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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, 1997
[] 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
incorporation or organization) Identification No.)
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. $10,638,607
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
December 31, 1997 was $17,897,156.
The number of shares outstanding of the issuer's Common Stock as of
December 31, 1997 was 3,387,134.
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.
QualMark Corporation ("QualMark" or "the Company") designs, manufactures, and
markets proprietary systems that 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 their products perform within the
previously determined operating ranges (commonly known as "specifications").
ESS is the testing process used by these same manufacturers to expose
production-related defects.
The Company's systems allow manufacturers to determine the true operating
limits of their products. This gives 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 highly accelerated stress
testing on products such as circuit boards, blood glucose monitors, flight
navigation systems, cellular telephones, airbag sensors and consumer electronics
products.
The Company evolved from a business manufacturing and marketing its
proprietary OVS (Omni-axial Vibration System) equipment to a full service
organization offering HALT (Highly Accelerated Life Test) and HASS (Highly
Accelerated Stress Screen) test services as well. The Company operates a
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 eight test centers located in Denver, Colorado,
Huntington Beach, California, Santa Clara, California, Marlborough (Boston),
Massachusetts, New Brighton (Minneapolis-Saint Paul), Minnesota, Farmington
Hills, Michigan, Morrisville, North Carolina and Winter Park, Florida. In 1998,
the Company expects to add additional OVS capacity to existing test centers and
offer additional accelerated test services. As international demand for its
products and services grows, the Company may further expand its domestic and
international presence by expanding strategic alliance arrangements with other
test lab organizations.
The Company was organized in July 1991 as a Colorado limited liability company
and was later incorporated in Colorado in March 1992. The Company completed its
initial public offering in April 1996.
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 vibrational forces
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 virtually any vibration that could occur
naturally during product use. This is important in testing and screening
applications to expose most flaws, whether it is design or process related,
before the product is placed into service.
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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 2.25
square foot table size to a 16 square foot table size. 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
Attached to the bottom surface of the table are a set of pneumatic, piston
driven actuators (vibrators) that contain certain patented properties,
which help to maximize random motion of the vibration table. These
actuators, known as "AutoSmear" Vibrators, are mounted to the bottom of the
vibration table are 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.
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 patented and 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 four 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-1.5 contains a one and one half foot by one and one half foot
table, an OVS-2.5 contains a two and a half foot by two and a half 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. By cooling and
heating a smaller volume, the customer can save considerably on power and liquid
nitrogen requirements.
OVS-1.5:
The OVS-1.5 is a small, bench top version of the OVS product line. The
OVS-1.5 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-1.5 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-1.5 can generate random vibration
forces in excess of 90 Grms (2Hz-10,000 Hz) on the 18"x18" vibration table
and up to 60DEG. Centigrade per minute change on the product under test within
the 18"x17"x13" (ID) thermal chamber. The domestic price of the OVS-1.5 is
approximately $70,000.
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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 domestic price for a standard OVS-2.5 is approximately
$130,000, and the high performance version for heavy load applications is
approximately $139,000.
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 60 Grms random
vibration force (2Hz-10,000 Hz). The thermal chamber is 43"x42"x54" (ID)
(table in lower position) and can produce temperature changes on the product
under test of up to 60DEG. Centigrade per minute. The OVS-3 sells for
approximately $150,000 (domestic).
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"x54" (internal dimension) (table in lower position) 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 50 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 $183,000 (domestic); the high performance version for heavy
load applications is approximately $192,000 (domestic).
A two year limited warranty is included with each OVS system. Various options
and accessories are available for each OVS model, including oxygen monitors,
vacuum hold down apparatus (for product fixturing requirements), extended
warranties, and on-site applications assistance.
ACCELERATED RELIABILITY TEST CENTERS
The Company has a network of ARTC test centers throughout the United States,
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.
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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.
In 1997 the Company opened its seventh and eighth test centers in Huntington
Beach, California and Winter Park Florida. Also, the Company established its
first test center presence outside the U.S. via a strategic alliance with TUV
Product Service Ltd. near London (U.K.)
The Company may open additional test centers principally in metropolitan areas
with a heavy concentration of potential client companies and in which the
Company has a factory 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. Finally, the
Company may expand its international presence via strategic alliance
arrangements with other test lab organizations.
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.
MARKETING
The Company increased its market exposure in 1997 by conducting a number of
"open houses" at each of its nationwide ARTC's. Prospects for these open houses
are usually found in various electronic manufacturers databases. 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 intends to attend approximately twelve trade shows in 1998.
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 may make additions to its existing telemarketing staff in
Denver.
SALES STRATEGY
The Company's sales strategy combines telemarketing with regional vice
presidents who are primarily responsible for OVS system sales and regional
account executives who are responsible for ARTC service sales. At year end,
1997, the Company had three regional vice presidents and nine regional account
executives. In addition, the Company uses independent sales/service agents in
the United Kingdom, Israel and South Korea. During the next 12 months, the
Company intends to add to its international sales/service agent network and may
add additional regional account representatives in the United States.
The regional vice presidents, each of whom have multiple ARTC facilities within
their geographic areas of responsibility, direct the efforts of the regional
account executives in selling ARTC services. When customers express interest to
the regional account executive in buying an OVS system rather than using an
ARTC, the regional vice president assumes responsibility for the customer to
close the OVS sale.
