-----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, EGo2ueK1kzGGKNBWuuBkILkqhgifpaJsONrNI+Bswp12AzCRJHuoMWF96Af/yM6e yeA9jEOs1QViKpZt/h6W/Q== 0000891618-96-000183.txt : 19960402 0000891618-96-000183.hdr.sgml : 19960402 ACCESSION NUMBER: 0000891618-96-000183 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 8 CONFORMED PERIOD OF REPORT: 19951231 FILED AS OF DATE: 19960401 SROS: NASD 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: 1934 Act SEC FILE NUMBER: 000-10120 FILM NUMBER: 96543040 BUSINESS ADDRESS: STREET 1: 2690 MIDDLEFIELD RD CITY: REDWOOD CITY STATE: CA ZIP: 94063 BUSINESS PHONE: 4153632690 MAIL ADDRESS: STREET 1: 2690 MIDDLEFIELD ROAD CITY: REDWOOD CITY STATE: CA ZIP: 94063 10-K 1 FORM 10-K 1 SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K (Mark One) [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D)OF THE SECURITIES EXCHANGE ACT OF 1934 (FEE REQUIRED) For the fiscal year ended December 31, 1995 or [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 (NO FEE REQUIRED) For the transition period from ________________ to _______________. Commission file number 0-10120 FAFCO, INC. (Exact name of registrant as specified in its charter)
CALIFORNIA 94-2159547 (State or other jurisdiction of incorporation or organization) (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: 415/363-2690 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 ____ 2 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. [ ] The aggregate market value of the registrant's Common Stock held by non-affiliates of the registrant as of ____________________was____________________, 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 _________________, was _____________. DOCUMENTS INCORPORATED BY REFERENCE
DOCUMENT DESCRIPTION FORM 10-K PART Portions of Exhibit 13.1 (the Company's 1995 Annual Report to Shareholders (the "Annual Report").......................................................... I, II, IV The Company's Definitive Proxy Statement (the "Proxy Statement") for the 1996 Annual Meeting to be held on April 27, 1996 (the Proxy Statement is expected to be filed pursuant to Regulation 14A on or before April 1, 1996) ...................................................................... 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. 2 3 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 62% of net sales in 1995 compared to 57% of net sales in 1994 and 63% of net sales in 1993. Thermal energy storage sales amounted to 38% of net sales in 1995 compared to 42% of net sales in 1994 and 34% in 1993; (444 domestic hot water heater sales were discontinued in early 1994 and had amounted to 2% of net sales in 1993). 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. 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 (415) 363-2690. MARKETS Swimming Pool Heating Low temperature solar applications developed because of the cost effectiveness of solar systems in heating a high 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. 3 4 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. Domestic Water Heating Until early 1994, FAFCO also marketed solar systems for medium temperature applications, principally domestic water heating. This product line was discontinued due to lack of demand for such products at current energy price levels. 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 pool back to the water and water is drained from the collectors. When the water temperature drops or 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. 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 meter, four-by-eight feet, four-by-ten feet, or four-by-twelve 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 percent 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. 4 5 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. Domestic Water Heating In 1981, the Company began the design and development of an advanced passive solar domestic water heating system, the 444. In the second quarter of 1983, the Company began manufacturing and selling the 444 and has sold approximately 13,000 systems to date. Because of lack of demand for the Company's solar domestic water heating system, this product has been discontinued, effective the first quarter of 1994. The Company has ongoing obligations to service, and provide spare parts for, domestic water heaters sold prior to that time. Thermal Energy Storage The Company's thermal energy storage ("IceStor") systems utilize nighttime electrical 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 the building's air conditioning equipment to significantly reduce electrical requirements for cooling during times of high electrical demand and high electrical cost. Cool storage systems offer electrical utilities a solution to their fundamental, long-term problem: increasing peak demand for power during periods of limited available capacity (i.e. during business hours). IceStor technology shifts 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 distributor's sales personnel are generally assigned to contractor accounts seeking referrals for new construction sales. 5 6 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 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 IceStorproducts 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, including to design-and-build, heating, ventilating, and air-conditioning companies in Taiwan, Korea, and Japan. These licensing agreements provide for licensee's assembly and sale of IceStor products in those countries. SALES BY GEOGRAPHIC AREA The Company's net sales during 1995, 1994, and 1993 were geographically distributed approximately as follows:
1995 1994 1993 ---- ---- ---- California 21% 24% 25% Florida 37% 38% 44% Oklahoma 7% 10% 3% Other States 20% 13% 16% Foreign Countries 15% 15% 12% 100% 100% 100% ---- ---- ----
One of the Company's customers, Kailay International, accounted for 10% of the Company's fiscal 1995 net sales. During 1995, Kailay International was the licensee for the Company's IceStor(TM) products in Taiwan and as such purchased IceStor(TM) products and components for 6 7 assembly into products for resale to end users in Taiwan. No other customer accounted for 10% or more of the Company's sales in fiscal 1993, 1994 or 1995. 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 relating to such limitations. 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 has 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 in 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 solar collectors and IceStor heat exchangers, copper solar collectors, housings for solar collectors, housings for solar collectors, automatic controls, components for its solar systems, and IceStor containers. 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. 7 8 The Company's solar pool heating system utilizes collectors produced from polyolefin resins using a patented extrusion and thermoforming process. The Company's IceStor system utilizes heat exchangers, which are also made 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 Company's resins 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 Company's 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 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 less than ten other manufacturers of solar heating systems, and indirectly with conventional heating systems. The Company's AutoPool product currently competes directly with automatic controls manufactured by a number of companies in the United States. The Company believes that the principal competitive factors in the markets for FAFCO solar products and controls 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. 8 9 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, 1995, 1994, and 1993, the Company's research and development expenses were $460,100, $484,300, and $479,400, respectively. The majority of the research and development costs incurred in 1995 related to research and development of solar heating products for above ground swimming pools, which the Company introduced in February 1996, and an improved solar heating product for in-ground pools, which is currently scheduled to be introduced in April 1996. 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 four 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 1997 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 in Taiwan, Korea, and Japan to a Taiwanese company, a Korean company, and a Japanese company, respectively. See "Marketing and Sales" above. 9 10 EMPLOYEES At December 31, 1995, the Company had a total of forty-eight 48 full-time employees, including eight (8) in marketing, two (2) in research and development, thirty (30) in manufacturing, and eight (8) 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. No employees are represented by a labor organization. During 1995, the Company laid off 32% of its employees in order to bring expenses more in line with reduced sales levels. 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 Operation - Seasonality" on page 20 of the Annual Report, which information is incorporated 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. 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. This facility is covered by a lease expiring in the year 2000. See Note 11 of Notes to Consolidated Financial Statements on page 14 of the Annual Report, which information is incorporated herein by reference. The Company believe 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 second and third employee shifts. 10 11 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, 1995. EXECUTIVE OFFICERS OF THE REGISTRANT 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 55, 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 54, 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 40, serves as Vice President, Pool Products. 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). Michael Anderson, age 50, has served as Vice President, Commercial Products since May 1995. Mr. Anderson joined the Company in September 1984 as Vice President, Sales and Marketing and held that position until February 1987. Mr. Anderson served as President of Marcus Company, a manufacturer's representative for HVAC and refrigeration products from March 1987 until May 1993, when he rejoined the Company as President, Commercial Products Division. 11 12 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 19 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 18 and in the last sentence of the text under the table entitled "Common Stock Data" on page 19 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 20 through 22 of the Annual Report, which information is incorporated herein by reference. ITEM 8. Financial Statements and Supplementary Data The consolidated financial statements of the Company are set forth on pages 4 through 15 of the Annual Report, which information is incorporated herein by reference. The supplementary financial information of selected quarterly financial data is not required under Regulation S-K Item 302, 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 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. 12 13 Information regarding executive officers is set forth under the caption "Executive Officers of the Registrant" in Part I of this Form 10-K, which information is incorporated into this Item 10 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 - Compliance with Section 16(a) of the Exchange Act" 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, 1995 and 1994, the consolidated statements of income, of shareholders' equity, and of cash flows for each of the three years in the period ended December 31, 1995, and the notes thereto appear on pages 4 through 15 of Exhibit 13.1 to this Annual Report on Form 10-K. 13 14 2. Financial Statement Schedules Report of Independent Accountants on Financial Statement Schedule (see page 17 of this Annual Report on Form 10-K). The following schedule for the years ended December 31, 1995, 1994, and 1993 is included in this report. Such schedule should be read in conjunction with the consolidated financial statements in the Annual Report. Schedule VIII - Valuation and Qualifying Accounts and Reserves 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. 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. 3.1(a)(11) Form of Amended and Restated Articles of Incorporation, to be filed following shareholder approval. 3.2(3) Bylaws, as amended. 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.
