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U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-KSB
[X] ANNUAL REPORT UNDER SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the fiscal year ended: December 31, 1996
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the transition period from to
------------------- ------------------
Commission file number: 0-28484
QUALMARK CORPORATION
(Name of small business issuer in its charter)
COLORADO 84-1232688
(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)
1329 121ST WEST AVENUE, DENVER, COLORADO 80234
(Address of principal executive offices, including zip code)
(303) 254-8800
(Registrant's Telephone Number, including area code)
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE EXCHANGE ACT: None
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE EXCHANGE ACT:
COMMON STOCK (NO PAR VALUE)
(Title of Class)
Check whether the issuer (1) filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act during the past 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 _______
Check if there is no disclosure of delinquent filers in response to Item
405 of Regulation S-B contained in this form, and no disclosure will be
contained, to the best of registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form
10-KSB or any amendment to this Form 10-KSB. [ ]
State issuer's revenues for its most recent fiscal year. $5,694,000
The aggregate market value of the voting stock held by nonaffiliates
computed by reference to the average bid and asked prices of such stock as of
March 19, 1997 was $11,032,228.
The number of shares outstanding of the issuer's Common Stock as of March 19,
1997 was 3,330,484.
DOCUMENTS INCORPORATED BY REFERENCE
Registrant's definitive Proxy Statement to be filed pursuant to Regulation
14A under the Securities Exchange Act of 1934 is incorporated by reference in
Part III of this report.
Transitional Small Business Disclosure Format (Check One): Yes___ No /X/
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PART I
ITEM 1. DESCRIPTION OF BUSINESS.
The Company designs, manufactures, and markets proprietary systems which
rapidly and efficiently expose product design and manufacturing-related
defects for the purpose of improving product quality and reliability. The
Company's high performance physical stress systems support significant
improvements in the process of Design Verification Testing ("DVT") and
Environmental Stress Screening ("ESS"). DVT is the process by which
electronic product manufacturers ensure that their products perform within
the previously determined operating ranges (commonly known as
"specifications"), ESS is the testing process used by these same
manufacturers to detect production-related defects.
The Company's systems allow manufacturers to determine the true operating
limits of their products. This gives the manufacturers the necessary
information to reduce design costs, improve product reliability, shorten time
to market, reduce warranty costs, and extend warranty periods. The Company's
systems are used by manufacturers in a wide range of industries to perform
stress testing on products including circuit boards, blood glucose monitors,
flight navigation systems, cellular telephones, airbag sensors and consumer
electronics products.
The Company is evolving from an entity focused solely on manufacturing
and marketing its proprietary OVS physical stress screening equipment to a
full service organization offering HALT and HASS test services as well. HALT
(Highly Accelerated Life Test) consists of an accelerated series of
vibration, voltage, temperature, and other stresses used to test products in
their design phase. Tested products are stressed well above manufacturer
specifications until product failure occurs. Manufacturers are able to use
information derived from HALT testing procedures to improve product design
and performance to limits of the available product technology. HASS (Highly
Accelerated Stress Screen) utilizes the same stresses as in HALT but at
lessor intensity so that process deviations can be detected in-house before
the product is sent to the customer. It is a complementary process to HALT
and is used to verify or monitor production processes once a product is in
manufacturing. The Company operates a growing network of test centers,
known as Accelerated Reliability Test Centers ("ARTC"), which provide
comprehensive HALT and HASS test and support services to industry. These
services include accelerated reliability improvement test services (HALT and
HASS) using QualMark's OVS physical stress systems performed either in the
ARTC test centers or at the customer's site.
QualMark currently has six test centers located in Denver, Colorado,
Santa Clara, California, Marlborough (Boston), Massachusetts, New Brighton
(Minneapolis-Saint Paul), Minnesota, Farmington Hills (Detroit), Michigan,
and Morrisville (Raleigh), North Carolina. The Company expects to open at
least four additional test centers in 1997. As international demand for its
products and services grows, the Company may open ARTC facilities outside of
the United States.
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PRODUCTS AND SERVICES
THE OVS COMBINED STRESS SYSTEM
The Company's OVS Combined Stress Systems for HALT and HASS are comprised of
two main subassemblies: the OmniAxial Vibration Assembly, which applies
vibrational stresses, and the UltraRate Thermal Chamber Assembly, which
applies thermal stresses.
THE OMNIAXIAL VIBRATION ASSEMBLY
The OmniAxial Vibration Assembly is a true multi-axis vibration system
comprised of a table and vibrators and is the heart of the Company's
technology. The vibration table moves simultaneously in three linear axes
and three angular rotations. Each axis has broad-band random vibration, with
all frequencies present, all of the time. While the traditional frequency
range used for DVT and ESS is from 2Hz to 2,000 Hz, the Company's system
creates force generation between 2Hz and 10,000 Hz. This provides extremely
complex motion across a broad frequency range, which is desirable for many
current electronic technologies. Thus, the system creates any vibration that
could occur naturally during product use. This is important in testing and
screening applications to detect most flaws, whether it is design or process
related, before the product is placed into service.
The OmniAxial Vibration Assembly consists of two major components:
Vibration Table
---------------
The patented vibration table is constructed out of solid aluminum that
contains cored-out voids to enhance uniform distribution of vibration
energy across the table. The unique properties of this table allow the
Company to produce it in a number of different dimensions, from a one foot
by one foot size to a four foot by four foot dimension. As market demand
dictates, the Company will continue to explore opportunities to extend the
present product line to include vibration tables of different dimensions.
The Company uses an outside source to produce its vibration tables;
however, the Company is not dependent on a single source of supply and
controls all design and documentation.
AutoSmear Vibrators
-------------------
A set of pneumatic, piston driven actuators (vibrators) that contain
certain patented properties, which help to maximize random motion of the
vibration table are attached to the bottom surface of the table. These
actuators, known as "AutoSmear" Vibrators, are mounted to the bottom of the
vibration table and oriented in different directions to promote random
motion of the table. Compressed air is routed to the AutoSmear Vibrator
housings, forcing the pistons to impact the top surface of each AutoSmear
Vibrator, translating the energy to the vibration table. The unique design
of the AutoSmear Vibrator piston and housing allow for a variation in the
amount of energy produced by each AutoSmear.
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THE ULTRARATE THERMAL CHAMBER ASSEMBLY
The UltraRate Thermal Chamber, which houses the OmniAxial Vibration Assembly,
changes temperature at rates up to 60DEG. Centigrade per minute as measured on
the product being tested. This high rate of change results in highly
effective design verification during HALT and extremely short production
screens during HASS, requiring less equipment and personnel to perform a
given series of thermal cycles. The Company believes that its UltraRate
Thermal Chambers, comprised of patent pending features, have one of the
highest rate of thermal change available in the environmental stress
screening industry. This capability significantly reduces test time, with
resulting cost reductions in equipment and personnel.
In spite of rapid temperature change and complex vibration spectra, the
UltraRate Thermal Chamber is extremely quiet, allowing it to be used in
standard lab and manufacturing environments without the necessity of building
costly special stress screening rooms.
THE OVS COMBINED STRESS SYSTEM PRODUCT LINE
- -------------------------------------------
The Company's OVS Combined Stress Systems for HALT and HASS are presently
available in five sizes. The number after the "OVS" in the Company's product
models represents the linear footage of the vibration table as explained
below. Therefore, an OVS-1 contains a one foot by one foot table, an OVS-2
contains a two foot by two foot table, and so on. Through this product
spectrum, the Company provides systems capable of meeting virtually every
accelerated design ruggedization and production screening requirement. The
variety of chamber sizes allows customers to purchase equipment that meets
their requirements and to consume only the energy necessary to meet their
requirements. The OVS-3 and OVS-4 systems have a unique patented feature
which allows the user to raise the shaker table, thus decreasing the internal
volume of the chambers to the minimum size required. Lastly, by cooling and
heating a smaller volume, the customer can save considerably on power and
liquid nitrogen requirements.
OVS-1:
------
The OVS-1 is a small, bench top version of the OVS product line. The OVS-1
is a truly portable, multi-axis vibration and high performance thermal
chamber. Equipped with all the same operating features of the larger OVS
systems, including PC controller, the OVS-1 is primarily used by
manufacturers of small products (such as "palm size" circuit boards, modem
cards for notebook computers, disk drives, etc.) and usually in the product
development (HALT) area. The OVS-1 can generate random vibration forces in
excess of 90 Grms (2Hz-10,000 Hz) on the 12"x12" vibration table and up to
60DEG. Centigrade per minute change on the product under test within the
18"x17"x15" (ID) thermal chamber. The price of the OVS-1 is approximately
$63,500.
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OVS-2:
------
The OVS-2 is the smallest floor model version of the OVS product line. The
PC-controlled OVS-2 is equipped with a 24"x24" vibration table enclosed
within a 30"x30"x36" (ID) thermal chamber. The OVS-2 vibration table can
generate random vibration forces in excess of 40 Grms (2Hz- 10,000 Hz),
while the thermal chamber can produce temperature changes of up to 60DEG.
Centigrade per minute. The OVS-2 is designed for primarily small product
HALT applications (power supplies, motherboards, etc.) and small volume
HASS applications. The price of the OVS-2 is approximately $97,500.
