U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-KSB
Annual Report Pursuant to Section 13 or 15(d) of
the Securities Exchange Act of 1934
For the fiscal year ended December 31, 1996
Commission file number 1-12337
QC Optics, Inc.
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(Name of Small Business Issuer in Its Charter)
Delaware 04-2916548
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(State or Other Jurisdiction (I.R.S. Employer
of Incorporation or Organization) Identification No.)
154 Middlesex Turnpike, Burlington, Massachusetts 01803
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(Address of Principal Executive Offices) (Zip Code)
(617) 272-4949
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(Issuer's Telephone Number, Including Area Code)
Securities registered under Section 12(b) of the Act:
Name of Each Exchange
Title of Each Class on Which Registered
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Common Stock, $.01 par value per share American Stock Exchange
Redeemable Warrants American Stock Exchange
Securities registered under Section 12(g) of the Act: None
Indicate by check mark whether the issuer (1) filed all reports required to
be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 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
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Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-B is not contained herein, and will not be contained, to the
best of the 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. X
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The issuer's net sales for the fiscal year ended December 31, 1996 were
$13,577,104.
The aggregate market value of the voting stock held by non-affiliates based
upon the closing price for such stock on March 26, 1997 was approximately
$4,232,663. As of March 26, 1997, 3,242,500 shares of Common Stock, $.01 par
value per share, and 1,092,500 Redeemable Warrants, of the registrant were
issued and outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
The Definitive Proxy Statement for the Annual Meeting of Stockholders
for the fiscal year ended December 31, 1996, to be filed pursuant to
Regulation 14A, is incorporated by reference in Part III of this Form
10-KSB.
Transitional Small Business Disclosure Format (check one):
Yes No X
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PART I
ITEM 1. DESCRIPTION OF BUSINESS.
This report contains forward-looking statements regarding anticipated
increases in revenues, marketing of products and proposed products and other
matters. These statements, in addition to statements made in conjunction with
the words "anticipate," "expect," "intend," "believe," "seek," "estimate" and
similar expressions are forward- looking statements that involve a number of
risks and uncertainties. The following is a list of factors, among others, that
would cause actual results to differ materially from the forward-looking
statements: business conditions and growth in certain market segments and
general economy, an increase in competition, increased or continued market
acceptance of the Company's products and proposed products, and other risks and
uncertainties indicated from time to time in the Company's filings with the
Securities and Exchange Commission.
GENERAL
QC Optics, Inc. (the "Company" or "QCO") designs, manufactures and markets
laser based defect detection systems for the semiconductor, flat panel display
and computer hard disk drive markets. QCO uses its patented and other
proprietary technology in lasers and optical systems that scan a computer hard
disk, photomask or flat panel display for defects or contamination. The
Company's systems combine automatic handling, clean room capability and computer
control with reliable laser based technology. The Company believes that these
features enable the Company to maintain a leading market position in the United
States in the semiconductor, flat panel display and computer hard disk drive
industries where high quality inspection capabilities are required. The
Company's customers include many of the world's largest leading semiconductor
and computer hard disk manufacturers. Currently, QCO has over 200 systems
installed in fourteen countries.
QCO was formed in 1986 as a Delaware corporation to acquire the assets of a
division of GCA Corporation. The Company funded its product development
primarily with equity investments and debt financing from Kobe Steel Ltd. and
its subsidiaries including Kobe Steel USA Holdings, Inc., a Delaware
corporation, and Kobe Steel USA International, Inc., a Delaware corporation
(collectively, "Kobe Steel"). From 1986 to 1990, the Company focused its efforts
in developing inspection systems for computer hard disk inspection. Using the
Company's patented and proprietary information, the Company expanded its efforts
to use this technology for inspection of photomasks used to image integrated
circuit patterns onto semiconductor wafers. In early 1996, management of the
Company exercised an option granted in 1995 to acquire a 62.2% equity interest
through a management buyout with bank supplied debt financing personally
guaranteed by QCO's senior management.
The Company introduced its QCO-4000 automatic pelliclized (a protective
cover) photomask laser based inspection systems in March 1996, which has the
sensitivity to detect defects or contamination of 0.3 micrometers (the
equivalent of 0.06 micrometers on the semiconductor wafer),
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which will be required to detect defects in the next generation of
semiconductors. As semiconductor devices have become more complex, the
semiconductor manufacturing process has become very sensitive to photomask
errors, requiring more complex photomasks and, as a result, increasingly
sophisticated photomask inspection tools.
The Company's systems, such as its API-3000/5 and DISKAN-6000, are designed
to fit into its customers' production line virtually eliminating the need for
special handling or special production procedures while performing 100%
inspection throughout the process. In addition, these systems sort out fatal
defects on disks and pelliclized photomasks before they cause manufacturing
yield or other quality problems. As more manufacturers of computer hard disks
move toward total inspection protocols versus statistical sampling, demand
during the past year for the Company's products which can inspect computer hard
disks has increased significantly. The Company is also working on research and
development for porting, which is applying the Company's technology in its other
systems, to the inspection of flat panel displays.
QCO's principal offices and manufacturing facilities are based in
Burlington, Massachusetts. The Company also maintains regional sales or service
personnel in Texas, Florida, New Mexico, Oregon, Arizona and California. The
Company currently has approximately 60 employees and has manufacturer's
representatives in Europe and distributors in Asia.
MARKETS
The Company currently serves three markets with its inspection systems:
semiconductors, computer hard disks and flat panel displays. In addition, the
Company plans to continue to develop additional products, based on the Company's
existing patented and proprietary technologies, to further develop laser based
inspection systems.
The Company's core technology inspects by illuminating critical surfaces
and examining and analyzing light reflected from the surface. This analysis
allows the end user to analyze and determine the type of defect on the surface.
Lasers are used to provide the stable high intensity light source needed for
these inspection processes. Certain ultraviolet light lasers are used to detect
smaller defects. The angular distribution and the intensity of the reflected and
scattered light from the surface provides a "fingerprint" of the surface and
defects. This information passes through analog and digital signal processes and
is then analyzed using the Company's proprietary software.
SEMICONDUCTOR PHOTOMASK INSPECTION SYSTEMS
In the manufacture of semiconductors, photomasks are used to image
integrated circuit patterns onto silicon wafers. Semiconductor manufacturing
begins with the creation of a photomask,
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in which the circuit design is written onto the photomask, one layer at a time.
A wafer stepper uses the photomask like a photographic negative to rapidly make
numerous repetitive images of the circuit pattern on the wafer. The stepper
transfers light through the photomask onto photoresist that is spread over the
surface of the wafer. Those areas of the photoresist that have been exposed to
light are dissolved by chemical developers, and the exposed areas of the layer
under the resist are then etched. A different photomask is required for each
layer of the integrated circuit. Successive steps of deposition, lithography and
etch build the layers of patterns that make up a single integrated circuit.
In the 1990s, a number of advancements in photomask design have allowed
manufacturers to manufacture integrated circuits with increasingly smaller
linewidths. These linewidths are now as low as 0.5 micrometers and less. In the
late 1980s and early 1990s, the development of a number of technologies allowed
photomasks to be used much more efficiently. During this period, the demand for
photomask inspection equipment was less than the increased demand for
semiconductors as more advanced photomask technologies, such as
computer-automated design equipment and pellicles, were utilized. Pellicles are
a thin transparent membrane suspended over the photomask surface on a frame
mounted to the photomask. The pellicle increases semiconductor manufacturing
yields by preventing airborne particles from falling onto the surface of the
photomask and printing as defects on the wafer. Since their introduction in the
early 1980s, pellicles have significantly reduced the need to clean photomasks
during production, thus substantially extending the life of a photomask.
Accordingly, the introduction of pellicles significantly reduced the number of
photomasks required in high volume semiconductor device manufacturing.
Management believes that the increased complexity in semiconductor devices
has recently contributed to high demand for complex photomasks and for increased
sophistication in photomask inspection equipment. As semiconductors become more
and more complex, the potential for defects in photomasks has increased.
Similarly, demand for inspection of photomasks has increased to improve
manufacturing yields by identifying defects or contaminations in photomasks as
early as possible. Quickly attaining and then maintaining high yields is one of
the most important determinants of profitability in the semiconductor industry.
The Company believes that its customers typically experience rapid paybacks on
their investments in the Company's inspection systems. Semiconductor factories
are increasingly expensive to build and equip. Yield management and monitoring
systems, which typically represent a small percentage of the total investment
required to build and equip a fabrication facility, enable integrated circuit
manufacturers to leverage these expensive facilities and improve their returns
on investment. In addition to utilizing state-of-the-art inspection systems on a
statistical basis to improve manufacturing yields, semiconductor manufacturers
increasingly demand the ability to inspect photomasks during the manufacturing
process to provide real time inspection capability. In-process inspection is a
critical yield enhancement and cost reduction technique because it allows defect
detection in real-time rather than waiting until after final test results become
available to discover problems that have a significant negative impact on yield.
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The semiconductor industry has recently experienced a slow down in capital
spending. The overall semiconductor industry has been and could continue to be
cyclical with periods of oversupply. A downturn in the demand for semiconductors
would likely reduce the demand for photomasks as well as reduce the demand for
photomask inspection equipment or, alternatively, place pricing pressure on
photomask inspection equipment vendors. The Company's ability to reduce expenses
in response to any such downturn is limited by its needs for continued research
and development expenses and in customer service and support. Previous downturns
in capital investment by the semiconductor fabrication industry have materially
affected the operating results of other businesses in the semiconductor capital
equipment industry and future downturns may have similar adverse effects. In
order to address these concerns, the Company sells its inspection technologies
into other markets, such as computer hard disk inspection, and plans to expand
into other emerging markets, such as flat panel displays.
COMPUTER HARD DISK INSPECTION
Disk drive manufacturers use advanced deposition processes to produce thin
film disks. In order to assure cost-effective yields, disk drive manufacturers
are switching from low-volume sample inspection to production line inspection
techniques, rapidly increasing the demand for inspection of computer hard disks.
This demand is also driven by more memory requirements on the same size or
smaller disks. Any defect or contaminant on the disk increases the risk that
memory cannot be properly stored. Defect detection includes inspection of
substrates and in process computer hard disks. The Company believes that the
demand for production line inspection of computer hard disks could dramatically
increase the demand for its computer hard disk inspection products.
