Southwall Technologies Inc. 10-Q 3-31-2006
UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
Washington,
D.C. 20549
FORM
10-Q
(MARK
ONE)
|
x
|
QUARTERLY
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
|
For
the quarterly period ended March 31, 2006
or
|
o
|
TRANSITION
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
|
For
the transition period from to
Commission
File Number: 0-15930
SOUTHWALL
TECHNOLOGIES INC.
(Exact
name of registrant as specified in its charter)
|
Delaware
|
|
94-2551470
|
|
|
(State
or other jurisdiction of incorporation or organization)
|
|
(I.R.S.
Employer Identification Number)
|
|
|
|
|
|
|
|
3975
East Bayshore Road, Palo Alto, California
|
|
94303
|
|
|
(Address
of principal executive offices)
|
|
(Zip
Code)
|
|
Registrant's
telephone number, including area code:
(650) 962-9111
Indicate
by check mark whether the registrant (1) has filed all reports required to
be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past
90 days. Yes x No o
Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of “accelerated
filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check
One).
Large
accelerated filer ¨
|
Accelerated
filer ¨
|
Non-accelerated
filer x
|
Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act). Yes o No x
Applicable
only to Issuers Involved in Bankruptcy
Proceeding
During the Preceding Five Years
Indicate
by check mark whether the registrant has filed documents and reports required
to
be filed by Sections 12, 13 or 15(d) of the Securities Exchange Act of 1934
subsequent to the distribution of securities under a plan confirmed by a
court. Yes o No o
As
of May
1, 2006, there were 26,949,201 shares of the Registrant's Common Stock
outstanding.
INDEX
|
|
Page
|
|
|
|
________
|
|
|
|
|
|
|
|
3
|
|
|
4
|
|
|
5
|
|
|
|
|
|
14
|
|
|
21
|
|
|
23
|
|
|
|
|
|
|
|
|
|
|
|
24
|
|
|
24
|
|
|
27
|
|
|
27
|
|
|
27
|
|
|
27
|
|
|
27
|
|
|
28
|
PART
I.
FINANCIAL INFORMATION
Item
1--Financial
Statements:
UNAUDITED
CONDENSED CONSOLIDATED BALANCE SHEETS
(in
thousands, except per share data)
|
|
March
31,
2006
|
|
December
31,
2005
|
|
ASSETS
|
|
Current
assets:
|
|
|
|
|
|
Cash
and cash equivalents
|
|
$
|
5,117
|
|
$
|
6,600
|
|
Restricted
cash
|
|
|
398
|
|
|
402
|
|
Accounts
receivable, net of allowance for doubtful accounts of $203 at
March 31, 2006 and $208 at December 31, 2005
|
|
|
6,293
|
|
|
6,780
|
|
Inventories,
net
|
|
|
7,258
|
|
|
5,879
|
|
Other
current assets
|
|
|
909
|
|
|
982
|
|
Total
current assets
|
|
|
19,975
|
|
|
20,643
|
|
|
|
|
|
|
|
|
|
Property,
plant and equipment, net
|
|
|
16,929
|
|
|
16,857
|
|
Restricted
cash loans
|
|
|
1,021
|
|
|
995
|
|
Other
assets
|
|
|
1,126
|
|
|
1,146
|
|
Total
assets
|
|
$
|
39,051
|
|
$
|
39,641
|
|
|
|
|
|
|
|
|
|
LIABILITIES,
PREFERRED STOCK AND STOCKHOLDERS’ EQUITY
|
|
|
|
|
|
|
|
|
|
Current
liabilities:
|
|
|
|
|
|
|
|
Current
portion of long term debt
|
|
$
|
1,171
|
|
$
|
1,317
|
|
Line
of credit
|
|
|
2,996
|
|
|
2,996
|
|
Accounts
payable
|
|
|
2,551
|
|
|
1,402
|
|
Accrued
compensation
|
|
|
990
|
|
|
1,161
|
|
Other
accrued liabilities
|
|
|
4,518
|
|
|
5,076
|
|
Total
current liabilities
|
|
|
12,226
|
|
|
11,952
|
|
|
|
|
|
|
|
|
|
Term
debt
|
|
|
8,728
|
|
|
8,790
|
|
Government
grants advanced
|
|
|
398
|
|
|
396
|
|
Other
long term liabilities
|
|
|
2,585
|
|
|
2,564
|
|
Total
liabilities
|
|
|
23,937
|
|
|
23,702
|
|
|
|
|
|
|
|
|
|
Commitments
and contingencies (Note 5)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Series
A 10% cumulative convertible preferred stock, $0.001 par value; $1.00
stated value; 5,000 shares authorized, 4,893 shares outstanding at
March
31, 2006 and December 31, 2005, respectively (Liquidation preference:
$5,505 and $5,383 at March 31, 2006 and December 31, 2005,
respectively)
|
|
|
4,810
|
|
|
4,810
|
|
|
|
|
|
|
|
|
|
Stockholders’
equity:
|
|
|
|
|
|
|
|
Common
stock, $0.001 par value per share; 50,000 shares authorized, 26,893
shares
and 26,793 shares outstanding at March 31, 2006 and December 31,
2005,
respectively
|
|
|
27
|
|
|
27
|
|
Capital
in excess of par value
|
|
|
78,007
|
|
|
77,828
|
|
Accumulated
other comprehensive income:
|
|
|
|
|
|
|
|
Accumulated
translation adjustment
|
|
|
2,856
|
|
|
2,532
|
|
Accumulated
deficit
|
|
|
(70,586
|
)
|
|
(69,258
|
)
|
Total
stockholders’ equity
|
|
|
10,304
|
|
|
11,129
|
|
|
|
|
|
|
|
|
|
Total
liabilities, preferred stock and stockholders’ equity
|
|
$
|
39,051
|
|
$
|
39,641
|
|
See
accompanying notes to unaudited condensed consolidated financial
statements.
UNAUDITED
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in
thousands, except per share data)
|
|
Three
months ended
|
|
|
|
March
31,
2006
|
|
April
3,
2005
|
|
|
|
|
|
|
|
Net
revenues
|
|
$
|
10,034
|
|
$
|
15,647
|
|
Cost
of revenues
|
|
|
6,366
|
|
|
11,270
|
|
|
|
|
|
|
|
|
|
Gross
profit
|
|
|
3,668
|
|
|
4,377
|
|
|
|
|
|
|
|
|
|
Operating
expenses:
|
|
|
|
|
|
|
|
Research
and development
|
|
|
1,646
|
|
|
696
|
|
Selling,
general and administrative
|
|
|
2,562
|
|
|
2,026
|
|
Impairment
recoveries for long-lived assets
|
|
|
-
|
|
|
(170
|
)
|
Restructuring
charges
|
|
|
452
|
|
|
-
|
|
|
|
|
|
|
|
|
|
Total
operating expenses
|
|
|
4,660
|
|
|
2,552
|
|
Income
(loss) from operations
|
|
|
(992
|
)
|
|
1,825
|
|
|
|
|
|
|
|
|
|
Interest
expense, net
|
|
|
(192
|
)
|
|
(271
|
)
|
Other
income (expenses), net
|
|
|
150
|
|
|
292
|
|
|
|
|
|
|
|
|
|
Income
(loss) before provision for income taxes
|
|
|
(1,034
|
)
|
|
1,846
|
|
|
|
|
|
|
|
|
|
Provision
for income taxes
|
|
|
293
|
|
|
147
|
|
|
|
|
|
|
|
|
|
Net
income (loss)
|
|
|
(1,327
|
)
|
|
1,699
|
|
|
|
|
|
|
|
|
|
Deemed
dividend on preferred stock
|
|
|
122
|
|
|
123
|
|
|
|
|
|
|
|
|
|
Net
income (loss) attributable to common stockholders
|
|
$
|
(1,449
|
)
|
$
|
1,576
|
|
|
|
|
|
|
|
|
|
Net
income (loss) per share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
$
|
(0.05
|
)
|
$
|
0.06
|
|
Diluted
|
|
$
|
(0.05
|
)
|
$
|
0.05
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Shares
used in computing net income (loss) per share:
|
|
|
|
|
|
|
|
Basic
|
|
|
26,825
|
|
|
26,613
|
|
Diluted
|
|
|
26,825
|
|
|
33,181
|
|
See
accompanying notes to unaudited condensed consolidated financial
statements.
