Qualmark Cp - Recent Material Event
PART I
ITEM 1. DESCRIPTION OF BUSINESS.
Qualmark Corporation (“Qualmark” or “the Company”) was organized in July 1991 as a Colorado limited
liability company and was later incorporated in March 1992 in Colorado. The Company completed its
initial public offering in April 1996.
HALT/HASS Business Segment (“HALT/HASS”):
Qualmark designs, manufactures, and markets proprietary equipment that rapidly and efficiently
expose product design and manufacturing-related defects for the purpose of improving product
quality and reliability. The Company’s high performance physical stress equipment supports
significant improvements in the process of Design Verification Testing (“DVT”) and Environmental
Stress Screening (“ESS”). DVT is the process by which electronic product manufacturers ensure their
products perform within the previously determined operating ranges (commonly known as
“specifications”). ESS is the testing process used by these same manufacturers to expose
production-related defects.
Qualmark’s equipment allows manufacturers to determine the true operating limits of their products.
This gives manufacturers the necessary information to reduce design costs, improve product
reliability, shorten time to market, reduce warranty costs, and extend warranty periods. The
Company’s equipment is used by manufacturers in a wide range of industries to perform highly
accelerated stress testing on products such as circuit boards, personal computers, monitors, flight
navigation systems, cellular telephones, LAN/WAN equipment and consumer electronics.
Qualmark evolved from a business manufacturing and marketing its proprietary OVS (Omni-axial
Vibration System) or Typhoon (“Typhoon”) equipment to a full service organization offering HALT
(Highly Accelerated Life Test) and HASS (Highly Accelerated Stress Screen) test services as well.
The Company operates a network of direct and strategic agreement test centers, known as Accelerated
Reliability Test Centers (“ARTC”), which provide comprehensive HALT and HASS test and support
services to industry. These services include accelerated reliability improvement test services
(HALT and HASS) using Qualmark’s OVS physical stress equipment performed either in the ARTC test
centers or at the customer’s site.
Qualmark currently operates two test centers located in the metropolitan areas of Denver, Colorado
and Boston, Massachusetts. The Company also has entered into domestic strategic agreements with
large testing companies in Detroit, Michigan, and Huntsville, Alabama. In addition, the Company
has established strategic agreements with IMQ Instituto Del Marchia Di Qualita, Institutet For
Verkstadsteknisk Forskning, the Swedish Institute of Production Engineering and MB Electronique to
operate testing centers in Netherlands, Italy, Sweden and France. As domestic or international
demand for its products and services grows, the Company may further expand its domestic and
international presence by expanding strategic arrangements with other test lab organizations.
Electrodynamic Business Segment (“ED”):
On November 15, 2004, Qualmark completed the asset acquisition of Connecticut based ACG Dynamics
Inc.(“ACG”) an electrodynamic shaker service company. ACG is headquartered in West Haven,
Connecticut and is a leader in supplying electrodynamic systems, components, and service to the
worldwide vibration test equipment market. Qualmark formed a separate wholly-owned subsidiary,
Qualmark ACG Corporation (“Qualmark ACG”), to acquire substantially all assets subject to certain
liabilities of ACG. The newly formed Qualmark ACG provides turn-key vibration testing systems
consisting of factory rebuilt/upgraded electrodynamic systems, new Qualmark ACG built solid state
power amplifiers and new digital vibration controllers.
About ACG:
ACG was founded in June of 1972, as ACG Incorporated, a consultant engineering firm specializing in
electro-mechanical design, development and prototype buildup. The ongoing need for restoring
existing vibration test systems coupled with the expertise in this field gained by the original
founder, Andrew C. Grimaldi (as a vibration
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test engineer, electro-mechanical design engineer, vibration isolator designer and vibration test
equipment designer), caused ACG to eventually turn its attention fully toward the rebuilding and
upgrading of vibration test equipment.
Initially, ACG developed a capability to rebuild armatures for vibration exciters, to supply
replacement field coils and to supply replacement parts for exciters (shakers), amplifiers and
controls. Over the years, ACG has built its expertise in this field, with specialized personnel and
facilities dedicated to the restoration, upgrading, service / maintenance, trouble shooting and
repairing of vibration test equipment. In the past twenty-eight years ACG has become the largest
independent source in the world for armature rebuilding, replacement field coils and replacement
parts for all makes of vibration test equipment. ACG’s factory services complimented by its expert
field engineering services provide customers with prompt, professional assistance to resolve any
vibration test equipment problem in the most cost effective way.
In the past thirteen years, ACG has expanded it’s capability into system integrations, which
includes supplying complete vibration test systems consisting of pre-owned factory rebuilt and
upgraded shakers coupled with new ACG built solid state power amplifiers and a variety of new
computer based controllers. ACG frequently provides turnkey systems to its clients, consisting of
factory refurbished horizontal slip tables, new combination air-isolated bases, head plates / head
expanders, various instrumentation and field engineering support to install / demonstrate systems.
ACG also provides new solid state power amplifiers, special switching networks, special field
supplies and matching transformers to mate with any existing shaker, along with shaker refurbishing
and upgrades to a 2” stroke, to achieve state-of-the-art-performance.
On December 13, 2005, Qualmark Corporation completed an asset purchase agreement with SatCon Power
Systems, Inc. (“SatCon”) of Boston, Massachusetts, whereby it purchased certain of the assets and
assumed certain of the liabilities of SatCon related to its Ling Electronics (“Ling”) Shaker and
Amplifier business operations. SatCon is a division of SatCon Technology Corporation, which was
founded in 1986. Ling is one of the nation’s most experienced manufacturers of vibration, shock and
high intensity sound environmental test systems and fixtures. Qualmark formed a separate
wholly-owned subsidiary, Qualmark Ling Corporation (“Qualmark Ling”), to assume all acquired assets
subject to certain liabilities of Ling. Immediately following the acquisition, the Company moved
all purchased assets from Massachusetts to its Connecticut facility and began operations. The
Company combined ACG and Ling into one reporting business unit, ED, which provide a full complement
of new and refurbished electrodynamic systems, parts and service.
About Ling:
Ling was founded in 1947 by James Ling. Throughout the years, Ling went through a series of mergers
or acquisitions, including a merger in 1959 with acoustical based Altec (Altec-Lansing). In 1999,
SatCon purchased Ling from Mechanical Technology Inc. Ling is one of the nation’s most experienced
manufactures of vibration and shock environmental test systems and fixtures. Ling offers a full
complement of new turnkey vibration systems that include the shaker, slip table, fixture and
amplifier. To date, over 6,000 electrodynamic shaker systems have been sold and supplied by Ling.
Ling has been a leading manufacturer of vibration and acoustic testing systems for over 50 years
and serves an international cross-section of governmental, industrial and scientific markets.
Through participation in both commercial and government contracts, Ling has designed and
manufactured sophisticated systems to perform complex vibration, high intensity sound and shock
tests on all types of components, assemblies and aerospace vehicles.
PRODUCTS AND SERVICES
HALT/HASS SEGMENT:
THE TYPHOON COMBINED STRESS SYSTEM
The Company’s Typhoon Combined Stress Systems for HALT and HASS are comprised of two main
subassemblies: the X-LF Vibration Assembly, which applies vibrational stresses, and the UltraRate
Thermal Chamber Assembly, which applies thermal stresses and houses the vibration assembly.
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The X-LF Vibration Assembly
The X-LF system is a multi-axis vibration system comprised of a table, actuators and unique
attachment. The vibration table provides 6 degrees of freedom of motion that moves simultaneously
in three linear axes and three angular rotations. Each axis has broad-band random vibration, with
all frequencies present, all of the time. While the traditional frequency range used for Design
Verification Testing (DVT) and Environmental Stress Screening (ESS) is from 2Hz to 2,000 Hz, the
Company’s system creates vibrational forces between 2Hz and 10,000 Hz. The new X-LF table has
significantly increased low frequency energy available resulting in more effective testing and
screening for larger sub-systems. It also provides extremely complex motion across a broad
frequency range, which is desirable for many current electronic technologies. Thus, the system
creates virtually any vibration that could occur naturally during product use. This is important in
testing and screening applications to expose most flaws, whether it is design or process related,
before the product is placed into service.
