is recognized based on milestones, the fair value of
milestones completed equals the fair value of work performed. Under a fixed
price contract whereby we are paid based on performance of tasks, we recognize
revenue based on the estimated percentage of completion of the entire project
as measured by the costs for man hours and materials incurred to date compared
to the total estimated costs for man hours and materials. Any anticipated
losses on fixed price contracts are recorded in the period they are
determinable. Revenue related to design and engineering services is recognized
based on these methods and is non-refundable. We maintain an allowance for doubtful accounts for estimated losses
resulting from the inability of our customers to make required payments. We
determine the adequacy of this allowance by regularly evaluating individual
customer receivables and considering a customers financial condition, credit
history, and current 30




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economic conditions. If the financial condition of our customers were to
deteriorate, additional allowances could be required. We write down our inventory for obsolete inventory. We write down our
inventory to estimated market value based upon assumptions about future demand
and market conditions. If actual market conditions are less favorable than
those projected by us, additional inventory write-downs may be required. Financial Accounting Standards Board (FASB) Statement of Financial
Accounting Standards (SFAS) No. 109, Accounting for Income Taxes, requires
that a valuation allowance be established when it is more likely than not that
all or a portion of a deferred tax asset will not be realized. Changes in
valuation allowances from period to period are included in our tax provision in
the period of change. In determining whether a valuation allowance is
required, we take into account all evidence with regard to the utilization of a
deferred tax asset including our past earnings history, expected future
earnings, the character and jurisdiction of such earnings, unsettled
circumstances that, if unfavorably resolved, would adversely affect utilization
of a deferred tax asset, carryback and carryforward periods, and tax strategies
that could potentially enhance the likelihood of realization of a deferred tax
asset. Deferred tax assets resulting from net operating losses and tax credits
generated by our pre-spin-off operations were retained by TFS in accordance
with applicable tax law. In the near term, we do not expect to accrue for a
tax benefit on any losses that we incur. Long-term assets, such as property, plant, and equipment, intangibles, and
other investments, are originally recorded at cost. On an on-going basis, we
assess these assets to determine if their current recorded value is impaired.
When assessing these assets, we consider projected future cash flows to
determine if impairment is applicable. These cash flows are evaluated for
objectivity by using weighted probability techniques and also comparisons of
past performance against projections. We may also identify and consider
independent market values of assets that we believe are comparable. If we were
to believe that an assets value was impaired, we would write down the carrying
value of the identified asset and charge the impairment as an expense in the
period in which the determination was made. Our historical financial statements prior to our spin-off from TFS include
those assets, liabilities, revenues, and expenses directly attributable to our
operations and allocations of certain TFS corporate expenses to us. These
amounts have been allocated to us on the basis that we consider to reflect most
fairly or reasonably the utilization of the services provided to, or the
benefits received by, us. We believe the methods used to allocate these
amounts are reasonable. The financial information included herein for periods prior to the
spin-off is not necessarily indicative of our future financial position,
results of operations, or cash flows, nor is it necessarily indicative of what
the financial position, results of operations, and cash flows would have been
had we operated as a stand-alone public entity during the periods covered. Our costs and expenses prior to our spin-off from TFS include allocations
from TFS for centralized legal, accounting, treasury, quality assurance, real
estate, information technology, engineering, and other TFS corporate services
and infrastructure costs. These allocations have been determined on the basis
that we and TFS considered to be reasonable reflections of the utilization of
services provided to or the benefits received by us. Allocated costs included
in our cost of sales totaled $1.1 million, $2.4 million, and $2.4 million for
the years ended December 31, 2003, 2002, and 2001, respectively. Allocated
costs included in selling, general, and administrative expenses totaled $1.5
million, $2.6 million, and $1.8 million for the years ended December 31, 2003,
2002, and 2001, respectively. Allocated costs included in our research and
development expenses totaled $800,000, $2.6 million, and $2.8 million for the
years ended December 31, 2003, 2002, and 2001, respectively. The determination and basis of the amount of costs and expenses allocated
to us varied depending on the situation. Legal, accounting, treasury, quality
assurance, and other TFS corporate functions, including officers salaries,
were allocated based on an estimation of time devoted to the microdisplay
business for these functions. Facility costs and information technology
services were allocated on the basis of headcount of the microdisplay business,
which is most representative of utilization of these resources. Engineering
services were allocated to us based on the actual hours of services used. The
allocation methodologies utilized represent managements best estimate of the
actual services utilized by the microdisplay business. 31




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Our financial results subsequent to the spin-off may differ materially
from those recorded historically. These potential differences are the result
of several factors, including the following:  1.
    
    actual costs for services needed by our business may differ
from amounts historically allocated to us from TFS;2.
    
    certain items, including facilities charges, that were
recorded by the TFS combined entity as depreciation are now recorded
as rent expense by us, for which we pay cash; and3.
    
    changes in the way we manage our business as a stand-alone
entity as opposed to a division may result in different business
decisions. Since the spin-off, the actual costs for services needed by our business
have not differed materially from amounts historically allocated to us from
TFS. However, we are no longer part of a larger organization; therefore,
certain expense items may increase more rapidly. If this occurs and we are
unable to decrease other expense items or increase revenue to offset this
increased expense, our results of operations will be adversely affected. We and TFS have entered into a series of agreements to facilitate our
separation from TFS. These agreements include certain transitional services,
leases, intellectual property transfers, and tax sharing agreements. Certain
of these agreements require us to pay a negotiated fee. If we are unable to
build an infrastructure to provide these services internally, our operating
results could be adversely affected. Because our business serves new and developing markets, is based on a
relatively new technology, and is expected to be significantly influenced by
the introduction of new HDTV products, accurately forecasting revenue for a
particular future period is difficult. To date, the majority of our product
sales to customers have been for their use in designing their end products or
for improving their production processes as opposed to volume production lots.
Therefore, the amount of revenue recorded in any given period may fluctuate
significantly, and predictable revenue trends have not yet developed. While we
anticipate that our revenue will increase, there can be no assurances that this
will occur or when it will occur. Because a significant amount of our expenses
are fixed in nature and we still experience low manufacturing yields, we
anticipate that the amount of revenue recognized during the first half of 2004
will not result in a material impact to our cash consumption rate. We do
anticipate, however, that as we move into volume production, we will improve
our manufacturing yields and more fully absorb our fixed costs, which will
result in improved gross margins and results of operations later in 2004 and
beyond. However, as we increase our revenue and shift our product mix
predominantly to the HDTVs, we will use cash to finance increases in working
capital. Results of Operations The following table sets forth, for the periods indicated, the percentage
of net sales of certain items in our financial statements. Years Ended December 31,2003
    
    2002
    
    2001Net sales
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %Costs and expenses:Cost of sales
    
    
    448.0
    
    
    
    894.3
    
    
    
    634.2Selling, general, and administrative
    
    
    222.9
    
    
    
    231.6
    
    
    
    142.6Research and development
    
    
    335.8
    
    
    
    585.8
    
    
    
    275.8Total costs and expenses
    
    
    1,006.7
    
    
    
    1,711.7
    
    
    
    1,052.6Operating loss
    
    
    (906.7
    )
    
    
    (1,611.7
    )
    
    
    (952.6
    )Interest income
    
    
    2.6
    
    
    
    
    
    
    
    Loss on investment in start-up company
    
    
    
    
    
    
    
    
    
    
    (197.3
    )Loss before income taxes
    
    
    (904.1
    )%
    
    
    (1,611.7
    )%
    
    
    (1,149.9
    )%
 32




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##### Table of Contents



Year ended December 31, 2003 compared to year ended December 31, 2002 Net Sales.Net sales increased 52.5% to $2.2 million in 2003 compared to
$1.4 million in 2002. This increase in total net sales was due primarily to an
increase in net product sales of 111% to $1.6 million in 2003 from $772,000 in
2002. This increase in net product sales was partially offset by a 15.3%
decline in design and engineering services to $565,000 in 2003 from $667,000 in
2002. Revenue from design and engineering services decreased as we completed
certain contracts. Net sales in the near-to-eye market totaled $901,000, or 41.1% of total
net sales, in 2003 compared to $742,000, or 51.6% of total net sales, in 2002.
The remainder of our net sales were in the projection market. Net sales in North America totaled $1.2 million, or 55.8% of net sales, in
2003 compared to $971,000, or 67.5% of net sales, in 2002. Net sales in Asia
totaled $398,000, or 18.1% of net sales, in 2003 compared to $292,000, or 20.3%
of net sales, in 2002. Net sales in Europe totaled $571,000, or 26.0% of net
sales, in 2003 compared to $176,000, or 12.2% of net sales, in 2002. Cost of Sales.Cost of sales was $9.8 million, or 448% of net sales, in
2003 compared to $12.9 million, or 894% of net sales, in 2002. The decrease,
in absolute dollars, was the result of decreased inventory write-offs as well
as cost-reduction efforts that resulted in lower headcount and, therefore,
lower personnel costs of $700,000. In 2003, we had inventory write-offs of
approximately $463,000 compared to $1.8 million in 2002 when we wrote off
inventory in connection with the termination of our relationship with RCA
Thompson. The large negative gross margin in each year resulted primarily from
the low volume of shipments and low manufacturing yields in the shipped
products. To date, our manufacturing capacity has exceeded our manufacturing
volume, resulting in the inability to fully absorb the cost of our
manufacturing infrastructure. Cost of sales for design and engineering
services decreased to $518,000 in 2003 from $624,000 in 2002 due to the
decrease in design and engineering services provided to customers. As is typical in most segments of the high-technology industry, we
anticipate downward pressure on the prices of our products. A significant
portion of our manufacturing costs are fixed in nature and consist of items
such as utilities, depreciation, and amortization. The amount of these costs
do not vary period-to-period based on the number of units produced nor can the
amounts of these costs be adjusted in the short term. Therefore, in periods of
lower production volume, these fixed costs are absorbed by a lower number of
units, thus increasing the cost per unit. As a result, we expect it will be
difficult to attain significant improvements in gross margins until we operate
at higher production volumes. Selling, General, and Administrative Expense.Selling, general, and
administrative expense was $4.9 million in 2003 compared to $3.3 million in
2002. Selling, general, and administrative expense for 2003 included
approximately $1.5 million of costs related to the spin-off from TFS. Research and Development Expense.Research and development expense was
$7.4 million in 2003 compared to $8.4 million in 2002. Through the third
quarter of 2003, all of our research and development expense related to ongoing
efforts to develop LCoS microdisplay products as well as our continued
development of the manufacturing process for LCoS microdisplays. In the fourth
quarter of 2003, we incurred expenses of approximately $865,000 associated with
the development of our first HDTV product. The overall decrease in research
and development expense in 2003 was a result of cost-reduction efforts in late
2002 that resulted in lower headcount and, therefore, lower personnel costs in
comparison to 2002. Benefit from Income Taxes.In connection with the formation and spin-off
of our company by TFS, we assumed a net deferred tax liability of $1.1 million.
This net deferred tax liability is the result of differences between the book
and tax basis of the assets transferred to us. TFS retained the net operating
losses and tax credits that were generated by our operations before the
spin-off. The assumption of the net deferred tax liability resulted in a
corresponding reduction in the TFS net investment contributed to us in 2003.
Pursuant to SFAS No. 109, the assumption of the net deferred tax liability
enabled us to record additional deferred tax assets of approximately $1.1
million during the period from the spin-off date to December 31, 2003. A
valuation allowance has been recorded for deferred tax assets generated during
the period ended December 31, 2003 that exceeded our net deferred tax
liabilities. We recorded no benefit from income taxes in 2002. We do not
expect to record a deferred tax asset for 33