OVS-2.5:
--------
The OVS-2.5 is the most popular system in the OVS product line. A
mid-size system, the PC-controlled OVS-2.5 is available in two
configurations: a standard version that is equipped with four large
vibrators mounted to the vibration table, and a high performance version
that comes equipped with eight large vibrators, for heavier product
applications. The OVS-2.5 standard vibration system can generate 50 Grms
(the high performance system generates greater force than the standard
version with heavy loads) from 2Hz to 10,000 Hz. The vibration table is
30"x30", and is enclosed within a thermal chamber that is 36"x36x37" (ID).
The thermal chamber is capable of up to 60DEG. Centigrade per minute change
on the product under test. Typical uses of the OVS-2.5 include mid-size
product HALT applications (disk drives, small computers, power supplies,
monitors, etc.) and small volume HASS applications (multiple disk drives,
multiple modem cards for notebook computers, etc.) The price for a standard
OVS-2.5 is approximately $120,000, and the high performance version for
heavy load applications is approximately $127,000.
OVS-3:
------
The OVS-3 is commonly used for production screening (HASS) applications, or
for HALT on system-level products (such as work stations and other large
computers). The PC-controlled OVS-3 contains a 36"x36" vibration table
equipped with nine large vibrators that generate at least 35 Grms random
vibration force (2Hz-10,000 Hz). The thermal chamber is 43"x42"x36" (ID)
and can produce temperature changes on the product under test of up to
60DEG. Centigrade per minute. The OVS-3 sells for approximately $134,000.
OVS-4:
------
The OVS-4 is the largest system in the OVS product line. By far, the most
common application for the OVS-4 is for large volume production screening
(HASS) on computers, monitors, communications systems, etc. The
PC-controlled OVS-4 is equipped with a 48"x48" vibration table housed
within a 55"x54"x36" thermal chamber capable of producing temperature
changes of up to 60DEG. Centigrade per minute on the product under test. The
OVS-4 standard vibration system is equipped with eight large vibrators that
produce up to 40 Grms random vibration force, while the high performance
version is equipped with sixteen large vibrators for heavy load
applications. The standard OVS-4 sells for approximately $166,000; the
high performance version for heavy load
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applications is approximately $188,000.
Various options and accessories are available for each OVS model, including
oxygen monitors, vacuum hold down apparatus (for product fixturing
requirements), multi-year extended warranties, communications software and
on-site applications assistance.
ACCELERATED RELIABILITY TEST CENTERS
The Company has a growing network of ARTC test centers, which provide test
services and on-site applications support services. The Company is uniquely
positioned to offer comprehensive HALT/HASS test services to manufacturers.
The QualMark test service business includes accelerated reliability test
services performed in the Company's test centers and on-site applications
support services. These services allow a broad range of customers convenient
access to the Company's technology while also serving as valuable sales tools
for gaining system orders. Each test center is equipped with the high
performance version of the Company's mid-range system, the OVS-2.5, at least
one applications engineer and ancillary testing equipment. Offering these
services significantly differentiates the Company from the competition.
The Company opened its first ARTC facility in Denver in October 1993 and
subsequently opened additional facilities in Marlborough (Boston),
Massachusetts and Santa Clara, California in July 1994 and May 1995,
respectively. Since opening these facilities, many test service clients have
placed orders for systems as a result of the data gathered and analyzed at
the Company. The test center is a valuable tool for the Company sales people
to use in order to stimulate system sales from those clients who are not
willing to commit capital without being able to experience a demonstration of
the benefits using their own product. Of strategic importance to the
Company, the testing service business should help insulate the Company from
external economic factors which affect capital spending and provide for more
consistent revenues.
In addition to its Boston, Denver and Santa Clara test centers, during 1996
the Company opened test centers in New Brighton (Minneapolis-Saint Paul),
Minnesota, Farmington Hills (Detroit), Michigan, and Morrisville (Raleigh),
North Carolina. The Company expects to open approximately four additional
test centers in 1997.
The Company intends to open additional test centers principally in
metropolitan areas with a heavy concentration of potential client companies
and in which the Company has a factory or independent sales representative
responsible for the target metro area. Management believes demand for its
test services will continue to grow, allowing for controlled expansion into
additional metro areas.
Based on client demand, the Company offers on-site applications support
services, principally through its ARTC network, to its clients as well as
competitors' customers. Specifically, the Company advises customers how to
apply HALT and HASS techniques to their products. The Company also
incorporates applications support services into equipment quotations.
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MARKETING
The Company increased its market exposure in 1996 by expanding the number of
"open houses" at each of its nationwide ARTCs. Prospects for these open
houses are usually found in various electronic manufacturers data bases.
In-house sales personnel use these tools to identify and invite key
engineering and reliability decision makers to come find out how they can
dramatically increase their product reliability. Attendees are qualified to
determine which companies are high probability prospects to use the ARTC
and/or to begin in-house accelerated testing. Through the open houses, the
Company identifies many new customers for its products and services, while
rapidly expanding the market acceptance of HALT and HASS as premier
accelerated testing techniques.
The Company includes the following in its marketing plan for the next 12
months:
1) The Company will continue to encourage individuals and companies in the
electronic and reliability engineering market segments to publish articles
concerning accelerated reliability techniques and their successes
associated with using the techniques.
2) The Company will selectively advertise in periodicals that have significant
exposure with design engineers and reliability/ESS engineers.
3) The Company will continue to attend approximately one trade show per
quarter.
4) Management intends to have its marketing staff continue to effectively
orchestrate activities in the areas of public relations, advertising, trade
show attendance, point of sale materials development and telemarketing.
5) The Company intends to make additions to its existing telemarketing staff
in Denver.
SALES STRATEGY
The Company's sales strategy combines centralized telemarketing with regional
sales managers who are primarily responsible for OVS system sales and junior
account executives who are responsible for ARTC service sales. At December
31, 1996, the Company had three regional sales managers and one junior
account executive. In addition, the Company uses the services of an
independent manufacturer's representative in the Boston area, and independent
sales/service agents in the United Kingdom and Israel. During the next 12
months, the Company intends to add to its international sales/service agent
network, plus add one domestic regional sales manager and junior account
executives in Santa Clara, California, New Brighton, Minnesota, Morrisville,
North Carolina, and in each city selected for new ARTC locations.
The regional sales managers, each of whom have multiple ARTC facilities
within their geographic areas of responsibility, direct the efforts of the
junior account executives in selling ARTC services. When customers express
interest in buying an OVS system to the junior account executive rather than
use ARTC, the regional sales manager then assumes responsibility for the
customer in order to close the
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OVS sale.
Telemarketing resources are located at corporate headquarters to provide
follow-up phone calls on local mailings, advertisement inquiries and other
leads that are generated within each sales region. Telemarketing also
handles geographical areas not covered by regional offices, international
areas and any corporate campaigns that are developed by the Vice President,
Corporate Sales and Marketing. The Company telemarketers and the Hobbs
Engineering seminar telemarketing staff share sales leads with each other,
ensuring maximum follow-up with prospective customers.
The main functions of the telemarketing staff are to encourage prospective
customers to attend the local ARTC open houses and to follow up on leads from
geographical areas around the world that have no Company representation.
CUSTOMERS
The Company's systems are used by manufacturers in a wide variety of
industries. As of December 31, 1996, the Company had sold 126 systems to 68
different customers, in the following industries: Telecommunications and
Computer, 26; Defense and Aerospace, 14; Medical Electronics, 9; Other, 19.
The QualMark customer list includes major corporations such as Allied Signal,
AT&T, Cessna, Dupont, Cummins Engine, Hewlett-Packard, Honeywell, Hughes,
Intel, Lucent Technologies, Johnson & Johnson, National Semiconductor,
Magnavox, Nortel (formerly Northern Telecom), Sequent Computers, Tektronix,
United Technologies, U.S. Robotics, and Varian.
The following table sets forth some of the major industries and a number of
products that have undergone HALT or HASS testing protocol using the
Company's systems as part of the manufacturer's testing procedures.
<TABLE>
<S> <C> <C>
Aerospace and Defense Computer Related Products
- --------------------- ------------------------- glucose monitors
aviation electronics circuit boards infusion pumps
display switches disk drives IV pumps
flight navigation systems modems laboratory centrifuges
marine navigation systems monitors medical imaging systems
power supplies patient monitors
Telecommunications printers
- ------------------ tape backup drives Other
automated teller machines -----
air conditioning electronics automotive circuitry
cordless telephones Medical Electronics electronic oil and gas flow meters
fax machines ------------------- global positioning systems
electronic thermometers
</TABLE>
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RESEARCH AND PRODUCT DEVELOPMENT
Research and development expenditures for the fiscal years ending December
31, 1996 and 1995 were $182,000 and $211,000, respectively. It is the intent
of the Company in 1997 to devote considerable effort to the development of
the specifications for its next generation PC-controller. Further, the
Company intends in 1997 to refine the OVS product line by discontinuing the
OVS-1 and OVS-2 and adding the OVS-1.5. Additionally, the OVS-1 may be
reintroduced in an abbreviated version to accommodate the part of the market
that desires a lower cost version of the OVS combined stress technology. The
OVS-1.5 is larger than the OVS-1 and smaller than an OVS-2 and appears to be
a more desirable model in the marketplace than the OVS-1 or OVS-2.
Of great benefit to the Company is that its technology is extremely flexible
in regard to the physical size of its OVS systems; consequently, product line
extension opportunities normally do not require sizable expenditures on
product development.
The Company intends to continue taking advantage of design refinement
opportunities specific to its OVS combined stress technology. The Company
currently holds five domestic and one foreign patent, and has four domestic
and four foreign patent applications in process. Management is optimistic
that its fundamental OVS combined stress technology will allow the Company to
add to its product line as new opportunities develop.
