FAFCO, Inc. designs, manufactures and markets heat exchangers made primarily of
polymers for use in solar swimming pool heating and for thermal energy storage.
FAFCO markets its swimming pool products in the United States and overseas
through independent distributors who sell directly to end users. The Company
markets its IceStor products in the United States through independent
manufacturers' representatives. The Company also licenses its IceStor products
overseas.
FAFCO has manufactured over one million polymer heat exchangers since its
incorporation in 1972. The heat exchangers are made using proprietary and
patented processing technology. The Company is the largest manufacturer of
solar pool heating systems in the United States.
In 1987, FAFCO introduced IceStor, a static glycol ice builder for the thermal
storage market. The FAFCO IceStor utilizes a variation of the Company's polymer
heat exchanger placed in a galvanized steel container. The IceStor products, a
demand-side management for electric utilities, use chilled glycol flowing
through the heat exchanger to convert a static volume of water in the container
to ice. The ice is made at night using less expensive "off-peak" power. The
cooling energy stored in the ice is then reclaimed the next day during "peak
periods" to provide space or process cooling. The result is lowered cooling
costs.
FAFCO's products are manufactured and marketed with a common founding strategy
outlined below:
- - The choice of markets where high market share or growth are likely.
- - A high value-added manufacturing process that minimizes direct labor in
favor of proprietary processes.
- - An effort to maximize gross margin based on sophisticated manufacturing in
high volume to enable economies of scale.
- - Experienced management whose capabilities exceed the immediate demands of
the business.
- - A resolution to combine the foregoing to build a large and successful
enterprise.
Dear Fellow Shareholders:
In 1995, FAFCO interrupted seven years of continuous profitability with a loss
of $1,918,300 on net sales of $7,876,100. In 1996, strong growth in solar and
foreign IceStor sales combined with a substantial overhead reduction to yield a
profit of $386,800 on sales of $8,868,600. In 1997, solar and IceStor sales are
expected to grow. At the same time, our fixed overhead has been reduced to
approximately the same level as 1993. Consequently, we are hopeful that FAFCO's
profitability will continue in 1997.
Our belief is based on two simple premises. Foreign sales of our IceStor
products are expected to continue in 1997. Similarly, our newly introduced
Revolution and above ground solar pool heating products will allow us to grow
our solar business.
Foreign sales of our IceStor thermal energy storage products grew rapidly in
1996. Our IceStor products make use of our core competency in polymer heat
exchangers. This product line mitigates electrical shortages by making
efficient use of existing electrical generating capacity. Foreign sales are
expected to continue to grow in 1997 for four reasons:
- - We have focused on Asia where a warm climate, rapid growth in new
construction and limited electricity reserves create an ideal market for
thermal energy storage. The FAFCO IceStor product line allows electric
utilities to make better use of their resources.
- - Our technology lends itself to low-cost distribution through less expensive
sea container shipment combined with local assembly based on proprietary
manufacturing technology.
- - Our belief is that certain markets such as Japan and the People's Republic
of China are beginning to grow rapidly.
- - We are taking initiatives in other foreign countries, which show promise of
substantial future growth.
- - Solar sales are expected to grow in 1997 for three reasons:
- - Our Revolution solar product was introduced in mid 1996. As the name implies,
it is the most significant product improvement made by FAFCO since 1976. Our
customers are responding. We have applied for patent protection on this new
technology.
- - Our above ground pool system was introduced in 1996 and sales of this
product are expected to grow in 1997. We have applied for patent protection
for this technology as well.
- - In 1996, we successfully targeted the solar pool heating market outside of
California and Florida. We hope our success will continue in 1997.
Deregulation in the utilities industry made 1996 a disappointing year for our
domestic IceStor sales. In 1996, FAFCO management developed and implemented an
aggressive strategy to increase domestic sales. We hope to see positive results
from this strategy in 1997.
We believe that our best chance for success lies in focusing on our core
competency. In an effort to improve our business portfolio, we are no longer
producing electronic controls. Looking forward, our technical resources will
focus on supporting solar, thermal energy storage and other heat exchanger
applications that use FAFCO's core competence in manufacturing polymer heat
exchangers.
In 1996, we saw our 1995 investments in solar and IceStor begin to pay off. As
we move into 1997, we are leaner, more efficient and, frankly, a better
company. Low operating expenses combined with sales growth will allow us to
make the most of our investments and the significant opportunities we have
identified for FAFCO in 1997.
Finally, the financial turnaround in 1996 and the continuing momentum we are
seeing in 1997 would not have been possible without the dedication to
efficiency and loyalty of each of our employees. My thanks go out to each of
you.
Sincerely,
Freeman A. Ford
President
Consolidated Balance Sheet
December 31, 1996 1995
Assets
Current assets:
Cash and cash equivalents $ 88,200 $126,200
Accounts receivable, less allowance for doubtful
accounts of $512,600 in 1996 and $463,900 in 1995 1,890,700 1,149,600
Current portion of long-term notes receivable (net) 229,100 64,000
Inventories 835,400 717,200
Prepaid expenses and other current assets 150,800 145,500
Other accounts receivable, net of allowance 4,500
Deferred tax asset, net of allowance 221,500 125,200
Total current assets 3,420,200 2,327,700
Plant and equipment, at cost 2,465,800 2,345,100
Less accumulated depreciation and amortization (2,116,200) (2,085,900)
349,600 259,200
Notes receivable and other assets (net) 65,500 327,700
Deferred tax asset, net of allowance 427,900 485,800
Total assets $4,263,200 $ 3,400,400
Liabilities and shareholders' equity
Current liabilities:
Bank line of credit $758,600 $751,300
Accounts payable and other accrued expenses 1,037,800 949,100
Accrued compensation and benefits 187,000 188,900
Accrued warranty expense 234,100 216,000
Total current liabilities 2,217,500 2,105,300
Convertible subordinated notes ($600,000 and
$425,000 were owed to related parties in 1996
and 1995, respectively) 925,000 600,000
Other non-current liabilities 26,400 80,400
Total liabilities $3,168,900 $ 2,785,700
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; 3,298,311 issued and
outstanding in 1996 and 3,112,687 issued
and outstanding in 1995 412,200 389,000
Capital in excess of par value 5,105,200 5,035,600
Notes receivable secured by Common Stock (75,100) (75,100)
Accumulated deficit (4,348,000) (4,734,800)
Total shareholders, equity $1,094,300 $ 614,700
Commitments and contingent liabilities
Total liabilities and shareholders' equity $4,263,200 $ 3,400,400
The accompanying notes are an integral part of this statement.
