UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
Washington,
D.C. 20549
FORM
10-K
(Mark
One)
x
ANNUAL
REPORT
PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
For
the fiscal year ended December 31, 2005
OR
o TRANSITION
REPORT
PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
For
the transition period from ________to _________
Commission
file number 0-15930
Southwall
Technologies Inc.
(Exact
name of Registrant as specified in its Charter)
|
Delaware
|
94-2551470
|
|
(State
or Other Jurisdiction of Incorporation or
Organization)
|
(I.R.S.
Employer Identification Number)
|
3975
East Bayshore Road
Palo
Alto, California 94303
(Address
of Principal Executive Offices including Zip Code)
(650)
962-9111
(Registrant's
Telephone Number, Including Area Code)
|
Securities
registered pursuant to Section 12(b) of the Act:
None
|
|
Securities
registered pursuant to Section 12(g) of the
Act:
|
|
Common
Stock
(Title
of Class)
|
___________
1
Indicate
by check mark if the registrant is a well-known seasoned issuer, as defined
in
Rule 405 of the Securities Act. Yes
¨
No
x
Indicate
by check mark if the registrant is not required to file reports pursuant to
Section 13 or 15 (d) of the Act. Yes
¨
No x
Indicate
by check mark whether the registrant (1) has filed all reports required to
be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes x
No ¨
Indicate
by check mark if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any
amendment to this
Form 10-K. Yes
¨
No x
Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12B-2 of the Exchange Act). Yes ¨ No x
Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of “accelerated
filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check
One).
Large
accelerated filer ¨
Accelerated
filer ¨
Non-accelerated
filer x
The
approximate aggregate market value of the Common Stock held by non-affiliates
of
the registrant on July 3, 2005 (based upon the closing sales price of the Common
Stock on the Over-the-Counter Bulletin Market on such date) was $16 million.
For
purposes of this disclosure, Common Stock held by stockholders whose ownership
exceeds five percent of the Common Stock outstanding as of July 3, 2005, and
Common Stock held by officers and directors of the registrant has been excluded
in that such persons may be deemed to be "affiliates" as that term is defined
in
the rules and regulations promulgated under the Securities Act of 1933, as
amended. This determination is not necessarily conclusive.
The
number of shares of the registrant's Common Stock outstanding on March 1, 2006
was 26,792,681.
Documents
Incorporated by Reference
|
Document
Description
|
10-K
Part
|
|
|
Portions
of the Registrant’s Proxy Statement
|
III
|
|
|
for
the Annual Meeting of Stockholders to
|
||
|
be
held May 25, 2006
|
2
SOUTHWALL
TECHNOLOGIES INC.
2005
ANNUAL REPORT ON FORM 10-K
Table
of Contents
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Part
I.
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Page
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Item
1.
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5
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Item
1A.
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16
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Item
1B.
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24
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Item
2.
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25
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Item
3.
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25
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Item
4.
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26
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26
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Part
II.
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Item
5.
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29
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Item
6.
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30
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Item
7.
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34
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Item
7A.
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55
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Item
8.
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56
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Item
9.
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91
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Item
9A.
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91
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Item
9B
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91
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Part
III.
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Item
10.
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92
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Item
11.
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92
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Item
12.
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92
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Item
13.
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92
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Item
14.
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93
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Part
IV.
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Item
15.
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94
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95
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As
used
in this report, the terms "we," "us," "our," "Southwall" and the "Company"
mean
Southwall Technologies Inc. and its subsidiaries, unless the context
indicates another meaning. This
report contains forward-looking statements as that term is defined in the
Private Securities Litigation Reform Act of 1995 that are subject to a number
of
risks and uncertainties. All statements other than statements of historical
facts are forward-looking statements. These statements are identified by
terminology such as "may," "will," "could," "should," "expects," "plans,"
"intends," "seeks," "anticipates," "believes," "estimates," "potential," or
"continue," or the negative of such terms or other comparable terminology,
although not all forward-looking statements contain these identifying words.
Forward-looking statements are only predictions and include, without limitation,
statements relating to:
|
·
|
our
strategy, future operations and financial plans, including, without
limitation, our plans to install and commercially produce products
on new
machines;
|
|
·
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the
continued trading of our common stock on the Over-the-Counter Bulletin
Board Market;
|
|
·
|
future
applications of thin film coating technologies and our development
of new
products;
|
|
·
|
our
expectations with respect to future grants, investment allowances
and bank
guarantees from the Saxony
government;
|
|
·
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our
projected need for additional borrowings and future
liquidity;
|
|
·
|
statements
about our ability to implement and maintain effective controls and
procedures;
|
|
·
|
statements
about the future size of markets;
|
|
·
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pending
and threatened litigation and its
outcome;
|
|
·
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our
competition; and
|
|
·
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our
projected capital expenditures.
|
You
should not place undue reliance on our forward-looking statements. Actual events
or results may differ materially. In evaluating these statements, you should
specifically consider various factors, including the risks outlined under "Risk
Factors" below. These factors may cause our actual results to differ materially
from any forward-looking statement. Although we believe the expectations
reflected in our forward-looking statements are reasonable as of the date they
are being made, we cannot guarantee our future results, levels of activity,
performance, or achievements. Moreover, neither we nor any other person assumes
responsibility for the future accuracy and completeness of these forward-looking
statements.
XIR,
XUV,
Triangle Design, Superglass, Heat Mirror, California Series, Solis, ETCH-A-FLEX,
and Southwall are registered trademarks of Southwall. V-KOOL is a registered
trademark of Globamatrix Holdings Pte. Ltd. All other trade names and trademarks
referred to in this prospectus are the property of their respective
owners.
PART
I
ITEM
1. BUSINESS
Overview
We
are a
global developer, manufacturer and marketer of thin film coatings for the
automotive glass, electronic display, architectural glass and window film
markets. We have developed a variety of products that control sunlight in
automotive glass, reduce light reflection, reduce potentially harmful
electromagnetic emissions and improve image quality in electronic display
products, and conserve energy via the application of our architectural and
after-market window film products. Our products consist of transparent
solar-control films for automotive glass; anti-reflective films for computer
screens and reflective films for back-lighting in liquid crystal displays;
transparent conductive films for use in touch screen and plasma panel displays;
energy control films for architectural glass; and various other coatings.
We
maintain a website with the address of www.southwall.com. We are not including
the information contained on our website as a part of, or incorporating it
by
reference into, this Annual Report on Form 10-K. We make available free of
charge through our website our Annual Reports on Form 10-K, Quarterly
Reports on Form 10-Q and Current Reports on Form 8-K, and amendments
to these reports, as soon as reasonably practicable after we electronically
file
such material with, or furnish such material to, the Securities and Exchange
Commission. In addition, we intend to disclose on our website any amendments
to,
or waivers from, our code of business conduct and ethics that are required
to be
publicly disclosed pursuant to the rules of the Securities and Exchange
Commission.
Industry
Background
Large
area, single layer, thin film coatings were developed in the early 1960s using
vacuum evaporation, a less precise precursor to sputter coating. As a result
of
technological developments in the early 1970s, multi-layer coatings for large
substrates became possible. Sputtering based on these developments is used
today
in a large number of applications in which high quality; uniform coatings need
to be deposited on large surfaces or on many smaller surfaces simultaneously.
Examples of sputter coating include the deposition of various metal and metal
oxide layers on wafers in the semiconductor and hard disk industries, and
optical coatings on transparent surfaces in the automotive glass, electronic
display, and architectural markets.
Thin
film
coatings are used in a wide variety of applications to control the transmission
and reflection of light and the flow of energy. Thin film coatings can modify
the transmission, reflection and absorption of both visible and non-visible
light, such as infrared and ultra-violet light, to enhance the performance
and
characteristics of the material.
Thin
film process technologies
The
three
most common methods for commercially producing thin film coatings on glass
and
flexible substrates are:
Wet
coating.
The wet
coating process generally involves depositing a thin layer of material onto
glass by a spin coating technique or onto a flexible substrate, or film, by
a
number of different methods. In the case of spin coating, which is sometimes
used for computer display tubes, or CDTs, a small amount of liquid is placed
at
the center of a spinning CDT, forcing the liquid from the center towards the
outside edge. Once a uniform thin layer of liquid is thus applied, the layer
is
bake-dried at a moderate temperature. In the case of film coating, a thin layer
of liquid material is applied to the surface of plastic film and then dried
by
means of thermal or direct radiation. This process is generally less expensive
than sputter coating, but generally yields coatings with lower quality optical
and mechanical characteristics.
Direct
coating onto glass substrates.
Direct
coating onto glass can be accomplished by sputtering and by pyrolytic means.
Direct-to-glass sputtering is a mature, well-known process for applying thin
film coatings to glass. This technology is commonly used to manufacture products
that conserve energy in buildings. Pyrolytic coatings are formed directly on
the
glass as it is produced on a float line. The pyrolytic process uses the heat
of
the molten glass to make a single layer, metal oxide coating from a solution
sprayed onto the glass. Because this technique produces only single layer
coatings, the performance is limited.
Sputter
coating onto flexible film substrates.
The
sputter coating process, which is the process we primarily employ, deposits
a
thin layer of materials, generally metals and metal oxides, onto the surface
of
a flexible substrate, usually polyester. The substrate can then be either
laminated in or applied to glass or suspended between panes of glass. The
substrate can be applied to both flat glass and curved glass, such as is used
in
automotive applications.
The
thin
film coating process begins with a clear base substrate that is typically glass
or a flexible polyester film. When using a flexible film, a hard coat is
sometimes applied to prevent undesired interactions between the materials to
be
deposited and the base substrate, as well as improve the mechanical properties
of the coating. Various materials are then deposited in very thin layers on
the
substrate. The process of building up the various layers results in a "stack."
The stack consists of layers of materials that produce the desired optical
and
performance effects. In some applications, primarily with flexible films,
adhesive or protective layers may be applied to the substrate to improve the
subsequent application of the product onto a rigid substrate, such as
glass.
Our
Markets
The
primary markets for thin film coated substrates that we manufacture are the
automotive glass, electronic display, architectural glass and window film
markets. Advances in manufacturing processes coupled with improved thin film
deposition technologies in the automotive glass and electronic display markets
are reducing production costs, allowing thin film coated substrates to more
cost-effectively address these markets.
Automotive
glass products
The
thin
film coated substrates we sell in this market reflect infrared heat. These
coatings allow carmakers to use more glass and increase energy efficiency by
reducing the demand on a vehicle's air conditioning system, as well as improving
thermal comfort in the vehicle. Thin film coated substrates in this market
are
sold primarily to original equipment manufacturers, or OEMs, that produce glass
for sale to European manufacturers of new cars and trucks for worldwide
distribution.
Nearly
all-automotive glass in the world uses some degree of tint or coloration to
absorb light and solar energy, thus reducing solar transmission into the
vehicle. This tint is usually created through the mixing of inorganic metals
and
metal oxides into the glass as the glass is produced. The cost of adding these
materials is very low, but the solar control benefit is limited by the fact
that
solar energy is absorbed in the glass, causing the glass to heat up, which
eventually increases the temperature inside the automobile.
Electronic
display products
The
thin
film coated products we sell in this market primarily block electromagnetic
emissions and infrared energy, and enhance the light output of certain displays.
Our thin film coated substrates are used in liquid crystal and plasma displays,
and in applications such as touch screens. In 2002, we started shipping
production quantities and sizes of an anti-reflective film specifically designed
for the liquid crystal display, or LCD, market. In 2003, we started shipments
of
coatings for the plasma display panel, or PDP, market. Thin film coated
substrates in this market are generally sold to OEMs, which apply the film
to
flat screens.
Architectural
glass products
The
thin
film coated substrates we sell in this market are primarily used to control
the
transmission of heat through window glass, as well as to limit ultra-violet
light damage. Window glass is a poor thermal barrier; thus, the primary source
of heat build-up and loss in buildings is through the glass
windows.
Window
Film
The
thin
film coated substrates we sell in this market are similar to the films sold
into
the automotive and architectural glass markets. Differences include certain
product characteristics that allow the architectural window film products to
be
sold in the aftermarket rather than through the OEMs. In addition, our
automotive window film products are used for retrofit application to the inside
surface of a vehicle window and are sold through resellers who install the
film.
Technology
In
a
sputtering process, a solid target and a substrate are placed in a vacuum
chamber. By adding a small amount of process gas, typically argon, to the
chamber and negatively charging the target, the process gas is ionized and
a
plasma discharge is formed. The positively charged gas ions strike the solid
target with enough force to eject atoms from its surface. The ejected target
atoms condense on the substrate and a thin film coating is constructed atom
by
atom. By placing a magnet behind the target, the electrons in the ionized plasma
are confined to a specific region on the target enhancing the creation of
ionized gas atoms and increasing the efficiency of the target atom ejection
process. By using different targets as the substrate moves through the vacuum
chamber, we can create a multi-layered coating, or stack.
If
the
process gas is inert, such as argon, the coating will have the same composition
as the target material. As an example, many of our coatings have a layer of
silver in the stack. However, by adding a reactive gas such as oxygen or
nitrogen to the process, it is possible to create metal oxide or metal nitride
coatings from a metal target.
The
advantages of our sputtering process include the high density of the formed
coatings and the high degree of uniformity control that we can
achieve.
We
rely
extensively upon trade secrets and know-how to develop and maintain our
competitive position. We have 29 patents and 10 patent applications pending
in
the United States and 63 patents and more than 31 patent applications pending
outside the United States that cover materials, processes, products and
production equipment. Of our existing patents, four U.S. patents and one
international patent will expire in the next three years. We also seek to avoid
disclosure of our know-how and trade secrets through a number of means,
including requiring those persons with access to our proprietary information
to
execute nondisclosure agreements with us. We consider our proprietary
technology, as well as its patent protection, to be an important factor in
our
business.
Products
The
following table describes the markets into which we sell our products, the
applications of our products, our product families, key features of our various
products and representative customers.
|
MARKET
|
APPLICATION
|
FILM
PRODUCTS
|
KEY
FEATURES
|
REPRESENTATIVE
CUSTOMERS
|
||||
|
Automotive
glass
|
Windscreens,
side windows, and back windows
|
Infrared
reflective (XIR 70 and XIR 75)
|
Transmits
70%
or
75% visible light
Reflects
85% of
infrared
heat energy
|
Saint
Gobain Sekurit
Pilkington
PLC
AGC
Automotive Americas
Guardian
Glass
|
||||
|
Electronic
display
|
Liquid
crystal display (LCD) screens
|
Anti-reflective
clear (ARC)
|
Clear
anti-reflective
product
|
Berliner
Glass
Mitsui
Chemicals
|
||||
|
LCD
reflector for lighting sources
|
Silver
reflecting
|
95%
Reflecting
Light-weight
mirror
|
||||||
|
|
Plasma
display panels (PDP)
|
Infrared
reflective (TCP)
|
Clear
and Conductive
Clear
infrared blocking
|
Mitsui
Chemicals
|
||||
|
Architectural
glass
|
New
and retrofit residential and commercial windows and doors
|
Suspended
Heat Mirror
|
Cool
in summer
Warm
in winter
UV
blocking
Noise
reducing
|
Kensington
Windows
Zamil
Glass
Traco
|
||||
|
|
Commercial
buildings
|
Laminated
(XIR)
|
Infrared
reflecting
UV
blocking
Cool
in summer
Noise
reducing
|
Gulf
Glass Industries
Cristales
Curvados
|
||||
|
Window
film
|
After-market
installation
|
Solis/V-KOOL
Huper
Optik
|
Transmits
up to
75%
visible light
Reflects
up to 85% of
infrared
heat energy
|
Globamatrix
Huper
Optik
|
||||
|
|
Infrared
reflecting
UV
blocking
Cool
in summer
Noise
reducing
|
|
Automotive
glass products
Direct-to-glass
sputtering for automotive windshields has not historically been well developed
because of the need to bend the glass before it can be coated and then installed
in an automobile. Coating flat glass and then bending it to match complex
automobile designs is less difficult. Therefore, coating flat glass and then
bending it is the method currently used by most windshield glass producers.
Our
sputter coated flexible substrates can be applied to windshields with different
curvatures and incorporated into most in-line windshield production processes
used by glass companies today.
Our
XIR
coated solar-control films are transparent, sputter-coated, polyester films
used
in laminated glass for automobiles. The films have a patented, transparent
solar-control coating on one side and a proprietary adhesion-promotion layer
on
the other.
Our
net
revenues from sales of automotive glass products were $19.6 million, $20.6
million and $20.3 million in 2005, 2004 and 2003,
respectively.
Electronic
display products
Our
sputter coated substrates offer the high optical quality necessary for higher
resolution electronic displays. Our substrates can be easily cut into different
shapes and sizes, providing increased flexibility for our customers. In
addition, our products can effectively reduce undesirable or potentially harmful
emissions without affecting the resolution of the display.
Anti-reflective
films.
Our
anti-reflective films minimize reflection of visible light while allowing high
picture quality. Our anti-reflective clear, or ARC, films are clear and used
in
LCD and plasma display panel screens.
Silver
reflecting films.
Our
silver reflecting film is a mirror-like product used as a reflector in LCD
backlit screens and for mirrors in rear-projection TV systems.
Transparent
conductors.
XIR
films are used in the plasma display panel markets to block near-infrared and
electromagnetic radiation from the display. Our ALTAIR-M films are used in
products such as touch panels, liquid crystal displays and electroluminescent
displays where the circuit or conductive material must not obscure the screen.
ALTAIR films are also used in electromagnetic interference shielding, infrared
rejection and electrostatic discharge packaging applications.
Our
net
revenues from sales of electronic display products were $14.0 million, $20.6
million and $19.0 million in 2005, 2004 and 2003, respectively.
Architectural
glass products
Windows
containing our Heat Mirror product have approximately two to five times the
insulating capacity of conventional double-pane windows. They also provide
high
levels of solar shading while transmitting a high percentage of visible light.
In addition, our products also offer ultra-violet protection and reduce noise
and condensation build-up. Our products allow architectural glass manufacturers
to improve insulation without adding numerous panes of glass that are
impractical to lift and cannot be supported by a structure's frame. This drives
the need for thin film inside the glass that is a high performance insulator
at
a fraction of the weight of the glass.
Suspended
Heat Mirror films.
Our Heat
Mirror films provide a variety of shading and insulating properties as well
as
ultra-violet damage protection. Windows are the primary areas of heat loss
in
winter and a major source of heat gain in summer. Heat Mirror films, which
are
sold in rolls to window manufacturers, are suspended in the airspace between
sealed double-pane residential and commercial windows. We have developed
proprietary film-mounting technology, which we license to window fabricators.
There are more than 50 Heat Mirror licenses in approximately 20 countries.
We
currently offer 11 different Heat Mirror films for architectural
applications.
Laminated
films.
Our thin
film coated flexible substrates are laminated between panes of glass and perform
similarly to our XIR solar control films for automobiles. This film is currently
sold primarily to fabricators of laminated window glass for large commercial
building applications such as airports, office buildings, and museums. We have
sold more than 20 licenses for this architectural film product in approximately
15 countries.
Our
net
revenues from sales of architectural products were $5.9 million, $7.0 million
and $6.3 million in 2005, 2004 and 2003, respectively.
Window
Film Products
Our
Solis/V-KOOL and Huper Optik solar-control films for automotive glass and
architectural glass aftermarket installation use our XIR and other patented
coating technologies. These products are applied to existing windows and have
a
protective hard coat over the patented, transparent solar-control coating on
one
side and an adhesion layer on the other. Solis/V-KOOL and Huper Optik are sold
through a worldwide distribution network of companies owned by or affiliated
with Globamatrix.
Our
net
revenues from sales of window film products were $15.1 million, $9.4 million
and
$7.7 million in 2005, 2004 and 2003, respectively.
Sales
and Marketing
Distribution
channels
We
sell
our automobile and electronic display products primarily to OEMs in North
America, Europe, the Middle East and Asia, principally through our own direct
sales force and sales representatives. Mitsui Chemicals is our licensee and
distributor for certain of our electronic products, and has exclusive
manufacturing and distribution rights for certain of our electronic products
using our proprietary sputtering technology.
We
supply
our Heat Mirror architectural products to approximately 50 insulated glass
and
window fabricators and distributors worldwide. Our proprietary mounting
technology is licensed to our customers, who use special equipment for the
manufacture of Heat Mirror-equipped windows. Our field services organization
assists customers in the manufacture of Heat Mirror-equipped windows. In North
America, we also promote our Heat Mirror product line through approximately
6
regionally based architectural glass sales representatives.
We
sell
our Solis/V-KOOL and Huper Optik aftermarket products for the automotive glass
and architectural markets through a worldwide distribution network of companies
owned by or affiliated with Globamatrix.
International
revenues amounted to approximately 74%, 79% and 89% of our net revenues during
2005, 2004 and 2003, respectively. The principal foreign markets for our
products in 2005 were Japan ($12 million) and France ($11 million).
Quality
claims
We
accept
sales returns for quality claims on our products, which we believe are
competitive for the markets in which those products are sold. The nature and
extent of these quality claims depend on the product, the market, and in some
cases the customer being served. We carry liability insurance. However, our
insurance does not cover quality claims and there can be no assurance that
our
insurance will be sufficient to cover all product liability claims in the future
or that the costs of this insurance or the related deductibles will not increase
materially.
Customers
Our
customers include many of the world's leading OEMs in the automotive glass
and electronic display markets. Our customers in the OEM automotive glass market
include Saint Gobain Sekurit, Pilkington PLC, and Asahi, who sell glass to
automobile manufacturers including DaimlerChrysler, Renault, Audi, BMW, Volvo,
Volkswagen and the PSA Group (which includes Peugot and Citroen). Our supply
agreement with Saint Gobain Sekurit expired on December 31, 2005. We
entered into a new agreement with Saint Gobain Sekurit in March of 2006. The
new
agreement will expire on February 29, 2008. Our failure to produce the required
amounts of products under the new agreement could result in price penalties
on
future sales under the agreements.
Our
customers in the electronic display market include Mitsui Chemicals and a number
of other small accounts. Sales to Mitsui represented 23% of our total sales
in
2005.
In
2005,
our customers in the architectural market included approximately 50 fabricators
of insulated glass units and laminated glass for architectural
applications.
Our
aftermarket applied film in the automotive and architectural glass markets
is
sold pursuant to an exclusive worldwide license in our distribution agreement
with Globamatrix. Under the Agreement, which is scheduled to expire in 2011,
Globamatrix agreed to purchase a set amount of our products during the term
of
the agreement subject to volume and quality standards. Our failure to produce
required amounts of product under the agreement will result in penalties under
which we would be required to reimburse Globamatrix for the full cost of any
product not timely delivered. For each year after 2004 through and including
2011, Globamatrix is required to purchase an amount of product equal to 110%
of
the amount of product it was required to purchase in the prior year. Globamatrix
was obligated to purchase $10.3 million of products in 2005. During 2005,
Globamatrix purchased approximately $14.9 million of product.
Globamatrix
is obligated to purchase at least $11.3 million from us in 2006.
A
small
number of customers have accounted for a substantial portion of our revenues.
Our ten largest customers accounted for approximately 81%, 79% and 84% of our
net sales in, 2005, 2004 and 2003, respectively. During 2005, Mitsui Chemicals,
Saint Gobain Sekurit, V-Kool and Pilkington PLC accounted for 22.7%, 19.8%,
19.5% and 7.1%, respectively, of our net revenues. During 2004, Mitsui
Chemicals, Saint Gobain Sekurit, V-Kool and Pilkington PLC accounted for 28.4%,
17.8%, 11.4% and 10.9%, respectively, of our net revenues. During 2003, Mitsui
Chemicals, Saint Gobain Sekurit, Pilkington PLC and V-Kool accounted for 21.4%,
17.2%, 13.7% and 10.0%, respectively, of our net revenues. Because of our fixed
costs, the loss of, or substantial reduction in orders from, one or more of
these customers would have a material adverse affect on our profitability and
cash flow. The timing and amount of sales to these customers depends on sales
levels and shipping schedules for the OEM products into which our products
are
incorporated. We have no control over the shipping dates or volume of products
shipped by our OEM customers, and we cannot be certain that they will continue
to ship products that incorporate our products at current levels or at all.
In
addition, we rely on our OEM customers to timely inform us of opportunities
to
develop new products that serve end-user demands.
Research
and Development
Our
research and development activities are focused upon the development of new
proprietary products, thin film materials science, and deposition process
optimization and automation and applied engineering. Our research and
development expenditures totaled $5.1 million, $3.2 million and $6.7 million,
or
approximately 9.3%, 5.6% and 12.6% of total net revenues, in 2005, 2004 and
2003, respectively.
Historically,
our research and development efforts have been driven by customer requests
for
the development of new applications for thin film coated substrates. To meet
the
future needs of our customers, we continually seek to improve the quality and
functionality of our current products and enhance our core technology. For
example, in 2002 we began shipping production quantities and sizes of an
anti-reflective film specifically designed for the liquid crystal display and
plasma display panel markets that maintain optical clarity while reducing the
reflection of ambient light to improve image quality. In 2003, we developed
a
new conductive film to satisfy Class B infrared shielding requirements for
plasma display panels. In 2004, the Class B film was sold in substantial
quantities for the first time for use in PDP televisions sets. In 2005, we
began
development and sampling of a new class of films with improved performance
that
we believe will be beneficial across our product lines. We also initiated
significant research and development into thin film technology that we
anticipate will enable Southwall to produce products for new applications and
markets. We cannot guarantee that we will be successful in developing or
marketing these applications or that our films will continue to meet the
demanding requirements of the changing technology.
Although
our production systems are built by outside vendors, we work closely with our
vendors on the detailed implementation of the production machine designs. Our
experience with designing production systems is critical for the proper
construction of these machines. Once a new machine is installed and accepted
by
us, our engineers are responsible for transitioning the system into commercial
production to help ensure stable manufacturing yields.
In
2005,
we hired a new Chief Technology Officer and expanded our engineering
organization by hiring an additional eight engineers. We are committed to
developing new technologies and expanding our product offerings.
Manufacturing
The
table
below provides information about our current production machines and the class
of products that each is currently tooled to produce.
|
Machine
Number
|
Location
|
Primary
Markets For
Current
Production
|
Year
Commercial
Production
Initiated
|
Estimated
Annual
Capacity
(Millions
of
Sq. Ft.) (1)
|
|
|
PM
1
|
Palo
Alto
|
Architectural
|
1980
|
none
|
|
|
PM
2
|
Palo
Alto
|
Electronic
display (currently not in use)
|
1982
|
6.0
|
|
|
PM
4A
|
Palo
Alto
|
Automotive,
architectural, electronic display and
window film
|
1991
|
12.0
|
|
|
PM
4B
|
Palo
Alto
|
Automotive,
architectural, electronic display and
window film
|
1991
|
12.0
|
|
|
PM
8
|
Dresden
|
Automotive,
architectural, electronic display and
window film
|
2000
|
16.0
|
|
|
PM
9
|
Dresden
|
Automotive,
architectural, electronic displayand
window film
|
2001
|
16.0
|
|
|
PM
10
|
Dresden
|
Automotive,
architectural, electronic display and
window film
|
2003
|
16.0
|
_________________________________
(1)
Estimated annual capacity represents our estimated yields based on our
historical experience and anticipated product mix. The amount of product for
which we receive orders and which we actually produce in any year may be
materially less than these estimates.
On
January 19, 2006, we commenced restructuring actions to improve our cost
structure for 2006 and beyond. These actions include the closure of our Palo
Alto, California manufacturing facility in the first half of 2006. We intend
to
scrap or sell our production machines (PM 2, PM 4A and PM 4B) used for
manufacturing in Palo Alto. We will transfer our U.S. manufacturing operations
to our site located near Dresden, Germany in the first half of
2006.
Our
Dresden, Germany facility is ISO 9001/2000 certified.
Dresden,
Germany facility
We
own a
production plant in Grossroehrsdorf, Germany, near the city of Dresden. The
plant has three production machines and manufactures approximately 60% of our
products. Southwall’s Dresden plant is a supplier of automotive and
architectural energy management films used by glass companies to enhance the
thermal performance of their products; it is also a supplier of electronic
display and window film.
Environmental
Matters
We
use
potentially hazardous materials in our research and manufacturing operations
and
have air and water emissions that require controls. As a result, we are subject
to stringent federal, state and local regulations governing the storage, use
and
disposal of wastes. We contract with outside vendors to collect and dispose
of
waste at both of our production facilities in compliance with applicable
environmental laws. In addition, we have in place procedures that we believe
enable us to deal properly with the gasses emitted in our production process,
and we have implemented a program to monitor our past and present compliance
with environmental laws and regulations. Although we believe we are currently
in
material compliance with such laws and regulations, current or future laws
and
regulations may require us to make substantial expenditures for compliance
with
chemical exposure, waste treatment or disposal regulations.
Suppliers
and Subcontractors
We
manufacture our products using materials procured from third-party suppliers.
We
obtain certain of these materials from limited sources. For example, the
substrate we use in the manufacture of the Heat Mirror product is currently
available from one main qualified source, Teijin Limited. The loss of our
current source could adversely affect our ability to meet our scheduled product
deliveries to customers. Alternative sources of supply are being pursued;
however, it takes approximately 18 to 24 months for us to qualify a new
supplier and we may not be able to successfully develop such
sources.
We
rely
on third-party subcontractors to add properties, such as adhesives, to some
of
our products. There are only a limited number of qualified subcontractors that
can provide some of the services we require. A significant increase in the
price
charged by one or more of our subcontractors could force us to raise prices
on
our products or lower our margins, which could have a material adverse effect
on
our operating results.
Furthermore,
our production machines are large, complex and difficult to design and assemble.
It can take up to a year from the time we order a machine until it is delivered.
Following delivery, it can take us, with the assistance of the manufacturer,
up
to six additional months to test and prepare the machine for commercial
production. There are a limited number of companies that are capable of
manufacturing these machines to our specifications. Our inability in the future
to have new production machines manufactured and prepared for commercial
production in a timely manner would have a material adverse effect on our
business.
Backlog
Our
backlog primarily consists of purchase orders for products to be delivered
within 90 days. As of February 28, 2006 and February 28, 2005, we had a
backlog of orders able to be shipped over the next 12 months of
approximately $8.2 million and $7.6 million, respectively. Some of
these orders are not firm orders and are subject to cancellation. For these
reasons, these orders may not be indicative of our future revenues.
Competition
The
thin
film coatings industry and the markets in which our customers compete experience
rapid technological change, especially the electronic display market. Adoption
by our competitors of new equipment or process technologies could adversely
affect us. We have a number of present and potential competitors, including
our
customers, many of which have greater financial resources and greater selling,
marketing and technical resources than we possess.
Automotive
glass market.
Large,
worldwide glass laminators typically have divisions selling products to the
commercial flat glass industry and provide solar control products in the
automotive OEM market. We face technological competition from companies, such
as
PPG Industries, Pilkington PLC, Saint Gobain, Asahi, Guardian, and Glaverbel
that have direct-to-glass sputtering capability. We may also be subject to
future competition from companies that are able to infuse glass with solar
control properties. We estimate that in 2005 our coated substrates were used
in
less than 1% of the total worldwide automotive OEM glass produced.
Electronic
display market.
Competitors in the electronic display market include companies developing new
coatings, such as wet coatings, for flat panel displays, as well as competitors
who supply sputter coated films similar to those produced by us. Customers'
selection of products is driven by quality, price and capacity. In addition,
some of our current and potential customers are capable of creating products
that compete with our products. We estimate that in 2005 our coated substrates
were applied to less than 4% of the products in the worldwide, flat screen
plasma display market.
Architectural
glass market.
Products
that provide solar control and energy conservation have been available to this
market for almost 25 years. Since our introduction of our Heat Mirror
suspended film product in 1979, large glass producers, such as Guardian, PPG,
Apogee Enterprises, Pilkington, Saint Gobain Sekurit, and Asahi, have produced
their own direct-to-glass sputtered products that provide solar control and
energy conservation similar to our Heat Mirror product. We estimate that in
2005
our coated substrates were used in less than 1% of the glass used worldwide
in
residential and commercial buildings.
Window
film market. In
the
applied film segment of the market, companies such as 3M, Bekeart, CP Films
(a
subdivision of Solutia), and Lintec Inc. produce competitive solar control
products that are widely accepted in the market.
Basis
of competition
We
believe we compete principally on the basis of:
|
•
|
Proprietary
thin film sputtering process knowledge and control
systems;
|
|
•
|
Our
extensive thin film materials expertise and optical design
capabilities;
|
|
•
|
Our
state-of-the-art coating facility in a low-cost labor environment,
which
receives significant financial support from local and federal governments
in Germany; and
|
|
•
|
Our
ability to easily alter the format of our products, providing our
customers with inventory versatility and higher production
yields.
|
Employees
As
of
December 31, 2005, we had 179 full-time and 5 part-time employees, of whom
25
were engaged in engineering, 110 in manufacturing, 19 in sales and marketing,
and 30 in general management, finance and administration. We are highly
dependent upon the continuing services of certain technical and management
personnel. None of our U.S. employees is represented by a labor union. To our
knowledge, none of our German employees are represented by a labor union. We
consider our employee relations to be good.
ITEM
1A. RISK FACTORS
Financial
Risks
Our
working capital position, financial commitments and historical performance
may
raise doubt about our ability to have positive earnings in the
future.
We
incurred net losses in 2004 and 2003 and negative cash flows from operations
in
2003. These factors together with our working capital position and our
significant debt service and other contractual obligations at December 31,
2005,
may raise doubt about our ability to restore profitable operations, generate
cash flow from operating activities and obtain additional financing. These
and
other factors related to our business during recent years, our past failure
to
comply with covenants in our financing agreements and our voluntary delisting
from NASDAQ in March 2004 may make it difficult for us to secure the required
additional borrowings on favorable terms or at all. We intend to seek additional
borrowings or alternative sources of financing; however, difficulties in
borrowing money or raising financing could have a material adverse effect on
our
operations, planned capital expenditures and ability to comply with the terms
of
government grants.
