SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
---------------
FORM 10-K/A
Annual Report Under Section 13 or 15(d) of the Securities Exchange Act of 1934
For the fiscal year ended December 31, 1997
Commission File Number 1-4373
------
THREE-FIVE SYSTEMS, INC.
(Name of Issuer Specified in Its Charter)
Delaware 86-0654102
------------------------------- ----------------
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
1600 North Desert Drive, Tempe, Arizona 85281
---------------------------------------------
(Address of Principal Executive Offices)
(602) 389-8600
--------------
(Issuer's Telephone Number, Including Area Code)
Securities registered under Section 12(b) of the Exchange Act:
Title of Each Class Name of Each Exchange on Which Registered
Common Stock, Par Value $.01 Per Share New York Stock Exchange
- -------------------------------------- -----------------------
Securities registered under Section 12(g) of the Exchange Act: None
Check whether the issuer (1) has filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past 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 __
Check if there is no disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K contained in this form, and no disclosure will be contained, to
the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [_____]
State issuer's revenues for its most recent fiscal year: $84,642,000
As of March 6, 1998, the aggregate market value of the voting stock held by
non-affiliates of the issuer, computed by reference to the price at which stock
was sold as of such date in the stock market as reported on the New York Stock
Exchange, was $152,309,391. Shares of Common Stock held by each officer and
director and by each person who owns 10% or more of the outstanding Common Stock
have been excluded in that such persons may be deemed to be affiliates. This
determination of affiliate status is not necessarily conclusive and does not
constitute an admission of affiliate status.
As of March 6, 1998, there were 7,907,123 shares of the issuer's Common Stock
outstanding.
Documents incorporated by reference: Portions of the issuer's definitive Proxy
Statement for the 1998 Annual Meeting of Stockholders are incorporated by
reference into Part III hereof.
<PAGE>
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Reference is made to the financial statements, the report thereon, the
notes thereto and the supplementary data commencing at page F-1 of this Report,
which financial statements, report, notes and data are incorporated herein by
reference.
2
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
Date: March 19, 1998 THREE-FIVE SYSTEMS, INC.
By /s/ David R. Buchanan
--------------------------------------
David R. Buchanan, Chairman of the Board,
President, and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934,
this Report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
<TABLE>
<CAPTION>
Name Title Date
---- ----- ----
<S> <C> <C>
/s/ David R. Buchanan Chairman of the Board, President, March 19, 1998
- ------------------------------------ And Chief Executive Officer
David R. Buchanan (Principal Executive Officer)
/s/ Jeffrey D. Buchanan Vice President - Finance, Administration, and March 19, 1998
- ------------------------------------ Legal; Chief Financial Officer; Secretary;
Jeffrey D. Buchanan and Treasurer (Principal Financial and
Accounting Officer)
Director March , 1998
- ------------------------------------
David C. Malmberg
/s/ Burton E. McGillivray Director March 19, 1998
- ------------------------------------
Burton E. McGillivray
/s/ Gary R. Long Director March 19, 1998
- ------------------------------------
Gary R. Long
/s/ Kenneth M. Julien Director March 19, 1998
- ------------------------------------
Kenneth M. Julien
</TABLE>
3
<PAGE>
THREE-FIVE SYSTEMS, INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page
Report of Independent Public Accountants ....................................F-2
Consolidated Balance Sheets as of December 31, 1997 and 1996 ................F-3
Consolidated Statements of Income (Loss) for the years ended
December 31, 1997, 1996 and 1995 .........................................F-4
Consolidated Statements of Stockholders' Equity for the
years ended December 31, 1997, 1996 and 1995 .............................F-5
Consolidated Statements of Cash Flows for the years ended
December 31, 1997, 1996 and 1995 .........................................F-6
Notes to Consolidated Financial Statements ..................................F-7
Schedule II - Valuation and Qualifying Accounts and Reserves ................S-1
F-1
<PAGE>
ARTHUR ANDERSEN LLP
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Three-Five Systems, Inc.:
We have audited the accompanying consolidated balance sheets of THREE-FIVE
SYSTEMS, INC. (a Delaware corporation) and subsidiaries as of December 31, 1997
and 1996, and the related consolidated statements of income (loss),
stockholders' equity and cash flows for each of the three years in the period
ended December 31, 1997. These financial statements are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audits to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Three-Five Systems, Inc. and
subsidiaries as of December 31, 1997 and 1996, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 1997, in conformity with generally accepted accounting principles.
Our audits were made for the purpose of forming an opinion on the basic
financial statements taken as a whole. The schedules listed in the index of
financial statements are presented for purposes of complying with the Securities
and Exchange Commission's rules and are not part of the basic financial
statements. These schedules have been subjected to the auditing procedures
applied in the audit of the basic financial statements and, in our opinion,
fairly state in all material respects the financial data required to be set
forth therein in relation to the basic financial statements taken as a whole.
ARTHUR ANDERSEN LLP
Phoenix, Arizona,
January 20, 1998.
