SECURITIES AND EXCHANGE COMMISSION

FORM 10-K

For the fiscal year ended December 31, 2004

Commission file number 1- 4373

THREE-FIVE SYSTEMS, INC.

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 þ No o

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

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

     The aggregate market value of Common Stock held by nonaffiliates of the registrant (17,362,905 shares) based on the closing price of the registrant’s Common Stock as reported on the New York Stock Exchange on June 30, 2004, which was the last business day of the registrant’s most recently completed second fiscal quarter, was $88,550,816. For purposes of this computation, all officers, directors, and 10% beneficial owners of the registrant are deemed to be affiliates. Such determination should not be deemed to be an admission that such officers, directors, or 10% beneficial owners are, in fact, affiliates of the registrant.

     As of March 28, 2005, there were outstanding 21,767,653 shares of the registrant’s Common Stock, par value $.01 per share.

Documents Incorporated by Reference

     Portions of the registrant’s definitive Proxy Statement for the 2005 Annual Meeting of Stockholders are incorporated by reference into Part III of this Form 10-K. If for any reason such statement is not filed within 120 days after the close of the fiscal year ended December 31, 2004, this annual report will be appropriately amended.

THREE-FIVE SYSTEMS, INC.

ANNUAL REPORT ON FORM 10-K

FOR THE YEAR ENDED DECEMBER 31, 2004

TABLE OF CONTENTS

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Statement Regarding Forward-Looking Statements

The statements contained in this report on Form 10-K that are not purely historical are forward-looking statements within the meaning of applicable securities laws. Forward-looking statements include statements regarding our “expectations,” “anticipation,” “intentions,” “beliefs,” or “strategies” regarding the future. Forward-looking statements also include statements regarding revenue, margins, expenses, and earnings analysis for fiscal 2005 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

Overview

     We are a global provider of electronics manufacturing services, or EMS. We design and/or manufacture electronic printed circuit board assemblies, radio frequency, or RF, modules, display modules and systems, and complete systems for customers in the computing, consumer, industrial, medical, telecommunications and transportation industries. Our services include advanced engineering support, “designed for” services, automated printed circuit board assembly, in-circuit and functional testing, systems level integration and box build, 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. Our design and manufacturing services include a distinctive competence in display modules and systems and the integration of display modules and systems into other products. The display modules and systems we design and manufacture primarily utilize liquid crystal displays, or LCDs. Those LCDs include small form factor monochrome and color LCDs, including thin film transistor LCDs, or TFTs, as well as large format flat panel monitors, all of which are TFTs. We refer to the business involving displays as our Display business. All other business, other than the Display business, is referred to herein as the EMS business.

     The products we manufacture for customers are of varying sizes and have varying levels of integration. The typical design program life cycle of a custom-designed product is three to fifteen months and includes technical design, prototyping, pilot manufacturing, and high-volume manufacturing. The cycle is shorter for products in which no display is involved or when the customer has already completed the design.

     Our website is located at www.tfsc.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, any amendments to those reports filed or furnished under the Securities Exchange Act, and our earnings press releases. These reports and press releases are available as soon as reasonably practical after we electronically file them with the Securities and Exchange Commission. We also post on our website the charters of our Audit, Compensation, and Nominating/Corporate Governance Committees; our Corporate Governance Guidelines, Code of Business Conduct and Ethics, and Code of Ethics for the CEO and Senior Financial Officers, and any amendments of or waiver thereto; and any other corporate governance materials contemplated by SEC and NYSE regulations. These documents are also available in print to any stockholder requesting a copy from our corporate secretary at our principal executive offices.

Industry Overview

     Historically, original equipment manufacturers, or OEMs, have been fully integrated, performing the engineering and design, new product introduction, assembly and manufacturing, testing, procurement, 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, OEMs have increasingly outsourced these functions to EMS companies. By focusing on these functions, we believe that EMS companies provide 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 add additional capital equipment and build internal manufacturing infrastructures.

     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 trend toward outsourcing by OEMs has continued in recent years, as OEMs have been 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 global footprints.

     Although EMS industry revenue declined in recent years as a result of significant cutbacks in customer production requirements, industry revenue has slowly begun to increase again over the last year as inventories have declined and customer production requirements generally have begun to stabilize. We believe further growth opportunities exist for EMS providers to penetrate the worldwide electronics markets. We also believe that an EMS

provider with a global presence will grow faster than the industry average because of the ability to 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:

	•	Reduce Operating Costs and Capital Investment. In the current economic environment, OEMs are under significant pressure to reduce manufacturing costs and capital expenditures. EMS companies can provide OEMs with flexible, cost-efficient manufacturing services. In addition, as OEM products have become more technologically advanced, the manufacturing and system test processes have become increasingly automated and complex, requiring significant capital investments. EMS companies enable OEMs to access technologically advanced manufacturing and test equipment and facilities without additional capital expenditures.
	•	Access Global Manufacturing Services. OEMs seek to reduce their manufacturing costs by having EMS companies manufacture their products in the lowest cost locations that are appropriate for their products and end customers. OEMs also are increasingly requiring particular products to be manufactured simultaneously in multiple locations, often near end users, to bring products to market more quickly, reduce shipping and logistics costs, and meet local product content requirements. Global EMS companies are able to satisfy these requirements by capitalizing on their geographically dispersed manufacturing facilities, including those in lower cost regions.
	•	Accelerate Time to Market. OEMs face increasingly short product life cycles resulting from increased competition and rapid technological changes. As a result, OEMs must reduce the time required to bring their products to market. OEMs can bring a product to market faster by using EMS companies’ expertise in new product introduction, including manufacturing design, engineering support, and prototype production. OEMs can more quickly achieve volume production of their products by capitalizing on EMS companies’ manufacturing expertise and global presence and infrastructure.
	•	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 Engineering and Manufacturing Technologies. OEMs continually seek access to engineering expertise and manufacturing technologies necessary to build their increasingly complex products, such as displays, as described below. OEMs are motivated to work with EMS companies to gain access to their expertise in product design, assembly, manufacturing, and testing technologies.
	•	Reduced Supply Chain Investment. Outsourcing to EMS companies allows OEMs to enter into short-term manufacturing contracts and lower their investment in inventory and long-term manufacturing assets, 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.

     As part of our suite of electronics manufacturing services, our expertise in display systems differentiates us from competitors. Displays are a prevalent feature in many OEM products. OEMs increasingly believe that a display interface is important because it makes products more useful and easier to operate. Custom LCDs, including both monochrome and color displays, address requirements for high performance, increased information content, low power, and low cost.

     Custom-designed display modules provide OEMs a cost-effective means to differentiate their products from the products of their competitors. In designing a product, an OEM must determine whether to use standard “off-the-shelf” display modules or a custom display module. OEMs recognize that standard “off-the-shelf” displays may be more cost-effective, but make it more difficult to differentiate their products from those of their competitors.

     Our EMS services include custom display solutions and standard display products. Our focus is on LCD display technologies. Historically, our emphasis was on small form factor displays, but since 2002 we have also offered our customers monitors with large-format displays for use in industrial and governmental applications.

Products and 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, display module assembly, RF module

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assembly, box build, testing, logistics and distribution, and aftermarket services. 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.

     Engineering and Design. We offer engineering, design, and related services for new products and assist our customers in designing products for optimal manufacturing and testing. Our design for manufacturability service 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. Our engineering and development activities also focus on display products intended to meet the requirements of our target markets. 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.

     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 help 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 custom products and deliveries of those products to our customers. Our supply chain process starts by selecting 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 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, display modules and systems, RF modules, box build, system and subsystem integration, downloading software, and building and configuring the final product.

     Display Products. Our services include display products incorporating both monochrome and color LCDs. We utilize inquiries from customers for display products to offer a manufacturing solution for the customer’s entire product. We typically deal with customers seeking custom designed displays that provide unique functionality and differentiation. Our large-format monitor products offer customized solutions for the industrial, human-machine interface, and kiosk markets and integrate various levels of system solutions, including innovative features like wireless interfaces.

     Platform Display Business. In the custom display business in 2004, we also began to devote significant effort to TFT color displays. TFT is the acronym for “thin-film transistor” and is the type of color LCD display typically used in a laptop computer or monitor. Those displays are now becoming prevalent in mobile phone handsets, which is our principal market focus. We refer to the TFT business as “Platform” business because it is not cost effective to create a custom LCD for every product. Instead, we create a platform of semi-custom LCDs and then further customize a module to fit a customer’s unique handset design.

     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.

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     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 at a lower 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.

Other Business Factors

Sales and Marketing

     We achieve worldwide sales coverage through a direct sales force and direct sale representatives that focus on generating new accounts. Program managers are responsible for managing relationships with existing customers and making follow-on sales. Application engineers work with their counterparts at customers to ensure all technical details are addressed. In addition to our sales force, program managers, and application engineers, our executive staff plays an integral role in our sales efforts.

     Our sales to customers in North America represented approximately 54.0% of net sales in 2003 and 62.2% of net sales in 2004. Our sales to customers in Asia represented approximately 20.5% of net sales in 2003 and 18.4% of net sales in 2004. Our sales to customers in Europe represented approximately 25.5% of net sales in 2003 and 19.4% of net sales in 2004.

     Our sales to customers in our EMS business represented approximately 50.6% of net sales in 2003 and 66.6% of net sales in 2004. Our sales to customers in our Display business represented approximately 49.4% of net sales in 2003 and 33.4% of net sales in 2004.

Customers

     Our customers include large multinational and smaller OEMs that have chosen outsourcing as a core manufacturing strategy. We service a diverse range of industries, including medical, industrial, telecommunications, transportation, consumer, and computing. We believe we are able to offer 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. Additionally, we also offer unique expertise in designing and manufacturing display systems and RF modules. We believe that providing display modules as part of our EMS offering provides us with a unique value proposition in 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.”

     In fiscal 2004, our ten largest customers accounted for approximately 71% of our net sales. Our largest customer during fiscal 2004 was Avocent, accounting for approximately 38% of net sales. No other customer accounted for more than 10% of net sales in fiscal 2004.

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     The following table lists in alphabetical order a representative sample of our largest customers in fiscal 2004 and the products of those customers for which we provide manufacturing services:

Backlog

     As of December 31, 2004, we had a backlog of orders of approximately $47.0 million. The backlog of orders as of December 31, 2003 was approximately $46.7 million. Our backlog consists of product orders for which confirmed purchase orders or fixed forecasts have been received and which are scheduled for shipment within 12 months. Orders are typically given with only a six to eight week lead time. Some of our largest customers provide purchase orders of only one week and fixed forecasts beyond the one week. 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.

Components and Raw Materials

     We purchase raw materials and electronic components from manufacturers and distribution companies. The key electronic components we purchase include printed circuit boards, specialized components, such as application-specific integrated circuits, LCD glass, semiconductors, interconnect products, electronic subassemblies (including memory modules, power supply modules, and cable and wire harnesses), inductors, resistors, and capacitors. Along with these electronic components, we also purchase components for use in higher-level assembly and manufacturing. These components include injection-molded plastics, pressure-formed plastics, vacuum-formed plastics, sheet metal fabrications, aluminum extrusions, die castings, and various other hardware and fastener components. These components range from standard to highly customized, and they vary widely in terms of market volatility and price.