A
few
stockholders own a majority of our shares and will be able to exert control
over
us and our significant corporate decisions.
As
a
result of the consummation of the financing transactions in December 2003 and
February 2004 with Needham & Company, Inc and its affiliates and Dolphin
Direct Equity Partners, L.P., these shareholders at December 31, 2005 owned
securities convertible into 57% of our outstanding common stock.
As our
largest stockholder and the guarantor of our line of credit, Needham could
prevent us from seeking additional borrowings or alternative sources of
financing that we require for future operations, could delay or prevent a change
of control of our company, or otherwise control the company in ways that might
have a material adverse effect on our company or our other
shareholders.
Covenants
or defaults under our credit and other loan agreements may prevent us from
borrowing or force us to curtail our operations.
As
of
December 31, 2005, we had total outstanding obligations under our credit and
other loan agreements of $13.1 million. Our inability to make timely payments
of
interest or principal under these facilities could materially adversely affect
our ability to borrow money under existing credit facilities, to secure
additional borrowings or to function as a going concern. Our current credit
facilities contain financial covenants that will require us to meet certain
financial performance targets and operating covenants that limit our discretion
with respect to business matters. Among other things, these covenants restrict
our ability to borrow additional money, create liens or other encumbrances,
and
make certain payments including dividends and capital expenditures. Many of
these loans contain provisions that permit the lender to declare the loans
immediately due if there is a material adverse change in our business. These
credit facilities also contain events of default that could require us to pay
off indebtedness before its maturity.
The
restrictions imposed by these credit facilities or the failure of lenders to
advance funds under these facilities could force us to curtail our operations
or
have a material adverse effect on our liquidity.
Our
ability to borrow is limited by the nature of our equipment and some of our
accounts receivable.
Our
equipment is custom designed for a special purpose. In addition, a large portion
of our accounts receivable are from foreign sales, which are often more
difficult to collect than domestic accounts receivable. As a result of the
nature of our equipment and accounts receivable, lenders will generally allow
us
to borrow less against these items as collateral than they would for other
types
of equipment or domestic accounts receivable, or require us to provide
additional credit enhancements.
If
we
default under our secured credit facilities and financing arrangements, the
lenders could foreclose on the assets we have pledged to them requiring us
to
significantly curtail or even cease our operations.
In
connection with our current borrowing facilities and financing arrangements,
we
have granted security interests in and liens on substantially all of our assets,
including our production machines and our Dresden facility, to secure the loans.
If our senior lenders were to repossess one or more of those machines, our
ability to produce product would be materially impaired. Our revenues, gross
margins and operating efficiency would also be materially adversely affected.
Our obligations under our secured credit facilities contain cross-default and
cross-acceleration provisions and provisions that allow the lenders to declare
the loans immediately due if there is a material adverse change in our business.
If we default under the credit facilities or financing arrangements the lenders
could declare all of the funds borrowed there under, together with all accrued
interest, immediately due and payable. If we are unable to repay such
indebtedness, the lenders could foreclose on the pledged assets. If the lenders
foreclose on our assets, we would be forced to significantly curtail or even
cease our operations.
Our
quarterly revenue and operating results are volatile and difficult to predict.
If we fail to meet the expectations of public market analysts or investors,
the
market price of our common stock may decrease significantly.
Our
quarterly revenue and operating results have varied significantly in the past
and will likely vary significantly in the future. Our revenue and operating
results may fall below the expectations of securities analysts or investors
in
future periods. Our failure to meet these expectations would likely adversely
affect the market price of our common stock.
Our
quarterly revenue and operating results may vary depending on a number of
factors, including:
|
•
|
fluctuating
customer demand, which is influenced by a number of factors, including
market acceptance of our products and the products of our customers
and
end-users, changes in product mix, and the timing, cancellation or
delay
of customer orders and shipments;
|
|
•
|
the
timing of shipments of our products by us and by independent
subcontractors to our customers;
|
|
•
|
manufacturing
and operational difficulties that may arise due to, among other things,
quality control, capacity utilization of our production machines,
unscheduled equipment maintenance, and the hiring and training of
additional staff;
|
|
•
|
our
ability to introduce new products on a timely basis; and
|
|
•
|
competition,
including the introduction or announcement of new products by competitors,
the adoption of competitive technologies by our customers, the addition
of
new production capacity by competitors and competitive pressures
on prices
of our products and those of our customers.
|
We
expect to be subject to increased foreign currency risk in our international
operations.
In
2003,
2004 and 2005, approximately 34%, 31% and 32% of our revenues, respectively,
were denominated in euros, primarily related to sales from our Dresden
operation, including sales to one of our largest customers, a European
automotive glass manufacturer. In addition, other customers may request to
make
payments in foreign currencies. Also, certain transactions with foreign
suppliers are denominated in foreign currencies, primarily Japanese Yen.
A
strengthening in the dollar relative to the currencies of those countries in
which we do business would increase the prices of our products as stated in
those currencies and could hurt our sales in those countries. Significant
fluctuations in the exchange rates between the U.S. dollar and foreign
currencies could cause us to lower our prices and thus reduce our profitability
and cash flows. These fluctuations could also cause prospective customers to
cancel or delay orders because of the increased relative cost of our products.
Our
suppliers and subcontractors may impose more onerous payment terms on
us.
As
a
result of our financial performance and voluntary delisting from NASDAQ, our
suppliers and creditors may impose more onerous payment terms on us, which
may
have a material adverse effect on our financial performance and our liquidity.
For example, one of our subcontractors has required us to provide it with a
security interest in all of our inventory held by it and has limited the amount
of unpaid invoices we may have outstanding with it at any time.
Operational
Risks
We
depend on a small number of customers for nearly all of our revenues, and the
loss of a large customer could materially adversely affect our revenues or
operating results.
Our
ten
largest customers accounted for approximately 82%, 79%, and 84% of net revenues
in 2005, 2004 and 2003, respectively. We expect to continue to derive a
significant portion of our net sales from this relatively small number of
customers. Accordingly, the loss of a large customer could materially hurt
our
business, and the deferral or loss of anticipated orders from a large customer
or a small number of customers could materially reduce our revenue and operating
results in any period. Some of our largest automotive glass customers have
used
a technology—direct-to-glass
sputtering—as
an
alternative to our window films, which in 2003 resulted in a decrease in orders
from these customers. The continued or expanded use of this technology by our
automotive glass customers would have a material adverse effect on our results
of operations and financial position.
We
must continue to develop new products or enhance existing products on a timely
basis to compete successfully in a rapidly changing
marketplace.
Our
future success depends upon our ability to introduce new products, improve
existing products and processes to keep pace with technological and market
developments, and to address the increasingly sophisticated and demanding needs
of our customers, especially in the electronic display and automotive markets.
Technological changes, process improvements, or operating improvements that
could adversely affect us include:
|
•
|
the
development of competing technologies to our anti-reflective and
silver
reflector films for liquid crystal displays in the flat panel display
industry;
|
|
•
|
changes
in the way coatings are applied to alternative substrates such as
tri-acetate cellulose, or TAC;
|
|
•
|
the
development of new technologies that improve the manufacturing efficiency
of our competitors;
|
|
•
|
the
development of new materials that improve the performance of products
that
could compete with our products; and
|
|
•
|
improvements
in the alternatives to the sputtering technology we use to produce
our
products, such as plasma enhanced chemical vapor deposition, or PECVD.
|
Our
research and development efforts may not be successful in developing products
in
the time, or with the characteristics, necessary to meet customer needs. If
we
do not adapt to technological changes or processes or operating improvements,
our competitive position, operations and prospects would be materially adversely
affected.
Our
ability to successfully identify suitable target companies and integrate
acquired companies or technologies may affect our future
growth.
A
potential part of our continuing business strategy is to consider acquiring
companies, products, and technologies that complement our current products,
enhance our market coverage, technical capabilities or production capacity,
or
offer other growth opportunities. Our ability to successfully complete
acquisitions requires that we identify suitable target companies, agree on
acceptable terms, and obtain acquisition financing on acceptable terms. In
connection with these acquisitions, we could incur debt, amortization expenses
relating to identified intangibles, impairment charges relating to goodwill,
or
merger related charges, or could issue stock that would dilute our current
shareholders' percentage of ownership. The success of any acquisitions will
depend upon our ability to integrate acquired operations, retain and motivate
acquired personnel, and increase the customer base of the combined businesses.
We may not be able to accomplish all of these goals. Any future acquisitions
would involve certain additional risks, including:
|
•
|
difficulty
integrating the purchased operations, technologies, or products;
|
|
•
|
unanticipated
costs, which would reduce our profitability;
|
|
•
|
diversion
of management's attention from our core business;
|
|
•
|
potential
entrance into markets in which we have limited or no prior experience;
and
|
|
•
|
potential
loss of key employees, particularly those of the acquired business.
|
If
one of our customers is able to enforce a European automotive film patent,
we
may be restricted from using the methods present in such patent to produce
some
of our products.
On
March
3, 2005, the European Patent Office allowed a European patent owned by
Pilkington Automotive GmBH entitled "Method for producing a laminated glass
pane
free of optical obstruction caused by warping, use of a particular carrier
film
for the production of the laminated glass pane and carrier films particularly
suitable for the method of use." This European patent covers certain laminated
films and methods of using them, which may prevent us from producing
certain films designed for the automotive markets. Our inability to use this
technology could adversely affect our ability to provide a full range of
products to the automotive film market. We participated in opposing the European
patent and have appealed the European Patent Office decision.
Failure
to meet the volume requirements of our customers may result in a loss of
business or contractual penalties.
Our
long-term competitive position will depend to a significant extent on our
manufacturing capacity. The failure to have sufficient capacity, to fully
utilize capacity when needed or to successfully integrate and manage additional
capacity in the future could adversely affect our relationships with customers
and cause customers to buy similar products from our competitors if we are
unable to meet their needs. For example, we believe that we lost substantial
potential architectural products sales in 2001 because we did not have the
capacity to manufacture the required amounts of products. Also, our failure
to
produce required amounts of products under some of our contracts will result
in
price reductions on future sales under such contracts or penalties under which
we would be required to reimburse the customer for the full cost of any product
not delivered in a timely manner, either of which would reduce our gross
margins.
We
depend on our OEM customers for the sale of our products.
We
sell a
substantial portion of our products to a relatively small number of original
equipment manufacturers, or OEMs. The timing and amount of sales to these
customers ultimately depend on sales levels and shipping schedules for the
OEM
products into which our products are incorporated. We have no control over
the
volume of products shipped by our OEM customers or shipping dates, and we cannot
be certain that our OEM customers will continue to ship products that
incorporate our products at current levels or at all. We currently have
long-term contracts with only two of our OEM customers. Failure of our OEM
customers to achieve significant sales of products incorporating our products
and fluctuations in the timing and volume of such sales could be harmful to
our
business. Failure of these customers to inform us of changes in their production
needs in a timely manner could also hinder our ability to effectively manage
our
business.
We
rely upon our OEM customers for information relating to the development of
new
products so that we are able to meet end-user demands.
We
rely
on our OEM customers to inform us of opportunities to develop new products
that
serve end-user demands. If our OEM customers do not present us with market
opportunities early enough for us to develop products to meet end-user needs
in
a timely fashion, or if the OEMs fail to anticipate end-user needs at all,
we may fail to develop new products or modify our existing products for the
end-user markets for our products. In addition, if our OEM customers fail to
accurately anticipate end-user demands, we may spend resources on products
that
are not commercially successful.
We
depend on a distributor for the sale of our after-market
products.
We
primarily use one independent distributor to sell our after-market products.
We
have a distribution agreement with Globamatrix Holdings Pte. Ltd., or
Globamatrix, under which we granted an exclusive worldwide license to distribute
our after-market applied film in the automotive and architectural glass markets.
Failure of Globamatrix to achieve significant sales of products incorporating
our products and fluctuations in the timing and volume of such sales could
be
harmful to our business. We believe that the success of our after-market
products will continue to depend upon this distributor.
We
face intense competition, which could affect our ability to increase our
revenue, maintain our margins and increase our market share.
The
market for each of our products is intensely competitive and we expect
competition to increase in the future. Competitors vary in size and in the
scope
and breadth of the products they offer. We compete both with companies using
technology similar to ours and companies using other technologies or developing
improved technologies. Direct-to-glass sputtering represents the principal
alternative technology to our sputter-coated film products. Direct-to-glass
is a
mature, well-known process for applying thin film coatings directly to glass,
which is used by some of our current and potential customers to produce products
that compete with our products. This technology is commonly used to manufacture
products that conserve energy in buildings and automobiles. Many of our current
and potential competitors have significantly greater financial, technical,
marketing and other resources than we have. In addition, many of our competitors
have well-established relationships with our current and potential customers
and
have extensive knowledge of our industry.
We
are dependent on key suppliers of materials, which may prevent us from
delivering product in a timely manner.
We
manufacture all of our products using materials procured from third-party
suppliers. We do not have long-term contracts with our third-party suppliers.
Certain of the materials we require are obtained from a limited number of
sources. Delays or reductions in product shipments could damage our
relationships with customers. Further, a significant increase in the price
of
one or more of the materials used in our products could have a material adverse
effect on our cost of goods sold and operating results.
We
are dependent on a few qualified subcontractors to add properties to some of
our
products.
We
rely
on third-party subcontractors to add properties, such as adhesives, to some
of
our products. There are only a limited number of qualified subcontractors that
can provide some of the services we require, and we do not have long-term
contracts with any of those subcontractors. Qualifying alternative
subcontractors could take a great deal of time or cause us to change product
designs. The loss of a subcontractor could adversely affect our ability to
meet
our scheduled product deliveries to customers, which could damage our
relationships with customers. If our subcontractors do not produce a quality
product, our yield will decrease and our margins will be lower. Further, a
significant increase in the price charged by one or more of our subcontractors
could force us to raise prices on our products or lower our margins, which
could
have a material adverse effect on our operating results.
We
are dependent on key suppliers of production machines, which may prevent us
from
delivering an acceptable product on a timely basis and limit our capacity for
revenue growth.
Our
production machines are large, complex and difficult to manufacture. It can
take
up to a year from the time we order a machine until it is delivered. Following
delivery, it can take us, with the assistance of the manufacturer, up to six
additional months to test and prepare the machine for commercial production.
There are a very limited number of companies that are capable of manufacturing
these machines. Our inability in the future to have new production machines
manufactured and prepared for commercial production in a timely manner would
prevent us from delivering product on a timely basis and limit our capacity
for
revenue growth.
Fluctuations
or slowdowns in the overall electronic display industry have and may continue
to
adversely affect our revenues.
Our
business depends in part on sales by manufacturers of products that include
electronic displays. The markets for electronic display products are highly
cyclical and have experienced periods of oversupply resulting in significantly
reduced demand for our products. For example, during 2005, we experienced a
decrease of 32% from 2004 in our net revenues in the electronic display market
primarily due to lower demand for our sputtered thin film filter products for
Plasma Display Panel products due to increased competition, and we expect this
trend to continue. Mitsubishi Electric was the only CRT manufacturer that buys
our anti-reflective, or AR, film and it decided to consolidate all of the
manufacturing of this product to Japan. In connection with that consolidation,
Mitsubishi ceased production of the 17" AR product in its Mexico plant during
the third quarter of 2003. In 2005, we stopped converting (cutting the film
to
the customer’s specifications) one of our window film product models and agreed
with our customers that they would complete this process. This resulted in
higher revenues on our TX products as our customers bought more products to
fill
their distribution pipeline.
If
we
are unable to adequately protect our intellectual property, third parties may
be
able to duplicate our products or develop functionally equivalent or superior
technology.
Our
success depends in large part upon our proprietary technology. We rely on our
know-how, as well as a combination of patent, trademark and trade secret
protection, to establish and protect our intellectual property rights. Despite
our efforts to protect our proprietary rights, unauthorized parties may attempt
to copy aspects of our products or to obtain and use information that we regard
as proprietary. Policing unauthorized use of our products is difficult. Our
means of protecting our proprietary rights may not be adequate. In addition,
the
laws of some foreign countries do not protect our proprietary rights to as
great
an extent as do the laws of the United States. One of our U.S. patents relating
to our architectural products, heat mirror, will expire in 2006. Expiration
of
these patents or our failure to adequately protect our proprietary rights may
allow third parties to duplicate our products or develop functionally equivalent
or superior technology. In addition, our competitors may independently develop
similar technology or design around our proprietary intellectual property.
Performance,
reliability or quality problems with our products may cause our customers to
reduce or cancel their orders.
We
manufacture our products based on specific, technical requirements of each
of
our customers. We believe that future orders of our products will depend in
part
on our ability to maintain the performance, reliability and quality standards
required by our customers. If our products have performance, reliability or
quality problems, then we may experience:
|
•
|
delays
in collecting accounts receivable;
|
|
•
|
higher
manufacturing costs;
|
|
•
|
additional
warranty and service expenses; and
|
|
•
|
reduced
or cancelled orders.
|
If
we
fail to recruit and retain a significant number of qualified technical personnel
we may not be able to develop, enhance and introduce our products on a timely
basis, and our business will be harmed.
We
require the services of a substantial number of qualified technical personnel.
Intense competition and aggressive recruiting, as well as a high-level of
employee mobility characterize the market for skilled technical personnel.
These
characteristics make it particularly difficult for us to attract and retain
the
qualified technical personnel we require. We have experienced, and we expect
to
continue to experience, difficulty in hiring and retaining highly skilled
employees with appropriate technical qualifications. It is especially difficult
for us to recruit qualified personnel to move to the location of our Palo Alto,
California offices because of the high-cost of living. If we are unable to
recruit and retain a sufficient number of qualified technical employees, we
may
not be able to complete the development of, or enhance, our products in a timely
manner. As a result, our business may be harmed and our operating results may
suffer.
We
may be unable to attract or retain the other highly skilled employees that
are
necessary for the success of our business.
In
addition to our dependence on our technical personnel, our success also depends
on our continuing ability to attract and retain other highly skilled employees.
We depend on the continued services of our senior management, particularly
Thomas G. Hood, our President and Chief Executive Officer and Neil Bergstrom,
our Chief Technology Officer and Senior Vice President. We do not have
employment contracts with any of our officers or key-person life insurance
covering any officer or employee. Our officers have technical and industry
knowledge that cannot easily be replaced. Competition for similar personnel
in
our industry where we operate is intense. We have experienced, and we expect
to
continue to experience, difficulty in hiring and retaining highly skilled
employees with appropriate qualifications. If we do not succeed in attracting
or
retaining the necessary personnel, our business could be adversely affected.
Our
business is susceptible to numerous risks associated with international
operations.
Revenues
from international sales amounted to approximately 74%, 79% and 89% of our
net
revenues during 2005, 2004 and 2003, respectively. The distance between our
two
manufacturing sites creates logistical and communications challenges. In
addition, to achieve acceptance in international markets, our products must
be
modified to handle a variety of factors specific to each international market
as
well as local regulations. We may also be subject to a number of other risks
associated with international business activities. These risks include:
|
•
|
unexpected
changes in and the burdens and costs of compliance with a variety
of
foreign laws and regulatory requirements;
|
|
•
|
potentially
adverse tax consequences; and
|
|
•
|
global
economic turbulence and political instability.
|
If
we
fail to comply with environmental regulations, our operations could be
suspended.
We
use
hazardous chemicals in producing our products and have air and water emissions
that require controls. As a result, we are subject to a variety of local, state
and federal governmental regulations relating to the storage, discharge,
handling, emission, generation, manufacture and disposal of toxic or other
hazardous substances used to manufacture our products, compliance with which
is
expensive. Our failure to comply with current or future regulations could result
in the imposition of substantial fines on us, suspension of production,
alteration of our manufacturing processes, increased costs or cessation of
operations.
We
rely on our domestic sales representatives, without whom our architectural
product sales may suffer.
We
use
independent sales representatives to promote our Heat Mirror products to
architects in the United States. If some or all of our sales representatives
experience financial difficulties, or otherwise become unable or unwilling
to
promote our products, our business could be harmed. These sales representatives
could reduce or discontinue promotion of our products. They may not devote
the
resources necessary to provide effective marketing support to us. In addition,
we depend upon the continued viability and financial resources of these
representatives, many of which are small organizations with limited working
capital. These representatives, in turn, depend substantially on general
economic conditions and other factors affecting the markets for the products
they promote. We believe that our success in this market will continue to depend
upon these sales representatives.
We
may experience unanticipated warranty or other claims with respect to our
products, which may lead to extensive litigation costs and
expenses.
In
the
ordinary course of business, we have periodically become engaged in litigation
principally as a result of disputes with customers of our architectural
products. We have settled some of these suits and others are pending. We may
become engaged in similar or other lawsuits in the future. Some of our products
that have been the basis for lawsuits against us could be the basis for future
lawsuits. An adverse outcome in the defense of a warranty or other claim could
subject us to significant liabilities to third parties. Any litigation,
regardless of the outcome, could be costly and require significant time and
attention of key members of our management and technical personnel.
We
may face extensive damages or litigation costs if our insurance carriers seek
to
have us indemnify them for settlements of past and outstanding
litigation.
Several
of our insurance carriers have reserved their rights to seek indemnification
from us for substantial amounts paid to plaintiffs by the insurance carriers
as
part of settlements of litigation relating to our architectural products. Our
insurance carriers in a case in which the plaintiff alleged we were responsible
for defects in window products manufactured by others have advised us that
they
intend to seek reimbursement for settlement and defense costs. Any claims,
with
or without merit, could require significant time and attention of key members
of
our management and result in costly litigation.
ITEM
1B. UNRESOLVED STAFF COMMENTS
None.
ITEM
2. PROPERTIES
Our
administrative, sales and marketing, research and development, engineering
and
manufacturing facilities are located in three buildings totaling approximately
58,000 square feet in Palo Alto, California. One of the buildings is occupied
under a lease that expired on January 31, 2006, and the other two are occupied
under leases that expire on July 31, 2006 and October 31, 2007. On January
19,
2006, we announced our plans to vacate our current Palo Alto facilities. We
intend to relocate to another Silicon Valley facility for these functions.
We
are working out a surrender plan with the landlord for these premises. On
February 19, 2004, we entered into the second amendment to the lease that was
due to expire on January 31, 2006. This amendment reflected a payment schedule
for a rent deferral for this facility. In January of 2006, we paid off
approximately $1.2 million of this deferred rent. On July 14, 2005, we moved
our
warehouse from 210 Littlefield, So. San Francisco, CA into 2629B Terminal Blvd.,
Mountain View, CA. The term of this lease is a period of one year, commencing
on
August 1, 2005 and terminating on July 31, 2006, with monthly rent payments
of
$5,655. In addition, we own a 60,000 square foot building in Dresden, Germany,
which we took possession of in May 2000.
ITEM
3. LEGAL PROCEEDINGS
The
Company was named as a defendant, along with Bostik, Inc., in an action
captioned WASCO Products, Inc. v. Southwall Technologies, Inc. and Bostik,
Inc.,
Civ. Action No. C 02 2926 SBA, which was filed in Federal District Court for
the
Northern District of California on June 18, 2002. We were served with the
Complaint in this matter on July 1, 2002. The plaintiff filed the matter as
a
class action on behalf of all entities and individuals in the United States
who
manufactured and/or sold and warranted the service life of insulated glass
units
manufactured between 1989 and 1999, which contained Southwall Heat Mirror film
and were sealed with a specific type of sealant manufactured by Bostik, Inc.
The
plaintiff alleged that the sealant provided by Bostik, Inc. was defective,
resulting in elevated warranty replacement claims and costs. The plaintiff
asserted claims against us for breach of an implied warranty of fitness,
misrepresentation, fraudulent concealment, negligence, negligent interference
with prospective economic advantage, breach of contract, unfair business
practices and false or misleading business practices. The plaintiff sought
recovery on behalf of the class of $100 million for damages allegedly resulting
from elevated warranty replacement claims, restitution, injunctive relief,
and
non-specific compensation for lost profits. By Order entered December 22, 2003,
the Court dismissed all claims against us. The plaintiff has filed a notice
of
appeal to the Ninth Circuit Court of Appeals. On January 13, 2006, the Court
of
Appeals affirmed the lower court decision. On January 26, 2006, the plaintiff
filed a petition for rehearing with the Ninth Circuit Court of Appeals. In
March
of 2006, the Ninth Circuit Court of Appeals denied the plaintiff’s petition. A
percentage of the Company’s defense costs are being paid by its insurance
carriers under reservation of rights.
The
insurance carriers in some of the litigation related to allege product failures
and defects in window products manufactured by others in which we were a
defendant in the past paid the defense and settlement costs related to such
litigation. Those insurance carriers reserved their rights to recover a portion
or all of such payments from us. As a result, those insurance carriers could
seek from us up to an aggregate of $12.9 million plus defense costs,
although any such recovery would be restricted to claims that were not covered
by our insurance policies. We intend to vigorously defend any attempts by these
insurance carriers to seek reimbursement. We are not able to estimate the
likelihood that these insurance carriers will seek to recover any such payments,
the amount, if any, they might seek, or the outcome of such
attempts.
On
June
13, 2002, Plaintiff Charles Ikekwere (“Plaintiff”) filed a Complaint against
Southwall in the Superior Court of California in and for the County of Santa
Clara, Case No. CV808644. Mr. Ikekwere is a former employee of our company.
Plaintiff’s Complaint alleged claims for race discrimination, national origin
discrimination, retaliation, medical condition discrimination, breach of
contract, breach of fiduciary duty, fraud, negligence, intentional infliction
of
emotional distress, and punitive damages. We challenged the sufficiency of
certain of Plaintiff’s allegations, which caused him to file a First Amended
Complaint alleging essentially the same claims. We also challenged certain
of
Plaintiff’s allegations in his First Amended Complaint, which caused him to file
a Second Amended Complaint. Following our legal challenges to Plaintiff’s Second
Amended Complaint, the following claims remain at issue in the litigation:
(1)
race discrimination; (2) national origin discrimination; (3) retaliation; (4)
medical condition discrimination; (5) breach of contract; (6) violation of
California Constitution Article I; and (7) fraud and deceit. In light of certain
deposition testimony given by Plaintiff, we removed this matter to Federal
Court
on January 6, 2004. The basis for our removal was that certain of Plaintiff’s
allegations were preempted by the Employee Retirement Income and Security Act
(ERISA). On February 4, 2004, Plaintiff filed a Motion to Remand the case to
State Court, which the Court denied. Plaintiff subsequently amended his Second
Amended Complaint to add a claim under ERISA. The parties have almost completed
all discovery, with just one deposition remaining. The parties have finished
expert discovery. We have filed a summary judgment motion, which, if granted,
will dispose of the entire action. If Plaintiff defeats our summary judgment
motion, trial is scheduled for July 2006. Until discovery is completed and
the
Court rules on our summary judgment motion, it is not possible to predict how
Plaintiff’s claims will be resolved, whether we will be found liable, or the
nature and extent of Plaintiff’s alleged damages.
In
addition, we are involved in certain other legal actions arising in the ordinary
course of business. We believe, however, that none of these actions, either
individually or in the aggregate, will have a material adverse effect on our
business, our consolidated financial position, results of operations or cash
flows.
ITEM
4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY
HOLDERS
None.
Executive
Officers of Registrant
The
names, ages and positions of our current executive officers are as
follows:
|
Name
|
Age
|
Position
|
||
|
Thomas
G. Hood
|
50
|
President,
Chief Executive Officer and Director
|
||
|
Neil
Bergstrom
|
56
|
Chief
Technology Officer and Senior Vice President,
Engineering
|
||
|
Dennis
Capovilla
|
46
|
Senior
Vice President, Sales and Marketing
|
||
|
Sylvia
Kamenski
|
53
|
Vice
President, Finance
|
||
|
Sicco
W.T. Westra
|
55
|
Vice
President, Business Development
|
||
|
Wolfgang
Heinze
|
57
|
Vice
President, General Manager Southwall Europe
GmbH
|
Thomas
G. Hood
has
served as our President and Chief Executive Officer since July 1998 and as
a
member of our board of directors since March 1998. From March 1998 until July
1998, he served as Interim President and Chief Executive Officer. From July
1996
to March 1998, he served as Senior Vice President, General Manager, Energy
Products Division. From January 1995 to July 1996, he was Vice President,
General Manager, International Operations, and from October 1991 to January
1995, he was Vice President, Marketing and Sales. He is the inventor of record
on ten of our patents. Mr. Hood has an MS degree in Mechanical Engineering
from
New Mexico State University.
Neil
Bergstrom joined
Southwall in June 2005 as Chief Technology Officer and Senior Vice President,
Engineering. His responsibilities include technology development, new product
development, and thin film engineering. From 2004 to 2005, Dr. Bergstrom was
Vice President of Engineering at Qualcomm MEMS Technologies, an LCD displays
manufacturer, and from 2002 to 2004, held the same position at Iridigm Display,
the iMoD displays manufacturer, prior to its acquisition by Qualcomm. In this
strategic role, he successfully developed and transferred new MEMS display
technology into existing LCD display manufacturing lines. Dr. Bergstrom joined
Iridigm Display as Vice President of Business Development and successfully
established key offshore manufacturing partnerships. From 1997 to 2002, Dr.
Bergstrom served as Chief Technology Officer at Inviso, an international
provider of high technology video/audio/data transport, signal management and
display solutions for television broadcast, telecommunications, cable television
and video production, and headed the technology development team and established
ongoing relationships with the company's key technology partners and suppliers.
From 1992 to 1996, he was with Apple Computer where he managed the Advanced
Display Department and initiated Apple's move into flat panel monitor products.
Dr. Bergstrom began his career at Intel Corporation as a researcher and as
Process Integration Manager for memory chip technologies in the Technology
Development Division from 1982 until 1986. He holds a Ph.D. in Physics from
U.C.
Berkeley.
Dennis
Capovilla
joined
Southwall in July 2003. Mr. Capovilla came to Southwall from Palm, Inc., a
manufacturer of personal digital assistant devices, where he was the Vice
President, Enterprise sales since 2002. From 1997 to 2002 he was with FATBRAIN,
LLC, an e-commerce provider of books and information products, as the President
and Chief Executive Officer from 2000-2002, the President and Chief Operating
Officer from 1999 to 2000, and the VP of Sales and Business Development from
1997-1999. From 1993-1997, Mr. Capovilla was with Apple Computer, Inc., a
computer manufacturer, as the Director, Americas Imaging Division and Worldwide
Printer Supplies (1996-1997), Manager Printer Supplies Business unit (1995-1996)
and as Worldwide Product Marketing Manager, Imaging Systems (1993-1995). Prior,
Mr. Capovilla held various Sales and Marketing Management positions with
Versatec, Inc. and Xerox Corporation. Dennis holds a B.S. in Marketing from
the
University of Santa Clara.
Sylvia
Kamenski
has been
our Vice President of Finance since December 16, 2005. She joined Southwall
in
June of 2004 as Corporate Controller. Ms. Kamenski was appointed as Acting
CFO
in June 2005, and has played an expanded role in the management of the financial
operations for the Company. Prior to joining Southwall from 2001 to 2003, Ms.
Kamenski worked as Corporate Controller at Genus, Inc., a manufacturer of
capital equipment and deposition processes for advanced semiconductor
manufacturing, and from 1991 to 1997 in senior financial positions at Acuson
Corporation, a manufacturer of high-performance systems that generate, display,
archive and retrieve medical diagnostic ultrasound images. From 1984 until
1989,
Ms. Kamenski worked for Raychem Corporation, a manufacturer of a variety of
high-performance products for applications in electronics, telecommunications,
transportation, infrastructure, and energy networks markets. Ms. Kamenski began
her career in the audit and tax departments of Price Waterhouse, LLP (now
PricewaterhouseCoopers), where she received her Certified Public Accountant
certification. Ms. Kamenski holds a B.S. in Business Administration with a
major
in accounting from the University of San Francisco.
Sicco
W. T. Westra
has been
Vice President, Business Development since June 2002. From August 1998 until
June 2002, he was the Senior Vice President, Engineering and Chief Technical
Officer of Southwall. From February 1998 until August 1998, he served as the
Director of Global Production Management for Applied Materials, Inc., a provider
of products and services to the semiconductor industry. From March 1994 to
August 1998, he served as a Manager of Business Development for BOC Coating
Technology, Inc., a manufacturer of sputter-coating equipment. Dr. Westra holds
a PhD. from the University of Leiden in the Netherlands.
Wolfgang
Heinze
joined
Southwall in January 1999 as Plant Manager of our Dresden factory. In December
2000, Mr. Heinze was promoted to the position of Vice President, General Manager
Southwall Europe GmbH. Prior to joining Southwall; Mr. Heinze had been the
Chief
Executive Officer of FUBA Printed Circuits, GmbH, a manufacturer of printed
circuit boards, from February 1991 to April 1998. Mr. Heinze has a MD of
Commercial Science from the Technical University in Merseburg,
Germany.