F-2
<PAGE>
THREE-FIVE SYSTEMS, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands, except share amounts)
ASSETS
December 31,
--------------------
1997 1996
-------- --------
CURRENT ASSETS:
Cash and cash equivalents (Note 2) $ 16,371 $ 12,580
Accounts receivable, net 12,540 6,830
Inventories, net (Note 2) 8,255 4,606
Deferred tax asset (Note 6) 4,311 5,930
Other current assets 1,228 1,384
-------- --------
Total current assets 42,705 31,330
PROPERTY, PLANT AND EQUIPMENT, net (Note 2) 29,847 30,913
OTHER ASSETS 283 326
-------- --------
$ 72,835 $ 62,569
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 8,513 $ 4,289
Accrued liabilities (Note 2) 5,079 4,524
Current taxes payable (Note 6) -- 1,004
-------- --------
Total current liabilities 13,592 9,817
-------- --------
DEFERRED TAX LIABILITY (Note 6) 2,718 1,568
COMMITMENTS AND CONTINGENCIES (Note 7)
STOCKHOLDERS' EQUITY (Note 4):
Preferred stock, $.01 par value; 1,000,000 shares
authorized -- --
Common stock, $.01 par value; 15,000,000 shares
authorized, 7,928,023 shares issued, 7,905,523 shares
outstanding at December 31, 1997; 7,779,829 shares
issued, 7,757,329 shares outstanding at
December 31, 1996 79 78
Additional paid-in capital 32,420 32,329
Retained earnings 24,259 19,016
Cumulative translation adjustment (Note 2) 20 14
Less- Treasury stock, at cost (22,500 shares) (253) (253)
-------- --------
Total stockholders' equity 56,525 51,184
-------- --------
$ 72,835 $ 62,569
======== ========
The accompanying notes are an integral part
of these consolidated balance sheets.
F-3
<PAGE>
THREE-FIVE SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF INCOME (LOSS)
(in thousands, except share amounts)
<TABLE>
<CAPTION>
Years Ended December 31,
-----------------------------------------
1997 1996 1995
----------- ----------- -----------
<S> <C> <C> <C>
NET SALES (Notes 5 and 8) $ 84,642 $ 60,713 $ 91,585
----------- ----------- -----------
COSTS AND EXPENSES:
Cost of sales 64,760 58,321 70,481
Selling, general and administrative 6,557 5,351 5,386
Research and development 5,106 4,065 2,396
----------- ----------- -----------
76,423 67,737 78,263
----------- ----------- -----------
Operating income (loss) 8,219 (7,024) 13,322
----------- ----------- -----------
OTHER INCOME (EXPENSE):
Interest, net 548 412 765
Other, net (190) (139) (122)
----------- ----------- -----------
358 273 643
----------- ----------- -----------
INCOME (LOSS) BEFORE PROVISION FOR
(BENEFIT FROM) INCOME TAXES 8,577 (6,751) 13,965
Provision for (benefit from) income taxes (Note 6) 3,334 (2,920) 5,548
----------- ----------- -----------
NET INCOME (LOSS) $ 5,243 $ (3,831) $ 8,417
=========== =========== ===========
EARNINGS (LOSS) PER COMMON SHARE (Note 2):
Basic $ 0.67 $ (0.49) $ 1.09
=========== =========== ===========
Diluted $ 0.65 $ (0.49) $ 1.04
=========== =========== ===========
WEIGHTED AVERAGE NUMBER OF COMMON SHARES:
Basic 7,854,053 7,767,744 7,715,996
=========== =========== ===========
Diluted 8,089,975 7,767,744 8,083,551
=========== =========== ===========
</TABLE>
The accompanying notes are an integral part of these consolidated statements.
F-4
<PAGE>
THREE-FIVE SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
(in thousands, except share amounts)
<TABLE>
<CAPTION>
Common Stock
--------------------- Additional Cumulative
Shares Paid-in Retained Translation Treasury
Issued Amount Capital Earnings Adjustment Stock Total
--------- --------- --------- --------- ---------- --------- ---------
<S> <C> <C> <C> <C> <C> <C> <C>
BALANCE, December 31, 1994 7,691,524 $ 77 $ 32,052 $ 14,430 $ 2 $ -- $ 46,561
Stock options exercised 44,221 -- 32 -- -- -- 32
Tax benefit from early disposition
of incentive stock options (Note 6) -- -- 202 -- -- -- 202
Net income -- -- -- 8,417 -- -- 8,417
Translation adjustment -- -- -- -- 12 -- 12
--------- --------- --------- --------- --------- --------- ---------
BALANCE, December 31, 1995 7,735,745 77 32,286 22,847 14 -- 55,224
Stock options exercised 44,084 1 11 -- -- -- 12
Tax benefit from early disposition
of incentive stock options (Note 6) -- -- 32 -- -- -- 32
Net loss -- -- -- (3,831) -- -- (3,831)
Purchase of treasury stock -- -- -- -- -- (253) (253)
--------- --------- --------- --------- --------- --------- ---------
BALANCE, December 31, 1996 7,779,829 78 32,329 19,016 14 (253) 51,184
Stock options exercised 148,194 1 50 -- -- -- 51
Tax benefit from early disposition
of incentive stock options (Note 6) -- -- 41 -- -- -- 41
Net income -- -- -- 5,243 -- -- 5,243
Translation adjustment -- -- -- -- 6 -- 6
--------- --------- --------- --------- --------- --------- ---------
BALANCE, December 31, 1997 7,928,023 $ 79 $ 32,420 $ 24,259 $ 20 $ (253) $ 56,525
========= ========= ========= ========= ========= ========= =========
</TABLE>
The accompanying notes are an integral part of these consolidated statements
F-5
<PAGE>
THREE-FIVE SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
<TABLE>
<CAPTION>
Years Ended December 31,
---------------------------------
1997 1996 1995
---------------------------------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $ 5,243 $(3,831) $ 8,417
Adjustments to reconcile net income (loss) to net cash
provided by operating activities:
Depreciation and amortization 4,135 3,551 2,278
Provision for (reduction of) accounts receivable
