SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(MARK ONE)
/X/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
- EXCHANGE ACT OF 1934 [NO FEE REQUIRED]
For the quarterly period ended JULY 2, 2000
/_/ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 [NO FEE REQUIRED]
For the transition period from ______ to ________
Commission File Number: 0-15930
SOUTHWALL TECHNOLOGIES INC.
------------------------------------------------------
(Exact name of registrant as specified in its charter)
DELAWARE 94-2551470
------------------------------- ----------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
1029 Corporation Way, Palo Alto, California 94303
------------------------------------------- ----------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (650) 962-9111
---------------
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes No X
---------
As of July 2, 2000 there were 7,662,967 shares of the Registrant's
Common Stock outstanding.
SOUTHWALL TECHNOLOGIES INC.
INDEX
PART I FINANCIAL INFORMATION
ITEM 1 FINANCIAL STATEMENTS: PAGE
Consolidated Balance Sheets - July 2, 2000
and December 31, 1999 .......................................... 3
Consolidated Statements of Operations -
three month and six month periods
ended July 2, 2000 and July 4, 1999............................. 4
Consolidated Statements of Cash Flows -
six month periods ended July 2, 2000
and July 4, 1999................................................ 5
Notes to Consolidated Financial Statements ..................... 6
ITEM 2 Management's Discussion and Analysis
of Financial Condition and Results of Operations................ 12
ITEM 3 Quantitative and Qualitative Disclosures about Market Risk ..... 19
PART II OTHER INFORMATION
ITEM 1 Legal Proceedings............................................... 20
ITEM 2 Changes in Securities........................................... 20
ITEM 3 Defaults Upon Senior Securities................................. 20
ITEM 4 Submission of Matters to a Vote of Stockholders................. 20
ITEM 5 Other Information............................................... 20
ITEM 6 Exhibits and Reports on Form 8-K................................ 20
Signatures...................................................... 21
2
PART I FINANCIAL INFORMATION
ITEM 1 - FINANCIAL STATEMENTS:
SOUTHWALL TECHNOLOGIES INC.
CONSOLIDATED BALANCE SHEETS
(in thousands, except per share data)
ASSETS July 2, 2000 December 31,1999
------------ ----------------
(Unaudited)
Current assets:
Cash and cash equivalents $ 49 $ 1,772
Restricted cash 2,197 1,883
Accounts receivable, net of allowance
for doubtful accounts of $863 and $875 12,920 11,129
Inventories 11,297 7,221
Other current assets 1,928 1,294
-------- --------
Total current assets 28,391 23,299
Property and equipment, net 49,762 43,533
Other assets 2,553 3,310
-------- --------
Total Assets $ 80,706 $ 70,142
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Bank line of credit $ 10,000 $ 4,920
Accounts payable 15,418 9,775
Accrued compensation 1,441 1,817
Other accrued liabilities 5,076 4,311
Current portion of long-term debt 15,521 14,175
-------- --------
Total current liabilities 47,456 34,998
Long-term debt 10,000 10,000
Deferred income taxes 564 564
-------- --------
Total liabilities 58,020 45,562
Stockholders' equity:
Common stock, $.001 par value,
20,000 shares authorized:
Issued and outstanding: 7,889 and 7,889 8 8
Capital in excess of par value 51,619 51,771
Less cost of treasury stock, 226
and 371 shares (1,145) (1,888)
Notes Receivable (101) (906)
Other Comprehensive Income
Translation loss on subsidiary - (40)
Accumulated deficit (27,695) (24,365)
-------- --------
Total stockholders' equity 22,686 24,580
-------- --------
Total liabilities and
stockholders' equity $ 80,706 $ 70,142
======== ========
See accompanying notes to consolidated financial statements.
3
SOUTHWALL TECHNOLOGIES INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
(Unaudited)
Three Months Ended Six Months Ended
------------------ ----------------
July 2, 2000 July 4, 1999 July 2, 2000 July 4, 1999
------------ ------------ ------------ ------------
(Restated) (Restated)
---------- ----------
Note 1 Note 1
------ ------
Net revenues $ 20,928 $ 13,479 $ 38,037 $ 24,337
-------- -------- -------- --------
Costs and expenses:
Cost of sales 16,922 9,444 31,705 18,355
Research and development 1,578 1,293 3,089 2,526
Selling, general and
administrative 3,102 1,970 5,094 3,936
Legal settlement 402 - 402 -
-------- -------- -------- --------
Total costs and expenses 22,004 12,707 40,290 24,817
-------- -------- -------- --------
Income(loss) from operations (1,076) 772 (2,253) (480)
Interest expense, net (530) (307) (1000) (562)
-------- -------- -------- --------
Income(loss)before income taxes (1,606) 465 (3,253) (1,042)
Provision for income taxes (41) (13) (77) (25)
-------- -------- -------- --------
Net Income(loss) $ (1,647) $ 452 $ (3,330) $ (1,067)
======== ======== ======== ========
Net Income(loss) per share
- Basic $ (0.22) $ 0.06 $ (0.44) $ ( .15)
- Diluted $ (0.22) $ 0.06 $ (0.44) $ ( .15)
Weighted average shares of
common stock and common
stock equivalents
- Basic 7,631 7,404 7,599 7,364
- Diluted 7,631 7,454 7,599 7,364
See accompanying notes to consolidated financial statements.
