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 June 30, 1998
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( )Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the transition period from to
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Commission File No. 0-5265
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SCAN-OPTICS, INC.
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(Exact name of registrant as specified in its charter)
Delaware 06-0851857
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
169 Progress Drive, Manchester, CT 06040
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(Address of principal executive offices) Zip Code
(860) 645-7878
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(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 August
10, 1998 was 7,369,682.
<PAGE>
SCAN-OPTICS, INC., AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
(thousands, except share data) June 30, 1998 December 31,
1997
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(UNAUDITED)
<S> <C> <C>
Assets
Current Assets:
Cash and cash equivalents $ 1,473 $ 4,386
Accounts receivable less allowance of $767 at
June 30, 1998 and $104 at December 31, 1997 14,125 16,167
Inventories 10,134 12,547
Deferred taxes 855 1,038
Prepaid expenses and other 1,332 969
--------------------------
Total current assets 27,919 35,107
Plant and equipment:
Equipment 14,614 13,355
Leasehold improvements 4,563 4,585
Office furniture and fixtures 1,266 1,275
--------------------------
20,443 19,215
Less allowances for depreciation and amortization 16,552 15,355
--------------------------
3,891 3,860
Goodwill 12,600
Other assets 825 212
--------------------------
Total Assets $ 45,235 $ 39,179
==========================
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
(thousands, except share data) June 30, 1998 December 31,
1997
- -----------------------------------------------------------------------------------
(UNAUDITED)
<S> <C> <C>
Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable $ 1,888 $ 2,071
Notes payable to bank 8,283
Salaries and wages 1,335 1,984
Taxes other than income taxes 794 744
Income taxes 942
Customer deposits 145 2,565
Deferred revenues, net of costs 1,290 1,206
Other 1,010 952
--------------------------
Total current liabilities 14,745 10,464
Deferred taxes 466 486
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, 7,368,349 shares at June 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 35,494 35,025
Retained-earnings deficit (3,488) (4,369)
Foreign currency translation adjustments (380) (421)
--------------------------
31,773 30,379
Less cost of common stock in treasury,
413,500 shares 2,646 2,646
--------------------------
Total stockholders' equity 29,127 27,733
--------------------------
Total Liabilities and Stockholders' Equity $ 45,235 $ 39,179
==========================
See accompanying notes.
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
SCAN-OPTICS, INC., AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
Three Months Ended Six Months Ended
June 30 June 30
(thousands, except share data) 1998 1997 1998 1997
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<S> <C> <C> <C> <C>
Revenues
Net sales $ 5,487 $ 10,385 $ 14,025 $ 19,453
Service revenues 3,900 3,540 8,156 6,885
Engineering revenues 33 100 16
Other operating revenues 284 136 315 137
--------------------------------------------
Total revenues 9,704 14,061 22,596 26,491
Costs and Expenses
Cost of sales 2,367 6,417 8,106 12,087
Service expenses 2,984 2,522 5,914 5,078
Sales and marketing expenses 1,566 1,684 2,919 3,300
Research and development expenses 1,235 1,089 2,519 2,098
General and administrative expenses 869 967 1,812 1,874
Interest expense 15 2 15 24
--------------------------------------------
Total costs and expenses 9,036 12,681 21,285 24,461
--------------------------------------------
Operating income 668 1,380 1,311 2,030
Other income, net 74 22 135 47
--------------------------------------------
Income before income taxes 742 1,402 1,446 2,077
Income taxes 289 61 565 118
--------------------------------------------
Net Income $ 453 $ 1,341 $ 881 $ 1,959
============================================
Basic earnings per share $ .07 $ .20 $ .13 $ .30
============================================
Basic weighted-average shares 6,956,478 6,576,347 6,884,584 6,568,551
Diluted earnings per share $ .06 $ .19 $ .12 $ .28
============================================
Diluted weighted-average shares 7,130,938 6,941,029 7,140,200 6,954,393
See accompanying notes.