     From time to time, allocation of components by suppliers becomes an integral part of the electronics industry, and component shortages can occur with respect to particular components. In response, we actively manage our business in a way to minimize our exposure to materials and component shortages. We create strong supplier alliances to ensure, to the extent possible, a steady flow of components at competitive prices. We have also established and continue to expand our strategic relationships with international purchasing offices, and we attempt to leverage our design position with suppliers.

     Our procurement strategy is to secure alternative supply sources 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 have experienced material shortages in the past. Those shortages prevented us from meeting customer demand for certain services. Similar shortages in the future could have a material adverse effect on our business.

     We attempt to procure components and other raw materials only when a purchase order or forecast is received from a customer. We experience component shortages and longer lead times for various components and raw materials from time to time. We generally have been able to reduce the impact of shortages by working with customers to reschedule deliveries and by working with suppliers to provide the needed components using just-in-time vendor managed or consigned inventory programs.

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Intellectual Property

     We own various service marks, including “Three-Five Systems,” the stylized “TFS”, and our logo. Although we own certain patents, they are not currently material to our business. We do not have any material copyrights.

Information Technology

     We are implementing a multi-year phased roll-out of a new enterprise resource planning, or ERP, platform for certain of our locations. This ERP platform is intended to augment our management information systems and includes software from SAP and several other vendors. The ERP platform is intended to enhance and standardize our ability to translate information globally from production facilities into operational and financial information and to create a consistent set of core business applications at our worldwide facilities, although we will not necessarily convert all of our facilities to the same system. We believe that the related licenses are of a general commercial character on terms customary for these types of agreements. We have invested approximately $2.1 million as of December 31, 2004 for the new ERP platform. In February, this implementation project was put on hold as we evaluate our situation regarding the possible sale of our Manila facility and the move of our corporate headquarters. Our current plan is to restart the implementation in the second half of 2005.

Employees

     We currently employ approximately 1,800 full-time employees. Given the quick response time required by our customers, we seek to maintain flexibility to scale our operations as necessary to maximize efficiency. To do so, we use skilled temporary labor in addition to our full-time employees. None of our employees are covered by union agreements. We have no history of labor disputes at any of our facilities. We believe that our employee relationships are good.

Competition

     We believe Benchmark Electronics, Plexus, Pemstar, Suntron, and other smaller, proximity-based domestic EMS providers constitute our principal competitors. In addition, we believe that AU Optronics Corp., Philips, Samsung, Seiko-Epson, Hosiden, Optrex, Seiko Instruments, International Displayworks, Wintek, and Sharp constitute the principal competitors for our EMS services involving display solutions. We compete primarily on the basis of engineering, design, testing, and production capabilities; our technological know-how; the responsiveness, quality, flexibility, and price of our services; and geographic locations. Many of our competitors have substantially greater manufacturing, financial, and research and development resources than we possess and offer broader geographic operations and a greater range of services than we do. We also face competition from the manufacturing operations of current and potential customers, which continually evaluate the benefits of internal manufacturing versus outsourcing.

Acquisitions and Strategic Ventures

     In September 2002, we purchased the assets and ongoing business of Advanced Video Technologies, a privately held company, located in Marlborough, Massachusetts that specialized in the design and integration of complex, high-resolution display systems. As a result, we now design and provide customized and ruggedized flat panel, touchscreen, and rackmount systems for OEMs in the industrial and medical markets. We outsource display components from a variety of companies, including Sony, Sharp, NEC, LG, and Samsung. The purchase price of the acquisition was $12.0 million, which we paid entirely in cash.

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

     In January 2003, we signed licensing and manufacturing agreements with Data International Co., Ltd. of Taiwan. Under those agreements, we became the exclusive channel in the Americas for LCD products

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manufactured by Data International. We also obtained the right to sell those products through our worldwide channels. In conjunction with the agreement, we established a sales office in Orlando, Florida, and hired sales and applications engineering personnel from a distributor that had previously supported Data International’s products. The cost of the license was $3.9 million, of which $1.0 million was paid upon signing and $2.9 million was a term loan. In the first quarter of 2004, we paid $1.4 million against the term loan. The remaining $1.5 million was due in January 2005, although it was subject to a reduction if certain margin targets were not met. As a result of a dispute with Data International, however, that note has not yet been paid. We recently determined that certain of the specified Data International display products have been simultaneously available in the United States through a third party and that we had not been provided exclusive distribution rights to the United States market as required by the license. Based on that determination, we believe that the license was breached, and we are exercising our rights of rescission. We notified Data International in February 2005 that we will not make the final $1.5 million payment to Data International that was due in January 2005. We also asserted damages of at least $2.5 million, plus interest and other expenses, against Data International. We also notified Data International that we will off-set our claimed damages against money owed by us to Data International for product purchases. We recently filed a complaint against Data International in Arizona requesting a declaratory judgment for breach of contract.

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

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

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

Government Regulation

     Our operations are subject to certain federal, state, and local regulatory requirements relating to environmental, waste management, health, and safety matters. We believe we operate in substantial compliance

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with all applicable requirements. There can be no assurance, however, that material costs and liabilities will not arise from complying with these requirements or from complying with new, modified, or more stringent requirements. In addition, our past, current, or future operations may give rise to claims of exposure by employees or the public or to other claims or liabilities relating to environmental, waste management, or health and safety concerns.

     Our 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.

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. Mr. Saltich serves as the Chairman of the Board of Brillian Corporation, a public company that designs and sells microdisplay products; as a member of the board of directors of Immersion Corporation, a public company that develops, licenses, and markets haptic technology and products; and as a member of the board of directors of Vitex Systems, Inc., a private company that commercializes transparent ultra-barrier films for use in flat panel displays.

     James E. Jurgens has served as Interim Chief Financial Officer of our company since February, 2005. Mr. Jurgens has been working with our company as a consultant since August 2004. From 2001 to 2003, Mr. Jurgens was an Operations Director for Intel Corporation. From 1999 to 2001, Mr. Jurgens was Chief Financial Officer and Operations Director of Ziatech Corporation, a privately held developer of embedded computers for telecom applications. From 1994 to 1999, Mr. Jurgens was Chief Financial Officer/Prokurist and European Finance Director for Advanced Micro Devices GmbH.

     David K. McQuiggan has served as Senior Vice President of Platform Display Products of our company since October 2004. Mr. McQuiggan served as Chief Executive Officer of Densitron Technologies, PLC from 2002 to 2004; General Management of North American Operations from 2000 to 2002; Vice President of Marketing and Business Development from 1998 to 2000; Regional Sales Manager from 1991 to 1996; and a Development Engineer from 1989 to 1991. Prior to joining Densitron Technologies, PLC, Mr. McQuiggan began his career in 1986 with Marconi Avionics.

     Van H. Potter has served as Senior Vice President — Electronic Manufacturing Services since October of 2004. From April through October of 2004, Mr. Potter served as Senior Vice President, Business Groups. Mr. Potter joined TFS as Vice President, Display Products in February 2003. Mr. Potter was Market Development Manager and Project Manager for Rogers Corporation, a manufacturer of specialty polymer composite materials,

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from February 2002 until February 2003. From April 1994 until February 2002, Mr. Potter held a variety of management, marketing, and new business development positions with Durel Corp., a joint venture between Rogers Corporation and 3M Corporation.

     Eric W. Haeussler has been Principal Accounting Officer of our company since May 2004 and Corporate Controller of our company since August 2002. Mr. Haeussler joined our company in October 1990 and served as Cost Accounting Supervisor until September 1996, Cost Accounting Manager from October 1996 until August 2000, and Director of Finance and Assistant Controller from September 2000 until August 2002.

DISCONTINUED OPERATIONS

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

RISK FACTORS

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

We may be delisted from the New York Stock Exchange.

     Our common stock is listed on the New York Stock Exchange. To continue trading on the NYSE, we must meet the NYSE listing maintenance standards. If we are unable to continue to meet the NYSE’s listing maintenance standards, our common stock could be delisted from the NYSE. If our common stock were delisted, we likely would seek to list the common stock on the Nasdaq SmallCap Market, the American Stock Exchange, or on a regional stock exchange. Listing on such other market or exchange could reduce the liquidity for our common stock. If our common stock were not listed on the Nasdaq SmallCap Market or an exchange, trading of our common stock would be conducted in the over-the-counter market on an electronic bulletin board established for unlisted securities or directly through market makers in our common stock. If our common stock were to trade in the over-the-counter market, an investor would find it more difficult to dispose of, or to obtain accurate quotations for the price of, the common stock.

We have received an unqualified report on our consolidated financial statements with an explanation paragraph from our independent registered public accounting firm.

     The report by the independent registered public accounting firm of our company on our consolidated financial statements states that the consolidated financial statements have been prepared assuming that we will continue as a going concern. The report indicates that our recurring losses from operations and difficulties financing future working capital needs raise substantial doubt about our ability to continue as a going concern.

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The majority of our sales come from a small number of customers, and our sales could decline significantly if we lose any of these customers.

     Sales to our ten largest customers have represented a significant percentage of our net sales in recent periods. Our ten largest customers accounted for approximately 71% and 79% of net sales in fiscal 2004 and fiscal 2003, respectively. Our largest customer during fiscal 2004 was Avocent, accounting for approximately 38% of net sales. Our largest customers during fiscal 2003 were Avocent and Vitelcom, accounting for approximately 23% and 13% of net sales, respectively. No other customer accounted for more than 10% of net sales in fiscal 2004 or fiscal 2003.

     Our principal customers have varied from year to year, and our principal customers may not continue to purchase services from us at current levels, if at all. Significant reductions in sales to any of these customers, or the loss of major customers, would seriously harm our business. If we are not able to timely replace expired, canceled, or reduced contracts with new business, our revenue could be harmed.

Our recent history of losses makes financing our working capital and ongoing business needs difficult.

     We have had several years of operating losses and reduced working capital resources. As a result, to fund our operations, we will be required to reduce our expenses significantly or raise additional funds through an offering of debt or equity securities, borrowings from financial institutions, or the sale of assets. We can provide no assurance that these efforts will be successful.

We have key suppliers that could limit our credit.

     Our recent history of losses and liquidity position could result in a lowering or elimination of our credit with key suppliers. In such instance, this could result in a material adverse effect to us including an accelerated depletion of our cash and an inability to timely deliver products to our customers because of our inability to procure raw materials.

Our operating results may be adversely affected by excess inventory.

     We typically purchase components and other materials in anticipation of customer orders based on customer purchase orders or forecasts. For a variety of reasons, such as decreased OEM customer or end-user demand, we may not be able to utilize various components or other supplies that we have purchased in anticipation of customer demand. In such event, we generally attempt to recoup our materials and manufacturing costs by various means, including returning components to our suppliers, disposing of excess inventory through other channels, or attempting to require our OEM customers to purchase or otherwise compensate us for such excess inventory. These efforts, however, may not be successful. To the extent we are unsuccessful in recouping our materials and manufacturing costs, our operating results would be adversely affected and excess inventory would utilize our working capital. Our operating results have been materially and adversely affected in the past as a result of the write-off of excess or obsolete inventory. In 2004, for example, we had expenses of $5.2 million relating to scrap, excess or obsolete inventory.

We must integrate our acquired businesses.

     We recently acquired ETMA Corporation, Unico, and Integrex. Among other things, we have been working through the integration of those businesses. Integration has proved difficult with respect to ETMA and Integrex. We have experienced losses and unexpected charges as a result of the difficulties with those integration efforts. We may not yet have remedied all integration issues, which could result in additional unexpected expenses and charges.

