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SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

For the Quarter Ended March 31, 2003

Commission file number 1-4373

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES [X] NO [ ]

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

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, at the latest practical date.

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THREE-FIVE SYSTEMS, INC.
QUARTERLY REPORT ON FORM 10-Q
FOR QUARTER ENDED MARCH 31, 2003
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ITEM 1.           FINANCIAL STATEMENTS

THREE-FIVE SYSTEMS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands)

The accompanying notes are an integral part of these condensed consolidated balance sheets.

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THREE-FIVE SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
(in thousands, except per share data)

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

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THREE-FIVE SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(in thousands)

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

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Note A		The accompanying unaudited Condensed Consolidated Financial Statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and the instructions to Form 10-Q. Accordingly, they do not include all the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. In our opinion, all adjustments, which include only normal recurring adjustments, necessary to present fairly the financial position, results of operations, and cash flows for all periods presented have been made. The results of operations for the three-month period ended March 31, 2003 are not necessarily indicative of the operating results that may be expected for the entire year ending December 31, 2003. These financial statements should be read in conjunction with our December 31, 2002 financial statements and the accompanying notes thereto.
		We announced in March 2003 that our board of directors has approved a decision to spin-off our Microdisplay division into a newly created and separately traded public company. We expect that the proposed spin-off will allow each company to focus its attention and financial resources on its target markets. In addition, each company will be able to more aggressively pursue its distinct business model and better meet the needs of its customers. The transaction is also expected to provide each independent company with greater strategic and financial flexibility to support growth opportunities in the future. Under the proposed spin-off, we will first transfer our entire LCoS microdisplay business, including all related manufacturing and business assets, personnel, and intellectual property, to a newly created subsidiary. Included in the transfer will be established manufacturing infrastructure, such as quality, logistics, planning, and procurement systems. We then expect to capitalize the new subsidiary with approximately $20 to $25 million in cash, an amount that we believe will be sufficient to enable the spun-off company to achieve its business objectives. We will then distribute 100% of the subsidiary’s common stock pro rata as a dividend to our stockholders. We have filed a ruling request with the Internal Revenue Service to qualify the spin-off as a nontaxable transaction. In addition, we expect to file a Form 10 with the Securities and Exchange Commission within the next 60 days providing detailed information regarding the proposed spin-off. No stockholder vote will be required to effect the spin-off, and no consideration will be required to be paid by our stockholders in order to receive the stock of the newly spun-off company.
Note B		Basic loss per common share is computed by dividing net loss by the weighted average number of shares of common stock outstanding during the three-month periods ended March 31, 2002 and 2003. Diluted loss per common share is determined assuming that outstanding dilutive options and warrants were exercised at the beginning of the period or at the time of issuance, if later. For the three months ended March 31, 2002 and March 31, 2003, the effect of 430,871 and 8,638 shares, respectively, were excluded from the calculation of loss per share as their effect would have been antidilutive and decreased the loss per share. Set forth below are the disclosures required pursuant to SFAS No. 128 — Earnings per Share for the three months ended March 31, 2002 and March 31, 2003.

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Note C

Inventories consist of the following at:

Note D

Property, plant, and equipment consist of the following at:

Note E		Intangibles:
		Intangibles consist of mask works, patents, licenses, customer lists, distribution rights, and other intangible assets. Intangibles are recorded at cost and amortized using the straight-line method over the estimated useful lives of the respective assets, which range from two to five years. Our policy is to commence amortization of intangibles when their related benefits begin to be realized. In January 2003, $3.9 million was recorded as distribution rights for the business license agreement with Data International, or DI, as described in Note K.
		Intangible assets consist of the following at March 31, 2003:

Intangible asset amortization expense for the three months ended March 31, 2002 was $423,000 as compared to $945,000 for the three months ended March 31, 2003. Estimated annual amortization expense through 2007 related to intangible assets reported as of March 31, 2003 is as follows (in thousands):

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Note F		Goodwill:
		Goodwill decreased $807,000 due to a fair value adjustment made on the inventory purchased in the ETMA acquisition, which closed in mid-December 2002.
		Changes in Goodwill from December 31, 2002 to March 31, 2003 (in thousands):