PART
II
ITEM
5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED
STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY
SECURITIES
Our
common stock is traded on the Over-the-Counter Bulletin Board Market under
the
symbol "SWTX.OB". From the completion of our initial public offering in
June 1987 until March 26, 2004, our common stock was traded on the
NASDAQ
National Market System. Effective March 26, 2004, we voluntarily de-listed
from
NASDAQ and applied to begin trading on the Over-the-Counter Bulletin Board
Market. As a result of our February 2004 financing transactions, in which we
issued convertible promissory notes and warrants, we were no longer in
compliance with certain NASDAQ listing requirements. We felt that a voluntary
delisting from NASDAQ and move to the Over-the-Counter Bulletin Board Market
would provide the best option to our stockholders by retaining liquidity in
our
common stock. Prices in the following table represent the high and low closing
sales prices per share for our common stock as reported by NASDAQ and
Over-the-Counter Bulletin Board Market during the periods
indicated.
|
|
High
|
Low
|
|||||
|
2005
|
|
|
|||||
|
1st
Quarter
|
$
|
1.82
|
$
|
1.00
|
|||
|
2nd
Quarter
|
1.65
|
1.07
|
|||||
|
3rd
Quarter
|
1.25
|
0.85
|
|||||
|
4th
Quarter
|
0.89
|
0.52
|
|||||
|
2004
|
|
|
|||||
|
1st
Quarter
|
$
|
2.09
|
$
|
0.98
|
|||
|
2nd
Quarter
|
0.94
|
0.40
|
|||||
|
3rd
Quarter
|
0.85
|
0.48
|
|||||
|
4th
Quarter
|
1.72
|
0.48
|
|||||
On
February 28, 2006, the last reported sale price for our common stock as reported
on the Over-the-Counter Bulletin Board Market was $0.73 per share. On such
date,
there were approximately 289 holders of record of our common stock, and we
believe there were approximately 3,000 beneficial owners of our common
stock.
Dividends
We
have
never declared or paid any cash dividends on our common stock, and we do not
anticipate paying cash dividends in the foreseeable future. The Series A 10%
Preferred Stock is entitled to cumulative dividends of 10% per year, payable
at
the discretion of our Board of Directors. We currently intend to retain future
earnings, if any, to fund the expansion and growth of our business. Furthermore,
payment of cash dividends on our common stock is prohibited without the consent
of our Series A 10% Preferred stockholders. Per our credit agreement with Wells
Fargo Bank, we are allowed to declare and pay up to $600,000 in preferred stock
dividends on a per annum basis.
ITEM
6. SELECTED CONSOLIDATED FINANCIAL DATA
The
following selected consolidated financial data as of and for each of the five
years ended December 31, 2005 are derived from our audited consolidated
financial statements. This information should be read together with
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and the consolidated financial statements and related notes included
elsewhere in this report.
Consolidated
Statements of Operations Data:
|
Years
Ended December 31,
|
||||||||||||||||
|
2005
|
2004
|
2003
|
2002
|
2001
|
||||||||||||
|
(in
thousands, except per share data)
|
||||||||||||||||
|
Net
revenues
|
$
|
54,574
|
$
|
57,573
|
$
|
53,326
|
$
|
68,759
|
$
|
82,976
|
||||||
|
Cost
of revenues
|
37,241
|
36,787
|
45,914
|
49,614
|
60,148
|
|||||||||||
|
Gross
profit
|
17,513
|
20,786
|
7,412
|
19,145
|
22,828
|
|||||||||||
|
Gross
profit %
|
32.0
|
%
|
36.1
|
%
|
13.9
|
%
|
27.8
|
%
|
27.5
|
%
|
||||||
|
Operating
expenses:
|
||||||||||||||||
|
Research
and development
|
5,104
|
3,199
|
6,714
|
7,685
|
5,456
|
|||||||||||
|
Selling,
general and administrative
|
8,332
|
10,217
|
12,348
|
12,450
|
11,036
|
|||||||||||
|
Restructuring
costs (recoveries)
|
--
|
--
|
(65
|
)
|
2,624
|
--
|
||||||||||
|
Impairment
charge (recoveries) for long-lived assets
|
(170
|
)
|
(1,513
|
)
|
27,990
|
--
|
--
|
|||||||||
|
Total
operating expenses
|
13,266
|
11,903
|
46,987
|
22,759
|
16,492
|
|||||||||||
|
Income
(loss) from operations
|
4,247
|
8,883
|
(39,575
|
)
|
(3,614
|
)
|
6,336
|
|||||||||
|
Interest
expense, net
|
(973
|
)
|
(2,206
|
)
|
(1,590
|
)
|
(1,734
|
)
|
(2,872
|
)
|
||||||
|
Costs
of warrants issued
|
--
|
(6,782
|
)
|
(865
|
)
|
--
|
--
|
|||||||||
|
Other
income, net
|
75
|
534
|
419
|
1,070
|
1,385
|
|||||||||||
|
Income
(loss) before provision for (benefit from) income taxes
|
3,349
|
429
|
(41,611
|
)
|
(4,278
|
)
|
4,849
|
|||||||||
|
Provision
for (benefit from) income taxes..
|
29
|
614
|
681
|
(87
|
)
|
214
|
||||||||||
|
Net
income (loss)
|
3,320
|
(185
|
)
|
(42,292
|
)
|
(4,191
|
)
|
4,635
|
||||||||
|
Deemed
dividend on preferred stock
|
490
|
--
|
--
|
--
|
--
|
|||||||||||
|
Net
income (loss) attributable to common stockholders
|
$
|
2,830
|
$
|
(185
|
)
|
$
|
(42,292
|
)
|
$
|
(4,191
|
)
|
$
|
4,635
|
|||
|
Net
income (loss) per share:
|
||||||||||||||||
|
Basic
|
$
|
0.11
|
$ |
(0.01
|
)
|
$ |
(3.37
|
)
|
$ |
(0.40
|
)
|
$
|
0.58
|
|||
|
Diluted
|
$
|
0.10
|
$ |
(0.01
|
)
|
$ |
(3.37
|
)
|
$ |
(0.40
|
)
|
$
|
0.57
|
|||
|
|
||||||||||||||||
|
Weighted
average shares used in computing net income (loss) per
share:
|
||||||||||||||||
|
|
||||||||||||||||
|
Basic
|
26,743
|
14,589
|
12,537
|
10,418
|
8,032
|
|||||||||||
|
Diluted
|
32,895
|
14,589
|
12,537
|
10,418
|
8,186
|
|||||||||||
Consolidated
Balance Sheet Data:
|
|
As
of December 31,
|
|||||||||||||||
|
|
2005
|
2004
|
2003
|
2002
|
2001
|
|||||||||||
|
|
(in
thousands)
|
|||||||||||||||
|
Cash,
cash equivalents and restricted cash
|
$
|
7,002
|
$
|
5,233
|
$
|
1,891
|
$
|
2,629
|
$
|
3,362
|
||||||
|
Working
capital (deficit)
|
8,691
|
6,528
|
(4,210
|
)
|
588
|
(6,471
|
)
|
|||||||||
|
Property,
plant and equipment
|
16,857
|
21,110
|
21,787
|
50,251
|
47,841
|
|||||||||||
|
Total
assets
|
39,641
|
44,947
|
41,721
|
76,582
|
73,158
|
|||||||||||
|
Term
debt and capital leases including current portion
|
10,107
|
13,107
|
15,700
|
16,752
|
22,828
|
|||||||||||
|
Total
liabilities
|
23,702
|
30,374
|
40,000
|
36,108
|
46,706
|
|||||||||||
|
Preferred
stock
|
4,810
|
4,810
|
--
|
--
|
--
|
|||||||||||
|
Total
stockholders' equity
|
11,129
|
9,763
|
1,721
|
40,474
|
26,452
|
|||||||||||
Selected
Cash Flow Data:
|
|
Years
Ended December 31,
|
|||||||||||||||
|
|
2005
|
2004
|
2003
|
2002
|
2001
|
|||||||||||
|
|
(in
thousands)
|
|||||||||||||||
|
Net
cash provided by (used in) operating activities
|
$
|
4,006
|
$
|
3,830
|
$
|
(2,990
|
)
|
$
|
(2,824
|
)
|
$
|
13,792
|
||||
|
Net
cash provided by (used in) investing activities
|
(342
|
)
|
1,261
|
(2,775
|
)
|
(6,014
|
)
|
(5,698
|
)
|
|||||||
|
Net
cash provided by (used in) financing activities
|
(1,566
|
)
|
(2,249
|
)
|
5,548
|
7,679
|
(4,628
|
)
|
||||||||
Quarterly
Financial Data:
The
following table sets forth consolidated statements of operations data for the
eight fiscal quarters ended December 31, 2005. This information has been
derived from our unaudited condensed consolidated financial statements and
has
been prepared on the same basis as our audited consolidated financial statements
contained in this report. It includes all adjustments, consisting only of normal
recurring adjustments that we consider necessary for a fair presentation of
such
information when read in conjunction with our audited financial statements
and
related notes. Operating results for any quarter are not necessarily indicative
of results for any future period. This information should be read together
with
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and the consolidated financial statements and related notes included
elsewhere in this report.
Selected
Quarterly Financial Information (Unaudited):
|
|
Quarters
Ended
|
||||||||||||
|
|
Apr.
3, 2005
|
Jul.
3, 2005
|
Oct.
2, 2005
|
Dec.
31, 2005
|
|||||||||
|
|
(in
thousands, except per share amounts)
|
||||||||||||
|
Net
revenues
|
$
|
15,647
|
$
|
15,172
|
$
|
12,025
|
$
|
11,910
|
|||||
|
Cost
of revenues
|
11,270
|
9,788
|
7,921
|
8,262
|
|||||||||
|
Gross
profit
|
4,377
|
5,384
|
4,104
|
3,648
|
|||||||||
|
Income
(loss) before provision for (benefit from) income taxes
|
1,846
|
1,580
|
465
|
(542
|
)
|
||||||||
|
Net
income
|
1,699
|
1,395
|
15
|
211
|
|||||||||
|
Deemed
dividend on preferred stock
|
123
|
120
|
120
|
127
|
|||||||||
|
Net
income (loss) attributable to common stockholders
|
$
|
1,576
|
$
|
1,275
|
$
|
(105
|
)
|
$
|
84
|
||||
|
Net
income per share:
|
|||||||||||||
|
Basic
|
$
|
0.06
|
$
|
0.05
|
$
|
0.00
|
$
|
0.00
|
|||||
|
Diluted
|
$
|
0.05
|
$
|
0.04
|
$
|
0.00
|
$
|
0.01
|
|||||
|
Weighted
average shares used in computing net income per share:
|
|||||||||||||
|
Basic
|
26,613
|
26,782
|
26,788
|
26,790
|
|||||||||
|
Diluted
|
33,181
|
33,094
|
32,720
|
32,375
|
|||||||||
|
|
Quarters
Ended
|
||||||||||||
|
|
Mar.
28, 2004
|
Jun.
27, 2004
|
Sep.
26, 2004
|
Dec.
31, 2004
|
|||||||||
|
|
(in
thousands, except per share amounts)
|
||||||||||||
|
Net
revenues
|
$
|
11,067
|
$
|
14,548
|
$
|
15,932
|
$
|
16,026
|
|||||
|
Cost
of revenues
|
8,466
|
8,936
|
10,152
|
9,233
|
|||||||||
|
Gross
profit
|
2,601
|
5,612
|
5,780
|
6,793
|
|||||||||
|
Income
(loss) before provision for (benefit from) income taxes
|
(6,335
|
)
|
1,529
|
1,834
|
3,401
|
||||||||
|
Net
income (loss)
|
$
|
(6,690
|
)
|
$
|
1,186
|
$
|
2,132
|
$
|
3,187
|
||||
|
Net
income (loss) per share:
|
|||||||||||||
|
Basic
|
$ |
(0.53
|
)
|
$
|
0.09
|
$
|
0.17
|
$
|
0.16
|
||||
|
Diluted
|
$ |
(0.53
|
)
|
$
|
0.04
|
$
|
0.07
|
$
|
0.10
|
||||
|
Weighted
average shares used in computing net income (loss) per
share:
|
|||||||||||||
|
Basic
|
12,548
|
12,548
|
12,550
|
20,327
|
|||||||||
|
Diluted
|
12,548
|
31,416
|
31,218
|
32,697
|
|||||||||
Our
results of operations have varied significantly from quarter to quarter, and
we
expect them to continue to do so in the future. As a result of our high fixed
costs, if revenues fall below our expectations, we may not be able to reduce
our
spending sufficiently to prevent a loss from operations. We anticipate that
our
sales will continue to have long sales cycles. Therefore, the timing of future
customer contracts could be difficult to predict, making it very difficult
to
predict revenues in future quarters, and our operating results may continue
to
vary significantly.
Other
factors that could affect our quarterly operating results include those
described elsewhere in this report and the following:
|
·
|
fluctuating
customer demand, which is influenced by a number of factors, including
market acceptance of our products and the products of our customers
and
end-users, changes in product mix, and the timing, cancellation or
delay
of customer orders and shipments;
|
|
·
|
our
ability to maintain sufficient
liquidity;
|
|
·
|
timing
of shipments of our products by us and by independent subcontractors
to
our customers;
|
|
·
|
manufacturing
and operational difficulties that may arise due to, among other things,
quality control, capacity utilization of our production machines,
unscheduled equipment maintenance, and the hiring and training of
additional staff;
|
|
·
|
progress
and outcome of litigation with which we are
involved;
|
|
·
|
announcement,
consummation or integration by us of any acquired businesses, technologies
or products;
|
|
·
|
our
ability to introduce new products on a timely
basis;
|
|
·
|
competition,
including the introduction or announcement of new products by competitors,
the adoption of competitive technologies by our customers, the addition
of
new production capacity by competitors and competitive pressures
on prices
of our products and those of our customers;
and
|
|
·
|
product
returns and customer allowances stemming from product quality
defects.
|
ITEM
7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
The
following discussion and analysis of our financial condition and results of
operations should be read in conjunction with Item 6, "Selected Consolidated
Financial Data", our consolidated financial statements and notes thereto
appearing elsewhere in this report and the risk factors set forth in Item 1A.
This discussion and analysis contains forward-looking statements that involve
risks and uncertainties. You should not place undue reliance on these
forward-looking statements. Our actual results may differ materially from those
anticipated in these forward-looking statements.
Overview
We
are a
global developer, manufacturer and marketer of thin film coatings on flexible
substrates for the automotive glass, electronic display, architectural glass
and
window film markets. We have developed a variety of products that control
sunlight in automotive glass, reduce light reflection, reduce electromagnetic
radiation and improve image quality in electronic display products and conserve
energy in architectural products. Our products consist of transparent
solar-control films for automotive glass; anti-reflective films for computer
screens, including flat panel displays, plasma displays; and transparent
conductive films for use in touch screen and liquid crystal displays; energy
control films for architectural glass; and various other coatings.
Our
cash
and cash equivalents increased by $2.1 million from $4.5 million at
December 31, 2004 to $6.6 million at December 31, 2005. Cash provided by
operating activities increased by $0.2 million from $3.8 million in 2004 to
$4.0
million in 2005. The increase in cash provided by operating activities during
2005 was primarily the result of net income for the year of $3.3 million,
non-cash depreciation of $2.2 million, and decreases in inventories of $2.5
million and in other current and non-current assets of $0.9 million partially
offset by impairment recoveries from long-lived assets of $0.2 million, change
in deferred income taxes of $0.5 million, an increase in accounts receivable
of
$0.9 million and a decrease in accounts payable and accrued liabilities of
$3.4
million. Cash used in investing activities in 2005 was $0.3 million compared
to
$1.3 million provided by investing activities in 2004. The decrease was
primarily due to proceeds from the sale of a fixed asset of $1.6 million in
2004. Cash used in financing activities decreased by $0.6 million from $2.2
million used in financing activities in 2004 to $1.6 million used in financing
activities in 2005. The decrease was the result of less debt outstanding in
2005, which resulted in lower principal repayments.
Demand
for our customers' products, which has a significant effect on our results,
has
changed rapidly from time to time in the past and may do so in the future.
For
example, as a result of changing demand in the personal computer industry from
1999 through 2003, our electronic display revenues rose from $16.0 million
in 1999 to $47.7 million in 2000 then declined to $29.7 million, $26.6
million and $19.0 million in 2001, 2002, and 2003, respectively, increased
to
$20.6 million in 2004 and decreased to $14.0 million in 2005. Similarly,
revenues from our automotive segment rose from $20.2 million in 2000, to
$37.4 million in 2001, and declined to $20.4 million, $20.3 million,
$20.6 million and $19.6 million in 2002, 2003, 2004, and 2005 respectively,
because of competition from alternative technology solutions. Demand for our
products can also be affected when the markets for the products in which our
films are used evolve to new technologies, such as the evolution from cathode
ray tubes, or CRTs, to flat panel displays.
Our
research and development expenditures increased from $3.2 million in 2004 to
$5.1 million in 2005. In 2005, we began development and sampling of a new class
of films with improved performance that we believe will be beneficial across
our
product lines. We also initiated significant research and development into
thin
film technology that we anticipate will enable Southwall to produce products
for
new applications and markets. In 2005, we hired a new Chief Technology Officer
and expanded our engineering organization by hiring an additional eight
engineers. We are committed to developing new technologies and expanding our
product offerings.
On
January 19, 2006, we commenced restructuring actions to improve our cost
structure for 2006 and beyond. These actions include the closure of our Palo
Alto, California manufacturing facility and a reduction in force at our Palo
Alto site during the first half of 2006. We will transfer our U.S. manufacturing
operations to the European site located near Dresden, Germany in the first
half
of 2006. As a result of these restructuring actions, we expect to substantially
reduce our total operating expenses.
Financing
and Related Transactions
Background.
During
2003, we experienced a significant decline in sales which led to a significant
deterioration in our working capital position, which raised concerns about
our
ability to fund our operations and continue as a going concern in the short
term
and our ability to meet obligations coming due over the following few
years.
At
this
time, management developed a restructuring plan that included:
|
•
|
Shutting
down a majority of our domestic manufacturing and transferring that
production to our Dresden, Germany
facility;
|
|
•
|
Beginning
a series of staggered layoffs;
|
|
•
|
Arranging
new payment terms with all major creditors and vendors to extend
or reduce
our payment obligations;
|
|
•
|
Accelerating
our cash collections;
|
|
•
|
Reducing
our operating expenses and inventory levels;
and
|
|
•
|
Minimizing
our capital expenditures.
|
We
also
began to solicit and receive proposals from potential investors and lenders.
We
evaluated a variety of public and private market alternatives to raise
additional capital, as well as alternatives to restructure our upcoming payment
obligations without raising additional capital. Our access to the traditional
capital markets was, and continues to be, constrained, however, by a number
of
factors, including the risks described under "Risk Factors" in Item 1A. As
a
result, we concluded that a private equity investment was the most attractive
alternative to continue as a going concern. On December 18, 2003, in order
to
raise cash to fund our operations and continue as a going concern, we entered
into an investment agreement with Needham & Company, Inc., Needham Capital
Partners II, L.P., Needham Capital Partners II (Bermuda), L.P., Needham Capital
Partners III, L.P., Needham Capital Partners IIIA, L.P., Needham Capital
Partners III (Bermuda), L.P., (together referred to as “Needham Company and its
Affiliates”) and Dolphin Direct Equity Partners, LP (collectively with Needham
Company and its Affiliates, “the Investors”). On January 19, 2004, due to the
structure of the transaction contemplated by the investment agreement, we did
not have enough authorized and un-issued shares to satisfy the existing
commitments had all outstanding warrants been exercised thereby triggering
liability classification for all outstanding warrants. We measured and
re-measured the fair value of the warrants at the issuance dates and each
subsequent quarter end based on a methodology used by a third party until our
stockholders approved the increase of the number of authorized shares of our
common stock in the fourth quarter of 2004.
On
February 20, 2004, we amended and restated the investment agreement and issued
$4.5 million of Secured Convertible Promissory Notes that were convertible
into our Series A 10% Cumulative Convertible Preferred Stock, par
value $0.001 per share, or the Series A shares, at a conversion price of $1.00
per share, together with warrants initially exercisable for 13,881,535 shares
of
our common stock at a nominal exercise price. Each of the Series A shares is
convertible into common stock at any time at the option of the holder at a
conversion price of $1.00 per share, subject to adjustment, plus accumulated
but
unpaid dividends. The securities issued were exempt from registration under
Regulation D of the Securities Act of 1933, as amended.
On
October 5, 2004, our stockholders approved an amendment to our certificate
of
incorporation to increase the number of authorized shares of common stock from
20,000,000 to 50,000,000 and the total number of authorized shares of capital
stock from 25,000,000 to 55,000,000. This provided us with sufficient number
of
available shares to cover all possible future conversions and exercises of
all
outstanding notes and warrants. We reclassified $8.1 million of accrued
warrant liability from other long term liabilities to additional paid in
capital in the fourth quarter of 2004 in connection with the stockholder
approval.
On
November 4, 2004, Needham Company and its Affiliates received a total of
9,155,379 shares of our common stock upon the exercise of warrants. In
exercising the warrants, the Needham entities elected to use a “cashless
exercise option” in which 98,977 of the shares underlying the warrants were
surrendered in lieu of paying in cash the exercise price. The warrants were
originally exercisable for 9,254,356 shares of our common stock at an exercise
price of $0.01 per share of common stock. The value of the 98,977 shares of
common stock surrendered was based upon the average trading price on November
3,
2004 of our common stock on the Over-the-Counter Bulletin Board
Market.
On
November 24, 2004, Dolphin Direct Equity Partners, LP exercised warrants to
purchase a total of 4,627,179 shares of our common stock. Dolphin paid
approximately $46,000 in cash as the exercise price.
On
December 31, 2004, Needham Company and its Affiliates and Dolphin Direct Equity
Partners, LP elected to convert all outstanding principal of, and accrued but
unpaid interest on, their Secured Convertible Promissory Notes into Series
A
shares. The Secured Convertible Promissory Notes by their terms were convertible
at the option of the holders into Series A shares at a rate of one share for
each $1.00 of principal or interest converted. The aggregate principal amount
of
the Secured Convertible Promissory Notes was $4,500,000 and interest accrued
thereon as of the time of conversion was $392,500. The aggregate number of
shares of Series A shares issued as a result of the conversion was 4,892,500.
In
particular, Needham Company and its Affiliates received 3,261,667 shares and
Dolphin Direct Equity Partners, LP received 1,630,833 shares. In 2005, we
accrued $0.5 million of deemed dividend on preferred stock as a result of the
conversion of our secured convertible promissory notes into shares of Series
A
preferred stock in December 2004.
At
December 31, 2005, Needham Company and Affiliates and Dolphin Direct Equity
Partners, LP own 31.9% and 17.3%, respectively, of our outstanding common stock.
In addition, if Needham Company and its Affiliates and Dolphin had converted
their Series A shares into common stock at December 31, 2005, they would have
owned 37.2% and 19.8%, respectively, of our outstanding common
stock.
Material
Terms of the Series A Shares
Our
Series A share have the following terms:
|
•
|
Dividends.
Each of the Series A shares have a stated value of $1.00 and are
entitled
to a cumulative dividend of 10% per year, payable at the discretion
of the
Board of Directors. Dividends on the Series A shares accrue daily
commencing on the date of issuance and are deemed to accrue whether
or not
earned or declared and whether or not there are profits, surplus
or other
funds legally available for the payment of dividends. Accumulated
dividends, when and if declared by the Board, will be paid in
cash.
|
|
•
|
Restrictions.
So
long as any Series A shares are outstanding, unless all accrued dividends
on all Series A shares have been paid, we are prohibited from taking
certain actions, including redeeming or purchasing shares of our
common
stock and paying dividends on our common
stock.
|
|
•
|
General
Voting Rights. Except
under certain circumstances or as otherwise provided by law, the
holders
of Series A shares have no voting rights. The approval of the holders
of a
majority of the Series A shares voting separately as a class will
be
required to effect certain corporate
actions.
|
|
•
|
Liquidation
Preference. Upon
a liquidation or dissolution of Southwall, the holders of Series
A shares
are entitled to be paid a liquidation preference out of assets legally
available for distribution to our stockholders before any payment
may be
made to the holders of common stock. The liquidation preference is
equal
to the stated value of the Series A shares, which is $1.00 per share,
plus
any accumulated but unpaid dividends. Mergers, the sale of all or
substantially all of our assets, or the acquisition of Southwall
by
another entity and certain other similar transactions may be deemed
to be
liquidation events for these
purposes.
|
|
•
|
Conversion.
Each of the Series A shares is convertible into common stock at any
time
at the option of the holder. Each of the Series A shares is convertible
into a number of shares of common stock equal to the sum of its stated
value plus any accumulated but unpaid dividends, divided by the conversion
price of the Series A shares. The conversion price of the Series
A shares
is $1.00 per share and is subject to adjustment in the event of any
stock
dividend, stock split, reverse stock split or combination affecting
such
shares. The Series A shares also have anti-dilution protection that
adjusts the conversion price downwards using a weighted-average
calculation in the event we issue certain additional securities at
a price
per share less than the closing price per share of our common stock
on any
stock exchange on which our common stock is listed. Each Series A
share is
initially convertible into one share of common stock. If the closing
price
of our common stock on any stock exchange on which our common stock
is
listed is $4.00 or more per share (subject to appropriate adjustment
if a
stock split, reverse split or similar transaction is affected) for
30
consecutive days, all outstanding Series A shares shall automatically
be
converted.
|
|
•
|
Redemption.
The
Series A shares are not redeemable.
|
Agreements
with Major Creditors
Judd
Properties, LLC.
In
January 2004, we reached an agreement with Judd Properties, L.P., or Judd,
to
modify our obligations under the lease for our executive offices. We agreed
to a
payment schedule that extends our obligations and provides us with options
to
extend the lease. We further agreed to issue a warrant issuable for 4% of our
capital stock on a fully diluted basis to be held in an escrow account as
security for our obligations in the event we fail to restore the property in
accordance with the original lease terms upon our departure from the premises.
Upon our departure, if we fail to restore the property in accordance with the
original lease the warrant will be released to Judd. The warrant is exercisable
for 1,410,426 shares of our common stock at a nominal exercise price. The other
terms of the warrant mirror the terms of the warrants issued to the Investors.
Judd will hold certain registration rights with respect to the warrant shares.
Because we did not have available enough authorized shares of common stock
to
issue upon exercise of the warrant, we were required to issue a letter of credit
in the amount of $1.0 million to be held by Judd as security for our obligations
until such time as the requisite number of authorized shares were approved
by
our stockholders on the condition that we are in compliance with the settlement
agreement.
The
letter of credit is collateralized by $1.0 million of our cash, which will
not
be released by the bank that issued the letter of credit until Judd releases
the
letter of credit. Following the approval of the charter amendment by our
stockholders, Judd maintained that we were not fully in compliance with the
settlement agreement and refused to release the letter of credit. Judd continues
to hold the letter of credit pending the resolution of discussions regarding
the
restoration of the property. At December 31, 2005 and December 31, 2004, our
accrued liability to Judd Properties L.P. was approximately $1.2 million and
$0.9 million, respectively. On January 19, 2006, the Company announced its
plans
to vacate its current Palo Alto facility, which also serves as its headquarters
and houses its research and development, sales and marketing and general and
administrative functions. The Company intends to relocate to another Silicon
Valley facility for these functions. The lease expired on January 31, 2006
and
the Company is working out a surrender plan with Judd Properties L.P. for these
premises. On January 31, 2006, the Company paid its accrued liability of $1.2
million to Judd. Until an agreement is reached, the Company intends to pay
its
monthly rent obligation to Judd.
Portfolio
Financial Servicing Company, Bank of America and Lehman
Brothers.
On
February 20, 2004, we entered into a settlement agreement with Portfolio
Financial Services, Bank of America and Lehman Brothers, which extinguished
a
claim arising out of sale-leaseback agreements, which we entered into in
connection with the acquisition of two of our production machines. As part
of
the settlement, we agreed to pay a total of $2.0 million plus interest over
a
period of 6 years. The settlement required us to make an interest payment in
2004, and beginning in 2005, we will make quarterly principal and interest
payments until 2010. We also agreed to return the production machines in
question. If we fail to make the required payments, Portfolio Financial
Services, Bank of America and Lehman Brothers may enter a confession of judgment
against us in the amount of $5.9 million. In 2005, we paid Portfolio Financial
Services $0.2 million in principal and interest payments.
Richard
A. Christina and Diane L. Christina Trust.
On
December 1, 2003, we reached an agreement with the Richard A. Christina and
Diane L. Christina Trust (the "Trust") to modify the lease agreement for a
building located in Palo Alto, California. Under the terms of the agreement
we
agreed to the Trust's claim for damages in the amount of $0.3
million.
At
December 31, 2005 and December 31, 2004, our accrued liability to the Trust
was
approximately $0.2 million and $0.3 million, respectively.
Other
Factors Affecting Our Financial Condition and Results of
Operations
Restructuring
activities.
As a
consequence of the decline in our revenues and negative cash flows, we
implemented several cost cutting and business restructuring activities during
2003 and 2004. These activities, which included employee layoffs and the closure
of several facilities (including the closure of our Tempe manufacturing facility
in the fourth quarter of 2003), were designed to improve our cash flow from
operations to allow us to continue as a going concern. During the fourth quarter
of 2003 and the first quarter of 2004, we agreed to new payment terms with
all
of our major creditors and vendors, which extended or reduced our payment
obligations. We also entered into the investment agreement described above
pursuant to which we issued $4.5 million of convertible promissory notes and
warrants to investors. The convertible promissory notes were converted to Series
A shares and the warrants were exercised for shares of common stock in the
fourth quarter of 2004. Our line of credit facility with Pacific Business
Funding (“PBF”) expired on May 5, 2005. On April 28, 2005, we entered into a
credit agreement (the “Credit Agreement”) with Wells Fargo HSBC Trade Bank, N.A.
(the “Bank”). The Credit Agreement provides for two facilities. All amounts
borrowed under both facilities under the Credit Agreement must be repaid on
or
before May 31, 2006. On January 19, 2006, the Company announced restructuring
activities that included the closure of it Palo Alto, California manufacturing
plant and reduction in force of approximately 22% of worldwide headcount. The
Company will accrue restructuring costs in 2006.
See
Note
13 of Notes to Consolidated Financial Statements (Item 8)- Subsequent Events.
Voluntary
Delisting from NASDAQ.
Effective March 26, 2004, we voluntarily delisted from the NASDAQ National
Market and applied to begin trading on the Over-the-Counter Bulletin Board
Market. Due to the structure of the transaction contemplated by the investment
agreement discussed above, we were no longer in compliance with certain NASDAQ
listing requirements. We felt that a voluntary delisting from NASDAQ and a
move
to the Over-the-Counter Bulletin Board Market would provide the best option
to
our shareholders by retaining liquidity in our common stock.
Demand
for our customers' products.
We
derive significant benefits from our relationships with a few large customers
and suppliers. Our revenues and gross profit can increase or decrease rapidly
reflecting underlying demand for the products of one or a small number of our
customers. We may also be unable to replace a customer when a relationship
ends
or demand for our product declines as a result of evolution of our customers’
products.
Our
customers in the automotive glass market include Pilkington PLC, Saint Gobain
Sekurit and Globamatrix Holdings Pte. Ltd., or Globamatrix, which
collectively accounted for approximately 54%, 45% and 45% of our total revenues
in 2005, 2004 and 2003, respectively.
In
September 2003, we entered into an amendment of the agreement with Globamatrix
to materially reduce the quantity of product they are required to purchase
from
us. The adjustment was due to certain events beyond the control of the parties,
including the Asian SARs epidemic, which affected the demand for our film
products distributed by Globamatrix. The amendment provided that Globamatrix
was
required to purchase at least $7.6 million of product in 2003 (rather than
$13.25 million as required in the original distribution agreement). In December
2003, the distribution agreement was further amended to set Globamatrix's 2004
minimum purchase commitments at $9.0 million.
Under
the original distribution agreement, Globamatrix had been required to purchase
at least $15.25 million of product in 2004. For each year after 2004 through
and
including 2011, Globamatrix is required to purchase an amount of product equal
to 110% of the amount of product it was required to purchase in the prior year.
Globamatrix was obligated to purchase $10.3 million of products in 2005. During
2005, Globamatrix purchased approximately $14.9 million of product.
For
the
year ended December 31, 2005, Globamatrix is obligated to purchase $11.3 million
of products in 2006.
Sales
returns and allowances.
Our
gross margins and profitability have been adversely affected from time to time
by product quality claims. From 2002 to 2005, our sales returns provision has
averaged approximately 2.7% to 4.5% of gross revenues. During 2005, our sales
returns provision has averaged approximately 3.4% of our gross revenues due
to
fewer quality claims received during the period.
Restructuring
costs.
Based on
lower revenue expectations, in December 2002, we transferred most of our product
manufacturing from our Palo Alto manufacturing site to our Tempe and Dresden
manufacturing facilities, which have lower cost structures. In addition, we
implemented a reduction in force at our Palo Alto location in
December 2002, and consolidated our Palo Alto facilities. As a result, we
incurred a restructuring charge of $2.6 million in 2002 relating to
employee severance packages and the remaining rents due on excess facilities
in
Palo Alto that would no longer be occupied. Of the $2.6 million, approximately
$0.2 million of the restructuring costs were paid in fiscal 2002. During
the first quarter of 2003, we recorded a $65,000 reduction to our restructuring
accrual as a result of modifications to the severance packages of certain
employees. In the second quarter of 2003, we implemented a reduction in force
in
our Tempe and Palo Alto locations. As a result, we incurred a charge and made
cash payments of $0.1 million relating to employee severance packages, which
is
recorded in cost of sales. During the fourth quarter of fiscal 2003, we
implemented another reduction-in-force as well as closed our Tempe manufacturing
facility; however, no restructuring charges were incurred in the fourth quarter
of 2003. We also did not incur restructuring charges during the year ended
December 31, 2005 and December 31, 2004.
Impairment
charge for long-lived assets.
During
2003, we experienced shortfalls in revenue compared to our budgeted and
forecasted revenues. In addition, in the third quarter of 2003, we determined
that due to reduced demand for our products, anticipated revenues through the
remainder of 2003 and 2004 would be substantially below historical levels.
As
our U.S. operations have a higher operating cash break-even point compared
to
our Dresden operations, we believed that the lower than anticipated revenues
indicated that an impairment analysis of the long-lived assets of our U.S.
operations was necessary at September 28, 2003. Subsequently, in the fourth
quarter of 2003, as a result of our decision to close the Tempe operation,
we
concluded that a further impairment analysis of the long-lived assets of the
U.S. operation was necessary at December 31, 2003. Our evaluation concluded
that
an impairment charge was required to write down the carrying amount of our
long-lived assets to their fair market values of $19.4 million and $8.6 million
for the periods ended September 28, 2003 and December 31, 2003, respectively.
