SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K/A
AMENDMENT NO. 1

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

For the fiscal year ended December 31, 2004

Commission file number 1- 4373

THREE-FIVE SYSTEMS, INC.

(Exact Name of Registrant as Specified in Its Charter)

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

1600 North Desert Drive, Tempe, Arizona 85281

(Address of Principal Executive Offices) (Zip Code)

(602) 389-8600

(Registrant’s telephone number, including area code)

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

Title of Each Class	Name of Each Exchange on Which Registered
Common Stock, par value $.01 per share	New York Stock Exchange
Preferred Stock Purchase Rights	New York Stock Exchange

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

     The aggregate market value of Common Stock held by nonaffiliates of the registrant (17,362,905 shares) based on the closing price of the registrant’s Common Stock as reported on the New York Stock Exchange on June 30, 2004, which was the last business day of the registrant’s most recently completed second fiscal quarter, was $88,550,816. 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 28, 2005, there were outstanding 21,767,653 shares of the registrant’s Common Stock, par value $.01 per share.

Documents Incorporated by Reference

None.

EXPLANATORY NOTE

     This Amendment No. 1 to the Annual Report on Form 10-K of Three-Five Systems, Inc. (the “Company”) amends the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2004, originally filed on April 4, 2005 (the “Original Filing”). The Company is filing this Amendment No. 1 to: (i) add the information required by Part III of Form 10-K, which was cross-referenced in the Original Filing to the Company’s Proxy Statement for the 2005 Annual Meeting of Stockholders; (ii) delete the incorporation by reference of the Company’s Proxy Statement for the 2005 Annual Meeting of Stockholders from the cover page; (iii) include the conformed signature of Deloitte & Touche LLP, independent registered public accounting firm, in its reports included in Part II, Items 8 and 9A, and on its Consent filed as Exhibit 23.1, which was inadvertently omitted in each such case in the Original Filing; (iv) correct an error in a square footage amount in footnote 3 to the first table appearing in Part I, Item 2. “Properties;” (v) correct the numbering of the footnotes to the Consolidated Financial Statements; (vi) revise the following portions of the Original Filing to add disclosure concerning our vacating certain leased property: Part I, Item 1. “Risk Factors” and footnote 3 to the first table appearing in Item 2. “Properties;” the third to last paragraph in Part II, Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Critical Accounting Policies and Estimates;” and Consolidated Financial Statements, Footnote 12 — Subsequent Events; and (vii) revise paragraphs in the following portions of the Original Filing regarding disclosure of our agreement with International DisplayWorks, Inc.: Part II, Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in the “Overview — Subsequent Events” and “Liquidity and Capital Resources” sections and Item 9B. “Other Information;” and Consolidated Financial Statements, Footnote 1 — Organization and Operation and Footnote 12 — Subsequent Events. In addition, in connection with the filing of this Amendment No. 1 and pursuant to the rules of the Securities and Exchange Commission, the Company is including currently dated certifications as Exhibits 31.1, 31.2, 32.1, and 32.2.

     Except as described above, no other changes have been made to the Original Filing. This Amendment No. 1 does not amend or update any other information set forth in the Original Filing, and the Company has not updated disclosures contained therein to reflect any events that occurred at a date subsequent to the filing of the Original Filing.

TABLE OF CONTENTS

PART I
	ITEM 1.	BUSINESS	1
	ITEM 2.	PROPERTIES	1
PART II
	ITEM 7.	MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS	2
	ITEM 8.	FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA	2
	ITEM 9A.	CONTROLS AND PROCEDURES	2
	ITEM 9B.	OTHER INFORMATION	4
PART III
	ITEM 10.	DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT	4
	ITEM 11.	EXECUTIVE COMPENSATION	8
	ITEM 12.	SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDERS MATTERS	17
	ITEM 13.	CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS	19
	ITEM 14.	PRINCIPAL ACCOUNTANT FEES AND SERVICES	19
SIGNATURES			20
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS			F-1
EXHIBIT 23.1
EXHIBIT 31.1
EXHIBIT 31.2
EXHIBIT 32.1
EXHIBIT 32.2

ITEM 1. BUSINESS

RISK FACTORS

We sublease some facilities and are subject to the credit risk of the subleases.

     We sold our 97,000 square foot Tempe facility in December 2004 and leased back the entire facility under a five-year lease. We subleased approximately 56,000 square feet of that Tempe facility to Brillian Corporation for the same five-year period. Brillian pays to us the same lease rate that we pay the lessor on the master lease. If Brillian were to default on its obligation to us, we would still be obligated on the master lease to continue to make payments on the Brillian space. In December 2004, we moved out of a building in Redmond, Washington, which we refer to as Building 1, into a new facility, which we refer to as Building 4. The lease on Building 1 expires in December 2007 and we have subleased that building to Pogo Linux for an amount that is approximately 70% of the original lease rate. Thus, we will continue to pay the 30% differential to the building owner. In addition, if Pogo Linux were to default on its lease obligations, we would still be obligated on the original lease to continue to make payments to the building owner. In January 2005, we moved out of another building in Redmond, which we refer to as Building 2. We are looking for a sublessor of that building, which has a lease that expires in January 2006. We will continue to be obligated on that lease through its remaining term. At the end of March 2005, we made the decision to vacate an additional building in Redmond. We refer to that building as Building 3. We are looking for a sublessor of that building which has a lease that expires in October 2006. We will continue to be obligated on that lease through its remaining term.

ITEM 2. PROPERTIES

Location	Type	Leased or Owned	Square Feet
Tempe, Arizona, USA	Administrative; sales; design	Leased1	97,0002
Redmond, Washington, USA	Manufacturing; sales (4 separate locations)	Leased3	230,0003
Marlborough, Massachusetts, USA	Manufacturing; sales	Leased		20,000
Orlando, Florida, USA	Sales	Leased	26,8006
Manila, Philippines	Manufacturing	Owned	71,0004
Penang, Malaysia	Manufacturing; design; sales	Leased		120,000
Beijing, Republic of China	Manufacturing; design; sales	Owned7		54,900
Swindon, England	Sales	Leased	3,1005

1	In December 2004, we sold our Tempe, Arizona building for approximately $11.3 million less selling costs of approximately $500,000. At the time of the sale, we entered into an agreement with the buyer to lease back the entire facility for a period of five years.
2	We sublease approximately 56,000 square feet of space to Brillian Corporation.
3	In October 2004 (effective January 1, 2005), we subleased approximately 32,000 square feet of our facilities to Pogo Linux, Inc. In December 2004, we recognized a charge of approximately $382,000 for future costs associated with the termination of the original lease and subsequent sublease of this facility to Pogo Linux, Inc. We also sublease approximately 1,000 square feet of space to Sindhara Super Media Corporation in our new building. In January 2005, we vacated an additional approximately 30,000 square feet. A charge of approximately $197,000 is expected to be recorded in the first quarter of 2005 to recognize future costs associated with the continuing lease obligation for this vacated facility. We have undertaken efforts to sublease this facility. At the end of March 2005, we vacated an additional 32,650 square feet. A charge of approximately $500,000 is expected to be recorded in the first quarter of 2005 to recognize future costs associated with the continuing lease obligation for this vacated facility. We have undertaken efforts to sublease this facility.
4	In the second quarter of 2004, we purchased our facility in Manila from our lessor for a total payment of $3.8 million. We also paid $614,000 to the RBF Development Corporation, or RBF, for a 50-year land right. Lastly,

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	we executed an agreement with RBF for the option to purchase the leased land for $1 at any time until April 23, 2014. In January 2005, we announced that we are exploring opportunities to sell this facility.
5	In February 2005, we vacated our space in Swindon and a charge of approximately $15,400 was recorded in February 2005 to recognize future costs associated with continuing lease obligations for this vacated facility. We have undertaken efforts to sublease this facility.
6	Our lease in Orlando expired in January 2005, and we vacated the facility. We moved into a new office and leased 570 square feet at that new location. We intend to vacate that facility by the end of the first quarter of 2005. A charge of approximately $24,000 is expected to be recorded in the first quarter of 2005 to recognize future lease costs associated with the continuing obligation for this vacated facility.
7	We own our manufacturing facility in China. That facility is situated on land of which we are the sole and exclusive holder of the land use rights certificate approved and issued by the local government in which the property is located. The certificate provides for a land use rights term of 50 years until approximately 2048.

PART II

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

Overview

  Subsequent Events

     We recently announced that we signed a definitive agreement to sell the assets of our small form factor display business to International DisplayWorks, Inc. which is expected to be finalized in April 2005. Revenues from our small form factor display business in 2004 were approximately $28 million.

Critical Accounting Policies and Estimates

     At the end of March 2005, we vacated an additional 32,650 square feet. A charge of approximately $500,000 is expected to be recorded in the first quarter of 2005 to recognize future costs associated with the continuing lease obligation for this vacated facility.

Liquidity and Capital Resources

     We recently signed a definitive agreement to sell the assets of our small form factor display business to International DisplayWorks, Inc. That sale would not include the display monitor business operated out of our Marlborough, Massachusetts facility. The sale to International DisplayWorks, Inc. is expected to be finalized in April 2005. TFS estimates the total value of that transaction will range between $11 million and $21 million and will include an $8 million cash payment at closing. The sale of the small form factor display operations to International DisplayWorks, Inc. will not only generate cash proceeds to us but eliminate the need for additional sources of funds for the sold operations.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

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

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, 2004. 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 reports filed under the Securities Exchange Act within the time periods specified by the Securities and Exchange Commission’s rules and forms. During the fiscal year covered by this report, there have not been any changes in our internal controls over financial reporting that have materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

     Subsequent to the date of their evaluation, there have not been any significant changes in our internal controls or in other facts that could significantly affect these controls, including any corrective action with regard to significant deficiencies and material weaknesses.

Management’s Report on Internal Control over Financial Reporting

To the Board of Directors and Stockholders of
Three-Five Systems, Inc.
Tempe, Arizona

     Management of Three-Five Systems, Inc., also referred to in this report as “the Company,” is responsible for establishing and maintaining adequate internal control over financial reporting. The Company’s internal control framework and processes were designed to provide reasonable assurance to management and the Board of Directors regarding the reliability of financial reporting and the preparation of the Company’s consolidated financial statements for external purposes in accordance with accounting principles generally accepted in the United States of America.

     The Company’s internal control over financial reporting includes those policies and procedures that:

     • pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company;

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     • provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and Directors of the Company; and

     • provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the Company’s assets that could have a material effect on the consolidated financial statements.

     Because of its inherent limitations, a system of internal control over financial reporting may not prevent or detect misstatements. Further, because of changing conditions, effectiveness of internal control over financial reporting may vary over time. Thus, projections of any evaluation of effectiveness to future periods are subject to the risks that controls may become inadequate because of changes in conditions and that the degree of compliance with the policies or procedures may deteriorate.

     Management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2004. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) in Internal Control — Integrated Framework. Management reviewed the results of its assessment with the Audit Committee and the Board of Directors of the Company.

     Based upon its assessment and those criteria set forth in COSO, management believes that the Company maintained effective internal control over financial reporting as of December 31, 2004.

     The Company’s independent registered public accounting firm, Deloitte & Touche LLP, has issued an attestation report on management’s assessment of the Company’s internal control over financial reporting and their report has been included herein. Their report on the Company’s consolidated financial statements appears in Form 10K, Part II, Item 8, Financial Statements and Supplementary Data.

Report of Independent Registered Public Accounting Firm

To the Board of Directors and Stockholders of
Three-Five Systems, Inc.
Tempe, Arizona

     We have audited management’s assessment, included in the accompanying Management’s Report on Internal Control Over Financial Reporting, that Three-Five Systems, Inc. and subsidiaries (the “Company”) maintained effective internal control over financial reporting as of December 31, 2004, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of the Company’s internal control over financial reporting based on our audit.

     We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinions.

     A company’s internal control over financial reporting is a process designed by, or under the supervision of, the company’s principal executive and principal financial officers, or persons performing similar functions, and effected by the company’s board of directors, management, and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in

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accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

     Because of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override of controls, material misstatements due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to future periods are subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

     In our opinion, management’s assessment that the Company maintained effective internal control over financial reporting as of December 31, 2004, is fairly stated, in all material respects, based on the criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2004, based on the criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.

     We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements and financial statement schedule as of and for the year ended December 31, 2004 of the Company and our report dated March 30, 2005 (April 19, 2005 as to the effect of vacating Building 3 in Redmond, Washington described in Note 12) expressed an unqualified opinion on those financial statements and financial statement schedule and included an explanatory paragraph regarding the Company’s ability to continue as a going concern at December 31, 2004.

/s/ DELOITTE & TOUCHE LLP

Phoenix, Arizona
March 30, 2005

ITEM 9B. OTHER INFORMATION

     On March 30, 2005, we signed a definitive agreement to sell the assets of our small form factor display business to International Display Works, Inc. That sale would not include the display monitor business operated out of our Marlborough, Massachusetts facility. The sale to International DisplayWorks, Inc. is expected to be finalized in April 2005. TFS estimates the total value of that transaction will range between $11 million and $21 million and will include an $8 million cash payment at closing. A copy of the purchase agreement is filed herewith.

PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

     The following table sets forth certain information regarding the current directors of our company:

Name	Age		Position
David C. Malmberg		62	Chairman of the Board
Jack L. Saltich		61	President, Chief Executive Officer, and Director
Thomas H. Werner		44	Director
David P. Chavoustie		61	Director
Murray A. Goldman		67	Director
Henry L. Hirvela		53	Director

     David C. Malmberg has been a director of our company since April 1993 and Chairman of the Board since April 1999. Mr. Malmberg is a private investor and management consultant. Mr. Malmberg serves as the Chairman of the Board of Kontron Mobile Computers, Inc., a public company serving the military and public safety markets; as Chairman of the Board of Sagebrush Corporation, a private company serving over 25,000 public schools; and as a member of the board of directors of PPT/Vision, Inc., a public company that designs and manufactures vision-based

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inspection systems. Before resigning in May 1994, Mr. Malmberg spent 22 years at National Computer Systems, Inc., including 13 years as its President and Chief Operating Officer.

     Jack L. Saltich has been a director and the President and Chief Executive Officer of our company since July 1999. Mr. Saltich also serves as Chairman of the Board of Brillian Corporation, a public company that designs and sells microdisplay products; as a member of the board of directors of Immersion Corporation, a public company that develops, licenses, and markets haptic technology and products; and as a member of the board of directors of Vitex Systems, Inc., a private company that commercializes transparent ultra-barrier films for use in flat panel displays. Mr. Saltich served as Vice President of Advanced Micro Devices from May 1993 until July 1999; as Executive Vice President of Applied Micro Circuits Corp. from January 1991 until March 1993; and as Vice President of VLSI from July 1988 until January 1991. Mr. Saltich held a variety of executive positions for Motorola from July 1971 until June 1988. These positions included serving as an Engineering Manager from May 1974 until January 1980, an Operations Manager from January 1980 until May 1982, a Vice President and Director of the Bipolar Technology Center from May 1982 until June 1986, and a Vice President and Director of the Advanced Product Research and Development Laboratory from June 1986 until June 1988.

     Thomas H. Werner has been a director of our company since March 1999. Mr. Werner is Chief Executive Officer of SunPower Corporation, a subsidiary of Cypress Semiconductor that manufactures high efficiency silicon solar cells. He previously served as Chief Executive Officer of Silicon Light Machines, Inc., also a subsidiary of Cypress Semiconductor, from June 2001 until June 2003. Mr. Werner was Vice President and General Manager for the Business Connectivity Group of 3Com Corporation from October 1998 until May 2001. Mr. Werner was Vice President of the Manufacturing Personal Communication Division of U.S. Robotics, which 3Com Corporation acquired in June 1997. Mr. Werner also served in various positions at Oak Frequency Control, a manufacturer of telecommunications components, most recently as President of the Networks Group, from February 1994 until January 1996.

     David P. Chavoustie has been a director of our company since January 2000. Mr. Chavoustie has served since April 1998 as Executive Vice President of Sales and Marketing of ASML, a manufacturer of lithography equipment used to manufacture semiconductors. Mr. Chavoustie is a member of the Board of Directors of Brillian Corporation, which is described above. From April 1992 until March 1998, Mr. Chavoustie held several positions with Advanced Micro Devices, Inc., a semiconductor company, including Vice President/General Manager Customer Specific Products Division, Vice President/General Manager Embedded Processor Division, and Vice President Worldwide Sales/Marketing — Vantis (a wholly owned subsidiary of AMD). From 1985 to 1992, Mr. Chavoustie held various positions with VLSI Technology, Inc., an ASIC semiconductor company, including Sales Director, Vice President Sales and Corporate Marketing, and Senior Vice President/General Manager ASIC Products. From 1974 to 1984, Mr. Chavoustie held various sales positions with Advanced Micro Devices, including area sales — Southeast United States, regional sales manager, and district sales manager — Upstate New York.

     Murray A. Goldman has been a director of our company since October 2000. Dr. Goldman has served as the Chairman of the Board of Directors of Transmeta since November 1998. Dr. Goldman served as Chief Executive Officer for Transmeta from October 2001 to April 2002, and as a business advisor to Transmeta from March 1997 to November 1998. From July 1969 to January 1997, Dr. Goldman was employed by Motorola, where he held a variety of positions, most recently as Executive Vice President and Assistant General Manager of the Semiconductor Products Sector. Dr. Goldman holds a B.S. in electrical engineering from the University of Pittsburgh and an M.S. and a Ph.D. in electrical engineering from New York University.

     Henry L. Hirvela has been a director of our company since February 2003. Mr. Hirvela has served as President of Phoenix Management Partners LLC since May 2000. From April 1996 to March 2000, Mr. Hirvela served as Vice President and Chief Financial Officer of Allied Waste Industries, Inc. He served as Vice President and Chief Financial Officer of Power Computing Corporation from September 1995 to March 1996 and as Vice President — Treasurer of Browning-Ferris Industries, Inc. from April 1988 to September 1995. Mr. Hirvela held various positions with Texas Eastern Corporation, including Manager — Corporate Development from June 1981 to March 1985 and Assistant Treasurer and Assistant Secretary from March 1985 to April 1988. Mr. Hirvela held various management positions with Bank of America from February 1973 to June 1981.