     In addition to business integration risks, substantially expanding our electronics manufacturing services has resulted in various other risks, including the following:

	•	the information technology challenges relating to the integration of disparate worldwide systems;
	•	the ability to procure and install necessary additional equipment;
	•	the ability to hire, train, and manage additional manufacturing personnel;

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	•	production delays, unfavorable manufacturing yields, and lengthening delivery schedules;
	•	the ability to service widespread customers in varied industries;
	•	the need to satisfy increasingly rapid product turnaround time and rapid increases in production levels;
	•	the volume of customer orders relative to our capacity;
	•	the typically short life cycle of our customers’ products;
	•	changes in our sales mix to our customers;
	•	the timing of our expenditures in anticipation of future orders;
	•	our effectiveness in managing manufacturing processes;
	•	changes in cost and availability of labor and components;
	•	changes in economic conditions; and
	•	local events that affect our production volume.

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. We compete against large EMS companies, which have greater market recognition, larger customer bases, and substantially greater financial, technical, marketing, distribution, and other resources than we possess. We compete primarily on the basis of our engineering, design, testing, and production capabilities; our technological know-how; the responsiveness, quality, flexibility, and price of our services; and our geographic locations. Certain sectors of the EMS industry are currently experiencing increased price competition, and a continuation of this increased level of competition would adversely affect our revenue and gross margin. In some cases, our smaller size may mean that we are required to accept less than favorable contractual obligations with larger vendors and customers. We also face competition from the manufacturing operations of current and potential customers, which continually evaluate the benefits of internal manufacturing versus outsourcing.

     Prior to the recent current economic downturn, many participants in the EMS industry, including us, substantially expanded their manufacturing capacity. In the last few years, however, the overall demand for electronics manufacturing services has decreased, resulting in increased capacity and substantial pricing pressures, which have harmed our operating results.

     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 providing design and manufacturing services, and in incorporating new technologies, processes, and product solutions;
	•	our ability to address the needs of our customers;
	•	the quality of our customer services;
	•	our efficiency of production;
	•	product or technology introductions by our competitors;
	•	the pricing, quality, performance, reliability, timeliness, technological sophistication, geographic location, and efficiency of our design and manufacturing services; and
	•	foreign currency devaluations, especially in Asian currencies, such as the Japanese Yen, the Korean Won, and the Taiwanese Dollar, which may cause foreign competitors’ products to be priced significantly lower than our product solutions.

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

     OEMs make the determination during their product development programs whether to utilize our services or pursue other alternatives. This requires us to make significant investments of time and capital well before our customers introduce their products utilizing our services and before we can be sure that we will generate any significant revenue from our customers or even recover our investment.

     During a customer’s entire product development process, we face the risk that our services will fail to meet our customer’s technical, performance, or cost requirements or will be replaced by an alternative solution. Even if we provide our services 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 commitments from our customers.

     Our customers generally do not provide us with firm, long-term volume commitments. In addition, worldwide economic conditions have led to substantially 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 commitments. As a result, customers can generally cancel commitments or reduce or delay orders at any time. The cancellation, delay, or reduction of customer commitments could result in reduced revenue and in our holding excess and obsolete inventory or having unabsorbed manufacturing capacity. The large percentage of our revenue from customers in the electronics industry, which is subject to severe competitive pressures, rapid technological change, and product obsolescence, increases our inventory and overhead risks.

     In addition, we make significant decisions, including determining the levels of business that we will seek or accept, production schedules, component procurement commitments, facility requirements, personnel needs, and other resource requirements, based on our estimates of customer requirements. The short-term nature of our customers’ commitments and the possibility of rapid changes in demand for their products reduce our ability to estimate accurately the future requirements of those customers. Because many of our costs and operating expenses are relatively fixed, a reduction in customer demand can harm our gross margins and operating results.

     On occasion, customers may require rapid increases in production, which can stress our resources and reduce operating margins. We may not have sufficient capacity at any given time to meet all of our customers’ demands or to meet the requirements of a specific project.

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

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

     In most instances, we do not provide services to end users. 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;

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	•	our ability to match our design and manufacturing capacity with customer demand and to maintain satisfactory delivery schedules;
	•	customer order patterns, changes in order mix, and the level and timing of orders placed by customers that we can complete in a quarter; and
	•	the cyclical nature of the industries and markets we serve.

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

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

     We rely on a limited number of suppliers for many components used in our manufacturing and assembly processes. We especially depend on a small number of strategic suppliers for key components such as LCD glass and drivers. We do not have any long-term supply agreements. At various times, there have been shortages of some of the key electronic components. Our inability to obtain sufficient quantities of components and other materials to support our electronics manufacturing services could result in reduced, delayed, or lost orders, increased inventory, and underutilized manufacturing capacity. Any reduction, delay, or loss of customer orders could adversely impact our operating results. In addition, we may not be able to pass on component and materials price increases to our customers, particularly in the case of turnkey manufacturing agreements. We obtain many of the materials we use from a limited number of foreign suppliers, particularly suppliers located in Asia. As a result, we are subject to increased costs, supply interruptions, and difficulties in obtaining materials. Our customers also may encounter difficulties or increased costs in obtaining from others the materials necessary to produce their products into which our product solutions are incorporated.

Our revenue and gross margins depend upon our ability to utilize our manufacturing capacity.

     Our revenue and gross margins depend to a great extent upon our ability to utilize our manufacturing capacity. We must balance the need to maintain manufacturing capacity to fulfill new customers’ orders while maintaining sufficient utilization of our manufacturing capacity to cover our fixed overhead expenses. Like most EMS companies under current market conditions, we have underutilized manufacturing capacity. As a result, we are considering the sale of our operations in Manila. There is no assurance that this sale will resolve our overcapacity issues or that we will not experience difficulties in satisfying any significant additional customer demand for our manufacturing services.

We must maintain satisfactory manufacturing yields and capacity.

     Our inability to maintain high levels of productivity or satisfactory delivery schedules at our manufacturing facilities would adversely affect our operating results. The design and manufacture of electronic devices are highly complex processes that are sensitive to a wide variety of factors, including the level of contaminants in the manufacturing environment, impurities in the materials used, and the performance of personnel and equipment. These problems could be heightened by moving the manufacturing of products to different facilities. As is typical in the EMS industry, at times we have experienced lower than anticipated manufacturing yields and lengthening of delivery schedules.

     Any problems with our manufacturing operations could result in the lengthening of our delivery schedules, reductions in the quality or performance of our design and manufacturing services, and reduced customer satisfaction.

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Products we manufacture may contain design or manufacturing defects, which could result in reduced demand for our services and liability claims against us.

     We manufacture products to our customers’ specifications, which are highly complex and may at times contain design or manufacturing errors or failures. Any defects in the products we manufacture, or in the products we purchase, whether caused by a design, manufacturing, or component failure or error, may result in delayed services to customers or reduced or cancelled customer orders. If these defects occur in large quantities or too frequently, our business reputation also may be impaired. In addition, these defects may result in liability claims against us.

Our inability to maintain our technological expertise in design and manufacturing processes would adversely affect our competitive condition.

     Our success depends on our ability to develop and provide design and manufacturing services that meet the changing needs of our customers. This requires us to anticipate and respond to technological changes in design and manufacturing processes in a cost-effective and timely manner. To achieve this goal, we continually evaluate the advantages and feasibility of new product design and manufacturing processes. We cannot assure that we will be successful.

We are exposed to intangible asset impairment.

     In 2004, we recorded charges of $23.1 million for impairment of goodwill and customer lists, leaving $13.4 million of goodwill and $0.6 million of customer lists assets on our balance sheet at the end of 2004. These intangible assets are attributable to acquisitions and represent the difference between the purchase price paid for the acquired businesses and the fair value of net tangible assets of the acquired businesses. We are required to evaluate goodwill for impairment on at least an annual basis, and other intangibles whenever changes in circumstances indicate that the carrying amount may not be recoverable from estimated future cash flows. As a result of our annual and other periodic evaluations, we may determine that these remaining intangible asset values should be written down to their fair values, which could result in material charges that could be adverse to our operating results and financial position.

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

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

We have risks associated with our real property in China.

     We own our manufacturing facility in China. That facility is situated on land of which we are the sole and exclusive holder of the land use rights certificate approved and issued by the Natural Resources Administration Bureau of the local jurisdiction in which the property is located. The certificate provides for a land use rights term of 50 years until approximately 2048. After issuance of that certificate, we subsequently learned that the approval may have not been consistent with relevant law in China because a higher level land bureau had not approved the grant. Although the relevant authorities have indicated a likely favorable resolution with regard to this issue, a risk exists as to the ownership of the land and whether any penalties may be owed as a result of this issue.

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We face risks associated with international operations.

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

	•	management of a multi-national organization;
	•	compliance with local laws and regulatory requirements as well as changes in those laws and requirements;
	•	imposition of restrictions on currency conversion or the transfer of funds;
	•	the possibility of appropriation of our assets without just compensation;
	•	transportation delays or interruptions and other effects of less developed infrastructures;
	•	foreign exchange rate fluctuations;
	•	limitations on imports and exports;
	•	difficulties in staffing and managing foreign personnel and diverse cultures;
	•	employment and severance issues;
	•	overlap of tax issues;
	•	tariffs and duties;
	•	possible employee turnover or labor unrest;
	•	the burdens and costs of compliance with a variety of foreign laws; and
	•	political or economic instability in countries in which we conduct business, including possible terrorist acts.

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

We face risks associated with international trade and currency exchange.

     Political and economic conditions abroad may adversely affect our foreign manufacturing and sales operations. Protectionist trade legislation in either the United States or foreign countries, such as a change in the current tariff structures, export or import compliance laws, or other trade policies, could adversely affect our ability to provide design and manufacturing services in foreign markets or for foreign customers and to purchase materials or equipment from foreign suppliers.

     While we transact business predominantly in U.S. Dollars and bill and collect most of our sales in U.S. Dollars, we collect a portion of our revenue in non-U.S. currencies, such as the Chinese Renminbi. In the future, customers increasingly may make payments in non-U.S. currencies, such as the Euro. In addition, we account for a portion of our costs, such as payroll, rent, and indirect operating costs, in non-U.S. currencies, including Philippine Pesos, British Pounds Sterling, Malaysian Ringgit, and Chinese Renminbi.

     Fluctuations in foreign currency exchange rates could affect our cost of goods and operating margins and could result in exchange losses. In addition, currency devaluation can result in a loss to us if we hold deposits of that currency. Hedging foreign currencies can be difficult, especially if the currency is not freely traded. We cannot predict the impact of future exchange rate fluctuations on our operating results.

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     The risks described above are particularly important since sales outside North America represented 37.8% of our net sales in 2004 and 46.0% of our net sales in 2003. Sales in foreign markets, primarily Europe and Asia, to OEMs based in the United States accounted for almost all of our international sales in both of these periods.

Our operating results have significant fluctuations.

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

	•	the timing of customer orders;
	•	the volume of customer orders relative to our capacity;
	•	changes in economic conditions generally or in our customers’ markets;
	•	product introductions and market acceptance of new products or new generations of products by customers and their competitors;
	•	evolution in the life cycles of customers’ products;
	•	timing of expenditures in anticipation of future customer orders;
	•	ability to manage inventory and inventory obsolescence;
	•	effectiveness in managing manufacturing processes and costs;
	•	changes in cost and availability of labor and components;
	•	product mix or our customers’ orders;
	•	pricing and other competitive pressures; and
	•	changes or anticipated changes in economic conditions.

