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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-K\A
(MARK ONE)
/X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
- EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1999
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OR
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
- EXCHANGE ACT OF 1934
For the transition period from __________ to _________
Commission file number 0-15930
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SOUTHWALL TECHNOLOGIES INC.
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(Exact name of registrant as specified in its charter)
Delaware 94-2551470
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
1029 Corporation Way, Palo Alto, California 94303
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(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 No X
----- -----
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\A or any amendment to
this Form 10-K\A. [X]
The approximate aggregate market value of the Common Stock held by
non-affiliates of the registrant on March 6, 2000 (based upon the closing sales
price of the Common Stock on the NASDAQ National Market System on such date) was
$ 88,212,860. For purposes of this disclosure, Common Stock held by stockholders
whose ownership exceeds five percent of the Common Stock outstanding as of March
6, 2000, 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
March 6, 2000 was 7,588,203.
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DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant's definitive Proxy Statement filed with the
Commission in connection with the Company's 2000 Annual Meeting of Stockholders
(the "Proxy Statement") are incorporated by reference in Part III of this Form
10-K\A. With the exception of the portions of the Proxy Statement expressly
incorporated into this Form 10-K\A by reference, the Proxy Statement shall not
be deemed filed as part of this Form 10-K\A.
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SOUTHWALL TECHNOLOGIES INC.
2000 FORM 10-K\A ANNUAL REPORT
TABLE OF CONTENTS
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PAGE
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ITEM 1 BUSINESS...................................................................................4
ITEM 2. PROPERTIES.................................................................................8
ITEM 3. LEGAL PROCEEDINGS..........................................................................9
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS........................................9
ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS......................11
ITEM 6. SELECTED FINANCIAL DATA...................................................................11
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.....12
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK................................18
ITEM 8. FINANCIAL STATEMENTS......................................................................19
ITEM 9. CHANGES IN AND DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.......................39
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF REGISTRANT............................................39
ITEM 11. EXECUTIVE COMPENSATION....................................................................39
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT............................39
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS............................................39
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K...........................39
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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 automotive glazing and electronic display markets and residential and
commercial architectural glazing. These products include transparent insulation
and solar-control films, anti-reflective films for computer monitor CRTs and
television monitors, transparent conductive films for use in touch screen
displays, and various other types of commercial films.
MARKETS AND PRODUCTS
Southwall is currently supplying products for use in three broad markets:
architectural glass (both commercial and residential), electronic displays and
automotive glass. The Company's current commercial products include: (1)
transparent coatings for use in conjunction with architectural and
transportation glazing laminates and applied film to provide solar control to
windows, (2) anti-reflective films, both OEM and after market, (3) its family of
transparent Heat Mirror-TM- films for high performance architectural glazing
applications, and (4) other commercial thin-film products.
BUILDING GLASS PRODUCTS
The thin-film coated substrates we sell in this market are primarily used
to control the transmission of heat through window glass and to limit
ultra-violet light damage. The primary source of heat build-up and loss in
buildings is through glass windows. According to The Freedonia Group, the market
for new and replacement glass sold for use in residential buildings is expected
to increase from approximately 2.1 billion square feet in 1998 to approximately
2.7 billion square feet in 2008. Also according to Freedonia, the market for new
and replacement glass for use in commercial buildings is expected to increase
from approximately 680 million square feet in 1998 to approximately 1.3 billion
square feet in 2008.
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 XUV
fading protection.
The Company believes that the Heat Mirror-TM- and Heat Mirror-TM-
related Superglass-Registered Trademark- 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.
SOLAR-CONTROL FILMS FOR LAMINATED GLAZING APPLICATIONS
The Company's Heat Mirror XIR-Registered Trademark- Coating
solar-control film 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. This film is
currently sold primarily to European OEM glass companies.
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APPLIED SOLAR-CONTROL FILMS
Another glazing product utilizing the Heat Mirror XIR-Registered
Trademark- coating is Solis/V-Kool solar-control film for the retrofit 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 its reflective features in large screen televisions, and to
other manufacturers for various applications including energy efficient
lighting, primarily for the retrofit market in North America.
ELECTRONIC DISPLAY PRODUCTS
The thin-film coated substrates we sell in this market primarily reduce
glare caused by reflection from glass surfaces, improve contrast and image
quality, and reduce electromagnetic emission and build up of static charge on
computer display screens. Thin-film coated substrates are used in computer
display tubes, or CDTs, liquid crystal and plasma displays, and in applications
such as touch screens, wireless telephones and automated teller machines. The
market for 17 inch and larger flat screen CDTs is anticipated to grow from 4
million units in 1999 to 32 million units in 2003, according to Stanford
Resources, Inc.
ANTI-REFLECTIVE FILM
Southwall's anti-reflective films for computer monitor CRTs minimize
reflection of ambient light, electromagnetic interference (EMI) radiation and
static. This film is currently sold primarily to Mitsubishi Electric Corporation
(MELCO) and Samsung Display Devices (Samsung) for use in their manufacturing of
CRTs.
TRANSPARENT CONDUCTORS
Southwall currently markets several transparent conductive thin-films under
the brand name 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.
AUTOMOTIVE GLASS PRODUCTS
The Company's Heat Mirror XIR-Registered Trademark- Coating
solar-control film is a transparent, sputter-coated, polyester film used in
laminated safety glass for automotive applications.
The thin-film coated substrates we sell in this market reflect infrared
heat and reduce ultra-violet light. These coatings allow carmakers to use more
glass and to increase the energy efficiency and comfort of their vehicles. We
sell thin-film coated substrates in this market primarily to original equipment
manufacturers for sale to European manufacturers of new cars. These products are
used in cars manufactured by Mercedes Benz, Renault, Audi, BMW, Volvo,
Volkswagen and the PSA Group, among other companies.
MANUFACTURING
Six large-scale sputtering production machines, of which four are located
in Palo Alto, California and two in Tempe, Arizona (one of which began
production of anti-reflective film in the fourth quarter of 1997 and one of
which began production of energy conservation products in the first quarter of
2000), currently provide most of the Company's sputtered thin-film coatings
manufacturing capacity. One additional machine is slated for delivery to the
Tempe facility during the second quarter of 2000 and is scheduled to commence
production in 2001. The Company also uses two small-scale sputtering machines in
Palo Alto for smaller production runs, and research and development projects.
Also
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located in the Tempe facility is a wet coating and laminating machine, which is
used to apply various topcoats and adhesives to film products and for lamination
of liner films.
Since June 1997 the Company has occupied a new 55,000 square foot leased
facility in Tempe, Arizona. 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 borrowed $5 million from a lending institution during
December 1996, and an additional $10 million through Sanwa Bank in April 1997,
guaranteed by Teijin Limited of Japan, a raw material supplier to the Company.
In addition, Teijin Limited purchased 667,000 shares of the Company's Common
Stock at $7.50 per share, an aggregate of approximately $5 million.
The latest production machine (PM#6) began to commercially produce limited
amounts of film in Tempe in the first quarter of 2000. One additional machine,
(PM#7), is slated for delivery in the second quarter of 2000 and is scheduled to
commence production in 2001. Additionally, the Company is building a third
manufacturing facility in Dresden, Germany, which is scheduled to commence
production in the second half of 2000.
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 XIR-Registered Trademark- film 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 $3.1 million, $3.9 million and $5.2 million,
6%, 8% and 10% of total net revenues during 1997, 1998 and 1999, 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 has exclusive manufacturing and distribution
rights for certain of the Company's electronic products in Japan using the
Company's proprietary sputtering technology. Samsung is the Company's sales
representative in Korea and China. Approximately 35%, 32% and 23% of the
Company's net revenues resulted from sales to customers located in the United
States in 1997, 1998 and 1999, 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-Registered Trademark- film sold to automotive glass manufacturers.
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 an
amendment 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, from which
product was first shipped during the fourth quarter of 1997, was designed to
meet the requirements of the Sony agreement. During the second quarter of 1999,
the supply agreement between the Company and Sony was amended again. As a
result, the Company received purchase orders from Sony for a significantly
reduced amount of product. As of September 30, 1999, Southwall terminated all
production of film as mutually agreed in the amendment to the supply agreement
and there have been no further shipments to Sony.
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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.
In North America, the Company also promotes its Heat Mirror-TM- product
line through approximately 30 regionally based architectural sales
representatives.
The Company sells its aftermarket anti-reflective filters through
Kensington Microwave Limited, a California based distributor with 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 quality issues with certain anti-reflective ("AR") film
manufactured in Tempe under an agreement with Sony and did not meet Sony's
expectations. As a result, certain AR film in Tempe and at Sony's plant in Japan
was 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.
A small number of customers have accounted for a substantial portion of the
Company's revenues. The Company's seven largest customers accounted for 67% and
62% of net product sales in 1998 and 1999, respectively. One customer, Sony
Corporation of Japan, accounted for 33% and 7% of net product sales in 1998 and
1999, respectively. In 1999, three customers accounted for approximately 39% of
sales. Sekurit St. Gobain was approximately 18%, Pilkington was approximately
11% and MELCO was approximately 9%. 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.
As of December 31, 1999, the Company's backlog was approximately $27
million. None of these orders are firm orders and are subject to cancellation.
For those reasons, these orders should not be considered future revenues.
COMPETITION
The thin-film coatings industry and the markets in which Southwall's
customers compete experience rapid technological change. New equipment or
process technologies that improve or change the methods of depositing films on
substrates could materially adversely affect Southwall's revenues and operating
results. 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 CP Films. One
of the largest U.K. 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.
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.
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The Company has 26 patents and 8 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 May 2001 to August 2018. 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, 1999, Southwall had 273 regular full-time employees, of
whom 47 were engaged in engineering, 183 in manufacturing, and 43 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 interpretation and enforcement of
current or future environmental laws and regulations will not materially
adversely affect the operations, business or assets of the Company.
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. The buildings in Palo Alto are occupied under leases
that expire from 2002 to 2005, 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 2001. 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 in locations
other than near its Palo Alto headquarters. The Company began construction on a
60,000 sq. ft. building in Dresden, Germany in August 1999. This building, phase
one of a two-phase process will contain up to three production machines. The
first production machine will commence commercial production in November of
2000. The second production machine is scheduled to commence production in the
first quarter of 2001. A third machine is anticipated but not yet scheduled.
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ITEM 3. LEGAL PROCEEDINGS
The Company has been named a defendant in a lawsuit filed on April 5, 1996
by Four Seasons 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
$32 million. The Company believes that this lawsuit is without merit and intends
to defend against it vigorously.
