10QSB: Optional form for quarterly and transition reports of small business issuers

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U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-QSB

(Mark One)

For the Quarterly Period Ended March 31, 2000

or

For the Transition Period From                to              
 .

Commission file number 000-25727

THE CHROMALINE CORPORATION
(Exact name of small business issuer as specified in its charter)

(218) 628-2217
Issuer's telephone number

Not Applicable
(Former name, former address and former fiscal year, if changed since last report)

    Check
whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act 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. Yes /x/  No / /

    State
the number of shares outstanding of each of the issuer's classes of common equity, as of the latest practical date: Common Stock, $.10 par value—1,298,056 shares
outstanding as of April 15, 2000.

    Transitional
Small Business Disclosure Format (check one): Yes / /  No /x/

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NAME="bg1553_the_chromaline_corporat__bg102315"> THE CHROMALINE CORPORATION
QUARTERLY REPORT ON FORM 10-QSB

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NAME="de1553_part_i_#151;financial_information"> PART I—FINANCIAL INFORMATION

Item 1. Financial Statements

THE CHROMALINE CORPORATION

BALANCE SHEETS

See notes to financial statements.

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THE CHROMALINE CORPORATION

STATEMENTS OF EARNINGS (Unaudited)

See
notes to financial statements.

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THE CHROMALINE CORPORATION

STATEMENTS OF CASH FLOWS (Unaudited)

See
notes to financial statements.

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THE CHROMALINE CORPORATION

NOTES TO FINANCIAL STATEMENTS

(Unaudited)

1.

The
balance sheet of The Chromaline Corporation (the Company) as of March 31, 2000, and the related statements of earnings and cash flows for the three months ended
March 31, 2000, have been prepared without being audited.

In
the opinion of management, these statements reflect all adjustments (consisting of only normal recurring adjustments) necessary to present fairly the financial position of The Chromaline
Corporation as of March 31, 2000, and the results of operations and cash flows for all periods presented.





Certain
information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted. Therefore,
these statements should be read in conjunction with the financial statements and notes thereto included in the Company's December 31, 1999 Form 10-KSB.





The
results of operations for interim periods are not necessarily indicative of results that will be realized for the full fiscal year.

2.

The
major components of inventory at March 31, 2000 and December 31, 1999 are as follows:

3.

The
Company is a defendant in a claim filed in the United States District Court, Western District of Washington at Seattle, in which the claimant alleges that certain of the
Company's products infringe on two U.S. patents owned by the claimant. The Company has filed an answer denying infringement and further believes that the claimant's patent to be invalid, and to have
been procured through inequitable conduct.

During
fiscal 1998, the lawsuit was stayed after the Company filed a Request for Reexamination with the United States Patent and Trademark Office (USPTO) with respect to the patents involved in the
suit. The request was granted. Subsequently, the USPTO, on three occasions rejected the claims of the claimant. The plaintiff appealed to the Board of Appeals in September 1999. In
February 2000, the USPTO issued reexamined patents to the plaintiff which substantially narrows the claims of the lawsuit. The Company has filed a motion for summary judgement to dismiss the
suit. During the three months ended March 31, 2000, the Company paid approximately $3,000 in legal and related costs in the defense of this matter. Such payments were applied against the
accrual of $250,000 established at December 31, 1997. At March 31, 2000, the Company had a remaining accrual of $25,000 for expected future legal costs relating to this matter.

4.

In
June 1998, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 133, "Accounting for Derivative
Instruments and Hedging Activities". SFAS No. 133 requires companies to record derivatives on the balance sheet as assets or liabilities, measured at fair value. Gains or losses
resulting from changes in the value of those derivatives would be accounted for depending on the use of the derivative and whether it qualifies for hedge accounting. In July 1999, FASB issued
SFAS No. 137 delaying the effective date of

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SFAS No. 133
for one year to fiscal years beginning after June 15, 2000, with earlier adoption encouraged. Management has not yet determined the effects of
SFAS No. 133 will have on its financial position or the results of its operations. The Company will be required to adopt SFAS No. 133 in fiscal 2001.

5.

Stockholders'
Equity

6.

Net
Income per Common Share

Basic
and diluted earnings per share are presented in accordance with Statement of Financial Accounting Standards (SFAS) No. 128, "Earnings per Share". The difference between average common
shares and average common and common equivalent shares is the result of outstanding stock options.

