10-K

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10K

[Mark One]

x Annual report pursuant to Section 13 or 15[d] of the Securities Exchange Act of 1934

For the fiscal year ended December 31, 2002 or

o Transition report pursuant to Section 13 or 15[d] of the Securities Exchange Act of 1934

For the transition period from           to          .

Commission file number 0-10120

FAFCO, Inc.

[Exact name of registrant as specified in its charter]

California	94-2159547
[State or other jurisdiction of incorporation or organization]	[IRS Employer Identification No.]
435 Otterson Drive, Chico, California	95928
[Address of principal executive offices]	[Zip Code]

Registrant’s telephone number, including area code: 530-332-2100

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 o

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 10K or any amendment to this Form 10K. x

The aggregate market value of the registrant’s Common Stock held by non-affiliates of the registrant as of June 30, 2002, the last day of the registrant’s most recently completed second fiscal quarter, was $909,782 based upon the average of the bid and ask prices reported for such date by the National Quotation Bureau. Shares of common stock held by each officer and director and each person who owns 5% or more of the outstanding shares of common stock have been excluded in that such persons may be deemed affiliates. The determination of affiliate status in this context is not necessarily a conclusive determination for other purposes.

The number of shares of the registrant’s Common Stock outstanding as of March 13, 2003, was 3,864,111.

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TABLE OF CONTENTS

PART I
	Item 1. Business
	Item 2. Properties
	Item 3. Legal Proceedings
	Item 4. Submission of Matters to a Vote of Security Holders
PART II
	Item 5. Market for Registrant’s Common Equity and Related Stockholder Matters
	Item 6. Selected Financial Data
	Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
	Item 7A. Quantitative and Qualitative Disclosures about Market Risk
	Item 8. Financial Statements and Supplementary Data
	Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
PART III
	Item 10. Directors and Executive Officers of the Registrant
	Item 11. Executive Compensation
	Item 12. Security Ownership of Certain Beneficial Owners and Management
	Item 13. Certain Relationships and Related Transactions
PART IV
	Item 14. Controls and Procedures
	Item 15.Exhibits, Financial Statement Schedules, and Reports on Form 8K
Schedule II
SIGNATURES
CERTIFICATION
EXHIBIT INDEX
EX-4.4
EX-4.2.A
EX-4.2.B
EX-10.11.I
EX-10.11.J
EX-99.1

PART I

This Annual Report on Form 10K contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Actual results could differ materially from those projected in the forward-looking statements. Please see the section in this Form 10K entitled “Managements Discussion and Analysis of Financial Condition and Results of Operation — Factors Affecting Future Results,” for a description of certain risks that may cause our actual results to vary from the forward-looking statements.

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 65% of net sales in 2002 compared to 75% of net sales in 2001 and 66% of net sales in 2000. Thermal energy storage sales amounted to 35% of net sales in 2002 compared to 25% of net sales in 2001 and 34% of net sales in 2000.

FAFCO, Inc. was incorporated under the laws of the State of California in 1972. Its principal executive offices are located at 435 Otterson Drive, Chico, California. Its telephone number at that address is [530] 332-2100.

Markets

Swimming Pool Heating

FAFCO offers a range of products designed for heating outdoor swimming pools using solar energy. Low temperature solar applications developed because of the cost effectiveness of solar systems in heating a large volume of water to produce a small temperature change. The market for swimming pool heating developed for several reasons. First, pool owners normally use their pools when solar energy is abundant [during daylight hours and the summer swimming season]. Second, pools already have two elements needed for low temperature water heating: storage [the pool water] and circulation [the existing pool pump and associated plumbing]. Third, pool owners are an easily identifiable market.

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Thermal Energy Storage

FAFCO also designs, develops, manufactures, and markets a static, glycol ice builder for the thermal energy storage market. Since the product’s introduction, FAFCO has sold “ice banks” primarily to the commercial air conditioning market for use in peak load-shifting air conditioning systems.

Products

Swimming Pool Heating

The FAFCO solar pool heating system is composed of six to twelve solar collectors, a sun sensor, an automatic control, and associated accessories. The collectors and sensor are typically mounted on the roof of a pool owner’s home and connected to the pool pump and to an automatic control.

The customer sets the automatic control for the desired water temperature and, when the sensor detects that there is sufficient solar energy for the system to function efficiently, the automatic control directs the flow of water from the pool to the collectors. The water absorbs heat as it passes through the collectors and then flows back to the pool. When the desired water temperature is achieved or when there is insufficient solar energy, the automatic control redirects the flow of water back to the pool and water is drained from the collectors. When the water temperature drops and there is sufficient solar energy, the system is reactivated automatically.

In February 1996, the Company introduced a version of its solar pool heating system specifically designed for above-ground swimming pools. This system is composed of one or two solar collectors optimized for use in heating aboveground swimming pools and designed to lie flat on the ground or to be mounted on a rack on the ground.

In May 1996, the Company introduced a new and improved version of its solar collector that has a higher thermal performance due to its unique heat exchanger tube design. The tube design incorporates molded indentations, which enhance the heat transfer coefficient by increasing fluid turbulence.

The Company’s solar collectors are composed entirely of a polyolefin material [a high molecular weight polymer compound] and made up of small round tubes formed side by side in a rectangular shape either one-by-two meters, four-by-eight feet, four-by-ten feet, four-by-twelve feet or four-by-twenty feet in size, with sub manifolds and header pipes thermoformed on each end. This design provides for a maximum heating surface and even water flow in order to transfer 75% to 90% of the available solar energy to the pool water. The polyolefin material, which has been specially formulated by the Company, is black in color [to optimize solar energy absorption] and has the inherent advantages over other possible materials of lower cost, lighter weight, and higher resistance to the corrosive effects of pool chemicals and degradation resulting from ultraviolet radiation, heat, and other environmental effects.

In May 1993, the Company introduced a proprietary microprocessor-based control [AutoPool] for its solar pool heating systems. Prior to May 1993, the Company had a private label arrangement with an automatic control manufacturer. AutoPool has built-in “intelligence” that allows it to optimize the heating and filtration time for the swimming pool and can also control non-conventional solar swimming pool heaters. Because of lack of demand for the Company’s

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AutoPool Control, this product was discontinued effective January 1, 1997. The Company has ongoing obligations to service and provide spare parts for AutoPool controls sold prior to that time.

Thermal Energy Storage

The Company’s thermal energy storage [“IceStor”] systems utilize nighttime electric capacity to create stored cooling energy. Inexpensive “off-peak” energy is stored in the form of either chilled water or ice. During peak hours, stored cooling capacity is used in conjunction with a building’s air conditioning equipment to significantly reduce electrical power requirements for cooling and reduce overall power costs.

Thermal energy storage systems also offer electric utilities a solution to a fundamental, long-term problem: increased peak demand for power during periods of limited available capacity [i.e., during business hours]. IceStor technology products shift power consumption to off-peak periods when there is available capacity and lower demand.

Marketing and Sales

Solar Systems

FAFCO markets its solar systems in the United States through independent distributors who sell directly to end-users. Distributors generally have sales, installation, and service personnel who are supported by extensive FAFCO marketing and technical materials as well as in-depth factory and field training programs.

The majority of sales personnel employed by the typical distributor are assigned to retrofit sales, which are sales to existing pool owners. Retrofit sales are generated through direct mail, customer referrals, canvassing, and, to a lesser extent, selected media advertising. The balance of the typical distributor’s sales personnel is generally assigned to contractor accounts and seeks referrals for new construction sales.

FAFCO usually provides direct mail literature and other advertising materials to distributors and mails or places these materials with local advertisers on the distributors’ behalf and partially at the distributors’ expense. In certain instances, distributors will also engage in direct mailing and advertising. In addition, the Company recently established a sales office in Florida to serve the local market.

In the past, the Company has canceled several distributor agreements for reasons of inadequate performance by the distributor, primarily for failure to provide adequate sales, installation and service support for the Company’s products. In such instances, the Company has generally been able to find qualified replacements.

All work relating to the installation of FAFCO solar systems is covered by a full one-year warranty provided by the distributor. The Company’s solar collectors are covered by a variety of warranties ranging from a ten-year limited to a fifteen-year full, depending on the product. 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.

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FAFCO solar systems are designed to require only minimal maintenance, which can be performed either by the consumer using an owner’s manual or by the distributor’s service personnel.

Thermal Energy Storage Systems

The Company markets its IceStor products through independent contractors who design and build heating and cooling systems for commercial and industrial applications. The Company has also licensed its IceStor products for sale overseas, to design-and-build, heating, ventilating, and air-conditioning companies in Taiwan, Korea, Japan, and The Peoples Republic of China. These licensing agreements provide for licensees’ assembly, sales, support, and maintenance of IceStor products in those countries.

Sales by Geographic Area

The Company’s net sales during 2002, 2001, and 2000 were geographically distributed approximately as follows:

	2002			2001			2000
California		24	%		30	%		22	%
Florida		31	%		34	%		38	%
Other U.S		22	%		18	%		14	%
Foreign Countries		23	%		18	%		26	%
		100	%		100	%		100	%

During 2002, Ebara Corporation accounted for 17.5% of the Company’s fiscal net sales. During 2001, no single customer accounted for 10% or more of the Company’s net sales. Two of the Company’s customers, Ebara Corporation and Florida Solar, accounted for 19.3% and 10.4% of the Company’s fiscal 2000 net sales. During 2000, 2001, and 2002 Ebara Corporation was the licensee for the Company’s IceStor products in Japan, and, as such, purchased IceStor products and components for assembly into products for resale to end users in Japan. During 2000, Florida Solar was a distributor of the Company’s pool products and, as such, purchased pool panels and components for resale to end users in Florida. No other customer accounted for 10% or more of the Company’s net sales in fiscal 2000. Any material cancellation, reduction or rescheduling of orders from a major customer, or the loss of any such customer would have a material adverse effect on the Company’s financial condition and operating results. All material assets of the Company are located in California.

Foreign sales of the Company’s products are made through independent foreign distributors and licensees. Sales to foreign distributors and licensees are shipped directly from the Company’s facilities in California and invoiced in U.S. dollars. Export sales are subject to certain controls and restrictions, including tariffs and import duties, and are subject to certain risks, including changing regulatory requirements of foreign jurisdictions and transportation delays and interruptions; however, the Company has not experienced any material difficulties in the past relating to such limitations.

Backlog

Sales to solar products 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

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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 could have a substantial impact on the Company’s business. There is currently no federal tax credit for solar heating systems and state solar tax credits are available only in a few states. The Company does not anticipate that solar tax credits will become available for solar heating systems in any additional states, nor does it anticipate a significant increase in sales due to existing or future tax credits.

Manufacturing

FAFCO’s manufacturing activities consist primarily of the production of polyolefin heat exchangers used in solar heating applications and off-peak cooling applications and associated accessories. A total system approach is emphasized in order to ensure the effectiveness and reliability of the Company’s products after they have been installed, eliminating the need for distributors to rely upon materials from other suppliers.

The Company’s heat exchangers are produced from polyolefin resins using a patented extrusion and thermoforming process. Substantially all equipment used in these processes has been designed and built by the Company’s research and development engineers.

The resins employed by the Company are a petroleum by-product. The market price of these resins has fluctuated over the years with an increase in 1990 and early 1991 due to tensions in the Middle East, followed by stabilization after the completion of Desert Storm. It is expected that the price of the resins will continue to fluctuate as a result of domestic and international political and economic conditions.

FAFCO has qualified multiple sources of supply for all of its resins, materials, and subassemblies. However, certain materials and subassemblies are currently obtained from single sources. The Company believes these items could be supplied by the Company’s other qualified sources if sufficient lead-time were provided. The Company attempts to maintain additional inventory of such materials to mitigate the risk of supply shortages; however, any prolonged inability to obtain such items would have a material adverse effect on the Company’s results of operations. To date, the Company has not experienced any significant manufacturing problems or delays due to shortages of materials.

Quality assurance is performed by FAFCO at its manufacturing facility. Test and inspection procedures are a part of substantially all production and assembly operations. In addition, the

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Company uses it own diagnostic equipment and laboratory to continually test and inspect raw materials, work in process, and finished goods.

Competition

The Company’s solar heating products currently compete directly with solar heating products offered by other domestic and international manufacturers of solar heating systems, and indirectly with conventional heating systems.

The Company believes that the principal competitive factors in the markets for FAFCO solar products are [i] product performance and reliability; [ii] marketing and technical support from the manufacturer for distribution channels; [iii] selling, installation, and service capabilities of distribution channels; and [iv] price. The Company believes that it competes favorably with respect to all of these factors. However, certain of its competitors may have greater financial, marketing, and technological resources than those of the Company.

A number of companies in the United States manufacture thermal energy storage systems of various types similar to the Company’s IceStor product. The industry is in the early stages of development and additional competitors are expected to enter the market over time.

At the present time, the Company believes that the main competitive factors in the thermal energy storage market are performance, reliability, and price. The Company believes that it competes favorably with respect to these factors. However, several of its competitors have greater financial, marketing, and technological resources than those of the Company.

Research and Development

For the years ended December 31, 2002, 2001, and 2000, the Company’s research and development expenses were $294,300, $239,400, and $294,500, respectively.

The Company currently uses consulting engineers, in addition to staff engineers, who are responsible for existing product improvement, applications engineering, and new product research and development. The Company is exploring other potential revenue-producing uses for its polyolefin extrusions.

Patents, Trademarks and Licenses

FAFCO currently holds four United States patents and has two patents pending relating to certain aspects of its products and manufacturing technology. These patents expire at various times between July 2003 and December 2017. However, the Company believes that patent protection is secondary to such factors as ongoing product development and refinement, the knowledge and experience of its personnel, and their ability to design, manufacture, and successfully market the Company’s products.

From time to time, the Company has registered as trademarks certain product names and marks in order to preserve its right to those product names and marks.

The Company has granted licenses to assemble and sell IceStor systems in Taiwan, Korea, Japan, and the Peoples Republic of China to local manufacturers. See “Marketing and Sales” above.

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Employees

At December 31, 2002, the Company had a total of 62 regular personnel and 16 “contract personnel” for a total of 78 full-time personnel in the Chico, California facility. The personnel included 6 in marketing, 2 in research and development, 50 in manufacturing, and 20 in general management and administration. The Company also uses temporary personnel from agencies to fill seasonal needs. The Company has never had a work stoppage. To the Company’s knowledge, no employees are represented by a labor organization.

At December 31, 2002, the Company had a total of 19 contract personnel at its Tampa, Florida sales office.

Seasonality

Information regarding the seasonality of the Company’s business is set forth in “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Seasonality” included elsewhere in this Form 10K.

Segment Information

The Company believes it has operations in only a single market segment, the polymer heat exchanger segment.

Environmental Regulations

The Company is subject to a number of environmental regulations concerning potential air and water pollution. These regulations have not in the past had, and are not expected to have, any material adverse effect on the Company’s business. However, there can be no assurance that compliance with existing or future regulations will not require the expenditure of funds or the modification of the Company’s manufacturing process, which could have a material adverse effect on the Company’s business or financial condition.

Item 2. Properties

The Company’s principal executive offices and manufacturing facilities for its products are located in a single 57,500 square foot facility that the Company owns in Chico, California. In addition, the Company leases a 5,840 square foot sales office in Tampa, Florida. This lease expires in August 2006.

The Company believes that its current facilities are adequate to meet its requirements for space in the near future. Manufacturing space is being fully utilized at the present time. However, adding additional employee shifts can accommodate additional demand.

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.

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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, 2002.

PART II

Item 5. Market for Registrant’s Common Equity and Related Stockholder Matters

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 2002 and 2001 were as follows:

Quarter Ended	March 31		June 30		September 30		December 31
2002 High	$	0.45	$	0.45	$	0.47	$	0.47
2002 Low	$	0.35	$	0.30	$	0.35	$	0.35
2001 High	$	0.25	$	0.50	$	0.70	$	0.55
2001 Low	$	0.05	$	0.05	$	0.35	$	0.30

The National Quotation Bureau provided the quotations above. All quotations reflect inter-dealer prices, without retail mark-up, markdown or commission and may not necessarily represent actual transactions. At February 28, 2003, the Company had 625 shareholders of record. The Company has never paid dividends on its Common Stock, has no plans to do so in the foreseeable future and is prohibited from so doing under its bank credit line covenants.

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Equity Compensation Plan Information

The following table provides certain information as of December 31, 2002 with respect to the Company’s equity compensation plans under which equity securities of the Company are authorized for issuance:

					Number of securities
					remaining available for
					future issuance under
	Number of Securities to		Weighted-average		equity compensation
	be issued upon exercise		exercise price of		plans [excluding
	of outstanding options,		outstanding options,		securities reflected in
Plan category	warrants and rights		warrants and rights		column [a]]
		[a]		[b]		[c]
Equity compensation plans approved by security holders [1]		187,500		0.333		500,000
Equity compensation plans not approved by security holders		N/A		N/A		N/A
Total		187,500		0.333		500,000

[1] These plans include the 2002 Stock Plan and the 1991 Stock Option Plan

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Item 6. Selected Financial Data

Selected financial information and other data presented below should be read in conjunction with the “Consolidated Financial Statements,” “Notes to Consolidated Financial Statements,” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included elsewhere in this Form 10K.

Year Ended December 31,	2002		2001		2000		1999		1998
		[in thousands, except per share amounts]
Net sales	$	15,037	$	12,100	$	11,482	$	10,622	$	11,236
Income [loss] before income taxes	$	899	$	155	$	[41]	$	196	$	734
Provision for [benefit from] income taxes	$	329	$	63	$	19	$	[45]	$	[107]
Net income [loss]	$	570	$	92	$	[60]	$	241	$	841
Basic net income [loss] Per share	$	0.15	$	0.02	$	[0.02]	$	0.07	$	0.25
Diluted net income [loss] per share	$	0.14	$	0.02	$	[0.02]	$	0.06	$	0.20

At December 31,	2002		2001		2000		1999		1998
Working capital	$	1,746	$	354	$	756	$	1,487	$	2,637
Total assets		10,042		10,056		9,656		4,987		5,377
Long-term obligations		4,062		3,808		3,625		17		957
Shareholders’ equity		3,828		3,229		3,133		3,127		2,886

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

This Annual Report on Form 10K contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Actual results could differ materially from those projected in the forward-looking statements as a result of the risk factors including those set forth below under the heading “Factors Affecting Future Results” and elsewhere in this report 10K.

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The following table sets forth certain items from the Consolidated Statement of Operations as a percentage of net sales for the periods indicated:

	Fiscal Year Ended December 31,
	2002			2001			2000
Net sales		100.0	%		100.0	%		100.0	%
Cost of goods sold		59.8	%		59.1	%		64.3	%
Marketing and selling expense		16.9	%		19.6	%		18.8	%
General and administrative expense		12.2	%		14.7	%		15.6	%
Research and development expense		2.0	%		2.0	%		2.6	%
Net interest expense		2.7	%		3.6	%		0.8	%
Relocation costs [net]								[1.8	%]
Other income [expense], net		[0.4	%]		0.3	%		[0.1	%]
Income before provision for income taxes		6.0	%		1.3	%		[0.4	%]
Provision for income taxes		2.2	%		0.5	%		0.2	%
Net income		3.8	%		0.8	%		[0.5	%]

Critical Accounting Policies

The preparation of consolidated financial statements of the Company requires management to make estimates and judgments that affect the amounts reported in the financial statements and the related footnotes. The Company considers the following accounting policies to be most significantly impacted by the estimates and judgments used in the preparation of its consolidated financial statements.

Allowance for Doubtful Accounts

The Company provides for an allowance for doubtful accounts based on the age of the trade accounts receivables in total along with the expected collectibility of specific accounts. The specific reserves are reevaluated and adjusted as additional information that impacts the amount reserved is received. Management analyzes accounts receivable and historical bad debts, customer credit-worthiness and customer payment trends when evaluating the adequacy of the allowance for doubtful accounts.

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Warranty Reserve

The Company records a provision for potential warranties based on the estimated future expense of such warranties. These estimates are based on historical experience and are monitored regularly.

Inventories

Inventories are valued at the lower of cost or market determined using the first in, first out [FIFO] method. The Company provides a reserve for obsolete inventory based on periodic evaluations for slow moving items.

2002 Compared with 2001

Net sales for 2002 increased by 24.3% to $15,036,500 from $12,100,300 in 2001 due to increased unit sales of the Company’s IceStor and pool products.

Net sales of the Company’s pool products were 8.4% higher in 2002 than in 2001 due mainly to increased unit sales. IceStor product sales were 71.8% higher in 2002 than in 2001 due primarily to increased sales to the Company’s licensee in Japan and increased unit sales in the domestic market.

Cost of goods sold increased in absolute dollars to $8,992,600 in 2002 [59.8% of net sales] from $7,146,300 [59.1% of net sales] in 2001. This increase in absolute dollars was due to increased sales; the slight increase as a percentage of net sales was primarily due to higher sales of the Company’s lower margin products.

Marketing and selling expenses increased to $2,547,200 [16.9% of net sales] in 2002 compared with $2,371,900 [19.6% of net sales] in 2001. This increase in absolute dollars was due to sales-related costs resulting from higher net sales revenues. The decrease as a percent of sales was due to the higher sales volume in 2002 compared with 2001.

General and administrative expenses remained relatively stable in absolute dollars at $1,831,800 [12.2% of net sales] in 2002 compared with $1,782,000 [14.7% of net sales] in 2001. The decrease as a percent of net sales was due to higher sales volume in 2002 compared to 2001.

Research and development expenses increased to $294,300 [2.0% of net sales] in 2002 compared with $239,400 [2.0% of net sales] in 2001 due to an increase in process improvement and product development projects.

Net interest expense decreased to $407,900 [2.7% of net sales] in 2002 compared with $438,600 [3.6% of net sales] in 2001.

Other income [expense] included $103,900 of costs related to the loss on disposition of fixed assets [primarily inefficient production equipment] that were scrapped during 2002, offset in part by a refund of $17,700 prior year’s insurance premium along with license fee income [net] of $25,000 resulting from a license agreement with a third party in the Peoples Republic of China. During 2001 other income [expense] included $102,500 in grant income from the California Energy Commission related to an energy efficiency program in which the Company participated.

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Seasonality

Historically, the Company has experienced lower solar sales during the first quarter than during other quarters of each year. In addition, sales typically have increased significantly during the second quarter, declined slightly, and then remained relatively constant during the third and fourth quarters, respectively. 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 2001 and 2002, the Company experienced its typical seasonality, except that lower sales and net income occurred during the fourth quarter.

2001 Compared with 2000

Net sales for 2001 increased by 5.4% to $12,100,300 from $11,481,500 in 2000 due mainly to increased unit sales of pool products partially offset by decreased sales of the Company’s IceStor products.

Net sales of the Company’s pool products were 19.7% higher in 2001 than in 2000 mainly to increased unit sales. IceStor product sales were 22.3% lower in 2001 than in 2000 due to softness in the domestic market along with a decrease in international sales to Japan and Taiwan offset in part by increased sales to Korea. Pool product sales amounted to 75% of net sales in 2001 compared to 66% of net sales in 2000. IceStor sales amounted to 25% of net sales in 2001 compared to 34% in 2000.

Cost of goods sold decreased to $7,146,300 [59.1% of net sales] in 2001 from $7,380,500 [64.3% of net sales] in 2000. This decrease was due primarily to increased sales of the Company’s higher margin IceStor products, combined with increased efficiencies realized as a result of the Company’s relocation from Redwood City to Chico, California.

Marketing and selling expenses increased to $2,371,900 [19.6% of net sales] in 2001 from $2,162,200 [18.8% of net sales] in 2000. These increases were due primarily to increased costs associated with the Company’s office in Tampa, Florida combined with increased personnel costs.

General and administrative expenses were stable at $1,782,000 [14.7% of net sales] in 2001 and $1,786,500 [15.6% of net sales] in 2000.

Research and development expenses decreased from $239,400 [2.0% of net sales] in 2001 from $294,500 [2.6% of net sales] in 2000.

Net interest expense increased to $438,200 [3.6% of net sales] in 2001 from $93,200 [0.8% of net sales] in 2000. This increase was due to increased bank borrowing [primarily attributable to the Company’s mortgage] during 2001, offset slightly by decreased borrowing costs.

Other income [net] includes $102,500 in grant income from the California Energy Commission related to an energy efficiency program in which the Company participated.

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Liquidity and Capital Resources

The Company’s cash position decreased to $100,400 at 2002 fiscal year end from $121,200 at 2001 fiscal year end.

At December 31, 2002, the Company’s net accounts receivable had increased to $1,974,200 from $1,620,500 at December 31, 2001 due to a general increase in sales for the year offset in part by increased collections.

At December 31, 2002, the Company’s net inventory had increased to $1,331,900 from $1,171,800 at December 31, 2001. This increase in inventory was due to a build-up of inventories to meet first quarter 2003 demand.

At December 31, 2002, deferred tax asset had decreased to $478,600 from $814,800 at December 31, 2001, due to the utilization of net operating loss carryforwards. 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 with the exception of fiscal year 2000. However, there can be no assurance that the Company will continue profitability or, if it does, that profits will be sufficient to utilize the deferred asset.

At December 31, 2002, the Company’s current ratio was 1.81:1.00 compared to 1.12:1.00 at December 31, 2001. The Company had working capital of $1,746,200 at December 31, 2002 compared with $353,500 at December 31, 2001. Total assets exceeded total liabilities by $3,828,100 at December 31, 2002 compared with $3,229,200 at December 31, 2001.

The Company believes that its cash flow from operations, together with bank borrowings and the issuance of $500,000 in convertible subordinated notes in 2002, as discussed in Note 4 of the financial statements, will be sufficient to support operations during the next twelve months. The foregoing statement of how long the Company’s capital resources are expected to last is a forward-looking statement involving risks and uncertainties, including the amount of the Company’s sales and the ability of the Company to control its operating expenses. If sales decline from current levels additional debt or equity financing may be required. There can be no assurance that financing, if required, would be available on favorable terms or at all or that such financing would not significantly dilute the ownership interests and rights of existing shareholders. The Company has a line of credit, of which $0 had been utilized and $1,000,000 remained available under the formula applied to net accounts receivable at December 31, 2002. This line of credit expires on August 10, 2003.

In addition to the line of credit, the Company has a 36-month term loan facility in the amount of $445,000 bearing interest at prime plus 1.5%. At December 31, 2002, the Company had an outstanding balance of $59,000 under this loan facility.

The Company also has a 60-month term loan facility available in the amount of $500,000 bearing interest at prime plus 1.5%. At December 31, 2002, the Company had an outstanding balance of $356,200 under this loan facility.

The Company has outstanding promissory notes with an aggregate principal amount of $500,000 [“the Notes”]. The principal amount of the Notes is due and payable in January 2005. Interest is payable quarterly at a rate of 12% per annum starting in January 2003.

16

At December 31, 2002, the Company owed an aggregate of $3,764,800 under various bank credit facilities. Payments due under these credit facilities are as follows:

	Total amounts
	committed		Amount of commitment expiration per period
			Less than year		1-3 years		4-5 years		Over 5 years
Bank term loans	$	415,200	$	164,300	$	250,900	$	—	$	—
Mortgage	$	3,349,600	$	65,000	$	235,300	$	195,200	$	2,854,100
Notes	$	500,000	$	—	$	500,000	$	—	$	—
Total	$	4,264,800	$	229,300	$	986,200	$	195,200	$	2,854,100

The bank may accelerate payment of the amount owed if we fail to meet financial and other covenants set forth in the loan agreement.

Factors Affecting Future Results

U.S. Economic Conditions: A protracted U.S. recession could adversely impact new housing and commercial construction in our largest market, which in turn could cause us to miss our revenue growth goals.

Asian Economic Conditions: Sales in these Asian countries account for virtually all our international sales, and contribute a significant portion of our overall revenues. In the event that these economies experience declining growth or contraction in 2003, our sales in this region could be adversely impacted.

Growth of U.S. Thermal Energy Storage [TES] Market: Our ability to increase sales of our thermal energy storage products is dependent on growth in the overall market because opportunities for market share growth are limited. An extended recession in the general economy, a general decline in construction of commercial properties or a decline in energy prices could all adversely affect demand for thermal energy storage systems.

Destabilizing Incidents: Additional destabilizing events such as terrorist attacks or overseas conflicts, if they occur, could disrupt our supply chain, increase our materials costs, reduce demand for our products, and otherwise negatively impact our operating results.

Materials Prices: Raw materials including resins account for a major portion of our cost of sales. Any increase in these prices because of supply shortages or otherwise would reduce our operating margins and adversely impact our profitability.

17

Export Sales are subject to certain controls and restrictions, including tariffs and import duties and are subject to certain risks, including changing regulatory requirements of foreign jurisdictions and transportation delays and interruptions. However, the Company has not experienced any material difficulties in the past relating to such limitations.

Item 7A Quantitative and Qualitative Disclosures about Market Risk

The following discussion about the Company’s market risk exposure involves forward-looking statements. Actual results could differ materially from those projected in the forward-looking statements. The Company is exposed to market risk related to changes in interest rates, foreign currency exchange rates and equity security price risk. The Company does not use derivative financial instruments for any purpose, including hedging interest and foreign exchange risks.

The Company is exposed to financial market risks, including changes in foreign currency exchange rates and interest rates. The Company attempts to minimize its currency fluctuation risk by pricing its overseas product sales and license fees in United States dollars. A 10% change in the foreign currency exchange rates would not have a material effect on foreign sales denominated in local currencies. However, such an increase may make our products, which are priced in dollars, less competitive in overseas markets, which may have a material adverse impact on our overseas sales revenues.

The Company maintains short-term investments consisting of variable interest accounts. However, due to the short-term nature of the Company’s debt investments, the impact of interest rate changes would not have a material impact on the value of such investments.

As of December 31, 2002, the Company had $3,349,600 in indebtedness outstanding under the mortgage with respect to its headquarters facilities, and $415,200 in obligations under bank credit facilities. The interest rate charged under the mortgage is subject to adjustment based on market rates once every five years, with the next adjustment due in June 2005. The interest rate applicable to the Company’s bank credit facilities is adjusted on a daily basis. The Company’s interest rate exposure on variable rate debt obligations is currently relatively insignificant. Interest rate changes would not have a material impact on the Company’s results of operations.

The Company currently holds no marketable equity securities of other issuers that are subject to market price volatility.

The following should be read in conjunction with the “Consolidated Financial Statements” and “Notes to Consolidated Financial Statements” included elsewhere in this Form 10K.

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Item 8. Financial Statements and Supplementary Data

The consolidated financial statements of the Company are listed in Item 15 of this report. The quarterly financial data [unaudited] of the Company for the two years ended December 31, 2002 are as follows:

		Quarter Ended
		Mar 31, 2002		June 30, 2002		Sept 30, 2002		Dec 31, 2002		Mar 31, 2001		June 30, 2001		Sept 30, 2001		Dec 31, 2001
		(in thousands, except per share amounts)
[Unaudited]
Net sales		$	3,753	$	4,520	$	3,495	$	3,269	$	2,863	$	4,026	$	2,653	$	2,558
Gross profit			1,515		2,004		1,297		1,228		1,199		1,779		984		992
Income [loss] from operations			203		596		133		[33]		29		509		[225]		[158]
Net income [loss]			150		344		88		[12]		22		375		[139]		[166]
Net income [loss] per share
	Basic	$	0.04	$	0.09	$	0.02	$	—	$	0.01	$	0.10	$	[0.04]	$	[0.05]
	Diluted	$	0.04	$	0.08	$	0.02	$	—	$	0.01	$	0.10	$	[0.04]	$	[0.05]

Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

Not applicable.

19

PART III

Item 10. Directors and Executive Officers of the Registrant

Executive Officers

Freeman A. Ford, age 62, 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 61, serves as Executive Vice President 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 47, serves as Vice President, Sales. Mr. Harris joined the Company in August 1981 as a sales representative and has held the positions of Pool Builder Manager, National Sales Manager-Pool Products, Pacific Northwestern Region Sales Manager, National Sales Manager-Solar Division, National Sales Manager, Vice President-Sales and Marketing (from June 1988 until April 1993) and President-Pool Products Division (from May 1993 until May 1995).

Nancy I. Garvin, age 57, serves as Vice President, Finance. Ms. Garvin joined the Company in May 1974 as an accounting clerk and has since held the positions of Accounting Manager and Controller with the Company.

Board of Directors

Mr. William A. Berry, age 64, is Senior Vice President and Chief Financial Officer of the Electric Power Research Institute, an energy industry research consortium. Mr. Berry has served as a Director of the Company since 1974 and is also a member of the Audit Committee.

Mr. Robert W. Selig, Jr., age 63, is President of Davis Instruments Corporation, a manufacturer and distributor of marine and weather equipment. Mr. Selig has served as a Director of the Company since 1974 and is also a member of the Audit Committee.

Mr. William F. Chisholm, age 34, is a Partner at Symphony Technology Group, a venture capital firm. Mr. Chisholm has served as a Director of the Company since 1999.

Mr. David F. Ford, age 35, is President of Danger! Books, a book publisher and distributor. Mr. Ford has served as a Director of the Company since 1999.

David Ford and William Chisholm are the son and son-in-law, respectively, of Mr. Freeman A. Ford.

Based solely on its review of the copies of Forms 3, 4 and 5 received by the Company, or written representations from certain reporting persons that no Forms 5 were required for such persons, the Company believes that, during the fiscal year ended December 31, 2002, all filing requirements under Section 16[a] of the Securities Exchange Act applicable to its officers, directors and 10% shareholders were complied with.

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Item 11. Executive Compensation

The following table sets forth for the three years ended December 31, 2002 certain information as to the compensation paid by the Company to the Chief Executive Officer and the other executive officers of the Company who received salary and bonus compensation of $100,000 or more (the “Named Executive Officers”).

Summary Compensation Table
											Long-Term
											Compensation
											Awards
								Other
								Annual			Securities		All Other
Name and				Salary		Bonus		Compensation			Underlying		Compensation
Principal Position		Year		[$]		[$]		[$][1]			Options [#]		[$][2]
Freeman A. Ford			2002	$	169,200	$	4,539	$	17,113	(3)		0	$	2,488
	Chairman of the Board,		2001		156,000		3,615		16,159	(3)		0		2,488
	Chief Executive Officer		2000		156,000		0		—			0		1,662
Alex N. Watt			2002	$	148,854		3,990	$	18,871	(3)		0	$	2,218
	Executive Vice President		2001		137,238		3,180		15,454	(3)		0		2,218
			2000		137,035		0		—			0		2,218
David K. Harris			2002	$	148,854	$	34,624	$	13,705	(3)		0	$	578
	Vice President Sales and		2001		137,238		3,180		13,829	(3)		0		578
	Marketing		2000		143,633		0		—			0		542
Nancy I. Garvin			2002	$	85,173	$	17,556	$	16,848	(3)		0		—
			2001		78,520		10,736		13,367	(3)			$	760
			2000		75,232		2,211							760

[1] Excludes certain perquisites and other benefits that did not exceed the lesser of $50,000 or 10% of any officer’s total salary and bonus.
[2] Consists of premiums paid by the Company for term life insurance
[3] Consists of 401K contribution [Company match], health insurance, and personal benefits

The Company did not make any grant of stock options to the Named Executive Officers during the Last Fiscal Year.

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The following table sets forth information regarding the value of all unexercised stock options and warrants held by the Named Executive Officers as of the end of the Last Fiscal Year.

Aggregated Options Exercised In Last Fiscal Year-End And Fiscal Year-End
Option And Warrant Values

					Number of		Value of
					Securities		Unexercised
					Underlying		In-The-Money
					Unexercised		Options/Warrants At
					Options/ Warrants		Fiscal Year-End
					At Fiscal Year-End		[$][1]
					[#]
	Shares Acquired on				Exercisable/		Exercisable/
Name	Exercise [#]		Value Realized		Unexercisable		Unexercisable
Freeman A. Ford		0		N/A		75,000 / 0	$	17,500/0
Alex N. Watt		0		N/A		45,000 / 0	$	7,000/0
David K. Harris		0		N/A		45,000 / 0	$	7,000/0
Nancy I. Garvin		0		N/A		15,000 / 0	$	1,750/0

[1] The last reported sale price for the Company’s Common Stock for the last trading day prior to 2002 fiscal year-end was $0.35.

