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 [FEE REQUIRED]
For the fiscal year ended December 31, 1998
---------------------------------------------
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 [NO FEE REQUIRED]
For the transition period from __________ to _________
Commission file number 0-15930
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SOUTHWALL TECHNOLOGIES INC.
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(Exact name of registrant as specified in its charter)
Delaware 94-2551470
------------------------------- ----------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
1029 Corporation Way, Palo Alto, California 94303
------------------------------------------- ---------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (650) 962-9111
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock
(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 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]
1
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The approximate aggregate market value of the Common Stock held by
non-affiliates of the registrant on February 28, 1999, (based upon the closing
sales price of the Common Stock on the Nasdaq National Market System on such
date) was $17,000,000. For purposes of this disclosure, Common Stock held by
stockholders whose ownership exceeds five percent of the Common Stock
outstanding as of February 28, 1999, and Common Stock held by officers and
directors of the registrant has been excluded in that such persons may be deemed
to be "affiliates" as that term is defined in the rules and regulations
promulgated under the Securities Act of 1933, as amended. This determination is
not necessarily conclusive.
The number of shares of the registrant's Common Stock outstanding on
February 28, 1999, was 7,324,123.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant's definitive Proxy Statement to be filed with
the Commission in connection with the Company's 1999 Annual Meeting of
Stockholders (the "Proxy Statement") are incorporated by reference in Part III
of this Form 10-K. With the exception of the portions of the Proxy Statement
expressly incorporated into this Form 10-K by reference, the Proxy Statement
shall not be deemed filed as part of this Form 10-K.
2
<PAGE>
<TABLE>
SOUTHWALL TECHNOLOGIES INC.
1998 FORM 10-K ANNUAL REPORT
Table of Contents
<CAPTION>
Page
PART I
<S> <C>
ITEM 1. BUSINESS................................................................................. 4
ITEM 2. PROPERTIES.............................................................................. 10
ITEM 3. LEGAL PROCEEDINGS........................................................................10
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SERURITY HOLDERS......................................10
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER
MATTERS...........................................................................11
ITEM 6. SELECTED FINANCIAL DATA..................................................................12
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.............................................................12
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK...............................19
ITEM 8. FINANCIAL STATEMENTS.....................................................................20
ITEM 9. CHANGES IN AND DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURE......................37
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF REGISTRANT...........................................38
ITEM 11. EXECUTIVE COMPENSATION...................................................................38
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT...........................38
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS...........................................38
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K..........................39
</TABLE>
3
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PART I
ITEM 1 BUSINESS
General
Southwall Technologies Inc. ("Southwall" or the "Company") designs,
develops, manufactures and markets sputtered thin-film coatings on wide-web,
flexible substrates for energy conservation and electronics applications. The
Company has developed and currently offers a variety of thin-film products for
the residential and commercial architectural glazing, automotive glazing and
electronic display markets. These products include transparent insulation and
solar-control films, anti-reflective film for computer monitor CRTs and
television monitors, transparent conductive films for use in touch screen
displays, and various other types of commercial film.
During 1998 and years prior, the Company also manufactured or had available
products for various applications in the aerospace industry, including thin-film
materials for shielding and other applications, adhesiveless conductive films
for use in flexible electronic circuits and films that reduce detectability of
objects in selected portions of the electromagnetic spectrum. However, the
Company began a phase out of these products during 1996 and is no longer
pursuing these markets.
In September, 1994, the Company entered into an agreement to lease all the
assets formerly of Safety Glass, Inc., dba Armour Worldwide Glass, a glass
laminator in Southern California. The Company created a subsidiary, Southwall
Worldwide Glass Inc., which operated the facility to manufacture the Company's
proprietary California SeriesJ solar control laminated glass, as well as bullet
resistant, security, custom and standard laminated glass products. That
subsidiary operation was closed in March 1996 and certain custom and laminated
glass products were discontinued. The Company continues to manufacture the
proprietary California Series(TM) solar control product line.
Effective October 31, 1994, the Company acquired Sunflex L.P., which
assembles and markets aftermarket film, mesh and glass anti-reflective filters
primarily for personal computer monitors under such trademark names as Krystal
Clear(TM), OPTIVIEW(TM) and Protector(TM). During 1997, the Company began
phasing out of the mesh and glass filter product lines, and began contracting
out the assembly of film filters, but will continue to market film filter
products.
Markets and Products
Southwall is currently supplying products for use in two broad markets:
energy conservation and electronic displays. The Company's current commercial
products include: (1) its family of transparent Heat Mirror(TM) films for high
performance architectural glazing applications, (2) transparent coatings for use
in conjunction with architectural and transportation glazing laminates and
applied film to provide solar control to windows, (3) anti-reflective films,
both OEM and after market, (4) its Altair(TM) family of transparent conductors,
(5) laminated glass products, and (6) other commercial thin-film products.
4
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Energy Conservation Products
Heat Mirror(TM) - Transparent Window Insulation
The Company offers a family of Heat Mirror(TM) films with various shading
and insulating properties. Windows are primary areas of heat loss in winter and
a major source of heat gain in summer. Windows containing Heat Mirror(TM), while
generally more expensive, have approximately double the insulating capacity of
conventional double-pane windows, and transmit high levels of visible light with
desired degrees of shading. Heat Mirror(TM) films, which are sold in rolls to
window manufacturers, are suspended in the airspace between sealed double-pane
residential and commercial windows. The Company has developed and patented this
film-mounting technology, which it licenses to window fabricators. The Company
currently offers a variety of different Heat Mirror(TM) films for residential
and commercial architectural applications, including Heat Mirror(TM) with XUV7
fading protection.
The Company believes that the Heat Mirror(TM) and Heat Mirror(TM) related
Superglass(R) system is the most comprehensive window glass product available
today, providing R-6 to R-10 insulation, transparent solar shading and
protection from damaging ultraviolet radiation, while also reducing noise and
condensation build-up.
Sales of the Company's Heat Mirror(TM) products have been subject to
seasonal buying patterns in the past. See "Management's Discussion and Analysis
of Financial Condition and Results of Operations."
Solar-Control Films for Laminated Glazing Applications
The Company's Heat Mirror XIR(R) Coating is a transparent, sputter-coated,
polyester film used in laminated safety glass for architectural and
transportation applications. The film has a patented, transparent solar-control
coating on one side and a proprietary adhesion-promotion layer on the other
side.
The Company's California Series(TM) laminated glazing product is comprised
of Heat Mirror XIR(R), PVB and glass, for architectural and specialty
transportation applications such as agricultural and construction vehicles.
Applied Solar-Control Films
Another glazing product utilizing the Heat Mirror XIR(R) coating is
Solis(R) solar-control films for the retro-fit market for both architectural and
automotive glass. The product is applied to existing windows and has a
protective hard coat over the patented, transparent solar-control coating on one
side and an adhesion layer on the other side.
Silver Reflector Films
Southwall markets these silver mirrored films to fluorescent reflector
manufacturers for energy efficient lighting, primarily for the retrofit market
in North America, and to other manufacturers for various applications including
large screen televisions.
5
<PAGE>
Electronic Products
Anti-Reflective Film
Southwall's anti-reflective film for computer monitor CRTs minimize
reflection of ambient light, electromagnetic interference (AEMI@) radiation and
static. This film is currently sold primarily to Sony Corporation under a supply
agreement for use in Sony's manufacture of CRTs.
Transparent Conductors
Southwall currently markets several transparent conductive thin-films under
the brand names ALTAIR-O(TM) and ALTAIR-M(TM). Transparent conductive thin films
combine high visible light transmission with electrical conductivity and
environmental stability. They are typically used where the circuit or conductive
material must not obscure visual information behind the coating. ALTAIR-M(TM)
films are sold in roll and sheet form for incorporation into such electronic
devices as touch panels, liquid crystal displays and electroluminescent lighting
and displays. ALTAIR(TM) films are also used in EMI shielding, infrared
rejection and electrostatic discharge packaging applications.
Manufacturing
Four large-scale sputtering production machines, of which three are located
in Palo Alto, California and one in Tempe, Arizona, currently provide most of
the Company's sputtered thin-film coatings manufacturing capacity. The Company
also uses two small-scale sputtering machines for smaller production runs, and
research and development projects. One of the large-scale machines was
commissioned during the fourth quarter of 1997, and is located in the new
facility in Tempe, Arizona. Also located in the Tempe facility is a new wet
coating and laminating machine, which will be used to apply various top coats
and adhesives to film products and for lamination of liner films.
In 1998 the Company ordered a second large-scale sputtering production
machine for its Tempe facility. The Company estimates the machine and leasehold
improvements to integrate the machine will cost approximately $11 million. The
machine is scheduled to begin production of Heat Mirror XIR(R) film in late
1999.
In June 1997 the Company began to occupy a new 55,000 square foot leased
facility in Tempe, Arizona for the manufacturing of anti-reflective film and
began shipping product from that operation during the fourth quarter of 1997.
See Item 7, "Management's Discussion and Analysis of Financial Condition and
Results of Operations," for a discussion of problems associated with the
production of the anti-reflective film. The cost of equipment and leasehold
improvements for the facility totaled approximately $12 million. Financing of
the project and related working capital requirements were secured through a
combination of debt and equity. The Company secured $5 million of financing from
a lending institution during December 1996, and an additional $15 million
through an agreement with Teijin Limited of Japan, a raw material supplier to
the Company, in April 1997. This $15 million included the purchase of 667,000
shares of the Company's Common Stock at $7.50 per share, or approximately $5
million, and guaranteed a loan through Sanwa Bank for an additional $10 million.
6
<PAGE>
Sources of Supply
The Company has more than one supplier for much of its raw materials and
maintains inventories and close working relationships with its suppliers to
ensure timely and reliable delivery. The substrates used in the manufacture of
Heat Mirror(TM) and anti-reflective film being sold to Sony Corporation are
currently available only from a single source, Teijin Limited of Japan, holder
of approximately 9% of the Company's Common Stock. In each case, an alternative
source of supply is being pursued; however, there can be no assurance that
alternative sources of supply will be successfully developed. Although the
Company has not experienced major interruptions in production due to a shortage
of raw materials, prolonged supply shortages would materially and adversely
affect the Company's manufacturing operations, business and financial
performance.
Research and Development
Southwall's research and development activities are focused upon the
development of new proprietary products, thin-film materials science, and
deposition process optimization and automation. Company funded research and
development expenditures totaled $2.5 million, $3.1 million and $3.9 million,
6%, 6% and 8% of total net revenues during each of the three years 1996, 1997
and 1998, respectively.
Marketing and Customers
The Company markets its products to OEMs in the United States, Canada,
Europe, the Middle East and Asia principally through its own direct sales force
and sales representatives. Mitsui and Marubeni Corporation are the Company's
distributors for Heat Mirror(TM) and certain electronics products in Japan.
Mitsui also has exclusive manufacturing rights for certain of the Company's
electronics products in Japan using the Company's proprietary sputtering
technology. Approximately 43%, 35% and 32% of the Company's net revenues
resulted from sales to customers located in the United States in 1996, 1997 and
1998, respectively.
Since 1992, the Company has maintained a European office to provide
marketing, sales and field service support in Europe, primarily for the
Company's Heat Mirror(TM) product line and, since 1995, for Heat Mirror XIR(R)
film sold to automotive glass manufacturers.