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NAME="di1553_the_chromaline_corporation"> THE CHROMALINE CORPORATION

    The information presented below in Management's Discussion and Analysis of Financial Condition and Results of Operations contains
forward-looking statements within the meaning of the safe harbor provisions of Section 21E of the Securities Exchange Act of 1934, as amended. Such statements are subject to risks and
uncertainties, including those discussed under "Factors that May Affect Future Results" below, that could cause actual results to differ materially from those projected. Because actual results may
differ, readers are cautioned not to place undue reliance on these forward-looking statements. Certain forward-looking statements are indicated by italics..

Item 2.  Management's Discussion and Analysis of Financial Condition and Results of Operations.

    The following management's discussion and analysis focuses on those factors that had a material effect on the Company's financial results of operations during
the first quarter of 2000 and the same period of 1999. They should be read in connection with the Company's unaudited financial statements and notes thereto included in this
Form 10-QSB.

Factors that May Affect Future Results

    Certain statements made in this Quarterly Report on Form 10-QSB, which are summarized below, are forward-looking statements that involve
risks and uncertainties, and actual results may be materially different. Factors that could cause actual results to differ include, but are not limited to, those identified as follows:

•

The expectation that selling, general and administrative expenses will remain at current levels during the remainder of the year
2000—This expectation may be impacted by general economic conditions and unanticipated events causing changes in expenses or sales.




•

The Company's plans to continue to invest in research and development efforts and the expected focus and results of such
efforts—These plans and expectations may be impacted by general market conditions, unanticipated changes in expenses or sales, delays in the development of new
products, technological advances or other changes in competitive conditions.




•

The belief that the Company's current financial resources, cash generated from operations and the Company's capacity for debt
and/or equity financing will be sufficient to fund current and anticipated business operations—Changes in anticipated operating results, credit availability and
equity market conditions may further enhance or inhibit the Company's ability to maintain or raise appropriate levels of cash.




•

The Company's belief that its vulnerability to foreign currency fluctuations and general economic conditions in foreign countries
is not significant—This belief may be impacted by economic, political and social conditions in foreign markets and changes in regulatory and competitive conditions
or a change in the amount or geographic focus of the Company's international sales.




•

The Company's efforts to grow its international business—These efforts may be impacted by
economic, political and social conditions in current and anticipated foreign markets, regulatory conditions in such markets, unanticipated changes in expenses or sales, changes in competitive
conditions or other barriers to entry or expansion.




•

The Company's plan to seek acquisitions—This plan may be impacted by general market conditions,
competitive conditions in the Company's industry, unanticipated changes in the Company's financial position or the inability to identify attractive acquisition targets.

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Results of Operations

Quarter Ended March 31, 2000 Compared to Quarter Ended March 31, 1999

    Sales.  The Company's sales during the first quarter of 2000 increased 3% to $2.30 million, from the
$2.24 million in sales during the same period in 1999. The increase is attributable to higher unit volume sales in the Company's international markets and in its decorative sandblast markets,
which were partially offset by lower unit selling prices due to competitive forces in the global marketplace.

    Cost of Goods Sold.  Cost of goods sold during the first quarter of 2000 was $1.12 million, or 48.6% of sales,
compared to $1.06 million, or 47.5% of sales, during the same period in 1999. The increase in the first quarter of 2000 was due to a shift in the
Company's product mix within its domestic U.S. decorative sandblasting market.

    Selling, General and Administrative Expenses.  Selling, general and administrative expenses increased to $933,000, or
40.6% of sales, in the first quarter of 2000, from $789,000, or 35.4% of sales, for the same period in 1999. A portion of the increase reflects the separation costs for the Company's CEO who resigned
February 7, 2000. The balance of the increase was due to increased sales and marketing costs related to trade shows and advertising. The Company also incurred higher costs than the previous
year's quarter for expenses related to its listing on the Nasdaq SmallCap Market and preparation of its proxy statement and annual report. These increased expenses were partially offset by lower
administrative salaries, fringes and travel expenses.

    Research and Development Expenses.  Research and development expenses during the first quarter of 2000 increased to
$194,000, or 8.4% of sales, from $162,000, or 7.2%, for the same period in 1999. The increase was attributable to production trial costs related to development projects. The Company intends to
continue to invest in research and development as appropriate to maintain its innovation.

    Interest Income.  Interest income increased to $27,000 for the first quarter of 2000 compared to $3,000 for the same
period in 1999. The increase is due to the Company's investment in the second half of 1999 in general revenue obligation bonds for certain municipalities in the state of Minnesota that pay interest on
a quarterly basis.