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

We depend on key personnel.

     We depend on the efforts and abilities of our senior management and technical personnel. The competition for qualified management and technical personnel is intense. The loss of services of one or more of our key employees or the inability to add key personnel could have a material adverse effect on us. Although we maintain non-competition and nondisclosure covenants with certain key personnel, we do not have any fixed-term agreements with, or key person life insurance covering, any officer or employee. We have announced that we are moving our corporate headquarters in 2005 from Tempe, Arizona to Redmond, Washington. Most of our finance staff will be replaced in the move. This change in staff may result in delayed financial reporting and other related issues during the course of the move. The move may also adversely affect our internal control over financial reporting.

Potential strategic alliances may not achieve their objectives.

     We have entered into various strategic alliances, and we plan on entering into other similar types of alliances in the future. Among other matters, we will explore strategic alliances designed to enhance or complement our technology or to work in conjunction with our technology; to increase our manufacturing capacity; to provide necessary know-how, components, or supplies; and to develop, introduce, and distribute products and services utilizing our technology and know-how. Any strategic alliances may not achieve their strategic objectives, and parties to our strategic alliances may not perform as contemplated.

The market price of our common stock may be volatile.

     The market price of our common stock has been extremely volatile. Our stock price increased dramatically during the three-year period ended December 31, 1994, but declined significantly during 1995 and 1996. Our stock

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price increased again during 1997, but declined significantly in 1998. Our stock price again increased significantly during 1999 and in early 2000, but suffered a major decline in the second half of 2000 and again in 2001 and 2002. It declined significantly again in the last half of 2004 and to date in 2005.

     The trading price of our common stock in the future could continue to be subject to wide fluctuations in response to various factors, including the following:

	•	variations in our quarterly operating results;
	•	announcements about the prospects or financial performance of the industries or customers we serve;
	•	changes in analysts’ estimates of our financial performance;
	•	failure to meet performance estimates of securities analysts;
	•	general conditions in the electronics industry; and
	•	worldwide economic and financial conditions.

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

Adverse trends in the electronics industry may adversely affect our operating results.

     The electronics manufacturing services industry is impacted by the state of the electronics industry, general U.S. and global economic conditions, and worldwide events. A continued slowdown in the U.S. or global economies or the particular industries served by us may result in customers reducing orders. Our revenue may be adversely impacted by the slowdown in the worldwide electronics markets, which have been subject to reduced end-market demand and reduced capital spending.

     Our business also depends on the electronics industry in general, which is subject to rapid technological change, short product life cycles, and margin pressures. In addition, the electronics industry historically has been cyclical and subject to significant downturns characterized by diminished product demand, accelerated erosion of average selling prices, and production over-capacity. We seek to reduce our exposure to industry downturns and cyclicality by providing design and production services for leading companies in a variety of rapidly expanding segments of the electronics industry. Despite these efforts, economic conditions affecting the electronics industry in general or our major customers may adversely affect our operating results.

We could be required to expend substantial resources to comply with governmental regulations.

     Our operations are subject to certain federal, state, and local regulatory requirements relating to environmental, waste management, health, and safety matters. As a publicly traded company in the United States, we are also subject to federal and state governance and internal control requirements as well as to the New York Stock Exchange listing requirements. We believe we operate in substantial compliance with all applicable requirements. There can be no assurance, however, that material costs and liabilities will not arise from complying with these or from new, modified, or more stringent requirements. In addition, our past, current, or future operations, including any operations we have acquired, may give rise to claims of exposure by employees or the public or to other claims or liabilities relating to environmental, waste management, or health and safety concerns. The costs of complying with all regulatory requirements may be material when compared to our revenue.

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Change in control provisions may adversely affect existing stockholders.

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

     We have also adopted a stockholders’ rights plan intended to encourage anyone seeking to acquire our company to negotiate with our board of directors prior to attempting a takeover. While the plan was designed to guard against coercive or unfair tactics to gain control of our company, the plan may have the effect of making more difficult or delaying any attempts by others to obtain control of our company.

We do not pay cash dividends.

     We have never paid any cash dividends on our common stock and do not anticipate that we will pay cash dividends in the foreseeable future.

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

     Not applicable.

PART II

     Our common stock has been listed on the New York Stock Exchange under the symbol “TFS” since December 29, 1994. The following table sets forth the quarterly high and low sales prices of our common stock as reported on the New York Stock Exchange for the periods indicated:

     As of March 28, 2005, there were approximately 565 holders of record of our common stock. The closing sale price of our common stock on the New York Stock Exchange on March 28, 2005 was $0.89 per share.

     Our policy is to retain earnings to provide funds for the operation and expansion of our business. We have never paid cash dividends on our common stock and do not anticipate that we will do so in the foreseeable future.

     The selected historical financial data presented below are derived from our consolidated financial statements. The balance sheet data as of December 31, 2003, and 2004 and statements of operations data for the fiscal years ended December 31, 2002, 2003, and 2004 were derived from the consolidated financial statements and notes included elsewhere in this report that have been audited by Deloitte & Touche LLP, independent registered

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public accounting firm. The selected financial data should be read in conjunction with Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the Consolidated Financial Statements and the Notes thereto included elsewhere in this report.

Overview

     We are a global provider of electronics manufacturing services, or EMS. We design and/or manufacture electronic printed circuit board assemblies, radio frequency, or RF, modules, display modules and systems, and complete systems for customers in the computing, consumer, industrial, medical, telecommunications, and transportation industries. Our services include advanced engineering support, “designed for” services, automated printed circuit board assembly, in-circuit and functional testing, systems level integration and box build, and turn-key supply chain management services, all of which enable our customers the ability to outsource all stages of

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product engineering, design, development, materials procurement and management, manufacturing, and testing. Our design and manufacturing services include a distinctive competence in display modules and systems and the integration of display modules and systems into other products. The display modules and systems we design and manufacture primarily utilize liquid crystal displays, or LCDs. Those LCDs include small form factor monochrome and color LCDs, including thin film transistor LCDs, or TFTs, as well as large format flat panel monitors, all of which are TFTs. We refer to the business involving displays as our Display business. All other business other than the Display business is referred to herein as the EMS business.

     The products we manufacture for customers are of varying sizes and have varying levels of integration. The typical design program life cycle of a custom-designed product is three to fifteen months and includes technical design, prototyping, pilot manufacturing, and high-volume manufacturing. The cycle is shorter in products where no display is involved and/or where the customer has already completed the design.

     Several factors impact our gross margins, including manufacturing efficiencies, product mix, product differentiation, product uniqueness, inventory management, and volume pricing. We have factories in Washington and Massachusetts in the United States and in the Philippines, Malaysia, and China. In Washington and in Malaysia, we provide engineering support, automated printed circuit board assembly, in-circuit and functional testing, systems integration and box build, complete supply chain management, and turnkey packaging and fulfillment services. In Massachusetts, we provide aftermarket customization of flat panel displays. In China, we primarily assemble displays into modules. In the Philippines, we assemble and test RF modules. We recently announced that we are exploring the potential sale of our Philippines facility.

     Selling, general, and administrative expense consists principally of administrative and selling costs; salaries, commissions, and benefits to personnel; and related facility costs. In general, these costs have risen as a result of the acquisitions we have completed in the last two years and from increased costs related to complying with the Sarbanes-Oxley Act of 2002. We make substantially all of our sales directly to customers through a sales force that consists mainly of direct technical sales persons, but also includes a small representative network. As a result, there is no material cost of distribution in our selling, general, and administrative expense.

     Research, development, and engineering expense consists principally of salaries and benefits to design engineers and other technical personnel, related facility costs, process development costs, and various expenses for projects, including new product development. In general, these costs have declined in the last few years because we no longer conduct pure research work. Thus, most of our expense relates to the development engineering costs associated with preproduction design and prototyping of custom products and the conceptual formulation and design of potential standard display products. We have moved most of our engineering resources to Asia, resulting in lower costs.

     We also incur expenses related to the amortization of intangibles as described below.

   Historic Operations

     Prior to 2002, our business strategy was to seek large-volume display programs from major original equipment manufacturers, or OEMs, typically 100,000 units per year or higher, with selling prices of approximately $7 per unit. Although our focus was designing and manufacturing display modules, we often engaged in extended contract manufacturing services for other items related to the display modules, such as printed circuit boards, keyboards, microphones, speakers, plastic housings, and other similar components. We also manufactured liquid crystal display glass cells from 1995 to 2002. In 2001, new monochrome design wins in that business became unprofitable; thus, we began to refocus our strategy to expand our customer base and our product and service offerings. We further modified our strategy in late 2002 to expand our manufacturing services to include products that do not need displays.

     As a result of the foregoing, we have substantially changed our business since late in 2002. The selling price of the products we manufacture now ranges from below $10 to as high as $8,000 per unit. We have numerous customers in six principal markets. We have expanded our capabilities organically, such as moving into the color display business, and through the acquisitions of AVT, ETMA, and Unico. We have also expanded our capabilities through the license arrangement with Integrex and through our manufacturing agreement with Microtune.

     The substantial shift in our business strategy has resulted in increased selling and administrative costs. By previously focusing primarily on one market and one customer, we were able to maintain selling, general, and

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administrative costs at a very low level. By contrast, we now have many more customers requiring more sales interface. In addition, administrative costs have increased as we have increased the number of operating locations in the United States and around the world. In addition, as a result of the Sarbanes-Oxley Act of 2002, we have incurred additional administrative expenses, such as additional auditing fees and the costs related to the establishment of an internal auditing function. In addition, the shift in sales strategy from a high-volume focus to a more value-add focus has resulted in reduced volumes at higher selling prices. The reduced volumes have resulted in excess capacity at our factories overseas.

  Acquisitions and Strategic Transactions

     In September 2002, we purchased the assets and ongoing business of Advanced Video Technologies, a privately held company, located in Marlborough, Massachusetts, that specializes in the design and integration of complex, high-resolution display systems. As a result, we now design and provide customized and ruggedized flat panel, touchscreen, and rackmount systems for OEMs in the industrial and medical markets. We outsource display components from a variety of companies, including Sony, Sharp, NEC, LG, and Samsung. The purchase price of the acquisition was $12.0 million, which we paid entirely in cash.

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

     In January 2003, we signed certain agreements, including a technology licensing agreement, with Data International Co., Ltd. of Taiwan. Under those agreements, we became the exclusive channel in the Americas for LCD products manufactured by Data International. We also obtained the right to sell those products through our worldwide channels. In conjunction with the agreement, we established a sales office in Orlando, Florida, and hired sales and applications engineering personnel from a distributor that had previously supported Data International’s products. The cost of the license was $3.9 million, of which $1.0 million was paid upon signing and $2.9 million was a term loan. In the first quarter of 2004, we paid $1.4 million against the term loan. The remaining $1.5 million was due in January 2005, although it was subject to reduction if certain margin targets were not met. That note has not yet been paid. For a further explanation, please refer to the Subsequent Events section below.

