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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, 1999
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, 1999 were
$5,350,247.
The aggregate market value of the voting stock held by non-affiliates
based upon the closing price for such stock on March 10, 2000 was approximately
$8,536,674. As of March 10, 2000, 2,977,058 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, 1999, 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 computer hard disk industry, 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 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 risks and uncertainties
include, but are not limited to the following: business conditions and growth in
certain market segments and the general economy; fluctuating operating results;
new product development; the cyclical nature of the semiconductor and computer
hard disk industries; 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; 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; 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 our filings with the Securities
and Exchange Commission. See also "Factors That May Affect Future Results."
GENERAL
We design, manufacture and market laser-based defect detection systems
primarily for the semiconductor and computer hard disk markets. We use our
patented and other proprietary technology in lasers and optical systems that
scan a computer hard disk or photomask for defects or contamination. Our systems
combine automatic handling, clean room capability and computer control with
reliable laser based technology. We believe that these features enable us to
maintain a strong presence in the United States in the semiconductor and
computer hard disk inspection industries where high quality inspection
capabilities are required. Our customers include many of the world's largest
leading semiconductor and computer hard disk manufacturers. Currently, we have
over 350 systems installed in 17 countries.
Our systems, such as the QCO-4000(TM) and DISKAN-9000(TM), are designed
to fit into our 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, potential
demand for our products that inspect computer hard disks increases. We are also
working on research and development for a new higher sensitivity photomask
inspection system, which we expect to release as a product during 2000.
QC Optics, Inc. (the "Company") was formed in 1986 as a Delaware
corporation to acquire the assets of a division of GCA Corporation. 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 the Company'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.
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Our principal offices and manufacturing facilities are based in
Wilmington, Massachusetts. We also maintain regional sales or service personnel
in Florida and California. We currently have approximately 42 employees and have
manufacturer representatives in Europe and Asia and distributors in Asia.
MARKETS
We currently serve primarily two markets with our inspection systems:
semiconductors and computer hard disks. In addition, we plan to continue to
develop additional products, based on our existing patented and proprietary
technologies, to further develop laser-based inspection systems.
Our 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 our 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
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 1980's, 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.
We believe 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
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the most important determinants of profitability in the semiconductor industry.
We believe that our customers typically experience rapid paybacks on their
investments in our 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. Our ability to reduce expenses in response
to any such downturn is limited by our needs for continued research and
development and for customer service and support. Previous downturns in capital
investment by the semiconductor fabrication industry have materially affected
our operating results and other businesses in the semiconductor capital
equipment industry and future downturns may have similar adverse effects. Demand
for laser inspection equipment typically lags demand for production equipment.
We anticipate increased demand for our semiconductor products in the second half
of 2000.
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
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. Our computer
hard disk inspection systems have been utilized for over 15 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. Over 80 of our installed systems are used for 100%
inspection.
The overall computer hard disk drive industry has been and could
continue to be cyclical with periods of oversupply. Our ability to reduce
expenses in response to this downturn is limited by our needs for continued
research and development and for customer service and support. Previous
downturns in capital investment by the computer hard disk industry have
materially affected our operating results and other businesses in the computer
hard disk industry and future downturns may have similar adverse effects.
The computer hard disk industry is currently in a severe downturn,
which has lead to large reductions in capital expenditures. Technological
advances in data storage density have reduced the average number of disks per
drive, and unit volume increases in disk drives have not kept pace with these
disks per drive reductions. As a result, the unit volume of disks has decreased.
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An over capacity of disk production factories has led to a precipitous decline
in capital equipment expenditures in the industry. As industry consolidation and
increased demand for disk drives bring supply and demand into balance, capital
expenditures will resume. We believe that in the long-term the computer hard
disk industry will grow. New applications, such as storage for personal video
recorders ("PVR") ought to increase demand for disk storage.
STRATEGY
Our goal is to maintain a leadership position in the photomask and
computer hard disk inspection system markets and use our patented and
proprietary technology to pursue other opportunities in high performance
inspection systems. We intend to achieve this goal through the implementation of
the following strategies:
* EXPAND MARKETING EFFORTS FOR EXISTING PRODUCTS. We have extended
our sales, service and marketing activities in Europe and Asia,
where we believe long-term market demand exists for
state-of-the-art inspection systems in photomasks and computer
hard disks. In the computer hard disk market, we intend to
continue to market our computer hard disk inspection systems for
100% production line inspection versus statistical sampling
inspection, and to penetrate additional inspection points in the
manufacturing process.
* MAINTAIN TECHNOLOGY LEADERSHIP POSITION. To maintain technology
leadership, we intend to continue to make investments in
engineering programs and to work closely with our major
customers, several of which are leading suppliers of
semiconductors and computer hard disks.
* BROADEN PRODUCT OFFERINGS THROUGH ACQUISITIONS. Although no
assurance can be given that we will complete any acquisition, we
plan to expand our activities in related markets. There are a
number of smaller companies that have technology, manufacturing
and market links with our existing businesses.
* PROVIDE BROAD RANGE OF PHOTOMASK INSPECTION SOLUTIONS. We provide
a broad range of technical solutions, leveraged off of existing
technologies, with different performance characteristics. Certain
of our 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. We are currently working on research and
development for a new higher sensitivity photomask inspection
system, which we expect to release as a new product during 2000.
* PROVIDE BROAD RANGE OF COMPUTER HARD DISK INSPECTION SOLUTIONS.
Our strategy is to expand and improve our product offerings by
strengthening our current technologies to provide 100% inspection
tools such as the DISKAN-9000(TM) as well as failure analysis
tools, such as the DISKAN-FA-ST(TM) introduced in the third
quarter of 1999.
* LEVERAGE INSTALLED BASE. In marketing new products to existing
customers, we intend to leverage our existing customer base to
upgrade the over 350 of our systems currently in the field with
new product offerings. Many of our products are built with
modular systems that are designed to facilitate future
enhancements, as well as new system software.