    Income Taxes.  Income taxes decreased to $31,000, or an effective rate of 38%, during the first quarter of 2000 from
$84,000, or an effective rate of 37%, for the first quarter of 1999. The difference in the effective rate is due to permanent differences for allowable tax deductions including foreign sales
corporation credits.

Liquidity and Capital Resources

    The Company has financed its operations principally with funds generated from operations. These funds have been sufficient to cover the Company's normal
operating expenditures and annual capital requirements, as well as research and development expenditures.

    Cash
and cash equivalents were $718,000 and $479,000 at March 31, 2000 and March 31, 1999, respectively. The Company generated $115,000 in cash from operating activities
during the three months ended March 31, 2000 and $225,000 for the same period in 1999. Cash generated by operating activities is primarily provided by net income as adjusted for
non-cash depreciation. During the first three months of 2000, trade receivables decreased by $136,000 reflecting payments early in the quarter from its European customers. Prepaid expenses
increased $152,000 reflecting certain prepaid marketing expenditures. Inventories increased $170,000 primarily to an increase in raw materials. Accounts payable increased $156,000, accrued expenses
increased $49,000 and income taxes payable decreased $55,000 reflecting first quarter federal and state tax deposits. For the three months ended March 31, 1999, trade receivables increased
$99,000. Prepaid expenses increased $148,000 while inventories decreased $190,000. Accounts payable

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decreased
$27,000, accrued expenses increased $13,000. Income taxes payable increased $54,000 reflecting the tax refund the Company received on its 1998 corporate federal tax return.

    The
Company used $104,000 and $23,000 in cash for investing activities during the three months ended March 31, 2000 and March 31, 1999, respectively. In both periods,
net cash used for investing activities for plant and equipment was $72,000 and $24,000, respectively. During the first quarter of 2000, the Company made an additional investment of $15,000 to
Chromaline Europe, S.A. in order to maintain its 19.5% ownership. The Company purchased municipal revenue bonds that are carried at fair value and classified and accounted as "available for sale".

    The
Company generated no additional cash from financing activities during the three months ended March 31, 2000. During the same period in 1999, $2,000 in cash was generated
from the exercise of stock options.

    A
bank line of credit exists providing for borrowings of up to $1,250,000. Outstanding debt under this line of credit is collateralized by accounts receivable and inventory and bears
interest at 2.25 percentage points over the 30-day LIBOR rate. The Company has not utilized this line of credit and there is no debt outstanding under this line as of
March 31, 2000.

    The
Company believes that current financial resources, its line of credit, cash generated from operations and the Company's capacity for debt and/or equity financing will be
sufficient to fund current and anticipated business operations. Future activities undertaken to expand the Company's business may include acquisitions, building expansion and additions, equipment
additions, new product development and marketing opportunities.

Capital Expenditures

    Through March 31, 2000, the Company had spent $72,000 on capital expenditures in 2000. This spending included primarily, plant security equipment, lab
equipment and two vehicles for the sales force.

    Commitments
for capital expenditures include building maintenance, research and development equipment to modernize the capabilities and processes of Chromaline's laboratory and
research and development to improve measurement and quality control processes. These commitments are to be funded with cash generated from operating activities. Total year 2000 capital commitments are
approximately $350,000 at March 31, 2000.

International Activity

    The Company markets its products to over 50 countries in North America, Europe, Latin America, Asia and other parts of the world. Foreign sales were
approximately 34% of total sales for the three months ended March 31, 2000. This compares with foreign sales accounting for 35% of total sales during the same period in 1999. Foreign sales in
1999 were affected by overseas economies that were slow in recovering from recent economic crises. These economies have improved and the Company expects its sales to grow during 2000. Recent weakening
of certain foreign currencies has not significantly impacted the Company's operations because the Company's foreign sales are not concentrated in any one region of the world. The Company believes its
vulnerability to uncertainties due to foreign currency fluctuations and general economic conditions in foreign countries is not significant.

    Substantially
all of the Company's foreign transactions are negotiated, invoiced and paid in U.S. dollars. Chromaline has not implemented a hedging strategy to reduce the risk of
foreign currency translation exposures, which management does not believe to be significant based on the scope and geographic diversity of the Company's foreign operations as of March 31, 2000.

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Future Outlook

    Chromaline has invested over 6% of its sales dollars for the past several years on research and development. The Company plans to expand its efforts in this
area and expedite internal product development as well as form technological alliances with outside experts to ensure commercialization of new product opportunities. In addition to its film, emulsion
and self-adhesive products, Chromaline's research and development efforts will also focus on improving the efficiency of its automated photo developers for the decorative sand blasting
product line.

