SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
Annual Report Under Section 13 or 15(d) of the Securities Exchange Act of 1934
For the fiscal year ended December 31, 1998
Commission File Number 1-4373
THREE-FIVE SYSTEMS, INC.
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(Exact Name of Registrant as Specified in Its Charter)
Delaware 86-0654102
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(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
1600 North Desert Drive, Tempe, Arizona 85281
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(Address of Principal Executive Offices)
(602) 389-8600
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(Registrant'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
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Common Stock, Par Value $.01 Per Share New York Stock Exchange
Securities registered under Section 12(g) of the Exchange Act: None
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Exchange Act during the preceding 12
months (or for such shorter period that the registrant was required to file such
reports) and (2) has been subject to such filing requirements for the past 90
days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not 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. [ ]
As of March 8, 1999, 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 $68,080,668. 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 8, 1999, there were 7,012,107 shares of the issuer's Common Stock
outstanding.
Documents incorporated by reference: Portions of the issuer's definitive Proxy
Statement for the 1999 Annual Meeting of Stockholders are incorporated by
reference into Part III hereof.
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THREE-FIVE SYSTEMS, INC.
ANNUAL REPORT ON FORM 10-K
FOR THE YEAR ENDED DECEMBER 31, 1998
TABLE OF CONTENTS
Page
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PART I
ITEM 1. BUSINESS.......................................................... 1
ITEM 2. PROPERTIES........................................................ 22
ITEM 3 LEGAL PROCEEDINGS................................................. 22
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS............... 22
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND
RELATED STOCKHOLDER MATTERS..................................... 23
ITEM 6. SELECTED FINANCIAL DATA........................................... 24
ITEM 7 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS............................. 25
ITEM 7A QUANTITATIVE AND QUALITATIVE DISCLOSURES
ABOUT MARKET RISK............................................... 34
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA....................... 35
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE............................. 35
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS.................................. 35
ITEM 11. EXECUTIVE COMPENSATION............................................ 35
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
AND MANAGEMENT.................................................. 35
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.................... 35
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES,
AND REPORTS ON FORM 8-K......................................... 36
SIGNATURES.................................................................. 38
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STATEMENT REGARDING FORWARD-LOOKING STATEMENTS
THE STATEMENTS CONTAINED IN THIS REPORT ON FORM 10-K THAT ARE NOT
PURELY HISTORICAL ARE FORWARD-LOOKING STATEMENTS WITHIN THE MEANING OF
APPLICABLE SECURITIES LAWS. FORWARD-LOOKING STATEMENTS INCLUDE STATEMENTS
REGARDING THE COMPANY'S "EXPECTATIONS," "ANTICIPATION," "INTENTIONS," "BELIEFS,"
OR "STRATEGIES" REGARDING THE FUTURE. FORWARD-LOOKING STATEMENTS ALSO INCLUDE
STATEMENTS REGARDING REVENUE, MARGINS, EXPENSES, AND EARNINGS ANALYSIS FOR
FISCAL 1999 AND THEREAFTER; TECHNOLOGICAL INNOVATIONS; FUTURE PRODUCTS OR
PRODUCT DEVELOPMENT; THE COMPANY'S PRODUCT DEVELOPMENT STRATEGIES; POTENTIAL
ACQUISITIONS OR STRATEGIC ALLIANCES; THE SUCCESS OF PARTICULAR PRODUCT OR
MARKETING PROGRAMS; THE AMOUNTS OF REVENUE GENERATED AS A RESULT OF SALES TO
SIGNIFICANT CUSTOMERS; AND LIQUIDITY AND ANTICIPATED CASH NEEDS AND
AVAILABILITY. ALL FORWARD-LOOKING STATEMENTS INCLUDED IN THIS REPORT ARE BASED
ON INFORMATION AVAILABLE TO THE COMPANY AS OF THE FILING DATE OF THIS REPORT,
AND THE COMPANY ASSUMES NO OBLIGATION TO UPDATE ANY SUCH FORWARD-LOOKING
STATEMENTS. THE COMPANY'S ACTUAL RESULTS COULD DIFFER MATERIALLY FROM THE
FORWARD-LOOKING STATEMENTS. AMONG THE FACTORS THAT COULD CAUSE ACTUAL RESULTS TO
DIFFER MATERIALLY ARE THE FACTORS DISCUSSED IN ITEM 1, "BUSINESS - SPECIAL
CONSIDERATIONS."
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PART I
ITEM 1. BUSINESS
INTRODUCTION
The Company designs and manufactures a wide range of display modules
for use in the end products of original equipment manufacturers ("OEMs"). Most
of the Company's sales consist of custom display modules 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") 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 experienced substantial growth from 1993 through 1995 with
net sales increasing from $38.0 million in 1993 to $91.6 million in 1995. The
Company's growth during that period, however, depended 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 to $60.7 million, largely as the result of the
phase-out by that major customer of a significant family of programs in early
1996, and the Company reported a loss in 1996 as a result of that phase-out and
the significant inventory reserve taken during the third quarter. The Company's
sales increased to $84.6 million in 1997 and $95.0 million in 1998, primarily as
a result of several new programs, including programs for a telecommunications
customer and an office automation customer. The growth that occurred during the
period from 1993 through 1995 allowed the Company to construct the highest
volume passive matrix LCD glass production facility in North America, which
enables the Company to produce a substantial portion of its LCD glass
requirements, as well as to attract key personnel, expand its research and
development efforts, and build its infrastructure. The Company has undertaken
substantial efforts to broaden its customer base by obtaining new customers and
by increasing its business with those existing customers that historically have
comprised a small percentage of the Company's revenue. The Company has also
undertaken efforts to expand its markets by (1) placing sales personnel in new
geographic locations, (2) setting up a new manufacturing facility in China, (3)
targeting new industrial applications, and (4) developing new kinds of products.
The Company believes that it is positioned to continue the growth that
it experienced in 1997 and 1998 as a result of its efforts in expanding its
customer base and the markets it serves as well as its strength in designing,
prototyping, and producing, on a timely and cost-efficient basis, a wide range
of innovative, distinctive, and high-quality display modules required in the end
products of OEMs. In the past few years, the Company has refocused its research
and development capabilities with the intention of developing display
technologies and manufacturing processes that will be useful for its current and
future customers. The Company's design processes utilize advanced computer-aided
design software to provide custom solutions for customers' products in time
frames and on cost bases that it believes are competitive. The Company utilizes
advanced, flexible manufacturing systems that can accommodate low-volume
production runs or highly sophisticated applications in Arizona and high-volume,
price sensitive runs in Manila, the Philippines and Beijing, China.
The Company maintains its principal executive offices at 1600 North
Desert Drive, Tempe, Arizona 85281, and its telephone number is (602) 389-8600.
Unless the context indicates otherwise, all references to the "Company" refer to
Three-Five Systems, Inc., its subsidiaries and predecessors.
TECHNOLOGY
Since the commercial introduction of the first light emitting diodes
("LEDs") in the 1960s and twisted nematic liquid crystal displays in the 1970s,
the use of LCD and LED indicators has become widespread in industrial and
consumer electronic products. Prior to these innovations, the most common
displays or indicators had substantial limitations as to their use, especially
in terms of size, life, and power consumption. LCD and LED technologies were
developed in order to overcome these limitations.
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An LCD modifies light that passes through or is reflected by it, rather
than emitting light like an LED. An LCD generally consists of a layer of liquid
crystalline material suspended between two glass plates. The crystals align
themselves in a predictable manner, and this alignment changes when stimulated
electrically. This changed alignment produces a visual representation of the
information desired when used in conjunction with a polarizer and either natural
ambient light or an external light source.
The Company also has undertaken substantial efforts with respect to
liquid crystal on silicon (LCoS(TM)) microdisplays. Liquid crystal on silicon
displays are a form of LCD where, instead of suspending liquid crystalline
material between two glass plates, the material is suspended between a glass
plate and silicon backplate. The silicon backplate is an integrated circuit that
provides drive signals for each element of the display (for instance,
active-matrix drive) and also provides logic functions, such as serial to
parallel conversion and data storage. Because highly developed silicon
integrated circuits form the basis of these displays, the LCoS(TM) technology
provides very high information displays in a small size and at a relatively low
cost. The high information presented by such displays is magnified for view,
generally either in a projector or in a view-finder.
INDUSTRY OVERVIEW
The Company has benefited from the determination by certain OEMs in the
electronics industry to outsource the design and production of certain
components included in the end products of those OEMs. The Company believes that
the following factors have contributed to this growing trend among OEMs:
+ As technology has become increasingly sophisticated and complex, it
has become more difficult for even the leading OEMs to maintain the
necessary technology, expertise, personnel, and equipment to design
and produce internally all of the various components necessary for
their products.
+ Advanced design and manufacturing processes require increasingly
greater investments for research and development, personnel, and
equipment.
+ Competitive market conditions require OEMs to reduce the period of
time from product conception to delivery, to differentiate their
products from those of their competitors, to improve user
friendliness, and to continually enhance product performance and
reduce product cost during the life cycle of the product.
OEMs often design their products to contain display modules as a highly
cost-effective means of differentiating their products from competing products.
OEMs then make the decision of whether to use standard devices, to design and
produce the devices in-house, or to outsource with a third party for design and
production. In making this decision, companies often recognize that their
greatest strengths consist of consumer recognition of brand names, market
research and product development expertise, and highly developed sales and
distribution channels. OEMs also recognize that the desired devices often cannot
be obtained "off-the-shelf" and that time constraints and limitations on
available resources often preclude them from maintaining the specialized
in-house expertise and equipment necessary to design and manufacture the desired
devices. OEMs often conclude that the logical solution is to focus their
resources on those areas (such as marketing and distribution) where they possess
the greatest leverage and to outsource the design and production of devices and
components in which they lack the requisite technology and expertise.
Outsourcing enables OEMs to obtain the following desired benefits:
+ To gain access to specialized design and manufacturing technology and
expertise.
+ To accelerate the design process and to reduce design and
manufacturing costs by utilizing the specialized personnel, equipment,
and facilities of the supplier.
+ To reduce their own investment in personnel, equipment, and facilities
necessary for specialized design and production capabilities.
+ To streamline their own operations by concentrating their resources on
the design, production, and distribution of their core products.
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By eliminating the duplication and overlap of investment and resources,
outsourcing permits the Company and the OEMs to work together and grow at a
faster rate than would otherwise be possible. Outsourcing greatly reduces the
Company's need to devote time and resources on market development for specific
products and allows the Company to concentrate on the development of its display
technologies and their applications to a multitude of products.
PRODUCTS AND SERVICES
The Company currently emphasizes custom-designed display modules. The
Company believes that custom devices represent a significant source of its
profits and growth potential. For each custom device, the Company works directly
with its customer to develop and produce the original design and to manufacture
the device in accordance with the customer's specifications. The Company also
designs and produces standard or "off-the-shelf" devices, which involve designs
that are adaptable to various fixed end uses without modification or with slight
modifications. In the last few years, the Company's standard devices have
accounted for less than 10 percent of its revenues. In 1999, however, the
Company is planning to introduce new standard products using some of the
Company's new display technologies.
The Company pursues a strategy designed to enable it to enhance its
position as a major, worldwide supplier of custom-designed and manufactured
display modules for products of leading OEMs in various high growth industries.
The Company attempts to identify industries that present the greatest long-term
potential for growth at any given time. The Company's research and development
activities then focus upon technological developments that attempt to meet the
current and future requirements of those industries. The Company seeks to
establish strong and long-lasting customer relationships by aligning its
prospects with those of its customers and by seeking to make its engineering and
advanced manufacturing functions seamless extensions of the product design and
production departments of its customers. The Company engages in a careful
customer selection process because it recognizes that its own growth and
development will be closely aligned with the growth and development of the
customers it serves. The Company's strategy currently involves concentrating its
efforts on providing design and production services to leading companies in five
primary industries: cellular telephones and other wireless communications, data
collection, office automation, medical devices, and industrial process controls.
More recently, with the availability of the high-volume LCD
manufacturing line in Arizona, the Company has begun focusing its efforts on
creating advanced display technologies. These advanced display technologies will
allow the Company to provide its customers with differentiating products or
products that provide higher information content. These products may be
available for use in custom devices or in standard devices. The Company
currently has three announced technology initiatives. First, the Company has
patented a new type of LCD display that emulates an emissive LED display, which
the Company calls LCiD(TM) or Liquid Crystal intense Display. This low
information content device provides a multi-colored emissive-looking display at
passive LCD prices. The second initiative involves the creation of a high
information content display with numerous gray shades but again at the price of
a more typical LCD. This new product is called LCaD(TM) or Liquid Crystal active
Drive(TM). This technology is based, in part, on technology licensed from Motif,
Inc. and additional proprietary technology developed by the Company. The third
technology initiative is liquid crystal on silicon microdisplays or LCoS(TM).
LCoS(TM) microdisplays provide high-resolution (up to one million pixels and
beyond) active matrix displays that are less than 8/10 of an inch in diameter on
the diagonal. LCoS(TM) microdisplays are expected to serve the need for
portable, high information content displays in industries such as wireless
communications, office automation, and industrial process controls. In addition,
the Company expects that LCoS(TM) microdisplays will open new market industries
for the Company in areas such as business and consumer electronics, as well as
provide a source for inexpensive, high resolution displays in projection
products such as rear-projection monitors, high-definition televisions, and
front projection audio-visual units.
CUSTOM DEVICES
LCD and LED custom displays currently account for approximately 95.3
percent of the Company's revenue, with the majority consisting of LCD custom
displays. A manufacturer of a complete system or product requiring a specific
type of visual display (such as a cellular telephone, medical instrument,
business machine, or hand-held data collection device) represents a typical
buyer for a custom device.
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The Company has developed a sophisticated design process to meet the
specific needs of its customers' applications. Each design project normally
involves a cross-functional team of Company engineers who are assigned to a
customer program. The team consults with the customer's engineers throughout the
design phase, prototype development, and manufacturing process. The Company
continues to supply value-added engineering support after the design solution
has been developed and integrated into the manufacturing process in an ongoing
effort to provide customers with product performance enhancements and
cost-reduction opportunities.
STANDARD DEVICES
Standard devices encompass a wide variety of LCD and LED devices having
varied applications. "Visible" LCD and LED standard devices include
+ solid state lamps used for indicators, status lights, on-board circuit
monitors, and instrumentation;
+ multi-digit numerical displays used for calculators, industrial
controls, data terminals, instrumentation timers, hand-held
instruments, event counters, test equipment, embedded computing
equipment, and consumer applications;
+ integrated displays (with on-board integrated circuit drivers) and
alpha numeric displays used for hand-held terminals, embedded
computing equipment and telecommunications; and
+ bar graph displays (with integrated circuit drivers) used as linear,
logarithmic and VU meters in stereo systems, radios, magnetic
recording devices, process control instruments, and volt meters.
Standard infrared devices include infrared emitters used in remote
controllers, disk drives, tape drives, printers, encoders, solid state relays,
photoelectric controls, slotted switches, reflective switches, intrusion alarms,
touch screens, wireless data entry terminals, and positioning sensor
applications.
Standard LCiD(TM) display devices will include a 1 line by 10 character
and 2 line by 10 character dot matrix display available in a variety of colors.
The Company expects that LCiD(TM) displays will be used primarily in lower
information content applications where high contrast, desired color, and ease of
readability from full sunlight to complete darkness are required. Typical
applications for LCiD(TM) display standard devices would include automotive
instrumentation, appliances, hand-held instrumentation devices, vending
equipment, stereo equipment, embedded computing equipment, remote sensing
equipment, outdoor monitor equipment, and industrial controls.
Standard LCaD(TM) display devices will include a variety of backlit
quarter VGA (240 rows x 320 columns), 16 gray shade capable display systems. The
standard LCaD(TM) display will consist of a complete display system
incorporating LCD panel, lighting, memory, LCD controller, and interface
electronics. Typical applications for the LCaD(TM) display would include medical
and industrial instrumentation, test equipment, point-of-sale terminals, mapping
and hand held global positioning system devices, stereo equipment, and embedded
computing equipment.
MANUFACTURING SERVICES
The Company has geographically organized its manufacturing capabilities
in a manner that optimizes the combination of technology and human resources.
This enables the Company to compete solely on the basis of cost, if necessary,
with suppliers of similar products and services throughout the world. Advanced
manufacturing techniques include surface mount technologies, chip-on-board,
chip-on-flex, flip-chip, tape automated bonding, and sophisticated testing
systems throughout the process.
The Company seeks to increase its value to its customers by providing
responsive, flexible, total manufacturing services. To date, manufacturing
services have been concentrated toward the manufacture of LCDs and assembly of
Company-designed display module assemblies. The Company will provide extended
manufacturing services beyond these core services, however, if the customer
requires them. Extended services may include adding additional components, such
as a keypad, microphone, card reader, product housing, or non-display electronic
sub-assembly, or the turn-key manufacture of a complete OEM product.
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MANUFACTURING FACILITIES
The Company currently conducts manufacturing operations in Tempe,
Arizona; Manila, the Philippines; and Beijing, China. The Arizona facility
houses a Class 1000 "clean room" and LCD fabrication and prototyping operation.
The Company utilizes this facility primarily to conduct LCD research and
development, to produce prototype and pre-production runs of devices for
customer approval, to conduct full production runs of low-volume devices, and to
develop advanced manufacturing processes that can be applied in the Philippines
and China during full-scale production. In addition, the facility has the
largest fully automated LCD glass production capacity in North America. This
highly automated line enables the Company to reduce its dependence on foreign
suppliers of LCD glass. Facility personnel include a team of experts ranging
from LCD research scientists to specialized engineers with backgrounds in
electronics, mechanics, chemistry, physics, and manufacturing. The Company
maintains a wide variety of state-of-the-art testing and quality control
equipment at the facility.
High volume display module manufacturing is done in Manila, the
Philippines and Beijing, China. In Manila, the Company is a party to an
agreement (the "Sub-Assembly Agreement") with Technology Electronic Assembly and
Management Pacific Corporation ("TEAM"), pursuant to which TEAM supplies direct
manufacturing services at a facility owned by TEAM located in Manila. The
Company is also party to a lease agreement (the "Lease Agreement") with TEAM
pursuant to which TEAM leases space to the Company with respect to those
manufacturing operations services performed by TEAM under the Sub-Assembly
Agreement. TEAM manufactures, assembles, and tests devices designed by the
Company in the space leased to the Company and pursuant to procedures set forth
in the Sub-Assembly Agreement in accordance with specifications supplied by the
Company. In 1997, TEAM and the Company entered into an amendment to the
Sub-Assembly Agreement whereby all indirect manufacturing employees (primarily
technicians, supervisors, and engineers) became employees of the Company. As a
result, under the Sub-Assembly Agreement TEAM now only supplies the direct labor
and certain incidental services required to manufacture the Company's products.
The Company owns the manufacturing, assembling, and testing equipment (including
automated die attach and wire bond equipment with automatic pattern recognition
features for die and wire placement for LED die) as well as the processes and
documentation used by TEAM at the Manila facility. The Company pays TEAM for the
direct manufacturing personnel based upon a negotiated available hourly rate.
The Company employs all professional personnel, including an Operations Manager,
with a support staff consisting of manufacturing supervisors; manufacturing,
quality, and process engineers; and logistics and administrative personnel at
the Manila facility.
The Sub-Assembly Agreement and Lease Agreement between the Company and
TEAM extend through December 31, 1999 and are renewable from year to year
thereafter. The Sub-Assembly Agreement requires the Company to maintain minimum
production levels. The termination of the Lease Agreement or Sub-Assembly
Agreement or the inability of TEAM to fulfill its requirements under the
Sub-Assembly Agreement would require the Company to acquire additional
manufacturing facilities or to contract for additional manufacturing services.
The Philippines has been subject to volcanic eruptions, typhoons, and
substantial civil disturbances, including attempted military coups against the
government. Although there has not been any material interruption of operations
to date, these circumstances could affect the Company's ability to obtain
products pursuant to the Sub-Assembly Agreement. The termination or 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.
The Company commenced manufacturing operations in the People's Republic
of China ("China") during 1998. The China facility is a high-volume display
module manufacturing facility similar to the Company's current facility in
Manila. The Company initially leased a facility in Beijing on a temporary basis,
and the Company commenced manufacturing in that temporary facility in the third
quarter of 1998. The Company has begun construction of its own facility in
Beijing and expects to move into that new facility in the middle of 1999. The
Company employs all direct and indirect manufacturing employees at the facility,
including technicians, supervisors, and engineers. The Company expects the
initial cost of equipping and constructing the China facility to be
approximately $10.0 million. For further discussions on the Company's operations
in China, see Item 7, "Management's Discussion and Analysis of Financial
Conditions and Results of Operations" and Item 1, "Special Considerations - The
Company Faces Risks Associated with International Operations."
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QUALITY CONTROL
The Company has an aggressive quality control program and maintains at
each of its facilities quality systems and processes that meet or exceed the
demanding standards set by many leading OEMs in targeted industries. The Company
bases its quality control program upon Statistical Process Control, which
advocates continual quantitative measurements of crucial parameters and uses
those measurements in a closed-loop feedback system to control the manufacturing
process. The Company performs product life testing to help ensure long-term
product reliability. The Company analyzes results of product life tests and
takes actions to refine the manufacturing process or enhance the product design.
Increased global competition has led to increased customer expectations
with respect to price, delivery, and quality. Customers often evaluate price in
the quotation process, while delivery and quality are evaluated only after the
product is received. Therefore, many customers preview a company's quality by
viewing the quality systems employed. The Company has received ISO 9002
certification of its Manila manufacturing facility. ISO is a quality standard
established by the International Organization for Standardization, which
attempts to ensure that the processes used in development and production remain
consistent. This is accomplished through documentation maintenance, training,
and management review of the processes used. Although achievement of ISO 9002
certification is no guarantee of the Company's ability to obtain future
business, it is a factor that enables the Company's customers to recognize that
the Company's production processes meet this established, global standard of
performance.
SALES AND MARKETING
The Company markets its services primarily in North America and Europe
through direct technical sales persons. In 1998, the Company added direct
technical sales persons in Asia. To a much lesser extent, the Company also
markets some standard products through an independent sales and distribution
network. This network includes two franchised distributors in approximately 91
sales offices. A staff of in-house, Arizona-based sales and engineering
personnel directs and aids all direct and distribution sales. The Company also
has sales personnel in California, Massachusetts, Illinois, North Carolina, and
Florida.
The Company's sales to customers in Europe represented approximately 35
percent of net sales in 1998. In addition to a direct technical sales force, the
Company distributes products in Europe through a network of distributors,
augmented in some regions by marketing representatives. This network receives
support from the marketing, customer service, and support staff employed by the
Company's subsidiary, Three-Five Systems Limited, located in Swindon, England.
In addition, the Company's design engineers in Tempe, Arizona provide design
input for customers in Europe.
The Company's sales to customers is Asia represented approximately 7.0
percent of net sales in 1998. The Company has added several direct technical
sales and marketing persons in Asia and has also trained Chinese design
engineers to provide design input for customers in Asia.
CUSTOMERS
The Company's strategy involves concentrating its efforts on providing
design and production services to leading companies in five primary industries:
cellular telephones and other wireless communications, data collection, office
automation, medical devices, and industrial process controls. As a result, the
Company generally derives its revenue from services provided to a limited number
of customers. The Company's largest customer is Motorola, Inc. ("Motorola"). The
Company currently designs and manufactures display modules used in approximately
45 individual product programs for Motorola. Sales to Motorola accounted for
63.6 percent of the Company's revenue during 1998. Devices that are used in
cellular telephones accounted for substantially all of the Company's sales to
Motorola in 1998. Motorola continues to award new design programs to the
Company. Motorola has an LCD module allocation process in which it designates
three or four key LCD module vendors, including the Company, and communicates to
each vendor the anticipated annual amount of purchases. Although the allocation
process does not provide a guarantee of business to the Company, it provides an
indication that purchases by Motorola during 1999 could continue at 1998 levels.
The Company's second-largest customer in 1998 was Hewlett-Packard
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Company ("Hewlett-Packard"). Sales to Hewlett-Packard accounted for 6.6 percent
of the Company's revenue during 1998. As the display modules manufactured by the
Company for Hewlett-Packard moved into second generation versions in 1998, the
selling price of some of those modules was greatly reduced. In addition, the
number of LCD display modules required by Hewlett-Packard was also greatly
reduced as Hewlett-Packard moved to less expensive front panel devices in an
extremely competitive market. Consequently, in 1998 the percentage of the
Company's revenue attributed to Hewlett-Packard declined substantially. See Item
1, "Special Considerations - Certain Customers Account for a Significant Portion
of the Company's Sales."
BACKLOG
As of December 31, 1998, the Company had a backlog of orders of
approximately $23.3 million, all of which are believed to be firm and all of
which are expected to be filled during fiscal 1999. The backlog of orders at
December 31, 1997 was approximately $21.8 million. The Company's business has
some seasonality as the result of the significant amount of retail products into
which its products are placed. Design cycles have shortened and many customers
finish cycles in the fourth quarter (because of the holiday sales season) and
ramp up new products in the second quarter of the calendar year. Consequently,
the first quarter of a calendar year may have a disproportionately lower
percentage of the year's total sales. In both 1997 and 1998, sales in the fourth
quarter were approximately 60 percent greater than sales in the first quarter.
PATENTS AND TRADEMARKS
The Company relies on a combination of patent, trade secrets and
trademark laws, confidentiality procedures, and contractual provisions to
protect its intellectual property. Although the Company's existing core business
does not depend on any patent or trademark protection, the Company is
manufacturing more advanced display products in which there are patent or
trademark issues. For example, the Company has patents on its LCiD(TM) display
technology. The Company also signed a license agreement with Motif, Inc. to
license the technology that forms the basis of its LCaD(TM) or Liquid Crystal
active Drive. The Company has applied for a patent on its LCaD(TM) technology
and has filed several patents relating to its LCoS(TM) microdisplay technology.
The Company has also applied for numerous other process and product patents, all
related to display technologies.
RAW MATERIALS
The principal raw materials used in producing the Company's displays
consist of LCD glass, driver die, circuit boards, molded plastic parts, lead
frames, wire, chips, and packaging materials. The Company's procurement strategy
provides alternative sources of supplies for the majority of these materials.
Many of such materials, however, must be obtained from foreign suppliers, which
subjects the Company to the risks inherent in obtaining materials from foreign
sources, including supply interruptions and currency fluctuations. The Company's
suppliers currently are meeting the requirements of the Company, and strategic
supplier alliances have further strengthened relations with offshore suppliers.
The Company's ability to produce a significant percentage of its requirements of
LCD glass in its Arizona facility has reduced the Company's dependence on
foreign LCD glass suppliers. See Item 1, "Special Considerations - The Company
May be Subject to Shortages of Raw Materials and Supplies."
COMPETITION
The Company believes that Optrex, Seiko-Epson, Samsung, Seiko
Instruments, Sharp, Hosiden, Hyundai, PCI, and Philips Components constitute the
principal competitors for the Company's LCD devices. Hewlett-Packard, Rohm,
LiteOn, Siemens, Stanley Electric Company, and Quality Technologies Corp.
constitute its principal competitors for its LED devices and for its LCiD(TM).
Most of these competitors are large companies that have greater financial,
technical, marketing, manufacturing, and personnel resources than the Company.
The revenue, profitability, and success of the Company depend substantially upon
its ability to compete with other providers of display modules. The Company
cannot provide assurance that it will continue to be able to compete
successfully with such organizations.
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The Company currently competes principally on the basis of the
technical innovation and performance of its display modules, including their
ease of use and reliability, as well as on their cost, timely design, and
manufacturing and delivery schedules. The Company's competitive position could
be adversely affected if one or more of its customers, particularly Motorola,
determines to design and manufacture their display modules internally or secure
them from other parties. See Item 1, "Special Considerations - The Company Faces
Intense Competition."
RESEARCH AND DEVELOPMENT
The Company conducts an active and ongoing research, development, and
engineering program that focuses on advancing technology, developing improved
design and manufacturing processes, and improving the overall quality of the
products and services that the Company provides. Research and development
personnel concentrate on LCD technology, especially improving the performance of
current products and expanding the technology to serve new markets. The Company
also conducts research and development in manufacturing processes, including
those associated with efficient, high-volume production and electronic
packaging.
More recently, the Company has focused its research and development
efforts on new display technologies. See Item 1, "Business - Products and
Services." The Company has undertaken a significant research and development
program with respect to the development of LCoS(TM) microdisplays and expects
that the majority of available research and development personnel hours will be
dedicated to LCoS(TM) microdisplays in 1999.
ENVIRONMENTAL REGULATION
The operations of the Company result in the creation of small amounts
of hazardous waste, including various epoxies, gases, inks, solvents, and other
wastes. The amount of hazardous waste produced by the Company may increase in
the future depending on changes in the Company's operations. The general issue
of the disposal of hazardous waste has received increasing focus from federal,
state, local, and international governments and agencies and has been subject to
increasing regulation. See Item 1, "Special Considerations - Environmental
Regulation."
In a separate matter, the Company conducted a clean-up of limited
chemical contamination at its former property located in Barkhamsted,
Connecticut. The contamination was caused by the previous owner of the property,
and not as a result of any of the Company's operations. The Company has
contracted with an environmental consulting firm for assistance with the
clean-up process and has complied with the requests and recommendations of the
Connecticut Environmental Protection Agency throughout the process. The Company
believes that the source of the contamination has been removed from the property
and that the clean-up has been completed. Four monitoring wells have been
installed to permit periodic chemical analysis to be made at the property. The
property was sold on June 25, 1995, subject to the Company making its best
efforts to obtain from either the Connecticut or Federal Environmental
Protection Agency documentation to the effect that the property is clean and
that there is no actionable contamination in the vicinity of the property.
EMPLOYEES
As of December 31, 1998, the Company employed a total of 867 persons.
This number includes 172 full-time and approximately 16 temporary employees at
its principal U.S. facility in Tempe, Arizona and U.S. sales offices; 256
employees at its manufacturing facility in Manila, the Philippines; 415
employees at its manufacturing facility in Beijing, China; and 8 employees at
its Three-Five Systems, Ltd. subsidiary in Swindon, England. The Company
considers its relationship with its employees to be good, and none of its
employees currently are represented by a union in collective bargaining with the
Company.
TEAM provides the personnel engaged in the direct assembly of the
Company's devices in Manila pursuant to the Sub-Assembly Agreement between the
Company and TEAM. See Item 1, "Business - Manufacturing Facilities." As of
December 31, 1998, approximately 1,152 persons performed direct labor operations
at the Manila facility through the Sub-Assembly Agreement with TEAM.
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EXECUTIVE OFFICERS
The following table sets forth information concerning each of the
Company's executive officers.
NAME AGE POSITION
---- --- --------
David R. Buchanan 66 Chairman of the Board, President, and Chief
Executive Officer
Lawrence E. Kagemann, Sr. 56 Vice President - Operations
Radu Andrei 48 Vice President - Marketing and Sales
Jeffrey D. Buchanan 43 Executive Vice President - Finance,
Administration, and Legal; Chief Financial
Officer; Secretary; Treasurer; and Director
Dan J. Schott 59 Vice President - Research and Development
Robert T. Berube 60 Principal Accounting Officer and Corporate
Controller
DAVID R. BUCHANAN has been Chairman of the Board of the Company since
its formation in February 1990. Mr. Buchanan served as the Company's President
and Chief Executive Officer from February 1990 until July 1998. In January 1999,
Mr. Buchanan reassumed duties as interim President and Chief Executive Officer
while the Board of Directors conducts a search for a new President and Chief
Executive Officer. Mr. Buchanan also served as Treasurer of the Company from May
1990 until January 1994 and as Chairman of the Board, Chief Executive Officer,
President, and a director of one of the predecessors of the Company from October
1986, February 1987, and November 1985, respectively, until the predecessor's
merger into the Company in May 1990.
LAWRENCE E. KAGEMANN, SR. has been Vice President - Operations of the
Company since August 10, 1998. Mr. Kagemann served as Vice President - Quality
and Manufacturing Technology for Harman OEM Group ("Harman") from 1990 until
December 1996, where he led quality, plant, manufacturing, advanced
manufacturing, and supplier engineering for the U.S. and Wales sites. In 1997,
Mr. Kagemann was appointed Vice President - Audio for Computer Operations and
Quality for Harman, where he had responsibility for maintaining quality and
supplier engineering for the U.S. and Wales sites. From August 1997 to August
1998, Mr. Kagemann held the position of Vice President - Quality and Supplier
Engineering for Harman, where he was assigned the responsibility of quality and
supplier engineering for the group.
RADU ANDREI has been Vice President - Marketing and Sales of the
Company since June 1, 1998. Mr. Andrei served a Research Director for Semico
Research Arizona and Intechno Consulting Director - Basel, Switzerland/Phoenix,
Arizona from 1996 until June 1998. His responsibilities included assessing the
market, analyzing external market drivers, correlating the results of business
core competencies, resources and objectives, and devising a long-term plan. In
1994 and 1995, Mr. Andrei held the position of Manager, Strategic Marketing and
Systems Engineering (Director) for Motorola SPS Division in Phoenix, Arizona.
JEFFREY D. BUCHANAN has served as a director and Executive Vice
President - Finance, Administration, and Legal of the Company since June 1998;
as Chief Financial Officer and Treasurer of the Company since June 1996; and as
Secretary of the Company since May 1996. Mr. Buchanan served as Vice President -
Finance, Administration, and Legal of the Company from June 1996 until July 1998
and as Vice President - Legal and Administration of the Company from May 1996 to
June 1996. Mr. Buchanan served as a Senior Member of O'Connor, Cavanagh,
Anderson, Killingsworth & Beshears from June 1986 until May 1996, where he
practiced as a business lawyer with an emphasis on mergers and acquisitions,
joint ventures, and taxation. Mr. Buchanan was associated with the international
law firm of Davis Wright Tremaine from 1984 to 1986, and he was a senior staff
person at Deloitte & Touche from 1982 to 1984. Mr. Buchanan is a member of the
Arizona and Washington state
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bars and passed the certified public accounting examination in 1983. Mr.
Buchanan is the son of David R. Buchanan.
DAN J. SCHOTT has been Vice President - Research and Development of the
Company since July 1996. From January 1994 until July 1996 he served as the
Company's Vice President of Technology. From 1988 to January 1994, Mr. Schott
was an Associate Director with Honeywell Inc., where his responsibilities
included flat panel display research and development. From 1981 until 1987, Mr.
Schott held various engineering management and program management positions with
Sperry Rand Corp.
ROBERT T. BERUBE has been the Company's Principal Accounting Officer
since July 1998 and has served as the Company's Corporate Controller since July
1990.
SPECIAL CONSIDERATIONS
A VARIETY OF FACTORS AFFECT THE COMPANY'S OPERATING RESULTS
A wide variety of factors affect the Company's operating results and
could adversely impact its net sales and profitability. These factors, many of
which are beyond the control of the Company, include the following:
+ the Company's ability to identify industries that have significant
growth potential and to establish strong and long-lasting
relationships with companies in those industries;
+ the Company's ability to provide significant design and manufacturing
services for those companies on a timely and cost-effective basis;
+ the Company's success in maintaining customer satisfaction with its
design and manufacturing services;
+ market acceptance of products of its customers incorporating devices
designed and manufactured by the Company;
+ customer order patterns, changes in order mix, and the level and
timing of orders placed by customers that the Company can complete in
a quarter;
+ the performance and reliability of devices designed and manufactured
by the Company;
+ the life cycles of its customers' products;
+ the availability and utilization of manufacturing capacity;
+ fluctuations in manufacturing yield and productivity;
+ the quality, availability, and cost of raw materials, equipment, and
supplies;
+ the timing of expenditures in anticipation of orders;
+ the cyclical nature of the industries and the markets served by the
Company;
+ technological changes; and
+ competition and competitive pressures on prices.
The Company's ability to increase its design and manufacturing capacity
to meet customer demand and maintain satisfactory delivery schedules represent
important factors in its long-term prospects. Although the Company's product
solutions are incorporated into a wide variety of communications, consumer,
medical, office automation, and industrial products, a majority of its sales in
1998 were display modules for cellular products. A slowdown in demand for
customer products, particularly cellular and office automation products that
utilize the Company's products, as a result of economic or other conditions in
the United States or worldwide markets served by the Company or other
broad-based factors would adversely affect the Company's operating results.
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CERTAIN CUSTOMERS ACCOUNT FOR A SIGNIFICANT PORTION OF THE COMPANY'S SALES
In the past few years, the Company has generated most of its revenue
from sales to a few significant customers. Motorola, the Company's largest
customer, accounted for 63.6 percent of the Company's revenue in 1998, 34.6
percent of revenue in 1997, and 65.1 percent of revenue in 1996. Devices used in
cellular telephones accounted for substantially all of the Company's sales to
Motorola in 1998. The Company anticipates that sales to Motorola in 1999 will
reach or exceed 1998 levels, but believes that the percentage of its net revenue
from sales to Motorola should decrease in 1999 as a result of increased sales to
other customers. The Company's second largest customer is Hewlett-Packard, which
accounted for 6.6 percent of the Company's revenue during 1998. This amount
represents a significant reduction from sales to Hewlett-Packard that accounted
for 32.0 percent of the Company's sales in 1997. See Item 1, "Business -
Customers."
Although the Company has begun 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. Customers generally do
not provide firm long-term volume purchase commitments to the Company. Thus,
customers can cancel purchase commitments and change or delay expected volume
levels. The Company may be unable to replace canceled, delayed, or reduced
commitments in a timely manner. The cancellation, delay, or reduction of
customer commitments could result in the Company holding excess and obsolete
inventory or having unfavorable manufacturing variances as a result of
under-absorption. These risks are enhanced because of the large percentage of
sales to customers in the retail electronics industry, which is subject to
severe competitive pressures, rapid technological change, and obsolescence. The
Company's operating results have been materially and adversely affected in the
past as a result of the non-realization of anticipated orders and deferrals or
cancellations of orders as a result of changes in customer requirements. For
example, in 1998 the Company made two announcements that sales would not meet
its expectations because of delays in customer programs. Cancelled, delayed, or
reduced commitments from any of the Company's major customers, particularly
Motorola, would have a material adverse effect on the Company's results of
operations.
A few of the Company's customers have inquired about "inventory
hubbing" agreements, under which the Company would maintain stocks of finished
goods at or near the customer's factory. Although the Company has not yet
entered into such agreements, the use of such type of agreements for significant
customers could result in higher inventory balances and excess inventory.
THE COMPANY FACES INTENSE COMPETITION
The Company serves intensely competitive industries that are
characterized by price erosion, rapid technological change, and foreign
competition. The Company competes with major domestic and international
companies. Most of the Company's competitors are located in Asia, and many have
greater market recognition and substantially greater financial, technical,
marketing, distribution, and other resources than the Company possesses. See
Item 1, "Business - Competition." Emerging companies also may increase their
participation in the display module market. The Company currently competes
principally on the basis of the technical innovation and performance of its
display modules, including their ease of use and reliability, as well as on
pricing and timely design, manufacturing, and delivery schedules. The Company's
ability to compete successfully depends on a number of factors, both within and
outside its control. These factors include the following:
+ the quality, performance, reliability, features, ease of use, pricing,
and diversity of its product solutions;
+ foreign currency fluctuations, which may cause a foreign competitor's
products to be priced significantly lower than the Company's products;
+ the quality of its customer services;
+ its ability to address the needs of its customers;
+ its success in designing and manufacturing new product solutions,
including those implementing new technologies;
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+ the availability of adequate sources of raw materials and other
supplies at acceptable prices;
+ its efficiency of production;
+ the rate at which customers incorporate the Company's display modules
into their own products;
+ product solution introductions by the Company's competitors;
+ the number, nature, and success of its competitors in a given market;
and
+ general market and economic conditions.
The Company's competitive position could be adversely affected if one
or more of its customers increase their own capacity and decide to design and
manufacture their own display modules, to use standard devices, or to outsource
with a competitor. The Company cannot provide assurance that it will continue to
be able to compete successfully in the future.
THE COMPANY'S BUSINESS DEPENDS ON NEW PRODUCTS AND TECHNOLOGIES
The Company operates in fast changing industries. Technological
advances, the introduction of new products, and new design and manufacturing
techniques could adversely affect the Company's operations unless it is able to
adapt to the resulting changing conditions. As a result, the Company will be
required to expend substantial funds for and commit significant resources to
+ continuing research and development activities;
+ engaging additional engineering and other technical personnel;
+ purchasing advanced design, production, and test equipment; and
+ enhancing design and manufacturing processes and techniques.
The Company's future operating results will depend to a significant
extent on its ability to continue to provide design and manufacturing services
for new products that compare favorably on the basis of time to introduction,
cost, and performance with the design and manufacturing capabilities of OEMs and
other third-party suppliers. The success of new design and manufacturing
services depends on various factors, including the following:
+ proper customer selection;
+ utilization of advances in technology;
+ innovative development of new solutions for customer products;
+ efficient and cost-effective services;
+ timely completion and delivery of new product solutions; and
+ market acceptance of customers' end products.
Because of the complexity of the Company's design and manufacturing services,
the Company from time to time may experience delays in completing the design and
manufacture of new product solutions. In addition, certain new product solutions
may not receive or maintain customer or market acceptance. The Company's
inability to design and manufacture solutions for its customers' new products on
a timely and cost-effective basis would adversely affect its future operating
results. See Item 1, "Business - Products and Services."
Finally, circumstances outside of the Company's control may cause the
loss of expected revenue even when the Company satisfactorily completes a design
and manufacturing solution. For example, a customer may terminate or delay its
own program for any number of reasons unrelated to the Company, including
problems with other suppliers to the program or lack of market acceptance of the
customer's product.
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THE COMPANY FACES RISKS ASSOCIATED WITH RESEARCH AND DEVELOPMENT EFFORTS
The Company currently is investing in research and development of
several new technologies that it plans to introduce in the future. Some or all
of those technologies may not successfully make the transition from the research
and development lab to cost-effective manufacturability as a result of
technology problems, competitive cost issues, yield problems, and other factors.
An investment of significant amounts of resources in one or more technologies
that fail to achieve manufacturability could have a material adverse effect on
the Company. In addition, even if a new technology proves to be manufacturable,
the Company's customers and the customers' marketplaces may not accept the
technology because of price or technology issues or because of unfavorable
comparisons with products introduced by others. The Company will be required to
make significant expenditures, including development expenses and various
capital expenditures and investments, for these new technologies. For example,
the Company estimates that its initial capital expenditures for LCoS(TM)
microdisplays will be approximately $3.0 million to $4.0 million. The Company
also made an equity investment of $3.3 million in Siliscape, Inc. during 1998
for the purposes of further developing the LCoS(TM) microdisplay product.
