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SECURITIES AND EXCHANGE COMMISSION

FORM 10K

[Mark One]

For the fiscal year ended December 31, 2002 or

For the transition period from           to          .

Commission file number 0-10120

FAFCO, Inc.

Registrant’s telephone number, including area code: 530-332-2100

Securities registered pursuant to Section 12[b] of the Act: None

Securities registered pursuant to Section 12[g] of the Act:

Common Stock, $0.125 par value
[Title of Class]

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

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Indicate by check mark if the disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10K or any amendment to this Form 10K. x

The aggregate market value of the registrant’s Common Stock held by non-affiliates of the registrant as of June 30, 2002, the last day of the registrant’s most recently completed second fiscal quarter, was $909,782 based upon the average of the bid and ask prices reported for such date by the National Quotation Bureau. Shares of common stock held by each officer and director and each person who owns 5% or more of the outstanding shares of common stock have been excluded in that such persons may be deemed affiliates. The determination of affiliate status in this context is not necessarily a conclusive determination for other purposes.

The number of shares of the registrant’s Common Stock outstanding as of March 13, 2003, was 3,864,111.

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PART I

This Annual Report on Form 10K contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Actual results could differ materially from those projected in the forward-looking statements. Please see the section in this Form 10K entitled “Managements Discussion and Analysis of Financial Condition and Results of Operation — Factors Affecting Future Results,” for a description of certain risks that may cause our actual results to vary from the forward-looking statements.

Introduction

FAFCO, Inc. [“FAFCO,” the “Company” or “Registrant” designs, develops, manufactures, and markets solar heating systems for swimming pools and thermal energy storage systems for commercial and industrial cooling. Pool product sales amounted to 65% of net sales in 2002 compared to 75% of net sales in 2001 and 66% of net sales in 2000. Thermal energy storage sales amounted to 35% of net sales in 2002 compared to 25% of net sales in 2001 and 34% of net sales in 2000.

FAFCO, Inc. was incorporated under the laws of the State of California in 1972. Its principal executive offices are located at 435 Otterson Drive, Chico, California. Its telephone number at that address is [530] 332-2100.

Markets

Swimming Pool Heating

FAFCO offers a range of products designed for heating outdoor swimming pools using solar energy. Low temperature solar applications developed because of the cost effectiveness of solar systems in heating a large volume of water to produce a small temperature change. The market for swimming pool heating developed for several reasons. First, pool owners normally use their pools when solar energy is abundant [during daylight hours and the summer swimming season]. Second, pools already have two elements needed for low temperature water heating: storage [the pool water] and circulation [the existing pool pump and associated plumbing]. Third, pool owners are an easily identifiable market.

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Thermal Energy Storage

FAFCO also designs, develops, manufactures, and markets a static, glycol ice builder for the thermal energy storage market. Since the product’s introduction, FAFCO has sold “ice banks” primarily to the commercial air conditioning market for use in peak load-shifting air conditioning systems.

Products

Swimming Pool Heating

The FAFCO solar pool heating system is composed of six to twelve solar collectors, a sun sensor, an automatic control, and associated accessories. The collectors and sensor are typically mounted on the roof of a pool owner’s home and connected to the pool pump and to an automatic control.

The customer sets the automatic control for the desired water temperature and, when the sensor detects that there is sufficient solar energy for the system to function efficiently, the automatic control directs the flow of water from the pool to the collectors. The water absorbs heat as it passes through the collectors and then flows back to the pool. When the desired water temperature is achieved or when there is insufficient solar energy, the automatic control redirects the flow of water back to the pool and water is drained from the collectors. When the water temperature drops and there is sufficient solar energy, the system is reactivated automatically.

In February 1996, the Company introduced a version of its solar pool heating system specifically designed for above-ground swimming pools. This system is composed of one or two solar collectors optimized for use in heating aboveground swimming pools and designed to lie flat on the ground or to be mounted on a rack on the ground.

In May 1996, the Company introduced a new and improved version of its solar collector that has a higher thermal performance due to its unique heat exchanger tube design. The tube design incorporates molded indentations, which enhance the heat transfer coefficient by increasing fluid turbulence.

The Company’s solar collectors are composed entirely of a polyolefin material [a high molecular weight polymer compound] and made up of small round tubes formed side by side in a rectangular shape either one-by-two meters, four-by-eight feet, four-by-ten feet, four-by-twelve feet or four-by-twenty feet in size, with sub manifolds and header pipes thermoformed on each end. This design provides for a maximum heating surface and even water flow in order to transfer 75% to 90% of the available solar energy to the pool water. The polyolefin material, which has been specially formulated by the Company, is black in color [to optimize solar energy absorption] and has the inherent advantages over other possible materials of lower cost, lighter weight, and higher resistance to the corrosive effects of pool chemicals and degradation resulting from ultraviolet radiation, heat, and other environmental effects.

In May 1993, the Company introduced a proprietary microprocessor-based control [AutoPool] for its solar pool heating systems. Prior to May 1993, the Company had a private label arrangement with an automatic control manufacturer. AutoPool has built-in “intelligence” that allows it to optimize the heating and filtration time for the swimming pool and can also control non-conventional solar swimming pool heaters. Because of lack of demand for the Company’s

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AutoPool Control, this product was discontinued effective January 1, 1997. The Company has ongoing obligations to service and provide spare parts for AutoPool controls sold prior to that time.

