-----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, Oogeg6O6ecT1xzvT7GVzN+LXEffNGhgNxEVoGHQquI9DMvdC293DSQXicNNWU1pN GwbFCLDOEYP0+f9D/zCFjw== 0000906602-98-000192.txt : 19980817 0000906602-98-000192.hdr.sgml : 19980817 ACCESSION NUMBER: 0000906602-98-000192 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19980630 FILED AS OF DATE: 19980814 SROS: NONE 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: 98689998 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 June 30, 1998 ------------- ( )Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the transition period from to ----------- ------------- Commission File No. 0-5265 ---------- SCAN-OPTICS, INC. - -------------------------------------------------------------------------------- (Exact name of registrant as specified in its charter) Delaware 06-0851857 - ------------------------------------------------------------------------------- (State or other jurisdiction of (I.R.S. Employer 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 August 10, 1998 was 7,369,682. SCAN-OPTICS, INC., AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS
(thousands, except share data) June 30, 1998 December 31, 1997 - ----------------------------------------------------------------------------------- (UNAUDITED) Assets Current Assets: Cash and cash equivalents $ 1,473 $ 4,386 Accounts receivable less allowance of $767 at June 30, 1998 and $104 at December 31, 1997 14,125 16,167 Inventories 10,134 12,547 Deferred taxes 855 1,038 Prepaid expenses and other 1,332 969 -------------------------- Total current assets 27,919 35,107 Plant and equipment: Equipment 14,614 13,355 Leasehold improvements 4,563 4,585 Office furniture and fixtures 1,266 1,275 -------------------------- 20,443 19,215 Less allowances for depreciation and amortization 16,552 15,355 -------------------------- 3,891 3,860 Goodwill 12,600 Other assets 825 212 -------------------------- Total Assets $ 45,235 $ 39,179 ==========================
(thousands, except share data) June 30, 1998 December 31, 1997 - ----------------------------------------------------------------------------------- (UNAUDITED) Liabilities and Stockholders' Equity Current liabilities: Accounts payable $ 1,888 $ 2,071 Notes payable to bank 8,283 Salaries and wages 1,335 1,984 Taxes other than income taxes 794 744 Income taxes 942 Customer deposits 145 2,565 Deferred revenues, net of costs 1,290 1,206 Other 1,010 952 -------------------------- Total current liabilities 14,745 10,464 Deferred taxes 466 486 Other liabilities 897 496 Stockholders' Equity Preferred stock, par value $.02 per share, authorized 5,000,000 shares; none issued or outstanding Common stock, par value $.02 per share, authorized 15,000,000 shares; issued, 7,368,349 shares at June 30, 1998 and 7,218,455 shares at December 31, 1997 147 144 Common stock Class A Convertible, par value $.02 per share, authorized 3,000,000 shares; available for issuance 2,145,536 shares; none issued or outstanding Capital in excess of par value 35,494 35,025 Retained-earnings deficit (3,488) (4,369) Foreign currency translation adjustments (380) (421) -------------------------- 31,773 30,379 Less cost of common stock in treasury, 413,500 shares 2,646 2,646 -------------------------- Total stockholders' equity 29,127 27,733 -------------------------- Total Liabilities and Stockholders' Equity $ 45,235 $ 39,179 ========================== See accompanying notes.
SCAN-OPTICS, INC., AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED) Three Months Ended Six Months Ended June 30 June 30 (thousands, except share data) 1998 1997 1998 1997 - -------------------------------------------------------------------------------- Revenues Net sales $ 5,487 $ 10,385 $ 14,025 $ 19,453 Service revenues 3,900 3,540 8,156 6,885 Engineering revenues 33 100 16 Other operating revenues 284 136 315 137 -------------------------------------------- Total revenues 9,704 14,061 22,596 26,491 Costs and Expenses Cost of sales 2,367 6,417 8,106 12,087 Service expenses 2,984 2,522 5,914 5,078 Sales and marketing expenses 1,566 1,684 2,919 3,300 Research and development expenses 1,235 1,089 2,519 2,098 General and administrative expenses 869 967 1,812 1,874 Interest expense 15 2 15 24 -------------------------------------------- Total costs and expenses 9,036 12,681 21,285 24,461 -------------------------------------------- Operating income 668 1,380 1,311 2,030 Other income, net 74 22 135 47 -------------------------------------------- Income before income taxes 742 1,402 1,446 2,077 Income taxes 289 61 565 118 -------------------------------------------- Net Income $ 453 $ 1,341 $ 881 $ 1,959 ============================================ Basic earnings per share $ .07 $ .20 $ .13 $ .30 ============================================ Basic weighted-average shares 6,956,478 6,576,347 6,884,584 6,568,551 Diluted earnings per share $ .06 $ .19 $ .12 $ .28 ============================================ Diluted weighted-average shares 7,130,938 6,941,029 7,140,200 6,954,393 See accompanying notes.