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

     In April 2003, we acquired the business and certain assets of Unico Technology Bhd., a privately held Malaysian company located in Penang. Unico was an electronics manufacturer for OEM customers in the computer, computer peripheral, and communications industries. The Unico business was acquired by TFS Electronics Manufacturing Services Sdn. Bhd., or TFS-Malaysia, a former joint venture owned 60% by an overseas TFS subsidiary and 40% by Unico Holdings Bhd., the former parent of Unico. Unico Holdings is the investment arm of the Chinese Chamber of Commerce of Malaysia. Our share of the initial cost of capitalizing TFS-Malaysia was $3.8 million and Unico Holdings’ share was $2.5 million, most of which was used for working capital. TFS-Malaysia purchased $4.1 million in inventory from Unico, for which $2.7 million was paid at the time of the purchase and $1.4 million was subsequently paid. No advance payment was required for the acquisition of the property, plant, and equipment of Unico, all of which is leased from the seller. The equipment lease is accounted for as a capital lease payable by TFS-

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Malaysia. In the second quarter of 2004, Unico Holdings exchanged its ownership interest in TFS-Malaysia for approximately 423,000 shares of our common stock held in treasury in a transaction valued at $2.8 million, compared with Unico Holdings’ interest of $2.6 million. As a result of that transaction, we now own 100% of TFS-Malaysia.

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

  Discontinued Operations

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

   Subsequent Events

     We recently announced that we signed a definitive agreement to sell the assets of our small form factor-display business to International DisplayWorks, Inc. and that the closing of the transaction, which is subject to normal conditions, is expected to occur in April 2005. Revenues from our small form factor display business in 2004 were approximately $28 million.

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

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

	•	$8 million in cash to be paid to us at closing;
	•	Up to an estimated $3 million in additional cash to be paid to us over time, based upon inventory consumption and accounts receivable collections ; and
	•	An estimated zero to $9 million in the common stock of International DisplayWorks to be paid to us in May 2006, based on a percentage of the transferred display business revenue for the preceding 12-month period if certain minimum revenue targets are met.

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

     We also recently announced that we had retained SG Cowen & Company to review strategic alternatives aimed at maximizing shareholder value and that we will continue to work with SG Cowen with regard to our large form factor display, EMS, and RF module manufacturing businesses. We are exploring a range of possible alternatives, such as acquisitions, strategic alliances, business combinations, and the sale of a portion or all of the company. We are currently in discussions with multiple potential buyers of the RF business and have received an

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initial offer from a potential buyer of the EMS business. We indicated that there is no assurance that any business transactions will be effected or what the timing and terms of any such business transactions could be.

     In March 2005, we determined to discontinue our distribution of certain display products that we licensed from Data International. The decision follows the exercise by us of our right to rescind a technology licensing agreement, or TLA, that was entered into during January 2003 with Data International Co, Ltd., and discussed above in this Item 7 in “Acquisitions and Strategic Transactions.” Revenue from those Data International products in 2004 were approximately $17 million. The TLA designated us as the exclusive distributor of certain Data International display products in the Americas in return for deferred payments to Data International of $3.9 million. Through the end of 2004, we had paid approximately $2.4 million to Data International, and a final payment of approximately $1.5 million was due in January 2005.

     We recently determined that certain of the specified Data International display products have been simultaneously available in the United States through a third party and that we had not been provided exclusive distribution rights to the United States market as required by the TLA. Based on that determination, we believe that the TLA was breached, and we are exercising our rights of rescission. We notified Data International in February 2005 that we will not make the final $1.5 million payment to Data International that was due in January 2005. We also asserted damages of at least $2.5 million, plus interest and other expenses, against Data International. We notified Data International that we will off-set our claimed damages against money owed by us to Data International for product purchases. We recently filed a complaint against Data International in Arizona requesting a declaratory judgment for breach of contract.

     We also announced in January 2005 that we are considering the sale of our RF module manufacturing business and that we are going to move our corporate headquarters from Tempe, Arizona to Redmond, Washington.

Critical Accounting Policies and Estimates

     Our discussion and analysis of our financial condition and results of operations are based upon our financial statements, which have been prepared in accordance with generally accepted accounting principles (GAAP) in the United States. During preparation of these financial statements, we are required to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue, and expenses, and related disclosure of contingent assets and liabilities. On an ongoing basis, we evaluate our estimates and judgments, including those related to sales returns, bad debts, inventories, fixed assets, goodwill, intangible assets, income taxes, and contingencies. We base our estimates on historical experience and on various other assumptions that we believe are reasonable under the circumstances. The results form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

     We believe the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our financial statements.

     We assemble and manufacture products for our customers and recognize revenue when persuasive evidence of a sale exists; that is, a product is shipped under an agreement with a customer; risk of loss and title have passed to the customer; the fee is fixed or determinable; and collection of the resulting receivable is reasonably assured. This means that when a product is shipped from one of our factories under the terms “FOB Factory” then the risk of loss passes to the customer when the product leaves our factory and we recognize revenue at that time. On the other hand, when a product is shipped under the title transfer terms of “FOB Destination” then the risk of loss during transit is maintained by us. Thus, we recognize revenue when the product is accepted by the customer. Shipping terms with one of our major customers is FOB Destination, and many of those products are shipped by sea, taking four to six weeks to reach their destination. As a result, we frequently have a significant amount of product in transit recorded in our finished goods inventory. At December 31, 2004 and 2003, we had $3.1 million and $3.6 million of product in transit, respectively.

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

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

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

     We scrap inventory when materials are determined to be defective, damaged or no longer required. We also write down our inventory for estimated obsolescence or unmarketable inventory based upon assumptions and estimates about future demand and market conditions. If actual market conditions are less favorable than those projected by us, additional inventory write-downs may be required. As noted below, we have had a significant history of inventory charges and write-offs, with over $5 million of expenses in 2004:

	•	In the fourth quarter of 2003, we learned from a customer that a product shipped by us to them contained potentially defective parts. Those potentially defective parts were printed circuit boards supplied to us by a vendor specified by our customer. At year-end 2003, we believed the parts could be repaired or that the component supplier would reimburse us for the damages. We determined in the first quarter of 2004 that the latent defect in the materials purchased was not repairable and that it was possible that the component supplier would not reimburse us for damages beyond the cost of those boards. As a result, we established a reserve for the value of that inventory, which included other component parts that had already been included on those boards less the $158,000 value of the boards for which we believe the supplier is obligated to repay at a minimum. The amount reserved was approximately $1.0 million.
	•	At year-end 2003, we held $778,000 of inventory relating to a program cancelled by a customer. At that time, we believed we would recover the carrying value of this inventory and did not establish a reserve. After further discussions and negotiations with this customer during the first quarter of 2004, we wrote off $332,000 of this inventory while receiving settlement against the remainder of the inventory.
	•	In the second quarter of 2004, a telecommunications customer declared bankruptcy. As a result of that event, we wrote off $127,000 in accounts receivable and recorded a $567,000 reserve against inventory relating to specific programs for that customer.
	•	In the third quarter of 2004, we wrote off $1.4 million as follows: (a) $435,000 of Redmond inventory due to the pending end-of-life of several long-running programs; (b) $806,000 for inventory write-offs and other charges relating to the shut-down of various programs as a result of the move of the display module operations from Manila to Beijing; and (c) $202,000 of inventory in Manila related to Microtune.
	•	In the fourth quarter of 2004, we wrote off $1.8 million of inventory as follows: (a) $284,000 of Redmond inventory relating to termination of customer programs; (b) $284,000 of Penang inventory for quality issues related to a new customer start-up; (c) $469,000 of Manila inventory for excess and obsolete inventory relating to Microtune; and (d) $774,000 display platform related inventory charges, most of which were due to excess and obsolete issues.

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     Despite these write-offs, the inventory balances at the end of 2004 still exceeded the inventory amounts needed to satisfy all open orders. This is a typical situation in the manufacturing industry, however, and we have estimated that all unreserved inventory will be utilized.

     Pursuant to Financial Accounting Standards Board (“FASB”) Statement of Financial Accounting Standards (“SFAS”) No. 109, “Accounting for Income Taxes”, income taxes are recorded based on current year amounts payable or refundable, as well as the consequences of events that give rise to deferred tax assets and liabilities. We base our estimate of current and deferred taxes on the tax laws and rates that are currently in effect in the appropriate jurisdiction. Changes in tax laws or rates may affect the current amounts payable or refundable as well as the amount of deferred tax assets or liabilities.

     At the end of the second quarter of 2003, we had $19.8 million of net deferred tax assets, resulting primarily from net operating loss and tax credit carryforwards. SFAS No. 109 requires that a valuation allowance be established when it is more likely than not that all or a portion of a deferred tax asset will not be realized. In determining whether a valuation allowance is required, we are required to take into account all positive and negative evidence with regard to the utilization of a deferred tax asset, including our past earnings history, market conditions, management forecasts of future profitability, the character and jurisdiction of such earnings, unsettled circumstances that, if unfavorably resolved, would adversely affect utilization of a deferred tax asset, carryback and carryforward periods, and tax strategies that could potentially enhance the likelihood of realization of a deferred tax asset. SFAS No. 109 further states that it is difficult to conclude that a valuation allowance is not needed when there is negative evidence such as cumulative losses in recent years. Therefore, despite the fact that a major portion of the losses came from our spun-off microdisplay division, the expectation in the third quarter of 2003 was that we would have three years of cumulative losses. Those cumulative losses weighed heavily in the overall required assessment and outweighed our forecasted future profitability and expectation that we will be able to utilize all of our net operating loss carryforwards. As a result, in the third quarter of 2003, we recorded a charge to establish a full valuation allowance against our deferred tax asset. We expect to continue to record a full valuation allowance on future tax benefits until we return to sustained profitability.

     Long-term assets, such as property, plant, and equipment, intangibles, goodwill, and other investments, are originally recorded at cost. On an ongoing basis, we assess these assets to determine if their current recorded value is impaired. When assessing these assets, we consider projected future cash flows to determine if impairment is applicable. Assets may also be evaluated by identifying independent market values of assets that we believe to be comparable. If we believe that an asset’s value is impaired, we write down the carrying value of the identified asset and charge the impairment as an expense in the period in which the determination is made.

     In the third quarter of 2004, we determined that the $27.1 million goodwill balance associated with the EMS reporting unit was impaired. Because of the ongoing performance issues experienced by the Redmond location, including the integration issues experienced in Redmond in the second and third quarters of 2004, and because of the reduction in market comparables, we engaged a professional valuation firm to assist us in determining the fair value of the EMS goodwill. The valuation included a market comparable study and a present value valuation based on our best estimates of the future cash flows. The amount of the impairment loss was $21.3 million, and was determined in accordance with the provisions of SFAS No. 142. As a result of the valuation analysis, a goodwill balance of $5.7 million remains associated with the EMS reporting unit. The valuation analysis involves significant management judgment regarding future operations. If actual performance is less than forecasted, additional impairments could be required.

     We also conducted an analysis of the goodwill relating to the AVT acquisition, and that analysis indicated no impairment of the AVT goodwill asset.

