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SECURITIES AND EXCHANGE COMMISSION

FORM 10-K

For the fiscal year ended December 31, 2002

Commission file number 1-4373

Securities regisered 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 [X] No [   ]

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

     Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2). Yes [X] No [   ]

     The aggregate market value of Common Stock held by nonaffiliates of the registrant (18,004,680 shares) based on the closing price of the registrant’s Common Stock as reported on the New York Stock Exchange on June 28, 2002, was $205,253,352. 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 21, 2003, there were outstanding 21,286,039 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 2003 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, 2002

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PART I

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 2003 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 – Risk Factors.”

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PART I

ITEM 1. BUSINESS

Introduction

     We design and manufacture display modules and display system solutions, develop and manufacture microdisplays, and provide electronic manufacturing services for original equipment manufacturers, or OEMs. Through our Integrated Systems and Display, or ISD, division, we offer a broad range of custom and standard display products and product solutions, including monochrome and color liquid crystal display, or LCD, components and modules, organic light emitting diodes, or OLEDs, cathode ray tubes, or CRTs, and flat panel monitors for use in the end products of OEMs. 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, consumer, and industrial marketplaces. Through this division, we also offer electronic manufacturing services to OEMs, which include advanced engineering support, “designed for” services, automated printed circuit board assembly, in-circuit and functional testing, systems level integration and box build, turn-key packaging, fulfillment services, and turn-key supply chain management services, all of which enable our customers the ability to outsource all stages of product engineering, design, development, materials procurement and management, manufacturing, and testing. Through our Microdisplay division, we offer discrete microdisplay devices through completely integrated microdisplay engine solutions based on our liquid crystal on silicon, or LCoS®, microdisplay technology. Examples of applications for our microdisplay products and services include rear-projector, high-definition, televisions; front-projector multimedia and home theater projectors; and “near-to-eye” or personal display applications, including head-mounted monocular or binocular headsets or viewers for industrial, medical, military, commercial, and consumer applications. We market our services in North America, Europe, and Asia through a direct and representative technical sales force.

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

     Our website is located at www.threefive.com. Through our website, we make available free of charge our annual report on Form 10-K, our proxy statement, our quarterly reports on Form 10-Q, our current reports on Form 8-K, amendments to reports filed under the Securities Exchange Act, and earnings press releases. We also post on our website the charters of our Audit, Compensation, and Nominating/Corporate Governance Committees; our various codes of ethics and any amendments of or waiver to those codes of ethics; and any other corporate governance materials contemplated by SEC and NYSE regulations.

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Industry Overview

Displays

   Display Technology

     Prior to 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 the 1970s 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 becoming more common 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 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.

     An LCD is primarily a reflective type of display. Other display technologies are also available. Recent progress in the development of organic electro-luminescent materials has revived interest in organic light-emitting diodes, or OLEDs. Two classes of electro-luminescent materials have been used in OLED development: small molecules and light-emitting polymers. The advantages promised by OLED technology include the ability to have thin, light-weight displays with low voltage, low power, a wide viewing angle, and a broad color gamut. OLEDs have only recently begun to be manufactured, but there is strong industry interest in OLEDs and a significant level of industry investment in the development of this technology.

   Display Markets

     Displays are becoming a ubiquitous feature in consumer, commercial, and industrial products. OEMs increasingly believe that a display interface is important because it makes products more useful and easier to operate. In addition, 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 LCDs, including both monochrome and color displays, address these requirements for high performance, increased information content, low power, and low cost. In addition, OLED displays are making advances in technology development, cost reduction, and power consumption and are beginning to be used in mobile and other 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 may be more cost-effective, but make it more

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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. We believe that combining the display module with other manufacturing services could be a key differentiator.

     The products that we sell include both standard and custom displays. Applications include displays used in mobile handsets and other communications equipment; business, industrial, and transportation equipment; and computer, consumer, and industrial products. The display technologies that we focus on are LCDs, OLEDs, and CRTs. Historically, our emphasis was on small form factor displays, but we recently acquired a monitor product line with displays ranging up to 21 inches for use in industrial and governmental applications. We estimate that the world-wide market we service for display products was approximately $12 billion in 2002.

Electronic Manufacturing Services

     Historically, OEMs have been fully integrated, performing the engineering and design, new product introduction, assembly and manufacturing, testing, distribution and logistics, and aftermarket support functions for their products. In recent years, however, OEMs have been under intense pressure to reduce costs, focus on core competencies, and reduce supply chain investment. In response, they have increasingly outsourced these functions to electronic manufacturing services, or EMS, companies. By focusing on these functions, we believe that EMS companies have provided OEMs with cost savings, superior technological know-how, and access to more advanced manufacturing processes. These services enable OEMs to concentrate on their core competencies, such as product development, marketing, and sales. As a result of this outsourcing strategy, many OEMs are divesting a significant portion of their manufacturing facilities, and many newer OEMs are choosing to outsource rather than build an internal manufacturing infrastructure.