Year ended December 31, 1996 1995 1994
Net sales $8,868,600 $7,876,100 $10,526,000
Other income (net) 54,000 39,700 108,800
Total revenues 8,922,600 7,915,800 10,634,800
Cost of goods sold 5,424,900 5,637,900 6,542,900
Marketing and selling expense 1,575,400 2,137,200 1,767,500
General and administrative expense 1,286,300 1,502,000 1,257,100
Research and development expense 116,000 460,100 484,300
Net interest expense 169,900 95,300 79,400
Total costs and expenses 8,572,500 9,832,500 10,131,200
Income (loss) before income taxes 350,100 (1,916,700) 503,600
Provision for (benefit from) income taxes (36,700) 1,600 49,100
Net income (loss) $386,800 $(1,918,300) $454,500
Primary net income (loss) per share $0.12 $(0.62) $0.13
Fully diluted net income (loss) per share $0.12 $(0.62) $0.13
The accompanying notes are an integral part of this statement.
Number of Common Capital in Notes Retained
Shares Stock Excess of Receivable Earnings
Par Value Secured by
Common Stock
Balance at December
31,1993 3,051,755 $381,500 $5,026,600 $(99,100) $(3,271,000)
Net income for the year 454,500
Cancellation of shares and
related notes receivable of
other notes receivable (32,000) (4,000) (20,000) 24,000
Cancellation of shares in
satisfaction of other notes
receivable (11,218) (1,400) (7,000)
Issuance of shares
pursuant to exercise of
Directors' Warrants 15,000 1,900 5,600
Issuance of shares under
the 1981 Employee
Incentive Stock Option
Plan 77,850 9,700 29,200
Cancellation of shares
pursuant to a rescission
offer (500) (100) (300)
Balance at December
31, 1994 3,100,887 $387,600 $5,034,100 $(75,100) $(2,816,500)
Net loss for the year (1,918,300)
Cancellation of shares in
satisfaction of other notes
receivable (3,000) (400) (4,100)
Issuance of shares under
the 1981 Employee
Incentive Stock Option
Plan 8,800 1,100 3,300
Issuance of shares under
the 1991 Employee
Incentive Stock Option
Plan 6,000 700 2,300
Balance at December 31,
1995 3,112,687 $389,000 $5,035,600 $(75,100) $4,734,800)
Net income for the year 386,800
Issuance of shares
pursuant to exercise of
subordinated note
conversion option 185,624 23,200 69,600
Balance at December 31,
1996 3,298,311 $412,200 $5,105,200 $(75,100) $(4,348,000)
The accompanying notes are an integral part of this statement.
Year Ended December 31, 1996 1995 1994
Cash flow from Operating activities:
Net income (loss) $386,800 $(1,918,300) $454,500
Adjustments to reconcile net income
(loss) to net cash provided by (used
in) operating activities:
Depreciation 121,200 178,700 169,400
Allowance for doubtful accounts 48,700 33,900 51,700
Provision for inventory reserve 42,400 105,800 (800)
(Gain) loss on disposition of fixed
assets (18,700) 22,700
Change in assets and liabilities:
Change in receivables (794,300) 1,367,800 (372,400)
Change in inventories (160,600) 20,200 (86,200)
Change in prepaid expenses (5,300) (28,600) 55,900
Change in deferred tax assets (38,400)
CHange in other assets 97,100 (333,000) 9,90O
Change in payables and accrued
expenses 104,900 (288,900) 63,800
Change in other non-current
liabilities (54,000) (27,800) (6,300)
Net cash (used in) provided by
operations (270,200) (867,500) 340,200
Cash flow from investing activities:
Purchase of fixed assets (211,600) (81,300) (104,900)
Proceeds from sale of fixed assets 18,700
Net cash used in investing
activities (192,900) (81,300) (104,900)
Cash flow from financing activities:
Proceeds of subordinated debt
issuance 325,000
Proceeds from sale of common stock 92,800 7,400 46,000
Payments on line of credit (1,350,000) (490,000)
Borrowings on line of credit 1,357,300 1,241,300
Miscellaneous borrowings (21,700) (19,300)
Net cash provided by (used in)
financing activities 425,100 737,000 26,700
Net (decrease) increase in cash
and cash equivalents (38,000) (211,800) 262,000
Cash and cash equivalents,
beginning of year 126,200 338,000 76,000
Cash and cash equivalents, end
of year $88,200 $126,200 $338,000
Supplemental disclosures of
cash flow information:
Cash paid during the year for
interest $159,339 $89,800 $83,400
Net cash paid during the year
for income taxes $7,500 $49,000
The accompanying notes are an integral part of this statement.
