-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, TsP0VXgLxkrOqCQa34ZJpaC5RwT/RDJ4nmzUgWZ9nW4jhhvfH9NYeXwcNXyG7Sna 1u1uJtp0UjB72TZGQuk8pw== 0000906602-99-000134.txt : 19990518 0000906602-99-000134.hdr.sgml : 19990518 ACCESSION NUMBER: 0000906602-99-000134 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19990331 FILED AS OF DATE: 19990517 FILER: COMPANY DATA: COMPANY CONFORMED NAME: SCAN OPTICS INC CENTRAL INDEX KEY: 0000087086 STANDARD INDUSTRIAL CLASSIFICATION: COMPUTER PERIPHERAL EQUIPMENT, NEC [3577] IRS NUMBER: 060851857 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 000-05265 FILM NUMBER: 99625243 BUSINESS ADDRESS: STREET 1: 169 PROGRESS DR CITY: MANCHESTER STATE: CT ZIP: 06040 BUSINESS PHONE: 8606457878 MAIL ADDRESS: STREET 1: 169 PROGRESS DR CITY: MANCHESTER STATE: CT ZIP: 06040 10-Q 1 UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q (Mark One) ( X ) Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the quarterly period ended MARCH 31, 1999 ------------------------------------------ ( ) Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the transition period from to ------------------ ------------------ Commission File No. 0-5265 ----------------------------------------------------- SCAN-OPTICS, INC. - -------------------------------------------------------------------------- (Exact name of registrant as specified in its charter) DELAWARE 06-0851857 - -------------------------------------------------------------------------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification Number) 169 PROGRESS DRIVE, MANCHESTER, CT 06040 - -------------------------------------------------------------------------- (Address of principal executive offices) Zip Code (860) 645-7878 - -------------------------------------------------------------------------- (Registrant's telephone number, including area code) Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. ( X ) YES ( ) NO The number of shares of common stock, $.02 par value, outstanding as of May 12, 1999 was 7,396,232. SCAN-OPTICS, INC., AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (thousands, except share data) March 31, 1999 December 31, 1998 - ------------------------------------------------------------------------------ (UNAUDITED) Assets Current Assets: Cash and cash equivalents $ 234 $ 216 Accounts receivable less allowance of $192 at March 31, 1999 and $206 at December 31,1998 21,630 22,725 Inventories 10,694 11,478 Deferred taxes 930 960 Deferred costs, net of revenues 419 502 Prepaid expenses and other 919 1,012 --------------------------------- Total current assets 34,826 36,893 Plant and equipment: Equipment 13,861 13,601 Leasehold improvements 4,830 4,815 Office furniture and fixtures 1,311 1,307 --------------------------------- 20,002 19,723 Less allowances for depreciation and 16,612 16,367 --------------------------------- ammortization 3,390 3,356 Goodwill, net 11,820 12,110 Other assets 1,483 633 --------------------------------- Total Assets $ 51,519 $ 52,992 ================================= (thousands, except share data) March 31, 1999 December 31, 1998 - ------------------------------------------------------------------------------ (UNAUDITED) Liabilities and Stockholders' Equity Current liabilities: Accounts payable $ 3,936 $ 5,487 Notes payable to bank 11,545 11,524 Salaries and wages 1,023 2,007 Taxes other than income taxes 867 691 Income taxes 35 Customer deposits 1,132 99 Other 1,827 1,943 ---------------------------------- Total current liabilities 20,330 21,786 Deferred taxes 171 263 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, 7,391,232 shares at March 31, 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 35,555 35,501 Retained-earnings deficit (2,160) (2,240) Foreign currency translation adjustments (576) (516) ---------------------------------- 32,967 32,892 Less cost of common stock in treasury, 413,500 shares 2,646 2,646 ---------------------------------- Total stockholders' equity 30,321 30,246 ---------------------------------- Total Liabilities and Stockholders' Equity $ 51,519 $ 52,992 ================================== See accompanying notes.
