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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, 1998
Commission file number 1-12337
QC OPTICS, INC.
(Name of Small Business Issuer in Its Charter)
DELAWARE
- --------------------------------- 04-2916548
(State or Other Jurisdiction -------------------
of Incorporation or Organization) (I.R.S. Employer
Identification No.)
46 Jonspin Road, Wilmington, Massachusetts 01887
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(Address of Principal Executive Offices) (Zip Code)
(978) 657-7007
(Issuer's Telephone Number, Including Area Code)
Securities registered under Section 12(b) of the Exchange Act:
Name of Exchange on
Title of each class Which Registered
------------------- -------------------
Common Stock, $.01 par value per share American Stock Exchange
Redeemable Warrants American Stock Exchange
Securities registered under Section 12(g) of the Exchange 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 Exchange Act during the past
12 months (or for such shorter period that the registrant was required to file
such reports), and (2) has been subject to such filing requirements for the past
90 days.
Yes X No
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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].
The issuer's net sales for the fiscal year ended December 31, 1998 were
$9,909,876.
The aggregate market value of the voting stock held by non-affiliates
based upon the closing price for such stock on March 1, 1999 was approximately
$1,515,159. As of March 1, 1999, 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
Portions of the Definitive Proxy Statement for the Annual Meeting of
Stockholders for the fiscal year ended December 31, 1998, to be filed pursuant
to Regulation 14A (the "Proxy Statement"), are 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, liquidity,
downturns in the semiconductor and computer hard disk industries, Year 2000
compliance issues, product performance, patents, patent applications,
competition, adequacy of the Company's facilities 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. Such statements are based on management's current expectations
and are subject to a number of factors and uncertainties that could cause actual
results to differ materially from those described in the forward-looking
statements. Such factors and uncertainties include, but are not limited to the
following: business conditions and growth in certain market segments and general
economy; the cyclical nature of the semiconductor and computer hard disk
industries; the uncertainties concerning the Asian markets, an increase in
competition; increased or continued market acceptance of the Company's products
and proposed products; the loss of the services of one or more of the Company's
key employees, which could have a material adverse effect on the Company; the
uncertainty that existing patents will be valid, if challenged, and that any
additional patents will be issued or that the scope of any patent protection
will exclude competitors; the Company's ability to effectively address Year 2000
issues; dependence on few customers; the availability of additional capital to
fund expansion on acceptable terms, if at all; and other risks and uncertainties
indicated from time to time in the Company's filings with the Securities and
Exchange Commission. See also "Factors That May Affect Future Results."
GENERAL
QC Optics, Inc. (the "Company" or "QCO") designs, manufactures and
markets laser based defect detection systems for the semiconductor, computer
hard disk and flat panel display 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, computer hard disk and flat panel display
inspection 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 300
systems installed in 16 countries.
In the fourth quarter of 1997, the Company shipped the DISKAN-9000(TM),
which is targeted to provide computer hard disk manufacturers with the
capability to inspect 100% of their production volume. Compared to the Company's
previous equipment, the DISKAN-9000(TM) provides more than 70% higher throughput
and a 30% reduction in footprint. Over 50 of these systems were sold during its
first year on the market.
In the first quarter of 1998, the Company released the DISKAN-FA-2(TM),
a failure analysis tool that complements the DISKAN-9000(TM). The
DISKAN-FA-2(TM) offers full failure analysis capabilities, including automatic
microscope review of defects, which allows customers to identify and correct
process problems.
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The Company's systems, such as its QCO-4000(TM) and DISKAN-9000(TM),
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 that can inspect computer
hard disks has increased. The Company is also working on research and
development for a new photomask inspection system, which it expects to release
as a product during 1999.
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. Applying 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. In October 1996, the Company completed
its initial public offering through the sale of Common Stock and Redeemable
Warrants and received net proceeds of approximately $5,000,000.
QCO's principal offices and manufacturing facilities are based in
Wilmington, Massachusetts. The Company also maintains regional sales or service
personnel in Florida, New Mexico and California. The Company currently has
approximately 46 employees and has a manufacturer's representative in Europe and
manufacturer's representatives 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 then 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 provide 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, 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
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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 1990's, 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 0.18 micrometers and
less. In the late 1980's and early 1990's, 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 will contribute 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.
The overall semiconductor industry has been and could continue to be
cyclical with periods of oversupply. The current downturn in the demand for
semiconductors has reduced the demand for photomasks as well as reduced the
demand for photomask inspection and has placed 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 the Company and other businesses in the
semiconductor capital equipment industry and future downturns may have similar
adverse effects.
COMPUTER HARD DISK INSPECTION
Computer hard disk manufacturers use advanced deposition processes to
produce thin film disks. Typically, an aluminum substrate is nickel plated and
then precision polished to provide the extremely smooth and flat surface
required for the recording head to "fly" over the disk in the disk drive. Other
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substrates, such as glass, are gaining market share, and the DISKAN(TM) product
series is generally compatible with these alternative substrate materials. The
substrate is then commonly textured (portions of the disk are modified to
slightly roughen the surface, to prevent the recording head from sticking to the
surface of the disk). Thin films of magnetic material and a protective overcoat
are then deposited onto the surface of the disk. Prior to shipment the disks are
checked for quality, most commonly by visual and electronic tests. QC Optics'
computer hard disk inspection systems have been utilized for over 14 years for
inspecting disks throughout the manufacturing process to identify conditions
outside set control ranges by inspecting a small sample of the total production
volume. Any defect or contaminant on the disk increases the risk that
information cannot be properly stored. As storage densities have increased, the
size of defects that affect data storage has decreased, and computer hard disk
manufacturers have begun to find it cost effective to move from inspecting a
sample of their production volume to inspecting close to 100% of their products.
This transition to 100% inspection increases the potential market for computer
hard disk inspection equipment and resulted in the increase in the Company's
DISKAN-9000 product sales in 1997 and 1998.
The overall computer hard disk drive industry has been and could
continue to be cyclical with periods of oversupply. The current downturn in the
demand for computer hard disk drives has reduced the demand for computer hard
disks as well as reduced the demand for computer hard disk inspection and has
placed pricing pressure on computer hard disk 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 computer
hard disk industry have materially affected the operating results of the Company
and other businesses in the computer hard disk industry and future downturns may
have similar adverse effects.
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. The
manufacture of these devices is still in the very early stages of commercial
development in the United States and manufacturing capacity expansion has slowed
during 1998 primarily due to the rapid decrease in the price of finished FPDs.
FPDs are currently being designed to include electronic substrates that undergo
a lithography process similar to semiconductors as well as glass substrates
which require inspection prior to the lithography process.
The market for FPDs has grown significantly in recent years as a result
of the increasing popularity of portable computers and other electronic devices
that 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 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 Company expects that FPD
manufacturers will eventually 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.
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
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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 has extended
its sales, service and marketing activities outside of the
United States into Europe and Asia, where the Company believes
long term market demand exists for state-of-the-art inspection
systems in both photomasks and computer hard disks. In
addition, in the computer hard disk market, the Company
intends to continue 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 leading
suppliers of semiconductors and computer hard disks in their
respective industries.
* BROADEN PRODUCT OFFERINGS THROUGH ACQUISITIONS. Although no
acquisition is currently planned and no assurance can be given
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(TM), are designed to address the most sophisticated
photomasks currently used. The Company is currently working on
research and development for a new photomask inspection
system, which it expects to release as a new product during
1999.
* PROVIDE BROAD RANGE OF COMPUTER HARD DISK INSPECTION
SOLUTIONS. The Company's strategy is to expand and improve its
product offerings by strengthening its current technologies to
provide 100% inspection tools such as the DISKAN-9000(TM) as
well as failure analysis tools, such as the DISKAN-FA-1(TM)
introduced in the third quarter of 1997, and the
DISKAN-FA-2(TM) introduced in the first quarter of 1998.
* LEVERAGE INSTALLED BASE. In marketing new products to existing
customers, the Company intends to leverage its existing
customer base to upgrade the over 300 Company systems
currently in the field with new product offerings. Many of the
Company's products are built with modular systems that 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, New Mexico and Florida in addition to its
principal engineering services at its Wilmington,
Massachusetts headquarters. The Company also has factory
trained service representatives in the UK, France, Japan,
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Korea, Taiwan, Malaysia and Thailand. 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.
