SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
Quarterly Report Pursuant to Section 13 or 15 (d)
of the Securities Exchange Act of 1934
For the Quarterly Period Ended September 30, 1998
Commission File Number 0-7092
RELIABILITY INCORPORATED
----------------------------------------------------
(Exact name of registrant as specified in its charter)
TEXAS 75-0868913
- -------------------------------- ------------------------------------
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
16400 Park Row
Post Office Box 2318370
Houston, Texas 77218-8370
- ---------------------------------------- ----------
(Address of principal executive offices) (Zip Code)
(281) 492-0550
---------------
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of
1934 during the preceding twelve 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 ninety days.
YES X NO
------- -------
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
6,125,812 - Common Stock - No Par Value
as of October 30, 1998
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RELIABILITY INCORPORATED
FORM 10-Q
TABLE OF CONTENTS
September 30, 1998
PART I - FINANCIAL INFORMATION
Page No.
Item 1. Financial Statements:
Consolidated Balance Sheets:
September 30, 1998 and December 31, 1997 3-4
Consolidated Statements of Income:
Nine Months Ended September 30, 1998 and 1997 5
Three Months Ended September 30, 1998 and 1997 6
Consolidated Statements of Cash Flows:
Nine Months Ended September 30, 1998 and 1997 7
Notes to Consolidated Financial Statements 8-14
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 15-23
PART II - OTHER INFORMATION
Item 1.
through
Item 5. Not applicable.
Item 6. Exhibits and Reports on Form 8-K 24
Signatures 25
The information furnished in this report reflects all adjustments (none of
which were other than normal recurring accruals) which are considered
necessary, in the opinion of management, for a fair statement of the results of
the interim periods presented.
2
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PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
RELIABILITY INCORPORATED
CONSOLIDATED BALANCE SHEETS
(In thousands)
ASSETS
September 30, December 31,
1998 1997
(unaudited)
Current assets:
Cash and cash equivalents $14,832 $ 7,108
Accounts receivable 5,146 6,753
Inventories 2,053 4,156
Deferred tax assets 569 601
Other current assets 496 501
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Total current assets 23,096 19,119
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Property, plant and equipment, at cost:
Machinery and equipment 11,672 16,279
Building and improvements 5,022 7,958
Land 530 792
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17,224 25,029
Less accumulated depreciation 9,940 14,347
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7,284 10,682
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Assets held for sale 2,193 -
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$32,573 $29,801
======= =======
See accompanying notes
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RELIABILITY INCORPORATED
CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)
LIABILITIES AND STOCKHOLDERS' EQUITY
September 30, December 31,
1998 1997
(unaudited)
Current liabilities:
Current maturities on long-term debt $ 849 $ 401
Accounts payable 189 1,659
Accrued liabilities 3,719 4,426
Income taxes payable 1,184 727
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Total current liabilities 5,941 7,213
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Long-term debt - 1,560
Deferred tax liabilities 512 386
Commitments and contingencies - -
Stockholders' equity:
Common stock, without par value;
20,000,000 shares authorized, 7,330,850
and 7,269,502 shares issued in 1998
and 1997, respectively 7,181 6,690
Retained earnings 26,783 21,844
------- -------
33,964 28,534
Less treasury stock at cost, 1,206,762
and 1,214,211 shares in 1998 and 1997,
respectively 7,844 7,892
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Total stockholders' equity 26,120 20,642
------- -------
$32,573 $29,801
======= =======
See accompanying notes
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RELIABILITY INCORPORATED
CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except per share data)
Nine Months Ended September 30,
1998 1997
(unaudited)
Revenues $29,826 $32,794
Costs and expenses:
Cost of revenues 13,943 16,220
Marketing, general and administrative 6,871 6,634
Research and development 1,636 1,176
Provision for asset impairment 100 -
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22,550 24,030
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Operating income 7,276 8,764
Interest income (expense), net 295 (104)
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Income before income taxes 7,571 8,660
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Provision for income taxes:
Current 2,474 2,895
Deferred 158 36
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2,632 2,931
------- -------
Net income $ 4,939 $ 5,729
======= =======
Earnings per share:
Diluted $ .80 $ .85
======= =======
Basic $ .81 $ .86
======= =======
Weighted average shares:
Diluted 6,208 6,730
======= =======
Basic 6,088 6,656
======= =======
See accompanying notes
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RELIABILITY INCORPORATED
CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except per share data)
Three Months Ended September 30,
1998 1997
(unaudited)
Revenues $9,203 $13,494
Costs and expenses:
Cost of revenues 4,230 6,448
Marketing, general and administrative 2,493 2,644
Research and development 533 338
------ -------
7,256 9,430
------ -------
Operating income 1,947 4,064
Interest income (expense), net 150 (11)
------ -------
Income before income taxes 2,097 4,053
------ -------
Provision for income taxes:
Current 771 1,313
Deferred 21 73
------ -------
792 1,386
------ -------
Net income $1,305 $ 2,667
====== =======
Earnings per share:
Diluted $ .21 $ .43
====== =======
Basic $ .21 $ .45
====== =======
Weighted average shares
Diluted 6,189 6,178
====== =======
Basic 6,111 5,962
====== =======
See accompanying notes
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RELIABILITY INCORPORATED
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