4
SOUTHWALL TECHNOLOGIES INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(Unaudited)
Six Months Ended
----------------
July 2, 2000 July 4, 1999
------------ ------------
(Restated)
Cash flows (used in) from operating activities: Note 1
Net loss $ (3,330) $ (1,067)
Adjustments to reconcile net income (loss) to net cash used in operating
activities:
Depreciation and amortization 2,413 2,380
Decrease (increase) in accounts receivable (1,791) 2,299
Decrease (increase) in inventories (4,054) 87
Decrease (increase) in other current and non current assets 58 (401)
(Decrease) increase in accounts payable
and accrued liabilities 5,793 (1,017)
-------- --------
Cash (used in) from operating activities (911) 2,281
-------- --------
Cash flows from investing activities:
Decrease (increase) in short-term investments - 7
Decrease (increase) in restricted cash (465) (1,329)
Expenditures for property, plant and equipment and other assets (8,985) (5,638)
-------- --------
Net cash used in investing activities (9,450) (6,960)
-------- --------
Cash flows from financing activities:
Proceeds from long-term debt 4,766 -
Principal payments on long-term debt - (3,333)
Proceeds from bank line of credit 2,343 4,111
Principal payments on bank line of credit - -
Repayment of stock option loans 724 80
Issuance of treasury stock, net 805 223
-------- --------
Net cash provided by financing activities 8,638 1,081
-------- --------
Net decrease in cash and cash
equivalents (1,723) (3,598)
Cash and cash equivalents, beginning of year 1,772 4,136
-------- --------
Cash and cash equivalents, end of period $ 49 $ 538
======== ========
See accompanying notes to consolidated financial statements.
5
SOUTHWALL TECHNOLOGIES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands)
(Unaudited)
NOTE 1 - INTERIM PERIOD REPORTING:
While the information presented in the accompanying consolidated
financial statements is unaudited, it includes all adjustments (consisting only
of normal recurring adjustments) which, in the opinion of management, are
necessary to present fairly the Company's financial position and results of
operations, and changes in financial position as of the dates and for the
periods indicated.
Certain information and footnote disclosures normally contained in
financial statements prepared in accordance with generally accepted accounting
principles have been condensed or omitted. It is suggested that these
consolidated financial statements be read in conjunction with the financial
statements contained in the Company's Form 10-K\A for the year ended December
31, 1999 filed on October 2, 2000. The results of operations for the interim
periods presented are not necessarily indicative of the operating results of the
full year.
The previously issued second quarter 1999 interim financial results
have been restated for deferral of revenue recognition in the amount of $48.
NOTE 2 - BALANCE SHEET:
RESTRICTED CASH
The restricted cash reflected on the balance sheet is restricted to use
for the German project.
INVENTORIES, NET
Inventories are stated at the lower of cost (determined by the
first-in- first-out method) or market. Inventories consisted of the following:
July 2, 2000 December 31, 1999
------------ -----------------
Raw materials $ 5,704 $ 2,715
Work-in-process 4,519 2,834
Finished goods 1,074 1,672
------- -------
Total $11,297 $ 7,221
======= =======
NOTE 3 - FINANCING LINE OF CREDIT:
The Company has a $10 million receivable financing line of credit with
a bank. Availability under the line of credit is based on 80% of the approved
account receivable balance and bears a finance fee of 0.088% per month of the
average daily account balance outstanding during the settlement period. In
connection with the line of credit, the Company has granted the bank, a
continuing lien upon and security interest in, and right of set off with respect
to all of the Company's rights, title and interest in all accounts receivable,
inventory, monies, remittances and fixed assets. There was $10.0 million of
borrowing outstanding under this line of credit at July 2, 2000. (See Note 9 -
Going Concern and Loan Covenants)
6
NOTE 4 - NET INCOME (LOSS) PER SHARE:
Basic net income (loss) per share is computed by dividing income
available to common shareholders (numerator) by the weighted average number of
common shares outstanding (denominator) for the period. Diluted net income
(loss) per share gives effect to all dilutive potential common shares
outstanding during the period. The computation of diluted earnings per share
uses the average market prices during the period. During each of the periods
presented there were no differences between the numerators used for calculation
of basic and diluted net income (loss) per share. The total amount of the
difference in the basic and diluted weighted average shares of common stock and
common stock equivalents in the periods where there is net income is
attributable to the effect of dilutive stock options. In net loss periods, the
basic and diluted weighted average shares of common stock and common stock
equivalents are the same because inclusion of stock options would be
anti-dilutive. Stock options aggregating 1,822 thousand and 1,415 thousand
shares at July 2, 2000 and July 4, 1999, respectively, were not included in the
computations of net loss for those six month periods because the effect on the
calculations would be anti-dilutive.
NOTE 5 - LONG-TERM DEBT:
The Company's long-term debt consisted of the following at July 2,
2000:
Promissory note dated December 16, 1996 ..................... $ 611
Promissory note dated May 6, 1997 ........................... 10,000
Sale-leaseback agreement dated July 19,1999 ................. 2,675
Sale-leaseback agreement dated October 19, 1999 ............. 3,600
Bank loan dated May 12, 1999 ................................ 2,960
Bank loan dated May 28, 1999 ................................ 3,998
Bank loan dated August 14, 1999 ............................. 1,606
Other ....................................................... 71
-------
Total ....................................................... 25,521
Less current portion ........................................ (15,521)
-------
$10,000
=======
The promissory note dated December 16, 1996 is payable to a leasing
company. The borrowings are collateralized on certain production equipment, bear
interest of 9.7037% per annum and are subjected to certain financial covenants.