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##### Table of Contents



the tax benefit on any losses that we may incur until we believe it is
more likely than not that all or a portion of the deferred tax asset will be
realized. Net Loss.We recorded a net loss of $18.7 million in 2003 compared to a
net loss of $23.2 million in 2002. Year ended December 31, 2002 compared to year ended December 31, 2001 Net Sales.Net sales were $1.4 million in 2002 compared to $1.9 million
in 2001. The 26.3% reduction in sales was primarily because of a reduced
volume of business with RCA Thompson. Specifically, net sales to RCA Thompson
were $123,000 in 2002 compared to $1,265,000 in 2001. In mid-2002, RCA
Thompson made the decision to discontinue the manufacture of a television that
used our LCoS microdisplays. This reduction in our sales to RCA Thompson was
partially offset by our increased sales in the near-to-eye market. Net sales in the near-to-eye market totaled $742,000 in 2002. In January
2002, we hired seven key technical persons formerly employed by Zight
Corporation, a private company focused on microdisplays for personal display
system applications. At that time, Zight had ceased operations. We then
purchased certain fixed assets of Zight at a liquidators auction for
approximately $600,000. Following that auction, we then negotiated with the
representatives of the defunct Zight Corporation to purchase its intellectual
property for approximately $2.0 million. Prior to this series of transactions,
substantially all of our sales were for use in projection-based applications. Net sales in North America totaled $971,000, or 67.5% of net sales, in
2002 compared to $1.7 million, or 88.9% of net sales, in 2001. Net sales in
Asia totaled $292,000, or 20.3% of net sales, in 2002 compared to $113,000, or
5.8% of net sales, in 2001. The remainder of our net sales were in Europe. Cost of Sales.Cost of sales was $12.9 million, or 894% of net sales, in
2002 compared to $12.3 million, or 634% of net sales, in 2001. The increase,
in absolute dollars, was primarily the result of an inventory write-down in
2002 of $1.8 million compared to $1.2 million in 2001, partially offset by
lower materials costs commensurate with the reduction in product sales. The
large negative gross margin in each year resulted primarily from the low volume
of shipments and low manufacturing yields in the shipped products. To date,
our manufacturing capacity has exceeded our manufacturing volume, resulting in
the inability to fully absorb the cost of our manufacturing infrastructure.
Cost of sales for design and engineering services increased to $624,000 in 2002
from $78,000 in 2001 due to the increase in design and engineering services
provided to customers. Selling, General, and Administrative Expense.Selling, general, and
administrative expense was $3.3 million in 2002 compared to $2.8 million in
2001. Selling costs remained flat during 2002 and 2001 while administrative
costs for 2002 increased by approximately $600,000. The increase in 2002 was
the result of changing the allocation of costs between our company and TFS
based upon the increased time spent by personnel involved with managing the
microdisplay business. Research and Development Expense.Research and development expense was
$8.4 million in 2002 compared to $5.3 million in 2001. All of our research and
development expense relates to ongoing efforts to develop LCoS microdisplay
products as well as our continued development of the manufacturing process for
LCoS microdisplays. Our increased expenses in 2002 related to increased
personnel, facilities, and supplies expenses associated with the opening of our
facility in Boulder, Colorado in early 2002, which totaled $2.7 million. Other Expense.We had no other expense in 2002 compared to other expense
of $3.8 million in 2001. All of the other expense in 2001 related to a $3.8
million write-off of our investment in Inviso, Inc. During 1998, we acquired a
minority equity interest in Inviso for approximately $3.3 million. In 2000, we
acquired an additional interest in Inviso for $500,000, raising our total
equity interest to $3.8 million. In the second quarter of 2001, we wrote off
our investment of $3.8 million in Inviso because we determined that our
investment was impaired. Subsequent to our write-off, Inviso was unable to
raise funds to operate its business and ceased operations. No interest income
or expense was incurred in either year since we were a division of TFS at that
time, and all cash needs were funded by TFS on an as-needed basis. Benefit from Income Taxes.We recorded no benefit from income taxes in
2002 or 2001. All of the tax benefit related to our losses incurred will be
retained by TFS after the spin-off. We do not expect to record a 34




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##### Table of Contents



deferred tax asset for the tax benefit on any losses that we may incur
until we believe it is more likely than not that all or a portion of the
deferred tax asset will be realized. Net Loss.We recorded a net loss of $23.2 million in 2002 compared to a
net loss of $22.3 million in 2001. Quarterly Results of Operations The following table presents unaudited consolidated statements of
operations data for each of the eight quarters in the period ended December 31,
2003. We believe that all necessary adjustments have been included to present
fairly the quarterly information when read in conjunction with our annual
financial statements and related notes. The operating results for any quarter
are not necessarily indicative of the results for any subsequent quarter. Quarters Ended2003
    
    2002Dec. 31
    
    Sept. 30
    
    June 30
    
    March 31
    
    Dec. 31
    
    Sept. 30
    
    June 30
    
    March 31(in thousands)Net sales
    
    $
    360
    
    
    $
    703
    
    
    $
    760
    
    
    $
    371
    
    
    $
    645
    
    
    $
    345
    
    
    $
    223
    
    
    $
    226Cost and expenses:Cost of sales
    
    
    2,635
    
    
    
    2,376
    
    
    
    2,686
    
    
    
    2,132
    
    
    
    3,090
    
    
    
    2,638
    
    
    
    3,811
    
    
    
    3,330Selling, general, and
administrative
    
    
    1,456
    
    
    
    1,169
    
    
    
    1,051
    
    
    
    1,214
    
    
    
    696
    
    
    
    825
    
    
    
    882
    
    
    
    930Research and development
    
    
    2,156
    
    
    
    1,814
    
    
    
    1,714
    
    
    
    1,683
    
    
    
    1,802
    
    
    
    2,004
    
    
    
    2,168
    
    
    
    2,4566,247
    
    
    
    5,359
    
    
    
    5,451
    
    
    
    5,029
    
    
    
    5,588
    
    
    
    5,467
    
    
    
    6,861
    
    
    
    6,716Operating loss
    
    
    (5,887
    )
    
    
    (4,656
    )
    
    
    (4,691
    )
    
    
    (4,658
    )
    
    
    (4,943
    )
    
    
    (5,122
    )
    
    
    (6,638
    )
    
    
    (6,490
    )Interest income
    
    
    43
    
    
    
    14
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Benefit from income taxes
    
    
    931
    
    
    
    160
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Net loss
    
    $
    (4,913
    )
    
    $
    (4,482
    )
    
    $
    (4,691
    )
    
    $
    (4,658
    )
    
    $
    (4,943
    )
    
    $
    (5,122
    )
    
    $
    (6,638
    )
    
    $
    (6,490
    )
 Historically, we have not experienced fluctuations related to seasonality,
as we have had limited sales and production volume of our products. Because
our new products, particularly our HDTV products, are focused more on the
consumer markets, we expect to experience seasonality in our revenue and cost
of sales. We anticipate that these seasonal trends will reflect consumers
patterns of increasing purchases during the year-end holiday period. We have experienced negative gross margins in each quarter as a result of
the low volume of shipments and low manufacturing yields in the shipped
products. To date, our manufacturing capacity has exceeded our manufacturing
volume, resulting in the inability to fully absorb the cost of our
manufacturing infrastructure. Selling, general, and administrative expense for the first, second, and
third quarters of 2003 includes spin-off related expenses of $464,000,
$338,000, and $699,000, respectively. Selling, general, and administrative
expense for the fourth quarter of 2003 includes a one-time charge of $434,000
relating to our guarantee of the financial obligations of, and the write-off of
a note receivable from, VoiceViewer, Inc. Research and development expense decreased beginning in the fourth quarter
of 2002 as a result of cost-cutting efforts by TFS, which resulted in lower
headcount and, therefore, lower personnel costs. Research and development
expense in the fourth quarter of 2003 includes costs totaling approximately
$865,000 associated with the development of our HDTV products. In the third and fourth quarters of 2003, we recorded a benefit from
income taxes of $160,000 and $931,000, respectively. In connection with the
formation and spin-off of our company by TFS, we assumed a net deferred tax
liability of $1.1 million. This net deferred tax liability is the result of
differences between the book and tax basis of the assets transferred to us.
TFS retained the net operating losses and tax credits that were generated by
our operations before the spin-off. The assumption of the net deferred tax
liability resulted in a corresponding reduction in the TFS net investment
contributed to us in 2003. Pursuant to SFAS No. 109, the assumption of the net
deferred tax liability enabled us to record an additional deferred tax asset of
approximately $1.1 million during the 35




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##### Table of Contents



period from the spin-off date to December 31, 2003. A valuation allowance
has been recorded for deferred tax assets generated during the period ended
December 31, 2003 that exceeded our net deferred tax liabilities. Liquidity and Capital Resources At December 31, 2003, we had $14.4 million in cash, cash equivalents, and
short-term investments. At December 31, 2002, we had no cash, cash
equivalents, or short-term investments. At that time, we were a division of
TFS and all cash needs were funded by TFS on an as-needed basis. In 2003, we had $15.9 million in net cash outflow from operations. In
2002, we had $20.1 million in net cash outflow from operations. Most of the
cash outflow in each period related to our losses since we had very little
changes in our working capital in each period. Our depreciation and
amortization expense was $3.6 million in 2003 and $3.4 million in 2002. Prior
to our spin-off in September 2003, our entire cash outflow was funded by TFS on
an as-needed basis. In 2003, net cash used for investing activities totaled $12.8 million, of
which $12.0 million was for the purchase of short-term investments. The
remainder was primarily for the purchase of intangible assets related to mask
sets and tooling investments and purchases of property and equipment. Cash used in investing activities during 2002 totaled approximately $13.8
million, which consisted of the following: $3.7 million related to the
purchase of manufacturing equipment; $5.1 million related to purchases of
intangible assets such as the intellectual property from Zight and Inviso as
well as mask sets and related tooling investments; and $5.1 million related to
our investment in ColorLink. We have incurred recurring operating losses and negative cash flows since
our inception as a division of TFS. Our net loss was $18.7 million, $23.2
million, and $22.3 million in 2003, 2002, and 2001, respectively. Net cash
used in operating activities was $15.9 million, $20.1 million, and $17.7
million in 2003, 2002, and 2001, respectively. At December 31, 2003, we had
$17.2 million of working capital, including cash, cash equivalents, and
short-term investments of $14.4 million. A key element of our business involves the ongoing commercialization of
our LCoS microdisplay technology. LCoS microdisplays are an emerging
technology with target markets that could be slow to develop or could utilize
competing technologies. Therefore, accurately forecasting revenue for any
given future period is difficult. We are currently focusing a majority of our
resources on penetrating the premium segment of the HDTV market. HDTV has only
recently become available to consumers, and widespread market acceptance is
uncertain. The successful introduction of an HDTV product to market and securing
volume orders from consumer electronics retailers for HTDVs represent a key
ingredient in our success. If we achieve significant sales volume of our
HDTVs, we will need to raise additional funds in order to finance the working
capital associated with increasing sales. Consequently, we are planning an
equity offering, the proceeds of which will be used primarily for the working
capital needed to fund the growth of our HDTV business. If we are unable to achieve sufficient revenue from our HDTV sales, then
it will be necessary for us to reduce substantially our operating losses
through increased sales of other microdisplay products or by reducing or
delaying expenditures. If necessary, we can reduce overhead and administrative
expenditures, postpone or defer research and development projects, or take
other actions to continue our operations beyond 2004. 36




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##### Table of Contents



Aggregate Contractual Obligations The following table lists our commercial commitments: Amount of Commitment Expiration Per PeriodTotalAmounts
    
    Less
    
    
    
    
    
    
    
    
    
    6 YearsOther Commercial Commitments
    
    Committed
    
    than 1 Year
    
    1-3 Years
    
    4-5 Years
    
    and Over(in thousands)Facilities leases
    
    $
    1,560
    
    
    $
    936
    
    
    $
    624
    
    
    $
    
    
    
    $
    Guarantee
    
    $
    425
    
    
    $
    425
    
    
    $
    
    
    