The X-LF Vibration System consists of two major components:
Vibration Table
The patented table is constructed out of a top plate, thermal insulation. silicon sheet layer,
and supporting understructure. This design results in higher low frequency energy and improved
energy distribution over the active frequency range. This table has proved particularly
effective in the testing of assemblies with larger components. The Company, while continuing to
supply a range of standard table sizes, has also produced custom sizes to meet customer
requirements. The Company uses an outside source to produce its vibration tables, however the
Company is not dependent on a single source of supply and controls all design and documentation.
Actuators
Attached to the bottom surface of the vibration table understructure are a set of pneumatic
piston driven actuators. The method of attachment is also the subject of a patent application,
as the unique method shapes the frequency distribution. There are three types of actuators used,
ASX, LF and MF. The combination of actuators provides excitation in both the low and high
frequency areas of the energy spectrum. Compressed air is used to drive the pistons in the
actuators to impact the top of the actuators, translating the energy through the attachment
system to vibration energy in the table.
The unique design of these actuators when used in conjunction with the new table generates an
even distribution of vibratory energy in the frequency spectrum. This provides for more
effective fault detection and screening. The Company has released this technology in all of the
Typhoon system sizes.
TYPHOON TECHNOLOGY
The Typhoon technology represents the newest development in UltraRate Thermal technology. The
UltraRate Thermal Chamber, which houses the X-LF Vibration Assembly, changes temperature at rates
up to 60 degrees Centigrade per minute. This high rate of change results in highly effective design
verification during HALT and extremely short production screens during HASS, requiring less
equipment and personnel to perform a given series of thermal cycles. This capability significantly
reduces test time, with resulting cost reductions in equipment and personnel. The technology
lowers operating costs by reducing thermal mass of the chamber and optimizing the efficiency of the
air flow system, which consequently reduces operating costs.
The Company’s Typhoon Combined Stress Systems for HALT and HASS are presently available in six
sizes, including a vibration only tabletop model (OVTT). The number after the “Typhoon” in the
Company’s product models represents the linear footage of the vibration table as explained below.
Therefore, a Typhoon-1.5 contains a 1.5’ x 1.5’ (18” x 18”) table, a Typhoon-2.5 contains a 2.5’ x
2.5’ (30” x 30”) table, and so on. In addition to these standard systems, the Company has also
designed and manufactured custom systems to meet unique customer requirements. Through this product
spectrum, the Company provides systems capable of meeting virtually every accelerated design
ruggedization and production-screening requirement. The variety of chamber sizes allows customers
to purchase equipment that meets their requirements and to consume only the energy necessary to
meet their requirements. The Typhoon-2.5 through Typhoon 8.0 has a feature which allows the user to
raise the vibration
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table, thus decreasing the internal volume of the chambers to the minimum size required. By cooling
and heating a smaller volume, the customer can save considerably on power and liquid nitrogen
requirements.
Typhoon-1.5 and Typhoon-2.0:
The Typhoon-1.5/2.0 is the smallest version of the Typhoon product line. The Typhoon-1.5/2.0 is
a truly portable, multi-axis vibration and high performance thermal chamber. Equipped with all
of the same operating features of the larger Typhoon systems, including a PC controller, the
Typhoon-1.5/2.0 is primarily used by manufacturers of small products (such as “palm size”
circuit boards, modem cards for notebook computers, disk drives, etc.) and usually in the
product development (HALT) area.
Typhoon-2.5 and Typhoon-3.0:
The Typhoon-2.5, historically, is the most popular system in the Typhoon product line. The
Typhoon-3.0 has begun to generate the most attention in the Typhoon product line. The
Typhoon-3.0 contains the same capabilities as the Typhoon-2.5, but allows for additional testing
area. The additional testing area allows the user to utilize the chamber for either HALT
(engineering based tests) or HASS (production line tests). The Typhoon-2.5/3.0 is a mid-size
system and is PC-controlled. Typical uses of the Typhoon-2.5/3.0 include mid-size product HALT
applications (disk drives, small computers, power supplies, monitors, etc.) and small volume
HASS applications (multiple disk drives, multiple modem cards for notebook computers, etc.)
Typhoon-4.0:
The Typhoon-4.0 is the largest standard PC-controlled system in the Company’s product line. The
most common application for the Typhoon-4.0 is large volume production screening (HASS)
incorporated on a manufacturing line, which tests products such as computers, monitors,
communications systems, etc.
Typhoon-8.0:
The Typhoon-8.0 is the largest specialized system in the Company’s product line. The most common
application for the Typhoon-8.0 is large volume production screening (HASS) incorporated on a
manufacturing line, which tests oversized products such as 100” flat screen televisions,
appliances, etc. The Typhoon-8.0 is PC-controlled and contains the largest 6 degree of freedom
vibration table available, measuring an impressive 48” wide x 100” long.
Omniaxial Vibration Table Top (OVTT):
The OVTT (Omniaxial Vibration Table Top) system enables users to quickly and conveniently
perform vibrational evaluations for field returns, spot audits and pre- and post- release
product design verifications. The OVTT system uses the Company’s patented six degrees of freedom
vibration technology and was designed with low air requirements and low noise levels, making it
efficient and inexpensive to use. The OVTT has the flexibility of a table top vibration system,
which allows companies to mount the OVTT into most environmental chambers.
A one year limited warranty is included with each Typhoon system sold. Various options and
accessories are available for each Typhoon model including oxygen monitors, spectrum analyzers,
HALT Fixture kits, extended warranties, and on-site applications assistance.
QUALMARK ENGINEERING SERVICES (“QES”)
The Company offers a range of engineering services tailored to help solve test process problems.
The services that are offered under QES are:
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HALT and HASS testing procedure development |
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Precision HALT and HASS product fixturing solutions |
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The Company reviews each project with experts in the various fields and compiles a proposal, which
typically includes investigation, specification, and execution. After the system or process is
installed, the Company continues to work with its customers to monitor and support the product and
process. This approach gives customers access to experts in varying fields at a time when internal
resources are often overburdened. The result is a better product delivered to the marketplace,
faster.
ACCELERATED RELIABILITY TEST CENTERS (“ARTC”)
The Company has a network of direct and strategic agreement ARTC test centers at various locations
in the United States and Europe, which provide test services and on-site applications support
services. The Company is uniquely positioned to offer comprehensive HALT/HASS test services to
manufacturers. The Qualmark test service business includes accelerated reliability test services
performed in the Company’s test centers and on-site applications support services. These services
allow a broad range of customers convenient access to the Company’s technology while also serving
as valuable sales tools for gaining system orders. Each test center is equipped with a Typhoon-2.5,
Typhoon-3.0, or Typhoon-4.0, at least one applications engineer and ancillary testing equipment.
The Company’s strategic agreements with test centers in the U.S. and throughout Europe consist of
the Company contributing one Typhoon-2.5, Typhoon-3.0 or Typhoon-4.0 system and the partner
providing the lab facility, personnel and sales management. In return for its contribution of these
systems to these agreements, the Company receives a percentage of the revenues generated by the
Typhoon systems.
The test center is a valuable tool for the Company’s sales organization to stimulate system sales
from those clients who are not willing to commit capital without being able to experience a
demonstration of the benefits using their own product.
The Company may open additional test centers or enter into strategic agreements with large testing
companies, domestically or internationally, principally in metropolitan areas with a heavy
concentration of potential client companies and in which the Company has a factory sales
representative responsible for the target metro area.
The Company offers on-site applications support services, through its ARTC network, to advise on
the proper application of HALT and HASS techniques.
ED SEGMENT :
QUALMARK ACG CORPORATION (ACG)
ACG manufacturing services include complete factory rebuilt vibration test systems and shakers. ACG
offers new solid-state amplifiers to help drive existing shakers of all models, as well as to be
utilized in conjunction with older restored systems. ACG will rebuild all makes and models of
exciters (shakers) and upgrade exciters to produce longer stroke, as well as rebuilding armatures
or the moving elements on all makes and models. Replacement field coils can be rebuilt for most
makes and models of exciters; field-degaussing coils can also be repaired or reconditioned. ACG has
improved the suspension systems for higher reliability and ease of maintenance. Fully bonded
replacement of moving elements is also provided. ACG has the capabilities to design and fabricate
high-tech low-weight, high frequency armatures as well as custom dynamic testing equipment. Special
transformers and electric coils can also be designed and built or rebuilt if necessary.
