-----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, INzL9bey12L7t0Q9N/LD+qCKLox8kr/Iew+/zKsAucGOjEPAozurWeVMJeQ0fv9K SNarO9gyfKBHSJJUT5tgaQ== 0000950159-04-000797.txt : 20040816 0000950159-04-000797.hdr.sgml : 20040816 20040816171913 ACCESSION NUMBER: 0000950159-04-000797 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 8 CONFORMED PERIOD OF REPORT: 20040630 FILED AS OF DATE: 20040816 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: 04979887 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 scan6-0410q.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 June 30, 2004 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 July 30, 2004 was 7,026,232. 1 SCAN-OPTICS, INC. FORM 10-Q I N D E X PAGE NO. PART I - FINANCIAL INFORMATION Item 1. Consolidated Financial Statements...................................3 Item 2. Management's Discussion and Analysis of Consolidated Financial Condition and Results of Operations................................14 Item 3. Quantitative and Qualitative Disclosures About Market Risk ........21 Item 4. Controls and Procedures............................................21 PART II - OTHER INFORMATION Item 6. Exhibits and Reports on Form 8-K...................................22 2 S PAPART I - FINANCIAL INFORMATION Item 1. Consolidated Financial Statements. SCAN-OPTICS, INC., AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS
(thousands, except share data) June 30, 2004 December 31, 2003 - ----------------------------------------------------------------------------------------------------------------------- (UNAUDITED) Assets Current Assets: Cash and cash equivalents $ 916 $ 585 Accounts receivable less allowance of $311 at June 30, 2004 and $1,206 at December 31, 2003 5,017 6,043 Unbilled receivables - contracts in progress 805 415 Inventories 7,371 7,282 Prepaid expenses and other 1,131 597 -------------------------------------------------------------- Total current assets 15,240 14,922 Plant and equipment: Equipment 3,815 3,682 Leasehold improvements 4,010 4,010 Office furniture and fixtures 755 745 -------------------------------------------------------------- 8,580 8,437 Less allowances for depreciation and amortization 7,614 7,422 -------------------------------------------------------------- 966 1,015 Goodwill 9,040 9,040 Other assets 1,143 1,096 -------------------------------------------------------------- Total Assets $ 26,389 $ 26,073 ==============================================================
3
(thousands, except share data) June 30, 2004 December 31, 2003 - ---------------------------------------------------------------------------------------------------------------------------- (UNAUDITED) Liabilities and Stockholders' Equity Current liabilities: Accounts payable $ 2,843 $ 2,323 Salaries and wages 652 1,484 Taxes other than income taxes 677 758 Income taxes 101 189 Customer deposits 620 929 Deferred revenues 3,687 2,787 Other 1,558 1,495 ------------------------------------------------------------------ Total current liabilities 10,138 9,965 Note payable 10,500 7,989 Other liabilities 1,939 1,876 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, including treasury shares at June 30, 2004 and December 31, 2003 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 (34,901) (32,570) Accumulated other comprehensive loss (944) (844) ------------------------------------------------------------------ 2,658 5,089 Less cost of common stock in treasury, 413,500 shares 2,646 2,646 ------------------------------------------------------------------ Total stockholders' equity 12 2,443 ------------------------------------------------------------------ Total Liabilities and Stockholders' Equity $ 26,389 $ 26,073 ================================================================== See accompanying notes.
4 SCAN-OPTICS, INC., AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
Three Months Ended Six Months Ended June 30 June 30 (thousands, except share data) 2004 2003 2004 2003 - ---------------------------------------------------------------------------------------------------------------------------------- Revenues Hardware and software $ 2,549 $ 4,079 $ 5,976 $ 8,301 Professional services 1,497 1,239 3,007 2,623 Access services 2,832 2,789 5,228 5,293 ----------------------------------- ---------------------------------- Total revenues 6,878 8,107 14,211 16,217 Costs of Revenue Hardware and software 1,914 2,310 4,519 4,938 Professional services 759 684 1,638 1,452 Access services 2,505 2,380 4,837 4,511 ----------------------------------- ---------------------------------- Total costs of revenue 5,178 5,374 10,994 10,901 Gross Margin 1,700 2,733 3,217 5,316 Operating Expenses Sales and marketing 802 919 1,492 1,847 Research and development 629 440 1,180 779 General and administrative 1,665 901 2,498 1,829 Interest 191 283 358 482 ----------------------------------- ---------------------------------- Total operating expenses 3,287 2,543 5,528 4,937 ----------------------------------- ---------------------------------- Operating income (loss) (1,587) 190 (2,311) 379 Other income (loss), net (2) 44 30 61 ----------------------------------- ---------------------------------- Income (loss) before income taxes (1,589) 234 (2,281) 440 Income tax expense 30 20 50 30 ----------------------------------- ---------------------------------- Net Income (loss) $ (1,619) $ 214 $ (2,331) $ 410 =================================== ================================== Basic earnings (loss) per share $ (0.23) $ 0.03 $ (0.33) $ 0.06 =================================== ================================== Basic weighted-average shares 7,026,232 7,026,232 7,026,232 7,026,232 Diluted earnings (loss) per share $ (0.23) $ 0.03 $ (0.33) $ 0.05 =================================== ================================== Diluted weighted-average shares 7,026,232 7,812,441 7,026,232 7,487,598 See accompanying notes.