SCAN-OPTICS, INC., AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
Six Months Ended June 30 (thousands) 1998 1997 - -------------------------------------------------------------------------------- Operating Activities Net income $ 881 $ 1,959 Adjustments to reconcile net income to net cash provided (used) by operating activities: Depreciation 600 622 Amortization 801 672 Provision for losses on accounts receivable 663 324 Provision for inventory obsolescence 350 Deferred taxes 163 Changes in operating assets and liabilities: Accounts receivable 1,678 (2,797) Inventories 1,612 842 Prepaid expenses and other (363) (232) Accounts payable (183) (139) Accrued salaries and wages (649) (546) Taxes other than income taxes 50 (194) Income taxes (942) 2 Deferred revenues, net of costs (215) Customer deposits (2,420) (991) Other (113) (1) --------------------------- Net cash provided (used) by operating activities 1,563 (129) Investing Activities Business acquisitions (12,600) Purchases of plant and equipment (631) (682) --------------------------- Net cash used by investing activities (13,231) (682) Financing Activities Proceeds from issuance of common stock 472 141 Proceeds from borrowings 8,285 6,652 Principal payments on borrowings (2) (6,750) --------------------------- Net cash provided by financing activities 8,755 43 Decrease in cash and cash equivalents (2,913) (768) Cash and Cash Equivalents at Beginning of Year 4,386 1,279 --------------------------- Cash and Cash Equivalents at End of Period $ 1,473 $ 511 =========================== See accompanying notes.
NOTE 1 - Basis of Presentation The accompanying unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three and six month periods ended June 30, 1998, are not necessarily indicative of the results that may be expected for the year ending December 31, 1998. For further information, refer to the consolidated financial statements and footnotes thereto included in the Company's annual report on Form 10-K for the year ended December 31, 1997. Certain 1997 amounts have been reclassified to conform to current year presentation. NOTE 2 - Inventories The components of inventories were as follows:
June 30 December 31 (thousands) 1998 1997 - ------------------------------------------------------------------ Finished goods $ 2,708 $ 2,586 Work-in-process 2,242 3,823 Service parts 3,250 3,807 Materials and component parts 1,934 2,331 ------- ------- $ 10,134 $ 12,547 ======= =======
NOTE 3 - Acquisition Activities The Company completed two acquisitions during the month of June 1998. The first was Southern Computer Systems (SCS), a privately held company, for $7 million in cash. The Company acquired cash and accounts receivable net of reserves of $.4 million, fixed assets net of accumulated depreciation of $.3 million and other assets of $.1 million. The Company also assumed certain liabilities as follows: accounts payable of $.5 million, salary and benefits accruals of $.2 million, deferred revenue of $.1 million, note payable to Scan- Optics, Inc. of $.5 million, acquisition related expenses for investment banker and legal services of $.4 million and bank debt of $1.4 million. Immediately following the closing, the bank debt was repaid. The Company reported goodwill related to the SCS transaction of $9.2 million. The proforma unaudited results of operations for the six months ended June 30, 1998 and for the year ended December 31, 1997, assuming consummation of the purchase as of January 1, 1997, are as follows (for additional detail see Item 5):
June 30 December 31 (thousands) 1998 1997 - ----------------------------------------------------------------------------- Total revenue $ 24,357 $ 63,076 Net income (2,479) 4,680 Basic earnings per share (.36) .71 Diluted earnings per share (.35) .66
The second acquisition was the Maintenance Division of Access Corporation for $3.2 million in cash. The Company acquired accounts receivable net of reserves of $.5 million. The Company also assumed a liability for deferred revenue of $.5 million and acquisition related expenses for investment banker and legal services of $.2 million. The Company reported goodwill related to the Access Corporation transaction of $3.4 million. NOTE 4 - Credit Arrangements On May 28, 1998, the Company amended its credit agreement (Agreement) with a bank to extend the maturity date to May 27, 1999, and to increase the line from $4 million to $10 million. The Agreement contains covenants which, among other things, require the maintenance of specified working capital, debt to equity ratios, net income levels and tangible net worth levels. The line bears interest at prime and the unused portion of the line is subject to a commitment fee of 1/2 % per annum. The weighted average interest rates on borrowings during the first half of 1998 and 1997 were 8.4% and 8.0% respectively. The available balance on the total line of credit was $1,717,000 as of June 30, 1998. NOTE 5 - Income Taxes At June 30, 1998, the Company had approximately $3,600,000 of net operating loss carryforwards for foreign income tax purposes which are scheduled to expire periodically between 1998 and 2005. At December 31, 1997, the Company had approximately $3,800,000 of net operating loss carryforwards for foreign income tax purposes. For financial reporting purposes, a valuation allowance has been recorded to offset a significant portion of the deferred tax assets related to the foreign net operating loss carryforwards and other temporary differences. Significant components of the Company's deferred tax liabilities and assets were as follows :
June 30 December 31 (thousands) 1998 1997 - --------------------------------------------------------------------------- Deferred tax assets: Net operating losses $ 1,395 $ 1,479 Depreciation 92 92 Inventory valuation 265 275 Deferred revenue 69 130 Accounts receivable reserves 24 36 Revenue recognition 330 347 Vacation accrual 247 193 Other 135 287 --------------------------- Total deferred tax assets 2,557 2,839 Deferred tax liabilities: Depreciation and other (467) (486) Inventory (64) (80) Valuation allowance (1,637) (1,721) --------------------------- Net deferred taxes $ 389 $ 552 ===========================
NOTE 6 - Earnings Per Share The following table sets forth the computation of basic and diluted earnings per share:
Three Months Ended Six Months Ended June 30 June 30 1998 1997 1998 1997 - ----------------------------------------------------------------------------------- Numerator: Net income $ 453 $ 1,341 $ 881 $ 1,959 =============================================== Denominator: Denominator for basic earnings per share (weighted-average shares) 6,956,478 6,576,347 6,884,584 6,568,551 Effect of dilutive securities: Employee stock options 174,460 364,682 255,616 385,843 Denominator for diluted earnings per share (adjusted weghted- average shares and assumed - ---------------------------------------------- conversions) 7,130,938 6,941,029 7,140,200 6,954,393 ============================================== Basic earnings per share $ .07 $ .20 $ .13 $ .30 ============================================== Diluted earnings per share $ .06 $ .19 $ .12 $ .28 ==============================================
