UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
Washington,
D.C. 20549
FORM
10-K
(Mark
One)
T
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF
1934
For
the fiscal year ended December 31, 2006
OR
£
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)
|
3788
Fabian Way
Palo
Alto, California 94303
(Address
of Principal Executive Offices including Zip Code)
(650)
798-1200
(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
T
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
T
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 T
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. T
Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act). Yes
£ No
T
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 T
The
approximate aggregate market value of the Common Stock held by non-affiliates
of
the registrant on July 3, 2006 (based upon the closing sales price of the Common
Stock on the Over-the-Counter Bulletin Market on such date) was $6.2 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,
2006, 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, 2007
was 27,139,035
Documents
Incorporated by Reference
|
Document
Description
|
10-K
Part
|
|
Portions
of the Registrant’s Proxy Statement
for
the Annual Meeting of Stockholders to
be
held May 24, 2007
|
III
|
2
SOUTHWALL
TECHNOLOGIES INC.
2006
ANNUAL REPORT ON FORM 10-K
Table
of Contents
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|
Page
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1.
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Item
7A.
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8.
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9A.
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Item
10.
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Item
14.
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Item
15.
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| 92 | |||
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;
|
|
·
|
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;
|
|
·
|
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;
|
|
·
|
pending
and threatened litigation and its
outcome;
|
|
·
|
our
competition; and
|
|
·
|
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 V-Kool International 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.
You
may read and copy any material that we file with the SEC at the SEC’s Public
Reference Room at 100 F Street, N.E., Washington, D.C. 20549. You may obtain
information on the operation of the Public Reference Room by calling the SEC
at
1-800-SEC-0330. The SEC also maintains an Internet site at http://www.sec.gov
that
contains reports, proxy and information statements, and other information
regarding issuers, including Southwall, that file electronically with the
SEC.
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 displays, or LCDs
and
plasma display panels or PDPs, and in applications such as touch screens.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 23 patents and 18 patent applications pending
in
the United States and 68 patents and more than 34 patent applications pending
outside the United States that cover materials, processes, products and
production equipment. Of our existing patents, three U.S. patents and eighteen
international patents will expire in 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
RODUCTS
|
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
LCD
reflector for lighting sources
|
Anti-reflective
clear (ARC)
Silver
reflecting
|
Clear
anti-reflective
product
95%
Reflecting
Light-weight
mirror
|
Berliner
Glass
Mitsui
Chemicals
|
||||
|
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
|
V-Kool
International
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 $13.4 million, $19.6
million and $20.6 million in 2006, 2005 and 2004, 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 $10.8 million, $14.0
million and $20.6 million in 2006, 2005 and 2004, 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 $5.5 million, $5.9 million
and $7.0 million in 2006, 2005 and 2004, 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 V-Kool International.
Our
net
revenues from sales of window film products were $10.5 million, $15.1 million
and $9.4 million in 2006, 2005 and 2004, 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
six
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 V-Kool International.
International
revenues amounted to approximately 68%, 74% and 79% of our net revenues during
2006, 2005 and 2004, respectively. The principal foreign markets for our
products in 2006 were Japan ($10 million) and the Pacific Rim other than Japan
($8 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 25% of our total sales
in
2006.
In
2006,
our customers in the architectural market included approximately 57 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 V-Kool International. Under the Agreement, which is scheduled to expire
in
2011, V-Kool International 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 V-Kool International
for the full cost of any product not timely delivered. For each year after
2004
through and including 2011, V-Kool International 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. V-Kool International was obligated to purchase
$10.9
million of products in 2006. During 2006, V-Kool International purchased
approximately $9 million of product.
The
remaining balance was rescheduled to Q1 2007 by mutual agreement. V-Kool
International is obligated to purchase at least $11.9 million from us in
2007.
A
small
number of customers have accounted for a substantial portion of our revenues.
Our ten largest customers accounted for approximately 77%, 81% and 79% of our
net sales in, 2006, 2005 and 2004, respectively. During 2006, Mitsui Chemicals,
Saint Gobain Sekurit, V-Kool and Pilkington PLC accounted for 24.6%, 8.5%,
20.0%
and 9.5%, respectively, of our net revenues. 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, Pilkington PLC and V-Kool accounted for 28.4%,
17.8%, 11.4% and 10.9%, 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 effect 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 $6.8 million, $5.1 million and $3.2 million,
or
approximately 16.9%, 9.3% and 5.6% of total net revenues, in 2006, 2005 and
2004, 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 invested in additional engineering resources to support our increased focus
on new products and technologies.
Manufacturing
The
table
below provides information about our current production machines and the class
of products that each was tooled to produce in 2006.
|
Machine
Number
|
Location
|
Primary
Markets For Current
Production
|
Year
Commercial Production Initiated
|
Estimated
Annual Capacity (Millions of
Sq. Ft.) (1)
|
||||
|
PM
1 (2)
|
Palo
Alto
|
Architectural
|
1980
|
none
|
||||
|
PM
2
|
Palo
Alto
|
Research
and development
|
1982
|
6.0
|
||||
|
PM
4A (2)
|
Palo
Alto
|
Automotive,
architectural, electronic display and window film
|
1991
|
12.0
|
||||
|
PM
4B (2)
|
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 display nd 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.
|
|
(2)
|
These
machines were scrapped and sold during the first half of
2006.
|
On
January 19, 2006, we commenced restructuring actions with the goal of improving
our cost structure for 2006 and beyond. These actions included the closure
of
our Palo Alto, California manufacturing facility in the first half of 2006.
We
scrapped and sold our production machines (PM 1, PM 4A and PM 4B) used for
manufacturing in Palo Alto. We currently use PM2 for research and development
in
Palo Alto. We transferred 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 manufactured approximately 60% of our
products during the first half of 2006 and 100% of our products during the
second half of 2006. 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, 2007 and February 28, 2006, we had a backlog
of orders able to be shipped over the next 12 months of approximately $7.9
million and $8.2 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 2006 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 2006 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 2006 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, 2006, we had 140 full-time and one part-time employee, of whom
24
were engaged in engineering, 76 in manufacturing, 17 in sales and marketing,
and
24 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 2006 and 2004. These factors together with our working
capital position and our significant debt service and other contractual
obligations at December 31, 2006, 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, 2006 owned
securities convertible into 59% 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, 2006, we had total outstanding obligations under our credit and
other loan agreements of $12.6 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
2004,
2005 and 2006, approximately 31%, 32% and 30% 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, 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 77%, 81% and 79%, of net revenues
in 2006, 2005 and 2004, 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 V-Kool International Holdings Pte. Ltd.,
or
V-Kool International, under which we granted an exclusive worldwide license
to
distribute our after-market applied film in the automotive and architectural
glass markets. Failure of V-Kool International 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 2006, we experienced a
decrease of 23% from 2005 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. 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, expired 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
Dr.
R. Eugene Goodson, our President. We do not have formal 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 68%, 74% and 79% of our
net
revenues during 2006, 2005 and 2004, respectively. 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, marketing, research and development facilities are
located in two buildings totaling approximately 39,000 square feet in Palo
Alto,
California. One of the buildings is occupied under lease that will expire on
June 30, 2011. The second building is occupied under a lease that will expire
on
December 31, 2007. We have an option to renew this lease for another
year.
On
January 19, 2006, we commenced restructuring actions to attempt to improve
our
cost structure for 2006 and beyond. These actions have included 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 accrued $1.5 million in the
third quarter of 2006 as a leasehold asset retirement obligation in connection
with this surrender plan. We expect to complete our surrender of this building
to our landlord in the second quarter of 2007.
We
have
transferred our U.S. manufacturing operations to our European site located
near
Dresden, Germany in the first half of 2006, at which we own a 60,000 square
foot
building.
In
January 2004, we had renegotiated a lease in Palo Alto, which required a final
$1.2 million payment in 2006. We made this payment in January 2006.
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. 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.
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
|
||
|
R.
Eugene Goodson
|
71
|
President,
Chief Executive Officer and Director
|
||
|
Neil
Bergstrom
|
57
|
Chief
Technology Officer and Senior Vice President,
Engineering
|
||
|
Dennis
Capovilla
|
47
|
Senior
Vice President, Sales and Marketing
|
||
|
Sylvia
Kamenski
|
54
|
Vice
President, Finance
|
||
|
Sicco
W.T. Westra
|
56
|
Vice
President, Business Development
|
||
|
Wolfgang
Heinze
|
58
|
Vice
President, General Manager Southwall Europe
GmbH
|
Dr.
R. Eugene Goodson
joined
Southwall's board of directors in April 2006 and in November 2006, Dr. Goodson
became President and CEO. He has held leadership positions in industry,
government and universities. Most recently, he served as the Chief Executive
Officer and President of Williams Controls Inc., a manufacturer of electronic
throttle controls, where he remains Chairman of the Board. Prior to Williams
Controls, Dr. Goodson was Chairman and Chief Executive Officer of Oshkosh Truck
Corporation, a developer and producer of heavy-duty on and off road trucks.
After retiring from Oshkosh in 1998, he became an Adjunct Professor at the
University of Michigan Business School, teaching operations management. Gene
was
also a director of the Executive Officer Association of American Industrial
Partners, a private equity firm, from 1998 to 2005.
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. On March 16, 2007, our CTO announced his intention to resign effective
April 2, 2007.
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 Over-the-Counter
Bulletin Board Market during the periods indicated.
|
|
High
|
Low
|
|||||
|
2006
|
|
|
|||||
|
1st
Quarter
|
$
|
0.88
|
$
|
0.59
|
|||
|
2nd
Quarter
|
0.92
|
0.63
|
|||||
|
3rd
Quarter
|
0.68
|
0.47
|
|||||
|
4th
Quarter
|
0.63
|
0.37
|
|||||
|
|
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
|
|||||
On
March
5, 2007, the last reported sale price for our common stock as reported on the
Over-the-Counter Bulletin Board Market was $0.65 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, but are not permitted to pay any other
dividends, including dividends on our common stock.
Comparison
of Cumulative Total Stockholder Return
The
following performance graph assumes an investment of $100 on December 31, 2001
and compares the changes thereafter in the market price of our common stock
with
a broad market index, Composite Market Index, and an industry index, General
Building Materials Index. We paid no dividends during the periods shown; the
performance of the indexes is shown on a total return (dividend reinvestment)
basis. The graph lines merely connect fiscal year-end dates and do not reflect
fluctuations between those dates.
|
|
12/01
|
12/02
|
12/03
|
12/04
|
12/05
|
12/06
|
|||||||||||||
|
Southwall
Technologies Inc.
