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 March 31, 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 Identification Number)
incorporation or organization)
169 Progress Drive, Manchester, CT 06040
- ---------------------------------- --------------------------------------
(Address of principal executive Zip Code
offices)
(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 May 11,
1998 was 7,368,349.
<TABLE>
<CAPTION>
SCAN-OPTICS, INC., AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(thousands, except share data) March 31, 1998 December 31, 1997
(UNAUDITED)
- ------------------------------ -------------- -----------------
<S> <C> <C>
Assets
Current Assets:
Cash and cash equivalents $ 4,947 $ 4,386
Accounts receivable less allowance of
$104 at March 31, 1998 and $104 at
December 31, 1997 13,802 15,695
Inventories 9,769 12,547
Deferred taxes 820 1,038
Prepaid expenses and other 651 969
----------------------------------
Total current assets 29,989 34,635
Plant and equipment:
Equipment 13,205 13,355
Leasehold improvements 4,563 4,585
Office furniture and fixtures 1,267 1,275
----------------------------------
19,035 19,215
Less allowances for depreciation
and amortization 15,316 15,355
----------------------------------
3,719 3,860
Other assets 212 212
----------------------------------
Total Assets $ 33,920 $ 38,707
==================================
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
(thousands, except share data) March 31, 1998 December 31, 1997
(UNAUDITED)
- ------------------------------ -------------- -----------------
<S> <C> <C>
Liabilities and Stockholders' Equity
Current Liabilities:
Accounts payable $ 1,293 $ 2,071
Salaries and wages 938 1,984
Taxes other than income taxes 370 744
Income taxes 234 942
Customer deposits 291 2,565
Deferred revenues, net of costs 647 734
Other 878 952
-------------------------------
Total current liabilities 4,651 9,992
Deferred taxes 510 486
Other liabilities 497 496
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, 7,236,789 shares at March 31, 1998
and 7,218,455 shares at December 31, 1997 145 144
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 35,088 35,025
Retained-earnings deficit (3,941) (4,369)
Foreign currency translation adjustments (384) (421)
--------------------------------
30,908 30,379
Less cost of common stock in treasury,
413,500 shares 2,646 2,646
--------------------------------
Total stockholders' equity 28,262 27,733
--------------------------------
Total Liabilities and Stockholders' Equity $ 33,920 $ 38,707
================================
See accompanying notes.
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
SCAN-OPTICS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
Three Months Ended
March 31
(thousands, except share data) 1998 1997
- --------------------------------------------------------------------------------
<S> <C> <C>
Revenues
Net sales $ 8,538 $ 9,068
Service revenues 4,256 3,329
Engineering revenues 67 16
Other operating revenues 31 17
---------------------------
Total revenues 12,892 12,430
Costs and Expenses
Cost of sales 5,740 5,506
Service expenses 2,725 2,556
Sales and marketing expenses 1,609 1,616
Research and development expenses 1,231 1,173
General and administrative expenses 944 907
Interest expense 22
---------------------------
Total costs and expenses 12,249 11,780
---------------------------
Operating income 643 650
Other income, net 61 25
---------------------------
Income before income taxes 704 675
Income taxes 276 57
---------------------------
Net Income $ 428 $ 618
===========================
Basic earnings per share $ .06 $ .09
===========================
Basic weighted-average shares 6,812,689 6,560,754
Diluted earnings per share $ .06 $ .09
===========================
Diluted weighted-average shares 7,149,461 6,967,757
See accompanying notes.
</TABLE>
<PAGE>
SCAN-OPTICS, INC., AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
Three Months Ended
March 31
(thousands) 1998 1997
- --------------------------------------------------------------------------------
[S] [C] [C]
Operating Activities
Net income $ 428 $ 618
Adjustments to reconcile net income to net
cash provided (used) by operating activities:
Depreciation 298 300
Amortization 402 337
Provision for losses on accounts receivable 327
Provision for inventory obsolescence 350
Deferred taxes 242
Changes in operating assets and liabilities:
Accounts receivable 1,893 118
Inventories 2,376 (113)
Prepaid expenses and other 318 (143)
Accounts payable (778) (266)
Accrued salaries and wages (1,046) (877)
Taxes other than income taxes (374) (231)
Income taxes (708) (42)
Deferred revenues, net of costs (87)
Customer deposits (2,274) (885)
Other (36) (230)
----------------------------
Net cash provided (used) by operating
activities 654 (737)
Investing Activities
Purchases of plant and equipment (157) (242)
----------------------------
Net cash used by investing activities (157) (242)
Financing Activities
Proceeds from issuance of common stock 64 142
Proceeds from borrowings 4,369
Principal payments on borrowings (4,467)
----------------------------
Net cash provided by financing activities 64 44
Increase (Decrease) in cash and cash equivalents 561 (935)
Cash and Cash Equivalents at Beginning of Year 4,386 1,279
----------------------------
Cash and Cash Equivalents at End of Period $ 4,947 $ 344
============================
See accompanying notes.
