<PAGE> 1
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, 1997
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.
<TABLE>
<CAPTION>
CLASS OUTSTANDING AS OF SEPTEMBER 30, 1997
- ----- ------------------------------------
<S> <C>
Common 7,887,273
Par value $.01 per share
</TABLE>
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THREE-FIVE SYSTEMS, INC.
QUARTERLY REPORT ON FORM 10-Q
FOR THE QUARTER ENDED SEPTEMBER 30, 1997
TABLE OF CONTENTS
PART I - FINANCIAL INFORMATION
<TABLE>
<CAPTION>
Page
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<S> <C> <C>
ITEM 1. FINANCIAL STATEMENTS:
Consolidated Balance Sheets-
September 30, 1997 and December 31, 1996...............................................1
Consolidated Statements of Income (loss)-
Three Months and Nine Months Ended September 30, 1997 and 1996.........................2
Consolidated Statements of Cash Flows-
Nine Months Ended September 30, 1997 and 1996..........................................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>
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THREE-FIVE SYSTEMS, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands)
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1997 1996
---- ----
(Unaudited)
ASSETS
<S> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents $10,198 $12,580
Accounts receivable, net 13,792 6,830
Inventories, net 10,148 4,606
Deferred tax asset 4,863 5,930
Other current assets 273 1,384
-------- --------
Total current assets 39,274 31,330
PROPERTY, PLANT AND EQUIPMENT, net 30,355 30,913
COST IN EXCESS OF NET ASSETS ACQUIRED, net 101 130
OTHER ASSETS 192 196
-------- --------
$69,922 $62,569
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 7,347 $ 4,289
Accrued liabilities 5,498 4,524
Income taxes payable 891 1,004
-------- --------
Total current liabilities 13,736 9,817
-------- --------
DEFERRED TAX LIABILITY 1,568 1,568
-------- --------
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY:
Preferred stock - -
Common stock 79 78
Additional paid-in capital 32,372 32,329
Retained earnings 22,373 19,016
Cumulative translation adjustment 47 14
Less - Treasury Stock at cost (22,500 shares) (253) (253)
-------- --------
Total stockholders' equity 54,618 51,184
-------- --------
$69,922 $62,569
========= =========
</TABLE>
The accompanying notes are an integral part of these consolidated balance
sheets.
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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,
1997 1996 1997 1996
---- ---- ---- ----
<S> <C> <C> <C> <C>
NET SALES $ 24,074 $ 13,118 $ 58,940 $ 45,657
----------- ----------- ----------- -----------
COSTS AND EXPENSES:
Cost of sales 18,511 19,798 45,376 46,143
Selling, general and administrative 1,822 1,316 4,767 4,246
Research and development 1,314 1,074 3,759 2,904
----------- ----------- ----------- -----------
21,647 22,188 53,902 53,293
----------- ----------- ----------- -----------
Operating income (loss) 2,427 (9,070) 5,038 (7,636)
OTHER INCOME (EXPENSE):
Interest, net 152 90 463 242
Other, net (41) (17) (60) (116)
----------- ----------- ----------- -----------
INCOME (LOSS) BEFORE PROVISION FOR
(BENEFIT FROM) INCOME TAXES 2,538 (8,997) 5,441 (7,510)
Provision for (benefit from) income 1,010 (3,519) 2,084 (2,924)
taxes
----------- ----------- ----------- -----------
NET INCOME (L0SS) $ 1,528 $ (5,478) $ 3,357 $ (4,586)
=========== =========== =========== ===========
EARNINGS (LOSS) PER COMMON SHARE
AND COMMON SHARE EQUIVALENT $ 0.19 $ (0.70) $ 0.42 $ (0.59)
=========== =========== =========== ===========
WEIGHTED AVERAGE NUMBER OF
COMMON SHARES AND COMMON
SHARE EQUIVALENTS OUTSTANDING 8,181,152 7,779,492 8,081,632 7,763,687
=========== =========== =========== ===========
</TABLE>
The accompanying notes are an integral part of these consolidated statements.
