UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
( X ) Quarterly Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the quarterly period ended September 30, 1998
( ) Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the transition period from to
Commission File No. 0-5265
SCAN-OPTICS, INC.
(Exact name of registrant as specified in its charter)
Delaware 06-0851857
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
169 PROGRESS DRIVE, MANCHESTER, CT 06040
(Address of principal executive offices) Zip Code
(860) 645-7878
(Registrant's telephone number, including area code)
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. ( X ) YES ( ) NO
The number of shares of common stock, $.02 par value, outstanding as of
November 11, 1998 was 7,369,682.
<PAGE>
<TABLE>
<CAPTION>
SCAN-OPTICS, INC., AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(thousands, except share data) September 30, 1998 December 31, 1997
- - ---------------------------------------------------------------------------------------------------
(UNAUDITED)
<S> <C> <C>
Assets
Current Assets:
Cash and cash equivalents $ 140 $ 4,386
Accounts receivable less allowance of $580 at
September 30, 1998 and $104 at December 31, 1997 18,984 15,695
Inventories 10,907 12,547
Deferred taxes 1,443 1,038
Prepaid expenses and other 1,313 969
-----------------------------------
Total current assets 32,787 34,635
Plant and equipment:
Equipment 13,682 13,355
Leasehold improvements 4,545 4,585
Office furniture and fixtures 1,302 1,275
-----------------------------------
19,529 19,215
Less allowances for depreciation and amortization 15,932 15,355
-----------------------------------
3,597 3,860
Goodwill, net 12,390
Other assets 912 212
-----------------------------------
Total Assets $ 49,686 $ 38,707
===================================
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
<S> <C> <C>
(thousands, except share data) September 30, 1998 December 31, 1997
- - ---------------------------------------------------------------------------------------------------
(UNAUDITED)
Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable $ 4,845 $ 2,071
Notes payable to bank 8,772
Salaries and wages 1,047 1,984
Taxes other than income taxes 467 744
Income taxes 44 533
Customer deposits 36 2,565
Deferred revenues, net of costs 1,938 734
Other 2,065 1,361
-----------------------------------
Total current liabilities 19,214 9,992
Deferred taxes 503 486
Other liabilities 897 496
Stockholders' Equity
Preferred stock, par value $.02 per share,
authorized 5,000,000 shares; none
issued or outstanding
Common stock, par value $.02 per share,
authorized 15,000,000 shares;
issued, 7,369,682 shares at September 30, 1998
and 7,218,455 shares at December 31, 1997 147 144
Common stock Class A Convertible, par
value $.02 per share, authorized 3,000,000
shares; available for issuance 2,145,536 shares;
none issued or outstanding
Capital in excess of par value 35,499 35,025
Retained-earnings deficit (3,527) (4,369)
Foreign currency translation adjustments (401) (421)
-----------------------------------
31,718 30,379
Less cost of common stock in treasury,
413,500 shares 2,646 2,646
-----------------------------------
Total stockholders' equity 29,072 27,733
-----------------------------------
Total Liabilities and Stockholders' Equity $ 49,686 $ 38,707
===================================
See accompanying notes.
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
SCAN-OPTICS, INC., AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
Three Months Ended Nine Months Ended
September 30 September 30
(thousands, except share data) 1998 1997 1998 1997
- - -----------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Revenues
Net sales $ 6,261 $ 11,139 $ 20,286 $ 30,592
Service revenues 5,427 3,619 13,583 10,504
Other operating revenues 134 70 549 223
--------------------------- --------------------------
Total revenues 11,822 14,828 34,418 41,319
Costs and Expenses
Cost of sales 3,295 6,962 11,915 19,049
Service expenses 4,024 2,501 9,936 7,579
Sales and marketing expenses 1,567 1,783 4,481 5,083
Research and development expenses 1,239 1,242 3,759 3,340
General and administrative expenses 1,141 943 2,958 2,817
Interest expense 181 1 196 25
--------------------------- --------------------------
Total costs and expenses 11,447 13,432 33,245 37,893
--------------------------- --------------------------
Operating income 375 1,396 1,173 3,426
Other income (expense), net (5) 69 130 116
--------------------------- --------------------------
Income before income taxes 370 1,465 1,303 3,542
Income taxes 96 29 461 147
--------------------------- --------------------------
Net Income $ 274 $ 1,436 $ 842 $ 3,395
--------------------------- --------------------------
Basic earnings per share $ 0.04 $ 0.22 $ 0.12 $ 0.52
--------------------------- --------------------------
Basic weighted-average shares 6,957,811 6,605,816 6,908,993 6,580,972
Diluted earnings per share $ 0.04 $ 0.20 $ 0.12 $ 0.48
===========================
==========================
Diluted weighted-average shares 7,097,777 7,129,814 7,126,059 7,012,867
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
SCAN-OPTICS, INC., AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
Nine Months Ended
September 30
(thousands) 1998 1997
- - --------------------------------------------------------------------------------------
