EXHIBIT 13.1
FAFCO, Inc.
1998 Annual Report
(Annual Report Cover)
The Company
FAFCO was formed in 1969, was incorporated in 1972, and has produced over one
million polymer heat exchangers, primarily for the solar heating and thermal
energy storage markets. FAFCO is the leading U.S. manufacturer of solar
heating panels, with nearly twice the installed base of solar panel systems
of its nearest competitor. In addition, FAFCO is a leading producer of
polymer heat exchangers for thermal energy storage applications. FAFCO's
IceStor(tm) product line of thermal energy storage equipment significantly
increases the effective capacity of electric utilities without the burden of
adding new capacity. FAFCO has been issued more than 20 patents and operates
worldwide.
There are three bar graphs showing
1. Earnings per Share for years 1996, 1997, and 1998
2. Working Capital for years 1995, 1996, 1997, and 1998
3. Shareholders' Equity for years 1995, 1996, 1997, and 1998
This Annual Report to Shareholders contains forward-looking statements within
the meaning of Section 27A of the Securities Act of 1933 and Section 21E of
the Securities Exchange Act of 1934. Actual results could differ materially
from those projected in the forward-looking statements as a result of the
risk factors set forth below under the heading "Factors Affecting Future
Results" and elsewhere in this Annual Report to Shareholders.
FAFCO Page 1 (inside front cover)
President's Letter
FAFCO was founded in 1969 and manufactures polymer heat exchangers for the
solar and thermal energy storage markets worldwide. Net sales grew by 6.5%
to $11,235,800 in 1998. Net profit was $841,600 compared with $866,000 in
1997. Early indications point toward a continuation of the upward trend in
sales and continued profitability in 1999.
Net sales of FAFCO's aboveground solar pool heating system grew 19% in 1998
to $817,500. Total solar sales (both inground and aboveground pools) were
$5,899,500 in 1998. Continuing new product introduction and marketing
initiatives are expected to positively affect solar system sales revenues.
FAFCO's thermal energy storage business uses unique polymer heat exchanger
technology to shift peaking electrical loads to off-peak times. This
significantly increases the effective capacity of electric utilities without
the burden of adding new capacity. FAFCO's IceStorT products are sold
principally in the United States, Asia, and the Middle East. Sales of
IceStorT products, which accounted for 47% of total sales, were up 15% in 1998.
As of December 31, 1998, FAFCO's bank line of credit was unused and there was
$477,500 of cash on hand. Working capital increased to $2,637,200 at December
31, 1998 from $2,006,800 at the end of 1997.
FAFCO has been issued 21 patents and is investing significantly in new patent-
applied-for technologies, which we believe will significantly increase the
likelihood of entering new markets with solutions that are more cost
effective than was possible with the prior technologies.
FAFCO's steady sales and profitability performance are a direct result of the
hard work and dedication of each and every FAFCO employee and the loyalty of
our customers. I offer my personal thanks to each and every one of you.
Sincerely,
Freeman A. Ford
President
Highlights of 1998 1997 %Change
Operations
Net Sales $11,235,800 $10,551,500 7%
Net Income $841,600 $866,000 (3%)
Diluted Earnings
per Common Share $0.20 $0.22 (10%)
Shareholders'
Equity $2,886,400 $2,042,300 41%
Working Capital $2,637,200 $2,006,800 30%
There is a bar graph showing Net Slaes for the years 1995, 1996, 1997, and
1998.
FAFCO Page 2
Consolidated Balance Sheet
December 31, 1998 1997
Assets
Current assets:
Cash and cash equivalents $ 477,500 $ 46,300
Accounts receivable,
less allowance for doubtful
accounts of $536,300 in 1998
and $540,100 in 1997 1,876,600 1,833,400
Current portion of long-term
notes receivable (net) 87,600 88,800
Inventories 1,265,400 1,082,900
Prepaid expenses and
other current assets 183,500 174,000
Other accounts receivable,
net of allowance 7,300 12,200
Deferred tax asset,
net of allowance 273,000 183,300
Total current assets 4,170,900 3,420,900
Plant and equipment, at cost 2,901,900 2,614,900
Less accumulated depreciation
and amortization (2,318,500) (2,236,300)
583,400 378,600
Notes receivable and
other assets (net) 58,200 151,200
Deferred tax asset, net of allowance 564,500 485,800
Total assets $5,377,000 $4,436,500
Liabilities and shareholders' equity
Current liabilities:
Accounts payable and
other accrued expenses $1,065,600 $ 850,900
Accrued compensation and benefits 217,300 331,600
Accrued warranty expense 232,200 211,000
Income taxes payable 18,600 20,600
Total current liabilities 1,533,700 1,414,100
Subordinated notes ($600,000
was owed to related parties
in 1998 and 1997) 925,000 925,000
Other non-current liabilities 31,900 55,100
Total liabilities $2,490,600 $2,394,200
Shareholders' equity:
Preferred Stock-authorized
1,000,000 shares of $1.00
par value, none of which has
been issued Common Stock-authorized
10,000,000 shares of $0.125 par value;
3,303,311 issued and outstanding in
1998 and 3,298,311 issued and
outstanding in 1997 412,800 412,200
Capital in excess of par value 5,107,100 5,105,200
Notes receivable secured by
Common Stock (75,100) (75,100)
Accumulated deficit (2,558,400) (3,400,000)
Total shareholders' equity $2,886,400 $2,042,300
Commitments and contingent
liabilities
Total liabilities and
shareholders' equity $5,377,000 $4,436,500
The accompanying notes are an integral part of this statement.
