-----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, CcacNA+SX3OTdqc1ofgIXs6EyrihlNm0qvF+keCZ3IRR94tvQx1mbweH1m6ckefb 2PCSPrglvm1C22NZZvK1tQ== 0000950159-02-000206.txt : 20020415 0000950159-02-000206.hdr.sgml : 20020415 ACCESSION NUMBER: 0000950159-02-000206 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 20011231 FILED AS OF DATE: 20020401 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: 1934 Act SEC FILE NUMBER: 000-05265 FILM NUMBER: 02598162 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 scanoptics10k.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, 2001 ( ) Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the transition period from ------------------------------------------------- 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) Securities registered pursuant to Section 12(b) of the Act: None ------------------- Common stock, Securities registered pursuant to Section 12(g) of the Act: $.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: $2,231,920 as of March 26, 2002. The number of shares of common stock, $.02 par value, outstanding as of March 26, 2002 was 7,439,732. 1 DOCUMENTS INCORPORATED BY REFERENCE Portions of the definitive Proxy Statement, relating to the 2002 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, develops, manufactures and services production image scanning systems and designs, develops and integrates software-based solutions that use state of the art technology for imaging, automated data capture with forms processing, 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 33 years, the Company has provided innovative solutions to its customers, using advanced technology for forms processing, document management 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 data management 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 of a specific customer or industry. 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, assessment, commercial voting systems such as proxy ballot and tabulation, 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 maintenance support for equipment related to scanning, imaging and automated data capture, as well as supplying maintenance services for other manufacturers of electro-mechanical equipment. The Company's Manufacturing Services Division created a contract manufacturing function in 1998 to provide electro-mechanical assembly and test services for third party providers of equipment such as large-format scanners and other 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' AccuScore, for the automatic scoring of "bubble" forms, uses electronic image-capture technology in conjunction with patent pending image processing software for performing the scoring with: * No expensive paper or printing required * No specialized LED-array scanner * Flexible, easy-to-use forms definition tool * Extremely high accuracy rates * Greater flexibility in forms design Scan-Optics' AddressBuilder, automatically reads customer names and addresses from incoming documents and prepares the data for the customer's database, using patented technology. AddressBuilder automatically corrects OCR ("optical character recognition") rejects, OCR substitutions, and erroneous data from original documents - without operator intervention. Scan-Optics' DocWise, provides a secure digital information archive. DocWise can store virtually any type of electronic file: E-mail, computer documents (Microsoft Excel and Word), digital photos, faxes, XML files and ERM reports. DocWise provides security with Windows NT security with seven levels of access rights built in. DocWise has the capacity to import and index thousands of documents per hour in standard Tiff format. 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. 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' PayWise, is a turnkey solution designed to increase the efficiency of an Accounts Payable department by integrating image processing of the supplier invoice to a company's Accounts Payable system. 4 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' 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. Products In June 1992, the Company introduced the Series 9000 scanner. The Series 9000 integrates 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 camera technology, and black and white or grayscale output. Both models are based on Windows NT operating environment, 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 over-training 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 5 designed for high-speed key-entry, key-from-image, and state-of-the-art character recognition (OCR/ICR) applications. 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 Docwise product set was enhanced through the addition of dwWEB and dwINDEX. The dwWEB software product provides access to stored images via the World Wide Web and the dwINDEX provides an off-line indexing application for higher volume forms processing. The Company added a new scanner series to its line in 1999, the Vision Series 8000, due to the acquisition of product rights and certain assets of Photomatrix Corporation. 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. SONAR (Scan-Optics Neural Auxiliary Recognition) is a software product released in 2001. SONAR incorporates the Company's patented Context Edit product and ICR recognition technology for lower volume forms/data capture applications. Applications such as address changes are ideally suited for SONAR. In 2002, the Company intends to continue its aggressive program of research and development of enhancements with 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. Core Competencies Key product disciplines utilize integration skills and experience 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 Document Management, Workflow and Access Line of Business Domain Knowledge Professional Services (Design, Development, Installation and Support) Value Added Engineering Services and Solutions 6 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 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. In 2001, the Company released the 9000mm, a 100 page per minute scanner based upon the 9000M product. 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 systems have rapidly overtaken 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 expanded this recognition to include barcode, patch code, special educational test scoring analysis, and special stamp recognition. In addition to these recognition processes, the Company 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. 7 Document Management, Workflow and Access In 1999, the Company introduced DocWise which extends the value of the digitized documents to workflow, storage and retrieval functions. This enables the use of image technology to research source documents in a customer service environment. 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; ImageEMC++, ORDERexpress(TM), PROOFexpress(TM) and TAXexpress(TM). 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: Application Expertise Industry Standards Open Systems Archival / Retrieval Installation Paper Handling Custom Engineering Microfilming Project Management Development Tools Networking Systems Engineering Forms Design Neural Technology System Integration Imaging OCR Technology Training The Company has provided software solutions to its customers since 1968. Utilizing both Company developed products and third party products, the Professional Services group provides turnkey solutions to address the customer's mission critical applications. 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, assessment, transportation, financial, and order entry markets. 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. 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, archival storage and retrieval, 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. Similar techniques have been used to provide quality and fraud control application for the indicia from postal meters. 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. 8 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, test scoring, 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. MANUFACTURING SERVICES DIVISION The contract manufacturing services function, within the Manufacturing Services Division, 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: 9 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 2001, no customers accounted for more than 10% of total revenue. In 2000, the Company derived 13% 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. BACKLOG The backlog for the Company's products and services as of December 31, 2001 was approximately $22.5 million. As of December 31, 2000, the backlog was approximately $15.3 million. The backlog consists of equipment, software and services to be sold and non-cancelable 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. 10 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 2001, 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 with other third party maintenance providers for this revenue by using its reputation for quality and its 32 years of experience in providing scanner repair. Contract Manufacturing, a function 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. 11 ISO 9001 CERTIFICATION On November 12, 1999, the Company received ISO 9001-1994 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 expanding its quality program by bringing the Access Service Division into compliance. The Company also performed internal audits to test for compliance in the sales, design, manufacturing and service areas to continue to improve the quality management system. The registering body performed four surveillance audits on the Company's product development and manufacturing divisions, all of which were successful. In 2001, the Company maintained its quality systems and prepared for the transition to ISO 9001:2000. The Company expects to achieve ISO 9001:2000 compliance by May 2002. PATENTS The Company currently has nine United States patents in force which expire between 2003 and 2021. 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 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 an ultrasonic overlapping document detection system for our scanners. In 2001, the Company received the patent for the ultrasonic-based system. EMPLOYEES As of December 31, 2001 the Company employed 221 persons, including 23 with administrative and support responsibilities, 19 in marketing and sales, 122 in software and service activities, 20 in engineering and 37 in manufacturing capacities. The Company considers its employee relations to be good. The Company has not experienced any work stoppages. FUNDED DEVELOPMENT AGREEMENTS 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 12 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 and 2001, the Company completed a number of small custom development contracts for specific customers resulting in revenue of approximately $200,000 and $110,000, respectively. 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. 13 BUSINESS SEGMENTS The Company views its business in three distinct operating segments: 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) 2001 2000 1999 - -------------------------------------------------------------------------------------------------------- Revenues Solutions and products $16,667 $ 23,295 $ 36,841 Access services 13,193 12,669 14,083 Contract manufacturing services 880 2,338 1,068 -------- -------- -------- Total revenues 30,740 38,302 51,992 Cost of solutions and products 13,298 22,806 28,816 Service expenses 11,200 11,287 11,657 -------- -------- -------- Gross profit margin 6,242 4,209 11,519 Operating expenses, net 12,522 21,918 19,934 -------- -------- -------- Loss before income taxes $ (6,280) $(17,709) $ (8,415) ======== ======== ======== Total assets $ 25,279 $ 34,436 $ 55,186 Total expenditures for additions to long-lived assets $ 121 $ 109 $ 596
Certain 2000 and 1999 amounts have been reclassified to conform to the current year presentation. Note: In 2001, no customers accounted for more than 10% of total revenue. In 2000, the Company derived 13% 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. All international sales other than sales originating from the UK and Canadian subsidiaries are denominated in United States dollars. Changes in the economic climates of foreign markets could have an unfavorable impact on future international sales. 14 Export sales by geographic area (based on the location of the customer) were as follows:
(thousands) 2001 2000 1999 - ---------------------------------------------------------------------------------------------------------- Latin America $ 152 3% $ 152 2% $ 77 2% Europe 3,706 73% 1,667 22% 1,982 41% Pacific Rim 1,220 24% 5,881 76% 2,743 57% --------------------------------------------------------- $ 5,078 $ 7,700 $ 4,802 =========================================================
Export sales represented 45%, 43%, and 20% of hardware and software revenues for the three years ended December 31, 2001, 2000, and 1999, 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 are two lawsuits currently pending against the Company. The lawsuits are both in reaction to lawsuits filed by the Company against the plaintiffs. Although the ultimate outcome is uncertain, based on currently known facts, the Company believes that it has strong defenses against both lawsuits and the resolution of these matters 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 2001 to a vote of the stockholders. 15 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 56 Chairman, Chief Executive Officer and President 1996 Joseph P. Crouch 39 Vice President - Manufacturing Services Division 1999 Marianna C. Emanuelson 40 Vice President - Human Resources 1997 Richard C. Goyette 50 Vice President - Sales and Marketing 1996 Richard D. Harris 41 Corporate Secretary 2001 Joel K. Howser 54 Vice President - Software Development 1998 Clarence W. Rife 62 Vice President - Access Services Division and Hardware Engineering 1975 Michael J. Villano 42 Chief Financial Officer, Vice President and Treasurer 1992 Alan W. Ware 63 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. 16 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 - Sales and Marketing. Mr. Harris joined the law firm of Day, Berry and Howard LLP in 1990 and became a partner in 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. He is currently Vice President - Software Development. 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 and Hardware Engineering. 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. 17 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. 18 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 would 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 929 stockholders of record at December 31, 2001.
Quarter Ended March 31 June 30 September 30 December 31 High Low High Low High Low High Low - --------------------------------------------------------------------------------------------------------------- 2001 $ .33 $ .14 $ .35 $.21 $ .93 $.27 $.35 $.20 2000 $4.75 $1.56 $1.97 $.44 $1.19 $.53 $.84 $.13
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 and the Company's loan agreement does not allow dividend payments. The Company issued mandatory redeemable preferred stock and common stock warrants to its lender in a private transaction in exchange for the forgivenes of indeptedness in the Company's total debt restructuring. (See Note F to the consolidated financial statements for further information.) 19 ITEM 6 - SELECTED FINANCIAL DATA SCAN-OPTICS, INC. AND SUBSIDIARIES FIVE YEAR SUMMARY OF OPERATIONS SELECTED FINANCIAL DATA
(thousands, except share data) 2001 2000 1999 1998 1997 -------------------------------------------------------------------------------------------------------------------------------- Total Revenues $ 30,740 $ 38,302 $ 51,992 $ 53,971 $ 56,608 ======================================================================================== Income (loss) before income taxes (6,280) (17,709) (8,415) 3,234 5,691 Income taxes (benefit) 33 61 (240) 1,105 (99) ---------------------------------------------------------------------------------------- Net Income (Loss) $ (6,313) $ (17,770) $ (8,175) $ 2,129 $ 5,790 ======================================================================================== Basic earnings (loss) per share $ (.90) $ (2.53) $ (1.17) $ 0.31 $ 0.87 Basic weighted-average shares 7,026,232 7,025,064 6,979,651 6,921,331 6,632,248 Diluted earnings (loss) per share $ (.90) $ (2.53) $ (1.17) $ 0.30 $ 0.82 Diluted weighted-average shares 7,026,232 7,025,064 6,979,651 7,102,658 7,070,013 SELECTED BALANCE SHEET DATA Total assets $ 25,279 $ 34,436 $ 55,186 $ 52,992 $ 38,707 Working capital (deficit) $ 3,886 $ (9,833) $ 4,727 $ 15,107 $ 24,643 Long term obligation $ 10,392 Mandatory redeemable preferred stock $ 3,800 Total stockholders' equity $ 360 $ 4,307 $ 22,081 $ 30,246 $ 27,733
The Company has not paid any dividends for the five year period ended December 31, 2001. The above financial data should be read in conjunction with the related consolidated financial statements and notes thereto. 20 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. Although the Company recently completed a total debt restructuring (see Note F to the consolidated financial statements for further information), the Company remains highly leveraged and could be adversely affected by a significant increase in interest rates. A one percent increase in the prime rate would increase the annual interest cost on the outstanding loan balance at December 31, 2001 of approximately $12 million by $.1 million. 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 $6.3 million in 2001, including $.6 million of one time charges associated with the accrual of severance costs and a stay bonus for senior executive management. The operating loss, without the one time charges, was $5.7 million. The loss was mainly due to the reduction in revenue related 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. Even with this negative impact, the decline in revenue was offset by a reduction of costs of revenue and operating expenses over the same period due to the efficiency and productivity of the organization. Furthermore, the professional services sector of the solutions division experienced four consecutive quarters of profitability during 2001. The gross margin for professional services for 2001 was 38% compared to negative margin of 8% for the same period in 2000. This improvement shows continued progress on the transition to 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 21 income, cash flow from operating activities, and other consolidated income or cash flow data prepared in accordance with generally accepted accounting principles. EBITDA was $.4 million in 2001, as compared to an EBITDA loss of $10.7 million in 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 seek opportunities 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, assessment, commercial balloting, 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 $7.2 million from 2000 to 2001 due to the general economic conditions and other matters as discussed earlier. 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 million or 122% in Europe from 2000 to 2001. The Pacific Rim declined by $4.7 million or 79% in 2001 as compared to 2000. The economic environment in Latin America has been an impediment to growth, and revenue from Latin America was flat in comparison with the prior year at $.2 million. The third initiative relates to leveraging the Company's core competencies in an effort to absorb fixed expenses and increase 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. Access Services revenue increased by $.5 million or 4% from 2000 to 2001. Contract manufacturing revenue decreased by $1.5 million or 62% from 2000 to 2001 due to the completion of a contract with a major customer and product release delays from new customers. 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 - 2001 VS. 2000 Total revenues decreased $7.6 million or 20% from 2000 to 2001. 22 Hardware and software revenue decreased $6.9 million or 38% from the prior year. North American sales decreased $4.3 million or 41% due mainly 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. Total international sales decreased $2.6 million or 34% from 2000. International sales in the Pacific Rim decreased 79% or $4.6 million due to the significant reduction of spare parts orders and scanner systems sold to Japan's National Ministry of Health. Sales to Europe increased $2 million or 122% due to a large integrated solution sale to the British government, Latin American sales remained consistent with the prior year mainly due to the continued decline in economic conditions in the Latin American countries. Professional services revenue decreased $1.2 million or 16% from 2000 to 2001 mainly due to the completion of various contracts during 2001 that were not completed during 2000 and the slowdown in orders as noted above. Access services revenue increased $.5 million or 4% from 2000 to 2001 due mainly to an increase in new third party maintenance contracts and the increased retention of existing customers using Scan-Optics manufactured equipment. Cost of hardware and software revenue decreased $5.4 million or 36% from 2000. Cost of hardware and software revenue as a percentage of revenue was 83% in 2001, as compared to 81% in 2000. This decrease is mainly due to the decline in hardware and software revenue. Cost of professional services revenue decreased $4.2 million or 51% in 2001 compared to the prior year mainly due to a decrease in contractor expense, salaries and related benefits and travel expense. Cost of professional services revenue as a percentage of revenue was 62% in 2001, as compared to 108% in 2000. Cost of Access services revenue remained consistent from 2000 to 2001. Cost of Access services revenue as a percentage of revenue was 85% in 2001, as compared to 89% in 2000. Sales and marketing expenses decreased $2 million or 34% from 2000 mainly due to a decrease in salaries, commissions and related benefits, travel expense and a provision for uncollectable accounts receivable. Research and development expenses decreased $.8 million or 21% from 2000 mainly due to a decrease in consulting expense and salaries and related benefits. General and administrative expenses decreased $6 million or 60% from 2000 mainly due to the accounts receivable allowance recorded during the fourth quarter of 2000 for various accounts that were determined to be uncollectable which was not required in 2001 and 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 C). Interest expense decreased $.6 million from 2000 due mainly to a change in the interest rate on the Company's indebtedness. Both the line of credit and term loan carried an interest rate of 23 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 was 9.8% in 2001 compared to 13.2% in 2000. RESULTS OF OPERATIONS - 2000 VS. 1999 Total revenues decreased $13.7 million or 26% from 1999 to 2000. Hardware and software revenue 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 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%, Latin American sales remained consistent with the prior year mainly due to the continued decline in economic conditions in the Latin American countries. Professional services revenue decreased $6.6 million or 47% from 1999 to 2000 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. Access services revenue decreased $1.4 million or 10% from 1999 to 2000 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. Cost of hardware and software revenue decreased $1.4 million from 1999 to 2000. Cost of hardware and software revenue as a percentage of hardware and software revenue 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 revenue. Cost of professional services revenue decreased $4.6 million or 36% 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. Cost of Access services revenue 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. 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. 24 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. 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. LIQUIDITY AND CAPITAL RESOURCES Cash and cash equivalents increased $1.6 million from 2000 to 2001. At December 31, 2001, the Company had $11.9 million in outstanding borrowings, with $1.5 million classified as current, against its $12.8 million available borrowings. The Company anticipates meeting its current and long-term obligations through the funds generated from operations. The average borrowing level for 2001 was $18.3 million compared to $18.1 million for 2000. The increase in borrowing level is directly related to the loss the Company reported in 2000. Effective December 31, 2001, the Company restructured its loan agreements with Patriarch Partners, LLC. ("Patriarch") that contains a forgiveness of a portion of the term debt, additional borrowing capability in the short term and reduced interest expense due to reduced debt levels. In exchange for the forgiveness of debt, the Company issued shares of preferred stock and warrants to purchase common stock. The debt agreement expires on December 31, 2004. The Company believes that the restructuring will allow execution of the Company's business plans for the foreseeable future. The loan agreement contains covenants which, among other things, require the maintenance of minimum earnings before interest and taxes, depreciation and amortization, capital expenditure spending limits, accounts receivable write-offs and backlog levels. (See Note F.) The Company's ability to achieve the required financial covenants is premised upon the attainment of 2002 planned revenue objectives and continued planned cost containment. The Company began the year 2002 with a backlog in excess of $22 million or 68% of its 2002 revenue plan and believes that it will be able to achieve its 2002 revenue and cost containment objectives. 25 The Company's achievement of its 2002 revenue forecast is dependent upon sales of the Company's software and solutions products and services. The Company continues to focus on achieving strong software and solutions revenues in 2002 by, among other things, adding six experienced software and solution sales people over the last several months. The market the Company addresses has experienced a slow down due to general economic conditions and recent world events; however, the Company continues to believe that there is sound financial justification within the user community for acquiring the products and services it provides, which should generate ongoing sales. There are also signs over the last few months indicating general improvement in the domestic economy, which has materialized in increased customer and prospect activity. The Company believes that its strong backlog position as of the beginning of 2002, combined with the additions to the sales force and a continued improvement in the economy within its market will lead to the achievement of its business plan and covenant compliance. However, there can be no assurance that the Company will achieve its revenue objectives and covenant compliance. (See Note A.) The following summarizes the Company's significant contractual obligations and commitments that impact its liquidity.