5 SCAN-OPTICS, INC., AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
Six Months Ended June 30 (thousands) 2004 2003 - -------------------------------------------------------------------------------------------------------------------------------- Operating Activities Net Income (loss) $ (2,331) $ 410 Adjustments to reconcile net income (loss) to net cash provided (used) by operating activities: Depreciation 150 194 Amortization of customer service inventory and software license 1,092 1,023 Changes in operating assets and liabilities: Accounts receivable and unbilled receivables 636 (2,210) Inventories (1,096) (570) Prepaid expenses and other (534) 112 Accounts payable 520 313 Accrued salaries and wages (832) 298 Taxes other than income taxes (81) (145) Income taxes (88) (3) Deferred revenues 900 301 Customer deposits (309) 177 Other (106) 565 ----------------------------------------------------- Net cash provided (used) by operating activities (2,079) 465 Investing Activities Purchases of plant and equipment, net (101) (63) ------------------------------------------------------ Net cash used by investing activities (101) (63) Financing Activities Proceeds from borrowings 4,711 2,850 Principal payments on borrowings (2,200) (2,792) ------------------------------------------------------ Net cash provided by financing activities 2,511 58 Increase in cash and cash equivalents 331 460 Cash and Cash Equivalents at Beginning of Year 585 274 ----------------------------------------------------- Cash and Cash Equivalents at End of Period $ 916 $ 734 ===================================================== See accompanying notes.
6 NOTE 1 - Basis of Presentation and Significant Accounting Policies The accompanying unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the six month period ended June 30, 2004 are not necessarily indicative of the results that may be expected for the year ending December 31, 2004. 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, 2003. 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 June 30, 2004 or on the results of operations for the three and six-month periods ending June 30, 2004. 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 June 30, 2004 or on the results of operations for the three and six-month periods ending June 30, 2004. As required, the Company adopted FASB Interpretation No. 46, Consolidation of Variable Interest Entities, an Interpretation of Accounting Research Bulletin 7 No. 51 beginning in January 2004. Based on management's evaluation, adoption did not have a significant impact on the Company's financial position or results of operations. 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, "Accounting for Stock-Based Compensation". The Company did recognize compensation expense of $29,000 in the second quarter of 2004 associated with options granted to non-employees. For the purpose of pro forma disclosures, the estimated fair value of the stock options is expensed ratably over the vesting period, which is generally 36 months for key employees and 6 months for members of 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 (loss) and income (loss) per share if the Company had applied the fair value recognition provisions of SFAS No. 123:
For the three months ended For the six months ended June 30 June 30 (thousands, except per share amounts) 2004 2003 2004 2003 - ------------------------------------------------------------------------------------------------------------------------ Net income (loss) , as reported $ (1,619) $ 214 $ (2,331) $ 410 Stock option expense (17) (25) (32) (38) ----------------------------------------------------------------- Pro forma net income (loss) $ (1,636) $ 189 $ (2,363) $ 372 ================================================================= Basic earnings (loss) per share, as reported $ (.23) $ .03 $ (.33) $ .06 Stock option expense .00 .00 .00 (.01) ----------------------------------------------------------------- Pro forma basic earnings (loss) per share $ (.23) $ .03 $ (.33) $ .05 ================================================================= Diluted earnings (loss) per share, as reported $ (.23) $ .03 $ (.33) $ .05 Stock option expense .00 .00 .00 (.01) ----------------------------------------------------------------- Pro forma diluted earnings (loss) per share $ (.23) $ .03 $ (.33) $ .04 ================================================================
8 NOTE 2 - Inventories Inventories, determined by the lower of cost (first-in, first-out) or market, consist of:
June 30 December 31 (thousands) 2004 2003 - -------------------------------------------------------------------------------------------------------- Finished goods $ 58 $ 57 Work-in-process 597 1,066 Service parts 2,893 3,291 Materials and component parts 3,823 2,868 ------------ ---------- $ 7,371 $ 7,282 ============ ==========
During the quarter-ended June 30, 2004, the Company reduced inventory by $.3 million. The adjustment which represented a change in management's estimate of the required reserve for excess and obsolete inventory related to service parts held by its wholly-owned subsidiary Scan Optics, Ltd., was recorded as $.2 million (or $0.04 per share) of additional amortization expense and reflected in costs of revenue for the period and the remaining $.1 million represented the impact of foreign exchange and was charged to other comprehensive loss. NOTE 3 - Credit Arrangements Effective March 30, 2004, the Company entered into a new credit agreement with lenders affiliated with Patriarch Partners, LLC. (the "Lenders") that, among other things, extends from December 31, 2004 through June 1, 2005 the repayment date for all of the Company's secured debt. At June 30, 2004 and December 31, 2003, the Company's outstanding borrowings were $10.5 million and $8.0 million, respectively, all of which are classified as long-term as the Company has refinanced the notes on a long-term basis. The available balance on the credit agreements was $2.5 million and $3.6 million at June 30, 2004 and December 31, 2003, respectively. The weighted average interest rate on borrowings during the second quarter of 2004 was 6.3% compared to 5.4% in the comparative period of 2003. As of June 30, 2004, the Company was in default of the EBITDA covenant. The default was subsequently waived by the Lenders by allowing certain one-time charges incurred during the quarter to be eliminated for purposes of calculating rolling EBITDA. Should the Company be unable to satisfy the EBITDA and other financial covenants in future periods, the debt may need to be classified as a current obligation, as the Lenders could exercise their right to call the debt as a result of future covenant violations. The Company's new secured term loan is payable in annual amounts of $90,000 beginning April 1, 2005 with the balance due at maturity. There is a $2.5 million revolving credit facility, provided as part of the debt restructuring, which can be used for working capital and other general business purposes. 