-----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, B1kq25jtkGYplLq3B7Dztu5Hof65AqATHMudJfQRzS1rbIBG+INd/l2UJqJdrjPN yx8JpgyE7mSMUtMh1nofrw== 0000950159-01-500025.txt : 20010402 0000950159-01-500025.hdr.sgml : 20010402 ACCESSION NUMBER: 0000950159-01-500025 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 20001231 FILED AS OF DATE: 20010330 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-K405 SEC ACT: SEC FILE NUMBER: 000-05265 FILM NUMBER: 1587030 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-K405 1 file001.txt UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K (Mark One) ( X ) Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the fiscal year ended December 31, 2000 ( )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) Securities registered pursuant to Section 12(b) of the Act: None ------------------- Securities registered pursuant to Section 12(g) of the Act: Common stock, $.02 par value ------------------- (Title of Class) 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 --- --- Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X] The aggregate market value of the voting stock (common) held by non-affiliates of the registrant: $1,785,536 as of March 21, 2001. The number of shares of common stock, $.02 par value, outstanding as of March 21, 2001 was 7,439,732 1 DOCUMENTS INCORPORATED BY REFERENCE Portions of the definitive Proxy Statement, relating to the 2001 Annual Meeting of Stockholders, which will be filed pursuant to Regulation 14A with the Securities and Exchange Commission not later than 120 days after the end of the fiscal year, are incorporated by reference and included in the following: Part III-Item 10 - Directors and Executive Officers of the Registrant Part III-Item 11 - Executive Compensation Part III-Item 12 - Security Ownership of Certain Beneficial Owners and Management Part III-Item 13 - Certain Relationships and Related Transactions 2 PART I ITEM 1 - BUSINESS Scan-Optics, Inc. (the "Company") was incorporated in Delaware in 1968 and has its principal office at 169 Progress Drive, Manchester, Connecticut 06040. The Company designs, manufactures, markets and services client/server based information-processing systems and software-based products that use state of the art technology for imaging, automated data capture, document management, and workflow. The Company is a leader in applying technology to solve information capture and customer service challenges for government agencies and commercial businesses. For 32 years, the Company has provided innovative solutions to its customers, using advanced technology for imaging and automated data capture. The Company was among the first to develop Optical Character Recognition (OCR) technology for data capture and is a leading provider of image scanning systems worldwide. Building on its core competencies of high-speed paper handling, digital image processing, optical character recognition, and data entry, the Company has transitioned to become a provider of solutions that focus on the business needs of its customers. The Company's strategy is to provide a "Total Solution" to specific image, data capture, document management and workflow needs within its chosen lines of business. This allows the Company to position itself as a single source provider. The Company has three distinct divisions: Solutions and Products, Access Services and Manufacturing Services. The Company's Solutions and Products Division combines technology and expertise to develop cost-effective solutions for applications in the government, insurance, transportation, financial and order entry markets. The Company's ability to offer customized and integrated system solutions has helped customers all over the world to meet their productivity and profitability objectives. The Access Services Division of the Company provides third party and proprietary maintenance services nationwide, as well as to the UK and Canada. The division provides hardware and software maintenance support for equipment and software related to scanning, imaging and automated data capture, as well as other forms of electro-mechanical equipment. Contract Manufacturing, a component of the Company's Manufacturing Services Division, formed in 1998 provides electro-mechanical assembly and test services for equipment such as large-format scanners and other large-scale electro-mechanical devices. 3 SOLUTIONS AND PRODUCTS DIVISION Solutions The Company's solutions employ high speed document handling, image capture, ink jet printing, character recognition, multi-pocket document sorting, key-entry, image storage and retrieval products, as well as software/hardware integration services, application software development services, and project management services. Scan-Optics' TAXexpress(TM), an automated image-based tax processing and data capture solution, consists of processing modules to handle income tax, sales tax and other tax returns. It applies the technologies of character recognition, data and image capture, data correction, and verification, transfer to a host system, image workflow, and archive capabilities. As a result, TAXexpress(TM) can achieve the principal goal of most tax and revenue departments in implementing an image-based tax processing system. Scan-Optics' ORDERexpress(TM) is an automated image-based data capture solution for "club" style order solicitation and order processing. ORDERexpress(TM) provides mark sense, machineprint, and handprint recognition, which are integral parts of most reply cards. It also offers processing modules to handle order reply cards, return non-orders, and process payments. This solution eliminates the need to manually sort and separately process orders from non-orders and name and address changes. Also available are hardware and application software to process mail-out announcements, return order documents and payments. Scan-Optics' PROOFexpress(TM) is an automated image-based solution for delivery, data capture, and storage and retrieval. It provides processing modules to process waybills, delivery tickets, and other billing documents. It applies the technologies of character recognition, data and image capture, data correction and verification, and transfer to a host system. As a result, PROOFexpress(TM) can achieve the principal goal of most billing departments in implementing an image-based storage and retrieval system. Scan-Optics' ImageEMC++, developed as a result of the Company's experience with many of the nation's leading health insurance and other claim payment companies is a comprehensive business solution designed to efficiently process the paper forms and other documents these organizations receive. It minimizes the time and labor involved with processing single and multi-part health claims, enrollments, and other forms, as well as correspondence, re-pricing sheets and other general documents. Products In June 1992, the Company introduced the Series 9000 scanner. The Series 9000 integrates the latest in character recognition, image capture, and paper handling technology into a high speed scanner. During 1993, the Company introduced several options for this scanner. These options permit character recognition and image processing on the "reverse side" of documents, a special small document stacker module, and the ability to recognize several industry standard bar-codes. With the announcement of the 9000M (at 220ppm) in 2000 and the 9000mm (at 100ppm) in 2001, the Company continues to lead in the high volume document processing systems market. The 9000M and the 9000mm feature modular design, advanced digital 4 camera technology, and black and white or grayscale output. Both models are based on Windows NT, and can process intermixed forms of varying sizes and weights, and both are available as simplex or duplex, with an integrated image quality monitor, acoustic double-detect feeder, and recognition rates up to 10,000 characters per second. In July 1996, the Company introduced a high-speed neural-network based handprint recognition system for use in the Series 9000 scanner. The In-Line Neural Classifier operates at speeds of up to 7,500 characters per second while achieving a 50% reject rate reduction and 10% substitution rate reduction over the previous handprint recognition engine. The classifier is based on a special neural network algorithm that is resistant to overtraining making it an ideal candidate for character recognition systems. The Company has been involved in leveraging the power of neural recognition engines to achieve success with each application. The Company's patented Context Edit analyzes data, conducts a database library search, compares fields character by character to locate a correct match, and then automatically updates the data batch with the correct information. With an extensive electronic postal/name library virtually every combination is considered but only the correct value is accepted. The Company released VistaCapture in 1998. VistaCapture represents a new paradigm for creating data entry applications. The VistaCapture product suite, an open-system solution based on Microsoft's VisualBasic, utilizes Microsoft ActiveX (OCX) technology. VistaCapture is designed for high-speed key-entry, key-from-image, and state-of-the-art character recognition (OCR/ICR) applications. During 1998, the Company announced the 7400 scanner. This scanner is a versatile, efficient, affordably priced desktop solution for businesses with single or multiple locations, each with its own data capture and forms scanning requirements. It can be used to add new scanning capabilities or to augment a larger solution and is ideal for businesses with low to mid range (40-70 ppm) scanner needs. In 1999, the Company announced a document management tool with Internet access, DocWise, which was acquired through a licensing agreement with Bluebird Systems. DocWise provides an environment where users can capture, index, secure, store, access, distribute, and use the information contained in documents simply and efficiently. The Company added a new scanner series to its line in 1999, the Vision Series 8000. The Vision Series 8000 is targeted at the mid-range requirements for scanning. Rated at 100 ppm to 200 ppm, the Series 8000 scanner family converts large volumes of documents into compressed electronic images. In 2000, Gray Scale Optical Mark Read (GSOMR) was released which is a patent pending product with capabilities to more accurately detect mark sense information for processing such forms as test scoring and balloting. The Company intends to continue its program of development of additional options and capabilities for its existing products as well as the development of new products that take advantage of the Company's core competencies. 5 Core Competencies Key product disciplines utilize integration skills that leverage the core competencies of the Company to provide broad solution alternatives. These core competencies include: Document Scanning Image Enhancement Algorithms and Image Quality Character Recognition (OCR, ICR, Barcode, Mark Sense, OMR, etc.) Key-From-Image and Key-From-Paper Data Entry Line of Business Domain Knowledge Professional Services (Design, Development, Installation and Support) Value Added Engineering Services and Solutions Document Scanning The Company has addressed the high-speed, high-volume, page/document-processing marketplace since its inception. During 1992, the Company introduced the Series 9000 generation of scanners. This was followed in 1998 with the 9000T. In 2000, the Company announced the 9000M. These systems provide full-page document scanning, including options for front and back imaging, OCR reading, serialization, and sorting of documents in a single pass, black and white and/or Grayscale output as standard components, Windows NT platform, resolutions from 200 to 400 dpi, and in-line recognition speeds up to 10,000 characters per second. In 1998, the Company introduced the Model 7400 scanner, targeted at the mid-volume production market. In 1999, the Company added the Vision Series 8000 scanner to its line. The Series 8000 scanner rated at 100 ppm to 200 ppm, converts large volumes of documents into compressed electronic images. Image Enhancement Algorithms and Image Quality Image enhancement starts at the scanner capture system. Various embedded algorithms are utilized to ensure a quality image is taken the first time. These algorithms include code for straightening a page, removing black "noise", adjusting the contrast, and trimming the image to the exact size of the document. The Company provides the fastest page capture and image system on the market today. This processing is carried forward into the Company's OCR, Key-From-Image and image storage and retrieval systems. Management believes that the Company's image quality is among the best in the industry. Electronic image processing and storage are rapidly overtaking the use of microfilm and the Company is on the leading edge of this technology with its hardware and application software solutions. Character Recognition The Company has developed and provided its own high-speed character recognition since 1968. OCR and its related technologies are able to lift data automatically from paper forms, without the need for manual keying of the data into the computer system. The Company's recognition technology has always included in-line recognition of machine printed, handprinted and mark sense forms. In-line recognition occurs at very high speed, in real-time, as the paper is moving down the scanning transport. With the introduction of the Series 9000 system, the Company has expanded this recognition to include barcode, patch code, special educational test scoring analysis, and special stamp 6 recognition. In addition to these recognition processes, the Company has integrated and developed neural recognition technologies that support both in-line and post capture recognition. The Company's character recognition technology was enhanced in 1999 with its patented Context Edit capability that brings a new level of data purification to the integrated solutions. Key-From-Image and Key-From-Paper Data Entry The Company has been providing complete hardware and software solutions using Key-From-Image (KFI) and Key-From-Paper (KFP) data entry since 1976. This KFI and KFP solution remains important today, using the latest open network and platform designs with Windows, UNIX, Novell, TCP/IP, NT, and other industry standard components. By combining the high-speed scanning systems with the flexibility of KFI and KFP, customers are able to lower their overall data capture and document processing costs while improving the level of data accuracy and availability. Line of Business Domain Knowledge The Company provides solutions that are proven, cost-effective, and production-ready. The Company has the domain knowledge to provide total solutions in the following industries: government, insurance, transportation, financial and order entry. That domain knowledge is utilized in the product suite of applications; TAXexpress(TM), ORDERexpress(TM), PROOFexpress(TM), and ImageEMC++. Professional Services In order to provide a total solution to the customer, the Company has provided a consultative approach to integrate solutions with proven Professional Services core competencies in the following areas: Paper Handling Application Expertise Project Management Installation Training Archival / Retrieval Custom Engineering Development Tools Forms Design Open Systems Neural Technology System Integration Microfilming OCR Technology Industry Standards Imaging Networking The Company has provided software solutions to its customers since 1968. The Company's scanners and assorted network system products provide the hardware platforms for delivering advanced high-volume forms processing, imaging, and document management system solutions, especially in government, insurance, transportation, financial, and order entry. These software solutions enable the Company to provide full production-ready application systems that can be tailored to the customer's specific needs. These targeted solutions are provided through professional services offered by the Company. The Company also provides individual, custom software services as requested by the customer. In this way, the Company can either provide the entire package of software support or simply provide those services that the customer desires. 7 Value Added Engineering Services and Solutions The Company has been supplying engineering services and solutions to meet customer needs since introducing its first fully integrated solution in 1976. The solutions include scanning, recognition, Key-From-Image, data entry, and communications. During 1993, the Company was selected to develop a prototype system to process medical claims for a healthcare agency in Japan. This system was designed with 36 stacker pockets for sorting forms; expanded paper handling capabilities for light-weight, flimsy forms; high resolution image cameras to permit recognition of complex Japanese kanji characters; and software forms recognition for up to 20,000 different document formats. The Company has been involved in special recognition techniques to process order forms that contain stamps. These stamps are used as an entry into a sweepstakes contest or to select ordered items for a record or book club. The stamps are of a multitude of colors and are successfully processed through the Company's special recognition features. In addition to stamp processing, the Company has been engaged in recognition analysis for educational test scoring. This process is accomplished in full duplex mode at a transport speed of 50 inches per second. Test scoring and balloting includes Optical Mark Read (OMR) and image presentment of text pages to knowledge workers for value added analysis and grading. ACCESS SERVICES DIVISION The Company has been offering service and maintenance support to its broad customer base since 1968. This support is available with either leased or purchased systems in both domestic and international markets. In June of 1998, the Company acquired the hardware maintenance division of Access Corporation of Cincinnati, Ohio. This business was combined with Scan-Optics' existing hardware maintenance division to form Access Services, a separate division, dedicated to serving the Scan-Optics customer base and the third party maintenance marketplace. Service is provided through a network of over 140 service centers worldwide. The Company provides on-site service with response times of 2 to 24 hours based on the service plan selected by the customer. The Company focuses on comprehensive diagnostic routines, modular designs, preventive maintenance procedures and customer surveys to provide its users high system availability to perform mission critical applications. The Company's customers include government, healthcare organizations, transportation, subscription and catalog fulfillment companies, financial institutions and manufacturers in the U.S., Canada, Latin America, Europe and Asia. The Company maintains high standards of teamwork and customer satisfaction. 8 CONTRACT MANUFACTURING SERVICES Through this component of the Manufacturing Services Division, the Company provides electro-mechanical assembly and test services under contracts with customers who develop and sell a variety of equipment. Beginning with the customer's plans, Scan-Optics can manage each project from concept to completion. The capabilities provided include: Project Management Engineering and Prototyping Procurement and Materials Management Precision Machining, Sheet Metal Fabrication and Welding Networks/System Integration Systems Testing Just-in-Time/Kanban Delivery Systems Professional Services and Training Worldwide Field Service - through Access Services Strong Supplier Partnerships with: Agency Standards Certification (FCC, UL, LE, CSA, ISO 9001) Commercial Painting and Metal Finishing Printed Circuit Board Assemblies and Testing Wire Harness and Cable Assembly and Testing Specialty Packaging Worldwide Shipping SIGNIFICANT CUSTOMERS In 2000 and 1998, the Company derived 13% and 12% respectively, of its total revenue from one customer, Toyo Officemation, Inc., one of the Company's distributors in Japan. In 1999, the Company derived 11% of its total revenue from one customer, the Kentucky Revenue Cabinet, a state government taxing authority. CHANNELS OF DISTRIBUTION The Company sells directly to end-users and distributors. It also pools resources with selected system integration firms and specialized niche suppliers. The cooperative effort with system integrators and other vendors has introduced the Scan-Optics logo to new markets both domestically and internationally. 9 BACKLOG The backlog for the Company's products and services as of December 31, 2000 was approximately $15.3 million. As of December 31, 1999, the backlog was approximately $18.4 million. The backlog consists of equipment, software and services to be sold and noncancelable rentals and maintenance due on existing rental and maintenance contracts over the next year. The Company normally delivers a system within 30 to 180 days after receiving an order, depending upon the degree of software customization required. MANUFACTURING Manufacture of the Company's products requires the fabrication of sheet metal and mechanical parts, the subassembly of electronic and mechanical parts and components, and operational and quality control testing of components, assemblies and completed systems. The Company's products consist of standard and Company-specified mechanical and electronic parts, sub-assemblies and major components, including microcomputers. A majority of parts are purchased, including many complex electronic and mechanical subassemblies. The Company also purchases major standard components, including low speed scanners, jukeboxes, PCs, printers and servers. An important aspect of the Company's manufacturing activities is its quality control program, which uses computer-controlled testing equipment. The Company has not experienced significant shortages of any components or subassemblies. Alternate sources for such components and subassemblies have been developed. Certain sole source items have been evaluated and the Company has determined that a minor engineering effort would be required to qualify a replacement. During 2000, the Company experienced delays in the shipment of components and subassemblies arising from the Company's lack of liquidity. COMPETITION The Company's Solutions and Products Division competes with service providers who integrate systems with products from multiple vendors. The Company differentiates its solutions by offering a total system, including post installation support of hardware and software services along with image scanning and document handling transports. The Company focuses on industry specific "application" areas with solutions utilizing image and data entry/data capture systems provided by the Company. A large portion of the revenue generated by the Access Services Division is from post installation hardware and software services on integrated systems installed by the Company's Solutions and Products Division. Due to the proprietary nature of these integrated systems, this division faces little competition for this business. The remaining revenue is generated by the field repair of electro-mechanical devices manufactured by Original Equipment Manufacturers, primarily of scanner products, that do not have their own field staff. The division competes 10 with other third party maintenance providers for this revenue by using its reputation for quality and its 31 years of experience in providing scanner repair. Contract Manufacturing, a component of the Manufacturing Services Division, provides electro-mechanical assembly and test services under contracts with customers who develop and sell a variety of equipment. The primary competition for this business is the customers themselves who can decide to manufacture the products instead of outsourcing them. Competition from other contract manufacturers is minimal due to the Company's expertise in the electo-mechanical field as well as the flexibility to handle various order requirements. ISO 9001 CERTIFICATION On November 12, 1999, the Company received ISO 9001 certification for its product development and manufacturing divisions. The scope of the certification is for the design and production of scanning equipment and contract manufacturing of electronic equipment. In 2000, the Company took the first step in expanded its quality program by bringing the service and installation areas into compliance. The Company also performed internal audits to test for compliance in the sales, design and manufacturing areas. The registering body performed two surveillance audits on the Company's product development and manufacturing divisions, both of which were successful. PATENTS The Company currently has nine United States patents in force which expire between 2003 and 2018. The patents are on mechanical systems, electronic circuits, electronic systems and software algorithms, which are used throughout the product lines. The Company values the investments made in new technology and makes all efforts to protect its intellectual property. The Company expects to continue to apply for patents on its new technological developments when it believes they are significant. In November 1997, the Company licensed a patent to Imaging Business Machines, LLC. for their use in an image transport designed for processing airline tickets. In 1999, this same patent was licensed to Nale Corporation for use on its paper handling transports. In 2000, the engineering organization filed for a patent for gray scale OMR used in test scoring applications and a patent for a double document detection system for our scanners. EMPLOYEES As of December 31, 2000 the Company employed 247 persons, including 21 with administrative and support responsibilities, 23 in marketing and sales, 139 in software and service activities, 23 in engineering and 41 in manufacturing capacities. The Company considers its employee relations to be good. The Company has not experienced any work stoppages. 11 FUNDED DEVELOPMENT AGREEMENTS During 1998, the Company completed a $200,000 custom development project with a specific customer. The project involved adding fluorescent bar code printing and reading to the Series 9000 product and adding additional stacker modules to accommodate the document sorting requirement. The Company recorded all revenue related to this development agreement in 1998. These revenues offset related costs incurred to develop the modifications and enhancements. The ownership of the technologies created as a result of this development agreement remains with the Company. No royalties or other considerations are required as a part of this agreement. During 1999, the Company entered into four custom development agreements for specific customers. A $125,000 agreement involved the development of localization software for screen displays in Japanese. A $115,000 agreement was for recognition enhancements to a current product. A $75,000 agreement involved enhancements for the reading of Japanese stock certificates. A $58,000 agreement involved software developments for the processing of mortgage payments and taxes. The Company recorded all revenue related to these development agreements in 1999. These revenues offset the related costs incurred for this development. The ownership of these technologies remains with the Company. No royalties or other considerations are required as part of these agreements. During 2000, the Company completed a number of small custom development contracts for specific customers resulting in approximately $200,000 of revenue recognized during the year. The Company recorded all revenue related to these development agreements in 2000. These revenues offset the related costs incurred for this development. The ownership of these technologies remains with the Company. No royalties or other considerations are required as part of these agreements. EFFECTS OF ENVIRONMENTAL LAWS The effect of federal and state environmental regulations on the Company's operations is insignificant. 12 BUSINESS SEGMENTS The Company views its business in three distinct revenue categories: solutions and products, Access Services and contract manufacturing services. 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.
