U.S. SECURITIES AND EXCHANGE COMMISSION Washington, DC 20549 Form 10-QSB [X] QUARTERLY REPORT UNDER SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For quarterly period ended June 30, 1998 0-18145 Commission file number QUALITY PRODUCTS, INC. (Exact name of registrant as specified in its charter) Delaware 75-2273221 (State or other jurisdiction (IRS Employer of incorporation or organization) Identification No.) 560 Dublin Avenue, Columbus, OH 43215 (Address of principal executive offices) (614) 228-8120 (Issuer's telephone number) Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 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. (I) Yes X No ---- ---- As of June 30, 1998, there were 2,554,056 shares of the Company's common stock outstanding. 1 QUALITY PRODUCTS, INC. CONSOLIDATED BALANCE SHEET June 30, 1998 (Unaudited) ASSETS Current Assets Cash $ 545,710 Restricted Cash 15,575 Accounts Receivable, Net of Allowance for Doubtful Accounts of $11,867 750,396 Inventories 905,388 Other Current Assets 151,469 ----------- Total Current Assets 2,368,538 ----------- Property, Plant and Equipment 848,766 Less Accumulated Depreciation (818,706) ----------- Net Property, Plant and Equipment 30,060 ----------- Other Assets 7,280 ----------- TOTAL ASSETS $ 2,405,878 ----------- See notes to Consolidated Financial Statements 2 QUALITY PRODUCTS, INC. CONSOLIDATED BALANCE SHEET - CONTINUED June 30, 1998 (Unaudited) LIABILITIES AND STOCKHOLDERS' DEFICIT CURRENT LIABILITIES: Note payable, short term portion $ 200,000 Accounts payable 476,408 Accrued expenses 201,672 Customer deposits 427,021 Income Taxes payable 4,160 ------------ Total Current Liabilities 1,309,261 ------------ NON-CURRENT LIABILITIES: Notes payable, non-current 1,150,000 Notes payable, related parties, non-current 400,000 ------------ Total non-current liabilities 1,550,000 ------------ COMMITMENTS AND CONTINGENCIES STOCKHOLDERS' DEFICIT: Preferred stock, convertible, voting, par Value $.00001; 10,000,000 shares authorized; No shares issued and outstanding Common stock, $.00001 par value; 20,000,000 25 shares authorized; 2,554,056 shares issued and outstanding; 808,333 shares reserved Additional paid in capital 30,053,284 Accumulated deficit (25,480,720) Less: Treasury stock, 176,775 shares at cost (5,025,972) ------------ Total stockholders' deficit ( 453,383) ------------ TOTAL LIABILITIES AND STOCKHOLDERS' DEFICIT $ 2,405,878 ------------ See notes to Consolidated Financial Statements 3 QUALITY PRODUCTS, INC. CONSOLIDATED STATEMENT OF INCOME (Unaudited) For the three months ended For the nine months ended June 30, June 30, ---------------------------- ----------------------------- 1998 1997 1998 1997 ----------- ----------- ----------- ----------- Net Sales $ 1,441,994 $ 1,730,069 $ 4,883,401 $ 4,864,011 Cost of Goods Sold 971,247 1,082,336 3,216,659 3,036,733 ----------- ----------- ----------- ----------- Gross Manufacturing Profit 470,747 647,733 1,666,742 1,827,278 Selling, General, & Admin Expenses 519,876 308,036 1,337,772 919,860 ----------- ----------- ----------- ----------- Operating Income/(Loss) (49,129) 339,697 328,970 907,418 ----------- ----------- ----------- ----------- Other Income (Expense): Gain on sale of assets held for sale -- -- -- 80,934 Interest Expense (16,907) (37,930) (66,097) (117,776) Other 108,824 (2,283) 105,194 (11,064) ----------- ----------- ----------- ----------- Total Other Income (Expense) 91,917 (40,213) 39,097 (47,906) ----------- ----------- ----------- ----------- Income Before Provision for Income Taxes 42,788 299,484 368,067 859,512 Provision for Income Taxes 24,414 -- 36,847 -- ----------- ----------- ----------- ----------- Net Income $ 18,374 $ 299,484 $ 331,220 $ 859,512 ----------- ----------- ----------- ----------- ----------- ----------- ----------- ----------- Earnings per share: (Note 5) Basic earnings per common share $ 0.01 $ 0.13 $ 0.13 $ 0.36 ----------- ----------- ----------- ----------- ----------- ----------- ----------- ----------- Diluted earnings per common share $ 0.01 $ 0.12 $ 0.12 $ 0.33 ----------- ----------- ----------- ----------- ----------- ----------- ----------- ----------- See notes to Consolidated Financial Statements 4 QUALITY PRODUCTS, INC. CONSOLIDATED STATEMENT OF CASH FLOWS (Unaudited) For the nine months ended June 30, ------------------------------- 1998 1997 ----------- --------- Cash Flows From Operating Activities: Net Income $ 331,220 $ 859,512 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 9,829 11,064 Cash provided by (used for) current assets and liabilities: Restricted Cash 26,661 101,154 Accounts receivable (47,802) (164,932) Inventories (97,071) (47,531) Other assets (131,203) (4,916) Accounts payable 106,355 156,588 Accrued expenses (261,130) (163,873) Customer Deposits 164,980 -- Income Taxes Payable (23,840) -- Due to related party -- (47,000) ----------- --------- Cash provided by operating activities 77,999 700,066 ----------- --------- Cash flows From Investing Activities - Purchase of machinery & equipment (3,913) (16,845) ----------- --------- Cash Flows From Financing Activities: Repayments - notes payable (135,000) (193,033) Issuance of Debentures 1,530,000 -- Repayment - Debentures (150,000) -- Repayment - Bank Line of Credit (1,180,000) -- Unsecured note payable issued -- 2,500 ----------- --------- Cash provided by (used for) financing activities 65,000 (190,533) ----------- --------- Net Increase in Cash 139,086 492,688 Cash at Beginning of Period 406,624 8,094 ----------- --------- Cash at End of Period $ 545,710 $ 500,782 ----------- --------- ----------- --------- 5 See notes to Consolidated Financial Statements Cash Flow Information - continued The Company's cash payments for interest and income taxes were as follows: Nine Months Ended June 30, ------------------------- 1998 1997 --------- --------- Cash paid for interest $ 88,380 $ 117,776 Cash paid for taxes $ 66,989 $ -- 6 QUALITY PRODUCTS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) 1. Basis of Presentation The accompanying unaudited consolidated financial statements are presented in accordance with the requirements for Form 10-QSB and Article 10 of Regulation S-X. Accordingly, they do not include all the disclosures normally required by generally accepted accounting principles. Reference should be made to the Quality Products, Inc. (the "Company") Form 10-KSB for the year ended September 30, 1997, for additional disclosures including a summary of the Company's accounting policies, which have not significantly changed. The information furnished reflects all adjustments (all of which were of a normal recurring nature) which, in the opinion of management, are necessary to fairly present the financial position, results of operations, and cash flows on a consistent basis. Operating results for the nine months ended June 30, 1998, are not necessarily indicative of the results that may be expected for the year ended September 30, 1998. 2. Restricted Cash The Restricted Cash is held at the Company's bank as collateral for a Letter of Credit securing the Company's potential obligations for a Worker's Compensation insurance policy. The policy expires November 30, 1998. 3. Inventories Inventories at June 30, 1998 consist of: Raw materials and supplies $ 438,049 Work-in-process 382,698 Finished goods 88,459 Reserve for obsolescence (3,818) --------- Total $ 905,388 --------- --------- 4. Commitments and Contingencies In November 1993, the Company and its Multipress subsidiary were sued in Indiana Superior Court by an employee of a company that had purchased one of the Company's presses from a 3rd party. The plaintiff seeks unspecified monetary damages for a personal injury that occurred in her employer's facility. Although the Company's subsidiary carries full product liability insurance, the Company's former management did not notify the 7 insurance carrier within the prescribed time period. Accordingly, this claim is not covered by insurance. Based upon consultation with the Company's counsel, the Company does not believe that the litigation will have a material adverse effect on the consolidated financial position, results of operations or cash flows of the Company. The company has made a provision for the estimated potential loss on this matter. 5. Earnings Per Share On December 31, 1997, the Company adopted Financial Accounting Statement No. 128 issued by the Financial Accounting Standards Board. Under Statement 128, the Company was required to change the method previously used to compute earnings per share and to restate all prior periods. Under the new requirements for calculating basic earnings per share, the dilutive effect of stock options are excluded. The impact of Statement 128 on the calculation of earnings per share is as follows: 3 Months Ended 9 Months Ended June 30, June 30, ----------------------- ----------------------- 1998 1997 1998 1997 ---- ---- ---- ---- Basic: Average Shares Outstanding 2,554,056 2,395,680 2,554,056 2,395,680 Income (Loss) From Operations $(49,129) $339,697 $328,970 $907,418 Basic Earnings (Loss) Per Share (FAS 128) $ (0.02) $ 0.14 $ 0.13 $ 0.38 Net Income $ 18,374 $299,484 $331,220 $859,512 Basic Earnings Per Share (FAS 128) $ 0.01 $ 0.13 $ 0.13 $ 0.36 Primary Earnings Per Share, As Previously Reported N.A. $ 0.13 N.A. $ 0.36 8 (Note 5 - continued) 3 Months Ended 9 Months Ended June 30, June 30, ------------------------- ------------------------ 1998 1997 1998 1997 ---------- ---------- ---------- ---------- Diluted: Average Shares Outstanding 2,554,056 2,395,680 2,554,056 2,395,680 Net Effect of Dilutive Stock options and warrants based on the treasury stock method using average market price 240,020 131,796 297,453 175,784 ---------- ---------- ---------- ---------- Total Shares 2,794,076 2,527,476 2,851,509 2,571,464 Income (Loss) From Operations $ (49,129) $ 339,697 $ 328,970 $ 907,418 Diluted Earnings Per Share (FAS 128) $ (0.02) $ 0.13 $ 0.12 $ 0.35 Net Income $ 18,374 $ 299,484 $ 331,220 $ 859,512 Diluted Earnings Per Share (FAS 128) $ 0.01 $ 0.12 $ 0.12 $ 0.33 Fully Diluted Earnings Per Share, As Previously Reported N.A. $ 0.08 N.A. $ 0.24 Average Market Price of Common Stock $ 1.1288 $ 0.1604 $ 1.2129 $ 0.2009 Ending Market Price of Common Stock $ 1.0625 $ 0.15625 $ 1.0625 $ 0.15625 The following securities were excluded from the calculation of diluted earnings per share at June 30, 1998 because they are considered anti-dilutive under FAS 128: 1. Options granted to an officer and director to purchase 50,000 shares of the Company's common stock at $2.00 per share. 