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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
----------------------
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
----------------
For the fiscal year ended December 31, 1997 Commission file number 0-7092
RELIABILITY INCORPORATED
(Exact name of registrant as specified in its charter)
Texas 75-0868913
(State or other jurisdiction (I.R.S. employer
of incorporation) identification number)
16400 Park Row, Houston, Texas 77084
(Address of principal (Zip Code)
executive offices)
Registrant's telephone number, including area code: (281) 492-0550
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, no par value per share
(title of class)
---------------
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 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days.
X Yes No
----- -----
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be
contained, to the best of registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form
10-K or any amendment to this Form 10-K.
-----
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State the aggregate market value of the voting stock held by non-
affiliates of the registrant. The aggregate market value shall be computed
by reference to the price at which the stock was sold, or the average bid
and asked prices of such stock, as of a specific date within 60 days prior
to the date of filing.
$71,387,168, based on the last sales price as reported on The Nasdaq
Stock Market System on March 4, 1998.
Indicate the number of shares outstanding of each of the registrant's
classes of common stock, as of the latest practicable date:
Common Stock, no par value per share 6,063,578
(title of class) (number of shares outstanding)
as of March 4, 1998
-----------------------
Documents Incorporated by Reference
Listed hereunder are the documents incorporated by reference and the
Part of the Form 10-K into which such documents are incorporated:
Part III........................... Proxy Statement for the 1998 Annual
Meeting of Shareholders of the
Registrant (to be filed within 120
days of the close of the registrant's
fiscal year)
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RELIABILITY INCORPORATED
1997 FORM 10-K
TABLE OF CONTENTS
PART I
Page
Item 1. Business. . . . . . . . . . . . . . . . . . . . . . . . . . 4
Item 2. Properties. . . . . . . . . . . . . . . . . . . . . . . . . 12
Item 3. Legal Proceedings . . . . . . . . . . . . . . . . . . . . . 12
Item 4. Submission of Matters to a Vote of Security Holders . . . . 12
Item 4A. Executive Officers of the Registrant. . . . . . . . . . . . 13
PART II
Item 5. Market for the Registrant's Common Stock and
Related Stockholder Matters . . . . . . . . . . . . . . . 14
Item 6. Selected Financial Data . . . . . . . . . . . . . . . . . . 15
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations . . . . . . . . . . . 16
Item 7A. Quantitative and Qualitative Disclosures
About Market Risk . . . . . . . . . . . . . . . . . . . . 22
Item 8. Consolidated Financial Statements and
Supplementary Data. . . . . . . . . . . . . . . . . . . . F-1
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure . . . . . . . . . . . 23
PART III
Item 10. Part III is omitted as the Company will file a
Item 11. Proxy Statement for the 1998 Annual Meeting of
Item 12. Shareholders as indicated in this report. . . . . . . . 23
Item 13.
PART IV
Item 14. Exhibits, Financial Statement Schedules, and
Reports on Form 8-K . . . . . . . . . . . . . . . . . . . 23
Signatures. . . . . . . . . . . . . . . . . . . . . . . . . 24
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PART I
Item 1. Business.
(a) GENERAL DEVELOPMENT OF BUSINESS. Reliability Incorporated
("Reliability") and its subsidiaries are principally engaged in the design,
manufacture and sale of equipment used to test and condition integrated
circuits. The Company and its subsidiaries also operate service facilities
which condition and test integrated circuits as a service to others and
design, manufacture and sell power sources, primarily a line of DC to DC
power converters, which convert direct current voltage into a higher or
lower voltage.
The following table shows the subsidiaries of the Company as of the date
of this report:
Reliability Incorporated
(a Texas corporation)
------------------------
RICR de Costa Rica, S.A. Reliability Singapore Pte Ltd.
(a Costa Rica corporation) (a Singapore corporation)
As used in this report, the terms "Company" and "Registrant" refer to
Reliability, its present subsidiaries and their predecessors, unless a
different meaning is stated or indicated.
The Company was incorporated under the laws of Texas in 1953. All
subsidiaries are incorporated under a variant of the "Reliability" name.
The Company's business was started in 1971 when substantially all of the
assets of a testing laboratory owned by Texas Instruments Incorporated were
acquired by Reliability, Inc. The Registrant, in 1974, acquired
Reliability, Inc. and began providing conditioning and testing services.
In 1984, this separate company was merged into Reliability Incorporated.
Reliability Singapore Pte Ltd. began operations during 1978 and provides
conditioning services, including manufacturing certain conditioning products
for sale to its services customer. Reliability Singapore also manufactured
power sources until 1993, when its power sources manufacturing operations
were transferred to Costa Rica. RICR de Costa Rica, S.A. began operating
in 1990 and manufactures and sells power sources.
The Company operates in three industry segments as discussed below.
TESTING AND CONDITIONING PRODUCTS ("Testing Products").
Under current semiconductor technology and manufacturing processes,
manufacturers are unable to consistently produce batches of integrated
circuits ("ICs" or "semiconductors") that are completely free of defects
which cause the ICs to fail. An IC may be defective at the time it is
produced or it may have a latent defect which eventually will cause it to
fail. An IC with such a defect will almost always fail during the first 500
to 1,000 hours of normal use. Accordingly, it has become customary to
"condition" or "burn-in" ICs (i.e., to subject them, during a relatively
short period of time, to controlled stresses which simulate the first
several hundred hours of operation) to identify defects prior to delivery.
Such conditioning subjects the ICs to maximum rated temperatures, voltages
and electrical signals. Following burn-in, an IC is tested to determined
whether it functions as designed.
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The Company manufactures equipment that performs burn-in and testing,
as well as equipment that performs burn-in only. The Company was one of the
first to design, manufacture and market systems that utilized burn-in and
test technology within the same product. The Company has manufactured
equipment to burn-in and test ICs since 1980. The Company's burn-in and
testing products contain sophisticated software systems, most of which are
designed and developed by the Company contemporaneously with the related
hardware. The Testing Products segment provided 50% of the Company's
revenues in 1997.
Since 1992, the Company has focused its research and development on
equipment and related software that performs functional testing during burn-
in of memory and micrologic devices. This focus has led to the development
of two major product families - the INTERSECT line for the DRAM market and
the CRITERIA 18 line for the micrologic device market.
Set forth below is the year of introduction, device capacity, power
dissipation and type of semiconductor processed by each of the primary
Testing Products that the Company currently offers:
Burn-In and Test Year Device Power Primary
Product Type Introduced Capacity Dissipation(1) Application
---------------- ---------- -------- -------------- -----------
CRITERIA(r) 18. . . . . . 1991 1,152 7KW Micrologic
INTERSECT(tm) 30(2) . . . 1992 8,640 - Memory
CRITERIA 18-HD(tm). . . . 1994 1,152 15KW Microprocessors
INTERSECT 2000(2) . . . . 1994 8,640 - Memory
- ---------------
(1) Power/heat dissipation rate in kilowatts.
(2) 64 Meg DRAMs.
The Company manufactures and sells the CRITERIA 18 and CRITERIA 18-HD
(High Dissipation) burn-in and test systems. The CRITERIA 18-HD system
provides a cost effective means for functional testing during burn-in of
high frequency micrologic devices which dissipate large quantities of heat.
Solid state switching, in conjunction with the Reliability logic controller
software system, provides an environment of very low AC electrical noise for
testing devices with .25 to .35 micron line widths. The system also offers
the ability to dissipate 15 KW of power in an economically sized system
without having to use chilled water as a cooling mechanism. This feature
allows users to reduce significantly the amount of floor space used when
performing burn-in and test of high power micrologic devices.
The Company also manufactures, under the trade name INTERSECT, systems
which functionally test memory devices during burn-in. This represents a
difference in the way most memory devices have historically been tested.
Most functional testing is performed serially after the device is
conditioned. INTERSECT systems perform parallel functional testing during
the burn-in process. The testing currently performed by INTERSECT systems
during burn-in has historically been performed by serial testers capable of
testing 64 individual DRAMs at a time. Because INTERSECT systems can test
up to 3,072 individual DRAMs at a time, and are less expensive than serial
testers, testing costs per IC can be reduced 30% to 60%.
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The Company's first INTERSECT system was introduced in 1980. INTERSECT
systems are computer controlled for high volume burn-in and testing of
memory devices. The Company's INTERSECT systems vary in their burn-in and
testing capabilities. The current generation of INTERSECT products are
based on the INTERSECT 30 ("I-30") technology which was introduced in 1992.
The I-30 is capable of functionally testing 8,640 64 Meg memory devices
during the burn-in process in a single chamber. It is capable of testing
MOS, CMOS, Bipolar, ECL and BiCMOS DRAMs and SRAMs. During 1994, the
Company introduced a lower cost version of the I-30 burn-in and test system
called the INTERSECT 2000 ("I-2000"). The I-2000 has the capacity to
functionally test 8,640 64 Meg memory devices during the burn-in process in
a single chamber and has become the principal product in the INTERSECT
product line.
The Company has developed a network integrated burn-in and test
management software system known as RELNET(tm), which enables users of
CRITERIA and INTERSECT systems to connect multiple systems to a single host
computer. This provides users with a flexible software tool and a
convenient central location to monitor system status, track burn-in boards
and device lots, schedule equipment maintenance, control and store test
profiles, and generate and store burn-in and testing results.
Burn-in and testing products are designed and manufactured at the
Company's Houston, Texas facility, and certain limited manufacturing is also
done at the Company's facility in Singapore.
The Company manufactures burn-in systems marketed under the name
CRITERIA. Demand for burn-in only systems has declined significantly, and
is being replaced by demand for products that perform both burn-in and
testing. The original CRITERIA systems were designed for internal use in the
Company's service facilities but, since 1974, these systems and their
successors have been sold to outside customers. Burn-in systems generally
are used on new IC production lines, but may also be added to existing
production lines. There are several different models within the product
line, each with a different capacity and burn-in capability. The CRITERIA
systems burn-in relatively large numbers of similar ICs at one time.
CRITERIA products are usually purchased by companies that manufacture large
volumes of similar ICs, but they also may be purchased by companies that
independently burn-in and test ICs.
The Company also designs, manufactures, markets and supports automatic
loaders and unloaders that transfer ICs to and from burn-in boards. The
INNOVATION(r) Loader/Unloader family of products is designed to offer
flexibility in handling surface mount and dual in-line IC packages. IDEA
Automatic Loader and IDEA Automatic Unloader products provide dedicated
high-volume throughput for dual in-line and surface mount IC packages. The
INNOVATION product line provides automation features, such as device and
burn-in board handling. These features improve productivity by providing
continuous and unattended device loading and unloading, allowing one
operator to handle multiple machines or operations.
SERVICES ("Services").
The Company currently operates two service facilities, one in Singapore,
dedicated to the burn-in of DRAMs and one in Durham, North Carolina,
dedicated to processing (burn-in, final test and other services) DRAMs. The
Services segment accounted for 43% of the Company's revenues in 1997. The
Company announced in January 1998 that the Durham services facility will be
closed in April 1998 (Reference is made to Note 11 of the Company's
Consolidated Financial Statements for additional information).
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The Company uses CRITERIA systems and burn-in boards to provide burn-in
services. The Company currently utilizes serial testing equipment
manufactured by other vendors in certain testing procedures. Services are
generally sold on a periodically adjusted per-unit-processed basis.
POWER SOURCES ("Power Sources").
The operating components of electronic equipment frequently have varying
electrical requirements. Rather than provide electricity to each component
separately, specialized devices, called DC-DC converters or power sources,
are used to convert direct current voltage into a higher or lower voltage.
By using small DC-DC converters, electronic equipment can operate from a
single output power supply, yet provide different voltages to different
operating components. These DC-DC converters allow designers of electronic
equipment to localize power requirements, increase modularity in the product
design, and expand equipment features without having to redefine power
needs. The Company specializes in the one watt to thirty watt DC-DC
converter market and designs, manufactures and markets a wide range of power
sources classified into various product series. The Power Sources segment
accounted for 7% of the Company's revenues in 1997.
The Company introduced its initial power sources product series, the
V-PAC(r), in 1972. The V-PAC is a DC-DC converter compatible with
electronic equipment assembly operations. The Company also manufactures the
Z-PAC(r), which is a high efficiency DC-DC power source; the S-PAC(tm), a
smaller one watt unit which is similar to the V-PAC; the TELECOM-PAC(r),
which is a power source designed for the telecommunications industry; and
the LAN-PAC(tm), a power source designed to operate with Local Area Network
computer applications.
