-----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, HoybJryeUDx/2/NDp7GL7EEA60EM73vbZh+srMSRsPuF3XjqVccEbcuXuLZ9AXH+ B5+tyuUKOhqgkP7eU5WQkw== 0000950159-03-000957.txt : 20031114 0000950159-03-000957.hdr.sgml : 20031114 20031114153804 ACCESSION NUMBER: 0000950159-03-000957 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 20030930 FILED AS OF DATE: 20031114 FILER: COMPANY DATA: COMPANY CONFORMED NAME: SCAN OPTICS INC CENTRAL INDEX KEY: 0000087086 STANDARD INDUSTRIAL CLASSIFICATION: COMPUTER PERIPHERAL EQUIPMENT, NEC [3577] IRS NUMBER: 060851857 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 000-05265 FILM NUMBER: 031004226 BUSINESS ADDRESS: STREET 1: 169 PROGRESS DR CITY: MANCHESTER STATE: CT ZIP: 06040 BUSINESS PHONE: 8606457878 MAIL ADDRESS: STREET 1: 169 PROGRESS DR CITY: MANCHESTER STATE: CT ZIP: 06040 10-Q 1 scan10q9-03.txt UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q (X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 2003 ------------------ OR ( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to ----------- ------------ Commission File No. 0-5265 ----------------- SCAN-OPTICS, INC. - -------------------------------------------------------------------------------- (Exact name of registrant as specified in its charter) Delaware 06-0851857 - -------------------------------------------------------------------------------- (State or other jurisdiction of (I.R.S. Employer Identification Number) incorporation or organization) 169 Progress Drive, Manchester, CT 06040 - -------------------------------------------------------------------------------- (Address of principal executive offices) Zip Code (860) 645-7878 - -------------------------------------------------------------------------------- (Registrant's telephone number, including area code) Indicate by check mark whether the Registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. ( X ) YES ( ) NO Indicate by check mark whether the Registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). ( ) YES ( X ) NO The number of shares of common stock, $.02 par value, outstanding as of November 1, 2003 was 7,439,732. 1 SCAN-OPTICS, INC. FORM 10-Q I N D E X
PAGE NO. PART I - FINANCIAL INFORMATION Item 1. Financial Statements.................................................................... 3 Item 2. Management's Discussion and Analysis of Consolidated Financial Condition and Results of Operations........................................................... 13 Item 3. Quantitative and Qualitative Disclosures About Market Risk............................... 19 Item 4. Controls and Procedures.................................................................. 19 PART II - OTHER INFORMATION Item 6. Exhibits and Reports on Form 8-K........................................................ 20
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PART I - FINANCIAL INFORMATION Item 1. Financial Statements. SCAN-OPTICS, INC., AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (thousands, except share data) September 30, December 31, 2003 2002 - ------------------------------------------------------------------------------------------- (UNAUDITED) Assets Current Assets: Cash and cash equivalents $ 399 $ 274 Accounts receivable less allowance of $1,080 at September 30, 2003 and $1,574 at December 31, 2002 6,658 5,554 Unbilled receivables - contracts in progress 244 377 Inventories 8,555 9,139 Prepaid expenses and other 1,014 591 -------------------------- Total current assets 16,870 15,935 Plant and equipment: Equipment 3,731 8,836 Leasehold improvements 4,009 5,209 Office furniture and fixtures 614 725 -------------------------- 8,354 14,770 Less allowances for depreciation and amortization 7,310 13,456 -------------------------- 1,044 1,314 Goodwill 9,040 9,040 Other assets 117 117 -------------------------- Total Assets $27,071 $26,406 ==========================
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(thousands, except share data) September 30, December 31, 2003 2002 - --------------------------------------------------------------------------------------------- (UNAUDITED) Liabilities and Stockholders' Equity Current liabilities: Accounts payable $ 2,860 $ 2,454 Notes payable 1,500 1,500 Salaries and wages 1,200 958 Taxes other than income taxes 373 501 Income taxes 47 45 Customer deposits 1,319 1,308 Deferred revenues 2,648 2,217 Other 1,647 1,669 ---------------------------- Total current liabilities 11,594 10,652 Notes payable 7,989 9,042 Other liabilities 1,925 1,640 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 at September 30, 2003 and December 31, 2002 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 (33,245) (33,667) Accumulated other comprehensive loss (849) (918) ---------------------------- 4,409 3,918 Less cost of common stock in treasury, 413,500 shares 2,646 2,646 ---------------------------- Total stockholders' equity 1,763 1,272 ---------------------------- Total Liabilities and Stockholders' Equity $ 27,071 $ 26,406 ============================ See accompanying notes.