valuation reserves (69) 47 (1)
Provision for (reduction of) inventory valuation reserves (2,473) 4,015 1,218
Loss on disposal of assets 2 12 24
Changes in assets and liabilities:
(Increase) decrease in accounts receivable (5,641) 2,469 (624)
(Increase) decrease in inventories (1,176) 5,082 (5,264)
(Increase) decrease in other assets 505 (1,070) (32)
Increase (decrease) in accounts payable and accrued liabilities 4,778 4,296 (3,170)
Increase (decrease) in taxes payable, net 1,461 (2,358) (1,568)
--------- --------- -------
Net cash provided by operating activities 6,765 12,213 1,278
--------- --------- -------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property, plant and equipment (3,049) (948) (27,051)
Proceeds from sale of property, plant and equipment 19 5 326
--------- --------- -------
Net cash used for investing activities (3,030) (943) (26,725)
--------- --------- -------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net proceeds from (payments on) notes payable to banks - (3,000) 3,000
Principal payments on and retirement of long-term debt - - (182)
Stock options exercised 52 12 32
Purchase of treasury stock - (253) -
--------- --------- ------
Net cash provided by (used for) financing activities 52 (3,241) 2,850
--------- --------- -------
Effect of exchange rate changes on cash 4 - 12
--------- --------- -------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 3,791 8,029 (22,585)
CASH AND CASH EQUIVALENTS, beginning of year 12,580 4,551 27,136
--------- --------- -------
CASH AND CASH EQUIVALENTS, end of year $ 16,371 $ 12,580 $ 4,551
========= ========= =======
SUPPLEMENTAL CASH FLOW INFORMATION:
Interest paid $ 4 $ 60 $ 12
========= ========= =======
Income taxes paid $ 1,973 $ 1,832 $ 7,296
========= ========= =======
</TABLE>
The accompanying notes are an integral part of these consolidated statements.
F-6
<PAGE>
THREE-FIVE SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997, 1996 AND 1995
(1) ORGANIZATION AND OPERATIONS:
The Company designs and manufactures a wide range of user interface devices for
operational control and informational display functions required in the end
products of original equipment manufacturers ("OEMs"). Most of the Company's
sales consist of custom devices developed in close collaboration with its
customers. Devices designed and manufactured by the Company find application in
cellular telephones and other wireless communication devices as well as in
medical equipment, office automation equipment, industrial process controls,
instrumentation, consumer electronic products, automotive equipment, and
industrial and military control products. The Company currently specializes in
liquid crystal display ("LCD") and light emitting diode ("LED") components and
technology in providing its design and manufacturing services for its customers.
The Company markets its services primarily in North America, Europe, and Asia
through direct technical sales persons and, to a much lesser extent, through an
independent sales and distribution network.
The Company maintains its primary manufacturing facility in Manila, the
Philippines. A third-party subcontractor operates the facility under a
sub-assembly agreement with the Company utilizing equipment, processes, and
documentation owned by the Company. The sub-assembly agreement has a current
term extending through December 31, 1999, and from year to year thereafter, but
may be terminated by either party upon 180 days written notice. The termination
of or the inability of the Company to obtain products pursuant to the
sub-assembly agreement, even for a relatively short period, would have a
material adverse effect on the operations and profitability of the Company.
Since December 1994, the Company has made advances totaling approximately $1.7
million to the subcontractor to help the subcontractor in meeting its working
capital needs, all of which have been paid in full in 1997. The Company plans on
incorporating a wholly-owned subsidiary during 1998 which will be engaged in the
manufacturing and sale of the Company's products in China. Management expects
that capital expenditures to acquire the property, plant, and equipment for this
expansion will total approximately $8.0 million in 1998.
During 1995, the Company formed a wholly-owned subsidiary, Three-Five Systems
Pacific, Inc. (Pacific). Pacific, a Philippines corporation, procures supplies
primarily from Philippine vendors, as well as manages and assists production
personnel of a third party subcontractor the Company employs. Three-Five Systems
Limited (Limited), a wholly-owned subsidiary of the Company, is incorporated in
the United Kingdom. Limited sells and distributes the Company's products to
customers on the European continent.
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
Principles of Consolidation and Preparation of Financial Statements
The consolidated financial statements include the accounts of the Company and
its wholly-owned subsidiaries. All material intercompany transactions have been
eliminated.
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
F-7
<PAGE>
Fair Value of Financial Instruments
The estimated fair value of financial instruments has been determined by the
Company using available market information and valuation methodologies.
