-----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, Vd/7AUjmejXKLBRXJQ21LeGIW/SM9VzQHKBpQbwS5D3m4Oyn2N0KCCJqBprm4UT6 13p3IzXsfqfQd259PJOIiQ== 0000950159-03-000284.txt : 20030331 0000950159-03-000284.hdr.sgml : 20030331 20030331151157 ACCESSION NUMBER: 0000950159-03-000284 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 6 CONFORMED PERIOD OF REPORT: 20021231 FILED AS OF DATE: 20030331 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-K SEC ACT: 1934 Act SEC FILE NUMBER: 000-05265 FILM NUMBER: 03629891 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-K 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, 2002 ----------------------------------------- ( )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 (I.R.S. Employer Identification Number) of 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 ---------------------- Securities registered pursuant to Section 12(g) of the Act: Common stock, $.02 par value ---------------------------- (Title of Class) Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. (X) YES ( ) NO Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X] Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 126-2) (_) YES (X) NO The aggregate market value of the voting and non-voting common equity held by non-affiliates computed by reference to the price at which common equity was last sold, or the average bid and asked price of such common equity, as of the last day of the registrant's most recently completed second fiscal quarter: $2,083,125 as of June 30, 2002. The number of shares of common stock, $.02 par value, outstanding as of March 24, 2003 was 7,439,732. 1 DOCUMENTS INCORPORATED BY REFERENCE - ----------------------------------- Portions of the definitive Proxy Statement, relating to the 2003 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 provides information capture hardware and software products combined with lifecycle support and maintenance services, which constitute the platform for its systems integration and professional services organization to create information management solutions in response to a customer's business needs. The Company is a leader in developing, applying and supporting technology to solve information capture and customer service problems for government agencies and commercial businesses. Historically the Company's research and development activity has focused on improving accuracy and performance of the image and "OCR" (optical character recognition) scanning platforms yielding the premier scanner in the industry. More recently this effort has grown to encompass the expansion and enhancement of the software suites that surround these versatile scanner platforms. Acquired and developed expertise in database, storage, network and Microsoft development environments have enhanced the Company's strength in developing and supporting complex system integration projects. Still focused on the information capture portion of system architecture, the Company has built a comprehensive development and support infrastructure. The range of these solutions has expanded to include data capture, data perfection and archival solutions, adding value to the information available for our customers to better serve their customers and manage their business. The Company's strategy is to provide information capture solutions to select vertical markets. With demonstrated success in, government, insurance, assessment, transportation, order fulfillment and financial markets, the Company has chosen to focus on and serve these industries. The Company has three distinct divisions: Solutions and Products, Access Services and Manufacturing Services. These divisions are established to focus the Company's resources and assets in a cost-effective manner on the clients that it serves. Although each division is autonomous in pursuit of new business and revenue sources, they possess tremendous synergy for the end-user community that is searching for a "single-source" supplier. The Company's Solutions and Products Division combines technology with its experience and expertise in the development of cost-effective, high quality solutions for applications in the government, insurance, assessment, transportation, order fulfillment and financial 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 product maintenance services nationwide, as well as in the UK and Canada. The Company has been selected by over 18 companies to provide maintenance services for their products at the customer site or through the Company's depot 3 maintenance facility. In support of its many third-party contracts, the Company has implemented a logistics and dispatch center that is being utilized in support of several high volume, low cost products. This business model demonstrates the flexibility of the Company to provide customized services to meet customer needs, versus having the customer adapt to Company's business model. Like the rest of the Company this division depends on its ISO9001 quality processes to assure high levels of customer satisfaction. The Manufacturing Services Division manufactures the Company's high performance proprietary scanning platforms. Due to its ability to deliver high quality products, this division is able to attract several contract manufacturing customers. Recently it supplemented its ISO9001 certification with initial FDA registration that authorizes the Company to manufacture medical diagnostic imaging equipment. This division is also establishing an outsourcing capability, Business Process Outsourcing ("BPO"), which is a service to image-enable documents for subsequent document management, storage and retrieval. These services provide a low-risk, cost-effective solution for customers with document imaging needs and will follow the disciplined process for quality control that have served the division in the past. SOLUTIONS AND PRODUCTS DIVISION Solutions Focused on the needs of the client, the Company follows an ISO9001 documented process to define the customer requirements prior to proposing a value-based information capture solution. The solution may be rich in Scan-Optics product and technology content or may integrate third-party technology to meet specific customer objectives. Because of its investment in the skills and expertise of its development organization, the Company is well positioned to deliver quality solutions in a timely manner. This capability is further enhanced by over 33 years of experience serving specific target markets. Target Markets The Company has six defined target markets that are a focus for its go-to-market strategy. The following describe these markets: o Government - federal, state and local tax processing, licensing and labor reporting o Insurance - medical claims and enrollments o Assessment - test scoring o Transportation - proof of delivery and 3rd party billing accounting o Order Fulfillment - subscription and order processing o Financial - proxy balloting and real estate taxes Scan-Optics Technology The Company has continually been on the leading edge of technological developments in the OCR, "ICR" (intelligent character recognition), "OMR" (optical mark read) and Imaging arena. Our most recent developments have yielded a patent application for gray scale OMR recognition for assessment applications and software based endorsement of images and a patent for "detecting double documents" using acoustic sensors. 4 Software Products Scan-Optics' AccuScore, for the automatic scoring of "bubble" forms, uses electronic image-capture technology in conjunction with patent pending gray scale OMR recognition software for performing the scoring with: o Inexpensive paper or printing o Industry standard image scanners o Flexible, easy-to-use forms definition tool o Extremely high accuracy rates o Greater flexibility in forms design Scan-Optics' DocWise, provides a secure digital information archive utilizing sophisticated workflow processes. 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 under Windows NT, 2000 and XP security architecture with seven levels of access rights built in. DocWise has the capacity to import and index thousands of documents per hour in industry 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 claims payment companies, is a comprehensive business solution designed to efficiently process the paper forms and other documents these organizations receive. It equips the organization with the technology to minimize 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' 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. The Company has implemented this product in its own SAP accounts payable function with significant cost and efficiency savings. TIS eFLOW, comes to the Company through a cooperative marketing agreement with Top Image Systems, Ltd. and provides forms processing in both structured and unstructured environments. TIS eMobilis, comes to the Company through a marketing agreement with Top Image Systems, Ltd. and provides electronic data entry via electronic devices such as personal digital assistants (PDA's). Mitek, is a character recognition engine that has been integrated into many Scan-Optics solutions. 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 enrollments with address changes are ideally suited for SONAR. 5 Hardware Products Scan-Optics' Series 9000M and the Series 9000mm image scanners feature modular design, advanced digital camera technology, with black and white, color or grayscale output. Both scanners are based on Windows 2000 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 character recognition rates up to 10,000 characters per second. Scan-Optics' Series 8000 image only scanner is targeted at the mid-range market for production scanning. Rated at 200 pages per minute, the Series 8000 scanner family converts large volumes of documents into compressed industry standard electronic images. In 2003, the Company intends to continue its aggressive program of research and development enhancements of additional options and capabilities for its existing products as well as the development of new products that utilize the advantage of the Company's core competencies. The Company will continue to develop relationships with other technology companies to provide technology outside its product suite to be implemented through the Company's integration services organization to meet customer requirements. Core Competencies Key product disciplines utilize integration expertise and experience that leverage the core competencies of the Company to provide specific 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 Availability Line of Business Domain Knowledge Professional Services (Design, Development, Installation and Support) Value Added Engineering Services and Solutions 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 Microsoft 2000 Database Performance Tuning 6 The Company has provided software solutions to its customers since 1968. Utilizing Company developed products and third-party products, the professional services group provides turn-key solutions to address the customer's mission critical applications. The Company's image scanners provide the hardware platforms for delivering advanced high-volume forms processing, imaging, and document management system solutions, especially in its target markets. These targeted solutions are provided through the 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 solution of hardware and software with support or simply provide those specific services that the customer desires. Customer Satisfaction Expansion of this business has been possible with the excellent customer relationships that we enjoy. Customer satisfaction continues to be a key area of focus for the Company. Our quality processes focus on the delivery of quality products and services and we monitor, measure and report customer satisfaction levels in various surveys conducted throughout the year. The surveys also follow a documented quality process within our ISO9001 certification program. Management meets weekly to assure the proper attention is focused on the needs of our customers. 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. The following are three examples of the capabilities of the Company's engineering services organization: o 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. o The Company has developed 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. o The Company has also developed recognition analysis for educational test scoring. This process is accomplished in full duplex mode at a transport speed of 50 inches per second. 7 ACCESS SERVICES DIVISION The Company has been offering service and maintenance support to its customer base since 1968. This support is available with either leased or purchased systems in both domestic and international markets. Maintenance service is provided through a network of over 120 service technicians worldwide. The Company provides on-site service with response times of 2 to 24 hours based on the service plan selected by the customer. In support of its third-party maintenance contracts Scan-Optics has developed comprehensive depot maintenance capability with logistics and call center support. 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, insurance, assessment, transportation, and order 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 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 documented in the ISO9001 quality system. One of the many methods to assure quality is the use of 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. 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. 8 Beginning with the customer's plans, the Company can manage each project from concept to completion. The capabilities provided include: Project Management Engineering and Prototyping Procurement and Materials Management Precision Machining, Sheet metal Fabrication and Welding Networks/System Integration Systems Testing Just-in-Time/Kanban Delivery Systems Professional Services and Training Worldwide Field Service - through Access Services Agency Standards Certification (FCC, UL, CE, CSA, ISO9001) Strong Supplier Relationships with: Commercial Painting and Metal Finishing Printed Circuit Board Assemblies and Testing Wire Harness and Cable Assembly and Testing Specialty Packaging Worldwide Shipping This division is also utilizing its manufacturing process disciplines in structuring an outsourcing service capability for image capture and data entry. Although it is in the early stages of development the Company believes the disciplines that are practiced everyday in the manufacturing process will add significant customer value in terms of quality and efficiency to an outsourcing function. SIGNIFICANT CUSTOMERS In 2002 and 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. CHANNELS OF DISTRIBUTION The Company sells directly to end-users and integrators in the USA and distributors internationally. QUALITY All aspects of the Company's business fall under the ISO9001 certification requirements. Customer satisfaction is a driving priority and the chosen method of producing the measurable results is through the documented procedures defined in the Company's quality manual. 9 BACKLOG The backlog for the Company's products and services as of December 31, 2002 was approximately $18.7 million. As of December 31, 2001, the backlog was approximately $22.5 million. Backlog as of March 19, 2003 was approximately $24.9 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 professional services and software customization required. COMPETITION The Company's Solutions and Products Division competes with software 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 under the defined processes in the ISO9001 quality manual. The Division focuses on industry specific "application" areas with solutions utilizing image and data entry/data capture systems provided by the Company and implemented under strictly defined quality processes. 