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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 telemarketing staff also encourage prospective customers to
attend 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, 1997, the Company had sold 184 systems to 99 different
customers, in the following industries: Telecommunications and Computer, 40;
Defense and Aerospace, 17; Medical Electronics, 12 Other, 30. 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, Medtronic, Motorola, National Semiconductor,
Magnavox, Nortel (formerly Northern Telecom), Sequent Computers, Tektronix,
3-COM, United Technologies, U.S. Robotics, and Varian. During 1997, there were
no customers that comprised 10% or more of the Company's revenue.
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.
AEROSPACE AND DEFENSE COMPUTER RELATED PRODUCTS OTHER
aviation electronics circuit boards automotive circuitry
display switches disk drives electronic oil and gas
flight navigation systems modems flow meters
marine navigation systems monitors global positioning
power supplies systems
printers
tape backup drives
TELECOMMUNICATIONS MEDICAL ELECTRONICS
automated teller machines electronic thermometers
air conditioning glucose monitors
electronics infusion pumps
cordless telephones IV pumps
fax machines laboratory centrifuges
medical imaging systems
patient monitors
RESEARCH AND PRODUCT DEVELOPMENT
Research and development expenditures for the fiscal years ending December 31,
1997 and 1996 were $236,000 and $182,000, respectively. It is the intent of the
Company in 1998 to devote considerable effort to the development of the
specifications for its next generation PC-controller and expects its research
and development expenditures to increase to over $850,000. In 1997, the Company
refined the OVS product line by discontinuing the OVS-1 and OVS-2 and adding the
OVS-1.5. However, the OVS-1 may be reintroduced in an abbreviated version to
accommodate that part of the market that desires a lower cost version of the OVS
combined stress technology.
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 six domestic and one foreign patent, and has four domestic and
one foreign patent applications in process. The Company is optimistic that the
flexibility and scalability of its fundamental OVS combined stress technology
will allow the Company to add to its product line as new opportunities develop.
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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 areas of highly
accelerated test methods and virtual verification. As the demand and viability
of these new test methods and technologies are verified, the Company intends to
add them to its ARTC service offering.
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
representatives to observe its operation.
INTELLECTUAL PROPERTY
The Company has maintained the practice, where possible, to pursue patent
protection on its products. The Company has been issued six United States
patents (the "Patents") which protect certain features of the OmniAxial
Vibration Assembly of the Company's OVS Combined Stress Systems or certain
design features of the pneumatic, piston-driven actuators (vibrators) that help
create random motion of the vibration table. The Company was issued U.S. Patent
No. 5,365,788 on November 22, 1994, for certain design features of pneumatic,
piston driven, actuators that create motion for a vibration table. The Company
was issued U.S. Patent No. 5,412,991 on May 9, 1995, for certain design
features of the Company's vibration table. The Company was issued U.S. Patent
No. 5,517,857 on May 21, 1996, for certain design features related to
positioning of a vibration table within a stress screening chamber. The Company
was issued U.S. Patent No. 5,540,109 on July 30, 1996, and U.S. Patent No.
5,675,098 on October 7, 1997, for certain design features related to use of
multiple stress screening chambers. The Company was issued U.S. Patent No.
5,589,637 on December 31, 1996, for certain design features of mountings of
actuators to a vibration table. The remaining duration of each of the Patents
is between thirteen and fifteen years.
The Company has four United States patent applications and one foreign patent
application pending relating to its OVS Combined Stress Systems. The Company
plans to make additional patent applications as appropriate.
There are six foreign patents issued for certain design features of the
pneumatic, piston-driven actuators (vibrators) that help create random motion of
the vibration table. The countries in which these patents have been issued are
France, Germany, Italy, Luxembourg, Sweden, and the United Kingdom.
The Patents provide barriers to competition in the equipment sales portion of
its business. The loss of some or all of the protection of the Patents would
make it easier for other companies to enter the Company's market and compete
against the Company by eroding the Company's ability to differentiate itself on
the basis of technical superiority.
In addition to the Patents, the Company tries to protect its proprietary
technology and know-how through established security practices and
confidentiality agreements with each of its employees, consultants, suppliers,
and technical advisors. There can be no assurance, however, that these
agreements or procedures will provide meaningful protection for the Company's
trade secrets in the event of unauthorized use or disclosure of such
information.
While the Company believes the protection afforded by the Patents is strong,
there can be no assurance that other companies will not be able to design and
build competing vibration tables in a manner that does not infringe the Patents.
On March 22, 1996, Screening Systems, Inc. filed a patent infringement action
against the Company alleging that the Company infringed U.S. Patent No.
4,181,026. See "Item 3. Litigation."
The Company has the following registered marks with the United States Patent and
Trademark Office: QUALMARK, ACCELERATE THE FUTURE, ACCELERATED RELIABILITY TEST
CENTER, ARTC, and AUTOSMEAR. The Company has one U.S. certification mark
application and one foreign mark application pending relating to the Company
name and service. The Company plans to make additional trademark, service mark,
and certification mark applications as appropriate.
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
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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, CA. See "Business -- Litigation," and see "Risk Factors -
Patent Litigation."
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.
Several traditional ESS equipment manufacturing companies, such as Thermotron
and Weiss, enjoy annual revenues in excess of $50 million dollars, according to
the Thomas Register, which is an industrial products directory. These firms
manufacture thermal chambers and singe/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 emerging test methods, 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
QualMark's assembly of the OVS systems 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 that include vibration systems, chamber
systems and control systems.
To ensure that all subassemblies meet specifications when received, 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 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 primarily uses a "make-to-order" approach in assembling the
OVS-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.
