-----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, Nf+DY06s/Eg/5u1/xR7mFVGdG/c4muyZC1RSBL+U4c4/8QbLMirye8uInBH4sCoG y/m942g0alxSU6U8V0BWrA== 0000950159-01-500231.txt : 20010815 0000950159-01-500231.hdr.sgml : 20010815 ACCESSION NUMBER: 0000950159-01-500231 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 20010630 FILED AS OF DATE: 20010814 FILER: COMPANY DATA: COMPANY CONFORMED NAME: SCAN OPTICS INC CENTRAL INDEX KEY: 0000087086 STANDARD INDUSTRIAL CLASSIFICATION: COMPUTER PERIPHERAL EQUIPMENT, NEC [3577] IRS NUMBER: 060851857 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 000-05265 FILM NUMBER: 1712205 BUSINESS ADDRESS: STREET 1: 169 PROGRESS DR CITY: MANCHESTER STATE: CT ZIP: 06040 BUSINESS PHONE: 8606457878 MAIL ADDRESS: STREET 1: 169 PROGRESS DR CITY: MANCHESTER STATE: CT ZIP: 06040 10-Q 1 scanopt6-01q.txt SCAN-OPTICS, INC. 6/30/01 FORM 10-Q UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q (Mark One) ( X ) Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the quarterly period ended June 30, 2001 ---------------------------- ()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 Identification Number) incorporation or organization) 169 Progress Drive, Manchester, CT 06040 - -------------------------------------------------------------------------------- (Address of principal executive offices) Zip Code (860) 645-7878 - -------------------------------------------------------------------------------- (Registrant's telephone number, including area code) Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. ( X ) YES ( ) NO The number of shares of common stock, $.02 par value, outstanding as of July 27, 2001 was 7,439,732. SCAN-OPTICS, INC., AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS
(thousands, except share data) June 30, 2001 December 31, 2000 - -------------------------------------------------------------------------------------------- (UNAUDITED) Assets Current Assets: Cash and cash equivalents $ 1,614 $ 36 Accounts receivable less allowance of $2,006 at June 30, 2001 and $2,926 at December 31, 2000 3,809 8,664 Unbilled receivables - contracts in progress less allowance of $0 at June 30, 2001 and $2,689 at December 31, 2000 972 1,064 Refundable income taxes 4 124 Inventories 9,115 8,898 Deferred costs, net of revenues 172 171 Prepaid expenses and other 286 798 -------------------------- Total current assets 15,972 19,755 Plant and equipment: Equipment 13,618 13,574 Leasehold improvements 5,183 5,183 Office furniture and fixtures 1,352 1,362 -------------------------- 20,153 20,119 Less allowances for depreciation and amortization 18,433 18,126 -------------------------- 1,720 1,993 Software license, net 1,045 1,463 Goodwill, net 9,901 10,975 Other assets 250 250 -------------------------- Total Assets $28,888 $34,436 ==========================
2
(thousands, except share data) June 30, 2001 December 31, 2000 - ----------------------------------------------------------------------------------------- (UNAUDITED) Liabilities and Stockholders' Equity Current liabilities: Accounts payable $ 3,968 $ 6,066 Notes payable to bank 18,387 18,000 Salaries and wages 805 854 Taxes other than income taxes 428 393 Income taxes 121 Customer deposits 735 1,212 Other 1,669 2,942 ----------------------------- Total current liabilities 25,992 29,588 Other liabilities 541 541 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 at June 30, 2001 and December 31, 2000 149 149 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 35,654 Retained earnings deficit (29,789) (28,185) Foreign currency translation adjustments (1,013) (665) ----------------------------- 5,001 6,953 Less cost of common stock in treasury, 413,500 shares 2,646 2,646 ----------------------------- Total stockholders' equity 2,355 4,307 ----------------------------- Total Liabilities and Stockholders' Equity $ 28,888 $ 34,436 =============================
See accompanying notes. 3 SCAN-OPTICS, INC., AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
Three Months Ended Six Months Ended June 30 June 30 (thousands, except share data) 2001 2000 2001 2000 - ---------------------------------------------------------------------------------------------------------------------- Revenues Hardware and Software $ 1,722 $ 4,583 $ 7,886 $ 9,896 Professional Services 1,943 1,778 3,386 4,578 Access Services 3,326 3,563 6,627 6,552 --------------------------------- --------------------------------- Total revenues 6,991 9,924 17,899 21,026 Costs of Revenue Hardware and software 1,545 3,555 5,944 7,061 Professional services 1,104 2,017 2,300 4,958 Access services 2,689 3,274 5,430 6,013 --------------------------------- --------------------------------- Total costs of revenue 5,338 8,846 13,674 18,032 Gross Margin 1,653 1,078 4,225 2,994 Operating Expenses Sales and marketing 913 1,591 1,895 3,165 Research and development 686 963 1,431 2,075 General and administrative 545 1,113 1,530 2,255 Interest 439 669 951 1,063 --------------------------------- --------------------------------- Total operating expenses 2,583 4,336 5,807 8,558 --------------------------------- --------------------------------- Operating loss (930) (3,258) (1,582) (5,564) Other income (expense), net (2) 20 8 64 --------------------------------- --------------------------------- Loss before income taxes (932) (3,238) (1,574) (5,500) Income tax expense 8 18 30 31 --------------------------------- --------------------------------- Net Loss $ (940) $ (3,256) $ (1,604) $ (5,531) ================================= ================================= Basic loss per share $ (.13) $ (.46) $ (.23) $ (.79) ================================= ================================= Basic weighted-average shares 7,027,712 7,027,861 7,026,972 7,022,267 Diluted loss per share $ (.13) $ (.46) $ (.23) $ (.79) ================================= ================================= Diluted weighted-average shares 7,027,712 7,027,861 7,026,972 7,022,267
Certain 2000 amounts have been reclassified to conform to the current year presentation. 4 SCAN-OPTICS, INC., AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
Six Months Ended June 31 (thousands) 2001 2000 - ----------------------------------------------------------------------------------------------- Operating Activities Net loss $ (1,604) $ (5,531) Adjustments to reconcile net loss to net cash provided (used) by operating activities: Depreciation 346 454 Amortization of customer service inventory and software license 1,265 1,099 Amortization of goodwill 674 642 Provision for losses on accounts receivable 100 Changes in operating assets and liabilities: Accounts receivable 4,947 1,664 Refundable income taxes 120 1,742 Inventories (1,064) (1,370) Prepaid expenses and other 512 (75) Accounts payable (2,098) 760 Accrued salaries and wages (49) (286) Taxes other than income taxes 35 (637) Income taxes (121) 74 Deferred costs, net of revenues (1) (25) Customer deposits (477) 343 Other (1,620) 75 --------------------------- Net cash provided (used) by operating activities 865 (971) Investing Activities Acquisition related settlement - See Note 8 400 Proceeds from the sale of plant and equipment 215 Purchases of plant and equipment (73) (82) --------------------------- Net cash provided by investing activities 327 133 Financing Activities Proceeds from issuance of common stock 87 Proceeds from borrowings 3,484 13,772 Principal payments on borrowings (3,098) (12,983) --------------------------- Net cash provided by financing activities 386 876 Increase in cash and cash equivalents 1,578 38 Cash and Cash Equivalents at Beginning of Year 36 38 --------------------------- Cash and Cash Equivalents at End of Period $ 1,614 $ 76 ===========================