</TABLE>
<PAGE>
SCAN-OPTICS, INC., AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
<TABLE>
<CAPTION>
Six Months Ended
June 30
(thousands) 1998 1997
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<S> <C> <C>
Operating Activities
Net income $ 881 $ 1,959
Adjustments to reconcile net income to net
cash provided (used) by operating activities:
Depreciation 600 622
Amortization 801 672
Provision for losses on accounts receivable 663 324
Provision for inventory obsolescence 350
Deferred taxes 163
Changes in operating assets and liabilities:
Accounts receivable 1,678 (2,797)
Inventories 1,612 842
Prepaid expenses and other (363) (232)
Accounts payable (183) (139)
Accrued salaries and wages (649) (546)
Taxes other than income taxes 50 (194)
Income taxes (942) 2
Deferred revenues, net of costs (215)
Customer deposits (2,420) (991)
Other (113) (1)
---------------------------
Net cash provided (used) by operating activities 1,563 (129)
Investing Activities
Business acquisitions (12,600)
Purchases of plant and equipment (631) (682)
---------------------------
Net cash used by investing activities (13,231) (682)
Financing Activities
Proceeds from issuance of common stock 472 141
Proceeds from borrowings 8,285 6,652
Principal payments on borrowings (2) (6,750)
---------------------------
Net cash provided by financing activities 8,755 43
Decrease in cash and cash equivalents (2,913) (768)
Cash and Cash Equivalents at Beginning of Year 4,386 1,279
---------------------------
Cash and Cash Equivalents at End of Period $ 1,473 $ 511
===========================
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 six month
periods ended June 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>
June 30 December 31
(thousands) 1998 1997
- ------------------------------------------------------------------
<S> <C> <C>
Finished goods $ 2,708 $ 2,586
Work-in-process 2,242 3,823
Service parts 3,250 3,807
Materials and component parts 1,934 2,331
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$ 10,134 $ 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 six months ended June 30, 1998 and for the year ended
December 31, 1997, assuming consummation of the purchase as of January 1, 1997,
are as follows (for additional detail see Item 5):
<TABLE>
<CAPTION>
June 30 December 31
(thousands) 1998 1997
- -----------------------------------------------------------------------------
<S> <C> <C>
Total revenue $ 24,357 $ 63,076
Net income (2,479) 4,680
Basic earnings per share (.36) .71
Diluted earnings per share (.35) .66
</TABLE>
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.
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 half of 1998 and 1997 were 8.4% and 8.0% respectively. The
available balance on the total line of credit was $1,717,000 as of June 30,
1998.
<PAGE>
NOTE 5 - Income Taxes
At June 30, 1998, the Company had approximately $3,600,000 of net operating
loss carryforwards for foreign income tax purposes which are scheduled to
expire periodically between 1998 and 2005. At December 31, 1997, the Company
had approximately $3,800,000 of net operating loss carryforwards for foreign
income tax purposes. 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.
Significant components of the Company's deferred tax liabilities and assets
were as follows :
<TABLE>
<CAPTION>
June 30 December 31
(thousands) 1998 1997
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<S> <C> <C>
Deferred tax assets:
Net operating losses $ 1,395 $ 1,479
Depreciation 92 92
Inventory valuation 265 275
Deferred revenue 69 130
Accounts receivable reserves 24 36
Revenue recognition 330 347
Vacation accrual 247 193
Other 135 287
---------------------------
Total deferred tax assets 2,557 2,839
Deferred tax liabilities:
Depreciation and other (467) (486)
Inventory (64) (80)
Valuation allowance (1,637) (1,721)
---------------------------
Net deferred taxes $ 389 $ 552
===========================
</TABLE>
<PAGE>
NOTE 6 - Earnings Per Share
The following table sets forth the computation of basic and diluted earnings
per share:
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30 June 30
1998 1997 1998 1997
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<S> <C> <C> <C> <C>
Numerator:
Net income $ 453 $ 1,341 $ 881 $
1,959
===============================================
Denominator:
Denominator for basic
earnings per share
(weighted-average shares) 6,956,478 6,576,347 6,884,584
6,568,551
Effect of dilutive securities:
Employee stock options 174,460 364,682 255,616
385,843
Denominator for diluted earnings
per share (adjusted weghted-
average shares and assumed
- ----------------------------------------------
conversions) 7,130,938 6,941,029 7,140,200
6,954,393
==============================================
Basic earnings per share $ .07 $ .20 $ .13 $
.30
==============================================
Diluted earnings per share $ .06 $ .19 $ .12 $
.28
==============================================
</TABLE>
NOTE 7 - Year 2000 Compliance
The Company has addressed the Year 2000 compliance issues with its products.
During the first half of 1997, an initial mailing went out to notify customers
that current standard operating systems are in the process of modification to
insure Year 2000 compliance. They were also notified that application software
will be changed at the request of the individual customer on a chargeable basis
and that the Company does not plan to modify the operating systems of
non-current products to achieve Year 2000 compliance. A follow-up mailing is
planned for the third quarter of 1998.