In
June
2004, we had a recovery for long-lived assets as a result of selling a
production machine from our Tempe manufacturing facility to a third party.
The
sale value was $1.7 million, which included the price of the production machine,
other miscellaneous hardware, training to be provided by us and operating
software to run the machine. All of our obligations were completed and we
recognized a gain of $1.5 million, representing 90% of the sale value, less
book
value of the machine of $0.1 million. Collection of the final 10% was contingent
on installation of the machine by a third party or 120 days after shipment.
We
collected the final 10% in January 2005 and recognized the gain in the amount
of
$0.2 million in the first quarter of 2005.
Critical
Accounting Policies and Estimates
The
preparation of our consolidated financial statements requires us to make
estimates and assumptions that affect the amounts of assets and liabilities
we
report, our disclosure of contingencies, and the amounts of revenue and expenses
we report in our consolidated financial statements. If we used different
judgments or different estimates, there might be material differences in the
amount and timing of revenues and expenses we report. See Note 1 of our
Notes to Consolidated Financial Statements (Item 8) for details of our
accounting policies. The critical accounting policies, judgment and estimates,
which we believe have the most significant effect on our consolidated financial
statements, are set forth below:
|
•
|
Revenue
recognition;
|
|
•
|
Allowances
for doubtful accounts and sales
returns;
|
|
•
|
Valuation
of inventories;
|
|
•
|
Assessment
of the probability of the outcome of current
litigation;
|
|
•
|
Restructuring
costs;
|
|
•
|
Impairment
charge for long-lived assets; and
|
|
•
|
Accounting
for income taxes.
|
Revenue
recognition.
We
recognize revenue when persuasive evidence of an arrangement exists, delivery
has occurred or services have been provided, the sale price is fixed or
determinable, and collectibility is reasonably assured. Accordingly, we
generally recognize revenue from product sales when the terms of sale transfer
title and risk of loss, which occurs either upon shipment or upon receipt by
customers. In connection with product sales, we make allowances for estimated
returns and allowances. We adjust these allowances periodically to reflect
our
actual and anticipated experience. If any of these conditions to recognize
revenue are not met, we defer revenue recognition.
Allowances
for doubtful accounts and sales returns.
We
establish allowances for doubtful accounts and sales returns for specifically
identified, as well as anticipated, doubtful accounts and product quality claims
based on credit profiles of our customers, current economic trends, contractual
terms and conditions, and historical payment and sales returns experience.
As of
December 31, 2005, our consolidated balance sheet included allowances for
doubtful accounts and sales returns of $0.2 million and $1.6 million,
respectively. As of December 31, 2004, our consolidated balance sheet
included allowances for doubtful accounts and sales returns of $0.3 million
and $2.7 million, respectively. During 2005, 2004 and 2003, we recorded
sales return costs of $0.7 million, $2.4 million and $2.5 million,
respectively. Bad debt expenses were $0.3 million in 2003. We incurred a credit
of $0.1 million and $0.5 million in 2005 and 2004, respectively, as a result
of
our customers paying written-off receivable balances. If our actual bad debt
and
product quality costs differ from estimates or we adjust our estimates in future
periods, our operating results, cash flows and financial position could be
materially adversely affected.
Valuation
of inventories.
We state
inventories at the lower of cost or market. We establish provisions for excess
and obsolete inventories after periodic evaluation of historical sales, current
economic trends, forecasted sales, predicted lifecycle and current inventory
levels. During 2005, 2004 and 2003, we charged $1.5 million, $2.1 million
and $0.9 million, respectively, against cost of sales for excess and
obsolete inventories. If our actual experience of excess and obsolete
inventories differs from estimates or we adjust our estimates, or changes occur
in forecasted sales and expected product lifecycle, our operating results,
cash
flows and financial position could be materially adversely
affected.
Assessment
of the probability of the outcome of current litigation.
In the
ordinary course of business, we have periodically become engaged in litigation
principally as a result of disputes with customers of our architectural
products. We have relied upon insurance coverage to fund the defense of these
actions and significant portions of the settlements that were reached. Based
on
our review of pending litigation, we record accruals for loss contingencies
when
we believe that a liability is likely of being incurred and we can reasonably
estimate the amount of our share of the loss. In connection with recent
settlements related to sales of architectural products, we have been advised
by
some of our insurers that they have reserved the right to proceed against us
to
recoup a portion or all of the settlements paid to plaintiffs.
Restructuring
costs.
We have
recorded reserves/accruals for restructuring costs related to the restructuring
of operations. The restructuring reserves include payments to employees for
severance, termination fees associated with leases and other contracts, and
other costs related to the closure of facilities. After the adoption of
Statement of Financial Accounting Standards ("SFAS") No. 146, “Accounting for
Costs Associated with Exit or Disposal Activities”, (“SFAS 146”) on January 1,
2003, the reserves have been recorded when management has approved a plan to
restructure operations and a liability has been incurred rather than the date
upon which management has approved and announced a plan. The restructuring
reserves are based upon management estimates at the time they are recorded.
These estimates can change depending upon changes in facts and circumstances
subsequent to the date the original liability was recorded. Accruals for
facility leases under which we ceased using the benefits conveyed to us under
the lease may change if market conditions for subleases change or if we later
negotiate a termination of the lease. Prior to the adoption of SFAS 146,
restructuring reserves were recorded at the time we announced a plan to exit
certain activities and were based on estimates of the costs and length of time
to exit those activities. See Note 2 - Balance Sheet Detail of the Notes to
the
Consolidated Financial Statements (Item 8) for a complete discussion of our
restructuring actions and all related restructuring reserves by type as of
December 31, 2005.
Valuation
of long-lived assets.
We
assess the impairment of long-lived assets if events or changes in circumstances
indicate that the carrying value may not be recoverable. Factors that could
trigger an impairment review include the following: (i) significant negative
industry or economic trends; (ii) exiting an activity in conjunction with a
restructuring of operations; (iii) current, historical or projected losses
that
demonstrate continuing losses associated with an asset; or (iv) a significant
decline in our market capitalization, for an extended period of time, relative
to net book value. When we determine that there is an indicator that the
carrying value of long-lived assets may not be recoverable, we measure
impairment based on estimates of future cash flows. These estimates include
assumptions about future conditions such as future revenues, gross margins,
operating expenses within our company, the fair values of certain assets based
on appraisals, and industry trends.
Accounting
for income taxes.
In
preparing our consolidated financial statements, we estimate our income taxes
for each of the jurisdictions in which we operate, including Germany. We include
differences between our deferred tax assets, such as net operating loss carry
forwards, and deferred tax liabilities in our consolidated balance sheet. We
must then assess the likelihood that our deferred tax assets will be recovered
from future taxable income, and to the extent we believe that recovery is not
likely, we must establish a valuation allowance. To the extent we establish
a
valuation allowance or increase this allowance in any period, we must include
an
expense within the tax provision in our statement of operations. To date, we
have recorded a full allowance against our U.S. deferred tax assets. The
valuation allowances were $21.7 million and $22.3 million at
December 31, 2005 and 2004, respectively, which fully reserved our net
deferred tax assets related to temporary differences, net operating loss carry
forwards and other tax credits. Future income tax liabilities may be reduced
to
the extent permitted under federal and applicable state income tax laws, when
the future tax benefit can be utilized by applying it against future
income.
Significant
management judgment is required in determining our provisions for income taxes,
our deferred tax assets and liabilities and our future taxable income for
purposes of assessing our ability to utilize any future tax benefit from our
deferred tax assets. If actual results differ from these estimates or we adjust
these estimates in future periods, our financial position, cash flows and
results of operations could be materially affected.
Recently
issued accounting pronouncements
In
November 2004, the Financial Accounting Statement Board issued SFAS No. 151,
“Inventory Costs - An Amendment of ARB No. 43, Chapter 4 (“SFAS 151”). SFAS 151
amends the guidance in ARB No. 43, Chapter 4, “Inventory Pricing,” to clarify
the accounting for abnormal amounts of idle facility expense, freight, handling
costs, and wasted material (spoilage). Among other provisions, the new rule
requires that items such as idle facility expense, excessive spoilage, double
freight and re-handling costs must be recognized as current-period charges
regardless of whether they meet the criterion of “so abnormal” as stated in ARB
No. 43. Additionally, SFAS 151 requires that the allocation of fixed production
overheads to the costs of conversion be based on the normal capacity of the
production facilities. SFAS 151 is effective for fiscal years beginning after
June 15, 2005 and is required to be adopted by us beginning on January 1, 2006.
We are currently evaluating the effect that the adoption of SFAS 151 will have
on our consolidated results of operations and financial condition but do not
expect SFAS 151 to have a material impact.
In
December 2004, the FASB issued SFAS No. 123 (revised 2004), “Share-Based
Payment” (“SFAS 123R”), which replaces SFAS No. 123, “Accounting for Stock-Based
Compensation,” (“SFAS 123”), and supercedes APB Opinion No. 25, “Accounting for
Stock Issued to Employees.” SFAS 123R requires all share-based payments to
employees, including grants of employee stock options, to be recognized in
the
financial statements based on their fair values beginning with the first fiscal
year after June 15, 2005, with early adoption encouraged. The pro forma
disclosures previously permitted under SFAS 123 no longer will be an alternative
to financial statement recognition. We are required to adopt SFAS 123R beginning
January 1, 2006. The Company will apply the Black-Scholes valuation model in
determining the fair value of share-based payments to employees, which will
then
be amortized on a straight-line basis over the requisite service period. The
Company will apply the modified prospective method, which requires that
compensation expense be recorded for all unvested stock options and restricted
stock upon adoption of SFAS 123R.
In
March
2005, the SEC issued Staff Accounting Bulletin No. 107 (“SAB 107”) regarding the
SEC’s interpretation of SFAS 123R and the valuation of share-based payments for
public companies. The Company is evaluating the requirements of SFAS 123R and
SAB 107 and expects that the adoption of SFAS 123R on January 1, 2006 will
have
a material impact on the Company’s consolidated results of operations and
earnings per share beginning in the first quarter of 2006.
In
December 2004, the FASB issued SFAS No. 153, “Exchanges of Non-monetary Assets -
An Amendment of APB Opinion No. 29, Accounting for Non-monetary Transactions”
(“SFAS 153”). SFAS 153 eliminates the exception from fair value measurement for
non-monetary exchanges of similar productive assets in paragraph 21(b) of APB
Opinion No. 29, “Accounting for Non-monetary Transactions,” and replaces it with
the exception for exchanges that do not have commercial substance. SFAS 153
specifies that a non-monetary exchange has commercial substance if the future
cash flows of the entity are expected to change significantly as a result of
the
exchange. SFAS 153 is effective for the fiscal periods beginning after June
15,
2005 and is required to be adopted by us beginning on January 1, 2006. We are
currently evaluating the effect that the adoption of SFAS 153 will have on
our
consolidated results of operations and financial condition but do not expect
it
to have a material impact.
In
March
2005, the FASB issued FASB Interpretations No. 47, “Accounting for Conditional
Asset Retirement Obligations, an interpretation of FASB Statement No. 143.” This
interpretation clarifies that the term conditional asset retirement obligation
to perform an asset retirement activity in which the timing and (or) method
of
settlement are conditional on a future event that may or may not be within
the
control of the entity. FIN 47 is effective no later than the end of fiscal
years
ending after December 15, 2005; retrospective application for interim financial
information is permitted but not required. The Company is evaluating the effect
that the adoption of FIN 47 will have on its consolidated result of operations
and financial condition in the future and has determined that it cannot
ascertain the fair value of any potential obligation because the settlement
date
and method of settlement for our obligation have not been specified. See Note
13
of Notes to Consolidated Financial Statements (Item 8) - Subsequent
Events.
In
May
2005, the FASB issued SFAS No. 154, “Accounting and Error Correction” (“SFAS
154”), which replaces APB Opinion No. 20, “Accounting Changes” and SFAS No 3,
“Reporting Changes in Interim Financial Statements - An Amendment of APB Opinion
No. 28.” SFAS 154 provides guidance on the accounting and reporting of
accounting changes and error corrections. It establishes retrospective
application, or the latest practicable date, as the required method for
reporting a change in accounting principle and the reporting of a correction
of
an error. SFAS 154 is effective for accounting changes and corrections of errors
made in fiscal years beginning after December 15, 2005 and is required to be
adopted by the Company in the first quarter of fiscal 2006. The Company is
currently evaluating the effect that adoption of SFAS 154 will have on its
consolidated results of operations and financial condition but does not expect
it to have a material impact.
In
February 2006, FASB issued SFAS No. 155, “Accounting for Certain Hybrid
Financial Instruments”—an amendment of FASB Statements No. 133 and 140 (“SFAS
155”). SFAS 155 permits fair value measurement for any hybrid financial
instrument that contains an embedded derivative, clarifies which interest-only
strips and principal-only strips are not subject to the requirement of Statement
133, establishes a requirement to evaluate interests in securitized financial
assets, clarifies the concentrations of credit risk, and eliminates the
prohibition on a qualifying special-purpose entity from holding a derivative
financial instrument. SFAS 133 improves financial reporting by eliminating
the
exemption from applying Statement 133 to interest in securitized financial
assets and allowing to elect fair value measurement at acquisition, at issuance,
or when a previously recognized financial instrument is subject to a
measurement. SFAS 155 is effective for all financial instruments acquired or
issued in fiscal years beginning after September 15, 2006. The implementation
of
SFAS 155 is not expected to have a material impact on the Company’s consolidated
results of operations, financial position or cash flows.
Results
of Operations
Consolidated
Statements of Operations Data:
|
|
Years
Ended December 31,
|
|||||||||||||||
|
|
2005
|
Percent
Change
|
2004
|
Percent
Change
|
2003
|
|||||||||||
|
|
(dollars
in thousands)
|
|||||||||||||||
|
Net
revenues, by product:
|
||||||||||||||||
|
Automotive
glass
|
$
|
19,647
|
(5
|
)%
|
$
|
20,584
|
1
|
%
|
$
|
20,297
|
||||||
|
Electronic
display
|
14,039
|
(32
|
)
|
20,554
|
8
|
19,019
|
||||||||||
|
Architectural
|
5,934
|
(15
|
)
|
7,010
|
11
|
6,297
|
||||||||||
|
Window
film
|
15,134
|
61
|
9,425
|
22
|
7,713
|
|||||||||||
|
Total
net revenues
|
54,754
|
(5
|
)
|
57,573
|
8
|
53,326
|
||||||||||
|
Cost
of sales
|
37,241
|
1
|
36,787
|
(20
|
)
|
45,914
|
||||||||||
|
Gross
profit
|
17,513
|
(16
|
)
|
20,786
|
180
|
7,412
|
||||||||||
|
Operating
expenses:
|
||||||||||||||||
|
Research
and development
|
5,104
|
60
|
3,199
|
(52
|
)
|
6,714
|
||||||||||
|
Selling,
general and administrative
|
8,332
|
(18
|
)
|
10,217
|
(17
|
)
|
12,348
|
|||||||||
|
Restructuring
expenses (recoveries)
|
--
|
--
|
--
|
--
|
(65
|
)
|
||||||||||
|
Impairment
charge (recoveries) for long-lived assets.
|
(170
|
)
|
(89
|
)
|
(1,513
|
)
|
nm*
|
27,990
|
||||||||
|
Total
operating expenses
|
13,266
|
12
|
11,903
|
(75
|
)
|
46,987
|
||||||||||
|
Income
(loss) from operations
|
4,247
|
52
|
8,883
|
nm*
|
(39,575
|
)
|
||||||||||
|
Interest
expense, net
|
(973
|
)
|
(56
|
)
|
(2,206
|
)
|
(39
|
)
|
(1,590
|
)
|
||||||
|
Costs
of warrants issued
|
--
|
nm*
|
(6,782
|
)
|
(684
|
)
|
(865
|
)
|
||||||||
|
Other
income, net
|
75
|
(86
|
)
|
534
|
27
|
419
|
||||||||||
|
Income
(loss) before provision for income taxes
|
3,349
|
681
|
429
|
nm*
|
(41,611
|
)
|
||||||||||
|
Provision
for income taxes
|
29
|
(95
|
)
|
614
|
(10
|
)
|
681
|
|||||||||
|
Net
income (loss)
|
3,320
|
nm*
|
(185
|
)
|
(100
|
)
|
(42,292
|
)
|
||||||||
|
|
||||||||||||||||
|
Deemed
dividend on preferred stock
|
490
|
--
|
--
|
--
|
--
|
|||||||||||
|
Net
income (loss) attributable to common stockholders
|
$
|
2,830
|
nm*
|
$
|
(185
|
)
|
(100
|
)%
|
$
|
(42,292
|
)
|
|||||
*not
meaningful
The
following table sets forth our results of operations expressed as a percentage
of total revenues:
|
|
Year
Ended December 31,
|
|||||||||
|
|
2005
|
2004
|
2003
|
|||||||
|
Net
Revenues:
|
||||||||||
|
Automotive
glass
|
35.9
|
%
|
35.8
|
%
|
38.0
|
%
|
||||
|
Electronic
display
|
25.6
|
35.7
|
35.7
|
|||||||
|
Architectural
|
10.8
|
12.2
|
11.8
|
|||||||
|
Window
film
|
27.6
|
16.4
|
14.5
|
|||||||
|
Total
net revenues
|
100.0
|
100.0
|
100.0
|
|||||||
|
Cost
of sales
|
68.0
|
63.9
|
86.1
|
|||||||
|
Gross
profit
|
32.0
|
36.1
|
13.9
|
|||||||
|
Research
and development
|
9.3
|
5.6
|
12.6
|
|||||||
|
Selling,
general and administrative
|
15.2
|
17.7
|
23.2
|
|||||||
|
Restructuring
expenses (recoveries)
|
--
|
--
|
(0.1
|
)
|
||||||
|
Impairment
charge (recoveries) for long-lived assets
|
(0.3
|
)
|
(2.6
|
)
|
52.4
|
|||||
|
Total
operating expenses
|
24.2
|
20.7
|
88.1
|
|||||||
|
Income
(loss) from operations
|
7.8
|
15.4
|
(74.2
|
)
|
||||||
|
Interest
expense
|
(1.8
|
)
|
(3.8
|
)
|
(3.0
|
)
|
||||
|
Cost
of warrants issued
|
--
|
(11.8
|
)
|
(1.6
|
)
|
|||||
|
Other
income, net
|
0.1
|
0.9
|
0.8
|
|||||||
|
Income
(loss) before provision for income taxes
|
6.1
|
0.7
|
(78.0
|
)
|
||||||
|
Provision
for income taxes
|
0.1
|
1.0
|
1.3
|
|||||||
|
Net
income (loss)
|
6.1
|
(0.3
|
)
|
(79.3
|
)
|
|||||
|
Deemed
dividend on preferred stock
|
0.9
|
--
|
--
|
|||||||
|
Net
income (loss) attributable to common stockholders
|
5.2
|
%
|
(0.3)
|
%
|
(79.3)
|
%
|
||||
Net
revenues
Net
revenues were $54.8 million in 2005, $57.6 million in 2004, and $53.3 million
in
2003. Net revenues for 2005 decreased by $2.8 million, or 5% from 2004, and
net
revenues for 2004 increased by $4.2 million, or 8% from 2003.
Our
net
revenues in the automotive market decreased by $0.9 million, or 5%, from $20.6
million in 2004 to $19.6 million in 2005. The decrease was primarily due to
a
reduction in demand by the OEMs for solar control features in the automotive
market. Our net revenues in the automotive market remained relatively the same
in 2004 and 2003 at $20.6 million and $20.3 million, respectively.
Our
net
revenues in the electronic display market decreased by $6.5 million, or 32%,
from $20.6 million in 2004 to $14.0 million in 2005. The decrease was primarily
due to lower average selling prices for Plasma Display Panel products, resulting
in price pressures on all suppliers in the market. Mitsui Chemicals is our
primary customer in the electronic display market. Sales to Mitsui decreased
$3.9 million from $16.4 million in 2004 to $12.4 million in 2005. In addition,
we phased out our unprofitable anti-reflective product lines and stopped selling
these products in 2005, resulting in a decrease of $0.8 million over 2004.
Our
net revenues in the electronic display market increased by 8% or $1.5 million
in
2004 when compared to 2003 as a result of increased sales to Mitsui Chemicals
in
the plasma display market, partially offset by decreased sales to Mitsubishi
as
Mitsubishi ceased production of their 17-inch CRT monitor. The decline in our
CRT business of $4.0 million was partially offset by an increase in sales of
our
reflective film products of $5.0 million used in liquid crystal displays, or
LCDs, which provide backlighting for laptop computers, and our plasma display
film product, TCP, which provides electronic and infrared shielding for the
PDP
market. Revenues from these products increased to $16.4 million in 2004 from
$11.4 million in 2003.
Our
net
revenues in the architectural market decreased 15% or $1.1 million in 2005
when
compared to 2004. The decrease was due to softness in the Asian market and
a
decrease in business from one of our largest accounts in Europe and the Middle
East. Our net revenues in the architectural market increased 11% or $0.7 million
in 2004 when compared to 2003 due to an increase in sales from our customers
in
all regions.
Our
net
revenues in our window film market increased 61% or $5.7 million in 2005 when
compared to 2004. In 2005, we stopped converting (cutting the film to the
customer’s specification) one of our window film product models and agreed with
our customers that they would complete this process. This resulted in higher
revenues on our TX products as our customers bought more products to fill their
distribution pipelines. In addition, we experienced higher demand for our Solis
product in 2005. Our net revenues in our window film market increased 22% or
$1.7 million in 2004 when compared to 2003. We sell our window film products
primarily to customers located in the Pacific Rim and the Middle East.
Cost
of Sales
Cost
of
sales increased 1.2% or $0.5 million in 2005 from 2004. As a percent of sales,
cost of sales was 68% in 2005 compared to 63.9% in 2004. Facility costs,
depreciation expense and labor costs have historically comprised the majority
of
our manufacturing expenses, and these costs are relatively fixed and do not
fluctuate proportionately with net revenues. The increase in 2005 from 2004
was
the result of increased material costs for component materials and increased
production levels in the United States which has higher manufacturing costs
than
in Germany. The production levels have increased in 2005 compared to 2004 due
to
the increase in customers’ demand for our products as well as due to the
transfer of Tempe manufacturing to Palo Alto manufacturing facility.
Cost
of
sales decreased 20% or $9.1 million in 2004 from 2003. As a percent of sales,
cost of sales was 63.9% in 2004 compared to 86.1% in 2003. The reduction in
2004
from 2003 in cost of goods sold was the result of a reduction of overhead costs,
the increased production from our Dresden facility which has lower manufacturing
costs and lower fixed costs than in the United States as a result of our
restructuring actions taken in 2003. Depreciation expense is lower for our
Dresden plant due to the grants and investment allowances for plant and
equipment provided to us by the Saxony government. The grants and allowances
are
recorded as a reduction of property and equipment costs, thereby lowering the
depreciation base of those assets.
Gross
margin
Gross
margin decreased from 36.1% in 2004 to 32% in 2005. The decrease in gross margin
was largely the result of product mix and increased component material costs.
Our window film products cost more to make than other products. Gross margin
increased from 13.9% in 2003 to 36.1% in 2004. The improvement in gross margin
was largely due to product mix and manufacturing efficiencies. Continued
improvements in our Dresden operations, combined with stabilized U.S.
production, have played an important role in the increase of our gross margin
in
2004 when compared to 2003.
Operating
expenses
Research
and development spending increased 60% or $1.9 million in 2005 compared to
2004.
The increase was due in part to an increase in labor and employee benefits
costs
as a result of expanding our engineering organization. In June 2005, we hired
a
new Chief Technology Officer/ Senior Vice President. In 2005, we hired an
additional eight employees in the engineering department. Research and
development spending decreased 52% or $3.5 million in 2004 compared to 2003.
The
decrease was due to lower headcount in 2004 of 16 compared to 33 in 2003 as
a
result of restructuring activities in 2003. Also, patent service costs, tool
and
allocation expenses were all reduced in 2004 compared to 2003.
Our
selling, general and administrative expenses decreased 18% or $1.9 million
in
2005 from 2004. The decrease in general and administrative expenses in 2005
was
primarily due to higher legal and accounting fees of $0.8 million, outside
services and consulting expense of $0.5 million, and compensation expense of
$0.5 million in 2004, partially offset by higher Sarbanes-Oxley compliance
expenses of $0.3 million in 2005 and higher adjustment to bad debt expense
of
$0.4 million in 2004. Our selling, general and administrative expenses decreased
17% or $2.1 million in 2004 from 2003 due to lower business insurance premiums
of $0.5 million, lower bad debts of $0.7 million, lower depreciation expenses
of
$0.5 million, reduced legal fees of $0.5 million and decrease in accounting
fees
of $0.2 million, offset by higher consulting fees of $0.3 million and outside
services of $0.2 million.
Restructuring
costs
In
2003,
we recorded a credit to operating expenses of $65,000 as a result of
modifications to the severance packages of certain employees. During 2005 and
2004, we did not incur restructuring costs.
Impairment
charge/recoveries for long-lived assets
During
2003, we experienced shortfalls in revenue compared to our budgeted and forecast
revenues. In the third quarter of 2003, we determined that, due to reduced
demand for our products, anticipated revenues through the remainder of 2003
and
2004 would be substantially below historical levels. We believed that the
reduced demand for our products was caused by the decline in personal computer
sales worldwide, competition from alternative technologies in the automotive
glass segment, as well as declines in certain residential and commercial
construction markets as a result of the economic recession in the U.S. As our
U.S. operations have a higher operating cash break-even point compared to our
Dresden operations, we believed that the lower than anticipated revenues
indicated that an impairment analysis of the assets of our U.S. operations
was
necessary at September 28, 2003. As a result of our decision to close the Tempe
operations in the fourth quarter, we concluded that a further impairment
analysis of the long-lived assets of the U.S. operations was necessary at
December 31, 2003. We, therefore, performed an evaluation of the recoverability
of long-lived assets related to the U.S. business at September 28, 2003 and
December 31, 2003 in accordance with Statement of Financial Accounting Standards
("SFAS") No. 144, "Accounting for the Impairment or Disposal of Long-Lived
Assets". For long-lived assets to be held and used, the determination of
recoverability is based on an estimate of undiscounted cash flows expected
to
result from the use and eventual disposition of the assets. Our evaluation
concluded that the undiscounted expected future cash flows were less than the
carrying values of these assets, and an impairment charge was required. The
impairment charge represents the amount required to write-down long-lived assets
to our best estimate of fair value. For long-lived assets to be disposed of
by
sale or abandonment, principally the long-lived assets located at the Tempe
operation, the impairment loss is estimated as the excess of the carrying value
of the assets over fair value. As a result of our assessment we recorded
non-cash, impairment charges of $19.4 million and $8.6 million for the periods
ended September 28, 2003 and December 31, 2003, respectively. The factors
considered by us in performing this assessment included current operating
results, trends, and prospects, the closure of our Tempe operation, as well
as
the effects of obsolescence, demand, competition, and other economic
factors.
In
June
2004, we had a recovery for long-lived assets as a result of selling a
production machine from our Tempe manufacturing facility to a third party.
The
sale value was $1.7 million, which included the price of the production machine,
other miscellaneous hardware, training to be provided by us and operating
software to run the machine. All of our obligations were completed and we
recognized a gain of $1.5 million, representing 90% of the sale value, less
book
value of the machine of $0.1 million. Collection of the final 10% was contingent
on installation of the machine by a third party or 120 days after shipment.
We
collected the final 10% in January 2005 and recognized the gain in the amount
of
$0.2 million in the first quarter of 2005.
Income
(loss) from operations
Income
from operations decreased from $8.9 million in 2004 to $4.2 million in 2005.
The
decrease was a result of lower revenues, higher research and development
expenses, and lower recoveries for long-lived assets. Income from operations
was
$8.9 million in 2004 compared to loss from operations of $39.6 million in 2003.
Income from operations in 2004 was a result of higher net sales and gross profit
margin, lower operating expenses and recovery from long-lived assets.
Interest
expense, net
Interest
expense decreased from $2.2 million in 2004 to $1.0 million in 2005. The
decrease in interest expense was primarily attributable to less outstanding
debt
in 2005 compared to 2004. Interest expense increased from $1.6 million in 2003
to $2.2 million in 2004. The increase in interest expense in 2004 compared
to
2003 was mainly due to a $0.3 million interest expense incurred for amortization
of debt issuance costs related to warrants, $0.4 million interest expense
attributable to interest incurred on our convertible promissory notes and $0.2
million interest incurred with our line of credit, offset by interest income
of
$0.2 million.
Cost
of warrants issued
Warrants
issued in connection with the Letter of Intent
In
connection with the November 11, 2003 Letter of Intent signed between Needham
& Company, Inc., or Needham, and us outlining the proposed debt guarantee
and equity financing, we issued a warrant for 1,254,235 shares of common stock,
representing 10% of the outstanding common stock of Southwall, exercisable
at
$0.01 per share. We valued the warrant at $0.1 million and the amount was
recorded as a non-operating expense. This warrant terminated upon signing of
definitive documentation with Needham on December 18, 2003.
Warrants
issued in connection with the investment agreement
In
accordance with the investment agreement, warrants were to be issued to the
Investors on the closing of each guarantee and equity tranche. However, the
terms of the investment agreement were such that the Investors were entitled
to
receive the 752,892 warrants associated with the second tranche of equity
regardless of whether the second equity closing occurred. This term was included
as further incentive for the Investors to enter into definitive agreements.
Because we had an enforceable obligation to issue the warrants and because
the
terms of the warrant were known as of the date of the investor agreement, the
warrants were considered issued for accounting purposes as of December 18,
2003.
Because
they were issued as an incentive to enter into definitive agreements for
transactions to which the Investors are not committed, we determined that the
value of the warrants should be recorded as a non-operating expense. We
determined the value of the warrants to be $0.3 million.
The
investment agreement also included terms that required us to issue additional
warrants to the Investors if, as part of the restructuring efforts, we issued
any equity instruments, notes or other debt instruments to any creditor,
landlord, employee, director, agent or consultant.
Following
the issuance of equity instruments we are required to issue to each of the
Investors warrants in such amounts as would allow the Investors to maintain
their aggregate ownership percentage (on a fully-diluted basis) as if such
issuance had not occurred. Such warrants represent anti-dilution protection
for
the Investor and are therefore not valued as a stand-alone
instrument.
Following
note or debt issuances to creditors we are required to issue additional warrants
to each of the Investors representing the right to purchase that number of
shares of common stock equal to the product of (x) 1.25 and (y) the original
principal amount of such note or debt instrument. Such warrants represent
penalties for our failing to eliminate obligations to creditors, and are
regarded as issued for accounting purposes as of the date of the agreement
triggering legal entitlement.
In
December 2003, additional warrants totaling 409,246 were triggered by note
or
debt issuances. We determined the value of the warrants to be $0.2 million.
The
fair value of the warrants was recorded as a non-operating expense.
Warrants
issued in connection with the guarantee from Needham
In
connection with the guarantee from Needham and as additional incentive to
complete the financing closings, as contemplated in the investment agreement,
we
issued warrants for 941,115 shares of common stock. We have determined the
value
of the guarantee and warrants at $0.1 million and $0.4 million,
respectively.
We
recorded the amount of the warrant value equal to the fair value of the
guarantee, $0.1 million, as debt issuance costs to be amortized as interest
expense over the life of our line of credit with our senior lender. The residual
value of the warrants, $0.3 million, is recorded as a non-operating expense,
because it represented an incentive to enter into definitive agreements for
transactions to which Needham is not committed.
In
the
first quarter of 2004, due to the structure of the transaction contemplated
by
the investment agreement, the Company had insufficient authorized and un-issued
shares to satisfy the existing commitments had all outstanding warrants been
exercised, thereby triggering liability classification for all outstanding
warrants and a charge to non-operating expense. The Company re-measured the
fair
value of the warrants at the issuance date and each subsequent quarter-end,
based on a methodology used by a third party, until the Company’s stockholders
approved the increase of the number of authorized shares of its common stock
in
the fourth quarter of 2004. As a result of this, the Company incurred $6.8
million in cost of warrants issued in 2004. No warrants were issued in 2005.
Other
income, net
Other
income decreased from $0.5 million in 2004 to $0.1 million in 2005. Other
income, net, reflects foreign exchange transaction gains and losses. Some of
our
transactions with foreign customers are denominated in foreign currencies,
principally the Euro. As exchange rates fluctuate relative to the U.S. dollar,
exchange gains and losses occur. The reduction in other income in 2005 from
2004
was primarily attributable to the net exchange loss due to Euro fluctuation
of
$0.3 million. Other income increased from $0.4 million in 2003 to $0.5 million
in 2004. The increase in other income in 2004 from 2003 was attributable to
an
increase in foreign currency gain recognized from receivables denominated in
Euros and VAT refunds, also denominated in Euros.
Income
(loss) before provision for income taxes
The
pre-tax income increase from $0.4 million in 2004 to $3.3 million in 2005 was
a
result of lower interest expense and no cost of warrants issued. The pre-tax
income in 2004 compared to the pre-tax loss in 2003 was a result of higher
net
revenue and gross profit margin, lower operating expenses, and impairment
recovery for long-lived assets, partially offset by interest expense and cost
of
warrants issued.
Provision
for income taxes
The
provision for income taxes in 2005, 2004 and 2003 was related to our German
subsidiary, Southwall Europe Gmbh (“SEG”). In 2005, our provision for income
taxes decreased approximately $0.6 million. The decrease relates to a reversal
of approximately $0.4 million of foreign income tax accrual relating to prior
years, recognition of deferred tax assets of approximately $0.1 million at
December 31, 2005 and lower taxable income in our German subsidiary. The
decrease in the provision for income taxes in 2004 from 2003 was due to lower
taxable income for SEG in 2004 compared to 2003. In 2003, we fully utilized
our
operating loss carry forward for German statutory tax purposes, and as a result,
we expect to incur tax obligations related to our Dresden plant for the
foreseeable future based on expected continuing profitability of our German
operations on a stand-alone basis.