UNAUDITED
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in
thousands)
|
|
Three
months ended
|
|
|
|
March
31,
2006
|
|
April
3,
2005
|
|
|
|
|
|
|
|
Cash
flows from operating activities:
|
|
|
|
|
|
Net
income (loss)
|
|
$
|
(1,327
|
)
|
$
|
1,699
|
|
Adjustments
to reconcile net income (loss) to net cash (used in) provided by
operating
activities:
|
|
|
|
|
|
|
|
Deferred
income tax
|
|
|
82
|
|
|
-
|
|
Impairment
recoveries from long-lived assets
|
|
|
-
|
|
|
(170
|
)
|
Depreciation
and amortization
|
|
|
518
|
|
|
623
|
|
Stock
compensation
|
|
|
231
|
|
|
91
|
|
Change
in assets and liabilities:
|
|
|
|
|
|
|
|
Deferred
revenues
|
|
|
(8
|
)
|
|
(8
|
)
|
Accounts
receivable, net
|
|
|
487
|
|
|
(334
|
)
|
Inventories,
net
|
|
|
(1,379
|
)
|
|
(8
|
)
|
Other
current and non current assets
|
|
|
69
|
|
|
(570
|
)
|
Accrued
restructuring
|
|
|
421
|
|
|
-
|
|
Accrued
liabilities—deferred rent
|
|
|
(1,192
|
)
|
|
-
|
|
Accounts
payable and accrued liabilities
|
|
|
1,110
|
|
|
(764
|
)
|
|
|
|
|
|
|
|
|
Net
cash (used in) provided by operating activities
|
|
|
(988
|
)
|
|
559
|
|
|
|
|
|
|
|
|
|
Cash
flows from investing activities:
|
|
|
|
|
|
|
|
Decrease
in restricted cash
|
|
|
5
|
|
|
191
|
|
Proceeds
from sale of property, plant and equipment
|
|
|
-
|
|
|
170
|
|
Expenditures
for property, plant and equipment
|
|
|
(168
|
)
|
|
(136
|
)
|
|
|
|
|
|
|
|
|
Net
cash provided by (used in) investing activities
|
|
|
(163
|
)
|
|
225
|
|
|
|
|
|
|
|
|
|
Cash
flows from financing activities:
|
|
|
|
|
|
|
|
Repayments
under capital lease
|
|
|
-
|
|
|
(4
|
)
|
Proceeds
from exercise of stock options
|
|
|
-
|
|
|
19
|
|
Principal
payments on borrowings
|
|
|
(422
|
)
|
|
(812
|
)
|
Investment
credit in Germany
|
|
|
(9
|
)
|
|
(5
|
)
|
|
|
|
|
|
|
|
|
Net
cash used in financing activities
|
|
|
(431
|
)
|
|
(802
|
)
|
|
|
|
|
|
|
|
|
Effect
of foreign exchange rate changes on cash
|
|
|
99
|
|
|
(10
|
)
|
|
|
|
|
|
|
|
|
Net
decrease in cash and cash equivalents
|
|
|
(1,483
|
)
|
|
(28
|
)
|
Cash
and cash equivalents, beginning of period
|
|
|
6,600
|
|
|
4,547
|
|
|
|
|
|
|
|
|
|
Cash
and cash equivalents, end of period
|
|
$
|
5,117
|
|
$
|
4,519
|
|
See
accompanying notes to unaudited condensed consolidated financial
statements.
NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(in
thousands, except per share data)
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,
2005 filed with the Securities and Exchange Commission on March 29, 2006. 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 March 31, 2006 and April 3, 2005 each included 13 weeks.
Note 2--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 March 31, 2006 and December 31, 2005,
inventories consisted of the following (in thousands):
|
|
March
31,
2006
|
|
December
31,
2005
|
|
Raw
materials
|
|
$
|
3,754
|
|
$
|
3,482
|
|
Work-in-process
|
|
|
1,603
|
|
|
1,409
|
|
Finished
goods
|
|
|
1,901
|
|
|
988
|
|
|
|
$
|
7,258
|
|
$
|
5,879
|
|
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
convertible preferred stock. Preferred stock dividends are added back to net
income attributable to common stockholders since they would not have been
accrued if the preferred stock had been converted to common stock at the
beginning of the period.
The
Company excludes options from the computation of diluted weighted average shares
outstanding if the exercise price of the options is greater than the average
market price of the shares because the inclusion of these options would be
anti-dilutive to earnings per share. Accordingly, stock options to
purchase 1,800 shares at a weighted average price of $3.82 per share were
excluded from the computation of diluted weighted average shares outstanding
for
the three-month period ended April 3, 2005.
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 three-month period
ended March 31, 2006, there was no difference between the denominators used
for
the calculation of basic and diluted net income (loss) per share. For the
three-month period ended March 31, 2006, there were 5,680 options outstanding
and excluded from the net loss per share calculation.
Tables
summarizing net income (loss) attributable to common stockholders, for diluted
net income (loss) per share, and shares outstanding are shown below (in
thousands):
|
|
Three
months ended
|
|
|
|
March
31,
2006
|
|
April
3,
2005
|
|
Net
income (loss) attributable to common stockholders-basic
|
|
$
|
(1,449
|
)
|
$
|
1,576
|
|
Add:
Deemed dividend on preferred stock
|
|
|
122
|
|
|
123
|
|
Net
income (loss) attributable to common stockholders-diluted
|
|
$
|
(1,327
|
)
|
$
|
1,699
|
|
|
|
|
|
|
|
|
|
Weighted
average common shares outstanding-basic
|
|
|
26,825
|
|
|
26,613
|
|
Dilutive
effect of warrants
|
|
|
-
|
|
|
357
|
|
Dilutive
effect of performance shares
|
|
|
-
|
|
|
149
|
|
Dilutive
effect of Series A preferred shares
|
|
|
-
|
|
|
4,893
|
|
Dilutive
effect of stock options
|
|
|
-
|
|
|
1,169
|
|
Weighted
average common shares outstanding - diluted
|
|
|
26,825
|
|
|
33,181
|
|
Note 4
- Segment Reporting:
Southwall
operates in one segment.