The promissory note is payable in monthly installments plus interest for a term
of 48 months. At July 2, 2000 the Company was not in compliance with certain of
the financial covenants pertaining to this promissory note. The Company has
received a waiver from the leasing company for failure to comply with such
covenants through the remaining term of the loan. The amount outstanding is
repayable within the next 6 months and has been classified as current debt. (See
Note 9 - Going Concern and Loan Covenants)
The promissory note dated May 6, 1997 is payable to a bank. The note
payments are guaranteed by Teijin Limited in Japan (Teijin), a stockholder and
supplier of the Company. The Teijin guarantee is collateralized by certain
equipment located in the Company's Tempe manufacturing facility and inventory,
to the extent necessary to provide 120% net book value coverage of the
outstanding loan balance. The interest rate on the loan is re-set semi-annually
at LIBOR plus 0.4375%, (7.4515% at July 2, 2000). The Company is also subject to
certain financial covenants. A loan guarantee service fee is payable to Teijin
semi-annually on the outstanding balance at the rate of 0.5625%. The note
provides for semi-annual payments of interest only during the first four years,
followed by semi-annual installments plus interest for the remaining three and
one half year term. Teijin also received warrants in 1997 to purchase 158,000
shares of the Company's common stock at $9 per share. These warrants were not
exercised and expired on May 30, 2000. At July 2, 2000 the Company was not in
compliance with certain of the financial covenants
7
with Teijin, the guarantor, pertaining to this promissory note. The Company
received a waiver from Teijin through October 1, 2001. (See Note 9 - Going
Concern and Loan Covenants)
During 1999, the Company entered into two equipment sale-leaseback
agreements with a leasing company ("Lessor"). Because the Company has an option
to purchase the equipment at a price to be determined between the Company and
the Lessor at the end of the lease period, the sale-leaseback agreements have
been treated as financing. One lease agreement has a lease term of three years
and the other lease agreement has an initial lease term of two years with an
option to extend it for an additional year. At July 2, 2000, the Company had a
total of $6,275 outstanding and due under these leases. The leases are
collateralized by the leased equipment and certain other production equipment of
the Company. The effective interest rate of both leases is approximately 13% per
annum and they are repayable over their lease term commencing in May 2000.
Additionally, the Company has provided the Lessor an irrevocable standby letter
of credit in the amount of $0.5 million to collateralize all of the Company's
obligations under these agreements. The letter of credit shall not expire before
January 1, 2002. In addition, $1 million of the amounts received from the Lessor
is in an escrow account and will be released to the Company, pending the Company
satisfying certain financial conditions. Due to the uncertainty of compliance
with these financial conditions, the Company has classified the amount in escrow
under non-current "Other Assets." (See Note 9 - Going Concern and Loan
Covenants)
On May 12, 1999, the Company entered into a loan agreement with a
German bank that provides for borrowings up to $2.9 million (DM 6.0 million).
Under the terms of this agreement, the funds will be used solely for the purpose
of capital investment by the German subsidiary. The term of the loan is for a
period of 10 years and the principal is repayable in Deutschemarks after the end
of 5 years in 10 equal semi-annual payments. The loan bears interest at 7.10%
per annum for the first five years, and will be revised to the prevailing rate
at the end of the fifth year. (See Note 9 - Going Concern and Loan Covenants)
An additional loan for $733 (DM 1.5 million) was received from the
German bank discussed above. This loan is an advance on a government grant to
be received approximately August 2001. The proceeds of the grant are
collateral for the loan and, per legal arrangements, will be paid directly to
the bank by the government. Payments of interest only are due until then at
7.10% per annum. (See Note 9 - Going Concern and Loan Covenants)
On May 28, 1999, the Company entered into a loan agreement with a
German bank that provides for borrowings up to $6.4 million (DM 12.5 million).
Under the terms of this agreement, the funds shall be used solely for the
purpose of capital investment by the German subsidiary. The term of the loan is
for a period of 20 years and the principal is repayable in Deutschemarks after
the end of 10 years in 20 equal semi-annual payments. The loan bears interest at
7.10% per annum for the first ten years, and will be revised to the prevailing
rate at the end of the tenth year. (See Note 9 - Going Concern and Loan
Covenants)
On August 14, 1999, the Company entered into a loan agreement with a
German bank that provides for borrowings up to $1.7 million (DM 3.3 million).
Under the terms of this agreement, the funds will be used solely for the purpose
of capital investment by the German subsidiary. The principal balance is due in
a single payment on June 30, 2009 and bears interest at a rate of 5.75% per
annum. The interest is payable quarterly in Deutschemarks. 50% of the loan
proceeds are restricted in an escrow account for the duration of the loan
8
period and are classified as non-current "Other Assets." (See Note 9 - Going
Concern and Loan Covenants)
The preceding German bank loans are collateralized by the production
equipment, building and land owned by the German subsidiary.
Other long-term debt consists of capitalized leases primarily related
to certain computer equipment used by the Company.
Principal reductions of long-term debt (excluding long-term debt
reclassified to current portion) are scheduled as follows:
Year Amount
---- ------
2000 $ 1,704
2001 4,951
2002 4,870
2003 4,073
2004 2,500
Thereafter 7,655
-------
Total $25,521
=======
The Company incurred total interest expense of $1,260 and $307 in the
second quarter of 2000 and 1999 respectively. Of these amounts, the Company
capitalized $730 and nil in the second quarter of 2000 and 1999, respectively,
as part of the costs related to the construction of new manufacturing facilities
in Tempe and Dresden, Germany.
NOTE 6 - GOVERNMENT GRANT:
In August 2000, the Company finalized an agreement to receive a grant
award (the "Grant") approved by the State Government of Saxony in Germany (the
"Grantor") in May 1999. The agreement provides for investment grants to a
maximum amount of $9.9 million (DM 20.3 million). During the year ended December
31, 1999, the Company received approximately $4.9 million (DM 9.6 million) under
this Grant and accounted for the Grant by applying the proceeds received against
the cost of the German manufacturing facility. The Company is scheduled to
receive the remaining balance through 2002.
The Grant is subject to the following requirements:
a) The grant is earmarked to co-finance the costs of the construction
of a facility to manufacture Heat Mirror XIR-Registered Trademark- film for the
automotive glass industry, located at Grossroehrsdorf, Germany.
b) The construction period for the project is from March 15, 1999 to
March 14, 2002.
c) The total investment should be at least $39.2 million (DM 80.3
million).
d) The project must create at least 143 permanent jobs and 7
apprenticeships.
In the event that the Company fails to meet the above requirements, the
Grantor has the right to reclaim the Grant.
The Company is further eligible for investment allowances calculated
based on the capital investment of $39.2 million (DM 80.3 million) amounting to
$3.7 million (DM 7.7 million), subject to European Union regulatory approval.