Net
income (loss)
The
increase from net loss of $0.2 million in 2004 to net income of $3.3 million
in
2005 was a result of lower interest expense, no cost of warrants issued and
lower provision for income taxes. The decrease in net loss in 2004 compared
to
the loss in 2003 was a result of higher net revenue and gross profit margin,
lower operating expenses, and impairment recovery for long-lived assets,
partially offset by interest expense and cost of warrants issued.
Deemed
dividend on preferred stock
We
accrued $0.5 million of deemed dividend on preferred stock in 2005 as a result
of the conversion of our secured convertible promissory notes into shares of
Series A preferred stock in December 2004. The Series A preferred stock carries
a 10% cumulative dividend rate. There was no such dividend in 2004 and
2003.
Liquidity
and capital resources
Liquidity
Our
principal liquidity requirements are for working capital, consisting primarily
of accounts receivable and inventories. We believe that because of the
relatively long production cycle of certain of our products, our inventories
will continue to represent a significant portion of our working capital. We
incurred a net income in 2005 and net loss in 2004 and 2003 and negative cash
flows from operations in 2003. We incurred positive cash flow from operations
in
2005 and 2004.
Our
cash
and cash equivalents increased by $2.1 million from $4.5 million at
December 31, 2004 to $6.6 million at December 31, 2005. Cash provided by
operating activities increased by $0.2 million from $3.8 million provided by
operations in 2004, to $4.0 million provided by operations in 2005. The increase
in cash provided by operating activities during 2005 was primarily the result
of
net income for the year of $3.3 million, non-cash depreciation of $2.2 million,
and decreases in inventories of $2.5 million and in other current and
non-current assets of $0.9 million partially offset by impairment recoveries
from long-lived assets of $0.2 million, change in deferred income taxes of
$0.5
million, an increase in accounts receivable of $0.9 million and a decrease
in
accounts payable and accrued liabilities of $3.4 million. Cash used in investing
activities in 2005 was $0.3 million compared to $1.3 million provided by
investing activities in 2004. The decrease was primarily due to proceeds from
the sale of a fixed asset of $1.6 million in 2004. Cash used in financing
activities decreased by $0.6 million from $2.2 million used in financing
activities in 2004 to $1.6 million used in financing activities in 2005. The
decrease was the result of less debt outstanding in 2005, which resulted in
lower principal repayments.
We
entered into an agreement with the Saxony government in May 1999 under
which we receive investment grants. As of December 31, 2005, we had
received 5.0 million Euros, or $5.0 million at historical rate of the
grants and accounted for these grants by applying the proceeds received to
reduce the cost of our fixed assets of our Dresden manufacturing facility.
Additionally, as of December 31, 2005, we had a balance remaining from the
government grants received in May 1999 of 0.3 million Euros, or $0.4 million,
which has been recorded as an advance and held as restricted cash until we
receive approval from the Saxony government to apply the funds to reduce our
capital expenditures. If we fail to meet certain requirements in connection
with
these grants, the Saxony government has the right to demand repayment of the
grants. The total annual amount of investment grants and investment allowances
that we are entitled to seek varies from year to year based upon the amount
of
our capital expenditures that meet certain requirements of the Saxony
government. Generally, we are not eligible to seek total investment grants
and
allowances for any year in excess of 33% of our eligible capital expenditures
in
Germany for that year. We expect to continue to finance a portion of our capital
expenditures in Dresden with additional grants from the Saxony government and
additional loans from German banks, some of which may be guaranteed by the
Saxony government. However, we cannot guarantee that we will be eligible for
or
will receive additional grants in the future from the Saxony
government.
Borrowing
arrangements
On
April
28, 2005, we entered into a credit agreement (the “Credit Agreement”) with Wells
Fargo HSBC Trade Bank, N.A. (the “Bank”). The Credit Agreement provides for two
facilities. All amounts borrowed under both facilities under the Credit
Agreement must be repaid on or before May 31, 2006. It is our intention to
renew
this credit facility in May 2006.
The
first
facility is a revolving line of credit under which we may from time to time
borrow up to $3 million, subject to satisfaction of certain conditions. Amounts
borrowed under the first facility bear interest at the prime rate minus 1.75%
per annum or LIBOR plus 1% per annum, at our option. We borrowed approximately
$3.0 million from this facility on April 28, 2005 which amount remained
outstanding as of December 31, 2005.
The
second facility is a formula line under which we may, from time to time, borrow
up to $3 million, subject to certain conditions, with advances of up to 80%
of
eligible accounts receivable. Amounts borrowed under the second facility bear
interest at the prime rate minus 0.25% per annum. We may borrow under the second
facility only if we meet certain financial covenants. As of December 31, 2005,
we met these financial covenants. There is no balance outstanding under the
second facility.
All
borrowings under both facilities are collateralized by our inventory,
receivables, raw material and work in progress. In addition, the first facility
under the Credit Agreement is collateralized by a letter of credit posted by
Needham & Company, one of our stockholders.
The
terms
of the Credit Agreement, among other things, limit our ability to (i) incur,
assume or guarantee additional indebtedness in excess of $13.5 million (other
than pursuant to the Credit Agreement), (ii) pay dividends or repurchase stock
(except up to $0.6 million per year of dividends on preferred stock), (iii)
incur liens upon the collateral pledged to the bank, (iv) make any loans or
advances to, or investments in, any person or entity outside the ordinary course
of business, (v) merge, consolidate, sell or otherwise dispose of substantially
all or a substantial or material portion of our assets, (vi) enter into
transactions with affiliates, and (vii) make acquisitions other than up to
an
aggregate amount of $3 million and (viii) to make capital expenditures in any
fiscal year in excess of $1.5 million.
The
Credit Agreement provides for events of default, which include, among others,
(a) nonpayment of amounts when due (with no grace periods), (b) the breach
of
our representations or covenants or other agreements in the Credit Agreement
or
related documents, (c) payment defaults or accelerations of our other
indebtedness, (d) a failure to pay certain judgments, (e) the occurrence of
any
event or condition that the Bank believes impairs or is substantially likely
to
impair the prospects of payment or performance by us, and (f) certain events
of
bankruptcy, insolvency or reorganization. Generally, if an event of default
occurs, the Bank may declare all outstanding indebtedness under the Credit
Agreement to be due and payable.
The
foregoing description does not purport to be a complete statement of the
parties' rights and obligations under the Credit Agreement and the transactions
contemplated thereby or a complete explanation of the material terms
thereof.
Our
borrowing arrangements with various German banks as of December 31, 2005 are
described in Note 5 of Notes to our Consolidated Financial Statements (Item
8) set forth herein. We are in compliance with all of the covenants of the
German bank loans, and we have classified $1.0 million and $7.2 million
outstanding under the German bank loans as a short-term liability and long-term
liability, respectively, at December 31, 2005. We are obligated to pay an
aggregate of $1.0 million in principal amount under our German bank loans in
2006.
As
of
December 31, 2003, we were in default under a master sale-leaseback agreement
with respect to two of our production machines. We had withheld lease payments
in connection with a dispute with the leasing company, Matrix Funding
Corporation. An agent purporting to act on behalf of the leasing company filed
suit against us to recover the unpaid lease payments and the alleged residual
value of the machines, totaling $6.5 million in the aggregate. In February
2004, we reached a settlement agreement with the agent for $2.0 million to
be
repaid over six years at a stepped rate of interest, and we returned the
equipment in question to the plaintiffs (See Note 5 of Notes to Consolidated
Financial Statements (Item 8) - Term Debt and Capital Leases). At December
31,
2005, the carrying value of the liability was $4.3 million ($1.9 million of
principal, plus $2.4 million of accrued interest). We are obligated to pay
an
aggregate of $0.3 million under this agreement in 2006.
Capital
expenditures
We
spent
approximately $0.4 million in capital expenditures in 2004. We spent
approximately $0.8 million in capital expenditures in 2005, primarily to
maintain and upgrade our production facilities. We expect to spend approximately
$1.5 million in 2006 on maintenance of the production machines and research
and
development tools.
Future
Obligations
Our
future payment obligations on our borrowings pursuant to our term debt, capital
lease obligations, non-cancelable operating leases and other non-cancelable
contractual commitments are as follows (in thousands):
|
Total
|
Less
Than
1
Year
|
1-3
Years
|
3-5
Years
|
Greater
Than
5
Years
|
||||||||||||
|
Contractual
Obligations:
|
||||||||||||||||
|
Term
debt (1)
|
$
|
10,107
|
$
|
1,317
|
$
|
1,961
|
$
|
4,322
|
$
|
2,507
|
||||||
|
Line
of credit
|
2,996
|
2,996
|
--
|
--
|
--
|
|||||||||||
|
Operating
Leases (2)
|
1,844
|
1,586
|
250
|
8
|
--
|
|||||||||||
|
Total
Contractual Cash Obligations
|
$
|
14,947
|
$
|
5,899
|
$
|
2,211
|
$
|
4,330
|
$
|
2,507
|
||||||
________________
|
(1)
|
Represents
loan agreements with Portfolio Financing Servicing Company, Bank
of
America and Lehman Brothers, and several German
banks.
|
|
(2)
|
Represents
the remaining rents owed on a building we rent in Palo Alto, California.
On July 14, 2005, we moved our warehouse from 210 Littlefield, So.
San
Francisco, CA into 2629B Terminal Blvd., Mountain View, CA. The term
of
this lease is a period of one year, commencing on August 1, 2005
and
terminating on July 31, 2006, with monthly rent payments of
$5,655.
|
ITEM
7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET
RISK
We
are
exposed to the impact of interest rate changes, foreign currency fluctuations,
and changes in the market values of our investments.
Financing
risk: Our exposure to market rate risk for changes in interest rates relates
primarily to our line of credit which bears an interest rate equal to 1.0%
above
the bank LIBOR rate (which was 5.5% at December 31, 2005) and is calculated
based on amounts borrowed under the facility. In addition, the interest rate
on
one of our German loans has been reset to the prevailing market rate of 5.75%
and another of our German loans will have its interest rate reset to the
prevailing market rate in 2009. Fluctuations or changes in interest rates may
adversely affect our expected interest expense. The effect of a 10% fluctuation
in the interest rate on our line of credit would have had an effect of about
$21,000 on our interest expense for 2005.
Investment
risk: We invest our excess cash in money market accounts and, by practice,
limit
the amount of exposure to any one institution. Investments in both fixed rate
and floating rate interest earning instruments carry a degree of interest rate
risk. Fixed rate securities may have their fair market value adversely affected
due to a rise in interest rates, while floating rate securities may produce
less
income than expected if interest rates fall. The effect of a 10% fluctuation
in
the interest rate of any of our floating rate securities would have had an
adverse effect of less than $10,000 for 2005.
Foreign
currency risk: International revenues (defined as sales to customers located
outside of the United States) accounted for approximately 74% of our total
sales
in 2005. Approximately 44% of our international revenues were denominated in
Euros relating to sales from our Dresden operation in 2005. The other 56% of
our
international sales were denominated in US dollars. In addition, certain
transactions with foreign suppliers are denominated in foreign currencies
(principally Japanese Yen). The effect of a 10% fluctuation in the Euro exchange
rate would have had an effect of approximately $2.2 million on net revenues
for 2005 and the effect on expenses of a 10% fluctuation in the Yen exchange
rate would have been immaterial.
ITEM
8. FINANCIAL STATEMENTS AND SUPPLEMENTARY
DATA
TABLE
OF CONTENTS
|
Page
|
|
|
Report
of Independent Registered Public Accounting Firm
|
57
|
|
Report
of Independent Registered Public Accounting Firm
|
58
|
|
Consolidated
Balance Sheets
|
59
|
|
Consolidated
Statements of Operations
|
60
|
|
Consolidated
Statements of Stockholders’ Equity
|
61
|
|
Consolidated
Statements of Cash Flows
|
62
|
|
Notes
to Consolidated Financial Statements
|
63
|
REPORT
OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To
the
Board of Directors and Stockholders of
Southwall
Technologies Inc.
We
have
audited the accompanying consolidated balance sheets of Southwall Technologies
Inc. and its subsidiaries as of December 31, 2005 and 2004, and the related
consolidated statements of operations, stockholders’ equity and cash flows for
each of the two years in the period ended December 31, 2005. Our audits also
included the financial statement schedule listed in the Index at Item 15(a)(2).
These consolidated financial statements and financial statement schedule are
the
responsibility of the Company’s management. Our responsibility is to express an
opinion on these consolidated financial statements and financial statement
schedule based on our audits.
We
conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). 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 consolidated financial statements referred to above present fairly,
in all material respects, the consolidated financial position of Southwall
Technologies Inc. and its subsidiaries as of December 31, 2005 and 2004, and
the
results of their operations and their cash flows for each of the two years
in
the period ended December 31, 2005, in conformity with accounting principles
generally accepted in the United States of America. Also, in our opinion, the
related financial statement schedule, when considered in relation to the
consolidated financial statements taken as a whole, presents fairly, in all
material respects, the information set forth therein.
/s/
Burr,
Pilger & Mayer LLP
Palo
Alto, California
February
17, 2006
REPORT
OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To
the
Board of Directors and Shareholders of
Southwall
Technologies Inc.
In
our
opinion, the consolidated statements of operations, shareholders’ equity and
cash flows present
fairly, in all material respects, the results of operations of Southwall
Technologies Inc. and its subsidiaries and their cash flows for the year ended
December 31, 2003, in conformity with accounting principles generally accepted
in the United States of America. In addition, in our opinion, the accompanying
financial statements schedule presents fairly, in all material respects, the
information set forth therein when read in conjunction with the related
consolidated financial statements. These financial statements and financial
statement schedule are the responsibility of the Company's management; our
responsibility is to express an opinion on these financial statements and
financial statement schedule based on our audit. We conducted our audit of
these
statements in accordance with the standards of the Public Company Accounting
Oversight Board (United States), which require that we plan and perform the
audit to obtain reasonable assurance about whether the financial statements
are
free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements,
assessing the accounting principles used and significant estimates made by
management, and evaluating the overall financial statement presentation. We
believe that our audit provides a reasonable basis for our opinion.
The
accompanying consolidated financial statements have been prepared assuming
that
the Company will continue as going concern. The Company incurred a net loss
and
negative cash flow from operating activities in 2003 and had significant debt
service and other contractual obligations at December 31, 2003. These factors
raise substantial doubt about its ability to continue as a going concern. The
consolidated financial statements do not include any adjustments that may result
from the ultimate resolution of this matter.
/s/
PricewaterhouseCoopers LLP
San
Jose,
California
April
13,
2004
SOUTHWALL
TECHNOLOGIES INC.
CONSOLIDATED
BALANCE SHEETS
(in
thousands, except per share data)
|
|
December
31,
|
||||||
|
|
2005
|
2004
|
|||||
|
ASSETS
|
|||||||
|
Current
Assets:
|
|||||||
|
Cash
and cash equivalents
|
$ |
6,600
|
$
|
4,547
|
|||
|
Restricted
cash
|
402
|
686
|
|||||
|
Accounts
receivable, net of allowance for doubtful accounts of $208 and $292
in
2005 and 2004, respectively
|
6,780
|
6,186
|
|||||
|
Inventories,
net
|
5,879
|
8,355
|
|||||
|
Other
current assets
|
982
|
1,757
|
|||||
|
Total
current assets
|
20,643
|
21,531
|
|||||
|
Property,
plant and equipment, net
|
16,857
|
21,110
|
|||||
|
Restricted
cash loans
|
995
|
1,149
|
|||||
|
Other
assets
|
1,146
|
1,157
|
|||||
|
Total
assets
|
$
|
39,641
|
$
|
44,947
|
|||
|
LIABILITIES,
PREFERRED STOCK AND STOCKHOLDERS' EQUITY
|
|||||||
|
Current
Liabilities:
|
|||||||
|
Current
portion of long term debt and capital leases
|
$
|
1,317
|
$
|
1,463
|
|||
|
Short
term obligations
|
2,996
|
2,975
|
|||||
|
Accounts
payable
|
1,402
|
2,544
|
|||||
|
Accrued
compensation
|
1,161
|
1,378
|
|||||
|
Other
accrued liabilities
|
5,076
|
6,643
|
|||||
|
Total
current liabilities
|
11,952
|
15,003
|
|||||
|
Term
debt and capital leases
|
8,790
|
11,644
|
|||||
|
Government
grants advanced.
|
396
|
505
|
|||||
|
Other
long term liabilities
|
2,564
|
3,222
|
|||||
|
Total
liabilities
|
23,702
|
30,374
|
|||||
|
Commitments
and contingencies (Note 11)
|
|||||||
|
Series
A convertible preferred stock, $0.001 par value; 5,000 shares authorized,
4,893 shares outstanding at 2005 and 2004, respectively (Liquidation
preference: $5,383 and $4,893 at 2005 and 2004,
respectively)
|
4,810
|
4,810
|
|||||
|
Stockholders'
Equity:
|
|||||||
|
Common
stock, $0.001 par value; 50,000 shares authorized, and 26,793 and
26,488
shares outstanding at 2005 and 2004, respectively
|
27
|
26
|
|||||
|
Capital
in excess of par value
|
77,828
|
77,957
|
|||||
|
Accumulated
other comprehensive income
|
|||||||
|
Translation
gain on subsidiary
|
2,532
|
4,358
|
|||||
|
Accumulated
deficit
|
(69,258
|
)
|
(72,578
|
)
|
|||
|
Total
stockholders' equity
|
11,129
|
9,763
|
|||||
|
Total
liabilities, preferred stock and stockholders' equity
|
$ |
39,641
|
$
|
44,947
|
|||
The
accompanying notes are an integral part of these consolidated financial
statements.
SOUTHWALL
TECHNOLOGIES INC.
CONSOLIDATED
STATEMENTS OF OPERATIONS
(in
thousands, except per share data)
|
Years
Ended December 31,
|
||||||||||
|
2005
|
2004
|
2003
|
||||||||
|
Net
revenues
|
$
|
54,754
|
$
|
57,573
|
$
|
53,326
|
||||
|
Cost
of revenues
|
37,241
|
36,787
|
45,914
|
|||||||
|
Gross
profit
|
17,513
|
20,786
|
7,412
|
|||||||
|
Operating
expenses:
|
||||||||||
|
Research
and development
|
5,104
|
3,199
|
6,714
|
|||||||
|
Selling,
general and administrative
|
8,332
|
10,217
|
12,348
|
|||||||
|
Restructuring
expenses (recoveries)
|
--
|
--
|
(65
|
)
|
||||||
|
Impairment
charge (recoveries) for long-lived assets
|
(170
|
)
|
(1,513
|
)
|
27,990
|
|||||
|
Total
operating expenses
|
13,266
|
11,903
|
46,987
|
|||||||
|
Income
(loss) from operations
|
4,247
|
8,883
|
(39,575
|
)
|
||||||
|
Interest
expense, net
|
(973)
|
|
(2,206
|
)
|
(1,590 | ) | ||||
|
Costs
of warrants issued
|
--
|
(6,782
|
)
|
(865
|
)
|
|||||
|
Other
income, net
|
75
|
534
|
419
|
|||||||
|
Income
(loss) before provision for income taxes
|
3,349
|
429
|
(41,611
|
)
|
||||||
|
Provision
for incomes taxes
|
29
|
614
|
681
|
|||||||
|
Net
income (loss)
|
3,320
|
(185
|
)
|
(42,292
|
)
|
|||||
|
Deemed
dividend on preferred stock
|
490
|
--
|
--
|
|||||||
|
Net
income (loss) attributable to common stockholders
|
$
|
2,830
|
$
|
(185
|
)
|
$
|
(42,292
|
)
|
||
|
Net
income (loss) per share:
|
||||||||||
|
Basic
|
$
|
0.11
|
$
|
(0.01
|
)
|
$
|
(3.37
|
)
|
||
|
Diluted
|
$
|
0.10
|
$
|
(0.01
|
)
|
$
|
(3.37
|
)
|
||
|
Weighted
average shares used in computing net income (loss) per
share:
|
||||||||||
|
Basic
|
26,743
|
14,589
|
12,537
|
|||||||
|
Diluted
|
32,895
|
14,589
|
12,537
|
|||||||
The
accompanying notes are an integral part of these consolidated financial
statements.
SOUTHWALL
TECHNOLOGIES INC.
CONSOLIDATED
STATEMENTS OF STOCKHOLDERS' EQUITY
(in
thousands)
|
Accumulated
|
|||||||||||||||||||||||||
|
Other
|
|||||||||||||||||||||||||
|
_________
|
Compre-
|
Total
|
Compre-
|
||||||||||||||||||||||
|
Capital
in
|
hensive
|
Stock-
|
hensive
|
||||||||||||||||||||||
|
Common
Stock
|
Excess
of
|
Notes
|
Income
|
Accumulated
|
holders’
|
Income
|
|||||||||||||||||||
|
Shares
|
Amount
|
Par
Value
|
Receivable
|
(Loss)
|
Deficit
|
Equity
|
(Loss)
|
||||||||||||||||||
|
Balances,
January 1, 2003
|
12,527
|
$
|
12
|
$
|
69,657
|
$
|
(126
|
)
|
$
|
1,032
|
$
|
(30,101
|
)
|
$
|
40,474
|
||||||||||
|
Issuance
of shares to employees under stock purchase plan
|
21
|
1
|
21
|
--
|
--
|
--
|
22
|
||||||||||||||||||
|
Issuance
of warrants to investors
|
--
|
--
|
865
|
--
|
--
|
--
|
865
|
||||||||||||||||||
|
Issuance
of warrants to creditors
|
--
|
--
|
201
|
--
|
--
|
--
|
201
|
||||||||||||||||||
|
Issuance
of shares to directors
|
--
|
--
|
83
|
--
|
--
|
--
|
83
|
||||||||||||||||||
|
Accelerated
vesting on exercise of stock option
|
--
|
--
|
34
|
--
|
--
|
--
|
34
|
||||||||||||||||||
|
Forgiveness
of notes receivable
|
--
|
--
|
--
|
126
|
--
|
--
|
126
|
||||||||||||||||||
|
Foreign
currency translation adjustment
|
--
|
--
|
--
|
--
|
2,208
|
--
|
2,208
|
$
|
2,208
|
||||||||||||||||
|
Net
loss
|
--
|
--
|
--
|
--
|
--
|
(42,292
|
)
|
(42,292
|
)
|
(42,292
|
)
|
||||||||||||||
|
Balances,
December 31, 2003
|
12,548
|
13
|
70,861
|
--
|
3,240
|
(72,393
|
)
|
1,721
|
(40,084
|
)
|
|||||||||||||||
|
Issuance
of shares to employees under stock purchase plan
|
7
|
--
|
2
|
--
|
--
|
--
|
2
|
||||||||||||||||||
|
Issuance
of warrants to investors
|
--
|
--
|
6,990
|
--
|
--
|
--
|
6,990
|
||||||||||||||||||
|
Issuance
of shares to directors
|
150
|
--
|
72
|
--
|
--
|
--
|
72
|
||||||||||||||||||
|
Issuance
of shares from exercise of warrants
|
13,783
|
13
|
32
|
--
|
--
|
--
|
45
|
||||||||||||||||||
|
Foreign
currency translation adjustment
|
--
|
--
|
--
|
--
|
1,118
|
--
|
1,118
|
1,159
|
|||||||||||||||||
|
Net
loss
|
--
|
--
|
--
|
--
|
--
|
(185
|
)
|
(185
|
)
|
(185
|
)
|
||||||||||||||
|
Balances,
December 31, 2004
|
26,488
|
26
|
77,957
|
--
|
4,358
|
(72,578
|
)
|
9,763
|
974
|
||||||||||||||||
|
Issuance
of shares to employees under stock purchase plan
|
13
|
1
|
11
|
--
|
--
|
--
|
12
|
||||||||||||||||||
|
Issuance
of shares on stock options exercise.
|
38
|
--
|
19
|
--
|
--
|
--
|
19
|
||||||||||||||||||
|
Issuance
of shares to directors
|
24
|
--
|
15
|
--
|
--
|
--
|
15
|
||||||||||||||||||
|
Issuance
of shares under executive performance bonus plan
|
230
|
--
|
271
|
--
|
--
|
--
|
271
|
||||||||||||||||||
|
Compensation
expense for vesting modification
|
--
|
--
|
45
|
--
|
--
|
--
|
45
|
||||||||||||||||||
|
Dividend
accrual on Series A Preferred Stock.
|
--
|
--
|
(490
|
)
|
--
|
--
|
--
|
(490
|
)
|
||||||||||||||||
|
Foreign
currency translation adjustment
|
--
|
--
|
--
|
--
|
(1,826
|
)
|
--
|
(1,826
|
)
|
(1,826
|
)
|
||||||||||||||
|
Net
income
|
--
|
--
|
--
|
--
|
--
|
3,320
|
3,320
|
3,320
|
|||||||||||||||||
|
Balances,
December 31, 2005
|
26,793
|
$
|
27
|
$
|
77,828
|
$
|
--
|
$
|
2,532
|
$
|
(69,258
|
)
|
$
|
11,129
|
$
|
1,494
|
|||||||||
The
accompanying notes are an integral part of these consolidated financial
statements.
SOUTHWALL
TECHNOLOGIES INC.
CONSOLIDATED
STATEMENTS OF CASH FLOWS
(in
thousands)
|
|
Years
Ended December 31,
|
|||||||||
|
|
2005
|
2004
|
2003
|
|||||||
|
Cash
flows provided by (used in) operating activities:
|
||||||||||
|
Net
income (loss)
|
$ |
3,320
|
$
|
(185
|
)
|
$
|
(42,292
|
)
|
||
|
Adjustments
to reconcile net income (loss) to net cash provided by (used in)
operating
activities:
|
||||||||||
|
Deferred
income tax
|
(508
|
)
|
--
|
--
|
||||||
|
Impairment
(recoveries) charge for long-lived assets
|
(170
|
)
|
(1,513
|
)
|
27,990
|
|||||
|
Depreciation
and amortization
|
2,195
|
2,503
|
6,071
|
|||||||
|
(Gain)/loss
on disposal of capital equipment
|
--
|
(26
|
)
|
39
|
||||||
|
Stock-based
compensation charge
|
45
|
--
|
117
|
|||||||
|
Amortization
of debt issuance costs
|
--
|
274
|
28
|
|||||||
|
Amortization
of debt discount
|
--
|
115
|
--
|
|||||||
|
Accrued
interest on convertible notes payable
|
--
|
393
|
--
|
|||||||
|
Warrants
issued to investors and creditors
|
--
|
6,782
|
865
|
|||||||
|
Common
stock issued for services
|
15
|
72
|
--
|
|||||||
|
Officer
loan forgiveness
|
--
|
--
|
126
|
|||||||
|
Changes
in operating assets and liabilities:
|
||||||||||
|
Accounts
receivable
|
(914
|
)
|
910
|
1,899
|
||||||
|
Inventories
|
2,476
|
(1,525
|
)
|
1,707
|
||||||
|
Other
current and non-current assets
|
898
|
(137
|
)
|
2,344
|
||||||
|
Accounts
payable and accrued liabilities
|
(3,351
|
)
|
(3,833
|
)
|
(1,884
|
)
|
||||
|
Net
cash provided by (used in) operating activities
|
4,006
|
3,830
|
(2,990
|
)
|
||||||
|
Cash
flows provided by (used in) investing activities:
|
||||||||||
|
Restricted
cash
|
254
|
3
|
--
|
|||||||
|
Proceeds
from sale of fixed assets
|
170
|
1,640
|
--
|
|||||||
|
Expenditures
for property, plant and equipment and other assets
|
(766
|
)
|
(382
|
)
|
(2,775
|
)
|
||||
|
Net
cash provided by (used in) investing activities
|
(342
|
)
|
1,261
|
(2,775
|
)
|
|||||
|
Cash
flows provided by (used in) financing activities:
|
||||||||||
|
Proceeds
from borrowings
|
--
|
--
|
88
|
|||||||
|
Principal
payments on borrowings
|
(1,532
|
)
|
(2,769
|
)
|
(2,962
|
)
|
||||
|
Borrowings
on line of credit
|
2,996
|
--
|
--
|
|||||||
|
Repayments
of line of credit
|
(2,975
|
)
|
(3,869
|
)
|
6,844
|
|||||
|
Repayments
under capital lease
|
(44
|
)
|
--
|
--
|
||||||
|
Proceeds
from (use of) investment allowances
|
(42
|
)
|
(158
|
)
|
1,556
|
|||||
|
Proceeds
from stock option, warrant and employee stock purchase plan
exercises
|
31
|
47
|
22
|
|||||||
|
Proceeds
from convertible promissory notes
|
--
|
4,500
|
--
|
|||||||
|
Net
cash provided by (used in) financing activities
|
(1,566
|
)
|
(2,249
|
)
|
5,548
|
|||||
|
Effect
of foreign exchange rate changes on cash
|
(45
|
)
|
553
|
(629
|
)
|
|||||
|
Net
increase (decrease) in cash and cash equivalents
|
2,053
|
3,395
|
(846
|
)
|
||||||
|
Cash
and cash equivalents, beginning of year
|
4,547
|
1,152
|
1,998
|
|||||||
|
Cash
and cash equivalents, end of year
|
$
|
6,600
|
$
|
4,547
|
$
|
1,152
|
||||
|
Supplemental
cash flow disclosures:
|
||||||||||
|
Interest
paid
|
$
|
854
|
$
|
1,019
|
$
|
1,153
|
||||
|
Income
taxes paid
|
$
|
764
|
$
|
135
|
$
|
211
|
||||
|
Supplemental
schedule of non-cash investing and financing activities:
|
||||||||||
|
Dividends
accrued
|
$
|
490
|
$
|
--
|
$
|
--
|
||||
|
Warrants
issued to creditors and investors
|
$
|
--
|
$
|
--
|
$
|
1,060
|
||||
|
Conversion
of convertible promissory notes and accrued interest to Series A
convertible preferred stock
|
--
|
$
|
4,810
|
--
|
||||||
The
accompanying notes are an integral part of these consolidated financial
statements.
SOUTHWALL
TECHNOLOGIES INC.
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
(amounts
in thousands, except per share data)
NOTE
1 - THE COMPANY AND A SUMMARY OF ITS SIGNIFICANT ACCOUNTING
POLICIES:
The
Company
Southwall
Technologies Inc. (“Southwall”, “we”, “us”, “our”, and the “Company” refer to
Southwall Technologies Inc. and its subsidiaries) is a global developer,
manufacturer and marketer of thin film coatings on flexible substrates for
the
automotive glass, electronic display, window film, and architectural glass
markets. We have developed a variety of products that control sunlight in
automotive glass, reduce light reflection, reduce electromagnetic radiation
and
improve image quality in electronic display products and conserve energy in
architectural products. Our products consist of transparent solar-control films
for automotive glass; anti-reflective films for computer screens, including
flat
panel displays, plasma displays, and transparent conductive films for use in
touch screen and liquid crystal displays; energy control films for architectural
glass; and various other coatings.
Principles
of consolidation
The
consolidated financial statements include the accounts of Southwall and its
wholly-owned subsidiaries. All inter-company balances and transactions have
been
eliminated in consolidation.
Foreign
currency translation
The
Company's German subsidiary uses the Euro as its functional currency.
Accordingly, the financial statements of this subsidiary are translated into
U.S. dollars in accordance with Statement of Financial Accounting Standards
("SFAS") No. 52, "Foreign Currency Translation." Assets and liabilities are
translated at exchange rates in effect at the balance sheet date and revenue
and
expense accounts at average exchange rates during the quarter. Exchange gains
or
losses from the translation of assets and liabilities of $1,826 in 2005 are
included in the cumulative translation adjustment component of accumulated
other
comprehensive income (loss). Gains and losses arising for transactions
denominated in currencies other than the functional currency were $320, $457,
and $37 in 2005, 2004, and 2003, respectively, and were included in other
income, net.
Management
estimates
The
preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosures of contingent assets and liabilities at the date
of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those estimates.
Cash
and cash equivalents
The
Company considers all highly liquid instruments with an original maturity of
three months or less from the date of purchase to be cash
equivalents.
Restricted
cash
Restricted
cash consists of the unapplied portion of grants received from the Saxony
government to co-finance the costs of the construction of the Company's Dresden
facility. In the event the Company fails to meet certain conditions related
to
the grants, the Saxony government has the right to reclaim the total grants.
(See Note 6).
Revenue
recognition
We
recognize revenue when persuasive evidence of an arrangement exists, delivery
has occurred or services have been provided, the sale price is fixed or
determinable, and collectibility is reasonably assured. Accordingly, we
generally recognize revenue from product sales when the terms of sale transfer
title and risk of loss, which occurs either upon shipment or upon receipt by
customers. In connection with product sales, we make allowances for estimated
returns and warranties. We adjust these allowances periodically to reflect
our
actual and anticipated experience. If any of these conditions to recognize
revenue is not met, we defer revenue recognition.
The
Company has agreements under which it receives fees for certain licensing rights
to technology and products. The Company does not allocate cost of sales to
license revenues because such costs are insignificant. License revenues
associated with these agreements are recognized ratably over the period of
the
contract when collection of the resulting receivable is probable. License
revenues were $57, $191 and $525 in 2005, 2004 and 2003,
respectively.
Accounts
receivable and allowances for doubtful accounts
Accounts
receivable are recorded at the invoiced amount and are not interest bearing.
We
establish allowances for doubtful accounts for specifically identified, as
well
as anticipated, doubtful accounts based on credit profiles of our customers,
current economic trends, contractual terms and conditions and historical
payment. As of December 31, 2005 and 2004, our balance sheets included
allowances for doubtful accounts of $208 and $292, respectively.
