-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, VJI26rLHALbvH6jvM0o6OwH6pM6zxN/PJa/xCf+C74eH8B4BYb9Yf+Lkir0JgblI oiD0Bqk4w/vXLw/QVVsLxA== 0000352956-99-000007.txt : 19990407 0000352956-99-000007.hdr.sgml : 19990407 ACCESSION NUMBER: 0000352956-99-000007 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 6 CONFORMED PERIOD OF REPORT: 19981231 FILED AS OF DATE: 19990406 FILER: COMPANY DATA: COMPANY CONFORMED NAME: FAFCO INC CENTRAL INDEX KEY: 0000352956 STANDARD INDUSTRIAL CLASSIFICATION: HEATING EQUIPMENT, EXCEPT ELECTRIC & WARM AIR FURNACES [3433] IRS NUMBER: 942159547 STATE OF INCORPORATION: CA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 000-10120 FILM NUMBER: 99587985 BUSINESS ADDRESS: STREET 1: 2690 MIDDLEFIELD RD CITY: REDWOOD CITY STATE: CA ZIP: 94063 BUSINESS PHONE: 6503632690 MAIL ADDRESS: STREET 1: 2690 MIDDLEFIELD ROAD CITY: REDWOOD CITY STATE: CA ZIP: 94063 10-K 1 THIS DOCUMENT IS A COPY OF THE ANNUAL REPORT ON FORM 10-K FILED ON APRIL 1ST, 1999 PURSUANT TO A RULE 201 TEMPORARY HARDSHIP EXEMPTION. SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K (Mark One) [X] Annual report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the fiscal year ended December 31, 1998 or [ ] Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the transition period from ________________ to _______________. Commission file number 0-10120 FAFCO, Inc. (Exact name of registrant as specified in its charter) California (State or other jurisdiction of incorporation or organization) 94-2159547 (IRS Employer Identification No.) 2690 Middlefield Road, Redwood City, California 94063 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: 650/363-2690 Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: Common Stock, $0.125 par value (Title of Class) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No ____ Indicate by check mark if the disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X ] The aggregate market value of the registrant's Common Stock held by non- affiliates of the registrant as of March 12, 1999 was $2,216,100 , based upon the average of the bid and ask prices reported for such date by the National Quotation Bureau. For purposes of this disclosure, shares of Common Stock held by persons who hold more than 5% of the outstanding shares of Common Stock and shares held by executive officers and directors of the registrant have been excluded in that such persons may be deemed to be "affiliates" as that term is defined under the rules and regulations promulgated under the Securities Act of 1933. This determination is not necessarily conclusive for other purposes. The number of shares of the registrant's Common Stock outstanding as of December 31, 1998, was 3,303,311. Documents Incorporated by Reference Document Description Form 10-K Part Portions of Exhibit 13.1 (the Company's 1998 Annual Report to Shareholders) (the "Annual Report") .............................................I, II, IV The Company's Definitive Proxy Statement (the "Proxy Statement") for the 1999 Annual Meeting of Stockholders to be held on May 6, 1999 (the Proxy Statement is expected to be filed pursuant to Regulation 14A on or before April 30, 1999)................................... .................... III _____________________________ With the exception of the information specifically incorporated by reference in Parts I, II, III and IV of this Form 10-K, neither the Company's Annual Report nor the Company's Proxy Statement is to be deemed filed as part of this report. PART I Item 1. Business Introduction FAFCO, Inc. ("FAFCO," the "Company" or "Registrant") designs, develops, manufactures, and markets solar heating systems for swimming pools and thermal energy storage systems for commercial and industrial cooling. Pool product sales amounted to 53% of net sales in 1998 compared to 56% of net sales in 1997 and 58% of net sales in 1996. Thermal energy storage sales amounted to 47% of net sales in 1998 compared to 44% of net sales in 1997 and 42% of net sales in 1996. The Company manufactures products for the solar heating of water for low and medium temperature applications. From the inception of the Company's predecessor as a sole proprietorship in 1969 until 1976, efforts were largely devoted to the refinement of the Company's initial product, a solar heating system for swimming pools - a low temperature solar application. Since that time, the Company has focused on increasing its share of the pool heating market by extending its network of independent distributors, decreasing its manufacturing costs, and improving its initial product. In 1983, a passive domestic hot water heating system, the 444, was introduced (this product was discontinued in early 1994). In 1987, the Company introduced a thermal energy storage system based on the same heat exchanger technology as is used in its swimming pool heating systems. In 1993, the Company introduced a state-of-the-art control system for swimming pool solar heating systems (this product was discontinued in December 1996). FAFCO, Inc. was incorporated under the laws of the State of California in 1972. Its principal executive offices are located at 2690 Middlefield Road, Redwood City, California. Its telephone number at that address is (650) 363-2690. Safe Harbor Statement This Annual Report on Form 10-K contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Actual results could differ materially from those projected in the forward-looking statements as a result of the risk factors set forth on page 16 of the Annual Report under the heading "Factors Affecting Future Results" which is incorporated herein by reference and elsewhere in this Form 10-K. Markets Swimming Pool Heating Low temperature solar applications developed because of the cost effectiveness of solar systems in heating a large volume of water to produce a small temperature change. The market for swimming pool heating developed for several reasons. First, pool owners normally use their pools when solar energy is abundant (during daylight hours and the summer swimming season). Second, pools already have two elements needed for low temperature water heating: storage (the pool water) and circulation (the existing pool pump and associated plumbing). Third, pool owners are an easily identifiable market. Thermal Energy Storage FAFCO also designs, develops, manufactures, and markets a static, glycol ice builder for the thermal storage market. Since the product's introduction, FAFCO has sold "ice banks" primarily to the commercial air conditioning market for use in off-peak air conditioning systems. Products Swimming Pool Heating The FAFCO solar pool heating system is composed of six to twelve solar collectors, a sun sensor, an automatic control, and associated accessories. The collectors and sensor are typically mounted on the roof of a pool owner's home and connected to the pool pump and automatic control. The customer sets the automatic control for the desired water temperature and, when the sensor detects that there is sufficient solar energy for the system to function efficiently, the automatic control directs the flow of water from the pool to the collectors. The water absorbs heat as it passes through the collectors and then flows back to the pool. When the desired water temperature is achieved or when there is insufficient solar energy, the automatic control redirects the flow of water back to the pool and water is drained from the collectors. When the water temperature drops and there is sufficient solar energy, the system is reactivated automatically. In February 1996, the Company introduced a version of its solar pool heating system specifically designed for above-ground swimming pools. This system is composed of one or two solar collectors optimized for use in heating above-ground swimming pools and designed to lie flat on the ground or to be mounted on a rack on the ground. In May 1996, the Company introduced a new and improved version of its solar collector that has a higher thermal performance due to its unique heat exchanger tube design. The tube design incorporates molded indentations, which enhance the heat transfer coefficient by increasing fluid turbulence. The Company's solar collectors are composed entirely of a polyolefin material (a high molecular weight polymer compound) and made up of small round tubes formed side by side in a rectangular shape either one-by-two meters, four-by-eight feet, four-by-ten feet, four-by-twelve feet or four-by-twenty feet in size, with submanifolds and header pipes thermoformed on each end. This design provides for a maximum heating surface and even water flow in order to transfer 75% to 90% of the available solar energy to the pool water. The polyolefin material, which has been specially formulated by the Company, is black in color (to optimize solar energy absorption) and has the inherent advantages over other possible materials of lower cost, lighter weight, and higher resistance to the corrosive effects of pool chemicals and degradation resulting from ultraviolet radiation, heat, and other environmental effects. In May 1993, the Company introduced a proprietary microprocessor-based control (AutoPool) for its solar pool heating systems. Prior to May 1993, the Company had a private label arrangement with an automatic control manufacturer. AutoPool has built-in "intelligence" that allows it to optimize the heating and filtration time for the swimming pool and can also control non-conventional solar swimming pool heaters. Because of lack of demand for the Company's AutoPool Control, this product was discontinued effective January 1, 1997. The Company has ongoing obligations to service and provide spare parts for AutoPool controls sold prior to that time. Thermal Energy Storage The Company's thermal energy storage ("IceStor?") systems utilize nighttime electric capacity to create stored cooling energy. This is normally done by storing inexpensive "off-peak" energy in the form of either chilled water or ice. The next day this stored cooling capacity is used in conjunction with a building's air conditioning equipment to significantly reduce electrical power requirements for cooling during times of high power demand and high electrical cost. Cool storage systems offer power utilities a solution to a fundamental, long-term problem: increased peak demand for power during periods of limited available capacity (i.e., during business hours). IceStor? technology shifts power consumption to off-peak periods when there is available capacity and lower demand. Marketing and Sales Solar Systems FAFCO markets its solar systems and controls in the United States through independent distributors who sell directly to end users. Distributors generally have sales, installation, and service personnel who are supported by extensive FAFCO marketing and technical materials as well as in-depth factory and field training programs. The majority of sales personnel employed by the typical distributor are assigned to retrofit sales, which are sales to existing pool owners. Retrofit sales are generated through direct mail, customer referrals, canvassing, and, to a lesser extent, selected media advertising. The balance of the typical distributor's sales personnel are generally assigned to contractor accounts and seek referrals for new construction sales. FAFCO usually provides direct mail literature and other advertising materials to distributors and mails or places these materials with local advertisers on the distributors' behalf and partially at the distributors' expense. In certain instances, distributors will also engage in direct mailing and advertising. In the past, the Company has canceled several distributor agreements for reasons of inadequate performance by the distributor, primarily for failure to provide adequate sales, installation and service support for the Company's products. In such instances, the Company has generally been able to find qualified replacements. All work relating to the installation of FAFCO solar systems is covered by a full one-year warranty provided by the distributor. The Company's solar collectors used to be covered by a ten-year limited warranty, which was changed to a ten-year full warranty beginning in 1991. Its automatic controls, pumps, and drain-down valves are covered by a three-year limited warranty. FAFCO warranties cover defects in materials and workmanship provided that the related products are used for their intended purpose. FAFCO solar systems are designed to require only minimal maintenance, which can be performed either by the consumer using an owner's manual or by the distributor's service personnel. Thermal Energy Storage Systems The Company markets its IceStor? products through independent contractors who design and build heating and cooling systems for commercial and industrial applications. The Company has also licensed its IceStor? products for sale overseas, to design-and-build, heating, ventilating, and air-conditioning companies in Taiwan, Korea, Japan, and The Peoples Republic of China. These licensing agreements provide for licensees' assembly, sales, support, and maintenance of IceStor? products in those countries. Sales by Geographic Area The Company's net sales during 1998, 1997, and 1996 were geographically distributed approximately as follows: 1998 1997 1996 California 19% 22% 17% Florida 31% 31% 34% Other U.S. 14% 19% 35% Foreign Countries 36% 28% 14% 100% 100% 100%