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 low 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. All of QCO's systems
have the sensitivity to detect defects or contamination down to less than 0.5
micrometers. In the fourth quarter of 1997, the Company introduced the
DISKAN-9000(TM), which provides computer hard disk manufacturers with the
capability to inspect 100% of their production volume. Compared to the Company's
previous equipment, the DISKAN-9000(TM) provides more than 70% higher throughput
and a 30% reduction in footprint. Over 50 of these systems were sold during its
first year on the market. The Company is also working on research and
development for a new photomask inspection system, which it expects to release
as a product during 1999.
Specific Company products include the following:
QCO-4000(TM): The QCO-4000(TM) 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(TM) 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(TM) 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(TM) 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 price of a specific system.
API-3000/5(TM): 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 price of a specific system.
API-1100(TM): 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
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utilized by photomask blank substrate manufacturers for final inspection and
transfers the finished product directly into a shipping cassette from a process
cassette. Quartz and glass manufacturers also use this equipment for final
inspection. The average selling price for this system is approximately $400,000
to $600,000, although various options can increase or reduce the price of a
specific system.
DISKAN(TM) SERIES: These are computer hard disk inspection systems that
are equipped with integrated automatic handling or external handling systems.
The Company's newest product, the DISKAN-9000(TM) which was introduced in 1997,
is configured to provide the customer with the ability to inspect 100% of their
production and has 70% higher throughput with a 30% smaller footprint than the
Company's previous systems. Over 50 of these systems were sold during its first
year on the market. During 1998, the Company experienced increasing demand from
customers to provide a system for 100% inspection. In addition, the Company
offers the DISKAN-FA-1(TM), which incorporates multiple cassette-to-cassette
automatic handling, and is used to inspect a sample of the customer's total
production for process control. The DISKAN-FA-2(TM), where disks are loaded from
a single cassette into the system, is used for failure analysis, process
development and process control. The average selling price for these systems is
approximately $100,000 to $450,000, although various options can increase or
reduce the price of a specific system.
API-1100FP(TM): The API-1100FP(TM) is a Company product that addresses
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 price 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 14 individuals who assist the Company's customers in
integrating the Company's products into the customer's work environment. This
work provides the Company an opportunity to keep abreast of new market
opportunities for the Company's technologies.
Currently the Company is working on product enhancements to both its
QCO photomask and DISKAN(TM) product lines. During 1998, the Company introduced
the new disk failure analysis tool, the DISKAN-FA-2(TM), with capabilities to
inspect computer hard disks that target new inspection points in the
manufacturing process. If the new inspection points prove to be economically
justified for 100% inspection, it would further increase the market potential
for the DISKAN(TM) product series. This system provides even higher
sensitivities in measurements and higher throughput. Management expects that
these new systems will significantly improve the cost effectiveness of the
equipment for 100% inspection of the customers' production. 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 and as a result, the Company expects that it will be required to
continue to expend 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
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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 provides individualized engineering services for
customers as well as technical support worldwide. The Company's service and
support personnel also 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. However, many customers request service and support beyond the
warranty period. Generally, 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, 1998 and the fiscal year
ended December 31, 1997 were $879,874 and $1,135,094, respectively.
Historically, warranty expenses have been consistent with established
allowances.
CUSTOMERS
The Company's customers include semiconductor and other device
fabricators, photomask fabricators and their 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 300
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. Approximately
95% of net sales in Fiscal 1998 and Fiscal 1997 were to the ten largest
customers in each fiscal year. Sales to the largest customer accounted for
approximately 55% of net sales during Fiscal 1998. 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.
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SALES AND MARKETING
QCO markets and distributes its products directly in the United States.
The Company maintains sales and service offices in Wilmington, Massachusetts and
Santa Clara, California, and service or sales personnel in New Mexico and
Florida. The Company also sells through manufacturer's 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.
Accordingly, the Company's systems typically have a lengthy sales cycle during
which the 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. 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 13 individuals in engineering and development as
of December 31, 1998. During Fiscal 1998 and Fiscal 1997, the Company's
engineering expenses totaled approximately $1,196,000 and $1,316,000, or 12% and
13% of net sales, respectively. The Company expenses all software development
costs as incurred.
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.
COMPETITION
The markets in which the Company competes are highly competitive and
are characterized by rapid technological change, evolving industry standards,
rapid product obsolescence and intense competition. Competitors in the
semiconductor photomask inspection market include Hitachi, Horiba, KLA
Instruments and Nikon. In the computer hard disk inspection market competitors
include DPI Technology Systems, Hitachi, Phase Metrics and System Seiko. 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 and potential competitors have greater financial,
marketing and technological resources than the Company. There can be no
assurance that companies with complementary technologies and greater financial
resources will not enter
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<PAGE>
these industries and develop products that are superior to the Company's
products or achieve market acceptance.
A substantial investment is required by customers to install and
integrate capital equipment into a production line. As a result, once a
manufacturer has selected a particular vendor's capital equipment, management
believes that the manufacturer generally relies upon that equipment for the
specific production line application and frequently will attempt to consolidate
its other capital equipment requirements with the same vendor. Accordingly, if a
particular customer selects a competitor's capital equipment, the Company
expects to experience difficulty in selling to that customer for a significant
period of time.
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 or that it
will be able to make the technological advances necessary to remain competitive.
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, computer hard disk
and flat panel display technologies and processes. No assurance can be given
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
$258,000 at December 31, 1998, compared to approximately $6,370,000 at December
31, 1997 and $740,000 at December 31, 1996. As of March 1, 1999, the Company's
backlog for products and services was approximately $3,429,000. 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 sometimes subject to cancellation charges. Although
a significant indicator of business levels, backlog is not necessarily
representative of future sales.
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<PAGE>
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. The Company's reliance on a
limited group of suppliers involves several risks, including the potential
inability to obtain an adequate supply of components and reduced control over
pricing and delivery time. 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, no assurance can be given 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 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.
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 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 14 United States patents. Several of the issued
patents are also issued in Japan, Europe and Canada and there is one or more
patent applications pending in Europe and Japan. Most of the issued patents
relate to advanced inspection measurement techniques. The issued United
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States patents expire from 2000 to 2015. The Company also has three registered
trademarks in the United States that are due for renewal in 2008 and 2009.
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, 1998, the Company had 46 full-time employees, of
whom 12 were in sales, marketing and service, 13 were in engineering and product
development, 6 were in administration and 15 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 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 approximately 25,000 square feet of
a facility in Wilmington, Massachusetts subleased from Caprius, Inc. (formerly
Advanced NMR Systems, Inc.). The Company currently pays base rent in the amount
of approximately $16,270 per month plus utility charges with respect to the
facility, pursuant to a sublease that expires on May 1, 2001.
The Company also maintains a technical center and sales office in an
approximately 1,500 square foot facility in Santa Clara, California, leased from
Koll/Intereal Bay Area. The Company currently pays base rent of $2,652 per month
plus certain expenses related to the facility, pursuant to a lease that expires
on November 30, 2001 . The Company believes that its facilities for its
technical center and 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.
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<PAGE>
ITEM 3. LEGAL PROCEEDINGS.
On August 6, 1998, K. Andrew Bernal, a beneficial owner of
approximately 9.7% of the issued and outstanding Common Stock of the Company,
filed a civil lawsuit against the Company and Eric T. Chase, individually, as a
director of the Company and as the trustee of the QC Optics Voting Trust (the
"Voting Trust"). The suit alleges violations of federal and state securities
laws, breach of contract, fraud and other claims relating to Mr. Bernal's shares
of Common Stock held in the Voting Trust. Mr. Bernal is seeking the release of
his shares from the Voting Trust as well as monetary and punitive damages. The
Company believes that Mr. Bernal's claims are without merit, intends to
vigorously defend the suit and has filed a motion to dismiss the claims.
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.
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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 1, 1999, the closing price of the
Company's Common Stock as reported on the AMEX was $1.39. The Company's
Redeemable Warrants are traded on AMEX under the symbol "OPC+." On March 1,
1999, the closing price of the Company's Redeemable Warrants as reported on the
AMEX was $.375.