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* EXPAND CUSTOMER SUPPORT SERVICES. We currently provide local
support and service with personnel located in California and
Florida in addition to our principal engineering services at our
Wilmington, Massachusetts headquarters. We also have factory
trained service representatives in the UK, France, Japan, Korea,
Taiwan, Malaysia and Thailand. We intend 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
Our current products consist of photomask and computer hard disk
inspection systems. Our systems are designed to provide a low cost of ownership
through high performance, reliability and integration into the manufacturing
process. We utilize a number of different forms of lasers in our laser- based
inspection systems, allowing us to cover a broad range of technical requirements
and cost sensitivities for our customers.
Many of our newer systems are designed to fit into our customer's
production lines, virtually eliminating the need for special handling or
production procedures while performing 100% inspection throughout the process.
Our systems sort out fatal defects on disks and pelliclized photomasks before
they become manufacturing yield or other quality problems. All of our systems
have the sensitivity to detect defects or contamination down to less than 0.25
micrometers. The DISKAN-9000(TM) provides computer hard disk manufacturers with
the capability to inspect 100% of their production volume. Compared to our
previous equipment, the DISKAN-9000(TM) provides more than 70% higher throughput
and a 30% reduction in footprint. We are also working on research and
development for a new higher sensitivity photomask inspection system, which we
expect to release as a new product during 2000.
The following is a list of some of our products:
QCO-4000(TM): The QCO-4000(TM) represents what we believe is a
state-of-the-art system for inspecting pelliclized photomasks. Defects on
complex, small featured photomasks are non-destructively detected and
characterized with a sensitivity down to 0.25 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 the 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.
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.
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 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.
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DISKAN(TM) SERIES: These are computer hard disk inspection systems that
are equipped with integrated automatic handling or external handling systems.
DISKAN-9000(TM) 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 our previous systems. In addition, we offer 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 DISKAN-FA-ST(TM), is used for failure analysis and is
optimized for glass substrates.
PRODUCTS UNDER DEVELOPMENT
Our product development strategy is to make continuous improvements to
our existing product line by relying on our proprietary technologies and to
expand prior development efforts in applications related to the markets we
serve. We currently have an engineering and product development staff of 15
individuals who assist our customers in integrating our products into the
customer's work environment. This work provides us an opportunity to keep
abreast of new market opportunities for our technologies.
Currently we are working on product enhancements to both our QCO
photomask and DISKAN(TM) product lines. During 1999, we introduced a new disk
failure analysis tool, the DISKAN-FA-ST(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 is optimized for glass substrates. We expect that these new
systems will significantly improve the cost effectiveness of the equipment for
100% inspection of the customers' production. We plan to introduce a next
generation photomask inspection tool in 2000, with improved sensitivity to
support future generation (0.15 micrometer and below design rule) photomasks. In
addition, we are developing photomask handling systems, which will be sold to a
leading factory automation company on an OEM basis.
Our 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. Our 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 our 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, we provide individualized engineering services for customers
as well as technical support worldwide. Our service and support personnel also
advise customers about product applications, provide customer training,
coordinate upgrades, manage spare parts and provide preventative maintenance.
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Our warranty obligations for our systems generally cover a 12-month
period. However, many customers request service and support beyond the warranty
period. Generally, we have historically derived less than 10% of our revenues
from annual service and maintenance for our installed base of systems. Some of
our 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, 1999 were $842,341 compared to $879,874 for the fiscal
year ended December 31, 1998. Historically, warranty expenses have been
consistent with established allowances.
CUSTOMERS
Our customers include semiconductor and other device fabricators,
photomask fabricators and their suppliers and computer hard disk manufacturers.
Repeat sales to existing customers represent a significant portion of our
product revenues, and we believe that our installed base of over 350 systems
represents a significant competitive advantage, particularly in the United
States.
Historically, we have sold a significant proportion of our systems to a
limited number of customers as the markets that we participate in are primarily
dominated by a few major companies. Approximately 95% of net sales in Fiscal
1999 and Fiscal 1998 were to the ten largest customers in each fiscal year.
Sales to the largest customer accounted for approximately 65% of net sales
during Fiscal 1999. The failure to replace sales with sales to other customers
in succeeding periods would have a material adverse effect on our business,
financial condition and results of operations. We expect that sales to
relatively few customers will continue to account for a high percentage of our
revenues in any accounting period in the foreseeable future. A reduction in
orders from any such customer, the cancellation of any significant order or the
inability of a customer to pay invoices when due could have a material adverse
effect on our business, financial condition and results of operations. None of
our customers has entered into a long-term agreement requiring it to purchase
our products.
Due to the substantial purchase price for our products and systems,
revenues and operating results may vary significantly from quarter to quarter
depending upon the timing of orders and shipments.
SALES AND MARKETING
We market and distribute our products directly in the United States. We
maintain sales and service offices in Wilmington, Massachusetts and Santa Clara,
California, and service personnel in Florida. We also sell through
manufacturer's representatives, distributors and directly to certain customers
internationally.
Due to the significant involvement required to purchase our 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 our organization. Accordingly,
our systems typically have a lengthy sales cycle during which we may expend
substantial funds and management time and effort with no assurance that a sale
will result.
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ENGINEERING AND PRODUCT DEVELOPMENT
We direct our engineering and design efforts at products for which we
believe there is growing market demand. In particular, we seek to meet the
requirements of our customers for products aimed at emerging applications in the
semiconductor and computer hard disk inspection markets by applying the latest
available technology and the design and engineering know-how gained from our
focus on these markets. For many of our customers, we provide engineering and
design support to help integrate our products into production environments. By
working closely with these customers, we are exposed to new market opportunities
for our products.
We employed 13 individuals in engineering as of March 27, 2000. During
Fiscal 1999 and Fiscal 1998, our engineering expenses totaled approximately 19%
and 12% of net sales or $1,013,000 and $1,196,000 respectively. This investment
in our product line enables us to meet customer requirements in the future. We
expense all software development costs as incurred.
Our business strategy includes investing in or acquiring companies
which offer us access to complementary technologies and new markets.
COMPETITION
The markets we compete in 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 Brown & Sharpe
Manufacturing Company, Hitachi, Phase Metrics and System Seiko. Based on the
number of installations, we believe we are a leading supplier of semiconductor
photomask soft defect inspection systems and computer hard disk inspection
systems in the United States. We compete based on our installed base of
customers, engineering and service capabilities, breadth of products, patents
and proprietary information and reputation. Many of our competitors and
potential competitors have greater financial, marketing and technological
resources than us. No assurance can be given that companies with complementary
technologies and greater financial resources will not enter these industries and
develop products that are superior to our 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, we believe
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, we expect to
experience difficulty in selling to that customer for a significant period of
time.