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THREE-FIVE SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(in thousands)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30,
1997 1996
---- ----
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $ 3,357 $(4,586)
Adjustments to reconcile net income (loss) to net cash
Provided by operating activities:
Depreciation and amortization 3,066 2,626
Provision of accounts receivable valuation reserves (108) 46
Provision (reduction) of inventory valuation reserves (1,620) 6,203
Loss on disposal of assets 3 15
Change in assets and liabilities:
(Increase) decrease in accounts receivable (6,854) 4,614
(Increase) decrease in inventories (3,922) 1,285
(Increase) decrease in other assets 1,114 (671)
Increase in accounts payable and accrued liabilities 4,032 3,826
Increase (decrease) in taxes payable, net 954 (4,592)
-------- -------
Net cash provided by operating activities 22 8,766
-------- -------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property, plant and equipment (2,498) (453)
Proceeds from sale of furniture and equipment 16 1
-------- -------
Net cash used in investing activities (2,482) (452)
-------- -------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net payments on notes payable to banks -- (3,000)
Stock options exercised 44 13
-------- -------
Net cash provided by (used in) financing activities 44 (2,987)
-------- -------
Effect of exchange rate changes on cash and cash equivalents 34 --
-------- -------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (2,382) 5,327
CASH AND CASH EQUIVALENTS, beginning of period 12,580 4,551
-------- -------
CASH AND CASH EQUIVALENTS, end of period $ 10,198 $ 9,878
======== =======
</TABLE>
The accompanying notes are an integral part of these consolidated statements.
3
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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, 1997 are not necessarily indicative of
the operating results that may be expected for the entire year
ending December 31, 1997. These financial statements should be
read in conjunction with the Company's December 31, 1996
consolidated 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 loss per share as the effect was antidilutive. For
all other periods presented, common share equivalents have been
included in the calculation of earnings per share. Fully diluted
earnings (loss) per share are considered equal to primary earnings
(loss) per share in all periods presented. Effective January 1,
1998, the Company will adopt Statement of Financial Accounting
Standards (SFAS) No. 128, "Earnings per Share." At that time, the
Company will be required to change the method currently used to
calculate earnings per share and to restate all prior periods. The
new requirements will include a calculation of basic earnings per
share, from which the dilutive effect of stock options and
warrants will be excluded. The basis earnings (loss) per share
calculated pursuant to SFAS No. 128 for the three months ended
September 30, 1997 and 1996 is $0.19 and $(0.70), respectively,
and for the nine months ended September 30, 1997 and 1996 is $0.43
and $(0.59), respectively. Diluted earnings (loss) per share
calculated pursuant to SFAS No. 128 for the three months ended
September 30, 1997 and 1996 is $0.19 and $(0.70), respectively,
and for the nine months ended September 30, 1997 and 1996 is $0.41
and $(0.59), respectively.
Note C Inventories consist of the following at:
<TABLE>
<CAPTION>
September 30, 1997 December 31, 1996
------------------ -----------------
(Unaudited)
(in thousands)
<S> <C> <C>
Raw Materials $ 7,927 $ 3,147
Work-in-Process 1,467 780
Finished Goods 754 679
------- -------
$10,148 $ 4,606
======= =======
</TABLE>
Note D Property, plant, and equipment consist of the following at:
<TABLE>
<CAPTION>
September 30, 1997 December 31, 1996
------------------ -----------------
(Unaudited)
(in thousands)
<S> <C> <C>
Building and Improvements $ 10,431 $10,431
Furniture and Equipment 31,274 28,776
------- -------
$41,705 $39,207
Less, accumulated depreciated (11,350) (8,294)
--------- -------
$ 30,355 $30,913
========= =======
</TABLE>
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Three Months Ended September 30, 1997 Compared with Three Months Ended September
30, 1996.
Net sales were $24.1 million for the quarter ended September 30, 1997,
an increase of 83.9 percent compared with net sales of $13.1 million for the
quarter ended September 30, 1996. The Company's net sales have not been subject
to any significant seasonal fluctuations or variations. The sales increase in
the quarter ending September 30, 1997 was as a result of several new major
programs in 1997 for a variety of customers, including a major office automation
customer.