Since 1995, the Company has maintained a sales office in Asia, currently in
Singapore, to provide marketing and sales support in Australia and Asia,
primarily for the Company's window products.
In 1995, Southwall started selling its proprietary anti-reflective film
under a Supply Agreement to Sony Corporation of Japan ("Sony") for computer
monitor CRTs. During the first quarter of 1996, the Company and Sony signed
Addendum #1 to the Supply Agreement. Under the terms of the amended agreement,
among other things, Sony agreed to increase its minimum order of anti-reflective
film beginning July 1, 1997 and extending through December 31, 2000, and
Southwall agreed to install any necessary additional manufacturing capacity by
July 1, 1997. The Company's new manufacturing facility in Tempe, Arizona, from
which product was first shipped during the fourth quarter of 1997, was designed
to meet the requirements of the Sony agreement.
Southwall supplies Heat Mirror(TM) products to approximately 60 insulating
glass and window fabricators and distributors worldwide. The Company's
proprietary mounting technology is licensed to its customers, who must acquire
or build specialized mounting equipment for the manufacture of Heat
Mirror-equipped windows. The Company's field services organization trains
customers in the manufacture of Heat Mirror-equipped windows.
7
<PAGE>
In North America, the Company also promotes its Heat Mirror(TM) product
line, including its California Series(TM) laminated glazing product to the
design community, through approximately 30 regionally based architectural sales
representatives.
The Company sells its aftermarket anti-reflective filters through
distributors and independent direct sales organizations.
Southwall's products are sold with a limited warranty. During 1998 the
Company did not experience significant product returns and the costs of its
warranty programs were not substantial. However, in the fourth quarter of 1998
the Company discovered that certain anti-reflective ("AR") film manufactured in
Tempe, Arizona under an agreement with Sony had quality issues. As a result,
certain AR film in Tempe and at Sony's plant in Japan is affected by this
problem. The Company reserved $4.0 million in the fourth quarter of 1998 to
cover the inventory in Tempe and returns from Sony. The Company is currently
working with Sony to determine the exact amount of film to be returned.
A small number of customers have accounted for a substantial portion of the
Company's revenues. The Company's ten largest customers accounted for 63% and
67% of net product sales in 1997 and 1998, respectively. One customer, Sony
Corporation of Japan, accounted for 31% and 26% of net product sales in 1997 and
1998, respectively. The loss of any of these customers could have a materially
adverse effect on the Company's operating results. The Company anticipates that
customer concentration will continue for the foreseeable future.
Orders for the Company's products are typically short-term and Southwall
usually ships its products from inventory or produces special customer runs
within 90 days of receiving orders. As a result, the Company generally
experiences no significant order backlog.
Competition
The thin-film coatings industry and the markets in which Southwall's
customers compete experience rapid technological change. Southwall's revenues
and operating results could be materially adversely affected by new equipment or
process technologies that improve or change the methods of depositing films on
substrates. Technological change in customers' markets may also result in
obsolescence of the Company's products. Southwall's future success will depend,
in large part, on its ability to anticipate technological change and to
introduce new products.
Southwall has a number of present and potential competitors, many of which
have greater financial resources and greater selling, marketing and technical
resources than the Company. Other U.S. companies serving some of the same
markets as the Company include Material Sciences Corporation and Optical Coating
Laboratories, Inc. One of the largest U.K. polymer film companies, Courtaulds
PLC, entered the market in the mid-1980's by acquiring certain U.S. thin-film
manufacturers. The Company also competes in certain markets with a number of
Japanese companies. Southwall believes that competition for its commercial
products comes primarily from other types of films, various chemical coatings
and solar control coatings deposited directly on glass, and heat absorbing
glass, and that the principal competition to its electronic display products is
currently from non-thin-film alternatives as well as thin-film alternatives.
The Company competes primarily on the basis of the characteristics and
quality of its products, its ability to meet individual customer specifications
and the quality and level of technical assistance furnished to customers.
8
<PAGE>
Patents and Licenses
The Company relies primarily upon trade secrets and know-how to develop and
maintain its competitive position. There can be no assurance that others will
not develop and patent similar technology or that the confidentiality agreements
upon which the Company relies will be honored.
The Company has twenty-four (24) patents and nine (9) patent applications
pending in the United States that cover materials, processes, products and
production equipment. The Company also has patents and patent applications
pending in various foreign countries covering the same technology. Expiration
dates for the various patents range from 1999 to 2016. Southwall considers its
proprietary technology, as well as its patent protection, to be a significant
factor in its business. There can be no assurance that any patent will be issued
on pending applications or that any patent issued will provide adequate
protection for the technology or product covered by it. In addition, other
companies and universities have obtained patents covering film configurations
and processes. The Company has obtained licenses under some of these patents and
may from time to time require licenses under additional patents. There can be no
assurance that the Company will be able to obtain such licenses, if required,
upon commercially reasonable terms or at all.
Litigation has been and may in the future be necessary from time to time to
enforce patents issued to the Company to protect trade secrets and know-how
owned by the Company or to determine the enforceability, scope or validity of
the proprietary rights of others. Any such litigation could result in
substantial costs to the Company and division of effort by the Company's
management and technical personnel.
Employees
As of December 31, 1998, Southwall had 236 regular full-time employees, of
whom 43 were engaged in engineering, 146 in manufacturing, and 47 in selling,
general management, finance and administration. The Company is highly dependent
upon the existence and continuing services of certain key scientists, engineers
and management personnel. The loss of services of these employees could have a
materially adverse impact on the business and prospects of the Company. Many of
the Company's employees are highly skilled, and the Company faces strong
competition in recruiting and retaining such personnel.
None of the Company's employees are covered by a collective bargaining
agreement, and the Company has not experienced any work stoppages. The Company
believes that its employee relations are good.
Environmental Matters
The Company uses certain hazardous materials in its research and
manufacturing operations and has air and water emissions that require controls.
As a result, the Company is subject to stringent federal, state and local
regulations governing the storage, use and disposal of wastes. The Company has
implemented a program to monitor its past and present compliance with
environmental laws and regulations. Although the Company believes that it is
currently in material compliance with such laws and regulations, current or
future laws and regulations may require the Company to make expenditures for
compliance with chemical exposure, waste treatment or disposal regulations.
There can be no assurance that the operations, business or assets of the
Company will not be materially adversely affected by the interpretation and
enforcement of current or future environmental laws and regulations.
9
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ITEM 2. PROPERTIES
Southwall's administrative, marketing, engineering and manufacturing
facilities are located in five buildings totaling approximately 119,000 square
feet in Palo Alto, California and one building of approximately 55,000 square
feet in Tempe, Arizona. A 15,000 square foot assembly facility in Ireland was
vacated during January 1998, and the Company's anti-reflective film filters are
currently being assembled by a company owned by former employees of that
facility. The buildings in Palo Alto are occupied under leases that expire from
December 1999 to July 2002, with options to extend some of these leases for
terms expiring through 2009. The lease for the building in Tempe will expire in
June 2007, with options through 2017. The Company believes that these facilities
are suitable for its manufacturing requirements at least through 2000. However,
should demand for the Company's products increase significantly, additional
facilities could be necessary. The Company believes that such additional
facilities could be available on commercially reasonable terms.
ITEM 3. LEGAL PROCEEDINGS
The Company has been named a defendant in a lawsuit filed on April 5, 1996
by one of its customers in the United States District Court for the Eastern
District of New York. The lawsuit alleges certain unfair competition, tort and
contractual violations by the Company and seeks relief in an aggregate amount in
excess of $35 million. The Company believes that this lawsuit is without merit
and intends to defend against it vigorously.
In addition, the Company is involved in certain other legal actions arising
in the ordinary course of business. The Company believes, however, that none of
these actions, either individually or in the aggregate, will have a material
adverse effect on the Company's business or its consolidated financial position
or results of operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the quarter
ended December 31, 1998.
Following is a list of the executive officers of Southwall Technologies
Inc. with their ages and present positions. All of these officers have been
employed full time by Southwall over the last 5 years except Bill R. Finley,
Sicco W.T. Westra and John J. Flaig, who joined Southwall on June 15, 1998,
August 31, 1998 and March 1, 1999, respectively. No family relationships exist
among any of the executive officers named, nor is there any arrangement or
understanding pursuant to which any person was selected as an officer.
Thomas G. Hood 43 President and Chief Executive Officer
Bill R. Finley 58 Vice President, Chief Financial Officer, and
Secretary
Robert Hier 45 Senior Vice President, Marketing and Sales
Sicco W.T. Westra 48 Senior Vice President, Engineering and
Product Development
Catherine B. Poliak 41 Vice President, Human Resources
John J. Flaig 53 Vice President, Quality Assurance
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PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS
The Company's Common Stock has been traded on the Nasdaq National
Market System under the symbol "SWTX" since the completion of the Company's
initial public offering in June 1987. Prices in the following table represent
the high and low closing sales prices for the Company's Common Stock as reported
by Nasdaq as of quarter ends in 1997 and 1998.
1997 by Quarter High Low
--------------- ---- ---
1st $7.25 $6.13
2nd $7.50 $5.94
3rd $8.75 $5.88
4th $8.38 $6.38
1998 by Quarter High Low
--------------- ---- ---
1st $8.63 $6.63
2nd $7.25 $5.00
3rd $5.50 $4.37
4th $6.00 $4.00
The Company has not paid cash dividends and has no present plans to do so.
There were approximately 2,600 stockholders at December 31, 1998, which includes
stockholders of record and an estimate of the number of stockholders holding
Common Stock in broker name.
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<TABLE>
ITEM 6. SELECTED FINANCIAL DATA
<CAPTION>
Year ended December 31,
-----------------------------------------------------------------
1994 1995 1996 1997 1998
---- ---- ---- ---- ----
(In thousands, except per share data)
<S> <C> <C> <C> <C> <C>
Statement of Operations Data:
- - -----------------------------
Revenues $ 21,739 $ 33,501 $ 41,720 $ 50,089 $ 50,033
Income(loss) from
operations (1)(2)(3) (3,913) 726 2,568 2,446 (7,130)
Net income(loss) (3,888) 633 2,427 2,281 (7,869)
Net income(loss) per
share:
Basic $ (.67) $ .11 $ .39 $ .32 $ (1.03)
Diluted (.67) .10 .35 .29 (1.03)
Weighted average shares of
common stock and common
stock equivalents:
Basic 5,808 5,880 6,200 7,107 7,608
Diluted 5,808 6,218 7,034 7,799 7,608
<FN>
(1) Year 1994 includes $1 million of charges during the fourth quarter to eliminate three minor product lines
($.5 million) and to consolidate facilities ($.5 million).
(2) Year 1997 includes $1.6 million of start up costs related to the new manufacturing facility in Tempe,
Arizona.
(3) Year 1998 includes $4.0 million of charges during the fourth quarter related to quality issues of the
anti-reflective film product for Sony Corporation.
