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, 1999
-------------------------------------------
( )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 Identification Number)
incorporation or organization)
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
13, 1999 was 7,396,232.
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<TABLE>
<CAPTION>
SCAN-OPTICS, INC., AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(thousands, except share data) June 30, 1999 December 31, 1998
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(UNAUDITED)
<S> <C> <C>
Assets
Current Assets:
Cash and cash equivalents $ 251 $ 216
Accounts receivable less allowance of
$221 at June 30, 1999 and
$206 at December 31, 1998 28,378 22,725
Inventories 10,682 11,478
Deferred taxes 1,082 960
Deferred costs, net of revenues 499 502
Prepaid expenses and other 1,364 1,012
-----------------------------
Total current assets 42,256 36,893
Plant and equipment:
Equipment 14,063 13,601
Leasehold improvements 4,847 4,815
Office furniture and fixtures 1,311 1,307
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20,221 19,723
Less allowances for depreciation and
amortization 16,894 16,367
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3,327 3,356
Goodwill, net 12,621 12,110
Other assets 1,531 633
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Total Assets $ 59,735 $ 52,992
=============================
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
(thousands, except share data) June 30, 1999 December 31, 1998
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(UNAUDITED)
<S> <C> <C>
Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable $ 4,439 $ 5,487
Notes payable to bank 11,094 11,524
Salaries and wages 1,513 2,007
Taxes other than income taxes 1,067 691
Income taxes 35
Customer deposits 258 99
Other 1,754 1,943
------------------------------
Total current liabilities 20,125 21,786
Deferred taxes 76 263
Note payable to bank 8,500
Other liabilities 697 697
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, 7,396,232 shares
at June 30, 1999 and
7,370,482 shares
at December 31, 1998 150 147
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 35,566 35,501
Retained-earnings deficit (2,097) (2,240)
Foreign currency translation adjustments (636) (516)
------------------------------
32,983 32,892
Less cost of common stock in treasury,
413,500 shares 2,646 2,646
------------------------------
Total stockholders' equity 30,337 30,246
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Total Liabilities and
Stockholders' Equity $ 59,735 $ 52,992
==============================
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) 1999 1998 1999 1998
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<S> <C> <C> <C> <C>
Revenues
Product sales $ 6,941 $ 5,735 $ 13,520 $ 14,273
Service revenues 7,770 3,900 14,341 8,156
Engineering revenues 114 33 187 100
Other operating revenues 4 36 13 67
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Total revenues 14,829 9,704 28,061 22,596
Costs and Expenses
Cost of product sales 4,327 2,880 8,808 8,620
Service expenses 5,331 2,984 9,869 5,914
Sales and marketing expenses 2,218 1,566 3,577 2,919
Research and development expenses 1,424 1,235 2,908 2,519
General and administrative expenses 1,198 869 2,279 1,812
Interest expense 293 15 515 15
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Total costs and expenses 14,791 9,549 27,956 21,799
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Operating income 38 155 105 797
Other income, net 40 74 92 135
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Income before income taxes 78 229 197 932
Income taxes 15 89 54 365
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Net Income 63 140 143 567
========================================================================
Basic earnings per share .01 .02 .02 .08
========================================================================
Basic weighted-average shares 6,984,361 6,956,478 6,974,941 6,884,584
Diluted earnings per share .01 .02 .02 .08
========================================================================
Diluted weighted-average shares 7,174,591 7,130,938 7,121,768 7,140,200
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
SCAN-OPTICS, INC., AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
Six Months Ended
June 30
(thousands) 1999 1998
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<S> <C> <C>
Operating Activities
Net income $ 143 $ 568
Adjustments to reconcile net income to net
cash provided (used) by operating activities:
Depreciation 529 600
Amortization 844 801
Amortization of goodwill 579 663
Provision for losses on accounts receivable 30
Deferred taxes (309) 163
Changes in operating assets and liabilities:
Accounts receivable (5,198) 1,678
Inventories 1,342 2,125
Prepaid expenses and other (276) (363)
Accounts payable (1,639) (183)
Accrued salaries and wages (711) (649)
Taxes other than income taxes 376 50
Income taxes (35) (942)
Deferred costs, net of revenues 3 (215)
Customer deposits 159 (2,420)