     Directors hold office until the next annual meeting of stockholders or until their successors have been elected and qualified.

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Information Relating to Corporate Governance and the Board of Directors

     Our bylaws authorize our Board of Directors to appoint among its members one or more committees consisting of one or more directors. Our Board of Directors has created four standing committees: an Audit Committee, a Compensation Committee, a Nominating/Corporate Governance Committee, and an Employee Committee. Our Board of Directors has determined, after considering all the relevant facts and circumstances, that Messrs. Malmberg, Werner, Chavoustie, Goldman, and Hirvela are independent directors, as “independence” is defined by the listing standards of the New York Stock Exchange, because they have no material relationship with us (either directly or as a partner, stockholder, or officer of an organization that has a relationship with us). Mr. Saltich is an employee director.

     Our Board of Directors has adopted charters for the Audit, Compensation, and Nominating/Corporate Governance Committees describing the authority and responsibilities delegated to each committee by the Board. Our Board of Directors has also adopted Corporate Governance Guidelines, a Code of Business Conduct and Ethics, and a Code of Ethics for the CEO and Senior Financial Officers. We post on our website at www.tfsc.com, the charters of our Audit, Compensation, and Nominating/Corporate Governance Committees; our Corporate Governance Guidelines, Code of Business Conduct and Ethics, and 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 New York Stock Exchange regulations. These documents are also available in print to any stockholder requesting a copy in writing from our corporate secretary at our executive offices.

     We regularly schedule executive sessions in which independent directors meet without the presence or participation of management. The presiding director of such executive session rotates among the Chairs of the Audit Committee, Compensation Committee, and the Nominating/Corporate Governance Committee.

     Interested parties may communicate with our Board of Directors or specific members of our Board of Directors, including the members of our various Board committees, by submitting a letter addressed to the Board of Directors of Three-Five Systems, Inc. c/o any specified individual director or directors at our executive offices. Any such letters are sent to the indicated directors.

     We have filed the required certifications under Section 302 of the Sarbanes Oxley Act of 2002 as Exhibits 31.1 and 31.2 to our Annual Report on Form 10-K for the fiscal year ended December 31, 2004. The company has also submitted to the NYSE its 2004 Annual Chief Executive Officer Certification required pursuant to Section 303A.12(a) of the NYSE Listed Company Manual.

   The Audit Committee

     The purpose of the Audit Committee is to assist the oversight of our Board of Directors of the integrity of the financial statements of our company, our company’s compliance with legal and regulatory matters, the independent registered public accounting firm’s qualifications and independence, and the performance of our company’s independent registered public accounting firm and internal audit function. The primary responsibilities of the Audit Committee are set forth in its charter and include various matters with respect to the oversight of our company’s accounting and financial reporting process and audits of the financial statements of our company on behalf of our Board of Directors. The Audit Committee also selects the independent certified public accountants to conduct the annual audit of the financial statements of our company; reviews the proposed scope of such audit, reviews accounting and financial controls of our company with the independent registered public accounting firm and our financial accounting staff; and reviews and approves transactions between us and our directors, officers, and their affiliates.

     The Audit Committee currently consists of Messrs. Hirvela, Malmberg, and Goldman, each of whom is an independent director of our company under the New York Stock Exchange rules as well as under rules adopted by the Securities and Exchange Commission pursuant to the Sarbanes-Oxley Act of 2002. The Board of Directors has determined that Mr. Hirvela (whose background is detailed above) qualifies as an “audit committee financial expert” in accordance with applicable rules and regulations of the SEC. Mr. Hirvela serves as the Chairman of the Committee.

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   The Compensation Committee

     The purpose and responsibilities of the Compensation Committee include reviewing and approving corporate goals and objectives relevant to the compensation of our Chief Executive Officer, evaluating the performance of our Chief Executive Officer in light of those goals and objectives, and determining and approving the compensation level of our Chief Executive Officer based on this evaluation. The Compensation Committee also recommends to the Board of Directors with respect to, or, as directed by the Board of Directors, determines and approves, compensation of our other executive officers, and considers the grant of stock options to our executive officers under our stock option plans. The Compensation Committee currently consists of Messrs. Malmberg, Werner, and Goldman, with Mr. Werner serving as Chairman.

   The Nominating/Corporate Governance Committee

     The purpose and responsibilities of the Nominating/Corporate Governance Committee include the identification of individuals qualified to become Board members, the selection or recommendation to the Board of Directors of nominees to stand for election as directors at each election of directors, the development and recommendation to the Board of Directors of a set of corporate governance principles applicable to our company, the oversight of the selection and composition of committees of the Board of Directors, and the oversight of the evaluations of the Board of Directors and management. The Nominating/Corporate Governance Committee currently consists of Messrs. Malmberg, Hirvela, Werner, Goldman, and Chavoustie, with Mr. Chavoustie serving as Chairman. The Nominating/Corporate Governance committee will consider persons recommended by stockholders for inclusion as nominees for election to our Board of Directors if the names, biographical data, and qualifications of such persons are submitted in writing in a timely manner addressed and delivered to our company’s secretary at our executive offices. The Nominating/Corporate Governance Committee identifies and evaluates nominees for our Board of Directors, including nominees recommended by stockholders, based on numerous factors it considers appropriate, some of which may include strength of character, mature judgment, career specialization, relevant technical skills, diversity, and the extent to which the nominee would fill a present need on our Board of Directors. As discussed above, the members of the Nominating/Corporate Governance Committee are independent, as that term is defined by the listing standards of the New York Stock Exchange.

   The Employee Committee

     The responsibilities of the Employee Committee include overseeing matters relating to stock options for our employees not including our executive officers. The Employee Committee currently consists of Messrs. Saltich and Jurgens.

     Our Board of Directors held a total of nine meetings during the fiscal year ended December 31, 2004. During the fiscal year ended December 31, 2004, the Audit Committee held ten meetings; the Compensation Committee held three meetings; and the Nominating/Corporate Governance Committee held one meeting. No director attended fewer than 75% of the aggregate of (i) the total number of meetings of our Board of Directors, and (ii) the total number of meetings held by all Committees of our Board of Directors on which he was a member. We encourage each of our directors to attend each annual meeting of stockholders. To that end, and to the extent reasonably practicable, we regularly schedule a meeting of the Board of Directors on the same day as our annual meeting of stockholders. Each member of our Board of Directors attended the 2004 annual meeting of stockholders.

Director Compensation and Other Information

     We pay each non-employee director an annual retainer fee in the amount of $15,000, plus $1,250 for each Board meeting attended and $500 for each committee meeting held on a day other than the same day as a Board meeting. Each non-employee director is required to receive two-thirds of his annual retainer fee in shares of our common stock pursuant to our Directors’ Stock Plan. See “Executive Compensation — Directors’ Stock Plan.” The non-executive Chairman of the Board and the non-executive Chairman of the Audit Committee each receive an additional $15,000 per year over the standard outside director compensation, with such $15,000 paid in cash immediately upon election each year after the annual stockholder meeting. We also reimburse each non-employee director for travel and related expenses incurred in connection with attendance at Board and committee meetings. Employees who also serve as directors receive no additional compensation for their services as a director.

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     The terms of our 2004 Incentive Compensation Plan provide that each non-employee director will receive an automatic grant of options to acquire 5,000 shares of our common stock on the date of his or her first appointment or election to our Board of Directors. The 2004 Plan also provides for the automatic grant of options to purchase 2,000 shares of our common stock to non-employee directors at the time of the meeting of our Board of Directors held immediately following each annual meeting of stockholders. In addition, in May 2004, the board of directors approved a one-time grant of options to acquire 10,000 shares of our common stock to each non-employee director.

SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE

     Section 16(a) of the Exchange Act requires our directors, officers, and persons that own more than 10 percent of a registered class of our company’s equity securities to file reports of ownership and changes in ownership with the SEC. Officers, directors, and greater than 10 percent stockholders are required by SEC regulations to furnish our company with copies of all Section 16(a) forms they file.

     Based solely upon our review of the copies of such forms received by us during the fiscal year ended December 31, 2004, and written representations that no other reports were required, we believe that each person who, at any time during such fiscal year, was a director, officer, or beneficial owner of more than 10 percent of our common stock complied with all Section 16(a) filing requirements during such fiscal year, except for the following:

Mr. Van H. Potter, our Senior Vice President, Electronic Manufacturing Services, filed a late Form 4 relating to a sale of common stock and a late Form 4 relating to one stock option grant.

ITEM 11. EXECUTIVE COMPENSATION

Summary of Cash and Other Compensation

     The following table sets forth, for the fiscal years ended 2002, 2003, and 2004, the total compensation for services in all capacities to us and our subsidiaries received by our Chief Executive Officer, our four most highly compensated executive officers, our Interim Chief Financial Officer and certain former executive officers who are no longer employed by us whose aggregate cash compensation exceeded $100,000 for the fiscal year ended December 31, 2004.

SUMMARY COMPENSATION TABLE

							Long Term
							Compensation
							Awards
							Securities		All Other
	Annual Compensation(1)						Underlying		Compensation
Name and Principal Position	Year		Salary($)		Bonus($)		Options (#)		($)(2)
Jack L. Saltich		2004	$	332,308	$	—		35,000	$	7,781
President, Chief Executive		2003		320,000		—		100,000		82,174
Officer, and Director		2002		320,000		—		80,000		15,000
Jeffrey D. Buchanan Former Executive Vice President,		2004	$	233,654	$	—		33,000	$	11,682
Chief Financial Officer, Secretary,		2003		220,000		—		60,000		29,596
Treasurer, and Director		2002		210,000		—		65,000		8,600
Van H. Potter(3)		2004	$	186,731	$	—		56,000	$	10,788
Senior Vice President,		2003		121,000		—		45,000		2,810
Electronic Manufacturing Services

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							Long Term
							Compensation
							Awards
							Securities		All Other
	Annual Compensation(1)						Underlying		Compensation
Name and Principal Position	Year		Salary($)		Bonus($)		Options (#)		($)(2)
Eric W. Haeussler(4)		2004	$	112,423	$	—		12,000	$	4,653
Corporate Controller and		2003		93,901		12,000		5,000	$	3,965
Principal Accounting Officer		2002		94,124		—		8,000	$	3,429
David K. McQuiggan(5)		2004	$	34,615	$	—		70,000	$	504
Senior Vice President, Platform Display Products
Joe D. Tanner(6)		2004	$	192,066	$	—		26,000	$	16,959
Former Senior Vice President,		2003		202,000		—		10,000		19,571
Electronics Manufacturing Services		2002		—		—		40,000		—
Dr. Carl E. Derrington		2004	$	192,116	$	—		15,000	$	4,019
Former Senior Vice President,		2003		185,000		15,000		30,000		78,692
Chief Manufacturing Officer		2002		185,000		—		60,000		5,000
James E. Jurgens(7)		2004	$	50,000	$	—		20,000	$	—
Interim Chief Financial Officer

(1)	Certain executive officers also received certain perquisites, including a car allowance, the value of which did not exceed 10% of the annual salary and bonus. The annual salary amounts include an additional two weeks pay because of an extra pay period falling in fiscal 2004.
(2)	Amounts shown for fiscal 2004 include (a) matching contributions to our company’s 401(k) Plan earned in fiscal 2004, but not paid until fiscal 2005, in the amount of $4,051, $7,783, $6,885, $1,161, and $3,664 on behalf of Messrs. Saltich, Buchanan, Potter, Haeussler, and Tanner, respectively; (b) term life insurance premiums of $987, $224, $229, $77, $33, $800, $344 paid by us on behalf of Messrs. Saltich, Buchanan, Potter, Haeussler, McQuiggan, Tanner and Derrington, respectively; (c) an Executive Benefits Package of $2,742, $3,675, $3,675, $3,416, $471, $2,695, and $3,675 on behalf of Messrs. Saltich, Buchanan, Potter, Haeussler, McQuiggan, Tanner, and Derrington, respectively; and (d) $9,800 in housing expenses for Mr. Tanner.
(3)	Mr. Potter joined our company in February 2003. Mr. Potter became Senior Vice President, Electronic Manufacturing Services, in October 2004.
(4)	Mr. Haeussler became our Principal Accounting Officer in May 2004, and has been our Corporate Controller since August 2002.
(5)	Mr. McQuiggan joined our company as Senior Vice President — Platform Display Products in October 2004.
(6)	Mr. Tanner originally joined our company in connection with the ETMA transaction and became Senior Vice President in August 2003. The salary amount shown for fiscal 2003 includes commissions in the amount of $29,000, and the salary amount shown for fiscal year 2004 includes commissions in the amount of $5,145.
(7)	Mr. Jurgens became Interim Chief Financial Officer in February 2005. Prior to that, Mr. Jurgens had acted as a consultant to the company since August 2004. The compensation information for 2004 reflects amounts received by Mr. Jurgens from us for consulting services.

Option Grants

     The following table sets forth certain information with respect to stock options granted to the named executive officers during the fiscal year ended December 31, 2004.

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OPTION GRANTS IN LAST FISCAL YEAR

	Individual Grants								Potential Realizable Value at
	Number of		Percent of Total						Assumed Annual Rates of
	Securities		Options Granted to						Stock Price Appreciation
	Underlying Options		Employees in		Exercise Price		Expiration		for Option Term(1)
Name	Granted		Fiscal Year		Per Share		Date		5%		10%
Jack L. Saltich		35,000(2)		3.78%		$4.57		2/17/2014	$	100,592	$	254,919
Jeffrey D. Buchanan		33,000(3)		3.56%		$4.57		5/02/2005	$	—	$	—
David K. McQuiggan		70,000(4)		7.55%		$2.45		10/18/2014	$	107,855	$	273,327
Eric W. Haeussler		12,000(5)		1.29%		$4.19		2/23/2014	$	31,621	$	80,133
Van H. Potter		26,000(6)		2.81%		$4.57		2/17/2014	$	74,725	$	189,368
		30,000(7)		3.24%		$5.50		5/07/2014	$	103,768	$	262,968
James E. Jurgens		20,000(8)		2.16%		$2.98		12/31/2005	$	6,109	$	12,516
Dr. Carl E. Derrington		15,000(9)		1.62%		$4.57		5/05/2005	$	—	$	—
Joe D. Tanner		26,000(10)		2.81%		$4.57		5/29/2005	$	—	$	—

(1)	Potential gains are net of the exercise price, but before taxes associated with the exercise. Amounts represent hypothetical gains that could be achieved for the respective options if exercised at the end of the option term. The assumed 5% and 10% rates of stock price appreciation are provided in accordance with the rules of the SEC and do not represent our estimate or projection of the future price of our common stock. Actual gains, if any, on stock option exercises will depend upon the future market prices of our common stock.
(2)	Of these options, 11,667 vested and became exercisable on February 17, 2005, 11,666 vest and become exercisable on February 17, 2006, and 11,667 vest and become exercisable on February 17, 2007.
(3)	None of these options will vest or become exercisable as a result of Mr. Buchanan’s resignation effective February 1, 2005.
(4)	Of these options, 17,500 vest and become exercisable on each of October 18, 2005, 2006, 2007 and 2008.
(5)	Of these options, 4,000 vested and became exercisable on February 23, 2005, and 4,000 vest and become exercisable on each of February 23, 2006 and 2007.
(6)	Of these options, 6,500 vested and became exercisable on February 17, 2005, and 6,500 vest and become exercisable on each of February 17, 2006, 2007 and 2008.
(7)	Of these options, 7,500 vest and become exercisable on May 7, 2005, and 7,500 vest and become exercisable on each of May 7, 2006, 2007 and 2008.
(8)	All of these options are vested and exercisable. Mr. Jurgens received these options in 2004 while acting as a consultant to the company.
(9)	None of these options will vest or become exercisable as a result of Mr. Derrington’s resignation effective February 4, 2005.
(10)	None of these options will vest or become exercisable as a result of Mr. Tanner’s resignation effective February 28, 2005

Option Exercises and Option Holdings

     The following table contains certain information with respect to options exercised during fiscal 2004 and options held by the named executive officers as of December 31, 2004.

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AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR
AND
FISCAL YEAR-END OPTION VALUES

	Number of Securities				Value of Unexercised
	Underlying Unexercised				In-the Money Options
	Options at Fiscal Year-End				At Fiscal Year-End(1)
Name	Exercisable		Unexercisable		Exercisable		Unexercisable
Jack L. Saltich		565,669		224,333	$	—	$	—
Jeffrey D. Buchanan		196,336		94,666		—		—
David K. McQuiggan		—		70,000		—		—
Eric W. Haeussler		24,602		18,000		—		—
Van H. Potter		—		101,000		—		—
James E. Jurgens		20,000		—		—		—
Dr. Carl E. Derrington		178,002		—		—		—
Joe D. Tanner		30,001		45,999		—		—

(1) Calculated based upon the December 31, 2004, New York Stock Exchange closing price of $2.42 per share, multiplied by the number of shares held, less the aggregate exercise price for such shares. The exercise price of options outstanding prior to September 15, 2003 was adjusted to reflect the division of options into amended Company options and new Brillian Corporation options. The exercise prices of all of the options held by our executive officers on December 31, 2004 were greater than $2.42 per share.

Employment and Other Agreements

     We have signed terms-and-conditions agreements with Messrs. Saltich, Potter and Jurgens. None of these agreements provide for a fixed term of employment nor do any of the agreements provide for severance payments or, other than Mr. Jurgens, payments upon a change of control. The terms-and-conditions agreements provide for medical, dental, life, and disability insurance benefits. Salaries are determined yearly. These agreements include non-disclosure and confidentiality provisions while employed and after employment and an inventions assignment provision while employed. The agreements also include non-solicitation provisions after termination of employment for periods of one to two years. Mr. Potter also has a non-compete provision for a period of 12 months after termination of employment. There are no payments associated with any of these provisions. The executive officers also are eligible to participate in an executive benefits program as described in the Compensation Committee Report and are eligible to receive incentive bonuses and stock options under our stock option plans. In the event of a change of control, Mr. Jurgens’ options will immediately vest and become exercisable.