The Company has also been named a defendant in a lawsuit filed on March 9,
1998 by Richard McKernan in the Superior Court of California, County of Santa
Clara. The lawsuit alleges certain strict product liability, fraudulent
concealment, negligence and unfair business practice violations by the Company.
A third amended complaint was filed on December 7, 1999, limiting the negligence
claim to California class members. The Company believes that this lawsuit is
without merit and intends to defend against it vigorously.
The Company's German subsidiary is a defendant in a lawsuit filed by one of
its suppliers on March 21, 2000 in a German court to seek payment of $922 for
engineering services rendered in connection with developing the plans for a new
plant. The Company issued letters of award to the plaintiff amounting to $256
prior to terminating plaintiff's services for not meeting the Company's
expectations. The plaintiff claims fees for services rendered, including the
costs of significant modifications and revisions requested by the Company
calculated in accordance with the German Federal Schedule of Architects' fees.
The plaintiff further alleges that the Company utilized plaintiff's planning
work in further developing the plant. The Company believes that the suit is
without merit and intends to vigorously defend its position. Although the
Company believes that it will prevail, a $256 portion of the claim was accrued
as a liability on the December 31, 1999 balance sheet as it is likely that this
amount will be awarded to the plaintiff.
In August 2000, the Company, its Chief Executive Officer, Thomas P. Hood,
and former Chief Financial Officer, Bill R. Finley, have been named as
defendants in seven lawsuits, all filed in the United States District Court for
the Northern District of California (Docket Nos: C-00-2792-MMC; C-00-2795-BZ;
C-00-2834-SC; C-00-20856-EAI; C-00-3007-EDL; C-00-3027-JCS; and C-00-3079-MMC)
(the "Actions") all alleging violations of the federal securities laws. Each of
the plaintiffs in the Actions alleges that he purchased shares in the Company
and seeks to represent a class of shareholders who purchased shares during the
period April 26, 2000 through August 1, 2000, such dates constituting the period
from the Company's release of its financial results for the first quarter of FY
2000, to the date that it issued its press release announcing that it would be
restating its financial statements for that quarter. The substantive allegations
in each of the Actions are essentially the same, i.e., that the defendants knew,
or were reckless in not knowing, that the Company's first quarter financial
statements were in error and violated Generally Accepted Accounting Principles,
and that as a result the putative class members purchased stock at artificially
inflated prices and were damaged. It is anticipated that the Actions will be
consolidated into a single action by the filing of an Amended Consolidated
Complaint. No pleading in response to the Actions is yet due. The Company
believes the Actions to be wholly without merit and intends to defend them
vigorously.
In the third quarter of 2000, the Company was named a co-defendant, along
with a glass manufacturer, in a legal suit brought by certain contractors. The
contractors alleged the insulating glass units (`IGU') installed at an airport
project, which incorporated the Company's insulation film, have failed. The
Company is in the process of assessing the claim and expects to vigorously
defend this suit.
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, 1999.
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EXECUTIVE OFFICERS OF THE REGISTRANT
Following is a list of the executive officers of the Company with their
respective ages and current positions. Family relationships do not 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.
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Thomas G. Hood 44 President, Chief Executive Officer and Director
Robert R. Freeman 58 Senior Vice President, Chief Financial Officer and Secretary
Eric Buonassisi 53 Senior Vice President, Marketing and Sales
Sicco W.T. Westra 49 Senior Vice President, Engineering and Product Development
Catherine B. Poliak 42 Vice President, Human Resources
Vahid Ghassemian 43 Senior Vice President, Operations
</TABLE>
THOMAS G. HOOD has served as the Company's President and Chief Executive
Officer since July 1998 and as a member of the Board of Directors of the Company
since March 1998. From March 1998 until July 1998, he served as Interim
President and Chief Executive Officer. From July 1996 to March 1998, he served
as Senior Vice President, General Manager, Energy Products Division. From
January 1995 to July 1996, he was Vice President General Manager, International
Operations, and from October 1991 to January 1995, he was Vice President,
Marketing and Sales. Mr. Hood has an MS degree in Mechanical Engineering from
New Mexico State University.
ROBERT R. FREEMAN has been Senior Vice President, Chief Financial Officer
and Secretary since September 2000. Prior to that, from May 1999 to June 2000 he
served as Senior Vice President, Chief Financial Officer of Rosendin Electric,
Inc. From August 1993 to April 1999 he served as Senior Vice President, Chief
Financial Officer of Helix Electric, Inc. Mr. Freeman has an MBA from the
University of Southern California.
ERIC BUONASSISI has been Senior Vice President, Marketing and Sales, since
January 2000. From March 1997 until January 2000, he was a partner at the
Magellan Consulting Group. From July 1996 to March 1997, he served as President
of the Proteus Consulting Group. From January 1994 to July 1996, he was Chief
Operating Officer for Visucom Systems, Inc. Mr. Buonassisi has an MBA from the
University of Delaware and a BS degree in Chemical Engineering from the
Pennsylvania State University.
DR. SICCO W. T. WESTRA has been Senior Vice President, Engineering and
Product Development since August 1998. Prior to that, from February 1998 until
August 1998 he served as Director of Global Production Management for Applied
Materials, Inc. From March 1994 to August 1998, he served as a Manager of
Business Development for BOC Coating Technology, Inc. Dr. Westra has a Ph.D. and
an MS degree in Physical Chemistry from the University of Leiden in The
Netherlands.
CATHERINE B. POLIAK has been Vice President, Human Resources since January
1994. Ms. Poliak has an MBA from the Santa Clara University.
VAHID GHASSEMIAN has been Senior Vice President, Operation, since May 1999.
From January 1999 until May 1999, he served as the President of NexGen Storage
Technologies. From January 1998 until December 1998, he served as the Senior
Vice President of Operations for Kobe Precision, Inc. From 1991 until January
1998 he served as Executive Vice President and Chief Operating Officer of
Akashic Memories. Mr. Ghassemian has a BS degree in Mechanical Engineering from
the University of Texas.
Effective August 31, 2000 Southwall Technologies terminated the employment
of Bill R. Finley, the former Chief Financial Officer.
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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 1998 and 1999.
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1998 by Quarter High Low
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1st $8.63 $6.63
2nd $7.25 $5.00
3rd $5.50 $4.37
4th $6.00 $4.00
1999 by Quarter High Low
--------------- ---- ---
1st $3.77 $3.52
2nd $3.45 $3.20
3rd $4.68 $4.39
4th $4.40 $4.08
</TABLE>
The Company has not paid cash dividends and has no present plans to do so.
There were approximately 280 stockholders of record at December 31, 1999.
<TABLE>
<CAPTION>
ITEM 6. SELECTED FINANCIAL DATA Year Ended December 31,
-----------------------
1995 1996 1997 1998 1999
---- ---- ---- ---- (Restated)(3)
-------------
(In thousands, except per share data)
<S> <C> <C> <C> <C> <C>
Statement of Operations Data:
-----------------------------
Net Revenues $33,501 $41,720 $50,089 $50,033 $54,598
Income (loss) from operations (1)(2) 726 2,568 2,446 (7,130) (527)
Net income (loss) 633 2,427 2,281 (7,869) (1,865)
Net income (loss) per share:
Basic 0.11 0.39 0.32 (1.03) (0.25)
Diluted 0.10 0.35 0.29 (1.03) (0.25)
Weighted average shares of common
stock and common stock equivalents:
Basic 5,880 6,200 7,107 7,608 7,421
Diluted 6,218 7,034 7,799 7,608 7,421
</TABLE>
(1) Year 1997 includes $1.6 million of start up costs related to the new
manufacturing facility in Tempe, Arizona.
(2) 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.
(3) Restated as described in Item 7, and Note 11 in Item 8 - Consolidated
Financial Statements of this Form 10K\A.
<TABLE>
<CAPTION>
December 31
-----------
1995 1996 1997 1998 1999
---- ---- ---- ---- ----
Balance Sheet Data: (Restated)(3)
------------------- -------------
<S> <C> <C> <C> <C> <C>
Working capital $9,724 $15,846 $23,999 $(4,256) $(11,699)
Total assets 34,105 42,509 61,469 54,019 70,142
Long-term obligations 2,890 6,591 15,539 141 10,000
Stockholders' equity 23,914 27,597 35,740 25,817 24,580
</TABLE>
11
<PAGE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Except for the historical information contained herein, certain matters
discussed in this Form 10-K/A Report are forward-looking statements that involve
risks and uncertainties, including those discussed below. Actual results may
differ materially from those projected. These forward-looking statements
represent the Company's judgment as of the date of the filing of this Form
10-K/A Report. The Company disclaims, however, any intent or obligation to
update these forward-looking statements.
General
We are a designer and manufacturer of technologically advanced thin-film
coatings that selectively absorb, reflect or transmit light and electromagnetic
and infrared emissions. Our products are used in a number of electronic,
automotive and building products to enhance optical and thermal performance
characteristics, improve user comfort and reduce energy costs. From our founding
in 1979 through the early 1990's, we developed and produced thin-film coated
substrates primarily for residential and commercial buildings, and for military
applications. In the early 1990's, we began to develop products for the
electronic display and automotive markets.
In 1996, we realized our first material revenue from the electronic display
and automotive markets. Currently, electronic display products account for
almost one-half of our revenues. We expect most of our revenue growth to
continue to come from the electronic display and automotive markets.
Several factors affect our gross margins, including manufacturing
efficiencies, product mix, product differentiation, inventory management, volume
pricing, and the start-up of equipment and new plants. Over the past several
years, each of these factors has contributed to margin volatility as we have
added new capacity to meet the demand of our electronics and automotive markets.
Capital Expenditures
In 2000, we expect to spend approximately $14.0 million for capital
expenditures to increase production capacity. From the time we order a new
production machine, it typically takes 12 to 18 months until we are able to
produce in commercial volumes. The last six months of this period are typically
spent testing the machine to make sure it meets our product quality requirements
and those of our customers. During this period the new production machines
typically produce minimal revenues. In accordance with generally accepted
accounting principles, all substrate, target and material costs incurred prior
to a machine beginning any commercial production are expensed as incurred and
classified as costs of sales. In addition, interest costs associated with
borrowings for capital expenditures are capitalized until these assets begin
commercial production.
In the first quarter of 2000, our second machine at Tempe (PM 6) began to
produce limited amounts of film for commercial use. An additional machine (PM 7)
was delivered to Tempe in the third quarter of 2000. This production machine is
expected to commence commercial production in 2001. Additionally, we took
possession of our new facility in Dresden in May 2000, which will contain two
new production machines (PM 8 and PM 9) by the end of 2000. We expect these two
production machines to commence commercial production in the second half of 2000
and the first half of 2001, respectively.