14 15
EXHIBIT NO. DESCRIPTION 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, ated 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) Loan Modification Agreement between Registrant as Borrower and Silicon Valley Bank as Lender dated June 5, 1995. 10.19(c) Loan Modification Agreement between Registrant as Borrower and Silicon Valley Bank as Lender dated August 7, 1995. 10.19(d) Loan Modification Agreement between Registrant as Borrower and Silicon Valley Bank as Lender dated August 7, 1995. 10.19(e) Loan Modification Agreement between Registrant as Borrower and SiliconValley Bank as Lender dated September 22, 1995. 10.19(f) Loan Modification Agreement between Registrant as Borrower and Silicon Valley Bank as Lender dated February 8, 1996. 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 pages 14 and 15 of the Annual Report). 13.1 Registrant's 1995 Annual Report to Shareholders. 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. 15 16 (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 (b) Reports on Form 8-K: No Current Reports on Form 8-K were filed by the Company during the fourth quarter of 1995. (c) Exhibits: See subsection (a) (3) above. (d) Financial Statement Schedules: See subsection (a) (2) above. 16 17 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 27, 1996 appearing on page 17 of the 1995 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. Price Waterhouse LLP San Francisco, California March 27, 1996 17 18 FAFCO, INC. SCHEDULE VIII Valuation and Qualifying Accounts and Reserves
Balance at Additions Charged Beginning of to Costs and Balance at End of Description Period Expenses Deductions Period - ----------- ------------ ----------------- ---------- ----------------- 1995: Allowance for doubtful accounts $5,700(1) current accounts receivable $469,100 $39,600 39,100(4) $463,900 short-term receivable 39,100 39,100 Warranty reserve 247,000 10,500 41,500(2) 216,000 Deferred tax asset valuation allowance 600,900 782,900 1,383,800 - ------------------------------- 1994: Allowance for doubtful accounts current accounts receivable $417,400 $52,600 $ 900(1) $469,100 long-term receivable Warranty reserve 280,300 71,800 105,100(2) 247,000 Deferred tax asset valuation allowance 893,900 293,000 600,900 1993: Allowance for doubtful accounts current accounts receivable $320,200 $98,500 $1,300(1) $417,400 long-term receivable 203,700 23,200 226,900(1) Warranty reserve 310,900 99,700 130,300(2) 280,300 Deferred tax asset valuation allowance 717,400(3) 176,500 893,900 - -------------------------------
(1) Write-offs of uncollectible accounts, including allowance on related party receivable from FAFCO Solar Partners II deemed uncollectible in 1993. (2) Cost of warranty claims processed. (3) Beginning balance at adoption of SFAS 190 (Accounting for Income Taxes). (4) Reclassified to allowance for short-term notes receivable. 18 19 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 27, 1996 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 27, 1996 /s/Freeman A. Ford Chief Executive Officer (Principal - ----------------------- Freeman A. Ford Executive Officer) and Director Vice President, Finance & Administration March 27, 1996 /s/Alex N. Watt and Chief Financial Officer (Principal - ----------------------- Alex N. Watt Financial and Accounting Officer) /s/William A. Berry Director March 27, 1996 - ----------------------- William A. Berry /s/Robert W. Selig, Jr. Director March 27, 1996 - -----------------------
Robert W. Selig, Jr. 19 20 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) of FAFCO, Inc. of our report dated March 27, 1996, appearing on page 17 of the 1995 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 18 of this Form 10-K. Price Waterhouse LLP San Francisco, California March 27, 1996 20 21 ITEMS
EXHIBIT NO. DESCRIPTION 3.1(1) Articles of Incorporation, as amended. 3.1(8) Form of Amended and Restated Articles of Incorporation, to be filed following shareholder approval. 3.2(3) Bylaws, as amended. 4.1(1) Stock Purchase Agreement dated as of April 14, 1977, between Registrant and certain investors. 4.2(3) 10% Convertible Subordinated Notes Purchase Agreement dated as of 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, 1993. 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 Freemen 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 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 Exhibit 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) For 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 Directors' 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) Loan Modification Agreement between Registrant as Borrower and Silicon Valley Bank as Lender dated June 5, 1995. 10.19(c) Loan Modification Agreement between Registrant as Borrower and Silicon Valley Bank as Lender dated August 7, 1995. 10.19(d) Loan Modification Agreement between Registrant as Borrower and Silicon Valley Bank as Lender dated September 22, 1995. 10.19(e) Loan Modification Agreement between Registrant as Borrower and Silicon Valley Bank as Lender dated February 8, 1996. 10.20 Agency/Distributorship Agreement between Registrant, as Borrower and Silicon Valley Bank, as Lender, dated 12/10/94. 11.1 Computation of Earnings Per Share (see Note 12 of Notes to Consolidated Financial Statements on pages 14 and 15 of the Annual Report). 13.1 Registrant's 1995 Annual Report to Shareholders. 21.1 Subsidiaries of Registrant. 23.1 Consent of Independent Accounts (see page 20). 24.1 Power of Attorney (see page 19).
21 EX-10.19(B) 2 LOAN MODIFICATION AGREEMENT DATED JUNE 5, 1995 1 EXHIBIT 10.19(b) LOAN MODIFICATION AGREEMENT This Loan Modification Agreement is entered into as of June 5, 1995, by and between FAFCO, INC. ("Borrower") whose address is 2690 Middlefield Road, Redwood City, CA 94063, and Silicon Valley Bank ("Lender") whose address is 3000 Lakeside Drive, Santa Clara, CA 95054. 1. DESCRIPTION OF EXISTING INDEBTEDNESS: Among other indebtedness which may be owing by Borrower to Lender, Borrower is indebted to Lender pursuant to, among other documents, a Promissory Note, dated June 10, 1992, in the original principal amount of Five Hundred Thousand and 00/100 Dollars ($500,000.00) (the "Note"). The Note has been modified pursuant to Change in Terms Agreements, dated February 15, 1993 and April 29, 1993, and a Loan Modification Agreement, dated March 8, 1994, pursuant to which, among other things, the principal amount of the Note was increased to One Million and 00/100 Dollars ($1,000,000.00). The Note, together with other promissory notes from Borrower to Lender, is governed by the terms of a Business Loan Agreement, dated June 10, 1992, between Borrower and Lender, as may be amended from time to time (the "Loan Agreement"). Hereinafter, all indebtedness owing by Borrower to Lender shall be referenced to as the "Indebtedness." 2. DESCRIPTION OF COLLATERAL: Repayment of the Indebtedness is secured by a Commercial Security Agreement, dated June 3, 1994 (the "Security Agreement"). Hereinafter, the above-described security documents, together with all other documents securing payment of the Note (and other notes executed by Borrower in favor of Lender) 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 Note. 1. Payable in one payment of all outstanding principal plus all accrued unpaid interest on June 5, 1996. In addition, Borrower will pay regular monthly payments of all accrued unpaid interest due as of each payment date, beginning July 5, 1995, and all subsequent interest payments will be due on the same day of each month there- after. 2. The principal amount of the Note is hereby increased to One Million Five Hundred Thousand and 00/100 Dollars ($1,500,000.00). B. Modification(s) to Loan Agreement. 1. The Tangible Net Worth and Profitability covenant as provided in the paragraph entitled "Financial Covenants" are hereby amended as follows: Borrower shall maintain, on a monthly basis, a minimum Tangible Net Worth plus Subordinated Debt of $2,000,000.00. Further, maintain profitability as follows: Allow loss for quarter ended March 31, 1995; Loss for quarter ended June 30, 1995, not to exceed $150,000.00; Loss for quarter ended September 30, 1995, not to exceed $150,000.00; 2 EXHIBIT 10.19(b) page two Profits of at least $300,000.00 for quarter ended December 31, 1995. 2. Accounts receivable audits will now be performed on an annual basis (rather than when borrowings under the Note exceed $100,000.00). 4. CONSISTENT CHANGES. The Existing Loan Documents are hereby amended wherever necessary to reflect the changes described above. 5. 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 agrees that, as of this date, it has no defenses against the obligations to pay any amounts under the Indebtedness. 7. CONTINUING VALIDITY. Borrower understands and agrees that in modifying the existing Indebtedness, Lender 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 and in full force and effect. Lender's agreement to modifications to the existing Indebtedness pursuant to this Loan Modification Agreement in no way shall obligate Lender 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 Lender and Borrower to retain as liable parties all makers and endorsers of Existing Loan Documents, unless the party is expressly released by Lender 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 payment of the Loan Fee and Lender's receipt of the Amendment and Reaffirmation of Subordination Agreements executed by each Creditor. This Loan Modification Agreement is executed as of the date first written above. BORROWER: LENDER: FAFCO, INC. SILICON VALLEY BANK By: \s\ Alex N. Watt By: \s\ Julie Schneider Name: Alex N. Watt Name: Julie Schneider Title: V.P. Finance & Administration Title: CBD EX-10.19(C) 3 LOAN MOSIFICATION AGREEMENT DATED AUGUST 7, 1995 1 EXHIBIT 10.19(c) LOAN MODIFICATION AGREEMENT This Loan Modification Agreement is entered into as of August 7, 1995, by and between FAFCO, INC. ("Borrower") whose address is 2690 Middlefield Road, Redwood City, CA 94063, and Silicon Valley Bank ("Lender") whose address is 3000 Lakeside Drive, Santa Clara, CA 95054. 