     We have agreed to pay Mr. McQuiggan severance in an amount equal to three months of his regular salary.

     We have entered into an agreement with Mr. Haeussler concerning payments upon his separation from the company. Under this agreement, we will pay Mr. Haeussler severance equal to 15 weeks of pay, payable upon August 31, 2005 if he is still employed by us on that date. In addition, we also agreed to provide nine months of executive outplacement services starting on September 1, 2005, and to the continuation of health insurance coverage on Mr. Haeussler and his family until September 1, 2006 or until Mr. Haeussler and his family are covered under another health insurance plan, whichever is earlier. In addition, we will pay Mr. Haeussler a retention bonus if he remains with the company through May 9, 2005, which amount will increase if he remains with the company through August 31, 2005.

     On January 26, 2005, we entered into a Severance Agreement and General Release with Mr. Buchanan. Under this agreement, we will pay Mr. Buchanan $165,000 in severance pay, payable in nine equal installments. In addition, we extended the exercise date on options to purchase 101,667 shares of our common stock held by Mr. Buchanan and agreed to provide nine months of executive outplacement services to Mr. Buchanan. The agreement also provides for the continuation of health insurance coverage on Mr. Buchanan and his family until January 31, 2006 or until Mr. Buchanan and his family are covered under another health insurance plan, whichever is earlier.

     Mr. Derrington’s employment with the company ended on February 4, 2005. Under our separation agreement with Mr. Derrington, we will pay Mr. Derrington $185,000 in severance pay, payable bi-weekly on TFS

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regular pay dates for a period of one year commencing on the first pay period following his separation from the company. In addition, we extended the exercise date on options to purchase 116,667 shares of our common stock held by Mr. Derrington, and agreed to provide nine months of executive outplacement services to Mr. Derrington. The agreement also provides for the continuation of health insurance coverage on Mr. Derrington and his family until February 28, 2006 or until Mr. Derrington and his family are covered under another health insurance plan, whichever is earlier.

401(k) Profit Sharing Plan

     We maintain a profit sharing plan pursuant to Section 401(k) of the Internal Revenue Code of 1986. Under the 401(k) Plan, all eligible employees may contribute through payroll deductions up to the maximum allowable under Section 402(g) of the Internal Revenue Code, which generally was $13,000 for calendar 2004. In addition, the 401(k) Plan provides that we may make matching and discretionary contributions in such amount as may be determined by our Board of Directors. We made matching contributions pursuant to the 401(k) Plan to the executive officers named in the summary compensation table of this proxy statement for 2004 in the amount of $23,544.

Stock Option Plans

     We currently have six stock option plans: the 1990 Incentive Stock Option Plan; the 1993 Stock Option Plan; the Amended and Restated 1994 Automatic Stock Option Plan for Non-Employee Directors; the Amended and Restated 1997 Employee Stock Option Plan; the Amended and Restated 1998 Stock Option Plan; and the 2004 Incentive Compensation Plan. All of our stock option plans have been approved by our stockholders other than our 1997 Plan. When we adopted our 2004 Plan, we consolidated all of our prior plans and no longer make any awards under the prior plans. Eligible persons under the 2004 Plan include key personnel (including directors and executive officers), consultants, and independent contractors who perform valuable services for us or our subsidiaries. Directors who are not employees receive automatic grants of stock options under the 2004 Plan.

     In conjunction with stockholder approval of the 1993 Plan, our Board of Directors terminated the 1990 Plan with respect to 170,909 options that were unissued as of the date that the 1993 Plan was adopted. There were 70,015 options issued but unexercised under the 1990 Plan as of March 31, 2005. The 1990 Plan expired May 1, 2000.

     The 1993 Plan expired February 24, 2003. There were options issued but unexercised to acquire 260,367 shares of our common stock under the 1993 Plan as of March 31, 2005. In addition, an aggregate of 2,750 shares of common stock has been directly granted under the 1993 Plan.

     The 1994 Plan expired April 12, 2004. There were options issued but unexercised to acquire 51,092 shares of our common stock under the 1994 Plan as of March 31, 2005.

     In conjunction with its adoption of the 2004 Plan, our Board of Directors decided to discontinue making any awards under the 1997 Plan. There were outstanding issued but unexercised options to acquire 1,215,031 shares of our common stock under the 1997 Plan as of March 31, 2005.

     In conjunction with its adoption of the 2004 Plan, our Board of Directors decided to discontinue making any awards under the 1998 Plan. There were outstanding issued but unexercised options to acquire 1,347,463 shares of our common stock under the 1998 Plan as of March 31, 2005.

     An aggregate of 4,079,299 shares of common stock may be issued upon exercise of options granted pursuant to the 2004 Plan. This plan provides for the granting of options to purchase our common stock, restricted stock, stock appreciation rights, and other stock-based awards. If any change in our common stock occurs through merger, consolidation, reorganization, capitalization, stock dividend, split-up, combination of shares, exchange of shares, change in corporate structure, or otherwise, adjustments will be made as to the maximum number of shares subject to the 2004 Plan, and the number of shares and exercise price per share of stock subject to outstanding options. This plan also provides that each non-employee director will receive an automatic grant of options pursuant to the terms described in the section above titled “Election of Directors — Director Compensation and Other Information.” There were outstanding issued but unexercised options to acquire 446,100 shares of our common stock under the 2004 Plan as of March 31, 2005.

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Directors’ Stock Plan

     On January 29, 1998, our Board of Directors adopted the Directors’ Stock Plan. Stockholder approval of the Directors’ Plan was not initially required because treasury shares were used to fund the Directors’ Plan. Our Board of Directors adopted the Amended and Restated Directors’ Stock Plan on January 27, 2000, and our stockholders approved the Amended and Restated Directors’ Stock Plan on April 27, 2000. Under the Directors’ Plan, we issued to the non-employee members of our Board of Directors shares of common stock equal in value to two-thirds of the annual retainer fee paid to the non-employee directors in lieu of an equivalent amount of cash. In conjunction with its adoption of the 2004 Plan, our Board of Directors decided to discontinue making any awards under the Directors’ Plan. As of March 31, 2005, 32,642 shares of our common stock had been issued under the Directors’ Plan.

COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION

     During the fiscal year ended December 31, 2004, our Compensation Committee consisted of Messrs. Malmberg, Werner, and Goldman. None of these individuals had any contractual or other relationships with us during the fiscal year except as directors.

COMPENSATION COMMITTEE REPORT ON EXECUTIVE COMPENSATION

Introduction

     The Compensation Committee of our Board of Directors (the “Committee”) consists exclusively of independent directors. The Committee is responsible for reviewing and approving corporate goals and objectives relevant to the compensation of our Chief Executive Officer, evaluating the performance of our Chief Executive Officer in light of those goals and objectives, and determining and approving the compensation level of our Chief Executive Officer based on this evaluation. The Compensation Committee also makes recommendations to the Board of Directors with respect to, or, as directed by the Board of Directors, determines and approves, compensation of our other executive officers, and considers the grant of stock options to our executive officers under our stock option plans. The Committee generally reviews base salary levels for executive officers of our company at the beginning of each fiscal year and recommends actual bonuses at the end of each fiscal year based upon our company’s and individual performance. The Compensation Committee held three meetings during fiscal 2004.

     Mr. Werner is the Chairman of the Committee, and Messrs. Malmberg and Goldman are the Committee members.

Philosophy

     The executive compensation program seeks to provide a level of compensation that is competitive with companies similar in both size and industry. The Committee obtains the comparative data used to assess competitiveness from a variety of resources. Actual total compensation levels may differ from competitive levels in surveyed companies as a result of annual and long-term performance of our company, as well as individual performance. The Committee uses its discretion to recommend executive compensation when, in its judgment, external, internal, or an individual’s circumstances warrant.

Compensation Program

     The primary components of executive compensation consist of base salary, executive health benefit and perquisite program, annual incentive bonuses, and stock option grants.

   Base Salary

     The Committee reviews salaries recommended by the Chief Executive Officer for executive officers other than the Chief Executive Officer. In formulating these recommendations, the Chief Executive Officer considers the overall performance of our company and conducts an informal evaluation of individual officer performance. The Committee, with input from the Chief Executive Officer, makes final recommendations to the full Board of Directors on any adjustments to the base salary for executives other than the Chief Executive Officer. The

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Committee’s evaluation of the recommendations by the Chief Executive Officer considers the same factors outlined above and is subjective, with no particular weight assigned to any one factor. Base salaries for fiscal 2004 were determined by the Committee in May 2004. Base salaries for 2004 were adjusted for one executive officer and was based on competitive compensation requirements.

   Annual Incentive Bonuses

     Annual bonuses are intended to provide incentive compensation to executive officers and other employees who contribute substantially to the success of our company. The bonuses are calculated and paid out of the Management Incentive Compensation Plan, or MICP, which was approved by the Board of Directors in April 1997. The MICP is intended to enhance and reinforce our company’s goals of profitable growth and a sound overall financial condition by making incentive compensation awards available to senior level management and key employees.

     The granting of such awards is based upon the achievement of our company’s performance objectives and predefined individual performance objectives. Individual performance objectives are developed for every senior level manager and key employee early in each fiscal year. Upon the close of each fiscal year, executive management and the Committee conduct an assessment of individual performance achieved versus individual performance objectives. This assessment may include, but is not limited to, individual responsibility, performance, and compensation level. Simultaneously, the Board conducts an assessment of our company’s overall performance to date, which may include, but is not limited to, the achievement of sales, net income, and other performance criteria. The combination of these factors determines any incentive bonuses to be paid, including those to executive officers.

     In fiscal 2004, based on the Board’s assessment of our company’s overall performance for 2004, no bonuses were awarded to any officers.

   Stock Option Grants

     We grant stock options periodically to our U.S. employees and non-U.S.-based managers, including executive officers, to provide additional incentive to work to maximize long-term total return to stockholders. Under our stock option plan, the Board of Directors is specified to act as the plan administrator, although the Board has authorized the Compensation Committee to make all recommendations to the Board regarding grants of options to senior officers of our company, including executive officers. In addition, with respect to grants of options to employees other than senior officers, the Board has delegated its administrative authority under the stock option plans to an Employee Committee, which consists of those Board members that are employees of our company. In general, stock options are granted to U.S. employees and non-U.S.-based managers at the onset of employment. If, in the opinion of the plan administrator, the outstanding service of an existing employee merits an increase in the number of options held, the plan administrator may elect to issue additional stock options to that employee. The vesting period on grants of stock options is generally four years for newly hired salaried employees. The vesting period on grants of stock options is three years for salaried employees who have been employed for two years or longer. The four-year vesting schedules and the three-year vesting schedules are evenly weighted, vesting an equal number of options each year. Certain officers may sometimes have longer or shorter vesting schedules. In 2004, the Board and the Employee Committee authorized the issuance of stock options to certain executive officers and other employees.

   Benefits

     We provide various employee benefit programs to our executive officers, including medical, dental, life and long-term disability insurance benefits, and a 401(k) retirement savings plan. These benefits are generally available to all employees of our company. We also maintain an executive benefit program for our executive officers, through which we pay a larger percentage of the costs than is paid on behalf of our other employees. The executive benefit program also provides executive officers with annual physical examinations, salary continuation for short-term disability, tax and estate planning, and auto allowances.

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  Chief Executive Officer Compensation

     The Committee considers the same factors outlined above for other executive officers in evaluating the base salary and other compensation of Jack L. Saltich, our Chief Executive Officer. The Committee’s evaluation of Mr. Saltich’s base salary is subjective, with no particular weight assigned to any one factor. Mr. Saltich requested that the Committee not increase his base salary in 2002, 2003 and 2004. Based on Mr. Saltich’s request and other factors including market competitive data, the Committee maintained Mr. Saltich’s annual base salary at $320,000 for 2002, 2003 and 2004. Mr. Saltich’s base salary has remained at this same level since he joined our company in 1999. Based upon the Board’s assessment of the overall performance of our company in 2004, the Committee also determined that Mr. Saltich would receive no bonus in 2004. The Committee granted Mr. Saltich an option to purchase 35,000 shares of our common stock in February 2004. The vesting schedule for the grant was based on our standard vesting schedule in which options vest evenly over three years.

Compliance with Internal Revenue Code Section 162(m)

     Section 162(m) of the Internal Revenue Code generally disallows a tax deduction to public companies for compensation in excess of $1 million paid to each of any publicly held corporation’s chief executive officer and four other most highly compensated executive officers. Qualifying performance-based compensation is not subject to the deduction limit if certain requirements are met. We currently intend to structure the performance-based portion of the compensation of our executive officers in a manner that complies with Section 162(m).

     This report has been furnished by the Compensation Committee of our Board of Directors.

                                                          Thomas H. Werner, Chairman
                                                          David C. Malmberg
                                                          Murray A. Goldman

     The information contained in this Compensation Committee Report on Executive Compensation shall not be deemed “filed” with the Securities and Exchange Commission or subject to Regulations 14A or 14C, or to the liabilities of Section 18 of the Securities Exchange Act of 1934.

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PERFORMANCE GRAPH

     The following line graph compares cumulative total stockholder returns for the five years ended December 31, 2004 for (1) our common stock; (2) the Standard and Poor’s SmallCap 600 Index; and (3) a peer group. The graph assumes an investment of $100 on December 31, 1999. The calculations of cumulative stockholder return on the SmallCap 600 and the peer group include reinvestment of dividends. The calculation of cumulative stockholder return on our common stock includes reinvestment of dividends as a result of the spin-off of Brillian Corporation but does not otherwise include reinvestment of dividends because we did not pay any other dividends during the measurement period. The performance shown is not necessarily indicative of future performance.

     The information contained in this Performance Graph shall not be deemed “filed” with the Securities and Exchange Commission or subject to Regulations 14A or 14C, or to the liabilities of Section 18 of the Securities Exchange Act of 1934.

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ITEM 12.  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

EQUITY COMPENSATION PLAN INFORMATION

     The following table sets forth information with respect to our common stock that may be issued upon the exercise of stock options under our 1990 Plan, 1993 Plan, 1994 Plan, 1997 Plan, 1998 Plan, 2004 Plan, and Directors’ Stock Plan as of March 31, 2005.

			(c) Number of Securities
	(a) Number of		Remaining Available for
	Securities to be	(b) Weighted	Future Issuance Under
	Issued Upon Exercise	Average Exercise	Equity Compensation
	of Outstanding	Price of Outstanding	Plans (Excluding
	Options, Warrants,	Options, Warrants,	Securities Reflected in
Plan Category	and Rights	and Rights	Column (a))
Equity Compensation Plans Approved by Stockholders	2,175,037	$7.56	607,223
Equity Compensation Plans Not Approved by Stockholders	1,215,031	$8.53	20,874
Total	3,390,068	$7.91	628,097

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SECURITY OWNERSHIP OF CERTAIN BENEFICIAL
OWNERS AND MANAGEMENT

     The following table sets forth certain information regarding the beneficial ownership of our common stock on April 4, 2005, except as indicated, by (1) each director and each named executive officer of our company, (2) all directors and executive officers of our company as a group, and (3) each person known by us to own more than five percent of our common stock.

	Shares Beneficially Owned
Name and Address of Beneficial Owner	Number(1)		Percent(2)
Directors and Named Executive Officers:
Jack L. Saltich(3)		731,669		3.36	%
Jeffrey D. Buchanan(4)		255,666		1.17	%
Dr. Carl E. Derrington(5)		182,002		*
David C. Malmberg(6)		88,048		*
Joe D. Tanner(7)		48,668		*
Van H. Potter(8)		26,000		*
Thomas H. Werner(9)		32,042		*
David P. Chavoustie(10)		26,530		*
Murray A. Goldman(11)		47,331		*
Eric W. Haeussler(12)		34,335		*
Henry L. Hirvela(13)		32,772		*
James E. Jurgens(14)		20,000		*
David K. McQuiggan		—		*
All directors and executive officers as a group (13 persons)		1,525,063		7.01	%
5% Stockholders:
Dimensional Fund Advisors Inc.(15)		1,666,563		7.66	%

*	Less than 1% of the outstanding shares of common stock
(1)	Includes, when applicable, shares owned of record by such person’s minor children and spouse and by other related individuals and entities over whose shares of common stock such person has custody, voting control, or power of disposition. Also includes shares of common stock that the identified person had the right to acquire within 60 days of March 31, 2005 by the exercise of vested stock options.
(2)	The percentages shown include the shares of common stock that the person will have the right to acquire within 60 days of March 31, 2005. In calculating the percentage of ownership, all shares of common stock which the identified person will have the right to acquire within 60 days of March 31, 2005 upon the exercise of vested stock options are deemed to be outstanding for the purpose of computing the percentage of shares of common stock owned by such person, but are not deemed to be outstanding for the purpose of computing the percentage of shares of common stock owned by any other person.
(3)	Includes 661,669 shares of common stock issuable upon exercise of vested stock options and 70,000 shares of common stock held by Jack L. Saltich and Pamela C. Saltich, Trustee of Saltich Trust U/A dated 12/17/91.
(4)	Includes 196,336 shares of common stock issuable upon exercise of vested stock options.
(5)	Includes 178,002 shares of common stock issuable upon exercise of vested stock options, 400 shares of common stock held by Dr. Derrington as custodian for his minor child, and 3,600 shares of common stock held by the Derrington Family Trust.
(6)	Includes 24,755 shares of common stock issuable upon exercise of vested stock options.
(7)	Includes 38,668 shares of common stock issuable upon exercise of vested stock options.
(8)	Includes 23,000 shares of common stock issuable upon exercise of vested stock options.
(9)	Includes 21,751 shares of common stock issuable upon exercise of vested stock options.
(10)	Includes 21,250 shares of common stock issuable upon exercise of vested stock options.
(11)	Includes 19,000 shares of common stock issuable upon exercise of vested stock options.

