THIS DOCUMENT IS A COPY OF THE ANNUAL REPORT ON FORM 10-K FILED ON APRIL 1ST,
1999 PURSUANT TO A RULE 201 TEMPORARY HARDSHIP EXEMPTION.
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
[X] Annual report pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934
For the fiscal year ended December 31, 1998 or
[ ] Transition report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the transition period from ________________ to
_______________.
Commission file number 0-10120
FAFCO, Inc.
(Exact name of registrant as specified in its charter)
California
(State or other jurisdiction of incorporation or organization)
94-2159547
(IRS Employer Identification No.)
2690 Middlefield Road, Redwood City, California 94063
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: 650/363-2690
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $0.125 par value
(Title of Class)
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 by check mark if the 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. [X ]
The aggregate market value of the registrant's Common Stock held by non-
affiliates of the registrant as of March 12, 1999 was $2,216,100 , based
upon the average of the bid and ask prices reported for such date by the
National Quotation Bureau. For purposes of this disclosure, shares of Common
Stock held by persons who hold more than 5% of the outstanding shares of
Common Stock and shares held by executive officers and directors of the
registrant have been excluded in that such persons may be deemed to be
"affiliates" as that term is defined under the rules and regulations
promulgated under the Securities Act of 1933. This determination is not
necessarily conclusive for other purposes.
The number of shares of the registrant's Common Stock outstanding as of
December 31, 1998, was 3,303,311.
Documents Incorporated by Reference
Document Description Form 10-K Part
Portions of Exhibit 13.1 (the Company's 1998 Annual Report to Shareholders)
(the "Annual Report") .............................................I, II, IV
The Company's Definitive Proxy Statement (the "Proxy Statement") for the
1999 Annual Meeting of Stockholders to be held on May 6, 1999 (the Proxy
Statement is expected to be filed pursuant to Regulation 14A on or before
April 30, 1999)................................... .................... III
_____________________________
With the exception of the information specifically incorporated by reference
in Parts I, II, III and IV of this Form 10-K, neither the Company's Annual
Report nor the Company's Proxy Statement is to be deemed filed as part of
this report.
PART I
Item 1. Business
Introduction
FAFCO, Inc. ("FAFCO," the "Company" or "Registrant") designs, develops,
manufactures, and markets solar heating systems for swimming pools and
thermal energy storage systems for commercial and industrial cooling. Pool
product sales amounted to 53% of net sales in 1998 compared to 56% of net
sales in 1997 and 58% of net sales in 1996. Thermal energy storage sales
amounted to 47% of net sales in 1998 compared to 44% of net sales in 1997 and
42% of net sales in 1996.
The Company manufactures products for the solar heating of water for low and
medium temperature applications. From the inception of the Company's
predecessor as a sole proprietorship in 1969 until 1976, efforts were largely
devoted to the refinement of the Company's initial product, a solar heating
system for swimming pools - a low temperature solar application. Since that
time, the Company has focused on increasing its share of the pool heating
market by extending its network of independent distributors, decreasing its
manufacturing costs, and improving its initial product. In 1983, a passive
domestic hot water heating system, the 444, was introduced (this product was
discontinued in early 1994). In 1987, the Company introduced a thermal
energy storage system based on the same heat exchanger technology as is used
in its swimming pool heating systems. In 1993, the Company introduced a
state-of-the-art control system for swimming pool solar heating systems (this
product was discontinued in December 1996).
FAFCO, Inc. was incorporated under the laws of the State of California in
1972. Its principal executive offices are located at 2690 Middlefield Road,
Redwood City, California. Its telephone number at that address is
(650) 363-2690.
Safe Harbor Statement
This Annual Report on Form 10-K contains forward-looking statements within
the meaning of Section 27A of the Securities Act of 1933 and Section 21E of
the Securities Exchange Act of 1934. Actual results could differ materially
from those projected in the forward-looking statements as a result of the
risk factors set forth on page 16 of the Annual Report under the heading
"Factors Affecting Future Results" which is incorporated herein by reference
and elsewhere in this Form 10-K.
Markets
Swimming Pool Heating
Low temperature solar applications developed because of the cost effectiveness
of solar systems in heating a large volume of water to produce a small
temperature change. The market for swimming pool heating developed for
several reasons. First, pool owners normally use their pools when solar
energy is abundant (during daylight hours and the summer swimming season).
Second, pools already have two elements needed for low temperature water
heating: storage (the pool water) and circulation (the existing pool pump
and associated plumbing). Third, pool owners are an easily identifiable
market.
Thermal Energy Storage
FAFCO also designs, develops, manufactures, and markets a static, glycol ice
builder for the thermal storage market. Since the product's introduction,
FAFCO has sold "ice banks" primarily to the commercial air conditioning
market for use in off-peak air conditioning systems.
Products
Swimming Pool Heating
The FAFCO solar pool heating system is composed of six to twelve solar
collectors, a sun sensor, an automatic control, and associated accessories.
The collectors and sensor are typically mounted on the roof of a pool owner's
home and connected to the pool pump and automatic control.
The customer sets the automatic control for the desired water temperature and,
when the sensor detects that there is sufficient solar energy for the system
to function efficiently, the automatic control directs the flow of water from
the pool to the collectors. The water absorbs heat as it passes through the
collectors and then flows back to the pool. When the desired water
temperature is achieved or when there is insufficient solar energy, the
automatic control redirects the flow of water back to the pool and water is
drained from the collectors. When the water temperature drops and there is
sufficient solar energy, the system is reactivated automatically.
In February 1996, the Company introduced a version of its solar pool heating
system specifically designed for above-ground swimming pools. This system is
composed of one or two solar collectors optimized for use in heating
above-ground swimming pools and designed to lie flat on the ground or to be
mounted on a rack on the ground.
In May 1996, the Company introduced a new and improved version of its solar
collector that has a higher thermal performance due to its unique heat
exchanger tube design. The tube design incorporates molded indentations,
which enhance the heat transfer coefficient by increasing fluid turbulence.
The Company's solar collectors are composed entirely of a polyolefin material
(a high molecular weight polymer compound) and made up of small round tubes
formed side by side in a rectangular shape either one-by-two meters,
four-by-eight feet, four-by-ten feet, four-by-twelve feet or four-by-twenty
feet in size, with submanifolds and header pipes thermoformed on each end.
This design provides for a maximum heating surface and even water flow in
order to transfer 75% to 90% of the available solar energy to the pool water.
The polyolefin material, which has been specially formulated by the Company,
is black in color (to optimize solar energy absorption) and has the inherent
advantages over other possible materials of lower cost, lighter weight, and
higher resistance to the corrosive effects of pool chemicals and degradation
resulting from ultraviolet radiation, heat, and other environmental effects.
In May 1993, the Company introduced a proprietary microprocessor-based
control (AutoPool) for its solar pool heating systems. Prior to May 1993,
the Company had a private label arrangement with an automatic control
manufacturer. AutoPool has built-in "intelligence" that allows it to
optimize the heating and filtration time for the swimming pool and can also
control non-conventional solar swimming pool heaters. Because of lack of
demand for the Company's AutoPool Control, this product was discontinued
effective January 1, 1997. The Company has ongoing obligations to service
and provide spare parts for AutoPool controls sold prior to that time.
Thermal Energy Storage
The Company's thermal energy storage ("IceStor?") systems utilize nighttime
electric capacity to create stored cooling energy. This is normally done by
storing inexpensive "off-peak" energy in the form of either chilled water or
ice. The next day this stored cooling capacity is used in conjunction with a
building's air conditioning equipment to significantly reduce electrical power
requirements for cooling during times of high power demand and high
electrical cost.
Cool storage systems offer power utilities a solution to a fundamental,
long-term problem: increased peak demand for power during periods of limited
available capacity (i.e., during business hours). IceStor? technology shifts
power consumption to off-peak periods when there is available capacity and
lower demand.
Marketing and Sales
Solar Systems
FAFCO markets its solar systems and controls in the United States through
independent distributors who sell directly to end users. Distributors
generally have sales, installation, and service personnel who are supported
by extensive FAFCO marketing and technical materials as well as in-depth
factory and field training programs.
The majority of sales personnel employed by the typical distributor are
assigned to retrofit sales, which are sales to existing pool owners.
Retrofit sales are generated through direct mail, customer referrals,
canvassing, and, to a lesser extent, selected media advertising. The balance
of the typical distributor's sales personnel are generally assigned to
contractor accounts and seek referrals for new construction sales.
FAFCO usually provides direct mail literature and other advertising materials to
distributors and mails or places these materials with local advertisers on
the distributors' behalf and partially at the distributors' expense. In
certain instances, distributors will also engage in direct mailing and
advertising.
In the past, the Company has canceled several distributor agreements for
reasons of inadequate performance by the distributor, primarily for failure
to provide adequate sales, installation and service support for the Company's
products. In such instances, the Company has generally been able to find
qualified replacements.
All work relating to the installation of FAFCO solar systems is covered by a
full one-year warranty provided by the distributor. The Company's solar
collectors used to be covered by a ten-year limited warranty, which was
changed to a ten-year full warranty beginning in 1991. Its automatic
controls, pumps, and drain-down valves are covered by a three-year limited
warranty. FAFCO warranties cover defects in materials and workmanship provided
that the related products are used for their intended purpose.
FAFCO solar systems are designed to require only minimal maintenance, which
can be performed either by the consumer using an owner's manual or by the
distributor's service personnel.
Thermal Energy Storage Systems
The Company markets its IceStor? products through independent contractors who
design and build heating and cooling systems for commercial and industrial
applications. The Company has also licensed its IceStor? products for sale
overseas, to design-and-build, heating, ventilating, and air-conditioning
companies in Taiwan, Korea, Japan, and The Peoples Republic of China. These
licensing agreements provide for licensees' assembly, sales, support, and
maintenance of IceStor? products in those countries.
Sales by Geographic Area
The Company's net sales during 1998, 1997, and 1996 were geographically
distributed approximately as follows:
<TABLE>
1998 1997 1996
<S> <C> <C> <C>
California 19% 22% 17%
Florida 31% 31% 34%
Other U.S. 14% 19% 35%
Foreign Countries 36% 28% 14%
100% 100% 100%
</TABLE>
One of the Company's customers, Ebara Corporation, accounted for 23.4% of the
Company's fiscal 1998 net sales and 18.6% of the Company's fiscal 1997 net
sales. Kailay International (now known as FAPCO), Ebara Corporation, and
Florida Solar are accounted for 14.0%, 12.1%, and 11.8% of the Company's
fiscal 1996 net sales, respectively. During 1996, 1997 and 1998 Kailay
International and Ebara Corporation were the licensees for the Company's
IceStorT products in Taiwan and Japan, respectively, and, as such, purchased
IceStorT products and components for assembly into products for resale to end
users in Taiwan and Japan, respectively. During 1996, Florida Solar was a
distributor of the Company's pool products and, as such, purchased pool panels
and components for resale to end users in Florida. No other customer
accounted for 10% or more of the Company's net sales in fiscal 1996, 1997 or
1998. Any material cancellation, reduction or rescheduling of orders from a
major customer, particularly Ebara Corporation, or the loss of any such
customer would have a material adverse effect in the Company's financial
condition and operation results.
Foreign sales of the Company's products are made through independent foreign
distributors and licensees. Sales to foreign distributors and licensees are
shipped directly from the Company's facilities in California and invoiced in
U.S. dollars. Export sales are subject to certain controls and restrictions,
including tariffs and import duties, and are subject to certain risks,
including changing regulatory requirements of foreign jurisdictions and
transportation delays and interruptions; however, the Company has not
experienced any material difficulties in the past relating to such
limitations. The financial crisis in Southeast Asia has not had any
noticeable negative effect on sales; however, there is no assurance that
sales will not be negatively affected if the crisis worsens or is
prolonged.