We expect competition to continue in the future from existing
competitors and from other companies that may enter our existing or future
markets with similar or alternative solutions that may be less costly or provide
additional features. We believe that our 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 us, our customers and our
competitors, the number and nature of our 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 our business and
results of operations. No assurance can be given that we will compete
successfully in the future or that we will be able to make the technological
advances necessary to remain competitive.
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Changes in manufacturing processes could also have a materially adverse
effect on our business, financial condition and results of operations. We
anticipate continued changes in semiconductor and computer hard disk
technologies and processes. No assurance can be given that we will be able to
develop, manufacture and sell products that respond adequately to such changes.
BACKLOG
Our backlog for products and services was approximately $507,000 at
December 31, 1999, compared to approximately $258,000 at December 31, 1998. We
define 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.
MANUFACTURING
Our manufacturing activities consist of final assembly of
subassemblies, which are then integrated into finished systems and tested for
compliance with customer requirements. We believe that production lead time,
product quality and customer response are key elements to our success.
Although we manufacture some of the subassemblies used in our systems,
most are purchased from unaffiliated subcontractors, typically to our
specifications. None of our suppliers are obligated to provide us with any
specific quantity of components or subassemblies over any specific period.
Certain of the components and subassemblies included in our products are
obtained from a limited group of suppliers. In addition, because we believe that
subsystem vendors have increased their manufacturing expertise, we expect to
continue to obtain virtually all of our components and subassemblies from third
parties in order to devote our resources toward systems design, software
development and systems integration, our primary areas of competence. Our
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, we have generally been able to
obtain adequate and timely delivery of critical subassemblies and components,
although we have 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 our supply
of critical components and subassemblies could prevent us from meeting our
manufacturing schedules, which could damage relationships with customers and
would have a material adverse effect on our business, financial condition and
results of operations.
Our ability to increase our 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. Our failure 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 we will be successful in increasing our
manufacturing capacity.
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GOVERNMENTAL REGULATIONS AND INDUSTRY STANDARDS
Our 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 our customers, have subscribed to voluntary
health and safety standards and decline to purchase equipment not meeting such
standards. We believe that our 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
We own 13 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 States patents expire from
2000 to 2015. We also have three registered trademarks in the United States that
are due for renewal in 2008 and 2009.
Our products require technical know-how to engineer and manufacture and
are based, in part, upon proprietary technology. To the extent proprietary
technology is involved, we rely on patents and trade secrets that we seek to
protect, in part, through confidentiality agreements. No assurance can be given
that such agreements will not be breached, that we will have adequate remedies
for any breach, or that our trade secrets will not otherwise become known to, or
independently developed by, our existing or potential competitors. We may be
involved from time to time in litigation to determine the enforceability, scope
and validity of our rights. No assurance can be given that our products will not
infringe any patents of others. Litigation could result in substantial cost to
us and diversion of effort by our management and technical personnel.
EMPLOYEES
As of March 27, 2000, we had 42 full-time employees, of whom 9 were in
sales, marketing and service, 13 were in engineering, 8 were in administration
and 12 were in manufacturing.
None of our employees is represented by a labor union. We consider our
relationships with our employees to be satisfactory. Our financial performance
will depend significantly upon the continued contributions of our officers and
key management, technical, sales and support personnel, many of whom would be
difficult to replace. No assurance can be given that we will be successful in
attracting or retaining qualified personnel.
ITEM 2. FACILITIES
We occupy approximately 25,000 square feet of subleased space in
Wilmington, Massachusetts for our principal executive offices, research and
development and manufacturing operations. These premises are subleased from
Aurora Imaging Technology, Inc. (formerly Advanced NMR Systems, Inc.). The
current base rent for this facility is approximately $16,270 per month plus
utility charges. This sublease expires on May 1, 2001.
We maintain 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 base rent of this facility is $2,652 per month plus certain
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expenses related to the facility. This lease expires on November 30, 2001. We
believe that our facilities for our technical center and sales office are
adequate for our current needs.
Although no assurance can be given, we believe that adequate facilities
for expansion, if required, are available at competitive rates. Although we have
no present plans to acquire additional research and development, manufacturing
or shipping facilities, we may in the future seek to establish additional
research and development, manufacturing or shipping facilities as a result of
our anticipated growth or acquisitions.
ITEM 3. LEGAL PROCEEDINGS.
In February 2000, we settled the previously reported litigation with K.
Andrew Bernal. Mr. Bernal's suit against us has been dismissed with prejudice,
and the 314,754 shares of Common Stock beneficially owned by Mr. Bernal were
repurchased by us and are now classified as treasury shares. The settlement will
not have a material adverse effect on our financial condition or results of
operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
No matters were submitted to a vote of security holders during the
fourth quarter of Fiscal 1999 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.
Our Common Stock is traded on the American Stock Exchange ("AMEX")
under the symbol "OPC." On March 10, 2000, the closing price of the Company's
Common Stock as reported on the AMEX was $6.69. Our Redeemable Warrants are
traded on AMEX under the symbol "OPC+." On March 10, 2000, the closing price of
the Company's Redeemable Warrants as reported on the AMEX was $1.125.
As of March 10, 2000, there were approximately 34 holders of record of
the Company's Common Stock and approximately 33 holders of record of our
Redeemable Warrants. We believe that there are over 500 beneficial owners of our
Common Stock and over 500 beneficial owners of our Redeemable Warrants.
For the periods indicated, the following table sets forth the range of
high and low sale prices for our Common Stock and Redeemable Warrants as
reported by AMEX.
