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SECURITIES AND EXCHANGE COMMISSION

FORM 10-K

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

For the fiscal year ended December 31, 2001

Commission file number 1-4373

THREE-FIVE SYSTEMS, INC.

(602) 389-8600

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

         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     No  

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

         The aggregate market value of Common Stock held by nonaffiliates of the registrant (18,126,880 shares) based on the closing price of the registrant’s Common Stock as reported on the New York Stock Exchange on March 11, 2002, was $254,863,933. 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 11, 2002, there were outstanding 21,510,463 shares of the registrant’s Common Stock, par value $.01 per share.

Documents Incorporated by Reference

         Portions of the registrant’s definitive Proxy Statement for the 2002 Annual Meeting of Stockholders are incorporated by reference into Part III of this Form 10-K.

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THREE-FIVE SYSTEMS, INC.

ANNUAL REPORT ON FORM 10-K

FOR THE YEAR ENDED DECEMBER 31, 2001

TABLE OF CONTENTS

PART I

PART II

PART III

PART IV

Statement Regarding Forward-Looking Statements

         The statements contained in this report on Form 10-K that are not purely historical are forward-looking statements within the meaning of applicable securities laws. Forward-looking statements include statements regarding our “expectations,” “anticipation,” “intentions,” “beliefs,” or “strategies” regarding the future. Forward-looking statements also include statements regarding revenue, margins, expenses, and earnings analysis for fiscal 2002 and thereafter; technological innovations; future products or product development; our product development strategies; potential acquisitions or strategic alliances; the success of particular product or marketing programs; the amounts of revenue generated as a result of sales to significant customers; and liquidity and anticipated cash needs and availability. All forward-looking statements included in this report are based on information available to us as of the filing date of this report, and we assume no obligation to update any such forward-looking statements. Our actual results could differ materially from the forward-looking statements. Among the factors that could cause actual results to differ materially are the factors discussed in Item 1, “Business - Special Considerations.”

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PART I

ITEM 1.    BUSINESS

Introduction

         We design and manufacture display modules for use in the end products of original equipment manufacturers, or OEMs. We currently specialize in custom liquid crystal display, or LCD, components and technology. We collaborate closely with our customers in providing our design and manufacturing services. Our LCD modules are used in mobile handsets and other wireless communication devices as well as in the data collection, medical electronics, and other commercial and consumer marketplaces. We refer to this business as our direct view display business. In 2001, Motorola was our largest customer. In addition to our direct view display business, we are pursuing the commercialization of our liquid crystal on silicon, or LCoS, microdisplays following substantial research and development over the past several years. We market our services in North America, Europe, and Asia primarily through a direct technical sales force.

Industry Overview

  Liquid Crystal Displays

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

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

         There are two types of LCDs: active matrix and passive matrix. Active matrix LCD displays are relatively complex devices that require manufacturing operations involving very large capital investments. Historically, active matrix LCD displays have been used in larger, high-information content applications, such as laptop computers, but they are beginning to appear in mobile devices, such as cellular handsets and PDAs. Passive matrix LCD displays are less complex and less expensive to manufacture. Currently, passive matrix LCDs are the primary display used in applications such as mobile handsets and PDAs, as well as in office equipment, data collection terminals, point-of-sale equipment, medical devices, transportation instrumentation, and industrial instruments and controls.

  The Custom Mobile LCD Market

         We estimate that the worldwide market that we service for custom passive and small form factor (ten-inch or less diagonal) active matrix LCD modules was approximately $6.6 billion in 2001. This market includes displays used in mobile handsets and other communications equipment; business, industrial and transportation equipment; and computer and consumer products. According to industry resources, the worldwide market for LCDs in mobile handsets was slightly under 400 million units in 2001.

         The increasing complexity and functionality of handheld products, such as wireless computing and communication devices, require OEMs to increase the visual performance and information content of the displays incorporated into their products. At the same time, the market continues to demand that OEMs incorporate displays with reduced power requirements and lower costs. Custom passive LCDs, including both monochrome and color

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displays, address these requirements for high performance, increased information content, low power, and low cost. In addition, active matrix displays are rapidly making advances in cost reduction and power consumption and are beginning to be used in mobile applications.

