SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
----
FORM 10-Q
Quarterly Report Pursuant to Section 13 or 15(d) of Securities Exchange
Act of 1934
For Quarter Ended September 30, 1996
------------------
Commission File Number 1-4373
------
THREE-FIVE SYSTEMS, INC.
------------------------------------------------------
(Exact name of registrant as specified in its charter)
Delaware 86-0654102
- ------------------------------- ---------------------
(State or other jurisdiction of I.R.S. Employer
incorporation or organization) Identification Number
1600 North Desert Drive, Tempe, Arizona 85281
- --------------------------------------- ---------
(Address of principal executive offices) (Zip Code)
(602)389-8600
----------------------------------------------------
(Registrant's telephone number, including area code)
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 the number of shares outstanding of each of the issuer's classes of
common stock, at the latest practical date.
CLASS OUTSTANDING AS OF September 30, 1996
- ----- ------------------------------------
Common 7,779,829
Par value $.01 per share
<PAGE>
THREE-FIVE SYSTEMS, INC.
QUARTERLY REPORT ON FORM 10-Q
FOR THE QUARTER ENDED SEPTEMBER 30, 1996
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PART I - FINANCIAL INFORMATION
Page
----
<S> <C> <C>
ITEM 1. FINANCIAL STATEMENTS:
Consolidated Balance Sheets-
September 30, 1996 and December 31, 1995.......................... 1
Consolidated Statements of Income (Loss)-
Three Months and Nine Months Ended September 30, 1996 and 1995.... 2
Consolidated Statements of Cash Flows-
Nine Months Ended September 30, 1996 and 1995..................... 3
Notes to Consolidated Financial Statements................................. 4
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION...................................... 5
PART II - OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.......................................... 10
SIGNATURES.................................................................................. 11
</TABLE>
<PAGE>
THREE-FIVE SYSTEMS, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands)
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1996 1995
------------- ------------
(Unaudited)
ASSETS
------
<S> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents $ 9,878 $ 4,551
Accounts receivable, net 4,686 9,346
Inventories, net 6,215 13,703
Deferred tax asset 6,376 1,826
Other current assets 2,696 491
------- -------
Total current assets 29,851 29,917
PROPERTY, PLANT AND EQUIPMENT, net 31,334 33,493
COST IN EXCESS OF NET ASSETS ACQUIRED, net 140 170
OTHER ASSETS 197 200
------- -------
$61,522 $63,780
======= =======
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
CURRENT LIABILITIES:
Accounts payable $ 3,658 $ 3,199
Accrued liabilities 4,685 1,318
Current maturities of long-term debt -- 3,000
Current taxes payable -- --
------- -------
Total current liabilities 8,343 7,517
------- -------
LONG-TERM DEBT, net of current maturities -- --
------- -------
DEFERRED TAX LIABILITY 2,528 1,039
------- -------
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY:
Preferred stock -- --
Common stock 78 77
Additional paid-in capital 32,298 32,286
Retained earnings 18,261 22,847
Cumulative translation adjustment 14 14
------- -------
Total stockholders' equity 50,651 55,224
------- -------
$61,522 $63,780
======= =======
</TABLE>
The accompanying notes are an integral part of these consolidated balance
sheets.