In general, we have experienced significant start-up costs in connection
with bringing new production machines into commercial viability. In 1998, our
operating results were adversely affected by quality problems associated with
the electronic display film product produced by a new production machine (PM 5)
in Tempe. In the fourth quarter of 1998, we discovered quality issues with
product that had been shipped to Sony and other electronic display film that was
still in inventory in Tempe that did not meet Sony's specifications. We recorded
a $4.0 million provision in the fourth quarter of 1998 to account for product
returns from Sony and the related write-off of inventory. During 1999, we
continued to experience ongoing production problems with the Sony electronic
display film. In March 1999, we amended the terms of the supply agreement to
eliminate purchase and supply requirements. Sales to Sony through the first
three quarters of 1999
12
<PAGE>
declined significantly. We discontinued the manufacture and sale of coated
anti-reflective film to Sony in September 1999.
Due to the unprofitable relationship with Sony and our increased capital
expenditures, we have been operating with minimal cash balances. We have been
using cash available from operations, German government grants, bank borrowings
and other long-term debt to finance our increased capital expenditures.
Restatement of 1999 Financial Statements
On August 1, 2000, the Company announced that it expected to restate its
previously issued first quarter interim results and that there would be a
delay in the issuance of the second quarter results. Subsequently, the
Company determined that previously issued 1999 financial statements required
restatement for the following items: under recognition of expenses
($1,142,000); deferral of revenue recognition ($733,000); and recognition of
the settlement of a lawsuit in March 2000 ($500,000). The Company also
reclassified to restricted cash that portion of cash, ($1,883,000) that is
restricted to payments for the facility in Germany. The Company further
reclassified long-term debt ($12,084,000) to current liabilities to the
extent that it cannot determine if it can meet the covenants.
The following table sets forth for the periods indicated the percentage
relationship to revenues of expenses and income items. 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\A.
<TABLE>
<CAPTION>
PERCENTAGE OF TOTAL REVENUES
December 31,
------------
1997 1998 1999
---- ---- (Restated)
Note 11
-------
<S> <C> <C> <C>
Net revenues 100.0 100.0 100.0
Costs and expenses:
Cost of sales 67.2 88.4 74.6
Start-up costs -- Tempe 3.2 -- --
Research and development 6.2 7.7 9.6
Selling, general and 18.4 18.1 15.9
administrative
Legal settlement -- -- 0.9
Total costs and expenses 95.1 114.2 101.0
Income (loss) from operations 4.9 (14.2) (1.0)
Interest expense, net -- (1.4) (2.4)
Income (loss) before income tax 4.8 (15.6) (3.3)
Provision for income taxes 0.3 0.1 0.1
Net income (loss) 4.6 (15.7) (3.4)
</TABLE>
Results of Operations
Fiscal 1998 Compared to Fiscal 1999
13
<PAGE>
Net revenues
Net revenues increased $4.6 million or 9.1% from $50.0 million in 1998 to
$54.6 million in 1999. In 1999, Sale of our automotive glass film increased $6.6
million, primarily due to the receipt of a significant purchase order from a
European automobile glass OEM. This was offset by a reduction of sales for
electronic display film of $1.4 million and architectural glass of $0.7 million.
The reduction of sales in electronic display film is a result of the
cancellation of the Sony contract, offset by new contract sales to MELCO and
Samsung for use in their manufacturing of CRTs.
Costs and expenses
Cost of sales
Cost of sales expense consists primarily of materials, production labor and
machine overhead. Cost of sales decreased $3.5 million, or 8.0% from $44.3
million in 1998 to $40.7 million in 1999. 1998 cost of sales included a $1.7
provision related to the product produced for Sony (See Note 9 to the
Consolidated Financial Statements). Excluding the provision for Sony, cost of
sales for 1998 was 85.1% of net revenues compared to 74.6% of net revenues for
1999. The decrease was attributable to the resumed production of PM5 in the
Tempe facility and improved throughput and yields of our products in 1999.
Research and development expenses
Total research and development expenses increased $1.3 million, or 35.8%,
from $3.9 million in 1998 to $5.2 million in 1999. Research and development
expenses, as a percentage of net revenues, increased from 7.7% for 1998 to 9.6%
for 1999. The increase in these expenses was primarily attributable to costs
associated with re-certifying PM 5 for commercial production, the costs
associated with retrofitting PM 1, and the costs incurred to design and install
two new production machines (PM 6 and PM 8).
Selling, general and administrative expenses
Selling, general and administrative expenses decreased $0.4 million, or
4.2%, from $9.0 million in 1998 to $8.6 million in 1999. Selling, general and
administrative expenses, as a percentage of net revenues, decreased from 18.1%
in 1998 to 15.9% in 1999. The primary reason for the decrease in these expenses
was the elimination of certain positions related to the sales and service
functions for after-market building products. In 1999, we contracted with an
independent distributor that agreed to perform these functions.
The Company accrued $500,000 as of December 31, 1999 for the settlement of
a lawsuit in March 2000 (See Note 9 of Item 8).
Income (loss) from operations
Loss from operations decreased $6.6 million from a loss of $7.1 million
for 1998 to a loss of $0.5 million for 1999. Decreased loss from operations
was primarily due to increased sales of automotive products, the adverse
affect on 1998 results of the provision for Sony and the discontinuance of
unprofitable sales of electronic display products to Sony.
Interest income (expense), net
Net interest expense increased $0.6 million from $0.7 million for 1998 to
$1.3 million for 1999, primarily due to our borrowing approximately $13.6
million of additional debt and overall higher interest rates.
Income (loss) before provision for income taxes
We reported a pre-tax loss of $7.8 million for 1998, compared to a pre-tax
loss of $1.8 million for 1999. Our lower loss in 1999 was primarily due to the
increase in sales of automotive products and the elimination of unprofitable
electronic display product sales to Sony.
14
<PAGE>
Fiscal 1997 Compared to Fiscal 1998
Net revenues
Net revenues decreased by $0.1 million, or 0.1%, from $50.1 million in 1997
to $50.0 million in 1998. Sales of our automotive glass products in 1998
increased approximately $6.2 million from 1997. Sales to an OEM glass
manufacturer increased by $8.1 million, partially offset by a decrease of $1.9
million in sales to GMX as a result of the economic recession in Asia. Sales of
our electronic display products in 1998 decreased by $5.0 million primarily due
to a reduction in sales to Sony of approximately $3.0 million and a provision of
$2.3 million related to the return of product from Sony. This decrease was
partially offset by sales to one new customer of approximately $2.6 million.
Costs and expenses
Cost of sales
Cost of sales increased $10.6 million, or 31.4%, from $33.7 million in 1997
to $44.3 million in 1998. As a percentage of net revenues, cost of sales for
1997 was 67.2% compared to 88.4% for 1998. The increase was primarily due to the
write-off of anti-reflective film produced for Sony in 1998 and low yields on
electronic display products manufactured for Sony in Tempe in 1998.
Research and development expenses
Research and development expenses increased by $0.7 million, or 24.0%, from
$3.1 million in 1997 to $3.9 million in 1998. Research and development expenses,
as a percentage of net revenues, increased from 6.2% for 1997 to 7.7% for 1998.
The increase was largely attributable to the hiring of 19 additional research
and development personnel to support increased new product development,
primarily in film for new electronic display, laminated automotive and Solis
products.
Selling, general and administrative expenses
Selling, general and administrative expenses decreased $0.2 million, or
1.8%, from $9.2 million in 1997 to $9.0 million in 1998. As a percentage of net
revenue, these expenses decreased from 18.4% in 1997 to 18.1% in 1998. The
decrease in these expenses was due to a reduction in administrative personnel
and cost control measures adopted in the second half of 1998.
Income (loss) from operations
Income from operations decreased $9.6 million from a profit of $2.4 million
for 1997 to a loss of $7.1 million for 1998. The principal reason for the loss
in 1998 was the $4.0 million provision for products produced for Sonly and low
production yields associated with the manufacture of electronic display product
for Sony.
Interest income (expense), net
Net interest expense increased from an immaterial amount in 1997 to $0.7
million for 1998 primarily due to higher average outstanding borrowings in 1998.
Income (loss) before provision for income taxes
We reported pre-tax income of $2.4 million for 1997, compared to a pre-tax
loss of $7.8 million for 1998. The principal reason for the loss in 1998 was the
$4.0 million provision for products for Sony and low production yields
associated with the manufacture of electronic display product for Sony.
Liquidity and Capital Resources
Capital expenditures
Since 1998, we have used borrowings, German government grants and cash from
operations to fund our capital
15
<PAGE>
expenditures. During 1999, we invested approximately $24.0 million in capital
expenditures, including approximately $13.5 million of progress payments for our
new manufacturing facility and first production machine (PM 8) in Dresden,
approximately $7.5 million for two new production machines (PM 6 and PM 7) and
leasehold improvements for our Tempe facility, and approximately $2.5 million
for the upgrade of two production machines (PM 1 and PM 2) in Palo Alto. These
investments were financed by $10.5 million of short and long-term debt, $6.6
million in sales-leaseback financings, $4.9 million in German government grants,
and $4.5 million of cash from operations. The German government grants subject
us to a number of covenants (See Note 5 of Item 8).
We anticipate spending approximately $14.0 million for capital expenditures
in 2000, approximately $12.0 million of which will consist of final progress
payments on our two new production machines (PM 8 and PM 9) in Dresden and the
completion of our Dresden facility. We expect to finance our capital
expenditures in Germany primarily through the receipt of additional bank loans
and the release of $3.1 million of cash currently restricted by the German
government to use in the financing the completion of our Dresden facility.
We expect to limit spending for capital expenditures on PM 7 and leasehold
improvements at Tempe. We anticipate these expenditures will only commence with
an increased line of credit, additional equipment financing or sufficient cash
generated from operations.
Liquidity
Operating activities generated $4.3 million in net cash in 1998 and $4.5
million in 1999. In addition, $1.0 million of proceeds from a sale-leaseback
transaction in 1999 was withheld by the lessor and classified in "Other assets".
Furthermore, 50% of the proceeds from a $1.7 million loan from a German bank are
restricted in an escrow account for the duration of the loan period and also
classified in "Other assets." The Company also reclassified to "Restricted cash"
that portion of cash, $1.9 million that is restricted to payments for the
facility in Germany. Capital expenditures were approximately $7.2 million in
1998 and $24.0 million in 1999. The Company reduced borrowings $1.3 million and
repurchased stock for $2.9 million in 1998. In 1999 the Company received $4.9
million from foreign government grants and $13.6 million from net increased
borrowings.