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Item 12. Security Ownership of Certain Beneficial Owners and Management

The following table sets forth the beneficial ownership of Common Stock of the Company as of March 13, 2003 by [1] each person known by the Company to beneficially own more than 5% of the Company’s Common Stock, [2] each director and nominee for director, [3] the named executive officers of the Company, and [4] all current directors and executive officers as a group:

		Shares of Common Stock
		Beneficially Owned
		Number of		Percent of
Name of Beneficial Owner		Shares(1)		Total(2)
Freeman A. Ford			1,866,096[3]		46.9	%
435 Otterson Drive Chico, California 95928
Alex N. Watt			95,136[4]		2.4	%
David K. Harris			87,199[5]		2.2	%
Nancy I. Garvin			35,907[6]		*
David F. Ford			56,988[7]		1.4	%
Robert W. Selig, Jr.			48,528[8]		1.3	%
William F. Chisholm			24,750[9]		*
William A. Berry			22,500[10]		*
All current directors and executive officers as a group			2,237,104[11]		53.0	%
	[8 persons]

* Less than 1%

[1]	Except as otherwise indicated in the footnotes to this table or as otherwise provided by community property laws, the beneficial owner has sole voting and investment power with respect to all shares.
[2]	Based on 3,864,111 shares of Common Stock outstanding as of March 13, 2003.
[3]	Includes [i] 298,000 shares held of record by trusts for the benefit of Freeman Ford’s children, for which he and his spouse serve as trustees and as to which shares he disclaims beneficial ownership, [ii] 449,344 shares jointly owned by Freeman Ford and his spouse, and [iii] 112,250 shares issuable upon exercise of options and warrants held by Freeman Ford exercisable within 60 days of March 13, 2003.
[4]	Includes [i] 72,950 shares issuable upon exercise of outstanding options held by Mr. Watt exercisable within 60 days of March 13, 2003 and [ii] 3,000 shares held by Mr. Watt and Sandra S. Watt as joint tenants.
[5]	Includes 72,950 shares issuable upon exercise of outstanding options held by Mr. Harris exercisable within 60 days of March 13, 2003.
[6]	Includes 23,800 shares issuable upon exercise of outstanding options held by Ms. Garvin exercisable within 60 days of March 13, 2003.
[7]	Includes 36,938 shares issuable upon exercise of outstanding options held by David Ford exercisable within 60 days of March 13, 2003.
[8]	Includes [i] 15,000 shares issuable upon exercise of outstanding options held by Mr. Selig exercisable within 60 days of March 13, 2003, and [ii] 5,700 shares held of record by trusts for the benefit of Mr. Selig’s children, as to which shares he disclaims beneficial ownership.
[9]	Includes [i] 6,000 shares issuable upon exercise of outstanding options held by Mr. Chisholm exercisable within 60 days of March 13, 2003 and [ii] 18,750 shares jointly owned by Mr. Chisholm and his wife.
[10]	Includes 15,000 shares issuable upon exercise of outstanding options held by Mr. Berry exercisable within 60 days of March 13, 2003.
[11]	Includes [i] 281,950 shares issuable upon exercise of outstanding options exercisable within 60 days of March 13, 2003 held by four executive officers (one of whom is also a director), and [ii] 72,938 shares issuable upon exercise of outstanding options exercisable within 60 days of the March 13, 2003 held by four outside directors.

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Item 13. Certain Relationships and Related Transactions

By virtue of his position as Chairman of the Board, President and Chief Executive Office of the Company and his beneficial ownership of approximately 46.9% of the Company’s Common Stock as of the Record Date, Freeman A. Ford may be deemed to be a “parent” and/or “control person” of the Company within the meaning of the rules and regulations promulgated under the Securities Act of 1933, as amended. Freeman A. Ford can elect a majority of the Board of Directors and controls any shareholder vote that does not require a supermajority with respect to which his shares are eligible to be voted. In addition, Freeman A. Ford, his son [David F. Ford] and his son-in-law [William Chisholm] comprise three out of five directors of the Company.

During 2000, Freeman A. Ford, David F. Ford [Freeman A. Ford’s son] and Kimberley Ford Chisholm [Freeman A. Ford’s daughter and William Chisholm’s spouse] exercised options to purchase, at a purchase price of $0.125 per share: 240,000; 18,750; and 18,750; shares of FAFCO Common Stock, respectively.

During January 2002, the Company raised $500,000 in debt financing through the issuance of subordinated promissory notes [the “Notes”]. The Notes have a term of three years and accrued interest at an annual rate of 10%, payable quarterly during 2002. The notes may be prepaid at any time. The applicable interest rate increased to 12% per annum effective January 2003.

In connection with the issuance of the Notes, the Company issued warrants to purchase an aggregate of 100,000 shares of our common stock to the investors [the “Warrants”]. The Warrants have an exercise price of $.125 per share and a term of three years from the date of issuance. Because the Notes were not prepaid by the first anniversary of the issuance date, the Company issued additional Warrants to purchase 1,000 shares of our common stock for each $10,000 of principal that remains outstanding.

Freeman A. Ford, our Chairman and Chief Executive Officer, and Diana V. Ford [Mr. Ford’s wife] purchased $150,000 of the principal amount raised, and received Warrants to purchase 30,000 shares of common stock.

During 2002, the Company hired David F. Ford [Freeman A. Ford’s son and a director of the Company] to do consulting on sales and marketing of solar heating systems for swimming pool and domestic thermal energy storage systems for commercial and industrial cooling markets. Total payments made with respect to Mr. Ford’s engagement were $6,000.

PART IV

Item 14. Controls and Procedures

Evaluation of Disclosure Controls and Procedures: The Company’s principal executive officer and principal financial officer have concluded that the Company’s disclosure controls and procedures [as defined in Rule 13a-14[c] and 15d-14[c] under the Securities and Exchange Act of 1934, as amended], based on their evaluation of these controls and procedures as of a date within ninety days prior to the filing date of this Form 10K, are effective to ensure that information required to be disclosed is accumulated and communicated to management to allow timely decisions regarding required disclosures.

24

Changes in Internal Controls: There have been no significant changes in the Company’s internal controls or in other factors that could significantly affect these controls subsequent to the date of the evaluation thereof, including any corrective actions with regard to significant deficiencies and materials weaknesses.

Item 15. Exhibits, Financial Statement Schedules, and Reports on Form 8K

[a][1] The following documents are filed as part of this report:

			Page No.
1. Report of Independent Auditors				28
2. Consolidated Financial Statements:
	Consolidated Balance Sheets at December 31, 2002 and 2001			29
	For the Three years ended December 31, 2002, 2001, and 2000:
		Consolidated Statements of Operations		30
		Consolidated Statements of Shareholders’ Equity		30
		Consolidated Statements of Cash Flow		31
	Notes to Consolidated Financial Statements			32
[a][2] Financial Statement Schedule. The following Financial Statement Schedule of FAFCO Inc., is filed as part of this report and should be read in conjunction with the Consolidated Financial Statements:
	Schedule for fiscal years ended December 31, 2002, 2001 and 2000:
	Schedule II Valuation and Qualifying Accounts			43

Schedules not included in these financial statement schedules have been omitted because they are not applicable or required information is shown in the financial statements or notes thereto.

25

[a][3] Exhibits

Exhibit No.	Description
3.1[1]	Articles of Incorporation, as amended.
3.2[2]	Bylaws, as amended.
3.2[a][1]	Certificate of Amendment of Bylaws.
4.1	Reference Exhibits 3.1 and 3.2.
4.2	Subordinated Notes Purchase Agreement dated January 2, 2002, between Registrant and certain investors [the “Purchase Agreement"]
4.2[a]	Forms of Subordinated Promissory Note issued under Purchase Agreement.
4.2[b]	Form of Warrant issued under Purchase Agreement.
10.1	Reference Exhibit 4.1.
10.2[4]*	1981 Incentive Stock Option Plan.
10.3[4]*	Form of 1981 Incentive Stock Option Agreement.
10.4[1]	Standard Form of Distributor Agreement.
10.5[3]	Licensing Agreement between the Registrant, as Licensor, and Enercon Engineering, as Licensee, dated May 20, 1988.
10.6[8]*	1991 Stock Option Plan, as amended.
10.6[a][5]*	Form of Stock Option Agreement used under the 1991 Stock Option Plan.
10.7[5]*	1991 Directors’ Stock Option Plan.
10.7[a][5]*	Form of Nonstatutory Stock Option Agreement used under 1991 Director’s Stock Option Plan.
10.8[5]*	Employee Stock Purchase Plan.
10.8[a][5]*	Form of Subscription Agreement used under Employee Stock Purchase Plan.
10.9[6]	Licensing Agreement and Addendum between the Registrant, as Licensor, and Jang-Han Systems Engineering, as Licensee, dated January 1, 1993.
10.10[7]	Export — Import and Technical License Agreement between the Registrant, as Licensor, and Ebara Corporation, as Licensee, dated October 22, 1993.
10.11(11)	Construction Trust Deed between Registrant as Trustor and Butte Community Bank as Lender, dated April 13, 2000.
10.11[a][12]	Promissory Note between Registrant as Borrower and Butte Community Bank as Lender dated April 13, 2000.
10.11[b][12]	Change in Terms Agreement between Registrant as Borrower and Butte Community Bank as Lender dated October 16, 2000.
10.11[c][12]	Change in Terms Agreement between Registrant as Borrower and Butte Community Bank as Lender dated December 15, 2000.
10.11[d][12]	Business Loan Agreement between Registrant as Borrower and Butte Community Bank as Lender, dated May 15, 2000.
10.11[e][12]	Change in Terms Agreement between Registrant as Borrower and Butte Community Bank as Lender dated May 9, 2001.
10.11[f][12]	Promissory Note between Registrant as Borrower and Butte Community Bank as Lender, dated May 15, 2000.
10.11[g][12]	Promissory Note between Registrant as Borrower and Butte Community Bank as Lender dated January 26, 2001.
10.11[h][12]	Promissory Note between Registrant as Borrower and Butte Community Bank as Lender dated July 26, 2001.
10.11[i]	Change in Terms Agreement between Registrant as Borrower and Butte Community Bank as Lender dated August 8, 2002.
10.11[j]	Change in Terms Agreement between Registrant as Borrower and Butte Community Bank as Lender dated November 10, 2002.
10.12[8]	Agency/Distributorship Agreement between Registrant as Manufacturer and Jabria Establishment, as Agent/Distributorship, dated December 10, 1994.
10.13	Licensing Agreement between Registrant, as Licensor, and Beijing ZhongDian Duoli Refrigeration Engineering Co. Ltd., as Licensee, dated May 16, 2002 (to be filed by amendment)
10.14*	2002 Stock Plan (to be filed by amendment)
18.1[9]	Letter re change in Accounting Principle from Burr, Pilger & Mayer dated November 5, 1997.
21.1[10]	Subsidiaries of Registrant.
23.1	Consent of Independent Accountants [see page 48]
24.1	Power of Attorney [see page 45]
99.1	Management Certifications pursuant to 18U.S.C. 1350

*Denotes a management contract or compensatory plan or arrangement.

(1)	Incorporated by reference to exhibit filed with Registrant’s Registration Statement on Form S-1 [File No. 2-72297] filed May 14, 1981.
(2)	Incorporated by reference to exhibit filed with Registrant’s Annual Report on Form 10-K for the fiscal year ended December 31, 1983.
(3)	Incorporated by reference to exhibit filed with Registrant’s Annual Report on Form 10-K for the fiscal year ended December 31, 1988.
(4)	Incorporated by reference to exhibit filed with Registrant’s Annual Report on Form 10-K for the fiscal year ended December 31, 1990.

26

(5)	Incorporated by reference to exhibit filed with Registrant’s Annual Report on Form 10-K for the fiscal year ended December 31, 1991.
(6)	Incorporated by reference to exhibit filed with Registrant’s Annual Report on Form 10-K for the fiscal year ended December 31, 1992.
(7)	Incorporated by reference to exhibit filed with Registrant’s Annual Report on Form 10-K for the fiscal year ended December 31, 1993.
(8)	Incorporated by reference to exhibit filed with Registrant’s Annual Report on Form 10-K for the fiscal year ended December 31, 1994
(9)	Incorporated by reference to exhibit filed with Registrant’s Annual Report on Form 10K for the fiscal year ended December 31, 1998.
(10)	Incorporated by reference to exhibit filed with Registrant’s Annual Report on Form 10K for the fiscal year ended December 31, 1999.
(11)	Incorporated by reference to exhibit filed with Registrant’s Annual Report on Form 10K for the fiscal year ended December 31, 2000.
(12)	Incorporated by reference to exhibit filed with Registrant’s Annual Report on Form 10K for the fiscal year ended December 31, 2002, as amended.

[b]	Reports on Form 8-K: No Reports on Form 8-K were filed by the Company during the fourth quarter of 2002.
[c]	Exhibits: See subsection [a] [3] above.
[d]	Financial Statement Schedules: See subsection [a] [2] above.

27

BPM
Burr, Pilger, & Mayer, LLP
600 California Street, Suite 1300
San Francisco, CA 94108
(415) 421-5757 phone
(415) 288-6288 fax

INDEPENDENT AUDITORS’ REPORT

To the Board of Directors and Stockholders
of FAFCO, Inc:

We have audited the accompanying consolidated balance sheets of FAFCO, Inc. (a California corporation) and its subsidiary as of December 31, 2002 and 2001, and the related consolidate statements of operations, shareholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2002. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evident supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of FAFCO, Inc. and its subsidiary as of December 31, 2002 and 2001, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2002 in conformity with accounting principles generally accepted in the United States of America.

/s/ Burr, Pilger & Mayer LLP

San Francisco, California
February 28, 2003

28

Consolidated Balance Sheet

December 31,		2002		2001
Assets
	Current assets:
	Cash and cash equivalents	$	100,400	$	121,200
	Accounts receivable, less allowance for doubtful accounts of $292,000 in 2002 and $479,600 in 2001		1,974,200		1,620,500
	Current portion of long term notes receivable		11,400
	Inventories		1,331,900		1,171,800
	Prepaid expenses and other current assets		264,200		174,200
	Other accounts receivable, net of allowance		9,600		35,500
	Deferred tax asset		206,200		249,600
Total current assets			3,897,900		3,372,800
Property, plant and equipment, at cost			8,290,200		8,190,400
Less accumulated depreciation and amortization			[2,490,800]		[2,079,500]
			5,799,400		6,110,900
Notes receivable less current portion and other assets [net]			72,000		7,200
Deferred tax asset			272,400		565,200
Total assets		$	10,041,700	$	10,056,100
Liabilities and shareholders’ equity
	Current liabilities:
	Bank line of credit			$	768,700
	Notes Payable to bank – current portion	$	229,300		282,600
	Accounts payable and other accrued expenses		1,292,300		1,360,800
	Accrued compensation and benefits		338,400		355,200
	Accrued warranty expense		291,700		252,000
Total current liabilities			2,151,700		3,019,300
Mortgage			3,284,600		3,340,000
Notes payable to bank – less current portion			250,900		432,200
Subordinated debt			500,000
Other non-current liabilities			26,400		35,400
Total liabilities		$	6,213,600	$	6,826,900
Commitments and contingent liabilities
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; 3,855,591 issued and outstanding at December 31, 2002 and 2001	$	481,900	$	481,900
	Capital in excess of par value		5,137,300		5,108,500
	Notes receivable secured by Common Stock		[75,100]		[75,100]
	Accumulated deficit		[1,716,000]		[2,286,100]
Total shareholders’ equity		$	3,828,100	$	3,229,200
Total liabilities and shareholders’ equity		$	10,041,700	$	10,056,100

The accompanying notes are an integral part of this statement

29

Consolidated Statement of Operations

Year ended December 31,	2002		2001		2000
Net Sales	$	15,036,500	$	12,100,300	$	11,481,500
Other income [expense] net		[63,300]		32,800		[7,400]
Total revenues		14,973,200		12,133,100		11,474,100
Cost of goods sold		8,992,600		7,146,300		7,380,500
Marketing and selling expense		2,547,200		2,371,900		2,162,200
General and administrative expense		1,831,800		1,782,000		1,786,500
Research and development expense		294,300		239,400		294,500
Net interest expense		407,900		438,600		93,200
Relocation costs [net]						[202,100]
Total costs and expense		14,073,800		11,978,200		11,514,800
Income [loss] before income taxes		899,400		154,900		[40,700]
Provision for [benefit from] income taxes		329,300		63,400		19,500
Net income [loss]	$	570,100	$	91,500	$	[60,200]
Basic net income [loss] per share	$	0.15	$	0.02	$	[0.02]
Diluted net income [loss] per share	$	0.14	$	0.02	$	[0.02]

The accompanying notes are an integral part of this statement

Consolidated Statement of Shareholder’s Equity

	Number				Capital in		Notes Receivable		Retained		Total
	of		Common		Excess of		Secured by Common		Earnings		Shareholders
	Shares		Stock		Par Value		Stock		Deficit		Equity
Balance at December 31, 1999		3,303,311	$	412,800	$	5,107,100	$	[75,100]	$	[2,317,400]	$	3,127,400
Net loss for the year										[60,200]		[60,200]
Issuance of shares upon exercise of stock warrants		540,000		67,500								67,500
Purchase of stock		[8,520]		[1,000]		[1,100]						[2,100]
Balance at December 31, 2000		3,834,791	$	479,300	$	5,106,000	$	[75,100]	$	[2,377,600]	$	3,132,600
Net income for the year										91,500		91,500
Issuance of shares upon exercise of stock warrants		20,800		2,600		2,500						5,100
Balance at December 31, 2001		3,855,591	$	481,900	$	5,108,500	$	[75,100]	$	[2,286,100]	$	3,229,200
Net income for the year										570,100		570,100
Discount on issuance of Warrants to purchase shares accompanying subordinated notes						28,800						28,800
Balance at December 31, 2002		3,855,591	$	481,900	$	5,137,300	$	[75,100]	$	[1,716,000]	$	3,828,100

30

Consolidated Statement of Cash Flow

Year ended December 31,			2002		2001		2000
Cash flow from operating activities:
Net income [loss]			$	570,100	$	91,500	$	[60,200]
Adjustments to reconcile net income to net cash
	Provided by operating activities:
	Depreciation and amortization			570,300		485,500		289,000
	Write offs and allowance for doubtful accounts			49,700		79,600		89,100
	[Gain] loss on disposition of fixed assets			103,400				4,600
		Deferred tax assets		336,200		49,500		28,500
Change in assets and liabilities:
		Accounts receivable		[377,500]		255,400		[300,400]
		Inventories		[160,100]		54,100		[184,300]
		Prepaid expenses and other assets		[101,400]		37,300		42,700
		Other assets [net]		[45,600]		2,100		22,000
		Accounts payable, accrued expenses and other current liabilities		[45,600]		[303,800]		924,000
		Other non-current liabilities		[9,000]		1,200		17,600
Net cash provided by operations			$	890,500	$	752,400	$	872,600
Cash flow from investing activities:
	Purchase of fixed assets			[353,200]		[1,252,400]		[4,715,200]
	Proceeds from disposition of fixed assets			600
Net cash used in investing activities			$	[352,600]	$	[1,252,400]	$	[4,715,200]
Cash flow from financing activities:
	Proceeds from exercise of warrants							67,500
	Proceeds from exercise of stock options					5,100
	Repurchase of common stock							[2,100]
	Proceeds from subordinated debt			500,000
	Proceeds from bank line of credit			3,886,800		2,747,700
	Repayment of bank line of credit			[4,655,500]		[2,429,500]		[11,000]
	Proceeds from notes payable to bank					499,900		3,733,500
	Repayment of notes payable to bank			[234,600]		[190,000]
	Repayment of mortgage			[55,400]		[22,100]
Net cash [used in] provided by financing activities				[558,700]		611,100		3,787,900
Net [decrease] increase in cash & cash equivalents				[20,800]		111,100		[54,700]
Cash and cash equivalents, beginning of period				121,200		10,100		64,800
Cash and cash equivalents, end of period			$	100,400	$	121,200	$	10,100
Supplemental disclosures of cash flow information:
Cash paid during the period for:
	Interest, net of capitalized interest of $89,300 in 2000		$	430,100	$	434,900	$	76,300
	Income taxes			300

Non-Cash Financing Activity: In January 2002, the Company recorded $28,800, the deemed fair value of the warrants to purchase common shares with the issuance of the subordinated notes. See Note 4.

The accompanying notes are an integral part of this statement

31

Notes to Consolidated Financial Statements

Note 1: Organization and Summary of Significant Accounting Policies

The Company designs, develops, manufactures, and markets polymer heat exchangers for use in solar heating systems for swimming pools and thermal energy storage systems for commercial and industrial cooling. The heat exchangers for solar heating systems are sold to wholesalers and distributors primarily in California and Florida and in other locations throughout the United States and overseas. The heat exchangers for thermal energy storage systems are marketed through manufacturers’ representatives throughout the United States and internationally. A summary of significant accounting policies follows:

Principles of Consolidation: The consolidated financial statements include the accounts of the Company and its wholly owned subsidiary. All significant inter-company balances and transactions have been eliminated in consolidation. The subsidiary currently has no ongoing business activities.

Revenue Recognition: Revenue on sales of products or services is recognized when persuasive evidence of an arrangement exists, delivery occurs or services are rendered, the sale price is fixed or determinable and collectibility is reasonably assured. Product is considered delivered, and revenue is recognized when title and risk of loss have been transferred to the customer. Under the terms and conditions of the sale, this may occur either at the time of shipment or when product is delivered to the customer. Product revenue consists mainly of revenue from the Pool products and the thermal energy storage products (IceStor). Service revenue consists mainly of revenue from time and material contracts which are recognized as services are rendered.

Use of Estimates: The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ materially from those estimates.

Allowance for Doubtful Accounts: The provision for doubtful accounts represents the Company’s best estimate of the doubtful accounts for each period. Management specifically analyzes accounts receivable, historical bad debts, customer credit – worthiness and customer payment trends when evaluation the adequacy of the allowance for doubtful accounts. During the year ending December 31, 2002, the Company wrote off $237,300 as uncollectible accounts receivable.

Cash and Cash Equivalents: For purposes of reporting cash flows, cash and cash equivalents include highly liquid investments with maturity of three months or less.

Inventories: Inventories are stated at the lower of cost or market determined using the first in, first out [FIFO] method.

Property, Plant, and Equipment: Property, plant and equipment are estimated based on historical cost adjusted for accumulated depreciation. Depreciation and amortization of plant and equipment, excluding the building, vehicles and leasehold improvements, are determined using

32

accelerated methods. For the building, vehicles and leasehold improvements, the straight-line method is used. The estimated useful lives of the assets, with the exception of the building and leasehold improvements range between three and ten years. The estimated useful life of the building and leasehold improvements is thirty-nine and a half years. Minor replacements, improvements, maintenance, and repairs are expensed as incurred. Major replacements and improvements are capitalized and depreciated over the remaining useful life of the related asset. Gains and losses on sales and retirement of plant and equipment are credited or charged to income.

Accounting for the Impairment of Long-lived Assets and for Long-lived to be disposed of: Long-lived assets held and used by the Company are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Impairments are recorded when indications of impairments are present and the undiscounted cash flows estimated to be generated by those assets are less than the asset’s carrying value.

Income Taxes: Deferred tax assets and liabilities are recognized for the tax consequences of temporary differences between the financial reporting and tax basis of assets and liabilities.

Earnings per Common Share: Basic earnings [loss] per common share are computed using the weighted average number of shares outstanding. Diluted earnings [loss] per common share are computed using the weighted average number of shares outstanding adjusted for potentially dilutive incremental shares attributed to outstanding options and warrants to purchase common stock and shares issuable upon conversion of certain convertible securities.

Warranties: In the normal course of business, the Company makes certain warranties as to workmanship and materials. Product warranty periods range from two to fifteen years for full coverage. The estimated future expense of these warranties is accrued at the time of sale. The estimates inherent in accounting or such warranties are reviewed and revisions to previous estimates are made as required reflecting the most current information available.

Accounting for Stock-Based Compensation: The Company has stock-based employee compensation plans, which are described more fully in Note 6. The Company accounts for these plans under the recognition and measurement principles of Accounting Principles Board [APB] Opinion 25, Accounting for Stock Issued to Employees, and related Interpretations.

The following table illustrates the effect on net loss if the Company had applied the fair value recognition provisions of Financial Accounting Standard No. 123, Accounting for Stock-Based Compensation, to stock-based employee compensation.

		2002		2001		2000
Net income [loss]
	As reported	$	570,100	$	91,500	$	[60,200]
	Pro forma	$	570,000	$	91,500	$	[60,200]
Basic earnings per share
	As reported	$	0.15	$	0.02	$	[0.02]
	Pro forma	$	0.15	$	0.02	$	[0.02]
Diluted earnings per share
	As reported	$	0.14	$	0.02	$	[0.02]
	Pro forma	$	0.14	$	0.02	$	[0.02]

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The weighted average fair value of each option granted was estimated on the grant date using the Black-Scholes model.

The following assumptions were made in estimating fair value:

Assumption	2002			2001			2000
Dividend yield		0	%		0	%		0	%
Risk free interest rate		N/A			N/A			N/A
Expected life		N/A			N/A			N/A
Volatility		N/A			N/A			N/A

The following is a summary of the status of the plans during 2002, 2001, and 2000.

	Number of		Weighted Average Exercise
	Shares		Price
Options exercisable at December 31, 2002		186,500	$	0.332
Weighted average fair value of options granted during 2002		N/A

	Number of		Weighted Average Exercise
	Shares		Price
Options exercisable at December 31, 2001		299,150	$	0.266
Weighted average fair value of options granted during 2001		N/A

	Number of		Weighted Average Exercise
	Shares		Price
Options exercisable at December 31, 2000		308,550	$	0.291
Weighted average fair value of options granted during 2000		N/A

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, notes receivable, short-term borrowings, accounts payable, and accrued expenses approximate fair value because of their short maturity.

Long-Term Debt: The fair value of the Company’s long-term debt is estimated based on the borrowing rates currently available to the Company for loans with similar terms. At December 31, 2002, the carrying amount approximated estimated fair value of long-term debt.

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Recently Issued Accounting Pronouncements: In June 2001, the Financial Accounting Standards Board [FASB] issued SFAS No. 141, Accounting for Business Combinations. This statement requires the purchase method of accounting be used for all business combinations initiated after June 30, 2001, and establishes specific criteria for the recognition of intangible assets separately from goodwill.

In June 2001, the FASB issued SFAS No. 142, Goodwill and Other Intangible Assets. Under SFAS No. 142, goodwill and intangible assets with indefinite life are not amortized. Instead of amortizing goodwill and intangible assets deemed to have an indefinite life, the statement requires a test for impairment to be performed annually, or immediately if conditions indicate that such an impairment could exist. The amortization period of intangible assets with finite lives will no longer be limited to forty years. This statement is effective for fiscal years beginning after December 15, 2001, and permits early adoption for fiscal years beginning after March 15, 2001.

In August 2001, The FASB issued SFAS No. 144, “Accounting for the Impairment or Disposal of Long Lived Assets” which addresses financial accounting and reporting for the impairment and disposal of long-lived assets with adoption required no later than fiscal year 2003.

In June 2002, the Financial Accounting Standards Board issued SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities.” SFAS No. 146 addresses the timing and amount of costs recognized as a result of restructuring and similar activities. The Company will apply SFAS NO. 146 to activities initiated after December 31, 2002. The adoption of SFAS No. 146 is not expected to have a material impact on the Company’s consolidated statements of income or financial position.

In December 2002, the FASB issued SFAS No. 148, “Accounting for Stock-Based Compensation—Transition and Disclosure.” This statement amends SFAS No. 123, “Stock-Based Compensation,” to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, this Statement amends the disclosure requirements of SFAS No. 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. The alternative methods of transition of SFAS 148 are effective for fiscal years ending after December 15, 2002. The Company follows APB 25 in accounting for its employee stock options. The disclosure provision of SFAS 148 is effective for years ending after December 15, 2002 and have been incorporated into these financial statements and accompanying footnotes.

The Company does not believe that any of these recent accounting pronouncements will have a material impact on their financial position or results of operations.

35

Note 2: Inventories:

Inventories consist of the following:

December 31,	2002		2001
Raw materials	$	636,600	$	515,700
Work in progress		329,900		230,200
Finished Goods		365,400		425,900
	$	1,331,900	$	1,171,800

Note 3: Property , Plant and Equipment:

Property, plant and equipment consist of the following:

December 31,	2002		2001
Building	$	3,679,100	$	3,679,100
Land		550,400		550,400
Machinery and equipment		2,649,500		2,590,900
Office and computer equipment		477,800		474,900
Leasehold improvements		599,800		585,200
Vehicles		333,600		309,900
	$	8,290,200	$	8,190,400
Less accumulated deprecation and amortization		[2,490,800]		[2,079,500]
	$	5,799,400	$	6,110,900

Depreciation expense was $560,700, $485,500, and $289,000 for the years ended 2002, 2001, and 2000, respectively.

As of December 31, 2002 and 2001, the Company had $126,700 and $226,800, respectively, of construction in progress that is included in the above asset balances by category. These assets are expected to be placed in service during the year ending December 31, 2003.

During the fiscal year ended December 31, 2002, the Company wrote off $253,400 in assets of which $149,400 were fully depreciated. These assets [primarily inefficient production equipment] were scrapped. During the fiscal year ended December 31, 2001, the Company wrote off $166,100 in fully depreciated assets. These assets were scrapped or abandoned as a result of the Company’s relocation to Chico, California.

As of December 31, 2001, construction costs for the Company’s new office and manufacturing facility in Chico were complete at $3,679,100. Interest was capitalized in connection with construction costs. The capitalized interest was recorded as part of the asset to which it relates and is amortized over the asset’s useful life. No interest was capitalized in 2002.

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Note 4: Subordinated Notes and Warrants

In January 2002, the Company issued $500,000 in principal amount of subordinated promissory notes, accompanied by warrants to purchase up to 200,000 shares of the common stock of the Company. The warrants have an exercise price of $0.125 per share. The three-year notes bear interest, payable quarterly, at an initial annual rate of 10%, and 12% for all periods after the first anniversary of the date of the notes. The notes are subordinated to bank borrowings and other secured indebtedness for the money borrowed. The company may at its option call the notes for redemption at any time with ten [10] days notice. Holders of the notes are entitled to certain rights with respect to registration of the common stock issuable upon exercise to the warrants. The Chairman and Chief Executive officer of the Company and his spouse purchased notes with a principal amount of $150,000 in this offering, and received warrants to purchase 30,000 shares of common stock.

The Company estimated the fair value of the warrants using the Black-Scholes option model. The fair value of the warrants was amortized on a straight-line basis over the life of the notes. Amortization expense was $9,600 for 2002.

Note 5: Bank Borrowing:

The Company has a bank line of credit secured by substantially all the assets of the Company other than real estate. The line of credit allows the Company to borrow the lesser of $1,000,000 or an amount determined by a formula applied to net accounts receivable. Amounts borrowed bear interest at the bank’s prime rate plus 1.5% [5.75% at December 31, 2002]. The line of credit agreement contains certain covenants relating to working capital, current ratio, and tangible net worth, prohibits the payment of cash dividends, and expires on August 10, 2003. At December 31, 2002 and 2001, the Company had complied with or obtained waivers of compliance with the loan covenants.

As of December 31, 2002 and 2001, the Company had utilized $0 and $768,700 respectively, of this facility.

In addition to the line of credit, the Company has a 36-month term loan in the amount of $445,000 bearing interest at prime plus 1.5% [5.75% at December 31, 2002]. At December 31, 2002 and 2001, the Company had an outstanding balance of $59,000 and $223,300, respectively, on this loan facility. The Company also has a 60-month term loan available in the amount of $500,000 bearing interest at prime plus 1.5% [5.75% at December 31, 2002]. At December 31, 2002 and 2001, the Company had an outstanding balance of $356,200 and $453,700, respectively, on this loan facility. The Company also has a $3,400,000 mortgage loan with a maturity date of June 10, 2030. Principal is amortized over a twenty-nine and one half year term from January 10, 2001. The interest rate is fixed for five year increments and is currently fixed at 8.00% through June 10, 2005. The interest rate will be changed on June 10th of each fifth year to the then prime rate plus .35%. The balance on this mortgage at December 31, 2002 and 2001 was $3,349,600 and $3,377,800, respectively.

37

As of December 31, 2002 the aggregate amount of principal maturities on bank borrowings over each of the succeeding years is as follows:

Year ending
December 31,
		2003	$	229,300
		2004		181,200
		2005		197,400
		2006		107,600
		2007		93,700
Thereafter				2,955,600
	Total		$	3,764,800

Note 6: Shareholders’ Equity

The Board of Directors, without shareholder approval, may determine the rights, preferences, privileges, and restrictions of the Company’s unissued Preferred Stock. Such shares may be issued in one or more series. In 1980, the Company issued 202,300 shares of Common Stock at a price of $2.43 per share in exchange for non-interest bearing promissory notes, which have a balance due of $75,100 at December 31, 2002 and 2001.

The notes are due and payable and the Company intends to pursue collection of these notes. In the event that any of the notes are non-collectable, the Company will demand surrender of the related shares issued and will cancel and write off the related notes receivable balance.

The Company has a 2002 Stock Plan under which 500,000 shares of Common Stock have been reserved for issuance to employees and consultants. Options to purchase Common Stock are also outstanding under the Company’s 1991 Stock Option Plan. During 1999, the Company granted options to purchase 136,000 shares, exercisable at $0.50 per share, the fair market value on the date of grant. During 2001 and 2002, no options were granted. Options to purchase 800 and 20,000 shares were exercised in 2000 and 2001 respectively. No new grants may be made under the 1991 Stock Option Plan.

The Company has a 1991 Director’s Stock Option Plan under which 50,000 shares of Common Stock are reserved for issuance. During 1999, the Company granted options to purchase 20,000 shares, exercisable at $0.50 per share, the fair market value on the date of grant. No new grants may be made under this plan.

Options granted under these plans become exercisable at a rate of 20% per year for five years from date of grant and expire six years or ten years from date of grant.

38

The following is a summary of activity under the 1981 and 1991 Incentive Stock Option Plan:

	Shares Subject to		Exercise Price
	Option		Per Share
Outstanding at December 31, 1999		387,950	$	0.125-0.550
Canceled		[52,200]	$	0.125-0.550
Exercised		[800]	$	0.125
Outstanding at December 31, 2000		334,950	$	0.125-0.550
Canceled		[12,500]	$	0.125-0.550
Exercised		[20,000]	$	0.25
Outstanding at December 31, 2001		302,450	$	0.125-0.50
Canceled		[114,950]	$	0.125-0.50
Exercised		0	$
Outstanding at December 31, 2002		187,500	$	0.125-0.550

Following is a summary of the status of options outstanding at December 31, 2002.

Outstanding						Exercisable
				Weighted
				Average		Weighted				Weighted
				Remaining		Average				Average
Exercise				Contractual		Exercise				Exercise
Price		Number		Life		Price		Number		Price
$0.125			87,000		4	$	0.125		87,000	$	0.125
$0.500			75,500		7	$	0.500		74,500	$	0.500
$0.550			25,000		7	$	0.550		25,000	$	0.550
	Total		187,500		6	$	0.333		186,500	$	0.332

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Note 7: Income Taxes

The provisions for income taxes consist of the following:

Years Ended
December 31,		2002		2001		2000
Taxes on income:
U.S. Federal
	Current	$	[10,900]	$	4,000	$	4,000
	Deferred		322,400		48,000		27,100
			311,500		52,000		31,100
State
	Current		4,000		8,000		3,200
	Deferred		13,800		3,400		[14,800]
			17,800		11,400		[11,600]
Net income tax provision [benefit]		$	329,300	$	63,400	$	19,500

A reconciliation of the statutory federal income tax rate with the effective tax rate reported in the financial statements follows:

Years ended December 31	2002			2001			2000
Statutory federal income tax rate		34.0	%		34.0	%		34.0	%
Effect on tax rate resulting from State and foreign income taxes, net of federal tax benefit		2.0	%		7.4	%		[17.0%]
Tax effect of change in valuation allowance					[7.4%]			[26.5%]
Expiration of tax credits					6.1	%		22.0	%
Other		0.6	%		0.8	%		16.0	%
Effective tax rate		36.6	%		40.9	%		28.5	%

The Company records its deferred taxes on a tax jurisdiction basis and classifies those net amounts as current or noncurrent based on the balance sheet classifications.

40

\

Deferred tax assets are comprised of the following:

December 31	2002		2001		2000
Allowance for doubtful accounts	$	114,800	$	188,600	$	157,400
Accrued expenses		151,900		133,400		135,500
Loss carry forwards		245,700		503,800		549,300
Tax credits						11,500
Other		[33,800]		[11,000]		22,100
	$	478,600	$	814,800	$	875,800
Deferred tax asset valuation allowance						[11,500]
Total deferred taxes, net	$	478,600	$	814,800	$	864,300

At December 31, 2002, the Company had unused federal net operating loss carry forwards of approximately $720,000. The net operating losses expire in varying amounts until 2022. The Company believes that the “total deferred taxes, net” in the amount of $478,600 are more likely than not to be realized.

Note 8: Transactions with Related Parties

During January 2002, Mr. Ford and his wife, Dianna, acquired $150,000 in principal amount of the Company’s subordinated notes and related warrants to purchase common stock[see Note 4].