Nine Months Ended September 30,
1998 1997
(unaudited)
Cash flows from operating activities:
Net income $ 4,939 $ 5,729
Adjustments to reconcile net income to cash
provided by operating activities:
Depreciation 1,403 1,136
Deferred tax provision 158 36
Provision for inventory obsolescence 49 223
Provision for asset impairment 100 -
Increase (decrease) in operating cash flows:
Accounts receivable 1,607 (4,076)
Inventories 2,054 (1,473)
Other current assets (9) (137)
Prepaid income taxes - 286
Accounts payable (1,470) 1,201
Accrued liabilities (707) 869
Income taxes payable 457 571
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Total adjustments 3,642 (1,364)
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Net cash provided by operating activities 8,581 4,365
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Cash flows from investing activities:
Expenditures for property, plant and equipment (755) (2,513)
Proceeds from sale of equipment 471 -
------ ------
Net cash (used) in investing activities (284) (2,513)
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Cash flows from financing activities:
Payments on long-term debt (1,112) (272)
Borrowings under revolving credit facility 105 6,969
Payments under revolving credit facility (105) (6,969)
Proceeds from issuance of common and treasury
stock pursuant to stock options and employee
stock savings plans 490 525
Purchase of treasury stock - (8,256)
Other 49 -
------ ------
Net cash (used) by financing activities (573) (8,003)
------ ------
Net increase (decrease) in cash 7,724 (6,151)
Cash at beginning of period 7,108 8,504
------ ------
Cash at end of period $14,832 $ 2,353
====== ======
Supplemental disclosures:
Interest paid $ 109 $ 243
====== ======
Income taxes paid $ 1,923 $ 2,031
====== ======
See accompanying notes
7
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RELIABILITY INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 1998
1. NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Description of Business
- -----------------------
Reliability Incorporated is a United States based corporation with
operations in the United States, Singapore and Costa Rica. The Company and its
subsidiaries are principally engaged in the design, manufacture and sale of
equipment used to test and condition integrated circuits. Subsidiaries of the
Company operate a service facility which conditions integrated circuits as a
service to others and manufacture and sell power sources, primarily a line of
DC to DC power converters. The Company's testing products are sold to companies
that manufacture semiconductor products and are shipped to locations in the
U.S., Europe, Asia and Pacific Rim countries. Services have been provided
principally to only two customers, one in the U.S. (Durham, North Carolina) and
one in Singapore. The Company's U.S. services facility was closed in April 1998
(See Note 6) and operations at the Singapore facility will be affected by
events discussed in a Subsequent Events footnote (See Note 7). Power sources
are sold to U.S., European and Asian based companies that design and sell
electronic equipment.
The consolidated financial statements include the accounts of the Company
and its subsidiaries, all of which are wholly owned. All significant
intercompany balances and transactions have been eliminated in consolidation.
The accompanying unaudited financial statements have been prepared in
accordance with generally accepted accounting principles for interim financial
information and the instructions to Form 10-Q and Rule 10-01 of Regulation S-X.
Accordingly, they do not include all of the information and footnotes required
by generally accepted accounting principles for complete financial statements.
In the opinion of management, adjustments (consisting of normal recurring
accruals) considered necessary for a fair presentation have been included.
Operating results for the interim period ended September 30, 1998 are not
necessarily indicative of the results that may be expected for the year. For
further information, refer to the financial statements and footnotes thereto
included in the Company's annual report on Form 10-K for the year ended
December 31, 1997.
Accounting 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 period. Actual results may differ from those estimates.
8
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RELIABILITY INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 1998
Stock Dividend
- --------------
On September 5, 1997, the Company's Board of Directors declared a two-for-
one stock split effected as a 100% stock dividend which was distributed on
October 6, 1997, to shareholders of record on September 22, 1997. The stock
split was recorded by a transfer of $30,000 from retained earnings to common
stock, representing $0.01 value for each additional share issued. Weighted
average share and per share data have been restated to reflect the stock split.
Treasury stock information has not been restated because the stock split in the
form of a dividend did not apply to treasury stock.
Segment Information
- -------------------
In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standard No. 131 - "Disclosures about Segments of an
Enterprise and Related Information" ("SFAS No. 131"). Although SFAS No. 131 is
effective beginning the first quarter of 1998, the Company has elected not to
report segment information in interim financial statements in the first year of
application, consistent with the provisions of the statement.
Comprehensive Income
- --------------------
As of January 1, 1998, the Company adopted Statement of Financial
Accounting Standards No. 130 - "Reporting Comprehensive Income" ("SFAS No.
130"). SFAS No. 130 establishes new rules for reporting and display of
comprehensive income and certain components of comprehensive income which are
referred to as "Other Comprehensive Income". The Company does not have any
items of Other Comprehensive Income; thus the adoption of SFAS No. 130 had no
impact on the Company's net income or shareholders' equity. During the nine
month periods ending September 30, 1998 and 1997, total comprehensive income
amounts were $4,939,000 and $5,729,000, respectively, which are the same as net
income.