The investment allowance is subject to the following requirements:
a) The movable and immovable assets which acquisition cost are taken
into account in determining the investment allowance shall be employed within
the
9
subsidized territory for a period of at least five years following the
acquisition or production.
b) The movable assets which acquisition cost are taken into account in
determining the increased investment allowance shall remain in a business that
is engaged in the processing industry, or in a similar production industry for a
period of at least five years following the acquisition or production.
In the event that the Company fails to meet the above requirements, the
investment allowance must be paid back with interest.
NOTE 7 - SEGMENT REPORTING:
In 1998, the Company adopted Statement of Financial Accounting
Standards No. 131 ("SFAS 131"), "Disclosures about Segments of an Enterprise and
Related Information." SFAS 131 supercedes SFAS 14, "Financial Reporting for
Segments of a Business Enterprise" replacing the "industry segment" approach
with the "management" approach. The management approach designates the internal
organization that is used by management for making operating decisions and
assessing performance as the source of the Company's reportable segments. SFAS
131 also requires disclosures about products and services, geographic areas, and
major customers. The adoption of SFAS 131 did not affect results of operations
or financial position or the segments reported in 1997. The Company is organized
on the basis of products and services. The total net revenues for the Electronic
Display, Automotive Glass and Building product lines were as follows:
July 2, 2000 July 4, 1999
------------ ------------
(Restated)
Note 1
Electronic display.......................... $20,674 $4,525
Automotive glass............................ 9,773 10,552
Building.................................... 7,590 9,260
----- -----
Total net revenues........................ $38,037 $24,337
======= =======
NOTE 8 - CONTINGENCIES:
The Company has been named a defendant in a purported class action
lawsuit. Plaintiffs contend that Heat Mirror equipped glass units manufactured
throughout the country are subject to clouding and discoloration. The Company is
in the process of filing demurrers and setting pleadings. In addition, several
of the Company's co-defendants have settled their portions of the case. At this
point, the Company believes the class action lawsuit is without merit and
intends to vigorously defend this lawsuit by moving to defeat the class action
certification. No reasonable estimate could be made of the likely range of
claims prior to class certification.
In 1997, the Company was named a defendant in a lawsuit with a
manufacturer of insulated glass units wherein the plaintiff claimed that the
insulated glass manufactured with the use of coated film manufactured by the
Company was subject to various failures and deficiencies, giving rise to
warranty and other consumer claims. Plaintiff is claiming damages for past
replacement cost and future potential claims. The lawsuit was settled in March
2000 for $500. Accordingly an expense of $500 was accrued at December 31, 1999.
The Company has been named a defendant in a lawsuit filed on April 5,
1996 by one of its customers in the United States District Court for the Eastern
District of New York. The lawsuit alleges certain unfair competition, tort and
contractual violations by the Company and seeks relief in an aggregate amount in
excess of $32 million. The Company believes the lawsuit is without merit and
intends to vigorously defend its position.
10
The Company's German subsidiary is a defendant in a lawsuit filed by
one of its suppliers on March 21, 2000 in a German court to seek payment of $922
for engineering services rendered in connection with developing the plans for a
new plant. The Company issued letters of award to the plaintiff amounting to
$256 prior to terminating their services for not meeting their expectations. The
plaintiff claims fees for services rendered, including the costs of significant
modifications and revisions requested by the Company calculated in accordance
with the German Federal Schedule of Architects' fees. The plaintiff further
alleged that the Company utilized their planning work in further developing the
plant. The Company believes that the suit is without merit and intends to
vigorously defend its position. Although the Company believes that it will
prevail, a $256 portion of the claim was accrued as a liability on the December
31, 1999 balance sheet as it is likely that this amount will be awarded to the
plaintiff.
In August 2000, the Company, its Chief Executive Officer, Thomas P.
Hood, and former Chief Financial Officer, Bill R. Finley, have been named as
defendants in seven lawsuits, all filed in the United States District Court for
the Northern District of California (Docket Nos: C-00-2792-MMC; C-00-2795-BZ;
C-00-2834-SC; C-00-20856-EAI; C-00-3007-EDL; C-00-3027-JCS; and C-00-3079-MMC)
(the "Actions") all alleging violations of the federal securities laws. Each of
the plaintiffs in the Actions alleges that he purchased shares in the Company
and seeks to represent a class of shareholders who purchased shares during the
period April 26, 2000 through August 1, 2000, such dates constituting the period
from the Company's release of its financial results for the first quarter of FY
2000, to the date that it issued its press release announcing that it would be
restating its financial statements for that quarter. The substantive allegations
in each of the Actions are essentially the same, i.e., that the defendants knew,
or were reckless in not knowing, that the Company's first quarter financial
statements were in error and violated Generally Accepted Accounting Principles,
and that as a result the putative class members purchased stock at artificially
inflated prices and were damaged. It is anticipated that the Actions will be
consolidated into a single action by the filing of an Amended Consolidated
Complaint. No pleading in response to the Actions is yet due. The Company
believes the Actions to be wholly without merit and intends to defend them
vigorously.
In the third quarter of 2000, the Company was named a co-defendant,
along with a glass manufacturer, in a legal suit brought by certain contractors.
The contractors alleged the insulating glass units (`IGU') installed at an
airport project, which incorporated the Company's insulation film, have failed.
The Company is in the process of assessing the claim and expects to vigorously
defend this suit.
In addition, the Company is involved in a number of other legal actions arising
in the ordinary course of business. The Company believes, that the various
asserted claims and litigation in which it is involved will not materially
affect its consolidated financial position, future operating results or cash
flows.
NOTE 9 - GOING CONCERN AND LOAN COVENANTS
Loan Covenants
Pursuant to the loan and or lease agreements listed above, and related
terms, conditions and covenants we requested and received waivers from the
financial institutions, except the German bank loans and sale-leaseback
agreements as discussed below, related to the Company's default or event of
default pursuant to these respective agreements or otherwise arising in
connection with the Company's requirement to restate prior financial periods,
the financial position of the Company reflected in such restated financial
statements, the Company's failure to file its Form 10-Q for the second quarter
11
of 2000 in a timely manner and trading halts or other actions taken or
threatened to be taken by NASDAQ, or any law suits filed or threatened to be
filed in connection with such restatements or late filings.