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SCAN-OPTICS, INC., AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED) Three Months Ended Nine Months Ended September 30 September 30 (thousands, except share data) 2003 2002 2003 2002 - ------------------------------------------------------------------------------------------------------------------------- Revenues Hardware and software $ 3,451 $ 2,799 $ 11,752 $ 9,095 Professional services 1,241 1,628 3,864 4,962 Access services 2,673 2,741 7,966 8,777 -------------------------------------- ---------------------------------- Total revenues 7,365 7,168 23,582 22,834 Costs of Revenue Hardware and software 2,410 1,785 7,348 5,999 Professional services 645 754 2,097 2,182 Access services 2,172 2,105 6,683 6,671 -------------------------------------- ---------------------------------- Total costs of revenue 5,227 4,644 16,128 14,852 Gross Margin 2,138 2,524 7,454 7,982 Operating Expenses Sales and marketing 767 874 2,614 2,539 Research and development 207 323 986 1,389 General and administrative 900 879 2,729 2,754 Interest 185 203 667 642 -------------------------------------- ---------------------------------- Total operating expenses 2,059 2,279 6,996 7,324 -------------------------------------- ---------------------------------- Operating income 79 245 458 658 Other income (expense), net (56) (5) 5 7 --------------------------------------- ---------------------------------- Income before income taxes 23 240 463 665 Income tax expense 11 20 41 61 -------------------------------------- ---------------------------------- Net Income $ 12 $ 220 $ 422 $ 604 ====================================== ================================== Basic earnings per share $ 0.00 $ 0.03 $ 0.06 $ 0.09 ====================================== ================================== Basic weighted-average common shares 7,026,232 7,026,232 7,026,232 7,026,232 Diluted earnings per share $ 0.00 $ 0.03 $ 0.05 $ 0.08 ====================================== ================================== Diluted weighted-average common shares 8,171,929 7,229,109 7,715,708 7,314,788 See accompanying notes.
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SCAN-OPTICS, INC., AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) Nine Months Ended September 30 (thousands) 2003 2002 - ------------------------------------------------------------------------------------------ Operating Activities Net Income $ 422 $ 604 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation 259 314 Amortization of customer service inventory and software license 1,532 1,800 Disposal of fixed assets 46 Changes in operating assets and liabilities: Accounts receivable and unbilled receivables (971) 377 Inventories (948) (1,758) Prepaid expenses and other (423) (28) Accounts payable 406 (531) Accrued salaries and wages 242 (90) Taxes other than income taxes (128) (137) Income taxes 2 Deferred revenues 431 (85) Customer deposits 11 701 Other 360 246 ---------------------------- Net cash provided by operating activities 1,241 1,413 Investing Activities Purchases of plant and equipment, net (63) (72) ---------------------------- Net cash used by investing activities (63) (72) Financing Activities Proceeds from borrowings 5,300 2,626 Principal payments on borrowings (6,353) (4,876) ---------------------------- Net cash used by financing activities (1,053) (2,250) Increase (decrease) in cash and cash equivalents 125 (909) Cash and Cash Equivalents at Beginning of Period 274 1,662 ---------------------------- Cash and Cash Equivalents at End of Period $ 399 $ 753 ============================
See accompanying notes. 6 NOTE 1 - Basis of Presentation and Significant Accounting Policies - ------ The accompanying unaudited interim consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the nine month period ended September 30, 2003 are not necessarily indicative of the results that may be expected for the year ending December 31, 2003. For further information, refer to the consolidated financial statements and footnotes thereto included in the Company's Annual Report on Form 10-K for the year ended December 31, 2002. Certain 2002 amounts have been reclassified to conform to current year presentation. New Accounting Pronouncements In May 2003, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards No. 150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity" ("SFAS 150"). This statement establishes standards for classifying and measuring, as liabilities, certain financial instruments that embody