Accounting for Derivative Instruments and Hedging Activities
- -----------------------------------------------------------
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133 - "Accounting for Derivative Instruments
and Hedging Activities" ("SFAS No. 133"), which is required to be adopted in
years beginning after June 15, 1999. Because the Company does not use
derivatives, adoption of the new Statement will not have an effect on earnings
or the financial position of the Company.
9
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RELIABILITY INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 1998
Inventories
- -----------
Inventories are stated at the lower of standard cost (which approximates
first-in, first-out) or market (replacement cost or net realizable value) and
include (in thousands):
September 30, December 31,
1998 1997
Raw materials $1,124 $1,611
Work-in progress 798 2,189
Finished goods 131 356
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$2,053 $4,156
====== ======
Inventories are presented net of reserves for excess and obsolete
inventories of $914,000 and $871,000 at September 30, 1998 and December 31,
1997, respectively.
Income Taxes
- ------------
Deferred income taxes are provided under the liability method and reflect
the net tax effects of temporary differences between the tax basis of assets
and liabilities and their reported amounts in the consolidated financial
statements.
The differences between the effective rate reflected in the provision for
income taxes on income before income taxes and the amounts determined by
applying the statutory U.S. tax rate of 34% are analyzed below (in thousands)
for the nine month periods ended:
September 30,
1998 1997
Provision at statutory rate $2,574 $2,944
Tax effects of:
Lower effective income tax rates related
to undistributed foreign earnings (158) (272)
Foreign losses for which a tax benefit is
not available 185 167
State income taxes, net 48 101
Change in valuation allowance - (114)
Other (17) 105
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Provision for income taxes $2,632 $2,931
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RELIABILITY INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 1998
Effective January 1, 1997, the Company changed its policy with respect to
providing U.S. income taxes on undistributed earnings of a foreign subsidiary.
Demand for services provided by the subsidiary necessitated permanently
reinvesting future earnings of the subsidiary. Deferred U.S. income taxes have
not been provided on earnings of the subsidiary that were accumulated after
January 1, 1997.
2. LONG-TERM DEBT AND DEBT AGREEMENTS
Long-term debt consisted of the following:
September 30, December 31,
1998 1997
(in thousands)
Mortgage payable; due in monthly install-
ments of $26,777 ($196,777 as explained
below), including interest at 9% $ 849 $1,961
Revolving line of credit (described below) - -
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849 1,961
Less current maturities 849 401
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Long-term debt due after one year $ -0- $1,560
====== ======
The mortgage was payable in 180 equal monthly installments, including
interest at 9%. The Company began making additional principal payments of
$20,000 each month in 1997 and $170,000 each month in 1998. Current maturities
as of September 30, 1998 assume the Company will continue making the additional
$170,000 principal payment, resulting in the note being paid in full on
March 1, 1999. The mortgage is collateralized by land and a building.
During 1997, the Company amended its Loan Agreement with Wells Fargo Bank
Texas, N.A. to increase its credit availability to $4.0 million (compared to
$2.0 million at December 31, 1996) and to extend the term of the Loan Agreement
to December 31, 1999. Interest is payable at the Bank's prime rate minus 1/4%
(8% at September 30, 1998). The unpaid principal of the note is due
December 31, 1999. The Loan Agreement provides for a revolving line of credit,
secured by substantially all assets of the Company which are located in the
U.S., except for land and buildings. The credit facility requires compliance
with certain financial loan covenants related to the Company's current ratio,
debt service coverage and funded debt to net income before income taxes plus
non-cash items plus interest expense. The agreement prohibits the payment of
cash dividends by the Company unless otherwise agreed to by the bank. The
Company was in compliance with the financial requirements of the agreement at
September 30, 1998, and there were no balances outstanding under the agreement
at September 30, 1998 or December 31, 1997.
11
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RELIABILITY INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 1998
The Company's Singapore subsidiary maintains an agreement with a Singapore
bank to provide an overdraft facility to the subsidiary of 500,000 Singapore
dollars (U.S. $296,000) at the bank's prime rate plus 2% (9.25% at September
30, 1998). There were no balances outstanding at September 30, 1998, but
amounts utilized under letter of credit commitments totaled $135,000, resulting
in credit availability of $161,000 at September 30, 1998. The loan is
collateralized by all assets of the subsidiary and requires maintenance of a
minimum net worth of the Singapore subsidiary. Payment of dividends requires
written consent from the bank, and continuation of the credit facility is at
the discretion of the bank.
Interest income (expense) for the nine month periods ended September 30,
is presented net as follows (in thousands):
1998 1997
Interest income $404 $ 138
Interest (expense) (109) (242)
---- ----
Interest income (expense), net $295 $(104)
==== ====
3. TREASURY STOCK PURCHASE
In March 1997, the Company purchased 1,270,221 shares of its common stock
from a shareholder for $6.50 per share. The treasury stock may be used to issue
shares under the 1997 Stock Option Plan and to fund the Company's contributions
to its employee stock savings plan.