1
<PAGE>
THREE-FIVE SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF INCOME (LOSS)
(UNAUDITED)
(in thousands, except share amounts)
<TABLE>
<CAPTION>
THREE MONTHS NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
--------------------------- ---------------------------
1996 1995 1996 1995
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
NET SALES $ 13,118 $ 24,217 $ 45,657 $ 70,805
----------- ----------- ----------- -----------
COSTS AND EXPENSES:
Cost of sales 19,798 19,790 46,143 53,510
Selling, general and administrative 1,316 1,419 4,246 3,904
Research and development 1,074 770 2,904 1,576
----------- ----------- ----------- -----------
22,188 21,979 53,293 58,990
----------- ----------- ----------- -----------
Operating income (loss) (9,070) 2,238 (7,636) 11,815
OTHER INCOME (EXPENSE):
Interest, net 90 120 242 741
Other, net (17) (14) (116) (29)
----------- ----------- ----------- -----------
INCOME (LOSS) BEFORE PROVISION FOR (BENEFIT FROM) INCOME TAXES (8,997) 2,344 (7,510) 12,527
Provision for (benefit from) income taxes (3,519) 961 (2,924) 5,011
----------- ----------- ----------- -----------
NET INCOME (LOSS) $ (5,478) $ 1,383 $ (4,586) $ 7,516
=========== =========== =========== ===========
EARNINGS (LOSS) PER COMMON SHARE AND COMMON
SHARE EQUIVALENT $ (0.70) $ 0.17 $ (0.59) $ 0.93
=========== =========== =========== ===========
WEIGHTED AVERAGE NUMBER OF COMMON
SHARES AND COMMON SHARE EQUIVALENTS
OUTSTANDING 7,779,492 8,088,318 7,763,687 8,086,454
=========== =========== =========== ===========
</TABLE>
The accompanying notes are an integral part of these consolidated statements.
2
<PAGE>
THREE-FIVE SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(in thousands)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30,
---------------------
1996 1995
-------- --------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $ (4,586) $ 7,516
Adjustments to reconcile net income (loss) to net cash
provided by operating activities:
Depreciation and amortization 2,626 1,553
Provision (reduction) of accounts receivable valuation reserves 46 (61)
Provision of inventory valuation reserves 6,203 1,076
(Gain) loss on disposal of assets 15 (38)
Change in assets and liabilities:
(Increase) decrease in accounts receivable 4,614 (3,499)
(Increase) decrease in inventories 1,285 (6,968)
Increase in other assets (671) (550)
Increase in accounts payable and accrued liabilities 3,826 3,206
Decrease in taxes payable, net (4,592) (1,246)
-------- --------
Net cash provided by operating activities 8,766 989
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property, plant and equipment (453) (26,119)
Proceeds from sale of furniture and equipment 1 278
-------- --------
Net cash used for investing activities (452) (25,841)
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net payments on notes payable to banks (3,000) --
Principal payments on and retirement of long-term debt -- (182)
Stock options exercised 13 29
-------- --------
Net cash used for financing activities (2,987) (153)
-------- --------
Effect of exchange rate changes on cash and cash equivalents 0 (2)
-------- --------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 5,327 (25,007)
CASH AND CASH EQUIVALENTS, beginning of period 4,551 27,136
-------- --------
CASH AND CASH EQUIVALENTS, end of period $ 9,878 $ 2,129
======== ========
</TABLE>
The accompanying notes are an integral part of these consolidated statements.
3
<PAGE>
ITEM 1. (continued)
Three-Five Systems, Inc. and Subsidiaries Notes to Consolidated
------------------------------------------------------------------
Financial Statements
--------------------
Note A The accompanying unaudited Consolidated Financial Statements
have been prepared in accordance with generally accepted
accounting principles for interim financial information and the
instructions to Form 10-Q. Accordingly, they do not include all
the information and footnotes required by generally accepted
accounting principles for complete financial statements. In the
opinion of management, 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-
and nine-month periods ended September 30, 1996 are not
necessarily indicative of the operating results that may be
expected for the entire year ending December 31, 1996. These
financial statements should be read in conjunction with the
Company's December 31, 1995 financial statements and accompanying
notes thereto.
Note B Earnings (loss) per share is computed by dividing net earnings
(loss) by the weighted average number of common shares and common
share equivalents assumed outstanding during the three- and
nine-month periods. For the three and nine months ended September
30, 1996, no common share equivalents were considered in the
calculation of earnings (loss) per share as the effect was
antidilutive. For all other periods presented common share
equivalents have been included in the calculation of earnings
(loss) per share. Fully diluted earnings (loss) per share is
considered equal to primary earnings (loss) per share in all
periods presented.