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 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 Six Months Ended
June 30 June 30
1998 1997 1998 1997
- --------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Net income $ 453 $ 1,341 $ 881 $ 1,959
Foreign currency
translation adjustments 2 30 24 (21)
-----------------------------------------------
Comprehensive income $ 455 $ 1,371 $ 905 $ 1,938
===============================================
</TABLE>
The components of accumulated comprehensive income, net of related tax, at June
30, 1998 and December 31, 1997 are as follows:
<TABLE>
<CAPTION>
June 30 December 31
(thousands) 1998 1997
- --------------------------------------------------------------------------------
<S> <C> <C>
Foreign currency translation adjustments $ (379) $ (404)
--------------------------------
Accumulated comprehensive income $ (379) $ (404)
================================
</TABLE>
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF CONSOLIDATED FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Results of Operations for the Three Months and Six Months Ended June 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 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 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 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 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.
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. 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 40 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 six months of 1998 decreased $5.4 million or 28%
compared with the first six months of 1997 and $4.9 million or 47% for the
second quarter of 1998 compared to the second quarter of 1997. Compared to the
first six months of 1997, international sales decreased $6.7 million while
North American sales increased $1.3 million. International sales related to
the Japanese Health Organization represented $5.2 million in sales during the
second quarter of 1997 and this contract was completed with $5.7 million in
sales during the first quarter of 1998. Other international sales decreased
$1.9 million during the second quarter of 1998 compared to 1997. North
American sales for the quarter increased $2.2 million to $4.5 million compared
to $2.3 million in the second quarter of 1997.
Service revenues increased $1.3 million in the first six months of 1998
compared with the first six months of 1997. Service revenues in the second
quarter of 1998 increased $.4 million from the second quarter of 1997. Customer
service revenue in the first six months of 1998 decreased $.2 million mainly
due to the continued transition of older product on maintenance surcharges with
currently released products. Year-to-date professional services revenue
increased $1.5 million due to the continued focus on the solutions business and
the four vertical lines of business.
Cost of sales decreased $4 million from the first half of 1997 and decreased
$4 million from the second quarter of 1997. The year-to-date and second
quarter decreases are a reflection of the completion of the Japanese Health
Organization contract during the first quarter of 1998. Cost of sales as a
percentage of net sales was 58% for the first six months of 1998, compared to
62% in the prior year. This percentage for the second quarter of 1998 was 43%,
compared to 62% for the same period in 1997. The decreases are due to a change
in the overall sales mix.
Service expenses increased $.8 million in the first half of 1998 and increased
$.5 million in the second quarter of 1998 compared with 1997. Customer service
expenses increased $.5 million in the first half of 1998 and $.3 million in the
second quarter of 1998 due to increases in staffing levels and outside service
expenses. Professional service expenses increased $.3 million in the first
half of 1998 and increased $.2 million in the second quarter mainly due to
increases in staffing levels and associated travel costs related directly to
the increase in revenues.
Sales and marketing expenses decreased $.4 million in the first half of 1998
primarily due to a specific accounts receivable reserve in the first half of
1997. Expenses for the second quarter decreased $.1 million from 1997 to 1998,
mainly due to decreases in travel related expenses.
Research and development expenses in 1998 increased $.4 million from the first
half of 1997 and increased $.1 million in the second quarter. These increases
are mainly due to increases in consulting expenses related to the Company's
Image EMC++ product line.
General and administrative expenses remained consistent in the first half of
1998 compared with the first half of 1997.
<PAGE>
Liquidity and Capital Resources
Cash and cash equivalents at June 30, 1998 decreased $2.9 million from December
31, 1997, for the reasons discussed below.
Borrowings increased to $8.3 million at June 30, 1998 from a zero balance at
the end of 1997. The borrowings were due to acquisition related activities, as
discussed in Item 5. 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. (See Note 3 for further details.)
The available balance on the line of credit was $2,228,028 as of August 12,
1998.
Operating activities provided $1.4 million of cash in the first half of 1998.
Non-cash expenses recorded during the first six months of 1998 were $2.2
million vs. $2 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 $2 million during the first half of the
year mainly due to the timing of collections. Accounts receivable purchased
from Southern Computer Systems (SCS) and the Maintenance Division of Access
Corporation, offset by an increase in reserves, added $2.5 million to accounts
receivable.
Inventories decreased $2.4 million in the first half of 1998. Total
manufacturing inventories decreased $1.9 million from the beginning of the year
mainly due to a $1.6 million decrease in work-in-process inventory and a $.4
million decrease in raw materials, offset by a $.1 million increase in finished
goods inventory. These 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 completion of the Japanese
Health Organization order. Customer service inventories decreased by $.5
million in the first half of the year mainly due to the amortization of parts
inventory.