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 third-party equipment manufacturers, primarily of scanner products, that do not have their own field maintenance staff. The division competes with other third party maintenance providers for this revenue by using its reputation for quality, which has been generated from the strict adherence to its ISO9001 quality process manual and its 33 years of experience in providing scanner repair in this market. 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. 10 ISO9001 CERTIFICATION In 2000, the Company took the first step in expanding its quality program by bringing the Access Service Division into compliance with the already certified product development organization and manufacturing division. 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 began to prepare for the transition to ISO9001:2000. During November 2002, the Company introduced the new quality scope, which encompasses all areas of the Company. The scope of the certification is for the design, manufacture, installation and service of scanning equipment; the contract manufacturing, installation and service of electro-mechanical devices; the provision of related products and software services including the design, development, installation and support; and project management of integrated solutions for targeted lines of business. In 2003, we continue our transition to ISO9001:2000. The Company expects to complete the transition process and obtain ISO9001:2000 certification by October 2003. PATENTS The Company currently has nine United States patents in force and one pending which expire between 2003 and 2022. 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 attempts 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 Company filed for a patent for gray scale OMR used in test scoring applications. In 2001, the Company received the patent for the ultrasonic overlapping document detection system for our scanners. 11 EMPLOYEES As of December 31, 2002 the Company employed 192 people, including 17 with administrative responsibilities, 22 in marketing and sales, 101 in software and service activities, 14 in engineering and 38 in manufacturing capacities. The Company considers its employee relations to be good. The Company has not experienced any work stoppages. FUNDED DEVELOPMENT AGREEMENTS During 2002, 2001 and 2000, the Company completed a number of small custom development contracts for specific customers resulting in revenue of approximately $43,000, $110,000 and $200,000, 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. 12 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) 2002 2001 2000 - ------------------------------------------------------------------------------------------------------- Revenues Solutions and products $ 16,376 $ 16,667 $ 23,295 Access services 11,499 13,193 12,669 Contract manufacturing services 1,466 880 2,338 ------------------------------------------------- Total revenues 29,341 30,740 38,302 Cost of solutions and products 10,715 13,298 22,806 Service expenses 8,539 11,200 11,287 ------------------------------------------------- Gross profit margin 10,087 6,242 4,209 Operating expenses, net 9,175 12,522 21,918 ------------------------------------------------- Income (loss) before income taxes $ 912 $ (6,280) $ (17,709) ================================================= Total assets $ 26,406 $ 27,380 $ 36,513 Total expenditures for additions to long-lived assets $ 79 $ 121 $ 109
Certain 2001 and 2000 amounts have been reclassified to conform to the current year presentation. The Solutions and Products Division includes the sale of hardware and software products as well as professional services. Contract Manufacturing Services provides assembly and test services under contracts with customers who develop and sell a variety of equipment. Note: In 2002 and 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. 13 The Company has international distributors located in 13 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. Export sales by geographic area (based on the location of the customer) were as follows: (thousands) 2002 2001 2000 - --------------------------------------------------------------------- Latin America $ 72 24% $ 152 3% $ 152 2% Europe 149 49% 3,706 73% 1,667 22% Pacific Rim 81 27% 1,220 24% 5,881 76% --------------------------------------------------- $ 302 $ 5,078 $ 7,700 =================================================== Export sales represented 3%, 45%, and 43% of hardware and software revenues for the three years ended December 31, 2002, 2001, and 2000, respectively. ITEM 2 - PROPERTIES - -------------------- The Company's world headquarters and manufacturing facility is located in an 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 2005, 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. 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 2002 to a vote of the stockholders. 14 EXECUTIVE AND OTHER OFFICERS OF THE REGISTRANT Officers of the Company are set forth in the schedule below. Officer Name Age Principal Occupation: Since - ----------------------------------------------------------------------------- James C. Mavel 57 Chairman, Chief Executive Officer and President 1996 Joseph P. Crouch 40 Vice President - Manufacturing Services Division 1999 Richard C. Goyette 51 Vice President - Sales and Marketing 1996 Richard D. Harris 42 Corporate Secretary 2001 Joel K. Howser 55 Vice President - Software Development 1998 Clarence W. Rife 63 Vice President - Access Services Division and Hardware Engineering 1975 Michael J. Villano 43 Chief Financial Officer, Vice President and Treasurer 1992 Alan W. Ware 64 Vice President - Project and System Integration 2000 Mr. Mavel joined the Company in January 1996 as President and Chief Operating Officer. In June 1996, Mr. Mavel became a Director of the Company. On December 31, 1996, Mr. Mavel was promoted to Chief Executive Officer. In May 1997, Mr. Mavel was elected Chairman of the Board of Directors. Prior to joining the Company, from 1992 through 1995, Mr. Mavel was Vice President and General Manager of the Imaging Systems Division of Unisys. From 1991 to 1992, he was Group Vice President of the Financial Information Systems Division of National Data Corporation. 15 Mr. Crouch joined the Company in March 1999 and was appointed 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. 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 partner in 1998. He was appointed 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 appointed 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. 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, Inc. from 1968 to 1974. The executive officers are elected for a one year term effective at the conclusion of the Annual Meeting of Stockholders each year. There are no family relationships between any of the listed officers. 16 PART II ITEM 5 - MARKET PRICE OF AND DIVIDENDS ON THE REGISTRANT'S COMMON - ----------------------------------------------------------------- EQUITY AND RELATED STOCKHOLDER MATTERS -------------------------------------- COMMON STOCK MARKET PRICES AND DIVIDENDS The following is a two-year history of Common Stock prices for each quarter. The table sets forth the high and low closing quotations per share for the periods indicated of the Common Stock in the over-the-counter market based upon information provided by the National Association of Securities Dealers, Inc. Effective November 10, 2000 the Company was notified by The NASDAQ Stock Market, Inc. that its common stock 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 912 stockholders of record at December 31, 2002.
Quarter Ended March 31 June 30 September 30 December 31 High Low High Low High Low High Low - ---------------------------------------------------------------------------------------------------------------- 2002 $ .41 $ .22 $ .38 $ .26 $ .39 $ .25 $ .40 $ .25 2001 $ .33 $ .14 $ .35 $ .21 $ .93 $ .27 $ .35 $ .20
The Company has not paid dividends on its Common Stock and the Board of Directors of the Company has no intention of declaring dividends in the foreseeable future. The Company's loan agreement does not allow dividend payments on common stock. 17 ITEM 6 - SELECTED FINANCIAL DATA - -------------------------------- SCAN-OPTICS, INC. AND SUBSIDIARIES FIVE YEAR SUMMARY OF OPERATIONS SELECTED FINANCIAL DATA
(thousands, except share data) 2002 2001 2000 1999 1998 - ------------------------------------------------------------------------------------------------------------------------------------ Total Revenues $ 29,341 $ 30,740 $ 38,302 $ 51,992 $ 53,971 ======================================================================================= Income (loss) before income taxes 912 (6,280) (17,709) (8,415) 3,234 Income taxes (benefit) 81 33 61 (240) 1,105 --------------------------------------------------------------------------------------- Net Income (Loss) $831 $ (6,313) $ (17,770) $(8,175) $ 2,129 ======================================================================================= Basic earnings (loss) per share .12 (.90) (2.53) (1.17) 0. 31 Basic weighted-average shares 7,026,232 7,026,232 7,025,064 6,979,651 6,921,331 Diluted earnings (loss) per share .11 (.90) (2.53) (1.17) 0.30 Diluted weighted-average shares 7,317,437 7,026,232 7,025,064 6,979,651 7,102,658 SELECTED BALANCE SHEET DATA Total assets 26,406 27,380 36,513 56,792 54,301 Working capital (deficit) 5,283 4,184 (9,833) 4,727 15,107 Long Term Obigations 10,682 11,397 Mandatory redeemable preferred stock 3,800 3,800 Total stockholders' equity 1,272 360 4,307 22,081 30,246
The Company has not paid any dividends for the five-year period ended December 31, 2002. The above financial data should be read in conjunction with the related consolidated financial statements and notes thereto. Certain amounts have been reclassified to conform to the current year presentation. 18 ITEM 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF CONSOLIDATED FINANCIAL - ----------------------------------------------------------------------- CONDITION AND RESULTS OF OPERATIONS - ----------------------------------- Outlook The forward-looking statements contained in this Outlook and elsewhere in this document are based on current expectations. Scan-Optics, Inc. (the "Company") and its future operations are subject to a number of risks, including those discussed below. The following list is not intended to be an exhaustive list of all the risks to which the Company's business is subject, but only to highlight certain substantial risks faced by the Company. Although the Company completed a total debt restructuring effective December 31, 2001 (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, 2002 of approximately $10.5 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 and services may be replaced by alternative technologies. The Company's business could be adversely affected by technological changes. The foregoing factors should not be construed as exhaustive. The Company reported net income for the year of $.8 million or $.11 per diluted share, compared to a net loss of $6.3 million, or $.90 per diluted share, for 2001. During the fourth quarter of 2002, the Company determined that certain amounts previously recorded as liabilities were no longer due or have been settled for amounts less than previously recorded. This resulted in other income of $.4 million in the fourth quarter of 2002. During the third quarter of 2002, the Company negotiated a reduction in the final payment due BlueBird Systems, Inc. for the 1999 purchase of the DocWise source code license which resulted in a reduction of previously recorded amortization expense of $.3 million. The Company has delivered excellent operational results even though the industry has been burdened with a difficult economic environment. Our efforts to improve efficiencies through quality control have paid significant benefits to our customers and our bottom line. We are fully committed to delivering successful solutions by using the quality standards we have established under our ISO9001 certification. The Company has three major initiatives currently underway to develop sources of revenue growth and increase profitability. They are to emphasize the "Business of Solutions" focus in targeted markets, introduction of a Business Process Outsourcing Service, and expansion of the Access Services Division to include enterprise wide maintenance services. 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 19 target market approach and has chosen to place its primary focus on the government and insurance markets, while continuing to address the transportation, assessment, financial and order fulfillment 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 increased $1.8 million from 2001 to 2002 mainly in the assessment market. The second initiative, introduced in early 2003, is a Business Process Outsourcing ("BPO") Service to image-enable documents for subsequent document management, storage and retrieval. The Company's' new BPO Services provide a low-risk, cost-effective solution for customers with document imaging needs. As increasing numbers of both government and commercial clients migrate from paper-based filing systems to state-of-the-art image-based storage and retrieval systems, they are faced with the need to convert their existing paper files or opt to outsource the activity to a proven solution provider. The BPO services offer customers a high quality, ISO9001 certified, turnkey outsourcing solution utilizing the Company's proprietary hardware technology, and further leveraging software skills, resources and process controls. The third initiative, recently announced by our Access Services Division, is an expansion to include enterprise wide maintenance services. Leveraging off the experience it has gained through its many third party agreements, Access Services is well positioned to expand maintenance coverage and provide customers with "one number to call" for maintenance services regardless of the equipment manufacturer. Through the division's 120 technical service representatives strategically located throughout the US, the Company believes that it can provide high quality, cost effective enterprise maintenance to its existing customer base as well as new accounts. While the Company is principally focused on improving the profitability of its existing operations, the Company may consider acquiring key strategic products or enterprises. Acquisitions will be considered based upon their individual merit and benefit to the Company. 20 RESULTS OF OPERATIONS - 2002 VS. 2001 Total revenues decreased $1.4 million or 5% from 2001 to 2002. Hardware and software revenue increased $.1 million or 1% from the prior year. North American sales increased $4.9 million or 80% due mainly to the replacement of obsolete Series 9000 systems that were at least seven years old and were not capable of being maintained due to the lack of parts availability. Total international sales decreased $4.8 million or 94% from 2001. International sales in the Pacific Rim decreased 93% or $1.1 million due to the significant reduction of spare parts orders and scanner systems sold to the Company's distributor in Japan. Sales to Europe decreased $3.6 million or 96% due to a large integrated solution sale to the British government that was recorded in 2001. 