The Company has received from the German banks a waiver of the Events
of Default pursuant to the agreements but the German banks did not provide a
waiver of the Events of Default or any rights it may have with respect to any
further material adverse change in the financial condition of the Company
resulting from the Events of Default and the German banks have reserved the
right to terminate the loan agreements after the third and fourth quarter of
2000 if the expectations relating to turnover and profit as provided by the
Company don't occur and provide a cause for termination. The Company cannot
currently determine with reasonable certainty whether it will be able to comply
with these provisions and accordingly has reclassified these loans from
long-term to current liabilities in the balance sheet.
Also the Company is in discussions with the leasing company for the
sale-leaseback agreements dated July 19, 1999 and October 19, 1999 concerning a
waiver of Events of Default related to the material adverse change discussed
above. The Company cannot currently determine with reasonable certainty whether
it will obtain such waiver and accordingly has reclassified these agreements
from long-term to current liabilities in the balance sheet.
Going Concern
On July 12, 2000, the Company's receivable financing line of credit was
increased to $12.0 million. This increase will expire September 30, 2000, at
which time the credit limit will be reduced to $10.0 million. The Company is
exploring other potential revolving credit arrangements, although no assurance
can be given that it will succeed. In addition, the Company's promissory note
dated December 16, 1996 will be fully repaid by November 2000. The Company is
seeking new equipment financing to replace this loan, using its underlying
security as collateral.
These consolidated financial statements have been prepared assuming that the
Company will continue as a going concern. The Company has experienced recurring
losses from operations, has significant current and long-term debt containing
certain covenants with which the Company has not complied requiring the Company
to obtain waivers and to classify as a current liability the debt for which
waivers have not been obtained, and on-going capital commitments for debt
service, manufacturing facilities and equipment that raise substantial doubt
about its ability to continue as a going concern. The financial statements do
not include any adjustments that might result from the outcome of this
uncertainty. As a result of this uncertainty, the Company may not be able to
carry out all of its proposed capital expenditures or to otherwise finance its
operations as currently proposed. The Company believes that it will need
additional financing to meet its operating cash requirements through 2000 and
beyond. However, the Company can give no assurances it will be successful in
obtaining the required additional financing and cash from operations.
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS:
Except for the historical information contained herein, certain matters
discussed in this Form 10-Q Report are forward-looking statements that involve
risks and uncertainties, including those discussed below and in the Company's
Annual Report on Form 10-K\A. Actual results may differ materially from those
projected. These forward-looking statements represent the Company's judgment as
of the date of the filing of this Form 10-Q Report. The Company disclaims,
however, any intent or obligation to update these forward-looking statements.
GENERAL
12
We are a designer and manufacturer of technologically advanced
thin-film coatings that selectively absorb, reflect or transmit light and
electromagnetic and infrared emissions. Our products are used in a number of
electronic, automotive and building products to enhance optical and thermal
performance characteristics, improve user comfort and reduce energy costs. From
our founding in 1979 through the early 1990's, we developed and produced
thin-film coated substrates primarily for residential and commercial buildings,
and for military applications. In the early 1990's, we began to develop products
for the electronic display and automotive markets.
In 1996, we realized our first material revenue from the electronic
display and automotive markets. Currently, electronic display products account
for almost one-half of our revenues. We expect most of our revenue growth to
continue to come from the electronic display and automotive markets.
Several factors affect our gross margins, including manufacturing
efficiencies, product mix, product differentiation, inventory management, volume
pricing, and the start-up of equipment and new plants. Over the past several
years, each of these factors has contributed to margin volatility as we have
added new capacity to meet the demand of our electronics and automotive markets.
CAPITAL EXPENDITURES
In 2000, we expect to spend approximately $14.0 million for capital
expenditures to increase production capacity in our operations. From the time we
order a new production machine, it typically takes 12 to 18 months until we are
able to produce in commercial volumes. The last six months of this period are
typically spent testing the machine to make sure it meets our product quality
requirements and those of our customers. During this period the new production
machines typically produce minimal revenues. In accordance with generally
accepted accounting principles, all substrate, target and material costs
incurred prior to a machine beginning any commercial production are expensed as
incurred and classified as costs of sales. In addition, interest costs
associated with borrowings for capital expenditures are capitalized until these
assets begin commercial production.
In the first quarter of 2000, our second machine at Tempe (PM 6) began
to produce limited amounts of film for commercial use. An additional machine (PM
7) was delivered to Tempe in the third quarter of 2000. This production machine
is expected to commence commercial production in the first half of 2001.
Additionally, we took possession of our new facility in Dresden in May 2000,
which will contain two new production machines (PM 8 and PM 9). We expect these
two production machines to commence commercial production in the second half of
2000 and the first half of 2001, respectively.
In general, we have experienced significant start-up costs in
connection with bringing new production machines into commercial viability. In
1998, our operating results were adversely affected by quality problems
associated with the electronic display film product produced by a new production
machine (PM 5) in Tempe. In the fourth quarter of 1998, we discovered quality
issues with product that had been shipped to Sony and other electronic display
film that was still in inventory in Tempe that did not meet Sony's
specifications. We recorded a $4.0 million provision in the fourth quarter of
1998 to account for product returns from Sony and the related write-off of
inventory. During 1999, we continued to experience ongoing production problems
with the Sony electronic display film. In March 1999, we amended the terms of
the supply agreement to eliminate purchase and supply requirements. Sales to
Sony through the first three quarters of 1999 declined significantly. We
discontinued the manufacture and sale of coated anti-reflective film to Sony in
September 1999.
13
Due to the unprofitable relationship with Sony and our increased
capital expenditures, we have been operating with minimal cash balances. We have
been using cash available from operations, German government grants, bank
borrowings and other long-term debt to finance our increased capital
expenditures.