Through its association with the University of Maryland's CALCE EPRC
(Computer Aided Life Cycle Enhancement, Electronic Packaging Research Center)
research program, the Company has aligned itself with one of the premier
electronic packaging research centers in the world. As a CALCE EPRC
affiliate, the Company has ongoing access to leading-edge technology
development in the area.
The association with the University of Maryland allows the Company to better
manage its investment in research and development, while enjoying the benefit
of having an OVS system on site at CALCE EPRC for visiting prospective client
company representatives to observe its operation.
COMPETITION
EQUIPMENT
There are many companies that could be considered competitors of QualMark.
These companies provide either electrodynamic shaker tables or
temperature/humidity chambers. Companies will occasionally team to provide a
shaker table within a separate temperature/humidity chamber. However, the
Company believes that Screening Systems, Inc. (Laguna Hills, CA) is its only
major direct equipment competitor that offers a six-axis vibration table
integrated into a thermal chamber which can be used for HALT/HASS
applications. On March 22, 1996, Screening Systems, Inc. filed a patent
infringement suit against the Company in federal district court in Santa Ana,
California (see
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item 3 - Legal Proceedings).
Hanse Environmental, Inc. (Allegan, MI) is a relatively new company that
began assembly and sales in 1993 of combined stress systems essentially
equivalent to the Company's technology. The president of Hanse Environmental
is a former employee of the Company. The Company filed suit against Hanse,
et. al. for misappropriation of trade secrets and patent infringement, with
jurisdiction established in Colorado. This suit was settled to the Company's
satisfaction in August, 1996.
Several traditional ESS equipment manufacturing companies, such as Thermotron
Industries and Weiss Environmental Technology, Inc., enjoy annual revenues in
excess of $50 million dollars, according to the Thomas Register, an
industrial products directory. These firms manufacture thermal chambers and
single/multiple axes vibration systems that support traditional screening
methods.
The equipment manufactured by traditional ESS equipment manufacturers is
well-accepted in the market, since ESS supports traditional "pass-fail"
specification test protocols that have been in use for several decades. The
Company's technology supports new accelerated test protocols relating to
improving product design and manufacturing processes rather than the
"pass-fail" test processes. As such, the Company is attempting to expand a
new market segment and plans to allocate considerable resources to an effort
to convince prospective customers to adopt accelerated test protocols in
addition to, or in replacement of, traditional methods.
ARTC AND APPLICATIONS SUPPORT SERVICES
As an emerging technology, HALT and HASS acceptance in industry is at the
introduction stage. The Company is unaware of any national commercial
testing laboratory network similar to ARTC offering HALT/HASS services using
the Company's or Screening Systems Inc. equipment or on-site applications
support services. However, the Company assumes that Screening Systems, Inc.
has provided at least three independent environmental test labs with SSI
equipment. The terms of these arrangements are not known by the Company.
Since several hundred commercial testing laboratories exist in the U.S., the
Company anticipates that new competitors will aggressively enter this market.
MANUFACTURING
The assembly of the OVS systems has evolved from a "job shop" approach into a
manufacturing line approach. Drawings of all subassemblies used by the
Company are maintained using computer aided design (CAD). Company products
are organized around three major elements: vibration systems, chamber
systems and control systems.
To ensure that all subassemblies meet specifications when received by the
Company, key suppliers remain actively involved throughout product design. Key
suppliers perform source inspection at the point of manufacture. Most key
suppliers are local companies. It is the Company's intent to further develop
local suppliers, with back-ups as required. To date, the components and
assemblies from these suppliers have met or exceeded all specifications. The
Company is not dependent on any one
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or a few major suppliers for any of the key parts or components of its
systems.
While the Company maintains a small inventory of OVS-2.5 systems in finished
goods, the Company uses a "make-to-order" approach in assembling the
OVS-1/1.5, OVS-3, OVS-4 and special order systems. Because of increased
sales volume, the Company is producing certain common subassemblies that are
integrated into the final systems when orders are booked. This helps provide
a more even manufacturing flow and minimizes the "peaks and valleys"
associated with small volume manufacturing.
To minimize inventory, the Company only orders major assemblies after
customer orders have been received. The Company is in the process of
implementing Material Requirements Planning to maximize the effectiveness in
which an order can be filled while minimizing required inventory. Management
uses fully costed Bills of Materials (BOM) which ensure that all parts of an
OVS system are identified and ordered in a timely manner.
PRODUCT WARRANTIES AND SERVICE
The Company offers a limited, one year parts and labor warranty on all new
OVS systems. OVS customers can purchase one year extended warranties on
their OVS systems, which includes two preventive maintenance visits during
the year by a qualified Company representative. In addition, the Company
offers for sale a comprehensive spare parts kit for each OVS system, which
further minimizes OVS system down time. Because of the relatively simplistic
design of the OVS systems, the Company rarely sends its technicians into the
field for warranty repairs. Nearly all problems can be diagnosed over the
phone, and if necessary, replacement parts are sent to the customer via
overnight mail; hence, the Company does not maintain a separate and formal
service department.
EMPLOYEES
As of December 31, 1996, the Company had 37 employees, all of which are
full-time. 30 of the company's employees are employed at its principal
offices and headquarters in Denver, Colorado, two are employed at its
facilities in Santa Clara, California, one in New Brighton, Minnesota, one
in Farmington Hills, Michigan, two in Marlborough, Massachusetts, and one in
Morrisville, North Carolina. No employees are represented by labor
organizations and there are no collective bargaining agreements. Employee
relations are believed to be good.
ITEM 2. DESCRIPTION OF PROPERTY.
The Company's principal offices and headquarters operate out of leased
facilities located at 1329 and 1343 West 121st Avenue, Denver, Colorado. The
three-year lease for the properties located at 1329 and 1343 West 121st
Avenue expires on January 31, 1998. The leased properties consists of
approximately 11,800 square feet. The lease calls for monthly payments over
the term of the lease of $6,930.00. In addition, the Company is responsible
for certain expenses, including property taxes, insurance and maintenance.
The Company's manufacturing, sales, administrative operations and
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regional ARTC services are conducted at this facility.
The suburban Boston ARTC facility is located at 41 Brigham Street, Unit 11,
Marlborough, Massachusetts. The five-year lease expires June 31, 1999. The
leased property consists of approximately 2,250 square feet. The lease calls
for average monthly payments over the term of the lease of $1,734.00. In
addition, The Company is responsible for certain expenses, including property
taxes, insurance and maintenance. The Company's regional ARTC service
business is conducted at this facility.
The Silicon Valley ARTC facility is located at 2225 Martin Avenue, Suite K,
Santa Clara, California. The three-year lease expires on February 28, 1998.
The leased property consists of approximately 4,660 square feet. The lease
calls for average monthly payments of $3,927.00. In addition, the Company is
responsible for certain expenses, including property taxes, insurance and
maintenance. The Company's regional ARTC service business is conducted at
this facility.
The suburban Minneapolis ARTC facility is located at Rush Lake Business
Park, 1775 Old Highway 8, Suite 110, New Brighton, Minnesota. The five-year
lease expires in February 2001. The leased property consists of 2,783 square
feet. The lease calls for average monthly payments of $1,913.50. In
addition, the Company is responsible for certain expenses, including property
taxes, insurance and maintenance. The Company's regional ARTC service
business is conducted at this facility.
The North Carolina ARTC facility is located at 215 Southport Drive, Suite
300, Morrisville, North Carolina. The five-year lease expires in July
2001. The leased property consists of approximately 4,692 square feet . The
lease calls for average monthly payments of $3,175.00 In addition, The
Company is responsible for certain expenses, including property taxes,
insurance and maintenance. The Company's regional ARTC service business is
conducted at this facility.
The suburban Detroit ARTC facility is located at 39255 Country Club Drive,
Suite B-8, Farmington Hills, Michigan. The five-year lease expires in
September 2001. The leased property consists of approximately 4,491 square
feet. The lease calls for average monthly payments of $4,491. In addition,
the Company is responsible for certain expenses, including property taxes,
insurance and maintenance. The Company's regional ARTC service business is
conducted at this facility.
The southern California ARTC facility is located at 15661 Producer Lane, Unit
H, Huntington Beach, California. The five-year lease begins January 1, 1997
and expires in December 2002. The leased property consists of 3,420 square
feet. The lease calls for average monthly payments of $2,150.00. In
addition, the Company is responsible for certain expenses, including property
taxes, insurance and maintenance. The Company's regional ARTC service
business will be conducted at this facility.
The Company believes that its facilities are adequate for its current needs
and that suitable additional space can be acquired if needed.
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ITEM 3. LEGAL PROCEEDINGS.
On February 22, 1994, the Company filed an action in the District Court for
Boulder County, Colorado, against defendants Hanse Environmental Inc., John
K. Hanse ("Hanse"), Hytech Spring and Machine Corp. ("Hytech"), and Andrew
Magiera ("Magiera") (collectively, "Defendants") for, among other claims,
misappropriation of trade secrets. On April 13, 1994, Defendants removed the
case to the United States District court for the District of Colorado,
(QualMark Corporation v. Hanse Environmental, Inc., et al.). On March 14,
1995, the Company reached a favorable settlement with defendants Hytech and
Magiera.