As of March 1, 1999, there were approximately 27 holders of record of
the Company's Common Stock and approximately 22 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
---- --- ---- ---
1997
----
<S> <C> <C> <C> <C>
First Quarter $5.875 $3.75 $1.50 $.50
Second Quarter $3.75 $2.375 $ .75 $.3125
Third Quarter $5.25 $3.25 $1.1875 $.4375
Fourth Quarter $5.00 $3.25 $1.1875 $.4375
1998
----
First Quarter $5.125 $3.375 $1.00 $.375
Second Quarter $4.875 $2.375 $.938 $.25
Third Quarter $2.625 $1.50 $.50 $.25
Fourth Quarter $1.875 $1.188 $.313 $.125
1999
----
First Quarter (through March 1, 1999) $2.25 $1.25 $.563 $.125
</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.
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<PAGE>
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
YEAR ENDED DECEMBER 31, 1998 ("FISCAL 1998") COMPARED TO YEAR ENDED DECEMBER 31,
1997 ("FISCAL 1997").
The Company has been adversely affected by a general slowdown in
capital equipment spending in the semiconductor and computer disk drive
industries as evidenced by the low $258,000 customer order backlog at December
31, 1998. Backlog at March 1, 1999 improved to $3,429,000. Although a
significant indicator of business levels, backlog is not necessarily
representative of future sales. Additionally, the current financial instability
in certain Asian countries adversely affects the Company.
Net sales for Fiscal 1998 were $9,909,876 compared to net sales of
$10,091,834 for Fiscal 1997, a decrease of 1.8%. Historically, the Company has
experienced significant fluctuations in operating results due to the relatively
small number of high dollar volume sales in any year. Management expects these
fluctuations to continue. As a result of the steep declines in capital
expenditures in the semiconductor and computer hard disk industries, the Company
expects that (i) it will have lower revenue levels for the first quarter of 1999
as compared to the preceding quarters of 1998, and (ii) it will not achieve
break-even results for such quarter.
Cost of sales for Fiscal 1998 was $5,248,844 as compared to $4,786,110
for Fiscal 1997. Gross profit for Fiscal 1998 was $4,661,032 (47.0% of net
sales) as contrasted to $5,305,724 (52.6% of net sales) in Fiscal 1997, a
decrease of 12.2%. The decrease in gross profit was due primarily to the
decreased margins on certain newly introduced products.
Selling, general and administrative expenses decreased to $3,315,869
for Fiscal 1998 as compared to $3,785,536 in Fiscal 1997. This decrease of 12.4%
was due primarily to decreased professional fees and commissions, offset
partially by increases in staffing costs and certain field service expenses.
Engineering expenses in Fiscal 1998 decreased to $1,196,393 from
$1,316,469 in Fiscal 1997. The decrease resulted primarily from decreases in
staffing, materials and travel expenses. Research and development costs, which
are included in engineering expenses, remained relatively constant at
approximately $415,000 for Fiscal 1998 and $440,000 for Fiscal 1997.
Income before provision for income taxes was $329,883 for Fiscal 1998
as compared to $392,196 in Fiscal 1997. The decrease reflects the decrease in
gross profit offset somewhat by smaller decreases in operating expenses.
The provision for income taxes for Fiscal 1998 was $118,800 (an
effective rate of 36.0%) compared to $146,900 (an effective rate of 37.5%). The
higher 1997 effective tax rate relates primarily to the effect of state taxes.
Net income was $211,083 for Fiscal 1998 as compared to $245,296 for
Fiscal 1997.
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<PAGE>
LIQUIDITY AND CAPITAL RESOURCES
At December 31, 1998, the Company had cash and cash equivalents of
$3,313,889, a decrease of $452,645 from $3,766,534 at December 31, 1997. Working
capital was $8,023,392 at December 31, 1998 as compared to $7,607,447 at
December 31, 1997, an increase of $415,945. Cash used by operating activities
was $421,793 in 1998 compared to $1,074,204 in 1997.
The Company has a revolving line of credit with State Street Bank and
Trust Company. The revolving line of credit agreement was amended on June 29,
1998 and allows for maximum borrowings of $2,000,000 and requires monthly
payment of interest on the outstanding balance to maturity on June 30, 2000.
Borrowings under the revolving line of credit agreement are limited to 80% of
qualifying accounts receivable. Borrowings under the agreement bear interest at
the bank's prime rate (7.75% at December 31, 1998). The terms of the loan
agreement provide for the maintenance of certain specified financial ratios
including the quick ratio and debt to equity, minimum earnings tests and other
negative and affirmative covenants and restricts certain transactions without
the bank's prior written consent. As of December 31, 1998, the Company was in
default of the minimum earnings covenant, but obtained a waiver of compliance
from its bank. At December 31, 1998, the Company had no borrowings outstanding
under the revolving credit agreement and availability of approximately $411,000.
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.
YEAR 2000 DISCLOSURE
The Year 2000 issue is the result of computer programs using two digits
rather than four to define the applicable year. Any of the Company's computer
programs or hardware or other equipment that have date-sensitive software or
embedded chips may recognize a date using "00" as the year 1900 rather than the
year 2000. This could result in a system failure or miscalculations causing
disruptions of operations, including, among other things, a temporary inability
to process transactions, send invoices or engage in similar normal business
activities.
The Company uses computer software programs in its internal operations,
such as for performing administrative and financial functions. The Company has
tested its key internal systems and implemented remedial measures where
necessary. The Company is also contacting its significant suppliers to determine
those whose failure to be Year 2000 compliant could seriously disrupt the
Company's business operations. The Company expects to complete this review by
the second quarter of 1999.
Based on the Company's on-going review of its equipment in operation at
customer sites, the Company believes that a number of its systems are not Year
2000 compliant. The Company has been and will continue to contact its customers
and offer modifications to make such systems Year 2000 compliant. The Company
estimates that the costs incurred to remediate Year 2000 problems related to
noncompliant
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<PAGE>
products will not materially adversely affect its operations or financial
condition.
At this time, the Company cannot give any assurance that it will be
successful in completing its planned actions to become Year 2000 compliant on or
before the Year 2000. Additionally, no assurance can be given that instances of
noncompliance which could have a material adverse effect on the Company's
operations or financial condition will be identified; that the systems of other
companies with which the Company transacts business will be corrected on a
timely basis; that a failure by such entities to correct a Year 2000 problem or
a conversion which is incompatible with the Company's systems would not have a
material adverse effect on the Company's operations or financial condition; or
that even if all planned actions are completed, the Company will not experience
some adverse effects from Year 2000 related issues.
FACTORS THAT MAY AFFECT FUTURE RESULTS
--------------------------------------
As previously discussed, information provided by the Company or
statements made by its employees from time to time may contain "forward-looking"
information which involves risks and uncertainties. In particular, statements
contained in this report that are not historical facts may be "forward-looking"
statements. The Company's actual future results may differ significantly from
those stated in any forward-looking statements. Factors that may cause such
differences include, but are not limited to, the factors discussed below.
CYCLICAL NATURE OF THE SEMICONDUCTOR, COMPUTER HARD DISK AND FLAT PANEL
DISPLAY INDUSTRIES. The Company's operating results depend on capital
expenditures by semiconductor, computer hard disk and flat panel display
manufacturers. The semiconductor and computer hard disk industries are cyclical
and have historically experienced periodic downturns, which have had a severe
effect on the demand for capital equipment. Prior semiconductor and computer
hard disk industry downturns and construction of excess capacity by the industry
have adversely affected the Company's revenues, gross margin and net income and
have also adversely affected the market price for the Company's Common Stock.
Moreover, the overall computer industry has been and is likely to continue to be
cyclical with periods of oversupply. Recently, such industries have experienced
excess capacity and poor operating results and, as a result, the Company's sales
to semiconductor customers were substantially weaker in 1998 than in 1997. The
Company's ability to reduce expenses in response to any such downturn is limited
by its need for continued investment in research and development and in customer
service and support. A downturn in demand for semiconductor, computer hard disk
and flat panel display manufacturing equipment would have a material adverse
effect on the Company's business, financial condition and results of operations.