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

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

  The Emerging Microdisplay Market

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

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

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

         A well-developed front projector market currently exists. These products are typically referred to as audio-visual projectors and are generally fixed or portable products used in business applications. Most front projectors currently use microdisplays that are either transmissive polysilicon or digital micro-mirror devices, also called DMDs. We believe, however, that reflective liquid crystal on silicon technology will provide more information at a lower cost.

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         Emerging market segments are beginning to develop for large, cost-effective, higher-resolution television screens and monitors. Current display technologies for digital and high-definition televisions and computer monitors encounter serious barriers related to cost, resolution, and dimensions when used for high-resolution large screens. Many companies have begun incorporating microdisplays into large, high-resolution screens to enable affordable display solutions. As in the front projection marketplace, we believe that LCoS microdisplays can provide more information at a lower cost as compared with transmissive polysilicon or DMDs.

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

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

The Three-Five Approach

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

         Our custom product solutions provide OEMs with the following benefits:

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

         By eliminating the duplication and overlap of investment and resources, we and our OEM customers are able to work together more economically. We concentrate on the development of our display technologies and their applications to products, while our customers devote time and resources on market development for these products.

         Our historical target market consists of high-end monochrome passive matrix LCD modules of 1/4 VGA (320 x 240 pixels) or less resolution, primarily those having smaller than ten-inch diagonal screen sizes. We do not address low-end LCD display markets, such as watches and calculators. In 2001, we added color passive and active matrix LCD technologies for small display product applications. Our target market for LCoS microdisplays consists of displays of SVGA (800 x 600 pixels) or higher resolution.

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Direct View Display Strategy

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

   Target Leading Customers in High-Growth Industries

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

         Within each industry, we target leading companies that we believe would benefit from our design and manufacturing services. Targeted customers typically are Fortune 1000 manufacturing companies whose products require display devices. Our sales and engineering staffs then attempt to demonstrate the benefits that the potential customer would derive by outsourcing to us the design and production of display devices required in their products. Recently, we have refocused our efforts on high-end products where our advanced technologies, design expertise and response time provide an advantage over more commodity-oriented LCD vendors.

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

   Expand Customer Base

         We intend to continue our efforts to expand our customer base. We also plan to target specialized markets that have both volume requirements and require a more complex display solution. We will continue to seek opportunities in growing and emerging markets, both in the United States and internationally.

   Establish Close Relationships with Customers

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

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

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

         We continually attempt to enhance the competitive position of our customers by providing them with innovative, distinctive, and high-quality display devices on a timely and cost-effective basis. To do so, we work continually to improve our productivity, lower our costs, and speed the delivery of our product solutions. We endeavor to streamline the entire design through delivery process by maintaining an ongoing engineering and manufacturing improvement effort.

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

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   Provide Advanced Custom Design and Manufacturing Services

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

         Until the end of the third quarter of 2001, we operated our highly automated, high-volume LCD manufacturing line in Arizona to produce the majority of our LCDs. In order to enhance cost-effectiveness and take advantage of lower cost manufacturing environments, we made the decision in 2001 to move the LCD line to Asia. We expect that the high-volume LCD line will resume production in Asia later in 2002. Until that time, we are outsourcing all of our LCD glass fabrication. In addition, we have entered into relationships with manufacturers of color LCDs. Under these relationships, we will custom design the color LCD screens for our customers’ unique applications and then outsource the manufacture of these screens.

         Regardless of whether we manufacture or outsource LCD screens, we perform all back-end and module manufacturing for our products. We utilize advanced, flexible manufacturing systems for high-volume module assembly in Manila and Beijing. We believe our manufacturing facilities provide us with a competitive advantage in meeting the custom LCD needs of our customers. We anticipate that our ability to design, prototype, and manufacture customized product solutions will be enhanced by the expansion of our engineering personnel, our increased design capacity, and our ability to meet our LCD requirements. We will continue to explore the most advanced and cost-efficient production methods for each product solution.

   Exceed Customer Requirements Through Speed and Efficiency

         We emphasize innovative design and manufacturing techniques to improve the speed, efficiency, and performance of our design and manufacturing services. This enables our customers to address the pressure to reduce the lead times for market introduction of their products. As part of our development process, we continually improve and modify our design and manufacturing processes, controls, and methodology in an effort to support our customers’ requirements.