On August 16, 1996, the Company settled its claims against the remaining
defendants for fraud, misappropriation of trade secrets, breach of fiduciary
duty, interference with prospective economic advantage, civil conspiracy,
civil theft of trade secrets, unfair competition, deceptive trade practices,
and infringement of United States Patent No. 5,412,991 (the "Patents");
states that none of the defendants is an inventor or joint inventor of
Patents or has any ownership interest in QualMark's Patents; acknowledges that
the tables previously manufactured by Hanse infringe QualMark's U.S. Patent
No 5,412,991; and prohibits Hanse from making , using or selling any such
infringing tables. As part of the settlement, Hanse has also agreed to
attempt to remove specific vibration tables he has sold and installed with
Hanse customers. The Company has released Hanse customers from liability for
infringement of the Patents. The settlement allows Hanse eighteen months to
remove the tables, with the payment by the Company to Hanse of $2,000 per
table removed. The Company believes there are up to twenty (20) such tables.
On March 22, 1996, Screening Systems, Inc. ("SSI)") filed a patent
infringement action in the United States District Court for the Central
District of California, Southern Division, against the Company, alleging that
the Company has infringed U.S. Patent No. 4,181,026. SSI amended its
complaint in September 1996 to add claims for infringement of U.S. Patent
Nos. 4,181,025 and 4,181,028, and for contributory and inducing infringement.
Each of the patents-in-suit is owned by Hughes Electronics Company ("Hughes")
and licensed to SSI. Trial of this matter was originally set for March 25,
1997.
In October 1996, the Company filed a motion to dismiss the action to the
basis that SSI did not alone have standing to pursue the action pursuant to
the terms of its License Agreement with Hughes. In November 1996, the Court
ruled on the Company's motion by ordering that Hughes be joined as an
interested party. Because Hughes declined to join the action as a plaintiff,
SSI joined Hughes as a defendant in its November 22, 1996 Second Amended
Complaint.
With limited exception, the parties completed discovery on January 10, 1997.
On February 3, 1997, the Company filed motions for summary judgment of
non-infringement on each of the three patents in suit. SSI filed a motion
for summary judgment with respect to U. S. Patent No. 4,181,028 and other
motions addressing the Company's defenses. On February 6, 1997, Judge
McLaughlin vacated all pending dates, including the March 25, 1997 trial
date, and referred the motions for summary judgment to Magistrate Judge Elgin
Edwards for determination.
Magistrate Judge Edwards set a hearing known as a "MARKMAN hearing" to determine
the scope and
13
<PAGE>
meaning of the relevant claims and terms of the patents-in-suit before ruling
on any motions for summary judgment of non-infringement. The MARKMAN hearing
has been set for March 25, 1997. After the MARKMAN hearing, the Company
plans to refile its motions for summary judgment on non-infringement on each
of the patents-in-suit. The Court has not set a new trial date and the
Company understands that no trial date will be set until after the Court has
conducted the MARKMAN hearing and ruled on any subsequent summary judgment
motions.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
There were no matters submitted to a vote of shareholders during the last
quarter of the fiscal year ended December 31, 1996.
14
<PAGE>
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
The common stock of the Company has been traded on the Nasdaq Small-Cap
Stock Market since the Company's initial public offering in April 1996. The
following table sets forth the range of high and low closing bid prices of
the Company's common stock as reported by Nasdaq during fiscal year 1996:
Fiscal Year Ended December 31, 1996
High Close Low Close
First Fiscal Quarter n/a n/a
Second Fiscal Quarter $5.875 $4.125
Third Fiscal Quarter 4.125 2.875
Fourth Fiscal Quarter 4.250 3.000
The foregoing quotations represent quotations between dealers without
adjustment for retail markups, markdowns or commissions and may not represent
actual transactions.
At December 31, 1996, the Company had approximately 900 shareholders of
record. The Company has never paid a dividend, and does not anticipate the
payment of dividends in the foreseeable future.
15
<PAGE>
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Forward-Looking Statements
The statements contained in this report which are not historical facts are
forward-looking statements that are subject to risks and uncertainties that
could cause actual results to differ materially from those set forth or
implied by forward-looking statements, including but not limited to the risk
of an unfavorable outcome in the SSI litigation, variability in order flow
and operating results, the ability of the Company to find and retain
qualified personnel to staff its manufacturing and marketing operations and
existing and anticipated test centers, and the risk that the demand for the
Company's systems will not continue to grow.
The following table sets forth for the fiscal periods indicated the
percentage of total revenues, unless otherwise indicated, represented by
certain items reflected in the Company's consolidated statement of operations:
Fiscal Year Ended
------------------------------------
December 31, 1996 December 31, 1995
Statement of Operations Data:
Net Sales.................................. 100.0% 100.0%
Cost of Revenue............................ 59.0 60.5
------------------------------------
Gross Profit............................... 41.0 39.5
Selling, general and administrative
expenses................................... 62.1 33.7
Research and development
expenses................................... 3.2 5.2
------------------------------------
Income (loss) from operations.............. (24.3) .6
Other income (expense)..................... .1 (3.5)
------------------------------------
Net loss................................... (24.2)% (2.9)%
------------------------------------
------------------------------------
Results of Operations
Revenue
Net revenue in the year ended December 31, 1996 increased $1,662,000
(41%) as compared with the year ended December 31, 1995. Seminar revenue of
$263,000 was included in the 1995 period. On September 30, 1995, the Company
sold the seminar business to its founder and accordingly, no
16
<PAGE>
revenue was recorded for the seminar business during 1996. Excluding seminar
revenue, revenue in 1996 increased $1,925,000 (51%) compared to 1995.
System sales revenue increased $985,000 (33%) in 1996, from $2,989,000 to
$3,974,000, as compared to 1995. Unit shipments increased from 27 to 32 for
the years ended December 31, 1995 and 1996, respectively. The Company sold a
greater number of larger, more expensive systems in 1996 compared to 1995,
which was a significant factor in system revenue growth of 33% on systems
unit sales growth of 19% over such period.
Test center revenue for the year ended December 31, 1996 increased
$940,000 (121%), from $780,000, to $1,720,000 over the year ended December
31, 1995. At December 31, 1996 the Company operated six test centers
containing eight systems compared to three test centers containing three
systems at December 31, 1995.
The Company's quarterly operating results could be subject to
fluctuations for a variety of reasons. The Company operates with a small
backlog relative to its revenue; thus most of its sales in each quarter
result from orders received in the current or prior quarter. In addition,
because prices for the Company's products are relatively substantial, a
significant portion of net sales for each quarter is attributable to a
relatively small number of units.
Gross Margin
The gross margin in the year ended December 31, 1996 was 41.0% compared
to a 39.5% gross margin for the year ended December 31, 1995. The increase
in gross margin is attributable to the increase in revenue from systems and
test centers. As a significant portion of costs are fixed, the increased
revenue enabled the Company to better cover it's manufacturing overhead as
well as compensate for the lower gross margins from the more recently opened
ARTC locations.
Operating Expense
General and administrative expenses increased in 1996 to $2,528,000 from
$862,000 in 1995. The increase reflects added costs for test center
administration and legal costs incurred from the Company's involvement in two
patent litigation matters. The Company incurred $1,280,000 in legal fees in
1996 compared to $49,000 in 1995. The majority of this expense was due to
the litigation with Screening Systems, Inc. ("SSI"). In addition to the SSI
litigation costs, the Company had significant legal fees in the first six
months of 1996 associated with the successful settlement of the Hanse
Environmental, Inc. case, which was settled on August 19, 1996.
Sales expenses increased $514,000, from $494,000 in 1995 to $1,008,000 in
1996. This increase was primarily due to increases in the number of sales
and marketing personnel and increased sales and marketing efforts over the
comparable period in 1995. Further increases in sales and marketing
personnel and expenses are expected in 1997.
Research and development costs decreased from $211,000 in 1995, to
$182,000 in 1996. This
17
<PAGE>
decrease is due to a reorganization of the Company's research and development
department. It is expected that the research and development expense will
increase for the year ended December 31, 1997.
Other Income (expense) consisted primarily of net interest income in 1996
totaling $44,000 compared with a net interest expense of $149,000 in 1995.
The change from a net interest expense to net interest income was due to the
retirement of all debt and interest earned from short term investments using
the proceeds of the Company's initial public offering early in the second
quarter of 1996.
Liquidity and Capital Resources
The Company's initial public offering resulted in proceeds (after
expenses) of $4,505,000. The Company's debt, aggregating $701,000, was
retired in connection with the initial public offering. During 1996, the
Company's operations used $850,000 of cash in operating activities, invested
$862,000 for equipment and patents and paid $51,000 in lease payments. The
Company also had short term investments of $1,911,000 at year end. Together,
these operating activities resulted in a cash increase of $159,000, to a
balance of $411,000 at December 31, 1996. At December 31, 1996, cash and
short term investments totaled $2,322,000. The majority of these funds will
be invested in capital equipment and working capital necessary to sustain the
growth of its business.
In May 1996, the Company entered into a line of credit arrangement with a
bank. The credit line provides for draws up to $750,000, bears interest at
prime plus 1.5%, and is secured by substantially all of the assets of the
Company. The Company must maintain certain financial and other covenants in
order to draw amounts available under the line of credit. Through December
31, 1996 the Company has not drawn any amounts under the line of credit.
The Company expects to meet long term liquidity requirements through cash
flows generated by operations, existing cash balances and the line of credit.
The Company is dependent, however, on its ability to maintain and grow its
systems and test center businesses in order to generate adequate operating
cash flows.