NOTE 7 - Year 2000 Compliance The Company has addressed the Year 2000 compliance issues with its products. During the first half of 1997, an initial mailing went out to notify customers that current standard operating systems are in the process of modification to insure Year 2000 compliance. They were also notified that application software will be changed at the request of the individual customer on a chargeable basis and that the Company does not plan to modify the operating systems of non-current products to achieve Year 2000 compliance. A follow-up mailing is planned for the third quarter of 1998. The Company is in the early stages of implementing a fully compliant Enterprise Resource Planning system as a replacement for the current manufacturing and financial reporting system. This implementation is scheduled to be completed by the second quarter of 1999 and will eliminate the potential information technology internal risks associated with the Year 2000 compliance. A team of individuals is analyzing other potential areas of risk associated with Year 2000 compliance. The costs and effects of these areas are unknown by the Company at this time but are not expected to be material. NOTE 8 - Comprehensive Income As of January 1, 1998, the Company adopted Financial Accounting Standards Board Statement 130, REPORTING COMPREHENSIVE INCOME. Statement 130 establishes new rules for the reporting and display of comprehensive income and its components; however, the adoption of this Statement had no impact on the Company's net income or shareholders' equity. Statement 130 requires the Company's foreign currency translation adjustments, which were reported separately in shareholders' equity prior to adoption, to be included in other comprehensive income. The components of comprehensive income, net of related tax, are as follows:
Three Months Ended Six Months Ended June 30 June 30 1998 1997 1998 1997 - -------------------------------------------------------------------------------- Net income $ 453 $ 1,341 $ 881 $ 1,959 Foreign currency translation adjustments 2 30 24 (21) ----------------------------------------------- Comprehensive income $ 455 $ 1,371 $ 905 $ 1,938 ===============================================
The components of accumulated comprehensive income, net of related tax, at June 30, 1998 and December 31, 1997 are as follows:
June 30 December 31 (thousands) 1998 1997 - -------------------------------------------------------------------------------- Foreign currency translation adjustments $ (379) $ (404) -------------------------------- Accumulated comprehensive income $ (379) $ (404) ================================
MANAGEMENT'S DISCUSSION AND ANALYSIS OF CONSOLIDATED FINANCIAL CONDITION AND RESULTS OF OPERATIONS Results of Operations for the Three Months and Six Months Ended June 30, 1998 vs. 1997 Outlook The forward-looking statements contained in this Outlook and elsewhere in this document are based on current expectations. As such, actual results may differ materially. The ability for Scan-Optics, (the "Company") to achieve the following expectations could be impacted by increased competition or a slowdown in growth within the scanning and imaging market, alternate forms of processing, inability to consummate accretive acquisitions and changes in the economic climates of foreign markets as well as that of the United States. The foregoing factors should not be construed as exhaustive. In 1997, the Company derived 39% of its total revenue from one customer, Toyo Officemation, Inc., one of the Company's distributors in Japan. Health claims processing systems represented 90% of this revenue. The Company completed its order of ten high-volume scanning systems for this customer in the first quarter of 1998. This order brings the total health claims processing systems ordered on this contract to ninety-five. The Company's original expectation was for one hundred and fifty systems to be delivered over the contract life. The efficiencies created by the application of the Company's technology will reduce the overall requirements for this contract. This customer is currently evaluating its system requirements going forward. The Company believes that with the continued pressures on the Yen and the objective to reduce the cost of medical fee processing in Japan, the customer is faced with a challenge to continue to improve its efficiency. The Company expects to receive the results from this internal study in the second half of 1998. The Company believes that success in achieving the initiatives described below will help offset a foreseen significant reduction in sales from this customer for the balance of 1998 as compared to 1997. The inability of the Company to achieve these initiatives may have a materially adverse effect on earnings. Five major initiatives currently underway are expected to help compensate for this anticipated decline in revenues. The first initiative is in the healthcare industry, combining the Company's ImageEMC++ system with its high performance image capture transports, to process HCFA Medicare claim forms as well as other types of medical claim forms. The Company has focused on and has experienced success with this vertical line of business and believes it provides an opportunity for growth. The second initiative consists of the Company's development of target market data capture applications that, combined with its other high speed transports and archival systems, will provide cost effective solutions. The current focus is on the healthcare/insurance, government/tax, transportation, and order entry markets. The Company expects to continue to emphasize its "Solutions at Work" focus on these targeted markets for the foreseeable future. As other market opportunities emerge, the Company will evaluate the potential of using its products and services to provide "Solutions at Work" in new markets. The third initiative is further expansion into the international marketplace. The Company has successfully supplied product to the Japanese market and has experienced strong sales activity through relationships with highly qualified and productive distributors. Over the next two years, the Company will focus on developing comparably strong relationships in Europe, Latin America and other Pacific Rim countries. The fourth initiative relates to leveraging the Company's core competencies in an effort to add revenues and profits. The Company