   Leverage Research, Development, and Engineering

         We continually strive to develop and acquire new technologies and utilize technological developments in order to provide practical solutions for our customers. We conduct an active research and development program designed to:

	•		continually improve our products and create new products;
	•		increase our efficiency;
	•		reduce our costs;
	•		improve the speed, efficiency, and performance of our design and manufacturing services;
	•		develop new design and manufacturing processes and techniques; and
	•		enhance the quality, cost-effectiveness, and value of our services.

         We plan to expand our research and development efforts through increased expenditures and the hiring of additional personnel to meet the expectations of our customers and to satisfy our goal to design and produce the most advanced product solutions on a timely and cost-effective basis. In addition, we are continuing the development and expansion of existing LCD technologies as well as new technologies, such as polymer light emitting displays. In 2001, we formed a company with DuPont Displays to develop and commercialize OLED technology. Under that arrangement, we will supply design, engineering and module manufacturing services and DuPont Displays will supply OLED screens and development services.

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LCoS Microdisplay Strategy

         Our strategy in LCoS microdisplays is to become a leading worldwide supplier of microdisplays for use in both projection and mobile applications. Key elements of our strategy include the following:

   Develop Leading Customers in Targeted Industries

         We identify industries that we believe have the greatest potential for using microdisplays, both immediately and in the future, and we focus on the leading companies in those industries. We believe that the use of our microdisplays by leading companies will encourage other companies to adopt this new technology. Current targeted industries include large screen televisions, AV projectors, monitors, mobile handsets, and other mobile wireless communication, medical equipment, and other commercial and consumer marketplace products.

   Establish Close Relationships with Customers; Provide Advanced Products and Manufacturing Services

         As in our direct view display business, we seek to establish strong and long-lasting customer relationships through “customer partnering.” This involves aligning our prospects with those of our customers and seeking to make our engineering and production staffs seamless extensions of the product design and production departments of our customers.

         Unlike our direct view display business, however, we are focusing on standard products in microdisplays. We seek to work closely with our customers and potential customers to understand their display needs and then design products that attempt to meet those needs, both from a technological and cost point of view.

         We utilize an advanced manufacturing line in our Tempe facility to manufacture and test LCoS microdisplay imagers. We continue to increase our production personnel and add sophisticated manufacturing equipment to meet expanding capacity requirements. We will continue to explore the most advanced and cost-efficient production methods for each product solution. As part of our development process, we continually improve and modify our design and manufacturing processes, specifications, controls, and methodology in an effort to support our customers’ requirements.

   Continue Research, Development, and Engineering

         We consider microdisplays a new product category that is in the process of starting high-volume manufacturing, but which requires substantial, additional development work. Therefore, we will continue our active research and development program designed to:

	•		continually improve our microdisplay products and create new products;
	•		increase our yields;
	•		reduce our costs;
	•		develop new design, test, and manufacturing processes and techniques; and
	•		enhance the quality, cost-effectiveness, and value of our services.

         We plan to continue our substantial focus on research and development efforts and we may even increase expenditures and hire additional personnel to meet the expectations of our customers and to satisfy our goal of designing and producing the most advanced product solutions on a timely and cost-effective basis. We recently acquired the intellectual property of Zight Corporation. As a result, we will also expand our efforts to enhance the products initially developed by Zight.

Products and Services

         We currently engage in the design and manufacture of direct view display modules, microdisplay imagers, and the development and commercialization of manufacturing technologies for use in various products of OEMs.

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   Direct View Display Business

         Most of our revenue currently results from the sale of custom designed LCD display modules. A manufacturer of a complete system or product requiring a specific type of visual display, such as a mobile handset, medical instrument, business machine, or hand-held data collection device, represents a typical buyer for a custom LCD display module. For each custom display module, we work directly with our customer to develop and produce the original design and to manufacture the display module in accordance with the customer’s specifications. At a minimum, each module includes an LCD, a custom LCD driver, and a flexible connector. We also provide value-added services by assembling additional components onto the module, such as keypads, microphones, speakers, light guides, and optics. In 2001, LCD custom display modules accounted for approximately 95% of our net sales.