Backlog
Sales to solar distributors are made against individual purchase orders
rather than through volume purchase arrangements. The Company typically
ships its products within one to five days of receipt of an order; therefore,
the Company's backlog at any date is usually insignificant and is not a
meaningful indicator of future sales. FAFCO distributors tend to order
frequently in small quantities in order to minimize their inventory levels and
match inventory levels with current installation schedules.
Sales of IceStor? products are made against individual purchase orders to
general contractors or Heating, Ventilating, and Air conditioning (HVAC)
contractors for specific new construction projects or for retrofit in
existing buildings. The Company typically ships these products within six
weeks or less of receipt of an order; therefore, the Company's backlog with
respect to IceStor? products at any date is also usually insignificant and
not a meaningful indicator of future sales.
Government Tax Incentives
Although the Company's operations are not directly subject to extensive
governmental regulations, the existence or lack of federal, state, and local
tax incentives for the sale and installation of solar systems would have a
substantial impact on the Company's business. There is currently no federal
tax credit for solar heating systems and state solar tax credits are
available only in a few states. The Company does not anticipate that solar
tax credits will become available for solar heating systems in any additional
states, nor does it anticipate a significant increase in sales due to
existing or future tax credits.
Manufacturing
FAFCO's manufacturing activities consist primarily of the production of
polyolefin heat exchangers used in solar heating applications and off-peak
cooling applications and associated accessories. A total system approach is
emphasized in order to ensure the effectiveness and reliability of the
Company's products after they have been installed, eliminating the need for
distributors to rely upon materials from other suppliers.
The Company's heat exchangers are produced from polyolefin resins using a
patented extrusion and thermoforming process. Substantially all equipment
used in these processes has been designed and built by the Company's research
and development engineers.
The resins employed by the Company are a petroleum by-product. The market
price of these resins has fluctuated over the years with an increase in 1990
and early 1991 due to tensions in the Middle East, followed by a
stabilization after the completion of Desert Storm. It is expected that the
price of the resins will continue to fluctuate as a result of domestic and
international political and economic conditions.
FAFCO has qualified multiple sources of supply for all of its resins,
materials, and subassemblies. However, certain materials and subassemblies
are currently obtained from single sources. The Company believes these items
could be supplied by the Company's other qualified sources if sufficient
lead-time were provided. The Company attempts to maintain additional inventory
of such materials to mitigate the risk of supply shortages; however, any
prolonged inability to obtain such items would have a material adverse effect on
the Company's results of operations. To date, the Company has not
experienced any significant manufacturing problems or delays due to shortages of
materials.
Quality assurance is performed by FAFCO at its manufacturing facility. Test
and inspection procedures are a part of substantially all production and
assembly operations. In addition, the Company uses it own diagnostic
equipment and laboratory to continually test and inspect raw materials, work in
process, and finished goods.
Competition
The Company's solar heating products currently compete directly with solar
heating products offered by other domestic and international manufacturers of
solar heating systems, and indirectly with conventional heating systems.
The Company believes that the principal competitive factors in the markets
for FAFCO solar products are (i) product performance and reliability; (ii)
marketing and technical support from the manufacturer for distribution
channels; (iii) selling, installation, and service capabilities of
distribution channels; and (iv) price. The Company believes that it competes
favorably with respect to all of these factors. However, certain of its
competitors may have greater financial, marketing, and technological
resources than those of the Company.
A number of companies in the United States manufacture thermal energy storage
systems of various types similar to the Company's IceStor? product. The
industry is in the early stages of development and additional competitors are
expected to enter the market over time.
At the present time, the Company believes that the main competitive factors
in the thermal energy storage market are performance, reliability, and price.
The Company believes that it competes favorably with respect to these factors.
However, several of its competitors have greater financial, marketing, and
technological resources than those of the Company.
Research and Development
For the years ended December 31, 1998, 1997, and 1996, the Company's research
and development expenses were $194,100, $202,800, and $116,000, respectively.
The Company currently uses consulting engineers, in addition to staff
engineers, who are responsible for existing product improvement, applications
engineering, and new product research and development. The Company is
exploring other potential revenue-producing uses for its polyolefin extrusions.
Patents, Trademarks and Licenses
FAFCO currently holds two United States patents and one foreign patent
relating to certain aspects of its products and manufacturing technology.
These patents expire at various times between March 2000 and July 2003.
However, the Company believes that patent protection is secondary to such
factors as ongoing product development and refinement, the knowledge and
experience of its personnel, and their ability to design, manufacture, and
successfully market the Company's products.
From time to time, the Company has registered as trademarks certain product
names and marks in order to preserve its right to those product names and marks.
The Company has granted licenses to assemble and sell IceStor? systems in
Taiwan, Korea, Japan, and the Peoples Republic of China to local
manufacturers. See "Marketing and Sales" above.
Employees
At December 31, 1998, the Company had a total of 61 full-time employees,
including eight in marketing, five in research and development, 37 in
manufacturing, and 11 in general management and administration. The Company
also uses temporary employees from agencies to fill seasonal needs. The
Company has never had a work stoppage. To the Company's knowledge, no
employees are represented by a labor organization.
Seasonality
Information regarding the seasonality of the Company's business is set forth
in "Management's Discussion and Analysis of Financial Condition and Results of
Operations - Seasonality" on page 16 of the Annual Report, which information
isincorporated herein by reference.
Segment Information
Following the sale of the business of the Company's subsidiary, The Gregory
Company, in 1988, the Company has only had continuing operations in the
energy products segment.
Environmental Regulations
The Company is subject to a number of environmental regulations concerning
potential air and water pollution. However, such regulations have not in the
past had, and are not expected to have, any material adverse effect on the
Company's business. However, there can be no assurance that compliance with
existing or future regulations will not require the expenditure of funds
or the modification of the Company's manufacturing process, which could have a
material adverse effect on the Company's business or financial condition.
Item 2. Properties
The Company's principal executive offices and manufacturing facilities for
its products are located in a single 42,500 square foot facility in
Redwood City, California. A lease expiring in the year 2000 covers this
facility. This lease has an option to extend through 2005. See Note 10 of
Notes to Consolidated Financial Statements on page 13 of the Annual Report,
which information is incorporated herein by reference.
The Company believes that its current facilities are adequate to meet its
requirements for space in the near future. Manufacturing space is being
fully utilized at the present time. However, additional demand can be
accommodated by adding additional employee shifts.
Item 3. Legal Proceedings
There are presently no material pending legal proceedings to which the
Company is a party or to which any of its property is subject, except for
ordinary routine legal proceedings incidental to the Company's business.
Item 4. Submission of Matters to a Vote of Security Holders
The Company did not submit any matter to a vote of security holders during
the fourth quarter of its fiscal year ended December 31, 1998.
The executive officers of the Company are set forth below. All officers
serve at the pleasure of the Board of Directors. There are no family
relationships between any executive officers or directors.
Freeman A. Ford, age 58, serves as Chairman of the Board, President, and
Chief Executive Officer. Mr. Ford, a co-founder of the Company, has served
as Chairman of the Board since 1972, as Chief Executive Officer of the
Company since May 1979, and as President since September 1984. Mr. Ford is
also a Director of H.B. Fuller Company.
Alex N. Watt, age 57, serves as Vice President of Finance and Administration,
Chief Financial Officer, and Secretary. Mr. Watt joined the Company as its
Vice President-Finance and Chief Financial Officer in July 1984, and has
served as Secretary since March 1985.
David Harris, age 43, serves as Vice President, Sales. Mr. Harris joined the
Company in August 1981 as a sales representative and has held the positions
of Pool Builder Manager, National Sales Manager-Pool Products, Pacific
Northwestern Region Sales Manager, National Sales Manager-Solar Division,
National Sales Manager, Vice President-Sales and Marketing (from June 1988
until April 1993) and President-Pool Products Division (from May 1993 until
May 1995).
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder
Matters
Information regarding the market for and market prices of the Company's
Common Stock, the number of shareholders of record, and information regarding
dividends is set forth under the heading "Common Stock Data" on page 15 of
the Annual Report, which information is incorporated herein by reference.
Item 6. Selected Financial Data
Selected financial data for the Company is set forth in the table entitled
"Five-Year Summary of Operations" on page 15 and in the last sentence of the
text under the table entitled "Common Stock Data" on page 15 of the Annual
Report, which information is incorporated herein by reference.
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations
Information regarding Management's Discussion and Analysis of Financial
Condition and Results of Operations is set forth under the heading
"Management's Discussion and Analysis," on pages 16 through 18 of the Annual
Report, which information is incorporated herein by reference.
Item 7A. Quantitative and Qualitative Disclosures about Market Risk
The following discussion about the Company's market risk exposure involves
forward-looking statements. Actual results could differ materially from
those projected in the forward-looking statements. The Company is exposed to
market risk related to changes in interest rates, foreign currency exchange
rates and equity security price risk. The Company does not use derivative
financial instruments for any purpose, including hedging interest and foreign
exchange risks.
The Company is exposed to financial market risks, including changes in
foreign currency exchange rates and interest rates. The Company attempts to
minimize its currency fluctuation risk by pricing its overseas product sales
and license fees in United States dollars. A 10% change in the foreign
currency exchange rates would not have a material impact on the Company's
results of operations.
The Company maintains short-term investments consisting of variable interest
accounts. However, due to the short-term nature of the Company's debt
investments, the impact of interest rate changes would not have a material
impact on the value of such investments.
The Company is also exposed to interest rate risk on outstanding fixed rate
promissory notes. However, the balance of fixed rate debt obligations of the
Company is currently relatively insignificant. As a result, the Company does
not actively manage the risk associated with these obligations. The impact of
interest rate changes would not have a material impact on the Company's
results of operations.
The Company currently holds no marketable equity securities of other issuers
that are subject to market price volatility.
Item 8. Financial Statements and Supplementary Data
The consolidated financial statements of the Company are set forth on pages 3
through 12 of the Annual Report, which information is incorporated herein by
reference. The supplementary financial information requirements of Regulation
S-K Item 302 do not apply to the Company, because the Company does not meet
the tests set forth therein.
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
Not applicable.
PART III
Item 10. Directors and Executive Officers of the Registrant
Information regarding directors and nominees for directors is to be set forth
under the heading "Election of Directors - Nominees" in the Company's Proxy
Statement, which information is incorporated herein by reference.
Information regarding the filing of reports by insiders under Section 16(a) of
the Exchange Act is to be set forth under the heading "Election of Directors -
Section 16(a) Beneficial Ownership Reporting Compliance" in the Company's Proxy
Statement, which information is incorporated herein by reference.
Item 11. Executive Compensation
Information regarding the Company's remuneration of its executive officers and
directors is to be set forth under the headings "Election of Directors -
Executive Compensation" and "Election of Directors - Director Compensation" in
the Company's Proxy Statement, which information is incorporated herein by
reference.
Item 12. Security Ownership of Certain Beneficial Owners and Management
Information regarding the security ownership of certain beneficial owners and
management is to be set forth under the headings "Election of Directors -
Security Ownership" and "Information Concerning Solicitation and Voting -
Record Date and Outstanding Shares" in the Company's Proxy Statement, which
information is incorporated herein by reference.
Item 13. Certain Relationships and Related Transactions
Information regarding certain relationships and related transactions is to be
set forth under the headings "Election of Directors - Nominees" and "Election
of Directors - Certain Transactions" in the Company's Proxy Statement, which
information is incorporated herein by reference.
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K
(a) Documents filed as part of this report:
1. Financial Statements
The consolidated balance sheets for the years ended December 31, 1998 and .