Redeemable
Common Stock Warrants
High Low High Low
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 $2.25 $1.063 $.563 $.125
Second Quarter $1.50 $.875 $.250 $.125
Third Quarter $1.375 $.75 $.250 $.063
Fourth Quarter $1.50 $.75 $.188 $.031
2000
First Quarter (through March 10, 2000) $11.50 $1.063 $3.00 $.031
We have not paid cash dividends on our Common Stock since inception and
do not anticipate paying any cash dividends on our Common Stock in the
foreseeable future. We currently intend to reinvest earnings, if any, in the
development and expansion of our business. Any future determination with respect
to the payment of dividends will be subject to the discretion of our Board of
Directors and will depend upon our earnings, capital requirements, financial
position, general economic conditions and other pertinent factors. Our agreement
with our primary bank lender prohibits the payment of dividends without the
bank's prior written consent.
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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, 1999 ("FISCAL 1999") COMPARED TO YEAR ENDED DECEMBER 31,
1998 ("FISCAL 1998").
We have been adversely affected by a general slowdown in capital
equipment spending in the computer disk drive industry as evidenced by the low
$507,000 customer order backlog at December 31, 1999.
Net sales for Fiscal 1999 were $5,350,247 compared to net sales of
$9,909,876 for Fiscal 1998, a decrease of 46%. Historically, we have experienced
significant fluctuations in operating results due to the relatively small number
of high dollar volume sales in any year. We expect these fluctuations to
continue. As a result of the steep declines in capital expenditures in the
computer hard disk industry, we expect that we will not achieve break-even
results for the first quarter of 2000.
The Securities and Exchange Commission released Staff Accounting
Bulletin No. 101, Revenue Recognition in Financial Statements (SAB 101), on
December 3, 1999. This SAB provides additional guidance on the accounting for
revenue recognition including both broad conceptual discussion as well as
certain industry-specific guidance. We are in the process of accumulating the
information necessary to quantify the potential impact of this new guidance, if
any.
The gross margin remained the same as a result of cost reductions and
changes in the mix of product sales. Cost of sales for Fiscal 1999 was
$2,846,949 as compared to $5,248,844 for Fiscal 1998. Gross profit for Fiscal
1999 was $2,503,298 (47% of net sales) as contrasted to $4,661,032 (47% of net
sales) in Fiscal 1998, a decrease of 46.3%. The decrease in gross profit was due
primarily to lower system sales in 1999.
Selling, general and administrative expenses decreased to $2,860,512
for Fiscal 1999 as compared to $3,315,869 in Fiscal 1998. This decrease of 13.7%
was due primarily to decreased travel and staffing costs in 1999.
Engineering expenses as a percentage of sales increased from 12% to 19%
in Fiscal 1999. The $183,881 decrease in engineering expenses from Fiscal 1998
to Fiscal 1999 resulted primarily from decreases in staffing and travel
expenses. Research and development costs, which are included in engineering
expenses, remained relatively constant at approximately $443,000 for Fiscal 1999
and $415,000 for Fiscal 1998.
Fiscal 1999 pretax losses of $1,186,322 compare unfavorably to Fiscal
1998 pretax income of $329,883. The decrease reflects the decrease in gross
profit offset somewhat by smaller decreases in operating expenses.
The provision for income taxes for Fiscal 1999 was $15,000 (an
effective rate of 1.3%) compared to $118,800 (an effective rate of 36.0%) for
Fiscal 1998. The lower tax rate relates to not benefiting operating losses in
Fiscal 1999 due to the uncertainty surrounding the ability to utilize such
losses in the future.
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Net loss was $1,201,322 for Fiscal 1999 as compared to net income of
$211,083 for Fiscal 1998.
LIQUIDITY AND CAPITAL RESOURCES
At December 31, 1999, we had cash and cash equivalents of $3,844,168,
an increase of $530,279 from $3,313,889 at December 31, 1998. Working capital
was $7,147,446 at December 31, 1999 as compared to $8,023,392 at December 31,
1998, a decrease of $875,946. Cash provided by operating activities was
$541,354 in 1999 compared to cash used by operating activities of $421,793 in
1998.
We have a revolving line of credit with Citizens Bank (formerly State
Street Bank and Trust Company). At December 31, 1999, we had no borrowings
outstanding under the revolving credit agreement and availability of
approximately $573,000. 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 (8.5% at December 31, 1999). 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, 1999, we were in default of
the minimum earnings covenant, but obtained a waiver of compliance from our
bank.
Based on our current cash balances, current bank credit facilities and
anticipated results of operations, we believe that we have sufficient funds to
meet our working capital requirements for the next twelve months. Thereafter, we
anticipate that we could need additional financing to meet our current plans for
expansion and working capital needs. No assurance can be given of our ability to
obtain financing on favorable terms, if at all. If we are unable to obtain
additional financing, our ability to meet our current plan for expansion and
working capital needs could be materially adversely affected.
INFLATION
To date, inflation has not had a material effect on our business.
YEAR 2000 DISCLOSURE
We have not experienced any Year 2000 problems, and we are not aware of
any situations of noncompliance that would have a material adverse effect on our
operations or financial condition. Year 2000 costs were not material for Fiscal
1999. No assurance can be given that instances of noncompliance which could have
a material adverse effect on our operations or financial condition will be
identified; that the systems of other companies with which we transact 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 our systems would
not have a material adverse effect on our operations or financial condition; or
that even if all planned actions are completed, we 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"
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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.
DEPENDENCE ON CYCLICAL INDUSTRIES. Our business is significantly
dependent on capital expenditures by semiconductor and computer hard disk
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 our revenues, gross margin and net income and have also
adversely affected the market price for our Common Stock. Moreover, the overall
computer industry has been and is likely to continue to be cyclical with periods
of oversupply. Recently, computer hard disk manufacturers have experienced
excess capacity and poor operating results and, as a result, our sales to
computer hard disk customers were substantially weaker in 1999 compared to 1998
and 1997. Our ability to reduce expenses in response to any such downturn is
limited by our need for continued investment in research and development and in
customer service and support. A downturn in demand for semiconductor and
computer hard disk equipment would have a material adverse effect on our
business, financial condition and results of operations.
FLUCTUATIONS IN OPERATING RESULTS. We derive most of our 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 our
results of operations for a given accounting period. In addition, some of our
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 our results of operations for that quarter.
