SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
Quarterly Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
For the Quarter Ended June 30, 2000
Commission File Number 1-4373
THREE-FIVE SYSTEMS, INC.
------------------------------------------------------
(Exact name of registrant as specified in its charter)
Delaware 86-0654102
------------------------------- ---------------------
(State or other jurisdiction of I.R.S. Employer
incorporation or organization) Identification Number
1600 North Desert Drive, Tempe, Arizona 85281
---------------------------------------- ----------
(Address of principal executive offices) (Zip Code)
(602) 389-8600
----------------------------------------------------
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. YES [X] NO [ ]
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, at the latest practical date.
CLASS OUTSTANDING AS OF JULY 20, 2000
----- -------------------------------
Common 21,508,275
Par value $.01 per share
<PAGE>
THREE-FIVE SYSTEMS, INC.
QUARTERLY REPORT ON FORM 10-Q
FOR THE QUARTER ENDED JUNE 30, 2000
TABLE OF CONTENTS
PART I - FINANCIAL INFORMATION
Page
----
ITEM 1. FINANCIAL STATEMENTS:
Condensed Consolidated Balance Sheets -
December 31, 1999 and June 30, 2000................................1
Condensed Consolidated Statements of Income -
Three Months and Six Months Ended June 30, 1999 and 2000...........2
Condensed Consolidated Statements of Cash Flows -
Six Months Ended June 30, 1999 and 2000............................3
Notes to Condensed Consolidated Financial Statements.................4
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS..................................7
PART II - OTHER INFORMATION
ITEM 4. SUBMISSIONS OF MATTERS TO A VOTE OF SECURITY HOLDERS................14
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K....................................14
SIGNATURES..................................................................15
<PAGE>
ITEM 1. FINANCIAL STATEMENTS
THREE-FIVE SYSTEMS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands)
DECEMBER 31, JUNE 30,
1999 2000
--------- ---------
(UNAUDITED)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 45,363 $ 127,559
Short-term investments -- 46,545
Accounts receivable, net 20,886 25,785
Inventories 12,344 15,187
Deferred tax asset 3,231 4,202
Other current assets 1,047 1,864
--------- ---------
Total current assets 82,871 221,142
PROPERTY, PLANT AND EQUIPMENT, net 40,546 42,726
OTHER ASSETS 3,513 4,246
--------- ---------
$ 126,930 $ 268,114
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 13,450 $ 14,423
Accrued liabilities 7,526 7,921
Current taxes payable 1,042 3,059
--------- ---------
Total current liabilities 22,018 25,403
--------- ---------
DEFERRED TAX LIABILITY 3,692 3,710
--------- ---------
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY:
Common stock 189 215
Additional paid-in capital 67,388 197,265
Retained earnings 33,639 41,552
Cumulative translation adjustment 7 (30)
Less - Treasury stock, at cost (3) (1)
--------- ---------
Total stockholders' equity 101,220 239,001
--------- ---------
$ 126,930 $ 268,114
========= =========
The accompanying notes are an integral part of these
condensed consolidated balance sheets.
1
<PAGE>
THREE-FIVE SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(unaudited)
(in thousands, except per share amounts)
<TABLE>
<CAPTION>
THREE MONTHS SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
---------------------- ----------------------
1999 2000 1999 2000
-------- -------- -------- --------
<S> <C> <C> <C> <C>
NET SALES $ 31,600 $ 44,926 $ 54,644 $ 84,088
-------- -------- -------- --------
COSTS AND EXPENSES:
Cost of sales 25,103 34,157 45,294 63,517
Selling, general and administrative 2,493 2,418 4,942 4,680
Research, development and engineering 2,008 2,989 3,829 5,752
-------- -------- -------- --------
29,604 39,564 54,065 73,949
-------- -------- -------- --------
Operating income 1,996 5,362 579 10,139
-------- -------- -------- --------
OTHER INCOME (EXPENSE):
Interest, net (211) 1,185 (366) 1,789
Other, net (3) (20) (33) (44)
-------- -------- -------- --------
(214) 1,165 (399) 1,745
-------- -------- -------- --------
INCOME BEFORE PROVISION FOR (BENEFIT FROM)
INCOME TAXES: 1,782 6,527 180 11,884
Provision for (benefit from) income taxes 742 2,158 (218) 3,928
-------- -------- -------- --------
NET INCOME $ 1,040 $ 4,369 $ 398 $ 7,956
======== ======== ======== ========
EARNINGS PER COMMON SHARE:
Basic $ 0.07 $ 0.22 $ 0.03 $ 0.41
======== ======== ======== ========
Diluted $ 0.07 $ 0.21 $ 0.03 $ 0.39
======== ======== ======== ========
WEIGHTED AVERAGE NUMBER OF COMMON SHARES:
Basic 14,035 19,807 14,030 19,370
======== ======== ======== ========
Diluted 14,212 21,083 14,239 20,593
======== ======== ======== ========
</TABLE>
The accompanying notes are an integral part of these
condensed consolidated financial statements.
