U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-QSB
(Mark One)
/x/ Quarterly Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 For the Quarterly Period Ended June 30, 1999
or
/ / Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 For the Transition Period From _______________ to
________________.
Commission file number 000-25727
THE CHROMALINE CORPORATION
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(Exact name of small business issuer as specified in its charter)
Minnesota 41-0730027
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(State or other jurisdiction of (I.R.S. employer
incorporation or organization) identification no.)
4832 Grand Avenue
Duluth, Minnesota 55807
- ---------------------------------------- ----------
(Address of principal executive offices) (Zip code)
(218) 624-6400
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Issuer's telephone number
Not Applicable
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(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 -
1,180,061 shares outstanding as of August 9, 1999.
Transitional Small Business Disclosure Format (check one): Yes / / No /x/
THE CHROMALINE CORPORATION
QUARTERLY REPORT ON FORM 10-QSB
PART I. FINANCIAL INFORMATION PAGE NO.
- ------- --------------------- --------
Item 1. Financial Statements:
Consolidated Balance Sheets
as of June 30, 1999 and December 31, 1998 3
Consolidated Statements of Earnings
for the Three Months and Six Months Ended
June 30, 1999 and 1998 4
Consolidated Statements of Cash Flows
for the Six Months Ended June 30, 1999 and 1998 5
Notes to Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis
of Financial Condition and Results of
Operations 8
PART II. OTHER INFORMATION 13
SIGNATURES 15
2
PART I -- FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
THE CHROMALINE CORPORATION
CONSOLIDATED BALANCE SHEETS
- ------------------------------------------------------------------------------
JUNE 30 DECEMBER 31
1999 1998
(UNAUDITED)
ASSETS
Current Assets:
Cash and cash equivalents $ 378,545 $ 274,757
Trade receivables, less allowance for doubtful accounts of
$14,542 and $14,400 respectively 1,545,180 1,128,568
Trade receivable from related party 237,264 271,443
Inventories 1,389,549 1,255,192
Prepaid expenses and other assets 222,502 97,409
Marketable securities 505,739 508,445
Income tax refund receivable 21,223 61,801
Deferred taxes (Note 4) 54,000 54,000
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Total current assets 4,354,002 3,651,615
PROPERTY, PLANT, AND EQUIPMENT, at cost:
Land and building 1,220,001 1,171,560
Machinery and equipment 2,038,057 1,991,566
Office equipment 647,780 516,935
Vehicles 258,616 199,335
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4,164,454 3,879,396
Less accumulated depreciation 2,650,240 2,455,816
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1,514,214 1,423,580
PATENTS, net of amortization of $10,447 and $5,752 respectively 99,020 103,715
OTHER 38,733 38,733
DEFERRED TAXES 43,000 43,000
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$ 6,048,969 $ 5,260,643
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LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 314,578 $ 207,813
Accrued expenses 243,812 129,673
Accrued legal costs (Note 3) 57,689 63,324
Income taxes payable 161,499 0
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Total current liabilities 777,578 400,810
CONTINGENCIES (Note 3)
STOCKHOLDERS' EQUITY:
Preferred stock, par value $.10 per share; authorized 250,000 shares;
issued none
Common stock, par value $.10 per share; authorized 4,750,000 shares;
issued and outstanding 1,180,061 and 1,178,311 respectively 118,006 117,831
Additional paid-in capital 418,847 408,225
Retained earnings 4,734,538 4,333,777
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Total stockholders' equity 5,271,391 4,859,833
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$ 6,048,969 $ 5,260,643
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See notes to financial statements.