<S> <C> <C>
Operating Activities
Net income $ 842 $ 3,395
Adjustments to reconcile net income to net
cash provided (used) by operating activities:
Depreciation 945 912
Amortization 1,192 1,028
Amortization of goodwill 210
Provision for losses on accounts receivable 324
Provision for inventory obsolescence 600
Deferred taxes (388)
Changes in operating assets and liabilities:
Accounts receivable (2,424) (5,713)
Inventories 448 (300)
Prepaid expenses and other (331) 213
Accounts payable 2,324 1,138
Accrued salaries and wages (1,167) (326)
Taxes other than income taxes 123 11
Income taxes (489) 18
Deferred revenues, net of costs 574 928
Customer deposits (2,529) (1,155)
Other (464) 459
-------------------------------
Net cash provided (used) by operating activities (1,134) 1,532
Investing Activities
Business acquisitions (12,019)
Purchases of plant and equipment (342) (781)
-------------------------------
Net cash used by investing activities (12,361) (781)
Financing Activities
Proceeds from issuance of common stock 477 320
Proceeds from borrowings 14,658 6,652
Principal payments on borrowings (5,886) (6,750)
-------------------------------
Net cash provided by financing activities 9,249 222
Decrease in cash and cash equivalents (4,246) 973
Cash and Cash Equivalents at Beginning of Year 4,386 1,279
-------------------------------
Cash and Cash Equivalents at End of Period $ 140 $ 2,252
===============================
See accompanying notes.
</TABLE>
<PAGE>
NOTE 1 - Basis of Presentation
The accompanying unaudited consolidated financial statements have been prepared
in accordance with generally accepted accounting principles for interim
financial information and with the instructions to Form 10-Q and Article 10 of
Regulation S-X. Accordingly, they do not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, all adjustments
(consisting of normal recurring accruals) considered necessary for a fair
presentation have been included. Operating results for the three and nine
month periods ended September 30, 1998, are not necessarily indicative of the
results that may be expected for the year ending December 31, 1998. For
further information, refer to the consolidated financial statements and
footnotes thereto included in the Company's annual report on Form 10-K for the
year ended December 31, 1997.
Certain 1997 amounts have been reclassified to conform to current year
presentation.
NOTE 2 - Inventories
The components of inventories were as follows:
<TABLE>
<CAPTION>
September 30 December 31
(thousands) 1998 1997
- - ------------------------------------------------------------------------------
<S> <C> <C>
Finished goods $ 1,851 $ 2,586
Work-in-process 2,625 3,823
Service parts 3,276 3,807
Materials and component parts 3,155 2,331
------------------------------
$ 10,907 $ 12,547
==============================
</TABLE>
NOTE 3 - Acquisition Activities
The Company completed two acquisitions during the month of June 1998. The
first was Southern Computer Systems (SCS), a privately held company, for $7
million in cash. The Company acquired cash and accounts receivable net of
reserves of $.4 million, fixed assets net of accumulated depreciation of $.3
million and other assets of $.1 million. The Company also assumed certain
liabilities as follows: accounts payable of $.5 million, salary and benefits
accruals of $.2 million, deferred revenue of $.1 million, note payable to Scan-
Optics, Inc. of $.5 million, acquisition related expenses for investment banker
and legal services of $.4 million and bank debt of $1.4 million. Immediately
following the closing, the bank debt was repaid. The Company reported goodwill
related to the SCS transaction of $9.2 million. The proforma unaudited results
of operations for the nine months ended September 30, 1998 and for the year
ended December 31, 1997, assuming consummation of the purchase as of January 1,
1997, are as follows:
<TABLE>
<CAPTION>
September 30 December 31
(thousands) 1998 1997
- - ------------------------------------------------------------------------------
<S> <C> <C>
Total revenue $ 36,179 $ 63,076
Net income, (loss) (2,797) 4,680
Basic earnings, (loss) per share (.40) .71
Diluted earnings, (loss) per share (.40) .66
</TABLE>
During 1997 interim financial statements were not prepared for SCS.
The Company entered into consulting and non-competition agreements with the two
principals of SCS. The agreements call for 8 quarterly payments of $50,000 per
principal, beginning in the fourth quarter of 1998. The agreements provide for
consulting services to be performed by the principals as well as preventing the
principals from becoming directly involved with a competing business in the
Image Data Capture marketplace. The amount of the quarterly payments is being
amortized over a two-year period.
The second acquisition was the Maintenance Division of Access Corporation for
$3.2 million in cash. The Company acquired accounts receivable net of reserves
of $.5 million. The Company also assumed a liability for deferred revenue of
$.5 million and acquisition related expenses for investment banker and legal
services of $.2 million. The Company reported goodwill related to the Access
Corporation transaction of $3.4 million.
The Company determines the amount of goodwill and the amortization period based
upon a review of the acquired business and its earnings potential.