     Today, the EMS industry consists of companies that provide a broad range of services, including engineering and design, new product introduction, printed circuit board assembly, or PCBA, box build, testing, distribution and logistics, and aftermarket support services for OEMs in the electronics industry. The penetration of EMS companies into the total available market remains low. Technology Forecasters, Inc. estimates that the total cost of goods sold outsourced by OEMs will grow from 18.9% in 2002 to an estimated 24.4% by 2005. As a result, Technology Forecasters, Inc. estimates the EMS industry will grow at 16.6% comparable annually from approximately $92 billion in 2002 to $139 billion in 2005. The trend toward outsourcing by OEMs has continued in the recent economic downturn, as OEMs are under increased pressure to pursue aggressive cost savings.

     In addition, OEMs have continued to move manufacturing programs to lower cost regions and sought EMS providers with a global footprint. As a result, Asia’s share of the global EMS market, as reported by Technology Forecasters, Inc., is estimated to increase from 29% in 2002 to 42% in 2006. We also believe that EMS providers with a global presence will grow faster than the industry average because they can offer multinational OEMs a comprehensive set of outsourced services through a single global manufacturing platform.

     The factors driving OEMs to favor an outsourcing strategy include the following:

•

Reduced Total Production Cost. OEMs must continually reduce costs to remain competitive. EMS companies can manufacture products at a reduced total cost to OEMs because of higher utilization of

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			manufacturing capacity, access to leading-edge manufacturing technologies, superior procurement and inventory management capabilities, and a continual focus on improving supply chain management practices from product design to aftermarket support.
	•		Ability to Focus on Core Competencies. By shifting design, manufacturing, testing, logistics and distribution, and aftermarket support functions to EMS companies, OEMs can focus their resources on their core competencies, including product development, marketing, and sales.
	•		Access to Leading Technologies. OEMs continually seek access to engineering expertise and manufacturing technologies necessary to build their increasingly complex products. OEMs are motivated to work with EMS companies to gain access to their expertise in product design, assembly, manufacturing, and testing technologies, as well as their expertise in global supply chain management and aftermarket support. In addition, EMS companies provide OEMs with access to advanced information systems, enabling OEMs to better monitor and control the global inventory and distribution of their products.
	•		Reduced Supply Chain Investment. Outsourcing to EMS companies allows OEMs to lower their investment in inventory and manufacturing assets and shift more of their fixed costs to variable costs, enabling them to increase their return on assets. As a result, OEMs can react more quickly to changing market conditions and allocate capital to other core activities.
	•		Accelerated Time-to-Market and Time-to-Global Volume. By using EMS companies with capabilities in major global markets, OEMs can expand sales and simultaneously introduce new products worldwide. Once products have been developed, OEMs must quickly reach commercial volume production and distribute their products in all major markets in order to achieve the greatest impact in a competitive market.

Microdisplays

   Industry Background

     Market trends demand high-information content, power-efficient displays with increasing functionality and smaller sizes at low costs. Microdisplays provide a response to those demands. Microdisplays are thumbnail sized, but deliver high-resolution images, including full motion video and computer screen content. The tiny image on a microdisplay is projected onto a screen or other surface for individual or group viewing or is viewed through a magnifying device similar to a viewfinder in portable applications.

     As a result, microdisplays are increasingly used in a wide array of products in established and developing markets. These products include rear projectors, such as large-screen televisions; multimedia front projectors, such as those used in conference room and home theater settings; and various “near-to-eye” industrial, medical, military, commercial, and consumer applications.

     Rear-projection televisions shine a magnified image onto the back of a translucent screen for viewing; multimedia front projectors cast the image produced by a microdisplay on a distant screen; and near-to-eye microdisplay devices produce a virtual image that can be viewed through a magnifying headset or viewer.

   Display Resolution Standards

     The following table sets forth various standard resolutions with pixel count, or the number of dots on a screen, and applications for liquid crystal on silicon microdisplays:

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   Rear-Projector Applications

     The rear-projector market consists primarily of televisions. Substantial growth is anticipated for microdisplays in large-screen, high-resolution televisions and also in new types of large-screen monitors.

     One of the primary drivers in the television market is the conversion to high-definition television, or HDTV. Until now, HDTV has been very slow to emerge, despite government-mandated broadcasting of HDTV resolution, because HDTV sets have been unavailable at costs acceptable to the broad consumer market. It now appears that rear-projection, high-definition televisions using microdisplays will become the primary avenue for delivering large-screen, high-definition televisions at reasonable costs. For smaller screen sizes, it appears that AMLCD-based televisions will become important in the HDTV market.