18

(12)	Includes 31,935 shares of common stock issuable upon exercise of vested stock options.
(13)	Includes 19,000 shares of common stock issuable upon exercise of vested stock options.
(14)	Includes 20,000 shares of common stock issuable upon exercise of vested stock options.
(15)	The information is as reported on Schedule 13G/A as filed February 9, 2005. The address of Dimensional Fund Advisors Inc. is 1299 Ocean Avenue, 11th Floor, Santa Monica, California 90401. Dimensional Fund Advisors Inc. has sole voting and dispositive power with respect to such shares.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

     Since January 1, 2004, there has not been, nor is there any currently proposed, any transactions or series of similar transactions or relationships with our officers, directors, or holders of more than 5% of our common stock that require disclosure under Item 404 of the Securities and Exchange Commission’s Regulation S-K.

ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES

     We engaged Deloitte & Touche LLP as our new independent registered public accounting firm as of May 13, 2002. During the past two most recent fiscal years prior to their engagement on May 13, 2002, we had not consulted with Deloitte & Touche LLP regarding (1) the application of accounting principles to a specified transaction, either completed or proposed; (2) the type of audit opinion that might be rendered on our financial statements, and in no case was a written report provided to us nor was oral advice provided that we concluded was an important factor in reaching a decision as to an accounting, auditing, or financial reporting issue; or (3) any matter that was either the subject of a disagreement, as that term is defined in Item 304(a)(1)(iv) of Regulation S-K and the related instructions to Item 304 of Regulation S-K, or a reportable event, as that term is defined in Item 304(a)(1)(v) of Regulation S-K.

     The Audit Committee has considered whether the provision of non-audit services by Deloitte & Touche LLP is compatible with maintaining Deloitte & Touche LLP’s independence.

Audit Fees

     The aggregate fees billed to our company by Deloitte & Touche LLP, the member firms of Deloitte Touche Tomatsu, and their respective affiliates (collectively “Deloitte”) for the fiscal years ended December 31, 2003 and 2004 are as follows:

	2003		2004
Audit Fees	$	813,000	$	1,250,000
Audit-Related Fees	$	14,000		—
Tax Fees	$	381,000	$	205,000
All Other Fees	$	2,000		—

     Audit services in 2003 and 2004 consisted of the audit of our financial statements, the audit of our internal controls over financial reporting under Section 404 of Sarbanes Oxley, the review of our quarterly financial statements, and statutory overseas audits. In 2003, $358,000 related to the spin-off of Brillian Corporation, including the re-audit of our 2001 financial statements. In 2004, $772,000 related to the audit of our internal controls over financial reporting under Section 404 of Sarbanes Oxley.

     Audited-related services in 2003 consisted of Section 404 Sarbanes Oxley advisory services, and audit-related work with respect to potential acquisitions.

     Tax compliance services in 2003 and 2004 consisted of federal, state, and local income tax return assistance; tax return filings in foreign jurisdictions; research and development tax credit documentation and analysis; transfer pricing documentation; and preparation of expatriate tax returns. Tax planning and advisory services related to structuring of proposed acquisitions, the spin-off of Brillian Corporation, employee benefit plans, and intra-group restructuring.

19

     Fees for other services in 2003 were in relation to training and literature.

Audit Committee Pre-Approval Policies

     The charter of our Audit Committee provides that the duties and responsibilities of our Audit Committee include the pre-approval of all audit, audit related, tax, and other services permitted by law or applicable SEC regulations (including fee and cost ranges) to be performed by our independent registered public accounting firm. Any pre-approved services that will involve fees or costs exceeding pre-approved levels will also require specific pre-approval by the Audit Committee. Unless otherwise specified by the Audit Committee in pre-approving a service, the pre-approval will be effective for the 12-month period following pre-approval. The Audit Committee will not approve any non-audit services prohibited by applicable SEC regulations or any services in connection with a transaction initially recommended by the independent registered public accounting firm, the purpose of which may be tax avoidance and the tax treatment of which may not be supported by the Internal Revenue Code and related regulations.

     To the extent deemed appropriate, the Audit Committee may delegate pre-approval authority to the Chairman of the Board or any one or more other members of the Audit Committee provided that any member of the Audit Committee who has exercised any such delegation must report any such pre-approval decision to the Audit Committee at its next scheduled meeting. The Audit Committee will not delegate to management the pre-approval of services to be performed by the independent registered public accounting firm.

     Our Audit Committee requires that our independent registered public accounting firm, in conjunction with our Chief Financial Officer, be responsible for seeking pre-approval for providing services to us and that any request for pre-approval must inform the Audit Committee about each service to be provided and must provide detail as to the particular service to be provided.

     All of the services provided by Deloitte described above under the captions “Audit-Related Fees,” “Tax Fees,” and “All Other Fees” were approved by our Audit Committee pursuant to our Audit Committee’s pre-approval policies beginning in April 2003.

SIGNATURES

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

                                                                                                            THREE-FIVE SYSTEMS, INC.

Date: April 19, 2005	By:	/s/ Jack L. Saltich
		Jack L. Saltich
		President and Chief Executive Officer

20

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

	Page
Report of Independent Registered Public Accounting Firm	F-2
Consolidated Balance Sheets as of December 31, 2003 and 2004	F-3
Consolidated Statements of Operations for the years ended December 31, 2002, 2003 and 2004	F-4
Consolidated Statements of Stockholders’ Equity for the years ended December 31, 2002, 2003 and 2004	F-5
Consolidated Statements of Comprehensive Loss for the years ended December 31, 2002, 2003 and 2004	F-6
Consolidated Statements of Cash Flows for the years ended December 31, 2002, 2003 and 2004	F-7
Notes to Consolidated Financial Statements	F-8
Schedule II – Valuation and Qualifying Accounts and Reserves for the years ended December 31, 2002, 2003 and 2004	S-1

F-1

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholders of
Three-Five Systems, Inc.

We have audited the accompanying consolidated balance sheets of Three-Five Systems, Inc. and subsidiaries (the “Company”) as of December 31, 2004 and 2003, and the related consolidated statements of operations, stockholders’ equity, comprehensive loss, and cash flows for each of the three years in the period ended December 31, 2004. Our audits also included the financial statement schedule listed in the Index at Item 15. These financial statements and the financial statement schedule are the responsibility of the Company’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 the standards of the Public Company Accounting Oversight Board (United States). 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, such consolidated financial statements present fairly, in all material respects, the financial position of Three-Five Systems, Inc. and subsidiaries as of December 31, 2004 and 2003, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2004, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, the financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.

The accompanying financial statements for the year ended December 31, 2004 have been prepared assuming that the Company will continue as a going concern. As discussed in Note 1 to the financial statements, the Company’s recurring losses from operations and difficulties financing future working capital needs raise substantial doubt about its ability to continue as a going concern. Management’s plans concerning these matters are also described in Note 1. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of the Company’s internal control over financial reporting as of December 31, 2004, based on the criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 30, 2005 expressed an unqualified opinion on management’s assessment of the effectiveness of the Company’s internal control over financial reporting and an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.

/s/ DELOITTE & TOUCHE LLP

Phoenix, Arizona
March 30, 2005 (April 19, 2005 as to the effect of vacating Building 3 in Redmond, Washington described in Note 12)

F-2

THREE-FIVE SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands, except share data)

	December 31,
	2003			2004
ASSETS
Current Assets:
Cash and cash equivalents	$	27,976		$	16,198
Short-term investments		5,130			—
Accounts receivable, net		28,133			22,050
Inventories		25,854			23,445
Income taxes receivable		678			181
Deferred tax asset		130			122
Assets held for sale		8,615			10
Other current assets		2,782			3,675
Total current assets		99,298			65,681
Property, Plant and Equipment, net		25,323			26,713
Intangibles, net		7,574			3,704
Goodwill		34,606			13,444
Other Assets		436			2,259
Total Assets	$	167,237		$	111,801
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current Liabilities:
Accounts payable	$	30,826		$	23,638
Accrued liabilities		4,529			4,721
Customer deposits		388			3,043
Deferred revenue		48			69
Deferred sale leaseback gain, short-term portion		—			545
Income taxes payable		—			40
Current portion of long-term debt		1,515			1,547
Current portion of capital leases		2,352			2,762
Lines of credit		—			2,416
Total Current Liabilities		39,658			38,781
Long-term Debt		1,441			—
Deferred Sale Leaseback Gain, Long-term Portion		—			2,178
Capital Leases		6,543			3,995
Other Long-term Liabilities		—			1,010
Total Long-term Liabilities		7,984			7,183
Commitments and Contingencies (Note 9)
Minority Interest in Consolidated Subsidiary		2,563			—
Preferred stock, $.01 par value; 1,000,000 shares authorized, No shares issued or outstanding		—			—
Common stock, $.01 par value; 60,000,000 shares authorized, 21,972,020 and 21,995,804 shares issued at December 31, 2003 and 2004, respectively		220			220
Additional paid-in capital		200,930			201,065
Accumulated deficit		(74,915	)		(133,730	)
Stock subscription note receivable		(185	)		—
Accumulated other comprehensive loss		(515	)		(547	)
Less — Treasury stock, at cost, 651,317 shares at December 31, 2003 and 228,151 shares at December 31, 2004		(8,503	)		(1,171	)
Total stockholders’ equity		117,032			65,837
	$	167,237		$	111,801

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

F-3

THREE-FIVE SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Dollars in thousands, except per share data)

	Years Ended
	December 31,
	2002			2003			2004
Net Sales	$	86,587		$	159,018		$	158,947
Costs and Expenses:
Cost of sales		78,718			155,125			161,009
Selling, general and administrative		10,382			17,524			24,961
Research, development and engineering		4,913			4,742			2,912
Impairment of goodwill		—			—			21,350
Impairment of intangibles		—			—			1,850
Loss (gain) on sale of assets		4,545			(25	)		(100	)
Amortization of intangibles		256			2,043			1,893
		98,814			179,409			213,875
Operating loss		(12,227	)		(20,391	)		(54,928	)
Other Income (Expense):
Interest, net		3,328			(179	)		(929	)
Other, net		164			1,043			1,361
		3,492			864			432
Minority Interest in Loss (Income) of Consolidated Subsidiary		84			(36	)		(22	)
Loss from Continuing Operations before Income Taxes		(8,651	)		(19,563	)		(54,518	)
Provision for (benefit from) income taxes		(3,921	)		14,338			(226	)
Loss from Continuing Operations		(4,730	)		(33,901	)		(54,292	)
Loss from Discontinued Operation, net of taxes		(12,241	)		(10,552	)		—
Net Loss	$	(16,971	)	$	(44,453	)	$	(54,292	)
Loss Per Common Share — Basic and Diluted:
Loss from Continuing Operations	$	(0.22	)	$	(1.59	)	$	(2.50	)
Loss from Discontinued Operation		(0.57	)		(0.50	)		—
Net Loss	$	(0.79	)	$	(2.09	)	$	(2.50	)
Weighted Average Number of Common Shares:
Basic and Diluted		21,465			21,301			21,719

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

F-4

THREE-FIVE SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
For the Years Ended December 31, 2002, 2003 and 2004
(Dollars in thousands, except share data)

										Stock			Accumulated
					Additional					Subscription			Other						Total
	Common Stock				Paid-in		Retained			Note			Comprehensive			Treasury			Stockholders’
	Shares Issued		Amount		Capital		Earnings			Receivable			Income (Loss)			Stock			Equity
Balance, December 31, 2001		21,894,628	$	219	$	200,395	$	30,666		$	(163	)	$	(21	)	$	(7,152	)	$	223,944
Net loss		—		—		—		(16,971	)		—			—			—			(16,971	)
Unrealized losses on investments		—		—		—		—			—			(197	)		—			(197	)
Foreign currency translation adjustments		—		—		—		—			—			(114	)		—			(114	)
Stock subscription note receivable		—		—		—		—			(11	)		—			—			(11	)
Stock options exercised and other		42,728		—		323		—			—			—			—			323
Tax benefit on stock option exercises		—		—		45		—			—			—			—			45
Purchase of treasury stock		—		—		—		—			—			—			(1,351	)		(1,351	)
Balance, December 31, 2002		21,937,356		219		200,763		13,695			(174	)		(332	)		(8,503	)		205,668
Net loss		—		—		—		(44,453	)		—			—			—			(44,453	)
Unrealized losses on investments		—		—		—		—			—			(65	)		—			(65	)
Foreign currency translation adjustments		—		—		—		—			—			(118	)		—			(118	)
Stock subscription note receivable		—		—		—		—			(11	)		—			—			(11	)
Stock options exercised and other		34,664		1		167		—			—			—			—			168
Distribution related to discontinued operation		—		—		—		(44,157	)		—			—			—			(44,157	)
Balance, December 31, 2003		21,972,020		220		200,930		(74,915	)		(185	)		(515	)		(8,503	)		117,032
Net loss		—		—		—		(54,292	)		—			—			—			(54,292	)
Unrealized losses on investments		—		—		—		—			—			2			—			2
Foreign currency translation adjustments		—		—		—		—			—			(34	)		—			(34	)
Stock subscription note receivable		—		—		—		—			185			—			—			185
Stock options exercised and stock compensation		23,784		—		135		—			—			—			—			135
Issuance of treasury stock for acquisition of minority interest in TFS Malaysia		—		—		—		(4,523	)		—			—			7,332			2,809
Balance, December 31, 2004		21,995,804	$	220	$	201,065	$	(133,730	)	$	—		$	(547	)	$	(1,171	)	$	65,837

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

F-5

CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
For the Years Ended December 31, 2002, 2003 and 2004
(Dollars in thousands)

	Years Ended December 31,
	2002			2003			2004
Net Loss	$	(16,971	)	$	(44,453	)	$	(54,292	)
Other Comprehensive Loss, net of taxes:
Unrealized gains (losses), net of tax expense (benefit) of ($96) for the year ended 2002		(197	)		(65	)		2
Foreign currency translation adjustment		(114	)		(118	)		(34	)
Comprehensive loss	$	(17,282	)	$	(44,636	)	$	(54,324	)

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

F-6

THREE-FIVE SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands)

	Years Ended December 31,
	2002			2003			2004
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss	$	(16,971	)	$	(44,453	)	$	(54,292	)
Less loss — discontinued operations		(12,241	)		(10,552	)		—
Loss — continuing operations		(4,730	)		(33,901	)		(54,292	)
Adjustments to reconcile net loss to net cash (used in) provided by operating activities:
Depreciation and amortization		3,950			7,588			8,650
Stock compensation		104			50			62
Minority interest in consolidated subsidiary		(84	)		36			22
Deferred revenue		23			25			21
Provision for accounts receivable valuation reserves		323			271			212
Loss on impairment of intangibles and goodwill		—			—			23,200
Loss (gain) on disposal of assets		4,545			(25	)		(100	)
Tax benefit on stock options exercised		45			—			—
Provision for (benefit from) deferred taxes, net		(2,289	)		14,164			8
Foreign currency translation adjustments		(114	)		(118	)		(34	)
Interest on notes payable		—			74			41
Interest on employee loan		(11	)		(11	)
CHANGES IN OPERATING ASSETS AND LIABILITIES:
(Increase) decrease in accounts receivable		6,961			(12,077	)		5,871
(Increase) decrease in inventories		7,010			(593	)		3,755
(Increase) decrease in other assets		452			(360	)		720
Increase (decrease) in accounts payable and accrued liabilities		(13,959	)		23,000			(3,331	)
Increase (decrease) in taxes payable/receivable		3,399			(117	)		537
Net cash (used in) provided by operating activities		5,625			(1,994	)		(14,658	)
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property, plant, and equipment		(1,211	)		(2,644	)		(8,121	)
Proceeds from sale of assets		2,100			1,030			9,642
Purchase of intangibles		(547	)		(1,444	)		(97	)
Purchase of investments		(102,591	)		(13,262	)		—
Proceeds from maturities/sales of short-term investments		159,233			70,245			5,132
Acquisitions and strategic investments		(50,089	)		(10,441	)		(2,746	)
Net cash provided by investing activities		6,895			43,484			3,810
CASH FLOWS FROM FINANCING ACTIVITIES:
Borrowings from lines of credit		2,706			—			2,416
Payments on debt		(2,706	)		(2,734	)		(1,450	)
Stock options exercised		210			118			73
Payments on capital leases		—			(1,722	)		(2,154	)
Payments on stock subscription note receivable		—			—			185
(Distribution to) receipt from minority interest		(239	)		2,527			—
Purchase of treasury stock		(1,351	)		—			—
Net cash used in financing activities		(1,380	)		(1,811	)		(930	)
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS — CONTINUING OPERATIONS		11,140			39,679			(11,778	)
NET CASH USED IN AND CONTRIBUTED TO DISCONTINUED OPERATIONS		(29,754	)		(30,092	)		—
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS		(18,614	)		9,587			(11,778	)
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR		37,003			18,389			27,976
CASH AND CASH EQUIVALENTS, END OF YEAR	$	18,389		$	27,976		$	16,198
SUPPLEMENTAL INFORMATION AND NONCASH INVESTING AND FINANCING ACTIVITIES:
Interest paid	$	178		$	1,007		$	1,195
Treasury stock issued for purchase of minority interest in TFS Malaysia		—			—			2,809
Income taxes paid (refunded)		(5,088	)		387			278
Note payable due on purchase of distribution rights license		—			2,956			—
Capital leases due on purchase of equipment		—			8,895			—

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

F-7

THREE-FIVE SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2002, 2003 and 2004

(1) Organization and Operations:

     Three-Five Systems, Inc. (together with its subsidiaries, herein referred to as “we,” “us,” or “the Company”) is a global provider of electronics manufacturing services, or EMS. We design and manufacture electronic printed circuit board assemblies, radio frequency, or RF, modules, display modules and systems, and complete systems for customers in the computing, consumer, industrial, medical, telecommunications and transportation industries. Our design and manufacturing services include a distinctive competence in display modules and systems and the integration of display modules and systems into other products.