1997, the Consolidated Statement of Operations, of Shareholders' Equity and
Cash Flows for each of the three years in the period ended December 31, 1998,
and the notes thereto appear on pages 4 through 14 of the Annual Report.
2. Financial Statement Schedules
The following schedule for the years ended December 31, 1998, 1997, and
1996 is included in this report. Such schedule should be read in
conjunction with the consolidated financial statements in the Annual Report.
Report of Independent Accountants on Financial Statement Schedule
(see page 17).
Schedule II - Valuation and Qualifying Accounts and Reserves (see page 18).
Schedules not included in these financial statement schedules have been
omitted because they are not applicable or the required information is
shown in the financial statements or notes thereto.
3. Index to Exhibits
The following exhibits are filed as part of or incorporated by reference,
to the extent indicated herein, in this Annual Report on Form 10-K.
<TABLE>
Exhibit No. Description (footnotes appear at the end of the exhibit list)
<S> <C>
3.1(1) Articles of Incorporation, as amended.
3.2(3) Bylaws, as amended.
3.2(a)
4.1(1) Stock Purchase Agreement dated April 14, 1977, between Registrant
and certain investors.
4.2(3) 10% Convertible Subordinated Notes Purchase Agreement dated
March 27, 1984, between Registrant and certain investors.
4.2(a)(2) Amendment to Subordinated Note Purchase Agreement dated March 27,
1990.
4.2(b)(9) Amendment to 10% Subordinated Note Agreement dated March 25, 1991.
4.3(4)* Security and Guaranty Agreement and Common Stock Purchase Warrant
between the Registrant and Freeman A. Ford dated
February 16, 1987.
4.3(a)(5)* Amendment to the Security and Guaranty Agreement between the
Registrant and Freeman A. Ford dated December 8, 1987.
4.3(b)(6)* Amendment to the Security and Guaranty Agreement between the
Registrant and Freeman A. Ford dated February 1, 1988.
4.3(c)(7)* Second Amendment to the Promissory Notes between the Registrant
and Freeman A. Ford dated March 26, 1991.
4.3(d)(9)* Form of Common Stock Purchase Warrant issued March 25,
1993 by the Registrant to Freeman A. Ford.
4.3(e)(9) Amendment to the Promissory Notes between the
Registrant and Freeman A. Ford dated March 25, 1993.
4.4(10) Common Stock Warrant issued January 19, 1994 to B. Severns.
4.5 Reference Exhibits 3.1 and 3.2.
10.1 Reference Exhibit 4.1.
10.2 Reference Exhibit 4.2, 4.2(a), and 4.2(b).
10.3(7)* 1981 Incentive Stock Option Plan.
10.4(7)* Form of 1981 Incentive Stock Option Agreement.
10.8(1) Standard Form of Distributor Agreement.
10.9(7) Lease Agreement and Addenda for 2690 Middlefield Road,
Redwood City, California, between Registrant, as Lessee, and
Beals Martin and Associates, as Lessor, dated January 18, 1990.
10.10(3) FAFCO Solar Partners II Certificate of Limited Partnership and
Limited Partnership Agreement.
10.11 Reference Exhibits 4.3, 4.3(a), 4.3(b), 4.3(c), 4.3(d), and
4.3(e).
10.12(6) Licensing Agreement between the Registrant, as Licensor, and
Enercon Engineering, as Licensee, dated May 20, 1988.
10.13(6)* Form of Director's Warrant issued February 1988 to directors
Berry and Selig.
10.14(11)* 1991 Stock Option Plan, as amended.
10.14(a)(8)* Form of Stock Option Agreement used under the 1991 Stock Option
Plan.
10.15(8)* 1991 Directors' Stock Option Plan.
10.15(a)(8)* Form of Nonstatutory Stock Option Agreement used under 1991
Director's Stock Option Plan.
10.16(8)* Employee Stock Purchase Plan.
10.16(a)(8)* Form of Subscription Agreement used under Employee Stock
Purchase Plan.
10.17(9) Licensing Agreement and Addendum between the Registrant, as
Licensor, and Jang-Han Systems Engineering, as Licensee, dated
January 1, 1993.
10.18(10) Export - Import and Technical License Agreement between the
Registrant, as Licensor, and Ebara Corporation, as Licensee,
dated October 22, 1993.
10.19(10) Business Loan Agreement between Registrant, as Borrower, and
Silicon Valley Bank, as Lender, dated June 10, 1992.
10.19(a)(10) Loan Modification Agreement between Registrant as Borrower, and
Silicon Valley Bank, as Lender, dated March 8, 1994.
10.19(b)(12) Loan Modification Agreement between Registrant as Borrower, and
Silicon Valley Bank, as Lender, dated June 5, 1995.
10.19(c)(12) Loan Modification Agreement between Registrant as Borrower, and
Silicon Valley Bank, as Lender, dated August 7, 1995.
10.19(d)(12) Loan Modification Agreement between Registrant as Borrower, and
Silicon Valley Bank, as Lender, dated September 22, 1995.
10.19(e)(12) Loan Modification Agreement between Registrant as Borrower, and
Silicon Valley Bank, as Lender, dated February 8, 1996.
10.19(f)(13) Loan Modification agreement between Registrant as Borrower, and
Silicon Valley Bank, as Lender, dated October 30, 1996.
10.19(g)(13) Loan Modification Agreement between Registrant, as Borrower, and
Silicon Valley Bank, as Lender, dated December 11, 1996.
10.19(h)(13) Loan Modification Agreement between Registrant, as Borrower, and
Silicon Valley Bank, as Lender, dated January 6, 1997.
10.19(i)(13) Loan Modification Agreement between Registrant, as Borrower, and
Silicon Valley Bank, as Lender, dated January 21, 1997.
10.19(j)(14) Loan Modification Agreement between Registrant, as Borrower, and
Silicon Valley Bank, a Lender, dated April 1, 1998.
10.19(k) Loan Modification Agreement between Registrant, as Borrower, and
Silicon Valley Bank, a Lender, dated March 22, 1999.
10.20(11) Agency/Distributorship Agreement between Registrant as
Manufacturer and Jabria Establishment, as Agent/Distributorship,
dated December 10, 1994.
11.1 Computation of Earnings Per Share (see Note 12 of Notes to
Consolidated Financial Statements on the 1997 Annual Report).
13.1 Registrant's 1998 Annual Report to Shareholders.
18.1(14) Letter re change in Accounting Principle from Burr, Pilger &
Meyer dated November 5, 1997.
21.1 Subsidiaries of Registrant.
23.1 Consent of Independent Accountants (see page 20)
24.1 Power of Attorney (see page 19).
27.1 Financial Data Schedule.
</TABLE>
* Denotes a management contract or compensatory plan or arrangement.
<TABLE>
<S> <C>
(1) Incorporated by reference to exhibit filed with Registrant's Registration
Statement on Form S-1 (File No. 2-72297) filed May 14, 1981.
(2) Incorporated by reference to exhibit filed with Registrant's Annual Report
on Form 10-K for the fiscal year ended December 31, 1989.
(3) Incorporated by reference to exhibit filed with Registrant's Annual Report
on Form 10-K for the fiscal year ended December 31, 1983.
(4) Incorporated by reference to exhibit filed with Registrant's Annual Report
on Form 10-K for the fiscal year ended December 31, 1986.
(5) Incorporated by reference to exhibit filed with Registrant's Annual Report
on Form 10-K for the fiscal year ended December 31, 1987.
(6) Incorporated by reference to exhibit filed with Registrant's Annual Report
on Form 10-K for the fiscal year ended December 31, 1988.
(7) Incorporated by reference to exhibit filed with Registrant's Annual Report
on Form 10-K for the fiscal year ended December 31, 1990.
(8) Incorporated by reference to exhibit filed with Registrant's Annual Report
on Form 10-K for the fiscal year ended December 31, 1991.
(9) Incorporated by reference to exhibit filed with Registrant's Annual Report
on Form 10-K for the fiscal year ended December 31, 1992.
(10) Incorporated by reference to exhibit filed with Registrant's Annual
Report on Form 10-K for the fiscal year ended December 31, 1993.
(11) Incorporated by reference to exhibit filed with Registrant's Annual
Report on Form 10-K for the fiscal year ended December 31, 1994
(12) Incorporated by reference to exhibit filed with Registrant's Annual
Report on Form 10-K for the fiscal year ended December 31, 1995.
(13) Incorporated by reference to exhibit filed with Registrant's Annual
Report on Form 10-K for the fiscal year ended December 31, 1996.
(14) Incorporated by reference to exhibit filed with Registrant's Annual
Report on Form 10K for the fiscal year ended December 31, 1998.
(b) Reports on Form 8-K: No Reports on Form 8-K were filed by the Company
during the fourth quarter of 1998 .
(c) Exhibits: See subsection (a) (3) above.
(d) Financial Statement Schedules: See subsection (a) (2) above.
</TABLE>
Report of Independent Accountants on
Financial Statement Schedule
To the Board of Directors of FAFCO, Inc.
Our audits of the consolidated financial statements referred to in our report
dated March 1,1999 appearing on page 13 of the 1998 Annual Report to
Shareholders of FAFCO, Inc. (which report and consolidated financial
statements are incorporated by reference in this Annual Report on Form 10-K)
also included an audit of the Financial Statement Schedule listed in Item
14(a) of this Form 10-K. In our opinion, this Financial Statement Schedule
presents fairly, in all material respects, the information set forth therein
when read in conjunction with the related consolidated financial statements.
Burr, Pilger & Mayer
Palo Alto, California
March 29, 1999
FAFCO, Inc.
Schedule
II
Valuation and Qualifying Accounts and Reserves
<TABLE>
Balance at Additions Charged
Beginning of to Cost and Balance at End of
Description Period Expenses Deductions Period
<S> <C> <C> <C> <C>
1998:
Allowance for
doubtful accounts
current accounts
receivable $540,100 $53,900 $57,700 (1) $536,300
short-term
receivable 126,400 126,400(1)
long-term
receivable 29,300 29,300
Warranty reserve 211,000 190,600 169,400 232,200
Deferred tax
asset valuation
allowance 708,000 534,800 173,200
1997:
Allowance for
doubtful accounts
current accounts
receivable $512,600 $172,600 $145,100 (1) $540,100
short-term
receivable 28,800 97,600 126,400
long-term
receivable 34,000 4,700 (3) 29,300
warranty reserve 234,100 85,600 108,700 (2) 211,000
Deferred tax
asset valuation
allowance 1,191,800 483,800 708,000
1996:
Allowance for
doubtful accounts
current accounts
receivable $463,900 $50,400 $1,700 (1) $512,600
short-term
receivable 28,800 28,800
long-term
receivable 39,100 5,100 (3) 34,000
Warranty reserve 216,000 94,100 76,000 (2) 234,100
Deferred tax
asset valuation
allowance 1,383,800 192,000 1,191,800
</TABLE>
(1) Write-off of uncollectible accounts.
(2) Cost of warranty claims processed.
(3) Reclassification to allowance for short-term notes receivable.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Registrant has duly caused this Annual Report on Form 10-K to
be signed on its behalf by the undersigned, thereunto duly authorized.
Date: March 29, 1999 FAFCO, Inc.
/s/Freeman A. Ford
Freeman A. Ford,
Chairman of the Board, President
and Chief Executive Officer
POWER OF ATTORNEY
Each person whose signature appears below constitutes and appoints
Freeman A. Ford and Alex N. Watt, or either of them, his attorneys-in-fact,
each with the power of substitution, for him in any and all capacities, to
sign any amendments to this Annual Report on Form 10-K and to file the same,
with exhibits thereto and other documents in connection therewith, with the
Securities and Exchange Commission, hereby ratifying and confirming all that
either of said attorneys-in-fact, or his substitute or substitutes, may do or
cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this
Annual Report on Form 10-K has been signed below by the following persons on
behalf of the Registrant and in the capacities and on the dates indicated.
