SECURITIES
AND EXCHANGE COMMISSION
Washington,
D.C. 20549
__________________
FORM
10-Q
|
(MARK
ONE)
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|
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|
x
|
QUARTERLY
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
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|
For
the quarterly period ended July 3, 2005
or
|
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|
o
|
TRANSITION
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
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For
the transition period from
to
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Commission
File Number: 0-15930
___________________
SOUTHWALL
TECHNOLOGIES INC.
(Exact
name of registrant as specified in its charter)
|
Delaware
(State
or other jurisdiction of incorporation or organization)
|
|
94-2551470
(I.R.S.
Employer Identification Number)
|
|
|
|
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3975
East Bayshore Road, Palo Alto, California
(Address
of principal executive offices)
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94303
(Zip
Code)
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Registrant's
telephone number, including area code:
(650) 962-9111
___________________
Indicate
by check mark whether the registrant (1) has filed all reports required to
be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes x No o
Indicate
by check mark whether the registrant is an accelerated filer (as defined
in Rule
12b-2 of the Exchange Act). Yes
o No x
As
of
August 1, 2005, there were 26,787,881 shares of the Registrant's Common
Stock
outstanding.
INDEX
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Page
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PART
I - FINANCIAL INFORMATION
|
|
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3 |
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4 |
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5 |
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6
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11
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17
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25
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PART
II - OTHER INFORMATION
|
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|
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26
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|
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26
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|
|
26
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|
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26
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|
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26
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|
|
27
|
|
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28
|
UNAUDITED
CONDENSED CONSOLIDATED BALANCE SHEETS
(in
thousands, except per share data)
|
|
July
3,
|
|
December
31,
|
|
|
|
2005
|
|
2004
|
|
ASSETS
|
|
Current
assets:
|
|
|
|
|
|
Cash
and cash equivalents
|
|
$
|
7,628
|
|
$
|
4,547
|
|
Restricted
cash
|
|
|
426
|
|
|
686
|
|
Accounts
receivable, net of allowance for doubtful accounts of $221
at July 3, 2005
and $292 at December 31, 2004
|
|
|
5,772
|
|
|
6,186
|
|
Inventories,
net
|
|
|
7,081
|
|
|
8,355
|
|
Other
current assets
|
|
|
1,337
|
|
|
1,757
|
|
Total
current assets
|
|
|
22,244
|
|
|
21,531
|
|
|
|
|
|
|
|
|
|
Property,
plant and equipment, net
|
|
|
18,007
|
|
|
21,110
|
|
Restricted
cash loans
|
|
|
1,020
|
|
|
1,149
|
|
Other
assets
|
|
|
1,134
|
|
|
1,157
|
|
Total
assets
|
|
$
|
42,405
|
|
$
|
44,947
|
|
|
|
|
|
|
|
|
|
LIABILITIES,
REDEEMABLE PREFERRED STOCK AND STOCKHOLDERS’
EQUITY
|
|
|
|
|
|
|
|
|
|
Current
liabilities:
|
|
|
|
|
|
|
|
Current
portion of long term debt and capital leases
|
|
$
|
1,280
|
|
$
|
1,463
|
|
Line
of credit
|
|
|
2,996
|
|
|
2,975
|
|
Accounts
payable
|
|
|
1,984
|
|
|
2,544
|
|
Accrued
compensation
|
|
|
952
|
|
|
1,378
|
|
Other
accrued liabilities
|
|
|
5,940
|
|
|
6,643
|
|
Total
current liabilities
|
|
|
13,152
|
|
|
15,003
|
|
|
|
|
|
|
|
|
|
Term
debt and capital leases
|
|
|
9,637
|
|
|
11,644
|
|
Government
grants advance
|
|
|
426
|
|
|
505
|
|
Other
long term liabilities
|
|
|
2,947
|
|
|
3,222
|
|
Total
liabilities
|
|
|
26,162
|
|
|
30,374
|
|
|
|
|
|
|
|
|
|
Commitments
and contingencies (Note 5)
|
|
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|
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Series
A 10% cumulative preferred stock, $0.001 par value; $1.00 stated
value;
5,000 shares authorized, 4,810 shares outstanding (Liquidation
preference $4,893)
|
|
|
4,810
|
|
|
4,810
|
|
|
|
|
|
|
|
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Stockholders’
equity:
|
|
|
|
|
|
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|
Common
stock, $0.001 par value per share; 50,000 shares authorized,
26,788 shares
and 26,488 shares outstanding at July 3, 2005 and December
31, 2004,
respectively
|
|
|
27
|
|
|
26
|
|
Capital
in excess of par value
|
|
|
78,072
|
|
|
77,957
|
|
Accumulated
other comprehensive income:
|
|
|
|
|
|
|
|
Cumulated
translation adjustment
|
|
|
2,818
|
|
|
4,358
|
|
Accumulated
deficit
|
|
|
(69,484
|
)
|
|
(72,578
|
)
|
Total
stockholders’ equity
|
|
|
11,433
|
|
|
9,763
|
|
|
|
|
|
|
|
|
|
Total
liabilities, redeemable preferred stock and stockholders’ equity
|
|
$
|
42,405
|
|
$
|
44,947
|
|
See
accompanying notes to unaudited condensed consolidated financial
statements.
UNAUDITED
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in
thousands, except per share data)
|
|
Three
months ended
|
|
Six
months ended
|
|
|
|
July
3,
|
|
June
27,
|
|
July
3,
|
|
June
27,
|
|
|
|
2005
|
|
2004
|
|
2005
|
|
2004
|
|
|
|
|
|
|
|
|
|
|
|
Net
revenues
|
|
$
|
15,172
|
|
$
|
14,548
|
|
$
|
30,819
|
|
$
|
25,615
|
|
Cost
of revenues
|
|
|
9,788
|
|
|
8,936
|
|
|
21,058
|
|
|
17,402
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross
profit
|
|
|
5,384
|
|
|
5,612
|
|
|
9,761
|
|
|
8,213
|
|
|
|
|
|
|
|
|
|
|
|
|
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|
|
Operating
expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Research
and development
|
|
|
1,017
|
|
|
771
|
|
|
1,713
|
|
|
1,581
|
|
Selling,
general and administrative
|
|
|
2,331
|
|
|
2,520
|
|
|
4,357
|
|
|
5,583
|
|
Impairment
recoveries for long-lived assets
|
|
|
-
|
|
|
(1,428
|
)
|
|
(170
|
)
|
|
(1,428
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
operating expenses
|
|
|
3,348
|
|
|
1,863
|
|
|
5,900
|
|
|
5,736
|
|
Income
from operations
|
|
|
2,036
|
|
|
3,749
|
|
|
3,861
|
|
|
2,477
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest
expense, net
|
|
|
(297
|
)
|
|
(635
|
)
|
|
(568
|
)
|
|
(1,240
|
)
|
Cost
of warrants issued
|
|
|
-
|
|
|
(1,473
|
)
|
|
-
|
|
|
(6,291
|
)
|
Other
income (expenses), net
|
|
|
(159
|
)
|
|
(112
|
)
|
|
133
|
|
|
248
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income
(loss) before provision for income taxes
|
|
|
1,580
|
|
|
1,529
|
|
|
3,426
|
|
|
(4,806
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Provision
for income taxes
|
|
|
185
|
|
|
343
|
|
|
332
|
|
|
698
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
income (loss)
|
|
|
1,395
|
|
|
1,186
|
|
|
3,094
|
|
|
(5,504
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Deemed
dividend on redeemable preferred stock
|
|
|
120
|
|
|
-
|
|
|
243
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
income (loss) attributable to common stockholders
|
|
$
|
1,275
|
|
$
|
1,186
|
|
$
|
2,851
|
|
$
|
(5,504
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
income (loss) per share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
$
|
0.05
|
|
$
|
0.09
|
|
$
|
0.11
|
|
$
|
(0.44
|
)
|
Diluted
|
|
$
|
0.04
|
|
$
|
0.04
|
|
$
|
0.09
|
|
$
|
(0.44
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Shares
used in computing net income (loss) per share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
|
26,782
|
|
|
12,548
|
|
|
26,697
|
|
|
12,548
|
|
Diluted
|
|
|
33,094
|
|
|
31,416
|
|
|
33,138
|
|
|
12,548
|
|
See
accompanying notes to unaudited condensed consolidated financial
statements.