Thermal Energy Storage

The Company’s thermal energy storage [“IceStor”] systems utilize nighttime electric capacity to create stored cooling energy. Inexpensive “off-peak” energy is stored in the form of either chilled water or ice. During peak hours, stored cooling capacity is used in conjunction with a building’s air conditioning equipment to significantly reduce electrical power requirements for cooling and reduce overall power costs.

Thermal energy storage systems also offer electric utilities a solution to a fundamental, long-term problem: increased peak demand for power during periods of limited available capacity [i.e., during business hours]. IceStor technology products shift power consumption to off-peak periods when there is available capacity and lower demand.

Marketing and Sales

Solar Systems

FAFCO markets its solar systems in the United States through independent distributors who sell directly to end-users. Distributors generally have sales, installation, and service personnel who are supported by extensive FAFCO marketing and technical materials as well as in-depth factory and field training programs.

The majority of sales personnel employed by the typical distributor are assigned to retrofit sales, which are sales to existing pool owners. Retrofit sales are generated through direct mail, customer referrals, canvassing, and, to a lesser extent, selected media advertising. The balance of the typical distributor’s sales personnel is generally assigned to contractor accounts and seeks referrals for new construction sales.

FAFCO usually provides direct mail literature and other advertising materials to distributors and mails or places these materials with local advertisers on the distributors’ behalf and partially at the distributors’ expense. In certain instances, distributors will also engage in direct mailing and advertising. In addition, the Company recently established a sales office in Florida to serve the local market.

In the past, the Company has canceled several distributor agreements for reasons of inadequate performance by the distributor, primarily for failure to provide adequate sales, installation and service support for the Company’s products. In such instances, the Company has generally been able to find qualified replacements.

All work relating to the installation of FAFCO solar systems is covered by a full one-year warranty provided by the distributor. The Company’s solar collectors are covered by a variety of warranties ranging from a ten-year limited to a fifteen-year full, depending on the product. Its automatic controls, pumps, and drain-down valves are covered by a three-year limited warranty. FAFCO warranties cover defects in materials and workmanship provided that the related products are used for their intended purpose.

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FAFCO solar systems are designed to require only minimal maintenance, which can be performed either by the consumer using an owner’s manual or by the distributor’s service personnel.

Thermal Energy Storage Systems

The Company markets its IceStor products through independent contractors who design and build heating and cooling systems for commercial and industrial applications. The Company has also licensed its IceStor products for sale overseas, to design-and-build, heating, ventilating, and air-conditioning companies in Taiwan, Korea, Japan, and The Peoples Republic of China. These licensing agreements provide for licensees’ assembly, sales, support, and maintenance of IceStor products in those countries.

Sales by Geographic Area

The Company’s net sales during 2002, 2001, and 2000 were geographically distributed approximately as follows:

During 2002, Ebara Corporation accounted for 17.5% of the Company’s fiscal net sales. During 2001, no single customer accounted for 10% or more of the Company’s net sales. Two of the Company’s customers, Ebara Corporation and Florida Solar, accounted for 19.3% and 10.4% of the Company’s fiscal 2000 net sales. During 2000, 2001, and 2002 Ebara Corporation was the licensee for the Company’s IceStor products in Japan, and, as such, purchased IceStor products and components for assembly into products for resale to end users in Japan. During 2000, Florida Solar was a distributor of the Company’s pool products and, as such, purchased pool panels and components for resale to end users in Florida. No other customer accounted for 10% or more of the Company’s net sales in fiscal 2000. Any material cancellation, reduction or rescheduling of orders from a major customer, or the loss of any such customer would have a material adverse effect on the Company’s financial condition and operating results. All material assets of the Company are located in California.

Foreign sales of the Company’s products are made through independent foreign distributors and licensees. Sales to foreign distributors and licensees are shipped directly from the Company’s facilities in California and invoiced in U.S. dollars. Export sales are subject to certain controls and restrictions, including tariffs and import duties, and are subject to certain risks, including changing regulatory requirements of foreign jurisdictions and transportation delays and interruptions; however, the Company has not experienced any material difficulties in the past relating to such limitations.

Backlog

Sales to solar products distributors are made against individual purchase orders rather than through volume purchase arrangements. The Company typically ships its products within one to five days of receipt of an order; therefore, the Company’s backlog at any date is usually

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insignificant and is not a meaningful indicator of future sales. FAFCO distributors tend to order frequently in small quantities in order to minimize their inventory levels and match inventory levels with current installation schedules.

Sales of IceStor products are made against individual purchase orders to general contractors or Heating, Ventilating, and Air Conditioning [HVAC] contractors for specific new construction projects or for retrofit in existing buildings. The Company typically ships these products within six weeks or less of receipt of an order; therefore, the Company’s backlog with respect to IceStor products at any date is also usually insignificant and not a meaningful indicator of future sales.