Contractual Obligations Payments Due by Period - ---------------------------------------------------------------------------------------------------------------- (thousands) Less than 1 1- 3 Years 4 - 5 Years After 5 years Total year - ---------------------------------------------------------------------------------------------------------------- Long term debt $ 10,392 $ 10,392 Operating leases 3,099 $ 822 1,492 $ 488 $ 297 ---------------------------------------------------------------------- Total contractual cash obligations $ 13,491 $ 822 $ 11,884 $ 488 $ 297 ----------------------------------------------------------------------
Operating activities provided $.9 million of cash in 2001 compared to a use of cash of $.7 million in 2000. The non-cash expenses in 2001 were $5.1 million compared to $11.2 million in 2000. The non-cash items relate to depreciation of fixed assets which is discussed in net plant and equipment below, amortization of customer service inventory and software license, 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 $6.5 million from December 31, 2000. There are two main factors associated with the net decrease in accounts receivables. The first factor is the collection of older solution accounts receivable whose collections were delayed due to the professional service issues encountered in prior years. The second factor is the reduction in total revenue from 2000 levels. Total inventories decreased $.4 million from 2000 levels. Manufacturing inventories increased $.2 million during the year due to an increase in work-in-process inventory of $.7 million and a decrease in materials and component parts of $.5 million, mainly due to the Company's increase in production schedule for the first quarter of 2002. The manufacturing inventory increase was offset by a decrease in customer service inventory of $.6 million which was mainly attributable to the reduced level of purchases of new inventory and amortization of spare parts inventory. Net plant and equipment decreased $.6 million in 2001. This decrease is mainly due to depreciation. Software license decreased by $.8 million due to amortization of the source code license recorded during the year. Goodwill decreased by $1.7 million in 2001 due to amortization of $1.3 million and a $.4 million adjustment to goodwill resulting from the settlement of disputes with the former owners of Southern Computer Systems (SCS) that arose under the June 1998 stock purchase agreement pursuant to which Scan-Optics acquired 100% of the equity in SCS. The transaction was accounted for as a purchase and the excess cost over the fair value of the net assets acquired of $8.8 million is being amortized over a twenty-year period. The acquisition of the maintenance division of Access Corporation, which also occurred in June of 1998, was accounted for as a purchase and the excess cost over fair value of the net assets acquired of $3.5 million is being amortized over a five-year period. The acquisition of the scanner and maintenance division of Photomatrix Corp. 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. Other assets decreased by $.1 million mainly due to the expiration of the non-compete agreements with the former principals of SCS. 26 Accounts payable decreased $2.6 million from December 31, 2000 due to the control of expenses and the timing of payments. Notes payable to bank decreased $6.1 million related to the total debt restructuring effective December 31, 2001. (See Note F.) Salaries and wages increased $.5 million from 2000 mainly due to the accrual of a stay bonus for senior management and the severance accrual for headcount reductions. Other current liabilities decreased $.3 million due to the reduction in professional service consulting and other accruals. Other long term liabilities increased $.2 million mainly due to the deferral of lease payments due to Patriarch as part of the total debt restructuring. (See Note F.) Mandatory reedemable preferred stock of $3.8 million was issued by the Company as part of the total debt restructuring. (See Note F.) Capital in excess of par increased by $2.7 million due the common stock warrants issued by the Company as part of the total debt restructuring. (See Note F.) Foreign currency translation adjustments increased $.3 million due to changes in exchange rates on assets and liabilities deployed in the Company's two active subsidiaries in the United Kingdom and Canada. OTHER MATTERS New Accounting Standards Refer to Note B of the Notes to Consolidated Financial Statements in Item 8 for a discussion of new accounting pronouncements and the potential impact to the Company's consolidated results of operations and consolidated financial position. Critical Accounting Policies The policies discussed below are considered by management to be critical to an understanding of the financial statements because their application places the most significant demands on management's judgement, with financial reporting results relying on estimation about the effect of matters that are inherently uncertain. Specific risks for these critical accounting policies are described in the following paragraphs. Allowance for doubtful accounts: The Company evaluates the collectability of accounts receivable based on a combination of factors. In cases where the Company has knowledge of a specific customer's inability to meet its financial obligations (e.g., bankruptcy filings, substantial slow-down in recent payment history) or contract disputes, a specific reserve for uncollectable amounts will be recorded. For all other customers, the Company records a reserve for bad debts based on the age of the receivable balance. If circumstances change (i.e., 27 higher than expected defaults, unexpected material adverse change in a significant customer's ability to meet its financial obligations to the Company or contract disputes), estimates of the collectability of amounts due could be reduced by a material amount. Revenue recognition - percentage of completion: The Company recognizes revenue and profit on professional services engagements using the percentage of completion method of accounting, which relies on estimates of total expected contract revenues and costs. The Company follows this method since reasonably dependable estimates of the revenue and costs applicable to various stages of a contract can be made. Since the financial reporting of these contracts depends on estimates, which are assessed continually during the term of the contract, recognized revenues and profit are subject to revisions as the contract progresses to completion. Revisions in profit estimates are reflected in the period in which the facts that give rise to the revision become known. Accordingly, favorable changes in estimates result in additional profit recognition, and unfavorable changes in estimates result in the reversal of previously recognized revenue and profits. When estimates indicate a loss under a contract, the provision for such loss is recorded in that period. As work progresses under a loss contract, revenue continues to be recognized, and a portion of the contract costs incurred in each period is charged to the contract loss reserve. The estimated loss is calculated and adjusted each period. If estimates change, the professional services revenue, cost of revenue and gross margins will be impacted. Inventories - slow moving and obsolete: The Company performs an annual review of excess and obsolete manufacturing inventories to determine if the inventory reserve recorded on the balance sheet is adequate to cover the value of parts deemed excess or obsolete. The review is based upon current inventory levels, expected product sales over the next twelve to twenty four months and Access Services requirements for spare parts. Should the Company not achieve expected product sales or if Access Services parts requirements should change, future losses may occur through the requirement of additional reserves for excess and obsolete inventory. 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. If the business plans the Company utilized to calculate the undiscounted cash flows are not achieved, a potential impairment could exist and a write-down of the net book value of goodwill could be required. 28 ITEM 7A - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The Company recently completed a total debt restructuring (see Note F for further information), however, the Company remains highly leveraged and could be adversely affected by a significant increase in interest rates. A one percent increase in the prime rate would increase the annual interest cost on the outstanding loan balance at December 31, 2001 of approximately $12 million by $.1 million. The Company has minimal foreign currency translation risk. All international sales other than sales originating from the UK and Canadian subsidiaries are denominated in United States dollars. 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. 29 ITEM 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA 30 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, 2001 and 2000, and the related consolidated statements of operations, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 2001. 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, 2001 and 2000, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2001, 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. The accompanying financial statements have been prepared assuming that Scan-Optics, Inc. will continue as a going concern. As more fully described in Note A, the Company has incurred operating losses for the past three years. Effective December 31, 2001, the Company restructured its loan agreements with its lender. These agreements contain certain financial covenants with which the Company must comply. Failure to meet these conditions raises 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 Note A. 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 22, 2002 31 SCAN-OPTICS, INC., AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS
December 31 (thousands, except share data) 2001 2000 - ------------------------------------------------------------------------------------------------------------------------ Assets Current Assets: Cash and cash equivalents $ 1,662 $ 36 Accounts receivable less allowance of $1,936 in 2001 and $2,926 in 2000 2,252 8,664 Unbilled receivables - contracts in progress less allowance of $2,689 in 2000 945 1,064 Refundable income taxes 124 Inventories 8,543 8,898 Deferred costs, net of revenues 179 171 Prepaid expenses and other 325 798 -------------------------------------------------------- Total current assets 13,906 19,755 Plant and Equipment: Equipment 13,340 13,574 Leasehold improvements 5,232 5,183 Office furniture and fixtures 1,338 1,362 -------------------------------------------------------- 19,910 20,119 Less allowances for depreciation and amortization 18,530 18,126 -------------------------------------------------------- 1,380 1,993 Software license, net of accumulated amortization of $1,773 in 2001 and $937 in 2000 627 1,463 Goodwill, net of accumulated amortization of $4,462 in 2001 and $3,136 in 2000 9,249 10,975 Other assets 117 250 -------------------------------------------------------- Total Assets $ 25,279 $ 34,436 ========================================================
32
December 31 (thousands, except share data) 2001 2000 - ------------------------------------------------------------------------------------------------------------------------ Liabilities and Stockholders' Equity Current liabilities: Accounts payable $ 3,462 $ 6,066 Notes payable to bank 1,500 18,000 Salaries and wages 1,380 854 Taxes other than income taxes 524 393 Income taxes 5 121 Customer deposits 507 1,212 Other 2,642 2,942 -------------------------------------------------------- Total current liabilities 10,020 29,588 Note payable to bank 10,392 Other liabilities 707 541 Mandatory redeemable preferred stock, par value $.02 per share, authorized 3,800,000 shares; 3,800,000 issued and outstanding 3,800 Stockholders' Equity Preferred stock, par value $.02 per share, authorized 1,200,000 shares; none issued or outstanding Common stock, par value $.02 per share, authorized 15,000,000 shares; issued 7,439,732 shares in 2001 and 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 38,354 35,654 Retained-earnings deficit (34,498) (28,185) Accumulated other comprehensive loss (999) (665) -------------------------------------------------------- 3,006 6,953 Less cost of common stock in treasury, 413,500 shares 2,646 2,646 -------------------------------------------------------- Total stockholders' equity 360 4,307 -------------------------------------------------------- Total Liabilities and Stockholders' Equity $ 25,279 $ 34,436 ========================================================
See accompanying notes. 33 SCAN-OPTICS, INC., AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS
Year Ended December 31 (thousands, except share data) 2001 2000 1999 - --------------------------------------------------------------------------------------------------------------------------- Revenues Hardware and software $ 11,195 $ 18,099 $ 23,813 Professional services 6,352 7,534 14,096 Access services 13,193 12,669 14,083 ------------------------------------------------------------- Total revenues 30,740 38,302 51,992 Costs of Revenue Hardware and software 9,331 14,685 16,056 Professional services 3,967 8,121 12,760 Access services 11,200 11,287 11,657 ------------------------------------------------------------- Total costs of revenues 24,498 34,093 40,473 Gross Margin 6,242 4,209 11,519 Operating Expenses Sales and marketing expenses 3,914 5,909 7,980 Research and development expenses 2,936 3,720 5,688 General and administrative expenses 3,899 9,867 4,950 Interest expense 1,788 2,393 1,276 ------------------------------------------------------------- Total costs and expenses 12,537 21,889 19,894 ------------------------------------------------------------- Operating loss (6,295) (17,680) (8,375) Other income (loss), net 15 (29) (40) ------------------------------------------------------------- Loss before income taxes (6,280) (17,709) (8,415) Income tax expense (benefit) 33 61 (240) ------------------------------------------------------------- Net Loss $ (6,313) $ (17,770) $ (8,175) ============================================================= Basic loss per share $ (.90) $ (2.53) $ (1.17) ============================================================= Basic weighted-average shares 7,026,232 7,025,064 6,979,651 Diluted loss per share $ (.90) $ (2.53) $ (1.17) ============================================================= Diluted weighted-average shares 7,026,232 7,025,064 6,979,651
See accompanying notes. 34
SCAN-OPTICS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY Accumulated Common Stock Capital in Retained- Other ------------------- Excess of Earnings Comprehensive Treasury (thousands, except share data) Shares Amount Par Value Deficit Loss Stock Total ---------------------------------------------------------------------------------------------------------------------------------- Balance January 1, 1999 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 Issuance of common stock warrants 2,700 2,700 Net loss (6,313) (6,313) Currency translation adjustments (334) (334) --------- Comprehensive loss (6,647) ---------------------------------------------------------------------------------------------------------------------------------- Balance December 31, 2001 7,439,732 $ 149 $ 38,354 $(34,498) $ (999) $ (2,646) $ 360 ==================================================================================================================================
See accompanying notes. 35 SCAN-OPTICS, INC., AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS
Year Ended December 31 (thousands) 2001 2000 1999 - ------------------------------------------------------------------------------------------------------ Operating Activities Net loss $ (6,313) $(17,770) $ (8,175) Adjustments to reconcile net loss to net cash provided (used) by operating activities: Depreciation 677 887 1,115 Amortization of customer service inventory and software license 2,886 2,400 1,912 Amortization of goodwill 1,326 1,308 1,251 Provision for losses on accounts receivable 5,505 94 Provision for inventory obsolescence 178 1,064 229 Deferred taxes 697 Changes in operating assets and liabilities: Accounts receivable 6,531 8,503 (586) Refundable income taxes 124 1,158 (1,282) Recoverable income taxes 740 (740) Inventories (1,873) (1,578) 450 Prepaid expenses and other 473 178 112 Software license (174) (2,225) Accounts payable (2,604) (2,013) 1,790 Accrued salaries and wages 526 (946) (424) Taxes other than income taxes 131 (717) 419 Income taxes (116) 121 (35) Deferred costs, net of revenues (8) 359 (28) Customer deposits (705) (141) 1,254 Other (330) 371 699 ---------------------------------------- Net cash provided (used) by operating activities 903 (745) (3,473) Investing Activities Business acquisitions, net of cash acquired (2,111) Acquisition related settlement 400 Proceeds from the sale of plant and equipment 215 Purchases of plant and equipment, net (64) (122) (575) ---------------------------------------- Net cash provided (used) by investing activities 336 93 (2,686) Financing Activities Proceeds from issuance of common stock 87 68 Proceeds from borrowings 3,485 25,686 51,941 Principal payments on borrowings (3,098) (25,123) (46,028) ---------------------------------------- Net cash provided by financing activities 387 650 5,981 Increase (decrease) in cash and cash equivalents 1,626 (2) (178) Cash and Cash Equivalents at Beginning of Year 36 38 216 ---------------------------------------- Cash and Cash Equivalents at End of Year $ 1,662 $ 36 $ 38 ======================================== Supplemental Cash Flow Information Interest paid $ 1,579 $ 2,301 $ 1,229 ======================================== Income taxes paid $ 61 $ 8 $ 1,183 ========================================
See accompanying notes 36 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 government, insurance, assessment, 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. Management's Plan: 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 $6.3 million in 2001 and has incurred losses for the prior two years. Effective December 31, 2001, the Company restructured its loan agreements with its lender, which is expected to improve the Company's liquidity as no principal payments are required until maturity on December 31, 2004, except for excess cash flow recapture. As discussed in Note F to the consolidated financial statements, the agreements contain certain financial covenants which, among other things, require the Company to achieve quarterly planned earnings before interest, taxes, depreciation and amortization ("EBITDA") levels during 2002. The Company's ability to achieve the required EBITDA levels is dependent upon the attainment of 2002 planned revenue levels and continued planned cost containment each quarter. If the financial covenants are not met during 2002 and a waiver from the lender is not obtained, all outstanding debt could become due and payable. These matters raise substantial doubt about the Company's ability to continue as a going concern. With respect to attainment of its revenue plan for 2002, the Company began the year with a backlog of $22.5 million towards its 2002 revenue plan and has increased its sales force with experienced software/solutions sales people over the last several months to assist in increasing solution revenues during 2002. Management is also committed to continuing its cost containment efforts. The Company believes that its cost containment efforts, strong backlog position, combined with the additions to the sales force and a continued improvement in the economy within its targeted markets, will lead to the achievement of its business plan and covenant compliance. 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. 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. 37 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 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 2001, 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. 38 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 2000 and 1999 amounts have been reclassified to conform to the current year presentation. 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 asset 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 acquirer's intent to do so. The Company is required to adopt Statement No. 142 for fiscal year 2002 and management does not believe there will be any financial impact associated with the adoption. The Company incurred $1.3 million of amortization expense related to goodwill during 2001. NOTE C- Acquisition Activities 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 is 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. 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. 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 39 date of purchase. The settlement provided 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 forgave $.5 million due under the consulting and non-compete agreements and made 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 was 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 was accounted for as an adjustment of the original purchase price through a decrease in goodwill. The Company prepared a detailed analysis in accordance with FASB 121, at December 31, 2001. Based upon the undiscounted cash flow analysis of the three individual business segments, no impairment of goodwill in any of the Company's business segments exists at December 31, 2001. 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 million and $1.3 million at December 31, 2001 and 2000, respectively. Unbilled amounts in accounts receivable were $.9 million and $1 million at December 31, 2001 and 2000, respectively and are recoverable from the customer upon completion of the phase or milestone. NOTE E- INVENTORIES The components of inventories were as follows: December 31 (thousands) 2001 2000 - ----------------------------------------------------------------- Finished goods $ 199 $ 196 Work-in-process 1,604 846 Service parts 3,941 4,552 Materials and component parts 2,799 3,304 -------------------------- $ 8,543 $ 8,898 ========================= 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. 40 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 was $8.5 million, 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. Effective December 31, 2001, the Company restructured its loan agreements with Patriarch Partners, LLC. ("Patriarch"). The restructuring includes the following terms: o The maturity date of the Company's Loan Agreement with Patriarch is extended through December 31, 2004. o Patriarch's commitment under the Company's existing revolving line of credit was increased from $10 million to $10.75 million until June 30, 2002, at which point the commitment amount will return to $10 million. All revolving loans continue to accrue interest at a rate of prime plus 2%. o The Company's existing term loan was reduced from $8.5 million to $2 million and continues to accrue interest at a rate of prime plus 2%. No principal payments are required on the term loan until maturity on December 31, 2004. The agreement contains a provision that allows for the quarterly recapture of fifty percent of the excess cash flow to be applied to the term loan, based upon the calculation of consolidated cash flow minus the aggregate amount of consolidated financial obligations. o The Company issued to Patriarch, shares of preferred stock and warrants to purchase common stock in exchange for forgiveness of the remaining $6.5 million balance of the term loan. o The warrants represent the right to purchase up to 4,975,000 shares of common stock of the Company, or approximately 33% of the currently outstanding shares, plus shares reserved for stock options. The Company may repurchase the warrants once the term loan and revolving loan are paid off, if the Company also redeems the preferred stock. The repurchase price of the warrants is $2.7 million plus accrued interest calculated at prime plus 2%. In addition, if the warrants are repurchased in 2002, 10% of the Company's common stock will transfer to Patriarch. This amount increases to 15% in 2003 and 30% in 2004. The warrants are not exercisable until after December 31, 2004, except upon certain events of default. The exercise price of the warrants is $.02 per share. The warrants are accounted for as an equity instrument through an increase to additional paid in capital. o The mandatory redeemable preferred stock ("preferred stock") is subject to redemption for $3.8 million plus interest at prime plus 2% on December 31, 2004. The preferred stock is non-voting except upon exercise of the warrants. The preferred stock is accounted as a quasi equity instrument found on the balance sheet between other liabilities and stockholders' equity. 41 o All monthly lease payments owed to Patriarch have been deferred and become due on December 31, 2004. The lease obligation that accrues on a monthly basis will be added to the term loan. o The Agreement contains covenants which, among other things, require the maintenance of minimum earnings before interest, taxes, depreciation and amortization, capital expenditure spending limits, accounts receivable write-offs and backlog levels. As a result of the debt restructuring the term loan as of December 31, 2001 was reduced by $6.5 million and warrants to purchase common stock of $2.7 million were recorded as paid in capital and preferred stock of $3.8 million was recorded, accordingly, no gain resulted from the transaction. At December 31, 2001, the Company had $11.9 million in outstanding borrowings. The revolving line of credit has been classified as long term, with the exception of $1.5 million classified as current, since management has the ability to maintain the December 31, 2001 outstanding balance through fiscal year 2002. The available balance on the outstanding borrowings was $.9 million and $.5 million at December 31, 2001 and December 31, 2000, respectively. The weighted average interest rate on borrowings during 2001 and 2000 was 9.8% and 13.2%, respectively. The carrying value of the notes payable to bank approximates its fair value and is secured by all of the Company's assets. 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. As of December 31, 2001, the Company issued 3,800,000 shares of mandatory redeemable preferred stock. These shares do not contain voting rights until the warrants issued to Patriarch are exercised. At December 31, 2001, the Company had reserved 2,357,955 shares of common stock for the issuance or exercise of stock options. The Company has also reserved 4,975,000 shares of common stock, as part of the total debt restructuring, for the exercise of warrants.(See Note F) 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, 2001 and 2000. 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 42 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 six 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 senior management that were granted on December 31, 2001 as part of the total debt restructuring are not exercisable until six months after the grant thereof. Options for Directors are also 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, 2001:
Number of Option Price Shares Per Share - ------------------------------------------------------------------------------------------ Outstanding January 1, 1999 (531,420 exercisable) 688,433 $1.50 to $9.19 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 2001 Activity Granted 1,145,000 .24 to .25 Canceled (69,050) .31 to 3.69 --------------------------------- Outstanding December 31, 2001 (782,261 exercisable) 2,198,033 $.24 to $9.19 ==================================
At December 31, 2001 there were 159,872 options available for grant of which 90,000 were reserved for the Directors. The weighted-average fair value of options granted was $.24, $.46 and $3.45 during 2001, 2000, and 1999, respectively. The weighted-average remaining contractual life of the options outstanding at December 31, 2001 was 8 years. 44 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 1.24 to 1.50. 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. Options for senior management that were granted on December 31, 2001 as part of the total debt restructuring are exercisable six months after the date of grant. The Company's pro forma information follows:
December 31 (thousands, except per share amounts) 2001 2000 1999 - ------------------------------------------------------------------------------------------ Net loss, as reported $ (6,313) $ (17,770) $(8,175) Stock option expense (134) (51) (693) ------------------------------------------ Pro forma net loss $ (6,447) $ (17,821) $(8,868) ========================================== Basic and diluted loss per share, as reported $ (.90) $ (2.53) $ (1.17) Stock option expense (.02) (.01) (.10) ------------------------------------------- Pro forma basic and diluted loss per share $ (.92) $ (2.54) $ (1.27) ==========================================
NOTE I - RESEARCH AND DEVELOPMENT AGREEMENTS 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 and 2001, the Company completed a number of small custom development contracts for specific customers resulting in revenue of approximately $200,000 and $110,000, respectively. These revenues offset the related costs incurred for 44 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 and in 2001, the employer match was increased to 67% of the first 6%. The Company's contributions to this plan were $254,000, $306,000 and $374,000, in 2001, 2000 and 1999, 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 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 2001, 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 2001, 2000 and 1999. NOTE K - INCOME TAXES At December 31, 2001, the Company has U.S. federal and state operating loss carryforwards of approximately $25,140,000 and $27,630,000, respectively. The U.S. federal and state net operating loss carryforwards expire through 2021. At December 31, 2001, the Company has approximately $400,000, $3,500,000 and $800,000 of net operating loss carryforwards for Canada, the United Kingdom and Germany, respectively, which begin to expire in 2007. For financial reporting purposes, a valuation allowance has been recorded for 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. Loss before income taxes is set forth in the following tabulation: Year Ended December 31 (thousands) 2001 2000 1999 - --------------------------------------------------------------------------- Domestic $ (6,270) $(17,436) $(7,806) Foreign (10) (273) (609) ---------------------------------------------- Loss before income taxes $ (6,280) $(17,709) $(8,415) ============================================== 45 Income taxes (benefit) are summarized as follows: Year Ended December 31 (thousands) 2001 2000 1999 - ------------------------------------------------------------------------------ Current (benefit): Federal $ (956) State $ 28 $ 49 26 Foreign 5 12 (7) ------------------------------------------ Total current (benefit) $ 33 $ 61 $ (937) ------------------------------------------ Deferred (benefit): Federal 620 State 77 ------------------------------------------ Total deferred (benefit) $ 697 ------------------------------------------ $ 33 $ 61 $ (240) ========================================== Significant components of the Company's deferred tax liabilities and assets were as follows: December 31 (thousands) 2001 2000 - --------------------------------------------------------------------------- Deferred tax assets: Net operating loss carryforward $8,557 $ 8,556 Alternative minimum tax credit carryforward 168 168 Depreciation 92 92 Charitable contribution carryforward 37 53 Inventory valuation 586 553 Inventory 328 180 Accounts receivable reserves 669 2,057 Goodwill 604 206 Vacation accrual 209 216 Other 157 156 -------------------------- Total gross deferred tax assets 11,407 12,237 Deferred tax liabilities: Depreciation and other (359) (449) --------------------------- Total gross deferred tax liabilities (359) (449) Valuation allowance (11,048) (11,788) -------------------------- Net deferred tax asset $ -- $ -- =========================== 47 A reconciliation of the statutory tax rate to the effective rate is as follows: Year Ended December 31 2001 2000 1999 - --------------------------------------------------------------------------- Statutory federal income tax rate (34)% (34)% (34)% State income taxes, net of federal benefit .44 .3 1 Adjustments to prior year taxes (3) Foreign income taxes .1 2 Net operating loss carryforward 34 34 33 Other .09 (2) ----------------------------- Effective tax rate .53% .4% (3)% ============================= 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, 2001, are as follows: Minimum Rental (thousands) Payments - -------------------------------------------------------------- 2002 $ 822 2003 657 2004 412 2005 423 2006 438 Thereafter 347 ------- Total minimum lease payments $ 3,099 ======= Rental expense for the years ended December 31, 2001, 2000, and 1999 was $718,000, $1,114,000, and $1,062,000, respectively. NOTE M - CONTINGENCIES There are two lawsuits currently pending against the Company. Both lawsuits are in reaction to lawsuits filed by the Company against the plaintiffs. Although the ultimate outcome is uncertain, based on currently known facts, the Company believes that it has strong defenses against these lawsuits and the resolution of these matters will not have a material adverse effect on the Company's financial position or annual operating results. 47 NOTE N - SEGMENT INFORMATION Business segment data and geographic area data for the years ended 2001, 2000 and 1999 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 2001, 2000, and 1999 included bill and hold transactions of $.1 million, $1.7 million and $5.6 million, respectively. Accounts receivable included bill and hold receivables of $.1 million and $.4 million at December 31, 2001 and 2000, respectively. 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) 2001 2000 1999 - ---------------------------------------------------------------------------------------------- Numerator: Net Loss $ (6,313) $(17,770) $ (8,175) ============================================== Denominator: Denominator for basic and diluted loss per share (weighted-average 7,026,232 7,025,064 6,979,651 shares) ============================================== Basic loss per share $ (.90) $ (2.53) $ (1.17) ============================================== Diluted loss per share $ (.90) $ (2.53) $ (1.17) ==============================================
49 NOTE Q - QUARTERLY RESULTS OF OPERATIONS (UNAUDITED) The following is a summary of the quarterly results of operations for the years ended December 31, 2001 and 2000.