Significant investments in one or more of the new technologies, especially
LCoS(TM) microdisplays, that ultimately prove to be unsuccessful for any reason
could have a material adverse impact on the Company. In addition, if Siliscape
were to encounter technological or financial difficulties, the value of the
Company's investment in that company could decline, in which case the Company
would have to write down all or a portion of its investment and report a loss
equal to such write-down.
THE COMPANY FACES RISKS ASSOCIATED WITH INTERNATIONAL OPERATIONS
GENERAL. The Company currently has substantial manufacturing operations
located in the Philippines, China, and the United States. The Company also
maintains a sales office and distribution warehouse in Europe. The geographical
distances between Asia, Europe, and North America create a number of logistical
and communications challenges. Because of the location of manufacturing
facilities in a number of countries, the Company may be affected by economic and
political conditions in those countries, including the following:
+ management of a multi-national organization;
+ compliance with local laws and regulatory requirements as well as
changes in such laws and requirements;
+ employment and severance issues;
+ overlap of tax issues;
+ fluctuations in the value of currency;
+ tariffs and duties;
+ possible employee turnover or labor unrest;
+ lack of developed infrastructure;
+ longer payment cycles;
+ greater difficulty in collecting accounts receivable;
+ the burdens and costs of compliance with a variety of foreign laws;
and
+ political or economic instability in certain parts of the world.
Changes in policies by the United States or foreign governments resulting in,
among other things, increased duties, higher taxation, currency conversion
limitations, restrictions on the transfer or repatriation of funds, limitations
on imports or exports, or the expropriation of private enterprises also could
have a material adverse effect on the Company, its results of operations,
prospects, and ability to service debt. The Company's operating results also
could be adversely affected if its host countries were to reverse the current
policies encouraging foreign investment or foreign trade. In addition, U.S.
trade policies, such as "most favored nation" status and trade preferences for
certain Asian nations, affect the attractiveness of the Company's services to
its U.S. customers. In particular, the
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Company's operations and assets are subject to significant political, economic,
legal, and other uncertainties in the Philippines and China.
MANUFACTURING OPERATIONS IN THE PHILIPPINES. The Company has maintained
its primary manufacturing facility in Manila, the Philippines since 1986. TEAM,
a third-party subcontractor, owns the facility, which is located on land it
leases from the Philippine government. TEAM operates the facility under the
Sub-Assembly Agreement and the Lease Agreement, utilizing equipment, processes,
and documentation owned by the Company and supervisory personnel employed by the
Company. TEAM provides direct-level production personnel under the Sub-Assembly
Agreement and leases space to the Company under the Lease Agreement. TEAM also
utilizes additional space in the facility to produce products for other entities
unrelated to the Company. The Sub-Assembly Agreement and the Lease Agreement
have current terms extending through December 31, 1999 and are renewable from
year to year thereafter. The Company has made advance payments to TEAM since
1994 for a variety of reasons, including to assist it in meeting its working
capital needs while it negotiates new financing arrangements for generators and
equipment needed for building improvements. The outstanding advances to TEAM at
December 31, 1998 totaled approximately $205,000.
The Company has made cumulative capital investments in the Philippines
amounting to approximately $12.0 million through December 31, 1998. The
Company's reliance on personnel and facilities in the Philippines and its
maintenance of inventories abroad expose the Company to certain economic and
political risks, including the following:
+ the business and financial condition of the subcontractor;
+ political instability and expropriation;
+ supply disruption;
+ currency controls and exchange fluctuations; and
+ changes in tax laws, tariffs, and freight rates.
The Company has not experienced any significant interruptions in its business
operations in the Philippines to date despite the fact that the Philippines has
been subject to volcanic eruptions, typhoons, and substantial civil
disturbances, including attempted military coups against the government. The
Company believes that its manufacturing operations in the Philippines constitute
one of the Company's most important resources, and that it would be difficult to
replace the low-cost, high-performance facility or the high-quality,
hard-working production staff if its manufacturing operations in the Philippines
were disrupted or terminated. As a result, any disruption or termination of
operations in the Philippines or air transportation with the Philippines even
for a relatively short period of time, would adversely effect the Company's
operations. See Item 1, "Business - Manufacturing Facilities."
MANUFACTURING OPERATIONS IN CHINA. The Company commenced manufacturing
operations in China during 1998. The China facility is a high-volume LCD module
manufacturing facility similar to the Company's facility in Manila. The Company
initially leased a facility in Beijing on a temporary basis and commenced
manufacturing in that temporary facility in the third quarter of 1998. The
Company has begun construction of its own facility in Beijing and expects to
move into that new facility in mid-1999. The Company expects that the initial
cost of equipping and constructing the permanent China facility will be
approximately $10.0 million. The Company's lease of its temporary facility
expires in 1999. Therefore, any significant delay in the construction of the
permanent facility could result in the temporary suspension of the China
manufacturing operations. Construction delays for a variety of reasons are not
unusual in China. Any such suspension could adversely affect the Company's
operations. For further discussions on the Company's operations in China, see
Item 7, "Management's Discussion and Analysis of Financial Conditions and
Results of Operations" and Item 1, "Business - Manufacturing Facilities."
The Company's operations and assets will be subject to significant
political, economic, legal and other uncertainties in China. Under its current
leadership, the Chinese government has been pursuing economic reform policies,
including the encouragement of foreign trade and investment and greater economic
decentralization. The
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Chinese government may not continue to pursue such policies. In addition, such
policies may not be successful if pursued or the Chinese government may
significantly alter the policies from time to time. Despite progress in
developing its legal system, China does not have a comprehensive and highly
developed system of laws, particularly with respect to foreign investment
activities and foreign trade. Enforcement of existing and future laws and
contracts is uncertain, and implementation and interpretation of such laws may
be inconsistent. As the Chinese legal system develops, the promulgation of new
laws, changes to existing laws, and the preemption of local regulations by
national laws may adversely affect foreign investors. The Company also could be
adversely affected by a number of other factors, including the following:
+ the imposition of austerity measures intended to reduce inflation;
+ inadequate development or maintenance of infrastructure, including the
unavailability of adequate power and water supplies, transportation,
raw materials, and parts; or
+ a deterioration of the general political, economic or social
environment in China.
In addition, China currently enjoys "most favored nation" ("MFN")
status granted by the U.S. government, pursuant to which the United States
imposes the lowest applicable tariffs on Chinese exports to the United States.
The United States annually reconsiders the renewal of MFN trading status for
China. The Company cannot provide assurance that the United States will renew
China's MFN status in future years. The failure or refusal of the U.S.
government to renew China's MFN status could adversely affect the Company by
increasing the cost to U.S. customers of products manufactured by the Company in
China.
THE COMPANY FACES RISKS ASSOCIATED WITH INTERNATIONAL TRADE AND CURRENCY
EXCHANGE
International sales represented approximately 42 percent of the
Company's net sales in 1998. Sales in foreign markets, primarily Europe and
China, to OEMs based in the United States accounted for almost all of the
Company's international sales in 1998. In 1999, the Company expects sales to
OEMs based in Europe and China to increase. Political and economic conditions
abroad may adversely affect the foreign manufacture and sale of products.
Protectionist trade legislation in either the United States or foreign
countries, such as a change in the current tariff structures, export or import
compliance laws, or other trade policies, could adversely affect the Company's
ability to manufacture or sell devices in foreign markets and to purchase
materials or equipment from foreign suppliers.
While the Company transacts business predominantly in U.S. dollars and
bills and collects most of its sales in U.S. dollars, the Company collects a
portion of its revenue in non-U.S. currencies, such as the Chinese renminbi
("RMB"). In the future, customers increasingly may make payments in non-U.S.
currencies, such as the newly created Euro. In addition, the Company accounts
for a portion of its costs, such as payroll, rent, and indirect operating costs,
in non-U.S. currencies, including Philippine pesos ("PhP"), British pounds
sterling, and Chinese RMB. For example, the Company's Sub-Assembly Agreement
with TEAM is based on a fixed conversion rate, which exposes the Company to
exchange rate fluctuations with the Philippine peso.
Historically, fluctuations in foreign currency exchange rates have not
resulted in significant exchange losses to the Company. Changes in the relation
of these and other currencies to the U.S. dollar, however, could affect the
Company's cost of goods sold and operating margins and could result in exchange
losses. In addition, currency devaluation can result in a reportable loss to the
Company if the Company holds deposits of that currency. The Company cannot
predict the impact of future exchange rate fluctuations on its results of
operations. In late 1997, the Philippine peso suffered a major devaluation from
its historic levels of around $1.00 to PhP 25 down to as much as $1.00 to PhP
49. Over the last five years, the Chinese RMB has experienced significant
devaluation against most major currencies. The establishment of the current
exchange rate system as of January 1, 1994 produced a significant devaluation of
the RMB from $1.00 to RMB 5.7 to approximately $1.00 to RMB 8.7. The rates at
which exchanges of RMB into U.S. dollars may take place in the future may vary,
and any material increase in the value of the RMB relative to the U.S. dollar
would increase the Company's costs and expenses and therefore would have a
material adverse effect on the Company. In addition, any decrease in the value
of the RMB may adversely affect the Company's operations if there are U.S.
dollar-denominated
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intercompany loans from the Company to its subsidiary or if the Company has
substantial RMB deposits or receivables. Hedging RMB is difficult because the
currency is not freely traded.
In January 1999, a new currency called the "Euro" was introduced in
certain Economic and Monetary Union ("EMU") countries in Europe. All EMU
countries are expected to be operating with the Euro as their single currency by
2002. Although a significant amount of uncertainty exists as to the effect the
Euro currency will have on the marketplace generally, the Company currently does
not believe that introduction of the Euro will create a material adverse effect
on the Company's business or operating results. The Company intends to monitor
the impact, if any, of the introduction of the Euro currency on the Company's
internal systems and the sale of its products and will take appropriate actions
to address those issues if required. The Company cannot predict the impact, if
any, of the introduction of the Euro on its business, financial condition, or
results of operations.
THE COMPANY MUST MAINTAIN SATISFACTORY MANUFACTURING YIELDS AND CAPACITY
The design and manufacture of LCDs and display modules are highly
complex processes that are sensitive to a wide variety of factors, including the
level of contaminants in the manufacturing environment, impurities in the
materials used, and the performance of the design and production personnel and
equipment. As is typical in the industry, the Company from time to time has
experienced lower than anticipated manufacturing yields and lengthening of
delivery schedules. This may be particularly true as the Company continues to
ramp up its high-volume LCD line to greater production levels in 1999 and begins
to manufacture LCoS(TM) microdisplays. See Item 7, "Management's Discussion and
Analysis of Financial Condition and Results of Operations - Liquidity and
Capital Resources." Additionally, as the sophistication of display modules
increases, so does the level of complexity in the required manufacturing
processes. The Company continually reviews its processes in an effort to
increase its manufacturing productivity, achieve higher manufacturing yields,
and reduce design and manufacturing errors. In addition, the Company reviews
ongoing procedures regularly to maintain its ability to meet delivery schedules
to satisfy increased business. The Company's inability to maintain high levels
of productivity or satisfactory delivery schedules in its manufacturing plants
in the Philippines or China, or at its Arizona high-volume LCD line would
adversely affect the Company's operating results.
Manufacturing yields and delivery schedules also may be affected as the
Company ramps up its manufacturing capabilities in China and moves into its new
facility in 1999. Other companies in the industry have experienced difficulty in
expanding or relocating manufacturing output and capacity, resulting in reduced
yields or delays in product deliveries. The Company could experience similar
manufacturing yield or delivery problems. Any such problems could adversely
affect the Company's operating results. See Item 1, "Business - Manufacturing
Facilities."
VARIABILITY OF CUSTOMER REQUIREMENTS MAY AFFECT OPERATING RESULTS
Custom manufacturers for OEMs must provide increasingly rapid product
turnaround and respond to ever-shorter lead times. The Company generally does
not obtain long-term purchase orders, but instead works with its customers to
anticipate the volume of future orders. Based upon its estimates of anticipated
future orders, the Company must procure components and determine the levels of
business that it will seek and accept, production schedules, personnel needs,
and other resource requirements, in each case without the benefit of long-term
purchase commitments. A variety of conditions, both specific to the individual
customer and generally affecting the industry, may cause customers to cancel,
reduce, or delay orders. Cancellations, reductions, or delays by a significant
customer or by a group of customers could adversely affect the Company, its
results of operations, prospects, and ability to service its debt. On occasion,
customers may require rapid increases in production, which can strain the
Company's resources and reduce margins. Although the Company has increased its
manufacturing capacity, the Company may lack sufficient capacity at any given
time to meet its customers' demands if such demands exceed anticipated levels.
In addition to the variability resulting from the short-term nature of
its customers' commitments, other factors have contributed, and may contribute
in the future, to significant periodic and quarterly fluctuations in the
Company's results of operations. These factors include, among other things, the
following:
16
<PAGE>
+ the timing of orders;
+ the volume of orders relative to the Company's capacity;
+ customers' announcements, product introductions, and market acceptance
of new products or new generations of products;
+ evolution in the life cycles of customers' products;
+ timing of expenditures in anticipation of future orders;
+ effectiveness in managing manufacturing processes;
+ changes in cost and availability of labor and components;
+ product mix;
+ pricing and availability of competitive products and services; and
+ changes or anticipated changes in economic conditions.
The Company uses existing design programs to gauge the expected future
volume of business. Completion of a particular design, however, depends on a
variety of factors, including the customer's changing needs, and not every
design is successful in meeting those needs.
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. Material components of some of the Company's major
programs from time to time 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. In addition, the Company purchases many
product components from vendors in Asian countries. Economic instability in
certain Asian countries could cause supply problems with respect to these
components.
THE COMPANY MUST EFFECTIVELY UTILIZE ITS ARIZONA FACILITY
The Company has made substantial expenditures in constructing its
facility in Tempe, Arizona, and equipping the facility with a high-volume LCD
manufacturing line. The Company placed the high-volume line in service in 1996,
although the Company continued to commit a significant amount of time and
resources in 1996 and 1997 to the development of manufacturing processes on the
line. The Company utilizes the high-volume line to produce a substantial portion
of its own requirements for LCD glass.
The successful utilization of the LCD glass line requires the Company
to (i) 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)
utilize the LCD glass it produces in devices it designs and manufactures in a
manner satisfactory to its customers. The Company experienced some delays in
fully implementing its LCD glass manufacturing operations in 1996. The Company
could experience problems or delays in the future in conducting its LCD glass
manufacturing operations. Any such problems could result in the lengthening of
the Company's delivery schedules, reductions in the quality or performance of
the Company's design and manufacturing services, and reduced customer
satisfaction. Such problems also could require the Company to purchase its LCD
glass requirements from third parties and could delay the Company's ability to
recover its investment in the high-volume LCD line.
In addition, the Company added additional equipment to the LCD glass
line in 1998 to enhance its ability to manufacture LCoS(TM) microdisplays. See
Item 1, "Business - Research and Development." Manufacturing a LCoS(TM)
microdisplay is a significantly different procedure than manufacturing a typical
liquid crystal display. The manufacturing of microdisplays will require the
Company to overcome challenges, including the following:
+ the use of a new material (silicon);
+ the modification of equipment and processes to accommodate the
miniature size of the product;
17
<PAGE>
+ the implementation of new scribing and breaking techniques;
+ the incorporation of new handling procedures;
+ the maintenance of cleaner manufacturing environments; and
+ the ability to master tighter tolerances in the manufacturing process.
Utilization of the LCD line for microdisplays also will require higher yields
because of the significant cost of the silicon backplane. The Company could
experience significant problems in starting up volume production of LCoS(TM)
microdisplays. Any such problems could result in the delay of the full
implementation of high-volume LCoS(TM) microdisplay production. In addition,
lower-than-expected yields could significantly and adversely effect the Company
because of the relative high cost of the silicon backplane.
THE COMPANY MUST EFFECTIVELY MANAGE ITS GROWTH
The failure of the Company to manage its growth effectively could
adversely affect its operations. The Company's revenue increased substantially
during the period from 1993 through 1995, but declined significantly in 1996 as
a result of the discontinuation of a few significant programs by its major
customer. During 1997 and 1998, the Company increased the number of its
manufacturing and design programs and plans to further expand the number and
diversity of its programs in the future. The Company's ability to manage its
planned growth effectively will require it to
+ enhance its operational, financial, and management systems;
+ expand its facilities and equipment; and
+ successfully hire, train, and motivate additional employees, including
the technical personnel necessary to operate its new production
facility in China.
As the Company expands and diversifies its product and customer base,
it may be required to further increase its overhead and selling expenses. The
Company also may be required to increase staffing and other expenses as well as
its expenditures on capital equipment and leasehold improvements in order to
meet the anticipated demand of its customers. Customers, however, generally do
not commit to firm production schedules for more than a short time in advance.
Any increase in expenditures in anticipation of future orders that do not
materialize would adversely affect the Company's profitability. For example, the
Company substantially increased its manufacturing capacity in 1998 by starting
up manufacturing operations in Beijing, China. Customers also may require rapid
increases in design and production services that place an excessive short-term
burden on the Company's resources.
THE COMPANY DEPENDS ON KEY PERSONNEL
The Company's development and operations depend substantially on the
efforts and abilities of its senior management and technical personnel,
including David R. Buchanan, who has served as the Chairman of the Board since
1986 and served as President and Chief Executive Officer ("CEO") of the Company
from 1987 to mid-1998. When Mr. Buchanan's successor resigned in January 1999,
Mr. Buchanan reassumed his duties as President and CEO on an interim basis until
the Company retains a replacement CEO. Mr. Buchanan has announced his intention
to retire from the Board of Directors upon the hiring of a new President and
CEO.
The competition for qualified management and technical personnel is
intense. The loss of services of one or more of its key employees or the
inability to add key personnel (including those required for its LCD glass
production facility) could have a material adverse effect on the Company. See
Item 1, "Business - Executive Officers." The Company does not have any
fixed-term agreements with, or key person life insurance covering, any officer
or employee. The Company, however, maintains non-competition and nondisclosure
agreements with its key personnel.
18
<PAGE>
THE COMPANY MUST PROTECT ITS INTELLECTUAL PROPERTY
The Company relies on a combination of patent, trade secret, and
trademark laws, confidentiality procedures, and contractual provisions to
protect its intellectual property. The Company seeks to protect certain of its
technology under trade secret laws, which afford only limited protection. The
Company faces risks associated with its intellectual property, including the
following:
+ pending patent applications may not be issued;
+ intellectual property laws may not protect the Company's intellectual
property rights;
+ third parties may challenge, invalidate, or circumvent any patent
issued to the Company;
+ rights granted under patents issued to the Company may not provide
competitive advantages to the Company;
+ despite the Company's efforts to protect its proprietary rights,
unauthorized parties may attempt to obtain and use information that
the Company regards as proprietary;
+ others may independently develop similar technology or design around
any patents issued to the Company; and
+ effective protection of intellectual property rights may be limited or
unavailable in certain foreign countries in which the Company
operates, such as China.
Third parties in the future may claim that the Company is infringing
certain patents or other intellectual property rights, although there are no
such pending lawsuits against the Company or unresolved notices that it is
infringing intellectual property rights of others. In the event that a third
party alleges that the Company is infringing its rights, the Company may not be
able to obtain licenses on commercially reasonable terms from the third party,
if at all, or the third party may commence litigation against the Company. The
failure to obtain necessary licenses or other rights or the occurrence of
litigation arising out of such claims could materially and adversely affect the
Company, its results of operations, prospects, or ability to service its debt.
THE MARKET PRICE OF THE COMPANY'S COMMON STOCK MAY BE VOLATILE
The market price of the Company's Common Stock increased dramatically
during the three-year period ended December 31, 1994, but declined significantly
during 1995 and 1996. The stock price increased again during 1997, but declined
significantly in 1998. See Item 5, "Market for Registrant's Common Equity and
Related Stockholder Matters." The trading price of the Company's Common Stock in
the future could continue to be subject to wide fluctuations in response to
various factors, including the following:
+ quarterly variations in operating results of the Company;
+ actual or anticipated announcements of technical innovations or new
product developments by the Company or its competitors;
+ changes in analysts' estimates of the Company's financial performance;
+ general conditions in the electronics industry; and
+ worldwide economic and financial conditions.
In addition, the stock market has experienced extreme price and volume
fluctuations that have particularly affected the market prices for many high
technology companies and that often have been unrelated to the operating
performance of such companies. These broad market fluctuations and other factors
may adversely affect the market price of the Company's Common Stock.
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<PAGE>
THE COMPANY MAY BE SUBJECT TO SHORTAGES OF RAW MATERIALS AND SUPPLIES
The principal raw materials used in producing the Company's product
solutions consist of LCD glass, driver die, circuit boards, molded plastic
parts, lead frames, wire, chips, and packaging materials. The Company purchases
most of these materials from Asian sources. The Company does not have long-term
contracts with its suppliers. During 1998, the Company occasionally was required
to delay sales because it was unable to complete timely deliveries of certain
products as a result of the unavailability of certain raw materials, including
LCD polarizers and drivers.
Because the Company obtains many materials from foreign suppliers, the
Company may be subject to certain risks, including supply interruptions and
currency fluctuations. Purchasers of these materials, including the Company,
from time to time experience difficulty in obtaining such materials.
THE ELECTRONICS INDUSTRY IS CYCLICAL
The electronics industry has experienced significant economic downturns
at various times, characterized by diminished product demand, accelerated
erosion of average selling prices, and production over-capacity. In addition,
the electronics industry is cyclical in nature. The Company has sought to reduce
its exposure to industry downturns and cyclicality by providing design and
production services for leading companies in rapidly expanding segments of the
electronics industry. However, the Company may experience substantial
period-to-period fluctuations in future operating results because of general
industry conditions or events occurring in the general economy.
THE COMPANY MUST FINANCE THE GROWTH OF ITS BUSINESS AND THE DEVELOPMENT OF NEW
PRODUCTS
To remain competitive, the Company must continue to make significant
investments in research and development, equipment, and facilities. As a result
of the increase in fixed costs and operating expenses related to these capital
expenditures, the failure of the Company to sufficiently increase its net sales
to offset these increased costs will adversely affect the Company's operating
results.
The Company from time to time may seek additional equity or debt
financing to provide for the capital expenditures required to maintain or expand
the Company's design and production facilities and equipment. The Company cannot
predict the timing and amount of any such capital requirements at this time. If
such financing is not available on satisfactory terms, the Company may be unable
to expand its business or to develop new customers at the rate desired and its
operating results may be adversely affected. Debt financing increases expenses
and must be repaid regardless of operating results. Equity financing could
result in additional dilution to existing stockholders. See Item 7,
"Management's Discussion and Analysis of Financial Condition and Results of
Operations - Liquidity and Capital Resources."
THE COMPANY IS SUBJECT TO ENVIRONMENTAL REGULATIONS
The operations of the Company result in the creation of small amounts
of hazardous waste, including various epoxies, gases, inks, solvents, and other
wastes. The Company, therefore, is subject to federal, state, and local
governmental regulations related to the use, storage, discharge, and disposal of
toxic, volatile, or otherwise hazardous chemicals used in its design and
manufacturing processes. The amount of hazardous waste produced by the Company
may increase in the future depending on changes in the Company's operations. The
failure of the Company to comply with present or future environmental
regulations could result in the imposition of fines, suspension of production,
or a cessation of operations. Compliance with such regulations could require the
Company to acquire costly equipment or to incur other significant expenses. Any
failure by the Company to control the use, or adequately restrict the discharge,
of hazardous substances could subject it to future liabilities. For example, the
Company has removed contamination from and continues to conduct periodic
chemical monitoring at the Company's former Connecticut property. Other
environmental problems may be discovered in the future, which could subject the
Company to future costs or liabilities.
20
<PAGE>
CHANGE IN CONTROL PROVISIONS
The Company's Restated Certificate of Incorporation (the "Restated
Certificate") and the Delaware General Corporation Law (the "Delaware GCL")
contain provisions that may have the effect of making more difficult or delaying
attempts by others to obtain control of the Company, even when these attempts
may be in the best interests of stockholders. The Restated Certificate also
authorizes the Board of Directors, without stockholder approval, to issue one or
more series of Preferred Stock, which could have voting and conversion rights
that adversely affect or dilute the voting power of the holders of Common Stock.
The Delaware GCL also imposes conditions on certain business combination
transactions with "interested stockholders" (as defined therein).
YEAR 2000 COMPLIANCE
Many existing computer programs and databases use only two digits to
identify a year in the date field (I.E., 99 would represent 1999). These
programs and databases were designed and developed without considering the
impact of the upcoming millennium. Consequently, date sensitive computer
programs may interpret the date "00" as 1900 rather than 2000. If not corrected,
many computer systems could fail or create erroneous results in 2000. Failure in
the Company's systems, or in the systems of its vendors or customers, could
cause significant adverse effects to the Company. For a full discussion of those
potential effects, see Item 7, "Management's Discussion and Analysis of
Financial Condition and Results of Operations - Year 2000 Compliance
Disclosure."
RIGHTS TO ACQUIRE SHARES
At December 31, 1998, an aggregate of 695,800 shares of common stock
were reserved for issuance upon exercise of options previously granted under the
Company's stock option plans. The weighted average exercise price of those
options is $12.14 per share. During the terms of such options, the holders
thereof will have an opportunity to profit from an increase in the market price
of Common Stock with resulting dilution in the interests of holders of Common
Stock. The existence of such stock options may adversely affect the terms on
which the Company can obtain additional financing, and the holders of such
options can be expected to exercise such options at a time when the Company, in
all likelihood, would be able to obtain additional capital by offering shares of
its Common Stock on terms more favorable to the Company than those provided by
the exercise of such options.
REPURCHASES OF COMMON STOCK
In August 1996, the Board of Directors authorized the repurchase from
time to time of up to 1,000,000 shares of the Company's Common Stock on the open
market or in negotiated transactions, depending on market conditions and other
factors. In October 1998, the Board of Directors further extended and revised
the repurchase program to authorize the repurchase of up to $10 million of the
Company's stock. As of December 31, 1998, the Company had purchased 969,794
shares of the Company's Common Stock at a total purchase price of $8.3 million.
The repurchase of shares by the Company significantly reduced the Company's
capital. In addition, the Company has obtained long-term financing for such
repurchases, which increases the liabilities of the Company. The reduction in
capital or increase in liabilities could adversely affect the Company's ability
to expand its business or commit resources to needed expenditures. See Item 7,
"Management's Discussion and Analysis of Financial Condition and Results of
Operations - Liquidity and Capital Resources." A significant reduction in the
number of shares outstanding on the open market also could increase the
volatility of the stock as a result of the reduced supply of available shares on
the open market.
SHARES ELIGIBLE FOR FUTURE SALE; POTENTIAL DEPRESSIVE EFFECT ON STOCK PRICE
Currently, Rule 144 under the securities laws provides that each person
who beneficially owns restricted securities with respect to which at least one
year has elapsed since the later of the date the shares were acquired from the
Company or an affiliate of the Company may, every three months, sell in ordinary
brokerage transactions or to market makers an amount of shares equal to the
greater of one percent of the Company's then-outstanding Common Stock or the
average weekly trading volume for the four weeks prior to the proposed sale of
such shares. An aggregate of 960,492 shares of Common Stock held by all the
executive officers and directors of the Company currently are available for sale
under Rule 144. Sales of substantial amounts of Common Stock by the stockholders
21
<PAGE>
of the Company, or even the potential for such sales, may have a depressive
effect on the market price of the Common Stock and could impair the Company's
ability to raise capital through the sale of its equity securities.
THE COMPANY DOES NOT PAY CASH DIVIDENDS
The Company has never paid any cash dividends on its Common Stock and
does not anticipate that it will pay cash dividends in the near term. Instead,
the Company intends to apply any earnings to the expansion and development of
its business. See Item 5, "Market for Registrant's Common Equity and Related
Stockholder Matters."
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS
Certain statements and information contained in this Report concerning
future, proposed, and anticipated activities of the Company; certain trends with
respect to the Company's revenue, operating results, capital resources, and
liquidity or with respect to the markets in which the Company competes or the
electronics industry in general; and other statements contained in this Report
regarding matters that are not historical facts are forward-looking statements,
as such term is defined under applicable securities laws. Forward-looking
statements, by their very nature, include risks and uncertainties, many of which
are beyond the Company's control. Accordingly, actual results may differ,
perhaps materially, from those expressed in or implied by such forward-looking
statements. Factors that could cause actual results to differ materially include
those discussed elsewhere under this Item 1, "Business - Special
Considerations."
ITEM 2. PROPERTIES
The Company occupies a 97,000 square foot facility in Tempe, Arizona,
which houses its United States-based manufacturing operations; its research,
development, engineering, design, and corporate functions; and the largest fully
automated LCD glass manufacturing operations in North America. The Company
entered into a ground lease through December 31, 2069, subject to renewal and
purchase options as well as early termination provisions. Costs to construct,
furnish, and equip the new facility were approximately $24.0 million.
The Company leases approximately 3,500 square feet of office space in
Swindon, United Kingdom, where it maintains its European administrative and
executive offices.
The Company leases approximately 60,000 square feet of manufacturing
space in Manila, the Philippines. Approximately 40,000 square feet is subject to
a lease that expires on December 31, 1999, and the remaining 20,000 square feet
is subject to a lease that expires on March 31, 1999, and is renewable from year
to year thereafter.
The Company currently leases approximately 27,000 square feet of
manufacturing space in Beijing, China, which includes 4,200 square feet of
office space. The lease will expire on July 25, 1999. The Company is
constructing a permanent manufacturing facility in Beijing, China near the
existing leased facility. The permanent facility will occupy 46,000 square feet,
of which 29,000 square feet will be manufacturing space, and is being
constructed on property that the Company has purchased on a long-term land use
contract. The Company expects the cost to construct the facility will be
approximately $5.3 million. The Company currently anticipates the facility will
be completed in mid-1999.
ITEM 3. LEGAL PROCEEDINGS
There are no legal proceedings to which the Company is a party or to
which any of its properties are subject, other than routine litigation incident
to the Company's business that is covered by insurance or an indemnity or that
are not expected to have a material adverse effect on the Company. It is
possible, however, that the Company could incur claims for which it is not
insured or that exceed the amount of its insurance coverage.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
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<PAGE>
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's Common Stock has been listed on the New York Stock
Exchange ("NYSE") under the symbol "TFS" since December 29, 1994. The Company's
Common Stock was listed on the American Stock Exchange ("AMEX") from January 28,
1993 through December 28, 1994. The Company's Common Stock was listed on the
AMEX Emerging Company Marketplace from March 18, 1992 until January 27, 1993,
and on the Nasdaq National Market system from May 1, 1990 until March 17, 1992.
The following table sets forth the quarterly high and low prices of the
Company's Common Stock for the periods indicated.
High Low
---- ---
1996:
First Quarter............................................ $21 7/8 $11 5/8
Second Quarter........................................... 14 1/8 9 1/8
Third Quarter............................................ 13 8 3/4
Fourth Quarter........................................... 14 10 5/8
1997:
First Quarter............................................ $16 1/4 $12 1/4
Second Quarter........................................... 16 11 5/8
Third Quarter............................................ 26 7/8 14 1/4
Fourth Quarter........................................... 26 1/2 16 1/4
1998:
First Quarter............................................ $23 1/16 $17 3/4
Second Quarter........................................... 20 3/8 14 7/8
Third Quarter............................................ 18 3/16 7 1/16
Fourth Quarter........................................... 13 7/8 6 1/2
1999:
First Quarter (through March 8, 1999).................... $16 $11 1/8
As of March 8, 1999, there were approximately 1,100 holders of record
and approximately 6,000 beneficial owners of the Company's Common Stock. The
closing sale price of the Company's Common Stock on the NYSE on March 8, 1999
was $11.25 per share.
The present policy of the Company is to retain earnings to provide
funds for the operation and expansion of its business. The Company has not paid
dividends on its Common Stock and does not anticipate that it will do so in the
near term. Furthermore, the Company's line of credit with Imperial Bank Arizona
("Imperial Bank") does not permit the payment of dividends without the consent
of Imperial Bank. The payment of dividends in the future will depend on the
Company's growth, profitability, financial condition, and other factors that the
directors may deem relevant.
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<PAGE>
ITEM 6. SELECTED FINANCIAL DATA
The following table summarizes certain selected consolidated financial
data of the Company and is qualified in its entirety by the more detailed
consolidated financial statements and notes thereto appearing elsewhere herein.
The data have been derived from the consolidated financial statements of the
Company audited by Arthur Andersen LLP, independent public accountants. All
share amounts and per share data have been adjusted to reflect the two-for-one
split of the Company's Common Stock effected as a stock dividend in May 1994.
<TABLE>
<CAPTION>
1998 1997 1996 1995 1994
-------- -------- -------- -------- --------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C> <C> <C>
Net sales ................................ $ 95,047 $ 84,642 $ 60,713 $ 91,585 $ 85,477
-------- -------- -------- -------- --------
Costs and expenses:
Cost of sales .......................... 76,149 64,760 58,321 70,481 59,409
Selling, general, and administrative ... 7,334 6,557 5,351 5,386 4,867
Research and development ............... 7,159 5,106 4,065 2,396 1,270
-------- -------- -------- -------- --------
90,642 76,423 67,737 78,263 65,546
-------- -------- -------- -------- --------
Operating income (loss) .................. 4,405 8,219 (7,024) 13,322 19,931
-------- -------- -------- -------- --------
Other income (expense):
Interest, net .......................... 75 548 412 765 859
Other, net ............................. (117) (190) (139) (122) (135)
-------- -------- -------- -------- --------
(42) 358 273 643 724
-------- -------- -------- -------- --------
Income (loss) before provision for
(benefit from) income taxes ............ 4,363 8,577 (6,751) 13,965 20,655
Provision for (benefit from) income taxes 1,773 3,334 (2,920) 5,548 8,109
-------- -------- -------- -------- --------
Net income (loss) ........................ $ 2,590 $ 5,243 $ (3,831) $ 8,417 $ 12,546
======== ======== ======== ======== ========
Earnings (loss) per common share:
Basic .................................. $ 0.34 $ 0.67 $ (0.49) $ 1.09 $ 1.88
======== ======== ======== ======== ========
Diluted ................................ $ 0.33 $ 0.65 $ (0.49) $ 1.04 $ 1.59
======== ======== ======== ======== ========
Weighted average number of common shares:
Basic .................................. 7,639 7,854 7,768 7,716 6,666
======== ======== ======== ======== ========
Diluted ................................ 7,802 8,090 7,768 8,084 7,890
======== ======== ======== ======== ========
CONSOLIDATED BALANCE SHEET DATA
(AT END OF PERIOD):
Working capital .......................... $ 24,825 $ 29,113 $ 21,513 $ 22,400 $ 37,638
Total assets ............................. 77,904 72,835 62,569 63,780 56,280
Notes payable to banks and long-term debt 8,095 -- -- 3,000 182
Stockholders' equity ..................... 51,096 56,525 51,184 55,224 46,561
</TABLE>
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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
ANNUAL TABLE: PERCENTAGES OF NET SALES
The following table sets forth, for the periods indicated, the percentage of net
sales of certain items in the Company's Consolidated Financial Statements. The
table and the discussion below should be read in conjunction with the
Consolidated Financial Statements and Notes thereto.
YEARS ENDED DECEMBER 31,
-----------------------
1998 1997 1996
----- ----- -----
Net sales .......................................... 100.0% 100.0% 100.0%
----- ----- -----
Costs and expenses:
Cost of sales .................................... 80.1 76.5 96.1
Selling, general, and administrative ............. 7.7 7.8 8.8
Research and development ......................... 7.6 6.0 6.7
----- ----- -----
95.4 90.3 111.6
Operating income (loss) ............................ 4.6 9.7 (11.6)
Other income ....................................... -- 0.4 0.5
----- ----- -----
Income (loss) before provision for
(benefit from) income taxes ...................... 4.6 10.1 (11.1)
Provision for (benefit from) income taxes .......... 1.9 3.9 (4.8)
----- ----- -----
Net income (loss) .................................. 2.7% 6.2% (6.3)%
===== ===== =====
YEAR ENDED DECEMBER 31, 1998 COMPARED WITH YEAR ENDED DECEMBER 31,1997
Net sales were $95.0 million for 1998, an increase of 12.3 percent
compared with net sales of $84.6 million for 1997. The sales increase was as a
result of several new programs in 1998 for a variety of customers, including a
major communications customer. In 1998, the Company's largest customer accounted
for net sales of $60.5 million compared with net sales of $29.2 million to that
customer in 1997, for an overall increase of 107.2 percent. The Company's major
customer accounted for approximately 63.6 percent of net sales for 1998 compared
with approximately 34.6 percent for 1997. No other customer accounted for
greater than 10 percent of sales in 1998.
Cost of sales, as a percentage of net sales, increased to 80.1 percent
for 1998 as compared with 76.5 percent for 1997. The corresponding decrease in
the gross margin was the result of a number of factors, including manufacturing
variances occurring as a result of the start-up of the new manufacturing
facility in Beijing, some unfavorable yields occurring on the start-up of
several new programs, and increased pricing pressure from customers and
competitors, partially as a result of the Asian economic crisis.
Selling, general, and administrative expense was $7.3 million for 1998,
as compared with $6.6 million in 1997. Selling, general, and administrative
expense increased in absolute terms as a result of increased selling expenses
and the addition of administrative personnel. As a result of increased revenue
in 1998, however, selling, general, and administrative expense declined to 7.7
percent of net sales from 7.8 percent of net sales in 1997.
Research and development expense totaled $7.2 million, or 7.6 percent
of net sales for 1998, as compared with $5.1 million, or 6.0 percent of net
sales, for 1997. Research and development expense consists principally of
salaries and benefits to scientists and other personnel; related facilities
costs, including certain expenses associated with the development of new
processes on the LCD line in Tempe, Arizona; and various expenses for projects.
Research and development expense has increased as the Company has invested in
new technologies and manufacturing processes, developed new potential products,
continued its in-house process development efforts related to the high-volume
manufacturing LCD line, and developed application specific integrated circuits
("ASICs") for its new display technologies. The Company believes that continued
investments in research and development
25
<PAGE>
relating to manufacturing processes and new display technology are necessary to
remain competitive in the marketplace, as well as to provide opportunities for
growth.
Interest income (net) for 1998 was $75,000, down from $548,000 for
1997. The decrease in interest income was the result of investing lower average
cash balances during the year as well as increased interest expense as a result
of increased debt. Other expenses (net) decreased to $117,000 for 1998 from
$190,000 for 1997. The decrease was primarily attributed to reduced foreign
exchange losses.
The Company recorded a provision for income taxes of $1.8 million for
1998, as compared with a provision for income taxes of $3.3 million for 1997.
The overall tax rate for the Company for 1998 was 40.6 percent as compared with
38.9 percent for 1997. The increased tax rate is primarily as a result of the
Company having incurred losses in China, which is a low tax rate jurisdiction.
In such instance, the Company does not obtain a tax benefit for the losses equal
to its tax rate elsewhere in the world. The Company expects that the tax rate
for 1999 will approximate 40.0 percent.
For 1998, the Company reported net income of $2.6 million, or $0.33 per
share (diluted), as compared with net income of $5.2 million, or $0.65 per share
(diluted), for 1997.
YEAR ENDED DECEMBER 31, 1997 COMPARED WITH YEAR ENDED DECEMBER 31,1996
Net sales were $84.6 million for 1997, an increase of 39.4 percent
compared with net sales of $60.7 million for 1996. The sales increase was as a
result of several new programs in 1997 for a variety of customers, including a
major office automation customer. In 1997, the Company's largest customer
accounted for net sales of $29.2 million compared with net sales of $39.5
million to that customer in 1996, for an overall decrease of 26.1 percent. The
Company's major customer accounted for approximately 34.6 percent of net sales
for 1997 compared with approximately 65.1 percent for 1996. One other customer
accounted for $27.1 million, or 32.0 percent of the net sales, in 1997.
Cost of sales, as a percentage of net sales, decreased to 76.5 percent
for 1997 as compared with 96.1 percent for 1996. The corresponding increase in
the gross margin was the result of a number of factors, including decreased
provisions for excess and obsolete inventory, decreased unfavorable
manufacturing variances occurring as a result of increased manufacturing volume,
labor utilization, and material purchases, and a more mature product mix with
higher margins and better yields. In the third quarter of 1996, the Company took
a special one-time provision for excess and obsolete inventory related primarily
to end-of-life programs for which the majority of shipments, expected to occur
in the latter part of 1996, never materialized. Furthermore, the Company was
required to make significant design modifications to a new product, which also
resulted in obsolete inventory. Without the provision for excess and obsolete
inventory taken in the third quarter of 1996, the cost of sales, as a percentage
of net sales, would have been 84.5 percent for 1996.
Selling, general, and administrative expense was $6.6 million for 1997,
as compared with $5.4 million in 1996. Selling, general and administrative
expenses increased in absolute terms as a result of increased selling expenses
and the addition of administrative personnel. As a result of increased revenue
in 1997, however, selling, general, and administrative expense declined to 7.8
percent of net sales from 8.8 percent of net sales in 1996.
Research and development expense totaled $5.1 million, or 6.0 percent
of net sales, for 1997 as compared with $4.1 million, or 6.7 percent of net
sales, for 1996. Research and development expense consists principally of
salaries and benefits to scientists and other personnel, related facilities
costs, including certain expenses associated with the development of new
processes on the LCD line in Tempe, Arizona, and various expenses for projects.
Research and development expense increased in 1997 as the Company invested in
new technologies and manufacturing processes, developed new potential products,
and continued its in-house process development efforts related to the
high-volume manufacturing LCD line.
Interest income (net) for 1997 was $548,000, up from $412,000 for 1996.
The increase in interest income was the result of investing higher average cash
balances during the year. Other expenses (net) increased to $190,000 for 1997
from $139,000 for 1996. The increase was primarily attributed to foreign
exchange losses.
26
<PAGE>
The Company recorded a provision for income taxes of $3.3 million for
1997, as compared with a benefit from income taxes of $2.9 million for 1996.
This resulted primarily from having a loss in 1996 as compared with reporting
net income in 1997. The overall tax rate for the Company for 1997 was 38.9
percent as compared with 43.3 percent for 1996.
For 1997, the Company reported net income of $5.2 million, or $0.65 per
share (diluted), as compared with a net loss of $3.8 million, or $0.49 per share
(diluted), for 1996. Without the provision for excess and obsolete inventory
taken in 1996, the Company would have reported net income of $158,000, or $0.02
per share, in 1996.
QUARTERLY RESULTS OF OPERATIONS
The following table presents unaudited consolidated financial results
for each of the eight quarters in the period ended December 31, 1998. The
Company believes that all necessary adjustments have been included to present
fairly the quarterly information when read in conjunction with the Consolidated
Financial Statements. The operating results for any quarter are not necessarily
indicative of the results for any subsequent quarter.