Year Ended December 31 (thousands) 2000 1999 1998 - ----------------------------------------------------------------------------------------- Revenues Solutions and products $ 21,272 $ 34,921 $ 40,174 Access services 14,692 16,003 13,222 Contract manufacturing services 2,338 1,068 575 ----------------------------------------------- Total revenues 38,302 51,992 53,971 Cost of solutions and products 21,717 27,656 24,438 Service expenses 12,376 12,817 9,590 ----------------------------------------------- Gross profit margin 4,209 11,519 19,943 Operating expenses, net 21,918 19,934 16,709 ----------------------------------------------- Income (loss) before income taxes $ (17,709) $ (8,415) $ 3,234 =============================================== Total assets $ 34,436 $ 55,186 $ 52,992 Total expenditures for additions to long-lived assets $ 109 $ 596 $ 560
Certain 1999 and 1998 amounts have been reclassified to conform to the current year presentation. Note: In 2000 and 1998, the Company derived 13% and 12% respectively, of its total revenue from one customer, Toyo Officemation, Inc., one of the Company's distributors in Japan. In 1999, the Company derived 11% of its total revenue from one customer, the Kentucky Revenue Cabinet, a state government taxing authority. Sales of product to customers in the international market represent an important source of the Company's revenues. The Company has international distributors located in 46 countries and covering six continents. Changes in the economic climates of foreign markets could have an unfavorable impact on future international sales. 13 Export sales by geographic area (based on the location of the customer) were as follows: (thousands) 2000 1999 1998 - ----------------------------------------------------------------------------- Latin America $ 152 2% $ 77 2% $ 88 1% Europe 1,667 22% 1,982 41% 328 3% Pacific Rim 5,881 76% 2,743 57% 9,649 96% -------------------------------------------------------- $ 7,700 $ 4,802 $ 10,065 ======================================================== Export sales represented 43%, 20%, and 31% of product sales for the three years ended December 31, 2000, 1999, and 1998, respectively. ITEM 2 - PROPERTIES The Company's world headquarters and manufacturing facility is located in a 84,000 square foot, one-story building in Manchester, Connecticut, leased for a term expiring in December 2006. The Company also leases 1,238 square feet of office space, under a lease expiring in July 2002, in Dallas, Texas for professional services and sales. Scan-Optics, Ltd., a wholly owned subsidiary in the United Kingdom, also leases office space for sales, service, and equipment demonstration. ITEM 3 - LEGAL PROCEEDINGS There is one lawsuit currently pending against the Company. This lawsuit is in reaction to a lawsuit filed by the Company against the plaintiff. Although the ultimate outcome is uncertain, based on currently known facts, the Company believes that it has strong defenses against this lawsuit and the resolution of this matter will not have a material adverse effect on the Company's financial position or annual operating results. ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS The Company did not submit any matters during the fourth quarter of 2000 to a vote of the stockholders. 14 EXECUTIVE AND OTHER OFFICERS OF THE REGISTRANT Officers of the Company are set forth in the schedule below. Officer Name Age Principal Occupation: Since - -------------------------------------------------------------------------------- James C. Mavel 55 Chairman, Chief Executive Officer, President and Director 1996 Joseph P. Crouch 38 Vice President - Manufacturing Services Division 1999 Marianna C. Emanuelson 39 Vice President - Human Resources 1997 Richard C. Goyette 49 Vice President - Sales and Marketing 1996 Richard D. Harris 40 Corporate Secretary 2001 Joel K. Howser 53 Vice President - Software Development 1998 Clarence W. Rife 61 Vice President - Access Services Division and Hardware Engineering 1975 Michael J. Villano 41 Chief Financial Officer, Vice President and Treasurer 1992 Alan W. Ware 62 Vice President - Project and System Integration 2000 Mr. Mavel joined the Company in January 1996 as President and Chief Operating Officer. In June 1996, Mr. Mavel became a Director of the Company. On December 31, 1996, Mr. Mavel was promoted to Chief Executive Officer. In May 1997, Mr. Mavel was elected Chairman of the Board of Directors. Prior to joining the Company, from 1992 through 1995, Mr. Mavel was Vice President and General Manager of the Imaging Systems Division of Unisys. From 1991 to 1992, he was Group Vice President of the Financial Information Systems Division of National Data Corporation. 15 Mr. Crouch joined the Company in March 1999 and was elected to the position of Vice President - Manufacturing Services Division in November 1999. Prior to joining the Company, Mr. Crouch was Director of Manufacturing Operations for CalComp's Input Technologies Division. Mr. Crouch had over ten years of contract manufacturing experience before joining the Company. Ms. Emanuelson joined the Company in August 1994, and was elected to the position of Vice President in 1997. She is currently Vice President - Human Resources. Mr. Goyette joined the Company in March 1996 as Vice President - Sales and Marketing. Prior to joining the Company, from 1993 through 1995, Mr. Goyette was Vice President of the Imaging Systems Division of Unisys. From 1992 to 1993, he was Vice President of the Software Products Group of Unisys. From 1990 to 1992 he was Vice President of Corporate Information Productivity Systems of Unisys. He is currently Vice President - Solutions and Products Division. Mr. Harris has been a partner in the law firm of Day, Berry and Howard LLP since 1998. He was elected to the position of Corporate Secretary in January 2001. Mr. Howser joined the Company in February 1997 as Vice President - Marketing. In December of 1997, Mr. Howser assumed the responsibility of Vice President - Product Development. Prior to joining the Company, from 1989 through 1996, he was director of development for Unisys in its image program. Mr. Howser had twenty years of experience in transaction processing and OCR/image development prior to joining Unisys. Mr. Rife has been employed by the Company since 1969 and was elected to the position of Vice President in 1975. He is currently Vice President - Access Services Division. Mr. Villano joined the Company in 1986 and in 1988 was named Assistant Controller. In 1989 he was promoted to the position of Controller, in February 1992 was named Vice President and Controller and in March 1994 was named Chief Financial Officer and Vice President. Mr. Villano was appointed Treasurer in May 1997. Mr. Ware joined the Company in October 2000 as Vice President - Project and System Integration. Prior to joining the Company he was Chief Executive Officer and Chairman of American OBGYN, Inc. (formally Spectrascan Imaging Services, Inc.) from 1984 to 2000. He was Vice President of Sales and Marketing for Scan-Optics from 1974 to 1984 and Director of Engineering and Customer Service at Recognition Equipment from 1968 to 1974. Mr. Ware is a member of the Board of Directors of Quality Care Solutions Inc. The executive officers are elected for a one year term effective at the conclusion of the Annual Meeting of Stockholders each year. There are no family relationships between any of the listed officers. 16 PART II ITEM 5 - MARKET PRICE OF AND DIVIDENDS ON THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS COMMON STOCK MARKET PRICES AND DIVIDENDS The following is a two year history of Common Stock prices for each quarter. The table sets forth the high and low closing quotations per share for the periods indicated of the Common Stock in the over-the-counter market based upon information provided by the National Association of Securities Dealers, Inc. Effective November 10, 2000 the Company was notified by The NASDAQ Stock Market, Inc. that its common stock will begin listing on the Over the Counter Bulletin Board. This action was taken because of the inability to maintain the $1 per share bid price requirement for continued listing on the NASDAQ Stock Market. The closing quotations represent prices between dealers and do not include retail markups, markdowns or commissions and may not represent actual transactions. There were 1,051 stockholders of record at December 31, 2000.
Quarter Ended March 31 June 30 September 30 December 31 High Low High Low High Low High Low - --------------------------------------------------------------------------------------------------------------- 2000 4 3/4 1 9/16 2 6/16 1 3/16 1/2 13/16 1/8 1999 5 1/2 3 1/2 4 3/8 3 1/8 4 7/16 2 3/4 2 7/8 1 1/8
The Company has not paid dividends on its Common Stock and the Board of Directors of the Company has no intention of declaring dividends in the foreseeable future. The declaration and payment of dividends in the future will be determined by the Board of Directors in light of conditions then existing, including the Company's earnings, financial condition, capital requirements and other factors. 17 ITEM 6 - SELECTED FINANCIAL DATA SCAN-OPTICS, INC. AND SUBSIDIARIES FIVE YEAR SUMMARY OF OPERATIONS SELECTED FINANCIAL DATA
(thousands, except share data) 2000 1999 1998 1997 1996 - --------------------------------------------------------------------------------------------------------------------------------- Total Revenues $ 38,302 $ 51,992 $ 53,971 $ 56,608 $ 46,034 =========================================================================================== Income (loss) before income taxes (17,709) (8,415) 3,234 5,691 3,265 Income taxes (benefit) 61 (240) 1,105 (99) (9) ------------------------------------------------------------------------------------------- Net Income (Loss) $ (17,770) $ (8,175) $ 2,129 $ 5,790 $ 3,274 =========================================================================================== Basic earnings (loss) per share $ (2.53) $ (1.17) $ 0.31 $ 0.87 $ 0.50 Basic weighted-average shares 7,025,064 6,979,651 6,921,331 6,632,248 6,530,244 Diluted earnings (loss) per share $ (2.53) $ (1.17) $ 0.30 $ 0.82 $ 0.49 Diluted weighted-average shares 7,025,064 6,979,651 7,102,658 7,070,013 6,715,942 SELECTED BALANCE SHEET DATA Total assets $ 34,436 $ 55,186 $ 52,992 $ 38,707 $ 31,121 Working capital (deficit) $ (9,833) $ 4,727 $ 15,107 $ 24,643 $ 17,318 Total stockholders' equity $ 4,307 $ 22,081 $ 30,246 $ 27,733 $ 21,207
The Company has not paid any dividends for the five year period ended December 31, 2000. The above financial data should be read in conjunction with the related consolidated financial statements and notes thereto. The earnings per share amounts prior to 1997 have been restated as required to comply with Statement of Financial Accounting Standards No. 128, Earnings Per Share. For further discussion of earnings per share, see Notes to Consolidated Financial Statements. 18 ITEM 7 - 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, Scan-Optics, Inc. (the "Company") and its future operations are subject to a number of risks, including those discussed below. The following list is not intended to be an exhaustive list of all the risks to which the Company's business is subject, but only to highlight certain substantial risks faced by the Company. The Company will need to negotiate an extension from its existing lender or locate alternative sources of financing in order to continue to operate its business as currently conducted and implement its business plan. The Company's ability to ship its products and fulfill contracts on a timely basis may be limited by a lack of liquidity. The Company's business could be adversely affected by downturns in the domestic and international economy. The Company's international sales and operations are subject to various international business risks. The Company's revenues depend in part on contracts with various state or federal governmental agencies, and could be adversely affected by patterns in government spending. The Company faces competition from many sources, and its products may be replaced with products relying on alternative technologies. The Company's business could be adversely affected by technological changes. The foregoing factors should not be construed as exhaustive. The Company experienced a net loss of $17.8 million in 2000, $6.3 million of which related to one time charges associated with various allowances for accounts receivable, inventories and an investment in a contract manufacturing customer. The operating loss, without the one time charges, was $11.5 million. This loss was primarily related to professional services projects started in 1999 that resulted in revenue delays and expense overruns in both 1999 and 2000. The Company is substantially complete with these projects as of December 31, 2000. The Company also suffered from a shortage of liquidity, which caused various scanner systems and parts shipments to be delayed, which impacted revenue in the second, third and fourth quarters of 2000. The Company has three major initiatives currently underway to improve revenue growth and profitability. They are to emphasize the "Business of Solutions" focus in targeted markets, to decrease market risk through expansion in the international marketplace, and to capitalize on existing core competencies of the Company. A fourth initiative that is currently on hold is to add long term value through the acquisition of key strategic products or enterprises. The inability of the Company to carry out these initiatives may have a material adverse effect on revenue growth and earnings. The first initiative is to provide cost effective solutions through the Company's development of target market data capture applications combined with its high speed transports and archival systems. The Company has refined its target market approach and has chosen to focus primarily on the government and insurance markets, while continuing to address the transportation, financial and order entry markets. The Company expects to continue to 19 emphasize its "Business of Solutions" 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 in these new markets. The Company's revenue in the solutions initiative declined by $6.5 million or 27% from 1999. The health insurance market increased by 174% while the other markets showed a decline of 50%. 