UNAUDITED
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in
thousands)
|
|
Six
months ended
|
|
|
|
July
3,
|
|
June
27,
|
|
|
|
2005
|
|
2004
|
|
|
|
|
|
|
|
Cash
flows from operating activities:
|
|
|
|
|
|
Net
income (loss)
|
|
$
|
3,094
|
|
$
|
(5,504
|
)
|
Adjustments
to reconcile net income (loss) to net cash provided by (used
in)operating activities:
|
|
|
|
|
|
|
|
Impairment
recoveries from long-lived assets
|
|
|
(170
|
)
|
|
(1,428
|
)
|
Depreciation
and amortization
|
|
|
1,134
|
|
|
1,218
|
|
Charges
related to warrants issued to investors and creditors
|
|
|
-
|
|
|
6,291
|
|
Amortization
of debt issuance costs
|
|
|
-
|
|
|
59
|
|
Unamortized
debt discount
|
|
|
-
|
|
|
116
|
|
Stock
compensation
|
|
|
45
|
|
|
-
|
|
Change
in assets and liabilities:
|
|
|
|
|
|
|
|
Deferred
revenues
|
|
|
(17
|
)
|
|
-
|
|
Accounts
receivable, net
|
|
|
246
|
|
|
1,381
|
|
Inventories,
net
|
|
|
1,274
|
|
|
159
|
|
Other
current and non current assets
|
|
|
443
|
|
|
(1,316
|
)
|
Accounts
payable and accrued liabilities
|
|
|
(1,850
|
)
|
|
(2,556
|
)
|
|
|
|
|
|
|
|
|
Net
cash provided by (used in) operating activities
|
|
|
4,199
|
|
|
(1,580
|
)
|
|
|
|
|
|
|
|
|
Cash
flows from investing activities:
|
|
|
|
|
|
|
|
Restricted
cash
|
|
|
237
|
|
|
147
|
|
Proceeds
from sale of property, plant and equipment
|
|
|
170
|
|
|
1,180
|
|
Expenditures
for property, plant and equipment
|
|
|
(406
|
)
|
|
(512
|
)
|
|
|
|
|
|
|
|
|
Net
cash provided by investing activities
|
|
|
1
|
|
|
815
|
|
|
|
|
|
|
|
|
|
Cash
flows from financing activities:
|
|
|
|
|
|
|
|
Repayments
under capital lease
|
|
|
(5
|
)
|
|
-
|
|
Proceeds
from exercise of stock options
|
|
|
19
|
|
|
-
|
|
Principal
payment on borrowings
|
|
|
(986
|
)
|
|
(1,600
|
)
|
Payments
on line of credit
|
|
|
(2,975
|
)
|
|
(2,295
|
)
|
Borrowings
on line of credit
|
|
|
2,996
|
|
|
-
|
|
Proceeds
from sale of convertible promissory notes
|
|
|
-
|
|
|
4,500
|
|
Investment
credit in Germany
|
|
|
(22
|
)
|
|
-
|
|
|
|
|
|
|
|
|
|
Net
cash provided by (used in) financing activities
|
|
|
(973
|
)
|
|
605
|
|
|
|
|
|
|
|
|
|
Effect
of foreign exchange rate changes on cash
|
|
|
(146
|
)
|
|
433
|
|
|
|
|
|
|
|
|
|
Net
increase in cash and cash equivalents
|
|
|
3,081
|
|
|
273
|
|
Cash
and cash equivalents, beginning of period
|
|
|
4,547
|
|
|
1,152
|
|
|
|
|
|
|
|
|
|
Cash
and cash equivalents, end of period
|
|
$
|
7,628
|
|
$
|
1,425
|
|
See
accompanying notes to unaudited condensed consolidated financial
statements.
NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Note 1--Interim
Period Reporting:
The
accompanying interim condensed consolidated financial statements of Southwall
Technologies Inc. (“Southwall” or the “Company”) are unaudited and have been
prepared in accordance with accounting principles generally accepted in
the
United States of America for interim financial information and with the
instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly,
certain
information and footnote disclosure normally included in financial statements
prepared in accordance with accounting principles generally accepted in
the
United States of America have been condensed or omitted. In the opinion
of
management, the unaudited condensed consolidated financial statements reflect
all adjustments, consisting only of normal recurring adjustments, considered
necessary to present fairly the financial position, results of operations
and
cash flows of Southwall and its subsidiaries for all periods presented.
The
Company suggests that these condensed consolidated financial statements
be read
in conjunction with the consolidated financial statements and notes thereto
contained in the Company's Form 10-K for the year ended December 31,
2004 filed with the Securities and Exchange Commission on March 30, 2005.
The
results of operations for the interim periods presented are not necessarily
indicative of the operating results of the full year.
The
Company uses a 52-week fiscal year ending on December 31. The quarters
ended July 3, 2005 and June 27, 2004 each included 13 weeks.
Note 2--Balance
Sheet:
Inventories,
net
Inventories
are stated at the lower of cost (determined by the first-in, first-out
method)
or market. Cost includes materials, labor and manufacturing overhead. The
Company establishes provisions for excess and obsolete inventories to reduce
such inventories to their estimated net realizable value. Such provisions
are
charged to cost of revenues. At July 3, 2005 and December 31, 2004, inventories
consisted of the following (in thousands):
|
|
July
3,
|
|
December
31,
|
|
|
|
2005
|
|
2004
|
|
Raw
materials
|
|
$
|
3,727
|
|
$
|
4,755
|
|
Work-in-process
|
|
|
1,829
|
|
|
2,059
|
|
Finished
goods
|
|
|
1,525
|
|
|
1,541
|
|
|
|
$
|
7,081
|
|
$
|
8,355
|
|
Other
long-term liabilities
Other
long-term liabilities consisted of the following at July 3, 2005 and December
31, 2004 (in thousands):
|
|
July
3,
|
|
December
31,
|
|
|
|
2005
|
|
2004
|
|
Liabilities
associated with Settlement Agreement
|
|
|
2,354
|
|
|
2,354
|
|
Deferred
tax liability
|
|
|
219
|
|
|
397
|
|
Long-term
restructuring costs
|
|
|
147
|
|
|
200
|
|
Other
|
|
|
227
|
|
|
271
|
|
|
|
$
|
2,947
|
|
$
|
3,222
|
|
Note 3--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
redeemable 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 was 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, stock options to
purchase 1,844,255 shares at an average price of $4.61 per share were
excluded from the computation of diluted weighted average shares outstanding
for
the three and six-month periods ended July 3, 2005. Stock options to purchase
2,972,571 shares at an average price of $4.43 per share were excluded from
the
computation of diluted weighted average shares outstanding for the three-month
period ended June 27, 2004.
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, for the six-month period
ended
June 27, 2004 there was no difference between the denominators used for
the
calculation of basic and diluted net income (loss) per share. For the six-month
period ended June 27, 2004, there were 24,400 and 18,741,500 anti-dilutive
options and warrants outstanding, respectively, excluded from the net loss
per share calculation. Tables
summarizing net income (loss) attributable to common stockholders, for
diluted
net income per share and shares outstanding are shown below (in
thousands):
|
|
Three
months ended
|
|
Six
months ended
|
|
|
|
July
3,
|
|
June
27,
|
|
July
3,
|
|
June
27,
|
|
|
|
2005
|
|
2004
|
|
2005
|
|
2004
|
|
Net
income (loss) attributable to common stockholders-basic
|
|
$
|
1,275
|
|
$
|
1,186
|
|
$
|
2,851
|
|
$
|
(5,504
|
)
|
Add:
Interest expense on convertible promissory notes
|
|
|
-
|
|
|
147
|
|
|
-
|
|
|
-
|
|
Add:
Deemed dividend on redeemable preferred stock
|
|
|
120
|
|
|
-
|
|
|
243
|
|
|
-
|
|
Net
income (loss) attributable to common stockholders-diluted
|
|
$
|
1,395
|
|
$
|
1,333
|
|
$
|
3,094
|
|
$
|
(5,504
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted
average common shares outstanding-basic
|
|
|
26,782
|
|
|
12,548
|
|
|
26,697
|
|
|
12,548
|
|
Dilutive
effect of warrants
|
|
|
357
|
|
|
14,241
|
|
|
357
|
|
|
-
|
|
Dilutive
effect of performance shares
|
|
|
-
|
|
|
-
|
|
|
75
|
|
|
-
|
|
Dilutive
effect of Series A preferred shares
|
|
|
4,893
|
|
|
4,500
|
|
|
4,893
|
|
|
-
|
|
Dilutive
effect of stock options
|
|
|
1,062
|
|
|
127
|
|
|
1,116
|
|
|
-
|
|
Weighted
average common shares outstanding - diluted
|
|
|
33,094
|
|
|
31,416
|
|
|
33,138
|
|
|
12,548
|
|
Note 4
- Segment Reporting:
Southwall
reports segment information using the management approach to determine
segment
information. The management approach designates the internal organization
that
is used by management for making operating decisions and assessing performance
as the source of its reportable segments. The Company is organized on the
basis
of products and services. The total net revenues for the automotive glass,
electronic display, window film and architectural product lines for the
three
and six month periods ended July 3, 2005 and June 27, 2004 were as follows
(in
thousands):
|
|
Three
months ended
|
|
Six
months ended
|
|
|
|
July
3,
|
|
June
27,
|
|
July
3,
|
|
June
27,
|
|
|
|
2005
|
|
2004
|
|
2005
|
|
2004
|
|
Automotive
glass
|
|
$
|
4,937
|
|
$
|
5,627
|
|
$
|
11,322
|
|
$
|
10,028
|
|
Electronic
display
|
|
|
3,297
|
|
|
5,796
|
|
|
7,376
|
|
|
9,215
|
|
Window
film
|
|
|
5,481
|
|
|
1,805
|
|
|
9,127
|
|
|
3,649
|
|
Architectural
|
|
|
1,457
|
|
|
1,320
|
|
|
2,994
|
|
|
2,723
|
|
Total
net revenues
|
|
$
|
15,172
|
|
$
|
14,548
|
|
$
|
30,819
|
|
$
|
25,615
|
|
The
following is a summary of net revenues by geographic area (based on the
location
of the Company's customers) for the second quarters and the first six months
of
2005 and 2004, respectively (in thousands):
|
|
Three
months ended
|
|
Six
months ended
|
|
|
|
July
3,
|
|
June
27,
|
|
July
3,
|
|
June
27,
|
|
|
|
2005
|
|
2004
|
|
2005
|
|
2004
|
|
United
States
|
|
$
|
3,995
|
|
$
|
2,966
|
|
$
|
7,711
|
|
$
|
4,447
|
|
Japan
|
|
|
2,631
|
|
|
5,285
|
|
|
6,430
|
|
|
8,259
|
|
France
|
|
|
3,170
|
|
|
2,471
|
|
|
6,493
|
|
|
4,719
|
|
Pacific
Rim
|
|
|
3,523
|
|
|
1,520
|
|
|
6,085
|
|
|
3,190
|
|
Germany
|
|
|
1,368
|
|
|
1,473
|
|
|
2,713
|
|
|
2,896
|
|
Rest
of the world
|
|
|
485
|
|
|
833
|
|
|
1,387
|
|
|
2,104
|
|
Total
net revenues
|
|
$
|
15,172
|
|
$
|
14,548
|
|
$
|
30,819
|
|
$
|
25,615
|
|
Note 5--Commitments
and Contingencies:
The
insurance carriers in some of the litigation related to alleged product
failures
and defects in window products manufactured by others in which the Company
was 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 the Company. As a result, those insurance
carriers
could seek from the Company 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 the Company's insurance policies. The Company intends
to
vigorously defend any attempts by these insurance carriers to seek
reimbursement. The Company is 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, the Company is involved, from time to time, in certain other
legal
actions arising in the ordinary course of business. Southwall believes,
however,
that none of these actions, either individually or in the aggregate, will
have a
material adverse effect on its business, its consolidated financial position,
results of operations or cash flows.