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

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

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

   LCoS Microdisplay Business

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

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

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         We believe that the initial markets for our LCoS microdisplay products will be in front projectors, large screen television sets and computer monitors, and near-to-the-eye applications, such as wearable displays. Currently, the front projector, and digital and large screen television markets are being served by active matrix polysilicon microdisplays and DMD microdisplays. Polysilicon microdisplays are manufactured by two large Japanese companies. At resolutions above XGA, these products generally need special optics and are generally larger and more expensive than anticipated costs for LCoS microdisplays. DMD microdisplays are a proprietary product of Texas Instruments. DMDs are relatively expensive to manufacture, especially for larger devices with higher resolutions, and involve a high cost of capital. The expected relatively low cost for LCoS microdisplays makes them more suitable for competitive consumer marketplaces.

         We believe another market for LCoS microdisplay products will be in personal display system applications, such as converged wireless products requiring high-information content displays for e-mail and access to the Internet. Use of an LCoS microdisplay in a personal display system application would enable a person to carry a portable device capable of delivering information at the same SVGA resolution as the person’s desktop or laptop computer. This has the potential to allow portable access to the Internet and critical information, such as calendars, maps, e-mail, and documentation, in a handheld product. The high resolution of the device would avoid scrolling or time-consuming text conversions in accessing the Internet for needed information. Other potential viewfinder applications would be in entertainment and medical devices.

         We plan to offer a range of LCoS product solutions with different levels of integration from individual imagers to fully integrated display systems. In addition, we have been working with optical companies that are interested in developing optical light engines for sale to OEMs that manufacture monitors and televisions. A light engine consists of a projection lens, color management system, illumination systems, including a lamp, and the microdisplays. LCoS microdisplays require different optics than those employed when using transmissive polysilicon microdisplays.

         We have undertaken extensive development efforts in LCoS products, and we expect to incur substantial losses in the microdisplay business until volume production of LCoS microdisplays occurs. We initially expected volume production of LCoS microdisplays to commence in 2001. High-volume production was delayed, however, due to manufacturing and yield issues in our manufacturing line as well as product delays by our customers.

Sales and Marketing

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

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

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         Our sales to customers in North America represented approximately 15.8% of net sales in 2000 and 16.8% of net sales in 2001. Our sales to customers in China represented approximately 38.5% of net sales in 2000 and 40.6% of net sales in 2001. Our sales to customers in other foreign countries represented approximately 45.7% of net sales in 2000 and 42.6% of net sales in 2001.

         We have a representative relationship with Mitsui Co., Ltd. of Tokyo, Japan. Under this relationship, Mitsui markets and sells LCoS microdisplay products in Japan.

Customers

         Our strategy in our direct view display business involves concentrating our efforts on providing design and production services to leading companies in mobile handsets and other wireless communication, data collection, office automation, medical equipment, and other commercial and consumer marketplaces. As a result, we derive our net sales from services provided to a limited number of customers.

         Our largest customer is Motorola. Sales to Motorola, including their subcontractors, accounted for approximately 85.4% of our net sales in 2001 and 86.9% of our net sales in 2000. No customer other than Motorola accounted for more than 10.0% of our net sales in 2000 or 2001. Substantially all of the net sales for Motorola programs in 2001 were for mobile handset applications. In 2001, however, we received no design wins at Motorola for mobile handset applications. Instead, our design wins with Motorola were in other applications, such as telematics, which is cellular applications in automobiles. Motorola has an LCD module allocation process in which it communicates to each vendor the anticipated annual range of purchases. Under that program, it provided an indication that purchases by Motorola from us during 2002 would be substantially less than 2001 levels. See Item 1 “Business — Special Considerations — Motorola accounts for a significant portion of our sales.”

Backlog

         As of December 31, 2001, we had a backlog of orders of approximately $18.7 million. The backlog of orders as of December 31, 2000 was approximately $63.8 million. Our backlog consists of product orders for which confirmed purchase orders have been received and which are scheduled for shipment within 12 months. The lead time for orders was substantially reduced during 2001; in fact, most orders are now given with only a six to eight week lead time. Most orders are subject to rescheduling or cancellation by the customer with limited penalties. Because of the possibility of customer changes in delivery schedules or cancellations and potential delays in product shipments, our backlog as of a particular date may not be indicative of net sales for any succeeding period.

Manufacturing Services, Facilities, and Quality Control

   Manufacturing Services

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

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

  Manufacturing Facilities

         We currently conduct manufacturing operations in Tempe, Arizona; Manila, the Philippines; and Beijing, China.