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

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     Under GAAP, we are required to amortize cash lease incentives that we receive up-front relating to a lease over the term of the respective lease. In addition, when we sublease property for an amount of consideration that is less than the lease amount we pay, we are required to report as an expense the amount by which the total amount of lease consideration due under the original lease exceeds the total amount of sublease income due under the sublease. In the fourth quarter of 2004, we moved into a new facility in Redmond and signed a seven year lease, under which the lessor paid to us $900,000 upon moving into that new facility, in part to offset the costs of the move. We have the option to renew the lease for an incremental five year term. We will offset our lease expense on that new facility by the $900,000 ratably over the term of that lease. In addition, in connection with that move, we moved out of an older, leased facility that had 36 months remaining on the lease. We subleased that building for a monthly amount that was approximately 30% less than the original lease amount due. As a result, we expensed in the fourth quarter the cumulative loss on that sublease of $382,000. In January of 2005, we moved out of another older facility in Redmond, Washington that had 12 months remaining on the lease. A charge of approximately $197,000 is expected to be recorded in the first quarter of 2005 to recognize future costs associated with the continuing lease obligation of this facility.

     In the fourth quarter of 2004, we sold our Tempe building for $11.3 million, less selling costs of approximately $500,000. Under the terms of the sale, we received net cash (after expenses) of $8.8 million and a promissory note of $2 million payable in five years, resulting in a $2.7 million gain on the sale of that building. Because we leased back the Tempe facility for five years, we will recognize the gain ratably over the life of the lease.

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

Results of Operations

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

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   Year ended December 31, 2004 compared to year ended December 31, 2003

     Overview of 2004. We continued our transition from being mainly a display company to becoming a full service electronic manufacturing services, or EMS, company. Our revenue was flat in 2004 over 2003. Our display sales were down, primarily because we are in a transition period with our display business as we move from manufacturing only passive display modules to focusing on manufacturing color TFT products. Our EMS sales were up, primarily because we had a full year of sales in 2004 in our Penang operations and only a partial year of operations in 2003. We also completed a transaction in early 2004 with Integrex, which provided us with several new EMS customers in our Redmond operation. We reported losses throughout 2004 for several reasons. We continue to have excess capacity in our factories. We had integration problems with Integrex in the second and third quarters. We also reported substantial write-offs of excess, scrap, and obsolete inventory in each quarter in 2004 as a result of several factors, including changes in customer demand, lost customers, and defective materials. We consolidated our display module operations in Beijing and closed the display module operations in Manila, which resulted in expenses associated with layoffs and excess inventory. We had impairment charges of some of our intangible assets associated with past acquisitions. We also made several changes in our ownership and leasing of our factories in 2004. In mid 2004, we purchased our Manila factory. In late 2004, we sold our Tempe building and leased it back for 5 years. We also moved into a new facility in Redmond with the plan to sublease some or all of our other facilities in Redmond. Finally, in early 2005 we announced that we are considering the sale of Manila, moving our corporate headquarters to Redmond, and closing down our line of display products provided by Data International.

     Net Sales. Net sales were $158.9 million in 2004 and $159.0 million in 2003. In 2004, our sales were distributed over six major markets: computing, consumer, industrial, medical, telecommunications, and transportation. In 2003, we primarily sold to the same six major markets. In 2004, we experienced a decline in our sales to the telecommunications industry. Our net sales distributed by industry were as follows:

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          Geographically, in 2004, 62.2% of our sales were in the United States; 18.4% of our sales were in Asia; and 19.4% of our sales were in Europe.

          Sales in our two segments, in millions, were as follows:

          Sales in the display business declined as a result of our decision to transition our products from monochrome and passive color to the more advanced thin film transistor (TFT) color. That transition resulted in reduced passive display sales before the TFT ramp up, which is now expected in mid 2005. Sales in the EMS business increased primarily as a result of the acquisition of Unico in April 2003 and Integrex in February 2004.

          Cost of Sales. Cost of sales increased to 101.3% of net sales in 2004 from 97.6% in 2003. Our gross margin is equal to the difference between our revenue and our cost of sales. Consequently, our company-wide gross margin in 2004 was a negative $2.1 million. The gross margin dollars in our two segments, in millions, were as follows:

          The negative gross margins in 2004 were caused by several factors, including excess capacity in the manufacturing facilities, integration problems with the new Integrex customers, and operational issues resulting in write-downs of excess inventory. Specifically, nearly $5.2 million of charges relate to inventory write-offs for excess, scrap, and obsolete inventory, of which $2.7 related to the EMS business and $2.5 related to the Display business. Also included in the Display gross margins was the cost of consolidating the display module business in Beijing, estimated at approximately $1.0 in 2004. That business was previously operating in both Beijing and Manila. Not including that consolidation cost, the Display business gross margins improved in 2004 because issues in 2003 relating to the initial ramp of passive color display modules were remedied at the end of 2003.

          Selling, General, and Administrative Expense. Selling, general, and administrative expense increased 42% to $24.9 million in 2004 from $17.5 million in 2003. As a percentage of net sales, SG&A expense increased from 11.0% of net sales in 2003 to 15.7% of net sales in 2004. This increase in SG&A expense occurred primarily as a result of additional finance and administrative expenses of $1.9 million associated with our increased infrastructure, costs of approximately $1.2 million associated with our compliance with the Sarbanes-Oxley Act of 2002, $1.0 million associated with incurring Brillian related facility costs under SG&A (all of which are paid for by Brillian under their sub-lease, which we report in other income), and additional selling expenses of $3.3 million associated with personnel added from acquisitions and expansion of our market focus.

          The SG&A expense in our two segments and for unallocated corporate costs for the last two years, in millions, were as follows:

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          The increase in the EMS costs were the result of several factors, including having a full year of costs associated with our Penang operations in 2004, but only a partial year of expenses in 2003 because that business was acquired in April 2003. The EMS business also had $561,000 of moving expenses relating to the move of Redmond’s manufacturing operation in the fourth quarter to a new building. Most of the moving expense was reimbursed by the new landlord, but that reimbursement will be amortized against the new lease expense ratably over the life of the new lease.

          The increase in the Display costs were primarily the result of moving engineering personnel that were formerly reported in RD&E, into the sales function. Other cost increases relate to increased sales and administrative personnel.

          Corporate costs include all unallocated finance, IT,, and administrative costs. Those costs increased primarily because of the increase in costs associated with compliance with Sarbanes-Oxley requirements, including the establishment of an internal auditing function and the increased external auditing costs associated with the Section 404 assessment.

          Research, Development, and Engineering Expense. Research, development, and engineering expense decreased to $2.9 million in 2004 from $4.7 million in 2003. Research, development, and engineering expense was 1.8% of net sales in 2004 compared with 3.0% of net sales in 2003. The RD&E expense in our two segments and for unallocated corporate costs for the last two years, in millions, was as follows:

The large drop in Display RD&E expense was due to moving engineering personnel into the sales function, as well as moving engineering operations offshore. The drop in Corporate was the result of the reduction of RD&E expenses associated with the Brillian spin off.

          Impairment of Goodwill. During 2004, in our EMS segment, we reduced the goodwill on our balance sheet relating to our ETMA acquisition. The write-off of goodwill was $21.3 million and was due to the ongoing performance issues experienced by our Redmond manufacturing facility, including the integration issues and the reduction in market comparables. We engaged a professional valuation firm to assist us in determining the fair market value of that goodwill.

          Impairment of Intangibles. During 2004, in our Display segment, we wrote off $1.8 million for customer lists associated with the AVT acquisition. These write-offs occurred as a result of numerous changes in the AVT business, including notification during the third quarter of 2004 that a customer was not renewing a program. That notification and other cumulative changes that have occurred since the acquisition resulted in a complete turnover in the customer base. Most of the changes were driven primarily by the fact that the original business when acquired by us was selling CRT displays and is now exclusively selling flat panel displays.

          Loss (Gain) on Sale of Assets. In 2004, we realized a gain of $100,000 compared with a gain of $25,000 in 2003 for the sale of certain assets. The gain in 2004 was primarily due to the sale of module production equipment no longer required in Manila.

          Amortization of Intangibles. The amortization of customer lists was $1.9 million in 2004 and $2.0 million in 2003. The amortization in 2003 and 2004 relates to the acquisitions of AVT and ETMA and to the license agreement with Data International, all described above in “Overview.” Going forward, the amortization of intangibles will relate solely to the ETMA customer list, as we wrote off the intangible related to AVT’s customer list in 2004 and we rescinded the license agreement with Data International in 2005. The original balance of the

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amortizable asset associated with ETMA was $2.0 million and is being amortized over three years starting in 2002. The original amortizable asset associated with Data International was $3.9 million and is being amortized over five years starting in 2003. The original amortizable asset associated with AVT was $3.0 million and was being amortized over five years starting in 2002. This asset was written off during the third quarter of 2004.

          Other Income (Expense), Net. Other income in 2004 was $432,000 compared with $864,000 in 2003. The composition and differences of the items that make up other income were as follows (in thousands):

The primary difference was an increase of $918,000 in rental and service income received from Brillian Corporation. Our interest income decreased $645,000 because of decreased cash and investments balances. Interest expense increased $105,000 and was primarily associated with the capital leases for our equipment acquired in Malaysia and Redmond in the Unico and ETMA acquisitions described above in “Overview”. In 2003, we reached a settlement of our legal claim against J.D. Edwards and recorded the settlement as other income of approximately $700,000.

          Minority Interest. During the second quarter of 2004 we agreed with Unico Holdings to exchange its ownership interest in TFS Electronic Manufacturing Services Sdn. Bhd. (“TFS – Malaysia”) for approximately 423,000 shares of TFS common stock held in treasury in a transaction valued at $2.8 million. As a result of that transaction, we now own 100% of TFS – Malaysia and no longer have a minority interest adjustment. During 2003 we controlled and owned only 60% of the business in Malaysia. During 2003 that business had losses and we recorded a benefit of $36,000 to account for the losses allocated to the minority interest holder.

          Provision for (Benefit from) Income Taxes. We recorded a benefit for income taxes of $226,000 in 2004 compared to a provision for income taxes of $14.3 million for 2003. The benefit in 2004 was for tax refunds. The charge recorded in 2003 was to establish a valuation allowance against our deferred tax asset, which consists primarily of net operating loss carryforwards, or NOLs. A further description of that allowance is described above in “Critical Accounting Policies and Estimates.” As a result, we generally no longer record a tax benefit for losses, except as previously described.

          Net Loss. We had a net loss of $54.3 million, or $2.50 per diluted share, in 2004 compared with a net loss of $44.5 million, or $2.09 per diluted share, in 2003. As noted above, the net loss in 2004 included $23.1 million associated with the write-off of the goodwill of ETMA and the customer list of AVT. The net loss in 2003 included $10.6 million from discontinued operations relating to our former microdisplay business and $14.3 million for the tax valuation allowance.

Year ended December 31, 2003 compared to year ended December 31, 2002

          Overview of 2003. This was a year of transition for us. Prior to late 2002, we were a monochrome custom LCD module supplier servicing primarily Motorola in the handset market. Beginning in the second half of 2002, we expanded our capabilities to include standard, color and large-format display products. More importantly, as a result of several acquisitions, we became a broad-based electronics manufacturing services company offering services such as advanced printed circuit board assembly, RF module assembly, and box build. In addition, we made the decision in 2003 to spin off our research-intensive microdisplay business to Brillian. Finally, we ceased manufacturing display modules for Motorola’s handset business in the second half of 2003. This rapid change resulted in several issues during the year, including integration issues with the RF module business, excess capacity at the display module factories, and negative margins on new color display products. In the fourth quarter of 2003, we remedied the initial negative margin issues on the color display products. We also made improvements in the manufacturing issues we had with the RF modules.