Our operating results have historically been subject to significant
quarterly and annual fluctuations. We believe that our 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 our inspection products, patterns of capital spending by customers,
the timing of significant orders, order cancellations and shipment rescheduling,
market acceptance of our products, fluctuations in the grant and funding of
development contracts, consolidation of customers, unanticipated delays in
design, engineering or production or in customer acceptance of product
shipments, changes in pricing by us or our competitors, the timing of product
announcements or introductions by us or our 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 years, our gross margin
has fluctuated and we anticipate that our gross margin will continue to
fluctuate. We cannot predict the impact of these and other factors on our
financial performance in any future period.
CUSTOMER CONCENTRATION AND CREDIT RISK. Relatively few customers
account for a substantial portion of our revenues. Sales to our ten largest
customers accounted for approximately 95% of net sales for each of the years
ended December 31, 1998 and December 31, 1999. Sales to the largest customer
accounted for approximately 55% and 65% of net sales for the years ended
December 31, 1998 and December 31, 1999, respectively. The failure to replace
sales with sales to other customers in succeeding periods would have a material
adverse effect on our business, financial condition and results of operations.
We expect that sales to relatively few customers will continue to account for a
high percentage of our revenues in any accounting period in the foreseeable
future. A reduction in orders from any such customer, the cancellation of any
significant order or the inability of a customer to pay invoices when due could
have a material adverse effect on our business, financial condition and results
of operations. Several companies including our customers in the computer hard
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disk industry have been adversely effected by the general slowdown in the disk
industry and are in poor financial condition, and may represent credit risks.
None of our customers has entered into a long-term agreement requiring it to
purchase our products.
NEW PRODUCTS AND TECHNOLOGICAL CHANGE. The semiconductor and computer
hard disk industries, in general, are characterized by rapid technological
advances, changing customer requirements, evolving industry standards and
frequent new product introductions and enhancements. We believe that these
trends will continue into the foreseeable future. Our success will depend upon
our ability to enhance our existing products and to develop new products to meet
customer requirements and to achieve market acceptance. There can be no
assurance that we will be successful in introducing products or product
enhancements on a timely basis, if at all, or that we will be able to market
successfully these products and product enhancements once developed. Further,
there can be no assurance that our products will not be rendered obsolete by new
industry standards or changing technology.
HIGHLY COMPETITIVE INDUSTRIES. The markets for our products are highly
competitive and are subject to 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 Brown & Sharpe Manufacturing Company, Hitachi, Phase Metrics and System
Seiko. A number of our current and potential competitors have substantially
greater resources than we do. There can be no assurance that we will be
successful in selling our products to end users, regardless of the performance
or the price of our products. Competitors may develop superior products or
products of similar quality at the same or lower prices. Other technical
innovations may impair our ability to market our products. There can be no
assurance that we will be able to compete successfully.
PATENTS AND PROPRIETARY INFORMATION. We attempt to protect our
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 us, it would be costly for us to enforce our rights in
an infringement action and would divert funds and other resources from our
operations. In addition, effective patent, copyright and trade secret protection
may be unavailable or limited in certain foreign countries. Our issued United
States patents expire from 2000 to 2015, and the expiration of patents could
cause additional competitive pressure. No assurance can be given that our
products or processes will not infringe any patents or other intellectual
property rights of third parties. If our products or processes do infringe the
rights of third parties, no assurance can be given that we can obtain a license
from the intellectual property owner on commercially reasonable terms or at all.
Some customers using certain products of ours 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 us that they may seek
indemnification from us for any damages and expenses resulting from this matter.
Neither QC Optics, Inc. nor any of our 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 us for
infringement or that we would prevail in any such action. If the Lemelson
Foundation were to prevail in any such action, we might be required to pay
license fees or royalties to the Foundation, which could have an adverse impact
on our profitability.
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We rely on trade secrets that we seek to protect, in part, through,
confidentiality agreement with employees, consultants and our customers and
potential customers. No assurance can be given that these agreements will not be
breached, that we will have adequate remedies for any breach or that our trade
secrets will not otherwise become known to or independently developed by
competitors. As we intend to enforce our patents, trademarks and copyrights and
protect our trade secrets, we 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 us and diversion of effort by our
management and technical personnel.
DEPENDENCE ON SUPPLIERS. We do not maintain any long-term supply
agreements with any of our suppliers and the majority of the critical components
and subassemblies included in our 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 our 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. We intend to continue to
rely on outside suppliers because of their specialized expertise in component
fabrication and subsystem assembly. Our 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. There
can be no assurance that delays or shortages caused by suppliers will not occur.
Any inability to obtain adequate, timely deliveries of subassemblies and
components could prevent us from meeting scheduled shipment dates, which would
damage relationships with current and prospective customers and materially
adversely affect our business, financial condition and results of operations.
RISKS OF ACQUISITIONS. Our business strategy includes expanding product
lines and markets through internal product development and/or acquisitions. 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 our 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 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, we have 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 our business and
results of operations.
MARKET PRICE OF SECURITIES. 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 us, have experienced dramatic volatility in the
market prices of their common stock. We believe that factors such as
announcements of developments related to our business or our competitors' or
customers' businesses, fluctuations in our financial results, general conditions
or developments in the semiconductor and computer hard disk drive industries and
the worldwide economy, sales of the Common Stock into the market, announcements
of technological innovations or new or enhanced products by us or our
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
our control could cause the price of our Common Stock to fluctuate, perhaps
substantially. There can be no assurance that the market price of our Common
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Stock will not experience significant fluctuations in the future, including
fluctuations that are material, adverse and unrelated to our performance.
CONTROL BY EXISTING STOCKHOLDERS. As of March 10, 2000, the QC Optics,
Inc. Voting Trust and Kobe Steel USA Holdings, Inc. beneficially owned
approximately 56% of the Company's outstanding shares of Common Stock.
Accordingly, acting together they have the ability to control all matters
requiring approval by our stockholders, including the election of directors.
This concentration of ownership may also have the effect of delaying or
preventing a change of control of QC Optics.
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 66% and 73% of
net sales in Fiscal 1998 and Fiscal 1999, respectively. We anticipate that the
international shipments, principally to Japan 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 our business, financial condition or results of operations. In
particular although our international sales are primarily denominated in U. S.
dollars, currency exchange fluctuations in countries where we do business could
materially adversely affect our business, financial condition and results of
operations by rendering us 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 our senior management, before reaching a
sufficient level of confidence in the system's performance characteristics and
compatibility with the customer's target applications. Accordingly, our systems
typically have a lengthy sales cycle during which we may expend substantial
funds and management time and effort with no assurance that a sale will result.