See accompanying notes. 5 SCAN-OPTICS, INC., AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) For the Quarter Ended June 30, 2001 NOTE 1 - Basis of Presentation - ------ The accompanying unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the six month period ended June 30, 2001, are not necessarily indicative of the results that may be expected for the year ending December 31, 2001. For further information, refer to the consolidated financial statements and footnotes thereto included in the Company's annual report on Form 10-K for the year ended December 31, 2000. Certain 2000 amounts have been reclassified to conform to current year presentation. NOTE 2 - Inventories - ------ The components of inventories were as follows: June 30 December 31 (thousands) 2001 2000 - ------------------------------------------------------------------------------ Finished goods $ 199 $ 196 Work-in-process 1,158 846 Service parts 4,338 4,552 Materials and component parts 3,420 3,304 ----------------------------- $ 9,115 $ 8,898 ============================= NOTE 3 - Credit Arrangements - ------ On June 29, 2001, the Company announced that it had reached an agreement with Patriarch Partners, LLC ("Patriarch") on terms and conditions to complete its debt restructuring. Under the proposed amendment from Patriarch, the maturity date of the Second Amended and Restated Loan Agreement, dated May 10, 1999 will extend to January 1, 2004. The current $8.5 million term loan will be restructured into a senior term loan of $6.5 million, which will remain at prime plus 2%; and a subordinated term loan of $2 million at a fixed rate of 10%. Monthly principal payments of $5,000 are required as part of the senior term loan. The revolving line of credit will remain at $10 million at an interest rate of prime plus 2%. This amendment will include warrants to purchase Scan-Optics common stock in an amount equal to 12.5% of the common equity on a fully diluted basis with reciprocal put and call rights. The 6 SCAN-OPTICS, INC., AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) For the Quarter Ended June 30, 2001 warrants will be purchased at a price of $.01 per share. The closing is scheduled to take place on or before September 1, 2001. The outstanding balance on the term loan at June 30, 2001 and December 31, 2000 was $8.5 million, all of which is classified as a current liability on the consolidated balance sheet due to the waiver of defaults which expires on September 1, 2001 as noted below. Both the line of credit and the term loan bore interest at prime plus 5% through January 30, 2001. This rate was reduced to prime plus 2% in accordance with the amendment as described below. The unused portion of the line is subject to a commitment fee of 3/8% per annum. The available balance on the line of credit was $.1 million and $.5 million at June 30, 2001 and December 31, 2000, respectively. The weighted average interest rate on borrowings during the first six months of 2001 and 2000 was 10.5% and 11.6%, respectively. Fleet National Bank sold the Agreement to Patriarch 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 on January 31, 2001 which waived defaults on the revolver and term loans through July 1, 2001. This amendment and waiver agreement was extended on June 29, 2001 for a period of sixty days to allow adequate time to document and execute the debt restructuring noted above. The amendment also reduced the interest rate to prime plus 2% effective January 30, 2001. The Company is in compliance with all covenants in effect under the amendment and waiver agreement relating to the line of credit and term loan as of June 30, 2001. The carrying value of the notes payable to the bank approximates its fair value and is secured by all of the Company's assets. NOTE 4 - Income Taxes - ------ At June 30, 2001, the Company has U.S. federal and state net operating loss carryforwards of approximately $18,000,000 and $19,700,000, respectively. The U.S. federal and state net operating loss carryforwards expire through 2015. At June 30, 2001, the Company has approximately $480,000, $2,700,000 and $800,000 of net operating loss carryforwards for Canada, the United Kingdom and Germany, respectively, which expire through 2007. At June 30, 2000, the Company had U.S. federal and state net operating loss carryforwards of approximately $13,400,000 and $16,000,000, respectively. At June 30, 2000, the Company had approximately $490,000, $3,300,000 and $800,000 of net operating loss carryforwards for Canada, the United Kingdom and Germany, respectively. For financial reporting purposes, a valuation allowance has been recorded for the first quarter of 2001 and 2000 to fully offset deferred tax assets relating to U.S. federal, state, and foreign net operating loss carryforwards and other temporary differences. 7 SCAN-OPTICS, INC., AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) For the Quarter Ended June 30, 2001 Significant components of the Company's deferred tax liabilities and assets were as follows:
June 30 December 31 (thousands) 2001 2000 - ------------------------------------------------------------------------------------------------------- Deferred tax assets: Net operating losses $ 8,499 $ 8,556 Alternative minimum tax credit carryforward 168 168 Depreciation 92 92 Charitable contribution carryforward 53 53 Inventory valuation 558 553 Inventory 180 180 Accounts receivable reserves 888 2,057 Goodwill 570 206 Vacation accrual 243 216 Other 155 156 --------------------------------------- Total gross deferred tax assets 11,406 12,237 Deferred tax liabilities: Revenue recognition - milestone and retainer contracts (4) Depreciation and other (437) (449) --------------------------------------- Total gross deferred tax liabilities (441) (449) Valuation allowance (10,965) (11,788) --------------------------------------- Net deferred tax asset $ - $ - =======================================
8 SCAN-OPTICS, INC., AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) For the Quarter Ended June 30, 2001 NOTE 5 - Earnings Per Share - ------ The following table sets forth the computation of basic and diluted earnings (loss) per share:
Three Months Ended Six Months Ended June 30 June 30 2001 2000 2001 2000 - ------------------------------------------------------------------------------------------------------------------- Numerator: Net loss $ (940) $ (3,256) $ (1,604) $ (5,531) =========================== =================================== Denominator: Denominator for basic and diluted earnings (loss) per share (weighted-average shares) 7,027,712 7,027,861 7,026,972 7,022,267 =============================================================== Basic earnings (loss) per share $ (.13) $ (.46) $ (.23) $ (.79) =============================================================== Diluted earnings (loss) per share $ (.13) $ (.46) $ (.23) $ (.79) ===============================================================
