<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 March 31, 1999
--------------------------------------------------
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE EXCHANGE ACT
For the Transition period from ______________________ to _______________________
Commission file number 0-28484
----------------------------------------------------------
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
- ---------------------------------------- -------------------
(Address of principal executive offices) (Zip Code)
(Issuer's telephone number) (303) 254-8800
-----------------------------------------------------
- --------------------------------------------------------------------------------
(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 ISSUERS INVOLVED IN BANKRUPTCY
PROCEEDINGS DURING THE PRECEDING FIVE YEARS
Check whether the registrant file all documents and reports required to
be filed by Section 12, 13 or 15(d) of the Exchange Act after the
distribution of securities under a plan confirmed by a court. [ ] 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 March 31, 1999 is
3,539,015.
- --------------------------------------------------------------------------------
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>
MARCH 31, 1999
(UNAUDITED) DEC. 31, 1998
-------------- -------------
<S> <C> <C>
ASSETS
Cash $ 575 $ 668
Trade accounts receivable, net of allowance for
doubtful accounts of $164 at March 31, 1999
and December 31, 1998 3,717 3,916
Inventories 1,690 1,363
Deferred income taxes 970 861
Other current assets 193 132
------- -------
Total current assets 7,145 6,940
Property and equipment, net 1,367 1,315
Note receivable from officer 103 104
Other assets 154 141
------- -------
Total assets $ 8,769 $ 8,500
------- -------
------- -------
LIABILITIES & SHAREHOLDERS' EQUITY
Accounts payable $ 753 $ 869
Accrued expenses 1,213 1,411
Customer deposits and deferred revenue 76 63
Current portion of long term obligations 905 441
------- -------
Total current liabilities 2,947 2,784
Noncurrent portion of long term obligations 1,111 975
Shareholders' Equity:
Common stock; no par value; 15,000,000
shares authorized; 3,539,015 and 3,485,015
shares issued and outstanding at March 31, 1999
and December 31, 1998, respectively 6,517 6,396
Accumulated deficit (1,806) (1,655)
------- -------
Total shareholders' equity 4,711 4,741
------- -------
Total liabilities and shareholders' equity $ 8,769 $ 8,500
------- -------
------- -------
</TABLE>
The accompanying notes are an integral part of the financial statements.
<PAGE>
QUALMARK CORPORATION
STATEMENT OF OPERATIONS
(UNAUDITED, AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
For the three For the three
months ended months ended
March 31, 1999 March 31, 1998
-------------- --------------
<S> <C> <C>
Net revenue $ 2,981 $ 3,151
Cost of revenue 1,803 1,796
------- -------
Gross profit 1,178 1,355
Selling, general and administrative expenses 1,235 1,142
Research and development expenses 170 188
------- -------
Income(loss) from operations (227) 25
Other income (expense):
Interest expense (37) (1)
Interest Income 8
Other income 12
------- -------
Income(loss) before taxes (256) 36
Income tax benefit (105)
------- -------
Net income (loss) ($ 151) $ 36
------- -------
------- -------
Basic and diluted income(loss) per share ($ 0.04) $ 0.01
Weighted average number of common shares - basic 3,510 3,395
Weighted average number of common shares - diluted 3,510 3,867
</TABLE>
The accompanying notes are an integral part of the financial statements.
<PAGE>
QUALMARK CORPORATION
STATEMENT OF CASH FLOWS
(UNAUDITED, AMOUNTS IN THOUSANDS)
<TABLE>
<CAPTION>
For the three For the three
months ended months ended
March 31, 1999 March 31, 1998
-------------- --------------
<S> <C> <C>
Cash Flows From Operating Activities:
Net income(loss) ($151) $ 36
Adjustments to reconcile net income(loss) to net cash from operating
activities:
Depreciation and amortization 133 119
Warrant and stock option expense 6 6
Change in deferred income taxes (109)
Change in assets and liabilities:
Accounts receivable 199 77
Inventories (327) 44
Other assets (63) (30)
Accounts payable and accrued expenses (313) (141)
Customer deposits and deferred revenue 13 35
------- -----
Net cash provided(used) by operating activities (612) 146
------- -----
Cash Flows From Investing Activities:
Acquisition of property and equipment (184) (216)
Investments in patents (11)
------- -----
Net cash used by investing activities (195) (216)
Cash Flow From Financing Activities:
Principal payments on long term obligations (1) (20)
Proceeds from borrowings 600
Sale of common stock 115 37
------- -----
Net cash provided by financing activities 714 17
------- -----
Net decrease in cash (93) (53)
Cash at beginning of period 668 459
------- -----
Cash at end of period $ 575 $ 406
------- -----
------- -----
SUPPLEMENTAL DISCLOSURE
Interest paid $ 26 $ 4
Taxes paid $ 4
</TABLE>
The accompanying notes are an integral part of the financial statements.