1. DESCRIPTION OF EXISTING INDEBTEDNESS: Among other indebtedness which may be owing by Borrower to Lender, Borrower is indebted to Lender pursuant to, among other documents, a Promissory Note, dated June 10, 1992, in the original principal amount of Five Hundred Thousand and 00/100 Dollars ($500,000.00) (the "Note"). The Note has been modified pursuant to Change in Terms Agreements, dated February 15, 1993 and April 29, 1993, and a Loan Modification Agreements, dated March 8, 1994, and June 5, 1995, pursuant to which, among other things, the principal amount of the Note was increased to One Million Five Hundred Thousand and 00/100 Dollars ($1,500,000.00). The Note, together with other promissory notes from Borrower to Lender, is governed by the terms of a Business Loan Agreement, dated June 10, 1992, between Borrower and Lender, as may be amended from time to time (the "Loan Agreement"). Hereinafter, all indebtedness owing by Borrower to Lender shall be referenced to as the "Indebtedness." 2. DESCRIPTION OF COLLATERAL: Repayment of the Indebtedness is secured by a Commercial Security Agreement, dated June 3, 1994. Hereinafter, the above-described security documents, together with all other documents securing payment of the Note (and other notes executed by Borrower in favor of Lender) 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. Agreement to Forbear. 1. Lender agrees to forebear from exercising it remedies under the Existing Loan Documents until September 30, 1995, notwithstanding Borrower's existing default under the Loan Agreement as result of Borrower's failure to comply with the profitability covenant as of the quarter ended June 30, 1995. By signing below, Borrower acknowledges that the Indebtedness currently is in default and as a result of such default, Lender is entitled to exercise its remedies as provided in the Existing Loan Documents and as provided under applicable law. Nothing in this Agreement in any way shall constitute Lender ''waiver of Borrower'' existing default under the Loan Agreement. Upon termination of the forbearance period described above, without any notice to Borrower, Lender may exercise any remedies available to Lender under the Existing Loan Documents and under applicable law. 2 EXHIBIT 10.19(c) page two B. Modification(s) to Loan Agreement. 1. The profitability covenant as provided in the paragraph entitled "Financial Covenants" is hereby amended to read, in its entirety: Borrower shall achieve profitability on a quarterly basis, with allowance for one loss not to exceed $350,000.00 for the quarter ending September 30, 1995. 2. Notwithstanding anything to the contrary as provided in the Loan Agreement and the Existing Loan Documents, Borrower may not repay the Subordinate Debt owing to its creditors; provided, however, upon Borrower's achievement of two consecutive quarters of profitability, Borrower may repay such Subordinated Debt, subject to, however, Lender's prior consent. 4. CONSISTENT CHANGES. The Existing Loan Documents are hereby amended wherever necessary to reflect the changes described above. 5. NO DEFENSES OF BORROWER. Borrower agrees that, as of this date, it has no defenses against the obligations to pay any amounts under the Indebtedness. 6. CONTINUING VALIDITY. Borrower understands and agrees that in modifying the existing Indebtedness, Lender 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 and in full force and effect. Lender's agreement to modifications to the existing Indebtedness pursuant to this Loan Modification Agreement in no way shall obligate Lender 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 Lender and Borrower to retain as liable parties all makers and endorsers of Existing Loan Documents, unless the party is expressly released by Lender 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. 7. CONDITIONS. The effectiveness of this Loan Modification Agreement is conditioned upon payment of the Loan Fee of Five Hundred Dollars ($500). This Loan Modification Agreement is executed as of the date first written above. BORROWER: LENDER: FAFCO, INC. SILICON VALLEY BANK By: \s\ Alex N. Watt By: \s\ Julie Schneider Name: Alex N. Watt Name: Julie Schneider Title: V.P. Finance & Administration Title: CBD EX-10.19(D) 4 LOAN MODIFICATION AGREEMENT SEPTEMBER 22, 1995 1 EXHIBIT 10.19(d) LOAN MODIFICATION AGREEMENT This Loan Modification Agreement is entered into as of September 22, 1995, by and between FAFCO, INC. ("Borrower") whose address is 2690 Middlefield Road, Redwood City, CA 94063, and Silicon Valley Bank ("Lender") whose address is 3000 Lakeside Drive, Santa Clara, CA 95054. 1. DESCRIPTION OF EXISTING INDEBTEDNESS: Among other indebtedness which may be owing by Borrower to Lender, Borrower is indebted to Lender pursuant to, among other documents, a Promissory Note, dated June 10, 1992, in the original principal amount of Five Hundred Thousand and 00/100 Dollars ($500,000.00) (the "Note"). The Note has been modified pursuant to Change in Terms Agreements, dated February 15, 1993 and April 29, 1993, and a Loan Modification Agreement, dated March 8, 1994, and June 5, 1995, pursuant to which, among other things, the principal amount of the Note was increased to One Million Five Hundred Thousand and 00/100 Dollars ($1,500,000.00). The Note, together with other promissory notes from Borrower to Lender, is governed by the terms of a Business Loan Agreement, dated June 10, 1992, between Borrower and Lender, as may be amended from time to time (the "Loan Agreement"). Hereinafter, all indebtedness owing by Borrower to Lender shall be referenced to as the "Indebtedness." 2. DESCRIPTION OF COLLATERAL: Repayment of the Indebtedness is secured by a Commercial Security Agreement, dated June 3, 1994 (the "Security Agreement"). Hereinafter, the above-described security documents, together with all other documents securing payment of the Note (and other notes executed by Borrower in favor of Lender) 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 Note. 1. The interest rate to be applied to the unpaid principal balance of the note is hereby increased, effective as of the date hereof, to a rate equal to one and one-half percent (1.50%) above the Lender's Index (as defined therein). B. Modification(s) to Loan Agreement. 1. The paragraph entitled "Financial Covenants" is hereby amended to read, in its entirety: Borrower shall maintain, on a monthly basis, beginning with the period ending September 30, 1995, on a monthly basis, a minimum quick ratio of 0.75 to 1.00; a maximum debt to tangible net worth ratio of 1.50 to 1.00; and a minimum tangible net worth plus subordinated debt of $1,500,000.00. Furthermore, Borrower shall achieve profitability, on a quarterl basis, beginning with the quarter ending December 31, 1995, and quarterly thereafter. 2. The first sentence of the paragraph entitled "Borrowing Base Formula" is hereby amended to read, in its entirety: Borrowing Base Formula. Funds shall be advanced under the Line according to 2 EXHIBIT 10.19(d) page two a borrowing base formula as determined by Lender on a monthly basis, defined as follows: the lesser of (a) $1,500,000.00 or (b) Eighty percent (80%) of eligible accounts receivable plus $150,000.00 through December 31, 1995, decreasing to the lesser of (C) $150,000.00 or (d) Seventy five percent (75%) of eligible accounts receivable as of January 1, 1996. C. Forbearance. 1. Lender agrees to forebear from exercising its remedies under the Existing Loan Documents until December 31, 1995, not withstanding Borrower's existing default under the Loan Agreement as a result of Borrower's failure to comply with the tangible net worth covenant as of August 31, 1995 and the profitability covenant as of the quarter ending September 30, 1995. By signing below, Borrower acknowledges that the Indebtedness currently is in default and as a result of such default, Lender is entitled to exercise its remedies as provided in the Existing Loan Documents and as provided under applicable law. Nothing in this Agreement in any way shall constitute Lender's waiver of Borrower's existing default under the Loan Agreement. Upon termination of the forbearance period described above, without any notice to Borrower, Lender may exercise any remedies available to Lender under the Existing Loan Documents and under applicable law. 4. CONSISTENT CHANGES. The Existing Loan Documents are hereby amended wherever necessary to reflect the changes described above. 5. NO DEFENSES OF BORROWER. Borrower agrees that, as of this date, it has no defenses against the obligations to pay any amounts under the Indebtedness. 6. CONTINUING VALIDITY. Borrower understands and agrees that in modifying the existing Indebtedness, Lender 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 and in full force and effect. Lender's agreement to modifications to the existing Indebtedness pursuant to this Loan Modification Agreement in no way shall obligate Lender 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 Lender and Borrower to retain as liable parties all makers and endorsers of Existing Loan Documents, unless the party is expressly released by Lender 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. 7. CONDITIONS. The effectiveness of this Loan Modification Agreement is conditioned upon payment of the Loan Fee and Lender's receipt of the Amendment and Reaffirmation of Subordination Agreements executed by each Creditor. This Loan Modification Agreement is executed as of the date first written above. BORROWER: LENDER: FAFCO, INC. SILICON VALLEY BANK By: \s\ Alex N. Watt By: \s\ Julie Schneider Name: Alex N. Watt Name: Julie Schneider Title: V.P. Finance & Administration Title: CBD EX-10.19(E) 5 LOAN MODIFICATION AGREEMENT DATED FEBRUARY 8, 1996 1 EXHIBIT 10.19(e) LOAN MODIFICATION AGREEMENT This Loan Modification Agreement is entered into as of February 8, 1996, by and between FAFCO, INC. ("Borrower") whose address is 2690 Middlefield Road, Redwood City, CA 94063, and Silicon Valley Bank ("Lender") whose address is 3000 Lakeside Drive, Santa Clara, CA 95054. 1. DESCRIPTION OF EXISTING INDEBTEDNESS: Among other indebtedness which may be owing by Borrower to Lender, Borrower is indebted to Lender pursuant to, among other documents, a Promissory Note, dated June 10, 1992, in the original principal amount of Five Hundred Thousand and 00/100 Dollars ($500,000.00) (the "Note"). The Note has been modified pursuant to Change in Terms Agreements, dated February 15, 1993 and April 29, 1993, and a Loan Modification Agreements, dated March 8, 1994, and June 5, 1995, pursuant to which, among other things, the principal amount of the Note was increased to One Million Five Hundred Thousand and 00/100 Dollars ($1,500,000.00). The Note, together with other promissory notes from Borrower to Lender, is governed by the terms of a Business Loan Agreement, dated June 10, 1992, between Borrower and Lender, as may be amended from time to time (the "Loan Agreement"). Hereinafter, all indebtedness owing by Borrower to Lender shall be referenced to as the "Indebtedness." 