Note 9: Employee Benefit Plans

The Company has a 401[k] retirement savings plan for all eligible employees who have completed one year of service. Eligible employees have the option to contribute up to 15% of their eligible salary. The Company contributes an amount equal to 50% of the employee contribution, up to a maximum of $750 per employee per year for a total of $22,713 for 2002.

Note 10: Lease Commitments

Rental expense, relating primarily to a lease for the Company’s former office and manufacturing facility, amounted to $77,100 in 2002; $51,600 in 2001; and $275,700 in 2000.

At December 31, 2002, minimum annual lease commitments under non-cancelable leases, primarily for the Company’s facility in Tampa, Florida were as follows:

2003	$	66,500
2004		53,000
2005		50,900
2006		0
Total	$	170,400

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Note 11: Net Income Per Share

Basic earnings per share were calculated as follows:

Years ended
December 31,	2002		2001		2000
Net income [loss]	$	570,100	$	91,500	$	[60,200]
Average common shares outstanding		3,855,591		3,851,845		3,711,566
Basic earnings per share	$	0.15	$	0.02	$	[0.02]

Diluted earnings per share are calculated by dividing net income by the weighted average number of shares issued and outstanding.

Diluted earnings per share were calculated as follows:

Year ended
December 31,	2002		2001		2000
Adjusted net income [loss]	$	570,100	$	91,500	$	[60,200]
Average common shares outstanding		3,855,591		3,851,845		3,711,566
Add: Exercise of options reduced by the number of shares purchased with proceeds		59,813		123,397		N/A
Add: Exercise of warrants reduced by the number of shares purchased with proceeds		65,742		57,455		N/A
Add: Exercise of warrants attached to debt reduced by the number of shares purchased with proceeds		68,750		N/A		N/A
Adjusted weighted average shares Outstanding		4,049,896		4,032,697		3,711,566
Earnings per common share assuming full dilution	$	0.14	$	0.02	$	[0.02]

At December 31, 2002 and 2001, options and warrants for the purchase of 194,305 and 180,851 common shares, respectively, at prices ranging from $0.50 to $0.625 per share were antidilutive and therefore not included in the computation of diluted earnings per share.

Note 12: Litigation

The Company is involved in certain litigation matters. Management believes resolution of these disputes will not have a material adverse effect on the Company’s financial condition and results of operation.

42

Note13: Business Segment and Concentration of Credit Risk

Business Segment: The Company operates in one business segment, the development, production and marketing of polymer heat exchangers for the solar and thermal energy storage markets worldwide.

Product Line	2002		2001		2000
Net Sales
Pool products	$	9,832,600	$	9,071,200	$	7,580,600
Thermal Energy Storage		5,203,900		3,029,100		3,900,900
	$	15,036,500	$	12,100,300	$	11,481,500

Geographic information for revenues and long-lived assets for the year ended December 31, 2002, 2001, and 2000 are as follows:

		2002		2001		2000
Net Sales
Domestic		$	11,565,500	$	9,862,700	$	8,416,500
Foreign
	Japan		2,626,700		1,128,300		2,218,500
	Other		844,300		1,109,300		846,500
		$	15,036,500	$	12,100,300	$	11,481,500
Long –lived assets
Domestic		$	5,799,400	$	6,110,900	$	5,344,000

For fiscal 2002, the Company had one major customer who individually accounted for 17.5% of sales. For fiscal 2001, the Company had no single customer who accounted for 10% or more of sales. For fiscal 2000, the Company had two major customers who individually accounted for 19.3% and 10.4% of sales, respectively.

Concentration of Credit Risk: Most of the Company’s business activity is with customers located in California, Florida, and foreign countries. As of December 31, 2002, unsecured trade accounts receivable from customers in California, Florida, and foreign countries were $260,200; $987,500; and $569,500; respectively.

For fiscal year 2002, the Company had two major customers who individually accounted for 10% or more of Accounts Receivable totaling $387,500 and $333,000.

The Company had a bank balance in excess of the federally insured limit in the amount of $84,489 at December 31, 2002.

43

FAFCO, Inc.

Schedule
II

Valuation and Qualifying Accounts and Reserves

		Balance at		Additions Charged
		Beginning of		to Costs and				Balance at End of
Description		Period		Expenses		Deductions		Period
2002:
Allowance for doubtful accounts current accounts receivable		$	479,600	$	49,700	$	237,300 [1]	$	292,000
Warranty reserve			252,000		222,400		182,700 [2]		291,700
2001:
Allowance for doubtful accounts current accounts receivable		$	400,000	$	79,600	$		$	479,600
Warranty reserve			287,700		141,500		177,200 [2]		252,000
Deferred tax asset valuation allowance			11,500				11,500
2000
Allowance for doubtful accounts current accounts receivable		$	317,800	$	89,000	$	6,800 [1]	$	400,000
	short-term receivable		27,600				27,600 [1]
	long-term receivable		31,700				31,700 [1]
Warranty reserve			282,700		156,700		151,700 [2]		287,700
Deferred tax asset valuation allowance			29,600				18,100		11,500

[1] Write-off of uncollectible accounts.
[2] Cost of warranty claims processed.

44

SIGNATURES

Pursuant to the requirements of Section 13 or 15[d] of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

Date: March 26, 2003	FAFCO, Inc.
	/s/ Freeman A. Ford
	Freeman A. Ford, Chairman of Board, President and Chief Executive Officer

POWER OF ATTORNEY

Each person whose signature appears below constitutes and appoints Freeman A. Ford and Nancy I. Garvin, 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 report on Form 10K 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 report 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
/s/ Freeman A. Ford Freeman A. Ford	Chairman of the Board, President and Chief Executive Officer [Principal Executive Officer]	March 26, 2003
/s/ Nancy I. Garvin Nancy I. Garvin	Vice President, Finance and Chief Financial Officer [Principal Financial and Accounting Officer]	March 26, 2003
/s/ William A. Berry William A. Berry	Director	March 26, 2003
/s/ Robert W. Selig, Jr. Robert W. Selig, Jr.	Director	March 26, 2003
/s/ William Chisholm William Chisholm	Director	March 26, 2003
/s/ David Ford David Ford	Director	March 26, 2003

45

CERTIFICATION

I, Freeman A. Ford, certify that:

1.	I have reviewed this annual report on Form 10K of FAFCO, Inc. [The “Registrant”]
2.	Based on my knowledge, this annual report does not contain any untrue statement of a material fact of omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;
3.	Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition results of operations and cash flows of the Registrant as of, and for, the periods presented in this annual report;
4.	The Registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures [as defined in Exchange Act Rules 13a-14 and 15d-14] for the Registrant and we have:

a.	designed such disclosure controls and procedures to ensure that material information relating to the Registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared;
b.	evaluated the effectiveness of the Registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report [the “Evaluation Date”]; and
c.	presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

5. The Registrant’s other certifying officers and I have disclosed, based on our most recent evaluation, to the Registrant’s auditors and the audit committee of Registrant’s board of directors [or persons performing the equivalent functions]:

a.	all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the Registrant’s auditors any material weaknesses in internal controls; and
b.	any fraud, whether or not material, that involves management of other employees who have a significant role in the Registrant’s internal controls; and

6. The Registrant’s other certifying officers and I have indicated in the annual report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

Date:	March 26, 2003
By:	/s/ Freeman A. Ford
Name:	Freeman A. Ford
Title:	Chairman of the Board, President, and Chief Executive Officer [Principal Executive Officer]

46

CERTIFICATION

I, Nancy I. Garvin, certify that:

1	I have reviewed this annual report on Form 10K of FAFCO, Inc. [The “Registrant”]
2	Based on my knowledge, this annual report does not contain any untrue statement of a material fact of omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;
3	Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition results of operations and cash flows of the Registrant as of, and for, the periods presented in this annual report;
4	The Registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures [as defined in Exchange Act Rules 13a-14 and 15d-14] for the Registrant and we have:

a.	designed such disclosure controls and procedures to ensure that material information relating to the Registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared;
b.	evaluated the effectiveness of the Registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report [the “Evaluation Date”]; and
c.	presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

5 The Registrant’s other certifying officers and I have disclosed, based on our most recent evaluation, to the Registrant’s auditors and the audit committee of registrant’s board of directors [or persons performing the equivalent functions]:

a.	all significant deficiencies in the design or operation of internal controls which could adversely affect the Registrant’s ability to record, process, summarize and report financial data and have identified for the Registrant’s auditors any material weaknesses in internal controls; and
b.	any fraud, whether or not material, that involves management of other employees who have a significant role in the Registrant’s internal controls; and

6 The Registrant’s other certifying officers and I have indicated in the annual report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

Date:	March 26, 2003
By:	/s/ Nancy I. Garvin
Name:	Nancy I. Garvin
Title:	Vice President of Finance and Chief Financial Officer [Principal Financial Officer]

47

CONSENT OF INDEPENDENT ACCOUNTANTS

We hereby consent to the incorporation by reference in the Registration Statements on Form S-8 [Nos. 2-75201, 2-86299, 2-95390 and 33-76220] and related prospectuses of FAFCO, Inc. of our report dated February 28, 2003, relating to the financial statements and financial statement schedule, which appears in this Annual Report on Form 10K.

 
 
 
Burr, Pilger & Mayer, LLP
San Francisco, California

March 24, 2003

48

EXHIBIT INDEX

Exhibit No.	Description
3.1[1]	Articles of Incorporation, as amended.
3.2[2]	Bylaws, as amended.
3.2[a][1]	Certificate of Amendment of Bylaws.
4.3	Reference Exhibits 3.1 and 3.2.
4.4	Subordinated Notes Purchase Agreement dated January 2, 2002, between Registrant and certain investors under [the “Purchase Agreement”]
4.2[a]	Forms of Subordinated Promissory Note issued under Purchase Agreement.
4.2[b]	Form of Warrant issued under Purchase Agreement.
10.1	Reference Exhibit 4.1.
10.2[4]*	1981 Incentive Stock Option Plan.
10.3[4]*	Form of 1981 Incentive Stock Option Agreement.
10.4[1]	Standard Form of Distributor Agreement.
10.5[3]	Licensing Agreement between the Registrant, as Licensor, and Enercon Engineering, as Licensee, dated May 20, 1988.
10.6[8]*	1991 Stock Option Plan, as amended.
10.6[a][5]*	Form of Stock Option Agreement used under the 1991 Stock Option Plan.
10.7[5]*	1991 Directors’ Stock Option Plan.
10.7[a][5]*	Form of Nonstatutory Stock Option Agreement used under 1991 Director’s Stock Option Plan.
10.8[5]*	Employee Stock Purchase Plan.
10.8[a][5]*	Form of Subscription Agreement used under Employee Stock Purchase Plan.
10.9[6]	Licensing Agreement and Addendum between the Registrant, as Licensor, and Jang-Han Systems Engineering, as Licensee, dated January 1, 1993.
10.10[7]	Export — Import and Technical License Agreement between the Registrant, as Licensor, and Ebara Corporation, as Licensee, dated October 22, 1993.
10.11(11)	Construction Trust Deed between Registrant as Trustor and Butte Community Bank as Lender, dated April 13, 2000.
10.11[a][12]	Promissory Note between Registrant as Borrower and Butte Community Bank as Lender dated April 13, 2000.
10.11[b][12]	Change in Terms Agreement between Registrant as Borrower and Butte Community Bank as Lender dated October 16, 2000.
10.11[c][12]	Change in Terms Agreement between Registrant as Borrower and Butte Community Bank as Lender dated December 15, 2000.
10.11[d][12]	Business Loan Agreement between Registrant as Borrower and Butte Community Bank as Lender, dated May 15, 2000.
10.11[e][12]	Change in Terms Agreement between Registrant as Borrower and Butte Community Bank as Lender dated May 9, 2001.
10.11[f][12]	Promissory Note between Registrant as Borrower and Butte Community Bank as Lender, dated May 15, 2000.
10.11[g][12]	Promissory Note between Registrant as Borrower and Butte Community Bank as Lender dated January 26, 2001.
10.11[h][12]	Promissory Note between Registrant as Borrower and Butte Community Bank as Lender dated July 26, 2001.
10.11[i]	Change in Terms Agreement between Registrant as Borrower and Butte Community Bank as Lender dated August 8, 2002.
10.11[j]	Change in Terms Agreement between Registrant as Borrower and Butte Community Bank as Lender dated November 10, 2002.
10.12[8]	Agency/Distributorship Agreement between Registrant as Manufacturer and Jabria Establishment, as Agent/Distributorship, dated December 10, 1994.
10.13	Licensing Agreement between Registrant, as Licensor, and Beijing ZhongDian Duoli Refrigeration Engineering Co. Ltd., as Licensee, dated May 16, 2002 (to be filed by amendment)
10.14*	2002 Stock Plan (to be filed by amendment)
18.1[9]	Letter re change in Accounting Principle from Burr, Pilger & Mayer dated November 5, 1997.
21.1[10]	Subsidiaries of Registrant.
23.1	Consent of Independent Accountants [see page 48]
24.1	Power of Attorney [see page 45]
99.1	Management Certifications pursuant to 18U.S.C. 1350

*Denotes a management contract or compensatory plan or arrangement.

49

(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, 1983.
(3)	Incorporated by reference to exhibit filed with Registrant’s Annual Report on Form 10-K for the fiscal year ended December 31, 1988.
(4)	Incorporated by reference to exhibit filed with Registrant’s Annual Report on Form 10-K for the fiscal year ended December 31, 1990.
(5)	Incorporated by reference to exhibit filed with Registrant’s Annual Report on Form 10-K for the fiscal year ended December 31, 1991.
(6)	Incorporated by reference to exhibit filed with Registrant’s Annual Report on Form 10-K for the fiscal year ended December 31, 1992.
(7)	Incorporated by reference to exhibit filed with Registrant’s Annual Report on Form 10-K for the fiscal year ended December 31, 1993.
(8)	Incorporated by reference to exhibit filed with Registrant’s Annual Report on Form 10-K for the fiscal year ended December 31, 1994
(9)	Incorporated by reference to exhibit filed with Registrant’s Annual Report on Form 10K for the fiscal year ended December 31, 1998.
(10)	Incorporated by reference to exhibit filed with Registrant’s Annual Report on Form 10K for the fiscal year ended December 31, 1999.
(11)	Incorporated by reference to exhibit filed with Registrant’s Annual Report on Form 10K for the fiscal year ended December 31, 2000.
(12)	Incorporated by reference to exhibit filed with Registrant’s Annual Report in Forms 10K for the fiscal year ended December 31, 2001, as amended.