<TABLE>
<S> <C> <C>
Signature Title Date
Chairman of the Board,
President and
March 29, 1999
/s/Freeman A. Ford Chief Executive Officer
Freeman A. Ford (Principal Executive
Officer) and Director
Vice President, Finance &
Administration March 29, 1999
/s/Alex N. Watt and Chief Financial Officer
Alex N. Watt (Principal Finacial
and Accounting Officer)
/s/William A. Berry Director March 29, 1999
William A. Berry
/s/Robert W. Selig, Jr. Director March 29, 1999
Robert W. Selig, Jr.
</TABLE>
CONSENT OF INDEPENDENT ACCOUNTANTS
We hereby consent to the incorporation by reference in the Registration
Statements on Form S-8 (Nos. 2-75201, 2-86299, 2-95390 and 33-76220) and
related prospectuses of FAFCO, Inc. of our report dated March 1, 1999,
appearing on page 13 of the 1998 Annual Report to Shareholders, which is
incorporated by reference in this Annual Report on Form 10-K. We also
consent to the incorporation by reference of our report on the Financial
Statement Schedule, which appears on page 17 of this Form 10-K.
Burr, Pilger & Mayer
San Francisco, California
March 29, 1999
<TABLE>
INDEX TO EXHIBITS
Exhibit No. Description
<S> <C>
3.1(1) Articles of Incorporation, as amended.
3.2(3) Bylaws, as amended.
3.2(a) Bylaws Certificate of Amendment
4.1(1) Stock Purchase Agreement dated April 14, 1977, between
Registrant and certain investors.
4.2(3) 10% Convertible Subordinated Notes Purchase Agreement dated
March 27, 1984, between Registrant and certain investors.
4.2(a)(2) Amendment to Subordinated Note Purchase Agreement dated
March 27, 1990.
4.2(b)(9) Amendment to 10% Subordinated Note Agreement dated March 25, 1991.
4.3(4)* Security and Guaranty Agreement and Common Stock Purchase
Warrant between the Registrant and Freeman A. Ford dated
February 16, 1987.
4.3(a)(5)* Amendment to the Security and Guaranty Agreement between the
Registrant and Freeman A. Ford dated December 8, 1987.
4.3(b)(6)* Amendment to the Security and Guaranty Agreement between the
Registrant and Freeman A. Ford dated February 1, 1988.
4.3(c)(7)* Second Amendment to the Promissory Notes between the Registrant
and Freeman A. Ford dated March 26, 1991.
4.3(d)(9)* Form of Common Stock Purchase Warrant issued March 25, 1993 by
the Registrant to Freeman A. Ford.
4.3(e)(9) Amendment to the Promissory Notes between the Registrant and
Freeman A. Ford dated March 25, 1993.
4.4(10) Common Stock Warrant issued January 19, 1994 to B. Severns.
4.5 Reference Exhibits 3.1 and 3.2.
10.1 Reference Exhibit 4.1.
10.2 Reference Exhibit 4.2, 4.2(a), and 4.2(b).
10.3(7)* 1981 Incentive Stock Option Plan.
10.4(7)* Form of 1981 Incentive Stock Option Agreement.
10.8(1) Standard Form of Distributor Agreement.
10.9(7) Lease Agreement and Addenda for 2690 Middlefield Road,
Redwood City, California, between Registrant, as Lessee, and
Beals Martin and Associates, as Lessor, dated January 18, 1990.
10.10(3) FAFCO Solar Partners II Certificate of Limited Partnership and
Limited Partnership Agreement.
10.11 Reference Exhibits 4.3, 4.3(a), 4.3(b), 4.3(c), 4.3(d), and
4.3(e).
10.12(6) Licensing Agreement between the Registrant, as Licensor, and
Enercon Engineering, as Licensee, dated May 20, 1988.
10.13(6)* Form of Director's Warrant issued February 1988 to directors
Berry and Selig.
10.14(11)* 1991 Stock Option Plan, as amended.
10.14(a)(8)* Form of Stock Option Agreement used under the 1991 Stock Option
Plan.
10.15(8)* 1991 Directors' Stock Option Plan.
10.15(a)(8)* Form of Nonstatutory Stock Option Agreement used under 1991
Director's Stock Option Plan.
10.16(8)* Employee Stock Purchase Plan.
10.16(a)(8)* Form of Subscription Agreement used under Employee Stock
Purchase Plan.
10.17(9) Licensing Agreement and Addendum between the Registrant, as
Licensor, and Jang-Han Systems Engineering, as Licensee, dated
January 1, 1993.
10.18(10) Export - Import and Technical License Agreement between the
Registrant, as Licensor, and Ebara Corporation, as Licensee,
dated October 22, 1993.
10.19(10) Business Loan Agreement between Registrant, as Borrower, and
Silicon Valley Bank, as Lender, dated June 10, 1992.
10.19(a)(10) Loan Modification Agreement between Registrant as Borrower, and
Silicon Valley Bank, as Lender, dated March 8, 1994.
10.19(b)(12) Loan Modification Agreement between Registrant as Borrower, and
Silicon Valley Bank, as Lender, dated June 5, 1995.
10.19(c)(12) Loan Modification Agreement between Registrant as Borrower, and
Silicon Valley Bank, as Lender, dated August 7, 1995.
10.19(d)(12) Loan Modification Agreement between Registrant as Borrower, and
Silicon Valley Bank, as Lender, dated September 22, 1995.
10.19(e)(12) Loan Modification Agreement between Registrant as Borrower, and
Silicon Valley Bank, as Lender, dated February 8, 1996.
10.19(f)(13) Loan Modification agreement between Registrant as Borrower, and
Silicon Valley Bank, as Lender, dated October 30, 1996.
10.19(g)(13) Loan Modification Agreement between Registrant, as Borrower, and
Silicon Valley Bank, as Lender, dated December 11, 1996.
10.19(h)(13) Loan Modification Agreement between Registrant, as Borrower, and
Silicon Valley Bank, as Lender, dated January 6, 1997.
10.19(i)(13) Loan Modification Agreement between Registrant, as Borrower, and
Silicon Valley Bank, as Lender, dated January 21, 1997.
10.19(j)(14) Loan Modification Agreement between Registrant, as Borrower, and
Silicon Valley Bank, a Lender, dated April 1, 1998.
10.19(k) Loan Modification Agreement between Registrant, as Borrower, and
Silicon Valley Bank, a Lender, dated March 22, 1999.
10.20(11) Agency/Distributorship Agreement between Registrant as
Manufacturer and Jabria Establishment, as Agent/Distributorship,
dated December 10, 1994.
11.1 Computation of Earnings Per Share (see Note 12 of Notes to
Consolidated Financial Statements on the 1997 Annual Report).
13.1 Registrant's 1997 Annual Report to Shareholders.
18.1(14) Letter re change in Accounting Principle from Burr, Pilger &
Meyer dated November 5, 1997.
21.1 Subsidiaries of Registrant.
23.1 Consent of Independent Accountants (see page 20)
24.16 Power of Attorney (see page 19).
27.1 Financial Data Schedule.
</TABLE>
* Denotes a management contract or compensatory plan or arrangement.
<TABLE>
<S> <C>
(1) Incorporated by reference to exhibit filed with Registrant's Registration
Statement on Form S-1 (File No. 2-72297) filed May 14, 1981.
(2) Incorporated by reference to exhibit filed with Registrant's Annual
Report on Form 10-K for the fiscal year ended December 31, 1989.
(3) Incorporated by reference to exhibit filed with Registrant's Annual
Report on Form 10-K for the fiscal year ended December 31, 1983.
(4) Incorporated by reference to exhibit filed with Registrant's Annual
Report on Form 10-K for the fiscal year ended December 31, 1986.
(5) Incorporated by reference to exhibit filed with Registrant's Annual
Report on Form 10-K for the fiscal year ended December 31, 1987.
(6) Incorporated by reference to exhibit filed with Registrant's Annual
Report on Form 10-K for the fiscal year ended December 31, 1988.
(7) Incorporated by reference to exhibit filed with Registrant's Annual
Report on Form 10-K for the fiscal year ended December 31, 1990.
(8) Incorporated by reference to exhibit filed with Registrant's Annual
Report on Form 10-K for the fiscal year ended December 31, 1991.
(9) Incorporated by reference to exhibit filed with Registrant's Annual
Report on Form 10-K for the fiscal year ended December 31, 1992.
(10) Incorporated by reference to exhibit filed with Registrant's Annual
Report on Form 10-K for the fiscal year ended December 31, 1993.
(11) Incorporated by reference to exhibit filed with Registrant's Annual
Report on Form 10-K for the fiscal year ended December 31, 1994
(12) Incorporated by reference to exhibit filed with Registrant's Annual
Report on Form 10-K for the fiscal year ended December 31, 1995.
(13) Incorporated by reference to exhibit filed with Registrant's Annual
Report on Form 10-K for the fiscal year ended December 31, 1996.
(14) Incorporated by reference to exhibit filed with Registrant's Annual
Report on Form 10K for the fiscal year ended December 31, 1998.
(b) Reports on Form 8-K: No Reports on Form 8-K were filed by the Company
during the fourth quarter of 1998 .
(c) Exhibits: See subsection (a) (3) above.
(d) Financial Statement Schedules: See subsection (a) (2) above.
</TABLE>
EXHIBIT 3.2(a)
CERTIFICATE OF AMENDMENT
OF
BYLAWS
OF
FAFCO, INC.
FAFCO, INC., a corporation organized and existing under the laws of the State
of California (the "Corporation"), pursuant to the provisions of the
California Corporations Code and the Bylaws of the Corporation, DOES HEREBY
CERTIFY as follows:
FIRST: the Bylaws of the Corporation are hereby amended by deleting the
first and second sentences of Section 3.2 in their present form and
substituting therefor a new first and second sentence of Section 3.2 in the
following form:
"The number of directors of the corporation shall be not less than three
(3) nor more than five (5). The exact number of directors shall be five
(5) until changed, within the limits specified above, by a bylaw
amending this Section 3.2, duly adopted by the board of directors or by the
shareholders."
SECOND: The amendment to the Bylaws of the Corporation set forth in this
Certificate of Amendment has been duly adopted in accordance with the
provisions of Section 212 of the California Corporations Code, the Board of
Directors of the Corporation having duly adopted a resolution setting forth,
approving and adopting such amendment.
IN WITNESS WHEREOF, the Corporation has caused this Certificate of
Amendment to be signed by Alex N. Watt, its Chief Financial Officer and
Secretary, this 30th day of March, 1999.
FAFCO, INC.
BY: /s/ Alex N. Watt
Alex N. Watt
Chief Financial Officer and Secretary
EXHITIT 10.19(k)
LOAN MODIFICATION AGREEMENT
This Loan Modification Agreement is entered into as of March 22, 1999,
by and between FAFCO, Inc. ("Borrower") and Silicon Valley Bank ("Bank").
1. DESCRIPTION OF EXISTING INDEBTNESS: Among other indebtedness which may
be owing by Borrower is indebted to Bank pursuant to, among other documents,
an Amended and Restated Loan and Security Agreement, dated June 5, 1996, as
may be amended from time to time, (the "Loan Agreement"). The Loan Agreement
provided for, among other things, a Committed Line in the original principal
amount of One Million and 00/100 Dollars ($1,000,000.00) (the "Revolving
Facility"). Defined terms used but not otherwise defined herein shall have
the same meanings as in the Loan Agreement.