</FN>
</TABLE>
<TABLE>
<CAPTION>
December 31,
----------------------------------------------------------------
1994 1995 1996 1997 1998
---- ---- ---- ---- ----
(In thousands)
<S> <C> <C> <C> <C> <C>
Balance Sheet Data:
- - -------------------
Working capital $ 8,102 $ 9,724 $ 15,846 $ 23,999 $ (4,256)
Total assets 31,372 34,105 42,509 61,469 54,019
Long-term obligations 2,650 2,890 6,591 15,539 141
Stockholders' equity 22,988 23,914 27,597 35,740 25,817
</TABLE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (in thousands)
This Form 10-K Report may contain, in this section and elsewhere in the
report, forward looking statements as that term is defined in the Private
Securities Litigation Reform Act of 1995, including, without limitation,
statements regarding the Company's expectations, beliefs, intentions or
strategies regarding the future. All forward-looking statements included in this
document are based on information available to the Company on the date hereof,
and the Company assumes no obligation to update any such forward-looking
statements.
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General
The Company has experienced significant fluctuations in quarterly results
of operations. Revenues have varied from quarter to quarter due to the seasonal
buying patterns for the Company's Heat Mirror(TM) products, which typically have
been strongest in the second and third quarters, and the timing of short-term
sales contracts. Sales of the Company's energy conservation products are
significantly influenced by the residential and commercial construction
industries, and reduction in construction has generally resulted in a reduction
in the sales of the Company's Heat Mirror(TM) products. In addition, prior to
1996, operating results historically varied from quarter to quarter as a
function of the utilization of the Company's production machines. In 1997,
operating results were affected by the start up of manufacturing operations in
Tempe, Arizona.
In 1998, operating results were affected by process and machine problems
resulting in quality issues associated with the anti-reflective ("AR") film
product for Sony Corporation ("Sony"). In the fourth quarter of 1998 the Company
discovered that certain AR film that had been shipped to Sony and that was still
in inventory in Tempe had quality issues and did not meet Sony's specifications.
While the Company is still working with Sony to settle the exact amount of the
quality issues, the Company has estimated that the returns from Sony and the
related inventory write-off will be approximately $4.0 million. Provisions for
this amount have been recorded in the Company's fourth quarter results. To a
lesser extent, manufacturing inefficiencies at the Palo Alto facility during
1998 resulted in lower product yields and higher manufacturing costs. The
development and introduction of new products and the changing mix of products
manufactured have added to the production problems and inefficiencies
experienced by the Company. Primarily as a result of these factors, and in view
of the Company's strategy of developing additional applications for its
thin-film technology, and its ongoing practice of upgrading its manufacturing
processes, the Company may continue to experience quarterly fluctuations in its
results of operations.
Although the Company has not experienced a significant amount of inventory
obsolescence and believes that its inventory is recoverable, obsolescence of the
Company's products could be affected by technological change, competition, loss
of customers and reduction in demand, among other factors.
The Company believes that it must continue to increase revenues and improve
manufacturing processes and yields to achieve sustained profitability. Although
the Company has expanded its capacity by opening a new manufacturing facility in
1997 in Tempe, Arizona and entered into a supply agreement in 1998 with Delta-V
for a new production machine to be completed and installed in Tempe by the
fourth quarter of 1999, and is continuously seeking to expand existing
applications, to develop new applications and to expand international marketing
and sales efforts, there can be no assurance that the Company will be able to
continue to increase revenues. Additionally, there can be no assurance that the
Company will be successful in consistently achieving production levels necessary
to fulfill the minimum supply requirements for the period ended December 31,
1999, thereby avoiding potential penalties provided for in the contract with
Sony.
13
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<TABLE>
The following table sets forth for the periods indicated (1) the percentage
relationship to revenues of expense and income items and (2) the percentage
change of such items as compared to the prior period. The table and the
subsequent discussion should be read in conjunction with the financial
statements and the notes thereto included elsewhere in this Form 10-K.
<CAPTION>
Percentage of Period to Period
Total Revenues Change
-------------- ----------------
December 31, 1997 1998
----------- vs. vs.
1996 1997 1998 1996 1997
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Net revenues 100.0 100.0 100.0 20.1 0.0
Costs and expenses:
Cost of sales 67.0 67.3 88.4 20.5 31.4
Start up costs - Tempe - 3.2 - 100.0 (100.0)
Research and development 6.0 6.2 7.7 25.3 24.0
Selling, general and
administrative 20.9 18.4 18.1 5.6 (1.8)
Total costs and expenses 93.8 95.1 114.2 21.7 20.0
Income(loss) from operations 6.2 4.9 (14.2) (4.8) (391.5)
Interest expense, net (0.1) - (1.4) (23.1) 3,305.0
Income(loss) before income taxes 6.1 4.8 (15.6) (4.6) (422.0)
Provision for income taxes 0.3 0.3 0.1 26.1 (60.0)
Net income(loss) 5.8 4.6 (15.7) (6.0) (445.0)
</TABLE>
Year 2000 readiness
The Company believes the Year 2000 issue represents a material risk to the
Company. The Year 2000 issue involves the potential inability of information or
other data dependent systems to properly distinguish year references at the turn
of the century.
The Company itself is heavily dependent upon the proper functioning of its
own computer systems, including (1) computers and related software for its
financial and manufacturing information systems, (2) computers, programmable
logic controllers and other data dependent equipment in its manufacturing
processes, and (3) computers, scientific equipment and related software for its
engineering, research and development activities. Any failure or malfunctioning
on the part of these or other systems could cause disruptions of operations,
including a temporary inability to process financial transactions, manufacture
products or engage in ordinary business activities in ways that are not
currently known, discernible, quantifiable or otherwise anticipated by the
Company.
14
<PAGE>
In October 1996 the Company began reviewing Year 2000 issues and prepared a
plan ("The Plan") to address those issues. The Plan consists of several phases.
The first is the inventory and prioritization of potential Year 2000 items, and
the assessment of Year 2000 compliance. The second phase is the remediation of
any noted problems. The third phase is the testing of material items and the
fourth phase is the preparation of contingency plans. All phases of The Plan
have been handled with existing staff and the Company believes the cost to
address Year 2000 issues will not be material.
The Company currently has no contingency plans to deal with the most likely
worst case scenarios. The Company currently anticipates that it will complete
contingency planning by June 30, 1999.
For the Company's most significant IT and non-IT systems (defined below),
the first and second phases have been completed. The Company has completed major
upgrades and modifications, which have made essentially all mainframe accounting
and inventory control software Year 2000 compliant. The scope of the Year 2000
compliance effort includes (1) information technology ("IT") such as software
and hardware; (2) non-IT systems or embedded technology such as
micro-controllers contained in various manufacturing and laboratory equipment;
environmental and safety systems, facilities and utilities, and (3) the
readiness of key third parties, including suppliers and customers, and the
electronic data interchange (EDI) with those key third parties.
The Company's suppliers (particularly sole-source and long lead time
suppliers) and key customers may be adversely affected by their respective
failures to address the Year 2000 issue. If the Company's suppliers are unable
to provide goods or services, the Company's operations could be materially
adversely affected. Key customers that encounter Year 2000 difficulties could
fail to order or take delivery of the Company's products, or could fail to make
or delay payments to the Company. Such failure or delay could have a material
adverse effect on the Company's business and results of operations. While some
of these risks are outside the control of the Company, the Company's Plan
includes communications with suppliers and customers to ascertain the state of
their Year 2000 compliance program. The questionnaire phase of this activity is
scheduled for completion by March 31, 1999. Remediation activities and
preparation of contingency plans related to suppliers and customers is scheduled
for completion by June 30, 1999.
The Company's products are not affected by calendar dating. Therefore,
there is no known or anticipated Year 2000 impact on its product offering.
The Company believes its Year 2000 Plan will significantly reduce the
probability of significant interruptions of normal operations resulting from
Year 2000 issues. However, the Company may not properly identify and assess all
Year 2000 issues, or it may not remediate and test all its IT and non-IT systems
in a timely or adequate manner. In addition, its key suppliers or customers
could experience Year 2000 problems. If any of these potential situations occur,
the Company's contingency plans may not be adequate to protect the Company from
the adverse effects of such problems. The worst case scenario resulting from
Year 2000 issues would be a material adverse impact on the Company's results of
operations, an interruption in normal business operations, or an adverse impact
on the Company's relationships with customers, suppliers or others.
15
<PAGE>
Recent Developments
On January 4, 1999 the Company announced it had received orders in excess
of $20 million for deliveries of its automotive XIR(R) solar control film for
use in laminated windows in 16 automobile models manufactured in Europe by Audi,
BMW, Mercedes Benz (including all models of the S class line), and Renault. The
Company is continuing to increase production of its automotive XIR(R) film and
in the first quarter of 1999 dedicated its highest capacity manufacturing
machine exclusively to the production of automotive XIR(R) film. By dedicating
this machine exclusively to the production of automotive XIR(R) film, the
Company believes it will realize measurable improvements in production
efficiencies and yields in 1999 for this product line.
During the first quarter of 1999 the Company began the process of
converting and upgrading one of its older, large-scale production machines,
located in Palo Alto, California to produce advanced anti-reflective films for
computer and television monitors, and other display devices. The conversion and
upgrade process will cost approximately $1.4 million and is expected to be
complete by the end of second quarter of 1999. The machine will resume
production in the third quarter of 1999 to satisfy the anticipated growth in
demand from our OEM customers.
During January and February of 1999, the manufacturing machine located in
Tempe, Arizona was taken out of production until the coating process associated
with the anti-reflective film product for Sony was achieving customer
specification. Production resumed in March 1999. The loss of production capacity
experienced in the first quarter of 1999 is expected to have a significant
adverse effect on the results of the quarter.
Results of Operations (in thousands)
1998 Compared to 1997
The Company's net revenues were $50.0 million in 1998 compared to $50.1
million in 1997. Net sales for automotive XIR(R) film increased $8.1 million
from 1997. In addition, net sales of anti-reflective film to OEM customers other
than Sony increased by approximately $2.5 million. Offsetting these product
increases was a decrease of approximately $5.1 million of Sony anti-reflective
film including $2.3 million in the fourth quarter of 1998 due to estimated
product returns for product not meeting Sony's specifications. All other
products combined decreased by approximately $5.6 million primarily due to
capacity constraints associated with increasing automotive XIR(R) production.
Cost of sales for 1998 was 88% of net revenue compared to 67% for 1997, or
an increase of 21%. The increase in cost of sales as a percentage of net
revenues was primarily due to anti-reflective film for Sony that does not meet
their specifications. The anti-reflective film not meeting Sony's specifications
is estimated to be $4.0 million and a provision in this amount was recorded in
the fourth quarter of 1998. This increase was partially offset by improved
yields of the Company's other products, including automotive XIR(R) film.
Management expects continued inefficiencies and higher cost of operations for
its Tempe, Arizona facility during the first quarter of 1999.
Research and development expenses, as a percent of net revenues, were 8%
for 1998, compared to 6% for 1997. The absolute dollars increased to $3.9
million in 1998 from $3.1 million in 1997. The increase was primarily
attributable to an increase in personnel, from 24 employees at December 31,
1997, to 43 at December 31, 1998. The increase in personnel was necessary to
support higher new product development, primarily in film for laminated glass
products, including film for the automotive, Solis(R) and California
16
<PAGE>
Series(TM) commercial and residential markets, and for new anti-reflective film
products.
Selling, general and administrative expenses, as a percent of net revenues,
decreased to 18.1% in 1998, from 18.4% in 1997 due mainly to cost cutting
measures. The absolute dollars decreased from $9.2 million in 1997 to $9.0
million in 1998. This decrease was primarily attributable to an effort to
decrease personnel and control costs.