9 2. Warrants issued pursuant to the Company's debentures to purchase 465,000 shares of common stock @ $2.00 per share. 6. Private Placement Debt On November 25, 1997, the Company consummated a private placement offering of 30 units of Company debentures in the amount of $1,530,000. Each unit represents: a) a $50,000 interest in a 6% $1,500,000 note payable, b) a warrant to purchase 10,000 shares of the Company's common stock at $1 per share during the period November 1, 1997 through September 30, 1999, and c) a warrant to purchase 15,000 shares of the Company's common stock at $2 per share during the period October 1, 1999 through September 30, 2001. The Company incurred expenses of approximately $150,000 in connection with this offering. The Company utilized the proceeds of the offering to repay the bank line of credit, a $135,000 note payable and expenses associated with the offering. Schedule of required future annual principal payments: Year Ended June 30 ------------------ 1999 $ 200,000 2000 200,000 2001 200,000 2002 750,000 ------------ TOTAL $ 1,350,000 ------------ ------------ 10 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Three Months Ended June 30, 1998 as Compared to June 30, 1997 Net Sales for the three months ended June 30, 1998 were $1,441,994 as compared to $1,730,069 for the three months ended June 30, 1997, a decrease of $311,311 or 17.7%. Gross profit was $470,747 or 32.6% of sales as compared to $647,733 or 37.4% of sales for the same period a year earlier. Sales were lower in the third quarter this year as compared to last year due to increased delivery times for more complex machines. The move to more complex machines is a continuing trend in the industry. This change in product mix presented a significant increase in workload for the engineering department. The Company is addressing this challenge by outsourcing some design work, as well as, attempting to increase the number of engineering personnel. A tight labor market has made the latter objective difficult. However, the Company's backlog remains strong at over $2,000,000, the highest level ever. Gross profit margins decreased 4.8% due to increases in material and labor costs with no corresponding price increases on the Company's products, as well as decreased sales volume. The company has been unable to increase prices due to competition. However, in October 1998 the Company plans to introduce a price increase to all products which, along with a recent cost reduction analysis of certain products, should improve profit margins. Selling, general and administrative expenses increased from $308,036 during the three months ended June 30, 1997 to $519,876 for the three months ended June 30, 1998. The increase is due to a number of items including annual meeting expenses, trade show expenses, and accelerated contract payments to and options buyback from the former Chief Financial Officer. Continuing legal fees and increases in wages and benefits to hire additional staff also contributed to the increase. Selling, general and administrative expenses as a percentage of sales were 36.0% during the three months ended June 30, 1998 as compared to 17.8% for the three months ended June 30, 1997. Interest expense of $24,675 was offset by $7,768 of interest revenue for a net interest expense of $16,907 for the three months ended June 30, 1998 as compared to $37,930 for the comparable period a year earlier. The decrease is due primarily to the reduction of the interest rate on the Company's outstanding indebtedness. The Company currently has $1,550,000 of 6% debt represented by $1,350,000 first secured debt issued in November 1997 and $200,000 second secured convertible debt which also bears interest at 6%. An additional $200,000 of the second secured convertible note is interest free as of March 1, 1998. Net income for the period was $18,374 as compared to $299,484 during the corresponding period a year earlier, a reduction of $281,110, due to reasons aforementioned. The current period net income includes a refund of worker's compensation premiums of $31,085 and the reversal of $77,092 in expenses previously estimated which have not been realized. The income tax provision for the period ending June 30 includes a benefit related to utilization of