Note 6--Stock-Based
Compensation:
Statement
of Financial Accounting Standards No. 148 (“SFAS 148”), “Accounting for
Stock-Based Compensation - Transition and Disclosure, an Amendment of FASB
Statement No. 123” amends the disclosure requirements of Statement of Financial
Accounting Standards No. 123 (“SFAS 123”), “Accounting for Stock-Based
Compensation,” to require more prominent disclosures in both annual and interim
financial standards regarding the method of accounting for stock-based
employee
compensation and the effect of the method used on reported results.
The
Company accounts for stock-based employee compensation arrangements in
accordance with provisions of Accounting Principles Board Opinion No. 25
(“APB25”), “Accounting for Stock Issued to Employees” and related
interpretations. Under APB 25, compensation expense is based on the difference,
if any, on the date of the grant, between the fair value of the Company's
stock
and the exercise price.
The
following table illustrates the effect on net income (loss) attributable
to
common stockholders and net income (loss) attributable to common stockholders
per share if the Company had applied the fair value recognition provisions
of
SFAS 123 and SFAS 148 to stock-based employee compensation (in thousands,
except
per share amounts):
|
|
Three
months ended
|
|
Six
months ended
|
|
|
|
July
3,
|
|
June
27,
|
|
July
3,
|
|
June
27,
|
|
|
|
2005
|
|
2004
|
|
2005
|
|
2004
|
|
Net
income (loss) attributable to common stockholders:
|
|
|
|
|
|
|
|
|
|
As
reported
|
|
$
|
1,275
|
|
$
|
1,186
|
|
$
|
2,851
|
|
$
|
(5,504
|
)
|
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
|
|
|
(149
|
)
|
|
(194
|
)
|
|
(302
|
)
|
|
(202
|
)
|
Pro
forma net income (loss) attributable to common
stockholders
|
|
$
|
1,126
|
|
$
|
992
|
|
$
|
2,594
|
|
$
|
(5,706
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
income (loss) attributable to common stockholders per
share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As
reported - basic
|
|
$
|
0.05
|
|
$
|
0.09
|
|
$
|
0.11
|
|
$
|
(0.44
|
)
|
Pro
forma - basic
|
|
$
|
0.04
|
|
$
|
0.08
|
|
$
|
0.10
|
|
$
|
(0.46
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As
reported - diluted
|
|
$
|
0.04
|
|
$
|
0.04
|
|
$
|
0.09
|
|
$
|
(0.44
|
)
|
Pro
forma - diluted
|
|
$
|
0.04
|
|
$
|
0.04
|
|
$
|
0.09
|
|
$
|
(0.46
|
)
|
The
fair
value of each option grant under the Company's stock option plans is estimated
on the date of grant using the Black-Scholes option pricing model, multiple
option approach, with the following weighted average assumptions used for
grants
in the second quarter of 2005 and 2004, respectively: expected volatility
of
116%, and 99%; risk-free interest rate of 3.75% and 3.8%; and expected
lives
from vesting date of 2.25 years and 2.89 years. The weighted average fair
value
of stock options granted in the second quarters of 2005 and 2004 was $0.97
and
$1.81 per share, respectively. The Company did not pay dividends on common
stock
during these periods and assumed no dividend yield. The Company granted
100,000
and no options during the second quarters of 2005 and 2004,
respectively.
The
following weighted average assumptions were used for grants during the
first six
months of 2005 and 2004, respectively: expected volatility of 116%, and
116%;
risk-free interest rate of 3.61% and 2.28%; and expected lives from vesting
date
of 1.63 years and 2.05 years. The weighted average fair value of stock
options
granted during the first six months of 2005 and 2004 was $0.59 and $1.05
per
share, respectively. The Company did not pay dividends on common stock
during
these periods and assumed no dividend yield. The Company granted 368,361
and
746,001 options during the first six months of 2005 and 2004,
respectively.
Note
7 - Restructuring:
The
Company implemented a reduction in force at its Palo Alto location in December
2002, and elected to vacate certain buildings in Palo Alto. As result of
these
actions, the Company incurred a restructuring charge of $2.6 million in
2002
relating to employee severance packages and the remaining rents due on
excess
facilities in Palo Alto no longer occupied.
The
following tables set forth the beginning and ending liability balances
relating
to the above described restructuring activity as well as activity during
the
fiscal quarters ended July 3, 2005 and June 27, 2004 (in
thousands):
|
|
Excess
|
|
|
|
Facilities
|
|
|
|
|
|
Balance
at January 1, 2004
|
|
$
|
1,569
|
|
Provisions
|
|
|
-
|
|
Adjustment
to reserve
|
|
|
(144
|
)
|
Cash
payments
|
|
|
(569
|
)
|
Balance
at June 27, 2004
|
|
$
|
856
|
|
|
|
Excess
|
|
|
|
Facilities
|
|
|
|
|
|
Balance
at January 1, 2005
|
|
$
|
274
|
|
Provisions
|
|
|
-
|
|
Adjustment
to reserve
|
|
|
-
|
|
Cash
payments
|
|
|
(21
|
)
|
Balance
at July 3, 2005
|
|
$
|
253
|
|
Note
8 - Guarantees:
The
Company establishes a reserve for sales returns and warranties for specifically
identified, as well as anticipated sales returns and warranties based on
experience. The reserve for sales returns and warranties at June 27, 2004
and
July 3, 2005 were as follows (in thousands):
|
|
Balance
at
|
|
|
|
|
|
Balance
at
|
|
|
|
December
31,
|
|
|
|
|
|
June
27,
|
|
|
|
2003
|
|
Provision
|
|
Utilized
|
|
2004
|
|
Accrued
sales returns and warranty
|
|
$
|
1,850
|
|
$
|
578
|
|
$
|
(434
|
)
|
$
|
1,994
|
|
|
|
Balance
at
|
|
|
|
|
|
Balance
at
|
|
|
|
December
31,
|
|
|
|
|
|
July
3,
|
|
|
|
2004
|
|
Provision
|
|
Utilized
|
|
2005
|
|
Accrued
sales returns and warranty
|
|
$
|
2,701
|
|
$
|
242
|
|
$
|
(808
|
)
|
$
|
2,135
|
|
Note
9 - Recent Accounting Pronouncements:
In
April
2005, the Securities and Exchange Commission approved a new rule that delays
the
effective date of Statement of Financial Accounting Standards No. 123 (revised
2004) to the first annual reporting period beginning after June 15, 2005.