|
100.00
|
43.78
|
13.43
|
24.06
|
8.53
|
6.43
|
|||||||||||||
|
Composite
Market Index
|
100.00
|
79.81
|
107.38
|
122.68
|
133.00
|
158.67
|
|||||||||||||
|
General
Building Materials Index
|
100.00
|
98.94
|
133.69
|
166.92
|
181.98
|
227.77
|
|||||||||||||
ITEM
6. SELECTED CONSOLIDATED FINANCIAL DATA
The
following selected consolidated financial data as of and for each of the five
years ended December 31, 2006 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,
|
||||||||||||||||
|
2006
|
2005
|
2004
|
2003
|
2002
|
||||||||||||
|
(in
thousands, except per share data)
|
||||||||||||||||
|
Net
revenues
|
$
|
40,209
|
$ |
54,754
|
$ |
57,573
|
$ |
53,326
|
$ |
68,759
|
||||||
|
Cost
of revenues
|
24,746
|
37,241
|
36,787
|
45,914
|
49,614
|
|||||||||||
|
Gross
profit
|
15,463
|
17,513
|
20,786
|
7,412
|
19,145
|
|||||||||||
|
Gross
profit %
|
38.5
|
%
|
32.0
|
%
|
36.1
|
%
|
13.9
|
%
|
27.8 | % | ||||||
|
Operating
expenses:
|
||||||||||||||||
|
Research
and development
|
6,782
|
5,104
|
3,199
|
6,714
|
7,685 | |||||||||||
|
Selling,
general and administrative
|
12,005
|
8,332
|
10,217
|
12,348
|
12,450 | |||||||||||
|
Restructuring
costs (recoveries), net
|
915
|
--
|
--
|
(65
|
)
|
2,624
|
||||||||||
|
Impairment
charge (recoveries) for long-lived
|
||||||||||||||||
|
assets,
net
|
(214
|
)
|
(170
|
)
|
(1,513
|
)
|
27,990
|
--
|
||||||||
|
Total
operating expenses
|
19,488
|
13,266
|
11,903
|
46,987
|
22,759
|
|||||||||||
|
Income
(loss) from operations
|
(4,025
|
)
|
4,247
|
8,883
|
(39,575
|
)
|
(3,614
|
)
|
||||||||
|
|
||||||||||||||||
|
Interest
expense, net
|
(737
|
)
|
(973
|
)
|
(2,206
|
)
|
(1,590
|
)
|
(1,734
|
)
|
||||||
|
Costs
of warrants issued
|
--
|
--
|
(6,782
|
)
|
(865
|
)
|
--
|
|||||||||
|
Other
income, net
|
210
|
75
|
534
|
419
|
1,070
|
|||||||||||
|
Income
(loss) before provision for benefit from) income taxes
|
(4,552
|
)
|
3,349
|
429
|
(41,611
|
)
|
(4,278
|
)
|
||||||||
|
Provision
for (benefit from) income taxes
|
958
|
29
|
614
|
681
|
(87
|
)
|
||||||||||
|
Net
income (loss)
|
(5,510
|
)
|
3,320
|
(185
|
)
|
(42,292
|
)
|
(4,191
|
)
|
|||||||
|
Deemed
dividend on preferred stock
|
489
|
490
|
--
|
--
|
--
|
|||||||||||
|
Net
income (loss) attributable to common stockholders
|
$
|
(5,999
|
)
|
$
|
2,830
|
$
|
(185
|
)
|
$
|
(42,292
|
)
|
$
|
(4,191
|
)
|
||
|
Net
income (loss) per share:
|
||||||||||||||||
|
Basic
|
($0.22
|
)
|
$
|
0.11
|
($0.01
|
)
|
($3.37
|
)
|
($0.40
|
)
|
||||||
|
Diluted
|
($0.22
|
)
|
$
|
0.10
|
($0.01
|
)
|
($3.37
|
)
|
($0.40
|
)
|
||||||
|
Weighted
average shares used in computing net income (loss) per
share:
|
||||||||||||||||
|
Basic
|
26,949
|
26,743
|
14,589
|
12,537
|
10,418
|
|||||||||||
|
Diluted
|
26,949
|
32,895
|
14,589
|
12,537
|
10,418
|
|||||||||||
Consolidated
Balance Sheet Data:
|
As
of December 31,
|
||||||||||||||||
|
2006
|
2005
|
2004
|
2003
|
2002
|
||||||||||||
|
(in
thousands)
|
||||||||||||||||
|
Cash,
cash equivalents and restricted cash
|
$
|
5,733
|
$
|
7,002
|
$
|
5,233
|
$
|
1,891
|
$
|
2,629
|
||||||
|
Working
capital (deficit)
|
3,686
|
8,691
|
6,528
|
(4,210
|
)
|
588
|
||||||||||
|
Property,
plant and equipment
|
17,232
|
16,857
|
21,110
|
21,787
|
50,251
|
|||||||||||
|
Total
assets
|
35,501
|
39,641
|
44,947
|
41,721
|
76,582
|
|||||||||||
|
Term
debt and capital leases including current portion
|
9,627
|
10,107
|
13,107
|
15,700
|
16,752
|
|||||||||||
|
Total
liabilities
|
23,655
|
23,702
|
30,374
|
40,000
|
36,108
|
|||||||||||
|
Preferred
stock
|
4,810
|
4,810
|
4,810
|
--
|
--
|
|||||||||||
|
Total
stockholders' equity
|
7,036
|
11,129
|
9,763
|
1,721
|
40,474
|
|||||||||||
Selected
Cash Flow Data:
|
Years
Ended December 31,
|
||||||||||||||||
|
2006
|
2005
|
2004
|
2003
|
2002
|
||||||||||||
|
(in
thousands)
|
||||||||||||||||
|
Net
cash provided by (used in) operating activities
|
$
|
748
|
$
|
4,006
|
$
|
3,830
|
$
|
(2,990
|
)
|
$
|
(2,824
|
)
|
||||
|
Net
cash provided by (used in) investing activities
|
(505
|
)
|
(342
|
)
|
1,261
|
(2,775
|
)
|
(6,014
|
)
|
|||||||
|
Net
cash provided by (used in) financing activities
|
(1,533
|
)
|
(1,566
|
)
|
(2,249
|
)
|
5,548
|
7,679
|
||||||||
Quarterly
Financial Data:
The
following table sets forth consolidated statements of operations data for the
eight fiscal quarters ended December 31, 2006. 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
|
|||||||||||||
|
Mar.
31, 2006
|
Jun.
30, 2006
|
Sep.
30, 2006
|
Dec.
31, 2006
|
||||||||||
|
(in
thousands, except per share amounts)
|
|||||||||||||
|
Net
revenues
|
$
|
10,034
|
$
|
11,337
|
$
|
9,597
|
$
|
9,241
|
|||||
|
Cost
of revenues
|
6,366
|
7,268
|
5,667
|
5,445
|
|||||||||
|
Gross
profit
|
3,668
|
4,069
|
3,930
|
3,796
|
|||||||||
|
Income
(loss) before provision for (benefit from) income taxes
|
(1,034
|
)
|
(1,154
|
)
|
(2,528
|
)
|
164
|
||||||
|
Net
loss
|
(1,327
|
)
|
(1,387
|
)
|
(2,721
|
)
|
(75
|
)
|
|||||
|
Deemed
dividend on preferred stock
|
122
|
122
|
123
|
122
|
|||||||||
|
Net
loss attributable to common stockholders
|
$
|
(1,449
|
)
|
$
|
(1,509
|
)
|
$
|
(2,844
|
)
|
$
|
(197
|
)
|
|
|
Net
loss per share:
|
|||||||||||||
|
Basic
|
($0.05
|
)
|
($0.06
|
)
|
($0.11
|
)
|
($0.01
|
)
|
|||||
|
Diluted
|
($0.05
|
)
|
($0.06
|
)
|
($0.11
|
)
|
($0.01
|
)
|
|||||
|
Weighted
average shares used in computing net loss per share:
|
|||||||||||||
|
Basic
|
26,825
|
26,939
|
26,957
|
27,073
|
|||||||||
|
Diluted
|
26,825
|
26,939
|
26,957
|
27,073
|
|||||||||
|
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 (loss) 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 (loss) per
share:
|
|||||||||||||
|
Basic
|
26,613
|
26,782
|
26,788
|
26,790
|
|||||||||
|
Diluted
|
33,181
|
33,094
|
32,720
|
32,375
|
|||||||||
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 decreased by $1.1 million from $6.6 million at December
31,
2005 to $5.5 million at December 31, 2006. Cash provided by operating activities
decreased by $3.3 million from $4.0 million in 2005 to $0.7 million in 2006.
The
decrease in cash provided by operating activities during 2006 was primarily
the
result of net loss for the year of $5.5 million, impairment recoveries from
long-lived assets of $0.2 million and an increase in other current and
non-current assets of $0.1 million partially offset by deferred income taxes
of
$0.05 million, non-cash depreciation of $2.4 million, a stock-based compensation
charge of $0.6 million, a decrease in accounts receivable of $3.1 million,
a
decrease in inventories of $0.3 million and an increase in accounts payable
and
accrued liabilities of $0.2 million. Cash used in investing activities in 2006
was $0.5 million compared to $0.3 million provided by investing activities
in
2005. The increase in cash used in investing activities from 2005 to 2006 was
due to increased expenditures for property, plant and equipment and other assets
partially offset by proceeds from sale of fixed assets. Cash used in financing
activities decreased by $0.1 million from $1.6 million used in financing
activities in 2005 to $1.5 million used in financing activities in 2006.
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 declined from $26.6 million
in 2002 to $19.0 million in 2003, increased to $20.6 million in 2004, decreased
to $14.0 million in 2005 and to $10.8 million in 2006. Similarly, revenues
from
our automotive segment were $20.4 million, $20.3 million, $20.6 million, $19.6
million and $13.4 million in 2002, 2003, 2004, 2005 and 2006, respectively.
The
decrease in 2006 was primarily due to a reduction in demand throughout the
year
by a major customer as a result of their large inventory build up at 2005 year
end and the ongoing “de-contenting” trend in the automotive industry.
De-contenting is a change by automotive manufacturers to make the part in which
products are found as optional features rather than standard features to control
their costs.
Our
research and development expenditures increased from $5.1 million in 2005 to
$6.8 million in 2006. 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 invested in additional engineering
resources to support our increased focus on new products and
technologies.
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. Also during the first half of 2006,
we
transferred our U.S. manufacturing operations to the European site located
near
Dresden, Germany. As a result of these restructuring actions, our
gross
margins increased from approximately 36% in the first half of 2006 to
approximately 41% in the second half of 2006.
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
that
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 years 2006
and
2005, we accrued, in the aggregate, $1.0 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, 2006, Needham Company and Affiliates (together with the Needham
Group Inc. and Needham Investment Management LLC) and Dolphin Direct Equity
Partners, LP own 41.7% and 17.1%, 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, 2006, they would have
owned 45.5% and 19.5%, 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, L.P.
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 extended 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, 2006 and December 31, 2005, our
accrued liability to Judd Properties L.P. was approximately $1.5 million and
$1.2 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 manufacturing, research and development, sales and marketing
and
general and administrative functions. The Company relocated to another Palo
Alto
facility for these functions, except manufacturing. The Judd lease expired
on
January 31, 2006 and the Company has worked 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 and the Company is paying its monthly
rent obligation to Judd. In connection with the surrender plan with Judd, $1.5
million was accrued in July 2006 as a leasehold asset retirement obligation.
The
Company is in the process of restoring the building in accordance with the
restoration plan.
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 2006, we paid Portfolio Financial
Services $0.4 million in principal and interest payments. As of December 31,
2006 the principal amount outstanding is $1.6 million with an additional amount
of $2.4 million in accrued interest.
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, 2006 and December 31, 2005, our accrued liability to the Trust
was
approximately $0.08 million and $0.2 million, respectively.
Other
Factors Affecting Our Financial Condition and Results of
Operations
Restructuring
activities.
On
January 19, 2006, we announced restructuring activities that included the
closure of our Palo Alto, California manufacturing plant and a reduction in
force of approximately 22% of our worldwide headcount. For 2006, the Company
incurred restructuring charges of $0.9 million.
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 include Mitsui Chemicals, Pilkington PLC, Saint Gobain Sekurit and
V-Kool International Holdings Pte. Ltd., or V-Kool International, which
collectively accounted for approximately 60.1%, 66.0% and 65.9% of our total
revenues in 2006, 2005 and 2004, respectively.
In
September 2003, we entered into an amendment of the agreement with V-Kool
International 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 V-Kool International. The amendment provided
that V-Kool International 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 V-Kool International's 2004 minimum purchase commitments
at $9.0 million.
Under
the original distribution agreement, V-Kool International had been required
to
purchase at least $15.25 million of product in 2004. For each year after 2004
through and including 2011, V-Kool International 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. V-Kool International was obligated to purchase
$10.9
million of products in 2006. During 2006, V-Kool International purchased
approximately $9.0 million of product.
The
remaining balance was rescheduled to the first quarter of 2007 by mutual
agreement.
For the
year ending December 31, 2007, V-Kool International is obligated to purchase
$11.9 million of our products.
Sales
returns and allowances.
Our
gross margins and profitability have been adversely affected from time to time
by product quality claims. From 2002 to 2006, our sales returns provision has
averaged between 2.7% and 4.5% of gross revenues. During 2006, our sales returns
provision has averaged approximately 3.5% of our gross revenues.
Impairment
charge for long-lived assets.
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. In 2006, we incurred approximately
$0.3 million in impairment charges for long-lived assets and realized recoveries
of approximately $0.5 million.
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 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;
|
|
.
|
Stock-based
compensation;
|
|
.
|
Allowances
for doubtful accounts and sales
returns;
|
|
.
|
Valuation
of inventories;
|
| . |
Assessment
of the probability of the outcome of current
litigation;
|
| . |
Restructuring
costs;
|
|
.
|
Valuation
of 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. As of December 31, 2006,
deferred revenues were $0.3 million.
Stock-Based
Compensation. Effective
January 1, 2006, we adopted the fair value recognition provisions of SFAS No.
123 (revised 2004), “Share-Based Payment” (“SFAS 123R”), using the modified
prospective transition method and therefore have not restated results for prior
periods. Under this transition method, stock-based compensation expense in
fiscal 2006 included stock-based compensation expense for all share-based
payment awards granted prior to, but not yet vested as of January 1, 2006,
based
on the grant-date fair value estimated in accordance with the original provision
of SFAS No. 123, “Accounting for Stock-Based Compensation” (“SFAS 123”).