<TABLE>
<CAPTION>
QUARTERS ENDED
-----------------------------------------------------------------------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
1998 1997
---------------------------------- ----------------------------------
MAR 31 JUN 30 SEP 30 DEC 31 MAR 31 JUN 30 SEP 30 DEC 31
------- ------- ------- ------- ------- ------- ------- -------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Net sales .................... $18,479 $22,682 $24,572 $29,314 $16,129 $18,737 $24,074 $25,702
Cost and expenses:
Cost of sales .............. 13,687 17,095 22,243 23,124 12,488 14,377 18,511 19,384
Selling, general, and
administrative ............. 1,619 1,815 1,721 2,179 1,466 1,479 1,822 1,790
Research and development ... 1,689 1,904 1,250 2,316 1,130 1,315 1,314 1,347
------- ------- ------- ------- ------- ------- ------- -------
16,995 20,814 25,214 27,619 15,084 17,171 21,647 22,521
------- ------- ------- ------- ------- ------- ------- -------
Operating income (loss) ...... 1,484 1,868 (642) 1,695 1,045 1,566 2,427 3,181
Other income (expense):
Interest, net .............. 192 130 (4) (243) 157 154 152 85
Other, net ................. (17) (6) (48) (46) (12) (7) (41) (130)
------- ------- ------- ------- ------- ------- ------- -------
Income (loss) before provision
for (benefit from) income
taxes ...................... 1,659 1,992 (694) 1,406 1,190 1,713 2,538 3,136
Provision for (benefit from)
income taxes ............... 664 869 (291) 531 389 685 1,010 1,250
------- ------- ------- ------- ------- ------- ------- -------
Net income (loss) ............ $ 995 $ 1,123 $ (403) $ 875 $ 801 $ 1,028 $ 1,528 $ 1,886
======= ======= ======= ======= ======= ======= ======= =======
Earnings (loss) per common
share:
Basic .................... $ 0.13 $ 0.14 $ (0.05) $ 0.12 $ 0.10 $ 0.13 $ 0.19 $ 0.24
------- ------- ------- ------- ------- ------- ------- -------
Diluted .................. $ 0.12 $ 0.14 $ (0.05) $ 0.12 $ 0.10 $ 0.13 $ 0.19 $ 0.23
------- ------- ------- ------- ------- ------- ------- -------
Weighted average number of
common shares:
Basic .................... 7,907 7,918 7,656 7,081 7,759 7,855 7,874 7,900
======= ======= ======= ======= ======= ======= ======= =======
Diluted .................. 8,165 8,128 7,656 7,146 8,048 8,071 8,181 8,168
======= ======= ======= ======= ======= ======= ======= =======
</TABLE>
LIQUIDITY AND CAPITAL RESOURCES
During 1998, the Company had net cash outflow from operations of
$62,000, as compared with positive cash inflow of $6.8 million during 1997. The
decrease in cash flow from operations was primarily due to the increase in
accounts receivable, the increase in inventory, and the decreased provision for
inventory valuation reserves. The increase in accounts receivable occurred
primarily as a result of the increased sales activity in 1998
27
<PAGE>
and the increase in inventory occurred primarily as a result of a build-up for
anticipated sales in the first quarter of 1999. Depreciation expense in 1998 was
$4.7 million versus $4.1 million in 1997. This increase was primarily as a
result of an increased number of starts on the LCD manufacturing line in Tempe,
Arizona. The high-volume LCD line is depreciated on a units of production method
based on units started. The Company anticipates that depreciation will continue
to rise in 1999 as a result of additional capital expenditures in 1999,
including the new building and equipment for the manufacturing facility in
China, the installation of additional equipment in its Manila manufacturing
location, and the installation of additional equipment in Tempe, Arizona to
manufacture LCoS(TM) microdisplays.
The Company's working capital was $24.8 million at December 31, 1998,
down from $29.1 million at December 31, 1997. The Company's current ratio at
December 31, 1998 was 2.5-to-1 as compared with a current ratio of 3.1-to-1 at
December 31, 1997. Including its cash and loan commitments, the Company had
nearly $22.0 million in readily available funds on December 31, 1998.
In November 1998, the Company entered into a new $25.0 million secured
revolving line of credit with Imperial Bank and the National Bank of Canada. The
new credit facility matures in May 2000 and consists of a $15.0 million
revolving line of credit, which will be available for general corporate purposes
(the "General Facility"), and a $10.0 million long-term loan, which will provide
available funds to repurchase the Company's stock (the "Repurchase Facility").
At December 31, 1998, $8.1 million of borrowings were outstanding under the
Repurchase Facility. Advances under the loans 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 for the General Facility and 225 basis points in
excess of the LIBOR Base Rate for the Repurchase Facility.
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 in July 1999. Three-Five Systems Limited had no borrowings outstanding
under this line of credit at December 31, 1998.
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 upon market conditions and
other factors. In October 1998, the Board of Directors further extended and
revised the repurchase program to authorize repurchases of up to $10.0 million
of Common Stock. During the quarter ended December 31, 1998, the Company
purchased approximately 410,700 shares under the repurchase program at a total
cost of $3.4 million. Taking into account previous purchases, as of December 31,
1998, the Company had purchased a total of approximately 971,798 shares under
the repurchase program at a cost of $8.3 million.
Capital expenditures during 1998 were approximately $8.1 million, as
compared with $3.0 million during 1997. Capital expenditures for 1998 consisted
primarily of manufacturing and office equipment for the Company's operations in
Manila, Arizona, and China and laboratory equipment for research and
development. The Company anticipates that it will increase its capital
expenditures during 1999. Those expenditures will primarily relate to advanced
manufacturing processes, the high-volume LCD line, and necessary manufacturing
equipment. In 1998, the Company spent $5.3 million for equipment and
construction related to its Beijing, China operations. The Company anticipates
the facilities and capital cost for China in 1999 to be approximately $4.7
million.
The Company anticipates that accounts receivable and inventory will
rise in 1999 if revenue levels increase as currently anticipated. The Company
believes that its existing capital and anticipated cash flow from operations and
credit lines will provide adequate sources to fund operations and planned
expenditures throughout 1999. Should the Company encounter additional cash
requirements, however, the Company may have to expand its loan commitments or
pursue alternate methods of financing or raising capital. The Company cannot
provide assurance, however, that adequate additional financing will be available
or, if available, that such financing will be on terms acceptable to the
Company.
28
<PAGE>
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
Sub-Assembly Agreement in the Philippines, which is based on a fixed conversion
rate, exposing the Company to exchange rate fluctuations with the Philippine
peso. The Company has not incurred any material exchange gains or losses to date
and there has been some minor benefit as a result of the peso devaluation,
although the Company is now required to pay approximately one-third of any peso
devaluation gain to its lessor and direct labor subcontractor in Manila.
The Company commenced operations in China in 1998. Although the Chinese
currency currently is stable, its value in relation to the U.S. dollar is
determined by the Chinese government. There is general speculation that China
may devalue its currency in response to the current Asian economic situation.
Devaluation of the Chinese currency could result in translation adjustments to
the Company's balance sheet as well as reportable losses depending on monetary
balances and loans of the Company at the time of devaluation. Recently, the
government in China has made it difficult to convert its local currency into
foreign currencies. Although the Company from time to time may enter into
hedging transactions in order to minimize its exposure to currency rate
fluctuations, the Chinese currency is not freely traded and thus is difficult to
hedge. In addition, the government of China has recently imposed restrictions on
Chinese currency loans to foreign-operated entities in China. Based on the
foregoing, there can be no assurance that fluctuations and currency exchange
rates in the future will not have an adverse affect on the Company's operations.
BUSINESS OUTLOOK AND RISK FACTORS
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
under "Special Considerations" in Item 1 of this Report.
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. In 1997, sales
returned to pre-1996 levels primarily as a result of several new programs and
customers, including a major office automation customer. In 1998, sales to that
office automation customer were greatly reduced, but that reduction was more
than offset by increased sales to the Company's largest telecommunications
customer. Sales in 1998 increased by about 12.3 percent over 1997, but net
profit declined as the Company increased R&D expenses significantly, incurred
start-up expenses for China, and experienced pricing pressures from its Asian
competitors, partially as a result of the Asian economic situation.
In 1998, the Company recorded almost 57 percent of its revenue in the
third and fourth quarters. Fourth quarter revenue in 1998 was almost 60 percent
greater than first quarter revenues in 1998. In 1999, the Company anticipates
that this type of revenue pattern will be repeated. The Company believes that it
has a pattern of seasonality to its sales as OEMs with retail products develop
shorter product life cycles and phase out old programs early in the year
following holiday sales.
The Company has undertaken efforts to diversify its business, broaden
its customer base, and expand its markets. The Company's historical major
customer, which accounted for approximately 80 percent of the Company's revenue
in 1995, accounted for 65 percent of the Company's revenue in 1996 and slightly
less than 35 percent of the Company's revenue in 1997. These reduced percentages
occurred as a result of the increased sales to other customers and reduced
product selling prices and revenues from that major customer. In 1998, however,
the Company's business with that customer has increased at a rate faster than
business with other customers. Therefore, the percentage of revenue attributed
to that customer substantially increased in 1998. In 1999, the Company expects
its business with that customer to remain at approximately the same dollar
amount. In addition, the Company plans
29
<PAGE>
to increase sales to other customers, which would result in declining customer
concentration. One other customer accounted for 32.0 percent of the Company's
revenue in 1997, but this percentage declined in 1998 to below 10 percent of the
Company's revenue as older programs have matured. Some replacement programs did
not have the type of LCD modules supplied by the Company and those that did had
significantly lower selling prices. The Company expects to do continued business
with this customer, but does not expect it to constitute more than 10 percent of
its revenue in 1999.
Several factors impact the Company's gross margins, including
manufacturing efficiencies, product differentiation, product uniqueness,
billings for non-recurring engineering services, inventory management,
engineering costs, product mix, and volume pricing. There is significant pricing
pressure in higher volume programs in the telecommunications and office
automation industries. As the production levels of some of the Company's new
high-volume programs increase, the lower standard gross margins on those
programs have had an impact on the Company's overall margins. In addition, in an
effort to secure sales to certain strategic customers, the Company may
aggressively price its products. Depending on the size of the programs achieved,
such pricing strategies also could have an effect on overall margins.
The Company's gross margins on its products are also typically lower at
the start of a program as a result of yield and other start-up issues. In the
third quarter of 1998, the Company started several new programs and incurred
substantial start-up costs. The Company expects to start up several new programs
throughout 1999.
The Company started operations in China in 1998, and the Company's
gross margins have been adversely affected by the start-up of those China
manufacturing operations. As the Company ramped up its manufacturing operations
in China, it incurred costs in advance of the receipt of significant revenues.
Generally, the incremental China-based expenses were in the total cost of sales.
Those incremental expenses arose mainly from under-absorption of the costs of
operating the China facility and are included in the cost of sales, thus
reducing overall gross margins. In the fourth quarter of 1998, the Company had a
slight profit in China because significant increases in manufacturing volumes
resulted in absorption of the existing costs. In the next few quarters,
profitability in China will be volume-dependent. In the long run, however, the
Company expects the China operations to positively impact gross margins because
of certain competitive cost advantages provided by maintaining operations in
China.
The Company anticipates that weakened Asian currencies will have a
continued impact on the Company's gross margins. Many of the Company's
competitors are Asian suppliers, and a strong U.S. dollar gives a competitive
pricing advantage to those suppliers. Thus, the Company may continue to see
competitive margin pressure from Asian suppliers, particularly those in Korea
and Japan.
Serving a variety of customers with complex and differing issues
requires increased personnel committed to those customers. As the Company
expands and diversifies its product and customer base, the Company has had to
increase its selling, general, and administrative expenses. The volume and
complexity of the Company's business is expected to continue to grow. As a
result, the Company anticipates that it will continue to increase its selling
and administrative expenses on a quarter-by-quarter basis.
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 and to provide opportunities
for growth. The Company continues to expand and intensify its internal research
and development to focus on proprietary display products as well as continue LCD
manufacturing process improvements. Use of the LCD manufacturing line in Tempe,
Arizona as a resource for testing new ideas is key to 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. Some of the Company's new display technologies also require the
development of application specific integrated circuits ("ASICs") to
electronically drive the displays. Development of custom ASICs is a lengthy and
expensive process.
The Company also intends to pursue technologies being developed in
related fields. The Company operates the highest volume fully automated LCD
manufacturing line in North America. As a result, several companies have
30
<PAGE>
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. For example, in 1997 National
Semiconductor Corporation and the Company entered into a strategic supplier
alliance agreement for the development and manufacture of LCoS(TM)
microdisplays. In April 1998, the Company acquired approximately a 19 percent
interest in Siliscape, Inc., a start-up company with numerous patents and
proprietary technology relating to microdisplays. The Company and Siliscape,
Inc. also entered into a strategic agreement under which they will focus on the
development of microdisplay products, with the Company providing certain
proprietary manufacturing capabilities and Siliscape, Inc. providing certain
patented and proprietary technologies and components.
The Company also is considering licensing from other companies
technologies that could be optimized on the LCD manufacturing line, as well as
entering into further alliances. The Company intends to continue this internal
and external focus on research and development indefinitely. As a result, the
actual dollar amount of such research and development expenditures in 1999 will
substantially increase over 1998.
As previously described, the Company has established manufacturing
operations in China. Three-Five Systems (Beijing) Co., Ltd. was incorporated in
China during the first quarter of 1998 and business license approval was
received from the governmental authorities. During the first quarter of 1998, a
temporary leased site was selected in Beijing, as was the permanent site. In the
second quarter of 1998, the Company moved into the temporary site and set up
manufacturing lines. In the third quarter of 1998, the factory was qualified by
customers and began making initial shipments. In the fourth quarter of 1998, the
Company shipped over $5.7 million in products.
The Company has established a China-based manufacturing operation for
several reasons. First, based upon growth expectations in the European and
United States marketplaces, the Company anticipated a need for manufacturing
capacity beyond what is available at its Philippine manufacturing facility.
China was selected because of the desire to diversify manufacturing locations
and because of the cost benefits that are expected to be achieved in China.
China also is expected to be a synergistic business location for the Company
because many of the components used by the Company are manufactured in China.
Second, many of the Company's existing and potential customers maintain
manufacturing operations near the Company's operations in China. Despite the
current Asian economic situation, those customers continue to require LCD
modules and the Company has limited participation in that market. There
currently are very few LCD module manufacturers in China. Under current Chinese
government rules, however, OEMs in China have a strong motivation to utilize
locally manufactured components.
RISK FACTORS
Forward-looking statements in this report include revenue, margin,
expense, and earnings analysis for 1999 as well as the Company's expectations
relating to operations in China; future technologies; and future designs,
inventory balances, 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 Report, 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.
A few core customers currently are responsible for a majority of the
Company's revenue, and the Company expects the high concentration levels with
its core customers to continue through 1999. 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. Customers generally do
not provide firm long-term volume purchase commitments to the Company. Thus,
customers can cancel purchase commitments and change or
31
<PAGE>
delay expected volume levels. The Company cannot provide assurance that it will
be able to replace canceled, delayed, or reduced commitments in a timely manner.
If customers cancel, delay, or reduce commitments, the Company could be left
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. A few of the Company's customers
have inquired about inventory hubbing agreements, pursuant to which the Company
will maintain stocks of finished goods at or near the customer's factory.
Although the Company has not yet entered into such agreements with any of its
customers, the use of such type of agreements could result in higher inventory
balances for the Company and/or excess inventory.
Another risk inherent in custom manufacturing is the satisfactory
completion of design services and securing of production orders. The Company
anticipates that a significant portion of its revenue for the future will come
from programs currently in the design or pilot production stage. Completion of
the design depends 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 currently is investing in research and development of
several new technologies that it plans to introduce in the future. The Company
faces the risk that some or all of those technologies may not successfully make
the transition from the research and development lab to cost-effective
manufacturability as a result of technology problems, competitive cost issues,
yield problems, and other factors. In addition, even if a new technology proves
to be manufacturable, the Company's customers and the customers' marketplaces
may not accept it because of price or technology issues or because it compares
unfavorably with products introduced by others. The Company will be required to
make significant expenditures, including development expenses and various
capital expenditures and investments, for these new technologies. For example,
the Company estimates that its initial capital expenditures for LCoS(TM)
microdisplays will be approximately $3.0 million to $4.0 million. The Company
also made an equity investment of $3.3 million in Siliscape during 1998 for the
purposes of further developing the LCoS(TM) microdisplay product. Significant
investments in one or more of the new technologies, especially LCoS(TM)
microdisplays, that ultimately prove to be unsuccessful for any reason could
have a material adverse impact on the Company. In addition, if Siliscape were to
encounter technological or financial difficulties, the value of the Company's
investment could decline, in which case the Company would have to write down all
or a portion of its investment and report a loss equal to such write-down.
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. Material components of some of the Company's major
programs from time to time 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. In addition, the Company purchases many
product components from vendors in Asian countries. Economic instability in
certain Asian countries could cause supply problems with respect to these
components.
The Company's primary competitors are located in Asia, including,
Japan, Korea, and Hong Kong, and most of the Company's customers are U.S.-based.
The recent currency devaluation of several Asian countries has had, and could
continue to have, a negative impact on the gross margins of the Company as the
competitors' products become less expensive to purchase with a stronger dollar.
The Company has established a manufacturing operation in China. The
Company's operations and assets will be subject to significant political,
economic, legal and other uncertainties in China. The Company's operations in
China also could be adversely affected by the imposition of austerity measures
intended to reduce inflation; the inadequate development or maintenance of
infrastructure, including the unavailability of adequate
32
<PAGE>
power and water supplies, transportation, raw materials, and parts; or a
deterioration of the general political, economic or social environment in China.
The Company has set up manufacturing operations in Beijing in an
interim leased facility. If there are delays in the completion of the permanent
facility, the Company may run into capacity issues in the interim facility
because of space constraints and/or power requirements. In addition, the Company
has a short-term lease on the interim facility and could be required to move out
if there are delays in the completion of the permanent facility, which would
severely interrupt the Company's manufacturing operations in China.
One of the reasons the Company is starting up operations in China is
because the Company believes that its Manila manufacturing facility may have
occasional capacity issues within the next year. Failure to begin operations in
the permanent China facility on a timely basis could result in capacity
restraints and late or canceled customer deliveries. Manufacturing yields and
delivery schedules also may be affected as the Company ramps up its
manufacturing capabilities in China. Other companies in the industry have
experienced difficulty in expanding or relocating manufacturing output and
capacity, with such difficulty resulting in reduced yields or delays in product
deliveries. The Company cannot provide assurance that it will not experience
manufacturing yield or delivery problems in the future. Such problems could
materially affect the Company's operating results.
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.
YEAR 2000 COMPLIANCE DISCLOSURE
Many existing computer programs and databases use only two digits to
identify a year in the date field (I.E., 99 would represent 1999). These
programs and databases were designed and developed without considering the
impact of the upcoming millennium. Consequently, date sensitive computer
programs may interpret the date "00" as 1900 rather than 2000. If not corrected,
many computer systems could fail or create erroneous results in 2000. The
following disclosure is as required by SEC Release No. 33-7558.
COMPANY'S STATE OF READINESS
The Company has completed an assessment of all of its internal and
external systems and processes with respect to the "Year 2000" issue. In
response to this assessment, the Company has created a multi-functional Year
2000 task force to resolve any non-compliant Year 2000 systems or processes. To
date, this group is on schedule to complete this task during 1999. The Company
plans to continuously test all of its internal and external systems and
processes, including the associated Year 2000 "fixes," for Year 2000 compliance
during 1999. As part of this process, the Company has assessed the potential
impact of Year 2000 failures from vendors and outside parties upon its business
and currently is taking steps to minimize that risk. Based on the Company's
current state of readiness and the steps currently being taken (I.E., installing
backup processes and systems), the Company does not believe that the Year 2000
problem will have a material adverse effect on the Company's financial position,
liquidity, or operations.
33
<PAGE>
COMPANY'S COSTS OF YEAR 2000 COMPLIANCE
The Company estimates that its total cost of Year 2000 compliance will
be less than $100,000. Those costs include updating of computer software and
hardware manufacturing equipment, as well as employment and other out-of-pocket
costs.
COMPANY'S RISKS OF YEAR 2000 ISSUES
The Company procures a significant amount of raw materials used in its
manufacturing processes from foreign vendors. As a result, the Company may be at
risk from foreign companies and countries that are not taking adequate measures
to ensure Year 2000 compliance or that may not be at the same level of
preparedness as the United States. For example, economic problems in Asia may
affect or divert resources with respect to the Year 2000 issue. Failure of those
foreign countries and companies to be Year 2000 compliant may cause new material
shortages that would adversely impact the Company's manufacturing operations. In
addition, the Company currently has significant manufacturing operations in
Manila, the Philippines and Beijing, China. As a result, the Company may be at
risk with respect to suppliers of necessary resources (such as power or water)
that may not be Year 2000 compliant. For example, brownouts or blackouts may
occur due to lack of Year 2000 compliance. In addition, the Company's customers
may have catastrophic Year 2000 failures, including prolonged interruptions in
factory productions, in which case they may have a reduced demand for the
Company's products.
COMPANY'S CONTINGENCY PLANS
The Company is developing contingency plans with respect to significant
Year 2000 issues within its control. For example, the Company is in the process
of assessing and verifying the Year 2000 compliance of its international and
domestic raw material vendors. Verification will be accomplished through the use
of written certifications and audits. The Company intends to replace any vendors
found not to be Year 2000 compliant with vendors that are Year 2000 compliant.
In the construction of its new Beijing facility, the Company will procure
material, processes, and equipment that are Year 2000 compliant. The Company
also is investigating the use of stand-by generators for its plants in the event
of a local power failure. The Company is investigating transferring all
manufacturing processes to alternate manufacturing facilities if external
factors beyond its control relative to the Year 2000 issue occur and the Company
cannot conduct manufacturing operations at any particular facility.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
DERIVATIVE FINANCIAL INSTRUMENTS, OTHER FINANCIAL INSTRUMENTS, AND DERIVATIVE
COMMODITY INSTRUMENTS.
At December 31, 1998 the Company did not participate in any derivative
financial instruments or other financial and commodity instruments for which
fair value disclosure would be required under Statement of Financial Accounting
Standards No. 107. The Company holds no investment securities that would require
disclosure of market risk.
PRIMARY MARKET RISK EXPOSURES.
The Company's primary market risk exposures are in the areas of interest
rate risk and foreign currency exchange rate risk. The Company incurs interest
on loans made under a revolving line of credit at interest rates under a
variable interest rate of the bank's prime rate (7.75% at December 31, 1998)
plus 2.375%, the principal of which is due 2004. At December 31, 1998, the
Company's outstanding borrowings on the line of credit was approximately $8.1
million. Substantially all of the Company's business outside the United States
is conducted in U.S. dollar denominated transactions. The Company operates
high-volume manufacturing facilities in Manilla, the Philippines and Beijing,
China, and a sales and distribution facility in the United Kingdom. Some of the
expenses of these foreign operations are denominated in the Philippine peso,
Chinese renminbi, and British pound sterling, respectively. These expenses
include local salaries and wages, utilities and some operating supplies.
However, the Company believes that the operating expenses currently incurred in
foreign currencies are immaterial, and therefore any associated market risk is
unlikely to have a material adverse effect on the Company's business, results of
operations or financial condition.
34
<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.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE
Not applicable.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS
The information required by this Item relating to directors of the
Company is incorporated by reference to the definitive Proxy Statement filed
pursuant to Regulation 14A of the Exchange Act for the Company's 1999 Annual
Meeting of Stockholders. The information required by this Item relating to
executive officers of the Company is included in "Business - Executive Officers"
contained in Item 1 of this Report.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this Item is incorporated herein by
reference to the definitive Proxy Statement filed pursuant to Regulation 14A of
the Exchange Act for the Company's 1999 Annual Meeting of Stockholders.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this Item is incorporated herein by
reference to the definitive Proxy Statement filed pursuant to Regulation 14A of
the Exchange Act for the Company's 1999 Annual Meeting of Stockholders.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Not applicable.
35
<PAGE>
PART IV
ITEM 14. EXHIBITS AND REPORTS ON FORM 8-K
(a) FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULE
(1) Financial Statements are listed in the Index to Financial
Statements on page F-1 of this Report.
(2) Financial Statement Schedule:
Schedule II Valuation and Qualifying Accounts and Reserves is set
forth on page S-1 of this Report.
Other schedules are omitted because they are not applicable, not
required or because required information is included in the consolidated
financial statements or notes thereto.
(b) REPORTS ON FORM 8-K
Not applicable.
(c) EXHIBITS
EXHIBIT
NUMBER EXHIBITS
- ------ --------
2 Amended and Restated Agreement and Plan of Reorganization(1)
3(a) Restated Certificate of Incorporation of the Company(2)
3(b) Bylaws of the Company(1)
10(a) 1990 Incentive Stock Option Plan(1)
10(c) Line of Credit Agreement between Three-Five Systems Limited and Barclays
Bank, PLC(1)
10(d) Sub-Assembly Agreement between Three-Five Systems, Inc. and TEAM Pacific
Corporation dated February 22, 1995(3)
10(g) Form of Three-Five Systems, Inc. Distributor Franchise Agreement(4)
10(j) 1993 Stock Option Plan(4)
10(k) 1994 Automatic Stock Option Plan(5)
10(l) Lease Agreement between Technology Electronic Assembly and Management
(T.E.A.M.) Pacific Corporation and Three-Five Systems Pacific, Inc.(6)
10(m) Lease Agreement between Regent Apparel Corporation and Three-Five
Systems Pacific, Inc.(6)
10(o) Lease dated April 1, 1994, between Papago Park Center, Inc. and
Three-Five Systems, Inc. (7)
10(t) Credit Agreement dated May 23, 1997 between Three-Five Systems, Inc. and
Imperial Bank(8)
10(u) Addendum No. 1 to Sub-Assembly Agreement between Three-Five Systems,
Inc. and TEAM Pacific Corporation dated March 12, 1997(8)
10(v) 1997 Employee Stock Option Agreement(8)
10(w) 1998 Stock Option Agreement(8)
10(x) 1998 Director's Stock Plan(8)
10(y) Addendum No. 2 to Sub-Assembly Agreement between Three-Five Systems,
Inc. and TEAM Pacific Corporation dated January 1, 1998(8)
10(z) 401(k) Profit Sharing Plan(9)
10(aa) Credit Agreement dated November 5, 1998, by and among Three-Five
Systems, Inc., its subsidiaries, the Banks named therein, and Imperial
Bank Arizona, as Agent.
10(bb) Security Agreement dated November 5, 1998, by Three-Five Systems, Inc.
in favor of Imperial Bank Arizona, as Agent.
21 List of Subsidiaries
23 Consent of Arthur Andersen LLP
27 Financial Data Schedule
36
<PAGE>
(1) Incorporated by reference to the Registration Statement on Form S-4 of TF
Consolidation, Inc. (Registration No. 33-33944) as filed March 27, 1990 and
declared effective March 27, 1990.
(2) Incorporated by reference to the Registrant's Form 10-QSB for the quarter
ended March 31, 1994, as filed with the Commission on or about May 12,
1994.
(3) Incorporated by reference to the Registrant's Form 10-KSB for the fiscal
year ended December 31, 1994 filed with the Commission on March 22, 1995,
as amended by Form 10-KSB/A as filed with the Commission on April 28, 1995.
(4) Incorporated by reference to the Registration Statement on Form S-1
(Registration No. 33-74788) as filed on February 3, 1994, and declared
effective March 15, 1994.
(5) Incorporated by reference to the Registration Statement on Form S-8
(Registration No. 33-88706) as filed on January 24, 1995.
(6) Incorporated by reference to the Registrant's Form 10-K for the fiscal year
ended December 31, 1995, as filed with the Commission on March 13, 1996.
(7) Incorporated by reference to the Registrant's Form 10-K for the fiscal year
ended December 31, 1996, as filed with the Commission on March 14, 1997.
(8) Incorporated by reference to the Registrant's Form 10-K for the fiscal year
ended December 31, 1997, as filed with the Commission on March 13, 1998,
and as amended by Form 10-K/A filed with the Commission on March 23, 1998.
(9) Incorporated by reference to the Registration Statement on Form S-8
(Registration No. 333-57933) as filed on June 26, 1998.
37
<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.
THREE-FIVE SYSTEMS, INC.
Date: March 9, 1999 By: /s/ David R. Buchanan
-------------------------------------
David R. Buchanan
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.
NAME TITLE DATE
---- ----- ----
/s/ David R. Buchanan President, Chief Executive Officer March 9, 1999
- -------------------------- (Principal Executive Officer),
David R. Buchanan and Director
/s/ Jeffrey D. Buchanan Executive Vice President March 9, 1999
- -------------------------- - Finance, Administration, and Legal;
Jeffrey D. Buchanan Chief Financial Officer; Secretary;
Treasurer (Principal Financial
Officer), and Director
/s/ Robert T. Berube Corporate Controller March 9, 1999
- -------------------------- (Principal Accounting Officer)
Robert T. Berube
/s/ David C. Malmberg Director March 9, 1999
- --------------------------
David C. Malmberg
/s/ Burton E. McGillivray Director March 9, 1999
- --------------------------
Burton E. McGillivray
/s/ Gary R. Long Director March 9, 1999
- --------------------------
Gary R. Long
/s/ Kenneth M. Julien Director March 9, 1999
- --------------------------
Kenneth M. Julien
/s/ Thomas A. Werner Director March 9, 1999
- --------------------------
Thomas A. Werner
38
<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, 1998 and 1997 ............... F-3
Consolidated Statements of Income (Loss) for the years ended
December 31, 1998, 1997 and 1996 ........................................ F-4
Consolidated Statements of Stockholders' Equity for the
years ended December 31, 1998, 1997 and 1996 ............................ F-5
Consolidated Statements of Cash Flows for the years ended
December 31, 1998, 1997 and 1996 ........................................ F-6
Notes to Consolidated Financial Statements ................................. F-7
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, 1998
and 1997, 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, 1998. 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, 1998 and 1997, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 1998, 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 audits 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.
/s/ Arthur Andersen LLP
Phoenix, Arizona,
January 22, 1999.
F-2
<PAGE>
THREE-FIVE SYSTEMS, INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
ASSETS
December 31,
--------------------
1998 1997
-------- --------
CURRENT ASSETS:
Cash and cash equivalents (Note 2) $ 4,946 $ 16,371
Accounts receivable, net 18,601 12,540
Inventories, net (Note 2) 12,493 8,255
Deferred tax asset (Note 5) 2,680 4,311
Other current assets 2,313 1,228
-------- --------
Total current assets 41,033 42,705
PROPERTY, PLANT AND EQUIPMENT, net (Note 2) 33,314 29,847
OTHER ASSETS 3,557 283
-------- --------
$ 77,904 $ 72,835
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 10,649 $ 8,513
Accrued liabilities (Note 2) 4,673 5,079
Current taxes payable (Note 5) 235 --
Current portion of long-term debt (Note 3) 651 --
-------- --------
Total current liabilities 16,208 13,592
-------- --------
LONG-TERM DEBT (Note 3) 7,444 --
-------- --------
DEFERRED TAX LIABILITY (Note 5) 3,156 2,718
-------- --------
COMMITMENTS AND CONTINGENCIES (Note 6)
STOCKHOLDERS' EQUITY (Note 4):
Preferred stock, $.01 par value; 1,000,000
shares authorized -- --
Common stock, $.01 par value; 15,000,000 shares
authorized, 7,974,901 shares issued, 7,005,107
shares outstanding at December 31, 1998;
7,928,023 shares issued, 7,905,523 shares
outstanding at December 31, 1997 80 79
Additional paid-in capital 32,484 32,420
Retained earnings 26,849 24,259
Cumulative translation adjustment (Note 2) 8 20
Less - Treasury stock, at cost (969,794 shares) (8,325) (253)
-------- --------
Total stockholders' equity 51,096 56,525
-------- --------
$ 77,904 $ 72,835
======== ========
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)
Years Ended December 31,
------------------------------------
1998 1997 1996
---------- ---------- ----------
NET SALES (Note 7) $ 95,047 $ 84,642 $ 60,713
---------- ---------- ----------
COSTS AND EXPENSES:
Cost of sales 76,149 64,760 58,321
Selling, general and administrative 7,334 6,557 5,351
Research and development 7,159 5,106 4,065
---------- ---------- ----------
90,642 76,423 67,737
---------- ---------- ----------
Operating income (loss) 4,405 8,219 (7,024)
---------- ---------- ----------
OTHER INCOME (EXPENSE):
Interest, net 75 548 412
Other, net (117) (190) (139)
---------- ---------- ----------
(42) 358 273
---------- ---------- ----------
INCOME (LOSS) BEFORE PROVISION FOR
(BENEFIT FROM) INCOME TAXES: 4,363 8,577 (6,751)
Provision for (benefit from)
income taxes (Note 5) 1,773 3,334 (2,920)
---------- ---------- ----------
NET INCOME (LOSS) $ 2,590 $ 5,243 $ (3,831)
========== ========== ==========
EARNINGS (LOSS) PER COMMON SHARE (Note 2):
Basic $ 0.34 $ 0.67 $ (0.49)
========== ========== ==========
Diluted $ 0.33 $ 0.65 $ (0.49)
========== ========== ==========
WEIGHTED AVERAGE NUMBER OF COMMON
SHARES:
Basic 7,638,631 7,854,053 7,767,744
========== ========== ==========
Diluted 7,802,041 8,089,975 7,767,744
========== ========== ==========
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, 1998, 1997 AND 1996
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
<TABLE>
<CAPTION>
Common Stock
---------------------- Additional
Shares Paid-in Retained
Issued Amount Capital Earnings
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
BALANCE, December 31, 1995 7,735,745 $ 77 $ 32,286 $ 22,847
Net loss -- -- -- (3,831)
Other comprehensive income-
Foreign currency translation
adjustments -- -- -- --
Comprehensive income -- -- -- --
Stock options exercised 44,084 1 11 --
Tax benefit from early disposition
of incentive stock options -- -- 32 --
Purchase of treasury stock -- -- -- --
--------- --------- --------- ---------
BALANCE, December 31, 1996 7,779,829 78 32,329 19,016
Net income -- -- -- 5,243
Other comprehensive income-
Foreign currency translation
adjustments -- -- -- --
Comprehensive income -- -- -- --
Stock options exercised 148,194 1 50 --
Tax benefit from early disposition
of incentive stock options -- -- 41 --
--------- --------- --------- ---------
BALANCE, December 31, 1997 7,928,023 79 32,420 24,259
Net income -- -- -- 2,590
Other comprehensive income-
Foreign currency translation
adjustments -- -- -- --
Comprehensive income -- -- -- --
Stock options exercised 46,878 1 64 --
Purchase of treasury stock -- -- -- --
--------- --------- --------- ---------
BALANCE, December 31, 1998 7,974,901 $ 80 $ 32,484 $ 26,849
========= ========= ========= =========
Cumulative Total
Treasury Translation Stockholders' Comprehensive
Stock Adjustment Equity Income
-------- ---------- ---------- ----------
BALANCE, December 31, 1995 $ -- $ 14 $55,224
Net loss -- -- (3,831) $(3,831)
Other comprehensive income-
Foreign currency translation
adjustments -- -- -- --
Comprehensive income -------
Stock options exercised -- -- -- $(3,831)
Tax benefit from early disposition =======
of incentive stock options -- -- 12
Purchase of treasury stock -- -- 32
(253) -- (253)
------- ------ -------
BALANCE, December 31, 1996 (253) 14 51,184
Net income -- -- 5,243 $ 5,243
Other comprehensive income-
Foreign currency translation
adjustments -- 6 6 6
Comprehensive income -- -- -- -------
Stock options exercised -- -- 51 $ 5,249
Tax benefit from early disposition =======
of incentive stock options -- -- 41
------- ------ -------
BALANCE, December 31, 1997 (253) 20 56,525
Net income -- -- 2,590 $ 2,590
Other comprehensive income-
Foreign currency translation
adjustments -- (12) (12) (12)
Comprehensive income -- -- -- -------
Stock options exercised -- -- 65 $ 2,578
Purchase of treasury stock (8,072) -- (8,072) =======
------- ------ -------
BALANCE, December 31, 1998 $(8,325) $ 8 $51,096
======= ====== =======
</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)
Years Ended December 31,
----------------------------
1998 1997 1996
-------- ------- -------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $ 2,590 $ 5,243 $(3,831)
Adjustments to reconcile net income (loss)
to net cash (used in) provided by
operating activities-
Depreciation and amortization 4,693 4,135 3,551
Provision for (reduction of) accounts
receivable valuation reserves (64) (69) 47
Provision for (reduction of) inventory
valuation reserves (3,184) (2,473) 4,015
Loss on disposal of assets -- 2 12
Changes in assets and liabilities:
(Increase) decrease in accounts receivable (5,997) (5,641) 2,469
(Increase) decrease in inventories (1,054) (1,176) 5,082
(Increase) decrease in other assets (1,425) 505 (1,070)
Increase in accounts payable and accrued
liabilities 1,730 4,778 4,296
Increase (decrease) in taxes payable, net 2,649 1,461 (2,358)
-------- ------- -------
Net cash (used in) provided by operating
activities (62) 6,765 12,213
-------- ------- -------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property, plant and equipment (8,119) (3,050) (948)
Proceeds from sale of property, plant and
equipment -- 19 5
Investment in Siliscape, Inc. (3,320) -- --
-------- ------- -------
Net cash used in investing activities (11,439) (3,031) (943)
-------- ------- -------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net proceeds from (payments on) notes
payable to banks 8,095 -- (3,000)
Stock options exercised 65 51 12
Purchase of treasury stock (8,072) -- (253)
-------- ------- -------
Net cash provided by (used in) financing
activities 88 51 (3,241)
-------- ------- -------
Effect of exchange rate changes on cash (12) 6 --
-------- ------- -------
NET (DECREASE) INCREASE IN CASH AND CASH
EQUIVALENTS (11,425) 3,791 8,029
CASH AND CASH EQUIVALENTS, beginning of year 16,371 12,580 4,551
-------- ------- -------
CASH AND CASH EQUIVALENTS, end of year $ 4,946 $16,371 $12,580
======== ======= =======
SUPPLEMENTAL CASH FLOW INFORMATION:
Interest paid $ 364 $ 4 $ 60
======== ======= =======
Income taxes paid $ 992 $ 1,973 $ 1,832
======== ======= =======
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, 1998, 1997 AND 1996
(1) ORGANIZATION AND OPERATIONS:
Three-Five Systems, Inc. (the Company) designs and manufactures a wide range of
user interface devices for operational control and information 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, consumer electronic products, and data collection 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 currently conducts manufacturing operations in Tempe, Arizona;
Manila, the Philippines; and Beijing, China. The Company believes that the
Arizona facility has the largest fully automated LCD glass production capacity
outside of Asia. High-volume LCD module manufacturing is done in Manila, the
Philippines and Beijing, China. In Manila, 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 $2.2 million to the subcontractor to help the subcontractor meet
its working capital needs. As of December 31, 1998, the subcontractor has repaid
$2.0 million of these advances. The amounts payable to the subcontractor more
than exceeded the $205,000 advances outstanding at December 31, 1998. These
advances are secured by future payments for subcontracting services to be
provided to the Company. The Company commenced manufacturing operations in China
during 1998. The China facility is a high-volume LCD module manufacturing
facility similar to the Company's facility in Manila. The Company initially
leased a facility in Beijing on a temporary basis, which expires in mid-1999,
and the Company commenced manufacturing operations in that temporary facility in
the second quarter of 1998. The Company has begun construction of its own
facility in Beijing and expects to move into the new facility in the middle of
1999. Any significant delay in the construction of the permanent facility could
result in the temporary shutdown of the China manufacturing operations.
(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.
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.
Three-Five Systems Pacific, Inc. (Pacific), a Philippines corporation, procures
supplies primarily from Philippine vendors. Pacific also manages and assists
production personnel of the third-party subcontractor that operates the facility
in the Philippines.
F-7
<PAGE>
During the first quarter of 1998, the Company formed a wholly-owned subsidiary
in China, Three-Five Systems (Beijing) Co., Ltd. (Beijing). Beijing manufactures
and sells the Company's products to customers primarily located in Asia.
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.
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.
In addition, the carrying amount on the outstanding line of credit is estimated
to approximate fair value as the actual interest rate is consistent with rates
estimated to be currently available for debt with similar terms and remaining
maturities.
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 $1,992,000 and $12,886,000 at December 31, 1998 and December
31, 1997, 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 $1,125,000
and $4,309,000 at December 31, 1998 and December 31, 1997, respectively.
Inventories at December 31 consist of the following:
1998 1997
--------- ---------
(in thousands)
Raw materials $ 9,367 $ 6,052
Work-in-process 1,459 1,195
Finished goods 1,667 1,008
--------- ---------
$ 12,493 $ 8,255
========= =========
F-8
<PAGE>
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:
1998 1997
-------- --------
(in thousands)
Building and improvements $ 13,031 $ 10,431
Furniture and equipment 37,324 31,804
-------- --------
50,355 42,235
Less - accumulated depreciation (17,041) (12,388)
-------- --------
$ 33,314 $ 29,847
======== ========
The Company utilizes 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 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 $975,000 and
$1,675,000 at December 31, 1998 and 1997, 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 functional
currency of each of Pacific and Limited is the same as the local currency. The
gain or loss resulting from the translation of these two subsidiaries' financial
statements has been included as a separate component of stockholders' equity.
The functional currency of Beijing is the U.S. dollar. Beijing, however,
maintains its books and records in the Renminbi. Therefore, the Company utilizes
the remeasurement method of foreign currency translation when Beijing is
consolidated. Any resulting remeasurement gain or loss is reported in the
Company's consolidated statements of operations.
The net foreign currency transaction loss in 1998, 1997, and 1996 was $177,000,
$183,000, and $46,000, respectively, and has been included in other expenses in
the accompanying statements of income (loss).
F-9
<PAGE>
REVENUE RECOGNITION
The Company recognizes revenue upon shipment. The Company provides reserves for
uncollectible accounts receivable. These reserves totaled $431,000 and $455,000
at December 31, 1998 and 1997, 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, 1998 and 1997 are determined assuming that outstanding
options were exercised at the beginning of each 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. Set forth below are the disclosures required
pursuant to SFAS No. 128 for the years ended December 31, 1998, 1997, and 1996:
Years Ended December 31,
------------------------------
1998 1997 1996
------- ------- --------
(in thousands, except per share data)
Basic earnings (loss) per share:
Income (loss) available to common
shareholders $ 2,590 $ 5,243 $ (3,831)
------- ------- --------
Weighted average common shares 7,639 7,854 7,768
------- ------- --------
Basic per share amount $ 0.34 $ 0.67 $ (0.49)
======= ======= ========
Diluted earnings (loss) per share:
Income (loss) available to common
shareholders $ 2,590 $ 5,243 $ (3,831)
------- ------- --------
Weighted average common shares 7,639 7,854 7,768
Options assumed exercised 163 236 -
------- ------- --------
Total common shares plus assumed
exercises 7,802 8,090 7,768
------- ------- --------
Diluted per share amount $ 0.33 $ 0.65 $ (0.49)
======= ======= ========
RECENTLY ADOPTED ACCOUNTING STANDARDS
In 1998, the Company adopted Statement of Financial Accounting Standards No.