Other (1,507) (313)
------------------------------
Net cash provided (used) by operating activities (5,670) 1,563
Investing Activities
Business acquisitions (2,100) (12,600)
Purchases of plant and equipment (333) (631)
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Net cash used by investing activities (2,433) (13,231)
Financing Activities
Proceeds from issuance of common stock 68 472
Proceeds from borrowings 24,437 8,285
Principal payments on borrowings (16,367) (2)
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Net cash provided by financing activities 8,138 8,755
Increase (decrease) in cash and cash equivalents 35 (2,913)
Cash and Cash Equivalents at Beginning of Year 216 4,386
------------------------------
Cash and Cash Equivalents at End of Period $ 251 $ 1,473
==============================
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 six month period ended June 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>
June 30 December 31
(thousands) 1999 1998
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<S> <C> <C>
Finished goods $ 564 $ 1,885
Work-in-process 2,259 2,129
Service parts 4,560 3,808
Materials and component parts 3,299 3,656
----------------------------------
$ 10,682 $ 11,478
==================================
</TABLE>
NOTE 3 - Acquisition Activities
On June 22, 1999 the Company completed the acquisition of the product rights and
certain assets of the Photomatrix Imaging Corporations subsidiary of
Photomatrix, Inc. for $2.1 million in cash. 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.
The Company recently announced that it had reached an agreement in principle to
acquire 100% of the stock in Agissar Corporation.
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 $406,000 and $1,717,000 as of June 30, 1999 and June 30, 1998 respectively.
The weighted average interest rates on borrowings during the first half of 1999
and 1998 were 8.0% and 8.4% 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.
NOTE 5 - Income Taxes
At June 30, 1999, the Company has approximately $340,000, $2,700,000 and
$800,000 of net operating loss carryforwards for Canada, the United Kingdom and
Germany respectively, which are scheduled to expire periodically between 1999
and 2005. At June 30, 1998, the Company had approximately $200,000, $2,750,000
and $650,000 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 six 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 effective tax
rate for the six months ended June 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:
<TABLE>
<CAPTION>
June 30 December 31
(thousands) 1999 1998
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<S> <C> <C>
Deferred tax assets:
Net operating losses $ 1,460 $ 1,475
Depreciation 179 92
Inventory valuation 174 174
Inventory 191 115
Deferred maintenance revenue 108 178
Accounts receivable reserves 26 26
Goodwill 73 59
Revenue recognition - systems
undergoing acceptance testing 147 29
Vacation accrual 186 188
Other 162 162
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Total deferred tax assets 2,706 2,498
Deferred tax liabilities:
Depreciation and other (84)
-----------------------------
Total deferred tax liabilities (84)
Valuation allowance (1,700) (1,717)
-----------------------------
Net deferred taxes $ 1,006 $ 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 Six Months Ended
June 30 June 30
1999 1998 1999 1998
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<S> <C> <C> <C> <C>
Numerator:
Net income $ 63 $ 140 $ 143 $ 567
============================================================
Denominator:
Denominator for basic earnings
per share (weighted-average shares) 6,984,361 6,956,478 6,974,941 6,884,584
Effect of dilutive securities:
Employee stock options 190,230 174,460 146,827 255,616
Denominator for diluted earnings
per share (adjusted weghted-average ------------------------------------------------------------
shares and assumed conversions) 7,174,591 7,130,938 7,121,768 7,140,200
============================================================
Basic earnings per share $ .01 $ .02 $ .02 $ .08
============================================================
Diluted earnings per share $ .01 $ .02 $ .02 $ .08
============================================================
</TABLE>
NOTE 7 - Year 2000 Compliance
The Company is continuing to devote 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 preliminary 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 recently completed the replacement of
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. The Company does not currently have sufficient information
about the Year 2000 exposure or remediation plans of such parties to predict the
risk they pose to the Company. If the third parties with which the Company
interacts have Year 2000 problems that are not remedied, resulting problems
could include the loss of telecommunications and electrical service, the receipt
of inaccurate financial and billing-related information, and the disruption of
capital flow potentially resulting in liquidity stress.