Accrual
for sales returns and warranties
We
establish allowances for sales returns for specifically identified product
quality claims as well as estimated potential future claims based on our sales
returns and warranty experience. We offer a ten-year, five-year and less than
a
year quality claim periods for our products. As of December 31, 2005 and 2004,
our balance sheets included accrual for sales returns and warranties of $1,556
and $2,701, respectively.
Concentration
of credit risk
Financial
instruments that potentially subject the Company to significant concentrations
of credit risk consist principally of cash and cash equivalents and trade
accounts receivable.
The
Company invests in a variety of financial instruments such as certificates
of
deposits and money market funds. By policy, the Company limits the amount of
credit exposure to any one financial institution or commercial issuer. For
US
funds, we have $5.1 million in excess of $0.1 million of FDIC coverage. We
also
have approximately $1.7 million in foreign banks.
The
Company sells its products throughout the world. The Company performs ongoing
credit evaluations of its customers' financial condition and, generally,
requires no collateral from its customers. The Company maintains an allowance
for doubtful accounts based upon anticipated collectibility of all accounts
receivable.
Our
ten
largest customers accounted for approximately 81%, 79% and 84% of our net sales
in, 2005, 2004 and 2003, respectively. During 2005, Mitsui Chemicals, Saint
Gobain Sekurit, V-Kool and Pilkington PLC accounted for 22.7%, 19.8%, 19.5%
and
7.1%, respectively, of our net revenues. During 2004, Mitsui Chemicals, Saint
Gobain Sekurit, V-Kool and Pilkington PLC accounted for 28.4%, 17.8%, 11.4%
and
10.9%, respectively, of our net revenues. During 2003, Mitsui Chemicals, Saint
Gobain Sekurit, Pilkington PLC and V-Kool accounted for 21.4%, 17.2%, 13.7%
and
10.0%, respectively, of our net revenues.
The
Company expects to continue to derive a significant portion of its net product
revenues from a relatively small number of customers. Accordingly, the loss
of a
large customer could materially hurt the Company's business, and the deferral
or
loss of anticipated orders from a small number of customers could materially
reduce its revenue, operating results and cash flows in any period.
At
December 31, 2005, receivables from three customers represented 24%, 20% and
13%
of the Company's total accounts receivable. At December 31, 2004, receivables
from three customers represented 27%, 25% and 12% of the Company's total
accounts receivable.
Inventories
Inventories
are stated at the lower of standard cost (determined on a first-in, first-out
basis) or market (net realizable value). Standard costs,
which
approximate actual, includes materials, labor and manufacturing overhead.
The Company establishes provisions for excess and obsolete inventories to reduce
such inventories to their estimated net realizable value. Such provisions are
charged to cost of sales.
Property,
plant and equipment
Property
and equipment are stated at cost. The Company uses the units-of-production
method for calculating depreciation on certain of its production machines and
the straight-line method for all other property and equipment. Estimated useful
lives of the assets range from five to ten years. On its large-scale production
machines for which the units-of- production depreciation method is used, the
Company records minimum annual depreciation of at least one-half of the
depreciation that would have been recorded utilizing the straight-line
depreciation method over a ten-year life. Leasehold improvements are amortized
using the term of the related lease or the economic life of the improvements,
if
shorter.
Additions,
major improvements and enhancements are included in the asset accounts at cost.
Ordinary maintenance and repairs are charged to expense as incurred. Gains
or
losses from disposal are included in earnings.
Depreciation
and amortization expense related to property and equipment for 2005, 2004 and
2003 was $2,195, $2,503 and $6,071, respectively.
Impairment
of long-lived assets
Long-lived
assets held and used by the Company are reviewed for impairment whenever events
or circumstances indicate that the carrying amount of an asset may not be
recoverable. Factors that could trigger an impairment review include the
following: (i) significant negative industry or economic trends; (ii) exiting
an
activity in conjunction with a restructuring of operations; (iii) current,
historical or projected losses that demonstrate continuing losses associated
with an asset; or (iv) a significant decline in our market capitalization,
for
an extended period of time, relative to net book value. When we determine that
there is an indicator that the carrying value of long-lived assets may not
be
recoverable, we measure impairment based on estimates of future cash flows.
These estimates include assumptions about future conditions such as future
revenues, gross margins, operating expenses within our company, the fair values
of certain assets based on appraisals, and industry trends. All long-lived
assets to be disposed of are reported at the lower of carrying amount or fair
market value, less expected selling costs.
Fair
value disclosures of financial instruments
The
Company has estimated the fair value amounts of its financial instruments,
including cash and cash equivalents, accounts receivable, accounts payable
and
accrued liabilities using available market information and valuation
methodologies considered to be appropriate and have determined that the book
value of those instruments at December 31, 2005 and 2004 approximates fair
value. Based on borrowing rates currently available to the Company for debt
and
capital leases with similar terms, the carrying value of its term debt and
capital leases approximate fair value.
Derivative
financial instruments
The
Company accounts for derivative financial instruments under SFAS No. 133,
Accounting for Derivative Instruments and Hedging Activities. SFAS No. 133
establishes methods of accounting for derivative financial instruments and
hedging activities related to those instruments as well as other hedging
activities. As of December 31, 2005, we did not have any derivative financial
instruments or hedging activities.
Stock-based
compensation expense
SFAS
No.
148, "Accounting for Stock-Based Compensation - Transition and Disclosure,
an
Amendment of FASB Statement No. 123" amends the disclosure requirements of
SFAS
No. 123, "Accounting for Stock-Based Compensation," to require more prominent
disclosures in both annual and interim financial statements regarding the method
of accounting for stock-based employee compensation and the effect of the method
used on reported results.
The
Company accounts for stock-based employee compensation arrangements in
accordance with provisions of Accounting Principles Board ("APB") Opinion No.
25, "Accounting for Stock Issued to Employees" and related interpretations.
Under APB 25, compensation expense is based on the difference, if any, on the
date of the grant, between the quoted market price of the Company's stock and
the exercise price.
The
following table illustrates the effect on net loss and net loss per share if
the
Company had applied the fair value recognition provisions of SFAS 123 and SFAS
148 to stock-based employee compensation:
|
Years
Ended December 31,
|
||||||||||
|
2005
|
2004
|
2003
|
||||||||
|
Net
income (loss) attributable to common stockholders
|
||||||||||
|
As
reported
|
$
|
2,830
|
$
|
(185
|
)
|
$
|
(42,292
|
)
|
||
|
Add:
Stock-based employee compensation expense included in reported net
income
(loss), net of related tax effects
|
45
|
--
|
34
|
|||||||
|
Deduct:
Total stock-based employee compensation determined under fair value
based
method for all awards, net of related tax effects
|
(686
|
)
|
(693
|
)
|
(695
|
)
|
||||
|
Pro
forma net income (loss)
|
$
|
2,189
|
$
|
(878
|
)
|
$
|
(42,258
|
)
|
||
|
Net
income (loss) per share:
|
||||||||||
|
As
reported - basic
|
$
|
0.11
|
$
|
(0.01
|
)
|
$
|
(3.37
|
)
|
||
|
As
reported - diluted
|
$
|
0.10
|
$
|
(0.01
|
)
|
$
|
(3.37
|
)
|
||
|
Pro
forma - basic
|
$
|
0.08
|
$
|
(0.06
|
)
|
$
|
(3.37
|
)
|
||
|
Pro
forma - diluted
|
$
|
0.08
|
$
|
(0.06
|
)
|
$
|
(3.37
|
)
|
||
For
the
stock option plans, the fair value of each option grant is estimated on the
date
of grant using the Black-Scholes option pricing model, for the multiple option
approach, with the following weighted average assumptions used for grants in
2005, 2004, and 2003, respectively: expected volatility of 117%, 116 % and
99%;
risk-free interest rate of 4.2%, 2.9% and 2.3%; and expected lives from vesting
date of 2.17, 1.70 and 2.77 years. Southwall has not paid dividends and
assumed no dividend yield. The weighted-average fair value of stock options
granted in 2005, 2004 and 2003 was $0.46, $0.54 and $1.00 per share,
respectively.
For
the
employee stock purchase plan, the fair value of each purchase right is estimated
at the beginning of the offering period using the Black-Scholes option pricing
model with the following weighted-average assumptions used in 2005, 2004, and
2003 respectively: expected volatility of 116%, 116% and 99%; risk-free interest
rate of 3.9%, 3.6% and 2.7%; and expected lives of 0.5 years in each year.
The Company has not paid dividends and assumed no dividend yield. The
weighted-average fair value of those purchase rights granted in 2005, 2004,
and
2003 was $0.61, $0.23 and $0.56 per right, respectively.
Research
and development expense
Research
and development costs are expensed as incurred. Costs included in research
and
development expense are salaries, building costs, utilities, administrative
expenses and allocation costs.
Comprehensive
income (loss)
The
Company has adopted the provisions of SFAS No. 130 "Reporting Comprehensive
Income". SFAS 130 establishes standards for reporting and display in the
financial statements of total net income and the components of all other
non-owner changes in equity, referred to as comprehensive income (loss).
Accordingly, the Company has reported the translation gain (loss) from the
consolidation of its foreign subsidiary in comprehensive income
(loss).
Restructuring
costs
For
restructuring activities initiated prior to December 31, 2002, Southwall
recorded restructuring costs when the Company committed to a plan to exit
certain facilities, and significant changes to the exit plan were not likely
to
occur. For restructuring activities initiated after December 31, 2002, the
Company records restructuring reserves when management has approved a plan
to
restructure operations and a liability has been incurred in accordance with
SFAS
No. 146, "Accounting for Costs Associated with Exit or Disposal
Activities".
Income
taxes
The
Company accounts for deferred income taxes under the liability approach whereby
the expected future tax consequences of temporary differences between the book
and tax basis of assets and liabilities are recognized as deferred tax assets
and liabilities. A valuation allowance is established for any deferred tax
assets for which realization is uncertain.
Net
income (loss) per share
Basic
net
income (loss) per share is computed by dividing net income (loss) attributable
to common stockholders (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 common shares potentially outstanding during
the period, including stock options, warrants to purchase common stock and
convertible preferred stock. Preferred stock dividends are added back to net
income attributable to common stockholders since they would not have been
accrued if the preferred stock had been converted to common stock at the
beginning of the period.
The
Company excludes options from the computation of diluted weighted average shares
outstanding if the exercise price of the options is greater than the average
market price of the shares because the inclusion of these options would be
anti-dilutive to earnings per share. Accordingly, at December 31, 2005,
stock options to purchase 2,284 shares at a weighted average price of $2.83
per
share were excluded from the computation of diluted weighted average shares
outstanding.
In
net
loss periods, the basic and diluted weighted average shares of common stock
and
common stock equivalents are the same because inclusion of common stock
equivalents would be anti-dilutive. Accordingly, at December 31, 2004 and 2003,
there was no difference between the denominators used for the calculation of
basic and diluted net income (loss) per share. At December 31, 2004 and 2003,
there were 4,039 and 2,087 anti-dilutive options, respectively, excluded from
the net loss per share calculation.
Tables
summarizing net income (loss) attributable to common stockholders, for diluted
net income (loss) per share, and shares outstanding are shown below (in
thousands):
|
Years
Ended December 31,
|
||||||||||
|
2005
|
2004
|
2003
|
||||||||
|
Net
income (loss) attributable to common stockholders-basic
|
$
|
2,830
|
$
|
(185
|
)
|
$
|
(42,292
|
)
|
||
|
Add:
Deemed dividend on preferred stock
|
490
|
--
|
--
|
|||||||
|
Net
income (loss) attributable to common stockholders-diluted
|
$
|
3,320
|
$
|
(185
|
)
|
$
|
(42,292
|
)
|
||
|
Weighted
average common shares outstanding-basic
|
26,743
|
14,589
|
12,537
|
|||||||
|
Dilutive
effect of warrants
|
356
|
--
|
--
|
|||||||
|
Dilutive
effect of performance shares
|
38
|
--
|
--
|
|||||||
|
Dilutive
effect of Series A preferred shares
|
4,893
|
--
|
--
|
|||||||
|
Dilutive
effect of stock options
|
865
|
--
|
--
|
|||||||
|
Weighted
average common shares outstanding - diluted
|
32,895
|
14,589
|
12,537
|
|||||||
Reclassifications
Certain
reclassifications have been made to the prior years’ amounts to conform to the
current year’s presentation. These reclassifications did not change previously
reported net loss, total assets, or cash flows.
Recently
issued accounting pronouncements
In
November 2004, the Financial Accounting Statement Board issued SFAS No. 151,
“Inventory Costs - An Amendment of ARB No. 43, Chapter 4 (“SFAS 151”). SFAS 151
amends the guidance in ARB No. 43, Chapter 4, “Inventory Pricing,” to clarify
the accounting for abnormal amounts of idle facility expense, freight, handling
costs, and wasted material (spoilage). Among other provisions, the new rule
requires that items such as idle facility expense, excessive spoilage, double
freight and re-handling costs must be recognized as current-period charges
regardless of whether they meet the criterion of “so abnormal” as stated in ARB
No. 43. Additionally, SFAS 151 requires that the allocation of fixed production
overheads to the costs of conversion be based on the normal capacity of the
production facilities. SFAS 151 is effective for fiscal years beginning after
June 15, 2005 and is required to be adopted by us in the first quarter of 2006,
beginning on January 1, 2006. We are currently evaluating the effect that the
adoption of SFAS 151 will have on our consolidated results of operations and
financial condition but do not expect SFAS 151 to have a material
impact.
In
December 2004, the FASB issued SFAS No. 123 (revised 2004), “Share-Based
Payment” (“SFAS 123R”), which replaces SFAS No. 123, “Accounting for Stock-Based
Compensation,” (“SFAS 123”), and supercedes APB Opinion No. 25, “Accounting for
Stock Issued to Employees.” SFAS 123R requires all share-based payments to
employees, including grants of employee stock options, to be recognized in
the
financial statements based on their fair values beginning with the first fiscal
year after June 15, 2005, with early adoption encouraged. The pro forma
disclosures previously permitted under SFAS 123 no longer will be an alternative
to financial statement recognition. We are required to adopt SFAS 123R beginning
January 1, 2006. The Company will apply the Black-Scholes valuation model in
determining the fair value of share-based payments to employees, which will
then
be amortized on a straight-line basis over the requisite service period. The
Company will apply the modified prospective method, which requires that
compensation expense be recorded for all unvested stock options and restricted
stock upon adoption of SFAS 123R.
In
March
2005, the SEC issued Staff Accounting Bulletin No. 107 (“SAB 107”) regarding the
SEC’s interpretation of SFAS 123R and the valuation of share-based payments for
public companies. The Company is evaluating the requirements of SFAS 123R and
SAB 107 and expects that the adoption of SFAS 123R on January 1, 2006 will
have
a material impact on the Company’s consolidated results of operations and
earnings per share beginning in the first quarter of 2006.
In
December 2004, the FASB issued SFAS No. 153, “Exchanges of Non-monetary Assets -
An Amendment of APB Opinion No. 29, Accounting for Non-monetary Transactions”
(“SFAS 153”). SFAS 153 eliminates the exception from fair value measurement for
non-monetary exchanges of similar productive assets in paragraph 21(b) of APB
Opinion No. 29, “Accounting for Non-monetary Transactions,” and replaces it with
the exception for exchanges that do not have commercial substance. SFAS 153
specifies that a non-monetary exchange has commercial substance if the future
cash flows of the entity are expected to change significantly as a result of
the
exchange. SFAS 153 is effective for the fiscal periods beginning after June
15,
2005 and is required to be adopted by us beginning on January 1, 2006. We are
currently evaluating the effect that the adoption of SFAS 153 will have on
our
consolidated results of operations and financial condition but do not expect
it
to have a material impact.
In
March
2005, the FASB issued FASB Interpretations No. 47, “Accounting for Conditional
Asset Retirement Obligations, an interpretation of FASB Statement No. 143.” This
interpretation clarifies that the term conditional asset retirement obligation
to perform an asset retirement activity in which the timing and (or) method
of
settlement are conditional on a future event that may or may not be within
the
control of the entity. FIN 47 is effective no later than the end of fiscal
years
ending after December 15, 2005; retrospective application for interim financial
information is permitted but not required. The Company is evaluating the effect
that the adoption of FIN 47 will have on its consolidated result of operations
and financial condition and has determined that it cannot ascertain the fair
value of any potential obligation because the settlement date and method of
settlement for our obligation have not been specified.
In
May
2005, the FASB issued SFAS No. 154, “Accounting and Error Correction” (“SFAS
154”), which replaces APB Opinion No. 20, “Accounting Changes” and SFAS No 3,
“Reporting Changes in Interim Financial Statements - An Amendment of APB Opinion
No. 28.” SFAS 154 provides guidance on the accounting and reporting of
accounting changes and error corrections. It establishes retrospective
application, or the latest practicable date, as the required method for
reporting a change in accounting principle and the reporting of a correction
of
an error. SFAS 154 is effective for accounting changes and corrections of errors
made in fiscal years beginning after December 15, 2005 and is required to be
adopted by the Company in the first quarter of fiscal 2006. The Company is
currently evaluating the effect that adoption of SFAS 154 will have on its
consolidated results of operations and financial condition but does not expect
it to have a material impact.
In
February 2006, FASB issued SFAS No. 155, “Accounting for Certain Hybrid
Financial Instruments”—an amendment of FASB Statements No. 133 and 140 (“SFAS
155”). SFAS 155 permits fair value measurement for any hybrid financial
instrument that contains an embedded derivative, clarifies which interest-only
strips and principal-only strips are not subject to the requirement of Statement
133, establishes a requirement to evaluate interests in securitized financial
assets, clarifies the concentrations of credit risk, and eliminates the
prohibition on a qualifying special-purpose entity from holding a derivative
financial instrument. SFAS 155 improves financial reporting by eliminating
the
exemption from applying Statement 133 to interest in securitized financial
assets and allowing to elect fair value measurement at acquisition, at issuance,
or when a previously recognized financial instrument is subject to a
measurement. SFAS 155 is effective for all financial instruments acquired or
issued in fiscal years beginning after September 15, 2006. The implementation
of
SFAS 155 is not expected to have a material impact on the Company’s consolidated
results of operations, financial position or cash flows.
NOTE
2 - BALANCE SHEET DETAIL
|
December
31,
|
|||||||
|
2005
|
2004
|
||||||
|
Inventories,
net:
|
|||||||
|
Raw
materials
|
$
|
3,482
|
$
|
4,945
|
|||
|
Work-in-process
|
1,409
|
2,059
|
|||||
|
Finished
goods
|
988
|
1,351
|
|||||
|
$
|
5,879
|
$
|
8,355
|
||||
|
December
31,
|
|||||||
|
2005
|
2004
|
||||||
|
Property,
plant and equipment, net:
|
|||||||
|
Land,
buildings and leasehold improvements
|
$
|
7,296
|
$
|
8,363
|
|||
|
Machinery
and equipment
|
28,592
|
32,242
|
|||||
|
Furniture
and fixtures
|
946
|
1,737
|
|||||
|
36,834
|
42,343
|
||||||
|
Less
- accumulated depreciation and amortization
|
(19,977
|
)
|
(21,233
|
)
|
|||
|
Total
property, plant and equipment, net
|
$
|
16,857
|
$
|
21,110
|
|||
Restructuring
costs.
In
December 2002, we implemented a reduction in force at our Palo Alto
location and elected to vacate certain buildings in Palo Alto. As a result
of these actions, we incurred a restructuring charge of $2,624 in 2002 relating
to employee severance packages and the remaining rents due on excess facilities
in Palo Alto that we no longer occupy. In 2003, we recorded a credit to
operating expenses of $65 as a result of modifications to the severance packages
of certain employees.
The
following tables set forth the beginning and ending liability balances relating
to the above described restructuring activity as well as activity during 2005,
2004 and 2003 (in thousands):
|
Workforce
Reduction
|
Excess
Facilities
|
Total
|
||||||||
|
Balance
at January 1, 2003
|
$
|
125
|
$
|
2,281
|
$
|
2,406
|
||||
|
Provisions
|
143
|
--
|
143
|
|||||||
|
Adjustment
to reserve
|
(65
|
)
|
--
|
(65
|
)
|
|||||
|
Cash
payments
|
(203
|
)
|
(712
|
)
|
(915
|
)
|
||||
|
Balance
at December 31, 2003
|
$
|
--
|
$
|
1,569
|
$
|
1,569
|
||||
|
Provisions
|
--
|
--
|
--
|
|||||||
|
Adjustment
to reserve
|
--
|
(926
|
)
|
(926
|
)
|
|||||
|
Cash
payments
|
--
|
(369
|
)
|
(369
|
)
|
|||||
|
Balance
at December 31, 2004
|
$
|
--
|
$
|
274
|
$
|
274
|
||||
|
Provisions
|
--
|
--
|
--
|
|||||||
|
Adjustment
to reserve
|
--
|
--
|
--
|
|||||||
|
Cash
payments
|
--
|
(75
|
)
|
(75
|
)
|
|||||
|
Balance
at December 31, 2005
|
$
|
--
|
$
|
199
|
$
|
199
|
||||
At
December 31, 2005, $106 was included in other accrued liabilities, and $93
was
included in other long-term liabilities on the consolidated balance sheet.
Guarantees.
The
Company establishes a reserve for sales returns and warranties for specifically
identified, as well as, anticipated sales return and warranty claims based
on
experience. As of December 31, 2004 our reserve for sales returns and
warranties was as follows:
|
Balance
at December 31, 2003
|
Provision
|
Utilized
|
Balance
at December 31, 2004
|
||||||||||
|
Accrued
sales returns and warranties
|
$
|
1,851
|
$
|
2,359
|
$
|
(1,509
|
)
|
$
|
2,701
|
||||
As
of
December 31, 2005, our reserve for sales returns and warranties was as
follows:
|
Balance
at December 31, 2004
|
Provision
|
Utilized
|
Balance
at December 31, 2005
|
||||||||||
|
Accrued
sales returns and warranties
|
$
|
2,701
|
$
|
720
|
$
|
(1,865
|
)
|
$
|
1,556
|
||||
These
amounts are included in other accrued liabilities in the Company’s consolidated
balance sheets.
Indemnification
obligations.
The
Company's By-Laws require it to indemnify its officers and directors, as well
as
those who act as directors and officers of other entities, against expenses,
judgments, fines, settlements and other amounts actually and reasonably incurred
in connection with any proceedings arising out of their services to the Company.
The indemnification obligations are more fully described in the Company’s
By-Laws. The Company purchases insurance to cover claims made against its
directors and officers. Since a maximum obligation is not explicitly stated
in
the Company's By-Laws and will depend on the facts and circumstances that arise
out of any future claims, the overall maximum amount of the obligations cannot
be reasonably estimated. Historically, the Company has not made payments related
to these indemnifications and the estimated fair value of these indemnifications
is not considered to be material.
As
is
customary in the Company's industry and as provided for in local law in the
U.S.
and other jurisdictions, many of the Company's standard contracts provide
remedies to customers and other third parties with whom the Company enters
into
contracts, such as defense, settlement, or payment of judgment for intellectual
property claims related to the use of its products. From time to time, the
Company indemnifies customers, as well as suppliers, contractors, lessors,
lessees, and others with whom it enters into contracts, against combinations
of
loss, expense, or liability arising from various triggering events related
to
the sale and the use of the Company's products and services, the use of their
goods and services, the use of facilities and state of Company-owned facilities,
and other matters covered by such contracts, usually up to a specified maximum
amount. In addition, from time to time, the Company sometimes also provides
protection to these parties against claims related to undiscovered liabilities,
additional product liability, or environmental obligations. To date, claims
made
under such indemnifications have been insignificant and the estimated fair
value
of these indemnifications is not considered to be material.
NOTE
3 - FINANCING AGREEMENTS
On
December 18, 2003, the Company entered into definitive investment agreements
for
a new bank loan guarantee and equity-financing package of up to $7.5 million
with Needham,
affiliates of the Investors and PBF. The agreements enabled the Company to
receive up to $3,000 in new borrowings under its line of credit facility with
PBF, supported by guarantees provided by Needham, in two separate allotments
of
$2,250 and $750; and to receive $4,500 from the issuance of equity in two
separate tranches of $1,500 and $3,000. The new borrowings and the purchase
of
each equity tranche were subject to certain conditions, including, among other
things, the receipt of concessions by the Company from creditors and landlords,
the completion of certain restructuring actions and the achievement of cash
flow
break-even at quarterly revenue levels below those of third quarter
2003.
Needham
provided the $2,250 and $750 guarantees on December 18, 2003 and January 15,
2004, respectively. In exchange for the guarantees the Company issued two
allotments of warrants, both for 941 shares of common stock, on the date of
the
guarantees (See Note 9 - Warrants).
On
February 20, 2004, the parties amended and restated the investment agreement
to
provide that the Company would issue and sell to the Investors an aggregate
of
$4,500 of convertible notes in one tranche instead of Series A convertible
preferred shares in two separate tranches. The convertible notes were
convertible into Series A convertible preferred stock, which is convertible
into
common stock. In connection with the convertible notes, the Company issued
warrants for 1,694 shares of common stock.
On
November 4, 2004, Needham and its Affiliates received a total of 9,155 shares
of
the Company’s common stock upon exercise of the warrants. In exercising the
warrants, the Needham entities elected to use a “cashless exercise option” in
which 99 of the shares underlying the warrants were surrendered in lieu of
paying the exercise price in cash. The warrants were originally exercisable
for
9,254 shares of the Company’s common stock at an exercise price was $0.01 per
share of common stock. The value of the 99 shares of common stock surrendered
was based upon the average trading price on November 3, 2004 of the Company’s
common stock on the Over-the-Counter Bulletin Board Market.
On
November 24, 2004, Dolphin exercised warrants to purchase a total of 4,627
shares of the Company’s common stock. The exercise price was $0.01 per share of
common stock. Dolphin paid $46 in cash as the exercise price.
On
December 31, 2004, Needham and its Affiliates and Dolphin elected to convert
all
outstanding principal of, and accrued but unpaid interest on, their secured
convertible promissory notes of the Company into shares of the Company’s Series
A 10% Cumulative Preferred Stock. The Convertible Notes by their terms were
convertible at the option of the holders into Series A Stock at a rate of one
share for each $1.00 of principal or interest converted. The aggregate principal
amount of the Convertible Notes converted by the Note Holders was $4,500 and
interest accrued thereon as of the time of conversion was $392. The aggregate
number of shares of Series A Stock issued as a result of the conversion was
4,893. In particular, Needham and its Affiliates received 3,262 shares; and,
Dolphin received 1,631 shares.
The
Series A Shares have a stated value of $1.00 per share and are entitled to
cumulative dividends of 10% per year, payable at the discretion of the Company’s
board of directors. Each share of Series A Stock is convertible at any time
at
the option of the holder into a number of shares of common stock equal to the
sum of its stated value plus any accumulated but unpaid dividends, divided
by
the conversion price of the Series A Shares. The conversion price of the Series
A Shares is $1.00 per share and is subject to the adjustment in the event of
any
stock dividend, stock split, reverse stock split or combination affecting such
shares. The Series A Shares also have anti-dilution protection that adjusts
the
conversion price downwards using a weighted-average calculation in the event
Southwall issues certain additional securities at a price per share less than
the closing price per share of the common stock. Each share of Series A Stock
is
convertible into one share of common stock (such conversion rate is subject
to
adjustment upon certain events).
So
long
as any Series A Shares are outstanding, unless all accrued dividends have been
paid, the Company is generally prohibited from taking certain actions. Except
for certain matters with respect to which the approval of the holders of a
majority of the Series A Shares voting separately as a class is required, the
holders of the Series A Stock have no voting rights. Upon a liquidation or
dissolution of the Company (and for these purposes a sale of all or
substantially all of the Company’s assets or the acquisition of the Company by
another entity are considered liquidation events), the holders of the Series
A
Stock are entitled to be paid a liquidation preference equal to $1.00 per share
plus accumulated but unpaid dividends, out of assets legally available for
distribution to stockholders. As of December 31, 2005, $490 has been accrued
in
dividends and is included in other accrued liabilities in the accompanying
balance sheet.
Material
Terms of the Series A Shares
Our
Series A shares have the following terms:
|
•
|
Dividends.
Each of the Series A shares have a stated value of $1.00 and are
entitled
to a cumulative dividend of 10% per year, payable at the discretion
of the
Board of Directors. Dividends on the Series A shares accrue daily
commencing on the date of issuance and are deemed to accrue whether
or not
earned or declared and whether or not there are profits, surplus
or other
funds legally available for the payment of dividends. Accumulated
dividends, when and if declared by the Board, will be paid in cash.
|
|
•
|
Restrictions.
So
long as any Series A shares are outstanding, unless all accrued dividends
on all Series A shares have been paid, we are prohibited from taking
certain actions, including redeeming or purchasing shares of our
common
stock and paying dividends on our common
stock.
|
|
•
|
General
Voting Rights. Except
under certain circumstances or as otherwise provided by law, the
holders
of Series A shares have no voting rights. The approval of the holders
of a
majority of the Series A shares voting separately as a class will
be
required to effect certain corporate
actions.
|
|
•
|
Liquidation
Preference. Upon
a liquidation or dissolution of Southwall, the holders of Series
A shares
are entitled to be paid a liquidation preference out of assets legally
available for distribution to our stockholders before any payment
may be
made to the holders of common stock. The liquidation preference is
equal
to the stated value of the Series A shares, which is $1.00 per share,
plus
any accumulated but unpaid dividends. Mergers, the sale of all or
substantially all of our assets, or the acquisition of Southwall
by
another entity and certain other similar transactions may be deemed
to be
liquidation events for these
purposes.
|
|
•
|
Conversion.
Each of the Series A shares is convertible into common stock at any
time
at the option of the holder. Each of the Series A shares is convertible
into a number of shares of common stock equal to the sum of its stated
value plus any accumulated but unpaid dividends, divided by the conversion
price of the Series A shares. The conversion price of the Series
A shares
is $1.00 per share and is subject to adjustment in the event of any
stock
dividend, stock split, reverse stock split or combination affecting
such
shares. The Series A shares also have anti-dilution protection that
adjusts the conversion price downwards using a weighted-average
calculation in the event we issue certain additional securities at
a price
per share less than the closing price per share of our common stock
on any
stock exchange on which our common stock is listed. Each Series A
share is
initially convertible into one share of common stock. If the closing
price
of our common stock on any stock exchange on which our common stock
is
listed is $4.00 or more per share (subject to appropriate adjustment
if a
stock split, reverse split or similar transaction is affected) for
30
consecutive days, all outstanding Series A shares shall automatically
be
converted.
|
|
•
|
Redemption.
The
Series A shares are not redeemable.
|
NOTE
4 - LINE OF CREDIT
On
April
28, 2005, we entered into a credit agreement (the “Credit Agreement”) with Wells
Fargo HSBC Trade Bank, N.A. (the “Bank”). The Credit Agreement provides for two
facilities. All amounts borrowed under both facilities under the Credit
Agreement must be repaid on or before May 31, 2006.
The
first
facility is a revolving line of credit under which we may from time to time
borrow up to $3 million, subject to satisfaction of certain conditions. Amounts
borrowed under the first facility bear interest at the prime rate minus 1.75%
per annum or LIBOR plus 1% per annum, at our option. We borrowed approximately
$3.0 million from this facility on April 28, 2005, which amount remained
outstanding as of December 31, 2005.
The
second facility is a formula line under which we may, from time to time, borrow
up to $3 million, subject to certain conditions, with advances of up to 80%
of
eligible accounts receivable. Amounts borrowed under the second facility bear
interest at the prime rate minus 0.25% per annum. We may borrow under the second
facility only if we meet certain financial covenants. As of December 31, 2005,
we met these financial covenants. There was no amount outstanding under the
second facility at December 31, 2005.
All
borrowings under both facilities are collateralized by our inventory,
receivables, raw material, and work in progress. In addition, the first facility
under the Credit Agreement is collateralized by a letter of credit posted by
Needham & Company, one of our stockholders.
The
terms
of the Credit Agreement, among other things, limit our ability to (i) incur,
assume or guarantee additional indebtedness in excess of $13.5 million (other
than pursuant to the Credit Agreement), (ii) pay dividends or repurchase stock
(except up to $0.6 million per year of dividends on preferred stock), (iii)
incur liens upon the collateral pledged to the bank, (iv) make any loans or
advances to, or investments in, any person or entity outside the ordinary course
of business, (v) merge, consolidate, sell or otherwise dispose of substantially
all or a substantial or material portion of our assets, (vi) enter into
transactions with affiliates, and (vii) make acquisitions other than up to
an
aggregate amount of $3 million and (viii) to make capital expenditures in any
fiscal year in excess of $1.5 million.
The
Credit Agreement provides for events of default, which include, among others,
(a) nonpayment of amounts when due (with no grace periods), (b) the breach
of
our representations or covenants or other agreements in the Credit Agreement
or
related documents, (c) payment defaults or accelerations of our other
indebtedness, (d) a failure to pay certain judgments, (e) the occurrence of
any
event or condition that the Bank believes impairs or is substantially likely
to
impair the prospects of payment or performance by us, and (f) certain events
of
bankruptcy, insolvency or reorganization. Generally, if an event of default
occurs, the Bank may declare all outstanding indebtedness under the Credit
Agreement to be due and payable.
The
foregoing description does not purport to be a complete statement of the
parties' rights and obligations under the Credit Agreement and the transactions
contemplated thereby or a complete explanation of the material terms
thereof.