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 in the past through relationships with highly qualified and productive distributors. The Company will continue to focus on developing strong relationships in Europe, Latin America and other Pacific Rim countries. During 2000, the Company made significant progress with this initiative. The Company experienced a revenue increase of $3.1 million or 114% in Japan. The economic environment in Latin America has been an impediment to growth in these markets. The Company continues to strengthen its relationships in Europe as a target for future growth, although in 2000 there was a decline of 16% from 1999 levels. The third initiative relates to leveraging the Company's core competencies in an effort to offset fixed expense and add revenues and profits. The Company has demonstrated that Access Services and Contract Manufacturing Services have potential to sell their individual expertise, experience and cost effectiveness to other entities. During 2000, Access Services signed agreements with five new hardware manufacturers for third party maintenance, most notably with Canon. These agreements cover approximately 30 end-user customers. In 2000, Contract Manufacturing was successful in obtaining four new contracts, of which $.6 million was recorded as revenue during the year. The Company has put on hold its initiative of long term growth through accretive acquisitions of key strategic products or enterprises. No acquisitions were considered during 2000 due to management's focus on the operations of the business and the liquidity shortfall the Company faced. During the year, the Company entered into a joint marketing agreements with Neurascript, an automated data capture text recognition solution provider, Mitek, an offline neural OCR software engine, Maximal, a computer output to laser disk software provider, Actionpoint, a system integration software toolkit and KPMG, LLC, a professional service organization. During 1999, the Company completed an acquisition of the scanner and maintenance division of Photomatrix Imaging Corporation, a supplier of high performance imaging products. The Company also signed a licensing agreement with Bluebird Systems for a suite of document management software products that encompass object management and workflow in 1999. During 1998, the Company completed two acquisitions, Southern Computer Systems (SCS), a software and solutions provider and the hardware maintenance division of Access Corporation. RESULTS OF OPERATIONS - 2000 VS. 1999 Total revenues decreased $13.7 million or 26% from 1999 to 2000. Product sales decreased $5.7 million or 24% from the prior year. North American sales decreased $8.6 million or 45% due mainly to the focus of the sales organization on improving customer satisfaction and helping manage deliverables related to the professional services 20 implementations underway from the third and fourth quarters of 1999. Product sales were also impacted in the last three quarters of 2000 as orders were received but shipments were delayed due to the lack of cash liquidity. Total international sales increased $2.9 million or 60% from 1999. International sales in the Pacific Rim increased 114% or $3.1 million due to a substantial spare parts sale in support of the systems installed at the National Ministry of Health as well as eight new system sales for prefecture based claims processing. Sales to Europe decreased $.3 million or 16% and Latin American sales remained consistent with the prior year mainly due to the continued decline in economic conditions in the Latin American countries. Service revenues decreased $7.7 million from 1999 to 2000. Hardware maintenance and support revenue decreased $1.3 million or 8% due mainly to year 2000 non compliant systems removed from maintenance and either replaced with new systems that carried warranty periods and lower maintenance revenues or not replaced at all. Professional service revenue decreased $6.4 million or 55% due to the Company's focus on the completion of projects from the third and fourth quarters of 1999 as well as a cautious approach to accepting new business until the past issues relating to professional services deliverables were addressed and mitigated. Engineering revenues decreased $.3 million from 1999 to 2000 due to a decrease in customer funded development contracts from 1999 levels. (See Note I of the Notes to Consolidated Financial Statements.) Cost of product sales decreased $1.4 million from 1999 to 2000. Cost of product sales as a percentage of product sales increased from 67% in 1999 to 81% in 2000. The percentage increase is due mainly to a $2.3 million reduction in software product revenue from 1999 to 2000 which carries a significantly higher gross margin than hardware sales. Service expenses decreased by $5 million in 2000. Access service expenses decreased $.4 million or 3% due to a reduction in revenues and continued management of the field workforce in relation to the installed base of customers. Professional service expenses decreased $4.6 million from 1999 to 2000 due mainly to the Company completing the majority of the projects that were in process from the end of 1999 and a reduction in the number and total value of new projects that were initiated during the year. Sales and marketing expenses decreased by $2.1 million in 2000 due to a reduction in commissions expense related directly to the reduction in revenue and reductions in other expenses as part of the increased management focus on expenses. Research and development expenses decreased $2 million from 1999 due mostly to the reduction in headcount, outside contractors and third party purchased services. The Company is continuing to refine its focus on software products, solutions and specific development activities. As a result, certain development skills were no longer required, allowing for the reductions. General and administrative expenses increased $4.9 million in 2000 compared to the prior year. The increase is due to the accounts receivable allowance recorded for various accounts that were determined to be uncollectable during the fourth quarter of 2000. 21 Interest expense increased $1.1 million due to the change in interest rate at the end of the first quarter of 2000 from prime to prime plus five percent. RESULTS OF OPERATIONS - 1999 VS. 1998 Total revenues decreased $2 million or 4% from 1998 to 1999. Product sales decreased $9.2 million or 28% from the prior year. The Company's core business sales decreased $3.5 million or 13% from 1998 to 1999. The core business includes all domestic and international sales except those for health claims processing to the Japanese government. The Japanese Ministry of Health sales accounted for $5.7 million of product sales in 1998. There were no sales to this customer in 1999. North American sales decreased $3.9 million or 17% due mainly to Y2K concerns in the second half of 1999 that deferred purchase decisions by some potential customers as well as the internal focus of the sales organization on improving customer satisfaction and helping manage deliverables related to the professional services implementations underway in the third and fourth quarters of 1999. Total international sales decreased $5.3 million or 52% from 1998. International sales in the Pacific Rim that relate to the core business declined 31% or $1.2 million due to the continued slowdown in the Japanese economy and sales to Europe increased $1.6 million or 504%. Latin American sales remained consistent with the prior year mainly due to the continued decline in economic conditions in the Latin American countries. Service revenues increased $7.1 million from 1998 to 1999. Hardware maintenance and support revenue increased $2.8 million or 21% due to the June 1999 acquisition of the assets of PHRX as well as continued growth of the third party maintenance business. Professional service revenue increased $4.3 million or 58% due to an increase in the focus on the "Business of Solutions", the marketing campaign to provide greater customer value in the target markets, as well as the acquisition of SCS, in June of 1998, which had a full year of revenue in 1999 compared to a half year in 1998. Engineering revenues increased $.3 million from 1998 to 1999 due to an increase in customer funded development contracts from 1998 levels. (See Note I of the Notes to Consolidated Financial Statements.) Cost of product sales decreased $3.3 million or 17% from 1998 to 1999. Cost of product sales as a percentage of product sales increased 8% from 59% in 1998 to 67% in 1999. The percentage increase is due to decreased manufacturing production volumes, lower margins on commodity items sold as part of the total customer solution and increased contract manufacturing revenue which carries a lower margin. Service expenses increased by $9.7 million in 1999. Customer service expenses increased $3.2 million or 34% due to the acquisition of the assets of PHRX in June of 1999, a full year of expenses associated with the acquisition of the hardware maintenance division of Access Corporation compared to a half year of expenses in 1998 and the growth of the third party maintenance business. Professional service expenses increased $6.5 million from 1998 to 1999 due in part to the increase in revenue as well as a full year of expense associated with the purchase of SCS which occurred in June of 1998. However, the expenses associated with professional services integration projects were significantly higher than anticipated in the 22 second half of 1999 because of project management problems and the expense of hiring outside contractors to assist in project completions. This has been addressed with a management change and a comprehensive plan to improve system design, project management and customer implementations. Sales and marketing expenses increased by $1 million in 1999 due to the acquisition of the assets of PHRX and a full year of expenses associated with the acquisition of SCS compared to a half year of expenses in 1998 and commission expenses. Research and development expenses increased $.1 million from 1998 due mostly to the acquisition of PHRX assets offset by a reduction in headcount in the fourth quarter of 1999. The Company is continuing to refine its focus on software products and solutions, and as a result, certain development skills related to hardware platforms were no longer required. General and administrative expenses increased $1 million in 1999 compared to the prior year. The increase is mainly due to the amortization of goodwill for the SCS acquisition, expenses related to the non-compete agreements with the principals of SCS, outside services, expenses associated with tax planning activities, and legal expenses related to acquisition activities. Interest expense increased $.9 million due to the funding requirements related to the acquisition of PHRX assets completed during the second quarter, the purchase of the source code license from Bluebird Systems and the loss reported by the Company which required additional borrowings under the credit agreement. Income taxes decreased $1.3 million from 1998. The Company's effective tax benefit rate for 1999 was 3% as the current income tax benefit of $.9 million was limited to amounts that are recoverable for taxes paid in prior years for which a tax carryback is available, offset by a valuation allowance of $.7 million for net deferred tax assets. LIQUIDITY AND CAPITAL RESOURCES Cash and cash equivalents remained consistent from 1999 to 2000. At December 31, 2000, the Company had $18 million in outstanding borrowings against its $18.5 million available borrowings. The average borrowing level for 2000 was $18.1 million compared to $15.5 million for 1999. The increase in borrowing level is directly related to the loss the Company reported in 2000. The Company is operating under a credit agreement with Patriarch Partners LLC (Agreement) which Fleet National Bank sold to Patriarch Partners, LLC on January 4, 2001. The Agreement 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. The Company entered into an amendment and waiver agreement with Patriarch Partners, LLC on January 31, 2001 that waived defaults on the Company's revolving and term loans through July 1, 2001. The Company is in the process of negotiating with Patriarch Partners, LLC a total 23 debt restructuring to meet its short-term and long-term capital needs. If negotiations on the revision of the Agreement with Patriarch Partners, LLC are not complete by the end of the second quarter, the Company will continue to negotiate with other bank and finance companies, as well as review other business and financing options. There can be no assurance that alternative sources of financing will be available on acceptable terms. These matters raise substantial doubt about the Company's ability to continue as a going concern. Operating activities used $.7 million of cash in 2000 compared to $3.5 million in 1999. The non-cash expenses in 2000 were $11.2 million compared to $5.3 million in 1999. The non-cash items relate to depreciation of fixed assets which is discussed in net plant and equipment below, amortization of customer service spare parts inventory, amortization of goodwill, provisions for losses on accounts receivable, provisions for inventory obsolescence and deferred taxes. Other components of operating activities are discussed below. Net accounts receivable and unbilled receivables decreased $14 million from December 31, 1999. There are four main factors associated with the net decrease in accounts receivables. The first factor is the $5.3 million of receivables reserved during the fourth quarter of 2000, due to the status of various accounts with payment issues. The second factor is