2
<PAGE>
THREE-FIVE SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(in thousands)
<TABLE>
<CAPTION>
SIX MONTHS ENDED
JUNE 30,
------------------------
1999 2000
--------- ---------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 398 $ 7,956
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 2,605 3,087
Provision for accounts receivable valuation reserves 117 105
Change in assets and liabilities:
(Increase) in accounts receivable (6,106) (5,005)
(Increase) in inventories (2,755) (2,843)
(Increase) decrease in other assets 363 (1,062)
Increase in accounts payable and accrued liabilities 6,443 1,368
Increase (decrease) in taxes payable and deferred taxes, net (238) 1,064
--------- ---------
Net cash provided by operating activities 827 4,670
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property, plant and equipment, net (5,102) (5,254)
Purchase of short-term investments -- (46,545)
Investment in Inviso, Inc. -- (500)
--------- ---------
Net cash used in investing activities (5,102) (52,299)
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net proceeds from notes payable to banks 5,000 --
Net proceeds from equity offering -- 128,638
Issuance of treasury stock 43 --
Stock options exercised 61 1,224
--------- ---------
Net cash provided by financing activities 5,104 129,862
--------- ---------
EFFECT OF EXCHANGE RATE CHANGES ON CASH AND CASH EQUIVALENTS 2 (37)
--------- ---------
NET INCREASE IN CASH AND CASH EQUIVALENTS 831 82,196
CASH AND CASH EQUIVALENTS, beginning of period 4,946 45,363
--------- ---------
CASH AND CASH EQUIVALENTS, end of period $ 5,777 $ 127,559
========= =========
</TABLE>
The accompanying notes are an integral part of these
condensed consolidated financial statements.
3
<PAGE>
THREE-FIVE SYSTEMS, INC. AND SUBSIDIARIES (THE COMPANY)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Note A The accompanying unaudited Condensed Consolidated Financial Statements
have been prepared in accordance with accounting principles generally
accepted in the United States for interim financial information and
the instructions to Form 10-Q. Accordingly, they do not include all
the information and footnotes required by accounting principles
generally accepted in the United States for complete financial
statements. In the opinion of management, all adjustments (which
include only normal recurring adjustments) necessary to present fairly
the financial position, results of operations, and cash flows for all
periods presented have been made. The results of operations for the
three and six-month periods ended June 30, 2000 are not necessarily
indicative of the operating results that may be expected for the
entire year ending December 31, 2000. These financial statements
should be read in conjunction with the Company's December 31, 1999
financial statements and accompanying notes thereto.
Note B Basic earnings per common share are computed by dividing net income by
the weighted average number of shares of common stock outstanding
during the three and six-month periods. Diluted earnings per common
share for the three- and six-month periods are determined assuming
that the options and warrants were exercised at the beginning of the
period or at the time of issuance, if later. Set forth below are the
disclosures for the three- and six-month periods ended June 30, 1999
and 2000.
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------- -------------------
1999 2000 1999 2000
------- ------- ------- -------
(UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C>
Basic earnings per share:
Income available to common stockholders $ 1,040 $ 4,369 $ 398 $ 7,956
------- ------- ------- -------
Weighted average common shares 14,035 19,807 14,030 19,370
------- ------- ------- -------
Basic per share amount $ 0.07 $ 0.22 $ 0.03 $ 0.41
======= ======= ======= =======
Diluted earnings per share:
Income available to common stockholders $ 1,040 $ 4,369 $ 398 $ 7,956
------- ------- ------- -------
Weighted average common shares 14,035 19,807 14,030 19,370
Options and warrants assumed exercised 177 1,276 209 1,223
------- ------- ------- -------
Total common shares plus common
stock equivalents 14,212 21,083 14,239 20,593
------- ------- ------- -------
Diluted per share amount $ 0.07 $ 0.21 $ 0.03 $ 0.39
======= ======= ======= =======
</TABLE>
Note C Inventories consist of the following at:
DECEMBER 31, JUNE 30,
1999 2000
-------- --------
(unaudited)
(in thousands)
Raw materials $ 9,554 $ 11,925
Work-in-process 1,336 1,743
Finished goods 1,454 1,519
-------- --------
$ 12,344 $ 15,187
======== ========
4
<PAGE>
Note D Property, plant, and equipment consist of the following at:
DECEMBER 31, JUNE 30,
1999 2000
-------- --------
(unaudited)
(in thousands)
Building and improvements $ 16,411 $ 16,412
Furniture and equipment 47,036 52,289
-------- --------
63,447 68,701
Less accumulated depreciation (22,901) (25,975)
-------- --------
$ 40,546 $ 42,726
======== ========
Note E Segment information:
Management monitors and evaluates the financial performance of the
Company's operations by its four operating segments located in various
parts of 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.