130, REPORTING COMPREHENSIVE INCOME, which requires companies to report all
changes in equity during a period, except those resulting from investment by
owners and distribution to owners, in a financial statement for the period in
which they are recognized. The Company has chosen to disclose Comprehensive
Income, which encompasses net income and foreign currency translation
adjustments, in the Consolidated Statement of Shareholder's Equity. Prior years
have been restated to conform to the SFAS No. 130 requirements.
F-10
<PAGE>
In 1998, the Company also adopted Statement of Financial Accounting Standards
No. 131, DISCLOSURES ABOUT SEGMENTS OF AN ENTERPRISE AND RELATED INFORMATION.
The new rules establish revised standards for public companies relating to the
reporting of financial and descriptive information about their operating
segments in financial statements. The Company adopted SFAS No. 131 and all of
the required disclosures (Note 7).
(3) LONG-TERM DEBT:
Long-term debt at December 31 consists of the following:
1998 1997
------- -------
(in thousands)
$15.0 million revolving line of credit, interest
due monthly at the bank's prime rate (7.75% at
December 31, 1998) or at the LIBOR base rate
(5.064% at December 31, 1998) plus 1.75%, unpaid
balance due May 22, 2000, secured by all assets
other than real property. $ -- $ --
$10.0 million revolving line of credit/term loan,
interest due monthly at the bank's prime rate or
at the LIBOR base rate plus 2.375%, unpaid balance
due August 5, 2004, secured by all assets other
than real property. 8,095 --
$350,000 United Kingdom credit facility, interest
due quarterly at the bank's base rate plus 2%,
unpaid balance due July 15, 1999, secured by
United Kingdom accounts receivable. -- --
------- -------
8,095
Less - current maturities (651) --
------- -------
$ 7,444 $ --
======= =======
In November 1998, the Company entered into a new commitment from Imperial Bank
and the National Bank of Canada for a $25.0 million credit facility. This new
credit facility consists of (i) a $15.0 million revolving line of credit is
available for general corporate needs, and (ii) a $10.0 million term loan, which
provides available funds to repurchase a portion of the Company's common stock.
The amount of the term loan is available for advances until August 5, 1999,
followed by a five-year amortization period in which principal and interest will
be payable quarterly in equal installments. Advances under the term loan will be
made as either Prime Rate Advances, which accrue interest payable monthly, at
the bank's prime lending rate, or as LIBOR Rate Advances which bear interest at
237.5 basis points in excess of the LIBOR Base Rate. The credit facility is
secured by all of the Company's assets other than the Company's real property.
The Company must apply all proceeds from the sale of any treasury stock to the
outstanding principal balance of the term loan.
The credit facility contains restrictive covenants that include, among other
things, restrictions on the declaration or payment of dividends and the amount
of capital expenditures. The credit facility also requires the Company to
maintain a specified net worth, as defined, to maintain required debt to equity
ratio, and to maintain certain other financial ratios.
Any unpaid balance of the United Kingdom credit facility is due July 15, 1999,
and is secured by United Kingdom accounts receivable.
F-11
<PAGE>
(4) BENEFIT PLANS:
The Company has five stock option plans, the 1998 Stock Option Plan (1998 Plan),
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).
1998 STOCK OPTION PLAN
The 1998 Plan provides for the granting of incentive stock options and/or
nonqualified options to purchase up to 300,000 shares of the Company's common
stock. Under the 1998 Plan, options may be issued to key personnel and others
providing valuable services to the Company and its subsidiaries. The options
issued will be incentive stock options or nonqualified 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 1998 Plan. There were options outstanding to
acquire 122,500 shares of the Company's common stock under the 1998 Plan at
December 31, 1998.
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 are
determined by the plan administrator, but may not be less than 100% of the fair
market value of the common stock at the time of the grant (110% if the option is
an incentive stock option granted to a stockholder who at the time the option is
granted owns stock representing more than 10% of the total combined voting power
of all classes of stock of the Company). The 1998 Plan will remain in force
until January 28, 2008.
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 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 38,300 shares of the Company's common stock under
the 1997 Plan at December 31, 1998.
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 are
determined by the plan administrator, but may not be less than 100% 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 receives 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 immediately
after the director's second successive election to the Board of Directors (the
First Vesting Date), the second installment becoming exercisable 10 months after
the First Vesting
F-12
<PAGE>
Date, and the third installment becoming exercisable 22 months after the First
Vesting Date (provided that the director has not ceased serving as a director
prior to a vesting 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% of the fair market
value of the Company's common stock on the date such options are granted. There
were outstanding options to acquire 11,000 shares of the Company's common stock
under the 1994 Plan at December 31, 1998.
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 360,900 shares of
the Company's common stock under the 1993 Plan at December 31, 1998.
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 are determined by the plan administrator, but may not be less
than 100% (110% if the option is an incentive stock option granted to a
stockholder who at the time the option is granted owns stock representing more
than 10% 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 163,100 options issued but unexercised as of
December 31, 1998. In conjunction with stockholder approval of the 1993 Plan,
the Board terminated the 1990 Plan with respect to unissued options to purchase
85,454 shares of common stock which remained and were unissued as of the date
the 1993 Plan was adopted. The exercise prices of options are determined by the
plan administrator, but may not be less than 100% (110% if the option is granted
to a stockholder who at the time the option is granted owns stock representing
more than 10% of the total combined voting power of all classes of stock of the
Company). 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
Plan and 1990 Plan 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:
F-13
<PAGE>
Years Ended December 31,
------------------------------
1998 1997 1996
------- ------- -------
(in thousands, except per share data)
Net income (loss): As reported $ 2,590 $ 5,243 $(3,831)
Pro forma 1,998 4,785 (4,076)
Basic earnings (loss)
per share: As reported $ 0.34 $ 0.67 $ (0.49)
Pro forma 0.26 0.61 (0.52)
Diluted earnings (loss)
per share: As reported $ 0.33 $ 0.65 $ (0.49)
Pro forma 0.26 0.59 (0.52)
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 1998, 1997, and 1996, respectively: risk-free interest
rates of 4.52%, 5.45%, and 6.31%; expected dividend yields of zero; expected
lives of 6.6, 6.4, and 6.1 years; and expected volatility (a measure of the
amount by which a price has fluctuated or is expected to fluctuate during a
period) of 61.4%, 60.0%, and 61.9%.
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 exercised in 1998 was $14.03.
A summary of the status of the Company's five stock option plans at December 31,
1998, 1997, and 1996 and changes during the years then ended, are presented in
the table and narrative below:
1998 1997 1996
------------------ ------------------ ------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
------- -------- ------- -------- ------- --------
Outstanding at
beginning of year 550,970 $11.01 551,776 $ 6.92 539,576 $ 8.06
Granted 334,800 13.87 200,500 14.63 250,100 11.89
Exercised (47,020) 1.08 (162,306) 1.34 (44,900) 0.49
Expired 142,950) 15.45 (39,000) 12.23 (193,000) 18.04
------- -------- --------
Outstanding at
end of year 695,800 $12.14 550,970 $11.01 551,776 $ 6.92
======= ======== ========
Exercisable at end of
year 226,731 165,110 294,982
======= ======== ========
Weighted average fair
value of options
granted $10.25 $ 9.19 $ 7.57
====== ====== ======
F-14
<PAGE>
The following table summarizes information about stock options outstanding at
December 31, 1998:
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 1998 Life Price 1998 Price
- ------------- -------------- ----------- --------- -------------- ----------
$0.25 - $9.00 85,100 4.1 years $ 2.46 63,600 $ 0.81
9.01 - 20.00 588,700 7.9 years 13.14 153,799 12.85
20.01 - 34.38 22,000 8.1 years 22.97 9,332 24.41
------- --------- ------- ---------
695,800 7.5 years $ 12.14 226,731 $ 9.95
======= ========= ======= =========
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 $100,000, $71,000, and $65,000 for the years ended December 31,
1998, 1997, and 1996, respectively.
(5) 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 (benefit) for income taxes for the years ended December 31
consists of the following:
1998 1997 1996
------- ------- -------
(in thousands)
Current, net of operating loss carryforwards
and tax credits utilized
Federal, net of tax benefit from early
termination of incentive stock options $ (509) $ 356 $ 556
State (24) 97 58
Foreign 237 71 9
------- ------- -------
(296) 524 623
Deferred provision (benefit) 2,069 2,769 (3,575)
Tax benefit from early termination of incentive
stock options, reflected in stockholders' equity -- 41 32
------- ------- -------
Provision (benefit) for income taxes $ 1,773 $ 3,334 $(2,920)
======= ======= =======
In accordance with SFAS No. 109, a tax benefit for net operating losses of
approximately $-0-, $35,000, and $102,000 and tax credits of approximately $-0-,
$-0-, and $938,000 utilized in 1998, 1997, and 1996, respectively, are included
as a reduction of the current provision for income taxes in the consolidated
statements of income (loss).
F-15
<PAGE>
The components of deferred taxes at December 31 are as follows:
1998 1997
------- -------
(in thousands)
Net long-term deferred tax liabilities:
Accelerated tax depreciation $ 3,156 $ 2,685
Other -- 33
------- -------
$ 3,156 $ 2,718
======= =======
Net short-term deferred tax assets:
Inventory reserve $ 436 $ 1,721
Uniform capitalization 1,076 1,251
Accrued liabilities not currently deductible 1,022 1,080
Allowance for doubtful accounts 156 156
Tax effect of regular U.S. net operating
loss carryforward -- 12
Other (10) 91
------- -------
$ 2,680 $ 4,311
======= =======
A reconciliation of the U.S. federal statutory rate to the Company's effective
tax rate is as follows:
1998 1997 1996
------ ------ ------
Statutory federal rate 34% 34% (34)%
Effect of state taxes 3 5 (6)
Other 4 -- (3)
------ ------ ------
41% 39% (43)%
====== ====== ======
(6) 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. The lease expires March 31, 1999. The Company has an option to
extend the lease for an additional year at substantially the same rates as the
current lease.
Rent expense was approximately $917,000, $793,000, and $477,000 for the years
ended December 31, 1998, 1997, and 1996, 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 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-16
<PAGE>
The Company's future lease commitments under the non-cancelable operating leases
as of December 31, are as follows (in thousands):
1999 $ 373
2000 100
2001 100
2002 100
2003 100
Thereafter 6,525
------
$7,298
======
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.
(7) SEGMENT INFORMATION:
The Company designs and manufactures a wide range of user interface devices for
operational control and information display functions required in the end
products of OEMs. The Company's products are specialized in LCD and LED
components and technology. The majority of the Company's sales are attributed to
the LCD product line. The Company's products are included in end-user devices
for the following product categories: cellular telephones and other wireless
communication devices, medical equipment, office automation equipment,
industrial process controls, consumer electronic products, and data collection
products.
Management monitors and evaluates the financial performance of the Company's
operations by its four operating segments located throughout the world. These
segments consist of three manufacturing operations, located in the United
States, China, and the Philippines, and a sales and distribution operation in
the United Kingdom.
The following operating segment information includes financial information (in
thousands) for all four of the Company's operating segments. Financial
information for the China operation is presented beginning from the date those
operations commenced, June 1998.
<TABLE>
<CAPTION>
United United
December 31, 1998 States Kingdom China Philippines Eliminations Total
- ----------------- -------- -------- -------- ----------- ------------ --------
<S> <C> <C> <C> <C> <C> <C>
Net sales $92,251 $33,438 $ 7,205 $3,010 $(40,857) $95,047
Operating income (loss) 4,643 676 (947) (2) (7) 4,363
Provision for
income taxes 1,537 209 -- 27 -- 1,773
Depreciation 4,408 36 168 41 -- 4,653
Total assets 60,514 9,195 12,301 642 (4,748) 77,904
Capital expenditures 2,809 10 5,298 2 -- 8,119
</TABLE>
F-17
<PAGE>
<TABLE>
<CAPTION>
United United
December 31, 1997 States Kingdom China Philippines Eliminations Total
- ----------------- -------- -------- -------- ----------- ------------ --------
<S> <C> <C> <C> <C> <C> <C>
Net sales $83,023 $10,755 $ -- $3,107 $(12,243) $84,642
Operating income 7,990 436 -- 104 47 8,577
Provision for
income taxes 3,263 32 -- 39 -- 3,334
Depreciation 4,058 27 -- 9 -- 4,094
Total assets 68,039 4,896 -- 354 (454) 72,835
Capital expenditures 3,036 14 -- -- -- 3,050
United United
December 31, 1996 States Kingdom China Philippines Eliminations Total
- ----------------- -------- -------- -------- ----------- ------------ --------
Net sales $58,709 $27,814 $ -- $1,494 $(27,304) $60,713
Operating income (loss) (6,935) 28 -- 12 144 (6,751)
Provision for (benefit
from) income taxes (2,929) 9 -- -- -- (2,920)
Depreciation 3,375 8 -- 57 -- 3,440
Total assets 58,828 3,824 -- 288 (371) 62,569
Capital expenditures 856 42 -- 50 -- 948
</TABLE>
Revenues are generated from the sale of LCD or LED user interface device
components, which are applied in several different end-use products. Total
revenues by these product categories are as follows:
For the Years Ended December 31,
--------------------------------
(in thousands)
1998 1997 1996
------- ------- -------
Cellular telephones and other wireless
communication devices $62,073 $31,415 $40,360
Office automation equipment 12,658 33,528 5,979
Other 20,316 19,699 14,374
------- ------- -------
Total $95,047 $84,642 $60,713
======= ======= =======
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. 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, that accounted for approximately 35% and 65% of the
Company's revenue in 1997 and 1996, respectively, accounted for approximately
64% of the Company's revenue during 1998. This increased percentage occurred as
a result of increased sales to that customer as well as decreased sales to other
customers. The Company's other significant customer accounted for less than 10%
of the Company's revenue during 1998. Sales to this customer were 32% of the
Company's revenue during 1997 and less than 10% of the Company's revenue during
1996.
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
telephone, computer hardware, and other electronic products industries. These
customers are located primarily in the United States and Europe.
F-18
<PAGE>
THREE-FIVE SYSTEMS, INC.
SCHEDULE II
VALUATION AND QUALIFYING ACCOUNTS AND RESERVES
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
<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 12/31/98 $ 580 (24) (40)(1) -- $ 516
Year ended 12/31/97 649 (105) 36(1) -- 580
Year ended 12/31/96 602 14 33(1) -- 649
Inventory Reserve:
Year ended 12/31/98 $ 4,309 (1,660) -- (1,524)(2) $1,125
Year ended 12/31/97 6,782 1,114 -- (3,587)(2) $4,309
Year ended 12/31/96 2,767 5,939 142(3) (2,066)(2) 6,782
</TABLE>
- --------
(1) Actual return activity
(2) Obsolete inventory written off
(3) Inventory adjustments
S-1
================================================================================
CREDIT AGREEMENT
by and among
THREE-FIVE SYSTEMS, INC.
and its Subsidiaries
The Banks Named Herein
and
IMPERIAL BANK ARIZONA
as Agent
Dated as of
November 5, 1998
================================================================================
<PAGE>
TABLE OF CONTENTS
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RECITALS..................................................................1
ARTICLE 1 DEFINITION OF TERMS...................................2
1.1 Definitions...........................................2
1.2 Terms Generally......................................13
ARTICLE 2 THE RLC..............................................14
2.1 RLC Commitment.......................................14
2.2 Revolving Line.......................................14
2.3 RLC Notes............................................14
2.4 RLC..................................................15
2.5 Excess Balance Repayment.............................18
2.6 Reduction of RLC Commitment..........................18
2.7 Conditions...........................................18
2.8 Other RLC Advances...................................19
2.9 Assignment...........................................19
2.10 Issuance of Letters of Credit........................19
2.11 Issuance Procedure for Letter of Credit..............20
2.12 Letter of Credit Fees................................20
2.13 Disbursements........................................20
2.14 Reimbursement Obligations of Borrower................20
2.15 Nature of Reimbursement Obligations..................21
2.16 Banks Obligation.....................................21
2.17 Certain Requirements.................................22
2.18 Risk Participations, Drawings, and Reimbursements....22
2.19 Repayment of Participations..........................24
2.20 Role of the Issuing Bank.............................25
ARTICLE 2A THE RLCT.............................................26
2A.1 RLCT Commitment......................................26
2A.2 Revolving Line.......................................26
2A.3 RLCT Notes...........................................26
2A.4 RLCT.................................................27
2A.5 Excess Balance Repayment.............................30
2A.6 Reduction of RLCT Commitment.........................30
2A.7 Conditions...........................................30
2A.8 Other RLCT Advances..................................31
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2A.9 Assignment...........................................31
ARTICLE 3 PAYMENTS, FEES AND EURODOLLAR PROVISIONS.............32
3.1 Payments.............................................32
3.2 Loan Fees............................................32
3.3 Computations.........................................33
3.4 Maintenance of Accounts..............................33
3.5 Certain Contingencies................................33
3.6 Increased Capital Requirements; Tax..................34
3.7 Special Provisions for LIBOR Rate Advances...........35
3.8 Prepayments..........................................37
3.9 Non U.S. Subsidiaries - Currency Indemnity...........38
ARTICLE 4 SECURITY DOCUMENTS...................................39
4.1 Security.............................................39
4.2 Security Documents...................................39
ARTICLE 5 CONDITIONS PRECEDENT.................................40
5.1 Initial Advance......................................40
5.2 No Event of Default..................................41
5.3 No Material Adverse Effect...........................41
5.4 Representations and Warranties.......................41
ARTICLE 6 REPRESENTATIONS AND WARRANTIES.......................42
6.1 Recitals.............................................42
6.2 Organization and Good Standing.......................42
6.3 Authorization and Power..............................42
6.4 Enforceable Obligations..............................42
6.5 No Conflicts or Consents.............................42
6.6 No Litigation........................................43
6.7 Financial Condition..................................43
6.8 Taxes................................................43
6.9 No Stock Purchase....................................43
6.10 Advances.............................................43
6.11 Solvent..............................................43
6.12 ERISA................................................44
6.13 Full Disclosure......................................44
6.14 No Default...........................................44
6.15 Significant Debt Agreements..........................44
6.16 Compliance with Law..................................44
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6.17 Subsidiaries.........................................44
6.18 Year 2000 Compliance.................................44
ARTICLE 7 AFFIRMATIVE COVENANTS................................45
7.1 Financial Statements, Reports and Documents..........45
7.2 Maintenance of Existence.............................46
7.3 Maintain Business....................................46
7.4 Insurance............................................46
7.5 Compliance with Credit Documents.....................47
7.6 Books and Records; Access............................47
7.7 Payment of Taxes and Other Indebtedness..............47
7.8 Notice of Default....................................47
7.9 Other Notices........................................47
7.10 ERISA Compliance.....................................47
7.11 Further Assurances...................................48
7.12 Compliance with Significant Debt Agreements..........48
7.13 Compliance with Law..................................48
7.14 Authorizations and Approvals.........................48
7.15 News Releases........................................48
7.16 New Subsidiaries.....................................48
7.17 Change in Control....................................48
7.18 Year 2000 Compliance.................................49
7.19 Treasury Stock.......................................49
ARTICLE 8 NEGATIVE COVENANTS...................................50
8.1 No Debt..............................................50
8.2 Liens................................................50
8.3 Loans................................................50
8.4 Dividends............................................50
8.5 Existence; Sale or Transfer of Assets................50
8.6 Fiscal Year..........................................51
8.7 Margin Stock.........................................51
8.8 Amendments to Organizational Documents...............51
8.9 Treasury Stock.......................................51
8.10 Investment in China..................................51
8.11 Financial Covenants..................................51
ARTICLE 9 EVENTS OF DEFAULT....................................53
9.1 Events of Default....................................53
9.2 Remedies Upon Event of Default.......................55
9.3 Performance by the Banks.............................57
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ARTICLE 9A ADMINISTRATIVE AGENT.................................58
9A.1 Appointment and Authorization........................58
9A.2 Exculpation..........................................58
9A.3 Administrative Agent and Affiliates..................58
9A.4 Banks' Credit Decisions..............................58
9A.5 Indemnification......................................59
9A.6 Administration.......................................59
9A.7 Default by a Bank....................................61
9A.8 Collections; Sharing of Payments.....................62
9A.9 Successor Administrative Agent.......................62
9A.10 Issuing Bank.........................................62
ARTICLE 10 MISCELLANEOUS........................................64
10.1 Modification.........................................64
10.2 Waiver...............................................64
10.3 Payment of Expenses..................................64
10.4 Notices..............................................64
10.5 Governing Law; Jurisdiction, Venue...................65
10.6 Invalid Provisions...................................66
10.7 Binding Effect.......................................66
10.8 Entirety.............................................66
10.9 Relationship of the Banks and Borrower...............66
10.10 Time of the Essence..................................66
10.11 Good Faith Standard..................................66
10.12 Assignments and Participations; Transferees..........67
10.13 Headings.............................................69
10.14 Survival.............................................69
10.15 No Third Party Beneficiary...........................69
10.16 Joint Liability......................................70
10.17 Schedules and Exhibits Incorporated..................70
10.18 Waiver of Jury Trial.................................70
10.19 Counterparts.........................................71
Schedule 1.1 - Pro Rata Share and Notice Address of each Bank
Schedule 6.17 - Subsidiaries
Schedule 8.2 - Existing Liens
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Exhibit "A" - Form of Compliance Certificate
Exhibit "B" - Form of Advance Notice
Exhibit "C" - Form of Notes
Exhibit "D" - Form of Assumption Agreement
Exhibit "E" - Administrative Details Reply Form
Exhibit "F" - Form of Assignment and Acceptance
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CREDIT AGREEMENT
BY THIS CREDIT AGREEMENT (together with any amendments or
modifications, the "Credit Agreement"), entered into as of the 5th day of
November, 1998 by and between THREE- FIVE SYSTEMS, INC., a Delaware corporation
(the "Company"), all present and future Subsidiaries (as hereinafter defined) of
the Company (with the Company, the "Borrower"), the banks listed from time to
time in Schedule 1.1 (the "Banks"), and IMPERIAL BANK ARIZONA, an Arizona
banking corporation, as administrative agent for the Banks (in such capacity,
together with any successor agent appointed hereunder, the "Administrative
Agent") and as Issuing Bank (as hereinafter defined) or as agent for the Issuing
Bank (as Administrative Agent and as agent for the Issuing Bank, the "Agent"),
in consideration of the mutual promises herein contained and for other valuable
consideration, the parties hereto do hereby agree as follows:
RECITALS
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A. Borrower has requested that the Banks establish the following
financial accommodations:
1. A revolving line of credit (the "RLC") in the principal
amount of $15,000,000.00 to provide working capital financing and for
the issuance from time to time of letters of credit; and
2. A revolving line of credit term loan (the "RLCT") in the
principal amount of $10,000,000.00 to provide liquidity for a common
stock repurchase program by Borrower.
B. The Banks have agreed to do so upon the terms, conditions and
provisions set forth herein.
C. Effective as of the delivery of this Credit Agreement, the Company
acknowledges and agrees that the Credit Agreement dated as of May 23, 1997
between the Company and Imperial Bank, a California banking corporation, shall
be terminated and Imperial Bank shall have no further obligations to the Company
under said Credit Agreement and the Company shall have no further obligation to
Imperial Bank under said Credit Agreement.
Accordingly, the parties hereto agree as follows:
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ARTICLE 1
DEFINITION OF TERMS
-------------------
1.1 Definitions. For the purposes of this Credit Agreement, unless the
context otherwise requires, the following terms shall have the respective
meanings assigned to them in this Article 1 or in the section hereof referred to
below:
"Administrative Agent": See the Preamble hereto.
"Administrative Questionnaire" means that Administrative
Details Reply Form substantially in the form of Exhibit "E" attached hereto
delivered to the Agent pursuant to Section 10.12.
"Advance" means an RLC Advance or an RLCT Advance.
"Affiliate" of any Person means any Person which, directly or
indirectly, controls, is controlled by, or is under common control with, such
Person. For the purposes of this definition, "control" (including, with
correlative meanings, the terms "controlled by" and "under common control
with"), as used with respect to any Person, shall mean the possession, directly
or indirectly, of the power to direct or cause the direction of the management
and policies of such Person, whether by contract or otherwise.
"Agent": See the Preamble hereto.
"Assignment and Acceptance" means that Assignment and
Acceptance substantially in the form of Exhibit "F" attached hereto delivered to
the Agent pursuant to Section 10.12.
"Authorized Officer" means the chief executive officer, chief
financial officer or the chief accounting officer of Borrower, or such other
individual who is from time to time designated to the Banks in writing by said
officer as authorized to act for Borrower with respect to the Loans.
"Banking Day" means a day of the year on which commercial
banks are not required or authorized to close in Inglewood, California, and,
with respect to a LIBOR Rate Advance, a day on which dealings are carried on in
the London interbank market.
"Banks": See the Preamble hereto.
"Borrower": See the Preamble hereto.
"Cash Flow" means the sum for the relevant period of
Borrower's Net Income, tax expense (less taxes actually paid in cash),
depreciation expense, amortization of intangibles expense and interest expense,
all to the extent deducted in the calculation of Net Income.
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"Change in Control" means the occurrence or existence of
either of the following events or conditions without the prior written consent
of the Banks, if different than the state of affairs as of the Closing Date:
(a) the acquisition by any Person or two or more
Persons acting in concert of "beneficial ownership" (within
the meaning of Rule 13d-3 promulgated by the SEC under the
Exchange Act or as otherwise specified under the provisions of
this Credit Agreement) of securities of Borrower having more
than 50% of the ordinary voting power for the election of
directors; or
(b) the acquisition of Control of Borrower by any
Person or two or more Persons acting in concert of Control of
Borrower.
"Closing Date" means November 5, 1998.
"Co-Borrowers," each a "Co-Borrower" means the Subsidiaries
that are a party to this Credit Agreement from time to time.
"Code" means the Internal Revenue Code of 1986, as amended.
"Collateral" means any property subject to the Security
Documents.
"Commitment" means the RLC Commitment and the RLCT Commitment.
"Company": See the Preamble hereto.
"Compliance Certificate": See Section 7.1(c).
"Control" when used with respect to any Person means the
power, directly or indirectly, to direct the management policies of such Person,
whether through the ownership of voting securities, by contract or otherwise;
and the terms "controlling" and "controlled" have meanings correlative to the
foregoing.
"Controlled Group" means, severally and collectively, the
members of the group controlling, controlled by and/or in common control of
Borrower, within the meaning of Section 4001(b) of ERISA.
"Controlled Subsidiary" means any Subsidiary in which the
Company owns in excess of fifty percent (50.0%) of both all voting rights and
all equity interests.
"Credit Agreement": See the Preamble hereto.
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"Credit Documents" means this Credit Agreement, the Notes
(including any renewals, extensions, restatements and refundings thereof), the
Security Documents, and any written agreements, certificates or documents (and
with respect to this Credit Agreement, the Notes, the Security Documents and
such other written agreements and documents, any amendments or supplements
thereto or modifications thereof) executed or delivered pursuant to the terms of
this Credit Agreement.
"Credit Facilities" means the RLC and the RLCT.
"Current Assets" means all assets of Borrower classified as
current assets under GAAP, determined on a consolidated basis.
"Current Liabilities" means all liabilities of Borrower
classified as current liabilities under GAAP, determined on a consolidated
basis.
"Current Ratio" means as of any date the ratio of Borrower's
Current Assets as of such date to its Current Liabilities as of such date.
"Debt Coverage Ratio" means for any date the ratio of
Borrower's Cash Flow to its Debt Service Requirement, calculated on a rolling
four-quarter basis.
"Debt Service Requirement" means the sum of the following that
are due within the relevant period: all current maturities of long-term debt
(excluding the RLC), capital lease obligations, interest expense and off-balance
sheet lease expense.
"Default Rate" means an interest rate per annum equal to five
percent (5.0%) over the Variable Rate, which Default Rate shall change when and
as the Variable Rate changes.
"Disbursement": See Section 2.13.
"Disbursement Date": See Section 2.13.
"Dollars" and the sign "$" mean lawful currency of the United
States of America.
"EBITDA" means Net Income, plus the sum of all interest
expense, tax expense, depreciation and amortization deducted in computing such
Net Income.
"EBITDA Ratio" means as of any date the ratio of Funded Debt
to EBITDA, calculated on a rolling four-quarter basis.
"Equity" means Borrower's stockholders' equity, determined on
a consolidated basis in accordance with GAAP.
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"ERISA" means the Employee Retirement Income Security Act of
1974, as amended, together with all final and permanent regulations issued
pursuant thereto. References herein to sections and subsections of ERISA are
deemed to refer to any successor or substitute provisions therefor.
"Eurocurrency Liabilities" has the meaning assigned to that
term in Regulation D of the Board of Governors to the Federal Reserve System, as
in effect from time to time.
"Eurodollar Rate Reserve Percentage" for the LIBOR Interest
Period for each LIBOR Rate Advance means the reserve percentage applicable two
(2) Banking Days before the first day of such LIBOR Interest Period under
regulations issued from time to time by the Board of Governors of the Federal
Reserve System (or any successor) for determining the maximum reserve
requirement (including, but not limited to, any emergency, supplemental, or
other marginal reserve requirement) for a member bank of the Federal Reserve
System in San Francisco with respect to liabilities or assets consisting of or
including Eurocurrency Liabilities (or with respect to any other category of
liabilities which includes deposits by reference to which the interest rate on
LIBOR Rate Advances) having a term equal to such Interest Period.
"Event of Default": See Section 9.1.
"Exchange Act" means the Securities Exchange Act of 1934, as
amended.
"Federal Funds Rate" means, as of any date of determination,
the rate set forth in the weekly statistical release designated as H.15(519), or
any successor publication, published by the Federal Reserve Board (including any
such successor, "H.15(519)") for such date opposite the caption "Federal Funds
(Effective)." If for any relevant date such rate is not yet published in
H.15(519), the rate for such date will be the rate set forth in the daily
statistical release designated as the Composite 3:30 p.m. Quotations for U.S.
Government Securities, or any successor publication, published by the Federal
Reserve Bank of New York (including any such successor, the "Composite 3:30 p.m.
Quotation") for such date under the caption "Federal Funds Effective Rate." If
on any relevant date the appropriate rate for such date is not yet published in
either H.15(519) or the Composite 3:30 p.m. Quotations, the rate for such date
will be the arithmetic mean of the rates for the last transaction in overnight
Federal funds arranged prior to 9:00 a.m. (New York City time) on that date by
each of three leading brokers of Federal funds transactions in New York City
selected by the Agent.
"Financial Covenants": See Section 8.11 hereof.
"Funded Debt" means as of the end of any fiscal quarter, with
respect to any Person, its interest-bearing Indebtedness including without
limitation any capital lease debt.
"GAAP" means those generally accepted accounting principles
and practices which are recognized as such by the American Institute of
Certified Public Accountants acting through its Accounting Principles Board or
by the Financial Accounting Standards Board or through other
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appropriate boards or committees thereof and which are consistently applied for
all periods after the date hereof so as to properly reflect the financial
condition, and the results of operations and changes in the financial position,
of Borrower, including without limitation accounting rules promulgated pursuant
to Regulations SX and SK, except that any accounting principle or practice
required to be changed by the said Accounting Principles Board or Financial
Accounting Standards Board (or other appropriate board or committee of the said
Boards) in order to continue as a generally accepted accounting principle or
practice may be so changed.
"Governmental Authority" means any government (or any
political subdivision or jurisdiction thereof), court, bureau, agency or other
governmental authority having jurisdiction over Borrower or any of its business,
operations or properties.
"Honor Date" has the meaning specified in Section 2.18(b).
"Imperial" means Imperial Bank Arizona, an Arizona banking
corporation.
"Indebtedness" means, with respect to any Person, all of its
monetary and contingent obligations and liabilities, including without
limitation each of the following (without duplication): (a) obligations of that
Person to any other Person for payment of borrowed money, (b) capital lease
obligations, (c) notes and drafts drawn or accepted by that Person payable to
any other Person, whether or not representing obligations for borrowed money
(but without duplication of indebtedness for borrowed money), (d) any obligation
for the purchase price of property the payment of which is deferred for more
than one year or evidenced by a note or equivalent instrument, (e) guarantees of
Indebtedness of third parties, and (f) a recourse or non recourse payment
obligation of any other Person that is secured by a Lien on any property of the
first Person, whether or not assumed by the first Person, up to the fair market
value (from time to time) of such property (absent manifest evidence to the
contrary, the fair market value of such property shall be the amount determined
under GAAP for financial reporting purposes), but excluding any trades accounts
payables and any accruals.
"Insolvency Proceeding" means any proceeding undertaken under
the Debtor Relief Laws.
"Issuance Date" means the date on which a Letter of Credit is
delivered to the beneficiary thereof.
"Issuance Request" means a request for a Letter of Credit duly
executed by Borrower in a form satisfactory to the Issuing Bank.
"Issue" means, with respect to any Letter of Credit, to issue
or, by amendment or otherwise, to extend the expiry of, or to renew or increase
or decrease the amount of, such Letter of Credit; and the terms "Issued,"
"Issuing" and "Issuance" have corresponding meanings.
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"Issuing Bank" means Imperial and/or any Affiliate thereof in
its capacity as issuer of one or more Letters of Credit hereunder, together with
any replacement Letter of Credit issuer arising under this Credit Agreement.
"LC Borrowing" means an extension of credit resulting from a
drawing under any Letter of Credit which shall not have been reimbursed on the
date when made nor converted into a Variable Rate Advance.
"LC Obligations" means at any time the sum of (a) the
Outstanding LC Balance under the RLC, plus (b) the amount of all unreimbursed
drawings under all Letters of Credit, including all outstanding LC Borrowings.
"Letter of Credit" means a letter of credit issued by the
Issuing Bank for the account of Borrower pursuant to Article 2.
"LIBOR" means the London Interbank Offered Rate, determined as
provided herein, for the applicable LIBOR Interest Period to be specified by the
Borrower as provided herein. For each Advance under the LIBOR option, the LIBOR
rate will remain in effect through the end of the LIBOR Interest Period. If
prior to the due date for a LIBOR Rate Advance Borrower requests a continuation
of said LIBOR Rate Advance, Borrower's request shall comply with the request
procedure specified below and the LIBOR rate for the LIBOR Rate Advance shall be
re-determined for the next LIBOR Interest Period as provided below. LIBOR shall
mean with respect to any LIBOR Interest Period the rate equal to the arithmetic
mean (rounded upwards, if necessary, to the nearest one-sixteenth (1/16th) of
one percent (1%)) of:
(a) the offered rates per annum for deposits in U.S.
Dollars for a period equal to such LIBOR Interest Period which
appears at 11:00 a.m., London time, on the Reuters Screen
LIBOR Page on the Banking Day that is two (2) Banking Days
before the first day of such LIBOR Interest Period, in each
case if at least four (4) such offered rates appear on such
page, or
(b) if clause (a) is not available, (x) the offered
rate per annum for deposits in U.S. Dollars for a period equal
to such LIBOR Interest Period for a LIBOR Rate Advance
hereunder which appears as of 11:00 a.m., London time on the
Telerate Monitor on Telerate Screen 3750 on the Banking Day
which is two (2) Banking Days before the first day of such
LIBOR Interest Period; or (y) if clause (x) above is not
available, the arithmetic mean (rounded upwards, if necessary,
to the nearest one-sixteenth (1/16th) of one percent (1%)) of
the interest rates per annum offered by at least three (3)
prime banks selected by the Banks at approximately 11:00 a.m.,
London time, on the Banking Day which is two (2) Banking Days
before such date for deposits in U.S. Dollars to prime banks
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in the London interbank market, in each case for a period
equal to such LIBOR Interest Period for a LIBOR Rate Advance
hereunder in an amount equal to the amount to which the LIBOR
applies. "Reuters Screen LIBOR Page" as used herein means the
display designated as page LIBOR on the Reuters Monitor Money
Rates Service or such other page as may replace the LIBOR page
on that service for the purpose of displaying London interbank
offered rates of major banks.
"LIBOR Advance" means an Advance or a portion of a Loan
designated by Borrower, that bears, or is requested to bear, interest at a LIBOR
Based Rate. Each LIBOR Advance shall be in a minimum amount of $500,000.00 with
integral multiples of $1,000.00 in excess thereof.
"LIBOR Based Rate" means the rate per annum equal (A) to the
sum of LIBOR and the following margin:
(i) one hundred seventy-five basis points (175 bp) as
to an RLC Advance;
(ii) two hundred thirty-seven and one-half basis
points (237.5 bp) as to an RLCT Advance;
in each case divided by (B) a percentage equal to one hundred percent (100%)
minus the Eurodollar Rate Reserve Percentage for the period equal to the
applicable LIBOR Interest Period.
"LIBOR Interest Period" means, for each LIBOR Rate Advance,
the period commencing on the date of such LIBOR Rate Advance and ending on the
last day of the period selected by Borrower pursuant to the provisions herein
and, thereafter, each subsequent period commencing on the last day of the
immediately preceding LIBOR Interest Period and ending on the last day of the
period selected by Borrower pursuant to the provisions herein. The duration of
each LIBOR Interest Period shall be one, two, three or six months, as selected
by Borrower (A), for a new Advance, in the request for a LIBOR Rate Advance or
(B), for an outstanding Advance, in the request for a LIBOR Rate Advance to
continue bearing interest at the LIBOR Based Rate or (C), for an outstanding
Variable Rate Advance, in the request to convert to a LIBOR Rate Advance;
provided, however, that:
(i) LIBOR Interest Periods commencing on the same
date shall be of the same duration;
(ii) Whenever the last day of any LIBOR Interest
Period would otherwise occur on a day other than a Banking
Day, the last day of such LIBOR Interest Period shall be
extended to occur on the next succeeding Banking Day, provided
that if such extension
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would cause the last day of such LIBOR Interest Period to
occur in the next following calendar month, the last day of
such LIBOR Interest Period shall occur on the next preceding
Banking Day; and
(iii) No LIBOR Interest Period with respect to any
RLC Advance shall extend beyond the applicable Maturity Date.
"Lien" means any lien, mortgage, security interest, tax lien,
pledge, encumbrance, conditional sale or title retention arrangement, or any
other interest in property designed to secure the repayment of Indebtedness
whether arising by agreement or under any statute or law, or otherwise.
"Loans" means together the RLC and the RLCT, each being a
Loan.
"Loan Fees": See Section 3.2 hereof.
"Material Adverse Effect" means any circumstance or event
which (i) has any material adverse effect upon the validity or enforceability of
any Credit Document, (ii) materially impairs the ability of Borrower to fulfill
its obligations under the Credit Documents, or (iii) causes an Event of Default
or any event which, with notice or lapse of time or both, would become an Event
of Default.
"Maturity Date" means the RLC Maturity Date or the RLCT
Maturity Date, as applicable.
"Maximum LC Commitment" means SEVEN MILLION FIVE HUNDRED
THOUSAND AND NO/100 DOLLARS ($7,500,000.00).
"Net Income" means for any period the net income of Borrower
for such period in accordance with GAAP, determined on a consolidated basis.
"New Subsidiary": See Section 7.16 hereof.
"Notes" means the RLC Note and the RLCT Note, each being a
Note.
"Obligation" means all present and future indebtedness,
obligations and liabilities of Borrower to the Banks, and all renewals and
extensions thereof, or any part thereof, arising pursuant to this Credit
Agreement or represented by the Notes, including without limitation the Loans
and all interest accruing thereon, and attorneys' fees incurred in the
enforcement or collection thereof, regardless of whether such indebtedness,
obligations and liabilities are direct, indirect, fixed, contingent, joint,
several or joint and several; together with all indebtedness, obligations and
liabilities of Borrower evidenced or arising pursuant to any of the other Credit
Documents, and all renewals and extensions thereof, or part thereof.
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"Outstanding LC Balance" in effect at any time means the
maximum aggregate amount available to be drawn at such time under all
outstanding Letters of Credit, the determination of such maximum amount to
assume compliance with all conditions for a Disbursement.
"Payment Date" means:
(i) as to a Variable Rate Advance, the first day of
each month, provided that if any such day is not a Banking
Day, then such Payment Date shall be the next successive
Banking Day; and
(ii) as to a LIBOR Rate Advance, the earlier of (A)
the last day of its LIBOR Interest Period, or (B) the last day
of each three month period during such LIBOR Interest Period.
"PBGC" means the Pension Benefit Guaranty Corporation, and any
successor to all or substantially all of the Pension Benefit Guaranty
Corporation's functions under ERISA.
"Permitted Liens" means Liens which consist of the following:
(a) Liens for taxes, assessments or governmental charges not
yet delinquent;
(b) Liens to which the Banks shall consent in writing, in
their sole and absolute discretion; and
(c) Existing Liens listed on Schedule 8.2.
"Person" includes an individual, a corporation, a joint
venture, a partnership, a trust, a limited liability company, an unincorporated
organization or a government or any agency or political subdivision thereof.
"Plan" means an employee defined benefit plan or other plan
maintained by Borrower for employees of Borrower and covered by Title IV of
ERISA, or subject to the minimum funding standards under Section 412 of the
Code.
"Prime Rate" means the interest rate per annum publicly
announced by Imperial Bank, a California banking corporation, or its successors,
as its "prime rate" as in effect from time to time. Borrower acknowledges that
the Prime Rate is not necessarily the best or lowest rate offered by Imperial
Bank and Imperial Bank may lend to its customers at rates that are at, above or
below its Prime Rate.
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"Pro Rata Share" means, as to each Bank, that amount shown at
any time on Schedule 1.1 attached hereto as that Bank's share of each
Commitment, each Advance and each Letter of Credit.
"Quarterly End Date" means the last day of each March, June,
September and December.
"Regulation U" means Regulation U promulgated by the Board of
Governors of the Federal Reserve System, 12 C.F.R. Part 221, or any other
regulation hereafter promulgated by said Board to replace the prior Regulation U
and having substantially the same function.
"Regulatory Change" means any change effective after the date
of this Credit Agreement in United States federal, state, or foreign law,
regulations, or rules or the adoption or making after such date of any
interpretation, directive, or request applying to a class of banks including the
Banks, of or under any United States federal, state, or foreign law, regulation
or rule (whether or not having the force of law) by any court or governmental or
monetary authority charged with the interpretation or administration thereof.
"Reportable Event" means any "reportable event" as described
in Section 4043(b) of ERISA with respect to which the thirty (30) day notice
requirement has not been waived by the PBGC.
"Required Banks" means, at any time, Banks having Pro Rata
Shares representing at least sixty-five percent (65.0%) of the aggregate
Commitment.