FLUCTUATIONS IN OPERATING RESULTS. 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 single
products, systems or upgrades 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 but not limited to the cyclical nature 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 rescheduling, market acceptance of the Company's products, fluctuations
in the grant and funding of development contracts, consolidation of
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<PAGE>
customers, unanticipated delays in design, engineering or production or in
customer acceptance of product shipments, changes in pricing by the Company or
its competitors, the timing of product announcements or introductions by the
Company or its competitors, the mix of systems sold, the relative proportions of
product revenues and service revenues, the timing of payments of sales
commissions, the availability of components and subassemblies, changes in
product development costs, expenses associated with acquisitions and exchange
rate fluctuations. Over the last three years, the Company's gross margin has
fluctuated and the Company anticipates that its gross margin will continue to
fluctuate. The Company cannot predict the impact of these and other factors on
its financial performance in any future period.
CONCENTRATION OF CUSTOMERS. Historically, the Company has sold a
significant proportion of its systems to a limited number of customers as a few
major companies primarily dominate the markets in which the Company
participates. Sales to the Company's ten largest customers accounted for
approximately 95% of net sales for each of the years ended December 31, 1997 and
December 31, 1998. Sales to the largest customer accounted for approximately 49%
and 55% of net sales for the years ended December 31, 1997 and December 31,
1998, respectively. 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.
RAPID TECHNOLOGICAL CHANGE AND DEPENDENCE ON PRODUCT DEVELOPMENT. The
semiconductor, computer hard disk and flat panel display industries, in general,
are characterized by rapid technological advances, changing customer
requirements, evolving industry standards and frequent new product introductions
and enhancements. As a result, the Company must continue to enhance its existing
products and develop and manufacture new products and upgrades with improved
capabilities, which 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 operation. 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.
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 requirements for inspection processes one year or more in
advance of sales. Any failure to predict accurately 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, as customers may defer ordering products from the Company's
existing product lines. 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. If new
products have reliability or quality problems, then reduced orders, higher
manufacturing costs, delays in collecting accounts receivable and additional
service and warranty expense may result. There can be no assurance that the
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<PAGE>
Company will successfully develop and manufacture new products or that any
product enhancements or new products developed by the Company will gain market
acceptance. There can be no assurance that the Company will be able to develop
enhancements and new products successfully or in time to meet emerging demand,
or that enhancements and new products developed by the Company will be accepted
by the Company's customers.
COMPETITION. The markets in which the Company competes are highly
competitive and are characterized by rapid technological change, evolving
industry standards, rapid product obsolescence and intense competition.
Competitors in the semiconductor photomask inspection market include Hitachi,
Horiba, KLA Instruments and Nikon. In the computer hard disk inspection market
competitors include DPI Technology Systems, Hitachi, Phase Metrics and System
Seiko. 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 and potential competitors have greater financial,
marketing and technological resources than the Company. There can be no
assurance that companies with complementary technologies and greater financial
resources will not enter these industries and develop products that are superior
to the Company's products or achieve market acceptance.
A substantial investment is required by customers to install and
integrate capital equipment into a production line. As a result, once a
manufacturer has selected a particular vendor's capital equipment, management
believes that the manufacturer generally relies upon that equipment for the
specific production line application and frequently will attempt to consolidate
its other capital equipment requirements with the same vendor. Accordingly, if a
particular customer selects a competitor's capital equipment, the Company
expects to experience difficulty in selling to that customer for a significant
period of time.
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.
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, computer hard disk
and flat panel display technologies and processes. No assurance can be given
that the Company will be able to develop, manufacture and sell products that
respond adequately to such changes.
ASIAN ECONOMIES. Asian countries are having economic difficulties that
are causing economic slowdowns or recessions in those countries. The current
trend in foreign exchange rates raises the cost of equipment manufactured in the
United States to Asian companies. Furthermore, it makes equipment
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<PAGE>
manufactured in Asia more price competitive to local customers than the
equipment of the Company. The region does not appear to be responding to efforts
to stimulate its economies. Asia has historically been an important region for
the semiconductor, computer hard disk and flat panel display capital equipment
industry. If these economies do not recover in the near future, the recovery in
the capital equipment industry may be extended in time or reduced in scale. The
economic difficulties of these countries could also have a negative impact on
the economies of the U.S. and Europe, leading to further declines in demand for
the Company's products.
YEAR 2000. The Year 2000 issue is the result of computer programs using
two digits rather than four to define the applicable year. Any of the Company's
computer programs or hardware or other equipment that have date-sensitive
software or embedded chips may recognize a date using "00" as the year 1900
rather than the year 2000. This could result in a system failure or
miscalculations causing disruptions of operations, including, among other
things, a temporary inability to process transactions, send invoices or engage
in similar normal business activities.
The Company uses computer software programs in its internal operations,
such as for performing administrative and financial functions. The Company has
tested its key internal systems and implemented remedial measures where
necessary. The Company is also contacting its significant suppliers to determine
those whose failure to be Year 2000 compliant could seriously disrupt the
Company's business operations. The Company expects to complete this review by
the second quarter of 1999.
Based on the Company's on-going review of its equipment in operation at
customer sites, the Company believes that a number of its systems are not Year
2000 compliant. The Company has been and will continue to contact its customers
and offer modifications to make such systems Year 2000 compliant. The Company
estimates that the costs incurred to remediate Year 2000 problems related to
noncompliant products will not materially adversely affect its operations or
financial condition.
At this time, the Company cannot give any assurance that it will be
successful in completing its planned actions to become Year 2000 compliant on or
before the Year 2000. Additionally, no assurance can be given that instances of
noncompliance which could have a material adverse effect on the Company's
operations or financial condition will be identified; that the systems of other
companies with which the Company transacts business will be corrected on a
timely basis; that a failure by such entities to correct a Year 2000 problem or
a conversion which is incompatible with the Company's systems would not have a
material adverse effect on the Company's operations or financial condition; or
that even if all planned actions are completed, the Company will not experience
some adverse effects from Year 2000 related issues.
PATENTS AND PROPRIETARY INFORMATION. The Company's patent and trade
secret rights are of material importance to the Company and its future prospects
because the Company relies on these rights to protect proprietary technology.
The Company attempts to protect its proprietary technology through patents,
copyrights, trademarks and trade secrets. No assurance can be given as to the
issuance of additional patents or, if so issued, as to their scope and validity.
Patents granted may not provide meaningful protection from competitors. Even if
a competitor's products were to infringe patents owned by the Company, it would
be costly for the Company to enforce it rights in an infringement action and
would divert funds and other resources from the Company's operations. In
addition, effective patent, copyright and trade secret protection may be
unavailable or limited in certain foreign countries. No assurance can be given
that the Company' products or processes will not infringe any patents or other
intellectual property rights of third parties. If the Company's products or
processes do infringe the rights of third parties, no assurance can be given
that the Company can obtain a license from the intellectual property owner on
commercially reasonable terms or at all.
-21-
<PAGE>
Some customers using certain products of the Company have received a
notice of infringement from the Lemelson Foundation, alleging that equipment
used in the manufacture of semiconductor products infringes patents issued to
Mr. Jerome H. Lemelson relating to "computer image analysis" or "digital signal
generation and analysis." Certain of these customers have notified the Company
that they may seek indemnification from the Company for any damages and expenses
resulting from this matter. Neither the Company nor any of its products has been
identified by the Lemelson Foundation as infringing its patents. There can be no
assurance, however, that the Lemelson Foundation would not bring a claim against
the Company for infringement or that the Company would prevail in any such
action. If the Lemelson Foundation were to prevail in any such action, the
Company might be required to pay license fees or royalties to the Foundation,
which could have an adverse impact on the Company' s profitability.
The Company relies on trade secrets that it seeks to protect, in part,
through, confidentiality agreement with employees, consultants and its customers
and potential customers. No assurance can be given that these 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 competitors. As the Company intends to enforce its
patents, trademarks and copyrights and protect its trade secrets, it may be
involved from time to time in litigation to determine the enforceability, scope
and validity of these rights. Any such litigation could result in substantial
cost to the Company and diversion of effort by the Company's management and
technical personnel.