NOTE 6 - Comprehensive Income - ------ The components of comprehensive income (loss), net of related tax, for the three and six months ended June 30, 2001 and 2000 are as follows:
Three Months Ended Six Months Ended June 30 June 30 2001 2000 2001 2000 - ------------------------------------------------------------------------------------------------------------------- Net loss $ (940) $ (3,256) $ (1,604) $ (5,531) Foreign currency translation adjustments 16 (69) (358) (97) --------------------------------------------------------------- Comprehensive loss $ (924) $ (3,325) $ (1,962) $ (5,628) ===============================================================
9 SCAN-OPTICS, INC., AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) For the Quarter Ended June 30, 2001 The components of accumulated comprehensive loss, net of related tax, at June 30, 2001 and December 31, 2000 are as follows:
June 30 December 31 (thousands) 2001 2000 - -------------------------------------------------------------------------------------------- Foreign currency translation adjustments $ (982) $ (624) --------------------------------- Accumulated comprehensive loss $ (982) $ (624) =================================
NOTE 7 - Segment Information - ------ The Company views its business in three distinct revenue categories: Product and solution sales, 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.
Three Months Ended Six Months Ended June 30 June 30 2001 2000 2001 2000 - ------------------------------------------------------------------------------------------------------------------- Revenues Solutions and products $ 3,494 $ 5,470 $ 10,601 $ 12,528 Access services 3,326 4,037 6,627 7,511 Contract manufacturing services 171 417 671 987 --------------------------------------------------------------- Total revenues 6,991 9,924 17,899 21,026 Cost of solutions and products 2,649 5,600 8,244 11,820 Service expenses 2,689 3,247 5,430 6,213 --------------------------------------------------------------- Gross profit margin 1,653 1,077 4,225 2,993 Operating expenses and other income, net 2,585 4,315 5,799 8,493 --------------------------------------------------------------- Loss before income taxes $ (932) $ (3,238) $ (1,574) $ (5,500) =============================================================== Total expenditures for additions to long-lived assets $ 32 $ 33 $ 73 $ 81
10 NOTE 8 - Recent Developments - ------ On June 19, 2001 the Company reached a settlement with the former owners of Southern Computer Systems (SCS) regarding certain disputes that arose under their original stock purchase agreement executed in June 1998 pursuant to which Scan-Optics acquired 100% of the equity in SCS. As part of the stock purchase agreement, Scan-Optics was required to make certain payments to the former owners of SCS in connection with a consulting and non-compete agreement, some of which remained due. The stock purchase agreement also required the deposit of funds in a representation and warranty general escrow, which funds were to be released to the former owners of SCS on the second anniversary following the date of purchase. The settlement calls for the release of all claims made by Scan-Optics relating to the former owners' representations and warranties and the release of all claims made by the former owners against Scan-Optics. In exchange for this release, the former owners will forgive $.5 million due under the consulting and non-compete agreements and will make a cash payment from the general escrow account of $.4 million to Scan-Optics. The forgiveness of the $.5 million for the consulting and non-compete retainer is recorded as a reduction in Scan-Optics' general and administrative expense in the second quarter of 2001. The $.4 million payment from the general escrow account is accounted for as an adjustment of the original purchase price through a decrease in goodwill. Note 9 - New Accounting Pronouncements - ------ In July 2001, the Financial Accounting Standards Board ("FASB") issued Statements of Financial Accounting Standards No. 141, "Business Combinations" and 142,"Goodwill and Other Intangibles". Statement No. 141 requires all business combinations initiated after June 30, 2001 to be accounted for using the purchase method of accounting. Statement No. 142 eliminates amortization of goodwill and requires at least an annual assessment for impairment applying a fair value based test. Furthermore, an acquired intangible assets should be separately recognized if the benefit of the intangible asset is obtained through contractual or other legal rights, or if the intangible asset can be sold, transferred, licensed, rented, or exchanged, regardless of the acquisrer's intent to do so. The Company is required to adopt Statement No. 142 for fiscal year 2002 and is in the process of determining the impact of these pronouncements on its financial position and results of operations. 11 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'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 $.9 million in the second quarter of 2001 as compared with a loss of $3.3 million in the second quarter of 2000. The Company experienced a loss in the first six months of 2001 of $1.6 million, which is an improvement over the prior year loss of $5.5 million. Compared to the first six months of 2000, hardware and software revenues decreased $2 million due to the concern over the expiration on July 1, 2001 and potential non-renewal of the bank agreement as well as the general economic environment for goods and services. In the second quarter of 2001 the professional services organization experienced another quarter of profitability improving over the positive results in the first quarter. The gross margin for professional services for the first six months of 2001 was 32% compared to negative margin of 8% in the same period in 2000. This improvement shows continued progress on the transition to becoming a Solutions company. Because of the existence of significant non-cash expenses, such as depreciation of fixed assets and amortization of intangible assets and customer service inventory, the Company believes that EBITDA (earning before interest, taxes, depreciation and amortization) contributes to a better understanding of the Company's ability to satisfy its obligations and to utilize cash for other purposes. EBITDA should not be considered in isolation from or as a substitute for operating income, cash flow from operating activities, and other consolidated income or cash flow data prepared in accordance with generally accepted accounting principles. The operating income before interest, taxes, depreciation and amortization (EBITDA) was $.6 million in the second quarter of 2001, as compared to an EBITDA loss of $1.5 million in the second quarter of 2000. EBITDA was $1.7 million in the first six months of 2001, as compared to an EBITDA loss of $2.2 million in same period of 2000. 12 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 materially 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 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 decreased $1.8 million in the first six months of 2001 as compared to 2000 and decreased $2.7 million during the second quarter of 2001 compared to the second quarter of 2000. 