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 increased $.2 million or 3% from 2001 to 2002 mainly due to the increase in hardware and software revenue. Access services revenue decreased $1.7 million or 13% from 2001 to 2002 due mainly to a decrease in revenue from the Company's proprietary maintenance contracts as a result of lower maintenance rates for the latest generation of the Series 9000 scanner, the 9000M, as compared to the earlier Series 9000 scanner. The Company was also impacted by a few customers discontinuing maintenance due to changes in their business or the use of other technologies. Cost of hardware and software revenue decreased $1.5 million or 16% from 2001. Cost of hardware and software revenue as a percentage of revenue was 69% in 2002, as compared to 83% in 2001. The decrease is mainly due to the improvement in gross margins related to the sales mix. In 2002, the Company recorded approximately three times the number of Series 9000 scanners as compared to 2001, which accounted for more revenue and increased margins. In 2001, a significant portion of the revenue was made up of third-party products and distributor sales of Series 8000 scanners, which yield lower margins than Series 9000 scanners. Cost of professional services revenue decreased $1.1 million or 27% in 2002 compared to the prior year mainly due to decreases in salaries and related expenses of $.3 million, contractor expenses of $.5 million, travel expenses of $.1 million and other expenses of $.2 million. Cost of professional services revenue as a percentage of revenue was 44% in 2002, as compared to 62% in 2001. Cost of Access services revenue decreased $2.7 million or 24% from 2001 to 2002. The decrease is mainly due to a decrease in goodwill amortization expense of $.8 million, a decrease in UK operating expense of $.7 million and a decrease in salaries and related expenses of $.6 million. Cost of Access services revenue as a percentage of revenue was 74% in 2002, as compared to 85% in 2001. 21 Sales and marketing expenses decreased $.6 million or 16% from 2001 mainly due to a decrease in UK operations. Research and development expenses decreased $1.1 million or 39% from 2001 mainly due to a decrease in salaries and related expenses of $.6 million and amortization of the software license agreement of $.5 million in 2001. General and administrative expenses decreased $.2 million or 6% from 2001 mainly due to decrease in goodwill amortization expense of $.5 million, and a $.2 million decrease in legal and accounting fees, offset by 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 in 2001. Interest expense decreased $.9 million from 2001 due to the $6.5 million reduction in the Company's outstanding debt as a result of the debt restructuring that was effective December 31, 2001, as well as the reduction in the prime rate that occurred in 2002. The weighted average interest rate was 5.5% in 2002 compared to 9.8% in 2001. Other Income increased $.4 million due to the reduction of certain amounts previously recorded as liabilities that were no longer due or have been settled for amounts less than previously recorded. RESULTS OF OPERATIONS - 2001 VS. 2000 Total revenues decreased $7.6 million or 20% from 2000 to 2001. 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. 22 Cost of hardware and software revenue decreased $5.4 million or 36% from 2000. This decrease is mainly due to the decline in hardware and software revenue. Cost of hardware and software revenue as a percentage of revenue was 83% in 2001, as compared to 81% in 2000. 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 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. LIQUIDITY AND CAPITAL RESOURCES Cash and cash equivalents decreased $1.4 million from 2001 to 2002 mainly due to the paydown of the revolving line of credit. At December 31, 2002, the Company had $10.5 million in outstanding borrowings, with $1.5 million classified as current, against its $12 million available borrowings. The Company anticipates meeting its current obligations and resource needs through the funds generated from operations. The average borrowing level for 2002 was $10.7 million compared to $18.3 million for 2001. The decrease is due to the debt restructuring that was effective December 31, 2001 (See Note F) and payments of portions of the outstanding debt from cash flow generated in 2002. 23 Effective December 31, 2001, the Company restructured its loan agreements with Patriarch Partners, LLC. ("Patriarch"), which resulted in forgiveness of a portion of outstanding 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 plan through the term of the debt agreement. The Company currently anticipates that it will be able to renew or refinance its long term debt at maturity in December 2004, although there can be no assurance as to the availability or terms of such financing. The loan agreement with Patriarch 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 following summarizes the Company's significant contractual obligations and commitments that impact its liquidity as of December 31, 2002.
Contractual Obligations Payments Due by Period - ------------------------------------------------------------------------------------------------------------------- (thousands) Less than 1 1- 3 4 - 5 After 5 Total year Years Years years - ------------------------------------------------------------------------------------------------------------------- Notes payable $ 10,542 $ 1,500 $ 9,042 Interest payable 407 407 Executive insurance agreement 408 50 $ 100 $ 258 Capital leases 361 74 222 65 Operating leases 2,337 646 1,327 104 260 - ------------------------------------------------------------------------------------------------------------------- Total contractual cash obligations $ 14,055 $ 2,220 $ 11,048 $ 269 $ 518 - -------------------------------------------------------------------------------------------------------------------
Operating activities used $.2 million of cash in 2002 compared to providing $.9 million in 2001. The non-cash expenses in 2002 were $2.5 million compared to $5.1 million in 2001. 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 non-cash income from a reversal of previously recorded liabilities. These and other components of operating activities are discussed below. Net accounts receivable and unbilled receivables increased $.6 million from December 31, 2001. The increase is mainly related to the slowdown in the economy, which the Company believes has caused many companies to extend beyond their traditional payment timeframes. Total inventories increased $.6 million from 2001 levels. Manufacturing inventories increased $.8 million during the year due to an increase in materials and component parts of $1.2 million which was offset by a decrease in work-in-process and finished goods inventory of $.4 million. The increase in materials and component parts is mainly due to an increase in the production schedule for the first quarter of 2003. The manufacturing inventory increase was offset by a decrease in customer service inventory of $.2 million, which was mainly attributable to the amortization of spare parts inventory. 24 Net plant and equipment decreased $.1 million in 2002. This decrease is due to depreciation of $.4 million which was offset by new capital leases of $.3 million. Software license decreased by $.6 million due to amortization of the source code license recorded during the year of $.3 million and a negotiated settlement which reduced the final payment due of $.3 million. Goodwill decreased by $.2 million in 2002 due to the reduction of certain amounts previously recorded as liabilities that were no longer due or have been settled for amounts less than previously recorded. The amortization of goodwill was eliminated as of January 1, 2002 due to the issuance of Financial Accounting Standards Board Statements of Financial Accounting Standards No. 142 "Goodwill and Other Intangibles". Accounts payable decreased $1 million from December 31, 2001 due to the control of expenses and the timing of payments along with a $.6 million decrease due to the reduction of certain amounts recorded as accounts payable that were no longer due or have been settled for amounts less than previously recorded. Notes payable to bank decreased $1.4 million due to pay down of the notes payable during the year. (See Note F.) Salaries and wages decreased $.4 million from 2001 mainly due to a $.2 million decrease in accrued commissions, a $.1 million decrease in bonus accrual, and a $.1 million decrease in accrued vacation. Deferred revenue increased $.1 million as a result of the increase in annual and quarterly maintenance billings that are subsequently recognized in revenue over the maintenance period covered by the billing. Customer deposits increased $.8 million due mainly to two large orders that contained deposit requirements as part of the contract. Other current liabilities decreased $.7 million due mainly to a decrease in legal and accounting fees of $.2 million, a decrease in accrued health and other employee related insurance of $.1 million, a decrease of $. 3 million due to a negotiated reduction in the final payment due BlueBird Systems, Inc. for the 1999 purchase of the DocWise source code license. Other long term liabilities increased $.6 million mainly due to accruals for lease payments that were deferred as part of the debt restructuring and will mature on December 31, 2004, and accrued interest on the mandatory redeemable preferred stock and a new capital lease. 25 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. 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. 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., 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. 26 Inventories - slow moving and obsolete: The Company performs regular reviews 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. Long-lived assets: The Company records impairment losses 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 longlived 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 long-lived assets could be required. Goodwill: Goodwill consists of the excess of cost over the fair value of identifiable net assets of businesses acquired and were amortized on a straight-line basis over five to twenty years. Beginning January 1, 2002, goodwill is no longer amortized, but is be tested on at least an annual basis for impairment, see Note C. 27 ITEM 7A - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK - -------------------------------------------------------------------- In 2001, the Company 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, 2002 of approximately $10.5 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. 28 ITEM 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA ---------------------------------------------------- 29 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, 2002 and 2001, and the related consolidated statements of operations, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 2002. Our audits also included the financial statement schedule listed in the Index at Item 15(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, 2002 and 2001, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2002, 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. /s/ Ernst & Young LLP Hartford, Connecticut March 18, 2003 30 SCAN-OPTICS, INC., AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS
December 31 (thousands, except share data) 2002 2001 - ------------------------------------------------------------------------------------------------------------------------- Assets Current Assets: Cash and cash equivalents $ 274 $ 1,662 Accounts receivable less allowance of $1,574 in 2002 and $1,936 in 2001 5,554 4,353 Unbilled receivables - contracts in progress 377 945 Inventories 9,139 8,543 Prepaid expenses and other 591 504 -------------------------------------------------------- Total current assets 15,935 16,007 Plant and Equipment: Equipment 8,836 13,340 Leasehold improvements 5,209 5,232 Office furniture and fixtures 725 1,338 -------------------------------------------------------- 14,770 19,910 Less allowances for depreciation and amortization 13,456 18,530 -------------------------------------------------------- 1,314 1,380 Software license, net of accumulated amortization of $2,140 in 2002 and $1,773 in 2001 627 Goodwill 9,040 9,249 Other assets 117 117 -------------------------------------------------------- Total Assets $ 26,406 $ 27,380 ========================================================
31
December 31 (thousands, except share data) 2002 2001 - --------------------------------------------------------------------------------------------------------------- Liabilities and Stockholders' Equity Current liabilities: Accounts payable $ 2,454 $ 3,462 Note payable 1,500 1,500 Salaries and wages 958 1,380 Taxes other than income taxes 501 524 Income taxes 45 5 Deferred revenue 2,217 2,101 Customer deposits 1,308 507 Other 1,669 2,344 --------------------------------------------- Total current liabilities 10,652 11,823 Notes payable 9,042 10,392 Other liabilities 1,640 1,005 Mandatory redeemable preferred stock, par value $.02 per share, authorized 3,800,000 shares; 3,800,000 issued and outstanding 3,800 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 2002 and 2001 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 38,354 Accumulated Retained-earnings deficit (33,667) (34,498) Accumulated other comprehensive loss (918) (999) --------------------------------------------- 3,918 3,006 Less cost of common stock in treasury, 413,500 shares 2,646 2,646 --------------------------------------------- Total stockholders' equity 1,272 360 --------------------------------------------- Total Liabilities and Stockholders' Equity $ 26,406 $ 27,380 =============================================
See accompanying notes. 32 SCAN-OPTICS, INC., AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS
Year Ended December 31 (thousands, except share data) 2002 2001 2000 - ---------------------------------------------------------------------------------------------------------------------------- Revenues Hardware and software $ 11,292 $ 11,195 $ 18,099 Professional services 6,550 6,352 7,534 Access services 11,499 13,193 12,669 -------------------------------------------------------------- Total revenues 29,341 30,740 38,302 Costs of Revenue Hardware and software 7,816 9,331 14,685 Professional services 2,899 3,967 8,121 Access services 8,539 11,200 11,287 -------------------------------------------------------------- Total costs of revenues 19,254 24,498 34,093 Gross Margin 10,087 6,242 4,209 Operating Expenses Sales and marketing 3,273 3,914 5,909 Research and development 1,798 2,936 3,720 General and administrative 3,677 3,899 9,867 Interest 846 1,788 2,393 -------------------------------------------------------------- Total costs and expenses 9,594 12,537 21,889 -------------------------------------------------------------- Operating income (loss) 493 (6,295) (17,680) Other income (loss), net 419 15 (29) -------------------------------------------------------------- Income (loss) before income taxes 912 (6,280) (17,709) Income tax expense 81 33 61 -------------------------------------------------------------- Net Income (Loss) $ 831 $ (6,313) $ (17,770) ============================================================== Basic earnings (loss) per share $ .12 $ (.90) $ (2.53) ============================================================== Basic weighted-average shares 7,026,232 7,026,232 7,025,064 Diluted earnings (loss) per share $ .11 $ (.90) $ (2.53) ============================================================== Diluted weighted-average shares 7,317,437 7,026,232 7,025,064 See accompanying notes.