FLAT PANEL DISPLAYS
Over time, the use of flat panel displays ("FPDs") is expected to
significantly replace vacuum tube monitors used in televisions and computer
monitors, providing users with quality images on less bulky displays. This
market is in the very early stages of commercial development in the United
States and extensive funding by government and industry consortia, as well as
private efforts to advance this technology, are proceeding at a fast pace. FPDs
are currently being designed to include electronic substrates which undergo a
lithography process similar to semiconductors as well as glass substrates which
require inspection prior to the lithography process. Following the management
buyout, the Company now qualifies to join United States government-industry
consortia which have been formed to help speed the development and
commercialization of the flat panel display industry in the United States. The
Company has already collaborated with several companies, including one Fortune
100 company, to speed the development of technology solutions in this market.
The market for FPDs has grown significantly in recent years as a result of
the increasing popularity of portable computers and other electronic devices
which utilize screens and other types of displays to provide information in
digital format and graphical displays to the end user. The weight and narrow
form factor of FPDs are enabling new display applications where the previously
predominant monitor technology, cathode ray tubes ("CRTs"), did not allow such
use. Laptop and
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notebook computers, personal digital assistants, portable video games, digital
phones and a variety of devices for the automotive, technical, medical and
military markets are examples of electronic products in fast growing markets
which cannot be served by CRT technology. The FPD market is estimated by
Stanford Resources, Inc. ("Stanford Resources"), a market research firm located
in San Jose, California, to have grown from approximately $2 billion in 1990 to
approximately $10.7 billion in 1995, and is estimated to grow to approximately
$18 billion by the year 2001. The Company expects that FPD manufacturers will
increase their purchases of inspection equipment in response to both the growth
in the FPD market as well as the shift to larger and higher resolution displays.
Different applications for FPDs have varying cost, size and performance
requirements, and alternative FPD technologies have been developed to address
these different applications. Different types of FPDs that are currently being
produced to address certain segments in the broader FPD market include liquid
crystal ("LCD"), plasma, electroluminescent ("EL") and field emissive ("FED")
displays and digital micro-mirror devices ("DMDs"). Currently the most common
type of FPD is the LCD, which first emerged in the form of watch and calculator
displays in the 1970s. The most advanced form of LCD available today is the
AMLCD which utilizes three individual emissive transistors at each pixel,
enabling the AMLCD both to produce full color images and to operate at much
faster refresh rates than earlier passive monochrome LCDs. The color capability,
resolution, speed and picture quality of AMLCDs currently make these displays a
preferred choice for high performance portable computer, multimedia and other
applications requiring the display of video and graphics. Stanford Resources
estimates that AMLCDs represented more than 50% of the overall dollar volume of
the FPD market in 1995. The trend toward higher resolution video and graphic
displays has been reflected in a generational movement from VGA displays (640 x
480 lines of resolution) to higher resolution SVGA displays (800 x 600 lines of
resolution) which in turn are anticipated to be replaced by the next generation
XGA displays (1,280 x 1,024 lines of resolution). To achieve these higher
resolution display capabilities and enhanced picture quality, the number of
pixels utilized in AMLCDs is increased which in turn increases the complexity
associated with the manufacture of these displays.
STRATEGY
The Company's goal is to maintain a leadership position in the photomask
and computer hard disk inspection system markets and use its patented and
proprietary technology to pursue other opportunities in high performance
inspection systems. The Company intends to achieve this goal through the
implementation of the following strategies:
* Expand Marketing Efforts for Existing Products. Since its
introduction of photomask and computer hard disk inspection
systems, the Company's objective has been to expand its
leadership position in these fields. The Company is also
working to extend its sales and marketing activities outside
of the United States into Europe and Asia, where the Company
believes very sizable market demand exists for state-
of-the-art inspection systems in both photomasks and computer
hard disks. In particular, the Company believes that
significant demand exists in Korea, Singapore,
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Malaysia, and other areas in Asia. In addition, in the
computer hard disk market, the Company intends to market its
computer hard disk inspection systems for 100% production line
inspection versus statistical sampling inspection.
* Maintain Technology Leadership Position. Since its formation,
the Company's objective has been to maintain a leadership
position in inspection technology in the photomask and
computer hard disk inspection system markets. To maintain
technology leadership, the Company intends to continue to work
closely with major customers, several of which are the leading
suppliers of microprocessors and computer hard disks in their
respective industries. Now that a majority of the Company is
no longer owned by a foreign company, the Company is eligible
and intends to join government-industry consortia to develop
leading edge technologies for existing and other inspection
markets not yet served by the Company. In addition, the
Company believes that the recent management buyout, as well as
the funds received from its initial public offering, will
increase its attraction as a joint venture or strategic
alliance partner with other semiconductor and computer hard
disk manufacturers.
* Broaden Product Offerings through Acquisitions. Although no
acquisition is currently planned and there can be no assurance
that the Company will complete any acquisition; QCO plans to
expand its activities in related inspection markets, such as
the expected market for flat panel displays. In addition,
there are a number of smaller companies in the inspection
market that have technology and market links with the
Company's existing businesses, including material handling and
stocking equipment, cleaning equipment, and related products.
* Provide Broad Range of Photomask Inspection Solutions. The
Company's strategy is to provide a broad range of technical
solutions, leveraged off of existing technologies, with
different performance characteristics. Certain of the
Company's inspection systems currently address less complex
photomask designs while new products, such as the QCO-4000,
are designed to address the most sophisticated photomasks
currently used.
* Leverage Installed Base. In marketing new products to existing
customers, the Company intends to leverage its existing
customer base to upgrade the over 200 Company systems
currently in the field with new product offerings. Many of the
Company's products are built with modular systems which are
designed to facilitate future enhancements, as well as new
system software.
* Expand Customer Support Services. The Company currently
provides local support and service with personnel located in
California, Texas, New Mexico, Oregon, Florida and Arizona in
addition to its principal engineering services at its
Burlington, Massachusetts headquarters. The Company intends to
expand the number of customer support sites in both the United
States and overseas to help facilitate customer support as
well as support future sales opportunities.
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PRODUCTS AND SERVICES
QCO's current products consist of photomask, computer hard disk and flat
panel display inspection systems. The Company's systems are designed to provide
a lower cost of ownership through high performance, reliability and integration
into the manufacturing process. The Company utilizes a number of different forms
of lasers in its laser based inspection systems, allowing it to cover a broad
range of technical requirements and cost sensitivities for its customers.
Many of QCO's newer systems are designed to fit into its customer
production lines virtually eliminating the need for special handling or
production procedures while performing 100% inspection throughout the process.
QCO's systems sort out fatal defects on disks and pelliclized photomasks before
they become manufacturing yield or other quality problems. Many of QCO's systems
have the sensitivity to detect defects or contamination less than 0.5
micrometers. The Company also introduced its new QCO-4000 in March 1996. This
new system has the ability to detect defects or contamination of 0.3 micrometers
(the equivalent of 0.06 micrometers on the semiconductor wafer), which will be
required to detect defects in the next generation of semiconductors. Specific
Company products include the following:
QCO-4000: The QCO-4000 represents what the Company believes is a
state-of-the-art breakthrough for inspecting pelliclized photomasks. Defects on
complex, small featured photomasks are non-destructively detected and
characterized with a sensitivity down to .25 micrometers, using the latest
technologies in ultraviolet argon ion laser optics and innovative signal
processing. The QCO-4000 is capable of inspecting all four critical surfaces of
the photomask, which are the front and back pellicles and the front and back of
the photomask. The QCO-4000 also provides for inspection both on a sampling
basis as well as 100% inspection. This allows this system to be extremely
versatile for needs ranging from incoming inspection to complete process
characterization and documentation. Utilizing advanced systems control
technology, the operator has complete control over all system operations and
decisions. Computers incorporated in the product and several communication ports
allow the QCO-4000 to be easily integrated into the manufacturing process,
manufacturing resource planning ("MRP") and similar systems. The average selling
price for this system is approximately $900,000 to $1,300,000, although various
options can increase or reduce the cost of a specific system.
API-3000/5: This automatic pelliclized photomask inspection system has a
sensitivity of 0.5 micrometers and is compatible with many of the photomasks
most commonly used in today's semiconductor manufacturing processes. This
product is used by semiconductor manufacturers to qualify the photomask just
prior to its use on lithography equipment as well as for incoming inspection.
Photomask manufacturers utilize the system for final inspection as well as
process control. The average selling price for this system is approximately
$500,000 to $750,000, although various options can increase or reduce the cost
of a specific system.
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RSO (Reticle System One): The RSO is a cluster tool incorporating an
API-3000/5 inspection system, a cassette handling system (which holds cassettes
of photomasks) which loads photomasks into lithography equipment cassettes, and
an original equipment manufacturer ("OEM") photomask stocker with a storage
capacity of between 740 and 1500 photomasks. The RSO is utilized by
semiconductor manufacturers for photomask management and can eliminate manual
handling and the associated risks of damage and contamination of the photomask
once incoming inspection is accomplished. The average selling price for this
system is approximately $1,500,000, although various options can increase or
reduce the cost of a specific system.
API-1100: This equipment is a photomask blank inspection system with full
automatic handling capable of detecting pinholes and particulates as small as
0.3 micrometers. This product is utilized by photomask blank substrate
manufacturers for final inspection and transfers the finished product directly
into a shipping cassette from a process cassette. Quartz manufacturers also use
this equipment for final inspection. The average selling price for this system
is approximately $300,000 to $600,000, although various options can increase or
reduce the cost of a specific system.
DISKAN SERIES: These are computer hard disk inspection systems with
integrated automatic handling, manual handling and external handling systems.
DISKANs are used by magnetic media and other substrate manufacturers for both
100% inspection and sample inspection. In the United States, all of the major
media manufacturers use the DISKAN for sample inspection on their lines to
achieve process control. In 1996, the Company has experienced increasing demand
by manufacturers to incorporate DISKANs directly in the production line for 100%
inspection. The average selling price for this system is approximately $130,000
to $300,000, although various options can increase or reduce the cost of a
specific system.
API-1100FP: The API-1100FP is the Company's first product to address the
inspection demands for flat panel display substrates inspection systems,
including systems with automatic handling capability. This product is utilized
for process control by flat panel display manufacturers, as well as flat panel
display glass substrate manufacturers. The average selling price for this system
is approximately $300,000 to $600,000, although various options can increase or
reduce the cost of a specific system.
PRODUCTS UNDER DEVELOPMENT
The Company's product development strategy is to make continuous
improvements to its existing product line relying on its proprietary
technologies and to expand prior development efforts in applications related to
the markets it serves. The Company currently has an engineering and product
development staff of 16 individuals who assist the Company's customers in
integrating the Company's products into the customer's work environment. This
engineering work provides the Company an opportunity to keep abreast of new
market opportunities for the Company's technologies.