Cost of sales, as a percentage of net sales, decreased to 76.9 percent
for the quarter ended September 30, 1997 as compared with 150.9 percent for the
quarter ended September 30, 1996. The corresponding increase in the gross margin
in the third quarter was the result of a number of factors, including decreased
provisions for excess and obsolete inventory and decreased unfavorable
manufacturing variances occurring as a result of increased labor utilization and
material purchases. In the quarter ended September 30, 1996, the Company took a
special one-time provision for excess and obsolete inventory. Without the
special provision, the cost of sales in that quarter would have been 97.3
percent of net sales.
Selling, general, and administrative expense increased to $1.8 million
for the quarter ended September 30, 1997 from $1.3 million for the quarter ended
September 30, 1996. Selling, general, and administrative expense decreased as a
percentage of net sales to 7.6 percent for the quarter ended September 30, 1997
from 10.0 percent for the quarter ended September 30, 1996 primarily as a result
of increased sales. Selling, general and administrative expenses have increased
in absolute terms as the result of increased selling expenses and the addition
of administrative personnel.
Research and development expense totaled $1.3 million, or 5.5 percent
of net sales, for the quarter ended September 30, 1997 as compared with $1.1
million, or 8.2 percent of net sales, for the quarter ended September 30, 1996.
Research and development expenses consist principally of salaries and benefits
to scientists and other personnel, related facilities costs, process development
costs, and various expenses for projects, including new product development.
Research and development expense has increased as the Company has worked to
develop new display products and technologies while continuing with its in-house
process development efforts related to the high-volume manufacturing LCD line
located in Tempe, Arizona.
Interest income (net) for the quarter ended September 30, 1997 was
$152,000, up from $90,000 for the quarter ended September 30, 1996. The increase
in interest income was the result of investing higher average cash balances
during the quarter. Other expense (net) was $41,000 for the quarter ended
September 30, 1997, as compared with $17,000 for the quarter ended September 30,
1996. The difference was due primarily to increased foreign currency transaction
losses for the quarter ended September 30, 1997.
The provisions for income taxes increased to $1 million for the quarter
ended September 30, 1997 from a benefit of $3,519,000 for the quarter ended
September 30, 1996. This difference resulted primarily from having pre-tax
income for the quarter ended September 30, 1997 as compared with a loss for the
same period in 1996.
Net income was $1.5 million, or $0.19 per share, for the quarter ended
September 30, 1997 as compared with a net loss of $5,478,000, or $0.70 per
share, for the quarter ended September 30, 1996.
Nine Months Ended September 30, 1997 Compared with Nine Months Ended September
30, 1996.
Net sales were $58.9 million for the nine months ended September 30,
1997, an increase of 28.9 percent compared with net sales of $45.7 million for
the nine months ended September 30, 1996. The Company's net sales have not been
subject to any significant seasonal fluctuations or variations. The sales
increase was primarily a result of several new programs for new and existing
customers. In the nine-month period ended September 30, 1997, the Company had
two customers that each accounted for slightly less than 33 percent of the
Company's net sales. For
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the comparable period in 1996, those two customers accounted for 69.0 percent
and less than one percent, respectively, of the Company's net sales.
Cost of sales, as a percentage of net sales, was 77 percent for the
nine months ended September 30, 1997 as compared with 101.1 percent for the nine
months ended September 30, 1996. The corresponding increase in the gross margin
was the result of a number of factors, including decreased provisions for excess
and obsolete inventory and favorable manufacturing variances occurring as a
result of increased labor utilization and material purchases.
Selling, general, and administrative expense of $4.8 million for the
nine months ended September 30, 1997 increased from $4.2 million for the nine
months ended September 30, 1996, with such increase primarily attributed to
increased selling expenses and additional administrative personnel. Selling,
general, and administrative expense decreased as a percentage of net sales to
8.1 percent for the nine months ended September 30, 1997 from 9.3 percent for
the nine months ended September 30, 1996, primarily as a result of increased
sales. Research and development expense totaled $3.8 million, or 6.4 percent of
net sales, for the nine months ended September 30, 1997 as compared with $2.9
million, or 6.3 percent of net sales, for the nine months ended September 30,
1996. The increase in research and development expense was as a result of the
Company's continued focus on the development of advanced display technologies
and development of its in-house efforts relative to the high-volume
manufacturing LCD line.