50 EX-4.4 3 f88879exv4w4.txt EX-4.4 THESE SECURITIES HAVE NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933. THEY MAY NOT BE SOLD, OFFERED FOR SALE, PLEDGED, OR HYPOTHECATED IN THE ABSENCE OF AN EFFECTIVE REGISTRATION STATEMENT RELATED THERETO OR AN OPINION OF COUNSEL, REASONABLY SATISFACTORY TO THE COMPANY THAT SUCH REGISTRATION IS NOT REQUIRED UNDER THE SECURITIES ACT OF 1933. WARRANT TO PURCHASE SHARES OF COMMON STOCK OF FAFCO, INC. THIS CERTIFIES that, for value received ____________________________ ("_______________"), is entitled, upon the terms and subject to the conditions hereinafter set forth, to purchase from FAFCO, Inc., a California corporation (the "Company"), that number of fully paid and nonassessable shares of the Company's Common Stock at the purchase price per share as set forth in Section 1 below ("Exercise Price"). The number of shares and Exercise Price are subject to adjustment as provided in Section 10 hereof. 1. Number of Shares; Exercise Price; Term. (a) Subject to adjustments as provided herein, this Warrant is exercisable at an Exercise Price of $0.125 per share. (b) Subject to adjustment as provided below, this Warrant shall be exercisable for up to _______ shares of the Company's Common Stock (the "Shares"). (c) This Warrant shall be exercisable during the term commencing on the date hereof and ending on the earliest of (i) the fifth anniversary of the issuance date of this Warrant, (ii) the closing of a sale of all or substantially all assets of the Company or a merger, consolidation or other business combination transaction as a result of which the holders of capital immediately prior to such transaction hold less than 50% of the aggregate voting securities of the surviving entity (a "Change of Control Transaction"). 2. Title to Warrant. This Warrant and all rights hereunder are transferable, in whole or in part, but only with the prior written consent of the Company. Transfers shall occur at the office or agency of the Company by the holder hereof in person or by duly authorized attorney, upon surrender of this Warrant together with the Assignment Form annexed hereto properly endorsed. 3. Exercise or Conversion of Warrant. (a) The purchase and conversion rights represented by this Warrant are exercisable by the registered holder hereof, in whole or in part, at any time, or from time to time, during the term hereof as described in Section l above, by the surrender of this Warrant and the Notice of Exercise and Investment Representation Statement annexed hereto duly completed and executed on behalf of the holder hereof, at the office of the Company in Chico, California (or such other office or agency of the Company as it may designate by notice in writing to the registered holder hereof at the address of such holder appearing on the books of the Company), and subject to Section 4 hereof, upon payment of the purchase price, the holder of this Warrant shall be entitled to receive a certificate for the number of shares so purchased and, if this Warrant is exercised in part, an amended Warrant for the unexercised portion of this Warrant. (b) Notwithstanding any provisions herein to the contrary, if the Fair Market Value (as hereinafter defined) is greater than the Exercise Price (at the date of calculation, as set forth below), in lieu of exercising this Warrant as hereinabove permitted, the Holder may elect to convert this Warrant into shares of Common Stock equal to the value (as determined below) of this Warrant by surrender of this Warrant for conversion at the office of the Company referred to in paragraph (a) above, together with the Notice of Exercise or Conversion, in which event the Company shall issue to the Holder that number of shares of Common Stock computed using the following formula: CS = WCS x (FMV-EP) -------------- FMV Where CS equals the number of shares of Common Stock to be issued to the Holder WCS equals the number of shares of Common Stock purchasable under the Warrant FMV equals the current fair market value of one share of Common Stock (at the date of such calculation) EP equals the Exercise Price (as adjusted to the date of such calculation). For the purpose of any computation pursuant to this Section 3, the Fair Market Value at any date of one share of Common Stock shall as determined in good faith by the Board of Directors of the Company (c) The Company agrees that, upon exercise or conversion of this Warrant in accordance with the terms hereof, the shares so acquired shall be deemed to be issued to such holder as the record owner of such shares as of the close of business on the date on which this Warrant shall have been exercised. Certificates for shares purchased hereunder shall be issued by the Company promptly and in no event later than twenty-one (21) days after the date of exercise or conversion, and, on partial exercise or conversion of this Warrant, an amended Warrant for the unexercised or uncovered portion of this Warrant shall be delivered to the holder hereof as promptly as practicable after the date on which this Warrant shall have been exercised or conversion. All other terms and conditions of such amended Warrant shall be identical to those contained herein. The Company covenants that all shares which may be issued upon the exercise or conversion of this Warrant will, upon exercise of the rights represented by this Warrant or conversion of the aggregate Exercise Price, if applicable be fully paid and nonassessable and free from all taxes, liens and charges in respect of the issue thereof (other than taxes in respect of any transfer occurring contemporaneously or otherwise specified herein). -2- 4. No Fractional Shares or Scrip. No fractional shares or scrip representing fractional shares shall be issued upon the exercise or conversion of this Warrant. In lieu of any fractional share to which such holder would otherwise be entitled, such holder shall be entitled, at its option, to receive either (i) a cash payment equal to the excess of fair market value for such fractional share above the Exercise Price for such fractional share (as mutually determined by the Company and the holder) or (ii) a whole share if the holder tenders the Exercise Price for one whole share. 5. Charges, Taxes and Expenses. Issuance of certificates for shares upon the exercise or conversion of this Warrant shall be made without charge to the holder hereof for any issue or transfer tax or other incidental expense in respect of the issuance of such certificates, all of which taxes and expenses shall be paid by the Company, and such certificates shall be issued in the name of the holder of this Warrant or in such name or names as may be directed by the holder of this Warrant (with the prior written consent of the Company); provided, however, that in the event certificates for shares are to be issued in a name other than the name of the holder of this Warrant, this Warrant when surrendered for exercise or conversion shall be accompanied by the Assignment Form attached hereto duly executed by the holder hereof and the Notice of Exercise duly completed and executed and stating in whose name and certificates are to be issued; and provided further, that such assignment shall be subject to applicable laws and regulations. Upon any transfer involved in the issuance or delivery of any certificates for shares of the Company's securities, the Company may require, as a condition thereto, the payment of a sum sufficient to reimburse it for any transfer tax incidental thereto. 6. No Rights as Shareholders. This Warrant does not entitle the holder hereof to any voting rights, dividend rights or other rights as a shareholder of the Company prior to the exercise hereof. 7. Exchange and Registry of Warrant. The Company shall maintain a registry showing the name and address of the registered holder of this Warrant. This Warrant may be surrendered for exchange, transfer or exercise, in accordance with its terms, at the office of the Company, and the Company shall be entitled to rely in all respects, prior to written notice to the contrary, upon such registry. 8. Loss, Theft, Destruction or Mutilation of Warrant. Upon receipt by the Company of evidence reasonably satisfactory to it of the loss, theft, destruction or mutilation of this Warrant, and in case of loss, theft or destruction, of indemnity or security reasonably satisfactory to it, and upon reimbursement to the Company of all reasonable expenses incidental thereto, and upon surrender and cancellation of this Warrant, if mutilated, the Company will make and deliver a new Warrant of like tenor and dated as of such cancellation, in lieu of this Warrant. 9. Saturdays, Sundays, Holidays, etc. If the last or appointed day for the taking of any action or the expiration of any right required or granted herein shall be a Saturday or a Sunday or shall be a legal holiday, then such action may be taken or such right may be exercised on the next succeeding day not a Saturday or a Sunday or a legal holiday. 10. Adjustments and Termination of Rights. The purchase price per share and the number of shares purchasable hereunder are subject to adjustment from time to time as follows: -3- (a) Merger. If at any time there shall be a merger or consolidation of the Company with or into another corporation when the Company is not the surviving corporation (other than a Change of Control Transaction resulting in the expiration of this Warrant), then, as a part of such merger or consolidation, lawful provision shall be made so that the holder of this Warrant shall thereafter be entitled to receive upon exercise of this Warrant, during the period specified herein and upon payment of the aggregate Exercise Price then in effect, the number of shares of stock or other securities or property of the successor corporation resulting from such merger or consolidation, to which a holder of the stock deliverable upon exercise of this Warrant would have been entitled in such merger or consolidation if this Warrant had been exercised immediately before such merger or consolidation. In any such case, appropriate adjustment shall be made in the application of the provisions of this Warrant with respect to the rights and interests of the holder after the merger or consolidation. (b) Reclassification, etc. If the Company at any time shall, by subdivision, combination or reclassification of securities or otherwise, change any of the securities as to which purchase rights under this Warrant exist into the same or a different number of securities of any other class or classes, this Warrant shall thereafter represent the right to acquire such number and kind of securities as would have been issuable as the result of such change with respect to the securities which were subject to the purchase rights under this Warrant immediately prior to such subdivision, combination, reclassification or other change. (c) Split, Subdivision or Combination of Shares. If the Company at any time while this Warrant remains outstanding and unexpired shall split, subdivide or combine the securities as to which purchase rights under this Warrant exist, the Exercise Price shall be proportionately decreased in the case of a split or subdivision or proportionately increased in the case of a combination. (d) Adjustment of Number of Shares. Upon each adjustment in the Exercise Price pursuant to 10(c) above, the number of shares purchasable hereunder shall be adjusted, to the nearest whole share, to the product obtained by multiplying the number of shares purchasable immediately prior to such adjustment in the Exercise Price by a fraction (i) the numerator of which shall be the Exercise Price immediately prior to such adjustment, and (ii) the denominator of which shall be the Exercise Price immediately after such adjustment. 11. Notice of Adjustments; Notices. Whenever the Exercise Price or number of shares purchasable hereunder shall be adjusted pursuant to Section 10 hereof, the Company shall issue a certificate signed by its an executive officer of the Company setting forth, in reasonable detail, the event requiring the adjustment, the amount of the adjustment, the method by which such adjustment was calculated and the Exercise Price and number of shares purchasable hereunder after giving effect to such adjustment, and shall cause a copy of such certificate to be mailed (by first class mail, postage prepaid) to the holder of this Warrant. 12. "Market Stand-off" Agreement. The Holder agrees, if requested by the Company or an underwriter of such registered public offering, not to sell or otherwise transfer or dispose of any Common Stock (or other securities) of the Company held by such holder during a period of up to 90 days -4- following the effective date of any registration statement of the Company filed under the Securities Act in connection with an underwritten offering of Common Stock of the Company. Such agreement shall be in writing in the form satisfactory to the Company and such underwriter, and may be included in the underwriting agreement. The Company may impose stock-transfer instructions with respect to the securities subject to the foregoing restriction until the end of the required stand-off period. 13. Miscellaneous. (a) Governing Law. This Warrant shall be binding upon any successors or assigns of the Company. This Warrant shall constitute a contract under the laws of California and for all purposes shall be construed in accordance with and governed by the laws of said state, without giving effect to the conflict of laws principles. (b) Restrictions. THESE SECURITIES HAVE NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933. THEY MAY NOT BE SOLD, OFFERED FOR SALE, PLEDGED, OR HYPOTHECATED IN THE ABSENCE OF AN EFFECTIVE REGISTRATION STATEMENT RELATED THERETO OR AN OPINION OF COUNSEL, REASONABLY SATISFACTORY TO THE COMPANY THAT SUCH REGISTRATION IS NOT REQUIRED UNDER THE SECURITIES ACT OF 1933. (c) Attorney's Fees. In any litigation, arbitration or court proceeding between the Company and the holder relating hereto, the prevailing party shall be entitled to reasonable attorneys' fees and expenses incurred in enforcing this Warrant. (d) Amendments. This Warrant may be amended and the observance of any term of this Warrant may be waived only with the written consent of the Company and the then holders of Warrants exercisable for a majority of the shares of the Company's Common Stock then issuable upon exercise of all outstanding unexercised Warrants sold pursuant to the Purchase Agreement. (e) Notice. Any notice required or permitted hereunder shall be deemed effectively given upon personal delivery to the party to be notified or upon deposit with the United States Post Office, by certified mail, postage prepaid and addressed to the party to be notified at the address indicated below for such party, or at such other address as such other party may designate by ten-day advance written notice. -5- IN WITNESS WHEREOF, FAFCO, Inc. has caused this Warrant to be executed by its officer thereunto duly authorized. Dated: , 200 -------------------- -- FAFCO, INC. 435 Otterson Drive Chico, California 95428-8207 By: --------------------------------- Alex N. Watt, Chief Financial Officer AGREED AND ACCEPTED: - ------------------------------ - ------------------------------ Street Address - ------------------------------ City, State, Zip Code -6- NOTICE OF EXERCISE To: FAFCO, Inc. 1. The undersigned hereby elects to purchase _______ shares of Common Stock ("Stock") of FAFCO, Inc. (the "Company") pursuant to the terms of the attached Warrant, and tenders herewith payment of the purchase price and any transfer taxes payable pursuant to the terms of the Warrant, together with an Investment Representation Statement in form attached. 2. The undersigned hereby elects to acquire ________ shares of Stock, upon conversion of the attached Warrant pursuant to Section 3(b) thereof, and hereby surrenders __________shares of Common Stock subject to the Warrant, together with an Investment Representation Statement in form and substance satisfactory to legal counsel to the Company. [STRIKE PARAGRAPH ABOVE WHICH DOES NOT APPLY] 3. The shares of Stock to be received by the undersigned upon exercise of the Warrant are being acquired for its own account, not as a nominee or agent, and not with a view to resale or distribution of any part thereof, and the undersigned has no present intention of selling, granting any participation in, or otherwise distributing the same. The undersigned further represents that it does not have any contract, undertaking, agreement or arrangement with any person to sell, transfer or grant participation to such person or to any third person, with respect to the Stock. The undersigned believes it has received all the information it considers necessary or appropriate for deciding whether to purchase the Stock. 4. The undersigned understands that the shares of Stock are characterized as "restricted securities" under the federal securities laws inasmuch as they are being acquired from the Company in transactions not involving a public offering and that under such laws and applicable regulations such securities may be resold without registration under the Securities Act of 1933, as amended (the "Act"), only in certain limited circumstances. In this connection, the undersigned represents that it is familiar with SEC Rule 144, as presently in effect, and understands the resale limitations imposed thereby and by the Act. 5. The undersigned understands the instruments evidencing the Stock may bear one or all of the following legends: (a) "THESE SECURITIES HAVE NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933. THEY MAY NOT BE SOLD, OFFERED FOR SALE, PLEDGED OR HYPOTHECATED IN THE ABSENCE OF A REGISTRATION STATEMENT IN EFFECT WITH RESPECT TO THE SECURITIES UNDER SUCH ACT OR AN OPINION OF COUNSEL SATISFACTORY TO THE COMPANY THAT -7- SUCH REGISTRATION IS NOT REQUIRED OR UNLESS SOLD PURSUANT TO RULE 144 OF SUCH ACT." (b) Any legend required by applicable state law. 6. Please issue a certificate or certificates representing said shares of Stock in the name of the undersigned: -------------------------- [Name] 7. Please issue a new Warrant for the unexercised portion of the attached Warrant in the name of the undersigned: -------------------------- [Name] -------------------- -------------------------- [Date] [Signature] -8- ASSIGNMENT FORM (To assign the foregoing Warrant, execute this form and supply required information. Do not use this form to purchase shares.) FOR VALUE RECEIVED, the foregoing Warrant and all rights evidenced thereby are hereby assigned to - ------------------------------------------------------------ (Please Print) whose address is ------------------------------------------- (Please Print) Dated: , 200 . ----------------- -- Holder's Signature: ------------------------------- Holder's Address: ------------------------------ ------------------------------ Signature Guaranteed: -------------------------------- NOTE: The signature to this Assignment Form must correspond with the name as it appears on the face of the Warrant, without alteration or enlargement or any change whatever, and must be guaranteed by a bank or trust company. Officers of corporations and those acting in a fiduciary or other representative capacity should file proper evidence of authority to assign the foregoing Warrant. INVESTMENT REPRESENTATION STATEMENT PURCHASER : COMPANY : FAFCO, Inc. SECURITIES : Common Stock DATE : In connection with the purchase of the above-listed Securities, the undersigned, the Purchaser represents to the Company the following: (a) The undersigned is sufficiently aware of the Company's business affairs and financial condition to reach an informed and knowledgeable decision to acquire the Securities. The undersigned is purchasing these Securities for its own account for investment purposes only and not with a view to, or for the resale in connection with, any "distribution" thereof for purposes of the Securities Act of 1933, as amended (the "Securities Act"). (b) The undersigned understands that the Securities have not been registered under the Securities Act in reliance upon a specific exemption therefrom, which exemption depends upon, among other things, the bona fide nature of its investment intent as expressed herein. In this connection, the undersigned understands that, in the view of the Securities and Exchange Commission (the "SEC"), the statutory basis for such exemption may be unavailable if its representation was predicated solely upon a present intention to hold these Securities for the minimum capital gains period specified under tax statutes, for a deferred sale, for or until an increase or decrease in the market price of the Securities, or for a period of one year or any other fixed period in the future. (c) The undersigned further understands that the Securities must be held indefinitely unless subsequently registered under the Securities Act or unless an exemption from registration is otherwise available (such as Rule 144 under the Securities Act). Moreover, the undersigned understands that the Company is under no obligation to register the Securities. In addition, the undersigned understands that the certificate evidencing the Securities may be imprinted with a legend which prohibits the transfer of the Securities unless they are registered or such registration is not required in the opinion of counsel for the Company. (d) The undersigned is familiar with the provisions of Rule 144, promulgated under the Securities Act, which, in substance, permits limited public resale of "restricted securities" acquired, directly or indirectly, from the issuer thereof (or from an affiliate of such issuer), in a non-public offering subject to the satisfaction of certain conditions, including, among other things: (1) The availability of certain public information about the Company; (2) the resale occurring not less than one year after the party has purchased, and made full payment for, within the meaning of Rule 144, the securities to be sold; and, in the case of an affiliate, or of a non-affiliate who has held the securities less than two years, (3) the sale being made through a broker in an unsolicited "broker's transaction" or in transactions directly with a market maker, as said term is defined under the Securities Exchange Act of 1934 (the "Exchange Act") and the amount of securities being sold during any three month period not exceeding the specified limitations stated therein, if applicable. There can be no assurances that the requirements of Rule 144 will be met, or that the Securities will ever be saleable. (e) The undersigned further understands that at the time the undersigned wishes to sell the Securities there may be no public market upon which to make such a sale, and that, even if such a public market then exists, the Company may not be satisfying the current public information requirements of Rule 144, and that, in such event, the undersigned would be precluded from selling the Securities under Rule 144 even if the two-year minimum holding period had been satisfied. (f) The undersigned further understands that in the event all of the applicable requirements of Rule 144 are not satisfied registration under the Securities Act, compliance with Regulation A, compliance with some other registration exemption or the notification to the Company of the proposed disposition by it and the furnishing to the Company of (i) detailed information regarding the disposition, and (ii) and opinion of its counsel to the effect that such disposition will not require registration (the undersigned understands such counsel's opinion shall concur with the opinion by counsel for the Company and the undersigned shall have been informed of such compliance) will be required and that, notwithstanding the fact that Rule 144 is not exclusive, the Staff of the SEC has expressed its opinion that persons proposing to sell private placement securities other than in a registered offering and otherwise than pursuant to Rule 144 will have a substantial burden of proof in establishing that an exemption from registration is available for such offers or sales, and that such persons and their respective brokers who participate in such transactions do so at their own risk. Signature of Purchaser: By: ----------------------------------- Title: -------------------------- -2- EX-4.2.A 4 f88879exv4w2wa.txt EX-4.2.A Exhibit 4.2(A) THIS NOTE AND THE SECURITIES REPRESENTED HEREBY HAVE NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933, AS AMENDED, OR QUALIFIED UNDER APPLICABLE STATE SECURITIES LAWS. THEY MAY NOT BE OFFERED FOR SALE, SOLD OR OTHERWISE TRANSFERRED IN THE ABSENCE OF AN EFFECTIVE REGISTRATION STATEMENT AS TO THE SECURITIES UNDER SAID ACT OR AN OPINION OF COUNSEL SATISFACTORY TO THE CORPORATION THAT SUCH REGISTRATION AND QUALIFICATION IS NOT REQUIRED. SUBORDINATED PROMISSORY NOTE $ , ------------ ------------- ----- Chico, California FOR VALUE RECEIVED, FAFCO, Inc., a California corporation (the "Company") promises to pay to _________________ ("Lender"), or its registered assigns, the principal sum of ___________________ __________ Dollars ($___________), or such lesser amount as shall equal the outstanding principal amount hereof, together with interest from the date of this Note on the unpaid principal balance at a rate equal to the Interest Rate, as defined below, computed on the basis of the actual number of days elapsed and a year of 365 days. All unpaid principal, together with any then unpaid and accrued interest and other amounts payable hereunder, shall be due and payable on the third anniversary of the date hereof (the "Payment Date"). Accrued interest shall be payable on January 1, April 1, July 1 and October 1 of each year, commencing April 1, 2002, the last payment of any accrued and unpaid interest to be made together with payment of the principal on the Payment Date [Check with Alex: may want to accrue and pay at maturity]. This Note may be prepaid only in accordance with Section 4 below. This Note is issued pursuant to a Subordinated Note and Warrant Purchase Agreement dated as of December __, 2001 (the "Purchase Agreement") between the Company and the purchasers listed on the Schedule of Purchasers to such Purchase Agreement, and is subject to the terms and provisions of the Purchase Agreement, a copy of which may be obtained from the Company at its principal executive offices. The following is a statement of the rights of Lender and the conditions to which this Note is subject, and to which Lender, by the acceptance of this Note, agrees: 1. DEFINITIONS. As used in this Note, the following capitalized terms have the following meanings: (a) "Articles" shall mean the Articles of Incorporation of Company, as amended and/or restated from time to time. (b) "Company" includes the corporation initially executing this Note and any Person that shall succeed to or assume the obligations of Company under this Note. (c) "Event of Default" has the meaning given in Section 2 hereof. (d) "Interest Rate" shall initially mean a rate of ten percent (10.0%) per annum, and for all periods after the first anniversary of date of this Note, a rate of twelve percent (12.0%) per annum. (e) "Lender" shall mean the Person specified in the introductory paragraph of this Note or any Person who shall at the time be the registered holder of this Note. (f) "Person" shall mean and include an individual, a partnership, a corporation (including a business trust), a joint stock company, a limited liability company, an unincorporated association, a joint venture or other entity or a governmental authority. 2. EVENTS OF DEFAULT. The occurrence of any of the following shall constitute an "Event of Default" under this Note. (a) Failure to Pay. The Company shall fail to pay any principal, interest or other payment due hereunder within ten (10) days of Company's receipt of Lender's written demand; or (b) Voluntary Bankruptcy or Insolvency Proceedings. The Company shall (i) apply for or consent to the appointment of a receiver, trustee, liquidator or custodian of itself or of all or a substantial part of its property, (ii) make a general assignment for the benefit of its or any of its creditors, (iii) be dissolved or liquidated in full or in part, (iv) commence a voluntary case or other proceeding seeking liquidation, reorganization or other relief with respect to itself or its debts under any bankruptcy, insolvency or other similar law now or hereafter in effect or consent to any such relief or to the appointment of or taking possession of its property by any official in an involuntary case or other proceeding commenced against it or (v) take any action for the purpose of effecting any of the foregoing; or (c) Involuntary Bankruptcy or Insolvency Proceedings. Proceedings for the appointment of a receiver, trustee, liquidator or custodian of Company or of all or a substantial part of the property thereof, or an involuntary case or other proceedings seeking liquidation, reorganization or other relief with respect to Company or the debts thereof under any bankruptcy, insolvency or other similar law now or hereafter in effect shall be commenced and an order for relief entered or such proceeding shall not be dismissed or discharged within ninety (90) days of commencement. 3. RIGHTS OF LENDER UPON DEFAULT. Upon the occurrence or existence of an Event of Default described in Paragraph 2(a) and at any time thereafter during the continuance of such Event of Default, Lender may, by written notice to Company, declare all outstanding amounts payable by Company hereunder to be immediately due and payable without presentment, demand, protest or any other notice of any kind, all of which are hereby expressly waived, anything contained herein to the contrary notwithstanding. Upon the occurrence or existence of any Event of Default described in Paragraphs 2(b) and 2(c), immediately and without notice, all outstanding amounts payable by Company hereunder shall automatically become immediately due and payable, without presentment, -2- demand, protest or any other notice of any kind, all of which are hereby expressly waived, anything contained herein to the contrary notwithstanding. In addition to the foregoing remedies, upon the occurrence or existence of any Event of Default, Lender may exercise any other right, power or remedy permitted to it by law, either by suit in equity or by action at law, or both. 4. PREPAYMENT. Upon ten (10) days prior written notice to Lender, the Company may, without premium or penalty, at any time and from time to time, prepay all or any portion of the outstanding principal balance due under this Note, provided that each such prepayment is accompanied by the accrued interest on the amount of principal prepaid calculated to the date of such prepayment. 5. REPRESENTATIONS AND WARRANTIES OF LENDER. In addition to the representations and warranties contained in Section 4 of the Purchase Agreement, by its acceptance hereof, the Lender represents and warrants to Company that: (a) Securities Law Compliance. Lender has been advised that this Note has not been registered under the Securities Act of 1933, as amended (the "Act") and, therefore, cannot be resold unless it is registered under the Act and qualified under applicable state securities laws or unless an exemption from such registration and qualification requirements is available. Lender is aware that Company is under no obligation to effect any such registration and qualification with respect to this Note or to file for or comply with any exemption from registration and qualification. Lender has not been formed solely for the purpose of making this investment and is acquiring this Note for its own account for investment, not as a nominee or agent, and not with a view to, or for resale in connection with, the distribution thereof. Lender has such knowledge and experience in financial and business matters that such Lender is capable of evaluating the merits and risks of such investment, is able to incur a complete loss of such investment and is able to bear the economic risk of such investment for an indefinite period of time. Lender is an accredited investor as such term is defined in Rule 501 of Regulation D under the Act. (b) Access to Information. Lender acknowledges that Company has given Lender access to all documents and other information required for Lender to make an informed decision with respect to the purchase of this Note. 6. SUBORDINATION. (a) "Senior Indebtedness" means the principal of and premium, if any, and interest on indebtedness of the Company for money borrowed from commercial banks, equipment lessors or other financial institutions under a secured or unsecured line of credit, term loan, equipment lease or similar facility. (b) The Company agrees and the holder of this Note, by acceptance hereof, agrees, expressly for the benefit of the present and future holders of Senior Indebtedness, that, except as otherwise provided herein, upon (i) an event of default under any Senior Indebtedness, or (ii) any dissolution, winding up or liquidation of the Company, whether or not in bankruptcy, insolvency or receivership proceedings, the Company shall not pay, and the holder of such Note shall not be entitled to receive, any amount in respect of the principal and interest of such -3- Note unless and until the Senior Indebtedness shall have been paid or otherwise discharged. Upon (1) an event of default under any Senior Indebtedness, or (2) any dissolution, winding up or liquidation of the Company, any payment or distribution of assets of the Company, which the holder of this Note would be entitled to receive but for the provisions hereof, shall be paid by the liquidating trustee or agent or other person making such payment or distribution directly to the holders of Senior Indebtedness ratably according to the aggregate amounts remaining unpaid on Senior Indebtedness after giving effect to any concurrent payment or distribution to the holders of Senior Indebtedness. Subject to the payment in full of the Senior Indebtedness and until this Note is paid in full, the holder of this Note shall be subrogated to the rights of the holders of the Senior Indebtedness (to the extent of payments or distributions previously made to the holders of Senior Indebtedness pursuant to this paragraph 6(b)) to receive payments or distributions of assets of the Company applicable to the Senior Indebtedness. (c) This Section 6 is not intended to impair, as between the Company, its creditors (other than the holders of Senior Indebtedness) and the holder of this Note, the unconditional and absolute obligation of the Company to pay the principal of and interest on the Note or affect the relative rights of the holder of this Note and the other creditors of the Company, other than the holders of Senior Indebtedness. Nothing in this Note shall prevent the holder of this Note from exercising all remedies otherwise permitted by applicable law upon default under the Note, subject to the rights, if any, of the holders of Senior Indebtedness in respect to cash, property or securities of the Company received upon the exercise of any such remedy. 7. SUCCESSORS AND ASSIGNS. Subject to the restrictions on transfer described in Sections 9 and 10 below, the rights and obligations of Company and Lender shall be binding upon and benefit the successors, assigns, heirs, administrators and transferees of the parties. 8. AMENDMENTS WITH CONSENT OF HOLDERS. With the written consent of the Holders of not less than a majority in principal amount of outstanding Notes issued pursuant to the Purchase Agreement, the Company may amend this or any other Note by executing and delivering to the Lenders an amendment thereto for the purpose of adding any provisions to or changing in any manner or eliminating any of the provisions of the Notes or of modifying in any manner the rights of the Lenders; provided, however, that no such amendment shall, without the consent of the Lender of this Note affected thereby, change the maturity of the principal of, [or any installment of interest on,] [Check with Alex] the Note, or reduce the principal amount thereof or the interest thereon or payable upon the redemption thereof or impair the right to institute suit for the enforcement of any such payment on or after the maturity thereof (or, in the case of redemption, on or after the Redemption Date). 9. TRANSFER OF THIS NOTE. Transfers of this Note may only be made in compliance with the provisions of the Purchase Agreement, which are incorporated herein by reference. With respect to any offer, sale or other disposition of this Note, Lender will give written notice to Company prior thereto, describing briefly the manner thereof, together with a written opinion of Lender's counsel, to the effect that such offer, sale or other distribution may be effected without registration or qualification (under any federal or state law then in effect). Promptly upon receiving such written notice and reasonably satisfactory opinion, if so requested, Company, as promptly as practicable, shall notify Lender that Lender may sell or otherwise dispose of this Note, all in accordance with the -4- terms of the notice delivered to Company. If a determination has been made pursuant to this Section 9 that the opinion of counsel for Lender is not reasonably satisfactory to Company, Company shall so notify Lender promptly after such determination has been made. Each Note thus transferred and each certificate representing the securities thus transferred shall bear a legend as to the applicable restrictions on transferability in order to ensure compliance with the Act, unless in the opinion of counsel for Company such legend is not required in order to ensure compliance with the Act. Company may issue stop transfer instructions to its transfer agent in connection with such restrictions. Subject to the foregoing, transfers of this Note shall be registered upon registration books maintained for such purpose by or on behalf of the Company. Prior to presentation of this Note for registration of transfer, Company shall treat the registered holder hereof as the owner and holder of this Note for the purpose of receiving all payments of principal and interest hereon and for all other purposes whatsoever, whether or not this Note shall be overdue and Company shall not be affected by notice to the contrary. 10. ASSIGNMENT BY COMPANY. Neither this Note nor any of the rights, interests or obligations hereunder may be assigned, other than by operation of law (such as in a merger), in whole or in part, by Company without the prior written consent of Lender. 11. NOTICES. Any notice, request or other communication required or permitted hereunder shall be in writing and shall be deemed to have been duly given if personally delivered, sent by facsimile or mailed by registered or certified mail, postage prepaid, or by recognized overnight courier or personal delivery at the respective addresses or facsimile phone number of the parties as set forth below. Any party hereto may by notice so given change its address for future notice hereunder. Notice shall conclusively be deemed to have been given when received. If to Lender: At the address set forth in the Schedule of Purchasers to the Purchase Agreement. If to Company: FAFCO, Inc. 435 Otterson Drive Chico, CA 95928 Attention: Alex N. Watt, Executive Vice President With a copy to: Ann Yvonne Walker, Esq. Wilson, Sonsini, Goodrich & Rosati, P.C. 650 Page Mill Road Palo Alto, CA 94304 Each of the above addressees may change its address for purposes of this paragraph by giving to the other addressee notice of such new address in conformance with this paragraph. 12. PAYMENT. Payment shall be made in lawful tender of the United States. 13. DEFAULT RATE; USURY. In the event that any payment of principal or interest provided for herein is not paid by Company when due (including the entire unpaid balance of this Note in the event such amount is made immediately due and payable pursuant to the terms hereof), then -5- Company shall pay interest on the such amounts not paid when due at a rate per annum two percent (2%) higher than the rate otherwise applicable hereunder. In the event any interest is paid on this Note which is deemed to be in excess of the then legal maximum rate, then that portion of the interest payment representing an amount in excess of the then legal maximum rate shall be deemed a payment of principal and applied against the principal of this Note. 14. EXPENSES; WAIVERS. If action is instituted to collect this Note, Company promises to pay all costs and expenses, including, without limitation, reasonable attorneys' fees and costs, incurred in connection with such action. Company hereby waives notice of default, presentment or demand for payment, protest or notice of nonpayment or dishonor and all other notices or demands relative to this instrument. No delay on the part of Lender in exercising any right hereunder shall operate as a waiver of such right or any other right. 15. GOVERNING LAW. This Note and all actions arising out of or in connection with this Note shall be governed by and construed in accordance with the laws of the State of California, without regard to the conflicts of law provisions of the State of California or of any other state. -6- IN WITNESS WHEREOF, Company has caused this Note to be issued as of the date first written above. FAFCO, Inc. a California corporation By: ------------------------------------- Name: ----------------------------------- Title: ---------------------------------- ACKNOWLEDGED AND AGREED TO: "LENDER" ------------------------------------ By: --------------------------------- Title: ------------------------------ -7- EX-4.2.B 5 f88879exv4w2wb.txt EX-4.2.B Exhibit 4.2(B) FAFCO, INC. SUBORDINATED NOTE AND WARRANT PURCHASE AGREEMENT This Agreement is made as of __________, ______, between FAFCO, Inc., a California corporation (the "COMPANY"), and the persons and entities (the "PURCHASERS") listed on the Schedule of Purchasers attached hereto as Exhibit A (the "SCHEDULE OF PURCHASERS"). SECTION 1 SALE OF CONVERTIBLE NOTES AND STOCK WARRANTS 1.1. The Notes. The Company has authorized the issuance and sale to the Purchasers of subordinated promissory notes with an aggregate principal amount of up to $500,000. Each Purchaser severally agrees, on the terms of and subject to the conditions specified in this Agreement, to lend to the Company the sum set forth in Column 2 of Exhibit A hereto opposite such Purchaser's name ("PURCHASER LOAN") at the Closing (as defined below). Each Purchaser Loan shall be evidenced by a promissory note (individually a "NOTE" and collectively the "NOTES"), dated as of the date of Closing, in the form of Exhibit B. 1.2. The Warrants. In connection with the Purchaser Loans, the Company agrees to issue to each Purchaser at the Closing a stock purchase warrant in the form of Exhibit C (individually a "WARRANT" and collectively the "WARRANTS") exercisable initially for the number of shares of Common Stock ("COMMON STOCK") set forth in Column 3 of Exhibit A opposite such Purchaser's name. The securities issued or issuable upon exercise of the Warrants are referred to as the "WARRANT COMMON." In the event that all or any of portion of the principal amount of any Note is outstanding on the date of any one-year anniversary of the date of issuance of such Note (an "ANNIVERSARY DATE"), the Company further agrees to issue to the Purchaser holding such Note on such Anniversary Date an additional Warrant exercisable for 1,000 shares of Common Stock for each $10,000 in principal which remains unpaid as of such Anniversary Date. Such additional Warrants will be in the same form as the Warrants issued at the Closing. SECTION 2 CLOSING DATE; DELIVERY 2.1. Closing Date. The closing of the purchase and sale of the Notes and Warrants hereunder (the "CLOSING") shall be held at 11:00 a.m. on ________, _____ or on such later date or dates as the Company and the Purchasers may agree to (the date of such Closing being referred to as the "CLOSING DATE"). The place of the Closing shall be at the offices of Wilson Sonsini Goodrich & Rosati, P.C., 650 Page Mill Road, Palo Alto, California 94304-1050, or such other place as the Purchasers and the Company may mutually agree. The date of any closing of the transactions contemplated by this Agreement is sometimes also referred to herein as the "Closing Date." 2.2. Delivery. At Closing, (i) each Purchaser will make payment to the Company of the amount of the Purchaser Loan, if any, by wire transfer of immediately available funds and (ii) the Company and the Purchasers will each execute and deliver the other documents and instruments required to be executed and delivered on the Closing Date. Promptly following the Closing, the Company will deliver to each Purchaser the Note and Warrant issuable to such Purchaser pursuant hereto. 2.3. Subsequent Closings. Any Notes and Warrants not sold on the Closing may be sold at additional closings to be held at times and places to be agreed upon by the Company and a majority-in-interest of the Purchasers purchasing at each such closing (a "Subsequent Closing"), but no later than June 30, 2002. At each Subsequent Closing, the Company shall deliver to each Purchaser participating in such Subsequent Closing the Note and Warrant which such Purchaser is purchasing against payment of the consideration therefor, specified in Section 1 hereof. The Company and each such Purchaser shall execute and deliver signature pages to this Agreement. SECTION 3 REPRESENTATIONS AND WARRANTIES OF THE COMPANY Subject to and except as set forth in the Schedule of Exceptions attached as Exhibit D hereto (the "SCHEDULE OF EXCEPTIONS"), the Company hereby represents and warrants to the PURCHASERS as of the date hereof as follows: 3.1. Organization and Standing; Articles and By-Laws. The Company is a corporation duly organized and existing under, and by virtue of, the laws of the State of California and is in good standing under such laws. The Company has requisite corporate power to own and operate its properties and assets, and to carry on its business as presently conducted. The Company is qualified to do business as a foreign corporation in each jurisdiction where such qualification is required, except jurisdictions where the failure to be so qualified would not materially adversely affect the business or financial condition of the Company. 3.2. Corporate Power. The Company will have at the Closing Date all requisite legal and corporate power to execute and deliver this Agreement, to sell and issue the Notes and Warrants hereunder, to issue the Warrant Common upon exercise of the Warrants and to carry out and perform its obligations under the terms of this Agreement. 3.3. Financial Statements and Other Information. The Company has delivered to each Purchaser the following: (a) Annual Report on Form 10-K for the year ended December 31, 2000, as filed with the Securities and Exchange Commission (the "COMMISSION" of the "SEC") pursuant to Section 13 of the Securities Exchange Act of 1934, as amended (the "EXCHANGE ACT"), together with the index to exhibits thereto; -2- (b) Definitive Proxy Statement dated May 30, 2001 for the Annual Meeting of Shareholders held on June 28, 2001, as filed with the Commission pursuant to Section 14 of the Exchange Act and Regulation 14A promulgated thereunder; (c) 2000 Annual Report to Shareholders, as filed with the Commission pursuant to Section 14 of the Exchange Act and Rule 14a-3(c) promulgated thereunder; (d) A confidential copy of the Company's preliminary unaudited draft balance sheet as of November 30, 2001, and of the Company's preliminary unaudited draft statement of operations for the two months ended November 30, 2001. These unaudited financial results as of November 30, 2001 are not necessarily indicative of the Company's fiscal results for the quarter ending December 31, 2001. (e) Quarterly Reports on Form 10-Q for the quarters ended March 31, 2001, June 30, 2001 and September 30, 2001, as filed with the Commission pursuant to Section 13 of the Exchange Act, together with the indices to exhibits thereto; and (f) Term Sheet including a brief description of the Notes and Warrants. 3.4. Authorization. All corporate action on the part of the Company, its directors and shareholders necessary for the authorization, execution, delivery and performance of this Agreement by the Company, the authorization, sale, issuance and delivery of the Notes and the Warrants (and the Common Stock issuable upon exercise of the Warrants) and the performance of the Company's obligations hereunder has been taken or will be taken prior to the Closing. This Agreement, when executed and delivered by the Company, shall constitute a valid and binding obligation of the Company enforceable in accordance with its terms, subject to laws of general application relating to bankruptcy, insolvency and the relief of debtors and rules of law governing specific performance, injunctive relief or other equitable remedies. The Notes and the Warrants, when issued in compliance with the provisions of this Agreement, will be validly issued and will be free of any liens and encumbrances, and the Warrant Common has been duly and validly reserved and, when issued in compliance with the provisions of this Agreement, will be validly issued and will be fully paid and nonassessable, and will be free of any liens or encumbrances; provided, however, that the Notes and the Warrants (and the Warrant Common) may be subject to restrictions on transfer under state and/or federal securities laws and as set forth herein. 3.5 Compliance with Other Instruments. The Company is not in violation of any term of its Articles of Incorporation or Bylaws, as amended, or in violation of any material agreement, instrument, judgment or decree or, to the best of its knowledge, any order, statute, rule or regulation applicable to the Company. The execution, delivery and performance of this Agreement and the consummation of the transactions contemplated herein will not result in any such violation or be in conflict with or constitute a default under any such provision or agreement, and will not accelerate the performance provided by the terms of any material agreement or instrument to which the Company is a party, or constitute a default thereunder, or an event which, with the lapse of time or action by a third party, could result in a default thereof, or result in the creation of any lien, charge or encumbrance upon any assets or properties of the Company, which breach, default, lien, charge or -3- encumbrance, singularly or in the aggregate, would materially and adversely affect the business or property of the Company. 3.6. Litigation. There are no actions, suits, proceedings or investigations pending against the Company or its properties before any court or governmental agency (nor, to the best of the Company's knowledge, is there any basis therefor or threat thereof), which, either in any case or in the aggregate, might result in any material adverse change in the business or financial condition of the Company or any of its properties or assets, or in any material impairment of the right or ability of the Company to carry on its business as now conducted or as proposed to be conducted, or in any material liability on the part of the Company, and none which questions the validity of this Agreement or any action taken or to be taken in connection herewith. SECTION 4 PURCHASER REPRESENTATIONS Each Purchaser hereby represents and warrants to the Company as follows: 4.1. Investment Representation. (a) The Purchaser understands and confirms that this Agreement is made with the Purchasers in reliance upon each Purchaser's representation to the Company that the Notes and Warrants to be received are to be acquired for investment and not with a view to the sale or distribution of any part thereof, and that it has no present intention of selling, granting participation in or otherwise distributing the same, but subject nevertheless to any requirement of law that the disposition of its property shall at all times be within its control. By executing this Agreement, such Purchaser further represents that it does not have any contract, undertaking, agreement or arrangement with any person to sell, transfer or grant participations to such person or to any third person, with respect to the Notes, the Warrants, or the Warrant Common. (b) The Purchaser understands that the Notes, the Warrants and the Warrant Common are not registered under the Securities Act of 1933, as amended (the "Act") on the basis that the sale provided for in this Agreement and the issuance of securities is exempt pursuant to Section 4(2) of the Act and Regulation D promulgated thereunder, and that the Company's reliance on such exemption is predicated on the Purchasers' representations set forth herein. (c) The Purchaser agrees that it will not make a disposition of the Notes or Warrants purchased hereunder (or the Warrant Common) except in compliance with Section 6 hereof. (d) The Purchaser represents that it is able to fend for itself in the transactions contemplated by this Agreement, has such knowledge and experience in financial and business matters as to be capable of evaluating the merits and risks of its investment, has the ability to bear the economic risks of its investment, and has had all questions which it has asked answered by the Company. -4- (e) The Purchaser represents and warrants that, at a reasonable time prior to the Closing Date, it has been given the opportunity to ask questions and receive answers concerning the terms and conditions of this offering, to obtain any additional information which the Company possesses or can acquire without unreasonable effort or expense that is necessary to verify the accuracy of the information furnished pursuant to Section 3.3 hereof, and to discuss the Company and its plans, operations and financial condition with its officers and that it has heretofore received all such information as it deems necessary and appropriate to enable it to evaluate the financial risk inherent in making an investment in the securities of the corporation. It further represents and warrants that it has received satisfactory and complete information concerning the business and financial condition of the Company in response to all inquiries in respect thereof. (f) The Purchaser understands that the Notes, Warrants and Warrant Common have not been registered under the Act in reliance upon a specific exemption therefrom, which exemption depends upon, among other things, the bona fide nature of its investment intent as expressed herein. In this connection, the Purchaser understands that, in view of the Securities and Exchange Commission (the "SEC"), the statutory basis for such exemption may be unavailable if its representation was predicated solely upon a present intention to hold these securities for the minimum capital gains period specified under tax statutes, for a deferred sale, for or until an increase or decrease in the market price of the Securities, or for a period of one year or any other fixed period in the future. (g) The Purchaser further understands that the Notes, Warrants and Warrant Common must be held indefinitely unless subsequently registered under the Act or unless an exemption from registration is otherwise available (such as Rule 144 under the Act). Moreover, the Purchaser understands that, except as set forth in Section 6 hereof, the Company is under no obligation to register the Notes, Warrants or Warrant Common. In addition, the Purchaser understands that the certificates evidencing the Notes, Warrants, and Warrant Common may be imprinted with a legend which prohibits the transfer of such securities unless they are registered or such registration is not required in the opinion of counsel for the Company. (h) The Purchaser is familiar with the provisions of Rule 144, promulgated under the Act, which, in substance, permits limited public resale of "restricted securities" acquired, directly or indirectly, from the issuer thereof (or from an affiliate of such issuer), in a non-public offering subject to the satisfaction of certain conditions, including among other things: (1) The availability of certain public information about the Company; (2) the resale occurring not less than one year after the party has purchased, and made full payment for, within the meaning of Rule 144, the securities to be sold; and, in the case of an affiliate, or of a non-affiliate who has held the securities less than two years, (3) the sale being made through a broker in an unsolicited "broker transaction" or in transactions directly with a market maker, as said term is defined under the Exchange Act and the amount of securities being sold during any three month period not exceeding the specified limitations stated therein, if applicable. There can be no assurances that the requirements of Rule 144 will be met, or that the Notes, Warrants or Warrant Common will ever be saleable. (i) The Purchaser further understands that at the time the Purchaser wishes to sell the Notes, Warrants or Warrant Common there may be no public market upon which to make such a sale, and that, even if such a public market then exists, the Company may not be satisfying the -5- current public information requirements of Rule 144, and that, in such event, the Purchaser would be precluded from selling such securities under Rule 144 even if the one-year minimum holding period had been satisfied. (j) The Purchaser further understands that in the event all of the applicable requirements of Rule 144 are not satisfied, registration under the Act, compliance with Regulation A, compliance with some other registration exemption or the notification to the Company of the proposed disposition by it and the furnishing to the Company of (i) detailed information regarding the disposition, and (ii) and opinion of its counsel to the effect that such disposition will not require registration (the Purchaser understands such counsel's opinion must be acceptable to counsel for the Company) will be required and that, notwithstanding the fact that Rule 144 is not exclusive, the Staff of the SEC has expressed its opinion that persons proposing to sell private placement securities other than in a registered offering and otherwise than pursuant to Rule 144 will have a substantial burden of proof in establishing that an exemption from registration is available for such offers or sales, and that such persons and their respective brokers who participate in such transactions do so at their own risk. 4.2. Accredited Investor. The Purchaser represents and warrants that one or more of the following criteria are applicable to such Purchaser: (a) The Purchaser is a director or executive officer of the Company; (b) The Purchaser is a natural person who has an individual net worth or joint net worth with the Purchaser's spouse exceeding $1,000,000 at the time of purchase; (c) The Purchaser is a natural person who had an individual income in excess of $200,000 in each of the two most recent years or joint income with that Purchaser's spouse in excess of $300,000 in each of those years and who reasonably expects to reach the same level of income in the current year; (d) The Purchaser is either (i) a bank as defined in Section 3(a)(2) of the Act, or any savings and loan association or other institution as defined in Section 3(a)(5)(A) of the Act, whether acting in its individual capacity or fiduciary capacity, (ii) a broker or dealer registered pursuant to Section 15 of the Exchange Act, (iii) an insurance company as defined in Section 2(13) of the Act, (iv) an investment company registered under the Investment Company Act of 1940 or a business development company as defined in Section 2(a)(48) of such Act, (v) a Small Business Investment Company licensed by the U.S. Small Business Administration under Section 301(c) or (d) of the Small Business Investment Act of 1958, (vi) a plan established and maintained by a state or its political subdivisions, or any agency or instrumentality of a state or its political subdivisions, for the benefit of its employees, which plan has total assets of $5,000,000, or (vii) an employee benefit plan within the meaning of the Employee Retirement Income Security Act of 1974, if the investment decision is made by a plan fiduciary, as defined in Section 3(21) of such act, which plan fiduciary is either a bank, savings and loan association, insurance company or registered investment adviser, or which employee benefit plan has total assets in excess of $5,000,000 or, if a self-directed plan, with investment decisions made solely by persons that are accredited investors; -6- (e) The Purchaser is a private business development company as defined in Section 202(a)(22) of the Investment Advisers Act of 1940; (f) Any organization described in Section 501(c)(3) of the Internal Revenue Code, corporation, Massachusetts or similar business trust, or partnership, not formed for the specific purpose of acquiring the securities offered, with total assets of $5,000,000; (g) The Purchaser is a not-for-profit organization or other entity exempt from income tax under Section 501(c)(3) of the Internal Revenue Code, not formed with the specific purpose of acquiring the securities offered hereunder, with total assets in excess of $5,000,000; or (h) The Purchaser is a trust, with total assets in excess of $5,000,000, not formed for the specific purpose of acquiring the securities offered hereunder, whose purchase is directed by a person who has such experience in business and financial matters as to enable such person to evaluate the merits and risks of acquiring the securities offered hereunder, (i) The Purchaser is an entity in which all of the equity owners meet the qualifications set forth in (a), (b), (c), (d), (e), (f), (g) or (h) above. As used in this Section 4.2, the term "net worth" means the excess of total assets over total liabilities. In computing net worth for purposes of paragraph (b) above, the principal residence of the Purchaser must be valued at cost (including cost of improvements), or at a recently appraised value established by an institutional lender making a secured loan, in either case net of encumbrances. SECTION 5 CONDITIONS TO CLOSING The Purchasers' and the Company's obligations to purchase and to sell and issue, respectively, the Notes and Warrants at the Closing are subject to the fulfillment on or prior to the Closing Date of the following conditions: 5.1. Representations and Warranties of Company Correct. The representations and warranties made by the Company in Section 3 hereof shall be true and correct when made, and shall be true and correct on the Closing Date with the same force and effect as if they had been made on and as of said date. 5.2. Representations of Purchasers Correct. The representations made by the Purchasers in Section 4 hereof shall be true and correct when made, and shall be true and correct on the Closing Date with the same force and effect as if they had been made on and as of said date. 5.3. Covenants and Laws. All covenants, agreements and conditions contained in this Agreement to be performed by the Company on or prior to the Closing Date shall have been performed or complied with in all respects and the purchase and sale of the Notes and Warrants -7- pursuant to the terms of this Agreement shall not violate any law or regulation to which any of the Purchasers or the Company is subject. SECTION 6 RESTRICTIONS ON TRANSFERABILITY OF SECURITIES; COMPLIANCE WITH SECURITIES ACT 6.1. Certain Definitions. As used in this Section, the following terms shall have the following respective meanings: "Commission" shall mean the Securities and Exchange Commission or any other federal agency at the time administering the Act. "Act" shall mean the Securities Act of 1933, as amended, or any similar federal statute and the rules and regulations of the Commission thereunder, all as the same shall be in effect at the time. "Restricted Securities" shall mean the Notes, the Warrants and the Warrant Common required to bear the legend set forth in Section 6.3 hereof. "Registrable Securities" means (i) the Warrant Common, and (ii) any Common Stock issued in respect of such shares upon any stock split, stock dividend, recapitalization or similar event, which shares, in each of the foregoing instances, have not been sold to the public pursuant to Rule 144 under the Act or otherwise. The terms "register", "registered" and "registration" refer to a registration effected by preparing and filing a registration statement in compliance with the Act, and the declaration or ordering of the effectiveness of such registration statement. "Registration Expenses" shall mean all expenses incurred by the Company in complying with Section 6.5 hereof, including, without limitation, all registration and filing fees, printing expenses, fees and disbursements of counsel for the Company, blue sky fees and expenses, and the expense of any special audits incident to or required by any such registration. "Selling Expenses" shall mean all underwriting discounts and selling commissions applicable to the sale and any expenses incurred by a Holder for its own benefit including all fees and disbursements of counsel to the Holders participating in the offering (including the allocable portion of the fees and disbursements of counsel to the Company, if such counsel is also serving as counsel to the selling shareholders), except those expenses included in the definition of Registration Expenses. "Holder" shall mean any Purchaser or any permitted transferee or assignee of such Purchaser pursuant to Section 6.10 who continues to hold of record Warrants or Registrable Securities as of the applicable date. -8- 6.2. Restrictions on Transferability. The Notes, the Warrants and the Warrant Common shall not be transferable except upon the conditions specified in this Section, which conditions are intended to insure compliance with the provisions of the Act. Each Purchaser will cause any proposed transferee of the Notes, the Warrants or the Warrant Common held by a Purchaser to agree to take and hold such Notes, Warrants or Warrant Common subject to the provisions and upon the conditions specified in this Section. 6.3. Restrictive Legend. Each certificate representing (i) the Notes, (ii) the Warrants, (iii) shares of Warrant Common, and (iv) any other securities issued in respect of the Notes, the Warrants or the Warrant Common upon any stock split, stock dividend, recapitalization, merger, consolidation or similar event, shall (unless otherwise permitted by the provisions of Section 6.4 below) be stamped or otherwise imprinted with a legend in substantially the following form (in addition to any legend required under applicable state securities laws): THESE SECURITIES HAVE NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933. THEY MAY NOT BE SOLD, OFFERED FOR SALE, PLEDGED OR HYPOTHECATED IN THE ABSENCE OF AN EFFECTIVE REGISTRATION STATEMENT RELATED THERETO OR AN OPINION OF COUNSEL, REASONABLY SATISFACTORY TO THE COMPANY, THAT SUCH REGISTRATION IS NOT REQUIRED UNDER THE SECURITIES ACT OF 1933. 6.4. Notice of Proposed Transfers. Each holder of a certificate representing Restricted Securities by acceptance thereof agrees to comply in all respects with the provisions of this Section 6.4. Prior to any proposed transfer of any Restricted Securities (other than under circumstances described in Section 6.5 hereof), the holder thereof shall give written notice to the Company of such holder's intention to effect such transfer. Each such notice shall describe the manner and circumstances of the proposed transfer in sufficient detail, and, if requested by the Company, shall be accompanied (except in transactions in compliance with Rule 144) by an unqualified written opinion of legal counsel, which opinion shall be addressed to the Company and reasonably satisfactory in form and substance to the Company's counsel, to the effect that the proposed transfer of the Restricted Securities may be effected without registration under the Act. The holder of such Restricted Securities shall be entitled to transfer such Restricted Securities in accordance with the terms of such legal opinion (if reasonably acceptable as above provided) and the terms of the notice delivered by the holder to the Company. Each certificate evidencing the Restricted Securities transferred as above provided shall bear the appropriate restrictive legend set forth in Section 6.3 above, except that such certificate shall not bear such restrictive legend if transferred in compliance with Rule 144 or if the opinion of counsel referred to above is to the further effect that such legend is not required in order to establish compliance with any provisions of the Act. 6.5. Piggy-Back Registration Rights. (a) Notice of Registration. Whenever the Company proposes to register any of its Common Stock under the Act for a public offering for cash, whether as a primary or secondary offering (or pursuant to the registration rights granted to other holders of securities of the Company), -9- other than a registration relating to employee benefit plans or in connection with a Rule 145 transaction or equivalent, the Company will: (i) give to each Holder at the address indicated on the books of the transfer agent written notice of the intent to so register its securities; and (ii) include in such registration (and any related qualification under blue sky laws or other compliance), and in any underwriting involved therein, all the Registrable Securities specified in a written request or requests delivered to the Company or its legal counsel by any Holder or Holders within 15 days after the date of mailing of such written notice by the Company, except as set forth in subparagraphs (b) and (c) below. (b) Underwriting. If the registration of which the Company gives notice is for a registered public offering involving an underwriting, the Company shall so advise the Holders as a part of the written notice given pursuant to subparagraph (a)(i) of this Section. In such event the right of any Holder to registration pursuant to this Section shall be conditioned upon such Holder's participation in such underwriting and the inclusion of such Holder's Registrable Securities in the underwriting to the extent provided herein. All Holders proposing to distribute their securities through such underwriting shall (together with the Company and the other holders distributing their securities through such underwriting) enter into an underwriting agreement in customary form with the underwriter or underwriters selected for such underwriting by the Company or by holders exercising demand registration rights, as the case may be. Notwithstanding any other provisions of this Section, if the underwriter determines that marketing factors require a limitation of the number of shares to be underwritten, the underwriter may exclude some or all Registrable Securities from such registration and underwriting. The Company shall so advise all Holders, and the number of shares of Registrable Securities that may be included in the registration and underwriting shall be allocated among all Holders requesting inclusion in such proportion, as nearly as practicable, as the respective amounts of Registrable Securities entitled to inclusion in such registration held by such Holders at the time of filing the registration statement bear to the aggregate amount of such securities held by all such Holders. To the extent that other persons holding the Company's securities may possess registration rights with respect to such securities (whether heretofore or hereafter granted), the total number of shares to be sold by selling shareholders under a registration statement, if less than the total amount requested to be sold by such persons, shall be allocated on a pro rata basis according to the total number of shares held by such persons which are entitled to registration rights with respect to such offering, subject to the prior rights set forth in subsection (c) hereof. If any Holder disapproves of the terms of any such underwriting, he may elect to withdraw therefrom at any time prior to filing of the registration statement by written notice to the Company and the underwriter. Any Registrable Securities excluded or withdrawn from such underwriting shall not be included in such registration. (c) Prior Rights. Certain holders (the "Prior Holders") of the Company's Common Stock may continue to have registration rights granted pursuant to a Stock Purchase Agreement dated as of April 14, 1977 (the "Prior Agreement"). In the event that a registration is effected pursuant to the Prior Holders' demand rights set forth in Section 6.5 of the Prior Agreement, securities held by the Holders and others desiring to sell securities in the registration may only be included to the extent that the amount of securities being registered for the account of the Prior -10- Holders will not be diminished. In the event of a registration which is not initiated by a demand of the Prior Holders but with respect to which such Prior Holders have piggyback rights under Section 6.6 of the Prior Agreement, the securities to be sold by the Prior Holders may not be reduced to less than 33-1/3% of the total amount of securities being registered. The Company has also granted registration rights similar to those provided herein to certain investors pursuant to a Subordinated Note and Warrant Purchase Agreement dated March 1996. 6.6. Expenses of Registration. All Registration Expenses incurred in connection with any registration, qualification or compliance pursuant to this Section shall be borne by the Company; and all Selling Expenses shall be borne by the Holders of the securities so registered for whose account such expenses were incurred. 6.7. Registration Procedures. In the case of each registration, qualification or compliance effected by the Company pursuant to this Section, the Company will advise each participating Holder as to the filing of the registration statement with the Commission and the effective date thereof. The Company shall also advise each participating Holder, concurrently with the notice of effectiveness, of the jurisdictions in which the securities being registered have been qualified for sale to the public. In connection with each registration other than in connection with a firm commitment underwritten public offering, at its expense, the Company will: (a) Keep such registration, qualification or compliance effective for a period of 90 days after effectiveness with the Commission or until the Holder or Holders have completed the distribution described in the registration statement relating thereto, whichever first occurs; and (b) Furnish such number of prospectuses and other documents incident thereto as a Holder from time to time may reasonably request. 6.8. Indemnification. (a) The Company will indemnify each participating Holder, each of its officers and directors and partners, and each person controlling such Holder, with respect to which registration, qualification or compliance has been effected pursuant to this Section 6, and each underwriter, if any, and each person who controls any underwriter against all claims, losses, damages and liabilities (or actions in respect thereof) arising out of or based on any untrue statement (or alleged untrue statement) of a material fact contained in any prospectus, offering circular or other document (including any related registration statement, notification or the like) incident to any such registration, qualification or compliance, or based on any omission (or alleged omission) to state therein a material fact required to be stated therein or necessary to make the statements therein not misleading, or any violation by the Company of any rule or regulation promulgated under the Act applicable to the Company and relating to action or inaction required of the Company in connection with any such registration, qualification or compliance, and will reimburse each such Holder, each of its partners, officers and directors, and each person controlling such Holder, each such underwriter and each person who controls any such underwriter, for any legal and any other expenses reasonably incurred in connection with investigating or defending any such claim, loss, damage, liability or action, provided that the Company will not be liable in any such case to the extent that any such claim, loss, damage, liability or action arises out of or is based on any untrue statement or omission -11- based upon written information furnished to the Company by an instrument duly executed by such Holder or underwriter. (b) Each Holder will, if Registrable Securities held by such Holder are included in the securities as to which such registration, qualification or compliance is being effected, indemnify the Company, each of its directors and officers, each legal counsel and independent accountant of the Company, each underwriter, if any, of the Company's securities covered by such a registration statement, each person who controls the Company or such underwriter within the meaning of the Act, and each other such Holder, each of its partners, officers and directors and each person controlling such Holder, against all claims, losses, damages and liabilities (or actions in respect thereof) arising out of or based on any untrue statement (or alleged untrue statement) of a material fact contained in any such registration statement, prospectus, offering circular or other document, or any omission (or alleged omission) to state therein a material fact required to be stated therein or necessary to make the statements therein not misleading, and will reimburse the Company, such Holders, such partners, directors, officers, persons, underwriters or control persons for any legal or any other expenses reasonably incurred in connection with investigating or defending any such claim, loss, damage, liability or action, in each case to the extent, but only to the extent, that such untrue statement (or alleged untrue statement) or omission (or alleged omission) is made in such registration statement, prospectus, offering circular or other document in reliance upon and in conformity with written information furnished to the Company by an instrument duly executed by such Holder; provided, however, that the obligations of such Holders hereunder shall be limited to an amount equal to the proceeds to each such Holder from the sale of Registrable Securities as contemplated herein. (c) Each party entitled to indemnification under this Section (the "Indemnified Party") shall give notice to the party required to provide indemnification (the "Indemnifying Party") promptly after such Indemnified Party has actual knowledge of any claim as to which indemnity may be sought, and shall permit the Indemnifying Party to assume the defense of any such claim or any litigation resulting therefrom, provided that counsel for such Indemnifying Party, who shall conduct the defense of such claim or litigation, shall be approved by the Indemnified Party (whose approval shall not unreasonably be withheld), and the Indemnified Party may participate in such defense at such party's expense, and provided further that the failure of any Indemnified Party to give notice as provided herein shall not relieve the Indemnifying Party of its obligations under this Section. No Indemnifying Party, in the defense of any such claim or litigation, shall, except with the consent of each Indemnified Party, consent to entry of any judgment or enter into any settlement which does not include as an unconditional term thereof the giving by the claimant or plaintiff to such Indemnified Party of a release from all liability in respect to such claim or litigation. (d) Notwithstanding the foregoing, if the Registrable Securities are to be distributed by means of an underwritten public offering, to the extent that the provisions on indemnification and contribution contained in the underwriting agreement entered into in connection with such underwriting are in conflict with the foregoing provisions, the provisions in the underwriting agreement shall be controlling. 6.9. Information by Holder. The Holder or Holders of Registrable Securities included in any registration shall furnish to the Company such information regarding such Holder or Holders -12- and the distribution proposed by such Holder or Holders as the Company may request in writing and as shall be required in connection with any registration, qualification or compliance referred to in this Section 6. 6.10. Transfer of Piggy-Back Registration Rights. The rights to cause the Company to register a Purchaser's Registrable Securities granted hereunder by the Company, may be assigned to a transferee or assignee of 25,000 or more shares of Warrant Common (as adjusted to reflect stock splits, stock dividends and similar events) provided that the Company is given advance written notice by such Purchaser of said transfer and of the intent to transfer such Purchaser's registration rights together with such securities, stating the name and address of said transferee or assignee and identifying the Registrable Securities with respect to which such registration rights are being assigned, and provided, further, that no transferee or assignee of any of such Restricted Securities shall be entitled to the registration rights provided in this Section if such transferee or assignee would be permitted to sell all of the Restricted Securities so transferred or assigned to him within one three-month period pursuant to Rule 144 promulgated under the Act. 6.11. "Market Stand-off" Agreement. Any Holder of Registrable Securities being registered under this Section 6 agrees, if requested by the Company or an underwriter of such registered public offering, not to sell or otherwise transfer or dispose of any Common Stock (or other securities) of the Company held by such Holder during a period of up to 180 days following the effective date of the registration statement of the Company filed under the Act, provided that all executive officers and directors of the Company enter into similar agreements. Such agreement shall be in writing in the form satisfactory to the Company and such underwriter, and may be included in the underwriting agreement. The Company may impose stop-transfer instructions with respect to the securities subject to the foregoing restriction until the end of the required stand-off period. 6.12. Termination of Registration Rights. The rights granted under this Section shall terminate as to any Purchaser or permissible transferee or assignee of such rights if such person would be permitted to sell all of the Restricted Securities held by such person within one three-month period pursuant to Rule 144 promulgated under the Act. SECTION 7 MISCELLANEOUS 7.1. Agreement Is Entire Contract. This Agreement, the Exhibits hereto and the other documents delivered pursuant hereto constitute the entire contract between the parties hereto and no party shall be liable or bound to the other in any manner by any warranties, representations or covenants except as specifically set forth herein. The terms and conditions of this Agreement shall inure to the benefit of and be binding upon the respective successors and assigns of the parties hereto. Nothing in this Agreement, express or implied, is intended to confer upon any party, other than the parties hereto, and their respective successors and assigns, any rights, remedies, obligations or liabilities under or by reason of this Agreement, except as expressly provided herein. -13- 7.2. Amendment by Agreement. Any provision of this Agreement may be amended or waived by a written instrument signed by the Company and by a majority in interest of the holders of the Warrants (on an as-if-exercised basis) and the Warrant Common. 7.3. Notices. Any notice, request or other communication required or permitted hereunder shall be in writing and shall be deemed to have been duly given if personally delivered, sent by facsimile or mailed by registered or certified mail, postage prepaid, or by recognized overnight courier or personal delivery at the respective addresses or facsimile phone number of the parties as set forth below. Any party hereto may by notice so given change its address for future notice hereunder. Notice shall conclusively be deemed to have been given when received. If to a Purchaser: At the address set forth in the Schedule of Purchasers If to Company: FAFCO, Inc. 435 Otterson Drive Chico, CA 95928 Attention: Alex N. Watt, Executive Vice President With a copy to: Ann Yvonne Walker, Esq. Wilson, Sonsini, Goodrich & Rosati, P.C. 650 Page Mill Road Palo Alto, CA 94304 Each of the above addressees may change its address for purposes of this paragraph by giving to the other addressee notice of such new address in conformance with this paragraph. 7.4. Agent's Fees. (a) The Company hereby agrees to indemnify and to hold each Purchaser harmless of and from any liability for commission or compensation in the nature of an agent's fee to any broker or other person or firm (and the costs and expenses of defending against such liability or asserted liability) for which the Company, or any of its employees or representatives, is responsible. (b) Each Purchaser (i) represents and warrants that no finders or brokers have been retained in connection with the transactions contemplated by this Agreement, and (ii) hereby agrees to indemnify and to hold the Company and the Purchasers (other than himself) harmless of and from any liability for any commission or compensation in the nature of an agent's fee to any broker or other person or firm (and the costs and expenses of defending against such liability or asserted liability) for which such Purchaser, or any of his employees or representatives, are responsible. 7.5. Severability. If one or more provisions of this Agreement are held to be unenforceable under applicable law, such provision shall be severed from this Agreement as if such provision were not included and the balance of this Agreement shall be enforceable in accordance with its terms. -14- 7.6. Expenses. The Company and each Purchaser shall bear its own expenses and legal fees incurred on its behalf with respect to this Agreement and the transactions contemplated hereby. 7.7. California Corporate Securities Law. THE SALE OF THE SECURITIES WHICH ARE THE SUBJECT OF THIS AGREEMENT HAS NOT BEEN QUALIFIED WITH THE COMMISSIONER OF CORPORATIONS OF THE STATE OF CALIFORNIA AND THE ISSUANCE OF SUCH SECURITIES OR THE PAYMENT OR RECEIPT OF ANY PART OF THE CONSIDERATION THEREFOR PRIOR TO SUCH QUALIFICATION, OR EXEMPTION THEREFROM, IS UNLAWFUL. THE RIGHTS OF ALL PARTIES TO THIS AGREEMENT ARE EXPRESSLY CONDITIONED UPON SUCH QUALIFICATION, OR EXEMPTION THEREFROM, BEING OBTAINED. 7.8. Governing Law. This Agreement shall be governed by and construed under the laws of the State of California. 7.9. Counterparts. This Agreement may be executed in two or more counterparts, each of which shall be deemed an original, but all of which together shall constitute one and the same instrument. -15- IN WITNESS WHEREOF, the parties hereto have executed this Agreement as of the date first above written. FAFCO, INC. PURCHASERS: By: -------------------------------- --------------------------------- Title: ------------------------------- EXHIBIT A SCHEDULE OF PURCHASERS