Government Tax Incentives

Although the Company’s operations are not directly subject to extensive governmental regulations, the existence or lack of federal, state, and local tax incentives for the sale and installation of solar systems could have a substantial impact on the Company’s business. There is currently no federal tax credit for solar heating systems and state solar tax credits are available only in a few states. The Company does not anticipate that solar tax credits will become available for solar heating systems in any additional states, nor does it anticipate a significant increase in sales due to existing or future tax credits.

Manufacturing

FAFCO’s manufacturing activities consist primarily of the production of polyolefin heat exchangers used in solar heating applications and off-peak cooling applications and associated accessories. A total system approach is emphasized in order to ensure the effectiveness and reliability of the Company’s products after they have been installed, eliminating the need for distributors to rely upon materials from other suppliers.

The Company’s heat exchangers are produced from polyolefin resins using a patented extrusion and thermoforming process. Substantially all equipment used in these processes has been designed and built by the Company’s research and development engineers.

The resins employed by the Company are a petroleum by-product. The market price of these resins has fluctuated over the years with an increase in 1990 and early 1991 due to tensions in the Middle East, followed by stabilization after the completion of Desert Storm. It is expected that the price of the resins will continue to fluctuate as a result of domestic and international political and economic conditions.

FAFCO has qualified multiple sources of supply for all of its resins, materials, and subassemblies. However, certain materials and subassemblies are currently obtained from single sources. The Company believes these items could be supplied by the Company’s other qualified sources if sufficient lead-time were provided. The Company attempts to maintain additional inventory of such materials to mitigate the risk of supply shortages; however, any prolonged inability to obtain such items would have a material adverse effect on the Company’s results of operations. To date, the Company has not experienced any significant manufacturing problems or delays due to shortages of materials.

Quality assurance is performed by FAFCO at its manufacturing facility. Test and inspection procedures are a part of substantially all production and assembly operations. In addition, the

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Company uses it own diagnostic equipment and laboratory to continually test and inspect raw materials, work in process, and finished goods.

Competition

The Company’s solar heating products currently compete directly with solar heating products offered by other domestic and international manufacturers of solar heating systems, and indirectly with conventional heating systems.

The Company believes that the principal competitive factors in the markets for FAFCO solar products are [i] product performance and reliability; [ii] marketing and technical support from the manufacturer for distribution channels; [iii] selling, installation, and service capabilities of distribution channels; and [iv] price. The Company believes that it competes favorably with respect to all of these factors. However, certain of its competitors may have greater financial, marketing, and technological resources than those of the Company.

A number of companies in the United States manufacture thermal energy storage systems of various types similar to the Company’s IceStor product. The industry is in the early stages of development and additional competitors are expected to enter the market over time.

At the present time, the Company believes that the main competitive factors in the thermal energy storage market are performance, reliability, and price. The Company believes that it competes favorably with respect to these factors. However, several of its competitors have greater financial, marketing, and technological resources than those of the Company.

Research and Development

For the years ended December 31, 2002, 2001, and 2000, the Company’s research and development expenses were $294,300, $239,400, and $294,500, respectively.

The Company currently uses consulting engineers, in addition to staff engineers, who are responsible for existing product improvement, applications engineering, and new product research and development. The Company is exploring other potential revenue-producing uses for its polyolefin extrusions.

Patents, Trademarks and Licenses

FAFCO currently holds four United States patents and has two patents pending relating to certain aspects of its products and manufacturing technology. These patents expire at various times between July 2003 and December 2017. However, the Company believes that patent protection is secondary to such factors as ongoing product development and refinement, the knowledge and experience of its personnel, and their ability to design, manufacture, and successfully market the Company’s products.

From time to time, the Company has registered as trademarks certain product names and marks in order to preserve its right to those product names and marks.

The Company has granted licenses to assemble and sell IceStor systems in Taiwan, Korea, Japan, and the Peoples Republic of China to local manufacturers. See “Marketing and Sales” above.

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Employees

At December 31, 2002, the Company had a total of 62 regular personnel and 16 “contract personnel” for a total of 78 full-time personnel in the Chico, California facility. The personnel included 6 in marketing, 2 in research and development, 50 in manufacturing, and 20 in general management and administration. The Company also uses temporary personnel from agencies to fill seasonal needs. The Company has never had a work stoppage. To the Company’s knowledge, no employees are represented by a labor organization.

At December 31, 2002, the Company had a total of 19 contract personnel at its Tampa, Florida sales office.

Seasonality

Information regarding the seasonality of the Company’s business is set forth in “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Seasonality” included elsewhere in this Form 10K.

Segment Information

The Company believes it has operations in only a single market segment, the polymer heat exchanger segment.

Environmental Regulations

The Company is subject to a number of environmental regulations concerning potential air and water pollution. These regulations have not in the past had, and are not expected to have, any material adverse effect on the Company’s business. However, there can be no assurance that compliance with existing or future regulations will not require the expenditure of funds or the modification of the Company’s manufacturing process, which could have a material adverse effect on the Company’s business or financial condition.

The Company’s principal executive offices and manufacturing facilities for its products are located in a single 57,500 square foot facility that the Company owns in Chico, California. In addition, the Company leases a 5,840 square foot sales office in Tampa, Florida. This lease expires in August 2006.