The
total
net revenues for the automotive glass, electronic display, window film and
architectural product lines for the three-month periods ended March 31, 2006
and
April 3, 2005 were as follows (in thousands):
|
|
Three
months ended
|
|
|
|
March
31,
2006
|
|
April
3,
2005
|
|
Automotive
glass
|
|
$
|
2,879
|
|
$
|
6,385
|
|
Electronic
display
|
|
|
2,491
|
|
|
4,079
|
|
Window
film
|
|
|
3,452
|
|
|
3,646
|
|
Architectural
|
|
|
1,212
|
|
|
1,537
|
|
Total
net revenues
|
|
$
|
10,034
|
|
$
|
15,647
|
|
The
following is a summary of net revenues by geographic area (based on the location
of the Company's customers) for the three-month periods ended March 31, 2006
and
April 3, 2005, respectively (in thousands):
|
|
Three
months ended
|
|
|
|
March
31,
2006
|
|
April
3,
2005
|
|
United
States
|
|
$
|
3,647
|
|
$
|
3,716
|
|
Japan
|
|
|
2,108
|
|
|
3,799
|
|
France
|
|
|
142
|
|
|
3,323
|
|
Pacific
Rim
|
|
|
2,915
|
|
|
2,562
|
|
Germany
|
|
|
779
|
|
|
1,345
|
|
Rest
of the world
|
|
|
443
|
|
|
902
|
|
Total
net revenues
|
|
$
|
10,034
|
|
$
|
15,647
|
|
Note 5--Commitments
and Contingencies:
Commitments
On
January 19, 2006, the Company announced its plans to close its Palo Alto
manufacturing facility. As a result of this decision, the Company is in
negotiation with its landlords to decommission and surrender these premises.
The
Company has recognized $0.2 million of liability on one of its buildings. No
liability has been recognized with respect to the second building at this time
because the Company cannot ascertain the fair value of any potential obligation
to this landlord because the settlement date and method of settlement for our
obligation have not been specified, and the Company currently does not have
sufficient information to reasonably estimate any potential obligation. The
Company believes that it can resolve this issue with this landlord and will
pay
for any potential obligations in the second half of 2006. It is possible that
our estimate of our lease obligation could change in the near term.
On
February 19, 2004, the Company entered into the second amendment to the lease
for the second building. The amendment reflected a payment schedule for a rent
deferral for this legal agreement. In January of 2006, the Company paid off
approximately $1.2 million of this deferred rent. As of March 31, 2006, there
was no deferred rent outstanding.
Contingencies
The
Company was named as a defendant, along with Bostik, Inc., in an action
captioned WASCO Products, Inc. v. Southwall Technologies, Inc. and Bostik,
Inc.,
Civ. Action No. C 02 2926 SBA, which was filed in Federal District Court for
the
Northern District of California on June 18, 2002. We were served with the
Complaint in this matter on July 1, 2002. The plaintiff filed the matter as
a
class action on behalf of all entities and individuals in the United States
who
manufactured and/or sold and warranted the service life of insulated glass
units
manufactured between 1989 and 1999, which contained Southwall Heat Mirror film
and were sealed with a specific type of sealant manufactured by Bostik, Inc.
The
plaintiff alleged that the sealant provided by Bostik, Inc. was defective,
resulting in elevated warranty replacement claims and costs. The plaintiff
asserted claims against us for breach of an implied warranty of fitness,
misrepresentation, fraudulent concealment, negligence, negligent interference
with prospective economic advantage, breach of contract, unfair business
practices and false or misleading business practices. The plaintiff sought
recovery on behalf of the class of $100 million for damages allegedly resulting
from elevated warranty replacement claims, restitution, injunctive relief,
and
non-specific compensation for lost profits. By Order entered December 22, 2003,
the Court dismissed all claims against us. The plaintiff has filed a notice
of
appeal to the Ninth Circuit Court of Appeals. On January 13, 2006, the Court
of
Appeals affirmed the lower court decision. On January 26, 2006, the plaintiff
filed a petition for rehearing with the Ninth Circuit Court of Appeals. In
March
of 2006, the Ninth Circuit Court of Appeals denied the plaintiff’s petition. A
percentage of the Company’s defense costs are being paid by its insurance
carriers under reservation of rights. It is not possible to predict how
Plaintiff’s claims will be resolved, whether the Company will be found liable,
or the nature and extent of Plaintiff’s alleged damages.
The
insurance carriers in some of the litigation related to allege product failures
and defects in window products manufactured by others in which we were a
defendant in the past paid the defense and settlement costs related to such
litigation. Those insurance carriers reserved their rights to recover a portion
or all of such payments from us. As a result, those insurance carriers could
seek from us up to an aggregate of $12.9 million plus defense costs,
although any such recovery would be restricted to claims that were not covered
by our insurance policies. We intend to vigorously defend any attempts by these
insurance carriers to seek reimbursement. We are not able to estimate the
likelihood that these insurance carriers will seek to recover any such payments,
the amount, if any, they might seek, or the outcome of such
attempts.
On
June
13, 2002, Plaintiff Charles Ikekwere (“Plaintiff”) filed a Complaint against the
Company in the Superior Court of California in and for the County of Santa
Clara, Case No. CV808644. Mr. Ikekwere is a former employee of the Company.
Plaintiff’s Complaint alleged claims for race discrimination, national origin
discrimination, retaliation, medical condition discrimination, breach of
contract, breach of fiduciary duty, fraud, negligence, intentional infliction
of
emotional distress, and punitive damages. The Company challenged the sufficiency
of certain of Plaintiff’s allegations, which caused him to file a First Amended
Complaint alleging essentially the same claims. The Company also challenged
certain of Plaintiff’s allegations in his First Amended Complaint, which caused
him to file a Second Amended Complaint. Following the Company’s legal challenges
to Plaintiff’s Second Amended Complaint, the following claims remain at issue in
the litigation: (1) race discrimination; (2) national origin discrimination;
(3)
retaliation; (4) medical condition discrimination; (5) breach of contract;
(6)
violation of California Constitution Article I; and (7) fraud and deceit. In
light of certain deposition testimony given by Plaintiff, the Company removed
this matter to Federal Court on January 6, 2004. The basis for the Company’s
removal was that certain of Plaintiff’s allegations were preempted by the
Employee Retirement Income and Security Act (ERISA). On February 4, 2004,
Plaintiff filed a Motion to Remand the case to State Court, which the Court
denied. Plaintiff subsequently amended his Second Amended Complaint to add
a
claim under ERISA. The Company has filed a summary judgment motion, which,
if
granted, will dispose of the entire action. If Plaintiff defeats the Company’s
summary judgment motion, trial is scheduled for July 2006. Until discovery
is
completed and the Court rules on the Company’s summary judgment motion, it is
not possible to predict how Plaintiff’s claims will be resolved, whether the
Company will be found liable, or the nature and extent of Plaintiff’s alleged
damages.
In
addition, 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 its business, consolidated financial position, results of operations
or cash flows.
