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, 1999
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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
November 10, 1999 was 7,421,232.
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<TABLE>
<CAPTION>
SCAN-OPTICS, INC., AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(thousands, except share data) September 30, 1999 December 31, 1998
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(UNAUDITED)
<S> <C> <C>
Assets
Current Assets:
Cash and cash equivalents 1,593 216
Accounts receivable less allowance of
$244 at September 30, 1999 and $206 at
December 31, 1998 25,974 22,725
Refundable income taxes 947
Inventories 10,957 11,478
Deferred taxes 2,165 960
Deferred costs, net of revenues 531 502
Prepaid expenses and other 931 1,012
---------------------------------------------
Total current assets 43,098 36,893
Plant and equipment:
Equipment 13,753 13,601
Leasehold improvements 5,147 4,815
Office furniture and fixtures 1,322 1,307
---------------------------------------------
20,222 19,723
Less allowances for depreciation and
amortization 17,110 16,367
---------------------------------------------
3,112 3,356
Goodwill, net 12,356 12,110
Deferred taxes 833
Other assets 2,656 633
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Total Assets 62,055 52,992
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(thousands, except share data) September 30, 1999 December 31, 1998
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(UNAUDITED)
<S> <C> <C>
Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable 6,661 5,487
Notes payable to bank 18,875 11,524
Salaries and wages 1,297 2,007
Taxes other than income taxes 1,194 691
Income taxes 35
Customer deposits 259 99
Other 4,152 1,943
---------------------------------------------
Total current liabilities 32,438 21,786
Deferred taxes 771 263
Other liabilities 397 697
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, 7,421,232 shares at
September 30, 1999 and 7,370,482
shares at December 31, 1998 148 147
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 35,568 35,501
Retained-earnings deficit (4,060) (2,240)
Foreign currency translation adjustments (561) (516)
---------------------------------------------
31,095 32,892
Less cost of common stock in treasury,
413,500 shares 2,646 2,646
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Total stockholders' equity 28,449 30,246
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Total Liabilities and Stockholders' Equity 62,055 52,992
=============================================
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) 1999 1998 1999 1998
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<S> <C> <C> <C> <C>
Revenues
Product sales $ 5,857 $ 6,359 $ 19,377 $ 20,632
Service revenues 6,345 5,427 20,686 13,583
Engineering revenues 254 441 100
Other operating revenues 36 13 103
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Total revenues 12,456 11,822 40,517 34,418
Costs and Expenses
Cost of product sales 3,530 3,295 12,338 11,915
Service expenses 6,994 4,024 16,863 9,936
Sales and marketing expenses 2,115 1,567 5,692 4,481
Research and development expenses 1,355 1,239 4,263 3,759
General and administrative
expenses 1,312 1,141 3,591 2,958
Interest expense 467 181 982 196
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Total costs and expenses 15,773 11,447 43,729 33,245
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Operating income (loss) (3,317) 375 (3,212) 1,173
Other income (loss), net (58) (5) 34 130
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Income (loss) before income taxes (3,375) 370 (3,178) 1,303
Income tax expense (benefit) (1,412) 96 (1,358) 461
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Net income (loss) $ (1,963) $ 274 $ (1,820) $ 842
===================================================================
Basic earnings (loss) per share $ (.28) $ .04 $ (.26) $ .12
===================================================================
Basic weighted-average shares 6,984,361 6,957,811 6,978,081 6,908,993
Diluted earnings (loss) per share $ (.28) $ .04 $ (.26) $ .12
===================================================================
Diluted weighted-average shares 6,984,361 7,097,777 6,978,081 7,126,059
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
SCAN-OPTICS, INC., AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
Nine Months Ended
September 30
(thousands) 1999 1998
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<S> <C> <C>
Operating Activities
Net (loss) income $ (1,820) $ 842
Adjustments to reconcile net(loss) income to
net cash used by operating activities:
Depreciation 803 945
Amortization 1,268 1,192
Amortization of goodwill 902 210
Provision for losses on accounts receivable 50
Deferred taxes (1,530) (388)
Changes in operating assets and liabilities:
Accounts receivable (2,814) (2,424)
Inventories 643 448
Prepaid expenses and other 157 (331)
Accounts payable 583 2,324
Accrued salaries and wages (927) (1,167)
Taxes other than income taxes 503 123
Income taxes (982) (489)
Deferred costs, net of revenues (29) 574
Customer deposits 160 (2,529)
Other (459) (464)
---------------------------------------
Net cash used by operating (3,492) (1,134)
activities
Investing Activities
Business acquisitions (2,158) (12,019)
Purchases of plant and equipment (392) (342)
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Net cash used by investing activities (2,550) (12,361)
Financing Activities
Proceeds from issuance of common stock 68 477
Proceeds from borrowings 31,102 14,658
Principal payments on borrowings (23,751) (5,886)
----------------------------------------
Net cash provided by financing activities 7,419 9,249
Increase (decrease) in cash and cash equivalents 1,377 (4,246)
Cash and Cash Equivalents at Beginning of Year 216 4,386
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Cash and Cash Equivalents at End of Period $ 1,593 $ 140
========================================
See accompanying notes.