The excess of cost over net assets acquired (goodwill) related to the
acquisition of SCS is being amortized over 20 years. The goodwill related to
the acquisition of the Maintenance Division of Access Corporation is being
amortized over 5 years. The Company continually monitors its goodwill to
determine whether any impairment has occurred. In making such determination,
the Company evaluates the performance, on an undiscounted basis, of the
underlying assets which gave rise to such amounts.
NOTE 4 - Credit Arrangements
On May 28, 1998, the Company amended its credit agreement (Agreement) with a
bank to extend the maturity date to May 27, 1999, and to increase the line from
$4 million to $10 million. The Agreement contains covenants which, among other
things, require the maintenance of specified working capital, debt to equity
ratios, net income levels and tangible net worth levels. The line bears
interest at prime and the unused portion of the line is subject to a commitment
fee of 1/2 % per annum. The weighted average interest rates on borrowings
during the first nine months of 1998 and 1997 were 7.0% and 8.0% respectively.
The available balance on the total line of credit was $1,228,000 as of
September 30, 1998.
The Company further amended the Agreement with the bank effective November 6,
1998. The bank increased the line of credit from $10 million to $13 million
through February 28, 1999. The line of credit will be reset to the $10 million
borrowing level at March 1, 1999. Also, as part of the amendment, two
covenants were modified by the bank. All other terms and conditions remain
unchanged from the initial terms negotiated as part of the renewal on May 28,
1998.
NOTE 5 - Income Taxes
At September 30, 1998, the Company had approximately $400,000, $2,600,000 and
$800,000 of net operating loss carryforwards for Canadian, United Kingdom and
German income tax purposes, respectively. These carryforwards are scheduled to
expire periodically between 1998 and 2005. At December 31, 1997, the Company
had approximately $600,000, $2,500,000 and $700,000 of net operating loss
carryforwards for Canadian, United Kingdom and German income tax purposes,
respectively. For financial reporting purposes, a valuation allowance has been
recorded to offset a significant portion of the deferred tax assets related to
the foreign net operating loss carryforwards and other temporary differences.
This valuation allowance was reduced from a full reserve as the Company
utilized all of its domestic net operating loss carryforwards during 1997.
Significant components of the Company's deferred tax liabilities and assets
were as follows:
<TABLE>
<CAPTION>
September 30 December 31
(thousands) 1998 1997
- - ------------------------------------------------------------------------------
<S> <C> <C>
Deferred tax assets:
Net operating losses $ 1,447 $ 1,479
Depreciation 92 92
Inventory valuation 226 275
Deferred revenue 34 130
Accounts receivable reserves 30 36
Goodwill 30
Revenue recognition 893 347
Vacation accrual 262 193
Other 118 287
------------------------------
Total deferred tax assets 3,132 2,839
Deferred tax liabilities:
Depreciation and other (450) (486)
Inventory (54) (80)
Valuation allowance (1,688) (1,721)
------------------------------
Net deferred taxes $ 940 $ 552
==============================
</TABLE>
The deferred tax asset for deferred revenue relates to a multi-year service
contract recognized in the current year for tax purposes but amortized over the
contract life for accounting purposes. The deferred tax asset for revenue
recognition relates to systems in acceptance recognized in the current year for
tax purposes and recognized in the following year for accounting purposes.
NOTE 6 - Earnings Per Share
The following table sets forth the computation of basic and diluted earnings
per share:
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30 September 30
1998 1997 1998 1997
- - ---------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Numerator:
Net income $ 274 $ 1,436 $ 842 $ 3,395
=============================================
Denominator:
Denominator for basic earnings
per share (weighted-average shares) 6,957,811 6,605,816 6,908,993 6,580,972
Effect of dilutive securities:
Employee stock options 139,966 523,998 217,066 431,895
Denominator for diluted earnings
per share (adjusted weighted-average -----------------------------------------------
shares and assumed conversions) 7,097,777 7,129,814 7,126,059 7,012,867
===============================================
Basic earnings per share $ .04 $ .22 $ .12 $ .52
===============================================
Diluted earnings per share $ .04 $ .20 $ .12 $ .48
===============================================
</TABLE>
NOTE 7 - Year 2000 Compliance
The Company is currently evaluating its exposure to the Year 2000 problem. In
general terms, the problem arises from the fact that many existing computer
systems and other equipment containing date-sensitive embedded technology
(including non-information technology equipment and systems) use only two digits
to identify a year in the date field, with the assumption that the first two
digits of the year are always "19". As a result of this and other common
date-related programming errors (collectively, the "Year 2000 problem"), such
systems may misinterpret dates after December 31, 1999, which may result in
miscalculations, other malfunctions or the total failure of such systems.
Because the Company is dependent upon the proper functioning of computer systems
and other equipment containing date-sensitive technology, a failure of such
systems and equipment to be Year 2000 compliant could have a material adverse
effect on the Company. If not remedied, potential risks include business
interruption or shutdown, financial loss, regulatory actions and legal
liability.