The Company introduced, in 1997, two additional models in a new series
of wide input range 30 watt DC-DC converters, which increased the number of
higher wattage units in the product line. In 1997, the Company continued
to convert to the use of surface mount technology for manufacturing power
source products. Surface mount technology removes the human element from
certain manufacturing processes, thereby enhancing the reliability of the
power sources. The technology also allows product assembly in smaller
packages and therefore provides higher power output from smaller units.
The Company's power sources are designed at the Company's Houston, Texas
facility and manufactured in the Company's Costa Rica facility.
(b) FINANCIAL INFORMATION ABOUT INDUSTRY SEGMENTS. The Company's
business is divided into three industry segments - (i) manufacture of
testing and conditioning products (Testing Products), (ii) services which
condition and test ICs for others (Services), and (iii) manufacture of power
sources (Power Sources). The table included in Note 5 of the Company's
Consolidated Financial Statements provides certain information regarding the
Company's industry segments.
(c) NARRATIVE DESCRIPTION OF BUSINESS. The business of the Company
is generally described in part (a) of this Item 1. The following paragraphs
provide additional information concerning various aspects of the Company's
business. Unless otherwise indicated, the information provided is
applicable to all industry segments in which the Company operates.
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(i) PRINCIPAL PRODUCTS. Information as to the principal products and
services of the Company is given in part (a) of this Item 1. The Testing
Products segment of the Company's business is the dominant segment. The
following table sets forth the percentage of the Company's total revenues
by business segment:
Years Ended December 31,
------------------------
Business Segment 1997 1996 1995
- ---------------- ---- ---- ----
Testing Products 50% 50% 55%
Services 43 36 32
Power Sources 7 14 13
--- --- ---
Total revenues 100% 100% 100%
=== === ===
Reference is made to Note 5 of the Company's Consolidated Financial
Statements for additional information.
(ii) NEW PRODUCTS. During 1997, Reliability concentrated research
activities on developing various automation options and other enhancement
features for the CRITERIA 18 and I-2000 product lines. Reliability
completed development, in 1997, of an add-on automation package for the
CRITERIA 18. This option provides a vertically operated door that
automatically inserts and extracts burn-in boards into and out of the
system. This enhancement reduces system floor space requirements and
provides users with the ability to automate handling of burn-in boards and
devices in the burn-in and testing operation. The Company also introduced
a number of software enhancements for the CRITERIA 18 HD which greatly
enhances system throughput for customers who process large numbers of small
lots. The CRITERIA 18 HD now allows customers to simultaneously burn-in and
test up to 72 different lots within a single system.
Also in 1997, the Company upgraded its INTERSECT 2000 product line to
comply with European regulatory requirements. The product now offers the
CE mark for its European customers. Reliability also completed development
of various system advancements to meet the demands of next generation
devices. The Company entered into a joint software development program with
a major customer. The outputs from the program will result in a reduction
in cost of operating the Company's products by enhancing the system software
tools, resulting in improved productivity of the people who program systems.
In 1997, the Company further expanded the use of surface mount
technology in manufacturing power source products and in 1997 and 1996
introduced and expanded product offerings in the wide input range 10 to 30
watt DC to DC converter line. During 1997, the Company developed and sold
custom one watt and three watt converters for specific key customers.
(iii) RAW MATERIALS AND INVENTORY. The Company's products are designed
by its engineers and are manufactured, assembled, and tested at its
facilities in Houston, Texas; San Jose, Costa Rica; and, to a limited
degree, in Singapore. The Company's products utilize certain parts which
it manufactures and components purchased from others. Certain metal
fabrications and subassembly functions are performed by others for the
Company.
The Company maintains an inventory of components and parts for its
manufacturing activities. There are many sources for most of the raw
materials needed for the Company's manufacturing activities, although a few
8
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components come from sole sources. The Company has not experienced any
significant inability to obtain components or parts, but does experience
occasional delays in receiving certain items.
(iv) PATENTS, TRADEMARKS. The Company believes that the rapidly
changing technology in the electronics industry makes the Company's future
success dependent more on the quality of its products, services and
performance, the technical skills of its personnel, and its ability to adapt
to the changing technological environment than upon the protection of any
proprietary rights. The Company has patents and pending patent applications
in the United States and certain other countries which cover key components
of testing and conditioning products and ancillary equipment.
The Company considers its patents for the EX-SERT(tm) backplane system
to be material. These patents cover the use of a cavity at the rear wall
of the burn-in chamber to isolate power and signal connectors from the harsh
environment of the burn-in chamber. In many burn-in systems the power and
signal connectors are subjected to intense heat generated within the burn-in
chamber, resulting in shortened connector life. The connection assembly
disclosed in the patents reduces connector maintenance problems, increases
the life of the components and reduces equipment down time. The United
States patent was granted in February 1983, and a Japanese patent was
granted in 1995.
The Company also considers its patents relating to a method of IC
extraction during the process of unloading burn-in boards and a floating
head mechanism used in the loading and unloading of ICs onto burn-in boards
to be significant. These patents were granted in 1984 and 1988,
respectively. A patent with respect to the floating head mechanism was
granted in Europe in 1994, designating France, Germany and the United
Kingdom, and an application for a Japanese patent with respect to such
technology is pending.
The Company has certain trademarks which are registered with the U.S.
Patent & Trademark Office for use in connection with its products and
services, including "ri (and design)," "RELIABILITY," "CRITERIA," "V-PAC,"
"Z-PAC," "INNOVATION," and "TELECOM-PAC." In addition, the Company uses
certain other trade names which are not presently registered, including
"INTERSECT," "RELNET," "EX-SERT," "UNLOADER," "S-PAC," "ISDN-PAC," "RK-94,"
"SERIES 1000," "CRITERIA 18-HD" and others not listed here which are used
less frequently. The Company relies on copyrights and trade secrets to
protect its computer software.
The Company has in the past and will in the future take appropriate
action to protect all of its patents, copyrights, trade secrets and
trademarks as well as its other proprietary rights.
(v) SEASONALITY. The Company's business is not seasonal, but is
cyclical depending on the electronics manufacturing and semiconductor
industries.
(vi) WORKING CAPITAL. The Company finances its inventory and other
working capital needs out of internally generated funds and has in the past
used periodic borrowings to finance its needs. The Company has short-term
credit facilities on which it could draw additional funds as of December 31,
1997. Reference is made to Note 2 of the Company's Consolidated Financial
Statements for additional information as to the credit agreements under
which working capital is or could be available if required.
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(vii) MAJOR CUSTOMERS. In 1997 and 1996, four customers accounted for
90% and 82%, respectively, of the Company's consolidated revenues. The
four customers are Intel Corporation, International Business Machines
Corporation, Mitsubishi Semiconductor America, Inc. and Texas Instruments
Incorporated. In 1997, two of the customers accounted for approximately 75%
and 24% and in 1996, 60% and 38% of revenues, respectively, in the Services
segment. In addition, in 1997, two other customers accounted for 58% and
38% and in 1996, 64% and 28% of revenues, respectively, in the Testing
Products segment. Note 5 to the Company's Consolidated Financial Statements
discloses information concerning customers that accounted for more than 10%
of consolidated revenues. The Company believes that its relationships with
its customers are good. In the Testing Products and Power Sources segments,
decreased business from one customer may be replaced by new or increased
business from other customers, but there is no assurance that this will
occur. The Company's North Carolina services facility provides service to
one customer, Mitsubishi Semiconductor America, Inc. The customer notified
the Company in January 1998 that it is necessary to reduce the output of
DRAMs burned-in and tested by the Company's Durham facility. The Company
will close the Durham facility in April 1998. The facility accounted for
approximately 10% of Reliability's consolidated revenues in 1997. The
closure is not expected to have a material adverse impact on the Company
(See Note 11 of the Company's Consolidated Financial Statements for
additional information concerning the closure of the Durham facility). The
loss of other major customers or a significant reduction in orders from a
major customer in any business segment and the failure of the Company to
obtain other sources of revenue could have a material adverse impact on the
Company. The Company has no long-term contracts with its major customers.
(viii) BACKLOG. The following table sets forth the Company's backlog at
the dates indicated:
December 31,
--------------------
Business Segment 1997 1996
- ---------------- ---- ----
(In thousands)
Testing Products $11,185 $6,787
Services 2,260 2,728
Power Sources 681 347
------ -----
Total $14,126 $9,862
====== =====
Backlog for sales of Testing Products and Power Sources represents
orders for delivery within twelve months from the date on which backlog is
reported. Backlog for Services represents orders for services where the ICs
to be conditioned have been delivered to the Company and orders for testing
products, for delivery within 12 months from the date on which backlog is
reported, that are directly related to providing services to customers. The
Company's backlog as of December 31, 1997, is believed to be firm, although
portions of the backlog are not subject to legally binding agreements.
(ix) GOVERNMENTAL BUSINESS. The Company does not carry on a material
amount of business with any governmental agency.
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(x) COMPETITION. The markets for the Company's products and services
are subject to intense competition. The Company's primary competitors in
the Testing Products segment are other independent manufacturers of such
systems and manufacturers of ICs who design their own equipment. The
primary methods of competition in this segment are quality, service,
delivery, price, and product features. The Company believes that its
service after the sale, including its ability to provide installation,
maintenance service, and spare parts, enhances its competitiveness.
The primary areas of competition for the Company's Services are price,
service level and geographic location. The Singapore service facility
provides services to a major IC manufacturer in Singapore and, to a limited
degree, to companies in southeast Asia that manufacture and use ICs, and the
Durham service facility provides services to a major IC manufacturer in the
Research Triangle area of North Carolina.
The world market for power sources is divided into the merchant and the
captive markets. There are less than one thousand competitors in the
merchant market of the power source manufacturing business, most of which
target a particular application for their business. The Company believes
there are approximately twenty significant competitors whose products
compete directly with those of the Company in its U.S. and foreign markets.
Competition in the Power Sources segment is based primarily on the specific
features of the power sources, price and quality.
(xi) RESEARCH. The demand of the semiconductor industry for
increasingly complex and sophisticated equipment requires the Company to
continuously develop new products and to review and modify its existing
products and services to adapt to technology changes in the industry. The
Company also focuses on the development of peripheral equipment and options
for its INTERSECT, CRITERIA and other product lines. In 1997, 1996 and
1995, the Company spent $1.6 million, $2.2 million and $2.2 million,
respectively, on research and development activities. Developmental
projects, which are primarily related to the Testing Products segment, are
on-going.
(xii) ENVIRONMENTAL MATTERS. The business of the Company is not
expected to be affected by zoning, environmental protection, or other
similar laws or ordinances.
(xiii) EMPLOYEES. On December 31, 1997, the Company had 409 employees,
of which 33 were contract or temporary employees. Continued growth of the
Company is dependent upon the Company's ability to attract and retain its
technical staff and skilled employees. During recent years, the Company has
experienced a low turnover rate among its U.S. employees. Due to the low
unemployment rate in Singapore, turnover at the Singapore subsidiary has
been high. Turnover at the Company's Costa Rica subsidiary increased in
1997. The increase was primarily related to a decrease in production
levels, resulting in the subsidiary needing fewer employees.
(d) FINANCIAL INFORMATION ABOUT FOREIGN AND DOMESTIC OPERATIONS AND
EXPORT SALES. See Note 5 to the Company's Consolidated Financial Statements
for a table showing information about foreign and domestic operations of the
Company for the last three years.
11
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Item 2. Properties
The corporate headquarters of the Company, as well as the Company's
manufacturing and research and development facilities for testing and
conditioning products, are located in a 131,000 square foot facility on a
seven acre tract of land in Park 10, an office and industrial park on
Interstate Highway 10 located on the west side of Houston. The Company
leased this facility until March 1995, when the Company purchased the
facility. The Company financed the purchase of its headquarters; at
December 31, 1997, outstanding indebtedness secured by the property was
$1,961,000. The Company occupies 96,000 square feet in the building and the
remaining 35,000 square feet of space have been leased to an outside party.
A subsidiary of the Registrant occupies 24,000 square feet of leased
space in Singapore. The Singapore facility is devoted to a service facility
and limited manufacture of burn-in boards. The Durham service facility is
located in a 43,500 square foot building (purchased in December, 1995),
located in Durham, North Carolina. In October 1995, a subsidiary of the
Registrant purchased a 29,500 square foot building in the free trade zone
in San Jose, Costa Rica. The subsidiary in Costa Rica utilizes 22,600
square feet in the building for the manufacture of power sources. Neither
the Durham nor the San Jose facility is subject to any encumbrance. See
Notes 2 and 8 to the Company's Consolidated Financial Statements for
information concerning encumbrances and leases.