Due to the uncertainties presented by such third party Year 2000 problems, and
the possibility that, despite its efforts, the Company may be unsuccessful in
preparing its internal systems and equipment for the Year 2000, the Company is
developing contingency plans for dealing with the most reasonably likely worst
case scenarios. The exact nature and scope of the Company's contingency plans
will be based upon an analysis of information gathered during the inventory,
assessment and remediation phases of its Year 2000 program. The Company expects
to complete its contingency planning during the third quarter of 1999, and to
have all contingency systems in place and fully tested by the fourth quarter of
1999.
The Company estimates that, as of June 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
six months ended June 30, 1999 and 1998 are as follows:
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30 June 30
1999 1998 1999 1998
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<S> <C> <C> <C> <C>
Net income $ 63 $ 140 $ 143 $ 567
Foreign currency translation adjustments (48) 2 (88) 24
-----------------------------------------------
Comprehensive income $ 15 $ 142 $ 55 $ 591
===============================================
</TABLE>
The components of accumulated comprehensive income, net of related tax, at June
30, 1999 and December 31, 1998 are as follows:
<TABLE>
<CAPTION>
June 30 December 31
(thousands) 1999 1998
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<S> <C> <C>
Foreign currency translation adjustments $ (561) $ (473)
-----------------------------------
Accumulated comprehensive income $ (561) $ (473)
===================================
</TABLE>
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 Six Months Ended
June 30 June 30
1999 1998 1999 1998
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<S> <C> <C> <C> <C>
Revenues
Product and solution sales $ 10,898 $ 6,582 $ 19,979 $ 16,832
Maintenance revenue 3,753 2,874 7,484 5,516
Contract manufacturing 178 248 598 248
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Total revenues 14,829 9,704 28,061 22,596
Cost of product sales 4,327 2,880 8,808 8,620
Service expenses 5,331 2,984 9,869 5,914
-----------------------------------------------------------
Gross profit margin 5,171 3,840 9,384 8,062
Operating expenses
and other income, net 5,093 3,611 9,187 7,130
-----------------------------------------------------------
Income before income taxes $ 78 $ 229 $ 197 $ 932
===========================================================
Total expenditures for additions
to long-lived assets $ 219 $ 198 $ 498 $ 505
</TABLE>
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, 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.
The Company has four major growth initiatives currently underway 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 $14.5 million from four of the target
markets during the first six months of 1999, compared to $4.4 million in target
market revenue during the first six months of 1998. Revenue of $8.6 million was
reported from four of the target markets during the second quarter of 1999
compared to $2.1 during the second 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. During 1998, the Company had minimal achievements with this
initiative. The Asian marketplace, due to its economic challenge, most notably
Japan, was a significant disappointment to the Company during 1998 and the first
six 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 $1.6 million in sales during the first
six months of 1999, compared to $.6 million in sales during the first six months
of 1998. Revenue from sales in Europe during the second quarter of 1999 were
$.6 million compared to $.2 million during the second 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.
The last initiative is growth through accretive acquisitions. 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 includes
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. 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. The Company recently announced that it
had reached an agreement in principle to acquire 100% of the stock of Agissar
Corporation.
RESULTS OF OPERATIONS FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 1999 VS. 1998
Total revenues in the first six months of 1999 increased $5.5 million or 24%
compared with the first six months of 1998 and $5.1 million or 53% for the
second quarter of 1999 compared to the second quarter of 1998.