     The accompanying financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. However, we have incurred recurring operating losses and used $14.7 million of cash in our operating activities during 2004. These factors, among others, have led our auditors to believe that we may be unable to continue as a going concern for a reasonable period of time. The financial statements do not include any adjustments relating to the recoverability and classification of recorded asset amounts or the amounts and classifications of liabilities that might be necessary should we be unable to continue as a going concern. Our continuation as a going concern is dependent upon a combination of our ability to generate sufficient cash flows from operations, to obtain additional debt or equity financing, or to sell additional assets to meet our obligations on a timely basis, and ultimately to attain successful operations.

     Our cash balance as of December 31, 2004 was $16.2 million. We expect to have continued operating losses in 2005, primarily in our EMS segment. Therefore, we have taken numerous steps to provide adequate liquidity to operate through the end of 2005.

     We recently signed a definitive agreement to sell the assets of our small form factor display business to International DisplayWorks, Inc. That sale would not include the display monitor business operated out of our Marlborough, Massachusetts facility. The sale to International DisplayWorks, Inc. is expected to be finalized in April 2005. Revenues from our small form factor display business in 2004 were approximately $28 million. TFS estimates the total value of that transaction will range between $11 million and $21 million and will include an $8 million cash payment at closing. The sale of the small form factor display operations to International DisplayWorks, Inc. will not only generate cash proceeds to us but eliminate the need for additional sources of funds for the sold operations.

     In March 2005, we determined to discontinue our display product offerings from Data International which is included in our Display segment. Revenues from those products in 2004 were approximately $17 million.

     In January 2005 we began to explore the sale of our Manila factory, and we currently are reviewing indications of interest made with respect to that facility. In the second quarter, we expect either to sell that operation intact or terminate the operations at that facility and sell the liquidated assets, including the equipment, inventory, and real property.

     Additional potential sources of capital in 2005 will be bank financings. We are pursuing a loan in Malaysia, and we expect to finalize the documentation of that loan in the second quarter. It also is possible that the sale of display operations could enable us to re-establish loan commitments or debt financing with a domestic bank or banks. We cannot provide assurance on potential loans or that the terms of such loan commitments or debt financing would be on terms acceptable to us.

     Based upon our cash balances, our expected use of cash in 2005, and the definitive agreement with International DisplayWorks, Inc., we believe that we have adequate sources to fund our remaining operations and planned expenditures through 2005, as well as to meet our contractual obligations. The expected use of funds through the rest of 2005, however, is based on our judgments and forecasts. Actual results could prove materially

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different and, in such instances, may require additional funds. We cannot provide assurance that additional asset sales, such as the sale of the Manila operations, loan commitments, or other methods of financing will be available for any such unexpected additional requirements or, if available, that they will be on terms acceptable to us.

     On September 1, 2003, we transferred all of the net assets of our microdisplay division, plus approximately $20.9 million in cash, into a newly created Delaware corporation called Brillian Corporation. On September 15, 2003, we spun off Brillian by distributing all of the outstanding common stock of Brillian to our stockholders on a pro rata basis, with each stockholder of Three-Five Systems, Inc., or TFS, receiving one share of Brillian common stock for every four shares of our common stock. Brillian is now traded on the NASDAQ National Market under the symbol “BRLC.” Brillian had $44.1 million of net assets on the spin-off date. The microdisplay business that we transferred to Brillian is now reported in these consolidated financial statements as Discontinued Operations.

     Net loss from discontinued operation before income taxes was $19.0 million and $10.6 million in 2002 and 2003, respectively. We had no discontinued operations in 2004. The income tax benefit for discontinued operation was $6.7 million in 2002. There was no tax benefit in 2003 for the discontinued operation. Net loss from discontinued operations was $12.3 million and $10.6 million in 2002 and 2003, respectively. Sales from discontinued operations were $1.4 million and $1.6 million in 2002 and 2003, respectively. There were no sales from discontinued operations in 2004. The major classes of discontinued assets and liabilities included in the Consolidated Balance Sheet as of the day of spin-off were as follows:

	September 15,
(Dollars in thousands)	2003
Assets:
Cash	$	20,453
Accounts receivable		473
Inventories		2,937
Other current assets		961
Property, plant and equipment, net		6,884
Intangibles, net		8,894
Other long-term assets		4,730
Total assets from discontinued operations	$	45,332
Liabilities:
Accounts payable and accrued liabilities	$	1,063
Deferred revenue		112
Total liabilities from discontinued operations	$	1,175

(2) Summary of Significant Accounting Policies:

   Principles of Consolidation and Preparation of Financial Statements

     The consolidated financial statements include the accounts of Three-Five Systems, Inc. and its wholly owned subsidiaries. All material intercompany transactions and balances have been eliminated.

     The accompanying financial statements have been prepared to reflect our historical financial position and results of operations and cash flows as adjusted for the reclassification of our microdisplay division as a discontinued operation. Historical results of operations of the microdisplay division are reported as a discontinued operation in the accompanying consolidated financial statements.

   Use of Accounting Estimates

     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 our estimates and judgments, including those related to sales returns, bad debts, inventories, fixed assets, intangible assets, income taxes, and contingencies. We base our estimates on historical experience and on various other assumptions that we believe are

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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.

  Customer Concentration

     Product sales for our historical major customer, Motorola, accounted for approximately 78% of sales in 2002 and less than 10% of our net sales in 2003 and 2004, respectively. In 2003, two customers each accounted for more than 10% of our net sales, Avocent and Vitelcom, accounting for 23% and 13% of our net sales, respectively. In 2004, one customer, Avocent, accounted for more than 10% of our net sales, accounting for 38% of our net sales.

  Fair Value of Financial Instruments

     We have determined the estimated fair value of financial instruments using available market information and valuation methodologies. Estimating fair values requires considerable judgment. Accordingly, the estimates may not be indicative of amounts that would be realized in a current market exchange. The carrying values of cash, short-term investments, accounts receivable, and accounts payable approximate fair value due to the short maturities of these instruments. In addition, at December 31, 2003 and 2004, the carrying amount of the term loan payable and capital lease obligations is estimated to approximate fair value as the actual interest rate is consistent with rates estimated to be currently available for debt with similar terms and remaining maturities.

  Cash 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. Cash equivalents consist of investments in money market mutual funds. A portion of our funds held in money market mutual funds are invested in repurchase agreements. These repurchase agreements are collateralized by U.S. Treasury and Government obligations. Cash and cash equivalents at December 31 consisted of the following:

	December 31,
(Dollars in thousands)	2003		2004
Cash and cash equivalents:
Cash	$	19,568	$	16,198
Money market		8,408		—
	$	27,976	$	16,198

  Investments

     Short-term investments have original maturities greater than three months and remaining maturities of less than one year. All investments are classified as available for sale and are 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. Short-term investments of $5.1 million as of December 31, 2003 consisted of corporate notes and bonds. There were no short-term investments as of December 31, 2004.

  Accounts Receivable, net

     We estimate sales allowances based upon historical experience of sales returns. To establish our allowance for doubtful accounts, we perform credit evaluations of our customers’ financial condition, along with analyzing past experience, and make provisions for doubtful accounts based on the outcome of our credit valuations and analysis. We evaluate the collectability of our accounts receivable based on specific customer circumstances, current economic trends, historical experience with collections, and the age of past due receivables. We believe the allowances that we have established are adequate under the circumstances; however, a change in the economic environment or a customer’s financial condition could cause our estimates of allowances and, consequently, the provision for doubtful accounts, to change. Allowance for doubtful accounts was $509,000 and $651,000 as of

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December 31, 2003 and 2004, respectively. Allowance for sales returns was $227,000 and $292,000 as of December 31, 2003 and 2004, respectively.

     During 2004, we entered into a series of agreements with Vitelcom, a former European customer, with regard to its payment of an outstanding balance due us. The first agreement was entered into in June 2004 with regard to $5.9 million due to us and provided for the amount due to be paid to us in a series of installments through October 2004. In September 2004, we agreed to a revised payment schedule with installments due through the end of 2004. At the end of the year $1.4 million remained unpaid under that revised payment schedule. We have not taken a reserve for doubtful accounts for this amount because we believe this amount will be paid. In the first quarter of 2005 we filed a lawsuit against Vitelcom in Spain for the unpaid amount.

  Inventories

     Inventories are stated at the lower of cost (first-in, first-out) or net realizable value and consisted of the following at:

	December 31,
(Dollars in thousands)	2003		2004
Raw materials	$	14,188	$	15,128
Work-in-process		5,321		2,444
Finished goods		6,345		5,873
	$	25,854	$	23,445

     Shipping terms with one of our major customers is FOB destination, and many of those products are shipped by sea, taking four to six weeks to reach their destinations. As a result, product in transit that was in our finished goods inventory was $3.1 million as of December 31, 2004 compared with $3.6 million as of December 31, 2003.

     We scrap inventory when materials are determined to be defective, damaged or no longer required. We also write down our inventory for estimated obsolescence or unmarketable inventory based upon assumptions and estimates 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. As noted below, we have had a significant history of inventory charges and write-offs with over $5 million of expenses written off in 2004:

•   In the fourth quarter of 2003, we learned from a customer that a product shipped by us to the customer contained potentially defective parts. Those potentially defective parts were printed circuit boards supplied to us by a vendor specified by our customer. At year-end 2003, we believed the parts could be repaired or that the component supplier would reimburse us for the damages. We determined in the first quarter of 2004 that the latent defect in the materials purchased was not repairable and that it was possible that the component supplier would not reimburse us for damages beyond the cost of those boards. As a result, we established a reserve for the value of that inventory, which included other component parts that had already been included on those boards less the $158,000 value of the boards for which we believe the supplier is obligated to repay at a minimum. The amount reserved was approximately $1.0 million.

•   At year-end 2003, we held $778,000 of inventory relating to a program cancelled by a customer. At that time, we believed we would recover the carrying value of this inventory and did not establish a reserve. After further discussions and negotiations with this customer during the first quarter of 2004, we wrote off $332,000 of this inventory while receiving settlement against the remainder of the inventory.

•   In the second quarter of 2004, a telecommunications customer declared bankruptcy. As a result of that event, we wrote off $127,000 in accounts receivable and recorded a $567,000 reserve against inventory relating to specific programs for that customer.

•   In the third quarter of 2004, we wrote off $1.4 million as follows: (a) $435,000 of Redmond inventory due to the pending end-of-life of several long-running programs; (b) $806,000 for inventory write-offs and

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other charges relating to the shut-down of various programs as a result of the move of our display module operations from Manila to Beijing; and (c) $202,000 of inventory in Manila related to Microtune.

•   In the fourth quarter of 2004, we wrote off $1.8 million of inventory as follows: (a) $284,000 of Redmond inventory relating to termination of customer programs; (b) $284,000 of Penang inventory for quality issue related to a new customer start-up; (c) $469,000 of Manila inventory for excess and obsolete inventory relating to Microtune; and (d) $774,000 display platform related inventory charges, most of which were due to excess and obsolete issues.

     Of the total write-offs and charges in 2004, $4.1 million was charged as excess inventory. Excess inventory charges in 2003 and 2002 were $1.6 million and $1.9 million, respectively.

  Property, Plant, and Equipment

     Property, plant, 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:

	Lives
Buildings	35 – 39 years
Building Improvements	10 – 35 years
Equipment	3 – 7 years
Furniture	3 – 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 expense as incurred. Depreciation expense totaled $3.7 million, $5.5 million, and $6.5 million for the years ended December 31, 2002, 2003, and 2004, respectively. Property, plant, and equipment consisted of the following at the dates indicated:

	December 31,
(Dollars in thousands)	2003			2004
Land and building	$	6,122		$	10,494
Furniture and equipment		40,907			39,599
		47,029			50,093
Less accumulated depreciation		(21,706	)		(23,380	)
	$	25,323		$	26,713

     In 1994, we conveyed our Tempe, Arizona facility and certain improvements to the city of Tempe as consideration for a rent-free 75-year lease. We had the option to repurchase the facility for $1,000 after ten years; therefore, the building lease was accounted for as a capital lease. We exercised that right in mid-2004 and took ownership of the facility.

     In April 2004, we purchased our facility in Manila from our lessor for $3.8 million. Of the $3.8 million paid, $3.2 million was assigned to the carrying value of the building and $585,000 was applied to accrued rent liabilities. We also paid $614,000 to the RBF Development Corporation, or RBF, for a 50 year land right. Lastly, we executed an agreement with RBF for an option to purchase the leased land for $1 at any time until April 23, 2014. In January 2005, we issued a press release in which we stated that we are exploring opportunities to sell this facility.

     In December 2004, we sold our Tempe, Arizona building for approximately $11.3 million, less selling costs of approximately $500,000. As part of this transaction, we received a $2.0 million note receivable due in five years. At the time of the sale, we entered into an agreement with the buyer to leaseback the entire facility for a period of five years.

     The remaining capital expenditures for 2004 related primarily to equipment purchased from Integrex, our ongoing ERP implementation, and additions in China related to our TFT clean room. We have invested $2.1 million in our ERP implementation.

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  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”, we evaluate the recoverability of property, plant, equipment, and intangibles with definite lives not held for sale. Whenever events or changes in circumstances indicate that the carrying amounts of the assets may not be recoverable, we evaluate recoverability 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 is recorded. These cash flows are evaluated for objectivity by using weighted probability techniques and also comparisons of past performance against projections. Assets may also be evaluated by identifying independent market values. The loss is measured as the difference between the fair value and carrying value of the asset or group of assets being evaluated. Assets held for sale are reported at the lower of the carrying amount or the fair value less cost to sell. The estimated fair value is based on the best information available under the circumstances, including prices for similar assets or the results of valuation techniques, including the present value of expected future cash flows using a discount rate commensurate with the risks involved.

  Intangibles

     Intangibles consist of mask works, trademarks, customer lists, and licensing/distribution rights. SFAS 142, Goodwill and Other Intangible Assets, requires purchased intangible assets with finite lives to be amortized over their useful lives. Purchased intangibles are recorded at cost and amortized using the straight-line method over the estimated useful lives of the respective assets, which range from two to five years. Our policy is to commence amortization of intangibles when their related benefits begin to be realized.

     In January 2003, we signed licensing and manufacturing agreements with Data International Co., Ltd. of Taiwan. Under those agreements, we agreed to pay $3.9 million to become the exclusive channel in the Americas for LCD products manufactured by Data International. The remaining $1.5 million cost of the license was due in January 2005. We have not paid the $1.5 million due to an ongoing dispute with Data International. See footnote 12, Subsequent Events for additional information.

     In the third quarter of 2004, we wrote off the remaining $1.8 million of the customer list associated with the AVT acquisition. The acquisition value of the customer lists acquired from our AVT acquisition was $3.0 million and the accumulated amortization was $1.2 million. This write-off occurred as a result of numerous changes in the AVT business, including notification during the quarter that a customer was not renewing a program. That notification, along with the other cumulative changes that have occurred since the acquisition, have now resulted in a complete turnover in the customer base. Most of these changes were driven by the fact that the original business when acquired by us was selling CRT displays and now is exclusively selling LCD flat panel displays.

     Intangible assets consisted of the following:

			Accumulated			Book		Weighted
(Dollars in thousands)	Acquisition Value		Amortization			Value		Avg Life
December 31, 2003
Amortized Intangible Assets:
Mask works	$	991	$	—		$	991		3.0
Customer lists		5,000		(1,523	)		3,477		4.2
License		3,882		(776	)		3,106		5.0
	$	9,873	$	(2,299	)	$	7,574		4.4

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			Accumulated			Book		Weighted
(Dollars in thousands)	Acquisition Value		Amortization			Value		Avg Life
December 31, 2004
Amortized Intangible Assets:
Mask works	$	988	$	(225	)	$	763		2.4
Customer lists		2,000		(1,389	)		611		3.0
License		3,882		(1,552	)		2,330		5.0
	$	6,870	$	(3,166	)	$	3,704		4.0

     Intangible asset amortization expense for the years ended December 31, 2002, 2003 and 2004 was $256,000, $2.0 million and $2.1 million, respectfully. During 2004, approximately $225,000 of amortization expense was included in cost of sales.

     Estimated annual amortization expense through 2009 and thereafter related to intangible assets reported as of December 31, 2004 was as follows:

Fiscal Year	(Dollars in thousands)
2005	$	1,815
2006		1,057
2007		832
2008		—
2009		—
Thereafter		—
	$	3,704

  Goodwill

     In accordance with SFAS No. 142, “Goodwill and Other Intangible Assets”, goodwill is analyzed for impairment, on at least an annual basis, or more frequently under certain circumstances, and written down when impaired rather than being amortized.

     Changes in goodwill from December 31, 2003 to December 31, 2004 were as follows:

(Dollars in thousands)	Total
Balance at December 31, 2002	$	34,901
Purchase of Unico Technology, Bhd.		315
Reduction of ETMA Corporation purchase price		(610	)
Balance at December 31, 2003	$	34,606
Purchase of minority interest in TFS Malaysia		232
Other adjustments		(44	)
Goodwill impairment		(21,350	)
Balance at December 31, 2004	$	13,444

  Other Assets

     Other assets consist primarily of the $2.0 million note receivable that we received in connection with the sale and leaseback of the Tempe building.

  Accrued Liabilities

     Accrued liabilities included, among other things, accrued compensation of approximately $1.9 million and $1.5 million at December 31, 2003 and 2004, respectively.

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  Customer Deposits

     Customer deposits include approximately $2.9 million of invoices issued in the fourth quarter of 2004 to a specific customer in accordance with the terms and conditions of that customer’s purchase order. The invoices are to cover costs associated with the establishment of the supply chain and the long lead times required for materials used in the manufacturing process.

  Deferred Sale Leaseback Gain

     In December 2004, we sold our Tempe building for approximately $11.3 million less selling costs of approximately $500,000. Under the terms of the sale, we received net cash (after expenses) of $8.8 million and a promissory note of $2 million payable in five years, resulting in a $2.7 million gain on the sale of that building. The $2.7 million deferred gain on the sale and leaseback of our Tempe, Arizona corporate facility will be amortized over the five year term of the lease.