DEPENDENCE ON SUPPLIERS. The Company does not maintain any long-term
supply agreements with any of its suppliers and the majority of the critical
components and subassemblies included in the Company's products are obtained
from a limited group of suppliers. The manufacture of certain components and
subassemblies is very complex and requires long lead times and the Company's
systems cannot be produced without certain critical components. Additionally,
alternative suppliers for many of these components may not be readily available,
and no substantial increase in the number of alternative suppliers is
anticipated. The Company intends to continue to rely on outside suppliers
because of their specialized expertise in component fabrication and subsystem
assembly. The Company's reliance on a limited group of suppliers involves
several risks, including the potential inability to obtain an adequate supply of
components and reduced control over pricing and delivery time. 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. There can be no assurance that delays or shortages caused by suppliers
will not occur in the future. Any inability to obtain adequate, timely
deliveries of subassemblies and components could prevent the Company from
meeting scheduled shipment dates, which would damage relationships with current
and prospective customers and materially adversely affect the Company's
business, financial condition and results of operations.
RISKS OF ACQUISITIONS. The Company's business strategy includes
expanding its product lines and markets through internal product development
and/or acquisitions. Although no acquisitions are currently contemplated by the
Company, any acquisition may result in potentially dilutive issuances of equity
securities, the incurrence of debt and contingent liabilities, and amortization
expense related to intangible assets acquired, any of which could materially
adversely affect the Company's financial condition and results of operations. In
addition, acquired businesses may be experiencing operating losses. Any
acquisition will involve numerous risks, including difficulties in the
assimilation of the
-22-
<PAGE>
acquired Company's operations and products, the diversion of management's
attention from other business concerns, uncertainties associated with operating
in new markets and working with new customers, and the potential loss of the
acquired company's key employees. To date, the Company has had no experience in
acquisitions. There can be no assurance that any such integration will be
accomplished smoothly or successfully. The difficulties of such integration may
be increased by the necessity of coordinating organizations, which are separated
geographically. The inability of management to successfully integrate the
operations of such acquired businesses could have a material adverse effect on
the business and results of operations of the Company.
VOLATILITY OF STOCK PRICE. The stock market in general and the market
for shares of technology companies in particular have experienced extreme price
fluctuations, which have often been unrelated to the operating performance of
the affected companies. Many companies in the semiconductor and computer hard
disk industries, including the Company have experienced dramatic volatility in
the market prices of their common stock. The Company believes that factors such
as announcements of developments related to the Company's business or its
competitors' or customers' businesses, fluctuations in the Company's financial
results, general conditions or developments in the semiconductor, computer hard
disk drive and flat panel display industries and the worldwide economy, sales of
the Common Stock into the market, announcements of technological innovations or
new or enhanced products by the Company or its competitors, a shortfall in
revenue, gross margin, earnings or other financial results or changes in
research analysts' expectations, the limited number of shares of Common Stock
traded on a daily basis, or a variety of factors beyond the Company's control
could cause the price of the Company's Common Stock to fluctuate, perhaps
substantially. There can be no assurance that the market price of the Company's
Common Stock will not experience significant fluctuations in the future,
including fluctuations that are material, adverse and unrelated to the Company's
performance.
CONTROL BY EXISTING STOCKHOLDERS. The QC Optics, Inc. Voting Trust and
Kobe Steel USA Holdings, Inc. beneficially own approximately 69% of the
Company's outstanding shares of Common Stock. Accordingly, these stockholders
acting together have the ability to control all matters requiring approval by
the stockholders of the Company, including the election of directors. This
concentration of ownership may also have the effect of delaying or preventing a
change of control of the Company.
RISKS ASSOCIATED WITH INTERNATIONAL SALES AND OPERATIONS. Based on the
location to which products were shipped or services were rendered, sales to
customers in countries other than the United States accounted for 53%, and 66%
of net sales in Fiscal 1997 and Fiscal 1998, respectively. The Company
anticipates that the international shipments, principally to Japan, Thailand and
Malaysia, will continue to account for a significant portion of net sales for
the foreseeable future. Sales and operations outside of the United States are
subject to certain inherent risks, including fluctuations in the value of the U.
S. dollar relative to foreign currencies, tariffs, quotas, taxes and other
market barriers, political and economic instability, restrictions on the export
or import of technology, potentially limited intellectual property protection,
difficulties in staffing and managing international operations and potentially
adverse tax consequences. There can be no assurance that any of these factors
will not have a material adverse effect on the Company's business, financial
condition or results in operations. In particular although the Company's
international sales are primarily denominated in U. S. dollars, currency
exchange fluctuations in countries where the Company does business could
materially adversely affect the Company's business, financial condition and
results of operations by rendering the Company less price-competitive than
foreign manufacturers.
LENGTHY SALES CYCLE. Installing and integrating inspection equipment
requires a substantial investment by a customer. In addition, customers often
require a significant number of product presentations and demonstrations, as
well as substantial interaction with the Company's senior
-23-
<PAGE>
management, before reaching a sufficient level of confidence in the system's
performance characteristics and compatibility with the customer's target
applications. Accordingly, the Company's systems typically have a lengthy sales
cycle during which the Company may expend substantial funds and management time
and effort with no assurance that a sale will result.
HEALTH AND SAFETY REGULATIONS AND STANDARDS. The Company's products and
worldwide operation are subject to numerous governmental regulations designed to
protect the health and safety of operators of manufacturing equipment. In
particular, the European Union ("EU") regulations relating to electromagnetic
fields, electrical power and human exposure to laser radiation have been
implemented. 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 and standards,
including those of the EU, and with the voluntary industry standards currently
in effect. In part because the future scope of these and other regulations and
standards cannot be predicted, there can be no assurance that the Company will
be able to comply with any future regulation or industry standard. Noncompliance
could result in governmental restrictions on sales or reductions in customer
acceptance of the Company's products. Compliance may also require significant
product modifications; potentially resulting in increased costs and impaired
product performance.
DEPENDENCE ON KEY PERSONNEL AND POSSIBLE LACK OF AVAILABILITY OF
QUALIFIED PERSONNEL. The Company is dependent to a large degree on the
experience and abilities of its Chief Executive Officer, President and Chairman,
Eric T. Chase, and its Vice President of Technology, Jay L. Ormsby. The loss of
the services of either of these individuals could have a material adverse effect
on the Company. The Company has entered into employment agreements, containing
noncompetition restrictions, with each of Messrs. Chase and Ormsby. The Company
is the sole beneficiary of key person life insurance policies, each in the
amount of $1,000,000, on the lives of Messrs. Chase and Ormsby.
The Company's future success and growth strategy will depend in large
part upon its ability to attract and retain highly skilled managerial, technical
and marketing personnel. Competition for such personnel in the Company's
industry is intense. No assurance can be given that the Company will be
successful in attracting or retaining the qualified personnel necessary for its
business and anticipated growth, and the failure to attract or retain such
personnel could have a material adverse effect on the Company's business,
financial conditions and results of operations.
-24-
<PAGE>
ITEM 7. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
The following financial statements are filed as part of this report:
PAGE
Report of Independent Public Accountants ............................... F-2
Balance Sheets as of December 31, 1997 and December 31, 1998.............. F-3
Statements of Operations for the years ended December 31, 1997 and
December 31, 1998...................................................... F-4
Statements of Stockholders' Equity for the years ended
December 31, 1997 and December 31, 1998................................ F-5
Statements of Cash Flows for the years ended December 31, 1997
and December 31, 1998.................................................. F-6
Notes to Financial Statements............................................. F-7
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.
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, 1998. 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, to be filed with the Commission not later than 120 days
after the close of the Company's fiscal year ended December 31, 1998.
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The information required by this Item is incorporated by reference from
the Proxy Statement, to be filed with the Commission not later than 120 days
after the close of the Company's fiscal year ended December 31, 1998.
-25-
<PAGE>
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
The information required by this Item is incorporated by reference from
the Proxy Statement, to be filed with the Commission not later than 120 days
after the close of the Company's fiscal year ended December 31, 1998.
13. EXHIBITS AND REPORTS ON FORM 8-K.
(A) EXHIBITS.
(1) The following exhibits are filed herewith:
Exhibit
No. Title
- ------ -----
23 Consent of Arthur Andersen LLP.
27 Financial Data Schedule.
(2) The following exhibits were filed as part of the Company's
Quarterly Report on Form 10-QSB for the quarter ended June 30, 1998 and are
incorporated herein by reference:
Exhibit
No. Title
- ------- -----
10h Allonge to Promissory Note of the Company to State Street Bank
and Trust Company ("State Street"), dated June 29, 1998.
10j Amended and Restated Credit Agreement by and between the
Company and State Street, dated June 29, 1998.