the collection of older solution accounts receivable whose collections were delayed due to the professional service issues encountered in the second half of 1999. The third factor is the adoption of a credit hold policy for all outstanding accounts receivable greater than sixty days and the fourth factor is the reduction in total revenue from 1999 levels. Refundable and recoverable income taxes decreased $1.9 million due to the collection of amounts due. Substantially all operating loss carrybacks have been exhausted at December 31, 2000. Total inventories decreased $1.1 million from 1999 levels. Manufacturing inventories decreased $1.2 million during the year due to a decrease in finished goods inventory of $.2 million, a decrease in work-in-process inventory of $1 million, mainly due to the Company's focused effort to reduce inventory levels and reduced product sales. The manufacturing inventory reduction was offset by an increase in customer service inventory of $.1 million which was mainly attributable to the increase in series 8000 inventories. Net plant and equipment decreased $.9 million in 2000. This decrease is mainly due to recorded depreciation of $.9 million. The additions of $.2 million were offset by the sale of plant and equipment of $.2 million. Software license decreased by $.6 million due to amortization of the source code license recorded during the year. Goodwill decreased by $1.5 million in 2000 due to amortization of $1.3 million and a $.2 million adjustment to goodwill for Photomatrix. The acquisition of Photomatrix assets occurred in June of 1999. The acquisition was accounted for as a purchase and the excess cost over the fair value of the net assets acquired of $1.6 million is being amortized over an average period of twelve and one-half years. Southern Computer Systems (SCS), a privately held company, was purchased in June of 1998. The transaction was accounted for as a purchase and the excess cost over the fair value of the net assets acquired of $9.2 million is being amortized over a 24 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 decreased by $.2 million mainly due to the conclusion of the non-compete agreements with the principals of SCS which was related to the 1998 acquisition. Accounts payable decreased $2 million from December 31, 1999 due to the reduction in inventory purchases and the control of expenses. Salaries and wages decreased $.9 million from 1999 mainly due to the reduction of headcount and related benefits during 2000. Taxes other than income taxes decreased by $.7 million due to timing of accruals and related payments and the reduction of headcount. ITEM 7A - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Refer to the Outlook section of Management's Discussion and Analysis of Consolidated Financial Condition and Results of Operations, and to Note A of the Notes to Consolidated Financial Statements. 25 ITEM 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA 26 REPORT OF INDEPENDENT AUDITORS Stockholders and Board of Directors Scan-Optics, Inc. We have audited the accompanying consolidated balance sheets of Scan-Optics, Inc. and subsidiaries as of December 31, 2000 and 1999, and the related consolidated statements of operations, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 2000. Our audits also included the financial statement schedule listed in the Index at Item 14(a). These financial statements and schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States. 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 consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Scan-Optics, Inc. and subsidiaries at December 31, 2000 and 1999, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2000, in conformity with accounting principles generally accepted in the United States. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein. 27 The accompanying financial statements have been prepared assuming that Scan-Optics, Inc. will continue as a going concern. As more fully described in Notes A and F, the Company has incurred operating losses in 2000 and 1999 and is operating under an amendment and waiver agreement with its lender that expires in July 2001. These conditions raise substantial doubt about the Company's ability to continue as a going concern. Management's plans in regard to these matters are also described in Notes A and F. The financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classification of liabilities that may result from the outcome of this uncertainty. /s/ Ernst & Young LLP Hartford, Connecticut February 19, 2001 28 SCAN-OPTICS, INC., AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS
December 31 (thousands, except share data) 2000 1999 - --------------------------------------------------------------------------------------------------------- Assets Current Assets: Cash and cash equivalents $ 36 $ 38 Accounts receivable less allowance of $2,926 in 2000 and $308 in 1999 8,664 18,713 Unbilled receivables - contracts in progress less allowance of $2,689 in 2000 1,064 5,023 Refundable income taxes 124 1,282 Recoverable income taxes 740 Inventories 8,898 10,033 Deferred costs, net of revenues 171 530 Prepaid expenses and other 798 976 ----------------------------------- Total current assets 19,755 37,335 Plant and Equipment: Equipment 13,574 13,735 Leasehold improvements 5,183 5,146 Office furniture and fixtures 1,362 1,312 ----------------------------------- 20,119 20,193 Less allowances for depreciation and amortization 18,126 17,337 ----------------------------------- 1,993 2,856 Software license, net of accumulated amortization of $937 in 2000 and $185 in 1999 1,463 2,040 Goodwill, net of accumulated amortization of $ 3,136 in 2000 and $1,828 in 1999 10,975 12,523 Other assets 250 432 ----------------------------------- Total Assets $34,436 $55,186 ===================================
29
December 31 (thousands, except share data) 2000 1999 - ------------------------------------------------------------------------------------------------------ Liabilities and Stockholders' Equity Current liabilities: Accounts payable $ 6,066 $ 8,079 Notes payable to bank 18,000 17,437 Salaries and wages 854 1,800 Taxes other than income taxes 393 1,110 Income taxes 121 Customer deposits 1,212 1,353 Other 2,942 2,829 ------------------------------------ Total current liabilities 29,588 32,608 Other liabilities 541 497 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, 7,439,732 shares in 2000 and 7,396,232 shares in 1999 149 148 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 35,654 35,568 Retained-earnings deficit (28,185) (10,415) Accumulated other comprehensive loss (665) (574) ------------------------------------ 6,953 24,727 Less cost of common stock in treasury, 413,500 shares 2,646 2,646 ------------------------------------ Total stockholders' equity 4,307 22,081 ------------------------------------ Total Liabilities and Stockholders' Equity $ 34,436 $ 55,186 ====================================
See accompanying notes. 30 SCAN-OPTICS, INC., AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS
Year Ended December 31 (thousands, except share data) 2000 1999 1998 - -------------------------------------------------------------------------------------------------------------------------- Revenues Product sales $ 18,099 $ 23,800 $ 32,988 Service revenues 19,971 27,642 20,577 Engineering revenues 232 537 284 Other operating revenues 13 122 -------------------------------------------------------------------- Total revenues 38,302 51,992 53,971 Costs and Expenses Cost of product sales 14,685 16,056 19,335 Service expenses 19,408 24,417 14,693 Sales and marketing expenses 5,909 7,980 7,011 Research and development expenses 3,720 5,688 5,560 General and administrative expenses 9,867 4,950 3,903 Interest expense 2,393 1,276 397 -------------------------------------------------------------------- Total costs and expenses 55,982 60,367 50,899 -------------------------------------------------------------------- Operating income (loss) (17,680) (8,375) 3,072 Other income (loss), net (29) (40) 162 -------------------------------------------------------------------- Income (loss) before income taxes (17,709) (8,415) 3,234 Income tax expense (benefit) 61 (240) 1,105 -------------------------------------------------------------------- Net Income (Loss) $ (17,770) $ (8,175) $ 2,129 ==================================================================== Basic earnings (loss) per share $ (2.53) $ (1.17) $ 0.31 ==================================================================== Basic weighted-average shares 7,025,064 6,979,651 6,921,331 Diluted earnings (loss) per share $ (2.53) $ (1.17) $ 0.30 ==================================================================== Diluted weighted-average shares 7,025,064 6,979,651 7,102,658
See accompanying notes 31 SCAN-OPTICS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Capital in Accumulated Common Stock Excess of Retained- Other ------------------- Par Earnings Comprehensive Treasury (thousands, except share data) Shares Amount Value Deficit Loss Stock Total - -------------------------------------------------------------------------------------------------------------------------------- Balance January 1, 1998 7,218,455 $144 $ 35,025 $ (4,369) $ (421) $ (2,646) $ 27,733 Issuance of common stock upon Exercise of stock options 152,027 3 476 479 Net income 2,129 2,129 Currency translation adjustments (95) (95) ------------ Comprehensive income 2,034 - -------------------------------------------------------------------------------------------------------------------------------- Balance December 31, 1998 7,370,482 147 35,501 (2,240) (516) (2,646) 30,246 Issuance of common stock upon Exercise of stock options 25,750 1 67 68 Net loss (8,175) (8,175) Currency translation adjustments (58) (58) ------------ Comprehensive loss (8,233) - -------------------------------------------------------------------------------------------------------------------------------- Balance December 31, 1999 7,396,232 148 35,568 (10,415) (574) (2,646) 22,081 Issuance of common stock upon Exercise of stock options 43,500 1 86 87 Net loss (17,770) (17,770) Currency translation adjustments (91) (91) ------------ Comprehensive loss (17,861) - -------------------------------------------------------------------------------------------------------------------------------- Balance December 31, 2000 7,439,732 $149 $ 35,654 $(28,185) $ (665) $ (2,646) 4,307 ================================================================================================================================
See accompanying notes. 32 SCAN-OPTICS, INC., AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS
Year Ended December 31 (thousands) 2000 1999 1998 - -------------------------------------------------------------------------------------------------------------------------------- Operating Activities Net income (loss) $(17,770) $ (8,175) $ 2,129 Adjustments to reconcile net income (loss) to net cash used by operating activities: Depreciation 887 1,115 1,392 Amortization of customer service inventory and software license 2,400 1,912 1,687 Amortization of goodwill 1,308 1,251 577 Provision for losses on accounts receivable 5,505 94 Provision for inventory obsolescence 1,064 229 Deferred taxes 697 (145) Changes in operating assets and liabilities: Accounts receivable 8,503 (586) (6,176) Refundable income taxes 1,158 (1,282) Recoverable income taxes 740 (740) Inventories (1,578) 450 (618) Prepaid expenses and other 178 112 (51) Software license (174) (2,225) Accounts payable (2,013) 1,790 2,890 Accrued salaries and wages (946) (424) 49 Taxes other than income taxes (717) 419 (53) Income taxes 121 (35) (498) Deferred costs, net of revenues 359 (28) (1,849) Customer deposits (141) 1,254 (2,466) Other 371 699 (442) --------------------------------------------------------------- Net cash used by operating activities (745) (3,473) (3,574) Investing Activities Business acquisitions, net of cash acquired (2,111) (12,042) Proceeds from the sale of plant and equipment 215 Purchases of plant and equipment (122) (575) (557) --------------------------------------------------------------- Net cash provided (used) by investing activities 93 (2,686) (12,599) Financing Activities Proceeds from issuance of common stock 87 68 479 Proceeds from borrowings 25,686 51,941 22,045 Principal payments on borrowings (25,123) (46,028) (10,521) --------------------------------------------------------------- Net cash provided by financing activities 650 5,981 12,003 Decrease in cash and cash equivalents (2) (178) (4,170) Cash and Cash Equivalents at Beginning of Year 38 216 4,386 --------------------------------------------------------------- Cash and Cash Equivalents at End of Year $ 36 $ 38 $ 216 =============================================================== Supplemental Cash Flow Information Interest paid $ 2,301 $ 1,229 $ 320 =============================================================== Income taxes paid $ 8 $ 1,183 $ 1,754 =============================================================== See accompanying notes