Note C Inventories consist of the following at:
September 30, 1996 December 31, 1995
------------------ -----------------
(Unaudited)
(in thousands)
Raw Materials $ 2,871 $ 9,257
Work-In-Process 1,829 2,002
Finished Goods 1,515 2,444
-------- --------
$ 6,215 $ 13,703
======== ========
Note D Property, plant, and equipment consist of the following at:
September 30, 1996 December 31, 1995
------------------ -----------------
(Unaudited)
(in thousands)
Building and
improvements $10,427 $10,375
Furniture and
equipment 28,304 27,971
------- -------
38,731 38,346
Less-accumulated
depreciation (7,397) (4,853)
------- -------
$31,334 $33,493
======= =======
4
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS
- ------------------------------------------------------
Three Months Ended September 30, 1996 Compared with Three Months Ended September
- --------------------------------------------------------------------------------
30, 1995.
- ---------
Net sales were $13,118,000 for the quarter ended September 30, 1996, a
decrease of 45.8 percent compared with net sales of $24,217,000 for the quarter
ended September 30, 1995. The Company's net sales have not been subject to any
significant seasonal fluctuations or variations. The sales decrease was
primarily a result of lower order rates from a major wireless communications
customer for existing product programs. That customer informed the Company
during the first quarter that it had decided to phase out the Company's highest
volume, longest running programs more quickly than originally planned. The
unexpected reduction of those programs was the greatest contributor to the
reduced revenue in the third quarter. The long product development time in the
custom business prevented the Company from quickly replacing the phased out
programs. In the third quarter, the Company's largest customer accounted for net
sales of $8,905,000 compared with net sales of $19,300,000 to that customer for
the quarter ended September 30, 1995, for an overall decrease in net sales to
the Company's largest customer of 53.9 percent. The Company's major customer
accounted for approximately 67.9 percent of the net sales in the third quarter
1996 compared with approximately 79.7 percent for the comparable quarter in
1995. All other customers accounted for net sales of $4,213,000 for the quarter
ended September 30, 1996 compared with the net sales of $4,917,000 for the
quarter ended September 30, 1995, for an overall decrease of 14.3%.
Cost of sales, as a percentage of net sales, increased to 150.9 percent
for the quarter ended September 30, 1996 as compared with 81.7 percent for the
quarter ended September 30, 1995. The corresponding decline in the gross margin
in the third quarter was the result of a number of factors, including increased
provisions for excess and obsolete inventory, manufacturing variances occurring
as a result of decreased manufacturing volume and material purchases, and sales
of low margin rework products. Without the provision for excess and obsolete
inventory, the cost of sales, as a percentage of net sales, would have been 97.3
percent for the third quarter.
Selling, general, and administrative expense decreased to $1,316,000
for the quarter ended September 30, 1996 from $1,419,000 for the quarter ended
September 30, 1995. The 7.3 percent decrease was due to lower bad debt expense
and lower directors and officers insurance premiums offset by increased salaries
and benefits. Selling, general, and administrative expense increased as a
percentage of net sales to 10.0 percent for the quarter ended September 30, 1996
from 5.9 percent for the quarter ended September 30, 1995, primarily as a result
of decreased sales.
Research and development expense totaled $1,074,000, or 8.2 percent of
net sales, for the quarter ended September 30, 1996 as compared with $770,000,
or 3.2 percent of net sales, for the quarter ended September 30, 1995. Research
and development expenses consist principally of salaries and benefits to
scientists and other personnel, related facilities costs, and various expenses
for projects. Research and development expense has increased as the Company has
invested in new technologies and manufacturing processes and has continued with
its in-house process development efforts related to the high-volume
manufacturing LCD line located in Tempe, Arizona. The Company believes that
continued investments in research and development relating to manufacturing
processes and new display technology are necessary to remain competitive in its
marketplace as well as providing opportunities for growth. Further, the
development of the high-volume manufacturing LCD line will help reduce its
dependence on foreign suppliers. Accordingly, the Company expects that research
and development expenses will continue to increase in absolute dollars for the
remainder of 1996 and on into 1997.