         Our dedicated LCoS microdisplay production line is at our Arizona facility. The facility consists of 16,000 square feet of Class 100, 1000 and 10,000 clean room areas where wafer scale LCoS processing, core assembly,

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packaging, and automated testing is preformed. We are also completing construction of new clean rooms so that we can perform all manufacturing, packaging, and module assembly for LCoS products at our Arizona facility. Facility personnel include a team of experts ranging from research scientists to specialized engineers with backgrounds in electronics, mechanics, chemistry, physics, and manufacturing. We maintain a wide variety of state-of-the-art testing and quality control equipment at the facility.

         The Arizona facility previously housed a fully automated LCD production facility. We utilized this facility to manufacture high-volume LCD glass panels and to conduct LCD research and development, to produce prototype and pre-production runs of devices for customer approval, to conduct full production runs of low-volume devices, and to develop advanced manufacturing processes that could be applied in Manila and Beijing during full-scale production.

         We made the decision in 2001, however, to move the LCD line, as well as all prototyping activities, to Asia to take advantage of its lower cost manufacturing environment. All prototyping activities are now conducted in Manila and Beijing. We expect that the high-volume LCD line will resume production in Asia later in 2002.

         We conduct high-volume LCD module manufacturing in Manila and Beijing. In January 2001, we moved from our old location in Manila into a custom-designed, built-to-suit manufacturing facility in the Carmelray Industrial Park near Manila in the Philippines. The term of this lease for the factory in Manila is 125 months. This new 65,000 square foot manufacturing and design facility incorporates state-of-the-art manufacturing equipment and a class 10,000 cleanroom environment. This new facility is focused on module manufacturing and is staffed entirely with direct labor employed by us. In addition, the new manufacturing facility has been outfitted with specific tooling and equipment unique to our manufacturing needs. The new facility is located in a special Philippines economic zone (PEZA), which will allow us to take advantage of certain tax benefits. In Manila, we also operate certain back-end LCD functions pursuant to a sub-assembly agreement with Technology Electronic Assembly and Management Pacific Corporation, or TEAM. Those services are performed in TEAM’s buildings, but during 2002 all functions will be transferred to our own Carmelray facility.

         Our Beijing facility is a high-volume display module manufacturing facility similar to our facility in Manila. We own the manufacturing facility in Beijing, which we completed in 1999, and all of the equipment in that facility. In addition, we employ all of the direct and indirect manufacturing employees at the facility, including technicians, supervisors, and engineers.

   Quality Control

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

         Increased global competition has led to increased customer expectations with respect to price, delivery, and quality. Customers often evaluate price in the quotation process and evaluate delivery and quality only after receiving the product. Therefore, many customers preview a company’s quality by viewing the quality systems employed. We have received ISO 9001 and QS 9000 certification of our new Manila manufacturing facility and ISO 9001 certification of our manufacturing facility and corporate headquarters in Tempe, Arizona. ISO and QS are quality standards established by international organizations that attempt to ensure that the processes used in development and production remain consistent. This is accomplished through documentation maintenance, training, and management review of the processes used. Although achieving an ISO or QS certification does not assure that we will obtain future business, it is a factor that enables our customers to recognize that our production processes meet these established, global standards of performance.

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Components and Raw Materials

         Components and raw materials constitute a substantial portion of our product costs. The principal components and raw materials we use in producing our displays consist of LCD glass, silicon wafers (for LCoS microdisplays), application specific integrated circuits, or ASICs, circuit boards, molded plastic parts, lead frames, and packaging materials. Our procurement strategy is to secure alternative sources of supplies for the majority of these materials. Many of these materials, however, must be obtained from foreign suppliers, which subjects us to the risks inherent in obtaining materials from foreign sources, including supply interruptions and currency fluctuations. Our suppliers generally are meeting our requirements, and we believe our strategic supplier alliances have further strengthened our relations with offshore suppliers. We experienced material shortages of ASICs in 1999 and 2000 as a result of the increased worldwide demand for cellular handsets and as a result of supplier issues encountered in the fourth quarter of 2000. These shortages prevented us from meeting customer demand for certain of our products. Similar shortages in the future could have a material adverse effect on our business.