NOTE TO CONSOLIDATED FINANCIAL STATEMENTS
1. Organization and Summary of - Significant Accounting Policies
The Company designs, develops, manufactures and markets solar heating systems
for swimming pools and thermal energy storage systems for commercial and
industrial cooling. The solar heating systems are sold to wholesalers and
distributors primarily in California and Florida and in other locations in
the United States and overseas. Thermal energy storage systems are marketed
through manufacturers' representatives throughout the United States and
internationally. Three of the Company's customers each accounted for more
than 10% of the Company's fiscal 1996 net sales. One of the Company's
customers accounted for 10% of the Company's fiscal 1995 net sales. No
customer accounted for 10% or more of the Company's sales in fiscal 1994.
During 1996, the Company had sales to unaffiliated customers in foreign
countries amounting to 14% of total net sales. During 1995 and 1994, such sales
amounted to 15% of total net sales. A summary of significant accounting
policies follows:
Principles of Consolidation: The consolidated financial statements include the
accounts of FAFCO, Inc. and its wholly-owned subsidiary. All significant
inter-company balances and transactions have been eliminated in consolidation.
Revenue Recognition: Revenues on sales of products are recognized at the time
of shipment of goods or performance of service.
Use of Estimates: The preparation of financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ materially from those estimates.
Cash and Cash Equivalents: For purposes of reporting cash flows, cash and cash
equivalents include highly liquid investments with a maturity of three months
or less.
Inventories: Inventories are stated at the lower of cost or market determined
using the last-in, first-out (LIFO) method. At December 31, 1996 and 1995,
inventories would have been approximately $917,400 and $874,600, respectively,
if the first-in, first-out method had been used.
Plant and Equipment: Plant and equipment are stated based on historical cost
adjusted for accumulated depreciation. Depreciation and amortization of plant
and equipment, excluding vehicles and leasehold improvements, are determined
using accelerated methods. For vehicles and leasehold improvements, the
straight line method is used. The estimated useful lives of the assets range
between three and ten years. Minor replacements, improvements, maintenance
and repairs are expensed as incurred. Major replacements and improvements are
capitalized and depreciated over the remaining useful life of the related
asset. Gains and losses on sales and retirement of plant and equipment are
credited or charged to income.
Accounting for the Impairment of Long-lived Assets and for Long-lived Assets
to be Disposed of: As required by generally accepted accounting principles
(GAAP), effective January 1, 1996, the Company adopted Statement of Financial
Accounting Standards No. 121, "Accounting for the Impairment of Long-lived
Assets and for Long-lived Assets to be Disposed of." The new standard provides
guidance on when to recognize and how to measure impairment losses of long-
lived assets and certain identifiable intangibles and how to value long-lived
assets to be disposed of. The new standard had no material effect on the
Consolidated Balance Sheets for 1996 and 1995 nor the Consolidated Statements
of Operations for 1996, 1995 or 1994.
Income Taxes: As required by generally accepted accounting principles (GAAP)
effective January 1, 1993, the Company adopted Statement of Financial
Accounting Standards No. 109, "Accounting for Income Taxes" (FAS No. 109), on a
prospective basis. The new standard requires an asset and liability approach
for financial accounting and reporting for income taxes. Under this approach,
deferred tax assets and liabilities are recognized for the tax consequences
of temporary differences between the financial reporting and tax basis of
assets and liabilities. (See Note 8.)
Concentration of Credit Risk: Most of the Company's business activity is with
customers located in California, Florida and foreign countries. As of December
31,1996, unsecured trade accounts receivable from customers in California,
Florida and foreign countries were $513,900, $824,400, and $789,300.
Warranties: In the normal course of business, the Company makes certain
warranties as to workmanship and materials. Product warranty periods range from
two to ten years for full coverage. The estimated future expense of these
warranties is accrued at the time of sale. The estimates inherent in accounting
for such warranties are reviewed and revisions to previous estimates are made
as required to reflect the most current information available.
Net Income per Share: Net income per share is based on the sum of the weighted
average number of shares issued and outstanding during the year (see Note 12).
Accounting for Stock-Based Compensation: The FASB issued a new standard, FAS
No. 123, "Accounting for Stock-Based Compensation," which contains a fair
value-based method for valuing stockbased compensation that entities may use,
which measures compensation cost at the grant date based on the fair value of
the award. Compensation is then recognized over the service period.
Alternatively, the standard permits entities to continue accounting for
employee stock options and similar equity instruments under APB Opinion 25,
"Accounting for Stock Issued to Employees." Entities that continue to account
for stock options using APB Opinion 25 are required to make pro forma
disclosures of net income and earnings per share, as if the fair value-based
method of accounting defined in FAS No. 123 had been adopted. The Company has
decided to continue accounting for employee stock options and similar equity
instruments under APB Opinion 25, "Accounting for Stock Issued to Employees."
(see Note 7.)
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, l; 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, 1996, the carrying amount approximates estimated
fair value of longterm debt.
2. Inventories
Inventories consist of the following:
December 31, 1996 1995
Raw materials $370,500 $395,200
Work in progres s 100,800 118,500
Finished goods 364,100 203,500
$835,400 $717,200
3. Plant and Equipment
Plant and equipment consists of the following:
December31, 1996 1995
Machinery and equipment $1,902,800 $1,754,500
Office and computer equipment 372,000 370,500
Leasehold improvements 88,600 88,600
Vehicles 101,800 131,500
$2,465,800 $2,345,100
Less accumulated depreciation
and amortization (2,116,200) (2,085,900)
$349,600 $259,200
Notes Receivable
During 1996, the Company converted $4,700 of accounts receivable from a
customer into a note receivable. During 1995, the Company converted $429,700 of
ccounts receivable from two customers into notes receivable, one of which is
secured by an interest in real property. All of the notes are being repaid in
monthly installments.