believes that its hardware service, manufacturing and custom engineering organizations have potential to sell their individual expertise, experience and cost effectiveness to other entities. During the first quarter of 1998, the Company achieved favorable results from this initiative by executing its first contract manufacturing relationship under an agreement to manufacture secured access systems for RAPOR, and through an agreement with Docutronix, Inc., that leverages the services of the Company's field service personnel. The last initiative is growth through an accretive acquisition(s). In the fourth quarter of 1997, the Company engaged the services of an investment banking firm to assist in a corporate growth strategy that is focused on the consolidation occurring in the imaging and data capture market. The imaging industry is made up of many smaller companies and management believes achieving greater critical mass will increase the likelihood of growth in the adoption of this technology. With that in mind, the Company is pursuing acquisitions that will utilize its core competencies and will provide immediately accretive earnings. It is the Company's policy not to discuss or comment on negotiations regarding such transactions until a definitive agreement is signed or after circumstances indicate a high degree of probability that a transaction will be consummated, unless the law otherwise requires. The Company completed two acquisitions during the month of June 1998. The first was Southern Computer Systems (SCS), a privately held company, for $7 million in cash. The Company acquired cash and accounts receivable net of reserves of $.4 million, fixed assets net of accumulated depreciation of $.3 million and other assets of $.1 million. The Company also assumed certain liabilities as follows: accounts payable of $.5 million, salary and benefits accruals of $.2 million, deferred revenue of $.1 million, note payable to Scan- Optics, Inc. of $.5 million, acquisition related expenses for investment banker and legal services of $.4 million and bank debt of $1.4 million. Immediately following the closing, the bank debt was repaid. The Company reported goodwill related to the SCS transaction of $9.2 million. SCS develops, markets and supports a portfolio of data entry and document automation software products that enable customers to realize high quality data, image capture, and character recognition for high speed document recognition and data entry applications. These products are designed to create, verify, validate and export documents such as invoices, bills of lading, credit card applications and order forms. SCS also provides document automation consulting, network and application integration services. SCS markets and sells its products and services to its 2,700 customers in the transportation, financial services, health care and state and federal government markets. SCS currently has approximately 40 employees. The Company intends to keep SCS at its present location in Birmingham, Alabama. The second acquisition was the Maintenance Division of Access Corporation for $3.2 million in cash. The Company acquired accounts receivable net of reserves of $.5 million. The Company also assumed a liability for deferred revenue of $.5 million and acquisition related expenses for investment banker and legal services of $.2 million. The Company reported goodwill related to the Access Corporation transaction of $3.4 million. The Maintenance Division has contracts with Original Equipment Manufacturers (OEMs) and Distributors to supply on-site warranty and remedial maintenance for more than 1,000 customers. Net sales in the first six months of 1998 decreased $5.4 million or 28% compared with the first six months of 1997 and $4.9 million or 47% for the second quarter of 1998 compared to the second quarter of 1997. Compared to the first six months of 1997, international sales decreased $6.7 million while North American sales increased $1.3 million. International sales related to the Japanese Health Organization represented $5.2 million in sales during the second quarter of 1997 and this contract was completed with $5.7 million in sales during the first quarter of 1998. Other international sales decreased $1.9 million during the second quarter of 1998 compared to 1997. North American sales for the quarter increased $2.2 million to $4.5 million compared to $2.3 million in the second quarter of 1997. Service revenues increased $1.3 million in the first six months of 1998 compared with the first six months of 1997. Service revenues in the second quarter of 1998 increased $.4 million from the second quarter of 1997. Customer service revenue in the first six months of 1998 decreased $.2 million mainly due to the continued transition of older product on maintenance surcharges with currently released products. Year-to-date professional services revenue increased $1.5 million due to the continued focus on the solutions business and the four vertical lines of business. Cost of sales decreased $4 million from the first half of 1997 and decreased $4 million from the second quarter of 1997. The year-to-date and second quarter decreases are a reflection of the completion of the Japanese Health Organization contract during the first quarter of 1998. Cost of sales as a percentage of net sales was 58% for the first six months of 1998, compared to 62% in the prior year. This percentage for the second quarter of 1998 was 43%, compared to 62% for the same period in 1997. The decreases are due to a change in the overall sales mix. Service expenses increased $.8 million in the first half of 1998 and increased $.5 million in the second quarter of 1998 compared with 1997. Customer service expenses increased $.5 million in the first half of 1998 and $.3 million in the second quarter of 1998 due to increases in staffing levels and outside service expenses. Professional service expenses increased $.3 million in the first half of 1998 and increased $.2 million in the second quarter mainly due to increases in staffing levels and associated travel costs related directly to the increase in revenues. Sales and marketing expenses decreased $.4 million in the first half of 1998 primarily due to a specific accounts receivable reserve in the first half of 1997. Expenses for the second quarter decreased $.1 million from 1997 to 1998, mainly due to decreases in travel related expenses. Research and development expenses in 1998 increased $.4 million from the first half of 1997 and increased $.1 million in the second quarter. These increases are mainly due to increases in consulting expenses related to the Company's Image EMC++ product line. General and administrative expenses remained consistent in the first half of 1998 compared with the first half of 1997. Liquidity and Capital Resources