obligations of the issuer and have characteristics of both liabilities and equity. SFAS 150 generally requires liability classification for financial instruments, including mandatorily redeemable equity instruments and other non-equity instruments requiring, from inception, the repurchase by the issuer of its equity shares. This statement is applicable to the Company as of the beginning of the first interim financial reporting period beginning after June 15, 2003. The adoption of this Statement did not have a significant effect on the Company's financial position as of September 30, 2003 or on the results of operations for the three-month or nine-month periods ending September 30, 2003. In May 2003, the FASB's Emerging Issues Task Force defined the scope of Issue 00-21, "Revenue Arrangements With Multiple Deliverables" ("EITF No. 00-21") and its interaction with other authoritative literature. This statement is applicable to agreements entered into for reporting periods beginning after June 15, 2003 and requires companies with revenue arrangements including multiple deliverables to be divided into separate units of accounting for revenue recognition purposes, if the deliverables in the arrangement meet certain criteria, including standalone value to the customer, objective and reliable evidence of the fair value of the undelivered items exists and if the arrangement includes a general right of return relative to the delivered item, delivery or performance of the undelivered item is considered probable and substantially in the control of the vendor. The adoption of this Statement did not have a significant effect on the Company's financial position as of September 30, 2003 or on the results of operations for the three-month or nine-month periods ending September 30, 2003. 7 Stock Based Compensation The Company 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. 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. In December 2002, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") 148, "Accounting for Stock-Based Compensation--Transition and Disclosure". SFAS 148 amends the disclosure requirements of SFAS 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. The following table illustrates the effect on net income and income per share if the Company had applied the fair value recognition provisions of SFAS No. 123:
For the three months ended For the nine months ended September 30 September 30 (thousands, except per share amounts) 2003 2002 2003 2002 - ---------------------------------------------------------------------------------------------------------------------- Net income, as reported $ 12 $ 220 $ 422 $ 604 Stock option (income) expense (25) 28 (38) (223) --------------------------------------------------------------------- Pro forma net income (loss) $ (13) $ 248 $ 384 $ 381 ===================================================================== Basic earnings per share, as reported $ .00 $ .03 $ .06 $ .09 Stock option expense .00 .00 (.01) (.03) --------------------------------------------------------------------- Pro forma basic earnings per share $ .00 $ .03 $ .05 $ .06 ===================================================================== Diluted earnings per share, as reported $ .00 $ .03 $ .05 $ .08 Stock option expense .00 .00 (.01) (.03) --------------------------------------------------------------------- Pro forma diluted earnings per share $ .00 $ .03 $ .04 $ .05 =====================================================================
8 NOTE 2 - Inventories - ------ The components of inventories were as follows: September 30 December 31 (thousands) 2003 2002 - --------------------------------------------------------------------------- Finished goods $ 58 $ 56 Work-in-process 1,250 1,325 Service parts 3,322 3,715 Materials and component parts 3,925 4,043 ------------------------------------ $ 8,555 $ 9,139 ==================================== NOTE 3 - 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 an initial term loan of $2 million. 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. The outstanding borrowings at September 30, 2003 and December 31, 2002 were $9.5 million and $10.5 million, respectively. 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 September 30, 2003 outstanding balance through the next fiscal year. All outstanding borrowings under the Agreement will be due and payable as of December 31, 2004. The available balance on the outstanding borrowings was $2.1 million and $1.5 million at September 30, 2003 and December 31, 2002, respectively. The weighted average interest rate for the third quarter of 2003 was 4.9% compared to 5.6% in 2002. 