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          Net Sales. Net sales increased 83.6% to $159.0 million in 2003 from $86.6 million in 2002. Sales in our two segments, in millions, were as follows:

          We first acquired a business that could be characterized as electronics manufacturing services, or EMS, in December 2002. Therefore, the EMS business conducted in 2002 was very small, constituting only $3.8 million. In 2003, revenue in the EMS business had grown to $80.5 million, and the revenue in the Display business was $78.5 million, which was slightly down from $82.8 million in 2002.

          The increase in the EMS revenue was primarily a result of the acquired business in Redmond and Malaysia of $66.4 million, and growth in our EMS business through the addition of the RF module business of $10.3 million. The decrease in the Display business was as a result of a decline in sales to Motorola of $54.2 million. That decline was offset by the addition of our display products from Data International of $15.9 million and sales of color display modules of $24.7 million. Our sales to Motorola declined because we did not win any display module business in handsets after 2001 because of pricing issues.

          Motorola accounted for less than 10% of our total net sales in 2003 compared to 78% in 2002. We had two customers that each exceeded more than 10% of our net sales in 2003. Avocent, which is in the computer peripherals business and an EMS business customer, accounted for 23% of our net sales, and Vitelcom, a European telecom company and a Display business customer, accounted for 13% of our net sales.

          In 2003, our sales were distributed over six major markets: transportation, computing, consumer, industrial, medical/instrumentation, and telecommunications. By contrast, in 2002, we were highly concentrated, with 82.0% of our sales coming from a single market, telecommunications. Our net sales distributed by industry were as follows:

          Geographically, in 2003, 54.0% of our sales were in the United States; 20.5% of our sales were in Asia; and 25.5% of our sales were in Europe. Our recent trend has shown increased sales in the United States and Europe. Our increased sales in the United States were primarily a result of several recently acquired businesses and because of increased display-oriented manufacturing business. Our increased sales in Europe were primarily a result of the increased sales of color LCD modules to a European handset manufacturing company. Asia sales declined because of the reduced sales to Motorola, most of which were in China. Not including Motorola, however, the trend has been that our sales in Asia are increasing. Most of our Asian sales in 2003 were to U.S.-based, multinational companies with factories located in Asia.

          Cost of Sales. Cost of sales increased to 97.6% of net sales in 2003 from 90.9% in 2002. Our gross margin is equal to the difference between our revenue and our cost of sales. Consequently, our company-wide gross margin in 2003 was $3.9 million or 2.4% of net sales, as compared to $7.9 million, or 9.1% of net sales in 2002. The gross margin dollars in our two segments, in millions, were as follows:

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          The gross margin in the Display segment was impacted in 2003 because of the reduced sales to Motorola and because the replacement sales to other display customers had lower volumes but higher selling prices. These reduced manufacturing volumes resulted in under-absorption of our fixed manufacturing costs. Also, in Manila, the gross margins on our color display products were negative because of introductory pricing on new products and because we had not obtained expected pricing reductions from vendors of color panels. The gross margin in the EMS segment was impacted in 2003 because we were still in the process of ramping up our RF module manufacturing in Manila and moving those processes from Microtune’s factory to ours. As a result, those products sold at below breakeven during the ramp-up phase.

          Selling, General, and Administrative Expense. Selling, general, and administrative expense increased 68.3% to $17.5 million in 2003 from $10.4 million in 2002. As a percentage of net sales, however, SG&A expense decreased from 12.0% of net sales in 2002 to 11.0% of net sales in 2003. The SG&A expense in our two segments and for unallocated corporate costs for the two comparative years, in millions, were as follows:

          This overall change in SG&A expense occurred primarily because of four factors: (1) the additional SG&A costs in the EMS segment associated with the acquired EMS business in Redmond of $2.9 million and the acquired EMS business in Penang of $1.5 million, (2) increased sales expenses of $1.3 million in the Display segment as a result of increased sales, and (3) increased expenses in corporate, including the recording of expenses of approximately $1.2 million associated with an arbitration claim we pursued against J.D. Edwards, which was settled.

          Research, Development, and Engineering Expense. Research, development, and engineering expense decreased slightly to $4.7 million in 2003 from $4.9 million in 2002. Research, development, and engineering expense decreased as a percentage of net sales, declining to 3.0% of net sales in 2003 from 5.7% of net sales in 2002. Corporate costs are related to our prior microdisplay business. The RD&E expense in our two segments and for unallocated corporate costs for the two comparative years, in millions, was as follows:

          Loss (Gain) on Sale of Assets. In 2003, we realized a gain of $25,000 from the sale of certain assets compared to a loss of $4.5 million in 2002. The loss in 2002 related to the sale of our front-end manufacturing LCD equipment for $3 million.

          Amortization of Intangibles. During 2003, we had $2.0 million of amortization relating to customer lists and distribution rights compared to $256,000 of amortization expense during 2002. The amortization in 2003 relates to the acquisitions of AVT and ETMA and to the license agreement with Data International, all described above in “Overview.” The amortizable asset associated with ETMA was $2.0 million and was being amortized over three years. The amortizable asset associated with Data International was $3.9 million and was being amortized over five years. The amortizable asset associated with AVT was $3.0 million and was being amortized over five years starting in 2002. This asset was written off during the third quarter of 2004.

          Other Income (Expense), Net. Other income in 2003 was $864,000 compared to $3.5 million in 2002. The primary difference was that interest income decreased $2.6 million because of decreased cash and investments balances and because the interest rate earned on investments was lower in 2003 than 2002. The interest expense increased $886,000 and was primarily associated with the capital leases for our equipment acquired in Malaysia and

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Redmond in the Unico and ETMA acquisitions described above in “Overview”. In 2003, we reached a settlement of our legal claim against J.D. Edwards and recorded the settlement as other income of approximately $700,000.

          Minority Interest. Prior to 2004, we owned only 60% of the business in Malaysia. Since that business had losses in 2003, we recorded a benefit of $36,000 to account for the losses allocated to the minority interest holder compared to a charge of $84,000 in 2002 relating to the winding-up of another investment with a different minority partner.

          Provision for (Benefit from) Income Taxes. We recorded a provision for income taxes of $14.3 million in 2003 compared to a benefit from income taxes of $3.9 million for 2002. We recorded a charge in 2003 to establish a valuation allowance against our deferred tax asset, which consists primarily of net operating loss carryforwards, or NOLs. A further description of that allowance is described above in “Critical Accounting Policies and Estimates.” The loss from discontinued operations was net of a tax benefit of $6.7 million for the year ended December 31, 2002. There was no tax benefit in 2003 for discontinued operations.

          Net Loss. We had a net loss of $44.5 million, or $2.09 per diluted share, in 2003 compared with a net loss of $17.0 million, or $0.79 per diluted share, in 2002. The net loss in 2003 included $10.6 million, or $0.50 per share, from discontinued operations relating to our former microdisplay business. As described above in “Discontinued Operations,” our microdisplay division was spun off as a separate public company as of September 15, 2003, as Brillian Corporation. The net loss for the Brillian discontinued operations in 2002 was $12.3 million, or $0.57 per share.

Liquidity and Capital Resources

          At December 31, 2004, we had cash, cash equivalents, and short-term investments of $16.2 million compared with $33.1 million at December 31, 2003, which was a reduction, or cash outflow of $16.9 million. The primary components of the reduction can be summarized for 2004, in millions, as follows:

          In reviewing our consolidated statement of cash flows, we had $14.7 million in net cash outflow from operations in 2004 compared with $2.0 million in net cash outflow from operations in 2003. Our inventory turns were 6.8 and day sales outstanding, or DSOs, were 52 days in 2004 compared with 7.2 inventory turns and 51 DSOs in 2003. Our depreciation and amortization expense was $8.6 million in 2004 and $7.6 million in 2003. The increased operating loss was the primary reason for increased net cash outflow from operations.

          We had purchases of property, plant and equipment of approximately $8.1 million, which included our ongoing ERP implementation and additions in China related to our TFT clean room. Also included in those expenditures was the purchase of our facility in Manila from our lessor for a total payment of $3.8 million, of which $3.2 million was assigned to the carrying value of the building and $585,000 was applied to accrued rent liabilities. We also paid $614,000 to the RBF Development Corporation for a 50-year land right. Lastly, we executed an agreement with RBF for an option to purchase the leased land for $1 at any time until April 23, 2014. As a result of the building purchase and land right agreement, we were released from the obligation to pay $7.8 million in lease payments that were due over the next seven years that were remaining on our original ten- year lease agreement.

          In 2004, we realized net proceeds from the sale of assets of $9.6 million. Those proceeds were generated from the sale of various pieces of unused manufacturing equipment as well as from the sale of our facility in Tempe, Arizona, which generated $8.8 million in cash. On the sale of the Tempe facility, we also received a $2.0 million note receivable from the buyer, which bears simple interest at 6% per year. Interest is payable monthly beginning on February 1, 2005. The principal is due in a lump sum payment on December 30, 2009. At the time of the Tempe sale, we entered into a lease agreement with the buyer for a period of five years. Under the terms of the lease, if we default on the rental payments during the five-year period, the buyer is relieved of its obligation to pay the $2.0 million note.

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          During 2004, we also completed further acquisitions and strategic investments of $2.7 million all of which related to the Integrex transaction, which included license fees. The Integrex transaction is described above in Overview – Acquisitions and Strategic Investments in this Item.

          During 2004, we had payments on our capital leases of $2.2 million. Most of those payments related to our capital leases for our manufacturing equipment in Penang.

          Our working capital was $26.9 million at December 31, 2004, down from $59.6 million at December 31, 2003. Our current ratio at December 31, 2004 was 1.7-to-1 compared with 2.5-to-1 at December 31, 2003. The decrease in working capital was primarily because of reduced cash, short-term investments, and accounts receivable balances.

          While we transact business predominantly in U.S. dollars and invoice and collect most of our sales in U.S. dollars, we collect a portion of our revenue in non-U.S. currencies, such as the Chinese Renminbi. In the future, customers increasingly may make payments in non-U.S. currencies, such as the Euro. In addition, we account for a portion of our costs, such as payroll, rent, and indirect operating costs, in non-U.S. currencies, including Philippine Pesos, British Pounds Sterling, Malaysian Ringgit, and Chinese Renminbi. Thus, fluctuations in foreign currency exchange rates could affect our cost of goods and operating margins and could result in exchange losses. In addition, currency devaluation can result in a loss to us if we hold deposits of that currency. Hedging foreign currencies can be difficult, especially if the currency is not freely traded. We cannot predict the impact of future exchange rate fluctuations on our operating results. These currency risks are particularly important since sales outside North America represented 37.8% of our net sales in 2004 and 46.0% of our net sales in 2003. Sales in foreign markets, primarily Europe and Asia, to OEMs based in the United States accounted for almost all of our international sales in both of these periods.

          In the first quarter of 2004, we entered into a credit facility with the First National Bank under which we borrowed $5.0 million secured by restricted cash deposits. In the second quarter of 2004, we repaid and terminated that credit facility.