18
<PAGE>
ITEM 7. FINANCIAL STATEMENTS.
Index to Financial Statements and Schedules:
Page
Number
------
Report of Independent Public Accountants
Balance Sheet
Statement of Operations
Statement of Shareholders' Equity
Statement of Cash Flows
Notes to Financial Statements
All schedules for which provision is made in the applicable accounting
regulation of the Securities and Exchange Commission are not required under
the related instructions or are inapplicable, and therefore have been omitted.
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
None.
PART III
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS;
COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT.
The Company's definitive Proxy Statement to be filed pursuant to Schedule
14A under the Securities Exchange Act of 1934.
ITEM 10. EXECUTIVE COMPENSATION.
The Company's definitive Proxy Statement to be filed pursuant to Schedule
14A under the Securities Exchange Act of 1934.
19
<PAGE>
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The Company's definitive Proxy Statement to be filed pursuant to Schedule
14A under the Securities Exchange Act of 1934 is incorporated herein by
reference.
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
The Company's definitive Proxy Statement to be filed pursuant to Schedule
14A under the Securities Exchange Act of 1934 is incorporated herein by
reference.
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Financial Statements - See Index to Financial Statements and Schedules
(Part II-Item 7)
(b) Reports on Form 8-K during the last quarter of the Company's fiscal year
ended December 31, 1996 - None
(c) Exhibits - See Index to Exhibits
20
<PAGE>
SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act, the
registrant caused this Report to be signed on its behalf by the undersigned,
thereunto duly authorized.
Dated: March 24, 1997 QUALMARK CORPORATION
By: /s/ W. PRESTON WILSON
-----------------------------------
W. Preston Wilson
President, Chief Executive Officer
In accordance with the Exchange Act, this report has been signed below by
the following persons on behalf of the registrant and in the capacities and
on the dates indicated.
Signature Title Date
- --------- ----- ----
/s/ W. Preston Wilson
- ---------------------------- Chief Executive Officer, March 24, 1997
W. Preston Wilson President and Director
/s/ Vernon W. Settle
- ---------------------------- Vice President, Administration March 24, 1997
Vernon W. Settle and Principal Accounting Officer
/s/ H. Robert Gill
- ---------------------------- Director March 24, 1997
H. Robert Gill
s/ Philip A. Gordon
- ---------------------------- Director March 24, 1997
Philip A. Gordon
/s/ Charles A. French
- ---------------------------- Director March 24, 1997
Charles A. French
/s/ William B. Phillips
- ---------------------------- Director March 24, 1997
William B. Phillips
21
<PAGE>
QUALMARK CORPORATION
STATEMENT OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
- ------------------------------------------------------------------------------
YEAR ENDED DECEMBER 31,
-------------------------
1996 1995
---------- ----------
Revenues $ 5,694 $ 4,032
Cost of revenues 3,359 2,440
---------- ----------
Gross profit 2,335 1,592
Selling, general and administrative expenses 3,718 1,567
---------- ----------
Income (loss) from operations (1,383) 25
Other income (expense):
Interest expense (49) (149)
Interest income 93
Other income (expense), net (42) 8
---------- ----------
Net loss $ (1,381) $ (116)
---------- ----------
---------- ----------
Net loss per share $ (0.47)
----------
----------
Weighted average number of common shares 2,927
----------
----------
Unaudited pro forma net loss per share $ (0.05)
----------
----------
Unaudited pro forma weighted average number of
common shares 1,866
----------
----------
The accompanying notes are an integral
part of these financial statements.
<PAGE>
QUALMARK CORPORATION
STATEMENT OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
- ------------------------------------------------------------------------------
DECEMBER 31,
-------------------------
1996 1995
---------- ----------
ASSETS
Current assets:
Cash and cash equivalents $ 411 $ 252
Short-term investments 1,911
Trade accounts receivable, net of allowance
for doubtful accounts of $21 and $0, respectively 1,246 889
Inventories 536 281
Other current assets 120 59
---------- ----------
Total current assets 4,224 1,481
Property and equipment, net 1,073 411
Patents, net of accumulated amortization of
$254 and $232, respectively 28 33
Other assets 116 18
---------- ----------
$ 5,441 $ 1,943
---------- ----------
---------- ----------
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 699 $ 376
Customer deposits and deferred revenue 47 160
Accrued expenses 984 181
Notes payable - shareholders 293
Notes payable - other 616
Current portion of capital lease obligations 31 31
---------- ----------
Total current liabilities 1,761 1,657
Noncurrent portion of capital lease obligations 18 21
---------- ----------
Total liabilities 1,779 1,678
---------- ----------
Commitments and contingencies (Notes 5, 9 and 10)
Shareholders' equity:
Convertible preferred stock; no par value; 2,000,000
shares authorized; 490,929 designated as Series A,
332,063 issued and outstanding; 99,619 designated as
Series B, none outstanding 1,100
Common stock; no par value; 15,000,000
shares authorized; 3,330,484 and 934,098 shares
issued and outstanding, respectively 6,131 253
Accumulated deficit (2,469) (1,088)
---------- ----------
Total shareholders' equity 3,662 265
---------- ----------
$ 5,441 $ 1,943
---------- ----------
---------- ----------
The accompanying notes are an integral
part of these financial statements.
<PAGE>
QUALMARK CORPORATION
STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY
(IN THOUSANDS, EXCEPT FOR NUMBER OF SHARES)
- --------------------------------------------------------------------------------
<TABLE>
PREFERRED STOCK COMMON STOCK ACCUMULATED
SHARES AMOUNT SHARES AMOUNT DEFICIT TOTAL
------- ------ ------- ------- ----------- ------
<S> <C> <C> <C> <C> <C> <C>
Balance December 31, 1994 332,063 $1,063 934,098 $ 169 $ (972) $ 260
Issuance of warrants to purchase 50,781 shares
of Series A convertible preferred stock in
connection with issuance of convertible secured
promissory notes 37 37
Issuance of warrants to purchase 32,550 shares
of common stock to directors for services 18 18
Issuance of warrants to purchase 15,000 shares
of common stock to shareholder 13 13
Issuance of warrants to purchase 7,875 shares
of common stock to two former employees 11 11
Compensation expense recorded in connection
with the issuance of options to purchase 31,895
shares of common stock under the Company's
incentive stock option plan 7 7
Issuance of warrants to purchase 50,009 shares
of common stock in connection with issuance
of 10% secured notes 35 35
Net loss (116) (116)
------- ------ ------- ------ ------- ------
Balance December 31, 1995 332,063 1,100 934,100 253 (1,088) 265
Conversion of note payable to common stock 117,188 250 250
Conversion of outstanding convertible
preferred stock to common stock (332,063) (1,100) 498,095 1,100 -
Exchange of warrants for common stock 296,101
Amortization of deferred compensation
related to issuance of warrants and options 23 23
Initial public offering of common stock, net
of issuance costs 1,485,000 4,505 4,505
Net loss (1,381) (1,381)
------- ------ ------- ------ ------- ------
Balance December 31, 1996 - $ - 3,330,484 $6,131 $(2,469) $ 3,662
------- ------ ------- ------ ------- ------
------- ------ ------- ------ ------- ------
</TABLE>
The accompanying notes are an integral
part of these financial statements.
<PAGE>
QUALMARK CORPORATION
STATEMENT OF CASH FLOWS
(IN THOUSANDS)
- ------------------------------------------------------------------------------
YEAR ENDED DECEMBER 31,
-----------------------
1996 1995
------- -----
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss $(1,381) $(116)
Adjustments to reconcile net loss to net cash from
operating activities:
Gain on sale of equipment (36)
Depreciation 219 118
Patent amortization 22 43
Amortization of debt issue costs 42 30
Amortization of deferred compensation 23 49
Change in assets and liabilities:
Increase in accounts receivable (357) (428)
Increase in inventories (255) (114)
Increase in other assets and patents (176) (35)
Increase (decrease) in accounts payable
and accrued expenses 1,126 (67)
Increase (decrease) in customer deposits
and deferred revenue (113) 154
------- -----
Net cash used in operating activities (850) (402)
------- -----
CASH FLOWS FROM INVESTING ACTIVITIES
Acquisition of property and equipment (862) (89)
Proceeds on sale of property and equipment 29 104
Purchase of short-term investments (5,355)
Proceeds on sale/redemption of short-term investments 3,444
------- -----
Net cash (used in) provided by investing activities (2,744) 15
------- -----
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from borrowings - shareholders 233
Proceeds from borrowings - other 642
Repayments of borrowings - shareholders (293) (75)
Repayments of borrowings - other (408) (238)
Proceeds from issuance of common stock 4,505
Proceeds from issuance of warrants 1
Principal payments on capital lease obligations (51) (33)
------- -----
Net cash provided by financing activities 3,753 530
------- -----
Net increase in cash 159 143
Cash and cash equivalents at beginning of year 252 109
------- -----
Cash and cash equivalents at end of year $ 411 $ 252
------- -----
------- -----
NONCASH FINANCING ACTIVITIES
Conversion of note payable to common stock $ 250
Conversion of preferred stock to common stock 1,100
Acquisition of equipment under capital lease 48 $ 45
SUPPLEMENTAL DISCLOSURE
Interest paid $ 69 $ 103
The accompanying notes are an integral
part of these financial statements.