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Currently the Company is working on product enhancements to both its
QCO-4000 and DISKAN product lines. The Company is commencing early development
activities for the next generation of the photomask inspection market and
anticipates introducing a new product in 1998 which will provide even higher
sensitivities in measurements than currently provided with the QCO- 4000. The
Company is also working on a transfer system which will allow it to
automatically handle different photomask storage boxes. Currently many of the
photomasks are in different sizes and are kept in different sizes and types of
storage boxes. The new transfer system is designed to allow the systems to
automatically handle the boxes so that the photomasks will never be manually
handled. Management expects that this new system will significantly reduce the
risk of contamination or damage to the photomask. The Company believes that this
system will allow it to be the only Company that can handle all of the different
photomasks used in stepper systems. In addition, the Company continues its
efforts in the flat panel display market to modify its existing products for
research and development in the inspection of flat panel displays. The
technology used in flat panel displays will continue to evolve significantly in
the near term and as a result, the Company expects that it will be required to
continue to spend significant efforts in improving and developing new
technologies for the flat panel display markets.
The Company's success in developing and selling new and enhanced products
depends upon a variety of factors, including accurate prediction of future
customer requirements, introduction of new products on schedule, cost-effective
manufacturing and product performance in the field. The Company's new product
decisions and development commitments must anticipate the equipment needed to
satisfy the requirements for inspection processes one or more years in advance
of sales. Any failure to accurately predict customer requirements and to develop
new generations of products to meet those requirements would have a sustained
material adverse effect on the Company's business, financial condition and
results of operations. New product transitions could adversely affect sales of
existing systems, and product introductions could contribute to quarterly
fluctuations in operating results as orders for new products commence and orders
for existing products or enhancements of existing products fluctuate.
CUSTOMER SERVICE AND SUPPORT
In addition to selling and installing standard products and providing
support services, the Company also provides individualized engineering services
for customers as well as technical support worldwide. In addition to providing
technical support, the Company's service and support personnel advise customers
about product applications, provide customer training, coordinate upgrades,
manage spare parts and provide preventative maintenance.
The Company's warranty obligations for its systems generally cover a
12-month period beginning upon final customer acceptance. However, many
customers request service and support beyond the warranty period. The Company
has historically derived less than 10% of its revenues from annual service and
maintenance for its installed base of systems. Some of the Company's systems are
currently serviced under service contracts and other customers purchase repairs
on a labor and materials basis. Service revenues for the fiscal year ended
December 31, 1996 and the
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fiscal year ended December 31, 1995 were $1,210,508 and $614,590, respectively.
Historically, warranty expenses have been consistent with established
allowances.
CUSTOMERS
The Company's customers include semiconductor fabricators, photomask
fabricators and suppliers, computer hard disk manufacturers and customers
interested in developing flat panel displays. Repeat sales to existing customers
represent a significant portion of the Company's product revenues, and the
Company believes that its installed base of over 200 systems represents a
significant competitive advantage, particularly in the United States.
Historically, the Company has sold a significant proportion of its systems
to a limited number of customers as the markets that the Company participates in
are primarily dominated by a few major companies. Sales to the Company's ten
largest customers accounted for approximately 75% and 95% of net sales in Fiscal
1996 and Fiscal 1995, respectively. Sales to the largest customer accounted for
approximately 22% of total net sales for Fiscal 1996 and Fiscal 1995. The
failure to replace sales with sales to other customers in succeeding periods
would have a material adverse effect on the Company's business, financial
condition and results of operations. The Company expects that sales to
relatively few customers will continue to account for a high percentage of the
Company's revenues in any accounting period in the foreseeable future. A
reduction in orders from any such customer or the cancellation of any
significant order could have a material adverse effect on the Company's
business, financial condition and results of operations. None of the Company's
customers has entered into a long-term agreement requiring it to purchase the
Company's products.
In addition, due to the substantial purchase price for the Company's
products and systems, revenues and operating results may vary significantly from
quarter to quarter depending upon the timing of orders and shipments.
SALES AND MARKETING
QCO markets and distributes its products directly in the United States. The
Company maintains sales offices in Burlington, Massachusetts and Santa Clara,
California, and service or sales personnel in Arizona, Oregon, New Mexico,
Florida and Texas. The Company also sells through manufacturers representatives,
distributors and directly to certain customers internationally.
Due to the significant involvement required to purchase QCO's systems and
their highly technical nature, the sales process is often complex, requiring
interaction with several levels of the customer's organization and extensive
technical exchanges, product demonstrations and commercial negotiations. As a
result, the sales cycle can often be quite long. Purchase decisions are
typically made at a high level within the customer's organization and the sales
process often requires broad participation across the QCO organization, from the
President to the engineers who designed the product. Accordingly, the Company's
systems typically have a lengthy sales cycle during which the
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Company may expend substantial funds and management time and effort with no
assurance that a sale will result.
ENGINEERING AND PRODUCT DEVELOPMENT
The Company directs its engineering and design efforts at products for
which the Company believes there is growing market demand and strong margins. In
particular, the Company seeks to meet the requirements of its customers for
products aimed at emerging applications in the semiconductor, computer hard disk
and flat panel display inspection markets by applying the latest available
technology and the design and engineering know-how gained from the Company's
focus on this market. For many of its customers, the Company provides
engineering and design support to help integrate the Company's products into
production environments. By working closely with these customers, the Company is
exposed to new market opportunities for its products.
The Company employed 17 individuals in engineering and product development
as of December 31, 1996. During Fiscal 1996 and Fiscal 1995, the Company's
engineering expenses totaled approximately $1,405,000 and $1,587,000, or 10.3%
and 15.3% of sales, respectively. The Company expenses all software development
costs as incurred. During Fiscal Year 1995, engineering expenses increased due
to efforts in connection with development of the QCO-4000.
The Company's business strategy includes investing in or acquiring
companies which offer the Company access to complementary technologies, and new
markets within the Company's target industries. Historically, governmental
sources did not fund QCO's product development efforts as a majority of QCO was
foreign owned. After the management buyout, the Company joined SEMI- SEMATECH,
an organization of equipment manufacturers and suppliers serving SEMATECH, and
expects to seek funding for product development efforts from SEMATECH, a
consortium of semiconductor manufacturers, Advanced Research Projects Agency
("ARPA") and other governmental and quasi-governmental agencies, including the
U.S. Display Symposium. There can be no assurance that the Company will be
successful in obtaining such funding.
COMPETITION
The markets in which the Company competes are characterized by rapid
technological change, evolving industry standards, rapid product obsolescence
and intense competition. Competitors in the semiconductor photomask inspection
market include KLA Instruments, Hitachi and Nikon. In the computer hard disk
inspection market competitors include DPI Technology Systems, System Seiko,
Phase Metrics and Hitachi. Based on the number of installations, the Company
believes it is a leading supplier of semiconductor photomask soft defect
inspection systems and computer hard disk inspection systems in the United
States. The Company competes based on its installed base of customers,
engineering and service capabilities, breadth of products, patents and
proprietary information, and reputation. Many of the Company's competitors or
potential competitors have greater financial, marketing and technological
resources than the Company.
-12-
The Company expects competition to continue in the future from existing
competitors and from other companies that may enter the Company's existing or
future markets with similar or alternative solutions that may be less costly or
provide additional features. The Company believes that its ability to compete
successfully depends on a number of factors, which include product quality and
performance, order turnaround, the provision of competitive design capabilities,
success in developing new applications, adequate manufacturing capacity,
efficiency of production, timing of new product introductions by the Company,
its customers and its competitors, the number and nature of the Company's
competitors in a given market, price and general market and economic conditions.
In addition, increased competitive pressure may lead to intensified price
competition, resulting in lower prices and gross margins, which could materially
adversely affect the Company's business and results of operations. No assurance
can be given that the Company will compete successfully in the future.
The semiconductor, computer hard disk and flat panel display industries in
general, are characterized by rapid technological change and evolving industry
standards. As a result, the Company must continue to enhance its existing
products and to develop and manufacture new products and upgrades with improved
capabilities. This has required and will continue to require substantial
investments in research and development by the Company to advance a number of
state- of-the-art technologies. Continuous investments in research and
development will also be required to respond to the emergence of new
technologies. The failure to develop, manufacture and market new products, or to
enhance existing products, would have a material adverse effect on the Company's
business, financial condition and results of operations. In addition, the
Company's competitors can be expected to continue to develop and introduce new
and enhanced products, any of which could cause a decline in market acceptance
of the Company's products or a reduction in the Company's margins as a result of
intensified price competition.
Changes in manufacturing processes could also have a materially adverse
effect on the Company's business, financial condition and results of operations.
The Company anticipates continued changes in semiconductor and flat panel
display technologies and processes. There can be no assurance that the Company
will be able to develop, manufacture and sell products that respond adequately
to such changes.
BACKLOG
The Company's backlog for products and services was approximately $740,000
at December 31, 1996. QCO defines backlog to include only those systems,
accessories and upgrades with respect to which a purchase order has been
received and a delivery schedule has been specified for shipment over the next
twelve (12) months, and contracts for services to be provided for longer periods
up to 36 months. Cancellations of product purchase orders are subject to
penalties, depending upon the time of cancellation. Although a significant
indicator of business levels, backlog is not necessarily representative of
future sales.
-13-
MANUFACTURING
The Company's manufacturing activities consist of final assembly of
subassemblies, which are then integrated into finished systems and tested for
compliance with customer requirements. The Company believes that production lead
time, product quality and customer response are key elements to its success.
Although the Company manufactures some of the subassemblies used in its
systems, most are purchased from unaffiliated subcontractors, typically to the
Company's specifications. None of the Company's suppliers is obligated to
provide the Company with any specific quantity of components or subassemblies
over any specific period. Certain of the components and subassemblies included
in the Company's products are obtained from a limited group of suppliers. In
addition, because the Company believes that subsystem vendors have increased
their manufacturing expertise, the Company expects to continue to obtain
virtually all of its components and subassemblies from third parties in order to
devote its resources toward systems design, software development and systems
integration, its primary areas of competence. To date, the Company has generally
been able to obtain adequate and timely delivery of critical subassemblies and
components, although it has experienced occasional delays. Because the
manufacture of these components and subassemblies is very complex and requires
long lead times, and although alternative sources are available, such sources
may not be readily available. As a result, there can be no assurance that delays
or shortages caused by suppliers will not occur in the future. Any disruption of
the Company's supply of critical components and subassemblies could prevent the
Company from meeting its manufacturing schedules, which could damage
relationships with customers and would have a materially adverse effect on the
Company's business, financial condition and results of operations.