The Company has established a Year 2000 task force comprised of senior
management and operating personnel to coordinate its Year 2000 efforts. This
task force is currently evaluating the Company's exposure to the Year 2000
problem and is preparing a formal plan for managing the risks and costs
associated therewith. The Company anticipates that a preliminary written plan
will be completed during the fourth quarter of this year.
The Company's general process of addressing the Year 2000 problem will consist
of the following steps: (a) inventorying products and services, systems,
equipment and other items (including those of third parties) that potentially
present a Year 2000 problem, (b) determining the materiality of such items to
the Company, (c) assessing the Year 2000 compliance of the material items
through internal testing and outside certification, (d) repairing, replacing or
preparing for the failure of material items that are determined to be
non-compliant, (e) testing repaired or replaced items, and (f) to the extent
advisable, designing and implementing contingency plans.
The Company is aware and has informed each of its customers for whom it has
current information that certain of its products, systems and applications
developed, produced or sold, to the extent they are date sensitive at all, may
not be Year 2000 compliant. Since the Company sells systems that are configured
to order, the Company also reminded its customers that it is the customers
responsibility to test the products, systems and applications purchased by them
to determine whether such items are Year 2000 compliant. The Company has
offered to its customers, where applicable, upgrades or consulting assistance at
the customer's cost. The Company has also posted information regarding the Year
2000 compliance of its products, systems and applications on its web site at
www.scanoptics.com.
In order to improve access to business information through common, integrated
computing systems, the Company is in the process of replacing its internal
corporate information system with systems that use programs primarily from SAP
America, Inc. The implementation of the new systems, which are expected to make
substantially all of the Company's internal corporate computer systems Year 2000
compliant, is 40% complete and is expected to be completed during the first
quarter of 1999. The vendors of all new systems have certified them as being
Year 2000 compliant. The Company, however, intends to perform independent Year
2000 testing of these systems, which is expected to be completed during the
first quarter of 1999.
The Company has completed its preliminary inventory of other systems, equipment
and items that potentially present a Year 2000 problem. The Company intends to
begin internal testing of material inventoried items, and expects to complete
such assessment by the end of the first quarter of 1999. While the Company will
not know the nature and extent of required repairs and replacements of
non-compliant systems and equipment until such assessment is completed, it
currently anticipates completing and testing such repairs and replacements by
June 1999.
In addition to its own systems and equipment, the Company depends upon the
proper function of computer systems and other date-sensitive equipment of
outside parties. These parties include banks, telecommunications service
providers and electric and other utilities and significant suppliers. The
Company has compiled a preliminary list of such parties. The Company has begun
to contact such parties to determine the extent to which they are vulnerable to
the Year 2000 problem, and expects to complete this process by the end of the
first quarter of 1999. The Company does not currently have sufficient
information about the Year 2000 exposure or remediation plans of such parties to
predict the risk they pose to the Company. If the third parties with which the
Company interacts have Year 2000 problems that are not remedied, resulting
problems could include the loss of telecommunications and electrical service,
the receipt of inaccurate financial and billing-related information, and the
disruption of capital flow potentially resulting in liquidity stress.
Due to the uncertainties presented by such third party Year 2000 problems, and
the possibility that, despite its efforts, the Company is unsuccessful in
preparing its internal systems and equipment for the Year 2000, the Company
intends to develop contingency plans for dealing with the most reasonably likely
worst case scenario. The exact nature and scope of the Company's contingency
plans will be based upon an analysis of information gathered during the
inventory, assessment and remediation phases of its Year 2000 program. The
Company expects to complete its contingency planning during the second quarter
of 1999, and to have all contingency systems in place and fully tested by the
fourth quarter of 1999.
The Company estimates that, as of September 30, 1998, its costs of addressing
the Year 2000 problem have been less than $100,000. The Company's best estimate
at this time, of the future costs of addressing the Year 2000 problem, is that
the costs will not exceed an additional $200,000. The Company has funded, and
expects to continue to fund, the costs of its Year 2000 efforts through
operating cash flow, and to expense such costs as incurred.
This description of matters relating to the Year 2000 problem contains a number
of forward-looking statements. See the Outlook section of Management's
Discussion and Analysis. The Company's assessment of the costs of its Year 2000
program and the timetable for completing its Year 2000 preparations are based on
current estimates, which reflect numerous assumptions about future events,
including the continued availability of certain resources, the timing and
effectiveness of third-party remediation plans and other factors. The Company
can give no assurance that these estimates will be achieved, and actual results
could differ materially from those currently anticipated. In addition, there
can be no assurance that the Company's Year 2000 program will be effective or
that its contingency plans will be sufficient. Specific factors that might
cause material differences include, but are not limited to, the availability and
cost of personnel trained in this area, the ability to locate and correct
relevant computer software codes and embedded technology, the results of
internal and external testing and the timeliness and effectiveness of
remediation efforts of third parties.