<PAGE>
SCAN-OPTICS, INC., AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
For Quarter Ended March 31, 1998
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 month period
ended March 31, 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>
March 31 December 31
(THOUSANDS) 1998 1997
- ------------------------------------------------------------------
<S> <C> <C>
Finished goods $ 1,413 $ 2,586
Work-in-process 2,639 3,823
Service parts 3,524 3,807
Materials and component parts 2,193 2,331
-------- -------
$ 9,769 $ 12,547
======== =======
</TABLE>
NOTE 3 - Credit Arrangements
The Company has a line of credit agreement (the "Agreement") with a bank which
expires on May 28, 1998. The Agreement has two components, a $2 million line
(international) guaranteed by the Export-Import Bank of the United States,
which is collateralized by international accounts receivable and inventory, and
which bears interest at prime (8 1/4 % at March 31, 1998); and a $2 million
line (domestic) which is collateralized by domestic accounts receivable and
inventory, and which also bears interest at prime (8 1/4 % at March 31, 1998).
There were no borrowings during the first quarter of 1998, and during the first
quarter of 1997, the weighted average interest rate on borrowings was 8.7%. The
unused portion of the $2 million domestic line is subject to a commitment fee
of 1/2 % per annum. Borrowings under the Agreement are subject to various
limitations based upon percentages of eligible receivables and inventories of
the Company. In addition, 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 available balance
on the total line of credit was $4 million as of March 31, 1998.
The Company expects to receive a commitment letter from the bank extending the
maturity date of the outstanding line of credit to May 27, 1999, based on the
same limitations and covenants in the current Agreement. The commitment letter
is subject to the extension of the guarantee by the third party bank on the
international line. The Company expects that the guarantee will be extended.
NOTE 4 - Income Taxes
At March 31, 1998, the Company has approximately $3,900,000 of net operating
loss carryforwards for foreign income tax purposes which are scheduled to
expire periodically between 1998 and 2005. At March 31, 1997, the Company had
approximately $5,000,000, $4,100,000 and $2,600,000 of net operating loss
carryforwards for federal, state and foreign income tax purposes, respectively.
The net operating loss carryforwards for federal and state purposes were
utilized during 1997. For financial reporting purposes, a valuation allowance
has been recorded for the first quarter of 1998 to offset a significant portion
of the deferred tax assets related to the foreign net operating loss
carryforwards and other temporary differences. In 1997, the valuation
allowance was recorded to offset all of the deferred tax assets related to the
carryforwards and other temporary differences.
Significant components of the Company's deferred tax liabilities and assets
were as follows :
<TABLE>
<CAPTION>
March 31 December 31
(THOUSANDS) 1998 1997
- --------------------------------------------------------------------------
<S> <C> <C>
Deferred tax assets:
Net operating losses $ 1,520 $ 1,479
Depreciation 92 92
Inventory valuation 290 275
Deferred revenue 103 130
Accounts receivable reserves 38 36
Revenue recognition 261 347
Vacation accrual 232 193
Other 150 287
-------- -------
Total deferred tax assets 2,686 2,839
Deferred tax liabilities:
Depreciation and other (516) (486)
Inventory (74) (80)
-------- -------
Total deferred tax liabilities (590) (566)
Valuation allowance (1,786) (1,721)
-------- -------
Net deferred taxes $ 310 $ 552
======== =======
</TABLE>
NOTE 5 - Earnings Per Share
The following table sets forth the computation of basic and diluted earnings
per share:
<TABLE>
<CAPTION>
March 31 March 31
1998 1997
- ------------------------------------------------------------------------
<S> <C> <C>
Numerator:
Net income $ 428 $ 618
========= =========
Denominator:
Denominator for basic earnings
per share (weighted-average shares) 6,812,689 6,560,754
Effect of dilutive securities:
Employee stock options 336,772 407,003
Denominator for diluted earnings
per share (adjusted weighted-average --------- ---------
shares and assumed conversions) 7,149,461 6,967,757
========= =========
Basic earnings per share $ .06 $ .09
========= =========
Diluted earnings per share $ .06 $ .09
========= =========
NOTE 6 - Year 2000 Compliance
The Company has addressed the Year 2000 compliance issues with its products.