(thousands, except per share amounts) March June September December - ----------------------------------------------------------------------------------------------------- 2001 Revenues $ 10,908 $ 6,991 $ 5,586 $ 7,255 Cost of product sales and service expenses 8,336 5,338 4,547 6,277 Net loss (664) (940) (1,809) (2,900) Basic loss per share (.09) (.13) (.26) (.41) Diluted loss per share $ (.09) $ (.13) $ (.26) $ (.41) 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 loss per share (.32) (.46) (.25) (1.49) Diluted loss per share $ (.32) $ (.46) $ (.25) $ (1.49)
Fourth quarter 2001 net loss of $2.9 million includes charges to expense of $1.5 million or $.21 per share. The major components of these charges include $.4 million of inventory reserves related to obsolete parts, $.2 million of additional amortization of Access Services parts inventory, $.2 million of accrued severance costs, $.3 million of accrued lease expense and $.4 million of a management stay bonus. 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. 49 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 June 6, 2002 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 June 6, 2002 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 June 6, 2002 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 June 6, 2002 and is incorporated herein by reference. 50 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, 2001 and 2000 Consolidated Statements of Operations for the years ended December 31, 2001, 2000 and 1999 Consolidated Statements of Stockholders' Equity for the years ended December 31, 2001, 2000 and 1999 Consolidated Statements of Cash Flows for the years ended December 31, 2001, 2000 and 1999 Notes to Consolidated Financial Statements - December 31, 2001 (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. 51 *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). *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. *+10.2 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. 52 *+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. *+10.16 Executive severance agreement between Alan W. Ware and Scan-Optics, Inc. dated May 22, 2001, is filed as Exhibit 10.16 in the Company's Quarterly Report on Form 10-Q filed for the quarter ended June 30, 2001. *10.17 Certificate of Designations, Preferences, Rights and Restrictions for Series A Redeemable Preferred Stock dated December 31, 2001, is filed as Exhibit 3.3 in the Company's Registration statement on Form S-8 (no. 333-83598), filed on March 1, 2002. 10.18 Warrant to Purchase Shares of Common Stock of Scan-Optics, Inc. dated December 31, 2001, is filed as Exhibit 10.18 in the Company's Annual Report on Form 10-K filed for the year ended December 31, 2001. 10.19 Fourth Amendment Agreement dated as of December 31, 2001 between ARK CLO 2000-1, Limited and Scan-Optics, Inc. and prior loan agreements, is filed as Exhibit 10.19 in the Company's Annual Report on Form 10-K filed for the year ended December 31, 2001. *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. 53 + 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, 2001. (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. 54 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: /ss/ ---------------------------------------- James C. Mavel Chairman, Chief Executive Officer and President Date: March 27, 2002 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. /ss/ - --------------------- James C. Mavel Chairman, Chief Executive Officer and President (Principal Executive Officer) Date: March 27, 2002 /ss/ - --------------------- Michael J. Villano Chief Financial Officer, Vice President and Treasurer (Principal Financial and Accounting Officer) Date: March 27, 2002 /ss/ - --------------------- Logan Clarke, Jr. Director March 27, 2002 /ss/ - --------------------- Richard J. Coburn Director March 27, 2002 /ss/ - --------------------- E. Bulkeley Griswold Director March 27, 2002 /ss/ - --------------------- Lyman C. Hamilton, Jr. Director March 27, 2002 /ss/ - --------------------- John J. Holton Director March 27, 2002 /ss/ - --------------------- Robert H. Steele Director March 27, 2002 A majority of the Directors 55
SCHEDULE II SCAN-OPTICS, INC. AND SUBSIDIARIES VALUATION AND QUALIFYING ACCOUNTS THREE YEARS ENDED DECEMBER 31, 2001, 2000 AND 1999 (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, 2001 $ 5,615 $ 93 $3,772(1) $ 1,936 Reserve for doubtful accounts (billed and unbilled) 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 (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. 56 EX-10 3 exhibit10-18.txt EXHIBIT 10.18 Exhibit 10.18 [EXECUTION COPY] THE WARRANTS REPRESENTED BY THIS CERTIFICATE AND THE SHARES OF COMMON STOCK ISSUABLE UPON EXERCISE HEREOF HAVE NOT BEEN REGISTERED OR QUALIFIED UNDER THE SECURITIES ACT OF 1933, AS AMENDED (THE "1933 ACT"), OR UNDER ANY STATE SECURITIES LAWS AND SUCH WARRANTS HAVE BEEN ISSUED TO THE HOLDER IN RELIANCE UPON CERTAIN EXEMPTIONS FROM REGISTRATION PROVIDED IN THE 1933 ACT AND THE RULES AND REGULATIONS THEREUNDER AND THE APPLICABLE STATE SECURITIES LAWS. ACCORDINGLY, NEITHER SUCH SECURITIES NOR ANY INTEREST THEREIN MAY BE OFFERED, SOLD, PLEDGED, ASSIGNED OR OTHERWISE TRANSFERRED UNLESS (1) A REGISTRATION STATEMENT WITH RESPECT THERETO IS EFFECTIVE UNDER THE 1933 ACT AND ANY APPLICABLE STATE SECURITIES LAWS OR (2) THE COMPANY RECEIVES AN OPINION OF COUNSEL TO THE HOLDER OF SUCH SECURITIES, WHICH COUNSEL AND OPINION ARE REASONABLY SATISFACTORY TO THE COMPANY, THAT SUCH SECURITIES MAY BE OFFERED, SOLD, PLEDGED, ASSIGNED, OR TRANSFERRED IN THE MANNER CONTEMPLATED WITHOUT AN EFFECTIVE REGISTRATION STATEMENT UNDER THE 1933 ACT AND APPLICABLE STATE SECURITIES LAWS. Warrant No.: W-1 December 31, 2001 WARRANT TO PURCHASE SHARES OF COMMON STOCK OF SCAN-OPTICS, INC. THIS CERTIFIES THAT, for value received, ARK CLO 2000-1, LIMITED, or any assignee or transferee permitted under the terms hereof (the "Holder"), is entitled, in accordance with the terms and conditions hereinafter set forth, to subscribe for and purchase from Scan-Optics, Inc., a Delaware corporation (the "Company"), at any time after the date on which a Trigger Event (as defined below) shall occur (such date being the "Commencement Date") and on or prior to 5:00 p.m. New York City time on December 31, 2011 (the "Expiration Date"), 33.20% of the Company's Common Stock (as defined in Section 11 below) on a Fully Diluted Basis (as defined below) as of the date hereof (such number of shares as from time to time adjusted as hereinafter provided, the "Warrant Shares"), at the price of $0.02 per share (as such price may be adjusted from time to time as hereafter provided, the "Exercise Price") and to receive a certificate or certificates for the Warrant Shares so purchased, upon presentation and surrender of this Warrant at the location set forth in Section 1(a) below, together with the Exercise Price of the shares so purchased. "Credit Agreement" means that certain Second Amended and Restated Loan Agreement, dated as of May 10, 1999, as amended pursuant to that certain Amendment and Waiver Agreement, dated as of January 29, 2001, the Second Amendment and Waiver Agreement, dated as of July 1, 2001, the Third Amendment and Waiver Agreement, dated as of September 1, 2001 and the Fourth Amendment Agreement, of even date herewith. "Fully Diluted Basis" shall mean, for the Company, all outstanding shares of Common Stock plus all shares which would be outstanding upon the exercise in full of all Convertible Securities (as defined in Section 2(j) below), Options (as defined in Section 2(j) below) and Stock Purchase Rights (as defined below). "Stock Purchase Rights" shall mean any warrants, options or other rights of any kind to subscribe for, purchase or otherwise acquire any shares of Common Stock, Options or any Convertible Securities. "Trigger Event" means the earlier to occur of (a) January 1, 2005, and (b) an Event of Default (as defined in the Credit Agreement) listed in Section 11(a) (so long as such an Event of Default under Section 11(a) shall continue for a period of 5 business days), 11(b) (so long as such an Event of Default under Section 11(b) shall continue for a period of 120 consecutive days), 11(e) (so long as an Event of Default under Section 11(e) shall continue for a period of 5 business days), 11(g), 11(h) or 11(i) of the Credit Agreement. Section 1. Exercise. (a) Method of Exercise. Subject to compliance with all applicable securities laws, this Warrant may be exercised from time to time in whole or in part from and after the Commencement Date and on or prior to the Expiration Date, by delivering to the Company at 169 Progress Drive, Manchester, Connecticut 06040 (i) this Warrant, (ii) a subscription form, substantially in the form of Exhibit A attached hereto (the "Subscription Form"), duly completed and executed by the Holder and (iii) payment of the Exercise Price as set forth below in Section 1(b). (b) Payment of Exercise Price. Payment of the Exercise Price may be made, at the option of the Holder, either (i) by payment to the Company, by check or wire transfer of an amount in immediately available funds equal to the product of (A) the then applicable Exercise Price, multiplied by (B) the number of Warrant Shares then being purchased, or (ii) by surrender of the right to receive upon exercise of this Warrant a number of shares of Common Stock having a value (as determined below) equal to the product of (A) the then applicable Exercise Price, multiplied by (B) the number of Warrant Shares then being purchased, in which case, the number of Warrant Shares to be issued to the Holder upon such exercise shall be calculated using the following formula: Y * (A - B) ----------- X = A with X = the number of shares of Common Stock to be issued to the Holder -2- Y = the number of Warrant Shares with respect to which the Warrant is being exercised A = the Fair Market Value (as determined below) of one share of Common Stock B = the then applicable Exercise Price of the Warrant. For purposes of this Warrant, the following capitalized terms have the following meanings: "Fair Market Value" shall mean the average of the daily Closing Prices (as hereinafter defined) for the 10 consecutive Trading Days (as hereinafter defined) immediately prior to the date in question. "Closing Price" on any day means the last sales price, regular way, per share of such stock on such day, or if no such sale takes place on such day, the average of the closing bid and asked prices, regular way, as reported in the principal consolidated transaction reporting system with respect to securities listed or admitted to trading on the principal consolidated transaction reporting system with respect to securities listed on the principal national securities exchange on which the shares of such stock are listed or admitted to trading, or, if the shares of such stock are not listed or admitted to trading on any national securities exchange, the average of the high bid and low asked prices as reported on the NASDAQ stock market or in the over-the-counter market as reported on the OTC Bulletin Board maintained by the National Association of Securities Dealers Inc. or another over-the-counter market reporting system. "Trading Day" means a day on which the principal national securities exchange on which such shares of such stock are listed or admitted to trading is open for the transaction of business or, if the shares of such stock are not listed or admitted to trading on any national securities exchange, a Monday, Tuesday, Wednesday, Thursday or Friday on which banking institutions in the Borough of Manhattan, City and State of New York, are not authorized or obligated by law or executive order to close. (c) Date of Exercise. This Warrant shall be deemed to have been exercised immediately prior to the close of business on the date of its surrender for exercise as provided in Section 1(a) above, and the person entitled to receive the Warrant Shares issuable upon such exercise shall be treated for all purposes as the holder of record of such Warrant Shares as of the close of business on such date. (d) Issuance of Certificates for Warrant Shares; No Fractional Shares. As soon as practicable after the Company's receipt of the Warrant surrendered in connection with an exercise provided for in Section 1(a) above, the Company shall issue and deliver to the person or persons entitled to receive the Warrant Shares issuable upon such exercise of the Warrant, a certificate or certificates for the number of whole shares of Warrant Shares issuable upon such exercise, together with cash in lieu of any fraction of a share equal to such fraction of the current Fair Market Value of one whole share of Common Stock as of the date -3- of exercise. No fractional shares shall be issued upon the exercise of this Warrant, and any fractions shall be rounded down to the nearest whole number of shares. (e) Partial Exercise. Upon a partial exercise of this Warrant, this Warrant shall be surrendered by the Holder and replaced with a new Warrant of like tenor in the name of the Holder providing for the right to purchase the number of shares of Common Stock as to which this Warrant has not then been exercised. (f) Taxes. The issuance of certificates for shares of Common Stock upon the exercise of this Warrant will be made without charge by the Company to the Holder for any issue tax (other than applicable income tax). Section 2. Adjustment of Exercise Price and Number of Warrant Shares. The Exercise Price and the number of Warrant Shares shall each be subject to adjustment from time to time as set forth below. (a) Dividends and Distributions. In the event the Company shall, at any time or from time to time, distribute to the holders of any of its Common Stock any dividend or other distribution of any Assets (as defined in Section 2(j) below), other than dividends payable in Common Stock, Options or Convertible Securities, and any cash dividend that, when added to all other cash dividends paid in the 12 months immediately preceding the declaration date of such dividend (excluding any such other dividend included in a previous adjustment of the Exercise Price pursuant to this paragraph (a)), does not exceed 2% (on an annualized basis) of the Current Market Price (as defined in Section 2(j) below) per share of Common Stock on such declaration date, then: (i) the Exercise Price shall be reduced to equal the product obtained by multiplying (A) the Exercise Price then in effect by (B) a fraction, (x) the numerator of which shall be (I) the Current Market Price per share of Common Stock on the record date for such distribution less (II) the sum of (a) the cash portion, if any, of such distribution per share of Common Stock outstanding (exclusive of any treasury shares) on the record date for such distribution plus (b) the then fair market value (as determined in good faith by the Board of Directors of the Company) per share of Common Stock outstanding (exclusive of any treasury shares) on the record date for such distribution of that portion, if any, of such distribution consisting of Assets other than cash, and (y) the denominator of which shall be such Current Market Price per share of Common Stock on the record date for such distribution, and (ii) the number of Warrant Shares shall be increased to equal the product obtained by multiplying (A) the Warrant Shares in effect immediately prior to the record date for such distribution by (B) a fraction, (x) the numerator of which shall be the Exercise Price in effect immediately prior to the adjustment required by clause (i) of this paragraph and (y) the denominator of which shall be the Exercise Price in effect immediately after such adjustment. The adjustments required by this paragraph (a) shall be made whenever any such distribution is made and shall be retroactive to the record date for the determination of stockholders entitled to receive such distribution. -4- (b) Dividends Payable in Common Stock and Changes in Common Stock. In the event the Company shall, at any time or from time to time, (x) issue any shares of Common Stock as a stock dividend to the holders of Common Stock or (y) subdivide or combine any outstanding shares of Common Stock into a greater or lesser number of shares (each such event being a "Change of Shares"), then: (i) the number of Warrant Shares immediately prior to such action shall be adjusted so that the Holder, upon exercising the Warrant shall be entitled to the number of shares of Common Stock that the Holder would have owned or have been entitled to receive after the happening of such event had the Warrant been exercised immediately prior to the record date (or, if there is no record date, the effective date) for such event, and (ii) the Exercise Price shall be adjusted to equal the product determined by multiplying (A) the Exercise Price in effect immediately prior to such event by (B) a fraction, (x) the numerator of which shall be the number of Warrant Shares immediately prior to such event and (y) the denominator of which shall be the number of Warrant Shares after the adjustment referred to above. An adjustment made pursuant to this clause (b) shall become effective retroactively immediately after the record date in the case of a dividend and shall become effective immediately after the effective date in other cases, but any shares of Common Stock issuable solely as a result of such adjustment shall not be issued prior to the effective date of such event. (c) Common Stock Issuances. In the event the Company shall, at any time or from time to time, issue, sell or otherwise distribute (including by way of deemed distributions pursuant to paragraphs (e) and (f) below) any shares of Common Stock (other than pursuant to a Change of Shares or the exercise of any Option or Convertible Security) (any such event, including any deemed distributions described in paragraphs (e) and (f) below, being herein called a "Common Stock Distribution"), for a consideration per share less than the Exercise Price in effect at the time of such distribution, then, effective upon such Common Stock Distribution: (i) the Exercise Price shall be reduced to equal the product obtained by multiplying (A) the Exercise Price in effect immediately prior to such Common Stock Distribution by (B) a fraction, (x) the numerator of which shall be the sum of the number of shares of Common Stock outstanding (exclusive of any treasury shares) immediately prior to such Common Stock Distribution plus the number of shares of Common Stock which the aggregate consideration received by the Company would purchase at the Exercise Price in effect immediately prior to such Common Stock Distribution, and (y) the denominator of which shall be the total number of shares of Common Stock outstanding (exclusive of any treasury shares) immediately after such Common Stock Distribution, and (ii) the number of Warrant Shares shall be increased to equal the product obtained by multiplying (A) the number of Warrant Shares in effect immediately prior to such Common Stock Distribution by (B) a fraction, (x) the numerator of which shall be the Exercise Price in effect immediately prior to such adjustment and (y) the denominator of which shall be the Exercise Price in effect immediately after such adjustment. -5- The provisions of this paragraph (c) (including by operation of paragraph (e) or (f) below) shall not operate to increase the Exercise Price or reduce the number of Warrant Shares, except by operation of paragraph (g) below. (d) Other Securities. In the event that (i) the Company shall, at any time or from time to time, issue any shares of its capital stock in a reclassification or reorganization of the Common Stock, or (ii) at any time, as a result of an adjustment made pursuant to this Section 2, the Holder shall become entitled to receive any securities of the Company other than shares of Common Stock, thereafter, in each such case, the number of such other securities so receivable upon exercise of the Warrant and the Exercise Price applicable to such exercise shall be subject to adjustment from time to time in a manner and on terms as nearly equivalent as practicable to the provisions with respect to the shares of Common Stock contained in this Section. (e) Issuance of Options. Except as provided in Section 2(l) below, in the event the Company shall, at any time or from time to time, issue, sell, distribute or otherwise grant in any manner (including by assumption) any Options, whether or not such Options (or in the case of Options to acquire Convertible Securities, the right to convert or exchange such Convertible Securities) are immediately exercisable, and the exercise price per share with respect to such Options shall be less than either (i) the Current Market Price per share of Common Stock on the date of the issuance, sale, distribution or granting of such Options or (ii) the Exercise Price then in effect, then, for purposes of paragraph (c) above, the total maximum number of shares of Common Stock issuable upon the exercise of all such Options or upon the conversion or exchange of the total maximum amount of the Convertible Securities issuable upon the exercise of all such Options shall be deemed to have been issued as of the date of the issuance, sale, distribution or granting of such Options and thereafter shall be deemed to be outstanding and the Company shall be deemed to have received as consideration such exercise price per share, determined as provided above, therefor. Except as otherwise provided in paragraph (g) below, no additional adjustment of the Exercise Price shall be made upon the actual exercise of such Options or upon conversion or exchange of the Convertible Securities issuable upon the exercise of such Options. (f) Issuance of Convertible Securities. In the event the Company shall, at any time or from time to time, issue, sell or otherwise distribute (including by assumption) any Convertible Securities (other than upon the exercise of any Option), whether or not the right to convert or exchange such Convertible Securities are immediately exercisable, and the exercise price per share shall be less than (i) the Current Market Price per share of Common Stock on the date of such issuance, sale or distribution or (ii) the Exercise Price then in effect, then, for purposes of paragraph (c) above, the total maximum number of shares of Common Stock, issuable upon the conversion or exchange of all such Convertible Securities shall be deemed to have been issued as of the date of the issuance, sale or distribution of such Convertible Securities and thereafter shall be deemed to be outstanding and the Company shall be deemed to have received as consideration such exercise price per share, determined as provided above, therefor. Except as otherwise provided in paragraph (g) below, no additional adjustment of the Exercise Price shall be made upon the actual conversion or exchange of such Convertible Securities. -6- (g) Changes in Options and Convertible Securities. If (i) the exercise price provided for in any Options referred to in paragraph (e) above, (ii) the additional consideration, if any, payable upon the conversion or exchange of any Convertible Securities referred to in paragraph (e) or (f) above, or (iii) the rate at which any Convertible Securities referred to in paragraph (e) or (f) above are convertible into or exchangeable for Common Stock, shall change at any time (other than under or by reason of provisions designed to protect against dilution upon an event which results in a related adjustment pursuant to this Section), the Exercise Price then in effect and the number of Warrant Shares shall forthwith be readjusted to the Exercise Price and the number of Warrant Shares that would then be in effect had the adjustment made upon the issuance, sale, distribution or granting of such Options or Convertible Securities been made based upon such changed purchase price, additional consideration or conversion rate, as the case may be, but only with respect to such Options and Convertible Securities as then remain outstanding. (h) Certain Distributions. If the Company shall pay a dividend or make any other distribution payable in Options or Convertible Securities, then, for purposes of paragraph (c) above (by operation of paragraph (e) or (f) above, as the case may be), such Options or Convertible Securities shall be deemed to have been issued or sold without consideration except for such amounts of consideration as shall have been deemed to have been received by the Company pursuant to paragraphs (e) or (f) above, as appropriate. (i) Equitable Adjustments. In case any other corporate event or transaction of the Company, outside the ordinary course of business consistent with past practice, not specified in this Section occurs which equitably requires an anti-dilutive adjustment to the Warrant, the Company's Board of Directors and the Holder shall consult with each other in good faith and mutually agree upon appropriate adjustments to the Exercise Price and the number of Warrant Shares, so that the property (including securities) to be received by the Holder hereunder upon exercise of the Warrant after the effective date of such event, shall be substantially similar, as nearly as practicable, to those which the Holder would have been entitled immediately prior to such event had the Holder exercised the Warrant prior to such event. (j) Definitions. For purposes of this Section 2, the following capitalized terms have the following meanings: "Assets" means cash, evidences of indebtedness, other securities or other properties or assets, or any options, warrants or other rights to subscribe for or purchase any of the foregoing. "Convertible Securities" means any stock or securities convertible into or exchangeable for Common Stock. "Current Market Price" per share of Common Stock at any date shall be the Closing Price. "Options" means any rights to subscribe for or to purchase, or any warrants or