Cash and cash equivalents at June 30, 1998 decreased $2.9 million from December 31, 1997, for the reasons discussed below. Borrowings increased to $8.3 million at June 30, 1998 from a zero balance at the end of 1997. The borrowings were due to acquisition related activities, as discussed in Item 5. On May 28, 1998, the Company amended its loan agreement extending the maturity date to May 27, 1999 and increasing the line of credit from $4 million to $10 million. (See Note 3 for further details.) The available balance on the line of credit was $2,228,028 as of August 12, 1998. Operating activities provided $1.4 million of cash in the first half of 1998. Non-cash expenses recorded during the first six months of 1998 were $2.2 million vs. $2 million for the same period in 1997. These expenses relate to depreciation of fixed assets (discussed in net plant and equipment below), amortization of customer service spare parts inventory, provisions for losses on accounts receivable, provisions for inventory obsolescence and deferred taxes. Net accounts receivable decreased $2 million during the first half of the year mainly due to the timing of collections. Accounts receivable purchased from Southern Computer Systems (SCS) and the Maintenance Division of Access Corporation, offset by an increase in reserves, added $2.5 million to accounts receivable. Inventories decreased $2.4 million in the first half of 1998. Total manufacturing inventories decreased $1.9 million from the beginning of the year mainly due to a $1.6 million decrease in work-in-process inventory and a $.4 million decrease in raw materials, offset by a $.1 million increase in finished goods inventory. These decreases reflect the Company's focus on reducing inventory levels and improving just-in-time purchases, as well as the completion of several system orders including the completion of the Japanese Health Organization order. Customer service inventories decreased by $.5 million in the first half of the year mainly due to the amortization of parts inventory. Prepaid expenses and other current assets increased $.4 million primarily due to increases in prepaid costs related to the consulting and non-competition agreements for the principals of SCS. Net plant and equipment remained flat during the first half of 1998. Additions of $.6 million for purchases related to the implementation of the Enterprise Resource and Planning system, the SCS acquisition, and leasehold improvements were offset by $.6 million of depreciation expense recorded during the first half of the year. Goodwill of $12.6 million was recorded during the second quarter of 1998, due to the acquisitions of SCS and the Maintenance Division of Access Corporation. Accounts payable decreased $.2 million from December 31, 1997, due to the timing of payments. Accrued salaries and wages decreased $.6 million reflecting the disbursement of the 1997 incentive compensation of $1.1 million, offset by the current year's accruals for incentive compensation and vacation. Income taxes decreased $.9 million due to payment of the 1997 estimated income tax liability and quarterly payments made for estimated 1998 tax liability. Customer deposits decreased $2.4 million mainly due to the acceptance of the Japanese health claims processing systems, recognized in revenue during the first half of 1998, which had included substantial deposits. SCAN-OPTICS, INC., AND SUBSIDIARIES PART II - OTHER INFORMATION ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS At the registrant's annual meeting of stockholders held on May 21,1998, the following matters were voted on. 1. Election of Directors for 3-year term: ABSTENTIONS AND NAME VOTES FOR VOTES WITHHELD BROKER NONVOTES Logan Clarke, Jr. 6,115,462 72,648 0 Richard J. Coburn 6,118,024 70,086 0 2. Appointment as Ernst & Young LLP as auditors for the fiscal year ending December 31, 1998: ABSTENTIONS AND VOTES FOR VOTES AGAINST BROKER NONVOTES 6,154,445 23,809 9,856 SCAN-OPTICS, INC., AND SUBSIDIARIES PART II - OTHER INFORMATION ITEM 5 - OTHER INFORMATION Filed with respect to Form 8-K filed on June 30, 1998. ITEM 7 - FINANCIAL STATEMENTS AND EXHIBITS ITEM 7(a) - Financial statements of business acquired Independent Auditors' Report - ---------------------------- The Board of Directors Southern Computer Systems, Inc.: We have audited the accompanying balance sheets of Southern Computer Systems, Inc. as of December 31, 1997 and 1996, and the related statements of income, stockholders' equity, and cash flows for the years then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Southern Computer Systems, Inc. as of December 31, 1997 and 1996, and the results of its operations and its cash flows for the years then ended in conformity with generally accepted accounting principles. KPMG Peat Marwick LLP March 16, 1998
SOUTHERN COMPUTER SYSTEMS, INC. Balance Sheets December 31, 1997 and 1996 1997 1996 - ---------------------------------------------------------------------------------------------- Assets Current Assets: Cash $ 15,346 19,483 Trade accounts receivable, less allowance for doubtful receivables of $50,000 and $130,578 in 1997 and 1996, respectively (notes 2 and 4) 2,165,898 2,201,426 Inventory (note 2) 69,041 153,400 Prepaid expenses 44,981 64,430 Other current assets 33,926 36,017 ------------------------------ Total current assets 2,329,192 2,474,756 Equipment, furniture and fixtures, net of accumulated depreciation of $865,841 and $703,792 in 1997 and 1996, respectively (note 2) 305,350 289,866 Note receivable from affiliate (note 2) - 15,000 Investment in Imaging Business Machines, LLC (note 4) 9,690 9,690 Other assets 113,097 88,237 ------------------------------ $ 2,757,329 2,877,549 ============================== Liabilities and Stockholders' Equity Current Liabilities: Bank overdraft $ 207,024 348,969 Borrowing under the line of credit (note 2) 85,054 638,281 Notes payable to bank 507,752 - Current portion of long-term doubt (note 2) 30,458 46,908 Accounts payable (note 4) 483,754 3,543 Accrued expenses 80,515 82,670 Deferred revenue 222,124 400,830 ------------------------------ Total Current Liabilities 1,616,681 1,521,20 Long-term debt, excluding current portion (note 2) 5,268 35,685 ------------------------------ Total Liabilities 1,621,949 1,556,88 Stockholders' equity: Common stock, $1 par value, authorized and issued 1,000 shares 1,000 1,000 Additional paid-in capital 13,676 13,676 Retained earnings 1,325,678 1,510,961 - ------------------------------ 1,340,354 1,525,637 Cost of 516-2/3 shares of common stock held in treasury (204,974) (204,974) ------------------------------ Net stockholders' equity 1,135,380 1,320,663 Commitments (notes 2,3 and 5) ------------------------------ $ 2,757,329 2,877,549 ============================== See accompanying notes to financial statements.