Interest income (net) for the quarter ended September 30, 1996 was
$90,000, down from $120,000 for the quarter ended September 30, 1995. The
decrease in interest income was the result of investing lower average cash
balances during the quarter. Other expenses (net) was $17,000 for the quarter
ended September 30, 1996 as compared with $14,000 for the quarter ended
September 30, 1995. The difference was due to increased foreign exchange loss,
decreased closed facilities expenses, a loss on sale of assets for the quarter
ended September 30, 1996 as compared to a gain on sale of assets for the quarter
ended September 30, 1996 and miscellaneous income for the quarter ended
September 30, 1996.
5
<PAGE>
There was a benefit from income taxes of $3,519,000 for the quarter
ended September 30, 1996 as compared to a provision for income taxes of $961,000
for the quarter ended September 30, 1995. This resulted primarily from a loss in
the quarter ended September 30, 1996, as compared with income in the same period
in 1995.
Net loss was $5,478,000, or $0.70 per share, for the quarter ended
September 30, 1996 as compared to net income of $1,383,000, or $0.17 per share,
for the quarter ended September 30, 1995. Without the provision for excess and
obsolete inventory, the net loss for the third quarter would have been
$1,179,000 or $0.15 per share.
Nine Months Ended September 30, 1996 Compared with Nine Months Ended September
- --------------------------------------------------------------------------------
30, 1995.
- ---------
Net sales were $45,657,000 for the nine months ended September 30,
1996, a decrease of 35.5 percent compared with net sales of $70,805,000 for the
nine months ended September 30, 1995. The Company's net sales have not been
subject to any significant seasonal fluctuations or variations. The sales
decrease was primarily a result of lower order rates from a major wireless
communications customer for existing product programs. The long product
development time in the custom business prevented the Company from quickly
replacing the phased out programs. In the nine-month period ended September 30,
1996, the Company's largest customer accounted for net sales of $31,523,000
compared with net sales of $57,035,000 to that customer for the nine months
ended September 30, 1995 for an overall decrease of 44.7 percent. The Company's
major customer accounted for approximately 69.0 percent of the net sales for the
nine months ended September 30, 1996 compared with approximately 80.6 percent
for the comparable period in 1995. All other customers accounted for net sales
of $14,134,000 for the nine months ended September 30, 1996 compared with net
sales of $13,770,000 for the nine months ended September 30, 1995.
Cost of sales, as a percentage of net sales, increased to 101.1 percent
for the nine months ended September 30, 1996 as compared with 75.6 percent for
the nine months ended September 30, 1995. The corresponding decline in the gross
margin was the result of a number of factors, including increased provisions for
excess and obsolete inventory, manufacturing variances occurring as a result of
decreased manufacturing volume and material purchases, and sales of low margin
rework products. Without the provision for excess and obsolete inventory taken
in the third quarter, the cost of sales, as a percentage of net sales, would
have been 85.7 percent for the nine month period.
Selling, general, and administrative expense increased to $4,246,000
for the nine months ended September 30, 1996 from $3,904,000 for the nine months
ended September 30, 1995. The 8.8 percent increase resulted primarily from
wages, legal, accounting and consulting expenses offset by lower directors and
officers insurance premiums and bad debt expense. Selling, general, and
administrative expense increased as a percentage of net sales to 9.3 percent for
the nine months ended September 30, 1996 from 5.5 percent for the nine months
ended September 30, 1995, primarily as a result of decreased sales. Research and
development expense totaled $2,904,000, or 6.4 percent of net sales, for the
nine months ended September 30, 1996 as compared with $1,576,000, or 2.2 percent
of net sales, for the nine months ended September 30, 1995. Research and
development expenses consist principally of salaries and benefits to scientists
and other personnel, related facilities costs, and various expenses for
projects. Research and development expense has increased as the Company has
invested in new technologies and manufacturing processes and has continued with
its in-house process development efforts related to the high-volume
manufacturing LCD line located in Tempe, Arizona
Interest income (net) for the nine months ended September 30, 1996 was
$242,000, down from $741,000 for the nine months ended September 30, 1995. The
decrease in interest income was the result of investing lower average cash
balances during the nine months. Other expenses (net) increased to $116,000 for
the nine months ended September 30, 1996 from $29,000 for the nine months ended
September 30, 1995. The increase was due primarily to increased closed
facilities expenses, increased foreign exchange loss and a loss on sale of
assets for the nine months ended September 30, 1996 as compared to a gain on
sale of assets for the nine months ended September 30, 1995.