<TABLE>
<CAPTION>
Three Months Ended United United
June 30, 1999 States Kingdom China Philippines Eliminations Total
------------- ------ ------- ----- ----------- ------------ -----
(UNAUDITED)
<S> <C> <C> <C> <C> <C> <C>
Net sales $ 10,535 $ 14,225 $ 6,840 $ -- $ -- $ 31,600
Intersegment sales 18,427 -- 2,694 804 (21,925) --
Income before provision
for (benefit from)
income taxes 1,345 245 292 16 (116) 1,782
Three Months Ended United United
June 30, 2000 States Kingdom China Philippines Eliminations Total
------------- ------ ------- ----- ----------- ------------ -----
(UNAUDITED)
Net sales $ 18,321 $ 13,882 $ 12,723 $ -- $ -- $ 44,926
Intersegment sales 20,501 -- 605 825 (21,931) --
Income before provision
for (benefit from)
income taxes 2,519 1,025 3,000 16 (33) 6,527
Six Months Ended United United
June 30, 1999 States Kingdom China Philippines Eliminations Total
---------------- -------- -------- -------- -------- -------- --------
(UNAUDITED)
Net sales $ 17,483 $ 24,576 $ 12,585 $ -- $ -- $ 54,644
Intersegment sales 33,518 -- 3,839 1,595 (38,952) --
Income before provision
for (benefit from)
income taxes (609) 382 349 31 27 180
</TABLE>
5
<PAGE>
<TABLE>
<CAPTION>
Six Months Ended United United
June 30, 2000 States Kingdom China Philippines Eliminations Total
------------- ------ ------- ----- ----------- ------------ -----
(UNAUDITED)
<S> <C> <C> <C> <C> <C> <C>
Net sales $ 33,918 $ 32,478 $ 17,692 $ -- $ -- $ 84,088
Intersegment sales 39,564 -- 5,328 1,524 (46,416) --
Income before provision
for (benefit from)
income taxes 4,018 2,510 5,413 30 (87) 11,884
</TABLE>
Note F Comprehensive income for the periods was as follows:
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30
------------------- -------------------
1999 2000 1999 2000
------- ------- ------- -------
(unaudited)
(in thousands)
<S> <C> <C> <C> <C>
Net income $ 1,040 $ 4,369 $ 398 $ 7,956
Other comprehensive income:
Cumulative foreign currency
translation adjustment 2 (35) 2 (37)
------- ------- ------- -------
Comprehensive income $ 1,042 $ 4,334 $ 400 $ 7,919
======= ======= ======= =======
</TABLE>
Note G 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 has a current term extending through December
31, 2000. Also, in April 1995, the Company entered into a
non-cancelable operating lease for an additional manufacturing
facility in Manila, the Philippines. This lease expired on March 31,
2000 and has been renewed to March 31, 2001.
In July 2000, the Company notified the lessor of its primary
manufacturing facility in Manila that the Company was canceling the
lease for its primary manufacturing facility effective as of December
31, 2000.
In conjunction with that cancellation, Three-Five Systems, Pacific,
Inc., the Company's wholly owned foreign subsidiary, is currently in
the process of negotiating a new lease with the Company's primary
manufacturing facility in Manila. Under the proposed terms of the new
lease, the leasehold period will be for a term of five years, with an
annual review period. If during this annual review period either party
desires to terminate the lease, either party may do so by giving a
180-day written notice to the other party.
In May 2000, Three-Five Systems Pacific, Inc. signed a lease for a
build-to-suit factory in Manila. The term of the lease is 120 months
starting upon completion of the factory. In conjunction with that
lease, Three-Five Systems Pacific, Inc. has made security deposits of
approximately $650,000.
Note H Benefit Plans
On January 27, 2000, the Board of Directors increased the number of
shares of the Company's common stock available for issuance under the
1997 Stock Option Plan by 150,000 to 350,000 shares.
6
<PAGE>
Note I Stockholders' Equity
In May 2000, the Company issued 2,150,000 shares of common stock at a
price of $55.00 per share in a public offering. In June 2000, the
Company issued an additional 322,500 shares of common stock at a price
of $55.00 per share to cover over-allotments pertaining to the
offering.
On April 18, 2000, the Board of Directors approved a three-for-two
stock split, to be effected in the form of a 50 percent stock
dividend. The Board's approval of the stock split was contingent upon
the approval by the stockholders of an increase in the number of
authorized shares of common stock, which occurred on April 27, 2000.
At that time, the stockholders approved an increase in the number of
authorized shares of the Company's common stock from 15 million to 60
million. The stock dividend was paid on May 12, 2000, to stockholders
of record at the close of business of May 1, 2000. The increase in the
authorized shares and the stock split have been given retroactive
recognition for all periods presented in the accompanying condensed
consolidated financial statements.
Note J Short-term Investments
The Company considers all liquid interest-earning investments with a
maturity of three months or less at the date of purchase to be cash
equivalents. Short-term investments generally mature between three
months and one year from the purchase date. All short-term investments
are classified as available for sale and are presented at market using
the specific identification method. Unrealized gains and losses are
reflected in other comprehensive income. Realized and unrealized gains
and losses were not material at June 30, 2000.
Note K Recently Issued Accounting Standards
In June 1998, the Financial Accounting Standards Board (FASB) issued
SFAS No. 133 (as amended by SFAS No. 138), "ACCOUNTING FOR DERIVATIVE
INSTRUMENTS AND HEDGING ACTIVITIES," which requires that an entity
recognize all derivatives as either assets or liabilities in the
statement of financial position and measure those instruments at fair
value. The issuance of SFAS No. 137, "ACCOUNTING FOR DERIVATIVE
INSTRUMENTS AND HEDGING ACTIVITIES - DEFERRAL OF THE EFFECTIVE DATE OF
FASB STATEMENT NO. 133," delayed the required effective date of SFAS
No. 133 to all fiscal years beginning after June 15, 2000. The Company
will be required to adopt SFAS No. 133, as amended, on January 1,
2001. Management does not believe that the adoption of SFAS No. 133,
as amended, will have a material impact on its results of operations
or financial position.