Prepaid expenses and other current assets increased $.4 million primarily due
to increases in prepaid costs related to the consulting and non-competition
agreements for the principals of SCS.
Net plant and equipment remained flat during the first half of 1998.
Additions of $.6 million for purchases related to the implementation of the
Enterprise Resource and Planning system, the SCS acquisition, and leasehold
improvements were offset by $.6 million of depreciation expense recorded during
the first half 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.
Accounts payable decreased $.2 million from December 31, 1997, due to the
timing of payments.
Accrued salaries and wages decreased $.6 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.
Income taxes decreased $.9 million due to payment of the 1997 estimated income
tax liability and quarterly payments made for estimated 1998 tax liability.
Customer deposits decreased $2.4 million mainly due to the acceptance of the
Japanese health claims processing systems, recognized in revenue during the
first half of 1998, which had included substantial deposits.
<PAGE>
SCAN-OPTICS, INC., AND SUBSIDIARIES
PART II - OTHER INFORMATION
ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
At the registrant's annual meeting of stockholders held on May 21,1998, the
following matters were voted on.
1. Election of Directors for 3-year term:
ABSTENTIONS AND
NAME VOTES FOR VOTES WITHHELD BROKER NONVOTES
Logan Clarke, Jr. 6,115,462 72,648 0
Richard J. Coburn 6,118,024 70,086 0
2. Appointment as Ernst & Young LLP as auditors for the fiscal year ending
December 31, 1998:
ABSTENTIONS AND
VOTES FOR VOTES AGAINST BROKER NONVOTES
6,154,445 23,809 9,856
<PAGE>
SCAN-OPTICS, INC., AND SUBSIDIARIES
PART II - OTHER INFORMATION
ITEM 5 - OTHER INFORMATION
Filed with respect to Form 8-K filed on June 30, 1998.
ITEM 7 - FINANCIAL STATEMENTS AND EXHIBITS
ITEM 7(a) - Financial statements of business acquired
Independent Auditors' Report
- ----------------------------
The Board of Directors
Southern Computer Systems, Inc.:
We have audited the accompanying balance sheets of Southern Computer Systems,
Inc. as of December 31, 1997 and 1996, and the related statements of income,
stockholders' equity, and cash flows for the years then ended. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Southern Computer Systems,
Inc. as of December 31, 1997 and 1996, and the results of its operations and
its cash flows for the years then ended in conformity with generally accepted
accounting principles.
KPMG Peat Marwick LLP
March 16, 1998
<PAGE>
<TABLE>
<CAPTION>
SOUTHERN COMPUTER SYSTEMS, INC.
Balance Sheets
December 31, 1997 and 1996
1997
1996
- ----------------------------------------------------------------------------------------------
<S> <C> <C>
Assets
Current Assets:
Cash $ 15,346 19,483
Trade accounts receivable, less allowance for doubtful
receivables of $50,000 and $130,578 in 1997 and
1996, respectively (notes 2 and 4) 2,165,898 2,201,426
Inventory (note 2) 69,041 153,400
Prepaid expenses 44,981 64,430
Other current assets 33,926 36,017
------------------------------
Total current assets 2,329,192 2,474,756
Equipment, furniture and fixtures, net of accumulated
depreciation of $865,841 and $703,792 in 1997 and
1996, respectively (note 2) 305,350 289,866
Note receivable from affiliate (note 2) - 15,000
Investment in Imaging Business Machines, LLC (note 4) 9,690 9,690
Other assets 113,097 88,237
------------------------------
$ 2,757,329 2,877,549
==============================
Liabilities and Stockholders' Equity
Current Liabilities:
Bank overdraft $ 207,024 348,969
Borrowing under the line of credit (note 2) 85,054 638,281
Notes payable to bank 507,752 -
Current portion of long-term doubt (note 2) 30,458 46,908
Accounts payable (note 4) 483,754 3,543
Accrued expenses 80,515 82,670
Deferred revenue 222,124 400,830
------------------------------
Total Current Liabilities 1,616,681 1,521,20
Long-term debt, excluding current portion (note 2) 5,268 35,685
------------------------------
Total Liabilities 1,621,949 1,556,88
Stockholders' equity:
Common stock, $1 par value, authorized and
issued 1,000 shares 1,000
1,000
Additional paid-in capital 13,676
13,676
Retained earnings 1,325,678
1,510,961
- ------------------------------
1,340,354
1,525,637
Cost of 516-2/3 shares of common stock held in
treasury (204,974) (204,974)
------------------------------
Net stockholders' equity 1,135,380 1,320,663
Commitments (notes 2,3 and 5) ------------------------------
$ 2,757,329 2,877,549
==============================
See accompanying notes to financial statements.