<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 customers' 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, 1998 and notes thereto.
The interim financial data as of March 31, 1999 and for the three months
ended March 31, 1999 and 1998 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 months are not necessarily indicative of results for the remainder
of 1999.
NOTE 2 - Inventories
Inventories consist of the following (in thousands):
<TABLE>
<CAPTION>
3/31/99
(unaudited) 12/31/98
----------- --------
<S> <C> <C>
Raw materials $ 585 $ 708
Work in process 484 198
Finished goods 621 457
------ ------
$1,690 $1,363
------ ------
------ ------
</TABLE>
1
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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 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 the quarter end March
31, 1999, a calculation of earnings per share assuming dilution is not
required. Options and warrants to purchase 815,983 shares were not included
in the computation of earnings per share assuming dilution at March 31, 1999
because including the options would result in an antidilutive effect on
earnings per share. Options and warrants to purchase 926,961 are included in
the computation of earnings per share at March 31, 1998, assuming dilution as
the options and warrants would have had a dilutive effect on earnings.
NOTE 4 - Litigation
On March 22, 1996, the Company was served with a summons and complaint
in the U.S. District Court in the Central District of California 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
2
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infringement did not exist and has seen nothing since to change that
conclusion.
The trial has been set to begin August 31, 1999. In response to that
action, the Company consulted with its current legal and patent counsel, who
agreed with prior patent counsels' opinion that the Company's vibration
system does not infringe the SSI patents. Both sides have filed motions with
the Court to limit issues for trial, or perhaps obviate the need for trial.
SSI filed a second action against QualMark in March 1998 asserting one
claim for a declaratory judgment and several additional claims in the nature
of false advertising and unfair competition. The case had been stayed until
March 1999 when the Court consolidated it with the patent infringement case
and set it for trial on August 31, 1999.
Management intends to vigorously defend both actions. 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 the loss of management time
needed to deal with the suit. At December 31, 1997, the Company accrued an
estimate provided by its legal counsel as to costs related to cover the legal
fees associated with defending the suit. No additional accrual was warranted
for 1998 and the quarter ended March 31, 1999.
The Company believes that the legal action by the plaintiff is without
merit and will continue to vigorously defend itself in these matters.
NOTE 5 - Segment Information
The Company operates two business segments, equipment and Accelerated
Reliability Test Centers ("ARTC"). The equipment segment ("Equipment") is
engaged in the manufacture and sale of vibration and thermal chambers for
quality control testing for various electronic devices. The ARTC segment
operates service centers where vibration and thermal chambers are available
to customers for daily rental.
3
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The accounting policies for these segments are the same as those described
in Note 1 of the Company's Form 10-K-SB for 1998 and there are no
intersegment transactions. The Company evaluates the performances of its
segments and allocates resources to them based primarily on gross profit. All
operating revenues and expenses are allocated to business segments in
determining their gross profit. All other expenses are not utilized in
determining the allocation of resources on a segment basis.
The table below summarizes information about the reported segments (in
thousands):
<TABLE>
<CAPTION>
EQUIPMENT ARTC TOTAL
<S> <C> <C> <C>
THREE MONTHS ENDED 3/31/99
Sales $2,158 $823 $2,981
Gross profit 887 291 1,178
Property and equipment, net 423 944 1,367
THREE MONTHS ENDED 3/31/98
Sales $2,193 $958 $3,151
Gross profit 933 422 1,355
Property and equipment, net 516 1,011 1,527
</TABLE>
The following is sales by geographic area (in thousands):
<TABLE>
<CAPTION>
THREE MONTHS ENDED THREE MONTHS ENDED
MARCH 31, 1999 MARCH 31, 1998
<S> <C> <C>
United States $2,373 $3,148
International 608 3
--------------------------------------
Total $2,981 $3,151
--------------------------------------
</TABLE>
4
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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, problems resulting from the
Year 2000 issue, 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.
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 decreased $170,000 or 5.4% for the three months ended March 31,
1999, as compared with the three months ended March 31, 1998, from $3,151,000
to $2,981,000.