The Company believes that its current facilities are adequate to meet its requirements for space in the near future. Manufacturing space is being fully utilized at the present time. However, adding additional employee shifts can accommodate additional demand.

There are presently no material pending legal proceedings to which the Company is a party or to which any of its property is subject, except for ordinary routine legal proceedings incidental to the Company’s business.

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The Company did not submit any matter to a vote of security holders during the fourth quarter of its fiscal year ended December 31, 2002.

PART II

Common Stock Data

FAFCO, Inc. Common Stock is traded on the over-the-counter market but is not listed on an exchange or quoted on any automated quotation system. The high and low closing bid quotations for each quarter during 2002 and 2001 were as follows:

The National Quotation Bureau provided the quotations above. All quotations reflect inter-dealer prices, without retail mark-up, markdown or commission and may not necessarily represent actual transactions. At February 28, 2003, the Company had 625 shareholders of record. The Company has never paid dividends on its Common Stock, has no plans to do so in the foreseeable future and is prohibited from so doing under its bank credit line covenants.

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Equity Compensation Plan Information

The following table provides certain information as of December 31, 2002 with respect to the Company’s equity compensation plans under which equity securities of the Company are authorized for issuance:

[1] These plans include the 2002 Stock Plan and the 1991 Stock Option Plan

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Selected financial information and other data presented below should be read in conjunction with the “Consolidated Financial Statements,” “Notes to Consolidated Financial Statements,” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included elsewhere in this Form 10K.

This Annual Report on Form 10K contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Actual results could differ materially from those projected in the forward-looking statements as a result of the risk factors including those set forth below under the heading “Factors Affecting Future Results” and elsewhere in this report 10K.

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The following table sets forth certain items from the Consolidated Statement of Operations as a percentage of net sales for the periods indicated:

Critical Accounting Policies

The preparation of consolidated financial statements of the Company requires management to make estimates and judgments that affect the amounts reported in the financial statements and the related footnotes. The Company considers the following accounting policies to be most significantly impacted by the estimates and judgments used in the preparation of its consolidated financial statements.

Allowance for Doubtful Accounts

The Company provides for an allowance for doubtful accounts based on the age of the trade accounts receivables in total along with the expected collectibility of specific accounts. The specific reserves are reevaluated and adjusted as additional information that impacts the amount reserved is received. Management analyzes accounts receivable and historical bad debts, customer credit-worthiness and customer payment trends when evaluating the adequacy of the allowance for doubtful accounts.

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Warranty Reserve

The Company records a provision for potential warranties based on the estimated future expense of such warranties. These estimates are based on historical experience and are monitored regularly.

Inventories

Inventories are valued at the lower of cost or market determined using the first in, first out [FIFO] method. The Company provides a reserve for obsolete inventory based on periodic evaluations for slow moving items.

2002 Compared with 2001

Net sales for 2002 increased by 24.3% to $15,036,500 from $12,100,300 in 2001 due to increased unit sales of the Company’s IceStor and pool products.

Net sales of the Company’s pool products were 8.4% higher in 2002 than in 2001 due mainly to increased unit sales. IceStor product sales were 71.8% higher in 2002 than in 2001 due primarily to increased sales to the Company’s licensee in Japan and increased unit sales in the domestic market.

Cost of goods sold increased in absolute dollars to $8,992,600 in 2002 [59.8% of net sales] from $7,146,300 [59.1% of net sales] in 2001. This increase in absolute dollars was due to increased sales; the slight increase as a percentage of net sales was primarily due to higher sales of the Company’s lower margin products.

Marketing and selling expenses increased to $2,547,200 [16.9% of net sales] in 2002 compared with $2,371,900 [19.6% of net sales] in 2001. This increase in absolute dollars was due to sales-related costs resulting from higher net sales revenues. The decrease as a percent of sales was due to the higher sales volume in 2002 compared with 2001.

General and administrative expenses remained relatively stable in absolute dollars at $1,831,800 [12.2% of net sales] in 2002 compared with $1,782,000 [14.7% of net sales] in 2001. The decrease as a percent of net sales was due to higher sales volume in 2002 compared to 2001.

Research and development expenses increased to $294,300 [2.0% of net sales] in 2002 compared with $239,400 [2.0% of net sales] in 2001 due to an increase in process improvement and product development projects.

Net interest expense decreased to $407,900 [2.7% of net sales] in 2002 compared with $438,600 [3.6% of net sales] in 2001.

Other income [expense] included $103,900 of costs related to the loss on disposition of fixed assets [primarily inefficient production equipment] that were scrapped during 2002, offset in part by a refund of $17,700 prior year’s insurance premium along with license fee income [net] of $25,000 resulting from a license agreement with a third party in the Peoples Republic of China. During 2001 other income [expense] included $102,500 in grant income from the California Energy Commission related to an energy efficiency program in which the Company participated.