3
THE CHROMALINE CORPORATION
CONSOLIDATED STATEMENTS OF EARNINGS (UNAUDITED)
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THREE MONTHS SIX MONTHS ENDED
ENDED JUNE 30 JUNE 30
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1999 1998 1999 1998
SALES $2,551,177 $ 2,383,892 $ 4,787,902 $ 4,727,119
COSTS AND EXPENSES:
Cost of goods sold 1,105,033 1,037,437 2,166,941 2,127,333
Selling, general, and administrative 864,853 674,992 1,656,336 1,390,703
Research and development 178,343 160,366 340,341 317,572
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2,148,229 1,872,795 4,163,618 3,835,608
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INCOME FROM OPERATIONS 402,948 511,097 624,284 891,511
INTEREST INCOME 6,287 10,137 11,844 19,576
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INCOME BEFORE INCOME TAXES 409,235 521,234 636,128 911,087
FEDERAL AND STATE INCOME
TAXES 151,467 198,000 235,367 346,000
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NET INCOME $ 257,768 $ 323,234 $ 400,761 $ 565,087
---------- ----------- ------------- --------------
---------- ----------- ------------- --------------
BASIC EARNINGS PER
COMMON SHARE $ 0.22 $ 0.28 $ 0.34 $ 0.48
---------- ----------- ------------- --------------
---------- ----------- ------------- --------------
DILUTED EARNINGS PER
COMMON SHARE $ 0.22 $ 0.28 $ 0.34 $ 0.48
---------- ----------- ------------- --------------
---------- ----------- ------------- --------------
WEIGHTED AVERAGE NUMBER
OF COMMON SHARES
OUTSTANDING 1,179,498 1,159,886 1,179,084 1,159,886
---------- ----------- ------------- --------------
---------- ----------- ------------- --------------
WEIGHTED AVERAGE NUMBER
OF COMMON AND COMMON
EQUIVALENT SHARES
OUTSTANDING 1,187,586 1,168,436 1,186,603 1,168,436
---------- ----------- ------------- --------------
---------- ----------- ------------- --------------
See notes to financial statements.
4
THE CHROMALINE CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
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SIX MONTHS
ENDED JUNE 30
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1999 1998
CASH FLOWS FROM OPERATING
ACTIVITIES:
Net income $ 400,761 $ 565,087
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation and amortization 198,931 166,226
Loss on disposal of assets
Deferred income taxes Changes in working capital components:
Decrease (increase) in:
Trade receivables (382,432) 70,276
Prepaid expenses and other assets (125,093) (5,076)
Inventories (134,357) (173,019)
(Decrease) increase in:
Accounts payable 106,763 127,719
Accrued expenses 132,807 (102,225)
Accrued legal costs (5,634) (53,930)
Income taxes payable 185,696 (7,885)
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Net cash provided by
operating activities 377,442 587,181
CASH FLOWS FROM INVESTING
ACTIVITIES:
Purchase of property and equipment (285,058) (216,405)
Proceeds from sale of marketable securities 2,707
Purchase of patents (106,705)
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Net cash used in investing activities (282,351) (323,110)
CASH FLOWS FROM
FINANCING ACTIVITIES:
Payments on note payable (21,897)
Proceeds from exercise of stock options 8,697 29,807
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Net cash provided by
financing activities 8,697 7,910
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NET INCREASE IN CASH
AND CASH EQUIVALENTS 103,788 271,981
CASH AND CASH EQUIVALENTS AT
BEGINNING OF PERIOD 274,757 732,381
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CASH AND CASH EQUIVALENTS AT
END OF PERIOD $ 378,545 $ 1,004,362
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SUPPLEMENTAL DISCLOSURES OF
CASH FLOW INFORMATION:
Cash payments for interest $ 0 $ 55
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Cash payments for income taxes $ 90,000 $ 354,000
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See notes to financial statements.
5
THE CHROMALINE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. The consolidated balance sheet of The Chromaline Corporation (the Company)
as of June 30, 1999, and the related statement of earnings and cash flows
for the three and six months ended June 30, 1999, have been prepared
without being audited.
In the opinion of management, these consolidated statements reflect all
adjustments (consisting of only normal recurring adjustments) necessary to
present fairly the consolidated financial position of The Chromaline
Corporation as of June 30, 1999, 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 Form 10-SB filing of June 4, 1999.
The results of operations for interim periods are not necessarily
indicative of results that will be realized for the full fiscal year.
Comprehensive income is a measure of all non-owner changes in shareholders'
equity and includes such items as net income, certain foreign currency
translation items, minimum pension liability adjustments and changes in the
value of available-for-sale securities. For the three and six months ended
June 30, 1999 and 1998, comprehensive income for The Chromaline Corporation
was equivalent to net income.
2. The major components of inventory at June 30, 1999 and December 31, 1998
are as follows:
June 30, 1999 December 31, 1998
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Raw materials $ 613,695 $ 524,199
Work-in-progress 391,829 409,539
Finished goods 502,025 459,454
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Reduction to LIFO cost (118,000) (138,000)
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Total Inventory $1,389,549 $1,255,192
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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 a U.S. patent
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 1997, the Company
incurred $445,000 of legal costs for this matter, including a $250,000
accrual at December 31, 1997 to cover future legal costs.