On December 3, 1999, the Securities and Exchange Commission staff (the
Staff) issued Staff Accounting Bulletin (SAB) 101, "Revenue
Recognition." Subsequent to its issuance, the Staff elected to defer
the required implementation date. The Company will be required to
adopt SAB 101 during the fourth quarter of 2000. Management believes
that the adoption of SAB 101 will not have a material impact on the
Company's financial position or results of operations.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
FORWARD-LOOKING STATEMENTS AND FACTORS THAT MAY AFFECT RESULTS
Except for the historical information contained herein, this Report
contains forward-looking statements, including those relating to revenue
concentration, margins, pricing pressures, quarterly fluctuations, the impact of
our China facility, material shortages, research, development, and engineering
expense, and liquidity and anticipated cash needs that involve risks and
uncertainties that could cause actual results to differ materially.
We caution that these statements are subject to various factors that may
affect future results, including the following: changes in the market for our
products and the success of our customers' products, the failure of key
technologies to deliver commercially acceptable performance, our dependence on
one large customer, the absence of long-term purchase commitments, and our
lengthy development periods and product acceptance cycles. This Report should be
7
<PAGE>
read in conjunction with our Report on Form 10-K for the fiscal year ended
December 31, 1999 and our Registration Statement on Form S-3 (Registration No.
333-35788) as declared effective by the Securities and Exchange Commission on
May 5, 2000.
OVERVIEW
We offer advanced design and manufacturing services to original equipment
manufacturers, commonly referred to as OEMs. We specialize in custom display
modules utilizing liquid crystal display, or LCD, components and technology. Our
LCD modules have varying levels of integration. At a minimum, each module
includes an LCD, a custom LCD driver, and a flexible connector. We also provide
value-added services, which increase our competitiveness, by assembling
additional components onto the module based upon the specific needs of the
customer. These additional components include such items as keypads,
microphones, speakers, light guides, and optics.
We currently sell substantially all of our LCD modules to major OEMs. We
derived more than 85% of our net sales in 1999 and in the first half of 2000
from the mobile handset market. When we win a design program, our customer
typically pays all or a portion of our nonrecurring engineering expenses to
defray the costs of custom design, as well as the costs of nonrecurring tooling
for custom components. The typical program life cycle of a custom-designed LCD
module is three to twelve months and includes technical design, prototyping,
pilot manufacturing, and high-volume manufacturing. We typically seek large
volume programs from major OEMs. The minimum production quantity for an LCD
module typically approximates 100,000 units per year, although the production
rate for some programs has been as high as 100,000 units per week. The selling
price of our LCD modules usually ranges between $5 and $20 per unit. We
recognize revenue upon product shipment.
We experienced substantial growth from 1993 through 1995, primarily as a
result of sales to OEMs in the wireless communications industry, which grew
substantially during that period. During that period, our primary customer was
Motorola. In 1996, our net sales declined, primarily as a result of the
phase-out by Motorola of a significant family of programs. In 1997, our net
sales returned to pre-1996 levels primarily as a result of several new programs
and customers. Motorola accounted for 65.1% of our net sales in 1996, 34.6% in
1997, and 63.6% in 1998. In 1999, net sales to Motorola increased at a rate
faster than net sales to our other customers and represented 86.1% of our net
sales. In the first half of 2000, net sales to Motorola represented 87.8% of our
net sales. Since 1998 no other customer has accounted for more than 10% of our
net sales.
During the past several years, we have experienced seasonal quarterly
fluctuations in our net sales as our OEM customers developed retail products
with shorter product life cycles and phased out older programs early in the year
following holiday sales. As a result, sales usually peak in the fourth quarter
of a calendar year and are lower in the following quarter.
Several factors impact our gross margins, including manufacturing
efficiencies, product mix, product differentiation, product uniqueness,
inventory management, and volume pricing. Currently, significant pricing
pressure exists in the LCD module market, especially in higher volume programs
in the wireless communications industry. Accordingly, as the production levels
of some of our new higher volume programs have increased, the lower standard
gross margins on those programs have impacted our overall margins.
We vertically integrate our manufacturing facilities. In Arizona, we own
and operate the largest high-volume LCD production line in North America. We
generally use the Arizona facility for the manufacture of more technologically
complex and custom high-volume LCDs. We also purchase LCDs from Asian and
European sources to provide us an alternate source and to ensure available
capacity. In order to take advantage of lower labor costs, we ship our LCDs to
our facilities in Manila, the Philippines, or Beijing, China, for assembly into
modules.
Historically, we have conducted most of our manufacturing operations at our
facility in Manila. At that facility, we assemble LCDs into modules and perform
certain back-end LCD processing operations. We conduct our operations in Manila
under an agreement with a third-party subcontract manufacturer. Under this
agreement, the subcontractor supplies direct labor and incidental services
required to manufacture our products. We also lease our manufacturing facility
from the subcontractor. All indirect manufacturing employees, primarily
technicians, supervisors, and engineers, are our employees.
8
<PAGE>
In early 1998, we decided to open a similar display module manufacturing
facility in Beijing. Within six months, we located a temporary manufacturing
facility, equipped the facility, trained our personnel, qualified the facility
for customers, and qualified products manufactured at the facility. We commenced
construction of our permanent Beijing facility in late 1998. This facility was
substantially completed in early July 1999, and we began production in the new
manufacturing facility late in the third quarter of 1999. All production in
Beijing beginning in the fourth quarter of 1999 was conducted at our new
permanent facility. We own our Beijing facility through a wholly owned foreign
subsidiary.