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Seasonality

Historically, the Company has experienced lower solar sales during the first quarter than during other quarters of each year. In addition, sales typically have increased significantly during the second quarter, declined slightly, and then remained relatively constant during the third and fourth quarters, respectively. Net income is affected by the seasonality of sales as well as by significant marketing and selling expenses typically incurred during the first quarter of each year. These expenses are incurred to develop programs and materials for use throughout the remainder of the year.

In 2001 and 2002, the Company experienced its typical seasonality, except that lower sales and net income occurred during the fourth quarter.

2001 Compared with 2000

Net sales for 2001 increased by 5.4% to $12,100,300 from $11,481,500 in 2000 due mainly to increased unit sales of pool products partially offset by decreased sales of the Company’s IceStor products.

Net sales of the Company’s pool products were 19.7% higher in 2001 than in 2000 mainly to increased unit sales. IceStor product sales were 22.3% lower in 2001 than in 2000 due to softness in the domestic market along with a decrease in international sales to Japan and Taiwan offset in part by increased sales to Korea. Pool product sales amounted to 75% of net sales in 2001 compared to 66% of net sales in 2000. IceStor sales amounted to 25% of net sales in 2001 compared to 34% in 2000.

Cost of goods sold decreased to $7,146,300 [59.1% of net sales] in 2001 from $7,380,500 [64.3% of net sales] in 2000. This decrease was due primarily to increased sales of the Company’s higher margin IceStor products, combined with increased efficiencies realized as a result of the Company’s relocation from Redwood City to Chico, California.

Marketing and selling expenses increased to $2,371,900 [19.6% of net sales] in 2001 from $2,162,200 [18.8% of net sales] in 2000. These increases were due primarily to increased costs associated with the Company’s office in Tampa, Florida combined with increased personnel costs.

General and administrative expenses were stable at $1,782,000 [14.7% of net sales] in 2001 and $1,786,500 [15.6% of net sales] in 2000.

Research and development expenses decreased from $239,400 [2.0% of net sales] in 2001 from $294,500 [2.6% of net sales] in 2000.

Net interest expense increased to $438,200 [3.6% of net sales] in 2001 from $93,200 [0.8% of net sales] in 2000. This increase was due to increased bank borrowing [primarily attributable to the Company’s mortgage] during 2001, offset slightly by decreased borrowing costs.

Other income [net] includes $102,500 in grant income from the California Energy Commission related to an energy efficiency program in which the Company participated.

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Liquidity and Capital Resources

The Company’s cash position decreased to $100,400 at 2002 fiscal year end from $121,200 at 2001 fiscal year end.

At December 31, 2002, the Company’s net accounts receivable had increased to $1,974,200 from $1,620,500 at December 31, 2001 due to a general increase in sales for the year offset in part by increased collections.

At December 31, 2002, the Company’s net inventory had increased to $1,331,900 from $1,171,800 at December 31, 2001. This increase in inventory was due to a build-up of inventories to meet first quarter 2003 demand.

At December 31, 2002, deferred tax asset had decreased to $478,600 from $814,800 at December 31, 2001, due to the utilization of net operating loss carryforwards. The Company believes that it is more likely than not that this asset will be fully realized. This belief is based upon the Company’s recent history of profitable operations with the exception of fiscal year 2000. However, there can be no assurance that the Company will continue profitability or, if it does, that profits will be sufficient to utilize the deferred asset.

At December 31, 2002, the Company’s current ratio was 1.81:1.00 compared to 1.12:1.00 at December 31, 2001. The Company had working capital of $1,746,200 at December 31, 2002 compared with $353,500 at December 31, 2001. Total assets exceeded total liabilities by $3,828,100 at December 31, 2002 compared with $3,229,200 at December 31, 2001.

The Company believes that its cash flow from operations, together with bank borrowings and the issuance of $500,000 in convertible subordinated notes in 2002, as discussed in Note 4 of the financial statements, will be sufficient to support operations during the next twelve months. The foregoing statement of how long the Company’s capital resources are expected to last is a forward-looking statement involving risks and uncertainties, including the amount of the Company’s sales and the ability of the Company to control its operating expenses. If sales decline from current levels additional debt or equity financing may be required. There can be no assurance that financing, if required, would be available on favorable terms or at all or that such financing would not significantly dilute the ownership interests and rights of existing shareholders. The Company has a line of credit, of which $0 had been utilized and $1,000,000 remained available under the formula applied to net accounts receivable at December 31, 2002. This line of credit expires on August 10, 2003.

In addition to the line of credit, the Company has a 36-month term loan facility in the amount of $445,000 bearing interest at prime plus 1.5%. At December 31, 2002, the Company had an outstanding balance of $59,000 under this loan facility.

The Company also has a 60-month term loan facility available in the amount of $500,000 bearing interest at prime plus 1.5%. At December 31, 2002, the Company had an outstanding balance of $356,200 under this loan facility.

The Company has outstanding promissory notes with an aggregate principal amount of $500,000 [“the Notes”]. The principal amount of the Notes is due and payable in January 2005. Interest is payable quarterly at a rate of 12% per annum starting in January 2003.

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At December 31, 2002, the Company owed an aggregate of $3,764,800 under various bank credit facilities. Payments due under these credit facilities are as follows:

The bank may accelerate payment of the amount owed if we fail to meet financial and other covenants set forth in the loan agreement.