ACG field engineering services include onsite complete diagnostic testing, troubleshooting and
repair of all makes and models of vibration systems. ACG has the capability to rebuild or upgrade
systems onsite, as well as replace solid-state electronics. ACG provides technical expertise on all
makes and models of exciters, amplifiers and vibration controllers. Individual instruction on
system installation, maintenance, calibration and operation of all systems can also be provided
onsite.
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QUALMARK LING CORPORATION (LING)
Ling offers a full complement of new turnkey vibration and shock environmental test systems that
include the shaker, slip table, fixture and amplifier that range from 5lbs of sine force to over
40,000 lbs of sine force. These test systems are ideal for modal testing, research and development,
product qualification, vibration screening and testing.
The Ling product line contains three primary size categories High Force Vibration Systems, Medium
Force Vibration Systems and Low Force Vibration Systems.
High Force Vibration Systems (HFVS):
High Force Vibration Systems consist of shaker models that displace between 18,000 lbs to 45,000
lbs of sine force or 13,000 lbs to 36,000 lbs of random force. The HFVS can support a static
load of up to 3,000 lbs are water cooled and are powered by a max kVA ranging between 142 and
400.
Medium Force Vibration Systems (MFVS):
Medium Force Vibration Systems consist of shaker models that displace between 2,800 lbs to
12,000 lbs of sine force or 2,000 lbs to 10,000 lbs of random force. The MFVS can support a
static load of up to 1,500 lbs are air cooled and are powered by a max kVA ranging between 28
and 100.
Low Force Vibration Systems (LFVS):
Low Force Vibration Systems consist of shaker models that displace between 6 lbs to 600 lbs of
sine force or 5 lbs to 600 lbs of random force. The LFVS can support a static load of up to
50lbs are air cooled and are powered by a max approximate kVA of two.
MARKETING
During 2007, the Company continued its strategic marketing and sales programs to maximize market
exposure.
The Company leverages its technological expertise through web-based seminars (webinars) and
education forums (seminars) in order to expand the Company’s knowledge base in the overall
reliability process. The Company emphasizes the unique advantages that Qualmark brings to the
market, as one of the only major manufacturer in the world producing both HALT/HASS and ED
products.
The Company believes that the combined worldwide market for these two technology groups is in
excess of $175 million and that the Company can expand its share of this large market through
structured and focused marketing and sales efforts. Qualmark’s HALT/HASS segment is highly
recognized in the industry, with a reputation for quality and successful HALT tests. The Company
utilizes an approach to educate and train to a successful HALT/HASS implementation. The Company’s
ED segment reflects small market share with room to expand as the Company re-energizes the
brand-awareness and brand-image of Ling Electronics that was historically built over the previous
55 years.
SALES STRATEGY
Qualmark utilizes a partner sales model, whether through sales representatives or sales/service
distributors, in order to expand the Company’s reach and scale. The Company has three primary
world regions and three Sales Director positions overseeing these regions, which are the United
States, Europe and Asia. The Company also utilizes thirty-one independent international and
domestic sales representatives including representatives from the European, Mexican, Middle
Eastern, and Asian sectors.
CUSTOMERS
The Company continues to market and sell its systems to the leading corporations of the world in
the Consumer Electronics, Personal Computing, Medical, Avionics, Automotive, and Defense
industries.
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The Company’s customer base continues to be varied and is as follows:
AEROSPACE AND DEFENSE
Aviation electronics
Display switches
Flight navigation systems
Marine navigation systems
Naval weapons systems
COMPUTER RELATED PRODUCTS
Circuit boards
Disk drives Modems
Monitors
Power supplies
Printers
Tape backup drives
OTHER
Automotive circuitry
Electronic oil and gas flow meters
Global positioning systems
Power supplies of all types
TELECOMMUNICATIONS
Automated teller machines
Air conditioning electronics
Cellular telephones
Fax machines
Switching systems
MEDICAL ELECTRONICS
Electronic thermometers
Glucose monitors
Infusion pumps
IV pumps
Hearing aids
Pacemakers
Catheter control systems
EKG machines
Hearing aids
CONSUMER ELECTRONICS
Refrigerators
Televisions
Video Recorders
LED flat screens
Plasma flat screens
Garage door electronics
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RESEARCH AND PRODUCT DEVELOPMENT
Research and product development expenditures for the fiscal years ending December 31, 2007 and
2006 were $849,000 and $784,000, respectively. During 2007, the Company further refined its
proprietary thermal and vibration control systems to provide more precise control for the growing
base of HASS users. Additionally, user interface enhancements were developed that add new HASS
features while further improving ease of use and substantially improving chamber safety systems
designed to protect test units in the event of test errors or component failure. During 2006, the
Company released an upgraded Typhoon-3.0 designed for international standards for reliability and
safety. The Company also released a higher performance, longer life pneumatic vibrator. The
Company developed and launched an upgraded software package improving thermal control of its
HALT/HASS chambers, which also provides an easier method of tuning thermal properties. Design was
completed on a redesigned Typhoon-4.0 production level HASS chamber, marking the first use of
Finite Element Analysis for thermal/air flow design, as well as chamber structural design.
The Company continues to apply research and new technology towards improving vibration and thermal
performance of Typhoon chambers while improving the life and reliability of components and systems.
New development activities will focus on further refinement of existing products and integration
between HALT/HASS and ED test offerings.
INTELLECTUAL PROPERTY
The Company continues the practice, where possible, to pursue patent protection on its products.
The Company has been issued 12 United States patents (the “Patents”) and numerous foreign patents
issued in six countries. These patents protect certain features of the OmniAxial and X-LF Vibration
Assemblies of the Company’s OVS Combined Stress Systems or certain design features of the
pneumatic, piston-driven actuators (vibrators) that help create random motion of the vibration
table. The company recently responded to patent office actions on new patent applications.
The Patents provide barriers to competition in the equipment sales portion of its business. The
loss of some or all of the protection of the Patents would make it easier for other companies to
enter the Company’s market, and to compete, by eroding the Company’s ability to differentiate
itself on the basis of technical superiority.
The Company has received three copyrights (the “Copyrights”) from the Register of Copyrights of the
United States of America. The Copyrights include; all seminar material and related text, graphics,
graphs, illustrations, tables, and slides, Qualmark Corporation Typhoon Manager 5.0 software and
related object and source code, and Qualmark Corporation Q-Link 5.0 software and related object and
source code.
In addition to the Patents and Copyrights, the Company tries to protect its proprietary technology
and know-how through established security practices and confidentiality agreements with each of its
employees, consultants, suppliers and technical advisors. There can be no assurance, however, that
these agreements or procedures will provide meaningful protection for the Company’s trade secrets
in the event of unauthorized use or disclosure of such information.
While the Company believes the protection afforded by the Patents and Copyrights is strong, there
can be no assurance that other companies will not be able to design and build competing vibration
tables in a manner that does not infringe the Patents.
The Company has the following registered or pending marks with the United States Patent and
Trademark Office: QUALMARK and LING ELECTRONICS. The Company plans to make additional trademark,
service mark, and certification mark applications as appropriate. The Company also has received
Certificate Europa (CE) approval on its Typhoon chambers and OVTT, which is required for sale in
the European Community.
The Company’s Patents, Copyrights, and Trademarks range in duration from between two and twenty
years.
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COMPETITION
HALT/HASS SEGMENT:
Equipment:
The following represents a listing of competitors known to the Company within the served
industries:
1. Thermotron Industries, Michigan
2. Envirotronics, Michigan
3. Screening Systems, Inc., California
4. HALT/HASS, Inc., Colorado
5. Hanse Industries, Colorado
6. ACS, Italy
ARTC Labs:
The following represents a listing of competitors known to the Company within the served
industries:
1. Thermotron Industries, Michigan
2. Reliant Labs, California
3. Sypris Test and Measurement, Massachusetts
4. Environ Laboratories, Minnesota
5. Trace Laboratories, Illinois
ED SEGMENT:
Qualmark ACG Corporation:
The following represents a listing of competitors known to the Company within the served
industries:
1. Dynamic Solutions, California
2. CVMS, United Kingdom
Qualmark Ling Corporation:
The following represents a listing of competitors known to the Company within the served
industries:
1. Unholtz Dickie, Connecticut
2. LDS, United Kingdom
3. TIRA, Germany
4. MB Electronics, Ohio
5. Dynamic Solutions, China
6. King Design, Taiwan
7. Data Physics, California
MANUFACTURING
HALT/HASS SEGMENT:
The Company’s primary manufacturing facility is located in Denver, Colorado. Qualmark’s assembly of
the Typhoon systems follow a manufacturing line approach, in which drawings of all subassemblies
used by the Company are maintained using computer aided design (CAD). The assembly of the Company’s
products is organized around three major elements that include vibration systems, chamber systems
and control systems.