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 and the reexamination is presently ongoing. As of June
30, 1999, the USPTO has on two occasions rejected the claims of the
claimant. During the six months ended June 30, 1999 and the year ended
December 31, 1998, the Company paid approximately $5,000 and $187,000,
respectively, in legal
6
and related costs in the defense of this matter. Such payments were applied
against the accrual established at December 31, 1997. At June 30, 1999, the
Company had a remaining accrual of $58,000 for expected future legal cost
relating to this matter.
4. In June 1998 the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards (SFAS) No. 133, "Accounting for Derivative
Instruments and Hedging Activities". SFAS No. 133 requires that all
derivatives are recognized in the financial statements as either assets or
liabilities measured at fair value and also specifies new methods of
accounting for hedging transactions. The Company has not yet adopted SFAS
No. 133. The nature of the business transactions of the Company are such
that no derivative instruments are or are planned to be used during the
normal course of operations.
5. Shareholders' Equity
Six Months Ended
June 30, 1999
-------------
Balance at December 31, 1998 $ 4,859,833
Net income (unaudited) 400,761
Issuance of 1,750 shares of common stock
upon exercise of options (unaudited) 8,697
Tax benefit resulting from exercise of
Options (unaudited) 2,100
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Total Stockholders' Equity (unaudited) $ 5,271,391
------------
------------
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.
7
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 AN ASTERISK.
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 second quarter of 1999, the first half of 1999 and the same periods
of 1998. 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
LEVEL OFF DURING THE REMAINDER OF THE YEAR--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 BELIEF THAT EVALUATIONS OF AND MODIFICATIONS TO ITS YEAR
2000 COMPLIANCE STATUS, INCLUDING YEAR 2000 COMPLIANCE OF THIRD-PARTY
SUPPLIERS, WILL NOT HAVE A MATERIAL ADVERSE EFFECT ON THE COMPANY'S
OPERATIONS OR FINANCIAL POSITION--This belief may be impacted by
presently unanticipated delays in assessment or remediation,
unanticipated increases in costs or non-compliance by third parties.
- THE COMPANY'S EXPECTATIONS OF THE TIME AND COSTS ASSOCIATED WITH ITS
YEAR 2000 PROJECT--These expectations may be impacted by presently
unanticipated delays in assessment, unanticipated increases in costs
or non-compliance by third parties.
- 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
8
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.
RESULTS OF OPERATIONS
QUARTER ENDED JUNE 30, 1999 COMPARED TO QUARTER ENDED JUNE 30, 1998
SALES. The Company's sales during the second quarter of 1999 increased to
$2.55 million, a 7% increase from the $2.38 million in sales during the same
period in 1998. The increase is attributable to higher domestic sales and higher
sales in Europe. Sales to Asia and Latin America were flat.
COST OF GOODS SOLD. The cost of goods sold during the second quarter of
1999 was $1.11 million, or 43.3% of sales, compared to $1.04 million, or 43.5%
of sales, during the same period in 1998.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses increased to $865,000, or 33.9% of sales, in the second
quarter of 1999, from $675,000, or 28.3% of sales, for the same period in 1998.
The increase was due to higher worldwide expenditures for product promotion and
marketing. These costs are expected to level off during the remainder of the
year. Also contributing to the increase in expenses were approximately $30,000
in costs associated with the filing of a Form 10-SB Registration Statement under
the Securities Exchange Act of 1934, as amended, registering the Company's
Common Stock. In addition, approximately $10,000 was incurred related to the
cost of Year 2000 compliance.
RESEARCH AND DEVELOPMENT EXPENSES. Research and development expenses during
the second quarter of 1999 increased to $178,000, or 7.0% of sales, from
$160,000, or 6.7%, for the same period in 1998. The increase was primarily
attributable to new product development and reflects an effort by the Company to
continue its technological advancements. The Company intends to continue to
invest in research and development as appropriate to maintain its innovation.
INCOME TAXES. Income taxes decreased to $152,000, or an effective rate of
37%, during the second quarter of 1999 from $198,000, or an effective rate of
38%, for the second quarter of 1998, due to the Company's reduction in pretax
income in 1999.
SIX MONTHS ENDED JUNE 30, 1999 COMPARED TO THE SIX MONTHS ENDED JUNE 30, 1998
SALES. The Company's sales during the six months ended June 30, 1999
increased to $4.79 million compared to $4.73 million for the same period in
1998. This reflects a 0.8% increase in domestic United States sales offset by
lower international sales due to the slow recovery of foreign markets the
Company serves from recent economic crises.
COST OF GOODS SOLD. The cost of goods sold during the six months ended June
30, 1999 was $2.17 million, or 45.3% of sales, compared to $2.13 million, or
45.0% of sales, for the same period in 1998. The increase as a percentage of
sales, reflects the Company's product mix primarily during the first quarter of
1999, which improved significantly in the second quarter of 1999.