    $
    
    
    
    $
    
 At present, the only contractual operating commitments we have are the
property leases for our Tempe headquarters and for our development center in
Boulder, Colorado. The guarantee relates to our guarantee in connection with a
Small Business Administration loan to VoiceViewer Technology, Inc., a private
company developing microdisplay products. If the lending institution were to
declare VoiceViewer to be in default under the loan, we would be required to
pay the guaranteed amount. During the fourth quarter of 2003, we determined that it is probable that
VoiceViewer will be unable to meet its obligations under the loan agreement.
Therefore, we have accrued $359,000, which represents our anticipated
obligation under the guarantee agreement. Our maximum exposure under this
guarantee is $425,000. We have a security interest in, and second rights to,
the intellectual property of VoiceViewer, while the lending institution has the
first rights. We would obtain the VoiceViewer intellectual property if in the
future we are required to pay amounts under the guarantee. However, we do not
believe we can realize any significant value from VoiceViewers intellectual
property. Under the Tax Sharing Agreement, we have agreed to indemnify TFS against
any taxes, other than Separation Taxes, that are attributable to us since our
formation, even while we were a member of TFS federal consolidated tax group.
TFS has agreed to indemnify us against any taxes, other than Separation Taxes,
that are attributable to the businesses retained by TFS. The Tax Sharing
Agreement sets forth rules for determining taxes attributable to us and taxes
attributable to the businesses retained by TFS. Pursuant to the Tax Sharing Agreement, we have agreed not to take any
action that would cause the spin-off not to qualify under Section 355 of the
Internal Revenue Code. We have agreed not to take certain actions for two
years following the spin-off, unless we obtain an IRS ruling or an opinion of
counsel to the effect that these actions will not affect the tax-free nature of
the spin-off. These actions include certain issuances of our stock, a
liquidation or merger of our company, and dispositions of assets outside the
ordinary course of our business. If any of these transactions were to occur,
the spin-off could be deemed to be a taxable distribution to TFS. This would
subject TFS to a substantial tax liability. We have agreed to indemnify TFS
and its affiliates to the extent that any action we take or fail to take gives
rise to a tax incurred by TFS or any of its affiliates with respect to the
spin-off. In addition, we have agreed to indemnify TFS for any tax resulting
from an acquisition by one or more persons of a 50% or greater interest in our
company. We have no debt. In addition, we have no capital lease obligations,
unconditional purchase obligations, other long-term obligations, or any other
commercial commitments except as noted above. Off-Balance Sheet Arrangements We do not have any off-balance sheet arrangements. Impact of Recently Issued Standards In July 2001, the FASB issued SFAS No. 146, Accounting for Costs
Associated with Exit or Disposal Activities. SFAS No. 146 requires companies
to recognize costs associated with exit or disposal activities when they are
incurred rather than at the date of a commitment to an exit or disposal plan.
SFAS No. 146 will apply to 37




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##### Table of Contents



exit or disposal activities initiated after December 31, 2002. We adopted
SFAS No. 146 on January 1, 2003, and there was no impact on our financial
position or results of operations. In December 2002, the FASB issued SFAS No. 148, Accounting for
Stock-Based Compensation - Transition and Disclosure. This Statement amends
SFAS No. 123 to provide alternative methods of transition for a voluntary
change to the fair value method of accounting for stock-based employee
compensation. Specifically, SFAS No. 148 prohibits companies from utilizing
the prospective method of transition, the only method offered under the
original SFAS No. 123, in fiscal years beginning after December 15, 2003.
However, the Statement permits two additional transition methods for companies
that adopt the fair value method of accounting for stock-based compensation,
which include the modified prospective and retroactive restatement methods.
The modified prospective method recognizes stock-based employee compensation
cost from the beginning of the fiscal year in which the provisions are first
applied, as if the fair value method had been used to account for all employee
awards granted, modified, or settled in fiscal years beginning after December
15, 1994. Under the retroactive restatement method, all periods presented are
restated to reflect stock-based employee compensation cost under the fair value
method for all employee awards granted, modified, or settled in fiscal years
beginning after December 15, 1994. In addition, this Statement amends the
disclosure requirements of SFAS No. 123 to require prominent disclosures in
both annual and interim financial statements about the method of accounting for
stock-based employee compensation and the effect of the method used on reported
results using a prescribed tabular format and requiring disclosure in the
Summary of Significant Accounting Policies or its equivalent. We intend to
continue to measure stock-based compensation for option grants using the
intrinsic value method pursuant to APB No. 25, Accounting for Stock Issued to
Employees. We have adopted the new disclosure requirements and are currently
evaluating the impact if we were to adopt the fair value method of accounting
for stock-based employee compensation under each of the two additional
transition methods discussed above. In November 2002, the FASB issued FASB Interpretation No. 45 (FIN 45),
Guarantors Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others. This Interpretation addresses
the disclosures to be made by a guarantor in its financial statements and its
obligations under guarantees. The Interpretation also clarifies the
requirements related to the recognition of a liability by the guarantor at the
inception of a guarantee. Per the Interpretation, initial recognition of a
liability will be applied only on a prospective basis to guarantees issued or
modified after December 31, 2002. We adopted the disclosure requirements of
FIN 45 as of January 1, 2003, and there was no impact on our financial position
or results of operations. 
 Item 7A. Quantitative and Qualitative Disclosures about Market Risk Derivative Financial Instruments, Other Financial Instruments, and
Derivative Commodity Instruments At December 31, 2003, we did not participate in any derivative financial
instruments, or other financial or commodity instruments for which fair value
disclosure would be required under SFAS 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 foreign currency
exchange rate risk. Foreign currency devaluations, especially in Asian
currencies, such as the Japanese yen, the Korean won, and the Taiwanese dollar,
may cause a foreign competitors products to be priced significantly lower than
our products. Fluctuations in foreign currency exchange rates could affect our cost of
goods and operating margins. In addition, currency devaluation can result in a
loss to us if we hold deposits of that currency. Hedging foreign currencies
can be difficult, especially if the currency is not freely traded. We have not attempted to hedge or otherwise mitigate this risk because our
exposure to any given currency is nominal. A change in the currency exchange
rate of 10% in any given currency would not have a material impact on our
results of operations. If, in the future, our exposure to a given currency
increases, we would contemplate hedging at that time. 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. 38




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##### Table of Contents



Item 8. Financial Statements and Supplementary Data Reference is made to the financial statements, the notes thereto, and the
report thereon, commencing on page F-1 of this report, which financial
statements, notes, and report are incorporated herein by reference. 
 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure Not applicable. 
 Item 9A. Controls and Procedures We have evaluated, with the participation of our Chief Executive Officer
and Chief Financial Officer, the effectiveness of our disclosure controls and
procedures as of December 31, 2003. Based on this evaluation, our Chief
Executive Officer and Chief Financial Officer have each concluded that our
disclosure controls and procedures are effective to ensure that we record,
process, summarize, and report information required to be disclosed by us in
our quarterly reports filed under the Securities Exchange Act within the time
periods specified by the Securities and Exchange Commissions rules and forms.
During the companys fourth fiscal quarter, there were no changes in our
internal control over financial reporting that have materially affected, or are
reasonably likely to materially affect, our internal control over financial
reporting. 
 PART III 
 Item 10. Directors and Executive Officers of the Registrant The information required by this Item relating to our directors is
incorporated herein by reference to the definitive Proxy Statement to be filed
pursuant to Regulation 14A of the Exchange Act for our 2004 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 2004 Annual Meeting of Stockholders. 
 Item 12. Security Ownership of Certain Beneficial Owners and Management and
Related Stockholder Matters 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 2004 Annual Meeting of Stockholders. 
 Item 13. Certain Relationships and Related Transactions 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 2004 Annual Meeting of Stockholders. 
 Item 14. Principal Accountant Fees and Services 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 2004 Annual Meeting of Stockholders. 
 PART IV 
 Item 15. Exhibits, Financial Statement Schedules, and Reports On Form 8-K  (a)
    
    Financial Statements and Financial Statement Schedules  (1)
    
    Financial Statements are listed in the Index to Financial
Statements on page F-1 of this report. 39




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##### Table of Contents



(2)
    
    See Index to Financial Statements for financial statement
schedules.  (b)
    
    Reports on Form 8-K  (1)
    
    Report on Form 8-K dated October 30, 2003, furnishing Item 12
Results of Operations and Financial Condition information.  (c)
    
    Exhibits ExhibitNumber
    
    Exhibit2
    
    Master Separation and Distribution Agreement (1)3.1
    
    Certificate of Incorporation of the Registrant (2)3.2
    
    Certificate of Designation of Series A Junior Participating Preferred Stock (1)3.3
    
    Bylaws of the Registrant (2)4.1
    
    Specimen of Common Stock Certificate (1)4.2
    
    Rights Agreement between the Registrant and The Bank of New York, as Rights
Agent, including Form of Right Certificate (1)10.1
    
    Assignment and Assumption Agreement (1)10.2
    
    Intellectual Property Agreement (1)10.3
    
    Tax Sharing Agreement (1)10.4
    
    Real Property Sublease Agreement (1)10.5
    
    Transition Services Agreement (1)10.6
    
    2003 Incentive Compensation Plan (3)10.7
    
    Profit Sharing/401(k) Plan (1)10.8
    
    2003 Employee Stock Purchase Plan (4)10.9
    
    Form of Indemnity Agreement for directors and executive officers (2)23.1
    
    Consent of Deloitte & Touche LLP*31.1
    
    Certification of Chief Executive Officer pursuant to Rule 13a-14(a) and Rule
15d-14(a), promulgated under the Securities Exchange Act of 1934, as amended*31.2
    
    Certification of Chief Financial Officer pursuant to Rule 13a-14(a) and Rule
15d-14(a), promulgated under the Securities Exchange Act of 1934, as amended*32.1
    
    Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002*32.2
    
    Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002*
     (1)
    
    Incorporated by reference to the Registration Statement on Form 10/A
(Amendment No. 4) as filed with the SEC on September 3, 2003.(2)
    
    Incorporated by reference to the Registration Statement on Form 10/A
(Amendment No. 1) as filed with the SEC on June 27, 2003.(3)
    
    Incorporated by reference to Exhibit 10.6 to the Registration Statement
on Form S-8 (Registration No. 333-108362) as filed with the SEC on August
29, 2003.(4)
    
    Incorporated by reference to Exhibit 10.8 to the Registration Statement
on Form S-8 (Registration No. 333-108363) as filed with the SEC on August
29, 2003. 40




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##### Table of Contents



SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed
on its behalf by the undersigned, thereunto duly authorized. BRILLIAN CORPORATIONDate: March 26, 2004
    
    /s/ VINCENT F. SOLLITTO, JR.Vincent F. Sollitto, Jr.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 date indicated. Signature
    
    Capacity
    
    Date/s/ VINCENT F. SOLLITTO, JR.
Vincent F. Sollitto, Jr.
    
