<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 June 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 JUNE 30, 1997
- ----- -------------------------------
<S> <C>
Common 7,854,985
Par value $.01 per share
</TABLE>
<PAGE> 2
THREE-FIVE SYSTEMS, INC.
QUARTERLY REPORT ON FORM 10-Q
FOR THE QUARTER ENDED JUNE 30, 1997
TABLE OF CONTENTS
PART I - FINANCIAL INFORMATION
Page
ITEM 1. FINANCIAL STATEMENTS:
Consolidated Balance Sheets-
June 30, 1997 and December 31, 1996........................1
Consolidated Statements of Income-
Three Months and Six Months Ended June 30, 1997 and 1996...2
Consolidated Statements of Cash Flows-
Six Months Ended June 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 4. SUBMISSIONS OF MATTERS TO A VOTE OF SECURITY HOLDERS............11
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K................................11
SIGNATURES..................................................................12
<PAGE> 3
THREE-FIVE SYSTEMS, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands)
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1997 1996
---- ----
(Unaudited)
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $11,661 $12,580
Accounts receivable, net 9,777 6,830
Inventories, net 7,864 4,606
Deferred tax asset 4,863 5,930
Other current assets 674 1,384
------- -------
Total current assets 34,839 31,330
PROPERTY, PLANT AND EQUIPMENT, net 30,995 30,913
COST IN EXCESS OF NET ASSETS ACQUIRED, net 111 130
OTHER ASSETS 194 196
------- -------
$66,139 $62,569
======= =======
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 6,109 $ 4,289
Accrued liabilities 5,143 4,524
Current taxes payable 269 1,004
------- -------
Total current liabilities 11,521 9,817
------- -------
DEFERRED TAX LIABILITY 1,568 1,568
------- -------
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY:
Preferred stock -- --
Common stock 79 78
Additional paid-in capital 32,365 32,329
Retained earnings 20,845 19,016
Cumulative translation adjustment 14 14
Less - Treasury Stock at cost (22,500 shares) (253) (253)
------- -------
Total stockholders' equity 53,050 51,184
------- -------
$66,139 $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
(UNAUDITED)
(in thousands, except share amounts)
<TABLE>
<CAPTION>
THREE MONTHS SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
---------------------------- ----------------------------
1997 1996 1997 1996
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
NET SALES $ 18,737 $ 14,457 $ 34,866 $ 32,539
---------- ---------- ---------- ----------
COSTS AND EXPENSES:
Cost of sales 14,377 11,944 26,865 26,345
Selling, general and administrative 1,479 1,471 2,945 2,930
Research and development 1,315 820 2,445 1,830
---------- ---------- ---------- ----------
17,171 14,235 32,255 31,105
---------- ---------- ---------- ----------
Operating income 1,566 222 2,611 1,434
OTHER INCOME (EXPENSE):
Interest, net 154 133 311 152
Other, net (7) (72) (19) (99)
---------- ---------- ---------- ----------
INCOME BEFORE PROVISION FOR
INCOME TAXES 1,713 283 2,903 1,487
Provision for income taxes 685 113 1,074 595
---------- ---------- ---------- ----------
NET INCOME $ 1,028 $ 170 $ 1,829 $ 892
========== ========== ========== ==========
EARNINGS PER COMMON SHARE
AND COMMON SHARE EQUIVALENT $ 0.13 $ 0.02 $ 0.23 $ 0.11
========== ========== ========== ==========
WEIGHTED AVERAGE NUMBER OF
COMMON SHARES AND COMMON
SHARE EQUIVALENTS OUTSTANDING 8,059,974 8,032,263 8,053,217 8,036,766
========== ========== ========== ==========
</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>
SIX MONTHS ENDED
JUNE 30,
----------------------
1997 1996
------- -------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 1,829 $ 892
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 2,034 1,739
Provision (reduction) of accounts receivable valuation reserves (174) 49
Provision (reduction) of inventory valuation reserves (980) 1,567
Loss on disposal of assets 3 11
Change in assets and liabilities:
(Increase) decrease in accounts receivable (2,773) 5,171
Increase in inventories (2,278) (3,106)
(Increase) decrease in other assets 712 (147)
Increase in accounts payable and accrued liabilities 2,439 519
Increase in taxes payable, net 332 601
------- -------
Net cash provided by operating activities 1,144 7,296
------- -------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property, plant and equipment (2,116) (396)
Proceeds from sale of furniture and equipment 16 1
------- -------
Net cash used in investing activities (2,100) (395)
------- -------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net payments on notes payable to banks -- (3,000)
Stock options exercised 37 9
------- -------
Net cash provided by (used in) financing activities 37 (2,991)
------- -------
Effect of exchange rate changes on cash and cash equivalents -- --
------- -------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (919) 3,910
CASH AND CASH EQUIVALENTS, beginning of period 12,580 4,551
------- -------
CASH AND CASH EQUIVALENTS, end of period $11,661 $ 8,461
======= =======
</TABLE>
The accompanying notes are an integral part of these consolidated statements.