5. Convertible Subordinated Notes
The notes outstanding at December 31, 1995 were due on March 27, 1996, bore
interest at 10% per annum payable quarterly, and were partially convertible
into Common Stock of the Company at any time at the option of the holder. The
notes were subordinated to any bank debt or other senior indebtedness (as
defined) of the Company. The Company could, at its option, call the notes for
redemption at any time. The conversion price was $0.50 per share and the
maximum aggregate number of shares issuable upon conversion of all of the notes
was 270,000 shares.
In February 1996, the Company borrowed an additional $325,000 from certain of
the noteholders,with interest at 12%, in the form of bridge financing, through
March 27, 1996, $125,000 of which was from related parties (see Note 9). On
March 27, 1996, four of the Noteholders exercised the conversion option and
acquired a total of 185,624 shares of FAFCO Common Stock of which 140,624 were
acquired by related parties. On March 27, 1996, the Company exchanged the
$600,000 of convertible subordinated notes and the $325,000 of bridge notes for
new notes, due March 27, 2000, bearing interest at 11% per annum payable
quarterly and warrants to purchase Common Stock. The exercise price of the
warrants is $0.125 per share, the maximum aggregate number of shares issuable
is 555,000, and the unexercised warrants expire March 27, 2000.
6. Bank Line of Credit
The Company has a bank line of credit secured by substantially all the assets
of the Company. The line of credit allows the Company to borrow the lesser of
$1,000,000 or an amount determined by a formula applied to net accounts
receivable, inventories, and net plant and equipment. Amounts borrowed bear
interest at the bank's prime rate plus 2%. The line of credit contains certain
covenants relating to working capital, current ratio, and tangible net worth,
prohibits the payment of cash dividends and expires on June 6, 1997. At
December 31, 1996 and 1995, the Company had complied with or obtained waivers
for compliance with the loan covenants.
As of December 31, 1996 and 1995, the Company had utilized $758,600 and
$751,300, respectively, of this facility.
During March 1997, the line of credit was extended through March 31, 1998.
7. Shareholders' Equity
The Board of Directors, without shareholder approval, may determine the rights,
preferences, privileges, and restrictions of the Company's unissued Preferred
Stock. Such shares may be issued in one or more series.
In 1980, the Company issued 202,300 shares of Common Stock at a price of $2.43
per share in exchange for non-interest bearing promissory notes, which have a
balance due of $75,100 at December 31, 1996 and 1995. The notes are due and
payable and the Company intends to pursue collection of these notes. In the
event that any of the notes are uncollectible, the Company will demand
surrender of the related shares issued and will cancel and write off the
related notes receivable balance.
Under the Company's Employee Stock Purchase Plan, 150,000 shares of Common
Stock have been reserved for issuance at 85% of fair market value as of
specified dates. The Plan was suspended in 1991 and no shares were issued
thereunder since 1991.
The Company has a 1991 Incentive Stock Option Plan under which 250,000 shares
of Common Stock were reserved for issuance to employees and consultants. During
November 1994, the Board of Directors approved an increase in the number of
shares of Common Stock reserved for issuance to a total of 500,000 shares
subject to shareholder approval, which was obtained in April 1995. During 1993,
options were granted to purchase 214,000 shares exercisable at $0.50 per share,
the fair market value on the date of grant. No options were granted or execised
under the 1991 plan during 1994. During 1995, options were granted to purchase
124,000 shares exercisable at $0.56 per share, the fair market value on the
date of grant. During 1995, options to purchase 6,000 shares were exercised.
During 1996, options were granted to purchase 236,950 shares exercisable at
$0.125 per share, the fair market value on the date of grant.
The Company has a 1991 Director's Stock Option Plan under which 50,000 shares
of Common Stock are reserved for issuance. During 1991, options were granted to
purchase a total of 20,000 shares at $0.50 per share, the fair market value at
date of grant, to two outside directors. During 1993, options were granted to
purchase a total of 10,000 shares at $0.50 per share, the fair market value at
date of grant, to two outside directors. None of these options have been
exercised. No options were granted or exercised during 1994, 1995, or 1996.
Options granted under these plans vest at 20% per year for five years from date
of grant and expire six years or ten years from date of grant.
During 1994, the Company granted nonqualified options to purchase a total of
43,218 shares at $0.75 per share to a consultant and four employees and during
1995, the Company granted nonqualified options to purchase 20,000 shares at
$0.56 per share to a consultant. These options were fully vested at the date of
grant and expire six years from date of grant. None of these options have been
exercised. During 1995, options to purchase 234 shares were canceled.
A summary of activity under the 1981 and 1991 Incentive Stock Option Plans
follows:
Shares Subject to Option Exercise Price Per Share
Outstanding at December 31, 1993 417,900 $0.50-0.625
Granted 0
Canceled (7,500) $0.500
Exercised (77,850) $0.500
Outstanding at December 31, 1994 332,550 $0.50-0.625
Granted 124,000 $0.50
Canceled (166,300) $0.50-0.560
Exercised (14,800) $0.500
Outstanding at December 31, 1995 275,450 $0.50-0.625
Granted 236,950 $0.125
Canceled (126,650) $0.50-0.560
Exercised 0
Outstanding at December 31, 1996
385,450 $0.125-0.625
The Company applies APB Opinion 25 in accounting for its stock option plans.
Accordingly, no compensation cost has been recognized for the plan in 1995 or
1996. Had compensation cost been determined on the basis of fair value pursuant
to FASB Statement No. 123, net income and earnings per share would have been
reduced as follows:
1996 1995 1994
Net income (loss) As reported $386,800 $(1,918,300) $454,500
Pro forma $367,100 $(1,919,500) $453,700
Primary earnings (loss) per
share As reported $0.12 $(0.62) $0.13
Fully diluted earnings (loss)
per share as reported $0.12 $(0.62) $0.13
Pro forma $0.11 $(0.62) $0.13
The fair value of each option granted was estimated on the grant date using the
Black-Scholes model. The following assumptions were made in estimating fair
value:
Assumption
Dividend yield 0%
Risk-free interest rate 6.50%
Expected life 6 years
Expected volatility 96.74%
Following is a summary of the status of the plans during 1996, 1995, and 1994.