33 SCAN-OPTICS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE A - DESCRIPTION OF BUSINESS The Company combines technology, experience and expertise to develop cost-effective solutions for applications that include, insurance, government, transportation, financial and order entry. The Company's systems, software and services are marketed worldwide to commercial and government organizations either directly by the Company's sales organization or through distributors. The Company also markets with system integrators and specialized niche suppliers. The Company's business is vulnerable to a number of factors beyond its control. These include (1) the effect of a weakening in the domestic and international economies which potentially impacts capital investments by customers, (2) the cyclical nature of funding within federal and state government agencies, (3) competition from similar products, (4) the implementation of other technologies which may provide alternative solutions, and (5) the stability of sole source suppliers. Future Operations: The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. The Company experienced a net loss of $17.8 million in 2000, $6.3 million of which related to one time charges associated with various allowances for accounts receivable, inventories and an investment in a contract manufacturing customer. The operating loss without the one time charges was $11.5 million which primarily related to the completion of professional services integration projects which caused the Company to incur additional costs to complete the projects. At year end the Company was substantially complete on the professional services contracts that were the result of prior periods poor performance. The Company also suffered from a shortage of liquidity, which caused various scanner systems and parts shipments to be delayed, which impacted revenue in the second, third and fourth quarters of 2000. On January 4, 2001 Fleet National Bank sold the Company's credit agreement to Patriarch Partners, LLC, under which the Company was in default at December 31, 2000 because of certain covenant violations. On January 31, 2001, the Company amended its line of credit and received a waiver of defaults through July 1, 2001. As discussed in Note F to the consolidated financial statements, the recently signed amendment and waiver is expected to help the Company's liquidity through the 3% reduction in the interest rate and the deferral of principal payments until September 30, 2001. The Company is in the process of negotiating a total debt restructuring to meet its short-term and long-term capital needs. These matters raise substantial doubt about the Company's ability to continue as a going concern. The consolidated financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classification of liabilities that might result from the outcome of this uncertainty. 34 NOTE B - ACCOUNTING POLICIES Basis of Presentation: The consolidated financial statements include the accounts of Scan-Optics, Inc. and its subsidiaries, all wholly-owned. All intercompany accounts and transactions are eliminated in the consolidated financial statements. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. While management believes that the estimates and related assumptions used in the preparation of these financial statements are appropriate, actual results could differ from those estimates. Cash Equivalents: Highly liquid investments purchased with maturities of three months or less are considered cash equivalents. Inventories: Inventories are valued at the lower of cost (first-in, first-out method) or market. The Company periodically reviews for obsolete and slow-moving inventory based on historical usage, future requirements and anticipated spare parts demand. Plant and Equipment: Plant and equipment is stated on the basis of cost. Depreciation is computed principally using the straight-line method over periods of 3 to 10 years. Leasehold improvements are amortized over the useful life of the improvements or the life of the lease, whichever is shorter. Intangibles: Goodwill relating to the acquisitions completed in 1998 and 1999 represents the excess cost over fair value of tangible and identifiable intangible net assets acquired. It is amortized on a straight-line basis over 5 to 20 years. Software license acquired in 1999 is amortized on a straight-line basis over 3 years. Impairment of Long-Lived Assets: The Company records impairment losses on goodwill and on long-lived assets used in operations when events and circumstances indicate that the assets might be impaired and the undiscounted cash flows estimated to be generated by those assets are less than net book value. The Company also evaluates the amortization periods of assets, including goodwill and other intangible assets, to determine whether events or circumstances warrant revised estimates of useful lives. Revenue Recognition: Revenues relating to sales of certain equipment (principally optical character recognition equipment) are recognized upon acceptance, shipment, or installation depending on the contract specifications. When customers, under the terms of specific orders or contracts, request that the Company manufacture and invoice the equipment on a bill and hold basis, the Company recognizes revenue based upon an in-house acceptance test that is certified by the customer. Revenues under systems integration and professional services contracts are recognized on the basis of the ratio of earned revenue to total contract price, after considering accumulated costs and estimated costs to complete each contract or when services have been performed and accepted, depending on the nature of the project. Under fixed price contracts, the Company may encounter, and on certain contracts from time to time has encountered, cost overruns caused by project management problems and the 35 expense of hiring outside contractors to assist in project completions, as well as changes to previously agreed upon project designs. Adjustments to contract cost estimates are made in the periods in which the facts requiring such revisions become known. When the estimates indicate a loss, such loss is provided for when identified. Revenues from maintenance services are recognized as earned. Income Taxes: Deferred income taxes are provided for differences between the income tax and the financial reporting bases of assets and liabilities at the statutory tax rates that will be in effect when the differences are expected to reverse. A valuation allowance for deferred tax assets is recorded to the extent the Company cannot determine that the ultimate realization of net deferred tax assets is more likely than not. In making such determination, the Company considers estimated future reversals of existing temporary differences, estimated future earnings and available tax planning strategies. To the extent that the estimates of these items are reduced or not realized, the amount of the deferred tax assets considered realizable could be adversely affected. Stock Based Compensation: The Company generally grants stock options to key employees and members of the Board of Directors with an exercise price equal to the fair value of the shares on the date of grant. The Company accounts for stock option grants in accordance with APB Opinion No. 25, Accounting for Stock Issued to Employees, and, accordingly, recognizes no compensation expense for the stock option grants. Therefore, the Company has elected the disclosure provisions only of FASB Statement No. 123. Earnings (Loss) Per Share: Basic and diluted earnings (loss) per share is calculated in accordance with FASB Statement No. 128, Earnings Per Share. For 2000 and 1999, the computation of diluted earnings (loss) per share was antidilutive, therefore, the amounts reported for basic and diluted earnings (loss) per share were the same. Foreign Currency Translation: The financial statements of foreign subsidiaries have been translated into U.S. dollars in accordance with FASB Statement No. 52, Foreign Currency Translation. All balance sheet accounts have been translated using the exchange rates in effect at the balance sheet date. Statement of operations amounts have been translated using the average exchange rate for the year. The gains and losses resulting from the changes in exchange rates from year to year have been reported in other comprehensive loss, a component of Stockholders' Equity. Reclassifications: Certain 1999 and 1998 amounts have been reclassified to conform to the current year presentation. NOTE C- Acquisition Activities The Company completed two acquisitions during 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 of $.4 million, fixed assets 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 operations of SCS are included in the 36 consolidated statement of operations from the date of acquisition. The transaction was accounted for as a purchase and the excess cost over fair value of the net assets acquired of $9.2 million is being amortized over a twenty year period. The proforma unaudited results of operations for the year ended December 31, 1998, assuming consummation of the purchase as of January 1, 1997, are as follows: December 31 (thousands, except per share amounts) 1998 - -------------------------------------------------------------------------- Total revenue $ 55,732 Net loss (1,459) Basic earnings (loss) per share (.21) Diluted earnings (loss) per share $ (.21) The Company entered into consulting and non-competition agreements with the two principals of SCS. The agreements call for eight quarterly payments of $50,000 per principal, beginning in the fourth quarter of 1998. The agreements provide for consulting services to be performed by the principals as well as preventing the principals from becoming directly involved with a competing business in the Image Data Capture marketplace. The amount of the quarterly payments is being amortized over a two-year period. The second acquisition was the maintenance division of Access Corporation for $3.3 million in cash. The Company acquired accounts receivable 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 operations of the maintenance division of Access Corporation are included in the consolidated statement of operations from the date of acquisition. The transaction 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. During June 1999, the Company completed the acquisition of the product rights and certain assets of the Photomatrix Imaging Corporation's subsidiary of Photomatrix, Inc. for $2.1 million in cash. The Company acquired accounts receivable net of reserves of $1 million, manufacturing and customer service inventory net of reserves of $1.2 million and other assets of $.1 million. The Company also assumed liabilities for accounts payable of $.8 million, deferred revenue of $.5 million, salary and benefits accruals of $.2 million and acquisition related expenses of $.3 million. The acquisition was accounted for as a purchase and the operations are included in the consolidated statement of operations from the date of acquisition. The Company reported goodwill related to the transaction of $1.6 million, which will be amortized over an average period of twelve and one-half years. Subsequent to the acquisition date adjustments of $.6 million have been made to decrease goodwill to $1 million. The Company determines the amount of goodwill and the amortization period based upon a review of the acquired business and its earnings potential. NOTE D - UNBILLED RECEIVABLES - CONTRACTS IN PROGRESS Amounts billed under contracts in progress and included in accounts receivable were $1.3 million and $.5 million at December 31, 2000 and 1999, respectively. Unbilled amounts in accounts receivable were $.9 million and $5 million at December 31, 2000 and 1999, respectively and are recoverable from the 37 customer upon completion of the phase or milestone. The Company estimates that substantially all unbilled amounts will be collected in 2001. NOTE E- INVENTORIES The components of inventories were as follows: December 31 (thousands) 2000 1999 - ------------------------------------------------------------------------ Finished goods $ 196 $ 363 Work-in-process 846 1,927 Service parts 4,552 4,429 Materials and component parts 3,304 3,314 ------------------------- $ 8,898 $ 10,033 ========================= NOTE F - 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 $.5 million and $2.1 million at December 31, 2000 and December 31, 1999, respectively. The weighted average interest rate on borrowings during 2000 and 1999 was 13.2% and 8.3%, 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 outstanding balance on the term loan at December 31, 2000 and 1999 was $8.5 million and $9.5 million, respectively, all of which is classified as a current liability on the consolidated balance sheet. Both the line of credit and the term loan bore interest at prime through March 24, 2000, at which point the rate increased to prime plus 5%. Fleet National Bank sold the Agreement to Patriarch Partners, LLC on January 4, 2001. The Agreement 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. The Company entered into an amendment and waiver agreement with Patriarch Partners, LLC on January 31, 2001 that waived defaults on the revolver and term loans through July 1, 2001. The amendment also reduced the interest rate to prime plus 2% effective January 30, 2001. The Company is in the process of negotiating a total debt restructuring to meet its short-term and long-term capital needs. These matters raise substantial doubt about the Company's ability to continue as a going concern. If negotiations on the revision of the Agreement with Patriarch Partners LLC are not complete by the end of the second quarter, the Company will continue to negotiate with other bank and finance companies, as well as review other business and financing options. The carrying value of the notes payable to bank approximates its fair value and is secured by all of the Company's assets. 38 NOTE G- CAPITAL STOCK The Board of Directors is authorized to issue shares of the Company's preferred stock in series, to establish from time to time the number of shares to be included in each series and to fix the designation, powers, preferences and other terms and conditions with respect to such stock. No shares have been issued to date. At December 31, 2000, the Company had reserved 1,242,955 shares of common stock for the issuance or exercise of stock options. There are no shares reserved for the exercise of warrants. Class A Convertible stock has the same rights as common stock, except that its holders may not vote for the election of directors, and it is convertible into common stock on a share for share basis. On September 2, 1994, all outstanding shares of Class A Convertible stock were converted to common stock. No shares were outstanding at December 31, 2000 and 1999. NOTE H - STOCK OPTION PLANS The Company has elected to follow Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (APB No. 25) and related interpretations in accounting for its stock options. Under APB No. 25, because the exercise price of the Company's stock options equals market price of the underlying stock on the date of grant, no compensation expense is recognized. The Company has five stock option plans for key employees and board members. Options granted under the plans are for a period of ten years and at prices not less than 85% of the fair market value of the shares at date of grant. Options for employees are not exercisable for one year following the date of grant and then are exercisable in such installments during the period prior to expiration, as the Stock Option and Executive Compensation Committee shall determine. Options for Directors are not exercisable until six months after the grant thereof. Options may be exercised from time to time, in part or as a whole, on a cumulative basis as determined by the Stock Option and Executive Compensation Committee under all stock option plans. The following schedule summarizes the changes in stock options for each of the three years in the period ended December 31, 2000:
Number of Option Price Shares Per Share - --------------------------------------------------------------------------------------------- Outstanding January 1, 1998 (678,688 exercisable) 817,393 $1.50 to $9.19 Granted 35,000 5.69 to 9.19 Exercised (152,027) 2.13 to 3.75 Canceled (11,933) 2.13 to 6.38 --------------------------------- Outstanding December 31, 1998 (531,420 exercisable) 688,433 1.50 to 9.19 39 1999 Activity Granted 140,000 3.25 to 3.50 Exercised (25,750) 2.00 to 3.25 Canceled (47,700) 2.00 to 9.19 --------------------------------- Outstanding December 31, 1999 (560,457 exercisable) 754,983 1.50 to 9.19 2000 Activity Granted 561,700 .31 to 1.06 Surrendered (42,500) 6.38 to 9.19 Exercised (43,500) 2.00 to 2.00 Canceled (108,550) 1.06 to 5.75 ---------------------------------- Outstanding December 31, 2000 (545,245 exercisable) 1,122,133 $.31 to $9.19 ==================================
At December 31, 2000 there were 120,822 options available for grant of which 120,000 were reserved for the Directors. The weighted-average fair value of options granted was $.46, $3.45 and $6.21 during 2000, 1999, and 1998, respectively. The weighted-average remaining contractual life of the options outstanding at December 31, 2000 was 8 years. Pro forma information regarding net income and earnings per share is required by FASB Statement No. 123, and has been determined as if the Company had accounted for its stock options under the fair value method of that Statement. The fair value of these options was estimated at the date of grant using a Black-Scholes option pricing model. Option valuation models require the input of highly subjective assumptions including the expected stock price volatility. The assumptions used in the valuation model were: risk free interest rate - 7%, expected life - 10 years and expected volatility of .80 to 1.02. Because the Company's stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management's opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its stock options. For the purpose of pro forma disclosures, the estimated fair value of the stock options is expensed ratably over the vesting period, which is 36 months for key employees and 6 months for the Board of Directors. The Company's pro forma information follows:
December 31 (thousands, except per share amounts) 2000 1999 1998 - ----------------------------------------------------------------------------------------------- Net income (loss), as reported $(17,770) $ (8,175) $ 2,129 Stock option expense (51) (693) (563) ------------------------------------------ Pro forma net income (loss) $(17,821) $ (8,868) $ 1,566 ========================================== 40 Basic earnings (loss) per share, as reported $ (2.53) $ (1.17) $ .31 Stock option expense (.01) (.10) (.08) ------------------------------------------ Pro forma basic earnings (loss) per share $ (2.54) $ (1.27) $ .23 ========================================== Diluted earnings (loss) per share, as reported $ (2.53) $ (1.17) $ .30 Stock option expense (.01) (.10) (.08) ------------------------------------------ Pro forma diluted earnings (loss) per share $ (2.54) $ (1.27) $ .22 ==========================================
NOTE I - RESEARCH AND DEVELOPMENT AGREEMENTS During 1998, the Company entered into a $200,000 custom development project with a specific customer. The project involved adding fluorescent bar code printing and reading to the Series 9000 product and adding additional stacker modules to accommodate the document sorting requirement. The Company recorded all revenue related to this development agreement in 1998. These revenues offset related costs incurred to develop the modifications and enhancements. The ownership of the technologies created as a result of this development agreement remains with the Company. No royalties or other considerations are required as a part of this agreement. During 1999, the Company entered into four custom development agreements for specific customers. A $125,000 agreement involved the development of localization software for screen displays in Japanese. A $115,000 agreement was for recognition enhancements to a current product. A $75,000 agreement involved enhancements for the reading of Japanese stock certificates. A $58,000 agreement involved software developments for the processing of mortgage payments and taxes. The Company recorded all revenue related to these development agreements in 1999. These revenues offset the related costs incurred for this development. The ownership of these technologies remains with the Company. No royalties or other considerations are required as part of these agreements. During 2000, the Company completed a number of small custom development contracts for specific customers resulting in approximately $200,000 of revenue recognized during the year. The Company recorded all revenue related to these development agreements in 2000. These revenues offset the related costs incurred for this development. The ownership of these technologies remains with the Company. No royalties or other considerations are required as part of these agreements. NOTE J - EMPLOYEE BENEFITS The Company maintains a Retirement Savings Plan for United States employees. Under this plan, all employees may contribute up to 15% of their salary to a retirement account up to the maximum amount allowed by law. Starting in 1997, the Company contributed an amount equal to 50% of the first 6% contributed by the participant. The Company's contributions to this plan were $306,000, $374,000 and $329,000, in 2000, 1999 and 1998, respectively. The Company sponsors an Employee Stock Ownership Plan (the "Plan") covering substantially all full-time employees. The Plan, which is a tax qualified employee benefit plan, was adopted by the Board of Directors of the Company in 1988 to provide retirement benefits for employees. The Plan borrowed $1,325,000 to purchase 260,000 shares of the Company's stock to be allocated to participants ratably 41 over a ten year period. The ESOP loan was guaranteed by the Company and the outstanding balance of the loan was repaid in 1991. The Company did not allocate any additional shares to the Plan in 2000 or 1999. At December 31, 1998, all shares had been allocated. The Company, at its discretion, may make annual allocations to the Plan in the future. There were no expenses related to the Plan in 2000, 1999 and 1998. NOTE K - INCOME TAXES At December 31, 2000, the Company has U.S. federal and state operating loss carryforwards of approximately $17,490,000 and $19,980,000, respectively. The U.S. federal and state net operating loss carryforwards expire through 2020. At December 31, 2000, the Company has approximately $575,000, $3,270,000 and $800,000 of net operating loss carryforwards for Canada, the United Kingdom and Germany, respectively, which begin to expire in 2008. For financial reporting purposes, a valuation allowance has been recorded for 2000 and 1999 to fully offset deferred tax assets relating to U.S. federal, state, and foreign net operating loss carryforwards and other temporary differences. 42 Income (loss) before income taxes is set forth in the following tabulation:
Year Ended December 31 (thousands) 2000 1999 1998 - ----------------------------------------------------------------------------------- Domestic $(17,436) $ (7,806) $ 3,228 Foreign (273) (609) 6 ---------------------------------------------- Income (loss) before income taxes $(17,709) $ (8,415) $ 3,234 ============================================== Income taxes (benefit) are summarized as follows: Year Ended December 31 (thousands) 2000 1999 1998 - ------------------------------------------------------------------------------------ Current (benefit): Federal $ (956) $ 944 State $ 49 26 311 Foreign 12 (7) (5) -------------------------------------------- Total current (benefit) 61 (937) 1,250 -------------------------------------------- Deferred (benefit): Federal 620 (129) State 77 (16) --------------------------------------------- Total deferred (benefit) 697 (145) -------------------------------------------- $ 61 $ (240) $ 1,105 =============================================
Significant components of the Company's deferred tax liabilities and assets were as follows:
December 31 (thousands) 2000 1999 - ----------------------------------------------------------------------------------------------- Deferred tax assets: Net operating loss carryforward $ 8,556 $ 5,671 Alternative minimum tax credit carryforward 168 168 Depreciation 92 92 Charitable contribution carryforward 53 Inventory valuation 553 163 Inventory 180 101 Deferred maintenance revenue 6 Accounts receivable reserves 2,057 113 Goodwill 206 71 Revenue recognition - systems undergoing acceptance testing 8 Vacation accrual 216 237 Other 156 13 ------------------------- Total gross deferred tax assets 12,237 6,643 43 Deferred tax liabilities: Revenue recognition - milestone and retainer contracts (989) Depreciation and other (449) (263) ------------------------- Total gross deferred tax liabilities (449) (1,252) Valuation allowance (11,788) (5,391) ------------------------- Net deferred tax asset $ -- $ -- =========================
A reconciliation of the statutory tax rate to the effective rate is as follows: Year Ended December 31 2000 1999 1998 - ------------------------------------------------------------------------------- Statutory federal income tax rate (34)% (34)% 34% State income taxes, net of federal benefit .3 1 7% Adjustments to prior year taxes (3) Foreign sales corporation benefit (9) Foreign income taxes .1 2 Net operating loss carryforward 34 33 Other (2) 2 -------------------------------- Effective tax rate .4% (3)% 34% ================================ NOTE L - LEASE COMMITMENTS The Company's principal lease commitment is for its corporate office and manufacturing facility in Manchester, Connecticut. The Manchester lease expires on December 31, 2006. Minimum rental payments for all noncancelable leases, which are operating leases with terms equal to or in excess of one year as of December 31, 2000, are as follows: Minimum Rental (thousands) Payments - ----------------------------------------------------------------------- 2001 $ 979 2002 824 2003 659 2004 414 2005 426 Thereafter 755 ------ Total minimum lease payments $ 4,057 ======= Rental expense for the years ended December 31, 2000, 1999, and 1998 was $1,114,000, $1,062,000, and $865,000, respectively. 44 NOTE M - CONTINGENCIES There is one lawsuit currently pending against the Company. This lawsuit is in reaction to a lawsuit filed by the Company against the plaintiff. Although the ultimate outcome is uncertain, based on currently known facts, the Company believes that it has strong defenses against this lawsuit and the resolution of this matter will not have a material adverse effect on the Company's financial position or annual operating results. NOTE N - SEGMENT INFORMATION Business segment data and geographic area data for the years ended 2000, 1999 and 1998 as included in Item 1 of this report are an integral part of these financial statements. NOTE O - BILL AND HOLD TRANSACTIONS Revenues relating to sales of certain equipment (principally optical character recognition equipment) are recognized upon acceptance, shipment, or installation depending on the contract specifications. When customers, under the terms of specific orders or contracts, request that the Company manufacture and invoice the equipment on a bill and hold basis, the Company recognizes revenue based upon an in-house acceptance test that is certified by the customer. Revenues recorded during 2000, 1999 and 1998 included bill and hold transactions of $1.7 million, $5.6 million and $3.7 million, respectively. Accounts receivable included bill and hold receivables of $.4 million and $3.5 million at December 31, 2000 and 1999, respectively. 45 NOTE P - EARNINGS PER SHARE The following table sets forth the computation of basic and diluted earnings per share:
December 31 (thousands, except share data) 2000 1999 1998 - ----------------------------------------------------------------------------------------------------------- Numerator: Net Income (Loss) $ (17,770) $ (8,175) $ 2,129 ========================================================= Denominator: Denominator for basic earnings per share (weighted-average shares) 7,025,064 6,979,651 6,921,331 Effect of dilutive securities: Employee stock options 181,327 Denominator for diluted earnings per share (adjusted weighted-average shares and assumed Conversions) 7,025,064 6,979,651 7,102,658 ========================================================= Basic earnings (loss) per share $ (2.53) $ (1.17) $ .31 ========================================================= Diluted earnings (loss) per share $ (2.53) $ (1.17) $ .30 =========================================================
46 NOTE Q - QUARTERLY RESULTS OF OPERATIONS (UNAUDITED) The following is a summary of the quarterly results of operations for the years ended December 31, 2000 and 1999.