SCAN-OPTICS, INC. CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED) Three Months Ended March 31 (thousands, except share data) 1999 1998 - ------------------------------------------------------------------------------- Revenues Product sales $ 6,579 $ 8,538 Service revenues 6,571 4,256 Engineering revenues 73 67 Other operating revenues 9 31 ------------------------------- Total revenues 13,232 12,892 Costs and Expenses Cost of product sales 4,481 5,739 Service expenses 4,538 2,930 Sales and marketing expenses 1,359 1,353 Research and development expenses 1,484 1,284 General and administrative expenses 1,081 943 Interest expense 222 ------------------------------- Total costs and expenses 13,165 12,249 ------------------------------- Operating income 67 643 Other income, net 52 61 ------------------------------- Income before income taxes 119 704 Income taxes 39 276 ------------------------------- Net Income $ 80 $ 428 =============================== Basic earnings per share $ .01 $ .06 =============================== Basic weighted-average shares 6,965,521 6,812,689 Diluted earnings per share $ .01 $ .06 =============================== Diluted weighted-average shares 7,068,944 7,149,461 See accompanying notes.
SCAN-OPTICS, INC., AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) Three Months Ended March 31 (thousands) 1999 1998 - ------------------------------------------------------------------------------- Operating Activities Net income $ 80 $ 428 Adjustments to reconcile net income to net cash provided (used) by operating activities: Depreciation 237 298 Amortization 411 402 Amortization of goodwill 290 Provision for losses on accounts receivable 10 Deferred taxes (62) 242 Changes in operating assets and liabilities: Accounts receivable 1,085 1,893 Inventories 373 2,376 Prepaid expenses and other 93 318 Accounts payable (1,551) (778) Accrued salaries and wages (984) (1,046) Taxes other than income taxes 176 (374) Income taxes (35) (708) Deferred costs, net of revenues 83 (87) Customer deposits 1,033 (2,274) Other (1,026) (36) ----------------------------- Net cash provided by operating activities 213 654 Investing Activities Purchases of plant and equipment (271) (157) ----------------------------- Net cash used by investing activities (271) (157) Financing Activities Proceeds from issuance of common stock 55 64 Proceeds from borrowings 11,385 Principal payments on borrowings (11,364) ----------------------------- Net cash provided by financing activities 76 64 Increase in cash and cash equivalents 18 561 Cash and Cash Equivalents at Beginning of Year 216 4,386 ----------------------------- Cash and Cash Equivalents at End of Period $ 234 $ 4,947 ============================= See accompanying notes.
SCAN-OPTICS, INC., AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) For the Quarter Ended March 31, 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 three month period ended March 31, 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: March 31 December 31 (THOUSANDS) 1999 1998 - ----------------------------------------------------------------------- Finished goods $ 1,863 $ 1,885 Work-in-process 1,298 2,129 Service parts 3,816 3,808 Materials and component parts 3,717 3,656 --------------------------------- $ 10,694 $ 11,478 =================================
NOTE 3 - Acquisition Activities The Company recently announced the signing of a memorandum of agreement to acquire the Photomatrix Scanner and Maintenance Division of Photomatrix Imaging Corporation of Carlsbad, California, including certain product and technology rights. The acquisition is subject to the negotiation and execution of a definitive asset purchase agreement, a related agreement for Photomatrix to manufacture certain products for the Company, and the approval of the Boards of Directors of both corporations. NOTE 4 - Credit Arrangements On May 28, 1998, the Company amended its credit agreement (the "Agreement") with a bank to extend the maturity date to May 27, 1999 and to increase the line from $4 million to $10 million. Subsequently, the line of credit was increased from $10 million to $13 million through May 27, 1999. 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 3/8% per annum. The available balance on the line of credit was $1,455,000 at March 31, 1999. There were no borrowings during the first quarter of 1998. The weighted average interest rate on borrowings during the first quarter of 1999 was 7.84%. The Company negotiated changes to the line of credit effective May 10, 1999. The $13 million line of credit has been reduced to $10 million with a three year term. The unused portion of the line continues to be subject to a commitment fee of 3/8% per annum. Additionally, a five year term loan in the amount of $10 million has been 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 March 31, 1999, the Company has approximately $350,000, $2,600,000 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 March 31, 1998, the Company had approximately $450,000, $2,600,000 and $700,000 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 quarter of 1999 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: March 31 December 31 (THOUSANDS) 1999 1998 - ------------------------------------------------------------------------- Deferred tax assets: Net operating losses $ 1,444 $ 1,475 Depreciation 92 92 Inventory valuation 174 174 Inventory 153 115 Deferred maintenance revenue 133 178 Accounts receivable reserves 26 26 Goodwill 89 59 Revenue recognition - systems undergoing acceptance testing 6 29 Vacation accrual 187 188 Other 162 162 --------------------------- Total deferred tax assets 2,466 2,498 Deferred tax liabilities: Depreciation and other (21) (84) --------------------------- Total deferred tax liabilities (21) (84) Valuation allowance (1,686) (1,717) --------------------------- Net deferred taxes $ 759 $ 697 ===========================