33 SCAN-OPTICS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Accumulated Accumulated Capital in Retained- Other Common Stock Excess of Earnings Comprehensive Treasury ------------------- Par Value Deficit Income (Loss) Stock Total (thousands, except share data) Shares Amount - -------------------------------- ---------------------- --------------- --------------- ------------- --------------- ----------- Balance January 1, 2000 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 Net income 831 831 Currency translation adjustments 81 81 ------------ Comprehensive income 912 - -------------------------------- ---------------------- -------------- ------------------ ------------- --------------- ------------ Balance December 31, 2002 7,439,732$ 149 $ 38,354 $ (33,667) $ (918) $ (2,646) $ 1,272 ================================ ====================== ============== ================== ============= =============== ============ See accompanying notes.
34 SCAN-OPTICS, INC., AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS
Year Ended December 31 (thousands) 2002 2001 2000 - -------------------------------------------------------------------------------------------------------------- Operating Activities Net income (loss) $ 831 $ (6,313) $(17,770) Adjustments to reconcile net income (loss) to net cash provided (used) by operating activities: Depreciation 425 677 887 Amortization of customer service inventory and Software license 2,355 2,886 2,400 Amortization of goodwill 1,326 1,308 Provision for losses on accounts receivable 35 5,505 Provision for inventory obsolescence 50 178 1,064 Reversal of previously recorded liabilities (369) Changes in operating assets and liabilities: Accounts receivable (668) 6,507 8,032 Refundable income taxes 124 1,158 Recoverable income taxes 740 Inventories (2,634) (1,873) (1,578) Prepaid expenses and other (87) 465 537 Software license (174) Accounts payable (639) (2,604) (2,013) Accrued salaries and wages (422) 526 (946) Taxes other than income taxes (23) 131 (717) Income taxes 40 (116) 121 Deferred revenue 116 24 471 Customer deposits 801 (705) (141) Other 21 (330) 371 ---------------------------------------------- Net cash provided (used) by operating activities (168) 903 (745) Investing Activities Acquisition related settlement 209 400 Proceeds from the sale of plant and equipment 35 215 Purchases of plant and equipment, net (114) (64) (122) ---------------------------------------------- Net cash provided by investing activities 130 336 93 Financing Activities Proceeds from issuance of common stock 87 Proceeds from borrowings 4,376 3,485 25,686 Principal payments on borrowings (5,726) (3,098) (25,123) ---------------------------------------------- Net cash provided (used) by financing activities (1,350) 387 650 Increase (decrease) in cash and cash equivalents (1,388) 1,626 (2) Cash and Cash Equivalents at Beginning of Year 1,662 36 38 --------------------------------------------- Cash and Cash Equivalents at End of Year $ 274 $ 1,662 $ 36 ============================================= Supplemental Cash Flow Information Interest paid $ 667 $ 1,579 $ 2,301 ============================================= Income taxes paid $ 44 $ 61 $ 8 =============================================
See accompanying notes 35 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. 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. Goodwill: Goodwill consists of the excess of cost over the fair value of identifiable net assets of businesses acquired and were amortized on a straight-line basis over five to twenty years. Beginning January 1, 2002, goodwill is no longer amortized, but is tested on at least an annual basis for impairment, see Note C. 36 Long-Lived Assets: Long-lived assets are recorded at the lower of amortized cost or fair value. As part of an ongoing review of the valuation of long-lived assets, the Company assesses the carrying value of such assets if facts and circumstances suggest they may be impaired. If this review indicates that the carrying value of these assets may not be recoverable, as determined by nondiscounted cash flow analysis over the remaining useful life, the carrying value would be reduced to its estimated fair value. There have been no material impairments recognized in these financial statements. Software license acquired in 1999 was amortized on a straight-line basis over 3 years. Fair Value of Financial Instruments: The carrying amounts reported in the balance sheets for accounts receivable, accounts payable, and accrued expenses and other liabilities approximate fair value due to the immediate to short-term maturity of these financial instruments. The fair values of the revolving credit facility and term loan, are determined using current interest rates for similar instruments as of December 31, 2002 and 2001 and approximate the carrying value of these financial instruments. 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 terms and conditions. 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 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, in prior years, 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 may consider 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. 37 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. 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) 2002 2001 2000 - -------------------------------------------------------------------------------------------------- Net income (loss), as reported $ 831 $ (6,313) $ (17,770) Stock option expense (199) (134) (51) ------------------------------------------ Pro forma net income (loss) $ 632 $ (6,447) $ (17,821) ========================================== Basic earnings (loss) per share, as reported $ .12 $ (.90) $ (2.53) Stock option expense (.03) (.02) (.01) Pro forma basic earnings (loss) per share $ .09 $ (.92) $ (2.54) ========================================== Diluted earnings (loss) per share, as reported $ .11 $ (.90) $ (2.53) Stock option expense (.03) (.02) (.01) Pro forma diluted earnings (loss) per share $ .08 $ (.92) $ (2.54) ==========================================
The weighted-average fair value of options granted was $.34, $.24 and $.46 during 2002, 2001, and 2000, respectively. The weighted-average remaining contractual life of the options outstanding at December 31, 2002 was 7 years. 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 1.39. 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. 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 and 2000, the effect of stock options 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 2001 and 2000 amounts have been reclassified to conform to the current year presentation. New Accounting Pronouncements: The Company adopted the Financial Accounting Standards Board ("FASB") Statement of Financial Accounting Standards ("SFAS") No. 142, "Goodwill and Other Intangible Assets". effective January 1, 2002. This standard addresses financial accounting and reporting for acquired goodwill and other intangible assets and supercedes APB Opinion No. 17, "Intangible Assets". Under this standard, goodwill and other intangible assets deemed to have indefinite lives are no longer amortized but are subject to annual impairment tests on a reporting unit level. Other intangible assets are being amortized over their estimated useful lives. In August 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets". This standard addresses financial accounting and reporting for the impairment or disposal of long-lived assets and supercedes SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed of". The Company adopted this standard on January 1, 2002 and such adoption did not have an impact on its consolidated financial position or results of operations. In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections". This standard rescinds SFAS No. 4, "Reporting Gains and Losses from Extinguishment of Debt", and an amendment of that Statement, SFAS No. 64, "Extinguishments of Debt Made to Satisfy Sinking-Fund Requirements". This standard amends SFAS No. 13, "Accounting for Leases", to eliminate an inconsistency related to the required accounting for sale-leaseback transactions and certain lease modifications. This standard also amends other existing authoritative pronouncements to make various technical corrections, clarify meanings, or describe their applicability under changed conditions. The Company will adopt this standard on January 1, 2003, and such adoption is not expected to have an impact on its consolidated financial position or results of operations. In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities". This standard addresses financial accounting and reporting for costs associated with exit or disposal activities and requires companies to recognize costs associated with exit or disposal activities when they are incurred rather than at the date of a commitment to an exit or disposal plan. This standard nullifies EITF Issue No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)". Adoption of this standard beginning in the first quarter of 2003 is expected to impact the timing of the recognition of the costs associated with future exit or disposal activities, if any. 39 In November 2002, the FASB issued Interpretation No. 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others". This interpretation requires certain guarantees to be initially recognized and recorded at fair value and also requires new disclosures related to guarantees even if the likelihood of a guarantor having to make payments under the guarantees is remote. The Company adopted this interpretation as of December 31, 2002 and such adoption did not have an impact on the Company's consolidated financial position, results of operations or on disclosures in the financial statements. In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based Compensation--Transition and Disclosure". This standard provides alternative methods of transition of the fair value method of accounting for stock-based employee compensation under SFAS No. 123, "Accounting for Stock-Based Compensation," but does not require the Company to use the fair value method. This standard also amends certain disclosure requirements related to stock-based employee compensation. The Company adopted the additional disclosure required of this standard as of December 31, 2002. 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 of $1 million, manufacturing and customer service inventory 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 recorded goodwill related to the transaction of $1.6 million. Subsequent to the acquisition date, adjustments of $.8 million have been made to decrease goodwill to $.8 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 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. 40 NOTE D - UNBILLED RECEIVABLES - CONTRACTS IN PROGRESS Unbilled amounts in accounts receivable under contracts in progress were $.4 million and $.9 million at December 31, 2002 and 2001, respectively, and are recoverable from the customer upon completion of the phase or milestone. The Company estimates that substantially all unbilled amounts will be collected in 2003. NOTE E- INVENTORIES The components of inventories were as follows: December 31 (thousands) 2002 2001 - ------------------------------------------------------------------------------- Finished goods $ 56 $ 199 Work-in-process 1,325 1,604 Service parts 3,715 3,941 Materials and component parts 4,043 2,799 ------------------------- $ 9,139 $ 8,543 ========================= NOTE F - CREDIT ARRANGEMENTS Notes payable reflect borrowings under a credit agreement ("Agreement") with Patriarch Partners, LLC. ("Patriarch"). The Agreement allows for borrowings under a revolving line of credit facility of $10 million and a term loan of $2 million. Effective December 31, 2001, the Company restructured its loan agreements with Patriarch, which included the following terms: o The maturity date of the Agreement with Patriarch was 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 returned 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 ($2 million outstanding at December 31, 2002 and 2001) 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. 