Interest income (net) for the nine months ended September 30, 1997 was
$463,000 up from $242,000 for the nine months ended September 30, 1996. The
increase in interest income was the result of investing higher average cash
balances during the nine months ended September 30, 1997. Other expense (net)
decreased to $60,000 for the nine months ended September 30, 1997 from $116,000
for the nine months ended September 30, 1996. The decrease was due primarily to
decreased closed facilities expenses and decreased loss on sale of assets for
the nine months ended September 30, 1997.
The provisions for income taxes was $2.1 million for the nine months
ended September 30, 1997 as compared to a benefit of $2.9 million for the nine
months ended September 30, 1996. This difference resulted primarily from having
pre-tax income in the nine months ended September 30, 1997 as compared with a
loss for the same period in 1996.
Net income was $3.4 million, or $0.42 per share, for the nine months
ended September 30, 1997 as compared with a net loss of $4.6 million, or $0.59
per share, for the nine months ended September 30, 1996.
LIQUIDITY AND CAPITAL RESOURCES
During the nine months ended September 30, 1997, the Company generated
$22,000 in cash flow from operations as compared with $8,766,000 during the
first nine months of 1996. The decrease in the amount of positive cash flow from
operations was primarily due to (i) an increase in inventory balances and (ii)
an increase in accounts receivable for the first nine months of 1997 versus the
reduction in accounts receivable that occurred in the first nine months of 1996.
The increase in inventory balances and accounts receivable has occurred
primarily as a result of the increased sales activity.
Overall, the Company's depreciation expense for the nine months ended
September 30, 1997 is 17 percent higher than for the same period in 1996. The
high-volume LCD line is depreciated on a units-of-production method based on
units started. It is anticipated that depreciation will continue to rise in 1997
as a result of an expected higher number of starts for the high-volume LCD
manufacturing line in 1997 versus 1996, as well as having additional capital
expenditures in 1997. The Company's working capital increased to $25.5 million
at September 30, 1997 from the $21.5 million that it had at December 31, 1996.
The Company's current ratio at September 30, 1997 was 2.86-to-1 as compared with
a ratio of 3.2-to-1 at December 31, 1996.
In May 1997, the Company entered into a new $15 million unsecured
revolving line of credit with Imperial Bank, which matures May 31, 1998. At
September 30, 1997, no borrowings were outstanding under this credit facility.
Advances under the revolving line may be made as Prime Rate Advances, which
accrue interest payable
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monthly, at the bank's prime lending rate, or as LIBOR Rate Advances which bear
interest at 175 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, 1998.
Three-Five Systems Limited had no borrowings outstanding under this line of
credit at September 30, 1997.
In August 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. As of September 30, 1997, a total of 22,500 treasury shares had
been purchased by the Company under the repurchase program at a cost of
$253,000.
Capital expenditures during the nine months ended September 30, 1997
were approximately $2.5 million, as compared with $453,000 during the same
period of 1996. Capital expenditures for the nine months ended September 30,
1997 have consisted primarily of manufacturing and office equipment for the
Company's operations in Manila and Arizona and laboratory equipment for research
and development. The Company anticipates that its capital expenditures should
continue at a similar pace during the remainder of 1997 and then increase for
1998. Those expenditures will primarily relate to advanced manufacturing
processes, the high-volume LCD line, and other manufacturing equipment. In late
1998, the Company will likely expand its overseas manufacturing capabilities.
The Company anticipates the facilities and capital costs for such expansion to
be in the range of $3 million to $4 million. In addition, in early 1998 the
Company anticipates expending approximately $2 million on the capital equipment
necessary to begin manufacturing liquid crystal on silicon (LCOS) microdisplays.
It is expected that there will be significant additional expenditures in 1999 to
increase the LCOS capacity.
The Company anticipates that accounts receivable and inventory will
continue to rise if revenue levels increase. The Company believes that its
existing capital and anticipated cash flow from operations will provide adequate
sources to fund operations throughout 1997 and 1998 without any need for
borrowings. Should the Company encounter unexpected additional cash
requirements, however, the Company believes that its existing loan commitments
of $15 million will be adequate. The Company also expects that its existing
capital, anticipated cash flow from operations, and existing loan commitments
will provide adequate sources for its long-term liquidity and capital
requirements, such as expansion of its manufacturing facilities overseas.