(thousands, except per share amounts) March June September December - -------------------------------------------------------------------------------------------------------------- 2000 Revenues $ 11,102 $ 9,924 $ 10,015 $ 7,261 Cost of product sales and service expenses 9,186 8,847 7,719 8,341 Net loss (2,275) (3,256) (1,781) (10,458) Basic earnings (loss) per share (.32) (.46) (.25) (1.49) Diluted earnings (loss) per share $ (.32) $ (.46) $ (.25) $ (1.49) 1999 Revenues $ 13,232 $ 14,829 $ 12,456 $ 11,475 Cost of product sales and service expenses 9,019 9,658 10,524 11,272 Net income (loss) 80 63 (1,963) (6,355) Basic earnings (loss) per share .01 .01 (.28) (.91) Diluted earnings (loss) per share $ .01 $ .01 $ (.28) $ (.91)
Fourth quarter 2000 net loss of $10.5 million includes charges to expense of $6.3 million or $.90 per share. The major components of these charges include $5.3 million of accounts receivable allowances for various accounts, $.7 million for inventories and an investment in a contract manufacturing customer, and $.3 million of inventory reserves. The fourth quarter of 1999 includes a $1.3 million reduction of the income tax benefit recorded for the nine month period ended September 30, 1999 and a valuation allowance was established for $.7 million for net deferred tax assets. 47 ITEM 9 - CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. PART III ITEM 10 - DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT Information pertaining to Directors and additional information pertaining to Executive Officers is included under the captions "Governance of the Company" and "Compliance with Section 16(a) of the Securities Exchange Act of 1934" in the Company's definitive proxy statement for the Annual Meeting of Stockholders to be held on May 17, 2001 and is incorporated herein by reference and made a part hereof. ITEM 11 - EXECUTIVE COMPENSATION This information is included in the Company's definitive proxy statement for the Annual Meeting of Stockholders to be held on May 17, 2001 and is incorporated herein by reference. ITEM 12 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT This information is included under the captions "Security Ownership of Certain Beneficial Owners" and "Share Ownership of Management" in the Company's definitive proxy statement for the Annual Meeting of Stockholders to be held on May 17, 2001 and is incorporated herein by reference. ITEM 13 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS This information is included under the caption "Certain Transactions" in the Company's definitive proxy statement for the Annual Meeting of Stockholders to be held on May 17, 2001 and is incorporated herein by reference. 48 PART IV ITEM 14 - EXHIBITS, FINANCIAL STATEMENT SCHEDULE AND REPORTS ON FORM 8-K (a) The following consolidated financial statements and report of independent auditors of the Company and its subsidiaries are included in Item 8: (1) Report of Independent Auditors Consolidated Balance Sheets at December 31, 2000 and 1999 Consolidated Statements of Operations for the years ended December 31, 2000, 1999 and 1998 Consolidated Statements of Stockholders' Equity for the years ended December 31, 2000, 1999 and 1998 Consolidated Statements of Cash Flows for the years ended December 31, 2000, 1999 and 1998 Notes to Consolidated Financial Statements - December 31, 2000 (2) The following consolidated financial statement schedule is included in Item 14(a): Schedule II -- Valuation and Qualifying Accounts All other schedules for which provision is made in the applicable accounting regulation of the Securities and Exchange Commission are not required under the related instructions or are inapplicable, and therefore have been omitted. (3) Listing of Exhibits *3.1(a) Certificate of Incorporation, including amendments thereto (filed as Exhibit 3.1 to the Company's Registration Statement on Form S-1, File No. 2-70277). *3.1(b) Amendments to Certificate of Incorporation adopted May 17, 1984, included in Exhibits A, B, C and D in the Company's Proxy Statement dated April 17, 1984 for the Annual Meeting of Stockholders held May 17, 1984. *3.1(c) Amendment to Article Tenth of the Certificate of Incorporation included as Exhibit A in the Company's Proxy Statement dated April 16, 1987 for the Annual Meeting of Stockholders held May 19, 1987. *3.2(a) By-laws of the Company (filed as Exhibit 3.2 to the Company's Registration Statement on Form S-1, File No. 2-70277). 49 *3.2(b) Amendments to By-laws of the Company adopted May 17, 1984, included in Exhibits A and B in the Company's Proxy Statement dated April 17, 1984 for the Annual Meeting of Stockholders held May 17, 1984. *3.2(c) Amendment to By-laws of the Company adopted at the meeting of the Board of Directors on January 28, 1991, included as Exhibit 3.2(c) in the Company's Annual Report on Form 10K filed for the year ended December 31, 1991. *+10.1 The Scan-Optics, Inc. 1979 Incentive and Non-Qualified Stock Option Plan included in Exhibit B in the Company's Proxy Statement dated June 8, 1979 for the Annual Meeting of Stockholders held on June 27, 1979. *+10.2 The Scan-Optics, Inc. 1984 Incentive and Non-Qualified Stock Option Plan included in Exhibit E in the Company's Proxy Statement dated April 19, 1984 for the Annual Meeting of Stockholders held on May 17, 1984. *+10.3 The Scan-Optics, Inc. 1987 Incentive and Non-Qualified Stock Option Plan included in Exhibit B in the Company's Proxy Statement dated April 16, 1987 for the Annual Meeting of Stockholders held on May 19, 1987. *+10.4 The Scan-Optics, Inc. 1990 Incentive and Non-Qualified Stock Option Plan included in Exhibit A in the Company's Proxy Statement dated April 30, 1990 for the Annual Meeting of Stockholders held on June 12, 1990. *+10.5 The Scan-Optics, Inc. 1990 Stock Option Plan for Outside Directors included in Exhibit B in the Company's Proxy Statement dated April 30, 1990 for the Annual Meeting of Stockholders held on June 12, 1990. *+10.6 The Scan-Optics, Inc. 1990 Incentive and Non-Qualified Stock Option Plan amendment included as Item 2 in the Company's Proxy Statement dated April 14, 1994 for the Annual Meeting of Stockholders held on May 18, 1994. *+10.7 The Scan-Optics, Inc. 1990 Stock Option Plan for Outside Directors amendment included as Item 2 in the Company's Proxy Statement dated April 15, 1996 for the Annual Meeting of Stockholders held on May 15, 1996. *+10.8 The Scan-Optics, Inc. 1999 Incentive and Non-Qualified Stock Option Plan included in Exhibit A in the Company's Proxy Statement dated April 8, 1999 for the Annual Meeting of Stockholders held on May 20, 1999. *+10.9 Employment agreement, effective as of December 31, 1996, between Scan-Optics, Inc. and James C. Mavel, included as Exhibit 10.10 in the Company's Annual Report on Form 10-K filed for the year ended December 31, 1996. *+10.10 Executive severance agreement between Joseph P. Crouch and Scan-Optics, Inc. dated November 15, 1999, is filed as Exhibit 10.10 in the Company's Annual Report on Form 10-K filed for the year ended December 31, 1999. 50 *+10.11 Executive severance agreement between Marianna C. Emanuelson and Scan-Optics, Inc. dated November 17, 1997, is filed as Exhibit 10.11 in the Company's Annual Report on Form 10-K filed for the year ended December 31, 1999. *+10.12 Executive severance agreement between Richard C. Goyette and Scan-Optics, Inc. dated November 17, 1997, is filed as Exhibit 10.12 in the Company's Annual Report on Form 10-K filed for the year ended December 31, 1999. *+10.13 Executive severance agreement between Joel K. Howser and Scan-Optics, Inc. dated November 17, 1997, is filed as Exhibit 10.13 in the Company's Annual Report on Form 10-K filed for the year ended December 31, 1999. *+10.14 Executive severance agreement between Clarence W. Rife and Scan-Optics, Inc. dated November 17, 1997, is filed as Exhibit 10.14 in the Company's Annual Report on Form 10-K filed for the year ended December 31, 1999. *+10.15 Executive severance agreement between Michael J. Villano and Scan-Optics, Inc. dated November 17, 1997, is filed as Exhibit 10.15 in the Company's Annual Report on Form 10-K filed for the year ended December 31, 1999. *22. List of subsidiaries of the Company, included as Exhibit 10.8 in the Company's Annual Report on Form 10-K filed for the year ended December 31, 1999. 23. Consent of Independent Auditors. * Exhibits so marked have heretofore been filed by the Company with the Securities and Exchange Commission and are incorporated herein by reference. + Management contract for compensatory plan or arrangement required to be filed as an exhibit to this form pursuant to Item 14(c) of this report. (b) Reports on Form 8-K No report on Form 8-K was filed for the quarter ended December 31, 2000. (c) Exhibits The exhibits required by this item are included herein. (d) Financial Statement Schedule The response to this portion of Item 14 is submitted as a separate section of this report. 51 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this annual report to be signed on its behalf by the undersigned, thereunto duly authorized. SCAN-OPTICS, INC. Registrant By: /s/ James C. Mavel ---------------------------------------- James C. Mavel Chairman, Chief Executive Officer, President and Director Date: March 26, 2001 Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant in the capacities and on the dates indicated. /s/ James C. Mavel - --------------------------- James C. Mavel Chairman, Chief Executive Officer, President and Director (Principal Executive Officer) Date: March 26, 2001 /s/ Michael J. Villano - --------------------------- Michael J. Villano Chief Financial Officer, Vice President and Treasurer (Principal Financial and Accounting Officer) Date: March 26, 2001 /s/ Logan Clarke, Jr. - --------------------------- Logan Clarke, Jr. Director March 26, 2001 /s/ Richard J. Coburn - --------------------------- Richard J. Coburn Director March 26, 2001 /s/ E. Bulkeley Griswold - --------------------------- E. Bulkeley Griswold Director March 26, 2001 /s/ Lyman C. Hamilton, Jr. - --------------------------- Lyman C. Hamilton, Jr. Director March 26, 2001 /s/ John J. Holton - --------------------------- John J. Holton Director March 26, 2001 /s/ Robert H. Steele - --------------------------- Robert H. Steele Director March 26, 2001 A majority of the Directors 52
SCHEDULE II SCAN-OPTICS, INC. AND SUBSIDIARIES VALUATION AND QUALIFYING ACCOUNTS THREE YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998 (thousands) COLUMN A COLUMN B COLUMN C COLUMN D COLUMN E Additions --------------------------------- Balance at Charged to Charged to Balance at Beginning Costs and Other End of Description Of Period Expenses Accounts Deductions Period - ---------------------------------------------------------------------------------------------------------------------------------- Year ended December 31, 2000 $ 308 $ 5,505 $ 13 (2) $ 211(1) $ 5,615 Reserve for doubtful accounts (billed and unbilled) Year ended December 31, 1999: $ 206 $ 94 $ 56 (2) $ 48 (1) $ 308 Reserve for doubtful accounts Year ended December 31, 1998: $ 104 $ $ 149 (2) $ 47 (1) $ 206 Reserve for doubtful accounts (1) Uncollectible accounts written off, net of recoveries. (2) Represents reclassifications from other accounts.
The required information regarding the valuation allowance for deferred tax assets is included in Note K. 53 EX-23 2 file002.txt 49 EXHIBIT 23 -- CONSENT OF INDEPENDENT AUDITORS We consent to the incorporation by reference in the Registration Statements (Form S-8 No. 33-37253, Form S-8 No. 33-37829, Form S-8 No. 33-16362. Form S-8 No. 2-93268 and Form S-8 No. 2-65503) of Scan-Optics, Inc. of our report dated February 19, 2001, with respect to the consolidated financial statements and schedule of Scan-Optics, Inc. and subsidiaries included in the Annual Report (Form 10-K) for the year ended December 31, 2000. /s/ Ernst & Young LLP Hartford, Connecticut March 26, 2001 -----END PRIVACY-ENHANCED MESSAGE-----