4. COMMITMENTS
A subsidiary of the Company leases a conditioning services and office
facility under a non-cancelable operating lease agreement expiring in 2000.
Future minimum rental payments under the lease at September 30, 1998 are as
follows: 1998 - $68,000; 1999 - $280,000; and 2000 - $132,000.
The Company leases manufacturing and office space in its U.S. facility to
a third party under an agreement expiring in January 2001. Future income under
the lease will be: 1998 - $45,000; 1999 - $179,000; 2000 - $179,000; and
2001 - $15,000.
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RELIABILITY INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 1998
5. EARNINGS PER SHARE
The following table sets forth the computation of basic and diluted
earnings per share (in thousands, except per share data):
Nine months ended Three months ended
September 30, September 30,
1998 1997 1998 1997
Numerator for basic and diluted
earnings per share - net income $4,939 $5,729 $1,305 $2,667
===== ===== ===== =====
Denominator:
Denominator for basic earnings per
share - weighted average shares 6,088 6,656 6,111 5,962
Dilutive effect assuming
conversion of stock options 120 74 78 216
----- ----- ----- -----
Denominator for diluted earnings per
share - adjusted weighted average
shares and assumed conversions 6,208 6,730 6,189 6,178
===== ===== ===== =====
Earnings per share:
Diluted $ .80 $ .85 $ .21 $ .43
===== ===== ===== =====
Basic $ .81 $ .86 $ .21 $ .45
===== ===== ===== =====
Stock options related to the purchase of 243,000 shares of common stock
were not included in the computation of diluted earnings per share for the
first three quarters of 1998 because the options' respective exercise prices
were greater than the average market price of the common stock and, therefore,
the effect would have been antidilutive.
6. SHUT-DOWN OF FACILITY AND ASSETS HELD FOR SALE
The Company's North Carolina services facility accounted for approximately
10% of consolidated revenues in 1997 and provided service to one customer. The
customer notified the Company in January 1998 that it was necessary to reduce
the output of DRAMs burned-in and tested by the Company's Durham facility. The
customer ceased sending product and the Company shut down the facility in April
1998. The Company recorded a $100,000 impairment reserve related to the land
and building located at the Durham facility in the first quarter of 1998 in
order to state these assets at the lower of carrying amount or fair value, less
cost to sell. The land and a building located in Durham are presented as assets
held for sale in the accompanying consolidated balance sheet. The assets held
for sale are being actively marketed, although no assurances can be given that
they will be sold during 1998.
13
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RELIABILITY INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 1998
In connection with the shut-down of the facility, 46 Durham employees were
terminated. Severance and other related shut-down costs, which were not
material, were recorded in the first quarter of 1998, and it is currently
estimated that there will be no significant additional expenses related to the
shut-down.
7. SUBSEQUENT EVENTS
Texas Instruments Incorporated has accounted for substantially all of the
revenues of the Company's Singapore services facility. On October 1, 1998
Micron Technology acquired the Texas Instruments facility in Singapore and
informed the Company that it will continue to utilize the Company's burn-in
services for a period of six to nine months. Texas Instruments' revenues at the
Singapore facility accounted for 32% of consolidated revenues for the year
ended December 31, 1997 and 24% of consolidated revenues for the nine months
ended September 30, 1998.
On October 13, 1998, the Company announced that it had signed a letter of
intent to purchase certain assets of Best I.C. Laboratories, Inc. ("Best")
located in Austin, Texas and Singapore. Best operates services facilities that
are similar to the Company's Singapore facility.
The Company will incur costs during 1998, and possibly 1999, related to
the downsizing of the Singapore operation and/or integration of the Singapore
operations of the Company and Best. The Company's current estimate is that
costs of $1.5 million will be incurred related to the changes in operations at
the Singapore facility. The costs will relate to personnel reductions,
integration of operating facilities, elimination of duplicate functions and
disposal of excess equipment. The amount of the costs to be recorded cannot be
determined until the Best negotiations are concluded because acquiring the Best
assets will have an impact on the future operations of the Singapore facility.
The Company currently estimates that the Best transaction, if concluded, will
be completed by November 30, 1998.
14
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RELIABILITY INCORPORATED
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
September 30, 1998
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
This Management's Discussion and Analysis of Financial Condition and
Results of Operations and other parts of this document contain forward-looking
statements that involve risks and uncertainties. All forward-looking statements
included in this document are based on information available to the Company on
the date hereof, and the Company assumes no obligation to update any such
forward-looking statements. The Company's actual results could differ
materially from those anticipated in these forward-looking statements as a
result of a number of factors, including those set forth elsewhere in this
document.
FINANCIAL CONDITION
The primary sources of Reliability's liquidity are cash provided by
operations and retained earnings. The Company and its Singapore subsidiary have
substantial cash available to support liquidity requirements in 1998 and 1999.