All current standard operating systems are in the process of modification to
ensure Year 2000 compliance. Application software will be changed at the
request of the individual customer on a chargeable basis. Customers of non-
current products will be notified that the Company does not plan to modify the
operating systems to achieve Year 2000 compliance.
The Company is in the early stages of implementing a fully compliant Enterprise
Resource Planning system as a replacement for the current manufacturing and
financial reporting system. This implementation is scheduled to be completed
by the second quarter of 1999 and will eliminate the potential information
technology internal risks associated with the Year 2000 compliance. A team of
individuals is analyzing other potential areas of risk associated with Year
2000 compliance. The costs and effects of these areas are unknown by the
Company at this time but are not expected to be material.
NOTE 7 - 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, for the three-
months ended March 31, 1998 and 1997 are as follows:
</TABLE>
<TABLE>
<CAPTION>
March 31 March 31
(THOUSANDS) 1998 1997
- -----------------------------------------------------------------------
<S> <C> <C>
Net income $ 428 $ 618
Foreign currency translation adjustments 22 (51)
-------- --------
Comprehensive income $ 450 $ 567
======== ========
</TABLE>
The components of accumulated comprehensive income, net of related tax, at
March 31, 1998 and December 31, 1997 are as follows:
<TABLE>
<CAPTION>
March 31 December 31
(THOUSANDS) 1998 1997
- -------------------------------------------------------------------------
<S> <C> <C>
Foreign currency translation adjustments $ (382) $ (404)
-------- --------
Accumulated comprehensive income $ (382) $ (404)
======== ========
</TABLE>
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF CONSOLIDATED FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED MARCH 31, 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 its
order of ten high-volume scanning systems for this customer in the first
quarter of 1998. This order brings the total health claims processing systems
ordered on this contract to ninety-five. The Company's original expectation
was for one hundred and fifty systems to be delivered over the contract life.
The efficiencies created by the application of the Company's technology will
reduce the overall requirements for this contract. This customer 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 customer is faced with a challenge to
continue to improve its efficiency. The Company expects to receive the
results from this internal study in the second half of 1998. The Company
believes that success in achieving the initiatives described below will help
offset a foreseen significant reduction in sales from this customer for the
balance of 1998 as compared to 1997. The inability of the Company to meet 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 has
experienced success with this vertical line of business and believes it
provides an opportunity for growth.
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 these new markets.
The third initiative is further expansion into the international marketplace.
The Company has successfully supplied product to the Japanese market and has
experienced strong sales activity through relationships with highly qualified
and productive distributors. Over the next two years, the Company will focus
on developing comparably strong relationships in Europe, Latin America and
other Pacific Rim countries.
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
service, manufacturing and custom engineering organizations have potential to
sell their individual expertise, experience and cost effectiveness to other
entities. During the first quarter of 1998, the Company achieved favorable
results from this initiative by executing its first contract manufacturing
relationship under an agreement to manufacture secured access systems for
RAPOR, and through an agreement with Docutronix, Inc., that leverages the
services of the Company's field service personnel.
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.
Total revenues increased $.5 million or 4% from the first quarter of 1997 to
the first quarter of 1998.
Net sales decreased $.5 million or 6% in the first quarter of 1998 compared
with the first quarter of 1997. International sales increased $.4 million or 7%
due to an increase in the number of systems sold to the Japanese health agency.
North American sales decreased $.9 million or 34% for the same period due to
delay of a contract which the Company expects to receive in the second quarter
of 1998.
Service revenues increased $.9 million compared to the same period in 1997.
Hardware maintenance and support revenue decreased $.2 million mainly due to
the replacement of older product lines with current products which require less
maintenance than the earlier product lines. Professional services revenue
increased $1.1 million or 235% reflecting the Company's growth in the solutions
marketplace.
Cost of sales increased $.2 million from the first quarter of 1997. Cost of
sales as a percentage of net sales was 67% for the first quarter of 1998,
compared to 61% in the prior year. These increases are due to a change in the
overall sales mix.
Service expenses increased $.2 million in the first quarter of 1998 compared
with the respective period of 1997. Professional service expenses increased
$.2 million mainly due to increases in headcount and travel related expenses.
This increase indicates the Company's continued focus on growth in the
solutions marketplace.