One of the Company's customers, Ebara Corporation, accounted for 23.4% of the Company's fiscal 1998 net sales and 18.6% of the Company's fiscal 1997 net sales. Kailay International (now known as FAPCO), Ebara Corporation, and Florida Solar are accounted for 14.0%, 12.1%, and 11.8% of the Company's fiscal 1996 net sales, respectively. During 1996, 1997 and 1998 Kailay International and Ebara Corporation were the licensees for the Company's IceStorT products in Taiwan and Japan, respectively, and, as such, purchased IceStorT products and components for assembly into products for resale to end users in Taiwan and Japan, respectively. During 1996, Florida Solar was a distributor of the Company's pool products and, as such, purchased pool panels and components for resale to end users in Florida. No other customer accounted for 10% or more of the Company's net sales in fiscal 1996, 1997 or 1998. Any material cancellation, reduction or rescheduling of orders from a major customer, particularly Ebara Corporation, or the loss of any such customer would have a material adverse effect in the Company's financial condition and operation results. Foreign sales of the Company's products are made through independent foreign distributors and licensees. Sales to foreign distributors and licensees are shipped directly from the Company's facilities in California and invoiced in U.S. dollars. Export sales are subject to certain controls and restrictions, including tariffs and import duties, and are subject to certain risks, including changing regulatory requirements of foreign jurisdictions and transportation delays and interruptions; however, the Company has not experienced any material difficulties in the past relating to such limitations. The financial crisis in Southeast Asia has not had any noticeable negative effect on sales; however, there is no assurance that sales will not be negatively affected if the crisis worsens or is prolonged. Backlog Sales to solar distributors are made against individual purchase orders rather than through volume purchase arrangements. The Company typically ships its products within one to five days of receipt of an order; therefore, the Company's backlog at any date is usually insignificant and is not a meaningful indicator of future sales. FAFCO distributors tend to order frequently in small quantities in order to minimize their inventory levels and match inventory levels with current installation schedules. Sales of IceStor? products are made against individual purchase orders to general contractors or Heating, Ventilating, and Air conditioning (HVAC) contractors for specific new construction projects or for retrofit in existing buildings. The Company typically ships these products within six weeks or less of receipt of an order; therefore, the Company's backlog with respect to IceStor? products at any date is also usually insignificant and not a meaningful indicator of future sales. Government Tax Incentives Although the Company's operations are not directly subject to extensive governmental regulations, the existence or lack of federal, state, and local tax incentives for the sale and installation of solar systems would have a substantial impact on the Company's business. There is currently no federal tax credit for solar heating systems and state solar tax credits are available only in a few states. The Company does not anticipate that solar tax credits will become available for solar heating systems in any additional states, nor does it anticipate a significant increase in sales due to existing or future tax credits. Manufacturing FAFCO's manufacturing activities consist primarily of the production of polyolefin heat exchangers used in solar heating applications and off-peak cooling applications and associated accessories. A total system approach is emphasized in order to ensure the effectiveness and reliability of the Company's products after they have been installed, eliminating the need for distributors to rely upon materials from other suppliers. The Company's heat exchangers are produced from polyolefin resins using a patented extrusion and thermoforming process. Substantially all equipment used in these processes has been designed and built by the Company's research and development engineers. The resins employed by the Company are a petroleum by-product. The market price of these resins has fluctuated over the years with an increase in 1990 and early 1991 due to tensions in the Middle East, followed by a stabilization after the completion of Desert Storm. It is expected that the price of the resins will continue to fluctuate as a result of domestic and international political and economic conditions. FAFCO has qualified multiple sources of supply for all of its resins, materials, and subassemblies. However, certain materials and subassemblies are currently obtained from single sources. The Company believes these items could be supplied by the Company's other qualified sources if sufficient lead-time were provided. The Company attempts to maintain additional inventory of such materials to mitigate the risk of supply shortages; however, any prolonged inability to obtain such items would have a material adverse effect on the Company's results of operations. To date, the Company has not experienced any significant manufacturing problems or delays due to shortages of materials. Quality assurance is performed by FAFCO at its manufacturing facility. Test and inspection procedures are a part of substantially all production and assembly operations. In addition, the Company uses it own diagnostic equipment and laboratory to continually test and inspect raw materials, work in process, and finished goods. Competition The Company's solar heating products currently compete directly with solar heating products offered by other domestic and international manufacturers of solar heating systems, and indirectly with conventional heating systems. The Company believes that the principal competitive factors in the markets for FAFCO solar products are (i) product performance and reliability; (ii) marketing and technical support from the manufacturer for distribution channels; (iii) selling, installation, and service capabilities of distribution channels; and (iv) price. The Company believes that it competes favorably with respect to all of these factors. However, certain of its competitors may have greater financial, marketing, and technological resources than those of the Company. A number of companies in the United States manufacture thermal energy storage systems of various types similar to the Company's IceStor? product. The industry is in the early stages of development and additional competitors are expected to enter the market over time. At the present time, the Company believes that the main competitive factors in the thermal energy storage market are performance, reliability, and price. The Company believes that it competes favorably with respect to these factors. However, several of its competitors have greater financial, marketing, and technological resources than those of the Company. Research and Development For the years ended December 31, 1998, 1997, and 1996, the Company's research and development expenses were $194,100, $202,800, and $116,000, respectively. The Company currently uses consulting engineers, in addition to staff engineers, who are responsible for existing product improvement, applications engineering, and new product research and development. The Company is exploring other potential revenue-producing uses for its polyolefin extrusions. Patents, Trademarks and Licenses FAFCO currently holds two United States patents and one foreign patent relating to certain aspects of its products and manufacturing technology. These patents expire at various times between March 2000 and July 2003. However, the Company believes that patent protection is secondary to such factors as ongoing product development and refinement, the knowledge and experience of its personnel, and their ability to design, manufacture, and successfully market the Company's products. From time to time, the Company has registered as trademarks certain product names and marks in order to preserve its right to those product names and marks. The Company has granted licenses to assemble and sell IceStor? systems in Taiwan, Korea, Japan, and the Peoples Republic of China to local manufacturers. See "Marketing and Sales" above. Employees At December 31, 1998, the Company had a total of 61 full-time employees, including eight in marketing, five in research and development, 37 in manufacturing, and 11 in general management and administration. The Company also uses temporary employees from agencies to fill seasonal needs. The Company has never had a work stoppage. To the Company's knowledge, no employees are represented by a labor organization. Seasonality Information regarding the seasonality of the Company's business is set forth in "Management's Discussion and Analysis of Financial Condition and Results of Operations - Seasonality" on page 16 of the Annual Report, which information isincorporated herein by reference. Segment Information Following the sale of the business of the Company's subsidiary, The Gregory Company, in 1988, the Company has only had continuing operations in the energy products segment. Environmental Regulations The Company is subject to a number of environmental regulations concerning potential air and water pollution. However, such regulations have not in the past had, and are not expected to have, any material adverse effect on the Company's business. However, there can be no assurance that compliance with existing or future regulations will not require the expenditure of funds or the modification of the Company's manufacturing process, which could have a material adverse effect on the Company's business or financial condition. Item 2. Properties The Company's principal executive offices and manufacturing facilities for its products are located in a single 42,500 square foot facility in Redwood City, California. A lease expiring in the year 2000 covers this facility. This lease has an option to extend through 2005. See Note 10 of Notes to Consolidated Financial Statements on page 13 of the Annual Report, which information is incorporated herein by reference. The Company believes that its current facilities are adequate to meet its requirements for space in the near future. Manufacturing space is being fully utilized at the present time. However, additional demand can be accommodated by adding additional employee shifts. Item 3. Legal Proceedings There are presently no material pending legal proceedings to which the Company is a party or to which any of its property is subject, except for ordinary routine legal proceedings incidental to the Company's business. Item 4. Submission of Matters to a Vote of Security Holders The Company did not submit any matter to a vote of security holders during the fourth quarter of its fiscal year ended December 31, 1998. The executive officers of the Company are set forth below. All officers serve at the pleasure of the Board of Directors. There are no family relationships between any executive officers or directors. Freeman A. Ford, age 58, serves as Chairman of the Board, President, and Chief Executive Officer. Mr. Ford, a co-founder of the Company, has served as Chairman of the Board since 1972, as Chief Executive Officer of the Company since May 1979, and as President since September 1984. Mr. Ford is also a Director of H.B. Fuller Company. Alex N. Watt, age 57, serves as Vice President of Finance and Administration, Chief Financial Officer, and Secretary. Mr. Watt joined the Company as its Vice President-Finance and Chief Financial Officer in July 1984, and has served as Secretary since March 1985. David Harris, age 43, serves as Vice President, Sales. Mr. Harris joined the Company in August 1981 as a sales representative and has held the positions of Pool Builder Manager, National Sales Manager-Pool Products, Pacific Northwestern Region Sales Manager, National Sales Manager-Solar Division, National Sales Manager, Vice President-Sales and Marketing (from June 1988 until April 1993) and President-Pool Products Division (from May 1993 until May 1995). PART II Item 5. Market for Registrant's Common Equity and Related Stockholder Matters Information regarding the market for and market prices of the Company's Common Stock, the number of shareholders of record, and information regarding dividends is set forth under the heading "Common Stock Data" on page 15 of the Annual Report, which information is incorporated herein by reference. Item 6. Selected Financial Data Selected financial data for the Company is set forth in the table entitled "Five-Year Summary of Operations" on page 15 and in the last sentence of the text under the table entitled "Common Stock Data" on page 15 of the Annual Report, which information is incorporated herein by reference. Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations Information regarding Management's Discussion and Analysis of Financial Condition and Results of Operations is set forth under the heading "Management's Discussion and Analysis," on pages 16 through 18 of the Annual Report, which information is incorporated herein by reference. Item 7A. Quantitative and Qualitative Disclosures about Market Risk The following discussion about the Company's market risk exposure involves forward-looking statements. Actual results could differ materially from those projected in the forward-looking statements. The Company is exposed to market risk related to changes in interest rates, foreign currency exchange rates and equity security price risk. The Company does not use derivative financial instruments for any purpose, including hedging interest and foreign exchange risks. The Company is exposed to financial market risks, including changes in foreign currency exchange rates and interest rates. The Company attempts to minimize its currency fluctuation risk by pricing its overseas product sales and license fees in United States dollars. A 10% change in the foreign currency exchange rates would not have a material impact on the Company's results of operations. The Company maintains short-term investments consisting of variable interest accounts. However, due to the short-term nature of the Company's debt investments, the impact of interest rate changes would not have a material impact on the value of such investments. The Company is also exposed to interest rate risk on outstanding fixed rate promissory notes. However, the balance of fixed rate debt obligations of the Company is currently relatively insignificant. As a result, the Company does not actively manage the risk associated with these obligations. The impact of interest rate changes would not have a material impact on the Company's results of operations. The Company currently holds no marketable equity securities of other issuers that are subject to market price volatility. Item 8. Financial Statements and Supplementary Data The consolidated financial statements of the Company are set forth on pages 3 through 12 of the Annual Report, which information is incorporated herein by reference. The supplementary financial information requirements of Regulation S-K Item 302 do not apply to the Company, because the Company does not meet the tests set forth therein. Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure Not applicable. PART III Item 10. Directors and Executive Officers of the Registrant Information regarding directors and nominees for directors is to be set forth under the heading "Election of Directors - Nominees" in the Company's Proxy Statement, which information is incorporated herein by reference. Information regarding the filing of reports by insiders under Section 16(a) of the Exchange Act is to be set forth under the heading "Election of Directors - Section 16(a) Beneficial Ownership Reporting Compliance" in the Company's Proxy Statement, which information is incorporated herein by reference. Item 11. Executive Compensation Information regarding the Company's remuneration of its executive officers and directors is to be set forth under the headings "Election of Directors - Executive Compensation" and "Election of Directors - Director Compensation" in the Company's Proxy Statement, which information is incorporated herein by reference. Item 12. Security Ownership of Certain Beneficial Owners and Management Information regarding the security ownership of certain beneficial owners and management is to be set forth under the headings "Election of Directors - Security Ownership" and "Information Concerning Solicitation and Voting - Record Date and Outstanding Shares" in the Company's Proxy Statement, which information is incorporated herein by reference. Item 13. Certain Relationships and Related Transactions Information regarding certain relationships and related transactions is to be set forth under the headings "Election of Directors - Nominees" and "Election of Directors - Certain Transactions" in the Company's Proxy Statement, which information is incorporated herein by reference. PART IV Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K (a) Documents filed as part of this report: 1. Financial Statements The consolidated balance sheets for the years ended December 31, 1998 and . 1997, the Consolidated Statement of Operations, of Shareholders' Equity and Cash Flows for each of the three years in the period ended December 31, 1998, and the notes thereto appear on pages 4 through 14 of the Annual Report. 2. Financial Statement Schedules The following schedule for the years ended December 31, 1998, 1997, and 1996 is included in this report. Such schedule should be read in conjunction with the consolidated financial statements in the Annual Report. Report of Independent Accountants on Financial Statement Schedule (see page 17). Schedule II - Valuation and Qualifying Accounts and Reserves (see page 18). Schedules not included in these financial statement schedules have been omitted because they are not applicable or the required information is shown in the financial statements or notes thereto. 3. Index to Exhibits The following exhibits are filed as part of or incorporated by reference, to the extent indicated herein, in this Annual Report on Form 10-K. Exhibit No. Description (footnotes appear at the end of the exhibit list) 3.1(1) Articles of Incorporation, as amended. 3.2(3) Bylaws, as amended. 3.2(a) 4.1(1) Stock Purchase Agreement dated April 14, 1977, between Registrant and certain investors. 4.2(3) 10% Convertible Subordinated Notes Purchase Agreement dated March 27, 1984, between Registrant and certain investors. 4.2(a)(2) Amendment to Subordinated Note Purchase Agreement dated March 27, 1990. 4.2(b)(9) Amendment to 10% Subordinated Note Agreement dated March 25, 1991. 4.3(4)* Security and Guaranty Agreement and Common Stock Purchase Warrant between the Registrant and Freeman A. Ford dated February 16, 1987. 4.3(a)(5)* Amendment to the Security and Guaranty Agreement between the Registrant and Freeman A. Ford dated December 8, 1987. 4.3(b)(6)* Amendment to the Security and Guaranty Agreement between the Registrant and Freeman A. Ford dated February 1, 1988. 4.3(c)(7)* Second Amendment to the Promissory Notes between the Registrant and Freeman A. Ford dated March 26, 1991. 4.3(d)(9)* Form of Common Stock Purchase Warrant issued March 25, 1993 by the Registrant to Freeman A. Ford. 4.3(e)(9) Amendment to the Promissory Notes between the Registrant and Freeman A. Ford dated March 25, 1993. 4.4(10) Common Stock Warrant issued January 19, 1994 to B. Severns. 4.5 Reference Exhibits 3.1 and 3.2. 10.1 Reference Exhibit 4.1. 10.2 Reference Exhibit 4.2, 4.2(a), and 4.2(b). 10.3(7)* 1981 Incentive Stock Option Plan. 10.4(7)* Form of 1981 Incentive Stock Option Agreement. 10.8(1) Standard Form of Distributor Agreement. 10.9(7) Lease Agreement and Addenda for 2690 Middlefield Road, Redwood City, California, between Registrant, as Lessee, and Beals Martin and Associates, as Lessor, dated January 18, 1990. 10.10(3) FAFCO Solar Partners II Certificate of Limited Partnership and Limited Partnership Agreement. 10.11 Reference Exhibits 4.3, 4.3(a), 4.3(b), 4.3(c), 4.3(d), and 4.3(e). 10.12(6) Licensing Agreement between the Registrant, as Licensor, and Enercon Engineering, as Licensee, dated May 20, 1988. 10.13(6)* Form of Director's Warrant issued February 1988 to directors Berry and Selig. 10.14(11)* 1991 Stock Option Plan, as amended. 10.14(a)(8)* Form of Stock Option Agreement used under the 1991 Stock Option Plan. 10.15(8)* 1991 Directors' Stock Option Plan. 10.15(a)(8)* Form of Nonstatutory Stock Option Agreement used under 1991 Director's Stock Option Plan. 10.16(8)* Employee Stock Purchase Plan. 10.16(a)(8)* Form of Subscription Agreement used under Employee Stock Purchase Plan. 10.17(9) Licensing Agreement and Addendum between the Registrant, as Licensor, and Jang-Han Systems Engineering, as Licensee, dated January 1, 1993. 10.18(10) Export - Import and Technical License Agreement between the Registrant, as Licensor, and Ebara Corporation, as Licensee, dated October 22, 1993. 10.19(10) Business Loan Agreement between Registrant, as Borrower, and Silicon Valley Bank, as Lender, dated June 10, 1992. 10.19(a)(10) Loan Modification Agreement between Registrant as Borrower, and Silicon Valley Bank, as Lender, dated March 8, 1994. 10.19(b)(12) Loan Modification Agreement between Registrant as Borrower, and Silicon Valley Bank, as Lender, dated June 5, 1995. 10.19(c)(12) Loan Modification Agreement between Registrant as Borrower, and Silicon Valley Bank, as Lender, dated August 7, 1995. 10.19(d)(12) Loan Modification Agreement between Registrant as Borrower, and Silicon Valley Bank, as Lender, dated September 22, 1995. 10.19(e)(12) Loan Modification Agreement between Registrant as Borrower, and Silicon Valley Bank, as Lender, dated February 8, 1996. 10.19(f)(13) Loan Modification agreement between Registrant as Borrower, and Silicon Valley Bank, as Lender, dated October 30, 1996. 10.19(g)(13) Loan Modification Agreement between Registrant, as Borrower, and Silicon Valley Bank, as Lender, dated December 11, 1996. 10.19(h)(13) Loan Modification Agreement between Registrant, as Borrower, and Silicon Valley Bank, as Lender, dated January 6, 1997. 10.19(i)(13) Loan Modification Agreement between Registrant, as Borrower, and Silicon Valley Bank, as Lender, dated January 21, 1997. 10.19(j)(14) Loan Modification Agreement between Registrant, as Borrower, and Silicon Valley Bank, a Lender, dated April 1, 1998. 10.19(k) Loan Modification Agreement between Registrant, as Borrower, and Silicon Valley Bank, a Lender, dated March 22, 1999. 10.20(11) Agency/Distributorship Agreement between Registrant as Manufacturer and Jabria Establishment, as Agent/Distributorship, dated December 10, 1994. 11.1 Computation of Earnings Per Share (see Note 12 of Notes to Consolidated Financial Statements on the 1997 Annual Report). 13.1 Registrant's 1998 Annual Report to Shareholders. 18.1(14) Letter re change in Accounting Principle from Burr, Pilger & Meyer dated November 5, 1997. 21.1 Subsidiaries of Registrant. 23.1 Consent of Independent Accountants (see page 20) 24.1 Power of Attorney (see page 19). 27.1 Financial Data Schedule.
* Denotes a management contract or compensatory plan or arrangement. (1) Incorporated by reference to exhibit filed with Registrant's Registration Statement on Form S-1 (File No. 2-72297) filed May 14, 1981. (2) Incorporated by reference to exhibit filed with Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1989. (3) Incorporated by reference to exhibit filed with Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1983. (4) Incorporated by reference to exhibit filed with Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1986. (5) Incorporated by reference to exhibit filed with Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1987. (6) Incorporated by reference to exhibit filed with Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1988. (7) Incorporated by reference to exhibit filed with Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1990. (8) Incorporated by reference to exhibit filed with Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1991. (9) Incorporated by reference to exhibit filed with Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1992. (10) Incorporated by reference to exhibit filed with Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1993. (11) Incorporated by reference to exhibit filed with Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1994 (12) Incorporated by reference to exhibit filed with Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1995. (13) Incorporated by reference to exhibit filed with Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1996. (14) Incorporated by reference to exhibit filed with Registrant's Annual Report on Form 10K for the fiscal year ended December 31, 1998. (b) Reports on Form 8-K: No Reports on Form 8-K were filed by the Company during the fourth quarter of 1998 . (c) Exhibits: See subsection (a) (3) above. (d) Financial Statement Schedules: See subsection (a) (2) above.