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. An exception is the
Company's Philippine labor force, which is paid in Philippine pesos and exposes
the Company to exchange rate fluctuations between the Philippine peso and the
U.S. dollar. Although the Company has not incurred any material exchange gains
or losses to date, there has been some minor benefit in the three months ending
September 30, 1997 as a result of the recent peso devaluation. If the peso
devaluation were to continue, any benefit to the Company will likely be offset
in the coming quarters by an increase in the Philippine labor rates and costs.
There can be no assurance that fluctuations in 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
Business Outlook
This Business Outlook section has numerous forward-looking statements.
Some of the risk factors associated with those forward-looking statements are
set forth in "Risk Factors" below. Other important risk factors are set forth in
the Company's other filings with the Securities and Exchange Commission.
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The Company offers advanced design and manufacturing services to
original equipment manufacturers. The Company specializes in custom displays and
front panel displays utilizing liquid crystal display (LCD) and light emitting
diode (LED) components and technology. The Company experienced substantial
growth from 1993 through 1995 with such growth dependent primarily upon the
Company's participation in the substantial growth of the wireless communications
market and sales to a single major customer in that industry. In 1996, the
Company's sales declined, largely as a result of the phase-out by that major
customer of a significant family of programs in early 1996.
The Company has had substantial growth in its revenues in the last
several quarters with a 50 percent rate of growth since the first quarter of
this year. This growth occurred because several strong new programs began
production while many existing programs were in the middle of their life cycles.
Although the Company expects some significant new programs to begin production
in the next few quarters, several existing programs are nearing the completion
of their natural life cycles. As a result the revenue from these new programs
will be partially offset by the completion of the older programs and, although
the Company plans for sequential growth, the rate of the Company's revenue
growth over the next few quarters will likely be modest. If additional programs
currently in development ramp their production levels up in mid-1988 as
anticipated, the Company should resume a more accelerated growth rate. It is the
stated desire of the Company to achieve a 25 to 30 percent compounded annual
growth rate in revenues from year to year.
In the past several quarters, the Company has undertaken substantial
efforts to diversify its business, broaden its customer base, and expand its
markets, and the Company intends to continue those efforts. The Company's
historical major customer, who accounted for approximately 80 percent of the
Company's revenue in 1995, accounted for slightly less than 33 percent of the
Company's revenue in the first nine months of 1997. This reduced percentage
occurred as a result of the increased sales to other customers and reduced
product selling prices and revenues from that major customer. The percentage of
revenue attributed to that wireless communications customer may increase over
the next few quarters, but the current business plan of the Company targets that
customer to account for no more than 40 percent of its revenue. Another customer
also accounted for slightly less than 33 percent of the Company's revenue for
the first nine months of 1997, but this percentage is expected to drop over the
next few quarters as current programs reach the end of their cycles and
replacements programs with lower selling prices are introduced.
The Company's gross margins are impacted by several factors, including
manufacturing efficiencies, product differentiation, product uniqueness,
billings for non-recurring engineering services, product mix, and volume
pricing. Generally, higher-volume programs using more generic, low-information
content LCD displays have lower margins. In addition, many of the Company's
competitors are Asian suppliers, and a strong dollar gives a competitive pricing
advantage to those suppliers. As the production levels of some of the Company's
new high-volume programs increase in early 1998, the standard gross margins on
those programs, which are generally lower, may have more of an impact on the
Company's overall margins. It is the goal of the Company, however, for increased
manufacturing efficiencies to occur on those high-volume programs to help
maintain its gross margins at existing levels. The Company expects that a
variety of factors, including more advanced display modules commanding higher
margins, should enable the Company's margins to eventually rise into the
mid-twenty range in late 1998.
As the Company expands and diversifies its product and customer base,
it may have to further increase its selling and administrative expenses. Serving
a myriad of customers with complex and differing issues requires increased
personnel committed to those customers. As a result, the actual dollar amount of
the selling, general, and administrative expenses in 1997 should be 20 to 25
percent greater than in 1996, although SG&A expenditures as a percentage of net
sales should continue decreasing in 1997.