3
<PAGE> 6
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 six-month periods ended June 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 financial statements and accompanying notes thereto.
Note B Earnings per share are computed by dividing net earnings by the
weighted average number of common shares and common share equivalents
assumed outstanding during the three- and six-month periods. Fully
diluted earnings per share are considered equal to primary earnings
per share in all periods presented.
Note C Inventories consist of the following at:
<TABLE>
<CAPTION>
June 30, 1997 December 31, 1996
------------- -----------------
(Unaudited)
(in thousands)
<S> <C> <C>
Raw Materials $5,670 $3,147
Work-In-Process 1,317 780
Finished Goods 877 679
------ ------
$7,864 $4,606
====== ======
</TABLE>
Note D Property, plant, and equipment consist of the following at:
<TABLE>
<CAPTION>
June 30, 1997 December 31, 1996
------------- -----------------
(Unaudited)
(in thousands)
<S> <C> <C>
Building and
improvements $ 10,431 $10,431
Furniture and
equipment 30,851 28,776
-------- -------
41,282 39,207
Less-accumulated
depreciation (10,287) (8,294)
-------- -------
$ 30,995 $30,913
======== =======
</TABLE>
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Three Months Ended June 30, 1997 Compared with Three Months Ended June 30, 1996.
Net sales were $18.7 million for the quarter ended June 30, 1997, an
increase of 29 percent compared with net sales of $14.5 million for the quarter
ended June 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 June 30, 1997 was as a result of the production ramp up of
several new major programs for a variety of customers, including a major office
automation customer.
Cost of sales, as a percentage of net sales, decreased to 76.7 percent
for the quarter ended June 30, 1997 as compared with 82.6 percent for the
quarter ended June 30, 1996. The corresponding increase in the gross margin in
the second quarter was the result of a number of factors, including decreased
provisions for excess and obsolete inventory and decreased manufacturing
variances occurring as a result of increased labor utilization and material
purchases.
Selling, general, and administrative expense of $1.5 million for the
quarter ended June 30, 1997 was equal to the expense of $1.5 million for the
quarter ended June 30, 1996. Selling, general, and administrative expense
decreased as a percentage of net sales to 8 percent for the quarter ended June
30, 1997 from 10.3 percent for the quarter ended June 30, 1996 primarily as a
result of increased sales.
Research and development expense totaled $1.3 million, or 7 percent of
net sales, for the quarter ended June 30, 1997, as compared with $820,000, or
5.7 percent of net sales, for the quarter ended June 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 June 30, 1997 was $154,000,
up from $133,000 for the quarter ended June 30, 1996. The increase in interest
income was the result of investing higher average cash balances during the
quarter. Other expense (net) was $7,000 for the quarter ended June 30, 1997, as
compared with $72,000 for the quarter ended June 30, 1996. The difference was
due primarily to decreased foreign exchange loss and closed facilities expenses
for the quarter ended June 30, 1997.