Considerable judgment is required in estimating fair values. Accordingly, the
estimates may not be indicative of amounts that would be realized in a current
market exchange. The carrying values of cash, accounts receivable and accounts
payable approximate fair value due to the short maturities of these instruments.
Cash and Cash Equivalents
For purposes of the statements of cash flows, all highly liquid investments with
a maturity of three months or less at the time of purchase are considered to be
cash equivalents. Cash equivalents consist of investments in commercial paper,
marketable debt securities, money market mutual funds, and United States
government agencies' obligations and are classified as held-to-maturity in
accordance with Statement of Financial Accounting Standards (SFAS) No. 115,
Accounting for Certain Investments in Debt and Equity Securities. Cash
equivalents were $12,886,000 and $11,243,000 at December 31, 1997 and December
31, 1996, respectively.
Inventories
Inventories are stated at the lower of cost (first-in, first-out) or net
realizable value. Reserves are established against Company-owned inventories for
excess, slow-moving, and obsolete items and for items where the net realizable
value is less than cost. The reserve for obsolete inventory totaled $4,309,000
and $6,782,000 at December 31, 1997 and December 31, 1996, respectively.
Inventories at December 31 consist of the following:
1997 1996
--------- ----------
(in thousands)
Raw materials $ 6,052 $ 3,147
Work-in-process 1,195 780
Finished goods 1,008 679
--------- ----------
$ 8,255 $ 4,606
========= ==========
Property, Plant and Equipment
Property, plant and equipment is recorded at cost and generally is depreciated
using the straight-line method over the estimated useful lives of the respective
assets, which range from 3 to 39 years. During 1996, the Company placed into
service a high-volume LCD glass manufacturing line in its Tempe, Arizona
manufacturing facility. The Company is depreciating the LCD glass line using the
units of production method. Depreciation expense recorded using this method may
be subject to significant fluctuation from year to year resulting from changes
in actual production levels and ongoing analysis of the capacity of the
equipment. Property, plant and equipment at December 31 consist of the
following:
1997 1996
---------- -----------
(in thousands)
Building and improvements $ 10,431 $ 10,431
Furniture and equipment 31,804 28,776
---------- -----------
42,235 39,207
Less- accumulated depreciation (12,388) (8,294)
---------- -----------
$ 29,847 $ 30,913
========== ===========
F-8
<PAGE>
The Company intends to utilize a significant portion of the high-volume LCD
glass manufacturing line facility to produce a substantial portion of its own
requirements for LCD glass. The successful utilization of the manufacturing
facility will require the Company (i) to produce LCD glass on a timely and
cost-effective basis at quality levels at least equal to the LCD glass available
from independent suppliers and (ii) to utilize the LCD glass it produces in
devices it designs and manufactures in a manner satisfactory to its customers.
Although management believes that the manufacturing facility will be
successfully utilized, no assurance can be given that the Company will not
experience problems or delays in the future in conducting its LCD glass
manufacturing operations. Such problems could require the Company to continue to
purchase its LCD glass requirements from third parties and result in the
inability of the Company to recover its investment in the manufacturing
facility.
During 1996, the Company entered into a transaction in which it conveyed its
Tempe, Arizona facility and certain improvements to the City of Tempe as
consideration for a rent-free 75-year lease. The Company has the option to
repurchase the facility for $1,000 after ten years; therefore, the lease is
accounted for as a capital lease.
Accrued Liabilities
Accrued liabilities include accrued compensation of approximately $1,675,000 and
$988,000 at December 31, 1997 and 1996, respectively.
Foreign Currency Translation
Financial information relating to the Company's foreign subsidiaries is reported
in accordance with SFAS No. 52, Foreign Currency Translation. The gain or loss
resulting from the translation of the subsidiaries' financial statements has
been included as a separate component of stockholders' equity. The net foreign
currency transaction loss in 1997, 1996 and 1995 was $183,000, $46,000, and
$32,000, respectively, and has been included in other expenses in the
accompanying statements of income (loss).
Revenue Recognition
The Company recognizes revenue upon shipment. The Company's distributor
agreements provide for stock (inventory) rotation and price protection. Reserves
are provided for each of these programs based on past return experience. These
reserves are established at the time of shipment and reduce gross sales to
arrive at net sales as presented in the accompanying consolidated statements of
income (loss). These reserves are reflected as a reserve against accounts
receivable from sales to distributors and totaled $125,000 and $89,000 at
December 31, 1997 and 1996, respectively. The Company's distributors generally
offset any returns and allowances against payments on accounts receivable. The
Company also provides reserves for uncollectible accounts receivable. These
reserves totaled $455,000 and $560,000 at December 31, 1997 and 1996,
respectively. The Company performs ongoing credit evaluations of all of its
customers and considers various factors in establishing its allowance for
doubtful accounts.
Research and Development
Research and development costs are expensed as incurred. The Company currently
is 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 manufacturable products.