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, two year parts and labor warranty on all new OVS
systems. OVS customers can purchase extended warranties on their OVS systems,
which may include 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 efficient design of 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.
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GOVERNMENT REGULATION
To its knowledge, the Company complies with all international, federal, state,
and local regulations governing the conduct of its business and the costs of
such compliance are minimal.
EMPLOYEES
As of December 31, 1997, the Company had 58 employees, all of which are full-
time. Thirty eight of the company's employees are employed at its principal
offices and headquarters in Denver, Colorado, four are employed at its
facilities in Santa Clara, CA, three in Huntington Beach, CA , two in New
Brighton, MN, three in Farmington Hills, MI, four in Marlborough, MA, two in
Morrisville, NC and two in Winter Park, FL. 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 operates 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 May 31, 2000. The leased
properties consists of approximately 18,093 square feet. The lease calls for
monthly payments over the term of the lease of $14,007. In addition, the
Company is responsible for certain expenses, including property taxes, insurance
and maintenance. The Company's manufacturing, sales, administrative operations
and 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. 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, 2001.
The leased property consists of approximately 4,660 square feet. The lease
calls for average monthly payments of $7,222. 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. 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. 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 expires in December 2002.
The leased property consists of 3,420 square feet. The lease calls for average
monthly payments of $2,154. 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 Orlando facility is located at Crossroads Business Center, Suite
212 931 Semoran Boulevard, Winter Park, Florida. The five year lease expires
April 30, 2002. The lease calls for average monthly payments of $2,969. 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 Company believes that its facilities are adequate for its current
needs and that suitable additional space can be acquired if needed.
9
<PAGE>
ITEM 3. LEGAL PROCEEDINGS.
On March 22, 1996, the Company was served with a summons and complaint from
Screening Systems, Inc. ("SSI"), a competitor. The complaint, as amended,
alleges that the Company's vibration system infringes three patents owned by
Hughes Electronics ("Hughes") and licensed to SSI, and seeks injunctive relief,
monetary damages and costs of litigation. Because Hughes would not voluntarily
join the action as a plaintiff, SSI has named Hughes as a defendant in the
action.
The Company has been aware of the patents 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
the patents. The Company's vibration system has been used continuously in its
products since 1991. On two prior occasions, Hughes put the Company on notice
that the Company's vibration system might infringe its patents, 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.
Discovery in the action has been completed; however, the trial date has been
vacated. In April 1997, the court conducted a "Markman hearing" to determine the
scope and meaning of the relevant claims and terms of the patents-in-suit. In
October 1997, the court issued its Order re Construction of Patent Claims.
Based on that Order, in November 1997, the Company moved for summary judgment of
non-infringement with respect to each of the patents in issue. SSI has moved
for summary judgment of infringement with respect to one of the patents in
issue and filed a summary judgment motion on several of the Company's defenses.
The court has not yet ruled on any of these motions and has not yet set a trial
date.
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 patents. 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, 1997, 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
The Company believes that the legal action by the plaintiff is without merit
and will continue to vigorously defend itself in these matters.
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, 1997.
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
The common stock of the Company has been traded on the NASDAQ (National
Association of Securities Dealers Automated Quotations) Small-Cap 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 years 1997 and 1996:
Fiscal Year Ended December 31, 1997
<TABLE>
<CAPTION>
High Close Low Close
<S> <C> <C>
First Fiscal Quarter $3.500 $2.750
Second Fiscal Quarter 5.000 3.000
Third Fiscal Quarter 5.250 3.625
Fourth Fiscal Quarter 6.500 4.625
</TABLE>
10
<PAGE>
Fiscal Year Ended December 31, 1996
<TABLE>
<CAPTION>
High Close Low Close
<S> <C> <C>
First Fiscal Quarter n/a n/a
Second Fiscal Quarter $5.875 $4.125
Third Fiscal Quarter 4.125 2.875
Fourth Fiscal Quarter 4.25 3.00
</TABLE>
The foregoing quotations represent quotations between dealers without
adjustment for retail markups, markdowns or commissions and may not represent
actual transactions.
At December 31, 1997 the Company had approximately 860 shareholders of
record. The Company has never paid a dividend, and does not anticipate the
payment of dividends in the foreseeable future.
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS
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
<TABLE>
<CAPTION>
December 31, 1997 December 31, 1996
<S> <C> <C>
Statement of Operations Data:
Net Sales............................... 100.0% 100.0%
Cost of Revenue......................... 57.9 56.3
-------------------------------------
Gross Profit............................ 42.1 43.7
Selling, general and administrative
expenses................................ 48.5 64.8
Research and development
expenses................................ 2.2 3.2
-------------------------------------
Loss from............................... (8.6) (24.3)
operations..............................
Other income (expense).................. .1 .0
-------------------------------------
Net loss................................ (8.5)% (24.3)%
-------------------------------------
-------------------------------------
</TABLE>
RESULTS OF OPERATIONS
The Company's annual and 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.
COMPARISON OF YEARS ENDED DECEMBER 31, 1997 AND 1996
REVENUE
Net revenue in the year ended December 31, 1997 increased $4,945,000 (86.8%)
as compared with the year ended December 31, 1996.
System revenue increased $3,709,000 (93.3%) in 1997 from $3,974,000 to
$7,682,000 as compared to 1996. Unit shipments increased from 32 to 58 for 1996
and 1997, respectively. The Company experienced a greater concentration of
larger, more expensive systems in 1997 compared to 1996, which was a significant
factor in system revenue growth of 93.3% on systems unit sales growth of 81.3%
over such period.