Selling, general, and administrative expense consists principally of
administrative and selling costs, salaries, commissions, and benefits to
personnel and related facility costs. We make substantially all of our sales
directly to OEMs, and our sales force consists of a small number of direct
technical sales persons. As a result, there is no material cost of distribution
in our selling, general, and administrative expense. Selling, general, and
administrative expense has increased as we have expanded our business and
increased our diversification efforts. In addition, we have recently incurred
substantial marketing and administrative expenses in connection with our LCOS
microdisplay business.
Research, development, and engineering expense consists principally of
salaries and benefits to scientists, design engineers, and other technical
personnel, related facility costs, process development costs, and various
expenses for projects, including new product development. Research, development,
and engineering expense continues to increase as we develop new display products
and technologies, especially LCOS microdisplays, while we continue with our
in-house process development efforts related to the high-volume LCD
manufacturing line located in Arizona.
Since 1997, we have been working on the development of LCOS microdisplays.
In 1997, we entered into a strategic alliance with National Semiconductor
Corporation for the development of LCOS microdisplay products. Under that
alliance, National focused on the silicon technologies needed for microdisplays,
and we focused on the liquid crystal technologies. In 1999, National decided to
close its microdisplay business unit. In connection with that closing, in July
1999, we purchased certain assets and licensed silicon technologies from
National relating to LCOS microdisplays. We paid approximately $3.0 million in
cash and issued warrants to purchase 140,000 shares of our common stock in the
transaction, which valued the total transaction at approximately $3.6 million.
No additional payments are required under the licenses. We also hired several
key technical employees of National to assist in the implementation of the
acquired technologies.
In April 1998, we entered into a strategic relationship with Inviso, Inc.,
formerly Siliscape, Inc., a privately held company with numerous patents and
proprietary technology related to microdisplay development. We acquired a
minority equity interest in Inviso for approximately $3.3 million. In March
2000, we acquired an additional interest in Inviso for $500,000, raising our
total minority equity interest to $3.8 million. As part of this strategic
relationship, we provide proprietary manufacturing capabilities and liquid
crystal expertise, and Inviso provides patented and proprietary technologies and
components for the joint development of microdisplay products.
In August 1999, we licensed the microdisplay technology of S-Vision
Corporation, which had recently ceased operations. This license is an
irrevocable, royalty free, fully paid-up, worldwide license to manufacture and
package certain microdisplay products and patented optical engines.
In October 1999, we entered into an agreement with Tecdis S.p.A., a
European-based LCD company, to form an ASIC design center in Chatillon, Italy.
The ASIC design center will be known as Dora and will focus on the design of
ASICs necessary to drive the LCDs we and Tecdis design for our respective
customers. STMicroelectronics is also participating in Dora and has agreed to
manufacture the ASICs designed by Dora.
These acquisitions, investments, and licenses will result in increased
research, development, and engineering expense as we expand our LCOS
microdisplay development efforts in preparation for the commercial introduction
of LCOS microdisplay products. We are also considering licensing other
technologies from other companies that could be optimized on our LCD
manufacturing line as well as entering into further alliances. We expect to
continue to devote substantial resources to research and development, especially
on our LCOS microdisplay technology and related products. As a result, the
actual dollar amount of our research, development, and engineering expense will
continue to increase.
9
<PAGE>
THREE MONTHS ENDED JUNE 30, 2000 COMPARED TO THREE MONTHS ENDED JUNE 30, 1999
NET SALES. Net sales increased 42.1% to $44.9 million in the three months
ended June 30, 2000 from $31.6 million in the three months ended June 30, 1999.
This increase occurred because of the increased level of programs at our largest
customer and strong growth in the mobile handset market. As a result of delayed
programs and product mix issues at that largest customer, however, second half
net sales is estimated to be in the same range as first half net sales.
COST OF SALES. Cost of sales decreased to 76.0% of net sales in the three
months ended June 30, 2000 from 79.4% in the three months ended June 30, 1999.
This percentage decrease resulted primarily from accelerated operating
efficiencies and cost reduction efforts as a result of the continued high levels
of production for programs that have been ongoing for several quarters. In
addition, we had nearly $500,000 in microdisplay development revenue during the
second quarter, which had a positive effect on the cost of sales percentage. The
cost of sales slightly increased from the first quarter of 2000 because of new
pricing for some high volume programs.
SELLING, GENERAL, AND ADMINISTRATIVE EXPENSE. Selling, general, and
administrative expense slightly decreased to $2.4 million in the three months
ended June 30, 2000 from $2.5 million in the three months ended June 30, 1999.
Selling, general, and administrative expense was 5.4% of net sales in the three
months ended June 30, 2000 compared to 7.9% in the three months ended June 30,
1999. The decrease in selling, general, and administrative expense reflected our
efforts to hold the costs of SG&A in 2000 to 1999 levels in order to leverage
those expenses as we continued to expand the business. In the three months ended
June 30, 2000, we incurred approximately $600,000 of marketing and
administrative expenditures relating to the LCoS microdisplay business compared
to approximately $400,000 in the three months ended June 30, 1999.
RESEARCH, DEVELOPMENT AND ENGINEERING EXPENSE. Research, development and
engineering expense increased 50.0% to $3.0 million in the three months ended
June 30, 2000 from $2.0 million in the three months ended June 30, 1999.