Adoption of this statement will have an impact on the Company's consolidated
financial statements as the Company will be required to expense the fair
value
of the Company's stock option grants and stock purchases under the Company's
employee stock purchase plan rather than disclose the impact on the Company's
consolidated net income (loss) within the Company's footnotes, as is the
Company's current practice. The Company is currently evaluating the impact
that
adoption of this standard will have on its consolidated results of operations
and financial condition beginning January 1, 2006 when it becomes
effective.
Item
2--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 our unaudited condensed
consolidated financial statements and notes thereto appearing elsewhere
in this
report. This discussion and analysis contains forward-looking statements
that
involve risks and uncertainties, including those discussed below under
"Forward-Looking Statements" and "Risk Factors" and in our Annual Report
on
Form 10-K for the year ended December 31, 2004. You should not place
undue reliance on these forward-looking statements. Actual results may
differ
materially from those anticipated in the forward-looking statements. These
forward-looking statements represent our judgment as of the date of the
filing
of this Form 10-Q.
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; transparent conductive
films for use in touch screen and liquid crystal displays; energy control
films
for architectural glass; and various other coatings.
Restructuring
and financing activities.
As a
consequence of the decline in our revenues and negative cash flows in 2003,
we
implemented several cost cutting and business restructuring activities
during
2003 and 2004. These activities, which included employee layoffs and the
closure
of several facilities (including the closure of our Tempe manufacturing
facility
in the fourth quarter of 2003), were designed to improve our cash flow
from
operations to allow us to continue as a going concern. During the fourth
quarter
of 2003 and the first quarter of 2004, we agreed to new payment terms with
all
of our major creditors and vendors, which extended or reduced our payment
obligations. We also issued $4.5 million of convertible promissory notes
and
warrants to investors. The convertible promissory notes were converted
to Series
A preferred shares and the warrants were exercised for shares of common
stock in
the fourth quarter of 2004.
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.
In
1999,
we expanded our relationship with customers in the automotive glass and
window
film markets, including Pilkington PLC, Saint Gobain Sekurit and Globamatrix
Holdings Pte. Ltd., or Globamatrix, which collectively accounted for
approximately 58%, 45%, 45% and 37% of our total revenues during the first
six
months of 2005 and in 2004, 2003 and 2002, respectively.
Under
our
agreement with Globamatrix, as amended, Globamatrix agreed to a 2004 minimum
purchase commitment of $9.0 million of products.
For each
year after 2004 through and including 2011, Globamatrix is required to
purchase
an amount of product equal to 110% of the amount of product it was required
to
purchase in the prior year. Globamatrix is obligated to purchase $10.3
million
of products in 2005. During the second quarter and the first six months
of 2005,
Globamatrix purchased approximately $5.5 and $8.9 million of products,
respectively.
Sales
returns and allowances.
Our
gross margins and profitability have been adversely affected from time
to time
by product quality claims. From 2000 to 2004 our sales returns provision
has
averaged approximately 3.5% to 4.7% of gross revenues. In 2002, we had
certain
quality claims with respect to products produced for Globamatrix, which
reduced
our gross profit by approximately $1.5 million. During
the first six months of 2005, our sales returns provision has average
approximately 2.6% of our gross revenues due to fewer quality claims received
during the period.
Three
Months Ended July 3, 2005 compared with Three Months Ended June 27,
2004
Results
of Operations
Net
revenues.
Our net
revenues for the three months ended July 3, 2005 and June 27, 2004 were
$15.2
million and $14.5 million, respectively.
Our
net
revenues in the window film market increased by $3.7 million, or 203.7%,
from
$1.8 million in the second quarter of 2004 to $5.5 million in the same
period in
2005. Revenues from our Solis products for the second quarter of 2005 increased
to $3.8 million from $1.4 million in the same period of 2004 due to higher
demand for this product. In addition, revenues from our TX products for
the
second quarter of 2005 increased to $1.7 million from $0.4 million in the
same
period of 2004 as a result of a change in the supply chain to improve the
company’s profitability. We expect future revenues from TX products to be at the
same level as 2004.
Our
net
revenues in the electronic display market decreased by $2.5 million, or
43.1%,
from $5.8 million in the second quarter of 2004 to $3.3 million in the
same
period of 2005. The decrease was primarily due to lower demand for our
sputtered
thin film filter products for Plasma Display Panel products due to increased
competition. Mitsui Chemicals is our primary customer in the electronic
display
market. Sales to Mitsui decreased $1.9 million from $4.2 million in the
second
quarter of 2004 to $2.3 million in the same period in 2005 due to lower
demand
for our product in the flat panel display, or FPD market. In addition, we
phased out our unprofitable anti-reflective product lines and stopped selling
these products in 2005. We sold $0.3 million anti-reflective products in
the
second quarter of 2004.
Our
net
revenues in the automotive and architectural markets remained relatively
the
same in the second quarter of 2005 compared to the same period in
2004.
Cost
of revenues.
Cost of
revenues consists of materials and subcontractor services, labor and
manufacturing overhead. Cost of revenues was $9.8 million in the second
quarter
of 2005 compared to $8.9 million in the same period of 2004. The increase
in
cost of nrevenues was primarily due to an increase in materials cost related
to
our increased sales.
Gross
profit and gross margin.
Our
gross profit decreased $0.2 million from $5.6 million in the second quarter
of
2004 to $5.4 million in the same period of 2005. As a percent of sales,
gross
profit decreased from 38.6% in the second quarter of 2004 to 35.5% in the
same
period in 2005. The decrease related to lower average selling prices in
all
products lines in the second quarter of 2005 due increased competition,
which we
expect to continue.
Operating
expenses
Research
and development.
Research and development expenses increased $0.2 million from $0.8 million
in
the second quarter of 2004 to $1.0 million in the same period of 2005.
The 31.9%
increase from year to year was due in part to an increase in labor and
employee
benefits costs as a result of the expanding our engineering organization.
In
June 2005, we hired a new Chief Technology Officer and Senior Vice President
and
a new Director of Engineering for the automotive market. In addition, we
spent
more on research and development materials in the second quarter of 2005
than in
the same period in 2004. We expect to continue to hire new scientific and
engineering positions in the third and fourth quarters of 2005, which will
increase our research and development expense.
Selling,
general and administrative.
Selling, general and administrative expenses consist primarily of corporate
and
administrative overhead, selling commissions, advertising costs and occupancy
costs. Selling, general and administrative expenses decreased $0.2 million
from
$2.5 million in the second quarter of 2004 to $2.3 million in the same
period of
2005. The decrease in general and administrative expenses in 2005 was primarily
due to higher legal, consulting and accounting expenses of $0.4 million
in the
second quarter of 2004, partially offset by higher Sarbanes-Oxley compliance
expenses of $0.2 million in the second quarter of 2005.
Impairment
recoveries from long-lived assets.
In the
second quarter of 2004, we sold
a
production machine, which was impaired in the third quarter of 2003, 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. By June 27, 2004, all of our obligations were completed and we
recognized a gain in the second quarter of 2004 of $1.4 million representing
90%
of the sale value less the book value of $0.1 million. There were no such
recoveries in the second quarter of 2005.
Income
from operations.
Income
from operations decreased $1.7 million from $3.7 million in the second
quarter
of 2004 to $2.0 million in the same period of 2005. The decrease was a
result of
the impairment recoveries from long-lived assets and higher gross margin
in the
second quarter of 2004.
Interest
expense, net.
Interest
expense decreased by $0.3 million from $0.6 million in the second quarter
of
2004 to $0.3 million in the same period of 2005. The decrease in interest
expense was primarily attributable to less outstanding debt during the
second
quarter of 2005.
Costs
of warrants issued. In
the second quarter of 2004, the Company incurred $1.5 million in warrants
expense as a result of the re-measurement of all outstanding warrants and
other
financial instruments. There was no warrants expense recorded in the second
quarter
of 2005.
Other
income, net.
Other
income, net, reflects foreign exchange transaction gains and losses in
the
second quarter
of 2004 and 2005. 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.
Income
(loss) before provision for income taxes.
We
recorded a pre-tax profit of $1.6 million in the second quarter of 2005
and $1.5
million in the second quarter of 2004.
Provision
for income taxes.
The
provisions for income taxes in the second quarters of 2005 and 2004 were
primarily related to our German subsidiary, Southwall Europe GmBH (SEG).
The
decrease in the provision for income taxes during the second quarter of
2005
compared to the same period in 2004 was due to lower taxable income in
SEG in
the 2005 period.
Net
income (loss).
Net
income for the second quarter of 2005 and 2004 was $1.4 million and $1.2
million, respectively.
Deemed
dividend on redeemable preferred stock.
We
incurred $0.1 million of deemed dividend on redeemable preferred stock
in the
second quarter of 2005. The holders of our secured convertible promissory
notes
converted those notes to shares of Series A redeemable preferred stock
in
December 2004. The Series A shares accrue cumulative dividends at the rate
of
10% per annum.