Weighted
Number Average
of Exercise
Shares Price
Outstanding at January 1, 1996 275,450 $0.488
Granted 236,950 0.125
Exercised 0 0
Forfeited (126,950) 0.502
Outstanding at December 31, 1996 385,450 0.258
Options exercisable at December
31, 1996 199,650 0.297
Weighted average fair value of
options granted during 1996 $.0101
Weighted
Number Average
of Exercise
Shares Price
Outstanding at January 1,1995 332,550 $0.5020
Granted 124,000 0.5100
Exercised (14,800) 0.5000
Forfeited (166,300) 0.0536
Outstanding at December31, 1995 275,450 0.4850
Options exercisable at
December 31, 1995 163,750 0.5030
Weighted average fair value of
options granted during 1995 $0.41
The range of exercise prices for the options outstanding at December 31, 1996
is $0.125-$0.625 with a weighted average contractual life of 5 years. The
Company estimates that based on vesting at 20% per year at December 31, 1996,
approximately 100% of such options will eventually vest.
Weighted
Number Average
of Exercise
Shares Price
Outstanding January 1, 1994 417,900 $0.501
Granted 0 N/A
Exercised (77,850) 0.500
Forfeited (7,500) 0.500
Outstanding at December 31,
1994 332,500 0.502
Options exercisable at
December 31, 1994 139,040 0.503
Weighted average fair
value of options granted
during 1994 N/A
Following is a summary of the status of options outstanding at December 31,
1996:
Outstanding Exercisable
Weighted
Average Weighted Weighted
Exercise Number Remaining Average Average
Price Contractural Exercise Exercise
Range Number Life Price Number Price
$0.625 5,000 1 $0.625 5,000 0.625
$0.500 123,500 3 $0.500 83,700 $0.500
$0.250 20,000 5 $0.250 4,000 $0.250
$0.125 236,960 6 $0.125 106,950 $0.125
----------- -------
$385,450 5 199,650
The range of exercise prices for the options outstanding at December 31, 1996
is $0.125-$0.625 with a weighted average contractual life of 5 years. The
Company estimated that based on vesting at 20% per year at December 31, 1996,
approximately 100% of such options will eventually vest.
8. Income Taxes
The provisions for income taxes consist of the following:
Years Ended December 31, 1996 1995 1994
Taxes on income:
U.S. Federal
Current $0 $0 $5,300
Deferred (40,300) 0 6,600
(40,300) 0 11,900
State
Current 1,600 1,600 43,100
Deferred 2,000 (5,900)
3,600 1,600 37,200
Net income tax
(benefit) provision $(36,700) $1,600 $49,100
Effective January 1, 1993, as required by GAAP, the Company changed its method
of account from income taxes by adopting FAS No. 109.
A reconciliation of the statutory federal income tax rate with the effective
tax rate reported in the financial statements follows:
Years Ended December 31, 1996 1995 1994
Statutory federal income
tax (benefit) rate 34.0% (34.0%) 34.0%
Effect on tax rate
resulting from: State and
foreign income taxes, net
of federal tax benefit 7.7% (1.4%) 6.0%
Tax effect of change in
valuation allowance (58.8%) 40.9% (49.4%)
Expiration of tax credits 2.0% 0.7% (18.2%)
Other 0.6% (6.2%) (0.4%)
Effective tax rate (10.5%) 0% 8.4%
The Company records its deferred taxes on a tax jurisdiction basis and, with
the adoption of FAS No. 109 in 1993, classifies those net amounts as current or
noncurrent based on the balance sheet classifications.
Deferred tax assets are comprised of the following:
December 31, 1996 1995
Allowance for doubtful accounts $215,600 197,000
Accrued expenses 184,300 142,300
Loss carryforwards 1,157,800 1,360,500
Tax credits 175,700 178,600
Other 107,800 116,400
1,841,200 1,994,800
Deferred tax asset
valuation allowance $(1,191,800) (1,383,800)
Total deferred taxes, net $ 649,400 $ 611,000
The Company had unused federal net operating loss carryforwards of
approximately $3,191,500 and $3,669,700, state loss carryforwards of
approximately $1,083,000 and $1,554,100, and investment and other tax credits
of approximately $175,700 and $178,600 available to offset future tax
liabilities at December 31, 1996 and December 31, 1995, respectively. The net
operating losses and credits expire in varying amounts until 2010. The use of
the tax credits has been limited by the provisions of the Tax Reform Act of
1986 to reflect the benefit associated with an overall reduction in the
corporate tax rate. The Company believes that the "total deferred taxes, net"
in the amount of $649,400 is more likely than not to be realized.
9. Transactions with Related Parties
The Company has a financing agreement with Freeman A. Ford, an officer,
director, and major shareholder of the Company, under which Mr. Ford has made a
$275,000 line of credit available to the Company. Borrowings under the line of
credit bear interest at Silicon Valley Bank's prime rate plus 4%. Pursuant to
the agreement, Mr. Ford was granted a warrant to purchase 45,000 shares of
Common Stock for making the line available and a warrant to purchase up to
90,000 additional shares of Common Stock under a formula based on usage of the
line of credit. At December 31, 1996 and 1995, the Company had no borrowings
under this line of credit. The line of credit terminated and the outstanding
warrants expired on March 27, 1996.
In 1984, Freeman A. Ford and Janet V. Ford (Mr. Ford's mother) purchased
$100,000 and $50,000 of the Company's convertible subordinated notes,
respectively, from the Company. (See Note 5.) In January 1994, Mr. Ford
purchased $50,000 of the Company's convertible subordinated notes from the
estate of Janet Ford.