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. The Company experienced a revenue increase of $2.6 million or 298% in Europe during the first six months of 2001 from 2000 and remained consistent on a quarter to quarter comparison. The Pacific Rim declined in the first six months by $1.6 million or 74% and increased $.2 million in the second quarter of 2001 as compared to 2000. The economic environment in Latin America has been an impediment to growth where the Company experienced only a slight increase in revenue. The Company plans on the continuation of its international expansion effort in the future. 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 the first six months of 2001 compared to 2000, Access Services revenue increased by $.1 million or 1% and decreased $.2 million or 7% for the quarter. Contract manufacturing revenue decreased by $.3 million or 32% during the first six months of 2001 compared to 2000 and decreased $.2 million or 59% in the second quarter comparison. 13 The Company has put on hold its initiative of long term growth through accretive acquisitions of key strategic products or enterprises. No acquisitions are currently being considered due to management's focus on the operations of the business and the liquidity position of the Company. Results of Operations for the Three and Six Months Ended June 30, 2001 vs. 2000 - ------------------------------------------------------------------------------- Total revenues decreased $3.1 million or 15% from the first six months of 2000 to the first six months of 2001 and decreased $2.9 million or 30% from the second quarter of 2000 to the second quarter of 2001. Hardware and software revenues decreased $2 million or 20% in the first six months of 2001 compared with the first six months of 2000. Hardware and software revenues decreased $2.9 or 62% in the second quarter of 2001 compared with the second quarter of 2000. Compared to the first six months of 2000, North American sales decreased $3 million or 45% and decreased $3.1 million or 74% during the second quarter of 2001 compared to the second quarter of 2000 due to the concern over the expiration on July 1, 2001 and potential non-renewal of the bank agreement as well as the general economic environment. International sales during the first six months of 2001 increased $1 million or 33% and increased $.2 or 63% during the second quarter of 2001 mainly due to a large integrated solution sale to the British government. Professional services revenues decreased $1.2 million or 26% in the first six months of 2001 compared with the first six months of 2000 and increased $.2 million or 9% during the second quarter of 2001 compared to the second quarter of 2000, mainly due to the completion of various contracts that were behind schedule during 2000 along with a reduced level of current projects which allowed the Company to achieve expected profitability targets. Access services revenues remained consistent in the first six months and the second quarter of 2001 as compared with the same periods in 2000. Cost of hardware and software decreased $1.1 million from the first six months of 2000 compared to the first six months of 2001 and decreased $2 million from the second quarter of 2000 compared to the second quarter of 2001. Cost of hardware and software sales as a percentage of revenue was 75% for the first six months of 2001, compared to 71% in the first six months of the prior year. Cost of hardware and software sales as a percentage of revenue was 90% during the second quarter of 2001, compared to 78% in the second quarter of the prior year. This increase is due to the reduced sales volume and product mix. 14 Cost of professional services decreased $2.7 million in the first six months of 2001 vs. 2000 and decreased $1 million in the second quarter of 2001 compared to the prior year mainly due to a decrease in contractor expense, salaries and related benefits, travel expense and the Alabama facility closing. Cost of Access services decreased $.6 million in the first six months of 2001 vs. 2000 and the second quarter of 2001 vs. 2000 due to a decrease in a provision for uncollectable accounts receivable, third party contractor expense, salaries and related benefits and travel expense. Sales and marketing expenses decreased $1.3 million from the first six months of 2000 and decreased $.7 million from the second quarter of 2000 mainly due to a decrease in salaries and related benefits, travel expense and a provision for uncollectable accounts receivable. Research and development expenses decreased $.6 million from the first six months of 2000 and decreased $.3 million from the second quarter of 2000 mainly due to a decrease in consulting expense, salaries and related benefits and the Alabama facility closing. General and administrative expenses decreased $.7 million from the first six months of 2000 and decreased $.6 from the second quarter of 2000 mainly due to the recording of the settlement of the Southern Computer Systems stock purchase agreement which forgave $.5 million due under the consulting and non-compete retainer (See Note 8). Interest expense decreased $.1 million from the first six months of 2000 and decreased $.2 million from the first quarter of 2000 due to the change in the interest rate. Both the line of credit and term loan carried an interest rate of prime through March 24, 2000 when the rate increased to prime plus 5%. As of January 30, 2001 the interest rate was reduced to prime plus 2%. The weighted average interest rate for the first six months of 2001 was 10.5% compared to 11.6% in 2000. Liquidity and Capital Resources - ------------------------------- Cash and cash equivalents at June 30, 2001 increased $1.6 million from December 31, 2000 levels. Total borrowings increased to $18.4 million at June 30, 2001 from $18 million at the end of 2000. The available balance on the line of credit was $.1 million at June 30, 2001. As of June 30, 2001, the Company is in compliance with all of the financial covenants related to its bank debt. On June 29, 2001, the Company announced that it had reached an agreement with Patriarch on terms and conditions to complete its debt restructuring. (See Note 3 for further details.) 15 The Company entered into an amendment and waiver agreement with Patriarch on January 31, 2001 which waived defaults on the revolver and term loans through July 1, 2001. This amendment and waiver was extended on June 29, 2001 for a period of sixty days to allow adequate time to document the debt restructuring noted above. (See Note 3 for further details.) Operating activities provided $.9 million of cash in the first six months of 2001. Non-cash expenses recorded during the first six months of the year were $2.3 million consistent with the same period in 2000. These expenses relate to depreciation of fixed assets (discussed in net plant and equipment below), amortization of customer service spare parts inventory, amortization of software license, amortization of goodwill and provision for losses on accounts receivable. Net accounts receivable and unbilled receivables at June 30, 2001 decreased $4.9 million from December 31, 2000 due to the collection of outstanding receivables that were related to various contracts that were behind schedule in 2000, along with a lower than expected hardware and software revenue recorded in the second quarter of 2001. Total inventories at June 30, 2001 increased $.2 million