"RLC": See Recital A hereto.
"RLC Advance" means a disbursement of the proceeds of the RLC.
"RLC Balance" means (i) with respect to the RLC on any date,
the aggregate outstanding principal amount thereof after giving effect to any
borrowings and prepayments or repayments of RLC Advances occurring on such date;
plus (ii) with respect to any outstanding LC Obligations on any date, the amount
of such LC Obligations on such date after giving effect to any Issuances of
Letters of Credit occurring on such date and any other changes in the aggregate
amount of the LC Obligations as of such date, including changes occurring as a
result of any reimbursements of outstanding unpaid drawings under any Letters of
Credit or any reductions in the maximum amount available for drawing under
Letters of Credit taking effect on such date.
"RLC Commitment" means FIFTEEN MILLION AND NO/100 DOLLARS
($15,000,000.00).
"RLC Maturity Date" means May 22, 2000.
"RLC Non-Use Fee": See Section 3.2(a).
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"RLC Note" means a Revolving Promissory Note of even date
herewith substantially in the form attached hereto as Exhibit C-1, in the amount
of a Bank's Pro Rata Share of the RLC Commitment, executed by Borrower and
delivered to a Bank pursuant to the terms of this Credit Agreement, together
with any renewals, extensions, modifications, restatements or replacements
thereof.
"RLCT": See Recital A hereto.
"RLCT Advance" means a disbursement of the proceeds of the
RLCT.
"RLCT Balance" means the aggregate outstanding principal
amount of all RLCT Advances, after giving effect to any borrowings and
prepayments or repayments of RLCT Advances occurring on such date.
"RLCT Commitment" means TEN MILLION AND NO/100 DOLLARS
($10,000,000.00).
"RLCT Maturity Date" means August 5, 2004.
"RLCT Non-Use Fee": See Section 3.2(c).
"RLCT Note" means a Revolving Promissory Note of even date
herewith substantially in the form attached hereto as Exhibit C-2 in the amount
of a Bank's Pro Rata Share of the RLCT Commitment executed by Borrower and
delivered to a Bank pursuant to the terms of this Credit Agreement, together
with any renewals, extensions, modifications or replacements thereof.
"RLCT Principal Date" means initially November 5, 1999 and
every 3 month anniversary thereafter.
"RLCT Termination Date" means August 5, 1999.
"SEC" means the Securities and Exchange Commission.
"Security Agreement": See Section 4.1.
"Security Documents": See Section 4.2.
"Significant Debt Agreement" means all documents, instruments
and agreements executed by Borrower, evidencing, securing or ensuring any
Indebtedness of Borrower or any guaranty in excess of $50,000 in outstanding
principal (or principal equivalent) amount.
"Stated Amount" of a Letter of Credit means the amount of the
Letter of Credit as stated in the Letter of Credit.
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"Stated Expiry Date" of a Letter of Credit means the stated
expiry date or expiration date as stated in the Letter of Credit.
"Subsidiary" means any business association directly or
indirectly controlled by the Borrower.
"Tangible Net Worth" means, at any given date, the total
shareholder's equity (including capital stock, additional paid in capital and
retained earnings after deducting treasury stock) which would appear on a
balance sheet of Borrower prepared as of such date in accordance with generally
accepted accounting principles consistently applied, less the aggregate book
value of "Intangible Assets" (as defined below) shown on such balance sheet.
"Intangible Assets" means those assets that are (i) deferred assets, other than
prepaid taxes; (ii) patents, copyrights, trademarks, tradenames, franchises,
goodwill, experimental expenses and other similar assets which would be
classified as intangible assets on a balance sheet prepared in accordance with
generally accepted accounting principles consistently applied; and (iii)
unamortized debt discount and expense.
"Tangible Net Worth Minimum" means the sum of (i)
$55,000,000.00, plus (ii) beginning December 31, 1998, fifty percent (50.0%) of
its positive Net Income for each fiscal quarter thereafter, less (iii) the
amount of its treasury stock acquired by Borrower since August 1, 1998.
"U.S." means the United States of America.
"Variable Rate" means the rate per annum equal to the Prime
Rate per annum as in effect from time to time. The Variable Rate will change on
each day that the "Prime Rate" changes.
"Variable Rate Advance" means an Advance or a portion of a
Loan designated by Borrower, that bears, or is requested to bear, interest at
the Variable Rate.
1.2 Terms Generally.
(a) The definitions in Section 1.1 shall apply equally to both
the singular and plural forms of the terms defined.
(b) Whenever the context may require, any pronoun shall
include the corresponding masculine, feminine and neuter forms.
(c) All references herein to Articles, Sections, Exhibits and
Schedules shall be deemed references to Articles and Sections of, and
Exhibits and Schedules to, this Agreement unless the context shall
otherwise require.
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(d) Except as otherwise expressly provided herein, all terms
of an accounting or financial nature shall be construed in accordance
with GAAP, as in effect from time to time.
ARTICLE 2
THE RLC
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2.1 RLC Commitment. Each Bank agrees, severally but not jointly, to
loan to or for the benefit of Borrower, and Borrower shall be entitled to draw
upon and borrow, in the manner and upon the terms and conditions contained in
this Credit Agreement, an amount that shall not exceed that Bank's Pro Rata
Share of the RLC Commitment.
2.2 Revolving Line.
(a) Subject to the terms and conditions set forth in this
Credit Agreement, each Bank shall provide to Borrower a revolving line
of credit (each, a "RLC"), against which a Bank shall fund its Pro Rata
Share of each RLC Advance to be made to Borrower, repaid by Borrower,
and readvanced to Borrower, as Borrower may request, and the Issuing
Bank shall issue such Letters of Credit as Borrower shall request,
which may be terminated or repaid by Borrower and reissued provided
that (i) there is no Event of Default under any provision of this
Credit Agreement, (ii) no RLC Advance shall be made or Letter of Credit
issued that would cause the RLC Balance to exceed the RLC Commitment,
(iii) no Bank shall be obligated under any circumstances to fund an RLC
Advance in excess of that Bank's Pro Rata Share of the requested RLC
Advance, (iv) the aggregate amount of a Bank's funding of the RLC
Balance at any one time outstanding shall not exceed its Pro Rata Share
of the RLC Commitment, and (v) no Letter of Credit shall be issued with
a Stated Expiry Date later than the RLC Maturity Date. The Banks shall
not be obligated to fund their Pro Rata Share of any RLC Advance if,
after giving effect thereto, any of the foregoing limitations would be
exceeded.
(b) The failure of any Bank to fund its Pro Rata Share of an
RLC Advance in accordance with its Pro Rata Share of the RLC Commitment
shall not relieve any other Bank of its several obligations hereunder,
but no Bank shall be liable with respect to the obligation of any other
Bank hereunder.
(c) RLC Advances may be made for the purpose of providing to
Borrower working capital financing or in connection with a Disbursement
under a Letter of Credit.
2.3 RLC Notes. The RLC of each Bank shall be evidenced by an RLC Note
and shall bear interest and be payable to the order of such Bank upon the terms
and conditions contained therein. The aggregate amount funded by a Bank under
its RLC Note less all repayments of
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principal thereof shall be the principal amount owing and unpaid on its RLC Note
and its RLC. The principal amount funded by a Bank and all principal payments
and prepayments thereof may be noted by such Bank on a schedule attached to its
RLC Note and shall be entered by the Bank on its ledgers and computer records;
provided that the failure of the Bank to make such notations or entries shall
not affect the principal amount owing and unpaid on its RLC Note. The entries
made in the ordinary course of business by a Bank on its ledgers and computer
records and any notations made in the ordinary course of business by a Bank on
any such schedule annexed to its RLC Note shall be presumed to be accurate until
the contrary is established. If requested, Borrower shall confirm in writing to
the Administrative Agent each RLC Advance.
2.4 RLC. The RLC shall bear interest and be payable to the Banks upon
the terms and conditions contained therein, which include the following
provisions:
(a) Interest shall accrue:
(i) On the unpaid principal of an RLC Advance at the
Variable Rate except to the extent that an RLC Advance bears
interest at the LIBOR Based Rate.
(ii) On the unpaid principal of an RLC Advance at the
LIBOR Based Rate to the extent Borrower shall elect and to the
extent not otherwise provided herein.
(b) All interest shall be computed on the basis of a 360-day
year and accrue on a daily basis for the actual number of days elapsed.
All accrued interest shall be due and payable on each Payment Date.
(c) The entire unpaid principal balance, all accrued and
unpaid interest, and all other amounts payable under the RLC Note shall
be due and payable in full on the RLC Maturity Date.
(d) Each request for an RLC Advance shall be substantially in
the form attached hereto as Exhibit "B" from an Authorized Officer and
shall, in addition to complying with the other requirements in this
Credit Agreement, (i) specify the date and amount of the requested RLC
Advance, (ii) specify whether the RLC Advance shall be an RLC Advance
that bears interest at the Variable Rate or shall be an RLC Advance
that bears interest at the LIBOR Based Rate, (iii) be in a minimum
amount of $500,000.00 with integral multiples of $1,000.00 in excess
thereof, and (iv) if the RLC Advance is to bear interest at the LIBOR
Based Rate, (A) specify the LIBOR Interest Period, and (B) be delivered
to Administrative Agent before 9:00 a.m. (Inglewood, California local
time) at least three (3) Banking Days prior to the date of the
requested RLC Advance. Any request for an RLC Advance not complying
with the foregoing requirements for an RLC Advance bearing interest at
the LIBOR Based Rate shall bear interest at the
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Variable Rate; provided that in the event such non-compliance is due to
Borrower's failure to specify the required information, the Banks agree
to notify Borrower of such failure and to provide Borrower the
opportunity to provide such information prior to directing that the
Advance bear interest at the Variable Rate.
(e) After receiving a request for an RLC Advance in the manner
provided herein, the Administrative Agent shall promptly, before 11:30
a.m. (Inglewood, California local time) on the date an RLC Advance is
requested, notify each Bank by telephone (confirmed promptly in
writing), telefacsimile or cable of the terms of such request and such
Bank's Pro Rata Share of the requested Rate Advance. Each Bank shall,
before 1:00 p.m. (Inglewood, California local time) on the date an RLC
Advance is to be made as specified in a request for an RLC Advance,
deposit with the Administrative Agent such Bank's Pro Rata Share of the
requested RLC Advance in immediately available funds. Upon fulfillment
of all applicable conditions set forth herein and after receipt by the
Administrative Agent of such funds, the Administrative Agent shall pay
or deliver all funds so received to the order of Borrower at the
principal office of the Administrative Agent. The failure of any Bank
to fund its Pro Rata Share of any RLC Advance required of it hereunder
shall not relieve any other Bank of its obligation to fund its Pro Rata
Share of any RLC Advance hereunder. If any Bank fails to fund its Pro
Rata Share of the requested RLC Advance and if all conditions to such
RLC Advance have apparently been satisfied, the Administrative Agent
will make available to Borrower the funds received by it from the other
Bank. Neither the Administrative Agent nor any Bank shall be
responsible for the performance by any other Bank of its obligations
hereunder.
Unless the Administrative Agent shall have received notice
from a Bank prior to the date of any RLC Advance that such Bank will
not make available to the Administrative Agent such Bank's Pro Rata
Share of the requested RLC Advance, the Administrative Agent may assume
that such Bank has made such amount available to the Administrative
Agent on the date of such RLC Advance in accordance with this Section
and the Administrative Agent may, in reliance upon such assumption,
make available a corresponding amount to or on behalf of Borrower on
such date. If and to the extent any Bank shall not have so made its Pro
Rata Share of the requested RLC Advance available to the Administrative
Agent (the "Principal Shortfall Amount"), Borrower agrees to repay the
Principal Shortfall Amount to the Administrative Agent forthwith on
demand, together with interest thereon for each day from (and
including) the date such amount is made available to or on behalf of
Borrower to (but excluding) the date such amount is repaid to the
Administrative Agent, at the rate per annum equal to the rate otherwise
applicable to the RLC Advance in question.
(f) If Borrower desires that a LIBOR Rate Advance continue to
bear interest at the LIBOR Based Rate after the end of an existing
LIBOR Interest
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Period, Borrower shall deliver to the Administrative Agent at least
three (3) Banking Days prior to the end of the existing LIBOR Interest
Period; a notice making such election and specifying the new LIBOR
Interest Period. If Borrower does not deliver such notice within such
time, then after the existing LIBOR Interest Period the LIBOR Rate
Advance shall become a Variable Rate Advance and shall bear interest at
the Variable Rate.
(g) Borrower may upon written notice to and received by the
Administrative Agent not later than 9:00 a.m. (Inglewood, California
local time) (i) on the third Banking Day, in the case of any conversion
of a Variable Advance into a LIBOR Rate Advance and (ii) on the first
Banking Day in the case of any conversion of a LIBOR Rate Advance into
a Variable Rate Advance, prior to the date of the proposed conversion,
convert any RLC Advance of one type into an RLC Advance of the other
type; provided, however, that any conversion of a LIBOR Rate Advance
(A) shall only be made on the last day of the applicable LIBOR Interest
Period except as otherwise provided herein, and (B) shall be made only
as to an RLC Advance in a minimum amount of $500,000.00 with integral
multiples of $1,000.00 in excess thereof. Each such notice of a
conversion shall specify the date of such conversion and the RLC
Advance(s) to be converted. After receiving any such notice, the
Administrative Agent shall promptly notify each Bank by telephone,
telefacsimile or cable and deliver a copy thereof to each Bank.
(h) Each request for an RLC Advance as well as each election
by the Borrower that an RLC Advance continue to bear interest at the
LIBOR Based Rate after the end of an existing LIBOR Interest Period and
each conversion request shall be irrevocable and binding on Borrower
once the request is received by the Administrative Agent and the
Administrative Agent notifies the Banks of the request. Prior to the
Administrative Agent's notice of the request to the Banks, Borrower may
revoke the request. Borrower shall indemnify each Bank against any
cost, loss or expense incurred by any Bank as a result of Borrower's
failure to fulfill, on or before the date specified for an RLC Advance
in any request for an RLC Advance, the conditions to such RLC Advance
set forth herein, including any cost, loss or expense incurred by
reason of the liquidation or reemployment of deposits or other funds
acquired by a Bank to fund such RLC Advance when such RLC Advance, as a
result of such failure, is not made on the date so specified.
(i) No RLC Advance shall be requested by Borrower to bear a
LIBOR Based Rate, whether pursuant to a request for an RLC Advance or a
conversion hereunder, so long as there shall have occurred an Event of
Default and such Event of Default is continuing.
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(j) Nothing herein shall be deemed to relieve any Bank from
its obligation to fulfill its Pro Rata Share of the RLC Commitment
hereunder or to prejudice any right which the Administrative Agent or
the Borrower may have against any Bank as a result of any default by
such Bank hereunder.
(k) If any payment of interest and/or principal is not
received by the Administrative Agent when such payment is due, then in
addition to the remedies conferred upon the Banks under the Credit
Documents, a late charge of five percent (5%) of the amount of the
installment due and unpaid will be added to the delinquent amount to
compensate the Banks for the expense of handling the delinquency for
any payment past due in excess of ten (10) days, regardless of any
notice and cure period.
(l) Upon the occurrence of an Event of Default and after
maturity, including maturity upon acceleration, the unpaid principal
balance, all accrued and unpaid interest and all other amounts payable
hereunder shall bear interest at the Default Rate.
2.5 Excess Balance Repayment. There shall be due and payable from
Borrower to the Banks, and Borrower shall immediately repay to the Banks three
(3) days after notice to Borrower, from time to time, any amount by which the
RLC Balance exceeds the RLC Commitment.
2.6 Reduction of RLC Commitment. Borrower shall have the right at any
time upon at least seven days' prior written notice to the Administrative Agent
to reduce the aggregate amount of the RLC Commitment; provided, that the amount
of each such reduction shall be in a minimum aggregate amount of $1,000,000.00
or an integral aggregate multiple of $100,000.00 in excess thereof and that no
such reduction shall reduce (i) the amount of the RLC Commitment to less than
the RLC Balance, or (ii) the amount of a Bank's Pro Rata Share of the RLC
Commitment to less than the amount of the RLC Balance funded by such Bank. Any
reduction in the aggregate amount of the RLC Commitment shall reduce each Bank's
share of the RLC Commitment by its Pro Rata Share of the aggregate amount of
such reduction. The Administrative Agent shall promptly notify each Bank of any
such notice of reduction received from the Borrower. Any reduction in the RLC
Commitment may not be reinstated without the mutual prior consent of the
Borrower and the Banks.
2.7 Conditions. The Banks shall have no obligation to fund their Pro
Rata Shares of any RLC Advance unless and until all of the conditions and
requirements of this Credit Agreement are fully satisfied. However, the Banks in
their sole and absolute discretion may elect to make one or more RLC Advances
prior to full satisfaction of one or more such conditions and/or requirements.
Notwithstanding that such an RLC Advance or RLC Advances are made, such
unsatisfied conditions and/or requirements shall not be waived or released
thereby. Borrower shall be and continue to be obligated to fully satisfy such
conditions and requirements, and the
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Banks, at any time, in their sole and absolute discretion, may stop making RLC
Advances until all conditions and requirements are fully satisfied.
2.8 Other RLC Advances. The Administrative Agent, at the direction of
the Banks, after giving written notice to Borrower, from time to time, may make
RLC Advances in any amount in payment of (i) insurance premiums, taxes,
assessments, liens or encumbrances existing against the Collateral, (ii)
interest accrued and payable upon the RLC, (iii) any indebtedness, charges and
expenses that are the obligation of Borrower under this Credit Agreement, and
(iv) any charges or matters necessary to cure any Event of Default.
2.9 Assignment. Borrower shall have no right to any RLC Advance other
than to have the same disbursed by the Administrative Agent in accordance with
the disbursement provisions contained in this Credit Agreement. Any assignment
or transfer, voluntary or involuntary, of this Credit Agreement or any right
hereunder shall not be binding upon or in any way affect the Banks without their
written consent; the Administrative Agent, at the direction of the Banks may
make RLC Advances under the disbursement provisions herein, notwithstanding any
such assignment or transfer.
2.10 Issuance of Letters of Credit.
(a) Subject to the terms and conditions of this Credit
Agreement, (i) the Issuing Bank agrees from time to time before the RLC
Maturity Date to issue Letters of Credit for the account of the
Borrower; and (ii) the Banks severally agree to participate in Letters
of Credit issued for the account of the Borrower, subject to the prior
approval by each Bank of the provisions of each Letter of Credit. Each
reference in this Credit Agreement to the "issue" or "issuance" or
other forms of such words in relation to Letters of Credit shall be
deemed to include any extension or renewal of a Letter of Credit.
(b) Each Letter of Credit shall (i) by its terms be issued in
a Stated Amount; (ii) have a Stated Expiry Date no later than the RLC
Maturity Date; (iii) expire or be terminated by the beneficiary
thereunder on or before its Stated Expiry Date; (iv) not cause the RLC
Balance after the issuance of said Letter of Credit to exceed the RLC
Commitment; and (v) not cause the Outstanding LC Balance after the
issuance of said Letter of Credit to exceed the Maximum LC Commitment.
(c) In addition to the conditions otherwise specified in this
Section, the obligation of the Issuing Bank to issue a Letter of Credit
shall be subject to the further condition precedent that the following
statements shall be correct, and each of the application for such
Letter of Credit and the issuance of such Letter of Credit shall
constitute a representation and warranty by Borrower that on the date
of the issuance of such Letter of Credit such statements are correct:
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(i) The representations and warranties in Article 6
are correct on and as of the date of the issuance of such
Letter of Credit, before and after giving effect to such
issuance, as though made on and as of such date;
(ii) No Event of Default has occurred and is
continuing; and
(iii) The conditions in Section 2.2(a) are satisfied
as of the date of issuance of the Letter of Credit, before and
after giving effect to such issuance.
2.11 Issuance Procedure for Letter of Credit. By delivery to the
Issuing Bank of an Issuance Request on or before 9:00 a.m. (Inglewood,
California time) three (3) Banking Days prior to the requested Issuance Date,
and the execution of such applications and agreements as the Issuing Bank may
reasonably request, Borrower may request the issuance of a Letter of Credit in
such form as Borrower may reasonably request. Each Issuance Request shall
include the form of the Letter of Credit, the amount and other terms thereof.
Subject to the terms and conditions of this Credit Agreement, the Issuing Bank
will issue such Letter of Credit on the Issuance Date specified in the Issuance
Request submitted in connection therewith. The Issuing Bank and Borrower agree
that all Letters of Credit issued pursuant to the terms of this Article shall be
subject to the terms and conditions, and entitled to the benefits, of this
Credit Agreement and the other Credit Documents.
2.12 Letter of Credit Fees. Borrower agrees to pay to the Issuing Bank
a charge for all reasonable administrative expenses of the Issuing Bank in
connection with the issuance, amendment or modification (if any) and
administration of the Letter of Credit upon demand from time to time, which
charge shall not exceed $150.00 per draw, transfer or transaction.
2.13 Disbursements. The Issuing Bank will notify Borrower of the
presentment for payment of a Letter of Credit by any beneficiary thereto,
together with notice of the date (the "Disbursement Date") such payment shall be
made. Subject to the terms and provisions of the Letter of Credit, the Issuing
Bank shall make such payment (a "Disbursement") to the beneficiary of the Letter
of Credit. Each such Disbursement shall be deemed to be an RLC Advance
hereunder.
2.14 Reimbursement Obligations of Borrower. Borrower's obligation under
Section 2.13 to reimburse the Banks with respect to each Disbursement (including
interest thereon) in respect of any Letter of Credit shall be absolute and
unconditional under any and all circumstances and irrespective of any setoff,
counterclaim, or defense to payment which Borrower may have or have had against
the Banks, the Issuing Bank, the Administrative Agent or the beneficiary
thereof, including any defense based upon the occurrence of any Event of
Default, any draft, demand or certificate or other document presented under the
Letter of Credit proving to be forged, fraudulent, invalid or insufficient, the
failure of any Disbursement to conform to the terms
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of the Letter of Credit (if, in Issuing Bank's good faith opinion, such
Disbursement is determined to be appropriate) or any non-application or
misapplication by the beneficiary of the proceeds of such Disbursement, or the
legality, validity, form, regularity or enforceability of the Letter of Credit;
provided, however, that nothing herein shall adversely affect the right of
Borrower to commence any proceeding against Issuing Bank for any wrongful
Disbursement made by Issuing Bank under the Letter of Credit as a result of acts
or omissions constituting gross negligence or willful misconduct on the part of
Issuing Bank.
2.15 Nature of Reimbursement Obligations. Borrower shall assume all
risks of the acts, omissions or misuse of any Letter of Credit by the
beneficiary thereof. Neither the Banks nor the Issuing Bank (except to the
extent of its own gross negligence or willful misconduct) shall be responsible
for:
(a) the form, validity, sufficiency, accuracy, genuineness or
legal effect of any Letter of Credit or any document submitted by any
party in connection with the issuance of any Letter of Credit, even if
such document should in fact prove to be in any or all respects
invalid, insufficient, inaccurate, fraudulent or forged;
(b) the form, validity, sufficiency, accuracy, genuineness or
legal effect of any instrument transferring or assigning or purporting
to transfer or assign any Letter of Credit;
(c) failure of any beneficiary of any Letter of Credit to
comply fully with conditions required in order to demand payment under
a Letter of Credit;
(d) errors, omissions, interruption or delays in transmission
or delivery of any messages, by mail, cable, telegraph, telex or
otherwise; or
(e) any loss or delay in the transmission or otherwise of any
document or draft required by or from a beneficiary of a Letter of
Credit in order to make a Disbursement under a Letter of Credit or of
the proceeds thereof.
None of the foregoing shall affect, impair or prevent the vesting of any of the
rights or powers granted the Banks or the Issuing Bank hereunder. In furtherance
and extension, and not in limitation or derogation of any of the foregoing, any
action taken or omitted to be taken by the Banks or the Issuing Bank in good
faith shall be binding upon the Borrower and shall not put the Banks or the
Issuing Bank under any resulting liability to Borrower.
2.16 Banks Obligation. Nothing herein shall be deemed to relieve any
Bank from its obligations to fulfill its Pro Rata Share of the RLC Commitment
hereunder or to prejudice any right which the Administrative Agent or the
Borrower may have against any Bank as a result of any default by such Bank
hereunder.
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2.17 Certain Requirements. The Issuing Bank is under no obligation to
Issue any Letter of Credit if:
(i) any order, judgment or decree of any Governmental
Authority or arbitrator shall by its terms purport to enjoin or
restrain the Issuing Bank from Issuing such Letter of Credit, or any
requirement of law applicable to the Issuing Bank or any request or
directive (with which it is customary for banks in the relevant
jurisdiction to comply whether or not having the force of law) from any
Governmental Authority with jurisdiction over the Issuing Bank shall
prohibit, or request that the Issuing Bank refrain from, the Issuance
of letters of credit generally or such Letter of Credit in particular
or shall impose upon the Issuing Bank with respect to such Letter of
Credit any restriction, reserve, or capital requirement (for which the
Issuing Bank is not otherwise compensated hereunder) not in effect on
the Closing Date, or shall impose upon the Issuing Bank any
unreimbursed loss, cost, or expense which was not applicable on the
Closing Date and which the Issuing Bank in good faith deems material to
it;
(ii) the Issuing Bank has received written notice
from any Bank, the Administrative Agent or Borrower, on or prior to the
Banking Day prior to the requested date of Issuance of such Letter of
Credit, that one or more of the applicable conditions contained in
Article 5 is not then satisfied;
(iii) the Stated Expiry Date of any requested Letter
of Credit is not in accord with the requirements of Section 2.10(b),
unless all of the Banks have approved such Stated Expiry Date;
(iv) any requested Letter of Credit does not provide
for drafts, or is not otherwise in form and substance acceptable to the
Issuing Bank, or the Issuance of a Letter of Credit shall violate any
applicable policies of the Issuing Bank; or
(v) such Letter of Credit is to be denominated in a
currency other than Dollars.
2.18 Risk Participations, Drawings, and Reimbursements.
(a) Immediately upon the Issuance of each Letter of Credit,
each Bank shall be deemed to, and hereby irrevocably and
unconditionally agrees to, purchase from the Issuing Bank a
participation in such Letter of Credit and each drawing thereunder in
an amount equal to the product of (i) the Pro Rata Share of such Bank,
times (ii) the maximum amount available to be drawn under such Letter
of Credit and the amount of any Drawing, respectively. For purposes of
the applicable Commitment, each Issuance of a Letter of Credit shall be
deemed to
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utilize each Bank's Pro Rata Share of said Commitment by an amount
equal to the amount of such participation.
(b) In the event of any request for a drawing under a Letter
of Credit by the beneficiary or transferee thereof, the Issuing Bank
will promptly notify the Borrower. The Issuing Bank shall honor any
Disbursement request under any Letter of Credit only if (i) such
request is delivered to the Issuing Bank by the beneficiary of such
Letter of Credit, and (ii) such request is accompanied by the original
documents required by the Letter of Credit for any Disbursement. Except
as otherwise provided herein, the Borrower shall reimburse the Issuing
Bank prior to 11:00 a.m. (Inglewood, California local time) on each
date that any amount is paid by the Issuing Bank under any Letter of
Credit (each such date, an "Honor Date"), in an amount equal to the
amount so paid by the Issuing Bank. In the event the Borrower is
required but fails to reimburse the Issuing Bank for the full amount of
any drawing under any Letter of Credit by 11:00 a.m. (Inglewood,
California local time) on the Honor Date, the Issuing Bank will
promptly notify the Administrative Agent and the Administrative Agent
will promptly notify each Bank thereof. Any notice given by the Issuing
Bank or the Administrative Agent pursuant to this Section may be oral
if immediately confirmed in writing (including by facsimile); provided
that the lack of such an immediate confirmation shall not affect the
conclusiveness or binding effect of such notice.
(c) Each Bank shall upon any notice pursuant to this Section
make available to the Administrative Agent for the account of the
Issuing Bank an amount in Dollars and in immediately available funds
equal to its Pro Rata Share of the amount of the drawing, whereupon the
Banks shall (subject to paragraph (d)) each be deemed to have made a
Variable Rate Advance to the Borrower in that amount. If any Bank so
notified fails to make available to the Administrative Agent for the
account of the Issuing Bank the amount of such Bank's Pro Rata Share of
the amount of the drawing by no later than 3:00 p.m. (Inglewood,
California local time) on the Honor Date, then interest shall accrue on
such Bank's obligation to make such payment, from the Honor Date to the
date such Bank makes such payment, at a rate per annum equal to the
Federal Funds Rate in effect from time to time during such period and
such amount and interest shall be immediately due and payable to the
Administrative Agent; the obligation of such Bank to make such payment
to the Administrative Agent shall not be waived by the Administrative
Agent without the prior written consent of the Borrower. The
Administrative Agent will promptly give notice of the occurrence of the
Honor Date, but failure of the Administrative Agent to give any such
notice on the Honor Date or in sufficient time to enable any Bank to
effect such payment on such date shall not relieve such Bank from its
obligations under this Section.
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(d) With respect to any unreimbursed drawing, the Borrower
shall be deemed to have incurred from the Issuing Bank a Variable Rate
RLC Advance in the amount of such drawing.
(e) Each Bank's obligation in accordance with this Credit
Agreement to make the Variable Rate Advance, as contemplated by this
Section, as a result of a drawing under a Letter of Credit, shall be
absolute and unconditional and without recourse to the Issuing Bank and
shall not be affected by any circumstance, including (i) any set-off,
counterclaim, recoupment, defense, or other right which such Bank may
have against the Issuing Bank, the Borrower, or any other Person for
any reason whatsoever, (ii) the occurrence or continuance of a default,
an Event of Default, or a Material Adverse Effect, or (iii) any other
circumstance, happening, or event whatsoever, whether or not similar to
any of the foregoing.
2.19 Repayment of Participations.
(a) Upon (and only upon) receipt by the Administrative Agent
for the account of the Issuing Bank of immediately available funds from
the Borrower (i) in reimbursement of any payment made by the Issuing
Bank under a Letter of Credit with respect to which any Bank has paid
the Administrative Agent for the account of the Issuing Bank for such
Bank's participation in such Letter of Credit pursuant to Section 2.18,
or (ii) in payment of interest thereon, the Administrative Agent will
pay to each Bank, in the same funds as those received by the
Administrative Agent for the account of the Issuing Bank, the amount of
such Bank's Pro Rata Share of such funds, and the Issuing Bank shall
receive the amount of the Pro Rata Share of such funds of any Bank that
did not so pay the Administrative Agent for the account of the Issuing
Bank.
(b) If the Administrative Agent or the Issuing Bank is
required at any time to return to the Borrower, or to a trustee,
receiver, liquidator, custodian, or any official in any Insolvency
Proceeding, any portion of the payments made by the Borrower to the
Administrative Agent for the account of the Issuing Bank pursuant to
paragraph (a) in reimbursement of a payment made under a Letter of
Credit or interest or fee thereon, each Bank shall, on demand of the
Administrative Agent, forthwith return to the Administrative Agent or
the Issuing Bank the amount of its Pro Rata Share of any amounts so
returned by the Administrative Agent or the Issuing Bank plus interest
thereon from the date such demand is made to the date such amounts are
returned by such Bank to the Administrative Agent or the Issuing Bank,
at a rate per annum equal to the Federal Funds Rate in effect from time
to time.
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2.20 Role of the Issuing Bank.
(a) Each Bank and Borrower agree that, in paying any drawing
under a Letter of Credit, the Issuing Bank shall not have any
responsibility to obtain any document (other than any sight draft and
certificates expressly required by the Letter of Credit) or to
ascertain or inquire as to the validity or accuracy of any such
document or the authority of the Person executing or delivering any
such document.
(b) No Administrative Agent-related Person nor any of the
respective correspondents, participants or assignees of the Issuing
Bank shall be liable to any Bank for: (i) any action taken or omitted
in connection herewith at the request or with the approval of the Banks
or (ii) any action taken or omitted in the absence of gross negligence
or willful misconduct.
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ARTICLE 2A
THE RLCT
--------
2A.1 RLCT Commitment. Each Bank agrees, severally but not jointly, to
loan to or for the benefit of Borrower, and Borrower shall be entitled to draw
upon and borrow, in the manner and upon the terms and conditions contained in
this Credit Agreement, an amount that shall not exceed that Bank's Pro Rata
Share of the RLCT Commitment.
2A.2 Revolving Line.
(a) Subject to the terms and conditions set forth in this
Credit Agreement, each Bank shall provide to Borrower a revolving line
of credit (each, a "RLCT"), against which a Bank shall fund its Pro
Rata Share of each RLCT Advance to be made to Borrower, repaid by
Borrower, and readvanced to Borrower, as Borrower may request, provided
that (i) there is no Event of Default under any provision of this
Credit Agreement, (ii) no RLCT Advance shall be made that would cause
the RLCT Balance to exceed the RLCT Commitment, (iii) no Bank shall be
obligated under any circumstances to fund an RLCT Advance in excess of
that Bank's Pro Rata Share of the requested RLCT Advance, (iv) the
aggregate amount of a Bank's funding of the RLCT Balance at any one
time outstanding shall not exceed its Pro Rata Share of the RLCT
Commitment, and (v) no RLCT Advance shall be made after the RLCT
Termination Date. The Banks shall not be obligated to fund their Pro
Rata Share of any RLCT Advance if, after giving effect thereto, any of
the foregoing limitations would be exceeded.
(b) The failure of any Bank to fund its Pro Rata Share of an
RLCT Advance in accordance with its Pro Rata Share of the RLCT
Commitment shall not relieve any other Bank of its several obligations
hereunder, but no Bank shall be liable with respect to the obligation
of any other Bank hereunder.
(c) RLCT Advances may be made for the purpose of providing
liquidity for a common stock repurchase program by Borrower including
without limitation of reimbursing itself for common stock repurchases
made since August 1, 1998.
2A.3 RLCT Notes. The RLCT of each Bank shall be evidenced by an RLCT
Note and shall bear interest and be payable to the order of such Bank upon the
terms and conditions contained therein. The aggregate amount funded by a Bank
under its RLCT Note less all repayments of principal thereof shall be the
principal amount owing and unpaid on its RLCT Note and its RLCT. The principal
amount funded by a Bank and all principal payments and prepayments thereof may
be noted by such Bank on a schedule attached to its RLCT Note and shall be
entered by the Bank on its ledgers and computer records; provided that the
failure of the Bank to make such notations or entries shall not affect the
principal amount owing and unpaid on
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its RLCT Note. The entries made in the ordinary course of business by a Bank on
its ledgers and computer records and any notations made in the ordinary course
of business by a Bank on any such schedule annexed to its RLCT Note shall be
presumed to be accurate until the contrary is established. If requested,
Borrower shall confirm in writing to the Administrative Agent each RLCT Advance.
2A.4 RLCT. The RLCT shall bear interest and be payable to the Banks
upon the terms and conditions contained therein, which include the following
provisions:
(a) Interest shall accrue:
(i) On the unpaid principal of an RLCT Advance at the
Variable Rate except to the extent that an RLCT Advance bears
interest at the LIBOR Based Rate.
(ii) On the unpaid principal of an RLCT Advance at
the LIBOR Based Rate to the extent Borrower shall elect and to
the extent not otherwise provided herein.
(b) All interest shall be computed on the basis of a 360-day
year and accrue on a daily basis for the actual number of days elapsed.
All accrued interest shall be due and payable on each Payment Date.
(c) Principal under the RLCT Note shall be due and payable on
each RLCT Principal Date, beginning with the first RLCT Principal Date
after the RLCT Termination Date in an amount sufficient to fully
amortize the principal balance of the RLCT on the RLCT Termination Date
over twenty equal payments of such principal. The entire unpaid
principal balance, all accrued and unpaid interest, and all other
amounts payable under the RLCT Note shall be due and payable in full on
the RLCT Maturity Date.
(d) Each request for an RLCT Advance shall be substantially in
the form attached hereto as Exhibit "A" from an Authorized Officer, and
shall, in addition to complying with the other requirements in this
Credit Agreement, (i) specify the date and amount of the requested RLCT
Advance, (ii) specify whether the RLCT Advance shall be an RLCT Advance
that bears interest at the Variable Rate or shall be an RLCT Advance
that bears interest at the LIBOR Based Rate, (iii) be in a minimum
amount of $500,000.00 with integral multiples of $1,000.00 in excess
thereof, and (iv) if the RLCT Advance is to bear interest at the LIBOR
Based Rate, (A) specify the LIBOR Interest Period, and (B) be delivered
to Administrative Agent before 9:00 a.m. (Inglewood, California local
time) at least three (3) Business Days prior to the date of the
requested RLCT Advance. Any request for an RLCT Advance not complying
with the foregoing requirements for an RLCT Advance bearing interest at
the LIBOR Based Rate shall bear interest at
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the Variable Rate; provided that in the event such non-compliance is
due to Borrower's failure to specify the required information, the
Banks agree to notify Borrower of such failure and to provide Borrower
the opportunity to provide such information prior to directing that the
Advance bear interest at the Variable Rate.
(e) After receiving a request for an RLCT Advance in the
manner provided herein, the Administrative Agent shall promptly, before
11:30 a.m. (Inglewood, California local time) on the date an RLCT
Advance is requested, notify each Bank by telephone (confirmed promptly
in writing), telefacsimile or cable of the terms of such request and
such Bank's Pro Rata Share of the requested RLCT Advance. Each Bank
shall, before 1:00 p.m. (Inglewood, California local time) on the date
an RLCT Advance is to be made as specified in a request for an RLCT
Advance, deposit with the Administrative Agent such Bank's Pro Rata
Share of the requested RLCT Advance in immediately available funds.
Upon fulfillment of all applicable conditions set forth herein and
after receipt by the Administrative Agent of such funds, the
Administrative Agent shall pay or deliver all funds so received to the
order of Borrower at the principal office of the Administrative Agent.
The failure of any Bank to fund its Pro Rata Share of any RLCT Advance
required of it hereunder shall not relieve any other Bank of its
obligation to fund its Pro Rata Share of any RLCT Advance hereunder. If
any Bank fails to fund its Pro Rata Share of the requested RLCT Advance
and if all conditions to such RLCT Advance have apparently been
satisfied, the Administrative Agent will make available to Borrower the
funds received by it from the other Bank. Neither the Administrative
Agent nor any Bank shall be responsible for the performance by any
other Bank of its obligations hereunder.
Unless the Administrative Agent shall have received notice
from a Bank prior to the date of any RLCT Advance that such Bank will
not make available to the Administrative Agent such Bank's Pro Rata
Share of the requested RLCT Advance, the Administrative Agent may
assume that such Bank has made such amount available to the
Administrative Agent on the date of such RLCT Advance in accordance
with this Section and the Administrative Agent may, in reliance upon
such assumption, make available a corresponding amount to or on behalf
of Borrower on such date. If and to the extent any Bank shall not have
so made its Pro Rata Share of the requested RLCT Advance available to
the Administrative Agent (the "Principal Shortfall Amount"), Borrower
agrees to repay the Principal Shortfall Amount to the Administrative
Agent forthwith on demand, together with interest thereon for each day
from (and including) the date such amount is made available to or on
behalf of Borrower to (but excluding) the date such amount is repaid to
the Administrative Agent, at the rate per annum equal to the rate
otherwise applicable to the RLCT Advance in question.
(f) If Borrower desires that a LIBOR Rate Advance continue to
bear interest at the LIBOR Based Rate after the end of an existing
LIBOR Interest
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Period, Borrower shall deliver to the Administrative Agent at least
three (3) Banking Days prior to the end of the existing LIBOR Interest
Period; a notice making such election and specifying the new LIBOR
Interest Period. If Borrower does not deliver such notice within such
time, then after the existing LIBOR Interest Period the LIBOR Rate
Advance shall become a Variable Rate Advance and shall bear interest at
the Variable Rate.
(g) Borrower may upon written notice to and received by the
Administrative Agent not later than 9:00 a.m. (Inglewood, California
local time) (i) on the third Business Day, in the case of any
conversion of a Variable Rate Advance into a LIBOR Rate Advance and
(ii) on the first Business Day in the case of any conversion of a LIBOR
Rate Advance into a Variable Rate Advance, prior to the date of the
proposed conversion, convert any RLCT Advance of one type into an RLCT
Advance of the other type; provided, however, that any conversion of a
LIBOR Rate Advance (A) shall only be made on the last day of the
applicable LIBOR Interest Period except as otherwise provided herein,
and (B) shall be made only as to an RLCT Advance in a minimum amount of
$500,000.00 with integral multiples of $1,000.00 in excess thereof.
Each such notice of a conversion shall specify the date of such
conversion and the RLCT Advance(s) to be converted. After receiving any
such notice, the Administrative Agent shall promptly notify each Bank
by telephone, telefacsimile or cable and deliver a copy thereof to each
Bank.
(h) Each request for an RLCT Advance as well as each election
by the Borrower that an RLCT Advance continue to bear interest at the
LIBOR Based Rate after the end of an existing LIBOR Interest Period and
each conversion request shall be irrevocable and binding on Borrower
once the request is received by the Administrative Agent and the
Administrative Agent notifies the Banks of the request. Prior to the
Administrative Agent's notice of the request to the Banks, Borrower may
revoke the request. Borrower shall indemnify each Bank against any
cost, loss or expense incurred by any Bank as a result of Borrower's
failure to fulfill, on or before the date specified for an RLCT Advance
in any request for an RLCT Advance, the conditions to such RLCT Advance
set forth herein, including any cost, loss or expense incurred by
reason of the liquidation or reemployment of deposits or other funds
acquired by a Bank to fund such RLCT Advance when such RLCT Advance, as
a result of such failure, is not made on the date so specified.
(i) No RLCT Advance shall be requested by Borrower to bear a
LIBOR Based Rate, whether pursuant to a request for an RLCT Advance or
a conversion hereunder, so long as there shall have occurred an Event
of Default and such Event of Default is continuing.
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(j) Nothing herein shall be deemed to relieve any Bank from
its obligation to fulfill its Pro Rata Share of the RLCT Commitment
hereunder or to prejudice any right which the Administrative Agent or
the Borrower may have against any Bank as a result of any default by
such Bank hereunder.
(k) If any payment of interest and/or principal is not
received by the Administrative Agent when such payment is due, then in
addition to the remedies conferred upon the Banks under the Credit
Documents, a late charge of five percent (5%) of the amount of the
installment due and unpaid will be added to the delinquent amount to
compensate the Banks for the expense of handling the delinquency for
any payment past due in excess of ten (10) days, regardless of any
notice and cure period.
(l) Upon the occurrence of an Event of Default and after
maturity, including maturity upon acceleration, the unpaid principal
balance, all accrued and unpaid interest and all other amounts payable
hereunder shall bear interest at the Default Rate.