11
<PAGE>
Test center revenue for 1997 increased $1,236,000 (71.8%) from $1,720,000 to
$2,956,000 over 1996. At December 31, 1997 the Company operated eight test
centers containing ten systems compared to six test centers containing eight
systems at December 31, 1996.
GROSS MARGIN
The gross margin in 1997 was 42.1% compared to 43.7% for 1996. The decrease
in gross margin is mostly attributable to increased royalty expenses under an
agreement the Company has with its founder. Under that agreement, if revenues
exceed certain levels, an increased percentage of total sales is paid as a
royalty to the founder. During 1997, revenues exceeded certain of those levels
and resulted in increased royalty expense. Royalty expense in 1997 was $324,000
versus $114,000 in 1996. The agreement expires at the end of 1999. Other
decreases in gross margin were due to the costs of opening and operating the
newer test centers.
OPERATING EXPENSE
General and administrative expenses increased in 1997 to $3,450,000 from
$2,684,000 in 1996. The increase reflects added costs for test center
administration and legal costs incurred from the Company's involvement in a
patent litigation matter. The Company incurred $1,608,000 in legal fees in 1997
compared to $1,280,000 in 1996. The 1997 expense and a portion of the 1996
legal expense was due to the litigation with Screening Systems, Inc. ("SSI").
The balance of the legal fees in 1996 were due to fees associated with
litigation with Hanse Environmental, Inc. That case was settled to the
Company's satisfaction on August 19, 1996.
Sales and Marketing expenses increased $696,000, from $1,008,000 in 1996 to
$1,704,000 in 1997. 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 1996.
Research and development costs increased from $182,000 in 1996, to $236,000
in 1997. This increase is due to increased efforts and headcount in the
Company's research and development department. It is the intent of the Company
in 1998 to devote considerable effort to the development of the specifications
for its next generation PC-controller and expects its research and development
expenditures to increase to over $850,000.
Net interest income in 1997 was $22,000 compared with a net interest income
of $45,000 in 1996. The decrease in interest income was due to a decrease in
interest-earning cash and short term investment balances.
LIQUIDITY AND CAPITAL RESOURCES
During 1997, the Company's operations used $1,365,000 of cash in operating
activities, invested $846,000 for equipment and patents, paid $33,000 in lease
payments, and borrowed $200,000 from its bank. The Company also redeemed short
term investments of $2,111,000. Former employees also exercised options to
purchase 55,000 shares of common stock for a total change in common stock of
$116,000. Together, these activities resulted in a cash increase of $48,000 to
a balance of $459,000 at December 31, 1997. These numbers compare to 1996,
when the Company completed its initial public offering that resulted in net
proceeds (after expenses) of $4,505,000. From these amounts, the company
retired $701,000 in debt. Also during 1996 the Company used $850,000 in
operating activities, invested $862,000 in for equipment and patents and paid
$51,000 in lease payments. Together, these 1996 operating activities resulted
in a cash increase of $159,000 to a balance of $411,000 at December 31, 1996.
The Company also had short-term investments of $2,322,000 at December 31, 1996.
In September 1997, the Company renegotiated its line of credit arrangement
with its bank. The credit line provides for draws up to $1,300,000; 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. In addition, on
the effective date of the agreement, September 18, 1997, and according to its
terms, the Company borrowed $200,000 secured by certain fixed assets. This loan
bears interest at prime plus 1.75% and is to be repaid in equal monthly payments
over a three year term.
The Company expects to meet long term liquidity requirements through cash
flows generated by operations, existing cash balances and its 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.
12
<PAGE>
YEAR 2000 ISSUE
Many currently installed computer systems and software products in use by
businesses and government organizations are coded to accept two digits, rather
than four, to specify the year. As a result, in less than two years, computer
systems and/or software used by many companies may need to be upgraded to comply
with such "Year 2000" requirements. Significant uncertainty exists in the
software industry concerning the potential effects associated with such
compliance.
The company has extensively tested its proprietary software and believes that
it has successfully addressed this issue in its proprietary software, upon which
its business operations are significantly dependent. In addition, other third
party software used internally is Year 2000 compliant. The Company will
continue to monitor its third party software vendors for compliance. Based upon
the above facts, the Company believes that costs related to the Year 2000 issue
will be minimal.
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.
ITEM 7. FINANCIAL STATEMENTS.
Index to Financial Statements and Schedules:
Page Number
-----------
Report of Independent Public Accountants F-1
Balance Sheet F-2
Statement of Operations F-3
Statement of Shareholders' Equity F-4
Statement of Cash Flows F-5
Notes to Financial Statements F-6
All schedules for which provision is made in the applicable accounting
regulations 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 is incorporated herein by reference.
ITEM 10. EXECUTIVE COMPENSATION.
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 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.
13
<PAGE>
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) Exhibits - See Index to Exhibits
(b) Reports on Form 8-K during the last quarter of the Company's fiscal year
ended December 31, 1997 - None
14
<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 27, 1998 QUALMARK CORPORATION
By: /s/ W. PRESTON WILSON
---------------------------------
W. Preston Wilson, President and
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 President, Chief Executive Officer March 27, 1998
- ------------------------ and Director
W. Preston Wilson
/s/ Vernon W. Settle Vice President Administration and March 27, 1998
- ------------------------ Principal Accounting Officer
Vernon W. Settle
/s/ H. Robert Gill Director March 27, 1998
- ------------------------
H. Robert Gill
/s/ Philip A. Gordon Director March 27, 1998
- ------------------------
Philip A. Gordon
/s/ Charles A. French Director March 27, 1998
- ------------------------
Charles A. French
/s/ William B. Phillips Director March 27, 1998
- ------------------------
William B. Phillips
/s/ William J. Sanko Director March 27, 1998
- ------------------------
William J. Sanko
15
<PAGE>
INDEX TO EXHIBITS
Exhibit Sequential
Number Description Page No.