Product sales decreased $.8 million or 5% in the first six months of 1999
compared with the first six months of 1998. Product sales increased $1.2
million or 21% in the second quarter of 1999 compared with the second quarter of
1998. Compared to the first six months of 1998, North American sales increased
$3.8 million during the first six months of 1999. International sales decreased
$4.6 million during the first six months of 1999 compared with the first six
months of 1998. This decrease was mainly because $5.7 million in sales to the
Japanese health organization during the first six months of 1998 were not
repeated in 1999 but were partly offset by increases in sales to Europe. North
American sales increased $.9 million during the second quarter of 1999 compared
to the second quarter of 1998 due to the Company's continued focus on solutions
sales. International sales increased $.3 million during the second quarter of
1999 due to the focus on sales to Europe.
Service revenues increased $6.2 million in the first six months of 1999 compared
to the first six months in 1998 and increased $3.9 million during the second
quarter of 1999 compared to the same period in 1998. Customer service revenue
in the first six months of 1999 increased $2.0 million compared to the first six
months of 1998 and increased $.9 million during the second quarter of 1999
compared to the same period in 1998, mainly due to increases in the third party
maintenance business. Year to date professional service revenue increased $4.2
million and increased $3.0 million in the second quarter reflecting the
Company's drive to provide greater customer value through total solutions in the
targeted markets.
Cost of product sales increased $.2 million from the first six months of 1998
and increased $1.4 million from the second quarter of 1998. Cost of product
sales as a percentage of product sales was 65% for the first six months of 1999
compared to 60% in the prior year. This percentage was 62% for the second
quarter of 1999, compared to 50% 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 $4 million in the first six months of 1999 and
increased $2.3 million in the second quarter of 1999 compared with the
respective periods of 1998. Customer service expenses increased $1.8 million
during the first six months of 1999 and $1 million during the second 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. Professional service expenses increased $2.2 million during
the first six months of 1999 and $1.3 million during the second quarter of 1999,
reflective of the increase in revenue. The professional services gross margin
increased 10% to 42% in the first six months of 1999 compared to 32% in the
first six months of 1998. This margin increased 37% to 44% in the second
quarter of 1999 compared to 7% in the second quarter of 1998. The Company
continues to focus on and invest in the target market solution applications
which require skilled employees to deliver the hardware, software, and
professional services to meet the customers' complete solution requirements.
Research and development expenses increased $.4 million during the first six
months of 1999 and increased $.2 million during the second quarter of 1999
compared to the respective periods in 1998 mainly due to the continued
investment in core technologies and application software to meet the
requirements of the target markets.
General and administrative expenses increased $.5 million during the first six
months of 1999 compared with the first six months of 1998. These expenses also
increased $.3 million during the second quarter of 1999 compared to the second
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 $.5 million during the first six months of 1999 and
increased $.3 million during the second 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 June 30, 1999 increased $35,000 from December 31,
1998.
Total borrowings increased to $19.6 million at June 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. (See Note 4 for further details.)
Additional acquisition activity may cause the Company to review other financing
alternatives.
Operating activities used $6.5 million of cash in the first six months of 1999.
Non-cash expenses recorded during the first six months of 1999 were $1.7 million
vs. $2.2 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 $5.7 million during the first six months of
the year. This increase is partially due to the timing of collections. The
collection of receivables has been slowing as a result of the transition from a
product based supplier which traditionally has quicker payment time frames and
experience to a more complete solutions provider which typically has extended
payment terms and a slower payment history, 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 language that better fits the
solutions business, in order to set a proper level of expectations with its
customers. The increase in accounts receivable was also due to the acquisition
of Photomatrix Imaging Corporation assets which accounted for $1 million. In
addition, unbilled receivables relating to professional services revenue
increased $1.4 million.