NOTE 8 - Comprehensive Income
As of January 1, 1998, the Company adopted Financial Accounting Standards Board
Statement 130, REPORTING COMPREHENSIVE INCOME. Statement 130 establishes new
rules for the reporting and display of comprehensive income and its components;
however, the adoption of this Statement had no impact on the Company's net
income or shareholders' equity. Statement 130 requires the Company's foreign
currency translation adjustments, which were reported separately in
shareholders' equity prior to adoption, to be included in other comprehensive
income.
The components of comprehensive income, net of related tax, are as follows:
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30 September 30
1998 1997 1998 1997
- - --------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Net income $ 274 $ 1,465 $ 842 $ 3,395
Foreign currency translation
adjustments (16) (38) 8 (59)
----------------------------------------------
Comprehensive income $ 258 $ 1,427 $ 850 $ 3,336
==============================================
</TABLE>
The components of accumulated comprehensive income, net of related tax, at
September 30, 1998 and December 31, 1997 are as follows:
<TABLE>
<CAPTION>
September 30 December 31
(thousands) 1998 1997
- - --------------------------------------------------------------------------------
<S> <C> <C>
Foreign currency translation adjustments $ (396) $ (404)
--------------------------------
Accumulated comprehensive income $ (396) $ (404)
================================
</TABLE>
NOTE 9 - Segment Reporting
In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 131, DISCLOSURES ABOUT SEGMENTS OF AN
ENTERPRISE AND RELATED INFORMATION, which is effective for years beginning
after December 15, 1997. Statement 131 establishes standards for the way that
public business enterprises report information about operating segments in
annual financial statements and requires that those enterprises report selected
information about operating segments in interim financial reports. It also
establishes standards for related disclosures about products and services,
geographic areas, and major customers. Statement 131 is effective for
financial statements for fiscal years beginning after December 15, 1997, and
therefore the Company will adopt the new requirements retroactively in 1998.
Management has not completed its review of Statement 131, but does not
anticipate that the adoption of this statement will have a significant effect
on the Company's reported segments.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF CONSOLIDATED FINANCIAL
CONDITION AND
RESULTS OF OPERATIONS
RESULTS OF OPERATIONS FOR THE THREE MONTHS AND NINE MONTHS ENDED
SEPTEMBER 30,
1998 VS. 1997
Outlook
The forward-looking statements contained in this Outlook and elsewhere in this
document are based on current expectations. As such, actual results may differ
materially. The ability for Scan-Optics, (the "Company") to achieve the
following expectations could be impacted by increased competition or a slowdown
in growth within the scanning and imaging market, alternate forms of processing,
inability to consummate accretive acquisitions and changes in the economic
climates of foreign markets as well as that of the United States. The foregoing
factors should not be construed as exhaustive.
In 1997, the Company derived 39% of its total revenue from one customer, Toyo
Officemation, Inc., one of the Company's distributors in Japan. Health claims
processing systems represented 90% of this revenue. The Company completed the
order received in the fourth quarter of 1997 for 10 high-volume scanning
systems for this customer in the first quarter of 1998. This order brings the
total health claims processing systems ordered and delivered to date to 95.
The Company's practice is to disclose the number of systems to be delivered
upon receipt of a purchase order. The Company's expectation was for 150
systems to be delivered over a period of time. The efficiencies created by the
application of the Company's technology will reduce the overall requirements
for this implementation. The Japanese health organization, the end user of
these systems is currently evaluating its system requirements going forward.
The Company believes that with the continued pressures on the Yen and the
objective to reduce the cost of medical fee processing in Japan, the user is
faced with a challenge to continue to improve its efficiency. The Company
expects to receive the results from this internal study by the end of 1998.
The Company believes that success in achieving the initiatives described below
will help offset the significant reduction of $14.5 million in sales from this
customer for 1998 as compared to 1997. The inability of the Company to achieve
these initiatives may have a materially adverse effect on earnings.
Five major initiatives currently underway are expected to help compensate for
this anticipated decline in revenues. The first initiative is in the
healthcare industry, combining the Company's ImageEMC++ system with its high
performance image capture transports, to process HCFA Medicare claim forms as
well as other types of medical claim forms. The Company has focused on and
experienced early success with this vertical line of business and believes it
provides an opportunity for growth. This initiative has not performed up to
expectations in 1998, however, the level of prospect activity is high and the
Company believes that this segment of the Image Data Capture market will
provide continued sales opportunities and growth in the future.
The second initiative consists of the Company's development of target market
data capture applications that, combined with its other high speed transports
and archival systems, will provide cost effective solutions. The current focus
is on the healthcare/insurance, government/tax, transportation, and order entry
markets. The Company expects to continue to emphasize its "Solutions at Work"
focus on these targeted markets for the foreseeable future. As other market
opportunities emerge, the Company will evaluate the potential of using its
products and services to provide "Solutions at Work" in new markets. The
Company is pleased with the results of this initiative in 1998. The Company's
solution business has increased by $3.3 million or 27% for the first nine
months of 1998 compared to the first nine months of 1997. The government/tax
line of business has provided the largest increase in activity with $12.1
million in orders announced since June of 1998.