The Company believes that continued investments in research and
development relating to new display technology and manufacturing processes are
necessary to remain competitive in the marketplace as well as providing
opportunities for growth. In 1996, the Company began to expand and intensify its
internal research and development to focus on proprietary display products
rather than emphasizing manufacturing process improvements. Use of the LCD
manufacturing line in Tempe, Arizona as a resource for the testing of the new
ideas is the key to the development of these products, some of which will be
proprietary and not available from other display manufacturers. Further, the
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development of the high-volume manufacturing LCD line has helped reduce the
Company's dependence on foreign suppliers of LCD glass.
The Company also intends to pursue technologies being developed in
related fields. The Company operates the highest volume LCD manufacturing line
in North America. As a result, several companies have approached the Company
about potential alliances. The Company believes that a strategic alliance with
one or more of those companies could minimize the cost of entry into new markets
and new technologies. In August 1997, National Semiconductor Corporation and the
Company entered into a strategic alliance agreement for the development and
manufacture of liquid crystal on silicon (LCOS) microdisplays. Under the
alliance, the two companies are working together in developing the LCOS
technology with each company focusing on its core competency of silicon and
LCDs, respectively. Once manufacturing begins, the companies will act as
exclusive suppliers to one another with National supplying the silicon and the
Company supplying the LCD manufacturing.
The Company is also considering licensing technologies from other
companies that could be optimized on the LCD manufacturing line. This internal
and external focus on research and development will continue indefinitely. As a
result, the actual dollar amount of such expenditures in 1997 should be 20 to 25
percent greater than in 1996, although R&D expenditures should decrease in 1997
as a percentage of net sales.
Risk Factors
Forward-looking statements in this report include revenue, margin,
expense, and earnings analysis for 1997 and 1998 as well as the Company's
expectations relating to future technologies and future design and production
orders. 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 its goals. In addition, there are trends, developments, and
factors beyond the Company's control that may affect its operations. The
cautionary statements and risk factors set forth below and elsewhere in this
document, and in the Company's other filings with the Securities and Exchange
Commission, 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.
As noted previously, two customers are each currently responsible for
slightly less than 33 percent of the Company's revenue. As a result, the
majority of the Company's revenue comes 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 be changed or
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 or having unfavorable manufacturing variances as a
result of under-absorption. These risks are exacerbated because the Company
expects that a majority of its sales will be to customers in the retail
electronics industry, which is subject to severe competitive pressures, rapid
technological change, and obsolescence.
Another risk inherent in custom manufacturing is the satisfactory
completion of design services and securing of production orders. A significant
portion of the Company's anticipated revenue for the future will come from
programs currently in the design or pilot production stage. Completion of the
design is dependent on a variety of factors, including 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 adverse effect on the Company's operations if the
expected production order for that product was significant. Finally, even when a
design is satisfactorily completed, the customer may terminate or delay the
program as a result of marketing or other pressures. The Company is expected to
introduce several new products over the next few years. These new products will
require significant expenditures,
9
<PAGE> 12
including expenses for custom integrated circuits as well as various capital
expenditures for manufacturability. For example, LCOS microdisplays will
initially require approximately $2 million of capital expenditures. The failure
of the Company to sell LCOS microdisplays for any reason could have a material
adverse impact on the Company.
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. Recently, several material components of some of
the Company's major programs have been subject to allocation because of
shortages by vendors and continued or increased shortages could have a material
adverse effect on the Company in the future.
The Company is currently spending research and development dollars on
several new technologies that it plans to introduce in the future. There is a
risk that some or all of those technologies may not successfully make the
transition from the research and development lab to cost-effective
manufacturability, and such failure could have a material adverse effect on the
Company. Risks include technology problems, competitive cost issues, and yield
problems. In addition, even if a new technology proves to be manufacturable, it
may not be accepted by the Company's customer and the customer's marketplace
because of price or technology issues or it may compare unfavorably with
products previously introduced by others.
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
affect the Company's operations.
As a result of the foregoing and other factors, the Company's stock
price may be subject to significant volatility, particularly on a quarterly
basis. Any shortfall in revenue or earnings from levels expected by investors,
analysts, 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 common stock to fluctuate substantially over
short periods for reasons unrelated to the Company's performance.