There was a benefit from income taxes of $2,924,000 for the nine months
ended September 30, 1996 as compared to a provision for income taxes of
$5,011,000 for the nine months ended September 30, 1995. This
6
<PAGE>
resulted primarily from a loss in the nine months ended September 30, 1996 as
compared with income in the same period in 1995.
Net loss was $4,586,000, or $0.59 per share, for the nine months ended
September 30, 1996 as compared to net income of $7,516,000, or $0.93 per share,
for the nine months ended September 30, 1995. Without the provision for excess
and obsolete inventory taken in the third quarter, the net loss for the first
nine months in 1996 would have been $287,000 or $0.04 per share.
Liquidity and Capital Resources
During the nine months ended September 30, 1996, the Company generated
$8,766,000 in cash flow from operations as compared with $989,000 during the
same period in 1995. The increase in cash flow from operations with
substantially lower earnings was primarily due to the significant increase in
the Company's non-cash depreciation expense and inventory reserve provision as
well as the substantial reduction of its accounts receivable and inventory. The
Company's working capital decreased to $21,508,000 at September 30, 1996 from
$22,400,000 at December 31, 1995, primarily as a result of increased accrued
liabilities. The Company's current ratio at September 30, 1996 was 3.6-to-1 as
compared with a current ratio of 4.0-to-1 at December 31, 1995.
During the nine months ended September 30, 1996, the Company's primary
financing activity was to repay with cash flow from operations $3,000,000 of
debt that was outstanding under the revolving line of credit at December 31,
1995. In August 1996, the Company modified its $15.0 million unsecured revolving
line of credit, which matures May 31, 1997, with its primary lender, Wells Fargo
Bank (formerly, First Interstate Bank of Arizona). The unsecured revolving line
of credit modified the $5.0 million revolving line of credit entered into in
September 1995. At September 30, 1996, no borrowings were outstanding under this
credit facility. Advances under the revolving line may be made as Prime Rate
Advances, which accrue interest payable monthly, at the bank's prime lending
rate, or as LIBOR Rate Advances which bear interest at 150 basis points in
excess of the LIBOR Base Rate. The Company's subsidiary, Three-Five Systems
Limited, has established an annually renewable credit facility with a United
Kingdom bank, Barclays Bank PLC, in order to fund its working capital
requirements. The facility provides $350,000 of borrowing capacity secured by
accounts receivable of Three-Five Systems Limited. Advances are based on
accounts receivable, as defined. Advances under the credit facility accrue
interest, which is payable quarterly, at the bank's base rate plus 200 basis
points. The United Kingdom credit facility matures June 20, 1997. Three-Five
Systems Limited had no borrowings outstanding under this line of credit at
September 30, 1996.