NAME AND ADDRESS OF PURCHASER LOAN AMOUNT WARRANT SHARES ----------------------------- ----------- -------------- Leo Helzel $ 100,000 5550 Redwood Ave. Oakland, CA 94619 Freeman & Diana Ford $ 100,000 172 Toyon Road Atherton, CA 94027 Murray Stoltz $ 50,000 21 Hemlock Road Bronxville, NY 10708 Richard O. Rhodes $ 50,000 4440 18th Street San Francisco, CA 94114 Wally Niemasik, Jr. $ 50,000 6 Fennwood Drive Atherton, CA 94027

EX-10.11.I 6 f88879exv10w11wi.txt EX-10.11.I . . . EXHIBIT 10.11(I) CHANGE IN TERMS AGREEMENT

PRINCIPAL LOAN DATE MATURITY LOAN NO. CALL/COL ACCOUNT OFFICER INITIALS $1,000,000.00 08-08-2002 08-10-2003 0400707337 016/6666 120144 019 - ----------------------------------------------------------------------------------------------------------- References in the shaded area are for Lender's use only and do not limit the applicability of this document to any particular loan or item. Any item above containing "***" has been omitted due to text length limitations. - -----------------------------------------------------------------------------------------------------------

BORROWER: FAFCO, INC. LENDER: BUTTE COMMUNITY BANK 435 OTTERSON DRIVE CHICO OFFICE CHICO, CA 95928 2041 FOREST AVE CHICO, CA 95928 ================================================================================ PRINCIPAL AMOUNT: $1,000,000.00 INITIAL RATE: 6.250% DATE OF AGREEMENT: AUGUST 8, 2002 DESCRIPTION OF EXISTING INDEBTEDNESS. THIS IS A VARIABLE RATE (1.500% OVER PRIME RATE AS PUBLISHED BY BUTTE COMMUNITY BANK, MAKING AN INITIAL RATE OF 6.250%), NONDISCLOSABLE REVOLVING LINE OF CREDIT LOAN TO A CORPORATION FOR $1,500,000.00 DUE ON AUGUST 10, 2002. DESCRIPTION OF COLLATERAL. UCC FILING ON ALL INVENTORY, CHATTEL PAPER, ACCOUNTS/CONTRACT RIGHTS, EQUIPMENT, GENERAL INTANGIBLES AND FIXTURES. DESCRIPTION OF CHANGE IN TERMS. EXTEND MATURITY DATE FROM AUGUST 10, 2002 TO AUGUST 10, 2003. DECREASE IN MAXIMUM CREDIT AMOUNT FROM $1,500,000.00 TO $1,000,000.00. ALL OTHER TERMS AND CONDITIONS ARE TO REMAIN THE SAME. PROMISE TO PAY. FAFCO, INC. ("Borrower") promises to pay to Butte Community Bank ("Lender"), or order, in lawful money of the United States of America, the principal amount of One Million & 00/100 Dollars ($1,000,000.00) or so much as may be outstanding, together with interest on the unpaid outstanding principal balance on each advance. Interest shall be calculated from the date of each advance until repayment of each advance. PAYMENT. Borrower will pay this loan on demand. Payment in full is due immediately upon Lender's demand. If no demand is made, Borrower will pay this loan in one payment of all outstanding principal plus all accrued unpaid interest on August 10, 2003. In addition, Borrower will pay regular monthly payments of all accrued unpaid interest due as of each payment date, beginning August 10, 2002, with all subsequent interest payments to be due on the same day of each month after that. Interest on this Agreement is computed on a 365/360 simple interest basis; that is, by applying the ratio of the annual interest rate over a year of 360 days, multiplied by the outstanding principal balance, multiplied by the actual number of days the principal balance is outstanding. Borrower will pay Lender at Lender's address shown above or at such other place as Lender may designate in writing. VARIABLE INTEREST RATE. The interest rate on this Agreement is subject to change from time to time based on changes in an index which is Lender's Prime Rate (the "Index"). This is the rate Lender charges, or would charge, on 90-day unsecured loans to the most creditworthy corporate customers. This rate may or may not be the lowest rate available from Lender at any given time. Lender will tell Borrower the current index rate upon Borrower's request. The interest rate change will not occur more often than each DAY. Borrower understands that Lender may make loans based on other rates as well. The Index currently is 4.750% per annum. The interest rate to be applied to the unpaid principal balance of the Note will be at a rate of 1.500 percentage points over the index, resulting in an initial rate of 6.250% per annum. NOTICE: Under no circumstances will the interest rate on the Note be more than the maximum rate allowed by applicable law. PREPAYMENT; MINIMUM INTEREST CHARGE. In any event, even upon full prepayment of this Agreement, Borrower understands that Lender is entitled to a minimum interest charge of $60.00. Other than Borrower's obligation to pay any minimum interest charge, Borrower may pay without penalty all or a portion of the amount owed earlier than it is due. Early payments will not, unless agreed to by Lender in writing, relieve Borrower of Borrower's obligation to continue to make payments of accrued unpaid interest. Rather, early payments will reduce the principal balance due. Borrower agrees not to send Lender payments marked "paid in full", "without recourse", or similar language. If Borrower sends such a payment, Lender may accept it without losing any of Lender's rights under this Agreement, and Borrower will remain obligated to pay any further amount owed to Lender. All written communications concerning disputed amounts, including any check or other payment instrument that indicates that the payment constitutes "payment in full" of the amount owed or that is tendered with other conditions or limitations or as full satisfaction of a disputed amount must be mailed or delivered to: Butte Community Bank, CHICO OFFICE, 2041 FOREST AVE, CHICO, CA 95928. LATE CHARGE. If a payment is 10 days or more late, Borrower will be charged 5.000% of the regularly scheduled payment or $5.00, whichever is greater. INTEREST AFTER DEFAULT. Upon Borrower's failure to pay all amounts declared due pursuant to this section, including failure to pay upon final maturity, the total sum due under this Agreement will bear interest from the date of acceleration or maturity at the variable interest rate on this Agreement. DEFAULT. Each of the following shall constitute an Event of Default under this Agreement. PAYMENT DEFAULT. Borrower fails to make any payment when due under the indebtedness. OTHER DEFAULTS. Borrower fails to comply with or to perform any other term, obligation, covenant or condition contained in this Agreement or in any of the Related Documents or to comply with or to perform any term, obligation, covenant or condition contained in any other agreement between Lender and Borrower. FALSE STATEMENTS. Any warranty, representation or statement made or furnished to Lender by Borrower or on Borrower's behalf under this Agreement or the Related Documents is false or misleading in any material respect, either now or at the time made or furnished or becomes false or misleading at any time thereafter. INSOLVENCY. The dissolution or termination of Borrower's existence as a going business, the insolvency of Borrower, the appointment of a receiver for any part of Borrower's property, any assignment for the benefit of creditors, any type of creditor workout, or the commencement of any proceeding under any bankruptcy or insolvency laws by or against Borrower. CREDITOR OR FORFEITURE PROCEEDINGS. Commencement of foreclosure or forfeiture proceedings, whether by judicial proceeding, self-help, repossession or any other method, by any creditor or Borrower or by any governmental agency against any collateral securing the indebtedness. This includes a garnishment of any of Borrower's accounts, including deposit accounts, with Lender. However, this Event of Default shall not apply if there is a good faith dispute by Borrower as to the validity or reasonableness of the claim which is the basis of the creditor or forfeiture proceedings and if Borrower gives Lender written notice of the creditor or forfeiture proceeding and deposits with Lender monies or a surely bond for the creditor or forfeiture proceeding, in an amount determined by Lender, in its sole discretion, as being an adequate reserve or bond for the dispute. EVENTS AFFECTING GUARANTOR. Any of the preceding events occurs with respect to any guarantor, endorser, surety, or accommodation party of any of the indebtedness or any guarantor, endorser, surety, or accommodation party dies or becomes incompetent, or revokes or disputes the validity of, or liability under, any Guaranty of the indebtedness evidenced by this Note. In the event of a death, Lender, at its option, may, but shall not be required to, permit the guarantor's estate to assume unconditionally the obligations arising under the guaranty in a manner satisfactory to Lender, and, in doing so, cure any Event of Default. CHANGE IN OWNERSHIP. Any change in ownership of twenty-five percent (25%) or more of the common stock of Borrower. ADVERSE CHANGE. A material adverse change occurs in Borrower's financial condition, or Lender believes the prospect of payment or performance of the indebtedness is impaired. INSECURITY. Lender in good faith believes itself insecure. CURE PROVISIONS. If any default, other than a default in payment is curable and if Borrower has not been given a notice of a breach of the same provision of this Agreement within the preceding twelve (12) months, it may be cured (and no event of default will have occurred) if Borrower, after receiving written notice from Lender demanding cure of such default: (1) cures the default within fifteen (15) days; or (2) if the cure requires more than fifteen (15) days, immediately initiates steps which Lender deems in Lender's sole discretion to be sufficient to cure the default and thereafter continues and completes all reasonable and necessary steps sufficient to produce compliance as soon as reasonably practical. LENDER'S RIGHTS. Upon default, Lender may declare the entire unpaid principal balance on this Agreement and all accrued unpaid interest immediately due, and then Borrower will pay that amount. ATTORNEYS' FEES; EXPENSES. Lender may hire or pay someone else to help collect this Agreement if Borrower does not pay. Borrower will pay Lender that amount. This includes, subject to any limits under applicable law, Lender's attorneys' fees and Lender's legal expenses, whether or not there is a lawsuit, including attorneys' fees, expenses for bankruptcy proceedings (including efforts to modify or vacate any automatic stay or injunction), and appeals. Borrower also will pay any court costs, in addition to all other sums provided by law. GOVERNING LAW. This Agreement will be governed by, construed and enforced in accordance with federal law and the laws of the State of CHANGE IN TERMS AGREEMENT Loan No. 0400707337 (Continued) Page 2 =============================================================================== California. This Agreement has been accepted by Lender in the State of California. CHOICE OF VENUE. If there is a lawsuit, Borrower agrees upon Lender's request to submit to the jurisdiction of the courts of BUTTE County, State of California. DISHONORED ITEM FEE. Borrower will pay a fee to Lender of $10.00 if Borrower makes a payment on Borrower's loan and the check or preauthorized charge with which Borrower pays is later dishonored. RIGHT OF SETOFF. To the extent permitted by applicable law, Lender reserves a right of setoff in all Borrower's accounts with Lender (whether checking, savings, or some other account). This includes all accounts Borrower holds jointly with someone else and all accounts Borrower may open in the future. However, this does not include any IRA or Keogh accounts, or any trust accounts for which setoff would be prohibited by law. Borrower authorizes Lender, to the extent permitted by applicable law, to charge or setoff all sums owing on the indebtedness against any and all such accounts. COLLATERAL. Borrower acknowledges this Agreement is secured by the following collateral described in the security instrument listed herein: inventory, chattel paper, accounts, equipment, general intangibles and fixtures described in a Commercial Security Agreement dated August 8, 2002. LINE OF CREDIT. This Agreement evidences a revolving line of credit. Advances under this Agreement may be requested orally by Borrower or as provided in this paragraph. Lender may, but need not, require that all oral requests be confirmed in writing. All communications, instructions, or directions by telephone or otherwise to Lender are to be directed to Lender's office shown above. The following persons currently are authorized to request advances and authorize payments under the line of credit until Lender receives from Borrower, at Lender's address shown above, written notice of revocation of their authority: ALEX N. WATT, Executive VP/Secretary of FAFCO, INC.; NANCY I. GARVIN, Vice President of Finance of FAFCO, INC.; and FREEMAN A. FORD, President of FAFCO, INC. Borrower agrees to be liable for all sums either: (A) advanced in accordance with the instructions of an authorized person or (B) credited to any of Borrower's accounts with Lender. The unpaid principal balance owing on this Agreement at any time may be evidenced by endorsements on this Agreement or by Lender's internal records, including daily computer print-outs. Lender will have no obligation to advance funds under this Agreement if: (A) Borrower or any guarantor is in default under the terms of this Agreement or any agreement that Borrower or any guarantor has with Lender, including any agreement made in connection with the signing of this Agreement; (B) Borrower or any guarantor ceases doing business or is insolvent; (C) any guarantor seeks, claims or otherwise attempts to limit, modify or revoke such guarantor's guarantee of this Agreement or any other loan with Lender; (D) Borrower has applied funds provided pursuant to this Agreement for purposes other than those authorized by Lender; or (E) Lender in good faith believes itself insecure. CONTINUING VALIDITY. Except as expressly changed by this Agreement, the terms of the original obligation or obligations, including all agreements evidenced or securing the obligation(s), remain unchanged and in full force and effect. Consent by Lender to this Agreement does not waive Lender's right to strict performance of the obligation(s) as changed, nor obligate Lender to make any future change in terms. Nothing in this Agreement will constitute a satisfaction of the obligation(s). It is the intention of Lender to retain as liable parties all makers and endorsers of the original obligation(s), including accommodation parties, unless a party is expressly released by Lender in writing. Any maker or endorser, including accommodation makers, will not be released by virtue of this Agreement. If any person who signed the original obligation does not sign this Agreement below, then all persons signing below acknowledge that this Agreement is given conditionally, based on the representation to Lender that the non-signing party consents to the changes and provisions of this Agreement or otherwise will not be released by it. This waiver applies not only to any initial extension, modification or release, but also to all such subsequent actions. SUCCESSORS AND ASSIGNS. Subject to any limitations stated in this Agreement on transfer of Borrower's interest, this Agreement shall be binding upon and inure to the benefit of the parties, their successors and assigns. If ownership of the Collateral becomes vested in a person other than Borrower, Lender, without notice to Borrower, may deal with Borrower's successors with reference to this Agreement and the indebtedness by way of forbearance or extension without releasing Borrower from the obligations of this Agreement or liability under the indebtedness. NOTIFY US OF INACCURATE INFORMATION WE REPORT TO CONSUMER REPORTING AGENCIES. Please notify us if we report any inaccurate information about your account(s) to a consumer reporting agency. Your written notice describing the specific inaccuracy(ies) should be sent to us at the following address: Butte Community Bank, CHICO OFFICE, 2041 FOREST AVE, CHICO, CA 95928. MISCELLANEOUS PROVISIONS. This Agreement is payable on demand. The inclusion of specific default provisions or rights of Lender shall not preclude Lender's right to declare payment of this Agreement on its demand. Lender may delay or forgo enforcing any of its rights or remedies under this Agreement without losing them. Borrower and any other person who signs, guarantees or endorses this Agreement, to the extent allowed by law, waive any applicable statute of limitations, presentment, demand for payment, and notice of dishonor. Upon any change in the terms of this Agreement, and unless otherwise expressly stated in writing, no party who signs this Agreement, whether as maker, guarantor, accommodation maker or endorser, shall be released from liability. All such parties agree that Lender may renew or extend (repeatedly and for any length of time) this loan or release any party or guarantor or collateral; or impair, fail to realize upon or perfect Lender's security interest in the collateral; and take any other action deemed necessary by Lender without the consent of or notice to anyone. All such parties also agree that Lender may modify this loan without the consent of or notice to anyone other than the party with whom the modification is made. The obligations under this Agreement are joint and several. PRIOR TO SIGNING THIS AGREEMENT, BORROWER READ AND UNDERSTOOD ALL THE PROVISION OF THIS AGREEMENT, INCLUDING THE VARIABLE INTEREST RATE PROVISIONS. BORROWER AGREES TO THE TERMS OF THE AGREEMENT. CIT SIGNERS: FAFCO, INC. By: /s/ Nancy I. Garvin -------------------- NANCY I. GARVIN, Vice President of Finance of FAFCO, INC. ================================================================================ [ILLEGIBLE] EX-10.11.J 7 f88879exv10w11wj.txt EX-10.11.J . . . Exhibit 10.11(J) CHANGE IN TERMS AGREEMENT

Principal Loan Date Maturity Loan No. Cell/Call Accounts Officer Initials $3,356,768.76 11-10-2002 06-10-2005 0400706081 016/1111 [20] 44 019

References in the shaded area are for Lender's use only and do not limit the applicability of this document to any particular loan or item. Any item above containing "***" has been omitted due to text length limitations. - -------------------------------------------------------------------------------- Borrower: FAFCO, INC. Lender: Butte Community Bank 435 OTTERSON DRIVE CHICO OFFICE CHICO, CA 95928 2041 FOREST AVE CHICO, CA 92928 - -------------------------------------------------------------------------------- PRINCIPAL AMOUNT: $3,356,768.76 INTEREST RATE: 8.000% DATE OF AGREEMENT: NOVEMBER 10, 2002 DESCRIPTION OF EXISTING INDEBTEDNESS. THIS IS A FIXED RATE (9.050%) NONDISCLOSABLE DRAW DOWN LINE OF CREDIT TO A CORPORATION FOR $3,400,000.00 DUE ON JUNE 10, 2005. DESCRIPTION OF COLLATERAL. 1ST D/T 435 OTTERSON DRIVE, CHICO, CA 95928. DESCRIPTION OF CHANGE IN TERMS. INTEREST RATE TO BE CHANGED FROM 9.050% TO 8.000% FIXED, ON THE CURRENT PRINCIPAL BALANCE OF $3,356,768.76. ON JUNE 10, 2005, INTEREST RATE TO BE CHANGED TO PRIME RATE (AS PUBLISHED BY BUTTE COMMUNITY BANK) PLUS .350% AND FIXED FOR THE NEXT FIVE YEAR PERIOD. EACH SUBSEQUENT FIVE YEAR PERIOD WILL BE ADJUSTED TO PRIME RATE (AS PUBLISHED BY BUTTE COMMUNITY BANK) PLUS .350% AND FIXED FOR FIVE YEARS. A DOCUMENTATION FEE OF $250.00 TO BE PAID IN CASH. ALL OTHER TERMS AND CONDITIONS ARE TO REMAIN THE SAME. PROMISE TO PAY. FAFCO, INC. ("Borrower") promises to pay to Butte Community Bank ("Lender"), or order, in lawful money of the United States of America, the principal amount of Three Million Three Hundred Fifty-six Thousand Seven Hundred Sixty-eight & 76/100 Dollars ($3,356,768.76) or so much as may be outstanding, together with interest at the rate of 8.000% on the unpaid outstanding principal balance of each advance. Interest shall be calculated from the date of each advance until repayment of each advance. PAYMENT. Borrower will pay this loan in one payment of all outstanding principal plus all accrued unpaid interest on June 10, 2005. In addition, Borrower will pay regular monthly payments of all accrued unpaid interest due as of each payment date, beginning December 10, 2002, with all subsequent interest payments to be due on the same day of each month after that. Interest on this Agreement is computed on a 365/360 simple interest basis; that is, by applying the ratio of the annual interest rate over a year of 360 days, multiplied by the outstanding principal balance, multiplied by the actual number of days the principal balance is outstanding. Borrower will pay Lender at Lender's address shown above or at such other place as Lender may designate in writing. PREPAYMENT; MINIMUM INTEREST CHARGE. Borrower agrees that all loan fees and other prepaid finance charges are earned fully as of the date of the loan and will not be subject to refund upon early payment (whether voluntary or as a result of default), except as otherwise required by law. In any event, even upon full prepayment of this Agreement, Borrower understands that Lender is entitled to a minimum interest charge of $50.00. Other than Borrower's obligation to pay any minimum interest charge, Borrower may pay without penalty all or a portion of the amount owed earlier than it is due. Early payments will not, unless agreed to by Lender in writing, relieve Borrower of Borrower's obligation to continue to make payments of accrued unpaid interest. Rather, early payments will reduce the principal balance due. Borrower agrees not to send Lender payments marked "paid in full", "without recourse", or similar language. If Borrower sends such a payment, Lender may accept it without losing any of Lender's rights under this Agreement, and Borrower will remain obligated to pay any further amount owed to Lender. All written communications concerning disputed amounts, including any check or other payment instrument that indicates that the payment constitutes "payment in full" of the amount owed or that is tendered with other conditions or limitations or as full satisfaction of a disputed amount must be mailed or delivered to: Butte Community Bank, NOTE DEPARTMENT, 1390 RIDGEWOOD DRIVE CHICO, CA 95973. LATE CHARGE. If a payment is 10 days or more late, Borrower will be charged 5.000% of the regularly scheduled payment. INTEREST AFTER DEFAULT. Upon Borrower's failure to pay all amounts declared due pursuant to this section, including failure to pay upon final maturity, the total sum due under this Agreement will bear interest from the date of acceleration or maturity at the interest rate on this Agreement. DEFAULT. Each of the following shall constitute an Event of Default under this Agreement: PAYMENT DEFAULT. Borrower fails to make any payment when due under the indebtedness. OTHER DEFAULTS. Borrower fails to comply with or to perform any other term, obligation, covenant or condition contained in this Agreement or in any of the Related Documents or to comply with or to perform any term, obligation, covenant or condition contained in any other agreement between Lender and Borrower. FALSE STATEMENTS. Any warranty, representation or statement made or furnished to Lender by Borrower or on Borrower's behalf under this Agreement or the Related Documents is false or misleading in any material respect, either now or at the time made or furnished or becomes false or misleading at any time thereafter. INSOLVENCY. The dissolution or termination of Borrower's existence as a going business, the insolvency of Borrower, the appointment of a receiver for any part of Borrower's property, any assignment for the benefit of creditors, any type of creditor workout, or the commencement of any proceeding under any bankruptcy or insolvency laws by or against Borrower. CREDITOR OR FORFEITURE PROCEEDINGS. Commencement of foreclosure or forfeiture proceedings, whether by judicial proceeding, self-help, repossession or any other method, by any creditor of Borrower or by any governmental agency against any collateral securing the indebtedness. This includes a garnishment of any of Borrower's accounts, including deposit accounts, with Lender. However, this Event of Default shall not apply if there is a good faith dispute by Borrower as to the validity or reasonableness of the claim which is the basis of the creditor or forfeiture proceeding and if Borrower gives Lender written notice of the creditor or forfeiture proceeding and deposits with Lender monies or a surety bond for the creditor or forfeiture proceeding, in an amount determined by Lender, in its sole discretion, as being an adequate reserve or bond for the dispute. EVENTS AFFECTING GUARANTOR. Any of the preceding events occurs with respect to any guarantor, endorser, surety, or accommodation party of any of the indebtedness or any guarantor, endorser, surety, or accommodation party dies or becomes incompetent, or revokes or disputes the validity of, or liability under, any Guaranty of the indebtedness evidenced by this Note. In the event of a death, Lender, at its option, may, but shall not be required to, permit the guarantor's estate to assume unconditionally the obligations arising under the guaranty in a manner satisfactory to Lender, and, in doing so, cure any Event of Default. CHANGE IN OWNERSHIP. Any change in ownership of twenty-five percent (25%) or more of the common stock of Borrower. ADVERSE CHANGE. A material adverse change occurs in Borrower's financial condition, or Lender believes the prospect of payment or performance of the indebtedness is impaired. INSECURITY. Lender in good faith believes itself insecure. CURE PROVISIONS. If any default, other than a default in payment is curable and if Borrower has not been given a notice of a breach of the same provision of this Agreement within the preceding twelve (12) months, it may be cured (and no event of default will have occurred) if Borrower, after receiving written notice from Lender demanding cure of such default: (1) cures the default within fifteen (15) days; or (2) if the cure requires more than fifteen (15) days, immediately initiates steps which Lender deems in Lender's sole discretion to be sufficient to cure the default and thereafter continues and completes all reasonable and necessary steps sufficient to produce compliance as soon as reasonably practical. LENDER'S RIGHTS. Upon default, Lender may declare the entire unpaid principal balance on this Agreement and all accrued unpaid interest immediately due, and then Borrower will pay that amount. ATTORNEYS' FEES; EXPENSES. Lender may hire or pay someone else to help collect this Agreement if Borrower does not pay. Borrower will pay Lender that amount. This includes, subject to any limits under applicable law, Lender's attorneys' fees and Lender's legal expenses, whether or not there is a lawsuit, including attorneys' fees, expenses for bankruptcy proceedings (including efforts to modify or vacate any automatic stay or injunction), and appeals. Borrower also will pay any court costs, in addition to all other sums provided by law. GOVERNING LAW. This Agreement will be governed by, construed and enforced in accordance with federal law and the laws of the State of California. This Agreement has been accepted by Lender in the State of California. CHOICE OF VENUE. If there is a lawsuit, Borrower agrees upon Lender's request to submit to the jurisdiction of the courts of BUTTE County, State of California. DISHONORED ITEM FEE. Borrower will pay a fee to Lender of $10.00 if Borrower makes a payment on Borrower's loan and the check or preauthorized charge with which Borrower pays is later dishonored. COLLATERAL. Borrower acknowledges this Agreement is secured by the following collateral described in the security instrument listed herein: a Deed of Trust dated November 10, 2002, to a trustee in favor of Lender on real property located in BUTTE County, State of California. That agreement CHANGE IN TERMS AGREEMENT Loan No: 0400706081 (CONTINUED) PAGE 2 - -------------------------------------------------------------------------------- contains the following due on sale provision: Lender may, at Lender's option, declare immediately due and payable all sums secured by the Deed of Trust upon the sale or transfer, without Lender's prior written consent, of all or any part of the Real Property, or any interest in the Real Property. A "sale or transfer" means the conveyance of Real Property or any right, title or interest in the Real Property; whether legal, beneficial or equitable; whether voluntary or involuntary; whether by outright sale, deed, installment sale contract, land contract, contract for deed, leasehold interest with a term greater than three (3) years, lease-option contract, or by sale, assignment, or transfer of any beneficial interest in or to any land trust holding title to the Real Property, or by any other method of conveyance of an interest in the Real Property. If any Borrower is a corporation, partnership or limited liability company, transfer also includes any change in ownership of more than twenty-five percent (25%) of the voting stock, partnership interests or limited liability company interests, as the case may be, of such Borrower. However, this option shall not be exercised by Lender if such exercise is prohibited by applicable law. LINE OF CREDIT. This Agreement evidences a straight line of credit. Once the total amount of principal has been advanced, Borrower is not entitled to further loan advances. Advances under this Agreement may be requested orally by Borrower or as provided in this paragraph. Lender may, but need not, require that all oral requests be confirmed in writing. All communications, instructions, or directions by telephone or otherwise to Lender are to be directed to Lender's office shown above. The following persons currently are authorized to request advances and authorize payments under the line of credit until Lender receives from Borrower, at Lender's address shown above, written notice of revocation of their authority; ALEX N. WATT, Executive VP/Secretary of FAFCO, INC.; NANCY I. GARVIN, Vice President of Finance of FAFCO, INC.; and FREEMAN A. FORD, President of FAFCO, INC. Borrower agrees to be liable for all sums either: 1. advanced in accordance with the instructions of an authorized person or 2. credited to any of Borrower's accounts with Lender. The unpaid principal balance owing on this Agreement at any time may be evidenced by endorsements on this Agreement or by Lender's internal records, including daily computer print-outs. CONTINUING VALIDITY. Except as expressly changed by this Agreement, the terms of the original obligation or obligations, including all agreements evidenced or securing the obligation(s), remain unchanged and in full force and effect. Consent by Lender to this Agreement does not waive Lender's right to strict performance of the obligation(s) as changed, nor obligate Lender to make any future change in terms. Nothing in this Agreement will constitute a satisfaction of the obligation(s). It is the intention of Lender to retain as liable parties all makers and endorsers of the original obligation(s), including accommodation parties, unless a party is expressly released by Lender in writing. Any maker or endorser, including accommodation makers, will not be released by virtue of this Agreement. If any person who signed the original obligation does not sign this Agreement below, then all persons signing below acknowledge that this Agreement is given conditionally, based on the representation to Lender that the non-signing party consents to the changes and provisions of this Agreement or otherwise will not be released by it. This waiver applies not only to any initial extension, modification or release, but also to all such subsequent actions. SUCCESSORS AND ASSIGNS. Subject to any limitations stated in this Agreement on transfer of borrower's interest, this Agreement shall be binding upon and inure to the benefit of the parties, their successors and assigns. If ownership of the Collateral becomes vested in a person other than Borrower, Lender, without notice to Borrower, may deal with Borrower's successors with reference to this Agreement and the Indebtedness by way of forbearance or extension without releasing Borrower from the obligations of this Agreement or liability under the Indebtedness. NOTIFY US OF INACCURATE INFORMATION WE REPORT TO CONSUMER REPORTING AGENCIES. Please notify us if we report any inaccurate information about your account(s) to a consumer reporting agency. Your written notice describing the specific inaccuracy(ies) should be sent to us at the following address: Butte Community Bank, CHICO OFFICE, 2041 FOREST AVE, CHICO, CA 95928. MISCELLANEOUS PROVISIONS. Lender may delay or forgo enforcing any of its rights or remedies under this Agreement without losing them. Borrower and any other person who signs, guarantees or endorses this Agreement, to the extent allowed by law, waive any applicable statute of limitations, presentment, demand for payment, and notice of dishonor. Upon any change in the terms of this Agreement, and unless otherwise expressly stated in writing, no party who signs this Agreement, whether as maker, guarantor, accommodation maker or endorser, shall be released from liability. All such parties agree that Lender may renew or extend (repeatedly and for any length of time) this loan or release any party or guarantor or collateral; or impair, fail to realize upon or perfect Lender's security interest in the collateral; and take any other action deemed necessary by Lender without the consent of or notice to anyone. All such parties also agree that Lender may modify this loan without the consent of or notice to anyone other than the party with whom the modification is made. The obligations under this Agreement are joint and several. PRIOR TO SIGNING THIS AGREEMENT, BORROWER READ AND UNDERSTOOD ALL THE PROVISIONS OF THIS AGREEMENT. BORROWER AGREES TO THE TERMS OF THE AGREEMENT. CIT SIGNERS: FAFCO, INC. BY: /S/ Nancy I. Garvin ----------------------------------------------------------------- NANCY I. GARVIN, VICE PRESIDENT OF FINANCE OF FAFCO, INC. - ------------------------------------------------------------------------------- EX-99.1 8 f88879exv99w1.txt EX-99.1 EXHIBIT 99.1 CERTIFICATION OF CHIEF EXECUTIVE OFFICER PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 I, Freeman A. Ford, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that the Annual Report of FAFCO, Inc. on Form 10-K for the annual period ended December 31, 2002 fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934 and that information contained in such Annual Report on Form 10-K fairly presents in all material respects the financial condition and results of operations of FAFCO, Inc. By: /s/ FREEMAN A. FORD --------------------------- Name: Freeman A. Ford Title: Chief Executive Officer CERTIFICATION OF CHIEF FINANCIAL OFFICER PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 I, Nancy Garvin, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that the Annual Report of FAFCO, Inc. on Form 10-K for the annual period ended December 31, 2002 fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934 and that information contained in such Annual Report on Form 10-K fairly presents in all material respects the financial condition and results of operations of FAFCO, Inc. By: /s/ NANCY GARVIN --------------------------- Name: Nancy Garvin Title: Chief Financial Officer -----END PRIVACY-ENHANCED MESSAGE-----

EX-4.4

      THESE SECURITIES HAVE NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF
      1933. THEY MAY NOT BE SOLD, OFFERED FOR SALE, PLEDGED, OR HYPOTHECATED IN
      THE ABSENCE OF AN EFFECTIVE REGISTRATION STATEMENT RELATED THERETO OR AN
      OPINION OF COUNSEL, REASONABLY SATISFACTORY TO THE COMPANY THAT SUCH
      REGISTRATION IS NOT REQUIRED UNDER THE SECURITIES ACT OF 1933.