Note 6--Stock-Based
Compensation:
The
Company has a stock-based compensation program that provides its Board of
Directors broad discretion in creating employee equity incentives. The Company
has granted stock options under various option plans and agreements in the
past
and currently grants stock options under the 1997 Stock Incentive Plan and
the
1998 Stock Option Plan for employees, board members and consultants. The Board
of Directors adopted the 1998 Stock Option Plan for employees and consultants
on
August 6, 1998. The Compensation Committee of the Board of Directors
administers the plans and agreements. The exercise price of options granted
under the 1997 and 1998 plans must be at least 85% of the fair market value
of
the stock at the date of grant. Options granted under the 1998 plan prior to
October 2004 generally vest at a rate of 25% per year, are non-transferable
and
expire over terms not exceeding ten years from the date of grant or three months
after the optionee terminates his relationship with the Company. Options granted
under the 1997 plan prior to October 2004 generally vest at a rate of 25% per
year, are non-transferable and expire over terms not exceeding ten years from
the date of grant or eighteen months after the optionee terminates his
relationship with the Company. In October 2004, the board of directors changed
the vesting. Grants from and after October 2004 under both plans vest at a
rate
of 25% after six months and then evenly monthly thereafter for the remaining
42
months. The Company also has an Employee Stock Purchase Plan (ESPP) that allows
employees, subject to certain limitations, to purchase shares at 85% of the
lower of the fair market value of the Common Stock at the beginning of the
six-month offering period, or the last day of the purchase period. As of March
31, 2006, the Company had approximately 2,527 shares of common stock reserved
for future issuance under our stock option plans and ESPP.
On
January 1, 2006, the Company adopted the provisions of SFAS 123R, “Shared-Based
Payment” (SFAS 123R), requiring it to recognize expense related to the fair
value of our stock-based compensation awards. The Company elected to use the
modified prospective transition method as permitted by SFAS 123R and therefore
has not restated its financial results for prior periods. Under this transition
method, stock-based compensation expense for the three months ended March 31,
2006 includes compensation expense for all stock-based compensation awards
granted prior to, but not yet vested as of January 1, 2006, based on the grant
date fair value estimated in accordance with the original provisions of SFAS
123. Stock-based compensation expense for all stock-based compensation awards
granted subsequent to January 1, 2006 was based on the grant-date fair value
estimated in accordance with the provisions of SFAS 123R. The Company recognized
compensation expense for stock option awards on a graded vesting basis over
the
requisite service period of the award.
The
following table sets forth the total stock-based compensation expense resulting
from stock options included in the condensed consolidated statements of
operations (in thousands):
|
|
___________________
|
|
|
|
Three
months ended
March
31,
2006
|
|
Cost
of sales
|
|
$
|
11
|
|
Research
and development
|
|
|
54
|
|
Selling,
general and administrative
|
|
|
162
|
|
Stock-based
compensation expense before income taxes
|
|
|
227
|
|
Income
tax benefit
|
|
|
-
|
|
Total
stock-based compensation expense after income taxes
|
|
$
|
227
|
|
Net
cash
proceeds from the exercise of stock options were none and $19 for the three
months ended March 31, 2006, and April 3, 2005, respectively. No income tax
benefit was realized from stock option exercises during the three months ended
March 31, 2006, and April 3, 2005. In accordance with SFAS 123R, the Company
presents excess tax benefits from the exercise of stock options, if any, as
financing cash flows rather than operating cash flows.
Prior
to
the adoption of SFAS 123R, the Company applied SFAS No. 123, “Accounting for
Stock-Based Compensation” (SFAS 123), amended by SFAS No. 148, “Accounting for
Stock-Based Compensation - Transition and Disclosure” (SFAS 148), which allowed
companies to apply the existing accounting rules under APB 25, “Accounting for
Stock Issued to Employees” (APB 25), and related Interpretations. In general, as
the exercise price of options granted under these plans was equal to the market
price of the underlying common stock on the grant date, no stock-based employee
compensation cost was recognized in the Company’s net income (loss). As required
by SFAS 148 prior to the adoption of SFAS 123R, the Company provided pro forma
net income (loss) and pro forma net income (loss) per common share disclosures
for stock-based awards, as if the fair-value-based method defined in SFAS 123
had been applied.
The
following table illustrates the effect on net income after tax and net income
per common share as if the Company had applied the fair value recognition
provisions of SFAS 123 to stock-based compensation during the three-month period
ended April 3, 2005 (in thousands, except per share amounts):
|
|
Three
months ended
April
3,
2005
|
|
Net
income attributable to common stockholders:
|
|
___________________ |
|
As
reported
|
|
$
|
1,576
|
|
Add:
Stock-based employee compensation expense included in reported net
income,
net of related tax effects
|
|
|
91
|
|
Deduct:
Total stock-based employee compensation determined under fair value
based
method for all awards, net of related tax effects
|
|
|
(153
|
)
|
Pro
forma net income attributable to common stockholders
|
|
$
|
1,514
|
|
Net
income attributable to common stockholders per share:
|
|
|
|
|
|
|
|
As
reported - basic
|
|
$
|
0.06
|
|
Pro
forma - basic
|
|
$
|
0.06
|
|
|
|
|
|
|
As
reported - diluted
|
|
$
|
0.05
|
|
Pro
forma - diluted
|
|
$
|
0.05
|
|
The
fair
value of stock-based awards was estimated using the Black-Scholes model with
the
following weighted-average assumptions for the three months ended March 31,
2006, and April 3, 2005, respectively:
|
|
Three
months ended
|
|
|
|
March
31,
2006
|
|
April
3,
2005
|
|
Expected
life (in years)
|
|
|
1.9
|
|
|
1.4
|
|
Interest
value
|
|
|
4.63
|
%
|
|
3.56
|
%
|
Volatility
|
|
|
109
|
%
|
|
116
|
%
|
Dividend
|
|
|
-
|
|
|
-
|
|
Weighted-average
fair value at grant date
|
|
$
|
0.36
|
|
$
|
0.45
|
|
The
Company’s computation of expected volatility for the quarter ended March 31,
2006 is based on historical volatility. The Company’s computation of expected
life is based on historical exercise patterns. The interest rate for periods
within the expected life of the award is based on the U.S. Treasury yield in
effect at the time of grant.
Stock
option activity for the three months ended March 31, 2006, was as follows (in
thousands, except per share amounts):
|
|
Shares
|
|
Weighted-Average
Exercise
Price
|
|
Weighted-Average
Remaining
Contractual
Term
|
|
Aggregate
Intrinsic
Value
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding
at December 31, 2005
|
|
|
5,572
|
|
$
|
1.53
|
|
|
|
|
|
|
|
Grants
|
|
|
190
|
|
|
0.68
|
|
|
|
|
|
|
|
Exercises
|
|
|
-
|
|
|
-
|
|
|
|
|
|
|
|
Forfeitures
or expirations
|
|
|
82
|
|
|
3.70
|
|
|
|
|
|
|
|
Outstanding
at March 31, 2006
|
|
|
5,680
|
|
$
|
1.47
|
|
|
7.58
|
|
$
|
899
|
|
Exercisable
at March 31, 2006
|
|
|
3,098
|
|
$
|
1.89
|
|
|
6.40
|
|
$
|
428
|
|
The
aggregate intrinsic value in the table above represents the total pretax
intrinsic value (i.e., the difference between Southwall’s closing stock price on
the last trading day of its first quarter of fiscal 2006 and the exercise price,
times the number of shares) that would have been received by the option holders
had all option holders exercised their options on March 31, 2006. This amount
changes based on the fair market value of Southwall’s stock. Total intrinsic
value of options exercised is zero for the three months ended March 31, 2006.
Total fair value of options vested is $69 for the three months ended March
31,
2006.
As
of
March 31, 2006, $943 of total unrecognized compensation cost related to stock
options was expected to be recognized over a weighted-average period of 1.9
years.