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
SOUTHERN COMPUTER SYSTEMS, INC.
Statements of Income
Years Ended December 31,1997 and 1996
1997 1996
- ------------------------------------------------------------------------------------
<S> <C> <C>
Net revenues (note 4) $ 6,468,331 4,714,969
Costs and expenses:
Costs of revenues (note 4) 4,246,938 2,545,170
Sales and marketing 749,195 1,004,572
Research and development 668,660 556,922
General and administrative 686,571 400,468
--------------------------------
Total costs and expenses 6,351,364 4,507,132
--------------------------------
Income from operations 116,967 207,837
Other income (expense):
Interest income (note 4) 1,672 2,267
Interest expense (47,882) (16,827)
Other expense (65,000) (87,800)
--------------------------------
Total other expense (111,210) (102,360)
--------------------------------
Net income $ 5,757 105,477
================================
See accompanying notes to financial statements
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
SOUTHERN COMPUTER SYSTEMS, INC.
Statements of Stockholders' Equity
Years Ended December 31, 1997 and 1996
Additional
Common paid-in Retained Treasury
stock capital earnings stock Total
- -------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Balance at December 31,1995 $ 1,000 13,676 1,849,675 (204,974) 1,659,377
Net income 105,477 105,477
Stockholders' distributions - - (444,191) - (444,191)
-----------------------------------------------------------------
Balance at December 31,1996 1,000 13,676 1,510,961 (204,974) 1,320,663
Net income 5,757 5,757
Stockholders' distributions (191,040) (191,040)
-----------------------------------------------------------------
Balance at December 31, 1997 $ 1,000 13,676 1,325,678 (204,974) 1,135,380
=================================================================
See accompanying notes to financial statements.
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
SOUTHERN COMPUTER SYSTEMS, INC.
Statements of Cash Flows
Years Ended December 31,1997 and 1996
1997 1996
- ---------------------------------------------------------------------------------------------------
<S> <C> <C>
Reconciliation of net income to net cash provided by
(used in) operating activities:
Net income $ 5,757 105,477
Adjustments to reconcile net income to net cash
provided by (used in) operating activities:
Depreciation and amortization 171,224 158,400
Increase (decrease) in trade accounts receivable 35,528 (157,117)
Decrease (increase) in inventory (7,501) 41,802
Decrease in prepaid expenses 19,449 23,784
Decrease (increase) in note receivable from affiliate 15,000 (15,000)
Increase in other assets (22,769) (41,766)
Increase (decrease) in accounts payable 480,211 (481,895)
Decrease in deferred revenue (178,706) (49,776)
Decrease in accrued expenses (2,155) (13,787)
--------- ---------
Total adjustments 510,281 (535,355)
--------- ---------
Net cash provided by (used in) operating activities 516,038 (429,878)
--------- ---------
Cash flows from investing activities:
Proceeds from disposal of equipment, furniture and fixtures - 83,922
Purchase of equipment, furniture and fixtures (94,848) (71,020)
--------- ---------
Net cash provided by (used in) investing activities (94,848) 12,902
--------- ---------
Cash flows from financing activities:
Increase (decrease) in bank overdraft (141,945) 348,969
Stockholders' distributions (191,040) (211,645)
Net (decrease) increase in bank credit line borrowing (553,227) 327,351
Principal payments on long-term debt (46,867) (42,791)
Proceeds from note payable to bank 507,752 -
--------- ---------
Net cash provided by (used in) financing activities (425,327) 421,884
--------- ---------
Net increase (decrease) in cash (4,137) 4,908
Cash at beginning of year 19,483 14,575
--------- ---------
Cash at end of year $ 15,346 19,483
========= =========
Supplemental disclosure of cash flow information:
Cash paid for interest during the year $ 39,108 17,828
========= =========
Inventory converted to equipment $ 91,860 -
========= =========
Supplemental disclosure of noncash financing activities:
Distribution of investments in IBM, LLC $ - 232,546
========= =========
See accompanying financial statements.
</TABLE>
<PAGE>
SOUTHERN COMPUTER SYSTEMS, INC.