(3) The following exhibits were filed as part of the Company's
Annual Report on Form 10-KSB for the year ended December 31, 1997 and are
incorporated herein by reference:
Exhibit
No. Title
- ------- -----
10a Sublease Agreement between the Company and Advanced NMR
Systems (now known as Caprius, Inc.), dated as of April 15,
1997.
(4) 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:
Exhibit
No. Title
- ------- -----
3a Certificate of Incorporation, as amended.
3b Bylaws, as amended.
-26-
<PAGE>
4a Sections of Bylaws and Certificate of Incorporation defining
the rights of security holders (contained in Exhibits 3a and
3b).
4b Specimen Common Stock Certificate.
4c Form of Representative's Warrant Agreement (revised).
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.
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 and Abdu Boudour.
(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.
-27-
<PAGE>
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 22, 1999
- ---------------------------------- and Chairman of the Board of
Eric T. Chase Directors (Principal Executive
Officer)
/s/ Richard C. Allard Vice President of Finance and March 22, 1999
- ---------------------------------- Treasurer (Principal Financial
Richard C. Allard and Principal Accounting Officer)
/s/ Allan Berman Director March 22, 1999
- ---------------------------------
Allan Berman
/s/ John M. Tarrh Director March 22, 1999
- ---------------------------------
John M. Tarrh
</TABLE>
-28-
<PAGE>
QC OPTICS, INC.
INDEX
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS F-2
BALANCE SHEETS AS OF DECEMBER 31, 1997 AND 1998 F-3
STATEMENTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 1997 AND 1998 F-4
STATEMENTS OF STOCKHOLDERS' EQUITY FOR THE YEARS ENDED DECEMBER 31,
1997 AND 1998 F-5
STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 1997 AND 1998 F-6
NOTES TO FINANCIAL STATEMENTS F-7
</TABLE>
F-1
<PAGE>
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, 1997 and 1998, and the related statements of
operations, stockholders' equity and cash flows for the years ended December 31,
1997 and 1998. 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, 1997 and 1998, and the results of its operations and its cash flows for the
years ended December 31, 1997 and 1998, in conformity with generally accepted
accounting principles.
ARTHUR ANDERSEN LLP
Boston, Massachusetts
February 12, 1999
F-2
<PAGE>
QC OPTICS, INC.
BALANCE SHEETS--DECEMBER 31, 1997 AND 1998
ASSETS
<TABLE>
<CAPTION>
1997 1998
---- ----
<S> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents $ 3,766,534 $ 3,313,889
Accounts receivable, less allowance of $50,000 at December 31, 1997 and 1998 2,509,002 1,897,564
Inventory 4,025,428 3,732,134
Prepaid expenses 76,974 68,001
--------------- ---------------
Total current assets 10,377,938 9,011,588
--------------- ---------------
PROPERTY AND EQUIPMENT, AT COST:
Furniture and fixtures 189,350 217,024
Machinery and equipment 342,609 345,787
Leasehold improvements 76,714 76,714
Motor vehicles 21,574 21,574
--------------- ---------------
630,247 661,099
Less--Accumulated depreciation 402,528 484,974
--------------- ---------------
Property and equipment, net 227,719 176,125
--------------- ---------------
DEFERRED TAX ASSETS 349,500 243,500
--------------- ---------------
OTHER ASSETS 82,924 35,656
--------------- ---------------
Total assets $ 11,038,081 $ 9,466,869
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 742,563 $ 119,414
Accrued payroll and related expenses 457,505 271,244
Accrued commissions 59,894 9,615
Accrued income taxes 221,789 -
Accrued expenses 642,923 455,491
Customer deposits 645,817 132,432
--------------- ---------------
Total current liabilities 2,770,491 988,196
--------------- ---------------
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY:
Preferred stock, $.01 par value-
Authorized--1,000,000 shares
Issued and outstanding--No shares at December 31, 1997 and 1998 - -
Common stock, $.01 par value-
Authorized--10,000,000 shares
Issued and outstanding--3,242,500 shares at December 31, 1997 and 1998 32,425 32,425
Additional paid-in capital 9,902,886 9,902,886
Accumulated deficit (1,667,721) (1,456,638)
--------------- ---------------
Total stockholders' equity 8,267,590 8,478,673
--------------- ---------------
Total liabilities and stockholders' equity $ 11,038,081 $ 9,466,869
============= =============
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-3
<PAGE>
QC OPTICS, INC.
STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 1997 AND 1998
<TABLE>
<CAPTION>
1997 1998
---- ----
<S> <C> <C>
NET SALES $ 10,091,834 $ 9,909,876
COST OF SALES 4,786,110 5,248,844
-------------- --------------
Gross profit 5,305,724 4,661,032
-------------- --------------
OPERATING EXPENSES:
Selling, general and administrative expenses 3,785,536 3,315,869
Engineering expenses 1,316,469 1,196,393
-------------- --------------
Total operating expenses 5,102,005 4,512,262
-------------- --------------
Operating income 203,719 148,770
INTEREST INCOME 202,434 190,074
INTEREST EXPENSE (13,957) (8,961)
-------------- --------------
Income before provision for income taxes 392,196 329,883
PROVISION FOR INCOME TAXES 146,900 118,800
-------------- --------------
Net income $ 245,296 $ 211,083
============== ==============
BASIC AND DILUTED NET INCOME PER COMMON AND COMMON EQUIVALENT SHARE $ 0.08 $ 0.06
====== ======
BASIC WEIGHTED AVERAGE COMMON SHARES OUTSTANDING 3,242,500 3,242,500
============== ==============
DILUTED WEIGHTED AVERAGE COMMON AND COMMON EQUIVALENT SHARES OUTSTANDING 3,245,478 3,251,465
============== ==============
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-4
<PAGE>
QC OPTICS, INC.
STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 1997 AND 1998
<TABLE>
<CAPTION>
PREFERRED STOCK COMMON STOCK
ADDITIONAL TOTAL
NUMBER OF PAR NUMBER OF PAID-IN ACCUMULATED STOCKHOLDERS'
SHARES VALUE SHARES PAR VALUE CAPITAL DEFICIT EQUITY
<S> <C> <C> <C> <C> <C> <C> <C>
BALANCE, DECEMBER 31, 1996 - $ - 3,242,500 $ 32,425 $ 9,902,886 $ (1,913,017) $ 8,022,294
Net income - - - - - 245,296 245,296
----- ----- ------------ -------------- -------------- -------------- --------------
BALANCE, DECEMBER 31, 1997 - - 3,242,500 32,425 9,902,886 (1,667,721) 8,267,590
Net income - - - - - 211,083 211,083
----- ----- ------------ -------------- -------------- -------------- --------------
BALANCE, DECEMBER 31, 1998 - $ - 3,242,500 $ 32,425 $ 9,902,886 $ (1,456,638) $ 8,478,673
===== ===== ============ ============== ============== ============== ==============
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-5
<PAGE>
QC OPTICS, INC.
STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 1997 AND 1998
<TABLE>
<CAPTION>
1997 1998
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 245,296 $ 211,083
--------------- ---------------
Adjustments to reconcile net income to net cash used in operating activities-
Depreciation and amortization 74,169 82,446
(Increase) decrease in deferred taxes, net (141,500) 106,000
Changes in operating assets and liabilities-
Accounts receivable (624,308) 611,438
Inventory (642,368) 293,294
Prepaid expenses and other assets (65,358) 56,241
Accounts payable 58,716 (623,149)
Accrued expenses (467,106) (645,761)
Customer deposits 488,255 (513,385)
--------------- ---------------
Total adjustments (1,319,500) (632,876)
--------------- ---------------
Net cash used in operating activities (1,074,204) (421,793)
--------------- ---------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment (182,034) (30,852)
--------------- ---------------
Net cash used in investing activities (182,034) (30,852)
--------------- ---------------
CASH FLOWS FROM FINANCING ACTIVITIES: - -
--------------- ---------------
NET DECREASE IN CASH AND CASH EQUIVALENTS (1,256,238) (452,645)
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 5,022,772 3,766,534
--------------- ---------------
CASH AND CASH EQUIVALENTS, END OF YEAR $ 3,766,534 $ 3,313,889
=============== ===============
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid for-
Interest $ 14,422 $ 9,177
=============== ===============
Income taxes $ 535,811 $ 242,450
=============== ===============
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-6
<PAGE>
QC OPTICS, INC.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1998
(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 industries.