9 Borrowings against both such loans will continue to accrue interest at a rate of prime plus 2%. There is no balance outstanding on the revolving credit facility at June 30, 2004. An additional $1.5 million term loan working capital facility was made available to the Company, effective March 30, 2004 with the Company obligated to repay $2.0 million at maturity. The working capital term loan will accrue interest on $2.0 million at the prime rate. The Company borrowed $1.5 million against this facility during the second quarter. As part of the restructuring, the Company's financial covenants with respect to backlog, capital expenditure and EBITDA have been modified to enhance the financial flexibility of the Company. Pursuant to the March 30, 2004 debt restructuring, the Company also exchanged the $3.8 million mandatorily redeemable Series A preferred stock held by the Lenders for $3.8 million of mandatorily redeemable Series B preferred stock, which Series B preferred stock has substantially the same terms as the Series A, except that the redemption date was extended to coincide with the Company's secured debt. On August 6, 2004, the Company completed a recapitalization with its Lenders, after obtaining stockholder approval of an amendment to the certificate of incorporation of the Company to increase the authorized common stock of the Company in order to permit the recapitalization at the July 15, 2004 annual meeting. The recapitalization included, among other terms, the cancellation of the $3.8 million mandatorily redeemable Series B preferred stock, including accrued dividends, and the existing warrants held by the Lenders, and the issuance of common stock of the Company to the Lenders so that following such issuance the Lenders own 79.8% of the fully-diluted common stock of the Company, subject to dilution for certain current and future compensatory stock options granted by the Company. Effective upon the closing of the recapitalization on August 6, 2004, the maturity date for all of the Company's secured indebtedness to the Lenders has been extended through March 30, 2007. The carrying value of the notes payable, which is secured by all of the Company's assets, approximates fair value. NOTE 4 - Income Taxes At June 30, 2004, the Company recorded $50,000 of tax expense for the first six months, which is an effective tax rate of 2.2%. No federal tax expense has been recorded due to the Company's available federal net operating loss carry forwards. For financial reporting purposes, a valuation allowance has been recorded to fully offset deferred tax assets relating to federal, state and 10 foreign taxes due to net operating loss carry forwards and other temporary differences as it is not more likely than not that the Company will benefit from future utilization of the net deferred tax assets. The Company's future ability to utilize the available net operating loss carryforwards may be restricted due to utilization limitations effected by change in control ramifications that would be triggered upon shareholder approval of the proposed restructuring (Note 3). NOTE 5 - Earnings Per Share The following table sets forth the computation of basic and diluted earnings (loss) per share:
Three Months Ended Six Months Ended June 30 June 30 2004 2003 2004 2003 Numerator: Net earnings (loss) $ (1,619) $ 214 $ (2,331) 410 =============================================================== Denominator: Denominator for basic earnings (loss) per share (weighted-average shares) 7,026,232 7,026,232 7,026,232 7,026,232 Effect of dilutive securities: Employee stock options - 786,209 - 461,366 --------------------------------------------------------------- Denominator for diluted earnings (loss) per share (adjusted weighted-average shares and assumed conversions) 7,026,232 7,812,441 7,026,232 7,487,598 =============================================================== Basic earnings (loss) per share $ (.23) $ .03 $ (.33) $ .06 =============================================================== Diluted earnings (loss) per share $ (.23) $ .03 $ (.33) $ .05 ===============================================================
11 NOTE 6 - Comprehensive Income The components of comprehensive income (loss), net of related tax, for the three and six months ended June 30, 2004 and 2003 are as follows:
Three Months Ended Six Months Ended June 30 June 30 (thousands) 2004 2003 2004 2003 ------------ ------------- ------------ ------------ Net Income (loss) $ (1,619) $ 214 $ (2,331) $ 410 Foreign currency translation adjustments (113) 107 (100) 103 ------------ ------------- ------------ ------------ Comprehensive income (loss) $ (1,732) $ 321 $ (2,431) $ 513 ============ ============= ============ ============
The components of accumulated comprehensive loss, at June 30, 2004 and December 31, 2003 are as follows:
June 30 December 31 (thousands) 2004 2003 Foreign currency translation adjustments $ (944) $ (844) ------------------ --------------- Accumulated comprehensive loss $ (944) $ (844) ================== ===============
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. 12
Three Months Ended Six Months Ended June 30 June 30 (thousands) 2004 2003 2004 2003 Revenues Solutions and products $ 3,703 $ 5,246 $ 8,530 $ 10,844 Access services 2,832 2,789 5,228 5,293 Contract manufacturing services 343 72 453 80 ------------ ------------- ------------ ------------ Total revenues 6,878 8,107 14,211 16,217 Cost of solutions and products 2,673 2,994 6,157 6,390 Service expenses 2,505 2,380 4,837 4,511 ------------ ------------- ------------ ------------ Gross profit margin 1,700 2,733 3,217 5,316 Operating expenses and other income, net 3,289 2,499 5,498 4,876 ------------ ------------- ------------ ------------ Income (loss) before income taxes $ (1,589) $ 234 $ (2,281) $ 440 ============ ============= ============ ============ Total expenditures for additions to long-lived assets $ 58 $ 7 $ 124 $ 60