Hereinafter, all indebtedness owing by Borrower to Bank shall be referred to
as the "Indebtedness."
2. DESCRIPTION OF COLLATERAL AND GUARANTIES. Repayment of the Indebtedness
is secured by the Collateral as described in the Loan Agreement.
Hereinafter, the above-described security documents and guaranties, together
with all other documents securing repayment of the Indebtedness shall be
referred to as the "Security Documents". Hereinafter, the Security Documents,
together with all other documents evidencing or securing the Indebtedness
shall be referred to as the "Existing Loan Documents".
3. DESCRIPTION OF CHANGE IN TERMS.
A. Modification(s) to Loan Agreement.
1. The defined term "Maturity Date" is hereby amended
in its entirety to read as: March 30, 2000.
2. Section 2.3 (a) entitled "Interest Rate" is hereby
amended in part to provide that Advances shall
bear interest, on the average Daily Balance, at a
per annum rate equal to one (1.00) percentage
point above the Prime Rate.
3. The first sentence in section 2.3 (c) entitled
"Payments" is hereby amended to read as follows:
Interest hereunder shall be due and payable on the
last calendar day of each month during the term hereof.
4. Section 6.8 entitled "Quick Ratio" is hereby amended
in its entirety to read as follows:
Borrower shall maintain, as of the last day of
each calendar month, a ratio of Quick Assets to Current
Liabilities of at least 1.00 to 1.00.
5. Section 6.9 entitled "Debt-Net Worth Ratio" is
hereby amended in its entirety to read as follows:
Borrow shall maintain as of the last day of each
calendar month, a ratio of Total Liabilities less
Subordinated Debt to Tangible Net Worth plus
Subordinated Debt of not more than 1.25 to 1.00.
6. Section 6.10 entitled "Tangible New Worth" is
hereby amended in its entirety to read as follows:
Borrower shall maintain, as of the last day of
each calendar month, a Tangible Net Worth plus
Subordinated Debt of not less than Three Million
and 00/100 Dollars ($3,000,000.00).
4. CONSISTENT CHANGES. The Existing Loan Documents are hereby
amended wherever necessary to reflect the changes described above.
5. PAYMENT OF LOAN FEE. Borrower shall pay to Lender a fee in the
amount of Seven Thousand Five Hundred and 00/100 Dollars ($7,500.00)
(the "Loan Fee") plus all out-of-pocket expenses.
6. NO DEFENSES OF BORROWER. Borrower (and each guarantor and
pledgor signing below) agrees that it has no defenses against the
obligations to pay any amounts under the Indebtedness.
7. CONTINUING VALIDITY. Borrower (and each guarantor and pledgor
signing below) understands and agrees that in modifying the existing
Indebtedness, Bank is relying upon Borrower's representations,
warranties, and agreements, as set forth in the Existing Loan Documents.
Except as expressly modified pursuant to this Loan Modification Agreement,
the terms of the Existing Loan Documents remain unchanged an in full force
and effect. Bank's agreement to modifications to the existing Indebtedness
pursuant to this Loan Modification Agreement in no way shall obligate Bank
to make any future modifications to the Indebtedness. Nothing in this
Loan Modification Agreement shall constitute a satisfaction of the
Indebtedness. It is the intention of Bank and Borrower to retain as liable
parties all makers and endorsers of Existing Loan Documents, unless the party
is expressly released by Bank in writing. No maker, endorser, or guarantor
will be released by virtue of this Loan Modification Agreement. The terms of
this paragraph apply not only to this Loan Modification Agreement, but also
to all subsequent loan modification agreements.
8. CONDITIONS. The effectiveness of this Loan Modification Agreement is
conditioned upon Borrower's payment of the Loan Fee.
This Loan Modification Agreement is executed as of the date
first written above.
BORROWER: BANK:
FAFCO, INC. SILICON VALLEY BANK
By:______________________
By:____________________
Name:___________________ Name:_________________
Title:_____________________ Title:___________________
EXHIBIT 13.1
FAFCO, Inc.
1998 Annual Report
(Annual Report Cover)
The Company
FAFCO was formed in 1969, was incorporated in 1972, and has produced over one
million polymer heat exchangers, primarily for the solar heating and thermal
energy storage markets. FAFCO is the leading U.S. manufacturer of solar
heating panels, with nearly twice the installed base of solar panel systems
of its nearest competitor. In addition, FAFCO is a leading producer of
polymer heat exchangers for thermal energy storage applications. FAFCO's
IceStor(tm) product line of thermal energy storage equipment significantly
increases the effective capacity of electric utilities without the burden of
adding new capacity. FAFCO has been issued more than 20 patents and operates
worldwide.
There are three bar graphs showing
1. Earnings per Share for years 1996, 1997, and 1998
2. Working Capital for years 1995, 1996, 1997, and 1998
3. Shareholders' Equity for years 1995, 1996, 1997, and 1998
This Annual Report to Shareholders contains forward-looking statements within
the meaning of Section 27A of the Securities Act of 1933 and Section 21E of
the Securities Exchange Act of 1934. Actual results could differ materially
from those projected in the forward-looking statements as a result of the
risk factors set forth below under the heading "Factors Affecting Future
Results" and elsewhere in this Annual Report to Shareholders.
FAFCO Page 1 (inside front cover)
President's Letter
FAFCO was founded in 1969 and manufactures polymer heat exchangers for the
solar and thermal energy storage markets worldwide. Net sales grew by 6.5%
to $11,235,800 in 1998. Net profit was $841,600 compared with $866,000 in
1997. Early indications point toward a continuation of the upward trend in
sales and continued profitability in 1999.
Net sales of FAFCO's aboveground solar pool heating system grew 19% in 1998
to $817,500. Total solar sales (both inground and aboveground pools) were
$5,899,500 in 1998. Continuing new product introduction and marketing
initiatives are expected to positively affect solar system sales revenues.
FAFCO's thermal energy storage business uses unique polymer heat exchanger
technology to shift peaking electrical loads to off-peak times. This
significantly increases the effective capacity of electric utilities without
the burden of adding new capacity. FAFCO's IceStorT products are sold
principally in the United States, Asia, and the Middle East. Sales of
IceStorT products, which accounted for 47% of total sales, were up 15% in 1998.
As of December 31, 1998, FAFCO's bank line of credit was unused and there was
$477,500 of cash on hand. Working capital increased to $2,637,200 at December
31, 1998 from $2,006,800 at the end of 1997.
FAFCO has been issued 21 patents and is investing significantly in new patent-
applied-for technologies, which we believe will significantly increase the
likelihood of entering new markets with solutions that are more cost
effective than was possible with the prior technologies.
FAFCO's steady sales and profitability performance are a direct result of the
hard work and dedication of each and every FAFCO employee and the loyalty of
our customers. I offer my personal thanks to each and every one of you.
Sincerely,
Freeman A. Ford
President
<TABLE>
<S> <C> <C> <C>
Highlights of 1998 1997 %Change
Operations
Net Sales $11,235,800 $10,551,500 7%
Net Income $841,600 $866,000 (3%)
Diluted Earnings
per Common Share $0.20 $0.22 (10%)
Shareholders'
Equity $2,886,400 $2,042,300 41%
Working Capital $2,637,200 $2,006,800 30%
</TABLE>
There is a bar graph showing Net Slaes for the years 1995, 1996, 1997, and
1998.
FAFCO Page 2
Consolidated Balance Sheet
<TABLE>
<S> <C> <C>
December 31, 1998 1997
Assets
Current assets:
Cash and cash equivalents $ 477,500 $ 46,300
Accounts receivable,
less allowance for doubtful
accounts of $536,300 in 1998
and $540,100 in 1997 1,876,600 1,833,400
Current portion of long-term
notes receivable (net) 87,600 88,800
Inventories 1,265,400 1,082,900
Prepaid expenses and
other current assets 183,500 174,000
Other accounts receivable,
net of allowance 7,300 12,200
Deferred tax asset,
net of allowance 273,000 183,300
Total current assets 4,170,900 3,420,900
Plant and equipment, at cost 2,901,900 2,614,900
Less accumulated depreciation
and amortization (2,318,500) (2,236,300)
583,400 378,600
Notes receivable and
other assets (net) 58,200 151,200
Deferred tax asset, net of allowance 564,500 485,800
Total assets $5,377,000 $4,436,500
Liabilities and shareholders' equity
Current liabilities:
Accounts payable and
other accrued expenses $1,065,600 $ 850,900
Accrued compensation and benefits 217,300 331,600
Accrued warranty expense 232,200 211,000
Income taxes payable 18,600 20,600
Total current liabilities 1,533,700 1,414,100
Subordinated notes ($600,000
was owed to related parties
in 1998 and 1997) 925,000 925,000
Other non-current liabilities 31,900 55,100
Total liabilities $2,490,600 $2,394,200
Shareholders' equity:
Preferred Stock-authorized
1,000,000 shares of $1.00
par value, none of which has
been issued Common Stock-authorized
10,000,000 shares of $0.125 par value;
3,303,311 issued and outstanding in
1998 and 3,298,311 issued and
outstanding in 1997 412,800 412,200
Capital in excess of par value 5,107,100 5,105,200
Notes receivable secured by
Common Stock (75,100) (75,100)
Accumulated deficit (2,558,400) (3,400,000)
Total shareholders' equity $2,886,400 $2,042,300
Commitments and contingent
liabilities
Total liabilities and
shareholders' equity $5,377,000 $4,436,500
</TABLE>
The accompanying notes are an integral part of this statement.
FAFCO Page 3
Consolidated Statement of Operations
<TABLE>
<S> <C> <C> <C>
Year ended December 31, 1998 1997 1996
Net sales $ 11,235,800 $ 10,551,500 $ 8,868,600
Other income (net) 30,600 171,800 54,000
Total revenues 11,266,400 10,723,300 8,922,600
Cost of goods sold 6,801,700 5,956,500 5,500,300
Marketing and selling expense 1,942,800 1,770,000 1,575,400
General and administrative expense 1,480,200 1,776,100 1,286,300
Research and development expense 194,100 202,800 116,000
Net interest expense 113,400 128,700 169,900
Total costs and expenses 10,532,200 9,834,100 8,647,900
Income before income taxes 734,200 889,200 274,700
Provision for (benefit from)
income taxes (107,400) 23,200 (36,700)
Net income $ 841,600 $ 866,000 $ 311,400
Basic net income per share $ 0.25 $ 0.26 $ 0.10
Diluted net income per share $ 0.20 $ 0.22 $ 0.10
</TABLE>
The accompanying notes are an integral part of this statement.
FAFCO Page 4
Consolidated Statement of shareholders' Equity
<TABLE>
Notes Receivable
Number Capital in Secured by Retained
of Common Excess of Common Earnings
Shares Stock Par Value Stock Deficit
Balance at
December 31,
<S> <C> <C> <C> <C> <C>
Balance at
December 31,
1995 $3,112,687 $389,000 $5,035,600 $(75,100) $(4,577,400)
Net income for the year 311,400
Issuance of shares upon
conversion of
subordinated
note 185,624 23,200 69,600
Balance at
December 31,
1996 $3,298,311 $412,200 $5,105,200 $(75,100) $(4,266,000)
Net income for the year 866,000
Balance at
December 31,
1997 $3,298,311 $412,200 $5,105,200 $(75,100) $(3,400,000)
Net income for the year 841,600
Issuance of shares upon
exercise of
an option 5,000 600 1,900
Balance at
December 31,
1998 $3,303,311 $412,800 $5,107,100 $(2,558,400)
</TABLE>
The accompanying notes are an integral part of this statement.