The Company's systems have a large number of components and are highly
complex. To date, the Company has experienced only limited delays in
manufacturing and delivering systems and upgrades and may experience similar or
more extended delays in the future. Any inability to manufacture and ship
systems or upgrades on schedule could adversely affect the Company's
relationships with its customers and thereby materially adversely affect the
Company's business, financial condition and results of operations. Due to recent
increases in demand, the average time between order and shipment of the
Company's systems has increased over the last fiscal year. The Company's ability
to increase its manufacturing capacity in response to an increase in demand is
limited given the complexity of the manufacturing process, the lengthy lead
times necessary to obtain critical components and the need for highly skilled
personnel. The failure of the Company to keep pace with customer demand would
lead to further extensions of delivery times, which could deter customers from
placing additional orders, and could adversely affect product quality. No
assurance can be given that the Company will be successful in increasing its
manufacturing capacity.
-14-
GOVERNMENTAL REGULATIONS AND INDUSTRY STANDARDS
The Company's products and worldwide operations are subject to numerous
governmental regulations designed to protect the health and safety of operators
of manufacturing equipment. In particular, the European Union ("EU") has
recently issued regulations relating to electromagnetic fields, electrical power
and human exposure to laser radiation. In addition, numerous domestic
semiconductor manufacturers including certain of the Company's customers, have
subscribed to voluntary health and safety standards and decline to purchase
equipment not meeting such standards. The Company believes that its products
currently comply with all applicable material governmental health and safety
regulations, including those of the EU, and with the voluntary industry
standards currently in effect.
PROTECTION OF PROPRIETARY INFORMATION
The Company holds eight United States patents and has an additional five
patent applications pending. Several of the issued patents are also issued in
Japan, Europe and Canada. The Company has many patent applications pending, a
number of which are associated with the new QCO-4000. Most of the issued patents
relate to advanced inspection measurement techniques. The issued United States
patents expire from 2001 to 2114.
The Company's products require technical know-how to engineer and
manufacture and are based, in part, upon proprietary technology. To the extent
proprietary technology is involved, the Company relies on patents and trade
secrets that it seeks to protect, in part, through confidentiality agreements.
No assurance can be given that such agreements will not be breached, that the
Company will have adequate remedies for any breach, or that the Company's trade
secrets will not otherwise become known to, or independently developed by,
existing or potential competitors of the Company. The Company may be involved
from time to time in litigation to determine the enforceability, scope and
validity of its rights. In addition, no assurance can be given that the
Company's products will not infringe any patents of others. Litigation could
result in substantial cost to the Company and diversion of effort by the
Company's management and technical personnel.
EMPLOYEES
As of December 31, 1996, the Company had 60 full-time employees, of which
17 were in sales, marketing and service, 16 were in engineering and product
development, 7 were in administration and 20 were in manufacturing.
None of the Company's employees are represented by a labor union. The
Company considers its relationships with its employees to be satisfactory. The
Company's financial performance will depend significantly upon the continued
contributions of its officers and key management, technical, sales and support
personnel, many of whom would be difficult to replace. In addition, the Company
believes that certain of its former employees currently provide services or
technical support to the
-15-
Company's customers or competitors. No assurance can be given that the Company
will be successful in attracting or retaining qualified personnel.
ITEM 2. FACILITIES
The Company maintains its principal executive offices, research and
development, and manufacturing operations in an approximately 30,000 square foot
facility in Burlington, Massachusetts leased from N.W. Building 24 Trust. The
Company currently pays base rent in the amount of approximately $16,250 per
month plus taxes, betterment assessments, insurance costs and utility charges
with respect to the facility, pursuant to a lease that expires on June 30, 1997.
Although no assurance can be given, the Company believes that adequate
facilities for its principal executive offices, research and development and
manufacturing operations are available at competitive rates for its needs upon
expiration of its current lease.
The Company also maintains a sales office in an approximately 1,000 square
foot facility in Santa Clara, California, leased from Koll/Intereal Bay Area.
The Company currently pays base rent of $1,385 per month plus certain expenses
related to the facility, pursuant to a lease that expires on July 21, 1999. The
Company believes that its facilities for its sales office are adequate for its
current needs.
Although no assurance can be given, the Company believes that adequate
facilities for expansion, if required, are available at competitive rates.
Although the Company has no present plans to acquire additional research and
development, manufacturing or shipping facilities, it may in the future seek to
establish additional research and development, manufacturing or shipping
facilities as a result of its anticipated growth or acquisitions.
ITEM 3. LEGAL PROCEEDINGS
The Company is not involved in any litigation of a material nature.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Company did not submit any matter during the fourth quarter of the
fiscal year covered by this report to a vote of the Company's security holders,
through the solicitation of proxies or otherwise.
-16-
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
The Company's Common Stock is traded on the American Stock Exchange
("AMEX") under the symbol "OPC." On March 26, 1997, the closing price of the
Company's Common Stock as reported on the AMEX was $3.875. The Company's
Redeemable Warrants are traded on AMEX under the symbol "OPC+." On March 26,
1997, the closing price of the Company's Redeemable Warrants as reported on the
AMEX was $.625.
As of March 25, 1997, there were approximately 9 holders of record of the
Company's Common Stock and approximately 6 holders of record of the Company's
Redeemable Warrants. Management believes that there are over 500 beneficial
owners of the Company's Common Stock and over 500 beneficial owners of the
Company's Redeemable Warrants.
For the periods indicated, the following table set forth the range of high
and low sale prices for the Company's Common Stock and Redeemable Warrants as
reported by AMEX.
<TABLE>
<CAPTION>
REDEEMABLE
COMMON STOCK WARRANTS
------------ --------
HIGH LOW HIGH LOW
---- --- ---- ---
1996
----
<S> <C> <C> <C> <C>
Fourth Quarter (from October 24, 1996)(1) $6.50 $4.75 $1.625 $.625
1997
----
First Quarter (through March 26, 1997) $5.875 $3.75 $1.50 $.625
- ------------------
(1) The Company's securities began trading on AMEX on October 24, 1996.
</TABLE>
The Company has not paid cash dividends on its Common Stock since its
inception and does not anticipate paying any cash dividends on its Common Stock
in the foreseeable future. The Company currently intends to reinvest earnings,
if any, in the development and expansion of its business. Any future
determination with respect to the payment of dividends will be subject to the
discretion of the Company's Board of Directors and will depend upon the
earnings, capital requirements, and financial position of the Company, general
economic conditions, and other pertinent factors. In addition, the Company's
agreement with its primary bank lender prohibits the payment of dividends
without the bank's prior written consent.
-17-
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS.
The following discussion and analysis should be read in conjunction with
the financial statements and notes thereto appearing elsewhere herein.
RESULTS OF OPERATIONS
Fiscal Year Ended December 31, 1996 ("Fiscal 1996") Compared to Fiscal Year
Ended December 31, 1995 ("Fiscal 1995")
Net sales for Fiscal 1996 were $13,577,104 compared to net sales of
$10,373,464 for Fiscal 1995, an increase of 30.9%. The increase resulted
primarily from increased demand for the Company's products for the inspection of
computer hard disks.
Cost of sales for Fiscal 1996 was $5,900,121 as compared to $4,798,902 for
Fiscal 1995. As a result of increased sales, gross profit for Fiscal 1996 was
$7,676,983 (56.5% of net sales) as contrasted to $5,574,562 (53.7% of net sales)
in Fiscal 1995, an increase of 37.7%. The improvement in gross profit as a
percentage of net sales was due primarily to the spreading of fixed overhead
costs over a larger revenue base.
Selling, general and administrative expenses increased to $3,824,002 for
Fiscal 1996 (28.2% of net sales) as compared to $2,843,266 in Fiscal 1995 (27.4%
of net sales). The increase was due to increased commissions as well as
increases in administrative staff and expenses.
Engineering expenses in Fiscal 1996 decreased to $1,404,850 (10.3% of net
sales) from $1,586,951 in Fiscal 1995 (15.3% of net sales). The decrease in
engineering expenses of $182,101 or 11.5% from Fiscal 1995 is attributable to
higher materials and consulting expenses during Fiscal 1995 for development of
QCO-4000. Engineering expenses as a percent of net sales were 10.3% in Fiscal
1996 as compared to 15.3% for Fiscal 1995 primarily due to the 30.9% increase in
net sales.
The Company recorded a management buyout charge of $1,701,000 in the first
quarter of Fiscal 1996 which represents a non-cash, non-recurring charge
associated with the acquisition of a 62.2% equity interest in the Company by
management. This charge (12.5% of net sales) is not deductible for income tax
purposes and as a result of this charge additional paid-in capital was increased
by a like amount. See footnote 9 to the financial statements.
Net interest expense was $107,786 (.8% of net sales) for Fiscal 1996
compared to $156,345 in Fiscal 1995 (1.5% of net sales). The decrease is due to
lower levels of borrowing during Fiscal 1996.
-18-
Income before provision for income taxes was $639,345 (4.7% of net sales)
for Fiscal 1996 as compared to $988,000 in Fiscal 1995 (9.5% of net sales).
Without the non-cash, non-recurring management buyout charge, in Fiscal 1996 the
income before provision for taxes would have been $2,340,345 (17.2% of net
sales).
Due to limitations on the utilization of the Company's net operating loss
("NOLs") carryforwards and the non-deductibility of the management buyout
charge, there was a provision for income taxes of $846,200 for Fiscal 1996. With
the utilization of NOLs in Fiscal 1995 the provision for income taxes was
$79,781. In connection with the management buyout and the issuances of shares in
the Company's initial public offering ("IPO"), the Company is restricted in the
NOLs it can use in future fiscal years in accordance with Section 382 of the
Internal Revenue Code of 1986, as amended. As a result of the management buyout,
the Company is limited to approximately $180,000 of loss utilization per year.
The improvement in net sales and gross profit offset by the non-recurring,
non-cash management buyout charge and the inability to fully utilize NOLs in
Fiscal 1996 resulted in the Company incurring a net loss for Fiscal 1996 of
$206,855 (1.5% of net sales) as compared to a net income in Fiscal 1995 of
$908,219 (or 8.8% of net sales). Excluding the non-cash, non-recurring
management buyout charge, the Company would have had net income
of $1,494,145 (11.0% of net sales) in Fiscal 1996.
LIQUIDITY AND CAPITAL RESOURCES
At December 31, 1996, the Company had cash and cash equivalents of
$5,022,772, an increase of $3,591,808 from $1,430,964 at December 31, 1995.