NOL carry forwards of approximately $12,000. The 1998 provision relates to city income taxes, and the federal alternative minimum tax. 11 Nine Months Ended June 30, 1998 as Compared to June 30, 1997 Net Sales for the nine months ended June 30, 1998 were $4,883,401 as compared to $4,864,011 for the nine months ended June 30, 1997, an increase of $19,390 or 0.3%. Gross profit was $1,666,742 or 34.1% of sales as compared to $1,827,278 or 37.5% of sales for the same period a year earlier. Sales did not increase as expected during the nine months as compared to last year and in fact, were lower in the third quarter this year as compared to last year due to increased delivery times for more complex machines. The move to more complex machines is a continuing trend in the industry. This change in product mix presented a significant increase in workload for the engineering department. The Company is addressing this challenge by outsourcing some design work, as well as, attempting to increase the number of engineering personnel. A tight labor market has made the latter objective difficult. However, the Company's backlog remains strong at over $2,000,000, the highest level ever. Gross profit margins decreased 3.4% due to increases in material and labor costs with no corresponding price increases on the Company's products. The Company has been unable to increase prices due to competition. However, in October 1998 the Company plans to introduce a price increase to all products which, along with a recent cost reduction analysis of certain products, should improve profit margins. Selling, general and administrative expenses increased from $919,860 during the nine months ended June 30, 1997 to $1,337,772 for the nine months ended June 30, 1998. The increase is due to several one time payments during the nine months totaling $126,000, composed of $65,000 paid to the Company's President and former Chief Financial Officer as part of an agreement to reprice their 350,000 stock options from $0.10 to $1.00, a subsequent buyout of the former CFO's stock options totaling $26,250 and accelerated payments on his employment contract of $35,000. Also contributing to the increase were commissions of approximately $105,000 paid to outside manufacturers' representatives compared to the same period last year as more sales were made by outside commissioned reps than by salaried salespersons. Additionally, continuing legal fees of $105,000, increased wages and benefits for additional staff of approximately $65,000 and annual meeting expenses of approximately $40,000 raised the selling, general and administrative expenses. Selling, general and administrative expenses as a percentage of sales were 27.4% during the nine months ended June 30, 1998 as compared to 18.9% for the nine months ended June 30, 1997. Interest expense of $86,473 was offset by $20,376 of interest revenue for a net interest expense of $66,097 for the nine months ended June 30, 1998 as compared to $117,776 for the comparable period a year earlier. The decrease is due primarily to the reduction of the interest rate on the Company's outstanding indebtedness. The Company currently has $1,550,000 of 6% debt represented by $1,350,000 first secured debt issued in November 1997 and $200,000 second secured convertible debt which also bears interest at 6%. An additional $200,000 of the second secured convertible note is interest free as of March 1, 1998. 12 Nine Months Ended June 30, 1998 as Compared to June 30, 1997 - continued Net income for the period was $331,220 as compared to $859,512 during the corresponding period a year earlier, a reduction of $528,292. This reduction is due mainly to the increase in selling, general and administrative expenses as described above and income tax expenses of $36,847. At the annual meeting on May 22, 1998, Jonathan Reuben resigned as an officer and Director of the Company. Mr. Reuben and the Company agreed on certain payments being made to Mr. Reuben in accordance with his employment contract by the end of the fiscal year. The Company paid him $62,637 in the third quarter composed of $26,250 to repurchase his stock options and approximately $36,387 of compensation. The Company will pay Mr. Reuben approximately $38,000 of compensation during the fourth quarter to complete the terms of the agreement. This will have a negative impact on expected income over the final three months of the fiscal year. The income tax provision for the period ending June 30 includes a benefit related to utilization of NOL carry forwards of approximately $140,000. The 1998 provision relates to city income taxes, and the federal alternative minimum tax. Liquidity and Capital Resources As of June 30, 1998, the Company had a working capital surplus of $1,059,277 as compared to a working capital deficiency of $599,013 at June 30, 1997 and a working capital deficiency of $459,977 at September 30, 1997. The change from a working capital deficit to a working