Note
7 - Restructuring:
In
December 2002, we implemented a reduction in force at our Palo Alto
location and elected to vacate certain buildings in Palo Alto. As a result
of these actions, we incurred a restructuring charge of $2,624 in 2002 relating
to employee severance packages and the remaining rents due on excess facilities
in Palo Alto that we no longer occupy. In 2003, we recorded a credit to
operating expenses of $65 as a result of modifications to the severance packages
of certain employees. On
January 19, 2006, we commenced restructuring actions to improve our cost
structure. These actions include the closure of our Palo Alto, California
manufacturing facility and a reduction in force at our Palo Alto site in the
first half of 2006. As
a
result of these actions, we incurred a restructuring charge of $452 during
the
first quarter of 2006 relating to employee severance packages, and related
charges.
The
following tables set forth the beginning and ending liability balances relating
to the above described restructuring activities as well as activity during
the
three-month periods ended March 31, 2006 and April 3, 2005 (in
thousands):
|
|
Restructuring
Plan
2006
|
|
Restructuring
Plan
2002
|
|
|
|
|
|
Severance
and
Benefits
|
|
Facilities
Related
and
Other
|
|
Facilities
Related
|
|
Total
|
|
Balance
at January 1, 2005
|
|
$
|
-
|
|
$
|
-
|
|
$
|
274
|
|
$
|
274
|
|
Provisions
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
-
|
|
Adjustment
to reserve
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
-
|
|
Cash
payments
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
-
|
|
Balance
at April 3, 2005
|
|
$
|
-
|
|
$
|
-
|
|
$
|
274
|
|
$
|
274
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Severance
and
Benefits
|
|
|
Facilities
Related
and
Other
|
|
|
Facilities
Related
|
|
|
Total
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance
at January 1, 2006
|
|
$
|
-
|
|
$
|
-
|
|
$
|
199
|
|
$
|
199
|
|
Provisions
|
|
|
375
|
|
|
77
|
|
|
-
|
|
|
452
|
|
Adjustment
to reserve
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
-
|
|
Cash
payments
|
|
|
(11
|
)
|
|
(20
|
)
|
|
-
|
|
|
(31
|
)
|
Balance
at March 31, 2006
|
|
$
|
364
|
|
$
|
57
|
|
$
|
199
|
|
$
|
620
|
|
At
March
31, 2006, $527
was
included in other accrued liabilities, and $93 was included in other long-term
liabilities on the condensed consolidated balance sheet.
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 activity in the reserve for sales returns and warranties account
during the three-month periods ended March 31, 2006 and April 3, 2005 was as
follows (in thousands):
|
|
Balance
at
December
31,
2004
|
|
Provision
|
|
Utilized
|
|
Balance
at
April
3,
2005
|
|
Accrued
sales returns and warranty
|
|
$
|
2,701
|
|
$
|
58
|
|
$
|
(564
|
)
|
$
|
2,195
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
____________
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance
at
December
31,
2005
|
|
|
Provision
|
|
|
Utilized
|
|
|
Balance
at
March
31,
2006
|
|
Accrued
sales returns and warranty
|
|
$
|
1,556
|
|
$
|
(86
|
)
|
$
|
(166
|
)
|
$
|
1,304
|
|
These
amounts are included in other accrued liabilities in the condensed consolidated
balance sheets.
Note
9 - Comprehensive Income:
The
Company has adopted the provisions of SFAS No. 130 "Reporting Comprehensive
Income". SFAS 130 establishes standards for reporting and display in the
financial statements of total net income and the components of all other
non-owner changes in equity, referred to as comprehensive income (loss).
Accordingly, the Company has reported the translation gain (loss) from the
consolidation of its foreign subsidiary in comprehensive income (loss).
The
total
comprehensive income (loss) at March 31, 2006, December 31, 2005, and April
3,
2005 was as follows (in thousands):
|
|
March
31,
2006
|
|
December
31,
2005
|
|
April
3,
2005
|
|
Foreign
Currency Translation Adjustment
|
|
$
|
324
|
|
$
|
(1,826
|
)
|
$
|
(670
|
)
|
Net
Income (Loss)
|
|
|
(1,327
|
)
|
|
3,320
|
|
|
1,699
|
|
Other
Comprehensive Income (Loss)
|
|
$
|
(1,003
|
)
|
$
|
1,494
|
|
$
|
1,029
|
|
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”, set forth in Item 1A, and in
our Annual Report on Form 10-K for the year ended December 31, 2005.
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, and 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. On
January 19, 2006, we commenced restructuring actions to improve our cost
structure. These actions include the closure of our Palo Alto, California
manufacturing facility and a reduction in force at our Palo Alto site in the
first half of 2006. We expect to reduce its total operating expenses by
approximately $4 million on an annual basis from these restructuring activities.
As
a
result of these actions, we incurred a restructuring charge of $452 during
the
first quarter of 2006 relating to employee severance packages, and related
charges (see Note 7 of Notes to Unaudited Condensed Consolidated Financial
Statements—Restructuring).
Demand
for our customers' products.
We
derive significant benefits from our relationships with a few large customers
and suppliers. Our revenues and gross profit can increase or decrease rapidly
reflecting underlying demand for the products of one or a small number of our
customers. We may also be unable to replace a customer when a relationship
ends
or demand for our product declines as a result of evolution of our customers'
products.
Our
three
largest customers in the automotive glass and window film markets include
Pilkington PLC, Saint Gobain Sekurit and Globamatrix Holdings Pte. Ltd., or
Globamatrix, which collectively accounted for approximately 45%, 54% and 50% of
our total revenues during the first three months of 2006, 2005 and 2004,
respectively.
Under
our
agreement with Globamatrix, as amended, Globamatrix agreed to a 2004 minimum
purchase commitment of $9.0 million of product.
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 $11.3 million
of products in 2006. During the first quarter of 2006, Globamatrix purchased
approximately $3.4 million of product.
Sales
returns and allowances. Our
gross
margins and profitability have been adversely affected from time to time by
product quality claims. From 2002 to 2005, our sales returns provision has
averaged approximately 2.8% to 4.5% of gross revenues. During 2005, our sales
returns provision has averaged approximately 3.4% of our gross revenues due
to
fewer quality claims received during the period. During
the first three months of 2006, our sales returns provision has averaged
approximately 1.7% of our gross revenues due to fewer quality claims received
during the period.
Critical
Accounting Policies and Estimates
The
accompanying discussion and analysis of our financial condition and results
of
operations are based upon our condensed consolidated financial statements,
which
have been prepared in accordance with generally accepted accounting principles
in the United States (U.S. GAAP). The preparation of these financial statements
requires us to make estimates and judgments that affect the reported amounts
of
assets, liabilities, revenues and expenses, and related disclosure of contingent
assets and liabilities. These estimates form the basis for making judgments
about the carrying values of assets and liabilities that are not readily
apparent from other sources. We base our estimates and judgments on historical
experience and on various other assumptions that we believe are reasonable
under
the circumstances. However, future events cannot be forecasted with certainty
and the best estimates and judgments routinely require adjustment. We are
required to make estimates and judgments in many areas, including those related
to revenue recognition, allowance for doubtful accounts and sales returns,
valuation of inventories, assessment of probability of the outcome of current
litigation, restructuring costs, impairment charge for long-lived assets and
accounting for income taxes. We believe the policies disclosed are the most
critical to our financial statements because their application places the most
significant demands on management’s judgment. Senior management has discussed
the development, selection and disclosure of these estimates with the Audit
Committee of our Board of Directors.