</TABLE>
<PAGE>
SCAN-OPTICS, INC., AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
For the Quarter Ended September 30, 1999
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 nine month period
ended September 30, 1999, are not necessarily indicative of the results that
may be expected for the year ending December 31, 1999. 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, 1998.
Certain 1998 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) 1999 1998
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<S> <C> <C>
Finished goods $ 524 $ 1,885
Work-in-process 1,493 2,129
Service parts 4,421 3,808
Materials and component parts 4,519 3,656
-----------------------------------
$ 10,957 $ 11,478
===================================
</TABLE>
NOTE 3 - Acquisition Activities
On June 22, 1999, the Company completed the acquisition of the Photomatrix
Scanner and Maintenance Division of Photomatrix Imaging Corporation of Carlsbad,
California, including certain product and technology rights. The Company
acquired accounts receivable net of reserves of $1.0 million, manufacturing and
customer service inventory net of reserves of $1.4 million, fixed assets net of
accumulated depreciation of $.1 million and other assets of $.1 million. The
Company also assumed liabilities for accounts payable of $.6 million, deferred
revenue of $.5 million, salary and benefits accruals of $.2 million and
acquisition related expenses of $.3 million. The Company reported goodwill
related to the transaction of $1.1 million which will be amortized over an
average period of twelve and one-half years.
NOTE 4 - Credit Arrangements
On May 10, 1999, the Company amended its credit agreement (the "Agreement")
with a bank to extend the maturity date to May 10, 2002 and to reduce the line
from $13 million to $10 million. The unused portion of the line is subject to a
commitment fee of 3/8% per annum. The available balance on the line of credit
was $875,000 and $1,228,000 as of September 30, 1999 and September 30, 1998
respectively. The weighted average interest rates on borrowings during the
first nine months of 1999 and 1998 were 8.2% and 7.0% respectively.
Additionally, on May 10, 1999, a five-year term loan in the amount of $10
million was established to better match the cash expenditures for acquisitions
with the cash flow that results from the acquired businesses. The term loan
contains covenants which, among other things, require the maintenance of
specified working capital, debt to equity ratios, net income levels, tangible
net worth levels and backlog levels. Both the line of credit and the term loan
bear interest at prime.
As of September 30, 1999, the Company is in default of certain financial
covenants on its bank debt and is currently negotiating with its bank to
restructure the borrowing arrangements and agree to new terms and conditions.
Accordingly, all bank debt has been classified as a current liability on the
consolidated balance sheet.