As a result of the factors discussed above, the Company reported a pre-tax
loss of $7.8 million for 1998, compared to pre-tax income of $2.4 million for
1997.
1997 Compared to 1996
The Company's net revenues were $50.1 million for 1997 compared to $41.7
million in 1996, an increase of 20%. This increase was primarily volume related
of which approximately $5 million was from increased sales of anti-reflective
film to Sony. In addition, sales of Heat Mirror XIR(R) film to OEM automotive
glass customers increased by approximately $2.1 million and silver reflector
film sales increased by approximately $2 million, about $1 million each for
energy conservation and electronics customers. Sales of all other energy
conservation products were essentially flat from 1996 to 1997. Sales of all
other electronics products, excluding anti-reflective and silver reflector
films, decreased by approximately $.9 million from 1996 to 1997.
Cost of sales for 1997, excluding start up costs for the new manufacturing
facility in Tempe, Arizona were 67% of net revenue compared to 67% for 1996.
Start up costs in 1997 for the new manufacturing facility were approximately
$1.6 million or 3% of net revenues. The new facility in Tempe began producing
anti-reflective product for shipment to Sony during the fourth quarter of 1997,
but production was inefficient, resulting in low yields and throughput.
Production efficiency improvements which had taken place in 1997 and the later
part of 1996 at the Company's Palo Alto, California facility resulted in
improved yields and throughputs on most of the Company's other products produced
during 1997. These improvements were offset by; (1) the inefficient operations
in Tempe during the fourth quarter of 1997, (2) the costs of unplanned
maintenance downtime, which occurred primarily during the third quarter of 1997
on two of the Company's production machines, and, (3) the costs realized
throughout 1997 to scale up production of automotive OEM products for new
customers in Europe.
Research and development expenses, as a percent of net revenues, were 6%
for 1997, compared to 6% for 1996. The absolute dollars increased to $3.1
million in 1997 from $2.5 million in 1996. The increase was primarily
attributable to an increase in personnel to support higher new product
development, primarily in film for laminated glass products, including film for
the automotive and California SeriesJ commercial and residential markets, and
anti-reflective products.
Selling, general and administrative expenses, as a percent of net revenue,
decreased to 18% in 1997, from 21% in 1996 due to increased sales volume. The
absolute dollars increased from $8.7 million in 1996 to $9.2 million in 1997.
This increase was primarily attributable to salary inflation and sales
commissions, plus increased personnel to provide greater focus on management of
the two major product groupings, energy and electronics products, and to broaden
selling coverage in Europe and South America.
As a result of the factors discussed above, the Company reported a pre-tax
income of $2.4 million for 1997, compared to pre-tax income of $2.5 million for
1996.
17
<PAGE>
Liquidity and Capital Resources
On December 16, 1996, the Company borrowed $5 million from an institutional
lender for partial financing of the new manufacturing facility in Tempe,
Arizona. On April 9, 1997, the Company signed an agreement with Teijin Limited
of Japan (Teijin), a major raw material supplier of the Company, which included
arrangements for additional financing for the new manufacturing facility and for
related potential working capital growth. Teijin purchased 667,000 shares of the
Company's common stock at a price of $7.50 per share, and guaranteed a loan
through Sanwa Bank for an additional $10 million. Teijin also received warrants
to purchase 158,000 shares of common stock at a price of $9.00 per share at any
time within three years of the date of the agreement. The stock purchase
transaction of approximately $5 million was completed on April 28, 1997. In
addition, a loan agreement with Sanwa Bank was signed on May 2, 1997, and the
Company received the first $5 million of funding on May 6, 1997, and the
remaining $5 million was received on November 6, 1997. The new manufacturing
facility began operations during the fourth quarter 1997, and is currently
dedicated to the production of anti-reflective film product to fulfill the
supply requirements of the supply agreement with Sony.
From December 31, 1997 to December 31, 1998, cash and short-term
investments decreased by $6.4 million, primarily due to expenditures for
property and equipment, the purchase of treasury stock and payments on long-term
debt, offset by cash provided by operations. The Company used approximately $7.4
million for capital expenditures during 1998, of which approximately $2.0
million was for the new manufacturing machine to be located in its Tempe
facility. The cash provided by operations resulted primarily from a decrease in
inventories, including approximately $1.7 million of unusable inventory
associated with anti-reflective film reserved in the fourth quarter of 1998,
depreciation and amortization of $4.3 million, and increases in accounts payable
and accrued liabilities, offset by the net loss for the year.
At December 31, 1998, the Company had $4.1 million of cash and short-term
investments. The Company also has a $6 million line of credit with a bank, which
expires June 5, 1999, and term loans of $10 million and $5 million which are
subject to certain financial covenants. As of December 31, 1998, there were no
borrowings under the line of credit with the bank. The Company was not in
compliance with certain financial covenants pertaining to the term loans and the
bank line of credit at December 31, 1998. The Company has requested and received
waivers of these covenant violations through December 31, 1998; however, the
Company is in continuing default of these covenants and has therefore classified
this debt as a current liability as of December 31, 1998. The Company has
maintained favorable relations with all of its financing institutions and is
working closely with its lenders to reset the covenants based on the Company's
current 1999 projections. While there can be no assurance that the Company will
be successful in these efforts the Company anticipates a favorable resetting of
such covenants and the ability to pay these loans in accordance with their
original terms. The Company is currently negotiating with the bank to extend the
line of credit for an additional one year term.
The Company anticipates that it will acquire approximately $14 million to
$17 million of new capital equipment in 1999 which includes the purchase of two
new production machines for Heat Mirror XIR(R) film products and a planned
expansion in the European automotive film market. The Company is currently
seeking approximately $10 million of additional equipment financing from one of
its current lenders and expects this financing to be in place early in the
second quarter of 1999, although there can be no assurance that the Company will
be successful in obtaining this financing. The Company also expects that foreign
government grants and incentives will be available to help finance the expansion
into the European automotive film market, although there is no assurance that
the Company will be successful in this effort. Additionally, the Company's
Convertible Subordinated Note for $2.65 million is due and payable on May 31,
1999 and accordingly,
18
<PAGE>
has been reclassified in the December 31, 1998 financial statements in the
current portion of long-term debt.
While there can be no assurance that the Company will be successful in its
efforts to renegotiate its financial covenants with its lenders or obtain the
additional financing that will be necessary for its 1999 operating cash
requirements, the Company believes that existing cash, cash anticipated to be
generated from operations, the extended line of credit, the additional term loan
borrowing and the availability of foreign grants and incentives, as discussed
above, will be sufficient to meet the Company's operating cash requirements
through fiscal 1999.
If the Company is not successful in obtaining the financing described
above, it may also need to raise additional funds through public or private
equity or debt financing from other sources. The sale of additional equity or
convertible debt may result in additional dilution to the Company's stockholders
and such securities may have rights, preferences or privileges senior to those
of the Common Stock. There can be no assurance that additional equity or debt
financing will be available or that if available it can be obtained on terms
favorable to the Company or its stockholders.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company is exposed to the impact of interest rate changes, foreign
currency fluctuations, and changes in the market values of its investments.
FINANCING RISK. The Company's exposure to market rate risk for changes in
interest rates relates primarily to the Company's term loans which are tied to
the London Interbank Offered Rate ("LIBOR") and the Company's Convertible
Subordinated Note and bank line of credit which are tied to the prime rate.
Fluctuations in interest rates may adversely impact the interest expense
expected for the Company. The effect of interest rate fluctuations on the
Company in 1998 was not material.
INVESTMENT RISK. The Company invests its excess cash in certificates of
deposit and money market accounts and, by policy, limits the amount of exposure
to any one institution. Investments in both fixed rate and floating rate
interest earning instruments carries a degree of interest rate risk. Fixed rate
securities may have their fair market value adversely impacted due to a rise in
interest rates, while floating rate securities may produce less income than
expected if interest rates fall.
FOREIGN CURRENCY RISK. International revenues amounted to 68% of the
Company's total sales in 1998 and, by policy, the Company limits foreign
currency risk by requiring all sales to be denominated in U.S. dollars. The
Company's international business is subject to risks typical of an international
business, including, but not limited to differing economic conditions, changes
in political climate, differing tax structures, other regulations and
restrictions, and foreign exchange rate volatility. Accordingly, the Company's
future results could be materially adversely impacted by changes in these or
other factors. The effect of foreign exchange rate fluctuations on the Company
in 1998 was not material.
19
<PAGE>
ITEM 8. FINANCIAL STATEMENTS
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and
Stockholders of Southwall Technologies Inc.
In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of operations, cash flows and stockholders' equity
present fairly, in all material respects, the financial position of Southwall
Technologies Inc. and its subsidiaries, (the "Company"), at December 31, 1998
and 1997, and the results of their operations and their cash flows for each of
the three years in the period ended December 31, 1998, in conformity with
generally accepted accounting principles. These financial statements are the
responsibility of the Company's management; our responsibility is to express an
opinion on these financial statements based on our audits. We conducted our
audits of these statements in accordance with generally accepted auditing
standards, which 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, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for the opinion expressed above.
PricewaterhouseCoopers LLP
San Jose, California
March 8, 1999
20
<PAGE>
<TABLE>
SOUTHWALL TECHNOLOGIES INC.
CONSOLIDATED BALANCE SHEETS
(in thousands, except per share data)
ASSETS
<CAPTION>
December 31,
1 9 9 7 1 9 9 8
------- --------
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 10,524 $ 4,136
Short-term investments 7 7
Accounts receivable, net of
allowance for bad debts
of $834 and $845 11,926 12,355
Inventories 10,118 6,057
Other current assets 1,118 813
-------- --------
Total current assets 33,693 23,368
Property and equipment, net 26,272 29,068
Other assets 1,504 1,583
-------- --------
Total assets $ 61,469 $ 54,019
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 4,835 $ 6,307
Accrued compensation 2,009 2,265
Other accrued liabilities 1,546 3,655
Current portion of long-term debt 1,304 15,397
-------- --------
Total current liabilities 9,694 27,624
Long-term debt 15,539 141
Deferred income taxes 496 437
-------- --------
Total liabilities 25,729 28,202
-------- --------
Commitments (Note 8)
Stockholders' equity:
Common stock, $.001 par value, 20,000 shares
authorized; issued and outstanding 7,636
and 7,889 8 8
Capital in excess of par value 51,513 52,181
Notes receivable (656) (1,020)
Accumulated deficit (14,631) (22,500)
Less cost of treasury stock, 123 and
565 shares outstanding (494) (2,852)
-------- --------
Total stockholders' equity 35,740 25,817
-------- --------
Total liabilities and
stockholders' equity $ 61,469 $ 54,019
======== ========
<FN>
See accompanying notes to consolidated financial statements.