Earnings (Loss) Per Share
During 1997, the Company adopted SFAS No. 128, Earnings per Share. Pursuant to
SFAS No. 128, basic earnings per common share are computed by dividing net
income (loss) by the weighted average number of shares of common stock
outstanding during the year. Diluted earnings (loss) per common share for the
years ended December 31, 1997, 1996 and 1995 are determined assuming that
options were exercised at the beginning of each
F-9
<PAGE>
year or at the time of issuance, if later. No outstanding options were assumed
to be exercised for purposes of calculating diluted earnings per share for the
year ended December 31, 1996 as their effect was anti-dilutive. Below are the
disclosures required pursuant to SFAS No. 128 for the years ended December 31,
1997, 1996 and 1995 (in thousands, except per share data):
For the Years
Ended December 31,
----------------------------
1997 1996 1995
------- ------- -------
Basic earnings (loss) per share:
Income available to common shareholders $ 5,243 $(3,831) $ 8,417
Weighted average common shares 7,854 7,768 7,716
------- ------- -------
Basic per share amount $ 0.67 $ (0.49) $ 1.09
======= ======= =======
Diluted earnings (loss) per share:
Income available to common shareholders $ 5,243 $(3,831) $ 8,417
Weighted average common shares 7,854 7,768 7,716
Options assumed converted 236 -- 368
------- ------- -------
Total common shares plus assumed
conversions 8,090 7,768 8,084
------- ------- -------
Diluted per share amount $ 0.65 $ (0.49) $ 1.04
======= ======= =======
(3) LONG-TERM DEBT:
In May 1997, the Company entered into a new $15.0 million unsecured revolving
line of credit which matures May 22, 1998. This line of credit bears interest at
the bank's prime rate (8.50% at December 31, 1997) or at the LIBOR base rate
(5.7% to 6.0% at December 31, 1997) plus 1.75%, and is payable monthly. There
was no balance outstanding at December 31, 1997 or 1996. In addition, the
Company has a $350,000 United Kingdom credit facility with interest due
quarterly at the bank's base rate (7.75% at December 31, 1997) plus 2%. Any
unpaid balance is due June 20, 1998, and is secured by United Kingdom accounts
receivable. Management intends to renew the United Kingdom credit facility and
does not anticipate any material changes to the existing terms.
The lines of credit contain certain restrictive covenants which include, among
other things, restrictions on the declaration or payment of dividends and the
amount of capital expenditures. The lines also require the Company to maintain a
specified net worth, as defined, to maintain a required debt to equity ratio and
to maintain certain other financial ratios.
(4) BENEFIT PLANS:
The Company has four stock option plans: the 1997 Stock Option Plan (1997 Plan),
the 1994 Non-Employee Directors Stock Option Plan (1994 Plan), the 1993 Stock
Option Plan (1993 Plan), and the 1990 Stock Option Plan (1990 Plan).
1997 Stock Option Plan
The 1997 Plan provides for the granting of nonqualified options to purchase up
to 100,000 shares of the Company's common stock. Under the 1997 Plan, options
may be issued to key personnel and others providing valuable services to the
Company and its subsidiaries. The options issued will be nonqualified stock
options and shall not be "incentive stock options" as defined in Section 422 of
the Internal Revenue Code of 1986 (the Code). Any option that expires or
terminates without having been exercised in full will again be available for
grant pursuant to the 1997 Plan. There were options outstanding to acquire
22,000 shares of the Company's common stock under the 1997 Plan at December 31,
1997.
F-10
<PAGE>
The expiration date, maximum number of shares purchasable and the other
provisions of the options will be established at the time of grant. Options may
be granted for terms of up to ten years and become exercisable in whole or in
one or more installments at such time as may be determined by the plan
administrator upon grant of the options. The exercise prices of the options will
be determined by the plan administrator, but may not be less than 100 percent of
the fair market value of the common stock at the time of the grant. The 1997
Plan will remain in force until May 12, 2007.
1994 Non-Employee Directors Stock Option Plan
The 1994 Plan provides for the automatic grant of stock options to non-employee
directors to purchase up to 100,000 shares of the Company's common stock. Under
the 1994 Plan, options to acquire 500 shares of common stock will be
automatically granted to each non-employee director at the meeting of the Board
of Directors held immediately after each annual meeting of stockholders, with
such options to vest in a series of 12 equal and successive monthly installments
commencing one month after the annual automatic grant date. In addition, each
non-employee director serving on the Board of Directors on the date the 1994
Plan was approved by the Company's stockholders received an automatic grant of
options to acquire 1,000 shares of common stock and each subsequent newly
elected non-employee member of the Board of Directors will receive an automatic
grant of options to acquire 1,000 shares of common stock on the date of their
first appointment or election to the Board of Directors. Those options become
exercisable and vest in a series of three equal and successive annual
installments, with the first such installment becoming exercisable 13 months
after the automatic grant date. A non-employee member of the Board of Directors
is not eligible to receive the 500 share automatic option grant if that option
grant date is within 30 days of such non-employee member receiving the 1,000
share automatic option grant. The exercise price per share of common stock
subject to options granted under the 1994 Plan will be equal to 100 percent of
the fair market value of the Company's common stock on the date such options are
granted. There were outstanding options to acquire 9,000 shares of the Company's
common stock under the 1994 Plan at December 31, 1997.