SOUTHERN COMPUTER SYSTEMS, INC. Statements of Income Years Ended December 31,1997 and 1996 1997 1996 - ------------------------------------------------------------------------------------ Net revenues (note 4) $ 6,468,331 4,714,969 Costs and expenses: Costs of revenues (note 4) 4,246,938 2,545,170 Sales and marketing 749,195 1,004,572 Research and development 668,660 556,922 General and administrative 686,571 400,468 -------------------------------- Total costs and expenses 6,351,364 4,507,132 -------------------------------- Income from operations 116,967 207,837 Other income (expense): Interest income (note 4) 1,672 2,267 Interest expense (47,882) (16,827) Other expense (65,000) (87,800) -------------------------------- Total other expense (111,210) (102,360) -------------------------------- Net income $ 5,757 105,477 ================================ See accompanying notes to financial statements
SOUTHERN COMPUTER SYSTEMS, INC. Statements of Stockholders' Equity Years Ended December 31, 1997 and 1996 Additional Common paid-in Retained Treasury stock capital earnings stock Total - ------------------------------------------------------------------------------------------------- Balance at December 31,1995 $ 1,000 13,676 1,849,675 (204,974) 1,659,377 Net income 105,477 105,477 Stockholders' distributions - - (444,191) - (444,191) ----------------------------------------------------------------- Balance at December 31,1996 1,000 13,676 1,510,961 (204,974) 1,320,663 Net income 5,757 5,757 Stockholders' distributions (191,040) (191,040) ----------------------------------------------------------------- Balance at December 31, 1997 $ 1,000 13,676 1,325,678 (204,974) 1,135,380 ================================================================= See accompanying notes to financial statements.
SOUTHERN COMPUTER SYSTEMS, INC. Statements of Cash Flows Years Ended December 31,1997 and 1996 1997 1996 - --------------------------------------------------------------------------------------------------- Reconciliation of net income to net cash provided by (used in) operating activities: Net income $ 5,757 105,477 Adjustments to reconcile net income to net cash provided by (used in) operating activities: Depreciation and amortization 171,224 158,400 Increase (decrease) in trade accounts receivable 35,528 (157,117) Decrease (increase) in inventory (7,501) 41,802 Decrease in prepaid expenses 19,449 23,784 Decrease (increase) in note receivable from affiliate 15,000 (15,000) Increase in other assets (22,769) (41,766) Increase (decrease) in accounts payable 480,211 (481,895) Decrease in deferred revenue (178,706) (49,776) Decrease in accrued expenses (2,155) (13,787) --------- --------- Total adjustments 510,281 (535,355) --------- --------- Net cash provided by (used in) operating activities 516,038 (429,878) --------- --------- Cash flows from investing activities: Proceeds from disposal of equipment, furniture and fixtures - 83,922 Purchase of equipment, furniture and fixtures (94,848) (71,020) --------- --------- Net cash provided by (used in) investing activities (94,848) 12,902 --------- --------- Cash flows from financing activities: Increase (decrease) in bank overdraft (141,945) 348,969 Stockholders' distributions (191,040) (211,645) Net (decrease) increase in bank credit line borrowing (553,227) 327,351 Principal payments on long-term debt (46,867) (42,791) Proceeds from note payable to bank 507,752 - --------- --------- Net cash provided by (used in) financing activities (425,327) 421,884 --------- --------- Net increase (decrease) in cash (4,137) 4,908 Cash at beginning of year 19,483 14,575 --------- --------- Cash at end of year $ 15,346 19,483 ========= ========= Supplemental disclosure of cash flow information: Cash paid for interest during the year $ 39,108 17,828 ========= ========= Inventory converted to equipment $ 91,860 - ========= ========= Supplemental disclosure of noncash financing activities: Distribution of investments in IBM, LLC $ - 232,546 ========= ========= See accompanying financial statements.