Research and development expenses increased $.1 million from the first quarter
of 1997 to the first quarter of 1998 mainly due to consulting expenses required
to augment staff levels for short term projects near completion.
LIQUIDITY AND CAPITAL RESOURCES
Cash and cash equivalents at March 31, 1998 increased $.6 million from
December 31, 1997.
As of March 31, 1998, the Company had no borrowings outstanding against its $4
million line of credit. The Company expects to receive a commitment letter from
the bank extending the maturity date of the bank line of credit to May 27,
1999. The line of credit of $4 million ($2 million each for the international
and domestic lines) is reflective of the Company's current cash availability
and projected cash flow requirements for the next twelve months. Management
believes that the line of credit provides the Company with sufficient financial
resources to meet its working capital requirements. (See Note 3 for further
details.)
Operating activities provided $.7 million of cash in the first three months of
1998.
Non-cash expenses recorded during the quarter were $.9 million vs. $1.3 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 and deferred taxes.
Net accounts receivable decreased $1.9 million during the first quarter of the
year due to collections on 1997 sales.
Total inventories decreased $2.8 million in the first quarter of 1998. Total
manufacturing inventories decreased $2.5 million from the beginning of the year
due to reductions in raw materials of $.1 million, reductions in work-in-
process inventory of $1.2 million as well as decreases in finished goods
inventory of $1.2 million due to the completion and delivery of several system
orders in the first quarter of 1998 and the Company's focus on reducing
inventory levels. Customer service inventories decreased by $.3 million in the
first quarter mainly due to the amortization of parts inventory.
Deferred taxes decreased $.2 million during the first quarter due to the tax
timing differences generated from first quarter activity. (See Note 4 for
further details.)
Prepaid expenses and other decreased by $.3 million during the first three
months of the year mainly due to the amortization of prepaid engineering costs.
Net plant and equipment decreased $.1 million during the first quarter of 1998
mainly due to $.3 million of depreciation expense recorded during the first
three months of the year. The depreciation expense was offset by additions of
$.2 million for the capitalization of leasehold improvements related to the
renovation of facilities in Manchester, Connecticut, and for upgrades of
internal network computers.
Accounts payable decreased $.8 million from December 31, 1997 due to
improvements in the just-in-time inventory procurement process.
Accrued salaries and wages decreased $1 million during the first quarter of
1998 reflecting the disbursement of the 1997 incentive compensation of $.9
million.
Taxes other than income taxes decreased $.4 million due to the remittance of
sales tax incurred on fourth quarter 1997 sales.
Income taxes decreased $.7 million due to the payment of 1997 estimated income
tax liability.
Customer deposits decreased $2.3 million from December 31, 1997, mainly due to
the acceptance of the Japanese health claims processing systems, recognized in
revenue during the first quarter of 1998, which had included substantial
deposits.
<PAGE>
SCAN-OPTICS, INC., AND SUBSIDIARIES
PART II - OTHER INFORMATION
ITEM 6 (B) - REPORTS ON FORM 8-K
For the Three Months Ended March 31, 1998
No reports on Form 8-K were filed during the first three months of 1998.
<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 MAY 14, 1998 /s/ James C. Mavel
James C. Mavel
Chairman, Chief Executive Officer,
President and Director
Date MAY 14, 1998 /s/ Michael J. Villano
Michael J. Villano
Chief Financial Officer,
Vice President and Treasurer
<TABLE> <S> <C>
<ARTICLE> 5
EXHIBIT 27.
SCAN-OPTICS, INC.
FINANCIAL DATA SCHEDULE
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> MAR-31-1998
<CASH> 4,947,000
<SECURITIES> 0
<RECEIVABLES> 13,802,000
<ALLOWANCES> 104,000
<INVENTORY> 9,769,000
<CURRENT-ASSETS> 29,989,000
<PP&E> 19,035,000
<DEPRECIATION> 15,316,000
<TOTAL-ASSETS> 33,920,000
<CURRENT-LIABILITIES> 4,651,000
<BONDS> 0
<COMMON> 145,000
0
0
<OTHER-SE> 28,117,000
<TOTAL-LIABILITY-AND-EQUITY> 33,920,000
<SALES> 8,538,000
<TOTAL-REVENUES> 12,892,000
<CGS> 5,740,000
<TOTAL-COSTS> 12,249,000
<OTHER-EXPENSES> (61,000)
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 704,000
<INCOME-TAX> 276,000
<INCOME-CONTINUING> 428,000
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 428,000
<EPS-PRIMARY> .06
<EPS-DILUTED> .06
</TABLE>