Research, development and engineering expense was 6.7% of net sales in the three
months ended June 30, 2000 compared to 6.4% in the three months ended June 30,
1999. Research, development and engineering expense overall increased as the
result of the development of new display products and technologies. For example,
LCoS microdisplays accounted for approximately $1.6 million of research,
development and engineering expense in the three months ended June 30, 2000
compared to approximately $950,000 in the three months ended June 30, 1999.
OTHER INCOME/EXPENSE, NET. Other income in the three months ended June 30,
2000 was $1.2 million compared to other expense of $214,000 in the three months
ended June 30, 1999. The difference was a result of increased interest income
and reduced interest expense. The increase in interest income was primarily a
result of additional cash balances in the three months ended June 30, 2000 and
the elimination of all indebtedness.
PROVISION FOR INCOME TAXES. We had a provision for income taxes of $2.2
million in the three months ended June 30, 2000 compared to a provision for
income taxes of $742,000 in the three months ended June 30, 1999. This change
resulted primarily from higher pre-tax income in the three months ended June 30,
2000 compared to the same period in 1999. The tax rate decreased to 33.1% in the
three months ended June 30, 2000 compared to 41.6% in the three months ended
June 30, 1999. The decreased tax rate in the three months ended June 30, 2000
resulted primarily from reporting income in Beijing, which is a low tax rate
jurisdiction. In the second half of 2000, we expect our overall tax rate to
continue to be approximately 33%.
NET INCOME. Net income increased 320% to $4.4 million, or $0.21 per diluted
share, in the three months ended June 30, 2000 from $1.0 million, or $0.07 per
diluted share, in the three months ended June 30, 1999. Excluding our LCoS
microdisplay business, our net income in the three months ended June 30, 2000
was approximately $5.6 million, or $0.27 per diluted share.
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<PAGE>
SIX MONTHS ENDED JUNE 30, 2000 COMPARED TO SIX MONTHS ENDED JUNE 30, 1999.
NET SALES. Net sales increased 54.0% to $84.1 million in the six months
ended June 30, 2000 from $54.6 million in the six months ended June 30, 1999.
This increase occurred because of the increased level of programs at our largest
customer and strong growth in the mobile handset market. As a result of delayed
programs and product mix issues at that largest customer, however, second half
net sales is estimated to be in the same range as first half net sales.
COST OF SALES. Cost of sales decreased to 75.5% of net sales in the six
months ended June 30, 2000 from 82.9% in the six months ended June 30, 1999.
This percentage decrease resulted primarily from accelerated operating
efficiencies and cost reduction efforts as a result of the continued high levels
of production for programs that have been ongoing for several quarters. In
addition, we had nearly $500,000 in microdisplay development revenue during the
second quarter, which had a positive effect on the cost of sales percentage.
SELLING, GENERAL, AND ADMINISTRATIVE EXPENSE. Selling, general, and
administrative expense decreased 4.1% to $4.7 million in the six months ended
June 30, 2000 from $4.9 million in the six months ended June 30, 1999. Selling,
general, and administrative expense was 5.6% of net sales in the six months
ended June 30, 2000 compared to 9.0% in the six months ended June 30, 1999. The
decrease in selling, general, and administrative expense reflected our desire to
leverage those expenses as we continued to expand the business. In the first
half of 2000, we incurred approximately $1.2 million of marketing and
administrative expenditures relating to our LCoS microdisplay business compared
to approximately $800,000 in the first six months of 1999.
RESEARCH, DEVELOPMENT AND ENGINEERING EXPENSE. Research, development and
engineering expense increased 52.6% to $5.8 million in the six months ended June
30, 2000 from $3.8 million in the six months ended June 30, 1999. Research,
development and engineering expense was 6.8% of net sales in the six months
ended June 30, 2000 compared to 7.0% in the six months ended June 30, 1999.
Research, development and engineering expense overall increased as the result of
the development of new display products and technologies, primarily
microdisplays. For example, LCoS microdisplays accounted for approximately $3.1
million of research, development and engineering expense in the first six months
of 2000 compared to approximately $1.8 million in the first six months of 1999.
OTHER INCOME (EXPENSE), NET. Other income in the six months ended June 30,
2000 was $1.7 million compared to other expense of $399,000 in the six months
ended June 30, 1999. The difference was a result of increased interest income
and reduced interest expense. The increase in interest income was primarily a
result of additional cash balances and the elimination of all indebtedness.
PROVISION FOR (BENEFIT FROM) INCOME TAXES. We had a provision for income
taxes of $3.9 million for the six months ended June 30, 2000 compared to a
benefit from income taxes of $218,000 for the six months ended June 30, 1999.
This change resulted primarily from higher pre-tax income in the six months
ended June 30, 2000 compared to the same period in 1999.
NET INCOME. Net income increased over 20 times to $8.0 million, or $0.39
per diluted share, in the six months ended June 30, 2000 from $398,000, or $0.03
per diluted share, in the six months ended June 30, 1999. Excluding LCoS
microdisplay related expenses, our net income for the six months ended June 30,
2000 was approximately $10.5 million, or $0.51 per diluted share.
QUARTERLY RESULTS OF OPERATIONS
The following table presents unaudited consolidated statement of operations
data for each of the five quarters in the period ended June 30, 2000. We believe
that all necessary adjustments have been included to present fairly the
quarterly information when read in conjunction with the Condensed Consolidated
Financial Statements. The operating results for any quarter are not necessarily
indicative of the results for any subsequent quarter.