The provisions for income taxes increased to $685,000 for the quarter
ended June 30, 1997 from $113,000 for the quarter ended June 30, 1996. This
resulted primarily from higher pre-tax income in the quarter ended June 30, 1997
as compared with the same period in 1996.
Net income increased to $1,028,000, or $0.13 per share, for the quarter
ended June 30, 1997 from $170,000, or $0.02 per share, for the quarter ended
June 30, 1996.
Six Months Ended June 30, 1997 Compared with Six Months Ended June 30, 1996.
Net sales were $34.9 million for the six months ended June 30, 1997, an
increase of 7.4 percent compared with net sales of $32.5 million for the six
months ended June 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 the increased production of several new programs for new
and existing customers. In the six-month period ended June 30, 1997, the
Company's largest customer accounted for net sales of $12.2 million compared
with net sales of $22.6 million to that customer for the six months ended June
30, 1996. The Company's major customer accounted for approximately 35 percent of
the net sales for the six months ended June 30, 1997, compared with
approximately 69.5 percent for the comparable period in 1996. All other
customers accounted for net sales of $22.7 million for the
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six months ended June 30, 1997, compared with the net sales of $9.9 million for
the six months ended June 30, 1996, which is an overall increase of net sales to
other customers of 129.3 percent.
Cost of sales, as a percentage of net sales, decreased to 77.1 percent
for the six months ended June 30, 1997, as compared with 81 percent for the six
months ended June 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 decreased manufacturing variances occurring as a result
of increased labor utilization and material purchases.
Selling, general, and administrative expense of $2.9 million for the
six months ended June 30, 1997 was equal to the expense of $2.9 million for the
six months ended June 30, 1996. Selling, general, and administrative expense
decreased as a percentage of net sales to 8.3 percent for the six months ended
June 30, 1997 from 8.9 percent for the six months ended June 30, 1996, primarily
as a result of increased sales. Research and development expense totaled $2.4
million, or 6.9 percent of net sales, for the six months ended June 30, 1997 as
compared with $1.8 million, or 5.5 percent of net sales, for the six months
ended June 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 six months ended June 30, 1997 was
$311,000, up from $152,000 for the six months ended June 30, 1996. The increase
in interest income was the result of investing higher average cash balances
during the six months. Other expense (net) decreased to $19,000 for the six
months ended June 30, 1997 from $99,000 for the six months ended June 30, 1996.
The decrease was due primarily to decreased closed facilities expenses and
decreased loss on sale of assets for the six months ended June 30, 1997.
The provisions for income taxes increased to $1.1 million for the six
months ended June 30, 1997 from $595,000 for the six months ended June 30, 1996.
This resulted primarily from higher pre-tax income in the six months ended June
30, 1997 as compared with the same period in 1996.
Net income increased to $1,829,000, or $0.23 per share, for the six
months ended June 30, 1997 from $892,000, or $0.11 per share, for the six months
ended June 30, 1996.
LIQUIDITY AND CAPITAL RESOURCES
During the first six months of 1997, the Company generated $1.1 million
in cash flow from operations as compared with $7.3 million during the first six
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 half of 1997 versus the reduction in
accounts receivable that occurred in the first half of 1996. Overall, the
Company's depreciation expense has risen almost 17 percent since the first half
of 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 $23.3 million at June 30, 1997 from the $21.5 million that it had at December
31, 1996. The Company's current ratio at June 30, 1997 was 3.0-to-1 as compared
with a current ratio of 3.2-to-1 at December 31, 1996.