from December 31, 2001. Total manufacturing inventories increased $.5 million from the beginning of the year mainly due to an increase in work in process inventory. Customer service inventories decreased $.3 million mainly due to amortization of inventory. Net plant and equipment decreased $.3 million from December 31, 2000 mainly due to depreciation expense reported during the first six months of the year. Software license decreased by $.4 million from December 31, 2000 due to the amortization of the source code licensing agreement. Goodwill decreased by $1.1 million from December 31, 2000 due to amortization recorded for the first six months of 2001 and a reduction in goodwill of $.4 million related to the settlement of the Southern Computer Systems stock purchase agreement dispute (See Note 8). Accounts payable decreased $2.1 million from December 31, 2000 due to the timing of payments. Customer deposits decreased $.5 million from December 31, 2000 due to the completion of various contracts. Other current liabilities decreased by $1.3 million from December 31, 2000 due to the settlement with the prior owners of Southern Computer Systems that provided a reduction of $.5 million, a decrease in accrued interest expense and payments applied to accrued expenses. 16 SCAN-OPTICS, INC., AND SUBSIDIARIES PART II - OTHER INFORMATION Item 1. Legal Proceedings See Note 8 to the Company's Notes to Consolidated Financial Statements (Unaudited) for the quarter ended June 31, 2001 included herein. Item 4. Submission of Matters to a Vote of Security Holders The Company held its Annual Meeting of Stockholders on May 17, 2001 to elect two directors and to appoint the Company's independent auditors for the year ending December 31, 2001. Logan Clarke, Jr. and Richard J. Coburn were elected directors for terms expiring in 2004 by favorable votes of not less than 5,698,239. There were a total of 161,598 abstentions in the vote for Messrs. Clarke and Coburn and no broker nonvotes. The other members of the Board of Directors are E. Bulkeley Griswold, John J. Holton and Robert H. Steele, whose terms expire in 2002, and Lyman C. Hamilton, Jr. and James C. Mavel, whose terms expire in 2003. Ernst & Young, LLP were appointed as the Company's independent auditors for the year ending December 31, 2001 by a vote of 5,786,650 in favor, 63,225 against, 9,960 abstentions and no broker nonvotes. Item 6(a) Exhibits Exhibit 10 Executive Severance Agreement dated as of May 22, 2001, by and between the Company and Alan W. Ware. 17 ITEM 6 (B) - REPORTS ON FORM 8-K For the Six Months Ended June 30, 2001 No reports on Form 8-K were filed during the first six months of 2001. 18 SIGNATURES ---------- Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. SCAN-OPTICS, INC. ----------------- (Registrant) Date August 10, 2001 / ss/ James C. Mavel -------------------- ----------------------------------------------- James C. Mavel Chairman, Chief Executive Officer, President and Director Date August 10, 2001 / ss/ Michael J. Villano -------------------- ----------------------------------------------- Michael J. Villano Chief Financial Officer, Vice President and Treasurer 19 EX-10 3 exhibit10.txt EXHIBIT 10 Exhibit 10 Executive Severance Agreement dated as of May 22, 2001, by and between the Company and Alan W. Ware. EXECUTIVE SEVERANCE AGREEMENT This EXECUTIVE SEVERANCE AGREEMENT (the "Agreement") is made as of May 22, 2001, by and between SCAN-OPTICS, INC. (the "Company") and Alan W. Ware (the "Executive"). RECITALS: - --------- A. The Executive is an executive of the Company and has made and is expected to continue to make major contributions to the short- and long-term profitability, growth, and financial strength of the Company; B. The Company recognizes that the possibility of a Change of Control (as hereafter defined) exists; C. The Company desires to assure itself of both present and future continuity of its management and desires to establish certain severance benefits for key executive officers of the Company, including the Executive, applicable in the event of a Change of Control; and D. The Company wishes to aid in assuring that such executives are not practically disabled from discharging their duties in respect of a proposed or actual transaction involving a Change of Control. NOW, THEREFORE, the Company and the Executive agree as follows: 1. Certain Defined Terms: In addition to terms defined elsewhere herein, the following terms have the following meanings when used in this Agreement with initial capital letters: (a) "Base Pay" means the Executive's annual aggregate fixed base salary from the Company at the time in question. (b) "Board" means the Board of Directors of the Company. (c) "Change of Control" means a change of control of a nature that would be required to be reported in response to Item 5(f) of Schedule 14A of Regulation 14A promulgated under the Securities Exchange Act of 1934, as amended (the "Exchange Act"), whether or not the Company is then subject to such reporting requirement; provided that, without limitation, such a Change of Control shall be deemed to have occurred if (i) any "person" (as such term is used in Sections 13(d) and 14(d) of the Exchange Act) is or becomes the "beneficial owner" (as defined in Rule 13d-3 under the Exchange Act), directly or indirectly, of securities of the Company representing 22% or more of the combined voting power of the Company's then outstanding securities; or (ii) during any period of two consecutive years (not including any period prior to the execution of this Agreement), individuals who at the beginning of such period constitute the Board and any new directors, whose election by the Board or nomination for election by the Company's stockholders was approved by a vote of at least two-thirds (2/3) of the directors then still in office who either were directors at the beginning of the period or whose election or nomination for election was previously so approved, cease for any reason to constitute a majority thereof. (d) "Cause" means that, prior to any Termination by the Executive for Good Reason, the Executive shall have: (i) committed an intentional act of fraud, embezzlement, or theft in connection with the Executive's duties or in the course of his employment with the Company; (ii) committed intentional wrongful damage to property of the Company; or (iii) intentionally and wrongfully disclosed confidential information of the Company; and any such act shall have been materially harmful to the Company. For purposes of this Agreement, no act on the part of the Executive shall be deemed "intentional" if it was due primarily to an error in judgment or negligence, but shall be deemed "intentional" only if done by the Executive not in good faith and without reasonable belief that the Executive's action or omission was in the best interests of the Company. The determination of whether a Termination of the Executive's employment is for "Cause" shall be made by the Board. (e) "Commission Pay" means the average annual commissions paid to the Executive by the Company during the three year period ending at the time in question. (f) "Date of Termination" means the date of receipt of a Notice of Termination or any later date specified therein, as the case may be; provided, however, that if the Executive is Terminated by the Company