FAFCO Page 3
Consolidated Statement of Operations
Year ended December 31, 1998 1997 1996
Net sales $ 11,235,800 $ 10,551,500 $ 8,868,600
Other income (net) 30,600 171,800 54,000
Total revenues 11,266,400 10,723,300 8,922,600
Cost of goods sold 6,801,700 5,956,500 5,500,300
Marketing and selling expense 1,942,800 1,770,000 1,575,400
General and administrative expense 1,480,200 1,776,100 1,286,300
Research and development expense 194,100 202,800 116,000
Net interest expense 113,400 128,700 169,900
Total costs and expenses 10,532,200 9,834,100 8,647,900
Income before income taxes 734,200 889,200 274,700
Provision for (benefit from)
income taxes (107,400) 23,200 (36,700)
Net income $ 841,600 $ 866,000 $ 311,400
Basic net income per share $ 0.25 $ 0.26 $ 0.10
Diluted net income per share $ 0.20 $ 0.22 $ 0.10
The accompanying notes are an integral part of this statement.
FAFCO Page 4
Consolidated Statement of shareholders' Equity
Notes Receivable
Number Capital in Secured by Retained
of Common Excess of Common Earnings
Shares Stock Par Value Stock Deficit
Balance at
December 31,
Balance at
December 31,
1995 $3,112,687 $389,000 $5,035,600 $(75,100) $(4,577,400)
Net income for the year 311,400
Issuance of shares upon
conversion of
subordinated
note 185,624 23,200 69,600
Balance at
December 31,
1996 $3,298,311 $412,200 $5,105,200 $(75,100) $(4,266,000)
Net income for the year 866,000
Balance at
December 31,
1997 $3,298,311 $412,200 $5,105,200 $(75,100) $(3,400,000)
Net income for the year 841,600
Issuance of shares upon
exercise of
an option 5,000 600 1,900
Balance at
December 31,
1998 $3,303,311 $412,800 $5,107,100 $(2,558,400)
The accompanying notes are an integral part of this statement.
FAFCO Page 5
Consolidated Statement of Cash Flows
Year Ended December 31, 1998 1997 1996
Cash flow from operating activities:
Net income $ 841,600 $ 866,000 $ 311,400
Adjustments to reconcile net income
to net cash provided by (used in)
operating activities:
Depreciation 137,600 130,700 121,200
Allowance for doubtful accounts
and notes (130,200) 120,300 72,400
Provision for inventory reserve (18,600) (90,500) 42,400
Gain on disposition of fixed assets (19,000) (18,700)
Change in assets and liabilities:
Change in receivables (34,500) 22,100 (794,300)
Change in inventories (163,900) (75,000) (85,200)
Change in prepaid expenses (9,500) (23,200) (5,300)
Change in deferred tax assets (168,400) (19,700) (38,400)
Change in other assets 220,600 (38,200) 73,400
Change in payables and accrued expenses 119,600 (44,800) 104,900
Change in other non-current liabilities (23,200) 28,700 (54,000)
Net cash provided by (used in) operations 752,100 876,400 (270,200)
Cash flow from investing activities:
Purchase of fixed assets (342,400) (159,700) (211,600)
Proceeds from sale of fixed assets 19,000 18,700
Net cash used in investing activities (323,400) (159,700) (192,900)
Cash flow from financing activities:
Proceeds of subordinated debt issuance 325,000
Proceeds from sale of common stock 2,500 92,800
(Payments) borrowings on
line of credit (net) (758,600) 7,300
Net cash (used in) provided by
financing activities 2,500 (758,600) 425,100
Net increase (decrease) in cash and
cash equivalents 431,200 (41,900) (38,000)
Cash and cash equivalents,
beginning of year 46,300 88,200 126,200
Cash and cash equivalents,
end of year $ 477,500 $ 46,300 $ 88,200
Supplemental disclosures of cash flow
information:
Cash paid during the year
for interest $ 123,100 $ 142,100 $ 159,300
Net cash paid during the year
for income taxes $ 63,000 $ 10,000 $ 7,500
Noncash transaction (account receivable
converted to note receivable) $ 126,400
The accompanying notes are an integral part of this statement.
FAFCO Page 6
Notes to Consolidated Financial Statements
1) Organization and Summary of Significant Accounting Policies
The Company designs, develops, manufactures, and markets polymer heat
exchangers for use in solar heating systems for swimming pools and thermal
energy storage systems for commercial and industrial cooling. The heat
exchangers for solar heating systems are sold to wholesalers and distributors
primarily in California and Florida and in other locations in the United
States and overseas. The heat exchangers for thermal energy storage systems
are marketed through manufacturers' representatives throughout the
United States and internationally. A summary of significant accounting
policies follows:
Principles of Consolidation: The consolidated financial statements include
the accounts of FAFCO, Inc. and its wholly-owned subsidiary. All significant
inter-company balances and transactions have been eliminated in consolidation.