To ensure that all subassemblies meet specifications when received, key suppliers remain actively
involved throughout product design. Key suppliers perform source inspection at the point of
manufacture. Most key suppliers
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are local companies. The Company intends to further develop local suppliers, with back-up suppliers
as required. To date, the components and assemblies from these suppliers have met or exceeded all
specifications. The Company has developed relationships with what it considers critical vendors
that manufacture three components of its Typhoon system. The Company has also established
relationships with secondary suppliers for its three key components. Thus, if a primary supplier
was unable to deliver materials as required by the Company, it would take as many as 60 days to
begin taking delivery of these components from its secondary suppliers. The Company is dependent on
the availability of steel as its primary raw materials component. The Company believes that it will
have access to adequate amounts of the raw material component and that no shortages will exist.
While the Company maintains a small inventory of Typhoon systems in finished goods, the Company
primarily uses a rolling-quarter sales forecast in determining the number of Typhoon-1.5,
Typhoon-2.0, Typhoon-2.5, Typhoon-3.0, Typhoon-4.0, Typhoon-8.0 and OVTT systems to build during
the quarter. The Company also produces certain common subassemblies that are integrated into the
final systems when orders are booked. This helps provide a more even manufacturing flow and
minimizes the “peaks and valleys” associated with small volume manufacturing.
The Company has implemented Material Requirements Planning, a computer software driven inventory
management process, to maximize the effectiveness in which an order can be filled while minimizing
required inventory. Management uses fully-costed Bills of Materials (BOM) which ensure that all
parts of a Typhoon system are identified and ordered in a timely manner.
ED SEGMENT:
Qualmark ACG Corporation and Qualmark Ling Corporation (Ling/ACG)
Ling /ACG’s primary manufacturing facility is located in West Haven, Connecticut. Ling/ACG
manufactures a variety of products for the vibration test industry: new electrodynamic exciters,
reconditioned exciters, amplifiers, controllers, and integrated exciter test systems, reconditioned
exciter systems per customer order and specification, reconditioned exciter armature assemblies,
reconditioned exciter field coils, and other components and assemblies for the exciter industry.
Ling/ACG also sells new amplifiers and controllers to the exciter industry. Ling/ACG also
manufactures many replacement components for exciters and vibration systems to support its global
field service business.
Ling/ACG uses a flexible manufacturing cell approach as well as a just-in-time (JIT) inventory
control and vendor supply system. Ling/ACG’s major manufacturing capabilities include: primary and
secondary machine shop operations, welding and metal fabrication, armature winding and
reconditioning, coil winding and reconditioning, electro-mechanical assembly, electronics testing,
and system integration and testing. Ling/ACG maintains its own inventory of reconditioned exciters,
armatures, field coils, as well as builds exciters and systems to customer order.
Ling/ACG has a base of local vendors and suppliers to subcontract non-essential manufacturing and
to off-load production during peak demands. This vendor base is integrated into Ling/ACG’s
just-in-time manufacturing strategy. Ling/ACG does both source inspections at key suppliers as well
as quality inspection on purchased components. Ling/ACG has developed relationships with what it
considers critical vendors that manufacture key components of its rebuilt shaker systems. The
Company has also established relationships with secondary suppliers for its key components.
However, if a primary supplier was unable to deliver materials as required by the Company, it would
take as many as 90 days to begin taking delivery of these components from its secondary suppliers.
The Company is dependent on the availability of steel and amplifiers as its primary raw material
components. The Company believes that it will have access to adequate amounts of the raw material
component and that no shortages will exist.
Ling/ACG uses proprietary manufacturing processes to produce armatures and field coils which are
recognized by the industry as being superior to its competition, as well as being superior to many
exciter original equipment manufacturer (OEM) specifications.
Ling/ACG is in the process of integrating a material requirements planning (MRP), a computer
software driven inventory management process, to maximize the effectiveness in which an order can
be filled while minimizing required inventory.
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PRODUCT WARRANTIES AND SERVICE
In 2007 and 2006, the Company offered a limited one-year parts and labor warranty on all new
Typhoon (HALT/HASS) and electrodynamic (ED) factory rebuilt systems, respectively, and six months
on system upgrades (upgraded parts only). Customers can purchase extended warranties on their
HALT/HASS or ED systems, which may include up to two preventive maintenance visits during the year
by a qualified Company representative. The Company occasionally sends its technicians into the
field for warranty repairs. During 2008, the Company will continue to offer a standard, one-year
parts and 90 days labor warranty on all new HALT/HASS and ED systems, and six months on equipment
upgrades (upgraded parts only).
GOVERNMENT REGULATION
Periodically, the Company receives inquiries from regulatory agencies regarding its compliance with
laws and regulations. To its knowledge, the Company believes it complies with all international,
federal, state and local regulations, including environmental regulations. However, there is no
assurance that the Company will continue to remain in compliance with all such regulations.
EMPLOYEES
As of December 31, 2007, the Company had forty-nine employees, of which forty-five are full-time.
Twenty-eight of the Company’s employees are employed at its principal offices and headquarters in
Denver, Colorado, sixteen are employed in West Haven, CT, one in Eugan, MN, one in Marlborough,
MA, one in Navarre, FL, one in Huntsville, AL, one in Wanchai, Hong Kong. No employees are
represented by labor organizations and there are no collective bargaining agreements. Employee
relations are believed to be good.
AVAILABLE INFORMATION
Our internet website is www.qualmark.com. We make available our annual reports on Form 10-KSB,
quarterly reports on Form 10-QSB, current reports on Form 8-K, and any amendments to those reports
as soon as reasonably practicable after we electronically file or furnish such materials to the
SEC.
ITEM 2. DESCRIPTION OF PROPERTY.
The Company operates out of leased facilities located at 4580 Florence Street, Denver, Colorado.
The seven-year lease for the property expires on May 31, 2010. The leased property consists of
approximately 16,616 square feet. In addition to the lease payments, the Company is responsible for
certain expenses, including property taxes, insurance and maintenance. The Company’s manufacturing,
sales, administrative operations and regional ARTC services are conducted at this facility.
The suburban Boston ARTC facility is located at 98 South Street, Hopkinton, Massachusetts. The
two-year lease expires April 30, 2009. The leased property consists of approximately 5,000 square
feet. In addition to the lease payments, The Company is responsible for certain expenses, including
property taxes, insurance and maintenance. The Company’s regional ARTC service business is
conducted at this facility.
ACG and Ling operate out of leased facilities located at 232 Front Avenue, West Haven, Connecticut.
The four-year lease expires on November 13, 2008. The leased property consists of approximately
20,000 square feet. In addition to the lease payments, the Company is responsible for certain
expenses, including property taxes, insurance and maintenance. The Company’s ACG and Ling
manufacturing and service operations are conducted at this facility.
The Company believes that its facilities are adequate for its current needs and that suitable
additional space can be acquired if needed. All of the premises are in good condition, are neat in
their appearance and are located in business complexes with businesses of similar quality.
-12-
Investment Policies
The Company does not invest in real estate, real estate mortgages or securities.
ITEM 3. LEGAL PROCEEDINGS
Refer to Note 13 of the Financial Statements.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
There were no matters submitted to a vote of shareholders during the last quarter of the fiscal
year ended December 31, 2007.