41 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 2003, the Company must issue to Patriarch additional shares representing 15% of the Company's common stock. This amount increases to 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. 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. As of December 31, 2002, the Company executed an amendment to the loan with Patriarch to modify the capital expenditure covenant, from a maximum of $50,000 per quarter, to a maximum of $375,000 per year. At December 31, 2002, the Company had $10.5 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, 2002 outstanding balance through fiscal year 2003. The available balance on the outstanding borrowings was $1.5 million and $.9 million at December 31, 2002 and December 31, 2001, respectively. The weighted average interest rate on borrowings during 2002 and 2001 was 5.5% and 9.8%, respectively. The carrying value of the notes payable to bank approximates its fair value and is secured by all of the Company's assets. 42 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, 2002 and 2001, 3,800,000 shares of mandatory redeemable preferred stock are outstanding. These shares do not contain voting rights until the warrants issued to Patriarch are exercised. At December 31, 2002, the Company had reserved 2,852,955 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, 2002 and 2001. NOTE H - STOCK OPTION PLANS The Company has elected to follow Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (APB No. 25) and related interpretations in accounting for its stock options. Under APB No. 25, because the exercise price of the Company's stock options equals market price of the underlying stock on the date of grant, no compensation expense is recognized. The Company has 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. 43 The following schedule summarizes the changes in stock options for each of the three years in the period ended December 31, 2002:
Number of Option Price Shares Per Share - ------------------------------------------------------------------------------------------------ Outstanding January 1, 2000 (560,457 exercisable) 754,983 $1.50 to $9.19 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) 2,198,083 .24 to 9.19 2002 Activity Granted 30,000 .34 to .34 Canceled (236,800) .24 to 9.19 ----------------------------------- Outstanding December 31, 2002 (1,869,142 exercisable) 1,991,283 $.24 to $9.19 ===================================
At December 31, 2002 there were 861,672 options available for grant of which 85,000 were reserved for the Directors. NOTE I - RESEARCH AND DEVELOPMENT AGREEMENTS During 2002, 2001 and 2000, the Company completed a number of small custom development contracts for specific customers resulting in revenue of approximately $43,000, $110,000 and $200,000, 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. 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 $346,000, $254,000 and $306,000, in 2002, 2001 and 2000, respectively. 44 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 2002, 2001 or 2000. 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 2002, 2001 and 2000. NOTE K - INCOME TAXES At December 31, 2002 the Company has U.S. federal and state operating loss carryforwards of approximately $ 27,200,000 and $26,000,000, respectively. 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 2015. At December 31, 2002, the Company has approximately $226,000, $3,400,000 and $800,000 of net operating loss carryforwards for Canada, the United Kingdom and Germany, respectively. 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 2003 through 2009. For financial reporting purposes, a valuation allowance has been recorded for 2002 and 2001 to fully offset deferred tax assets relating to U.S. federal, state, and foreign net operating loss carryforwards and other temporary differences. Income (loss) before income taxes is set forth in the following tabulation:
Year Ended December 31 (thousands) 2002 2001 2000 - ----------------------------------------------------------------------------------------- Domestic $ 700 $(6,270) $ (17,436) Foreign 212 (10) (273) ---------------------------------------------- Income (loss) before income taxes $ 912 $(6,280) $ (17,709) ============================================== Income taxes are summarized as follows: Year Ended December 31 (thousands) 2002 2001 2000 - ----------------------------------------------------------------------------------------- Current : State $ 80 $ 28 $ 49 Foreign 1 5 12 ------------------------------------------------ Total current $ 81 $ 33 $ 61 Deferred - ----------------------------------------------------------------------------------------- Total $ 81 $ 33 $ 61 =========================================================================================
45 Significant components of the Company's deferred tax liabilities and assets were as follows:
December 31 (thousands) 2002 2001 - ------------------------------------------------------------------------------------- Deferred tax assets: Net operating loss carryforward $12,005 $ 8,557 Alternative minimum tax credit carryforward 168 168 Depreciation 92 92 Charitable contribution carryforward 37 Inventory 673 914 Accounts receivable allowance 538 669 Goodwill 119 604 Vacation accrual 172 209 Other 155 157 Total gross deferred tax assets 13,922 11,407 Deferred tax liabilities: Depreciation and other (306) (359) --------------------------- Total gross deferred tax liabilities (306) (359) Valuation allowance (13,616) (11,048) --------------------------- Net deferred tax asset $ - $ - =========================== A reconciliation of the statutory tax rate to the effective rate is as follows: Year Ended December 31 2002 2001 2000 - ---------------------------------------------------------------------------------------- Statutory federal income tax rate 34% (34)% (34)% State income taxes, net of federal benefit 9 .44 .3 Foreign income taxes .1 Valuation allowance (34) 34 34 Other .09 -------------------------- Effective tax rate 9% .53% .4% ==========================
46 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. The capital lease relates to a new phone system and photocopiers. Minimum rental payments for all noncancelable leases, with terms equal to or in excess of one year as of December 31, 2002, are as follows:
(thousands) Operating Leases Capital Lease - ------------------------------------------------------------------------------------------------------- 2003 $ 646 $ 74 2004 441 74 2005 443 74 2006 443 74 2007 52 65 Thereafter 312 -------------------------------------- Total minimum lease payments $ 2,337 361 ======== Amounts representing interest (81) -------- Present value of net minimum lease payments $ 280 ======== Rental expense for the years ended December 31, 2002, 2001, and 2000 was $681,000, $718,000 and $1,114,000, respectively. Long term capital leases are recorded in other long term liabilities on the balance sheet.
NOTE M - CONTINGENCIES There are two lawsuits currently pending against the Company. 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. 47 NOTE N - SEGMENT INFORMATION 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) 2002 2001 2000 - ---------------------------------------------------------------------------------------------------------------------- Revenues Solutions and products $ 16,376 $ 16,667 $ 23,295 Access services 11,499 13,193 12,669 Contract manufacturing services 1,466 880 2,338 ---------------------------------------------------------------- Total revenues 29,341 30,740 38,302 Cost of solutions and products 10,715 13,298 22,806 Service expenses 8,539 11,200 11,287 ---------------------------------------------------------------- Gross profit margin 10,087 6,242 4,209 Operating expenses, net 9,175 12,522 21,918 ----------------------------------------------------------------- Income (loss) before income taxes $ 912 $ (6,280) $ (17,709) ================================================================= Total assets $ 26,406 $ 27,380 $ 36,513 Total expenditures for additions to long-lived assets $ 79 $ 121 $ 109
Certain 2001 and 2000 amounts have been reclassified to conform to the current year presentation. The Solutions and Products Division includes the sale of hardware and software products as well as professional services. Contract Manufacturing Services provides assembly and test services under contracts with customers who develop and sell a variety of equipment. Note: In 2002 and 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. 48 The Company has international distributors located in 13 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. Export sales by geographic area (based on the location of the customer) were as follows:
(thousands) 2002 2001 2000 - -------------------------------------------------------------------------------------------- Latin America $ 72 24% $ 152 3% $ 152 2% Europe 149 49% 3,706 73% 1,667 22% Pacific Rim 81 27% 1,220 24% 5,881 76% ------------------------------------------------------------------ $ 302 $ 5,078 $ 7,700 ==================================================================
Export sales represented 3%, 45%, and 43% of hardware and software revenues for the three years ended December 31, 2002, 2001, and 2000, respectively. 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 acceptance test that is certified by the customer. Revenues recorded during 2002, 2001, and 2000 included bill and hold transactions of $1.3 million, $.1 million and $1.7 million, respectively. Accounts receivable included bill and hold receivables of $1.1 million, $.1 million and $.4 million at December 31, 2002, 2001 and 2000, respectively. 49 NOTE P - EARNINGS PER SHARE The following table sets forth the computation of basic and diluted earnings (loss) per share:
December 31 (thousands, except share data) 2002 2001 2000 - -------------------------------------------------------------------------------------------------- Numerator: Net earnings (loss) $ 831 $ (6,313) $ (17,770) ================================================ Denominator: Denominator for basic earnings (loss) per share (weighted-average shares) 7,026,232 7,026,232 7,025,064 Effect of dilutive securities: Employee stock options 291,205 Denominator for diluted earnings (loss) per share (adjusted weighted-average ------------------------------------------------ shares and assumed conversions) 7,317,437 7,026,232 7,025,064 Basic earnings (loss) per share $ .12 $ (.90) $ (2.53) ================================================ Diluted earnings (loss) per share $ .11 $ (.90) $ (2.53) ================================================
For 2001 and 2000, the effect of stock options was antidilutive, therefore, the amounts reported for basic and diluted earnings (loss) per share were the same. 50 NOTE Q - QUARTERLY RESULTS OF OPERATIONS (UNAUDITED) The following is a summary of the quarterly results of operations for the years ended December 31, 2002 and 2001.