The subsidiary currently has no ongoing business activities.
Revenue Recognition: Revenues on sales of products are recognized at the
time of shipment of goods or performance of service.
Use of Estimates: The preparation of financial statements in conformity with
generally accepted accounting principles requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date
of the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ materially from
those estimates.
Cash and Cash Equivalents: For purposes of reporting cash flows, cash and
cash equivalents include highly liquid investments with a maturity of three
months or less.
Inventories: Inventories are stated at the lower of cost or market determined
using the first-in, first-out (FIFO) method. (See Note 2.)
Plant and Equipment: Plant and equipment are stated based on historical cost
adjusted for accumulated depreciation. Depreciation and amortization of
plant and equipment, excluding vehicles and leasehold improvements, are
determined using accelerated methods. For vehicles and leasehold improvements,
the straight-line method is used. The estimated useful lives of the assets
range between three and ten years. Minor replacements, improvements,
maintenance, and repairs are expensed as incurred. Major replacements and
improvements are capitalized and depreciated over the remaining useful life
of the related asset. Gains and losses on sales and retirement of plant and
equipment are credited or charged to income.
Accounting for the Impairment of Long-lived Assets and for Long-lived Assets
to be Disposed of: Long-lived assets held and used by the Company are
reviewed for impairment whenever events or changes in circumstances indicate
that the carrying amount of an asset may not be recoverable. Impairments are
recorded when indications of impairment are present and the undiscounted cash
flows estimated to be generated by those assets are less than the assets'
carrying value.
Income Taxes: Deferred tax assets and liabilities are recognized for the tax
consequences of temporary differences between the financial reporting and tax
basis of assets and liabilities. (See Note 7.)
Earnings per Common Share: The Company adopted Statement of Financial
Accounting Standard No. 128 ("FAS 128"), Earnings per Share, beginning with
FAFCO's fourth quarter of 1997. All prior period earnings per common share
data have been restated to conform to the provisions of this statement.
Basic earnings per common share is computed using the weighted average number
of shares outstanding. Diluted earnings per common share is computed using
the weighted average number of shares outstanding adjusted for the incremental
shares attributed to outstanding options and warrants to purchase common stock
and shares issuable upon conversion of certain convertible securities. (See
Note 11.)
Warranties: In the normal course of business, the Company makes certain
warranties as to workmanship and materials. Product warranty periods range
from two to fifteen years for full coverage. The estimated future expense of
these warranties is accrued at the time of sale. The estimates inherent in
accounting for such warranties are reviewed and revisions to previous
estimates are made as required to reflect the most current information
available.
Accounting for Stock-Based Compensation: The Company has elected to account
for stock-based compensation under the intrinsic value method in accordance
with the provisions of Statement of Financial Accounting Standards ("SFAS")
No. 123, Accounting for Stock-Based Compensation. Under this method, no
compensation expense is recorded for stock options granted when the exercise
price of the option granted is equal to or exceeds the fair market value of
the Company's common stock. The Company makes the pro forma disclosures of
stock-based compensation required by SFAS No. 123. (See Note 6.)
Disclosures About Fair Value of Financial Instruments: The following methods
and assumptions were used to estimate the fair value of each class of
financial instruments for which it is practicable to estimate that value.
FAFCO Page 7
Notes to Consolidated Financial Statements
Current Assets and Current Liabilities: The carrying value of cash
equivalents, accounts receivable, notes receivable, short-term borrowings,
accounts payable, and accrued expenses approximate fair value because of their
short maturity.
Long-Term Debt: The fair value of the Company's long-term debt is estimated
based on the borrowing rates currently available to the Company for loans with
similar terms. At December 31, 1998, the carrying amount approximates
estimated fair value of long-term debt.
2) Inventories Consist of the Following:
December 31, 1998 1997
Raw materials $ 661,800 $ 462,800
Work in progress 211,500 114,000
Finished goods 392,100 506,100
$ 1,265,400 $ 1,082,900
3) Plant and Equipment
Plant and equipment consists of the following:
December 31, 1998 1997
Machinery and equipment $ 2,191,500 $ 1,957,600
Office and computer equipment 488,600 466,900
Leasehold improvements 88,600 88,600
Vehicles 133,200 101,800
$ 2,901,900 $ 2,614,900
Less accumulated depreciation
and amortization (2,318,500) (2,236,300)
$ 583,400 $ 378,600
4) Subordinated Notes and warrants
At December 31, 1998 and 1997, subordinated notes consisted of $925,000 of
notes bearing interest at 11% per annum payable quarterly with warrants
attached to purchase Common Stock. The exercise price of the warrants is
$0.125 per share, the maximum aggregate number of shares issuable upon
exercise of the warrants is 555,000, and the unexercised warrants expire
March 27, 2000. (See Note 8.)
5) Bank Line of Credit
The Company has a bank line of credit secured by substantially all the assets
of the Company. The line of credit allows the Company to borrow the lesser of
$1,000,000 or an amount determined by a formula applied to net accounts
receivable, inventories, and net plant and equipment. Amounts borrowed bear
interest at the bank's prime rate plus 1.5%. The line of credit agreement
contains certain covenants relating to working capital, current ratio, and
tangible net worth, prohibits the payment of cash dividends, and expires on
March 30, 2000. At December 31, 1998 and 1997, the Company had complied with
the loan covenants.