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. Excess cash flow is based upon the calculation of consolidated cash flow (the sum of earnings from operations before income taxes and interest plus depreciation and amortization minus cash taxes paid minus capital expenditures) minus the aggregate amount of consolidated financial obligations (payments on indebtedness or payments on capitalized leases). The recapture of excess cash flow for the year ending December 31, 2002 was $.4 million, which was paid in the third quarter of 2003 and reduced the term loan balance to $1.6 million. As the interest rates are variable, the carrying value of the notes payable approximates its fair value. The notes payable are secured by all of the Company's assets. 9 NOTE 4 - Income Taxes At September 30, 2003, the Company had U.S. federal and state net operating loss carryforwards of approximately $28,264,000 and $27,048,000, respectively. The U.S. federal and state net operating loss carryforwards expire through 2015. At September 30, 2003, the Company had approximately $3,549,000 and $800,000 of net operating loss carryforwards for the United Kingdom and Germany, respectively, which expire through 2007. At December 31, 2002, the Company had U.S. federal and state net operating loss carryforwards of approximately $27,200,000 and $26,000,000, respectively. At December 31, 2002, the Company had approximately $226,000, $3,400,000 and $800,000 of net operating loss carryforwards for Canada, the United Kingdom and Germany, respectively. For financial reporting purposes, a valuation allowance has been recorded to fully offset deferred tax assets relating to U.S. federal, state, and foreign net operating loss carryforwards and other temporary differences. NOTE 5 - Earnings Per Share The following table sets forth the computation of basic and diluted earnings per share:
Three Months Ended Nine Months Ended September 30 September 30 2003 2002 2003 2002 ------------------------------------------------------------------------ Numerator: Net earnings $ 12 $ 220 $ 422 $ 604 ======================================================================== Denominator: Denominator for basic earnings per share (weighted-average shares) 7,026,232 7,026,232 7,026,232 7,026,232 Effect of dilutive securities: Employee stock options 1,145,697 202,877 689,476 288,556 ------------------------------------------------------------------------ Denominator for diluted earnings per share (adjusted weighted-average shares and assumed conversions) 8,171,929 7,229,109 7,715,708 7,314,788 ======================================================================== Basic earnings per share $ .00 $ .03 $ .06 $ .09 ======================================================================== Diluted earnings per share $ .00 $ .03 $ .05 $ .08 ========================================================================
10 NOTE 6 - Comprehensive Income - ------ The components of comprehensive income (loss) for the three and nine months ended September 30, 2003 and 2002 are as follows:
Three Months Ended Nine Months Ended September 30 September 30 (thousands) 2003 2002 2003 2002 - ------------------------------------------------------------------------------------------------------------------- Net Income $ 12 $ 220 $ 422 $ 604 Foreign currency translation adjustments (34) 18 69 71 --------------------------------------------------------------- Comprehensive income (loss) $ (24) $ 238 $ 491 $ 675 =============================================================== The components of accumulated comprehensive loss at September 30, 2003 and December 31, 2002 are as follows: September 30 December 31 (thousands) 2003 2002 - ------------------------------------------------------------------------------------------- Foreign currency translation adjustments $ (849) $ (918) -------------------------------------- Accumulated comprehensive loss $ (849) $ (918) ======================================
NOTE 7 - Segment Information - ------ The Company views its business in three distinct revenue categories: Solution and products sales, Access services, and Contract manufacturing services. Revenues are used by management as a guide to determine the effectiveness of the individual segment. The Company manages its operating expenses through a traditional functional perspective and accordingly does not report operating expenses on a segment basis.