- -------- ----------- ----------
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)
10.11 Loan and Security Agreement dated April 30, 1996, by and
between QualMark Corporation and Silicon Valley Bank, as
amended by Amendment to Loan and Security Agreement dated
August 18, 1997. (2)
23.1 Consent of Price Waterhouse, LLP
27.1 Financial Data Schedule
- ---------------------
(1) Incorporated by reference from the Company's Registration Statement No.
333-1454-D on Form SB-2.
(2) Incorporated by reference from the Company's Quarterly Report on Form
10-QSB for the quarter ended September 30, 1997.
16
<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, 1997 and 1996, 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 6, 1998
F-1
<PAGE>
QUALMARK CORPORATION
BALANCE SHEET
(IN THOUSANDS, EXCEPT FOR NUMBER OF SHARES)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
DECEMBER 31,
1997 1996
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 459 $ 411
Short-term investments 1,911
Trade accounts receivable, net of allowance
for doubtful accounts of $21and $21, respectively 3,100 1,246
Inventories 608 536
Other current assets 52 120
------- -------
Total current assets 4,219 4,224
Property and equipment, net 1,428 1,073
Patents, net of accumulated amortization of
$271 and $256, respectively 13 28
Other assets 38 116
------- -------
$ 5,698 $ 5,441
------- -------
------- -------
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 646 $ 380
Customer deposits and deferred revenue 59 47
Accrued expenses 1,893 1,303
Current portion of long-term debt 62
Current portion of capital lease obligations 11 31
------- -------
Total current liabilities 2,671 1,761
Noncurrent portion of long-term debt 122
Noncurrent portion of capital lease obligations 5 18
------- -------
Total liabilities 2,798 1,779
------- -------
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, none outstanding; 99,619 designated as
Series B, none outstanding
Common stock; no par value; 15,000,000 - -
shares authorized; 3,387,134 and 3,330,484 shares
issued and outstanding, respectively 6,270 6,131
Accumulated deficit (3,370) (2,469)
------- -------
Total shareholders' equity 2,900 3,662
------- -------
$ 5,698 $ 5,441
------- -------
------- -------
</TABLE>
The accompanying notes are an integral
part of these financial statements.
F-2
<PAGE>
QUALMARK CORPORATION
STATEMENT OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
DECEMBER 31,
1997 1996
<S> <C> <C>
Revenues $10,639 $ 5,694
Cost of revenues 6,164 3,203
------- -------
Gross profit 4,475 2,491
Selling, general and administrative expenses 5,390 3,874
------- -------
Loss from operations (915) (1,383)
Other income (expense):
Interest expense (15) (49)
Interest income 37 93
Other income (expense), net (8) (42)
------- -------
Net loss $ (901) $(1,381)
------- -------
------- -------
Basic and diluted loss per share $ (0.27) $ (0.47)
------- -------
------- -------
Weighted average number of common shares 3,363 2,927
------- -------
------- -------
</TABLE>
The accompanying notes are an integral
part of these financial statements.
F-3
<PAGE>
QUALMARK CORPORATION
STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY
(IN THOUSANDS)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
PREFERRED STOCK COMMON STOCK ACCUMULATED
SHARES AMOUNT SHARES AMOUNT DEFICIT TOTAL
<S> <C> <C> <C> <C> <C> <C>
Balance December 31, 1995 332 $ 1,100 934 $ 253 $(1,088) $ 265
Conversion of note payable
to common stock 117 250 250
Conversion of outstanding convertible
preferred stock to common stock (332) (1,100) 498 1,100 -
Exchange of warrants for common stock 296 -
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 4,505 4,505
Net loss (1,381) (1,381)
---- ------- ----- ------ ------- -------
Balance December 31, 1996 - - 3,330 6,131 (2,469) 3,662
---- ------- ----- ------ ------- -------
Exercise of options for common stock 55 116 116
Exercise of warrants for common stock 2 -
Amortization of deferred
compensation related to issuance of
warrants and options 23 23
Net loss (901) (901)
---- ------- ----- ------ ------- -------
Balance December 31, 1997 - $ - 3,387 $6,270 $(3,370) $ 2,900
---- ------- ----- ------ ------- -------
---- ------- ----- ------ ------- -------
</TABLE>
The accompanying notes are an integral
part of these financial statements.