As of December 31, 1998 and 1997, the Company had no outstanding balances
under the bank line of credit.
6) Shareholders' Equity
The Board of Directors, without shareholder approval, may determine the rights,
preferences, privileges, and restrictions of the Company's unissued Preferred
Stock. Such shares may be issued in one or more series. In 1980, the Company
issued 202,300 shares of Common Stock at a price of $2.43 per share in
exchange for non-interest bearing promissory notes, which have a balance
due of $75,100 at December 31, 1998 and 1997. The notes are due and payable
and the Company intends to pursue collection of these notes. In the event
that any of the notes are uncollectible, the Company will demand surrender of
the related shares issued and will cancel and write off the related notes
receivable balance.
Under the Company's Employee Stock Purchase Plan, 150,000 shares of Common
Stock have been reserved for issuance at 85% of fair market value as of
specified dates. The Plan was suspended in 1991 and no shares have been
issued thereunder since 1991.
The Company has a 1991 Incentive Stock Option Plan under which 500,000 shares
of Common Stock have been reserved for issuance to employees and consultants.
The Company has a 1991 Director's Stock Option Plan under which 50,000 shares
of Common Stock are reserved for issuance. No options were granted or
exercised during 1996, 1997, or 1998.
FAFCO Page 8
Notes to Consolidated Financial Statements
Options granted under these plans become exercisable at a rate of 20% per year
for five years from date of grant and expire six years or ten years from date
of grant.
A summary of activity under the 1981 and 1991 Incentive Stock Option Plans
follows:
Shares Subject Exercise Price
to Option Per Share
Outstanding at
December 31, 1995 275,450 $ 0.500-0.625
Granted 236,950 $ 0.125
Canceled (126,950) $ 0.500-0.560
Exercised 0 0
Outstanding at
December 31, 1996 385,450 $ 0.125-0.625
Granted 21,000 $ 0.125
Canceled (31,500) $ 0.125-0.625
Exercised 0 0
Outstanding at
December 31, 1997 374,950 $ 0.125-0.500
Granted 0
Canceled (5,500) $ 0.125-0.500
Exercised 0
Outstanding at
December 31, 1998 369,450 $ 0.125-0.500
The Company applies the intrinsic value method of accounting for its stock
option plans. Accordingly, no compensation cost has been recognized for the
plan in 1998, 1997, or 1996. Had compensation cost been determined on the
basis of fair value pursuant to FASB Statement No. 123, net income and
earnings per share would have been reduced as follows:
1998 1997 1996
Net income
As reported $ 841,600 $ 866,000 $ 311,400
Pro forma $ 832,200 $ 860,200 $ 293,600
Basic earnings per share
As reported $ 0.25 $ 0.26 $ 0.10
Pro forma $ 0.25 $ 0.26 $ 0.09
Diluted earnings per share
As reported $ 0.20 $ 0.22 $ 0.10
Pro forma $ 0.19 $ 0.22 $ 0.09
The fair value of each option granted was estimated on the grant date using
the Black-Scholes model.
The following assumptions were made in estimating fair value:
Assumption 1998 1997
Dividend yield 0% 0%
Risk-free interest rate 5.0% 5.55%
Expected life 10 years 10 years
Expected volatility 121.9% 141.1%
Following is a summary of the status of the plans during 1998, 1997, and 1996.
Number of Weighted Average
Shares Exercise Price
Outstanding at January 1, 1998 374,950 $ 0.250
Granted 0 0
Exercised 0 0
Forfeited (5,500) 0.159
Outstanding atDecember 31, 1998 369,450 0.251
Options exercisable at
December 31, 1998 283,250 0.299
Weighted average fair value of
options granted during 1998 N/A
Number of Weighted Average
Shares Exercise Price
Outstanding at January 1, 1997 385,450 $0.258
Granted 21,000 0.125
Exercised 0 0
Forfeited (31,500) 0.460
Outstanding at December 31, 1997 374,950 0.250
Options exercisable at
December 31, 1997 231,150 0.282
Weighted average
fair value of options
granted during 1997 $0.123
Number of Weighted Average
Shares Exercise Price
Outstanding at January 1, 1996 275,450 $ 0.485
Granted 236,950 0.125
Exercised 0 0
Forfeited (126,950) 0.502
Outstanding at December 31, 1996 385,450 0.258
Options exercisable at
December 31,1996 199,650 0.297
Weighted average
fair value of options
granted during 1996 $0.101
Following is a summary of the status of options outstanding at
December 31, 1998:
Outstanding Exercisable
Weighted
Average Weighted Weighted
Remaining Average Average
Contractual Exercise Exercise
Exercise Price Number Life Price Number Price
$0.500 117,500 1 $0.500 117,500 $0.500
$0.250 20,000 3 $0.250 12,000 $0.250
$0.125 231,950 4 $0.125 153,750 $0.125
369,450 3 283,250
FAFCO Page 9
Notes to Consolidated Financial Statements
The range of exercise prices for the options outstanding at December 31, 1998
is $0.125-$0.50 with a weighted average contractual life of 3 years. The
Company estimates that based on vesting at 20% per year at December 31, 1998,
approximately 100% of options will eventually vest.