Item 3. Legal Proceedings.
Not applicable.
Item 4. Submission of Matters to a Vote of Security Holders.
Not applicable.
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Item 4A. Executive Officers of the Registrant.
The following table sets out certain information regarding each
executive officer of the Company:
Officer of
Reliability Position Currently
Incorporated Held with
Name Age Since Reliability Incorporated
---- --- ------------ ------------------------
Larry Edwards 56 1981 President and Chief
Executive Officer
Max T. Langley 51 1978 Senior Vice President,
Chief Financial Officer,
Secretary and Treasurer
Robert W. Hildenbrand, Jr. 49 1984 Vice President
James M. Harwell 43 1993 Vice President
Paul Nesrsta 41 1993 Vice President
J. E. (Jim) Johnson 52 1984(1) Vice President
(1) Mr. Johnson terminated employment with the Company in August 1996 and
was re-employed in September 1997.
Mr. Edwards has been President and the Chief Executive Officer of the
Company since March 1993 and became a Director and Chairman of the Board of
Directors in October 1995. He was President and Chief Operating Officer of
the Company from April 1990 to March 1993 and was Executive Vice President
and Chief Operating Officer of the Company for more than five years prior
to becoming the President in 1990.
Mr. Harwell has been Vice President - Manufacturing Operations since
August 1996. He was Vice President - Site Services from July 1993 until
August 1996 and was the division manager of the automation equipment
division of the Company from February 1991 to July 1993.
Mr. Nesrsta has been Vice President - Sales and Marketing since August
1996. He was Vice President - Testing Products Marketing from July 1993
until August 1996 and was manager of the test systems division of the
Company for more than five years prior to becoming a vice president in 1993.
Mr. Johnson has been Vice President - Engineering since September 1997.
He was Vice President of Engineering for Fusion Semiconductor from August
1996 until September 1997. He was Vice President - Systems Division of
Reliability Incorporated for more than five years prior to August 1996.
Each other person named above has held his present position for more
than five years.
13
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PART II
Item 5. Market for the Registrant's Common Stock and Related Stockholder
Matters.
The common stock of Reliability trades on The Nasdaq National Stock
Market under the stock symbol REAL. The high and low sale prices for 1997
and 1996, as reported by The Nasdaq Stock Market, are set forth below.
First Second Third Fourth
Quarter Quarter Quarter Quarter
------- ------- ------- -------
1997
- ----
High $4.50 $8.69 $23.38 $30.75
Low 2.94 4.06 7.56 12.25
1996
- ----
High $4.50 $4.37 $ 3.37 $ 3.56
Low 3.19 3.00 2.62 2.65
All prices have been restated to give effect to the 1997 two-for-one
stock split in the form of a dividend. (See Note 1 to the Consolidated
Financial Statements.)
The Company paid no cash dividends in 1997 or 1996. The Company intends
to retain earnings for use in its business and therefore does not anticipate
paying dividends in the foreseeable future.
The Company has only one class of stock, which is common stock with full
voting rights. The Company did not issue any common stock in 1995 or 1996.
In 1997, the Company sold and issued shares of common stock to its Employee
Stock Savings Plan and to key employees, officers and directors that
exercised stock options. All common stock shares which were sold in 1997
were registered under Registration Statements on Form S-8.
Reliability had approximately 760 shareholders of record as of
February 13, 1998. Management estimates there are approximately 4,500
beneficial owners of Reliability common stock.
14
<PAGE>
Item 6. Selected Financial Data.
The following table sets out certain selected financial data for the
years indicated:
Years Ended December 31,
---------------------------------------
1997 1996 1995 1994 1993
------ ------ ------ ------ ------
(In thousands, except per share data)
Revenues $47,220 $35,760 $33,930 $23,427 $27,022
Cost of revenues 23,653 18,027 16,837 12,737 15,405
------ ------ ------ ------ ------
Gross profit 23,567 17,733 17,093 10,690 11,617
Expenses:
Marketing, general and
administrative 9,679 8,043 8,862 7,056 7,975
Research and development 1,578 2,197 2,227 1,054 889
Provision for restructuring - - - - 288
Interest expense (income), net 66 53 60 (154) 43
------ ------ ------ ------ ------
Total expenses 11,323 10,293 11,149 7,956 9,195
------ ------ ------- ------ ------
Income before income taxes 12,244 7,440 5,944 2,734 2,422
Provision for income taxes 4,112 2,594 1,881 89 53
------ ------ ------ ------ ------
Net income $ 8,132 $ 4,846 $ 4,063 $ 2,645 $ 2,369
====== ====== ====== ====== ======
Earnings per share(1):
Basic $ 1.25 $ .57 $ .48 $ .31 $ .28
Diluted 1.23 .57 .48 .31 .28
Weighted average number of
shares used in earnings
per share calculation(1):
Basic 6,500 8,486 8,486 8,486 8,486
Diluted 6,604 8,486 8,486 8,486 8,486
Total assets $29,801 $26,603 $23,727 $13,284 $11,018
Working capital 11,906 12,728 8,504 8,974 5,846
Property and equipment, net 10,682 9,257 8,979 1,925 2,257
Long-term debt 1,560 1,961 2,482 - -
Total stockholders' equity 20,642 19,668 14,822 10,759 8,114
(1) The weighted average number of shares used in the earnings per share
calculations and earnings per share have been adjusted to give effect
to a two-for-one stock split in the form of a dividend. (See Notes 1
and 6 of the Notes to Consolidated Financial Statements.)
15
<PAGE>
Item 7. 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 maintains lines of credit to
supplement the primary sources of capital and, until 1995, had leased most
of its facilities, reducing the need to expend capital on such items.
Changes in the Company's financial condition and liquidity during the three
year period ended December 31, 1997 are generally attributable to changes
in cash flows from operating activities, changes in the levels of capital
expenditures and the purchase of 1.3 million shares of the Company's common
stock in March 1997.
Certain ratios and amounts monitored by management in evaluating the
Company's financial resources and performance are presented in the following
chart:
1997 1996 1995
------ ------ ------
Working capital:
Working capital (thousands) $11,906 $12,728 $8,504
Current ratio 2.7 to 1 3.8 to 1 2.4 to 1
Profitability ratios:
Gross profit 50% 50% 50%
Return on revenues 17% 14% 12%
Return on assets 27% 18% 17%
Return on equity 39% 25% 27%
Equity ratios:
Total liabilities to equity 0.4 0.4 0.6
Assets to equity 1.4 1.4 1.6
The Company's financial condition improved significantly throughout 1995
and 1996 and has remained very strong during 1997. Working capital totalled
$11.9 million at December 31, 1997, compared to $12.7 million and $8.5
million at December 31, 1996 and 1995, respectively. The ratio of current
assets to current liabilities decreased in 1997 to a very healthy 2.7 to 1
from 3.8 to 1 at December 31, 1996. The Company's current ratio was
unusually high at December 31, 1996 due to the fact that the Company had
approximately $8.5 million in cash. Cash provided by operations in 1997 and
1996 were used to purchase capital assets. In addition, in 1997,
management's evaluations indicated that the Company's Common Stock was
undervalued compared to industry peers. 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 balance and $2.5 million from its
revolving term loan to purchase the stock. The amount borrowed under the
term loan 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 amount avail-
16
<PAGE>
able under the line of credit was reduced to $4.0 million on December 31,
1997. The changes were related to the purchase of Company stock and
possible need to finance increases in capital expenditures and other working
capital items. The increase to $20 million was related to projected capital
expenditures associated with negotiations to expand operations at the North
Carolina services facility. The decrease to $4.0 million occurred when the
customer advised Reliability that the Company would not be required to
purchase capital assets to support the projected expansion.
Increased demand for the Company's products and services during 1997
resulted in a $14.1 million backlog at December 31, 1997, compared to $9.9
million at December 31, 1996. The operating effects related to the changes
in backlog during 1997 and 1996 affected various elements of cash provided
by operations, as reflected in the Consolidated Statements of Cash Flows.
Net cash provided by operating activities for the year ended
December 31, 1997 was $9.2 million, compared to $8.9 million and $1.2
million provided in 1996 and 1995, respectively. Significant items
contributing to cash provided by operations in 1997 were the sum of net
income plus depreciation of $9.7 million and increases in accrued
liabilities, primarily payroll related accruals, and accounts payable of
$1.2 and $1.0 million, respectively. Cash provided by operations in 1997
was reduced by increases in accounts receivable and inventories of $2.6 and
$1.2 million, respectively. The changes in 1997 are directly related to the
Company operating at levels required to support the increase in revenues in
1997, compared to 1996. The principal items contributing to the cash
provided by operations in 1996 were net income plus depreciation which
totaled $6.3 million, a decrease in accounts receivable of $4.3 million and
a $1.0 million provision for inventory obsolescence. Cash provided by
operations in 1996 was reduced by decreases in accounts payable, accrued
liabilities and income taxes payable totalling $1.9 million. The decrease
in accounts receivable in 1996 resulted from a reduction in the level of
revenues in the fourth quarter of 1996 compared to the fourth quarter of
1995. The principal items contributing to the cash provided by operations
in 1995 were increases in accounts receivable and inventories of $6.0
million and $2.0 million, respectively, reduced by the sum of net income
plus depreciation of $5.2 million and increases in accounts payable, accrued
liabilities and income taxes payable totalling $3.8 million.
Capital expenditures during 1997, 1996 and 1995 were $3.0, $1.8, and
$8.3 million, respectively. A significant portion of expenditures for 1997
includes equipment required by the Singapore services facility to support
increased demand for services. A significant portion of the 1996
expenditures included improvements at the services facility in North
Carolina, which was purchased in the fourth quarter of 1995, and equipment
required by the Singapore services facility. Expenditures for 1995 include
the purchase of the Company's Houston, Texas facility, purchase of the
facility occupied by the Costa Rica subsidiary and purchase of a facility
in North Carolina. In summary, 1995 capital expenditures included $6.3
million for land and buildings, plus $2.0 million for equipment. A
significant amount of the equipment which was purchased in 1997, 1996 and
1995 are items used by the Company's services facilities to process
increasing volumes of ICs.
The Company has a credit facility with a financial institution to
provide credit availability of $4.0 million to supplement cash provided by
operations, if required. The Company's Singapore subsidiary maintains a
small overdraft facility to support the subsidiary's credit commitments.
The subsidiary could borrow $163,000 under the facility at December 31,
1997.
17
<PAGE>
Reliability's revenue is dependent on conditions within the
semiconductor industry, and profitability is dependent on revenues and
controlling expenses. Semiconductor manufacturers experienced good unit
volume growth during 1996 and 1997, and current forecasts indicate volume
increases for the industry in 1998. Based on the Company's current backlog
and other available information, Reliability is forecasting revenue growth
in 1998 compared to 1997. The current forward-looking forecast indicates
revenues for the first quarter of 1998 to be approximately $10 to $11
million, compared to first quarter 1997 revenues of $6.7 million.
Current projections indicate that the Company's cash and cash equivalent
balances, future cash generated from operations and available lines of
credit will be sufficient to meet the projected cash requirements of the
Company during 1998.
RESULTS OF OPERATIONS.
OVERVIEW. Changes in revenues from the sale of Testing Products sold
by the Company during the three year period ending in 1997 reflected changes
in demand by the semiconductor industry resulting in volume increases.
Services revenues increased during the three year period due to increased
customer requirements for conditioning services. Product mix changes in the
Power Sources segment resulted in a decrease in unit volumes and a decline
in total revenues in 1997. The Company announced in January 1998 that its
Durham services facility will be closed in April 1998. The facility
accounted for approximately 10% of consolidated revenues in 1997, and will
continue normal operations until it is closed in April. Reliability
currently estimates the cost of closing the plant to be approximately
$500,000 or $.05 per share. (See Note 11 of the Company's Consolidated
Financial Statements for additional information.)
REVENUES. Revenues for 1997 increased 32% to $47.2 million, reflecting
a $5.8 million increase in the Testing Products segment and an increase of
$7.3 million in the Services segment. The revenue increases relate to
increased unit demand for semiconductors, which translates into increased
requirements for products and services supplied by the Company. Revenues in
the Power Sources segment declined $1.6 million in 1997. Revenues in the
Asia and Pacific and U.S. geographical segments all increased. The increase
in the Asia and Pacific segment was attributable to a significant increase
in demand for services provided by the Singapore subsidiary. The overall
increase in the U.S. segment was related to volume increases and product mix
changes in the Testing Products segment. Revenues for 1996 increased 5% to
$35.8 million, reflecting a $0.9 million decrease in the Testing Products
segment and revenue increases of $2.2 million and $0.5 million in the
Services and Power Sources segments, respectively.