2A.5 Excess Balance Repayment. There shall be due and payable from
Borrower to the Banks, and Borrower shall immediately repay to the Banks three
(3) days after notice to Borrower, from time to time, any amount by which the
RLCT Balance exceeds the RLCT Commitment.
2A.6 Reduction of RLCT Commitment. Borrower shall have the right at any
time upon at least seven days' prior written notice to the Administrative Agent
to reduce the aggregate amount of the RLCT Commitment; provided, that the amount
of each such reduction shall be in a minimum aggregate amount of $1,000,000.00
or an integral aggregate multiple of $100,000.00 in excess thereof and that no
such reduction shall reduce (i) the amount of the RLCT Commitment to less than
the RLCT Balance, or (ii) the amount of a Bank's Pro Rata Share of the RLCT
Commitment to less than the amount of the RLCT Balance funded by such Bank. Any
reduction in the aggregate amount of the RLCT Commitment shall reduce each
Bank's share of the RLCT Commitment by its Pro Rata Share of the aggregate
amount of such reduction. The Administrative Agent shall promptly notify each
Bank of any such notice of reduction received from the Borrower. Any reduction
in the RLCT Commitment may not be reinstated without the mutual prior consent of
the Borrower and the Banks.
2A.7 Conditions. The Banks shall have no obligation to fund their Pro
Rata Shares of any RLCT Advance unless and until all of the conditions and
requirements of this Credit Agreement are fully satisfied. However, the Banks in
their sole and absolute discretion may elect to make one or more RLCT Advances
prior to full satisfaction of one or more such conditions and/or requirements.
Notwithstanding that such an RLCT Advance or RLCT Advances are made, such
unsatisfied conditions and/or requirements shall not be waived or released
thereby. Borrower shall be and continue to be obligated to fully satisfy such
conditions and requirements,
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and the Banks, at any time, in their sole and absolute discretion, may stop
making RLCT Advances until all conditions and requirements are fully satisfied.
2A.8 Other RLCT Advances. The Administrative Agent, at the direction of
the Banks, after giving written notice to Borrower, from time to time, may make
RLCT Advances in any amount in payment of (i) insurance premiums, taxes,
assessments, liens or encumbrances existing against the Collateral, (ii)
interest accrued and payable upon the RLCT, (iii) any indebtedness, charges and
expenses that are the obligation of Borrower under this Credit Agreement, and
(iv) any charges or matters necessary to cure any Event of Default.
2A.9 Assignment. Borrower shall have no right to any RLCT Advance other
than to have the same disbursed by the Administrative Agent in accordance with
the disbursement provisions contained in this Credit Agreement. Any assignment
or transfer, voluntary or involuntary, of this Credit Agreement or any right
hereunder shall not be binding upon or in any way affect the Banks without their
written consent; the Administrative Agent, at the direction of the Banks may
make RLCT Advances under the disbursement provisions herein, notwithstanding any
such assignment or transfer.
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ARTICLE 3
PAYMENTS, FEES AND EURODOLLAR PROVISIONS
----------------------------------------
3.1 Payments.
(a) All payments and prepayments by the Borrower of principal
of and interest on the Notes and all fees, expenses and any other
Obligation payable to the Administrative Agent or the Banks in
connection with the Loans shall be nonrefundable and made in Dollars or
immediately available funds to the Banks not later than 11:00 a.m.
(Inglewood, California local time) on the dates called for under this
Credit Agreement, at the main office of the Administrative Agent in
Inglewood, California. Funds received after such hour shall be deemed
to have been received by the Administrative Agent on the next Banking
Day. Payment to the Administrative Agent as aforesaid shall be deemed
payment to the Banks as well, regardless of whether the Administrative
Agent makes the distributions contemplated by Section 9A.8(a) hereof.
(b) Unless otherwise required by applicable law, payments will
be applied first to accrued, unpaid interest, then to principal, and
any remaining amount to any unpaid collection costs, late charges and
other charges; provided, however, upon delinquency or other default,
the Banks reserve the right to apply payments among principal,
interest, late charges, collection costs and other charges at its
discretion.
(c) Interest shall be due and payable on each Loan on each
Payment Date and on each applicable Maturity Date.
(d) Whenever any payment to be made hereunder shall be stated
to be due on a day which is not a Banking Day, such payment shall be
made on the next succeeding Banking Day, and such extension of time
shall in such case be included in the computation of interest,
commission or fee, as the case may be.
3.2 Loan Fees.
(a) RLC Non-Use Fee. Borrower agrees to pay the Administrative
Agent for distribution to the Banks pursuant to Section 9A.8 hereof a
quarterly fee (the "RLC Non-Use Fee") in an annualized amount equal to
one-quarter percent (0.25%) of the average daily undrawn balance of the
RLC Commitment during the prior calendar quarterly period. For purposes
of calculating the RLC Non-Use Fee, the Outstanding LC Balance on any
date shall be deemed to have been drawn. The RLC Non-Use Fee shall
accrue from the Closing Date and shall be due and payable in arrears
within three (3) Banking Days after written notice of such amount due
by the Administrative Agent to Borrower and shall be non-refundable.
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The first such payment shall be prorated from the Closing Date and
shall be due on December 31, 1998 and thereafter on each Quarterly End
Date.
(b) RLCT Fee. Borrower agrees to pay Administrative Agent on
the Closing Date for distribution to the Banks pursuant to Section 9A.8
hereof a fee (the "RLCT Fee") in an amount equal to one quarter percent
(0.25%) of the RLCT Commitment.
(c) RLCT Non-Use Fee. Borrower agrees to pay Administrative
Agent for distribution to the Banks pursuant to Section 9A.8 hereof a
quarterly fee (the "RLCT Non-Use Fee") in an annualized amount equal to
one-quarter percent (0.25%) of the average daily undrawn balance of the
RLCT Commitment during the prior calendar quarterly period. The RLCT
Non-Use Fee shall accrue from the Closing Date until the RLCT
Termination Date and shall be due and payable in arrears within three
(3) Banking Days after written notice of such amount due by the
Administrative Agent to Borrower and shall be non-refundable. The first
such payment shall be prorated from the Closing Date and shall be due
on December 31, 1998 and thereafter on each Quarterly End Date until
the RLCT Termination Date. The final payment shall be prorated from the
prior Quarterly End Date until the RLCT Termination Date.
3.3 Computations. All fees and interest on each Note shall be computed
on the basis of a year of 360-days/year and accrue on a daily basis for the
actual number of days elapsed.
3.4 Maintenance of Accounts. The Banks shall maintain, in accordance
with their usual practice, an account or accounts evidencing the indebtedness of
the Borrower and the amounts payable and paid from time to time hereunder. In
any legal action or proceeding in respect of this Credit Agreement, the entries
made in the ordinary course of business in such account or accounts shall be
evidence of the existence and amounts of the obligations of the Borrower therein
recorded and shall be presumed to be accurate until the contrary is established.
The failure to record any such amount shall not, however, limit or otherwise
affect the obligations of the Borrower hereunder to repay all amounts owed
hereunder, together with all interest accrued thereon as provided in the Notes.
3.5 Certain Contingencies.
(a) If the contingency contemplated by Section 3.6, 3.7(b) or
3.7(c) should occur, the Borrower may at any time after receipt of such
notice, and as long as the circumstances giving rise to the relevant
claim continue, require the Banks to terminate upon not less than
thirty days' notice the participation agreement with such participant,
unless such participant has waived any claim to payment under those
provisions.
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(b) If circumstances arise which would (or would upon the
giving of notice) entitle a Bank to receive additional payments
pursuant to Section 3.6, 3.7(b) or 3.7(c), then the Bank shall
promptly, upon becoming aware of such circumstances, notify the
Borrower and, to the extent that it can legally do so without material
prejudice to its own position, the Bank shall take such reasonable
steps as may be available to it to mitigate the effects of such
circumstances.
3.6 Increased Capital Requirements; Tax.
(a) In the event that, as a result of any Regulatory Change,
compliance by any Bank with any applicable law or governmental rule,
requirement, regulation, guideline or order (with which it is customary
for banks in the relevant jurisdiction to comply whether or not having
the force of law) has or would have the effect of reducing the rate of
return on the capital of the Bank or any institution controlling the
Bank as a consequence of or with reference to any Commitment, the
issuance of a Letter of Credit or amounts outstanding under the Notes
to a level below that which the Bank or such other corporation could
have achieved but for such change or compliance (taking into
consideration the policies of the Bank or such other corporation with
respect to capital), then from time to time the Borrower shall pay to
such Bank such additional amount or amounts as will compensate the Bank
for such reduction. The Bank will notify the Borrower of any Regulatory
Change that will entitle the Bank to compensation pursuant to this
Section as promptly as practicable, but in any event within ninety (90)
days after the Bank obtains knowledge thereof; provided, however, that
if the Bank fails to give such notice within ninety (90) days after it
obtains knowledge of such a Regulatory Change, the Bank shall, with
respect to compensation payable in respect of any costs resulting from
such Regulatory Change, only be entitled to payment for costs incurred
from and after the date that the Bank does give such notice. Such Bank
shall deliver to the Borrower a written certificate which states the
additional amount(s) due and payable, showing in reasonable detail the
calculation of such amount and provide evidence to substantiate the
Bank's claim for such amount(s).
(b) Each Bank that is organized outside the United States (i)
on or before the date it becomes a party to this Credit Agreement and
(ii) with respect to each lending office located outside the United
States of such Bank, shall deliver to the Borrower and the
Administrative Agent such certificates, documents or other evidence, as
required by the Code or Treasury Regulations issued pursuant thereto,
including Internal Revenue Service Form 1001 or Form 4224, properly
completed and duly executed by such Bank establishing that payments
received hereunder are (i) not subject to withholding under the Code
because such payment is effectively connected with the conduct by such
Bank of a trade or business in the United States or (ii) totally exempt
from United States Federal withholding tax under a provision of an
applicable tax treaty. In addition, each such Bank shall, if legally
able to do
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so, thereafter deliver such certificates, documents or other evidence
from time to time establishing that payments received hereunder are not
subject to such withholding upon receipt of a written request therefor
from the Borrower or the Administrative Agent. Unless the Borrower and
the Administrative Agent have received forms or other documents
satisfactory to them indicating that payments hereunder or under the
Notes are not subject to United States Federal withholding tax, the
Borrower or the Administrative Agent shall withhold such taxes from
such payments at the applicable statutory rate.
(c) The Borrower shall not be required to pay any additional
amounts to any Bank or the Administrative Agent in respect to United
States Federal withholding tax if the obligation to pay such additional
amounts would not have arisen but for a failure by such Bank or the
Administrative Agent to deliver the certificates, documents or other
evidence specified in the preceding paragraph (b) unless such failure
is attributable to (i) a change in applicable law, regulation or
official interpretation thereof or (ii) an amendment or modification to
or a revocation of any applicable tax treaty or a change in official
position regarding the application or interpretation thereof, in each
case on or after the date such Bank or the Administrative Agent becomes
a party to this Credit Agreement.
(d) Nothing contained in this Section shall require any Bank
or the Administrative Agent to make available any of its tax returns
(or any other information relating to its taxes) which it deems to be
confidential.
3.7 Special Provisions for LIBOR Rate Advances.
(a) Funding: Notwithstanding any provision of the Credit
Documents to the contrary, the Banks shall be entitled to fund and
maintain their funding of all or any part of any Advance in any manner
they see fit; provided, however, that for the purposes of the Notes,
all determinations thereunder shall be made as if the Banks had
actually funded and maintained each Advance bearing interest at the
LIBOR Based Rate during the LIBOR Interest Period therefor through the
purchase of deposits having a maturity corresponding to the last day of
the LIBOR Interest Period and bearing an interest rate equal to the
LIBOR Based Rate for such LIBOR Interest Period.
(b) Inadequacy of Eurodollar Pricing: If, due to any
Regulatory Change, there shall be any increase in the cost to a Bank of
agreeing to make or making, funding, or maintaining Advances bearing
interest at the LIBOR Based Rate (including, without limitation, any
increase in any applicable reserve requirement), then the Borrower
shall from time to time, upon demand by the Bank, pay to the Bank such
amounts as the Bank may reasonably determine to be necessary to
compensate the Bank for any additional costs that the Bank reasonably
determines are attributable to such Regulatory Change. The Bank will
notify the Borrower of
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any Regulatory Change that will entitle the Bank to compensation
pursuant to this paragraph as promptly as practicable, but in any event
within ninety (90) days after the Bank obtains knowledge thereof;
provided, however, that if the Bank fails to give such notice within
ninety (90) days after it obtains knowledge of such a Regulatory
Change, the Bank shall, with respect to compensation payable in respect
of any costs resulting from such Regulatory Change, only be entitled to
payment for costs incurred from and after the date that the Bank does
give such notice. The Bank will furnish to the Borrower a certificate
setting forth in reasonable detail the basis for the amount of each
request by the Bank for compensation under this paragraph.
Determinations by the Bank of the amounts required to compensate the
Bank shall be conclusive, absent manifest error. The Bank shall be
entitled to compensation in connection with any Regulatory Change only
for costs actually incurred by the Bank.
(c) Illegality: Notwithstanding any provision of the Credit
Documents, if a Bank shall notify the Borrower that as a result of a
Regulatory Change it is unlawful for the Bank to make Advances at the
LIBOR Based Rate, or to fund or maintain Advances bearing interest at
the LIBOR Based Rate , (i) the obligations of the Bank to make Advances
at the LIBOR Based Rate and to convert Advances to the LIBOR Based Rate
shall be suspended until the Bank shall notify the Borrower that the
circumstances causing such suspension no longer exist, and (ii) in the
event such Regulatory Change makes the maintenance of Advances at the
LIBOR Based Rate unlawful, the Borrower shall forthwith prepay in full
all Advances bearing interest at the LIBOR Based Rate then outstanding,
together with interest accrued thereon and all amounts in connection
with such prepayment specified herein, unless the Borrower, within five
(5) Banking Days of notice from the Bank, converts all Advances bearing
interest at the LIBOR Based Rate then outstanding into Advances bearing
interest at the Variable Rate pursuant to the conversion procedures
herein and pays all amounts in connection with such prepayments or
conversions specified herein.
(d) Market Disruption: Notwithstanding any other provision of
the Credit Documents, if prior to the commencement of any LIBOR
Interest Period, the Banks shall determine (i) that United States
dollar deposits in the amount of any Advance bearing interest at the
LIBOR Based Rate to be outstanding during such LIBOR Interest Period
are not readily available to the Banks in the London interbank market,
or (ii) by reason of circumstances affecting the London interbank
market, adequate and reasonable means do not exist for ascertaining the
LIBOR Based Rate for such LIBOR Interest Period in the manner
prescribed in the definition of "LIBOR Based Rate," then the
Administrative Agent shall promptly give notice thereof to the Borrower
and the obligation of the Banks to create, continue, or effect by
conversion any Advance bearing interest at the LIBOR Based Rate in such
amount and for such LIBOR Interest Period shall terminate until United
States dollar deposits in such amount and for the LIBOR Interest Period
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shall again be readily available in the London interbank market and
adequate and reasonable means exist for ascertaining the LIBOR Based
Rate.
(e) Prepayment: Borrower may, upon at least two (2) Banking
Days' notice in the case of LIBOR Based Rate Advances and one (1)
Banking Day's notice in the case of Variable Rate Advances to the
Administrative Agent stating the proposed date and aggregate principal
amount of the prepayment, and if such notice is given Borrower shall,
prepay the outstanding principal balance of the Loan in whole or in
part at any time prior to the applicable Maturity Date as stated in
such notice by Borrower. With any prepayment of a LIBOR Based Rate
Advance or with any conversion of a LIBOR Based Rate Advance to a
Variable Rate Advance, in either case other than on the last Banking
Day of the LIBOR Interest Period for such LIBOR Based Rate Advance
(including any such prepayment made voluntarily or involuntarily as a
result of the acceleration of maturity upon a default or otherwise),
Borrower shall pay all accrued interest on the principal amount prepaid
with such prepayment and, on demand, shall reimburse the Banks and hold
the Banks harmless from all losses and expenses incurred by the Banks
as a result of such prepayment, including, without limitation, any
losses and expenses arising from the liquidation or reemployment of
deposits acquired to fund or maintain the principal amount prepaid.
Such reimbursement shall be calculated as though the Banks funded the
principal amount prepaid through the purchase of U.S. Dollar deposits
in the London, England interbank market having a maturity corresponding
to such LIBOR Interest Period and bearing an interest rate equal to the
LIBOR Based Rate for such LIBOR Interest Period, whether in fact that
is the case or not. The Banks' determination of the amount of such
reimbursement shall be conclusive in the absence of manifest error.
3.8 Prepayments.
(a) Borrower shall have the option to prepay the Loans, in
full or in part, at any time, subject to payment of all amounts
specified hereinbelow with respect to any LIBOR Rate Advance.
(b) If for any reason (including voluntary prepayment,
voluntary conversion of a LIBOR Rate Advance into a Variable Rate
Advance, or acceleration, but excluding any mandatory prepayment or
mandatory conversion such as pursuant to Section 3.7(b)), the Banks
receive all or part of the principal amount of a LIBOR Rate Advance
prior to the last day of the LIBOR Interest Period for such Advance,
the Borrower shall immediately notify the Borrower's account officer at
the Administrative Agent and, on demand by the Banks, pay the "LIBOR
Breakage Fees," defined as the amount (if any) by which (i) the
additional interest which would have been payable on the amount so
received had it not been received until the last day of such LIBOR
Interest Period exceeds (ii) the interest
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which would have been recoverable by the Banks (without regard to
whether the Banks actually so invest said funds) by placing the amount
so received on deposit in the certificate of deposit markets or the
offshore currency interbank markets or United States Treasury
investment products, as the case may be for a period starting on the
date on which it was so received and ending on the last day of such
LIBOR Interest Period at the interest rate determined by the Banks in
their reasonable discretion. The Banks' determination as to such amount
shall be conclusive and final, absent manifest error.
(c) The Borrower shall pay to the Banks, upon the demand of
the Required Banks, such other amount or amounts as shall be sufficient
to compensate them for any loss, costs or expense ("LIBOR Prepayment
Charges") incurred by them as a result of any prepayment by the
Borrower (including voluntary prepayment, voluntary conversion of a
LIBOR Rate Advance into a Variable Rate Advance, or prepayment due to
acceleration, but excluding any mandatory prepayment or mandatory
conversion such as pursuant to Section 3.7(b)) of all or part of the
principal amount of a LIBOR Rate Advance prior to the last day of the
LIBOR Interest Period for such Advance (including without limitation,
any failure by the Borrower to borrow a LIBOR Rate Advance on the loan
date for such borrowing specified in the relevant notice of borrowing
hereunder). Such LIBOR Prepayment Charges shall include, without
limitation, any interest or fees payable by the Banks to lenders of
funds obtained by them in order to make or maintain their loans based
on the London interbank eurodollar market. The Banks' determination as
to such LIBOR Prepayment Charges shall be conclusive and final, absent
manifest error.
(d) The Banks agree that they shall make a best effort to
minimize any such LIBOR Breakage Fees or any such LIBOR Prepayment
Charges.
3.9 Non U.S. Subsidiaries - Currency Indemnity. Borrower shall pay to
the Banks, upon the demand of the Required Banks, such other amount or amounts
as shall be sufficient to compensate them for any loss, cost or expense
("Currency Loss") incurred by them as a result of any repayment being made in a
currency other than Dollars. The Banks' determination as to such Currency Loss
shall be conclusive and final, absent manifest error.
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ARTICLE 4
SECURITY DOCUMENTS
------------------
4.1 Security.
(a) So long as any Loan is outstanding, Borrower shall cause
such Loan and Borrower's obligations under this Credit Agreement to be
secured at all times by a valid and effective security agreement (the
"Security Agreement"), duly executed and delivered by or on behalf of
the Company, granting the Agent on behalf of the Banks and the Issuing
Bank a valid and enforceable security interest in all of its assets
other than its real property, subject to no prior Lien other than
Permitted Liens.
(b) On and after the date hereof, Company will not create or
suffer to exist any Lien upon its property, real or personal, including
without limitation its patents, copyrights and trademarks, except as
permitted under Section 8.2.
4.2 Security Documents. All of the documents required by this Article 4
shall be in form satisfactory to the Banks, the Issuing Bank and their counsel,
and, together with any Financing Statements for filing and/or recording, and any
other items required by the Banks and the Issuing Bank to fully perfect and
effectuate the liens and security interests of the Banks and the Issuing Bank
contemplated by the Security Agreement and this Credit Agreement, may heretofore
or hereinafter be referred to as the "Security Documents."
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ARTICLE 5
CONDITIONS PRECEDENT
--------------------
The obligations of the Banks to make the Loans and to make the initial
Advance hereunder or the Issuing Bank's obligation to issue the initial Letter
of Credit is subject to the full prior satisfaction of each of the following
conditions precedent and, as to each future Advance, to the full prior
satisfaction at each such time of each of the conditions precedent in Sections
5.2, 5.3 and 5.4 hereof:
5.1 Initial Advance. Prior to its making the initial Advance, the
Administrative Agent shall have received the following, each in form and
substance satisfactory to the Required Banks:
(a) This Credit Agreement. This Credit Agreement, duly
executed by Borrower.
(b) The Notes. The Notes, each duly executed, as provided in
Articles 2 and 2A hereof.
(c) Officer's Certificate. A certificate signed by an
Authorized Officer of the Company and an Authorized Agent's Certificate
as to each Subsidiary, stating that (to the best knowledge and belief
thereof, after reasonable inquiry and review of matters pertinent to
the subject matter of such certificate): (i) all of the representations
and warranties contained in Article 6 of this Credit Agreement and in
the other Credit Documents are, in all material respects, true and
correct as of the date hereof (other than those of such representations
which by their express terms speak to a date prior to such date, which
representations are, in all material respects, true and correct as of
such respective dates); (ii) no event has occurred and is continuing,
or would result from the advance of the proceeds of the Loans, which
would constitute an Event of Default, and (iii) no change or changes
having a Material Adverse Effect have occurred in the business or
financial condition of Borrower since the date of the last financial
statements of Borrower heretofore delivered to the Banks.
(d) Organizational Documents. A copy of the current
organizational documents of Borrower, including all amendments thereto,
except for non U.S. Subsidiaries certified as current and complete by
the appropriate authority of the state of said corporation's
incorporation, together with evidence of said corporation's good
standing in said corporation's state of incorporation and in every
other state in which it is doing business or the conduct of said
corporation's business requires such standing for the enforcement of
material contracts.
(e) Certificate. A certificate of the corporate secretary of
Company, signed by the duly appointed secretary thereof and issued as
of the Closing Date,
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certifying that (i) attached thereto is a true and complete copy of the
corporate by-laws of said corporation in effect on the date of passage
of the corporate resolutions described immediately below and at all
subsequent times to and including the date of the certificate, (ii) no
change has been made to said corporation's charter documents other than
as reflected in the certified copies submitted in connection with the
delivery of this Credit Agreement or as approved in writing by the
Administrative Agent, and (iii) attached thereto are proper
resolutions, authorizations and certificates relating to the authority
of any person executing documents on behalf of such entity. As to each
Subsidiary, a unanimous Written Consent in Lieu of Special Meeting of
the Sole Shareholder together with an Authorized Agent's Certificate as
to the organizational documents of the Subsidiary, certifying that no
change has been made to said documents.
(f) Security Agreement. A Security Agreement executed by the
Company.
(g) Financing Statements. UCC-1 Financing Statements executed
by the Company for each state in which the Company has a business
location.
(h) Costs. Payment of costs of the Administrative Agent and
the Banks.
(i) Opinion of Counsel. An opinion of counsel to the Company
as to those matters reasonably required by the Banks.
(j) Compliance Certificate. A Compliance Certificate in the
form of Exhibit "A" attached hereto executed by the Company, indicating
that Borrower is in compliance with all Financial Covenants as of
September 30, 1998.
(k) Additional Information. Such other information and
documents as may reasonably be required by the Banks or their counsel.
5.2 No Event of Default. No Event of Default known to Borrower shall
have occurred and be continuing, or result from the making of the Loans.
5.3 No Material Adverse Effect. Since the date of the most recent
financial statements provided to the Banks by Borrower, no change shall have
occurred in the business or financial condition of Borrower that could have a
Material Adverse Effect.
5.4 Representations and Warranties. The representations and warranties
contained in Article 6 hereof shall be true and correct in all material
respects, with the same force and effect as though made on and as of the Closing
Date (other than those of such representations which by their express terms
speak to a date prior to that date, which representations shall, in all material
respects, be true and correct as of such respective date).
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ARTICLE 6
REPRESENTATIONS AND WARRANTIES
------------------------------
To induce the Banks to make the Loans, the Company and, to the extent
applicable, each Co-Borrower represents and warrants to the Banks that:
6.1 Recitals. The recitals and statements of intent appearing in this
Credit Agreement are true and correct.
6.2 Organization and Good Standing. It is duly organized under the laws
of the jurisdiction of its organization, is validly existing and is in good
standing, to the extent required by law, in each jurisdiction in which it is
doing business. It has the legal power and authority to own its properties and
assets and to transact the business in which it is engaged and is or will be
qualified in those jurisdictions wherein the nature of its proposed business and
property will make such qualifications necessary or appropriate in the future.
6.3 Authorization and Power. It has the corporate power and requisite
authority to execute, deliver and perform this Credit Agreement, the Notes and
the other Credit Documents to be executed by it; it is duly authorized to, and
has taken all action, corporate or otherwise, necessary to authorize it to,
execute, deliver and perform this Credit Agreement, the Notes and such other
Credit Documents and is and will continue to be duly authorized to perform this
Credit Agreement, the Notes and such other Credit Documents.
6.4 Enforceable Obligations. This Credit Agreement, the Notes and the
other Credit Documents are the legal, valid and binding obligations of Borrower,
enforceable against Borrower in accordance with their respective terms, except
as limited by bankruptcy, insolvency or other laws or equitable principles of
general application relating to the enforcement of creditors' rights.
6.5 No Conflicts or Consents. Neither the execution and delivery of
this Credit Agreement, the Notes or the other Credit Documents to which it is a
party, nor the consummation of any of the transactions herein or therein
contemplated, nor compliance with the terms and provisions hereof or with the
terms and provisions thereof, (a) will contravene or conflict with: (i) any
provision of law, statute or regulation to which it is subject, (ii) any
judgment, license, order or permit applicable to it, (iii) any indenture, loan
agreement, mortgage, deed of trust, or other agreement or instrument to which it
is a party or by which it may be bound, or to which it may be subject, or (b)
will violate any provision of its organizational documents. No consent,
approval, authorization or order of any court or Governmental Authority or other
Person is required in connection with the execution and delivery by it of the
Credit Documents or to consummate the transactions contemplated hereby or
thereby, or if required, such consent, approval, authorization or order shall
have been obtained.
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6.6 No Litigation. There are no actions, suits or legal, equitable,
arbitration or administrative proceedings pending, or to its actual knowledge
overtly threatened, against Borrower that would, if adversely determined, have a
Material Adverse Effect.
6.7 Financial Condition. It has delivered to the Banks copies of the
its audited consolidated financial statements as most recently filed with the
SEC. Such financial statements, in all material respects, fairly present the
financial position of Borrower as of such date and have been prepared in
accordance with GAAP. Since the date thereof, it has not discovered any
obligations, liabilities or indebtedness (including contingent and indirect
liabilities and obligations or unusual forward or long-term commitments) which
in the aggregate are material and adverse to the financial position or business
of Borrower that should have been but were not reflected in such financial
statements. No changes having a Material Adverse Effect have occurred in the
financial condition or business of Borrower since its most recent filings with
the SEC.
6.8 Taxes. It has filed or caused to be filed all returns and reports
which are required to be filed by any jurisdiction, and has paid or made
provision for the payment of all taxes, assessments, fees or other governmental
charges imposed upon its properties, income or franchises, as to which the
failure to file or pay would have a Material Adverse Effect, except such
assessments or taxes, if any, which are being contested in good faith by
appropriate proceedings.
6.9 No Stock Purchase. No part of the proceeds of any financial
accommodation made by the Banks in connection with this Credit Agreement will be
used to purchase or carry "margin stock," as that term is defined in Regulation
U, or to extend credit to others for the purpose of purchasing or carrying such
margin stock.
6.10 Advances. Each request for an Advance or for the extension of any
financial accommodation by the Banks whatsoever shall constitute an affirmation
that the representations and warranties of Section 6.7 are true and correct with
respect to any financial statements submitted by Borrower to the Banks between
the date of this Credit Agreement and the date of such request, and that the
representations and warranties of Sections 6.1, 6.4, 6.5, 6.6, 6.7 and 6.8
hereof are true and correct as of the time of such request. All representations
and warranties made herein shall survive the execution of this Credit Agreement,
all advances of proceeds of the Loans and the execution and delivery of all
other documents and instruments in connection with the Loans and/or this Credit
Agreement, so long as any Bank has any commitment to lend hereunder and until
the Loans have been paid in full and all of Borrower's obligations under this
Credit Agreement and the Notes been fully discharged.
6.11 Solvent. It (both before and after giving effect to the Loans
contemplated hereby) is solvent, has assets having a fair value in excess of the
amount required to pay its probable liabilities on its existing debts as they
become absolute and matured, and has, and is expected to have, access to
adequate capital for the conduct of its business and the ability to pay its
debts from time to time incurred in connection therewith as such debts mature.
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6.12 ERISA. (a) No Reportable Event has occurred and is continuing with
respect to any Plan; (b) PBGC has not instituted proceedings to terminate any
Plan; (c) neither the Borrower, any member of the Controlled Group, nor any
duly-appointed administrator of a Plan (i) has incurred any liability to PBGC
with respect to any Plan other than for premiums not yet due or payable or (ii)
has instituted or intends to institute proceedings to terminate any Plan under
Section 4041 or 4041A of ERISA; and (d) each Plan of Borrower has been
maintained and funded in all material respects in accordance with its terms and
in all material respects in accordance with all provisions of ERISA applicable
thereto. Neither the Borrower nor any of its Subsidiaries participates in, or is
required to make contributions to, any Multi-employer Plan (as that term is
defined in Section 3(37) of ERISA).
6.13 Full Disclosure. No certificate or statement delivered herewith or
heretofore by it to the Banks in connection with negotiations of this Credit
Agreement, contains any untrue statement of a material fact or omits to state
any material fact necessary to keep the statements contained herein or therein
from being misleading.
6.14 No Default. No event or condition has occurred and is continuing
that constitutes an Event of Default.
6.15 Significant Debt Agreements. It is not in default in any material
respect under any Significant Debt Agreement.
6.16 Compliance with Law. It is in substantial compliance with all
laws, rules, regulations, orders and decrees that are applicable to it, or its
properties, noncompliance with which would have a Material Adverse Effect.
6.17 Subsidiaries. Except for Subsidiaries listed on Schedule 6.17,
Company has no existing Subsidiary that conducts any business or operations.
6.18 Year 2000 Compliance. Company and its Subsidiaries have reviewed
the areas within their operations and business which could be adversely affected
by, and have developed or are developing a program to address on a timely basis,
the Year 2000 Problem and have made related appropriate inquiry of material
suppliers and vendors, and based on such review and program, the Year 2000
Problem will not have a Material Adverse Effect upon its financial condition,
operations or business as now conducted. "Year 2000 Problem" means the
possibility that any computer applications or equipment used by Borrower may be
unable to recognize and properly perform date-sensitive functions involving
certain dates prior to and any dates on or after December 31, 1999.
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ARTICLE 7
AFFIRMATIVE COVENANTS
---------------------
Until payment in full of the Notes and the complete performance of the
Obligation, and so long as any Bank has any Commitment outstanding to any
Borrower, the Company and, to the extent applicable, each Co-Borrower agrees
that:
7.1 Financial Statements, Reports and Documents. Borrower shall
deliver, or cause to be delivered, to the Banks each of the following:
(a) Consolidated Quarterly Statements of the Company. As soon
as available, and in any event within forty-five (45) days after the
end of the first three (3) fiscal quarterly periods of each fiscal year
of the Company, copies of the consolidated balance sheet of the Company
as of the end of such fiscal quarter, and consolidated statements of
income of the Company for that fiscal quarter and for the portion of
the fiscal year ending with such fiscal quarter, in each case setting
forth in comparative form the figures for the corresponding period of
the preceding fiscal year, all in reasonable detail and fairly stated
and prepared in accordance with GAAP.
(b) Consolidated Annual Statements of the Company. As soon as
available and in any event within ninety (90) days after the close of
each fiscal year of the Company, audited consolidated financial
statements of the Company, including its consolidated balance sheet as
of the close of such fiscal year and consolidated statements of income
of the Company for such fiscal year, in each case setting forth in
comparative form the figures for the preceding fiscal year, all in
reasonable detail and accompanied by an unqualified opinion thereon of
independent public accountants of recognized national standing selected
by the Company and acceptable to the Banks, to the effect that such
financial statements have been prepared in accordance with GAAP (except
for changes in which such accountants concur) and that the examination
of such accounts in connection with such financial statements has been
made in accordance with generally accepted auditing standards and,
accordingly, includes such tests of the accounting records and such
other auditing procedures as were considered necessary in the
circumstances.
(c) Compliance Certificate of the Company. Within forty-five
(45) days after the end of each fiscal quarter of the Company, a
certificate (the "Compliance Certificate") substantially in the form of
Exhibit "A" attached hereto signed by an Authorized Officer, (i)
stating that a review of the activities of the Company during such
quarter or year has been made under his/her supervision, that, as of
such date, the Company has observed, performed and fulfilled each and
every obligation and covenant contained herein and no Event of Default
exists under any of the
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same or, if any Event of Default shall have occurred, specifying the
nature and status thereof, and stating that all financial statements
delivered to the Banks during the respective period pursuant to Section
7.1(a) and 7.1(b) hereof, to such officer's knowledge after due
inquiry, fairly present in all material respects the financial position
of the Company and the results of its operations at the dates and for
the periods indicated, and have been prepared in accordance with GAAP,
subject to year end audit and adjustments, and (ii) setting forth in
such level of detail as the Banks shall reasonably require a
calculation of the Financial Covenants as of the end of that fiscal
quarter.
(d) Management Letters. With the audited fiscal year-end
statements submitted under Section 7.1(b) above, the management letter,
if any, of the Company's certified public accountants issued in
connection with such audit.
(e) SEC Filings. When filed, copies of each filing with the
SEC made by the Company, including without limitation its annual 10-K
and quarterly 10-Q reports.
(f) Projections. No later than thirty-one (31) days before the
end of each fiscal year, financial statements of the Company for the
following fiscal year and each fiscal quarter thereof, based on its
current financial projections for such fiscal year.
(g) Other Information. Such other information concerning the
business, properties or financial condition of Borrower as the Banks
shall reasonably request.
7.2 Maintenance of Existence. Borrower shall maintain its existence
with no material amendments or changes in its organizational documents without
the prior written approval of the Required Banks.
7.3 Maintain Business. Borrower shall maintain in full force and effect
all agreements, rights, trademarks, patents and licenses necessary to carry out
its business in its reasonable business judgment, shall keep all of its assets
and properties in good condition and repair, ordinary wear and tear excepted,
and shall make all needed and proper repairs and improvements to its properties
in order to properly conduct its business in its reasonable business judgment.
7.4 Insurance. To the extent Borrower is not self-insured, Borrower
shall maintain in full force and effect at all times policies of fire, flood and
extended coverage insurance and policies of public liability property damage,
workman's compensation insurance in scope and amount not less than, and not less
extensive than, the scope and amount of insurance coverages customary for
companies of comparable size and financial strength in the trades or businesses
in which Borrower is from time to time engaged. Upon request by the Banks,
Borrower shall deliver to the Banks certificates of, and copies of the originals
of, all such policies of insurance in effect
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from time to time, to be retained by the Banks so long as the Banks shall have
any commitment to lend to Borrower and/or any portion of the Loans shall be
outstanding or unsatisfied.
7.5 Compliance with Credit Documents. Borrower will comply with any and
all covenants and provisions of this Credit Agreement, the Notes and all other
Credit Documents.
7.6 Books and Records; Access. Borrower shall maintain, in a safe
place, proper and accurate books, ledgers, correspondence and other records
relating to its operations and business affairs. The Banks shall have the right
from time to time, upon reasonable notice to Borrower, to examine and audit
(within a reasonable scope of audit) at Borrower's expense (such expense not to
exceed $5,000.00 per annum) and to make abstracts from and photocopies of
Borrower's books, ledgers, correspondence and other records.
7.7 Payment of Taxes and Other Indebtedness. Borrower shall pay all of
its current obligations before they become delinquent under applicable
agreements or normal trade practices, including all accounts payable and all
federal, state and local taxes, assessments, levies and governmental charges and
all other payments required under any federal state or local law. Borrower may,
however, contest in good faith the validity or amount of any such taxes,
assessments, levies or other such governmental charges provided that the Banks
may require Borrower to provide security with respect thereto in the form of a
bond, insurance, security deposit, cash reserve or other evidence satisfactory
to the Banks of Borrower's ability to pay and discharge such matter in the event
such contest is unsuccessful where the failure to provide such security would
result in the occurrence of a Material Adverse Event.
7.8 Notice of Default. Borrower will furnish to the Banks immediately
upon becoming actually aware of the existence of any event or condition that
constitutes an Event of Default, a written notice specifying the nature and
period of existence thereof and the action which it is taking or proposes to
take with respect thereto.
7.9 Other Notices. Borrower will promptly notify the Banks of (a) any
Material Adverse Effect, (b) any waiver, release or default under any
Significant Debt Agreement, (c) except as to any claim not covered as a result
of an insurance deductible provision, any claim not covered by insurance against
Borrower or any of Borrower's properties, and (d) the commencement of, and any
material determination in, any litigation with any third party or any proceeding
before any Governmental Authority affecting it, except litigation or proceedings
which, if adversely determined, would not have a Material Adverse Effect.
7.10 ERISA Compliance. With respect to its Plans, Borrower shall (a) at
all times comply with the minimum funding standards set forth in Section 302 of
ERISA and Section 412 of the Code or shall have duly obtained a formal waiver of
such compliance from the proper authority; (b) at the Banks' request, within
thirty (30) days after the filing thereof, furnish to the Banks copies of each
annual report/return (Form 5500 Series), as well as all schedules and
attachments required to be filed with the Department of Labor and/or the
Internal Revenue Service pursuant to ERISA, in connection with each of its Plans
for each year of the plan; (c) notify the
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Banks within a reasonable time of any fact, including, but not limited to, any
Reportable Event arising in connection with any of its Plans, which constitutes
grounds for termination thereof by the PBGC or for the appointment by the
appropriate United States District Court of a trustee to administer such Plan,
together with a statement, if requested by the Banks, as to the reason therefor
and the action, if any, proposed to be taken with respect thereto; and (d)
furnish to the Banks within a reasonable time, upon the Banks' request, such
additional information concerning any of its Plans as may be reasonably
requested.
7.11 Further Assurances. Borrower will make, execute or endorse, and
acknowledge and deliver or file or cause the same to be done, all such notices,
certifications and additional agreements, undertakings or other assurances, and
take any and all such other action, as the Banks may, from time to time, deem
reasonably necessary or proper to fully evidence the Loan.
7.12 Compliance with Significant Debt Agreements. Borrower will comply
in all material respects with all Significant Debt Agreements.
7.13 Compliance with Law. Borrower will comply with all applicable
laws, rules, regulations, and all final, nonappealable orders of any
Governmental Authority applicable to it or any of its property, business
operations or transactions, a breach of which could result in a Material Adverse
Effect.
7.14 Authorizations and Approvals. Borrower will promptly obtain, from
time to time at its own expense, all such governmental licenses, authorizations,
consents, permits and approvals as may be required to enable it to comply with
its obligations hereunder and under the other Credit Documents and to operate
its businesses as presently or hereafter duly conducted.
7.15 News Releases. Borrower shall forward to the Banks copies of all
news releases made by it to the news media as to anything of material
significance with respect to its financial status or its business operations or,
in each case, that of its Subsidiaries.
7.16 New Subsidiaries. Company shall promptly and diligently take all
actions necessary to cause any existing Subsidiary which is not a Co-Borrower
and that subsequently undertakes to conduct any business or operations and
qualifies as a Controlled Subsidiary, and any new Controlled Subsidiary (each a
"New Subsidiary") to become a Co-Borrower. Within thirty (30) days of being
acquired, or in the case of an existing Subsidiary within thirty (30) days of
the later of undertaking to conduct any business or operations or qualifying as
a Controlled Subsidiary, such New Subsidiary shall deliver to the Banks an
executed Assumption Agreement in the form attached hereto as Exhibit "D", and
such other documents as the Banks may reasonably request. The term "Co-Borrower"
shall mean that such Subsidiary shall be jointly liable, and each severally and
unconditionally liable, for the full payment and satisfaction of the Loans and
all other obligations of Borrower under this Credit Agreement.
7.17 Change in Control. Should there be a Change in Control, the Loans
shall be immediately due and payable.
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7.18 Year 2000 Compliance. Borrower shall perform all acts reasonably
necessary to ensure that (a) Borrower and any business in which Borrower holds a
substantial interest, and (b) all customers, suppliers and vendors whose
compliance is likely to be material to Borrower's business, become Year 2000
Compliant in a timely manner. Such acts shall include, without limitation,
performing a comprehensive review and assessment of all Borrower's systems and
adopting a detailed plan, with itemized budget, for the remediation, monitoring
and testing of such systems. As used in this paragraph, "Year 2000 Compliant"
shall mean, in regard to any entity, that all software, hardware, firmware,
equipment, goods or systems utilized by or material to the business operations
or financial condition of such entity, will properly perform date sensitive
functions before, during and after the year 2000. Borrower shall, immediately
upon request, provide to the Banks such certifications or other evidence of
Borrower's compliance with the terms of this paragraph as the Banks may from
time to time require.
7.19 Treasury Stock. Upon its sale of any of its treasury stock,
Borrower shall apply the net proceeds from such sale to the repayment of the
RLCT.
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ARTICLE 8
NEGATIVE COVENANTS
------------------
Until payment in full of the Notes and the performance of the
Obligation, and so long as any Bank has any Commitment outstanding to any
Borrower, the Company and, to the extent applicable, each Co-Borrower agrees
that:
8.1 No Debt. The Company shall not become or remain obligated either
directly or as a guarantor or surety for any Indebtedness for borrowed money, or
for any Indebtedness incurred in connection with the acquisition of any
property, real or personal, tangible or intangible including, but not limited
to, lease purchase agreements, except:
(a) Indebtedness to the Banks hereunder.
(b) Unsecured trade, utility or accounts payable arising in
the ordinary course of its business.
(c) Lease purchase agreements and purchase money security
interests not exceeding the sum of $3,000,000.00 in payments during any
fiscal year.
(d) Borrower's line of credit up to $350,000 with Barclays
Bank PLC (U.K.) secured by U.K. receivables and inventory.