2. DESCRIPTION OF COLLATERAL: Repayment of the Indebtedness is secured by a Commercial Security Agreement, dated June 3, 1994 (the "Security Agreement"). Hereinafter, the above-described security documents, together with all other documents securing payment of the Note (and other notes executed by Borrower in favor of Lender) 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 Note. 1. The interest rate to be applied to the unpaid balance of the Note is hereby increased, effective as of the date hereof, to a rate equal to two and one-half percent (2.50%) above the Lender's Index (as defined therein). The principal amount of the Note is hereby reduced to One Million Dollars ($1,000,000.00). B. Modification(s) to Loan Agreement. 1. The paragraph entitled "Financial Covenants" is hereby amended to read, in its entirety:: Borrower shall maintain, on a monthly basis, beginning with the period ending January 31, 1996, a minimum quick ratio of 0.50 to 1.00, a maximum debt to tangible net worth ratio of 2.75 to 1.00, and a minimum tangible net worth plus subordinated debt of $1,050,000 plus the net proceeds received by Borrower from the sale of convertible securities after the date of this Amendment. Furthermore, Borrower shall achieve profitability, on a quarterly year-to-date basis, beginning with the quarter ending March 31, 1996, and quarterly thereafter. 2 EXHIBIT 10.19(e) page two 2. The first sentence of the paragraph entitled "Borrowing Base Formula" is hereby amended to read, in its entirety: C. Forbearance. 1. Lender agrees to forebear from exercising its remedies under the Existing Loan Documents until June 5, 1996, not withstanding Borrower's existing default under the Loan Agreement as a result of Borrower's failure to comply with certain covenants as of as of December 31, 1995. Borrower acknowledges that the Indebtedness currently is in default and as a result of such default, Lender is entitled to exercise its remedies as provided in the Existing Loan Documents and as provided under applicable law. Nothing in this Agreement in any way shall constitute Lender's waiver of Borrower's existing default under the Loan Agreement. Upon termination of the forbearance period described above, without any notice to Borrower, Lender may exercise any remedies available to Lender under the Existing Loan Documents and under applicable law. 4. CONSISTENT CHANGES. The Existing Loan Documents are hereby amended wherever necessary to reflect the changes described above. 5. NO DEFENSES OF BORROWER. Borrower agrees that, as of this date, it has no defenses against the obligations to pay any amounts under the Indebtedness. 6. CONTINUING VALIDITY. Borrower understands and agrees that in modifying the existing Indebtedness, Lender 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 and in full force and effect. Lender's agreement to modifications to the existing Indebtedness pursuant to this Loan Modification Agreement in no way shall obligate Lender 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 Lender and Borrower to retain as liable parties all makers and endorsers of Existing Loan Documents, unless the party is expressly released by Lender 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. 7. CONDITIONS. The effectiveness of this Loan Modification Agreement is conditioned upon payment of the Loan Fee of Five Hundred Dollars ($500). This Loan Modification Agreement is executed as of the date first written above. BORROWER: LENDER: FAFCO, INC. SILICON VALLEY BANK By: \s\ Alex N. Watt By: \s\ Julie Schneider Name: Alex N. Watt Name: Julie Schneider Title: V.P. Finance & Administration Title: CBD EX-13.1 6 1995 ANNUAL REPORT TO SHAREHOLDERS 1 FAFCO, Inc. 1995 Annual Report a manufacturer of polymer heat exchangers FAFCO, Inc. designs, manufactures, and markets heat exchangers made primarily of polymers for use in solar swimming pool heating and for thermal energy storage. FAFCO markets its swimming pool products in the United States and overseas through independent distributors who sell directly to end users. The Company markets its IceStor? products in the United States through independent manufacturers' representatives. The Company has also licensed its IceStor? products overseas. In addition, the Company sells certain electronic products to automate swimming pool functions which reduce the time and costs associated with the swimming pool operation. FAFCO has manufactured over one million polymer heat exchangers since its incorporation in 1972. The heat exchangers are made using proprietary and patented processing technology. The Company is the largest manufacturer of solar pool heating systems in the United States. In 1987, FAFCO introduced IceStor?, a static glycol ice builder for the thermal storage market. The FAFCO IceStor? utilizes a variation of the Company's polymer heat exchanger placed in a galvanized steel container. The IceStor? products, a demand-side management tool for electric utilities, use chilled glycol flowing through the heat exchanger to convert a static volume of water in the container to ice. The ice is made at night using less expensive (C)off-peaka power. The cooling energy stored in the ice is then reclaimed the next day during (C)peak periodsa to provide space or process cooling. The result is lowered cooling costs. FAFCO's products are manufactured and marketed with a common founding strategy outlined below: The choice of markets where high market share or growth are likely. A high value-added manufacturing process that minimizes direct labor in favor of proprietary processes. An effort to maximize gross margin based on sophisticated manufacturing in high volume to enable economies of scale. Experienced management whose capabilities exceed the immediate demands of the business. A resolution to combine the foregoing to build a large and successful enterprise. 2 Letter to Shareholders Dear Shareholder: Nineteen ninety-five has proven to be one of the most challenging years in FAFCO, Inc.'s twenty-six year history. FAFCO, Inc. recorded a net loss of $1,918,300 on net sales of $7,876,100. This compared with a profit of $454,500 and net sales of $10,526,000 in 1994. There were principally two reasons for FAFCO's loss. Ice storage sales that had grown aggressively for several years declined 31.8% in 1995. The decline was caused in large part by deregulation of certain electric utilities, which can cause the reduction or the elimination of ice storage incentive programs. In addition, solar sales declined 20.4%. Total sales in 1995 were off $2,649,900 (25.2%) compared with 1994. The following measures have been taken to improve operating results: We have reduced our number of employees from a high of 74 in July 1995 to 48 as of January 31, 1996. Monthly fixed expenses have been reduced by 32% from their peak in July 1995 and are at roughly the same level as in 1994. We hope to increase solar sales by introducing our first new solar panel since 1976. In addition, we are introducing a new solar heating system for above-ground pools and initiating more sales outside of California and Florida. We are seeking to increase thermal energy storage sales of our IceStor? product through efforts of a regional salesman hired in 1995 and emphasis on regionally attractive markets and by focusing on international business that has strong potential. Although I am delighted to put 1995 behind us, there were a number of accomplishments. New products were designed, prototyped, and readied for market. New production machines were designed and built. Productivity as measured by sales per employee increased substantially to reach $165,000 per employee. The foregoing, combined with the support of our bank and the raising of $325,000 additional subordinated debt, make me optimistic that FAFCO can recover from the financial setbacks of 1995 and show improved results in 1996. Early indications in 1996 are positive. FAFCO's resilience under considerable pressure is entirely due to the remarkable resourcefulness, dedication, and spirit of each and every one of our employees, for which I am grateful. Sincerely, Freeman A. Ford President 3 Consolidated Balance Sheet
December 31, 1995 1994 Assets Current assets: Cash and cash equivalents $ 126,200 $ 338,000 Accounts receivable, less allowance for doubtful accounts of $463,900 in 1995 and $469,100 in 1994 1,149,600 2,551,200 Current portion of long-term notes receivable 64,000 14,500 Inventories 717,200 843,200 Prepaid expenses and other current assets 145,500 116,900 Other accounts receivable 15,000 Deferred tax asset, net of allowance 125,200 140,600 Total current assets 2,327,700 4,019,400 Plant and equipment, at cost 2,345,100 2,286,500 Less accumulated depreciation and amortization (2,085,900) (1,907,200) 259,200 379,300 Notes receivable and other assets (net) 327,700 33,900 Deferred tax asset, net of allowance 485,800 470,400 Total assets $ 3,400,400 $ 4,903,000 Liabilities and shareholders' equity Current liabilities: Note payable to bank $ 751,300 $ Accounts payable and other accrued expenses 949,100 1,193,100 Accrued compensation and benefits 188,900 161,900 Accrued warranty expense 216,000 247,000 Income taxes payable 45,800 Total current liabilities 2,105,300 1,647,800 Convertible subordinated notes ($425,000 was owed to related parties in 1995 and 1994) 600,000 600,000 Other non-current liabilities 80,400 125,100 Total liabilities 2,785,700 2,372,900 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; 3,112,687 issued and outstanding in 1995 and 3,100,887 issued and outstanding in 1994 389,000 387,600 Capital in excess of par value 5,035,600 5,034,100 Notes receivable secured by Common Stock (75,100) (75,100) Deficit (4,734,800) (2,816,500) Total shareholders' equity 614,700 2,530,100 Commitments and contingent liabilities Total liabilities and shareholders' equity $ 3,400,400 $ 4,903,000
4 Consolidated Statement of Operations