</FN>
</TABLE>
21
<PAGE>
<TABLE>
SOUTHWALL TECHNOLOGIES INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
<CAPTION>
Year ended December 31,
-------------------------------------------
1 9 9 6 1 9 9 7 1 9 9 8
-------- -------- --------
<S> <C> <C> <C>
Net revenues $ 41,720 $ 50,089 $ 50,033
-------- -------- --------
Costs and expenses:
Cost of sales 27,936 33,669 44,253
Tempe start up costs -- 1,641 --
Research and development 2,487 3,117 3,864
Selling, general and administrative 8,729 9,216 9,046
-------- -------- --------
Total costs and expenses 39,152 47,643 57,163
-------- -------- --------
Income(loss) from operations 2,568 2,446 (7,130)
Interest income(expense), net (26) (20) (681)
-------- -------- --------
Income(loss) before provision
for income taxes 2,542 2,426 (7,811)
Provision for income taxes (115) (145) (58)
-------- -------- --------
Net income(loss) $ 2,427 $ 2,281 $ (7,869)
======== ======== ========
Net income(loss) per share:
Basic $ .39 $ .32 $ (1.03)
Diluted $ .35 $ .29 $ (1.03)
Weighted average shares of common stock
and dilutive common stock equivalents:
Basic 6,200 7,107 7,608
Diluted 7,034 7,799 7,608
<FN>
See accompanying notes to consolidated financial statements.
</FN>
</TABLE>
22
<PAGE>
<TABLE>
SOUTHWALL TECHNOLOGIES INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(in thousands)
<CAPTION>
Capital in Total
Common Stock Excess of Notes Accumulated Treasury Stockholders
Shares Amount Par Value Receivable Deficit Stock Equity
------ ------ --------- ---------- ------- ----- ------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance, Jan.1, 1995 6,917 $7 $47,206 $ - ($19,339) ($3,960) $ 23,914
Shares issued through:
Interest paid with
stock 86 193 279
Exercise of options (751) 2,111 1,360
Sales to employees
under Stock Purchase
Plan 9 81 90
Stock option loans (596) (596)
Stock option other 123 123
Net income 2,427 2,427
----------------------------------------------------------------------------------
Balance, Dec. 31, 1996 6,917 7 46,673 (596) (16,912) (1,575) 27,597
Shares issued through:
Interest paid with
stock 69 116 185
Exercise of options 52 (191) 811 620
Sale of stock, net 667 1 4,930 4,931
Sales to employees
under Stock Purchase
Plan 32 154 186
Stock option loans (60) (60)
Net income 2,281 2,281
---------------------------------------------------------------------------------
Balance, Dec. 31, 1997 7,636 8 51,513 (656) (14,631) (494) 35,740
Shares issued through:
Interest paid with
stock 24 162 186
Exercise of options 221 505 406 911
Sales to employees
under Stock Purchase
Plan 32 139 139
Repurchase of stock (2,926) (2,926)
Stock option loans (364) (364)
Net loss (7,869) (7,869)
-----------------------------------------------------------------------------------
Balance, Dec. 31, 1998 7,889 $8 $52,181 ($1,020) ($22,500) ($2,852) $25,817
===== == ======= ======== ========= ======== =======
<FN>
See accompanying notes to consolidated financial statements.
</FN>
</TABLE>
23
<PAGE>
<TABLE>
SOUTHWALL TECHNOLOGIES INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
<CAPTION>
Year ended December 31,
---------------------------------------
1996 1997 1998
-------- -------- --------
<S> <C> <C> <C>
Cash flows from operating activities:
Net income(loss) $ 2,427 $ 2,281 $ (7,869)
Adjustments to reconcile net income(loss)
to net cash provided by
operating activities:
Depreciation and amortization 2,313 2,703 4,315
Decrease (increase) in accounts receivable (1,809) (4,829) (429)
Decrease (increase) in inventories (1,782) (1,712) 4,061
Decrease (increase) in other current assets 367 (204) 246
(Decrease) increase in accounts payable
and accrued liabilities 190 1,845 4,023
-------- -------- --------
Cash provided by operating activities 1,706 84 4,347
-------- -------- --------
Cash flows from investing activities:
Decrease in short-term investments 2,125 -- --
Expenditures for property and equipment
and other assets (3,604) (11,727) (7,190)
-------- -------- --------
Net cash (used in) investing activities (1,479) (11,727) (7,190)
-------- -------- --------
Cash flows from financing activities:
Proceeds from issuance of stock, net
of related costs -- 4,931 --
Proceeds from issuance of long-term debt 5,000 10,393 --
Payments on long-term debt (219) (1,322) (1,305)
Repayment of stockholder's note receivable -- 234 180
Issuance of common stock upon exercise
of stock options -- -- 273
Issuance of common stock under employee
Stock purchase plan -- -- 139
Issuance (Purchase) of treasury stock, net 977 512 (2,832)
-------- -------- --------
Net cash provided by (used in) financing
activities 5,758 14,748 (3,545)
-------- -------- --------
Net increase (decrease) in cash
and cash equivalents 5,985 3,105 (6,388)
Cash and cash equivalents, beginning of year 1,434 7,419 10,524
-------- -------- --------
Cash and cash equivalents, end of year $ 7,419 $ 10,524 $ 4,136
======== ======== ========
Supplemental cash flow disclosures:
Interest paid $ 45 $ 620 $ 1,052
Income taxes paid $ 118 $ 100 $ 12
Supplemental schedule of non-cash investing
and financing activities:
Property and equipment acquired via
capital lease $ -- $ 365 $ --
Treasury stock used for payment
of interest $ 279 $ 185 $ 186
Exercise of stock options with issuance
of stockholders notes receivable $ 596 $ 220 $ 544
<FN>
See accompanying notes to consolidated financial statements.
</FN>
</TABLE>
24
<PAGE>
SOUTHWALL TECHNOLOGIES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except per share data)
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
Operations
Southwall Technologies Inc. (the "Company") is engaged in the design,
development and production of thin film coatings on flexible substrates. These
coatings selectively absorb, reflect or transmit certain types of
electromagnetic radiation for use in energy conservation and electronics
applications. The Company has developed and currently markets a variety of
thin-film products for the residential and commercial architectural glazing,
automotive glazing and electronic display markets. These products include
transparent insulation and solar-control films, anti-reflective film for
computer monitor CRTs and television screens, transparent conductive films for
use in touch screen displays, and various other commercial film products.
Principles of consolidation
The consolidated financial statements include the accounts of Southwall
Technologies Inc. and its wholly-owned subsidiaries. The Company's foreign
operations, which are not significant, are translated using appropriate rates of
exchange, with the U.S. dollar as the functional currency. Foreign currency
transaction gains and losses have not been significant. All significant
intercompany balances and transactions have been eliminated.
Management 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
disclosures of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
Cash equivalents and short-term investments
Cash equivalents and short-term investments consist of Eurodollar
certificates of deposit, money market and mutual funds. Investments with
maturities of three months or less from the date of purchase are included in
cash equivalents.
The Company has classified its short-term investments as
"available-for-sale securities". At December 31, 1998, the difference between
cost and fair market value was insignificant and the gains/losses on sales of
securities during the year were insignificant.
Fair value disclosures of financial instruments
The Company has estimated the fair value amounts of its financial
instruments using available market information and valuation methodologies
considered to be appropriate and have determined that the book value of the
Company's debt at December 31, 1998 approximates fair value.
25
<PAGE>
Concentration of credit risk
Financial instruments that potentially subject the Company to significant
concentrations of credit risk consist principally of cash equivalents and
short-term investments and trade accounts receivable.
The Company invests in a variety of financial instruments such as
certificates of deposits and money market funds. The Company, by policy, limits
the amount of credit exposure to any one financial institution or commercial
issuer.
The Company sells its products throughout the world. The Company performs
ongoing credit evaluations of its customer's financial condition and, generally,
requires no collateral from its customers. The Company maintains an allowance
for uncollectible accounts receivable based upon expected collectibility of all
accounts receivable. The write-off of uncollectible amounts has been
insignificant.
Revenue recognition
Revenues from product sales are recognized upon product shipment, provided
that no significant obligations remain and collectability is probable.
Provisions for estimated cost of warranty repairs and returns and allowances are
recorded at the time products are shipped.
The Company has agreements under which it receives fees for certain rights
to technology and products. License revenues associated with these agreements
are recognized when earned and receipt of payment is either received or is
certain to a reasonable degree.
Inventories
Inventories are stated at the lower of cost (determined by the first-in,
first-out method) or market. Cost includes materials, labor and manufacturing
overhead.
Property and equipment
Property and equipment are stated at cost. The Company uses the
units-of-production method for calculating depreciation on certain of its
production machines and the straight-line method for all other property and
equipment. Estimated useful lives of the assets range from five to ten years. On
its large scale production machines for which the units-of-production
depreciation method is used, the Company records minimum annual depreciation of
at least one-half of the depreciation that would have been recorded utilizing
the straight-line depreciation method over a ten-year life. Leasehold
improvements are amortized using the term of the related lease or the economic
life of the improvements, if shorter.
Additions, major renewals and betterments are included in the asset
accounts at cost. Ordinary maintenance and repairs are charged to expense as
incurred. Gains or losses from disposal are included in earnings.
26
<PAGE>
Intangible assets
Patents, licenses and trademarks relating to the Company's commercial
products are stated at cost less accumulated amortization. Amortization is
computed on the straight-line basis over terms of up to 17 years. At December
31, 1997 and 1998, patents, licenses and trademarks are included in other assets
in the amount of $843 and $852, net of accumulated amortization of $930 and
$947, respectively. Amortization expense for 1996, 1997 and 1998 was $121, $113
and $176, respectively.
Stock based compensation
The Company accounts for stock based compensation to employees using the
intrinsic value method in accordance with Accounting Principle Board Opinion No.
25, ("APB 25"), "Accounting for Stock Issued to Employees", as permitted under
the provisions of Statement of Financial Accounting Standards No. 123, ("SFAS
123"), "Accounting for Stock Based Compensation". Under APB 25, if the exercise
price of the Company's employee stock options equals the market price of the
underlying stock on the date of the grant, no compensation expense is
recognized. The Company has adopted the disclosure only provisions of SFAS 123.
Income taxes
The Company accounts for income taxes under the liability method, which
recognizes deferred tax assets and liabilities for the expected tax consequences
of temporary differences between the tax basis of assets and liabilities and
their financial statement reported amount.
Net income(loss) per share
Basic income(loss) per share is computed as net income(loss) divided by the
weighted-average number of common shares outstanding. Diluted income per share
is computed as net income divided by the weighted-average number of common
shares outstanding and dilutive potential common shares outstanding, including
stock options, restricted stock awards, warrants and other convertible
securities. Diluted loss per share is computed the same as basic income(loss)
per share since the inclusion of potential common shares would result in an
anti-dilutive (lower) loss per share amount. All options outstanding during 1998
were excluded from the diluted loss per share calculations because they were
anti-dilutive in view of the losses incurred by the Company.
During the years ended December 31, 1996, 1997 and 1998 there were no
differences between the numerators used for the basic and diluted income(loss)
per share calculations. The total amount of the differences in the denominators
in 1996 and 1997 are attributable to the effect of dilutive stock options.
Reclassifications
Certain prior year amounts have been reclassified to conform to the current
year presentation.
27
<PAGE>
<TABLE>
NOTE 2 - BALANCE SHEET DETAIL:
<CAPTION>
December 31,
-------------------------------
Inventories: 1 9 9 7 1 9 9 8
----------- --------- ---------
<S> <C> <C>
Work-in-process $ 2,551 $ 2,155
Raw materials 4,502 2,314
Finished goods 3,065 1,588
--------- ---------
$ 10,118 $ 6,057
========= =========
Property and Equipment: December 31,
---------------------- -------------------------------
1 9 9 7 1 9 9 8
--------- ---------
Machinery and equipment $ 38,108 $ 44,061
Leasehold improvements 3,319 3,714
Furniture and fixtures 3,105 2,915
Construction-in-process 5,264 4,987
--------- ---------
49,796 55,677
Less - accumulated depreciation
and amortization (23,524) (26,609)
--------- ---------
$ 26,272 $ 29,068
========= =========
</TABLE>
<TABLE>
Depreciation and amortization expense for the years ended December 31, 1996,
1997 and 1998 was $2,192, $2,590 and $4,139, respectively.