options for the purchase of, Common Stock or any Convertible Security. -7- (k) Miscellaneous. (i) Deferral of Certain Adjustments. No adjustment to the Exercise Price (including the related adjustment to the number of Warrant Shares) shall be required hereunder unless such adjustment, together with other adjustments carried forward as provided below, would result in an increase or decrease of at least 3% of the Exercise Price; provided, however, that any adjustment which by reason of this paragraph is not required to be made shall be carried forward and taken into account in any subsequent adjustment. No adjustment need be made for a change in the par value of the Common Stock. (ii) Notice of Certain Transactions. In the event that: (A) the Company takes any action that would require an adjustment in the Exercise Price or the number of Warrant Shares, (B) the Company declares or distributes any dividend, distribution, security, instrument or other rights to its stockholders that would require an adjustment pursuant to this Section, (C) the Company consolidates or merges with, or transfers all or substantially all of its assets to, or makes any statutory exchange of securities with, another corporation or engages in any reorganization, restructuring, recapitalization, reclassification of capital stock or spin-off or other similar transaction, or (D) there is a dissolution or liquidation or other winding up of the Company, the Company shall, not later than 10 days prior to the earliest of the proposed record or effective date, as the case may be, or any other applicable date with respect to any of the foregoing actions or transactions (including the date, if any is to be fixed, as of which holders of Common Stock shall be entitled to exchange their shares of Common Stock for securities or other property deliverable upon any such merger, consolidation, reorganization, restructuring, recapitalization, reclassification, transfer, dissolution, liquidation or winding up), give the Holder a written notice stating such proposed record or effective date, as the case may be, or such other applicable date. (iii) Consideration Received. If any shares of Common Stock, Options or Convertible Securities shall be issued, sold or distributed for a consideration other than cash, the amount of the consideration other than cash received by the Company in respect thereof shall be deemed to be the fair market value of such consideration (as mutually agreed in good faith by the Board of Directors of the Company and the Holder). If any Options shall be issued in connection with the issuance and sale of other securities of the Company, together comprising one integral transaction in which no specific consideration is allocated to such Options by the parties thereto, such Options shall be deemed to have been issued, sold or distributed for such amount of consideration as shall be allocated to such Options as mutually agreed in good faith by the Board of Directors of the Company and the Holder. (iv) Computation of Adjustments. Anything herein to the contrary notwithstanding, upon each computation of an adjustment in the Exercise Price or the number of Warrant Shares, the Exercise Price shall be computed to the nearest cent (i.e., fractions of less than half of a cent shall be disregarded and fractions of half of a cent, or more, shall be treated as being one cent) and the number of Warrant Shares, shall be calculated to the nearest share (i.e., fractions of less than half of a share shall be disregarded and fractions of half of a share, or more, shall be treated as being one share). -8- (v) Certificate as to Adjustments. Upon any adjustment to the Exercise Price or the number of Warrant Shares, the Company shall give written notice thereof, by first class mail, postage prepaid, addressed to the Holder at the address of the Holder as shown on the books of the Company, which notice shall state the Exercise Price resulting from such adjustment and the increase or decrease, if any, in the number of Warrant Shares resulting from such adjustment, setting forth in reasonable detail the calculations and the facts upon which such calculation is based. (l) Management Incentives. Notwithstanding anything to the contrary contained in the foregoing paragraphs, no adjustment to the Exercise Price or the number of Warrant Shares shall be made for the issuance of Common Stock and/or Options to purchase Common Stock to senior executives of the Company pursuant to an incentive plan to be adopted by the Company; provided, however, that the aggregate number of shares of Common Stock issued or issuable pursuant to such plan (including shares issuable upon exercise of Options granted pursuant to such plan) shall not exceed 1,100,000 (as such number may be adjusted for stock splits, stock dividends, combinations, recapitalizations, reorganizations and other similar transactions) shares. Section 3. Redemption Right; Closing Mechanics. (a) Redemption Right. (i) Grant of Redemption Right. At any time following the payment in full of the Loans (as defined in the Credit Agreement) and the redemption in full of all of the shares of the Company's Series A Redeemable Preferred Stock, the Company may repurchase (the "Redemption") the Warrant for a purchase price (the "Repurchase Amount") equal to the sum of (a) $2,700,000 plus (b) interest on such amount at an annual rate equal to the prime rate of interest in effect from time to time during such period as reported by the Wall Street Journal, plus 2%, compounded annually from December 31, 2001through the date the Repurchase Amount is actually paid, plus (c) if the Repurchase Amount is actually paid (i) prior to December 31, 2002, 10%of the Common Stock on a Fully Diluted Basis immediately prior to the Redemption, (ii) after December 31, 2002, but before December 31, 2003, 15% of the Common Stock on a Fully Diluted Basis immediately prior to the Redemption and (iii) any time after December 31, 2003, 30% of the Common Stock on a Fully Diluted Basis immediately prior to the Redemption. (ii) Exercise of the Redemption Right. In order to exercise the Redemption, the Company must deliver to the Holder an irrevocable written notice stating the Company's intention to cause the Holder to sell the Warrant to the Company (the "Redemption Notice"). (b) Closing Mechanics. -9- (i) Time and Place of the Closing. In connection with a Redemption, the closing of the sale of the Warrant (the "Closing") will take place at the offices of Richards Spears Kibbe & Orbe, One Chase Manhattan Plaza, New York, New York 10005, at 10:00 a.m. (New York City time), on the date which is ten business days following the date on which the Holder receives a Redemption Notice (such date of the Closing being hereinafter referred to as the "Closing Date"). (c) Transactions to be Effected at the Closing. Upon the terms and subject to the conditions of this Agreement, at the Closing: (i) the Holder will deliver to the Company the original agreement representing the Warrant; and (ii) the Company will deliver to the Holder the Repurchase Amount by wire transfer of immediately available funds in accordance with wire transfer instructions delivered by the Holder to the Company in writing prior to the Closing Date, plus, if applicable, stock certificates representing the appropriate percentage of the Company's Common Stock registered in the Holder's name. Section 4. Representations and Covenants of the Company. The Company hereby represents, warrants and covenants to and with the Holder as follows: (a) Power. The Company is a corporation duly incorporated, validly existing and in good standing under the laws of the jurisdiction of its incorporation. The Company has the necessary corporate power and authority, to execute and deliver this Warrant, to perform its obligations hereunder and to consummate the transactions contemplated hereby. (b) Binding Effect. This Warrant has been duly executed and delivered by the Company and is the legal, valid and binding obligations of the Company enforceable against it in accordance with its terms. (c) Contravention. Neither the execution, delivery and performance of this Warrant nor the consummation of the transactions contemplated hereby will (with or without notice or lapse of time or both) (i) conflict with or breach any provision of the Company's certificate of incorporation or bylaws, (ii) violate any law, rule or regulation by which the Company or any of its properties may be bound or affected, or (iii) conflict with or result in a default under any material contract or other material agreement to which the Company is a party or by which it or any of its properties may be bound or affected. (d) Approvals. No authorization, consent, order or approval of, notice to or registration or filing with, or any other action by any governmental authority or other person is required or advisable in connection with (i) the due execution and delivery by the Company of this Warrant, or (ii) the performance by the Company of its obligations under this Warrant. (e) Reservation of Shares. The Company shall reserve and keep available out of its authorized but unissued Common Stock for issuance upon the exercise of this Warrant, free from preemptive rights, a sufficient number of authorized but unissued shares of Common Stock so that the Company will at all times have a sufficient number of authorized shares of Common Stock available to issue upon -10- the exercise in full of this Warrant. Notwithstanding anything to the contrary contained herein, the Company shall not take any action that would cause an adjustment to be made to the Exercise Price or the number of Warrant Shares pursuant to Section 2 hereof unless, prior to such action, the Company has a sufficient number of authorized but unissued shares of Common Stock available to issue upon the exercise in full of this Warrant after such adjustment. (f) Warrant Shares Duly Authorized, etc. All shares of Common Stock which may be issued upon the exercise of this Warrant will, upon issuance, be fully paid and nonassessable and be free from all taxes, liens (except for liens created by the Holder) and charges in respect of the issuance thereof. (g) No Impairment. The Company will not, by amendment of its charter documents, or through reorganization, consolidation, merger, dissolution, issue or sale of securities, sale of assets or any other voluntary action, willfully avoid or seek to avoid the observance or performance of any of the terms of this Warrant, and will at all times in good faith assist in the carrying out of all such terms and in the taking of all such action as may be necessary or appropriate in order to protect the rights of the Holder under this Warrant. The Company covenants and agrees not to enter into any contractual arrangement or take any other action that would require any third-party consents for the exercise of this Warrant. (h) Regulatory Approval of Issuance. The Company further covenants and agrees that if any shares of Common Stock to be reserved for the purpose of the issuance of shares upon the exercise of this Warrant require registration with or approval of any governmental authority under any Federal or State law before such shares may be validly issued or delivered upon exercise of this Warrant, then the Company will in good faith and as expeditiously as possible endeavor to secure such registration or approval, as the case may be, and the right to exercise this Warrant shall be extended until 15 days after the completion of any such registration or approval. (i) Listing Requirements. If and so long as any Common Stock issuable upon the exercise of this Warrant is listed on any national securities exchange, the Company will, if permitted by the rules of such exchange, list and keep listed on such exchange, upon official notice of issuance, all shares of Common Stock issuable upon exercise of this Warrant. Section 5. Representations and Warranties of the Holder. The Holder hereby represents and warrants to the Company as follows: (a) Power. The Holder is an entity duly organized, validly existing and in good standing under the laws of the jurisdiction of its organization. The Holder has the necessary power and authority, to execute and deliver this Warrant, to perform its obligations hereunder and to consummate the transactions contemplated hereby. (b) Binding Effect. This Warrant has been duly executed and delivered by the Holder and is the legal, valid and binding obligation of the Holder enforceable against it in accordance with its terms. -11- (c) Contravention. Neither the execution, delivery and performance of this Warrant nor the consummation of the transactions contemplated hereby will (with or without notice or lapse of time or both) (i) conflict with or breach any provision of the Holder's organizational documents, (ii) violate any law, rule or regulation by which the Holder or any of its properties may be bound or affected, or (iii) conflict with or result in a default under any material contract or other material agreement to which the Holder is a party or by which it or any of its properties may be bound or affected. (d) Approvals. No authorization, consent, order or approval of, notice to or registration or filing with, or any other action by any governmental authority or other person is required or advisable in connection with (i) the due execution and delivery by the Holder of this Warrant, or (ii) the performance by the Holder of its obligations under this Warrant. (e) Review of Information. The Holder has carefully read and reviewed the material furnished to it with respect to the Company and the Warrant. (f) No Registration Under Securities Act. The Holder understands and acknowledges that the Warrants and the shares of Common Stock issuable upon conversion thereof are not being registered under the 1933 Act or any state securities laws, on the grounds that the issuance thereof is exempt under Section 4(2) of the 1933 Act, and such state securities laws as a transaction by an issuer not involving any public offering, and that reliance on such exemption is predicated in part on the representations by the Holder herein. The Holder understands that the Warrants cannot be sold unless they are subsequently registered under the 1933 Act and applicable state securities laws or an exemption from such registration is available. (g) Investment Intent. The Holder is acquiring the Warrant for investment, solely for the Holder's own account and not with a view to, or for resale in connection with, the distribution or other disposition thereof. (h) Accredited Investor. The Holder is an accredited investor, as defined in Rule 501 of Regulation D promulgated under the 1933 Act. Section 6. Registration Rights. Upon the exercise of this Warrant, or payment of a Repurchase Amount that includes any shares of Common Stock, the Company and the Holder shall enter into a registration rights agreement which provides the Holder: (i) (A) if the Holder receives 15% or less of the Company's Common Stock on a Fully-Diluted Bases, 1 demand registration right, (B) if the Holder receives 15% to 30% of the Company's Common Stock on a Fully-Diluted Basis, 2 demand registration rights, or (C) if the Holder receives 30% of the Company's Common Stock on a Fully-Diluted Basis, 3 demand registration rights, (ii) "piggy-back" registration rights, (iii) registration rights on Form S-3 and (iv) other customary terms reasonably acceptable to the Holder and the Company. Section 7. Transferability. This Warrant shall be transferable in whole or in part to (i) one or more transferees to which the Loans are being transferred; provided, however, that a transfer of this Warrant to a person or entity that either (A) is a direct competitor of the Company, or (B) is not in the business of making, buying, selling or trading loans, shall require the prior written consent of the Company, (ii) institutional investors with the prior written consent of the Company, or (iii) any Affiliate (as defined below) -12- of the Holder. Any such transfer, assignment or conveyance shall be made on the books of the Company maintained for such purpose at the principal office of the Company upon surrender of this Warrant and a properly completed and executed assignment substantially in the form of Exhibit B attached hereto. "Affiliate" means any person or entity that directly or indirectly controls, is controlled by, or is under common control with, the Holder. Section 8. Exchangeability. This Warrant is exchangeable, upon the surrender hereof by the Holder at said office of the Company, for new Warrants of like tenor and date representing in the aggregate the right to purchase the number of shares of Common Stock which may be purchased hereunder, each of such new Warrants to represent the right to purchase such number of shares as shall be designated by the Holder at the time of such surrender. Section 9. Lost, Stolen, Mutilated or Destroyed Warrant. Upon receipt of evidence reasonably satisfactory to the Company of the loss, theft, mutilation or destruction of this Warrant, receipt by the Company of an executed affidavit of lost or stolen warrant and, if reasonably requested by the Company's transfer agent or any federal or state laws, rules or regulations the post of a bond by the Holders and, in case of loss, theft or destruction, upon the agreement of the Holder to indemnify and hold harmless the Company, and its directors and officers against any and all loss, liability, damage, cost and expenses (including reasonable attorneys' fees) which may be incurred by the Company in connection with, or arising out of, the issuance of a new Warrant or, in the case of mutilation, upon surrender and cancellation of this Warrant, the Company shall issue a new Warrant of like denomination and tenor as the Warrant so lost, stolen, mutilated or destroyed. Section 10. No Voting Rights. This Warrant shall not entitle the Holder to any voting rights or other rights as a stockholder of the Company whatsoever, except the rights expressed herein, and no dividend or interest shall be payable or accrue in respect of this Warrant or the interest represented hereby or the shares purchasable hereunder until and unless, and except to the extent that, this Warrant shall be exercised. Section 11. Definition of Common Stock. As used herein, "Common Stock" shall mean the Common Stock, par value $0.02 per share, of the Company as authorized on the date hereof, and also any capital stock of any class of the Company hereafter authorized which shall not be limited to a fixed sum or percentage in respect of the rights of the holders thereof to participate in dividends or in the distribution of assets upon the voluntary or involuntary liquidation, dissolution or winding up of the Company; provided, however, that the shares purchasable pursuant to this Warrant shall include only shares designated as Common Stock, par value $0.02 per share, of the Company on the date hereof, or shares of any class or classes resulting from any reclassification or reclassifications thereof which are not limited to any such fixed sum or percentage and are not subject to redemption by the Company and in case at any time there shall be more than one such resulting class, the shares of each such class then so issuable shall be substantially in the proportion which the total number of shares of such class resulting from all such reclassifications bears to the total number of shares of all such classes resulting from all such reclassifications. -13- Section 12. Miscellaneous. (a) Amendment of Warrant. This Warrant may not be amended except by an instrument in writing signed on behalf of each of the parties hereto. (b) Successors and Assigns. This Warrant will be binding upon and inure to the benefit of and is enforceable by the respective successors and permitted assigns of the parties hereto. (c) No Waiver; Remedies. No failure or delay by any party in exercising any right, power or privilege under this Agreement will operate as a waiver of the right, power or privilege. A single or partial exercise of any right, power or privilege will not preclude any other or further exercise of the right, power or privilege or the exercise of any other right, power or privilege. The rights and remedies provided in this Agreement will be cumulative and not exclusive of any rights or remedies provided by law. (d) Severability. If any term or other provision of this Warrant is invalid, illegal or incapable of being enforced by any rule of law, or public policy, all other conditions and provisions of this Warrant will nevertheless remain in full force and effect so long as the economic or legal substance of the transactions contemplated hereby is not affected in any manner adverse to any party. Upon such determination that any term or other provision is invalid, illegal or incapable of being enforced, the parties hereto will negotiate in good faith to modify this Warrant so as to effect the original intent of the parties as closely as possible in an acceptable manner to the end that the transactions contemplated hereby are fulfilled to the extent possible. (e) Governing Law. This Warrant will be governed by, and construed in accordance with, the internal laws of the State of New York without giving effect to any choice of law or conflict of law, provision or rule of the State of New York. (f) Counterparts. This Warrant may be executed simultaneously in one or more counterparts, and by different parties hereto in separate counterparts, each of which when executed will be deemed an original, but all of which taken together will constitute one and the same instrument. (g) Descriptive Headings. The headings in this Warrant and in the schedules and exhibits hereto are included for convenience of reference only and will not affect in any way the meaning or interpretation of this Agreement. (h) Submission to Jurisdiction. Any lawsuit, action or proceeding with respect to this Warrant may be brought in the courts of the State of New York or of the United States of America for the Southern District of New York, and each of the Company and the Holder hereby accept for themselves and in respect of its property, generally and unconditionally, the jurisdiction of these courts. Each of the Company and the Holder hereby irrevocably waives any objection, including, without limitation, any objection to the laying of venue or based on the grounds of forum non conveniens, which it may now or hereafter have to the bringing of any lawsuit, action or proceeding in those jurisdictions. -14- IN WITNESS WHEREOF, the Company and the Holder have caused this Warrant to be executed as of the date first written above. SCAN-OPTICS, INC. By: /s/Michael J. Villano ---------------------- Name: Michael J. Villano Title: Chief Financial Officer ARK CLO 2000-1, LIMITED By: Patriarch Partners, LLC its collateral manager By: /s/ Dennis Dolan ---------------------- Name: Dennis Dolan Title: Manager -15- EXHIBIT A to WARRANT AGREEMENT Subscription Form To: Scan-Optics, Inc. 169 Progress Drive Manchester, Connecticut 06040 (a) The undersigned hereby elects to purchase [insert number of shares] of Common Stock of Scan-Optics, Inc., pursuant to the terms of the attached Warrant, and tenders payment of the purchase price for such shares in full. (b) In exercising this Warrant, the undersigned hereby confirms and acknowledges that all of the representations and warranties of the undersigned set forth in Section 6 of the Warrant are true and correct as of this date. (c) Please issue a certificate or certificates representing said shares of Common Stock in the name or names specified below: [insert name, address and number of shares to be issued] (d) Please issue a new Warrant for the unexercised portion of the attached Warrant in the name of the undersigned or in such other name as is specified below: [insert name of Holder if applicable] Dated: ____________________ HOLDER: ARK CLO 2000-1, LIMITED By: Patriarch Partners, LLC its collateral manager By:____________________________________ Name: Title: -16- EXHIBIT B to WARRANT AGREEMENT Form of Assignment To: Scan-Optics, Inc. 169 Progress Drive Manchester, Connecticut 06040 FOR VALUE RECEIVED, the undersigned Holder of the attached Warrant hereby sells, assigns and transfers unto each of the Assignee(s) named below all of the rights of the undersigned under such Warrant, with respect to the number of Warrant Shares set forth below: Number of Shares of Warrant Name of Assignee Address Stock Assigned - ---------------- ------- ----------------- - ------------------ ------------------------- ---------------- and does hereby irrevocably constitute and appoint the Secretary of Scan-Optics, Inc. (the "Company") as attorney to make such transfer on the books of the Company maintained for such purpose, with full power of substitution. Dated: ___________________ HOLDER: ARK CLO 2000-1, LIMITED By: Patriarch Partners, LLC its collateral manager By:____________________________________ Name: Title: -17- EX-10 4 exhibit10-19.txt EXHIBIT 10.19 Exhibit 10.19 FOURTH AMENDMENT AGREEMENT This Fourth Amendment Agreement (this "Agreement") dated as of December 31, 2001, is by and between ARK CLO 2000-1, Limited (the "Lender") (as assignee of Fleet National Bank, formerly known as BankBoston, N.A.) and Scan-Optics, Inc. (the "Borrower"), as parties to that certain Second Amended and Restated Loan Agreement, dated as of May 10, 1999 (the "Original Loan Agreement"), as amended pursuant to that certain Amendment and Waiver Agreement, dated as of January 29, 2001 (the "First Amendment"), the Second Amendment and Waiver Agreement, dated as of July 1, 2001 (the "Second Amendment") and the Third Amendment and Waiver Agreement, dated as of September 1, 2001 (the "Third Amendment"; together with the Original Loan Agreement, the First Amendment, the Second Amendment and the Third Amendment, collectively, the "Loan Agreement"). W I T N E S S E T H : WHEREAS, Lender has provided