Year Ended December 31, 1995 1994 1993 Net sales 7,876,100 10,526,000 9,352,200 Other income (expense) 39,700 108,800 (69,900) Total revenues 7,915,800 10,634,800 9,282,300 Cost of goods sold 5,637,900 6,542,900 5,563,800 Marketing and selling expense 2,137,200 1,767,500 1,546,900 General and administrative expense 1,502,000 1,257,100 1,361,100 Research and development expense 460,100 484,300 479,400 Net interest expense 95,300 79,400 76,900 Total costs and expenses 9,832,500 10,131,200 9,028,100 Income (loss) before income taxes and extraordinary item (1,916,700) 503,600 254,200 Provision for income taxes 1,600 49,100 116,700 Income (loss) before cumulative effect of change in method of accounting for income taxes (1,918,300) 454,500 137,500 Cumulative effect of change in method of accounting for income taxes 717,400 Net income (loss) (1,918,300) 454,500 854,900 Primary net income (loss) per share before cumulative effect of change in accounting principle $ (0.62) $ 0.13 $ 0.04 Primary net income per share from change in method of accounting for income taxes 0.22 Primary net income (loss) per share $ (0.62) $ 0.13 $ 0.26 Fully diluted net income (loss) per share before cumulative effect of change in accounting principle $ (0.62) $ 0.13 $ 0.05 Fully diluted net income per share from change in method of accounting for income taxes 0.19 Fully diluted net income (loss) per share $ (0.62) $ 0.13 $ 0.24
The accompanying notes are an integral part of this statement. 5 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, 1992 3,051,755 $381,500 $5,026,600 $(105,700) $(4,125,900) Net income for the year 854,900 Payment of notes receivable secured by Common Stock 6,600 Balance at December 31, 1993 3,051,755 381,500 5,026,600 (99,100) (3,271,000) Net income for the year 454,500 Cancellation of shares and related notes receivable (32,000) (4,000) (20,000) 24,000 Cancellation of shares in satisfaction of other notes receivable (11,218) (1,400) (7,000) Issuance of shares pursuant to exercise of Directors' Warrants 15,000 1,900 5,600 Issuance of shares under the 1981 Employee Incentive Stock Option Plan 77,850 9,700 29,200 Cancellation of shares pursuant to a rescission offer (500) (100) (300) Balance at December 31, 1994 3,100,887 $387,600 $5,034,100 (75,100) (2,816,500) Net loss for the year (1,918,300) Cancellation of shares in satisfaction of other notes receivable (3,000) (400) (4,100) Issuance of shares under the 1981 Employee Incentive Stock Option Plan 8,800 1,100 3,300 Issuance of shares under the 1991 Employee Incentive Stock Option Plan 6,000 700 2,300 Balance at December 31, 1995 3,112,687 $389,000 $5,035,600 $(75,100) $(4,734,800)
The accompanying notes are an integral part of this statement. 6 Consolidated Statement of Cash Flows
Year Ended December 31, 1995 1994 1993 Cash flow from operating activities: Net (loss) income (1,918,300) 454,500 854,900 Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: Depreciation 178,700 169,400 156,400 Allowance for doubtful accounts 33,900 51,700 97,200 Provision for inventory reserve 105,800 (800) (30,800) Loss on disposition of fixed assets 22,700 Cumulative effect of change in method of accounting for income taxes (717,400) Change in assets and liabilities: Change in receivables 1,367,800 (372,400) (394,100) Change in inventories 20,200 (86,200) (93,000) Change in prepaid expenses (28,600) 55,900 (80,000) Change in deferred tax assets 700 105,700 Change in other assets (333,000) 9,900 40,800 Change in payables and accrued expenses (288,900) 63,800 111,800 Change in other non-current liabilities (27,800) (6,300) 73,600 Net cash (used in) provided by operations (867,500) 340,200 125,100 Cash flow from investing activities: Purchase of fixed assets (81,300) (104,900) (209,400) Net cash used in investing activities (81,300) (104,900) (209,400) Cash flow from financing activities: Repayment of notes receivables secured by common stock 6,600 Proceeds from sale of common stock 7,400 46,000 Proceeds from borrowings 751,300 Repayment of borrowings ($250,000 was repaid to a related party in 1993) (21,700) (19,300) (251,400) Net cash provided by (used in) financing activities 737,000 26,700 (244,800) Net (decrease) increase in cash and cash equivalents (211,800) 262,000 (329,100) Cash and cash equivalents, beginning of year 338,000 76,000 405,100 Cash and cash equivalents, end of year 126,200 338,000 $76,000 Supplemental disclosures of cash flow information: Cash paid during the year for interest 89,800 $83,400 $85,400 Net cash paid during the year for income taxes 49,000 117,400
The accompanying notes are an integral part of this statement. 7 Notes to Consolidated Financial Statements 1. Organization and Summary of Significant Accounting Policies The Company designs, develops, manufactures, and markets solar heating systems for swimming pools and thermal energy storage systems for commercial and industrial cooling. The solar heating systems are sold to wholesalers and distributors primarily in California and Florida and in other locations in the United States and overseas. Thermal energy storage systems are marketed through manufacturers' representatives throughout the United States and internationally. One of the Company's customers accounted for 10% of the Company's fiscal 1995 net sales. No customer accounted for 10% or more of the Company's sales in fiscal 1994 or 1993. During 1995 and 1994, the Company had sales to unaffiliated customers in foreign countries amounting to 15% of total net sales. During 1993, such sales amounted to 12% of total net sales. 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. 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 from those estimates. Inventories Inventories are stated at the lower of cost or market determined using the last-in, first-out (LIFO) method. At December 31, 1995 and 1994, inventories would have been approximately $874,600 and $940,800, respectively, if the first-in, first-out method had been used. 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. 8 Notes to Consolidated Financial Statements (cont'd.) Accounting for the Impairment of Long-lived Assets and for Long-lived Assets to be Disposed of The FASB issued a new standard, FAS No. 121, (C)Accounting for the Impairment of Long-lived Assets and for Long-lived Assets to be Disposed of,a which provides guidance on when to recognize and how to measure impairment losses of long-lived assets and certain identifiable intangibles and how to value long-lived assets to be disposed of. The Company anticipates that the impact of FAS No. 121, when adopted, will not be material. The Company is required to adopt this new standard in 1996. Income Taxes As required by generally accepted accounting principles (GAAP) effective January 1, 1993, the Company adopted Statement of Financial Accounting Standards No. 109, (C)Accounting for Income Taxesa (FAS No. 109), on a prospective basis. The new standard requires an asset and liability approach for financial accounting and reporting for income taxes. Under this approach, 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 8.) Concentration of Credit Risk Most of the Company's business activity is with customers located in California and Florida. As of December 31, 1995, unsecured trade accounts receivable from customers in California and Florida were $811,100 and $796,300, respectively. Warranties In the normal course of business, the Company makes certain warranties as to workmanship and materials. Product warranty periods range from two to ten years for full coverage and up to an additional seven years of limited 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. Net Income Per Share Net income per share is based on the sum of the weighted average number of shares issued and outstanding during the years. (See Note 12.) Accounting for Stock-Based Compensation The FASB issued a new standard, FAS No. 123, (C)Accounting for Stock-Based Compensation,a which contains a fair value-based method for valuing stock-based compensation that entities may use, which measures compensation cost at the grant date based on the fair value of the award. Compensation is then recognized over the service period. Alternatively, the standard permits entities to continue accounting for employee stock options and similar equity instruments under APB Opinion 25, (C)Accounting for Stock Issued to Employees.a Entities that continue to account 9 Notes to Consolidated Financial Statements (cont'd.) for stock options using APB Opinion 25 are required to make pro forma disclosures of net income and earnings per share, as if the fair value-based method of accounting defined in FAS No. 123 had been adopted. The Company has not determined which method it will follow in the future. The Company will be required to adopt the new standard in its fiscal year 1996. 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. 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: Current Assets and Current Liabilities: The carrying value of cash equivalents, accounts receivable, short-term borrowings, accounts payable, and accrued expenses approximates 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, 1995, the carrying amount approximates estimated fair value of long-term debt. 2. Inventories Inventories consist of the following:
December 31, 1995 1994 Raw materials $ 395,200 $ 464,000 Work in progress 118,500 211,300 Finished goods 203,500 167,900
3. Plant and Equipment Plant and equipment consist of the following:
December 31, 1995 1994 Machinery and equipment $ 1,754,500 $1,752,700 Office and computer equipment 370,500 322,800 Leasehold improvements 88,600 79,500 Vehicles 131,500 131,500 $ 2,345,100 $2,286,500 Less accumulated depreciation and amortization (2,085,900) (1,907,200) $ 259,200 $ 379,300