(e) Indebtedness secured by liens permitted under Section 8.2
hereof.
8.2 Liens. On and after the date hereof, the Company will not create or
suffer to exist Liens upon its property, real or personal, including without
limitation its patents, copyrights and trademarks, except (i) Liens, if any, for
the benefit of the Banks, and (ii) Permitted Liens, including without limitation
those listed on Schedule 8.2 attached hereto.
8.3 Loans. It will not make any loan, advance, or direct extension of
credit in excess of $1,000,000.00, or, except as permitted under Section 8.10,
any investment (consisting of equity or debt convertible into equity) in excess
of $3,000,000.00, in aggregate on an annual basis to any person(s) or entities
other than in the ordinary course of business.
8.4 Dividends. It will not declare or pay any cash dividend.
8.5 Existence; Sale or Transfer of Assets. It will not (i) dissolve or
liquidate, or merge or consolidate with or into any corporation or entity, or
(ii) turn over the management or operation of its property, assets or businesses
to any other person, firm or corporation, or (iii) sell, lease, transfer or
dispose of more than $500,000.00 of its assets in any calendar year. The Company
will not transfer more than $100,000.00 in aggregate value per calendar year of
its assets that consist of accounts receivable or existing fixed assets located
in the U.S. to locations
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outside the U.S. Notwithstanding anything herein to the contrary, the Company
may transfer to locations outside the U.S. equipment purchased by the Company in
the U.S. with the sole intent to transfer it to its non-U.S. Subsidiaries.
8.6 Fiscal Year. It will not change the times of commencement or
termination of its fiscal year or other accounting periods; or change its
methods of accounting other than to conform to GAAP applied on a consistent
basis. After any such changes, its method of accounting shall conform to GAAP.
8.7 Margin Stock. Borrower shall not use any proceeds of the Loans, or
any proceeds of any other or future financial accommodation from the Banks for
the purpose, whether immediate, incidental or ultimate, of purchasing or
carrying any "margin stock" as that term is defined in Regulation U or to reduce
or retire any indebtedness undertaken for such purposes within the meaning of
said Regulation U, and will not use such proceeds in a manner that would involve
Borrower in a violation of Regulation U or of any other Regulation of the Board
of Governors of its Federal Reserve System, nor use such proceeds for any
purpose not permitted by Section 7 of the Exchange Act, as amended, or any of
the rules or regulations respecting the extensions of credit promulgated
thereunder.
8.8 Amendments to Organizational Documents. Borrower will not amend its
organizational documents if the result thereof could result in the occurrence
directly or indirectly of a Material Adverse Effect.
8.9 Treasury Stock. It will not make purchases of its common stock that
exceed in the aggregate $10,000,000.00 after August 1, 1998.
8.10 Investment in China. It will not make investments in land or other
real property, directly or indirectly through a Subsidiary, in the People's
Republic of China that exceed at any time in the aggregate $12,000,000.00.
8.11 Financial Covenants. It will not permit on a consolidated basis:
(a) Its Tangible Net Worth to be less than the Tangible Net
Worth Minimum at the end of any fiscal quarter.
(b) Its EBITDA Ratio to be more than 3.25 to 1.0 at the end of
any fiscal quarter.
(c) Its Debt Coverage Ratio to be less than 1.75 to 1.0 at the
end of any fiscal quarter.
(d) Its Current Ratio to be less than 1.50 to 1.0 at the end
of any fiscal quarter.
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(e) Its Net Income for any two consecutive fiscal quarters or
for any fiscal year to be less than zero (i.e. net loss).
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ARTICLE 9
EVENTS OF DEFAULT
-----------------
9.1 Events of Default. An "Event of Default" shall exist if any one or
more of the following events (herein collectively called "Events of Default")
shall occur and be continuing:
(a) Failure to pay any installment of principal or interest
under the Loans within five (5) Banking Days of when the same become
due and payable, or the failure to pay any other sum due under the
Loans or this Credit Agreement when the same shall become due and
payable and such failure continues for five (5) Banking Days after
notice thereof to Borrower;
(b) Any failure or neglect to perform or observe any of the
material terms, provisions, or covenants of this Credit Agreement
(other than a failure or neglect described in one or more of the other
provisions of this Section 9.1) and such failure or neglect either (i)
cannot be remedied, (ii) can be remedied within fifteen (15) days by
prompt and diligent action, but it continues unremedied for a period of
fifteen (15) days after notice thereof to Borrower, or (iii) can be
remedied, although not within fifteen (15) days even by prompt and
diligent action, but such remedy is not commenced within fifteen (15)
days after notice thereof to Borrower or is not diligently prosecuted
to completion within a total of forty-five (45) days from the date of
such notice;
(c) Any warranty, representation or statement contained in
this Agreement, or made or furnished to the Banks by or on behalf of
the Borrower, that shall be or shall prove to have been false in any
material respect when made or furnished;
(d) The occurrence of any "event of default" or "default" by
Borrower under any Credit Document or any agreement, now or hereafter
existing to which any Bank and Borrower are a party, after the
expiration of any notice and cure period;
(e) Borrower shall (i) fail to pay any Indebtedness of
Borrower (other than the Notes) due under any Significant Debt
Agreement, or any interest or premium thereon, when due (whether by
scheduled maturity, required prepayment, acceleration, demand, or
otherwise) or within any applicable grace period, (ii) fail to perform
or observe any term, covenant, or condition on its part to be performed
or observed under any agreement or instrument relating to such
Indebtedness, within any applicable grace period when required to be
performed or observed, if the effect of such failure to perform or
observe is to accelerate the maturity of such Indebtedness, or any such
Indebtedness shall be declared to be due and payable, or required to be
prepaid (other than by a regularly scheduled prepayment), prior
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to the stated maturity thereof, or (iii) allow the occurrence of any
material event of default with respect to such Indebtedness;
(f) Any one or more of the Credit Documents shall have been
determined to be invalid or unenforceable against Borrower executing
the same in accordance with the respective terms thereof, or shall in
any way be terminated or become or be declared ineffective or
inoperative, so as to deny the Banks the substantial benefits
contemplated by such Credit Document or Credit Documents;
(g) Borrower shall (i) apply for or consent to the appointment
of a receiver, trustee, custodian, intervenor or liquidator of itself
or of all or a substantial part of its assets, (ii) file a voluntary
petition in bankruptcy or admit in writing that it is unable to pay its
debts as they become due, (iii) make a general assignment for the
benefit of creditors, (iv) file a petition or answer seeking
reorganization of an arrangement with creditors or to take advantage of
any bankruptcy or insolvency laws, (v) file an answer admitting the
material allegations of, or consent to, or default in answering, a
petition filed against it in any bankruptcy, reorganization or
insolvency proceeding, or (vi) take corporate action for the purpose of
effecting any of the foregoing;
(h) An involuntary petition or complaint shall be filed
against Borrower, seeking bankruptcy or reorganization of Borrower, or
the appointment of a receiver, custodian, trustee, intervenor or
liquidator of Borrower, or all or substantially all of its assets, and
such petition or complaint shall not have been dismissed within sixty
(60) days of the filing thereof; or an order, order for relief,
judgment or decree shall be entered by any court of competent
jurisdiction or other competent authority approving a petition or
complaint seeking reorganization of Borrower, appointing a receiver,
custodian, trustee, intervenor or liquidator of Borrower, or all or
substantially all of its assets, and such order, judgment or decree
shall continue unstayed and in effect for a period of sixty (60) days;
(i) Any final judgment(s) (excluding those the enforcement of
which is suspended pending appeal) for the payment of money in excess
of the sum of $250,000.00 in the aggregate (other than any judgment
covered by insurance where coverage has been acknowledged by the
insurer) shall be rendered against Borrower, and such judgment or
judgments shall not be satisfied, settled, bonded or discharged at
least ten (10) days prior to the date on which any of its assets could
be lawfully sold to satisfy such judgment;
(j) Either (i) proceedings shall have been instituted to
terminate, or a notice of termination shall have been filed with
respect to, any Plans (other than a Multi-Employer Pension Plan as that
term is defined in Section 4001(a)(3) of ERISA) by Borrower, any member
of the Controlled Group, PBGC or any representative of any thereof, or
any such Plan shall be terminated, in each case
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under Section 4041 or 4042 of ERISA, and such termination shall give
rise to a liability of the Borrower or the Controlled Group to the PBGC
or the Plan under ERISA having an effect in excess of $500,000.00 or
(ii) a Reportable Event, the occurrence of which would cause the
imposition of a lien in excess of $500,000.00 under Section 4062 of
ERISA, shall have occurred with respect to any Plan (other than a
Multi-Employer Pension Plan as that term is defined in Section
4001(a)(3) of ERISA) and be continuing for a period of sixty (60) days;
(k) Any of the following events shall occur with respect to
any Multi- Employer Pension Plan (as that term is defined in Section
4001(a)(3) of ERISA) to which Borrower contributes or contributed on
behalf of its employees and the Required Banks determine in good faith
that the aggregate liability likely to be incurred by Borrower, as a
result of any of the events specified in Subsections (i), (ii) and
(iii) below, will have an effect in excess of $500,000.00; (i) Borrower
incurs a withdrawal liability under Section 4201 of ERISA; (ii) any
such plan is "in reorganization" as that term is defined in Section
4241 of ERISA; or (iii) any such Plan is terminated under Section 4041A
of ERISA;
(l) The occurrence of a Change in Control without the written
consent of the Banks;
(m) The dissolution, liquidation, sale, transfer, lease or
other disposal of all or substantially all of the assets or business of
Borrower;
(n) Any attachment, garnishment, levy or execution upon, or
judicial seizure of, any property of Borrower that has a fair market
value in excess of $500,000.00, that is not bonded or released within
thirty (30) days;
(o) The institution of any legal action or proceedings to
enforce a lien or security interest in any property of Borrower that
has a fair market value in excess of $500,000.00;
(p) The failure of Borrower to comply with any Financial
Covenant at the end of any fiscal quarter; or
(q) The occurrence of a Material Adverse Event if the Banks in
good faith shall believe that the prospect of payment or performance of
the Loans is impaired.
9.2 Remedies Upon Event of Default. If an Event of Default shall have
occurred and be continuing, then the Administrative Agent, at the request of the
Required Banks may, at their sole option, exercise any one or more of the
following rights and remedies, and any other remedies provided in any of the
Credit Documents, as the Required Banks in their sole discretion
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may deem necessary or appropriate, all of which remedies shall be deemed
cumulative, and not alternative:
(i) Cease making Advances or extensions of financial
accommodations in any form to or for the benefit of Borrower
and declare the principal of, and all interest then accrued
on, the Notes and any other liabilities hereunder to be
forthwith due and payable, whereupon the same shall become
immediately due and payable without presentment, demand,
protest, notice of default, notice of acceleration or of
intention to accelerate or other notice of any kind all of
which Borrower hereby expressly waives, anything contained
herein or in the Notes to the contrary notwithstanding;
(ii) Reduce any claim to judgment;
(iii) Without notice of default or demand, pursue and
enforce any of the Banks' and the Administrative Agent's
rights and remedies under the Credit Documents, or otherwise
provided under or pursuant to any applicable law or agreement;
(iv) Require the Borrower to deposit with the
Administrative Agent cash in an amount equal to the
Outstanding LC Balance;
provided, however, that if any Event of Default specified in Sections 9.1(g) and
9.1(h) shall occur, the principal of, and all interest on, the Notes and other
liabilities hereunder shall thereupon become due and payable concurrently
therewith, without any further action by the Banks and without presentment,
demand, protest, notice of default, notice of acceleration or of intention to
accelerate or other notice of any kind, all of which Borrower hereby expressly
waives.
Upon the occurrence and during the continuance of any Event of Default,
the Administrative Agent on behalf of the Banks, at the request of the Required
Banks is hereby authorized at any time and from time to time, without notice to
Borrower (any such notice being expressly waived by Borrower), to set off and
apply any and all moneys, securities or other property of Borrower and the
proceeds therefrom, now or hereafter held or received by or in transit to the
Banks or their agents, from or for the account of Borrower, whether for safe
keeping, custody, pledge, transmission, collection or otherwise, and also upon
any and all deposits (general or special) and credits of Borrower, and any and
all claims of Borrower against the Banks at any time existing. The Banks agree
to notify Borrower promptly after any such setoff and application, provided that
the failure to give such notice shall not affect the validity of such setoff and
application. The rights of the Banks under this Section are in addition to other
rights and remedies (including, without limitation, other rights of setoff)
which the Banks may have.
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9.3 Performance by the Banks. Should Borrower fail to perform any
covenant, duty or agreement with respect to the payment of taxes, obtaining
licenses or permits, or any other requirement contained herein or in any of the
Credit Documents within the period provided herein, if any, for correction of
such failure, the Banks may, at their option, perform or attempt to perform such
covenant, duty or agreement on behalf of Borrower. In such event, Borrower
shall, at the request of the Required Banks, promptly pay any amount expended by
the Banks and/or the Administrative Agent in such performance or attempted
performance to the Administrative Agent at its office in Inglewood, California,
together with interest thereon at the Default Rate, from the date of such
expenditure until paid. Notwithstanding the foregoing, it is expressly
understood that neither the Banks nor the Administrative Agent assume any
liability or responsibility for the performance of any duties of Borrower
hereunder or under any of the Credit Documents or other control over the
management and affairs of Borrower.
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ARTICLE 9A
ADMINISTRATIVE AGENT
--------------------
9A.1 Appointment and Authorization. Each Bank hereby irrevocably
appoints and authorizes the Administrative Agent to act on behalf of such Bank
to the extent provided herein or in any of the Credit Documents or any other
document or instrument delivered hereunder or in connection herewith, and to
take such other action as may be reasonably incidental thereto as determined by
Administrative Agent. The Banks agree that Borrower shall be entitled to rely
upon any communications to them by the Administrative Agent with respect to any
request or notice from, decision or consent of, the Banks.
9A.2 Exculpation. Administrative Agent shall be entitled to rely upon
advice of counsel concerning legal matters, and upon this Credit Agreement, any
Credit Documents and any schedule, certificate, statement, report, notice or
other writing which it believes to be genuine or to have been presented by a
proper person. Neither Administrative Agent nor any of its directors, officers,
employees, or agents shall (a) be responsible for any recitals, representations
or warranties contained in, or for the execution, validity, genuineness,
effectiveness or enforceability of, this Credit Agreement, any Credit Documents
or any other instrument or document delivered hereunder or in connection
herewith, (b) be under any duty to inquire into or pass upon any of the
foregoing matters, or to make any inquiry concerning the performance by the
Borrower or any other obligor of its obligations, or (c) in any event, be liable
as such for any action taken or omitted by it or them, except for its or their
own gross negligence or willful misconduct. The agency hereby created shall in
no way impair or affect any of the rights and powers of, or impose any duties or
obligations upon, Administrative Agent in its individual capacity.
9A.3 Administrative Agent and Affiliates. Administrative Agent has the
same rights and powers hereunder and under the Credit Documents as any other
Bank and may exercise the same as though it were not the Administrative Agent.
Administrative Agent and its Affiliates may accept deposits from, lend money to,
and generally engage in any kind of banking, trust or other business with
Borrower and any Affiliate of Borrower, as if it were not the Administrative
Agent and without any duty to account therefor to the Banks. Administrative
Agent need not account to any other Bank for any monies received by it for
reimbursement of its costs and expenses as Administrative Agent hereunder, or
for any monies received by it in its capacity as a Bank hereunder, except as
otherwise provided herein.
9A.4 Banks' Credit Decisions. Each Bank has made, and shall continue to
make, its own independent investigation or evaluation of the operations,
business, property and condition, financial and otherwise, of the Borrower, in
connection with the making of its respective Commitment, and each has made its
own appraisal of the creditworthiness of the Borrower. Except as explicitly
provided herein, the Administrative Agent has no duty or responsibility, either
initially or on a continuing basis, to provide any Bank with any credit or other
information with respect to such operations, business, property, condition or
creditworthiness, whether such information comes into its possession on or
before an Event of Default or at any time thereafter.
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Each Bank agrees and acknowledges that Administrative Agent makes no
representations or warranties about the creditworthiness of the Borrower or with
respect to the legality, validity, sufficiency or enforceability of this Credit
Agreement or any of the Credit Documents.
9A.5 Indemnification. Each Bank agrees to indemnify, hold harmless and
defend the Administrative Agent (to the extent not reimbursed by the Borrower),
ratably according to its Pro Rata Share, from and against any and all
liabilities, obligations, losses, damages, penalties, actions, judgments, suits,
costs, expenses or disbursements of any kind or nature whatsoever which may be
imposed on, incurred by or asserted against the Administrative Agent in any way
relating to or arising out of this Credit Agreement or the Credit Documents or
any action taken or omitted by the Administrative Agent under the Credit
Agreement or Credit Documents; provided, that no Bank shall be liable for any
portion of such liabilities, obligations, losses, damages, penalties, actions,
judgments, suits, costs, expenses or disbursements resulting from the
Administrative Agent's gross negligence or willful misconduct. Without
limitation of the foregoing, each Bank agrees to reimburse the Administrative
Agent promptly upon demand for its Pro Rata Share of any out-of-pocket expenses
(including, without limitation, attorney's fees and expenses) incurred by the
Administrative Agent in connection with the preparation, execution, delivery,
administration, modification, amendment or enforcement (whether through
negotiations, legal proceedings or otherwise) of, or legal advice in respective
rights or responsibilities under, this Credit Agreement and the Credit Documents
to the extent that the Administrative Agent is not reimbursed for such expenses
by the Borrower; provided, that no Bank shall be liable for any portion of any
such expenses resulting from the Administrative Agent's gross negligence or
willful misconduct.
9A.6 Administration.
(a) Administrative Agent shall administer and manage the Loans
in the ordinary course of its business and in accordance with its usual
practices and that degree of care it would use in administering,
managing, and servicing facilities of similar size and type for its own
account. Each Bank expressly agrees that, except as expressly otherwise
provided herein, Administrative Agent shall, in accordance with such
practices and degree of care, make any and all decisions and is hereby
authorized to do or cause to be done any and all acts regarding the
administration of the facilities in accordance with its sole and
absolute discretion.
(b) Unless in each case consented to in writing by all the
Banks, the Administrative Agent shall not (i) agree to the modification
or waiver of any of the terms of any of the Credit Documents, or (ii)
consent to any act or omission by the Borrower, or (iii) exercise any
rights which the Administrative Agent may have with respect to the
Loans, the Notes, or any of the other Credit Documents, if any such
agreement, consent or exercise would:
(i) change or modify the interest rate and repayment
provisions set forth in the Credit Documents;
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(ii) increase any Commitment;
(iii) extend the Maturity Date of any Loan;
(iv) postpone any date for payment or forgive the
payment of principal of, or interest on, the Loans or the
payment of any other sum due under the Credit Documents;
(v) change or modify or waive any Financial Covenant;
(vi) waive any Event of Default;
(vii) allow any assignment by Borrower of any right
or interest in the Credit Documents; or
(viii) release any Collateral.
(c) Other than upon the occurrence of an Event of Default
hereunder, any decision or consent required hereunder shall be made
jointly by the Banks and the Administrative Agent instructed
accordingly. Upon the occurrence of an Event of Default hereunder, the
Banks shall consult with each other and determine whether, and in what
manner and to what extent, any and all rights hereunder and under the
Credit Documents shall be exercised. The course of action so agreed
upon shall set forth what matters, if any, shall require the further
consent of the Banks and shall be carried out by Administrative Agent
in its name on behalf of the Banks.
(d) In the event that all or any portion of the Collateral is
acquired by the Administrative Agent on behalf of the Banks as a result
of the exercise of any remedies following an Event of Default
hereunder, or otherwise, title to any such Collateral or any portion
thereof shall be held in the name of the Administrative Agent or a
nominee or subsidiary of the Administrative Agent, in any case as
Administrative Agent, for the ratable benefit of the Banks. The
Administrative Agent, for the benefit of the Banks in accordance with
the course of action approved by the Banks, shall manage, operate,
repair, administer, complete, construct, restore or otherwise deal with
the Collateral so acquired and administer all transactions relating
thereto, including, without limitation, the employing of a managing
Administrative Agent and other Administrative Agents, contractors and
employees, including Administrative Agents for the sale of such
Collateral, or any portion thereof, and the collecting of any sums that
may come due from such Collateral, and the paying of expenses of such
Collateral. The Administrative Agent shall render, or cause to be
rendered by the managing Administrative Agent, to the Banks, monthly,
an income and expense statement for such Collateral. Each Bank shall
promptly contribute its Pro Rata Share of any operating loss for such
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Collateral, and such other expenses and operating reserves as
Administrative Agent shall deem reasonably necessary in accordance with
the course of action approved by the Banks. To the extent there is net
operating income from such Collateral, the Administrative Agent shall
make quarterly distributions to the Banks in accordance with their Pro
Rata Share.
(e) As to any matters which are subject to the consent of all
of the Banks, the Administrative Agent shall not be permitted or
required to exercise any discretion or take any action except with such
consent. The Administrative Agent shall be fully protected by the Banks
severally and in accordance with their respective Pro Rata Share in so
acting or in so refraining from action, but in no event shall the
Administrative Agent be required to take any action which exposes the
Administrative Agent to personal liability which is contrary to this
Credit Agreement or the Credit Documents or applicable law.
(f) All communications from the Administrative Agent to the
Banks requesting the Banks' determination, consent, approval or
disapproval shall be given in the form of a written notice to each Bank
containing (i) a reasonably detailed description of the matter or thing
as to which such determination, approval, consent or disapproval is
requested, accompanied by such information in Administrative Agent's
possession which, in Administrative Agent's opinion, is reasonably
relevant to such determination, approval, consent or disapproval, and
(ii) the course of action and determination recommended by the
Administrative Agent in respect thereof. Each Bank shall reply within
ten (10) Banking Days after such written notice is given by
Administrative Agent, and, if such reply is not so given by a Bank,
such course of action shall be deemed to have been approved by such
Bank.
9A.7 Default by a Bank. In the event that any Bank (the "Defaulting
Bank") fails to make timely payment to Administrative Agent of any sum due under
this Credit Agreement, including without limitation, such Bank's Pro Rata Share
of any Advance, Disbursement or liabilities, obligations, losses, damages,
penalties, actions, judgments, suits, costs and expenses or any other expenses
or amounts due Administrative Agent, the non-defaulting Bank may, but shall not
be required to, advance such amount and recover such amount on demand from the
Defaulting Bank, together with interest thereon at the Federal Funds Rate
commencing on the date such amount was made available to Administrative Agent
and ending on the date Administrative Agent recovers such amount. Until the full
repayment is made to Administrative Agent of such amount funded on behalf of the
Defaulting Bank together with interest thereon from the date advanced to the
date repaid by the Defaulting Bank at the Federal Funds Rate, the right of the
Defaulting Bank to participate in decisions or consents hereunder shall be
suspended and the entire interest in the Loans of the Defaulting Bank shall be
subordinated to the interest of the non-defaulting Bank and all payments or
recoveries on the Loans received by Administrative Agent from any source
whatsoever that would otherwise be credited by Administrative Agent to the
Defaulting Bank shall instead be credited to the non-defaulting Bank until full
repayment is made
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to the non-defaulting Bank. In addition, Administrative Agent shall be entitled
to exercise any and all remedies available to it at law or in equity against the
Defaulting Bank.
9A.8 Collections; Sharing of Payments.
(a) Administrative Agent, upon receipt, shall promptly
distribute in like funds as received to each Bank its Pro Rata Share of
all payments of principal, interest and fees received by Administrative
Agent on or with respect to the Loans, whether collected from Borrower,
or any security for the Loans, or otherwise, after first deducting any
costs, fees or other charges due Administrative Agent hereunder or
under the Credit Documents, with the exception of (i) any charge for
the administrative expenses of the Issuing Bank in connection with the
Letters of Credit paid by Borrower pursuant to Section 2.12, which
amounts shall be paid to the Issuing Bank, (ii) interest based on the
LIBOR Based Rate for purposes of distributions to the Banks other than
Imperial shall mean the rate per annum equal to the sum of LIBOR and
(A) as to an RLC Advance, one hundred seventy-five basis points (175
bp) and (B) as to an RLCT Advance, two hundred twenty-five basis points
(225 bp), and (iii) as to the RLC Non-Use Fee and the RLCT Non-Use Fee,
in each case 20 basis points (20 bp).
(b) If any Bank shall receive and retain any payment, whether
by set off, application of deposit balance or security, or otherwise,
in respect of the obligations of Borrower hereunder in excess of such
Bank's Pro Rata Share, then such Bank shall purchase from the other
Bank (for cash and at face value and without recourse) such
participation in the Loans held by it as shall be necessary to cause
such excess payment to be shared ratably as aforesaid with the other
Banks; provided, that if such excess payment or part thereof is
thereafter recovered from such purchasing Bank, the related purchases
from the other Bank shall be rescinded ratably and the purchase price
restored as to the portion of such excess payments so recovered, but
without interest.
9A.9 Successor Administrative Agent. The Administrative Agent may
resign at any time by giving written notice thereof to the Banks and the
Borrower. Borrower and the Banks agree to execute and deliver to such successor
Administrative Agent such documents and agreements as such successor
Administrative Agent may require to carry out the succession contemplated
herein.
9A.10 Issuing Bank. The Issuing Bank shall act on behalf of the Banks
with respect to any Letters of Credit Issued by it and the documents associated
therewith until such time and except for so long as the Administrative Agent may
agree at the request of all the Banks to act for such Issuing Bank with respect
thereto; provided, however, that the Issuing Bank shall have all of the benefits
and immunities (i) provided to the Administrative Agent in this Article 9A with
respect to any acts taken or omissions suffered by the Issuing Bank in
connection with Letters of Credit Issued by it or proposed to be Issued by it
and the application and agreements for letters
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of credit pertaining to the Letters of Credit as fully as if the term
"Administrative Agent," as used in this Article 9A, included the Issuing Bank
with respect to such acts or omissions, and (ii) as additionally provided in
this Credit Agreement with respect to the Issuing Bank.
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ARTICLE 10
MISCELLANEOUS
-------------
10.1 Modification. Except as otherwise required in Section 9A.6(b), all
modifications, consents, amendments or waivers of any provision of any Credit
Document, or consent to any departure by Borrower therefrom, shall be effective
only if the same shall be in writing and accepted by the Required Banks.
10.2 Waiver. No failure to exercise, and no delay in exercising, on the
part of the Banks, any right hereunder shall operate as a waiver thereof, nor
shall any single or partial exercise thereof preclude any other further exercise
thereof or the exercise of any other right. The rights of the Banks and
Administrative Agent hereunder and under the Credit Documents shall be in
addition to all other rights provided by law. No modification or waiver of any
provision of this Credit Agreement, the Notes or any Credit Documents, nor
consent to departure therefrom, shall be effective unless in writing and no such
consent or waiver shall extend beyond the particular case and purpose involved.
No notice or demand given in any case shall constitute a waiver of the right to
take other action in the same, similar or other instances without such notice or
demand.
10.3 Payment of Expenses. Borrower shall pay all costs and expenses of
the Banks and the Administrative Agent (including, without limitation,
reasonable attorneys' fees and costs) incurred by the Banks and the
Administrative Agent in connection with the documentation of the Loans, and the
preservation and enforcement of rights of the Banks and the Administrative Agent
under this Credit Agreement, the Notes, and/or the other Credit Documents;
provided, however, that notwithstanding the aforesaid, with respect to any legal
action between the parties hereto that is pursued to judgment the prevailing
party only shall be reimbursed by the other party for all costs and expenses
(including, without limitation, reasonable attorneys' fees and costs) incurred
in connection with the preservation and enforcement of its rights under this
Credit Agreement, the Notes and/or other Credit Documents. In addition, Borrower
shall pay all costs and expenses of the Banks and the Administrative Agent in
connection with the negotiation, preparation, execution and delivery of any and
all amendments, modifications and supplements of or to this Credit Agreement,
the Notes or any other Credit Document. In addition Borrower agrees to and shall
indemnify, hold harmless and defend the Banks from any liability, claims or
losses resulting from the disbursement of the proceeds of the Loans except for
their own gross negligence or willful misconduct. This provision shall survive
repayment of the Loans and shall continue in full force and effect so long as
the possibility of such liability, claims or losses exists.
10.4 Notices. Except for telephonic notices permitted herein, any
notices or other communications required or permitted to be given by this Credit
Agreement or any other documents and instruments referred to herein must be (i)
given in writing and personally delivered or mailed by prepaid certified or
registered mail, or (ii) made by telefacsimile delivered or transmitted, to the
party to whom such notice or communication is directed, to the address of such
party as follows:
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<PAGE>
Company: Three-Five Systems, Inc.
1600 North Desert Drive
Tempe, Arizona 85281-1212
Attention: Vice President - Administration
Telecopier: (602) 389-8836
Administrative Agent: Imperial Bank Arizona
One Arizona Center
400 East Van Buren
Suite 900
Phoenix, Arizona 85004
Attention: Kevin Halloran
Telecopier: (602) 261-7881
with a copy to: Imperial Bank
9920 South La Cienega Boulevard
Suite 636
Inglewood, California 90301
Attention: General Counsel
Telecopier: (310) 417-5695
Banks: See Schedule 1.1.
Any notice to be personally delivered may be delivered to the principal offices
(determined as of the date of such delivery) of the party to whom such notice is
directed. Any such notice or other communication shall be deemed to have been
given (whether actually received or not) on the day it is personally delivered
as aforesaid; or, if mailed, on the third day after it is mailed as aforesaid;
or, if transmitted by telefacsimile, on the day that such notice is transmitted
as aforesaid if sent before the end of the normal business hours of recipient.
Any party may change its address for purposes of this Credit Agreement by giving
notice of such change to the other parties pursuant to this Section. Any notice
required to be delivered by the Borrower to the Banks under the Credit Documents
shall be deemed to be so delivered if delivered to the Administrative Agent.
Borrower agrees that any notice required to be delivered by the Administrative
Agent and/or the Banks under the Credit Documents to the Borrower shall be
deemed to be so delivered if delivered to the Company.
10.5 Governing Law; Jurisdiction, Venue.
(a) The Credit Documents shall be governed by and construed in
accordance with the substantive laws (other than conflict laws) of the
State of Arizona, except to the extent the Banks has greater rights or
remedies under Federal law, whether as a national bank or otherwise, in
which case such choice of Arizona law shall not be deemed to deprive
the Banks of any such rights and remedies as may be available under
Federal law. Each party consents to the
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<PAGE>
personal jurisdiction and venue of the state courts located in Maricopa
County, State of Arizona in connection with any controversy related to
this Credit Agreement, waives any argument that venue in any such forum
is not convenient and agrees that any litigation initiated by any of
them in connection with this Credit Agreement shall be venued in the
Superior Court of Maricopa County, Arizona.
(b) Each Non-U.S. Subsidiary hereby appoints the Company as
its agent for the service of all process in the United States of
America.
10.6 Invalid Provisions. If any provision of any Credit Document is
held to be illegal, invalid or unenforceable under present or future laws during
the term of this Credit Agreement, such provision shall be fully severable; such
Credit Document shall be construed and enforced as if such illegal, invalid or
unenforceable provision had never comprised a part of such Credit Document; and
the remaining provisions of such Credit Document shall remain in full force and
effect and shall not be affected by the illegal, invalid or unenforceable
provision or by its severance from such Credit Document. Furthermore, in lieu of
each such illegal, invalid or unenforceable provision there shall be added as
part of such Credit Document a provision mutually agreeable to Borrower and the
Banks as similar in terms to such illegal, invalid or unenforceable provision as
may be possible and be legal, valid and enforceable.
10.7 Binding Effect. The Credit Documents shall be binding upon and
inure to the benefit of Borrower, the Banks and the Administrative Agent and
their respective successors, assigns and legal representatives; provided,
however, that Borrower may not, without the prior written consent of the Banks,
assign any rights, powers, duties or obligations thereunder.
10.8 Entirety. The Credit Documents embody the entire agreement between
the parties and supersede all prior agreements and understandings, if any,
relating to the subject matter hereof and thereof.
10.9 Relationship of the Banks and Borrower. The Banks and Borrower
each have separate and independent rights and obligations under this Credit
Agreement. Nothing contained herein shall be construed as creating, forming or
constituting any partnership, joint venture, merger or consolidation of Borrower
and the Banks for any purpose or in any respect.
10.10 Time of the Essence. Time is expressly made of the essence of
this Credit Agreement.
10.11 Good Faith Standard. Except where governed by a specific
provision of this Credit Agreement for a specific purpose, whenever the approval
or consent of the Banks is required hereunder, the Banks shall consider the
request for approval or consent on a timely basis, but the Banks shall have such
time as may be reasonably necessary to review and consider such request, as
determined in their sole judgment, and the Banks shall have the right to not
give their approval or consent or to impose such conditions or additional
requirements with respect to their approval or consent as the Banks in their
sole judgment shall determine. Approvals or consents by the
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Banks shall be effective only when given in writing, except when otherwise
specifically provided herein. The standard by which the Banks shall be governed
with respect to a request for approval or consent shall be "good faith" as that
term is defined in the Arizona Uniform Commercial Code.
10.12 Assignments and Participations; Transferees.
(a) This Credit Agreement shall be binding upon and inure to
the benefit of the parties hereto and their respective successors and
assigns, except that the Borrower may not assign its rights or
obligations hereunder, under any Note or under any other Credit
Document without the prior written consent of all of the Banks.
(b) Each Bank may at any time grant participations in any
portion of the Loans and Credit Documents owned by it to an Affiliate
of such Bank without the consent of the other Banks. Otherwise each
Bank may sell, assign, transfer or otherwise dispose of any portion of
its interest therein (each such grant of a participation or interest so
sold, assigned, transferred or disposed of being herein called a
"Transferred Interest") to other financial institutions ("Transferees")
only with the consent of the other Banks. In addition, each Bank may
pledge any portion of its Notes for security purposes to any Federal
Reserve Bank. Without in any way limiting the rights of Transferees
hereunder, the Borrower agrees that each Transferee shall be entitled
to the benefits of the Credit Documents to the extent of its
Transferred Interest as if it were the "Bank" in an aggregate amount
equal to such Transferred Interest, and that each Transferee may
exercise any and all rights of banker's lien, setoff and counterclaim
available pursuant to law with respect to its Transferred Interest as
fully as if such Transferee were a direct lender to the Borrower.
Borrower shall not be obligated to deal with or communicate with any
such participant.
(c) As to any such assignment to a Transferee, (i) each such
assignment shall be of a constant, and not a varying, percentage of all
the assigning Bank's rights and obligations under this Credit
Agreement, (ii) the amount of the Commitment of the assigning Bank
subject to each such assignment (determined as of the date the
Assignment and Acceptance with respect to such assignment is delivered
to the Administrative Agent) shall not be less than $1,000,000.00,
(iii) the amount of the Commitment retained by the assigning Bank,
unless the Assignment and Acceptance covers all or the remaining
portion of the assigning Bank's interest, rights and obligations under
this Credit Agreement, after each such assignment shall not be less
than $1,000,000.00, (iv) the parties to each such assignment shall
execute and deliver to the Administrative Agent an Assignment and
Acceptance, together with the Note or Notes subject to such assignment,
and (v) the Transferee, if it shall not be a Bank, shall deliver to the
Administrative Agent an Administrative Questionnaire. Upon acceptance
and recording pursuant to paragraph (f) of this Section, from and after
the effective date specified in each
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Assignment and Acceptance, (A) the Transferee thereunder shall be a
party hereto and shall become a "Bank" hereunder, and, to the extent of
the interest assigned by such Assignment and Acceptance, have all the
rights and obligations of a Bank under this Credit Agreement and (B)
the assigning Bank thereunder shall, to the extent of the interest
assigned by such Assignment and Acceptance, be released from its
obligations under this Credit Agreement (and, in the case of an
Assignment and Acceptance covering all or the remaining portion of an
assigning Bank's rights and obligations under this Credit Agreement,
such Bank shall cease to be a party hereto (but shall continue to be
entitled to the benefits of Sections 3.6, 3.7(b) and 10.3).
(d) By executing and delivering an Assignment and Acceptance,
the assigning Bank thereunder and the Transferee thereunder shall be
deemed to confirm to and agree with each other and the other parties
hereto as follows: (i) such assigning Bank warrants that it is the
legal and beneficial owner of the interest being assigned thereby free
and clear of any adverse claim and that its Commitment and the
outstanding balances of its Loans, without giving effect to assignments
thereof which have not become effective, are as set forth in such
Assignment and Acceptance, (ii) except as set forth in (i) above, such
assigning Bank makes no representation or warranty and assumes no
responsibility with respect to any statements, warranties or
representations made in or in connection with this Credit Agreement, or
the execution, legality, validity, enforceability, genuineness,
sufficiency or value of this Credit Agreement, any other Credit
Document or any other instrument or document furnished pursuant hereto
or the financial condition of the Borrower or the performance or
observance by the Borrower of any of its obligations under this Credit
Agreement, any other Credit Document or any other instrument or
document furnished pursuant hereto; (iii) such Transferee represents
and warrants that it is legally authorized to enter into such
Assignment and Acceptance; (iv) such Transferee confirms that it has
received a copy of this Credit Agreement, together with copies of the
most recent financial statements delivered pursuant to Section 7.1 and
such other documents and information as it has deemed appropriate to
make its own credit analysis and decision to enter into such Assignment
and Acceptance; (v) such Transferee will independently and without
reliance upon the Administrative Agent, such assigning Bank or any
other Bank and based on such documents and information as it shall deem
appropriate at the time, continue to make its own credit decisions in
taking or not taking action under this Credit Agreement; (vi) such
Transferee appoints and authorizes the Administrative Agent to take
such action as agent on its behalf and to exercise such powers under
this Credit Agreement as are delegated to the Administrative Agent by
the terms hereof, together with such powers as are reasonably
incidental thereto; and (vii) such Transferee agrees that it will
perform in accordance with their terms all the obligations which by the
terms of this Credit Agreement are required to be performed by it as a
Bank.
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(e) The Administrative Agent shall maintain at one of its
offices in Phoenix, Arizona, a copy of each Assignment and Acceptance
delivered to it and a register for the recordation of the names and
addresses of the Banks, and the Commitment of, and principal amount of
the Loans owing to, each Bank pursuant to the terms hereof from time to
time (the "Register"). The entries in the Register shall be conclusive
in the absence of manifest error and the Borrower, the Administrative
Agent and the Banks may treat each Person whose name is recorded in the
Register pursuant to the terms hereof as a Bank hereunder for all
purposes of this Credit Agreement. The Register shall be available for
inspection by the Borrower and any Bank, at any reasonable time and
from time to time upon reasonable prior notice.
(f) Upon its receipt of a duly completed Assignment and
Acceptance executed by an assigning Bank and an Transferee together
with the Note or Notes subject to such assignment, an Administrative
Questionnaire completed in respect of the Transferee (unless the
Transferee shall already be a Bank hereunder), the Administrative Agent
shall (i) accept such Assignment and Acceptance, (ii) record the
information contained therein in the Register, and (iii) give prompt
notice thereof to the Banks. Within five Banking Days after receipt of
notice, the Borrower, as applicable, shall execute and deliver to the
Administrative Agent, in exchange for the surrendered Note or Notes, a
new Note or Notes to the order of such assigning Bank in a principal
amount equal to the applicable Commitment retained by it. Such new Note
or Notes shall be in an aggregate principal amount equal to the
aggregate principal amount of such surrendered Note or Notes; such new
Notes shall be dated the date of the surrendered Notes which they
replace and shall otherwise be in substantially the applicable form of
Exhibit "C" hereto.
10.13 Headings. Section headings are for convenience of reference only
and shall in no way affect the interpretation of this Credit Agreement.
10.14 Survival. All representations and warranties made by Borrower
herein shall survive delivery of the Notes and the making of the Loans.
10.15 No Third Party Beneficiary. The parties do not intend the
benefits of this Credit Agreement to inure to any third party, nor shall this
Credit Agreement be construed to make or render the Banks and the Administrative
Agent liable to any materialman, supplier, contractor, subcontractor, purchaser
or lessee of any property owned by Borrower, or for debts or claims accruing to
any such persons against Borrower. Notwithstanding anything contained herein or
in the Notes, or in any other Credit Document, or any conduct or course of
conduct by any or all of the parties hereto, before or after signing this Credit
Agreement or any of the other Credit Documents, neither this Credit Agreement
nor any other Credit Document shall be construed as creating any right, claim or
cause of action against the Banks and the Administrative Agent, or any of their
officers, directors, agents or employees, in favor of any materialman, supplier,
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contractor, subcontractor, purchaser or lessee of any property owned by
Borrower, nor to any other person or entity other than Borrower.
10.16 Joint Liability.
(a) The Company and the Co-Borrowers each: (a) agrees that the
liability hereunder of all parties hereto is joint and several; and (b)
consents that the Banks may extend the time of payment or otherwise
modify the terms of payment of any part or the whole of the debt
evidenced hereby, at the request of any other person liable hereon, and
such consent shall not alter nor diminish the liability of any person
hereon.
(b) In addition, the Company and the Co-Borrowers each waives
and agrees not to assert: (a) any right to require the Banks to proceed
against the obligations, to proceed against or exhaust any security for
the obligations, to pursue any other remedy available to the Banks, or
to pursue any remedy in any particular order or manner; (b) the benefit
of any statute of limitations affecting its liability hereunder or the
enforcement hereof; (c) the benefits of any legal or equitable doctrine
or principle of marshalling; (d) notice of the existence, creation or
incurring of new or additional indebtedness of Borrower to the Banks;
(e) the benefits of any statutory provision limiting the liability of a
surety, including without limitation the provisions of Sections
12-1641, et seq., of the Arizona Revised Statutes; (f) any defense
arising by reason of any disability or other defense of Borrower or by
reason of the cessation from any cause whatsoever (other than payment
in full) of the liability of Borrower for payment of any other party
hereto; and (g) the benefits of any statutory provision limiting the
right of the Banks to recover a deficiency judgment, or to otherwise
proceed against any person or entity obligated for payment of the
obligations, after any foreclosure or trustee's sale of any security
for the obligations, including without limitation the benefits, if any,
to a surety of Arizona Revised Statutes Section 33-814. Until payment
in full of the obligations and the Banks have no obligation to make any
further advances of the proceeds hereof, no party shall have any right
of subrogation and each hereby waives any right to enforce any remedy
which the Banks now have, or may hereafter have, against Borrower or
any other party, and waives any benefit of, and any right to
participate in, any security now or hereafter held by the Banks.
10.17 Schedules and Exhibits Incorporated. All schedules and exhibits
attached hereto are hereby incorporated into this Credit Agreement by each
reference thereto as if fully set forth at each such reference.