SELLING, GENERAL AND ADMINISTRATIVE. Selling, general and
administrative expenses in the six months ended June 30, 1999 increased to $1.66
million, or 34.7% of sales, from $1.39 million, or 29.3% of sales, for the same
period in 1998. This increase was due to higher worldwide expenditures for
product promotion and marketing. These expenses are expected to remain at
current levels during the second half of 1999. The increase was also due to
approximately $40,000 in costs associated with the filing of the Company's Form
10-SB which became effective June 4, 1999. The Company incurred approximately
$20,000 in costs associated with Year 2000 compliance.
9
RESEARCH AND DEVELOPMENT EXPENSES. Research and development expenses for
the six months ended June 30, 1999 increased to $340,000, or 7.1% of sales, from
$318,000, or 6.7% of sales, for the same period in 1998. The increase reflects
costs associated with new product development.
INCOME TAXES. Income taxes for the six months ended June 30, 1999 decreased
to $235,000, or an effective rate of 37%, from $346,000, or an effective rate of
38%, for the same period in 1998 due to the Company's lower pretax income.
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 $379,000 and $275,000 at June 30, 1999 and
December 31, 1998, respectively. The Company generated $377,000 in cash from
operating activities during the six months ended June 30, 1999 and $587,000 for
the same period in 1998. Cash generated by operating activities is primarily
provided by net income as adjusted for non-cash depreciation. During the first
six months of 1999, trade receivables increased by $382,000 as the Company
modified its export sales terms in accordance with global market conditions.
Prepaid expenses increased $125,000 reflecting the acquisition of a new product
line. Inventories increased $134,000 due to new products entering the
marketplace. Accounts payable increased $107,000, accrued expenses increased
$133,000 reflecting payroll and fringe benefit requirements, and income taxes
payable increased $186,000. For the six months ended June 30, 1998, trade
receivables decreased $70,000 while inventories increased $173,000 reflecting
the new products developed last year for the market. Accounts payable increased
$128,000, accrued expenses decreased $102,000 and accrued legal costs decreased
$54,000.
The Company used $282,000 and $323,000 in cash for investing activities
during the six months ended June 30, 1999 and June 30, 1998, respectively. In
both periods net cash used for investing activities was used primarily for plant
and equipment. During the third quarter of 1998, the Company purchased municipal
revenue bonds with maturities of three years or less for $909,000 and generated
$401,000 from the sale of such marketable securities.
The Company generated $9,000 in cash from financing activities during the
six months ended June 30, 1999 as a result of the exercise of stock options.
During the same period of 1998, $30,000 in cash was generated from the exercise
of stock options, which was offset by a $22,000 payment on the Company's
revolving credit line.
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 to a
material extent and there is no debt outstanding under this line as of June 30,
1999.
The Company believes that 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. 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
As of June 30, 1999, the Company had spent $285,000 on capital expenditures
during 1999. This spending during the first six months of 1999 included
manufacturing equipment upgrades to improve efficiency and reduce operating
costs, new laboratory instrumentation and building facility upgrades.
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
10
improve measurement and quality control processes. These commitments are
funded with cash generated from operating activities.
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 25% of total sales for the six months ended June 30, 1999. This
compared with foreign sales accounting for 28% of total sales during the same
period in 1998. Foreign sales in 1999 are being affected by overseas economies
that are slow in recovering from recent economic crises. 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 June 30, 1999.
Effective January 1, 1999, eleven states if the European Union began the
conversion to a common currency, called the "euro". This action will most likely
cause a portion of Chromaline's European transactions to be negotiated, invoiced
and paid in "euros". The conversion will most likely add currency exchange costs
and risks. As of June 30, 1999, the impact of the "euro" conversion has not
significantly affected the Company's results.
YEAR 2000 ISSUE
The year 2000 issue is the result of certain computer systems that
recognize the year using only the last two digits. Any system utilizing
time-sensitive programming may recognize the date using "00" as the year 1900
rather than the year 2000. This could result in systems failures that may
disrupt normal business operations.
The Company began a comprehensive project in 1998 to test and prepare its
internal systems for the year 2000. The Company expects this project to be
completed in the third quarter of 1999. The project is on track to be completed
as planned. The project will replace all non-compliant software and hardware
with systems that are year 2000 compliant. This includes a review of both
information technology and non-information technology systems. A survey of major
suppliers is also being conducted as part of the project to assess the readiness
of the Company's business associates. If the necessary conversions are not
completed on a timely basis, the year 2000 could have a material adverse effect
on Chromaline's operations. Overall, management believes the year 2000 will not
have a significant impact on operations.