In May 1997, the Company canceled its line of credit with Wells Fargo
and entered into a new $15 million unsecured revolving line of credit with
Imperial Bank, which matures May 31, 1998. At June 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 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
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<PAGE> 9
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 June 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 June 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 first six months of 1997 were
approximately $2.1 million, as compared with $396,000 during the first six
months of 1996. Capital expenditures for 1997 have thus far consisted primarily
of manufacturing and office equipment for the Company's operations in Manila and
Arizona and laboratory equipment for research and development. Most of the
manufacturing expenditures are for technical or process improvements and not for
capacity increases. The Company anticipates that its capital expenditures should
continue at a similar pace during the remainder of 1997. Those expenditures will
primarily relate to advanced manufacturing processes, the high-volume LCD line,
and necessary manufacturing equipment. In addition, in early 1998 the Company
anticipates expending approximately $2 million on the capital equipment
necessary to extend the capabilities of its high-volume LCD line to
manufacturing liquid crystal on silicon (LCOS) microdisplays. Such expenditures
for LCOS microdisplays will be in addition to other more typical capital
expenditures for 1998.
The Company anticipates that accounts receivable and inventory will
continue to rise in 1997 if revenue levels increase as currently anticipated.
The Company believes that its existing capital and anticipated cash flow from
operations will provide adequate sources to fund operations and planned
expenditures throughout 1997 and 1998 without any need for borrowings. Should
the Company purchase a significant amount of treasury shares or 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. The Company anticipates such expansion may occur within the
next two years.
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 direct and indirect Philippine labor force, which is paid in
Philippine pesos exposing 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 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.
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 a 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.
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<PAGE> 10
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 major
customer, who accounted for approximately 80 percent of the Company's revenue in
1995, accounted for only 35 percent of the Company's revenue in the first six
months of 1997. This reduced percentage occurred as a result of the increased
sales to other customers and reduced product selling prices and revenue to 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 for all of 1997. The Company is planning for continued
revenue growth during the last half of the year.
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 could give a competitive
pricing advantage to those suppliers. As the production levels of some of the
Company's major programs increase over the next few quarters, the standard gross
margins on those programs, which are generally lower, will have more of an
impact on the Company's overall margins. On the other hand, the volume of those
programs should have a favorable impact on manufacturing variances. As a result,
it is the goal of the Company to maintain its gross margins in the low to
mid-twenties for the remainder of this year. 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.
As the Company expands and diversifies its product and customer base,
it may have to 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 10 to 25
percent greater than in 1996, although SG&A expenditures should continue
decreasing in 1997 as a percentage of net sales.
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 only 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
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. 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 10 to 15 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 analyses 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
8
<PAGE> 11
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, one customer is currently responsible for 35
percent of the Company's revenue and is expected to account for around 40
percent of the Company's revenue in 1997. In addition, the Company expects that
another customer could account for around 25 percent of the Company's 1997
revenue. As a result, the majority of the Company's revenue in 1997 will 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 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, including expenses for custom integrated
circuits as well as various capital expenditures for manufacturability. For
example, LCOS microdisplays will require approximately $2 million of capital
expenditures to extend the capabilities of the LCD high-volume manufacturing
line to accommodating silicon. 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. Although such shortages have not significantly affected
the Company to date, 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.
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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.
10
<PAGE> 13
PART II. OTHER INFORMATION
ITEM 4. SUBMISSIONS OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Company's Annual Meeting of Stockholders was held on April 24,
1997. All of the nominees were elected to the Company's Board of Directors as
set forth in the Proxy Statement as follows:
Nominees Votes in Favor Against
David R. Buchanan 7,354,919 82,642
David C. Malmberg 7,357,083 80,478
Burton E. McGillivray 7,357,273 80,288
Kenneth M. Julien 7,262,942 174,619
Gary R. Long 7,349,972 87,589
The following items were also voted upon and approved by the
Stockholders:
(a) To approve amendments to and the restatement of the Company's 1993 Stock
Option Plan (the "1993 Plan") to (i) permit all non-employee directors to
receive grants of options and awards pursuant to the 1993 Plan, (ii) limit the
number of options that may be granted to salaried employees in any one-year
period in order to comply with Section 162(m) of the Internal Revenue Code of
1986, as amended, and (iii) make certain other revisions, which do not require
stockholder approval, in order to bring the 1993 Plan into compliance with
recent revisions to rules promulgated under Section 16 of the Securities
Exchange Act of 1934, as amended.