1993 Stock Option Plan
The 1993 Plan provides for the granting of options to purchase up to 385,454
shares of the Company's common stock (which includes 85,454 shares previously
reserved for issuance under the Company's 1990 Stock Option Plan), the direct
granting of common stock (stock awards), the granting of stock appreciation
rights (SARs) and the granting of other cash awards (cash awards; stock awards,
SARs and cash awards are collectively referred to herein as Awards). Under the
1993 Plan, options and Awards may be issued to key personnel and others
providing valuable services to the Company and its subsidiaries. The options
issued may be incentive stock options or nonqualified stock options. If any
option or SAR terminates or expires without having been exercised in full, stock
not issued under such option or SAR will again be available for grant pursuant
to the 1993 Plan. There were options outstanding to acquire 309,750 shares of
the Company's common stock under the 1993 Plan at December 31, 1997.
To the extent that granted options are incentive stock options, the terms and
conditions of those options must be consistent with the qualification
requirement set forth in the Code. The expiration date, maximum number of shares
purchasable and the other provisions of the options will be established at the
time of grant. Options may be granted for terms of up to ten years and become
exercisable in whole or in one or more installments at such time as may be
determined by the plan administrator upon grant of the options. The exercise
prices of options will be determined by the plan administrator, but may not be
less than 100 percent (110 percent if the option is granted to a stockholder who
at the time the option is granted owns stock representing more than ten percent
of the total combined voting power of all classes of stock of the Company) of
the fair market value of the common stock at the time of the grant. The 1993
Plan will remain in force until February 24, 2003.
1990 Stock Option Plan
Under the 1990 Plan, there are 210,220 options issued but unexercised as of
December 31, 1997. In conjunction with stockholder approval of the 1993 Plan,
the Board terminated the 1990 Plan with respect to unissued options
F-11
<PAGE>
to purchase 85,454 shares of common stock which remained and were unissued as of
the date the 1993 Plan was adopted. The 1990 Plan will remain in force through
May 1, 2000.
The expiration date, maximum number of shares purchasable, and the other
provisions of the options granted under the 1990 Plan were established at the
time of grant. Options were granted for terms of up to ten years and become
exercisable in whole or in one or more installments at such times as were
determined by the Board of Directors upon grant of the options.
Tax benefits from early disposition of common stock by optionees under the 1993
and 1990 Plans and from the exercise of nonqualified options are credited to
additional paid-in capital.
Pursuant to the provisions of SFAS No. 123, Accounting for Stock-Based
Compensation, the Company accounts for transactions with its employees pursuant
to Accounting Principles Board Opinion No. 25, Accounting for Stock-Issued to
Employees, under which no compensation cost has been recognized. Had
compensation cost for these plans been determined consistent with SFAS No. 123,
the Company's net income (loss) and earnings (loss) per share would have been as
follows (in thousands, except per share data): <TABLE> <CAPTION>
1997 1996 1995
--------- ---------- ---------
<S> <C> <C> <C> <C>
Net income (loss): As reported $ 5,243 $ (3,831) $ 8,417
Pro forma 4,785 (4,076) 8,327
Basic earnings (loss)
per share: As reported $ 0.67 $ (0.49) $ 1.09
Pro forma 0.61 (0.52) 1.08
Diluted earnings (loss)
per share: As reported $ 0.65 $ (0.49) $ 1.04
Pro forma 0.59 (0.52) 1.03
</TABLE>
The fair value of each option grant is estimated on the date of grant using the
Black-Scholes option pricing model with the following weighted-average
assumptions for grants in 1997, 1996 and 1995, respectively: risk-free interest
rates of 5.45%, 6.31% and 6.31%; expected dividend yields of zero; expected
lives of 6.4, 6.1 and 5.7 years; and expected volatility (a measure of the
amount by which a price has fluctuated or is expected to fluctuate during a
period) of 60.0%, 61.9% and 58.7%.
Because the SFAS No. 123 method of accounting has not been applied to options
granted prior to January 1, 1995, the resulting pro forma compensation cost may
not be representative of that to be expected in future years. The weighted
average fair value of shares sold in 1997 was $14.98.