    In
addition to its traditional emphasis on domestic markets, the Company will continue efforts to grow its business internationally by attempting to develop new markets and expanding
market share where it has already established a presence.

    During
the second quarter of 1999, the Company began evaluating potential acquisitions. The Company plans to look for opportunities that complement its existing business and
technologies. The search and evaluation process continues to proceed in a cautious and prudent manner. The goal is to capitalize on
the Company's strong cash and low debt positions as well as the strengths of the Company's core businesses in order to grow shareholder value.

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NAME="dk1553_part_ii._other_information"> PART II.  OTHER INFORMATION

ITEM 1.  Legal Proceedings

    On October 22, 1996, Aicello North America, Inc., a Canadian corporation ("ANA"), filed suit against the Company in the United States District
Court for the Western District of Washington, alleging infringement by the Company of U.S. Patent No. 5,427,890 (the "890 patent"). Later, ANA added U.S. Patent No. 5,629,132 (the "132
patent") to the lawsuit. The 890 patent and the 132 patent had been assigned to Aicello Chemical Co. Ltd. of Japan ("ACLJ") on October 22, 1996 and were licensed to ANA shortly before
filing of the present infringement action. At Chromaline's request, ACLJ was joined to the suit. The subjects of the patents and the allegedly infringing Chromaline products are three-layer
photosensitive films used to engrave patterns or designs into hard surfaces such as metal, glass, stone and wood.

    The
Company and ANA attempted to settle the suit with two mediation sessions that did not result in a settlement. Following these mediations, Chromaline requested in
August 1998 that the U.S. Patent and Trademark Office ("USPTO") reexamine the 890 patent and the 132 patent. This request was granted as to both patents in November 1998 and the lawsuit
was stayed pending this review. In the USPTO's Office Action in Reexamination dated February 23, 1999, the USPTO initially rejected the
plaintiff's claims of patent infringement. The Office Action required the ANA and ACLJ to respond within 60 days, which they did. The USPTO's
subsequent Office Action once again rejected the plaintiff's claims of patent infringement. The plaintiff filed their final response with the USPTO on
August 2, 1999. The USPTO examiner then issued a Reexamination Advisory Action rejecting all claims of the patents on August 23, 1999. The plaintiff appealed to the Board of Appeals with
the USPTO on September 2, 1999. In February 2000, the USPTO issued reexamined patents to ANA with substantially narrowed claims. United States patent law provides that if the claims of
the reexamined patent are not identical to the original claims, there can be no infringement before the date of issuance of the reexamined patent. Since the Company has not manufactured the films at
issue in the suit after the reexamined patents were issued and the Company's newly developed films are, the Company believes, clearly outside of the claims of the reexamined patents, the suit should
now be dismissed. The Company has filed a motion for summary judgement to dismiss the suit. The response to this action is pending.

    The
Company has made provisions to cover certain legal proceedings and related costs and expenses as described in note 3 to its unaudited financial statements included herein.
However, the ultimate outcome and materiality of these matters cannot be determined. Accordingly, no provision for any liability that may result therefrom has been made in the unaudited financial
statements.

ITEM 2.  Changes in Securities

    None

ITEM 3.  Defaults upon Senior Securities

    Not applicable

ITEM 4.  Submission of Matters to a Vote of Security Holders

    None

ITEM 5.  Other Information

    None

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ITEM 6.  Exhibits and Reports on Form 8-K

     SIZE=2>(a) Exhibits

    The
following exhibits are filed as part of this Quarterly Report on Form 10-QSB for the quarterly period ended March 31, 2000:

(1)

Incorporated
by reference to the like numbered Exhibit to the Company's Registration Statement on Form 10-SB (File No. 000-25727).

    Copies
of Exhibits will be furnished upon request and payment of the Company's reasonable expenses in furnishing the Exhibits.

     SIZE=2>(b) Reports on Form 8-K

    No
reports on Form 8-K were filed by the registrant during the quarterly period ended March 31, 2000.

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NAME="dk1553_the_chromaline_corporation_signatures"> THE CHROMALINE CORPORATION
SIGNATURES

    In accordance with the requirements of the Securities Exchange Act of 1934, the registrant caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized.

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NAME="dk1553_index_to_exhibits"> INDEX TO EXHIBITS

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