Report of Independent Accountants on Financial Statement Schedule To the Board of Directors of FAFCO, Inc. Our audits of the consolidated financial statements referred to in our report dated March 1,1999 appearing on page 13 of the 1998 Annual Report to Shareholders of FAFCO, Inc. (which report and consolidated financial statements are incorporated by reference in this Annual Report on Form 10-K) also included an audit of the Financial Statement Schedule listed in Item 14(a) of this Form 10-K. In our opinion, this Financial Statement Schedule presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. Burr, Pilger & Mayer Palo Alto, California March 29, 1999 FAFCO, Inc. Schedule II Valuation and Qualifying Accounts and Reserves Balance at Additions Charged Beginning of to Cost and Balance at End of Description Period Expenses Deductions Period 1998: Allowance for doubtful accounts current accounts receivable $540,100 $53,900 $57,700 (1) $536,300 short-term receivable 126,400 126,400(1) long-term receivable 29,300 29,300 Warranty reserve 211,000 190,600 169,400 232,200 Deferred tax asset valuation allowance 708,000 534,800 173,200 1997: Allowance for doubtful accounts current accounts receivable $512,600 $172,600 $145,100 (1) $540,100 short-term receivable 28,800 97,600 126,400 long-term receivable 34,000 4,700 (3) 29,300 warranty reserve 234,100 85,600 108,700 (2) 211,000 Deferred tax asset valuation allowance 1,191,800 483,800 708,000 1996: Allowance for doubtful accounts current accounts receivable $463,900 $50,400 $1,700 (1) $512,600 short-term receivable 28,800 28,800 long-term receivable 39,100 5,100 (3) 34,000 Warranty reserve 216,000 94,100 76,000 (2) 234,100 Deferred tax asset valuation allowance 1,383,800 192,000 1,191,800
(1) Write-off of uncollectible accounts. (2) Cost of warranty claims processed. (3) Reclassification to allowance for short-term notes receivable. SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this Annual Report on Form 10-K to be signed on its behalf by the undersigned, thereunto duly authorized. Date: March 29, 1999 FAFCO, Inc. /s/Freeman A. Ford Freeman A. Ford, Chairman of the Board, President and Chief Executive Officer POWER OF ATTORNEY Each person whose signature appears below constitutes and appoints Freeman A. Ford and Alex N. Watt, or either of them, his attorneys-in-fact, each with the power of substitution, for him in any and all capacities, to sign any amendments to this Annual Report on Form 10-K and to file the same, with exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, hereby ratifying and confirming all that either of said attorneys-in-fact, or his substitute or substitutes, may do or cause to be done by virtue hereof. Pursuant to the requirements of the Securities Exchange Act of 1934, this Annual Report on Form 10-K has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated. Signature Title Date Chairman of the Board, President and March 29, 1999 /s/Freeman A. Ford Chief Executive Officer Freeman A. Ford (Principal Executive Officer) and Director Vice President, Finance & Administration March 29, 1999 /s/Alex N. Watt and Chief Financial Officer Alex N. Watt (Principal Finacial and Accounting Officer) /s/William A. Berry Director March 29, 1999 William A. Berry /s/Robert W. Selig, Jr. Director March 29, 1999 Robert W. Selig, Jr.
CONSENT OF INDEPENDENT ACCOUNTANTS We hereby consent to the incorporation by reference in the Registration Statements on Form S-8 (Nos. 2-75201, 2-86299, 2-95390 and 33-76220) and related prospectuses of FAFCO, Inc. of our report dated March 1, 1999, appearing on page 13 of the 1998 Annual Report to Shareholders, which is incorporated by reference in this Annual Report on Form 10-K. We also consent to the incorporation by reference of our report on the Financial Statement Schedule, which appears on page 17 of this Form 10-K. Burr, Pilger & Mayer San Francisco, California March 29, 1999 INDEX TO EXHIBITS Exhibit No. Description 3.1(1) Articles of Incorporation, as amended. 3.2(3) Bylaws, as amended. 3.2(a) Bylaws Certificate of Amendment 4.1(1) Stock Purchase Agreement dated April 14, 1977, between Registrant and certain investors. 4.2(3) 10% Convertible Subordinated Notes Purchase Agreement dated March 27, 1984, between Registrant and certain investors. 4.2(a)(2) Amendment to Subordinated Note Purchase Agreement dated March 27, 1990. 4.2(b)(9) Amendment to 10% Subordinated Note Agreement dated March 25, 1991. 4.3(4)* Security and Guaranty Agreement and Common Stock Purchase Warrant between the Registrant and Freeman A. Ford dated February 16, 1987. 4.3(a)(5)* Amendment to the Security and Guaranty Agreement between the Registrant and Freeman A. Ford dated December 8, 1987. 4.3(b)(6)* Amendment to the Security and Guaranty Agreement between the Registrant and Freeman A. Ford dated February 1, 1988. 4.3(c)(7)* Second Amendment to the Promissory Notes between the Registrant and Freeman A. Ford dated March 26, 1991. 4.3(d)(9)* Form of Common Stock Purchase Warrant issued March 25, 1993 by the Registrant to Freeman A. Ford. 4.3(e)(9) Amendment to the Promissory Notes between the Registrant and Freeman A. Ford dated March 25, 1993. 4.4(10) Common Stock Warrant issued January 19, 1994 to B. Severns. 4.5 Reference Exhibits 3.1 and 3.2. 10.1 Reference Exhibit 4.1. 10.2 Reference Exhibit 4.2, 4.2(a), and 4.2(b). 10.3(7)* 1981 Incentive Stock Option Plan. 10.4(7)* Form of 1981 Incentive Stock Option Agreement. 10.8(1) Standard Form of Distributor Agreement. 10.9(7) Lease Agreement and Addenda for 2690 Middlefield Road, Redwood City, California, between Registrant, as Lessee, and Beals Martin and Associates, as Lessor, dated January 18, 1990. 10.10(3) FAFCO Solar Partners II Certificate of Limited Partnership and Limited Partnership Agreement. 10.11 Reference Exhibits 4.3, 4.3(a), 4.3(b), 4.3(c), 4.3(d), and 4.3(e). 10.12(6) Licensing Agreement between the Registrant, as Licensor, and Enercon Engineering, as Licensee, dated May 20, 1988. 10.13(6)* Form of Director's Warrant issued February 1988 to directors Berry and Selig. 10.14(11)* 1991 Stock Option Plan, as amended. 10.14(a)(8)* Form of Stock Option Agreement used under the 1991 Stock Option Plan. 10.15(8)* 1991 Directors' Stock Option Plan. 10.15(a)(8)* Form of Nonstatutory Stock Option Agreement used under 1991 Director's Stock Option Plan. 10.16(8)* Employee Stock Purchase Plan. 10.16(a)(8)* Form of Subscription Agreement used under Employee Stock Purchase Plan. 10.17(9) Licensing Agreement and Addendum between the Registrant, as Licensor, and Jang-Han Systems Engineering, as Licensee, dated January 1, 1993. 10.18(10) Export - Import and Technical License Agreement between the Registrant, as Licensor, and Ebara Corporation, as Licensee, dated October 22, 1993. 10.19(10) Business Loan Agreement between Registrant, as Borrower, and Silicon Valley Bank, as Lender, dated June 10, 1992. 10.19(a)(10) Loan Modification Agreement between Registrant as Borrower, and Silicon Valley Bank, as Lender, dated March 8, 1994. 10.19(b)(12) Loan Modification Agreement between Registrant as Borrower, and Silicon Valley Bank, as Lender, dated June 5, 1995. 10.19(c)(12) Loan Modification Agreement between Registrant as Borrower, and Silicon Valley Bank, as Lender, dated August 7, 1995. 10.19(d)(12) Loan Modification Agreement between Registrant as Borrower, and Silicon Valley Bank, as Lender, dated September 22, 1995. 10.19(e)(12) Loan Modification Agreement between Registrant as Borrower, and Silicon Valley Bank, as Lender, dated February 8, 1996. 10.19(f)(13) Loan Modification agreement between Registrant as Borrower, and Silicon Valley Bank, as Lender, dated October 30, 1996. 10.19(g)(13) Loan Modification Agreement between Registrant, as Borrower, and Silicon Valley Bank, as Lender, dated December 11, 1996. 10.19(h)(13) Loan Modification Agreement between Registrant, as Borrower, and Silicon Valley Bank, as Lender, dated January 6, 1997. 10.19(i)(13) Loan Modification Agreement between Registrant, as Borrower, and Silicon Valley Bank, as Lender, dated January 21, 1997. 10.19(j)(14) Loan Modification Agreement between Registrant, as Borrower, and Silicon Valley Bank, a Lender, dated April 1, 1998. 10.19(k) Loan Modification Agreement between Registrant, as Borrower, and Silicon Valley Bank, a Lender, dated March 22, 1999. 10.20(11) Agency/Distributorship Agreement between Registrant as Manufacturer and Jabria Establishment, as Agent/Distributorship, dated December 10, 1994. 11.1 Computation of Earnings Per Share (see Note 12 of Notes to Consolidated Financial Statements on the 1997 Annual Report). 13.1 Registrant's 1997 Annual Report to Shareholders. 18.1(14) Letter re change in Accounting Principle from Burr, Pilger & Meyer dated November 5, 1997. 21.1 Subsidiaries of Registrant. 23.1 Consent of Independent Accountants (see page 20) 24.16 Power of Attorney (see page 19). 27.1 Financial Data Schedule.
* Denotes a management contract or compensatory plan or arrangement. (1) Incorporated by reference to exhibit filed with Registrant's Registration Statement on Form S-1 (File No. 2-72297) filed May 14, 1981. (2) Incorporated by reference to exhibit filed with Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1989. (3) Incorporated by reference to exhibit filed with Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1983. (4) Incorporated by reference to exhibit filed with Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1986. (5) Incorporated by reference to exhibit filed with Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1987. (6) Incorporated by reference to exhibit filed with Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1988. (7) Incorporated by reference to exhibit filed with Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1990. (8) Incorporated by reference to exhibit filed with Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1991. (9) Incorporated by reference to exhibit filed with Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1992. (10) Incorporated by reference to exhibit filed with Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1993. (11) Incorporated by reference to exhibit filed with Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1994 (12) Incorporated by reference to exhibit filed with Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1995. (13) Incorporated by reference to exhibit filed with Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1996. (14) Incorporated by reference to exhibit filed with Registrant's Annual Report on Form 10K for the fiscal year ended December 31, 1998. (b) Reports on Form 8-K: No Reports on Form 8-K were filed by the Company during the fourth quarter of 1998 . (c) Exhibits: See subsection (a) (3) above. (d) Financial Statement Schedules: See subsection (a) (2) above.