Research, Development, and Engineering

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

         We are also focusing our research and development efforts on new display technologies. We expect that these advanced display technologies will enable us to provide our customers with differentiating products or products that provide higher information content. These new technologies include active addressing, sunlight readable LCDs, color LCDs, plastic LCDs, bi-stable LCDs, graphics and color graphics, organic emitting displays, and pixel-related display technologies. These products may be available for use in custom devices or in standard devices. We have undertaken a significant research and development program and made substantial investments with respect to the development of our LCoS microdisplays. The majority of our available research and development personnel hours was dedicated to LCoS microdisplays in 2001, and we expect that to continue in 2002.

Intellectual Property

         We rely on a variety of intellectual property methods, including patents, trade secrets, trademarks, confidentiality agreements, licensing agreements, and other forms of contractual provisions, to protect and advance our intellectual property. Although our existing LCD display business has not historically depended on intellectual property protection, we are manufacturing more advanced display products for which we are actively seeking intellectual property protection. We have also applied for numerous other process, product, and design patents, all related to display technologies. There can be no assurance that any of these patents will be issued to us.

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

	•		We have filed numerous patents relating to our LCoS microdisplay technology. These patents cover the areas of product design and manufacturing process technology. We have a strong emphasis in this area and expect to continue to file additional disclosures.
	•		In July 1999, we purchased the assets, including all production and test equipment, specialized laboratory equipment, and supporting design documentation and software, of the former Light Valve business unit of National Semiconductor. We also hired several key scientists of that business unit and acquired an exclusive, paid-up, royalty free license on all of the patents and intellectual property related to that business unit. This license covers all intellectual property relating to the processing, packaging, and testing of light valves and the integrated circuits necessary to manufacture and sell both light valves and light engines.
	•		In August 1999, we licensed the microdisplay technology of S-Vision Corporation, a former microdisplay competitor that had recently ceased operations. Under this agreement, we acquired an irrevocable, royalty free, fully paid-up, worldwide license to the intellectual property associated with

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			S-Vision’s digital backplane and optical systems, which provides us rights to manufacture certain microdisplay products and patented optical engines. In addition, S-Vision assigned to us a patent relating to the design and manufacture of microdisplay products.
	•		In January 2002, we purchased the intellectual property of Zight Corporation, a private company that focused on microdisplays for personal display system applications. In addition, we purchased certain key assets of Zight’s at a creditor’s auction and hired six key technical persons formerly employed by Zight.

Competition

         We believe that Philips, Samsung, Seiko-Epson, Hosiden, Optrex, Seiko Instruments, Wintek, and Sharp constitute the principal competitors for our direct view display products. Most of these competitors are large companies that have greater financial, technical, marketing, manufacturing, vertical integration, and personnel resources than we do. Our sales, profitability, and success depend substantially upon our ability to compete with other providers of display modules. We cannot provide assurance that we will continue to be able to compete successfully with these organizations. We currently compete principally on the basis of the technical innovation, engineering service, and performance of our display modules, including their ease of use and reliability, as well as on their cost, timely design, and manufacturing and delivery schedules. Our competitive position could be adversely affected if one or more of our customers determines to design and manufacture their display modules internally or secures them from other parties.

         We believe that Texas Instruments, JVC, Hitachi, Aurora Systems, Epson, and Sony constitute the principal competitors for our microdisplay products. Texas Instruments has developed a product, referred to as a DMD microdisplay, that competes with our LCoS technology. JVC, Hitachi, and Aurora are producing a similar liquid crystal on silicon display based on their own technology. Epson and Sony manufacture transmissive polysilicon, which is a type of microdisplay that can be used in some of the same applications as LCoS microdisplays. Numerous other established and start-up companies are also pursuing similar and related technologies that may compete with our LCoS technology.