System sales decreased from $2,193,000 to $2,158,000 or 1.6% as unit
shipments decreased from eighteen to fifteen systems. Test center revenue
decreased from $958,000 to $823,000, or 14.1%. The Company operated eight
test centers in the U.S. and had three strategic partnership test center
operations in Europe during the period versus eight test centers in the U.S.
and one strategic partnership operation in Europe during the same period in
1998.
5
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Gross Margin
The gross margin for the three months ended March 31, 1999 was 39.5%. This
compares to a gross margin of 43.0% for the three months ended March 31,
1998. The reduction in the gross margin for the three months ended March 31,
1999 is mostly due to decreased 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 decreased sales in the period ending March
31, 1999, test center margin decreased accordingly.
Operating Expense
General and administrative expenses increased from $510,000 to $550,000 for
the three months ended March 31, 1999 compared to the same three month period
in 1998. The increase reflects additional costs for general company
administration, including the costs for international expansion efforts and
test center administration.
Sales and marketing expenses increased $53,000 from $632,000 for the three
months ended March 31, 1998 to $685,000 for the three months ended March 31,
1999. This increase is primarily due to increases in department headcount and
associated expenses over the same three month period in 1998.
Research and development costs decreased from $188,000 for the three months
ended March 31, 1998 to $170,000 for the three months ended March 31, 1999.
The decrease is associated with the management of the department's project
expenses. The overall 1999 R&D budget of approximately $1,000,000 is not
expected to be affected for the rest of 1999 but will be monitored as revenue
levels return to the expected growth patterns. Total R&D expenditures for all
of 1998 were $684,000.
For the three months ended March 31, 1999, interest expense was $37,000.
Interest income from a note receivable to an officer was $8,000. This
compares with interest expense of $1,000 in the prior year's three month
period ending March 31, 1998. Interest expense increased in the three month
period ended March 31, 1999 over the three month period ended March 31, 1998
because of increased borrowing. At March 31, 1999 the Company had utilized
$2,000,000 of its $5,000,000 credit facility with its bank
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compared to a $170,000 credit utilization at March 31, 1998.
Liquidity and Capital Resources
During the first three months of 1999, the Company's operations used $612,000
of cash in operating activities, invested $184,000 for equipment, invested
$11,000 for patents and paid $1,000 in lease payments. The Company also
borrowed $600,000 under its credit line agreement with its bank. An early
investor exercised warrants for a total net increase in common stock of
$115,000. Together, these activities resulted in a cash decrease of
approximately $93,000 to a quarter ending cash balance of $575,000.
The Company expects to meet long term liquidity requirements through cash
flows generated by operations, existing cash balances and by utilizing its
$5,000,000 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.
YEAR 2000 ISSUE
During the year ended December 31, 1998, management initiated a program to
prepare the Company's financial, manufacturing, service and other critical
systems and applications for the Year 2000. The program involves the
Company's upper management as well as project leaders from each department.
The focus of the program is to identify affected software and hardware,
develop a plan to correct that software or hardware in the most effective
manner and implement and monitor that plan. The program will also include
communications with the Company's significant suppliers and customers to
determine the extent to which the Company is vulnerable to any of their Year
2000 issues. Although the Company's Year 2000 program is in various stages of
completion in each department, the Company anticipates it will have all
modifications and replacements in place by June 30, 1999.
OVS Systems
The Company's OVS products include embedded controllers that have been tested
and have been determined to be Year 2000 compliant. The Company expects that
there will be no Year 2000 issues in
7
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regards to its products.
The Company's proprietary OVS operating system software that controls all of
the products in the OVS product line has been upgraded this year as part of
an overall product improvement program. Part of that program ensured that the
software control system be made Year 2000 compliant. Management believes that
this has been achieved. There were no material added costs for this
compliance. Previous versions of the control system have been investigated
for compliance issues. The findings do not indicate compliance problems for
operating system version 5.0 and later. Upgrade packages for versions prior
to 5.0 are now available.
Internal Hardware and Software
Each department is currently reviewing all of the software and hardware that
could affect its operations. With the exception of the OVS operating system
software, all software products in use were purchased from Microsoft or other
major software publishing companies. Anticipated costs for Year 2000
compliance for these software package upgrades are considered to be part of
the Company's normal ongoing business plan and are not expected to add
materially to the plan. Management has included approximately $23,000 for
software upgrades in its 1999 plan.