SOUTHERN COMPUTER SYSTEMS, INC. Notes to Financial Statements December 31, 1997 and 1996 (1) Description of Business and Summary of Significant Accounting Policies (a) Description of Business Southern Computer Systems, Inc. (the Company) is engaged in a variety of computer-related activities, including systems integration, consulting, manufacturing/publishing of packaged software for PC's, custom software development, and the research and development of new software. All of those activities are generally related to the facilitation of the data capture process. The Company markets high-speed document processing machines in combination with its various software products which include KeyEntry III(R) and ImageKey(R). The majority of the Company's revenues are derived from sales and installation and integration of the software and the related hardware to large corporations and government agencies. Although some products and services are marketed via secondary resellers, the majority of sales occur as the result of the Company's direct to end-user activities. (b) Revenue Recognition and Deferred Revenue Revenue from sales of products is recognized upon shipment, and revenue from customer support agreements is deferred and recognized over the terms of the agreements. Revenue from system implementation services is recognized as service is provided. (c) Inventories Inventories are stated at the lower of cost or market. Cost is determined using the first-in, first-out method. Inventory consists primarily of materials such as manuals and operating supplies. (d) Equipment, Furniture and Fixtures Equipment, furniture and fixtures are stated at cost less accumulated depreciation. Depreciation is calculated on the straight-line method over the estimated useful lives of the assets. (e) Research and Development Research and development costs are expensed as incurred. (f) Treasury Stock Treasury stock is accounted for under the cost method. (g) Prepaid Promotional Expense Promotional literature and other promotional items are recorded as prepaid promotional expense when received and recognized as promotional expense when they are used. Prepaid promotional expense is included in prepaid expenses in the accompanying financial statements. (h) Copyrights The Company owns various copyrights for its internally developed software, the value of which is not recorded in the financial statements. (i) Income Taxes The Company, with the consent of its stockholders, elected under the Internal Revenue Code to be taxed as an S Corporation effective March 1, 1987. The Company is not liable for income taxes as the stockholders of an S Corporation are taxed on their proportionate share of the Company's taxable income. (j) Use of Estimates Management of the Company has made a number of estimates and assumptions relating to the reporting of assets and liabilities to prepare these financial statements in conformity with generally accepted accounting principles. Actual results could differ from those estimates. (k) Reclassifications Certain reclassifications have been made in the December 31, 1996 financial statements to conform with the December 31, 1997 financial statement presentation. (2) Notes Payable and Long-term Debt The Company has a $750,000 line of credit with the National Bank of Commerce, which is secured by the Company's trade accounts receivable and inventories and the personal guarantees of certain Company officers and shareholders. Interest on the outstanding balance accrues at the bank's prime rate (8.0 percent at December 31, 1997). Borrowings under the line of credit totaled $85,054 and $638,281 at December 31, 1997 and 1996, respectively. The line of credit matures on January 31, 1998. The Company has a note payable to the National Bank of Commerce which bears interest at the bank's prime rate (8.0 percent at December 31, 1997) and is secured by certain equipment and fixtures, trade accounts receivable, inventories and the personal guarantees of certain Company officers. The note is payable on demand and matures on January 9, 1998. The Company has two other commercial notes with National Bank of Commerce which bear interest at 9.0 percent at December 31, 1997, and are secured by certain equipment and fixtures of the Company and the personal guarantees of certain Company officers. The balances at December 31, 1997, of $17,752 (due in June 1998) and $17,974 (due in May 1999) are payable in monthly installments of principal and interest totaling $3,225 and $1,148, respectively. The aggregate maturities of long-term debt for each of the five years subsequent to December 31,1997, and thereafter, are as follows: 1998 $30,458 1999 5,268 (3) Commitments The Company leases real estate under a two year noncancelable operating lease with monthly payments of $12,960. Total lease expense was $146,160 for 1997 and 1996. (4) Related Party Transactions Effective January 1, 1996, the shareholders of the Company distributed all but 4 percent ownership of Imaging Business Machines, LLC (IBM, LLC) to its stockholders. At December 31, 1997 and 1996, the following components of the Company's financial statements relate to IBM, LLC:
1997 1996 ---- ---- Investment in IBM, LLC $ 9,690 9,690 Trade accounts receivable 31,500 90,800 Accounts Payable 71,792 ---- Note Receivable ---- 15,000 Net revenue from IBM, LLC 77,000 21,000 Purchases from IBM, LLC 216,688 671,132
(5) Employee Benefit Plan The Company sponsors the Southern Computer Systems, Inc. 401 (k) Retirement Plan (the Plan). The Plan is a defined contribution employee benefit plan covering substantially all Company employees. In accordance with the Plan agreement, the Company matches 33 1/3 percent of participant contributions not to exceed $1,000 per participant per year. Company contributions to the Plan were $23,896 and $29,233 for the years ended December 31, 1997 and 1996, respectively. (6) Significant Customers During 1997, two customers accounted for 43.9 percent of sales and receivables from these customers were $997,865 at December 31, 1997. (7) Subsequent Event (Unaudited) During May, 1998, the Company was informed that a customer did not wish to proceed with a certain systems integration project under contract. The Company believes that services required under the contract were performed and it intends to pursue completion of the contract and collection of all amounts due under it. At December 31, 1997, the Company had a receivable recorded under the contract of $689,450. As of August 13, 1998, no payments related to the receivable had been received. SCAN-OPTICS, INC., AND SUBSIDIARIES PART II - OTHER INFORMATION (continued) ITEM 7 (b) - Pro forma statements of operations Scan-Optics, Inc. and Subsidiaries Unaudited Pro Forma Statements of Operations The following unaudited pro forma consolidated statement of operations have been prepared by Scan-Optics, Inc. ("SO") management. These statements reflect SO's acquisition of Southern Computer Systems, Inc. ("SCS") and combine the historical consolidated statement of operations of SO and SCS for the periods indicated using the purchase method of accounting. The unaudited pro forma consolidated statements of operations reflect the adjustments as if the acquisition had occurred on January 1, 1997. These pro forma statements should be read in conjunction with the historical financial statements and related notes of SO and SCS. The pro forma consolidated statements of operations have been prepared using the following facts and assumptions: SO acquired all the stock outstanding, 483 and 1/3 shares, of SCS for $7 million in cash. SO also paid off the bank debt of SCS, of $1.4 million, on the day of closing. Additionally, SO entered into a consulting and noncompetition agreement with the two sellers of SCS, Stephen M. Freeman and Raymond C. Griffin, Jr. SO also incurred direct costs of approximately $.4 million. These costs consist primarily of legal, accounting and financial advisory fees. SO utilized cash on hand and approximately $4 million of the Company's line of credit to fund the transaction. SO estimates that it will incur approximately $.2 million in indirect transaction costs. These costs relate primarily to personnel and travel costs associated with those individuals assigned management and transition responsibilities for SCS. The purchase price will be allocated to the assets and liabilities of SCS based upon their fair values at the date of acquisition. The purchase price in excess of the fair value of net assets acquired of approximately $9.2 million will be amortized over 20 years. Pro forma adjustments to the consolidated statement of operations reflecting anticipated additional sales, cost savings and other synergies, if any, resulting from the acquisition of SCS are not permitted, and accordingly have not been reflected in the pro forma financial statements. The pro forma financial results are not intended to be a projection of future results and are not necessarily indicative of the results which would have occurred if the acquisition had been in effect on the dates presented.