We
believe there have been no significant changes during the first three months
of
fiscal 2006 to the items that we disclosed as our critical accounting policies
and estimates in our discussion and analysis of financial condition and results
of operations in our 2005 Form 10-K, except as noted below.
Stock
Based Compensation Expense
We
account for stock-based compensation in accordance with the provisions of SFAS
123R. Under the fair value recognition provisions of SFAS 123R, stock based
compensation cost is estimated at the grant date based on the fair value of
the
award and is recognized as expense ratably over the requisite service period
of
the award. Determining the appropriate fair value model and calculating the
fair
value of stock-based awards requires judgment, including estimating stock price
volatility, forfeiture rates and expected lives.
Three
Months Ended March 31, 2006 compared with Three Months Ended April 3,
2005
Results
of Operations
Net
revenues.
Our net
revenues for the three months ended March 31, 2006 and April 3, 2005 were $10.0
million and $15.6 million, respectively. The decline in revenues affected all
of
our market segments as described below.
Our
net
revenues in the window film market decreased by $0.2 million, or 5%, from $3.6
million in the first quarter of 2005 to $3.4 million in the same period in
2006.
In
the
second half of 2005, we stopped converting (cutting the film to the customer’s
specifications) one of our window film product models and agreed with our
customers that they would complete this process. This resulted in
a
decline in average sales prices for the TX product line and the decrease in
window film market net revenues.
Our
net
revenues in the electronic display market decreased by $1.6 million, or 39%,
from $4.1 million in the first quarter of 2005 to $2.5 million in the same
period of 2006. The decrease was due to the termination of the AR product line
($0.4 million), a decline in demand for Silver reflector film for the LCD
back-light market ($0.6 million) and reduced average sales prices on film sold
to Mitsui for Plasma Display Panel, or PDP, filters ($0.6 million). An overall
decrease in the average selling prices for PDP products resulted in price
pressures on all suppliers in the market.
Our
net
revenues in the automotive market decreased by $3.5 million, or 55%, from $6.4
million in the first quarter of 2005 to $2.9 million in the same period of
2006.
The decrease was primarily due to a reduction in demand throughout the first
quarter by Saint Gobain as a result of their large inventory build-up at 2005
year end.
Our
net
revenues in the architectural market decreased by $0.3 million, or 21%, from
$1.5 million in the first quarter of 2005 to $1.2 million in the same period
of
2006. The decrease was due to softness in the Asian market and a decreased
demand from our U.S. customers due to inventory build-up at
year-end.
Cost
of revenues.
Cost of
revenues consists of materials and subcontractor services, labor and
manufacturing overhead. Cost of revenues was $6.4 million in the first quarter
of 2006 compared to $11.3 million in the same period of 2005. The decrease
in
cost of revenues was primarily due to lower revenues, transfer of production
to
our lower cost German manufacturing facility, and improved yields for the
products that were manufactured in Palo Alto.
Gross
profit and gross margin.
Our
gross profit decreased $0.7 million from $4.4 million in the first quarter
of
2005 to $3.7 million in the same period of 2006. As a percentage of sales,
gross
profit increased from 28% in the first quarter of 2005 to 37% in the same period
in 2006 due to lower overall manufacturing costs as detailed above.
Operating
expenses
Research
and development.
Research and development expenses increased $1 million from $0.7 million in
the
first quarter of 2005 to $1.65 million in the same period of 2006. The 136%
increase from year to year was due primarily to an increase in labor and
employee benefits costs as a result of expanding our engineering organization.
In June 2005, we hired a new Chief Technology Officer and Senior Vice President,
and a new Director of Engineering for the automotive market. In September 2005,
we hired a new Director of Engineering for the electronic display market. In
addition, we spent more on research and development materials in the first
quarter of 2006 than in the same period in 2005. We expect to continue investing
into research and development in 2006 at the same level of expenditure as in
the
first quarter of 2006. In
2005,
we began development and sampling of a new class of films with improved
performance that we believe will be beneficial across our product lines. We
also
initiated significant research and development into thin film technology that
we
anticipate will enable Southwall to produce products for new applications and
markets.
Selling,
general and administrative.
Selling, general and administrative expenses consist primarily of corporate
and
administrative overhead, selling commissions and occupancy costs. Selling,
general and administrative expenses increased $0.5 million from $2.0 million
in
the first quarter of 2005 to $2.56 million in the same period of 2006. The
increase in general and administrative expenses in 2006 was primarily due to
the
stock based compensation expense of $0.2 million, higher legal expense, and
building decommission expense of $0.2 million recorded in the first quarter
of
2006.
Impairment
recoveries from long-lived assets.
In the
first quarter of 2005, we recorded the recovery of $0.2 million of previously
recorded impairment charges related to the final payment from the sale of a
production machine which was impaired in the third quarter of 2003. There were
no such recoveries in the first quarter of 2006.
Restructuring.
On
January 19, 2006, we commenced restructuring actions to improve our cost
structure. These actions include the closure of our Palo Alto, California
manufacturing facility and a reduction in force at our Palo Alto site in the
first half of 2006. As
a
result of these actions, we incurred a restructuring charge of $452 during
the
first quarter of 2006 relating to employee severance packages, and related
charges. We
don’t
expect any restructuring activities for the rest of 2006. There was no such
restructuring charge in the first quarter of 2005.
Income
(loss) from operations.
Income
from operations decreased $2.8 million from the income of $1.8 million in the
first quarter of 2005 to the loss of $1.0 million in the same period of 2006.
The decrease was primarily due to a decrease in revenue, increase in research
and development costs, recognition of the stock based employee compensation
expense, and a restructuring charge in the first quarter of 2006 as detailed
above.
Interest
expense, net. Interest
expense, net decreased $0.1 million from $0.3 million in the first quarter
of
2005 to $0.2 million in the same period of 2006. The decrease in interest
expense was primarily attributable to less outstanding debt during the first
quarter of 2006 compared to the same period in 2005.
Other
income, net.
In the
first quarter of 2005 and 2006, other income, net, primarily relates to
our
German subsidiary, Southwall Europe GmBH, or SEG.
In the
first quarter of 2006, SEG received a lower energy and waste rebate refund
than
in the same period in 2005. Other income, net, also reflects foreign exchange
transaction gains and losses in the first quarter
of 2006 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. In
the
first quarter of 2006, other income, net, was $0.2 million, a decrease of $0.1
million from $0.3 million in the same period in 2005.
Income
(loss) before provision for income taxes.
We
recorded a pre-tax loss of $1.0 million in the first quarter of 2006 and a
pre-tax income of $1.8 million in the first quarter of 2005. The decrease of
$2.8 million was primarily due to a decrease in revenue, increase in research
and development costs, recognition of the stock based employee compensation
expense, a restructuring charge, and a lower other income, net, in the first
quarter of 2006.
Provision
for income taxes.
The
increase in the provision for income taxes in the first quarter of 2006 compared
to the same period in 2005 is related to higher taxable income in 2006 in SEG
as
this subsidiary no longer has net operating losses to offset net taxable income.
Net
income (loss).
In the
first quarters of 2006 and 2005, we recorded a net loss of $1.3 million and
a
net income of $1.7 million, respectively. The decrease of $3.0 million was
primarily due to a decrease in revenue, an increase in research and development
costs, recognition of the stock based employee compensation expense, a
restructuring charge, a lower other income, net, and a higher income tax
provision in the first quarter of 2006.