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
The following table sets forth the range of high and low closing bid prices of the Company’s common
stock as reported by the over the counter bulletin board (OTCBB) during fiscal years 2007 and 2006:
| |
|
|
|
|
|
|
|
|
| |
|
Fiscal Year Ended December 31, 2007 |
| |
|
High Close |
|
Low Close |
First Fiscal Quarter |
|
$ |
1.900 |
|
|
$ |
1.300 |
|
Second Fiscal Quarter |
|
|
1.950 |
|
|
|
1.380 |
|
Third Fiscal Quarter |
|
|
1.450 |
|
|
|
.800 |
|
Fourth Fiscal Quarter |
|
|
1.000 |
|
|
|
.580 |
|
| |
|
|
|
|
|
|
|
|
| |
|
Fiscal Year Ended December 31, 2006 |
| |
|
High Close |
|
Low Close |
First Fiscal Quarter |
|
$ |
2.200 |
|
|
$ |
1.730 |
|
Second Fiscal Quarter |
|
|
2.380 |
|
|
|
1.620 |
|
Third Fiscal Quarter |
|
|
1.930 |
|
|
|
1.600 |
|
Fourth Fiscal Quarter |
|
|
1.700 |
|
|
|
1.300 |
|
The foregoing quotations represent quotations between dealers without adjustment for retail
markups, markdowns or commissions and may not represent actual transactions.
The number of record holders of our common stock as of December 31, 2007 was 48 according to our
transfer agent. This figure excludes an indeterminate number of shareholders whose shares are held
in “street” or “nominee” name. The Company has never paid a cash dividend and does not intend to do
so in the future.
The Company participates in certain equity related compensation plans that are authorized for
securities issuance. The tabular disclosures of such plans are disclosed in Item 10 hereof.
-13-
ITEM 6. MANAGEMENT’S DISCUSSION AND ANALYSIS
The following table sets forth for the fiscal periods indicated the percentage of total revenues,
unless otherwise indicated, represented by certain items reflected in the Company’s consolidated
statement of operations:
| |
|
|
|
|
|
|
|
|
| |
|
Fiscal Year Ended |
| Statements of Income Date |
|
December 31, 2007 |
|
December 31, 2006 |
|
|
|
|
|
|
|
|
|
Revenues |
|
|
100.0 |
% |
|
|
100.0 |
% |
Cost of revenues |
|
|
64.5 |
|
|
|
57.6 |
|
|
|
|
|
|
|
|
|
|
Gross profit |
|
|
35.5 |
|
|
|
42.4 |
|
Selling, general and administrative expenses |
|
|
32.2 |
|
|
|
29.2 |
|
Research and development expenses |
|
|
5.9 |
|
|
|
4.8 |
|
Goodwill impairment |
|
|
3.1 |
|
|
|
— |
|
|
|
|
|
|
|
|
|
|
(Loss) income from operations |
|
|
(5.7 |
) |
|
|
8.4 |
|
Other expense |
|
|
(2.1 |
) |
|
|
(1.9 |
) |
|
|
|
|
|
|
|
|
|
(Loss) income before income taxes |
|
|
(7.8 |
) |
|
|
6.5 |
|
Income tax benefit |
|
|
3.8 |
|
|
|
0.5 |
|
|
|
|
|
|
|
|
|
|
Net (loss) income |
|
|
(4.0 |
)% |
|
|
7.0 |
% |
|
|
|
|
|
|
|
|
|
FORWARD-LOOKING STATEMENTS
The statements contained in this report which are not historical facts are forward-looking
statements that are subject to risks and uncertainties that could cause actual results to differ
materially from those set forth or implied by forward-looking statements, including but not limited
to variability in order flow and operating results, the ability of the Company to find and retain
qualified personnel, and the risk that the demand for the Company’s systems will not continue. See
caption “Risk Factors” below.
RESULTS OF OPERATIONS
The Company’s annual and quarterly operating results are subject to fluctuations for a variety of
reasons. The Company operates with a small backlog relative to its revenue; thus most of its sales
in each quarter result from orders received in the current or prior quarter. In addition, because
prices for the Company’s products are relatively substantial, a significant portion of net sales
for each quarter is attributable to a relatively small number of units. Further, shipping or not
shipping a product in a quarter can result in the difference between a profitable quarter or an
unprofitable one, given the significant sales price of the Company’s product and the related
margin.
Comparison of years ended December 31, 2007 and 2006
REVENUE
Consolidated revenue decreased $1,950,000 or 11.9% to $14,477,000 for the year ended December 31,
2007 from $16,427,000 for the year ended December 31, 2006.
HALT/HASS Revenue:
HALT/HASS revenue is comprised of two components; the manufacture and distribution of accelerated
reliability testing units, parts, and service, which represented 95% of HALT/HASS segment revenue
for the year ended December 31, 2007, and a network of test centers (ARTC) which represented 5% of
HALT/HASS segment revenue for the year ended December 31, 2007.
Total HALT/HASS revenue decreased $2,632,000 or 19.7% from $13,366,000 for the year ended December
31, 2006 to $10,734,000 for the year ended December 31, 2007. The decrease in revenue for the year
ended December 31, 2007 is primarily a direct result of adverse business conditions affecting two
of the Company’s customers in Asia and Europe and an overall, global, cautionary capital spending
market. The Company believes it is adequately
-14-
diversified through its current geographies and
markets to overcome the decline in revenue attributed to these
international customers, however no assurances can be given. The Company is continuing its
aggressive pursuit of international and domestic sales in the aerospace/avionics, defense,
automotive, medical and consumer/commercial electronic industries. The number of HALT/HASS units
sold decreased 24.4% for the year ended December 31, 2007 from the year ended December 31, 2006.
In addition, the Company’s test centers experienced a decrease in revenue of 45.6% from the year
ended December 31, 2007 from the year ended December 31, 2006, due to the Company continually
revamping the test center revenue model to include more strategic test center agreements and less
Company owned test center facilities. During the year ended December 31, 2007, the Company operated
two test centers in the U.S., maintained two domestic strategic agreement test center operations,
and four strategic agreement test center operations in Europe, versus four test centers in the
U.S., three domestic strategic agreement test center operations, and three strategic agreement test
center operations in Europe during the same period in 2006. The Company is continually evaluating
the performance of its various test lab locations, and as such assets of other locations may be
liquidated consistent with their performance goals. Under the domestic and international strategic
agreement test centers, the Company does not have any continuing obligation under any of the
agreements. The Company is continuing to implement the strategic agreement test center model, in
which additional agreements may be entered into to minimize both variable and fixed test center
costs, while benefiting in a revenue share. This strategic agreement test center model may result
in decreased revenues, but should provide the Company with higher test center profit margins,
however no assurances can be given. Qualmark utilizes thirty-one independent international and
domestic sales representatives including representatives from the European, Mexican, Middle
Eastern, and Asian sectors.
Electrodynamic Revenue (ED):
ED revenue is sold under two primary brands; Ling Electronics, which provides a full line of new
electrodynamic shakers, amplifies and ACG Dynamics, which provides used/refurbished electrodynamic
shakers, parts, and service.
ED revenue increased $682,000 or 22.3% from $3,061,000 for the year ended December 31, 2006 to
$3,743,000 for the year ended December 31, 2007. ED revenue generated for the year ended December
31, 2007 included new electrodynamic systems, replacement field coils, replacement armatures, as
well as field service support. The primary increase in ED revenue for the year ended December 31,
2007 is attributed to the completion and shipment of multiple Ling Electronics electrodynamic
shakers and the revenue recognition, through a percentage of completion methodology, of an extended
build contract for a large Ling Electronics electrodynamic shaker.
GROSS MARGIN
The gross margin for the year ended December 31, 2007 was 35.5%. This compares to a gross margin of
42.4% for the year ended December 31, 2006. The decrease in gross margin for the year ended
December 31, 2007 is primarily attributed to the write off of $537,000 of obsolete inventory in
the ED segment (refer to Note 2 of the financial statements) and to the decline in sales volume (as
compared to the year ended December 31, 2006).
OPERATING EXPENSE
Total operating expenses increased $386,000 or 6.9% to $5,965,000 for the year ended December 31,
2007 from $5,579,000 for the year ended December 31, 2006.
Selling, general and administrative expenses decreased $126,000 or 2.6% to $4,669,000 for the year
ended December 31, 2007 from $4,795,000 for the year ended December 31, 2006. The Company
experienced a decrease in variable sales related expenses for the year (based on lower sales
volume); however in the Company’s effort to continue to grow sales and expand market share certain
additional expenditures were incurred, which resulted in a selling, general and administrative
expense net decrease of only 2.6% for the year ended December 31, 2007. The Company continues to
monitor its selling, general, and administrative expenses during slower sales periods, in which
expenditure fluctuations may occur.