Net
income (loss) attributable to common stockholders.
Net
income attributable to common stockholders for the second quarter of 2005
was
$1.3 million and $1.2 million for the second quarter of 2004.
Six
Months Ended July 3, 2005 compared with Six Months Ended June 27,
2004
Results
of Operations
Net
revenues.
Our net
revenues for the six months ended July 3, 2005 and June 27, 2004 were $30.8
million and $25.6 million, respectively.
Our
net
revenues in the window film market increased by $5.5 million, or 150.1%,
from
$3.6 million in the first six months of 2004 to $9.1 million in the same
period
in 2005. Revenues from our Solis products for the first six months of 2005
increased to $6.4 million from $2.0 million in the same period of 2004.
In
addition, revenues from our TX products for the first six months of 2005
increased to $2.5 million from $1.6 million in the first six months of
2004 as a
result of a change in the supply chain to improve the company’s profitability.
We expect future revenues from TX products to be at the same level as
2004.
We
sell
our window film products primarily to customers located in the Pacific
Rim and
the Middle East. We believe our sales to this market during the first quarter
of
2004 were negatively affected by the SARs epidemic and the conflicts in
Iraq and
Afghanistan.
Our
net
revenues in the automotive market increased by $1.3 million, or 12.9%,
from
$10.0 million in the first six months of 2004 to $11.3 million in the same
period in 2005. The increase was due to higher demand from both our Original
Equipment Manufacturer, or OEM, and Automotive Replacement Glass, or ARG
accounts in the first quarter of 2005.
Our
net
revenues in the electronic display market decreased by $1.8 million, or
20.0%,
from $9.2 million in the first six months of 2004 to $7.4 million in the
same
period of 2005. The decrease was primarily due to lower demand for our
sputtered
thin film filter products for Plasma Display Panel products due to increased
competition. Sales to Mitsui, our primary customer in the electronic display
market, decreased $1.8 million from $9.2 million in the first six months
of 2004
to $7.4 million in the same period in 2005 due to lower demand for our
product
in the flat panel display, or FPD market. In addition, we phased out our
unprofitable anti-reflective product lines and stopped selling these products
in
2005. We sold $0.3 million anti-reflective products in the first six months
of
2004.
Our
net
revenues in the architectural markets remained relatively the same in the
first
six months of 2005 compared to the same period in 2004.
Cost
of revenues.
Cost of
revenues was $21.1 million in the first six months of 2005 compared to
$17.4
million in the same period of 2004. The increase in cost of revenues was
primarily due to an increase in materials cost related to our increased
sales.
Gross
profit margin.
Our
gross profit increased $1.5 million from $8.2 million in the first six
months of
2004 to $9.8 million in the same period of 2005. As a percent of sales,
gross
profit decreased from 32.1% in the first six months of 2004 to 31.7% in
the same
period in 2005. The decrease related to lower average selling prices in
automotive, electronic display and architecture products lines in first
six
months of 2005 due to increased competition, which we expect to
continue.
Operating
expenses
Research
and development.
Research and development expenses increased $0.1 million from $1.6 million
in
the first six months of 2004 to $1.7 million in the same period of 2005.
The
8.3% increase from year to year was due in part to an increase in labor
and
employee benefits costs as a result of the expanding our engineering
organization. In June 2005, we hired a new Chief Technology Officer and
Senior
Vice President and a new Director of Engineering for the automotive market.
We
expect to continue to hire new scientific and engineering positions in
the third
and fourth quarters of 2005, which will increase our research and development
expense.
Selling,
general and administrative.
Selling, general and administrative expenses decreased $1.2 million from
$5.6
million in the first six months of 2004 to $4.4 million in the same period
of
2005. The decrease in general and administrative expenses in 2005 was primarily
due to higher legal and accounting fees of $0.9 million, outside services
expense of $0.3 million and compensation expense of $0.2 million in the
first
six months of 2004, partially offset by higher Sarbanes-Oxley compliance
expenses of $0.2 million in the first six months of 2005.
Impairment
recoveries from long-lived assets.
In the
June 2004, we sold
a
production machine, which was impaired in the third quarter of 2003, from
our
Tempe manufacturing facility to a third party. The sale value was for $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. By June 27, 2004, all of our obligations were completed and we
recognized a gain in the second quarter of 2004 of $1.4 million representing
90%
of the sale value less the book value of $0.1 million. There was $0.2 million
impairment recoveries from long-lived assets in the first six months of
2005.
Income
from operations.
Income
from operations increased $1.4 million from $2.5 million in the first six
months
of 2004 to $3.9 million in the same period of 2005. The increase was a
result of
higher revenues, partiallyoffset by the decrease of recoveries for long-lived
assets.
Interest
expense, net.
Interest
expense decreased by $0.7 million from $1.2 million in the first six months
of
2004 to $0.6 million in the same period of 2005. The decrease in interest
expense was primarily attributable to less outstanding debt in the first
six
months of 2005.
Costs
of warrants issued. In
the first six months of 2004, the Company incurred $6.3 million in warrants
expense as a result of the re-measurement of all outstanding warrants and
other
financial instruments. There was no warrants expense recorded in the first
six
months of 2005.
Other
income, net.
Other
income, net, reflects foreign exchange transaction gains and losses in
the first
six months
of 2004
and 2005. 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 net income,
net for
the first six months of 2005 included an energy rebate from our German
subsidiary of approximately $0.4 million relating to the prior
year.
Income
(loss) before provision for income taxes.
We
recorded a pre-tax profit of $3.4 million in the first six months of 2005
compared to a pre-tax loss of $4.8 million in the same period of
2004.
Provision
for income taxes.
The
provisions for income taxes in the first six months of 2005 and 2004 were
primarily related to our German subsidiary, Southwall Europe GmbH (SEG).
The
decrease in the provision for income taxes during the first six months
of 2005
when compared to the same period in 2004 was due to lower taxable income
in SEG
in 2005.
Net
income (loss).
Net
income for the first six months of 2005 was $3.1 million compared to net
loss of
$5.5 million in the same period of 2004.
Deemed
dividend on redeemable preferred stock.
We
incurred $0.2 million of deemed dividend on redeemable preferred stock
in the
first six months of 2005 as a result of the conversion of our secured
convertible promissory notes to shares of Series A redeemable preferred
stock in
December 2004. The Series A shares carry a 10% cumulative dividend
rate.
Net
income (loss) attributable to common stockholders.
Net
income attributable to common stockholders for the first six months of
2005 was
$2.9 million compared to a net loss of $5.5 million during the same period
in
2004.
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.
Our
cash
and cash equivalents increased $3.1 million during the first six months
of 2005.
Cash provided from operations for the first six months of 2005 of $4.2
million
was primarily the result of net income of $3.1 million, non-cash depreciation
of
$1.1 million, and decreases in accounts receivable of $0.2 million, in
inventories of $1.3 million and in other current and non-current assets
of $0.4
million partially offset by impairment recoveries from long-lived assets
of $0.2
million and a decrease in accounts payable and accrued liabilities of $1.8
million. Our
cash
and cash equivalents increased by $0.3 million in the first six months of
2004. Cash used
in
operating activities of $1.6 million for the first six months of 2004 was
primarily the result of non-cash depreciation, cost of warrants issued
and gain
from impairment recoveries from long-lived assets, offsetting the net
loss.
Cash
provided by investing activities for the first six months of 2005 of $0.001
million was primarily the result of a decrease in restricted cash of $0.2
million and proceeds from the sale of fixed asset of $0.2 million, partially
offset by capital expenditures of $0.4 million. Cash
provided from investing activities during the six months ended June 27,
2004 was
$0.8 million, primarily from the proceeds from the sale of fixed assets
partially offset by capital expenditures during the first half of 2004.
Cash
used
in financing activities for the first six months of 2005 of $1.0 million
primarily the result of repayments under capital leases and principal payment
on
borrowings of $1.0 million. We
increased cash from financing activities by $0.6 million during the first
six
months of 2004, primarily as a result of issuing $4.5 million in convertible
promissory notes during the first quarter of 2004, which was partially
offset by
a reduction of $2.3 million in our line of credit facility, $1.0 million
in term
debt payments and $0.6 million in repayment of a loan payable.
We
entered into an agreement with the Saxony government in May 1999 under
which we receive investment grants. As of December 31, 2004, we had
received 5.0 million Euros or $6.8 million 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,
2004, we had a balance remaining from the government grants received in
May 1999
of 0.4 million Euros or $0.5 million, which has been recorded as an advance
and
held as restricted cash until we receive approval from the Saxony government
to
apply the funds to reduce our capital expenditures. We did not receive
any
grants during the first six months of 2005. If we fail to meet certain
requirements in connection with these grants, the Saxony government has
the
right to demand repayment of the grants. The total annual amount of investment
grants and investment allowances that we are entitled to seek varies from
year
to year based upon the amount of our capital expenditures that meet certain
requirements of the Saxony government. Generally, we are not eligible to
seek
total investment grants and allowances for any year in excess of 33% of
our
eligible capital expenditures in Germany for that year. We expect to continue
to
finance a portion of our capital expenditures in Dresden with additional
grants
from the Saxony government and additional loans from German banks, some
of which
may be guaranteed by the Saxony government. However, we cannot guarantee
that we
will be eligible for or will receive additional grants in the future from
the
Saxony government.