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 $.6 million of bill and hold revenue during the second quarter of 2003 and $2.3 million in the first six months of 2003. At June 30, 2003, accounts receivable included bill and hold receivables of $1.9 million. There were no bill and hold transactions in the first six months of 2004 and there are no bill and hold receivables at June 30, 2004. NOTE 9 - Contingencies In July 2004, Scan-Optics settled a long-standing dispute with a customer involving, among other matters, outstanding accounts receivable owed to Scan-Optics. As a result, each party has agreed to terminate litigation that has been pending since 2001. Earlier, the Company had recorded $.8 million as a reserve against the disputed accounts receivable. As part of the settlement terms, Scan-Optics has agreed to forgive the disputed account receivable in the amount of $1.3 million, which resulted in a $.5 million charge against current earnings (or $0.08 per share). The Company is aware that Millennium, L.P. has filed a complaint dated August 3, 2004 in the United States District Court for the Southern District of New York against the Company for patent infringement. The complaint alleges infringement of unspecified claims of five separate United States patents. The complaint has not been served on the Company, and the Company has not had an opportunity to analyze the claims to determine whether the suit has any merit. 13 Item 2. Management's Discussion and Analysis of Consolidated Financial Condition and Results of Operations. Overview Certain statements contained in this Quarterly Report on Form 10-Q may contain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities and Exchange Act of 1934 and as such may involve known or unknown risks, uncertainties and other factors which may cause the Company's actual results, performance or achievements to be materially different from future results, performance or achievements expressed or implied by such forward-looking statements. Forward-looking statements, which are based on certain assumptions and describe the Company's future plans, strategies and expectations are generally identifiable by use of the words "may," "will," "should," "expect," "anticipate," "estimate," "believe," "intend" or "project" or the negative thereof or other variations thereon or comparable terminology. Factors which could have a material adverse effect on the operations and future prospects of the Company include, but are not limited to those set forth below. These risks and uncertainties should be considered in evaluating any forward-looking statements contained or incorporated by reference herein. 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 debt restructuring effective March 30, 2004 (see "Liquidity and Capital Resources" 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 June 30, 2004 of approximately $10.5 million by $0.1 million. The recapitalization became effective on August 6, 2004 (see Note 3 for further details), and as a result the Company's lenders have acquired a significant voting control and accordingly have the right and the ability to influence the way in which the Company does business, including its strategy and tactics. 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 a net loss of $1.6 million in the second quarter of 2004 compared to net income of $0.2 million in the second quarter of 2003 and a net loss of $2.3 million year to date compared to net income of $0.4 million in 2003. The Company's ability to effectively address business issues will have a direct impact on its operating results, its ability to generate sufficient cash to fund operations and its ability to comply with existing debt covenants. Although, the quarterly operating results were significantly adversely affected by one-time events, including the settlement of some long outstanding litigation, and the Company's transition to the marketing and production of our 14 new SO Series image-scanning platform, we did have some encouraging successes in the form of new business activities. The launch of our new SO Series image-scanning platform continues to generate interest and orders in the United States and internationally. 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 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 decreased $2.9 million or 34% from the first six months of 2004 to 2003 and $1.9 million or 43% in a comparison of the second quarter of 2004 vs. 2003, mainly due to an decrease 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. 15 Results of Operations for the Three and Six Months Ended June 30, 2004 vs. 2003 Total revenues decreased $2.0 million or 12% from the first six months of 2003 to the first six months of 2004 and decreased $1.2 million or 15% from the second quarter of 2003 to the second quarter of 2004. Hardware and software revenues decreased $2.3 million or 28% in the first six months of 2004 compared with the same period in 2003 and decreased $1.5 million from the second quarter of 2003 compared to 2004. Compared to the first six months of 2003, North American sales decreased $4.7 million or 57% and decreased $1.7 million or 42% during the second quarter of 2004 compared to the second quarter of 2003 mainly due to a significant order in 2003, which replaced existing equipment at a current customer. International sales increased $2.4 million during the first six months of 2004 as compared with the first six months of 2003 and remained consistent with the second quarter of 2003 compared to 2004. The Company is in the process of phasing out the sale and production of its mature line of 9000 Series scanners and the Company is in the launch phase of its new generation of SO Series scanners which accounted for a majority of the decreased hardware revenue. Professional services revenues increased $.4 million or 15% in the first six months of 2004 compared with the first six months of 2003 and increased $.3 million or 21% during the second quarter of 2004 compared to the second quarter of 2003. These changes relate to increased solution sales to the Company's target customer base. Access services revenues decreased $.1 million or 1% in the first six months of 2004 compared with the first six months of 2003 and was flat during the second quarter of 2004 compared to the second quarter of 2003. The Company was impacted by a few customers discontinuing maintenance contracts due to changes in their businesses, which was partially offset by increased spare parts purchases. Cost of hardware and software decreased $.4 million or 8% in the first six months of 2004 compared to the first six months of 2003 and decreased $.4 million or 17% in the second quarter of 2004 compared to the second quarter of 2003. The gross margin was 24% for the first six months of 2004, compared to 41% in the first six months of the prior year. The gross margin was 25% during the second quarter of 2004, compared to 43% in the second quarter of the prior year. The decreases in gross margin are mainly due to changes in product mix as a result of the phase out of its mature 9000 series scanners and the launch of the new SO Series scanners. Cost of