Total inventories decreased $.8 million from December 31, 1998. Total
manufacturing inventories decreased $1.5 million from the beginning of the year
mainly due to reductions in finished goods inventory of $1.3 million due to year
to date sales. Customer service inventories increased $.7 million due to the
customer service inventory related to the acquisition of Photomatirx Imaging
Corporation assets.
Prepaid expenses and other increased $.4 million mainly due to the timing of
1999 tax payments.
Net plant and equipment remained flat during the first six months of 1999
mainly due to $.3 million of additions related to internal computer equipment
and the capitalization of test time related to the implementation of the
internal corporate information system and the acquisition of the Photomatrix
Imaging Corporation fixed assets of $.1 million, offset by depreciation expense
recorded during the first six months of the year.
Goodwill increased by $.5 million due to the acquisition of Photomatrix
Imaging Corporation assets offset by goodwill amortization recorded during the
first six months of 1999. 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.
Assets of Photomatrix Imaging Corporation were purchased in June 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.
Other assets increased by $.9 million due to the source code licensing agreement
signed with Bluebird Systems of Carlsbad, California.
Accounts payable decreased $1 million from December 31, 1998 due to the timing
of payments.
Accrued salaries and wages decreased $.5 million during the first six 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
commission and vacation.
Taxes other than income taxes increased $.4 million due to the timing of sales
and use tax payments.
<PAGE>
SCAN-OPTICS, INC., AND SUBSIDIARIES
PART II - OTHER INFORMATION
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
(a) The annual meeting of stockholders was held on May 21, 1999.
(c) The matters voted on at the meeting, number of votes cast or
withheld, number of abstentions and broker nonvotes were:
1. Election of Directors:
For Withheld
--- --------
E. Bulkeley Griswold 6,806,506 110,281
John J. Holton 6,680,639 125,866
Robert H. Steele 6,696,514 109,991
2. Approval of 1999 Incentive and Non-Qualified Stock Option
Plan:
Broker
For Against Abstentions Nonvotes
--- ------- ----------- --------
3,867,095 514,700 48,220 2,376,490
3. Appointment of Ernst & Young LLP as auditors for the fiscal
year ending December 31, 1999.
For Against Abstentions
--- ------- -----------
6,739,680 60,233 6,593
ITEM 6 - EXHIBITS AND REPORTS ON FORM 8-K
(a) 10.11. The Scan-Optics, Inc. 1999 Incentive and Non-Qualified Stock Option
Plan, approved by the stockholders on May 20,1999, is incorporated herein as an
Exhibit by reference to the copy filed as part of the Company's proxy statement
dated April 8, 1999 for its 1999 Annual Meeting of Stockholders.
(b) No reports on Form 8-K were filed during the first six 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 August 16, 1999 /ss/
--------------------------- ----------------------------------
James C. Mavel
Chairman, Chief Executive Officer,
President and Director
Date August 16, 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> 6-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-END> JUN-30-1999
<CASH> 251,000
<SECURITIES> 0
<RECEIVABLES> 28,378,000
<ALLOWANCES> 221,000
<INVENTORY> 10,682,000
<CURRENT-ASSETS> 42,256,000
<PP&E> 20,221,000
<DEPRECIATION> 16,894,000
<TOTAL-ASSETS> 59,735,000
<CURRENT-LIABILITIES> 20,125,000
<BONDS> 0
<COMMON> 150,000
0
0
<OTHER-SE> 30,187,000
<TOTAL-LIABILITY-AND-EQUITY> 59,735,000
<SALES> 13,520,000
<TOTAL-REVENUES> 28,061,000
<CGS> 8,808,000
<TOTAL-COSTS> 27,956,000
<OTHER-EXPENSES> (92,000)
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 515,000
<INCOME-PRETAX> 197,000
<INCOME-TAX> 54,000
<INCOME-CONTINUING> 143,000
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 143,000
<EPS-BASIC> .02
<EPS-DILUTED> .02
</TABLE>