Working capital was $7,669,497 at December 31, 1996 as compared to $2,060,723 at
December 31, 1995, an increase of $5,608,774. Cash provided by operating
activities was $3,569,831 during Fiscal 1996 compared to $1,102,581 of cash used
in operating activities in Fiscal 1995. During Fiscal 1996 and Fiscal 1995, the
Company only made limited investments in property and equipment.
From time to time since inception, the Company has received loans from Kobe
Steel and its affiliates to meet certain obligations, capital expenditures and
general working capital requirements of the Company. On March 29, 1996, Kobe
Steel USA Holdings, Inc. made a capital infusion of $4,250,000 to repay a loan
of $4,250,000 previously made to the Company by Kobe Steel USA International,
Inc. In addition, the Company repurchased 62.2% of the Company's common stock
(99.5% of the Company was previously held by Kobe Steel USA Holdings, Inc.) for
$5,000,000. Payment for the shares was made with $3,250,000 from a revolving
line of credit from the Company's bank, $1,000,000 of cash from the Company's
cash accounts and a $750,000 loan from Kobe Steel USA Holdings, Inc. which was
paid in full in October 1996 using a portion of the proceeds of the Company's
initial public offering in October 1996 (the "IPO"). Subsequent to the
repurchase, but prior to the IPO, the Company utilized cash provided from
operations to reduce borrowings under the revolving line of credit from the
Company's bank by $3,011,612.
-19-
In connection with the stock repurchase from Kobe Steel USA Holdings, Inc.,
the Company entered into a revolving line of credit with State Street Bank and
Trust Company. The revolving line of credit agreement allows for maximum
borrowings of $4,000,000 and requires monthly payment of interest on the
outstanding balance to maturity on June 30, 1998. Borrowings under the revolving
line of credit agreement are limited to 80% of qualifying accounts receivable
and 10% (not to exceed $350,000) of qualifying inventory. Borrowings under the
agreement bear interest at the bank's prime rate (8.25% at December 31, 1996)
plus .5%. The terms of the loan agreement provide for the maintenance of certain
specified financial ratios including, but not limited to, quick ratio, debt to
equity and net worth ratios, and restrict certain transactions without the
bank's prior written consent. As of December 31, 1996, the Company was not in
default of any of the covenants and provisions of the credit agreement.
Borrowings under the agreement are secured by substantially all the assets of
the Company. At December 31, 1996, the Company had no borrowings outstanding
under the revolving credit agreement and availability of approximately
$2,025,000.
On October 24, 1996, the Company's Registration Statement on Form SB-2 was
declared effective by the Securities and Exchange Commission and the Company
completed its IPO of 950,000 shares of Common Stock at $6.00 per share and
950,000 Redeemable Warrants at $.10 per warrant. Further, on November 15, 1996,
the underwriters exercised their over-allotment option and purchased an
additional 142,500 shares of Common Stock at $6.00 per share and 142,500
Redeemable Warrants at $.10 per warrant. The Company received total net proceeds
of $5,074,311 after deducting underwriters' discounts, commissions and other
offering expenses.
Based on its current cash balances, current bank credit facilities and
anticipated results of operations, management believes that the Company has
sufficient funds to meet its working capital requirements for the next twelve
months. Thereafter, the Company anticipates that it could need additional
financing to meet its current plans for expansion. No assurance can be given of
the Company's ability to obtain financing on favorable terms, if at all. If the
Company is unable to obtain additional financing, its ability to meet its
current plan for expansion could be materially adversely affected.
INFLATION
To date, inflation has not had a material effect on the Company's business.
-20-
ITEM 7. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
The following financial statements are filed as part of this report:
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Report of Independent Public Accountants ............................................... F-2
Balance Sheets as of December 31, 1995 and December 31, 1996.............................. F-3
Statements of Operations for the years ended December 31, 1995 and
December 31, 1996...................................................................... F-4
Statements of Stockholders' Equity for the years ended
December 31, 1995 and December 31, 1996................................................ F-5
Statements of Cash Flows for the years ended December 31, 1995
and December 31, 1996.................................................................. F-6
Notes to Financial Statements............................................................. F-7
</TABLE>
ITEM 8. CHANGE IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
During the two most recent fiscal years of the Company, there have been no
changes in the Company's independent public accountants or disagreements between
the Company and its independent public accountants.
-21-
PART III
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS AND CONTROL PERSONS; COMPLIANCE
WITH SECTION 16(A) OF THE EXCHANGE ACT.
The Company intends to file a Definitive Proxy Statement within 120 days of
the completion of the Company's fiscal year ended December 31, 1996. The
information required by this item is incorporated by reference from the Proxy
Statement.
ITEM 10. EXECUTIVE COMPENSATION.
The information required by this Item is incorporated by reference from the
Proxy Statement.
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The information required by this Item is incorporated by reference from the
Proxy Statement.
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
The information required by this Item is incorporated by reference from the
Proxy Statement.
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K.
(A) EXHIBITS.
(1) The following exhibits are filed herewith:
Exhibit
No. Title
--- -----
11 Earnings Per Share Computations.
27 Financial Data Schedule.
(2) The following exhibits were filed as part of the Company's
Registration Statement on Form SB-2 (No. 333-07683), declared effective by the
Commission on October 24, 1996 and are incorporated herein by reference:
-22-
EXHIBIT
NO. TITLE
--- -----
3a Certificate of Incorporation, as amended.
3b Bylaws, as amended.
4a Sections of Bylaws and Certificate of Incorporation defining
the rights of securityholders (contained in Exhibits 3a and
3b).
4b Specimen Common Stock Certificate.
4c Form of Representative's Warrant Agreement (revised).
4d Form of Lock-Up Letters.
4e Specimen Warrant Certificate.
4f Form of Warrant Agreement between the Company and the Warrant
Agent.
9 QC Optics Voting Trust u/d/t dated as of October 27, 1995 by
and among Eric T. Chase, as trustee, and Eric T. Chase, Karl
Andrew Bernal, Jay L. Ormsby, John R. Freeman, Albert E. Tobey
and Abdu Boudour.
10a Lease Agreement between the Company and Norwest Building 24
Trust, as extended and amended.
10b Stock Repurchase and Loan Repayment Agreement among the
Company, Kobe Steel USA Holdings, Inc., and Eric T. Chase, as
trustee of the QC Optics Voting Trust, dated October 27, 1995.
10c Agreement and Plan of Merger by and among the Company, Sally,
Inc. and the Stockholders of Sally, Inc., dated October 30,
1995.
10d First Amendment to the Stock Repurchase and Loan Repayment
Agreement by and among the Company, Kobe Steel USA Holdings,
Inc., and Eric T. Chase, as a trustee and on behalf of the QC
Optics Voting Trust, dated March 29, 1996.
10h Promissory Note of QC Optics, Inc. to State Street Bank and
Trust Company, dated March 29, 1996.
-23-
EXHIBIT
NO. TITLE
--- -----
10i Security Agreement (All Assets) by and between the Company and
State Street Bank and Trust Company, dated March 29, 1996.
10j Credit Agreement by and between the Company and State Street
Bank and Trust Company, dated March 29, 1996.
10k Collateral Assignment of Trademarks and Patents by and between
the Company and State Street Bank and Trust Company, dated
March 29, 1996.
10p 1996 Stock Option Plan.
10q 1996 Director Formula Stock Option Plan.
10r Form of Employment Agreements effective as of July 1, 1996
entered into by and between the Company and Eric T. Chase, Jay
L. Ormsby, Albert E. Tobey, K. Andrew Bernal, Abdu Boudour and
John R. Freeman.
10s Distribution Agreement by and between ETEC Systems, Inc. and
the Company, dated December 19, 1994.
(B) REPORTS ON FORM 8-K.
No reports on Form 8-K have been filed by the Company during the last
quarter of the period covered by this report.
-24-
SIGNATURES
In accordance with Section 13 or 15(d) of the Securities Exchange Act of
1934, as amended, the registrant caused this report to be signed on its behalf
by the undersigned, thereunto duly authorized.
QC OPTICS, INC.
By:/s/ Eric T. Chase
-------------------------------------
Eric T. Chase
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.
<TABLE>
<CAPTION>
Name Capacity Date
---- -------- ----
<S> <C> <C>
/s/ Eric T. Chase President, Chief Executive Officer, March 27, 1997
- ---------------------------------- and Chairman of the Board of
Eric T. Chase Directors (Principal Executive
Officer)
/s/ John R. Freeman Vice President of Finance and March 27, 1997
- --------------------------------- Treasurer (Principal Financial
John R. Freeman and Principal Accounting Officer)
/s/ Charles H. Fine Director March 27, 1997
- --------------------------------
Charles H. Fine
/s/ John M. Tarrh Director March 27, 1997
- -------------------------------
John M. Tarrh
</TABLE>
-25-
QC OPTICS, INC.
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
<S> <C>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS F-2
BALANCE SHEETS AS OF DECEMBER 31, 1995 AND 1996 F-3
STATEMENTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 1995 AND 1996 F-4
STATEMENTS OF STOCKHOLDERS' EQUITY FOR THE YEARS ENDED DECEMBER 31,
1995 AND 1996 F-5
STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 1995 AND 1996 F-6
NOTES TO FINANCIAL STATEMENTS F-7
</TABLE>
F-1
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To QC Optics, Inc.:
We have audited the accompanying balance sheets of QC Optics, Inc. (a Delaware
corporation) as of December 31, 1995 and 1996, and the related statements of
operations, stockholders' equity and cash flows for the years ended December 31,
1995 and 1996. 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 in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit 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. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of QC Optics, Inc. as of December
31, 1995 and 1996, and the results of its operations and its cash flows for of
the years ended December 31, 1995 and 1996, in conformity with generally
accepted accounting principles.
ARTHUR ANDERSEN LLP
Boston, Massachusetts
February 12, 1997
F-2
QC OPTICS, INC.