     Another primary driver in the television market is the worldwide conversion from analog to digital format. This conversion also is being mandated in the United States, Europe, and Asia by governments and government agencies. For example, in the United States, the FCC has mandated that all television transmissions be digital by 2005. The result is that analog televisions that are digital ready are quickly gaining market share over analog-only televisions.

     Within the home electronics market, there is a continuing trend toward larger and higher-resolution video screens for home entertainment systems. These systems are segmented into three categories: high-end home theater; large-screen, rear-projection television; and smaller-screen, direct-view television. Each of these segments is growing rapidly. Consumers are willing to spend more for higher quality entertainment in their homes to support their diverse television, video, Internet, and other digital entertainment needs.

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   Front-Projector Applications

     The front-projector market is a large, well-developed market, with an estimated 1.75 million units shipped worldwide in 2002 and a projected 4 million units to be shipped in 2005. These products, which are typically referred to as audio-visual or multimedia projectors, are generally fixed or portable products used in business applications. There is a trend to developing front projectors that have higher brightness, higher resolution, and reduced size and cost. Concurrently with the movement to large-screen, high-definition televisions is an expansion of the front-projector market to include home theater applications. A new generation of higher resolution front projectors will be required for full HDTV2.

   Near-to-Eye Applications

     The near-to-eye market for microdisplays consists of an established electronic viewfinder market and an emerging high-resolution viewer market. The established market is served by high-volume, low-cost monochrome and color microdisplay viewfinder products, nearly all of which are integrated into camcorders and digital cameras. These viewfinder products are low-resolution devices, typically QVGA.

     In the emerging high-resolution near-to-eye markets, professional applications in the industrial, medical, and military markets have been the first to develop. These markets demand superior image quality and high resolution for image, video, and multimedia applications. Wearable computing, endoscopic surgery, augmented reality systems, and riflescope applications are examples of product categories in this segment. Examples of products emerging in professional and commercial applications include wearable products for enterprise network access, headmounted displays for night vision systems, and viewers for test and measurement systems. As prices for near-to-eye high-resolution microdisplays decline, professional and commercial applications are expected to broaden.

     The consumer market is expected to be by far the largest unit volume microdisplay market. Anticipated initial applications include headmounted display products for video games, portable DVD viewers, and secondary monitors for privately viewing notebook computers. Headmounted microdisplays provide features that are unavailable in current video game products. These features include head tracking and stereo and 3-D vision, which provide superior game immersion and realism. Products currently offered in the headmounted video game market have low resolution and have experienced limited market success. By contrast, liquid crystal on silicon microdisplays offer high resolution and a much improved video game experience.

     The broadband wireless communications market also presents a large opportunity for microdisplays. In the communications market, microdisplay technology is seen as the potential method for delivering high-information content at low cost and with low power consumption for mobile, hand-held communication devices. Timing of the development of the broadband wireless near-to-eye microdisplay market is uncertain and has been curtailed by the limited availability and the high price of broadband wireless services. Nevertheless, many companies have prototype programs underway to assess the use of liquid crystal on silicon microdisplays for portable wireless devices.

   Limitations of Competing Technologies

     Currently, the large-screen, rear-projection television market is being served primarily by incumbent cathode ray tube, or CRT, technology as well as by emerging active matrix polysilicon and digital micro-mirror device, or DMD, technologies. CRTs used in rear-projection televisions utilize three projection devices to create a full motion, full color image. Projection CRTs present resolution, size, weight, cost, and performance issues. Polysilicon microdisplays use a transmissive silicon-based technology. Polysilicon microdisplays are available only from two large Japanese companies. At resolutions above XGA, polysilicon microdisplays generally need special optics and are large and expensive. In addition, the transmissive nature of polysilicon produces an undesirable

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screen door effect on the image. DMD microdisplays, which also are silicon based, are reflective devices containing an array of individually movable micro-mirrors, one for each pixel. DMD microdisplays are a proprietary product of Texas Instruments. DMDs are relatively expensive to manufacture, especially for larger devices with higher resolutions, and the manufacturing facilities involve major capital investments. In addition, DMD microdisplays have image quality issues, particularly related to color depth and video image fidelity.

     Most front projectors currently use either transmissive polysilicon or DMD microdisplays. Use of polysilicon and DMD technologies in the front-projector market has the same limitations as in the rear-projection market. As higher resolution images are demanded by the front-projector market, the limitations of polysilicon and DMD become more severe. Neither polysilicon nor DMD technology is likely to achieve full HDTV2 resolutions at reasonable cost.