F-4
<PAGE>
QUALMARK CORPORATION
STATEMENT OF CASH FLOWS
(IN THOUSANDS)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
1997 1996
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss $ (901) $(1,381)
Adjustments to reconcile net loss to net cash
used in operating activities:
Gain on sale of equipment (35)
Depreciation and amortization 483 306
Change in assets and liabilities:
Increase in accounts receivable (1,854) (357)
Increase in inventories (72) (255)
Decrease (increase) in other assets and patents 146 (176)
Increase in accounts payable and accrued expenses 856 1,126
Increase (decrease) in customer deposits and
deferred revenue 12 (113)
------- -------
Net cash used in operating activities (1,365) (850)
------- -------
CASH FLOWS FROM INVESTING ACTIVITIES
Acquisition of property and equipment (846) (862)
Proceeds on sale of property and equipment 81 29
Purchase of short-term investments (200) (5,355)
Proceeds from sale/redemption of short-term investments 2,111 3,444
------- -------
Net cash provided by (used in) investing
activities 1,146 (2,744)
------- -------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from borrowings - other 200
Repayments of borrowings - shareholders (293)
Repayments of borrowings - other (16) (408)
Proceeds from issuance of common stock 116 4,505
Principal payments on capital lease obligations (33) (51)
------- -------
Net cash provided by financing activities 267 3,753
------- -------
Net increase in cash and cash equivalents 48 159
Cash and cash equivalents at beginning of year 411 252
------- -------
Cash and cash equivalents at end of year $ 459 $ 411
------- -------
------- -------
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
SUPPLEMENTAL DISCLOSURE
Interest paid $ 14 $ 69
------- -------
------- -------
</TABLE>
The accompanying notes are an integral
part of these financial statements.
F-5
<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. Its principal business activity is the manufacture
and sale of vibration and thermal chambers for quality control testing of
various electronic devices. The Company's sole 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 which are located at the Company's Denver, Colorado facility, in
Marlborough, Massachusetts, Santa Clara, California, Huntington Beach,
California, Minneapolis, Minnesota, Detroit, Michigan, Orlando, Florida 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.
REVENUE RECOGNITION
Revenues are recognized upon the shipment of product or the performance of
services. Prepayments and progress billings are deferred until shipment
occurs or services are rendered.
ACCRUED LEGAL EXPENSE
Legal fees relating to litigation in which the Company is a defendant are
accrued when the liability 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 (FIFO) 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 shorter of the assets useful lives or 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. No such investments were outstanding at
December 31, 1997.
F-6
<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 1997 and 1996 was $148,000 and $68,000, 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.
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.
RECLASSIFICATIONS
Certain prior year amounts have been reclassified to conform to the current
year's presentation.
NEW ACCOUNTING PRONOUNCEMENTS
Statement of Financial Accounting Standards ("SFAS") No. 128 - The Company
adopted SFAS No. 128, "Earnings Per Share" in 1997. SFAS 128 established
new standards for computing and presenting earnings per share and requires
all prior period earnings per share data be restated to conform with the
provisions of the statement. Basic earnings per share is computed by
dividing net income available to common shareholders by the weighted
average number of shares outstanding during the period. Diluted earnings
per share are computed using the weighted average number of shares
determined for the basic computations plus the number of shares of common
stock that would be issued assuming all contingently issuable shares having
a dilutive effect on earnings per share were outstanding for the period.
Due to the Company's loss from continuing operations in 1997 and 1996, a
calculation of earnings per share assuming dilution is not required.
Options and warrants to purchase 617,293 and 487,785 shares were not
included in the computation of earnings per share assuming dilution at
December 31, 1997 and 1996, respectively, because including the options
would result in an antidilutive effect on earnings per share.
SFAS No. 130 - In June 1997, the Financial Accounting Standards Board
("FASB") issued SFAS No. 130, "Reporting Comprehensive Income." SFAS No.
130 establishes standards for reporting and display of comprehensive income
and its components in a full set of general-purpose financial statements.
SFAS No. 130 requires that all items that are required to be recognized
under accounting standards as components of comprehensive income be
reported in a financial statement that is displayed with the same
prominence as other financial statements. SFAS No. 130 is effective for
fiscal years beginning after December 15, 1997. Currently, the Company
does not have any items that are required to be recognized as components of
comprehensive income.
SFAS No. 131 - In June 1997, the FASB issued SFAS No. 131, "Disclosure
about Segments of an Enterprise and Related Information." SFS No. 131
revises the current requirements for reporting business segments by
redefining such segments as the way management disaggregates the business
for purposes of making operating decisions and allocating internal
resources. SFAS No. 131 is effective for fiscal years beginning after
December 15, 1997 and the Company will adopt SFAS No. 131 in fiscal 1998.
F-7
<PAGE>
QUALMARK CORPORATION
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
2. INVENTORIES
Inventories consist of the following (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
1997 1996
<S> <C> <C>
Raw materials $457 $334
Work in process 121 9
Finished goods 30 193
---- ----
$608 $536
---- ----
---- ----
</TABLE>
3. PROPERTY AND EQUIPMENT
Property and equipment consist of the following (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
1997 1996
<S> <C> <C>
Machinery and equipment $1,679 $1,116
Furniture and fixtures 165 115
Leasehold improvements 400 232
Less: Accumulated depreciation and amortization (816) (390)
------ ------
$1,428 $1,073
------ ------
------ ------
</TABLE>
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):
<TABLE>
<CAPTION>
DECEMBER 31,
1997 1996
<S> <C> <C>
Machinery and equipment $ 76 $ 145
Less: Accumulated amortization (38) (55)
------ ------
$ 38 $ 90
------ ------
------ ------
</TABLE>
4. Accrued Expenses
Accrued expenses consist of the following (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
1997 1996
<S> <C> <C>
Accrued warranty $ 190 $ 90
Accrued legal expense 1,152 919
Accrued employee related 359 212
Other 192 82
------ ------
$1,893 $1,303
------ ------
------ ------
</TABLE>
F-8
<PAGE>
QUALMARK CORPORATION
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
5. INDEBTEDNESS
In May 1996, the Company entered into a line of credit arrangement with a
bank. The credit line, as amended August 1997, provides for draws up to
$1,300,000, bears interest at prime plus 1.5%, matures August 2000 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, 1997, the
Company had not drawn any amounts under the line of credit.