HEALTH AND SAFETY REGULATIONS AND STANDARDS. Our 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
our customers, have subscribed to voluntary health and safety standards and
decline to purchase equipment not meeting such standards. We believe that our
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 we 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 our 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. We are dependent to a large degree on the experience and
abilities of our Chief Executive Officer, President and Chairman, Eric T. Chase,
and our Vice President of Technology, Jay L. Ormsby. The loss of the services of
either of these individuals could have a material adverse effect on us. The
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Company has entered into employment agreements, containing noncompetition
restrictions, with each of Messrs. Chase and Ormsby. We are 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.
Our future success and growth strategy will depend in large part upon
our ability to attract and retain highly skilled managerial, technical and
marketing personnel. Competition for such personnel in our industry is intense.
No assurance can be given that we will be successful in attracting or retaining
the qualified personnel necessary for our business and anticipated growth, and
the failure to attract or retain such personnel could have a material adverse
effect on our business, financial condition and results of operations.
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, 1998 and December 31, 1999............... F-3
Statements of Operations for the years ended December 31, 1998 and
December 31, 1999....................................................... F-4
Statements of Stockholders' Equity for the years ended
December 31, 1998 and December 31, 1999................................. F-5
Statements of Cash Flows for the years ended December 31, 1998
and December 31, 1999................................................... F-6
Notes to Financial Statements.............................................. F-7
ITEM 8. CHANGE IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
None.
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PART III
Items 9 to 12 are incorporated by reference to our definitive Proxy
Statement to be filed with the Securities and Exchange Commission in April 2000.
Item 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 Aurora Imaging Technology, 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.
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Exhibit
No. Title
- ------- -----
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.
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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 28, 2000
- ---------------------------------- and Chairman of the Board of
Eric T. Chase Directors (Principal Executive
Officer)
/s/ Richard C. Allard Vice President of Finance and March 28, 2000
- ---------------------------------- Treasurer (Principal Financial
Richard C. Allard and Principal Accounting Officer)
/s/ Allan Berman Director March 28, 2000
- ---------------------------------
Allan Berman
/s/ John M. Tarrh Director March 28, 2000
- ---------------------------------
John M. Tarrh
</TABLE>
-23-
<PAGE>
QC OPTICS, INC.
INDEX
PAGE
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS F-2
BALANCE SHEETS AS OF DECEMBER 31, 1998 AND 1999 F-3
STATEMENTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1999 F-4
STATEMENTS OF STOCKHOLDERS' EQUITY FOR THE YEARS ENDED DECEMBER 31,
1998 AND 1999 F-5
STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1999 F-6
NOTES TO FINANCIAL STATEMENTS F-7
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, 1998 and 1999, and the related statements of
operations, stockholders' equity and cash flows for the years ended December 31,
1998 and 1999. 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 auditing standards generally accepted
in the United States. 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, 1998 and 1999, and the results of its operations and its cash flows for the
years ended December 31, 1998 and 1999, in conformity with accounting principles
generally accepted in the United States.
ARTHUR ANDERSEN LLP
Boston, Massachusetts
February 23, 2000
F-2
<PAGE>
QC OPTICS, INC.
BALANCE SHEETS--DECEMBER 31, 1998 AND 1999
ASSETS
<TABLE>
<CAPTION>
1998 1999
<S> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents $ 3,313,889 $ 3,844,168
Accounts receivable, less allowance of $50,000 at December 31, 1998 and 1999 1,897,564 1,125,994
Inventory 3,732,134 2,861,571
Refundable income taxes -- 201,494
Prepaid expenses 68,001 58,056
------------- -------------
Total current assets 9,011,588 8,091,283
PROPERTY AND EQUIPMENT, NET 176,125 125,314
DEFERRED TAX ASSETS 243,500 --
OTHER ASSETS 35,656 4,591
------------- -------------
Total assets $ 9,466,869 $ 8,221,188
============= =============
CURRENT LIABILITIES:
Accounts payable $ 119,414 $ 102,710
Accrued payroll and related expenses 271,244 252,289
Accrued commissions 9,615 21,539
Accrued expenses 455,491 478,153
Customer deposits 132,432 89,146
--------------- -------------
Total current liabilities 988,196 943,837
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY:
Preferred stock, $.01 par value-
Authorized--1,000,000 shares
Issued and outstanding--No shares at December 31, 1998 and 1999 -- --
Common stock, $.01 par value-
Authorized--10,000,000 shares
Issued and outstanding--3,242,500 shares at December 31, 1998 and 1999 32,425 32,425
Additional paid-in capital 9,902,886 9,902,886
Accumulated deficit (1,456,638) (2,657,960)
--------------- -------------
Total stockholders' equity 8,478,673 7,277,351
--------------- ------------
Total liabilities and stockholders' equity $ 9,466,869 $ 8,221,188
============= ==============
</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, 1998 AND 1999
<TABLE>
<CAPTION>
1998 1999
<S> <C> <C>
NET SALES $ 9,909,876 $ 5,350,247
COST OF SALES 5,248,844 2,846,949
-------------- ----------------
Gross profit 4,661,032 2,503,298
OPERATING EXPENSES:
Selling, general and administrative expenses 3,315,869 2,860,512
Engineering expenses 1,196,393 1,012,512
-------------- ----------------
Total operating expenses 4,512,262 3,873,024
-------------- ----------------
Operating income (loss) 148,770 (1,369,726)
INTEREST INCOME 190,074 191,008
INTEREST EXPENSE (8,961) (7,604)
--------------- ---------------
Income (loss) before provision for income taxes 329,883 (1,186,322)
PROVISION FOR INCOME TAXES 118,800 15,000
-------------- --------------
Net income (loss) $ 211,083 $ (1,201,322)
============== ================
BASIC AND DILUTED NET INCOME (LOSS) PER COMMON AND COMMON EQUIVALENT SHARE $ 0.06 $ (0.37)
========= ==========
BASIC WEIGHTED AVERAGE COMMON SHARES OUTSTANDING 3,242,500 3,242,500
============== ===============
DILUTED WEIGHTED AVERAGE COMMON AND COMMON EQUIVALENT SHARES OUTSTANDING
3,251,465 3,242,500
============== ===============
</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, 1998 AND 1999
<TABLE>
<CAPTION>