Revenues in the Testing Products segment were $23.5 million for 1997,
which is an increase of 33% over the 1996 year. The increase is related to
increased demand resulting in volume increases and higher unit prices due
to product mix changes. Revenues from the sale of INTERSECT products
increased $1.9 million, while revenues from the sale of CRITERIA and loader
and unloader products increased $3.9 million. Revenues in the Testing
Products segment were $17.7 million for 1996, which was a decrease of 5%
from the same period in 1995. The decrease was related to changes in demand
resulting in volume changes and higher unit prices due to product mix
changes. Revenues from the sale of INTERSECT products increased $4.7
million, while revenues from the sale of CRITERIA and loader and unloader
products decreased $5.6 million. The decrease in CRITERIA revenues resulted
from a decrease in unit prices due to a significant increase in CRITERIA
systems that were retrofitted to upgrade the systems to include heat
dissipation features.
18
<PAGE>
Revenues in the Services segment increased 56% in 1997 to $20.3 million.
The increase is related to the Company's Singapore services facility and was
caused by volume increases resulting from increased demand, reduced by unit
price decreases resulting from product mix and volume changes and
approximately 70% of the increase relates to an increase in the sale of
burn-in boards to support product mix changes. Revenues in the Services
segment increased 21% in 1996 to $13.0 million. Services revenues in 1996
increased at both of the Company's services facilities. The 1996 increase
is related primarily to the Company's Singapore services facility and
resulted from volume increases related to increased demand and unit price
increases resulting from product mix changes. Revenues included in the
Services segment from the sale of conditioning products to Services
customers increased significantly during 1996 due to changes in the
customers' product mix.
Revenues in the Power Sources segment decreased 32% in 1997 to $3.4
million, after increasing 11% to $5.1 million in 1996. Revenues were
affected in 1997 by changes in demand, an aging product line and a decline
in market penetration resulting in volume decreases. Revenues during 1996
were affected by general increases in demand, beginning in the fourth
quarter of 1995, resulting in price increases related to product mix
changes.
COSTS AND EXPENSES. Changes in costs and expenses during the three year
period are primarily related to changes in revenues, and the effect of
stringent expense control programs during the three year period. The
expense control programs resulted in low expense levels.
Total costs and expenses, excluding interest, increased $6.6 million or
24% in 1997, compared to the 32% revenue increase of $11.5 million. Cost
of revenues increased $5.6 million; marketing, general and administrative
expenses increased $1.6 million; and research and development expenses
decreased $0.6 million. Total costs and expenses for the 1996 period
increased $0.3 million or only 1% compared to the 5% revenue increase of
$1.8 million. Cost of revenues increased $1.2 million; marketing, general
and administrative expenses decreased $0.8 million; and research and
development expenses decreased slightly.
The Company's gross profit, as a percent of revenues, was 50% in all
three years. Gross profit in the Testing Products segment, in 1997,
increased slightly due to efficiencies related to volume increases and to
product mix changes. The gross profit in the Power Sources segment, in 1997,
decreased due to the significant decrease in revenues resulting from volume
decreases. Gross profit in the Services segment, in 1997, decreased
slightly due to a significant increase in revenues related to sale of burn-
in boards to Services customers. Gross profit on burn-in boards is
traditionally lower because of price competition. The gross profit in the
Services and Power Sources segments increased slightly in 1996. The gross
profit in the Testing Products segment for 1996 was reduced by a $1.0
million reserve for excess inventory due to a significant decrease in demand
for a specific INTERSECT model. In 1995, the gross profit percentage in the
Services segment decreased slightly, while the gross profit percentage in
the Power Sources segment decreased because of volume and unit price
reductions, without a corresponding reduction in manufacturing overhead.
Marketing, general and administrative expenses for 1997 increased only
$1.6 million, or 20%, over the 1996 period, compared to a 32% increase in
revenues. This increase is primarily related to the Testing Products
segment and, to a lesser extent, to the Services segment and resulted from
19
<PAGE>
increases in variable expenses such as royalties, sales commissions and
warranty expenses, and an increase in incentive compensation accruals which
are directly related to an increase in profitability. Marketing, general
and administrative expenses for the 1996 period decreased $0.8 million. The
decrease is related to a decrease in volume related expenses in the Testing
Products segment which was reduced somewhat by an increase in incentive
compensation accruals that are directly related to the increase in
profitability.
Research and development expenses decreased $0.6 million in 1997 after
declining slightly in 1996. A significant portion of the expenditures in
each of the years relates to development of testing and conditioning
products. The Company completed development of new models of INTERSECT and
CRITERIA products during early 1995, and the new products accounted for a
substantial portion of the revenues in the three year period ending in 1997.
The Company classifies costs related to modifying existing products as
sustaining engineering expense. Sustaining engineering expenses are charged
to cost of product sales and thus are not included in research and
development expense. In 1997 substantial engineering resources were devoted
to sustaining engineering projects. Sustaining engineering expenses
increased $650,000 or 250% in 1997, compared to 1996 expenses, after
declining 9% in 1996. Reliability is committed to continuing a significant
research and development program, and development costs will increase in
1998.
PROVISION FOR INCOME TAXES. The Company's effective tax rates were 34%,
35% and 32% for 1997, 1996 and 1995, respectively. The principal items
affecting the Company's tax rate in 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 a change in the valuation allowance resulting from
utilization of foreign tax credits. Effective January 1, 1997, the Company
changed its policy with respect to providing U.S. income taxes on
undistributed earnings of its Singapore subsidiary. Increasing demand for
services provided by the subsidiary necessitates permanent reinvestment of
future earnings of the subsidiary; thus deferred U.S. income taxes have not
been provided after January 1, 1997. The effective tax rate in 1996 was
affected by a tax benefit from an export processing exemption in Costa Rica
and state income tax expense. The principal item affecting the 1995 tax
rate was a change in the deferred tax valuation allowance.
NET INCOME. Income before income taxes was $12.2 million for 1997,
compared to $7.4 million for 1996 and $5.9 million in 1995. Net income was
$8.1 million, $4.8 million and $4.1 million for the respective periods.
EARNINGS PER SHARE. Diluted earnings per share were $1.23, $.57 and
$.48 for the years ended December 31, 1997, 1996 and 1995, respectively;
$.29 of the 1997 increase was due to a decrease in the weighted average
number of shares outstanding. The decrease in average shares outstanding
resulted from the Company purchasing 1.3 million shares of its common stock
from a stockholder in March 1997. The Company declared a two-for-one stock
split as a 100% stock dividend on September 5, 1997. Weighted average share
and per share data have been restated to reflect the stock split.
SOUTHEAST ASIA ECONOMIC CONDITIONS. The Company has received numerous
inquiries concerning the impact of the financial crisis in Asia on the
future operations of the Company. During 1997 the Company's Singapore
subsidiary accounted for approximately 33% of consolidated revenues. The
subsidiary's revenues are denominated in U.S. dollars. The subsidiary's and
20
<PAGE>
the Company's principal customers are large multinational semiconductor
manufacturers. The customers sell their products, including DRAMs, into the
world semiconductor market. The average selling price of DRAMs declined as
much as 40% in 1997. The Company's Singapore subsidiary provides testing
services for DRAMs produced by a multinational semiconductor manufacturer.
The Company does not sell directly into the Asian market, thus the impact
of the Asian crisis on the Company's revenues should be limited to the
indirect impact from the world semiconductor and personal computer markets.
Since the Company's accounts are denominated in U.S. dollars, the current
strength of the U.S. dollar against the Singapore dollar will result in a
decrease in the converted U.S. dollar amount of those expenses which are
denominated in the local currency. The Company anticipates that, during
1998, this forecasted reduction in expenses and competitive factors will
result in the Singapore company's customer requesting a decrease in unit
sales prices ranging from 5% to 20%. However, higher prices due to product
mix changes may offset some or all of the decrease in revenues that result
from unit price decreases. In summary, management does not believe that the
economic downturn in Southeast Asia will have a material adverse impact on
the business of the Company. However, actual results could differ materially
from current projections.
IMPACT OF YEAR 2000. The Year 2000 Issue is the result of computer
programs being written using two digits rather than four to define the
applicable year. Any of the Company's computer programs that have time-
sensitive software may recognize a date using "00" as the year 1900 rather
than the year 2000. This could result in a system failure or
miscalculations causing disruption of normal business activities.
Based on a recent and ongoing assessment, the Company has determined
that it will be required to modify or replace portions of its software and
software that has been sold to customers so that computer systems will
function properly with respect to dates in the year 2000 and thereafter.
The Company presently believes that with modifications to existing software
or conversions to new software, the Year 2000 Issue will not pose
significant operational problems and will not materially affect future
financial results.
The Company has initiated communications with its significant suppliers
and major customers to determine the extent to which the Company is
vulnerable to any third party's failure to remedy their own Year 2000
issues.
The Company will utilize both internal and external resources to modify,
or replace, and test software for Year 2000 compliance. The Company
currently anticipates completing the Year 2000 project within one year, but
not later than March 31, 1999, which is prior to any anticipated impact on
its operating systems.
The costs of the project, which at the current time are projected to not
be material, and the date on which the Company believes it will complete
Year 2000 modifications are based on management's best estimates, which were
derived utilizing numerous assumptions of future events, including the
continued availability of certain resources, third party modification plans
and other factors. However, there can be no guarantee that these estimates
will be achieved and actual results could materially differ from those
anticipated.
21
<PAGE>
FORWARD-LOOKING STATEMENTS
From time to time, the Company may publish forward-looking statements
relating to such matters as anticipated financial performance, business
prospects, technological developments, new products, research and
development activities and similar matters. The Private Securities
Litigation Reform Act of 1995 provides a safe harbor for forward-looking
statements. In order to comply with the terms of the safe harbor, the
Company notes that a variety of factors could cause the Company's actual
results and experience to differ materially from the anticipated results or
other expectations expressed in the Company's forward-looking statements.
The risks and uncertainties that may affect the operations, performance,
development and results of the Company's business include, but are 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.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.
Not applicable.
22
<PAGE>
Item 8. Consolidated Financial Statements and Supplementary Data.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
AND FINANCIAL STATEMENT SCHEDULES
Page
Report of independent auditors . . . . . . . . . . . . . . . . . . . . F-2
Consolidated balance sheets at December 31, 1997 and 1996. . . . . . . F-3
For each of the three years in the period ended December 31, 1997:
Consolidated statements of income. . . . . . . . . . . . . . . . . . F-4
Consolidated statements of cash flows. . . . . . . . . . . . . . . . F-5
Consolidated statements of stockholders' equity. . . . . . . . . . . F-6
Notes to consolidated financial statements . . . . . . . . . . . . . . F-7
Schedule for each of the three years in the period
ended December 31, 1997:
II - Valuation and qualifying accounts and reserves. . . . . . . . . S-1
All other schedules are omitted since the required information is not
present, or is not present in amounts sufficient to require submission of
the schedule, or because the information required is included in the
consolidated financial statements and notes thereto.
F-1
<PAGE>
REPORT OF INDEPENDENT AUDITORS
The Board of Directors and Stockholders
Reliability Incorporated
We have audited the accompanying consolidated balance sheets of
Reliability Incorporated as of December 31, 1997 and 1996, and the related
consolidated statements of income, cash flows and stockholders' equity for
each of the three years in the period ended December 31, 1997. Our audits
also included the financial statement schedule listed in the Index on page
F-1. These financial statements and the schedule are the responsibility of
the Company's management. Our responsibility is to express an opinion on
these financial statements and the schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements.
An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial
position of Reliability Incorporated at December 31, 1997 and 1996, and the
consolidated results of its operations and its cash flows for each of the
three years in the period ended December 31, 1997, in conformity with
generally accepted accounting principles. Also, in our opinion, the related
financial statement schedule, when considered in relation to the basic
financial statements taken as a whole, presents fairly in all material
respects the information set forth therein.