    President, Chief Executive Officer, and
Director (Principal Executive Officer)
    
    March 26, 2004/s/ WAYNE A. PRATT
Wayne A. Pratt
    
    Vice President, Chief Financial Officer,
Secretary, and Treasurer (Principal Accounting and
Financial Officer)
    
    March 26, 2004/s/ JACK L. SALTICH
Jack L. Saltich
    
    Chairman of the Board
    
    March 26, 2004/s/ DAVID P. CHAVOUSTIE
David P. Chavoustie
    
    Director
    
    March 26, 2004/s/ DAVID N.K. WANG
David N.K. Wang
    
    Director
    
    March 26, 2004/s/ JOHN S. HODGSON
John S. Hodgson
    
    Director
    
    March 26, 2004
 41




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##### Table of Contents



BRILLIAN CORPORATION 
 INDEX TO FINANCIAL STATEMENTS
 PageIndependent Auditors Report
    
    
    F-2Balance Sheets as of December 31, 2003, and 2002
    
    
    F-3Statements of Operations for the years ended December 31, 2003, 2002, and 2001
    
    
    F-4Statements of Stockholders Equity for the years ended December 31, 2003, 2002, and 2001
    
    
    F-5Statements of Cash Flows for the years ended December 31, 2003, 2002, and 2001
    
    
    F-6Notes to Financial Statements
    
    
    F-7Schedule II  Valuation and Qualifying Accounts for the years
ended December 31, 2003, 2002, and 2001
    
    
    S-1
 F-1




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##### Table of Contents



INDEPENDENT AUDITORS REPORT To the Stockholders and Board of Directors of Brillian Corporation  We have audited the accompanying balance sheets of Brillian Corporation as of
December 31, 2003 and 2002, and the related statements of operations,
stockholders equity, and cash flows for each of the three years in the period
ended December 31, 2003. Our audits also included the financial statement
schedule listed as Schedule II  Valuation and Qualifying Accounts in the
Index. These financial statements and the financial statement schedule are the
responsibility of Brillian Corporations management. Our responsibility is to
express an opinion on the financial statements and the financial statement
schedule based on our audits. We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit 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 Brillian Corporation as of
December 31, 2003 and 2002, and the results of its operations and its cash
flows for each of the three years in the period ended December 31, 2003, in
conformity with accounting principles generally accepted in the United States
of America. Also, in our opinion, the financial statement schedule referred to
above, when considered in relation to the basic financial statements taken as a
whole, presents fairly in all material respects the information set forth
therein. Through September 14, 2003, the accompanying financial statements were prepared
from the separate records maintained for the microdisplay business of
Three-Five Systems, Inc. and may not necessarily be indicative of the results
of operations if the microdisplay business had been operated as an unaffiliated
company. Portions of certain expenses represent allocations made from
Three-Five Systems, Inc. As discussed in note 1 to the financial statements,
on September 15, 2003, Brillian Corporation was spun-off from Three-Five
Systems, Inc. and began operating as a separate company. /s/ DELOITTE & TOUCHE LLP Phoenix, Arizona
March 2, 2004. F-2




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##### Table of Contents



BRILLIAN CORPORATION
BALANCE SHEETS
(in thousands, except share data) December 31,2003
    
    2002ASSETSCurrent Assets:Cash and cash equivalents
    
    $
    2,417
    
    
    $
    Short-term investments
    
    
    12,000
    
    
    
    Accounts receivable, net of allowance for doubtful
accounts of $30 and $16
    
    
    447
    
    
    
    348Inventories
    
    
    2,735
    
    
    
    2,584Other current assets
    
    
    828
    
    
    
    427Total current assets
    
    
    18,427
    
    
    
    3,359Property and equipment, net
    
    
    6,267
    
    
    
    8,218Intangibles, net
    
    
    8,768
    
    
    
    9,627Other investments
    
    
    6,331
    
    
    
    6,331$
    39,793
    
    
    $
    27,535LIABILITIES AND STOCKHOLDERS EQUITYCurrent liabilities:Accounts payable
    
    $
    457
    
    
    $
    516Accrued compensation
    
    
    84
    
    
    
    573Accrued liabilities
    
    
    676
    
    
    
    192Deferred revenue
    
    
    21
    
    
    
    335Total current liabilities
    
    
    1,238
    
    
    
    1,616Commitments and contingencies (Note 6)Stockholders Equity:Three-Five Systems, Inc. net investment
    
    
    
    
    
    
    25,991Preferred Stock, $.001 par value; 10,000,000
shares authorized; no shares issued or
outstanding
    
    
    
    
    
    
    Common stock, $.001 par value; 60,000,000 shares
authorized; 5,357,047 shares issued and
outstanding
    
    
    5
    
    
    
    Additional paid-in capital
    
    
    45,708
    
    
    
    Deferred compensation
    
    
    (1,265
    )
    
    
    Accumulated deficit
    
    
    (5,893
    )
    
    
    Total stockholders equity
    
    
    38,555
    
    
    
    25,919$
    39,793
    
    
    $
    27,535
 The accompanying notes are an integral part of these financial statements. F-3




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##### Table of Contents



BRILLIAN CORPORATION
STATEMENTS OF OPERATIONS
(in thousands, except per share data) Years Ended December 31,2003
    
    2002
    
    2001Net product sales
    
    $
    1,629
    
    
    $
    772
    
    
    $
    1,829Design and engineering services
    
    
    565
    
    
    
    667
    
    
    
    107Total net sales
    
    
    2,194
    
    
    
    1,439
    
    
    
    1,936Costs and expenses:Cost of sales  products
    
    
    9,311
    
    
    
    12,245
    
    
    
    12,202Cost of sales  design and engineering services
    
    
    518
    
    
    
    624
    
    
    
    78Selling, general, and administrative
    
    
    4,890
    
    
    
    3,333
    
    
    
    2,760Research and development
    
    
    7,367
    
    
    
    8,430
    
    
    
    5,339Total costs and expenses
    
    
    22,086
    
    
    
    24,632
    
    
    
    20,379Operating loss
    
    
    (19,892
    )
    
    
    (23,193
    )
    
    
    (18,443
    )Other income (expense):Interest income
    
    
    57
    
    
    
    
    
    
    
    Loss on investment in start-up company
    
    
    
    
    
    
    
    
    
    
    (3,820
    )57
    
    
    
    
    
    
    
    (3,820
    )Loss before income taxes
    
    
    (19,835
    )
    
    
    (23,193
    )
    
    
    (22,263
    )Benefit from income taxes
    
    
    1,091
    
    
    
    
    
    
    
    Net loss
    
    $
    (18,744
    )
    
    $
    (23,193
    )
    
    $
    (22,263
    )Loss per common share:Basic and diluted
    
    $
    (3.51
    )
    
    $
    (4.35
    )
    
    $
    (4.18
    )Weighted average number of common shares:Basic and diluted
    
    
    5,337
    
    
    
    5,329
    
    
    
    5,329
 The accompanying notes are an integral part of these financial statements. F-4




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##### Table of Contents



BRILLIAN CORPORATION
STATEMENTS OF STOCKHOLDERS EQUITY
For the Years Ended December 31, 2003, 2002, and 2001
(in thousands, except share data) Common Stock
    
    AdditionalPaid-in
    
    Deferred
    
    Accumulated
    
    TFS Net
    
    TotalStockholdersShares Issued
    
    Amount
    
    Capital
    
    Compensation
    
    Deficit
    
    Investment
    
    EquityBalance, January 1, 2001
    
    
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    13,066
    
    
    $
    13,066Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (22,263
    )
    
    
    (22,263
    )Net transfers from TFS
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    24,411
    
    
    
    24,411Balance, December 31, 2001
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    15,214
    
    
    
    15,214Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (23,193
    )
    
    
    (23,193
    )Net transfers from TFS
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    33,898
    
    
    
    33,898Balance, December 31, 2002
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    25,919
    
    
    
    25,919Net loss prior to spin-off
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (12,851
    )
    
    
    (12,851
    )Net transfers from TFS
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    10,226
    
    
    
    10,226Initial capitalization at spin-off
    
    
    5,329,300
    
    
    
    5
    
    
    
    44,142
    
    
    
    
    
    
    
    
    
    
    
    (23,294
    )
    
    
    20,853Stock options exercised
and restricted stock grants
    
    
    27,747
    
    
    
    
    
    
    
    34
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    34Deferred compensation on employee
equity awards
    
    
    
    
    
    
    
    
    
    
    1,532
    
    
    
    (1,532
    )
    
    
    
    
    
    
    
    
    
    
    Amortization of deferred
compensation
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    267
    
    
    
    
    
    
    
    
    
    
    
    267Net loss after spin-off
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (5,893
    )
    
    
    
    
    
    
    (5,893
    )Balance, December 31, 2003
    
    
    5,357,047
    
    
    $
    5
    
    
    $
    45,708
    
    
    $
    (1,265
    )
    
    $
    (5,893
    )
    
    $
    
    
    
    $
    38,555
 The accompanying notes are an integral part of these financial statements. F-5




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##### Table of Contents



BRILLIAN CORPORATION
STATEMENTS OF CASH FLOWS
(in thousands) Years Ended December 31,2003
    
    2002
    
    2001CASH FLOWS FROM OPERATING ACTIVITIES:Net loss
    
    $
    (18,744
    )
    
    $
    (23,193
    )
    
    $
    (22,263
    )Adjustments to reconcile net loss to net cash used
in operating activities:Depreciation and amortization
    
    
    3,573
    
    
    
    3,430
    
    
    
    1,876Stock compensation
    
    
    284
    
    
    
    
    
    
    
    Deferred revenue
    
    
    (314
    )
    
    
    335
    
    
    
    Provision for doubtful accounts
    
    
    14
    
    
    
    12
    
    
    
    19Loss on investment in start-up company
    
    
    
    
    
    
    
    
    
    
    3,820Changes in assets and liabilities:(Increase) decrease in accounts receivable
    
    
    (113
    )
    
    
    (195
    )
    
    
    226(Increase) decrease in inventories
    
    
    (151
    )
    
    
    1,724
    
    
    
    (2,846
    )Increase in other current assets
    
    
    (401
    )
    
    
    (337
    )
    
    
    (5
    )Increase (decrease) in accounts payable and
accrued liabilities
    
    
    (64
    )
    
    
    (1,878
    )
    
    
    1,475Net cash used in operating activities
    
    
    (15,916
    )
    
    
    (20,102
    )
    
    
    (17,698
    )CASH FLOWS FROM INVESTING ACTIVITIES:Purchase of property and equipment
    
    
    (292
    )
    
    
    (3,733
    )
    
    
    (3,823
    )Proceeds from sales of assets
    
    
    
    
    
    
    123
    
    
    
    174Purchase of intangibles
    
    
    (471
    )
    
    
    (5,105
    )
    
    
    (1,814
    )Purchase of short-term investments
    
    
    (12,000
    )
    
    
    
    
    
    
    Other investments
    
    
    
    
    
    
    (5,081
    )
    
    
    (1,250
    )Net cash used in investing activities
    
    
    (12,763
    )
    
    
    (13,796
    )
    
    
    (6,713
    )CASH FLOWS FROM FINANCING ACTIVITIES:Net transfers from Three-Five Systems, Inc.
    