BALANCE SHEETS--DECEMBER 31, 1995 AND 1996
ASSETS
<TABLE>
<CAPTION>
1995 1996
<S> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents $ 1,430,964 $ 5,022,772
Accounts receivable, less allowance of $75,000 and $100,000 at 3,236,706 1,884,694
December 31, 1995 and 1996, respectively
Inventory 2,893,122 3,383,060
Prepaid expenses 18,003 69,597
------------- ---------------
Total current assets 7,578,795 10,360,123
------------- ---------------
PROPERTY AND EQUIPMENT, AT COST:
Furniture and fixtures 99,686 148,391
Machinery and equipment 296,193 299,822
Leasehold improvements 57,085 57,085
Motor vehicles 23,458 23,458
------------- ---------------
476,422 528,756
Less--Accumulated depreciation 358,243 408,902
------------- ---------------
Property and equipment, net 118,179 119,854
------------- ---------------
DEFERRED TAX ASSETS - 208,000
------------- ---------------
OTHER ASSETS 24,936 24,943
------------- ---------------
Total assets $ 7,721,910 $ 10,712,920
=========== ===============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Loan payable to affiliate $ 4,250,000 $ -
Accounts payable 487,774 683,847
Accrued payroll and related expenses 332,829 427,897
Accrued commissions 95,150 538,061
Accrued income taxes 71,000 469,200
Accrued expenses 245,402 414,059
Customer deposits 35,917 157,562
------------- ---------------
Total current liabilities 5,518,072 2,690,626
------------- ---------------
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY:
Preferred stock, $.01 par value-
Authorized--1,000,000 shares
Issued and outstanding--no shares at December 31, 1995 and 1996 - -
Common stock, $.01 par value-
Authorized--10,000,000 shares
Issued and outstanding--2,150,000 shares at December 31, 1995 and 3,242,500 at
December 31, 1996 21,500 32,425
Additional paid-in capital 3,888,500 9,902,886
Accumulated deficit (1,706,162) (1,913,017)
------------- ---------------
Total stockholders' equity 2,203,838 8,022,294
------------- ---------------
Total liabilities and stockholders' equity $ 7,721,910 $ 10,712,920
=========== ===============
The accompanying notes are an integral part of these financial statements.
</TABLE>
F-3
QC OPTICS, INC.
STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 1995 AND 1996
<TABLE>
<CAPTION>
1995 1996
<S> <C> <C>
NET SALES $ 10,373,464 $ 13,577,104
COST OF SALES 4,798,902 5,900,121
--------------- ---------------
Gross profit 5,574,562 7,676,983
--------------- ---------------
OPERATING EXPENSES:
Selling, general and administrative expenses 2,843,266 3,824,002
Engineering expenses 1,586,951 1,404,850
Management buyout charge (Note 9) - 1,701,000
--------------- ---------------
Total operating expenses 4,430,217 6,929,852
--------------- ---------------
Operating income 1,144,345 747,131
INTEREST INCOME 112,982 56,170
INTEREST EXPENSE (269,327) (163,956)
--------------- ---------------
Income before provision for income taxes 988,000 639,345
PROVISION FOR INCOME TAXES 79,781 846,200
--------------- ---------------
Net income (loss) $ 908,219 $ (206,855)
=============== ===============
NET INCOME (LOSS) PER COMMON AND COMMON EQUIVALENT SHARES $ .42 $ (.09)
======== ========
WEIGHTED AVERAGE COMMON AND COMMON EQUIVALENT SHARES OUTSTANDING
2,173,174 2,346,325
=========== ===========
The accompanying notes are an integral part of these financial statements.
</TABLE>
F-4
QC OPTICS, INC.
STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 1995 AND 1996
<TABLE>
<CAPTION>
PREFERRED STOCK COMMON STOCK ADDITIONAL
NUMBER PAR NUMBER PAR PAID-IN
OF SHARES VALUE OF SHARES VALUE CAPITAL
<S> <C> <C> <C> <C> <C>
BALANCE, DECEMBER 31, 1994 - $ - 2,150,000 $ 21,500 $ 3,888,500
Net income - - - - -
---------- --------- ------------ ----------- --------------
BALANCE, DECEMBER 31, 1995 - - 2,150,000 21,500 3,888,500
Net loss - - - - -
Issuance of shares--management buyout
(Note 9) - - - - 1,701,000
Issuance of initial public offering shares
(Note 10) - - 1,092,500 10,925 5,063,386
Recapitalization (Note 9) - - - - (750,000)
---------- --------- ------------ ----------- --------------
BALANCE, DECEMBER 31, 1996 - $ - 3,242,500 $ 32,425 $ 9,902,886
========== ====== ============ ========== ==============
</TABLE>
<TABLE>
<CAPTION>
TOTAL
ACCUMULATED STOCKHOLDERS'
DEFICIT EQUITY
<S> <C> <C>
BALANCE, DECEMBER 31, 1994 $ (2,614,381) $ 1,295,619
Net income 908,219 908,219
--------------- --------------
BALANCE, DECEMBER 31, 1995 (1,706,162) 2,203,838
Net loss (206,855) (206,855)
Issuance of shares--management buyout
(Note 9) - 1,701,000
Issuance of initial public offering shares
(Note 10) - 5,074,311
Recapitalization (Note 9) - (750,000)
--------------- --------------
BALANCE, DECEMBER 31, 1996 $ (1,913,017) $ 8,022,294
============== =============
The accompanying notes are an integral part of these financial statements.
</TABLE>
F-5
QC OPTICS, INC.
STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 1995 AND 1996
<TABLE>
<CAPTION>
1995 1996
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $ 908,219 $ (206,855)
--------------- ---------------
Adjustments to reconcile net income (loss) to net cash provided by (used in)
operating activities-
Management buyout charge (Note 9) - 1,701,000
Depreciation and amortization 55,504 50,659
Loss on sale of property 3,226 -
Increase in deferred taxes, net - (208,000)
Changes in operating assets and liabilities-
Accounts receivable (1,334,675) 1,352,012
Inventory (608,677) (489,938)
Prepaid expenses and other assets (710) (51,601)
Accounts payable (89,864) 196,073
Accrued expenses 182,028 1,104,836
Customer deposits (217,632) 121,645
--------------- ---------------
Total adjustments (2,010,800) 3,776,686
--------------- ---------------
Net cash provided by (used in) operating activities (1,102,581) 3,569,831
--------------- ---------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment (43,691) (52,334)
Proceeds on sale of property and equipment 6,438 -
--------------- ---------------
Net cash used in investing activities (37,253) (52,334)
--------------- ---------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from initial public offering, net (Note 10) - 5,074,311
Borrowings from revolving line of credit - 4,886,611
Payments on revolving line of credit - (8,136,611)
Recapitalization and management buyout-
Capital contribution from Kobe Steel - 4,250,000
Payment on loan payable to affiliate - (4,250,000)
Borrowings from revolving line of credit - 3,250,000
Redemption of common stock from Kobe Steel - (5,000,000)
--------------- ---------------
Net cash provided by financing activities - 74,311
--------------- ---------------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (1,139,834) 3,591,808
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 2,570,798 1,430,964
--------------- ---------------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 1,430,964 $ 5,022,772
=============== ===============
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid for-
Interest $ 288,886 $ 170,822
=============== ===============
Income taxes $ 35,021 $ 656,000
=============== ===============
SUPPLEMENTAL SCHEDULE OF NONCASH FINANCING AND INVESTING ACTIVITIES:
Issuance of shares (Note 9) $ - $ 1,701,000
=============== ===============
The accompanying notes are an integral part of these financial statements.
</TABLE>
F-6
QC OPTICS, INC.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1996
(1) DESCRIPTION OF BUSINESS
QC Optics, Inc. (the Company) was formed in 1986 and manufactures
high-end critical surface inspection systems for sales to the
semiconductor, flat panel display and computer hard disk drive
industries.
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Revenue Recognition
Revenues from product sales are recognized at the time equipment is
shipped. Revenues from service and maintenance agreements are recognized
ratably over the period covered by the agreement. Service and maintenance
revenues were less than 10% of total net sales in each of the years ended
December 31, 1995 and 1996.
The Company derives most of its annual revenues from a relatively small
number of sales of products, systems and upgrades. As a result, any delay
in the recognition of revenue for a single product, system or upgrade
would have a material adverse effect on the Company's results of
operations for a given accounting period. In addition, some of the
Company's net sales have been realized near the end of a quarter.
Accordingly, a delay in a shipment scheduled to occur near the end of a
particular quarter could materially adversely affect the Company's
results of operations for that quarter.
The Company's operating results have historically been subject to
significant quarterly and annual fluctuations. The Company believes that
its operating results will continue to fluctuate on a quarterly and
annual basis due to a variety of factors, including the cyclicality of
the industries served by the Company's inspection products; patterns of
capital spending by customers; the timing of significant orders; order
cancellations and shipment reschedulings; unanticipated delays in design,
engineering or production, or in customer acceptance of product
shipments; changes in pricing by the Company or its competitors; the mix
of systems sold; and the availability of components and subassemblies,
among others.
Warranty Costs
The Company accrues warranty costs in the period the related revenue is
recognized. Warranty costs were not material for the years ending
December 31, 1995 and 1996.
Research and Development Costs
Research and development costs are expensed as incurred and are included
in engineering expenses in the accompanying statements of operations.
Research and development costs for the years ended December 31, 1995 and
1996 amounted to $925,938 and $577,327, respectively.
F-7
QC OPTICS, INC.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1996
(Continued)
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Cash and Cash Equivalents
Cash and cash equivalents include highly liquid investments with original
maturities of three months or less.
Inventory
Inventory is stated at the lower of cost (first-in, first-out) or market
and consist of the following:
DECEMBER 31,
1995 1996
Raw materials and finished parts $ 1,390,362 $ 1,149,376
Work-in-process 1,502,760 2,233,684
-------------- --------------
$ 2,893,122 $ 3,383,060
============== ==============
Work-in-process and finished parts inventories include material, labor
and manufacturing overhead.
Property and Equipment
Property and equipment are stated at cost. Maintenance and repair items
are charged to expense when incurred; renewals and betterments are
capitalized. When property and equipment are retired or sold, their costs
and related accumulated depreciation are removed from the accounts, and
any resulting gain or loss is included in income.
The Company provides for depreciation using the straight-line method to
amortize the cost of plant and equipment over their estimated useful
lives, which generally are as follows:
ESTIMATED
ASSET CLASSIFICATION USEFUL LIFE
Furniture and fixtures 3-8 Years
Machinery and equipment 3-8 Years
Leasehold improvements 8-10 Years
Motor vehicles 3-5 Years
F-8
QC OPTICS, INC.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1996
(Continued)
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Income Taxes
The Company utilizes the liability method of accounting for income taxes,
as set forth in Statement of Financial Accounting Standards (SFAS) No.