                                     WARRANT
                      TO PURCHASE SHARES OF COMMON STOCK OF
                                   FAFCO, INC.


      THIS CERTIFIES that, for value received ____________________________
("_______________"), is entitled, upon the terms and subject to the conditions
hereinafter set forth, to purchase from FAFCO, Inc., a California corporation
(the "Company"), that number of fully paid and nonassessable shares of the
Company's Common Stock at the purchase price per share as set forth in Section 1
below ("Exercise Price"). The number of shares and Exercise Price are subject to
adjustment as provided in Section 10 hereof.

      1.    Number of Shares; Exercise Price; Term.

      (a)   Subject to adjustments as provided herein, this Warrant is
exercisable at an Exercise Price of $0.125 per share.

      (b)   Subject to adjustment as provided below, this Warrant shall be
exercisable for up to _______ shares of the Company's Common Stock (the
"Shares").

      (c)   This Warrant shall be exercisable during the term commencing on the
date hereof and ending on the earliest of (i) the fifth anniversary of the
issuance date of this Warrant, (ii) the closing of a sale of all or
substantially all assets of the Company or a merger, consolidation or other
business combination transaction as a result of which the holders of capital
immediately prior to such transaction hold less than 50% of the aggregate voting
securities of the surviving entity (a "Change of Control Transaction").

      2.    Title to Warrant. This Warrant and all rights hereunder are
transferable, in whole or in part, but only with the prior written consent of
the Company. Transfers shall occur at the office or agency of the Company by the
holder hereof in person or by duly authorized attorney, upon surrender of this
Warrant together with the Assignment Form annexed hereto properly endorsed.

      3.    Exercise or Conversion of Warrant. (a) The purchase and conversion
rights represented by this Warrant are exercisable by the registered holder
hereof, in whole or in part, at any time, or from time to time, during the term
hereof as described in Section l above, by the surrender of this Warrant and the
Notice of Exercise and Investment Representation Statement annexed hereto duly
completed and executed on behalf of the holder hereof, at the office of the
Company in Chico, California (or such other office or agency of the Company as
it may designate by notice in writing to the registered holder hereof

at the address of such holder appearing on the books of the Company), and
subject to Section 4 hereof, upon payment of the purchase price, the holder of
this Warrant shall be entitled to receive a certificate for the number of shares
so purchased and, if this Warrant is exercised in part, an amended Warrant for
the unexercised portion of this Warrant. (b) Notwithstanding any provisions
herein to the contrary, if the Fair Market Value (as hereinafter defined) is
greater than the Exercise Price (at the date of calculation, as set forth
below), in lieu of exercising this Warrant as hereinabove permitted, the Holder
may elect to convert this Warrant into shares of Common Stock equal to the value
(as determined below) of this Warrant by surrender of this Warrant for
conversion at the office of the Company referred to in paragraph (a) above,
together with the Notice of Exercise or Conversion, in which event the Company
shall issue to the Holder that number of shares of Common Stock computed using
the following formula:

                               CS = WCS x (FMV-EP)
                                    --------------
                                       FMV

Where

      CS    equals the number of shares of Common Stock to be issued to the
            Holder

      WCS   equals the number of shares of Common Stock purchasable under the
            Warrant

      FMV   equals the current fair market value of one share of Common Stock
            (at the date of such calculation)

      EP    equals the Exercise Price (as adjusted to the date of such
            calculation).

      For the purpose of any computation pursuant to this Section 3, the Fair
Market Value at any date of one share of Common Stock shall as determined in
good faith by the Board of Directors of the Company

            (c) The Company agrees that, upon exercise or conversion of this
      Warrant in accordance with the terms hereof, the shares so acquired shall
      be deemed to be issued to such holder as the record owner of such shares
      as of the close of business on the date on which this Warrant shall have
      been exercised. Certificates for shares purchased hereunder shall be
      issued by the Company promptly and in no event later than twenty-one (21)
      days after the date of exercise or conversion, and, on partial exercise or
      conversion of this Warrant, an amended Warrant for the unexercised or
      uncovered portion of this Warrant shall be delivered to the holder hereof
      as promptly as practicable after the date on which this Warrant shall have
      been exercised or conversion. All other terms and conditions of such
      amended Warrant shall be identical to those contained herein.

      The Company covenants that all shares which may be issued upon the
exercise or conversion of this Warrant will, upon exercise of the rights
represented by this Warrant or conversion of the aggregate Exercise Price, if
applicable be fully paid and nonassessable and free from all taxes, liens and
charges in respect of the issue thereof (other than taxes in respect of any
transfer occurring contemporaneously or otherwise specified herein).

                                      -2-

      4.    No Fractional Shares or Scrip. No fractional shares or scrip
representing fractional shares shall be issued upon the exercise or conversion
of this Warrant. In lieu of any fractional share to which such holder would
otherwise be entitled, such holder shall be entitled, at its option, to receive
either (i) a cash payment equal to the excess of fair market value for such
fractional share above the Exercise Price for such fractional share (as mutually
determined by the Company and the holder) or (ii) a whole share if the holder
tenders the Exercise Price for one whole share.

      5.    Charges, Taxes and Expenses. Issuance of certificates for shares
upon the exercise or conversion of this Warrant shall be made without charge to
the holder hereof for any issue or transfer tax or other incidental expense in
respect of the issuance of such certificates, all of which taxes and expenses
shall be paid by the Company, and such certificates shall be issued in the name
of the holder of this Warrant or in such name or names as may be directed by the
holder of this Warrant (with the prior written consent of the Company);
provided, however, that in the event certificates for shares are to be issued in
a name other than the name of the holder of this Warrant, this Warrant when
surrendered for exercise or conversion shall be accompanied by the Assignment
Form attached hereto duly executed by the holder hereof and the Notice of
Exercise duly completed and executed and stating in whose name and certificates
are to be issued; and provided further, that such assignment shall be subject to
applicable laws and regulations. Upon any transfer involved in the issuance or
delivery of any certificates for shares of the Company's securities, the Company
may require, as a condition thereto, the payment of a sum sufficient to
reimburse it for any transfer tax incidental thereto.

      6.    No Rights as Shareholders. This Warrant does not entitle the holder
hereof to any voting rights, dividend rights or other rights as a shareholder of
the Company prior to the exercise hereof.

      7.    Exchange and Registry of Warrant. The Company shall maintain a
registry showing the name and address of the registered holder of this Warrant.
This Warrant may be surrendered for exchange, transfer or exercise, in
accordance with its terms, at the office of the Company, and the Company shall
be entitled to rely in all respects, prior to written notice to the contrary,
upon such registry.

      8.    Loss, Theft, Destruction or Mutilation of Warrant. Upon receipt by
the Company of evidence reasonably satisfactory to it of the loss, theft,
destruction or mutilation of this Warrant, and in case of loss, theft or
destruction, of indemnity or security reasonably satisfactory to it, and upon
reimbursement to the Company of all reasonable expenses incidental thereto, and
upon surrender and cancellation of this Warrant, if mutilated, the Company will
make and deliver a new Warrant of like tenor and dated as of such cancellation,
in lieu of this Warrant.

      9.    Saturdays, Sundays, Holidays, etc. If the last or appointed day for
the taking of any action or the expiration of any right required or granted
herein shall be a Saturday or a Sunday or shall be a legal holiday, then such
action may be taken or such right may be exercised on the next succeeding day
not a Saturday or a Sunday or a legal holiday.

      10.   Adjustments and Termination of Rights. The purchase price per share
and the number of shares purchasable hereunder are subject to adjustment from
time to time as follows:

                                      -3-

            (a)   Merger. If at any time there shall be a merger or
consolidation of the Company with or into another corporation when the Company
is not the surviving corporation (other than a Change of Control Transaction
resulting in the expiration of this Warrant), then, as a part of such merger or
consolidation, lawful provision shall be made so that the holder of this Warrant
shall thereafter be entitled to receive upon exercise of this Warrant, during
the period specified herein and upon payment of the aggregate Exercise Price
then in effect, the number of shares of stock or other securities or property of
the successor corporation resulting from such merger or consolidation, to which
a holder of the stock deliverable upon exercise of this Warrant would have been
entitled in such merger or consolidation if this Warrant had been exercised
immediately before such merger or consolidation. In any such case, appropriate
adjustment shall be made in the application of the provisions of this Warrant
with respect to the rights and interests of the holder after the merger or
consolidation.

            (b)   Reclassification, etc. If the Company at any time shall, by
subdivision, combination or reclassification of securities or otherwise, change
any of the securities as to which purchase rights under this Warrant exist into
the same or a different number of securities of any other class or classes, this
Warrant shall thereafter represent the right to acquire such number and kind of
securities as would have been issuable as the result of such change with respect
to the securities which were subject to the purchase rights under this Warrant
immediately prior to such subdivision, combination, reclassification or other
change.

            (c)   Split, Subdivision or Combination of Shares. If the Company at
any time while this Warrant remains outstanding and unexpired shall split,
subdivide or combine the securities as to which purchase rights under this
Warrant exist, the Exercise Price shall be proportionately decreased in the case
of a split or subdivision or proportionately increased in the case of a
combination.

            (d)   Adjustment of Number of Shares. Upon each adjustment in the
Exercise Price pursuant to 10(c) above, the number of shares purchasable
hereunder shall be adjusted, to the nearest whole share, to the product obtained
by multiplying the number of shares purchasable immediately prior to such
adjustment in the Exercise Price by a fraction (i) the numerator of which shall
be the Exercise Price immediately prior to such adjustment, and (ii) the
denominator of which shall be the Exercise Price immediately after such
adjustment.

      11.   Notice of Adjustments; Notices. Whenever the Exercise Price or
number of shares purchasable hereunder shall be adjusted pursuant to Section 10
hereof, the Company shall issue a certificate signed by its an executive officer
of the Company setting forth, in reasonable detail, the event requiring the
adjustment, the amount of the adjustment, the method by which such adjustment
was calculated and the Exercise Price and number of shares purchasable hereunder
after giving effect to such adjustment, and shall cause a copy of such
certificate to be mailed (by first class mail, postage prepaid) to the holder of
this Warrant.

      12.   "Market Stand-off" Agreement. The Holder agrees, if requested by the
Company or an underwriter of such registered public offering, not to sell or
otherwise transfer or dispose of any Common Stock (or other securities) of the
Company held by such holder during a period of up to 90 days

                                      -4-

following the effective date of any registration statement of the Company filed
under the Securities Act in connection with an underwritten offering of Common
Stock of the Company. Such agreement shall be in writing in the form
satisfactory to the Company and such underwriter, and may be included in the
underwriting agreement. The Company may impose stock-transfer instructions with
respect to the securities subject to the foregoing restriction until the end of
the required stand-off period.

      13.   Miscellaneous.

            (a)   Governing Law. This Warrant shall be binding upon any
successors or assigns of the Company. This Warrant shall constitute a contract
under the laws of California and for all purposes shall be construed in
accordance with and governed by the laws of said state, without giving effect to
the conflict of laws principles.

            (b)   Restrictions. THESE SECURITIES HAVE NOT BEEN REGISTERED UNDER
THE SECURITIES ACT OF 1933. THEY MAY NOT BE SOLD, OFFERED FOR SALE, PLEDGED, OR
HYPOTHECATED IN THE ABSENCE OF AN EFFECTIVE REGISTRATION STATEMENT RELATED
THERETO OR AN OPINION OF COUNSEL, REASONABLY SATISFACTORY TO THE COMPANY THAT
SUCH REGISTRATION IS NOT REQUIRED UNDER THE SECURITIES ACT OF 1933.

            (c)   Attorney's Fees. In any litigation, arbitration or court
proceeding between the Company and the holder relating hereto, the prevailing
party shall be entitled to reasonable attorneys' fees and expenses incurred in
enforcing this Warrant.

            (d)   Amendments. This Warrant may be amended and the observance of
any term of this Warrant may be waived only with the written consent of the
Company and the then holders of Warrants exercisable for a majority of the
shares of the Company's Common Stock then issuable upon exercise of all
outstanding unexercised Warrants sold pursuant to the Purchase Agreement.

            (e)   Notice. Any notice required or permitted hereunder shall be
deemed effectively given upon personal delivery to the party to be notified or
upon deposit with the United States Post Office, by certified mail, postage
prepaid and addressed to the party to be notified at the address indicated below
for such party, or at such other address as such other party may designate by
ten-day advance written notice.

                                      -5-

      IN WITNESS WHEREOF, FAFCO, Inc. has caused this Warrant to be executed
by its officer thereunto duly authorized.


Dated:                     , 200
      --------------------      --

                                        FAFCO, INC.
                                        435 Otterson Drive
                                        Chico, California 95428-8207



                                        By:
                                           ---------------------------------
                                        Alex N. Watt, Chief Financial Officer

AGREED AND ACCEPTED:


- ------------------------------


- ------------------------------
Street Address



- ------------------------------
City,  State,   Zip Code

                                      -6-

                               NOTICE OF EXERCISE


To:   FAFCO, Inc.

      1.    The undersigned hereby elects to purchase _______ shares of Common
Stock ("Stock") of FAFCO, Inc. (the "Company") pursuant to the terms of the
attached Warrant, and tenders herewith payment of the purchase price and any
transfer taxes payable pursuant to the terms of the Warrant, together with an
Investment Representation Statement in form attached.

      2.    The undersigned hereby elects to acquire ________ shares of Stock,
upon conversion of the attached Warrant pursuant to Section 3(b) thereof, and
hereby surrenders __________shares of Common Stock subject to the Warrant,
together with an Investment Representation Statement in form and substance
satisfactory to legal counsel to the Company.

                  [STRIKE PARAGRAPH ABOVE WHICH DOES NOT APPLY]

      3.    The shares of Stock to be received by the undersigned upon exercise
of the Warrant are being acquired for its own account, not as a nominee or
agent, and not with a view to resale or distribution of any part thereof, and
the undersigned has no present intention of selling, granting any participation
in, or otherwise distributing the same. The undersigned further represents that
it does not have any contract, undertaking, agreement or arrangement with any
person to sell, transfer or grant participation to such person or to any third
person, with respect to the Stock. The undersigned believes it has received all
the information it considers necessary or appropriate for deciding whether to
purchase the Stock.

      4.    The undersigned understands that the shares of Stock are
characterized as "restricted securities" under the federal securities laws
inasmuch as they are being acquired from the Company in transactions not
involving a public offering and that under such laws and applicable regulations
such securities may be resold without registration under the Securities Act of
1933, as amended (the "Act"), only in certain limited circumstances. In this
connection, the undersigned represents that it is familiar with SEC Rule 144, as
presently in effect, and understands the resale limitations imposed thereby and
by the Act.

      5.    The undersigned understands the instruments evidencing the Stock may
bear one or all of the following legends:

            (a)   "THESE SECURITIES HAVE NOT BEEN REGISTERED UNDER THE
            SECURITIES ACT OF 1933. THEY MAY NOT BE SOLD, OFFERED FOR SALE,
            PLEDGED OR HYPOTHECATED IN THE ABSENCE OF A REGISTRATION STATEMENT
            IN EFFECT WITH RESPECT TO THE SECURITIES UNDER SUCH ACT OR AN
            OPINION OF COUNSEL SATISFACTORY TO THE COMPANY THAT

                                      -7-

            SUCH REGISTRATION IS NOT REQUIRED OR UNLESS SOLD PURSUANT TO RULE
            144 OF SUCH ACT."

            (b)   Any legend required by applicable state law.

      6.    Please issue a certificate or certificates representing said shares
            of Stock in the name of the undersigned:


                                        --------------------------
                                                 [Name]

      7.    Please issue a new Warrant for the unexercised portion of the
attached Warrant in the name of the undersigned:


                                        --------------------------
                                                 [Name]


            --------------------        --------------------------
            [Date]                               [Signature]

                                      -8-

                                 ASSIGNMENT FORM

            (To assign the foregoing Warrant, execute this form and supply
            required information. Do not use this form to purchase shares.)

      FOR VALUE RECEIVED, the foregoing Warrant and all rights evidenced
thereby are hereby assigned to

- ------------------------------------------------------------
                                 (Please Print)

whose address is
                 -------------------------------------------
                                 (Please Print)





                                     Dated:                   , 200  .
                                           -----------------       --



          Holder's Signature:
                             -------------------------------

             Holder's Address:
                              ------------------------------

                              ------------------------------





Signature Guaranteed:
                      --------------------------------





NOTE: The signature to this Assignment Form must correspond with the name as it
appears on the face of the Warrant, without alteration or enlargement or any
change whatever, and must be guaranteed by a bank or trust company. Officers of
corporations and those acting in a fiduciary or other representative capacity
should file proper evidence of authority to assign the foregoing Warrant.

                       INVESTMENT REPRESENTATION STATEMENT


PURCHASER   :

COMPANY     :  FAFCO, Inc.

SECURITIES  :   Common Stock

DATE        :


      In connection with the purchase of the above-listed Securities, the
undersigned, the Purchaser represents to the Company the following:

            (a)   The undersigned is sufficiently aware of the Company's
business affairs and financial condition to reach an informed and knowledgeable
decision to acquire the Securities. The undersigned is purchasing these
Securities for its own account for investment purposes only and not with a view
to, or for the resale in connection with, any "distribution" thereof for
purposes of the Securities Act of 1933, as amended (the "Securities Act").

            (b)   The undersigned understands that the Securities have not been
registered under the Securities Act in reliance upon a specific exemption
therefrom, which exemption depends upon, among other things, the bona fide
nature of its investment intent as expressed herein. In this connection, the
undersigned understands that, in the view of the Securities and Exchange
Commission (the "SEC"), the statutory basis for such exemption may be
unavailable if its representation was predicated solely upon a present intention
to hold these Securities for the minimum capital gains period specified under
tax statutes, for a deferred sale, for or until an increase or decrease in the
market price of the Securities, or for a period of one year or any other fixed
period in the future.

            (c)   The undersigned further understands that the Securities must
be held indefinitely unless subsequently registered under the Securities Act or
unless an exemption from registration is otherwise available (such as Rule 144
under the Securities Act). Moreover, the undersigned understands that the
Company is under no obligation to register the Securities. In addition, the
undersigned understands that the certificate evidencing the Securities may be
imprinted with a legend which prohibits the transfer of the Securities unless
they are registered or such registration is not required in the opinion of
counsel for the Company.

            (d)   The undersigned is familiar with the provisions of Rule 144,
promulgated under the Securities Act, which, in substance, permits limited
public resale of "restricted securities" acquired, directly or indirectly, from
the issuer thereof (or from an affiliate of such issuer), in a non-public
offering subject to the satisfaction of certain conditions, including, among
other things: (1) The availability of certain public information about the
Company; (2) the resale occurring not less than one year after the party has
purchased, and made full payment for, within the meaning of Rule 144, the
securities to be sold; and, in the case of an affiliate, or of a non-affiliate
who has held the securities less than two years, (3) the sale being made through
a broker in an unsolicited "broker's transaction" or in transactions

directly with a market maker, as said term is defined under the Securities
Exchange Act of 1934 (the "Exchange Act") and the amount of securities being
sold during any three month period not exceeding the specified limitations
stated therein, if applicable. There can be no assurances that the requirements
of Rule 144 will be met, or that the Securities will ever be saleable.

            (e)   The undersigned further understands that at the time the
undersigned wishes to sell the Securities there may be no public market upon
which to make such a sale, and that, even if such a public market then exists,
the Company may not be satisfying the current public information requirements of
Rule 144, and that, in such event, the undersigned would be precluded from
selling the Securities under Rule 144 even if the two-year minimum holding
period had been satisfied.

            (f)   The undersigned further understands that in the event all of
the applicable requirements of Rule 144 are not satisfied registration under the
Securities Act, compliance with Regulation A, compliance with some other
registration exemption or the notification to the Company of the proposed
disposition by it and the furnishing to the Company of (i) detailed information
regarding the disposition, and (ii) and opinion of its counsel to the effect
that such disposition will not require registration (the undersigned understands
such counsel's opinion shall concur with the opinion by counsel for the Company
and the undersigned shall have been informed of such compliance) will be
required and that, notwithstanding the fact that Rule 144 is not exclusive, the
Staff of the SEC has expressed its opinion that persons proposing to sell
private placement securities other than in a registered offering and otherwise
than pursuant to Rule 144 will have a substantial burden of proof in
establishing that an exemption from registration is available for such offers or
sales, and that such persons and their respective brokers who participate in
such transactions do so at their own risk.


                                        Signature of Purchaser:


                                        By:
                                           -----------------------------------


                                        Title:
                                              --------------------------



                                       -2-

EX-4.2.A

                                                                  Exhibit 4.2(A)

            THIS NOTE AND THE SECURITIES REPRESENTED HEREBY HAVE NOT BEEN
            REGISTERED UNDER THE SECURITIES ACT OF 1933, AS AMENDED, OR
            QUALIFIED UNDER APPLICABLE STATE SECURITIES LAWS. THEY MAY NOT BE
            OFFERED FOR SALE, SOLD OR OTHERWISE TRANSFERRED IN THE ABSENCE OF AN
            EFFECTIVE REGISTRATION STATEMENT AS TO THE SECURITIES UNDER SAID ACT
            OR AN OPINION OF COUNSEL SATISFACTORY TO THE CORPORATION THAT SUCH
            REGISTRATION AND QUALIFICATION IS NOT REQUIRED.

                          SUBORDINATED PROMISSORY NOTE

      $                                                                  ,
       ------------                                         -------------  -----
                                                               Chico, California

      FOR VALUE RECEIVED, FAFCO, Inc., a California corporation (the "Company")
promises to pay to _________________ ("Lender"), or its registered assigns, the
principal sum of ___________________ __________ Dollars ($___________), or such
lesser amount as shall equal the outstanding principal amount hereof, together
with interest from the date of this Note on the unpaid principal balance at a
rate equal to the Interest Rate, as defined below, computed on the basis of the
actual number of days elapsed and a year of 365 days. All unpaid principal,
together with any then unpaid and accrued interest and other amounts payable
hereunder, shall be due and payable on the third anniversary of the date hereof
(the "Payment Date"). Accrued interest shall be payable on January 1, April 1,
July 1 and October 1 of each year, commencing April 1, 2002, the last payment of
any accrued and unpaid interest to be made together with payment of the
principal on the Payment Date [Check with Alex: may want to accrue and pay at
maturity]. This Note may be prepaid only in accordance with Section 4 below.

      This Note is issued pursuant to a Subordinated Note and Warrant Purchase
Agreement dated as of December __, 2001 (the "Purchase Agreement") between the
Company and the purchasers listed on the Schedule of Purchasers to such Purchase
Agreement, and is subject to the terms and provisions of the Purchase Agreement,
a copy of which may be obtained from the Company at its principal executive
offices.

      The following is a statement of the rights of Lender and the conditions to
which this Note is subject, and to which Lender, by the acceptance of this Note,
agrees:

      1.    DEFINITIONS. As used in this Note, the following capitalized terms
have the following meanings:

                  (a)   "Articles" shall mean the Articles of Incorporation of
Company, as amended and/or restated from time to time.

                  (b)   "Company" includes the corporation initially executing
this Note and any Person that shall succeed to or assume the obligations of
Company under this Note.

                  (c)   "Event of Default" has the meaning given in Section 2
hereof.

                  (d)   "Interest Rate" shall initially mean a rate of ten
percent (10.0%) per annum, and for all periods after the first anniversary of
date of this Note, a rate of twelve percent (12.0%) per annum.

                  (e)   "Lender" shall mean the Person specified in the
introductory paragraph of this Note or any Person who shall at the time be the
registered holder of this Note.

                  (f)   "Person" shall mean and include an individual, a
partnership, a corporation (including a business trust), a joint stock company,
a limited liability company, an unincorporated association, a joint venture or
other entity or a governmental authority.

      2.    EVENTS OF DEFAULT. The occurrence of any of the following shall
constitute an "Event of Default" under this Note.

            (a)   Failure to Pay. The Company shall fail to pay any principal,
interest or other payment due hereunder within ten (10) days of Company's
receipt of Lender's written demand; or

            (b)   Voluntary Bankruptcy or Insolvency Proceedings. The Company
shall (i) apply for or consent to the appointment of a receiver, trustee,
liquidator or custodian of itself or of all or a substantial part of its
property, (ii) make a general assignment for the benefit of its or any of its
creditors, (iii) be dissolved or liquidated in full or in part, (iv) commence a
voluntary case or other proceeding seeking liquidation, reorganization or other
relief with respect to itself or its debts under any bankruptcy, insolvency or
other similar law now or hereafter in effect or consent to any such relief or to
the appointment of or taking possession of its property by any official in an
involuntary case or other proceeding commenced against it or (v) take any action
for the purpose of effecting any of the foregoing; or

            (c)   Involuntary Bankruptcy or Insolvency Proceedings. Proceedings
for the appointment of a receiver, trustee, liquidator or custodian of Company
or of all or a substantial part of the property thereof, or an involuntary case
or other proceedings seeking liquidation, reorganization or other relief with
respect to Company or the debts thereof under any bankruptcy, insolvency or
other similar law now or hereafter in effect shall be commenced and an order for
relief entered or such proceeding shall not be dismissed or discharged within
ninety (90) days of commencement.

      3.    RIGHTS OF LENDER UPON DEFAULT. Upon the occurrence or existence of
an Event of Default described in Paragraph 2(a) and at any time thereafter
during the continuance of such Event of Default, Lender may, by written notice
to Company, declare all outstanding amounts payable by Company hereunder to be
immediately due and payable without presentment, demand, protest or any other
notice of any kind, all of which are hereby expressly waived, anything contained
herein to the contrary notwithstanding. Upon the occurrence or existence of any
Event of Default described in Paragraphs 2(b) and 2(c), immediately and without
notice, all outstanding amounts payable by Company hereunder shall automatically
become immediately due and payable, without presentment,

                                      -2-

demand, protest or any other notice of any kind, all of which are hereby
expressly waived, anything contained herein to the contrary notwithstanding. In
addition to the foregoing remedies, upon the occurrence or existence of any
Event of Default, Lender may exercise any other right, power or remedy permitted
to it by law, either by suit in equity or by action at law, or both.

      4.    PREPAYMENT. Upon ten (10) days prior written notice to Lender, the
Company may, without premium or penalty, at any time and from time to time,
prepay all or any portion of the outstanding principal balance due under this
Note, provided that each such prepayment is accompanied by the accrued interest
on the amount of principal prepaid calculated to the date of such prepayment.

      5.    REPRESENTATIONS AND WARRANTIES OF LENDER. In addition to the
representations and warranties contained in Section 4 of the Purchase Agreement,
by its acceptance hereof, the Lender represents and warrants to Company that:

            (a)   Securities Law Compliance. Lender has been advised that this
Note has not been registered under the Securities Act of 1933, as amended (the
"Act") and, therefore, cannot be resold unless it is registered under the Act
and qualified under applicable state securities laws or unless an exemption from
such registration and qualification requirements is available. Lender is aware
that Company is under no obligation to effect any such registration and
qualification with respect to this Note or to file for or comply with any
exemption from registration and qualification. Lender has not been formed solely
for the purpose of making this investment and is acquiring this Note for its own
account for investment, not as a nominee or agent, and not with a view to, or
for resale in connection with, the distribution thereof. Lender has such
knowledge and experience in financial and business matters that such Lender is
capable of evaluating the merits and risks of such investment, is able to incur
a complete loss of such investment and is able to bear the economic risk of such
investment for an indefinite period of time. Lender is an accredited investor as
such term is defined in Rule 501 of Regulation D under the Act.

            (b)   Access to Information. Lender acknowledges that Company has
given Lender access to all documents and other information required for Lender
to make an informed decision with respect to the purchase of this Note.

      6.    SUBORDINATION.

            (a)   "Senior Indebtedness" means the principal of and premium, if
any, and interest on indebtedness of the Company for money borrowed from
commercial banks, equipment lessors or other financial institutions under a
secured or unsecured line of credit, term loan, equipment lease or similar
facility.

            (b)   The Company agrees and the holder of this Note, by acceptance
hereof, agrees, expressly for the benefit of the present and future holders of
Senior Indebtedness, that, except as otherwise provided herein, upon (i) an
event of default under any Senior Indebtedness, or (ii) any dissolution, winding
up or liquidation of the Company, whether or not in bankruptcy, insolvency or
receivership proceedings, the Company shall not pay, and the holder of such Note
shall not be entitled to receive, any amount in respect of the principal and
interest of such

                                      -3-

Note unless and until the Senior Indebtedness shall have been paid or otherwise
discharged. Upon (1) an event of default under any Senior Indebtedness, or (2)
any dissolution, winding up or liquidation of the Company, any payment or
distribution of assets of the Company, which the holder of this Note would be
entitled to receive but for the provisions hereof, shall be paid by the
liquidating trustee or agent or other person making such payment or distribution
directly to the holders of Senior Indebtedness ratably according to the
aggregate amounts remaining unpaid on Senior Indebtedness after giving effect to
any concurrent payment or distribution to the holders of Senior Indebtedness.
Subject to the payment in full of the Senior Indebtedness and until this Note is
paid in full, the holder of this Note shall be subrogated to the rights of the
holders of the Senior Indebtedness (to the extent of payments or distributions
previously made to the holders of Senior Indebtedness pursuant to this paragraph
6(b)) to receive payments or distributions of assets of the Company applicable
to the Senior Indebtedness.

            (c)   This Section 6 is not intended to impair, as between the
Company, its creditors (other than the holders of Senior Indebtedness) and the
holder of this Note, the unconditional and absolute obligation of the Company to
pay the principal of and interest on the Note or affect the relative rights of
the holder of this Note and the other creditors of the Company, other than the
holders of Senior Indebtedness. Nothing in this Note shall prevent the holder of
this Note from exercising all remedies otherwise permitted by applicable law
upon default under the Note, subject to the rights, if any, of the holders of
Senior Indebtedness in respect to cash, property or securities of the Company
received upon the exercise of any such remedy.

      7.    SUCCESSORS AND ASSIGNS. Subject to the restrictions on transfer
described in Sections 9 and 10 below, the rights and obligations of Company and
Lender shall be binding upon and benefit the successors, assigns, heirs,
administrators and transferees of the parties.

      8.    AMENDMENTS WITH CONSENT OF HOLDERS. With the written consent of the
Holders of not less than a majority in principal amount of outstanding Notes
issued pursuant to the Purchase Agreement, the Company may amend this or any
other Note by executing and delivering to the Lenders an amendment thereto for
the purpose of adding any provisions to or changing in any manner or eliminating
any of the provisions of the Notes or of modifying in any manner the rights of
the Lenders; provided, however, that no such amendment shall, without the
consent of the Lender of this Note affected thereby, change the maturity of the
principal of, [or any installment of interest on,] [Check with Alex] the Note,
or reduce the principal amount thereof or the interest thereon or payable upon
the redemption thereof or impair the right to institute suit for the enforcement
of any such payment on or after the maturity thereof (or, in the case of
redemption, on or after the Redemption Date).

      9.    TRANSFER OF THIS NOTE. Transfers of this Note may only be made in
compliance with the provisions of the Purchase Agreement, which are incorporated
herein by reference. With respect to any offer, sale or other disposition of
this Note, Lender will give written notice to Company prior thereto, describing
briefly the manner thereof, together with a written opinion of Lender's counsel,
to the effect that such offer, sale or other distribution may be effected
without registration or qualification (under any federal or state law then in
effect). Promptly upon receiving such written notice and reasonably satisfactory
opinion, if so requested, Company, as promptly as practicable, shall notify
Lender that Lender may sell or otherwise dispose of this Note, all in accordance
with the

                                      -4-

terms of the notice delivered to Company. If a determination has been made
pursuant to this Section 9 that the opinion of counsel for Lender is not
reasonably satisfactory to Company, Company shall so notify Lender promptly
after such determination has been made. Each Note thus transferred and each
certificate representing the securities thus transferred shall bear a legend as
to the applicable restrictions on transferability in order to ensure compliance
with the Act, unless in the opinion of counsel for Company such legend is not
required in order to ensure compliance with the Act. Company may issue stop
transfer instructions to its transfer agent in connection with such
restrictions. Subject to the foregoing, transfers of this Note shall be
registered upon registration books maintained for such purpose by or on behalf
of the Company. Prior to presentation of this Note for registration of transfer,
Company shall treat the registered holder hereof as the owner and holder of this
Note for the purpose of receiving all payments of principal and interest hereon
and for all other purposes whatsoever, whether or not this Note shall be overdue
and Company shall not be affected by notice to the contrary.

      10.   ASSIGNMENT BY COMPANY. Neither this Note nor any of the rights,
interests or obligations hereunder may be assigned, other than by operation of
law (such as in a merger), in whole or in part, by Company without the prior
written consent of Lender.