     Estimated annual amortization through 2009 and thereafter related to the deferred gain on the sale of fixed assets reported as of December 31, 2004 was as follows:

Fiscal Year	(Dollars in thousands)
2005	$	545
2006		544
2007		545
2008		544
2009		545
Thereafter		—
	$	2,723

  Line of Credit

     In the second quarter of 2004, our Beijing subsidiary obtained a $2.4 million line of credit with Hua Xia Bank secured principally by our building in Beijing. We have borrowed $2.4 million under that facility at December 31, 2004, which accrues simple, annual interest at 5.31%.

  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 bases of assets and liabilities and the tax rates in effect when these differences are expected to reverse.

  Foreign Currency Translation

     For foreign subsidiaries that use currency other than the U.S. dollar as their functional currency, assets and liabilities are translated at exchange rates in effect at the balance sheet date, and revenue and expenses are translated at the weighted average exchange rate for the period. The effects of these translation adjustments are reported in other comprehensive income and as a separate component of stockholders’ equity.

  Derivatives

     On January 1, 2001, we adopted SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, which establishes accounting and reporting standards requiring us to recognize derivatives as either assets or liabilities on the balance sheet and to measure those instruments at fair value. The adoption of SFAS No. 133 did not have a material impact on our financial position or results of operation.

     We may use derivatives to manage exposures to foreign currency fluctuations. The only type of derivative we use is foreign currency forward contracts. Our objectives for holding these forward contracts are to decrease the

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potential volatility of earnings and cash flows associated with changes in foreign currency exchange rates (see Note 9).

  Revenue Recognition

     We assemble and manufacture products for our customers and recognize revenue 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. This means that when a product is shipped from one of our factories under the terms of “FOB Factory,” then the risk of loss passes to the customer when the product leaves our factory and we recognize revenue at that time. On the other hand, when a product is shipped “FOB Destination,” then risk of loss during transit is maintained by us. Thus, we recognize revenue when the product is accepted by the customer. Shipping terms with one of our major customers is FOB Destination, and many of those products are shipped by sea, taking four to six weeks to reach their destination. As a result, we frequently have a significant amount of product in transit recorded in our finished goods inventory balance.

     We recognize revenue related to engineering, design, and other related services after the service has been rendered, which is determined based upon completion of agreed upon milestones or deliverables. Service revenues are not significant in any period presented.

  Research, Development, and Engineering

     Research, development, and engineering costs are expensed as incurred.

  Stock Compensation.

     Pursuant to the provisions of SFAS No. 123, Accounting for Stock-Based Compensation, we account for options granted to our employees pursuant to Accounting Principles Board Opinion (APB) No. 25, Accounting for Stock Issued to Employees, under which no compensation cost has been recognized. However, we have computed compensation cost, for pro forma disclosure purposes, based on the fair value of all options awarded on the date of grant, utilizing the Black-Scholes option pricing method with the following weighted assumptions: risk-free interest rates of 2.74%, 3.25% and 3.63% for 2002, 2003, and 2004; expected dividend yields of zero for all scenarios; expected lives of 6.1 years for 2002, 5.7 years for 2003, and 4.1 years for 2004; and expected volatility (a measure of the amount by which a price has fluctuated or is expected to fluctuate during a period) of 74.4%, 79.6%, and 77.81% for 2002, 2003, and 2004, respectively. The compensation costs for 2002 are tax-effected and the compensation costs for 2003 and 2004 are not tax-effected. Had compensation cost for these plans been determined consistent with SFAS No. 123, our net loss and loss per share would have been as follows:

		Years Ended December 31,
(In thousands, except per share data)		2002			2003			2004
Net loss:
	As reported	$	(16,971	)	$	(44,453	)	$	(54,292	)
	Total stock-based compensation expenses determined under fair value based method for all awards, net of related tax effects		(4,378	)		(5,035	)		(3,556	)
	Pro forma net loss	$	(21,349	)	$	(49,488	)	$	(57,848	)
Basic and diluted net loss per share:
	As reported	$	(0.79	)	$	(2.09	)	$	(2.50	)
	Pro forma		(0.99	)		(2.32	)		(2.66	)

  Earnings Per Share

     Basic net income (loss) per common share is computed by dividing net income (loss) by the weighted average number of common shares outstanding during the year before giving effect to stock options considered to be

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dilutive common stock equivalents. Diluted net income (loss) per common share is computed by dividing net income (loss) by the weighted average number of common shares outstanding during the year after giving effect to stock options considered to be dilutive common stock equivalents. Set forth below are the disclosures required pursuant to SFAS No. 128 — Earnings per Share:

	Years Ended December 31,
(In thousands, except per share data)	2002			2003			2004
Basic earnings (loss) per share:
Net income (loss)	$	(16,971	)	$	(44,453	)	$	(54,292	)
Weighted average common shares		21,465			21,301			21,719
Basic earnings (loss) per share amount	$	(0.79	)	$	(2.09	)	$	(2.50	)
Diluted earnings (loss) per share:
Net income (loss)	$	(16,971	)	$	(44,453	)	$	(54,292	)
Weighted average common shares		21,465			21,301			21,719
Dilutive stock options		—			—			—
Total common shares plus common stock equivalents		21,465			21,301			21,719
Diluted earnings (loss) per share amount	$	(0.79	)	$	(2.09	)	$	(2.50	)

     For the years ended December 31, 2002, 2003 and 2004, the effect of 314,569, 348,030 and 73,352 shares, respectively, were excluded from the calculation of loss per share as their effect would have been antidilutive and decreased the loss per share.

  Recently Issued Accounting Standards

     In November 2004, the FASB issued SFAS No. 151, “Inventory Costs — An Amendment of ARB No. 43, Chapter 4”. SFAS No. 151 amends the guidance in Accounting Research Bulletin (ARB) No. 43, Chapter 4, “Inventory Pricing,” to clarify the accounting for abnormal amounts of idle facility expense, freight, handling costs, and wasted material (spoilage). Among other provisions, the new rule requires that items such as idle facility expense, excessive spoilage, double freight, and rehandling costs be recognized as current-period charges regardless of whether they meet the criterion of “so abnormal” as stated in ARB No. 43. Additionally, SFAS No. 151 requires that the allocation of fixed production overheads to the costs of conversion be based on the normal capacity of the production facilities. SFAS No. 151 is effective for fiscal years beginning after June 15, 2005 and is required to be adopted by us effective January 1, 2006. We are currently evaluating the impact SFAS No. 151 will have on our consolidated results of operations and financial condition.

     In December 2004, the FASB issued Statement 123(R), “Share-Based Payment,” which replaces FASB Statement No. 123, Accounting for Stock-Based Compensation, and supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees. FASB Statement 123(R) will require compensation costs related to share-based payment transactions to be recognized in the financial statements. With limited exceptions, the amount of compensation cost will be measured based on the grant-date fair value of the equity instruments issued. Compensation cost will be recognized over the period that an employee provides service in exchange for the award. FASB Statement 123(R) becomes effective for interim or annual periods beginning after June 15, 2005. At this time, we are in the process of evaluating the impact this will have on our financial statements.

     We adopted the provisions of FASB Interpretation No. 46 (Revised), Consolidation of Variable Interest Entities (“Interpretation No. 46 (Revised)”) in our interim period ending March 31, 2004. Interpretation No. 46 (Revised) clarifies the application of existing consolidation requirements to entities where a controlling financial interest is achieved through arrangements that do not involve voting interests. The application of Interpretation No. 46 (Revised) did not have an impact on our financial statements.

  Assets Held For Sale and Loss (Gain) on Sale of Assets

     During 2002, we signed a Cooperative Agreement with a Chinese company under which we agreed to sell the equipment used in our front-end LCD equipment and establish a supply agreement. Under the terms of the Cooperative Agreement, in exchange for our front-end LCD line, we received a total of $3.0 million in cash during 2002 and 2003. In the second quarter of 2002, as a result of signing the Cooperative Agreement, we realized a

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charge of $4.5 million for the write-down on the LCD equipment sold to the Chinese company. This charge was reported as a separate line item in operating expense. In connection with the Cooperative Agreement, we received $2.1 million in 2002, all of which was applied against the $3.0 million sales price and recorded as a reduction in the carrying value of the LCD equipment held for sale. The sale of the equipment is now complete, and we received $900,000 in 2003.

     During the fourth quarter of 2003, we formalized plans to sell our Tempe, Arizona corporate facility; therefore, 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”, we reclassified $8.6 million of our building and improvements to assets held for sale. The building was listed and actively marketed for sale at the beginning of October 2003; therefore, no depreciation expense was recorded during the subsequent 12-month period. However, in the third quarter of 2004, we agreed to sell and leaseback the Tempe building. Accordingly, depreciation expense of $362,000, which would otherwise have been recorded during the period the building was held for sale, was recorded in the third quarter. In December 2004, we sold our Tempe, Arizona building for approximately $11.3 million less selling costs of approximately $500,000. Under the terms of the sale, we received net cash (after expenses) of $8.8 million and a promissory note of $2.0 million payable in five years, resulting in a $2.7 million gain on the sale of that building. Because we leased back the Tempe facility for five years, we will recognize the gain ratably over the life of the lease.

(3) Acquisitions and Strategic Transactions:

     In February 2004, we entered into a transaction with Integrex, a Seattle-based electronics manufacturing services company that was liquidating its business. Under that transaction, we bought the raw materials inventory of Integrex for $1.4 million and hired certain of its employees. We also obtained the rights to most of its customers and agreed with those customers that we would manufacture those customers’ products in our Redmond manufacturing facility. In exchange for those customer rights, we agreed to pay a license fee for between 15 and 24 months based on revenue receipts from former Integrex customers. In February 2004 and at a second closing in April 2004, we paid $1.3 million in non-refundable license fees to Integrex. At the second closing in April, we also acquired $300,000 of capital equipment.

     In April 2003, we acquired the business and certain assets of Unico Technology Bhd., a privately held Malaysian company located in Penang. Unico was an electronics manufacturer for OEM customers in the computer, computer peripheral, and communications industries. The Unico business was acquired by TFS Electronics Manufacturing Services Sdn. Bhd., or TFS-Malaysia, a former joint venture owned 60% by an overseas TFS subsidiary and 40% by Unico Holdings Bhd., the former parent of Unico. Unico Holdings is the investment arm of the Chinese Chamber of Commerce of Malaysia. Our share of the initial cost of capitalizing TFS-Malaysia was $3.8 million and Unico Holdings’ share was $2.5 million, most of which was used for working capital. TFS-Malaysia purchased $4.1 million in inventory from Unico, of which $2.7 million was paid at the time of the purchase and $1.4 million was subsequently paid. No advance payment was required for the acquisition of the property, plant, and equipment of Unico, all of which is leased from the seller. The equipment lease is accounted for as a capital lease payable by TFS-Malaysia. The principal balance on that lease was $6.1 million as of December 31, 2004. In the second quarter of 2004, Unico Holdings exchanged its ownership interest in TFS-Malaysia for approximately 423,000 shares of our common stock held in treasury in a transaction valued at $2.8 million, compared with Unico Holdings’ interest of $2.6 million. As a result of that transaction, we recorded approximately $232,000 in additional goodwill and we now own 100% of TFS-Malaysia.

     In March 2003, we signed an agreement with Microtune, Inc. under which we agreed to manufacture, assemble, and test Microtune’s radio frequency, or RF, tuner modules and wireless module products in our manufacturing facility in Manila, the Philippines. As part of the agreement, Microtune sold to us certain of its own equipment and inventory for $8.2 million, of which $2.7 million was a note payable due in September 2003, and contracted with us to provide 100% of Microtune’s current demand for fully assembled RF subsystems. We also hired approximately 500 Microtune employees in Manila. In October 2003, we paid off approximately $300,000 of the $2.7 million note payable to Microtune and entered into an agreement to cancel the remaining $2.4 million balance on that note payable in exchange for the return of inventory to Microtune. In January 2005, we announced that we are exploring the possible sale of our Manila manufacturing facility.

F-18

     In January 2003, we signed licensing and manufacturing agreements with Data International Co., Ltd. of Taiwan. Under those agreements, we became the exclusive channel in the Americas for LCD products manufactured by Data International. We obtained the right to sell those products through our worldwide channels. The cost of the license was $3.9 million, of which $1.0 million was paid upon signing and $2.9 million was a term loan. In the first quarter of 2004, we paid $1.4 million against the term loan. The remaining $1.5 million was due in January 2005 and is subject to reduction if certain margin targets are not met. We have not paid the remaining amount due as a result of an ongoing dispute with Data International. See footnote 12, Subsequent Events for additional information regarding the dispute.

     In September 2002, we purchased the assets and ongoing business of AVT, a privately held company located in Marlborough, Massachusetts that specialized in the design and integration of complex, high-resolution display systems. AVT designs and provides customized and ruggedized flat panel, touchscreen and rackmount systems for original equipment manufacturers. The purchase price of the acquisition was $12.0 million, which we paid entirely in cash.

     The purchase price was allocated as follows:

		(Dollars in thousands)
Current assets	$	2,115
Property, plant and equipment		105
Customer list intangibles		3,000
Goodwill		7,774
Other long-term assets		40
Current liabilities		(1,045	)
Net Acquisition price	$	11,989

     In December 2002, we purchased the stock of ETMA Corporation, located in Redmond, Washington, a privately held electronics services manufacturer for OEM customers in the automotive, computer/server, medical monitoring, and Internet security industries. ETMA offers the manufacturing capabilities of five surface mount manufacturing lines, including one dedicated to new product introduction and prototyping activity. ETMA provides engineering support, automated printed circuit board assembly, in-circuit and functional testing, systems integration and box build, complete supply chain management, and turnkey packaging and fulfillment services. The purchase price of the acquisition was $38.1 million, which we paid entirely in cash.

     The purchase price was allocated as follows:

		(Dollars in thousands)
Current assets	$	17,389
Property, plant and equipment		1,454
Customer list intangibles		2,000
Goodwill		27,127
Current liabilities		(9,842	)
Long-term liabilities		(28	)
Net Acquisition price	$	38,100

     In the third quarter of 2004, we determined that the $27.1 million goodwill balance associated with the EMS reporting unit was impaired. Because of the ongoing performance issues experienced by the Redmond location, including the integration issues experienced in Redmond in the second and third quarters of 2004, and because of the reduction in market comparables, we engaged a professional valuation firm to assist us in determining the fair value of the EMS goodwill. The valuation included a market comparable study and a present value valuation based on management’s best estimates of the future cash flows. The amount of the impairment loss was $21.3 million, and was determined in accordance with the provisions of SFAS No. 142, Goodwill and Other Intangible Assets.

     Total intangible assets from the acquisition of ETMA related to customer lists of $2.0 million will be amortized over their weighted averaged useful lives of approximately three years.

F-19

     The results of operations of AVT and ETMA have been included in the accompanying financial statements since their respective acquisition dates. The acquisition of AVT was considered immaterial and pro forma results are therefore not presented. Unaudited pro forma Consolidated Statements of Operations for 2002, presented as if ETMA had been acquired at the beginning of each year, are as follows:

	Years Ended December 31,
	2002
(Dollars in thousands, except per share data)	(unaudited)
Net sales	$	150,108
Net loss		(17,065	)
Loss per share (basic and diluted)		(0.80	)

     The pro forma amounts include a reduction in interest income related to the presumption that the acquisition occurred as of January 1, 2002 and investments were therefore reduced by $38.1 million.

(4) Long-Term Debt:

     Long-term balances were as follows at:

	December 31,
(Dollars in thousands)	2003		2004
Term loan due to Data International, interest rate of 2.6% due January 2005	$	2,956	$	1,547
Less current portion		1,515		1,547
Long-term portion	$	1,441	$	0

     In the first quarter of 2004 we entered into a temporary credit facility with First National Bank in which we borrowed $5 million secured by restricted cash deposits. In the second quarter of 2004, we repaid and terminated that credit facility.

     In the second quarter of 2004, we entered into a $10.0 million secured revolving line of credit with Silicon Valley Bank, or SVB, which matures on June 25, 2005. Initially, that line of credit bore interest at the bank’s prime rate plus 75 basis points, subject to a minimum rate of 4.75%. The SVB line also contained restrictive covenants that included, among other things, restrictions on the declaration of payments of dividends, restrictions on the sale or transfer of assets, and maintenance of specified net worth and quick ratio. We owed $5.0 million under that line of credit as of September 30, 2004. As of September 30, 2004, we did not meet some of the required covenants, although SVB did not call a default on the SVB line. During Q4 we signed an amendment to the original SVB line that substantially revises its terms and conditions. Under those new terms, the first $2.5 million of borrowings under that line of credit bears interest at the bank’s prime rate plus 125 basis points subject to a minimum rate of 4.75%, and borrowings above $2.5 million are subject to a factoring arrangement, bearing an initial discount fee and interest of prime plus 450 basis points on the factored receivables. The credit limit remains at $10 million, but there are fewer receivables that qualify as factorable as compared to the original borrowing base, resulting in a potentially lower borrowing base. Many of the restrictive covenants previously contained in the SVB line documents have been removed, although covenants do remain relating to cash earnings, revenue, and the Tempe building sale. Although there were no borrowings under the SVB line as of December 31, 2004, we were in violation of our covenants relating to cash earnings and revenue. SVB did not declare a default on the line, but we are currently under discussion with the SVB with regard to a re-negotiation of the terms of the line. During this re-negotiation period, SVB has issued a forbearance letter under which we are precluded access to the line. In addition, SVB required us to make a cash deposit in 2005 to secure a $600,000 letter of credit, which SVB had issued to the lessor of our building in Redmond.

     In January 2003, we signed a term loan of $2.9 million with Data International. In the first quarter of 2004, we paid $1.4 million against the term loan. The remaining $1.5 million was due in January 2005 and is subject to

F-20

reduction if certain margin targets are not met. We have not paid the remaining amount due as a result of an ongoing dispute with Data International. See footnote 12, Subsequent Events for additional information.

     Interest expense related to debt was $186,000, $204,000, and $144,000, respectively, for 2002, 2003, and 2004.