Deemed
dividend on preferred stock.
We
accrued $0.1 million of deemed dividend on preferred stock in the first quarter
of 2006. The holders of our secured convertible promissory notes converted
those
notes to shares of Series A preferred stock in December 2004. The Series A
preferred stock accrues cumulative dividends at the rate of 10% per
annum.
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 decreased $1.5 million from $6.6 million at December 31,
2005 to $5.1 million at March 31, 2006. Cash used in operating activities of
$1.0 million for the first three months of 2006 was primarily the result of
net
loss of $1.3 million, increase in inventories of $1.4 million, decrease in
accrued liabilities of $1.2 million due to a deferred rent payment and partially
offset by non-cash depreciation of $0.5 million, stock compensation of $0.2
million, decreases in accounts receivable of $0.5 million, increase in accrued
restructuring of $0.4 million and an increase in accounts payable and accrued
liabilities of $1.1 million. Cash provided from operations for the first quarter
of 2005 of $0.6 million was primarily the result of net income of $1.7 million
and non-cash depreciation of $0.6 million, partially offset by impairment
recoveries from long-lived assets of $0.2 million and increases in accounts
receivable of $0.3 million, other current and non-current assets of $0.6 million
and a decrease in accounts payable and accrued liabilities of $0.8
million.
Cash
used
in investing activities for the first three months of 2006 was $0.2 million
and
was the result of capital expenditures. Cash provided by investing activities
for the first quarter of 2005 of $0.2 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 $0.1
million.
Cash
used
in financing activities for the first three months of 2006 was $0.4 million
and
was primarily the result of payments of $0.4 million on our borrowings. Cash
used in financing activities for the first quarter of 2005 of $0.8 million
was
the result of repayments under capital leases and repayments of notes
payable.
We
entered into an agreement with the Saxony government in May 1999 under
which we receive investment grants. As of March 31, 2006, we had received
5.0 million Euros or $5.0 million at historical exchange rate of the grants
and accounted for these grants by applying the proceeds received to reduce
the
cost of our fixed assets in our Dresden manufacturing facility. Additionally,
as
of March 31, 2006, we had a balance remaining from the government grants we
are
entitled to receive of 0.3 million Euros, or $0.4 million, which has been
recorded as an advance and held as restricted cash until we receive approval
from the Saxony government to apply the funds to reduce our capital
expenditures. If we fail to meet certain requirements in connection with these
grants, the Saxony government has the right to demand repayment of the grants.
The total annual amount of investment grants and investment allowances that
we
are entitled to seek varies from year to year based upon the amount of our
capital expenditures that meet certain requirements of the Saxony government.
Generally, we are not eligible to seek investment grants and allowances in
the
aggregate for any year in excess of 33% of our eligible capital expenditures
in
Germany for that year. We expect to continue to finance a portion of our capital
expenditures in Dresden with additional grants from the Saxony government and
additional loans from German banks, some of which may be guaranteed by the
Saxony government. However, we cannot guarantee that we will be eligible for
or
will receive additional grants in the future from the Saxony
government.
Borrowing
arrangements
On
April
28, 2005, we entered into a credit agreement (the “Credit Agreement”) with Wells
Fargo HSBC Trade Bank, N.A. (the “Bank”). The Credit Agreement provides for two
facilities. All amounts borrowed under both facilities under the Credit
Agreement must be repaid on or before May 31, 2006. It is our intention to
renew
this credit facility in May 2006.
The
first
facility is a revolving line of credit under which we may from time to time
borrow up to $3 million, subject to satisfaction of certain conditions. Amounts
borrowed under the first facility bear interest at the prime rate minus 1.75%
per annum or LIBOR plus 1% per annum, at our option. We borrowed approximately
$3.0 million from this facility on April 28, 2005 which amount remained
outstanding as of March 31, 2006.
The
second facility is a formula line under which we may, from time to time, borrow
up to $3 million, subject to certain conditions, with advances on 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 March 31, 2006,
we
met these financial covenants. There is no balance outstanding under the second
facility.
All
borrowings under both facilities are collateralized by our inventory,
receivables, raw material and work in progress. In addition, the first facility
under the Credit Agreement is collateralized by a letter of credit posted by
Needham & Company, one of our stockholders.
The
terms
of the Credit Agreement, among other things, limit our ability to (i) incur,
assume or guarantee additional indebtedness in excess of $12.9 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 all or a
substantial or material portion of our assets, (vi) enter into transactions
with
affiliates, and (vii) make acquisitions other than up to an aggregate amount
of
$3 million and (viii) to make capital expenditures in any fiscal year in excess
of $1.5 million.
The
Credit Agreement provides for events of default, which include, among others,
(a) nonpayment of amounts when due (with no grace periods), (b) the breach
of
our representations or covenants or other agreements in the Credit Agreement
or
related documents, (c) payment defaults or accelerations of our other
indebtedness, (d) a failure to pay certain judgments, (e) the occurrence of
any
event or condition that the Bank believes impairs or is substantially likely
to
impair the prospects of payment or performance by us, and (f) certain events
of
bankruptcy, insolvency or reorganization. Generally, if an event of default
occurs, the Bank may declare all outstanding indebtedness under the Credit
Agreement to be due and payable.
The
foregoing description does not purport to be a complete statement of the
parties' rights and obligations under the Credit Agreement and the transactions
contemplated thereby or a complete explanation of the material terms
thereof.
Capital
expenditures
We
expect
to spend approximately $1.5 million in 2006 on upgrades and refurbishment of
our
production machines and research and development tools.
We spent
approximately $0.2 million in capital expenditures during the first three months
of 2006.
Future
payment obligations
Our
future payment obligations on our borrowings pursuant to our term debt, line
of
credit, non-cancelable operating leases and other non-cancelable contractual
commitments are as follows at March 31, 2006 (in thousands):
|
|
|
|
Less |
|
|
|
|
|
Greater |
|
|
|
|
|
Than |
|
|
|
|
|
Than |
|
|
|
Total
|
|
1
Year
|
|
1-3
Years
|
|
3-5
Years
|
|
5
Years
|
|
Contractual
Obligations:
|
|
|
|
|
|
|
|
|
|
|
|
Term
debt (1)
|
|
$
|
9,899
|
|
$
|
1,171
|
|
$
|
1,996
|
|
$
|
4,160
|
|
$
|
2,572
|
|
Line
of credit
|
|
|
2,996
|
|
|
2,996
|
|
|
--
|
|
|
--
|
|
|
--
|
|
Operating
leases (2)
|
|
|
593
|
|
|
380
|
|
|
208
|
|
|
5
|
|
|
--
|
|
Total
contractual cash obligations
|
|
$
|
13,488
|
|
$
|
4,547
|
|
$
|
2,204
|
|
$
|
4,165
|
|
$
|
2,572
|
|
|
(1)
|
Represents
loan agreements with Portfolio Financing Servicing Company, Wells
Fargo
Bank and several German banks.
|
|
(2)
|
Represents
the remaining rents owed on a building we rent in Palo Alto and Mountain
View, 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 4.875% at March 31, 2006) and is calculated
based
on amounts borrowed under the facility. In addition, the interest rate on one
of
our German loans has been reset to the prevailing market rate of 5.75% and
another of our German loans will have its interest rate reset to the prevailing
market rate in 2009. Fluctuations or changes in interest rates may adversely
affect our expected interest expense. The effect of a 10% fluctuation in the
interest rate on our line of credit and term debt would have had an effect
of
about $21,000 on our interest expense for the first quarter of
2006.