     Direct-view displays currently are the primary means of providing information content in portable devices. Delivery of high-information content through a small, direct-view display in a portable device, however, presents difficult technological challenges and human interface issues. As portable products become smaller, their direct-view displays also become smaller, limiting the information content and visual experience offered. Small direct-view displays can offer limited types of data, often involve cumbersome navigation, and usually present information only in black and white. Even if these small displays could present more information content, the user would not have the ability to read the small images, reducing the usefulness of such a display. Larger direct-view displays that can present more information and full-screen content, color, and motion consume battery power quickly, do not offer superior image quality, and are relatively costly.

     The only available microdisplay technologies targeting portable near-to-eye applications are polysilicon and other transmissive silicon technologies, OLED on silicon, and liquid crystal on silicon. Polysilicon and other transmissive silicon technologies have been unable to deliver resolutions at or above SVGA on a cost-effective basis. OLED on silicon is an immature technology with issues related to lifetime, cost, manufacturability, and image quality.

   Liquid Crystal on Silicon Microdisplays

     An increasing number of OEMs are evaluating liquid crystal on silicon microdisplays as an alternative to existing technologies in the projector and near-to-eye markets. In the projector markets, liquid crystal on silicon technology offers significant advantages in terms of resolution, image quality, size, and cost, particularly in larger screen sizes, over CRT, polysilicon, and DMD technologies. For high-resolution color near-to-eye applications, liquid crystal on silicon microdisplays appear to be the only commercially available solution.

     Today, we and several Japanese OEMs are the only significant liquid crystal on silicon microdisplay providers. The market participation of these large Japanese OEMs, which are incorporating liquid crystal on silicon technology in their own high-end products, is expected to spur the market penetration of liquid crystal on silicon microdisplays. Chinese, Taiwanese, and other non-Japanese manufacturers can be expected to consider sources other than the Japanese OEMs, such as us, for liquid crystal on silicon products.

     Stanford Resources projects that the worldwide market for microdisplay components will increase from $688 million in 2001 to $1.9 billion in 2007, a compounded annual growth rate of 19%, with more than 44 million units projected to be shipped in 2007.

Strategy

Integrated Systems and Display (ISD) Strategy

     Our objective in our ISD division is to establish a global electronic manufacturing and engineering organization that supports our position as a global supplier of display solutions and electronic manufacturing services. In both instances, we are focusing on providing both our display products and manufacturing services to OEMs in high-growth segments of the electronics industry. Key elements of our strategy to achieve these objectives include the following:

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   Target Strong Customers in High-Growth Industries

     We identify and target markets 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 markets we serve. Our display modules and solutions are targeted towards wireless communication, data collection, office automation, medical equipment, and other commercial, consumer, and industrial marketplace products. Our electronic manufacturing services business targets the automotive, computer/server, medical monitoring, and Internet security markets. Our broad range of products and services enables us to benefit from cross-marketing on a global and market segment basis.

     Within each industry, we target companies that we believe would benefit from our design and manufacturing services. Targeted customers include mid-level manufacturing companies whose products require display devices and/or advanced turn-key manufacturing services. 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 their products.

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

   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 staff’s 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 complete product life-cycle solutions to our customers beginning with early involvement in their product engineering, design, and new product introduction cycles and continuing through manufacturing, testing, logistics and distribution, and aftermarket support services. 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 embrace diversity as a key element in strengthening our customer relationships.

     We continually attempt to enhance the competitive position of our customers by providing them with innovative, distinctive, and high-quality display products and EMS services 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.

     We intend to continue our efforts to expand our customer base and to provide our customers with additional services. We actively pursue new customers, particularly those in growing and emerging markets that have both volume requirements and require complex solutions. We also evaluate the requirements of our customers and seek to provide them with additional services.

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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 products, including display modules for operational control and information display functions required in the end products of OEMs. Our design processes utilize world class technology and business processes to provide custom or semi-standard solutions for customers’ products in time frames and on cost bases that we believe are substantially shorter and competitive with industry norms. Our market position and insight enables us to continuously develop unique and difficult-to-replicate solutions.

     Until the end of the third quarter of 2001, we operated a 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, in the second quarter of 2002, we agreed to sell the manufacturing equipment of our front-end LCD line and entered into a supply agreement with the buyer under which we purchase our LCD glass on a favorable price basis with flexible but assured manufacturing capacity. 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. We continue to perform back-end and module manufacturing for those and other 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 needs of our customers. We will continue to explore the most advanced and cost-efficient production methods for each product solution.

     With the purchase of ETMA Corporation in December 2002, we substantially increased our ability to provide electronic manufacturing services from our domestic and Asian facilities, whether or not the products include a display component. This acquisition provides us with global “end-to-end” electronic manufacturing solutions for our OEM customers.