The following table sets forth the material terms of our short and
long-term indebtedness at December 31, 1999:
<TABLE>
<CAPTION>
Balance at
Description December 31, 1999 Interest Rate Maturity
----------- ----------------- ------------- --------
<S> <C> <C> <C>
Financing Line of Credit.................... $4,920 0.088% June 2001
====== monthly
Long term debt
Promissory note dated December 16, 1996. 1,312 9.7 (1)
Promissory note dated May 6, 1997....... 10,000 LIBOR + .4375 (2)
Sales-leaseback agreement dated July 19, 1999 2,990 13.0 (3)
Sales-leaseback agreement dated October 19,
1999.................................... 3,600 13.0 (4)
German bank loan dated May 28, 1999..... 4,397 7.1 (5)
German bank loan dated May 12, 1999..... - 7.1 (6)
German bank loan dated August 14, 1999 1,699 5.8 June 2009
Other equipment financings.............. 177 --- ---
-------
Total long-term debt................. 24,175
Less current portion................. 14,175
-------
$10,000
=======
</TABLE>
(1) We are required to make 48 equal monthly principal payments through December
2000.
(2) We are required to make equal semi-annual repayments from November 2000
through November 2002.
(3) We are required to make equal monthly principal payments over the 36-month
term of this financing.
16
<PAGE>
(4) We are required to make equal monthly principal payments over the 24-month
term of this financing.
(5) We are required to make equal semi-annual principal payments beginning ten
years from the date of the loan through May 2019.
(6) We are required to make equal semi-annual principal payments beginning five
years from the date of the loan through May 2009.
We have granted the lender of the financing line of credit a security
interest in our receivables, inventory and other assets not otherwise
collateralized. Our loans from German banks also subject us to covenants,
including covenants relating to the progress of the development of our Dresden
facility and the minimum number of our employees at Dresden by 2003. We have
granted the German banks security interests in our Dresden facility and the
assets located at the facility.
The promissory note dated December 16, 1996 is payable to a leasing
company. The borrowings are collateralized by certain production equipment and
subject us to certain financial covenants. At July 2, 2000, we were not in
compliance with certain of these financial covenants. We received a waiver from
the leasing company for failure to comply with these covenants through the
remaining term of the loan.
The promissory note dated May 6, 1997 is payable to a bank and guaranteed
by Teijin Limited, a stockholder and one of our suppliers. The Teijin guarantee
is secured by PM 5 and our inventory to the extent necessary to cover 120% of
the outstanding loan balance based on the net book value of the inventory. The
guarantee subjects us to certain financial and other covenants, including
covenants relating to our tangible net worth, our debt to tangible net worth,
and the ratio of our cash, cash equivalents and short term investments to our
total current liabilities. At December 31, 1999, we were not in compliance with
the financial covenants relating to the ratio of our debt to equity and the
ratio of our cash, cash equivalents and short-term investments to current
liabilities. Teijin delivered to us a waiver of these covenants at December 31,
1999 and through October 1, 2001.
We have provided the lessor under our sales-leaseback financings a $0.5
million irrevocable standby letter of credit to collateralize our obligations
under the sales-leaseback agreements. The letter of credit will not expire
before January 1, 2002. In addition, $1.0 million of the amount received from
the lessor is in an escrow account and will be released upon our meeting certain
financial conditions.
Loan Covenants
Pursuant to the loan and or lease agreements listed above, and related
terms, conditions and covenants we requested and received waivers from the
financial institutions, except the German bank loans and sales-leaseback
agreements as discussed below, related to the Company's default or event of
default pursuant to these respective agreements or otherwise arising in
connection with the Company's requirement to restate prior financial periods,
the financial position of the Company reflected in such restated financial
statements, the Company's failure to file its Form 10-Q for the second quarter
of 2000 in a timely manner and trading halts or other actions taken or
threatened to be taken by NASDAQ, or any law suits filed or threatened to be
filed in connection with such restatements or late filings.
The Company has received from the German banks a waiver of the Events of
Default pursuant to the agreements but the German banks did not provide a waiver
of the Events of Default or any rights it may have with respect to any further
material adverse change in the financial condition of the Company resulting from
the Events of Default and the German banks have reserved the right to terminate
the loan agreements after the third and fourth quarter of 2000 if the
expectations relating to turnover and profit as provided by the Company don't
occur and provide a cause for termination. The Company cannot currently
determine with reasonable certainty whether it will be able to comply with these
provisions and accordingly has reclassified these loans from long-term to
current liabilities in the balance sheet.
Also the Company is in discussions with the leasing company for the
sale-leaseback agreements dated July 19, 1999 and October 19, 1999 concerning a
waiver of Events of Default related to the material adverse change discussed
above. The Company cannot currently determine with reasonable certainty whether
it will obtain such waiver and accordingly has reclassified these agreements
from long-term to current liabilities in the balance sheet.
17
<PAGE>
Going Concern
On July 12, 2000, the Company's receivable financing line of credit was
increased to $12.0 million. This increase will expire September 30, 2000, at
which time the credit limit will be reduced to $10.0 million. The Company is
exploring other potential revolving credit arrangements, although no assurance
can be given that it will succeed. In addition, the Company's promissory note
dated December 16, 1996 will be fully repaid by November 2000. The Company is
seeking new equipment financing to replace this loan, using its underlying
security as collateral.
These consolidated financial statements have been prepared assuming that
the Company will continue as a going concern. The Company has experienced
recurring losses from operations, has significant current and long-term debt
containing certain covenants with which the Company has not complied requiring
the Company to obtain waivers and to classify as a current liability the debt
for which waivers have not been obtained, and on-going capital commitments for
debt service, manufacturing facilities and equipment that raise substantial
doubt about its ability to continue as a going concern. The financial statements
do not include any adjustments that might result from the outcome of this
uncertainty. As a result of this uncertainty, the Company may not be able to
carry out all of its proposed capital expenditures or to otherwise finance its
operations as currently proposed. The Company believes that it will need
additional financing to meet its operating cash requirements through 2000 and
beyond. However, the Company can give no assurances it will be successful in
obtaining the required additional financing and cash from operations.
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 bank line of credit
which is tied to the prime rate. The Company's German subsidiary also has
several fixed-rate term loans that are denominated and repayable in
Deutschemarks. Fluctuations in interest rates may adversely impact the
interest expense expected for the Company. The effect of interest rate
fluctuations on the Company in 1999 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 77% of the
Company's total sales in 1999 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 1999 was not material.
18
<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, of stockholders' equity and of cash
flows, present fairly, in all material respects, the financial position of
Southwall Technologies Inc. (the "Company") and its subsidiaries at December 31,
1999 and 1998, and the results of their operations and their cash flows for each
of the three years in the period ended December 31, 1999 in conformity with
accounting principles generally accepted in the United States. 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
auditing standards generally accepted in the United States, 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.
These consolidated financial statements have been prepared assuming that the
Company will continue as a going concern. As discussed in Note 12 to the
consolidated financial statements, the Company has experienced recurring losses
from operations, has significant current and long-term debt containing certain
covenants with which the Company has not been in compliance requiring the
Company to obtain waivers and to reclassify as a current liability the debt for
which waivers have not been obtained, and significant capital commitments for
debt service, manufacturing facilities and equipment that raise substantial
doubt about its ability to continue as a going concern. The financial statements
do not include any adjustments that might result from the outcome of this
uncertainty.
As indicated in Note 11, the Company restated its 1999 financial statements.
PricewaterhouseCoopers LLP
San Jose, California
March 3, 2000 except as to
Notes 4, 9, 11 and 12, which
are as of September 28, 2000
19
<PAGE>
SOUTHWALL TECHNOLOGIES INC.