Factors Affecting Future Results

U.S. Economic Conditions: A protracted U.S. recession could adversely impact new housing and commercial construction in our largest market, which in turn could cause us to miss our revenue growth goals.

Asian Economic Conditions: Sales in these Asian countries account for virtually all our international sales, and contribute a significant portion of our overall revenues. In the event that these economies experience declining growth or contraction in 2003, our sales in this region could be adversely impacted.

Growth of U.S. Thermal Energy Storage [TES] Market: Our ability to increase sales of our thermal energy storage products is dependent on growth in the overall market because opportunities for market share growth are limited. An extended recession in the general economy, a general decline in construction of commercial properties or a decline in energy prices could all adversely affect demand for thermal energy storage systems.

Destabilizing Incidents: Additional destabilizing events such as terrorist attacks or overseas conflicts, if they occur, could disrupt our supply chain, increase our materials costs, reduce demand for our products, and otherwise negatively impact our operating results.

Materials Prices: Raw materials including resins account for a major portion of our cost of sales. Any increase in these prices because of supply shortages or otherwise would reduce our operating margins and adversely impact our profitability.

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Export Sales are subject to certain controls and restrictions, including tariffs and import duties and are subject to certain risks, including changing regulatory requirements of foreign jurisdictions and transportation delays and interruptions. However, the Company has not experienced any material difficulties in the past relating to such limitations.

The following discussion about the Company’s market risk exposure involves forward-looking statements. Actual results could differ materially from those projected in the forward-looking statements. The Company is exposed to market risk related to changes in interest rates, foreign currency exchange rates and equity security price risk. The Company does not use derivative financial instruments for any purpose, including hedging interest and foreign exchange risks.

The Company is exposed to financial market risks, including changes in foreign currency exchange rates and interest rates. The Company attempts to minimize its currency fluctuation risk by pricing its overseas product sales and license fees in United States dollars. A 10% change in the foreign currency exchange rates would not have a material effect on foreign sales denominated in local currencies. However, such an increase may make our products, which are priced in dollars, less competitive in overseas markets, which may have a material adverse impact on our overseas sales revenues.

The Company maintains short-term investments consisting of variable interest accounts. However, due to the short-term nature of the Company’s debt investments, the impact of interest rate changes would not have a material impact on the value of such investments.

As of December 31, 2002, the Company had $3,349,600 in indebtedness outstanding under the mortgage with respect to its headquarters facilities, and $415,200 in obligations under bank credit facilities. The interest rate charged under the mortgage is subject to adjustment based on market rates once every five years, with the next adjustment due in June 2005. The interest rate applicable to the Company’s bank credit facilities is adjusted on a daily basis. The Company’s interest rate exposure on variable rate debt obligations is currently relatively insignificant. Interest rate changes would not have a material impact on the Company’s results of operations.

The Company currently holds no marketable equity securities of other issuers that are subject to market price volatility.

The following should be read in conjunction with the “Consolidated Financial Statements” and “Notes to Consolidated Financial Statements” included elsewhere in this Form 10K.

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The consolidated financial statements of the Company are listed in Item 15 of this report. The quarterly financial data [unaudited] of the Company for the two years ended December 31, 2002 are as follows:

Not applicable.

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PART III

Executive Officers

Freeman A. Ford, age 62, serves as Chairman of the Board, President, and Chief Executive Officer. Mr. Ford, a co-founder of the Company, has served as Chairman of the Board since 1972, as Chief Executive Officer of the Company since May 1979, and as President since September 1984. Mr. Ford is also a Director of H.B. Fuller Company.

Alex N. Watt, age 61, serves as Executive Vice President and Secretary. Mr. Watt joined the Company as its Vice President-Finance and Chief Financial Officer in July 1984, and has served as Secretary since March 1985.

David Harris, age 47, serves as Vice President, Sales. Mr. Harris joined the Company in August 1981 as a sales representative and has held the positions of Pool Builder Manager, National Sales Manager-Pool Products, Pacific Northwestern Region Sales Manager, National Sales Manager-Solar Division, National Sales Manager, Vice President-Sales and Marketing (from June 1988 until April 1993) and President-Pool Products Division (from May 1993 until May 1995).

Nancy I. Garvin, age 57, serves as Vice President, Finance. Ms. Garvin joined the Company in May 1974 as an accounting clerk and has since held the positions of Accounting Manager and Controller with the Company.

Board of Directors

Mr. William A. Berry, age 64, is Senior Vice President and Chief Financial Officer of the Electric Power Research Institute, an energy industry research consortium. Mr. Berry has served as a Director of the Company since 1974 and is also a member of the Audit Committee.

Mr. Robert W. Selig, Jr., age 63, is President of Davis Instruments Corporation, a manufacturer and distributor of marine and weather equipment. Mr. Selig has served as a Director of the Company since 1974 and is also a member of the Audit Committee.

Mr. William F. Chisholm, age 34, is a Partner at Symphony Technology Group, a venture capital firm. Mr. Chisholm has served as a Director of the Company since 1999.

Mr. David F. Ford, age 35, is President of Danger! Books, a book publisher and distributor. Mr. Ford has served as a Director of the Company since 1999.