NOTE 5 - Income Taxes
At September 30, 1999, the Company has approximately $498,000 of federal and
$171,000 of state net operating loss carryforwards which are scheduled to
expire periodically between 2004 and 2014. At September 30, 1999, the Company
has approximately $617,000, $2,975,000 and $786,000 of foreign net operating
loss carryforwards for Canada, the United Kingdom and Germany respectively,
which are scheduled to expire periodically between 1999 and 2005. At December
31, 1998, the Company had approximately $450,000, $2,600,000 and $800,000 of
net operating loss carryforwards for Canada, the United Kingdom and Germany,
respectively. For financial reporting purposes, a valuation allowance has been
recorded for the first nine months of 1999 to offset a significant portion of
the deferred tax assets related to the foreign net operating loss carryforwards
and other temporary differences. The Company has not recorded a valuation
allowance on U.S. tax loss carryforward balances as the Company believes that
the carryforward amounts will be utilized in the near future. The effective tax
rate for the nine months ended September 30, 1999 is less than the statutory
rate primarily due to foreign income tax benefits.
Significant components of the Company's deferred tax assets and liabilities
were as follows:
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<CAPTION>
September 30 December 31
(thousands) 1999 1998
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<S> <C> <C>
Deferred tax assets:
Net operating losses $ 3,309 $ 1,475
Alternative minimum tax credit 168
Depreciation 92
Inventory valuation 84 174
Inventory 106 115
Deferred maintenance revenue 9 178
Accounts receivable reserves 102 26
Goodwill 99 59
Revenue recognition - systems
undergoing acceptance testing 10 29
Vacation accrual 190 188
Other 209 162
-----------------------------
Total deferred tax assets 4,286 2,498
Deferred tax liabilities:
Depreciation and other (109) (84)
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Total deferred tax liabilities (109) (84)
Valuation allowance (1,950) (1,717)
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Net deferred taxes $ 2,227 $ 697
=============================
</TABLE>
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
1999 1998 1999 1998
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<S> <C> <C> <C> <C>
Numerator:
Net income (loss) $ (1,963) $ 274 $ (1,820) $ 842
=======================================================
Denominator:
Denominator for basic earnings
per share (weighted-average shares) 6,984,361 6,957,811 6,978,081 6,908,993
Effect of dilutive securities:
Employee stock options 139,966 217,066
Denominator for diluted earnings
per share (adjusted weighted-average
-------------------------------------------------------
shares and assumed conversions) 6,984,361 7,097,777 6,978,081 7,126,059
=======================================================
Basic earnings (loss) per share $ (.28) $ .04 $ (.26) $ .12
=======================================================
Diluted earnings (loss) per share $ (.28) $ .04 $ (.26) $ .12
=======================================================
</TABLE>
<PAGE>
NOTE 7 - Year 2000 Compliance
The Company has devoted significant resources to minimize the risk of potential
disruption from 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 has been evaluating the Company's exposure to the Year 2000 problem
and has prepared a written plan for managing the risks and costs associated
with the Year 2000 problem.
The Company's process of addressing the Year 2000 problem consists 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 designed
and integrated 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 worldwide, the Company has replaced its internal corporate
information system and several other systems 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, was completed March 1, 1999. The vendors
of all new systems have certified them as being Year 2000 compliant. The
Company has performed independent Year 2000 testing of these systems and will
continue to do so through the remainder of 1999.
The Company has completed its inventory of other systems, equipment and items
that potentially present a Year 2000 problem. The Company completed performing
internal testing and seeking outside certification of material inventoried
items during the second quarter of 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, electric and other utilities and significant suppliers. The Company
has contacted such parties to determine the extent to which they are vulnerable
to the Year 2000 problem and has completed this process during the second
quarter of 1999. 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 may be unsuccessful in
preparing its internal systems and equipment for the Year 2000, the Company
developed a contingency plan for dealing with the most reasonably likely worst
case scenarios. The nature and scope of the Company's contingency plan is
based upon an analysis of information gathered during the inventory, assessment
and remediation phases of its Year 2000 program. The Company completed its
contingency planning during the third quarter of 1999, and expects to have all
contingency systems in place and fully tested by the fourth quarter of 1999.