10 Notes to Consolidated Financial Statements (cont'd.) 4. Notes Receivable During 1995, the Company converted $429,700 of accounts receivable from two customers into notes receivable, one of which is secured by an interest in real property. Both notes are being repaid in monthly installments through 1997. 5. Convertible Subordinated Notes The notes outstanding at December 31, 1995 were due on March 27, 1996, bore interest at 10% per annum payable quarterly, and were partially convertible into Common Stock of the Company at any time at the option of the holder. The notes were subordinated to any bank debt or other senior indebtedness (as defined) of the Company. The Company could, at its option, call the notes for redemption at any time. The conversion price is $0.50 per share and the maximum aggregate number of shares issuable upon conversion of all of the notes is 270,000 shares. In February 1996, the Company borrowed an additional $325,000 from certain of the note holders, interest at 12%, in the form of bridge financing, through March 27, 1996, $125,000 of which was from related parties (see Note 9). On March 27, 1996, the Company exchanged the $600,000 of convertible subordinated notes and the $325,000 of bridge notes for new notes, due March 27, 2000, bearing interest at 11% per annum, payable quarterly, and warrants to purchase Common Stock. The exercise price of the warrants is $0.125 per share, the maximum aggregate number of shares issuable is 555,000, and the unexercised warrants expire March 27, 2000. 6. Bank Line of Credit The Company's bank line of credit, which is secured by substantially all assets of the Company, was modified on June 5, 1995 to allow the Company to borrow the lesser of $1,500,000 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 1/2%. The line of credit contains certain covenants relating to working capital, current ratio, and tangible net worth and expires on June 5, 1996. The line of credit was modified as to certain covenants on August 7, 1995, September 22, 1995, and February 8, 1996, and the interest rate was increased from the bank's prime rate plus 1/2% to the bank's prime rate plus 1-1/2% on September 22, 1995 and to the bank's prime rate plus 2-1/2% on February 8, 1996. The maximum borrowing under the line was reduced to $1,000,000 on February 8, 1996. At December 31, 1995, the Company has complied with or obtained waivers for compliance with the loan covenants. 11 Notes to Consolidated Financial Statements (cont'd.) As of December 31, 1995, the Company had utilized $751,300 of this facility. At December 31, 1994, the Company had no borrowing under this line of credit. 7. 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, 1995 and 1994. The notes are due and 12 Notes to Consolidated Financial Statements (cont'd.) 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. In 1990, the Company issued 74,000 shares of common stock at $0.75 per share. Payment for these shares was partially funded by full- recourse notes, which had a balance due of $24,000 and $30,600 at December 31, 1993 and 1992, respectively. During 1994, the Company canceled the balance of the shares that remained unpaid and the related balance of the notes outstanding. 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 were issued thereunder since 1991. The Company has a 1981 Incentive Stock Option Plan under which 310,000 shares of Common Stock are reserved for issuance. During 1995, options to purchase 8,800 shares were exercised. During 1994, options to purchase 77,850 shares were exercised. No options were exercised under the 1981 plan during 1993. The plan expired by its terms in 1991. In 1988, the Company's Board of Directors granted, and during 1988 the shareholders approved, the grant of six-year warrants to purchase a total of 15,000 shares of Common Stock at $0.50 per share, the fair market value on the date of grant, to outside directors. These warrants were exercised in January 1994. The Company has a 1991 Incentive Stock Option Plan under which 250,000 shares of Common Stock are reserved for issuance to employees and consultants. During November 1994, the Board of Directors approved an increase in the number of shares of Common Stock reserved for issuance to a total of 500,000 shares subject to shareholder approval, which was obtained in April 1995. During 1993, options were granted to purchase 214,000 shares exercisable at $0.50 per share, the fair market value on the date of grant. No options were granted or exercised under the 1991 plan during 1994. During 1995, options were granted to purchase 124,000 shares exercisable at $0.56 per share, the fair market value on the date of grant. During 1995, options to purchase 6,000 shares were exercised. The Company has a 1991 Director's Stock Option Plan under which 50,000 shares of Common Stock are reserved for issuance. During 1991, options were granted to purchase a total of 20,000 shares at $0.50 per share, the fair market value at date of grant, to two outside directors. During 1993, options were granted to purchase a total of 10,000 shares at $0.50 per share, the fair market value at date of grant, to two outside directors. None of these options have been exercised. No options were granted or exercised during 1994 or 1995. Options granted under these plans vest at 20% per year for five years from date of grant and expire six years from date of grant. During 1994, the Company granted nonqualified options to purchase a total of 43,218 shares at $0.75 per share to a consultant and four employees and during 1995, the Company granted nonqualified options to purchase 20,000 shares at $0.56 per share to a consultant. These options were fully vested at the date of grant and expire six years from date of grant. None of these options have been exercised. During 1995, options to purchase 234 shares were canceled. 13 Notes to Consolidated Financial Statements (cont'd.) Net income tax provision $ 1,600 $ 49,100 $ 116,700
Effective January 1, 1993, as required by GAAP, the Company changed its method of accounting for income taxes by adopting SFAS 109. The cumulative effect of this change on years prior to 1993 increased net income by $717,400. The cumulative effect, resulting primarily from the recognition of the tax effects of state and federal net operating loss carryforwards and net deductible temporary differences, totaled $1,434,800, which was offset by a valuation allowance of $717,400. A reconciliation of the statutory federal income tax rate with the effective tax rate reported in the financial statements follows:
Years ended December 31 1995 1994 1993 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 (1.4%) 6.0% 8.9% Tax effect of change in valuation allowance 40.9% (49.4%) Expiration of tax credits 0.7% 18.2% Other (6.2%) (0.4%) 3.0% Effective tax rate 0% 8.4% 45.9%
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 of the related assets or liabilities. 14 Notes to Consolidated Financial Statements (cont'd.) Deferred tax assets are comprised of the following: December 31, 1995 1994 Allowance for doubtful accounts $ 197,000 $199,400 Accrued expenses 142,300 140,000 Loss carryforwards 1,360,500 625,000 Tax credits 178,600 193,600 Other 116,400 53,900 1,994,800 1,211,900 Deferred tax asset valuation allowance (1,383,800) (600,900) Total deferred taxes, net $ 611,000 $611,000
The Company had unused federal net operating loss carryforwards of $3,669,700 and $1,769,200, and state loss carryforwards of $1,554,100 and $427,600, and investment and other tax credits of approximately $178,600 and $193,600 vailable to offset future tax liabilities at December 31, 1995 and December 31, 1994, respectively. 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 (C)total deferred taxes, neta in the amount of $611,000 is more likely than not to be realized. 9. Transactions with Related Parties The Company has a financing agreement with Freeman A. Ford, an officer, director, and major shareholder of the Company, under which Mr. Ford has made a $275,000 line of credit available to the Company. Borrowings under the line of credit bear interest at Silicon Valley Bank's prime rate plus 4%. Pursuant to the agreement, Mr. Ford was granted a warrant to purchase 45,000 shares of Common stock for making the line available and a warrant to purchase up to 90,000 additional shares of Common Stock under a formula based on usage of the line of credit. At December 31, 1995 and 1994, the Company had no borrowings under this line of credit. The line of credit terminates and the outstanding warrants expire on March 27, 1996. In 1984, Freeman A. Ford and Janet V. Ford (Mr. Ford's mother) purchased $100,000 and $50,000 of the Company's convertible subordinated notes, respectively, from the Company. (See 15 Notes to Consolidated Financial Statements (cont'd.) Note 5.) In January 1994, Mr. Ford purchased $50,000 of the Company's convertible subordinated notes from the estate of Janet Ford. In January 1990, David Ford, Kimberly Ford, Tod Ford, and Erin Ford, the children of Mr. Ford, purchased a total of $125,000 of the Company's convertible subordinated notes from certain noteholders. In January 1993, Mr. Ford purchased $100,000 of the Company's convertible subordinated notes from another noteholder. In March 1993, Alan G. Carlson, a principal and owner of one of the Company's customers, purchased $50,000 of the Company's convertible subordinated notes from another noteholder. In February 1996, Mr. Ford loaned the Company an additional $100,000 and Diana Ford (Mr. Ford's wife) loaned the Company $25,000 due in April 1996. On March 27, 1996, these notes were exchanged for subordinated notes due in March 2000 as part of the Company's refinancing of the outstanding convertible subordinated notes. (See Note 5.) 10. 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 18% of their eligible salary. The Company contributes an amount equal to 25% of the employee contribution, up to a maximum of $200 per employee. 11. Lease Commitments The Company's rental expense, relating primarily to a lease for its office and manufacturing facility, amounted to $359,400 in 1995, $340,000 in 1994, and $313,300 in 1993. At December 31, 1995, minimum annual lease commitments under operating leases were as follows: 1996 $ 377,000 1997 389,800 1998 391,900 1999 405,400 2000 139,000 Thereafter 0 Total $ 1,703,100
16 Notes to Consolidated Financial Statements (cont'd.) 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. 17 Notes to Consolidated Financial Statements (cont'd.) 2. Net Income Per Share Primary earnings per share were calculated as follows:
Years ended December 31, 1995 1994 1993 Net income (loss) $(1,918,300) $ 454,500 $ 854,900 Average common shares outstanding 3,102,564 3,035,137 3,051,755 Add: Exercise of options reduced by the number of shares purchased with proceeds N/A 262,892 163,431 Add: Exercise of warrants reduced by the number of shares purchased with proceeds N/A 118,261 100,371 Adjusted weighted average shares outstanding 3,102,564 3,416,290 3,315,557 Earnings (loss) per share $ (0.62) $ 0.13 $0.26
Primary earnings per share are calculated by dividing net income (loss) by the weighted average number of shares issued and outstanding and shares issuable upon exercise of dilutive stock options and warrants during each year. Fully diluted earnings per share were calculated as follows: 18 Notes to Consolidated Financial Statements (cont'd.)