other than for Cause or for disability pursuant to Section 2(a)(ii), the Date of Termination will be the date on which the Executive receives a Notice of Termination from the Company; and provided further, if the Executive is Terminated by reason of death or disability pursuant to Section 2(a)(i) or 2(a)(ii), the Date of Termination will be the last day of the month in which occurs the date of death or the disability effective date, as the case may be. (g) "Employee Benefits" means the perquisites, benefits and service credit for benefits as provided under the plans and programs maintained by the Company, including, but not limited to, plans and programs which are "employee benefit plans" under Section 3(3) of the Employee Retirement Income Security Act of 1974, as amended, and any amendment or successor to such plans or programs (whether insured, funded or unfunded). (h) "Good Reason" means the occurrence of any of the events listed in Sections 2(b)(i) through 2(b)(vii), inclusive. (i) "Incentive Pay" means an annual amount equal to the aggregate annual bonus, incentive compensation or performance pay, in addition to Base Pay, made or to be made in regard to services rendered in any calendar year or performance period pursuant to any bonus, incentive compensation or performance pay plan of the Company. (j) "Notice of Termination" means a written notice which (i) indicates the specific provision in this Agreement relied upon, (ii) sets forth in reasonable detail the facts and circumstances claimed to provide a basis for the Termination under the provision so indicated, and (iii) if the effective date of the Termination is other than the date of receipt of such notice, specifies the effective date of Termination (which date will be not more than sixty (60) days after the giving of such notice). The failure by the Executive to set forth in the Notice of Termination any fact or circumstance which contributes to a showing that the Executive is entitled to the benefits intended to be provided by this Agreement will not constitute a waiver of any right of the Executive hereunder or otherwise preclude the Executive from later asserting such fact or circumstance in enforcing the Executive's rights hereunder. (k) "Severance Period" means the period of time commencing on the date of an occurrence of a Change of Control and continuing until the earlier of (i) the date which is two years following the occurrence of the Change of Control and (ii) the Executive's death. (1) "Term" means (i) the period commencing on the date hereof and ending on the second anniversary of the date hereof; provided, however, that commencing on the date one year after the date hereof, and on each annual anniversary of such date (such date and each annual anniversary thereof shall be hereinafter referred to as the "Renewal Date"), unless previously terminated, the Term shall be automatically extended so as to terminate two years from such Renewal Date, unless at least sixty (60) days prior to the Renewal Date the Company shall give notice to the Executive that the Term shall not be so extended, (ii) if, prior to a Change of Control, for any reason the Executive is Terminated or Terminates, thereupon without further action the Term shall be deemed to have expired and this Agreement will immediately terminate and be of no further effect, and (iii) in the event of a Change of Control, the Term will, without further action, be considered to terminate at the expiration of the Severance Period. (m) "Terminate", "Termination" and correlative terms mean the termination of the Executive's employment with the Company and any Affiliate or Subsidiary. 2. Termination Following a Change of Control: (a) If, during the Severance Period, the Executive is Terminated, the Executive will be entitled to the benefits provided by Section 3 unless such Termination is by reason of one or more of the following events: (i) The Executive's death; (ii) The permanent and total disability of the Executive, as defined in any long term disability plan of the Company, applicable to the Executive, as in effect immediately prior to the Change of Control; (iii) Cause; or (iv) The Executive's voluntary Termination in circumstances in which Good Reason does not exist. (b) In the event of the occurrence of a Change of Control, the Executive may Terminate during the Severance Period with the right to severance compensation as provided in Section 3 upon the occurrence of one or more of the following events (regardless of whether any other reason, other than Cause as hereinabove provided, for Termination exists or has occurred, including, without limitation, other employment): (i) An adverse change in the nature or scope of the authorities, powers, functions, responsibilities, or duties attached to the position with the Company, which the Executive held immediately prior to the Change of Control; (ii) A reduction in the Executive's Base Pay as in effect immediately prior to any Change of Control, or as it may have been increased from time to time thereafter; (iii) Any failure by the Company to continue in effect any plan or arrangement providing Incentive Pay in which the Executive is participating at the time of a Change of Control (or any other plans or arrangements providing substantially similar benefits) or the taking of any action by the Company which would adversely affect the Executive's participation in any such plan or arrangement or reduce the Executive's benefits under any such plan or arrangement in a manner inconsistent with the practices of the Company prior to the Change of Control; (iv) Any failure by the Company to continue in effect any Employee Benefits in which the Executive is participating at the time of a Change of Control (or any other plans or arrangements providing the Executive with substantially similar benefits) or the taking of any action by the Company which would adversely affect the Executive's participation in or materially reduce the Executive's benefits under any Employee Benefits or deprive the Executive of any material fringe benefit enjoyed by the Executive at the time of a Change of Control; (v) The liquidation, dissolution, merger, consolidation, or reorganization of the Company or transfer of all or substantially all of its business and/or assets, unless the successor or successors (by liquidation, merger, consolidation, reorganization, transfer, or otherwise) to which all or a significant portion of its business and/or assets have been transferred (directly or by operation of law) assumed all duties and obligations of the Company under this Agreement pursuant to Section 9; (vi) Without limiting the generality or effect of the foregoing, any material breach of this Agreement by the Company or any successor thereto; or (vii) Any action by the Company which causes the Executive's services to be performed regularly at any office or location greater than thirty-five (35) miles from the office or location where the Executive was employed immediately preceding the date of the Change of Control. (c) Any Termination will be communicated by Notice of Termination hereto given in accordance with Section 10 of this Agreement. 