A vast majority of the employees of the Company utilize personal computers in
their work. One of the risks identified is that these personal computers may
not function or function properly due to the internal embedded controllers
not being Year 2000 compliant. The same problem may exist in the Company's
local network server, wide-area network server equipment and the Company's
internal telephone system. Management believes the potential for problems
primarily involves older equipment. Most of the personal computers and
network server equipment have been purchased within the last two years and
are believed to be at lower risk than the smaller population of older
computer equipment in use around the Company. The internal telephone system
was purchased from and is supported by a leading manufacturer of that type of
equipment. Software to diagnose Year 2000 compliance for the personal
computers and network servers has been identified and procurement is
underway. The cost for this software is less than $1,000. It is unknown at
this time how much of this equipment is subject to the Year 2000 problem,
however a worst case scenario assumes the cost of
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replacing non-compliant equipment to be $105,000. The most likely scenario of
replacing affected computer and telephone equipment has not been determined
at this time. However, management has included approximately $60,000 in
computer and telephone system upgrades into its 1999 operating plan.
The Company expects to incur internal staff costs as well as consulting fees
and other expenses related to the Year 2000 project. The Company has already
purchased and installed new accounting and manufacturing control software
that is Year 2000 compliant. The cost to do this was less than $10,000. This
upgrade was done in response to the Year 2000 issue, however this and many
other upgrades are part of the Company's normal business plan.
External Factors
The Company uses outside service providers for all of its human resource
administration functions. This includes payroll and employee benefits
management. It has been confirmed that the service provider is Year 2000
compliant in regard to the services it provides the Company.
An area that has been identified as bringing potential problems in Year 2000
compliance involves key suppliers of inventory materials. The Company
utilizes three key vendors as suppliers in the manufacture of its OVS
systems. The Company cannot guarantee that the systems of these suppliers, or
other companies on which the Company relies, will be Year 2000 compliant.
Other than those three vendors, the Company's inventory suppliers are
commodity or off-the-shelf parts distributors that can be replaced with
little or no notice. It is believed that the three critical key-component
suppliers could be replaced in the event that one or all were determined to
be subject to critical shipment delays due to Year 2000 issues. Due to the
lead times associated with bringing new suppliers on-line, early
determination of vendor Year 2000 compliance is necessary. It is believed
that the Company's vendors are Year 2000 compliant. Management had set a
compliance deadline of March 31, 1999 for its key vendors and those
identified as key vendors have certified that they are Year 2000 compliant.
Every attempt will be made to ensure that a continuous supply of the key
components is maintained.
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PART II OTHER INFORMATION
Item 1 Legal Proceedings
See Note 4 to Financial Statements.
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 March 31, 1999 - 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: May 10, 1999 By: /s/ W. PRESTON WILSON
------------------------
W. Preston Wilson
President, Chief Executive Officer
Date: May 10, 1999 /s/ VERNON W. SETTLE
------------------------
Vernon W. Settle
VP, Finance & Administration
Principal Accounting Officer
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INDEX TO EXHIBITS
<TABLE>
<CAPTION>
Exhibit Description
Number -----------
- ------
<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.(3)
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)
10.12 Loan and Security Agreement dated December 22, 1998, by and between
QualMark Corporation and U.S. Bank National Association.(4)
10.13 Waiver and Amendment to Loan Agreement dated March 15, 1999 by and
between QualMark and U.S. Bank National Association.(4)
27.1 Financial Data Schedule
</TABLE>
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(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.
(3) Filed as an Exhibit to the Company's Proxy Statement for the 1996 Annual
Meeting of Shareholders.
(4) Filed as an exhibit to the Company's Annual Report of Form 10-KSB for the
year ended December 31, 1999.
11
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED BALANCE SHEET AS OF MARCH 31, 1999 AND THE CONSOLIDATED STATEMENT
OF OPERATIONS FOR THE THREE MONTHS ENDED MARCH 31, 1999 AND IS QUALIFIED IN ITS
ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-END> MAR-31-1999
<CASH> 575
<SECURITIES> 0
<RECEIVABLES> 3,881
<ALLOWANCES> 164
<INVENTORY> 1,690
<CURRENT-ASSETS> 7,145
<PP&E> 2,903
<DEPRECIATION> 1,536
<TOTAL-ASSETS> 8,769
<CURRENT-LIABILITIES> 2,947
<BONDS> 0
0
0
<COMMON> 6,517
<OTHER-SE> 0
<TOTAL-LIABILITY-AND-EQUITY> 8,769
<SALES> 2,981
<TOTAL-REVENUES> 2,981
<CGS> 1,803
<TOTAL-COSTS> 1,405
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 29
<INCOME-PRETAX> (256)
<INCOME-TAX> (105)
<INCOME-CONTINUING> (151)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (151)
<EPS-PRIMARY> (.04)
<EPS-DILUTED> (.04)
</TABLE>