Years ended December 31, 1995 1994 1993 Adjusted net income (loss) $(1,918,300) $ 454,500 $ 887,400 Average common shares outstanding 3,102,564 3,035,137 3,051,755 Add: Exercise of options reduced by the number with proceeds N/A 262,892 291,517 Add: Exercise of warrants reduced by the number of shares purchased with proceeds N/A 118,261 118,281 Add: Conversion of convertible debt into shares N/A N/A 270,000 Adjusted weighted average shares outstanding 3,102,564 3,416,290 3,731,553 Earnings (loss) per common share assuming full dilution $ (0.62) $ 0.13 $0.24
19 Fully diluted earnings per share are calculated by dividing net income (loss), adjusted for the dilutive after-tax effect of the interest expense associated with the convertible debt, by the sum of the weighted average number of shares issued and outstanding and shares issuable upon exercise of dilutive stock options and warrants, and upon conversion of convertible debt during each year. For the years ended December 31, 1995 and 1994, primary earnings (loss) per share is repeated as fully diluted earnings per share as the calculation of fully diluted (loss) earnings per share was anti-dilutive. 13. Licensing Income During 1993, the Company entered into two license agreements with third parties in the Far East, under which the Company received and recognized license fee income net of foreign income taxes of $159,000. The agreements allow for the licensee to assemble and sell the IceStor? product in certain countries using the Company's technology and design specifications. For the terms of the agreements (three and eight years), the Company is required to provide parts and technical services to the licensee at prices and rates equivalent to normal list prices. 14. 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 operations. During the second quarter of 1994, the Company resolved a lawsuit and recorded other income, net of related costs, of $66,000. During the fourth quarter of 1993, the Company resolved a lawsuit and recorded other expense, including related costs, of $249,800. 20 Report of Independent Accountants To the Board of Directors and Shareholders of FAFCO, Inc. In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of operations, shareholders' equity, and of cash flows present fairly, in all material respects, the financial position of FAFCO, Inc. and its subsidiary at December 31, 1995 and 1994 and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1995, in conformity with generally accepted accounting principles. These financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with generally accepted auditing standards which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above. As discussed in Note 8 to the consolidated financial statements, the Company changed its method of accounting for income taxes effective January 1, 1993. PriceWaterhouse LLP San Francisco, California March 27, 1996 21 Summary of Operations Five-Year Summary of Operations (in thousands, except per share data)
Year Ended December 31, 1995 1994 1993 1992 1991* Net sales $ 7,876 $ 10,526 $ 9,352 $ 7,782 $ 8,062 Income (loss) before income taxes and extraordinary item $ (1,917) $ 504 $ 254 $ 587 $ 190 Provision for income taxes 1 49 116 242 78 Income (loss) before extraordinary item (1,918) 445 138 345 112 Extraordinary item-tax benefit resulting from net operating loss carryforward 174 62 Cumulative effect of change in method of accounting for income taxes 717 Net income (loss) $ (1,918) $ 455 $ 855 $ 519 $ 174 Primary net income (loss) per share before extraordinary item $ (0.62) $ 0.13 $ 0.04 $ 0.11 $ 0.04 Primary net income per share from extraordinary item 0.06 0.02 Primary net income per share from cumulative effect of change in method of accounting for income taxes 0.22 Primary net income (loss) per share $ (0.62) $ 0.13 $ 0.26 $ 0.17 $ 0.06 Fully diluted net income (loss) per share before extraordinary item $ (0.62) $ 0.13 $ 0.05 $ 0.11 $ 0.04 Fully diluted net income per share from extraordinary item 0.06 0.02 Fully diluted net income per share from cumulative effect of change in method of accounting for income taxes 0.19 Fully diluted net income (loss) per share $ (0.62) $ 0.13 $ 0.24 $ 0.17 $ 0.06
At December 31, 1995 1994 1993 1992 1991* Working capital $ 222 $ 2,371 $ 1,784 $ 1,624 $ 867 Total assets 3,400 4,903 4,373 3,577 3,032 Long-term obligations 680 725 751 928 917 Shareholders' equity 615 2,530 2,038 1,177 653
*Reclassified for comparative purposes. 22 Summary of Operations (cont'd.) 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 1995 and 1994 were as follows:
Quarter Ended March 31 June 30 September 30 December 31 1995 High $1.50 $1.50 $1.50 $0.75 Low $1.00 $1.00 $0.75 $0.25 1994 High $1.00 $2.00 $2.00 $1.50 Low $1.00 $1.00 $1.50 $1.50
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, 1996, the Company had 722 shareholders of record. FAFCO, Inc. has never paid dividends on its Common Stock and has no plans to do so in the foreseeable future. 23 Management's Discussion and Analysis 1995 Compared With 1994 Net sales for 1995 decreased by 25.2% from $10,526,000 in 1994 to $7,876,100 in 1995. This decrease was primarily due to decreased unit sales of the Company IceStor? products along with decreased unit sales of the Company's pool panel products. Net sales of the Company's pool products were 19.8% lower in 1995 than in 1994 due mainly to continued economic weakness in California and Florida, the main markets for the Company's pool products. Net sales of the Company's IceStor? products were 31.8% lower in 1995 than in 1994 due mainly to potential customers' beliefs that lower energy prices in the domestic marketplace will result from planned deregulation of energy prices. This domestic decrease was partly offset by increased foreign sales of IceStor? products. Pool product sales amounted to 62% of net sales in 1995 compared to 57% of net sales in 1994. Ice Stor? sales amounted to 38% of net sales in 1995 compared to 42% in 1994. There were no significant price changes in any of the Company's products during 1995. Cost of goods sold decreased from $6,542,900 in 1994 to $5,637,900 in 1995 while increasing as a percentage of net sales from 62.2% in 1994 to 71.6% in 1995. The increase as a percent of sales was due mainly to the fixed costs being allocated over significantly lower sales along with employee severance expenses associated with a 32% reduction in the work force. Marketing and selling expense increased from $1,767,500 (16.8% of net sales) in 1994 to $2,137,200 (27.1% of net sales) in 1995. This increase was due mainly to one-time expenses for market research projects during the second half of 1995 along with the addition of sales personnel and increased promotional expenses for pool products during the first half of 1995. General and administrative expenses increased from $1,257,100 (11.9% of net sales) in 1994 to $1,502,000 (19.1% of net sales) in 1995. These increases were primarily due to increased personnel costs during the first half of 1995 along with severance expense and increased legal expenses. Research and development expenses were relatively stable in absolute dollars at $484,300 in 1994 compared with $460,100 in 1995 while increasing from 4.6% of net sales in 1994 to 5.8% of net sales in 1995. The increase as a percent of sales was due entirely to the decreased level of sales in 1995. Net interest expense increased from $79,400 (0.8% of net sales) in 1994 to $95,300 (1.2% of net sales) in 1995. This increase was due primarily to higher than average daily borrowing in the second half of 1995 at higher interest rates, partially offset by lower than average daily borrowing during the first half of 1995 compared to 1994. Other income (expense) net included $24,000 in refunds of prior years' insurance premiums in 1995 compared with $38,400 in 1994. Other income (expense) net in 1994 also included $66,000 of proceeds, net of related costs, pertaining to a legal settlement resolved during 1994. 