The Company estimates that, as of September 30, 1999, 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 in Management's
Discussion and Analysis of Consolidated Financial Condition and Results of
Operations.) 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
The components of comprehensive income, net of related tax, for the three and
nine months ended September 30, 1999 and 1998 are as follows:
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30 September 30
1999 1998 1999 1998
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<S> <C> <C> <C> <C>
Net income (loss) $(1,963) $ 274 $(1,820) $ 842
Foreign currency translation adjustments 44 (16) (44) 8
----------------------------------------------------
Comprehensive income (loss) $(1,919) $ 258 $(1,864) $ 850
====================================================
</TABLE>
The components of accumulated comprehensive income, net of related tax, at
September 30, 1999 and December 31, 1998 are as follows:
<TABLE>
<CAPTION>
September 30 December 31
(thousands) 1999 1998
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<S> <C> <C>
Foreign currency translation adjustments $ (517) $ (473)
----------------------------------------------
Accumulated comprehensive income $ (517) $ (473)
==============================================
</TABLE>
<PAGE>
Note 9 - Segment Information
The Company views its business in three distinct revenue categories: Product
and solution sales, Maintenance revenue, and Contract manufacturing. Revenues
are used by management as a guide to determine the effectiveness of the
individual segment. The Company manages its operating expenses through a
traditional functional perspective and accordingly does not report operating
expenses on a segment basis.
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30 September 30
1999 1998 1999 1998
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<S> <C> <C> <C> <C>
Revenues
Product and solution sales $ 7,839 $ 8,147 $ 27,818 $ 24,979
Maintenance revenue 4,525 3,577 12,009 9,093
Contract manufacturing 92 98 690 346
----------------------------------------------------
Total revenues 12,456 11,822 40,517 34,418
Cost of product sales 3,530 3,295 12,338 11,914
Service expenses 6,994 4,024 16,863 9,936
----------------------------------------------------
Gross profit margin 1,932 4,503 11,316 12,568
Operating expenses
and other income, net 5,307 4,133 14,494 11,265
----------------------------------------------------
Income before income taxes $ (3,375) $ 370 $ (3,178) $ 1,303
====================================================
Total expenditures for additions
to long-lived assets $ 30 $ 55 $ 406 $ 413
</TABLE>
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF CONSOLIDATED FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Outlook
The forward-looking statements contained in this Outlook and elsewhere in this
document are based on current expectations and are made under safe harbor
provisions of Section 27A of the Securities Act of 1933, Section 21E of the
Securities Exchange Act of 1934 and the Private Securities Litigation Reform
Act of 1995. These forward-looking statements involve a number of risks and
uncertainties that could materially affect future results. Among these risk
factors are changes in general economic and business conditions in the United
States and foreign markets, increased competition or a slowdown in growth
within the scanning and imaging market, alternate forms of processing,
inability to consummate accretive acquisitions, inability to complete projects,
and other risk factors and cautionary statements listed from time to time in
the Company's periodic reports filed with the Securities and Exchange
Commission, including but not limited to the Company's Annual Report on Form
10-K for the fiscal year ended December 31, 1998. (See also Year 2000
Compliance in Note 7.) The foregoing factors should not be construed as
exhaustive.
On October 28, 1999, the Company announced that it sustained a loss for the
third quarter of 1999 and expects to incur a loss in the fourth quarter. The
loss is from the Professional Services organization within the Solutions
Services Division and is mainly attributable to revenue delays on some projects
and expense overruns on others. The Company has taken a number of actions to
correct the problems that relate to the third quarter loss and the projected
fourth quarter loss which include; a cost reduction in excess of $5 million for
year 2000 which involved a reduction in staff of over 40 employees and a major
restructuring of the professional services organization, including modifying
the mix of contractors to employees, the addition of project management tools
and adherence to the project implementation methodology.
The Company has four major growth initiatives that remain a focus to improve
shareholder value. The first 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 government, healthcare, transportation, financial
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 Company reported revenue of $19.4 million from four of the target
markets during the first nine months of 1999, compared to $13.6 million in
target market revenue during the first nine months of 1998. Revenue of $4.9
million was reported from four of the target markets during the third quarter
of 1999 compared to $3.5 during the third quarter of 1998.