NOTE
5 - TERM DEBT
The
Company's term debt consisted of the following:
|
Balance
at December 31,
|
Due
in
|
|||||||||
|
Description
|
Rate
|
2005
|
2006
|
|||||||
|
Term
debt:
|
||||||||||
|
German
bank loan dated May 12, 1999
|
6.13
|
%(1)
|
$
|
1,609
|
$
|
402
|
||||
|
German
bank loan dated May 28, 1999
|
7.10
|
%(2)
|
2,949
|
--
|
||||||
|
German
bank loan dated May 28, 1999
|
3.75
|
%
|
337
|
337
|
||||||
|
German
bank loan dated May 28, 2000
|
7.15
|
%(3)
|
1,321
|
278
|
||||||
|
German
bank loan dated August 14, 1999 (due June 30, 2009)
|
5.75
|
%
|
1,991
|
--
|
||||||
|
Settlement
agreement dated February 20, 2004
|
|
(4)
|
1,900
|
300
|
||||||
|
Total
term debt
|
|
10,107
|
$ |
1,317
|
||||||
|
Less
current portion
|
1,317
|
|||||||||
|
Term
debt, non-current
|
$
|
8,790
|
||||||||
|
(1)
|
Interest
rate was reset to the then prevailing market
rate.
|
|
(2)
|
Interest
rate will be reset to the then prevailing market rate in
2009.
|
|
(3)
|
Interest
rate will be reset to the then prevailing market rate in
2006.
|
|
(4)
|
Interest
rate was 4% for 2005, and will increase by one percentage point per
year
until 2010.
|
Settlement
agreement
During
1999, Southwall entered into a master equipment sale-leaseback agreement with
a
leasing company, Matrix Funding Corporation ("lessor"). The Company was in
dispute with the lessor over the interpretation of certain terms of the lease
agreement and withheld lease payments due from March 2001 until February
2004. The lessor notified the Company that it considered the Company to be
in
default and in January 2002 drew down on a letter of credit in the amount
of $0.5 million that collateralized the Company's obligations. In May 2002,
a suit was filed against the Company by an agent of the successor to the lease
demanding payment of unpaid lease payments and alleged residual values. (See
Note 11- Commitments and Contingencies.) In February 2004, the Company entered
into a settlement agreement with the agents pursuant to which the Company agreed
to pay an aggregate of $2.0 million bearing interest at a stepped rate. The
settlement required the Company to make an interest payment in 2004, and
beginning in 2005, to make quarterly principal payments of between $75,000
and
125,000, plus interest payments until 2010. At December 31, 2005, the carrying
value of the liability was $4,254 ($1,900 of principal, plus $2,354 of accrued
interest). The agreement included a confession of judgment, whereby the Company
acknowledges that it would owe damages of $5,900 in the event of payment
defaults under the settlement agreement.
The
Company performed an assessment under SFAS 15 and EITF 02-04 to assess whether
this debt restructuring constituted a troubled debt restructuring. The
Company concluded that the debt restructuring was in fact a troubled debt
restructuring as the Company was in financial difficulty and the lessors had
granted a concession to the Company, under the definitions of such conditions
as
set forth in EITF 02-04. The reduction in the amount of the debt indicated
that
a concession had been granted. SFAS 15 requires an assessment of the total
future cash payments specified by the new terms of the debt, including
principal, interest and contingent payments. If the payments are less than
the
carrying amount of the payable, the Company should reduce the carrying amount
to
an amount equal to the total future cash payments specified by the new terms
and
should recognize a gain on restructuring of payables equal to the amount of
the
reduction. In its assessment, management factored in the $5,900 confession
of
judgment as a contingent payment, thereby eliminating any potential gain on
restructuring. The carrying value of the debt remains on the consolidated
balance sheet and the liability will be reduced as payments are made, with
a
potential gain to be recorded at the date of the final payment and the expiry
of
the confession of judgment. Based on a SFAS 5 determination, when the Company
considers default probable, the liability would be increased to the $5,900
confession of judgment value. The excess of the carrying value over the $2,000
was recorded in other long-term liabilities on the balance sheet. The remaining
balance at December 31, 2005 is $1,900.
Loans
from German Banks
On
May 12, 1999, the Company entered into a loan agreement with a German bank
that provides for borrowings up to 3,100 Euros ($3,900). Under the terms of
this
agreement, the funds were used solely for the purpose of capital investment
by
Southwall's German subsidiary. The term of the loan is for a period of
10 years and the principal is repayable in Euros after the end of one year
in 36 quarterly payments. The loan bears interest at 6.125% per annum until
December 31, 2005, after which it will be revised to the prevailing rate. Of
the
borrowings outstanding of $1,609 under this bank loan at December 31, 2005,
$1,207 was classified as non-current in the accompanying consolidated balance
sheet.
On
May 28, 1999, the Company entered into a general loan agreement with a
German bank. Under the terms of the loan agreement, funds were made available
in
three tranches, and were used solely for the purpose of capital investment
by
the Company's German subsidiary. The agreement contains various covenants with
which the Company was in compliance at December 31, 2005; the Company is
current with respect to all principal and interest payments due under the loan
agreement. Under the first tranche, the Company borrowed 2,500 Euros ($3,200)
for a term of twenty years beginning on May 28, 1999. The principal is
repayable in Euros beginning after ten years in twenty equal, semi-annual
payments. The loan bears fixed interest of 7.1% per annum for the first ten
years, after which time the rate will be adjusted to a current prevailing rate.
Of the borrowings outstanding under this tranche of $2,949 at December 31,
2005, $2,949 was classified as non-current in the accompanying balance sheet.
Under the second tranche, the Company borrowed 1,700 Euros ($2,100) for a term
of seven years beginning May 28, 1999 and the principal is repayable after
one year in twelve equal, semi-annual payments. The loan bears fixed interest
at
3.75% per annum for the period of seven years. At December 31, 2005, the
amount due under this second tranche was $337, and $0 was classified as a
non-current liability. Under the third tranche, the Company borrowed 2,100
Euros
($2,700) for a term of ten years beginning on May 28, 2000, and the principal
is
repayable after one year, in 36 equal quarterly payments. The loan bears fixed
interest of 7.15% per annum for the first five years, after which time the
rate
will be adjusted to a current prevailing market rate. At December 31, 2005,
the amount due was $1,321; of this amount, $1,043 was classified as non-current
in the accompanying balance sheet.
On
August 14, 1999, the Company entered into a loan agreement with a German
bank that provides for borrowings up to 1,700 Euros ($2,300). As required by
this agreement, the funds were used solely for the purpose of capital investment
by the Company's 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 Euros. Fifty percent of the loan proceeds
are restricted in an escrow account for the duration of the loan period and
are
classified as a non-current asset "Restricted cash loans" in the accompanying
balance sheet. The amount due under this bank loan at December 31, 2005 was
$1,991, which was classified as a non-current liability in the accompanying
balance sheet.
The
preceding German bank loans are collateralized by the production equipment,
building and land owned by the Company's German subsidiary. The dollar
equivalent value of the remaining balances for the preceding German bank loans
has been calculated using the Euro exchange rate as of December 31,
2005.
Scheduled
principal payments of term debt for the next five years and thereafter, are
as
follows:
|
Amount
|
||||
|
2006
|
$
|
1,317
|
||
|
2007
|
981
|
|||
|
2008
|
980
|
|||
|
2009
|
3,318
|
|||
|
2010
|
1,004
|
|||
|
Thereafter
|
2,507
|
|||
|
Total
|
$
|
10,107
|
||
The
Company incurred total interest on indebtedness of $1,156, $2,300, and $1,600
in
2005, 2004 and 2003, respectively.
NOTE
6 - GOVERNMENT GRANTS AND INVESTMENT ALLOWANCES
The
Company has an agreement to receive cash grant awards (the "Grant"), which
was
approved by the Saxony government in May 1999. As of December 31,
2005, the Company had received approximately 5,000 Euros ($5,000 at historical
rate) under this Grant since 1999 and accounted for the Grant by applying
the proceeds received to reduce the cost of fixed assets of the Dresden
manufacturing facility. Additionally, as of December 31, 2005, the Company
had a balance remaining from the government grants received in May 1999 of
335 Euros ($396), which has been recorded as an advance and held as restricted
cash until the Company receives approval from the Saxony government to apply
the
funds to reduce its capital expenditures.
Giving
effect to an amendment of the terms of the Grant in 2002, the Grant is subject
to the following requirements:
|
(a)
|
The
grant was earmarked to co-finance the costs of the construction of
a
facility to manufacture XIR® film for the automotive glass
industry.
|
|
(b)
|
The
construction period for the project is from March 15, 1999 to
June 30, 2006.
|
|
(c)
|
The
total investment during the construction period should be at least
47,000
Euros ($59,400).
|
|
(d)
|
The
project must create at least one hundred forty-three permanent jobs
and
seven apprenticeships by June 30,
2006.
|
If
the
Company fails to meet the above requirements, the Saxony government has the
right to demand repayment of the Grant. In addition to the Grant, the Company
is
further eligible for cash investment allowances from the Saxony government
calculated based on the total projected capital investment by the Company in
its
Dresden facility of 47,000 Euros ($59,400), subject to European Union regulatory
approval. During 2000, 2001, 2002, 2003, 2004 and 2005 the Company received
1,200 Euros ($1,500), 2,500 Euros ($3,200), 1,200 Euros ($1,500), 1,300 Euros
($1,600), 400 Euros ($500), and 158 Euros ($190), respectively, in investment
allowances from the Saxony government, and those proceeds were applied to reduce
the capitalized construction cost of the Dresden facility. These investment
allowances are subject to the following requirements:
|
(a)
|
The
movable and immovable assets, the acquisition costs of which are
taken
into account in determining the investment allowance, shall be employed
within the subsidized territory for a period of at least five years
following the acquisition or production;
and
|
|
(b)
|
The
movable assets, the acquisition costs of which 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.
|
If
the
Company fails to meet the above requirements, the Saxony government has the
right to demand repayment of the allowances. The Grants and investment
allowances, if any, that the Company is entitled to seek from the Saxony
government vary from year to year based upon the amount of capital expenditures
that meet the above requirements. Generally, Southwall is not eligible to seek
total investment grants for any year in excess of 33% of its eligible capital
expenditures for that year. The Company cannot guarantee that it will be
eligible for or receive additional grants or allowances in the future. As of
December 31, 2005, we were in compliance with the requirements mentioned
above.
NOTE
7 - INCOME TAXES
For
financial reporting purposes, “Income (loss) before provision for income
taxes” included the following components for the years then ended December
31:
|
2005
|
2004
|
2003
|
||||||||
|
Domestic
|
$
|
1,826
|
$
|
(
1,893
|
)
|
$ | (43,847 | ) | ||
|
Foreign
|
1,523
|
2,322
|
2,236
|
|||||||
|
Total
|
$
|
3,349
|
$
|
429
|
$
|
(41,611
|
)
|
|||
The
provision for income taxes for the years then ended December 31, 2005, 2004
and
2003 consist of the following:
|
2005
|
2004
|
2003
|
||||||||
|
Current:
|
||||||||||
|
Federal
|
$
|
--
|
$
|
--
|
$
|
--
|
||||
|
State
|
(17
|
)
|
32
|
18
|
||||||
|
Foreign
|
554
|
525
|
316
|
|||||||
|
Total
current
|
$
|
537
|
$
|
557
|
$
|
334
|
||||
|
Deferred:
|
||||||||||
|
Federal
|
$
|
--
|
$
|
--
|
$
|
--
|
||||
|
State
|
--
|
--
|
--
|
|||||||
|
Foreign
|
(508
|
)
|
57
|
347
|
||||||
|
Total
deferred
|
$
|
(508
|
)
|
$
|
57
|
$
|
347
|
|||
|
Total
provision
|
$
|
29
|
$
|
614
|
$
|
681
|
||||
The
income tax provision relates primarily to foreign taxes, foreign withholding
taxes on royalty payments and state minimum tax obligations.
The
effective income tax rate differs from the federal statutory rate as a result
of
foreign taxes and valuation allowances established for deferred tax
assets.
Deferred
income taxes reflect the net tax effects of temporary differences between the
carrying amounts of assets and liabilities for financial reporting purposes
and
the amounts used for income tax purposes. Significant components of the
Company’s deferred tax assets (liabilities) are as follows:
|
December
31,
|
|||||||
|
2005
|
2004
|
||||||
|
Deferred
Tax Assets (Liabilities):
|
|||||||
|
Federal
and state net operating losses
|
$
|
12,160
|
$
|
12,112
|
|||
|
Research,
MIC, and other tax credits
|
1,822
|
2,422
|
|||||
|
Accruals
|
2,191
|
3,473
|
|||||
|
Depreciation
and amortization
|
5,545
|
4,341
|
|||||
|
Foreign
temporary differences
|
118
|
(397
|
)
|
||||
|
Other
|
--
|
--
|
|||||
|
Net
deferred tax assets
|
21,836
|
21,951
|
|||||
|
Deferred
tax assets valuation allowance
|
(21,718
|
)
|
(22,348
|
)
|
|||
|
Net
deferred tax asset (liability)
|
$
|
118
|
$
|
(397
|
)
|
||
The
2005
net deferred tax asset is included in other current assets and the 2004 net
deferred tax liability is included in other accrued liabilities in the
accompanying balance sheets.
Realization
of deferred tax assets is dependent upon future earnings, if any, the timing
and
amount of which are uncertain. Accordingly, the net deferred tax assets for
U.S.
components have been fully offset by a valuation allowance. The valuation
allowance decreased by $630 for the period ended December 31, 2005.
As
of
December 31, 2005, the Company has net operating loss carry forwards for federal
income tax purposes of approximately $33,606, which expire beginning in the
year
2006 through 2026. The Company also has California net operating loss carry
forwards of approximately $6,915, which expire beginning in the year 2006
through 2016.
The
Company has federal and California research and development tax credits of
$590
and $1,205, respectively. The federal research credits will begin to expire
in
the year 2019 and the California research credits have no expiration date.
The
Company also has California Manufacturers’ Investment Credit of $339, a portion
of which is currently expiring yearly.
Utilization
of the Company’s net operating loss may be subject to substantial annual
limitation due to the ownership change limitations provided by the Internal
Revenue Code and similar state provisions. Such an annual limitation could
result in the expiration of the net operating loss before
utilization.
NOTE
8 - STOCK OPTION AND EMPLOYEE STOCK PURCHASE PLANS
COMPENSATION
Stock
Option Plans
The
Company has granted stock options under various option plans and agreements
in
the past and currently grants stock options under the 1997 Stock Incentive
Plan
and the 1998 Stock Option Plan for employees, board members and consultants.
The
board of directors adopted the 1998 Stock Option Plan for employees and
consultants on August 6, 1998. The Compensation Committee of the board of
directors administers the plans and agreements. The exercise price of options
granted under the 1997 and 1998 plans must be at least 85% of the fair market
value of the stock at the date of grant.
Options
granted under the plans prior to October 2004 generally vest at a rate of 25%
per year, are non-transferable and expire over terms not exceeding ten years
from the date of grant or three months after the optionee terminates his
relationship with the Company. In October 2004, the board of directors changed
the vesting. Grants from and after October 2004 under both plans vest at a
rate
of 25% after six months and then evenly monthly thereafter for the remaining
42
months.
As
of
December 31, 2005, there were 2,578 shares of common stock available for
grant under the two stock option plans.
The
activity under the option plans, combined, was as follows:
|
Options
|
Range
of Exercise Price
|
Weighted
Average Exercise Price
|
||||||||
|
Options
outstanding at January 1, 2003
|
1,953
|
$
|
2.13
- $15.00
|
$
|
5.64
|
|||||
|
Granted
|
719
|
$
|
0.88
- $ 2.28
|
1.65
|
||||||
|
Exercised
|
--
|
--
|
--
|
|||||||
|
Cancelled
or expired
|
(585
|
)
|
$
|
1.92
- $15.00
|
5.18
|
|||||
|
Options
outstanding at December 31, 2003
|
2,087
|
$
|
1.56
- $11.50
|
4.39
|
||||||
|
Granted
Adjustments
|
300
|
$
|
0.88
- $ 0.88
|
0.88
|
||||||
|
Granted
|
2,379
|
$
|
0.50
- $ 1.81
|
0.95
|
||||||
|
Exercised
|
--
|
--
|
--
|
|||||||
|
Cancelled
or expired
|
(727
|
)
|
$
|
0.50
- $15.00
|
4.01
|
|||||
|
Options
outstanding at December 31, 2004
|
4,039
|
$
|
2.13
- $15.00
|
4.19
|
||||||
|
Granted
|
2,327
|
$
|
0.57
- $ 1.65
|
0.79
|
||||||
|
Exercised
|
(38
|
)
|
$
|
0.50
- $ 1.05
|
0.51
|
|||||
|
Cancelled
or expired
|
(766
|
)
|
$
|
0.50
- $11.50
|
2.82
|
|||||
|
Granted
Adjustments
|
10
|
$
|
0.50
- $11.50
|
1.54
|
||||||
|
Options
outstanding at December 31, 2005
|
5,572
|
$
|
0.50
- $15.00
|
$
|
1.53
|
|||||
The
following table summarizes information about stock options outstanding at
December 31, 2005:
|
Options
Outstanding
|
Options
Exercisable
|
|||||||||||||||
|
Range
of Exercise Prices
|
Number
Out-standing
|
Weighted
Average Remaining Contractual Life (years)
|
Weighted
Average Exercise Price
|
Number
Exercisable
|
Weighted
Average Exercise Price
|
|||||||||||
|
$
0.50 -- $0.50
|
1,233
|
8.38
|
$
|
0.50
|
1,023
|
$
|
0.50
|
|||||||||
|
$
0
52 -- $0.52
|
2
|
8.81
|
0.52
|
1
|
0.52
|
|||||||||||
|
$
0.58 -- $0.58
|
1,250
|
9.94
|
0.58
|
0
|
0.00
|
|||||||||||
|
$
0.64 -- $0.88
|
578
|
8.86
|
0.80
|
200
|
0.88
|
|||||||||||
|
$
0.89 -- $1.20
|
625
|
7.94
|
1.13
|
210
|
1.11
|
|||||||||||
|
$
1.22 -- $1.81
|
1,004
|
6.83
|
1.62
|
447
|
1.65
|
|||||||||||
|
$
1.92 -- $6.88
|
578
|
3.51
|
3.28
|
478
|
3.52
|
|||||||||||
|
$
7.00 -- $8.72
|
248
|
3.55
|
7.77
|
191
|
7.71
|
|||||||||||
|
$
9.90 -- $9.90
|
52
|
3.32
|
9.90
|
40
|
9.90
|
|||||||||||
|
$15.00
--$15.00
|
2
|
3.30
|
15.00
|
1
|
15.00
|
|||||||||||
|
$
0.50 --$15.00
|
5,572
|
7.68
|
$
|
1.53
|
2,591
|
$
|
2.02
|
|||||||||
Employee
Stock Purchase Plan
In
March 1997, the Company adopted the 1997 Employee Stock Purchase Plan ("the
1997 Plan") and reserved 100 shares of Common Stock for issuance there under.
Employees, subject to certain limitations, may purchase shares at 85% of the
lower of the fair market value of the Common Stock at the beginning of the
six-month offering period, or the last day of the purchase period. During 2005,
2004 and 2003, 13, 7 and 21 shares, respectively, were sold under the 1997
Plan.
At December 31, 2005, there were 57 shares available for issuance under the
1997 Plan.
401(k)
Plan
In
1998,
the Company sponsored a 401(k) defined contribution plan covering eligible
employees who elect to participate. Southwall is allowed to make discretionary
profit sharing and 401(k) matching contributions as defined in the plan and
as
approved by the board of directors. The Company matches 25% of each eligible
participant's 401(k) contribution up to a maximum of 20% of the participant's
compensation, not to exceed fifteen hundred dollars per year. Southwall's actual
contribution may be reduced by certain available forfeitures, if any, during
the
plan year. No discretionary or profit sharing contributions were made for the
years ending December 31, 2005, 2004 and 2003. Matching contributions
during 2005, 2004 or 2003 were $80, $100 and $100, respectively.
NOTE
9 - WARRANTS
The
warrants described below are for common stock at an exercise price of $0.01.
With the exception of the warrants issued in connection with the letter of
intent, the term of the warrants is five years from the date of issuance. As
a
result of the nominal exercise price of the warrants, the warrant value is
based
on the value of the common stock on the date of issuance.
The
quoted market price of the Company’s common stock was not regarded as an
appropriate basis for warrant values, on account of the dilution of the stock
and the thin trading of the stock. The fair value of the common stock was based
on a Company valuation performed by management and a third party using accepted
valuation methodologies.
Balance
sheet classification of warrants:
Emerging
Issues Task Force 00-19 identifies conditions necessary for equity
classification of warrants. One condition is that a sufficient number of
authorized and un-issued shares exist at the classification assessment date
to
control settlement by delivering shares. In that evaluation, a company
must compare (a) the number of currently authorized but un-issued shares, less
the maximum number of shares that could be required to be delivered during
the
contract period under existing commitments with (b) the maximum number of shares
that could be required to be delivered under share settlement (either net-share
or physical) of the contract. If the amount in (b) exceeds the amount in
(a), share settlement is not within the control of the company and asset or
liability classification is required.
As
of
December 31, 2003, the Company satisfied the conditions necessary for equity
classification of its warrants, including the availability of sufficient
authorized and un-issued shares to satisfy existing commitments.
On
January 19, 2004, in addition to issuing warrants to purchase 75 shares to
PBF,
the Company obligated itself to issue 1,597 warrants to Needham and Dolphin,
the
Investors, as a result of entering into a debt agreement with Teijin, as
detailed below. As a result, as of January 19, 2004, the Company had
insufficient authorized and un-issued shares to satisfy existing commitments
had
all outstanding warrants been exercised on that date, thereby triggering
liability classification for all outstanding warrants.
The
Company was required to re-measure all outstanding warrants as of January 19,
2004 and to transfer the fair value of the warrants to liabilities with the
difference between the equity carrying value and the re-measured fair value
of
the liability recorded as non-operating expense. The charge recorded on January
19, 2004 totaled $151.
The
warrants were classified as liabilities until the shareholders approved the
increase in authorized shares on October 5, 2004. The warrants were re-measured
as of the end of the first quarter of 2004, resulting in a charge of $23, which
was recorded as non-operating expense. The warrants were again re-measured
as of
the end of the second quarter of 2004, resulting in a charge of $1,282, and
as
of the end of the third quarter of 2004, resulting in a charge $427, which
was
recorded as non-operating expense.
Warrants
issued in connection with the Letter of Intent:
In
connection with the November 11, 2003 Letter of Intent signed between Needham
and the Company outlining the proposed debt guarantee and equity financing,
the
Company issued warrants for 1,254 shares of common stock, representing 10%
of
the outstanding common stock of the Company, with an exercise price of $0.01
per
share. The warrants were to expire on November 11, 2008 or the execution of
definitive investment agreements, whichever was earlier. The warrants expired
on
December 18, 2003, the date of the signing of the definitive investment
agreements.
The
warrants included anti-dilution protection whereby the number of warrants would
be increased to 10% of the fully diluted number of shares of the Company in
the
event that the Company entered into a financing agreement with an alternate
investor before the end of the first quarter of 2004.
Needham
did not seek exclusive negotiations with the Company and the warrants were
considered as compensation for Needham investing time in negotiating and
structuring the potential transaction.
The
Company valued the warrants at $100; and, that value reflected the relative
probabilities of an agreement being reached and the anti-dilution feature being
triggered. The fair value of the warrant was recorded as a non-operating expense
in the fourth quarter of 2003.
Warrants
issued in connection with the investment agreement:
In
accordance with the investment agreement, warrants were to be issued to the
Investors on the closing of each guarantee and equity tranche. However, the
investment agreement provided that the Investors were entitled to receive
warrants to purchase 753 shares of common stock associated with the second
tranche of equity regardless of whether the second equity closing occurred.
This
term was included in the agreements as further incentive for the Investors
to
enter into definitive agreements. As the Company had an enforceable obligation
to issue the warrants and as the terms of the warrants were known as of the
date
of the investor agreement, the warrants were considered issued for accounting
purposes as of December 18, 2003.
As
the
warrants were issued as an incentive to enter into definitive agreements for
transactions that the Investors were not necessarily committed to consummate,
the Company determined that the value of the warrants should be recorded as
a
non-operating expense, which was recorded in the fourth quarter of 2003. The
Company considered that the Investors were not necessarily committed to the
contemplated transactions because of the arguably subjective nature of
determining whether certain conditions to closing were satisfied. Management
determined the value of the warrants to be $309.
The
investment agreement also included terms that required the Company to issue
additional warrants to the Investors if, as part of its restructuring plan,
the
Company issued any equity instruments, notes or other debt instruments to any
creditor, landlord, employee, director, agent or consultant.
Following
the issuance of equity instruments as part of its restructuring plans the
Company is required to issue to each of the Investors warrants in such amounts
as would allow the Investors to maintain their aggregate ownership percentage
(on a fully-diluted basis) as if such issuance had not occurred. Such warrants
represent anti-dilution protection for the investor and are therefore not valued
as stand-alone instruments.
Following
note or debt issuances to creditors as part of its restructuring plan the
Company is required to issue additional warrants to each of the Investors
representing the right to purchase that number of shares of common stock equal
to the product of (x) 1.25 and (y) the original principal amount of such note
or
debt instrument. Such warrants represent protection for the investors for the
Company failing to eliminate obligations to creditors, and are regarded as
issued for accounting purposes as of the date of the agreement triggering legal
entitlement.
In
December 2003, the issuance to the Investors of additional warrants exercisable
for 409 shares of common stock was required by note or debt issuances under
the
restructuring plan. The Company determined the value of the warrants to be
$168.
The fair value of the warrants was recorded as non-operating expense in the
fourth quarter of 2003. In the first quarter of 2004, the Company issued 9,849
additional warrants to the Investors as a result of note or debt issuances
under
the restructuring plan. The Company determined the fair value of the warrants
to
be $4,256, which was recorded as a non-operating expense in the first quarter
of
2004.
Warrants
issued in connection with the guarantee from Needham and line of credit from
PBF:
In
connection with the first guarantee from Needham and as additional incentive
to
complete the financing closings, as contemplated in the investment agreement,
the Company issued warrants for 941 shares of common stock in the fourth quarter
of 2003. Management determined the value of the guarantee and warrants at $98
and $386, respectively.
The
Company recorded the amount of the warrant value equal to the fair value of
the
guarantee, $98, as debt issuance costs to be amortized over the life of the
line
of credit. The residual value of the warrants, $288 was recorded as a
non-operating expense in the fourth quarter of 2003, as representing an
incentive to enter into definitive agreements for transactions to which Needham
was not committed. A total of $274 of debt issuance cost was expensed in fiscal
2004 and there was no debt issuance cost on the consolidated balance sheet
at
December 31, 2004.
In
connection with the second guarantee from Needham and as additional incentive
to
complete the financing closings, as contemplated in the investment agreement,
the Company issued warrants for 941 shares of common stock in the first quarter
of 2004. Management determined the value of the guarantee and warrants at $33
and $356, respectively.
The
Company recorded the amount of the warrant value equal to the fair value of
the
guarantee, $33, as debt issuance costs to be amortized over the life of the
line
of credit. The residual value of the warrants, $334 was recorded as a
non-operating expense in the first quarter of 2004, as representing an incentive
to enter into definitive agreements for transactions to which Needham was not
committed.
In
November 2003, the Company defaulted under its Factoring Agreements with PBF.
As
a result of the default, PBF was entitled to demand immediate repayment of
all
outstanding obligations, or to foreclose its security interest in the Company’s
collateral. In consideration of PBF’s forbearance from exercising its rights and
as incentive to provide $3.0 million of borrowings under the line credit, the
Company agreed to issue warrants for 250 shares of the Company’s common stock.
In addition, the Company paid a forbearance fee of $70 and reimbursed PBF for
$31 of legal fees. The Company determined that the fair value of the warrants
was $103. The Company recorded the fair value of the warrants and the fees
to
debt issuance costs and amortized the amount over the life of the line of
credit.
On
January 19, 2004, the Company issued 75 warrants to PBF in consideration of
PBF’s consent to the execution by Southwall Europe GmbH (“Southwall Europe”) of
a written Guaranty Agreement in favor of Teijin Limited (“Teijin”). The Guaranty
by Southwall Europe was to guarantee the Company’s obligations to pay Teijin
$1.3 million in full settlement of the Company’s debts and obligations to Teijin
stemmed from the Company’s default on a Japanese bank loan for which Teijin was
the guarantor. The Company determined the fair value of the warrants was $33
and
has recorded the cost as debt issuance costs in the first quarter of
2004.
On
January 30, 2004, the Company issued 35 warrants to PBF in exchange for PBF
granting a two-week extension of its forbearance to enable the Company to
execute the investment agreement. The Company determined the fair value of
the
warrants to be $15. The Company recorded the fair value of the warrants to
debt
issuance costs and amortized the amount over the life of the line of
credit.
Issuance
Of Warrants In Connection With The Convertible Debt:
In
connection with the issuance of the convertible notes, the Company issued
warrants for 1,694 shares of common stock to the investors on February 20,
2004.
As
discussed above, the terms of the original investment agreement was such that
the Investors were entitled to receive the 753 warrants associated with the
second tranche of equity regardless of whether the second equity closing
occurred. As the Company had an enforceable obligation to issue the warrants
and
because the terms of the warrants were known as of the date of the investor
agreement, the warrants were considered issued for accounting purposes as of
December 18, 2003. As discussed above, the Company valued the 753 warrants
at
$309 and recorded the amount as non-operating expense in the fourth quarter
of
2003. As a result, the number of warrants issued for accounting purposes on
February 20, 2004 in connection with the issuance of convertible debt was 941
(that is, 1,694 shares underlying the warrants actually issued less the 753
shares underlying the warrants deemed previously issued on December 18,
2003).
The
fair
value of the 941 warrants was determined by management to be $414 and is
recorded as discount on the convertible notes in the first quarter of 2004
and
was expensed as interest expense over the life of the debt instrument using
the
effective interest rate method.
Embedded
Derivatives:
The
features of the convertible notes include the right to convert the notes into
Series A preferred stock (“Conversion Right”). This right was evaluated by the
Company to determine if it gave rise to an embedded derivative instrument that
would need to be accounted for separately in accordance with SFAS 133 and EITF
00-19.
The
Company concluded that the Conversion Right qualified as an embedded derivative
and did not meet the SFAS 133 scope exceptions. Therefore, the Company
bifurcated and fair valued the conversion feature. The fair value of the
Conversion Right was determined by management to be $820 and was recorded as
a
discount on the convertible notes and was amortized as interest expense over
the
life of the debt instrument using the effective interest rate
method.
The
embedded derivative was classified as a liability and was re-measured at the
end
of the first quarter, second quarter and third quarter of 2004. In accordance
with DIG Issue A18, “Application of Market Mechanism and Readily Convertible to
Cash Subsequent to the Inception or Acquisition of a Contract”, when the
contract ceased to be a derivative as a result of the stockholder approval
for
the increase in authorized shares, the Company discontinued accounting for
the
conversion option at fair value separate from the debt. The liability balance
for the conversion option recorded on the books resulted in an adjustment of
the
basis of the debt. The liability balance at October 5, 2004, the date the
stockholders approved the increase in authorized shares, was $1,036. The balance
of the debt discount when the debt was converted on December 31, 2004 to Series
A Preferred Stock was $1,119. The net amount between the balance of the
liability and the debt discount of $83 re-classed to preferred stock as a
reduction of the total value of the preferred stock.
The
total
net value of the warrants recorded in long-term liability of $8,055 before
the
stockholders’ approval to increase the number of authorized and un-issued shares
was re-classed to capital in excess of par value after the approval in October
2004.
NOTE
10 - SEGMENT REPORTING
Southwall
operates in one segment.
The
total
net revenues for the automotive glass, electronic display, architectural and
window film product lines were as follows:
|
2005
|
2004
|
2003
|
||||||||
|
Automotive
glass
|
$
|
19,647
|
$
|
20,584
|
$
|
20,297
|
||||
|
Electronic
display
|
14,039
|
20,554
|
19,019
|
|||||||
|
Architectural
|
5,934
|
7,010
|
6,297
|
|||||||
|
Window
film
|
15,134
|
9,425
|
7,713
|
|||||||
|
Total
net revenues
|
$
|
54,754
|
$
|
57,573
|
$
|
53,326
|
||||
The
following is a summary of net revenue by geographic area (based on location
of
customer):
|
2005
|
2004
|
2003
|
||||||||
|
United
States
|
$
|
14,362
|
$
|
12,186
|
$
|
5,707
|
||||
|
Japan
|
12,499
|
18,387
|
17,118
|
|||||||
|
France
|
10,870
|
10,283
|
9,327
|
|||||||
|
Pacific
Rim
|
10,461
|
7,228
|
7,335
|
|||||||
|
Germany
|
3,831
|
5,787
|
7,079
|
|||||||
|
Rest
of the world
|
2,731
|
3,702
|
6,760
|
|||||||
|
Total
net revenues
|
$
|
54,754
|
$
|
57,573
|
$
|
53,326
|
||||
Southwall
operates from facilities located in the United States and Germany. Long-lived
assets were as follows:
|
December
31,
|
|||||||
|
2005
|
2004
|
||||||
|
United
States
|
$
|
667
|
$
|
21
|
|||
|
Germany
|
16,190
|
21,089
|
|||||
|
Consolidated
|
$
|
16,857
|
$
|
21,110
|
|||
NOTE
11 - COMMITMENTS AND CONTINGENCIES
Commitments
The
Company leases certain property and equipment as well as its facilities under
noncancellable operating and capital leases. These leases expire at various
dates through 2008. As of December 31, 2005, the future minimum payments
under these leases are as follows:
|
Year
Ending December 31,
|
Operating
Leases
|
|||
|
2006
|
$
|
1,586
|
||
|
2007
|
239
|
|||
|
2008
|
11
|
|||
|
2009
|
8
|
|||
|
Future
minimum lease payments
|
$
|
1,844
|
||
Rent
expense under operating leases was approximately $861, $1,600 and $2,200 in
2005, 2004 and 2003, respectively. On January 19, 2006, the Company announced
its plans to close its Palo Alto manufacturing facility (see Note 13 Subsequent
Events). As a result of this decision, the Company is in negotiation with its
landlord to decommission and surrender these premises. No liability has been
recognized at this time because the Company cannot ascertain the fair value
of
any potential obligation to the landlord because the settlement date and method
of settlement for our obligation have not been specified, and the Company
currently does not have sufficient information to reasonably estimate any
potential obligation. The Company believes that it can resolve this issue with
the landlord and will pay for any potential obligations in 2006. It is possible
that our estimate of our lease obligation could change in the near term.