On August 19, 1996, the Board of Directors authorized the repurchase
from time to time of up to one million shares of the Company's common stock on
the open market or in negotiated transactions, depending on market conditions
and other factors. The closing price of the Company's common stock on the
previous trading day was $8.75. In September 1996, the Company received a
commitment from Wells Fargo Bank for a new $5 million non-revolving line of
credit/term loan to provide financing for the acquisition of any treasury shares
(the "Treasury Stock Loan"). It is expected that the Treasury Stock Loan will be
available for advances for one year followed by a three year amortization period
in which principal will be payable quarterly in equal installments. Advances
under the Treasury Stock Loan will be made as either Prime Rate Advances, which
accrue interest payable monthly, at the bank's prime lending rate, or as LIBOR
Rate Advances which bear interest at 225 basis points in excess of the LIBOR
Base Rate. At maturity of the draw period, the Company may chose either a fixed
rate at 250 basis points in excess of the Treasury Rate or a variable rate of
either the Prime Rate or LIBOR Rate. The Treasury Stock Loan will be secured by
all equipment located in the State of Arizona and a non-filed negative pledge on
the Company's real estate located at 1600 N. Desert Drive. The Company must
apply all proceeds from the sale of any treasury stock to the outstanding
principal balance of the Treasury Stock Loan. As of September 30, 1996, no
treasury shares had been purchased by the Company.
Capital expenditures during the nine months ended September 30, 1996
were approximately $453,000, as compared with $26,119,000 during the same period
in 1995. Capital expenditures for the nine months ended September 30, 1996
consisted primarily of manufacturing equipment for its operations in Manila and
Arizona. Expenditures for the nine months ended September 30, 1995 consisted
primarily of payments to complete and equip its new manufacturing and
headquarters facility in Tempe, Arizona as well as acquire equipment for its
7
<PAGE>
operations in Manila and Arizona. The Company expects to expend approximately $1
million in the remainder of 1996 on capital equipment and expenditures related
to advanced manufacturing processes, the high-volume LCD line and necessary
manufacturing equipment.
The Company believes that its capital, together with the loan
commitments described above and anticipated cash flow from operations, will
provide adequate sources to fund operations in the near term. The Company
anticipates that any additional cash requirements as the result of operations or
capital expenditures will be financed through cash flow from operations or
borrowings from the Company's primary lender.
Effects of Inflation and Foreign Currency Exchange Fluctuations
The results of operations of the Company for the periods discussed have
not been significantly affected by inflation or foreign currency fluctuations.
The Company generally sells its products and services and negotiates purchase
orders with its foreign suppliers in United States dollars. Such transactions
expose the Company to exchange rate fluctuations for the period of time from
inception of the transaction until it is settled. An exception is the Company's
sub-assembly agreement in the Philippines, which is based on a fixed conversion
rate, exposing the Company to exchange rate fluctuations with the Philippine
peso. Although the Company has not incurred any material exchange gains or
losses to date, there can be no assurance that fluctuations in the currency
exchange rates in the future will not have an adverse effect on the Company's
operations. The Company from time to time may enter into hedging transactions in
order to minimize its exposure to currency rate fluctuations.
Business Outlook and Risk Factors
The principal challenge facing the Company in the near future is the
ongoing development of new programs to replace those older programs of the
Company's major customer that are being phased out more quickly than expected.
Due to the long product life cycle inherent in the custom business, however, the
Company will continue to be adversely impacted in the fourth quarter by the
unexpected phase out of those programs by the Company's major customer. The
adverse impact will occur through reduced revenue and margins, with the margins
expected to suffer principally from decreased absorption (as a result of
manufacturing inefficiencies from reduced sales). Although the Company expects
that revenue in the fourth quarter will improve over the third quarter, it is
possible that the Company may have a loss for the fourth quarter. However, the
Company has several new significant programs which are expected to begin
production late in the fourth quarter and in the first quarter of 1997. As a
result, it is the business plan of the Company for the revenues in 1997 to
return to 1995 levels or better. Further, the Company expects that increased
production and inventory turns in 1997 will allow the Company's gross margins to
gradually return to the low- or mid-twenties as a percent of revenue.
In the past several years, a majority of the Company's business has
been in the communications industry and has been with one customer. The Company
continues, however, to establish new customer relationships with major OEMs in
an effort to diversify its customer and market base. Of the 24 programs in
design engineering, only three are with the Company's major customer, although
each of those three programs are significant in size. Fifteen of those 24
programs are in industries other than communications. In 1997, the business plan
of the Company calls for its current major customer to account for approximately
40 percent of its revenue and for communication products to account for less
than 50 percent of its revenue.