Three Months Ended Nine Months Ended September 30 September 30 (thousands) 2003 2002 2003 2002 - ------------------------------------------------------------------------------------------------------------------- Revenues Solutions and products $ 4,446 $ 4,129 $ 15,290 $ 12,988 Access services 2,673 2,741 7,966 8,777 Contract manufacturing services 246 298 326 1,069 --------------------------------------------------------------- 11 Total revenues 7,365 7,168 23,582 22,834 Cost of solutions and products 3,055 2,539 9,445 8,181 Service expenses 2,172 2,105 6,683 6,671 --------------------------------------------------------------- Gross profit margin 2,138 2,524 7,454 7,982 Operating expenses and other income, net 2,115 2,284 6,991 7,317 --------------------------------------------------------------- Income before income taxes $ 23 $ 240 $ 463 $ 665 =============================================================== Total expenditures for additions to long-lived assets $ 3 $ 24 $ 63 $ 72
Certain 2002 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 8 - 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 received from the customer. The Company recorded no bill and hold revenue during the third quarter of 2003 and $2.3 million in the first nine months of 2003. Revenues recorded during the first nine months of 2002 included bill and hold transactions of $.9 million. Accounts receivable included bill and hold receivables of $.7 million, and $1.1 million at September 30, 2003 and December 31, 2002, respectively. 12 Item 2. Management's Discussion and Analysis of Consolidated Financial Condition and Results of Operations. Outlook The forward-looking statements contained in this section 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 3 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 or an inability to comply with financial covenants in its debt agreements or a failure to extend or replace its existing debt agreements prior to December 31, 2004. A one percent increase in the prime rate would increase the annual interest cost on the outstanding loan balance at September 30, 2003 of approximately $9.5 million by $.1 million. All outstanding borrowings under the Company's existing debt agreements will be due and payable as of December 31, 2004 and, as of that date, the Company will also be obligated to redeem from its lender the Company's mandatorily redeemable non-voting preferred stock at a redemption price equal to $3.8 million plus interest accrued on such amount from December 31, 2001 through the date of redemption at an interest rate per annum equal to the prime rate of interest in effect from time to time during such period, plus 2% compounded annually. The Company's business could be adversely affected by downturns in the domestic and international economy. The Company's international sales and operations are subject to various international business risks. The Company's revenues depend in part on contracts with various state or federal governmental agencies, and could be adversely affected by patterns in government spending. The Company faces competition from many sources, and its products may be replaced with products relying on alternative technologies. The Company's business could be adversely affected by technological changes. The Company achieved net income of $12,000 in the third quarter of 2003 compared to $.2 million in the third quarter of 2002. Net income for the nine months ended September 30, 2003 was $.4 million compared to $.6 million for the comparable period in 2002. The Company has three major initiatives currently underway to improve revenue growth and profitability. They are designed to emphasize the "Business of Solutions" focus in targeted markets, introduce the Business Process Outsourcing Service and expand the Access Services Division to include enterprise-wide maintenance services. The inability of the Company to carry out these initiatives may have a material adverse effect on revenue growth and earnings. The first initiative is to provide cost-effective solutions through the Company's development of target market data capture applications combined with its high speed transports and archival systems. The Company has refined its target market approach and has chosen to focus primarily on the government and insurance markets, while continuing to address the 13 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 $2.7 million or 35% from the first nine months of 2002 to 2003 and $.2 million or 7% in a comparison of the third quarter of 2003 vs. 2002, mainly due to an increase in the government market. The second initiative, introduced in early 2003, is a Business Process Outsourcing ("BPO") Service to capture images of 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 image-based storage and retrieval systems, they are faced with the need to convert their existing paper files or to outsource the activity. The BPO Services offer customers a high quality, turnkey outsourcing solution utilizing the Company's proprietary hardware technology, as well as its software skills, resources and process controls. The third initiative, by our Access Services Division, is an expansion to include enterprise-wide maintenance services for network and network-related equipment. 