<PAGE>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-QSB
(Mark One)
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the quarterly period ended JUNE 30, 1998
-------------------------------------------------
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE EXCHANGE ACT
For the Transition period from to
------------------------------ ----------------
Commission file number 0-28484
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QUALMARK CORPORATION
- -------------------------------------------------------------------------------
(Exact name of small business issuer as
specified in its charter)
COLORADO 84-1232688
- --------------------------------------- -------------------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1329 WEST 121ST AVENUE, DENVER, CO 80234
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(Address of principal executive offices) (Zip Code)
(Issuer's telephone number) (303) 254-8800
----------------------------------------------------
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(Former name, former address and former fiscal year, if changed since last
report)
Check whether the issuer (1) filed all reports required to be filed by
Section 13 or 15(d) of the 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. [X] Yes [] No
APPLICABLE ONLY TO CORPORATE ISSUERS
State the number of shares outstanding of each of the issuer's classes of
common equity, as of latest practicable date:
THE NUMBER OF SHARES OF NO PAR VALUE COMMON STOCK AT JUNE 30, 1998 IS 3,484,328.
- --------------------------------------------------------------------------------
Transitional Small Business Disclosure Format (check one): [ ] Yes [X] No
<PAGE>
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
QUALMARK CORPORATION
BALANCE SHEET
(AMOUNTS IN THOUSANDS, EXCEPT SHARES)
<TABLE>
<CAPTION>
JUNE 30, 1998
(UNAUDITED) DEC. 31, 1997
---------------- ----------------
ASSETS
<S> <C> <C>
Cash $427 $459
Trade accounts receivable, net of
allowance for doubtful accounts of
$21 at June 30, 1998 and
December 31, 1997 3,951 3,100
Inventories 781 608
Other current assets 55 52
---------------- ----------------
Total current assets 5,214 4,219
Property and equipment, net 1,552 1,428
Long-term notes receviable 79 -
Other assets, net of accumulated
amortization of $278 and 271,
respectively 70 51
---------------- ----------------
Total assets $6,915 $5,698
---------------- ----------------
---------------- ----------------
LIABILITIES & SHAREHOLDERS' EQUITY
Accounts payable $1,129 $646
Customer deposits and deferred
revenue 84 59
Accrued expenses 1,463 1,893
Line of credit 775 -
Current portion of long term
obligations 72 73
---------------- ----------------
Total current liabilities 3,523 2,671
Noncurrent portion of long
term obligations 87 127
Shareholders' Equity:
Common stock; no par value; 15,000,000
shares authorized; 3,397,635 and
3,387,134 shares issued and outstanding
at June 30, 1998 and December 31, 1997,
respectively 6,383 6,270
Accumulated deficit (3,078) (3,370)
---------------- ----------------
Total shareholders' equity 3,305 2,900
---------------- ----------------
Total liabilities and shareholders'
equity $6,915 $5,698
---------------- ----------------
---------------- ----------------
</TABLE>
The accompanying notes are an integral part of the financial statements.
2
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QUALMARK CORPORATION
STATEMENT OF OPERATIONS
(UNAUDITED, AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
For the three For the three For the six For the six
months ended months ended months ended months ended
June 30, 1998 June 30, 1997 June 30, 1998 June 30, 1997
--------------- --------------- --------------- ---------------
<S> <C> <C> <C> <C>
Net revenue $3,429 $2,412 $6,580 $4,274
Cost of revenue 1,869 1,367 3,665 2,528
--------------- --------------- --------------- ---------------
Gross profit 1,560 1,045 2,915 1,746
Selling, general and
administrative expenses 1,079 1,183 2,221 1,894
Research and development
expenses 195 51 382 105
--------------- --------------- --------------- ---------------
Income(loss) from
operations 286 (189) 312 (253)
Other income (expense):
Interest (13) 2 (14) 27
Other - (6) 12 (6)
--------------- --------------- --------------- ---------------
Net income(loss) before
income taxes 273 (193) 310 (232)
Provision for income taxes 18 - 18 -
Net income (loss) $255 ($193) $292 ($232)
--------------- --------------- --------------- ---------------
--------------- --------------- --------------- ---------------
Basic earnings(loss)
per share $0.07 ($0.06) $0.09 ($0.07)
Diluted earnings(loss)
per share $0.07 ($0.06) $0.08 ($0.07)
Weighted average shares
outstanding 3,435 3,349 3,415 3,340
Weighted average number of
common shares plus common
stock equvialents 3,868 3,349 3,831 3,340
</TABLE>
The accompanying notes are an integral part of the financial statements.