The Company maintains lines of credit to supplement the primary sources of
capital. Changes in the Company's financial condition and liquidity since
September 30, 1997 are generally attributable to changes in cash flows from
operating activities, the purchase of 1.3 million shares of the Company's
Common Stock in March 1997 and repayment, in 1997, of borrowings that were used
to partially finance the purchase of the Common Stock. In addition, the shut-
down of the Company's North Carolina services facility in 1998 and the
anticipated substantial changes in operations at the Company's Singapore
facility will, during late 1998 and early 1999, negatively affect the Company's
future financial condition.
Certain ratios and amounts monitored by management in evaluating the
Company's financial resources and performance are presented in the following
chart. The periods presented related to the profitability ratios are for the
nine months ended September 30, and twelve months ended December 31:
September 30, December 31, September 30,
1998 1997 1997
Working capital:
Working capital (in thousands) $17,155 $11,906 $8,966
Current ratio 3.9 to 1 2.7 to 1 2.2 to 1
Equity ratios:
Total liabilities to equity 0.3 0.4 0.5
Assets to equity 1.3 1.4 1.5
Profitability ratios:
Gross profit 53 % 50 % 51 %
Return on revenues 17 % 17 % 17 %
Return on assets (annualized) 20 % 27 % 28 %
Return on equity (annualized) 25 % 39 % 43 %
15
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RELIABILITY INCORPORATED
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
September 30, 1998
The Company's financial condition improved throughout 1997 and 1998.
Working capital increased to a very healthy $17.2 million at September 30,
1998, from $9.0 million at September 30, 1997, and the ratio of current assets
to current liabilities increased from 2.2 to 1 at September 30, 1997, to 3.9 to
1 at September 30, 1998. The Company's current ratio and working capital were
lower at September 30, 1997, due to the fact the Company had used excess cash
to partially fund the purchase of treasury stock in March 1997. The Company
purchased 1.3 million shares from a shareholder for $8.3 million. The Company
used $5.8 million of its cash balances and $2.5 million from its line of credit
to purchase the stock. The amount borrowed was paid in full during the third
quarter of 1997. The Company obtained increases in its available line of credit
from $2.0 million to $7.5 million in March 1997 and to $20 million in August
1997. The changes related to the purchase of Company stock and possible need to
finance increases in capital expenditures and other working capital items. The
need to purchase capital assets and finance working capital items did not
materialize, thus the amount available under the line of credit was reduced to
$4.0 million on December 31, 1997. Cash provided by operating activities
totaled $8.6 million for the nine month period ended September 30, 1998 and
contributed to the increase in cash from $7.1 million at December 31, 1997 to
$14.8 million at September 30, 1998.
Demand for the Company's products and services increased during the first
quarter of 1998 resulting in an increase in the Company's backlog to $16.7
million at March 31, 1998, compared to $14.1 million at December 31, 1997.
Backlog declined to $3.0 million at September 30, 1998 due to significant
decreases in demand, during the second and third quarters of 1998, for products
and services sold by the Company. The decline in demand for products and
services sold by the Company is related to several factors that are affecting
the semiconductor industry. Excess production capacity, changes in demand for
various products, a significant decline in the sales price of DRAMs and other
less significant factors have resulted in the Company's customers significantly
reducing purchases of products and services from the Company during the second
and third quarters of 1998. Information available at this time indicates that
the reduced demand may continue for an indefinite period.
Net cash provided by operating activities for the nine months ended
September 30, 1998 was $8.6 million, compared with $4.4 million provided by
operations in the first nine months of 1997. The principal items contributing
to the cash provided by operations in 1998 were net income plus depreciation
which totaled $6.3 million and decreases in inventories and accounts receivable
of $2.1 and $1.6 million, respectively. Cash provided by operations was reduced
by a $1.5 million decrease in accounts payable and a $0.7 million decrease in
accrued liabilities. The decreases in accounts receivable, inventories and
accounts payable relate to changes in items of this nature, resulting from the
timing of receipt of purchased items and invoicing customers and collecting
accounts receivable. A decrease in backlog and a decrease in forecasted new
orders contributed to the decrease in inventories, accounts payable and accrued
liabilities during a period of declining operations and revenues. Accrued
liabilities decreased $0.7 million due to payment of performance bonuses
related to 1997 profitability and a general reduction in most items included in
16
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RELIABILITY INCORPORATED
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
September 30, 1998
accrued liabilities due to payment of year-end accruals in the first quarter of
1998 and a reduction in operations.
The Company does not anticipate that it will incur any additional material
expenses related to the shut-down of the Durham facility (see Note 6), provided
the $2.2 million of assets held for sale at September 30, 1998 can be disposed
of at its current carrying value.