      11.   NOTICES. Any notice, request or other communication required or
permitted hereunder shall be in writing and shall be deemed to have been duly
given if personally delivered, sent by facsimile or mailed by registered or
certified mail, postage prepaid, or by recognized overnight courier or personal
delivery at the respective addresses or facsimile phone number of the parties as
set forth below. Any party hereto may by notice so given change its address for
future notice hereunder. Notice shall conclusively be deemed to have been given
when received.

   If to Lender:     At the address set forth in the Schedule of Purchasers to
                     the Purchase Agreement.

   If to Company:    FAFCO, Inc.
                     435 Otterson Drive
                     Chico, CA 95928
                     Attention:  Alex N. Watt, Executive Vice President

   With a copy to:   Ann Yvonne Walker, Esq.
                     Wilson, Sonsini, Goodrich & Rosati, P.C.
                     650 Page Mill Road
                     Palo Alto, CA 94304

Each of the above addressees may change its address for purposes of this
paragraph by giving to the other addressee notice of such new address in
conformance with this paragraph.

      12.   PAYMENT. Payment shall be made in lawful tender of the United
States.

      13.   DEFAULT RATE; USURY. In the event that any payment of principal or
interest provided for herein is not paid by Company when due (including the
entire unpaid balance of this Note in the event such amount is made immediately
due and payable pursuant to the terms hereof), then

                                      -5-

Company shall pay interest on the such amounts not paid when due at a rate per
annum two percent (2%) higher than the rate otherwise applicable hereunder. In
the event any interest is paid on this Note which is deemed to be in excess of
the then legal maximum rate, then that portion of the interest payment
representing an amount in excess of the then legal maximum rate shall be deemed
a payment of principal and applied against the principal of this Note.

      14.   EXPENSES; WAIVERS. If action is instituted to collect this Note,
Company promises to pay all costs and expenses, including, without limitation,
reasonable attorneys' fees and costs, incurred in connection with such action.
Company hereby waives notice of default, presentment or demand for payment,
protest or notice of nonpayment or dishonor and all other notices or demands
relative to this instrument. No delay on the part of Lender in exercising any
right hereunder shall operate as a waiver of such right or any other right.

      15.   GOVERNING LAW. This Note and all actions arising out of or in
connection with this Note shall be governed by and construed in accordance with
the laws of the State of California, without regard to the conflicts of law
provisions of the State of California or of any other state.

                                      -6-

      IN WITNESS WHEREOF, Company has caused this Note to be issued as of the
date first written above.
                                        FAFCO, Inc.
                                        a California corporation

                                        By:
                                           -------------------------------------

                                        Name:
                                             -----------------------------------

                                        Title:
                                              ----------------------------------



      ACKNOWLEDGED AND AGREED TO:

      "LENDER"

      ------------------------------------

      By:
         ---------------------------------

      Title:
            ------------------------------


                                      -7-

EX-4.2.B

                                                                  Exhibit 4.2(B)

                                   FAFCO, INC.

                SUBORDINATED NOTE AND WARRANT PURCHASE AGREEMENT

      This Agreement is made as of __________, ______, between FAFCO, Inc., a
California corporation (the "COMPANY"), and the persons and entities (the
"PURCHASERS") listed on the Schedule of Purchasers attached hereto as Exhibit A
(the "SCHEDULE OF PURCHASERS").

                                    SECTION 1

                  SALE OF CONVERTIBLE NOTES AND STOCK WARRANTS

      1.1.  The Notes. The Company has authorized the issuance and sale to the
Purchasers of subordinated promissory notes with an aggregate principal amount
of up to $500,000. Each Purchaser severally agrees, on the terms of and subject
to the conditions specified in this Agreement, to lend to the Company the sum
set forth in Column 2 of Exhibit A hereto opposite such Purchaser's name
("PURCHASER LOAN") at the Closing (as defined below). Each Purchaser Loan shall
be evidenced by a promissory note (individually a "NOTE" and collectively the
"NOTES"), dated as of the date of Closing, in the form of Exhibit B.

      1.2.  The Warrants. In connection with the Purchaser Loans, the Company
agrees to issue to each Purchaser at the Closing a stock purchase warrant in the
form of Exhibit C (individually a "WARRANT" and collectively the "WARRANTS")
exercisable initially for the number of shares of Common Stock ("COMMON STOCK")
set forth in Column 3 of Exhibit A opposite such Purchaser's name. The
securities issued or issuable upon exercise of the Warrants are referred to as
the "WARRANT COMMON." In the event that all or any of portion of the principal
amount of any Note is outstanding on the date of any one-year anniversary of the
date of issuance of such Note (an "ANNIVERSARY DATE"), the Company further
agrees to issue to the Purchaser holding such Note on such Anniversary Date an
additional Warrant exercisable for 1,000 shares of Common Stock for each $10,000
in principal which remains unpaid as of such Anniversary Date. Such additional
Warrants will be in the same form as the Warrants issued at the Closing.

                                    SECTION 2

                             CLOSING DATE; DELIVERY

      2.1.  Closing Date. The closing of the purchase and sale of the Notes and
Warrants hereunder (the "CLOSING") shall be held at 11:00 a.m. on ________,
_____ or on such later date or dates as the Company and the Purchasers may agree
to (the date of such Closing being referred to as the "CLOSING DATE"). The place
of the Closing shall be at the offices of Wilson Sonsini Goodrich & Rosati,
P.C., 650 Page Mill Road, Palo Alto, California 94304-1050, or such other place
as the Purchasers and the Company may mutually agree. The date of any closing of
the transactions contemplated by this Agreement is sometimes also referred to
herein as the "Closing Date."

      2.2.  Delivery. At Closing, (i) each Purchaser will make payment to the
Company of the amount of the Purchaser Loan, if any, by wire transfer of
immediately available funds and (ii) the Company and the Purchasers will each
execute and deliver the other documents and instruments required to be executed
and delivered on the Closing Date. Promptly following the Closing, the Company
will deliver to each Purchaser the Note and Warrant issuable to such Purchaser
pursuant hereto.

      2.3.  Subsequent Closings. Any Notes and Warrants not sold on the Closing
may be sold at additional closings to be held at times and places to be agreed
upon by the Company and a majority-in-interest of the Purchasers purchasing at
each such closing (a "Subsequent Closing"), but no later than June 30, 2002. At
each Subsequent Closing, the Company shall deliver to each Purchaser
participating in such Subsequent Closing the Note and Warrant which such
Purchaser is purchasing against payment of the consideration therefor, specified
in Section 1 hereof. The Company and each such Purchaser shall execute and
deliver signature pages to this Agreement.

                                    SECTION 3

                  REPRESENTATIONS AND WARRANTIES OF THE COMPANY

      Subject to and except as set forth in the Schedule of Exceptions attached
as Exhibit D hereto (the "SCHEDULE OF EXCEPTIONS"), the Company hereby
represents and warrants to the PURCHASERS as of the date hereof as follows:

      3.1.  Organization and Standing; Articles and By-Laws. The Company is a
corporation duly organized and existing under, and by virtue of, the laws of the
State of California and is in good standing under such laws. The Company has
requisite corporate power to own and operate its properties and assets, and to
carry on its business as presently conducted. The Company is qualified to do
business as a foreign corporation in each jurisdiction where such qualification
is required, except jurisdictions where the failure to be so qualified would not
materially adversely affect the business or financial condition of the Company.

      3.2.  Corporate Power. The Company will have at the Closing Date all
requisite legal and corporate power to execute and deliver this Agreement, to
sell and issue the Notes and Warrants hereunder, to issue the Warrant Common
upon exercise of the Warrants and to carry out and perform its obligations under
the terms of this Agreement.

      3.3.  Financial Statements and Other Information. The Company has
delivered to each Purchaser the following:

            (a)   Annual Report on Form 10-K for the year ended December 31,
2000, as filed with the Securities and Exchange Commission (the "COMMISSION" of
the "SEC") pursuant to Section 13 of the Securities Exchange Act of 1934, as
amended (the "EXCHANGE ACT"), together with the index to exhibits thereto;

                                      -2-

            (b)   Definitive Proxy Statement dated May 30, 2001 for the Annual
Meeting of Shareholders held on June 28, 2001, as filed with the Commission
pursuant to Section 14 of the Exchange Act and Regulation 14A promulgated
thereunder;

            (c)   2000 Annual Report to Shareholders, as filed with the
Commission pursuant to Section 14 of the Exchange Act and Rule 14a-3(c)
promulgated thereunder;

            (d)   A confidential copy of the Company's preliminary unaudited
draft balance sheet as of November 30, 2001, and of the Company's preliminary
unaudited draft statement of operations for the two months ended November 30,
2001. These unaudited financial results as of November 30, 2001 are not
necessarily indicative of the Company's fiscal results for the quarter ending
December 31, 2001.

            (e)   Quarterly Reports on Form 10-Q for the quarters ended March
31, 2001, June 30, 2001 and September 30, 2001, as filed with the Commission
pursuant to Section 13 of the Exchange Act, together with the indices to
exhibits thereto; and

            (f)   Term Sheet including a brief description of the Notes and
Warrants.

      3.4.  Authorization. All corporate action on the part of the Company, its
directors and shareholders necessary for the authorization, execution, delivery
and performance of this Agreement by the Company, the authorization, sale,
issuance and delivery of the Notes and the Warrants (and the Common Stock
issuable upon exercise of the Warrants) and the performance of the Company's
obligations hereunder has been taken or will be taken prior to the Closing. This
Agreement, when executed and delivered by the Company, shall constitute a valid
and binding obligation of the Company enforceable in accordance with its terms,
subject to laws of general application relating to bankruptcy, insolvency and
the relief of debtors and rules of law governing specific performance,
injunctive relief or other equitable remedies. The Notes and the Warrants, when
issued in compliance with the provisions of this Agreement, will be validly
issued and will be free of any liens and encumbrances, and the Warrant Common
has been duly and validly reserved and, when issued in compliance with the
provisions of this Agreement, will be validly issued and will be fully paid and
nonassessable, and will be free of any liens or encumbrances; provided, however,
that the Notes and the Warrants (and the Warrant Common) may be subject to
restrictions on transfer under state and/or federal securities laws and as set
forth herein.

      3.5   Compliance with Other Instruments. The Company is not in violation
of any term of its Articles of Incorporation or Bylaws, as amended, or in
violation of any material agreement, instrument, judgment or decree or, to the
best of its knowledge, any order, statute, rule or regulation applicable to the
Company. The execution, delivery and performance of this Agreement and the
consummation of the transactions contemplated herein will not result in any such
violation or be in conflict with or constitute a default under any such
provision or agreement, and will not accelerate the performance provided by the
terms of any material agreement or instrument to which the Company is a party,
or constitute a default thereunder, or an event which, with the lapse of time or
action by a third party, could result in a default thereof, or result in the
creation of any lien, charge or encumbrance upon any assets or properties of the
Company, which breach, default, lien, charge or


                                      -3-


encumbrance, singularly or in the aggregate, would materially and adversely
affect the business or property of the Company.

      3.6. Litigation. There are no actions, suits, proceedings or
investigations pending against the Company or its properties before any court or
governmental agency (nor, to the best of the Company's knowledge, is there any
basis therefor or threat thereof), which, either in any case or in the
aggregate, might result in any material adverse change in the business or
financial condition of the Company or any of its properties or assets, or in any
material impairment of the right or ability of the Company to carry on its
business as now conducted or as proposed to be conducted, or in any material
liability on the part of the Company, and none which questions the validity of
this Agreement or any action taken or to be taken in connection herewith.

                                    SECTION 4

                            PURCHASER REPRESENTATIONS

      Each Purchaser hereby represents and warrants to the Company as follows:

      4.1. Investment Representation.

            (a) The Purchaser understands and confirms that this Agreement is
made with the Purchasers in reliance upon each Purchaser's representation to the
Company that the Notes and Warrants to be received are to be acquired for
investment and not with a view to the sale or distribution of any part thereof,
and that it has no present intention of selling, granting participation in or
otherwise distributing the same, but subject nevertheless to any requirement of
law that the disposition of its property shall at all times be within its
control. By executing this Agreement, such Purchaser further represents that it
does not have any contract, undertaking, agreement or arrangement with any
person to sell, transfer or grant participations to such person or to any third
person, with respect to the Notes, the Warrants, or the Warrant Common.

            (b) The Purchaser understands that the Notes, the Warrants and the
Warrant Common are not registered under the Securities Act of 1933, as amended
(the "Act") on the basis that the sale provided for in this Agreement and the
issuance of securities is exempt pursuant to Section 4(2) of the Act and
Regulation D promulgated thereunder, and that the Company's reliance on such
exemption is predicated on the Purchasers' representations set forth herein.
(c) The Purchaser agrees that it will not make a disposition of the Notes or
Warrants purchased hereunder (or the Warrant Common) except in compliance with
Section 6 hereof.

            (d) The Purchaser represents that it is able to fend for itself in
the transactions contemplated by this Agreement, has such knowledge and
experience in financial and business matters as to be capable of evaluating the
merits and risks of its investment, has the ability to bear the economic risks
of its investment, and has had all questions which it has asked answered by the
Company.


                                      -4-


            (e) The Purchaser represents and warrants that, at a reasonable time
prior to the Closing Date, it has been given the opportunity to ask questions
and receive answers concerning the terms and conditions of this offering, to
obtain any additional information which the Company possesses or can acquire
without unreasonable effort or expense that is necessary to verify the accuracy
of the information furnished pursuant to Section 3.3 hereof, and to discuss the
Company and its plans, operations and financial condition with its officers and
that it has heretofore received all such information as it deems necessary and
appropriate to enable it to evaluate the financial risk inherent in making an
investment in the securities of the corporation. It further represents and
warrants that it has received satisfactory and complete information concerning
the business and financial condition of the Company in response to all inquiries
in respect thereof.

            (f) The Purchaser understands that the Notes, Warrants and Warrant
Common have not been registered under the Act in reliance upon a specific
exemption therefrom, which exemption depends upon, among other things, the bona
fide nature of its investment intent as expressed herein. In this connection,
the Purchaser understands that, in view of the Securities and Exchange
Commission (the "SEC"), the statutory basis for such exemption may be
unavailable if its representation was predicated solely upon a present intention
to hold these securities for the minimum capital gains period specified under
tax statutes, for a deferred sale, for or until an increase or decrease in the
market price of the Securities, or for a period of one year or any other fixed
period in the future.

            (g) The Purchaser further understands that the Notes, Warrants and
Warrant Common must be held indefinitely unless subsequently registered under
the Act or unless an exemption from registration is otherwise available (such as
Rule 144 under the Act). Moreover, the Purchaser understands that, except as set
forth in Section 6 hereof, the Company is under no obligation to register the
Notes, Warrants or Warrant Common. In addition, the Purchaser understands that
the certificates evidencing the Notes, Warrants, and Warrant Common may be
imprinted with a legend which prohibits the transfer of such securities unless
they are registered or such registration is not required in the opinion of
counsel for the Company.

            (h) The Purchaser is familiar with the provisions of Rule 144,
promulgated under the Act, which, in substance, permits limited public resale of
"restricted securities" acquired, directly or indirectly, from the issuer
thereof (or from an affiliate of such issuer), in a non-public offering subject
to the satisfaction of certain conditions, including among other things: (1) The
availability of certain public information about the Company; (2) the resale
occurring not less than one year after the party has purchased, and made full
payment for, within the meaning of Rule 144, the securities to be sold; and, in
the case of an affiliate, or of a non-affiliate who has held the securities less
than two years, (3) the sale being made through a broker in an unsolicited
"broker transaction" or in transactions directly with a market maker, as said
term is defined under the Exchange Act and the amount of securities being sold
during any three month period not exceeding the specified limitations stated
therein, if applicable. There can be no assurances that the requirements of Rule
144 will be met, or that the Notes, Warrants or Warrant Common will ever be
saleable.

            (i) The Purchaser further understands that at the time the Purchaser
wishes to sell the Notes, Warrants or Warrant Common there may be no public
market upon which to make such a sale, and that, even if such a public market
then exists, the Company may not be satisfying the


                                      -5-


current public information requirements of Rule 144, and that, in such event,
the Purchaser would be precluded from selling such securities under Rule 144
even if the one-year minimum holding period had been satisfied.

            (j) The Purchaser further understands that in the event all of the
applicable requirements of Rule 144 are not satisfied, registration under the
Act, compliance with Regulation A, compliance with some other registration
exemption or the notification to the Company of the proposed disposition by it
and the furnishing to the Company of (i) detailed information regarding the
disposition, and (ii) and opinion of its counsel to the effect that such
disposition will not require registration (the Purchaser understands such
counsel's opinion must be acceptable to counsel for the Company) will be
required and that, notwithstanding the fact that Rule 144 is not exclusive, the
Staff of the SEC has expressed its opinion that persons proposing to sell
private placement securities other than in a registered offering and otherwise
than pursuant to Rule 144 will have a substantial burden of proof in
establishing that an exemption from registration is available for such offers or
sales, and that such persons and their respective brokers who participate in
such transactions do so at their own risk.

      4.2. Accredited Investor. The Purchaser represents and warrants that one
or more of the following criteria are applicable to such Purchaser:

            (a) The Purchaser is a director or executive officer of the Company;

            (b) The Purchaser is a natural person who has an individual net
worth or joint net worth with the Purchaser's spouse exceeding $1,000,000 at the
time of purchase;

            (c) The Purchaser is a natural person who had an individual income
in excess of $200,000 in each of the two most recent years or joint income with
that Purchaser's spouse in excess of $300,000 in each of those years and who
reasonably expects to reach the same level of income in the current year;

            (d) The Purchaser is either (i) a bank as defined in Section 3(a)(2)
of the Act, or any savings and loan association or other institution as defined
in Section 3(a)(5)(A) of the Act, whether acting in its individual capacity or
fiduciary capacity, (ii) a broker or dealer registered pursuant to Section 15 of
the Exchange Act, (iii) an insurance company as defined in Section 2(13) of the
Act, (iv) an investment company registered under the Investment Company Act of
1940 or a business development company as defined in Section 2(a)(48) of such
Act, (v) a Small Business Investment Company licensed by the U.S. Small Business
Administration under Section 301(c) or (d) of the Small Business Investment Act
of 1958, (vi) a plan established and maintained by a state or its political
subdivisions, or any agency or instrumentality of a state or its political
subdivisions, for the benefit of its employees, which plan has total assets of
$5,000,000, or (vii) an employee benefit plan within the meaning of the Employee
Retirement Income Security Act of 1974, if the investment decision is made by a
plan fiduciary, as defined in Section 3(21) of such act, which plan fiduciary is
either a bank, savings and loan association, insurance company or registered
investment adviser, or which employee benefit plan has total assets in excess of
$5,000,000 or, if a self-directed plan, with investment decisions made solely by
persons that are accredited investors;


                                      -6-


            (e) The Purchaser is a private business development company as
defined in Section 202(a)(22) of the Investment Advisers Act of 1940;

            (f) Any organization described in Section 501(c)(3) of the Internal
Revenue Code, corporation, Massachusetts or similar business trust, or
partnership, not formed for the specific purpose of acquiring the securities
offered, with total assets of $5,000,000;

            (g) The Purchaser is a not-for-profit organization or other entity
exempt from income tax under Section 501(c)(3) of the Internal Revenue Code, not
formed with the specific purpose of acquiring the securities offered hereunder,
with total assets in excess of $5,000,000; or

            (h) The Purchaser is a trust, with total assets in excess of
$5,000,000, not formed for the specific purpose of acquiring the securities
offered hereunder, whose purchase is directed by a person who has such
experience in business and financial matters as to enable such person to
evaluate the merits and risks of acquiring the securities offered hereunder,

            (i) The Purchaser is an entity in which all of the equity owners
meet the qualifications set forth in (a), (b), (c), (d), (e), (f), (g) or (h)
above.

            As used in this Section 4.2, the term "net worth" means the excess
of total assets over total liabilities. In computing net worth for purposes of
paragraph (b) above, the principal residence of the Purchaser must be valued at
cost (including cost of improvements), or at a recently appraised value
established by an institutional lender making a secured loan, in either case net
of encumbrances.

                                   SECTION 5

                              CONDITIONS TO CLOSING

         The Purchasers' and the Company's obligations to purchase and to sell
and issue, respectively, the Notes and Warrants at the Closing are subject to
the fulfillment on or prior to the Closing Date of the following conditions:

      5.1. Representations and Warranties of Company Correct. The
representations and warranties made by the Company in Section 3 hereof shall be
true and correct when made, and shall be true and correct on the Closing Date
with the same force and effect as if they had been made on and as of said date.


      5.2. Representations of Purchasers Correct. The representations made by
the Purchasers in Section 4 hereof shall be true and correct when made, and
shall be true and correct on the Closing Date with the same force and effect as
if they had been made on and as of said date.

      5.3. Covenants and Laws. All covenants, agreements and conditions
contained in this Agreement to be performed by the Company on or prior to the
Closing Date shall have been performed or complied with in all respects and the
purchase and sale of the Notes and Warrants


                                      -7-


pursuant to the terms of this Agreement shall not violate any law or regulation
to which any of the Purchasers or the Company is subject.

                                    SECTION 6

                 RESTRICTIONS ON TRANSFERABILITY OF SECURITIES;
                         COMPLIANCE WITH SECURITIES ACT

      6.1. Certain Definitions. As used in this Section, the following terms
shall have the following respective meanings:

                  "Commission" shall mean the Securities and Exchange Commission
or any other federal agency at the time administering the Act.

                  "Act" shall mean the Securities Act of 1933, as amended, or
any similar federal statute and the rules and regulations of the Commission
thereunder, all as the same shall be in effect at the time.

                  "Restricted Securities" shall mean the Notes, the Warrants and
the Warrant Common required to bear the legend set forth in Section 6.3 hereof.

                  "Registrable Securities" means (i) the Warrant Common, and
(ii) any Common Stock issued in respect of such shares upon any stock split,
stock dividend, recapitalization or similar event, which shares, in each of the
foregoing instances, have not been sold to the public pursuant to Rule 144 under
the Act or otherwise.

                  The terms "register", "registered" and "registration" refer to
a registration effected by preparing and filing a registration statement in
compliance with the Act, and the declaration or ordering of the effectiveness of
such registration statement.

                  "Registration Expenses" shall mean all expenses incurred by
the Company in complying with Section 6.5 hereof, including, without limitation,
all registration and filing fees, printing expenses, fees and disbursements of
counsel for the Company, blue sky fees and expenses, and the expense of any
special audits incident to or required by any such registration.

                  "Selling Expenses" shall mean all underwriting discounts and
selling commissions applicable to the sale and any expenses incurred by a Holder
for its own benefit including all fees and disbursements of counsel to the
Holders participating in the offering (including the allocable portion of the
fees and disbursements of counsel to the Company, if such counsel is also
serving as counsel to the selling shareholders), except those expenses included
in the definition of Registration Expenses.

                  "Holder" shall mean any Purchaser or any permitted transferee
or assignee of such Purchaser pursuant to Section 6.10 who continues to hold of
record Warrants or Registrable Securities as of the applicable date.


                                      -8-


      6.2. Restrictions on Transferability. The Notes, the Warrants and the
Warrant Common shall not be transferable except upon the conditions specified in
this Section, which conditions are intended to insure compliance with the
provisions of the Act. Each Purchaser will cause any proposed transferee of the
Notes, the Warrants or the Warrant Common held by a Purchaser to agree to take
and hold such Notes, Warrants or Warrant Common subject to the provisions and
upon the conditions specified in this Section.

      6.3. Restrictive Legend. Each certificate representing (i) the Notes, (ii)
the Warrants, (iii) shares of Warrant Common, and (iv) any other securities
issued in respect of the Notes, the Warrants or the Warrant Common upon any
stock split, stock dividend, recapitalization, merger, consolidation or similar
event, shall (unless otherwise permitted by the provisions of Section 6.4 below)
be stamped or otherwise imprinted with a legend in substantially the following
form (in addition to any legend required under applicable state securities
laws):

         THESE SECURITIES HAVE NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF
         1933. THEY MAY NOT BE SOLD, OFFERED FOR SALE, PLEDGED OR HYPOTHECATED
         IN THE ABSENCE OF AN EFFECTIVE REGISTRATION STATEMENT RELATED THERETO
         OR AN OPINION OF COUNSEL, REASONABLY SATISFACTORY TO THE COMPANY, THAT
         SUCH REGISTRATION IS NOT REQUIRED UNDER THE SECURITIES ACT OF 1933.

      6.4. Notice of Proposed Transfers. Each holder of a certificate
representing Restricted Securities by acceptance thereof agrees to comply in all
respects with the provisions of this Section 6.4. Prior to any proposed transfer
of any Restricted Securities (other than under circumstances described in
Section 6.5 hereof), the holder thereof shall give written notice to the Company
of such holder's intention to effect such transfer. Each such notice shall
describe the manner and circumstances of the proposed transfer in sufficient
detail, and, if requested by the Company, shall be accompanied (except in
transactions in compliance with Rule 144) by an unqualified written opinion of
legal counsel, which opinion shall be addressed to the Company and reasonably
satisfactory in form and substance to the Company's counsel, to the effect that
the proposed transfer of the Restricted Securities may be effected without
registration under the Act. The holder of such Restricted Securities shall be
entitled to transfer such Restricted Securities in accordance with the terms of
such legal opinion (if reasonably acceptable as above provided) and the terms of
the notice delivered by the holder to the Company. Each certificate evidencing
the Restricted Securities transferred as above provided shall bear the
appropriate restrictive legend set forth in Section 6.3 above, except that such
certificate shall not bear such restrictive legend if transferred in compliance
with Rule 144 or if the opinion of counsel referred to above is to the further
effect that such legend is not required in order to establish compliance with
any provisions of the Act.

      6.5. Piggy-Back Registration Rights.

            (a) Notice of Registration. Whenever the Company proposes to
register any of its Common Stock under the Act for a public offering for cash,
whether as a primary or secondary offering (or pursuant to the registration
rights granted to other holders of securities of the Company),


                                      -9-


other than a registration relating to employee benefit plans or in connection
with a Rule 145 transaction or equivalent, the Company will:

                  (i) give to each Holder at the address indicated on the books
of the transfer agent written notice of the intent to so register its
securities; and

                  (ii) include in such registration (and any related
qualification under blue sky laws or other compliance), and in any underwriting
involved therein, all the Registrable Securities specified in a written request
or requests delivered to the Company or its legal counsel by any Holder or
Holders within 15 days after the date of mailing of such written notice by the
Company, except as set forth in subparagraphs (b) and (c) below.

            (b) Underwriting. If the registration of which the Company gives
notice is for a registered public offering involving an underwriting, the
Company shall so advise the Holders as a part of the written notice given
pursuant to subparagraph (a)(i) of this Section. In such event the right of any
Holder to registration pursuant to this Section shall be conditioned upon such
Holder's participation in such underwriting and the inclusion of such Holder's
Registrable Securities in the underwriting to the extent provided herein. All
Holders proposing to distribute their securities through such underwriting shall
(together with the Company and the other holders distributing their securities
through such underwriting) enter into an underwriting agreement in customary
form with the underwriter or underwriters selected for such underwriting by the
Company or by holders exercising demand registration rights, as the case may be.
Notwithstanding any other provisions of this Section, if the underwriter
determines that marketing factors require a limitation of the number of shares
to be underwritten, the underwriter may exclude some or all Registrable
Securities from such registration and underwriting. The Company shall so advise
all Holders, and the number of shares of Registrable Securities that may be
included in the registration and underwriting shall be allocated among all
Holders requesting inclusion in such proportion, as nearly as practicable, as
the respective amounts of Registrable Securities entitled to inclusion in such
registration held by such Holders at the time of filing the registration
statement bear to the aggregate amount of such securities held by all such
Holders. To the extent that other persons holding the Company's securities may
possess registration rights with respect to such securities (whether heretofore
or hereafter granted), the total number of shares to be sold by selling
shareholders under a registration statement, if less than the total amount
requested to be sold by such persons, shall be allocated on a pro rata basis
according to the total number of shares held by such persons which are entitled
to registration rights with respect to such offering, subject to the prior
rights set forth in subsection (c) hereof. If any Holder disapproves of the
terms of any such underwriting, he may elect to withdraw therefrom at any time
prior to filing of the registration statement by written notice to the Company
and the underwriter. Any Registrable Securities excluded or withdrawn from such
underwriting shall not be included in such registration.

            (c) Prior Rights. Certain holders (the "Prior Holders") of the
Company's Common Stock may continue to have registration rights granted pursuant
to a Stock Purchase Agreement dated as of April 14, 1977 (the "Prior
Agreement"). In the event that a registration is effected pursuant to the Prior
Holders' demand rights set forth in Section 6.5 of the Prior Agreement,
securities held by the Holders and others desiring to sell securities in the
registration may only be included to the extent that the amount of securities
being registered for the account of the Prior


                                      -10-


Holders will not be diminished. In the event of a registration which is not
initiated by a demand of the Prior Holders but with respect to which such Prior
Holders have piggyback rights under Section 6.6 of the Prior Agreement, the
securities to be sold by the Prior Holders may not be reduced to less than
33-1/3% of the total amount of securities being registered. The Company has also
granted registration rights similar to those provided herein to certain
investors pursuant to a Subordinated Note and Warrant Purchase Agreement dated
March 1996.

      6.6. Expenses of Registration. All Registration Expenses incurred in
connection with any registration, qualification or compliance pursuant to this
Section shall be borne by the Company; and all Selling Expenses shall be borne
by the Holders of the securities so registered for whose account such expenses
were incurred.

      6.7. Registration Procedures. In the case of each registration,
qualification or compliance effected by the Company pursuant to this Section,
the Company will advise each participating Holder as to the filing of the
registration statement with the Commission and the effective date thereof. The
Company shall also advise each participating Holder, concurrently with the
notice of effectiveness, of the jurisdictions in which the securities being
registered have been qualified for sale to the public. In connection with each
registration other than in connection with a firm commitment underwritten public
offering, at its expense, the Company will:

            (a) Keep such registration, qualification or compliance effective
for a period of 90 days after effectiveness with the Commission or until the
Holder or Holders have completed the distribution described in the registration
statement relating thereto, whichever first occurs; and

            (b) Furnish such number of prospectuses and other documents incident
thereto as a Holder from time to time may reasonably request.

      6.8. Indemnification.

            (a) The Company will indemnify each participating Holder, each of
its officers and directors and partners, and each person controlling such
Holder, with respect to which registration, qualification or compliance has been
effected pursuant to this Section 6, and each underwriter, if any, and each
person who controls any underwriter against all claims, losses, damages and
liabilities (or actions in respect thereof) arising out of or based on any
untrue statement (or alleged untrue statement) of a material fact contained in
any prospectus, offering circular or other document (including any related
registration statement, notification or the like) incident to any such
registration, qualification or compliance, or based on any omission (or alleged
omission) to state therein a material fact required to be stated therein or
necessary to make the statements therein not misleading, or any violation by the
Company of any rule or regulation promulgated under the Act applicable to the
Company and relating to action or inaction required of the Company in connection
with any such registration, qualification or compliance, and will reimburse each
such Holder, each of its partners, officers and directors, and each person
controlling such Holder, each such underwriter and each person who controls any
such underwriter, for any legal and any other expenses reasonably incurred in
connection with investigating or defending any such claim, loss, damage,
liability or action, provided that the Company will not be liable in any such
case to the extent that any such claim, loss, damage, liability or action arises
out of or is based on any untrue statement or omission


                                      -11-


based upon written information furnished to the Company by an instrument duly
executed by such Holder or underwriter.

            (b) Each Holder will, if Registrable Securities held by such Holder
are included in the securities as to which such registration, qualification or
compliance is being effected, indemnify the Company, each of its directors and
officers, each legal counsel and independent accountant of the Company, each
underwriter, if any, of the Company's securities covered by such a registration
statement, each person who controls the Company or such underwriter within the
meaning of the Act, and each other such Holder, each of its partners, officers
and directors and each person controlling such Holder, against all claims,
losses, damages and liabilities (or actions in respect thereof) arising out of
or based on any untrue statement (or alleged untrue statement) of a material
fact contained in any such registration statement, prospectus, offering circular
or other document, or any omission (or alleged omission) to state therein a
material fact required to be stated therein or necessary to make the statements
therein not misleading, and will reimburse the Company, such Holders, such
partners, directors, officers, persons, underwriters or control persons for any
legal or any other expenses reasonably incurred in connection with investigating
or defending any such claim, loss, damage, liability or action, in each case to
the extent, but only to the extent, that such untrue statement (or alleged
untrue statement) or omission (or alleged omission) is made in such registration
statement, prospectus, offering circular or other document in reliance upon and
in conformity with written information furnished to the Company by an instrument
duly executed by such Holder; provided, however, that the obligations of such
Holders hereunder shall be limited to an amount equal to the proceeds to each
such Holder from the sale of Registrable Securities as contemplated herein.

            (c) Each party entitled to indemnification under this Section (the
"Indemnified Party") shall give notice to the party required to provide
indemnification (the "Indemnifying Party") promptly after such Indemnified Party
has actual knowledge of any claim as to which indemnity may be sought, and shall
permit the Indemnifying Party to assume the defense of any such claim or any
litigation resulting therefrom, provided that counsel for such Indemnifying
Party, who shall conduct the defense of such claim or litigation, shall be
approved by the Indemnified Party (whose approval shall not unreasonably be
withheld), and the Indemnified Party may participate in such defense at such
party's expense, and provided further that the failure of any Indemnified Party
to give notice as provided herein shall not relieve the Indemnifying Party of
its obligations under this Section. No Indemnifying Party, in the defense of any
such claim or litigation, shall, except with the consent of each Indemnified
Party, consent to entry of any judgment or enter into any settlement which does
not include as an unconditional term thereof the giving by the claimant or
plaintiff to such Indemnified Party of a release from all liability in respect
to such claim or litigation.

            (d) Notwithstanding the foregoing, if the Registrable Securities are
to be distributed by means of an underwritten public offering, to the extent
that the provisions on indemnification and contribution contained in the
underwriting agreement entered into in connection with such underwriting are in
conflict with the foregoing provisions, the provisions in the underwriting
agreement shall be controlling.

      6.9. Information by Holder. The Holder or Holders of Registrable
Securities included in any registration shall furnish to the Company such
information regarding such Holder or Holders


                                      -12-


and the distribution proposed by such Holder or Holders as the Company may
request in writing and as shall be required in connection with any registration,
qualification or compliance referred to in this Section 6.

      6.10. Transfer of Piggy-Back Registration Rights. The rights to cause the
Company to register a Purchaser's Registrable Securities granted hereunder by
the Company, may be assigned to a transferee or assignee of 25,000 or more
shares of Warrant Common (as adjusted to reflect stock splits, stock dividends
and similar events) provided that the Company is given advance written notice by
such Purchaser of said transfer and of the intent to transfer such Purchaser's
registration rights together with such securities, stating the name and address
of said transferee or assignee and identifying the Registrable Securities with
respect to which such registration rights are being assigned, and provided,
further, that no transferee or assignee of any of such Restricted Securities
shall be entitled to the registration rights provided in this Section if such
transferee or assignee would be permitted to sell all of the Restricted
Securities so transferred or assigned to him within one three-month period
pursuant to Rule 144 promulgated under the Act.

      6.11. "Market Stand-off" Agreement. Any Holder of Registrable Securities
being registered under this Section 6 agrees, if requested by the Company or an
underwriter of such registered public offering, not to sell or otherwise
transfer or dispose of any Common Stock (or other securities) of the Company
held by such Holder during a period of up to 180 days following the effective
date of the registration statement of the Company filed under the Act, provided
that all executive officers and directors of the Company enter into similar
agreements. Such agreement shall be in writing in the form satisfactory to the
Company and such underwriter, and may be included in the underwriting agreement.
The Company may impose stop-transfer instructions with respect to the securities
subject to the foregoing restriction until the end of the required stand-off
period.

      6.12. Termination of Registration Rights. The rights granted under this
Section shall terminate as to any Purchaser or permissible transferee or
assignee of such rights if such person would be permitted to sell all of the
Restricted Securities held by such person within one three-month period pursuant
to Rule 144 promulgated under the Act.

                                    SECTION 7

                                  MISCELLANEOUS

      7.1. Agreement Is Entire Contract. This Agreement, the Exhibits hereto and
the other documents delivered pursuant hereto constitute the entire contract
between the parties hereto and no party shall be liable or bound to the other in
any manner by any warranties, representations or covenants except as
specifically set forth herein. The terms and conditions of this Agreement shall
inure to the benefit of and be binding upon the respective successors and
assigns of the parties hereto. Nothing in this Agreement, express or implied, is
intended to confer upon any party, other than the parties hereto, and their
respective successors and assigns, any rights, remedies, obligations or
liabilities under or by reason of this Agreement, except as expressly provided
herein.