Borrower with (a) that certain revolving credit loan in the original principal amount of up to $10,000,000.00 as evidenced by, inter alia, (i) that certain Fourth Amended and Restated Revolving Credit Note from the Borrower to the Lender in the original principal amount of up to $10,000,000.00 dated as of May 10, 1999 (the "Revolving Credit Note" (as such term is amended as set forth below)), (ii) the Loan Agreement, and (iii) those certain Unlimited Guaranties in favor of the Lender from each of Scan-Optics Limited and Scan-Optics (Canada) Ltd. both dated as of April 7, 1993, as reaffirmed by a Reaffirmation of Guaranties dated May 10, 1999 (as amended and reaffirmed from time, to time, collectively, the "Guaranties"), and (b) that certain term loan in the original principal amount of $10,000,000.00 as evidenced by, inter alia, (i) that certain Term Note from the Borrower to the Lender in the original principal amount of $10,000,000.00 dated as of May 10, 1999 (the "Term Note" (as such term is amended as set forth below) and together with the Revolving Credit Note, collectively, the "Notes"), (ii) the Loan Agreement and (iii) the Guaranties. The Notes, the Loan Agreement, the Guaranties, this Agreement and all other instruments, agreements and documents executed and/or delivered in connection therewith are collectively referred to herein as the "Loan Documents"; WHEREAS, each of the Borrower, Scan-Optics Limited and Scan-Optics (Canada) Ltd., (collectively, the "Obligors") entered into the First Amendment, the Second Amendment and the Third Amendment with the Lender to, inter alia, waive certain Events of Default (as defined in the First Amendment, the Second Amendment and the Third Amendment) arising as a result of the Borrower's failure to comply with certain terms and conditions of the Original Loan Agreement until the Waiver Termination Date (as defined in the First Amendment) and the Second Waiver Termination Date (as defined in the Second Amendment) and the Third Waiver Termination Date (as defined in the Third Amendment) as set forth therein; WHEREAS, each of the Obligors acknowledges and agrees that (a) the Third Waiver Termination Date has occurred and that said Events of Default are continuing and (b) as a result thereof, the Lender may, if it so elects, proceed -1- to enforce its rights and remedies under the Loan Documents and to collect the Obligors' indebtedness to the Lender under the Loan Documents; WHEREAS, prior to giving effect to this Agreement, the Revolving Credit Commitment is $10,000,000, the outstanding principal amount of Revolving Credit Loans is $9,891,555.91 (the "Current Revolving Loan Balance"); WHEREAS, prior to giving effect to this Agreement, the outstanding principal amount of the Term Loan is $8,495,100.00 (the "Current Term Loan Balance"); WHEREAS, the Borrower has failed to comply with certain provisions of the Loan Documents set forth on Schedule 1 hereto, and each such failure constitutes an Event of Default under the Loan Agreement; and WHEREAS, the Obligors and the Lender wish to restructure the Loans (the "Restructuring") and amend certain terms and conditions of the Loan Agreement all on the terms and conditions set forth herein. NOW, THEREFORE, for good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the parties hereto agree as follows: Section 1. Definitions. Capitalized terms used herein without definition that are defined in the Loan Agreement shall have the same meanings herein as therein. Section 2. Condition Precedent. The effectiveness of the amendments contained herein shall be subject to the satisfaction of the following conditions precedent, on or before January 11, 2002: (a) the receipt by the Lender of financial projections and reports in form and substance satisfactory to Lender (in Lender's sole and absolute discretion); (b) Lender's approval (in Lender's sole and absolute discretion) of the form and substance of all the documents, agreements and instruments (including, without limitation, this Agreement and the Warrant (defined below)) executed in connection with this Agreement and the Restructuring; (c) no material adverse change having occurred with respect to the business or operations of any Obligor since September 1, 2001; (d) Borrower's execution and delivery to Lender of a revised Revolving Credit Note (as described in Section 3(c) below) (in the form attached hereto as Exhibit A), revised Term Note (as described in Section 3(d) below) (in the form attached hereto as Exhibit B), the Warrant (in the form attached hereto as Exhibit C (the "Warrant")) and 3,800,000 shares of Series A Redeemable Preferred Stock having the terms set forth in the Certificate of Designations set forth as Exhibit D (the "Preferred Shares"); and -2- (e) Lender's receipt of a legal opinion from Day, Berry & Howard LLP, counsel to Borrower, in form and substance acceptable to Lender (in Lender's sole and absolute discretion); provided, that if the above-referenced conditions have been met or satisfied as of January 11, 2002, the parties hereto agree that transactions set forth herein shall be deemed to be effective as of December 31, 2001. Section 3. Covenants and Amendments. Without any prejudice or impairment whatsoever to any of the rights and remedies of the Lender contained in the Loan Agreement or in any other Loan Documents, each of the Obligors covenants and agrees with the Lender as follows: (a) Effective as of the date hereof, the defined terms "Revolving Credit Commitment", "Revolving Credit Maturity Date", "Term Loan" and "Term Loan Maturity Date", each as set forth in Section 1 of the Loan Agreement, are hereby amended in their entirety to read as follows: "Revolving Credit Commitment: The obligation of the Bank to make Revolving Credit Loans to the Borrower up to an aggregate outstanding principal amount not to exceed (i) for the period from the date of the Fourth Amendment through June 30, 2002, $10,750,000.00, and (ii) for the period from July 1, 2002 through the Revolving Credit Maturity Date, $10,000,000.00, in each case as such amount may be reduced from time to time or terminated hereunder." "Revolving Credit Maturity Date: December 31, 2004." "Term Loan: The term loan that shall continue to be made to the Borrower pursuant to Section 3 hereof in the principal amount of $2,000,000.00 (after giving effect to the Fourth Amendment)." "Term Loan Maturity Date: December 31, 2004." (b) Effective as of the date hereof, the following terms "Fourth Amendment" and "Excess Cash Flow" are hereby added to Section 1 of the Loan Agreement. "Fourth Amendment: That certain Fourth Amendment Agreement, dated as of December 31, 2001), between the Borrower and the Lender." "Excess Cash Flow: For any period the amount equal to Consolidated Operating Cash Flow for such period minus the aggregate amount of Consolidated Financial Obligations payable during such period." (c) Effective as of the date hereof, the last sentence of Section 2(a) of the Loan Agreement is hereby amended in its entirety to read as follows: "Notwithstanding anything else contained herein to the contrary, the Borrower shall not maintain any Revolving Credit Loans, or request any Revolving Credit Loans that would result in the Borrower maintaining Revolving Credit Loans, in excess of the then applicable Revolving Credit Commitment. The obligation of the Borrower to repay to the Bank the principal of the Revolving Credit Loans and interest accrued thereon shall be evidenced by a fifth amended and restated promissory -3- note, dated as of the date of the Fourth Amendment, in the aggregate principal amount of $10,750,000.00 executed and delivered by the Borrower and payable to the order of the Bank, in the form and substance satisfactory to the Bank (the "Revolving Credit Note")." (d) Effective as of the date hereof, Section 3(a) and Section 3(b) of the Loan Agreement are hereby amended in their entirety to read as follows: "ss.3. The Term Loan. (a) Subject to the terms and conditions set forth in the Fourth Amendment, the Bank agrees to forgive all accrued and unpaid interest on the Term Loan through December 31, 2001, forgive the aggregate outstanding principal balance of the Term Loan above $2,000,000.00, and to continue to extend the remaining balance of the Term Loan (i.e., $2,000,000.00). The Term Loan shall be evidenced by an amended and restated promissory note of the Borrower in the aggregate principal amount of $2,000,000.00 in form and substance satisfactory to the Bank (the "Term Note"), dated as of the date of the Fourth Amendment and payable to the order of the Bank. (b) Subject to the terms and conditions set forth in this Agreement, the Borrower shall pay the outstanding principal amount of the Term Loan on the Term Loan Maturity Date. In addition, within thirty days of the last day of each calendar quarter beginning on March 31, 2002, the Borrower shall prepay the Term Loan in an amount equal to 50% of the Excess Cash Flow during such calendar quarter." (e) The Bank agrees to forgive all accrued and unpaid interest on the Revolving Credit Loans and all commitment fees on the unfunded portion of the Revolving Credit Commitment, in each case through December 31, 2001. (f) Effective as of the date hereof, the first sentence of Section 7(c) of the Loan Agreement is hereby amended in it entirety to read as follows: "All payments to be made by the Borrower hereunder or under any of the other Loan Documents shall be made in U.S. dollars in immediately available funds to Ark CLO 2000-1, Limited, c/o JPMorgan Chase Bank, 600 Travis Street, 50th Floor, Houston, Texas 77002, without set-off or counterclaim and without any withholding or deduction whatsoever." (g) Effective as of the date hereof, all Loans hereunder shall be Base Rate Loans. The first Interest Payment Date after the date hereof shall be -4- February 1, 2002 (which shall cover the first Interest Period ending on January 31, 2002). For the avoidance of doubt, each Interest Payment Date thereafter shall be the first day of such calendar month. (h) Effective as of the date hereof, Section 10(c) of the Loan Agreement is hereby amended in its entirety to read as follows: "(c) The Borrower agrees that as long as any Loan or Note is outstanding and until the termination of the Revolving Credit Commitment and the payment and satisfaction in full of all of the Obligations, the Borrower will not: (i) make any Capital Expenditures in any fiscal quarter ending on or after March 31, 2002 in excess of $50,000.00; or (ii) permit Consolidated Earnings Before Interest and Taxes, Depreciation and Amortization for (A) the fiscal quarter of the Borrower ending on March 31, 2002 to be less than $640,000.00, (B) the period of two consecutive fiscal quarters of the Borrower ending on June 30, 2002 to be less than $1,775,000.00, (C) the period of three consecutive fiscal quarters of the Borrower ending on September 30, 2002 to be less than $2,380,000.00 and (D) any period consisting of four (4) consecutive fiscal quarters of the Borrower ending on or after December 31, 2002 to be less than $3,570,000.00; or (iii) permit the Borrower's backlog (as defined in the Borrower's most recent 10K filed with the Securities and Exchange Commission) to be less than $13,000,000.00 for any fiscal quarter of the Borrower ending on or after March 31, 2002." (i) Effective as of the date hereof, the following clause is added to the end of the first paragraph of Section 11 (Events of Default), as an additional Event of Default: "; (j) or more than ten percent (10%) of those accounts receivable of the Borrower created or arising in connection with any contract disclosed in the Borrower's backlog report to the Lender are not valid and legally enforceable obligations of the applicable account debtors or are subject to any present or contingent offset, deduction or counterclaim, dispute or other defense on the part of such account debtors." (j) Effective as of the date hereof, Section 4(b) and Section 4(d) of the Third Amendment are hereby deleted in their entirety. (k) In addition to any of the following required to be delivered by the Borrower in accordance with and/or pursuant to the First Amendment, the Second Amendment and/or the Third Amendment, the Borrower shall, on or before January 15, 2002, provide Lender with the following: (i) fully executed UCC-1 financing statements for all jurisdictions requested by Lender; (ii) a fully executed perfection certificate in form and detail reasonably satisfactory to the Lender; (iii) fully executed lessor's agreements in form and substance reasonably satisfactory to the Lender for all leased property as reasonably requested by Lender; and (iv) first priority properly perfected security interests in all property, including without limitation intellectual property, owned by the Borrower and any of its Subsidiaries pursuant to documentation in form and -5- substance reasonably satisfactory to the Lender that may reasonably be required by Lender to properly perfect security interests in all such property owned by the Borrower and any of its Subsidiaries. (l) The Obligors shall comply with all of the terms, covenants and provisions contained in the Loan Agreement and the other Loan Documents (including for the avoidance of doubt, the First Amendment, Second Amendment and Third Amendment), except as such terms, covenants and provisions are expressly modified by this Agreement. (m) The Obligors shall at any time and from time to time execute and deliver such further instruments (including without limitation UCC-1 and other security/perfection documents), and take such further action as the Lender may reasonably request, in each case further to effect the purposes of this Agreement, the Loan Agreement and the other Loan Documents. Without limiting the generality of the immediately preceding sentence, the Obligors shall permit the Lender and/or its designated representatives, upon reasonable notice, to visit and inspect any of the Obligors' properties or any of its affiliates, to examine the books of account of the Obligors and their affiliates (and to make copies thereof and extracts therefrom), and to discuss the, affairs, finances and accounts of the Obligors and their affiliates with, and to be advised as to the same by, its and their officers, all during normal business hours. Section 4. Section Waivers under the Loan Agreement. Subject to the satisfaction of the conditions set forth herein (including without limitations in Section 2 hereof and the accuracy of the representations set forth in Section 5 hereof), the Lender waives those Events of Default that have occurred under the Loan Agreement as a result of the Borrower's failure on or before the date hereof to comply with the provisions of the Credit Agreement set forth on Schedule 1 attached hereto (the "Current Events of Default"). Section 5. Section Representations and Warranties. Each of the Obligors hereby represents and warrants to the Lender that (i) all of the representations and warranties made by such Obligors in the Loan Agreement and the other Loan Documents are true and correct on the date hereof as if made on and as of the date hereof, except to the extent that any of such representations and warranties expressly relate by their terms to a prior date and (ii) there are no defaults under the Loan Agreement except the Current Events of Default. Section 6. Section Ratification of Existing Agreements. Each of the Obligors agrees that the obligations of such Obligors to the Lender as evidenced by or otherwise arising under the Loan Agreement and the other Loan Documents, except as otherwise expressly modified in this Agreement upon the terms set forth herein, are, by each Obligor's execution of this Agreement, ratified and confirmed in all respects, including (without limitation) the Guaranties which are hereby reaffirmed and the Security Agreements. In addition, by the execution of this Agreement, each of the Obligors represents and warrants that it has no claim, counterclaim, right of set-off or defense of any kind against Lender (or its predecessors-in-interest) with respect to the obligations under the Loan Documents or otherwise. -6- Section 7. Section Release. The Obligors, on their own behalf and on behalf of their successors and assigns, hereby waive, release and discharge the Lender, Patriarch Partners, LLC and all affiliates of the Lender and/or Patriarch Partners, LLC, and all of their directors, officers, employees, attorneys and agents, from any and all claims, demands, actions or causes of action whether known or unknown, arising out of or in any way relating to this Agreement, the Loan Agreement, the Loan Documents and/or any documents, agreements, dealings or other matters connected with the Loan Agreement, the Loan Documents or the administration thereof. Section 8. Section Expenses. The Obligors agree to pay to the Lender (a) on or before the date hereof, Lender's legal fees and disbursements incurred through the date hereof in connection with the negotiation and preparation of this Agreement and related matters, (b) on or before the date hereof Lender's examiner and audit fees and disbursements incurred through the date hereof, and (c) upon demand from time to time any and all reasonable out-of-pocket costs or expenses (including consultants' fees, commercial examiner fees, audit fees and reasonable legal fees and disbursements) hereafter incurred by the Lender in connection with the administration of credit extended by the Lender to the Obligors or the preservation of or enforcement of its rights under the Loan Agreement, the Notes and/or the other Loan Documents or in respect of any of each Obligor's other obligations to the Lender. Section 9. Section Marshalling. The Lender shall not be required to marshal any present or future collateral security for the Obligors' obligations to the Lender under the Loan Documents or to resort to such collateral security or other assurances of payment in any particular order, and all of its rights in respect of such collateral security shall be cumulative and in addition to all other rights, however existing or arising. To the extent that it lawfully may, each of the Obligors hereby agrees that each will not invoke any law relating to the marshalling of collateral which might cause delay in or impede the Lender's rights under any document, agreement or instrument evidencing or securing any of the Obligors' obligations to the Lender under the Loan Documents and, to the extent that it lawfully may, each of the Obligors hereby irrevocably waives the benefits of all such laws. Section 10. Section No Waiver. Except as otherwise expressly provided for in this Agreement, nothing in this Agreement shall extend to or affect in any way any of the rights or obligations of the Obligors or any of the Lender's obligations, rights and remedies arising under the Loan Documents, and the Lender shall not be deemed to have waived any or all of its rights or remedies with respect to any default and which upon the execution and delivery of this Agreement might otherwise exist or which might hereafter occur. Section 11. Section Lien and Set-off. Each of the Obligors hereby grants to the Lender, a lien, security interest and right of set-off as security for all of the Obligors' liabilities and obligations to the Lender or the Lender's affiliates, whether now existing or hereafter arising, upon and against all deposits, credits, collateral and property of the Obligors (other than Borrower's payroll accounts), now or hereafter in the possession, custody, safekeeping or control of the Lender or any entity under the control of the Lender, or in transit to any of them. At any time on or after the date hereof, without demand or notice, the Lender may set-off the same or any part thereof and apply the same to any liability or obligation of any of the Obligors even though unmatured and regardless of the adequacy of any other collateral securing the Obligations. ANY AND ALL RIGHTS OF THE OBLIGORS TO REQUIRE THE LENDER TO -7- EXERCISE ITS RIGHTS OR REMEDIES WITH RESPECT TO ANY OTHER COLLATERAL WHICH SECURES THE OBLIGATIONS, PRIOR TO EXERCISING ITS RIGHT OF SET-OFF WITH RESPECT TO SUCH DEPOSITS, CREDITS OR OTHER PROPERTY OF THE OBLIGORS, ARE HEREBY KNOWINGLY, VOLUNTARILY AND IRREVOCABLY WAIVED. Section 12. Section Governing Law This Agreement shall be governed by and construed in accordance with the laws of the State of Connecticut. Section 13. Section Consent to Jurisdiction, Counsel. Each of the Obligors agrees that the following courts: (i) state court - any state or local court located in the City of Hartford, State of Connecticut and (ii) federal court - any United States District Court located in Hartford, Connecticut, or at the option of the Lender, any court in which the Lender shall initiate legal or equitable proceedings and which has subject matter jurisdiction over the matter in controversy, shall have exclusive jurisdiction to hear and determine any claims or disputes between any Obligor and the Lender pertaining directly or indirectly to this Agreement and/or the Loan Documents or to any matter arising therefrom. Each of the Obligors expressly submits and consents in advance to such jurisdiction in any action or proceeding commenced in such courts. Each of the Obligors acknowledges that it has carefully read this Agreement and that it has had an opportunity to consult with an attorney of its own selection before signing it and each of the Obligors understands the effects of this Agreement and is signing it voluntarily. Section 14. Section Waiver of Jury Trial. EACH OF THE OBLIGORS HEREBY WAIVES ITS RIGHT TO A JURY TRIAL WITH RESPECT TO ANY ACTION OR CLAIM ARISING OUT OF ANY DISPUTE IN CONNECTION WITH THIS AGREEMENT, THE LOAN DOCUMENTS OR ANY OF THE OBLIGORS' OBLIGATIONS HEREUNDER OR THEREUNDER OR THE PERFORMANCE OF SUCH OBLIGATIONS. Section 15. Section Entitlement to Relief from Stay. Each of the Obligors hereby acknowledges and agrees, in further consideration for the Lender entering into this Agreement with the Obligors, that, in the event that any Obligor shall make application for or seek relief or protection under any of the sections or chapters of the federal Bankruptcy Code, or in the event that any involuntary petition is filed against any Obligor under the federal Bankruptcy Code and an order for relief is entered as a result thereof, then the Lender shall thereupon be entitled (upon notice to Borrower and a hearing thereon) to immediate relief from any automatic stay imposed by Section 362 of the federal Bankruptcy Code, or otherwise, on or against the exercise of the Lender's rights and remedies under this Agreement or any of the other Loan Documents. The Lender in turn acknowledges that this Section 15 shall not be construed as a restriction or prohibition on the Obligors' right to make application for or seek relief or protection under the federal Bankruptcy Code. -8- Section 16. Section Miscellaneous Provisions. (a) Except as otherwise expressly provided by this Agreement, all of the terms, conditions and provisions of the Loan Agreement shall remain the same. It is declared and agreed by each of the parties hereto and thereto that the Loan Agreement, as amended hereby, shall continue in full force and effect, and that this Agreement and the Loan Agreement shall be read and construed as one instrument. (b) This Agreement may be executed in any number of counterparts, but all such counterparts shall together constitute but one instrument. In making proof of this Agreement it shall not be necessary to produce or account for more than one counterpart signed by each party hereto by and against which enforcement hereof is sought. TIME IS OF THE ESSENCE AS TO ALL OF THE PROVISIONS HEREIN. -9- IN WITNESS WHEREOF, each of the parties hereto have caused this Agreement to be executed in its name and behalf by its duly authorized officer as of the date first written above, SCAN-OPTICS, INC. By : _/s/ Michael J. Villano____________ ----------------------- Name: Michael J. Villano Title: Chief Financial Officer SCAN-OPTICS LIMITED By : _/s/ Michael J. Villano____________ ----------------------- Name: Michael J. Villano Title: Chief Financial Officer SCAN-OPTICS (CANADA) LTD. By : _/s/ Michael J. Villano____________ ----------------------- Name: Michael J. Villano Title: Chief Financial Officer ARK CLO 2000-1, LIMITED, as Assignee of Fleet National Bank (formerly known as BankBoston, N.A.) By: PATRIARCH PARTNERS, LLC, its Collateral Manager By : _/s/ Dennis Dolan_________________ ----------------- Name: Dennis Dolan Title: Manager -10- Exhibit A [Revolving Credit Note] -11- Exhibit B [Term Note] -12- Exhibit C [Warrant] -13- Exhibit D [Certificate of Designation for Preferred Stock] -14- Current Events of Default Schedule 1 to Fourth Amendment Agreement dated as of December 31, 20011 1. The Borrower's failure to pay the December 31, 2000 installment of principal on the Term Loan, as required under Section 3(b) of the Loan Agreement. 2. The Borrower's failure to furnish the Lender monthly unaudited consolidated Financials, as set forth in Section 10(a)(i)(c) of the Loan Agreement. 3. The Borrower's failure to maintain interest rate protection arrangements, as set forth in Section 10(a)(vi) of the Loan Agreement. 4. The Borrower's failure to satisfy each of the financial covenants set forth in Section 10(c) of the Loan Agreement. 5. The Borrower's failure to pay the required quarterly installments of principal on the Term Loan that became due and payable on December 31, 2000 and the last day of each calendar quarter in 2001, as required under Section 3(b) of the Loan Agreement. 6. The Borrower's failure to comply with the covenants in Sections 4(a), 4(d), 4(g) and 4(h) of the Third Amendment and Waiver Agreement. 7. The Borrower's failure to pay interest accrued on the principal amount of the Loans during the period beginning September 1, 2001 and ending on December 31, 2001 in accordance with the terms of the Loan Agreement. 