Votes in Favor Opposed Abstain
6,098,526 1,294,699 44,336
(b) To approve amendments to and the restatement of the Company's 1994
Automatic Stock Option Plan (the "1994 Plan") to (i) clarify that the
restriction on receiving the initial automatic grant of options to acquire 1,000
shares of the Company's common stock (the "Initial Grant") applies only to
non-employee directors who have previously received an Initial Grant, (ii)
revise the vesting period for the options granted pursuant to the Initial Grant,
and (iii) make certain other technical revisions to the 1994 Plan, which do not
require stockholder approval.
Votes in Favor Opposed Abstain
7,192,046 199,196 46,319
(c) To ratify the appointment of Arthur Andersen LLP as the independent
auditors of the Company for the fiscal year ending December 31, 1997.
Votes in Favor Opposed Abstain
7,373,302 36,117 28,142
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
11
<PAGE> 14
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: July 16, 1997 By: /s/ Jeffrey D. Buchanan
--------------------------------------
Name: Jeffrey D. Buchanan
Its: Vice President Finance, Administration
and Legal; Chief Financial Officer
12
<PAGE> 1
THREE-FIVE SYSTEMS, INC.
STATEMENT RE: COMPUTATION OF PER SHARE EARNINGS
EXHIBIT 11
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
--------------------------- ---------------------------
1997 1996 1997 1996
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Common shares outstanding beginning of period 7,762,129 7,737,095 7,757,329 7,735,745
Effect of Weighting Shares:
Employee stock options exercised 92,856 37,699 50,018 19,952
Employee stock options outstanding 204,989 257,469 245,870 281,069
---------- ---------- ---------- ----------
Primary 8,059,974 8,032,263 8,053,217 8,036,766
========== ========== ========== ==========
Common shares outstanding beginning of period 7,762,129 7,737,095 7,757,329 7,735,745
Effect of Weighting Shares:
Employee stock options exercised 92,856 37,699 50,018 19,952
Employee stock options outstanding 215,623 257,469 255,915 281,070
---------- ---------- ---------- ----------
Fully diluted 8,070,608 8,032,263 8,063,262 8,036,767
========== ========== ========== ==========
Net income $1,028,000 $ 170,000 $1,829,000 $ 892,000
========== ========== ========== ==========
NET INCOME PER COMMON AND
COMMON EQUIVALENT SHARES:
Net income per share
Primary $ 0.13 $ 0.02 $ 0.23 $ 0.11
========== ========== ========== ==========
Fully diluted $ 0.13 $ 0.02 $ 0.23 $ 0.11
========== ========== ========== ==========
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED BALANCE SHEET AT JUNE 30, 1997 AND THE RELATED CONSOLIDATED
STATEMENTS OF INCOME AND OF CASH FLOWS FOR THE SIX MONTHS ENDED JUNE 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> 6-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> JUN-30-1997
<EXCHANGE-RATE> 1
<CASH> 11,661
<SECURITIES> 0
<RECEIVABLES> 10,252
<ALLOWANCES> 475
<INVENTORY> 7,864
<CURRENT-ASSETS> 34,839
<PP&E> 41,282
<DEPRECIATION> 10,287
<TOTAL-ASSETS> 66,139
<CURRENT-LIABILITIES> 11,521
<BONDS> 0
0
0
<COMMON> 79
<OTHER-SE> 0
<TOTAL-LIABILITY-AND-EQUITY> 66,139
<SALES> 34,866
<TOTAL-REVENUES> 34,866
<CGS> 26,865
<TOTAL-COSTS> 32,255
<OTHER-EXPENSES> 19
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 2,903
<INCOME-TAX> 1,074
<INCOME-CONTINUING> 1,829
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 1,829
<EPS-PRIMARY> 0.23
<EPS-DILUTED> 0.23
</TABLE>