Environmental Regulations

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

         In 1991, we received a notice of potential liability at the Barkhamsted-New Hartford Landfill Site (the “Landfill”) in Barkhamsted, Connecticut from the United States Environmental Protection Agency (“EPA”). Fifty-seven other entities received similar letters. In January 1992, we received a 104(e) questionnaire from the EPA which was completed and submitted during 1992. We received verbal notification that we had no further liability in the matter. According to the EPA, groundwater contamination at the site, which includes volatile and semi-volatile organic compounds and low concentrations of metals, constitutes a low-level threat. As a result of previous actions at the site, groundwater is the only medium requiring additional cleanup. All source material and principal threats have been addressed through the landfill capping and related activity completed in 1999. On February 28, 2002, we received notification from the EPA that the EPA believes we are an involved party and indicated that the EPA was seeking to negotiate an agreement with the involved parties to fund the EPA’s chosen remedy of monitored natural attenuation of the groundwater. The EPA indicated that further notification would be made in the next 60 days, which notification will include the names of any other involved parties. We are evaluating our potential liability at the site. The Landfill is a semi-active waste disposal area consisting of 97.84 acres located in Barkhamsted and New Hartford, Connecticut. The Landfill is owned and operated by the Administrative Board of Regional Refuse Disposal and began operating as a landfill in 1974. Industrial wastes were received by the Landfill until 1993, and the Landfill was closed in 1995. The EPA has conducted a Remedial Investigation/Feasibility Study and issued a Proposed Plan to clean up the site.

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Employees

         As of December 31, 2001, we employed a total of 1,500 persons, of whom seven were employed through third-party contracts. Of our direct employees, 233 were employees at our principal U.S. facility in Arizona and U.S. sales offices; 739 were employees at our manufacturing facility in Manila; 516 were employees at our manufacturing facility in Beijing; and five were employees at our Three-Five Systems Limited subsidiary in Swindon, England. We consider our relationship with our employees to be good, and none of our employees currently are represented by a union in collective bargaining with us.

         In 2001, TEAM provided some of the personnel engaged in the back-end assembly of our LCD panels in Manila under a sub-assembly agreement between us and TEAM. As of December 31, 2001, 361 persons performed direct labor operations at the Manila facility through this sub-assembly agreement with TEAM.

Executive Officers

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

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

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

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

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

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

         Robert Harrison has been Vice President of the Direct View Display Group since January of 2001. From July 1999 to December 2000 he was Vice President of Sales and Marketing for the Direct View Display Group. From September 1998 to July 1999 Mr. Harrison was a principal at Harcom International, a display consultant and market research firm. From April 1996 to August 1998 Mr. Harrison was General Manager of the LCD Division of Hyundai Electronics America. He served as Senior Regional Sales Manager for Three-Five Systems from January 1995 to April 1996. Previously, he held positions with Optrex, an LCD manufacturing company, from August 1988 to 1995, including Regional Sales Manager from August 1988 to December 1990 and National Accounts Manager from January 1991 to January 1995.

         Tom Miller has been General Manager of Three-D OLED since July 2001. Previously, he was VP Sales and Marketing for Silicon Motion, Inc., from December 2000 until July 2001. Mr. Miller was a principal partner at Sapiential Prime, a management consulting company to high technology start-ups from April 1998 until December 2000. He was founder and CEO of Quantum 3D, a provider of high-end 3D graphics boards from April 1996 until April 1998. From May 1973 to April 1996, Mr. Miller held a variety of management positions, including Vice President of Marketing for Fujitsu Microelectronics, interim Chairman and CEO of SPARC International, an industry consortium, Chairman and CEO of VIA Technologies, Vice President of Sales and Marketing for Integrated CMOS Systems, and executive positions at Fairchild Semiconductor, NCR Microelectronics and Texas Instruments.

SPECIAL CONSIDERATIONS

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

Motorola accounts for a significant portion of our sales.

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

         Motorola, including its subcontractors, has been our largest customer during each of the last six years. Sales of Motorola products accounted for approximately 85.4% of our net sales in 2001, 86.9% in 2000, 86.1% in 1999, 63.6% in 1998, 34.6% in 1997, and 65.1% in 1996. Substantially all of our sales of Motorola products were for mobile handset applications. During 2001, the three largest of these product programs accounted for a total of 75.8% of our net sales, with the largest program accounting for 57.2% of our net sales.

         A significant decline in sales to Motorola is expected to occur in 2002 primarily as a result of receiving no new design wins in 2001 in its handset business. Further unexpected reductions could also occur at any time. For example, an unexpected reduction in Motorola mobile handset programs reduced our net sales to Motorola from $73.7 million in 1995 to $39.5 million in 1996 and $29.2 million in 1997. Since Motorola has no long-term contractual commitments to purchase any of our products, we could experience similar declines in our net sales at any time. If we do not receive any additional design wins in 2002 in Motorola’s handset business, additional significant declines in sales to Motorola could occur in 2003.