<PAGE>
QUALMARK CORPORATION
NOTES TO FINANCIAL STATEMENTS
- -------------------------------------------------------------------------------
1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
ORGANIZATION
QualMark Corporation (the "Company") was incorporated on March 11, 1992 in
the State of Colorado. The Company's principal business activity is the
manufacture and sale of vibration and thermal chambers for quality control
testing of various electronic devices. The Company's manufacturing facility
is located in Denver, Colorado. The Company also operates service centers
where vibration and thermal chambers are available to customers for daily
rental. These service centers are located at the Company's Denver, Colorado
facility, in Marlborough, Massachusetts, Santa Clara, California,
Minneapolis, Minnesota, Detroit, Michigan and Raleigh, North Carolina.
MAJOR CUSTOMERS AND CREDIT RISK
The Company's customers are generally concentrated in the electronics
manufacturing industry. A single customer accounted for 14% of the Company's
total revenues during 1996. A different customer accounted for 12% of the
Company's total revenues during 1995.
REVENUE RECOGNITION
Sales are recognized upon the shipment of product or the performance of
services. Prepayments and progress billings are deferred until shipment
occurs or services rendered.
EXPENSE RECOGNITION
Cost of revenues are recognized upon the shipment of product or the
performance of services. Selling, general and administrative expenses are
recognized/accrued when the expenditure is probable and the amount is
reasonably estimable.
INVENTORIES
Inventories are stated at the lower of cost or market with cost determined by
the first-in, first-out method.
PROPERTY AND EQUIPMENT
Property and equipment are recorded at cost. Depreciation is recorded using
the straight-line method over estimated useful lives of three to ten years.
Amortization of leasehold improvements and equipment under capital leases is
provided over the lives of the leases and is included in depreciation
expense.
PATENTS
The cost of obtaining patents on the Company's technology designs is
capitalized as incurred. Patents are amortized over four years using the
straight-line method.
INCOME TAXES
Deferred tax liabilities and assets are recognized for the expected future
tax consequences of temporary differences between the carrying amounts for
financial reporting purposes and the tax basis of individual assets and
liabilities.
CASH AND CASH EQUIVALENTS
Cash on hand and in banks, together with repurchase agreements and marketable
securities having original maturities of three months or less, are classified
as cash and cash equivalents by the Company.
SHORT-TERM INVESTMENTS
All short-term investments are classified as available-for-sale and are
available to support current operations or to take advantage of other
investment opportunities. The Company currently invests in only US Treasury
and agency securities. As such, there were no significant differences
between amortized costs and estimated fair value (based on market quotes) at
December 31, 1996.
-1-
<PAGE>
QUALMARK CORPORATION
NOTES TO FINANCIAL STATEMENTS
- -------------------------------------------------------------------------------
ADVERTISING EXPENSE
The Company charges advertising, including production costs, to expense on
the first date of the advertising period. Advertising and marketing expense
for 1996 and 1995 was $68,000 and $64,000, respectively.
PREOPENING COSTS
The Company charges to selling, general and administrative expense the
preopening costs of new service centers as incurred. These costs are
primarily labor, supplies, preopening marketing and advertising and other
expendable items.
FINANCIAL INSTRUMENTS
The carrying amounts of cash and cash equivalents, accounts receivable,
accounts payable, accrued expenses and customer deposits approximate fair
value due to the short-term nature of these items.
STOCK OPTIONS AND WARRANTS
No compensation expense is recorded for stock options issued to employees
under the Company's incentive stock option plan when the option's exercise
price is greater than or equal to the fair value of the Company's common
stock on the grant date. Otherwise, compensation expense is recorded, over
the vesting period, in an amount equal to the difference between the fair
value of the common stock on the grant date and the exercise price.
The fair value of warrants issued to non-employees for services rendered to
the Company is charged to expense in the period the services are performed.
The fair value of detachable stock warrants issued in connection with notes
payable is initially recorded as a discount to the related note and amortized
to interest expense, using the effective interest method, over the term of
the note.
NET LOSS PER SHARE
Net loss per share is computed using the weighted average number of common
shares outstanding during each period, including common equivalent shares
outstanding. Common equivalent shares consist of stock options and warrants
calculated using the treasury stock method, when dilutive.
PRO FORMA NET LOSS PER SHARE (UNAUDITED)
Pro forma net loss per common share was computed based on the weighted
average number of the Company's common shares outstanding during the year
ended December 31, 1995, after giving retroactive effect for the
recapitalization discussed in Note 7. Pursuant to Securities and Exchange
Commission Staff Accounting Bulletin No. 83, all stock options and warrants
granted (excluding warrants that are subject to the recapitalization) since
February 1, 1995 and the convertible secured promissory note discussed in
Note 4 have been considered exercised or converted and outstanding during all
of 1995 (911,384 shares) using the treasury stock method and the estimated
public offering price per share. Further, interest expense incurred in 1995
on the promissory note in the amount of $22,500 has been eliminated from the
net loss for purposes of the pro forma net loss per share calculation.
Historical earnings per share for 1995 has not been presented because such
amounts are not deemed meaningful due to the significant change in the
Company's capital structure which occurred in connection with the initial
public offering. Common stock equivalents were not considered in the pro
forma net loss per share calculation because the effect on the pro forma net
loss per shares would be antidilutive.
USE OF ESTIMATES AND ASSUMPTIONS
The preparation of the financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
-2-
<PAGE>
QUALMARK CORPORATION
NOTES TO FINANCIAL STATEMENTS
- -------------------------------------------------------------------------------
RECLASSIFICATIONS
Certain prior year amounts have been reclassified to conform to the current
year's presentation.
2. INVENTORIES
Inventories consist of the following (in thousands):
DECEMBER 31,
---------------
1996 1995
---- ----
Raw materials $334 $227
Work in process 9
Finished goods 193 54
---- ----
$536 $281
---- ----
---- ----
3. PROPERTY AND EQUIPMENT
Property and equipment consist of the following (in thousands):
DECEMBER 31,
---------------
1996 1995
------ -----
Machinery and equipment $1,096 $ 413
Furniture and fixtures 135 86
Leasehold improvements 232 111
Less: Accumulated depreciation and amortization (390) (199)
------ -----
$1,073 $ 411
------ -----
------ -----
The Company leases certain office and service center equipment under capital
leases. Property and equipment above includes the following amounts for
leases that have been capitalized (in thousands):
DECEMBER 31,
---------------
1996 1995
---- ----
Machinery and equipment $145 $ 97
Less: Accumulated amortization (55) (25)
---- ----
$ 90 $ 72
---- ----
---- ----
4. NOTES PAYABLE
All notes payable were repaid or converted to common stock concurrent with
the Company's initial public stock offering in April 1996. Notes payable as
of December 31, 1995 consisted of (in thousands):
Convertible secured promissory notes payable to
shareholders; due April 1, 1995; interest at 8% $201
Convertible secured promissory notes; due March 26,
1996; interest at 12% 250
Secured promissory notes; due June 30, 1996;
interest at 10% (shareholders $108) 500
----
951
Unamortized debt issue costs (42)
----
$909
----
----
-3-
<PAGE>
QUALMARK CORPORATION
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Convertible secured promissory notes in the amount of $250,000 were issued on
March 27, 1995 and were converted to 117,188 shares of common stock in March
1996. In connection with the original note issuance, the Company sold to the
issuer of the notes, warrants to purchase 48,437 shares of Series A
convertible preferred stock (see Note 7).
On December 19, 1995, the Company entered into an agreement with an
investment banking firm (the "Banker") under which the Banker sold $500,000
of the Company's secured promissory notes due June 30, 1996 and warrants to
purchase 50,009 shares of the Company's common stock. Of the total, $107,500
of the notes were sold to shareholders of the Company. Interest on the notes
accrued at 10% per annum. The warrants are exercisable for five years at a
price of $3.375 per share. A value of $35,117 was allocated to the warrants
and recorded as debt issue costs. The notes were subsequently fully paid
with the proceeds received from the Company's initial public offering.
In May 1996, the Company entered into a line of credit arrangement with a
bank. The credit line provides for draws up to $750,000, bears interest at
prime plus 1.5% and is secured by substantially all the assets of the
Company. The Company must maintain certain financial and other covenants in
order to draw amounts available under the line of credit. Through December
31, 1996 the Company has not drawn any amounts under the line of credit.
5. LEASE COMMITMENTS
The Company leases equipment, office space, and operating facilities under
capital and operating lease arrangements. Future minimum lease payments
consist of the following at December 31, 1996 (in thousands):
CAPITAL OPERATING
LEASES LEASES TOTAL
------- --------- -----
Year ended December 31,
1997 $ 41 $300 $341
1998 13 186 199
1999 3 163 166
2000 3 155 158
2000 - 105 105
---- ---- ----
60 $909 $969
Less: Interest (11) ---- ----
---- ---- ----
49
Current portion (31)
----
Long-term portion $ 18
----
----
Rent expense for the years ended December 31, 1996 and 1995 was $229,363 and
$172,660, respectively.
6. INCOME TAXES
As of December 31, 1996, the Company has a net operating loss (NOL)
carryforward of approximately $1,602,000 which is available to offset future
taxable income, of which approximately $1,000,000 as of December 31, 1996 is
subject to annual usage limitations of approximately $250,000. These
carryforwards expire between 2008 and 2011. If certain substantial changes
in the Company's ownership should occur, there would be additional annual
limitations on the utilization of these carryforwards.