Borrowing
arrangements
On
April
28, 2005, we entered into a credit agreement (the “Credit Agreement”) with Wells
Fargo HSBC Trade Bank, N.A. (the “Bank”). The Credit Agreement provides for two
facilities. All amounts borrowed under both facilities under the Credit
Agreement must be repaid on or before May 31, 2006.
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 July 3, 2005.
The
second facility is formula line under which we may from time to time borrow
up
to $3 million, subject to certain conditions, with advances of up to 80%
of
eligible accounts receivable. Amounts borrowed under the second facility
bear
interest at the prime rate minus 0.25% per annum. We may borrow under the
second
facility only if we meet certain financial covenants. As of July 3, 2005,
we met
these financial covenants. In addition, all borrowings under both facilities
under the Credit Agreement are subject to the satisfaction of the additional
financial covenants.
All
borrowings under both facilities are collateralized by our inventory,
receivables, raw material, works in progress and other assets. 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 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.
Capital
expenditures
We
anticipate spending approximately $1.1 million in capital expenditures
in 2005,
primarily to maintain and upgrade our production facilities in Dresden.
We spent
approximately $0.4 million in capital expenditures during the first six
months
of 2005.
Future
payment 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 at July 3, 2005 (in
thousands):
|
|
|
|
|
|
|
|
|
|
Greater
|
|
|
|
|
|
Less
than
|
|
|
|
|
|
Than
|
|
|
|
Total
|
|
1
Year
|
|
1-3
Year
|
|
4-5
Year
|
|
5
Year
|
|
Contractual
Obligations:
|
|
|
|
|
|
|
|
|
|
|
|
Term
debt (1)
|
|
$
|
10,879
|
|
$
|
1,242
|
|
$
|
2,167
|
|
$
|
4,782
|
|
$
|
2,688
|
|
Line
of credit
|
|
|
2,996
|
|
|
2,996
|
|
|
--
|
|
|
--
|
|
|
--
|
|
Capital
lease obligations
|
|
|
38
|
|
|
38
|
|
|
--
|
|
|
--
|
|
|
--
|
|
Operating
leases (2)
|
|
|
1,981
|
|
|
437
|
|
|
1,471
|
|
|
73
|
|
|
--
|
|
Total
contractual cash obligations
|
|
$
|
15,894
|
|
$
|
4,713
|
|
$
|
3,638
|
|
$
|
4,855
|
|
$
|
2,688
|
|
|
(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 building we rent in Palo Alto,
California.
|
Item 3--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 4.375% at July 3, 2005) and is calculated based on
amounts
borrowed under the facility. In addition, the interest rate on one of our
German
loans was reset to the prevailing market rate of 5.75% on December 31,
2004 and
another of our German loans will have its interest rate reset to the prevailing
market rate in 2009. Fluctuations or changes in interest rates may adversely
affect our expected interest expense. The effect of a 10% fluctuation in
the
interest rate on our line of credit would have had an effect of about $21,000
on
our interest expense for the second quarter of 2005.
Investment
risk:
We
invest our excess cash in money market accounts and, by practice, limit
the
amount of exposure to any one institution. Investments in both fixed rate
and
floating rate interest earning instruments carry a degree of interest rate
risk.
Fixed rate securities may have their fair market value adversely affected
due to
a rise in interest rates, while floating rate securities may produce less
income
than expected if interest rates fall. The effect of a 10% fluctuation in
the
interest rate of any of our floating rate securities would have had an
adverse
effect of less than $10,000 for the second quarter of 2005.
Foreign
currency risk:
International revenues (defined as sales to customers located outside of
the
United States) accounted for approximately 74% of our total sales in the
second
quarter of 2005. Approximately 46% of our international revenues were
denominated in Euros relating to sales from our Dresden operation in the
second
quarter of 2005. The other 54% 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 less
than
$0.5 million on net revenues for the second quarter of 2005 and the effect
on expenses of a 10% fluctuation in the Yen exchange rate would have been
minimal.
FORWARD-LOOKING
STATEMENTS
This
Quarterly Report contains forward-looking statements, which 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 statements
relating
to:
|
·
|
our
ability to remain as a going
concern;
|
|
·
|
our
strategy, future operations and financial plans, including, without
limitation, our plans to install and commercially produce products
on new
machines;
|
|
·
|
the
success of our restructuring
activities;
|
|
·
|
the
continued trading of our common stock on the Over-the-Counter
Bulletin
Board;
|
|
·
|
our
projected need for, and ability to obtain, additional borrowings
and our
future liquidity;
|
|
·
|
future
applications of thin-film technologies and our development of
new
products;
|
|
·
|
statements
about the future size of markets;
|
|
·
|
our
expectations with respect to future grants, investment allowances
and bank
guarantees from the Saxony
government;
|
|
·
|
our
expected results of operations and cash flows;
|
|
·
|
pending
and threatened litigation and its outcome; 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 below
under
"Risk Factors." 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,
assume
responsibility for the future accuracy and completeness of these forward-looking
statements.
RISK
FACTORS
Financial
Risks
Our
working capital position, financial commitments and historical performance
may
raise doubt about our ability to have positive earnings in the
future.
We
incurred net losses in 2004, 2003 and 2002 and negative cash flows from
operations in 2003 and 2002. These factors together with our working capital
position and our significant debt service and other contractual obligations
at
July 3, 2005, may raise doubt about our ability to restore profitable
operations, generate cash flow from operating activities and obtain additional
financing. These and other factors related to our business during recent
years,
including the restatement in 2000 of our consolidated financial statements
for
prior periods, operating losses in 1998, 1999, 2000, 2002 and 2003, 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.
The
transactions with Needham and Dolphin may have a negative effect on us
or our
stock price.
As
a
result of the consummation of the financing transactions in December 2003
and
February 2004 with Needham & Company and its affiliates and Dolphin
Direct Equity Partners, L.P, our shareholders suffered material dilution.
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 or otherwise control the
company
in ways that might have a material adverse effect on the company or our
stock
price.
Covenants
or defaults under our credit and other loan agreements may prevent us from
borrowing or force us to curtail our operations.
As
of
July 3, 2005, we had total outstanding obligations under our credit and
other
loan agreements of $13.9 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 thereunder, together with all accrued
interest, immediately due and payable. If we are unable to repay such
indebtedness, the lenders could foreclose on the pledged assets. If the
lenders
foreclose on our assets, we would be forced to significantly curtail or
even
cease our operations.
Our
quarterly revenue and operating results are volatile and difficult to predict.
If we fail to meet the expectations of public market analysts or investors,
the
market price of our common stock may decrease significantly.
Our
quarterly revenue and operating results have varied significantly in the
past
and will likely vary significantly in the future. Our revenue and operating
results may fall below the expectations of securities analysts or investors
in
future periods. Our failure to meet these expectations would likely adversely
affect the market price of our common stock.
Our
quarterly revenue and operating results may vary depending on a number
of
factors, including:
|
·
|
fluctuating
customer demand, which is influenced by a number of factors,
including
market acceptance of our products and the products of our customers
and
end-users, changes in product mix, and the timing, cancellation
or delay
of customer orders and shipments;
|
|
·
|
the
timing of shipments of our products by us and by independent
subcontractors to our customers;
|
|
·
|
manufacturing
and operational difficulties that may arise due to, among other
things,
quality control, capacity utilization of our production machines,
unscheduled equipment maintenance, and the hiring and training
of
additional staff;
|
|
·
|
our
ability to introduce new products on a timely basis; and
|
|
·
|
competition,
including the introduction or announcement of new products by
competitors,
the adoption of competitive technologies by our customers, the
addition of
new production capacity by competitors and competitive pressures
on prices
of our products and those of our customers.
|
We
expect to be subject to increased foreign currency risk in our international
operations.
In
2003
and 2004 and during the first six months of 2005, approximately 34%, 34%,
and
29% of our revenues, respectively, were denominated in Euros, primarily
related
to sales from our Dresden operation, including sales to one of our largest
customers, a European automotive glass manufacturer. In addition, other
customers may request to make payments in foreign currencies. Also, certain
transactions with foreign suppliers are denominated in foreign currencies,
primarily Japanese Yen.
A
strengthening in the dollar relative to the currencies of those countries
in
which we do business would increase the prices of our products as stated
in
those currencies and could hurt our sales in those countries. Significant
fluctuations in the exchange rates between the U.S. dollar and foreign
currencies could cause us to lower our prices and thus reduce our profitability
and cash flows. These fluctuations could also cause prospective customers
to
cancel or delay orders because of the increased relative cost of our
products.