7) Income Taxes
The provisions for income taxes consist of the following:
Years Ended December 31, 1998 1997 1996
Taxes on income:
U.S. Federal
Current $ 9,000 $ 12,000 $ 0
Deferred (183,400) (28,400) (40,300)
(174,400) (16,400) (40,300)
State
Current 52,000 20,000 1,600
Deferred 15,000 9,600 2,000
67,000 29,600 3,600
Foreign
Current 0 10,000 0
Deferred 0 0 0
$ 0 $ 10,000 $ 0
Net income tax
(benefit) provision $ (107,400) $ 23,200 $ (36,700)
A reconciliation of the statutory federal income tax rate with the effective
tax rate reported in the financial statements follows:
Years Ended December 31, 1998 1997 1996
Statutory federal
income tax(benefit) rate 34.0% 34.0% 34.0%
Effect on tax rate resulting from:
State and foreign income taxes,
net of federal tax benefit 8.2% 2.2% 7.7%
Tax effect of change in valuation
allowance (65.2%) (36.6%) (54.8%)
Expiration of tax credits 2.5% 1.7% 2.0%
Other 5.9% 1.3% 0.6%
Effective tax rate (14.6%) 2.6% (10.5%)
The Company records its deferred taxes on a tax jurisdiction basis and, with
the adoption of FAS No. 109 in 1993, classifies those net amounts as current
or noncurrent based on the balance sheet classifications.
Deferred tax assets are comprised of the following:
December 31, 1998 1997
Allowance for doubtful accounts $ 222,600 $ 227,700
Accrued expenses 97,300 132,500
Loss carryforwards 598,500 837,400
Tax credits 48,800 71,200
Other 43,500 108,300
1,010,700 1,377,100
Deferred tax asset valuation allowance (173,200) (708,000)
Total deferred taxes, net $ 837,500 $ 669,100
At December 31, 1998, the Company had unused federal net operating loss
carryforwards of approximately $1,756,600, Florida loss carryforwards of
approximately $168,700, and investment and other federal tax credits of
approximately $48,800 available to offset future tax liabilities. The net
operating losses and credits expire in varying amounts until 2010. The use
of the tax credits has been limited by the provisions of the Tax Reform Act
of 1986 to reflect the benefit associated with an overall reduction in the
corporate tax rate. The Company believes that the "total deferred taxes,
net" in the amount of $837,500 is more likely than not to be realized.
8) Transactions with Related Parties
At December 31, 1998 and 1997, $600,000 in principal amount of the Company's
subordinated notes (see Note 4) were held by Mr. Freeman A. Ford, an officer,
director, and major shareholder of the Company, and his immediate family
members.
In April 1996, the Company granted Mr. Ford a warrant to purchase 123,950
shares of Common Stock.
9) Employee Benefit Plans
The Company has a 401(k) retirement savings plan for all eligible employees
who have completed one year of service. Eligible employees have the option
to contribute up to 15% of their eligible salary. The Company contributes an
amount equal to 25% of the employee contribution, up to a maximum of $400 per
employee per year.
10) Lease Commitments
The Company's rental expense, relating primarily to a lease for its office
and manufacturing facility, amounted to $384,300 in 1998, $393,400 in 1997,
and $380,300 in 1996. At December 31, 1998, minimum annual lease
FAFCO Page 10
Notes to Consolidated Financial Statements
commitments under non-cancelable leases were as follows:
1999 405,400
2000 138,600
Total $ 544,000
The Company is required to pay property taxes, utilities, and insurance under
certain of these leases, some of which provide for renewal options at the end
of the initial lease term in the year 2000.
11) Net Income Per Share
Basic earnings per share were calculated as follows:
Years ended December 31, 1998 1997 1996
Net income $ 841,600 $ 866,000 $ 311,400
Average common shares
outstanding 3,303,311 3,298,311 3,254,066
Earnings
per shar $ 0.25 $ 0.26 $ 0.10
Basic earnings per share are calculated by dividing net income by the weighted
average number of shares issued and outstanding.
Diluted earnings per share were calculated as follows:
Years ended December 31, 1998 1997 1996
Adjusted net income $ 841,600 $ 866,000 $ 311,400
Average common shares
outstanding 3,303,311 3,298,311 3,254,066
Add: Exercise of options
reduced by the number of
shares purchased with
proceeds 325,849 186,026 N/A
Add: Exercise of warrants
reduced by the number of
shares purchased with
proceeds 102,361 63,173 N/A
Add: Expense of warrants
attached to debt reduced
by the number of shares
purchased with proceeds 472,778 384,231 N/A
Adjusted weighted
average shares outstanding 4,204,299 3,931,741 3,254,066
Earnings per common share
assuming full dilution $ 0.20 $ 0.22 $ 0.10
12) Licensing Income
During 1997, the Company entered into a licensee agreement with a third party
in the Far East under which the Company received and recognized license fee
income net of foreign income taxes of $90,000. The agreement allows for the
licensee to assemble and sell the IceStorT product in certain countries using
the Company's technology and design specifications. For the term of the
agreement (eight years), the Company is required to provide parts and
technical services to the licensee at prices and rates equivalent to normal
list prices.