Preferred Stock Common Stock Additional Total
Number of Number of Paid-in Accumulated Stockholders'
Shares Par Value Shares Par Value Capital Deficit Equity
<S> <C> <C> <C> <C> <C> <C> <C>
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
Net loss - - - - - (1,201,322) (1,201,322)
----------- ----------- ----------- ----------- ------------ ------------- -------------
BALANCE, DECEMBER 31, 1999 - $ - 3,242,500 $ 32,425 $ 9,902,886 $ (2,657,960) $ 7,277,351
=========== =========== =========== =========== ============ ============ ============
</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, 1998 AND 1999
<TABLE>
<CAPTION>
1998 1999
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $ 211,083 $ (1,201,322)
Adjustments to reconcile net income to net cash used in operating activities-
Depreciation and amortization 82,446 61,886
Decrease in deferred taxes, net 106,000 -
Changes in operating assets and liabilities-
Accounts receivable 611,438 771,570
Inventory 293,294 870,563
Prepaid expenses and other assets 56,241 41,010
Accounts payable (623,149) (16,704)
Accrued expenses (645,761) 57,637
Customer deposits (513,385) (43,286)
--------------- -------------
Total adjustments (632,876) 1,742,676
--------------- -------------
Net cash provided by (used in) operating activities (421,793) 541,354
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment (30,852) (11,075)
--------------- --------------
Net cash used in investing activities (30,852) (11,075)
CASH FLOWS FROM FINANCING ACTIVITIES: - -
--------------- --------------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (452,645) 530,279
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 3,766,534 3,313,889
CASH AND CASH EQUIVALENTS, END OF YEAR $ 3,313,889 $ 3,844,168
=============== ===============
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid (refunded) for-
Interest $ 9,177 $ 7,604
=============== ===============
Income taxes $ 242,450 $ (48,105)
=============== ================
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-6
<PAGE>
QC OPTICS, INC.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1999
(Continued)
(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 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
1998 1999
Products $ 8,479,725 $ 3,944,360
Spares and service 1,430,151 1,405,887
-------------- -------------
Total sales $ 9,909,876 $ 5,350,247
============== =============
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, exchange rate
fluctuations and the availability of components and subassemblies.
F-7
<PAGE>
QC OPTICS, INC.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1999
(Continued)
The Securities and Exchange Commission released Staff Accounting Bulletin
No. 101, Revenue Recognition in Financial Statements (SAB 101), on
December 3, 1999. This SAB provides additional guidance on the accounting
for revenue recognition including both broad conceptual discussion as
well as certain industry-specific guidance. The Company is in the process
of accumulating the information necessary to quantify the potential
impact of this new guidance, if any.
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, 1998 and
1999 amounted to approximately $415,000 and $443,000 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,
1998 1999
Raw materials and finished parts $ 1,815,183 $ 1,270,450
Work-in-process 1,189,882 1,002,563
Finished goods 727,069 588,558
-------------- --------------
$ 3,732,134 $ 2,861,571
============== ==============
Work-in-process and finished goods inventories include material, labor
and manufacturing overhead.
F-8
<PAGE>
QC OPTICS, INC.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1999
(Continued)
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.
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:
ESTIMATED
ASSET CLASSIFICATION USEFUL LIFE
Furniture and fixtures 3-8 years
Machinery and equipment 3-8 years
Motor vehicles 3-5 years
Accumulated depreciation of property and equipment was $484,974 and
$331,603 at December 31, 1998 and 1999, respectively.
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 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:
NET SALES FOR THE ACCOUNTS RECEIVABLE AS OF
YEARS ENDED DECEMBER 31, DECEMBER 31,
1998 1999 1998 1999
Company A $ 5,400,000 $ 3,485,000 $ 1,447,000 $ 384,000
Company B 1,693,000 108,000 2,000 27,000
Company C 260,000 644,000 15,000 457,000
F-9
<PAGE>
QC OPTICS, INC.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1999
(Continued)
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
$2,991,000 and $3,863,000 at December 31, 1998 and 1999, respectively.
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
1998 1999
United States $ 3,453,854 $ 1,448,447
Japan 1,906,440 107,687
Thailand 1,798,652 1,368
Malaysia 2,486,663 3,087,285
Other 264,267 705,460
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. Basic and diluted earnings per common
share for the years ended December 31, 1998 and 1999 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, 1999
(Continued)
COMPREHENSIVE INCOME (LOSS)
Comprehensive income (loss) for the years ended December 31, 1998 and
1999 were equal to the net income (loss) as included in the accompanying
statement of operations for the years ended December 31, 1998 and 1999.
SEGMENT REPORTING
QC Optics operates in one segment and does not analyze its operations
based upon separate geographical or product-line information.
(3) INCOME TAXES
The components of the income tax provision (benefit) are as follows:
FOR THE YEARS ENDED DECEMBER 31,
1998 1999
Current-
Federal $ 4,900 $ -
State 7,900 15,000
--------- ----------
12,800 15,000
--------- ----------
Deferred-
Federal 91,750 -
State 14,250 -
--------- ----------
106,000 -
$ 118,800 $ 15,000
========= ==========
The Company's effective tax rate differs from the federal statutory rate
of 34% in 1998 and 1999 due to the following:
1998 1999
Computed tax provision (benefit) at statutory rate $ 112,160 $ (403,349)
Increase resulting from-
State taxes 971 15,000
Net operating losses not benefited - 394,994
Items not deductible for income tax purposes 5,669 8,355
----- -----
$ 118,800 $ 15,000
========= ==========
F-11
<PAGE>
QC OPTICS, INC.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1999
(Continued)
Deferred income taxes at December 31, 1998 and 1999 consisted of the
following:
1998 1999
Deferred tax assets-
Inventories $ 580,000 $ 580,000
Other reserves 210,000 222,000
Net operating loss carryforwards 432,000 815,000
-------------- ---------------
Total gross deferred tax assets 1,222,000 1,617,000
Less--Valuation allowance 978,500 1,617,000
-------------- --------------
Net deferred tax assets $ 243,500 $ -
============== ===============
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 from
the management buyout and uncertainty surrounding the ability of the
Company to generate future income have caused management to conclude that
realizability of the deferred tax assets as of December 31, 1999 is
uncertain and has, therefore, provided a full valuation allowance against
its deferred tax assets.