Investment
risk: We invest our excess cash in money market accounts and, by practice,
limit
the amount of exposure to any one institution. Investments in both fixed rate
and floating rate interest earning instruments carry a degree of interest rate
risk. Fixed rate securities may have their fair market value adversely affected
due to a rise in interest rates, while floating rate securities may produce
less
income than expected if interest rates fall. The effect of a 10% fluctuation
in
the interest rate of any of our floating rate securities would have had an
adverse effect of less than $10,000 for the first quarter of 2006.
Foreign
currency risk: International revenues (defined as sales to customers located
outside of the United States) accounted for approximately 63% of our total
sales
in the first three months of 2006. Approximately 16% of our international
revenues were denominated in Euros relating to sales from our Dresden operation
in the first quarter of 2006. The other 84% of our international sales were
denominated in US dollars. In addition, certain transactions with foreign
suppliers are denominated in foreign currencies (principally Japanese Yen).
The
effect of a 10% fluctuation in the Euro exchange rate would have had an effect
of approximately $0.3 million on net revenues for the first three months of
2006 and the effect on expenses of a 10% fluctuation in the Yen exchange rate
would have been immaterial.
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"
and
under “Risk Factors” in our 2005 Form 10-K. 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.
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 vice president of finance,
we
conducted an evaluation of the effectiveness of the design and operation
of our disclosure controls and procedures, as defined in Rules 13a-15(e)
and 15d-15(e) under the Securities Exchange Act of 1934, as amended,
as of
March 31, 2006. Based on this evaluation, our chief executive officer
and
vice president of finance concluded as of the Evaluation Date that
our
disclosure controls and procedures were effective such that the
information relating to our company, including our consolidated
subsidiaries, required to be disclosed in our Securities and Exchange
Commission (“SEC”) reports (i) is recorded, processed, summarized and
reported with the time periods specified in SEC rules and forms,
and (ii)
is accumulated and communicated to our management, including our
chief
executive officer and vice president of finance, as appropriate to
allow
timely decisions regarding required
disclosure.
|
|
(b)
|
Report
on Internal Control Over Financial Reporting.
We will be required by the Sarbanes-Oxley Act to include an assessment
of our internal control over financial reporting and an attestation
from an independent registered public accounting firm in our Annual
Report
on Form 10-K beginning with the filing for our fiscal year ending
December 31, 2007.
|
|
(c)
|
Changes
in Internal Controls.
There were no changes during the first three months of 2006 in our
internal controls over financial reporting that have materially effected,
or are reasonably likely to materially affect, the internal controls
over
financial reporting.
|
PART
II--OTHER
INFORMATION
Item
1--Legal
Proceedings
Litigation
filed against the Company was described under Item 3 in the Company's Form
10-K
filed on March 29, 2006. 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.
The
following information updates, and should be read in conjunction with, the
information disclosed in Item 1A, “Risk Factors,” of our Annual Report on Form
10K for the year ended December 31, 2005 and filed with the SEC on March 29,
2006.
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 the first quarter of 2006, and in 2004 and 2003 and
negative cash flows from operations in the first quarter of 2006 and in 2003.
These factors together with our working capital position and our significant
debt service and other contractual obligations at December 31, 2005, may raise
doubt about our ability to restore profitable operations, generate cash flow
from operating activities and obtain additional financing. These and other
factors related to our business during recent years, our past failure to comply
with covenants in our financing agreements and our voluntary delisting from
NASDAQ in March 2004 may make it difficult for us to secure the required
additional borrowings on favorable terms or at all. We intend to seek additional
borrowings or alternative sources of financing; however, difficulties in
borrowing money or raising financing could have a material adverse effect on
our
operations, planned capital expenditures and ability to comply with the terms
of
government grants.
Covenants
or defaults under our credit and other loan agreements may prevent us from
borrowing or force us to curtail our operations.
As
of
March 31, 2006, we had total outstanding obligations under our credit and other
loan agreements of $12.9 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 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.
We
expect to be subject to increased foreign currency risk in our international
operations.
In
2003,
2004, 2005 and during the first quarter of 2006, approximately 34%, 31%, 32%
and
23% 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.
Operational
Risks
We
depend on a small number of customers for nearly all of our revenues, and the
loss of a large customer could materially adversely affect our revenues or
operating results.
Our
ten
largest customers accounted for approximately 79%, 82%, 79% and 84% of net
revenues during the first quarter 2006 and in 2005, 2004 and 2003, respectively.
We expect to continue to derive a significant portion of our net sales from
this
relatively small number of customers. Accordingly, the loss of a large customer
could materially hurt our business, and the deferral or loss of anticipated
orders from a large customer or a small number of customers could materially
reduce our revenue and operating results in any period. Some of our largest
automotive glass customers have used a technology—direct-to-glass
sputtering—as
an
alternative to our window films, which in 2003 resulted in a decrease in orders
from these customers. The continued or expanded use of this technology by our
automotive glass customers would have a material adverse effect on our results
of operations and financial position.
Fluctuations
or slowdowns in the overall electronic display industry have and may continue
to
adversely affect our revenues.
Our
business depends in part on sales by manufacturers of products that include
electronic displays. The markets for electronic display products are highly
cyclical and have experienced periods of oversupply resulting in significantly
reduced demand for our products. For example, during the first quarter of 2006,
we experienced a decrease of 39% from the first quarter of 2005 in our net
revenues in the electronic display market primarily due to lower demand for
our
sputtered thin film filter products for Plasma Display Panel products due to
increased competition, and we expect this trend to continue. Mitsubishi Electric
was the only CRT manufacturer that buys our anti-reflective, or AR, film and
it
decided to consolidate all of the manufacturing of this product to Japan. In
connection with that consolidation, Mitsubishi ceased production of the 17"
AR
product in its Mexico plant during the third quarter of 2003. In 2005, we
stopped converting (cutting the film to the customer’s specifications) one of
our window film product models and agreed with our customers that they would
complete this process. This resulted in
a
decline in average sales prices for the TX product line and the decrease in
window film market net revenues.
Our
business is susceptible to numerous risks associated with international
operations.
Revenues
from international sales amounted to approximately 63%, 74%, 79% and 89% of
our
net revenues during the first quarter of 2006 and in 2005, 2004 and 2003,
respectively. The distance between our two manufacturing sites creates
logistical and communications challenges. In addition, to achieve acceptance
in
international markets, our products must be modified to handle a variety of
factors specific to each international market as well as local regulations.
We
may also be subject to a number of other risks associated with international
business activities. These risks include:
|
•
|
unexpected
changes in and the burdens and costs of compliance with a variety
of
foreign laws and regulatory requirements;
|
|
•
|
potentially
adverse tax consequences; and
|
|
•
|
global
economic turbulence and political instability.
|
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
None.
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: May
15, 2006
|
|
|
|
|
|
Southwall
Technologies Inc.
|
|
|
|
|
|
|
By:
|
/s/
Thomas G. Hood
|
|
|
|
Thomas
G. Hood
|
|
|
President
and Chief Executive Officer
|
|
|
|
|
|
|
By:
|
/s/
Sylvia Kamenski
|
|
|
|
Sylvia
Kamenski
|
|
|
Vice
President of Finance
|
28