8. The Borrower's failure to pay lease payments on the outstanding leases with Patriarch Partners, LLC through the period ending on December 31, 2001. - --------------- 1 For the avoidance of doubt, the Lender is not waiving any Defaults or Events of Default under the Loan Agreement (as amended) that exist on or after January 1, 2002 (after giving effect to the Fourth Amendment Agreement). -15- SECOND AMENDED AND RESTATED LOAN AGREEMENT by and between SCAN-OPTICS, INC. (the "Borrower") and BANKBOSTON, N.A. (the "Bank") dated as of May 10, 1999 -16- TABLE OF CONTENTS ss.1. Definitions:..........................................................1 ss.2. Revolving Credit Facility.............................................11 ss.3. The Term Loan.........................................................13 ss.4. Interest..............................................................14 ss.5. Additional Costs, Etc.................................................16 ss.6. Changes in Circumstances..............................................17 ss.7. Fees and Payments.....................................................18 ss.8. Representations and Warranties........................................20 ss.9. Conditions Precedent..................................................21 ss.10. Covenants............................................................21 ss.11. Events of Default; Acceleration......................................27 ss.12. Setoff...............................................................28 ss.13. Miscellaneous........................................................28 ss.14. Prejudgment Remedy Waiver............................................29 ss.15. Effective Date.......................................................30 ss.16. Amendment and Restatement............................................30 SCHEDULES: Schedule 10(b)(i): Permitted Indebtedness Schedule 10(b)(ii): Existing Liens -17- SECOND AMENDED AND RESTATED LOAN AGREEMENT This SECOND AMENDED AND RESTATED LOAN AGREEMENT (this "Loan Agreement" or this "Agreement") is made as of May 10, 1999, by and between SCAN-OPTICS, INC. (the "Borrower"), a Delaware corporation having its principal place of business at 169 Progress Drive, Manchester, Connecticut 06040, and BANKBOSTON, N.A. (the "Bank"), a national banking association with an office at 100 Pearl Street, Hartford, Connecticut 06103 and successor by merger to Bank of Boston Connecticut. WHEREAS, the Borrower entered into a certain Amended and Restated Revolving Loan Agreement dated as of June 12, 1998 between the Borrower and the Bank, as previously amended by an Amendment Agreement dated as of July 30, 1998 and by a Second Amendment and Waiver Agreement dated as of September 28, 1998 (as heretofore amended, the "Prior Loan Agreement"); and WHEREAS, the Borrower and the Bank desire to amend and restate the Prior Loan Agreement in its entirety as set forth herein. NOW, THEREFORE, in consideration of the foregoing premises and other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the Borrower and the Bank hereby agree that as of the Effective Date (as hereinafter defined), the Prior Loan Agreement shall be amended and restated in its entirety as set forth herein: ss.1. Definitions: Certain capitalized terms are defined below: Base Rate: The higher of (i) the annual rate of interest announced from time to time by the Bank at its head office in Boston, Massachusetts, as its "base rate" and (ii) one-half of one percent (1/2%) above the Federal Funds Effective Rate. For the purposes of this definition, "Federal Funds Effective Rate" shall mean for any day, the rate per annum equal to the weighted average of the rates on overnight federal funds transactions with members of the Federal Reserve System arranged by federal funds brokers, as published for such day (or, if such day is not a Business Day, for the next preceding Business Day) by the Federal Reserve Bank of New York, or, if such rate is not so published for any day that is a Business Day, the average of the quotations for such day on such transactions received by the Bank from three funds brokers of recognized standing selected by the Bank. Base Rate Loans: Revolving Credit Loans and all or any portion of the Term Loan bearing interest calculated by reference to the Base Rate. Business Day: Any day on which banks in Hartford, Connecticut are open for business generally. Capital Expenditures: Amounts paid or indebtedness incurred by the Borrower or any of its Subsidiaries in connection with the purchase or lease by -18- the Borrower or any of its Subsidiaries of assets that would be required to be capitalized and shown on the balance sheet of such Person in accordance with GAAP. Charter Documents: With respect to any Person, the certificate or articles of incorporation or organization and the by-laws of such Person, or other constitutive documents of such entity. Collateral: All of the property, rights and interests of the Borrower and its Subsidiaries that are or are intended to be subject to the security interests created by the Security Documents. Consent: In respect of any Person, any permit, license or exemption from, approval, consent of, registration or filing with any local, state or federal governmental or regulatory agency or authority, required under applicable law. Consolidated Current Assets: All assets of the Borrower and its Subsidiaries on a consolidated basis that, in accordance with GAAP, are properly classified as current assets, provided that notes and accounts receivable shall be included only if good and collectible as determined by the Borrower in accordance with established practice consistently applied and, with respect to any such notes, only if payable on demand or within one (1) year from the date as of which Consolidated Current Assets are to be determined and if not directly or indirectly renewable or extendible at the option of the debtor(s) thereunder, by their terms, or by the terms of any instrument or agreement relating thereto, beyond such year, and, with respect to such accounts receivable, only if payable and outstanding not more than ninety (90) days after the date of the shipment of goods or other transaction out of which any such account receivable arose; and such notes and accounts receivable shall be taken at their face value less reserves determined to be sufficient in accordance with GAAP. Consolidated Current Liabilities: All liabilities of the Borrower and its Subsidiaries on a consolidated basis maturing on demand or within one (1) year from the date as of which Consolidated Current Liabilities are to be determined, and such other liabilities as may properly be classified as current liabilities in accordance with GAAP. Consolidated Earnings Before Interest and Taxes: For any period, an amount equal to the consolidated earnings (or loss) from the operations of the Borrower and its Subsidiaries for such period, after all expenses and other proper charges, but before payment or provision for any income taxes or interest expense for such period, determined in accordance with GAAP. Consolidated Earnings Before Interest and Taxes, Depreciation and Amortization: For any period, an amount equal to the sum of (i) the consolidated earnings (or loss) from the operations of the Borrower and its Subsidiaries for such period, after all expenses and other proper charges, but before payment or -19- provision for any income taxes or interest expense for such period, plus (ii) depreciation and amortization for such period, determined in accordance with GAAP. Consolidated Financial Obligations: For any period, an amount equal to the sum of all payments on Indebtedness that become due and payable or that are to become due and payable during such period pursuant to any agreement or instrument to which the Borrower or any of its Subsidiaries is a party relating to the borrowing of money or the obtaining of credit or in respect of capitalized leases. Demand obligations shall, as of any date of determination, be deemed to be due and payable during any period during which such obligations are outstanding. Consolidated Net Income (or Deficit): The consolidated net income (or deficit) of the Borrower and its Subsidiaries, after deduction of all expenses, taxes, and other proper charges, determined in accordance with GAAP. Consolidated Operating Cash Flow: For any period, an amount equal to (a) the sum of (i) the earnings (or loss) from the operations of the Borrower and its Subsidiaries for such period, after payment or provision for all expenses and other proper charges, but before payment or provision for any income taxes or interest expense, plus (ii) depreciation and amortization for such period, minus (b) cash payments for all taxes paid during such period, minus (c) Capital Expenditures made during such period to the extent permitted hereunder. Consolidated Tangible Net Worth: The excess of (a) all assets of the Borrower determined in accordance with GAAP, over (b) all liabilities of the Borrower determined in accordance with GAAP, minus (c) the sum of (i) the book value of all intangibles of the Borrower determined in accordance with GAAP, including good will and intellectual property, (ii) any write-up in the book value of assets of the Borrower since the most recent audited Financials in existence on the date hereof, and (iii) without duplication, any subscriptions receivable of the Borrower. Consolidated Total Funded Debt: As to the Borrower and its Subsidiaries and whether recourse is secured by or is otherwise available against all or only a portion of the assets of the Borrower or any of its Subsidiaries and whether or not contingent, but without duplication: (a) every obligation of the Borrower or any of its Subsidiaries for money borrowed; (b) every obligation of the Borrower or any of its Subsidiaries evidenced by bonds, debentures, notes or other similar instruments, including obligations incurred in connection with the acquisition of property, assets or businesses and the principal portion of rental obligations under any capitalized lease; -20- (c) every reimbursement obligation of the Borrower or any of its Subsidiaries with respect to letters of credit, bankers' acceptances or similar facilities issued for the account of the Borrower or any of its Subsidiaries; and (d) every obligation of the Borrower or any of its Subsidiaries issued or assumed as the deferred purchase price of property or services (including securities repurchase agreements but excluding trade accounts payable or accrued liabilities arising in the ordinary course of business which are not overdue or which are being contested in good faith). Consolidated Total Interest Expense: For any period, the aggregate amount of interest required to be paid or accrued by the Borrower and its Subsidiaries during such period on all Indebtedness of the Borrower and its Subsidiaries outstanding during all or any part of such period, whether such interest was or is required to be reflected as an item of expense or capitalized, including payments consisting of interest in respect of capitalized leases and including commitment fees, agency fees, facility fees, balance deficiency fees and similar fees or expenses incurred in connection with the borrowing of money. Consolidated Total Liabilities: All liabilities of the Borrower and its Subsidiaries that in accordance with GAAP are properly classified as liabilities. Default: An event or act which with the giving of notice and/or the lapse of time, would become an Event of Default. Dollars or $: Dollars in lawful currency of the United States of America. Drawdown Date: The date on which any Revolving Credit Loan or the Term Loan is made or is to be made, and the date on which any Revolving Credit Loan or the Term Loan is converted or continued. Effective Date: May 10, 1999. Environmental Laws: All laws pertaining to environmental matters, including without limitation, the Resource Conservation and Recovery Act, the Comprehensive Environmental Response Compensation and Liability Act of 1980, the Superfund Amendments and Reauthorization Act of 1986, the Federal Clean Water Act, the Federal Clean Air Act, the Toxic Substances Control Act, in each case as amended, and all rules, regulations, judgments, decrees, orders and licenses arising under all such laws. ERISA: The Employee Retirement Income Security Act of 1974, as amended, and all rules, regulations, judgments, decrees, and orders arising thereunder. Eurocurrency Reserve Rate: For any day with respect to all or any portion of a Eurodollar Rate Loan, the maximum rate (expressed as a decimal) at which the Bank would be required to maintain reserves under Regulation D of the Board of Governors of the Federal Reserve System (or any successor or similar -21- regulations relating to such reserve requirements) against "Eurocurrency Liabilities" (as that term is used in Regulation D), if such liabilities were outstanding. The Eurocurrency Reserve Rate shall be adjusted automatically on and as of the effective date of any change in the Eurocurrency Reserve Rate. Eurodollar Business Day: Any day on which commercial banks are open for international business (including dealings in Dollar deposits) in the London interbank market. Eurodollar Lending Office: Initially, the office of the Bank, if any, that shall be making or maintaining Eurodollar Rate Loans. Eurodollar Rate: For any Interest Period with respect to all or any portion of any Loan bearing interest at a rate determined by reference to the Eurodollar Rate, the rate of interest equal to (i) the arithmetic average of the rates per annum for the Bank (rounded upwards to the nearest 1/16 of one percent) of the rate at which the Bank's eurodollar lending office is offered Dollar deposits two Eurodollar Business Days prior to the beginning of such Interest Period in the interbank eurodollar market where the eurodollar and foreign currency and exchange operations of such eurodollar lending office are customarily conducted at or about 10:00 a.m., Boston time, for delivery on the first day of such Interest Period for the number of days comprised therein and in an amount comparable to the amount of all or any portion of any Loan bearing interest at a rate determined by reference to the Eurodollar Rate of the Bank to which such Interest Period applies, divided by (ii) a number equal to 1.00 minus the Eurocurrency Reserve Rate, if applicable. Eurodollar Rate Loans: Loans bearing interest calculated by reference to the Eurodollar Rate. Event of Default: Any of the events listed inss.11 hereof. Financials: With respect to any Person for any period, the balance sheet of such Person as at the end of such period, and the related statement of income and expense and statement of cash flow of such Person for such period, each setting forth in comparative form the figures for the previous comparable fiscal period, all in reasonable detail and prepared in accordance with GAAP. GAAP: Generally accepted accounting principles consistent with those adopted by the Financial Accounting Standards Board and its predecessor, (a) generally, as in effect from time to time, and (b) for purposes of determining compliance by the Borrower with the financial covenants set forth herein, as in effect for the fiscal year ended December 31, 1998. Guaranties: Collectively, the Unlimited Guaranties from each of Scan-Optics Canada and Scan-Optics England to the Bank, each as amended and reaffirmed from time to time. -22- Indebtedness: With respect to any Person, all obligations of such Person, contingent and otherwise, that in accordance with GAAP should be classified as liabilities, including without limitation (a) all debt obligations, (b) all liabilities secured by Liens, (c) all guarantees and (d) all liabilities in respect of bankers' acceptances or letters of credit. Interest Payment Date: (a) As to any Base Rate Loan, the first day of the calendar month; and (b) as to any Eurodollar Rate Loan in respect of which the Interest Period is (i) 3 months or less, the last day of such Interest Period and (ii) more than 3 months, the date that is 3 months from the first day of such Interest Period and, in addition, the last day of such Interest Period. Interest Period: With respect to each Loan, (a) initially, the period commencing on the Drawdown Date of such Loan and ending on the last day of one of the periods set forth below, as selected by the Borrower in a request for a Loan (i) for any Base Rate Loan, the last day of the calendar month, and (ii) for any Eurodollar Rate Loan, 1, 2 or 3 months; and (b) thereafter, each period commencing on the last day of the next preceding Interest Period applicable to such Loan and ending on the last day of one of the periods set forth above as selected by the Borrower in a request to convert a Loan; provided that all of the foregoing provisions relating to Interest Periods are subject to the following: (i) if any Interest Period with respect to a Eurodollar Rate Loan would otherwise end on a day that is not a Eurodollar Business Day, that Interest Period shall be extended to the next succeeding Eurodollar Business Day unless the result of such extension would be to carry such Interest Period into another calendar month, in which event such Interest Period shall end on the immediately preceding Eurodollar Business Day; (ii) if any Interest Period with respect to a Base Rate Loan would end on a day that is not a Business Day, that Interest Period shall end on the next succeeding Business Day; (iii) if the Borrower shall fail to give notice as provided in ss.2(d), the Borrower shall be deemed to have requested a conversion of the affected interest rate from one determined by reference to the Eurodollar Rate to one determined by reference to the Base Rate on the last day of the then current Interest Period with respect thereto; (iv) any Interest Period relating to all or any portion of the Loan bearing interest at a rate determined by reference to the Eurodollar Rate that begins on the last Eurodollar Business Day of a calendar month (or on a day for which there is no numerically corresponding day in the calendar month at the end of such Interest Period) shall end on the last Eurodollar Business Day of a calendar month; and -23- (v) any Interest Period that would otherwise extend beyond the Revolving Credit Maturity Date (if a Revolving Credit Loan) or the Term Loan Maturity Date (if the Term Loan) shall end on the Revolving Credit Maturity Date or (as the case may be) the Term Loan Maturity Date. Leverage Ratio: Seess.10(c)(v) hereof. Liens: Any encumbrance, mortgage, pledge, hypothecation, charge, restriction or other security interest of any kind securing any obligation of any Person. Loans: Collectively, the Revolving Credit Loans and the Term Loan. Loan Documents: This Agreement, the Notes, the Security Documents and any other documents, instruments or agreements executed and/or delivered in connection with this Agreement, in each case as from time to time amended, reaffirmed or supplemented. Lockbox Agreement: That certain Lockbox Agreement dated as of November 9, 1995 executed and delivered by the Borrower to the Bank, together with any and all UCC-1 financing statements executed in connection therewith, all as amended from time to time. Materially Adverse Effect: Any materially adverse effect on the financial condition or business operations of the Borrower and any of its Subsidiaries taken as a whole or material impairment of the ability of the Borrower to perform its obligations hereunder or under any of the other Loan Documents. Notes: Collectively, the Revolving Credit Note and the Term Note. Obligations: All indebtedness, obligations and liabilities of the Borrower to the Bank, existing on the date of this Agreement or arising thereafter, direct or indirect, joint or several, absolute or contingent, matured or unmatured, liquidated or unliquidated, secured or unsecured, arising by contract, operation of law or otherwise, arising or incurred under this Agreement or any other Loan Document or in respect of any of the Loans, the Notes or any other instruments at any time evidencing any thereof. Patent Security Agreement: The Patent Collateral Assignment and Security Agreement dated April 7, 1993 between the Bank and the Borrower, as amended from time to time. Permitted Acquisition: Shall mean any acquisition of all or substantially all the assets of, or shares or other equity interests in, Photomatrix Imaging Corporation, a Nevada corporation, and/or Agissar Corporation, a Connecticut corporation, if immediately after giving effect thereto: (a) no Default or Event of Default shall have occurred and be continuing or would result therefrom, (b) all transactions related thereto shall be consummated in accordance in all material respects with applicable laws, (c) the Bank shall have received evidence that the Bank has a fully perfected first priority security interest in all of the assets, shares or other equity interests acquired (except for liens permitted under ss.10(b)(ii)), (d) any such acquisition shall have been fully consummated on or before December 31, 1999, (e) solely with respect to the acquisition of Agissar Corporation, the total -24- purchase price (including, without limitation, any Indebtedness assumed in connection therewith) shall not exceed $2,200,000, and (f)(x) the Borrower and its Subsidiaries shall be in compliance, on a pro forma basis after giving effect to such acquisition, with the covenants contained in ss.10 recomputed as at the last day of each relevant period for testing such compliance, and the Borrower shall have delivered to the Bank an officer's certificate to such effect, together with all relevant financial information for such subsidiary or assets, and (y) any acquired or newly formed subsidiary shall not be liable for any Indebtedness (except for Indebtedness permitted by ss.10(b)(i) hereof). Person: Any individual, corporation, partnership, trust, limited liability company, unincorporated association, business, or other legal entity, any government or any governmental agency or political subdivision thereof. Requirement of Law: With respect to any Person, any law, treaty, rule, regulation or determination of an arbitrator, court, or other governmental authority, in each case applicable to or binding upon such Person or affecting any of its property. Revenue Amount: With respect to any fiscal quarter of the Borrower ending on or after March 31, 2000, an amount equal to the consolidated revenue of the Borrower and its Subsidiaries for the immediately preceding fiscal year, divided by four (4), determined in accordance with GAAP. Revolving Credit Commitment: The obligation of the Bank to make Revolving Credit Loans to the Borrower up to an aggregate outstanding principal amount not to exceed $10,000,000, as such amount may be reduced from time to time or terminated hereunder. Revolving Credit Eurodollar Rate Applicable Margin: With respect to any Revolving Credit Loan bearing interest by reference to the Eurodollar Rate and any fiscal quarter of the Borrower, the Revolving Credit Eurodollar Rate Applicable Margin will be calculated by the Bank after review of the Leverage Ratio of the Borrower and its Subsidiaries for the immediately preceding two fiscal quarters of the Borrower as at the last day of the immediately preceding fiscal quarter, all as follows: - -------------------------------------------------------------------------------- Revolving Credit Eurodollar Rate Leverage Ratio Applicable Margin - -------------------------------------------------------------------------------- Greater than or equal to 2.75 to 1.0 2.25% - -------------------------------------------------------------------------------- Less than 2.75 to 1.0 but greater than or equal to 2.5 to 1 2.00% - -------------------------------------------------------------------------------- Less than 2.5 to 1.0 1.75% - -------------------------------------------------------------------------------- -25- Notwithstanding the foregoing, for Revolving Credit Loans outstanding and bearing interest by reference to the Eurodollar Rate during the period beginning on the Effective Date through the Bank's receipt of the Financials for the fiscal quarter ending June 30, 1999, the Revolving Credit Eurodollar Rate Applicable Margin shall be 2.25%. The Bank shall calculate the Revolving Credit Eurodollar Rate Applicable Margin for each fiscal quarter on the sixtieth (60th) day following the last day of the immediately preceding fiscal quarter by reference to the Leverage Ratio for the immediately preceding two fiscal quarters as at the end of such immediately preceding fiscal quarter as set forth in the financial statements delivered to the Bank by the Borrower. Any downward adjustment in the Revolving Credit Eurodollar Rate Applicable Margin shall occur only if the applicable Leverage Ratio of the Borrower and its Subsidiaries has been achieved for each of such two consecutive fiscal quarters of the Borrower. Revolving Credit Loans: Any loan made or to be made to the Borrower pursuant toss.2 hereof. Revolving Credit Maturity Date: May 1, 2002. Revolving Credit Note: Seess.2(a). Scan-Optics Canada: Scan-Optics (Canada), Ltd., a limited liability company organized under the laws of Canada and a wholly-owned Subsidiary of the Borrower with its principal place of business at 7100 Woodbine Avenue, Suite 303, Markham, Ontario L3R 5J2 Canada. Scan-Optics England: Scan-Optics Limited, a limited liability company organized under the laws of the United Kingdom and a wholly-owned Subsidiary of the Borrower with its principal place of business at Dolphin Estate, Windmill Road, Unit C2, Sunbury-on-Thames, Middlesex TW16 7HE, United Kingdom. Scan-Optics Germany: Scan-Optics GmbH, a corporation organized under the laws of Germany and a wholly-owned Subsidiary of the Borrower with its principal place of business at Gervinusstrassee 17, 60322 Frankfurt, Germany Scan-Optics International: Scan-Optics International Ltd., a limited liability company organized under the laws of Barbados and a wholly-owned Subsidiary of the Borrower with its principal place of business at c/o Ernst & Young Services Ltd, P.O. Box 261 Bay Street, Bridgetown, Barbados, West Indies. Security Agreements: Collectively, the Security Agreements dated April 7, 1993 between the Bank and each of the Borrower and Scan-Optics Canada, each dated as of April 7, 1993 and each as amended and reaffirmed from time to time. Security Documents: Collectively, the Guaranties, the Stock Pledge Agreement, the Patent Security Agreement, the Trademark Security Agreement, the Lockbox Agreement, and the Security Agreements. -26- Stock Pledge Agreement: The Stock Pledge Agreement between the Bank and the Borrower dated as of April 7, 1993, as amended from time to time. Subsidiary: Any Person with respect to which the Borrower at any time owns or controls, directly or indirectly, more than fifty percent (50%) of the outstanding shares of stock or other equity securities or interests having voting power, regardless of whether such right to vote depends upon the occurrence of a contingency. Term Loan: The term loan made to the Borrower on the Effective Date pursuant toss.3 hereof in the principal amount of $10,000,000. Term Loan Eurodollar Rate Applicable Margin: With respect to all or any portion of the Term Loan bearing interest by reference to the Eurodollar Rate and any fiscal quarter of the Borrower, the Term Loan Eurodollar Rate Applicable Margin will be calculated by the Bank after review of the Leverage Ratio of the Borrower and its Subsidiaries for the immediately preceding two fiscal quarters of the Borrower as at the last day of the immediately preceding fiscal quarter, all as follows: - -------------------------------------------------------------------------------- Term Loan Eurodollar Leverage Ratio Rate Applicable Margin - -------------------------------------------------------------------------------- Greater than or equal to 2.75 to 1.0 2.50% - -------------------------------------------------------------------------------- Less than 2.75 to 1.0 but greater than or equal to 2.5 to 1 2.25% - -------------------------------------------------------------------------------- Less than 2.5 to 1.0 2.00% - -------------------------------------------------------------------------------- Notwithstanding the foregoing, for all or any portion of the Term Loan outstanding and bearing interest by reference to the Eurodollar Rate during the period beginning on the Effective Date through the Bank's receipt of the Financials for the fiscal quarter ending June 30, 1999, the Term Loan Eurodollar Rate Applicable Margin shall be 2.50%. The Bank shall calculate the Term Loan Eurodollar Rate Applicable Margin for each fiscal quarter on the sixtieth (60th) day following the last day of the immediately preceding fiscal quarter by reference to the Leverage Ratio for the immediately preceding two fiscal quarters as at the end of such immediately preceding fiscal quarter as set forth in the financial statements delivered to the Bank by the Borrower. Any downward adjustment in the Term Loan Eurodollar Rate Applicable Margin shall occur only if the applicable Leverage Ratio of the Borrower and its Subsidiaries has been achieved for each of such two consecutive fiscal quarters of the Borrower. Term Loan Maturity Date: May 1, 2004. -27- Term Note: Seess.3(a). Trademark Security Agreement: The Trademark Collateral Assignment and Security Agreement dated April 7, 1993 between the Bank and the Borrower, as amended from time to time. Type: As to any Revolving Credit Loan or all or any portion of the Term Loan, its nature as a Base Rate Loan or Eurodollar Rate Loan. ss.2. Revolving Credit Facility. (a) Upon the terms and subject to the conditions of this Agreement, the Bank agrees to lend to the Borrower such sums that the Borrower may request, from the date hereof until but not including the Revolving Credit Maturity Date; provided that the sum of the outstanding principal amount of all Revolving Credit Loans (after giving effect to all amounts requested) shall not exceed the Revolving Credit Commitment. Revolving Credit Loans shall be in the minimum aggregate amount of $25,000 or an integral multiple thereof. The Borrower shall notify the Bank in writing or telephonically (i) not later than 2:00 p.m. Hartford time on the proposed Drawdown Date of any Base Rate Loan and (ii) no less than three (3) Eurodollar Business Days prior to the proposed Drawdown Date of any Eurodollar Rate Loan. Each such notice shall specify (i) the principal amount of the Revolving Credit Loan requested, (ii) the proposed Drawdown Date of such Revolving Credit Loan, (iii) the Interest Period for such Revolving Credit Loan and (iv) the Type of such Revolving Credit Loan. Each request for a Revolving Credit Loan bearing interest by reference to the Eurodollar Rate shall be irrevocable and binding on the Borrower and shall obligate the Borrower to accept the Revolving Credit Loan requested from the Bank on the proposed Drawdown Date. Subject to the foregoing, so long as the Revolving Credit Commitment is then in effect and the conditions set forth in ss.9 hereof have been met, the Bank shall advance the amount requested to the Borrower's bank account at the Bank in immediately available funds not later than the close of business on such Drawdown Date. The obligation of the Borrower to repay to the Bank the principal of the Revolving Credit Loans and interest accrued thereon shall be evidenced by a fourth amended and restated promissory note in the aggregate principal amount of $10,000,000 executed and delivered by the Borrower and payable to the order of the Bank, in form and substance satisfactory to the Bank (the "Revolving Credit Note"). (b) The Borrower hereby agrees to pay the Bank on the Revolving Credit Maturity Date the entire unpaid principal of and interest on all Revolving Credit Loans. The Borrower may elect to prepay the outstanding principal of all or any part of any Revolving Credit Loan, without premium or penalty, provided that any full or partial prepayment of the outstanding amount of any Eurodollar Rate Loans pursuant to this ss.2 may be made only on the last day of the Interest Period relating thereto. The Borrower shall give the Bank, no later than 10:00 a.m., Hartford time, at least one (1) Business Day's prior written notice of any proposed prepayment pursuant to this ss.2 of Base Rate Loans, and two (2) Eurodollar Business Days' notice of any proposed prepayment -28- pursuant to this ss.2 of Eurodollar Rate Loans, in each case specifying the proposed date of prepayment of Revolving Credit Loans and the principal amount to be prepaid. Each such partial prepayment of the Revolving Credit Loans shall be in an integral multiple of $25,000, shall be accompanied by the payment of accrued interest on the principal prepaid to the date of prepayment and shall be applied, in the absence of instruction by the Borrower, first to the principal of Base Rate Loans and then to the principal of Eurodollar Rate Loans. (c) If at any time the outstanding principal amount of the Revolving Credit Loans exceeds the Revolving Credit Commitment, the Borrower shall pay immediately the amount of such excess to the Bank for application to the Revolving Credit Loans. The Borrower may elect to reduce or terminate the Revolving Credit Commitment by a minimum principal amount of $50,000 or an integral multiple thereof, upon written notice to the Bank given by 2:00 p.m. Hartford time on the proposed date of such reduction or termination. The Borrower shall not be entitled to reinstate the Revolving Credit Commitment following such reduction or termination (d) The Borrower may elect from time to time to convert any outstanding Revolving Credit Loan to a Revolving Credit Loan of another Type, provided that (i) with respect to any such conversion of a Revolving Credit Loan to a Base Rate Loan, the Borrower shall give the Bank at least one (1) Business Day's prior written notice of such election; (ii) with respect to any such conversion of a Base Rate Loan to a Eurodollar Rate Loan, the Borrower shall give the Bank at least three (3) Eurodollar Business Days' prior written notice of such election; (iii) with respect to any such conversion of a Eurodollar Rate Loan into a Revolving Credit Loan of another Type, such conversion shall only be made on the last day of the Interest Period with respect thereto; and (iv) no Loan may be converted into a Eurodollar Rate Loan when any Default or Event of Default has occurred and is continuing. All or any part of outstanding Revolving Credit Loans of any Type may be converted into a Revolving Credit Loan of another Type as provided herein, provided that (i) any partial conversion shall be in an aggregate principal amount of (A) $100,000 or a whole multiple thereof with respect to a conversion of a Base Rate Loan to a Eurodollar Rate Loan and (B) $100,000 or whole multiple thereof with respect to a conversion of a Revolving Credit Loan to a Base Rate Loan and (ii) with respect to Eurodollar Rate Loans, there shall be no more than five (5) separate Interest Periods in effect at one time. Each request relating to the conversion of a Revolving Credit Loan to a Eurodollar Rate Loan shall be irrevocable by the Borrower. (e) Any Revolving Credit Loan of any Type may be continued as a Revolving Credit Loan of the same Type upon the expiration of an Interest Period with respect thereto by compliance by the Borrower with the notice provisions contained in ss.2(d); provided that no Eurodollar Rate Loan may be -29- continued as such when any Default or Event of Default has occurred and is continuing, but shall be automatically converted to a Base Rate Loan on the last day of the first Interest Period relating thereto ending during the continuance of any Default or Event of Default of which officers of the Bank active upon the Borrower's account have actual knowledge. (f) Any conversion to or from Eurodollar Rate Loans shall be in such amounts and be made pursuant to such elections so that, after giving effect thereto, the aggregate principal amount of all Eurodollar Rate Loans having the same Interest Period shall not be less than $100,000 or a whole multiple of $100,000 in excess thereof. ss.3. The Term Loan. (a) Subject to the terms and conditions set forth in this Agreement, the Bank agrees to make the Term Loan to the Borrower on the Effective Date. The Term Loan shall be in the original principal amount of $10,000,000. The Term Loan shall be evidenced by a promissory note of the Borrower in form and substance satisfactory to the Bank (the "Term Note"), dated the Effective Date and payable to the order of the Bank. (b) The Borrower shall pay the outstanding principal amount of the Term Loan in twenty (20) consecutive quarterly installments in the amounts and during the periods set forth in the table below, such installments to be due and payable on the last day of each calendar quarter ending during such periods, commencing on June 30, 1999, with a final payment on the Term Loan Maturity Date in an amount equal to the unpaid principal amount of the Term Loan, if any, on such date:
Quarterly Annual Period Payment Amount Payment Amount May 10, 1999 through March 31, 2000 $250,000 $1,000,000 April 1, 2000 through March 31, 2000 $500,000 $2,000,000 April 1, 2001 through March 31, 2002 $500,000 $2,000,000 April 1, 2002 through March 31, 2003 $500,000 $2,000,000 April 1, 2003 through March 31, 2004 $500,000 $2,000,000 Term Loan Maturity Date The outstanding principal amount of the Term Loan, together with all interest accrued thereon.
-30- (c) The Borrower shall have the right at any time to prepay the Term Note on or before the Term Loan Maturity Date, as a whole, or in part, upon not less than three (3) Business Days' prior written notice to the Bank, without premium or penalty, provided that (i) each partial prepayment shall be in the minimum principal amount of (A) $100,000 and (B) no portion of the Term Loan bearing interest at the Eurodollar Rate may be prepaid pursuant to this ss.3(c) except on the last day of the Interest Period relating thereto. Any prepayment of principal of the Term Loan shall include all interest accrued to the date of prepayment and shall be applied against the scheduled installments of principal due on the Term Loan in the inverse order of maturity. No amount repaid with respect to the Term Loan may be reborrowed. Any voluntary prepayment of principal of the Term Loan shall also include all interest accrued on such principal to the date of prepayment. ss.4. Interest. (a) So long as no Event of Default is continuing, the Borrower shall pay interest on the Revolving Credit Loans as follows: (i) Each Base Rate Loan shall bear interest for the period commencing with the Drawdown Date thereof and ending on the last day of each Interest Period with respect thereto at the rate of the Base Rate from time to time in effect. (ii) Each Eurodollar Rate Loan shall bear interest for the period commencing with the Drawdown Date thereof and ending on the last day of each Interest Period with respect thereto at the rate of the Eurodollar Rate determined for such Interest Period plus the Revolving Credit Eurodollar Rate Applicable Margin. (iii) The Borrower promises to pay interest on each Revolving Credit Loan in arrears on each Interest Payment Date with respect thereto. (b) So long as no Event of Default is continuing, the Borrower shall pay interest on the Term Loan as follows: (i) To the extent that all or any portion of the Term Loan bears interest during such Interest Period at the Base Rate, the Term Loan or such portion thereof shall bear interest during such Interest Period at the rate of the Base Rate from time to time in effect. (ii) To the extent that all or any portion of the Term Loan bears interest during such Interest Period at the Eurodollar Rate, the Term Loan or such portion shall bear interest during such Interest Period at the rate of the Eurodollar Rate determined for such Interest Period plus the Term Loan Eurodollar Rate Applicable Margin. (iii) The Borrower promises to pay interest on the Term Loan or any portion thereof outstanding during each Interest Period in arrears on each Interest Payment Date applicable to such Interest Period. -32- (iv) The Borrower shall notify the Bank, such notice to be irrevocable, at least two (2) Business Days prior to the Drawdown Date of the Term Loan if all or any portion of the Term Loan is to bear interest at the Eurodollar Rate. After the Term Loan has been made, the provisions of ss.2(d) shall apply mutatis mutandis with respect to all or any portion of the Term Loan so that the Borrower may have the same interest rate options with respect to all or any portion of the Term Loan as it would be entitled to with respect to the Revolving Credit Loans. (v) Any portion of the Term Loan bearing interest at the Eurodollar Rate relating to any Interest Period shall be in the amount of $100,000 or an integral multiple thereof. No Interest Period relating to the Term Loan or any portion thereof bearing interest at the Eurodollar Rate shall extend beyond the date on which a regularly scheduled installment payment of the principal of the Term Loan is to be made unless a portion of the Term Loan at least equal to such installment payment has an Interest Period ending on such date or is then bearing interest at the Base Rate. (c) While an Event of Default is continuing, amounts payable with respect to any Loans shall bear interest (compounded monthly and payable on demand in respect of overdue amounts) at a rate per annum which is equal to the sum of (i) the Base Rate and (ii) five percent (5.0%) until such amount is paid in full or (as the case may be) such Event of Default has been cured or waived in writing by the Bank (after as well as before judgment). ss.5. Additional Costs, Etc. If any present or future applicable law, which expression, as used herein, includes statutes, rules and regulations thereunder and interpretations thereof by any competent court or by any governmental or other regulatory body or official charged with the administration or the interpretation thereof and requests, directives, instructions and notices at any time or from time to time hereafter made upon or otherwise issued to the Bank by any central bank or other fiscal, monetary or other authority (whether or not having the force of law), shall: (a) subject the Bank to any tax, levy, impost, duty, charge, fee, deduction or withholding of any nature with respect to this Agreement, the other Loan Documents, the Revolving Credit Commitment or the Loans (other than taxes based upon or measured by the income or profits of the Bank), or (b) materially change the basis of taxation (except for changes in taxes on income or profits) of payments to the Bank of the principal of or the interest on any Loans or any other amounts payable to any Bank or the Bank under this Agreement or any of the other Loan Documents, or (c) impose or increase or render applicable (other than to the extent specifically provided for elsewhere in this Agreement) any special deposit, reserve, assessment, liquidity, capital adequacy or other similar -33- requirements (whether or not having the force of law) against assets held by, or deposits in or for the account of, or loans by, or letters of credit issued by, or commitments of an office of the Bank, or (d) impose on the Bank any other conditions or requirements with respect to this Agreement, the other Loan Documents, the Loans, the Revolving Credit Commitment, or any class of loans or commitments of which any of the Loans or such Revolving Credit Commitment forms a part, and the result of any of the foregoing is (i) to increase the cost to the Bank of making, funding, issuing, renewing, extending or maintaining any of the Loans or such Revolving Credit Commitment, or (ii) to reduce the amount of principal, interest or other amount payable to the Bank hereunder on account of the Revolving Credit Commitment or any of the Loans, or (iii) to require the Bank to make any payment or to forego any interest or other sum payable hereunder, the amount of which payment or foregone interest or other sum is calculated by reference to the gross amount of any sum receivable or deemed received by the Bank from the Borrower hereunder, then, and in each such case, the Borrower will, upon demand made by the Bank at any time and from time to time and as often as the occasion therefor may arise, pay to the Bank such additional amounts as will be sufficient to compensate the Bank for such additional cost, reduction, payment or foregone interest or other sum. ss.6. Changes in Circumstances. If any change in banking law or regulation or the administration thereof (whether or not having the force of law) affects the amount of capital required or expected to be maintained by the Bank or any entity controlling it, and such amount is increased by reason of the Revolving Credit Commitment or the Loans, the Bank may notify the Borrower thereof. The Borrower and the Bank shall negotiate an adjustment payable to the Bank to compensate for such increase. If no agreement is reached within thirty (30) days, the Bank may increase the fees payable hereunder by the amount determined by the Bank to be necessary to provide such compensation. ss.7. Fees and Payments. (a) Contemporaneously with execution and delivery of this Agreement, the Borrower shall pay to the Bank a non-refundable closing fee in the amount of $15,000. (b) The Borrower shall also pay to the Bank a commitment fee calculated at the rate of one-quarter of one percent (0.25%) per annum of the average daily amount during each calendar quarter or portion thereof from the Effective Date to the Revolving Credit Maturity Date by which the Revolving Credit Commitment exceeds the aggregate amount outstanding under the Revolving Credit Loans during such calendar quarter. The commitment fee shall be payable quarterly in arrears on the first day of each calendar quarter for the immediately preceding calendar quarter commencing on the first such date following the Effective Date, with a final payment on the Revolving Credit Maturity Date or any earlier date on which the Revolving Credit Commitment shall terminate. -34- (c) All payments to be made by the Borrower hereunder or under any of the other Loan Documents shall be made in U.S. dollars in immediately available funds at the Bank's office at 100 Pearl Street, Hartford, Connecticut 06103, without set-off or counterclaim and without any withholding or deduction whatsoever. The Bank shall be entitled (but shall not be obligated) to charge any account of the Borrower with the Bank for any sum due and payable by the Borrower to the Bank hereunder or under any of the other Loan Documents. If any payment hereunder is required to be made on a day which is not a Business Day, it shall be paid on the immediately preceding Business Day. All computations of interest or of the closing or commitment fees payable hereunder shall be made by the Bank on the basis of actual days elapsed and on a 360-day year. (d) In the event, prior to the commencement of any Interest Period relating to any Eurodollar Rate Loan, the Bank shall determine that adequate and reasonable methods do not exist for ascertaining the Eurodollar Rate that would otherwise determine the rate of interest to be applicable to any Eurodollar Rate Loan during any Interest Period, the Bank shall forthwith give notice of such determination (which shall be conclusive and binding on the Borrower) to the Borrower. In such event (i) any request for a Loan or request to convert a Loan with respect to Eurodollar Rate Loans shall be automatically withdrawn and shall be deemed a request for Base Rate Loans, (ii) each Eurodollar Rate Loan will automatically, on the last day of the then current Interest Period relating thereto, become a Base Rate Loan, and (iii) the obligations of the Bank to make Eurodollar Rate Loans shall be suspended until the Bank determines that the circumstances giving rise to such suspension no longer exist, whereupon the Bank shall so notify the Borrower. (e) Notwithstanding any other provisions herein, if any present or future law, regulation, treaty or directive or in the interpretation or application thereof shall make it unlawful for the Bank to make or maintain Eurodollar Rate Loans, the Bank shall forthwith give notice of such circumstances to the Borrower and thereupon (i) the commitment of the Bank to make Eurodollar Rate Loans or convert Loans of another Type to Eurodollar Rate Loans shall forthwith be suspended and (ii) the Bank's Revolving Credit Loans then outstanding as Eurodollar Rate Loans, if any, shall be converted automatically to Base Rate Loans on the last day of each Interest Period -35- applicable to such Eurodollar Rate Loans or within such earlier period as may be required by law. The Borrower hereby agrees promptly to pay the Bank, upon demand by Bank, any additional amounts necessary to compensate the Bank for any costs incurred by the Bank in making any conversion in accordance with this ss.7(e), including any interest or fees payable by the Bank to lenders of funds obtained by it in order to make or maintain its Eurodollar Rate Loans hereunder. (f) The Borrower agrees to indemnify the Bank and to hold it harmless from and against any loss, cost or expense (including loss of anticipated profits) that Bank may sustain or incur as a consequence of (i) default by the Borrower in payment of the principal amount of or any interest on any Eurodollar Rate Loans as and when due and payable, including any such loss or expense arising from interest or fees payable by the Bank to lenders of funds obtained by it in order to maintain its Eurodollar Rate Loans, (ii) default by the Borrower in making a borrowing or conversion after the Borrower has given (or is deemed to have given) a request for a Loan, notice (in the case of all or any portion of the Term Loan pursuant to ss.4(b)(iv) or a request to convert a Loan relating thereto in accordance with ss.2(d) or ss.4(b)(iv), or (iii) the making of any payment of a Eurodollar Rate Loan or the making of any conversion of any such Loan to a Base Rate Loan on a day that is not the last day of the applicable Interest Period with respect thereto, including interest or fees payable by such Bank to lenders of funds obtained by it in order to maintain any such Loans. ss.8. Representations and Warranties. The Borrower represents and warrants to the Bank on the date hereof, on the date of any request for any Loan, and on each Drawdown Date that: (a) the Borrower and each of its Subsidiaries is duly organized, validly existing, and in good standing under the laws of its jurisdiction of incorporation and is duly qualified and in good standing in every other jurisdiction where it is doing business except where the failure to so qualify does not have a Materially Adverse Effect on the Borrower or any of its Subsidiaries, and the execution, delivery and performance by the Borrower and its Subsidiaries of the Loan Documents (i) are within their respective corporate authority, (ii) have been duly authorized, (iii) do not conflict with or contravene their respective Charter Documents; (b) upon execution and delivery thereof, each Loan Document shall constitute the legal, valid and binding obligation of the Borrower and each Subsidiary party thereto, enforceable in accordance with its terms; (c) the Borrower and each Subsidiary have good and marketable title to all their respective material properties, subject only to Liens permitted hereunder, and possess all assets, including intellectual properties, franchises and Consents, adequate for the conduct of their respective businesses as now conducted, without known conflict with any rights of others; (d) the Borrower has provided to the Bank its audited Financials