109, Accounting for Income Taxes. SFAS No. 109 requires the recognition
of deferred tax assets and liabilities for the temporary differences
between the tax and financial statement carrying amounts of assets and
liabilities. Deferred tax assets are recognized net of any valuation
allowance. The Company and Kobe Steel USA Holdings, Inc. (Kobe Steel),
99.5% owner of the Company prior to March 29, 1996 (see Note 9), had a
tax-allocation agreement. Prior to March 29, 1996, the Company's results
of operations were included in the consolidated federal return of Kobe
Steel. The agreement calls for the provision (benefit) and payments
(refunds) to be made as if the Company were to file its own separate
company tax returns.
Concentration of Credit Risk
Financial instruments that potentially expose the Company to a
concentration of credit risk include accounts receivable and cash and
cash equivalents.
The Company sells its products primarily to large corporate customers in
the semiconductor, flat panel displays and computer hard disk drive
industries and performs ongoing evaluations of its customers' financial
conditions. Concentration of credit risk with respect to sales and trade
receivables is primarily due to the following:
<TABLE>
<CAPTION>
NET SALES FOR THE ACCOUNTS RECEIVABLE AS OF
YEARS ENDED DECEMBER 31, DECEMBER 31,
1995 1996 1995 1996
<S> <C> <C> <C> <C>
Company A $ 3,295,000 $ 1,871,000 $ 1,945,000 $ 501,000
Company B 1,641,000 170,000 113,000 126,000
Company C 1,309,000 48,000 277,000 12,000
Company D 1,209,000 1,309,000 446,000 325,000
Company E 512,000 564,000 344,000 5,000
Company F - 1,596,000 - -
Company G - 358,000 - 250,000
Company H - 227,000 - 227,000
Company I - 441,000 - 288,000
</TABLE>
F-9
QC OPTICS, INC.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1996
(Continued)
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Concentration of Credit Risk (Continued)
The Company maintains cash balances and short-term investments in
commercial paper at financial institutions in Massachusetts. Accounts at
these institutions are insured by the Federal Deposit Insurance
Corporation up to $100,000. Uninsured cash and cash equivalent bank
balances amounted to approximately $1,501,000 and $4,976,000 at December
31, 1995 and 1996, respectively.
Export net sales, denominated in U.S. dollars, were as follows:
FOR THE YEARS ENDED
1995 1996
Asia/Pacific $ 1,819,717 $ 4,883,940
Europe 37,462 110,567
Other - 19,529
Fair Value of Financial Instruments
The Company's financial instruments consist primarily of cash and cash
equivalents, accounts receivable and accounts payable. The carrying
amounts of the Company's cash and cash equivalents, accounts receivable
and accounts payable approximate fair value due to their short-term
nature.
Impairment of Long-Lived Assets
Beginning on January 1, 1996, the Company was required to adopt SFAS No.
121, Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets To Be Disposed Of. SFAS No. 121 addresses accounting
and reporting requirements for long-term assets based on their fair
market values. Adoption of SFAS No. 121 did not have a material impact on
the Company's financial condition and results of operations.
Use of Estimates
The preparation of 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 periods. Actual results could differ from those
estimates.
F-10
QC OPTICS, INC.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1996
(Continued)
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Net Income (Loss) per Common Share
Net income (loss) per common share has been determined by dividing net
income (loss) by the weighted average of common and common equivalent
shares outstanding during the period. As required by the Securities and
Exchange Commission Staff Accounting Bulletin No. 83, all common and
common equivalent shares and other potentially dilutive instruments,
including stock options, issued during the twelve-month period prior to
the public offering date have been included in the calculation as if they
were outstanding for all periods prior to the date of the Company's
initial public offering.
In June 1996, the Company's Board of Directors approved an approximate
1.72-for-1 common stock split. Accordingly, all share and per share
amounts of common stock for all periods presented have been retroactively
adjusted to reflect the split. In addition, the stockholders increased
the authorized capital stock of the Company to 1,000,000 shares of $.01
par value preferred stock and 10,000,000 shares of $.01 par value common
stock.
(3) INCOME TAXES
The components of the income tax provision (benefit) are as follows:
FOR THE YEARS ENDED
DECEMBER 31,
1995 1996
Current-
Federal $ - $ 836,429
State 79,781 217,771
------------- ---------------
79,781 1,054,200
------------- ---------------
Deferred-
Federal - (208,000)
State - -
------------- ---------------
- (208,000)
------------- ---------------
$ 79,781 $ 846,200
=========== ==============
F-11
QC OPTICS, INC.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1996
(Continued)
(3) INCOME TAXES (Continued)
The Company's effective tax rate differs from the federal statutory rate
of 34% in 1995 and 1996 due to the following:
<TABLE>
<CAPTION>
1995 1996
<S> <C> <C>
Computed tax provision at statutory rate $ 335,920 $ 217,377
Increase (reductions) resulting from-
Management buyout charge - 578,340
State taxes 79,781 217,771
Items not deductible for income tax purposes 19,956 40,712
Change in valuation reserve (355,876) (208,000)
--------------- ---------------
$ 79,781 $ 846,200
============== ==============
</TABLE>
Under the Tax Reform Act of 1986, the amount of the benefit from net
operating losses may be impaired or limited in certain circumstances,
including a cumulative stock ownership change of more than 50% over a
three-year period, which occurred in connection with the management
buyout. As a result of the management buyout, the Company is limited to
approximately $180,000 of loss utilization per year.
Deferred income taxes at December 31, 1995 and 1996 consisted of the
following:
<TABLE>
<CAPTION>
1995 1996
<S> <C> <C>
DEFERRED TAX ASSETS:
Inventories $ 240,000 $ 460,000
Other reserves 154,000 196,000
Net operating loss carryforwards 870,000 811,000
-------------- --------------
Total gross deferred tax assets 1,264,000 1,467,000
Less--Valuation allowance 1,258,000 1,250,000
-------------------------------
Net deferred tax assets 6,000 217,000
-------------- --------------
DEFERRED TAX LIABILITIES:
Depreciation 6,000 9,000
-------------- --------------
Total deferred tax liabilities 6,000 9,000
-------------- --------------
Net deferred tax asset $ - $ 208,000
============== ==============
</TABLE>
F-12
QC OPTICS, INC.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1996
(Continued)
(3) INCOME TAXES (Continued)
Given the limitations on the utilization of the Company's net operating
losses as a result of the management buyout and uncertainty surrounding
the ability of the Company to generate future income in order to realize
deferred tax assets in the future, primarily due to such factors as
dependence on a few customers, rapid technological change and the
cyclical nature of the semiconductor, computer hard disk and flat panel
display industries, management has concluded that realizability of the
deferred tax assets as of December 31, 1996 is uncertain and has,
therefore, provided a valuation allowance against such deferred tax
assets.
For tax reporting purposes, the Company has a U.S. net operating loss
carryforward of approximately $2,028,000, subject to Internal Revenue
Service review and approval and certain IRS limitations on net operating
loss utilization. Utilization of the net operating loss carryforward is
contingent on the Company's ability to generate income in the future. The
net operating loss carryforwards will expire from 2000 to 2008 if not
utilized.
(4) COMMITMENTS AND CONTINGENCIES
The Company leases its operating facilities under two noncancelable
operating lease agreements, the largest of which expires in June 1997.
Rent expense for the years ended December 31, 1995 and 1996 amounted to
approximately $264,000 and $245,000, respectively. Future minimum
commitments under all noncancelable operating leases at December 31, 1996
are as follows:
1997 $ 114,000
1998 17,000
1999 1,000
---------------
$ 132,000
===============
(5) EMPLOYEE BENEFIT PLAN
The Company participated in the 401(k) retirement savings plan of an
affiliated company (the Plan) through July 1996. The Plan is a
defined-contribution plan that covers substantially all of the Company's
employees. Participants may make voluntary contributions of 1% to 15% of
their annual compensation. The Company makes matching contributions up to
a certain maximum percentage, and a future Company contribution can be
made at the Company's discretion. During July 1996, the Company ceased
participation in the Plan and began a new 401(k) retirement savings plan
sponsored by the Company with equivalent provisions to the former Plan.
F-13
QC OPTICS, INC.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1996
(Continued)
(5) EMPLOYEE BENEFIT PLAN (Continued)
The Company charged to expense approximately $92,000 and $113,000 related
to contributions to the Plan for the years ended December 31, 1995 and
1996, respectively. Included in accrued expenses is approximately $63,000
and $79,000 for Company matching and discretionary contributions to the
Plan for the years ended December 31, 1995 and 1996, respectively.
(6) RELATED PARTY TRANSACTIONS
In 1987, the Company entered into an agreement with Kobe Steel, Ltd.
(Kobe Japan), an affiliated Japanese company, which granted Kobe Japan an
exclusive license to distribute and manufacture the Company's products in
Japan and other Pacific Rim countries. During 1994, this agreement was
terminated by mutual consent.
The Company's sales to Kobe Japan amounted to approximately $611,000 or
6% of net sales for the year ended December 31, 1995.
Kobe Japan, through its various subsidiaries, has provided loans to the
Company by means of a revolving credit arrangement (the Affiliate Loan)
over the years. On March 29, 1996, the Company paid the outstanding
$4,250,000 of principal on the Affiliate Loan (see Note 9). Interest on
the loans during the year ended December 31, 1995 and 1996 amounted to
approximately $269,000 and $53,000, respectively.
(7) STOCK OPTION PLANS
In June 1996, the Board of Directors approved the 1996 Stock Option Plan
(the 1996 Plan) under which employees, including Directors who are
employees, may be granted options to purchase shares of the Company's
common stock at not less than fair market value on the date of grant, as
determined by the Board of Directors. The 1996 Plan also allows for
nonqualified stock options to be issued to employees and nonemployees at
prices that are less than fair market value. Options granted under the
1996 Plan are exercisable for up to a 10-year period from the date of
grant. The Company has reserved 360,000 shares of common stock for
issuance under the 1996 Plan. In June 1996, the Company granted options
under the 1996 Plan for the purchase of 124,492 shares at $5.10 per
share, the estimated fair market value on the date of grant, which become
exercisable over three years, beginning on June 20, 1997, one year from
the date of grant. Additionally, in June 1996, the Company granted
options to purchase 107,500 shares of common stock at $6.30 per share,
which became exercisable on October 24, 1996, the date the Company's
initial public offering became effective (see Note 10). To date, all
options have been issued with an exercise price at or above fair market
value.