During September 1997, the Company borrowed $200,000 from a bank to
purchase equipment. Interest on the loan accrues at a rate equal to the
prime rate plus 1.75%, which was 10.25% at December 31, 1997. The loan
is secured by substantially all equipment of the Company and is payable
in equal installments over three years. The following represents future
amounts payable (in thousands) at December 31, 1997:
<TABLE>
<CAPTION>
Year ended December 31,
<S> <S>
1998 $ 62
1999 69
2000 53
------
$ 184
------
------
</TABLE>
6. 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, 1997 (in thousands):
<TABLE>
<CAPTION>
CAPITAL OPERATING
LEASES LEASES TOTAL
<S> <C> <C> <C>
Year ended December 31,
1998 $ 13 $ 390 $ 403
1999 3 366 369
2000 2 271 273
2001 144 144
2002 13 13
------ ------ ------
18 $1,184 $1,202
------ ------
------ ------
Less: Interest (2)
------
Current portion 16
(11)
------
Long-term portion $ 5
------
------
</TABLE>
Rent expense for the years ended December 31, 1997 and 1996 was $389,000
and $229,000, respectively. The Company sublet some of the office space
under a cancelable agreement in 1997. Sublease income for the year ended
December 31, 1997 was $13,000.
7. INCOME TAXES
As of December 31, 1997 and 1996, the Company has a net operating loss
("NOL") carryforward of approximately $1,820,000 and $1,602,000,
respectively, which is available to offset future taxable income, of which
approximately $1,000,000 as of December 31, 1997 is subject to annual usage
limitations of approximately $250,000. These carryforwards expire between
2008 and 2012. If certain substantial changes in the Company's ownership
should occur, there would be additional annual limitations on the
utilization of these carryforwards.
Deferred tax assets and liabilities represent the future impact of
temporary differences between the financial
F-9
<PAGE>
QUALMARK CORPORATION
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
statement and tax bases of the Company's assets and liabilities and are as
follows (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
1997 1996
<S> <C> <C>
Deferred tax liabilities:
Depreciation and amortization $ - $ (30)
-------- ---------
Gross deferred tax liabilities - (30)
-------- ---------
Deferred tax assets:
NOL carryforwards 718 633
Accrued liabilities 402 251
Accrued warranty payable 76 36
Depreciation and amortization 33
Other 8 8
-------- ---------
Gross deferred tax assets 1,237 928
-------- ---------
Valuation allowance (1,237) (898)
-------- ---------
Net deferred tax assets - 30
-------- ---------
Net deferred tax asset (liability) $ - $ -
-------- ---------
-------- ---------
</TABLE>
The ultimate realization of the deferred tax 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, 1997 and 1996 is based on
management's conclusion that sufficient positive evidence regarding
realization of certain tax carryforward items does not exist.
A reconciliation of the statutory Federal income tax rate to the income
tax provision (benefit) is as follows (in thousands):
<TABLE>
<CAPTION>
1997 1996
---------------- ----------------
AMOUNT % AMOUNT %
<S> <C> <C> <C> <C>
Computed "expected" tax $ (306) (34.0)% $ (470) (34.0)%
State income taxes, net of Federal
income tax effect (30) (3.3) (46) (3.3)
Recording of valuation allowance 339 37.6 568 41.1
Other (3) (0.3) (52) (3.8)
------ ----- ------ -----
$ - - % $ - - %
------ ----- ------ -----
------ ----- ------ -----
</TABLE>
8. 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.
F-10
<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 a principal shareholder 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:
<TABLE>
<CAPTION>
NUMBER OF
PRE-SPLIT NUMBER OF NUMBER OF
PRE-EXCHANGE POST-EXCHANGE POST-SPLIT
SHARES/WARRANTS COMMON SHARES COMMON SHARES
<S> <C> <C> <C>
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
</TABLE>
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 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 $62,000 will be charged to expense over the
four-year vesting period which began January 1, 1996.
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. During 1997, 5,001 of these warrants were exercised to 1,650 shares
of common stock.
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 216,746 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:
<TABLE>
<CAPTION>
WEIGHTED AVERAGE
SHARES EXERCISE PRICE
<S> <C> <C>
Outstanding at December 31, 1995 216,746 $2.11
Forfeited (57,000) 2.12
------- -----
Outstanding at December 31, 1996 159,746 2.10
Exercised (54,750) 2.12
Forfeited (2,250) 2.04
------- -----
Outstanding at December 31, 1997 102,746 $2.10
------- -----
------- -----
</TABLE>
At December 31, 1997 and 1996, options were exercisable with respect to
64,774 and 93,462 shares,
F-11
<PAGE>
QUALMARK CORPORATION
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
respectively, with exercise prices ranging from $2.00 to $2.13 and a
weighted average exercise price of $2.09 and $2.10, respectively.
During 1997 and 1996, compensation expense of $7,000 was recorded in
connection with a November 1995 grant of 31,895 options to three
employees of the Company. Unamortized deferred compensation at December
31, 1997 related to these options totals $7,000 and will be charged to
expense in 1998, the final year 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,
1997, nonqualified options to purchase 59,700 shares of common stock at
an exercise price of $.67 per share and 116,088 shares at a price of
$2.00 per share were exercisable. 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 of common stock at an exercise price of
$2.00 per share were 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 415,000 are reserved for issuance
under the 1996 Plan, as amended. 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.