BY/s/ERNST & YOUNG LLP
Houston, Texas
February 6, 1998
F-2
<PAGE>
RELIABILITY INCORPORATED
CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)
ASSETS
December 31,
----------------
1997 1996
---- ----
Current assets:
Cash and cash equivalents $ 7,108 $ 8,504
Accounts receivable 6,753 4,188
Inventories 4,156 3,159
Prepaid income taxes - 286
Deferred tax assets 601 760
Other current assets 501 449
------ ------
Total current assets 19,119 17,346
Property, plant and equipment, at cost:
Machinery and equipment 16,279 13,807
Buildings and improvements 7,958 8,706
Land 792 792
------ ------
25,029 23,305
Less accumulated depreciation 14,347 14,048
------ ------
10,682 9,257
------ ------
$29,801 $26,603
====== ======
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current maturities on long-term debt $ 401 $ 367
Accounts payable 1,659 700
Accrued liabilities 4,426 3,220
Income taxes payable 727 331
------ ------
Total current liabilities 7,213 4,618
Long-term debt 1,560 1,961
Deferred tax liabilities 386 356
Commitments and contingencies - -
Stockholders' equity:
Common stock, without par value; 20,000,000
shares authorized; 7,269,502 and 4,242,848
shares issued in 1997 and 1996, respectively 6,690 5,926
Retained earnings 21,844 13,742
------ ------
28,534 19,668
Less treasury stock, at cost,
1,214,211 shares in 1997 7,892 -
------ ------
Total stockholders' equity 20,642 19,668
------ ------
$29,801 $26,603
====== ======
See accompanying notes.
F-3
<PAGE>
RELIABILITY INCORPORATED
CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except per share data)
Years Ended December 31,
------------------------
1997 1996 1995
---- ---- ----
Revenues:
Product sales $26,908 $22,770 $23,154
Services 20,312 12,990 10,776
------ ------ ------
47,220 35,760 33,930
Costs and expenses:
Cost of product sales 11,108 10,132 10,224
Cost of services 12,545 7,895 6,613
Marketing, general and administrative 9,679 8,043 8,862
Research and development 1,578 2,197 2,227
------ ------ ------
34,910 28,267 27,926
------ ------ ------
Operating income 12,310 7,493 6,004
Interest expense, net 66 53 60
------ ------ ------
Income before income taxes 12,244 7,440 5,944
Provision for income taxes 4,112 2,594 1,881
------ ------ ------
Net income $ 8,132 $ 4,846 $ 4,063
====== ====== ======
Earnings per share:
Basic $ 1.25 $ .57 $ .48
Diluted $ 1.23 $ .57 $ .48
Weighted average number of shares used in
earnings per share calculations:
Basic 6,500 8,486 8,486
Diluted 6,604 8,486 8,486
See accompanying notes.
F-4
<PAGE>
RELIABILITY INCORPORATED
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
Years Ended December 31,
------------------------
1997 1996 1995
---- ---- ----
Cash flows from operating activities:
Net income $ 8,132 $ 4,846 $ 4,063
Adjustments to reconcile net income to cash
provided by operating activities:
Depreciation and amortization 1,613 1,438 1,174
Change in deferred tax assets
and liabilities 189 (105) (218)
Provision for inventory obsolescence 233 1,043 179
Loss (gain) on disposal of fixed assets 6 (47) (24)
Increase (decrease) in operating cash flows:
Accounts receivable (2,565) 4,301 (5,987)
Inventories (1,230) (284) (1,998)
Prepaid income taxes 286 (286) -
Other current assets (52) (138) 197
Accounts payable 959 (675) 1,006
Accrued liabilities 1,206 (870) 2,091
Income taxes payable 396 (355) 669
------ ------ ------
Total adjustments 1,041 4,022 (2,911)
------ ------ ------
Net cash provided by operating activities 9,173 8,868 1,152
------ ------ ------
Cash flows from investing activities:
Expenditures for property, plant and equipment (3,046) (1,754) (8,268)
Proceeds from sale of equipment 2 85 74
------ ------ ------
Net cash (used) in investing activities (3,044) (1,669) (8,194)
------ ------ ------
Cash flows from financing activities:
Payments on long-term debt (367) (247) (65)
Proceeds from issuance of common and
treasury stock pursuant to stock option
and employee stock savings plans 957 - -
Purchase of treasury stock (8,256) - -
Borrowings under revolving credit facility 6,969 - -
Payments under revolving credit facility (6,969) - -
Issuance of mortgage payable - - 2,640
Other 141 - -
------ ------ ------
Net cash (used) provided by financing activities (7,525) (247) 2,575
------ ------ ------
Net (decrease) increase in cash and
cash equivalents (1,396) 6,952 (4,467)
Cash and cash equivalents:
Beginning of year 8,504 1,552 6,019
------ ------ ------
End of year $ 7,108 $ 8,504 $ 1,552
====== ====== ======
See accompanying notes.
F-5
<PAGE>
RELIABILITY INCORPORATED
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Years Ended December 31, 1997, 1996, and 1995
(In thousands)
Treasury Stock
Common Stock (at cost)
-------------- Retained -------------- Total
Shares Amount Earnings Shares Amount Amount
------ ------ -------- ------ ------ ------
Balance at December 31, 1994 4,243 $5,926 $4,833 - $ - $10,759
Net income 4,063 4,063
----- ------ ------ ------ ----- ------
Balance at December 31, 1995 4,243 5,926 8,896 - - 14,822
Net income 4,846 4,846
----- ------ ------ ------ ----- ------
Balance at December 31, 1996 4,243 5,926 13,742 - - 19,668
Net income 8,132 8,132
Purchase of treasury stock (1,270) (8,256) (8,256)
Treasury shares issued for
exercise of stock options 154 23 149 303
Stock dividend 2,999 30 (30) -
Shares issued for exercise
of stock options 28 130 130
Treasury shares issued
pursuant to employee
stock savings plan 309 33 215 524
Other 141 141
----- ----- ------ ------ ------ ------
Balance at December 31, 1997 7,270 $6,690 $21,844 (1,214)$(7,892) $20,642
===== ===== ====== ====== ====== ======
See accompanying notes.
F-6
<PAGE>
RELIABILITY INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1997
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. The Company
and its subsidiaries also operate service facilities which condition and
test 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 are provided principally to two customers, one in
the U.S. and one in Singapore. The Company's U.S. services facility will be
closed in the second quarter of 1998 (See Note 11). Power Sources are sold
to U.S., European and Asian based companies that design and sell electronic
equipment.
PRINCIPLES OF CONSOLIDATION
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.
CASH EQUIVALENTS
For the purposes of the statements of cash flows, the Company considers
all highly liquid cash investments with maturities of three months or less,
when purchased, to be cash equivalents.
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:
1997 1996
---- ----
(In thousands)
Raw materials $1,611 $1,874
Work-in-progress 2,189 872
Finished goods 356 413
----- -----
$4,156 $3,159
===== =====
Inventories are presented net of reserves for excess and obsolete
inventories of $871,000 and $1,509,000 as of December 31, 1997 and 1996,
respectively.
F-7
<PAGE>
RELIABILITY INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
December 31, 1997
PROPERTY, PLANT AND EQUIPMENT
For financial statement purposes, depreciation is computed principally
on the straight-line method using lives of 6 years for leasehold
improvements and 30 years for buildings and the straight-line and double-
declining balance methods using lives from 2 to 8 years for machinery and
equipment.
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 to be 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 $.01 value for each additional share issued. Weighted
average share and per share data, stock option information and employee
stock savings plan information 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.
STOCK OPTIONS
The Company follows Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees" ("APB 25"), in accounting for the
1997 Stock Option Plan because the alternative fair value accounting under
Statement of Financial Accounting Standards No. 123, "Accounting for Stock
Based Compensation" ("SFAS 123"), requires the use of option valuation
models that were not developed for use in valuing employee stock options.
Under APB 25, compensation expense is recognized only to the extent the
exercise price of stock options exceeds the fair value of the Company's
common stock on the measurement date, if any.
REVENUE RECOGNITION
Generally, revenues for the sales of products and services are
recognized when products are shipped and services are provided unless the
Company has obligations remaining under the purchase orders, in which case,
revenue is deferred until all obligations are satisfied. Sales returns have
historically been immaterial.
WARRANTY
The Company warrants products sold to customers for up to three years
from shipment. A provision for estimated future warranty costs, which
historically have been low, is recorded upon shipment.
FOREIGN CURRENCY TRANSLATION
The financial statements of foreign subsidiaries are translated into
U.S. dollar equivalents in accordance with Statement of Financial Accounting
Standards No. 52. The Company's primary functional currency is the U.S.
dollar. Accordingly, translation adjustments and transaction gains or losses
for foreign subsidiaries that use the U.S. dollar as their functional
currency are recognized in consolidated income in the year of occurrence.
F-8
<PAGE>
RELIABILITY INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
December 31, 1997
CONCENTRATION OF RISKS
Financial instruments that potentially subject the Company to
concentrations of credit risk consist of accounts receivable and cash
equivalents.
The Company invests primarily in money market instruments and commercial
paper with maturities of three months or less. The investments are made
through high quality financial institutions, and investments are made only
in those securities which have been assigned investment ratings in the two
most credit-worthy rating categories.
The Company sells its products and services to a limited number of
customers (See Notes 5 and 11).
The Company's revenues are primarily denominated in U.S. dollars and
thus the risks of foreign exchange fluctuations are generally not material.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The recorded amounts of cash, accounts receivable, accounts payable, and
accrued liabilities as presented in the financial statements approximate
fair value because of the short-term maturity of these instruments. The
recorded amount of long-term debt approximates fair value as the actual
interest rate approximates current competitive rates.
EARNINGS PER COMMON AND COMMON EQUIVALENT SHARE
In February 1997, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 128, "Earnings per Share"
("SFAS 128"), which specifies the computation, presentation and disclosure
requirements for earnings per share ("EPS"). SFAS 128 replaces the
presentation of primary and fully diluted EPS pursuant to Accounting
Principles Board Opinion No. 15, "Earnings per Share" ("APB 15"), with the
presentation of basic and diluted EPS. Basic EPS excludes dilution and is
calculated by dividing net income by the weighted average number of common
shares outstanding for the period. Diluted EPS reflects the potential
dilution that could occur if securities or other contracts to issue common
stock were exercised or converted into common stock. The Company adopted
SFAS 128 in the quarter ended December 31, 1997 and has, as required by the
statement, restated all prior-period EPS data.
DEFERRED 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.
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.
F-9
<PAGE>
RELIABILITY INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
December 31, 1997
RECENTLY ISSUED ACCOUNTING STANDARDS
In June 1997, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 130, "Reporting Comprehensive Income"
("SFAS 130"), and Statement of Financial Accounting Standards No. 131,
"Disclosures about Segments of an Enterprise and Related Information" ("SFAS
131"). SFAS 130 establishes standards for reporting and display of
comprehensive income and its components (revenues, expenses, gains and
losses) in a full set of general purpose financial statements. SFAS 131
establishes standards for the way that public business enterprises report
information about operating segments in annual financial statements and
requires that those enterprises report selected information about operating
segments in interim financial reports. It also establishes standards for
related disclosures about products and services, geographic areas and major
customers. Both standards must be adopted in 1998 and are not expected to
have a significant impact on the Company's disclosures.
2. SHORT-TERM BORROWINGS AND LONG-TERM DEBT
During 1997, the Company amended its Loan Agreement with Wells Fargo
Bank Texas, N.A. to increase its credit availability to $4 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 1/4% at December 31, 1997). 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 December 31, 1997, and there were
no balances outstanding under the agreement at December 31, 1997 or 1996.
The Company's Singapore subsidiary maintains an agreement with a
Singapore bank to provide an overdraft facility of 500,000 Singapore Dollars
(U.S. $301,000 at December 31, 1997) to the subsidiary at the bank's prime
rate plus 1% (8% at December 31, 1997). There were no balances outstanding
at December 31, 1997, but amounts utilized under letter of credit
commitments totaled $138,000, resulting in credit availability of $163,000
at December 31, 1997. 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.
F-10
<PAGE>
RELIABILITY INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
December 31, 1997
Long-term debt at December 31, consisted of the following:
1997 1996
---- ----
(In thousands)
Mortgage payable; due in monthly installments
of $26,777 ($46,777 as explained below),
including interest at 9% $1,961 $2,328
Revolving line of credit (described above) - -
----- -----
1,961 2,328
Less current maturities 401 367
----- -----
Long-term debt due after one year $1,560 $1,961
===== =====
The mortgage was payable in 180 equal monthly installments, including
interest at 9%. The Company began paying an additional principal payment of
$20,000 each month in 1996. Current maturities and aggregate maturities as
of December 31, 1997 assume the Company will continue making the additional
$20,000 principal payment, resulting in the note being paid in full in 84
payments. The mortgage is collateralized by land and a building. The
aggregate maturities of the note for the next five years are: 1998 -
$401,000; 1999 - $439,000; 2000 - $480,000; 2001 - $525,000; and 2002 -
$116,000.