Stock-based compensation expense for all share-based payment awards granted
after January 1, 2006, is based on the grant-date fair value estimated in
accordance with the provisions of SFAS 123R. SFAS 123R requires companies to
estimate the fair value of share-based payment awards on the date of grant
using
an option pricing model. We use the Black-Scholes option model. The value
portion of the award that is ultimately expected to vest is recognized as
compensation expense on a straight-line basis over the requisite service period
of the award, which is generally the option vesting term of four years. Prior
to
the adoption of SFAS 123R, we recognized stock-based compensation expense in
accordance with Accounting Principles Board (“APB”) Opinion No. 25, “Accounting
for Stock Issued to Employees” (“APB 25”). In March 2005, the Securities and
Exchange Commission (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. We have applied the provisions of
SAB
107 in our adoption of SFAS 123R.
In
November 2005, the Financial Accounting Standards Board (“FASB”) issued FASB
Staff Position (“FSP”) No. FAS 123R-3, “Transition Election Related To
Accounting for Tax Effects of Share-Based Payment Awards” (“FSP 123R-3”). We
have elected to adopt the alternative transition method provided in the FSP
123R-3 for calculating the tax effects of stock-based compensation pursuant
to
SFAS 123R. The alternative transition method includes simplified methods to
establish the beginning balance of the additional paid-in capital pool (“APIC
pool”) related to the tax effects of employee stock-based compensation, and to
determine the subsequent impact on the APIC pool and Consolidated Statements
of
Cash Flows of the tax effects of employee stock-based compensation awards that
are outstanding upon adoption of SFAS 123R.
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, 2006, our consolidated balance sheet included allowances for
doubtful accounts and sales returns of $0.1 million and $1.4 million,
respectively. 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. During 2006, 2005 and 2004, we recorded sales return
costs of $0.6 million, $0.7 million and $2.4 million, respectively. We incurred
a credit to bad debt expense of $0.1 million, $0.1 million and $0.5 million
in
2006, 2005 and 2004, respectively. These credits are incurred 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 each of 2006 and 2005, we charged $1.5 million against cost
of
sales for excess and obsolete inventories. In 2004, we charged $2.1 million.
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 3 - 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, 2006.
Valuation
of long-lived assets.
We
assess the valuation 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 $19.1 million, $21.7 million and $22.3 million at
December 31, 2006, 2005 and 2004, respectively, which fully reserved our U.S.
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
June
2006, the Financial Accounting Standards Board issued Interpretation No. 48,
Accounting for Uncertainty in Income Taxes, an interpretation of FAS 109,
Accounting for Income Taxes (FIN 48), to create a single model to address
accounting for uncertainty in tax positions. FIN 48 clarifies the accounting
for
income taxes, by prescribing a minimum threshold a tax position is required
to
meet before being recognized in the financial statements. FIN 48 also provides
guidance on derecognition, measurement, classification, interest and penalties,
accounting in interim periods, disclosure and transition. FIN 48 is effective
for fiscal years beginning after December 15, 2006. As required, we have adopted
FIN 48 as of January 1, 2007. We do not expect that the adoption of FIN 48
will
have a significant impact on our position and results of operations in the
first
quarter of 2007.
In
September 2006, the Financial Accounting Standards Board (“FASB”) issued
Statement of Financial Accounting Standards No. 157, “Fair Value Measurements”
(“SFAS 157”). This statement defines fair value, establishes a framework for
measuring fair value in generally accepted accounting principles and expands
disclosures about fair value measurements. SFAS 157 is effective for financial
statements issued for fiscal years beginning after November 15, 2007, and
interim periods within those fiscal years. We are currently evaluating the
effect that the adoption of SFAS 157 will have on our financial position and
results of operations.
On
September 13, 2006, the Securities and Exchange Commission (“SEC”) issued Staff
Accounting Bulletin No. 108 (“SAB 108”). The interpretations in SAB 108 were
issued to address diversity in practice in quantifying financial statement
misstatement and the potential under current practice for the build up of
improper amounts on the balance sheet. We do not expect that the adoption of
SAB
108 will have a significant impact on our position and results of operations
in
the first quarter of 2007.
In
February 2007, the Financial Accounting Standards Board (“FASB”) issued
Statement of Financial Accounting Standards No. 159, “The Fair Value Option for
Financial Assets and Financial Liabilities - Including an amendment of FASB
Statement No. 115” (“SFAS 159”). The objective of this statement is to improve
financial reporting by providing entities with the opportunity to mitigate
volatility in reported earnings caused by measuring related assets and
liabilities differently without having to apply complex hedge accounting
provisions. SFAS 159 is effective as of the beginning of an entity’s first
fiscal year that begins after November 15, 2007. We are currently evaluating
the
effect that the adoption of SFAS 159 will have on our financial position and
results of operations.
In
addition, the Company is reviewing the Emerging Issues Task Force 06-3 (“EITF
06-3”) issued in June 2006, effective to financial reporting for interim and
annual reporting periods beginning after December 15, 2006. This EITF applies
to
taxes assessed by various governmental authorities on many different types
of
transactions. These taxes range from sales taxes that are applied to a broad
class of transactions involving a wide range of goods and services to excise
taxes that are applied only to specific types of transactions or items. We
are
currently evaluating the effect that the adoption of EITF 06-3 will have on
our
financial position and results of operations.
Results
of Operations
Consolidated
Statements of Operations Data:
|
Years
Ended December 31,
|
||||||||||||||||
|
2006
|
Percent
Change
|
2005
|
Percent
Change
|
2004
|
||||||||||||
|
(dollars
in thousands)
|
||||||||||||||||
|
Net
revenues, by product:
|
||||||||||||||||
|
Automotive
glass
|
$
|
13,433
|
(32
|
)%
|
$
|
19,647
|
(5
|
)%
|
$
|
20,584
|
||||||
|
Electronic
display
|
10,799
|
(23
|
)
|
14,039
|
(32
|
)
|
20,554
|
|||||||||
|
Architectural
|
5,528
|
(7
|
)
|
5,934
|
(15
|
)
|
7,010
|
|||||||||
|
Window
film
|
10,449
|
(31
|
)
|
15,134
|
61
|
9,425
|
||||||||||
|
Total
net revenues
|
40,209
|
(27
|
)
|
54,754
|
(5
|
)
|
57,573
|
|||||||||
|
Cost
of sales
|
24,746
|
(34
|
)
|
37,241
|
1
|
36,787
|
||||||||||
|
Gross
profit
|
15,463
|
(12
|
)
|
17,513
|
(16
|
)
|
20,786
|
|||||||||
|
Operating
expenses:
|
||||||||||||||||
|
Research
and development
|
6,782
|
33
|
5,104
|
60
|
3,199
|
|||||||||||
|
Selling,
general and administrative
|
12,005
|
44
|
8,332
|
(18
|
)
|
10,217
|
||||||||||
|
Restructuring
expenses
|
915
|
--
|
--
|
--
|
--
|
|||||||||||
|
Recoveries
for long-lived assets, net
|
(214
|
)
|
26
|
(170
|
)
|
(89
|
)
|
(1,513
|
)
|
|||||||
|
Total
operating expenses
|
19,488
|
47
|
13,266
|
12
|
11,903
|
|||||||||||
|
Income
(loss) from operations
|
(4,025
|
)
|
nm*
|
4,247
|
52
|
8,883
|
||||||||||
|
Interest
expense, net
|
(737
|
)
|
(24
|
)
|
(973
|
)
|
(56
|
)
|
(2,206
|
)
|
||||||
|
Costs
of warrants issued
|
--
|
--
|
--
|
nm*
|
(6,782
|
)
|
||||||||||
|
Other
income, net
|
210
|
180
|
75
|
(86
|
)
|
534
|
||||||||||
|
Income
(loss) before provision for income taxes
|
(4,552
|
)
|
nm*
|
3,349
|
681
|
429
|
||||||||||
|
Provision
for income taxes
|
958
|
nm*
|
29
|
(95
|
)
|
614
|
||||||||||
|
Net
income (loss)
|
(5,510
|
)
|
nm*
|
3,320
|
nm*
|
(185
|
)
|
|||||||||
|
Deemed
dividend on preferred stock
|
489
|
--
|
490
|
--
|
--
|
|||||||||||
|
Net
income (loss) attributable to common stockholders
|
$
|
(5,999
|
)
|
nm*
|
$
|
2,830
|
nm*
|
$
|
(185
|
)
|
||||||
*
not
meaningful
The
following table sets forth our results of operations expressed as a percentage
of total revenues:
|
Year
Ended December 31,
|
||||||||||
|
2006
|
2005
|
2004
|
||||||||
|
Net
Revenues:
|
||||||||||
|
Automotive
glass
|
33.4
|
%
|
35.9
|
%
|
35.8
|
%
|
||||
|
Electronic
display
|
26.9
|
25.6
|
35.7
|
|||||||
|
Architectural
|
13.7
|
10.8
|
12.2
|
|||||||
|
Window
film
|
26.0
|
27.7
|
16.3
|
|||||||
|
Total
net revenues
|
100.0
|
100.0
|
100.0
|
|||||||
|
Cost
of sales
|
61.5
|
68.0
|
63.9
|
|||||||
|
Gross
profit
|
38.5
|
32.0
|
36.1
|
|||||||
|
Research
and development
|
16.9
|
9.3
|
5.6
|
|||||||
|
Selling,
general and administrative
|
29.9
|
15.2
|
17.7
|
|||||||
|
Restructuring
expenses
|
2.3
|
--
|
--
|
|||||||
|
Recoveries
for long-lived assets, net
|
(0.5
|
)
|
(0.3
|
)
|
(2.6
|
)
|
||||
|
Total
operating expenses
|
48.5
|
24.2
|
20.7
|
|||||||
|
Income
(loss) from operations
|
(10.0
|
)
|
7.8
|
15.4
|
||||||
|
Interest
expense
|
(1.8
|
)
|
(1.8
|
)
|
(3.8
|
)
|
||||
|
Cost
of warrants issued
|
--
|
--
|
(11.8
|
)
|
||||||
|
Other
income, net
|
0.5
|
0.1
|
0.9
|
|||||||
|
Income
(loss) before provision for income taxes
|
(11.3
|
)
|
6.1
|
0.7
|
||||||
|
Provision
for income taxes
|
2.4
|
0.1
|
1.0
|
|||||||
|
Net
income (loss)
|
(13.7
|
)
|
6.1
|
(0.3
|
)
|
|||||
|
Deemed
dividend on preferred stock
|
1.2
|
0.9
|
--
|
|||||||
|
Net
income (loss) attributable to common stockholders
|
(14.9
|
)%
|
5.2
|
%
|
(0.3)
|
%
|
||||
Net
revenues
Net
revenues were $40.2 million in 2006, $54.8 million in 2005 and $57.6 million
in
2004. Net revenues for 2006 decreased by $14.5 million, or 27% from 2005, and
net revenues for 2005 decreased by $2.8 million, or 5% from 2004. We expect
our
net revenues in 2007 to be at approximately the same level as in
2006.
Our
net
revenues in the automotive market decreased by $6.2 million, or 32%, from $19.6
million in 2005 to $13.4 million in 2006. The decrease was primarily due to
a
reduction in demand throughout 2006 by a major customer as a result of their
large inventory build up at 2005 year end and the ongoing “de-contenting” (a
change by auto manufacturers to make the parts in which our products are found
optional features rather than standard features to control their costs) trend
in
the automotive industry. Our net revenues in the automotive market remained
relatively the same in 2005 and 2004 at $19.6 million and $20.6 million,
respectively.
Our
net
revenues in the electronic display market decreased by $3.2 million, or 23%,
from $14.0 million in 2005 to $10.8 million in 2006. 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
$2.6 million from $12.4 million in 2005 to $9.9 million in 2006. 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 in net revenues
in 2006. Also, we encountered yield issues with one electronic display product
as we transferred the manufacture of this product from our Palo Alto facility
to
our German facility in the first half of 2006. Our net revenues in the
electronic display market decreased by 32% or $6.5 million in 2005 when compared
to 2004 as a result of decreased sales to Mitsui Chemicals in the plasma display
market and decreased sales to Mitsubishi as Mitsubishi ceased production of
their 17-inch CRT monitor.
Our
net
revenues in the architectural market decreased in 2006 to $5.5 million from
$5.9
million in 2005. The $0.4 million 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 decreased 15%
or
$1.1 million in 2005 when compared to 2004 due to a decrease in sales from
our
customers in all regions.
Our
net
revenues in our window film market decreased 31% or $4.7 million in 2006 when
compared to 2005. 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 lower
revenues on our TX products in 2006 and higher revenues in 2005 as our customers
bought more products to fill their distribution pipelines in 2005. Our net
revenues in our window film market increased 61% or $5.7 million in 2005 when
compared to 2004. We sell our window film products primarily to customers
located in the Pacific Rim and the Middle East.
Cost
of Sales
Cost
of
sales decreased 33.6% or $12.5 million in 2006 from 2005. As a percent of sales,
cost of sales was 61.5% in 2006 compared to 68% in 2005. 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 decrease in 2006 from 2005
was
primarily due to lower revenues, transfer of production to our lower cost German
manufacturing facility, manufacturing savings as a result of closing our Palo
Alto manufacturing location, partially offset by inventory reserves for our
window film products.