EX-3.2(A) 2 EXHIBIT 3.2(a) CERTIFICATE OF AMENDMENT OF BYLAWS OF FAFCO, INC. FAFCO, INC., a corporation organized and existing under the laws of the State of California (the "Corporation"), pursuant to the provisions of the California Corporations Code and the Bylaws of the Corporation, DOES HEREBY CERTIFY as follows: FIRST: the Bylaws of the Corporation are hereby amended by deleting the first and second sentences of Section 3.2 in their present form and substituting therefor a new first and second sentence of Section 3.2 in the following form: "The number of directors of the corporation shall be not less than three (3) nor more than five (5). The exact number of directors shall be five (5) until changed, within the limits specified above, by a bylaw amending this Section 3.2, duly adopted by the board of directors or by the shareholders." SECOND: The amendment to the Bylaws of the Corporation set forth in this Certificate of Amendment has been duly adopted in accordance with the provisions of Section 212 of the California Corporations Code, the Board of Directors of the Corporation having duly adopted a resolution setting forth, approving and adopting such amendment. IN WITNESS WHEREOF, the Corporation has caused this Certificate of Amendment to be signed by Alex N. Watt, its Chief Financial Officer and Secretary, this 30th day of March, 1999. FAFCO, INC. BY: /s/ Alex N. Watt Alex N. Watt Chief Financial Officer and Secretary EX-10.19(K) 3 EXHITIT 10.19(k) LOAN MODIFICATION AGREEMENT This Loan Modification Agreement is entered into as of March 22, 1999, by and between FAFCO, Inc. ("Borrower") and Silicon Valley Bank ("Bank"). 1. DESCRIPTION OF EXISTING INDEBTNESS: Among other indebtedness which may be owing by Borrower is indebted to Bank pursuant to, among other documents, an Amended and Restated Loan and Security Agreement, dated June 5, 1996, as may be amended from time to time, (the "Loan Agreement"). The Loan Agreement provided for, among other things, a Committed Line in the original principal amount of One Million and 00/100 Dollars ($1,000,000.00) (the "Revolving Facility"). Defined terms used but not otherwise defined herein shall have the same meanings as in the Loan Agreement. Hereinafter, all indebtedness owing by Borrower to Bank shall be referred to as the "Indebtedness." 2. DESCRIPTION OF COLLATERAL AND GUARANTIES. Repayment of the Indebtedness is secured by the Collateral as described in the Loan Agreement. Hereinafter, the above-described security documents and guaranties, together with all other documents securing repayment of the Indebtedness shall be referred to as the "Security Documents". Hereinafter, the Security Documents, together with all other documents evidencing or securing the Indebtedness shall be referred to as the "Existing Loan Documents". 3. DESCRIPTION OF CHANGE IN TERMS. A. Modification(s) to Loan Agreement. 1. The defined term "Maturity Date" is hereby amended in its entirety to read as: March 30, 2000. 2. Section 2.3 (a) entitled "Interest Rate" is hereby amended in part to provide that Advances shall bear interest, on the average Daily Balance, at a per annum rate equal to one (1.00) percentage point above the Prime Rate. 3. The first sentence in section 2.3 (c) entitled "Payments" is hereby amended to read as follows: Interest hereunder shall be due and payable on the last calendar day of each month during the term hereof. 4. Section 6.8 entitled "Quick Ratio" is hereby amended in its entirety to read as follows: Borrower shall maintain, as of the last day of each calendar month, a ratio of Quick Assets to Current Liabilities of at least 1.00 to 1.00. 5. Section 6.9 entitled "Debt-Net Worth Ratio" is hereby amended in its entirety to read as follows: Borrow shall maintain as of the last day of each calendar month, a ratio of Total Liabilities less Subordinated Debt to Tangible Net Worth plus Subordinated Debt of not more than 1.25 to 1.00. 6. Section 6.10 entitled "Tangible New Worth" is hereby amended in its entirety to read as follows: Borrower shall maintain, as of the last day of each calendar month, a Tangible Net Worth plus Subordinated Debt of not less than Three Million and 00/100 Dollars ($3,000,000.00). 4. CONSISTENT CHANGES. The Existing Loan Documents are hereby amended wherever necessary to reflect the changes described above. 5. PAYMENT OF LOAN FEE. Borrower shall pay to Lender a fee in the amount of Seven Thousand Five Hundred and 00/100 Dollars ($7,500.00) (the "Loan Fee") plus all out-of-pocket expenses. 6. NO DEFENSES OF BORROWER. Borrower (and each guarantor and pledgor signing below) agrees that it has no defenses against the obligations to pay any amounts under the Indebtedness. 7. CONTINUING VALIDITY. Borrower (and each guarantor and pledgor signing below) understands and agrees that in modifying the existing Indebtedness, Bank is relying upon Borrower's representations, warranties, and agreements, as set forth in the Existing Loan Documents. Except as expressly modified pursuant to this Loan Modification Agreement, the terms of the Existing Loan Documents remain unchanged an in full force and effect. Bank's agreement to modifications to the existing Indebtedness pursuant to this Loan Modification Agreement in no way shall obligate Bank to make any future modifications to the Indebtedness. Nothing in this Loan Modification Agreement shall constitute a satisfaction of the Indebtedness. It is the intention of Bank and Borrower to retain as liable parties all makers and endorsers of Existing Loan Documents, unless the party is expressly released by Bank in writing. No maker, endorser, or guarantor will be released by virtue of this Loan Modification Agreement. The terms of this paragraph apply not only to this Loan Modification Agreement, but also to all subsequent loan modification agreements. 8. CONDITIONS. The effectiveness of this Loan Modification Agreement is conditioned upon Borrower's payment of the Loan Fee. This Loan Modification Agreement is executed as of the date first written above. BORROWER: BANK: FAFCO, INC. SILICON VALLEY BANK By:______________________ By:____________________ Name:___________________ Name:_________________ Title:_____________________ Title:___________________ EX-13.1 4 EXHIBIT 13.1 FAFCO, Inc. 1998 Annual Report (Annual Report Cover) The Company FAFCO was formed in 1969, was incorporated in 1972, and has produced over one million polymer heat exchangers, primarily for the solar heating and thermal energy storage markets. FAFCO is the leading U.S. manufacturer of solar heating panels, with nearly twice the installed base of solar panel systems of its nearest competitor. In addition, FAFCO is a leading producer of polymer heat exchangers for thermal energy storage applications. FAFCO's IceStor(tm) product line of thermal energy storage equipment significantly increases the effective capacity of electric utilities without the burden of adding new capacity. FAFCO has been issued more than 20 patents and operates worldwide. There are three bar graphs showing 1. Earnings per Share for years 1996, 1997, and 1998 2. Working Capital for years 1995, 1996, 1997, and 1998 3. Shareholders' Equity for years 1995, 1996, 1997, and 1998 This Annual Report to Shareholders contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Actual results could differ materially from those projected in the forward-looking statements as a result of the risk factors set forth below under the heading "Factors Affecting Future Results" and elsewhere in this Annual Report to Shareholders. FAFCO Page 1 (inside front cover) President's Letter FAFCO was founded in 1969 and manufactures polymer heat exchangers for the solar and thermal energy storage markets worldwide. Net sales grew by 6.5% to $11,235,800 in 1998. Net profit was $841,600 compared with $866,000 in 1997. Early indications point toward a continuation of the upward trend in sales and continued profitability in 1999. Net sales of FAFCO's aboveground solar pool heating system grew 19% in 1998 to $817,500. Total solar sales (both inground and aboveground pools) were $5,899,500 in 1998. Continuing new product introduction and marketing initiatives are expected to positively affect solar system sales revenues. FAFCO's thermal energy storage business uses unique polymer heat exchanger technology to shift peaking electrical loads to off-peak times. This significantly increases the effective capacity of electric utilities without the burden of adding new capacity. FAFCO's IceStorT products are sold principally in the United States, Asia, and the Middle East. Sales of IceStorT products, which accounted for 47% of total sales, were up 15% in 1998. As of December 31, 1998, FAFCO's bank line of credit was unused and there was $477,500 of cash on hand. Working capital increased to $2,637,200 at December 31, 1998 from $2,006,800 at the end of 1997. FAFCO has been issued 21 patents and is investing significantly in new patent- applied-for technologies, which we believe will significantly increase the likelihood of entering new markets with solutions that are more cost effective than was possible with the prior technologies. FAFCO's steady sales and profitability performance are a direct result of the hard work and dedication of each and every FAFCO employee and the loyalty of our customers. I offer my personal thanks to each and every one of you. Sincerely, Freeman A. Ford President Highlights of 1998 1997 %Change Operations Net Sales $11,235,800 $10,551,500 7% Net Income $841,600 $866,000 (3%) Diluted Earnings per Common Share $0.20 $0.22 (10%) Shareholders' Equity $2,886,400 $2,042,300 41% Working Capital $2,637,200 $2,006,800 30%
There is a bar graph showing Net Slaes for the years 1995, 1996, 1997, and 1998. FAFCO Page 2 Consolidated Balance Sheet December 31, 1998 1997 Assets Current assets: Cash and cash equivalents $ 477,500 $ 46,300 Accounts receivable, less allowance for doubtful accounts of $536,300 in 1998 and $540,100 in 1997 1,876,600 1,833,400 Current portion of long-term notes receivable (net) 87,600 88,800 Inventories 1,265,400 1,082,900 Prepaid expenses and other current assets 183,500 174,000 Other accounts receivable, net of allowance 7,300 12,200 Deferred tax asset, net of allowance 273,000 183,300 Total current assets 4,170,900 3,420,900 Plant and equipment, at cost 2,901,900 2,614,900 Less accumulated depreciation and amortization (2,318,500) (2,236,300) 583,400 378,600 Notes receivable and other assets (net) 58,200 151,200 Deferred tax asset, net of allowance 564,500 485,800 Total assets $5,377,000 $4,436,500 Liabilities and shareholders' equity Current liabilities: Accounts payable and other accrued expenses $1,065,600 $ 850,900 Accrued compensation and benefits 217,300 331,600 Accrued warranty expense 232,200 211,000 Income taxes payable 18,600 20,600 Total current liabilities 1,533,700 1,414,100 Subordinated notes ($600,000 was owed to related parties in 1998 and 1997) 925,000 925,000 Other non-current liabilities 31,900 55,100 Total liabilities $2,490,600 $2,394,200 Shareholders' equity: Preferred Stock-authorized 1,000,000 shares of $1.00 par value, none of which has been issued Common Stock-authorized 10,000,000 shares of $0.125 par value; 3,303,311 issued and outstanding in 1998 and 3,298,311 issued and outstanding in 1997 412,800 412,200 Capital in excess of par value 5,107,100 5,105,200 Notes receivable secured by Common Stock (75,100) (75,100) Accumulated deficit (2,558,400) (3,400,000) Total shareholders' equity $2,886,400 $2,042,300 Commitments and contingent liabilities Total liabilities and shareholders' equity $5,377,000 $4,436,500
The accompanying notes are an integral part of this statement. FAFCO Page 3 Consolidated Statement of Operations Year ended December 31, 1998 1997 1996 Net sales $ 11,235,800 $ 10,551,500 $ 8,868,600 Other income (net) 30,600 171,800 54,000 Total revenues 11,266,400 10,723,300 8,922,600 Cost of goods sold 6,801,700 5,956,500 5,500,300 Marketing and selling expense 1,942,800 1,770,000 1,575,400 General and administrative expense 1,480,200 1,776,100 1,286,300 Research and development expense 194,100 202,800 116,000 Net interest expense 113,400 128,700 169,900 Total costs and expenses 10,532,200 9,834,100 8,647,900 Income before income taxes 734,200 889,200 274,700 Provision for (benefit from) income taxes (107,400) 23,200 (36,700) Net income $ 841,600 $ 866,000 $ 311,400 Basic net income per share $ 0.25 $ 0.26 $ 0.10 Diluted net income per share $ 0.20 $ 0.22 $ 0.10