3
<PAGE>
QUALMARK CORPORATION
STATEMENT OF CASH FLOWS
(UNAUDITED, AMOUNTS IN THOUSANDS)
<TABLE>
<CAPTION>
For the six For the six
months ended months ended
June 30, 1998 June 30, 1997
--------------- ---------------
<S> <C> <C>
Cash Flows From
Operating Activities:
Net income(loss) $292 ($232)
Adjustments to reconcile net
income(loss) to net cash
from operating activities:
Depreciation and amortization 279 197
Change in assets and liabilities:
Accounts receivable (851) (829)
Inventories (173) 40
Notes receivable (79) -
Other assets (29) 16
Accounts payable and accrued
expenses 53 (483)
Customer deposits and deferred
revenue 25 7
--------------- ---------------
Net cash used in operating
activities (483) (1,284)
--------------- ---------------
--------------- ---------------
Cash Flows From Investing Activities:
Acquisition of property and equipment (396) (519)
Purchase of short term investments - (238)
Proceeds on sale/redemption of short
term investments - 1,949
--------------- ---------------
Net cash provided(used) by
investing activities (396) 1,192
Cash Flow From Financing Activities:
Proceeds from borrowing 775 -
Proceeds from issuance of common stock 113 117
Payments on long term obligations (41) (19)
--------------- ---------------
Net cash from financing activities 847 98
--------------- ---------------
Net increase(decrease) in cash (32) 6
Cash at beginning of period 459 411
--------------- ---------------
Cash at end of period $427 $417
--------------- ---------------
--------------- ---------------
NONCASH FINANCING ACTIVITIES
SUPPLEMENTAL DISCLOSURE
Interest paid $15 $5
</TABLE>
The accompanying notes are an integral part of the financial statements.
4
<PAGE>
QUALMARK CORPORATION
NOTES TO FINANCIAL STATEMENTS
QualMark Corporation (the Company), was founded in 1991 and is a manufacturer of
physical stress systems. These systems rapidly and efficiently expose product
design and manufacturing related failures on its customer's products, thereby
providing manufacturers the necessary information to improve product quality.
The Company also operates a network of test centers that its customers may use
as an alternative, or in addition, to purchasing its systems.
NOTE 1 - Financial Presentation
These financial statements should be read in conjunction with the audited
financial statements for the year ended December 31, 1997 and notes thereto.
The interim financial data as of June 30, 1998 and for the three and six months
ended June 30, 1998 and 1997 is unaudited; however, in the opinion of management
of the Company, the interim data includes all adjustments, consisting only of
normal recurring adjustments, necessary for a fair presentation of the results
for the interim periods presented. Results for the three and six months ended
June 30, 1998 are not necessarily indicative of results for the remainder of
1998.
NOTE 2 - Inventories
Inventories consist of the following (in thousands):
<TABLE>
<CAPTION>
6/30/98
(UNAUDITED) 12/31/97
--------------------------
<S> <C> <C>
Raw materials $418 $457
Work in process 92 121
Finished goods 271 30
$781 $608
</TABLE>
NOTE 3 - Earnings(Loss) Per Share
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
5
<PAGE>
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, a calculation of
earnings per share assuming dilution is not required. Options and warrants to
purchase 421,496 shares were not included in the computation of earnings per
share for the three and six month periods assuming dilution at June 30, 1997
because including the options would result in an antidilutive effect on earnings
per share. Options and warrants to purchase 841,983 shares are included in the
computation of earnings per share for the three and six month periods ended June
30, 1998, assuming dilution as the options and warrants would have a dilutive
effect on earnings.