<CAPTION>
Other Accrued Liabilities: December 31,
------------------------- -------------------------------
1 9 9 7 1 9 9 8
--------- ---------
<S> <C> <C>
Reserve for warranties and sales
returns $ 917 $ 2,858
Other 629 797
--------- ---------
$ 1,546 $ 3,655
========= =========
</TABLE>
<TABLE>
NOTE 3 - LONG-TERM DEBT:
<CAPTION>
The Company's long-term debt consists of the following at December 31, 1998:
<S> <C>
Convertible Debenture $ 2,650
Promissory Note dated December 16, 1996 2,616
Promissory Note dated May 6, 1997 10,000
Other 272
---------
Total 15,538
Less current portion 15,397
---------
$ 141
=========
</TABLE>
The $2,650 convertible debenture is due May 31, 1999, bears interest that
is payable semi-annually with the Company's common stock, at 2% below prime, but
not less than 7%, nor higher than 11%, and is convertible at the option of the
holder into the Company's common stock at a price of $9.95 per share (subject to
certain adjustments).
The Promissory Note dated December 16, 1996 is secured by a production
machine, bears interest at an annual rate of 9.7037%, and is subject to certain
financial covenants. The note is payable in monthly installments plus interest
for a term of 48 months. At December 31, 1998 the Company was not in compliance
with some of the financial covenants pertaining to this Promissory Note. The
Company has received a waiver from the financial institution for failure to
comply with such covenants through December 31, 1998, however the Company
28
<PAGE>
is in continuing default of the covenants in 1999 and has therefore classified
this Note under the current portion of long-term debt. The Company is currently
working with the financial institution to reset the covenants to achieve
compliance in 1999.
The Promissory Note dated May 6, 1997 is payable to a bank. The note
payments are guaranteed by Teijin Limited of Japan (Teijin). The Teijin
guarantee is secured by certain equipment located in the Company's Tempe,
Arizona manufacturing facility and inventory to the extent necessary to provide
120% net book value coverage of the outstanding loan balance. The interest rate
on the loan is re-set semi-annually at LIBOR plus 0.4375%, (5.5175% at Dec. 31,
1998), and the Company is subject to certain covenants. A loan guarantee service
fee is payable to Teijin semi-annually on the outstanding balance at the rate of
0.5625%. The note provides for semi-annual payments of interest only during the
first four years, followed by semi-annual installments plus interest for the
remaining three and one half year term. At December 31, 1998 the Company was not
in compliance with some of the financial covenants pertaining to this Promissory
Note. The Company has received a waiver from Teijin for the Company's failure to
comply with such covenants through December 31, 1998, however the Company is in
continuing default of the covenants in 1999 and has therefore classified this
Note under the current portion of long-term debt. The Company is currently
working with Teijin to reset the covenants to achieve compliance in 1999.
Other long-term debt consists of capitalized leases related primarily to
certain computer equipment used by the Company.
Principal reductions of long-term debt are scheduled as follows:
Year Amount
---- --------
1999 $ 4,085
2000 1,453
2001 2,500
2002 2,500
2003 2,500
2004 2,500
--------
Total $ 15,538
========
The Company incurred total interest expense of $236, $892 and $1,162 in
1996, 1997 and 1998, respectively. Of these amounts, the Company capitalized
$464 in 1997 as part of the costs related to the construction of the new
manufacturing facility in Tempe, Arizona.
29
<PAGE>
NOTE 4 - INCOME TAXES:
The income tax provisions in 1996 and 1997 result primarily from minimum
tax liabilities related to federal taxes and foreign withholding taxes on
royalty payments. The income tax provision in 1998 relates primarily to foreign
withholding taxes on royalty payments. The effective income tax rate differs
from the federal statutory rate primarily as a result of the utilization of net
operating loss carryforwards in 1996 and 1997 and the reserves established for
deferred tax assets in 1998. The deferred tax assets valuation allowance at
December 31, 1996, 1997 and 1998 is attributable to federal and state deferred
tax assets. Management believes that sufficient uncertainty exists with regards
to the realizability of these tax assets such that a full valuation allowance is
necessary. These factors include the lack of a significant history of consistent
profits and the lack of carryback capacity to realize these assets. Based on
this absence of objective evidence management is unable to assert that it is
more likely than not that the Company will generate sufficient taxable income to
realize the Company's deferred tax assets. During 1996 and 1997 the Company
realized $.6 and $.5 million, respectively, of deferred tax assets previously
reserved.
Deferred tax (liabilities) assets are comprised of the following:
December 31,
-----------------------
1 9 9 7 1 9 9 8
-------- --------
Depreciation $ (3,793) $ (4,142)
Other (165) (300)
-------- --------
Gross deferred tax liabilities (3,958) (4,442)
-------- --------
Inventory reserves 383 924
Other 2,217 3,117
Loss carryforwards 6,723 7,971
Credit carryforwards 1,202 1,109
-------- --------
Gross deferred tax assets 10,525 13,121
-------- --------
Deferred tax assets valuation
allowance (6,567) (8,679)
-------- --------
Net deferred taxes $ -- $ --
======== ========
At December 31, 1998 the Company had net federal operating loss
carryforwards of approximately $22 million which expire at various dates from
1999 through 2018. The net operating loss carryforwards include approximately
$3.4 million resulting from employee exercises of non-incentive stock options or
disqualifying dispositions, the tax benefit of which, when realized, will be
accounted for as an addition to capital in excess of par value, rather than as a
reduction of the provision for income taxes. Research and development,
investment tax and foreign tax credit carryovers of approximately $0.8 million
are also available to reduce future federal and state income taxes and expire at
various dates through 2004. If certain substantial changes in the Company's
ownership occur, there would be an annual limitation on the amount of the
carryforwards which can be utilized.
30
<PAGE>
NOTE 5 - STOCKHOLDER'S EQUITY:
Stock Option Plans:
The Company has granted stock options under various option plans and
agreements in the past and currently under the 1997 Stock Incentive Plan and the
1998 Stock Option Plan for Employees and Consultants. The 1998 Stock Option Plan
for Employees and Consultants was adopted by the Board of Directors on August 6,
1998. The plans and agreements are administered by the Board of Directors. The
exercise price of options granted under the 1997 and 1998 plans must be at least
85% of the fair market value of the stock at the date of grant. All options
granted to date under these two plans have been at the fair market value of the
Company's stock on the date of the grant.
Options under the plans generally vest at a rate of 25% per year, are
non-transferable and generally expire over terms not exceeding ten years from
the date of grant or three months after termination of the optionee's
relationship with the Company.
During 1996, 1997 and 1998, certain employees, officers and directors of
the Company exercised stock options under the plans by issuing full recourse
notes to the Company with an interest rate of generally 7%. During 1996, 1997
and 1998 outstanding notes to certain of those employees, officers and directors
were extended from terms of one year to terms of two years. The principal and
accrued interest on the notes are due at the end of the term of each note. These
notes aggregate $596, $656 and $1,020, at December 31, 1996, 1997 and 1998,
respectively.
As of December 31, 1998, there were 203 shares of Common Stock available
for grant under the two stock option plans. In addition, at December 31, 1998,
563 options were vested and exercisable at prices ranging from $2.50 to $8.63.
31
<PAGE>
The activity under the option plans, combined, was as follows:
Shares of
Common Range of Weighted-Average
Stock Exercise Price Exercise Price
----- -------------- --------------
Options outstanding at
January 1, 1996 1,727 $2.50 - $7.25 $ 2.92
Granted 494 $4.63 - $8.13 $ 5.94
Exercises (523) $2.50 - $5.25 $ 2.60
Canceled or expired (34) $2.50 - $7.25 $ 4.66
-----
Options outstanding at
December 31, 1996 1,664 $2.50 - $8.13 $ 3.88
Granted 403 $6.38 - $8.25 $ 6.86
Exercised (212) $2.50 - $5.63 $ 2.92
Canceled or expired (115) $2.50 - $7.88 $ 5.06
-----
Options outstanding at
December 31, 1997 1,740 $2.50 - $8.25 $ 4.61
Granted 537 $4.50 - $8.63 $ 5.49
Exercised (409) $2.50 - $5.25 $ 2.91
Cancelled or expired (455) $2.50 - $8.25 $ 6.31
-----
Options outstanding at
December 31, 1998 1,413 $2.50 - $8.63 $ 4.89
=====
Employee Stock Purchase Plan
In April 1988, the Company adopted the Employee Stock Purchase Plan ("the
Purchase Plan") and reserved 150 shares of Common Stock for issuance thereunder.
In March 1997, the Company adopted the 1997 Employee Stock Purchase Plan ("the
1997 Plan") and reserved 100 shares of Common Stock for issuance thereunder.
Employees of the Company, subject to certain limitations, may purchase shares at
85% of the lower of the fair market value of the Common Stock at the beginning
of the six month offering period, or the last day of the purchase period. During
1996, 1997 and 1998, 20, 33 and 32 shares, respectively, were sold under the
Purchase Plan and the 1997 Plan. At December 31, 1998 there were no shares
remaining available for issuance under the 1988 Purchase Plan and 47 shares
available for issuance under the 1997 Plan.
32
<PAGE>
Accounting for Stock Based Compensation
The Company has stock option plans which reserve shares of Common Stock for
issuance to employees, officers, directors and consultants. The Company applies
APB Opinion 25 and related Interpretations in accounting for its plans.
Accordingly, no compensation cost has been recognized for the stock option
plans, except for $123 related to certain transactions in 1996. The Company has
adopted the disclosure-only provisions of SFAS No. 123, "Accounting for
Stock-Based Compensation". Had compensation cost for the Company's stock option
plans and stock purchase plans been determined based on the fair value at the
grant date for awards granted in 1996, 1997 and 1998 under those plans
consistent with the provisions of SFAS No. 123, the Company's net income(loss)
and net income(loss) per share would have been reduced to the pro forma amounts
indicated below:
1996 1997 1998
--------- --------- ---------
Net income(loss) - as reported ......... $ 2,427 $ 2,281 $ (7,869)
Net income(loss) - pro forma ........... $ 1,879 $ 1,450 $ (8,314)
Net income(loss) per share - as reported
Basic .................... $ .39 $ .32 $ (1.03)
Diluted .................. $ .35 $ .29 $ (1.03)
Net income(loss) per share - pro forma
Basic .................... $ .30 $ .20 $ (1.09)
Diluted .................. $ .27 $ .19 $ (1.09)
For the stock option plans, the fair value of each option grant is
estimated on the date of grant using the Black-Scholes option-pricing model for
the multiple option approach with the following weighted average assumptions
used for grants in 1996, 1997 and 1998, respectively. Expected volatility of 60%
in years 1996, 1997 and 58% in 1998; risk-free interest rate of 6.2%, 6.4% and
4.5%; and expected lives from vesting date of .72, .54 and 1.11 years. The
Company has not paid dividends and assumed no dividend yield. The weighted
average fair value of stock options granted in 1996, 1997 and 1998 was $2.99,
$6.86 and $2.51 per share, respectively.