(thousands, except per share amounts) March June September December - -------------------------------------------------------------------------------------------------------------- 2002 Revenues $ 7,824 $ 7,842 $ 7,242 $ 6,433 Cost of product sales and service expenses 5,065 5,143 4,718 4,328 Net income 166 218 220 227 Basic earnings per share .02 .03 .03 .03 Diluted earnings per share $ .02 $ .03 $ .03 $ .03 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)
Fourth quarter 2002 net income of $.2 million includes other income of $.4 million or $.05 per share resulting from a reduction of certain amounts previously recorded as liabilities that were no longer due or have been settled for amounts less than previously recorded. Third quarter 2002 net income of $.2 million includes a negotiated reduction of $.3 million or $.04 per share. This reduction in the final payment due Bluebird Systems for the 1999 purchase of the Docwise source code license resulted in the reduction of previously recorded research and development amortization expense. 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. 51 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 12, 2003 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 12, 2003 and is incorporated herein by reference. 52 ITEM 12 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT - ------------------------------------------------------------------------ RELATED STOCKHOLDER MATTERS - --------------------------- For information with respect to the security ownership of the Directors and Executive Officers and related stockholders matters, see the Proxy Statement for the Company's 2003 Annual Meeting of Shareholders filed pursuant to Regulation 14A, which is incorporated by reference herein. The Company has six equity compensation plans as of December 31, 2002. See Note H to the Notes to Consolidated Financial Statements of the Company included in this report for additional information regarding these plans. The following table gives information about the Company's equity compensation plans as of December 31, 2002.
Number of shares of Common Stock remaining available Number of shares of for future issuance under Common Stock to be Weighted -average equity compensation plans issued upon exercise of exercise price of (excluding shares outstanding options, outstanding options, reflected in the first Plan Category warrants and rights warrants and rights column) - ------------------------------------------------------------------------------------------------------------------------------ Equity compensation plans approved by stockholders 966,283 $ 2,472,445 861,672 Equity compensation plans not approved by stockholders: Senior management options 1,025,000 246,000 Debt restructuring warrants 4,975,000 2,700,000 -------------------------------------------------------------------------------- 6,966,283 $ 5,418,445 861,672 ================================================================================
Equity compensation plans not approved by stockholders include options for senior management and warrants issued to Patriarch, which were both part of the total debt restructuring. Options for senior management that were granted on December 31, 2001 were not exercisable until six months after the grant thereof. See Note H to the Notes to Consolidated Financial Statements of the Company included in this report for additional information. 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. See Note F to the Notes to Consolidated Financial Statements of the Company included in this report for additional information. 53 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 12, 2003 and is incorporated herein by reference. ITEM 14 - DISCLOSURE CONTROLS AND PROCEDURES - -------------------------------------------- The Company evaluated the design and operation of its disclosure controls and procedures to determine whether they are effective in ensuring that the disclosure of required information is timely made in accordance with the Exchange Act and the rules and forms of the Securities and Exchange Commission. This evaluation was made under the supervision and with the participation of management, including the Company's principal executive officer and principal financial officer within the 90-day period prior to the filing of this Annual Report on Form 10-K. The principal executive officer and principal financial officer have concluded, based on their review, that the Company's disclosure controls and procedures, as defined at Exchange Act Rules 13a-14(c) and 15d-14(c), are effective to ensure that information required to be disclosed by the Company in reports that it files under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms. No significant changes were made to the Company's internal controls or other factors that could significantly affect these controls subsequent to the date of their evaluation. 54 PART IV ITEM 15 - 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, 2002 and 2001 Consolidated Statements of Operations for the years ended December 31, 2002, 2001 and 2000 Consolidated Statements of Stockholders' Equity for the years ended December 31, 2002, 2001 and 2000 Consolidated Statements of Cash Flows for the years ended December 31, 2002, 2001 and 2000 Notes to Consolidated Financial Statements - December 31, 2002 (2) The following consolidated financial statement schedule is included in Item 15(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. 55 *3.2 Restated By-laws of the Company, as amended is filed as Exhibit 3.2 in the Company's Annual Report on Form 10-K filed for the year ended December 31, 2002. *+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. *+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. 56 *+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. 10.20 Fifth Amendment Agreement dated as of December 31, 2002 between ARK CLO 2000-1, Limited and Scan-Optics, Inc. and prior loan agreements, is filed as Exhibit 10.20 in the Company's Annual Report on Form 10-K filed for the year ended December 31, 2002. *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. 99.1 Certification of Chief Executive Officer pursuant to Section 906 of the Sabanes-Oxley Act. 99.2 Certification of Chief Financial Officer pursuant to Section 906 of the Sabanes-Oxley Act. * Exhibits so marked have heretofore been filed by the Company with the Securities and Exchange Commission and are incorporated herein by reference. 57 + 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, 2002. (c) Exhibits ------------ The exhibits required by this item are included herein. (d) Financial Statement Schedule -------------------------------------- The response to this portion of Item 15 is submitted as a separate section of this report. 58 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 26, 2003 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 26, 2003 /ss/ - ---------------------- Michael J. Villano Chief Financial Officer, Vice President and Treasurer (Principal Financial and Accounting Officer) Date: March 26, 2003 /ss/ - ---------------------- Logan Clarke, Jr. Director March 26, 2003 /ss/ - ---------------------- Richard J. Coburn Director March 26, 2003 /ss/ - ---------------------- E. Bulkeley Griswold Director March 26, 2003 /ss/ - ---------------------- Lyman C. Hamilton, J Director March 26, 2003 /ss/ - ---------------------- John J. Holton Director March 26, 2003 /ss/ - ---------------------- Robert H. Steele Director March 26, 2003 A majority of the Directors 59 CERTIFICATION OF CHIEF EXECUTIVE OFFICER I, James C. Mavel, Chairman, Chief Executive Officer and President of Scan-Optics, Inc., certify that: 1. I have reviewed this annual report on Form 10-K of Scan-Optics, Inc.; 2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statement were made, not misleading with respect to the period covered by this annual report; 3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: a) Designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared; b) Evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and c) Presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): a) All significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 60 6. The registrant's other certifying officers and I have indicated in this annual report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: March 26, 2003 ________/ ss_/____________________ James C. Mavel Chairman, Chief Executive Officer and President 61 CERTIFICATION OF CHIEF FINANCIAL OFFICER I, Michael J. Villano, Chief Financial Officer, Vice President and Treasurer of Scan-Optics, Inc., certify that: 1. I have reviewed this annual report on Form 10-K of Scan-Optics, Inc.; 2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statement were made, not misleading with respect to the period covered by this annual report; 3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: a) Designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared; b) Evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and c) Presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): a) All significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this annual report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: March 26, 2003 _______/ ss /_____________________ Michael J. Villano Chief Financial Officer, Vice President and Treasurer 62 SCHEDULE II
SCAN-OPTICS, INC. AND SUBSIDIARIES VALUATION AND QUALIFYING ACCOUNTS THREE YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000 (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, 2002 $ 1,936 $ 35 $ 397(1) $ 1,574 Allowance for doubtful accounts (billed and unbilled) Year ended December 31, 2001: $ 5,615 $ 93 $ 3,772(1) $ 1,936 Allowance for doubtful accounts (billed and unbilled) Year ended December 31, 2000: $ 308 $ 5,505 $ 13 (2) $ 211 (1) $ 5,615 Allowance for doubtful accounts (billed and unbilled)
(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. 63 EX-3.(II) 3 exhibit3-2.txt EXHIBIT 3.2 EXHIBIT - 3.2 - ------------- RESTATED ------- BY - LAWS --------- OF SCAN-OPTICS, INC. ---------------- (A Delaware Corporation) AS AMENDED ---------- _________________ ARTICLE I --------- STOCKHOLDERS ------------ 1. CERTIFICATES REPRESENTING STOCK. Every holder of stock in the corporation shall be entitled to have a certificate signed by, or in the name of, the corporation by the Chairman or Vice-Chairman of the Board of Directors, if any, or by the President or a Vice-President and by the Treasurer or an Assistant Treasurer or the Secretary or an Assistant Secretary of the corporation certifying the number of shares owned by him in the corporation. If such certificate is countersigned by a transfer agent other than the corporation or its employee or by a registrar other than the corporation or its employee, any other signature on the certificate may be a facsimile. In case any officer, transfer agent, or registrar who has signed or whose facsimile signature has been placed upon a certificate shall have ceased to be such officer, transfer agent, or registrar before such certificate is issued, it may be issued by the corporation with the same effect as if he were such officer, transfer agent, or registrar at the date of issue. Whenever the corporation shall be authorized to issue more than one class of stock or more than one series of any class of stock, and whenever the corporation shall issue any shares of its stock as partly paid stock, the certificates representing shares of any such class or series or of any such partly paid stock shall set forth thereon the statements prescribed by the General Corporation Law. Any restrictions on the transfer or registration of transfer of any shares of stock of any class or series shall be noted conspicuously on the certificate representing such shares. The corporation may issue a new certificate of stock in place of any certificate theretofore issued by it, alleged to have been lost, stolen, or destroyed, and the Board of Directors may require the owner of any lost, stolen, or destroyed certificate, or his legal representative, to give the corporation a bond sufficient to indemnify the corporation against any claim that may be made against it on account of the alleged loss, theft, or destruction of any such certificate or the issuance of any such new certificate. 2. FRACTIONAL SHARE INTERESTS. The corporation may, but shall not be required to, issue fractions of a share. In lieu thereof it shall either pay in cash the fair value of fractions of a share, as determined by the Board of Directors, to those entitled thereto or issue scrip or fractional warrants in registered or bearer form over the manual or facsimile signature of an officer of the corporation or of its agent, exchangeable as therein provided for full shares, but such scrip or fractional warrants shall not entitle the holder to any rights of a stockholder except as therein provided. Such scrip or fractional warrants may be issued subject to the condition that the same shall become void if not exchanged for certificates representing full shares of stock before a specified date, or subject to the condition that the shares of stock for which such scrip or fractional warrants are exchangeable may be sold by the corporation and the proceeds thereof distributed to the holders of such scrip or fractional warrants, or subject to any other conditions which the Board of Directors may determine. 3. STOCK TRANSFERS. Upon compliance with provisions restricting the transfer or registration of transfer of shares of stock, if any, transfers or registration of transfers of shares of stock of the corporation shall be made only on the stock ledger of the corporation by the registered holder thereof, or by his attorney thereunto authorized by power of attorney duly executed and filed with the Secretary of the corporation or with a transfer agent or a registrar, if any, and on surrender of the certificate or certificates for such shares of stock properly endorsed and the payment of all taxes due thereon. 