Research and development costs increased $65,000 or 8.3% to $849,000 for the year ended December
31, 2007 from $784,000 for the year ended December 31, 2006. The primary increase in research and
development costs for the year ended December 31, 2007 is attributed to the Company’s commitment to
product improvements and on-going
-15-
research and development. As a result, research and development
expenditures fluctuate, and may increase in future
years.
GOODWILL
The ED segment was tested for impairment in the fourth quarter of 2007, after the completion of the
annual forecasting process. Due to slower than expected integration of sales and distribution
channels, sales, operating profits and cash flows were lower than expected during 2007. Based on
that trend, the earnings forecast for the next four years was revised. In December 2007, a
goodwill impairment loss of $447,000 was recognized in the ED segment. The fair value of that
reporting unit was estimated using the expected present value of future cash flows. Goodwill
represents the excess of the amount paid over the fair value of net assets acquired in a business
combination and is not subject to amortization. Goodwill is tested for impairment at a minimum of
once a year or when a triggering event occurs. If a triggering event occurs, the undiscounted net
cash flows of the intangible asset or entity to which the goodwill relates are evaluated.
Impairment is indicated if undiscounted cash flows are less than the carrying value of the assets.
The amount of the impairment is measured using a discounted cash flow model considering future
revenues, operating costs, a risk adjusted discount rate and other factors.
INTEREST EXPENSE
Interest expense remained unchanged for the year ended December 31, 2007 as compared to the year
ended December 31, 2006. Although the Company’s commercial debt decreased by $1,000,000 during the
year ended December 31, 2007, the Company incurred $45,000 of additional (non-cash) interest
expense due to amortization of a beneficial conversion feature created through the execution of a
February 20, 2007 additional convertible debt agreement (refer to Note 6 of the Financial
Statements).
INTEREST INCOME
Interest income increased $27,000 or 122.7% to $49,000 for the year ended December 31, 2007 from
$22,000 for the year ended December 31, 2006. The increase in interest income for the year ended
December 31, 2007 was due to the Company’s improved treasury management utilization.
DEBT EXTINGUISHMENT
On December 7, 2007, the Company entered into an Amended and Restated Loan and Security Agreement
and an Export-Import Bank Loan and Security Agreement, with Silicon Valley Bank (“SVB”), which is
herein referred to as 2007 SVB Loan Agreement (“2007 SVB Loan Agreement”). The 2007 SVB Loan
Agreement amended and replaced the December 8, 2005 Silicon Valley Bank loan agreement (“2005 Loan
Agreement”). The replacement of the Loan Agreement with the 2007 SVB Loan Agreement included
substantially different terms, and as such, during the year ended December 31, 2007, the Company
expensed $18,000 of previously capitalized deferred loan costs associated with the 2005 Loan
Agreement as a loss on extinguishment of debt (Refer to Note 6 of the Financial Statements).
INCOME TAX
Income tax benefit increased $465,000 to $556,000 for the year ended December 31, 2007 from $91,000
for the year ended December 31, 2006.
For the year ended December 31, 2007, the Company incurred current income tax expense of $13,000
from estimates made for alternative minimum taxes and state taxes paid and recognized a deferred
income tax benefit of $569,000. During the fourth quarter of 2007, management assessed the
realization of its deferred tax assets. Based on this assessment it was determined to be more
likely than not that the Company’s deferred tax asset will be realizable in future periods. The
Company’s recognition of a portion of the deferred tax asset resulted from having a net operating
loss (“NOL”) carryforward of approximately $3,642,000 which is available to offset future taxable
income, if any from 2020 through 2027. The ultimate realizations of these assets are dependent upon
the generation of future taxable income sufficient to offset the related deductions and loss
carryforwards within the applicable carryforward period, in which no assurance can be given.
-16-
For the year ended December 31, 2006, the Company incurred current income tax expense of $44,000
from estimates made for alternative minimum taxes and recognized a deferred income tax benefit of
$135,000. The deferred income tax benefit recorded in 2007 was significantly higher than 2006 as
the Company incurred a taxable loss in 2007.
NET INCOME
The Company recorded a net loss of $583,000 for the year ended December 31, 2007 as compared to a
net income of $1,151,000 for the year ended December 31, 2006. The decrease is primarily
attributed to the Company’s decline in sales volume for the year ended December 31, 2007, resulting
in reduced operating profits, the write off of $537,000 of obsolete inventory, impairment write
down of goodwill of $447,000, (offset by a $569,000 credit for deferred tax assets.)
LIQUIDITY AND CAPITAL RESOURCES
During 2006, the Company experienced an 11% increase in consolidated revenue, which was attributed
to a 37% increase in revenue from the Company’s ED business segment and a 6% increase in revenue
from the company’s HALT/HASS segment. During 2007, the Company experienced a 12% decline in
consolidated revenue, which was attributed to a 20% decrease in revenue from the Company’s
HALT/HASS segment coupled with a 22% increase in revenue from the Company’s ED business segment.
The Company cannot give any assurance on the continued demand for its products and/or services.
During the year ended December 31, 2007, the Company reported a net loss of $583,000, which
included approximately $901,000 of net non-cash expenses. In order to strengthen the Company’s
balance sheet, on December 21, 2007, the Company received net proceeds of $573,000 from the
issuance of common stock (refer to Note 10 of the Financial Statements).
While there is no guarantee that the Company will be able to meet the operational and financial
requirements of its 2008 budget and limit the use of cash and cash equivalents, the Company’s
operating plan and execution thereof is focused on growing revenue, controlling costs and
conserving cash. The Company cannot predict with certainty the expected revenues, gross profit
margin, net profit or loss and provision or usage of cash and cash equivalents for 2008. However,
the Company’s management believes that the Company’s cash and cash equivalents, working capital,
and access to cash through its commercial bank revolving line of credit provide adequate capital
resources to fund its operations, 2008 scheduled debt payments and working capital needs through at
least the end of 2008. The Company’s inability to modify or replace its debt when it comes due, or
to obtain required capital when needed could have a material adverse effect on its business,
results of operations and financial condition, and the Company could be required to reduce its
level of operations, delay product development or take other actions to diminish the amount of cash
used in its business.
During 2007, the Company generated $952,000 of cash from operating activities, invested $62,000 in
available for sale securities, purchased the assets of Derritron for $69,000, invested $129,000 for
equipment, received $1,000 from the issuance of common stock through the exercise of employee
stock options, received net proceeds of $573,000 from the issuance of common stock, borrowed
$750,000 from a commercial bank and repaid $1,767,000 of commercial bank borrowings. These
activities resulted in a cash increase of $249,000, for a year-end balance of $1,428,000 at
December 31, 2007. During 2006, the Company generated $1,304,000 of cash from operating activities,
invested $206,000 for equipment, received $27,000 for the sale of equipment, invested $3,000 for
patents, copyrights and trademarks, borrowed $400,000 from a commercial bank, repaid $916,000 of
commercial bank borrowings recorded $14,000 for excess tax benefits from share-based payment
arrangements and received $30,000 from the issuance of common stock. These activities resulted in a
cash increase of $650,000, for a year-end balance of $1,179,000 at December 31, 2006.
The Company’s commercial borrowings consist of a revolving line of credit, and two convertible debt
agreements.
Revolving Line of Credit:
On December 7, 2007, the Company entered into an Amended and Restated Loan and Security Agreement
and an Export-Import Bank Loan and Security Agreement, with Silicon Valley Bank (“SVB”), which is
herein referred to as 2007 SVB Loan Agreement. The 2007 SVB Loan Agreement amends the December 8,
2005 Loan and Security
-17-
Agreement (“2005 Loan Agreement”). The terms of the 2005 Loan Agreement was reported by the Company
in a Form 8-K dated December 15, 2005, which is incorporated herein by reference. The terms of
the 2007 SVB Loan Agreement consolidate all outstanding SVB debt, which totaled $1,601,000 on
December 7, 2007, into a single revolving line of credit. The SVB Loan agreement has a one year
term (matures in December 2008) and allows for a maximum outstanding balance of $2,500,000, as
determined by an asset based formula, and also allows for letter of credit sub-limits (not to
exceed $200,000 in the aggregate), foreign exchange sub-limits and cash management services
sub-limits. The 2007 SVB Loan Agreement carries an interest rate of the lower of SVB’s prime rate
+ 1.00% to prime + 3.00% or 8.75%, based on the Company’s use of the revolving line of credit and
the Company’s ability to meet certain financial ratios. Interest payments are payable monthly. The
2007 SVB Loan Agreement does not require monthly payments, but charges monthly administrative fees
of between $750 to $1,250 and monthly unused revolving line of credit fees of 0.25% per annum. As
security for the 2007 SVB loan agreement, the Company has granted security interests of first
priority in all of the Company’s accounts receivable, inventory, equipment and general intangibles.