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<PAGE>
<TABLE>
<CAPTION>
Quarters Ended
------------------------------------------------------
(Unaudited)
(In Thousands)
------------------------------------------------------
Jun 30 Sep 30, Dec 31, Mar 31, Jun 30,
1999 2000
-------------------------------- -------------------
<S> <C> <C> <C> <C> <C>
Net sales $ 31,600 $ 42,723 $ 50,041 $ 39,162 $ 44,926
-------- -------- -------- -------- --------
Cost and expenses:
Cost of sales 25,103 33,882 38,407 29,360 34,157
Selling, general, and administrative 2,493 2,741 3,487 2,262 2,418
Research, development, and engineering 2,008 2,427 2,489 2,763 2,989
-------- -------- -------- -------- --------
29,604 39,050 44,383 34,385 39,564
-------- -------- -------- -------- --------
Operating income 1,996 3,673 5,658 4,777 5,362
Other income (expense), net (214) (160) 541 580 1,165
-------- -------- -------- -------- --------
Income before provision for income taxes 1,782 3,513 6,199 5,357 6,527
Provision for income taxes 742 1,476 1,710 1,770 2,158
-------- -------- -------- -------- --------
Net income $ 1,040 $ 2,037 $ 4,489 $ 3,587 $ 4,369
======== ======== ======== ======== ========
</TABLE>
Historically, we have experienced seasonal fluctuations in our net sales.
OEM customers that purchase our products for incorporation into retail products,
such as mobile handsets, typically increase their purchases during the year-end
holiday period and phase out old programs early in the year following holiday
sales. As a result, net sales typically peak in the fourth quarter and reach a
seasonal low point in the first quarter.
There is significant pricing pressure in higher volume programs in the
wireless communications and office automation industries. In addition,
high-volume programs that generally have lower gross margins began to represent
a larger percentage of net sales in the second half of 1998, thereby reducing
gross margins. In the third quarter of 1998, we also started several new
programs and incurred substantial start-up costs on those new programs. In
addition, excess inventory purchases occurred in the second quarter of 1998,
slowing purchases in the third quarter of 1998 and greatly reducing material
overhead absorption in that quarter. In the first quarter of 1999, we had an
unfavorable product mix, shipping principally lower margin products. In
addition, reduced manufacturing yields and under-absorption of fixed overhead
contributed to lower margins. In the second half of 1999, higher volumes in our
manufacturing facilities produced increased operating efficiencies, resulting in
better margins. We continued to improve the margins in the first half of 2000 as
we focused on cost-reduction efforts. We expect the margins to sequentially drop
over the next few quarters as new programs with lower margins begin to ramp to
production.
In 1999, we continued to expand and intensify our research and development
efforts on proprietary display products, such as LCOS microdisplays. Other
expense increased in the last half of 1998 and the first half of 1999 as our
cash balances declined and we increased our borrowings. All borrowings were paid
off and cash balances increased as a result of our equity offering in the third
quarter of 1999. As a result, we had sharply higher interest income in the
fourth quarter of 1999. In the second quarter of 2000, we had another equity
offering, which further raised our cash balances and increased our interest
income.
LIQUIDITY AND CAPITAL RESOURCES
At June 30, 2000, we had cash, cash equivalents, and short-term investments
of $174.1 million compared to $45.4 million at December 31, 1999.
In the quarter ended June 30, 2000, we had $1.9 million in net cash flow
from operations compared to $1.3 million in net cash outflow from operations in
the quarter ended June 30, 1999. Our cash flow was positively impacted in the
quarter ended June 30, 2000 primarily as a result of substantially higher net
income.
Depreciation expense increased to $1.5 million for the second quarter of
2000 compared to $1.3 million for the second quarter of 1999. This increase
primarily relates to increased starts on our LCD line and increased building
depreciation as a result of our China operations. The high-volume LCD line is
depreciated on a units-of-production method based on units started. Inventory
turns were 9.7 in the second quarter of 2000 compared to 7.8 in the second
quarter of 1999. Accounts receivable DSOs (Day Sales Outstanding) were 52 days
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in the second quarter of 2000 from 60 days in the second quarter of 1999.
Accounts receivable balances substantially increased this quarter primarily as a
result of strong shipments in June.
In the first six months of 2000, we had $4.7 million in net cash flow from
operations compared to $827,000 in net cash flow from operations during 1999.
Cash flow from operations improved during the first six months of 2000 primarily
as a result of increased net income.
Our working capital was $195.7 million at June 30, 2000 compared with $60.9
million at December 31, 1999. Our current ratio increased to 8.7-to-1 at June
30, 2000 from 3.8-to-1 at December 31, 1999. The substantial increase in our
working capital and current ratio during the second quarter of 2000 occurred
primarily because of the equity offering that was completed during that quarter.
In that offering, we raised $129 million and issued approximately 2.5 million
additional shares of common stock. Including our cash, cash equivalents,
short-term investments, and available credit facilities, we had $199.5 million
in readily available funds at June 30, 2000 compared to $70.7 million at
December 31, 1999.