NOTE 4 - Litigation
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 Magistrate Judge 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 Magistrate Judge issued its Order re
Construction of Patent Claims. Based on that Order, the Court has granted
the Company summary judgment on one of the eight patent claims at issue and
has given the Company the opportunity to file additional summary judgment
motions with respect to the
6
<PAGE>
other seven claims. In addition, the Court denied SSI's motion for summary
judgment on one of the three patents and granted SSI summary judgment
dismissing two of the Company's affirmative defenses. The court 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 2.
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 in nature 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.
7
<PAGE>
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.
Revenue
Net revenue increased $1,017,000 or 42.2% for the three months ended June 30,
1998, as compared with the three months ended June 30, 1997, from $2,412,000 to
$3,429,000. Net revenue also increased in the six-month period ended June 30,
1998 as compared with the six months ended June 30, 1997, by $2,306,000 (54.0%),
from $4,274,000 to $6,580,000.
System sales increased $766,000 (44%) in the three-month period ended June 30,
1998, from $1,738,000 to $2,504,000 as compared to the three month period ended
June 30, 1997. For the six-month period ended June 30, 1998 system revenue
increased $1,602,000 (51.8%) over the same six-month period in 1997, from
$3,095,000 to $4,697,000. Unit shipments increased from thirteen to sixteen
systems in the comparable three-month periods ended June 30, 1998 and 1997 and
from twenty four to thirty four systems in the comparable six-month periods
ended June 30, 1997 and 1998.
Test center revenue for the three months ended June 30, 1998 increased
$251,000 (37.2%) from $674,000 to $925,000 over the three months ended June
30, 1997. For the six months ended June 30, 1998, test center revenue
increased $704,000 (59.7%) from $1,179,000 to $1,883,000 over the same period
in 1997. The Company operated eight test centers during the 1998 and 1997
periods. The Company also began recognizing revenue from a strategic alliance
test center operation in the U.K. during the three months ended June 30,
1998. The U.K test center is part of an alliance with TUV Product Service
GmbH, Munich, Germany and the relationship requires QualMark to provide one of
its OVS 2.5 systems, training and marketing assistance in exchange for a
share of all future gross revenues from the operation. The Company's direct
costs for this strategic alliance are being charged to test center cost of
sales. The current agreement expires December 31, 1998 but the Company
expects to renew the agreement before its expiration.
8
<PAGE>
Gross Margin
The gross margin for the three months ended June 30, 1998 was 45.5%. This
compares to a gross margin of 43.3% for the three months ended June 30, 1997.
For the six months ended June 30, 1998, the gross margin was 44.3% compared to a
gross margin of 40.9% in the same six-month period in 1997. The improvement in
the gross margin for the three and six month periods is mostly due to increased
capacity utilization in the test centers. The test center costs are relatively
fixed with only minimal variable cost impact as sales increase. Thus, with the
increased sales in the three and six month periods ending June 30, 1998, test
center margin improved substantially.
Operating Expense
General and administrative expenses decreased from $777,000 to $527,000 for
the three months ended June 30, 1998 compared to the same three-month period
in 1997. For the six months ended June 30, 1998, general and administrative
costs decreased from $1,159,000 to 1,037,000. The decrease in general and
administrative expense in the three and six month periods is due to lower
litigation expenses due in part to a reserve that was established in 1997.
The Company believes the reserve will be sufficient to meet litigation
expenses for the remainder of the case.
Sales and marketing expenses increased $146,000 from $406,000 for the three
months ended June 30, 1997 to $552,000 for the three months ended June 30, 1998.
For the six months ended June 30, 1998, sales and marketing expense increased
$449,000 over the same period in 1997, from $735,000 to $1,184,000. This
increase is primarily due to increases in department headcount and associated
expenses over the same three and six month periods in 1997.
Research and development costs increased from $51,000 for the three months ended
June 30, 1997 to $195,000 for the three months ended June 30, 1998. For the six
month period ended June 30, 1998, research and development cost increased
$277,000 from $105,000 for the six months ended June 30, 1997 to $382,000 in the
current period. The increase in cost reflects efforts to update and improve
reliability of current products and for the development of new technology. The
Company expects research and development costs to continue at or above such
levels throughout 1998.