Our
suppliers and subcontractors may impose more onerous payment terms on
us.
As
a
result of our financial performance and voluntary delisting from NASDAQ,
our
suppliers and creditors may impose more onerous payment terms on us, which
may
have a material adverse effect on our financial performance and our liquidity.
For example, one of our subcontractors has required us to provide it with
a
security interest in all of our inventory held by it and has limited the
amount
of unpaid invoices we may have outstanding with it at any time.
Operational
Risks
We
depend on a small number of customers for nearly all of our revenues, and
the
loss of a large customer could materially adversely affect our revenues
or
operating results.
Our nine
largest customers accounted for approximately 80%, 77%, 76% and 84% of
net
revenues during the first six months of 2005 and in fiscal years 2004,
2003, and
2002, respectively. We have contracts extending past 2005 with only two
of these
customers. We expect to continue to derive a significant portion of our
net revenues 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 2002 and 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 process 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 cannot assure you that we will be able to accomplish all of these goals.
Any
future acquisitions would involve certain additional risks,
including:
|
·
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difficulty
integrating the purchased operations, technologies, or products;
|
|
·
|
unanticipated
costs, which would reduce our profitability;
|
|
·
|
diversion
of management's attention from our core business;
|
|
·
|
potential
entrance into markets in which we have limited or no prior experience;
and
|
|
·
|
potential
loss of key employees, particularly those of the acquired business.
|
If
one of our customers is able to enforce a European automotive film patent,
we
may be restricted from using the methods present in such patent to produce
some
of our products.
On
March
3, 2005, the European Patent Office allowed a European patent owned by
Pilkington Automotive GmBH entitled "Method for producing a laminated glass
pane
free of optical obstruction caused by warping, use of a particular carrier
film
for the production of the laminated glass pane and carrier films particularly
suitable for the method of use." This European patent covers certain laminated
films and methods of using them which may prevent us from producing certain
films designed for the automotive markets. Our inability to use this technology
could adversely affect our ability to provide a full range of products
to the
automotive film market. We participated in opposing the European patent
and have
appealed the European Patent Office decision.
Failure
to meet the volume requirements of our customers may result in a loss of
business or contractual penalties.
Our
long-term competitive position will depend to a significant extent on our
manufacturing capacity. The failure to have sufficient capacity, to fully
utilize capacity when needed or to successfully integrate and manage additional
capacity in the future could adversely affect our relationships with customers
and cause customers to buy similar products from our competitors if we
are
unable to meet their needs. For example, we believe that we lost substantial
potential architectural products sales in 2001 because we did not have
the
capacity to manufacture the required amounts of products. Also, our failure
to
produce required amounts of products under some of our contracts will result
in
price reductions on future sales under such contracts or penalties under
which
we would be required to reimburse the customer for the full cost of any
product
not delivered in a timely manner, either of which would reduce our gross
margins.
We
depend on our OEM customers for the sale of our products.
We
sell a
substantial portion of our products to a relatively small number of original
equipment manufacturers, or OEMs. The timing and amount of sales to these
customers ultimately depend on sales levels and shipping schedules for
the OEM
products into which our products are incorporated. We have no control over
the
volume of products shipped by our OEM customers or shipping dates, and
we cannot
be certain that our OEM customers will continue to ship products that
incorporate our products at current levels or at all. We currently have
long-term contracts with only two of our OEM customers. Failure of our
OEM
customers to achieve significant sales of products incorporating our products
and fluctuations in the timing and volume of such sales could be harmful
to our
business. Failure of these customers to inform us of changes in their production
needs in a timely manner could also hinder our ability to effectively manage
our
business.
We
rely upon our OEM customers for information relating to the development
of new
products so that we are able to meet end-user demands.
We
rely
on our OEM customers to inform us of opportunities to develop new products
that
serve end-user demands. If our OEM customers do not present us with market
opportunities early enough for us to develop products to meet end-user
needs in
a timely fashion, or if the OEMs fail to anticipate end-user needs at all,
we may fail to develop new products or modify our existing products for
the
end-user markets for our products. In addition, if our OEM customers fail
to
accurately anticipate end-user demands, we may spend resources on products
that
are not commercially successful.
We
depend on a distributor for the sale of our after-market
products.
We
primarily use one independent distributor to sell our after-market products.
We
have a distribution agreement with Globamatrix Holdings Pte. Ltd., or
Globamatrix, under which we granted an exclusive worldwide license to distribute
our after-market applied film in the automotive and architectural glass
markets.
Failure of Globamatrix to achieve significant sales of products incorporating
our products and fluctuations in the timing and volume of such sales could
be
harmful to our business. We believe that the success of our after-market
products will continue to depend upon this distributor.
We
face intense competition, which could affect our ability to increase our
revenue, maintain our margins and increase our market share.
The
market for each of our products is intensely competitive and we expect
competition to increase in the future. Competitors vary in size and in
the scope
and breadth of the products they offer. We compete both with companies
using
technology similar to ours and companies using other technologies or developing
improved technologies. Direct-to-glass sputtering represents the principal
alternative technology to our sputter-coated film products. Direct-to-glass
is a
mature, well-known process for applying thin film coatings directly to
glass,
which is used by some of our current and potential customers to produce
products
that compete with our products. This technology is commonly used to manufacture
products that conserve energy in buildings and automobiles. Many of our
current
and potential competitors have significantly greater financial, technical,
marketing and other resources than we have. In addition, many of our competitors
have well-established relationships with our current and potential customers
and
have extensive knowledge of our industry.
We
are dependent on key suppliers of materials, which may prevent us from
delivering product in a timely manner.
We
manufacture all of our products using materials procured from third-party
suppliers. We do not have long-term contracts with our third-party suppliers.
Certain of the materials we require are obtained from a limited number
of
sources. Delays or reductions in product shipments could damage our
relationships with customers. Further, a significant increase in the price
of
one or more of the materials used in our products could have a material
adverse
effect on our cost of goods sold and operating results.
We
are dependent on a few qualified subcontractors to add properties to some
of our
products.
We
rely
on third-party subcontractors to add properties, such as adhesives, to
some of
our products. There are only a limited number of qualified subcontractors
that
can provide some of the services we require, and we do not have long-term
contracts with any of those subcontractors. Qualifying alternative
subcontractors could take a great deal of time or cause us to change product
designs. The loss of a subcontractor could adversely affect our ability
to meet
our scheduled product deliveries to customers, which could damage our
relationships with customers. If our subcontractors do not produce a quality
product, our yield will decrease and our margins will be lower. Further,
a
significant increase in the price charged by one or more of our subcontractors
could force us to raise prices on our products or lower our margins, which
could
have a material adverse effect on our operating results.
We
are dependent on key suppliers of production machines, which may prevent
us from
delivering an acceptable product on a timely basis and limit our capacity
for
revenue growth.
Our
production machines are large, complex and difficult to manufacture. It
can take
up to a year from the time we order a machine until it is delivered. Following
delivery, it can take us, with the assistance of the manufacturer, up to
six
additional months to test and prepare the machine for commercial production.
There are a very limited number of companies that are capable of manufacturing
these machines. Our inability in the future to have new production machines
manufactured and prepared for commercial production in a timely manner
would
prevent us from delivering product on a timely basis and limit our capacity
for
revenue growth.
Fluctuations
or slowdowns in the overall electronic display industry have and may continue
to
adversely affect our revenues.
Our
business depends in part on sales by manufacturers of products that include
electronic displays. The markets for electronic display products are highly
cyclical and have experienced periods of oversupply resulting in significantly
reduced demand for our products. For example, due to the deteriorating
economic
environment, sales by flat cathode ray tube manufacturers decreased in
2002 and
further in 2003, contributing to our electronic display product revenues
declining by 11% in 2002, and another 3% for 2003. During the first six
months
of 2005, we experienced a decrease in our net revenues in the electronic
display
market primarily due to lower demand for our sputtered thin film filter
products
for Plasma Display Panel products due to increased competition, and we
expect
this trend to continue. Mitsubishi Electric was the only CRT manufacturer
that
buys our anti-reflective, or AR, film and it decided to consolidate all
of the
manufacturing of this product to Japan. In connection with that consolidation,
Mitsubishi ceased production of the 17" AR product in its Mexico plant
during
the third quarter of 2003. In 2005, we stopped converting our window film
products and agreed with our customers to own this process. This resulted
in
higher revenues on our TX products as our customers bought more products
to fill
their production lines. We expect higher revenues from the TX product line
to
continue through the end of 2005.
Performance,
reliability or quality problems with our products may cause our customers
to
reduce or cancel their orders.
We
manufacture our products based on specific, technical requirements of each
of
our customers. We believe that future orders of our products will depend
in part
on our ability to maintain the performance, reliability and quality standards
required by our customers. If our products have performance, reliability
or
quality problems, then we may experience:
|
·
|
delays
in collecting accounts receivable;
|
|
·
|
higher
manufacturing costs;
|
|
·
|
additional
warranty and service expenses; and
|
|
·
|
reduced
or cancelled orders.
|
If
we
fail to recruit and retain a significant number of qualified technical
personnel
we may not be able to develop, enhance and introduce our products on a
timely
basis, and our business will be harmed.