  Other Long-Term Liabilities

     In the fourth quarter of 2004, we moved into a new facility in Redmond and signed a seven year lease with a five year renewal option. Prior to moving into that building, which we refer to as Building 4, we leased three other buildings in the Redmond area. In the fourth quarter of 2004 we vacated Building 1 and subleased that building. All of the activities in Building 1 are now conducted in our new Building 4. As a part of that transaction, we received $900,000 from the landlord of building 4 as an inducement to enter into the new lease and to cover costs associated with the move. We are required to amortize the $900,000 against rent expense over the term of the lease. Therefore, at December 31, 2004, the long-term portion of the amount to be amortized was approximately $763,000.

     At the time we vacated Building 1, we recognized a charge of $382,000, which is equal to the difference between the amount of rent, property taxes and local improvement districts assessments that we would be required to pay during the remaining three years of the original five year lease less the amount of rent we will receive from the sublease of that facility, which commenced on January 1, 2005. Therefore, at December 31, 2004, the long-term portion attributable to the charge was approximately $247,000.

(5) Capital Leases:

     Capital leases were as follows at:

	December 31,
(Dollars in thousands)	2003		2004
Capital lease due on purchase of Unico equipment, interest rate 13.3%, payable through April 2007	$	8,135	$	6,058
Other capital leases with interest rate ranges from 1.9% to 14.2%, payable through December 2003 and July 2007		760		699
		8,895		6,757
Less current portion		2,352		2,762
Long-term portion	$	6,543	$	3,995

     The capital leases are for our equipment in Malaysia and Washington. One of the capital leases includes certain financial covenants that we were not in compliance with at December 31, 2004. The lessor has informed us that as a result of covenant violations, they are accelerating the payments due on the lease obligations.

     Interest expense related to capital leases was $868,000 and $1,012,000, respectfully, in 2003 and 2004.

     The following table lists our payments to be made on our capital leases reported as of December 31, 2004:

Fiscal Year	(Dollars in thousands)
2005	$	3,430
2006		3,236
2007		1,074
2008		30
Total lease payments		7,770
Less interest portion		(1,013	)
Capital lease obligations	$	6,757

F-21

(6) Stockholders’ Equity:

     On December 7, 2000, the Board of Directors authorized a stock repurchase program whereby our company, at the discretion of management, could buy back up to $30.0 million of our common stock in the open market. During the year ended December 31, 2002, we purchased 260,600 shares at a cost of $1,351,000. There were no stock repurchases in 2003 and 2004. This program was rescinded in May 2003.

     In the second quarter of 2004, we agreed with Unico Holdings to exchange its ownership interest in TFS-Malaysia for approximately 423,000 shares of our common stock held in treasury in a transaction valued at $2.8 million, compared with Unico Holdings’ interest of $2.6 million.

     During the second quarter of 2001, the Board of Directors adopted a stockholder rights plan (the “Rights Plan”). Under the Rights Plan, we issued a dividend of one Preferred Share Purchase Right (the “Right”) for each share of common stock of our company held by stockholders of record as of the close of business on May 14, 2001. Each Right entitles stockholders to buy one one-thousandth (1/1000^th) of a share of Series A Junior Participating Preferred Stock of our company at an exercise price of $120.00 (subject to adjustment). The Rights Plan was not adopted in response to any specific takeover threat. The Rights Plan, however, was designed to assure that all of our stockholders receive fair and equal treatment in the event of any proposed takeover of our company, and to guard against coercive or unfair tactics to gain control of our company without paying all stockholders a premium for that control.

(7) Benefit Plans:

     We have six different stock option plans covering our employees, officers, directors, and consultants and a Directors Stock Plan covering our directors; The 1990 Stock Option Plan (1990 Plan), the 1993 Stock Option Plan (1993 Plan), the 1994 Non-Employee Directors Stock Option Plan (1994 Plan), the 1997 Stock Option Plan (1997 Plan), 1998 Stock Option Plan (1998 Plan) and the 2004 Incentive Compensation Plan.

  1990 Stock Option Plan

     Under the 1990 Plan, there were options issued but unexercised to purchase 71,016 shares of our company’s common stock as of December 31, 2004. The 1990 Plan expired on May 1, 2001, at which time all unissued options expired.

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

  1993 Stock Option Plan

     Under the 1993 Plan, there were options outstanding to acquire 260,367 shares of our company’s common stock under the 1993 Plan at December 31, 2004. The 1993 Plan expired on February 24, 2003, at which time all unissued options expired.

  1994 Non-Employee Directors Stock Option Plan

     The 1994 Plan provides for the automatic grant of stock options to non-employee directors to purchase up to 100,000 shares of our common stock. On April 26, 2001, our stockholders approved a proposal to amend our 1994 Automatic Stock Option Plan for Non-Employee Directors (the “1994 Plan”). Now, under the 1994 Plan, options to acquire 2,000 shares of common stock will be automatically granted to each non-employee director at the meeting of our Board of Directors held immediately after each annual meeting of stockholders, with such options to vest in a series of 12 equal and successive monthly installments commencing one month after the annual automatic grant date. In addition, each non-employee director serving on our Board of Directors on the date the 1994 Plan was approved by our stockholders received an automatic grant of options to acquire 5,000 shares of common stock and each subsequent newly elected non-employee member of our Board of Directors receives an automatic grant of

F-22

options to acquire 5,000 shares of common stock on the date of their first appointment or election to our Board of Directors. Those options become exercisable and vest in a series of three equal and successive annual installments, with the first such installment becoming exercisable immediately after the director’s second successive election to our Board of Directors (the First Vesting Date), the second installment becoming exercisable 10 months after the first vesting date, and the third installment becoming exercisable 22 months after the first vesting date (provided that the director has not ceased serving as a director prior to a vesting date). A non-employee member of our Board of Directors is not eligible to receive the 2,000 share automatic option grant if that option grant date is within 30 days of such non-employee member receiving the 5,000 share automatic option grant. The exercise price per share of common stock subject to options granted under the 1994 Plan will be equal to 100% of the fair market value of our common stock on the date such options are granted. There were outstanding options to acquire 51,092 shares of our common stock under the 1994 Plan at December 31, 2004. The plan expired on April 12, 2004, at which time all unissued options expired.

  1997 Stock Option Plan

     The 1997 Plan provides for the granting of nonqualified options to purchase up to 2,100,000 shares of our common stock. Under the 1997 Plan, options may be issued to key personnel and others providing valuable services to our company. Any option that expires or terminates without having been exercised in full will again be available for grant pursuant to the 1997 Plan. There were options outstanding to acquire 1,442,593 shares of our common stock under the 1997 Plan at December 31, 2004.

     The expiration date, maximum number of shares purchasable, and the other provisions of the options will be established at the time of grant. Options may be granted for terms of up to ten years and become exercisable in whole or in one or more installments at such time as may be determined by the plan administrator upon grant of the options. The exercise prices of the options are determined by the plan administrator, but may not be less than 100% of the fair market value of the common stock at the time of the grant. The 1997 Plan will remain in force until May 12, 2007.

  1998 Stock Option Plan

     The 1998 Plan provides for the granting of incentive stock options and nonqualified options to purchase up to 1,600,000 shares of our common stock. Under the 1998 Plan, options may be issued to key personnel and others providing valuable services to our company. The options issued will be incentive stock options or nonqualified stock options as defined in Section 422 of the Code. Any option that expires or terminates without having been exercised in full will again be available for grant pursuant to the 1998 Plan. There were options outstanding to acquire 1,528,461 shares of our common stock under the 1998 Plan at December 31, 2004.

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

  2004 Incentive Compensation Plan

     On February 13, 2004, the Board of Directors adopted the 2004 Incentive Compensation Plan, or Incentive Plan. As of March 24, 2004, there were outstanding options for 3,544,657 shares in the five option plans that existed at December 31, 2003. The Incentive Plan was approved by our stockholders at our annual meeting of stockholders on May 7, 2004. No new shares are being added under the Incentive Plan. Instead, the aggregate number of shares of common stock to be issued under the Incentive Plan equals the aggregate number of shares of common stock under all of the five other stock option plans and Directors Stock Plan that are being consolidated into the Incentive Plan as of February 13, 2004.

F-23

     The Incentive Plan provides for an aggregate of 4,079,299 shares of common stock to be issued pursuant to options previously granted or to be granted to acquire common stock, the direct granting of restricted common stock and deferred stock, the granting of stock appreciation rights, and the granting of dividend equivalents. All options previously issued pursuant to the five original plans remain outstanding. The Incentive Plan consolidates only the un-issued options of the five original plans into one consolidated plan.

     The expiration date, maximum number of shares purchasable, and the other provisions of the options will be established at the time of grant. Options may be granted for terms of up to ten years and become exercisable in whole or in one or more installments at such time as may be determined by the committee or the Board of Directors upon grant of the options. The exercise price per share of stock purchasable under an Option shall not be less than 100% of the fair market value of the stock on the date of grant of the Option. If an employee owns or is deemed to own (by reason of the attribution rules applicable under Section 424(d) of the Code) more than 10% of the combined voting power of all classes of stock of our company or a subsidiary of our company and an incentive stock option is granted to such employee, the option price of such incentive stock option (to the extent required by the Code at the time of grant) shall be no less than 110% of the fair market value of the stock on the date such incentive option is granted.

     During the term of the Plan, we will make automatic grants of options (“Automatic Options”) to each director who is not employed by our company. Each year on the annual grant date, an Automatic Option to acquire 2,000 shares of stock will be granted to each director for as long as shares of stock are available. The “Annual Grant Date” will be the date of our annual stockholders meeting commencing as of the first annual meeting occurring after the effective date. On the initial grant date, every new member of the board that has not previously received an Automatic Option under this plan will be granted an Automatic Option to acquire 5,000 shares of stock for as long as shares of stock are available under this plan. The “Initial Grant Date” will be the date that a director is first appointed or elected to the board. The exercise price per share of stock subject to each Automatic Option granted will be equal to 100 percent of the fair market value per share of the stock on the date such Automatic Option was granted. Each Automatic Option (2,000 shares) granted will vest and become exercisable 12 months after the date of grant. Each Initial Automatic Option (5,000 options) granted will vest and become exercisable in a series of three equal and successive installments with the first installment vested on the date of grant and the next two installments 12 months and 24 months after the date of grant. Each Automatic Option will vest and become exercisable only if the option holder has not ceased serving as a board member as of such vesting date. Each Automatic Option will expire on the tenth anniversary (the “Expiration Date”) of the date on which such Automatic Option was granted.

     There were options outstanding to acquire 375,300 shares of our common stock under the 2004 Incentive Compensation Plan at December 31, 2004.

     Tax benefits from option exercises are credited to additional paid-in capital.

     The following table and narrative summarizes the status of our six stock option plans at December 31, 2002, 2003, and 2004 and changes during the years then ended:

F-24

	2002					2003					2004
				Weighted					Weighted					Weighted
				Average					Average					Average
				Exercise					Exercise					Exercise
	Options			Price		Options			Price		Options			Price
Outstanding at beginning of year		2,086,969		$	14.97		2,890,728		$	12.59		3,033,474		$	8.87
Granted		1,153,699			9.21		497,402			4.65		926,650			4.17
Exercised		(39,183	)		5.35		(24,684	)		4.79		(13,904	)		4.86
Expired or canceled		(310,757	)		16.94		(329,972	)		35.40		(217,391	)		6.74
Outstanding at end of year		2,890,728			12.59		3,033,474			8.87		3,728,829			7.84
Exercisable at end of year		1,042,169		$	11.48		1,648,170		$	9.57		2,154,898		$	9.44
Weighted average fair value of options granted				$	7.29				$	5.05				$	2.79

     The following table summarizes information about stock options outstanding at December 31, 2004:

Options Outstanding							Options Exercisable
	Number		Weighted				Number
	Outstanding		Average		Weighted		Exercisable		Weighted
Range of	at		Remaining		Average		at		Average
Exercise	December 31,		Contractual		Exercise		December 31,		Exercise
Prices	2004		Life		Price		2004		Price
0.00 – 2.00		6,500		9.9	$	1.97		—	$	—
2.01 – 4.00		686,935		5.9		3.48		230,434		3.70
4.01 – 6.00		1,351,927		6.0		4.73		539,978		4.85
6.01 – 8.00		515,086		4.5		6.50		506,428		6.50
8.01 – 10.00		414,786		4.8		9.48		307,423		9.49
10.01 – 15.00		167,181		5.8		11.27		89,816		11.51
15.01 – 17.50		314,589		4.9		15.48		209,869		15.37
17.51 – 20.00		42,450		4.4		18.80		41,575		18.80
20.01 – 30.00		204,625		2.6		22.39		204,625		22.39
30.01 – 100.00		24,750		5.0		41.70		24,750		41.70
		3,728,829		5.4	$	7.84		2,154,898	$	9.44

     In connection with the spin-off, each outstanding TFS option granted prior to the 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 options, and each preserved the ratio of the exercise price to the fair market value of the stock subject to the option.

  401(k) Profit Sharing Plan

     We have adopted a profit sharing plan (401(k) Plan). The 401(k) Plan covers substantially all full-time employees who meet the eligibility requirements and provides for a discretionary profit sharing contribution by us and an employee elective contribution with a discretionary matching provision by our company. We expensed discretionary contributions pursuant to the 401(k) Plan in the amount of $200,000, $187,000, and $427,000 for the years ended December 31, 2002, 2003, and 2004, respectively.

(8) Income Taxes:

     The following table presents the U.S. and international components of income (loss) from continuing operations before income taxes for the years ended December 31 (in thousands):

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Operations Before Income Tax

	December 31,
	2002			2003			2004
United States	$	(12,116	)	$	(18,866	)	$	(52,472	)
International		3,465			(697	)		(2,046	)
Total Pretax Loss from Continuing Operations	$	(8,651	)	$	(19,563	)	$	(54,518	)

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

	2002			2003		2004
Current provision (benefit), net of tax credits utilized:
Federal	$	(2,118	)	$	15	$	(127	)
States		0			0		1
Foreign		486			159		(108	)
		(1,632	)		174		(234	)
Deferred provision (benefit)		(2,289	)		14,164		8
Provision for (benefit from) income taxes	$	(3,921	)	$	14,338	$	(226	)

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

	2003			2004
Net current deferred tax assets:
Uniform capitalization	$	261		$	702
Accrued liabilities and reserves not currently deductible		952			522
Allowance for doubtful accounts		77			205
Valuation allowance		(1,294	)		(1,433	)
Other		134			126
	$	130		$	122

	2003			2004
Net long-term deferred tax (liabilities)/assets:
Accelerated tax depreciation	$	1,332		$	436
Goodwill and Intangibles		(535	)		9,333
Net operation loss and tax credit carryforward		23,303			31,820
Capital loss carryforward		1,288			1,288
Valuation allowance		(25,064	)		(44,183	)
Other		(324	)		1,306
	$	0		$	0

     We currently have $122,000 of short-term deferred tax assets resulting from operations in foreign jurisdictions. SFAS No. 109 requires that a valuation allowance be established when it is more likely than not that all or a portion of a deferred tax asset will not be realized. In determining whether a valuation allowance is required, we must take into account all positive and negative evidence with regard to the utilization of a deferred tax asset, including our past earnings, unsettled circumstances that, if unfavorably resolved, would adversely affect utilization of a deferred tax asset, carryback and carryforward periods, and tax strategies that could potentially enhance the likelihood of realization of a deferred tax asset. SFAS No. 109 further states that it is difficult to conclude that a valuation allowance is not needed when there is negative evidence such as cumulative losses in recent years.

     Cumulative losses weigh heavily in the overall assessment and outweigh our forecasted future profitability and expectation that we will be able to utilize all of our net operating loss carryforwards. As a result, in the third quarter of 2003, we recorded a charge to establish a full valuation allowance against our deferred tax asset and in 2004 we increased our valuation allowance by $19.3 million because we believe it is more likely than not that we will be unable to utilize our U.S. deferred tax assets. We expect to continue to record a full valuation allowance on future tax benefits until we return to profitability. During 2003, our tax expense was $14.3 million as a result of recording a full valuation allowance.

F-26

     Our capital loss carryforward expires in 2006. We have $82 million of federal net operating loss carryforwards that begin to expire in 2022, and $8.7 million of state net operating loss carryforwards that begin to expire in 2006. We have other general business credit carryforwards that begin to expire in 2017.

     In connection with the formation and spin-off of Brillian, Brillian assumed a net deferred tax liability of approximately $1.1 million. This net deferred tax liability is the result of differences between book and tax basis of assets transferred to Brillian. We retained the net operating losses that were generated by Brillian operations before the spin-off.

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

	2002			2003			2004
Statutory federal rate		(34	)%		(34	)%		(34	)%
Effect of state taxes		0			0			0
Foreign earnings taxed at different rate		(16	)		2			1
Other, net		(4	)		0			0
Valuation Allowance		9			105			33
		(45	)%		73	%		0	%

     A deferred U.S. tax liability has not been provided on the undistributed earnings of certain foreign subsidiaries because it is our intent to permanently reinvest such earnings. Undistributed earnings of foreign subsidiaries, which have been, or are intended to be permanently invested in accordance with APB No. 23, Accounting for Income Taxes — Special Areas, aggregated approximately $6.1 million at December 31, 2004. Currently, the Company is under a tax holiday in Penang, Malaysia.

     On October 22, 2004, the American Jobs Creation Act (“the AJCA”) was signed into law. The AJCA includes a deduction of 85% of certain foreign earnings that are repatriated, as defined in the AJCA. We may elect to apply this provision to qualifying earnings repatriations in either the balance of 2005 or in 2006. We have started an evaluation of the effects of the repatriation provision and are currently unable to estimate the potential earnings and related potential impact of any repatriation. We expect to complete our evaluation of the effects of the repatriation provision within a reasonable period of time.

     On March 30, 2005, we announced the sale of our small form factor display business, including 100% of the outstanding shares of Three-Five Systems (Beijing) Co., Ltd. Such sale could result in U.S. taxable income, which would be offset by our net operating loss carryforwards.