F-14
QC OPTICS, INC.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1996
(Continued)
(7) STOCK OPTION PLANS (Continued)
In June 1996, the Board of Directors approved a Director Formula Stock
Option Plan (the Formula Plan) in which options will be granted beginning
on June 18, 1996, and every four years thereafter, immediately following
the Company's annual meeting of stockholders, options shall be granted to
eligible nonemployee directors. Each director will receive options to
purchase 15,000 shares of common stock, which vest and are exercisable in
16 equal installments over a period of four years beginning on the first
day of the fiscal quarter immediately following the grant. The options
may be exercised at the fair market value of the shares of common stock
on the date of grant. The Company has reserved 100,000 shares of common
stock for issuance under the Formula Plan. In June 1996, the Company
granted options under the Formula Plan for the purchase of 30,000 shares
at $5.10 per share, the estimated fair market value on the date of grant,
which become exercisable as previously discussed.
Pro Forma Stock-Based Compensation Expense
In October 1995, the Financial Accounting Standards Board issued SFAS No.
123, Accounting for Stock-Based Compensation, which sets forth a
fair-value-based method of recognizing stock-based compensation expense.
As permitted by SFAS No. 123, the Company has elected to continue to
apply APB No. 25 to account for its stock-based compensation plans. Had
compensation cost for awards granted in 1996 under the Company's
stock-based compensation plans been determined based on the fair value at
the grant dates consistent with the method set forth under SFAS No. 123,
the effect on the Company's net loss and net loss per common and common
equivalent shares would have been as follows:
1996
Net loss-
As reported $ (206,855)
Pro forma (258,795)
Net loss per common and common
equivalent shares-
As reported $ (.09)
Pro forma (.11)
Compensation expense for options granted is reflected over the vesting
period; therefore, future compensation expense may be greater as additional
options are granted.
F-15
QC OPTICS, INC.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1996
(Continued)
(7) STOCK OPTION PLANS (Continued)
Pro Forma Stock-Based Compensation Expense (Continued)
The fair value of each option grant was estimated on the grant date using
the Black-Scholes option pricing model with the following weighted-average
assumptions:
1996
Volatility 50%
Risk-free interest rate 7.03%
Expected life of options 5 Years
The Black-Scholes option pricing model was developed for use in
estimating the fair value of traded options, which have no vesting
restrictions and are fully transferable. In addition, option pricing
models require the input of highly subjective assumptions, including
expected stock price volatility. Because the Company's stock options have
characteristics significantly different from those of traded options and
because changes in the subjective input assumptions can materially affect
the fair value estimate, in management's opinion, the existing models do
not necessarily provide a reliable single measure of the fair value of
its employee stock options.
F-16
QC OPTICS, INC.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1996
(Continued)
(7) STOCK OPTION PLANS (Continued)
Stock Option Activity
A summary of the Company's stock option activity is as follows:
<TABLE>
<CAPTION>
1996 PLAN FORMULA PLAN
WEIGHTED WEIGHTED
NUMBER OF SHARES AVERAGE NUMBER OF AVERAGE
EXERCISE PRICE SHARES EXERCISE PRICE
<S> <C> <C> <C> <C>
Options outstanding, beginning of year - $ - - $ -
Granted 231,992 5.66 30,000 5.10
Exercised - - - -
Forfeited (8,928) 5.10 - -
------------ ------------ ----------- ------------
Options outstanding, end of year 223,064 $ 5.68 30,000 $ 5.10
============ ========= =========== =========
Options exercisable 107,500 $ 6.30 3,750 $ 5.10
============ ========= =========== =========
Options available for grant 136,936 70,000
============ ===========
Weighted-average fair value of options
(whose exercise price equals market
value) during the year $ 2.68 $ 2.68
========= =========
Weighted-average fair value of options
(whose exercise price exceeds market
value) during the year $ 3.24
=========
A summary of the status of the Company's stock options at December 31, 1996 is as follows:
</TABLE>
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING AND EXERCISABLE
EXERCISE REMAINING CONTRACTUAL
PRICE NUMBER LIFE
<S> <C> <C> <C>
1996 Plan $ 6.30 107,500 9.5 Years
Formula Plan $ 5.10 3,750 9.5 Years
</TABLE>
F-17
QC OPTICS, INC.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1996
(Continued)
(8) REVOLVING LINE OF CREDIT
On March 29, 1996, the Company entered into a revolving line-of-credit
agreement (the Revolving Line of Credit) with State Street Bank and Trust
Company, which matures on June 30, 1998 and bears interest per annum at
the bank's prime rate plus .5% (8.75% at December 31, 1996). The
Revolving Line of Credit has a fee on the daily unused portion of the
facility at the rate of 0.25% per annum. The aggregate amount outstanding
under the Revolving Line of Credit is limited to the sum of 80% of
qualifying receivables and 10% of qualifying inventory (not to exceed
$350,000). At December 31, 1996, the Company had no outstanding
borrowings under the Revolving Line of Credit. The Revolving Line of
Credit is secured by all assets of the Company. The Revolving Line of
Credit provides for the maintenance of certain specified financial
ratios, including, but not limited to, a quick ratio, minimum capital
funds, maximum debt/capital funds ratio and a minimum earnings test,
among other negative and affirmative covenants, and restricts certain
transactions without the bank's prior written consent. The Company is in
compliance with all debt covenants under the Revolving Line of Credit as
of December 31, 1996.
(9) MANAGEMENT BUYOUT
During October 1995, the Company, certain management employees (through
an unaffiliated corporation, Sally, Inc.) and Kobe Steel entered into a
series of related agreements designed to restructure the capital of the
Company and allow management to acquire up to 89.6% of the common stock
of the Company for $7,200,000 (collectively referred to as the Management
Buyout Agreement). The Management Buyout Agreement allowed management to
acquire 62.2% of the Company by March 31, 1996 for $5,000,000 (the
Original Repurchase) and an additional 27.4% of the Company for
$2,200,000 within two years from the date of closing of the Original
Repurchase or upon the closing of an underwritten public offering,
pursuant to a registration statement declared effective under the
Securities Act of 1933, as amended. The Original Repurchase under the
Management Buyout Agreement, as amended on March 29, 1996, was
accomplished on March 29, 1996 through the redemption of shares from Kobe
Steel for $5,000,000 (the Redemption Price) and the tax-free merger under
Section 368 (a)(1)(A) of the Internal Revenue Code of 1986, as amended,
of Sally, Inc. and the Company. Of the $5,000,000 Redemption Price,
$3,250,000 was financed pursuant to the terms of a $4,000,000 revolving
credit agreement (see Note 8), $1,000,000 was provided from available
cash of the Company and $750,000 was financed pursuant to a promissory
note bearing interest at the rate of 8% per annum from the Company to
Kobe Steel (the Kobe Term Note). The transaction has been accounted for
as a recapitalization and management buyout. The Company recorded a
$1,701,000 nonrecurring, noncash charge in the accompanying statement of
operations for the year ending December 31, 1996 associated with
management's acquisition of 62.2% of the Company, with a corresponding
increase in additional paid-in capital on the accompanying balance sheet.
This charge is not deductible for income tax purposes. The Kobe Term Note
was subsequently repaid in October 1996.
F-18
QC OPTICS, INC.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1996
(Continued)
(9) MANAGEMENT BUYOUT (Continued)
Simultaneous with the Original Repurchase and as required per the terms
of the Management Buyout Agreement, Kobe Steel made a capital
contribution in cash of $4,250,000 on March 29, 1996 to the Company. The
Company used the proceeds received to pay off the outstanding principal
due on the Affiliate Loan in the same amount. In addition, as required
per the terms of the Management Buyout Agreement, the Company filed a
restated certificate of incorporation providing for the recapitalization
of the Company such that all shares of Class A voting common stock and
Class B nonvoting common stock became one class of voting common stock.
On October 27, 1995, the Company and certain management employees of the
Company entered into a voting trust agreement known as the QC Optics
Voting Trust (the Voting Trust), of which the President of the Company is
trustee. The Voting Trust continues in force for a period of 21 years
from October 27, 1995, unless terminated earlier as a result of a merger,
dissolution, sale of all or substantially all of the Company's assets, or
liquidation.
(10) INITIAL PUBLIC OFFERING
On October 24, 1996, the Company's registration statement on Form SB-2
was declared effective by the Securities and Exchange Commission, and the
Company completed its initial public offering of 950,000 shares of common
stock at $6.00 per share and 950,000 redeemable warrants at $.10 per
warrant. Further, on November 15, 1996, the underwriters exercised their
over-allotment option granted under the terms of the underwriting
agreement and purchased an additional 142,500 shares of common stock at
$6.00 per share and 142,500 warrants at $.10 per warrant. The Company
received total net proceeds of $5,074,311 after deducting underwriters'
discounts, commissions and other offering costs.
F-19
EXHIBIT INDEX
Exhibit
No. Title
--- -----
11 Earnings Per Share Computations.
27 Financial Data Schedule.
EXHIBIT 11
EARNINGS PER SHARE COMPUTATIONS
YEARS ENDED DECEMBER 31,
1995 1996
---- ----
PRIMARY EARNINGS PER SHARE:
Net income (loss) $908,219 $(206,855)
======== =========
Weighted average common
shares outstanding 2,150,000 2,346,325
Weighted shares issued
from exercise and assumed
exercise of:
Warrants -- --
Options 23,174 --
========= =========
Weighted average common
and common equivalent shares
outstanding 2,173,174 2,346,325
========= =========
REPORTED EARNINGS PER SHARE
Net income (loss) per common
and common equivalent share $0.42 ($0.09)
========= =========
FULLY DILUTED EARNINGS PER SHARE:
Fully diluted EPS is not shown as there is no dilution from Pimary EPS.
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information extracted from the
Company's financial statements as of and for the peiod ending December 31, 1996
and is qualified in its entirety by reference to such financial statements.
</LEGEND>
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> DEC-31-1996
<CASH> 5022772
<SECURITIES> 0
<RECEIVABLES> 1984694
<ALLOWANCES> 100000
<INVENTORY> 3383060
<CURRENT-ASSETS> 10360123
<PP&E> 528756
<DEPRECIATION> 408902
<TOTAL-ASSETS> 10712920
<CURRENT-LIABILITIES> 2690626
<BONDS> 0
0
0
<COMMON> 32425
<OTHER-SE> 7989869
<TOTAL-LIABILITY-AND-EQUITY> 10712920
<SALES> 13577104
<TOTAL-REVENUES> 13577104
<CGS> 5900121
<TOTAL-COSTS> 5900121
<OTHER-EXPENSES> 6904852
<LOSS-PROVISION> 25000
<INTEREST-EXPENSE> 107785
<INCOME-PRETAX> 639345
<INCOME-TAX> 846200
<INCOME-CONTINUING> (206855)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (206855)
<EPS-PRIMARY> (.09)
<EPS-DILUTED> (.09)
</TABLE>