In January 1990, David Ford, Kimberly Ford, Tod Ford, and Erin Ford, the
children of Mr. Ford, purchased a total of $125,000 of the Company's
convertible subordinated notes from certain noteholders.
In January 1993, Mr. Ford purchased $100,000 of the Company's convertible
subordinated notes from another noteholder.
In March 1993, Alan G. Carlson, a principal and owner of one of the Company's
customers, purchased $50,000 of the Company's convertible subordinated notes
from another noteholder.
In February 1996, Mr. Ford loaned the Company an additional $100,000 and
Diana Ford (Mr. Ford's wife) loaned the Company $25,000 due in April 1996. On
March 27, 1996, these notes were exchanged for subordinated notes due in March
2000 as part of the Company's refinancing of the outstanding subordinated
notes. (See Note 5.)
In April 1996, the Company granted Mr. Ford a warrant to purchase 123,750
shares of Common Stock.
10. Employee Benefit Plans
The Company has a 401 (k) retirement savings plan for all eligible employees
who have completed one year of service. Eligible employees have the option to
contribute up to 18% of their eligible salary. The Company contributes an
amount equal to 25% of the employee contribution, up to a maximum of $200 per
employee.
11. Lease Commitments
The Company's rental expense, relating primarily to a lease for its office and
manufacturing facility, amounted to $380,300 in 1996, $359,400 in 1995, and
$340,000 in 1994.
At December 31, 1996, minimum annual lease commitments under non-cancellable
leases were as follows:
1997 $397,600
1998 399,700
1999 409,900
Thereafter 139,000
Total $1,346,200
The Company is required to pay property taxes, utilities, and insurance under
certain of these leases, some of which provide for renewal options at the end
of the initial lease term in the year 2000.
12. Net Income Per Share
Primary earnings per share were calculated as follows:
Years ended December 31, 1996 1995 1994
Net income (loss) $386,800 $(1,918,300) $454,500
Average common shares
outstanding 3,254,066 3,102,564 3,035,137
Add: Exercise of options
reduced by the number of
shares purchased with
proceeds N/A N/A 262,892
Add: Exercise of warrants
reduced by the number of
shares purchased with
proceeds N/A N/A 118,261
Adjusted
weighted average shares
outstanding 3,254,066 3,102,564 3,416,290
Earnings(loss) per share $0.12 $(0.62) $0.13
Primary earnings per share are calculated by dividing net income (loss) by the
weighted average number of shares issued and outstanding and shares issuable
upon exercise of dilutive stock options and warrants during each year.
Fully diluted earnings per share were calculated as follows:
Years ended December 31, 1996 1995 1994
Net income (loss) $386,800 $(1,918,300) $454,500
Average common shares
outstanding 3,254,066 3,102,564 3,035,137
Add: Exercise of options
reduced by the number of
shares purchased with
proceeds N/A N/A 262,892
Add: Exercise of warrants
reduced by the number of
shares purchased with
proceeds N/A 118,261 N/A
Adjusted weighted average
shares outstanding 3,254,066 3,102,564 3,416,290
Earnings (loss) per common
share assuming full
dilution $0.12 $(0.62) $0.13
13. Licensing Income
During 1993, the Company entered into two licensee agreements with third
parties in the Far East, under which the Company received and recognized
license fee income net of foreign income taxes of $159,000. The agreements
allow for the licensee to assemble and sell the IceStor product in certain
countries using the Company's technology and design specifications. For the
terms of the agreements (three and eight years), the Company is required to
provide parts and technical services to the licensee at prices and rates
equivalent to normal list prices.
14. The Company is involved in certain litigation matters. Management believes
resolution of these disputes will not have a material adverse effect on the
Company's financial condition and results of operations.
Report to the Independent Auditors
To the Board of Directors of FAFCO, Inc.
We have audited the consolidated balnace sheet of FAFCO, Inc. and its subsidary
as of December 31, 1996 and the related consolidated statements of income,
retained earning, and cash flows for the year then ended. The financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audit. The financial statements of FAFCO, Inc. as of December 31, 1995 and
for each of the two years in the period ended December 31, 1995 were audited by
other auditors whose report dated March 27, 1996 expressed an unqualified
opinion on those statements.
We conducted our audit in accordance with generally accepted auditing standards.
Those standards require that we paln and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit included examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant extimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of FAFCO, Inc. and its subsidiary
as of December 31, 1996 and the results of its operations and its cash flows for
the year then ended in conformity with generally accepted accounting principles.