Micron Technology acquired the Texas Instruments Singapore DRAM facility
on October 1, 1998. Texas Instruments accounted for substantially all revenues
at the Company's Singapore services facility. Micron has indicated that it will
phase out the Texas Instruments manufacturing process and install the Micron
process over six to nine months. This will result in a significant reduction in
revenues over the phase-down period. The Singapore subsidiary is working with a
new customer that could replace a portion of the lost revenues and is
negotiating with Micron to provide future services to the Micron facility, but
at significantly reduced levels. In addition, the Company is negotiating with
Best I.C. Laboratories, Inc. to acquire certain Best assets located in Austin
and Singapore. This transaction can replace certain revenues at the Singapore
facility. Costs associated with downsizing and integrating the Singapore
facility with the Best Singapore facility are currently estimated to be
approximately $1.5 million. See Note 7 to the Consolidated Financial Statements
for additional information.
A slow-down in capital spending by the semiconductor industry has resulted
in a significant reduction in new orders for testing equipment sold by the
Company. A softening in demand for semiconductor equipment and a depressed DRAM
pricing environment are factors that are expected to affect the Company's
bookings of new business during the remainder of 1998 and for an indefinite
period in 1999. Based on currently available information, the Company's
forward-looking projections indicate that revenues for the fourth quarter
ending December 31, 1998, assuming the Best transaction (see Note 7) is closed
as projected, will be between $4 and $5 million and revenues for the fiscal
year ending December 31, 1998 will be approximately $33 to $34 million.
Management is optimistic about the long-term outlook for the semiconductor
industry and the Company, but believes that the imbalance in supply and demand
for certain semiconductors will adversely affect the semiconductor equipment
industry and the Company for several more quarters. Significant over-capacity
in the semiconductor industry has resulted in a significant decrease in capital
spending. Reliability's balance sheet and financial condition are very strong
and the Company has the financial resources necessary to weather the downturn,
and will use its resources and work closely with customers to develop the
products that they will require to process future generations of semiconductor
products.
The Company has implemented various measures to reduce expenses. During
1998, worldwide personnel levels decreased 35% through attrition and workforce
reductions. Additional workforce reductions, at selected locations, will be
implemented if necessary. Additional cost reduction measures will be
implemented if necessary, however, the Company will ensure that its research
and development projects and our ability to respond to customer requirements
are not affected.
17
<PAGE>
RELIABILITY INCORPORATED
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
September 30, 1998
Capital expenditures during the first nine months of 1998 and 1997 were
$0.8 million and $2.5 million, respectively. Expenditures for 1998 include
equipment required by the Singapore services facility. Proceeds from the sale
of equipment were $0.5 million in 1998 and relate to the disposal of assets at
the Durham facility. The Company currently forecasts that total capital
expenditures for 1998 will be less than $1.0 million.
The Company believes that its cash and cash equivalent balances, future
cash generated from operations and available lines of credit will be sufficient
to meet the cash requirements of the Company for the remainder of 1998 and
1999.
RESULTS OF OPERATIONS
Nine months ended September 30, 1998 compared to nine months ended
September 30, 1997.
Revenues. Revenues for the 1998 nine-month period were $29.8 million compared
to $32.8 million for the 1997 period. Revenues in the Testing Products segment
increased $3.4 million. Services and Power Sources revenues decreased $6.1 and
$0.3 million, respectively.
Revenues in the Testing Products segment were $19.6 million for the nine
months period of 1998, which is a 21% increase over the nine month period for
1997. The revenue increase relates to increased demand, during early 1998, for
certain products supplied by the semiconductor industry, which translated into
increased requirements for products supplied by the Company. The increase in
demand has declined substantially in the second and third quarters of 1998,
resulting in a significant decrease in backlog in this segment as of
September 30, 1998.
Revenues in the Services segment for the 1998 period were $8.0 million, a
decrease of 43% compared to the corresponding 1997 period. The decrease is
related to both of the Company's services facilities. The Company closed its
North Carolina services facility in April 1998, as explained in the Notes to
the Consolidated Financial Statements. Revenues in the Services segment for the
1998 nine month period decreased $6.1 million compared to the 1997 nine month
period. The shut-down of the North Carolina facility accounted for $2.3 million
of the decrease, volume and unit price decreases at the Singapore facility
accounted for $1.1 million and the remaining decrease of $2.7 million relates
to a reduction in the sale of burn-in boards at the Singapore facility. The
decrease in revenues at the Singapore facility is related to a decrease in
demand and unit price decreases.
Revenues in the Power Sources segment were $2.3 million for the nine month
period of 1998, reflecting a 11% decrease from the 1997 period. Revenues were
affected by an aging product line and a decline in market penetration resulting
in volume decrease. The Company has recently made changes in personnel and has
committed resources that are related to improving future product development
and marketing efforts.
18
<PAGE>
RELIABILITY INCORPORATED
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
September 30, 1998
Costs and Expenses. Total costs and expenses for the 1998 period decreased
$1.5 million or 6% compared to the 9% revenue decrease of $3.0 million. Cost of
revenues decreased $2.3 million, marketing, general and administrative expenses
increased $0.2 million and research and development expenses increased $0.5
million. A provision for asset impairment of $0.1 million, related to the
closing of the North Carolina services facility, was recorded in March 1998.