F-12
<PAGE>
A summary of the status of the Company's four stock option plans at December 31,
1997, 1996 and 1995 and changes during the three years then ended is presented
in the table and narrative below:
<TABLE>
<CAPTION>
1997 1996 1995
------------------------ ----------------------------- --------------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
--------- --------- --------- -------- ---------- --------
<S> <C> <C> <C> <C> <C> <C>
Outstanding at
beginning of year 551,776 $ 6.92 539,576 $ 8.06 465,326 $ 4.68
Granted 200,500 14.63 250,100 11.89 178,000 22.15
Exercised (162,306) 1.34 (44,900) 0.49 (44,250) 0.75
Expired (39,000) 12.23 (193,000) 18.04 (59,500) 29.24
--------- --------- ----------
Outstanding at
end of year 550,970 $ 11.01 551,776 $ 6.92 539,576 $ 8.06
========= ========= ==========
Exercisable at end of
year 165,110 294,982 308,940
========= ========= ==========
Weighted average fair
value of options
granted $ 9.19 $ 7.57 $ 13.19
======== ====== ========
</TABLE>
The following table summarizes information about stock options outstanding at
December 31, 1997:
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
----------------------------------------------------------- --------------------------
Weighted
Number Average Weighted Number Weighted
Range of Outstanding at Remaining Average Exercisable at Average
Exercise December 31, Contractual Exercise December 31, Exercise
Prices 1997 Life Price 1997 Price
-------------- -------------- ------------ ----------- --------------- --------
<S> <C> <C> <C> <C> <C>
$ 0.25 - $9.00 108,720 5.7 years $ 0.77 108,720 $ 0.77
9.01 - 20.00 422,250 8.0 years 13.06 51,390 13.52
20.01 - 34.38 20,000 8.9 years 23.23 5,000 26.93
--------- --------- -------- --------- ------
550,970 7.6 years $ 11.01 165,110 $ 5.53
========= ========= ======== ========= ======
</TABLE>
401(k) Profit Sharing Plan
Effective September 1, 1990, the Company adopted a profit sharing plan (401(k)
Plan) pursuant to Section 401(k) of the Code. The 401(k) Plan covers
substantially all full-time employees who meet the eligibility requirements and
provides for a discretionary profit sharing contribution by the Company and an
employee elective contribution with a discretionary Company matching provision.
The Company expensed discretionary contributions pursuant to the 401(k) Plan in
the amount of $71,000, $65,000, and $0 for the years ended December 31, 1997,
1996, and 1995, respectively.
F-13
<PAGE>
(5) MAJOR CUSTOMERS:
The Company's strategy involves concentrating its efforts on providing design
and production services to leading companies in a limited number of fast growing
industries. Beginning in 1996, the Company has been undertaking substantial
efforts to diversify its business, broaden its customer base, and expand its
markets. The Company's historical major customer, who accounted for
approximately 65 percent and 81 percent of the Company's revenue in 1996 and
1995, respectively, accounted for approximately 35 percent of the Company's
revenue during 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 Company's other significant customer
accounted for 32 percent of the Company's revenue during 1997. Sales to this
customer were less than 10 percent of the Company's revenue during 1996 and
1995.
The significant amount of sales to a few customers results in certain
concentrations of credit risk for the Company. The Company's accounts receivable
balance, including the accounts receivable of the Company's largest customers,
is comprised of a large number of customers, primarily in the cellular phone,
computer hardware and other electronic products industries. These customers are
located primarily in the United States and Europe.
(6) INCOME TAXES:
SFAS No. 109, Accounting for Income Taxes, requires the use of an asset and
liability approach in accounting for income taxes. Deferred tax assets and
liabilities are recorded based on the differences between the financial
statement and tax bases of assets and liabilities and the tax rates in effect
when these differences are expected to reverse.
The provision for income taxes for the years ended December 31 consists of the
following:
<TABLE>
<CAPTION>
1997 1996 1995
---------- ---------- --------
(in thousands)
<S> <C> <C> <C>
Current, net of operating loss carryforwards
and tax credits utilized
Federal, net of tax benefit from early
termination of incentive stock options $ 356 $ 556 $ 2,775
State 97 58 790
Foreign 71 9 1,681
---------- ---------- --------
524 623 5,246
Deferred provision (benefit) 2,769 (3,575) 100
Tax benefit from early termination of incentive
stock options, reflected in stockholders' equity 41 32 202
---------- ---------- --------
Provision (benefit) for income taxes $ 3,334 $ (2,920) $ 5,548
========== ========== ========
</TABLE>
In accordance with SFAS No. 109, a tax benefit for net operating losses of
approximately $35,000, $102,000, and $67,000 and tax credits of approximately
$0, $938,000, and $1,478,000 utilized in 1997, 1996, and 1995, respectively, are
included as a reduction of the provision for income taxes in the consolidated
statements of income (loss).
F-14
<PAGE>
The components of deferred taxes at December 31 are as follows:
<TABLE>
<CAPTION>
1997 1996
--------- --------
(in thousands)
<S> <C> <C>
Net long-term deferred tax liabilities:
Accelerated tax depreciation $ 2,685 $ 1,535
Other 33 33
--------- --------
$ 2,718 $ 1,568
========= ========
Net short-term deferred tax assets:
Inventory reserve $ 1,721 $ 2,675
Uniform capitalization 1,251 1,868
Accrued liabilities not currently deductible 1,080 1,080
Allowance for doubtful accounts 156 196
Tax effect of regular U.S. net operating loss carry forward 166 189
Other 91 76
--------- --------
4,465 6,084
Valuation allowance (154) (154)
--------- --------
$ 4,311 $ 5,930
========= ========
</TABLE>
SFAS No. 109 requires the reduction of deferred tax assets by a valuation
allowance if, based on the weight of available evidence, it is more likely than
not that some or all of the deferred tax assets will not be realized. As a
result of certain limitations on the use of net operating loss carryforwards
acquired in the ERA acquisition, a valuation allowance has been established for
those net operating losses not likely to be realized.
A reconciliation of the U.S. federal statutory rate to the Company's effective
tax rate is as follows:
1997 1996 1995
------ ------ ------
Statutory federal rate 34% 34% 34%
Effect of state taxes 5 6 6
Other - 3 -
------ ------ ------
39% 43% 40%
====== ====== ======
Net operating loss carryforwards for federal tax purposes totaled approximately
$490,000 at December 31, 1997. The use of these carryforwards is limited to
$67,000 per year and they expire through 2003.