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. The increase in 2005
from 2004 was the result of increased material costs for component materials
and
increased production levels. The production levels increased in 2005 compared
to
2004 due to the increase in customers’ demand for our products.
Gross
margin
Gross
margin increased from 32% in 2005 to 38.5% in 2006. The increase in gross margin
was largely the result of the transfer of our manufacturing operations from
our
Palo Alto facility to our lower cost German manufacturing facility in the second
half of 2006. Gross margin decreased from 36.1% in 2004 to 32% in 2005. This
decrease in gross margin was largely the result of product mix and increased
component material costs. Our window film and electronic display products cost
more to make than other products. We expect our gross margin percentage in
2007
to be higher than 2006 as a result of transferring all of our manufacturing
operations to our lower cost production facility in Germany.
Operating
expenses
Research
and development spending increased 33% or $1.7 million in 2006 compared to
2005.
The increase was due in part to a full year of increased labor and employee
benefit costs as a result of expanding our engineering organization. In 2005,
we
invested in additional engineering resources to support our increased focus
on
new products and technologies. Research and development spending increased
60%
or $1.9 million in 2005 compared to 2004. The increase was due to the expansion
of our engineering organization in the second half of 2005.
Our
selling, general and administrative expenses increased 44% or $3.7 million
in
2006 from 2005. The increase in selling, general and administrative expenses
in
2006 was primarily due to accruals for leasehold asset retirement obligations
of
$1.7 million, severance cost of our former CEO of $344,000, costs related to
the
settlement of a former employee lawsuit of $320,000, higher marketing expenses
of $179,000 and higher facility expenses of $200,000. Our selling, general
and
administrative expenses decreased 18% or $1.9 million in 2005 from 2004 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.
We
expect
out total operating expenses to be lower in 2007 than 2006 as a result of our
efforts to reduce costs.
Restructuring
costs
In
2006,
we recorded a charge to operating expenses of $915,000 as a result of further
reductions in workforce at our Palo Alto manufacturing facility and the
relocation of the company’s headquarters office to Fabian Way, Palo Alto,
California. During 2005 and 2004, we did not incur restructuring
costs.
Recoveries
for long-lived assets
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. In 2006, we incurred approximately
$0.3 million in impairment charges for long-lived assets and realized recoveries
of approximately $0.5 million.
Income
(loss) from operations
Income
from operations decreased from $4.2 million in 2005 to a loss of $4.0 million
in
2006. The decrease was a result of lower revenues, higher research and
development expenses, increased selling, general and administrative costs and
increased restructuring charges. 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.
Interest
expense, net
Interest
expense, net, decreased from $1.0 million in 2005 to $0.7 million in 2006.
The
decrease in interest expense, net, was primarily attributable to less
outstanding debt in 2006 compared to 2005. Interest expense, net, decreased
from
$2.2 million in 2004 to $1.0 million in 2005. The decrease in interest expense,
net, was primarily attributable to less outstanding debt in 2005 compared to
2004.
Cost
of warrants issued
In
the
first quarter of 2004, due to the structure of the transaction contemplated
by
the investment agreement with the Investors, we 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. We 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 our stockholders approved
the increase of the number of authorized shares of our common stock in the
fourth quarter of 2004. As a result of this, we incurred $6.8 million in cost
of
warrants issued in 2004. No warrants were issued in 2005 and 2006.
Other
income, net
Other
income, net, increased from $0.1 million in 2005 to $0.2 million in 2006. 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. Other income, net decreased from $0.5 million
in 2004 to $0.1 million in 2005. 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.
Income
(loss) before provision for income taxes
The
pre-tax income decrease from $3.3 million in 2005 to a loss of $4.6 million
in
2006 was a result of lower revenues and higher operating expenses. 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.
Provision
for income taxes
The
provision for income taxes in 2006, 2005 and 2004 was related to our German
subsidiary, Southwall Europe Gmbh (“SEG”). In 2006, our provision for income
taxes increased to approximately $0.9 million. The increase relates to higher
taxable income in our German subsidiary and additional taxes paid in 2006
relating to an income tax audit for years 1999 to 2002 at SEG. In 2005, our
provision for income taxes decreased approximately to $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.
Net
income (loss)
The
decrease from net income of $3.3 million in 2005 to net loss of $5.5 million
in
2006 was a result of lower revenues, higher operating expenses, recognition
of
stock compensation expense and a higher provision for income taxes. 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 a lower
provision for income taxes.
Deemed
dividend on preferred stock
We
accrued $0.5 million of deemed dividend on preferred stock in each of the years
2006 and 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.
Management
has a plan to return into profitability in the future starting with fiscal
year
2007, and believes that its planned cash flows will sustain its operations
in
2007 and beyond. However, there is no assurance that this would happen. See
item
A.Risk Factors.
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 net losses in 2006 and 2004 and we incurred net income in 2005. We
incurred positive cash flow from operations in 2006, 2005 and 2004.
Our
cash
and cash equivalents decreased by $1.1 million from $6.6 million at December
31,
2005 to $5.5 million at December 31, 2006. Cash provided by operating activities
decreased by $3.3 million from $4.0 million in 2005 to $0.7 million in 2006.
The
decrease in cash provided by operating activities during 2006 was primarily
the
result of net loss for the year of $5.5 million, impairment recoveries from
long-lived assets of $0.2 million and an increase in other current and
non-current assets of $0.1 million partially offset by deferred income taxes
of
$0.05 million, non-cash depreciation of $2.4 million, a stock-based compensation
charge of $0.6 million, a decrease in accounts receivable of $3.1 million,
a
decrease in inventories of $0.3 million and a an increase in accounts payable
and accrued liabilities of $0.2 million. Cash used in investing activities
in
2006 was $0.5 million compared to $0.3 million used in investing activities
in
2005. The increase in cash used in investing activities from 2005 to 2006 was
due to increased expenditures for property, plant and equipment and other assets
partially offset by proceeds from sale of fixed assets. Cash used in financing
activities decreased by $0.1 million from $1.6 million used in financing
activities in 2005 to $1.5 million used in financing activities in 2006. The
decrease was the result of less debt outstanding in 2006, which resulted in
lower principal repayments.
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 $0.7
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, 2006, we had received 5.0 million
Euros, or $5.0 million at a 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,
2006, we had a balance remaining from the government grants received in May
1999
of 167 Euros which had 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 grants and investment allowances, if any, that
we
are 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, we are not eligible to see total investment grants for any year
in
excess of 33% of our 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, 2006, we were in compliance with
the requirements mentioned above.
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. 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, 2006.
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. There were no amounts
outstanding under this second facility at December 31, 2006.
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.
On
May
31, 2006, we renewed the credit agreement for the first facility under the
Credit Agreement with the Bank but did not renew the second facility. The
renewed credit agreement will expire on May 31, 2007.
On
March
29, 2007, Southwall Technologies Inc. (“Southwall”) entered into a new Credit
Agreement (“Credit Agreement ”) with Bridge Bank, N.A. (“Bank”). The Credit
Agreement provides for two facilities. The first facility is a revolving line
of
credit for the lesser of $3 million OR the face value of the letter of credit
used to support the facility. The proceeds of the facility will be used to
pay
off Wells Fargo HSBC Trade Bank. Amounts borrowed under the first facility
bear
interest at the prime rate minus 1.75% and are collateralized by a $3 million
standby letter of credit from Needham & Company.(“Needham”). At December 31,
2006, Needham and its affiliates owned 41.7% of our outstanding common stock
and
series A 10% Cumulative Convertible Preferred Stock convertible into another
5%
of our outstanding common stock. If the letter of credit being provided by
Needham is not released by August 1, 2007, Needham will begin receiving from
us
quarterly interest payments on the $3 million supporting the letter of credit
at
the rate of 12.8% per annum.
The
second facility is a $3 million revolving line of credit line under which we
may, from time to time, borrow up to 80% of eligible accounts receivables (net
of pre-paid deposits, pre-billed invoices, deferred revenue, offsets, contras
related to each specific account debtor and other requirements in the lender’s
discretion). Amounts borrowed under the second facility bear interest at prime
plus 1.75% annualized on the average daily finance amount outstanding. The
second facility also provides for a $2 million letter of credit subfacility.
All
borrowings under the facilities will be collateralized by all of our assets
and
are subject to certain covenants. These covenants include that while the second
facility is outstanding (a) we will maintain a minimum current ratio of 1.00
to
1.00 for the months through May 31, 2007 (thereafter, starting with month ending
June 30, 2007, we need to maintain a current ratio of 1.25 to 1.00 on a monthly
basis); and (b) our quarterly net loss to shareholders (including deemed
dividend) will not exceed $400,000 for any quarter after September 30,
2007.
The
terms
of the Credit Agreement, among other things, limit our ability to (i) incur,
assume or guarantee additional indebtedness (other than pursuant to the Credit
Agreement), (ii) incur liens upon the collateral pledged to the bank, and (iii)
merge, consolidate, sell or otherwise dispose of substantially all or a
substantial or material portion of our assets.
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) 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
maturity date of the facilities is March 28, 2008.
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, 2006 are
described in Note 6 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 $0.8 million and $7.3 million outstanding
under the German bank loans as a short-term liability and long-term liability,
respectively, at December 31, 2006. We are obligated to pay an aggregate of
$0.8
million in principal amount under our German bank loans in 2007.
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 6 of Notes to Consolidated Financial
Statements (Item 8) - Term Debt). At December 31, 2006, the carrying value
of
the liability was $4.0 million ($1.6 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 2007.
Capital
expenditures
We
spent
approximately $0.8 million and $0.4 million in capital expenditures in 2005
and
2004, respectively, primarily to maintain and upgrade our production facilities.
In 2006, we spent approximately $1.2 million for maintenance of the production
machines and research and development tools. We expect to spend approximately
$1.8 million in 2007 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
1
Than
Year
|
1-3
Years
|
3-5
Years
|
Greater
5
Than
Years
|
||||||||||||
|
Contractual
Obligations:
|
||||||||||||||||
|
Term
debt (1)
|
$
|
9,627
|
$
|
1,059
|
$
|
4,708
|
$
|
1,391
|
$
|
2,469
|
||||||
|
Line
of credit
|
2,996
|
2,996
|
--
|
--
|
--
|
|||||||||||
|
Operating
Leases (2)
|
2,168
|
660
|
802
|
706
|
--
|
|||||||||||
|
Total
Contractual Cash Obligations
|
$
|
14,791
|
$
|
4,715
|
$
|
5,510
|
$
|
2,097
|
$
|
2,469
|
||||||
________________
|
(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.
|
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 5.3% at December 31, 2006) 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% adverse
fluctuation in the interest rate on our line of credit and bank loans would
have
had an effect of about $1.3 million on our interest expense for
2006.
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 2006.
Foreign
currency risk: International revenues (defined as sales to customers located
outside of the United States) accounted for approximately 68% of our total
sales
in 2006. Approximately 30% of our international revenues were denominated in
Euros relating to sales from our Dresden operation in 2006. The other 70% 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 $0.7 million on net revenues
for
2006 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
|
54
|
|
Consolidated
Balance Sheets
|
55
|
|
Consolidated
Statements of Operations
|
56
|
|
Consolidated
Statements of Stockholders’ Equity
|
57
|
|
Consolidated
Statements of Cash Flows
|
58
|
|
Notes
to Consolidated Financial Statements
|
59
|
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, 2006 and 2005, and the related
consolidated statements of operations, stockholders’ equity and cash flows for
each of the three years in the period ended December 31, 2006. 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. The Company is not required to
have, nor have we been engaged to perform, an audit of the Company’s internal
control over financial reporting. Our audits included consideration of internal
control over financial reporting as a basis for designing audit procedures
that
are appropriate in the circumstances, but not for the purpose of expressing
an
opinion on the effectiveness of the Company’s internal control over financial
reporting. Accordingly, we express no such opinion. 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, 2006 and 2005, and
the
results of their operations and their cash flows for each of the three years
in
the period ended December 31, 2006, 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.
As
discussed in Note 1 to the consolidated financial statements, on January 1,
2006
the Company changed its method of accounting for stock-based compensation as
a
result of adopting Statement of Financial Accounting Standards No. 123(revised
2004), “Share-Based Payment” applying the modified prospective
method.
/s/
Burr,
Pilger & Mayer LLP
_______________________
Palo
Alto, California
March
29,
2007
SOUTHWALL
TECHNOLOGIES INC.