The replacement of the 2005 Loan Agreement with the 2007 SVB Loan Agreement resulted in a
substantial debt modification due to substantially different terms and as such, during the year
ended December 31, 2007, the Company expensed $18,000 of previously capitalized deferred loan costs
associated with the 2005 Loan Agreement as a loss on extinguishment of debt. As of December 31,
2007, the Company had $764,000 available under the 2007 SVB Loan Agreement. The amount outstanding
under the 2007 SVB Loan Agreement at December 31, 2007 was $1,601,000.
Convertible Debt:
In November 2004, the Company entered into a $1,000,000, five-year, interest only subordinated,
Convertible Debt agreement (“Convertible Debt”) with an affiliate of SVB (the “Debt Holder”). The
Convertible Debt is subordinate to the 2007 SVB Loan Agreement with SVB. As long as the Company
remains in compliance with the Convertible Debt agreement, on the first day of the month following
each anniversary date, this interest rate will be reduced 2.083 basis points for each penny that
the average closing price of the Company’s common stock over the preceding 20 trading day period
exceeds $1.66. The interest rate at December 31, 2007 was 6.63%. The Convertible Debt conversion
provision allows for the initial $1,000,000 advance to be converted, at the Debt Holder’s option,
into common stock of the Company at a fixed price of $1.66 per share (the “Conversion Price”)
(which was the market price per share at the date of the Convertible Debt transaction) at any time
during the five-year period. The Company can initiate conversion of the Convertible Debt into
common stock at the Conversion Price any time after November 11, 2007, provided that the Company
has given the Convertible Debt holder 30 days notice, is in compliance with the financial
covenants, and the Company’s common stock has traded at $4.98 for 20 consecutive days. The
Convertible Debt matures in November 2009.
In December 2005, the Company entered into a Loan Modification Agreement (the “Loan Modification
Agreement”) with the Debt Holder, to modify certain existing loan documents. The Loan Modification
Agreement provided that the $2,000,000 proceeds received from the 2005 Loan Agreement on December
8, 2005 be used exclusively to acquire the assets of Ling. The Loan Modification Agreement further
provided that a cash deposit of $350,000 was made with the Debt Holder as additional security for
the obligations under the pre-existing loan agreement, which the Company has recorded as other
long-term assets. The deposit does not bear interest and at the maturity date of the loan, shall
be applied to the outstanding obligations or shall be returned to the Company if the Convertible
Debt is converted. The Loan Modification Agreement provides that monthly interest payments will be
paid quarterly in common stock. On March 1, 2006, the Convertible Debt holder converted $40,000 of
the outstanding Convertible Debt into 24,096 shares of the Company’s common stock. As of December
31, 2007, the principal balance of the Convertible Debt was $671,000.
On February 20, 2007, the Company entered into an additional convertible debt agreement (the
“Additional Convertible Debt”) with the Debt Holder. The Additional Convertible Debt agreement
provides for a term loan in the amount of $500,000. All of the proceeds were used to pay off a
portion of the 2005 Loan Agreement. The Additional Convertible Debt is due in monthly payments of
interest only, matures on November 2009, and is subordinate to the claims of SVB. The Additional
Convertible Debt agreement bears interest at a rate of 8% per annum, which is payable in common
stock. The conversion provisions of the Additional Convertible Debt agreement permit the Debt
Holder to convert the Additional Convertible Debt into the common stock of the Company at a fixed
price of $1.50 per share at any time prior to the maturity date. As of December 31, 2007, the
principal balance (net of a debt discount of $61,000), of the Additional Convertible Debt was
$289,000.
-18-
The conversion terms included within the Additional Convertible Debt agreement resulted in a
beneficial conversion feature of $100,000. This beneficial conversion feature resulted in an
increase in equity and a debt discount. The Company is accreting this discount to interest expense
over the term of the Additional Convertible Debt agreement. As a result of the beneficial
conversion feature, the effective interest rate on the Additional Convertible Debt agreement is
approximately 31%. The accretion recorded for the year ended December 31, 2007 was $39,000. The
Company is also amortizing the effect of the applicable conversion terms included within the
Additional Convertible Debt agreement on the interest payable in the Company’s common stock, which
resulted in additional interest expense of $7,000 for the year ended December 31, 2007. This
additional interest expense will be incurred through the term of the Additional Convertible Debt
agreement.
Debt Covenants
The Company must maintain certain financial and other covenants to be in compliance with the 2007
SVB Loan Agreement and its convertible debt. As of December 31, 2007, the Company was not in
compliance with certain financial covenants pertaining to both its convertible debt agreements. As
a result, both convertible debt agreements are now amortizable over a 30 month period, rather than
due in full in November 2009 (which is reflected on the balance sheet). The convertible debt
agreements call for an equal 30 month amortization of the outstanding balance, as cure for the
financial covenant defaults.
The weighted average interest rate on all outstanding debt for year ended December 31, 2007 and
2006 was 10.56% and 8.38%, respectively.
The following represents future amounts payable on long-term debt at December 31, 2007 (in
thousands):
| |
|
|
|
|
| Year ended |
|
|
|
|
| December 31, |
|
|
|
|
2008 |
|
$ |
584 |
|
2009 |
|
|
376 |
* |
2010 |
|
|
— |
|
|
|
|
|
|
|
$ |
960 |
|
|
|
|
|
|
|
|
| * |
|
Amount is reported net of debt discount totaling $61,000 as of December 31, 2007 |
OTHER CONTRACTUAL OBLIGATIONS
For more information on the Company’s contractual obligations on non-cancellable operating leases,
refer to Note 7 of Financial Statements. At December 31, 2007, the Company’s commitments under
these obligations were as follows (in thousands):
| |
|
|
|
|
| Year ended December 31, |
|
|
|
|
2008 |
|
$ |
250 |
|
2009 |
|
|
200 |
|
2010 |
|
|
77 |
|
|
|
|
|
|
|
$ |
527 |
|
|
|
|
|
Recently Issued Accounting Pronouncements
Refer to Note 1 of the Financial Statements.
Critical Accounting Policies and Estimates
The Company’s discussion and analysis of its financial condition and results of operations are
based upon its consolidated financial statements, which have been prepared in accordance with
accounting principles generally accepted in the United States. The preparation of these financial
statements requires the Company to make estimates
-19-
and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and
related disclosure of contingent assets and liabilities. On an on-going basis, the Company
evaluates its estimates, including those related to bad debts, inventories, long-lived assets,
income taxes, and stock-based compensation. The Company bases its estimates on historical
experience and on various other assumptions that are believed to be reasonable under the
circumstances, the results of which form the basis for making judgments about the carrying values
of assets and liabilities that are not readily apparent from other sources. Actual results may
differ from these estimates under different assumptions or conditions.
The Company believes the following critical accounting policies affect its more significant
judgments and estimates used in the preparation of its consolidated financial statements.
Revenue Recognition
Revenues from product sales are recognized when persuasive evidence of an arrangement exists,
delivery has occurred, the sales price is fixed or determinable and collectibility is probable.
Generally, the criteria are met upon shipment of products on an F.O.B shipping point basis and
transfer of title to customers. In certain instances, the Company will recognize revenue prior
to shipment when the customer requests in writing that the transaction be on a bill and hold
basis, the risk of ownership has passed to the customer, the manufactured equipment is
segregated, complete and ready for shipment, and there is a fixed schedule for delivery of the
equipment and no specific performance obligations exist. Revenue from services is recognized
when the services are performed and billable. Revenue from equipment service contracts is
recognized ratably over the term of the contract, resulting in deferred revenue.
During 2007, the Company entered into a long-term sales contract that the Company is accounting
for under the percentage of completion method. Accordingly, revenue is recognized in the ratio
that costs incurred bear to estimated total costs. Adjustments to cost estimates may be made
periodically, and any losses expected to be incurred on contracts in progress will be charged to
operations in the period such losses are determined. Contract costs include all direct material,
labor, subcontract costs and an estimate of indirect costs related to contract performance.