The third initiative is further expansion into the international marketplace.
The Company has successfully supplied product to the Japanese market and has
historically experienced strong sales activity through relationships with
highly qualified and productive distributors. During the last three years,
sales to Japanese distributors have averaged 40% of total revenues. Over the
next two years, the Company will focus on developing comparably strong
relationships in Europe, Latin America and other Pacific Rim countries.
During 1998, the Company has had minimal achievements with this initiative.
The Asian marketplace, most notably Japan, has been a significant
disappointment to the Company during 1998. The economic environment in the
Pacific Rim and Latin America has been an impediment to growth in these
markets. The Company has been strengthening its relationships in Europe,
demonstrated by three sales to a distributor in England and the active pursuit
of sales of the Series 7400 with 4 Value Added Resellers in Europe.
The fourth initiative relates to leveraging the Company's core competencies in
an effort to add revenues and profits. The Company believes that its hardware
maintenance service, manufacturing and custom engineering organizations have
potential to sell their individual expertise, experience and cost effectiveness
to other entities. The Company has been effective in leveraging all three of
these core competencies. During the first quarter of 1998, the Company
executed its first contract manufacturing relationship under an agreement to
manufacture secured access systems for RAPOR, Inc. The Company also received
an order in October 1998, to manufacture 100 RAPOR security doors, valued at
over $2 million. The Company has also expanded its service base of Original
Equipment Manufacturers (OEMs) and Distributors by adding 1 new partner and 427
sites where it will provide on-site warranty and remedial maintenance. The
Company has also utilized its engineering resources to develop the production
model of the RAPOR Fastrac security door and to provide specific enhancements
to the Series 9000 for a custom application in the United States.
The last initiative is growth through an accretive acquisition(s). In the
fourth quarter of 1997, the Company engaged the services of an investment
banking firm to assist in a corporate growth strategy that is focused on the
consolidation occurring in the imaging and data capture market. The imaging
industry is made up of many smaller companies and management believes achieving
greater critical mass will increase the likelihood of growth in the adoption of
this technology. With that in mind, the Company is pursuing acquisitions that
will utilize its core competencies and will provide immediately accretive
earnings. It is the Company's policy not to discuss or comment on negotiations
regarding such transactions until a definitive agreement is signed or after
circumstances indicate a high degree of probability that a transaction will be
consummated, unless the law otherwise requires.
The Company completed two acquisitions during the month of June 1998, which
were immediately accretive. The first was Southern Computer Systems (SCS), a
privately held company, for $7 million in cash. The Company acquired cash and
accounts receivable net of reserves of $.4 million, fixed assets net of
accumulated depreciation of $.3 million and other assets of $.1 million. The
Company also assumed certain liabilities as follows: accounts payable of $.5
million, salary and benefits accruals of $.2 million, deferred revenue of $.1
million, note payable to Scan-Optics, Inc. of $.5 million, acquisition related
expenses for investment banker and legal services of $.4 million and bank debt
of $1.4 million. Immediately following the closing, the bank debt was repaid.
The Company reported goodwill related to the SCS transaction of $9.2 million.
SCS develops, markets and supports a portfolio of data entry and document
automation software products that enable customers to realize high quality
data, image capture, and character recognition for high speed document
recognition and data entry applications. These products are designed to
create, verify, validate and export documents such as invoices, bills of
lading, credit card applications and order forms. SCS also provides document
automation consulting, network and application integration services. SCS
markets and sells its products and services to its 2,700 customers in the
transportation, financial services, health care and state and federal
government markets. SCS currently has approximately 50 employees. The Company
intends to keep SCS at its present location in Birmingham, Alabama.
The second acquisition was the Maintenance Division of Access Corporation for
$3.2 million in cash. The Company acquired accounts receivable net of reserves
of $.5 million. The Company also assumed a liability for deferred revenue of
$.5 million and acquisition related expenses for investment banker and legal
services of $.2 million. The Company reported goodwill related to the Access
Corporation transaction of $3.4 million. The Maintenance Division has
contracts with Original Equipment Manufacturers (OEMs) and Distributors to
supply on-site warranty and remedial maintenance for more than 1,000 customers.
Net sales in the first nine months of 1998 decreased $10.3 million or 34%
compared with the first nine months of 1997 and $4.9 million or 44% for the
third quarter of 1998 compared to the third quarter of 1997. Compared to the
first nine months of 1997, international sales decreased $13 million while
North American sales increased $2.7 million. International sales for the third
quarter of 1998 decreased $6.3 million compared to 1997. This decrease was
comprised of a reduction in sales to the Japanese health organization of $6.9
million, offset by an increase in other international sales of $.6 million.