professional services increased $.2 million or 13% in a comparison of the first six months of 2004 vs. 2003 and increased $.1 million in the second 16 quarter of 2004 compared to the prior year. The gross margin was 46% for the first six months and 49% in the second quarter of 2004, compared to 45% in the first six months and second quarter of 2003. The increase in gross margin was mainly due to increased sales volume, which results in higher utilization rates of available resources. Cost of Access Services increased $.3 million in the first six months of 2004 vs. 2003 and increased $.1 million in the second quarter of 2004 compared to the prior year. The gross margin was 7% for the first six months of 2004, compared to 15% in the first six months of 2003. The gross margin was 12% during the second quarter of 2004, compared to 15% in the second quarter of the prior year. The decrease in gross margin during the first six months of 2004 as compared to 2003 is due to $.3 million inventory provision related to operations in the United Kingdom. Sales and marketing expenses decreased $.4 million or 19% in the first six months of 2004 compared to the first six months of 2003 and decreased $.1 million in the second quarter of 2004 compared to the second quarter of 2003 mainly due to lower commission expenses which reflects lower sales revenue relative to prior periods. Research and development expenses increased $.4 million or 51% from the first six months of 2003 and increased $.2 million from the second quarter of 2003 mainly due to higher salary and benefit costs, increased software amortization expense related to the new SO series scanner and higher external consulting costs. General and administrative expenses increased $.6 million or 34% from the first six months of 2003 and $.7 million from the second quarter of 2003 due to the recording of a $.5 million provision for accounts receivable as a result of the settlement of a legal action and increased legal expenses. Interest expense decreased $.1 million or 26% from the first six months of 2003 and decreased $.1 million from the second quarter of 2003 due to lower average interest rates. The weighted average interest rate for the first six months of 2004 was 5.4% compared to 5.6% in 2003. Liquidity and Capital Resources Cash and cash equivalents at June 30, 2004 increased $.3 million from December 31, 2003 levels. Total borrowings increased $2.5 million at June 30, 2004 from $8.0 million at the end of 2003. The available balance on the line of credit was $2.5 million at June 30, 2004. As of June 30, 2004, the Company is in compliance with all of the financial covenants with the exception of the EBITDA (earnings before interest, taxes, depreciation and amortization) covenant. The company has received a waiver of the EBITDA covenant with respect to the covenant default for the period ending June 30, 2004 from its Lenders. Although the Company anticipates meeting 17 its current obligations and resource needs from funds generated through operations and use of the available line of credit, its ability to remain in compliance with these financial covenants could have a direct impact on its ability to do so. (See Note 3 for further details.) On August 6, 2004, the Company completed a recapitalization with its Lenders, after obtaining stockholder approval of an amendment to the certificate of incorporation of the Company to increase the authorized common stock of the Company in order to permit the recapitalization at the July 15, 2004 annual meeting. The recapitalization included, among other terms, the cancellation of the $3.8 million mandatorily redeemable Series B preferred stock, including accrued dividends, and the existing warrants held by the Lenders, and the issuance of common stock of the Company to the Lenders so that following such issuance the Lenders will own 79.8% of the fully-diluted common stock of the Company, subject to dilution for certain current and future compensatory stock options granted by the Company. More specifically, the financing arrangement includes the following items: * The Company's secured term and revolving debt was exchanged for a $9.0 million term loan and a $2.5 million revolving loan. The new term loan is payable in annual amounts of $90,000 beginning April 1, 2005 with the balance due at maturity. Borrowings against both such loans will continue to accrue interest at a rate of prime plus 2%. * An additional $1.5 million term loan working capital facility was made available to the Company, with the Company obligated to repay $2 million at maturity. The working capital term loan will accrue interest on $2 million at the prime rate. * The Company's financial covenants with respect to backlog, capital expenditure and EBITDA were modified to enhance the financial flexibility of the Company. * Effective March 30, 2004, the Company exchanged the $3.8 million mandatorily redeemable Series A preferred stock held by the Lenders for $3.8 million of mandatorily redeemable Series B preferred stock, which Series B preferred stock has substantially the same terms as the Series A, except that the redemption date was extended to coincide with the Company's secured debt. * The recapitalization which was effective August 6, 2004 included, among other terms, the cancellation of the $3.8 million mandatorily redeemable Series B preferred stock and the existing warrant, and the issuance of common stock of the Company to the Lenders so that following such issuance the Lenders own 79.8% of the fully-diluted common stock of the Company, subject to dilution for certain current and future compensatory stock options issued by the Company. * Effective upon the closing of the recapitalization on August 6, 2004, the maturity date for all of the Company's secured indebtedness to the Lenders was extended from through March 30, 2007. 