On
February 19, 2004, the Company entered into the second amendment to the lease
for this Palo Alto facility. This amendment reflected a payment schedule for
a
rent deferral for this facility. In January of 2006, the Company paid off
approximately $1.2 million of this deferred rent.
Contingencies
The
Company was named as a defendant, along with Bostik, Inc., in an action
captioned WASCO Products, Inc. v. Southwall Technologies, Inc. and Bostik,
Inc.,
Civ. Action No. C 02 2926 SBA, which was filed in Federal District Court for
the
Northern District of California on June 18, 2002. We were served with the
Complaint in this matter on July 1, 2002. The plaintiff filed the matter as
a
class action on behalf of all entities and individuals in the United States
who
manufactured and/or sold and warranted the service life of insulated glass
units
manufactured between 1989 and 1999, which contained Southwall Heat Mirror film
and were sealed with a specific type of sealant manufactured by Bostik, Inc.
The
plaintiff alleged that the sealant provided by Bostik, Inc. was defective,
resulting in elevated warranty replacement claims and costs. The plaintiff
asserted claims against us for breach of an implied warranty of fitness,
misrepresentation, fraudulent concealment, negligence, negligent interference
with prospective economic advantage, breach of contract, unfair business
practices and false or misleading business practices. The plaintiff sought
recovery on behalf of the class of $100 million for damages allegedly resulting
from elevated warranty replacement claims, restitution, injunctive relief,
and
non-specific compensation for lost profits. By Order entered December 22, 2003,
the Court dismissed all claims against us. The plaintiff has filed a notice
of
appeal to the Ninth Circuit Court of Appeals. On January 13, 2006, the Court
of
Appeals affirmed the lower court decision. On January 26, 2006, the plaintiff
filed a petition for rehearing with the Ninth Circuit Court of Appeals. In
March
of 2006, the Ninth Circuit Court of Appeals denied the plaintiff’s petition. A
percentage of the Company’s defense costs are being paid by its insurance
carriers under reservation of rights. It is not possible to predict how
Plaintiff’s claims will be resolved, whether the Company will be found liable,
or the nature and extent of Plaintiff’s alleged damages.
The
insurance carriers in some of the litigation related to allege product failures
and defects in window products manufactured by others in which we were a
defendant in the past paid the defense and settlement costs related to such
litigation. Those insurance carriers reserved their rights to recover a portion
or all of such payments from us. As a result, those insurance carriers could
seek from us up to an aggregate of $12.9 million plus defense costs,
although any such recovery would be restricted to claims that were not covered
by our insurance policies. We intend to vigorously defend any attempts by these
insurance carriers to seek reimbursement. We are not able to estimate the
likelihood that these insurance carriers will seek to recover any such payments,
the amount, if any, they might seek, or the outcome of such
attempts.
On
June
13, 2002, Plaintiff Charles Ikekwere (“Plaintiff”) filed a Complaint against the
Company in the Superior Court of California in and for the County of Santa
Clara, Case No. CV808644. Mr. Ikekwere is a former employee of the Company.
Plaintiff’s Complaint alleged claims for race discrimination, national origin
discrimination, retaliation, medical condition discrimination, breach of
contract, breach of fiduciary duty, fraud, negligence, intentional infliction
of
emotional distress, and punitive damages. The Company challenged the sufficiency
of certain of Plaintiff’s allegations, which caused him to file a First Amended
Complaint alleging essentially the same claims. The Company also challenged
certain of Plaintiff’s allegations in his First Amended Complaint, which caused
him to file a Second Amended Complaint. Following the Company’s legal challenges
to Plaintiff’s Second Amended Complaint, the following claims remain at issue in
the litigation: (1) race discrimination; (2) national origin discrimination;
(3)
retaliation; (4) medical condition discrimination; (5) breach of contract;
(6)
violation of California Constitution Article I; and (7) fraud and deceit. In
light of certain deposition testimony given by Plaintiff, the Company removed
this matter to Federal Court on January 6, 2004. The basis for the Company’s
removal was that certain of Plaintiff’s allegations were preempted by the
Employee Retirement Income and Security Act (ERISA). On February 4, 2004,
Plaintiff filed a Motion to Remand the case to State Court, which the Court
denied. Plaintiff subsequently amended his Second Amended Complaint to add
a
claim under ERISA. The parties have almost completed all discovery, with just
one deposition remaining. The parties have finished expert discovery. The
Company has filed a summary judgment motion, which, if granted, will dispose
of
the entire action. If Plaintiff defeats the Company’s summary judgment motion,
trial is scheduled for July 2006. Until discovery is completed and the Court
rules on the Company’s summary judgment motion, it is not possible to predict
how Plaintiff’s claims will be resolved, whether the Company will be found
liable, or the nature and extent of Plaintiff’s alleged damages.
In
addition, we are involved in certain other legal actions arising in the ordinary
course of business. We believe, however, that none of these actions, either
individually or in the aggregate, will have a material adverse effect on our
business, our consolidated financial position, results of operations or cash
flows.
NOTE
12 - IMPAIRMENT OF LONG-LIVED ASSETS
During
2003, the Company experienced shortfalls in revenue compared to its budgeted
and
forecast revenues. In addition, in the third quarter of 2003, the Company
determined that, due to reduced demand for its products, anticipated revenues
through the remainder of 2003 and 2004 would be substantially below expected
as
well as historical levels. The Company believed that the reduced demand for
its
products was caused by the decline in PC sales worldwide, competition from
alternative technologies in the automotive glass segment, as well as declines
in
certain residential and commercial construction markets as a result of the
economic recession in the U.S. As the Company's U.S. operations have a higher
operating cash break-even point compared to its Dresden operations, it believed
that the lower anticipated revenues indicated that an impairment analysis of
the
assets of its U.S. operations was necessary at September 28, 2003. As a result
of the Company's decision to close the Tempe operations in the fourth quarter,
it concluded that a further impairment analysis of the long-lived assets of
the
U.S. operations was necessary at December 31, 2003. The Company, therefore,
performed an evaluation of the recoverability of long-lived assets related
to
its U.S. business at September 28, 2003 and December 31, 2003 in accordance
with
the SFAS 144, "Accounting for the Impairment or Disposal of Long-Lived Assets".
For long-lived assets to be held and used, the determination of recoverability
is based on an estimate of undiscounted cash flows expected to result from
the
use and eventual disposition of the assets. The Company's evaluation concluded
that the undiscounted expected future cash flows were less than the carrying
values of these assets, and an impairment charge was required. The impairment
charge represents the amount required to write-down long-lived assets to the
Company's best estimate of fair value. For long-lived assets to be disposed
of
by sale or abandonment, principally the long-lived assets located at the Tempe
operation, the impairment loss is estimated as the excess of the carrying value
of the assets over fair value. As a result of the Company's assessment it
recorded non-cash, impairment charges of $19,380 and $8,610 for the periods
ended September 28, 2003 and December 31, 2003, respectively. The factors
considered by the Company in performing this assessment included current
operating results, trends, and prospects, the closure of its Tempe operation,
as
well as the effects of obsolescence, demand, competition, and other economic
factors.
During
2005 and 2004, the Company recovered $170 and $1,513, respectively, from the
sale of a previously written-down machine.
NOTE
13 - SUBSEQUENT EVENTS
On
January 19, 2006, we commenced restructuring actions to improve our cost
structure for 2006 and beyond. These actions include the closure of our Palo
Alto, California manufacturing facility and a reduction in force at our Palo
Alto site in the first half of 2006. We will transfer our U.S. manufacturing
operations to the European site located in Dresden, Germany in the first half
of
2006. The reduction in force will affect approximately 40 positions, or 22%
of
Southwall's total worldwide headcount. Severance costs associated with these
positions are estimated to be approximately $0.3 million. After this reduction,
Southwall will employ approximately 40 people in non-manufacturing positions
at
our site in California and 90 people in Germany and 7 in various remote sales
offices.
The
Company plans to vacate its current Palo Alto facility, which also serves as
its
headquarters and houses its research and development, sales and marketing and
general and administrative functions. The Company intends to relocate to another
Silicon Valley facility for these functions. Under the current lease agreement,
which expired on January 31, 2006, the Company is obligated to decommission
and
surrender its manufacturing premises. The Company is in negotiation with the
landlord regarding its obligation to decommission and surrender these premises
and no liability has been recognized at this time because the Company cannot
ascertain the fair value of this obligation at December 31, 2005 (See Note
11
Commitments and Contingencies). On February 19, 2004, the Company entered into
the second amendment to the lease for this Palo Alto facility. This amendment
reflected a payment schedule for a rent deferral for this facility. In January
of 2006, the Company paid off approximately $1.2 million of this deferred
rent.
ITEM
9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE
None
ITEM
9A. CONTROLS AND PROCEDURES
|
(a)
|
Evaluation
and Disclosure Controls and Procedures.
Under the supervision and with the participation of our management,
including our chief executive officer and vice president of finance,
we
conducted an evaluation of the effectiveness of the design and operation
of our disclosure controls and procedures, as defined in Rules 13a-15(e)
and 15d-15(e) under the Securities Exchange Act of 1934, as amended,
as of
December 31, 2005. Based on this evaluation, our chief executive
officer
and vice president of finance concluded as of the Evaluation Date
that our
disclosure controls and procedures were effective such that the
information relating to the Company, including our consolidated
subsidiaries, required to be disclosed in our Securities and Exchange
Commission (“SEC”) reports (i) is recorded, processed, summarized and
reported with the time periods specified in SEC rules and forms,
and (ii)
is accumulated and communicated to our management, including our
chief
executive officer and vice president of finance, as appropriate to
allow
timely decisions regarding required
disclosure.
|
|
(b)
|
Report
on Internal Control Over Financial Reporting.
We will be required by the Sarbanes-Oxley Act to include an assessment
of our internal control over financial reporting and an attestation
from an independent registered public accounting firm in our Annual
Report
on Form 10-K beginning with the filing for our fiscal year ending
December 31, 2007.
|
|
(c)
|
Changes
in Internal Controls.
There were no changes during 2005 in our internal controls over financial
reporting that have materially effected, or are reasonably likely
to
materially affect, the internal controls over financial
reporting.
|
ITEM
9B. OTHER INFORMATION
Not
applicable.
PART
III
Certain
information required by Part III is omitted from this annual report as we intend
to file a proxy statement (the “Proxy Statement”) for our Annual Meeting of
Stockholders, pursuant to Regulation 14A of the Securities Exchange Act of
1934,
as amended, not later than 120 days after the end of the fiscal year covered
by
this Report, and certain information included in that proxy statement is
incorporated herein by reference.
ITEM
10. DIRECTORS AND EXECUTIVE OFFICERS OF
REGISTRANT
The
information required by this item is contained under the heading “Executive
Officers of the Registrant” in Part I of this Annual Report on Form 10-K, and
the remainder is contained in the Proxy Statement under the heading “Election of
Directors,” and is incorporated herein by reference. Information relating to
certain filings on Forms 3, 4, and 5 is contained in the Proxy Statement under
the heading “Section 16(a) Beneficial Ownership Reporting Compliance,” and is
incorporated herein by reference. Information required by this item pursuant
to
Items 401(h), 401(i), and 401(j) of Regulation S-K relating to an audit
committee financial expert, the identification of the audit committee of our
board of directors and procedures of security holders to recommend nominees
to
our board of directors is contained in the Proxy Statement under the heading
“Corporate Governance” and is incorporated herein by reference.
We
have
adopted a written code of conduct that applies to all of our employees,
including our principal executive officer, principal financial officer,
principal accounting officer or controller, or persons performing similar
functions.
ITEM
11. EXECUTIVE COMPENSATION
Information
regarding the Company’s compensation of its named executive officers is set
forth under “Executive Compensation” in the Proxy Statement, which information
is incorporated herein by reference. Information regarding the Company’s
compensation of its directors is set forth under “Director Compensation” in the
Proxy Statement, which information is incorporated herein by
reference.
ITEM
12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT
Information
regarding security ownership of certain beneficial owners, directors and
executive officers is set forth under “Security Ownership of Certain Beneficial
Owners and Management” in the Proxy Statement, which information is incorporated
herein by reference.
Information
regarding the Company’s equity compensation plans, including both stock holder
approved plans and non-stockholder approved plans, is set forth in the section
entitled “EXECUTIVE OFFICER COMPENSATION—Securities Authorized for Issuance
Under Equity Compensation Plans” in the Proxy Statement, which information is
incorporated herein by reference.
ITEM
13. CERTAIN RELATIONSHIPS AND RELATED
TRANSACTIONS
Information
regarding certain relationships and related transactions is set forth under
“Certain Relationships and Related Transactions” in the Proxy Statement, which
information is incorporated herein by reference.
ITEM
14. PRINCIPAL ACCOUNTANT FEES AND
SERVICES
Information
regarding principal auditor fees and services is set forth under “Independent
Auditor Fees and Services” in the Proxy Statement, which information is
incorporated herein by reference.
PART
IV
ITEM
15. EXHIBITS, AND FINANCIAL STATEMENT
SCHEDULES
The
following documents are filed as part of this Form 10-K:
|
(a)
|
(1)
|
Financial
Statements.
The following Financial Statements of Southwall Technologies Inc. are
filed as part of this
Form 10-K:
|
|
|
Page
Number
|
|
Report
of Independent Registered Public Accounting Firm
|
57
|
|
Report
of Independent Registered Public Accounting Firm
|
58
|
|
Consolidated
Balance Sheets as of December 31, 2005 and 2004
|
59
|
|
Consolidated
Statements of Operations for the years ended December 31, 2005, 2004
and
2003
|
60
|
|
Consolidated
Statements of Stockholders' Equity for the years ended December 31,
2005,
2004 and 2003
|
61
|
|
Consolidated
Statements of Cash Flows for the years ended December 31, 2005, 2004
and
2003
|
62
|
|
Notes
to Consolidated Financial Statements
|
63
|
|
(2)
|
Financial
Statement Schedule.
|
Schedule
II - Valuation and qualifying accounts and reserves (amounts in
thousands):
|
Description
|
Balance
at Beginning of Year
|
Additions
|
Deductions
|
Balance
at End of Year
|
|||||||||
|
2005
|
|||||||||||||
|
Inventory
reserves
|
$
|
1,254
|
$
|
1,531
|
$
|
2,205
|
(2)
|
$
|
580
|
||||
|
Allowance
for Doubtful Accounts
|
$
|
292
|
$
|
--
|
$
|
84
|
(2)
|
$
|
208
|
||||
|
Reserves
for warranty and sales returns
|
$
|
2,701
|
$
|
720
|
(1)
|
$
|
1,865
|
(2)
|
$
|
1,556
|
|||
|
Tax
valuation allowance
|
$
|
22,348
|
$
|
--
|
$
|
630
|
(2)
|
$
|
21,718
|
||||
|
2004
|
|||||||||||||
|
Inventory
reserves
|
$
|
1,440
|
$
|
2,129
|
$
|
2,315
|
(2)
|
$
|
1,254
|
||||
|
Allowance
for Doubtful Accounts
|
$
|
778
|
$
|
--
|
$
|
486
|
(2)
|
$
|
292
|
||||
|
Reserves
for warranty and sales returns
|
$
|
1,851
|
$
|
2,359
|
(1)
|
$
|
1,509
|
(2)
|
$
|
2,701
|
|||
|
Tax
valuation allowance
|
$
|
29,521
|
$
|
--
|
$
|
7,173
|
(2)
|
$
|
22,348
|
||||
|
2003
|
|||||||||||||
|
Inventory
reserves
|
$
|
988
|
$
|
908
|
$
|
456
|
(2)
|
$
|
1,440
|
||||
|
Allowance
for Doubtful Accounts
|
$
|
552
|
$
|
275
|
$
|
49
|
(2)
|
$
|
778
|
||||
|
Reserves
for warranty and sales returns
|
$
|
2,069
|
$
|
2,271
|
(1)
|
$
|
2,489
|
(2)
|
$
|
1,851
|
|||
|
Tax
valuation allowance
|
$
|
14,671
|
$
|
14,850
|
$
|
--
|
$
|
29,521
|
|||||
|
(1)
|
Charged
against revenue.
|
|
(2)
|
Reserves
utilized during the year.
|
|
(3)
|
Exhibits.
|
Reference
is made to the Exhibit Index, which follows the signature pages of this
Form 10-K.
SIGNATURES
Pursuant
to the requirements of Section 13 or 15(d) of the Securities Exchange Act
of 1934, the registrant has duly caused this Report to be signed on its behalf
by the undersigned, thereunto duly authorized, as of the day of March 29,
2006.
|
SOUTHWALL
TECHNOLOGIES INC.
|
||
|
By:
|
/s/
Thomas G. Hood
|
|
|
Thomas
G. Hood
|
||
|
President
|
||
Pursuant
to the requirements of the Securities Exchange Act of 1934, this report has
been
signed below by the following persons on behalf of the Registrant in the
capacities indicated, as of March 29, 2006.
|
Signature
|
Title
|
|
/s/Thomas
G. Hood
Thomas
G. Hood
|
President,
Chief Executive Officer and Director (Principal Executive
Officer)
|
|
/s/Sylvia
Kamenski
Sylvia
Kamenski
|
Vice
President of Finance (Principal Accounting Officer)
|
|
/s/George
Boyadjieff
George
Boyadjieff
|
Chairman,
Board of Directors
|
|
/s/William
A. Berry
William
A. Berry
|
Director
|
|
/s/Jami
K. Nachtsheim
Jami
K. Nachtsheim
|
Director
|
|
/s/Joseph
B. Reagan
Joseph
B. Reagan
|
Director
|
|
/s/Walter
C. Segdwick
Walter
C. Segdwick
|
Director
|
|
/s/Peter
E. Salas
Peter
E. Salas
|
Director
|
EXHIBIT
INDEX
|
Exhibit No.
|
Exhibit
|
|
3.1(1)
|
Restated
Certificate of Incorporation of the Company.
|
|
3.1.1(30)
|
Amendment
to Amended and Restated Certificate of Incorporation of the
Company
|
|
3.2(1)
|
By-laws
of the Company.
|
|
3.3(26)
|
Amended
and Restated Certificate of Designation, Preferences and Rights
of Series
A 10% Cumulative Preferred Stock of the Company filed with the
Secretary
of State of Delaware on January 30, 2004.
|
|
10.35.1(11)
|
Lease
Agreement for the facilities at 3941 East Bayshore Road, dated
October 7,
1999, between the Company and Straube Associates, Inc.
|
|
10.36(1)
|
Lease
Agreement for the facilities at 3961 East Bayshore Road, dated
March 20,
1979, between the Company and Allan F. Brown and Robert V.
Brown.
|
|
10.36.1(11)
|
Amendment,
dated October 12, 1999, between the Company and Brown Investment
Company
to the Lease Agreement for the facilities at 3961 East Bayshore
Road,
dated March 20, 1979, between the Company and Allan F. Brown
and Robert V.
Brown.
|
|
10.59(3)
|
Lease
Agreement for the facilities at 3969-3975 East Bayshore Road
Palo Alto,
California, dated January 1, 1989, between the Company and Bay
Laurel
Investment Company.
|
|
10.59.1(11)
|
Amendment,
effective January 1, 2000, between the Company and Judd Properties,
LLC to
the Lease Agreement for the facilities at 3969-3975 East Bayshore
Road
Palo Alto, California, dated January 1, 1989, between the Company
and Bay
Laurel Investment Company.
|
|
10.59.2(27)
|
Second
Amendment to Lease for the facilities at 3969-3975 East Bayshore
Road Palo
Alto, California, dated February 19, 2004, between the Company
and Judd
Properties, LLC.
|
|
10.60.1(11)
|
Amendment,
effective January 1, 2000, between the Company and Judd Properties,
LLC to
the Lease Agreements for the facilities at 3977-3995 East Bayshore
Road
Palo Alto, California, dated January 1, 1989, between the Company
and Bay
Laurel Investment Company.
|
|
10.60.2(27)
|
Surrender
and Termination Agreement for the facilities at 3977- 3995 East
Bayshore
Road Palo Alto, California, dated February 19, 2004, between
the Company
and Judd Properties, LLC.
|
|
10.71(4)
|
Lease
Agreement for the facilities at 3780 Fabian Way, Palo Alto, California,
dated June 11, 1990, between the Company and The Fabian
Building.
|
|
10.72(4)
|
License
Agreement between Mitsui and the Company, dated December 28,
1990.
|
|
10.72.1(19)
|
Amendment
to the License Agreement dated as of December 28, 1990 between
Mitsui and
the Company, dated August 2000.
|
|
10.78(5)
|
Amendment
to property lease dated February 2, 1994 to extend lease period
on
building at 3961 E. Bayshore Road, Palo Alto, California. Original
lease
filed as Exhibit No. 10.36 above.
|
|
10.92(9)*
|
The
Company's 1997 Stock Incentive Plan.
|
|
10.93(10)*
|
The
Company's 1997 Employee Stock Purchase Plan, as
amended.
|
|
10.94(12)*
|
The
Company's October 22, 1999 Severance Policy in the Event of a
Merger.
|
|
10.99(15)*
|
1998
Stock Plan for Employees and Consultants.
|
|
10.103(15)
|
German
bank loan dated May 12, 1999.
|
|
10.104(15)
|
German
bank loan dated May 28, 1999.
|
|
10.105(22)
|
German
bank loans dated May 28, 1999 and December 1, 1999.
|
|
10.106(15)
|
German
bank loan due June 30, 2009.
|
|
10.107(15)
|
German
bank loan dated June 29, 2000.
|
|
10.108(15)
|
German
bank loan dated July 10, 2000.
|
|
10.109(15)
|
German
bank loans dated December 18, 2000 and December 19,
2000.
|
|
10.111(19)
|
Master
Lease Agreement between Matrix Funding Corporation and the Company,
dated
July 19, 1999.
|
|
10.116(18)
|
Distribution
Agreement between Globamatrix Holdings Pte. Ltd. and the Company,
dated as
of January 1, 2002 (portions of this exhibit have been omitted
based on a
request for confidential treatment; the non-public information
has been
filed with the Commission).
|
|
10.116.1(27)
|
Letter
Agreement dated August 28, 2003 between Globamatrix Holdings
Pte. Ltd. and
the Company amending the Distribution Agreement between the parties
dated
January 1, 2002.
|
|
10.116.2(27)
|
Letter
Agreement dated December 17, 2003 between Globamatrix Holdings
Pte. Ltd.
and the Company amending the Distribution Agreement between the
parties
dated January 1, 2002.
|
|
10.117(17)
|
Teijin
Waiver Letter dated May 9, 2002.
|
|
10.118(17)
|
Sanwa
Bank Waiver Letter dated May 15, 2002.
|
|
10.119(19)
|
Standard
Industrial Lease dated October 1999 for the facilities at 1029
Corporation
Way, Palo Alto, California between the Company and C&J
Development.
|
|
10.120(19)
|
Guarantee
Agreement Regarding 10 million US$ Credit Facility between Teijin
Limited
and the Company, dated May 6, 1997.
|
|
10.120.1(21)
|
Memorandum
Amendment to the Guarantee Agreement between Teijin Limited and
the
Company, dated August 1999.
|
|
10.121.
(23)
|
Pilkington
Supply and Purchase Agreement dated September 1,
2002.
|
|
10.122.
(23)
|
Xinyi
Group (Glass) Co. LTD. Purchase Agreement dated September 5,
2002.
|
|
10.123
(24)
|
Domestic
Factoring Agreement dated May 16, 2003, between Pacific Business
Funding
and the Company.
|
|
10.123.1
(24)
|
Amendment
to the Domestic Factoring Agreement dated June 16, 2003, between
Pacific
Business Funding and the Company.
|
|
10.124
(24)
|
Intellectual
Property Security Agreement dated May 16, 2003, between Pacific
Business
Funding and the Company.
|
|
10.125
(24)
|
Export-Import
Working Capital Guarantee Program Borrower Agreement, between
Pacific
Business Funding and the Company.
|
|
10.126
(24)
|
Export-Import
Factoring Agreement dated May 16, 2003, between Pacific Business
Funding
and the Company.
|
|
10.126.1
(24)
|
Amendment
to the Export- Import Factoring Agreement dated June 16, 2003,
between
Pacific Business Funding and the Company.
|
|
10.127
(24)
|
Manufacturing
and Supply Agreement between the Company and Mitsui Chemicals,
Inc. dated
July 19, 2003 (portions of this exhibit have been omitted based
on a
request for confidential treatment; the non-public information
has been
filed with the Commission).
|
|
10.128(27)
|
Guaranteed
Loan Agreement dated January 19, 2004, between Teijin Limited
and the
Company.
|
|
10.128.1(29)
|
Amendment
No. 1, dated June 9, 2004, to Guaranteed Loan Agreement by and
between
Southwall and Teijin, Limited.
|
|
10.129(27)
|
Guaranty
Agreement dated January 19, 2004, between Teijin Limited and
Southwall
Europe GmbH.
|
|
10.130(27)
|
Supply
Agreement between Saint Gobain Sekurit France and the Company,
effective
January 1, 2004 (portions of this exhibit have been omitted based
on a
request for confidential treatment; the non-public information
has been
filed with the Commission).
|
|
10.131
(26)
|
Amended
and Restated Investment Agreement, dated February 20, 2004, by
and among
the Company and Needham & Company, Inc., Needham Capital Partners II,
L.P., Needham Capital Partners II (Bermuda), L.P., Needham Capital
Partners III, L.P., Needham Capital Partners IIIA, L.P., Needham
Capital
Partners III (Bermuda), L.P., and Dolphin Direct Equity Partners,
LP
(collectively, the "Investors").
|
|
10.132
(26)
|
Amended
and Restated Registration Rights Agreement, dated February 20,
2004, by
and among the Company, Pacific Business Funding, Judd Properties,
LLC, and
the Investors.
|
|
10.133
(26)
|
Form
of Secured Convertible Promissory Note issued by the Company
to the
Investors.
|
|
10.134
(26)
|
Pledge
Agreement, dated February 20, 2004, between the Company and Needham
&
Company, Inc.
|
|
10.135
(25)
|
Form
of Warrant to purchase shares of the Company's common
stock.
|
|
10.136
(25)
|
Loan
and Security Agreement, dated December 18, 2003, between the
Company and
Pacific Business Funding.
|
|
10.136.1(28)
|
First
Amendment to Loan and Security Agreement dated as of December
18, 2003,
dated April 29, 2004.
|
|
10.137
(25)
|
Forbearance
Agreement, dated December 18, 2003, between the Company and Pacific
Business Funding.
|
|
10.137.1(27)
|
First
Amendment to Forbearance Agreement, dated December 29, 2003,
between the
Company and Pacific Business Funding.
|
|
10.137.2
(26)
|
Second
Amendment to Forbearance Agreement, dated February 20, 2004,
between the
Company and Pacific Business Funding.
|
|
10.138(27)
|
Mutual
Release and Settlement Agreement dated February 20, 2004, by
and among the
Company and Bank of America, N.A., Portfolio Financial Servicing
Company
and Lehman Brothers. Agreement relates to the Master Lease Agreement
between Matrix Funding Corporation and the Company filed as Exhibit
10.111.
|
|
10.139(28)
|
Third
Amendment to Domestic Factoring Agreement, dated April 29,
2004.
|
|
10.140
|
Lease
agreement for the facilities at 3780 Fabian Way, Palo Alto, CA,
dated
October 04, 2005 between the Company, Richard Christina and Diane
Christina.
|
|
10.141
|
Lease
agreement for the facilities at 2629B Terminal Boulevard, Mountain
View,
CA, dated July 14, 2005 between the Company and Dymond Development
Company, LLC.
|
|
14(27)
|
Code
of Ethics.
|
|
21(15)
|
List
of Subsidiaries of the Company.
|
|
Consent
of Independent Registered Public Accounting Firm (Burr, Pilger
& Mayer
LLP).
|
|
|
Consent
of Independent Registered Public Accounting Firm (PricewaterhouseCoopers
LLP).
|
|
|
Certification
pursuant to Exchange Act Rules 13a-14 and 15d-14 of the Chief
Executive
Officer
|
|
|
Certification
pursuant to Exchange Act Rules 13a-14 and 15d-14 of the Chief
Financial
Officer
|
|
|
Certification
pursuant to 18 U.S.C. Section 1350 of the Chief Executive
Officer
|
|
|
Certification
pursuant to 18 U.S.C. Section 1350 of the Chief Financial
Officer
|
_____
*
Relates
to management contract or compensatory plan or arrangement.
(1)
Filed
as an exhibit to the Registration Statement on Form S-1 filed with the
Commission on April 27, 1987 (Registration No. 33- 13779) (the
"Registration Statement") and incorporated herein by reference.
(2)
Filed
as an exhibit to the Form 10-Q Quarterly Report for Quarter Ended
June 30, 1988, filed with the Commission on August 15, 1988 and
incorporated herein by reference. Our 1934 Act registration number is
000-15930.
(3)
Filed
as an exhibit to the Form 10-Q Quarterly Report for Quarter Ended
July 2, 1989, filed with the Commission on August 16, 1989 and
incorporated herein by reference.
(4)
Filed
as an exhibit to the Form 10-K Annual Report 1990, filed with the
Commission on March 25, 1991 and incorporated herein by
reference.
(5)
Filed
as an exhibit to the Form 10-K Annual Report 1992, filed with the
Commission on March 15, 1993 and incorporated herein by
reference.
(6)
Filed
as an exhibit to the Form 10-Q Quarterly Report for Quarter Ended
July 3, 1994, filed with the Commission on August 15, 1994 and
incorporated herein by reference.
(7)
Filed
as an exhibit to the Form 10-K Annual Report 1996, filed with the
Commission on March 27, 1997 and incorporated herein by
reference.
(8)
Filed
as an exhibit to the Form 10-Q Quarterly Report for Quarter Ended
June 29, 1997, filed with the Commission on August 14, 1997 and
incorporated herein by reference.
(9)
Filed
as Proposal 3 included in the 1997 Proxy statement filed with the Commission
on
April 14, 1997 and incorporated herein by reference.
(10)
Filed as Proposal 3 included in the 2002 Proxy statement filed with the
Commission on April 22, 2002 and incorporated herein by
reference.
(11)
Filed as an exhibit to the Form 10-K Annual Report 1999, filed with the
Commission on April 6, 2000 and incorporated herein by
reference.
(12)
Filed as an exhibit to the Form 10-K Annual Report 2000, filed with the
Commission on April 9, 2001 and incorporated herein by
reference.
(13)
Filed as an exhibit to the Form 10-Q Quarterly Report for Quarter Ended
September 30, 2001, filed with the Commission on November 12, 2001 and
incorporated herein by reference.
(14)
Filed as an exhibit to the Form 10-Q Quarterly Report for the Quarter Ended
April 1, 2001, filed with the Commission on May 16, 2001 and
incorporated herein by reference.
(15)
Filed as an exhibit to the Form 10-K Annual Report 2001, filed with the
Commission on April 1, 2002 and incorporated herein by
reference.
(16)
Filed as an exhibit to the Form 10-K/A Annual Report 2001, filed with the
Commission on June 14, 2002 and incorporated herein by
reference.
(17)
Filed as an exhibit to the Form 10-Q Quarterly Report for the Quarter Ended
March 31, 2002, filed with the Commission on May 17, 2002 and
incorporated herein by reference.
(18)
Filed as an exhibit to the Form 10-Q/A Quarterly Report for the Quarter
Ended March 31, 2002, filed with the Commission on June 19, 2002 and
incorporated herein by reference.
(19)
Filed as an exhibit to Amendment No. 3 to the Registration Statement on
Form S-1 filed with the Commission on June 25, 2002 (Registration
No. 333-85576) and incorporated herein by reference.
(20)
Filed as an exhibit to the Registration Statement on Form S-1 filed with
the Commission on April 5, 2002 (Registration No. 333- 85576) and
incorporated herein by reference.
(21)
Filed as an exhibit to Amendment No. 1 to the Registration Statement on
Form S-1 filed with the Commission on May 31, 2002 (Registration
No. 333-85576) and incorporated herein by reference.
(22)
Filed as an exhibit to the Form 10-K/A Annual Report 2001, filed with the
Commission on June 27, 2002 and incorporated herein by
reference.
(23)
Filed as an exhibit to the Form 10-K Annual Report 2002, filed with the
Commission on March 31, 2003 and incorporated herein by reference.
(24)
Filed as an exhibit to the Form 10-Q Quarterly Report for the Quarter Ended
June 29, 2003, filed with the Commission on August 15, 2003 and incorporated
herein by reference.
(25)
Filed as an exhibit to the Form 8-K Current Report, filed with the Commission
on
December 23, 2003 and incorporated herein by reference.
(26)
Filed as an exhibit to the Form 8-K/A Current Report, filed with the Commission
on March 3, 2004 and incorporated herein by reference.
(27)
Filed as an exhibit to Form 10-K Annual Report 2003, filed with the Commission
on April 14, 2004 and incorporated herein by reference.
(28)
Filed as an exhibit to the Form 10-Q Quarterly Report, filed with the Commission
on May 17, 2004, and incorporated herein by reference.
(29)
Filed as an exhibit to the Form 10-Q Quarterly Report, filed with the Commission
on August 11, 2004, and incorporated herein by reference.
(30)
Filed as an exhibit to the Form 10-Q Quarterly Report, filed with the Commission
on November 8, 2004, and incorporated herein by reference.
98