FAFCO Page 5
Consolidated Statement of Cash Flows
<TABLE>
<S> <C> <C> <C>
Year Ended December 31, 1998 1997 1996
Cash flow from operating activities:
Net income $ 841,600 $ 866,000 $ 311,400
Adjustments to reconcile net income
to net cash provided by (used in)
operating activities:
Depreciation 137,600 130,700 121,200
Allowance for doubtful accounts
and notes (130,200) 120,300 72,400
Provision for inventory reserve (18,600) (90,500) 42,400
Gain on disposition of fixed assets (19,000) (18,700)
Change in assets and liabilities:
Change in receivables (34,500) 22,100 (794,300)
Change in inventories (163,900) (75,000) (85,200)
Change in prepaid expenses (9,500) (23,200) (5,300)
Change in deferred tax assets (168,400) (19,700) (38,400)
Change in other assets 220,600 (38,200) 73,400
Change in payables and accrued expenses 119,600 (44,800) 104,900
Change in other non-current liabilities (23,200) 28,700 (54,000)
Net cash provided by (used in) operations 752,100 876,400 (270,200)
Cash flow from investing activities:
Purchase of fixed assets (342,400) (159,700) (211,600)
Proceeds from sale of fixed assets 19,000 18,700
Net cash used in investing activities (323,400) (159,700) (192,900)
Cash flow from financing activities:
Proceeds of subordinated debt issuance 325,000
Proceeds from sale of common stock 2,500 92,800
(Payments) borrowings on
line of credit (net) (758,600) 7,300
Net cash (used in) provided by
financing activities 2,500 (758,600) 425,100
Net increase (decrease) in cash and
cash equivalents 431,200 (41,900) (38,000)
Cash and cash equivalents,
beginning of year 46,300 88,200 126,200
Cash and cash equivalents,
end of year $ 477,500 $ 46,300 $ 88,200
Supplemental disclosures of cash flow
information:
Cash paid during the year
for interest $ 123,100 $ 142,100 $ 159,300
Net cash paid during the year
for income taxes $ 63,000 $ 10,000 $ 7,500
Noncash transaction (account receivable
converted to note receivable) $ 126,400
</TABLE>
The accompanying notes are an integral part of this statement.
FAFCO Page 6
Notes to Consolidated Financial Statements
1) Organization and Summary of Significant Accounting Policies
The Company designs, develops, manufactures, and markets polymer heat
exchangers for use in solar heating systems for swimming pools and thermal
energy storage systems for commercial and industrial cooling. The heat
exchangers for solar heating systems are sold to wholesalers and distributors
primarily in California and Florida and in other locations in the United
States and overseas. The heat exchangers for thermal energy storage systems
are marketed through manufacturers' representatives throughout the
United States and internationally. A summary of significant accounting
policies follows:
Principles of Consolidation: The consolidated financial statements include
the accounts of FAFCO, Inc. and its wholly-owned subsidiary. All significant
inter-company balances and transactions have been eliminated in consolidation.
The subsidiary currently has no ongoing business activities.
Revenue Recognition: Revenues on sales of products are recognized at the
time of shipment of goods or performance of service.
Use of Estimates: 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 materially from
those estimates.
Cash and Cash Equivalents: For purposes of reporting cash flows, cash and
cash equivalents include highly liquid investments with a maturity of three
months or less.
Inventories: Inventories are stated at the lower of cost or market determined
using the first-in, first-out (FIFO) method. (See Note 2.)
Plant and Equipment: Plant and equipment are stated based on historical cost
adjusted for accumulated depreciation. Depreciation and amortization of
plant and equipment, excluding vehicles and leasehold improvements, are
determined using accelerated methods. For vehicles and leasehold improvements,
the straight-line method is used. The estimated useful lives of the assets
range between three and ten years. Minor replacements, improvements,
maintenance, and repairs are expensed as incurred. Major replacements and
improvements are capitalized and depreciated over the remaining useful life
of the related asset. Gains and losses on sales and retirement of plant and
equipment are credited or charged to income.
Accounting for the Impairment of Long-lived Assets and for Long-lived Assets
to be Disposed of: Long-lived assets held and used by the Company are
reviewed for impairment whenever events or changes in circumstances indicate
that the carrying amount of an asset may not be recoverable. Impairments are
recorded when indications of impairment are present and the undiscounted cash
flows estimated to be generated by those assets are less than the assets'
carrying value.
Income Taxes: Deferred tax assets and liabilities are recognized for the tax
consequences of temporary differences between the financial reporting and tax
basis of assets and liabilities. (See Note 7.)
Earnings per Common Share: The Company adopted Statement of Financial
Accounting Standard No. 128 ("FAS 128"), Earnings per Share, beginning with
FAFCO's fourth quarter of 1997. All prior period earnings per common share
data have been restated to conform to the provisions of this statement.
Basic earnings per common share is computed using the weighted average number
of shares outstanding. Diluted earnings per common share is computed using
the weighted average number of shares outstanding adjusted for the incremental
shares attributed to outstanding options and warrants to purchase common stock
and shares issuable upon conversion of certain convertible securities. (See
Note 11.)
Warranties: In the normal course of business, the Company makes certain
warranties as to workmanship and materials. Product warranty periods range
from two to fifteen years for full coverage. The estimated future expense of
these warranties is accrued at the time of sale. The estimates inherent in
accounting for such warranties are reviewed and revisions to previous
estimates are made as required to reflect the most current information
available.
Accounting for Stock-Based Compensation: The Company has elected to account
for stock-based compensation under the intrinsic value method in accordance
with the provisions of Statement of Financial Accounting Standards ("SFAS")
No. 123, Accounting for Stock-Based Compensation. Under this method, no
compensation expense is recorded for stock options granted when the exercise
price of the option granted is equal to or exceeds the fair market value of
the Company's common stock. The Company makes the pro forma disclosures of
stock-based compensation required by SFAS No. 123. (See Note 6.)
Disclosures About Fair Value of Financial Instruments: The following methods
and assumptions were used to estimate the fair value of each class of
financial instruments for which it is practicable to estimate that value.
FAFCO Page 7
Notes to Consolidated Financial Statements
Current Assets and Current Liabilities: The carrying value of cash
equivalents, accounts receivable, notes receivable, short-term borrowings,
accounts payable, and accrued expenses approximate fair value because of their
short maturity.
Long-Term Debt: The fair value of the Company's long-term debt is estimated
based on the borrowing rates currently available to the Company for loans with
similar terms. At December 31, 1998, the carrying amount approximates
estimated fair value of long-term debt.
2) Inventories Consist of the Following:
<TABLE>
<S> <C> <C>
December 31, 1998 1997
Raw materials $ 661,800 $ 462,800
Work in progress 211,500 114,000
Finished goods 392,100 506,100
$ 1,265,400 $ 1,082,900
</TABLE>
3) Plant and Equipment
Plant and equipment consists of the following:
<TABLE>
<S> <C> <C>
December 31, 1998 1997
Machinery and equipment $ 2,191,500 $ 1,957,600
Office and computer equipment 488,600 466,900
Leasehold improvements 88,600 88,600
Vehicles 133,200 101,800
$ 2,901,900 $ 2,614,900
Less accumulated depreciation
and amortization (2,318,500) (2,236,300)
$ 583,400 $ 378,600
</TABLE>
4) Subordinated Notes and warrants
At December 31, 1998 and 1997, subordinated notes consisted of $925,000 of
notes bearing interest at 11% per annum payable quarterly with warrants
attached to purchase Common Stock. The exercise price of the warrants is
$0.125 per share, the maximum aggregate number of shares issuable upon
exercise of the warrants is 555,000, and the unexercised warrants expire
March 27, 2000. (See Note 8.)
5) Bank Line of Credit
The Company has a bank line of credit secured by substantially all the assets
of the Company. The line of credit allows the Company to borrow the lesser of
$1,000,000 or an amount determined by a formula applied to net accounts
receivable, inventories, and net plant and equipment. Amounts borrowed bear
interest at the bank's prime rate plus 1.5%. The line of credit agreement
contains certain covenants relating to working capital, current ratio, and
tangible net worth, prohibits the payment of cash dividends, and expires on
March 30, 2000. At December 31, 1998 and 1997, the Company had complied with
the loan covenants.
As of December 31, 1998 and 1997, the Company had no outstanding balances
under the bank line of credit.
6) Shareholders' Equity
The Board of Directors, without shareholder approval, may determine the rights,
preferences, privileges, and restrictions of the Company's unissued Preferred
Stock. Such shares may be issued in one or more series. In 1980, the Company
issued 202,300 shares of Common Stock at a price of $2.43 per share in
exchange for non-interest bearing promissory notes, which have a balance
due of $75,100 at December 31, 1998 and 1997. The notes are due and payable
and the Company intends to pursue collection of these notes. In the event
that any of the notes are uncollectible, the Company will demand surrender of
the related shares issued and will cancel and write off the related notes
receivable balance.
Under the Company's Employee Stock Purchase Plan, 150,000 shares of Common
Stock have been reserved for issuance at 85% of fair market value as of
specified dates. The Plan was suspended in 1991 and no shares have been
issued thereunder since 1991.
The Company has a 1991 Incentive Stock Option Plan under which 500,000 shares
of Common Stock have been reserved for issuance to employees and consultants.
The Company has a 1991 Director's Stock Option Plan under which 50,000 shares
of Common Stock are reserved for issuance. No options were granted or
exercised during 1996, 1997, or 1998.
FAFCO Page 8
Notes to Consolidated Financial Statements
Options granted under these plans become exercisable at a rate of 20% per year
for five years from date of grant and expire six years or ten years from date
of grant.
A summary of activity under the 1981 and 1991 Incentive Stock Option Plans
follows:
<TABLE>
Shares Subject Exercise Price
to Option Per Share
Outstanding at
<S> <C> <C>
December 31, 1995 275,450 $ 0.500-0.625
Granted 236,950 $ 0.125
Canceled (126,950) $ 0.500-0.560
Exercised 0 0
Outstanding at
December 31, 1996 385,450 $ 0.125-0.625
Granted 21,000 $ 0.125
Canceled (31,500) $ 0.125-0.625
Exercised 0 0
Outstanding at
December 31, 1997 374,950 $ 0.125-0.500
Granted 0
Canceled (5,500) $ 0.125-0.500
Exercised 0
Outstanding at
December 31, 1998 369,450 $ 0.125-0.500
</TABLE>
The Company applies the intrinsic value method of accounting for its stock
option plans. Accordingly, no compensation cost has been recognized for the
plan in 1998, 1997, or 1996. Had compensation cost been determined on the
basis of fair value pursuant to FASB Statement No. 123, net income and
earnings per share would have been reduced as follows:
<TABLE>
1998 1997 1996
Net income
<S> <C> <C> <C>
As reported $ 841,600 $ 866,000 $ 311,400
Pro forma $ 832,200 $ 860,200 $ 293,600
Basic earnings per share
As reported $ 0.25 $ 0.26 $ 0.10
Pro forma $ 0.25 $ 0.26 $ 0.09
Diluted earnings per share
As reported $ 0.20 $ 0.22 $ 0.10
Pro forma $ 0.19 $ 0.22 $ 0.09
</TABLE>
The fair value of each option granted was estimated on the grant date using
the Black-Scholes model.
The following assumptions were made in estimating fair value:
<TABLE>
<S> <C> <C>
Assumption 1998 1997
Dividend yield 0% 0%
Risk-free interest rate 5.0% 5.55%
Expected life 10 years 10 years
Expected volatility 121.9% 141.1%
</TABLE>
Following is a summary of the status of the plans during 1998, 1997, and 1996.