18 The Company believes that the 2004 loan restructuring will allow execution of the Company's business plan through the term of the credit agreement by reducing required payments under the borrowing arrangements with the Lenders and increasing available funds through the working capital term loan facility, thereby enhancing the Company's ability to invest in its business, by lowering the thresholds of the financial covenants and by extending the loan maturities through March 2007. Operating activities used $2.1 million of cash in the first six months of 2004. Non-cash expenses recorded during the first six months of the year were $1.2 million, which is consistent with the same period in 2003. These expenses relate to 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 June 30, 2004 decreased $.6 million from December 31, 2003 due mainly to the timing of collections and lower sales levels in the second quarter of 2004. Total inventories at June 30, 2004 increased $.1 million from December 31, 2003. Total manufacturing inventories increased $.5 million from the beginning of the year due to the production build schedule of the new SO series scanner. Customer service inventories decreased $.4 million mainly due to an inventory provision related to operations in the UK and lower inventory purchases. Prepaid expenses and other increased $.5 million from December 31, 2003 reflecting legal and investment banking costs related to the Company's recapitalization and debt restructuring. Net plant and equipment remained flat relative to December 31, 2003. Other assets remained at December 31, 2003 levels. Accounts payable increased $.5 million from December 31, 2003 due to the timing of payments. Salaries and wages decreased $.8 million from December 31, 2003 due mainly to the payout of the bonus accrual related to the 2003 bonus plan. Taxes other than income taxes decreased $.1 million from December 31, 2003 due to payments made for sales and use taxes in various state. Customer deposits decreased $.3 million from December 31, 2003 due to the transfer of deposits to accounts receivable to offset recorded product sales. 19 Deferred revenues increased $.9 million from December 31, 2003 due to the timing of annual billings. Other liabilities remained consistent with December 31, 2003 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, 2003. 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. 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 June 30, 2004 or on the results of operations for the three-month period ending June 30, 2004. 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 June 30, 2004 or on the results of operations for the three-month period ending June 30, 2004. 20 In January 2004, the Company adopted FASB Interpretation No. 46, Consolidation of Variable Interest Entities, an Interpretation of Accounting Research Bulletin No. 51 beginning in January 2004. Based on management's evaluation, adoption did not have a significant impact on the Company's financial position as of June 30, 2004 or on the results of operations for the three-month period ending June 30, 2004. Item 3. Quantitative and Qualitative Disclosures About Market Risk. In 2004, 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. A one percent increase in the prime rate would increase the annual interest cost on the outstanding loan balance at June 30, 2004 of approximately $10.5 million by $0.1 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. 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. 21 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. Exhibit 10.1* Executive severance agreement between Peter H. Stelling and Scan-Optics, Inc. dated April 1, 2004. Exhibit 10.2* The Scan-Optics, Inc. 2004 Incentive and Non-qualified Stock Option Plan. Exhibit 10.3* The Scan-Optics, Inc. Amended and Restated Senior Executive Stock Option Plan. * Filed herewith. (b) Reports on Form 8-K. Report on Form 8-K filed May 18, 2004 regarding financial results for the first quarter of 2004. 22 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 August 16, 2004 /s/ James C. Mavel ---------------- ----------------------------------------- James C. Mavel Chairman, Chief Executive Officer and President Date August 16, 2004 /s/ Peter H. Stelling ---------------- ----------------------------------------- Peter H. Stelling Chief Financial Officer, Vice President and Treasurer 23 EX-10 2 ex10-1.txt EXHIBIT 10.1 EXECUTIVE SEVERANCE AGREEMENT This EXECUTIVE SEVERANCE AGREEMENT (the "Agreement") is made as of April 1, 2004, by and between SCAN-OPTICS, INC. (the "Company") and Peter H. Stelling (the "Executive"). RECITALS: --------- A. The Executive is an executive of the Company and has made and is expected to continue to make major contributions to the short- and long-term profitability, growth, and financial strength of the Company; B. The Company recognizes that the possibility of a Change of Control (as hereafter defined) exists; C. The Company desires to assure itself of both present and future continuity of its management and desires to establish certain severance benefits for key executive officers of the Company, including the Executive, applicable in the event of a Change of Control; and D. The Company wishes to aid in assuring that such executives are not practically disabled from discharging their duties in respect of a proposed or actual transaction involving a Change of Control. NOW, THEREFORE, the Company and the Executive agree as follows: 1. Certain Defined Terms: In addition to terms defined elsewhere herein, the following terms have the following meanings when used in this Agreement with initial capital letters: (a) "Base Pay" means the Executive's annual aggregate fixed base salary from the Company at the time in question. (b) "Board" means the Board of Directors of the Company. (c) "Change of Control" means a change of control of a nature that would be required to be reported in response to Item 6(e) of Schedule 14A of Regulation 14A promulgated under the Securities Exchange Act of 1934, as amended (the "Exchange Act"), whether or not the Company is then subject to such reporting requirement; provided that, without limitation, such a Change of Control shall be deemed to have occurred if (i) any "person" (as such term is used in Sections 13(d) and 14(d) of the Exchange Act) is or becomes the "beneficial owner" (as defined in Rule 13d-3 under the Exchange Act), directly or indirectly, of securities of the Company representing 22% or more of the combined voting power of the Company's then outstanding securities; or (ii) during any period of two consecutive years (not including any period prior to the execution of this Agreement), individuals who at the beginning of such period constitute the Board and any new directors, whose election by the Board or nomination for election by the Company's stockholders was approved by a vote of at least two-thirds (2/3) of the directors then still in office who either were directors at the beginning of the period or whose election or nomination for election was previously so approved, cease for any reason to constitute a majority thereof. (d) "Cause" means that, prior to any Termination by the Executive for Good Reason, the Executive shall have: (i) committed an intentional act of fraud, embezzlement, or theft in connection with the Executive's duties or in the course of his employment with the Company; (ii) committed intentional wrongful damage to property of the Company; or (iii) intentionally and wrongfully disclosed confidential information of