-4-
<PAGE>
QUALMARK CORPORATION
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Deferred tax assets and liabilities represent the future impact of temporary
differences between the financial statement and tax bases of assets and
liabilities and are as follows (in thousands):
DECEMBER 31,
-----------------
1996 1995
------ ------
Deferred tax liabilities:
Depreciation $ (10)
Amortization (20) $ (13)
----- -----
Gross deferred tax liabilities (30) (13)
----- -----
Deferred tax assets:
NOL carryforwards 633 311
Accrued liabilities 251 10
Accrued warranty payable 36 17
Other 8 5
----- -----
Gross deferred tax assets 928 343
Valuation allowance (898) (330)
----- -----
Net deferred tax assets 30 13
----- -----
Net deferred tax asset (liability) $ - $ -
----- -----
----- -----
The ultimate realization of these assets is dependent upon the generation of
future taxable income sufficient to offset the related deductions and loss
carryforwards within the applicable carryforward period. The valuation
allowance at December 31, 1996 and 1995 is based on management's conclusion
that sufficient positive evidence, as defined by Statement of Financial
Accounting Standards ("SFAS") 109, regarding realization of certain tax
carryforward items does not exist.
A reconciliation of the statutory Federal income tax rate to the income tax
provision is as follows (in thousands):
1996 1995
---------------- ----------------
AMOUNT % AMOUNT %
------ ------- ------ -------
Computed "expected" tax $(470) (34.0)% $(39) (34.0)%
State income taxes, net of Federal
income tax effect (46) (3.3) (4) (3.3)
Recording of valuation allowance 568 41.1 59 50.9
Other (52) (3.8) (16) (13.6)
----- ----- ---- -----
$ - - % $ - - %
----- ----- ---- -----
----- ----- ---- -----
7. CAPITAL STOCK, STOCK OPTIONS AND WARRANTS
RECAPITALIZATION AND PUBLIC OFFERING
Effective April 8, 1996, the Company offered its stock for sale to the
public. In connection therewith, the Company sold 1,485,000 shares of common
stock at an initial public offering price of $3.75 per share. Proceeds from
this offering, net of issuance costs, totaled $4,505,000. As part of the
offering, the Company issued to the underwriter a five-year warrant to
purchase up to 132,170 shares of common stock at $4.50 per share.
-5-
<PAGE>
QUALMARK CORPORATION
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Concurrent with the effective date of the offering, the Company exchanged all
outstanding preferred stock and warrants other than (i) a warrant to purchase
72,000 shares of common stock issued to Dr. Hobbs as described below; (ii) a
warrant to purchase 50,009 shares of common stock in connection with the
placement of $500,000 in secured promissory notes as described below; and
(iii) the warrant to purchase 132,170 shares of common stock issued to the
Company's underwriter, for common stock as follows:
NUMBER OF
PRE-SPLIT NUMBER OF NUMBER OF
PRE-EXCHANGE POST-EXCHANGE POST-SPLIT
SHARES/ COMMON COMMON
WARRANTS SHARES SHARES
------------ ------------- ----------
Convertible preferred stock 332,063 332,063 498,095
Warrants to buy common shares 51,950 40,002 60,003
Warrants to buy Preferred A 156,735 117,551 176,327
Warrants to buy Preferred B 99,619 39,848 59,771
In addition, the Company increased its authorized common shares to 15,000,000
and effected a 3-for-2 stock split of shares of outstanding common stock
concurrent with the effective date of the offering. Except for the first two
columns above, all common shares, common stock warrants and options, and
common per share amounts in the accompanying financial statements and notes
have been adjusted to reflect this stock split.
STOCK WARRANTS
On January 3, 1995, warrants to purchase an aggregate of 2,344 shares of
Series A preferred stock were issued to a shareholder in connection with the
issuance of $50,000 in secured 8% notes. A fair value of $1,887 was assigned
to the warrants. As stated above, concurrent with the effective date of the
public offering, the warrants were exchanged for 2,637 common shares.
On March 27, 1995, warrants to purchase 48,437 shares of the Company's Series
A Preferred Stock were sold for $.01 each in connection with the issuance of
$250,000 in 12% convertible secured promissory notes. A fair value of
$35,095 was assigned to the warrants. The excess of that fair value over the
cash received was recorded as debt issue costs and was amortized over the
term of the notes. As stated above, concurrent with the effective date of
the public offering, the warrants were exchanged for 54,492 common shares.
On September 30, 1995, warrants to purchase 72,000 shares of common stock at
an exercise price of $2.13 per share were issued to a principal shareholder,
in connection with the Company's sale of Hobbs Engineering Corporation to the
shareholder (Note 9). The warrants vest and are exercisable in 25%
increments on December 31, 1996, 1997, 1998 and 1999. All warrants expire
five years from the grant date. Compensation expense relative to these
warrants of $62,400 will be charged to expense over the four-year vesting
period which began January 1, 1996.
In addition, during 1995 options to purchase 22,875 shares of common stock at
exercise prices ranging from $1.00 to $3.20, previously issued to three
individuals, including the principal shareholder, under the Company's
incentive stock option plan, were canceled and reissued as warrants outside
of the plan. These warrants are exercisable immediately at an exercise price
of $2.13 per share and expire in five years. Expense of $13,000 was recorded
relative to the 15,000 warrants reissued to the principal shareholder,
representing the difference between the exercise price of the warrants and
the estimated fair value of the Company's common stock on the grant date.
The fair value of the remaining 7,875 warrants was estimated at $11,180 and
charged to expense during 1995. As stated above, concurrent with the
effective date of the public offering, the warrants were exchanged for 17,614
common shares.
As discussed in Note 4, on December 19, 1995, warrants to purchase 50,009
shares of common stock were issued in connection with the issuance of
$500,000 of 10% secured notes. The fair value of $35,117 assigned to these
warrants was recorded as debt issue costs and was amortized over the term of
the notes.
-6-
<PAGE>
QUALMARK CORPORATION
NOTES TO FINANCIAL STATEMENTS
- -------------------------------------------------------------------------------
During 1995, the Company issued warrants to purchase 32,550 shares of the
Company's common stock, exercisable at between $2.00 and $2.13 per share, to
two of the Company's directors, primarily for legal services. The fair value
of these warrants was estimated at $18,009 and charged to expense. As stated
above, concurrent with the effective date of the public offering, the
warrants were exchanged for 25,064 common shares.
STOCK OPTIONS
On March 1, 1993, the Company adopted an incentive stock option plan (the
"1993 Plan") which provides employees and officers with an opportunity to
purchase an aggregate of 380,400 shares of the Company's common stock. The
1993 Plan requires that incentive stock options be issued at exercise prices
which are at least 100% of the fair value of the stock at the date of the
grant. Options issued under the 1993 Plan vest at a rate of 25% per year
over four years and expire up to ten years from the date of grant at the
discretion of the Board of Directors.
Stock option transactions of the 1993 Plan are summarized below:
WEIGHTED AVERAGE
SHARES EXERCISE PRICE
------- ----------------
Outstanding at December 31, 1994 178,401 $2.10
Granted 70,520 2.13
Forfeited (32,175) 2.00
------- -----
Outstanding at December 31, 1995 216,746 2.11
Forfeited (57,000) 2.12
------- -----
Outstanding at December 31, 1996 159,746 $2.10
------- -----
------- -----
At December 31, 1996 and 1995, options were exercisable with respect to
93,462 and 49,383 shares, respectively, with exercise prices ranging from
$2.00 to $2.13 and a weighted average exercise price of $2.10 and $2.11,
respectively.
During 1996 and 1995, compensation expense of $6,910 was recorded in
connection with a November 1995 grant of 31,895 options to three employees of
the Company. Remaining expense of $13,822 related to these options has been
deferred and will be charged to expense ratably over the remaining two years
of the vesting period.
An additional 175,788 nonqualified stock options have been issued to the
Company's president outside of the plan described above. At December 31,
1996, nonqualified options to purchase 59,700 shares of common stock at an
exercise price of $.67 per share and 87,066 shares at a price of $2.00 per
share were exercisable. At December 31, 1995, nonqualified options to
purchase 59,700 shares of common stock at an exercise price of $.67 per share
and 79,810 shares of common stock at an exercise price of $2.00 per share are
exercisable.
The Company adopted the 1996 Stock Option Plan (the "1996 Plan") in December
1995. Under the 1996 Plan, grants of both incentive stock options and non-
qualified options are permitted. Incentive stock options may only be granted
to employees of the Company, including officers and directors who are also
employees. Non-qualified options may be issued to officers, directors,
employees or consultants of the Company. The exercise price of incentive
stock options granted under the 1996 Plan must be at least 100% (or 110% in
the case of a holder of 10% or more of the voting power of all classes of
stock of the Company) of the fair market value of the Company's stock at the
grant date, while the exercise price of non-qualified options is at the
discretion of the Board of Directors. Aggregate common shares of 165,000 are
reserved for issuance under the 1996 Plan. Shares forfeited can be reissued
under the 1996 Plan. Options issued under the 1996 Plan vest at a rate of
25% per year over four years and expire up to ten years from the date of
grant at the discretion of the Board of Directors.
-7-
<PAGE>
QUALMARK CORPORATION
NOTES TO FINANCIAL STATEMENTS
- -------------------------------------------------------------------------------
Stock option transactions of the 1996 Plan are summarized below:
WEIGHTED AVERAGE
SHARES EXERCISE PRICE
------- ----------------
Outstanding at December 31, 1995 -
Granted 180,250 $3.56
Forfeited (18,000) 3.25
------- -----
Outstanding at December 31, 1996 162,250 $3.59
------- -----
------- -----
At December 31, 1996, none of the options were exercisable.