CONSOLIDATED BALANCE SHEETS
(dollars and shares in thousands, except for per share amount)
<TABLE>
<CAPTION>
ASSETS
December 31,
1 9 9 8 1 9 9 9
-------- --------
(Restated)
Current assets: Note 11
<S> <C> <C>
Cash and cash equivalents $ 4,136 $ 1,772
Restricted Cash - 1,883
Short-term investments 7 -
Accounts receivable, net of allowance
allowance for bad debts of $845 and $875 12,355 11,129
Inventories, net 6,057 7,221
Other current assets 813 1,294
-------- --------
Total current assets 23,368 23,299
Property, plant and equipment, net 29,068 43,533
Other assets 1,583 3,310
-------- --------
Total assets $ 54,019 $ 70,142
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Bank line of credit $ - $ 4,920
Accounts payable 6,307 9,775
Accrued compensation 2,265 1,817
Other accrued liabilities 3,655 4,311
Current portion of long-term debt 15,397 14,175
-------- --------
Total current liabilities 27,624 34,998
Long-term debt 141 10,000
Other 437 564
-------- --------
Total liabilities 28,202 45,562
-------- --------
Stockholders' equity:
Common stock, $0.001 par value, 20,000 shares
authorized; issued and outstanding 7,889 and 7,889 8 8
Capital in excess of par value 52,181 51,771
Less cost of treasury stock, 565 and
371 shares outstanding (2,852) (1,888)
Notes receivable (1,020) (906)
Other Comprehensive Income
Translation loss on subsidiary - (40)
Accumulated deficit (22,500) (24,365)
-------- --------
Total stockholders' equity 25,817 24,580
-------- --------
Total liabilities and
stockholders' equity $ 54,019 $ 70,142
======== ========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
20
<PAGE>
SOUTHWALL TECHNOLOGIES INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(dollars and shares in thousands, except per share data)
<TABLE>
<CAPTION>
Year Ended December 31,
-----------------------
1 9 9 7 1 9 9 8 1 9 9 9
-------- -------- --------
(Restated)
Note 11
<S> <C> <C> <C>
Net revenues $ 50,089 $ 50,033 $ 54,598
-------- -------- --------
Costs and expenses:
Cost of sales 33,669 44,253 40,706
Tempe start up costs 1,641 - -
Research and development 3,117 3,864 5,249
Selling, general and administrative 9,216 9,046 8,670
Legal settlement - - 500
-------- -------- --------
Total costs and expenses 47,643 57,163 55,125
-------- -------- --------
Income(loss) from operations 2,446 (7,130) (527)
Interest income(expense), net (20) (681) (1,288)
-------- -------- --------
Income(loss) before provision
for income taxes 2,426 (7,811) (1,815)
Provision for income taxes (145) (58) (50)
-------- -------- --------
Net income(loss) $ 2,281 $ (7,869) $ (1,865)
======== ======== ========
Net income(loss) per share:
Basic $ 0.32 $ (1.03) $ (0.25)
Diluted $ 0.29 $ (1.03) $ (0.25)
Weighted average shares of common stock
and dilutive common stock equivalents:
Basic 7,107 7,608 7,421
Diluted 7,799 7,608 7,421
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
21
<PAGE>
SOUTHWALL TECHNOLOGIES INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(in thousands)
<TABLE>
<CAPTION>
Common Stock Capital in Other Total
--------------- Excess of Notes Accumulated Treasury Comprehensive Stockholders Comprehensive
Shares Amount Par Value Receivable Deficit Stock Income Equity Income (Loss)
------ ------ --------- ---------- ------- ----- ------ ------ -------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Balance at 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, net (60) (60)
Net income 2,281 2,281 2,281
--------------------------------------------------------------------------------------------------
Balance at Dec. 31, 1997 7,636 8 51,513 (656) (14,631) (494) 35,740 2,281
=====
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, net (364) (364)
Net loss (7,869) (7,869) (7,869)
--------------------------------------------------------------------------------------------------
Balance at Dec. 31, 1998 7,889 8 52,181 (1,020) (22,500) (2,852) 25,817 (7,869)
=====
Shares issued through:
Interest paid with
stock (55) 148 93
Exercise of options (264) 607 343
Sales to employees
under stock
purchase plan (81) 181 100
Issuance of stock for
bonuses (10) 28 18
Stock option loans, net 114 114
Translation loss on
foreign subsidiary (40) (40) (40)
Net loss (Restated-
Note 11) (1,865) (1,865) (1,865)
--------------------------------------------------------------------------------------------------
Balance at Dec. 31, 1999 7,889 $8 $51,771 $(906) $(24,365) $(1,888) $(40) 24,580 $(1,905)
=================================================================================================
(Restated - Note 11)
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
22
<PAGE>
SOUTHWALL TECHNOLOGIES INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
<TABLE>
<CAPTION>
Year Ended December 31,
-----------------------
1997 1998 1999
---- ---- ----
(Restated)
Cash flows (used in) from operating activities: Note 11
<S> <C> <C> <C>
Net income(loss) $ 2,281 $ (7,869) $ (1,865)
Adjustments to reconcile net income(loss) to net
cash provided by operating activities:
Depreciation and amortization 2,703 4,315 4,946
Decrease (increase) in accounts receivable, net (4,829) (429) 1,290
Decrease (increase) in inventories, net (1,712) 4,061 (1,164)
Decrease (increase) in other current and
non-current assets (204) 246 (2,442)
Increase in accounts payable
and accrued liabilities 1,845 4,023 3,758
-------- -------- --------
Cash provided by operating activities 84 4,347 4,523
-------- -------- --------
Cash flows from investing activities:
Decrease in short-term investments - - 7
Increase in restricted cash - - (1,883)
Expenditures for property, plant and equipment
and other assets (11,727) (7,190) (24,066)
-------- -------- --------
Net cash used in investing activities (11,727) (7,190) (25,942)
-------- -------- --------
Cash flows from financing activities:
Proceeds from foreign government grants - - 4,943
Proceeds from borrowings 15,324 - 34,512
Principal payments on borrowings (1,322) (1,305) (20,957)
Repayment of stockholder's note receivable 234 180 298
Issuance of common stock upon exercise
of stock options, net - 273 159
Issuance of common stock under employee
stock purchase plan - 139 100
Issuance (purchase) of treasury stock, net 512 (2,832) -
-------- -------- --------
Net cash provided by (used in) financing
activities 14,748 (3,545) 19,055
-------- -------- --------
Net increase (decrease) in cash
and cash equivalents 3,105 (6,388) (2,364)
Cash and cash equivalents, beginning of year 7,419 10,524 4,136
-------- -------- --------
Cash and cash equivalents, end of year $ 10,524 $ 4,136 $ 1,772
======== ======== ========
Supplemental cash flow disclosures:
Interest paid $ 620 $ 1,052 $ 1,408
Income taxes paid $ 100 $ 12 $ 50
Supplemental schedule of non-cash investing
and financing activities:
Property and equipment acquired via
capital lease $ 365 $ - $ 28
Treasury stock used for payment
of interest $ 185 $ 186 $ 93
Treasury stock used for payment
of bonuses $ - $ - $ 18
Exercise of stock options with issuance
of stockholders notes receivable $ 220 $ 544 $ 184
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
23
<PAGE>
SOUTHWALL TECHNOLOGIES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars and shares in thousands, except per share data)
NOTE 1 - THE COMPANY AND A SUMMARY OF ITS SIGNIFICANT ACCOUNTING POLICIES:
THE COMPANY
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. All significant
intercompany balances and transactions have been eliminated on consolidation.
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.
COMPREHENSIVE INCOME (LOSS)
The Company has adopted the provisions of Statement of Financial Accounting
Standards No. 130 "Reporting Comprehensive Income," ("SFAS No. 130"). SFAS No.
130 establishes standards for reporting and display in the financial statements
of total net income and the components of all other non-owner changes in equity,
referred to as comprehensive income (loss). Accordingly, the Company has
reported the translation loss from consolidation of its foreign subsidiary in
comprehensive income (loss).
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, 1999, the difference between
cost reflected in the balance sheet and fair market value was insignificant.
Gains/losses on sales of securities during each period presented 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 and 1999 approximates fair value.
24
<PAGE>
CONCENTRATION OF CREDIT RISK
Financial instruments that potentially subject the Company to significant
concentrations of credit risk consist principally of cash equivalents,
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 customers' 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.
At December 31, 1998, receivables from two customers represented 25% and
20% of the Company's accounts receivables, respectively. At December 31, 1999,
receivables from three customers represented 19%, 17% and 12% of the Company's
accounts receivable, respectively.
REVENUE RECOGNITION
Revenues from product sales are recognized upon product shipment if an
assigned purchase order exists, the sales price is fixed and determinable,
collection of resulting receivables is probable and product returns are
reasonably estimable. Provisions for estimated cost of warranty repairs and
returns and allowances are recorded at the time products are shipped and are
adjusted periodically to reflect historical and anticipated experience.
The Company has agreements under which it receives fees for certain rights
to technology and products. The Company does not allocate cost of sales to
license revenues because such costs are insignificant. License revenues
associated with these agreements are recognized ratably over the period of the
contract when collection of the resulting receivable is probable. License
revenues were $385, $713, and $515 for the years 1997, 1998 and 1999,
respectively.
RESEARCH AND DEVELOPMENT EXPENSE
Research and development costs are expensed as incurred in accordance with
Statement of Financial Position Standard No.2, "Accounting for Research and
Development Costs".
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.
IMPAIRMENT OF LONG-LIVED ASSETS
25
<PAGE>
The Company evaluates the recoverability of its long-lived assets in
accordance with Statement of Financial Accounting Standards ("SFAS") No. 121,
"Accounting for Impairment of Long-Lived Assets and for Long-Lived Assets to be
disposed of." SFAS No. 121 requires recognition of impairment of long-lived
assets in the event the net book value of such assets exceeds the future
undiscounted cash flows attributable to such assets. No such losses have been
recognized through December 31, 1999.
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, 1998 and 1999, patents, licenses and trademarks are included in other
assets in the amount of $843, $852 and $723, net of accumulated amortization of
$930, $947 and $1,119, respectively. Amortization expense for 1997, 1998 and
1999 was $113, $176 and $172, respectively.
STOCK-BASED COMPENSATION EXPENSE
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". The Company also provides
additional pro forma disclosures as required under 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 net income (loss) per share is computed as net income (loss)
available to common stockholders divided by the weighted-average number of
common shares outstanding. Diluted net income per share is computed as net
income available to common stockholders 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 net loss per share is computed the same as basic net 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 and 1999 were excluded from the diluted net loss per share calculations
because they were anti-dilutive in view of the losses incurred by the Company.
During the years ended December 31, 1997, 1998 and 1999 there were no
differences between the numerators used for the basic and diluted net income
(loss) per share calculations. The total amount of the differences in the
denominator in 1997 is attributable to the effect of dilutive common stock
options.
FOREIGN CURRENCY TRANSLATION
The Company's German subsidiary uses its local currency as its functional
currency. Assets and liabilities are translated at exchange rates in effect at
the balance sheet date and income and expense accounts at average exchange rates
during the year. Resulting translation adjustments are recorded directly to a
separate component of stockholders' equity.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board issued SFAS No.
133,"Accounting for Derivatives and Hedging Activities" ("SFAS 133"). SFAS 133
was effective for all fiscal quarters beginning with the quarter ending June 30,
1999. SFAS 133 establishes accounting and reporting standards of derivative
instruments, including certain derivative instruments embedded in other
contracts, and for hedging activities. In July 1999, the Financial Accounting
Standards Board issued SFAS No. 137 "Accounting for Derivative
26
<PAGE>
Instruments and Hedging Activities--Deferral of the Effective Date of FASB
Statement No. 133"("SFAS 137") SFAS 137 deferred the effective date until the
first fiscal quarter ending June 30, 2000. The Company has not engaged in
hedging activities or invested in derivative instruments.
In December 1999, the Securities and Exchange Commission issued SAB No.
101, "Revenue Recognition in Financial Statements," which provides guidance on
the recognition, presentation, and disclosure of revenue in financial statements
filed with the SEC. SAB No. 101 outlines the basic criteria that must be met to
recognize revenue and provides guidance for disclosures related to revenue
recognition policies. SAB 101 will be effective for fiscal years beginning after
December 15, 1999. The Company believes that adoption of SAB No. 101 will not
have a material impact on its financial position, results of operations or cash
flows.
NOTE 2 - BALANCE SHEET DETAIL
<TABLE>
<CAPTION>
December 31,
------------
Inventories, net: 1 9 9 8 1 9 9 9
----------------- ------- -------
(Restated)
Note 11
<S> <C> <C>
Raw materials $ 2,314 $ 3,369
Work-in-process 2,155 2,651
Finished goods 1,588 1,201
------- -------
Total inventories $ 6,057 $ 7,221
======= =======
</TABLE>
<TABLE>
<CAPTION>
December 31,
------------
Property, plant and equipment, net: 1 9 9 8 1 9 9 9
----------------------------------- ------- -------
(Restated)
Note 11
<S> <C> <C>
Land $ -- $ 207
Buildings -- 3,405
Machinery and equipment 44,061 45,577
Leasehold improvements 3,714 3,804
Furniture and fixtures 2,915 2,984
Construction-in-process 4,987 18,514
------- -------
55,677 74,491
Less - accumulated depreciation
and amortization (26,609) (30,958)
------- -------
Total property, plant & equipment $29,068 $43,533
======= =======
</TABLE>
Depreciation and amortization expense for the years ended December 31,
1997, 1998 and 1999 was $2,703, $4,315 and $4,946, respectively. See Note 5 to
the financial statements with respect to a government grant received to offset
construction and equipment costs for the German subsidiary.