SIX MONTHS ENDED JULY 4, 1999(1) COMPARED WITH THE SIX MONTHS ENDED JULY 2, 2000
(1) Restated as described in Note 1 of Item 1
NET REVENUES
Net revenues increased $13.7 million, or 56.3%, from $24.3 million for
the first six months of 1999 to $ 38.0 million for the first six months of 2000.
The increase in net revenues was primarily attributable to a $18.5 million
increase in sales of electronic display films, primarily due to the successful
yield improvements in our production machines located in Tempe and Palo Alto,
partially offset by decreases in heat mirror sales.
COST AND EXPENSES
COST OF SALES. Cost of sales expense consists primarily of materials,
production labor and machine overhead. Cost of sales increased $13.3 million,
or 73%, from $18.4 million in the first six months of 1999 to $31.7 million for
the similar period of 2000. As a percentage of net revenues, cost of sales
increased from 75.4% of net revenues in the first six months of 1999, to 83.4%
of net revenues for the similar period of 2000. The percentage increase in cost
of sales during the first six months of 2000 was due to the increased sales of
electronic display films, which have high raw material and processing costs and
a lower gross margin. The increase in the cost of sales was offset in part in
the recent period due to the return to commercial production of PM 5 which had
been shut down for product re-certification in the second quarter of 1999.
RESEARCH AND DEVELOPMENT EXPENSES. Our research and development
spending increased $0.6 million, or 22.3%, from $2.5 million in the first six
months of 1999 to $3.1 million in the first six months of 2000. Research and
development expenses decreased from 10.4% of net revenues for the first six
months of 1999, to 8.2% of net revenues for the similar period in 2000. The
increase in the first six months of 2000 was primarily attributable to
additional travel and personnel costs associated with supporting installation of
the new production machines in the Tempe and Dresden plants. In addition, we
incurred additional costs during the first six months of 2000 in the development
of a prototype antenna and a heatable windshield for automobiles using our XIR
films.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses consist primarily of corporate and administrative
overhead, selling commissions, advertising costs and occupancy costs. These
expenses increased $1.2 million, or 29.4%, from $3.9 million in the first six
months of 1999 to $5.1 million in the second quarter of 2000. Selling, general
and administrative expenses decreased from 16.2% of net revenues for the second
quarter of 1999 to 13.4% of net revenues for the similar period of 2000. The
$1.2 million increase in the first six months of 2000 was primarily related to
legal and accounting costs for preparation of a prospectus to raise additional
capital, increased rents in Palo Alto, and expenses related to the Tempe and
Germany operations. Additionally, travel and communication expenses also
increased as the additional sales personnel devoted themselves to international
sales.
LEGAL SETTLEMENT. In the second quarter of 2000, a settlement in the
amount of $0.4 million was reached on a legal matter.
14
INCOME (LOSS) FROM OPERATIONS. Loss from operations was $2.3 million
for the first six months of 2000 compared to a loss of $0.5 million for the
first six months of 1999, due to lower gross margins on the sale of electronic
display films, increased start up costs on the new production machines at our
Tempe and Dresden facilities, offering costs and a legal settlement.
INTEREST (EXPENSE), NET
Net interest expense increased $0.4 million from $0.6 million for the
first six months of 1999 compared to $1.0 million for the similar period in
2000. Interest expense increased from 1999 due to an increase in borrowings from
debt and bank credit lines at higher average annual interest rates.
INCOME (LOSS) BEFORE PROVISION FOR INCOME TAXES
We reported a pre-tax loss of $1.0 million for the first six months
of 1999, compared to a pre-tax loss of $3.3 million for the corresponding
period in 2000 due to lower gross margins on the sale of electronic display
films, increased start up costs on the new production machines at our Tempe
and Dresden facilities, offering costs, a legal settlement and interest costs.
THREE MONTHS ENDED JULY 4, 1999(1) COMPARED WITH THREE MONTHS ENDED JULY 2, 2000
(1) Restated as described in Note 1 of Item 1
NET REVENUES
Net revenues increased $7.4 million, or 55.3%, from $13.5 million for
the second quarter of 1999 to $20.9 million for the second quarter of 2000. The
increase in net revenues was primarily attributable to a $10.4 million increase
in sales of electronic display films, primarily due to the successful yield
improvements in our production machines located in Tempe and Palo Alto.
During the second quarter of 1999, our Tempe facility had minimal
production as a result of the re-certification of production processes for
product provided to Sony. Following the September 1999 termination of our
relationship with Sony, the Tempe production machine was converted to the
production of a similar anti-reflective product for new customers.
COST AND EXPENSES
COST OF SALES. Cost of sales expense consists primarily of materials,
production labor and machine overhead. Cost of sales increased $7.5 million, or
79.2%, from $9.4 million in the second quarter of 1999 to $16.9 million for the
similar period of 2000. As a percentage of net revenues, cost of sales increased
from 70.1% of net revenues in the second quarter of 1999, to 80.9% of net
revenues for the similar period of 2000. The percentage increase in cost of
sales was due to the increased sales of electronic display films, which have
high raw material and processing costs and a lower gross margin, during the
second quarter of 2000. The increase in the cost of sales was offset in part in
the recent period due to the return to commercial production of PM 5 which had
been shut down for product re-certification in the second quarter of 1999.