(7) COMMITMENTS AND CONTINGENCIES:
In March 1995, the Company entered into a non-cancelable operating lease for its
primary manufacturing facility in Manila, the Philippines. The lease expires
December 31, 1999. In April 1995, the Company entered into a non-cancelable
operating lease for an additional manufacturing facility in Manila, the
Philippines. In February 1997, the Company exercised its option to renew the
lease for two years. The lease expires March 31, 1999.
Rent expense was approximately $793,000, $477,000 and $683,000 for the years
ended December 31, 1997, 1996, and 1995, respectively.
In April 1994, the Company entered into a ground lease (with purchase options)
on a 5.7 acre site in Tempe, Arizona. Annual lease payments under the ground
lease, which will expire on March 31, 2069, subject to renewal and purchase
options as well as termination provisions, will average approximately $100,000
over the term of the lease subject to certain escalation provisions. A new
design, manufacturing, and corporate headquarters facility containing
approximately 97,000 square feet was completed on the land in 1995 at a cost of
approximately $10.4 million.
F-15
<PAGE>
The Company's future lease commitments under the non-cancelable operating leases
as of December 31, 1997, are as follows (in thousands):
1998 $ 419
1999 372
2000 100
2001 100
2002 100
Thereafter 6,625
--------
$ 7,716
========
The Company is involved in certain administrative proceedings arising in the
normal course of business. In the opinion of management, the Company's potential
exposure under the pending administrative proceedings is adequately provided for
in the accompanying financial statements.
(8) GEOGRAPHIC SEGMENTS:
Sales by geographic area and identifiable assets for the years ended December
31, 1997, 1996, and 1995 were as follows:
<TABLE>
<CAPTION>
North
America Europe Pacific Rim Eliminations Consolidated
--------- --------- ----------- ------------ ------------
(in thousands)
<S> <C> <C> <C> <C> <C>
December 31, 1997:
Net sales $ 73,887 $ 10,755 $ - $ - $ 84,642
Transfers to Europe 9,136 - - (9,136) -
Transfers to North America - - 3,107 (3,107) -
--------- --------- --------- ---------- --------
Total revenue $ 83,023 $ 10,755 $ 3,107 $ (12,243) $ 84,642
========= ========= ========= ========== =========
Net income $ 4,728 $ 404 $ 65 $ 46 $ 5,243
========= ========= ========= ========== =========
Identifiable assets $ 61,307 $ 4,896 $ 7,431 $ (799) $ 72,835
========= ========= ========= ========== =========
December 31, 1996:
Net sales $ 32,899 $ 27,814 $ - $ - $ 60,713
Transfers to Europe 25,810 - - (25,810) -
Transfers to North America - - 1,494 (1,494) -
--------- --------- --------- ---------- --------
Total revenue $ 58,709 $ 27,814 $ 1,494 $ (27,304) $ 60,713
========= ========= ========= ========== =========
Net income (loss) $ (4,005) $ 19 $ 12 $ 143 $ (3,831)
========= ========= ========= ========== =========
Identifiable assets $ 52,951 $ 3,824 $ 6,164 $ (370) $ 62,569
========= ========= ========= ========== =========
December 31, 1995:
Net sales $ 24,235 $ 67,350 $ - $ - $ 91,585
Transfers to Europe 60,361 - - (60,361) -
Transfers to North America - - 1,437 (1,437) -
--------- --------- --------- ---------- --------
Total revenue $ 84,596 $ 67,350 $ 1,437 $ (61,798) $ 91,585
========= ========= ========= ========== =========
Net income (loss) $ 5,093 $ 3,353 $ (46) $ 17 $ 8,417
========= ========= ========= ========== =========
Identifiable assets $ 50,779 $ 8,491 $ 7,789 $ (3,279) $ 63,780
========= ========= ========= ========== =========
</TABLE>
F-16
<PAGE>
THREE-FIVE SYSTEMS, INC.
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS AND RESERVES
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996, AND 1995
<TABLE>
<CAPTION>
Balance at Charged to Charged to Balance at
Beginning Costs and Other End of
of Period Expenses Accounts Other Period
--------- -------- -------- ----- ------
(in thousands)
<S> <C> <C> <C> <C> <C>
Allowance for doubtful accounts and sales returns and allowances:
- -----------------------
Year ended
December 31, 1997 $ 649 (105) 36(1) -- $ 580
Year ended
December 31, 1996 $ 603 14 32(1) -- $ 649
Year ended
December 31, 1995 $ 604 (36) 35(1) -- $ 603
Inventory Reserve:
- ------------------
Year ended
December 31, 1997 $6,782 1,114 (3,587)(2) $4,309
Year ended
December 31, 1996 $2,767 5,939 142(2) (2,066)(2) $6,782
Year ended
December 31, 1995 $1,548 1,563 391(3) (735)(2) $2,767
</TABLE>
(1) Actual return activity
(2) Obsolete inventory written off
(3) Inventory adjustments
S-1