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 U.S., 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. Results of Operations for the Three and Nine Months Ended September 30, 2003 vs. 2002 Total revenues increased $.7 million or 3% from the first nine months of 2002 to the first nine months of 2003 and increased $.2 million or 3% from the third quarter of 2002 to the third quarter of 2003. Hardware and software revenues increased $2.7 million or 29% in the first nine months of 2003 compared with the same period in 2002 and increased $.7 million or 23% from the third quarter of 2002 compared to 2003. Compared to the first nine months of 2002, North American sales increased $2.6 million or 29% and increased $.5 million or 19% during the third quarter of 2003 compared to the third quarter of 2002 mainly due to the increase in hardware sales to replace or upgrade existing equipment at current customer sites. International sales remained consistent with the first nine months of 2002 and the third quarter of 2002. 14 Professional services revenues decreased $1.1 million or 22% in the first nine months of 2003 compared with the first nine months of 2002 and decreased $.4 million or 24% during the third quarter of 2003 compared to the third quarter of 2002. These decreases relate to the difficulties in the current United States economy. Access services revenues decreased $.8 million or 9% in the first nine months of 2003 compared with the first nine months of 2002 and decreased $.1 million or 2% during the third quarter of 2003 compared to the third quarter of 2002. The decrease in revenue is mainly due to decreases in 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 increased $1.3 million or 22% in the first nine months of 2003 compared to the first nine months of 2002 and increased $.6 million or 35% in the third quarter of 2003 compared to the third quarter of 2002. The gross margin was 37% for the first nine months of 2003, compared to 34% in the first nine months of the prior year. The gross margin was 30% during the third quarter of 2003, compared to 36% in the third quarter of the prior year. The changes in gross margin are mainly due to changes in product mix and a decline in contract manufacturing volumes. Cost of professional services decreased $.1 million in the first nine months of 2003 vs. 2002 and decreased $.1 million in the third quarter of 2003 compared to the prior year. The gross margin was 46% for the first nine months and 48% for the third quarter of 2003, compared to 56% in the first nine months and 54% in the third quarter of 2002. The decrease in gross margin was mainly due to a decline in new solutions sales, as well as fixed costs that exist to support a higher volume of business. Cost of Access Services remained flat for the first nine months of 2003 vs. 2002 and increased $.1 million in the third quarter of 2003 compared to the prior year. The gross margin was 16% for the first nine months of 2003, compared to 24% in the first nine months of 2002. The gross margin was 19% during the third quarter of 2003, compared to 23% in the third quarter of the prior year. The decrease in margin is due to decreased Access Services revenue, which was only partially offset by a decrease in expenses. Sales and marketing expenses increased $.1 million in the first nine months of 2003 compared to the first nine months of 2002 and decreased $.1 million in the third quarter of 2003 compared to the third quarter of 2002. The increase is mainly in outside services related to the Company's new website as well as increases in consulting services for recoverable monthly payments related to an additional reseller in the Washington, D.C., area. 15 Research and development expenses decreased $.4 million from the first nine months of 2002 and decreased $.1 million from the third quarter of 2002 mainly due to a decrease in software license amortization related to the BlueBird software agreement, which has been fully amortized. General and administrative expenses remained consistent in the nine month and third quarter comparison from 2003 vs. 2002. Interest expense remained consistent with the first nine months of 2002 and the third quarter of 2002. The weighted average interest rate for the first nine months of 2003 was 5.1% compared to 5.6% in 2002. Liquidity and Capital Resources Cash and cash equivalents at September 30, 2003 increased $.1 million from December 31, 2002 levels. Total borrowings were $9.5 million or $1.1 million lower than the $10.6 million level at December 31, 2002. The available balance on the line of credit was $2.1 million at September 30, 2003. As of September 30, 2003, the Company is in compliance with all of the financial covenants. The Company anticipates meeting its current obligations and resource needs through the funds generated through operations. (See Note 3 for further details.) All outstanding borrowings under the Company's credit agreements will be due and payable as of December 31, 2004 and, as of that date, the Company will also be obligated to redeem from its lender the Company's mandatorily redeemable non-voting preferred stock. Although the Company expects to extend or refinance this indebtedness and redeem the preferred stock, there can be no assurance as to the availability or terms of any such extension or refinancing. If the Company fails to extend or refinance its existing indebtedness and redeem its preferred stock prior December 31, 2004, the Company's current lender has the right to exercise warrants to acquire up to 33.20% of the Company's common stock and to