4. RECORD DATE FOR STOCKHOLDERS. For the purpose of determining the stockholders entitled to notice of or to vote at any meeting of stockholders or any adjournment thereof, or to express consent to or dissent from any corporate action in writing without a meeting, or for the purpose of determining stockholders entitled to receive payment of any dividend or other distribution or the allotment of any rights, or entitled to exercise any rights in respect of any change, conversion, or exchange of stock, or for the purpose of any other lawful action, the directors may fix, in advance, a date as the record date for any such determination of stockholders. Such date shall not be more than sixty days nor less than ten days before the date of such meeting, nor more than sixty days prior to any other action. If no record date is fixed, the record date for the determination of stockholders entitled to notice of or to vote at a meeting of stockholders shall be at the close of business on the day next preceding the day on which notice is given, or, if notice is waived, at the close of business on the day next preceding the day on which the meeting is held; the record date for determining stockholders for any other purpose shall be at the close of business on the day on which the Board of Directors adopts the resolution relating thereto. When a determination of stockholders of record entitled to notice of or to vote at any meeting of stockholders has been made as provided in this paragraph, such determination shall apply to any adjournment thereof; provided, however, that the Board of Directors may fix a new record date for the adjourned meeting. 5. MEANING OF CERTAIN TERMS. As used herein in respect of the right to notice of a meeting of stockholders or a waiver thereof or to participate or vote thereat, as the case may be, the term "share" or "shares" or "share of stock" or "shares of stock" or "stockholder" or "stockholders" refers to an outstanding share or shares of stock and to a holder or holders of record of outstanding shares of stock when the corporation is authorized to issue only one class of shares of stock, and said reference is also intended to include any outstanding share or shares of stock and any holder or holders of record of outstanding shares of stock of any class upon which or upon whom the certificate of incorporation confers such rights where there are two or more classes or series of shares of stock or upon which or upon whom the General Corporation Law confers such rights notwithstanding that the certificate of incorporation may provide for more than one class or series of shares of stock, one or more of which are limited or denied such rights thereunder; provided, however, that no such right 66 shall vest in the event of an increase or a decrease in the authorized number of shares of stock of any class or series which is otherwise denied voting rights under the provisions of the certificate of incorporation. 6. STOCKHOLDER MEETINGS. - -------------------------- TIME. The annual meeting shall be held on the date and at the time fixed, from time to time, by the directors, provided, that the first annual meeting shall be held on a date within thirteen months after the organization of the corporation, and each successive annual meeting shall be held on a date within thirteen months after the date of the preceding annual meeting. A special meeting shall be held on the date and at the time fixed by the directors. PLACE. Annual meetings and special meetings shall be held at such place, within or without the State of Delaware, as the directors may, from time to time fix. Whenever the directors shall fail to fix such place, the meeting shall be held at the registered office of the corporation in the State of Delaware. CALL. Annual meetings and special meetings may be called by the directors or by any officer instructed by the directors to call the meeting. NOTICE OR WAIVER OF NOTICE. Written notice of all meetings shall be given, stating the place, date, and hour of the meeting and stating the place within the city or other municipality or community at which the list of stockholders of the corporation may be examined. The notice of an annual meeting shall state that the meeting is called for election of directors and for the transaction of other business which may properly come before the meeting, and shall, (if any other action which could be taken at a special meeting is to be taken at such annual meeting) state the purpose or purposes. The notice of a special meeting shall in all instances state the purpose or purposes for which the meeting is called. If any action is proposed to be taken which would, if taken, entitle stockholders to receive payment for their shares of stock, the notice shall include a statement of that purpose and to that effect. Except as otherwise provided by the General Corporation Law, a copy of the notice of any meeting shall be given, personally or by mail, not less than ten days nor more than fifty days before the date of the meeting, unless the lapse of the prescribed period of time shall have been waived, and directed to each stockholder at his record address or at such other address which he may have furnished by request in writing to the Secretary of the corporation. Notice by mail shall be deemed to be given when deposited, with postage thereon prepaid, in the United States mail. If a meeting is adjourned to another time, not more than thirty days hence, and/or to another place, and if an announcement of the adjourned time and/or place is made at the meeting, it shall not be necessary to give notice of the adjourned meeting unless the directors, after adjournment, fix a new record date for the adjourned meeting. Notice need not be given to any stockholder who submits a written waiver of notice by him or before or after the time stated therein. Attendance of a person at a meeting of stockholders shall constitute a waiver of notice of such meeting, except when the stockholder attends a meeting for the express purpose of objecting, at the beginning of the meeting, to the transaction of any business because the meeting is not lawfully called or convened. Neither the business to be transacted at, nor the purpose of, any regular or special meeting of the stockholders need be specified in any written waiver of notice. STOCKHOLDER LIST. The officer who has charge of the stock ledger of the corporation shall prepare and make, at least ten days before every meeting of stockholders, a complete list of 67 the stockholders, arranged in alphabetical order, and showing the address of each stockholder and the number of shares registered in the name of each stockholder. Such list shall be open to the examination of any stockholder, for any purpose germane to the meeting, during ordinary business hours, for a period of at least ten days prior to the meeting, either at a place within the city or other municipality or community where the meeting is to be held, which place shall be specified in the notice of the meeting, or if not so specified, at the place where the meeting is to be held. The list shall also be produced and kept at the time and place where the meeting is to be held. The list shall also be produced and kept at the time and place of the meeting during the whole time thereof, and may be inspected by any stockholder who is present. The stock ledger shall be the only evidence as to who are the stockholders entitled to examine the stock ledger, the list required by this section or the books of the corporation, or to vote at any meeting of stockholders. CONDUCT OF MEETING. Meetings of the stockholders shall be presided over by one of the following officers in the order of seniority and if present and acting - the Chairman of the Board, if any, the Vice-Chairman of the Board, if any, the President, a Vice-President, or, if none of the foregoing is in office and present and acting, by a chairman to be chosen by the stockholders. The Secretary of the corporation, or in his absence, an Assistant Secretary, shall act as secretary of every meeting, but if neither the Secretary nor an Assistant Secretary is present the Chairman of the meeting shall appoint a secretary of the meeting. PROXY REPRESENTATION. Every stockholder may authorize another person or persons to act for him by proxy in all matters in which a stockholder is entitled to participate, whether by waiving notice of any meeting, voting or participating at a meeting, or expressing consent or dissent without a meeting. Every proxy must be signed by the stockholder or by his attorney-in-fact. No proxy shall be voted or acted upon after three years from its date unless such proxy provides for a longer period. A duly executed proxy shall be irrevocable if it states that it is irrevocable and, if, and only as long as, it is coupled with an interest sufficient in law to support an irrevocable power. A proxy may be made irrevocable regardless of whether the interest with which it is coupled is an interest in the stock itself or an interest in the corporation generally. INSPECTORS AND JUDGES. The directors, in advance of any meeting, may, but need not, appoint one or more inspectors of election or judges of the vote, as the case may be, to act at the meeting or any adjournment thereof. If an inspector or inspectors or judge or judges are not appointed, the person presiding at the meeting may, but need not, appoint one or more inspectors or judges. In case any person who may be appointed as an inspector or judge fails to appear or act, the vacancy may be filled by appointment made by the directors in advance of the meeting or at the meeting by the person presiding thereat. Each inspector or judge, if any, before entering upon the discharge of his duties, shall take and sign an oath faithfully to execute the duties of inspector or judge at such meeting with strict impartiality and according to the best of his ability. The inspectors or judges, if any, shall determine the number of shares of stock outstanding and the voting power of each, the shares of stock represented at the meeting, the existence of a quorum, the validity and effect of proxies, and shall receive votes, ballots or consents, hear and determine all challenges and questions arising in connection with the right to vote, count and tabulate all votes, ballots or consents, determine the result, and do such acts as are proper to conduct the election or vote with fairness to all stockholders. On request of the person presiding at the meeting, the inspector or inspectors 68 or judge or judges, if any, shall make a report in writing of any challenge, question or matter determined by him or them and execute a certificate of any fact found by him or them. QUORUM. The holders of a majority of the outstanding shares of stock shall constitute a quorum at a meeting of stockholders for the transaction of any business. The stockholders present may adjourn the meeting despite the absence of a quorum. VOTING. Each share of stock shall entitle the holder thereof to one vote. In the election of directors, a plurality of the votes cast shall elect. Any other action shall be authorized by a majority of the votes cast except where the General Corporation Law prescribes a different percentage of votes and/or a different exercise of voting power. In the election of directors, voting need not be by ballot. Voting by ballot shall not be required for any other corporate action except as otherwise provided by the General Corporation Law. 7. NOTICE OF STOCKHOLDER PROPOSALS. (a) At an annual meeting, only such business shall be conducted, and only such proposals shall be acted upon, as shall have been brought before the annual meeting (i) by, or at the direction of, the Board of Directors or (ii) by a stockholder who complies with the notice procedures set forth in this Section of the By-Laws. For a proposal to be properly brought before an annual meeting by a stockholder, the stockholder must have given timely notice thereof in writing to the Secretary. To be timely, a stockholder's notice must be delivered to, or mailed and received at, the principal executive offices of the corporation not less than forty days nor more than ninety days prior to the scheduled annual meeting, regardless of any postponements, deferrals or adjournments of that meeting to a later date; provided, however, that if less than fifty days' notice or prior public disclosure of the date of the scheduled annual meeting is given or made, notice by the stockholder to be timely must be so delivered or received not later than the close of business on the tenth day following the earlier of the day on which such notice of the date of the scheduled annual meeting was mailed or the day on which such public disclosure was made. A stockholder's notice to the Secretary shall set forth as to each matter the stockholder proposes to bring before the annual meeting (i) a brief description of the proposal desired to be brought before the annual meeting and the reasons for conducting such business at the annual meeting, (ii) the name and address, as they appear on the corporation's books, of the stockholder proposing such business, (iii) the class and number of shares which are beneficially owned by the stockholder on the date of such stockholder notice and (iv) any material interest of the stockholder in such proposal. (b) If the presiding officer of the annual meeting determines that a stockholder proposal was not made in accordance with the terms of this Section, he shall so declare at the annual meeting and any such proposal shall not be acted upon at the annual meeting. (c) This provision shall not prevent the consideration and approval or disapproval at the annual meeting of reports of officers, directors and committees of the Board of Directors, but, in connection with such reports, no business shall be acted upon at such annual meeting unless stated, filed and received as herein provided. 8. STOCKHOLDER ACTION. No action by stockholders shall be taken except as provided in the certificate of incorporation. ARTICLE II ---------- DIRECTORS --------- 69 1. FUNCTIONS AND DEFINITION. The business of the corporation shall be managed by the Board of Directors of the corporation. The use of the phrase "whole board" herein refers to the total number of directors which the corporation would have if there were no vacancies. 