Notes to Financial Statements
December 31, 1997 and 1996
(1) Description of Business and Summary of Significant Accounting Policies
(a) Description of Business
Southern Computer Systems, Inc. (the Company) is engaged in a variety of
computer-related activities, including systems integration, consulting,
manufacturing/publishing of packaged software for PC's, custom software
development, and the research and development of new software. All of those
activities are generally related to the facilitation of the data capture
process. The Company markets high-speed document processing machines in
combination with its various software products which include KeyEntry III(R)
and ImageKey(R). The majority of the Company's revenues are derived from
sales and installation and integration of the software and the related
hardware to large corporations and government agencies. Although some
products and services are marketed via secondary resellers, the majority of
sales occur as the result of the Company's direct to end-user activities.
(b) Revenue Recognition and Deferred Revenue
Revenue from sales of products is recognized upon shipment, and revenue from
customer support agreements is deferred and recognized over the terms of the
agreements. Revenue from system implementation services is recognized as
service is provided.
(c) Inventories
Inventories are stated at the lower of cost or market. Cost is determined
using the first-in, first-out method.
Inventory consists primarily of materials such as manuals and operating
supplies.
(d) Equipment, Furniture and Fixtures
Equipment, furniture and fixtures are stated at cost less accumulated
depreciation. Depreciation is calculated on the straight-line method over
the estimated useful lives of the assets.
(e) Research and Development
Research and development costs are expensed as incurred.
(f) Treasury Stock
Treasury stock is accounted for under the cost method.
(g) Prepaid Promotional Expense
Promotional literature and other promotional items are recorded as prepaid
promotional expense when received and recognized as promotional expense when
they are used. Prepaid promotional expense is included in prepaid expenses
in the accompanying financial statements.
(h) Copyrights
The Company owns various copyrights for its internally developed software,
the value of which is not recorded in the financial statements.
(i) Income Taxes
The Company, with the consent of its stockholders, elected under the Internal
Revenue Code to be taxed as an S Corporation effective March 1, 1987. The
Company is not liable for income taxes as the stockholders of an S
Corporation are taxed on their proportionate share of the Company's taxable
income.
(j) Use of Estimates
Management of the Company has made a number of estimates and assumptions
relating to the reporting of assets and liabilities to prepare these
financial statements in conformity with generally accepted accounting
principles. Actual results could differ from those estimates.
(k) Reclassifications
Certain reclassifications have been made in the December 31, 1996 financial
statements to conform with the December 31, 1997 financial statement
presentation.
(2) Notes Payable and Long-term Debt
The Company has a $750,000 line of credit with the National Bank of Commerce,
which is secured by the Company's trade accounts receivable and inventories
and the personal guarantees of certain Company officers and shareholders.
Interest on the outstanding balance accrues at the bank's prime rate (8.0
percent at December 31, 1997). Borrowings under the line of credit totaled
$85,054 and $638,281 at December 31, 1997 and 1996, respectively. The line
of credit matures on January 31, 1998.
The Company has a note payable to the National Bank of Commerce which bears
interest at the bank's prime rate (8.0 percent at December 31, 1997) and is
secured by certain equipment and fixtures, trade accounts receivable,
inventories and the personal guarantees of certain Company officers. The
note is payable on demand and matures on January 9, 1998.
The Company has two other commercial notes with National Bank of Commerce
which bear interest at 9.0 percent at December 31, 1997, and are secured by
certain equipment and fixtures of the Company and the personal guarantees of
certain Company officers. The balances at December 31, 1997, of $17,752
(due in June 1998) and $17,974 (due in May 1999) are payable in monthly
installments of principal and interest totaling $3,225 and $1,148,
respectively.
The aggregate maturities of long-term debt for each of the five years
subsequent to December 31,1997, and thereafter, are as follows:
1998 $30,458
1999 5,268
(3) Commitments
The Company leases real estate under a two year noncancelable operating
lease with monthly payments of $12,960.
Total lease expense was $146,160 for 1997 and 1996.
(4) Related Party Transactions
Effective January 1, 1996, the shareholders of the Company distributed all
but 4 percent ownership of Imaging Business Machines, LLC (IBM, LLC) to its
stockholders.
At December 31, 1997 and 1996, the following components of the Company's
financial statements relate to IBM, LLC:
<TABLE>
<CAPTION>
<S> <C> <C>
1997 1996
---- ----
Investment in IBM, LLC $ 9,690 9,690
Trade accounts receivable 31,500 90,800
Accounts Payable 71,792 ----
Note Receivable ---- 15,000
Net revenue from IBM, LLC 77,000 21,000
Purchases from IBM, LLC 216,688 671,132
</TABLE>
(5) Employee Benefit Plan
The Company sponsors the Southern Computer Systems, Inc. 401 (k) Retirement
Plan (the Plan). The Plan is a defined contribution employee benefit plan
covering substantially all Company employees. In accordance with the Plan
agreement, the Company matches 33 1/3 percent of participant contributions
not to exceed $1,000 per participant per year. Company contributions to the
Plan were $23,896 and $29,233 for the years ended December 31, 1997 and
1996, respectively.