CONSOLIDATED
BALANCE SHEETS
(in
thousands, except per share data)
|
December
31,
|
|||||||
|
2006
|
2005
|
||||||
|
ASSETS
|
|||||||
|
Current
Assets:
|
|||||||
|
Cash
and cash equivalents
|
$
|
5,524
|
$
|
6,600
|
|||
|
Restricted
cash
|
209
|
402
|
|||||
|
Accounts
receivable, net of allowance for doubtful accounts of
|
|||||||
|
$102
and $208 in 2006 and 2005, respectively
|
3,608
|
6,780
|
|||||
|
Inventories,
net
|
5,598
|
5,879
|
|||||
|
Other
current assets
|
1,064
|
982
|
|||||
|
Total
current assets
|
16,003
|
20,643
|
|||||
|
Property,
plant and equipment, net
|
17,232
|
16,857
|
|||||
|
Restricted
cash loans
|
1,111
|
995
|
|||||
|
Other
assets
|
1,155
|
1,146
|
|||||
|
Total
assets
|
$
|
35,501
|
$
|
39,641
|
|||
|
LIABILITIES,
PREFERRED STOCK AND STOCKHOLDERS' EQUITY
|
|||||||
|
Current
Liabilities:
|
|||||||
|
Current
portion of long term debt
|
$
|
1,059
|
$
|
1,317
|
|||
|
Short
term obligations
|
2,996
|
2,996
|
|||||
|
Accounts
payable
|
955
|
1,402
|
|||||
|
Accrued
compensation
|
859
|
1,161
|
|||||
|
Other
accrued liabilities
|
6,448
|
5,076
|
|||||
|
Total
current liabilities
|
12,317
|
11,952
|
|||||
|
Term
debt
|
8,568
|
8,790
|
|||||
|
Government
grants advanced
|
220
|
396
|
|||||
|
Other
long term liabilities
|
2,550
|
2,564
|
|||||
|
Total
liabilities
|
23,655
|
23,702
|
|||||
|
Commitments
and contingencies (Note 11)
|
|||||||
|
Series
A convertible preferred stock, $0001 par value;
|
|||||||
|
5,000
shares authorized, 4,893 shares outstanding at December 31,2006 and
2005,
respectively (Liquidation preference: $5,788 and $5,383 at 2006 and
2005,
respectively)
|
4,810
|
4,810
|
|||||
|
Stockholders'
Equity:
|
|||||||
|
Common
stock, $0.001 par value; 50,000 shares authorized, and 27,139 and
26,793
shares outstanding at December 31, 2006 and 2005, respectively
|
27
|
27
|
|||||
|
Capital
in excess of par value
|
78,081
|
77,828
|
|||||
|
Accumulated
other comprehensive income: Translation gain on subsidiary
|
3,696
|
2,532
|
|||||
|
Accumulated
deficit
|
(74,768
|
)
|
(69,258
|
)
|
|||
|
Total
stockholders' equity
|
7,036
|
11,129
|
|||||
|
Total
liabilities, preferred stock and stockholders' equity
|
$ |
35,501
|
$
|
39,641
|
|||
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,
|
||||||||||
|
2006
|
2005
|
2004
|
||||||||
|
Net
revenues
|
$
|
40,209
|
$
|
54,754
|
$
|
57,573
|
||||
|
Cost
of revenues
|
24,746
|
37,241
|
36,787
|
|||||||
|
Gross
profit
|
15,463
|
17,513
|
20,786
|
|||||||
|
Operating
expenses:
|
||||||||||
|
Research
and development
|
6,782
|
5,104
|
3,199
|
|||||||
|
Selling,
general and administrative
|
12,005
|
8,332
|
10,217
|
|||||||
|
Restructuring
expenses, net
|
915
|
--
|
--
|
|||||||
|
Recoveries
for long-lived assets, net
|
(214
|
)
|
(170
|
)
|
(1,513
|
)
|
||||
|
Total
operating expenses
|
19,488
|
13,266
|
11,903
|
|||||||
|
Income
(loss) from operations
|
(4,025
|
)
|
4,247
|
8,883
|
||||||
|
Interest
expense, net
|
(737
|
)
|
(973
|
)
|
(2,206
|
)
|
||||
|
Costs
of warrants issued
|
--
|
--
|
(6,782
|
)
|
||||||
|
Other
income, net
|
210
|
75
|
534
|
|||||||
|
Income
(loss) before provision for income taxes
|
(4,552
|
)
|
3,349
|
429
|
||||||
|
Provision
for incomes taxes
|
958
|
29
|
614
|
|||||||
|
Net
income (loss)
|
(5,510
|
)
|
3,320
|
(185
|
)
|
|||||
|
Deemed
dividend on preferred stock
|
489
|
490
|
--
|
|||||||
|
Net
income (loss) attributable to common stockholders
|
$
|
(5,999
|
)
|
$
|
2,830
|
$
|
(185
|
)
|
||
|
Net
income (loss) per share:
|
||||||||||
|
Basic
|
$ |
(0.22
|
)
|
$
|
0.11
|
$
|
(0.01
|
)
|
||
|
Diluted
|
$ |
(0.22
|
)
|
$
|
0.10
|
$
|
(0.01
|
)
|
||
|
Weighted
average shares used in computing net income (loss) per share:
|
||||||||||
|
Basic
|
26,949
|
26,743
|
14,589
|
|||||||
|
Diluted
|
26,949
|
32,895
|
14,589
|
|||||||
The
accompanying notes are an integral part of these consolidated financial
statements.
SOUTHWALL
TECHNOLOGIES INC.
CONSOLIDATED
STATEMENTS OF STOCKHOLDERS' EQUITY
(in
thousands)
|
Accumulated
|
||||||||||||||||||||||
|
Other
|
Total
|
|||||||||||||||||||||
|
Capital
in
|
Comprehensive
|
Stock-
|
Comprehensive
|
|||||||||||||||||||
|
Common
Stock
|
Excess
of
|
Income
|
Accumulated
|
holders’
|
Income
|
|||||||||||||||||
|
Shares
|
Amount
|
Par
Value
|
(Loss)
|
Deficit
|
Equity
|
(Loss)
|
||||||||||||||||
|
Balances,
January 1, 2004
|
12,548
|
$
|
13
|
$
|
70,861
|
$
|
3,240
|
$
|
(72,393
|
)
|
$
|
1,721
|
||||||||||
|
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 option 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
|
||||||||||||||
|
Issuance
of shares to employees under stock purchase plan
|
13
|
--
|
10
|
--
|
--
|
10
|
||||||||||||||||
|
Issuance
of shares on stock options exercise
|
233
|
--
|
113
|
--
|
--
|
113
|
||||||||||||||||
|
Issuance
of shares under executive performance bonus plan
|
100
|
--
|
68
|
--
|
--
|
68
|
||||||||||||||||
|
Employee
stock-based compensation expense
|
--
|
--
|
551
|
--
|
--
|
551
|
||||||||||||||||
|
Dividend
accrual on Series A Preferred Stock
|
--
|
--
|
(489
|
)
|
--
|
--
|
(489
|
)
|
||||||||||||||
|
Foreign
currency translation adjustment
|
--
|
--
|
--
|
1,164
|
--
|
1,164
|
1,164
|
|||||||||||||||
|
Net
loss
|
--
|
--
|
--
|
--
|
(5,510
|
)
|
(5,510
|
)
|
(5,510
|
)
|
||||||||||||
|
Balances,
December 31, 2006
|
27,139
|
$
|
27
|
$
|
78,081
|
$
|
3,696
|
$
|
(74,768
|
)
|
$
|
7,036
|
$
|
(4,346
|
)
|
|||||||
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,
|
||||||||||
|
2006
|
2005
|
2004
|
||||||||
|
Cash
flows provided by operating activities:
|
||||||||||
|
Net
income (loss)
|
$
|
(5,510
|
)
|
$
|
3,320
|
$
|
(185
|
)
|
||
|
Adjustments
to reconcile net income (loss) to net cash provided by operating
activities:
|
||||||||||
|
Deferred
income tax
|
51
|
(508
|
)
|
--
|
||||||
|
Impairment
(recoveries) for long-lived assets, net
|
(214
|
)
|
(170
|
)
|
(1,513 |
)
|
||||
|
Depreciation
and amortization
|
2,406
|
2,195
|
2,503
|
|||||||
|
(Gain)/loss
on disposal of capital equipment
|
--
|
--
|
(26
|
)
|
||||||
|
Stock-based
compensation charge
|
551
|
45
|
--
|
|||||||
|
Amortization
of debt issuance costs
|
--
|
--
|
274
|
|||||||
|
Amortization
of debt discount
|
--
|
--
|
115
|
|||||||
|
Accrued
interest on convertible notes payable
|
--
|
--
|
393
|
|||||||
|
Warrants
issued to investors and creditors
|
--
|
--
|
6,782
|
|||||||
|
Common
stock issued for services
|
--
|
15
|
72
|
|||||||
|
Changes
in operating assets and liabilities:
|
||||||||||
|
Accounts
receivable
|
3,136
|
(914
|
)
|
910
|
||||||
|
Inventories
|
281
|
2,476
|
(1,525
|
)
|
||||||
|
Other
current and non-current assets
|
(81
|
)
|
898
|
(137
|
)
|
|||||
|
Accounts
payable and accrued liabilities
|
128
|
(3,351
|
)
|
(3,833
|
)
|
|||||
|
Net
cash provided by operating activities
|
748
|
4,006
|
3,830
|
|||||||
|
Cash
flows provided by (used in) investing activities:
|
||||||||||
|
Restricted
cash
|
168
|
254
|
3
|
|||||||
|
Proceeds
from sale of property, plant and equipment
|
519
|
170
|
1,640
|
|||||||
|
Expenditures
for property, plant and equipment and other assets
|
(1,192
|
)
|
(766
|
)
|
(382
|
)
|
||||
|
Net
cash provided by (used in) investing activities
|
(505
|
)
|
(342
|
)
|
1,261
|
|||||
|
Cash
flows used in financing activities:
|
||||||||||
|
Principal
payments on borrowings
|
(1,434
|
)
|
(1,532
|
)
|
(2,769
|
)
|
||||
|
Borrowings
on line of credit
|
--
|
2,996
|
--
|
|||||||
|
Repayments
of line of credit
|
--
|
(2,975
|
)
|
(3,869
|
)
|
|||||
|
Repayments
under capital lease
|
--
|
(44
|
)
|
--
|
||||||
|
Use
of investment allowances
|
(222
|
)
|
(42
|
)
|
(158
|
)
|
||||
|
Proceeds
from stock option, warrant and employee stock purchase plan
exercises
|
123
|
31
|
47
|
|||||||
|
Proceeds
from convertible promissory notes
|
--
|
--
|
4,500
|
|||||||
|
Net
cash used in financing activities
|
(1,533
|
)
|
(1,566
|
)
|
(2,249
|
)
|
||||
|
Effect
of foreign exchange rate changes on cash
|
214
|
(45
|
)
|
553
|
||||||
|
Net
increase (decrease) in cash and cash equivalents
|
(1,076
|
)
|
2,053
|
3,395
|
||||||
|
Cash
and cash equivalents, beginning of year
|
6,600
|
4,547
|
1,152
|
|||||||
|
Cash
and cash equivalents, end of year
|
$
|
5,524
|
$
|
6,600
|
$
|
4,547
|
||||
|
Supplemental
cash flow disclosures:
|
||||||||||
|
Interest
paid
|
$
|
944
|
$
|
854
|
$
|
1,019
|
||||
|
Income
taxes paid
|
$
|
836
|
$
|
764
|
$
|
135
|
||||
|
Supplemental
schedule of non-cash investing and financing activities:
|
||||||||||
|
Dividends
accrued
|
$
|
489
|
$
|
490
|
$
|
--
|
||||
|
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 period. Exchange gains
or
losses from the translation of assets and liabilities of $1,164 in 2006 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 $36,
($320) and $457 in 2006, 2005 and 2004, respectively, and are 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 7).
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. At December 31, 2006, deferred
revenues were $275 and are included in other accrued liabilities in the
accompanying balance sheet.
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 $64, $57 and $191 in 2006, 2005 and 2004,
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, 2006 and 2005, our balance sheets included
allowances for doubtful accounts of $102 and $208, 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, 2006 and 2005,
our balance sheets included accrual for sales returns and warranties of $1,415
and $1,556, 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 $4.2 million in excess of $0.1 million of FDIC coverage. We
also
have approximately $1.2 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 77%, 81% and 79% of our net sales
in, 2006, 2005 and 2004, respectively. During 2006, Mitsui Chemicals, Saint
Gobain Sekurit, V-Kool and Pilkington PLC accounted for 24.6%, 8.5%, 20.0%
and
9.5%, respectively, of our net revenues. 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.
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 our revenue, operating results and cash flows in any period.