2. QUALIFICATION AND NUMBER. A director need not be a stockholder, a citizen of the United States, or a resident of the State of Delaware. The number of directors constituting the whole board and of any class thereof shall be that number determined from time to time by the Board of Directors pursuant to the certificate of incorporation. 3. (a) NOMINATION OF DIRECTORS. Only persons who are nominated in accordance with the procedures set forth in these By-Laws shall be eligible to serve as directors. Nominations of persons for election to the Board of Directors may be made at a meeting of stockholders (a) by or at the direction of the Board of Directors or (b) by any stockholder who is a stockholder of record at the time of giving notice provided for in this Section, who shall be entitled to vote for the election of directors at the meeting and who complies with the notice procedures set forth in this Section. Such nominations, other than those made by or at the direction of the Board of Directors, shall be made pursuant to timely notice in writing to the Secretary. To be timely, a stockholder's notice shall be delivered to or mailed and received at the principal executive offices of the corporation not less than forty days nor more than ninety days prior to the meeting; provided, however, that in the event that less than fifty days' notice or prior public disclosure of the date of the meeting is given or made to stockholders, notice by the stockholder to be timely must be so received not later than the close of business on the tenth day following the earlier of the day on which such notice of the date of the meeting was mailed or the day on which such public disclosure was made. Such stockholder's notice shall set forth (a) as to each person whom the stockholder proposes to nominate for election or reelection as a director all information relating to such person that is required to be disclosed in solicitations of proxies for election of directors, or is otherwise required, in each case pursuant to Regulation 14A under the Securities Exchange Act of 1934, as amended (including such person's written consent to being named in a proxy statement as a nominee and to serving as a director if elected); and (b) as to the stockholder giving the notice (i) the name and address, as they appear on the corporation's books, of such stockholder proposing such nomination and any other stockholders known by such stockholder to be supporting such nomination, and (ii) the class and number of shares which are beneficially owned by such stockholder. At the request of the Board of Directors, any person nominated by the Board of Directors for election as a director shall furnish to the Secretary that information required to be set forth in a stockholder's notice of nomination which pertains to the nominee. The presiding officer of the meeting shall, if the facts warrant, determine and declare to the meeting that a nomination was not made in accordance with the procedures prescribed by the By-Laws, and if he should so determine, he shall so declare to the meeting and the defective nomination shall be disregarded. Notwithstanding the foregoing provision of this Section, a stockholder shall also comply with all applicable requirements of the Securities Exchange Act of 1934, as amended, and the rules and regulations thereunder with respect to the matters set forth in this Section. (b) DIRECTORS - ELECTION AND TERM. Directors shall be elected and shall hold office in accordance with the provisions of the certificate of incorporation. Any director may resign at any time upon written notice to the corporation. 70 4. MEETINGS. - ------------ TIME. Meetings shall be held at such time as the Board shall fix, except that the first meeting of a newly elected Board shall be held as soon after its election as the directors may conveniently assemble. PLACE. Meetings shall be held at such place within or without the State of Delaware as shall be fixed by the Board. CALL. No call shall be required for regular meetings for which the time and place have been fixed. Special meetings may be called by or at the direction of the Chairman of the Board, if any, the Vice-Chairman of the Board, if any, of the President, or of a majority of the directors in office. NOTICE OR ACTUAL OR CONSTRUCTIVE WAIVER. No notice shall be required for regular meetings for which the time and place have been fixed. Written, oral, or any other mode of notice of the time and place shall be given for special meetings in sufficient time for the convenient assembly of the directors thereat. The notice of any meeting need not specify the purpose of the meeting. Any requirement of furnishing a notice shall be waived by any director who signs a written waiver of such notice before or after the time stated therein. QUORUM AND ACTION. A majority of the whole Board shall constitute a quorum except when a vacancy or vacancies prevents such majority, whereupon a majority of the directors in office shall constitute a quorum, provided, that such majority shall constitute at least one-third of the whole Board. A majority of the directors present, whether or not a quorum is present, may adjourn a meeting to another time and place. Except as herein otherwise provided, and except as otherwise provided by the General Corporation Law, the act of the Board shall be the act by vote of a majority of the directors present at a meeting, a quorum being present. The quorum and voting provisions herein stated shall not be construed as conflicting with any provisions of the General Corporation Law and these By-Laws which govern a meeting of directors held to fill vacancies and newly created directorships in the Board. CHAIRMAN OF THE MEETING. The Chairman of the Board, if any and if present and acting, shall preside at all meetings. Otherwise, the Vice-Chairman of the Board, if any and if present and acting, or the President, if present and acting, or any other director chosen by the Board, shall preside. 5. REMOVAL OF DIRECTORS. One or more of the directors may be removed for cause by the Board of Directors. 6. COMMITTEES. The Board of Directors may, by resolution passed by a majority of the whole Board, designate one or more committees, each committee to consist of two or more of the directors of the corporation. The Board may designate one or more directors as alternate members of any committee, who may replace any absent or disqualified member at any meeting of the committee. Any such committee, to the extent provided in the resolution of the Board, shall have and may exercise the powers of the Board of Directors in the management of the business and affairs of the corporation, and may authorize the seal of the corporation to be affixed to all papers which may require it. In the absence or disqualification of any member of any such committee or committees, the member or members thereof present at any meeting and not disqualified from voting, whether or not he 71 or they constitute a quorum, may unanimously appoint another member of the Board of Directors to act at the meeting in the place of any such absent or disqualified member. 7. ACTION IN WRITING. Any action required or permitted to be taken at any meeting of the Board of Directors or any committee thereof may be taken without a meeting if all members of the Board or committee, as the case may be, consent thereto in writing, and the writing or writings are filed with the minutes of proceedings of the Board or committee. ARTICLE III ----------- OFFICERS -------- The directors shall elect a President, a Secretary, and a Treasurer, and may elect a Chairman of the Board of Directors, a Vice-Chairman thereof, and one or more Vice-Presidents, Assistant Secretaries, and Assistant Treasurers, and may elect or appoint such other officers and agents as are desired. The President may but need not be a director. Any number of offices may be held by the same person. Unless otherwise provided in the resolution of election or appointment, each officer shall hold office until the meeting of the Board of Directors following the next annual meeting of stockholders and until his successor has been elected and qualified. Any officer may resign at any time upon written notice. Officers shall have the powers and duties defined in the resolutions appointing them; provided, that the Secretary shall record all proceedings of the meetings or of the written actions of the stockholders and of the directors, and any committee thereof, in a book to be kept for that purpose. The Board of Directors may remove any officer for cause or without cause. 72 ARTICLE IV ---------- CORPORATE SEAL -------------- The corporate seal shall be in such form as the Board of Directors shall prescribe. ARTICLE V --------- FISCAL YEAR ----------- The fiscal year of the corporation shall be fixed, and shall be subject to change, by the Board of Directors. ARTICLE VI ---------- CONTROL OVER BY-LAWS -------------------- The power to amend, alter, and repeal these By-Laws and to adopt new By-Laws shall be vested in the Board of Directors; provided, that the Board of Directors may delegate such power, in whole or in part, to the stockholders; and provided, further, that any By-Law, other than an initial By-Law, which provides for the election of directors by classes for staggered terms shall be adopted by the stockholders. I HEREBY CERTIFY that the foregoing is a full, true and correct copy of the By-Laws of SCAN-OPTICS, INC., a Delaware corporation, as in effect on the date hereof. The foregoing By-Laws include the amendments to the By-Laws that were effective on May 17, 1984 and January 28, 1991. WITNESS my hand and the seal of the corporation. Dated: ___________/ ss /___________ Secretary of SCAN-OPTICS, INC. (SEAL) EX-10 4 exhibit10-20.txt EXHIBIT 10-20 EXHIBIT - 10.20 FIFTH AMENDMENT ARK CLO 2000-1, LIMITED c/o Patriarch Partners, LLC 40 Wall Street - 25th Floor New York, NY 10005 As of December 31, 2002 Scan-Optics, Inc. 169 Progress Drive Manchester, CT 06040-2294 Attention: Michael Villano, Chief Financial Officer Re: Fifth Amendment to Loan Agreement Ladies and Gentlemen: We refer to the Second Amended and Restated Loan Agreement dated as of May 10, 1999 (as amended, the "Loan Agreement") between Scan-Optics, Inc. (the "Borrower") and ARK CLO 2000-1, Limited, as successor-in-interest to Fleet Bank (the "Lender"), as amended by the 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 dated as of December 31, 2001. All capitalized terms used herein without definition that are defined in the Loan Agreement shall have the same meanings herein as therein. The Borrower and the Lender hereby agree that, effective as of the date hereof, Section 10(c)(i) of the Loan Agreement is hereby amended in its entirety to read as follows: "(i) make any Capital Expenditures in a fiscal year ending on or after December 31, 2002 in excess of $375,000; or:" Each of the Borrower, Scan-Optics, Limited and Scan-Optics (Canada) Ltd. (collectively, the "Obligors") hereby represents and warrants to the Lender that 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 date hereof, except to the extent that any of such representations and warranties expressly relate by their terms to a prior date. 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 the Guaranties which are hereby reaffirmed. In addition, by the execution of this Agreement, each of the Obligors represents and warrants that no counterclaim, right of set-off or defense of any kind exists or is outstanding with respect to such obligations. 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. 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. 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 IF OF THE ESSENCE AS TO ALL OF THE PROVISIONS HEREIN. If the foregoing correctly sets forth our understanding, we request that you execute a copy of this Agreement and return it to the undersigned as soon as possible. Sincerely, ARK CLO 2000-1, Limited By: Patriarch Partners, LLC, its Collateral Manager By: ______/ ss /____________ Name: Lynn Tilton Title: Authorized Signatory ACCEPTED AND AGREED TO: SCAN-OPTICS, INC. By: ______/ ss /____________ Michael J. Villano Its: CFO & VP SCAN-OPTICS LIMITED By: ______/ ss /____________ Michael J. Villano Its: Director SCAN-OPTICS (CANADA) LTD. By: ______/ ss /____________ Michael J. Villano Its: VP EX-23 5 exhibit23.txt EXHIBIT 23 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 March 26, 2003, 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, 2002. /s/ Ernst & Young LLP Hartford, Connecticut March 26, 2003 EX-99 6 exhibit99-1.txt EXHIBIT 99-1 EXHIBIT - 99.1 - -------------- CERTIFICATION I, James C. Mavel, the Chairman, Chief Executive Officer and President of Scan-Optics, Inc. (the "Company") certify, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that: (i) the Annual Report on Form 10-K of the Company for the period ended December 31, 2002 fully complies with the requirements of Section 13(a) of the Securities Exchange Act of 1934; and (ii) the information contained in such Quarterly Report fairly presents, in all material respects, the financial condition and results of operations of the Company. By: / ss/ Date March 26, 2003 --------------------------- -------------------------- James C. Mavel Chairman, Chief Executive Officer and President EX-99 7 exhibit99-2.txt EXHIBIT 99-2 EXHIBIT - 99.2 - -------------- CERTIFICATION I, Michael J. Villano, the Chief Financial Officer, Vice President and Treasurer of Scan-Optics, Inc. (the "Company") certify, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that: (i) the Annual Report on Form 10-K of the Company for the period ended December 31, 2002 fully complies with the requirements of Section 13(a) of the Securities Exchange Act of 1934; and (ii) the information contained in such Quarterly Report fairly presents, in all material respects, the financial condition and results of operations of the Company. Date March 26, 2003 / ss/ - ------------------------- ------------------------------ Michael J. Villano Chief Financial Officer, Vice President and Treasurer -----END PRIVACY-ENHANCED MESSAGE-----