David Ford and William Chisholm are the son and son-in-law, respectively, of Mr. Freeman A. Ford.

Based solely on its review of the copies of Forms 3, 4 and 5 received by the Company, or written representations from certain reporting persons that no Forms 5 were required for such persons, the Company believes that, during the fiscal year ended December 31, 2002, all filing requirements under Section 16[a] of the Securities Exchange Act applicable to its officers, directors and 10% shareholders were complied with.

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Item 11. Executive Compensation

The following table sets forth for the three years ended December 31, 2002 certain information as to the compensation paid by the Company to the Chief Executive Officer and the other executive officers of the Company who received salary and bonus compensation of $100,000 or more (the “Named Executive Officers”).

	[1] Excludes certain perquisites and other benefits that did not exceed the lesser of $50,000 or 10% of any officer’s total salary and bonus. [2] Consists of premiums paid by the Company for term life insurance [3] Consists of 401K contribution [Company match], health insurance, and personal benefits

The Company did not make any grant of stock options to the Named Executive Officers during the Last Fiscal Year.

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The following table sets forth information regarding the value of all unexercised stock options and warrants held by the Named Executive Officers as of the end of the Last Fiscal Year.

Aggregated Options Exercised In Last Fiscal Year-End And Fiscal Year-End
Option And Warrant Values

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Item 12. Security Ownership of Certain Beneficial Owners and Management

The following table sets forth the beneficial ownership of Common Stock of the Company as of March 13, 2003 by [1] each person known by the Company to beneficially own more than 5% of the Company’s Common Stock, [2] each director and nominee for director, [3] the named executive officers of the Company, and [4] all current directors and executive officers as a group:

*

Less than 1%

	[1]		Except as otherwise indicated in the footnotes to this table or as otherwise provided by community property laws, the beneficial owner has sole voting and investment power with respect to all shares.
	[2]		Based on 3,864,111 shares of Common Stock outstanding as of March 13, 2003.
	[3]		Includes [i] 298,000 shares held of record by trusts for the benefit of Freeman Ford’s children, for which he and his spouse serve as trustees and as to which shares he disclaims beneficial ownership, [ii] 449,344 shares jointly owned by Freeman Ford and his spouse, and [iii] 112,250 shares issuable upon exercise of options and warrants held by Freeman Ford exercisable within 60 days of March 13, 2003.
	[4]		Includes [i] 72,950 shares issuable upon exercise of outstanding options held by Mr. Watt exercisable within 60 days of March 13, 2003 and [ii] 3,000 shares held by Mr. Watt and Sandra S. Watt as joint tenants.
	[5]		Includes 72,950 shares issuable upon exercise of outstanding options held by Mr. Harris exercisable within 60 days of March 13, 2003.
	[6]		Includes 23,800 shares issuable upon exercise of outstanding options held by Ms. Garvin exercisable within 60 days of March 13, 2003.
	[7]		Includes 36,938 shares issuable upon exercise of outstanding options held by David Ford exercisable within 60 days of March 13, 2003.
	[8]		Includes [i] 15,000 shares issuable upon exercise of outstanding options held by Mr. Selig exercisable within 60 days of March 13, 2003, and [ii] 5,700 shares held of record by trusts for the benefit of Mr. Selig’s children, as to which shares he disclaims beneficial ownership.
	[9]		Includes [i] 6,000 shares issuable upon exercise of outstanding options held by Mr. Chisholm exercisable within 60 days of March 13, 2003 and [ii] 18,750 shares jointly owned by Mr. Chisholm and his wife.
	[10]		Includes 15,000 shares issuable upon exercise of outstanding options held by Mr. Berry exercisable within 60 days of March 13, 2003.
	[11]		Includes [i] 281,950 shares issuable upon exercise of outstanding options exercisable within 60 days of March 13, 2003 held by four executive officers (one of whom is also a director), and [ii] 72,938 shares issuable upon exercise of outstanding options exercisable within 60 days of the March 13, 2003 held by four outside directors.

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Item 13. Certain Relationships and Related Transactions

By virtue of his position as Chairman of the Board, President and Chief Executive Office of the Company and his beneficial ownership of approximately 46.9% of the Company’s Common Stock as of the Record Date, Freeman A. Ford may be deemed to be a “parent” and/or “control person” of the Company within the meaning of the rules and regulations promulgated under the Securities Act of 1933, as amended. Freeman A. Ford can elect a majority of the Board of Directors and controls any shareholder vote that does not require a supermajority with respect to which his shares are eligible to be voted. In addition, Freeman A. Ford, his son [David F. Ford] and his son-in-law [William Chisholm] comprise three out of five directors of the Company.

During 2000, Freeman A. Ford, David F. Ford [Freeman A. Ford’s son] and Kimberley Ford Chisholm [Freeman A. Ford’s daughter and William Chisholm’s spouse] exercised options to purchase, at a purchase price of $0.125 per share: 240,000; 18,750; and 18,750; shares of FAFCO Common Stock, respectively.