Interest paid on debt during 1997, 1996 and 1995 was $288,000, $224,000,
and $245,000, respectively.
Interest expense (income) is presented net as follows:
1997 1996 1995
---- ---- ----
(In thousands)
Interest expense $ 288 $ 229 $ 249
Interest (income) (222) (176) (189)
--- --- ---
Interest expense, net $ 66 $ 53 $ 60
=== === ===
3. INCOME TAXES
The provision for income taxes is based on income before income taxes
as follows:
Geographic area 1997 1996 1995
--------------- ---- ---- ----
(In thousands)
United States $ 9,695 $5,925 $5,814
Foreign 2,839 1,533 327
Eliminations and corporate items (290) (18) (197)
------ ----- -----
$12,244 $7,440 $5,944
====== ===== =====
F-11
<PAGE>
RELIABILITY INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
December 31, 1997
The components of the provision for income taxes are as follows:
Current Deferred Total
------- -------- -----
(In thousands)
1997
----
Federal $3,059 $ 36 $3,095
Foreign 586 153 739
State 278 - 278
----- ---- -----
$3,923 $189 $4,112
===== ==== =====
1996
----
Federal $2,238 $(133) $2,105
Foreign 275 28 303
State 186 - 186
----- ---- -----
$2,699 $(105) $2,594
===== ==== =====
1995
----
Federal $1,965 $(273) $1,692
Foreign - 55 55
State 134 - 134
----- ---- -----
$2,099 $(218) $1,881
===== ==== =====
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:
1997 1996 1995
---- ---- ----
(In thousands)
Provision at statutory rate $4,163 $2,530 $2,021
State income taxes 183 123 89
Tax effects of:
Lower effective income tax rates related
to undistributed foreign earnings (429) - -
Foreign expenses for which a tax benefit
is not available 201 - 87
Foreign tax benefit of export processing
exemption - (63) -
Change in valuation allowance (168) - (389)
Other 162 4 73
----- ----- -----
$4,112 $2,594 $1,881
===== ===== =====
F-12
<PAGE>
RELIABILITY INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
December 31, 1997
The significant components of the Company's net deferred tax liabilities
and assets are as follows:
1997 1996 1995
---- ---- ----
(In thousands)
Deferred tax liabilities:
Depreciation $ 333 $ 195 $ 155
Undistributed earnings of foreign subsidiary - 144 -
Other 53 17 24
---- ------ ----
Total deferred tax liabilities 386 356 179
---- ------ ----
Deferred tax assets:
Inventory reserves (296) (505) (224)
Accrued expenses not currently deductible (301) (223) (257)
Foreign tax credits - (473) (470)
Other (4) (32) 3
---- ------ ----
Total deferred tax assets (601) (1,233) (948)
Valuation allowance - 473 470
---- ------ ----
Deferred tax assets, net of valuation
allowance (601) (760) (478)
---- ------ ----
Net deferred tax (asset) $(215) $ (404) $(299)
==== ====== ====
Valuation allowances were provided in 1996 and 1995 since realization
of a portion of the deferred tax assets was uncertain. The reduction in the
valuation allowance in 1997 resulted from the pending expiration of the
related foreign tax credits. These foreign taxes were deducted as expenses
prior to their expiration, resulting in a partial realization of the
deferred tax asset equal to $168,000.
The Company's Singapore subsidiary has available an investment allowance
grant which provides a reduction in Singapore income taxes based on the
subsidiary's investment in certain fixed assets during the period September
1995 through September 1998. The total tax benefit available to the
subsidiary is approximately $425,000, of which $275,000 has been recorded
as a reduction of income tax expense as of December 31, 1997. The future
benefit available at December 31, 1997 is approximately $150,000. The tax
benefit associated with the investment allowance may be refundable if
conditions specified in the agreement are not met. The agreement requires
that the subsidiary expend an additional $950,000 on qualified fixed assets
prior to September 1998.
Effective January 1, 1997, the Company changed its policy with respect
to providing United States income taxes on undistributed earnings of a
foreign subsidiary. Increasing demand for services provided by the
subsidiary necessitates permanently reinvesting future earnings of the
subsidiary. Deferred United States income taxes have not been provided on
$2,700,000 of earnings that were accumulated after January 1, 1997. Earnings
prior to January 1, 1997 on which United States taxes have been provided
total $3,200,000 at December 31, 1997.
F-13
<PAGE>
RELIABILITY INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
December 31, 1997
Net income for 1996 included income of a subsidiary operating in Costa
Rica under an export processing tax exemption. The subsidiary is exempt
from Costa Rica income tax through 1999 and is 50% exempted for 2000 through
2003. A tax benefit of $63,000 was recorded in 1996 related to income of
the subsidiary in 1996. The subsidiary operated at a loss in 1997 and 1995.
Net cash payments for income taxes during 1997, 1996 and 1995 were
$3,357,000, $3,351,000, and $1,443,000, respectively.
4. STOCKHOLDERS' EQUITY
TREASURY STOCK
In March 1997, the Company purchased 1,270,221 shares of its common
stock from a stockholder for $6.50 per share. Shareholders approved the
1997 Stock Option Plan in April 1997, and treasury stock was used to issue
shares under the option plan. The treasury stock is also used to fund the
Company's contributions to its employee stock savings plan.
STOCK OPTIONS
In February 1997, the Company's Board of Directors adopted, and in April
1997 the shareholders approved, the 1997 Stock Option Plan ("Option Plan"),
under which 1,000,000 shares of common stock were made available for future
grants. The Option Plan permits the granting of both incentive stock
options, as defined under the Internal Revenue Code, and non-qualified
options to directors, executive officers and other key employees of the
Company and its subsidiaries. The term and vesting of each option will be
fixed by the Board of Directors. The term of each option may not exceed 10
years for incentive stock options. The exercise price is the fair market
value of the Company's common stock on the date the option is granted.
Incentive stock options generally vest in three equal installments beginning
six months after the option award. The second and third installments are
on March 1, one and two years after the initial vesting date. Non-qualified
options vest on the date granted. All option awards require that the
recipients own shares of common stock. The required stock ownership begins
approximately two years after the option grant date and increases in three
to five annual increments. Unexercised options terminate in installments if
the required number of shares of common stock is not owned on the specified
date. The number of shares available for future grant was 576,000 at
December 31, 1997.
F-14
<PAGE>
RELIABILITY INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
December 31, 1997
A summary of the Option Plan activity for the year ended December 31,
1997 is as follows:
Weighted
Average
Exercise
Options Price
------- --------
Outstanding at beginning of year -0- $ -0-
Granted 424,000 5.92
Exercised (74,000) 3.50
------- ----
Outstanding at end of year 350,000 $6.43
======= ====
Weighted average fair value of
options granted $4.49
====
The following table summarizes information about stock options
outstanding and exercisable at December 31, 1997:
Exercis-
Weighted Outstanding able
Average Weighted Weighted
Number of Remaining Average Number of Average
Exercise Options Contractual Exercise Options Exercise
Price Outstanding Life in Years Price Exercisable Price
---------- ----------- ------------- -------- ------------ --------
$ 3.50 266,000 9.2 $ 3.50 120,000 $ 3.50
13.31 54,000 9.2 13.31 - 13.31
20.25 30,000 9.2 20.25 15,000 20.25
------- ----- ------- -----
350,000 $ 6.43 135,000 $ 5.35
======= ===== ======= =====
F-15
<PAGE>
RELIABILITY INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
December 31, 1997
STATEMENT OF FINANCIAL ACCOUNTING STANDARDS NO. 123
SFAS 123 defines a fair value based method of accounting for employee
stock options or similar equity instruments. However, SFAS 123 allows the
continued measurement of compensation cost in the financial statements for
such plans using the intrinsic value based method prescribed by APB 25,
provided that certain pro forma disclosures are made of net income or loss,
assuming the fair value based method of SFAS 123 had been applied. For
purposes of the pro forma disclosures presented below, the Company has
computed the fair values of all options granted during 1997 using the Black-
Scholes pricing model and the following weighted average assumptions:
Risk-free interest rate 6.48%
Expected lives 5.3 years
Expected volatility 64%
Expected dividend yield 0%
To estimate expected lives of options for this valuation, it was assumed
options will be exercised at varying schedules after becoming fully vested.
All options are initially assumed to vest. Cumulative compensation cost
recognized in pro forma net income with respect to options that are
forfeited prior to vesting will be adjusted as a reduction of pro forma
compensation expense in the period of forfeiture.
For purposes of pro forma disclosures, the estimated fair value of the
options is amortized to expense over the options' vesting period. If the
Company had accounted for its stock-based compensation plan in 1997 in
accordance with SFAS 123, the Company's net income and earnings per share
would have been reported as follows (in thousands, except per share data):
Net income:
As reported $8,132
=====
Pro forma $7,232
=====
Earnings per share:
As reported - basic $ 1.25
=====
Pro forma - basic $ 1.11
=====
As reported - diluted $ 1.23
=====
Pro forma - diluted $ 1.09
=====
The pro forma disclosures above are not necessarily indicative of the
effects of applying SFAS 123 in future years.
F-16
<PAGE>
RELIABILITY INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
December 31, 1997
5. INFORMATION ON BUSINESS SEGMENTS AND GEOGRAPHIC AREAS
The Company operates in three industry segments: (1) manufacture of
testing products which are used in the testing and conditioning of
integrated circuits, (2) services which condition and test integrated
circuits and (3) manufacture of power sources. Corporate assets are cash
investments which are classified as cash equivalents.
Financial information by industry segment is as follows:
1997 1996 1995
---- ---- ----
(In thousands)
Revenues from unaffiliated customers:
Testing products $23,464 $17,697 $18,583
Services 20,312 12,990 10,776
Power sources 3,444 5,073 4,571
------ ------ ------
$47,220 $35,760 $33,930
====== ====== ======
Operating income (loss):
Testing products $ 8,012 $ 4,243 $ 4,316
Services 4,975 3,098 2,163
Power sources (270) 603 91
General corporate expenses (407) (451) (566)
------ ------ ------
$12,310 $ 7,493 $ 6,004
====== ====== ======
Identifiable assets:
Testing products $13,393 $ 8,649 $14,563
Services 10,927 8,205 6,374
Power sources 2,191 2,580 2,790
General corporate assets 3,290 7,169 -
------ ------ ------
$29,801 $26,603 $23,727
====== ====== ======
Depreciation:
Testing products $ 538 $ 520 $ 446
Services 970 811 575
Power sources 105 107 143
------ ------ ------
$ 1,613 $ 1,438 $ 1,164
====== ====== ======
Capital expenditures:
Testing products $ 641 $ 368 $ 4,176
Services 2,331 1,345 3,226
Power sources 74 41 866
------ ------ ------
$ 3,046 $ 1,754 $ 8,268
====== ====== ======
F-17
<PAGE>
RELIABILITY INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
December 31, 1997
Financial information by geographical area is as follows:
1997 1996 1995
---- ---- ----
(In thousands)
Revenues from unaffiliated customers:
United States $28,027 $22,492 $23,212
Asia and Pacific 15,749 8,195 6,147
Central America 3,444 5,073 4,571
Intergeographic revenues:
United States 1,823 649 678
Asia and Pacific 317 58 202
Eliminations (2,140) (707) (880)
------ ------ ------
$47,220 $35,760 $33,930
====== ====== ======
Operating income (loss):
United States $ 9,752 $ 5,858 $ 6,113
Asia and Pacific 3,235 1,483 366
Central America (270) 603 91
General corporate expenses (407) (451) (566)
------ ------ ------
$12,310 $ 7,493 $ 6,004
====== ====== ======
Identifiable assets:
United States $19,570 $19,591 $17,578
Asia and Pacific 8,093 4,456 3,357
Central America 2,138 2,556 2,792
------ ------ ------
$29,801 $26,603 $23,727
====== ====== ======
Intersegment sales, which are not material, and intergeographic sales
of manufactured products are priced at cost plus a reasonable profit.
The Company provides products and services to companies in the
electronics and semiconductor industries, many of which are industry
leaders. There are a limited number of companies which purchase testing
products and services sold by the Company. The Company's four largest
customers accounted for approximately 90%, 82%, and 80% of consolidated
revenues in 1997, 1996 and 1995, respectively. Accounts receivable are
generally due within 30 days, and collateral is not required due to the
credit worthiness of the customers to which the Company sells.