NOTE 6 - Earnings Per Share The following table sets forth the computation of basic and diluted earnings per share: March 31 March 31 1999 1998 - ------------------------------------------------------------------------- Numerator: Net income $ 80 $ 428 ============================= Denominator: Denominator for basic earnings per share (weighted-average shares) 6,965,521 6,812,689 Effect of dilutive securities: Employee stock options 103,423 336,772 Denominator for diluted earnings per share (adjusted weighted-average ----------------------------- shares and assumed conversions) 7,068,944 7,149,461 ============================= Basic earnings per share $ .01 $ .06 ============================= Diluted earnings per share $ .01 $ .06 =============================
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 intends to perform independent Year 2000 testing of these systems, and the testing is expected to be completed during the second quarter of 1999. The Company has completed its inventory of other systems, equipment and items that potentially present a Year 2000 problem. The Company in the process of performing internal testing, and seeking outside certification, of material inventoried items, and expects to complete such assessment by the end of the second quarter of 1999. While the Company will not know the nature and extent of required repairs and replacements of non-compliant systems and equipment until such assessment is completed, it currently anticipates completing and testing such repairs and replacements by June 1999. In addition to its own systems and equipment, the Company depends upon the proper function of computer systems and other date-sensitive equipment of outside parties. These parties include banks, telecommunications service providers, electric and other utilities and significant suppliers. The Company has contacted most of such parties to determine the extent to which they are vulnerable to the Year 2000 problem, and expects to complete 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 second quarter of 1999, and to have all contingency systems in place and fully tested by the fourth quarter of 1999. The Company estimates that, as of March 31, 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- months ended March 31, 1999 and 1998 are as follows: March 31 March 31 (THOUSANDS) 1999 1998 - ------------------------------------------------------------------------ Net income $ 80 $ 428 Foreign currency translation adjustments (40) 22 ---------------------------- Comprehensive income $ 40 $ 450 ============================
The components of accumulated comprehensive income, net of related tax, at March 31, 1999 and December 31, 1998 are as follows: March 31 December 31 (THOUSANDS) 1999 1998 - ------------------------------------------------------------------------ Foreign currency translation adjustments $ (513) $ (473) ---------------------------- Accumulated comprehensive income $ (513) $ (473) ============================
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. Three Months Ended March 31 (THOUSANDS) 1999 1998 - ------------------------------------------------------------------------ Revenues Product and solution sales $ 9,081 $ 10,250 Maintenance revenue 3,731 2,642 Contract manufacturing 420 --------------------------- Total revenues 13,232 12,892 Cost of product sales 4,481 5,739 Service expenses 4,538 2,930 --------------------------- Gross profit margin 4,213 4,223 Operating expenses, net 4,094 3,519 --------------------------- Income before income taxes $ 119 $ 704 =========================== Total expenditures for additions to long-lived assets $ 279 $ 307
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 $5.8 million from four of the target markets in the first quarter of 1999, compared to $2.3 million in target market revenue during the first 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. 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 million in sales during the first quarter of 1999, compared to $.4 million in sales during the first 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 the first quarter of 1999, the Company received an initial order from another customer for manufacture of its product. The Company expects follow on orders to be received after the completion of the initial order. The last initiative is growth through an accretive acquisition or 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.) The Company announced on April 13, 1999, that it had signed a memorandum of agreement to acquire the Photomatrix Scanner and Maintenance Division of Photomatrix Imaging Corporation of Carlsbad, California, including certain product and technology rights. 