<TABLE>
<CAPTION>
December 31,
------------
Other accrued liabilities: 1 9 9 8 1 9 9 9
-------------------------- ------- -------
(Restated)
Note 11
<S> <C> <C>
Reserve for warranties and sales
returns $ 2,858 $ 1,174
Payable for purchase of land - 276
Legal settlement - 500
Other 797 2,361
------- -------
$ 3,655 $ 4,311
======= =======
</TABLE>
NOTE 3 - FINANCING LINE OF CREDIT
The Company has a $7 million receivable financing line of credit with a
bank. Availability under the line of credit is based upon 80% of the approved
accounts receivable balances, and bears a finance fee of 0.088% per month of the
average daily account balance outstanding
27
<PAGE>
during the settlement period. In connection with the line of credit, the Company
granted to the bank a continuing lien upon and security interest in, and right
of set off with respect to all of the Company's right, title and interest in all
accounts receivable, inventory, monies, remittances and fixed assets. There was
$4.9 million of borrowing outstanding under this line of credit at December 31,
1999. (See Note 12 - GOING CONCERN AND LOAN COVENANTS)
NOTE 4 - LONG-TERM DEBT
The Company's long-term debt consists of the following:
<TABLE>
<CAPTION>
December 31,
1 9 9 8 1 9 9 9
------- -------
<S> <C> <C>
Convertible Debenture $ 2,650 $ -
Promissory note dated December 16, 1996 2,616 1,312
Promissory note dated May 6, 1997 10,000 10,000
Sale-leaseback agreement dated July 19,1999 - 2,990
Sale-leaseback agreement dated October 19, 1999 - 3,600
Bank loan dated May 28, 1999 - 4,397
Bank loan dated August 14, 1999 - 1,699
Other 272 177
------- -------
Total long-term debt 15,538 24,175
Less current portion 15,397 14,175
------- -------
Long Term Debt $ 141 $10,000
======= =======
</TABLE>
In June 1999, the Company repaid a $2,650 convertible debenture to a
related party. Interest was payable at 2% below prime, but not less than 7%, nor
higher than 11%, and was 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 payable to a leasing
company. The borrowings are collateralized by certain production equipment, bear
interest at an annual rate of 9.7037% and are subject to certain financial
covenants. The Note is payable in monthly installments plus interest for a term
of 48 months. At December 31, 1999 the Company was not in compliance with
certain of the financial covenants pertaining to this promissory note. The
Company has received a waiver from the leasing company for failure to comply
with such covenants through the remaining term of the loan. The amount is
repayable in the next 12 months and has been classified as current debt. (See
Note 12 - GOING CONCERN AND LOAN COVENANTS)
The promissory note dated May 6, 1997 is payable to a bank. The note
payments are guaranteed by Teijin Limited of Japan ("Teijin"), a stockholder and
supplier of the Company (See Note 10). The Teijin guarantee is collateralized by
certain equipment located in the Company's Tempe 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% and 6.1313% at December 31, 1998 and 1999
respectively), and the Company is subject to certain financial 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. Teijin also
received warrants in 1997 to purchase 158,000 shares of the Company's common
stock at $9 per share. These warrants were not exercised and expired on May 30,
2000. At December 31, 1998, the Company was not in compliance with certain of
the financial covenants, therefore, the full principal amount was classified as
a current liability. In August 1999, the Company negotiated new financial
covenants for the remainder of 1999 and 2000. At December 31, 1999 the Company
was not in compliance with certain of the financial covenants pertaining to this
promissory note, however, the Company received a waiver from Teijin through
December 31, 1999. In September 2000, the Company received a waiver through
October 1, 2001. The long-term principal amount at December 31, 1999 has been
classified according to the terms of this agreement. (See Note 12 - GOING
CONCERN AND LOAN COVENANTS)
During 1999, the Company entered into two equipment sale-leaseback
agreements with a
28
<PAGE>
leasing company ("Lessor"). Because the Company has an option to purchase the
equipment at a price to be determined between the Company and the Lessor at the
end of the lease period, the sale-leaseback agreements have been treated as
financing. One lease agreement has a lease term of three years and the other
lease agreement has an initial lease term of two years with an option to extend
it an additional year. At December 31, 1999, the Company had a total of $6,590
outstanding and due under the leases. The leases are collateralized by the
leased equipment and certain other production equipment of the Company. The
effective interest rate of both leases is approximately 13% per annum and they
are repayable over their term commencing in May 2000. Additionally, the Company
has provided the Lessor an irrevocable standby letter of credit in the amount of
$0.5 million to collateralize all of the Company's obligations under these
agreements. The letter of credit shall not expire before January 1, 2002. In
addition, $1 million of the amount received from the Lessor is in an escrow
account and will be released to the Company pending the Company meeting certain
financial conditions at December 31, 1999. Due to the uncertainty of compliance
with these financial conditions, the Company has classified this amount under
"Other Assets." (See Note 12 - GOING CONCERN AND LOAN COVENANTS)
On May 12, 1999, the Company entered into a loan agreement with a German
bank that provides for borrowings up to $ 2.9 million (DM 6.0 million). Under
the terms of this agreement, the funds will be used solely for capital
investment by the German subsidiary. The term of the loan is for a period of 10
years and the principal is repayable after the end of five years in 10 equal
semi-annual payments. The loan bears interest at 7.10% per annum for the first
five years, and will be revised to the prevailing rate at the end of the fifth
year. The loan is repayable in Deutschemarks but no principal had been drawn
down as of December 31, 1999. (See Note 12 - GOING CONCERN AND LOAN COVENANTS)
An additional loan for $733 (DM 1.5 million) was received from the German
bank discussed above. This loan is an advance on a government grant to be
received approximately August 2001. The proceeds of the grant are collateral for
the loan and, per legal arrangements, will be paid directly to the bank by the
government. Payments of interest only are due in Deutschemarks until then at
7.10% per annum.
On May 28, 1999, the Company entered into a loan agreement with a German
bank that provides for borrowings up to $6.4 million (DM 12.5 million). Under
the terms of this agreement, the funds will be used solely for capital
investment by the German subsidiary. The term of the loan is for 20 years and
the principal is repayable in Deutschemarks after the end of 10 years in 20
equal semi-annual payments. The loan bears interest at 7.10% per annum for the
first ten years, and will be revised to the prevailing rate at the end of the
tenth year. (See Note 12 - GOING CONCERN AND LOAN COVENANTS)
On August 14, 1999, the Company entered into a loan agreement with a German
bank that provides for borrowings up to $1.7 million (DM 3.3 million). Under the
terms of this agreement, the funds will be used solely for capital investment by
the German subsidiary. The principle balance is due in a single installment on
June 30, 2009 and bears interest at a rate of 5.75% per annum. The interest is
payable quarterly in Deutschemarks. 50% of the loan proceeds are restricted in
an escrow account for the duration of the loan period and are classified as
non-current "Other Assets." (See Note 12 - GOING CONCERN AND LOAN COVENANTS)
The preceding German bank loans are collateralized by the production
equipment, building and land owned by the German subsidiary.
Other long-term debt consists of capitalized leases related primarily to
certain computer equipment used by the Company.
Principal reductions of long-term debt (excluding reclassified debt) are
scheduled as follows:
<TABLE>
<CAPTION>
Year Amount
---- ------
<S> <C>
2000 $2,232
2001 4,700
2002 4,869
2003 4,073
2004 2,500
2005 -
Thereafter 5,801
-------
Total $24,175
</TABLE>
29
<PAGE>
The Company incurred total interest expense of $892, $681 and $2,573 in
1997, 1998 and 1999, respectively. Of these amounts, the Company capitalized
$464 in 1997, nil in 1998 and $1,144 in 1999 as part of the costs related to
the construction of new manufacturing facilities in Tempe, Arizona, and a
further $141 related to its construction of the new production facility in
Germany.
NOTE 5 - GOVERNMENT GRANT
The Company has an agreement to receive a grant award (the "Grant"),
which was approved by the State Government of Saxony in Germany (the
"Grantor") in May 1999. The agreement provides for investment grants to a
maximum amount of $9.9 million (DM 20.3 million). During the year ended
December 31, 1999, the Company received approximately $4.9 million (DM 9.6
million) under this Grant and accounted for the Grant by applying the
proceeds received against the cost of the German manufacturing facility. The
Company is scheduled to receive the remaining balance through 2002.
The Grant is subject to the following requirements:
a) The grant is earmarked to co-finance the costs of the
construction of a facility to manufacture Heat Mirror
XIR-Registered Trademark- film for the automotive glass
industry, located at Grossroehrsdorf, Germany.
b) The construction period for the project is from March 15, 1999 to
March 14, 2002.
c) The total investment should be at least $39.2 million (DM 80.3
million).
d) The project must create at least 143 permanent jobs and 7
apprenticeships.
In the event that the Company fails to meet the above requirements, the
Grantor has the right to reclaim the Grant.
The Company is further eligible for investment allowances calculated based
on the capital investment of $39.2 million (DM 80.3 million) amounting to $3.7
million (DM 7.7 million), subject to European Union regulatory approval.
The investment allowance is subject to the following requirements:
a) The movable and immovable assets which acquisition cost are taken
into account in determining the investment allowance shall be
employed within the subsidized territory for a period of at least
five years following the acquisition or production.
b) The movable assets which acquisition cost are taken into account
in determining the increased investment allowance shall remain in
a business that is engaged in the processing industry, or in a
similar production industry for a period of at least five years
following the acquisition or production.
In the event that the Company fails to meet the above requirements, the
investment allowance must be paid back with interest.
NOTE 6 - INCOME TAXES
The income tax provision in 1997 resulted primarily from minimum tax
liabilities related to federal taxes and foreign withholding taxes on royalty
payments. The income tax provision in 1999 and 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 1997 and the reserves
established for deferred tax assets in 1998 and 1999. The deferred tax assets
valuation allowance at December 31, 1997, 1998, and 1999 is attributable to
federal and state deferred tax assets. Management believes that sufficient
uncertainty exists with regard 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
30
<PAGE>
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.
Deferred tax (liabilities) assets are comprised of the following:
<TABLE>
<CAPTION>
December 31,
------------
1 9 9 8 1 9 9 9
--------- ---------
(Restated)
Note 11
<S> <C> <C>
Depreciation $ (4,142) $ (3,910)
Other (300) (220)
--------- ---------
Gross deferred tax liabilities (4,442) (4,130)
--------- ---------
Inventory reserves 924 599
Other 3,117 3,573
Loss carryforwards 7,971 9,174
Credit carryforwards 1,109 952
--------- ---------
Gross deferred tax assets 13,121 14,298
--------- ---------
Deferred tax assets valuation
allowance (8,679) (10,168)
--------- ---------
Net deferred taxes $ - $ -
========= =========
</TABLE>
At December 31, 1999 the Company had net federal operating loss
carryforwards of approximately $23.5 million that expire at various dates from
2000 through 2019. The net operating loss carryforwards include approximately
$3.5 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 $0.3 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 that can be utilized.