F-18
<PAGE>
RELIABILITY INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
December 31, 1997
The Company had export revenues from its United States operation to the
following geographical areas:
1997 1996 1995
---- ---- ----
(In thousands)
Asia and Pacific $ 8,006 $2,337 $10,677
Europe 5,611 3,046 1,336
North America and other 224 377 21
------ ----- ------
$13,841 $5,760 $12,034
====== ===== ======
The Company's revenues are concentrated in the electronics industry;
however, the Company's customers operate in diverse markets and geographic
areas. Revenues from major customers, as a percent of total revenues and
industry segments, are as follows:
Total Testing Power
Revenues Products Services Sources
-------- -------- -------- -------
1997
----
Customer A 32% -% 75% -%
Customer B 29 58 - -
Customer C 19 38 - -
Customer D 10 - 24 -
1996
----
Customer A 22% -% 60% -%
Customer B 32 64 - -
Customer C 14 28 - -
Customer D 14 - 38 -
1995
----
Customer A 18% -% 54% 6%
Customer B 18 33 - -
Customer C 30 55 - -
Customer D 14 - 45 -
Accounts receivable, at any point in time, are concentrated in one or
more of the Company's significant customers, depending on shipments at that
point in time to a particular customer. Historically, the Company's bad
debts have been very low, an indication of the credit worthiness of the
customers to which the Company sells.
F-19
<PAGE>
RELIABILITY INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
December 31, 1997
6. EARNINGS PER SHARE
The following table sets forth the computation of basic and diluted
earnings per share (in thousands, except per share data):
1997 1996 1995
---- ---- ----
Numerator for basic and diluted
earnings per share - net income $8,132 $4,846 $4,063
====== ====== ======
Denominator:
Denominator for basic earnings per
share - weighted average shares
outstanding 6,500 8,486 8,486
Dilutive effect assuming conversion of
stock options (as determined by the
application of the treasury stock method) 104 - -
------ ------ ------
Denominator for diluted earnings per
share - adjusted weighted average
shares and assumed conversions 6,604 8,486 8,486
====== ====== ======
Earnings per share:
Basic $ 1.25 $ .57 $ .48
====== ====== ======
Diluted $ 1.23 $ .57 $ .48
====== ====== ======
Shares and earnings per share have been adjusted to reflect the two-for-
one stock split effected in the form of a dividend in September 1997.
There were 30,000 options to purchase shares of common stock that were
outstanding during the fourth quarter of 1997 that were not included in the
computation of diluted earnings per share because the options' exercise
price was greater than the average market price of the common shares.
7. EMPLOYEE STOCK SAVINGS PLAN
The Company sponsors an Employee Stock Savings Plan and Trust (the
"Plan"). United States employees of the Company who have completed at least
six months of service become participants in the Plan. The Plan allows an
employee to contribute up to 15% of defined compensation to the Plan and to
elect to have contributions not be subject to Federal income taxes under
Section 401(k) of the Internal Revenue Code. The Company contributes a
matching amount to the Plan equal to 50% of the employee's contribution, to
a maximum of 2%, for employees who contribute 2% or more. The Company also
contributes, as a voluntary contribution, an amount equal to 1% of the
defined compensation of all participants and effective January 1, 1997,
contributes a profit sharing amount based on the consolidated profits of the
F-20
<PAGE>
RELIABILITY INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
December 31, 1997
Company. The maximum profit sharing contribution is 5% of compensation.
The Company's contribution for matching, voluntary and profit sharing
contributions amounted to $501,000 in 1997, $129,000 in 1996, and $121,000
in 1995. Employee contributions may be invested in Company stock or other
investment options offered by the Plan. The Company's contributions vest
with the employee over seven years and are invested solely in Company stock.
The Company, in May 1992, registered and reserved 500,000 shares of
common stock for sale to the Plan. The Plan purchased, in the open market,
26,867, 35,550, and 124,152 shares during 1997, 1996, and 1995, for an
aggregate purchase price of $525,000, $116,000, and $270,000, respectively.
During 1997, the Plan purchased 33,110 shares of treasury stock from the
Company for an aggregate purchase price of $524,000. The purchase price per
share for treasury stock was the closing price on the day prior to purchase
by the Plan. At December 31, 1997, 191,000 reserved shares remain unissued
under the registration statement.
8. COMMITMENTS
The Company has leased various manufacturing and office facilities under
non-cancelable operating lease agreements. Rental expense for 1997, 1996 and
1995 was $273,000, $388,000, and $529,000, respectively.
The Company leases a conditioning services and office facility under a
non-cancelable operating lease agreement, expiring in May 2000. Future
minimum rental payments under the lease are: 1998 - $384,000; 1999 -
$409,000; and 2000 - $209,000.
The Company leases manufacturing and office space in its U.S. facility
to a third party under an agreement expiring in January 2001. Rental income
for 1997, 1996 and 1995 was $180,000, $182,000, and $96,000, respectively.
Future income under the lease will be: 1998 - $179,000; 1999 - $179,000;
2000 - $179,000; subsequent to 2000 - $15,000.
9. ACCRUED LIABILITIES
Accrued liabilities consist of the following:
1997 1996
---- ----
(In thousands)
Payroll $3,670 $2,644
Warranty 188 102
Other 568 474
----- -----
$4,426 $3,220
===== =====
10. RELATED PARTY TRANSACTIONS
The spouse of an employee of the Company has an ownership interest in
a company that provided computer software development and technical
assistance for certain products sold by the Company. The technical
assistance agreement with the company expired in June 1996. The net expense
F-21
<PAGE>
RELIABILITY INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
December 31, 1997
accrued related to these transactions, including royalties, amounted to
$131,000 and $420,000 during 1996 and 1995, respectively. There were no
amounts payable to such company at December 31, 1997, or 1996.
11. SUBSEQUENT EVENT
The Company's North Carolina services facility provides service to one
customer. The customer notified the Company in January 1998 that it is
necessary to reduce the output of DRAMs burned-in and tested by the
Company's Durham facility. As a result, the Company will close the Durham
facility in April 1998. The facility accounted for approximately 10% of
Reliability's consolidated revenues in 1997, but the closure in 1998 had no
effect on 1997 revenues. Reliability currently estimates the cost of
closing the facility to be approximately $500,000, which includes severance
pay, loss on disposal of assets and operating costs subsequent to the shut-
down date.
12. SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
Summarized quarterly financial data are as follows (in thousands,
except per share amounts):
First Second Third Fourth
Quarter Quarter Quarter Quarter
------- ------- ------- -------
1997
----
Net sales $6,691 $12,609 $13,494 $14,426
Gross profit 2,981 6,547 7,046 6,993
Net income 739 2,323 2,667 2,403
Earnings per share:
Basic .09 .39 .45 .40
Diluted .09 .39 .43 .39
1996
----
Net sales $6,758 $9,409 $ 8,804 $10,789
Gross profit 3,719 4,659 4,493 4,862
Net income 691 1,285 1,348 1,522
Earnings per share:
Basic .08 .15 .16 .18
Diluted .08 .15 .16 .18
All per share amounts have been restated to give effect to a two-
for-one stock split effected as a stock dividend and the adoption of SFAS
128 (See Notes 1 and 6).
F-22
<PAGE>
RELIABILITY INCORPORATED
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS AND RESERVES
Years Ended December 31, 1997, 1996 and 1995
(In thousands)
1997 1996 1995
---- ---- ----
Reserves for obsolete and excess Inventory:
Reserves at beginning of year $1,509 $ 626 $ 630
Additions charged to costs and expenses 233 1,043 179
Amounts charged to reserve (871) (160) (183)
----- ----- -----
Reserves at end of year $ 871 $1,509 $ 626
===== ===== =====
S-1
<PAGE>
RELIABILITY INCORPORATED
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure.
Not applicable.
PART III
In accordance with paragraph (3) of General Instruction G to Form 10-K,
Part III of this Report is omitted because the Company will file with the
Securities and Exchange Commission not later than 120 days after the end of
1997 a definitive proxy statement pursuant to Regulation 14A involving the
election of directors.
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K.
(a) The following financial statements are filed as part of this
report:
1. Consolidated Financial Statements and Supplementary Data.
Listed in the Index to Financial Statements provided in
response to Item 8 hereof (see p. F-1 for Index).
2. Financial Statement Schedule. Listed in the Index to
Financial Statements provided in response to Item 8 hereof
(see p. F-1 for Index).
(b) The following exhibits are filed as part of this report:
3.1 Restated Articles of Incorporation (with amendment).
Reference is made to Exhibit 3 to the Company's Quarterly
Report on Form 10-Q for the quarter ended June 30, 1995.
3.2 Amended and Restated Bylaws. Reference is made to Exhibit
3 to the Company's Quarterly Report on Form 10-Q for the
quarter ended June 30, 1997.
3.3 Amendment to Amended and Restated Bylaws. Reference is
made to Exhibit 3.3 to the Company's Quarterly Report on
Form 10-Q for the quarter ended September 30, 1997.
4.1 Third Amendment to Loan Agreement, as of December 31, 1997,
between Reliability Incorporated and Wells Fargo Bank
(Texas) National Association.
21. List of subsidiaries.
23. Consent of Independent Auditors dated March 13, 1998
related to Employee Stock Savings Plan and Trust.
23.1 Consent of Independent Auditors dated March 13, 1998
related to 1997 Stock Option Plan.
27. Financial Data Schedule.
(c) No reports on Form 8-K were required to be filed by the Company
during the last quarter of the fiscal year covered by this
report.
23
<PAGE>
RELIABILITY INCORPORATED
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
DATE: March 16, 1998
RELIABILITY INCORPORATED (Registrant)
BY /s/ Max T. Langley
Max T. Langley, Senior Vice President
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
DATE: March 16, 1998
BY /s/ Larry Edwards
Larry Edwards, Chairman of the Board of
Directors, President and
Chief Executive Officer
DATE: March 16, 1998
BY /s/ Max T. Langley
Max T. Langley, Senior Vice President,
Chief Financial Officer,
Principal Accounting Officer
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
Company and in the capacities and on the dates indicated.
/s/ Larry Edwards DATE: March 16, 1998
Larry Edwards, Director
/s/ W. L. Hampton DATE: March 16, 1998
W. L. Hampton, Director
/s/ John R. Howard DATE: March 16, 1998
John R. Howard, Director
/s/ Thomas L. Langford DATE: March 16, 1998
Thomas L. Langford, Director
/s/ A. C. Lederer, Jr. DATE: March 16, 1998
A. C. Lederer, Jr., Director
/s/Philip Uhrhan DATE: March 16, 1998
Philip Uhrhan, Director
24
<PAGE>
RELIABILITY INCORPORATED
INDEX TO EXHIBITS
Exhibit Page
Number Description of Exhibits Number
- ------- ----------------------- ------
4.1 Third Amendment to Loan Agreement, as of
December 31, 1997, between Reliability Incor-
porated and Wells Fargo Bank (Texas) National
Association. 26
21. List of Subsidiaries. 31
23. Consent of Independent Auditors dated 32
March 13, 1998 related to Employee
Stock Savings Plan and Trust.
23.1 Consent of Independent Auditors dated 33
March 13, 1998 related to 1997 Stock
Option Plan.
27. Financial Data Schedule. 34
25
<PAGE>
RELIABILITY INCORPORATED
EXHIBIT 4.1.
THIRD AMENDMENT TO LOAN AGREEMENT
THIS THIRD AMENDMENT TO LOAN AGREEMENT (this "Amendment"), dated as of
December 31, 1997, is between RELIABILITY INCORPORATED, a Texas corporation
("Borrower"), and WELLS FARGO BANK (TEXAS), NATIONAL ASSOCIATION ("Lender").
RECITALS:
A. Borrower and Lender (which was formerly known as First Interstate
Bank of Texas, N.A.) entered into that certain Loan Agreement dated as of July
1, 1995, as amended by First Amendment to Loan Agreement dated as of March 10,
1997 and Second Amendment to Loan Agreement dated as of August 15, 1997
(collectively, the "Agreement").
B. Borrower and Lender now desire to amend the Agreement as herein set
forth.
NOW, THEREFORE, in consideration of the premises herein contained and
other good and valuable consideration, the receipt and sufficiency of which are
hereby acknowledged, the parties hereto agree as follows:
ARTICLE I
Definitions
Section 1.01. Definitions. Capitalized terms used in this Amendment, to
the extent not otherwise defined herein, shall have the meanings given to such
terms in the Agreement, as amended hereby.