convert its manditorily redeemable non-voting preferred stock into voting preferred stock. It is possible that the terms of any extension or refinancing of the indebtedness could require the issuance by the Company of equity that would dilute current stockholders. Operating activities provided $1.2 million of cash in the first nine months of 2003, as compared to $1.4 million in the first nine months of 2002. Non-cash expenses recorded during the first nine months of the year were $1.8 million, a decrease of $.3 million from the same period in 2002. These expenses relate to disposal losses and depreciation of fixed assets (discussed in net plant and equipment below) and amortization of customer service inventory and software license. Net accounts receivable and unbilled receivables at September 30, 2003 increased $1 million from December 31, 2002 16 due mainly to the increase in revenue from the fourth quarter of 2002 of $6.4 million to revenue of $7.4 million in the third quarter of 2003. The increase in revenue of $1 million along with the timing of payments resulted in the increase in accounts receivables. Total inventories at September 30, 2003 decreased $.6 million from December 31, 2002. Total manufacturing inventories decreased $.2 million from the beginning of the year mainly due to the timing of the 2003 fourth quarter build plan and third quarter delivery of equipment. Customer service inventories decreased $.4 million mainly due to amortization of inventory. Prepaid expenses and other increased $.4 million due to capitalized project engineering costs recorded in the third quarter of 2003. Net plant and equipment decreased $.3 million from December 31, 2002 mainly due to depreciation expense reported during the first nine months of the year. During 2003, the Company performed a physical inventory of all plant and equipment and based on the results of these procedures wrote-off assets, primarily fully depreciated assets, which are no longer used in operations. As a result, the gross cost of these assets, as well as, the related accumulated depreciation and amortization were reduced by $6.5 million. The impact of this activity on 2003 operating results was a loss of approximately $46,000, which was recognized during the third quarter. Accounts payable increased $.4 million from December 31, 2002 due to the timing of payments. Salaries and wages increased $.2 million due mainly to an increase in the vacation accrual that is expected to be utilized over the remainder of the year and an increase in accrued commissions. Taxes other than income taxes decreased $.1 million due to payments made for sales and use taxes in various states and Goods and Services Tax in Canada. Customer deposits were flat with December 31, 2002 balances. Deferred revenues increased $.4 million due to an increase in annual billings that were previously billed on a monthly basis. Other liabilities were consistent with December 31, 2002 levels. Critical Accounting Policies Our critical accounting policies are discussed in Management's Discussion and Analysis of Consolidated Financial Condition and Results of Operations in our Annual Report on Form 10-K for the year ended December 31, 2002. The preparation of our financial statements requires us to make estimates that affect the reported amounts of assets, liabilities, revenue and expenses and related disclosures of contingent assets and liabilities. We base our accounting estimates on historical experience and other factors that are believed to be reasonable under the circumstances. However, actual results may vary from these estimates under different assumptions or conditions. 17 New Accounting Pronouncements In May 2003, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards No. 150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity" ("SFAS 150"). This statement establishes standards for classifying and measuring, as liabilities, certain financial instruments that embody obligations of the issuer and have characteristics of both liabilities and equity. SFAS 150 generally requires liability classification for financial instruments, including mandatorily redeemable equity instruments and other non-equity instruments requiring, from inception, the repurchase by the issuer of its equity shares. This statement is applicable to the Company as of the beginning of the first interim financial reporting period beginning after June 15, 2003. The adoption of this Statement did not have a significant effect on the Company's financial position as of September 30, 2003 or on the results of operations for the three-month or nine-month periods ending September 30, 2003. In May 2003, the FASB's Emerging Issues Task Force defined the scope of Issue 00-21, "Revenue Arrangements With Multiple Deliverables" ("EITF No. 00-21") and its interaction with other authoritative literature. This statement is applicable to agreements entered into for reporting periods beginning after June 15, 2003 and requires companies with revenue arrangements including multiple deliverables to be divided into separate units of accounting for revenue recognition purposes, if the deliverables in the arrangement meet certain criteria, including standalone value to the customer, objective and reliable evidence of the fair value of the undelivered items exists and if the arrangement includes a general right of return relative to the delivered item, delivery or performance of the