3. Severance Compensation: (a) If, following the occurrence of a Change of Control, the Executive is Terminated by the Company during the Severance Period other than in the circumstances set forth in Section 2(a)(i), 2(a)(ii), or 2(a)(iii), or if the Executive Terminates for Good Reason: (i) The Company will pay to the Executive in a lump sum in cash within five business days after the later of the date on which the Company receives the determination of the Accounting Firm required in Section 4 hereof or the Date of Termination an amount (the "Severance Payment") equal to the sum of (A) 2.5 times the sum of Base Pay and Commission Pay at the highest rates in effect at any time within the 90-day period preceding the date the Notice of Termination was given or, if higher, at the highest rates in effect at any time within the 90-day period preceding the date of the first occurrence of a Change of Control, plus (B) an amount equal to 2.5 times the greatest amount of Incentive Pay received by the Executive during any year from and including the third year prior to the first occurrence of a Change of Control, plus (C) an amount equal to 2.5 times the matching contribution that would be made by the Company to the Scan-Optics, Inc. Retirement Savings Plan on the Executive's behalf if the Executive deferred under such Plan four percent (adjusted for any applicable limitation under the Internal Revenue Code of 1986, as amended) of the sum of Base Pay, Commission Pay and Incentive Pay (at the rates used in (A) and (B) above) or such higher percentage as may then be eligible for Company matching contributions, plus (D) an amount equal to the value (determined as of the Date of Termination and assuming exercisability as of such date) of all options granted to the Executive to acquire Company common stock that will not become exercisable as a result of Executive's Termination; and (ii) For two years following the Date of Termination, the Executive shall be eligible for participation in and shall receive all benefits under such benefit plans, practices, policies and programs of the Company that provide medical, prescription, dental, disability, accident or life insurance coverage, with the costs of such participation to be paid by the Company to the same extent as prior to the Executive's Termination. In the event that such continued participation is not allowed under the terms and provisions of such plans or programs, then in lieu thereof, the Company shall acquire individual insurance policies providing comparable coverage for the Executive; provided that if any such individual coverage is unavailable, the Company shall pay to the Executive an amount equal to the contributions that would have been made by the Company for such coverage on the Executive's behalf if the Executive had remained in the employ of the Company for two years following the Date of Termination. (b) There will be no right of set-off or counterclaim in respect of any claim, debt, or obligation against any payment to or benefit for the Executive provided for in this Agreement. (c) Without limiting the rights of the Executive at law or in equity, if the Company fails to make any payment or provide any benefit required to be made or provided under this Agreement (including under this Section 3 or Section 6) on a timely basis, the Company will pay interest on the amount or value thereof at an annualized rate of interest equal to the so-called composite "prime rate" as quoted from time to time during the relevant period in the Northeast Edition of The Wall Street Journal. Such interest will be payable as it accrues on demand. Any change in such prime rate will be effective on and as of the date of such change. (d) Notwithstanding any other provision hereof, the parties' respective rights and obligations under this Section 3 and under Sections 4 and 6 will survive any termination or expiration of this Agreement following a Change of Control or any Termination following a Change of Control for any reason whatsoever. 4. Excise and Other Taxes. The Executive shall bear all expense of, and be solely responsible for, all federal, state, local or foreign taxes due with respect to any payment received hereunder, including, without limitation, any excise tax imposed by Section 4999 of the Internal Revenue Code of 1986, as amended (the "Code"); provided, however, that the Severance Payment shall be reduced to the extent necessary so that no portion thereof shall be subject to the excise tax imposed by Section 4999 of the Code. The foregoing determination will be made by a nationally recognized accounting firm (the "Accounting Firm") selected by the Executive and reasonably acceptable to the Company (which may, but will not be required to be, the Company's independent auditors). The Executive will direct the Accounting Firm to submit its determination and detailed supporting calculations to both the Company and the Executive within fifteen (15) days after the Date of Termination. If the Accounting Firm determines that such reduction is required by this Section 4, the Company shall pay such reduced amount to the Executive in accordance with Section 3(a)(i). If the Accounting Firm determines that no reduction is necessary under this Section 4, it will, at the same time as it makes such determination, furnish the Company and the Executive an opinion that the Executive will not be liable for any excise tax under Section 4999 of the Code. The Company and the Executive will each provide the Accounting Firm access to and copies of any books, records, and documents in the possession of the Company or the Executive, as the case may be, reasonably requested by the Accounting Firm, and otherwise cooperate with the Accounting Firm in connection with the preparation and issuance of the determinations and calculations contemplated by this Section 4. The fees and expenses of the Accounting Firm for its services in connection with the determinations and calculations contemplated by this Section 4 will be borne by the Company. 5. No Mitigation Obligation: The Company hereby acknowledges that it will be difficult, and may be impossible, for the Executive to find reasonably comparable employment following the Date of Termination. The payment of the severance compensation by the Company to the Executive in accordance with the terms of this Agreement will be liquidated damages, and the Executive will not be required to mitigate the amount of any payment provided for in this Agreement by seeking other employment or otherwise, nor will any profits, income, earnings, or other benefits from any source whatsoever create any mitigation, offset, reduction, or any other obligation on the part of the Executive hereunder or otherwise. 6. Legal Fees and Expenses: If the Company has failed to comply with any of its obligations under this Agreement or in the event that the Company or any other person takes or threatens to take any action to declare this Agreement void or unenforceable, or institutes any litigation or other action or proceeding designed to deny, or to recover from, the Executive the benefits provided or intended to be provided to the Executive hereunder, the Company irrevocably authorizes the Executive from time to time to retain counsel of the Executive's choice, at the expense of the Company to the extent hereafter provided, to advise and represent the Executive in connection with any such interpretation, enforcement, or defense, including, without limitation, the initiation or defense of any litigation or other legal action, whether by or against the Company or any member of the Board, officer, stockholder, or other person or entity affiliated with the Company, in any jurisdiction. If the Executive prevails, in whole or in part, in connection with any such litigation, the Company will pay and be solely financially responsible for any and all attorneys' and related fees' and expenses incurred by the Executive in connection with such litigation. 