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Revenue Recognition
Revenues from product sales and the sale of spare parts are recognized at
the time equipment is shipped. Revenues from service and maintenance
agreements are recognized ratably over the period covered by the
agreement. Net sales of the Company by products, spares and service were
as follows:
FOR THE YEARS ENDED
1997 1998
Products $ 8,350,828 $ 8,479,725
Spares and service 1,741,006 1,430,151
-------------- --------------
Total sales $ 10,091,834 $ 9,909,876
============== ==============
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
could 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 have a material adverse affect on 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 rescheduling; market acceptance of the
Company's products; consolidation of customers; 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; the relative proportions of product revenues and service
revenues; the timing of payment of sales commissions; changes in product
development costs; expenses associated with acquisitions and exchange
rate fluctuations and the availability of components and subassemblies.
F-7
<PAGE>
QC OPTICS, INC.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1998
(Continued)
Warranty Costs
The Company accrues warranty costs in the period the related revenue is
recognized.
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, 1997 and
1998 amounted to approximately $440,000 and $415,000, respectively.
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 consists of the following:
DECEMBER 31,
1997 1998
Raw materials and finished parts $ 1,931,130 $ 1,815,183
Work-in-process 2,094,298 1,189,882
Finished goods - 727,069
-------------- --------------
$ 4,025,428 $ 3,732,134
============== ==============
Work-in-process and finished goods 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. Leasehold improvements
are depreciated over the life of the lease or useful life, whichever is
shorter.
F-8
<PAGE>
QC OPTICS, INC.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1998
(Continued)
The Company provides for depreciation using the straight-line method to
amortize the cost of plant and equipment over their estimated useful
lives, which are generally as follows:
ASSET CLASSIFICATION ESTIMATED
USEFUL LIFE
Furniture and fixtures 3-8 years
Machinery and equipment 3-8 years
Motor vehicles 3-5 years
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.
CONCENTRATION OF CREDIT RISK/SIGNIFICANT CUSTOMERS
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 a small number of 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 significant and summarized as
follows:
<TABLE>
<CAPTION>
NET SALES FOR THE ACCOUNTS RECEIVABLE AS OF
YEARS ENDED DECEMBER 31, DECEMBER 31,
1997 1998 1997 1998
<S> <C> <C> <C> <C>
Company A $ 4,956,000 $ 5,400,000 $ 1,615,000 $ 1,447,000
Company B 1,043,000 10,000 224,000 2,000
Company C - 1,693,000 - 2,000
</TABLE>
The Company maintains its cash and cash equivalents 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
$3,775,000 and $2,991,000 at December 31, 1997 and 1998, respectively.
F-9
<PAGE>
QC OPTICS, INC.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1998
(Continued)
Net sales by country, denominated in U.S. dollars, were as follows, based
on the location to which the products were shipped or the services
provided:
FOR THE YEARS ENDED
1997 1998
United States $ 4,757,722 $ 3,453,854
Japan 697,974 1,906,440
Thailand 982,656 1,798,652
Malaysia 1,376,947 2,486,663
Other 2,276,535 264,267
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.
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.
NET INCOME (LOSS) PER COMMON SHARE
Basic earnings per common share is computed by dividing net income (loss)
by the weighted average number of shares of common stock outstanding
during the year. Diluted earnings per common share is calculated the same
as basic except, if not antidilutive, stock options are included using
the treasury stock method to the extent that the average share trading
price exceeds the exercise price. As of December 31, 1997 and 1998, there
were 266,700 and 285,372 options outstanding, respectively. Of these
potentially dilutive securities, 70,647 and 116,424 qualified for
inclusion in the diluted earnings per share calculation for part of the
years ended December 31, 1997 and 1998, respectively. These options
yielded incremental shares of 11,910 and 8,849, or weighted average
incremental shares for the year of 2,978 and 8,965 for the years ended
December 31, 1997 and 1998, respectively. As a result, the year-end
weighted average shares outstanding were 3,245,478 and 3,251,465 as of
December 31, 1997 and 1998, respectively. Basic and diluted earnings per
common share for the years ended December 31, 1997 and 1998 were equal;
therefore, no reconciliation between basic and diluted earnings per
common share is required.
F-10
<PAGE>
QC OPTICS, INC.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1998
(Continued)
SEGMENT REPORTING
In June 1997 the Financial Accounting Standards Board (FASB) issued SFAS
No. 131, Disclosures About Segments of an Enterprise and Related
Information, effective for fiscal years beginning after December 15,
1997. SFAS No. 131 requires companies to report segment information using
the "management approach" of organizing the Company. Any relevant
divisions within the Company, whether they are geographical or
product-line related, should be disclosed as a separate segment and
should have a break out of various asset, liability, revenue and expense
information. Based upon QC Optics' analysis of their Company, they
believe that they operate in one segment and do not analyze their
operations based upon separate georgraphical or product-line information.
(3) INCOME TAXES
The components of the income tax provision (benefit) are as follows:
FOR THE YEARS ENDED DECEMBER 31,
1997 1998
Current-
Federal $ 248,400 $ 4,900
State 40,000 7,900
------------- -----------
288,400 12,800
------------- -----------
Deferred-
Federal (120,275) 91,750
State (21,225) 14,250
------------- -----------
(141,500) 106,000
------------- -----------
$ 146,900 $ 118,800
============= ===========
The Company's effective tax rate differs from the federal statutory rate
of 34% in 1997 and 1998 due to the following:
<TABLE>
<CAPTION>
1997 1998
<S> <C> <C>
Computed tax provision at statutory rate $ 133,347 $ 112,160
Increase resulting from-
State taxes 3,855 971
Items not deductible for income tax purposes 9,698 5,669
--------------- ---------------
$ 146,900 $ 118,800
============== ==============
</TABLE>
F-11
<PAGE>
QC OPTICS, INC.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1998
(Continued)
Deferred income taxes at December 31, 1997 and 1998 consisted of the
following:
<TABLE>
<CAPTION>
1997 1998
<S> <C> <C>
Deferred tax assets-
Inventories $ 560,000 $ 580,000
Other reserves 303,000 218,000
Net operating loss carryforwards 487,000 432,000
-------------- --------------
Total gross deferred tax assets 1,350,000 1,230,000
Less--Valuation allowance 986,500 978,500
-------------- --------------
Net deferred tax assets 363,500 251,500
-------------- --------------
Deferred tax liabilities-
Depreciation 14,000 8,000
-------------- --------------
Net deferred tax asset $ 349,500 $ 243,500
============== ==============
</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, which was consummated on March 29, 1996. As a result, the Company
is limited to approximately $161,000 of loss utilization per year.
Limitations on the utilization of the Company's net operating losses have
resulted from 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. Given the limitations, management has concluded that
realizability of the deferred tax assets as of December 31, 1998 is
uncertain and has, therefore, provided a valuation allowance against a
portion of the deferred tax assets.
For tax reporting purposes, the Company has a U.S. federal net operating
loss carryforward of approximately $1,270,000, subject to Internal
Revenue Service (IRS) 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 2001 to
2008 if not utilized.
F-12
<PAGE>
QC OPTICS, INC.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1998
(Continued)
(4) COMMITMENTS AND CONTINGENCIES
The Company leases its operating facilities under two noncancelable
operating lease agreements, the largest of which expires in 2001. Rent
expense for the years ended December 31, 1997 and 1998 amounted to
approximately $255,000 and $253,000, respectively. Future minimum
commitments under all noncancelable operating leases are approximately as
follows:
1999 $ 228,000
2000 229,000
2001 97,000
(5) EMPLOYEE BENEFIT PLAN
The Company sponsors a 401(k) retirement savings plan (the Plan) that
covers substantially all of the Company's employees. Participants may
make voluntary contributions of 1% to 16% of their annual compensation.
The Company makes matching contributions up to 100% of participant
voluntary contributions up to a maximum of 2%, and an additional Company
contribution can be made at the Company's discretion.
The Company charged to expense approximately $76,000 and $100,000 related
to contributions to the Plan for the years ended December 31, 1997 and
1998, respectively. Included in accrued expenses is approximately $60,000
and $71,000 for Company matching and discretionary contributions to the
Plan for the years ended December 31, 1997 and 1998, respectively.