as at December 31, 1998 and for the period then ended and its unaudited management prepared Financials as at March 31, 1999 for the period of three (3) months then ended, and such Financials are complete and correct and fairly present the position of the Borrower and its Subsidiaries as at such dates and for such periods in accordance with GAAP consistently applied; (e) except as previously disclosed by the Borrower to the Bank in writing since December 31, 1998, there has been no materially adverse change of any kind in the Borrower or any of its Subsidiaries which would have a Materially Adverse -36- Effect; (f) there are no legal or other proceedings or investigations pending or threatened against the Borrower or any of its Subsidiaries before any court, tribunal or regulatory authority which would, if adversely determined, alone or together, have a Materially Adverse Effect; (g) the execution, delivery, performance of their respective obligations, and exercise of their respective rights under the Loan Documents by the Borrower and each Subsidiary party thereto, including borrowing under this Agreement (i) do not require any Consents; and (ii) are not and will not be in conflict with or prohibited or prevented by (A) any Requirement of Law, or (B) any Charter Document, corporate minute or resolution, instrument, agreement or provision thereof, in each case binding on any of them or affecting any of their property; (h) neither the Borrower nor any Subsidiary are in violation of (i) any Charter Document, corporate minute or resolution, (ii) any instrument or agreement, in each case binding on it or affecting its property, or (iii) any Requirement of Law, in a manner which could have a Materially Adverse Effect, including, without limitation, all applicable federal and state tax laws, ERISA and Environmental Laws; (i) upon execution and delivery of the Security Documents and the filing of documents thereby required, the Bank shall have a first-priority perfected security interest in the properties and assets of the Borrower and its Subsidiaries stated to constitute collateral thereunder, subject only to Liens permitted hereunder and entitled to priority under applicable law, with no financing statements, chattel mortgages, real estate mortgages or similar filings on record anywhere which conflict with such first-priority interest; (j) the Borrower has no Subsidiaries except for Scan-Optics International, Scan-Optics England, Scan-Optics Canada and Scan-Optics Germany and is not a party to any partnership or joint venture; (k) each fiscal year of the Borrower begins on January 1 of each calendar year and ends on December 31 of each calendar year; (l) the Borrower and its Subsidiaries have reviewed the areas within their businesses and operations which could be adversely affected by, and have developed or are developing a program to address on a timely basis, the "Year 2000 Problem" (i.e. the risk that computer applications used by the Borrower or any of its Subsidiaries may be unable to recognize and perform properly date-sensitive functions involving certain dates prior to and any date after December 31, 1999) and that based upon such review, the Borrower reasonably believes that the "Year 2000 Problem" will not have any materially adverse effect on the business or financial condition of the Borrower or any of its Subsidiaries; and (m) any information delivered by or on behalf of the Borrower to the Bank in connection with the Permitted Acquisitions or this Agreement is accurate and complete in all material respects and is not false or misleading in any material respect as at the time made or deemed to have been made, it being understood that no representation is made with respect to projections of future performance of the Borrower, including without limitation, as a result of any Permitted Acquisition, other than that such projections were prepared in good faith and on assumptions the Borrower believes to be reasonable. ss.9. Conditions Precedent. In addition to the making of the foregoing representations and warranties and the delivery of the Loan Documents and such other documents and the taking of such actions as the Bank may require at or prior to the time of executing this Agreement, the obligation of the Bank to make any Loan to the Borrower hereunder is subject to the satisfaction of the -37- following further conditions precedent: (a) each of the representations and warranties of the Borrower to the Bank shall be true and correct in all material respects as of the time made or claimed to have been made; (b) no Default or Event of Default shall be continuing and (c) all proceedings in connection with the transactions contemplated hereby shall be in form and substance satisfactory to the Bank, and the Bank shall have received all information and documents as it may have reasonably requested. ss.10. Covenants. (a) The Borrower agrees that as long as any Loan or Note is outstanding and until the termination of the Revolving Credit Commitment and the payment and satisfaction in full of the Loans and all of the other Obligations, the Borrower will, and where applicable will cause each of its Subsidiaries to comply with its obligations as set forth throughout this Agreement and to: (i) furnish the Bank: (A) as soon as available but in any event within ninety (90) days after the close of each fiscal year, its audited consolidated Financials for such fiscal year, certified by the Borrower's accountants; (B) as soon as available but in any event within forty-five (45) days after the end of each fiscal quarter, its unaudited consolidated Financials for such quarter, certified by its chief financial officer; (C) as soon as available but in any event within fifteen (15) Business Days after the end of each fiscal month its unaudited consolidated Financials for such month, certified by its chief financial officer; and (D) together with the monthly, quarterly and annual audited consolidated Financials, a certificate of the Borrower setting forth computations demonstrating compliance with the Borrower's financial covenants set forth herein, and certifying that no Default or Event of Default has occurred, or if a Default or an Event of Default has occurred, the actions taken by the Borrower with respect thereto; (ii) keep true and accurate books of account in accordance with GAAP and to permit the Bank or its designated representatives, at the expense of the Borrower, to inspect the Borrower's premises and to examine and be advised as to such or other business records upon the request of the Bank, provided, that the Bank shall, prior to the occurrence of an Event of Default, inspect the Borrower's premises not more than twice each calendar year; (iii) maintain its corporate existence, business and assets, to keep its business and assets adequately insured, to maintain its chief executive office in the United States, to continue to engage in the same lines of business, and to comply in all material respects with all Requirements of Law, including ERISA and Environmental Laws; -38- (iv) notify the Bank promptly in writing (A) of the occurrence of any Default or Event of Default, (B) of any noncompliance with ERISA or any Environmental Law or proceeding in respect thereof which could have a Materially Adverse Effect, (C) of any change of address, (D) of any threatened or pending litigation or similar proceeding affecting the Borrower or such Subsidiary involving claims in excess of $100,000 in the aggregate or any material change in any such litigation or proceeding previously reported and (E) of claims in excess of $100,000 in the aggregate against any assets or properties of the Borrower or such Subsidiary encumbered in favor of the Bank; (v) use the proceeds of the Loans for refinancing existing indebtedness of the Borrower to the Bank, to make the Permitted Acquisitions and for general corporate and/or working capital purposes and not for the purchasing or carrying of "margin security" or "margin stock" within the meaning of Regulations U and X of the Board of Governors of the Federal Reserve System, 12 C.F.R. Parts 221 and 224; (vi) within 90 days of the Effective Date, effect and maintain interest rate protection arrangements with respect to the Term Loan on terms and conditions satisfactory to the Bank; (vii) on or before March 1, 2000, provide the Bank with a fully executed lessor's agreement with respect to its business operations located in Birmingham, Alabama, such lessor's agreement to be in form and substance satisfactory to the Bank; and (viii) cooperate with the Bank, take such action, execute such documents, and provide such information as the Bank may from time to time reasonably request in order further to effect the transactions contemplated by and the purposes of the Loan Documents. (b) The Borrower agrees that as long as any Loan or Note is outstanding and until the termination of the Revolving Credit Commitment and the payment and satisfaction in full of the Loans and all of the Obligations, the Borrower will not: (i) create, incur or assume any Indebtedness other than (A) Indebtedness to the Bank arising under the Loan Documents, (B) Indebtedness in respect of the acquisition of property which does not exceed $500,000 in aggregate amount, (C) current liabilities of the Borrower not incurred through the borrowing of money or the obtaining of credit except credit on an open account customarily extended, (D) Indebtedness in respect of taxes or other governmental charges contested in good faith by appropriate proceedings and for which the Borrower has made appropriate reserves; and (E) Indebtedness not included in clauses A through D (inclusive) above and listed on Schedule 10(b)(i) hereto; -39- (ii) create or incur, or cause any of its Subsidiaries to create or incur, any Liens on any of the property or assets of the Borrower or any of its Subsidiaries except (A) Liens securing the Obligations; (B) Liens securing taxes or other governmental charges not yet due; (C) deposits or pledges made in connection with social security obligations; (D) Liens of carriers, warehousemen, mechanics and materialmen, less than 120 days old as to obligations not yet due; (E) easements, rights-of-way, zoning restrictions and similar minor Liens which individually and in the aggregate do not have a Materially Adverse Effect; (F) purchase money security interests in or purchase money mortgages on real or personal property securing purchase money Indebtedness permitted by ss.10(b)(i)(B), covering only the property so acquired; and (G) other Liens existing on the date hereof and listed on Schedule 10(b)(ii) hereto; (iii) agree with any other Person to prohibit the creation of any Liens on any of the property or assets of the Borrower or any Subsidiary; (iv) make any investments other than investments in (A) marketable obligations of the United States maturing within one (1) year, (B) certificates of deposit, bankers' acceptances and time and demand deposits of United States banks having total assets in excess of $1,000,000,000 and otherwise acceptable to the Bank in its discretion, (C) Investments constituting the Permitted Acquisitions or (D) such other investments as the Bank may from time to time approve in writing; (v) make any distributions on or in respect of its capital of any nature whatsoever without the prior written consent of the Bank; (vi) (A) become party to a merger or consolidation, (B) effect any disposition of assets other than in the ordinary course, (C) purchase, sell, lease or otherwise dispose of assets other than in the ordinary course or other than the Permitted Acquisitions, (D) make any change in Borrower's corporate structure or identity which has a Materially Adverse Effect or (E) enter into any agreement to do any of the foregoing; provided, that, any Subsidiary of the Borrower may merge with and into the Borrower or any Subsidiary of the Borrower upon not less than thirty (30) days prior written notice to the Bank of such merger; (vii) change its or any of its Subsidiaries fiscal year without the prior written consent of the Bank; or (viii) without the prior written consent of the Bank, transfer, purchase or redeem, or permit any subsidiary to transfer or purchase, any shares of the Borrower's capital stock unless such transfer, purchase or redemption is effected solely from the proceeds of and within a reasonable time after the issuance to third parties by -40- the Borrower or its Subsidiary of capital stock which is in addition to the capital stock of the Borrower or its Subsidiary, as the case may be, outstanding on the date of this Agreement. (c) The Borrower agrees that as long as any Loan or Note is outstanding and until the termination of the Revolving Credit Commitment and the payment and satisfaction in full of all of the Obligations, the Borrower will not: (i) permit the ratio of Consolidated Total Liabilities to Consolidated Tangible Net Worth for any fiscal quarter of the Borrower ending during any period described in the table set forth below to exceed the ratio set forth opposite such period in such table: -------------------------------------------------------------------- Period Ratio -------------------------------------------------------------------- Effective Date - December 30, 2000 1.75 to 1.0 -------------------------------------------------------------------- December 31, 2000 and thereafter 1.50 to 1.0 -------------------------------------------------------------------- (ii) permit the ratio of Consolidated Current Assets to Consolidated Current Liabilities for any fiscal quarter of the Borrower ending on or after March 31, 1999 to be less than 1.5 to 1.0; (iii) permit Consolidated Net Income for any two consecutive fiscal quarters to be less than $1.00; (iv) permit the ratio of Consolidated Operating Cash Flow to Consolidated Financial Obligations of the Borrower and its Subsidiaries to be less than 1.25 to 1.0 for any period of four consecutive fiscal quarters of the Borrower ending on or after March 31, 1999; (v) permit the ratio of Consolidated Total Funded Debt to Consolidated Earnings Before Interest and Taxes, Depreciation and Amortization (the "Leverage Ratio") for any period consisting of four (4) consecutive fiscal quarters of the Borrower ending during any period described in the table set forth below to exceed the ratio set forth opposite such period in such table: -41- ----------------------------------------------------------------------- Period Ratio ----------------------------------------------------------------------- Effective Date - March 31, 2000 3.0 to 1.0 ----------------------------------------------------------------------- April 1, 2000 and thereafter 2.5 to 1.0 ----------------------------------------------------------------------- (vi) permit Consolidated Net Deficit for any fiscal quarter of the Borrower ending on or after March 31, 1999 to be greater than ten percent (10%) of Consolidated Tangible Net Worth of the Borrower on the last day of the immediately preceding fiscal quarter; (vii) permit the ratio of Consolidated Earnings Before Interest and Taxes to Consolidated Total Interest Expense to be less than 3.0 to 1.0 for any period of four consecutive fiscal quarters of the Borrower ending on or after March 31, 1999; or (viii) permit the Borrower's backlog (as defined in the Borrower's most recent 10K filed with the Securities and Exchange Commission) to be less than (A) $13,500,000 for each of the fiscal quarters ending March 31, 1999, June 30, 1999, September 30, 1999 and December 31, 1999 and (B) the Revenue Amount for any fiscal quarter of the Borrower ending on or after March 31, 2000. ss.11. Events of Default; Acceleration. If any of the following events ("Events of Default") shall occur: (a) the Borrower shall fail to pay when due and payable any principal of or interest on the Loans or any other sum due under any of the Loan Documents when the same becomes due; (b) the Borrower shall fail to perform any term, covenant or agreement contained in ss.10; (c) the Borrower or any of its Subsidiaries shall fail to perform any other term, covenant or agreement contained in the Loan Documents within thirty (30) days after the Bank has given written notice of such failure to the Borrower; (d) any representation or warranty of the Borrower or any of its Subsidiaries in the Loan Documents or in any certificate or notice given in connection therewith shall have been false or misleading in any material respect at the time made or deemed to have been made; (e) the Borrower or any of its Subsidiaries shall be in default under any agreement or agreements evidencing Indebtedness owing to the Bank or any affiliates of the Bank or any other Indebtedness for borrowed money to any other third party, or shall fail to pay such Indebtedness when due, or within any applicable period of grace; (f) any of the Loan Documents shall cease to be in full force and effect; (g) the Borrower or any of its Subsidiaries (i) shall make an assignment for the benefit of creditors, (ii) shall be adjudicated bankrupt or insolvent, (iii) shall seek the appointment of, or be the subject of an order appointing, a trustee, liquidator or receiver as to all or part of its assets, (iv) shall commence, approve or consent to, any case or proceeding under any bankruptcy, reorganization or similar law and, in the case of an involuntary case or proceeding, such case or proceeding is not dismissed within forty-five (45) days following the commencement thereof, or (v) shall be the subject of an order for -42- relief in an involuntary case under federal bankruptcy law; (h) the Borrower or any of its Subsidiaries shall be unable to pay debts as they mature; or (i) there shall remain undischarged for more than thirty (30) days any final judgment or execution action against the Borrower or any of its Subsidiaries that, together with other outstanding claims and execution actions against the Borrower and its Subsidiaries, exceeds $250,000 in the aggregate; THEN, or at any time thereafter: (1) In the case of any Event of Default under clause (g) or (h), the Revolving Credit Commitment shall automatically terminate, and the entire unpaid principal amount of the Loans, all interest accrued and unpaid thereon, and all other amounts payable hereunder and under the other Loan Documents shall automatically become forthwith due and payable, without presentment, demand, protest or notice of any kind, all of which are hereby expressly waived by the Borrower; and (2) In the case of any Event of Default other than (g) and (h), the Bank may, by written notice to the Borrower, terminate the Revolving Credit Commitment and/or declare the unpaid principal amount of the Loans, all interest accrued and unpaid thereof, and all other amounts payable hereunder and under the other Loan Documents to be forthwith due and payable, without presentment, demand, protest or further notice of any kind, all of which are hereby expressly waived by the Borrower. No remedy herein conferred upon the Bank is intended to be exclusive of any other remedy and each and every remedy shall be cumulative and in addition to every other remedy hereunder, now or hereafter existing at law or in equity or otherwise. ss.12. Setoff. Regardless of the adequacy of any collateral for the Obligations, any deposits or other sums credited by or due from the Bank to the Borrower may be applied to or set off against any principal, interest and any other amounts due from the Borrower to the Bank at any time without notice to the Borrower, or compliance with any other procedure imposed by statute or otherwise, all of which are hereby expressly waived by the Borrower. ss.13. Miscellaneous. The Borrower agrees to indemnify and hold harmless the Bank against all claims and losses of every kind arising out of the Loan Documents, including without limitation against those in respect of the application of Environmental Laws to the Borrower and its Subsidiaries, provided, however, Borrower shall not be obligated to indemnify the Bank from and hold it harmless against such claims or losses arising out of the gross negligence or willful misconduct of the Bank. The Borrower shall pay to the Bank promptly on demand all reasonable costs and expenses (including any taxes and legal and other professional fees and fees of its commercial finance examiner) incurred by the Bank in connection with the preparation, negotiation, execution, -43- amendment, administration or enforcement of any of the Loan Documents. Any communication to be made hereunder shall (i) be made in writing, but unless otherwise stated, may be made by telex, facsimile transmission or letter, and (ii) be made or delivered to the address of the party receiving notice which is identified with its signature below (unless such party has by five (5) days' written notice specified another address), and shall be deemed made or delivered, when dispatched, left at that address, or five (5) days after being mailed, postage prepaid, to such address. This Agreement shall be binding upon and inure to the benefit of each party hereto and its successors and assigns, but the Borrower may not assign its rights or obligations hereunder. This Agreement may not be amended or waived except by a written instrument signed by the Borrower and the Bank, and any such amendment or waiver shall be effective only for the specific purpose given. No failure or delay by the Bank to exercise any right hereunder shall operate as a waiver thereof, nor shall any single or partial exercise of any right, power or privilege preclude any other right, power or privilege. The provisions of this Agreement are severable and if any one provision hereof shall be held invalid or unenforceable in whole or in part in any jurisdiction, such invalidity or unenforceability shall affect only such provision in such jurisdiction. This Agreement, together with all Exhibits and Schedules hereto, expresses the entire understanding of the parties with respect to the transactions contemplated hereby. This Agreement and any amendment hereby may be executed in several counterparts, each of which shall be an original, and all of which shall constitute one agreement. In proving this Agreement, it shall not be necessary to produce more than one such counterpart executed by the party to be charged. THIS AGREEMENT AND THE NOTES ARE CONTRACTS UNDER THE LAWS OF THE STATE OF CONNECTICUT AND SHALL BE CONSTRUED IN ACCORDANCE THEREWITH AND GOVERNED THEREBY. THE BORROWER AGREES THAT ANY SUIT FOR THE ENFORCEMENT OF ANY OF THE LOAN DOCUMENTS MAY BE BROUGHT IN THE COURTS OF THE STATE OF CONNECTICUT OR ANY FEDERAL COURT SITTING THEREIN. The Borrower, as an inducement to the Bank to enter into this Agreement, hereby waives its right to a jury trial with respect to any action arising in connection with any Loan Document. ss.14. Prejudgment Remedy Waiver. THE BORROWER ACKNOWLEDGES THAT THE FINANCING EVIDENCED HEREBY IS A COMMERCIAL TRANSACTION WITHIN THE MEANING OF CHAPTER 903a OF THE CONNECTICUT GENERAL STATUTES. THE BORROWER HEREBY WAIVES ITS RIGHT TO NOTICE AND PRIOR COURT HEARING OR COURT ORDER UNDER CONNECTICUT GENERAL STATUTES SECTIONS 52-278a ET. SEQ. AS AMENDED OR UNDER ANY OTHER STATE OR FEDERAL LAW WITH RESPECT TO ANY AND ALL PREJUDGMENT REMEDIES THE BANK MAY EMPLOY TO ENFORCE ITS RIGHTS AND REMEDIES HEREUNDER. MORE SPECIFICALLY, THE BORROWER ACKNOWLEDGES THAT THE BANK'S ATTORNEY MAY, PURSUANT TO CONN. GEN. STAT. -44- ss.52-278F, ISSUE A WRIT FOR A PREJUDGMENT REMEDY WITHOUT SECURING A COURT ORDER. THE BORROWER ACKNOWLEDGES AND RESERVES ITS RIGHT TO NOTICE AND A HEARING SUBSEQUENT TO THE ISSUANCE OF A WRIT FOR PREJUDGMENT REMEDY AS AFORESAID AND THE BANK ACKNOWLEDGES THE BORROWER'S RIGHT TO SAID HEARING SUBSEQUENT TO THE ISSUANCE OF SAID WRIT. THE BORROWER FURTHER WAIVES ITS RIGHTS TO REQUEST THAT BANK POST A BOND, WITH OR WITHOUT SURETY, TO PROTECT BORROWER AGAINST DAMAGES THAT MAY BE CAUSED BY ANY PREJUDGMENT REMEDY SOUGHT OR OBTAINED BY BANK. ss.15. Effective Date. This Agreement shall become effective between the parties hereto as of the Effective Date. Until the Effective Date, the terms of the Prior Loan Agreement shall remain in full force and effect. ss.16. Amendment and Restatement. This Agreement amends and restates in its entirety the Prior Loan Agreement. The execution and delivery of this Agreement shall not extinguish the indebtedness evidenced by the Prior Loan Agreement or any promissory notes executed in connection therewith nor will it impair the lien of any security interest or pledge securing the Obligations, and no part of such indebtedness shall be discharged or cancelled by the execution of this Agreement or the execution and delivery of any further instruments evidencing or securing the Obligations. IN WITNESS WHEREOF, the undersigned have caused this Agreement to be duly executed as of the date first above written. SCAN-OPTICS, INC. By: /s/Michael J. Villano ---------------------- Its: CFO 169 Progress Drive Manchester, CT 06040 Tel: (860) 645-7878 Fax: (860) 645-7995 BANKBOSTON, N.A. By: /s/ ---------------------- Its: Vice President 100 Pearl Street Hartford, Connecticut 06103 Tel: (860) 547- 6570 Fax: (860) 547-6575 -45- SCHEDULE 10(b)(i) Permitted Indebtedness Leases with BancBoston Leasing, Inc. of office furniture and fixtures. Leases with Longshore Systems, Inc. of laptop computers. Schedule 10(b)(ii) Existing Liens Leases with BancBoston Leasing, Inc. of office furniture and fixtures. Leases with Longshore Systems, Inc. of laptop computers. EX-23 5 exhibit23.txt 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, Form S-8 No. 2-65503 and Form S-8 No. 333-83598) of Scan-Optics, Inc. of our report dated February 22, 2002 with respect to the consolidated financial statements and schedule of Scan-Optics, Inc. and subsidiaries included in this Annual Report (Form 10-K) for the year ended December 31, 2001. /s/ Ernst & Young LLP Hartford, Connecticut March 27, 2002 -----END PRIVACY-ENHANCED MESSAGE-----