10.18 Waiver of Jury Trial. EACH PARTY HERETO HEREBY KNOWINGLY,
VOLUNTARILY, AND INTENTIONALLY WAIVES ANY RIGHTS IT MAY HAVE TO REQUIRE A TRIAL
BY JURY IN ANY COURT ACTION PERTAINING TO OBLIGATIONS
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SECURED OR THE CREDIT DOCUMENTS OR THE COLLATERAL, AND AGREES THAT ANY SUCH
ACTION OR PROCEEDING SHALL BE TRIED BEFORE A COURT AND NOT BEFORE A JURY.
10.19 Counterparts. This Credit Agreement may be executed in multiple
counterparts, each of which, when so executed, shall be deemed an original but
all such counterparts shall constitute but one and the same agreement.
IN WITNESS WHEREOF, the undersigned have executed this Credit Agreement
as of the day and year first above written.
THREE-FIVE SYSTEMS, INC., a Delaware
corporation
By: /s/ Jeffrey D. Buchanan
--------------------------------
Name: Jeffrey D. Buchanan
-------------------------------
Title: Executive Vice President
------------------------------
COMPANY
THREE-FIVE SYSTEMS (BEIJING), LTD.,
a wholly foreign owned enterprise
organized under the laws of the
People's Republic of China.
By: /s/ Jeffrey D. Buchanan
--------------------------------
Name: Jeffrey D. Buchanan
-------------------------------
Title: Authorized Agent
------------------------------
THREE-FIVE SYSTEMS PACIFIC, INC., a
Philippine corporation
By: /s/ Jeffrey D. Buchanan
--------------------------------
Name: Jeffrey D. Buchanan
-------------------------------
Title: Authorized Agent
------------------------------
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THREE-FIVE SYSTEMS, LIMITED, a
corporation organized under the laws
of the United Kingdom
By: /s/ Jeffrey D. Buchanan
--------------------------------
Name: Jeffrey D. Buchanan
-------------------------------
Title: Authorized Agent
------------------------------
CO-BORROWERS
IMPERIAL BANK ARIZONA, an Arizona
banking corporation
By: /s/ Kevin C. Halloran
--------------------------------
Name: Kevin C. Halloran
-------------------------------
Title: Senior Vice President
------------------------------
AGENT AND BANK
NATIONAL BANK OF CANADA
By: /s/ R. A. McKerroll
--------------------------------
Name: R. A. McKerrol
-------------------------------
Title: Vice President
------------------------------
By: /s/ John Curry
--------------------------------
Name: John Curry
-------------------------------
Title: Vice President
------------------------------
BANK
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EXHIBIT "C"
FORM OF NOTES
-------------
<PAGE>
EXHIBIT "C-1"
REVOLVING PROMISSORY NOTE
(RLC)
$_______________ Phoenix, Arizona
______________, 1998
FOR VALUE RECEIVED, the undersigned (hereinafter called "Maker"),
promises to pay to the order of ______________________________________________
(the "Payee"; Payee and each subsequent transferee and/or owner of this Note,
whether taking by endorsement or otherwise, are herein successively called
"Holder"), at Imperial Bank, 9920 South La Cienega Boulevard, Lending Services,
Inglewood, California 90301, or at such other place as Holder may from time to
time designate in writing, the principal sum of ____________________
___________________________ AND NO/100 DOLLARS ($_____________) or so much
thereof as Holder may advance to or for the benefit of Maker plus interest
calculated on a daily basis (based on a 360-day year) from the date hereof on
the principal balance from time to time outstanding as hereinafter provided,
principal, interest and all other sums payable hereunder to be paid in lawful
money of the United States of America as follows:
1 Interest shall accrue:
1.1 On the unpaid principal of an RLC Advance at the
Variable Rate, except to the extent that an RLC Advance bears
interest at the LIBOR Based Rate.
1.2 On the unpaid principal of an RLC Advance at the
LIBOR Based Rate, to the extent Borrower shall elect and to
the extent not otherwise provided in the Credit Agreement.
2 All accrued interest shall be due and payable on each
Payment Date.
3 The entire unpaid principal balance, all accrued and unpaid
interest, and all other amounts payable hereunder shall be due and
payable in full on the RLC Maturity Date.
The "Variable Rate" means the rate per annum equal to the Prime Rate
per annum as in effect from time to time; the Variable Rate shall change on each
day that the "Prime Rate" changes. The LIBOR Based Rate means the rate per annum
equal (A) to the sum of LIBOR and one hundred seventy-five basis points (175
bp), divided by (B) a percentage equal to one hundred percent (100%) minus the
Eurodollar Rate Reserve Percentage with respect to the applicable LIBOR Interest
Period. The "RLC Maturity Date" means May 22, 2000.
<PAGE>
The principal balance of this Note represents a revolving credit all or
any part of which may be advanced to Maker, repaid by Maker, and re-advanced to
Maker from time to time, subject to the other terms hereof and the conditions,
if any, contained in the Credit Agreement, and provided that the principal
balance outstanding at any one time shall not exceed the face amount hereof.
Maker agrees to an effective rate of interest that is the rate stated
above plus any additional rate of interest resulting from any other charges in
the nature of interest paid or to be paid by or on behalf of Maker, or any
benefit received or to be received by Holder, in connection with this Note.
This Note is issued pursuant to that Credit Agreement dated as of
November 5, 1998 (the "Credit Agreement") between Maker, the Banks named therein
and Imperial Bank Arizona, an Arizona banking corporation as Agent and is
secured by the Security Documents. Capitalized terms used and not otherwise
defined herein shall have the meanings assigned to such terms in the Credit
Agreement.
Time is of the essence of this Note.
Maker shall pay all costs and expenses, including reasonable attorneys'
fees and court costs, incurred in the collection or enforcement of all or any
part of this Note. All such costs and expenses shall be secured by the Security
Documents.
Failure of Holder to exercise any option hereunder shall not constitute
a waiver of the right to exercise the same in the event of any subsequent
default or in the event of continuance of any existing default after demand for
strict performance hereof.
Maker and all sureties, guarantors and/or endorsers hereof (or of any
obligation hereunder) and accommodation parties hereon (severally each
hereinafter called a "Surety") each: (a) agree that the liability under this
Note of all parties hereto is joint and several; (b) severally waive any and all
formalities in connection with this Note to the maximum extent allowed by law,
including (but not limited to) demand, diligence, presentment for payment,
protest and demand, and notice of extension, dishonor, protest, demand and
nonpayment of this Note; and (c) consent that Holder may extend the time of
payment or otherwise modify the terms of payment of any part or the whole of the
debt evidenced by this Note, at the request of any other person liable hereon,
and such consent shall not alter nor diminish the liability of any person
hereon.
This Note shall be binding upon Maker and its successors and assigns
and shall inure to the benefit of Payee, and any subsequent holders of this
Note, and their successors and assigns.
All notices required or permitted in connection with this Note shall be
given at the place and in the manner provided in the Credit Agreement for the
giving of notices.
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<PAGE>
If any payment of interest and/or principal is not received by the
Holder hereof when such payment is due, then in addition to the remedies
conferred upon the Holder hereof and the other loan documents, a late charge of
five percent (5%) of the amount of the installment due and unpaid will be added
to the delinquent amount to compensate the Holder hereof for the expense of
handling the delinquency for any payment past due in excess of ten (10) days,
regardless of any notice and cure period.
In any action brought under or arising out of this Note, each obligor,
including successor(s) or assign(s), hereby consents to the application of
Arizona law, with the exception of provisions on conflicts of laws, to the
jurisdiction of any competent court within the State of Arizona, and to service
of process by any means authorized by Arizona law.
This Note may be executed in multiple counterparts, each of which, when
so executed, shall be deemed an original but all such counterparts shall
constitute but one and the same instrument.
IN WITNESS WHEREOF, these presents are executed as of the date first
written above.
THREE-FIVE SYSTEMS, INC., a Delaware
corporation
By:
--------------------------------
Name:
-------------------------------
Its:
------------------------------
THREE-FIVE SYSTEMS (BEIJING), LTD.,
a wholly foreign owned enterprise
organized under the laws of the
People's Republic of China.
By:
--------------------------------
Name:
-------------------------------
Its:
------------------------------
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<PAGE>
THREE-FIVE SYSTEMS PACIFIC, INC., a
Philippine corporation
By:
--------------------------------
Name:
-------------------------------
Its:
------------------------------
THREE-FIVE SYSTEMS, LIMITED, a
corporation organized under the laws
of the United Kingdom
By:
--------------------------------
Name:
-------------------------------
Its:
------------------------------
MAKER
-4-
<PAGE>
EXHIBIT "C-2"
REVOLVING PROMISSORY NOTE
(RLCT)
$_____________ Phoenix, Arizona
______________, 1998
FOR VALUE RECEIVED, the undersigned (hereinafter called "Maker"),
promises to pay to the order of ______________________________________________
(the "Payee"; Payee and each subsequent transferee and/or owner of this Note,
whether taking by endorsement or otherwise, are herein successively called
"Holder"), at Imperial Bank, 9920 South La Cienega Boulevard, Lending Services,
Inglewood, California 90301, or at such other place as Holder may from time to
time designate in writing, the principal sum of __________________________
_____________________________ AND NO/100 DOLLARS ($__________) or so much
thereof as Holder may advance to or for the benefit of Maker plus interest
calculated on a daily basis (based on a 360-day year) from the date hereof on
the principal balance from time to time outstanding as hereinafter provided,
principal, interest and all other sums payable hereunder to be paid in lawful
money of the United States of America as follows:
4 Interest shall accrue:
4.1 On the unpaid principal of an RLCT Advance at the
Variable Rate, except to the extent that an RLCT Advance bears
interest at the LIBOR Based Rate.
4.2 On the unpaid principal of an RLCT Advance at the
LIBOR Based Rate, to the extent Borrower shall elect and to
the extent not otherwise provided in the Credit Agreement.
5 All accrued interest shall be due and payable on each
Payment Date.
6 Principal hereunder shall be due and payable on each RLCT
Principal Date, beginning with the first RLCT Principal Date after the
RLCT Termination Date, in an amount sufficient to fully amortize the
principal balance of the RLCT on the RLCT Termination Date over twenty
equal payments of such principal. The entire unpaid principal balance,
all accrued and unpaid interest, and all other amounts payable
hereunder shall be due and payable in full on the RLCT Maturity Date.
The "Variable Rate" means the rate per annum equal to the Prime Rate
per annum as in effect from time to time; the Variable Rate shall change on each
day that the "Prime Rate" changes. The LIBOR Based Rate means the rate per annum
equal (A) to the sum of LIBOR and
<PAGE>
two hundred thirty-seven and one-half basis points (237.5 bp), divided by (B) a
percentage equal to one hundred percent (100%) minus the Eurodollar Rate Reserve
Percentage with respect to the applicable LIBOR Interest Period. The "RLCT
Maturity Date" means August 5, 2004.
The principal balance of this Note represents a revolving credit all or
any part of which may be advanced to Maker, repaid by Maker, and re-advanced to
Maker from time to time, subject to the other terms hereof and the conditions,
if any, contained in the Credit Agreement, and provided that the principal
balance outstanding at any one time shall not exceed the face amount hereof.
Maker agrees to an effective rate of interest that is the rate stated
above plus any additional rate of interest resulting from any other charges in
the nature of interest paid or to be paid by or on behalf of Maker, or any
benefit received or to be received by Holder, in connection with this Note.
This Note is issued pursuant to that Credit Agreement dated as of
November 5, 1998 (the "Credit Agreement") between Maker, the Banks named therein
and Imperial Bank Arizona, an Arizona banking corporation as Agent and is
secured by the Security Documents. Capitalized terms used and not otherwise
defined herein shall have the meanings assigned to such terms in the Credit
Agreement.
Time is of the essence of this Note.
Maker shall pay all costs and expenses, including reasonable attorneys'
fees and court costs, incurred in the collection or enforcement of all or any
part of this Note. All such costs and expenses shall be secured by the Security
Documents.
Failure of Holder to exercise any option hereunder shall not constitute
a waiver of the right to exercise the same in the event of any subsequent
default or in the event of continuance of any existing default after demand for
strict performance hereof.
Maker and all sureties, guarantors and/or endorsers hereof (or of any
obligation hereunder) and accommodation parties hereon (severally each
hereinafter called a "Surety") each: (a) agree that the liability under this
Note of all parties hereto is joint and several; (b) severally waive any and all
formalities in connection with this Note to the maximum extent allowed by law,
including (but not limited to) demand, diligence, presentment for payment,
protest and demand, and notice of extension, dishonor, protest, demand and
nonpayment of this Note; and (c) consent that Holder may extend the time of
payment or otherwise modify the terms of payment of any part or the whole of the
debt evidenced by this Note, at the request of any other person liable hereon,
and such consent shall not alter nor diminish the liability of any person
hereon.
This Note shall be binding upon Maker and its successors and assigns
and shall inure to the benefit of Payee, and any subsequent holders of this
Note, and their successors and assigns.
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<PAGE>
All notices required or permitted in connection with this Note shall be
given at the place and in the manner provided in the Credit Agreement for the
giving of notices.
If any payment of interest and/or principal is not received by the
Holder hereof when such payment is due, then in addition to the remedies
conferred upon the Holder hereof and the other loan documents, a late charge of
five percent (5%) of the amount of the installment due and unpaid will be added
to the delinquent amount to compensate the Holder hereof for the expense of
handling the delinquency for any payment past due in excess of ten (10) days,
regardless of any notice and cure period.
In any action brought under or arising out of this Note, each obligor,
including successor(s) or assign(s), hereby consents to the application of
Arizona law, with the exception of provisions on conflicts of laws, to the
jurisdiction of any competent court within the State of Arizona, and to service
of process by any means authorized by Arizona law.
This Note may be executed in multiple counterparts, each of which, when
so executed, shall be deemed an original but all such counterparts shall
constitute but one and the same instrument.
IN WITNESS WHEREOF, these presents are executed as of the date first
written above.
THREE-FIVE SYSTEMS, INC., a Delaware
corporation
By:
--------------------------------
Name:
-------------------------------
Its:
------------------------------
THREE-FIVE SYSTEMS (BEIJING), LTD.,
a wholly foreign owned enterprise
organized under the laws of the
People's Republic of China
By:
--------------------------------
Name:
-------------------------------
Its:
------------------------------
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<PAGE>
THREE-FIVE SYSTEMS PACIFIC, INC., a
Philippine corporation
By:
--------------------------------
Name:
-------------------------------
Its:
------------------------------
THREE-FIVE SYSTEMS, LIMITED, a
corporation organized under the laws
of the United Kingdom
By:
--------------------------------
Name:
-------------------------------
Its:
------------------------------
MAKER
-4-
SECURITY AGREEMENT
THIS SECURITY AGREEMENT is made and entered into as of the 5th day of
November, 1998, by THREE-FIVE SYSTEMS, INC., a Delaware corporation (hereinafter
called "Debtor"), whose chief executive office is located at 1600 North Desert
Drive, Tempe, Arizona 85281-1212, in favor of IMPERIAL BANK ARIZONA, an Arizona
banking corporation, as Agent for the Banks listed in the hereinafter defined
Credit Agreement and for the Issuing Bank (as defined in the Credit Agreement)
and its successors and assigns (hereinafter called "Secured Party"), whose
address is 400 East Van Buren, Suite 900, Phoenix, Arizona 85004.
1. SECURITY INTEREST
Debtor hereby grants to Secured Party a security interest (hereinafter
called the "Security Interest") in all of Debtor's right, title and interest in
and to the personal property described on Schedule A attached hereto (the
"Collateral").
2. OBLIGATION SECURED
The Security Interest shall secure, in such order of priority as
Secured Party may elect:
(a) Payment of the sum of $15,000,000.00 according to the
terms of that Revolving Promissory Note (RLC) dated November 5, 1998,
made by Debtor and all present and future Subsidiaries (collectively,
the "Borrower"), payable to the order of Secured Party, evidencing a
revolving line of credit, all or any part of which may be advanced to
Borrower, repaid by Borrower and readvanced to Borrower, from time to
time, subject to the terms and conditions thereof, with interest
thereon, extension and other fees, late charges and attorneys' fees,
according to the terms thereof, and all extensions, modifications,
renewals, restatements or replacements thereof (hereinafter called the
"RLC Note");
(b) Payment of the sum of $10,000,000.00 according to the
terms of that Revolving Promissory Note (RLCT) dated November 5, 1998,
made by Borrower, payable to the order of Secured Party, evidencing a
revolving line of credit, all or any part of which may be advanced to
Borrower, repaid by Borrower and readvanced to Borrower, from time to
time, subject to the terms and conditions thereof, with interest
thereon, extension and other fees, late charges and attorneys' fees,
according to the terms thereof, and all extensions, modifications,
renewals, restatements or replacements thereof (together with the RLC
Note, hereinafter called the "Note");
(c) Payment, performance and observance by Debtor of each
covenant, condition, provision and agreement contained herein and of
all monies expended or advanced by Secured Party pursuant to the terms
hereof, or to preserve any right
<PAGE>
of Secured Party hereunder, or to protect or preserve the Collateral or
any part thereof; and
(d) Payment, performance and observance by Debtor of each
covenant, condition, provision and agreement contained in that Credit
Agreement dated November 5, 1998, by and between Borrower, the Banks
and Secured Party as agent for the Banks and the Issuing Bank (as
extended, modified, renewed, restated or replaced hereinafter called
the "Credit Agreement") and in any other document or instrument related
to the indebtedness described in subparagraph (a) above and of all
monies expended or advanced by Secured Party pursuant to the terms
thereof or to preserve any right of Secured Party thereunder.
All of the indebtedness and obligations secured by this Agreement are
hereinafter collectively called the "Obligation."
3. USE; LOCATION; CONSTRUCTION
3.1 The Collateral is or will be used or produced primarily for
business purposes.
3.2 The Collateral will be kept at Debtor's address set forth at the
beginning of this Agreement and/or at the location(s) listed on Schedule B, if
any, attached hereto.
3.3 Debtor's records concerning the Collateral will be kept at Debtor's
address set forth at the beginning of this Agreement and/or at the location(s)
listed on Schedule B, if any, attached hereto.
4. REPRESENTATIONS AND WARRANTIES OF DEBTOR
Debtor hereby represents and warrants that:
4.1 Debtor is the owner of the Collateral free of all security
interests or other encumbrances except the Security Interest and Permitted Liens
(as defined in the Credit Agreement) and no financing statement covering the
Collateral is filed or recorded in any public office except with respect to any
Permitted Liens.
4.2 The Collateral is, and is intended to be, used, produced or
acquired by Debtor for use primarily for business purposes. The address of
Debtor set forth at the beginning of this Agreement is the chief executive
office of Debtor.
4.3 Each material account, chattel paper or general intangible included
in the Collateral is genuine and enforceable in accordance with its terms
against the party named therein who is obligated to pay the same (hereinafter
called "Obligor"), and the security interests that are part of each item of
chattel paper included in the Collateral are valid, first and prior perfected
security interests. To the knowledge of Debtor, each material Obligor is
solvent, and the amount that
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<PAGE>
Debtor has represented to Secured Party as owing by each such Obligor is the
amount actually and unconditionally owing by that Obligor, without deduction
except for normal cash discounts where applicable; to the knowledge of Debtor no
material Obligor has any defense, setoff, claim or counterclaim against Debtor
that can be asserted against Secured Party whether in any proceeding to enforce
the Security Interest or otherwise. Each document, instrument and chattel paper
included in the Collateral is materially complete and regular on its face and
free from evidence of forgery or alteration. No material default has occurred in
connection with any instrument, document or chattel paper included in the
Collateral, no payment in connection therewith is materially overdue and no
presentment, dishonor or protest has occurred in connection therewith.
5. COVENANTS OF DEBTOR
5.1 Except as otherwise permitted in the Credit Agreement, and except
as to its inventory which may be sold in the ordinary course of business, Debtor
shall not sell, transfer, assign or otherwise dispose of any Collateral or any
interest therein (except as permitted herein) without obtaining the prior
written consent of Secured Party and shall keep the Collateral free of all
security interests or other encumbrances except the Security Interest and any
Permitted Liens; provided however that Debtor may sell, transfer, assign or
otherwise dispose of any Collateral ("Disposed Collateral") or any interest
thereon without obtaining the prior written consent of Secured Party so long as
(i) Debtor is doing so in the ordinary course of business, (ii) the book value
of any such Disposed Collateral does not exceed $5,000.00, and (iii) the
aggregate book value of all such Disposed Collateral does not exceed $100,000.00
in any fiscal year. Although proceeds of Collateral are covered by this
Agreement, this shall not be construed to mean that Secured Party consents to
any sale of the Collateral.
5.2 Debtor shall keep and maintain the Collateral in good condition and
repair and shall not use the Collateral in violation of any provision of this
Agreement or any applicable statute, ordinance or regulation or any policy of
insurance insuring the Collateral.
5.3 Debtor shall provide and maintain insurance insuring the Collateral
against risks, with coverage and in form and amount satisfactory to Secured
Party. At Secured Party's request, Debtor shall deliver to Secured Party the
original policies of insurance containing endorsements naming Secured Party as a
loss payee.
5.4 Debtor shall pay when due all taxes, assessments and other charges
which may be levied or assessed against the Collateral.
5.5 Debtor shall prevent any portion of the Collateral that is not a
fixture from being or becoming a fixture and shall prevent any portion of the
Collateral from being or becoming an accession to other goods that are not part
of the Collateral.
5.6 Debtor shall keep all titled vehicles properly registered with and
licensed, shall provide Secured Party with the license numbers of all titled
vehicles, and if requested by Secured Party shall cause the Security Interest to
be shown as a valid first lien on the Certificate of Title.
-3-
<PAGE>
5.7 Debtor, upon demand, shall promptly deliver to Secured Party all
instruments, documents and chattel paper included in the Collateral and all
invoices, shipping or delivery records, purchase orders, contracts or other
items related to the Collateral. Debtor shall notify Secured Party immediately
of any material default by any Obligor in the payment or performance of its
obligations with respect to any Collateral.
5.8 Debtor shall give Secured Party immediate written notice of any
change in the location of: (i) Debtor's chief executive office; (ii) except as
its transfer is permitted under the Credit Agreement, the Collateral or any part
thereof; or (iii) Debtor's records concerning the Collateral.
5.9 After reasonable notice by Secured Party, Secured Party or its
agents may inspect the Collateral at reasonable times and may enter into any
premises where the Collateral is or may be located. Debtor shall keep records
concerning the Collateral in accordance with generally accepted accounting
principles. Secured Party shall have free and complete access to Debtor's
records and shall have the right to make extracts therefrom or copies thereof.
Upon request of Secured Party from time to time, Debtor shall submit up-to-date
schedules of the items comprising the Collateral in such detail as Secured Party
may require.
5.10 Debtor, at its reasonable cost and expense, shall protect and
defend this Agreement, all of the rights of Secured Party hereunder, and the
Collateral against all claims and demands of other parties, including without
limitation defenses, setoffs, claims and counterclaims asserted by any Obligor
against Debtor and/or Secured Party. Debtor shall pay all claims and charges
that in the reasonable opinion of Secured Party might prejudice, imperil or
otherwise affect the Collateral or the Security Interest. Debtor shall promptly
notify Secured Party of any levy, distraint or other seizure by legal process or
otherwise of any part of the Collateral and of any threatened or filed claims or
proceedings that might in any way affect or impair the terms of this Agreement.
5.11 The Security Interest, at all times, shall be perfected and except
for Permitted Liens shall be prior to any other interests in the Collateral.
Debtor shall act and perform as necessary and shall execute and file all
security agreements, financing statements, continuation statements and other
documents requested by Secured Party to establish, maintain and continue the
perfected Security Interest. Debtor, on demand, shall promptly pay all
reasonable costs and expenses of filing and recording, including the costs of
any searches, deemed reasonably necessary by Secured Party from time to time to
establish and determine the validity and the continuing priority of the Security
Interest.
5.12 If Debtor shall fail to pay any taxes, assessments, expenses or
charges, to keep all of the Collateral free from other security interests,
encumbrances or claims, to keep the Collateral in good condition and repair, to
procure and maintain insurance thereon, or to perform otherwise as required
herein, Secured Party may advance the monies necessary to pay the same, to
accomplish such repairs, to procure and maintain such insurance or to so
perform; after reasonable notice by Secured Party to Debtor, Secured Party is
hereby authorized to enter upon any property in the possession or control of
Debtor for such purposes.
-4-
<PAGE>
5.13 All rights, powers and remedies granted Secured Party herein, or
otherwise available to Secured Party, are for the sole benefit and protection of
Secured Party, and Secured Party may exercise any such right, power or remedy at
its option and in its sole and absolute discretion without any obligation to do
so. In addition, if under the terms hereof, Secured Party is given two or more
alternative courses of action, Secured Party may elect any alternative or
combination of alternatives at its option and in its sole and absolute
discretion. All monies advanced by Secured Party under the terms hereof and all
amounts paid, suffered or incurred by Secured Party in exercising any authority
granted herein, including reasonable attorneys' fees, shall be added to the
Obligation, shall be secured by the Security Interest, shall bear interest at
the Default Rate (as defined in the Credit Agreement) until paid, and shall be
due and payable by Debtor to Secured Party immediately without demand.
6. NOTIFICATION AND PAYMENTS; COLLECTION OF COLLATERAL; USE OF
COLLATERAL BY DEBTOR
6.1 Secured Party, after the occurrence of any Event of Default,
defined below, and with prior written notice to Debtor, may notify any or all
Obligors of the existence of the Security Interest and may direct the Obligors
to make all payments on the Collateral to Secured Party. Until Secured Party has
notified the Obligors to remit payments directly to it, Debtor, at Debtor's own
cost and expense, shall collect or cause to be collected the accounts and monies
due under the accounts, documents, instruments and general intangibles or
pursuant to the terms of the chattel paper. Secured Party shall not be liable or
responsible for any embezzlement, conversion, negligence or default by Debtor or
Debtor's agents with respect to such collections; all agents used in such
collections shall be agents of Debtor and not agents of Secured Party. Unless
Secured Party notifies Debtor in writing that it waives one or more of the
requirements set forth in this sentence, any payments or other proceeds of
Collateral received by Debtor, before or after notification to Obligors, shall
be held by Debtor in trust for Secured Party in the same form in which received,
shall not be commingled with any assets of Debtor and shall be turned over to
Secured Party not later than the next business day following the day of receipt.
All payments and other proceeds of Collateral received by Secured Party directly
or from Debtor shall be applied to the Obligation in such order and manner and
at such time as Secured Party, in its sole discretion, shall determine. In
addition, Debtor shall promptly notify Secured Party of the return to or
possession by Debtor of goods underlying any Collateral; Debtor shall hold the
same in trust for Secured Party and shall dispose of the same as Secured Party
directs.
6.2 Secured Party, after the occurrence of an Event of Default and
without notice to Debtor, may demand, collect and sue on the Collateral (either
in Debtor's or Secured Party's name), enforce, compromise, settle or discharge
the Collateral and endorse Debtor's name on any instruments, documents, or
chattel paper included in or pertaining to the Collateral; Debtor hereby
irrevocably appoints Secured Party its attorney in fact for all such purposes.
6.3 Until the occurrence of an Event of Default, Debtor may: (i) use,
consume and sell any inventory included in the Collateral in any lawful manner
in the ordinary course of Debtor's business provided that all sales shall be at
commercially reasonable prices; and (ii) subject to
-5-
<PAGE>
Paragraphs 6.1 and 6.2 above, retain possession of any other Collateral and use
it in any lawful manner consistent with this Agreement.
7. COLLATERAL IN THE POSSESSION OF SECURED PARTY
7.1 Secured Party shall use such reasonable care in handling,
preserving and protecting the Collateral in its possession as it uses in
handling similar property for its own account. Secured Party, however, shall
have no liability for the loss, destruction or disappearance of any Collateral
unless there is affirmative proof of a lack of due care; the lack of due care
shall not be implied solely by virtue of any loss, destruction or disappearance.
7.2 Debtor shall be solely responsible for taking any and all actions
to preserve rights against all Obligors; Secured Party shall not be obligated to
take any such actions whether or not the Collateral is in Secured Party's
possession. Debtor waives presentment and protest with respect to any instrument
included in the Collateral on which Debtor is in any way liable and waives
notice of any action taken by Secured Party with respect to any instrument,
document or chattel paper included in any Collateral that is in the possession
of Secured Party.
8. EVENTS OF DEFAULT; REMEDIES
8.1 The occurrence of any of the following events or conditions shall
constitute and is hereby defined to be an "Event of Default":
(a) Any failure or neglect to perform or observe any of the
terms, provisions, or covenants of this Agreement, and such failure or
neglect either (i) cannot be remedied, (ii) can be remedied within
fifteen (15) days by prompt and diligent action, but it continues
unremedied for a period of fifteen (15) days after notice thereof to
Debtor, or (iii) can be remedied, although not within fifteen (15) days
even by prompt and diligent action, but such remedy is not commenced
within fifteen (15) days after notice thereof to Debtor or is not
diligently prosecuted to completion within a total of forty-five (45)
days from the date of such notice.
(b) Any warranty, representation or statement contained in
this Agreement that shall be or shall prove to have been false when
made or furnished.
(c) Any levy or execution upon, or judicial seizure of, any
portion of the Collateral or any other collateral or security for the
Obligation.
(d) Any attachment or garnishment of, or the existence or
filing of any lien or encumbrance against, any portion of the
Collateral or any other collateral or security for the Obligation that
is not removed and released within fifteen (15) days after its
creation.
-6-
<PAGE>
(e) The institution of any legal action or proceedings to
enforce any lien or encumbrance upon any portion of the Collateral or
any other collateral or security for the Obligation, that is not
dismissed within sixty (60) days after its institution.
(f) The abandonment by Debtor of all or any part of the
Collateral.
(g) The loss, theft or destruction of, or any substantial
damage to, any portion of the Collateral or any other collateral or
security for the Obligation, that is not adequately covered by
insurance.
(h) The occurrence of any event of default under the Credit
Agreement.
8.2 Upon the occurrence of any Event of Default and at any time while
such Event of Default is continuing, Secured Party shall have the following
rights and remedies and may do one or more of the following:
(a) Declare all or any part of the Obligation to be
immediately due and payable, and the same, with all costs and charges,
shall be collectible thereupon by action at law.
(b) Without further notice or demand and without legal
process, take possession of the Collateral wherever found and, for this
purpose, enter upon any property occupied by or in the control of
Debtor. Debtor, upon demand by Secured Party, shall assemble the
Collateral and deliver it to Secured Party or to a place designated by
Secured Party that is reasonably convenient to both parties.
(c) Operate the business of Debtor as a going concern,
including, without limitation, extend sales or services to new
customers and advance funds for such operation. Secured Party shall not
be liable for any depreciation, loss, damage or injury to the
Collateral or other property of Debtor as a result of such action.
Debtor hereby waives any claim of trespass or replevin arising as a
result of such action.
(d) Pursue any legal or equitable remedy available to collect
the Obligation, to enforce its title in and right to possession of the
Collateral and to enforce any and all other rights or remedies
available to it.
(e) Upon obtaining possession of the Collateral or any part
thereof, after notice to Debtor as provided in Paragraph 8.4 herein,
sell such Collateral at public or private sale either with or without
having such Collateral at the place of sale. The proceeds of such sale,
after deducting therefrom all reasonable expenses of Secured Party in
taking, storing, repairing and selling the Collateral (including
reasonable attorneys' fees) shall be applied to the payment of the
Obligation, and
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<PAGE>
any surplus thereafter remaining shall be paid to Debtor or any other
person that may be legally entitled thereto. In the event of a
deficiency between such net proceeds from the sale of the Collateral
and the total amount of the Obligation, Debtor, upon demand, shall
promptly pay the amount of such deficiency to Secured Party.
8.3 Secured Party, so far as may be lawful, may purchase all or any
part of the Collateral offered at any public or private sale made in the
enforcement of Secured Party's rights and remedies hereunder.
8.4 Any demand or notice of sale, disposition or other intended action
hereunder or in connection herewith, whether required by the Uniform Commercial
Code or otherwise, shall be deemed to be commercially reasonable and effective
if such demand or notice is given to Debtor at least ten (10) days prior to such
sale, disposition or other intended action, in the manner provided herein for
the giving of notices.
8.5 Debtor shall pay all costs and expenses, including without
limitation costs of Uniform Commercial Code searches, court costs and reasonable
attorneys' fees, incurred by Secured Party in enforcing payment and performance
of the Obligation or in exercising the rights and remedies of Secured Party
hereunder. All such costs and expenses shall be secured by this Agreement and by
all deeds of trust and other lien and security documents securing the
Obligation. In the event of any court proceedings, court costs and attorneys'
fees shall be set by the court and not by jury and shall be included in any
judgment obtained by Secured Party.
8.6 In addition to any remedies provided herein for an Event of
Default, Secured Party shall have all the rights and remedies afforded a secured
party under the Uniform Commercial Code and all other legal and equitable
remedies allowed under applicable law. No failure on the part of Secured Party
to exercise any of its rights hereunder arising upon any Event of Default shall
be construed to prejudice its rights upon the occurrence of any other or
subsequent Event of Default. No delay on the part of Secured Party in exercising
any such rights shall be construed to preclude it from the exercise thereof at
any time while that Event of Default is continuing. Secured Party may enforce
any one or more rights or remedies hereunder successively or concurrently. By
accepting payment or performance of any of the Obligation after its due date,
Secured Party shall not thereby waive the agreement contained herein that time
is of the essence, nor shall Secured Party waive either its right to require
prompt payment or performance when due of the remainder of the Obligation or its
right to consider the failure to so pay or perform an Event of Default.
9. MISCELLANEOUS PROVISIONS
9.1 The acceptance of this Agreement by Secured Party shall not be
considered a waiver of or in any way to affect or impair any other security that
Secured Party may have, acquire simultaneously herewith, or hereafter acquire
for the payment or performance of the Obligation, nor shall the taking by
Secured Party at any time of any such additional security be construed as
-8-
<PAGE>
a waiver of or in any way to affect or impair the Security Interest; Secured
Party may resort, for the payment or performance of the Obligation, to its
several securities therefor in such order and manner as it may determine.
9.2 Without notice or demand, without affecting the obligations of
Debtor hereunder or the personal liability of any person for payment or
performance of the Obligation, and without affecting the Security Interest or
the priority thereof, Secured Party, from time to time, may: (i) extend the time
for payment of all or any part of the Obligation, accept a renewal note
therefor, reduce the payments thereon, release any person liable for all or any
part thereof, or otherwise change the terms of all or any part of the
Obligation; (ii) take and hold other security for the payment or performance of
the Obligation and enforce, exchange, substitute, subordinate, waive or release
any such security; (iii) join in any extension or subordination agreement; or
(iv) release any part of the Collateral from the Security Interest.
9.3 Debtor waives and agrees not to assert: (i) any right to require
Secured Party to proceed against any guarantor, to proceed against or exhaust
any other security for the Obligation, to pursue any other remedy available to
Secured Party, or to pursue any remedy in any particular order or manner; (ii)
the benefits of any legal or equitable doctrine or principle of marshalling;
(iii) demand, diligence, presentment for payment, protest and demand, and notice
of extension, dishonor, protest, demand and nonpayment, relating to the
Obligation; and (iv) any benefit of, and any right to participate in, any other
security now or hereafter held by Secured Party.
9.4 The terms herein shall have the meanings in and be construed under
the Uniform Commercial Code. This Agreement shall be governed by and construed
according to the laws of the State of Arizona. Each provision of this Agreement
shall be interpreted in such manner as to be effective and valid under
applicable law, but if any provision of this Agreement is held to be void or
invalid, the same shall not affect the remainder hereof which shall be effective
as though the void or invalid provision had not been contained herein.
9.5 No modification, rescission, waiver, release or amendment of any
provision of this Agreement shall be made except by a written agreement executed
by Debtor and a duly authorized officer of Secured Party.
9.6 This is a continuing Agreement which shall remain in full force and
effect until actual receipt by Secured Party of written notice of its revocation
as to future transactions and shall remain in full force and effect thereafter
until all of the Obligation incurred before the receipt of such notice, and all
of the Obligation incurred thereafter under commitments extended by Secured
Party before the receipt of such notice, shall have been paid and performed in
full.
9.7 No setoff or claim that Debtor now has or may in the future have
against Secured Party shall relieve Debtor from paying or performing the
Obligation.
9.8 Time is of the essence hereof. This Agreement shall be binding
upon, and shall inure to the benefit of, the parties hereto and their heirs,
personal representatives, successors and
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<PAGE>
assigns. The term "Secured Party" shall include not only the original Secured
Party hereunder but also any future owner and holder, including pledgees, of
note or notes evidencing the Obligation. The provisions hereof shall apply to
the parties according to the context thereof and without regard to the number or
gender of words or expressions used.
9.9 All notices required or permitted to be given hereunder shall be in
writing and may be given, and shall become effective, as provided in the Credit
Agreement.
9.10 A carbon, photographic or other reproduced copy of this Agreement
and/or any financing statement relating hereto shall be sufficient for filing
and/or recording as a financing statement.
9.11 Debtor authorizes Secured Party, without notice or demand, without
affecting the obligations of Debtor hereunder or the personal liability of any
person for payment or performance of the Obligation and without affecting the
lien or the priority of the Security Interest, from time to time, at the request
of any person primarily obligated therefor, to renew, compromise, extend,
accelerate or otherwise change the time for payment or performance of, or
otherwise change the terms of, all or any part of the Obligation, including
increase or decrease any rate of interest thereon. Debtor waives and agrees not
to assert: (i) any right to require Secured Party to proceed against Borrower;
(ii) the benefits of any statutory provision limiting the liability of a surety,
including without limitation the benefit of Section 12-1641, ET SEQ., of the
Arizona Revised Statutes; and (iii) any defense arising by reason of any
disability or other defense of Borrower or by reason of the cessation from any
cause whatsoever of the liability of Borrower. Debtor shall have no right of
subrogation and hereby waives any right to enforce any remedy which Secured
Party now has, or may hereafter have, against Borrower.
IN WITNESS WHEREOF, these presents are executed as of the date
indicated above.
THREE-FIVE SYSTEMS, INC., a Delaware
corporation
By: /s/ Jeffrey D. Buchanan
--------------------------------
Name: Jeffrey D. Buchanan
-------------------------------
Title: Executive Vice President
------------------------------
DEBTOR
-10-
<PAGE>
SCHEDULE "A"
COLLATERAL DESCRIPTION
All of the property described below in, to or under which Debtor now
has or hereafter acquires any right, title or interest, whether present, future
or contingent, and in Debtor's expectancy to acquire such property (all of the
property described on this schedule is herein called the "Collateral"):
1. All accounts, general intangibles, instruments, documents
and chattel paper (including all accounts receivable, notes, drafts,
lease agreements and security agreements), and all goods, if any,
represented thereby, whether now existing or hereafter acquired or
created from time to time in the course of Debtor's business;
2. All inventory now owned or hereafter acquired, including
all goods held for sale or lease in Debtor's business, as now or
hereafter conducted, and all materials, work in process and finished
goods used or to be consumed in Debtor's business (whether or not the
inventory is represented by warehouse receipts or bills of lading or
has been or may be placed in transit or delivered to a public
warehouse);
3. All equipment now owned or hereafter acquired, including
all furniture, fixtures, furnishings, vehicles (whether titled or
non-titled), machinery, materials and supplies, wherever located,
including but not limited to such items described on the collateral
schedule (if any) attached hereto and by this reference made a part
hereof, together with all parts, accessories, attachments, additions
thereto or replacements therefor;
4. All instruments, documents and chattel paper now held by or
hereafter delivered to Secured Party, together with all property rights
and security interests evidenced thereby, all increases thereof
(including, without limitation, stock dividends), all profits therefrom
and all transformations thereof, including but not limited to such
items described on the collateral schedule (if any) attached hereto and
by this reference made a part hereof (all hereinafter called the
"Specific Collateral-in-Possession");
5. All tax refund claims, all policies or certificates of
insurance covering any of the Collateral, all contracts, agreements or
rights of indemnification, guaranty or surety relating to any of the
Collateral, and all claims, awards, loss payments, proceeds and premium
refunds that may become payable with respect to any such policies,
certificates, contracts, agreements or rights;
<PAGE>
6. All ledger cards, invoices, delivery receipts, worksheets,
books of accounts, statements, correspondence, customer lists, files,
journals, ledgers and records in any form, written or otherwise,
related to any of the Collateral;
7. Tradenames, trademarks and service marks (subject to any
franchise or license agreements relating thereto);
8. All claims for loss or damage to or in connection with any
of the Collateral, all other claims in any form for the payment of
money, including tort claims, and all rights with respect to such
claims and all proceeds thereof;
9. All accessions to any of the Collateral; and
10. All products and proceeds of the Collateral, in any form,
including all proceeds received, due or to become due from any sale,
exchange or other disposition of any of the Collateral, whether such
proceeds are cash or noncash in nature or are represented by checks,
drafts, notes or other instruments for the payment of money.
All "Collateral Schedules," if any, attached hereto are hereby incorporated into
this collateral description as if set forth here and at each reference thereto.
EXHIBIT 21
LIST OF SUBSIDIARIES
Name Country of Incorporation
- ---- ------------------------
Three-Five Systems Limited United Kingdom
Three-Five Systems Pacific, Inc. Philippines
Three-Five Systems (Beijing) Co., Ltd. People's Republic of China
ARTHUR ANDERSEN LLP
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
As independent public accountants, we hereby consent to the incorporation of our
report included in this Form 10-K, into the Company's previously filed
Registration Statement File No.'s 33-77600, 33-76090, 33-36968, 33-88706,
333-32795, 333-50689 and 333-57933.
/s/ Arthur Andersen LLP
Phoenix, Arizona
March 10, 1999.
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED BALANCE SHEET AT DECEMBER 31, 1998 AND THE RELATED CONSOLIDATED
STATEMENT OF INCOME FOR THE TWELVE MONTHS ENDED DECEMBER 31, 1998 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. DOLLAR
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> DEC-31-1998
<EXCHANGE-RATE> 1
<CASH> 4,946
<SECURITIES> 0
<RECEIVABLES> 19,117
<ALLOWANCES> 516
<INVENTORY> 12,493
<CURRENT-ASSETS> 41,033
<PP&E> 50,355
<DEPRECIATION> 17,041
<TOTAL-ASSETS> 77,904
<CURRENT-LIABILITIES> 16,208
<BONDS> 7,444
0
0
<COMMON> 80
<OTHER-SE> 0
<TOTAL-LIABILITY-AND-EQUITY> 77,904
<SALES> 95,047
<TOTAL-REVENUES> 95,047
<CGS> 76,149
<TOTAL-COSTS> 90,642
<OTHER-EXPENSES> 117
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 418
<INCOME-PRETAX> 4,363
<INCOME-TAX> 1,773
<INCOME-CONTINUING> 2,590
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 2,590
<EPS-PRIMARY> 0.34
<EPS-DILUTED> 0.33
</TABLE>