The accompanying notes are an integral part of this statement. FAFCO Page 4 Consolidated Statement of shareholders' Equity Notes Receivable Number Capital in Secured by Retained of Common Excess of Common Earnings Shares Stock Par Value Stock Deficit Balance at December 31, Balance at December 31, 1995 $3,112,687 $389,000 $5,035,600 $(75,100) $(4,577,400) Net income for the year 311,400 Issuance of shares upon conversion of subordinated note 185,624 23,200 69,600 Balance at December 31, 1996 $3,298,311 $412,200 $5,105,200 $(75,100) $(4,266,000) Net income for the year 866,000 Balance at December 31, 1997 $3,298,311 $412,200 $5,105,200 $(75,100) $(3,400,000) Net income for the year 841,600 Issuance of shares upon exercise of an option 5,000 600 1,900 Balance at December 31, 1998 $3,303,311 $412,800 $5,107,100 $(2,558,400)
The accompanying notes are an integral part of this statement. FAFCO Page 5 Consolidated Statement of Cash Flows Year Ended December 31, 1998 1997 1996 Cash flow from operating activities: Net income $ 841,600 $ 866,000 $ 311,400 Adjustments to reconcile net income to net cash provided by (used in) operating activities: Depreciation 137,600 130,700 121,200 Allowance for doubtful accounts and notes (130,200) 120,300 72,400 Provision for inventory reserve (18,600) (90,500) 42,400 Gain on disposition of fixed assets (19,000) (18,700) Change in assets and liabilities: Change in receivables (34,500) 22,100 (794,300) Change in inventories (163,900) (75,000) (85,200) Change in prepaid expenses (9,500) (23,200) (5,300) Change in deferred tax assets (168,400) (19,700) (38,400) Change in other assets 220,600 (38,200) 73,400 Change in payables and accrued expenses 119,600 (44,800) 104,900 Change in other non-current liabilities (23,200) 28,700 (54,000) Net cash provided by (used in) operations 752,100 876,400 (270,200) Cash flow from investing activities: Purchase of fixed assets (342,400) (159,700) (211,600) Proceeds from sale of fixed assets 19,000 18,700 Net cash used in investing activities (323,400) (159,700) (192,900) Cash flow from financing activities: Proceeds of subordinated debt issuance 325,000 Proceeds from sale of common stock 2,500 92,800 (Payments) borrowings on line of credit (net) (758,600) 7,300 Net cash (used in) provided by financing activities 2,500 (758,600) 425,100 Net increase (decrease) in cash and cash equivalents 431,200 (41,900) (38,000) Cash and cash equivalents, beginning of year 46,300 88,200 126,200 Cash and cash equivalents, end of year $ 477,500 $ 46,300 $ 88,200 Supplemental disclosures of cash flow information: Cash paid during the year for interest $ 123,100 $ 142,100 $ 159,300 Net cash paid during the year for income taxes $ 63,000 $ 10,000 $ 7,500 Noncash transaction (account receivable converted to note receivable) $ 126,400
The accompanying notes are an integral part of this statement. FAFCO Page 6 Notes to Consolidated Financial Statements 1) Organization and Summary of Significant Accounting Policies The Company designs, develops, manufactures, and markets polymer heat exchangers for use in solar heating systems for swimming pools and thermal energy storage systems for commercial and industrial cooling. The heat exchangers for solar heating systems are sold to wholesalers and distributors primarily in California and Florida and in other locations in the United States and overseas. The heat exchangers for thermal energy storage systems are marketed through manufacturers' representatives throughout the United States and internationally. A summary of significant accounting policies follows: Principles of Consolidation: The consolidated financial statements include the accounts of FAFCO, Inc. and its wholly-owned subsidiary. All significant inter-company balances and transactions have been eliminated in consolidation. The subsidiary currently has no ongoing business activities. Revenue Recognition: Revenues on sales of products are recognized at the time of shipment of goods or performance of service. Use of Estimates: The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ materially from those estimates. Cash and Cash Equivalents: For purposes of reporting cash flows, cash and cash equivalents include highly liquid investments with a maturity of three months or less. Inventories: Inventories are stated at the lower of cost or market determined using the first-in, first-out (FIFO) method. (See Note 2.) Plant and Equipment: Plant and equipment are stated based on historical cost adjusted for accumulated depreciation. Depreciation and amortization of plant and equipment, excluding vehicles and leasehold improvements, are determined using accelerated methods. For vehicles and leasehold improvements, the straight-line method is used. The estimated useful lives of the assets range between three and ten years. Minor replacements, improvements, maintenance, and repairs are expensed as incurred. Major replacements and improvements are capitalized and depreciated over the remaining useful life of the related asset. Gains and losses on sales and retirement of plant and equipment are credited or charged to income. Accounting for the Impairment of Long-lived Assets and for Long-lived Assets to be Disposed of: Long-lived assets held and used by the Company are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Impairments are recorded when indications of impairment are present and the undiscounted cash flows estimated to be generated by those assets are less than the assets' carrying value. Income Taxes: Deferred tax assets and liabilities are recognized for the tax consequences of temporary differences between the financial reporting and tax basis of assets and liabilities. (See Note 7.) Earnings per Common Share: The Company adopted Statement of Financial Accounting Standard No. 128 ("FAS 128"), Earnings per Share, beginning with FAFCO's fourth quarter of 1997. All prior period earnings per common share data have been restated to conform to the provisions of this statement. Basic earnings per common share is computed using the weighted average number of shares outstanding. Diluted earnings per common share is computed using the weighted average number of shares outstanding adjusted for the incremental shares attributed to outstanding options and warrants to purchase common stock and shares issuable upon conversion of certain convertible securities. (See Note 11.) Warranties: In the normal course of business, the Company makes certain warranties as to workmanship and materials. Product warranty periods range from two to fifteen years for full coverage. The estimated future expense of these warranties is accrued at the time of sale. The estimates inherent in accounting for such warranties are reviewed and revisions to previous estimates are made as required to reflect the most current information available. Accounting for Stock-Based Compensation: The Company has elected to account for stock-based compensation under the intrinsic value method in accordance with the provisions of Statement of Financial Accounting Standards ("SFAS") No. 123, Accounting for Stock-Based Compensation. Under this method, no compensation expense is recorded for stock options granted when the exercise price of the option granted is equal to or exceeds the fair market value of the Company's common stock. The Company makes the pro forma disclosures of stock-based compensation required by SFAS No. 123. (See Note 6.) Disclosures About Fair Value of Financial Instruments: The following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate that value. FAFCO Page 7 Notes to Consolidated Financial Statements Current Assets and Current Liabilities: The carrying value of cash equivalents, accounts receivable, notes receivable, short-term borrowings, accounts payable, and accrued expenses approximate fair value because of their short maturity. Long-Term Debt: The fair value of the Company's long-term debt is estimated based on the borrowing rates currently available to the Company for loans with similar terms. At December 31, 1998, the carrying amount approximates estimated fair value of long-term debt. 2) Inventories Consist of the Following: December 31, 1998 1997 Raw materials $ 661,800 $ 462,800 Work in progress 211,500 114,000 Finished goods 392,100 506,100 $ 1,265,400 $ 1,082,900
3) Plant and Equipment Plant and equipment consists of the following: December 31, 1998 1997 Machinery and equipment $ 2,191,500 $ 1,957,600 Office and computer equipment 488,600 466,900 Leasehold improvements 88,600 88,600 Vehicles 133,200 101,800 $ 2,901,900 $ 2,614,900 Less accumulated depreciation and amortization (2,318,500) (2,236,300) $ 583,400 $ 378,600
4) Subordinated Notes and warrants At December 31, 1998 and 1997, subordinated notes consisted of $925,000 of notes bearing interest at 11% per annum payable quarterly with warrants attached to purchase Common Stock. The exercise price of the warrants is $0.125 per share, the maximum aggregate number of shares issuable upon exercise of the warrants is 555,000, and the unexercised warrants expire March 27, 2000. (See Note 8.) 5) Bank Line of Credit The Company has a bank line of credit secured by substantially all the assets of the Company. The line of credit allows the Company to borrow the lesser of $1,000,000 or an amount determined by a formula applied to net accounts receivable, inventories, and net plant and equipment. Amounts borrowed bear interest at the bank's prime rate plus 1.5%. The line of credit agreement contains certain covenants relating to working capital, current ratio, and tangible net worth, prohibits the payment of cash dividends, and expires on March 30, 2000. At December 31, 1998 and 1997, the Company had complied with the loan covenants. As of December 31, 1998 and 1997, the Company had no outstanding balances under the bank line of credit. 6) Shareholders' Equity The Board of Directors, without shareholder approval, may determine the rights, preferences, privileges, and restrictions of the Company's unissued Preferred Stock. Such shares may be issued in one or more series. In 1980, the Company issued 202,300 shares of Common Stock at a price of $2.43 per share in exchange for non-interest bearing promissory notes, which have a balance due of $75,100 at December 31, 1998 and 1997. The notes are due and payable and the Company intends to pursue collection of these notes. In the event that any of the notes are uncollectible, the Company will demand surrender of the related shares issued and will cancel and write off the related notes receivable balance. Under the Company's Employee Stock Purchase Plan, 150,000 shares of Common Stock have been reserved for issuance at 85% of fair market value as of specified dates. The Plan was suspended in 1991 and no shares have been issued thereunder since 1991. The Company has a 1991 Incentive Stock Option Plan under which 500,000 shares of Common Stock have been reserved for issuance to employees and consultants. The Company has a 1991 Director's Stock Option Plan under which 50,000 shares of Common Stock are reserved for issuance. No options were granted or exercised during 1996, 1997, or 1998. FAFCO Page 8 Notes to Consolidated Financial Statements Options granted under these plans become exercisable at a rate of 20% per year for five years from date of grant and expire six years or ten years from date of grant. A summary of activity under the 1981 and 1991 Incentive Stock Option Plans follows: Shares Subject Exercise Price to Option Per Share Outstanding at December 31, 1995 275,450 $ 0.500-0.625 Granted 236,950 $ 0.125 Canceled (126,950) $ 0.500-0.560 Exercised 0 0 Outstanding at December 31, 1996 385,450 $ 0.125-0.625 Granted 21,000 $ 0.125 Canceled (31,500) $ 0.125-0.625 Exercised 0 0 Outstanding at December 31, 1997 374,950 $ 0.125-0.500 Granted 0 Canceled (5,500) $ 0.125-0.500 Exercised 0 Outstanding at December 31, 1998 369,450 $ 0.125-0.500