<TABLE>
Number of Weighted Average
Shares Exercise Price
<S> <C> <C>
Outstanding at January 1, 1998 374,950 $ 0.250
Granted 0 0
Exercised 0 0
Forfeited (5,500) 0.159
Outstanding atDecember 31, 1998 369,450 0.251
Options exercisable at
December 31, 1998 283,250 0.299
Weighted average fair value of
options granted during 1998 N/A
</TABLE>
<TABLE>
Number of Weighted Average
Shares Exercise Price
<S> <C> <C>
Outstanding at January 1, 1997 385,450 $0.258
Granted 21,000 0.125
Exercised 0 0
Forfeited (31,500) 0.460
Outstanding at December 31, 1997 374,950 0.250
Options exercisable at
December 31, 1997 231,150 0.282
Weighted average
fair value of options
granted during 1997 $0.123
</TABLE>
<TABLE>
Number of Weighted Average
Shares Exercise Price
<S> <C> <C>
Outstanding at January 1, 1996 275,450 $ 0.485
Granted 236,950 0.125
Exercised 0 0
Forfeited (126,950) 0.502
Outstanding at December 31, 1996 385,450 0.258
Options exercisable at
December 31,1996 199,650 0.297
Weighted average
fair value of options
granted during 1996 $0.101
</TABLE>
Following is a summary of the status of options outstanding at
December 31, 1998:
<TABLE>
Outstanding Exercisable
Weighted
Average Weighted Weighted
Remaining Average Average
Contractual Exercise Exercise
<S> <C> <C> <C> <C> <C>
Exercise Price Number Life Price Number Price
$0.500 117,500 1 $0.500 117,500 $0.500
$0.250 20,000 3 $0.250 12,000 $0.250
$0.125 231,950 4 $0.125 153,750 $0.125
369,450 3 283,250
</TABLE>
FAFCO Page 9
Notes to Consolidated Financial Statements
The range of exercise prices for the options outstanding at December 31, 1998
is $0.125-$0.50 with a weighted average contractual life of 3 years. The
Company estimates that based on vesting at 20% per year at December 31, 1998,
approximately 100% of options will eventually vest.
7) Income Taxes
The provisions for income taxes consist of the following:
<TABLE>
<S> <C> <C> <C>
Years Ended December 31, 1998 1997 1996
Taxes on income:
U.S. Federal
Current $ 9,000 $ 12,000 $ 0
Deferred (183,400) (28,400) (40,300)
(174,400) (16,400) (40,300)
State
Current 52,000 20,000 1,600
Deferred 15,000 9,600 2,000
67,000 29,600 3,600
Foreign
Current 0 10,000 0
Deferred 0 0 0
$ 0 $ 10,000 $ 0
Net income tax
(benefit) provision $ (107,400) $ 23,200 $ (36,700)
</TABLE>
A reconciliation of the statutory federal income tax rate with the effective
tax rate reported in the financial statements follows:
<TABLE>
<S> <C> <C> <C>
Years Ended December 31, 1998 1997 1996
Statutory federal
income tax(benefit) rate 34.0% 34.0% 34.0%
Effect on tax rate resulting from:
State and foreign income taxes,
net of federal tax benefit 8.2% 2.2% 7.7%
Tax effect of change in valuation
allowance (65.2%) (36.6%) (54.8%)
Expiration of tax credits 2.5% 1.7% 2.0%
Other 5.9% 1.3% 0.6%
Effective tax rate (14.6%) 2.6% (10.5%)
</TABLE>
The Company records its deferred taxes on a tax jurisdiction basis and, with
the adoption of FAS No. 109 in 1993, classifies those net amounts as current
or noncurrent based on the balance sheet classifications.
Deferred tax assets are comprised of the following:
<TABLE>
<S> <C> <C>
December 31, 1998 1997
Allowance for doubtful accounts $ 222,600 $ 227,700
Accrued expenses 97,300 132,500
Loss carryforwards 598,500 837,400
Tax credits 48,800 71,200
Other 43,500 108,300
1,010,700 1,377,100
Deferred tax asset valuation allowance (173,200) (708,000)
Total deferred taxes, net $ 837,500 $ 669,100
</TABLE>
At December 31, 1998, the Company had unused federal net operating loss
carryforwards of approximately $1,756,600, Florida loss carryforwards of
approximately $168,700, and investment and other federal tax credits of
approximately $48,800 available to offset future tax liabilities. The net
operating losses and credits expire in varying amounts until 2010. The use
of the tax credits has been limited by the provisions of the Tax Reform Act
of 1986 to reflect the benefit associated with an overall reduction in the
corporate tax rate. The Company believes that the "total deferred taxes,
net" in the amount of $837,500 is more likely than not to be realized.
8) Transactions with Related Parties
At December 31, 1998 and 1997, $600,000 in principal amount of the Company's
subordinated notes (see Note 4) were held by Mr. Freeman A. Ford, an officer,
director, and major shareholder of the Company, and his immediate family
members.
In April 1996, the Company granted Mr. Ford a warrant to purchase 123,950
shares of Common Stock.
9) Employee Benefit Plans
The Company has a 401(k) retirement savings plan for all eligible employees
who have completed one year of service. Eligible employees have the option
to contribute up to 15% of their eligible salary. The Company contributes an
amount equal to 25% of the employee contribution, up to a maximum of $400 per
employee per year.
10) Lease Commitments
The Company's rental expense, relating primarily to a lease for its office
and manufacturing facility, amounted to $384,300 in 1998, $393,400 in 1997,
and $380,300 in 1996. At December 31, 1998, minimum annual lease
FAFCO Page 10
Notes to Consolidated Financial Statements
commitments under non-cancelable leases were as follows:
<TABLE>
<C> <C>
1999 405,400
2000 138,600
Total $ 544,000
</TABLE>
The Company is required to pay property taxes, utilities, and insurance under
certain of these leases, some of which provide for renewal options at the end
of the initial lease term in the year 2000.
11) Net Income Per Share
Basic earnings per share were calculated as follows:
<TABLE>
<S> <C> <C> <C>
Years ended December 31, 1998 1997 1996
Net income $ 841,600 $ 866,000 $ 311,400
Average common shares
outstanding 3,303,311 3,298,311 3,254,066
Earnings
per shar $ 0.25 $ 0.26 $ 0.10
</TABLE>
Basic earnings per share are calculated by dividing net income by the weighted
average number of shares issued and outstanding.
Diluted earnings per share were calculated as follows:
<TABLE>
<S> <C> <C> <C>
Years ended December 31, 1998 1997 1996
Adjusted net income $ 841,600 $ 866,000 $ 311,400
Average common shares
outstanding 3,303,311 3,298,311 3,254,066
Add: Exercise of options
reduced by the number of
shares purchased with
proceeds 325,849 186,026 N/A
Add: Exercise of warrants
reduced by the number of
shares purchased with
proceeds 102,361 63,173 N/A
Add: Expense of warrants
attached to debt reduced
by the number of shares
purchased with proceeds 472,778 384,231 N/A
Adjusted weighted
average shares outstanding 4,204,299 3,931,741 3,254,066
Earnings per common share
assuming full dilution $ 0.20 $ 0.22 $ 0.10
</TABLE>
12) Licensing Income
During 1997, the Company entered into a licensee agreement with a third party
in the Far East under which the Company received and recognized license fee
income net of foreign income taxes of $90,000. The agreement allows for the
licensee to assemble and sell the IceStorT product in certain countries using
the Company's technology and design specifications. For the term of the
agreement (eight years), the Company is required to provide parts and
technical services to the licensee at prices and rates equivalent to normal
list prices.
13) Litigation
The Company is involved in certain litigation matters. Management believes
resolution of these disputes will not have a material adverse effect on the
Company's financial condition and results of operation.
14. Business Segment and Concentration of Credit Risk
Business Segment: The Company operates in one business segment, the
development, production and marketing of polymer heat exchangers for the
solar and thermal energy storage markets worldwide.
<TABLE>
<S> <C> <C> <C>
Product Line 1998 1997 1996
Net Sales
Solar $ 5,899,500 $ 5,918,100 $ 5,164,900
Thermal Energy
Storage 5,336,300 4,633,400 3,703,700
$11,235,800 $10,551,500 $ 8,868,600
</TABLE>
Geographic information for revenues and long-lived assets for the year ended
December 31, 1998, 1997, and 1996 are as follows:
<TABLE>
1998 1997 1996
Net Sales
<S> <C> <C> <C>
Domestic $ 7,235,900 $ 7,555,300 $ 7,588,400
Foreign
Japan 2,634,100 1,961,600 1,070,100
Other 1,365,800 1,034,600 210,100
$11,235,800 $10,551,500 $ 8,868,600
Long-lived assets
Domestic $ 583,400 $ 378,600 $ 349,600
$ 583,400 $ 378,600 $ 349,600
</TABLE>
For fiscal 1998 and 1997, the Company had one major customer who individually
accounted for 10% or more of sales totaling $2,634,100 and $1,961,600 in 1998
and 1997, respectively. In fiscal 1996, the Company had three major customers
who individually accounted for 10% or more of sales totaling $1,242,700,
$1,070,100, and $1,061,000.
FAFCO Page 11
Notes to Consolidated Financial Statements
Concentration of Credit Risk: Most of the Company's business activity is with
customers located in California, Florida, and foreign countries. As of
December 31, 1998, unsecured trade accounts receivable from customers in
California, Florida, and foreign countries were $328,400, $1,302,900, and
$594,200, respectively.
FAFCO Page 12
Report of Independent Auditors
To the Board of Directors of FAFCO, Inc.
We have audited the accompanying consolidated balance sheets of FAFCO, Inc.
and its subsidiary as of December 31, 1998 and 1997 and the related
consolidated statements of operations, shareholders' equity, and cash flows
for each of the years in the three-year 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 audit.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit 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 FAFCO, Inc. and its
subsidiary as of December 31, 1998 and 1997 and the results of their
operations and their cash flows for each of the years in the three-year
period ended December 31, 1998 in conformity with generally accepted
accounting principles.
Burr, Pilger & Mayer
Palo Alto, California
March 1, 1999
FAFCO Page 13
Summary of Operations
Five-Year Summary of Operations (in thousands, except per share data)
<TABLE>
<S> <C> <C> <C> <C> <C>
Year Ended December 31, 1998 1997 1996 1995 1994
Net sales $ 11,236 $ 10,552 $ 8,869 $ 7,876 $ 10,526
Income (loss) before
income taxes $ 734 $ 889 $ 274 $(1,857) $ 547
(Benefit from) provision
for income taxes (107) 23 (37) 1 49
Net income (loss) $ 841 $ 866 $ 311 $(1,858) $ 498
Basic net income (loss)
per share $ 0.25 $ 0.26 $ 0.10 $ (0.60) $ 0.14
Diluted net income (loss)
per share $ 0.20 $ 0.22 $ 0.10 $ (0.60) $ 0.14
At December 31, 1998 1997 1996 1995 1994
Working capital $ 2,637 $ 2,007 $ 1,285 $ 379 $ 2,469
Total assets 5,377 4,437 4,345 3,557 5,001
Long-term obligations 957 980 951 680 725
Shareholders' equity $ 2,886 2,042 1,176 772 2,628
</TABLE>
Common Stock Data
FAFCO, Inc. Common Stock is traded on the over-the-counter market but is not
listed on an exchange or quoted on any automated quotation system. The high
and low closing bid quotations for each quarter during 1998 and 1997 were as
follows:
<TABLE>
<S> <C> <C> <C> <C>
Quarter Ended March 31 June 30 September 30 December 31
1998 High $0.75 $0.75 $0.94 $0.94
1998 Low $0.75 $0.75 $0.94 $0.94
1997 High $0.125 $0.125 $0.125 $0.750
1997 Low $0.125 $0.125 $0.125 $0.125
</TABLE>
The quotations above were provided by the National Quotation Bureau. All
quotations reflect inter-dealer prices, without retail mark-up, mark-down, or
commission and may not necessarily represent actual transactions. At
March 1, 1999, the Company had 706 shareholders of record. FAFCO, Inc. has
never paid dividends on its Common Stock and has no plans to do so in the
foreseeable future and is prohibited from so doing (see Note 6).