For the employee stock purchase plans, the fair value of each purchase
right is estimated at the beginning of the offering period using the
Black-Scholes option-pricing model with the following weighted-average
assumptions used in 1996, 1997 and 1998, respectively. Expected volatility of
57%, 60%, and 68%; risk-free interest rate of 5.4%, 5.5% and 5.0%; and expected
lives of .5 years in each year. The Company has not paid dividends and assumed
no dividend yield. The weighted-average fair value of those purchase rights
granted in 1996, 1997 and 1998 was $1.82, $2.16 and $2.33 per right,
respectively.
33
<PAGE>
<TABLE>
The following table summarizes information about stock options outstanding at
December 31, 1998:
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
- - ------------------------------------------------------------------------------------------------------------------
Weighted Weighted Weighted
Number Average Average Number Average
Range of Outstanding Remaining Exercise Exercisable Exercise
Exercise Prices As of 12/31/98 Contractual Life Price As of 12/31/98 Price
- - ------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
$2.50 - $4.13 434 2.51 $3.07 373 $2.99
$4.38 - $5.00 535 6.19 $4.88 76 $4.69
$5.25 - $6.88 398 6.18 $6.60 107 $6.65
$7.00 - $8.63 46 5.61 $7.60 7 $7.42
- - ------------------------------------------------------------------------------------------------------------------
$2.50 - $8.63 1,413 5.04 $4.89 563 $3.97
- - ------------------------------------------------------------------------------------------------------------------
</TABLE>
NOTE 6 - EMPLOYEE BENEFIT PLANS:
In 1998, the Company sponsored a 401(K) defined contribution plan covering
eligible employees who elect to participate. The Company is allowed to make
discretionary profit sharing and 401(K) matching contributions as defined in the
plan and as approved by the Board of Directors. The Company matches 25% of each
eligible participant's 401(K) contribution up to a maximum of 20% of the
participant's compensation, not to exceed one thousand dollars per year. The
Company's actual contribution may be reduced by certain available forfeitures,
if any, during the plan year. No discretionary or profit sharing contributions
were made for the years ending December 31, 1996, 1997 and 1998. 401(K) matching
contributions for the years ending December 31, 1996, 1997 and 1998 were $93,
$109 and $139, respectively. The Company has no intention to terminate the plan.
The Company has a non-qualified deferred compensation plan, known as a rabbi
trust, whereby certain key executives may defer a portion of their salary to be
included in the trust, the assets of which are available to satisfy the claims
of general creditors in the event of bankruptcy of the Company. The participants
are allowed to diversify the assets, and the deferred compensation obligation is
adjusted to reflect gains or losses on the assets in the trust. The assets are
classified as trading assets and are reported as other assets and as accrued
compensation on the balance sheet. These trading assets (classified with other
assets) and related obligations (classified with accrued compensation)
aggregated $355 and $726 at December 31, 1997 and 1998, respectively.
34
<PAGE>
NOTE 7 - SEGMENT REPORTING:
In 1998, the Company adopted Statement of Financial Accounting Standards
No. 131 ("SFAS 131"), "Disclosures about Segments of an Enterprise and Related
Information." SFAS 131 supercedes SFAS 14, "Financial Reporting for Segments of
a Business Enterprise" replacing the "industry segment" approach with the
"management" approach. The management approach designates the internal
organization that is used by management for making operating decisions and
assessing performance as the source of the Company's reportable segments. SFAS
131 also requires disclosures about products and services, geographic areas, and
major customers. The adoption of SFAS 131 did not affect results of operations
or financial position or the segments reported in 1997. The Company is organized
on the basis of products and services. Each of the Company's business units
(Energy Conservation and Electronic Products) have been aggregated into one
operating segment.
The following is a summary of net revenue by geographic area for 1996, 1997 and
1998.
1996 1997 1998
-------- ------- -------
United States $ 17,957 $ 17,593 $ 16,095
Pacific Rim 5,221 7,525 4,206
Japan 10,680 15,640 13,041
Europe 6,513 7,788 15,060
Canada 1,349 1,543 1,631
-------- ------- -------
Total net revenues $ 41,720 $ 50,089 $ 50,033
======== ======== ========
One customer accounted for approximately 26% and 31% of net sales in 1996
and 1997, respectively, and two customers accounted for approximately 38% in
1998.
NOTE 8 - COMMITMENTS:
The Company leases certain property and equipment as well as its facilities
under noncancellable operating leases and $365 of computer equipment under a
capital lease. These leases expire at various dates through 2007.
As of December 31, 1998, the future minimum payments under these leases are
as follows:
Capital Operating
-------- ---------
1999 150 $ 1,750
2000 137 915
2001 - 906
2002 - 852
2003 - 732
Thereafter - 1,440
-------- --------
Future minimum lease payments $ 287 $ 6,595
========
Less - amount representing interest 24
Present value of future minimum --------
lease payments 263
Current maturities 132
Long-term lease obligations $ 131
========
Rent expense under operating leases was approximately $1,398, $1,471 and
$1,562, in 1996, 1997 and 1998, respectively.
35
<PAGE>
During the first quarter 1996, the Company entered into an addendum to a
previous supply agreement with a major customer which provides for certain Abest
efforts@ sales and purchase commitments of the Company's anti-reflective film
from the date of the addendum through June 30, 1997. Beginning July 1, 1997, the
Company is firmly committed to supply and the customer is committed to purchase
fixed volumes for the period July 1, 1997 through December 31, 1997, and
annually thereafter until December 31, 2000. Should either the Company fail to
supply or the customer fail to purchase the specified quantities, a penalty,
based on the sales price to the customer from the prior period, must be paid to
the other. In order to meet the supply commitment, the Company opened a new
manufacturing facility, at a cost of approximately $12 million, initially
dedicated to the production of anti-reflective film. The new facility began
manufacturing operations during the fourth quarter of 1997.
NOTE 9 - LINE OF CREDIT AGREEMENT:
The Company has secured a $6 million revolving line of credit, which
expires June 5, 1999, but may be extended for additional one-year terms with the
bank's approval. The amount of borrowings is based upon a percentage of accounts
receivable, which at December 31, 1998, did not limit available borrowing under
the line. The line is secured by certain assets of the Company and bears
interest at an annual rate of prime plus 0.5%, (8.25% at Dec. 31, 1998). Under
the terms of the agreement, the Company is required to maintain certain
financial ratios. As of December 31, 1998, the Company was not in compliance
with some of the financial ratios. The Company is working with the bank to reset
the financial covenants to ensure future compliance and to extend the line of
credit for an additional one year term. There were no borrowings under this line
of credit at December 31, 1998.
NOTE 10 - CONTINGENCIES:
In the fourth quarter of 1998 the Company discovered that certain
anti-reflective film manufactured in Tempe, Arizona for Sony had quality
problems. This film did not meet Sony's specifications and is located at Sony in
Japan and in the Company's inventory in Tempe, Arizona. While the Company is
still working with Sony to settle the exact amount of the quality issues, the
Company has estimated that the returns from Sony and the related inventory
write-off will be approximately $4.0 million. Provisions for this amount were
recorded in the Company's fourth quarter results.
36
<PAGE>
NOTE 11 - SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED):
<TABLE>
Summarized quarterly financial data for 1997 and 1998 is as follows:
<CAPTION>
First Second Third Fourth
----- ------ ----- ------
<S> <C> <C> <C> <C>
1997:
-----
Net sales $ 10,855 $ 11,684 $ 12,083 $ 15,467
Gross margin 3,697 3,705 3,266 4,111
Net income 766 602 210 703
Net income per share-Basic .12 .09 .03 .09
Net income per share-Diluted .11 .08 .03 .09
1998:
-----
Net sales $ 10,416 $ 14,057 $ 14,011 $ 11,549
Gross margin 201 3,035 3,955 (1,411)
Net income(loss) (3,375) (348) 552 (4,698)
Net income(loss) per share-Basic (.45) (.05) .07 (.63)
Net income(loss) per share-Diluted (.45) (.05) .07 (.63)
</TABLE>
Per share amounts, based on average shares outstanding each quarter, may not
add to the total for the year.
ITEM 9. CHANGES IN AND DISAGREEMENTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE
None
37
<PAGE>
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF REGISTRANT
The information required by this Item concerning the Company's directors
and the Company's executive officers is contained at the end of Part I hereof
and incorporated by reference to the sections entitled "Nominees" and
"Management", respectively, appearing in the Company's Proxy Statement for its
1999 Annual Meeting of Stockholders (the "Proxy Statement").
ITEM 11. EXECUTIVE COMPENSATION
The information required by this Item is incorporated by reference to the
sections entitled "Executive Compensation", "Severance Agreements" and "Human
Resources Committee Report on Executive Compensation" appearing in the Proxy
Statement.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this Item is incorporated by reference to the
section entitled "Security Ownership of Officers, Directors and Principal
Stockholders" appearing in the Proxy Statement.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this Item is incorporated by reference to the
section entitled "Certain Relationships and Other Transactions" appearing in the
Proxy Statement.
38
<PAGE>
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON
FORM 8-K
The following documents are filed as part of this Form 10-K:
(a)(1) Index to Financial Statements. The following
Financial Statements of Southwall Technologies Inc.
are filed as part of this Form 10-K:
Form 10-K
Page Number
-----------
Report of Independent Accountants 20
Consolidated Balance Sheets as of
December 31, 1997 and 1998 21
Consolidated Statements of Operations
for the years ended December 31, 1996,
1997 and 1998 22
Consolidated Statements of Stockholders'
Equity for the years ended December 31,
1996, 1997 and 1998 23
Consolidated Statements of Cash Flows
for the years ended December 31, 1996,
1997 and 1998 24
Notes to Consolidated Financial Statements 25
(a)(2) Index to Financial Statement Schedules. Schedules
have been omitted because they are not applicable
or required, or the information required to be set
forth therein is included in the Financial
Statements or notes thereto.
(a)(3) Exhibits. Reference is made to the Exhibit Index on
pages 42 through 45 of this Form 10-K.
(b) Reports on Form 8-K.
None
For the purposes of complying with the amendments to the rules governing
Form S-8 (effective July 12, 1990) under the Securities Act of 1933, the
undersigned registrant hereby undertakes as follows:
39
<PAGE>
Insofar as indemnification for liabilities arising under the Securities Act
of 1933 may be permitted to directors, officers or controlling persons of the
registrant pursuant to the foregoing provisions, or otherwise, the registrant
has been advised that in the opinion of the Securities and Exchange Commission
such indemnification is against public policy as expressed in the 1933 Act and
is, therefore, unenforceable. In the event that a claim for indemnification
against such liabilities (other than the payment by the registrant of expenses
incurred or paid by a director, officer or controlling person of the registrant
in the successful defense of any action, suit or proceeding) is asserted by such
director, officer or controlling person in connection with the securities being
registered on the Form S-8 identified below, the registrant will, unless in the
opinion of its counsel the matter has been settled by controlling precedent,
submit to a court of appropriate jurisdiction the question whether such
indemnification by it is against public policy as expressed in the 1933 Act and
will be governed by the final adjudication of such issue.