The Company's future operating results may be affected by various
trends, developments and factors that the Company must successfully manage in
order to achieve favorable operating results. In addition, there are trends,
developments, and factors beyond the Company's control that may affect its
operations. In accordance with the provisions of the Private Securities
Litigation Reform Act of 1995, the cautionary statements and risk factors set
forth below and in the Company's other filings with the Securities and Exchange
Commission, including its Form 10-K, identify important trends, factors, and
currently known developments that could cause actual results to differ
materially from those in any forward-looking statements contained in this report
and in any written or oral statements of the Company. Forward-looking statements
in this report include revenue, margin, expense, and earnings analysis for the
remainder of 1996 and 1997 as well as the Company's expectations relating to
future design and production orders. Risk factors include the risk of having
just a few customers supplying the majority of its business, the ability of the
Company to complete satisfactory design services and secure future production
orders,
8
<PAGE>
the ability of the Company to penetrate new markets and diversify its customer
base, the impact of competitive products and pricing, product demand and
acceptance for the products of the Company's customers, manufacturing
inefficiencies, inventory risks, technological difficulties including the
ability of the Company to implement new manufacturing processes and ramp the LCD
line into full production, the availability of parts and supplies from
third-party suppliers on a timely basis and at reasonable prices, including the
availability of glass from its Asian suppliers and its own LCD line, and general
economic conditions.
As noted previously, one customer is currently responsible for a
majority of the Company's business. Although that customer is expected to
account for only 40 percent of the Company's revenue in 1997, the majority of
the Company's business in 1997 will still likely come from a core customer base.
Thus, any material delay, cancellation, or reduction of orders from one or more
of those core customers could have a material adverse effect on the Company's
operations.
Although the trend of the Company is to enter into more manufacturing
contracts with its customers, the principal benefit of these contracts is to
clarify order lead times, inventory risk allocation, and similar matters and not
to provide firm, long-term volume purchase commitments. The Company has no firm
long-term volume purchase commitments from its customers. Thus, customer
commitments can be canceled and expected volume levels can change or be delayed.
The timely replacement of canceled, delayed, or reduced commitments cannot be
assured and, among other things, could result in the Company holding excess and
obsolete inventory. These risks are exacerbated because a majority of the
Company's expected sales will be to customers in the electronics industry, which
is subject to severe competitive pressures, rapid technological change and
obsolescence.
Another risk, which is inherent in custom manufacturing, is the
satisfactory completion of design services and the securing of production
orders. Completion of the design is dependent on the customer's changing needs
and not every design is successful in meeting those needs. In addition, some
designs test new theories or applications and may not meet the desired results.
Failure of a design order to achieve the customer's desired results could result
in a material effect on the Company's operations if the expected production
order for that product was significant. It is expected that as much as
two-thirds of the Company's anticipated revenue for 1997 will come from programs
currently in the design or pilot production stage.
The Company designs and manufactures products based on firm quotes.
Thus, the Company bears the risk of component price increases, which could
adversely affect the Company's gross margins. In addition, the Company depends
on certain suppliers and the unavailability or shortage of materials could cause
delays or lost orders, either of which could have a material adverse effect on
the Company.
Finally, the Company's success, especially in penetrating new markets
and increasing its OEM customer base, depends to a large extent upon the efforts
and abilities of key managerial and technical employees. The loss of services of
certain key personnel could have a material adverse effect on the Company. The
Company's business also depends upon its ability to continue to attract and
retain senior managers and skilled employees. Failure to do so could adversely
effect the Company's operations.
As a result of the noted factors, the Company's stock price may be
subject to significant volatility, particularly on a quarterly basis. Any
shortfall in revenues or earnings from levels expected by investors and brokers
could have an immediate and significant adverse effect on the trading price of
the Company's common stock in any given period. Additionally, the Company may
not learn of such shortfalls until late in a fiscal quarter, which could result
in an even more immediate and adverse effect on the trading price of the
Company's common stock. Finally, other factors which generally affect the market
for stocks of high technology companies could cause the price of the Company's
stock to fluctuate substantially over short periods.