General and administrative costs are charged to expense as incurred. Changes in job performance,
job conditions, and estimated profitability may result in revisions to costs and revenue, which
will be recorded in the period in which the revisions are determined.
Allowance for Doubtful Accounts
The Company maintains allowances for doubtful accounts for estimated losses resulting from the
inability of its customers to make required payments. Customer account balances with invoices
dated over 90 days are considered delinquent. The Company maintains reserves for potential
credit losses based upon its loss history and its aging analysis. After all attempts to collect
a receivable have failed, the receivable is written off against the allowance. Such losses have
been within management’s expectations. If the financial condition of the Company’s customers
were to deteriorate, resulting in an impairment of their ability to make payments, additional
allowances may be required.
Warranty Reserve
The Company provides for the estimated cost of product warranties at the time revenue is
recognized. While the Company engages in extensive product quality programs and processes,
including actively monitoring and evaluating the quality of its component suppliers, the
Company’s warranty obligation is based upon historical experience and is also affected by
product failure rates and material usage incurred in correcting a product failure. Should actual
product failure rates or material usage costs differ from the Company’s estimates, revisions to
the estimated warranty liability would be required (Refer to Note 7 of the Financial
Statements).
Inventory Obsolescence Reserve
The Company reduces inventory for estimated obsolescence or unmarketable inventory equal to the
difference between the cost of inventory and the estimated market value based upon assumptions
about future demand and market conditions. During the quarter ended December 31, 2007, the Company wrote off $537,000 of
obsolete
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inventory. If actual market conditions are less favorable than those projected by
management, additional inventory write-downs may be required (Refer to Note 2 of the Financial
Statements).
Goodwill and Other Intangible Assets
In accordance with SFAS No. 142, Goodwill and Other Intangible Assets, goodwill and
indefinite-lived intangible assets (the Ling trade mark and trade name) are not amortized, but
reviewed for impairment upon the occurrence of events or changes in circumstances that would
reduce the fair value below its carrying amount. Goodwill represents the excess of the amount
paid over the fair value of net assets acquired in a business combination and is not subject to
amortization. Other intangible assets consist of, among other things, the Ling trade name and
trademark. Goodwill and the Ling trade name and trademark are tested for impairment at a
minimum of once a year or when a triggering event occurs. If a
triggering event occurs, the intangible asset or entity to which the
goodwill relates is evaluated. Impairment is indicated if the fair
value is less than the carrying value
of the assets. The amount of the impairment is measured using a discounted cash flow model
considering future revenues, operating costs, a risk adjusted discount rate and other factors.
These estimates are judgmental in nature and often involve the use of significant estimates and
assumptions. These estimates and assumptions could have a significant impact on whether or not
an impairment charge is recognized and also the magnitude of any such charge. The ED segment
was tested for impairment in the fourth quarter of 2007, after the completion of the annual
forecasting process. Due to slower than expected integration of sales and distribution
channels, sales, operating profits and cash flows were lower than expected during 2007. Based
on that trend, the earnings forecast for the next four years was revised. In December 2007, a
goodwill impairment loss of $447,000 was recognized in the ED segment. The fair value of that
reporting unit was estimated using the expected present value of future cash flows. At December
31, 2007 and 2006 management believed that no impairment has occurred on the Ling trade name and
trademark. In addition, at December 31, 2007, management has deemed that the Ling trade name
and trademark is no longer an indefinite-lived intangible asset and determined that it has an
estimated life of 18 years, therefore in 2008 the Company will begin amortizing the Ling trade
name and trademark over an 18 year period. This determination was made due to certain
competitive, economic and legal factors (arising during 2007) which were not evident at the date
of acquisition.
Long-lived Assets
In accordance with SFAS No. 144, Accounting for the Impairment or Disposal of Long-lived Assets,
long-lived assets, such as property, plant and equipment and purchased intangibles subject to
amortization are reviewed for impairment whenever events or changes in circumstances indicate
that the carrying value of an asset may not be recoverable. Recoverability of assets to be held
and used is measured by a comparison of the carrying value of an asset to estimated undiscounted
future cash flows expected to be generated by the asset. If the carrying value of an asset
exceeds its estimated future cash flows, an impairment charge is recognized in the amount by
which the carrying value of the asset exceeds the fair value of the asset. These estimates are
judgmental in nature and often involve the use of significant estimates and assumptions. These
estimates and assumptions could have a significant impact on whether or not an impairment charge
is recognized and also the magnitude of any such charge.
Share-based Compensation
Share-based compensation expense is based on the estimated grant date fair value of the portion
of share-based payment awards that are ultimately expected to vest during the period. The grant
date fair value of stock-based awards to employees and directors is calculated using the
Black-Scholes option pricing model. SFAS No. 123(R) requires forfeitures of share-based payment
awards to be estimated at the time of grant and revised, if necessary, in subsequent periods if
actual forfeitures differ from those estimates. The estimated average forfeiture rate for the
year ended December 31, 2007 ranged from 25% to 32% and for the year ended December 31, 2006
ranged from 18% to 25%.
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Deferred Tax Assets and Valuation Allowance
The Company records a valuation allowance to reduce its deferred tax assets to the amount that
is more likely than not to be realized. The Company considers future taxable income and ongoing
prudent and feasible tax planning strategies in assessing the need for the valuation allowance.
Should the Company determine that it would not be able to realize all or part of its deferred
tax asset in the future, an adjustment to the deferred tax asset could be charged to income in
the period such determination was made. During the year ended December 31, 2006, the Company
determined that a valuation allowance was not required. The Company’s decision was based on the
positive historical trend in the preceding years. In 2007, the Company determined that no
valuation allowance was required considering its current year net loss as adjusted for non-cash,
extraordinary items, as well as the estimated budgeted financial results for 2008. If future
taxable income is less than the amount that has been assumed in determining the deferred tax
asset, an increase in the valuation allowance will be required with a corresponding charge
against income (Refer to Note 8 of the Financial Statements).
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RISK FACTORS
Government Regulation
Periodically, the Company receives inquiries from regulatory agencies regarding its compliance with
laws and regulations. To its knowledge, the Company believes it complies with all international,
federal, state and local regulations, including environmental regulations. However, there is no
assurance that the Company will continue to remain in compliance with all such regulations.
Legal Proceedings
Refer to Note 13 of the Financial Statements.
Business Environment
If we are unable to compete effectively, our business would be harmed. Our products compete on the
basis of the following key characteristics:
Performance
Functionality
Reliability
Pricing
Quality
Time-to-market delivery
Compliance with industry standards
If we fail to address our competitive challenges, there could be a material adverse effect on our
business, financial conditions and results of operations.
The Company believes its strategy to actively purchase, refurbish and sell a surplus of used
Qualmark Typhoon equipment from the domestic equipment market, and enter into revenue share test
center partnerships will assist in providing a competitive edge. However, the inability to
favorably purchase and resell a majority of used Qualmark Typhoon equipment from the domestic
market or successfully compete in the changing test center market could result in a decrease in
demand for its new Typhoon equipment, an excess of inventory held, and a continual loss of test
center market share. These situations could have a material adverse effect on our business,
financial conditions and results of operations.
We have experienced, and may continue to experience, fluctuations in sales and operating results
from quarter to quarter. Our quarterly results fluctuate due to a number of factors, including:
variations in the timing, cancellation, or rescheduling of customer orders and shipments;
variations in manufacturing costs, capacities and efficiencies; capacity and production
constraints, including constraints associated with single-source part suppliers; product failures;
competitive factors, including pricing, availability and demand for competing products;
cancellations or reductions of customer orders and shipments due to economic slowdowns in the
customers’ operating regions; cancellations or rescheduling of customer orders and shipments due to
changes in demand; warranty expenses; the availability and cost of parts; the timing, availability
and sale of new products by us or our competitors; changes in the mix of products having differing
gross margins; changes in average sales prices; long sales cycles associated with our products;
variations in product development and other operating expenses; discounts given to certain
customers for large volume purchases; and high fixed expenses that increase operating expenses,
especially during a quarter with test center sales shortfalls. Our sales to customers are usually
made under purchase orders with short delivery requirements. Order deferrals and cancellations by
our customers, declining average sales prices, changes in the mix of products sold, delays in the
introduction of new products and longer than anticipated sales cycles for our products have, in the
past, advers |