the Company; and any such act shall have been materially harmful to the Company. For purposes of this Agreement, no act on the part of the Executive shall be deemed "intentional" if it was due primarily to an error in judgment or negligence, but shall be deemed "intentional" only if done by the Executive not in good faith and without reasonable belief that the Executive's action or omission was in the best interests of the Company. The determination of whether a Termination of the Executive's employment is for "Cause" shall be made by the Board. (e) "Commission Pay" means the average annual commissions paid to the Executive by the Company during the three year period ending at the time in question. (f) "Date of Termination" means the date of receipt of a Notice of Termination or any later date specified therein, as the case may be; provided, however, that if the Executive is Terminated by the Company other than for Cause or for disability pursuant to Section 2(a)(ii), the Date of Termination will be the date on which the Executive receives a Notice of Termination from the Company; and provided further, if the Executive is Terminated by reason of death or disability pursuant to Section 2(a)(i) or 2(a)(ii), the Date of Termination will be the last day of the month in which occurs the date of death or the disability effective date, as the case may be. (g) "Employee Benefits" means the perquisites, benefits and service credit for benefits as provided under the plans and programs maintained by the Company, including, but not limited to, plans and programs which are "employee benefit plans" under Section 3(3) of the Employee Retirement Income Security Act of 1974, as amended, and any amendment or successor to such plans or programs (whether insured, funded or unfunded). (h) "Good Reason" means the occurrence of any of the events listed in Sections 2(b)(i) through 2(b)(vii), inclusive. -2- (i) "Incentive Pay" means an annual amount equal to the aggregate annual bonus, incentive compensation or performance pay, in addition to Base Pay, made or to be made in regard to services rendered in any calendar year or performance period pursuant to any bonus, incentive compensation or performance pay plan of the Company. (j) "Notice of Termination" means a written notice which (i) indicates the specific provision in this Agreement relied upon, (ii) sets forth in reasonable detail the facts and circumstances claimed to provide a basis for the Termination under the provision so indicated, and (iii) if the effective date of the Termination is other than the date of receipt of such notice, specifies the effective date of Termination (which date will be not more than sixty (60) days after the giving of such notice). The failure by the Executive to set forth in the Notice of Termination any fact or circumstance which contributes to a showing that the Executive is entitled to the benefits intended to be provided by this Agreement will not constitute a waiver of any right of the Executive hereunder or otherwise preclude the Executive from later asserting such fact or circumstance in enforcing the Executive's rights hereunder. (k) "Severance Period" means the period of time commencing on the date of an occurrence of a Change of Control and continuing until the earlier of (i) the date which is two years following the occurrence of the Change of Control and (ii) the Executive's death. (1) "Term" means (i) the period commencing on the date hereof and ending on the second anniversary of the date hereof; provided, however, that commencing on the date one year after the date hereof, and on each annual anniversary of such date (such date and each annual anniversary thereof shall be hereinafter referred to as the "Renewal Date"), unless previously terminated, the Term shall be automatically extended so as to terminate two years from such Renewal Date, unless at least sixty (60) days prior to the Renewal Date the Company shall give notice to the Executive that the Term shall not be so extended, (ii) if, prior to a Change of Control, for any reason the Executive is Terminated or Terminates, thereupon without further action the Term shall be deemed to have expired and this Agreement will immediately terminate and be of no further effect, and (iii) in the event of a Change of Control, the Term will, without further action, be considered to terminate at the expiration of the Severance Period. (m) "Terminate", "Termination" and correlative terms mean the termination of the Executive's employment with the Company and any Affiliate or Subsidiary. 2. Termination Following a Change of Control: (a) If, during the Severance Period, the Executive is Terminated, the Executive will be entitled to the benefits provided by Section 3, unless such Termination is by reason of one or more of the following events: (i) The Executive's death; (ii) The permanent and total disability of the Executive, as defined in any long term disability plan of the Company applicable to the Executive, as in effect immediately prior to the Change of Control; -3- (iii) Cause; or (iv) The Executive's voluntary Termination in circumstances in which Good Reason does not exist. (b) In the event of the occurrence of a Change of Control, the Executive may Terminate during the Severance Period with the right to severance compensation as provided in Section 3 upon the occurrence of one or more of the following events (regardless of whether any other reason, other than Cause as hereinabove provided, for Termination exists or has occurred, including, without limitation, other employment): (i) An adverse change in the nature or scope of the authorities, powers, functions, responsibilities, or duties attached to the position with the Company, which the Executive held immediately prior to the Change of Control; (ii) A reduction in the Executive's Base Pay as in effect immediately prior to any Change of Control, or as it may have been increased from time to time thereafter; (iii) Any failure by the Company to continue in effect any plan or arrangement providing Incentive Pay in which the Executive is participating at the time of a Change of Control (or any other plans or arrangements providing substantially similar benefits) or the taking of any action by the Company which would adversely affect the Executive's participation in any such plan or arrangement or reduce the Executive's benefits under any such plan or arrangement in a manner inconsistent with the practices of the Company prior to the Change of Control; (iv) Any failure by the Company to continue in effect any Employee Benefits in which the Executive is participating at the time of a Change of Control (or any other plans or arrangements providing the