At
December 31, 2006, receivables from three customers represented 29%, 18% and
14%
of the Company's total accounts receivable. At December 31, 2005, receivables
from three customers represented 24%, 20% and 13% of the Company's total
accounts receivable.
Inventories
Inventories
are stated at the lower of standard cost (determined by the average cost method)
or market (net realizable value). In January 2006, the Company changed its
inventory valuation method from the first-in, first-out method to the average
cost method. With the closing of the Company’s Palo Alto, California
manufacturing facility and all production now being performed in our German
subsidiary’s facility, the use of the average cost method was deemed preferable
as it both accommodates our German subsidiary’s statutory reporting requirements
and fairly approximates actual costs. The impact of the change was not material.
Standard
costs, which approximate actual, include 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 other income (expense). Depreciation
and amortization expense related to property and equipment for 2006, 2005 and
2004 was $2,406, $2,195 and $2,503, 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. As a result of our decision to cease
manufacturing in Palo Alto, we recorded a $0.3 million impairment charge related
to a production machine which was decommissioned in the second quarter of 2006.
In addition for 2006, we recorded the recovery of $0.5 million of previously
recorded impairment charges related to long-lived assets which were impaired
in
prior and current years.
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, 2006 and 2005 approximates fair
value. Based on borrowing rates currently available to the Company for debt
with
similar terms, the carrying value of our term debt approximates 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, 2006, we did not have any derivative financial
instruments or hedging activities.
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 allocated costs.
Comprehensive
income (loss)
The
Company has adopted the provisions of SFAS No. 130 "Reporting Comprehensive
Income". SFAS No. 130 establishes standards for reporting and display in the
financial statements of total net income (loss) 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, in accordance with EITF 94-3, “Liability Recognition for Certain Employee
Termination Benefits and Other Costs to Exit an Activity”. 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".
Stock-Based
Compensation
Effective
January 1, 2006, the Company adopted the fair value recognition provisions
of
SFAS No. 123 (revised 2004), “Share-Based Payment” (“SFAS 123R”), using the
modified prospective transition method and therefore has not restated results
for prior periods. Under this transition method, stock-based compensation
expense in fiscal 2006 included stock-based compensation expense for all
share-based payment awards granted prior to, but not yet vested as of January
1,
2006, based on the grant-date fair value estimated in accordance with the
original provision of SFAS No. 123, “Accounting for Stock-Based Compensation”
(“SFAS 123”). Stock-based compensation expense for all share-based payment
awards granted after January 1, 2006, is based on the grant-date fair value
estimated in accordance with the provisions of SFAS 123R. SFAS 123R requires
companies to estimate the fair value of the share-based payment awards on the
date of grant using an option pricing model. The Company uses the Black-Scholes
option model. The value portion of the award that is ultimately expected to
vest
is recognized as compensation expense on a straight-line basis over the
requisite service period of the award, which is generally the option vesting
term of four years. Prior to the adoption of SFAS 123R, the Company recognized
stock-based compensation expense in accordance with Accounting Principles Board
(“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB 25”).
In March 2005, the Securities and Exchange Commission (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 has applied the provisions of SAB 107 in its adoption of SFAS
123R.
In
November 2005, the Financial Accounting Standards Board (“FASB”) issued FASB
Staff Position (“FSP”) No. FAS 123R-3, “Transition Election Related To
Accounting for Tax Effects of Share-Based Payment Awards” (“FSP 123R-3”). The
Company has elected to adopt the alternative transition method provided in
the
FSP 123R-3 for calculating the tax effects of stock-based compensation pursuant
to SFAS 123R. The alternative transition method includes simplified methods
to
establish the beginning balance of the additional paid-in capital pool (“APIC
pool”) related to the tax effects of employee stock-based compensation, and to
determine the subsequent impact on the APIC pool and Consolidated Statements
of
Cash Flows of the tax effects of employee stock-based compensation awards that
are outstanding upon adoption of SFAS 123R.
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, 2006 and 2004,
there was no difference between the denominators used for the calculation of
basic and diluted net income (loss) per share. At December 31, 2006 and 2004,
there were 5,519 and 4,039 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,
|
||||||||||
|
2006
|
2005
|
2004
|
||||||||
|
Net
income (loss) attributable to common stockholders-basic
|
$
|
(5,999
|
)
|
$
|
2,830
|
$
|
(185
|
)
|
||
|
Add:
Deemed dividend on preferred stock
|
489
|
490
|
--
|
|||||||
|
Net
income (loss) attributable to common stockholders-diluted
|
$
|
(5,510
|
)
|
$
|
3,320
|
$
|
(185
|
)
|
||
|
Weighted
average common shares outstanding-basic
|
26,949
|
26,743
|
14,589
|
|||||||
|
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
|
26,949
|
32,895
|
14,589
|
|||||||
Recent
Pronouncements
In
June
2006, the Financial Accounting Standards Board issued Interpretation No. 48,
Accounting for Uncertainty in Income Taxes, an interpretation of FAS 109,
Accounting for Income Taxes (FIN 48), to create a single model to address
accounting for uncertainty in tax positions. FIN 48 clarifies the accounting
for
income taxes, by prescribing a minimum threshold a tax position is required
to
meet before being recognized in the financial statements. FIN 48 also provides
guidance on derecognition, measurement, classification, interest and penalties,
accounting in interim periods, disclosure and transition. FIN 48 is effective
for fiscal years beginning after December 15, 2006. As required, the Company
has
adopted FIN 48 as of January 1, 2007. The Company does not expect that the
adoption of FIN 48 will have a significant impact on the Company’s financial
position and results of operations in the first quarter of 2007.
In
September 2006, the Financial Accounting Standards Board (“FASB”) issued
Statement of Financial Accounting Standards No. 157, “Fair Value Measurements”
(“SFAS 157”). This statement defines fair value, establishes a framework for
measuring fair value in generally accepted accounting principles and expands
disclosures about fair value measurements. SFAS 157 is effective for financial
statements issued for fiscal years beginning after November 15, 2007, and
interim periods within those fiscal years. We are currently evaluating the
effect that the adoption of SFAS 157 will have on our financial position and
results of operations.
On
September 13, 2006, the Securities and Exchange Commission (“SEC”) issues Staff
Accounting Bulletin No. 108 (“SAB 108”). The interpretations in SAB 108 were
issued to address diversity in practice in quantifying financial statement
misstatement and the potential under current practice for the build up of
improper amounts on the balance sheet. We do not expect that the adoption of
SAB
108 will have a significant impact on the Company’s financial position and
result of operations in the first quarter of 2007.
In
February 2007, the Financial Accounting Standards Board (“FASB”) issued
Statement of Financial Accounting Standards No. 159, “The Fair Value Option for
Financial Assets and Financial Liabilities - Including an amendment of FASB
Statement No. 115” (“SFAS 159”). The objective of this statement is to improve
financial reporting by providing entities with the opportunity to mitigate
volatility in reported earnings caused by measuring related assets and
liabilities differently without having to apply complex hedge accounting
provisions. SFAS 159 is effective as of the beginning of an entity’s first
fiscal year that begins after November 15, 2007. We are currently evaluating
the
effect that the adoption of SFAS 159 will have on our financial position and
results of operations.
In
addition, the Company is reviewing the Emerging Issues Task Force 06-3 (“EITF
06-3”) issued in June 2006, effective to financial reporting for interim and
annual reporting periods beginning after December 15, 2006. This EITF applies
to
taxes assessed by various governmental authorities on many different types
of
transactions. These taxes range from sales taxes that are applied to a broad
class of transactions involving a wide range of goods and services to excise
taxes that are applied only to specific types of transactions or items. We
are
currently evaluating the effect that the adoption of EITF 06-3 will have on
our
financial position and results of operations.
NOTE
2 - STOCK-BASED COMPENSATION
Prior
to
January 1, 2006, the Company accounted for its stock option plans
under the recognition and measurement provisions of APB 25. Accordingly, the
Company generally recognized compensation expense only when it granted options
with a discounted exercise price. Any resulting compensation expense was
recognized ratably over the associated service period, which was generally
the
option vesting term. Prior to January 1, 2006, the Company provided pro-forma
disclosure amounts in accordance with SFAS No. 148, “Accounting for Stock-Based
Compensation-Transition and Disclosure” (“SFAS 148”), as if the fair value
method defined by SFAS 123 had been applied to its stock-based compensation.
As
a result of adopting SFAS 123R, losses before income taxes in fiscal 2006 were
higher by $551, than if we had continued to account for stock-based compensation
under APB 25. The impact on both basic and diluted loss per share in fiscal
2006
was $0.02 per share.
Effective
January 1, 2006, the Company adopted the provisions of SFAS 123R requiring
it to
recognize expense related to the fair value of its stock-based compensation
awards. The Company elected to use the modified prospective transition method
as
permitted by SFAS 123R and therefore has not restated its financial results
for
prior periods. Under this transition method, stock-based compensation expense
for the fiscal year 2006 includes compensation expense for all stock-based
compensation awards granted prior to, but not yet vested as of January 1, 2006,
based on the grant date fair value estimated in accordance with the original
provisions of SFAS 123. Stock-based compensation expense for all stock-based
compensation awards granted subsequent to January 1, 2006 was based on the
grant-date fair value estimated in accordance with the provisions of SFAS 123R.
SFAS
123R
requires companies to estimate the fair value of the share-based payment awards
on the date of grant using an option pricing model. The Company uses the
Black-Scholes option model. The value portion of the award that is ultimately
expected to vest is recognized as compensation on
a
straight line basis over the requisite service period of the award, which is
generally four years.
The
following table sets forth the total stock-based compensation expense resulting
from stock options included in the consolidated statements of operations in
2006:
|
Cost
of sales
|
$
|
53
|
||
|
Research
and development
|
142
|
|||
|
Selling,
general and administrative
|
356
|
|||
|
Stock-based
compensation expense before income taxes
|
551
|
|||
|
Income
tax benefit
|
--
|
|||
|
Total
stock-based compensation expense after income taxes
|
$
|
551
|
Cash
proceeds from the exercise of stock options in 2006 were $113. There were
immaterial cash proceeds from the exercise of stock in 2005 and 2004. No income
tax benefit was realized from stock option exercises for 2006, 2005 and 2004.
In
accordance with SFAS 123R, the Company presents excess tax benefits from the
exercise of stock options, if any, as financing cash flows rather than operating
cash flows.
Prior
to
the adoption of SFAS 123R, the Company applied SFAS 123, amended by SFAS No.
148, which allowed companies to apply the existing accounting rules under APB
25, and related Interpretations. In general, as the exercise price of options
granted under these plans was equal to the market price of the underlying common
stock on the grant date, no stock-based employee compensation cost was
recognized in the Company's net income (loss). As required by SFAS 148 prior
to
the adoption of SFAS 123R, the Company provided pro forma net income (loss)
and
pro forma net income (loss) per common share disclosures for stock-based awards,
as if the fair-value-based method defined in SFAS 123 had been
applied.
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
|
||||||
|
Net
income (loss) attributable to common stockholders
|
|||||||
|
As
reported
|
$
|
2,830
|
$
|
(185
|
)
|
||
|
Add:
Stock-based employee compensation expense included in reported net
income
(loss), net of related tax effects
|
45
|
--
|
|||||
|
Deduct:
Total stock-based employee compensation determined under fair value
based
method for all awards, net of related tax effects
|
(686
|
)
|
(693
|
)
|
|||
|
Pro
forma net income (loss)
|
$
|
2,189
|
$
|
(878
|
)
|
||
|
Net
income (loss) per share:
|
|||||||
|
As
reported - basic.
|
$
|
0.11
|
$
|
(0.01
|
)
|
||
|
As
reported - diluted
|
$
|
0.10
|
$
|
(0.01
|
)
|
||
|
Pro
forma - basic
|
$
|
0.08
|
$
|
(0.06
|
)
|
||
|
Pro
forma - diluted
|
$
|
0.08
|
$
|
(0.06
|
)
|
||
The
Company has a stock-based compensation program that provides its Board of
Directors broad discretion in creating employee equity incentives. 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 1997 and 1998 Stock Option Plans on May 12, 1997 and
August 6, 1998, respectively. 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 1998 plan
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. Options granted under the 1997 plan 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 eighteen months after the optionee
terminates his relationship with the Company. Grants from and after October
2004
until April 2006 under both plans vest at a rate of 25% after six months and
then evenly monthly thereafter for the remaining 42 months. Grants from and
after April 2006 under both plans vest at a rate of 25% per year on each
anniversary of the grant date.