    
    10,226
    
    
    
    33,898
    
    
    
    24,411Cash received in spin-off
    
    
    20,853
    
    
    
    
    
    
    
    Stock options exercised
    
    
    17
    
    
    
    
    
    
    
    Net cash provided by financing activities
    
    
    31,096
    
    
    
    33,898
    
    
    
    24,411NET INCREASE IN CASH AND CASH EQUIVALENTS
    
    
    2,417
    
    
    
    
    
    
    
    CASH AND CASH EQUIVALENTS, beginning of year
    
    
    
    
    
    
    
    
    
    
    CASH AND CASH EQUIVALENTS, end of year
    
    $
    2,417
    
    
    $
    
    
    
    $
    
 The accompanying notes are an integral part of these financial statements. F-6




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##### Table of Contents



BRILLIAN CORPORATION
NOTES TO FINANCIAL STATEMENTS
December 31, 2003, 2002, and 2001  (1)
    
    Organization and Operations: We design and develop large-screen, rear-projection, high-definition
televisions, or HDTVs, utilizing our proprietary liquid crystal on silicon, or
LCoS®, microdisplay technology. We market our HDTVs for sale under the brand
names of retailers, including consumer electronics retailers, consumer retail
stores, personal computer manufacturers, and high-end audio/video
manufacturers. We have established a virtual manufacturing model utilizing
third-party contract manufacturers to produce our HDTVs, which incorporate the
LCoS microdisplays that we manufacture. We also offer a broad line of LCoS
microdisplay products and subsystems that original equipment manufacturers, or
OEMs, can integrate into proprietary HDTV products, home theater projectors,
and near-to-eye applications, such as head-mounted monocular or binocular
headsets and viewers, for industrial, medical, military, commercial, and
consumer applications. Historically, we operated as a division of Three-Five Systems, Inc.
(TFS). On March 17, 2003, TFS announced that its board of directors had
approved a decision to incorporate us as a wholly owned subsidiary of TFS, to
transfer our business and assets into this subsidiary, and to distribute the
common stock of this subsidiary to its stockholders in a spin-off. We were
formed in May 2003 in anticipation of this spin-off. The spin-off was
completed on September 15, 2003 as a special dividend to the stockholders of
TFS. On September 1, 2003, we and TFS entered into a Master Separation and
Distribution Agreement under which TFS transferred to us substantially all of
the assets of, and we assumed substantially all of the corresponding
liabilities of, TFS microdisplay business. On September 15, 2003, TFS
distributed all outstanding shares of Brillian common stock owned by TFS to TFS
stockholders as a dividend (the spin-off). Each TFS stockholder of record as
of September 4, 2003 received one share of our stock for every four shares of
TFS common stock they owned. In addition, we entered into ancillary agreements
that govern various ongoing relationships between us and TFS. In connection
with the spin-off, TFS received a ruling from the Internal Revenue Service (the
IRS) that the spin-off would be tax free. In connection with the spin-off,
TFS provided initial cash funding in the amount of $20.9 million, net of $1.1
million of spin-off related costs incurred prior to the spin-off. We incurred
spin-off related costs totaling approximately $1.5 million in the year ended
December 31, 2003, which are included in selling, general, and administrative
expense. We have incurred recurring operating losses and negative cash flows since
our inception as a division of TFS. Our net loss was $18.7 million, $23.2
million, and $22.3 million in 2003, 2002, and 2001, respectively. Net cash
used in operating activities was $15.9 million, $20.1 million, and $17.7
million in 2003, 2002, and 2001, respectively. At December 31, 2003, we had
$17.2 million of working capital, including cash, cash equivalents, and
short-term investments of $14.4 million. A key element of our business involves the ongoing commercialization of
our LCoS microdisplay technology. LCoS microdisplays are an emerging
technology with target markets that could be slow to develop or could utilize
competing technologies. We are currently focusing a majority of our resources
on penetrating the premium segment of the HDTV market. HDTV has only recently
become available to consumers, and widespread market acceptance is uncertain. The successful introduction of an HDTV product to market and securing
volume orders from consumer electronics retailers for HTDVs represent a key
ingredient in our success. If we achieve significant sales volume of our
HDTVs, we will need to raise additional funds in order to finance the working
capital associated with increasing revenues. Consequently, we are planning an
equity offering, the proceeds of which will be used primarily for the working
capital needed to fund the growth of our HDTV business. If we are unable to achieve sufficient revenue from our HDTV sales, then
it will be necessary for us to reduce substantially our operating losses
through increased sales of other microdisplay products or by reducing or
delaying expenditures. If necessary, we can reduce overhead and administrative
expenditures, postpone or defer research and development projects, or take
other actions to continue our operations beyond 2004. F-7




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##### Table of Contents



(2)
    
    Summary of Significant Accounting Policies: The preparation of financial statements in conformity with accounting
principles generally accepted in the United States requires us 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. On an on-going basis, we evaluate estimates and
judgments, including those related to revenue, bad debts, inventories,
investments, fixed assets, intangible assets, income taxes, and contingencies.
Estimates are based on historical experience and on various other assumptions
that we believe are reasonable under the circumstances. The results form the
basis for making judgments about the carrying values of assets and liabilities
that are not readily apparent from other sources. Actual results could differ
from those estimates. Basis of Presentation The accompanying financial statements include those assets, liabilities,
revenues, and expenses directly attributable to our operations, and for periods
prior to the spin-off, allocations of certain TFS corporate expenses to us.
These amounts were allocated to us on the basis that was considered by us and
TFS to reflect most fairly or reasonably the utilization of the services
provided to, or the benefits received by, us. We believe the methods used to
allocate these amounts are reasonable. The financial information for periods prior to the spin-off is not
necessarily indicative of what the financial position, results of operations,
and cash flows would have been had we operated as a stand-alone entity during
those periods. Cash and Cash Equivalents For purposes of the statements of cash flows, all highly liquid
investments with an original maturity of three months or less are considered to
be cash equivalents. For periods prior to the spin-off, cash receipts associated with our
business were transferred to TFS and TFS funded our disbursements.
Accordingly, during those periods, no cash or cash equivalents were assigned to
us because only the funding required to create a non-negative cash balance was
contributed by TFS. Short-Term Investments Short-term investments have original maturities greater than three months
and remaining maturities of less than one year. All short-term investments are
classified as available for sale and presented at market value using the
specific identification method based on quoted market prices. Unrealized gains
and losses are reflected in other comprehensive income. Realized gains and
losses are included in results of operations. There were no gains or losses in
2003, 2002, or 2001. Short-term investments consisted of the following (in
thousands): December 31,2003
    
    2002Short-term bond fund
    
    $
    12,000
    
    
    $
    
 Inventories Inventories are stated at the lower of cost (first-in, first-out) or net
realizable value and consisted of the following (in thousands): December 31,2003
    
    2002Raw materials
    
    $
    2,473
    
    
    $
    2,512Work-in-process
    
    
    51
    
    
    
    46Finished goods
    
    
    211
    
    
    
    26$
    2,735
    
    
    $
    2,584
 F-8




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##### Table of Contents



We write down inventories for obsolete inventory based upon assumptions
about future demand and market conditions. In addition, at December 31, 2003,
net inventories were in excess of our current requirements based on recent
sales levels. We believe all inventories will be utilized over the near term
and we believe that no additional loss will be incurred. If actual market
conditions are less favorable than those projected, then additional inventory
write-downs may be required. Property and Equipment Property and equipment is recorded at cost and is depreciated using the
straight-line method over the estimated useful lives of the respective assets.
Lives for the major asset categories are as follows: LivesLeasehold improvements
    
    Lesser of lease term or useful lifeEquipment
    
    3 - 5 yearsFurniture
    
    5 - 10 years
 Major additions and betterments are capitalized, while replacements,
maintenance, and repairs that do not extend the useful lives of the assets are
charged to operations as incurred. Depreciation expense totaled $2.3 million,
$1.7 million, and $1.1 million for the years ended December 31, 2003, 2002, and
2001, respectively. Property and equipment consisted of the following (in
thousands): December 31,2003
    
    2002Leasehold improvements
    
    $
    971
    
    
    $
    930Equipment
    
    
    13,495
    
    
    
    14,326Furniture
    
    
    62
    
    
    
    78Total property and equipment
    
    
    14,528
    
    
    
    15,334Less accumulated depreciation
    
    
    (8,261
    )
    
    
    (7,116
    )Net property and equipment
    
    $
    6,267
    
    
    $
    8,218
 During the year ended December 31, 2003, and prior to the spin-off, assets
having an original acquisition value of $320,000 and accumulated depreciation
of $177,000 were transferred to us from TFS, while assets having an original
acquisition value of $1.1 million and accumulated depreciation of $760,000 were
transferred from us to TFS. During the years ended December 31, 2002 and 2001,
assets having an original acquisition value of $3.3 million and $151,000,
respectively, and accumulated depreciation of $2.9 million and $151,000,
respectively, were transferred to us from TFS. In addition, we disposed of
equipment having an original acquisition value of $536,000 and accumulated
depreciation of $515,000 during the year ended December 31, 2003. Other Investments At December 31, 2003 and 2002, other investments consisted of
investments, at cost, in two start-up companies: ColorLink, Inc. for $5.1
million and Silicon Bandwidth, Inc. for $1.25 million. Our policy is to
evaluate the carrying amount of these investments in light of current
conditions. Given the early stage of these companies, it is reasonably
possible that our estimate that we will recover the carrying amount of these
investments could change in the future. In 2001, we invested $1.25 million in Series B Preferred Stock of Silicon
Bandwidth, Inc., which is convertible at any time into common stock of Silicon
Bandwidth at a conversion price of $2.29 per share. This investment represents
approximately 2.7% of the outstanding voting shares of Silicon Bandwidth. Our
investment does not entitle us to any representation on Silicon Bandwidths
board of directors. Since making the investment, we have worked closely with
Silicon Bandwidth to design unique, cost-effective, reconfigurable packaging
platforms for LCoS microdisplays. Our investment in Silicon Bandwidth is
accounted for under the cost method as our ownership is less than 20% and we do
not exert significant influence. In 2002, we invested $5.0 million in Series B Preferred Stock of
ColorLink, Inc., which is convertible at our election at any time into common
stock of ColorLink at a conversion price of $10 per share. This investment F-9




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##### Table of Contents



represents approximately 16.6% of the outstanding voting shares of
ColorLink. In connection with our investment, one of our executive officers
was elected as one of the seven members of ColorLinks board of directors.
ColorLink develops and manufactures color management technologies for liquid
crystal on silicon microdisplays. ColorLinks products consist of color
management components and system architectures that are critical for digital
projection systems that use high-resolution microdisplays. Those projection
systems include color monitors, high-definition televisions, and multi-media
projectors. This investment furthers our efforts to accelerate as much as
possible the establishment of the necessary infrastructure for LCoS
microdisplays. Our investment in ColorLink is accounted for under the cost
method, as our ownership is less than 20% and we do not exert significant
influence. An additional $81,000 was recorded as investment in ColorLink
during the third quarter of 2002 for legal and due diligence expenses. In 1998, we entered into a strategic relationship with Inviso, Inc., a
privately held company with numerous patents and proprietary technology related
to microdisplay development. We acquired a minority equity interest in Inviso
for approximately $3.3 million. In March 2000, we acquired an additional
interest in Inviso for $500,000, raising our total equity interest to $3.8
million. In the second quarter of 2001, we wrote off our investment of $3.8
million in Inviso because we determined that our investment was impaired, as
that term is defined under generally accepted accounting principles.
Subsequent to our write-off, Inviso was unable to raise funds to operate its
business and ceased operations. In the second quarter of 2002, we purchased
all of the intellectual property of Inviso for $780,000, which is included as a
component of intangibles. Intangibles Intangibles consist of mask works, patents, licenses, and other intangible
assets acquired from third parties. Intangibles are recorded at cost and
amortized using the straight-line method over the estimated useful lives of the
respective assets, which range from two to five years. Our policy is to
commence amortization of intangibles when their related benefits begin to be
realized. In January 2002, we hired seven key technical persons formerly employed by
Zight Corporation, a private company focused on microdisplays for personal
display system applications. At that time, Zight had ceased operations. We
purchased certain equipment of Zight at a liquidators auction. Following that
auction, we then negotiated with the representatives of the defunct Zight
Corporation to purchase its intellectual property for approximately $2.0
million. During April 2002, we also purchased the intellectual property of
Inviso, Inc. for $780,000 as discussed above. In each case, the intellectual
property purchased consisted of patents and patents pending. Other amounts
paid for intangible assets during 2003, 2002, and 2001 consisted primarily of
purchased mask sets and patent costs. Intangible assets as of December 31,
2003 and 2002 consisted of the following (in thousands): WeightedAmortizationPeriod in
    
    Acquisition
    
    Accumulated
    
    BookDecember 31, 2003
    
    Years
    
    Value
    
    Amortization
    
    ValueAmortized intangible assets:Mask works
    
    
    3.2
    
    
    $
    5,839
    
    
    $
    (2,206
    )
    
    $
    3,633Patents, patents
pending, and other
intangible assets
    
    
    5.0
    
    
    
    3,758
    
    
    
    (198
    )
    
    
    3,560Licenses
    
    
    5.0
    
    
    
    2,954
    
    
    
    (1,379
    )
    
    
    1,575$
    12,551
    
    
    $
    (3,783
    )
    