   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 and Engineering

     We continually strive to research new technologies and utilize technologies of our strategic partners and suppliers in order to provide services and practical product solutions for our customers. We also conduct an active research and development program designed to

	•		continually improve our products and services and create new products and services;
	•		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.

   Pursue Strategic Acquisitions and Alliances

     We intend to pursue strategic acquisitions, including OEM manufacturing divestitures, and alliances to expand our customer base, to expand our product and service offerings and geographic presence, to address new markets, to enhance our technological capabilities, or to participate in other growth opportunities.

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LCoS Microdisplay Strategy

     Provide Value-Added Customer Services

     We plan to foster strong and long-lasting customer relationships by providing customers with the most advanced microdisplays for their products. We strive to establish strong and long-lasting customer relationships through “customer partnering.” This process involves making our engineering and production staffs seamless extensions of the product design and production departments of our customers, understanding their microdisplay needs, and designing products to meet those needs, both from a performance and cost point of view. We recognize that our microdisplay products enable our customers to deliver a positive user experience and to differentiate their products from those of their competitors. We attempt to enhance the competitive position of our customers by providing them with high-quality microdisplay products on a timely and cost-effective basis that enable them to increase the functionality, reduce the size, lower the cost, and enhance the user experience of their own products. To do so, we work to improve our productivity, to reduce costs, and to speed the delivery of our microdisplay products. We also devote considerable effort to support our customers after the purchase of our microdisplay products.

     Develop Relationships with Leading OEMs

     We seek to develop relationships with leading companies in high-growth markets that have the greatest potential for using microdisplays, both immediately and in the future. We are currently targeting various high-growth markets, including large-screen, high-resolution televisions, multimedia and home entertainment projectors, headsets for video games, and mobile wireless communication devices. In addition, we are targeting specialized markets for industrial, medical, and military applications. We believe our strategy of targeting a wide array of applications in both the projector and near-to-eye markets will enable us to enhance our technology, expand our customer base, and achieve efficiencies of scale.

     Provide Components, Modules, and Subsystems to Meet Customer Needs

     We offer a range of product solutions designed to satisfy varying customer needs in the most efficient manner. For example, certain projector customers demand “plug-and play” light engine systems that can be simply installed as part of their projection systems. Other applications for which we supply subsystem solutions are medical, military, industrial, and consumer applications.

     Maintain Our Technological Leadership

     We plan to utilize our extensive intellectual property portfolio and technological expertise to provide competitive advantages, extend the functionality of our products, and offer innovative products to our customers across multiple market segments. We intend to continue to develop our technology to increase the performance of our products while reducing their size, weight, cost, and power consumption.

     Capitalize on Manufacturing Know-How and Increase Manufacturing Efficiencies

     We seek to emphasize our extensive manufacturing know-how. We utilize our advanced manufacturing line at our Tempe facility with its experienced manufacturing team to produce our microdisplay products. We seek to increase our manufacturing efficiencies, yields, and quality to reduce the cost and to speed the delivery of our products. We stress manufacturing processes, widely available quality materials, and standard products and seek to leverage our participation in both the projection and near-to-eye microdisplay markets.

     Pursue Strategic Relationships and Acquisitions

     We seek strategic relationships to enhance our ability to offer value-added customer solutions, address new markets, gain market share, and maintain technological leadership. We intend to enter into additional strategic relationships with leading companies serving our target markets. We also intend to acquire or make investments in companies that extend our technology and enhance our business and competitive position.

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Products and Services

     We currently sell both established and leading-edge display products, as well as provide global manufacturing outsourcing solutions for display and non-display related products and LCoS microdisplays.

Display Products

     We design and manufacture display modules for use in the end products of OEMs. 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 engineering and development activities focus on display products intended to meet the current and future requirements of our target marketing. 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 engineering and manufacturing services has positioned us to develop unique product solutions for our customers as they seek displays with more information content at lower cost.

     Our display 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.

     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.

     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.

     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 display module. For each display module, we work directly with our customer to develop and produce the design and to manufacture the display module in accordance with the customer’s specifications. We also provide value-added services by assembling additional components onto the display module, such as keypads, bezels, microphones, speakers, light guides, and optics.

     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. In late 2002, we also added OLED display modules through our strategic partnership with OSRAM Opto Semiconductor.

     Through our acquisition of Advanced Video Technologies in the third quarter of 2002, we also design and provide customized and ruggedized, large-sized flat panel, touch screen, and rack mount systems for OEMs. Our offerings include flat panel monitors in a variety of levels of integration from a monitor with an integrated touch screen to a monitor with custom electronic, mechanical, or cosmetic modifications, which will assist customers transitioning from CRTs to flat panel displays. The acquisition enables us to provide customers with complete custom LCD, CRT, and flat panel display solutions.