As of June 30, 1999, the Company has spent approximately $65,000 on the
project. The total cost of the project is expected to be approximately $75,000.
This cost includes replacing non-compliant hardware and software. It also
includes the internal human resource time to conduct systems and vendor surveys
and implement the required changes needed to become year 2000 compliant.
Management believes that this expenditure is not material to the Company and
will not adversely impact Chromaline's financial condition or liquidity.
Chromaline faces risk to the extent that suppliers of products and services
purchased by the Company and others with whom it transacts business on a
world-wide basis do not have business products and services that comply with
year 2000 requirements. The Company distributed a survey to its suppliers during
the second quarter of 1999 regarding their state of readiness for the year 2000.
As of June 30, 1999, the Company has received responses from 75% of its key
suppliers, all of which gave assurances that they will be year 2000 compliant.
In the event that a significant number of these third parties cannot, in a
timely manner, provide the Company with products and services because of the
year 2000 issue, Chromaline's operating results could be materially adversely
affected.
The Company is addressing contingency plans in the event of year 2000
disruptions. With respect to the Company's internal production and
administrative systems, the Company believes sufficient alternative plans are in
11
place to adequately conduct business. These plans include the identification of
back-up and manual systems necessary to conduct normal business operations.
While Chromaline believes that its year 2000 project and contingency plans are
sufficient, there can be no assurance that the year 2000 will not materially
adversely affect its business, operating or financial condition.
FUTURE OUTLOOK
Chromaline has invested over 6% of 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.
In June 1999, the Company introduced a line of glass and crystal to
increase its product offering to the decorative sand carving market. It is
presently anticipated that these new products will move the Company closer to
being a full service provider to this growing industry.
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 is
proceeding in a cautious and prudent manner with the goal of capitalizing on the
Company's strong cash and low debt positions as well as the strengths of the
Company's core businesses.
12
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. A favorable ruling by the USPTO may result in the dismissal of the case.
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 now has one final opportunity to appeal to
the USPTO regarding this case.
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
The Company's Annual Meeting of Shareholders was held on April 15, 1999.
The shareholders took the following actions:
(a) The shareholders elected five directors to hold office until the next
annual meeting of shareholders. The shareholders present in person of
by proxy cast the following numbers of votes in connection with the
election of directors, resulting in the election of all nominees:
Votes For Votes Against
--------- -------------
Charles H. Andresen 698,853 3,750
Philip J. Hourican 698,853 3,750
David O. Harris 698,853 3,750
Gerald W. Simonson 698,853 3,750
William C. Ulland 698,853 3,750
13
(b) The shareholders ratified and approved an 80,000 share increase in the
shares authorized for issuance under the 1995 Stock Incentive Plan to
89,724 shares. The votes on this proposal were 677,409 in favor,
25,194 votes against and no abstentions.
ITEM 5. OTHER INFORMATION
None
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBITS
The following exhibits are filed as part of this Quarterly Report on Form
10-QSB for the quarterly period ended March 31, 1997:
Exhibit Description
- ------- ------------
3.1 Restated Articles of Incorporation of Company, as amended.(1)
3.2 By-Laws of the Company, as amended.(1)
11 Computation of Net Earnings per Common Share
27 Financial Data Schedule
Copies of Exhibits will be furnished upon request and payment of the
Company's reasonable expenses in furnishing the Exhibits.
(b) REPORTS ON FORM 8-K
No reports on Form 8-K were filed by the registrant during the quarterly
period ended June 30, 1999.
- -------------------------
1 Incorporated by reference to the like numbered Exhibit to the Company's
Registration Statement on Form 10-SB (File No. 000-25727)
14
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.
THE CHROMALINE CORPORATION
DATE: August 16, 1999 By: /s/ Jeffery A. Laabs
--------------------------------------------
Jeffery A. Laabs,
Vice President of Finance, Controller,
Treasurer and Secretary
(Duly authorized officer and
Principal Financial Officer)
15
INDEX TO EXHIBITS
Exhibit Description Page
- ------- ----------- ----
3.1 Restated Articles of Incorporation of Company, as amended...................... Incorporated by Reference
3.2 By-Laws of the Company, as amended............................................. Incorporated by Reference
11 Computation of Net Earnings per Common Share................................... Filed Electronically
27.1 Financial Data Schedule........................................................ Filed Electronically