7. Employment Rights: Nothing expressed or implied in this Agreement will create any right or duty on the part of the Company or the Executive to have the Executive remain in the employment of the Company prior to or following any Change of Control. 8. Withholding of Taxes: Except as otherwise provided in this Agreement, the Company may withhold from any amounts payable under this Agreement all federal, state, city, or other taxes as the Company is required to withhold pursuant to any law or government regulation or ruling. 9. Successors and Binding Agreement: (a) The Company will require any successor (whether direct or indirect, by purchase, merger, consolidation, reorganization, or otherwise) to all or substantially all of the business and/or assets of the Company, by agreement in form and substance satisfactory to the Executive, expressly to assume and agree to perform this agreement in the same manner and to the same extent the Company would be required to perform if no such succession had taken place. This Agreement will be binding upon and inure to the benefit of the Company and any successor to the Company, including, without limitation, any persons acquiring directly or indirectly all or substantially all of the business and/or assets of the Company whether by purchase, merger, consolidation, reorganization, or otherwise (and such successor will thereafter be deemed the "Company" for the purposes of this Agreement), but will not otherwise be assignable, transferable, or delegable by the Company. (b) This Agreement will inure to the benefit of and be enforceable by the Executive's personal or legal representatives, executors, administrators, successors, heirs, distributees, and/or legatees. (c) This Agreement is personal in nature and neither of the parties hereto will, without the consent of the other, assign, transfer, or delegate this Agreement or any rights or obligations hereunder except as expressly provided in Sections 9(a) and 9(b). Without limiting the generality or effect of the foregoing, the Executive's right to receive payments hereunder will not be assignable, transferable, or delegable, whether by pledge, creation of a security interest, or otherwise, other than by a transfer by will or by the laws of descent and distribution and, in the event of any attempted assignment or transfer contrary to this Section 9(c), the Company will have no liability to pay any amount so attempted to be assigned, transferred, or delegated. 10. Notices: For all purposes of this Agreement, all communications, including, without limitation, notices, consents, requests, or approvals, required or permitted to be given hereunder will be in writing and will be deemed to have been duly given when hand delivered or dispatched by electronic facsimile transmission (with receipt thereof orally confirmed), or two business days after having been mailed by United States registered or certified mail, return receipt requested, postage prepaid, or one business day after having been sent by a nationally recognized overnight courier service, addressed to the Company (to the attention of the Chairman of the Board) at its principal executive office and to the Executive at the Executive's principal residence, or to such other address as any party may have furnished to the other in writing and in accordance herewith, except that notices of changes of address will be effective only upon receipt. 11. Governing Law: The validity, interpretation, construction, and performance of this Agreement will be governed by and construed in accordance with the substantive laws of the State of Connecticut, without giving effect to the principles of conflict of laws of such State, to the extent not preempted by applicable federal law. 12. Validity: If any provision of this Agreement or the application of any provision hereof to any person or circumstances is held invalid, unenforceable, or otherwise illegal, the remainder of this Agreement and the application of such provision to any other person or circumstances will not be affected, and the provision so held to be invalid, unenforceable, or otherwise illegal will be reformed to the extent (and only to the extent) necessary to make it enforceable, valid, or legal. 13. Non-Exclusivity of Rights: Nothing in this Agreement will prevent or limit the Executive's present or future participation in any benefit, bonus, incentive, or other plan or program provided by the Company for which the Executive may qualify, nor will this Agreement in any manner limit or otherwise affect such rights as the Executive may have under any stock option or other agreements with the Company. Amounts or benefits which are vested or which the Executive is otherwise entitled to receive under any plan or program of the Company at or subsequent to the Date of Termination will be payable in accordance with such plan or program, except as otherwise expressly provided in this Agreement; provided, however, that any amounts received by the Executive pursuant to this Agreement shall be in lieu of (but, if necessary to give effect to this provision, shall be reduced by) any benefits which the Executive is entitled to receive or may become entitled to receive under any reduction-in-force or severance pay plan or practice which the Company now has in effect or may hereafter put into effect, any other benefits to which the Executive may be entitled under any previous individual agreement of employment or severance agreement with the Company which would provide a benefit to the Executive upon the occurrence of, or the termination of employment following, a Change of Control (whether or not so defined in said individual agreement), and any severance benefits required under federal or state law to be paid to the Executive. 14. Miscellaneous: No provision of this Agreement may be modified, waived, or discharged unless such waiver, modification, or discharge is agreed to in writing signed by the Executive and the Company. No waiver by either party hereto at any time of any breach by the other party hereto or compliance with any condition or provision of this Agreement to be performed by such other party will be deemed a waiver of similar or dissimilar provisions or conditions at the same or at any prior or subsequent time. No agreements or representations, oral or otherwise, expressed or implied with respect to the subject matter hereof have been made by either party which are not set forth expressly in this Agreement. References to Sections are to references to Sections of this Agreement. IN WITNESS WHEREOF, the parties have caused this Agreement to be duly executed and delivered as of the date first above written. SCAN-OPTICS, INC. By __________/__ss__/______________ Name: JamesC.Mavel Title: Chairman, President and Chief Executive Officer _____________/__ss__/ Name: Alan W. Ware -----END PRIVACY-ENHANCED MESSAGE-----