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     The difficulties in developing a customer’s custom display 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 display 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 display 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 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 in either Manila or Beijing.

     We also have developed our own standard products, which we have designed and outsourced through Asian manufacturing companies. In addition, in January 2003, we entered into an agreement with Data International Co., Ltd. of Taiwan. Under that arrangement, we have become the exclusive channel in the Americas for standard custom LCD products manufactured by Data International. As a result of the addition of the product portfolio of Data International, we believe that we are now able to provide a full spectrum of display products and manufacturing services.

Electronic Manufacturing Services

     We provide integrated design, manufacturing, and supply chain solutions that address all stages of our customers’ product life cycles, including advanced engineering and design, new product introduction and prototyping, global supply chain management, printed circuit board assembly, box build, testing, logistics and distribution, and aftermarket services. We assist our customers in the design and product introduction phases of development to reduce product time-to-market and optimize designs for manufacturing. We obtain competitive component pricing and greater sourcing flexibility for our customers through our supply chain management expertise and our global information systems. We utilize sophisticated assembly and manufacturing techniques in order to provide the complex functionality and small product size that is required by OEMs. We subject our manufactured products to a comprehensive set of tests for quality, functionality, and reliability, including, in most cases, product-specific tests that we often design for our customers. In addition, we assist our customers in packaging and distribution logistics for the final products delivered to their distribution channels or to their end users. We also provide a wide range of aftermarket support, such as repairs, refurbishment, systems upgrades, and spare part manufacturing. By providing these design, engineering, manufacturing, and logistics services, we enable our customers to focus on their core competencies and to enhance their competitiveness by reducing the cost of their products, increasing product performance and functionality, and shortening the time from product conception to product introduction in the marketplace.

     We offer a broad range of integrated services that provide customers with total design, new product introduction, and manufacturing solutions to take a product from initial design through production, testing, distribution, and aftermarket support.

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     Engineering and Design. We offer engineering, design, and related services to assist our customers in designing products for optimal manufacturing and testing. Our design for manufacturability services seeks to achieve defect-free and cost-effective product designs, reduce product development cycles, create high production yields, and establish superior product quality. Our design for testability service focuses on achieving the highest level of in-circuit and functional test coverage prior to product shipment.

     New Product Introduction and Prototyping. We offer technical services that shorten the time it takes our customers to introduce their products into the market and that helps them to optimize the commercial manufacturing of their products. Our integrated approach draws on our engineering, design, supply chain management, prototyping and production manufacturing, quality, and test engineering experience to enable a fast, cost-effective ramp to volume production. We are able to assist our customers with component selection, materials strategies, supply chain development, manufacturing process development, reliability modeling, quality plan development, and test plan implementation.

     Supply Chain Management. Our global supply chain services include materials, logistics, and storage of materials for the manufacturing of goods and deliveries of those goods to our customers. Our supply chain process starts by choosing suppliers that provide high levels of quality, flexibility, competitive prices, and value added delivery programs, all on a global basis to service those needs. We communicate demand to these suppliers in the most automated process available so that we can meet the needs of our customer for swift reaction to change, maximize our inventory velocity and utilization, and create a valued customer-supplier relationship. We have established with our suppliers various delivery mechanisms from supplier delivery vehicles to consolidated shipping containers. These methods vary based on cost and proximity. These suppliers must also meet ongoing reviews for total cost reduction, flexibility, and quality. Our global supply chain provides value to our customers by increasing flexibility, reducing risk, improving time-to-market, and lowering cost.

     Assembly and Manufacturing. We provide turnkey and consigned manufacturing and assembly services. These services include printed circuit board and subsystems assembly, box build, system and subsystem integration, downloading software, and building and configuring the final product.

     Product Testing. We offer in-circuit testing of printed circuit boards and functional testing of subsystems and systems, which contributes significantly to our ability to deliver high-quality products on a consistent basis. We work with our customers to develop product-specific test strategies. Our test capabilities include design for test and manufacturing defect analysis, in-circuit development and implementation, and functional tests. We either custom design test equipment and software ourselves or use test equipment and software provided by our customers. In addition, we provide environmental stress tests to assure reliability.

     Logistics and Distribution. We offer flexible services related to the configuration and shipment of our customers’ products. We perform final product packaging, out-of-box audit, and distribution services for completed products as well as direct order fulfillment. We can deliver final products directly into our customers’ distribution channels and to our customers’ end-users. We believe that these services compliment our comprehensive manufacturing solutions, enabling our customers to be more responsive to changing market demands and to get their products to market more quickly with less total cost.

     Aftermarket Service. We provide a wide range of aftermarket services, including repair, refurbishment, remanufacturing, system upgrades, and spare part manufacturing. These services are supported by specific information systems and testing technologies and can be tailored to meet specific customer requirements.