The second 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. The Company will continue to focus on developing
comparably strong relationships in Europe, Latin America and other Pacific Rim
countries. The Asian marketplace, due to its economic challenge, most notably
Japan, was a significant disappointment to the Company during 1998 and the
first nine months of 1999. The economic environment in Latin America has also
been an impediment to growth in these markets. The Company has been
strengthening its relationships in Europe, demonstrated by $1.9 million in
sales during the first nine months of 1999, compared to $.3 million in sales
during the first nine months of 1998. Revenue from sales in Europe during the
third quarter of 1999 were $.6 million compared to nominal revenue in the third
quarter of 1998.
The third initiative relates to leveraging the Company's core competencies in
an effort to add revenues and profits. The Company believes that the hardware
service and manufacturing organizations have potential to sell their individual
expertise, experience and cost effectiveness to other entities. In 1998, the
Company was successful in attaining a $2 million contract manufacturing order
from Rapor, Inc., a security door provider, for delivery in 1999. In July
1999, the Company signed an agreement with MailCode, Inc., valued at more than
$1.5 million over twelve months for production and test of their mail sorter.
Contract manufacturing revenue was $.7 million during the first nine months of
1999, compared to $.3 million during the first nine months of 1998. Contract
manufacturing revenue for the third quarter of 1999 remained consistent with
the third quarter of 1998.
The last initiative is growth through accretive acquisitions. This initiative
has been put on hold for the present time until the Company resolves the issues
relating to the professional services organization, at which point acquisitions
will be considered based upon their individual merit and benefit to the
shareholders. During 1998, the Company completed two acquisitions, Southern
Computer Systems (SCS), a software and solutions provider, and the hardware
maintenance division of Access Corporation. (For more information, refer to
the Company's Annual Report on Form 10-K for the fiscal year ended December 31,
1998.) On June 22, 1999, the Company completed the acquisition of the
Photomatrix Scanner and Maintenance Division of Photomatrix Imaging Corporation
of Carlsbad, California, including certain product and technology rights.
Results of Operations for the Three and Nine Months Ended September 30, 1999
vs. 1998
Total revenues in the first nine months of 1999 increased $6.1 million or 18%
compared with the first nine months of 1998 and $.6 million or 5% for the third
quarter of 1999 compared to the third quarter of 1998.
Product sales decreased $1.3 million or 6% in the first nine months of 1999
compared with the first nine months of 1998. Product sales decreased $.5
million or 8% in the third quarter of 1999 compared with the third quarter of
1998. Compared to the first nine months of 1998, North American sales
increased $3 million during the first nine months of 1999. International sales
decreased $4.3 million during the first nine months of 1999 compared with the
first nine months of 1998. This decrease was mainly because $5.7 million in
sales to the Japanese health organization during the first nine months of 1998
were not repeated in 1999 but were partly offset by increases in sales to
Europe. North American sales decreased $.8 million during the third quarter of
1999 compared to the third quarter of 1998 partially offset by increases in
international sales of $.3 million during the same timeframe.
Service revenues increased $7.1 million in the first nine months of 1999
compared to the first nine months in 1998 and increased $.9 million during the
third quarter of 1999 compared to the same period in 1998. Customer service
revenue in the first nine months of 1999 increased $2.9 million compared to the
first nine months of 1998 and increased $.9 million during the third quarter of
1999 compared to the same period in 1998, mainly due to increases in the third
party maintenance business from the acquisition of the Maintenance Division of
Access Corporation, as well as the maintenance portion of the Photomatrix
acquisition. Year to date professional service revenue increased $4.2 million
compared to the same period in 1998 and remained consistent on a quarter to
quarter comparison. Professional service revenue for the third quarter was
below expectations due to revenue delays on certain projects.
Cost of product sales increased $.4 million from the first nine months of 1998
and increased $.2 million from the third quarter of 1998. Cost of product
sales as a percentage of product sales was 64% for the first nine months of
1999 compared to 58% in the prior year. This percentage was 60% for the third
quarter of 1999, compared to 52% in the prior year. These increases are due to
changes in the overall sales mix with an increased volume of lower margin
commodity items sold as part of the total customer solutions.