Stock option transactions of the 1996 Plan are summarized below:
<TABLE>
<CAPTION>
WEIGHTED AVERAGE
SHARES EXERCISE PRICE
<S> <C> <C>
Outstanding at December 31, 1995 -
Granted 180,250 $3.56
Forfeited (18,000) 3.25
------- -----
Outstanding at December 31, 1996 162,250 $3.59
Granted 236,750 4.67
Exercised (250) 3.25
Forfeited (10,750) 3.76
------- -----
Outstanding at December 31, 1997 388,000 $4.25
------- -----
------- -----
</TABLE>
At December 31, 1997, options were exercisable with respect to 35,688
shares, with exercise prices ranging from $3.25 to $4.19 and a weighted
average exercise price of $3.56. No options were exercisable at December
31, 1996.
F-12
<PAGE>
QUALMARK CORPORATION
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
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):
<TABLE>
<CAPTION>
DECEMBER 31,
1997 1996
<S> <C> <C>
Net loss:
As reported $ (901) $(1,381)
Pro forma $(1,001) $(1,414)
Basic and diluted loss per share:
As reported $ (0.27) $ (0.47)
Pro forma $ (0.30) $ (0.48)
</TABLE>
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, 1997 and 1996: dividend yield of zero; expected volatility of 46% and
52%, respectively; risk-free interest rates of 5.80% and 6.19%,
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 1997 and 1996 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.
9. PROFIT SHARING PLAN
The Company maintains 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 1997 or 1996.
10. RELATED PARTY TRANSACTIONS
Effective September 30, 1995, the Company sold the assets of Hobbs
Engineering Corporation (HEC), excluding any patents or other intellectual
property, to Dr. Gregg K. Hobbs, a principal shareholder of the Company.
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:
<TABLE>
<CAPTION>
ADDITIONAL 0.5% ROYALTY ADDITIONAL 1.0% ROYALTY
YEAR IF REVENUES EXCEED: IF REVENUES EXCEED:
<S> <C> <C>
1997 $ 9,000,000 $10,000,000
1998 11,000,000 12,000,000
1999 13,000,000 14,000,000
</TABLE>
During 1997 and 1996, royalties of $324,000 and $114,000, respectively,
were expensed relating to this agreement.
F-13
<PAGE>
QUALMARK CORPORATION
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
11. LEGAL MATTERS
On March 22, 1996, the Company was served with a summons and complaint from
Screening Systems, Inc. ("SSI"), a competitor. The complaint, as amended,
alleges that the Company's vibration system infringes three patents owned
by Hughes Electronics ("Hughes") and licensed to SSI, and seeks injunctive
relief, monetary damages and costs of litigation. Because Hughes would not
voluntarily join the action as plaintiff, SSI has named Hughes as a
defendant in the action.
The Company has been aware of the patents 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 the patents. The Company's vibration system has been used
continuously in its products since 1991. On two prior occasions, Hughes
put the Company on notice that the Company's vibration system might
infringe its patents, 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.
Discovery in the action has been completed; however, the trial date has
been vacated. In April 1997, the court conducted a "Markman hearing" to
determine the scope and meaning of the relevant claims and terms of the
patents-in-suit. In October 1997, the court issued its Order re
Construction of Patent Claims. Based on that Order, in November 1997, the
Company moved for summary judgment of non-infringement with respect to each
of the patents in issue. SSI has moved for summary judgment of
infringement with respect to one of the patents in issue and filed a
summary judgment motion on several of the Company's defenses. The court
has not yet ruled on any of these motions and has not yet set a trial date.
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
patents. 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, 1997, the Company has accrued an estimate of $850,000 provided
by its legal counsel as to the remaining costs related to cover the legal
fees associated with defending this suit.
F-14
<PAGE>
Exhibit 23.1
CONSENT OF INDEPENDENT ACCOUNTANTS
We hereby consent to the incorporation by reference in the Prospectus
constituting part of the Registration Statement on Form S-3 (No. 333-27273) of
QualMark Corporation and in the Registration Statement on Form S-8 (No.
333-29489) of QualMark Corporation of our report dated February 6, 1998
appearing on page F-1 of the 1997 Annual Report to Shareholders which is
incorporated in this Annual Report on Form 10-K.
Price Waterhouse LLP
Denver, Colorado
March 25, 1998
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
BALANCE SHEET AS OF DECEMBER 31, 1997 AND THE STATEMENT OF OPERATIONS FOR
THE TWELVE MONTHS ENDED DECEMBER 31, 1997
</LEGEND>
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-END> DEC-31-1997
<CASH> 459,000
<SECURITIES> 0
<RECEIVABLES> 3,121,000
<ALLOWANCES> 21,000
<INVENTORY> 608,000
<CURRENT-ASSETS> 4,219,000
<PP&E> 2,244,000
<DEPRECIATION> 816,000
<TOTAL-ASSETS> 5,698,000
<CURRENT-LIABILITIES> 2,798,000
<BONDS> 0
0
0
<COMMON> 6,270,000
<OTHER-SE> (3,370,000)
<TOTAL-LIABILITY-AND-EQUITY> 5,698,000
<SALES> 10,639,000
<TOTAL-REVENUES> 10,639,000
<CGS> 6,164,000
<TOTAL-COSTS> 6,164,000
<OTHER-EXPENSES> 5,390,000
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> (22,000)
<INCOME-PRETAX> (901,000)
<INCOME-TAX> 0
<INCOME-CONTINUING> (901,000)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (901,000)
<EPS-PRIMARY> (.27)
<EPS-DILUTED> (.27)
</TABLE>