Burr, Pilger & Mayer
Palo Alto, California
March 4, 1997
Summary of Operations
Five-Year Summary of Operations (in thousands, except per share data)
Year Ended December 31, 1996 1995 1994 1993 1992
Net sales $8,869 $7,876 $10,526 $9,352 $7,782
Income (loss) before
income taxes and
extraordinary item $350 $(1,917)$504 $254 $587
Provision for income
taxes (37) 1 49 116 242
Income (loss) before
extraordinary item 387 (1,918) 445 138 345
Extraordinary item-tax
benefit resulting from
net operating loss
carryforward 174
Cumulative effect of
change in method of
accounting for income
taxes 717
Net income (loss) $387 $(1,918) $455 $855 $519
Primary net income
(loss) per share
before extraordinary
item $0.12 $(0.62) $0.13 $0.04 $0.11
Primary net income per
share from extraordinary
item 0.06
Primary net income per
share from cumulative
effect of change in
method of accounting
for income taxes 0.22
Primary net income
(loss) per share $0.12 $(0.62) $0.13 $0.26 $0.17
Fully diluted net income
(loss) per share before
extraordinary items $0.12 $(0.62) $0.13 $0.05 $0.11
Fully diluted net income
per share from
extraordinary item 0.06
Fully diluted net income
per share from cumulative
effect of change in
method of accounting for
income taxes 0.19
Fully diluted net income
(loss) per share $0.12 $(0.62) $0.13 $0.24 $0.17
At December 31, 1996 1995 1994 1993 1992
Working capital $1,203 $222 $2,371 $1,784 $1,624
Total assets 4,263 3,400 4,903 4,373 3,577
Long-term obligations 951 680 725 751 928
Shareholders' equity 1,094 615 2,530 2,038 1,177
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 1996 and 1995 were as
follows:
Quarter Ended March 31 June 30 September 30 December 31
1996 High $0.25 $0.125 $0.125 $0.125
1996 Low $0.125 $0.125 $0.125 $0.125
1995 High $1.50 $1.50 $1.50 $0.75
1995 Low $1.00 $1.00 $0.75 $0.25
The quotations above were provided by the National Quotation Bureau. All
quotations reflect inter-dealer prices, without retail mark-up, mark-down or
commission and may not necessarily represent actual transactions. At February
10, 1997, the Company had 726 shareholders of record. FAFCO, Inc. has never
paid dividends on its Common Stock and has no plans to do so in the
foreseeable future.
1996 Compared with 1995
Net sales for 1996 increased by 12.6% from $7,876,100 in 1995 to $8,868,600 in
1996. This increase was due primarily to increased unit sales of the Company's
IceStor and pool panel products.
Net sales of the Company's pool products were 5.9% higher in 1996 than in
1995 due mainly to increased sales of its SunSaver model inground and
aboveground pool panels partially offset by decreased sales of its Revolution
model inground pool panels and decreased sales of its proprietary line of
automatic controls, which was phased out as of January 1, 1997. Net sales of the
Company's IceStor products were 24.0% higher in 1996 than in 1995 due mainly to
increased foreign sales partially offset by decreased domestic sales. The
Company believes the decreased domestic sales are due mainly to potential
customers' beliefs that lower energy prices in the domestic market place will
result from planned deregulation of energy prices.
Pool product sales amounted to 58% of net sales in 1996 compared to 62% of net
sales in 1995 IceStor sales amounted to 42% of net sales in 1996 compared to
38% of net sales in 1995. There were no significant price changes in any of
the Company's products during 1996.
Cost of goods sold decreased from $5,637,900 (71.6% of net sales) in 1995 to
$5,424,900 (61.2% of net sales) in 1996. This decrease was due mainly to the
fixed costs being allocated over higher sales along with increased sales of
higher margin products in both the pool product line and IceStor product line.
Marketing and selling expenses decreased from $2,137,200 (27.1% of net sales)
in 1995 to $1,575,400 (17.8% of net sales) in 1996. This decrease is due
mainly to reduced promotional expenses for pool products along with reduction
in support personnel for IceStor product.
General and administrative expenses decreased from $1,502,000 (19.1% of net
sales) in 1995 to $1,286,300 (14.5% of net sales) in 1996. This decrease is
due mainly to decreased personnel costs along with decreased legal and
accounting expenses.
Research and development expenses decreased from $460,100 (5.8% of net sales)
in 1995 to $116,000 (1.3% of net sales) in 1996. This decrease was due entirely
to the reduction in personnel in late 1995 and the continued low level of
personnel in 1996.
Net interest expense increased from $95,300 (1.2% of net sales) in 1995 to
$169,900 (1.9% of net sales) in 1996. This increase is due primarily to the
higher average daily borrowing in 1996 at higher interest rates than in 1995.
1995 Compared with 1994
Net sales for 1995 decreased by 25.2% from $10,526,000 in 1994 to $7,876,100
in 1995. This decrease was primarily due to decreased unit sales of the
Company's IceStor products along with decreased unit sales of the company's
pool panel products. Net sales of the Company's were 19.8% lower in 1995
than in 1994 due mainly to continued economic weakness in California and
Florida, the main markets for the Company's pool products. Net sales of the
Company's IceStor products were 31.8% lower in 1995 than in 1994 due mainly
to potential customers' beliefs that lower energy prices in the domestic
market place will result from planned deregualtion of energy prices. This
domestic decrease was partly offset by increased foreign sales of IceStor
products.
Pool product sales amounted to 62% of net sales in 1995 compared to 57% of
net sals in 1994. IceStor sales amounted to 38% of net sales in 1995
compared to 42% in 1994. There were no significant price changes in any of
the Company's products during 1995.
Cost of goods sold decreased from $6,542,900 in 1994 to $5,637,900 in 1995
while increasing as a percentage of net sales form 62.2% in 1994 to 71.6% in
1995. The increase as a percent of sales was due mainly to the fixed costs
being allocated over significantly lower sales along with employee severence
expenses associated with a 32% reduction in the work force.
Marketing and selling expenses increased from $1,767,500 (16.8% of net sales
in 1994 to $2,137,200 (27,1% of net sales) in 1995. The increase was due
mainly to one-time expenses for market research projects during the second
half of 1995 along with the addition of sales personnel and increased
promotional expenses for pool products during the first half of 1995.
General and administrative expenses increased from $1,257,100 (11.9% of net
sales) in 1994 to $1,502,000 (19.1% of net sales) in 1995. These increases
were primarily due to increased personnel costs during the first half of 1995
along with severance expenses and increased legal expenses.
Research and development expenses were relatively stable in absolute dollars
at $484,300 in 1994 compared with $460,100 in 1995 while increasing from 4.6%
of net sales in 1994 to 5.8% of net sales in 1995. The increase as a percent of
sales was due entirely to the decreased level of sales in 1995.