The Company applies the intrinsic value method of accounting for its stock option plans. Accordingly, no compensation cost has been recognized for the plan in 1998, 1997, or 1996. Had compensation cost been determined on the basis of fair value pursuant to FASB Statement No. 123, net income and earnings per share would have been reduced as follows: 1998 1997 1996 Net income As reported $ 841,600 $ 866,000 $ 311,400 Pro forma $ 832,200 $ 860,200 $ 293,600 Basic earnings per share As reported $ 0.25 $ 0.26 $ 0.10 Pro forma $ 0.25 $ 0.26 $ 0.09 Diluted earnings per share As reported $ 0.20 $ 0.22 $ 0.10 Pro forma $ 0.19 $ 0.22 $ 0.09
The fair value of each option granted was estimated on the grant date using the Black-Scholes model. The following assumptions were made in estimating fair value: Assumption 1998 1997 Dividend yield 0% 0% Risk-free interest rate 5.0% 5.55% Expected life 10 years 10 years Expected volatility 121.9% 141.1%
Following is a summary of the status of the plans during 1998, 1997, and 1996. Number of Weighted Average Shares Exercise Price Outstanding at January 1, 1998 374,950 $ 0.250 Granted 0 0 Exercised 0 0 Forfeited (5,500) 0.159 Outstanding atDecember 31, 1998 369,450 0.251 Options exercisable at December 31, 1998 283,250 0.299 Weighted average fair value of options granted during 1998 N/A
Number of Weighted Average Shares Exercise Price Outstanding at January 1, 1997 385,450 $0.258 Granted 21,000 0.125 Exercised 0 0 Forfeited (31,500) 0.460 Outstanding at December 31, 1997 374,950 0.250 Options exercisable at December 31, 1997 231,150 0.282 Weighted average fair value of options granted during 1997 $0.123
Number of Weighted Average Shares Exercise Price Outstanding at January 1, 1996 275,450 $ 0.485 Granted 236,950 0.125 Exercised 0 0 Forfeited (126,950) 0.502 Outstanding at December 31, 1996 385,450 0.258 Options exercisable at December 31,1996 199,650 0.297 Weighted average fair value of options granted during 1996 $0.101
Following is a summary of the status of options outstanding at December 31, 1998: Outstanding Exercisable Weighted Average Weighted Weighted Remaining Average Average Contractual Exercise Exercise Exercise Price Number Life Price Number Price $0.500 117,500 1 $0.500 117,500 $0.500 $0.250 20,000 3 $0.250 12,000 $0.250 $0.125 231,950 4 $0.125 153,750 $0.125 369,450 3 283,250
FAFCO Page 9 Notes to Consolidated Financial Statements The range of exercise prices for the options outstanding at December 31, 1998 is $0.125-$0.50 with a weighted average contractual life of 3 years. The Company estimates that based on vesting at 20% per year at December 31, 1998, approximately 100% of options will eventually vest. 7) Income Taxes The provisions for income taxes consist of the following: Years Ended December 31, 1998 1997 1996 Taxes on income: U.S. Federal Current $ 9,000 $ 12,000 $ 0 Deferred (183,400) (28,400) (40,300) (174,400) (16,400) (40,300) State Current 52,000 20,000 1,600 Deferred 15,000 9,600 2,000 67,000 29,600 3,600 Foreign Current 0 10,000 0 Deferred 0 0 0 $ 0 $ 10,000 $ 0 Net income tax (benefit) provision $ (107,400) $ 23,200 $ (36,700)
A reconciliation of the statutory federal income tax rate with the effective tax rate reported in the financial statements follows: Years Ended December 31, 1998 1997 1996 Statutory federal income tax(benefit) rate 34.0% 34.0% 34.0% Effect on tax rate resulting from: State and foreign income taxes, net of federal tax benefit 8.2% 2.2% 7.7% Tax effect of change in valuation allowance (65.2%) (36.6%) (54.8%) Expiration of tax credits 2.5% 1.7% 2.0% Other 5.9% 1.3% 0.6% Effective tax rate (14.6%) 2.6% (10.5%)
The Company records its deferred taxes on a tax jurisdiction basis and, with the adoption of FAS No. 109 in 1993, classifies those net amounts as current or noncurrent based on the balance sheet classifications. Deferred tax assets are comprised of the following: December 31, 1998 1997 Allowance for doubtful accounts $ 222,600 $ 227,700 Accrued expenses 97,300 132,500 Loss carryforwards 598,500 837,400 Tax credits 48,800 71,200 Other 43,500 108,300 1,010,700 1,377,100 Deferred tax asset valuation allowance (173,200) (708,000) Total deferred taxes, net $ 837,500 $ 669,100
At December 31, 1998, the Company had unused federal net operating loss carryforwards of approximately $1,756,600, Florida loss carryforwards of approximately $168,700, and investment and other federal tax credits of approximately $48,800 available to offset future tax liabilities. The net operating losses and credits expire in varying amounts until 2010. The use of the tax credits has been limited by the provisions of the Tax Reform Act of 1986 to reflect the benefit associated with an overall reduction in the corporate tax rate. The Company believes that the "total deferred taxes, net" in the amount of $837,500 is more likely than not to be realized. 8) Transactions with Related Parties At December 31, 1998 and 1997, $600,000 in principal amount of the Company's subordinated notes (see Note 4) were held by Mr. Freeman A. Ford, an officer, director, and major shareholder of the Company, and his immediate family members. In April 1996, the Company granted Mr. Ford a warrant to purchase 123,950 shares of Common Stock. 9) Employee Benefit Plans The Company has a 401(k) retirement savings plan for all eligible employees who have completed one year of service. Eligible employees have the option to contribute up to 15% of their eligible salary. The Company contributes an amount equal to 25% of the employee contribution, up to a maximum of $400 per employee per year. 10) Lease Commitments The Company's rental expense, relating primarily to a lease for its office and manufacturing facility, amounted to $384,300 in 1998, $393,400 in 1997, and $380,300 in 1996. At December 31, 1998, minimum annual lease FAFCO Page 10 Notes to Consolidated Financial Statements commitments under non-cancelable leases were as follows: 1999 405,400 2000 138,600 Total $ 544,000
The Company is required to pay property taxes, utilities, and insurance under certain of these leases, some of which provide for renewal options at the end of the initial lease term in the year 2000. 11) Net Income Per Share Basic earnings per share were calculated as follows: Years ended December 31, 1998 1997 1996 Net income $ 841,600 $ 866,000 $ 311,400 Average common shares outstanding 3,303,311 3,298,311 3,254,066 Earnings per shar $ 0.25 $ 0.26 $ 0.10
Basic earnings per share are calculated by dividing net income by the weighted average number of shares issued and outstanding. Diluted earnings per share were calculated as follows: Years ended December 31, 1998 1997 1996 Adjusted net income $ 841,600 $ 866,000 $ 311,400 Average common shares outstanding 3,303,311 3,298,311 3,254,066 Add: Exercise of options reduced by the number of shares purchased with proceeds 325,849 186,026 N/A Add: Exercise of warrants reduced by the number of shares purchased with proceeds 102,361 63,173 N/A Add: Expense of warrants attached to debt reduced by the number of shares purchased with proceeds 472,778 384,231 N/A Adjusted weighted average shares outstanding 4,204,299 3,931,741 3,254,066 Earnings per common share assuming full dilution $ 0.20 $ 0.22 $ 0.10
12) Licensing Income During 1997, the Company entered into a licensee agreement with a third party in the Far East under which the Company received and recognized license fee income net of foreign income taxes of $90,000. The agreement allows for the licensee to assemble and sell the IceStorT product in certain countries using the Company's technology and design specifications. For the term of the agreement (eight years), the Company is required to provide parts and technical services to the licensee at prices and rates equivalent to normal list prices. 13) Litigation The Company is involved in certain litigation matters. Management believes resolution of these disputes will not have a material adverse effect on the Company's financial condition and results of operation. 14. Business Segment and Concentration of Credit Risk Business Segment: The Company operates in one business segment, the development, production and marketing of polymer heat exchangers for the solar and thermal energy storage markets worldwide. Product Line 1998 1997 1996 Net Sales Solar $ 5,899,500 $ 5,918,100 $ 5,164,900 Thermal Energy Storage 5,336,300 4,633,400 3,703,700 $11,235,800 $10,551,500 $ 8,868,600
Geographic information for revenues and long-lived assets for the year ended December 31, 1998, 1997, and 1996 are as follows: 1998 1997 1996 Net Sales Domestic $ 7,235,900 $ 7,555,300 $ 7,588,400 Foreign Japan 2,634,100 1,961,600 1,070,100 Other 1,365,800 1,034,600 210,100 $11,235,800 $10,551,500 $ 8,868,600 Long-lived assets Domestic $ 583,400 $ 378,600 $ 349,600 $ 583,400 $ 378,600 $ 349,600
For fiscal 1998 and 1997, the Company had one major customer who individually accounted for 10% or more of sales totaling $2,634,100 and $1,961,600 in 1998 and 1997, respectively. In fiscal 1996, the Company had three major customers who individually accounted for 10% or more of sales totaling $1,242,700, $1,070,100, and $1,061,000. FAFCO Page 11 Notes to Consolidated Financial Statements Concentration of Credit Risk: Most of the Company's business activity is with customers located in California, Florida, and foreign countries. As of December 31, 1998, unsecured trade accounts receivable from customers in California, Florida, and foreign countries were $328,400, $1,302,900, and $594,200, respectively. FAFCO Page 12 Report of Independent Auditors To the Board of Directors of FAFCO, Inc. We have audited the accompanying consolidated balance sheets of FAFCO, Inc. and its subsidiary as of December 31, 1998 and 1997 and the related consolidated statements of operations, shareholders' equity, and cash flows for each of the years in the three-year period ended December 31, 1998. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of FAFCO, Inc. and its subsidiary as of December 31, 1998 and 1997 and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1998 in conformity with generally accepted accounting principles. Burr, Pilger & Mayer Palo Alto, California March 1, 1999 FAFCO Page 13 Summary of Operations Five-Year Summary of Operations (in thousands, except per share data) Year Ended December 31, 1998 1997 1996 1995 1994 Net sales $ 11,236 $ 10,552 $ 8,869 $ 7,876 $ 10,526 Income (loss) before income taxes $ 734 $ 889 $ 274 $(1,857) $ 547 (Benefit from) provision for income taxes (107) 23 (37) 1 49 Net income (loss) $ 841 $ 866 $ 311 $(1,858) $ 498 Basic net income (loss) per share $ 0.25 $ 0.26 $ 0.10 $ (0.60) $ 0.14 Diluted net income (loss) per share $ 0.20 $ 0.22 $ 0.10 $ (0.60) $ 0.14 At December 31, 1998 1997 1996 1995 1994 Working capital $ 2,637 $ 2,007 $ 1,285 $ 379 $ 2,469 Total assets 5,377 4,437 4,345 3,557 5,001 Long-term obligations 957 980 951 680 725 Shareholders' equity $ 2,886 2,042 1,176 772 2,628
Common Stock Data FAFCO, Inc. Common Stock is traded on the over-the-counter market but is not listed on an exchange or quoted on any automated quotation system. The high and low closing bid quotations for each quarter during 1998 and 1997 were as follows: Quarter Ended March 31 June 30 September 30 December 31 1998 High $0.75 $0.75 $0.94 $0.94 1998 Low $0.75 $0.75 $0.94 $0.94 1997 High $0.125 $0.125 $0.125 $0.750 1997 Low $0.125 $0.125 $0.125 $0.125