NOTE 7 - BENEFIT PLANS
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 Board of Directors
adopted the 1998 Stock Option Plan for Employees and Consultants 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 the optionee terminates their
relationship with the Company.
During 1997, 1998 and 1999, certain employees, officers and directors of
the Company exercised stock options under the plans by issuing full recourse
notes to the Company with an annual rate of interest of generally 7%. During
1997, 1998 and 1999 outstanding notes to certain of those employees, officers
and directors were extended from terms of one year to terms of two years. Both
the principal and the interest accrued on the notes are due at the end of the
term of each note. These notes aggregate $656, $1,020 and $906 at December 31,
1997, 1998 and 1999, respectively.
As of December 31, 1999, there were 518 shares of Common Stock available
for grant under
31
<PAGE>
the two stock option plans.
The activity under the option plans, combined, was as follows:
<TABLE>
<CAPTION>
Range of Weighted Average
Options Exercise Price Exercise Price
------- -------------- --------------
Options outstanding at
<S> <C> <C> <C>
January 1, 1997 1,664 $2.50 - $8.13 $3.88
Granted 403 6.38 - 8.25 6.86
Exercised ( 212) 2.50 - 5.63 2.92
Cancelled or expired ( 115) 2.50 - 7.88 5.06
-----
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
-----
December 31, 1998 1,413 $2.50 - $8.63 $4.89
Granted 637 2.75 - 4.50 3.77
Exercised ( 127) 2.50 - 4.38 2.89
Cancelled or expired ( 262) 2.50 - 8.63 5.15
-----
December 31, 1999 1,661 $2.50 - $8.63 $4.59
=====
</TABLE>
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
1997, 1998 and 1999, 33, 32 and 36 shares, respectively, were sold under the
Purchase Plan and the 1997 Plan. At December 31, 1999 there were no shares
remaining available for issuance under the 1988 Purchase Plan and 11 shares
available for issuance under the 1997 Plan.
ACCOUNTING FOR STOCK-BASED COMPENSATION
The Company has stock option plans that 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 1997, 1998 and 1999 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:
<TABLE>
<CAPTION>
1997 1998 1999
---- ---- ----
(Restated)
Note 11
<S> <C> <C> <C>
Net Income (loss) - as reported............................... $2,281 $(7,869) $(1,865)
Net Income (loss) - pro forma................................. $1,450 $(8,314) $(2,659)
Net income (loss) per share - as reported.....................
Basic................................. $ 0.32 $ (1.03) $ (0.25)
Diluted............................... $ 0.32 $ (1.03) $ (0.25)
Net income (loss) per share - pro forma.......................
Basic................................. $ 0.20 $ (1.09) $ (0.36)
Diluted............................... $ 0.19 $ (1.09) $ (0.36)
</TABLE>
32
<PAGE>
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 1997, 1998 and 1999, respectively. Expected
volatility of 60% in 1997, 58% in 1998 and 110% in 1999; risk-free interest
rate of 6.4%, 4.5% and 5.4%; and expected lives from vesting date of 0.54,
1.11 and 3.23 years. The Company has not paid dividends and assumed no
dividend yield. The weighted average fair value of stock options granted in
1997, 1998 and 1999 was $6.86, $2.51 and $2.60 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 1997, 1998 and 1999, respectively. Expected volatility of
60%, 68%, and 139%; risk-free interest rate of 5.5%, 5.0% and 5.8%; and expected
lives of 0.5 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 1997, 1998 and 1999 was $2.16, $2.33 and $1.98 per right,
respectively.
The following table summarizes information about stock options outstanding at
December 31, 1999:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
-------------------------------------------------------------------------------------------------------
Weighted Weighted Weighted
Number Average Average Number Average
Range of Outstanding Remaining Exercise Exercisable Exercise
Exercise Prices At 12/31/99 Contractual Life Price At 12/31/99 Price
-------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
$2.50 - $3.19 365 4.21 $2.92 147 $2.66
3.25 - 4.50 555 5.73 4.16 142 3.93
4.63 - 5.00 407 5.39 4.94 144 4.87
5.25 - 8.13 329 5.11 6.70 166 6.66
8.25 - 8.25 5 4.81 8.25 3 8.25
-------------------------------------------------------------------------------------------------------
$2.50 - $8.25 1,661 5.19 $4.59 602 $4.62
-------------------------------------------------------------------------------------------------------
</TABLE>
401(K)PLAN
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, 1997, 1998 and 1999. 401(k) matching
contributions for the years ended December 31, 1997, 1998 and 1999 were $109,
$139 and $230, respectively. The Company has no intention to terminate the plan.
NOTE 8 - 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
33
<PAGE>
"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. The total net revenues for the Electronic Display, Automotive Glass
and Building product lines were as follows:
<TABLE>
<CAPTION>
1 9 9 7 1 9 9 8 1 9 9 9
------- ------- -------
(Restated)
Note 11
<S> <C> <C> <C>
Electronic display................. $21,957 $16,954 $16,014
Automotive glass................... 6,629 12,845 19,477
Building........................... 21,503 20,234 19,107
------- ------- -------
Total net revenues............... $50,089 $50,033 $54,598
======= ======= =======
</TABLE>
The following is a summary of net revenue by geographic area for 1997, 1998 and
1999.
<TABLE>
<CAPTION>
1 9 9 7 1 9 9 8 1 9 9 9
------- ------- --------
(Restated)
Note 11
<S> <C> <C> <C>
United States.............................$ 17,593 $ 16,095 $ 11,948
South America............................. - - 569
Pacific Rim............................... 7,525 4,206 8,110
Japan..................................... 15,640 13,041 11,876
Europe.................................... 7,788 15,060 20,358
Canada.................................... 1,543 1,631 1,737
------ ------ ------
Total net revenues.......................$ 50,089 $ 50,033 $ 54,598
====== ====== ======
</TABLE>
The Company operates mainly from facilities located in the United States.
During 1999 a subsidiary was established in Germany. Property, plant and
equipment include long-lived assets in Germany with a net book value of $4.8
million.
One customer accounted for approximately 31% of net sales in 1997, two customers
accounted for 33% and 12% of net sales in 1998 and three customers accounted for
18%, 11% and 10% of net sales in 1999.
NOTE 9 - COMMITMENTS AND CONTINGENCIES
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, 1999, the future minimum payments under these leases are
as follows:
<TABLE>
<CAPTION>
OPERATING SUBLEASE
CAPITAL OPERATING INCOME
<S> <C> <C> <C>
2000 $ 178 $ 3,429 $ 292
2001 8 3,444 -
2002 8 3,476 -
2003 8 2,659 -
2004 6 2,673 -
Thereafter - 996 -
------ -------- -----
Future minimum lease payments $ 208 $ 16,677 $ 292
======== =====
Less - amount representing interest (31)
------
Present value of future minimum
lease payments 177
Current maturities 147
------
Long-term lease obligations $ 30
======
</TABLE>
34
<PAGE>
Rent expense under operating leases was approximately $1,471, $1,562 and
$1,484, in 1997, 1998 and 1999, respectively.
CONTINGENCIES
The Company has been named a defendant in a purported class action lawsuit.
Plaintiffs contend that Heat Mirror equipped glass units manufactured throughout
the country are subject to clouding and discoloration. The Company is in the
process of filing demurrers and setting pleadings. In addition, several of the
Company's co-defendants have settled their portions of the case. At this point,
the Company believes the class action lawsuit is without merit and intends to
vigorously defend this lawsuit by moving to defeat the class action
certification. No reasonable estimate could be made of the likely range of
claims prior to class certification.
In 1997, the Company was named a defendant in a lawsuit with a manufacturer
of insulated glass units wherein the plaintiff claimed that the insulated glass
manufactured with the use of coated film manufactured by the Company was subject
to various failures and deficiencies, giving rise to warranty and other consumer
claims. Plaintiff is claiming damages for past replacement cost and future
potential claims. The lawsuit was settled in March 2000 for $500. Accordingly an
expense of $500 was accrued at December 31, 1999.
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 $32 million. The Company believes the lawsuit is without merit and
intends to vigorously defend its position.
The Company's German subsidiary is a defendant in a lawsuit filed by one of
its suppliers on March 21, 2000 in a German court to seek payment of $922 for
engineering services rendered in connection with developing the plans for a new
plant. The Company issued letters of award to the plaintiff amounting to $256
prior to terminating their services for not meeting their expectations. The
plaintiff claims fees for services rendered, including the costs of significant
modifications and revisions requested by the Company calculated in accordance
with the German Federal Schedule of Architects' fees. The plaintiff further
alleged that the Company utilized their planning work in further developing the
plant. The Company believes that the suit is without merit and intends to
vigorously defend its position. Although the Company believes that it will
prevail, a $256 portion of the claim was accrued as a liability, as it is likely
that this amount will be awarded to the plaintiff.
In August 2000, the Company, its Chief Executive Officer, Thomas G. Hood,
and former Chief Financial Officer, Bill R. Finley, have been named as
defendants in seven lawsuits, all filed in the United States District Court for
the Northern District of California (Docket Nos: C-00-2792-MMC; C-00-2795-BZ;
C-00-2834-SC; C-00-20856-EAI; C-00-3007-EDL; C-00-3027-JCS; and C-00-3079-MMC)
(the "Actions") all alleging violations of the federal securities laws. Each of
the plaintiffs in the Actions alleges that he purchased shares in the Company
and seeks to represent a class of shareholders who purchased shares during the
period April 26, 2000 through August 1, 2000, such dates constituting the period
from the Company's release of its financial results for the first quarter of FY
2000, to the date that it issued its press release announcing that it would be
restating its financial statements for that quarter. The substantive allegations
in each of the Actions are essentially the same, i.e., that the defendants knew,
or were reckless in not knowing, that the Company's first quarter financial
statements were in error and violated Generally Accepted Accounting Principles,
and that as a result the putative class members purchased stock at artificially
inflated prices and were damaged. It is anticipated that the Actions will be
consolidated into a single action by the filing of an Amended Consolidated
Complaint. No pleading in response to the Actions is yet due. The Company
believes the Actions to be wholly without merit and intends to defend them
vigorously.