    $
    8,768
 F-10




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##### Table of Contents



WeightedAmortizationPeriod in
    
    Acquisition
    
    Accumulated
    
    BookDecember 31, 2002
    
    Years
    
    Value
    
    Amortization
    
    ValueAmortized intangible assets:Mask works
    
    
    2.6
    
    
    $
    5,695
    
    
    $
    (1,655
    )
    
    $
    4,040Patents, patents
pending, and other
intangible assets
    
    
    5.0
    
    
    
    3,431
    
    
    
    (10
    )
    
    
    3,421Licenses
    
    
    5.0
    
    
    
    2,954
    
    
    
    (788
    )
    
    
    2,166$
    12,080
    
    
    $
    (2,453
    )
    
    $
    9,627
 Intangible asset amortization expense was $1.3 million, $1.7 million, and
$749,000 for the years ended December 31, 2003, 2002, and 2001, respectively.
This expense was recognized as cost of sales as it was primarily related to
mask works on components, patents, and production licenses employed to build
and sell microdisplays. Estimated annual amortization expense through 2008 and thereafter related
to intangible assets at December 31, 2003 is as follows (in thousands): Fiscal Year2004
    
    $
    1,2702005
    
    
    2,5202006
    
    
    2,3232007
    
    
    1,9052008
    
    
    678Thereafter
    
    
    72$
    8,768
 Evaluation of Long-Lived Assets with Definite Lives In accordance with Financial Accounting Standards Board (FASB) Statement
of Financial Accounting Standards (SFAS) No. 144, Accounting for the
Impairment or Disposal of Long-Lived Assets, long-lived assets are tested for
recoverability whenever events or changes in circumstances indicate that the
carrying amounts of the asset may not be recoverable. We evaluate the
recoverability of property and equipment and intangibles by comparing the
carrying amount of the asset or group of assets against the estimated
undiscounted future cash flows expected to result from the use of the asset or
group of assets and their eventual disposition. If the undiscounted cash flows
are less than the carrying value of the asset or group of assets being
evaluated, an impairment loss would be recorded. The loss would be measured as
the difference between the fair value and carrying value of the asset or group
of assets being evaluated. Assets to be disposed of would be reported at the
lower of the carrying amount or the estimated fair value, less cost to sell.
The estimated fair value would be based on the best information available under
the circumstances, including prices for similar assets or the results of
valuation techniques, such as the present value of expected future cash flows
using a discount rate commensurate with the risks involved. Income Taxes Financial Accounting Standards Board (FASB) 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 basis of assets and liabilities and the
tax rates in effect when these differences are expected to reverse. We recognize deferred tax assets and liabilities for temporary differences
between the financial reporting basis and the tax basis of our assets and
liabilities along with net operating loss and credit carryforwards, if it is
more likely than not that the tax benefits will be realized. To the extent a
deferred tax asset cannot be recognized, a valuation allowance is established. Prior to the spin-off, our operations were included in TFS consolidated
U.S. federal and state income tax returns and in the tax returns of TFS
foreign subsidiaries. The provision for income taxes for periods prior to the
spin-off has been determined as if we had filed separate tax returns for the
periods presented. F-11




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##### Table of Contents



Revenue Recognition We recognize revenue from product sales when persuasive evidence of a sale
exists: that is, a product is shipped under an agreement with a customer; risk
of loss and title have passed to the customer; the fee is fixed or
determinable; and collection of the resulting receivable is reasonably assured.
Sales allowances are estimated based upon historical experience of sales
returns. We recognize revenue related to design and engineering services depending
on the relevant contractual terms. Under fixed-price contracts that contain
project milestones, revenue is recognized as milestones are met. Under
contracts where revenue is recognized based on milestones, the fair value of
milestones completed equals the fair value of work performed. Under a fixed
price contract whereby we are paid based on the performance of tasks, we
recognize revenue based on the estimated percentage of completion of the entire
project as measured by the costs for man hours and materials incurred to date
compared to the total estimated costs for man hours and materials. Any
anticipated losses on fixed price contracts are recorded in the period they are
determinable. Revenue related to design and engineering services is recognized
based on these methods and is non-refundable. We maintain an allowance for doubtful accounts for estimated losses
resulting from the inability of our customers to make required payments. We
determine the adequacy of this allowance by regularly evaluating individual
customer receivables and considering a customers financial condition, credit
history, and current economic conditions. If the financial condition of our
customers were to deteriorate, additional allowances could be required. The
allowance for doubtful accounts balance was $30,000 and $16,000 at December 31,
2003 and 2002, respectively. Research and Development We perform internal research and development activities, as well as
research and development activities contracted by our customers. Research and
development costs are expensed as incurred and consist primarily of salaries,
benefits, prototypes, experimentation, and facilities-related costs. Internal
research and development costs are included as a component of research and
development expenses. Research and development costs of customer-contracted
design and engineering activities are included in cost of sales. At December 31, 2003 and 2002, we had deferred revenue of $21,000 and
$335,000, respectively, related to customer-contracted design and engineering
activities. Stock Compensation We measure stock-based compensation for options granted to our employees
using the intrinsic value method pursuant to Accounting Principles Board
Opinion (APB) No. 25, Accounting for Stock Issued to Employees. However,
pursuant to the provisions of SFAS No. 123, Accounting for Stock-Based
Compensation, we have computed, for pro forma disclosure purposes, the value
of all options granted since the spin-off, using the Black-Scholes option
pricing method with the following weighted assumptions: risk-free interest
rates of 2.46%, expected dividend yields of zero; expected lives of five years;
and expected volatility (a measure of the amount by which a price has
fluctuated or is expected to fluctuate during a period) of 74%. Had
compensation cost for these stock options been determined consistent with SFAS
No. 123, our net loss and net loss per share for the year ended December 31,
2003 would have been as follows (in thousands except per share data): Net loss:As reported
    
    $
    (18,744
    )Total stock-based employee compensation expenses
determined under fair value based method for all awards
    
    
    (260
    )Pro forma net loss
    
    $
    (19,004
    )Basic and Diluted net loss per share:As reported
    
    $
    (3.51
    )Pro forma
    
    $
    (3.56
    )
 F-12




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Loss Per Share Basic and diluted loss per common share is computed by dividing net loss
by the weighted average number of shares of common stock outstanding for the
year ended December 31, 2003. For the year ended December 31, 2003, the effect
of approximately 1.4 million stock options was excluded from the calculation of
diluted loss per share as their effect would have been antidilutive and
decreased the loss per share. Per share information presented for the years ended December 31, 2002 and
2001, is calculated based on the number of shares issued in the spin-off. The
calculation of loss per share for these periods assumes that the common shares
were outstanding for the entire period. TFS Net Investment TFS net investment represented the cumulative investments in,
distributions from, and losses generated by our operations. We began to report
retained earnings in separate capital accounts as of the date of the spin-off. Reclassifications Certain amounts that were included as research and development expenses in
the 2002 and 2001 statements of operations have been reclassified to cost of
sales - products in order to be comparable with our reporting after the
spin-off. These are costs related to personnel expense, facilities,
depreciation, and amortization surrounding product and process engineering
activities after a product or process has been released to manufacturing. When
we were part of TFS, these costs were included in research and development
expense. These costs are more appropriately included in cost of sales.
Amounts reclassified from research and development expense to cost of
sales - products totaled $6.2 million and $6.6 million for the years ended December 31,
2002 and 2001, respectively. Recently Issued Accounting Standards In July 2001, the FASB issued SFAS No. 146, Accounting for Costs
Associated with Exit or Disposal Activities. SFAS No. 146 requires companies
to recognize costs associated with exit or disposal activities when they are
incurred rather than at the date of a commitment to an exit or disposal plan.
SFAS No. 146 replaces EITF Issue No. 94-3, Liability Recognition for Certain
Employee Termination Benefits and Other Costs to Exit an Activity (Including
Certain Costs Incurred in a Restructuring) and applies to exit or disposal
activities initiated after December 31, 2002. We adopted SFAS No. 146 on
January 1, 2003, and there was no impact on our financial position or results
of operations. In December 2002, the FASB issued SFAS No. 148, Accounting for
Stock-Based Compensation - Transition and Disclosure. This Statement amends
SFAS No. 123 to provide alternative methods of transition for a voluntary
change to the fair value method of accounting for stock-based employee
compensation. Specifically, SFAS No. 148 prohibits companies from utilizing
the prospective method of transition, the only method originally offered under
SFAS No. 123, in fiscal years beginning after December 15, 2003. However, the
statement permits two additional transition methods for companies that adopt
the fair value method of accounting for stock-based compensation, which include
the modified prospective and retroactive restatement methods. The modified
prospective method recognizes stock-based employee compensation cost from the
beginning of the fiscal year in which the provisions are first applied, as if
the fair value method had been used to account for all employee awards granted,
modified, or settled in fiscal years beginning after December 15, 1994. Under
the retroactive restatement method, all periods presented are restated to
reflect stock-based employee compensation cost under the fair value method for
all employee awards granted, modified, or settled in fiscal years beginning
after December 15, 1994. In addition, this Statement amends the disclosure
requirements of SFAS No. 123 to require prominent disclosures in both annual
and interim financial statements about the method of accounting for stock-based
employee compensation and the effect of the method used on reported results
using a prescribed specific tabular format and requiring disclosure in the
Summary of Significant Accounting Policies or its equivalent. We intend to
continue to measure stock-based compensation for option grants using the
intrinsic value method pursuant to APB No. 25, Accounting for Stock Issued to
Employees. We have adopted the new disclosure requirements and are currently
evaluating the impact if we were to adopt the fair value method of accounting
for stock-based employee compensation under each of the two additional
transitional methods discussed above. F-13




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In November 2002, the FASB issued FASB Interpretation No. 45 (FIN 45),
Guarantors Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others. This Interpretation addresses
the disclosures to be made by a guarantor in its financial statements and its
obligations under guarantees. The Interpretation also clarifies the
requirements related to the recognition of a liability by the guarantor at the
inception of a guarantee. Initial recognition of a liability will be applied
only on a prospective basis to guarantees issued or modified after December 31,
2002. We adopted the disclosure requirements of FIN 45 as of January 1, 2003,
and there was no impact on our financial position or results of operations.  (3)
    
    Transactions with TFS For periods prior to the spin-off, our costs and expenses included
allocations from TFS for centralized legal, accounting, treasury, quality
assurance, real estate, information technology, engineering, and other TFS
corporate services and infrastructure costs. These allocations were determined
on the basis that we and TFS considered to be reasonable reflections of the
utilization of services provided to, or the benefits received by, us. Cost of
sales allocations totaled $1.1 million, $2.4 million, and $2.4 million for the
years ended December 31, 2003, 2002, and 2001, respectively. Selling, general,
and administrative allocated costs totaled $1.5 million, $2.6 million, and $1.8
million for the years ended December 31, 2003, 2002, and 2001, respectively.
Research and development allocated costs totaled $800,000, $2.6 million, and
$2.8 million for the years ended December 31, 2003, 2002, and 2001,
respectively. The basis for the amounts allocated to us included the
following: legal, accounting, treasury, quality assurance, and other TFS
corporate functions including officers salaries were allocated based on
managements estimation of time devoted to the microdisplay business for these
functions; facility costs and information technology services were allocated on
the basis of headcount of the microdisplay business, which is most
representative of utilization of these resources; and engineering services were
allocated to us based on the actual hours of services used. The allocation
methodologies utilized represented managements best estimate of the actual
services utilized by the microdisplay business of TFS. On the spin-off date, we and TFS entered into a series of agreements to
facilitate our separation from TFS. These agreements included certain
transitional services, leases, intellectual property transfers, and tax sharing
agreements. These agreements require us to pay a negotiated fee. For the
period from September 15, 2003, the spin-off date, through December 31, 2003,
we paid $312,000 for rent and $28,000 for engineering services to TFS under
these agreements. During this period, we also paid TFS $160,000 for
engineering and design services related to the development of printed circuit
board assemblies for our HDTV product. Master Separation and Distribution Agreement The Master Separation and Distribution Agreement provided for, among other
things, the principal corporate transactions required to effect the separation
of our business from the remaining TFS businesses, the spin-off, and other
agreements governing the relationship between us and TFS after the spin-off. Subject to certain exceptions, the Master Separation and Distribution
Agreement provides for cross-indemnities principally designed to place
financial responsibility for the liabilities of our business with us and
financial responsibility for the obligations and liabilities of TFS retained
businesses with TFS. Specifically, we have agreed to assume liability for, and
to indemnify TFS against, any and all liabilities associated with our business.
These liabilities include any litigation, proceedings, or claims relating to
the products, services, and operations of our business whether or not the
underlying basis for such litigation, proceeding, or claim arose prior to or
arises after the date of transfer of the microdisplay business by TFS to us.
TFS has agreed to indemnify us against any and all liabilities associated with
TFS retained businesses. Tax Sharing Agreement Under the Tax Sharing Agreement, we have agreed to indemnify TFS against
any taxes (other than Separation Taxes) that are attributable to us since our
formation, even while we were a member of TFS federal consolidated tax group.
TFS has agreed to indemnify us against any taxes (other than Separation Taxes)
that are attributable to the businesses retained by TFS. The Tax Sharing
Agreement sets forth rules for determining taxes attributable to us and taxes
attributable to the businesses retained by TFS. F-14