(6) Significant Customers
During 1997, two customers accounted for 43.9 percent of sales and
receivables from these customers were $997,865 at December 31, 1997.
(7) Subsequent Event (Unaudited)
During May, 1998, the Company was informed that a customer did not wish to
proceed with a certain systems integration project under contract. The
Company believes that services required under the contract were performed and
it intends to pursue completion of the contract and collection of all
amounts due under it. At December 31, 1997, the Company had a receivable
recorded under the contract of $689,450. As of August 13, 1998, no payments
related to the receivable had been received.
<PAGE>
SCAN-OPTICS, INC., AND SUBSIDIARIES
PART II - OTHER INFORMATION
(continued)
ITEM 7 (b) - Pro forma statements of operations
Scan-Optics, Inc. and Subsidiaries
Unaudited Pro Forma Statements of Operations
The following unaudited pro forma consolidated statement of operations have
been prepared by Scan-Optics, Inc. ("SO") management. These statements reflect
SO's acquisition of Southern Computer Systems, Inc. ("SCS") and combine the
historical consolidated statement of operations of SO and SCS for the periods
indicated using the purchase method of accounting.
The unaudited pro forma consolidated statements of operations reflect the
adjustments as if the acquisition had occurred on January 1, 1997. These pro
forma statements should be read in conjunction with the historical financial
statements and related notes of SO and SCS.
The pro forma consolidated statements of operations have been prepared using
the following facts and assumptions:
SO acquired all the stock outstanding, 483 and 1/3 shares, of SCS for
$7 million in cash. SO also paid off the bank debt of SCS, of $1.4 million,
on the day of closing. Additionally, SO entered into a consulting and
noncompetition agreement with the two sellers of SCS, Stephen M. Freeman and
Raymond C. Griffin, Jr.
SO also incurred direct costs of approximately $.4 million. These costs
consist primarily of legal, accounting and financial advisory fees.
SO utilized cash on hand and approximately $4 million of the Company's line of
credit to fund the transaction.
SO estimates that it will incur approximately $.2 million in indirect
transaction costs. These costs relate primarily to personnel and travel costs
associated with those individuals assigned management and transition
responsibilities for SCS.
The purchase price will be allocated to the assets and liabilities of SCS based
upon their fair values at the date of acquisition. The purchase price in
excess of the fair value of net assets acquired of approximately $9.2 million
will be amortized over 20 years.
Pro forma adjustments to the consolidated statement of operations reflecting
anticipated additional sales, cost savings and other synergies, if any,
resulting from the acquisition of SCS are not permitted, and accordingly have
not been reflected in the pro forma financial statements.
The pro forma financial results are not intended to be a projection of future
results and are not necessarily indicative of the results which would have
occurred if the acquisition had been in effect on the dates presented.
<PAGE>
<TABLE>
<CAPTION>
SCAN-OPTICS, INC., AND SUBSIDIARIES
UNAUDITED PRO FORMA CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
YEAR ENDED DECEMBER 31, 1997
Southern Unaudited
(thousands, except share data) Scan-Optics, Inc. Computer Systems Adjustments Pro forma
- ----------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Revenues
Net sales $ 41,361 $ 1,455 $ 42,816
Service revenues 14,124 5,013 19,137
Engineering revenues 876 876
Other operating revenues 247 247
----------- --------- -------- ---------
Total revenues 56,608 6,468 63,076
Costs and Expenses
Cost of sales 25,066 4,247 29,313
Service expenses 10,400 10,400
Sales and marketing expenses 7,297 749 8,046
Research and development expenses 4,552 669 5,221
General and administrative expenses 3,737 686 $ 860 (a) 5,283
Interest expense 14 48 256 (b) 318
----------- --------- -------- ---------
Total costs and expenses 51,066 6,399 1,116 58,581
----------- --------- -------- ---------
Operating income 5,542 69 (1,116) 4,495
Other income (expense), net 149 (63) 86
----------- --------- -------- ---------
Income before income taxes 5,691 6 (1,116) 4,581
Income taxes (benefit) expense (99) (99)
----------- --------- -------- ---------
Net Income (loss) $ 5,790 $ 6 $(1,116) $ 4,680
=========== ========= ======== =========
Basic earnings per share $ .87 $ .71
=========== ========= ======== =========
Basic weighted-average shares 6,632,248 6,632,248
Diluted earnings per share $ .82 $ .66
=========== ========= ======== =========
Diluted weighted-average shares 7,070,013 7,070,013
See accompanying notes.