We
require the services of a substantial number of qualified technical personnel.
Intense competition and aggressive recruiting, as well as a high-level
of
employee mobility characterize the market for skilled technical personnel.
These
characteristics make it particularly difficult for us to attract and retain
the
qualified technical personnel we require. We have experienced, and we expect
to
continue to experience, difficulty in hiring and retaining highly skilled
employees with appropriate technical qualifications. It is especially difficult
for us to recruit qualified personnel to move to the location of our Palo
Alto,
California offices because of the high-cost of living. If we are unable
to
recruit and retain a sufficient number of qualified technical employees,
we may
not be able to complete the development of, or enhance, our products in
a timely
manner. As a result, our business may be harmed and our operating results
may
suffer.
We
may be unable to attract or retain the other highly skilled employees that
are
necessary for the success of our business.
In
addition to our dependence on our technical personnel, our success also
depends
on our continuing ability to attract and retain other highly skilled employees.
We depend on the continued services of our senior management, particularly
Thomas G. Hood, our President and Chief Executive Officer. We do not have
employment contracts with any of our officers or key-person life insurance
covering any officer or employee. Our officers have technical and industry
knowledge that cannot easily be replaced. Competition for similar personnel
in
our industry where we operate is intense. We have experienced, and we expect
to
continue to experience, difficulty in hiring and retaining highly skilled
employees with appropriate qualifications. If we do not succeed in attracting
or
retaining the necessary personnel, our business could be adversely
affected.
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. In the next three years,
one of
our U.S. patents relating to our architectural products will expire. Expiration
of this 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.
Our
business is susceptible to numerous risks associated with international
operations.
Revenues
from international sales amounted to approximately 75%, 83%, 89% and 85%
of our
net revenues during the first six months of 2005 and fiscal years 2004,
2003 and
2002, respectively. The distance between our two manufacturing sites creates
logistical and communications challenges. In addition, to achieve acceptance
in
international markets, our products must be modified to handle a variety
of
factors specific to each international market as well as local regulations.
We
may also be subject to a number of other risks associated with international
business activities. These risks include:
|
·
|
unexpected
changes in and the burdens and costs of compliance with a variety
of
foreign laws and regulatory requirements;
|
|
·
|
potentially
adverse tax consequences; and
|
|
·
|
global
economic turbulence and political
instability.
|
If
we
fail to comply with environmental regulations, our operations could be
suspended.
We
use
hazardous chemicals in producing our products and have air and water emissions
that require controls. As a result, we are subject to a variety of local,
state
and federal governmental regulations relating to the storage, discharge,
handling, emission, generation, manufacture and disposal of toxic or other
hazardous substances used to manufacture our products, compliance with
which is
expensive. Our failure to comply with current or future regulations could
result
in the imposition of substantial fines on us, suspension of production,
alteration of our manufacturing processes, increased costs or cessation
of
operations.
We
rely on our domestic sales representatives, without whom our architectural
product sales may suffer.
We
use
independent sales representatives to promote our Heat Mirror products to
architects in the United States. If some or all of our sales representatives
experience financial difficulties, or otherwise become unable or unwilling
to
promote our products, our business could be harmed. These sales representatives
could reduce or discontinue promotion of our products. They may not devote
the
resources necessary to provide effective marketing support to us. In addition,
we depend upon the continued viability and financial resources of these
representatives, many of which are small organizations with limited working
capital. These representatives, in turn, depend substantially on general
economic conditions and other factors affecting the markets for the products
they promote. We believe that our success in this market will continue
to depend
upon these sales representatives.
We
may experience unanticipated warranty or other claims with respect to our
products, which may lead to extensive litigation costs and
expenses.
In
the
ordinary course of business, we have periodically become engaged in litigation
principally as a result of disputes with customers of our architectural
products. We have settled some of these suits and others are pending. We
may
become engaged in similar or other lawsuits in the future. Some of our
products
that have been the basis for lawsuits against us could be the basis for
future
lawsuits. An adverse outcome in the defense of a warranty or other claim
could
subject us to significant liabilities to third parties. Any litigation,
regardless of the outcome, could be costly and require significant time
and
attention of key members of our management and technical personnel.
We
may face extensive damages or litigation costs if our insurance carriers
seek to
have us indemnify them for settlements of past and outstanding
litigation.
Several
of our insurance carriers have reserved their rights to seek indemnification
from us for substantial amounts paid to plaintiffs by the insurance carriers
as
part of settlements of litigation relating to our architectural products.
Our
insurance carriers in a case in which the plaintiff alleged we were responsible
for defects in window products manufactured by others have advised us that
they
intend to seek reimbursement for settlement and defense costs. Any claims,
with
or without merit, could require significant time and attention of key members
of
our management and result in costly litigation.
Item
4--Controls and Procedures
a.
|
Evaluation
and Disclosure Controls and Procedures.
Under the supervision and with the participation of our management,
including our chief executive officer and acting chief 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 July 3, 2005 (the “Evaluation Date”). Based on this
evaluation, our chief executive officer and acting chief 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 chief executive officer and acting
chief
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 and an attestation
from an independent registered public accounting firm in our
Annual Report
on Form 10-K beginning with the filing for our fiscal year ending
December 31, 2006.
|
c.
|
Changes
in Internal Controls.
There were no changes during the quarter ended July 3, 2005 in
our
internal controls over financial reporting that have materially
effected,
or are reasonably likely to materially affect, the internal controls
over
financial reporting.
|
Item
1--Legal Proceedings
Litigation
filed against the Company was described under Item 3 in the Company's Form
10-K
filed on March 30, 2005. No other material developments have occurred with
respect to the litigation described therein.
In
addition, the Company is involved in certain other legal actions arising
in the
ordinary course of business. The Company believes, however, that none of
these
actions, either individually or in the aggregate, will have a material
adverse
effect on Southwall's business, Southwall's consolidated financial position,
results of operations or cash flows.
Item
2-- Unregistered Sales of Equity Securities and Use of
Proceeds
None.
Item
3--Defaults upon Senior Securities
Not
applicable.
Item
4--Submission of Matters to a Vote of
Stockholders
On
May
26, 2005, we held our Annual Meeting of Stockholders. The
number of shares outstanding and eligible to vote as of March 30, 2005,
the
record date, were 26,778,482 shares. The following matters were voted
upon:
|
1.
|
Our
stockholders elected William A. Berry, George Boyadjieff, Thomas
G. Hood,
Jami K. Nachtsheim, Joseph B. Reagan and Walter C. Sedgwick as
directors
to serve until the 2006 Annual Meeting of Stockholders and until
their
successors are elected.
|
The
vote
for each director was as follows:
Director
|
For
|
Withheld
|
|
|
|
William
A. Berry
|
25,326,043
|
36,249
|
|
|
|
George
Boyadjieff
|
25,322,843
|
39,449
|
|
|
|
Thomas
G. Hood
|
25,300,843
|
61,449
|
|
|
|
Jami
K. Nachtsheim
|
25,323,043
|
39,249
|
|
|
|
Joseph
B. Reagan
|
25,208,618
|
153,674
|
|
|
|
Walter
C. Sedgwick
|
25,205,718
|
156,574
|
There
were no votes abstaining, nor
were
there any broker non-votes, in the election of directors.
|
2.
|
Our
stockholders ratified the selection of Burr, Pilger & Mayer LLP, our
independent registered public accounting firm for the fiscal
year ending
December 31, 2005. On
the matter, there were 25,292,314 votes "FOR", 57,533 votes "AGAINST",
12,445 votes "ABSTAINING", and no broker non-votes.
|
Item
5--Other Information
None.
Exhibit
|
|
Number
|
Item
|
|
|
|
Certification
of Principal Executive Officer pursuant to Exchange Act Rules
13a-14 and
15d-14
|
|
|
|
Certification
of Principal Financial Officer pursuant to Exchange Act Rules
13a-14 and
15d-14
|
|
|
|
Certification
of Principal Executive Officer pursuant to 18 U.S.C Section
1350
|
|
|
|
Certification
of Principal Financial Officer pursuant to 18 U.S.C Section
1350
|
Pursuant
to the requirements of the Securities Exchange Act of 1934, the registrant
has
duly caused this report to be signed on its behalf by the undersigned thereunto
duly authorized.
Dated:
August 5, 2005
|
|
|
|
|
|
Southwall
Technologies Inc.
|
|
|
|
|
|
|
By:
|
/s/
Thomas G. Hood
|
|
|
|
Thomas
G. Hood
|
|
|
|
President
and Chief Executive Officer
|
|
|
|
|
|
|
By:
|
/s/
Sylvia Kamenski
|
|
|
|
Sylvia
Kamenski
|
|
|
|
Acting
Chief Financial Officer
|
|