North American sales for the quarter increased $1.4 million to $5.2 million
compared to $3.9 million in the third quarter of 1997 due to the Company's
success in efforts to emphasize its "Solutions at Work" focus on the targeted
markets.
Service revenues increased $3.1 million in the first nine months of 1998
compared with the first nine months of 1997. Service revenues in the third
quarter of 1998 increased $1.8 million from the third quarter of 1997. Customer
service revenue in the first nine months of 1998 increased $.4 million due to a
$.7 million increase directly related to the Company's acquisition of the
Maintenance Division of Access Corporation, offset by a $.3 million reduction
related to the continued transition of older products on maintenance
surcharges. Year-to-date professional services revenue increased $2.8 million
due to the continued focus on the solutions business in the targeted markets
and the acquisition of SCS.
Cost of sales decreased $7.1 million from the first nine months of 1997 and
decreased $3.7 million from the third quarter of 1997. The year-to-date and
third quarter decreases are a reflection of the completion of the Japanese
Health Organization order during the first quarter of 1998. Cost of sales as a
percentage of net sales was 59% for the first nine months of 1998, compared to
62% in the prior year. This percentage for the third quarter of 1998 was 53%,
compared to 63% for the same period in 1997. The decreases are due to a change
in the overall sales mix.
Service expenses increased $2.4 million in the first nine months of 1998 and
increased $1.5 million in the third quarter of 1998 compared with 1997.
Customer service expenses increased $1.5 million in the first nine months of
1998 and $.9 million in the third quarter of 1998 due to product support costs
for SCS, ISO9001 certification costs and the normal operating expenses related
to the increase in revenue garnered by the acquisition of the Maintenance
Division of Access Corporation. Professional service expenses increased $.8
million in the first nine months of 1998 and increased $.6 million in the third
quarter mainly due to professional services expenses at Southern Computer
Systems.
Sales and marketing expenses decreased $.6 million in the first nine months of
1998 primarily due to a specific accounts receivable reserve recorded in 1997
and a decrease in commission expense directly attributable to the decrease in
net sales. Expenses for the third quarter decreased $.2 million from 1997 to
1998, mainly due to decreases in commissions.
Research and development expenses in 1998 increased $.4 million from the first
nine months of 1997 and in the third quarter of 1998 remained consistent with
the third quarter of 1997. The year to date increases are mainly due to
increases in consulting expenses related to the Company's Image EMC++ product
line and the acquisition of the product development organization of SCS.
General and administrative expenses increased $.1 million in the first nine
months of 1998 compared to the first nine months of 1997 and $.2 million in the
third quarter. These increases were due to the amortization of goodwill.
LIQUIDITY AND CAPITAL RESOURCES
Cash and cash equivalents at September 30, 1998 decreased $4.2 million from
December 31, 1997, for the reasons discussed below.
Borrowings increased to $8.8 million at September 30, 1998 from a zero balance
at the end of 1997. The borrowings were due to acquisition related activities,
as discussed in Note 3. On May 28, 1998, the Company amended its loan
agreement extending the maturity date to May 27, 1999 and increasing the line
of credit from $4 million to $10 million. On November 6, 1998, the Company
amended its loan agreement increasing the line of credit from $10 million to
$13 million through February 28, 1999. (See Note 4 for further details.) The
available balance on the line of credit was $3.1 million at November 10, 1998.
Operating activities used $.3 million of cash in the first nine months of 1998.
Non-cash expenses recorded during the first nine months of 1998 were $1.9
million vs. $2.9 million for the same period in 1997. These expenses relate to
depreciation of fixed assets (discussed in net plant and equipment below),
amortization of customer service spare parts inventory, provisions for losses
on accounts receivable, provisions for inventory obsolescence, amortization of
goodwill and deferred taxes.
Net accounts receivable increased $3.3 million during the first nine months of
the year. This increase of $.6 million is partially due to the timing of
collections. The collection of receivables has been slowing as a result of the
transition from a product based supplier which traditionally has quicker
payment time frames and experience to a more complete solutions provider which
typically has extended payment terms and a slower payment history. The Company
is addressing this issue with more pre-sales communications and contract
language that better fits the solutions business, in order to set a proper
level of expectations with its customers. The remaining increase of $2.7
million is due to the increased level of systems that are undergoing acceptance
testing at customer sites.
Inventories decreased $1.6 million in the first nine months of 1998. Total
manufacturing inventories decreased $1.1 million from the beginning of the year
mainly due to a $1.2 million decrease in work-in-process inventory and a $.7
million decrease in finished goods inventory, offset by a $.8 million increase
in raw materials. These overall decreases reflect the Company's focus on
reducing inventory levels and improving just-in-time purchases, as well as the
completion of several system orders including the Japanese health organization
order. Customer service inventories decreased by $.5 million in the first nine
months of the year mainly due to the amortization of parts inventory.
Prepaid expenses and other current assets increased $.3 million primarily due
to increases in prepaid costs related to the consulting and noncompetition
agreements for the principals of SCS, which was acquired on June 16, 1998, as
discussed in the June 30, 1998 Form 8-K.