The increase in gross profit from 51% in the 1997 period to 53% in the
1998 period is attributable to the Testing Products segment. The typical gross
profit in the Testing Products segment is higher than the gross profit in the
other two segments. Revenues in the Testing Products segment accounted for a
higher percent of total consolidated revenues in the 1998 nine month period,
resulting in the increase in gross profit in 1998 compared to 1997.
Marketing, general and administrative expenses for the 1998 period
increased $0.2 million. The increase in expenses is related to an increase in
Testing Products revenues which resulted in an increase in volume related
expenses, such as commissions, warranty and similar expenses. Expenses in the
Services segment declined $0.9 million. Approximately 50% of the decrease
relates to closing of the Company's North Carolina facility in April 1998 and
the balance of the decrease relates to a decrease in volume-related and
variable expenses at the Singapore facility.
The change in net interest reflects an increase in interest income and a
decrease in interest expense. Interest income increased due to a significant
increase in cash and interest expense decreased due to the fact the Company has
accelerated payments on the mortgage related to the Houston facility.
The Company's effective tax rate was 35% for the nine months periods ended
September 30, 1998 and 34% for the comparable 1997 period. The principal items
affecting the Company's tax rate in 1998 and 1997 were tax benefits not
available to a foreign subsidiary due to net operating loss limitations, state
income tax expense, U.S. tax which was not provided on earnings of a foreign
subsidiary and, in 1997, a change in the valuation allowance resulting from
utilization of foreign tax credits.
Three months ended September 30, 1998 compared to three months ended
September 30, 1997.
Revenues. Revenues for the 1998 three-month period were $9.2 million compared
to $13.5 million for the 1997 period. Revenues in the Services, Testing
Products and Power Sources segments decreased $3.3, $0.7 and $0.3 million,
respectively.
19
<PAGE>
RELIABILITY INCORPORATED
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
September 30, 1998
Revenues in the Testing Products segment were $7.3 million for the three
month period of 1998, which is a $0.7 million decrease over the same period in
1997. Revenues from the sale of CRITERIA products decreased $2.3 million and
revenues from the sale of INTERSECT products increased $1.6 million. Revenues
were affected by the same factors discussed in the above nine months
discussion.
Revenues in the Services segment for the 1998 three month period were $1.4
million compared to $4.7 million in the corresponding 1997 period. The shutdown
of the North Carolina facility accounted for $0.9 million of the decrease;
volume decreases at the Singapore facility accounted for $0.9 million; and the
remaining decrease of $1.5 million relates to a reduction in the sale of burn-
in boards at the Singapore facility. The decrease in revenues in the Services
segment is explained in the nine months discussion above.
Revenues in the Power Sources segment were $0.5 million for the three
months ended September 30, 1998, reflecting a 30% decrease from the 1997
period. Revenues were affected by an aging product line and a decline in market
penetration resulting in volume decreases.
Costs and Expenses. Total costs and expenses for the 1998 three month period
decreased $2.2 million or 23% compared to the 32% revenue decrease. Cost of
revenues decreased $2.2 million; marketing, general and administrative expenses
decreased $0.2 million and research and development expenses increased $0.2
million.
The increase in gross profit as a percent of revenues in the 1998 quarter
results from the same factors discussed in the above nine months discussion.
The overall gross profit for 1998 was affected somewhat by a decrease in the
gross profit in the Power Sources segment, which is related to volume
decreases.
Marketing, general and administrative expenses for the 1998 quarter
decreased $0.2 million, or 6% compared to a 32% decrease in revenues. Expenses
in the Services segment declined $0.4 million. Approximately 30% of the
decrease in the Services segment relates to closing the North Carolina facility
and the remaining decrease relates to decreases in volume-related and variable
expenses at the Singapore facility.
The Company's effective tax rate was 38% for the three months ended
September 30, 1998, compared to an effective tax rate of 34% for the 1997
period. In general, items affecting the tax rates for the quarters ended
September 30, 1998 and 1997 are the same as those noted in the nine months
discussion above. The higher effective rate in 1998 relates to the Company's
Singapore and Costa Rica facilities. Tax benefits associated with fixed asset
expenditures in Singapore were lower in 1998 than in 1997 due to a decrease in
expenditures and tax benefits are not available, in 1998, to reduce losses of
the Costa Rica subsidiary.
20
<PAGE>
RELIABILITY INCORPORATED
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
September 30, 1998
The Company disclosed information related to the impact of year
2000 in Form 10-K for the year ended December 31, 1997. The following
information supplements the Form 10-K disclosures.
The Company anticipates completing substantially all known Company year
2000 compliance projects by March 31, 1999. Readiness and compliance by third
parties will be monitored throughout 1999. The overall program has been
classified into three projects:
1. assessment of currently manufactured and supported products;
2. assessment of the Company's internal business and operating
systems; and
3. assessment of the impact of non-compliance by third party companies
that supply material and services to the Company and obtaining
confirmation that the third parties will correct known non-
compliance in a timely manner.
It is currently estimated that the total cost associated with the year
2000 compliance project will not exceed $200,000. Approximately 75% of the cost
has been incurred.