The preceding undertaking shall be incorporated by reference into
registrant's Registration Statements on Form S-8 Nos. 33-28599 (filed on May 9,
1989), 33-37247 (filed October 11, 1990), 33-42753 (filed on September 16,
1991), 33-51758 (filed on September 8, 1992), 33-82138 (filed on July 28, 1994),
333-34287 (filed August 25, 1997) and 333-66277 (filed on October 28, 1998).
40
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this Report to be signed on
its behalf by the undersigned, thereunto duly authorized, as of the 30th day of
March, 1999.
SOUTHWALL TECHNOLOGIES INC.
By /s/Thomas G. Hood
-----------------
Thomas G. Hood
President
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons in the capacities
indicated, as of March 30, 1999.
Signature Title
--------- -----
/s/J. Larry Smart Chairman of the Board of Directors
- - --------------------
J. Larry Smart)
/s/Thomas G. Hood President, Chief Executive Officer
- - -------------------- and Director (Principal Executive
(Thomas G. Hood) Officer)
/s/Bill R. Finley Vice President, Chief Financial
- - -------------------- Officer and Secretary (Principal
(Bill R. Finley) Financial and Accounting Officer)
/s/Bruce J. Alexander Director
- - --------------------
(Bruce J. Alexander)
/s/Yoshimichi Hase Director
- - --------------------
(Yoshimichi Hase)
/s/Joseph B. Reagan Director
- - --------------------
(Joseph B. Reagan)
/s/Walter C. Sedgwick Director
- - --------------------
(Walter C. Sedgwick)
41
<PAGE>
INDEX TO EXHIBITS FILED WITH
FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 1998
Exhibit
Number Description
------ -----------
3.1(1) Restated Certificate of Incorporation of the Company.
3.2(1) By-laws of the Company.
10.4(1) The Company's Management Incentive Plan.
10.23(1) Agreement, dated January 31, 1984, between the Company and
Mitsui Toatsu Chemicals, Inc., as amended (with certain
confidential information deleted therefrom and filed
separately).
10.35(1) Lease Agreement for the facilities at 3941 East Bayshore
Road, dated March 20, 1979, between the Company and
Straube Associates, Inc.
10.36(1) Lease Agreement for the facilities at 3961 East Bayshore
Road, dated March 20, 1979, between the Company and Allan
F. Brown and Robert V. Brown.
10.40(1) Exclusive License Agreement, dated April 20, 1987, between
the Company and Massachusetts Institute of Technology.
10.41(1) Agreement, dated April 16, 1987, between the Company and
the BOC Group, Inc., and amending letter.
10.42(1) Form of Indemnity Agreement, dated April 21, 1987, between
the Company and each of its officers and directors.
10.52(2) Marketing and Distribution Agreement dated as of May 20,
1988, among Mitsui Toatsu Chemicals, Inc. ("Mitsui"),
Marubeni Corporation ("Marubeni") and the Company, as
amended.
10.53(2) Common Stock Purchase Agreement dated as of May 23, 1988,
among Mitsui, Marubeni and the Company.
10.57 Restated 1987 Stock Option Plan, as amended.
10.58(2) Employee Stock Purchase Plan, as amended.
10.59(3) Lease Agreement for the facilities at 3969-3975 East
Bayshore Road Palo Alto, California, dated January 1,
1989, between the Company and Bay Laurel Investment
Company.
10.60(3) Lease Agreements for the facilities at 3977-3995 East
Bayshore Road Palo Alto, California, dated January 1,
1989, between the Company and Bay Laurel Investment
Company.
42
<PAGE>
10.62(3) Common Stock Sales Agreement, dated May 2, 1989, between
the Company and Monsanto Company.
10.63(3) Convertible Subordinated Note, Due May 31, 1999.
10.64(3) Warrants to Purchase Common Stock of Southwall
Technologies Inc., void after May 31, 1996.
10.65(3) Second Restated Registration Rights Amendment, Dated May
2,1989, among the Company, Lockheed Corporation, Minnesota
Mining and Manufacturing Company, Mitsui Toatsu Chemicals,
Inc. and Marubeni Corporation, and Monsanto Company.
10.66(3) Non-exclusive License Agreement, dated March 9, 1989,
between the Company and the Massachusetts Institute of
Technology (with certain confidential information
deleted).
10.69(4) Lease Agreement for the facilities at 1029 Corporation Way
Palo Alto, California, dated April 27, 1989, between the
Company and C&J Development, as amended.
10.71(5) Lease Agreement for the facilities at 3780 Fabian Way,
Palo Alto, California, dated June 11, 1990, between the
Company and The Fabian Building.
10.72(5) License Agreement between Mitsui Toatsu Chemicals, Inc.
and the Company, dated January 30, 1991.
10.74(6) License Agreement between the Company and the Dow Chemical
Company, dated February 1, 1993.
10.77(10) Fourth Amendment, dated March 3, 1993, between the Company
and C&J Development to the Lease for the facilities at
1029 Corporate Way filed as exhibit number 10.69.
10.78(7) Amendment to property lease dated February 2, 1994 to
extend lease period on building at 3961 E. Bayshore Road,
Palo Alto, California. Original lease filed as exhibit
number 10.36
10.79(7) Amendment to property lease dated April 4, 1994 to extend
lease period on building at 3941 E. Bayshore Road, Palo
Alto, California. Original lease filed as exhibit number
10.35.
10.80(8) Lease Agreement between Frank Gant, an individual, as
Lessor and Southwall Technologies Inc., a Delaware
corporation, as Lessee effective September 1, 1994.
10.81(8) Purchase Agreement among Southwall Technologies Inc.,
Southwall-Sunflex, Inc., Sunflex, L.P., and Sunflex
Partners effective October 31, 1994.
10.82(11) Supply Agreement between Sony Corporation and Southwall
Technologies Inc., effective October 23, 1995.
43
<PAGE>
10.83(12) Addendum #1 To Supply Agreement between Sony Corporation
and Southwall Technologies Inc., with effective dates of
April 1, 1996 and July 1, 1997(with certain confidential
information deleted therefrom and filed separately).
10.84(12) Lease Agreement between Chamberlain Development, L.L.C.,
as Lessor and Southwall Technologies Inc., a Delaware
corporation, as Lessee effective May 1, 1997.
10.85(12) Purchase Agreement, dated April 29, 1996, between an
equipment supplier and Southwall Technologies Inc., (with
certain confidential information deleted therefrom and
filed separately).
10.86(12) Agreement regarding separation of employment between
Alfred V. Larrenaga, an officer of the Company and
Southwall Technologies Inc., dated July 29, 1996 and
amended October 29, 1996.
10.87(12) Loan and security agreement dated as of December 3, 1996,
between the Company as debtor and CIT Group/Equipment
Financing, Inc.
10.88(13) Basic Agreement dated April 9, 1997, for the sale of
667,000 shares of the Company's common stock to Teijin
Limited, a Japanese corporation, and for mutually
beneficial cooperation and collaboration between Teijin
and Southwall Technologies Inc.
10.89(13) Credit Agreement dated May 6, 1997, between Sanwa Bank,
Limited and Southwall Technologies Inc.
10.90(13) Reimbursement and Security Agreement dated May 6, 1997,
between Teijin Limited, a Japanese corporation, and
Southwall Technologies Inc.
10.91(13) Promissory Note dated May 6, 1997 obligating Southwall
Technologies Inc. To Sanwa Bank, Limited in the amount of
$10 million.
10.92(14) The Company's 1997 Stock Incentive Plan.
10.93(15) The Company's 1997 Employee Stock Purchase Plan.
10.94 Letter agreement between Sony Corporation of Japan and
Southwall Technologies Inc. amending Addendum #1 To Supply
Agreement between Sony Corporation and Southwall
Technologies Inc., with effective dates of April 1, 1996.
21(11) List of Subsidiaries of Southwall Technologies Inc.
23.1 Consent of Independent Accountants.
99.1(9) Letter, dated June 5, 1987, from the U.S. Department of
the Air Force to the SEC Pursuant to Rule 171.
44
<PAGE>
(1) Filed as an exhibit to the Registration Statement on Form S-1 filed with
the Commission on April 27, 1987 (Registration No. 33- 13779) (the
"Registration Statement") and incorporated herein by reference.
(2) Filed as an exhibit to the Form 10-Q Quarterly Report for Quarter Ended
June 30, 1988, filed with the Commission on August 15, 1988 and
incorporated herein by reference.
(3) Filed as an exhibit to the Form 10-Q Quarterly Report for Quarter Ended
July 2, 1989, filed with the Commission on August 16, 1989 and incorporated
herein by reference.
(4) Filed as an exhibit to the Form 10-K Annual Report 1989, filed with the
Commission on March 30, 1990 and incorporated herein by reference.
(5) Filed as an exhibit to the Form 10-K Annual Report 1990, filed with the
Commission on March 25, 1991 and incorporated herein by reference.
(6) Filed as an exhibit to the Form 10-K Annual Report 1992, filed with the
Commission on March 15, 1993 and incorporated herein by reference.
(7) Filed as an exhibit to the Form 10-Q Quarterly Report for Quarter Ended
July 3, 1994, filed with the Commission on August 15, 1994 and incorporated
herein by reference.
(8) Filed as an exhibit to the Form 10-Q Quarterly report for Quarter Ended
October 2, 1994, filed with the Commission on November 9, 1994 and
incorporated herein by reference.
(9) Filed as Exhibit No. 28.1 to Post-Effective Amendment No. 1 to the
Registration Statement, filed with the Commission on June 9, 1987 and
incorporated herein by reference.
(10) Filed as an exhibit to the Form 10-K Annual Report 1994, filed with the
Commission on March 2, 1995 and incorporated herein by reference.
(11) Filed as an exhibit to the Form 10-K Annual Report 1995, filed with the
Commission on March 19, 1996 and incorporated herein by reference.
(12) Filed as an exhibit to the Form 10-K Annual Report 1996, filed with the
Commission on March 27, 1997 and incorporated herein by reference.
(13) Filed as an exhibit to the Form 10-Q Quarterly report for Quarter Ended
June 29, 1997, filed with the Commission on August 14, 1997 and
incorporated herein by reference.
(14) Filed as Proposal 3 included in the 1997 Proxy statement filed with the
Commission on April 14, 1997 and incorporated herein by reference.
(15) Filed as Proposal 4 included in the 1997 Proxy statement filed with the
Commission on April 14, 1997 and incorporated herein by reference.
45
SOUTHWALL TECHNOLOGIES INC.
EXHIBIT 21
----------
LIST OF SUBSIDIARIES OF SOUTHWALL TECHNOLOGIES INC.
---------------------------------------------------
Name State or other Jurisdiction of Incorporation
---- --------------------------------------------
Southwall Worldwide Glass Inc. California
Southwall-Sunflex, Inc. California
46
SOUTHWALL TECHNOLOGIES INC.
EXHIBIT 23.1
CONSENT OF INDEPENDENT ACCOUNTANTS
We hereby consent to the incorporation by reference in the Registration
Statements of Southwall Technologies Inc. on Form S-8 Nos. 33-28599 (filed on
May 9, 1989), 33-37247 (filed on October 11, 1990), 33-42753 (filed on September
16, 1991), 33-51758 (filed on September 8, 1992), 33-82138 (filed on July 28,
1994), 333-34287 (filed August 25, 1997) and 333-66277 (filed on October 28,
1998) of our report dated March 8, 1999 appearing on page 20 of this Form 10-K.
PricewaterhouseCoopers LLP
San Jose, California
March 29, 1999
47
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