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
SCAN-OPTICS, INC., AND SUBSIDIARIES
UNAUDITED PRO FORMA CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
SIX MONTHS ENDED JUNE 30, 1998
Southern Unaudited
(thousands, except share data) Scan-Optics, Inc. Computer Systems Adjustments Pro forma
- ----------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Revenues
Net sales $ 14,025 $ 703 $ 14,728
Service revenues 8,156 1,058 9,214
Engineering revenues 100 100
Other operating revenues 315 315
----------- --------- -------- --------
Total revenues 22,596 1,761 24,357
Costs and Expenses
Cost of sales 8,106 923 9,029
Service expenses 5,914 1,976 7,890
Sales and marketing expenses 2,919 356 3,275
Research and development expenses 2,519 371 2,890
General and administrative expenses 1,812 247 $430 (a) 2,489
Interest expense 15 41 128 (b) 128
----------- --------- -------- --------
Total costs and expenses 21,285 3,914 558 25,757
----------- --------- -------- --------
Operating income 1,311 (2,153) (558) (1,400)
Other income (expense), net 135 (649) (514)
----------- --------- -------- --------
Income before income taxes 1,446 (2,802) (558) (1,914)
Income taxes (benefit) expense 565 565
----------- --------- -------- --------
Net Income (loss) $ 881 $ (2,802) $(558) $ (2,479)
=========== ========= ======== =========
Basic earnings per share $ .13 $ (.36)
=========== ========= ======== =========
Basic weighted-average shares 6,884,584 6,884,584
Diluted earnings per share $ .12 $ (.35)
=========== ========= ======== =========
Diluted weighted-average shares 7,140,200 7,140,200
See accompanying notes.
</TABLE>
<PAGE>
Scan-Optics, Inc. and Subsidiaries
Notes to Unaudited Pro Forma Consolidated Financial Statements
(a) To record amortization expense related to the $9.2 million of goodwill over
20 years and to record the expenses for the consulting and noncompetition
agreement for the former owners of SCS.
(b) To record the interest charges on the line of credit for the borrowings
related to the acquisition.
<PAGE>
SCAN-OPTICS, INC., AND SUBSIDIARIES
PART II - OTHER INFORMATION
ITEM 6 (B) - REPORTS ON FORM 8-K
For the Quarter Ended June 30, 1998
A report on Form 8-K was filed on June 30, 1998 reporting the acquisition of
Southern Computer Systems under Item 2 thereof. The information called for in
Item 7 (a) of that report on Form 8-K, with respect to the financial statements
of the business acquired and pro forma financial information, is included under
Item 5 of this report on Form 10-Q.
<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 AUGUST 14, 1998 JAMES C. MAVEL
James C. Mavel
Chairman, President, Chief Executive
Officer and Director
Date AUGUST 14, 1998 MICHAEL J. VILLANO
Michael J. Villano
Chief Financial Officer and
Vice President
<PAGE>
<TABLE> <S> <C>
<ARTICLE> 5
EXHIBIT 27.
SCAN-OPTICS, INC.
FINANCIAL DATA SCHEDULE
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> JUN-30-1998
<CASH> 1,473,000
<SECURITIES> 0
<RECEIVABLES> 14,125,000
<ALLOWANCES> 767,000
<INVENTORY> 10,134,000
<CURRENT-ASSETS> 27,919,000
<PP&E> 20,443,000
<DEPRECIATION> 16,552,000
<TOTAL-ASSETS> 45,235,000
<CURRENT-LIABILITIES> 14,745,000
<BONDS> 0
<COMMON> 147,000
0
0
<OTHER-SE> 29,127,000
<TOTAL-LIABILITY-AND-EQUITY> 45,235,000
<SALES> 14,025,000
<TOTAL-REVENUES> 22,596,000
<CGS> 8,106,000
<TOTAL-COSTS> 21,285,000
<OTHER-EXPENSES> 135,000
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 15,000
<INCOME-PRETAX> 1,446,000
<INCOME-TAX> 565,000
<INCOME-CONTINUING> 881,000
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 881,000
<EPS-PRIMARY> .13
<EPS-DILUTED> .12
</TABLE>