ARTICLE II
Amendments
Section 2.01. Amendment to Certain Definitions. (a) Effective as of date
hereof, the definition of each of the following terms contained in Section 1.01
of the Agreement is amended to read in its respective entirety as follows:
"Commitment" means the obligation of Lender to make Advances
hereunder in an aggregate principal amount at any time outstanding up to
but not exceeding $4,000,000.00 as such amount may be reduced as provided
herein.
"Termination Date" means 11:00 a.m.. Houston, Texas time on December
31, 1999, or such earlier date on which the Commitment terminates as
provided in this Agreement.
(b) Effective as of the date hereof, the definition of the term
"Reduction Day" is deleted from Section 1.01 of the Agreement.
Section 2.02. Amendment to Section 2.03. Effective as of the date
hereof, the second sentence (which is also the last sentence) of Section 2.03
of the Agreement is deleted from the Agreement.
1
26
<PAGE>
Section 2.02. Amendment to Exhibits. Effective as of the date hereof,
Exhibit "A" to the Agreement (Note) is amended to conform in its entirety to
Annex "A" to this Amendment.
ARTICLE III
Conditions Precedent
Section 3.01. Conditions. The effectiveness of this Amendment is subject
to the receipt by Lender of the following in form and substance satisfactory to
Lender:
(a) Resolutions - Borrower. Resolutions of the Board of Directors
of Borrower certified by its Secretary or an Assistant Secretary which
authorize the execution, delivery and performance by Borrower of this
Amendment and the other Loan Documents to which Borrower is or is to be
a party hereunder.
(b) Incumbency Certificate - Borrower. A certificate of
incumbency certified by the Secretary or an Assistant Secretary of
Borrower certifying the names and signatures of the officers of Borrower
authorized to sign this Amendment and each of the other Loan Documents to
which Borrower is or is to be a party hereunder.
(c) Certificates of Existence and Good Standing - Borrower.
Certificates of the appropriate governmental officials regarding the
existence and good standing of Borrower in the State of Texas.
(d) Note. The Note executed by Borrower.
(e) Third Amendment to Security Agreement. The Third Amendment
to Security Agreement in the form of Annex "B" hereto, executed by
Borrower.
(f) UCC Search. A Uniform Commercial Code search showing all
financing statements and other documents or instruments on file against
Borrower in Harris County, Texas and the office of the Secretary of State
of Texas.
(g) Legal Fees. Payment of the reasonable legal fees and expenses
of Lender's counsel.
(h) Additional Information. Such additional documents,
instruments and information as Lender may request.
Section 3.02. Additional Conditions. The effectiveness of this Amendment
is also subject to the satisfaction of the additional conditions precedent that
(a) the representations and warranties contained herein and in all other Loan
Documents, as amended hereby, shall be true and correct as of the date hereof
as if made on the date hereof, (b) all proceedings, corporate or otherwise,
taken in connection with the transactions contemplated by this Amendment and all
documents, instruments and other legal matters incident thereto shall be
satisfactory to Lender, and (c) no Event of Default shall have occurred and be
continuing and no event or condition shall have occurred that with the giving
of notice or lapse of time or both would be an Event of Default.
2
27
<PAGE>
ARTICLE IV
Ratifications, Representations, and Warranties
Section 4.01. Ratifications. The terms and provisions set forth in this
Amendment shall modify and supersede all inconsistent terms and provisions set
forth in the Agreement and except as expressly modified and superseded by this
Amendment, the terms and provisions of the Agreement are ratified and confirmed
and shall continue in full force and effect. Borrower and Lender agree that the
Agreement as amended hereby shall continue to be the legal, valid and binding
obligation of such Persons enforceable against such Persons in accordance with
its terms.
Section 4.02. Representations, Warranties and Agreements. Borrower
hereby represents and warrants to Lender that as of the date hereof, and taking
into account the provisions of this Amendment, (a) the execution, delivery, and
performance of this Amendment and any and all other Loan Documents executed or
delivered in connection herewith have been authorized by all requisite corporate
action on the part of Borrower and will not violate the articles of
incorporation or bylaws of Borrower, (b) the representations and warranties
contained in the Agreement as amended hereby, and all other Loan Documents are
true and correct on and as of the date hereof as though made on and as of the
date hereof, (c) no Event of Default has occurred and is continuing and no event
or condition has occurred that with the giving of notice or lapse of time or
both would be an Event of Default, (d) Borrower is in full compliance with all
covenants and agreements contained in the Agreement as amended hereby, (e)
Borrower is obligated to Lender pursuant to the terms of the Note, as the same
may have been renewed, modified, extended, increased and rearranged, including,
without limitation, renewals, modifications, increases and extensions made
pursuant to this Amendment, (f) the liens, security interests, encumbrances and
assignments created and evidenced by the Loan Documents are, respectively, valid
and subsisting liens, security interests, encumbrances and assignments (except
as provided in the Security Agreement) and secure the Note as the same may have
been renewed, modified, increased or rearranged, including, without limitation,
renewals, modifications, increases and extensions made pursuant to this
Amendment, and (g) Borrower has no claims, credits, offsets, defenses or
counterclaims arising from the Loan Documents or Lender's performance under the
Loan Documents.
ARTICLE V
Miscellaneous
Section 5.01. Survival of Representations and Warranties. All
representations and warranties made in this Amendment or any other Loan
Documents including any Loan Document furnished in connection with this
Amendment shall fully survive the execution and delivery of this Amendment and
the other Loan Documents, and no investigation by Lender or any closing shall
affect the representations and warranties or the right of Lender to rely on
them.
Section 5.02. Reference to Agreement. Each of the Loan Documents,
including the Agreement and any and all other agreements, documents, or
instruments now or hereafter executed and delivered pursuant to the terms hereof
or pursuant to the terms of the Agreement, as amended hereby, are hereby amended
so that any reference in such Loan Documents to the Agreement shall mean a
reference to the Agreement, as amended hereby.
3
28
<PAGE>
Section 5.03. Expenses of Lender. As provided in the Agreement, Borrower
agrees to pay on demand all reasonable costs and expenses incurred by Lender in
connection with the preparation, negotiation and execution of this Amendment and
the other documents and instruments executed pursuant hereto and any and all
amendments, modifications and supplements thereto, including, without
limitation, the costs and fees of Lender's legal counsel, and all costs and
expenses incurred by Lender in connection with the enforcement or preservation
of any rights under the Agreement, as amended hereby, or any other Loan
Document, including, without limitation, the costs and fees of Lender's legal
counsel.
Section 5.04. Severability. Any provision of this Amendment held by a
court of competent jurisdiction to be invalid or unenforceable shall not impair
or invalidate the remainder of this Amendment and the effect thereof shall be
confined to the provision so held to be invalid or unenforceable.
Section 5.05. Applicable Law. This Amendment and all other Loan
Documents executed pursuant hereto shall be deemed to have been made and to be
performable in Houston, Harris County, Texas and shall be governed by and
construed in accordance with the laws of the State of Texas.
Section 5.06. Successors and Assigns. This Amendment is binding upon and
shall inure to the benefit of Lender and Borrower and their respective
successors and assigns, except Borrower may not assign or transfer any of its
rights or obligations hereunder without the prior written consent of Lender.
Section 5.07. Counterparts. This Amendment may be executed in one or
more counterparts, each of which when so executed shall be deemed to be an
original, but all of which when taken together shall constitute one and the same
instrument.
Section 5.08. Effect of Waiver. No consent or waiver, express or
implied, by Lender to or for any breach of or deviation from any covenant,
condition or duty by Borrower shall be deemed a consent or waiver to or of any
other breach of the same or any other covenant, condition or duty.
Section 5.09. Headings. The headings, captions, and arrangements used
in this Amendment are for convenience only and shall not affect the
interpretation of this Amendment.
Section 5.10. ENTIRE AGREEMENT. THIS AMENDMENT AND ALL OTHER
INSTRUMENTS, DOCUMENTS, AND AGREEMENTS EXECUTED AND DELIVERED IN CONNECTION WITH
THIS AMENDMENT EMBODY THE FINAL, ENTIRE AGREEMENT AMONG THE PARTIES HERETO WITH
RESPECT TO THE SUBJECT MATTER HEREOF AND THEREOF AND SUPERSEDE ANY AND ALL PRIOR
COMMITMENTS, AGREEMENTS, REPRESENTATIONS AND UNDERSTANDINGS, WHETHER WRITTEN OR
ORAL, RELATING TO THIS AMENDMENT AND THE OTHER INSTRUMENTS, DOCUMENTS AND
AGREEMENTS EXECUTED AND DELIVERED IN CONNECTION WITH THIS AMENDMENT, AND MAY NOT
BE CONTRADICTED OR VARIED BY EVIDENCE OF PRIOR, CONTEMPORANEOUS OR SUBSEQUENT
ORAL AGREEMENTS OR DISCUSSIONS OF THE PARTIES HERETO. THERE ARE NO ORAL
AGREEMENTS AMONG THE PARTIES HERETO.
4
29
<PAGE>
Section 5.11. Agreement for Binding Arbitration. Borrower and Lender
agree to be bound by the terms and provisions of Lender's current Arbitration
Program, which is acknowledged as having been received by Borrower and which is
incorporated by reference herein, pursuant to which any and all disputes
regarding the subject matter hereof or of any Loan Documents shall be resolved
by mandatory binding arbitration upon the request of Borrower or Lender.
Executed as of the date first written above.
BORROWER:
RELIABILITY INCORPORATED
By: /s/ Larry Edwards
Larry Edwards
President
LENDER:
WELLS FARGO BANK (TEXAS),
NATIONAL ASSOCIATION
By: /s/ Bennett Douglas
Bennett Douglas
Vice President
5
30
<PAGE>
RELIABILITY INCORPORATED
EXHIBIT 21
LIST OF SUBSIDIARIES
Name Place of Incorporation
---- ----------------------
RICR de Costa Rica, S.A. Costa Rica
Reliability Singapore Pte Ltd. Singapore
31
<PAGE>
RELIABILITY INCORPORATED
Exhibit 23
CONSENT OF INDEPENDENT AUDITORS
We consent to the incorporation by reference in the Registration
Statement (Form S-8 No. 33-47803) pertaining to the Reliability Incorporated
Employee Stock Savings Plan and Trust and in the related Prospectus of our
report dated February 6, 1998, with respect to the consolidated financial
statements and schedules of Reliability Incorporated included in this Annual
Report (Form 10-K) for the year ended December 31, 1997.
BY/s/ERNST & YOUNG LLP
Houston, Texas
March 13, 1998
10kx23.wp1 32
<PAGE>
RELIABILITY INCORPORATED
Exhibit 23.1
CONSENT OF INDEPENDENT AUDITORS
We consent to the incorporation by reference in the Registration
Statement (Form S-8 No. 333-26659) pertaining to the Reliability Incorporated
1997 Stock Option Plan and in the related Prospectus of our report dated
February 6, 1998, with respect to the consolidated financial statements and
schedules of Reliability Incorporated included in this Annual Report (Form
10-K) for the year ended December 31, 1997.
BY/s/ERNST & YOUNG LLP
Houston, Texas
March 13, 1998
33
<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> YEAR
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> DEC-31-1997
<CASH> 7,108
<SECURITIES> 0
<RECEIVABLES> 6,753
<ALLOWANCES> 0
<INVENTORY> 4,156
<CURRENT-ASSETS> 19,119
<PP&E> 25,029
<DEPRECIATION> 14,347
<TOTAL-ASSETS> 29,801
<CURRENT-LIABILITIES> 7,213
<BONDS> 0
0
0
<COMMON> 6,690
<OTHER-SE> 13,952
<TOTAL-LIABILITY-AND-EQUITY> 29,801
<SALES> 47,220
<TOTAL-REVENUES> 47,220
<CGS> 23,653
<TOTAL-COSTS> 23,653
<OTHER-EXPENSES> 11,257
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 66
<INCOME-PRETAX> 12,244
<INCOME-TAX> 4,112
<INCOME-CONTINUING> 8,132
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 8,132
<EPS-PRIMARY> 1.25<F1>
<EPS-DILUTED> 1.23<F1>
<FN>
<F1>SHARES AND EARNINGS PER SHARE HAVE BEEN ADJUSTED IN THE FINANCIAL STATEMENTS
AND IN THIS FINANCIAL DATA SCHEDULE 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>