Service expenses increased $6.9 million in the first nine months of 1999 and
increased $3 million in the third quarter of 1999 compared with the respective
periods of 1998. Customer service expenses increased $2.2 million during the
first nine months of 1999 and $.4 million during the third quarter of 1999,
which is reflective of the ongoing operating expenses related to the increase
in revenue garnered by the acquisition of the Maintenance Division of Access
Corporation as well as the maintenance portion of the Photomatrix acquisition.
Professional service expenses increased $4.7 million during the first nine
months of 1999 and $2.6 million during the third quarter of 1999, some of which
is reflective of the increase in revenue, however, approximately $1.6 million
of the third quarter increase is directly related to cost overruns on various
project implementations. The professional services gross margin decreased to
10% in the first nine months of 1999 compared to 29% in the first nine months
of 1998. This margin was a negative 111% in the third quarter of 1999 compared
to a 32% margin in the same period in 1998. As discussed in the Outlook
section of Management's Discussion and Analysis above, a major restructuring of
the professional services organization is taking place, including modifying the
mix of contractors to employees, the addition of project management tools and
strict adherence to the project implementation methodology.
Research and development expenses increased $.5 million during the first nine
months of 1999 mainly due to the continued investment in core technologies and
application software to meet the requirements of the target markets. These
expenses increased $.1 million during the third quarter of 1999 compared to the
respective period in 1998 mainly due to expenses related to research and
development activities of the acquired Photomatrix business.
General and administrative expenses increased $.6 million during the first nine
months of 1999 compared with the first nine months of 1998. These expenses
increased $.2 million during the third quarter of 1999 compared to the third
quarter of 1998. These increases are mainly due to the amortization of
goodwill and expenses related to the non-compete agreements with the principals
of Southern Computer Systems.
Interest expense increased $.8 million during the first nine months of 1999 and
increased $.3 million during the third quarter of 1999 due to the increased
borrowing levels of the Company. See Note 4 of the Consolidated Financial
Statements.
Liquidity and Capital Resources
Cash and cash equivalents at September 30, 1999 increased $1.4 million from
December 31, 1998.
Total borrowings increased to $18.9 million at September 30, 1999 from $11.5
million at the end of 1998. On May 10, 1999, the Company amended its credit
agreement with a bank to reduce the line of credit from $13 million to $10
million and to establish a $10 million, five year term loan. As of September
30, 1999, the Company is in default of certain financial covenants on its bank
debt and is currently negotiating with its bank to restructure the borrowing
arrangements and agree to new terms and conditions. Accordingly, all bank debt
has been classified as a current liability on the consolidated balance sheet.
(See Note 4 for further details.)
Operating activities used $3.5 million of cash in the first nine months of
1999.
Non-cash expenses recorded during the first nine months of 1999 were $2.4
million vs. $2 million for the same period in 1998. These expenses relate to
depreciation of fixed assets (discussed in net plant and equipment below),
amortization of customer service spare parts inventory, amortization of
goodwill, provisions for losses on accounts receivable and deferred taxes.
Net accounts receivable increased $3.2 million during the first nine months of
the year. This increase is partially due to the timing of collections. There
are two factors associated with the growth in accounts receivables. The first
is related to product deliverables that have been adversely affected by
customers experiencing professional services project delays which are a
component of the total customer solution. The second factor is the slowdown in
collection of receivables as a result of the transition from a product based
supplier which traditionally has quicker payment time frames to a more complete
solutions provider which typically has extended payment terms and slower
payment experience, as well as the timing of payments for large state
government installations. The Company is addressing this issue with more pre-
sales communications and contract terms that better fit the solutions business,
in order to set a proper level of expectations with its customers. In
addition, unbilled receivables relating to professional services revenue
increased $2.8 million from December 31, 1998 to September 30, 1999.
Refundable income taxes increased due to estimated payments made during 1999
that are now refundable as the result of the current year loss.
Total inventories decreased $.5 million from December 31, 1998. Total
manufacturing inventories decreased $1.1 million from the beginning of the year
mainly due to reductions in finished goods inventory of $1.4 million due to
better scheduling of the build process to meet customer requirements. Customer
service inventories increased $.6 million because of the acquisition of
Photomatrix Imaging Corporation assets.