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. RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED MARCH 31, 1999 VS. 1998 Total revenues increased $.4 million or 3% from the first quarter of 1998 to the first quarter of 1999. Product sales decreased $2.0 million or 23% in the first quarter of 1999 compared with the first quarter of 1998. North American sales increased $2.7 million or 149% due to the continued focus on solutions sales growth in this geographic area. International sales decreased $4.7 million or 70% mainly due to the $5.7 million in sales to the Japanese health organization in the first quarter of 1998, partly offset by an increase in sales to Europe during the first quarter of 1999. Service revenues increased $2.3 million during the first three months of 1999 compared to the same period in 1998. Hardware maintenance and support revenue increased $1.1 million mainly due to the increase in the third party maintenance business. Professional service revenue increased $1.2 million reflecting the Company's drive to provide greater customer value through total solutions in the targeted markets. Cost of product sales decreased $1.3 million from the first quarter of 1998. Cost of product sales as a percentage of product sales was 68% for the first quarter of 1999, compared to 67% in the prior year. The components of cost of sales changed markedly from the first quarter of 1998 to the first quarter of 1999. In the first quarter of 1998, cost of sales reflected a lower gross margin on sales, mainly due to the low margin on product sales to the Japanese health organization, offset by manufacturing efficiencies achieved from the production volume. In the first quarter of 1999, manufacturing volume was down; however, this was offset by the increased gross margin on end user sales. Service expenses increased $1.6 million in the first quarter of 1999 compared with the respective period of 1998. Customer service expenses increased $.7 million which is reflective of the increase in revenue. The gross margin on customer service revenue increased 3% from 21% in the first quarter of 1998 to 24% in the first quarter of 1999. Professional service expenses increased $.9 million, reflective of the increase in revenue. The gross margin on professional service revenue was 47% in the first quarter of 1998, and 40% in the first quarter of 1999. 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 $.2 million from the first quarter of 1998 to the first quarter of 1999 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 $.1 million from the first quarter of 1998 to the first quarter of 1999 mainly due to the amortization of goodwill. LIQUIDITY AND CAPITAL RESOURCES Cash and cash equivalents at March 31, 1999 increased $18,000 from December 31, 1998. As of March 31, 1999, the Company had $11.5 million in outstanding borrowings against its $13 million line of credit. The Company negotiated changes to the line of credit effective May 10, 1999, which are outlined in Note 4. Additional acquisition activity may cause the Company to review other financing alternatives. Operating activities provided $.4 million of cash in the first three months of 1999. Non-cash expenses recorded during the quarter were $.9 million vs. $.9 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 decreased $1.1 million during the first quarter of the year due to collections on 1998 sales offset by first quarter 1999 sales. Total inventories decreased $.8 million in the first quarter of 1999. Total manufacturing inventories decreased $.8 million from the beginning of the year due to reductions in work-in-process inventory of $.8 million due to the timing of the manufacturing production cycle. Customer service inventories remained consistent with the beginning of the year levels. Net plant and equipment remained flat during the first quarter 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, offset by $.3 million of depreciation expense recorded during the first three months of the year. Goodwill decreased by $.3 million due to the amortization recorded for the quarter. 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 $.9 million due to the source code licensing agreement signed with Bluebird Systems of Carlsbad, California. Accounts payable decreased $1.6 million from December 31, 1998 due to the timing of payments. Accrued salaries and wages decreased $1 million during the first quarter of 1999 reflecting the disbursement of the 1998 incentive compensation of $.6 million and the December 1998 commission of $.9 million. This was partly offset by the accrual of commissions related to the first quarter of 1999. Taxes other than income taxes increased $.2 million due to the timing of sales and use tax payments. Customer deposits increased $1 million from December 31, 1998, mainly due to the receipt of a $.9 million deposit from a customer for work to be performed during 1999. SCAN-OPTICS, INC., AND SUBSIDIARIES PART II - OTHER INFORMATION ITEM 6 (B) - REPORTS ON FORM 8-K For the Three Months Ended March 31, 1999 No reports on Form 8-K were filed during the first three months of 1999. SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. SCAN-OPTICS, INC. (Registrant) Date MAY 14, 1999 /ss/ ----------------- ------------------------------------- James C. Mavel Chairman, Chief Executive Officer, President and Director Date MAY 14, 1999 /ss/ ---------------- ------------------------------------- Michael J. Villano Chief Financial Officer, Vice President and Treasurer EX-27 2 ART. 5 FDS FOR SCAN-OPTICS CORPORATION
5 EXHIBIT 27. SCAN-OPTICS, INC. FINANCIAL DATA SCHEDULE 3-MOS DEC-31-1999 MAR-31-1999 234,000 0 21,630,000 192,000 10,694,000 34,826,000 20,002,000 16,612,000 51,519,000 20,330,000 0 148,000 0 0 30,173,000 51,519,000 6,579,000 13,232,000 4,481,000 13,165,000 (52,000) 0 222,000 119,000 39,000 80,000 0 0 0 80,000 .01 .01
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