LCoS Microdisplays

   Introduction

     We develop, manufacture, and market microdisplay products and system solutions utilizing our liquid crystal on silicon, or LCoS, microdisplay technology for a variety of markets. These markets include rear-projector high-definition televisions; front-projector multimedia and home theater projectors; and “near-to-eye” or personal display applications, including head-mounted monocular or binocular headsets or viewers for industrial, medical, military, commercial, and consumer applications. Our LCoS microdisplays consist of a CMOS backplane, liquid crystal layer, and glass packaged for connectivity using highly advanced packaging technologies.

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     The display market continually demands greater information content at reduced prices. We believe that the inherent capability of our LCoS technology provides a cost-effective solution to increased information demands. Our LCoS technology provides high-information content in a small size and at a low cost. As a result, we believe our microdisplay products and system solutions address market trends in those market segments that demand high-information, high-resolution, power-efficient displays with increasing functionality and smaller sizes at low costs.

     There are various types of microdisplay technologies. 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 integrated circuits, which is a highly developed technology, form the basis of these displays, liquid crystal on silicon technology permits a very high-information content, high-performance display in a small size and at a relatively low cost.

   Product Line

     Our microdisplay products include a line of LCoS display imagers and associated application specific integrated circuits, or ASICs, optical modules, and proprietary light engines and reference designs. Our imager products have resolutions and sizes designed for specific market segment applications. The following table sets forth certain information regarding our currently available imagers and our BR1920 imager currently in development.

     In association with the display imagers listed in the table above, we sell a line of ASICs that provide driver, controller, and converter functions in order to deliver a complete imager solution. In addition, our product line includes optical modules and “light engines” that incorporate illumination, prisms, color separators and combiners, and lenses to provide complete display solutions. We sell these complete display solutions as modules for near-to-eye applications and proprietary “light engines” for projector applications. Our microdisplay light engines also allow us to meet the different price points, development times, and resolution requirements for a variety of customer applications. The small microdisplays and precision optics included in our light engines separate light into its three primary colors and then recombine that light to produce brilliantly sharp images that cannot be accurately reproduced by traditional display technology. Our products include development kits and reference designs in order to accelerate time to market for our customers.

   Projector Applications

     We serve several projection markets: the rear-projection, high-definition television market with screen sizes of between 50 and 65 inches and the high-end multimedia and home theater front-projection markets. Additionally, we serve several smaller projection markets, including photo printer, digital cinema, and specialty military applications.

     For projection applications, we offer products with XGA, SXGA, and HDTV1 resolution and are developing products with HDTV2 resolution. We believe our LCoS microdisplays have significant advantages over

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competing technologies in the consumer marketplace in terms of resolution, image quality, size, and cost as well as in terms of manufacturability. In rear-projection televisions, our light engines containing our LCoS microdisplays replace the image-related components in a traditional rear-projection CRT television at approximately one-third the weight and size, while providing better image quality and much higher resolution.

   Near-to-Eye Applications

     We produce products to serve the near-to-eye market, including SVGA imagers, display modules, and reference designs. Our display modules are complete drop-in assemblies that allow customers to focus on end-product design and packaging, because they can use our full color SVGA resolution microdisplay as a drop-in assembly.

     Our near-to-eye products utilize a viewfinder, typically mounted in a headset, and provide image magnification. The image appears to the user with the clarity, size, and resolution of a computer monitor. These products also are compact, lightweight, and highly energy efficient. With high resolution and small size, LCoS microdisplays offer unique advantages to these wearable and portable products. Products based on LCoS microdisplays have long lifetimes and can be made lightweight with low power requirements and display sharp, bright images. Our LCoS microdisplays also withstand wide ambient temperature ranges, a feature which is important for industrial and portable applications. In addition, our associated ASICs enable fast rendering of images, an important attribute for viewing full-motion video.

     To date, our near-to-eye product sales have been concentrated in specific industrial, medical, and military applications. Product shipments have included LCoS microdisplays for monocular and binocular headmounted displays, video telescopes, surgical microscopes, and riflescopes.

     We are developing microdisplays for use in headsets for video games. These microdisplay headset products are designed to provide users with an enhanced video game experience. Like a joystick, our microdisplay headset products will allow users new dimensions of interface with the games and a greater immersion into the game.

     We also are pursuing the development of microdisplay-based monocular or binocular displays for use in various high-information content portable electronic devices, such as mobile handsets, pagers, PDAs, and wireless Internet appliances. Use of microdisplays in these personal display system applications will enable users to view the information delivered by the device at the same resolution as a desktop or notebook computer.