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We have agreed not to take any action that would cause the spin-off not to
qualify under Section 355 of the Internal Revenue Code of 1986, as amended (the
Code). We have agreed not to take certain actions for two years following
the spin-off, unless we obtain an IRS ruling or an opinion of counsel to the
effect that these actions will not affect the tax-free nature of the spin-off.
These actions include certain issuances of our stock, a liquidation or merger
of our company, and dispositions of assets outside the ordinary course of our
business. If any of these transactions were to occur, the spin-off could be
deemed to be a taxable distribution to TFS. This would subject TFS to a
substantial tax liability. We have agreed to indemnify TFS and its affiliates
to the extent that any action we take or fail to take gives rise to a tax
incurred by TFS or any of its affiliates with respect to the spin-off. In
addition, we have agreed to indemnify TFS for any tax resulting from an
acquisition by one or more persons of a 50% or greater interest in our company. Transition Services Agreement We and TFS have entered into a Transition Services Agreement under which
TFS provides to us certain administrative services that may be necessary to our
business. The most significant services that TFS provides to us relates to
document control. TFS will charge us mutually agreed upon hourly rates for
these services. This agreement will expire on August 31, 2004 unless the
parties mutually agree upon a renewal or unless earlier terminated by mutual
consent of the parties. Intellectual Property Agreement We and TFS have entered into an Intellectual Property Agreement under
which we granted to TFS a nonexclusive, royalty-free, worldwide, perpetual,
fully paid up license in and to all intellectual property that was assigned to
us, that is used in all fields other than the field of microdisplays. This
intellectual property includes all patents, copyrights, trademarks, tradenames,
trade dress, trade secrets, know how, and show how whether or not legal
protection has been sought or obtained. In addition, the license granted to
TFS is non-assignable and non-licensable to third parties except that TFS may
sublicense its rights to the intellectual property to any party or entity in
which TFS owns at least a 50% equity interest. Real Property Sublease Agreement We and TFS have entered into a Real Property Sublease Agreement under
which we lease office and manufacturing space in the TFS headquarters building.
The initial term of the sublease expires August 31, 2005, with automatic
one-year renewal terms thereafter unless either party elects to terminate the
sublease upon notice delivered at least six months prior to the expiration of
the then applicable sublease term. The agreement also sets forth certain
circumstances under which all or a portion of the sublease may be terminated
without penalty. We lease approximately 42,500 square feet of the building
from TFS and share certain common areas in the building with TFS. Our monthly
rent payable to TFS is approximately $40,000. This amount includes all normal
and customary services in connection with the operation and maintenance of the
building. This amount does not, however, include water or electrical
utilities, which we pay separately based on our use of those items. The
sublease also requires that TFS provide us with facilities-related information
technology management services, for which we pay a minimum monthly fee of
approximately $38,000. The sublease is not assignable by us without the prior
written consent of TFS, which consent may be withheld by TFS in its sole
discretion.  (4)
    
    Benefit Plans: Stock Options Our 2003 Incentive Compensation Plan was adopted by our board of directors
and approved by our stockholder on August 26, 2003. Under the 2003 Incentive
Compensation Plan, an aggregate of 1,650,000 shares of common stock may be
issued pursuant to options granted to acquire common stock, the direct granting
of restricted common stock, the granting of stock appreciation rights, and the
granting of dividend equivalents. On the first day of each fiscal year, an
additional number of shares equal to 4% of the total number of shares then
outstanding will be added to the number of shares that may be subject to the
granting of awards. Prior to the spin-off, certain of our employees were granted options to
purchase TFS stock under TFS stock-based compensation plans. In connection
with the spin-off, each outstanding TFS option granted prior to the F-15




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spin-off was converted into both an adjusted TFS option and a substitute
Brillian option. The treatment of such TFS options and the substitute Brillian
options is identical for those employees who remained employees of TFS
immediately after the spin-off and for those employees who became employees of
Brillian in connection with the spin-off. These TFS options were converted in
a manner that preserved the aggregate exercise price of each option, which was
allocated between the adjusted TFS option and the substitute Brillian option,
and each preserved the ratio of the exercise price to the fair market value of
the stock subject to the option. For employees who remained employees of TFS
after the spin-off, employment with TFS will be taken into account in
determining when each substitute Brillian option becomes exercisable and when
it terminates, and in all other respects the terms of the substitute option is
substantially the same as the original TFS option. Under this arrangement, on
September 15, 2003, we issued options to purchase 750,275 shares of Brillian
common stock. Of these options, 600,410 were issued to employees who remained
employees of TFS after the spin-off. Options granted under TFS plans
generally vest over a four-year period and are exercisable for a term of 10
years. The following table and narrative summarizes the status of our 2003
Incentive Compensation Plan at December 31, 2003, and changes during the year
then ended: Weighted AverageOptions
    
    Exercise PriceOutstanding at spin-off date
    
    
    
    
    
    $
    TFS options converted to
Brillian options on spin-off
date
    
    
    750,275
    
    
    
    10.65Granted
    
    
    618,925
    
    
    
    6.80Exercised
    
    
    (4,230
    )
    
    
    4.08Expired or canceled
    
    
    (1,387
    )
    
    
    20.09Outstanding at end of year
    
    
    1,363,583
    
    
    
    8.91Exercisable at end of year
    
    
    417,348
    
    
    $
    11.38Weighted average fair value of
options granted
    
    
    
    
    
    $
    5.62
 The following table summarizes information about stock options outstanding
at December 31, 2003: Options Outstanding
    
    Options ExercisableNumber
    
    Weighted
    
    
    
    
    
    NumberOutstanding
    
    Average
    
    Weighted
    
    Exercisable
    
    WeightedRange of
    
    at
    
    Remaining
    
    Average
    
    at
    
    AverageExercise
    
    December 31,
    
    Contractual
    
    Exercise
    
    December 31,
    
    ExercisePrices
    
    2003
    
    Life
    
    Price
    
    2003
    
    Price$
    3.27 - $6.34
    
    
    
    312,778
    
    
    
    7.6
    
    
    $
    5.29
    
    
    
    123,186
    
    
    $
    5.456.50 - 10.84
    
    
    
    754,885
    
    
    
    8.9
    
    
    
    6.99
    
    
    
    144,402
    
    
    
    7.9611.26 - 67.60
    
    
    
    295,920
    
    
    
    7.1
    
    
    
    17.64
    
    
    
    149,760
    
    
    
    19.551,363,583
    
    
    
    8.2
    
    
    
    8.91
    
    
    
    417,348
    
    
    
    11.38
 In addition to the Brillian substitute options granted under the terms of
the Master Separation and Distribution Agreement, on September 4, 2003, we
granted options to our employees to purchase approximately 526,000 shares of
our common stock. Options with respect to approximately 300,000 shares have a
vesting period of 32 months, and the remainder have vesting periods of 50
months. Additionally, on September 4, 2003, we granted approximately 56,000
shares of restricted common stock to employees with a vesting period of one
year. As of December 31, 2003, approximately 22,000 shares of this restricted
common stock had vested and been issued. On September 4, 2003, the spin-off
had not been completed and, therefore, no market had developed for our common
stock. For purposes of setting the exercise price of the options granted on
that date, fair market value was estimated by our board of directors. Based on
the initial trading prices of our common stock, we recorded deferred
compensation of approximately $1.5 million related to the stock option and
restricted stock grants of September 4, 2003. The total amount of deferred
compensation will be expensed over the vesting terms of the options and shares
of restricted stock. During the year ended December 31, 2003, we recorded
non-cash compensation expense of F-16




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##### Table of Contents



$267,000 related to these restricted stock and option grants. The
non-cash compensation expense was recorded as a component of cost of sales 
products; selling, general and administrative expense; and research and
development in the amounts of $34,000, $132,000, and $101,000, respectively.
Subsequent to September 4, 2003, we issued 92,925 options to acquire common
stock with exercise prices equal to the fair market value on the grant dates. 2003 Employee Stock Purchase Plan Our 2003 Employee Stock Purchase Plan was adopted by our board of
directors and approved by our stockholder on August 26, 2003. An aggregate of
200,000 shares of common stock are reserved for issuance under the 2003
Employee Stock Purchase Plan. This plan consists of a series of successive
offering periods, each with a maximum duration of 24 months. The initial
offering period began on September 16, 2003 and ended on December 31, 2003.
Subsequent to December 31, 2003, 13,502 shares of common stock were issued to
employees at a price per share of $7.16 pursuant to their participation in the
first offering period. 401(k)Profit Sharing Plan Provisions of the Master Separation and Distribution Agreement mandated
that we establish retirement savings and welfare plans. The Master Separation
and Distribution Agreement also provided that the account balances, including
outstanding loans, of all our employees participating in TFS 401(k) plan were
transferred to our new 401(k) plan and assets held in trust related to such
account balances were transferred to new trusts established by us. Accordingly, on August 26, 2003, we adopted a 401(k) profit sharing plan
for which our employees generally are eligible. The plan is intended to
qualify under Section 401(k) of the Internal Revenue Code, so that
contributions to the plan by employees or by us and the investment earnings on
the contributions are not taxable to the employees until withdrawn. Our
contributions, if any, are deductible by us when made. Our employees may elect
to reduce their current compensation by an amount equal to the maximum of 25%
of total annual compensation or the annual limit permitted by law and to have
those funds contributed to the plan. Although we may make matching
contributions to the plan on behalf of all participants, we have not made any
contributions since the plans adoption. Discretionary company contributions to the TFS 401(k) plan for our
employees totaled $0, $96,000, and $112,000 for the years ended December 31,
2003, 2002, and 2001, respectively.  (5)
    
    Income Taxes: The principal reasons for the difference between the income tax benefit
(provision) and the amounts computed by applying the statutory income tax rates
to the loss for the years ended December 31, are as follows: 2003
    
    2002
    
    2001Federal tax at statutory rates
    
    
    34
    %
    
    
    34
    %
    
    
    34
    %State tax at statutory rates
    
    
    5
    %
    
    
    5
    %
    
    
    5
    %Increase in valuation allowance
    
    
    (39
    %)
    
    
    (39
    %)
    
    
    (39
    %)Utilization of deferred tax liability
assumed in spin-off
    
    
    6
    %
    
    
    0
    %
    
    
    0
    %Total
    
    
    6
    %
    
    
    0
    %
    
    
    0
    %
 At December 31, deferred taxes represent the tax effect of temporary
differences related to the following (in thousands): 2003
    