As
of
December 31, 2006, there were 2,080 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, 2004
|
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
|
|||||
|
Granted
|
1,322
|
$
|
0.38
- $ 0.82
|
0.61
|
||||||
|
Exercised
|
(233
|
)
|
$
|
0.50
- $ 0.50
|
0.50
|
|||||
|
Cancelled
or expired
|
(824
|
)
|
$
|
0.50
- $15.00
|
2.07
|
|||||
|
Options
outstanding at December 31, 2006
|
5,837
|
$
|
0.38
- $ 9.90
|
$
|
1.28
|
|||||
The
fair
value of stock-based awards was estimated using the Black-Scholes model with
the
following weighted-average assumptions for 2006, 2005 and 2004:
|
2006
|
2005
|
2004
|
||||||||
|
Expected
life (in years)
|
4.3
|
2.17
|
1.7
|
|||||||
|
Risk-free
interest rate
|
4.80
|
%
|
4.20
|
%
|
2.90
|
%
|
||||
|
Volatility
|
109
|
%
|
117
|
%
|
116
|
%
|
||||
|
Dividend
|
n/a
|
n/a
|
n/a
|
|||||||
|
Weighted-average
fair value at grant date
|
.37
|
.46
|
.54
|
|||||||
The
Company's computation of expected volatility for 2006 is based on historical
volatility. The Company's computation of expected life is based on historical
exercise patterns. The interest rate for periods within the expected life of
the
award is based on the U.S. Treasury yield in effect at the time of grant. We
have not issued or declared any dividends on our common stock.
Additional
information regarding options outstanding, exercisable and expected to vest
as
of December 31, 2006 is as follows:
|
Shares
|
Weighted-Average
Exercise Price
|
Weighted-Average
Remaining Contractual Term (in years)
|
Aggregate
Intrinsic Value
|
||||||||||
|
Outstanding
at December 31, 2006
|
5,837
|
$
|
1.28
|
7.43
|
$
|
16
|
|||||||
|
Vested
and expected to vest at December 31, 2006
|
5,194
|
$
|
1.35
|
7.23
|
$
|
14
|
|||||||
|
Exercisable
at December 31, 2006
|
3,403
|
$
|
1.65
|
6.40
|
$
|
0
|
|||||||
The
aggregate intrinsic value in the table above represents the total pretax
intrinsic value (i.e., the difference between Southwall's closing stock price
on
the last trading day of fiscal 2006 and the exercise price, times the number
of
shares) that would have been received by the option holders had all option
holders exercised their options on December 31, 2006. This amount changes based
on the fair market value of Southwall's stock. Total intrinsic value of options
exercised was immaterial for 2006, 2005 and 2004.
As
of
December 31, 2006, $0.5 million of total recognized compensation cost related
to
stock options, net of forfeitures, was expected to be recognized over a
weighted-average period of approximately 1.39 years.
The
following table summarizes information about stock options outstanding at
December 31, 2006:
|
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
|
|||||||||||
|
$
0.38 -- $0.41
|
318
|
9.70
|
$
|
0.41
|
5
|
$
|
0.41
|
|||||||||
|
$
0.50 -- $0.50
|
972
|
7.53
|
0.50
|
895
|
0.50
|
|||||||||||
|
$
0.54 -- $0.54
|
100
|
9.85
|
0.54
|
0
|
0.00
|
|||||||||||
|
$
0.58 -- $0.58
|
1,025
|
8.94
|
0.58
|
430
|
0.58
|
|||||||||||
|
$
0.62 -- $0.71
|
876
|
9.31
|
0.68
|
118
|
0.68
|
|||||||||||
|
$
0.73 -- $0.98
|
599
|
7.37
|
0.84
|
398
|
0.86
|
|||||||||||
|
$
1.05 -- $1.22
|
638
|
7.60
|
1.18
|
348
|
1.17
|
|||||||||||
|
$
1.28 -- $1.81
|
696
|
5.35
|
1.69
|
632
|
1.71
|
|||||||||||
|
$
1.92 -- $8.00
|
577
|
2.71
|
4.89
|
541
|
4.89
|
|||||||||||
|
$
9.90 -- $9.90
|
36
|
2.32
|
9.90
|
36
|
9.90
|
|||||||||||
|
$
0.38 -- $9.90
|
5,837
|
3,403
|
||||||||||||||
Employee
Stock Purchase Plan
In
March
1997, the Company adopted the 1997 Employee Stock Purchase Plan ("the 1997
Plan"). 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 2006,
2005 and 2004, 13, 13 and 7 shares, respectively, were sold under the 1997
Plan.
At December 31, 2006, there were 1,190 shares available for issuance under
the
1997 Plan.
NOTE
3 - BALANCE SHEET DETAIL
|
December
31,
|
|||||||
|
2006
|
2005
|
||||||
|
Inventories,
net:
|
|||||||
|
Raw
materials
|
$
|
3,850
|
$
|
3,482
|
|||
|
Work-in-process
|
221
|
1,409
|
|||||
|
Finished
goods
|
1,527
|
988
|
|||||
|
$
|
5,598
|
$
|
5,879
|
||||
|
December
31,
|
|||||||
|
2006
|
2005
|
||||||
|
Property,
plant and equipment, net:
|
|||||||
|
Land,
buildings and leasehold improvements
|
$
|
7,507
|
$
|
7,296
|
|||
|
Machinery
and equipment
|
28,914
|
28,592
|
|||||
|
Furniture
and fixtures
|
1,364
|
946
|
|||||
|
37,785
|
36,834
|
||||||
|
Less
- accumulated depreciation and amortization
|
(20,553
|
)
|
(19,977
|
)
|
|||
|
Total
property, plant and equipment, net
|
$
|
17,232
|
$
|
16,857
|
|||
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.
In 2006, we incurred a restructuring charge of $915 relating to the closure
of
the Palo Alto manufacturing facility and the related severance and incentive
payout to terminated employees. A manufacturing asset was also decommissioned
in
2006.
The
following tables set forth the beginning and ending liability balances relating
to the above described restructuring activities as well as activity during
2006,
2005 and 2004:
|
Workforce
Reduction
|
Facilities
Related
|
Total
|
||||||||
|
Balance
at January 1, 2004
|
$
|
--
|
$
|
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
|
||||
|
Provisions
|
375
|
812
|
1,187
|
|||||||
|
Adjustment
to reserve
|
(7
|
)
|
(265
|
)
|
(272
|
)
|
||||
|
Cash
payments
|
(349
|
)
|
(644
|
)
|
(993
|
)
|
||||
|
Balance
at December 31, 2006
|
$
|
19
|
$
|
102
|
$
|
121
|
||||
At
December 31, 2006, $121 was included in other accrued liabilities in the
accompanying 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, 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
|
||||
As
of
December 31, 2006, our reserve for sales returns and warranties was as
follows:
|
Balance
at December 31,2005
|
Provision
|
Utilized
|
Balance
at December 31,2006
|
||||||||||
|
Accrued
sales returns and warranties
|
$
|
1,556
|
$
|
603
|
$
|
(744
|
)
|
$
|
1,415
|
||||
These
amounts are included in other accrued liabilities in the accompanying
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.
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.
NOTE
4 - 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 $7,500 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 $393. 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 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, 2006, $979 has been accrued
in
dividends and is included in other accrued liabilities in the accompanying
consolidated 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
5 - 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 were renewed on May 31, 2006 and must be repaid on or before May
31,
2007.
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, 2006.
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. There was no amount
outstanding under the second facility at December 31, 2006.
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
6 - TERM DEBT
The
Company's term debt consisted of the following:
|
Description
|
Rate
|
Balance
at December 31,2006
|
Due
in 2007
|
|||||||
|
Term
debt:
|
||||||||||
|
German
bank loan dated May 12, 1999
|
6.13
|
%
|
$
|
1,349
|
$
|
449
|
||||
|
German
bank loan dated May 28, 1999
|
7.10%
|
(1)
|
3,292
|
--
|
||||||
|
German
bank loan dated May 28, 2000
|
7.15%
|
(2)
|
1,164
|
310
|
||||||
|
German
bank loan dated
|
||||||||||
|
August
14, 1999 (due June 30, 2009)
|
5.75
|
%
|
2,222
|
--
|
||||||
|
Settlement
agreement dated February 20, 2004
|
|
(3)
|
1,600
|
300
|
||||||
|
Total
term debt
|
9,627
|
$
|
1,059
|
|||||||
|
Less
current portion
|
1,059
|
|||||||||
|
Term
debt, non-current
|
$
|
8,568
|
||||||||
|
(1)
|
Interest
rate will be reset to the then prevailing market rate in
2009.
|
|
(2)
|
Interest
rate is fixed at 7.15% until final repayment in
2010.
|
|
(3)
|
Interest
rate was 5% for 2006, and will increase by one percentage point peryear
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 and $125, plus interest
payments until 2010. At December 31, 2006, the carrying value of the liability
was $3,954 ($1,600 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 (“Accounting by Debtors and
Creditors for Troubled Debt Restructurings”) and EITF 02-04 (“Determining
Whether a Debtors’ Modification or Exchange of Debt Instruments Is Within The
Scope of FASB Statement No. 15”) 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, 2006 is $1,600.
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, 2009. Of the borrowings outstanding of $1,349 under this bank loan at
December 31, 2006, $900 was classified as non-current in the accompanying
consolidated balance sheet. The interest rate was 6.13% in 2006.
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, 2006; 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 $3,292 at December 31, 2006, $3,292 was
classified as non-current in the accompanying consolidated 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 bore fixed interest at 3.75%
per
annum for the period of seven years. At December 31, 2006, the amount due under
this second tranche was $0. 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 until the final payment in 2010. At
December 31, 2006, the amount due was $1,164; of this amount, $854 was
classified as non-current in the accompanying consolidated 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
consolidated balance sheet. The amount due under this bank loan at December
31,
2006 was $2,222, which was classified as a non-current liability in the
accompanying consolidated 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,
2006.
Scheduled
principal payments of term debt for the next five years and thereafter, are
as
follows:
|
Amount
|
||||
|
2007
|
$
|
1,059
|
||
|
2008
|
1,061
|
|||
|
2009
|
3,647
|
|||
|
2010
|
1,062
|
|||
|
2011
|
329
|
|||
|
Thereafter
|
2,469
|
|||
|
Total
|
$
|
9,627
|
||
The
Company incurred total interest on indebtedness of $944, $1,156 and $2,300
in
2006, 2005 and 2004, respectively.
NOTE
7 - 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, 2006, the
Company had received approximately 5,000 Euros ($5,000) 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, 2006, the Company had a balance remaining from the government
grants received in May 1999 of 167 Euros ($209), 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 was 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 was from March 15, 1999 to June
30,
2006.
|
|
(c)
|
The
total investment during the construction period should be at least
33,728
Euros ($33,883).
|
|
(d)
|
The
project must create at least one hundred fifteen permanent jobs and
five
apprenticeships by June 30, 2006.
|
We believe we have met the above requirements at June 30, 2006. However, we are at negotiations with the Saxony government with regards to the unused grants. We expect to close these grants by April 2007.
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 33,728 Euros
($33,883), subject to European Union regulatory approval. During 2000, 2001,
2002, 2003, 2004, 2005 and 2006 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),
158 Euros ($190) and 38 Euros ($49), 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, 2006, we were in compliance with the requirements mentioned
above.
NOTE
8 - INCOME TAXES
The
provision for income taxes for the years then ended December 31, 2006, 2005
and
2004 consist of the following:
|
2006
|
2005
|
2004
|
||||||||
|
Current:
|
||||||||||
|
Federal
|
$
|
--
|
$
|
--
|
$
|
--
|
||||
|
State
|
37
|
(17
|
)
|
32
|
||||||
|
Foreign
|
870
|
554
|
525
|
|||||||
|
Total
current
|
$
|
907
|
$
|
537
|
$
|
557
|
||||
|
Deferred:
|
||||||||||
|
Federal
|
$
|
--
|
$
|
--
|
$
|
--
|
||||
|
State
|
--
|
--
|
--
|
|||||||
|
Foreign
|
51
|
(508
|
)
|
57
|
||||||
|
Total
deferred
|
$
|
51
|
$
|
(508
|
)
|
$
|
57
|
|||
|
Total
provision
|
$
|
958
|
$
|
29
|
$
|
614
|
||||
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.
U.S.
and
foreign pre-tax income are broken-down as follows:
|
2006
|
2005
|
2004
|
||||||||
| U.S. | $ | (7,340 | ) | $ | 1,826 | $ | (1,893 | ) | ||
| Foreign | 2,788 | 1,523 | 2,322 | |||||||
| Total | $ | (4,552 | ) | $ | 3,349 | $ | 429 | |||
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 are as follows:
|
December
31,
|
|||||||
|
2006
|
2005
|
||||||
|
Deferred
Tax Assets:
|
|||||||
|
Federal
and state net operating losses
|
$
|
13,723
|
$
|
12,160
|
|||
|
Research,
MIC, and other tax credits
|
1,715
|
1,822
|
|||||
|
Accruals
|
3,049
|
2,191
|
|||||
|
Depreciation
and amortization
|
470
|
5,545
|
|||||
|
Stock-based
compensation
|
126
|
--
|
|||||
|
Foreign
temporary differences
|
105
|
118
|
|||||
|
Other
|
--
|
--
|
|||||
|
Net
deferred tax assets
|
19,188
|
21,836
|
|||||
|
Deferred
tax assets valuation allowance
|
(19,083
|
)
|
(21,718
|
)
|
|||
|
Net
deferred tax asset
|
$
|
105
|
$
|
118
|
|||
The
net
deferred tax asset is included in other current assets on the consolidated
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 have
been offset by a valuation allowance of $19,083. The valuation allowance
decreased by $2,635 for the period ended December 31, 2006.