capital surplus is due to the profitable operations of the Company and more importantly, the refinancing of the Company's outstanding bank indebtedness. At September 30, 1997 and in previous quarters, the Company's bank indebtedness had been due on demand and accordingly shown in current liabilities, thereby increasing the Company's working capital deficiency. On November 25, 1997, the Company completed a $1,530,000 financing consisting primarily of a $1,500,000 three year loan. This loan, except for the current portion of $200,000, is disclosed in long-term liabilities and accordingly results in a better working capital balance. This surplus should continue to increase as the Company anticipates profitable operations at least through the foreseeable future. The Company's major source of liquidity continues to be from available cash on hand which is generated from profitable cash flow from operations. The Company has no material commitments at this time other than its quarterly payments of $50,000 on the long-term note payable. Year 2000 Compliance The Company utilizes a number of computer programs in its operations. Any of the Company's programs that recognize a date using "00" as the year 1900 rather than the year 2000 could result 13 Year 2000 Compliance - continued in errors or system failures. The Company has selected and approved an accounting and inventory computer system which will lead to a one time material expenditure not to exceed $175,000. Financing for the system will be provided under a three year term loan from a local bank. The software is certified year 2000 compliant and is expected to be installed, implemented, and active by December 31, 1998. The Company believes that this purchase will materially reduce the exposure of the Company to future year 2000 compliance expenses. In the event the Company is unable to fully implement the software before January 1, 2000 the Company's accounting and information systems will fail resulting in a material financial risk to the Company. Statements in this Form 10-QSB that are not historical facts, including statements about the Company's prospects, about the future impact of litigation, and the possible conversion of notes to stock, are forward-looking statements that involve risks and uncertainties. These risks and uncertainties could cause actual results to differ materially from the statements made, including the impact of the litigation against the Company. Please see the information appearing in the Company's 1997 Form 10KSB under "Risk Factors." 14 PART II Item 4. Submission of Matters to a Vote of Security Holders The Company submitted the following issues for shareholder vote at an annual meeting held on May 22, 1998 at the Company's offices in Columbus, Ohio. 1. Amend the Company's bylaws to set the number of directors at not less than three nor more than seven and to permit the Board to determine the exact number. The Company did not receive the required quorum of votes to vote on this issue. For Against Abstain Broker Non-Votes ------- ------- ------- ---------------- 896,302 140,316 4,330 1,271,017 2. To elect nominees to the Company's Board. The shareholders elected the following four directors in accordance with the bylaws. For Withhold --------- -------- Bruce Weaver 2,292,877 19,088 Edward Varon 2,292,377 19,588 William Harrison, Jr. 2,292,377 19,588 Murray Koppelman 2,292,877 19,088 3. To approve the 1997 Stock Option Plan and to grant options to purchase 150,000 shares of common stock to certain employees. The Company did not receive the required quorum of votes to vote on this issue. As shareholder approval was requested, but not required, the Company approved the plan and granted the options. For Against Abstain Broker Non-Votes ------- ------- ------- ---------------- 789,888 180,180 10,884 1,331,013 4. To ratify the grant of options to purchase 225,000 shares each to Messrs. Weaver and Reuben. The Company did not receive the required quorum of votes to vote on this issue. As shareholder approval was requested, but not required, Messrs. Weaver and Reuben retained their options. For Against Abstain Broker Non-Votes ------- ------- ------- ---------------- 656,041 175,668 149,243 1,331,013 5. Appoint Farber & Hass LLP as independent auditors for fiscal year 1998. This proposal was approved. For Against Abstain --------- ------- ------- 2,285,852 7,842 18,271 15 Item 6. Exhibits and Reports of Form 8-K a. Exhibits 27.1 Financial Data Schedule b. Reports on Form 8-K c. Not applicable 16 Signatures In accordance with the requirements of the Exchange Act, the registrant has caused this report to be signed on its behalf by the undersigned thereunto duly authorized: Quality Products, Inc. Registrant Date: August 10, 1998 By /s/ Bruce C. Weaver -------------------------------- Bruce C. Weaver President (Principal Executive Officer) By /s/ Tac D. Kensler -------------------------------- Tac D. Kensler Chief Financial Officer 17