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Our revenue may decline significantly during 2002

         The year 2001 was characterized by a worldwide lack of growth in the handset market and excess LCD capacity. As a result, some OEMs expected LCD modules used in low-end handsets to be sold below industry costs. We have made the strategic decision, however, not to sell our products below standard industry costs. Instead, we are focusing on lower-volume, higher-priced products that utilize our advanced technologies and engineering services. As a result of our strategic decision, however, our volume of unit shipments and, consequently, our revenue, may decline significantly.

Our emerging microdisplay business may not be successful.

         A key element of our current business plan involves the commercialization of our microdisplay technology. The success of this effort depends on numerous factors. As a result, we could be unable to expand our business as we currently anticipate and may make substantial investments in product development, manufacturing, and marketing efforts that may not result in microdisplay sales.

         Manufacturing an LCoS microdisplay involves a significantly different procedure than manufacturing a typical liquid crystal display. Although we added additional equipment to our Arizona manufacturing facility in the last two years for manufacturing LCoS microdisplays, the manufacture of microdisplays will require us to overcome numerous challenges, including the following:

	•		the use of new materials, including silicon;
	•		the modification of equipment and processes to accommodate the round silicon wafers;
	•		the implementation of new manufacturing techniques;
	•		the incorporation of new handling procedures;
	•		the maintenance of cleaner manufacturing environments; and
	•		the ability to master tighter tolerances in the manufacturing process.

         We experienced significant issues in commencing volume production of LCoS microdisplays in 2001, and those issues could continue through 2002. These issues could result in the delay of the full implementation of high-volume LCoS microdisplay production. In addition, we experienced lower than expected manufacturing yields in LCoS microdisplays. Continued lower than expected manufacturing yields could significantly and adversely affect us because of the relatively high cost of the silicon backplanes used in LCoS microdisplays.

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

We face intense competition.

         We serve intensely competitive industries that are characterized by price erosion, rapid technological change, and competition from major domestic and international companies. In 2001, some OEM customers began expecting to purchase LCD modules at prices below industry costs, and many of our competitors agreed to those requests. Continued competition of this kind could result in additional pricing pressures, lower sales, reduced margins, and lower market share.

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         Many of our competitors have greater market recognition, larger customer bases, and substantially greater financial, technical, marketing, distribution, and other resources than we possess. As a result, they may be able to introduce new products and respond to customer requirements more quickly than we can.

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

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

	•		our success in designing and manufacturing new product solutions, including those implementing new technologies;
	•		our ability to address the needs of our customers;
	•		the pricing, quality, performance, reliability, features, ease of use, and diversity of our product solutions;
	•		foreign currency devaluations, especially in Asian currencies, such as the Japanese yen, the Korean won and the Taiwanese dollar, which may cause a foreign competitor’s products to be priced significantly lower than our product solutions;
	•		the quality of our customer services;
	•		our efficiency of production;
	•		the rate at which customers incorporate our product solutions into their own products; and
	•		product or technology introductions by our competitors.

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

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

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

         Our customers, including Motorola, generally do not provide us with firm, long-term volume purchase commitments. In addition, the worldwide adverse economic slowdown in 2001 led to radically shortened lead times on purchase orders. Although we sometimes enter into manufacturing contracts with our customers, these contracts clarify order lead times, inventory risk allocation, and similar matters rather than provide firm, long-term volume purchase commitments. As a result, customers can generally cancel purchase commitments or reduce or delay orders at any time. The cancellation, delay, or reduction of customer commitments could result in our holding excess and obsolete inventory or having unabsorbed manufacturing overhead. The large percentage of our sales to customers in the electronics industry, which is subject to severe competitive pressures, rapid technological change, and product obsolescence, increases our inventory and overhead risks.

         Our operating results have been materially and adversely affected in the past as a result of the failure to obtain anticipated orders and deferrals or cancellations of purchase commitments because of changes in customer

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requirements. For example, we have made announcements in the past that sales would not meet our expectations because of delays in customer programs. This problem was exacerbated in 2001 because of the limited visibility and shortened lead-time of purchase orders from our customers.

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

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

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

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

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