13) Litigation
The Company is involved in certain litigation matters. Management believes
resolution of these disputes will not have a material adverse effect on the
Company's financial condition and results of operation.
14. Business Segment and Concentration of Credit Risk
Business Segment: The Company operates in one business segment, the
development, production and marketing of polymer heat exchangers for the
solar and thermal energy storage markets worldwide.
Product Line 1998 1997 1996
Net Sales
Solar $ 5,899,500 $ 5,918,100 $ 5,164,900
Thermal Energy
Storage 5,336,300 4,633,400 3,703,700
$11,235,800 $10,551,500 $ 8,868,600
Geographic information for revenues and long-lived assets for the year ended
December 31, 1998, 1997, and 1996 are as follows:
1998 1997 1996
Net Sales
Domestic $ 7,235,900 $ 7,555,300 $ 7,588,400
Foreign
Japan 2,634,100 1,961,600 1,070,100
Other 1,365,800 1,034,600 210,100
$11,235,800 $10,551,500 $ 8,868,600
Long-lived assets
Domestic $ 583,400 $ 378,600 $ 349,600
$ 583,400 $ 378,600 $ 349,600
For fiscal 1998 and 1997, the Company had one major customer who individually
accounted for 10% or more of sales totaling $2,634,100 and $1,961,600 in 1998
and 1997, respectively. In fiscal 1996, the Company had three major customers
who individually accounted for 10% or more of sales totaling $1,242,700,
$1,070,100, and $1,061,000.
FAFCO Page 11
Notes to Consolidated Financial Statements
Concentration of Credit Risk: Most of the Company's business activity is with
customers located in California, Florida, and foreign countries. As of
December 31, 1998, unsecured trade accounts receivable from customers in
California, Florida, and foreign countries were $328,400, $1,302,900, and
$594,200, respectively.
FAFCO Page 12
Report of Independent Auditors
To the Board of Directors of FAFCO, Inc.
We have audited the accompanying consolidated balance sheets of FAFCO, Inc.
and its subsidiary as of December 31, 1998 and 1997 and the related
consolidated statements of operations, shareholders' equity, and cash flows
for each of the years in the three-year period ended December 31, 1998.
These financial statements are the responsibility of the Company's management.
Our responsibility is to express an opinion on these financial statements
based on our audit.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements.
An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of FAFCO, Inc. and its
subsidiary as of December 31, 1998 and 1997 and the results of their
operations and their cash flows for each of the years in the three-year
period ended December 31, 1998 in conformity with generally accepted
accounting principles.
Burr, Pilger & Mayer
Palo Alto, California
March 1, 1999
FAFCO Page 13
Summary of Operations
Five-Year Summary of Operations (in thousands, except per share data)
Year Ended December 31, 1998 1997 1996 1995 1994
Net sales $ 11,236 $ 10,552 $ 8,869 $ 7,876 $ 10,526
Income (loss) before
income taxes $ 734 $ 889 $ 274 $(1,857) $ 547
(Benefit from) provision
for income taxes (107) 23 (37) 1 49
Net income (loss) $ 841 $ 866 $ 311 $(1,858) $ 498
Basic net income (loss)
per share $ 0.25 $ 0.26 $ 0.10 $ (0.60) $ 0.14
Diluted net income (loss)
per share $ 0.20 $ 0.22 $ 0.10 $ (0.60) $ 0.14
At December 31, 1998 1997 1996 1995 1994
Working capital $ 2,637 $ 2,007 $ 1,285 $ 379 $ 2,469
Total assets 5,377 4,437 4,345 3,557 5,001
Long-term obligations 957 980 951 680 725
Shareholders' equity $ 2,886 2,042 1,176 772 2,628
Common Stock Data
FAFCO, Inc. Common Stock is traded on the over-the-counter market but is not
listed on an exchange or quoted on any automated quotation system. The high
and low closing bid quotations for each quarter during 1998 and 1997 were as
follows:
Quarter Ended March 31 June 30 September 30 December 31
1998 High $0.75 $0.75 $0.94 $0.94
1998 Low $0.75 $0.75 $0.94 $0.94
1997 High $0.125 $0.125 $0.125 $0.750
1997 Low $0.125 $0.125 $0.125 $0.125
The quotations above were provided by the National Quotation Bureau. All
quotations reflect inter-dealer prices, without retail mark-up, mark-down, or
commission and may not necessarily represent actual transactions. At
March 1, 1999, the Company had 706 shareholders of record. FAFCO, Inc. has
never paid dividends on its Common Stock and has no plans to do so in the
foreseeable future and is prohibited from so doing (see Note 6).
FAFCO Page 14
Management's Discussion and Analysis
This Annual Report to Shareholders contains forward-looking statements within
the meaning of Section 27A of the Securities Act of 1933 and Section 21E of
the Securities Exchange Act of 1934. Actual results could differ materially
from those projected in the forward-looking statements as a result of the
risk factors set forth below under the heading Factors Affecting Future
Results and elsewhere in this Annual Report to Shareholders.
1998 Compared with 1997
Net sales for 1998 increased by 6.5% from $10,551,500 in 1997 to $11,235,800
in 1998. This increase was due to increased unit sales of the Company's
IceStorT products.