(9) Commitments and Contingencies:

  Rent and Lease

     In April 2001, Three-Five Systems Pacific, Inc. began its lease of a build-to-suit factory in Manila. The term of the lease was 125 months. In April 2004, we purchased our facility in Manila from our lessor and paid $3.8 million. We also paid $614,000 to the RBF Development Corporation, or RBF, for a 50-year land right. We executed an agreement with RBF for an option to purchase the leased land for $1 at any time until April 23, 2014. In January 2005, we issued a press release in which we stated that we are exploring opportunities to sell this facility.

     In the fourth quarter of 2004, we moved into a new facility in Redmond and signed a seven-year lease, under which the lessor paid to us $900,000 upon moving into that new facility, in part to offset the costs of the move. We have the option to renew the lease for an incremental five year term. We will offset our lease expense on that new facility by the $900,000 ratably over the term of that lease. In addition, in connection with that move, we moved out of an older, leased facility that had 36 months remaining on the lease. We subleased that building for a monthly amount that was approximately 30% less than the original lease amounts due. As a result, we expensed in the fourth quarter the cumulative loss on that sublease of $382,000. In January of 2005, we moved out of another older facility that had 12 months remaining on the lease. A charge of approximately $197,000 is expected to be

F-27

recorded in the first quarter of 2005 to recognize future costs associated with the continuing lease obligations of this facility.

     In December 2004, we sold our Tempe, Arizona building for approximately $11.3 million, less selling costs of approximately $500,000. At the time of the sale, we entered into an agreement with the buyer to leaseback the entire facility for a period of five years, which extends through December 2009. This facility houses our U.S.-based manufacturing operations and our research, development, engineering, design, and corporate functions. We subleased approximately 56,000 square feet of that Tempe facility to Brillian Corp. for the same five-year period. Brillian pays to us the same lease rate that we pay the lessor on the master lease. If Brillian were to default on its obligation to us, we would still be obligated on the master lease to continue to make payments on the Brillian space.

     Our future lease commitments under all non-cancelable operating leases and expected future rental income for the sublease of facilities as of December 31, 2004 are as follows:

Lease commitments	(Dollars in thousands)
2005	$	4,908
2006		3,623
2007		2,998
2008		2,624
2009		2,643
Thereafter		8,537
	$	25,333

Future Rental Income	(Dollars in thousands)
2005	$	1,002
2006		1,001
2007		1,006
2008		739
2009		739
Thereafter		—
	$	4,487

     Rent expense was approximately $1,783,000, $3,806,000, and $3,047,000 for the years ended December 31, 2002, 2003, and 2004, respectively. We lease part of our Tempe facility to Brillian and received $68,000 for 2003 and $188,000 for 2004, respectively.

Letter of Credit

     In accordance with the terms of the lease for one of our facilities in Redmond, Washington, we have issued an unconditional, sight draft letter of credit in the amount of $600,000 to the landlord. The landlord letter of credit is security for the company’s performance of all of its covenants and obligations under the lease.

Guarantee

     In February 2002, we guaranteed up to $500,000 of the debt of a private start-up company, VoiceViewer Technology, Inc., which is developing microdisplay products. This guarantee was assumed by Brillian Corporation in the spin-off. We have not yet been released from our obligation on the guarantee, so if Brillian is unable to satisfy its obligation, then we are secondarily liable and will be required to pay this guarantee to the lender. As of December 31, 2004, our maximum liability under this guarantee was $327,000. This loan guarantee has a five-year term and matures in January 2007.

Legal Proceedings

     During the fourth quarter of 2003, we reached a settlement of our legal claim against J.D. Edwards for $700,000, which has been recorded as other income.

     We recently filed a complaint against Data International in Arizona requesting a declaratory judgment for breach of contract. Please refer to Note 12, Subsequent Events. We also filed a complaint against Vitelcom, a customer of ours in Spain, for unpaid monies due to us for product sales.

     We are also involved in certain administrative proceedings arising in the normal course of business. In our opinion, the ultimate settlement of these administrative proceedings will not materially impact our financial position or results of operations.

F-28

Derivative Instruments

     We have certain receivables denominated in Chinese Renminibi and certain payable denominations in Japanese Yen. To eliminate our exposure to changes in the U.S. Dollar exchange rate with Chinese Renminibi and Japanese Yen, we may enter into forward contracts to protect our future cash flows. Our forward contracts generally range from one to six months in original maturity.

     In accordance with SFAS No. 133, we designate such forward contracts as cash flow hedges. We account for changes in the fair value of our forward contracts based on changes in the forward exchange rate, with all such changes in fair value reported in other comprehensive income. Amounts in other comprehensive income are reclassified into earnings upon settlement of the forward contract at an amount that will offset the related transaction gain or loss arising from the re-measurement and adjust earnings for the cost of the forward contracts. During 2004, there were no significant gains or losses recognized in earnings for hedge ineffectiveness and we did not discontinue any hedges because it was probable that the original forecasted transaction would not occur. As of December 31, 2004 and 2003, there were no forward contracts outstanding.

(10) Segment Information:

     We offer advanced design and manufacturing services and display products to OEMs. Historically, we focused on display-oriented products, although we have always performed extended manufacturing in conjunction with the display module. In the past two years, we expanded the value-added manufacturing services we provide through several acquisitions. As a result, we now provide printed circuit board assembly, or PCBA, radio frequency, or RF, module assembly, new product introduction, or NPI, box build, and order fulfillment, even in products that do not need displays. In products that do include displays, we specialize in custom and standard display solutions utilizing various display technologies, including liquid crystal displays, or LCDs, organic light emitting diodes, or OLEDs, and cathode ray tubes, or CRTs. The products we manufacture for OEMs are of varying sizes and have varying levels of integration.

     At the end of 2004, we began to review our business performance using two segments, Display and EMS. Within the Display business, our design and manufacturing services include a distinctive competence in display modules and systems and the integration of display modules and systems into other products. The display modules and systems we design and manufacture primarily utilize liquid crystal displays, or LCDs. Those LCDs include small form factor monochrome and color LCDs, including thin film transistor LCDs, or TFTs, as well as large format flat panel monitors. Within the EMS business, we design and/or manufacture electronic printed circuit board assemblies, radio frequency, or RF, modules, display modules and systems, and complete systems for customers in the computing, consumer, industrial, medical, telecommunications, and transportation industries. Corporate costs not allocated to operating segments include administrative costs for the chief executive officer, chief financial officer and investor relations as well as accounting, legal and human resource costs in Tempe, Arizona. Corporate costs in 2002 and 2003 also include costs related to Microdisplays that could not be classified as discontinued operations. The segment information presented below for 2002 and 2003 has been restated to reflect our current business segments presentation. The following results are for our Display and EMS segments and unallocated corporate costs:

F-29

	(Dollars in thousands)
	Display			EMS			Corporate			Total
December 31, 2002
Net Sales	$	82,813		$	3,774		$	—		$	86,587
Gross margin (loss)		7,645			474			(250	)		7,869
Operating income (loss)		(3,387	)		246			(9,086	)		(12,227	)
Amortization expense		200			56			—			256
Goodwill		7,775			27,126			—			34,901
December 31, 2003
Net Sales	$	78,526		$	80,492		$	—		$	159,018
Gross margin (loss)		(1,394	)		5,482			(195	)		3,893
Operating income (loss)		(10,281	)		(34	)		(10,076	)		(20,391	)
Amortization expense		1,375			668			—			2,043
Goodwill		7,773			26,833			—			34,606
December 31, 2004
Net Sales	$	53,106		$	105,841		$	—		$	158,947
Gross margin (loss)		(928	)		(1,134	)		—			(2,062	)
Operating income (loss)		(13,826	)		(31,061	)		(10,041	)		(54,928	)
Amortization expense		1,449			669			—			2,118
Goodwill		7,729			5,715			—			13,444

     In 2002, the Display segment incurred a loss on sale of assets of $4.5 million related to the sale of the LCD line. In 2004, the EMS segment incurred an impairment on goodwill of $21.3 million for the write-off of goodwill associated with the acquisition of ETMA. In 2004, the Display segment incurred an impairment on intangibles of $1.8 million associated with the customer lists acquired during the AVT acquisition.

     We have not disclosed assets, liabilities, cost of property, plant and equipment acquired, and depreciation expense by segment as this information is not reviewed by the chief operating decision maker, is not produced internally and is not practical to prepare.

     We do however track net sales and certain property, plant, equipment, and intangibles by geographic location. Net sales by geographic area are determined based upon the location of the end customer, while long-lived assets are based upon physical location of the assets. The following includes net sales, property, plant and equipment for our designated geographic areas:

	(Dollars in thousands)
	North
	America		Asia		Europe		Total
December 31, 2002
Net sales	$	12,128	$	50,591	$	23,868	$	86,587
Property, plant and equipment		11,641		11,697		7		23,345
December 31, 2003
Net sales	$	85,813	$	32,632	$	40,573	$	159,018
Property, plant and equipment		3,477		21,842		4		25,323
December 31, 2004
Net sales	$	98,841	$	29,310	$	30,796	$	158,947
Property, plant and equipment		5,224		21,489		—		26,713

F-30

     In 2002, 2003 and 2004, our sales were distributed over six major markets: computing, consumer, industrial, medical, telecommunications and transportation. In 2004, 53% of our sales were into the computing market. In 2003, 38% of our sales came from the computing market and 28% came from telecommunications. Our net sales distributed by market was as follows:

Markets	2002			2003			2004
Computing		7	%		38	%		53	%
Consumer		1	%		6	%		11	%
Industrial		5	%		10	%		13	%
Medical		4	%		13	%		10	%
Telecommunications		82	%		28	%		8	%
Transportation		1	%		5	%		5	%

(11) Selected Quarterly Financial Data (Unaudited):

     The following table summarizes the unaudited consolidated quarterly results of operations as reported for 2003 and 2004:

	(Dollars in thousands, except per share amounts)
	Quarters Ended
	2003												2004
	Mar 31			Jun 30			Sep 30			Dec 31			Mar 31			Jun 30			Sep 30			Dec 31
Net sales	$	25,324		$	45,992		$	41,778		$	45,924		$	38,444		$	37,632		$	42,356		$	40,515
Gross profit (loss)		175			1,894			(272	)		2,096			(221	)		(133	)		(146	)		(1,562	)
Loss from continuing operations		(3,197	)		(2,533	)		(24,949	)		(3,222	)		(6,644	)		(6,721	)		(30,750	)		(10,177	)
Loss from discontinued operations		(2,278	)		(2,343	)		(5,931	)		—			—			—			—			—
Net loss		(5,475	)		(4,876	)		(30,880	)		(3,222	)		(6,644	)		(6,721	)		(30,750	)		(10,177	)
Earnings (loss) per common share basic and diluted:
Net loss from continuing operations	$	(0.15	)	$	(0.12	)	$	(1.17	)	$	(0.15	)	$	(0.31	)	$	(0.31	)	$	(1.41	)	$	(0.47	)
Net loss from discontinued operations	$	(0.11	)	$	(0.11	)	$	(0.28	)	$	0.00		$	0.00		$	0.00		$	0.00		$	0.00
Net loss	$	(0.26	)	$	(0.23	)	$	(1.45	)	$	(0.15	)	$	(0.31	)	$	(0.31	)	$	(1.41	)	$	(0.47	)

     The quarter ended September 30, 2003 included a $17.6 million charge to record a tax valuation allowance. The quarter ended December 31, 2003, included $700,000 in other income relating to the J.D. Edwards settlement. The quarter ended September 30, 2004, included a $23.2 million charge related to the impairment of Goodwill and Intangibles.

(12) Subsequent Events:

     We recently announced that we signed a definitive agreement to sell the assets of our small form factor display business to International DisplayWorks, Inc. which is expected to be finalized in April 2005. Revenues from our small form factor display business in 2004 were approximately $28 million.

F-31

     The small form factor display assets to be sold include 100% of the outstanding shares of Three-Five Systems, Beijing, Inc., our China-based display subsidiary, and display-related equipment currently housed at our Manila, Philippines factory. The sale will not include the display monitor business operated out of our Marlborough, Massachusetts facility and our electronic manufacturing services (EMS) business located in Redmond, Washington, Penang, Malaysia, and Manila, Philippines.

     We estimate the total value of the transaction to be in the range of between $11 million and $21 million, which will come from a variety of components. These components include the following:

   •   $8 million in cash to be paid to us at closing;

   •   Up to an estimated $3 million in additional cash to be paid to us over time, based upon inventory consumption and accounts receivable collections ; and

   •   An estimated zero to $9 million in the common stock of International DisplayWorks to be paid to us in May 2006, based on a percentage of the transferred display business revenue for the preceding 12-month period if certain minimum revenue targets are met.

     At closing, International DisplayWorks will assume the obligations of TFS Beijing, including a $2.4 million line of credit it had established with a bank located in China.

     We also recently announced that we had retained SG Cowen & Company to review strategic alternatives aimed at maximizing shareholder value and that we will continue to work with SG Cowen with regard to our large form factor display, EMS, and RF module manufacturing businesses. We are exploring a range of possible alternatives, such as acquisitions, strategic alliances, business combinations, and the sale of a portion or all of the company. We are currently in discussions with multiple potential buyers of the RF business and have received an initial offer from a potential buyer of the EMS business. We indicated that there is no assurance that any business transactions will be effected or what the timing and terms of any such business transactions could be.

     We announced in January 2005 that we are considering selling our Manila manufacturing facility.

     In March 2005, we determined to discontinue our product offerings from Data International which is included in our Display segment. The decision follows the exercise by us of our right to rescind a technology licensing agreement, or TLA, that was entered into during January 2003 with Data International Co, Ltd. Revenues from those products in 2004 were approximately $17 million. The TLA designated us as the exclusive distributor of certain Data International display products in the Americas in return for deferred payments to Data International of $3.9 million. Through the end of 2004, we had paid approximately $2.4 million to Data International, and a final payment of approximately $1.5 million was due in January 2005. We recently determined that certain of the specified Data International display products have been simultaneously available in the United States through a third party and that we had not been provided exclusive distribution rights to the United States market as required by the TLA. Based on that determination, we believe that the TLA was breached, and we are exercising our rights of rescission. We notified Data International in February 2005 that we will not make the final $1.5 million payment to Data International that was due in January 2005. We also asserted damages of at least $2.5 million, plus interest and other expenses, against Data International. We notified Data International that we will off-set our claimed damages against money owed by us to Data International for product purchases. We recently filed a complaint against Data International in Arizona requesting a declaratory judgment for breach of contract.

     In January 2005, we vacated approximately 30,020 square feet in a facility we refer to as Building 2 in Redmond, Washington. We moved all of the operations in that building to our new Building 4. We had 12 months remaining on our lease on Building 2 at the end of January 2005. A charge of approximately $197,000 is expected to be recorded in the first quarter of 2005 to recognize future costs associated with the continuing lease obligation for this vacated facility (Building 2). We have undertaken efforts to sublease this facility. At the end of March 2005, we vacated an additional 32,650 square feet in a facility we refer to as Building 3 in Redmond, Washington. We moved all of the operations in that building to our new Building 4. A charge of approximately $500,000 is

F-32

expected to be recorded in the first quarter of 2005 to recognize future costs associated with the continuing lease obligation for this vacated facility (Building 3). We have undertaken efforts to sublease this facility.

     In February of 2005, we vacated our office space in Swindon, England. A charge of approximately $15,400 was recorded in February 2005 to recognize future costs associated with the continuing lease obligation for this vacated facility. We have undertaken efforts to sublease this facility.

     In January of 2005, we announced that we are moving our corporate headquarters to Redmond, Washington. This move will result in additional expenses in severance costs and moving costs. Although we incurred some severance costs in the first quarter as a result of that announcement, not all of the costs have been identified yet. We also had layoffs in the first quarter as part of moving part of our engineering operations to Beijing.

     In the second quarter of 2004, we entered into a $10.0 million secured revolving line of credit with Silicon Valley Bank, or SVB, which matures on June 25, 2005. Although there are no borrowings under the SVB line as of December 31, 2004, we were in violation of our covenants relating to cash earnings and revenue at the end of 2004. SVB did not declare a default on the line, but we are currently under discussion with the SVB with regard to a re-negotiation of the terms of the line. During this re-negotiation period, SVB has issued a forbearance letter under which we are precluded access to the line at this time. In addition, SVB required us to make a cash deposit in the first quarter of 2005 to secure a $600,000 letter of credit, which SVB had issued to the lessor of our building in Redmond.

F-33

THREE-FIVE SYSTEMS, INC. AND SUBSIDIARIES

SCHEDULE II
VALUATION AND QUALIFYING ACCOUNTS AND RESERVES
For the Years Ended December 31, 2002, 2003 and 2004
(Dollars in thousands)

			Increases
			(Reductions)
	Balance at		Charged to					Balance at
	beginning		Costs and					End of
	of Period		Expenses		Write-offs			Period
Allowance for doubtful accounts and sales returns:
Year ended 12/31/2002	$	228	$	323	$	(64	)	$	487
Year ended 12/31/2003	$	487	$	271	$	(22	)	$	736
Year ended 12/31/2004	$	736	$	212	$	(5	)	$	943
Valuation allowance for deferred taxes:
Year ended 12/31/2002	$	1,299	$	765	$	—		$	2,064
Year ended 12/31/2003	$	2,064	$	24,294	$	—		$	26,358
Year ended 12/31/2004	$	26,358	$	19,258	$	—		$	45,616

S-1

EXHIBIT INDEX

Exhibit
Number		Exhibit
	23.1	Consent of Deloitte & Touche LLP
	31.1	Certification of Chief Executive Officer of the Registrant 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 the Chief Financial Officer of the Registrant pursuant to Rule 13a-14(a) and Rule 15d-14(a), promulgated under the Securities Exchange Act of 1934, as amended.
	32.1	Certification of the Chief Executive Officer of the Registrant pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
	32.2	Certification of the Chief Financial Officer of the Registrant pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.