PART II. OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBIT 11: Statement Re: Computation of Per Share Earnings.
EXHIBIT 27: Financial Data Schedule
(b) Reports on Form 8-K: None
10
<PAGE> 13
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: October 13,1997 By: /s/ Jeffrey D. Buchanan
------------------------ -------------------------------------
Name: Jeffrey D. Buchanan
Its: Vice President Finance,
Administration and Legal;
Chief Financial Officer
11
<PAGE> 1
THREE-FIVE SYSTEMS, INC.
STATEMENT RE: COMPUTATION OF PER SHARE EARNINGS
EXHIBIT 11
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
1997 1996 1997 1996
---- ---- ---- ----
<S> <C> <C> <C> <C>
Common shares outstanding beginning of period 7,854,985 7,775,129 7,757,329 7,735,745
Effect of Weighting Shares:
Employee stock options exercised 19,443 4,363 76,348 27,942
Employee stock options outstanding 306,724 -- 247,955 --
---------- ----------- ---------- -----------
Primary 8,181,152 7,779,492 8,081,632 7,763,687
========== =========== ========== ===========
Common shares outstanding beginning of period 7,854,985 7,775,129 7,757,329 7,735,745
Effect of Weighting Shares:
Employee stock options exercised 19,443 4,363 76,349 27,942
Employee stock options outstanding 306,983 -- 277,462 --
---------- ----------- ---------- -----------
Fully diluted 8,181,411 7,779,492 8,111,140 7,763,687
========== =========== ========== ===========
Net income (loss) $1,528,000 $(5,478,000) $3,357,000 $(4,586,000)
========== =========== ========== ===========
NET INCOME (LOSS) PER COMMON
AND COMMON EQUIVALENT SHARES:
Net income (loss) per share
Primary $ 0.19 $ (0.70) $ 0.42 $ (0.59)
========== =========== ========== ===========
Fully diluted $ 0.19 $ (0.70) $ 0.41 $ (0.59)
========== =========== ========== ===========
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED BALANCE SHEET AT SEPTEMBER 30, 1997 AND THE RELATED CONSOLIDATED
STATEMENTS OF INCOME AND OF CASH FLOWS FOR THE NINE MONTHS ENDED SEPTEMBER 30,
1997 OF THREE-FIVE SYSTEMS, INC. AND ITS SUBSIDIARIES AND IS QUALIFIED IN ITS
ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. THIS EXHIBIT SHALL NOT BE
DEEMED FILED FOR PURPOSES OF SECTION 11 OF THE SECURITIES ACT OF 1933 AND
SECTION 18 OF THE SECURITIES EXCHANGE ACT OF 1934, OR OTHERWISE SUBJECT TO THE
LIABILITY OF SUCH SECTIONS, NOR SHALL IT BE DEEMED A PART OF ANY OTHER FILING
WHICH INCORPORATES THIS REPORT BY REFERENCE, UNLESS SUCH OTHER FILING EXPRESSLY
INCORPORATES THIS EXHIBIT BY REFERENCE.
</LEGEND>
<MULTIPLIER> 1,000
<CURRENCY> U.S. DOLLARS
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> SEP-30-1997
<EXCHANGE-RATE> 1
<CASH> 10,198
<SECURITIES> 0
<RECEIVABLES> 14,207
<ALLOWANCES> 415
<INVENTORY> 10,148
<CURRENT-ASSETS> 39,274
<PP&E> 41,705
<DEPRECIATION> 11,350
<TOTAL-ASSETS> 69,922
<CURRENT-LIABILITIES> 13,736
<BONDS> 0
0
0
<COMMON> 79
<OTHER-SE> 0
<TOTAL-LIABILITY-AND-EQUITY> 69,922
<SALES> 58,940
<TOTAL-REVENUES> 58,940
<CGS> 45,376
<TOTAL-COSTS> 53,902
<OTHER-EXPENSES> 60
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 5,441
<INCOME-TAX> 2,084
<INCOME-CONTINUING> 3,357
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 3,357
<EPS-PRIMARY> 0.42
<EPS-DILUTED> 0.42
</TABLE>