1994 Compared With 1993 Net sales for 1994 increased by 12.6% from $9,352,200 in 1993 to $10,526,000 in 1994. This 24 Management's Discussion and Analysis (cont'd.) increase was primarily due to increased unit sales of the Company's IceStor? products and increased unit sales of the Company's AutoPool? swimming pool solar heating control, which was introduced in May 1993. These increases were partially offset by decreased unit sales of the Company's pool panel products along with decreased unit sales of the Company's domestic hot water product (444A), which was phased out in February 1994. Net sales of the Company's pool panel product were 16.8% lower in 1994 than in 1993. Net sales of the Company's IceStor? products were 38.1% higher in 1994 than in 1993 due mainly to increased domestic sales from the successful sales effort of an expanded manufacturer's representative group along with increased foreign sales. Pool product sales amounted to 57% of net sales in 1994 compared to 63% in 1993. Thermal energy storage sales amounted to 42% of net sales in 1994 compared to 34% in 1993. There were no significant price changes in any of the Company's products during 1994. Cost of goods sold increased from $5,563,800 in 1993 to $6,542,900 in 1994 and increased as a percentage of net sales from 59.5% in 1993 to 62.2% in 1994. These fluctuations were due primarily to shifts in product mix between higher and lower margin products between 1993 and 1994. There were no significant price increases in any of the Company's raw materials in 1994. Marketing and selling expenses increased from $1,546,900 (16.5% of net sales) in 1993 to $1,767,500 (16.8% of net sales) in 1994. These increases were due primarily to the addition of personnel to facilitate the sales of IceStor? products, along with increased promotional expenses for both IceStor? and pool products. General and administrative expenses decreased from $1,361,100 (14.6% of net sales) in 1993 to $1,257,100 (11.9% of net sales) in 1994. These decreases were due mainly to the Company's efforts to reduce costs as sales increased. Research and development expenses were relatively stable in absolute dollars at $479,400 (5.1% of net sales) in 1993 compared with $484,300 (4.6% of net sales) in 1994. However, the Company expects R&D expenses to increase in the future due to increased expenditures on development of new products. Other income (expense) included $66,000 of proceeds (net of related costs) from resolution of lawsuits during 1994. Refunds of prior year's insurance premiums included in other income (expense) were $38,400 in 1994 compared with $7,900 in 1993. The geographical distribution of the Company's sales changed from 1993 to 1994. Oklahoma and foreign sales increased from 3% and 12% of net sales in 1993 to 10% and 15%, respectively, due to increased IceStor? sales in Oklahoma and Pacific Rim Countries. Florida, California, and other states' sales decreased from 44%, 25%, and 16% of net sales in 1993 to 38%, 24%, and 13%, respectively, of net sales in 1994 due mainly to decreased IceStor? sales and pool panel sales in Florida and the fact that net sales increased significantly from 1993 to 1994. 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 25 Management's Discussion and Analysis (cont'd.) quarters, respectively. 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 product, 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 1993, sales experienced the traditional seasonality except that differences between quarters was not as great as in prior years due to increased sales of the non-seasonal IceStor? products. As a result of strong IceStor? sales, the traditional first quarter loss was not experienced. In 1994, sales and net income experienced their traditional seasonality, except that sales in the fourth quarter were increased due to sales of IceStor? product. As a result of the ice storage sales, the traditional fourth quarter loss was not experienced. In 1995, sales experienced the traditional seasonality except that the decline in sales in the third and fourth quarters was more pronounced than normal due to weak sales in both pool products and IceStor? during the second half of the year. There were net losses in all four quarters due to sales being below the planned levels in all four quarters. Liquidity and Capital Resources The Company's cash position decreased from $338,000 at 1994 fiscal year end to $126,200 at 1995 fiscal year end, principally due to the operating losses partially offset by a decrease in accounts receivable, bank borrowing and a decrease in inventories. At December 31, 1995, the Registrant's net accounts receivable had decreased to $1,149,600 from $2,551,200 at December 31, 1994, reflecting an improvement in promptness of payments particularly from the Registrant's IceStor? customers, the conversion of two customers' accounts receivable into notes receivable, one of which is secured by real property, and lower sales levels in 1995. At December 31, 1995, the Registrant's accounts payable and other accrued expenses had decreased to $922,900 from $1,165,100 at December 31, 1994. This decrease is primarily due to payments of expenses resulting from collection of receivables noted above. At December 31, 1995, the Company's inventories had decreased to $717,200 from $843,200 at December 31, 1994 due mainly to an inventory reduction focus within the Company and lower sales levels offset partially by the requirement to have inventory on hand for strong January 1996 sales and for the new product that began shipping in February 1996. The Company adopted SFAS 109 effective January 1, 1993. This resulted in the recognition of a deferred tax asset, net of valuation allowance, at year end of $611,000 in 1995 and 1994. 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 and the Company's expectation that this will resume and continue far enough into the future to realize the net deferred 26 Management's Discussion and Analysis (cont'd.) tax asset. However, there can be no assurance that the Company will return to profitability or, if it does, that profits will be sufficient to utilize the net deferred tax asset. At December 31, 1995, the Registrant's current ratio was 1.11 to 1 compared with 2.43 to 1 at December 31, 1994, as working capital decreased over the same period to $222,400 from $2,371,600. Total assets exceeded total liabilities by $614,700 at December 31,1995 compared with $2,530,100 at December 31, 1994. During the second half of 1995, the Company began and is continuing an aggressive cost reduction campaign, including the reduction of personnel from 74 employees to 48 employees. The Registrant believes that as a result of the cost-cutting measures, its cash flow from operations, together with bank borrowings, will be sufficient to support operations during the next twelve months. However, if sales remain slow or decline further from current levels, additional debt or equity financing may be required. The Company believes that the reduced rate of sales in IceStor?, which had an adverse impact on net revenues during the quarters ended June 30, 1995, September 30, 1995, and December 31, 1995, will not continue during 1996 and will, therefore, not have a negative effect on results of operations for 1996. However, if sales of IceStor? products do not recover, the Company's results of operations will be materially adversely affected. The Registrant has a line of credit, of which $751,300 had been utilized and $101,400 remained available under the formula applied to net accounts receivable. This line of credit expires on June 5, 1996. 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 Compression Labs, Inc. a manufacturer of video conferencing equipment Robert W. Selig, Jr.* President 27 Davis Instruments Corporation a manufacturer of marine and weather equipment * Member of the Audit Committee Executive Officers Freeman A. Ford President and Chief Executive Officer Alex N. Watt Vice President, Finance and Administration, Chief Financial Officer, and Secretary David K. Harris Vice President Pool Products Mike Anderson Vice President 28 Commercial Products 29 Transfer Agent and Registrar Bank of Boston c/o Boston EquiServe P.O. Box 644-02102 MS 45-02-09 Boston, Massachusetts 02102-0644 Telephone: (617) 575-3400 Legal Counsel Wilson, Sonsini, Goodrich & Rosati Professional Corporation 650 Page Mill Road Palo Alto, California 94304 Independent Accountants Price Waterhouse LLP 555 California Street San Francisco, California 94104 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: 30 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 2, 1996 at FAFCO, Inc., 2690 Middlefield Road, Redwood City, California Telephone: (415) 363-2690 EX-21.1 7 LIST OF SUBSIDIARIES 1 Exhibit 21.1 Subsidiaries of Registrant __________________________ Jurisdiction of Name Incorporation ___________________ ________________________ The Gregory Company California EX-27.1 8 FINANCIAL DATA SCHEDULE
5 YEAR DEC-31-1995 JAN-01-1995 DEC-31-1995 126,200 0 2,016,400 500,300 717,200 2,327,700 2,345,100 (2,085,900) 3,400,400 2,105,300 680,400 0 0 389,000 225,700 3,400,400 7,876,100 7,918,800 5,637,900 5,637,900 463,200 33,900 96,300 (1,916,700) 1,600 (1,918,300) 0 0 0 (1,918,300) (0.62) (0.62)
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