          In the second quarter of 2004, we entered into a $10.0 million secured revolving line of credit with Silicon Valley Bank, or SVB, which matures on June 25, 2005. Initially, that line of credit bore interest at the bank’s prime rate plus 75 basis points, subject to a minimum rate of 4.75%. The SVB line also contained restrictive covenants that included, among other things, restrictions on the declaration of payments of dividends, restrictions on the sale or transfer of assets, and maintenance of specified net worth and quick ratio. We owed $5.0 million under that line of credit as of September 30, 2004. As of September 30, 2004, we did not meet some of the required covenants, although SVB did not call a default on the SVB line. During the fourth quarter, we signed an amendment to the original SVB line that substantially revised its terms and conditions. Under those new terms, the first $2.5 million of borrowings under that line of credit accrue interest at the bank’s prime rate plus 125 basis points subject to a minimum rate of 4.75% and borrowings above $2.5 million are subject to a factoring arrangement, bearing an initial discount fee and interest of prime plus 450 basis points on the factored receivables. The credit limit remained at $10 million, but there were fewer receivables that qualified as factorable as compared to the original borrowing base, resulting in a potentially lower borrowing base. Many of the restrictive covenants previously contained in the SVB line documents were removed, although covenants did remain relating to cash earnings, revenue, and the Tempe building sale. We reduced our line of credit balance with SVB from $5 million to zero during the fourth quarter. Although there were no borrowings under the SVB line as of December 31, 2004, we were in violation of our covenants relating to cash earnings and revenue. SVB did not declare a default on the line, but we are currently under discussion with SVB with regard to a re-negotiation of the terms of the line. During this re-negotiation period, SVB has issued a forbearance letter under which we are precluded access to the line. In addition, SVB required us to make a cash deposit in the first quarter of 2005 to secure a $600,000 letter of credit, which SVB had issued to the lessor of our building in Redmond.

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

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          The following tables list our contractual obligations and commercial commitments as of December 31, 2004:

          The operating leases include leases for our factories in Penang, Washington, Massachusetts, our lease in Arizona, and our sales offices in Florida and in the United Kingdom. In the second quarter of 2004, we purchased our leased building in Manila. As a result of the building purchase, we will no longer be required to pay the $7.8 million over the next seven years that was remaining on our original ten year operating lease agreement. These leases are described in detail in Item 2 of this report. The capital leases are for our equipment in Malaysia and Washington. One of the capital leases includes certain financial covenants that we were not in compliance with at December 31, 2004. The lessor has advised us they are accelerating the payments due on the lease obligations. The guarantee relates to our guarantee in connection with a Small Business Administration loan to VoiceViewer Technology, Inc., a privately held company developing microdisplay products. Brillian assumed this guarantee in the spin-off. If Brillian Corporation were unable to satisfy its obligation as primary guarantor, then we would be required to pay the guaranteed amount.

          We have no other long-term debt, capital lease obligations, unconditional purchase obligations, or other long-term obligations, and we do not have any other commercial commitments or other off-balance sheet arrangements.

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

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

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

          Additional potential sources of capital in 2005 will be bank financings. We are pursuing a loan in Malaysia, and we expect to finalize the documentation of that loan in the second quarter. It also is possible that the sale of display operations could enable us to re-establish loan commitments or debt financing with a domestic bank

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or banks. We cannot provide assurance on potential loans or that the terms of such loan commitments or debt financing would be on terms acceptable to us.

          Based upon our cash balances, our expected use of cash in 2005, and the definitive agreement with International DisplayWorks, Inc., we believe that we have adequate sources to fund our remaining operations and planned expenditures through 2005, as well as to meet our contractual obligations. The expected use of funds through the rest of 2005, however, is based on our judgments and forecasts. Actual results could prove materially different and, in such instances, may require additional funds. We cannot provide assurance that additional asset sales, such as the sale of the Manila operations, loan commitments, or other methods of financing will be available for any such unexpected additional requirements or, if available, that they will be on terms acceptable to us.

Impact of Recently Issued Standards.

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

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

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

Rule 10b5-1 Trading Plans

          Our Insider Trading Policy permits our directors, officers, and other key personnel to establish purchase and sale programs in accordance with Rule 10b5-1 adopted by the Securities and Exchange Commission. The rule permits employees to adopt written plans at a time before becoming aware of material nonpublic information and to sell shares according to a plan on a regular basis (for example, weekly or monthly), regardless of any subsequent nonpublic information they receive. In our view, Rule 10b5-1 plans are beneficial because systematic, pre-planned sales that take place over an extended period should have a less disruptive influence on the price of our stock. We also believe plans of this type are beneficial because they inform the marketplace about the nature of the trading activities of our directors and officers. In the absence of such information, the market could mistakenly attribute transactions as reflecting a lack of confidence in our company or an indication of an impending event involving our company. We recognize that our directors and officers may have reasons totally apart from the company in determining to effect transactions in our common stock. These reasons could include the purchase of a home, tax and estate planning, the payment of college tuition, the establishment of a trust, the balancing of assets, or other personal reasons. The establishment of any trading plan involving our company requires the pre-clearance by our Chief Executive Officer or Chief Financial Officer. An individual adopting a trading plan must comply with all requirements of Rule 10b5-1, including the requirement that the individual not possess any material nonpublic

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information regarding our company at the time of the establishment of the plan. In addition, sales under a trading plan may be made no earlier than 30 days after the plan establishment date.

          No officers currently maintain trading plans.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

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

          At December 31, 2004, we did not participate in any derivative financial instruments, or other financial and commodity instruments for which fair value disclosure would be required under Statement of Financial Accounting Standards No. 107. We hold no investment securities that would require disclosure of market risk.

          We have certain receivables denominated in Chinese Renminbi and certain payables denominated in Japanese Yen. To eliminate our exposure to changes in the U.S. Dollar exchange rate with Chinese Renminbi and Japanese Yen, we may enter into forward contracts to protect future cash flows. We have designated the forward contracts as cash flow hedges. Accordingly, we account for changes in the fair value of our forward contracts, based on changes in the forward exchange rate, with all changes in fair value reported in other comprehensive income. Amounts in other comprehensive income will be reclassified into earnings upon settlement of the forward contract. As of December 31, 2004, we had no forward contracts outstanding.

     Primary Market Risk Exposures

          Our primary market risk exposures are in the areas of interest rate risk and foreign currency exchange rate risk. We currently have no outstanding borrowing under our credit facility in the United States.

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

          We are exposed to risks from fluctuations in foreign currency exchange rates, primarily U.S. Dollar/Japanese Yen, U.S. Dollar/Philippine Peso, U.S. Dollar/Malaysian Ringgit, and U.S. Dollar/Chinese Renminbi.

          At December 31, 2004, one U.S. Dollar was worth 102.47 Japanese Yen. For the year ended December 31, 2004, the U.S. Dollar/Japanese Yen exchange rate fluctuated between 1:102.47 and 1:114.43. If there were a 10% change in the U.S. Dollar/Japanese Yen exchange rate, the foreign currency gain/loss would be immaterial.

          At December 31, 2004, one U.S. Dollar was worth 56.13 Philippine Pesos. For the year ended December 31, 2004, the U.S. Dollar/Philippine Pesos exchange rate fluctuated between 1:55.13 and 1:56.46. If there were a 10% change in the U.S. Dollar/Philippine Pesos exchange rate, the foreign currency gain/loss would be immaterial.

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          Both the U.S. Dollar/Malaysian Ringgit and U.S. Dollar/Chinese Renminbi exchange rates have been pegged by the respective governments, and remained so throughout the year ended December 31, 2004. However, there is the possibility that the respective governments may decide to revalue their exchange rate against the U.S. Dollar. If there were a 10% change in the U.S. Dollar/Malaysian Ringgit and U.S. Dollar/Chinese Renminbi exchange rates, the foreign currency gain/loss would be immaterial.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

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

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

          Not applicable.

ITEM 9A. CONTROLS AND PROCEDURES

          We have evaluated, with the participation of our Chief Executive Officer and Chief Financial Officer, the effectiveness of our disclosure controls and procedures as of December 31, 2004. Based on this evaluation, our Chief Executive Officer and Chief Financial Officer have each concluded that our disclosure controls and procedures are effective to ensure that we record, process, summarize, and report information required to be disclosed by us in our reports filed under the Securities Exchange Act within the time periods specified by the Securities and Exchange Commission’s rules and forms. During the fiscal year covered by this report, there have not been any changes in our internal controls over financial reporting that have materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

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

Management’s Report on Internal Control over Financial Reporting

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

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

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

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

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•

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

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

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

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

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

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Report of Independent Registered Public Accounting Firm

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

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

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

     A company’s internal control over financial reporting is a process designed by, or under the supervision of, the company’s principal executive and principal financial officers, or persons performing similar functions, and effected by the company’s board of directors, management, and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

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

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

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

Phoenix, Arizona
March 30, 2005

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ITEM 9B. OTHER INFORMATION

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

PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

     The information required by this Item relating to our directors is incorporated herein by reference to the definitive Proxy Statement to be filed pursuant to Regulation 14A of the Exchange Act for our 2005 Annual Meeting of Stockholders. If for any reason such statement is not filed within 120 days after the close of the fiscal year ended December 31, 2004, this annual report will be appropriately amended. The information required by this Item relating to our executive officers is included in Item 1, “Business – Executive Officers” of this report.

ITEM 11. EXECUTIVE COMPENSATION

     The information required by this Item is incorporated herein by reference to the definitive Proxy Statement to be filed pursuant to Regulation 14A of the Exchange Act for our 2005 Annual Meeting of Stockholders. If for any reason such statement is not filed within 120 days after the close of the fiscal year ended December 31, 2004, this annual report will be appropriately amended.

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

     The information required by this Item is incorporated herein by reference to the definitive Proxy Statement to be filed pursuant to Regulation 14A of the Exchange Act for our 2005 Annual Meeting of Stockholders. If for any reason such statement is not filed within 120 days after the close of the fiscal year ended December 31, 2004, this annual report will be appropriately amended.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

     The information required by this Item is incorporated herein by reference to the definitive Proxy Statement to be filed pursuant to Regulation 14A of the Exchange Act for our 2005 Annual Meeting of Stockholders. If for any reason such statement is not filed within 120 days after the close of the fiscal year ended December 31, 2004, this annual report will be appropriately amended.

ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES

     The information required by this Item is incorporated herein by reference to the definitive Proxy Statement to be filed pursuant to Regulation 14A of the Exchange Act for our 2005 Annual Meeting of Stockholders. If for any reason such statement is not filed within 120 days after the close of the fiscal year ended December 31, 2004, this annual report will be appropriately amended.

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PART IV

ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES

(a)	Financial Statements and Financial Statement Schedule

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

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

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

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(b)

Exhibits

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45

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SIGNATURES

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

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

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THREE-FIVE SYSTEMS, INC. AND SUBSIDIARIES

F-1

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

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

We have audited the accompanying consolidated balance sheets of Three-Five Systems, Inc. and subsidiaries (the “Company”) as of December 31, 2004 and 2003, and the related consolidated statements of operations, stockholders’ equity, comprehensive loss, and cash flows for each of the three years in the period ended December 31, 2004. Our audits also included the financial statement schedule listed in the Index at Item 15. These financial statements and the financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on the financial statements and the financial statement schedule based on our audits.

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

In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Three-Five Systems, Inc. and subsidiaries as of December 31, 2004 and 2003, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2004, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, the financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.

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

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

Phoenix, Arizona
March 30, 2005

F-2

THREE-FIVE SYSTEMS, INC. AND SUBSIDIARIES

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

F-3

THREE-FIVE SYSTEMS, INC. AND SUBSIDIARIES

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

F-4

THREE-FIVE SYSTEMS, INC. AND SUBSIDIARIES