In January 2000, we entered into a new credit facility with Imperial Bank
to replace the then existing credit facility. The new credit facility is a $25.0
million unsecured revolving line of credit that matures in January 2001. Mellon
Bank is a participating lender on that new credit facility. No borrowings are
outstanding under the new credit facility. Advances under the new facility may
be made as prime rate advances, which accrue interest payable monthly at the
bank's prime lending rate, or as LIBOR rate advances, which bear interest at 150
basis points in excess of the LIBOR base rate. In addition, we have other
smaller credit facilities in Europe and China.
Capital expenditures during the first half of 2000 were approximately $5.3
million. These capital expenditures primarily consisted of equipment for our
operations in Manila, Beijing, and Arizona, including manufacturing equipment
for LCOS microdisplays. In the first quarter of 2000, we also made an additional
investment in Inviso, Inc. of $500,000, bringing our total minority investments
in Inviso to $3.8 million. Our total capital budget for 2000 is approximately
$14-16 million.
Capital expenditures during 1999 were approximately $12.5 million. These
capital expenditures consisted of $5.6 million for equipment and construction
costs relating to our manufacturing facility in Beijing; $1.8 million for
manufacturing and office equipment for our operations in Manila and Arizona; and
$5.1 million for LCOS microdisplays, including our purchase of assets and
licenses from National Semiconductor and S-Vision. The assets and licensed
silicon technologies from National Semiconductor relating to LCOS microdisplays
were acquired for approximately $3.0 million in cash and warrants to purchase
140,000 shares of our common stock. Substantially all of the purchase price was
allocated to depreciable assets, tooling and mask rights, and amortizable
licenses.
We believe that our existing balances of cash, cash equivalents, short term
investments, anticipated cash flows from operations, and available credit lines
will provide adequate sources to fund our operations and planned expenditures
through 2001.
EFFECTS OF INFLATION AND FOREIGN CURRENCY EXCHANGE FLUCTUATIONS
The results of our operations for the periods discussed have not been
significantly affected by inflation or foreign currency fluctuations. We
generally sell our products and services and negotiate purchase orders with our
foreign suppliers in U.S. dollars. However, we have certain foreign currency
exchange exposure as a result of our manufacturing operations in the Philippines
and China. The sub-assembly agreement relating to our operations in Manila is
based on a fixed conversion rate, exposing us to exchange rate fluctuations with
the Philippine peso. We have not incurred any material exchange gains or losses
to date. There has been some minor benefit as a result of the peso devaluation,
although we are now required to pay approximately one-third of any peso
devaluation gain to our lessor and direct labor subcontractor in Manila.
In China, we have accounts receivable and cash deposits in the local
currency. Although the Chinese currency currently is stable, its value in
relation to the U.S. dollar is determined by the Chinese government. There has
been general speculation since late 1998 that China may devalue its currency.
Devaluation of the Chinese currency could result in translation adjustments to
our balance sheet as well as reportable losses depending on our monetary
balances and outstanding indebtedness at the time of devaluation. The government
of China historically has made it difficult to convert its local currency into
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<PAGE>
foreign currencies. Although from time to time we may enter into hedging
transactions in order to minimize our 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 imposed restrictions on Chinese currency
loans to foreign-operated entities in China. Based on the foregoing, we cannot
provide assurance that fluctuations and currency exchange rates in the future
will not have an adverse effect on our financial condition or results of
operations.
QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
There are no material changes in reported market risks since the Company's
most recent filing on Form 10-K for the year ended December 31, 1999.
PART II. OTHER INFORMATION
ITEM 4. SUBMISSIONS OF MATTERS TO A VOTE OF SECURITY HOLDERS
Our Annual Meeting of Stockholders was held on April 27, 2000. All of the
nominees were elected to our Board of Directors as set forth in the Proxy
Statement as follows:
Nominees Votes in Favor Against
-------- -------------- -------
Jeffrey D. Buchanan 10,630,783 349,356
David C. Malmberg 10,630,783 349,356
Thomas H. Werner 10,628,850 351,289
Kenneth M. Julien 10,469,313 510,826
Gary R. Long 10,628,917 351,222
David P. Chavoustie 10,626,837 353,302
The following items were also voted upon and approved by the Stockholders:
(a) To approve the 1998 Amended and Restated Directors' Stock Plan (the
"1998 Plan").
Votes in Favor Opposed
-------------- -------
10,679,832 269,580
(b) To ratify the appointment of Arthur Andersen LLP as our independent
auditors for the fiscal year ending December 31, 2000.
Votes in Favor Opposed
-------------- -------
10,955,184 9,632
(c) To amend the Company's Restated Certificate of Incorporation to
increase the number of authorized shares of common stock from
15,000,000 to 60,000,000 shares.
Votes in Favor Opposed
-------------- -------
7,124,791 3,837,741
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
Exhibit 10(x): Amended and Restated Directors' Stock Plan.
Exhibit 10(aa): Credit Agreement dated January 21, 2000, by and
between Three-Five Systems, Inc., its subsidiaries,
the Banks listed therein, and Imperial Bank, as Agent
and as Issuing Bank.
Exhibit 27: Financial Data Schedule
(b) Reports on Form 8-K: None
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
THREE-FIVE SYSTEMS, INC.
------------------------
(Registrant)
Dated: July 21, 2000. By: /s/ Jeffrey D. Buchanan
------------------------------------
Name: Jeffrey D. Buchanan
Its: Executive Vice President;
Chief Financial Officer
15