    2002
    
    2001Current deferred taxes:Inventories
    
    
    636
    
    
    
    600
    
    
    
    537Accrued expenses
    
    
    143
    
    
    
    279
    
    
    
    174Allowance for doubtful accounts
    
    
    12
    
    
    
    6
    
    
    
    13Deferred tax valuation allowance
    
    
    (791
    )
    
    
    (885
    )
    
    
    (724
    )Total
    
    $
    
    
    
    $
    
    
    
    $
    
 F-17




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2003
    
    2002
    
    2001Non-current deferred taxes:Depreciation and amortization
    
    
    (1,705
    )
    
    
    (1,902
    )
    
    
    (1,565
    )Research and development credits
    
    
    
    
    
    
    280
    
    
    
    131Net operating losses
    
    
    2,385
    
    
    
    25,866
    
    
    
    16,259Deferred tax valuation allowance
    
    
    (680
    )
    
    
    (24,244
    )
    
    
    (14,825
    )Total
    
    $
    
    
    
    $
    
    
    
    $
    
 FASB SFAS No. 109, Accounting for Income Taxes, requires that a
valuation allowance be established when it is more likely than not that all or
a portion of a deferred tax asset will not be realized. Changes in valuation
allowances from period to period are included in our tax provision in the
period of change. In determining whether a valuation allowance is required, we
take into account all evidence with regard to the utilization of a deferred tax
asset, including our past earnings history, expected future earnings, the
character and jurisdiction of such earnings, unsettled circumstances that, if
unfavorably resolved, would adversely affect utilization of a deferred tax
asset, carryback and carryforward periods, and tax strategies that could
potentially enhance the likelihood of realization of a deferred tax asset. Prior to the spin-off, our operations were included in TFS consolidated
U.S. federal and state income tax returns and in the tax returns of TFS
foreign subsidiaries. The provision for income taxes for periods prior to the
spin-off has been determined as if we had filed separate tax returns for the
periods presented. In connection with the formation and spin-off of our company by TFS, we
assumed a net deferred tax liability of approximately $1.1 million. This net
deferred tax liability is the result of differences between the book and tax
basis of the assets transferred to us. TFS retained the net operating losses
and tax credits that were generated by our operations before the spin-off. The
assumption of the net deferred tax liability resulted in a corresponding
reduction in the TFS net investment contributed to us in 2003. Pursuant to
SFAS No. 109, the assumption of the net deferred tax liability enabled us to
record additional deferred tax assets of approximately $1.1 million during the
period from the spin-off date to December 31, 2003. A valuation allowance has
been recorded for deferred tax assets generated during the period ended
December 31, 2003 that exceeded our net deferred tax liabilities. We generated a net operating loss of approximately $6.1 million during the
period from the spin-off date to December 31, 2003, which expires in 2023 for
federal income tax purposes and earlier for state income tax purposes.  (6)
    
    Commitments and Contingencies: Rent and Lease We lease office and manufacturing space from TFS (see Note 3). We also
lease our development center in Boulder, Colorado. Rent expense was
approximately $397,000, $120,000, and $0 for the years ended December 31, 2003,
2002, and 2001, respectively. Future minimum lease commitments under these
leases are $936,000 and $624,000 for the years ending December 31, 2004 and
2005, respectively. Guarantee In February 2002, we guaranteed up to $500,000 of the debt of VoiceViewer
Technology, Inc., a private start-up company developing microdisplay products.
As of December 31, 2003, our maximum liability under this guarantee was
$425,000. This loan guarantee has a five-year term and matures in January
2007. We will be required to pay this guarantee to the lender if VoiceViewer
defaults on its debt obligations. During the fourth quarter of 2003, we
determined that it is probable that VoiceViewer will be unable to meet its
obligations under the loan agreement. Accordingly, we have accrued $359,000
for our estimated obligation under this guarantee. We have a security interest
in, and second rights to, the intellectual property of VoiceViewer, while the
lending institution has the first rights. We would obtain the VoiceViewer
intellectual property if in the future we are required to pay amounts under the
guarantee. However, we do not believe we can realize any significant value
from VoiceViewers intellectual property. Additionally, during the fourth
quarter of 2003, we wrote off a note receivable from VoiceViewer of
approximately $75,000. The combined amount of these two items, which was
$434,000, has been recorded as selling, general, and administrative expense. F-18




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Tax-Free Distribution We believe that the contribution by TFS of the assets related to our
business and the assumption by us of the related liabilities in exchange for
our common stock, which was part of the spin-off, should be treated as a
reorganization within the meaning of Section 368(a)(1)(D) of the Code, and the
distribution should qualify as a tax-free distribution under Section 355 of the
Code. It should be noted that the application of Section 355 of the Code to
the distribution is complex and may be subject to differing interpretation. If
the distribution does not qualify as a tax-free distribution under Section 355
of the Code, then (i) TFS would recognize capital gains but not losses equal to
the difference between the fair market value of our common stock on the date of
the distribution and TFS tax basis in such stock; and (ii) the distribution
may be taxable to individual stockholders, depending on their individual tax
basis. In addition, we have agreed to indemnify TFS in the event the
distribution is not tax-free to TFS because of actions taken by us or because
of our failure to take various actions (See Note 3). Certain of the events
that could trigger this obligation may be beyond our control. In particular,
we may be required to indemnify TFS if the distribution is deemed to be part of
a plan in which one or more persons acquire directly or indirectly stock
representing a 50% or greater interest in our company.  (7)
    
    Segment Reporting, Sales to Major Customers, and Geographic Information SFAS No. 131, Disclosures about Segments of an Enterprise and Related
Information, establishes standards for the reporting by public business
enterprises of information about operating segments, products and services,
geographic areas, and major customers. Because the products we sell for use in near-to-eye and projection devices
share the same underlying technology and have similar economic characteristics,
production processes, and customer types, we operate and report internally as
one segment in accordance with SFAS No. 131. All of our assets are located in
the United States. For the year ended December 31, 2003, sales to TQ Systems, Eastman Kodak
Company, and Brashear accounted for approximately 14%, 14%, and 12%,
respectively, of our net sales. For the year ended December 31, 2002, sales to
Brashear accounted for approximately 23% of our revenue and sales to Kodak
accounted for approximately 14% of our net sales. For the year ended December
31, 2001, sales to RCA Thomson accounted for approximately 65% of our net
sales. No other customer accounted for greater than 10% of our net sales
during those periods. Net sales by geographic area are determined based upon the location of the
end customer. Summary information by geographic region is as follows (in
thousands) for years ended: NorthAmerica
    
    Europe
    
    Asia
    
    TotalDecember 31, 2003Net Sales
    
    $
    1,225
    
    
    $
    571
    
    
    $
    398
    
    
    $
    2,194December 31, 2002Net Sales
    
    $
    971
    
    
    $
    176
    
    
    $
    292
    
    
    $
    1,439December 31, 2001Net Sales
    
    $
    1,721
    
    
    $
    102
    
    
    $
    113
    
    
    $
    1,936
 F-19




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##### Table of Contents



(8)
    
    Selected Quarterly Financial Data (Unaudited) The following table summarizes the unaudited consolidated quarterly
results of operations as reported for 2003 and 2002 (in thousands): Quarters Ended2003
    
    2002Dec. 31
    
    Sept. 30
    
    June 30
    
    March 31
    
    Dec. 31
    
    Sept. 30
    
    June 30
    
    March 31Net sales
    
    $
    360
    
    
    $
    703
    
    
    $
    760
    
    
    $
    371
    
    
    $
    645
    
    
    $
    345
    
    
    $
    223
    
    
    $
    226Gross profit (loss)
    
    
    (2,275
    )
    
    
    (1,673
    )
    
    
    (1,926
    )
    
    
    (1,761
    )
    
    
    (2,445
    )
    
    
    (2,293
    )
    
    
    (3,588
    )
    
    
    (3,104
    )Net loss
    
    
    (4,913
    )
    
    
    (4,482
    )
    
    
    (4,691
    )
    
    
    (4,658
    )
    
    
    (4,943
    )
    
    
    (5,122
    )
    
    
    (6,638
    )
    
    
    (6,490
    )
 F-20




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##### Table of Contents



BRILLIAN CORPORATION 
 SCHEDULE II
VALUATION AND QUALIFYING ACCOUNTS For the Years Ended December 31, 2003, 2002, and 2001
 IncreasesBalance
    
    (Reductions)at
    
    Charged to
    
    Charged
    
    
    
    
    
    Balancebeginning
    
    Costs and
    
    to Other
    
    
    
    
    
    at End ofof Period
    
    Expenses
    
    Accounts
    
    Write-offs
    
    Period(in thousands)Allowance for doubtful accounts:Year ended 12/31/2003
    
    $
    16
    
    
    $
    14
    
    
    $
    
    
    
    $
    
    
    
    $
    30Year ended 12/31/2002
    
    
    34
    
    
    
    12
    
    
    
    
    
    
    
    (30
    )
    
    
    16Year ended 12/31/2001
    
    
    15
    
    
    
    19
    
    
    
    
    
    
    
    
    
    
    
    34Valuation allowance for deferred tax asset:Year ended 12/31/2003
    
    $
    25,129
    
    
    $
    6,750
    
    
    $
    
    
    
    $
    (30,408
    )
    
    $
    1,471Year ended 12/31/2002
    
    
    15,549
    
    
    
    9,580
    
    
    
    
    
    
    
    
    
    
    
    25,129Year ended 12/31/2001
    
    
    6,923
    
    
    
    8,626
    
    
    
    
    
    
    
    
    
    
    
    15,549
 S-1




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##### Table of Contents



EXHIBIT INDEX ExhibitNumber
    
    Exhibit2
    
    Master Separation and Distribution Agreement (1)3.1
    
    Certificate of Incorporation of the Registrant (2)3.2
    
    Certificate of Designation of Series A Junior Participating Preferred Stock (1)3.3
    
    Bylaws of the Registrant (2)4.1
    
    Specimen of Common Stock Certificate (1)4.2
    
    Rights Agreement between the Registrant and The Bank of New York, as Rights
Agent, including Form of Right Certificate (1)10.1
    
    Assignment and Assumption Agreement (1)10.2
    
    Intellectual Property Agreement (1)10.3
    
    Tax Sharing Agreement (1)10.4
    
    Real Property Sublease Agreement (1)10.5
    
    Transition Services Agreement (1)10.6
    
    2003 Incentive Compensation Plan (3)10.7
    
    Profit Sharing/401(k) Plan (1)10.8
    
    2003 Employee Stock Purchase Plan (4)10.9
    
    Form of Indemnity Agreement for directors and executive officers (2)23.1
    
    Consent of Deloitte & Touche LLP*31.1
    
    Certification of Chief Executive Officer pursuant to Rule 13a-14(a) and Rule
15d-14(a), promulgated under the Securities Exchange Act of 1934, as amended*31.2
    
    Certification of Chief Financial Officer pursuant to Rule 13a-14(a) and Rule
15d-14(a), promulgated under the Securities Exchange Act of 1934, as amended*32.1
    
    Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002*32.2
    
    Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002*
   *
    
    Filed herewith.(1)
    
    Incorporated by reference to the Registration Statement on Form 10/A
(Amendment No. 4) as filed with the SEC on September 3, 2003.(2)
    
    Incorporated by reference to the Registration Statement on Form 10/A
(Amendment No. 1) as filed with the SEC on June 27, 2003.(3)
    
    Incorporated by reference to Exhibit 10.6 to the Registration Statement
on Form S-8 (Registration No. 333-108362) as filed with the SEC on August
29, 2003.(4)
    
    Incorporated by reference to Exhibit 10.8 to the Registration Statement
on Form S-8 (Registration No. 333-108363) as filed with the SEC on August
29, 2003.