Net plant and equipment decreased $.3 million during the first nine months of
1998. Additions of $.6 million for purchases related to the implementation of
the Enterprise Resource Planning system, the SCS acquisition, and leasehold
improvements were offset by $.9 million of depreciation expense recorded during
the first nine months of the year.
Goodwill of $12.6 million was recorded during the second quarter of 1998, due
to the acquisitions of SCS and the Maintenance Division of Access Corporation.
Amortization of goodwill of $.2 million was recorded during the third quarter.
Accounts payable increased $2.8 million from December 31, 1997, due to the
timing of payments and an increase in third-party purchases for solutions sales
currently undergoing the implementation process.
Accrued salaries and wages decreased $.9 million reflecting the disbursement of
the 1997 incentive compensation of $1.1 million, offset by the current year's
accruals for incentive compensation and vacation.
Taxes other than income taxes decreased $.3 million from December 31, 1997
mainly due to decreases in sales and use tax accruals on decreased revenue.
Income taxes decreased $.5 million due to payment of the 1997 estimated income
tax liability and quarterly payments made for estimated 1998 tax liability.
Customer deposits decreased $2.5 million mainly due to the acceptance of the
Japanese Health Organization claims processing systems, recognized in revenue
during the first quarter of 1998, which had included substantial deposits.
Deferred revenues, net of costs, increased $1.2 million from December 31, 1997,
due to systems awaiting customer acceptance.
Other accrued expenses increased $.7 million primarily due to accrued expenses
related to the acquisition activity.
<PAGE>
SCAN-OPTICS, INC., AND SUBSIDIARIES
PART II - OTHER INFORMATION
ITEM 6 - EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
10.5(a) Amendment adopted September 21, 1998 to Scan-Optics, Inc. Amended
1990 Stock Option Plan for Outside Directors
(b) Reports on Form 8-K.
None
<PAGE>
EXHIBIT 10.5(a)
AMENDMENT
RESOLVED: That Section 7(b) of the Scan-Optics, Inc. Amended 1990 Stock Option
Plan for Outside Directors is hereby amended to read as follows:
7. GRANT OF OPTIONS AND OPTION PRICE
(b) FUTURE PARTICIPANTS. Directors who are newly elected to the Board at an
annual meeting of the stockholders shall receive an automatic grant of an
Option to purchase 5,000 Shares on the first anniversary of the date of such
election; provided, that such automatic grant shall only be made if the
director is a Participant on such date, and the number of Shares subject to
future grant under the Plan is sufficient to make the automatic grants
required to be made pursuant to the Plan on such date. Directors who are
newly elected to the Board other than at an annual meeting of the
stockholders shall receive on the next anniversary of the Effective Date
subsequent to such election an automatic grant of an Option to purchase the
number of Shares equal to the product of (i) 5,000 multiplied by (ii) a
fraction, the numerator of which is the number of days in the period which
starts on the date of such election and ends on the date of such next
anniversary and the denominator of which is 365; provided, that such
automatic grant shall be made only if the director is a Participant on such
date, and the number of Shares subject to future grant under the Plan is
sufficient to make the automatic grants required to be made pursuant to the
Plan on such date.
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
SCAN-OPTICS, INC.
(Registrant)
Date November 13, 1998 JAMES C. MAVEL
----------------- ------------------------------------
James C. Mavel
Chairman, President, Chief Executive
Officer and Director
Date November 13, 1998 MICHAEL J. VILLANO
----------------- -------------------------------------
Michael J. Villano
Chief Financial Officer,
Vice President and Treasurer
<PAGE>
<TABLE> <S> <C>
<ARTICLE> 5
<CAPTION>
EXHIBIT 27.
SCAN-OPTICS, INC.
FINANCIAL DATA SCHEDULE
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> SEP-30-1998
<CASH> 140,000
<SECURITIES> 0
<RECEIVABLES> 18,984,000
<ALLOWANCES> 580,000
<INVENTORY> 10,907,000
<CURRENT-ASSETS> 32,787,000
<PP&E> 19,529,000
<DEPRECIATION> 15,932,000
<TOTAL-ASSETS> 49,686,000
<CURRENT-LIABILITIES> 19,214,000
<BONDS> 0
<COMMON> 147,000
0
0
<OTHER-SE> 29,072,000
<TOTAL-LIABILITY-AND-EQUITY> 49,686,000
<SALES> 20,286,000
<TOTAL-REVENUES> 34,418,000
<CGS> 11,915,000
<TOTAL-COSTS> 33,245,000
<OTHER-EXPENSES> (130,000)
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 196,000
<INCOME-PRETAX> 1,303,000
<INCOME-TAX> 461,000
<INCOME-CONTINUING> 842,000
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 842,000
<EPS-PRIMARY> .12
<EPS-DILUTED> .12
</TABLE>