SCAN-OPTICS, INC., AND SUBSIDIARIES UNAUDITED PRO FORMA CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED) YEAR ENDED DECEMBER 31, 1997 Southern Unaudited (thousands, except share data) Scan-Optics, Inc. Computer Systems Adjustments Pro forma - ---------------------------------------------------------------------------------------------------- Revenues Net sales $ 41,361 $ 1,455 $ 42,816 Service revenues 14,124 5,013 19,137 Engineering revenues 876 876 Other operating revenues 247 247 ----------- --------- -------- --------- Total revenues 56,608 6,468 63,076 Costs and Expenses Cost of sales 25,066 4,247 29,313 Service expenses 10,400 10,400 Sales and marketing expenses 7,297 749 8,046 Research and development expenses 4,552 669 5,221 General and administrative expenses 3,737 686 $ 860 (a) 5,283 Interest expense 14 48 256 (b) 318 ----------- --------- -------- --------- Total costs and expenses 51,066 6,399 1,116 58,581 ----------- --------- -------- --------- Operating income 5,542 69 (1,116) 4,495 Other income (expense), net 149 (63) 86 ----------- --------- -------- --------- Income before income taxes 5,691 6 (1,116) 4,581 Income taxes (benefit) expense (99) (99) ----------- --------- -------- --------- Net Income (loss) $ 5,790 $ 6 $(1,116) $ 4,680 =========== ========= ======== ========= Basic earnings per share $ .87 $ .71 =========== ========= ======== ========= Basic weighted-average shares 6,632,248 6,632,248 Diluted earnings per share $ .82 $ .66 =========== ========= ======== ========= Diluted weighted-average shares 7,070,013 7,070,013 See accompanying notes.
SCAN-OPTICS, INC., AND SUBSIDIARIES UNAUDITED PRO FORMA CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED) SIX MONTHS ENDED JUNE 30, 1998 Southern Unaudited (thousands, except share data) Scan-Optics, Inc. Computer Systems Adjustments Pro forma - ---------------------------------------------------------------------------------------------------- Revenues Net sales $ 14,025 $ 703 $ 14,728 Service revenues 8,156 1,058 9,214 Engineering revenues 100 100 Other operating revenues 315 315 ----------- --------- -------- -------- Total revenues 22,596 1,761 24,357 Costs and Expenses Cost of sales 8,106 923 9,029 Service expenses 5,914 1,976 7,890 Sales and marketing expenses 2,919 356 3,275 Research and development expenses 2,519 371 2,890 General and administrative expenses 1,812 247 $430 (a) 2,489 Interest expense 15 41 128 (b) 128 ----------- --------- -------- -------- Total costs and expenses 21,285 3,914 558 25,757 ----------- --------- -------- -------- Operating income 1,311 (2,153) (558) (1,400) Other income (expense), net 135 (649) (514) ----------- --------- -------- -------- Income before income taxes 1,446 (2,802) (558) (1,914) Income taxes (benefit) expense 565 565 ----------- --------- -------- -------- Net Income (loss) $ 881 $ (2,802) $(558) $ (2,479) =========== ========= ======== ========= Basic earnings per share $ .13 $ (.36) =========== ========= ======== ========= Basic weighted-average shares 6,884,584 6,884,584 Diluted earnings per share $ .12 $ (.35) =========== ========= ======== ========= Diluted weighted-average shares 7,140,200 7,140,200 See accompanying notes.
Scan-Optics, Inc. and Subsidiaries Notes to Unaudited Pro Forma Consolidated Financial Statements (a) To record amortization expense related to the $9.2 million of goodwill over 20 years and to record the expenses for the consulting and noncompetition agreement for the former owners of SCS. (b) To record the interest charges on the line of credit for the borrowings related to the acquisition. SCAN-OPTICS, INC., AND SUBSIDIARIES PART II - OTHER INFORMATION ITEM 6 (B) - REPORTS ON FORM 8-K For the Quarter Ended June 30, 1998 A report on Form 8-K was filed on June 30, 1998 reporting the acquisition of Southern Computer Systems under Item 2 thereof. The information called for in Item 7 (a) of that report on Form 8-K, with respect to the financial statements of the business acquired and pro forma financial information, is included under Item 5 of this report on Form 10-Q. SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. SCAN-OPTICS, INC. (Registrant) Date AUGUST 14, 1998 JAMES C. MAVEL James C. Mavel Chairman, President, Chief Executive Officer and Director Date AUGUST 14, 1998 MICHAEL J. VILLANO Michael J. Villano Chief Financial Officer and Vice President EX-27 2 ART. 5 FDS FOR SCAN-OPTICS CORPORATION
5 EXHIBIT 27. SCAN-OPTICS, INC. FINANCIAL DATA SCHEDULE 6-MOS DEC-31-1998 JUN-30-1998 1,473,000 0 14,125,000 767,000 10,134,000 27,919,000 20,443,000 16,552,000 45,235,000 14,745,000 0 147,000 0 0 29,127,000 45,235,000 14,025,000 22,596,000 8,106,000 21,285,000 135,000 0 15,000 1,446,000 565,000 881,000 0 0 0 881,000 .13 .12
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