During January 2002, the Company raised $500,000 in debt financing through the issuance of subordinated promissory notes [the “Notes”]. The Notes have a term of three years and accrued interest at an annual rate of 10%, payable quarterly during 2002. The notes may be prepaid at any time. The applicable interest rate increased to 12% per annum effective January 2003.

In connection with the issuance of the Notes, the Company issued warrants to purchase an aggregate of 100,000 shares of our common stock to the investors [the “Warrants”]. The Warrants have an exercise price of $.125 per share and a term of three years from the date of issuance. Because the Notes were not prepaid by the first anniversary of the issuance date, the Company issued additional Warrants to purchase 1,000 shares of our common stock for each $10,000 of principal that remains outstanding.

Freeman A. Ford, our Chairman and Chief Executive Officer, and Diana V. Ford [Mr. Ford’s wife] purchased $150,000 of the principal amount raised, and received Warrants to purchase 30,000 shares of common stock.

During 2002, the Company hired David F. Ford [Freeman A. Ford’s son and a director of the Company] to do consulting on sales and marketing of solar heating systems for swimming pool and domestic thermal energy storage systems for commercial and industrial cooling markets. Total payments made with respect to Mr. Ford’s engagement were $6,000.

PART IV

Item 14. Controls and Procedures

Evaluation of Disclosure Controls and Procedures: The Company’s principal executive officer and principal financial officer have concluded that the Company’s disclosure controls and procedures [as defined in Rule 13a-14[c] and 15d-14[c] under the Securities and Exchange Act of 1934, as amended], based on their evaluation of these controls and procedures as of a date within ninety days prior to the filing date of this Form 10K, are effective to ensure that information required to be disclosed is accumulated and communicated to management to allow timely decisions regarding required disclosures.

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Changes in Internal Controls: There have been no significant changes in the Company’s internal controls or in other factors that could significantly affect these controls subsequent to the date of the evaluation thereof, including any corrective actions with regard to significant deficiencies and materials weaknesses.

Item 15. Exhibits, Financial Statement Schedules, and Reports on Form 8K

[a][1] The following documents are filed as part of this report:

Schedules not included in these financial statement schedules have been omitted because they are not applicable or required information is shown in the financial statements or notes thereto.

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[a][3] Exhibits

*Denotes a management contract or compensatory plan or arrangement.

(1)		Incorporated by reference to exhibit filed with Registrant’s Registration Statement on Form S-1 [File No. 2-72297] filed May 14, 1981.
(2)		Incorporated by reference to exhibit filed with Registrant’s Annual Report on Form 10-K for the fiscal year ended December 31, 1983.
(3)		Incorporated by reference to exhibit filed with Registrant’s Annual Report on Form 10-K for the fiscal year ended December 31, 1988.
(4)		Incorporated by reference to exhibit filed with Registrant’s Annual Report on Form 10-K for the fiscal year ended December 31, 1990.

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(5)		Incorporated by reference to exhibit filed with Registrant’s Annual Report on Form 10-K for the fiscal year ended December 31, 1991.
(6)		Incorporated by reference to exhibit filed with Registrant’s Annual Report on Form 10-K for the fiscal year ended December 31, 1992.
(7)		Incorporated by reference to exhibit filed with Registrant’s Annual Report on Form 10-K for the fiscal year ended December 31, 1993.
(8)		Incorporated by reference to exhibit filed with Registrant’s Annual Report on Form 10-K for the fiscal year ended December 31, 1994
(9)		Incorporated by reference to exhibit filed with Registrant’s Annual Report on Form 10K for the fiscal year ended December 31, 1998.
(10)		Incorporated by reference to exhibit filed with Registrant’s Annual Report on Form 10K for the fiscal year ended December 31, 1999.
(11)		Incorporated by reference to exhibit filed with Registrant’s Annual Report on Form 10K for the fiscal year ended December 31, 2000.
(12)		Incorporated by reference to exhibit filed with Registrant’s Annual Report on Form 10K for the fiscal year ended December 31, 2002, as amended.

[b]		Reports on Form 8-K: No Reports on Form 8-K were filed by the Company during the fourth quarter of 2002.
[c]		Exhibits: See subsection [a] [3] above.
[d]		Financial Statement Schedules: See subsection [a] [2] above.

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BPM
Burr, Pilger, & Mayer, LLP
600 California Street, Suite 1300
San Francisco, CA 94108
(415) 421-5757 phone
(415) 288-6288 fax

INDEPENDENT AUDITORS’ REPORT

To the Board of Directors and Stockholders
of FAFCO, Inc:

We have audited the accompanying consolidated balance sheets of FAFCO, Inc. (a California corporation) and its subsidiary as of December 31, 2002 and 2001, and the related consolidate statements of operations, shareholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2002. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evident supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of FAFCO, Inc. and its subsidiary as of December 31, 2002 and 2001, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2002 in conformity with accounting principles generally accepted in the United States of America.

/s/ Burr, Pilger & Mayer LLP

San Francisco, California
February 28, 2003

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Consolidated Balance Sheet

The accompanying notes are an integral part of this statement

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Consolidated Statement of Operations

The accompanying notes are an integral part of this statement

Consolidated Statement of Shareholder’s Equity