RESEARCH AND DEVELOPMENT EXPENSES. Our research and development
spending increased $0.3 million, or 22.0%, from $1.3 million in the second
quarter of 1999 to $1.6 million in the second quarter of 2000. Research and
development expenses decreased from 9.6% of net revenues for the second quarter
of 1999, to 7.6% of net revenues for the similar period in 2000. The increase in
the
15
second quarter of 2000 was primarily attributable to additional travel and
personnel costs associated with supporting installation of the new production
machines in the Tempe and Dresden plants. In addition, we incurred additional
costs during the second quarter of 2000 in the development of a prototype
antenna and a heatable windshield for automobiles using our XIR films.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses consist primarily of corporate and administrative
overhead, selling commissions, advertising costs and occupancy costs. These
expenses increased $1.1 million, or 57.5%, from $2.0 million in the second
quarter of 1999 to $3.1 million in the second quarter of 2000. Selling, general
and administrative expenses increased from 14.6% of net revenues for the second
quarter of 1999 to 14.8% of net revenues for the similar period of 2000. The
$1.1 million increase in the second quarter of 2000 was primarily related to
legal and accounting costs for preparation of a prospectus to raise additional
capital, increased rents in Palo Alto, and expenses related to the Tempe and
Germany operations. Additionally, travel and communication expenses also
increased as the additional sales personnel devoted themselves to international
sales.
LEGAL SETTLEMENT. In the second quarter of 2000, a settlement in the
amount of $0.4 million was reached on a legal matter.
INCOME [LOSS] FROM OPERATIONS
Loss from operations was $1.1 million for the second quarter of 2000
compared to a profit of $0.8 million for the second quarter of 1999 due to lower
gross margins on the sale of electronic display films and increased start up
costs on the new production machines at our Tempe and Dresden facilities,
offering costs, and the legal settlement.
INTEREST (EXPENSE), NET
Net interest expense increased $0.2 million from $ 0.3 million for the
second quarter of 1999 compared to $0.5 million for the similar period in 2000.
Interest expense increased from 1999 due to an increase in borrowings from debt
and bank credit lines at a higher average annual interest rate.
INCOME (LOSS) BEFORE PROVISION FOR INCOME TAXES
We reported a pre-tax income of $0.5 million for the second quarter of
1999, compared to a pre-tax loss of $1.6 million for the corresponding period in
2000 due to lower gross margins on the sale of electronic display films and
start up costs on the new production machines at our Tempe and Dresden
facilities, offering expenses, and the legal settlement.
LIQUIDITY AND CAPITAL RESOURCES
CAPITAL EXPENDITURES
Since 1998, we have used borrowings, German government grants and cash
from operations to fund our capital expenditures. During 1999, we invested
approximately $23.5 million in capital expenditures, including approximately
$9.8 million of progress payments for our new manufacturing facility and first
production machine (PM 8) in Dresden, approximately $7.5 million for two new
production machines (PM 6 and PM 7) and leasehold improvements for our Tempe
facility, and approximately $6.2 million for the upgrade of two production
machines (PM 1 and PM 2) in Palo Alto. These investments were financed by $10.5
million of short and long-term debt, $6.6 million in sales-leaseback financings,
$4.9 million in German government grants, and $4.3 million of cash
16
from operations. The German government grants subject us to a number of
covenants (See Note 6 of Item 1). The German government may reclaim the
grants if we fail to meet any of the covenants. For the quarter ended July 2,
2000, we invested approximately $4.3 million in capital expenditures,
primarily to expand production capacity in our Tempe manufacturing facility
and to open and equip our Dresden facility.
We anticipate spending approximately $14.0 million for capital
expenditures in 2000, approximately $12.0 million of which will consist of final
progress payments on our two new production machines (PM 8 and PM 9) in Dresden
and the completion of our Dresden facility. We expect to finance our capital
expenditures in Germany primarily through the receipt of additional bank loans
and the release of $3.1 million of cash currently restricted by the German
government to use in financing the completion of our Dresden facility. The
German government may reclaim the grants if we fail to meet any of the
covenants.
We expect to limit spending for capital expenditures on PM 7 and
leasehold improvements at Tempe. We anticipate these expenditures will only
commence with an increased line of credit, additional equipment financing or
sufficient cash generated from operations.
LIQUIDITY
Operating activities generating cash of $2.2 million for the six-month
period ended July 4, 1999. Cash used in operating activities for the six- month
period ended July 2, 2000 was approximately $0.9 million. This increase in the
amount of cash used in operating activities compared to the similar period of
1999 was primarily due to receivables and inventory growth to support increased
sales of electronic display products, partially offset by an increase in
payables. Capital expenditures were approximately $5.6 million and $9.0 million
for the six months of 1999 and the six months of 2000, respectively.
The following table sets forth the material terms of our short and
long- term indebtedness at July 2, 2000:
Balance at
Description July 2, 2000 Interest Rate Maturity
----------- ------------ ------------- --------
Financing Line of Credit................................ $ 10,000 0.088% Monthly June 2001
========
Long-term debt
Promissory note dated December 16, 1996............ 611 9.7 (1)
Promissory note dated May 6, 1997.................. 10,000 LIBOR + .4375 (2)
Sales-leaseback agreement dated July 19, 1999...... 2,675 13.0 (3)
Sales-leaseback agreement dated October 19, 1999... 3,600 13.0 (4)
German bank loan dated May 28, 1999................ 3,998 7.1 (5)
German bank loan dated May 12, 1999................ 2,960 7.1 (6)
German bank loan dated August 14, 1999............. 1,606 5.8 June 2009
Other equipment financings......................... 71 --- ---
--------
Total long-term debt........................... 25,521
Less current portion........................... 15,521
--------
Long term debt................................. $ 10,000
========
(1) We are required to make 48 equal monthly payments through December
2000.
(2) We are required to make equal semi-annual repayments from November
2000 through November 2002.
17
(3) We are required to make equal monthly principal payments over the
36-month term of this financing.
(4) We are required to make equal monthly principal payments over the
24-month term of this financing.
(5) We are required to make equal semi-annual principal payments
beginning ten years from the date of the loan through May 2019.
(6) We are required to make equal semi-annual principal payments
beginning five years from the date of the loan through May 2009.
We have granted the lender of our financing line of credit a security
interest in our receivables, inventory and other assets not otherwise
collateralized. Our loans from German banks also subject us to covenants,
including covenants relating to the progress of the development of our Dresden
facility and the minimum number of our employees at Dresden by 2003. We have
granted the German banks security interests in our Dresden facility and the
assets located at the facility.