Net sales of the Company's pool products were relatively stable due to
increased unit sales of the Company's SunSaverT product offset by price
decreases due to competitive market pressures. Net sales of the Company's
IceStorT products were 15.2% higher in 1998 than in 1997 due mainly to
increased foreign sales. Pool product sales amounted to 53% of net sales in
1998 compared to 56% of net sales in 1997. IceStorT sales amounted to 47% of
net sales in 1998 compared to 44% of net sales in 1997.
Cost of goods sold increased from $5,956,500 (56.5% of net sales ) in 1997 to
$6,801,700 (60.5% of net sales ) in 1998. This increase was due primarily to
increased sales of lower margin products in both the pool and the IceStorT
lines.
Marketing and selling expenses increased from $1,770,000 (16.8% of net sales)
in 1997 to $1,942,800 (17.3% of net sales ) in 1998. This increase was due
mainly to increased sales and promotional activities in 1998 as compared to
1997.
General and administrative expenses decreased from $1,776,100 (16.8% of net
sales) in 1997 to $1,480,200 (13.2% of net sales) in 1998. These decreases
were due mainly to bonus and profit-sharing expenses incurred in 1997 which
were not incurred in 1998.
Research and development expenses were relatively stable at $202,800 (1.9% of
net sales) in 1997 compared with $194,100 (1.7% of net sales) in 1998. This
was due mainly to the stabilization in the number of projects designed to
improve current products and to develop potential new products, and in the
personnel to implement those projects.
Net interest expense was also relatively stable at $128,700 (1.2% of net
sales) in 1997 compared with $113,400 (1.0% of net sales) 1998. This
decrease was due mainly to lower average daily borrowing in 1998 along with
lower interest rates.
1997 Compared with 1996
Net sales for 1997 increased by 19% from $8,868,600 in 1996 to $10,551,500 in
1997. This increase was due primarily to increased unit sales of the
Company's pool panel products, along with increased unit sales of the
Company's IceStorT products partially offset by the effect of discontinuance
of the Company's automated swimming pool controls.
Net sales of the Company's pool products were 14.8% higher in 1997 than 1996
due mainly to increased sales of its Revolutionr model inground pool panels,
along with increased sales of its SunSaverT model inground pool panels and
increased sales of its SunSaverT model aboveground pool panels. These
increases were partially offset by the effect of discontinuance of its
proprietary line of automated swimming pool controls, which was phased out as
of January 1, 1997. Net sales of the Company's IceStorT products were 25.1%
higher in 1997 than in 1996 due mainly to increased domestic sales along with
higher foreign sales.
Pool product sales amounted to 56% of net sales in 1997 compared to 58% of net
sales in 1996. IceStorT sales amounted to 44% of net sales in 1997 compared
to 42% of net sales in 1996. There were no significant price changes in any of
the Company's products during 1997.
Cost of goods sold increased in absolute dollars from $5,500,300 in 1996 to
$5,956,500 in 1997 while decreasing from 62.0% of net sales in 1996 to 56.5%
of net sales in 1997. This decrease as a percent of net sales was due
primarily to the fixed costs being allocated over higher sales along with a
continued increase of sales of higher margin products in both the pool and
the IceStorT lines.
Marketing and selling expenses increased in absolute dollars from $1,575,400
in 1996 to $1,770,000 in 1997 while decreasing from 17.8% of net sales in 1996
to 16.8% of net sales in 1997. These decreases as a percent of net sales were
due mainly to the increased level of sales experienced in 1997 as compared to
1996.
General and administrative expenses increased from $1,286,300 (14.5% of net
sales) in 1996 to $1,776,100 (16.8% of net sales) in 1997. These increases
were due mainly to increased bad debt write-offs along with bonus and
profit-sharing expenses incurred in 1997 which were not incurred in 1996.
Research and development expenses increased from $116,000 (1.3% of net sales)
in 1996 to $202,800 (1.9%
FAFCO Page 15
Management's Discussion and Analysis
of net sales) in 1997. This increase was due mainly to an increase in the
number of projects designed to improve current products and to develop
potential new products, along with an increase in personnel to implement
those projects.
Net interest expense decreased from $169,900 (1.9% of net sales) in 1996 to
$128,700 (1.2% of net sales) in 1997. This decrease was due mainly to lower
average daily borrowing in 1997 along with lower interest rates.
Seasonality
Historically, the Company has experienced lower sales during the first quarter
than during other quarters of each year. In addition, sales typically have
increased significantly during the second quarter, declined slightly, and then
remained relatively constant during the third and fourth quarters. The Company
believes that this pattern derives primarily from the sales of solar heating
products. As the Company's product mix shifts to include a larger proportion
of other products, such as the thermal energy storage products, the
traditional seasonality is being mitigated. Net income is affected by the
seasonality of sales as well as by significant marketing and selling expenses
typically incurred during the first quarter of each year. These expenses are
incurred to develop programs and materials for use throughout the remainder of
the year.
In 1998 sales and net income experienced their typical seasonality.
In 1997 sales and net income experienced their typical seasonality, except
that sales of pool panel products in the first quarter were increased as a
result of the unusually dry and warm weather in both California and Florida.
As a result of the increased sales of pool panel products the traditional
first quarter loss was not experienced.