The quotations above were provided by the National Quotation Bureau. All quotations reflect inter-dealer prices, without retail mark-up, mark-down, or commission and may not necessarily represent actual transactions. At March 1, 1999, the Company had 706 shareholders of record. FAFCO, Inc. has never paid dividends on its Common Stock and has no plans to do so in the foreseeable future and is prohibited from so doing (see Note 6). FAFCO Page 14 Management's Discussion and Analysis This Annual Report to Shareholders contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Actual results could differ materially from those projected in the forward-looking statements as a result of the risk factors set forth below under the heading Factors Affecting Future Results and elsewhere in this Annual Report to Shareholders. 1998 Compared with 1997 Net sales for 1998 increased by 6.5% from $10,551,500 in 1997 to $11,235,800 in 1998. This increase was due to increased unit sales of the Company's IceStorT products. Net sales of the Company's pool products were relatively stable due to increased unit sales of the Company's SunSaverT product offset by price decreases due to competitive market pressures. Net sales of the Company's IceStorT products were 15.2% higher in 1998 than in 1997 due mainly to increased foreign sales. Pool product sales amounted to 53% of net sales in 1998 compared to 56% of net sales in 1997. IceStorT sales amounted to 47% of net sales in 1998 compared to 44% of net sales in 1997. Cost of goods sold increased from $5,956,500 (56.5% of net sales ) in 1997 to $6,801,700 (60.5% of net sales ) in 1998. This increase was due primarily to increased sales of lower margin products in both the pool and the IceStorT lines. Marketing and selling expenses increased from $1,770,000 (16.8% of net sales) in 1997 to $1,942,800 (17.3% of net sales ) in 1998. This increase was due mainly to increased sales and promotional activities in 1998 as compared to 1997. General and administrative expenses decreased from $1,776,100 (16.8% of net sales) in 1997 to $1,480,200 (13.2% of net sales) in 1998. These decreases were due mainly to bonus and profit-sharing expenses incurred in 1997 which were not incurred in 1998. Research and development expenses were relatively stable at $202,800 (1.9% of net sales) in 1997 compared with $194,100 (1.7% of net sales) in 1998. This was due mainly to the stabilization in the number of projects designed to improve current products and to develop potential new products, and in the personnel to implement those projects. Net interest expense was also relatively stable at $128,700 (1.2% of net sales) in 1997 compared with $113,400 (1.0% of net sales) 1998. This decrease was due mainly to lower average daily borrowing in 1998 along with lower interest rates. 1997 Compared with 1996 Net sales for 1997 increased by 19% from $8,868,600 in 1996 to $10,551,500 in 1997. This increase was due primarily to increased unit sales of the Company's pool panel products, along with increased unit sales of the Company's IceStorT products partially offset by the effect of discontinuance of the Company's automated swimming pool controls. Net sales of the Company's pool products were 14.8% higher in 1997 than 1996 due mainly to increased sales of its Revolutionr model inground pool panels, along with increased sales of its SunSaverT model inground pool panels and increased sales of its SunSaverT model aboveground pool panels. These increases were partially offset by the effect of discontinuance of its proprietary line of automated swimming pool controls, which was phased out as of January 1, 1997. Net sales of the Company's IceStorT products were 25.1% higher in 1997 than in 1996 due mainly to increased domestic sales along with higher foreign sales. Pool product sales amounted to 56% of net sales in 1997 compared to 58% of net sales in 1996. IceStorT sales amounted to 44% of net sales in 1997 compared to 42% of net sales in 1996. There were no significant price changes in any of the Company's products during 1997. Cost of goods sold increased in absolute dollars from $5,500,300 in 1996 to $5,956,500 in 1997 while decreasing from 62.0% of net sales in 1996 to 56.5% of net sales in 1997. This decrease as a percent of net sales was due primarily to the fixed costs being allocated over higher sales along with a continued increase of sales of higher margin products in both the pool and the IceStorT lines. Marketing and selling expenses increased in absolute dollars from $1,575,400 in 1996 to $1,770,000 in 1997 while decreasing from 17.8% of net sales in 1996 to 16.8% of net sales in 1997. These decreases as a percent of net sales were due mainly to the increased level of sales experienced in 1997 as compared to 1996. General and administrative expenses increased from $1,286,300 (14.5% of net sales) in 1996 to $1,776,100 (16.8% of net sales) in 1997. These increases were due mainly to increased bad debt write-offs along with bonus and profit-sharing expenses incurred in 1997 which were not incurred in 1996. Research and development expenses increased from $116,000 (1.3% of net sales) in 1996 to $202,800 (1.9% FAFCO Page 15 Management's Discussion and Analysis of net sales) in 1997. This increase was due mainly to an increase in the number of projects designed to improve current products and to develop potential new products, along with an increase in personnel to implement those projects. Net interest expense decreased from $169,900 (1.9% of net sales) in 1996 to $128,700 (1.2% of net sales) in 1997. This decrease was due mainly to lower average daily borrowing in 1997 along with lower interest rates. Seasonality Historically, the Company has experienced lower sales during the first quarter than during other quarters of each year. In addition, sales typically have increased significantly during the second quarter, declined slightly, and then remained relatively constant during the third and fourth quarters. The Company believes that this pattern derives primarily from the sales of solar heating products. As the Company's product mix shifts to include a larger proportion of other products, such as the thermal energy storage products, the traditional seasonality is being mitigated. Net income is affected by the seasonality of sales as well as by significant marketing and selling expenses typically incurred during the first quarter of each year. These expenses are incurred to develop programs and materials for use throughout the remainder of the year. In 1998 sales and net income experienced their typical seasonality. In 1997 sales and net income experienced their typical seasonality, except that sales of pool panel products in the first quarter were increased as a result of the unusually dry and warm weather in both California and Florida. As a result of the increased sales of pool panel products the traditional first quarter loss was not experienced. In 1996, sales and net income experienced their traditional seasonality, except that sales in the fourth quarter were increased due to sales of IceStorT product. As a result of the ice storage sales, the traditional fourth quarter loss was not experienced. Liquidity and Capital Resources The Company's cash position increased significantly from $46,300 at 1997 fiscal year end to $477,500 at 1998 fiscal year end, principally due to cash flow from operations (primarily net income) during the year, partially offset by cash used in investing activities (primarily purchase of fixed assets). At December 31, 1998, the Company's net accounts receivable had increased slightly to $1,876,600 from $1,833,400 at December 31, 1997, primarily as a result of increased sales in 1998 partially offset by slightly faster collection of accounts receivable. At December 31, 1998, the Company's accounts payable and other accrued expenses had increased to $1,065,600 from $850,900 at December 31, 1997. This increase is primarily due to increased inventories to support higher sales levels. At December 31, 1998, the Company's inventories had increased to $1,265,400 from $1,082,900 at December 31, 1997. This increase was due entirely to the buildup of inventories to support increased sales levels. The Company has a deferred tax asset, net of valuation allowance, at year-end of $837,500 in 1998 and $669,100 in 1997. The Company believes that it is more likely than not that this asset will be fully realized. This belief is based upon the Company's recent history of profitable operations prior to 1995, its return to profitability in 1996, 1997 and 1998, and the Company's expectation that operating results will allow it to realize the net deferred tax asset. However, there can be no assurance that the Company will continue profitability or, if it does, that profits will be sufficient to utilize the net deferred tax asset. At December 31, 1998, the Company's current ratio was 2.72 to 1 compared with 2.42 to 1 at December 31, 1997 and working capital increased over the same period to $2,637,200 from $2,006,800. Total assets exceeded total liabilities by $2,886,400 at December 31, 1998 compared with $2,042,300 at December 31, 1997. The Company believes that its cash flow from operations, together with bank borrowings, will be sufficient to support operations during the next twelve months. The foregoing statement of how long the Company's capital resources are expected to last is a forward-looking statement involving risks and uncertainties, including the amount of the Company's sales and the ability of the Company to control its operating expenses and the need to invest in sales and marketing activities in 1998. However, if sales decline from current levels additional debt or equity financing may be required. There can be no assurance that financing, if required, would be available on favorable terms or at all or that such financing will not significantly dilute the ownership interests and rights of existing shareholders. The Company has a line of credit, of which none had been utilized and $1,000,000 remained available under the formula applied to net FAFCO Page 16 Management's Discussion and Analysis accounts receivable at December 31,1998. This line of credit expires on March 30, 2000. Factors Affecting Future Results The Company has reviewed its internal computer systems for year 2000 compliance and is satisfied that all of its internal computer systems are either already year-2000 compliant or can be made year-2000 compliant through simple upgrades. The Company does not expect the costs of achieving full year-2000 compliance to be material for the internal systems. However, there can be no assurance that coding errors or other defects will not be discovered in the future. In addition, since the Company is very small in relation to many of its customers and suppliers, the Company has been unable to ascertain if any of its suppliers and customers are year-2000 compliant. Therefore, there can be no assurances that the Company's cash flow from customers and materials from suppliers will not be interrupted which could result in severe disruptions in the Company's operations. FAFCO Page 17 Corporate Directory and Information Board of Directors Freeman A. Ford Chairman of the Board, President, and Chief Executive Officer FAFCO, Inc. William A. Berry* Senior Vice President and Chief Financial Officer Electric Power Research Institute a private, nonprofit, research organization doing collaborative research for the electricity industry. Robert W. Selig, Jr.* President Davis Instruments Corporation a manufacturer of marine and weather equipment. ________________________ *Audit Committee Member Executive Officers Freeman A. Ford Chairman of the Board, President, and Chief Executive Officer Alex N. Watt Vice President, Finance and Administration,Chief Financial Officer, and Secretary David K. Harris Vice President, Sales Solar Products Transfer Agent and Registrar Continental Stock Transfer & Trust Company 2 Broadway New York, New York 10004 Telephone: (212) 509-4000 Web Site: http://www.continentalstock.com Legal Counsel Wilson, Sonsini, Goodrich & Rosati A Professional Corporation 650 Page Mill Road Palo Alto, California 94304 Independent Accountants Burr, Pilger & Mayer A Professional Corporation 261 Hamilton Avenue Palo Alto, California 94301 Form 10-K A copy of the Company's Annual Report on Form 10-K filed with the Securities and Exchange Commission, including financial statement schedules but excluding exhibits, is available without charge upon written request to: FAFCO, Inc. 2690 Middlefield Road Redwood City, California 94063-3455 Attention: Alex N. Watt Annual Shareholders' Meeting The Annual Shareholders' Meeting will be held at 3:00 p.m. on May 6, 1999 at FAFCO, Inc., 2690 Middlefield Road, Redwood City, California 94063-3455, Telephone: (650) 363-2690 (Inside back cover) EX-21.1 5 EXHIBIT 21.1 SUBSIDIARIES OF REGISTRANT 1. THE GREGORY COMPANY EX-27 6
5 0000352956 FAFCO,INC 12-MOS DEC-31-1998 DEC-31-1998 477,500 0 2,565,500 565,600 1,265,400 4,170,900 2,901,900 2,318,500 5,377,000 1,533,700 956,900 0 0 412,800 2,473,600 5,377,000 11,235,800 11,270,700 6,801,700 6,801,700 0 53,900 123,100 734,200 (107,400) 841,600 0 0 0 841,600 0.25 0.20
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