For tax reporting purposes, the Company has a U.S. federal net operating
loss carryforward of approximately $2,397,000, subject to Internal
Revenue Service (IRS) review and approval, of which $1,432,000 is subject
to the limitations of stock ownership changes discussed above.
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 2009 if not utilized.
F-12
<PAGE>
QC OPTICS, INC.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1999
(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, 1998 and 1999 amounted to
approximately $253,000 and $298,000, respectively. Future minimum
commitments under all noncancelable operating leases are approximately as
follows:
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 $100,000 and $113,000
related to contributions to the Plan for the years ended December 31,
1998 and 1999, respectively. Included in accrued expenses is
approximately $71,000 and $79,000 for Company matching and discretionary
contributions to the Plan for the years ended December 31, 1998 and 1999,
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 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 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 1999, the
Company granted options under the 1996 Plan for the purchase of 16,500
shares at $1.220 per share, the estimated fair market
F-13
<PAGE>
QC OPTICS, INC.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1999
(Continued)
value on the date of grant, which become exerciseable 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 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 (loss) and net
income (loss) per common and common equivalent shares would have been as
follows:
1998 1999
Net income (loss)-
As reported $ 211,083 $ (1,201,322)
Pro forma 100,596 (1,287,894)
Diluted net income (loss) per common and
common equivalent shares-
As reported $ .06 $ (.37)
Pro forma .03 (.40)
F-14
<PAGE>
QC OPTICS, INC.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1999
(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:
1998 1999
Volatility 46% 69%
Risk-free interest rate 4.97% 5.41%
Expected life of options 4.44 years 5.00 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, 1999
(Continued)
STOCK OPTION ACTIVITY
A summary of the Company's stock option activity is as follows:
<TABLE>
<CAPTION>
Year Ended December 31, 1998
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 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 options
(whose exercise price equals market
value) granted or repriced during the year $ 0.97 $ 1.48
========= =========
Year Ended December 31, 1999
1996 Plan Formula Plan
Weighted Weighted
Number of Average Number of Average
Shares Exercise Price Shares Exercise Price
Options outstanding, beginning of
year 240,372 $ 3.78 45,000 $ 3.50
Granted 16,500 1.22 - -
Exercised - - - -
Forfeited (15,676) 1.30 (4,688) 3.63
------------ ---------
Options outstanding, end of year 241,196 $ 3.77 40,312 $ 3.49
============ ========= =========== =========
Options exercisable 199,182 $ 4.29 32,812 $ 3.52
============ ========= =========== =========
Options available for grant 118,804 59,688
============ ===========
Weighted-average fair value of options
(whose exercise price equals market
value) granted or repriced during the year $ 0.86 $ -
========= =========
</TABLE>
F-16
<PAGE>
QC OPTICS, INC.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1999
(Continued)
A summary of the status of the Company's stock options at December 31,
1999 is as follows:
Number of Number of
Options Options Remaining Contractual
Exercise Price Outstanding Exerciseable Life
1996 Plan
$ 1.220 13,500 0 9 years
$ 1.313 105,196 76,682 6.5 to 9 years
$ 5.100 15,000 15,000 6.5 years
$ 6.300 107,500 107,500 6.5 years
Formula Plan
$ 3.250 15,000 9,375 7.5 years
$ 3.625 25,312 23,437 6.5 years
F-17
<PAGE>
QC OPTICS, INC.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1999
(Continued)
(7) COMMON STOCK WARRANTS
At December 31, 1999, there were outstanding warrants to purchase
1,092,500 shares of the Company's Common Stock for $7.80 per share
expiring October 23, 2001. The warrants are redeemable by the Company at
$.20 per redeemable warrant on 30 days prior written notice, provided
that the average closing bid price of the Common Stock equals or exceeds
$10.80 per share for 20 consecutive trading days ending within 10 days
prior to the notice of redemption.
(8) REVOLVING LINE OF CREDIT
The Company has a revolving line-of-credit with Citizens Bank (formerly
State Street Bank and Trust Company). The revolving line-of-credit
agreement 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 (8.5% at December
31, 1999). 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, 1999 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, 1999. At December 31, 1999 the Company had no borrowings
outstanding under the revolving line-of-credit agreement and availability
of approximately $573,000.
(9) 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. The Voting Trust represented approximately 42% of the
Company's outstanding shares at December 31, 1999.
F-18
Exhibit 23
Consent 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 24, 2000
<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,
1999 and is qualified in its entirety by reference to such financial statements.
</LEGEND>
<S> <C>
<PERIOD-TYPE> Year
<FISCAL-YEAR-END> Dec-31-1999
<PERIOD-START> Jan-01-1999
<PERIOD-END> Dec-31-1999
<CASH> 3,844,168
<SECURITIES> 0
<RECEIVABLES> 1,175,994
<ALLOWANCES> 50,000
<INVENTORY> 2,861,571
<CURRENT-ASSETS> 8,091,283
<PP&E> 456,917
<DEPRECIATION> 331,603
<TOTAL-ASSETS> 8,221,188
<CURRENT-LIABILITIES> 943,837
<BONDS> 0
0
0
<COMMON> 32,425
<OTHER-SE> 7,244,926
<TOTAL-LIABILITY-AND-EQUITY> 8,221,188
<SALES> 5,350,247
<TOTAL-REVENUES> 5,350,247
<CGS> 2,846,949
<TOTAL-COSTS> 2,846,949
<OTHER-EXPENSES> 3,873,024
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> (183,404)
<INCOME-PRETAX> (1,186,322)
<INCOME-TAX> 15,000
<INCOME-CONTINUING> (1,201,322)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (1,201,322)
<EPS-BASIC> (.37)
<EPS-DILUTED> (.37)
</TABLE>