                                      -13-


      7.2. Amendment by Agreement. Any provision of this Agreement may be
amended or waived by a written instrument signed by the Company and by a
majority in interest of the holders of the Warrants (on an as-if-exercised
basis) and the Warrant Common.

      7.3. Notices. Any notice, request or other communication required or
permitted hereunder shall be in writing and shall be deemed to have been duly
given if personally delivered, sent by facsimile or mailed by registered or
certified mail, postage prepaid, or by recognized overnight courier or personal
delivery at the respective addresses or facsimile phone number of the parties as
set forth below. Any party hereto may by notice so given change its address for
future notice hereunder. Notice shall conclusively be deemed to have been given
when received.

                  If to a Purchaser:    At the address set forth in the
                                        Schedule of Purchasers

                  If to Company:        FAFCO, Inc.
                                        435 Otterson Drive
                                        Chico, CA  95928
                                        Attention: Alex N. Watt, Executive
                                        Vice President

                  With a copy to:       Ann Yvonne Walker, Esq.
                                        Wilson, Sonsini, Goodrich & Rosati, P.C.
                                        650 Page Mill Road
                                        Palo Alto, CA  94304

Each of the above addressees may change its address for purposes of this
paragraph by giving to the other addressee notice of such new address in
conformance with this paragraph.

      7.4. Agent's Fees.

            (a) The Company hereby agrees to indemnify and to hold each
Purchaser harmless of and from any liability for commission or compensation in
the nature of an agent's fee to any broker or other person or firm (and the
costs and expenses of defending against such liability or asserted liability)
for which the Company, or any of its employees or representatives, is
responsible.

            (b) Each Purchaser (i) represents and warrants that no finders or
brokers have been retained in connection with the transactions contemplated by
this Agreement, and (ii) hereby agrees to indemnify and to hold the Company and
the Purchasers (other than himself) harmless of and from any liability for any
commission or compensation in the nature of an agent's fee to any broker or
other person or firm (and the costs and expenses of defending against such
liability or asserted liability) for which such Purchaser, or any of his
employees or representatives, are responsible.

      7.5. Severability. If one or more provisions of this Agreement are held to
be unenforceable under applicable law, such provision shall be severed from this
Agreement as if such provision were not included and the balance of this
Agreement shall be enforceable in accordance with its terms.


                                      -14-


      7.6. Expenses. The Company and each Purchaser shall bear its own expenses
and legal fees incurred on its behalf with respect to this Agreement and the
transactions contemplated hereby.

      7.7. California Corporate Securities Law. THE SALE OF THE SECURITIES WHICH
ARE THE SUBJECT OF THIS AGREEMENT HAS NOT BEEN QUALIFIED WITH THE COMMISSIONER
OF CORPORATIONS OF THE STATE OF CALIFORNIA AND THE ISSUANCE OF SUCH SECURITIES
OR THE PAYMENT OR RECEIPT OF ANY PART OF THE CONSIDERATION THEREFOR PRIOR TO
SUCH QUALIFICATION, OR EXEMPTION THEREFROM, IS UNLAWFUL. THE RIGHTS OF ALL
PARTIES TO THIS AGREEMENT ARE EXPRESSLY CONDITIONED UPON SUCH QUALIFICATION, OR
EXEMPTION THEREFROM, BEING OBTAINED.

      7.8. Governing Law. This Agreement shall be governed by and construed
under the laws of the State of California.

      7.9. Counterparts. This Agreement may be executed in two or more
counterparts, each of which shall be deemed an original, but all of which
together shall constitute one and the same instrument.


                                      -15-



         IN WITNESS WHEREOF, the parties hereto have executed this Agreement as
of the date first above written.

FAFCO, INC.                                    PURCHASERS:


By:
      --------------------------------         ---------------------------------

Title:
       -------------------------------







                                    EXHIBIT A

                             SCHEDULE OF PURCHASERS



  NAME AND ADDRESS OF PURCHASER             LOAN AMOUNT           WARRANT SHARES
  -----------------------------             -----------           --------------
                                                            
Leo Helzel                                  $ 100,000
5550 Redwood Ave.
Oakland, CA  94619

Freeman & Diana Ford                        $ 100,000
172 Toyon Road
Atherton, CA  94027

Murray Stoltz                               $  50,000
21 Hemlock Road
Bronxville, NY  10708

Richard O. Rhodes                           $  50,000
4440 18th Street
San Francisco, CA  94114

Wally Niemasik, Jr.                         $  50,000
6 Fennwood Drive
Atherton, CA  94027

EX-10.11.I

                                                                               .
                                                                               .
                                                                               .
                                                                EXHIBIT 10.11(I)

                           CHANGE IN TERMS AGREEMENT



        PRINCIPAL     LOAN DATE     MATURITY     LOAN NO.     CALL/COL     ACCOUNT     OFFICER     INITIALS
                                                                              
      $1,000,000.00  08-08-2002    08-10-2003   0400707337    016/6666     120144        019
- -----------------------------------------------------------------------------------------------------------
          References in the shaded area are for Lender's use only and do not limit the
                 applicability of this document to any particular loan or item.
          Any item above containing "***" has been omitted due to text length limitations.
- -----------------------------------------------------------------------------------------------------------


BORROWER:   FAFCO, INC.                          LENDER: BUTTE COMMUNITY BANK
            435 OTTERSON DRIVE                           CHICO OFFICE
            CHICO, CA 95928                              2041 FOREST AVE
                                                         CHICO, CA 95928

================================================================================

             PRINCIPAL AMOUNT: $1,000,000.00  INITIAL RATE: 6.250%
                       DATE OF AGREEMENT: AUGUST 8, 2002

DESCRIPTION OF EXISTING INDEBTEDNESS. THIS IS A VARIABLE RATE (1.500% OVER PRIME
RATE AS PUBLISHED BY BUTTE COMMUNITY BANK, MAKING AN INITIAL RATE OF 6.250%),
NONDISCLOSABLE REVOLVING LINE OF CREDIT LOAN TO A CORPORATION FOR $1,500,000.00
DUE ON AUGUST 10, 2002.

DESCRIPTION OF COLLATERAL. UCC FILING ON ALL INVENTORY, CHATTEL PAPER,
ACCOUNTS/CONTRACT RIGHTS, EQUIPMENT, GENERAL INTANGIBLES AND FIXTURES.

DESCRIPTION OF CHANGE IN TERMS. EXTEND MATURITY DATE FROM AUGUST 10, 2002 TO
AUGUST 10, 2003. DECREASE IN MAXIMUM CREDIT AMOUNT FROM $1,500,000.00 TO
$1,000,000.00. ALL OTHER TERMS AND CONDITIONS ARE TO REMAIN THE SAME.

PROMISE TO PAY. FAFCO, INC. ("Borrower") promises to pay to Butte Community Bank
("Lender"), or order, in lawful money of the United States of America, the
principal amount of One Million & 00/100 Dollars ($1,000,000.00) or so much as
may be outstanding, together with interest on the unpaid outstanding principal
balance on each advance. Interest shall be calculated from the date of each
advance until repayment of each advance.

PAYMENT. Borrower will pay this loan on demand. Payment in full is due
immediately upon Lender's demand. If no demand is made, Borrower will pay this
loan in one payment of all outstanding principal plus all accrued unpaid
interest on August 10, 2003. In addition, Borrower will pay regular monthly
payments of all accrued unpaid interest due as of each payment date, beginning
August 10, 2002, with all subsequent interest payments to be due on the same day
of each month after that. Interest on this Agreement is computed on a 365/360
simple interest basis; that is, by applying the ratio of the annual interest
rate over a year of 360 days, multiplied by the outstanding principal balance,
multiplied by the actual number of days the principal balance is outstanding.
Borrower will pay Lender at Lender's address shown above or at such other place
as Lender may designate in writing.

VARIABLE INTEREST RATE. The interest rate on this Agreement is subject to change
from time to time based on changes in an index which is Lender's Prime Rate (the
"Index"). This is the rate Lender charges, or would charge, on 90-day unsecured
loans to the most creditworthy corporate customers. This rate may or may not be
the lowest rate available from Lender at any given time. Lender will tell
Borrower the current index rate upon Borrower's request. The interest rate
change will not occur more often than each DAY. Borrower understands that Lender
may make loans based on other rates as well. The Index currently is 4.750% per
annum. The interest rate to be applied to the unpaid principal balance of the
Note will be at a rate of 1.500 percentage points over the index, resulting in
an initial rate of 6.250% per annum. NOTICE: Under no circumstances will the
interest rate on the Note be more than the maximum rate allowed by applicable
law.

PREPAYMENT; MINIMUM INTEREST CHARGE. In any event, even upon full prepayment of
this Agreement, Borrower understands that Lender is entitled to a minimum
interest charge of $60.00. Other than Borrower's obligation to pay any minimum
interest charge, Borrower may pay without penalty all or a portion of the amount
owed earlier than it is due. Early payments will not, unless agreed to by Lender
in writing, relieve Borrower of Borrower's obligation to continue to make
payments of accrued unpaid interest. Rather, early payments will reduce the
principal balance due. Borrower agrees not to send Lender payments marked "paid
in full", "without recourse", or similar language. If Borrower sends such a
payment, Lender may accept it without losing any of Lender's rights under this
Agreement, and Borrower will remain obligated to pay any further amount owed to
Lender. All written communications concerning disputed amounts, including any
check or other payment instrument that indicates that the payment constitutes
"payment in full" of the amount owed or that is tendered with other conditions
or limitations or as full satisfaction of a disputed amount must be mailed or
delivered to: Butte Community Bank, CHICO OFFICE, 2041 FOREST AVE, CHICO, CA
95928.

LATE CHARGE. If a payment is 10 days or more late, Borrower will be charged
5.000% of the regularly scheduled payment or $5.00, whichever is greater.

INTEREST AFTER DEFAULT. Upon Borrower's failure to pay all amounts declared due
pursuant to this section, including failure to pay upon final maturity, the
total sum due under this Agreement will bear interest from the date of
acceleration or maturity at the variable interest rate on this Agreement.

DEFAULT. Each of the following shall constitute an Event of Default under this
Agreement.

         PAYMENT DEFAULT. Borrower fails to make any payment when due under the
         indebtedness.

         OTHER DEFAULTS. Borrower fails to comply with or to perform any other
         term, obligation, covenant or condition contained in this Agreement or
         in any of the Related Documents or to comply with or to perform any
         term, obligation, covenant or condition contained in any other
         agreement between Lender and Borrower.

         FALSE STATEMENTS. Any warranty, representation or statement made or
         furnished to Lender by Borrower or on Borrower's behalf under this
         Agreement or the Related Documents is false or misleading in any
         material respect, either now or at the time made or furnished or
         becomes false or misleading at any time thereafter.

         INSOLVENCY. The dissolution or termination of Borrower's existence as a
         going business, the insolvency of Borrower, the appointment of a
         receiver for any part of Borrower's property, any assignment for the
         benefit of creditors, any type of creditor workout, or the commencement
         of any proceeding under any bankruptcy or insolvency laws by or against
         Borrower.

         CREDITOR OR FORFEITURE PROCEEDINGS. Commencement of foreclosure or
         forfeiture proceedings, whether by judicial proceeding, self-help,
         repossession or any other method, by any creditor or Borrower or by any
         governmental agency against any collateral securing the indebtedness.
         This includes a garnishment of any of Borrower's accounts, including
         deposit accounts, with Lender. However, this Event of Default shall not
         apply if there is a good faith dispute by Borrower as to the validity
         or reasonableness of the claim which is the basis of the creditor or
         forfeiture proceedings and if Borrower gives Lender written notice of
         the creditor or forfeiture proceeding and deposits with Lender monies
         or a surely bond for the creditor or forfeiture proceeding, in an
         amount determined by Lender, in its sole discretion, as being an
         adequate reserve or bond for the dispute.

         EVENTS AFFECTING GUARANTOR. Any of the preceding events occurs with
         respect to any guarantor, endorser, surety, or accommodation party of
         any of the indebtedness or any guarantor, endorser, surety, or
         accommodation party dies or becomes incompetent, or revokes or
         disputes the validity of, or liability under, any Guaranty of the
         indebtedness evidenced by this Note. In the event of a death, Lender,
         at its option, may, but shall not be required to, permit the
         guarantor's estate to assume unconditionally the obligations arising
         under the guaranty in a manner satisfactory to Lender, and, in doing
         so, cure any Event of Default.

         CHANGE IN OWNERSHIP. Any change in ownership of twenty-five percent
         (25%) or more of the common stock of Borrower.

         ADVERSE CHANGE. A material adverse change occurs in Borrower's
         financial condition, or Lender believes the prospect of payment or
         performance of the indebtedness is impaired.

         INSECURITY.  Lender in good faith believes itself insecure.

         CURE PROVISIONS. If any default, other than a default in payment is
         curable and if Borrower has not been given a notice of a breach of the
         same provision of this Agreement within the preceding twelve (12)
         months, it may be cured (and no event of default will have occurred) if
         Borrower, after receiving written notice from Lender demanding cure of
         such default: (1) cures the default within fifteen (15) days; or (2) if
         the cure requires more than fifteen (15) days, immediately initiates
         steps which Lender deems in Lender's sole discretion to be sufficient
         to cure the default and thereafter continues and completes all
         reasonable and necessary steps sufficient to produce compliance as soon
         as reasonably practical.

LENDER'S RIGHTS. Upon default, Lender may declare the entire unpaid principal
balance on this Agreement and all accrued unpaid interest immediately due, and
then Borrower will pay that amount.

ATTORNEYS' FEES; EXPENSES. Lender may hire or pay someone else to help collect
this Agreement if Borrower does not pay. Borrower will pay Lender that amount.
This includes, subject to any limits under applicable law, Lender's attorneys'
fees and Lender's legal expenses, whether or not there is a lawsuit, including
attorneys' fees, expenses for bankruptcy proceedings (including efforts to
modify or vacate any automatic stay or injunction), and appeals. Borrower also
will pay any court costs, in addition to all other sums provided by law.

GOVERNING LAW. This Agreement will be governed by, construed and enforced in
accordance with federal law and the laws of the State of




                           CHANGE IN TERMS AGREEMENT
Loan No. 0400707337               (Continued)                            Page 2
===============================================================================
California. This Agreement has been accepted by Lender in the State of
California.

CHOICE OF VENUE. If there is a lawsuit, Borrower agrees upon Lender's request to
submit to the jurisdiction of the courts of BUTTE County, State of California.

DISHONORED ITEM FEE. Borrower will pay a fee to Lender of $10.00 if Borrower
makes a payment on Borrower's loan and the check or preauthorized charge with
which Borrower pays is later dishonored.

RIGHT OF SETOFF. To the extent permitted by applicable law, Lender reserves a
right of setoff in all Borrower's accounts with Lender (whether checking,
savings, or some other account). This includes all accounts Borrower holds
jointly with someone else and all accounts Borrower may open in the future.
However, this does not include any IRA or Keogh accounts, or any trust accounts
for which setoff would be prohibited by law. Borrower authorizes Lender, to the
extent permitted by applicable law, to charge or setoff all sums owing on the
indebtedness against any and all such accounts.

COLLATERAL. Borrower acknowledges this Agreement is secured by the following
collateral described in the security instrument listed herein: inventory,
chattel paper, accounts, equipment, general intangibles and fixtures described
in a Commercial Security Agreement dated August 8, 2002.

LINE OF CREDIT. This Agreement evidences a revolving line of credit. Advances
under this Agreement may be requested orally by Borrower or as provided in this
paragraph. Lender may, but need not, require that all oral requests be confirmed
in writing. All communications, instructions, or directions by telephone or
otherwise to Lender are to be directed to Lender's office shown above. The
following persons currently are authorized to request advances and authorize
payments under the line of credit until Lender receives from Borrower, at
Lender's address shown above, written notice of revocation of their authority:
ALEX N. WATT, Executive VP/Secretary of FAFCO, INC.; NANCY I. GARVIN, Vice
President of Finance of FAFCO, INC.; and FREEMAN A. FORD, President of FAFCO,
INC. Borrower agrees to be liable for all sums either: (A) advanced in
accordance with the instructions of an authorized person or (B) credited to any
of Borrower's accounts with Lender. The unpaid principal balance owing on this
Agreement at any time may be evidenced by endorsements on this Agreement or by
Lender's internal records, including daily computer print-outs. Lender will have
no obligation to advance funds under this Agreement if: (A) Borrower or any
guarantor is in default under the terms of this Agreement or any agreement that
Borrower or any guarantor has with Lender, including any agreement made in
connection with the signing of this Agreement; (B) Borrower or any guarantor
ceases doing business or is insolvent; (C) any guarantor seeks, claims or
otherwise attempts to limit, modify or revoke such guarantor's guarantee of this
Agreement or any other loan with Lender; (D) Borrower has applied funds provided
pursuant to this Agreement for purposes other than those authorized by Lender;
or (E) Lender in good faith believes itself insecure.

CONTINUING VALIDITY. Except as expressly changed by this Agreement, the terms of
the original obligation or obligations, including all agreements evidenced or
securing the obligation(s), remain unchanged and in full force and effect.
Consent by Lender to this Agreement does not waive Lender's right to strict
performance of the obligation(s) as changed, nor obligate Lender to make any
future change in terms. Nothing in this Agreement will constitute a satisfaction
of the obligation(s). It is the intention of Lender to retain as liable parties
all makers and endorsers of the original obligation(s), including accommodation
parties, unless a party is expressly released by Lender in writing. Any maker or
endorser, including accommodation makers, will not be released by virtue of this
Agreement. If any person who signed the original obligation does not sign this
Agreement below, then all persons signing below acknowledge that this Agreement
is given conditionally, based on the representation to Lender that the
non-signing party consents to the changes and provisions of this Agreement or
otherwise will not be released by it. This waiver applies not only to any
initial extension, modification or release, but also to all such subsequent
actions.

SUCCESSORS AND ASSIGNS. Subject to any limitations stated in this Agreement on
transfer of Borrower's interest, this Agreement shall be binding upon and inure
to the benefit of the parties, their successors and assigns. If ownership of the
Collateral becomes vested in a person other than Borrower, Lender, without
notice to Borrower, may deal with Borrower's successors with reference to this
Agreement and the indebtedness by way of forbearance or extension without
releasing Borrower from the obligations of this Agreement or liability under the
indebtedness.

NOTIFY US OF INACCURATE INFORMATION WE REPORT TO CONSUMER REPORTING AGENCIES.
Please notify us if we report any inaccurate information about your account(s)
to a consumer reporting agency. Your written notice describing the specific
inaccuracy(ies) should be sent to us at the following address: Butte Community
Bank, CHICO OFFICE, 2041 FOREST AVE, CHICO, CA 95928.

MISCELLANEOUS PROVISIONS. This Agreement is payable on demand. The inclusion of
specific default provisions or rights of Lender shall not preclude Lender's
right to declare payment of this Agreement on its demand. Lender may delay or
forgo enforcing any of its rights or remedies under this Agreement without
losing them. Borrower and any other person who signs, guarantees or endorses
this Agreement, to the extent allowed by law, waive any applicable statute of
limitations, presentment, demand for payment, and notice of dishonor. Upon any
change in the terms of this Agreement, and unless otherwise expressly stated in
writing, no party who signs this Agreement, whether as maker, guarantor,
accommodation maker or endorser, shall be released from liability. All such
parties agree that Lender may renew or extend (repeatedly and for any length of
time) this loan or release any party or guarantor or collateral; or impair, fail
to realize upon or perfect Lender's security interest in the collateral; and
take any other action deemed necessary by Lender without the consent of or
notice to anyone. All such parties also agree that Lender may modify this loan
without the consent of or notice to anyone other than the party with whom the
modification is made. The obligations under this Agreement are joint and
several.

PRIOR TO SIGNING THIS AGREEMENT, BORROWER READ AND UNDERSTOOD ALL THE PROVISION
OF THIS AGREEMENT, INCLUDING THE VARIABLE INTEREST RATE PROVISIONS. BORROWER
AGREES TO THE TERMS OF THE AGREEMENT.

CIT SIGNERS:

FAFCO, INC.

By: /s/ Nancy I. Garvin
    --------------------
    NANCY I. GARVIN, Vice President of Finance of
    FAFCO, INC.
================================================================================
                                  [ILLEGIBLE]

EX-10.11.J

                                                                               .
                                                                               .
                                                                               .
                                                                Exhibit 10.11(J)

                           CHANGE IN TERMS AGREEMENT




                                                                       
Principal       Loan Date     Maturity      Loan No.      Cell/Call    Accounts   Officer   Initials
$3,356,768.76   11-10-2002   06-10-2005    0400706081     016/1111     [20] 44     019


  References in the shaded area are for Lender's use only and do not limit the
         applicability of this document to any particular loan or item.
Any item above containing "***" has been omitted due to text length limitations.
- --------------------------------------------------------------------------------
Borrower: FAFCO, INC.                             Lender: Butte Community Bank
          435 OTTERSON DRIVE                              CHICO OFFICE
          CHICO, CA 95928                                 2041 FOREST AVE
                                                          CHICO, CA 92928
- --------------------------------------------------------------------------------
PRINCIPAL AMOUNT: $3,356,768.76     INTEREST RATE: 8.000%
DATE OF AGREEMENT: NOVEMBER 10, 2002

DESCRIPTION OF EXISTING INDEBTEDNESS. THIS IS A FIXED RATE (9.050%)
NONDISCLOSABLE DRAW DOWN LINE OF CREDIT TO A CORPORATION FOR $3,400,000.00 DUE
ON JUNE 10, 2005.

DESCRIPTION OF COLLATERAL. 1ST D/T 435 OTTERSON DRIVE, CHICO, CA 95928.

DESCRIPTION OF CHANGE IN TERMS. INTEREST RATE TO BE CHANGED FROM 9.050% TO
8.000% FIXED, ON THE CURRENT PRINCIPAL BALANCE OF $3,356,768.76. ON JUNE 10,
2005, INTEREST RATE TO BE CHANGED TO PRIME RATE (AS PUBLISHED BY BUTTE
COMMUNITY BANK) PLUS .350% AND FIXED FOR THE NEXT FIVE YEAR PERIOD. EACH
SUBSEQUENT FIVE YEAR PERIOD WILL BE ADJUSTED TO PRIME RATE (AS PUBLISHED BY
BUTTE COMMUNITY BANK) PLUS .350% AND FIXED FOR FIVE YEARS. A DOCUMENTATION FEE
OF $250.00 TO BE PAID IN CASH. ALL OTHER TERMS AND CONDITIONS ARE TO REMAIN THE
SAME.

PROMISE TO PAY. FAFCO, INC. ("Borrower") promises to pay to Butte Community
Bank ("Lender"), or order, in lawful money of the United States of America, the
principal amount of Three Million Three Hundred Fifty-six Thousand Seven
Hundred Sixty-eight & 76/100 Dollars ($3,356,768.76) or so much as may be
outstanding, together with interest at the rate of 8.000% on the unpaid
outstanding principal balance of each advance. Interest shall be calculated
from the date of each advance until repayment of each advance.

PAYMENT. Borrower will pay this loan in one payment of all outstanding
principal plus all accrued unpaid interest on June 10, 2005. In addition,
Borrower will pay regular monthly payments of all accrued unpaid interest due
as of each payment date, beginning December 10, 2002, with all subsequent
interest payments to be due on the same day of each month after that. Interest
on this Agreement is computed on a 365/360 simple interest basis; that is, by
applying the ratio of the annual interest rate over a year of 360 days,
multiplied by the outstanding principal balance, multiplied by the actual
number of days the principal balance is outstanding. Borrower will pay Lender
at Lender's address shown above or at such other place as Lender may designate
in writing.

PREPAYMENT; MINIMUM INTEREST CHARGE. Borrower agrees that all loan fees and
other prepaid finance charges are earned fully as of the date of the loan and
will not be subject to refund upon early payment (whether voluntary or as a
result of default), except as otherwise required by law. In any event, even upon
full prepayment of this Agreement, Borrower understands that Lender is entitled
to a minimum interest charge of $50.00. Other than Borrower's obligation to pay
any minimum interest charge, Borrower may pay without penalty all or a portion
of the amount owed earlier than it is due. Early payments will not, unless
agreed to by Lender in writing, relieve Borrower of Borrower's obligation to
continue to make payments of accrued unpaid interest. Rather, early payments
will reduce the principal balance due. Borrower agrees not to send Lender
payments marked "paid in full", "without recourse", or similar language. If
Borrower sends such a payment, Lender may accept it without losing any of
Lender's rights under this Agreement, and Borrower will remain obligated to pay
any further amount owed to Lender. All written communications concerning
disputed amounts, including any check or other payment instrument that
indicates that the payment constitutes "payment in full" of the amount owed or
that is tendered with other conditions or limitations or as full satisfaction
of a disputed amount must be mailed or delivered to: Butte Community Bank, NOTE
DEPARTMENT, 1390 RIDGEWOOD DRIVE CHICO, CA 95973.

LATE CHARGE. If a payment is 10 days or more late, Borrower will be charged
5.000% of the regularly scheduled payment.

INTEREST AFTER DEFAULT. Upon Borrower's failure to pay all amounts declared due
pursuant to this section, including failure to pay upon final maturity, the
total sum due under this Agreement will bear interest from the date of
acceleration or maturity at the interest rate on this Agreement.

DEFAULT. Each of the following shall constitute an Event of Default under this
Agreement:

         PAYMENT DEFAULT. Borrower fails to make any payment when due under the
         indebtedness.

         OTHER DEFAULTS. Borrower fails to comply with or to perform any other
         term, obligation, covenant or condition contained in this Agreement or
         in any of the Related Documents or to comply with or to perform any
         term, obligation, covenant or condition contained in any other
         agreement between Lender and Borrower.

         FALSE STATEMENTS. Any warranty, representation or statement made or
         furnished to Lender by Borrower or on Borrower's behalf under this
         Agreement or the Related Documents is false or misleading in any
         material respect, either now or at the time made or furnished or
         becomes false or misleading at any time thereafter.

         INSOLVENCY. The dissolution or termination of Borrower's existence as a
         going business, the insolvency of Borrower, the appointment of a
         receiver for any part of Borrower's property, any assignment for the
         benefit of creditors, any type of creditor workout, or the commencement
         of any proceeding under any bankruptcy or insolvency laws by or against
         Borrower.

         CREDITOR OR FORFEITURE PROCEEDINGS. Commencement of foreclosure or
         forfeiture proceedings, whether by judicial proceeding, self-help,
         repossession or any other method, by any creditor of Borrower or by any
         governmental agency against any collateral securing the indebtedness.
         This includes a garnishment of any of Borrower's accounts, including
         deposit accounts, with Lender. However, this Event of Default shall not
         apply if there is a good faith dispute by Borrower as to the validity
         or reasonableness of the claim which is the basis of the creditor or
         forfeiture proceeding and if Borrower gives Lender written notice of
         the creditor or forfeiture proceeding and deposits with Lender monies
         or a surety bond for the creditor or forfeiture proceeding, in an
         amount determined by Lender, in its sole discretion, as being an
         adequate reserve or bond for the dispute.

         EVENTS AFFECTING GUARANTOR. Any of the preceding events occurs with
         respect to any guarantor, endorser, surety, or accommodation party of
         any of the indebtedness or any guarantor, endorser, surety, or
         accommodation party dies or becomes incompetent, or revokes or disputes
         the validity of, or liability under, any Guaranty of the indebtedness
         evidenced by this Note. In the event of a death, Lender, at its option,
         may, but shall not be required to, permit the guarantor's estate to
         assume unconditionally the obligations arising under the guaranty in a
         manner satisfactory to Lender, and, in doing so, cure any Event of
         Default.

         CHANGE IN OWNERSHIP. Any change in ownership of twenty-five percent
         (25%) or more of the common stock of Borrower.

         ADVERSE CHANGE. A material adverse change occurs in Borrower's
         financial condition, or Lender believes the prospect of payment or
         performance of the indebtedness is impaired.

         INSECURITY. Lender in good faith believes itself insecure.

         CURE PROVISIONS. If any default, other than a default in payment is
         curable and if Borrower has not been given a notice of a breach of the
         same provision of this Agreement within the preceding twelve (12)
         months, it may be cured (and no event of default will have occurred) if
         Borrower, after receiving written notice from Lender demanding cure of
         such default: (1) cures the default within fifteen (15) days; or (2) if
         the cure requires more than fifteen (15) days, immediately initiates
         steps which Lender deems in Lender's sole discretion to be sufficient
         to cure the default and thereafter continues and completes all
         reasonable and necessary steps sufficient to produce compliance as soon
         as reasonably practical.

LENDER'S RIGHTS. Upon default, Lender may declare the entire unpaid principal
balance on this Agreement and all accrued unpaid interest immediately due, and
then Borrower will pay that amount.

ATTORNEYS' FEES; EXPENSES. Lender may hire or pay someone else to help collect
this Agreement if Borrower does not pay. Borrower will pay Lender that amount.
This includes, subject to any limits under applicable law, Lender's attorneys'
fees and Lender's legal expenses, whether or not there is a lawsuit, including
attorneys' fees, expenses for bankruptcy proceedings (including efforts to
modify or vacate any automatic stay or injunction), and appeals. Borrower also
will pay any court costs, in addition to all other sums provided by law.

GOVERNING LAW. This Agreement will be governed by, construed and enforced in
accordance with federal law and the laws of the State of California. This
Agreement has been accepted by Lender in the State of California.

CHOICE OF VENUE. If there is a lawsuit, Borrower agrees upon Lender's request to
submit to the jurisdiction of the courts of BUTTE County, State of California.

DISHONORED ITEM FEE. Borrower will pay a fee to Lender of $10.00 if Borrower
makes a payment on Borrower's loan and the check or preauthorized charge with
which Borrower pays is later dishonored.

COLLATERAL. Borrower acknowledges this Agreement is secured by the following
collateral described in the security instrument listed herein: a Deed of Trust
dated November 10, 2002, to a trustee in favor of Lender on real property
located in BUTTE County, State of California. That agreement


                               CHANGE IN TERMS AGREEMENT
Loan No: 0400706081                   (CONTINUED)                         PAGE 2
- --------------------------------------------------------------------------------

contains the following due on sale provision: Lender may, at Lender's option,
declare immediately due and payable all sums secured by the Deed of Trust upon
the sale or transfer, without Lender's prior written consent, of all or any
part of the Real Property, or any interest in the Real Property. A "sale or
transfer" means the conveyance of Real Property or any right, title or interest
in the Real Property; whether legal, beneficial or equitable; whether voluntary
or involuntary; whether by outright sale, deed, installment sale contract, land
contract, contract for deed, leasehold interest with a term greater than three
(3) years, lease-option contract, or by sale, assignment, or transfer of any
beneficial interest in or to any land trust holding title to the Real Property,
or by any other method of conveyance of an interest in the Real Property. If
any Borrower is a corporation, partnership or limited liability company,
transfer also includes any change in ownership of more than twenty-five percent
(25%) of the voting stock, partnership interests or limited liability company
interests, as the case may be, of such Borrower. However, this option shall not
be exercised by Lender if such exercise is prohibited by applicable law.

LINE OF CREDIT. This Agreement evidences a straight line of credit. Once the
total amount of principal has been advanced, Borrower is not entitled to further
loan advances. Advances under this Agreement may be requested orally by
Borrower or as provided in this paragraph. Lender may, but need not, require
that all oral requests be confirmed in writing. All communications,
instructions, or directions by telephone or otherwise to Lender are to be
directed to Lender's office shown above. The following persons currently are
authorized to request advances and authorize payments under the line of credit
until Lender receives from Borrower, at Lender's address shown above, written
notice of revocation of their authority; ALEX N. WATT, Executive VP/Secretary
of FAFCO, INC.; NANCY I. GARVIN, Vice President of Finance of FAFCO, INC.; and
FREEMAN A. FORD, President of FAFCO, INC. Borrower agrees to be liable for all
sums either: 1. advanced in accordance with the instructions of an authorized
person or 2. credited to any of Borrower's accounts with Lender. The unpaid
principal balance owing on this Agreement at any time may be evidenced by
endorsements on this Agreement or by Lender's internal records, including daily
computer print-outs.

CONTINUING VALIDITY. Except as expressly changed by this Agreement, the terms of
the original obligation or obligations, including all agreements evidenced or
securing the obligation(s), remain unchanged and in full force and effect.
Consent by Lender to this Agreement does not waive Lender's right to strict
performance of the obligation(s) as changed, nor obligate Lender to make any
future change in terms. Nothing in this Agreement will constitute a satisfaction
of the obligation(s). It is the intention of Lender to retain as liable parties
all makers and endorsers of the original obligation(s), including accommodation
parties, unless a party is expressly released by Lender in writing. Any maker or
endorser, including accommodation makers, will not be released by virtue of this
Agreement. If any person who signed the original obligation does not sign this
Agreement below, then all persons signing below acknowledge that this Agreement
is given conditionally, based on the representation to Lender that the
non-signing party consents to the changes and provisions of this Agreement or
otherwise will not be released by it. This waiver applies not only to any
initial extension, modification or release, but also to all such subsequent
actions.

SUCCESSORS AND ASSIGNS. Subject to any limitations stated in this Agreement on
transfer of borrower's interest, this Agreement shall be binding upon and inure
to the benefit of the parties, their successors and assigns. If ownership of
the Collateral becomes vested in a person other than Borrower, Lender, without
notice to Borrower, may deal with Borrower's successors with reference to this
Agreement and the Indebtedness by way of forbearance or extension without
releasing Borrower from the obligations of this Agreement or liability under
the Indebtedness.

NOTIFY US OF INACCURATE INFORMATION WE REPORT TO CONSUMER REPORTING AGENCIES.
Please notify us if we report any inaccurate information about your account(s)
to a consumer reporting agency. Your written notice describing the specific
inaccuracy(ies) should be sent to us at the following address: Butte Community
Bank, CHICO OFFICE, 2041 FOREST AVE, CHICO, CA 95928.

MISCELLANEOUS PROVISIONS. Lender may delay or forgo enforcing any of its rights
or remedies under this Agreement without losing them. Borrower and any other
person who signs, guarantees or endorses this Agreement, to the extent allowed
by law, waive any applicable statute of limitations, presentment, demand for
payment, and notice of dishonor. Upon any change in the terms of this Agreement,
and unless otherwise expressly stated in writing, no party who signs this
Agreement, whether as maker, guarantor, accommodation maker or endorser, shall
be released from liability. All such parties agree that Lender may renew or
extend (repeatedly and for any length of time) this loan or release any party or
guarantor or collateral; or impair, fail to realize upon or perfect Lender's
security interest in the collateral; and take any other action deemed necessary
by Lender without the consent of or notice to anyone. All such parties also
agree that Lender may modify this loan without the consent of or notice to
anyone other than the party with whom the modification is made. The obligations
under this Agreement are joint and several.

PRIOR TO SIGNING THIS AGREEMENT, BORROWER READ AND UNDERSTOOD ALL THE
PROVISIONS OF THIS AGREEMENT. BORROWER AGREES TO THE TERMS OF THE AGREEMENT.


CIT SIGNERS:


FAFCO, INC.

BY:  /S/ Nancy I. Garvin
    -----------------------------------------------------------------
    NANCY I. GARVIN, VICE PRESIDENT OF FINANCE OF
    FAFCO, INC.

- -------------------------------------------------------------------------------

EX-99.1

                                  EXHIBIT 99.1

                    CERTIFICATION OF CHIEF EXECUTIVE OFFICER
                                   PURSUANT TO
                             18 U.S.C. SECTION 1350,
                             AS ADOPTED PURSUANT TO
                  SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

I, Freeman A. Ford, certify, pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that the Annual
Report of FAFCO, Inc. on Form 10-K for the annual period ended December 31, 2002
fully complies with the requirements of Section 13(a) or 15(d) of the Securities
Exchange Act of 1934 and that information contained in such Annual Report on
Form 10-K fairly presents in all material respects the financial condition and
results of operations of FAFCO, Inc.

                                                By:  /s/ FREEMAN A. FORD
                                                     ---------------------------
                                                Name:  Freeman A. Ford
                                                Title:   Chief Executive Officer

                    CERTIFICATION OF CHIEF FINANCIAL OFFICER
                                   PURSUANT TO
                             18 U.S.C. SECTION 1350,
                             AS ADOPTED PURSUANT TO
                  SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

I, Nancy Garvin, certify, pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that the Annual
Report of FAFCO, Inc. on Form 10-K for the annual period ended December 31, 2002
fully complies with the requirements of Section 13(a) or 15(d) of the Securities
Exchange Act of 1934 and that information contained in such Annual Report on
Form 10-K fairly presents in all material respects the financial condition and
results of operations of FAFCO, Inc.

                                                By: /s/ NANCY GARVIN
                                                     ---------------------------
                                                Name: Nancy Garvin
                                                Title:   Chief Financial Officer