(6) 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. To date, all options have been issued with
an exercise price at or above fair market value at the date of grant.
In June 1997, 64,996 options previously granted under the 1996 Plan were
repriced from an original exercise price of $5.10 per share to an
exercise price of $3.25 per share with vesting and option life calculated
from the original grant date. In November 1997, the Company granted
options under the 1996 Plan for the purchase of 26,500 shares at $4.13
per share, the estimated fair market value on the date of grant, which
become exercisable over three years beginning one year from the date of
grant. In January 1998, 20,232 options at $5.10 per share and 26,500
options at $4.13 per share previously granted under the 1996 Plan were
repriced to an exercise price of $3.625 per share with vesting and
F-13
<PAGE>
QC OPTICS, INC.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1998
(Continued)
option life calculated from the original grant date. In October 1998,
63,132 options at $3.625 per share and 43,108 options at $3.250 per share
previously granted under the 1996 Plan were repriced to an exercise price
of $1.313 per share with vesting and option life calculated from the
original grant date. In 1998, the Company granted options under the 1996
Plan for the purchase of 33,000 shares at $1.313 to $3.625 per share, the
estimated fair market value on the date of grant, which become
exercisable over three years beginning one year from the date of grant.
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 1997, the Company granted options to a new nonemployee director
under the Formula Plan for the purchase of 15,000 shares at $3.25 per
share, the estimated fair market value on the date of grant, which become
exercisable as previously discussed. In January 1998, 30,000 options
previously granted under the Formula Plan were repriced from an original
exercise price of $5.10 per share to an exercise price of $3.625 per
share with vesting and option life calculated from the original grant
date.
PRO FORMA STOCK-BASED COMPENSATION EXPENSE
SFAS No. 123, Accounting for Stock-Based Compensation, 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 Accounting Principles Board Opinion No. 25 to account for its
stock-based compensation plans. Had compensation cost for awards granted
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 income and net income
per common and common equivalent shares would have been as follows:
<TABLE>
<CAPTION>
1997 1998
<S> <C> <C>
Net income-
As reported $ 245,296 $ 211,083
Pro forma 166,528 100,596
Diluted net income per common and common
equivalent shares-
As reported $ .08 $ .06
Pro forma .05 .03
</TABLE>
F-14
<PAGE>
QC OPTICS, INC.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1998
(Continued)
Compensation expense for options granted is reflected over the vesting
period; therefore, future compensation expense may increase as additional
options are granted.
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:
1997 1998
Volatility 42% 46%
Risk-free interest rate 6.38% 4.97%
Expected life of options 5.28 years 4.44 years
Dividends none none
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-15
<PAGE>
QC OPTICS, INC.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1998
(Continued)
Stock Option Activity
A summary of the Company's stock option activity is as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1997
1996 PLAN FORMULA PLAN
WEIGHTED WEIGHTED
NUMBER OF AVERAGE NUMBER OF AVERAGE
SHARES EXERCISE PRICE SHARES EXERCISE PRICE
<S> <C> <C> <C> <C>
Options outstanding, beginning of year 223,064 $ 5.68 30,000 $ 5.10
============ ========= =========== =========
Granted 26,500 4.13 15,000 3.25
Exercised - - - -
Repricing--Extinguish old options (64,996) 5.10 - -
Repricing--Distribute new options 64,996 3.25 - -
Forfeited (27,864) 4.27 - -
------------ -----------
Options outstanding, end of year 221,700 $ 5.13 45,000 $ 4.48
============ ========= =========== =========
Options exercisable 136,733 $ 5.81 13,125 $ 4.84
============ ========= =========== =========
Options available for grant 138,300 55,000
============ ===========
Weighted-average fair value of $ 1.66 $ 1.81
========= =========
options (whose exercise price equals
market value) granted or repriced
during the year
</TABLE>
F-16
<PAGE>
QC OPTICS, INC.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1998
(Continued)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1998
1996 PLAN FORMULA PLAN
NUMBER OF WEIGHTED NUMBER OF WEIGHTED
SHARES AVERAGE SHARES AVERAGE
EXERCISE PRICE EXERCISE PRICE
<S> <C> <C> <C> <C>
Options outstanding, beginning of year 221,700 $ 5.13 45,000 $ 4.48
============ ========= =========== =========
Granted 33,000 2.71 - -
Exercised - - - -
Repricing--Extinguish old options (152,972) 3.80 (30,000) 5.10
Repricing--Distribute new options 152,972 2.02 30,000 3.63
Forfeited (14,328) 3.16 - -
------------ -----------
Options outstanding, end of year 240,372 $ 3.78 45,000 $ 3.50
============ ========= =========== =========
Options exercisable 165,240 $ 4.79 24,375 $ 3.54
============ ========= =========== =========
Options available for grant 119,628 55,000
============ ===========
Weighted-average fair value of $ 0.97 $ 1.48
========= =========
options (whose exercise price equals
market value) granted or repriced
during the year
</TABLE>
A summary of the status of the Company's stock options at December 31,
1998 is as follows:
OPTIONS OUTSTANDING AND EXERCISABLE
EXERCISE PRICE NUMBER REMAINING CONTRACTUAL
LIFE
--------------------- 1996 PLAN -----------------
$1.313 47,740 7.5 to 10 years
$5.100 10,000 7.5 years
$6.300 107,500 7.5 years
------------------- FORMULA PLAN ----------------
$3.250 5,625 8.5 years
$3.625 18,750 7.5 years
F-17
<PAGE>
QC OPTICS, INC.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1998
(Continued)
(7) REVOLVING LINE OF CREDIT
The Company has a revolving line-of-credit with State Street Bank and
Trust Company. The revolving line-of-credit agreement was amended on June
29, 1998 and allows for maximum borrowings of $2,000,000 and requires
monthly payment of interest on the outstanding balance to maturity on
June 30, 2000. Borrowings under the revolving line-of-credit agreement
are limited to 80% of qualifying accounts receivable. Borrowings under
the agreement bear interest at the bank's prime rate (7.75% at December
31, 1998). The terms of the loan agreement provide for the maintenance of
certain specified financial ratios including the quick ratio and debt to
equity, minimum earnings tests and other negative and affirmative
covenants and restricts certain transactions without the bank's prior
written consent. As of December 31, 1998 the Company was in default of
the minimum earnings covenant of the revolving line-of-credit agreement.
The Company obtained a waiver of this covenant for the year ended
December 31, 1998. At December 31, 1998 the Company had no borrowings
outstanding under the revolving line-of-credit agreement and availability
of approximately $411,000.
(8) VOTING TRUST
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.
F-18
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
As independent public accountants, we hereby consent to the incorporation of our
reports included in this Form 10-KSB, into the Company's previously filed
Registration Statement File No. 333-07683 and Registration Statement File No.
333-51383.
Arthur Andersen LLP
Boston, Massachusetts
March 19, 1999
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information extracted from the
financial statements of the issuer as of and for the year ended December 31,
1998 and is qualified in its entirety by reference to such financial statements.
</LEGEND>
<S> <C>
<PERIOD-TYPE> Year
<FISCAL-YEAR-END> Dec-31-1998
<PERIOD-START> Jan-01-1998
<PERIOD-END> Dec-31-1998
<CASH> 3,313,889
<SECURITIES> 0
<RECEIVABLES> 1,947,564
<ALLOWANCES> 50,000
<INVENTORY> 3,732,134
<CURRENT-ASSETS> 9,011,588
<PP&E> 661,099
<DEPRECIATION> 484,974
<TOTAL-ASSETS> 9,466,869
<CURRENT-LIABILITIES> 988,196
<BONDS> 0
0
0
<COMMON> 32,425
<OTHER-SE> 8,446,248
<TOTAL-LIABILITY-AND-EQUITY> 9,466,869
<SALES> 9,909,876
<TOTAL-REVENUES> 9,909,876
<CGS> 5,248,844
<TOTAL-COSTS> 5,248,844
<OTHER-EXPENSES> 4,512,262
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> (181,113)
<INCOME-PRETAX> 329,883
<INCOME-TAX> 118,800
<INCOME-CONTINUING> 211,083
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 211,083
<EPS-PRIMARY> .06
<EPS-DILUTED> .06
</TABLE>