In the third quarter of 2000, the Company was named a co-defendant, along
with a glass manufacturer, in a legal suit brought by certain contractors. The
contractors alleged the insulating glass units (`IGU') installed at an airport
project, which incorporated the Company's insulation film, have failed. The
Company is in the process of assessing the claim and expects to vigorously
defend this suit.
35
<PAGE>
In addition, the Company is involved in a number of other legal actions
arising in the ordinary course of business. The Company believes, that the
various asserted claims and litigation in which it is involved will not
materially affect its consolidated financial position, future operating results
or cash flows.
In 1995 the Company started selling its anti-reflective film under a Supply
Agreement to Sony Corporation of Japan ("Sony"). In the fourth quarter of 1998
the Company experienced some quality problems related to the anti-reflective
film that did not meet Sony's specifications. The Company further did not meet
the minimum shipping requirements stated in the Supply Agreement. As a result,
in the fourth quarter of 1998, the Company recorded a $4.0 million charge to
cover any loss contingency. $1.7 million of the charge related to the write-off
of inventory and was allocated to cost of goods sold. The remaining $2.3 million
related to sales returns and penalties associated with the shipment shortfall
and was recorded as a reduction to net revenues.
During the second quarter of 1999, the Company reached a settlement with
Sony, wherein Sony agreed to release the Company from any and all penalties,
claims, demands and liabilities that Sony has or will have against the Company
in connection with the shipment shortfall experienced in 1998. In consideration
of Sony's waiver, the Company agreed to waive its claims for payment of the
outstanding accounts receivable from Sony totaling $2.5 million brought forward
from 1998. The amount was written off against the $2.3 million sales return
reserve booked in 1998 and the remaining $200 was reversed. As of September 30,
1999, Southwall terminated all production of anti-reflective film for Sony, as
mutually agreed under an amended Supply Agreement, and there were no further
shipments to Sony.
NOTE 10 - RELATED PARTY TRANSACTIONS
The Company has the following transactions with related parties in which
the related parties are also shareholders of the Company.
<TABLE>
<CAPTION>
Year ended December 31
----------------------
1998 1999
---- ----
<S> <C> <C>
Sales $ 0 $ 230
Purchases of Raw Materials 7,800 10,700
License fee paid 100 100
Interest paid by stock 186 93
</TABLE>
NOTE 11 - RESTATEMENT OF 1999 FINANCIAL STATEMENTS
On August 1, 2000, the Company announced that it expected to restate its
previously issued first quarter interim results and that there would be a
delay in the issuance of the second quarter results. Subsequently, the
Company determined that previously issued 1999 financial statements required
restatement for the following items: under recognition of expenses ($1,142);
deferral of revenue recognition ($733); and recognition of the settlement of
a lawsuit in March 2000 ($500). The Company also reclassified to restricted
cash that portion of cash ($1,883) that is restricted to payments for the
facility in Germany. The Company further reclassified long-term debt
($12,084) to current liabilities to the extent that it cannot determine if it
can meet the covenants.
36
<PAGE>
<TABLE>
<CAPTION>
As Reported As Restated
----------- -----------
<S> <C> <C>
Net Revenue $55,331 $54,598
Cost of Sales 39,766 40,706
Legal Settlement - 500
Income (loss) from Operations 1,848 (527)
Net income (loss) $ 510 $(1,865)
=== =====
Net income (loss) per share
Basic $ 0.07 $ (0.25)
Diluted $ 0.07 $ (0.25)
</TABLE>
NOTE 12 -GOING CONCERN AND LOAN COVENANTS
Loan Covenants
Pursuant to the loan and or lease agreements listed above, and related
terms, conditions and covenants we requested and received waivers from the
financial institutions, except the German bank loans and sale-leaseback
agreements as discussed below, related to the Company's default or event of
default pursuant to these respective agreements or otherwise arising in
connection with the Company's requirement to restate prior financial periods,
the financial position of the Company reflected in such restated financial
statements, the Company's failure to file its Form 10-Q for the second quarter
of 2000 in a timely manner and trading halts or other actions taken or
threatened to be taken by NASDAQ, or any law suits filed or threatened to be
filed in connection with such restatements or late filings.
The Company has received from the German banks a waiver of the Events of
Default pursuant to the agreements but the German banks did not provide a waiver
of the Events of Default or any rights it may have with respect to any further
material adverse change in the financial condition of the Company resulting from
the Events of Default and the German banks have reserved the right to terminate
the loan agreements after the third and fourth quarter of 2000 if the
expectations relating to turnover and profit as provided by the Company don't
occur and provide a cause for termination. The Company cannot currently
determine with reasonable certainty whether it will be able to comply with these
provisions and accordingly has reclassified these loans from long-term to
current liabilities in the balance sheet.
Also the Company is in discussions with the leasing company for the
sale-leaseback agreements dated July 19, 1999 and October 19, 1999 concerning a
waiver of Events of Default related to the material adverse change discussed
above. The Company cannot currently determine with reasonable certainty whether
it will obtain such waiver and accordingly has reclassified these agreements
from long-term to current liabilities in the balance sheet.
Going Concern
37
<PAGE>
On July 12, 2000, the Company's receivable financing line of credit was
increased to $12.0 million. This increase will expire September 30, 2000, at
which time the credit limit will be reduced to $10.0 million. The Company is
exploring other potential revolving credit arrangements, although no assurance
can be given that it will succeed. In addition, the Company's promissory note
dated December 16, 1996 will be fully repaid by November 2000. The Company is
seeking new equipment financing to replace this loan, using its underlying
security as collateral.
These consolidated financial statements have been prepared assuming that the
Company will continue as a going concern. The Company has experienced recurring
losses from operations, has significant current and long-term debt containing
certain covenants with which the Company has not complied requiring the Company
to obtain waivers and to classify as a current liability the debt for which
waivers have not been obtained, and on-going capital commitments for debt
service, manufacturing facilities and equipment that raise substantial doubt
about its ability to continue as a going concern. The financial statements do
not include any adjustments that might result from the outcome of this
uncertainty. As a result of this uncertainty, the Company may not be able to
carry out all of its proposed capital expenditures or to otherwise finance its
operations as currently proposed. The Company believes that it will need
additional financing to meet its operating cash requirements through 2000 and
beyond. However, the Company can give no assurances it will be successful in
obtaining the required additional financing and cash from operations.
38
<PAGE>
ITEM 9. CHANGES IN AND DISAGREEMENTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE
None
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF REGISTRANT
The information required by this Item concerning the Company's executive
officers is contained at the end of Part I in the unnumbered item captioned
"Executive Officers of the Registrant." Certain other information required
regarding the Directors of the Company is contained in the Company's Proxy
Statement for its 2000 Annual Meeting of Stockholders (the "Proxy Statement")
under the caption "Election of Directors" and is incorporated herein by
reference.
Certain information regarding reports required to be filed pursuant to
Section 16(a) of the Securities Exchange Act of 1934 by directors, officers and
beneficial owners of 10% or more of the Company's common stock is contained in
the Company's Proxy Statement for its 2000 Annual Meeting of Stockholders (the
"Proxy Statement") under the caption "Section 16(a) Beneficial Ownership
Reporting Compliance" and is incorporated herein by reference.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this Item is incorporated by reference to
the sections entitled "Executive Officer 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.
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:
(a)(1) FINANCIAL STATEMENTS. The following Financial
Statements of Southwall Technologies Inc.
are filed as part of this Form 10-K\A:
<TABLE>
<CAPTION>
Form 10-K\A
Page Number
-----------
<S> <C>
Report of Independent Accountants 19
Consolidated Balance Sheets as of
December 31, 1998 and 1999 20
39
<PAGE>
Consolidated Statements of Operations
for the years ended December 31, 1997,
1998 and 1999 21
Consolidated Statements of Stockholders'
Equity for the years ended December 31,
1997, 1998 and 1999 22
Consolidated Statements of Cash Flows
for the years ended December 31, 1997,
1998 and 1999 23
Notes to Consolidated Financial Statements 24
</TABLE>
40
<PAGE>
(a)(2) FINANCIAL STATEMENT SCHEDULES.
VALUATION AND QUALIFYING ACCOUNTS AND RESERVES
<TABLE>
<CAPTION>
<S><C>
Additions
Balance at Charged to Charged to
Beginning Cost and other Balance at
Description of Year Expensed Accounts Deductions End of Year
----------- ------- -------- -------- ---------- -----------
A. Deducted from related assets
-------------------------------
Inventory reserves 2,257 1,699 - 2,774(2) 1,182
Allowance for Bad Debts 845 320 - 290(2) 875
B. Included with other accrued liabilities
------------------------------------------
Reserve for warranty
and sales returns 2,858 - 2,017 (1) 3,701(2) 1,174
</TABLE>
Notes:
------
(1) Charged against revenue
(2) Reserves utilized during the year
(a)(3) EXHIBITS. Reference is made to the Exhibit Index on
pages 43 through 46 of this Form 10-K\A.
(b) REPORTS ON FORM 8-K.
No reports on Form 8-K were filed during the
quarter ended December 31, 1999.
41
<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 29th day of
September 2000.
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 September 29, 2000.
Signature Title
--------- -----
/s/Thomas G. Hood President, Chief Executive Officer
----------------- and Director (Principal Executive
(Thomas G. Hood) Officer)
/s/Robert R. Freeman Senior Vice President, Chief Financial
-------------------- Officer and Secretary (Principal
(Robert R. Freeman) Financial and Accounting Officer)
42
<PAGE>
INDEX TO EXHIBITS
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(17) Lease Agreement for the facilities at 3941 East Bayshore
Road, dated October 7, 1999, 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.
10.36.1(17) Amendment, dated October 12, 1999, between the Company and
Brown Investment Company to the 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(17) 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.
10.59.1(17) Amendment, effective January 1, 2000, between the Company
and Judd Properties, LLC to the 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.
43
<PAGE>
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.
10.60.1(17) Amendment, effective January 1, 2000, between the Company
and Judd Properties, LLC to the 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.
10.62(3) Common Stock Sales Agreement, dated May 2, 1989, between
the Company and Monsanto Company.
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.
10.84(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.
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<PAGE>
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.
21 (16) List of Subsidiaries of Southwall Technologies Inc.
23 Consent of Independent Accountants.
27.1 Financial Data Schedule
99.1(9) Letter, dated June 5, 1987, from the U.S. Department of the
Air Force to the SEC Pursuant to Rule 171.
---------------
(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\A 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.
45
<PAGE>
(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.
(16) Filed as an exhibit to the Form 10-K Annual Report 1998, filed with the
Commission on March 31, 1999.
(17) Filed as an exhibit to the Form 10-K Annual Report 1999, filed with the
Commission on April 6, 2000.
46