Net plant and equipment decreased $.2 million during the first nine months of
1999 mainly due to $.4 million of additions related to internal computer
equipment and the capitalization of test time related to the implementation of
the internal corporate information system, $.1 million of other operating
capital requirements, and the acquisition of the Photomatrix Imaging
Corporation fixed assets of $.1 million, offset by depreciation expense
recorded during the first nine months of the year.
Goodwill increased by $.2 million due to the acquisition in June of 1999 of
Photomatrix Imaging Corporation assets offset by goodwill amortization recorded
during the first nine months of 1999. The transaction was accounted for as a
purchase and the excess cost over the fair value of the net assets acquired of
$1.1 million is being amortized over an average period of twelve and one half
years. Southern Computer Systems (SCS), a privately held company, was
purchased in June of 1998. The transaction was accounted for as a purchase and
the excess cost over the fair value of the net assets acquired of $9.2 million
is being amortized over a twenty year period. The acquisition of the
maintenance division of Access Corporation, which also occurred in June of
1998, was accounted for as a purchase and the excess cost over fair value of
the net assets acquired of $3.5 million is being amortized over a five year
period.
Other assets increased by $2 million due to the source code licensing agreement
signed with Bluebird Systems of Carlsbad, California.
Accounts payable increased $1.2 million from December 31, 1998 as a result of
the Company's cash availability. Account balances greater than 60 days
accounted for this increase.
Notes payable to bank increased $7.4 million from December 31, 1998 due mainly
to the acquisition of Photomatrix Imaging Corporation assets, payments to
Bluebird Systems and the delays noted above in collecting outstanding accounts
receivable.
Accrued salaries and wages decreased $.7 million during the first nine months
of 1999 reflecting payment of the 1998 incentive compensation of $.6 million
and the December 1998 commission of $.9 million in 1999, offset by accruals for
1999 commission and vacation.
Taxes other than income taxes increased $.5 million due to the timing of sales
and use tax payments.
Other current liabilities increased $2.2 million from December 31, 1998 mainly
due to accruals related to professional service consulting expenses, accruals
for the source code licensing agreement with Bluebird systems and accrued
interest on bank borrowings.
Other liabilities decreased $.3 million from December 31, 1998 due to payments
for the consulting and noncompetition agreements for the principals of Southern
Computer Systems.
<PAGE>
SCAN-OPTICS, INC., AND SUBSIDIARIES
PART II - OTHER INFORMATION
ITEM 6 (B) - EXHIBITS AND REPORTS ON FORM 8-K
No reports on Form 8-K were filed during the first nine months of 1999.
<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 15, 1999 /ss/
James C. Mavel
Chairman, Chief Executive Officer,
President and Director
Date November 15, 1999 /ss/
Michael J. Villano
Chief Financial Officer,
Vice President and Treasurer
<TABLE> <S> <C>
<ARTICLE> 5
<CAPTION>
EXHIBIT 27.
SCAN-OPTICS, INC.
FINANCIAL DATA SCHEDULE
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-END> SEP-30-1999
<CASH> 1,593,000
<SECURITIES> 0
<RECEIVABLES> 25,974,000
<ALLOWANCES> 244,000
<INVENTORY> 10,957,000
<CURRENT-ASSETS> 43,098,000
<PP&E> 20,222,000
<DEPRECIATION> 17,110,000
<TOTAL-ASSETS> 62,055,000
<CURRENT-LIABILITIES> 32,438,000
<BONDS> 0
<COMMON> 148,000
0
0
<OTHER-SE> 28,301,000
<TOTAL-LIABILITY-AND-EQUITY> 62,055,000
<SALES> 19,377,000
<TOTAL-REVENUES> 40,517,000
<CGS> 12,338,000
<TOTAL-COSTS> 31,391,000
<OTHER-EXPENSES> 58,000
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 982,000
<INCOME-PRETAX> (3,178,000)
<INCOME-TAX> (1,358,000)
<INCOME-CONTINUING> (1,820,000)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (1,820,000)
<EPS-BASIC> (.26)
<EPS-DILUTED> (.26)
</TABLE>