For the three months ended June 30, 1998, interest expense was $13,000. For the
six months ended June 30, 1998, interest expense was $14,000. This compares with
interest income in the prior year's three-month period ending June 30, 1997 of
$2,000 and interest income of $27,000 for the six months ended June 30,
9
<PAGE>
1997, from cash and short-term investment balances. During 1997, the
Company'scash balance was reduced and its short-term investments were
liquidated.
Liquidity and Capital Resources
During the first six months of 1998 the Company's operations used $483,000 of
cash in operating activities, invested $396,000 for equipment, paid $41,000
on long term obligations. The Company also borrowed $775,000 against a
$1,300,000 credit line with its bank. Options and warrants were exercised
during the six-month period for a total net increase in common stock of
$113,000. Together, these activities resulted in a cash decrease of
approximately $32,000 to a quarter ending balance of $427,000.
The Company expects to meet long term liquidity requirements through cash flows
generated by operations, existing cash balances and by utilizing the remaining
balance of its credit line with its bank. 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.
PART II OTHER INFORMATION
Item 1 Legal Proceedings
See Note 4 to Financial Statements.
Item 4 Submission of Matters to a Vote of Security Holders
The following matters were submitted to a vote of shareholders of the
Company at the Annual Meeting of Shareholders held May 15, 1998:
The Following members were elected to the Board of Directors to hold office
until the next annual meeting.
<TABLE>
<CAPTION>
NOMINEE FOR WITHHELD
<S> <C> <C>
W. Preston Wilson 2,234,088 513,120
Charles A. French 2,234,088 513,120
H. Robert Gill 2,234,088 513,120
Philip A. Gordon 2,235,503 511,705
William Sanko 2,233,438 513,770
</TABLE>
(b) PricewaterhouseCoopers LLP, independent public
10
<PAGE>
accountants, were selected as the auditors of the Company for the fiscal year
ending December 31, 1998, by a vote of 2,739,558 in favor, 6,000 against and
1,650 abstentions.
Item 6 Exhibits and Reports on Form 8-K.
(a) Exhibits - See Index to Exhibits
(b) Reports on Form 8-K during the quarter ended June 30, 1998 -
none.
SIGNATURES
In accordance with the requirements of the Exchange Act, the registrant caused
this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
QualMark Corporation
Date: August 7, 1998 By: /S/ W. PRESTON WILSON
-------------- ----------------------
W. Preston Wilson
President, Chief Executive Officer
Date: August 7, 1998 /S/ VERNON W. SETTLE
-------------- --------------------
Vernon W. Settle
VP, Finance & Administration
Principal Accounting Officer
11
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INDEX TO EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT DESCRIPTION SEQUENTIAL
NUMBER PAGE NO.
<S> <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)
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)
27.1 Financial Data Schedule
</TABLE>
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Incorporated by reference from the Company's Registration Statement No.
333-1454-D on Form SB-2. (1) Incorporated by reference from the Company's
Quarterly Report on Form 10-QSB for the quarter ended September 30, 1997.
12
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED BALANCE SHEET AS OF JUNE 30, 1998 AND THE CONSOLIDATED STATEMENT OF
OPERATIONS FOR THE SIX MONTHS ENDED JUNE 30, 1998 AND IN ITS ENTIRETY BY
REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> JUN-30-1998
<CASH> 427
<SECURITIES> 0
<RECEIVABLES> 3,972
<ALLOWANCES> 21
<INVENTORY> 781
<CURRENT-ASSETS> 5,214
<PP&E> 2,640
<DEPRECIATION> 1,088
<TOTAL-ASSETS> 6,915
<CURRENT-LIABILITIES> 3,523
<BONDS> 0
0
0
<COMMON> 6,383
<OTHER-SE> 0
<TOTAL-LIABILITY-AND-EQUITY> 6,915
<SALES> 6,580
<TOTAL-REVENUES> 6,580
<CGS> 3,665
<TOTAL-COSTS> 2,603
<OTHER-EXPENSES> (12)
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 14
<INCOME-PRETAX> 310
<INCOME-TAX> 18
<INCOME-CONTINUING> 292
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 292
<EPS-PRIMARY> 0.09
<EPS-DILUTED> 0.08
</TABLE>