FAFCO Page 14
Management's Discussion and Analysis
This Annual Report to Shareholders contains forward-looking statements within
the meaning of Section 27A of the Securities Act of 1933 and Section 21E of
the Securities Exchange Act of 1934. Actual results could differ materially
from those projected in the forward-looking statements as a result of the
risk factors set forth below under the heading Factors Affecting Future
Results and elsewhere in this Annual Report to Shareholders.
1998 Compared with 1997
Net sales for 1998 increased by 6.5% from $10,551,500 in 1997 to $11,235,800
in 1998. This increase was due to increased unit sales of the Company's
IceStorT products.
Net sales of the Company's pool products were relatively stable due to
increased unit sales of the Company's SunSaverT product offset by price
decreases due to competitive market pressures. Net sales of the Company's
IceStorT products were 15.2% higher in 1998 than in 1997 due mainly to
increased foreign sales. Pool product sales amounted to 53% of net sales in
1998 compared to 56% of net sales in 1997. IceStorT sales amounted to 47% of
net sales in 1998 compared to 44% of net sales in 1997.
Cost of goods sold increased from $5,956,500 (56.5% of net sales ) in 1997 to
$6,801,700 (60.5% of net sales ) in 1998. This increase was due primarily to
increased sales of lower margin products in both the pool and the IceStorT
lines.
Marketing and selling expenses increased from $1,770,000 (16.8% of net sales)
in 1997 to $1,942,800 (17.3% of net sales ) in 1998. This increase was due
mainly to increased sales and promotional activities in 1998 as compared to
1997.
General and administrative expenses decreased from $1,776,100 (16.8% of net
sales) in 1997 to $1,480,200 (13.2% of net sales) in 1998. These decreases
were due mainly to bonus and profit-sharing expenses incurred in 1997 which
were not incurred in 1998.
Research and development expenses were relatively stable at $202,800 (1.9% of
net sales) in 1997 compared with $194,100 (1.7% of net sales) in 1998. This
was due mainly to the stabilization in the number of projects designed to
improve current products and to develop potential new products, and in the
personnel to implement those projects.
Net interest expense was also relatively stable at $128,700 (1.2% of net
sales) in 1997 compared with $113,400 (1.0% of net sales) 1998. This
decrease was due mainly to lower average daily borrowing in 1998 along with
lower interest rates.
1997 Compared with 1996
Net sales for 1997 increased by 19% from $8,868,600 in 1996 to $10,551,500 in
1997. This increase was due primarily to increased unit sales of the
Company's pool panel products, along with increased unit sales of the
Company's IceStorT products partially offset by the effect of discontinuance
of the Company's automated swimming pool controls.
Net sales of the Company's pool products were 14.8% higher in 1997 than 1996
due mainly to increased sales of its Revolutionr model inground pool panels,
along with increased sales of its SunSaverT model inground pool panels and
increased sales of its SunSaverT model aboveground pool panels. These
increases were partially offset by the effect of discontinuance of its
proprietary line of automated swimming pool controls, which was phased out as
of January 1, 1997. Net sales of the Company's IceStorT products were 25.1%
higher in 1997 than in 1996 due mainly to increased domestic sales along with
higher foreign sales.
Pool product sales amounted to 56% of net sales in 1997 compared to 58% of net
sales in 1996. IceStorT sales amounted to 44% of net sales in 1997 compared
to 42% of net sales in 1996. There were no significant price changes in any of
the Company's products during 1997.
Cost of goods sold increased in absolute dollars from $5,500,300 in 1996 to
$5,956,500 in 1997 while decreasing from 62.0% of net sales in 1996 to 56.5%
of net sales in 1997. This decrease as a percent of net sales was due
primarily to the fixed costs being allocated over higher sales along with a
continued increase of sales of higher margin products in both the pool and
the IceStorT lines.
Marketing and selling expenses increased in absolute dollars from $1,575,400
in 1996 to $1,770,000 in 1997 while decreasing from 17.8% of net sales in 1996
to 16.8% of net sales in 1997. These decreases as a percent of net sales were
due mainly to the increased level of sales experienced in 1997 as compared to
1996.
General and administrative expenses increased from $1,286,300 (14.5% of net
sales) in 1996 to $1,776,100 (16.8% of net sales) in 1997. These increases
were due mainly to increased bad debt write-offs along with bonus and
profit-sharing expenses incurred in 1997 which were not incurred in 1996.
Research and development expenses increased from $116,000 (1.3% of net sales)
in 1996 to $202,800 (1.9%
FAFCO Page 15
Management's Discussion and Analysis
of net sales) in 1997. This increase was due mainly to an increase in the
number of projects designed to improve current products and to develop
potential new products, along with an increase in personnel to implement
those projects.
Net interest expense decreased from $169,900 (1.9% of net sales) in 1996 to
$128,700 (1.2% of net sales) in 1997. This decrease was due mainly to lower
average daily borrowing in 1997 along with lower interest rates.
Seasonality
Historically, the Company has experienced lower sales during the first quarter
than during other quarters of each year. In addition, sales typically have
increased significantly during the second quarter, declined slightly, and then
remained relatively constant during the third and fourth quarters. The Company
believes that this pattern derives primarily from the sales of solar heating
products. As the Company's product mix shifts to include a larger proportion
of other products, such as the thermal energy storage products, the
traditional seasonality is being mitigated. Net income is affected by the
seasonality of sales as well as by significant marketing and selling expenses
typically incurred during the first quarter of each year. These expenses are
incurred to develop programs and materials for use throughout the remainder of
the year.
In 1998 sales and net income experienced their typical seasonality.
In 1997 sales and net income experienced their typical seasonality, except
that sales of pool panel products in the first quarter were increased as a
result of the unusually dry and warm weather in both California and Florida.
As a result of the increased sales of pool panel products the traditional
first quarter loss was not experienced.
In 1996, sales and net income experienced their traditional seasonality,
except that sales in the fourth quarter were increased due to sales of
IceStorT product. As a result of the ice storage sales, the traditional
fourth quarter loss was not experienced.
Liquidity and Capital Resources
The Company's cash position increased significantly from $46,300 at 1997
fiscal year end to $477,500 at 1998 fiscal year end, principally due to cash
flow from operations (primarily net income) during the year, partially offset
by cash used in investing activities (primarily purchase of fixed assets).
At December 31, 1998, the Company's net accounts receivable had increased
slightly to $1,876,600 from $1,833,400 at December 31, 1997, primarily as a
result of increased sales in 1998 partially offset by slightly faster
collection of accounts receivable.
At December 31, 1998, the Company's accounts payable and other accrued
expenses had increased to $1,065,600 from $850,900 at December 31, 1997.
This increase is primarily due to increased inventories to support higher
sales levels.
At December 31, 1998, the Company's inventories had increased to $1,265,400
from $1,082,900 at December 31, 1997. This increase was due entirely to the
buildup of inventories to support increased sales levels.
The Company has a deferred tax asset, net of valuation allowance, at year-end
of $837,500 in 1998 and $669,100 in 1997. The Company believes that it is
more likely than not that this asset will be fully realized. This belief is
based upon the Company's recent history of profitable operations prior to
1995, its return to profitability in 1996, 1997 and 1998, and the Company's
expectation that operating results will allow it to realize the net deferred
tax asset. However, there can be no assurance that the Company will continue
profitability or, if it does, that profits will be sufficient to utilize the
net deferred tax asset.
At December 31, 1998, the Company's current ratio was 2.72 to 1 compared with
2.42 to 1 at December 31, 1997 and working capital increased over the same
period to $2,637,200 from $2,006,800. Total assets exceeded total liabilities
by $2,886,400 at December 31, 1998 compared with $2,042,300 at December 31,
1997.
The Company believes that its cash flow from operations, together with bank
borrowings, will be sufficient to support operations during the next twelve
months. The foregoing statement of how long the Company's capital resources
are expected to last is a forward-looking statement involving risks and
uncertainties, including the amount of the Company's sales and the ability of
the Company to control its operating expenses and the need to invest in sales
and marketing activities in 1998. However, if sales decline from current
levels additional debt or equity financing may be required. There can be no
assurance that financing, if required, would be available on favorable terms
or at all or that such financing will not significantly dilute the ownership
interests and rights of existing shareholders. The Company has a line of
credit, of which none had been utilized and $1,000,000 remained available
under the formula applied to net
FAFCO Page 16
Management's Discussion and Analysis
accounts receivable at December 31,1998. This line of credit expires on
March 30, 2000.
Factors Affecting Future Results
The Company has reviewed its internal computer systems for year 2000
compliance and is satisfied that all of its internal computer systems are
either already year-2000 compliant or can be made year-2000 compliant
through simple upgrades. The Company does not expect the costs of achieving
full year-2000 compliance to be material for the internal systems. However,
there can be no assurance that coding errors or other defects will not be
discovered in the future. In addition, since the Company is very small in
relation to many of its customers and suppliers, the Company has been unable
to ascertain if any of its suppliers and customers are year-2000 compliant.
Therefore, there can be no assurances that the Company's cash flow from
customers and materials from suppliers will not be interrupted which could
result in severe disruptions in the Company's operations.
FAFCO Page 17
Corporate Directory and Information
Board of Directors
Freeman A. Ford
Chairman of the Board, President, and Chief Executive Officer
FAFCO, Inc.
William A. Berry*
Senior Vice President and Chief Financial Officer
Electric Power Research Institute a private, nonprofit, research
organization doing collaborative research for the electricity industry.
Robert W. Selig, Jr.*
President
Davis Instruments Corporation a manufacturer of marine and weather
equipment.
________________________
*Audit Committee Member
Executive Officers
Freeman A. Ford
Chairman of the Board, President, and Chief Executive Officer
Alex N. Watt
Vice President, Finance and Administration,Chief Financial Officer, and
Secretary
David K. Harris
Vice President, Sales
Solar Products
Transfer Agent and Registrar
Continental Stock Transfer & Trust Company
2 Broadway
New York, New York 10004
Telephone: (212) 509-4000
Web Site: http://www.continentalstock.com
Legal Counsel
Wilson, Sonsini, Goodrich & Rosati
A Professional Corporation
650 Page Mill Road
Palo Alto, California 94304
Independent Accountants
Burr, Pilger & Mayer
A Professional Corporation
261 Hamilton Avenue
Palo Alto, California 94301
Form 10-K
A copy of the Company's Annual Report on Form 10-K filed with the
Securities and Exchange Commission, including financial statement
schedules but excluding exhibits, is available without charge
upon written request to:
FAFCO, Inc.
2690 Middlefield Road
Redwood City, California 94063-3455
Attention: Alex N. Watt
Annual Shareholders' Meeting
The Annual Shareholders' Meeting will be held at 3:00 p.m. on May
6, 1999 at FAFCO, Inc., 2690 Middlefield Road, Redwood City,
California 94063-3455, Telephone: (650) 363-2690
(Inside back cover)
EXHIBIT 21.1
SUBSIDIARIES OF REGISTRANT
1. THE GREGORY COMPANY
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<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> DEC-31-1998
<CASH> 477,500
<SECURITIES> 0
<RECEIVABLES> 2,565,500
<ALLOWANCES> 565,600
<INVENTORY> 1,265,400
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<COMMON> 412,800
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