     Another emerging market for LCoS microdisplays is mini-projectors for use with PDAs, notebook computers, and other portable electronics. These mini-projectors beam images onto walls, tabletops, or other surfaces for use by individuals or small groups. Mini-projectors can allow new dimensions to be added to users’ information manipulation and sharing capabilities. Any surface can be turned into a virtual computer monitor using a mini-projector. This small and seemingly simple accessory can turn computers, PDAs, and cell phones into more versatile mobile offices.

Other Business Factors

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. We also have established an extensive network of representatives selling our display solutions products throughout the world. 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 16.8% of net sales in 2001 and 14.9% of net sales in 2002. Our sales to customers in China represented approximately 40.6% of net sales in 2001 and 39.7% of net sales in 2002. Our sales to customers in other foreign countries represented approximately 42.6% of net sales in 2001 and 45.4% of net sales in 2002.

Customers

     Historically, Motorola has been our largest customer. Sales to Motorola, including its subcontractors, accounted for approximately 85.4% of our net sales in 2001 and 76.9% of our net sales in 2002. No customer other than Motorola accounted for more than 10.0% of our net sales in 2001 or 2002. Substantially all of the net sales for Motorola programs in 2001 and 2002 were for mobile handset applications. In 2002, we refocused our strategy on lower volume programs with higher gross margins. As a result, in 2001 and 2002, we received no design wins at Motorola for mobile handset applications. Instead, our design wins with Motorola were in other low-volume applications, such as telematics, which are cellular applications in automobiles. Based on the recent absence of design wins and anticipated ranges of purchases indicated by Motorola, we anticipate that purchases by Motorola from us will be substantially less than prior levels. See Item 1 “Business — Risk Factors — We anticipate significantly lower business volume from our historically largest customer.” In fact, we expect that Motorola will comprise less than 10% of our revenue in 2003.

     In the past, our strategy in our LCD display business involved 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, a significant portion of our net display sales has resulted from services provided to a limited number of customers. We have added an extensive standard product line with our acquisition of AVT and our arrangement with Data International. In addition, we are developing our own line of standard color display products. Therefore, as we have focused more on niche applications with higher selling prices and lower volumes, the breadth of our customer base has increased.

     Customers for our electronic manufacturing services include large multinational and smaller OEMs that have chosen outsourcing as a core manufacturing strategy. We maintain relationships with OEMs in a diverse range of industries, including automotive, computer/server, medical monitoring, and Internet security. We believe we are able to offer these customers an outsourcing solution that involves lower costs than typically would be provided by their internal operations. We seek to differentiate ourselves from our competitors by providing advanced methodologies and capabilities and exceptional customer focus by integrating our services into our customers’ operations. During 2002, we served more than 15 EMS customers.

     We believe that there will be substantial synergy between our display products group and our EMS group, providing us with a unique value proposition for our target markets. The printed circuit board assembly and the display represent a large portion of an OEM’s bill of materials, thus allowing us to offer “one-stop shopping.”

Backlog

     As of December 31, 2002, we had a backlog of orders of approximately $32.0 million. The backlog of orders as of December 31, 2001 was approximately $18.7 million. Our backlog consists of product orders for which confirmed purchase orders have been received and which are scheduled for shipment within 12 months. 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, automated printed circuit board assembly,

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end circuit and functional testing, systems integration and box-build, 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. In addition, we recently acquired ETMA Corporation, which provides us additional manufacturing capabilities for products beyond display modules. Specifically, ETMA provides engineering support, automated printed circuit board assembly, end circuit and functional testing, systems integration and box build, complete supply chain management, and turn-key packaging and fulfillment services.

   Manufacturing Facilities

     We currently conduct manufacturing operations in Tempe, Arizona; Redmond, Washington; Marlboro, Massachusetts; 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, packaging, and automated testing is preformed. We 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. In 2001, we decided to shut down and move our front-end manufacturing LCD line from Arizona to Asia. We now purchase all of our LCDs from third parties although we sometimes purchase partially completed LCDs and complete the back-end operations on those LCDs in Manila. During 2002, we entered into a Cooperative Agreement with a China-based company. Under the agreement, we sold the equipment of our front-end LCD line and established a supply arrangement, providing for favorable LCD glass pricing and flexible yet assured manufacturing capacity.

     We provide aftermarket customization of CRT and LCD monitors in Marlboro, Massachusetts. We operate state-of-the-art manufacturing facilities in Redmond, Washington, Manila, and Beijing. In Manila and Beijing, we assemble displays into modules and perform certain back-end LCD processing operations. In Redmond, Washington, we provide engineering support, automated printed circuit board assembly, in-circuit and functional testing, systems integration and box build, complete supply chain management, and turn-key packaging and fulfillment services.

     Our Manila operations are housed in a custom-designed, built-to-suit manufacturing facility in the Camelray 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 manufactu