9
<PAGE>
PART II. OTHER INFORMATION
ITEM 6. Exhibits and Reports on Form 8-K
--------------------------------
(a) EXHIBIT 11: Statement Re: Computation of Per Share Earnings.
(b) EXHIBIT 27: Financial Data Schedule
(c) Reports on Form 8-K: None
10
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of
1934, the Registrant has duly caused this report to be signed on its behalf by
the undersigned thereunto duly authorized.
THREE-FIVE SYSTEMS, INC.
------------------------
(Registrant)
Dated:_______________ By ______________________
Jeffrey D. Buchanan
Its: Vice President Finance, Administration
and Legal; Chief Financial Officer
11
THREE-FIVE SYSTEMS, INC.
STATEMENT RE: COMPUTATION OF PER SHARE EARNINGS
EXHIBIT 11
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
--------------------------- ---------------------------
1996 1995 1996 1995
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Common shares outstanding beginning of period 7,775,129 7,709,004 7,735,745 7,691,524
Effect of Weighting Shares:
Employee stock options exercised 4,363 12,273 27,942 17,976
Employee stock options outstanding -- 367,041 -- 376,954
----------- ----------- ----------- -----------
Primary 7,779,492 8,088,318 7,763,687 8,086,454
=========== =========== =========== ===========
Common shares outstanding beginning of period 7,775,129 7,709,004 7,735,745 7,691,524
Effect of Weighting Shares:
Employee stock options exercised 4,363 12,273 27,942 17,976
Employee stock options outstanding -- 367,041 -- 376,970
----------- ----------- ----------- -----------
Fully diluted 7,779,492 8,088,318 7,763,687 8,086,470
=========== =========== =========== ===========
Net income (loss) $(5,478,000) $ 1,383,000 $(4,586,000) $ 7,516,000
=========== =========== =========== ===========
NET INCOME (LOSS) PER COMMON AND
COMMON EQUIVALENT SHARES:
Net income (loss) per share
Primary $ (0.70) $ 0.17 $ (0.59) $ 0.93
=========== =========== =========== ===========
Fully diluted $ (0.70) $ 0.17 $ (0.59) $ 0.93
=========== =========== =========== ===========
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL
INFORMATION EXTRACTED FROM THE CONSOLIDATED
BALANCE SHEET AT SEPTEMBER 30, 1996 AND THE
RELATED CONSOLIDATED STATEMENTS OF INCOME AND OF
CASH FLOWS FOR THE NINE MONTHS ENDED SEPTEMBER 30,
1996 OF THREE-FIVE SYSTEMS, INC. AND ITS
SUBSIDIARIES AND IS QUALIFIED IN ITS ENTIRETY BY
REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<CURRENCY> U.S. Dollars
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> SEP-30-1996
<EXCHANGE-RATE> 1
<CASH> 9,878
<SECURITIES> 0
<RECEIVABLES> 4,686
<ALLOWANCES> 0
<INVENTORY> 6,215
<CURRENT-ASSETS> 29,851
<PP&E> 31,334
<DEPRECIATION> 0
<TOTAL-ASSETS> 61,522
<CURRENT-LIABILITIES> 8,343
<BONDS> 0
0
0
<COMMON> 78
<OTHER-SE> 0
<TOTAL-LIABILITY-AND-EQUITY> 61,522
<SALES> 45,657
<TOTAL-REVENUES> 45,657
<CGS> 46,143
<TOTAL-COSTS> 53,293
<OTHER-EXPENSES> 116
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> (7,510)
<INCOME-TAX> (2,924)
<INCOME-CONTINUING> (4,586)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (4,586)
<EPS-PRIMARY> (0.59)
<EPS-DILUTED> (0.59)
</TABLE>