undelivered item is considered probable and substantially in the control of the vendor. The adoption of this Statement did not have a significant effect on the Company's financial position as of September 30, 2003 or on the results of operations for the three-month or nine-month periods ending September 30, 2003. Item 3. Quantitative and Qualitative Disclosures About Market Risk. In 2001, the Company completed a total debt restructuring (see Note 3 for further information), however, the Company remains highly leveraged and could be adversely affected by a significant increase in interest rates or a failure to extend or replace its existing debt agreements prior to December 31, 2004. A one percent increase in the prime rate would increase the annual interest cost on the outstanding loan balance at September 30, 2003 of approximately $10.6 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. 18 Item 4. 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 Securities Exchange Act of 1934 (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 as of the end of the period covered by this Quarterly Report on Form 10-Q. 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 provide reasonable assurance that information required to be disclosed by the Company in reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms. There were no changes in the Company's internal control over financial reporting that occurred during the Company's most recent fiscal quarter that materially affected, or are reasonably likely to materially affect, the Company's internal control over financial reporting. 19 PART II - OTHER INFORMATION Item 6. Exhibits and Reports on Form 8-K. (a) Exhibits. Exhibit Number Description Exhibit 31.1* CEO Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. Exhibit 31.2* CFO Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. Exhibit 32.1* CEO Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. Exhibit 32.2* CFO Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. * Filed herewith. (b) Reports on Form 8-K. Report on Form 8-K filed August 1, 2003 regarding second quarter of 2003 earnings. 20 SIGNATURES ----------- Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. SCAN-OPTICS, INC. Date November 14, 2003 / s/ James C. Mavel ----------------- ------------------------------ James C. Mavel Chairman, Chief Executive Officer and President Date November 14, 2003 / s/ Michael J. Villano ----------------- ------------------------------ Michael J. Villano Chief Operating Officer, Chief Financial Officer, Vice President and Treasurer 21 EX-31 3 exhibit31-1.txt EXHIBIT 31.1 Exhibit 31.1 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 quarterly report on Form 10-Q of Scan-Optics, Inc. for the period ended September 30, 2003; 2. Based on my knowledge, this 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 statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this 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 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-15(e) and 15d-15(e)) for the registrant and have: a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, 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 report is being prepared; b) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and c) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: November 14, 2003 / s/ James C. Mavel --------------------------------- James C. Mavel Chairman, Chief Executive Officer and President EX-31 4 exhibit31-2.txt EXHIBIT 31.2 Exhibit 31.2 CERTIFICATION OF CHIEF FINANCIAL OFFICER I, Michael J. Villano, Chief Operating Officer, Chief Financial Officer, Vice President and Treasurer of Scan-Optics, Inc., certify that: 1. I have reviewed this quarterly report on Form 10-Q of Scan-Optics, Inc. for the period ended September 30, 2003; 2. Based on my knowledge, this 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 statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this 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 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-15(e) and 15d-15(e)) for the registrant and have: a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, 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 report is being prepared; b) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and c) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: November 14, 2003 / s/_Michael J. Villano ------------------------------------------- Michael J. Villano Chief Operating Officer, Chief Financial Officer, Vice President and Treasurer EX-32 5 exhibit32-1.txt EXHIBIT 32.1 Exhibit 32.1 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 Quarterly Report on Form 10-Q of the Company for the period ended September 30, 2003 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 November 14, 2003 By: /s/ James C. Mavel --------------------------- James C. Mavel Chairman, Chief Executive Officer and President EX-32 6 exhibit32-2.txt EXHIBIT 32.2 Exhibit 32.2 CERTIFICATION I, Michael J. Villano, the Chief Operating Officer, 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 Quarterly Report on Form 10-Q of the Company for the period ended September 30, 2003 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 November 14, 2003 /s/ Michael J. Villano ---------------------------------------- Michael J. Villano Chief Operating Officer, Chief Financial Officer, Vice President and Treasurer -----END PRIVACY-ENHANCED MESSAGE-----