The following is the current status of the three projects:
1. Evaluation of the year 2000 impact on products that are currently
sold by the Company is substantially complete. The Company has
provided year 2000 solutions to customers of currently supported
products. It is estimated that the Company and its customers have
completed approximated 75% of the testing of year 2000 solutions
related to Company supported products. The Company does not provide
year 2000 solutions for products that are no longer in production.
The Company will quote to customers the cost to provide year 2000
solutions for products that are no longer in production. It is
projected that there will be a limited number of requests for year
2000 solutions related to items that are not current products. The
Company believes that products that are being shipped currently and
that will be shipped in the future are year 2000 compliant. The
Company's year 2000 solutions are subject to typical uncertainties,
such as future identification of currently unknown problems and
that products will only be used for a reasonable number of years
related to the technology that the product is designed to process.
2. Internal business and operating systems located at the Company's
three facilities have been evaluated and necessary hardware and
software changes have been identified.
(a) The Houston conversion is approximately 95% complete and
additional testing is the principal item that remains to be
completed.
21
<PAGE>
RELIABILITY INCORPORATED
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
September 30, 1998
(b) The Costa Rica conversion is approximately 80% complete.
Additional hardware and software changes will be completed by
January 31, 1999, and it is estimated that the conversion will be
completed by March 31, 1999.
(c) The Singapore conversion is approximately 25% complete and it
is projected that the conversion will be 80% complete by
January 31, 1999 and substantially complete by March 31, 1999.
3. The Company has communicated with key third party suppliers and has
received responses from approximately 75% of the suppliers.
(a) This project is estimated to be only 50% complete because
certain suppliers have indicated that compliance will not be
completed until various times in 1999.
(b) The major item remaining to be completed is to follow up with
suppliers that have not responded or that are not year 2000
compliant.
(c) The status of this project will be updated quarterly and
specific action steps will be determined each quarter. The Company
and the public in general will be subject to uncertainties related
to continuation of public utility services, availability of major
freight carriers and availability of services from similar
suppliers. The Company will attempt to obtain written assurance
from as many key suppliers as possible and will, throughout 1999,
identify problem areas and develop and implement contingency plans,
if necessary.
The Company's year 2000 compliance project is being implemented based on
information that is generally available concerning identified year 2000
problems. Additional information is continually emerging concerning year 2000
problems and solutions and the Company is using reasonable efforts to assess
and correct year 2000 problems and will, as necessary, update the assessment.
22
<PAGE>
RELIABILITY INCORPORATED
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
September 30, 1998
SAFE HARBOR STATEMENT
"Safe Harbor" Statement under the Private Securities Litigation Reform Act
of 1995: Statements in this Form 10-Q regarding Reliability's business which
are not historical facts are "forward looking statements" that involve risk and
uncertainties, including, but not limited to, market acceptance of Company
products and services, the effects of general economic conditions, the impact
of competition, product development schedules, problems with technology,
delivery schedules, and supply and demand changes for Company products and
services and its customers' products and services. Actual results may
materially differ from projections.
23
<PAGE>
RELIABILITY INCORPORATED
OTHER INFORMATION
Part II. Other information
Items 1 through 5.
Not applicable.
Items 6. Exhibits and Reports on Form 8-K
(a) Exhibits
27.1 Financial Data Schedule
(b) Reports on Form 8-K. There were no reports on Form 8-K filed by the
Company during the quarter ended September 30, 1998.
24
<PAGE>
RELIABILITY INCORPORATED
SIGNATURES
September 30, 1998
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
RELIABILITY INCORPORATED
(Registrant)
November 6, 1998 /s/Larry Edwards
President and
Chief Executive Officer
November 6, 1998 /s/Max T. Langley
Sr. Vice President - Finance
and Chief Financial Officer
25
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information extracted from the
applicable SEC Form and is qualified in its entirety by reference to such
financial statements.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> SEP-30-1998
<CASH> 14,832
<SECURITIES> 0
<RECEIVABLES> 5,146
<ALLOWANCES> 0
<INVENTORY> 2,053
<CURRENT-ASSETS> 23,096
<PP&E> 17,224
<DEPRECIATION> 9,940
<TOTAL-ASSETS> 32,573
<CURRENT-LIABILITIES> 5,941
<BONDS> 0
0
0
<COMMON> 7,181
<OTHER-SE> 18,939
<TOTAL-LIABILITY-AND-EQUITY> 32,573
<SALES> 29,826
<TOTAL-REVENUES> 29,826
<CGS> 13,943
<TOTAL-COSTS> 13,943
<OTHER-EXPENSES> 8,507
<LOSS-PROVISION> 100
<INTEREST-EXPENSE> (295)
<INCOME-PRETAX> 7,571
<INCOME-TAX> 2,632
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<NET-INCOME> 4,939
<EPS-PRIMARY> 0.81<F1>
<EPS-DILUTED> 0.80<F1>
<FN>
<F1>Shares and earnings per share for the 1997 periods (prior year) have been
adjusted in the financial statements to reflect a two-for-one stock split
effected in the form of a dividend which was effective as of September 22,
1997.
</FN>
</TABLE>