As
of
December 31, 2006, the Company has net operating loss carry forwards for federal
income tax purposes of approximately $38,083 which expire beginning in the
year
2007 through 2026. The Company also has California net operating loss carry
forwards of approximately $6,850 which expire beginning in the year 2007 through
2016.
The
Company has federal and California research and development tax credits of
$645
and $1,272 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 $200, 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
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 a 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, both of
which were recorded as a 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 included 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 was 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:
|
2006
|
2005
|
2004
|
||||||||
|
Automotive
glass
|
$
|
13,433
|
$
|
19,647
|
$
|
20,584
|
||||
|
Electronic
display
|
10,799
|
14,039
|
20,554
|
|||||||
|
Architectural
|
5,528
|
5,934
|
7,010
|
|||||||
|
Window
film
|
10,449
|
15,134
|
9,425
|
|||||||
|
Total
net revenues
|
$
|
40,209
|
$
|
54,754
|
$
|
57,573
|
||||
The
following is a summary of net revenue by geographic area (based on location
of
customer):
|
2006
|
2005
|
2004
|
||||||||
|
United
States
|
$
|
12,850
|
$
|
14,362
|
$
|
12,186
|
||||
|
Japan
|
10,197
|
12,499
|
18,387
|
|||||||
|
France
|
3,457
|
10,870
|
10,283
|
|||||||
|
Pacific
Rim
|
7,997
|
10,461
|
7,228
|
|||||||
|
Germany
|
3,324
|
3,831
|
5,787
|
|||||||
|
Rest
of the world
|
2,384
|
2,731
|
3,702
|
|||||||
|
Total
net revenues
|
$
|
40,209
|
$
|
54,754
|
$
|
57,573
|
||||
Southwall
operates from facilities located in the United States and Germany. Long-lived
assets were as follows:
|
December
31,
|
|||||||
|
2006
|
2005
|
||||||
|
United
States
|
$
|
754
|
$
|
667
|
|||
|
Germany
|
16,478
|
16,190
|
|||||
|
Consolidated
|
$
|
17,232
|
$
|
16,857
|
|||
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, 2006, the future minimum payments under
these leases are as follows:
|
Year
Ending December 31,
|
Operating
Leases
|
|||
|
2007
|
$
|
660
|
||
|
2008
|
338
|
|||
|
2009
|
464
|
|||
|
2010
|
466
|
|||
|
2011
|
240
|
|||
|
Future
minimum lease payments
|
$
|
2,168
|
||
Rent
expense under operating leases was approximately $713, $861 and $1,600 in 2006,
2005 and 2004, respectively.
On
February 19, 2004, the Company entered into the second amendment to the lease
for its Palo Alto, California manufacturing facility. This amendment reflected
a
payment schedule for a rent deferral for this facility. In January 2006, the
Company paid off approximately $1.2 million of this deferred rent. On January
19, 2006, the Company announced its plans to close its Palo Alto manufacturing
facility. As a result of this decision, the Company is in negotiation with
its
landlord to decommission and surrender these premises. The Company has accrued
$1.5 million as a current leasehold asset retirement obligation in the third
quarter of 2006 and is included in other accrued liabilities in the accompanying
balance sheet. The method and timing of payments are yet to be finalized.
Environmental studies are currently being performed on this property before
it
is surrendered to the landlord. This estimate of our liability could differ
from
the actual future settlement amount.
In
January 2006, the Company renewed a lease agreement for its research and
development facility. Under this lease agreement, the Company accrued $0.2
million as a current leasehold obligation in the first quarter of 2006. The
method and timing of payments are not yet finalized.
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.
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 points 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
2006, 2005 and 2004, the Company recovered $214, $170 and $1,513, respectively,
from the sales of previously written-down equipment and production machines.
In
2006, the Company incurred impairment charges of $305 and recoveries of
$519.
NOTE
13 - SAVINGS 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 $1.5 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, 2006, 2005 and 2004. Matching contributions during 2006, 2005
or
2004 were $69, $80 and $100 respectively.
NOTE
14 - SUBSEQUENT EVENTS
Sunfilm
AG
On
March
16, 2007, Southwall entered into a Technology Transfer and Service Agreement
(the “Agreement”) with Sunfilm AG , a German company (“Sunfilm”). Pursuant to
the Agreement, Southwall will transfer to Sunfilm, and grant Sunfilm a royalty
free license in, certain technical know-how related to thin film technology
for
use in specific photovoltaic applications, not related to Southwall’s current
business activities. In addition, Southwall will provide Sunfilm with certain
management services to assist Sunfilm with the start-up of production
activities, including assistance with procuring a subsidy from the government
of
Saxony and assistance with the engineering and design of production facilities.
Southwall
has also agreed to purchase the site on which Sunfilm’s production facility is
expected to be located and to transfer the site to Sunfilm. Upon transfer of
the
site to Sunfilm, Sunfilm will reimburse Southwall for payments made by Southwall
related to the purchase price of the site. Sunfilm, however, will not be
obligated to take ownership of the site under certain conditions, including
if
the Sunfilm start-up does not proceed for any reason or is terminated on or
before September 1, 2007. Should this situation occur, the site purchase
agreement provides that Southwall can return the site to its original seller
in
exchange for the purchase price.
Sunfilm
will pay to Southwall up to $3,000 under the Agreement, based on the achievement
of milestones. Southwall will receive the first $1,000 upon approval of a Saxony
subsidy and entry into an agreement to buy the site by Southwall. Sunfilm is
required to make four additional payments of $500 each upon the achievement
of
additional milestones.
Bridge
Bank, N.A. Facility
On
March
29, 2007, Southwall Technologies Inc. (“Southwall”) entered into a new Credit
Agreement (“Credit Agreement ”) with Bridge Bank, N.A. (“Bank”). The Credit
Agreement provides for two facilities. The first facility is a revolving line
of
credit for the lesser of $3 million or the face value of the letter of
credit used to support the facility. The proceeds of the facility will be used
to pay off Wells Fargo HSBC Trade Bank. Amounts borrowed under the first
facility bear interest at the prime rate minus 1.75% and are collateralized
by a
standby letter of credit from Needham & Company Inc. (“Needham”). At
December 31, 2006, Needham and its affiliates owned 41.7% of our outstanding
common stock and series A 10% Cumulative Convertible Preferred convertible
into
another 5% of our outstanding common stock. If the letter of credit being
provided by Needham is not released by August 1, 2007, Needham will begin
receiving from us quarterly interest payments on the $3 million supporting
the
letter of credit at the rate of 12.8% per annum.
The
second facility is a $3 million revolving line of credit line under which we
may, from time to time, borrow up to 80% of eligible accounts receivables (net
of pre-paid deposits, pre-billed invoices, deferred revenue, offsets, contras
related to each specific account debtor and other requirements in the lender’s
discretion). Amounts borrowed under the second facility bear interest at prime
plus 1.75% annualized on the average daily finance amount outstanding. The
second facility also provides for a $2 million letter of credit subfacility.
All
borrowings under the facilities will be collateralized by all of our assets
and
are subject to certain covenants. These covenants include that while the second
facility is outstanding (a) we will maintain a minimum current ratio of 1.00
to
1.00 for the months through May 31, 2007 (thereafter, starting with month ending
June 30, 2007, we need to maintain a current ratio of 1.25 to 1.00 on a monthly
basis); and (b) our quarterly net loss to shareholders (including deemed
dividend) will not exceed $400 for any quarter after September 30,
2007.
The
terms
of the Credit Agreement, among other things, limit our ability to (i) incur,
assume or guarantee additional indebtedness (other than pursuant to the Credit
Agreement), (ii) incur liens upon the collateral pledged to the bank, and (iii)
merge, consolidate, sell or otherwise dispose of substantially all or a
substantial or material portion of our assets.
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) 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
maturity date of the facilities is March 28, 2008.
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 principal executive officer and principal financial
officer,
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, 2006. Based on this evaluation, our principal
executive officer and principal financial officer 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
principal executive officer and principal financial officer, 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 for the fiscal year
ending
December 31, 2007 and an attestation from our independent registered
public accounting firm in our Annual Report on Form 10-K beginning
with
the filing for our fiscal year ending December 31, 2008.
|
|
(c)
|
Changes
in Internal Controls.
There were no changes during 2006 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, EXECUTIVE OFFICERS OF REGISTRANT AND
CORPORATE GOVERNANCE
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 407 of Regulation S-K relating to board meetings, our nominating
committee, audit committee and compensation committee and shareholder
communications 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
AND RELATED STOCKHOLDER MATTERS
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,
AND DIRECTOR INDEPENDENCE
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. Information regarding director
independence is set forth under “Corporate Governance” 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
|
53
|
|
Consolidated
Balance Sheets as of December 31, 2006 and 2005
|
54
|
|
Consolidated
Statements of Operations for the years ended December 31, 2006, 2005
and
2004
|
55
|
|
Consolidated
Statements of Stockholders' Equity for the years ended December 31,
2006,
2005 and 2004
|
56
|
|
Consolidated
Statements of Cash Flows for the years ended December 31, 2006, 2005
and
2004
|
57
|
|
Notes
to Consolidated Financial Statements
|
58
|
(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
|
|||||||||
|
2006
|
|||||||||||||
|
Inventory
reserves
|
$
|
759
|
$
|
1,546
|
$
|
1,895
(2
|
)
|
$
|
410
|
||||
|
Allowance
for Doubtful Accounts
|
$
|
208
|
$
|
(63
|
)
|
$
|
43
(2
|
)
|
$
|
102
|
|||
|
Reserves
for warranty and sales returns
|
$
|
1,556
|
$
|
603
|
(1)
|
$
|
744
(2
|
)
|
$
|
1,415
|
|||
|
Tax
valuation allowance
|
$
|
21,718
|
$
|
--
|
$
|
2,635
(2
|
)
|
$
|
19,083
|
||||
|
2005
|
|||||||||||||
|
Inventory
reserves
|
$
|
1,254
|
$
|
1,710
|
$
|
2,205
(2
|
)
|
$
|
759
|
||||
|
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
|
||||
(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 30,
2007.
|
SOUTHWALL
TECHNOLOGIES INC.
|
||
|
By:
|
/s/
Raymond Eugene Goodson
|
|
|
R.
Eugene Goodson
|
||
|
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 30, 2007.
|
Signature
|
Title
|
|
/s/Raymond
Eugene Goodson
R.
Eugene Goodson
|
President,
Chief Executive Officer and Director (Principal Executive
Officer)
|
|
/s/Sylvia
Kamenski
Sylvia
Kamenski
|
Vice
President of Finance (Acting Principal Financial
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/Andre
R. Horn
Andre
R. Horn
|
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 V-Kool International 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 V-Kool International 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 V-Kool International 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.
|
|
|
10.120(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.
|
|
|
10.127
(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.
|
|
|
10.138(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(31)
|
Lease
agreement for the facilities at 3780 Fabian Way, Palo Alto, CA, dated
October 04, 2005 between the Company, Richard Christina and Diane
Christina.
|
|
| 10.142(32) | Sublease dated June 13, 2006, by and between the Registrant and Maxspeed Corporation. | |
| 10.142(32) | Amendment to lease dated June 21, 2006, by and between the Registrant Richard A. Christina and Diane L. Christina, Trustees of the Richard A. Christina and Diane L. Christina Trust. | |
|
10.143
|
Technology
Transfer and Service Agreement between Sunfilm AG and the Company
dated
03/14/07.
|
|
|
10.144
|
Business
Financing Agreement dated 03/29/07 between the Company and Bridge
Bank
NA.
|
|
|
14(27)
|
Code
of Ethics.
|
|
|
21(15)
|
List
of Subsidiaries of the Company.
|
|
|
Consent
of Independent Registered Public Accounting Firm (Burr, Pilger & Mayer
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.
(31)
Filed as an exhibit to the Form 10-K Annual Report, filed with the Commission
on
March 29, 2006, and incorporated herein by reference.
(32)
Filed as an exhibit to the Form 10-Q Quarterly Report, filed with the Commission
on August 11, 2006, and incorporated herin by reference.
95