In 1996, sales and net income experienced their traditional seasonality,
except that sales in the fourth quarter were increased due to sales of
IceStorT product. As a result of the ice storage sales, the traditional
fourth quarter loss was not experienced.
Liquidity and Capital Resources
The Company's cash position increased significantly from $46,300 at 1997
fiscal year end to $477,500 at 1998 fiscal year end, principally due to cash
flow from operations (primarily net income) during the year, partially offset
by cash used in investing activities (primarily purchase of fixed assets).
At December 31, 1998, the Company's net accounts receivable had increased
slightly to $1,876,600 from $1,833,400 at December 31, 1997, primarily as a
result of increased sales in 1998 partially offset by slightly faster
collection of accounts receivable.
At December 31, 1998, the Company's accounts payable and other accrued
expenses had increased to $1,065,600 from $850,900 at December 31, 1997.
This increase is primarily due to increased inventories to support higher
sales levels.
At December 31, 1998, the Company's inventories had increased to $1,265,400
from $1,082,900 at December 31, 1997. This increase was due entirely to the
buildup of inventories to support increased sales levels.
The Company has a deferred tax asset, net of valuation allowance, at year-end
of $837,500 in 1998 and $669,100 in 1997. The Company believes that it is
more likely than not that this asset will be fully realized. This belief is
based upon the Company's recent history of profitable operations prior to
1995, its return to profitability in 1996, 1997 and 1998, and the Company's
expectation that operating results will allow it to realize the net deferred
tax asset. However, there can be no assurance that the Company will continue
profitability or, if it does, that profits will be sufficient to utilize the
net deferred tax asset.
At December 31, 1998, the Company's current ratio was 2.72 to 1 compared with
2.42 to 1 at December 31, 1997 and working capital increased over the same
period to $2,637,200 from $2,006,800. Total assets exceeded total liabilities
by $2,886,400 at December 31, 1998 compared with $2,042,300 at December 31,
1997.
The Company believes that its cash flow from operations, together with bank
borrowings, will be sufficient to support operations during the next twelve
months. The foregoing statement of how long the Company's capital resources
are expected to last is a forward-looking statement involving risks and
uncertainties, including the amount of the Company's sales and the ability of
the Company to control its operating expenses and the need to invest in sales
and marketing activities in 1998. However, if sales decline from current
levels additional debt or equity financing may be required. There can be no
assurance that financing, if required, would be available on favorable terms
or at all or that such financing will not significantly dilute the ownership
interests and rights of existing shareholders. The Company has a line of
credit, of which none had been utilized and $1,000,000 remained available
under the formula applied to net
FAFCO Page 16
Management's Discussion and Analysis
accounts receivable at December 31,1998. This line of credit expires on
March 30, 2000.
Factors Affecting Future Results
The Company has reviewed its internal computer systems for year 2000
compliance and is satisfied that all of its internal computer systems are
either already year-2000 compliant or can be made year-2000 compliant
through simple upgrades. The Company does not expect the costs of achieving
full year-2000 compliance to be material for the internal systems. However,
there can be no assurance that coding errors or other defects will not be
discovered in the future. In addition, since the Company is very small in
relation to many of its customers and suppliers, the Company has been unable
to ascertain if any of its suppliers and customers are year-2000 compliant.
Therefore, there can be no assurances that the Company's cash flow from
customers and materials from suppliers will not be interrupted which could
result in severe disruptions in the Company's operations.
FAFCO Page 17
Corporate Directory and Information
Board of Directors
Freeman A. Ford
Chairman of the Board, President, and Chief Executive Officer
FAFCO, Inc.
William A. Berry*
Senior Vice President and Chief Financial Officer
Electric Power Research Institute a private, nonprofit, research
organization doing collaborative research for the electricity industry.
Robert W. Selig, Jr.*
President
Davis Instruments Corporation a manufacturer of marine and weather
equipment.
________________________
*Audit Committee Member
Executive Officers
Freeman A. Ford
Chairman of the Board, President, and Chief Executive Officer
Alex N. Watt
Vice President, Finance and Administration,Chief Financial Officer, and
Secretary
David K. Harris
Vice President, Sales
Solar Products
Transfer Agent and Registrar
Continental Stock Transfer & Trust Company
2 Broadway
New York, New York 10004
Telephone: (212) 509-4000
Web Site: http://www.continentalstock.com
Legal Counsel
Wilson, Sonsini, Goodrich & Rosati
A Professional Corporation
650 Page Mill Road
Palo Alto, California 94304
Independent Accountants
Burr, Pilger & Mayer
A Professional Corporation
261 Hamilton Avenue
Palo Alto, California 94301
Form 10-K
A copy of the Company's Annual Report on Form 10-K filed with the
Securities and Exchange Commission, including financial statement
schedules but excluding exhibits, is available without charge
upon written request to:
FAFCO, Inc.
2690 Middlefield Road
Redwood City, California 94063-3455
Attention: Alex N. Watt
Annual Shareholders' Meeting
The Annual Shareholders' Meeting will be held at 3:00 p.m. on May
6, 1999 at FAFCO, Inc., 2690 Middlefield Road, Redwood City,
California 94063-3455, Telephone: (650) 363-2690
(Inside back cover)