FAIR VALUE
Had compensation cost for the Company's stock option plans been determined
based on the fair values at the grant dates for awards under the plans
consistent with the method of accounting prescribed by SFAS No. 123, the
Company's net loss and loss per share would have been increased to the pro
forma amounts indicated below (in thousands):
DECEMBER 31,
------------------
1996 1995
-------- -------
Net loss:
As reported $(1,381) $ (116)
Pro forma $(1,414) $ (165)
Net loss per share:
As reported $ (0.47) $(0.05)
Pro forma $ (0.48) $(0.08)
The fair value of each option and warrant grant is estimated on the date of
grant using the Black-Scholes option-pricing model with the following
weighted-average assumptions used for grants in the years ended December 31,
1996 and 1995: dividend yield of zero; expected volatility of 52%; risk-free
interest rates of 6.19% and 5.4%, respectively, and an expected term of six
years. The risk-free interest rate used in the calculation is the yield on
the grant date of a U.S. Treasury Strip with a maturity equal to the expected
term of the option. The pro forma effect on net income for 1996 and 1995 is
not representative of the pro forma effect on operations in future years
because it does not take into consideration pro forma compensation expense
related to grants made prior to 1995.
8. PROFIT SHARING PLAN
Effective June 1, 1993, the Company adopted an employee profit sharing plan
under Section 401(k) of the Internal Revenue Code (the "Plan") covering
personnel who have been employed at least three months. Employees may
contribute up to the federal limit of their compensation to the Plan each
year. The Company may make discretionary contributions, as determined by the
Board of Directors each year, to employee participants who have more than one
year of service. Participants vest in employer contributions at a rate of
20% per year over five years. No employer contributions were made during
1996 or 1995.
9. RELATED PARTY TRANSACTIONS
On January 1, 1994, the Company purchased the assets of Hobbs Engineering
Corporation (HEC), a company owned by a then-controlling shareholder of the
Company (Dr. Gregg K. Hobbs), for $250,000. The book value of the assets
purchased at the time of the transaction was $1,597. Due to the common
control of the two companies, the excess of the amount paid over the book
value of the assets received was recorded as a dividend.
-8-
<PAGE>
QUALMARK CORPORATION
NOTES TO FINANCIAL STATEMENTS
- -------------------------------------------------------------------------------
Effective September 30, 1995, the Company sold the assets of HEC, excluding
any patents or other intellectual property, back to Dr. Hobbs for cash
consideration of $1,500. No gain or loss was recorded in connection with
this transaction. In connection with the sale, the Company agreed to make
quarterly royalty payments to Dr. Hobbs equal to two percent of the Company's
total revenues, increasing to a maximum of three percent if certain revenue
levels are achieved, for the period January 1, 1996 through December 31,
1999, in exchange for Dr. Hobbs being available to actively promote the
Company's products and services. Royalties in excess of the 2% base royalty
are calculated as .5% and 1% of total revenues if the following revenue
levels are achieved:
ADDITIONAL 0.5% ROYALTY ADDITIONAL 1.0% ROYALTY
YEAR IF REVENUES EXCEED: IF REVENUES EXCEED:
---- ----------------------- -----------------------
1996 $ 6,000,000 $ 7,000,000
1997 9,000,000 10,000,000
1998 11,000,000 12,000,000
1999 13,000,000 14,000,000
During 1996, royalties of $113,880 were paid to Dr. Hobbs. Additionally, the
Company granted Dr. Hobbs a warrant to purchase 72,000 shares of the
Company's common stock at an exercise price of $2.13 per share. The warrant,
which vests in cumulative quarterly increments on December 31, 1996, 1997,
1998 and 1999, is exercisable upon vesting and expires five years from the
grant date. Further, common stock options to purchase 22,875 shares of
common stock previously granted to Dr. Hobbs and two other HEC employees with
exercise prices ranging from $.67 to $2.13 that were unexercised as of the
effective date of the agreement, were exchanged for warrants to purchase
22,875 shares of common stock at $2.13 per share, expiring in five years.
HEC revenues totaled $262,588 in 1995, and the related cost of revenues was
$252,660.
Also, a note receivable from Dr. Hobbs was repaid in full concurrent with the
sale of HEC back to Dr. Hobbs.
10. LEGAL MATTERS
On March 22, 1996, the Company was served with a summons and complaint from
Screening Systems, Inc. ("SSI"), a competitor, alleging that the Company's
vibration system infringes three patents of which that Company is exclusive
licensee. The plaintiff requests injunctive relief as well as money damages
and litigation costs. The owner of all three patents, Hughes Aircraft
Company, has not been named as a defendant in the lawsuit.
The Company has been aware of the patent in question since the Company
commenced its operations and, with advice from patent counsel, designed its
vibration system, components of which are also patented, so as to not
infringe that patent. The Company's vibration system has been used
continuously in its products since 1991. On two prior occasions, the
plaintiff put the Company on notice that the Company's vibration system might
infringe its patent, although no litigation was commenced. On both
occasions, the Company concluded, after consultation with patent counsel,
that infringement did not exist and has seen nothing since to change that
conclusion.
On February 3, 1997, the Company and SSI each filed motions for summary
judgment. On February 13, 1997, the court referred those motions to the
magistrate and vacated the trial. At a hearing held on February 18, 1997,
the magistrate scheduled a hearing to be held on March 25, 1997, to determine
the scope of the claims of the two parties.
-9-
<PAGE>
QUALMARK CORPORATION
NOTES TO FINANCIAL STATEMENTS
- -------------------------------------------------------------------------------
In response to the current litigation, the Company consulted with its current
legal and patent counsel, who agreed with prior patent counsels' opinions
that the Company's vibration system does not infringe the SSI patent.
Consequently, management intends to vigorously defend this litigation.
However, no assurances can be given that the Company will be successful in
its defense. The Company believes that the suit may have a material adverse
effect on the results of operations and financial condition of the Company in
terms of legal fees and costs for defending the claim, the possibility of an
unfavorable outcome and an award of damages, and of the loss of management
time needed to deal with the suit. At December 31, 1996, the Company has
accrued an estimate provided by its legal counsel as to the costs related to
cover the legal fees associated with defending this suit.
-10-
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and
Shareholders of QualMark Corporation
In our opinion, the accompanying balance sheet and the related statements of
operations, of changes in shareholders' equity and of cash flows present fairly,
in all material respects, the financial position of QualMark Corporation at
December 31, 1996 and 1995, and the results of its operations and its cash flows
for the years then ended in conformity with generally accepted accounting
principles. These financial statements are the responsibility of the Company's
management; our responsibility is to express an opinion on these financial
statements based on our audits. We conducted our audits of these statements in
accordance with generally accepted auditing standards which require that we plan
and perform the audits to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements, assessing the accounting principles used and
significant estimates made by management, and evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for the opinion expressed above.
PRICE WATERHOUSE LLP
Denver, Colorado
February 21, 1997
<PAGE>
INDEX TO EXHIBITS
<TABLE>
Exhibit Sequential
Number Description Page No.
- ------- ----------- --------
<S> <C> <C>
3.1 Amended and Restated Articles of Incorporation of the Company. (1)
3.2 Amended and Restated Bylaws of the Company. (1)
4.1 Form of Certificate for Shares of Common Stock. (1)
4.6 Form of Warrant issued to holders of 10% secured promissory notes. (1)
10.1 QualMark Corporation 1993 Incentive Stock Option Plan. (1)
10.2 QualMark Corporation 1996 Stock Option Plan. (1)
10.3 Employment Agreement dated March 1, 1993 by and between
the Company and W. Preston Wilson. (1)
10.4 Employment Agreement dated August 15, 1994 by and between
the Company and J. Wayne Farlow. (1)
10.5 Agreement dated September 30, 1995 by and between the
Company and Gregg K. Hobbs. (1)
10.8 Addendum to Agreement dated as of December 21, 1995 by
and between the Company and Gregg K. Hobbs. (1)
11.1 Statement of Computation of Per Share Earnings.
</TABLE>
- --------------
(1) Incorporated by reference form the Company's Registration Statement No.
333-1454-D on Form SB-2.
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED BALANCE SHEET AS OF DECEMBER 31, 1996 AND THE CONSOLIDATED
STATEMENT OF OPERATIONS FOR THE TWELVE MONTHS ENDED DECEMBER 31, 1996 AND IS
QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-END> DEC-31-1996
<CASH> 411,000
<SECURITIES> 1,911,000
<RECEIVABLES> 1,267,000
<ALLOWANCES> 21,000
<INVENTORY> 536,000
<CURRENT-ASSETS> 4,224,000
<PP&E> 1,463,000
<DEPRECIATION> 390,000
<TOTAL-ASSETS> 5,441,000
<CURRENT-LIABILITIES> 1,761,000
<BONDS> 0
0
0
<COMMON> 6,131,000
<OTHER-SE> 0
<TOTAL-LIABILITY-AND-EQUITY> 5,441,000
<SALES> 5,694,000
<TOTAL-REVENUES> 5,694,000
<CGS> 3,359,000
<TOTAL-COSTS> 3,718,000
<OTHER-EXPENSES> 42,000
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> (44,000)
<INCOME-PRETAX> (1,381,000)
<INCOME-TAX> 0
<INCOME-CONTINUING> (1,381,000)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (1,381,000)
<EPS-PRIMARY> (.47)
<EPS-DILUTED> (.47)
</TABLE>