Net interest expense increased from $79,400 (0.8% of net sales) in 1994 to
$95,300 (1.2% of net sales) in 1995. This increase was due primarily to
higher than average daily borrowing during the first half of 1995 compared to
1994.
Other income (expense) net included $24,000 in refunds of prior years'
insurance premiums in 1995 compared with $38,400 in 1994. Other income
(expense) net in 1994 also included $66,000 of proceeds, net of related costs,
pertaining to a legal settlement resolved during 1994.
Seasonality
Historically, the Company has experienced lower sales during the first quarter
than during other quarters of each year. In addition, sales typically have
increased significantly during the second quarter, declined slightly, and
then remained relatively constant during the third and fourth quarters,
respectively. The Company believes that this pattern derives primarily from the
sales of solar heating products. As the Company's product mix shifts to include
a larger proportion of other products, such as the thermal energy storage
product, the traditional seasonality is being mitigated. Net income is affected
by the seasonality of sales as well as by significant marketing and selling
expenses typically incurred during the first quarter of each year. These
expenses are incurred to develop programs and materials for use throughout the
remainder of the year.
In 1994 and 1996, sales and net income experienced their traditional
seasonality, except that sales in the fourth quarter were increased due to
sales of IceStor product. As a result of the ice storage sales, the traditional
fourth quarter loss was not experienced.
In 1995, sales experienced the traditional seasonality except that the
decline in sales in the third and fourth quarters was more pronounced than
normal due to weak sales in both pool products and IceStor during the second
half of the year. There were net losses in all four quarters due to sales being
below the planned levels in all four quarters.
Liquidity and Capital Resources
The Company's cash position decreased from $126,200 at 1995 fiscal year end to
$88,200 at 1996 fiscal year end, principally due to increased accounts
receivable and increased inventories partially offset by increased borrowings
and increased accounts payable.
At December 31, 1996, the Registrant's net accounts receivable had increased
to $ 1,890,700 from $1,149,600 at December 31, 1995, primarily as a result of
increased sales in November and December 1996.
At December 31, 1996, the Registrant's accounts payable and other accrued
expenses had increased to $1,037,800 from $949,100 at December 31, 1995. This
increase is primarily due to expenses resulting from the increased sales in
November and December 1996.
At December 31, 1996, the Registrant's inventories had increased to $835,400
from $717,200 at December 31, 1995. This increase was due mainly to a buildup
of inventories for increased January 1997 sales.
The Company adopted SFAS 109 effective January 1, 1993. This resulted in the
recognition of a deferred tax asset, net of valuation allowance, at year end
of $649,400 in 1996 and $611,000 in 1995. The Company believes that it is
more likely than not that this asset will be fully realized. This belief is
based upon the Company's recent history of profitable operations prior to
1995, its return to profitability in 1996, and the Company's expectation that
this will continue far enough into the future to realize the net deferred tax
asset. However, there can be no assurance that the Company will continue
profitability or, if it does, that profits will be sufficient to utilize the
net deferred tax asset.
At December 31, 1996, the Registrant's current ratio was 1.54 to I compared
with 1.11 to I at December 31, 1995 and working capital increased over the
same period to $1,202,700 from $222,400. Total assets exceeded total
liabilities by $1,094,300 at December 31, 1996 compared with $614,700 at
December 31, 1995.
During the second half of 1995, the Company began and has continued an
aggressive cost reduction campaign. The Registrant believes that as a result
of the cost-cutting measures, its cash flow from operations, together with bank
borrowings, will be sufficient to support operations during the next twelve
months. The foregoing statement of how long the Company's capital resources
are expected to last is a forwardlooking statement involving risks and
uncertainties, including the amount of the Company's sales and the ability of
the Company to control its operating expenses, including the need to invest in
sales and marketing activities in 1997. However, if sales decline from current
levels, additional debt or equity financing may be required. The Registrant
has a line of credit, of which $758,600 had been utilized and $70,600 remained
available under the formula applied to net accounts receivable. This line of
credit expires on March 31, 1998.
BOARD OF DIRECTORS
EXECUTIVE OFFICERS
Freeman A. Ford
Chairman of the Board, President, and Chief Executive Officer FAFCO, Inc.
William A. Berry*
Senior Vice President and Chief Financial Officer Electric Power Research
Institute a private, nonprofit, research organization doing collaborative
research for the electricity industry.
Robert W. Selig,Jr.*
President Davis Instruments Corporation a manufacturer of marine and weather
equipment.
*Audit Committee Member
Executive Officers
Freeman A. Ford
Chairman of the Board, President, andChief Executive Officer
Alex N. Watt
Vice President, Finance and Administration,Chief Financial Officer, and
Secretary
David K. Harris
Vice President, Pool Products
Mike Anderson
Vice President, Commercial Products
Transfer Agent and Registrar
Bank of Boston
C/o Boston EquiServe
P.O. Box 644-02102
MS 45-02-09
Boston, Massachusetts 02102-0644
Telephone: (617) 575-3400
Legal Counsel
Wilson, Sonsini, Goodrich & Rosati
A Professional Corporation
650 Page Mill Road
Palo Alto, California 94304
Independent Accounts
Burr, Pilger & Mayer
A Professional Corporation
261 Hamilton Avenue
Palo Alto, California 94301
Form 10-K
A copy of the Company's Annual Report on Form 10-K filed with the Securities
and Exchange Commission, including financial statement schedules but excluding
exhibits, is available without charge upon written request to:
FAFCO, Inc.
2690 Middlefield Road
Redwood City, California 94063
Attention: Alex N. Watt
Annual Shareholders' Meeting
The Annual Shareholders' Meeting will be held at 3:00 p.m. on April 24, 1997 at
FAFCO, Inc., 2690 Middlefield Road, Redwood City, California 94063-3455,
Telephone: (415) 363-2690