The promissory note dated December 16, 1996 is payable to a leasing
company. The borrowings are collateralized by certain production equipment and
subject us to certain financial covenants. At July 2, 2000, we were not in
compliance with certain of these financial covenants. We received a waiver from
the leasing company for failure to comply with these covenants through the
remaining term of the loan.
The promissory note dated May 6, 1997 is payable to a bank and
guaranteed by Teijin Limited, a stockholder and one of our suppliers. The Teijin
guarantee is secured by PM 5 and our inventory to the extent necessary to cover
120% of the outstanding loan balance based on the net book value of the
inventory. The guarantee subjects us to certain financial and other covenants,
including covenants relating to our tangible net worth, our debt to tangible net
worth, and the ratio of our cash, cash equivalents and short term investments to
our total current liabilities. At July 2, 2000, we were not in compliance with
the financial covenants relating to the ratio of our debt to equity and the
ratio of our cash, cash equivalents and short-term investments to current
liabilities. Teijin delivered to us a waiver of these covenants at July 2, 2000
and through October 1, 2001.
We have provided the lessor under our sales-leaseback financings a $0.5
million irrevocable standby letter of credit to collateralize our obligations
under the sales-leaseback agreements. The letter of credit will not expire
before January 1, 2002. In addition, $1.0 million of the amount received from
the lessor is in an escrow account and will be released upon our meeting certain
financial conditions.
LOAN COVENANTS
Pursuant to the loan and or lease agreements listed above, and related
terms, conditions and covenants we requested and received waivers from the
financial institutions, except the German bank loans and sale-leaseback
agreements as discussed below, related to the Company's default or event of
default pursuant to these respective agreements or otherwise arising in
connection with the Company's requirement to restate prior financial periods,
the financial position of the Company reflected in such restated financial
statements, the Company's failure to file its Form 10-Q for the second quarter
of 2000 in a timely manner and trading halts or other actions taken or
threatened to be taken by NASDAQ, or any law suits filed or threatened to be
filed in connection with such restatements or late filings.
18
The Company has received from the German banks a waiver of the Events
of Default pursuant to the agreements but the German banks did not provide a
waiver of the Events of Default or any rights it may have with respect to any
further material adverse change in the financial condition of the Company
resulting from the Events of Default and the German banks have reserved the
right to terminate the loan agreements after the third and fourth quarter of
2000 if the expectations relating to turnover and profit as provided by the
Company don't occur and provide a cause for termination. The Company cannot
currently determine with reasonable certainty whether it will be able to comply
with these provisions and accordingly has reclassified these loans from
long-term to current liabilities in the balance sheet.
Also the Company is in discussions with the leasing company for the
sale-leaseback agreements dated July 19, 1999 and October 19, 1999 concerning a
waiver of Events of Default related to the material adverse change discussed
above. The Company cannot currently determine with reasonable certainty whether
it will obtain such waiver and accordingly has reclassified these agreements
from long-term to current liabilities in the balance sheet.
Going Concern
On July 12, 2000, the Company's receivable financing line of credit was
increased to $12.0 million. This increase will expire September 30, 2000, at
which time the credit limit will be reduced to $10.0 million. The Company is
exploring other potential revolving credit arrangements, although no assurance
can be given that it will succeed. In addition, the Company's promissory note
dated December 16, 1996 will be fully repaid by November 2000. The Company is
seeking new equipment financing to replace this loan, using its underlying
security as collateral.
These consolidated financial statements have been prepared assuming
that the Company will continue as a going concern. The Company has experienced
recurring losses from operations, has significant current and long-term debt
containing certain covenants with which the Company has not complied requiring
the Company to obtain waivers and to classify as a current liability the debt
for which waivers have not been obtained, and on-going capital commitments for
debt service, manufacturing facilities and equipment that raise substantial
doubt about its ability to continue as a going concern. The financial statements
do not include any adjustments that might result from the outcome of this
uncertainty. As a result of this uncertainty, the Company may not be able to
carry out all of its proposed capital expenditures or to otherwise finance its
operations as currently proposed. The Company believes that it will need
additional financing to meet its operating cash requirements through 2000 and
beyond. However, the Company can give no assurances it will be successful in
obtaining the required additional financing and cash from operations.
SAS 71 REVIEW
The interim financial statements contained in this Form 10-Q have not
been reviewed by our independent auditors, in accordance with the procedures set
forth in SAS 71.
ITEM 3 - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Disclosure about market risk is contained in the Company's Form 10-K\A
for the year ended December 31, 1999 filed on October 2, 2000. Subsequent to
such filing, no material developments have occurred with respect to the risks
described therein.
19
PART II OTHER INFORMATION
ITEM 1 LEGAL PROCEEDINGS AND OTHER MATTERS
Certain litigation filed against the Company was described under Item 3
in the Company's Revised Form 10-K\A filed on October 2, 2000. Subsequent to
such filing, no material developments have occurred with respect to the
litigation described therein.
In addition, the Company is involved in certain other legal actions
arising in the ordinary course of business. The Company believes, however, that
none of these actions, either individually or in the aggregate, will have a
material adverse effect on the Company's business or its consolidated financial
position or results of operations.
ITEM 2 CHANGES IN SECURITIES
Not applicable
ITEM 3 DEFAULTS UPON SENIOR SECURITIES
Not applicable
ITEM 4 SUBMISSION OF MATTERS TO A VOTE OF STOCKHOLDERS
No matters were submitted to a vote of security holders during the
quarter ended July 2, 2000.
ITEM 5 OTHER INFORMATION
Not applicable
ITEM 6 EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits -
Exhibit 27.1 Financial Data Schedule
(b) Reports on Form 8-K - None
20
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Dated: October 2, 2000
By:/s/Thomas G. Hood
-----------------
Thomas G. Hood
President and
Chief Executive Officer
By:/s/Robert R. Freeman
--------------------
Robert R. Freeman
Sr. Vice President and
Chief Financial Officer
21