Executive with substantially similar benefits) or the taking of any action by the Company which would adversely affect the Executive's participation in or materially reduce the Executive's benefits under any Employee Benefits or deprive the Executive of any material fringe benefit enjoyed by the Executive at the time of a Change of Control; (v) The liquidation, dissolution, merger, consolidation, or reorganization of the Company or transfer of all or substantially all of its business and/or assets, unless the successor or successors (by liquidation, merger, consolidation, reorganization, transfer, or otherwise) to which all or a significant portion of its business and/or assets have been transferred (directly or by operation of law) assumed all duties and obligations of the Company under this Agreement pursuant to Section 9; (vi) Without limiting the generality or effect of the foregoing, any material breach of this Agreement by the Company or any successor thereto; or -4- (vii) Any action by the Company which causes the Executive's services to be performed regularly at any office or location greater than thirty-five (35) miles from the office or location where the Executive was employed immediately preceding the date of the Change of Control. (c) Any Termination will be communicated by Notice of Termination hereto given in accordance with Section 10 of this Agreement. 3. Severance Compensation: (a) If, following the occurrence of a Change of Control, the Executive is Terminated by the Company during the Severance Period other than in the circumstances set forth in Section 2(a)(i), 2(a)(ii), or 2(a)(iii), or if the Executive Terminates for Good Reason: (i) The Company will pay to the Executive in a lump sum in cash within five business days after the later of the date on which the Company receives the determination of the Accounting Firm required in Section 4 hereof or the Date of Termination an amount (the "Severance Payment") equal to the sum of (A) 2.5 times the sum of Base Pay and Commission Pay at the highest rates in effect at any time within the 90-day period preceding the date the Notice of Termination was given or, if higher, at the highest rates in effect at any time within the 90-day period preceding the date of the first occurrence of a Change of Control, plus (B) an amount equal to 2.5 times the greatest amount of Incentive Pay received by the Executive during any year from and including the third year prior to the first occurrence of a Change of Control, plus (C) an amount equal to 2.5 times the matching contribution that would be made by the Company to the Scan-Optics, Inc. Retirement Savings Plan on the Executive's behalf if the Executive deferred under such Plan four percent (adjusted for any applicable limitation under the Internal Revenue Code of 1986, as amended) of the sum of Base Pay, Commission Pay and Incentive Pay (at the rates used in (A) and (B) above) or such higher percentage as may then be eligible for Company matching contributions, plus (D) an amount equal to the value (determined as of the Date of Termination and assuming exercisability as of such date) of all options granted to the Executive to acquire Company common stock that will not become exercisable as a result of Executive's Termination; and (ii) For two years following the Date of Termination, the Executive shall be eligible for participation in and shall receive all benefits under such benefit plans, practices, policies and programs of the Company that provide medical, prescription, dental, disability, accident or life insurance coverage, with the costs of such participation to be paid by the Company to the same extent as prior to the Executive's Termination. In the event that such continued participation is not allowed under the terms and provisions of such plans or programs, then in lieu thereof, the Company shall acquire individual insurance policies providing comparable coverage for the Executive; provided that if any such individual coverage is unavailable, the Company shall pay to the Executive an amount equal to the contributions that would have been made by the Company -5- for such coverage on the Executive's behalf if the Executive had remained in the employ of the Company for two years following the Date of Termination. (b) There will be no right of set-off or counterclaim in respect of any claim, debt, or obligation against any payment to or benefit for the Executive provided for in this Agreement. (c) Without limiting the rights of the Executive at law or in equity, if the Company fails to make any payment or provide any benefit required to be made or provided under this Agreement (including under this Section 3 or Section 6) on a timely basis, the Company will pay interest on the amount or value thereof at an annualized rate of interest equal to the so-called composite "prime rate" as quoted from time to time during the relevant period in the Northeast Edition of The Wall Street Journal. Such interest will be payable as it accrues on demand. Any change in such prime rate will be effective on and as of the date of such change. (d) Notwithstanding any other provision hereof, the parties' respective rights and obligations under this Section 3 and under Sections 4 and 6 will survive any termination or expiration of this Agreement following a Change of Control or any Termination following a Change of Control for any reason whatsoever. 4. Excise and Other Taxes. The Executive shall bear all expense of, and be solely responsible for, all federal, state, local or foreign taxes due with respect to any payment received hereunder, including, without limitation, any excise tax imposed by Section 4999 of the Internal Revenue Code of 1986, as amended (the "Code"); provided, however, that the Severance Payment shall be reduced to the extent necessary so that no portion thereof shall be subject to the excise tax imposed by Section 4999 of the Code. The foregoing determination will be made by a nationally recognized accounting firm (the "Accounting Firm") selected by the Executive and reasonably acceptable to the Company (which may, but will not be required to be, the Company's independent auditors). The Executive will direct the Accounting Firm to submit its determination and detailed supporting calculations to both the Company and the Executive within fifteen (15) days after the Date of Termination. If the Accounting Firm determines that such reduction is required by this Section 4, the Company shall pay such reduced amount to the Executive in accordance with Section 3(a)(i). If the Accounting Firm determines that no reduction is necessary under this Section 4, it will, at the same time as it makes such determination, furnish the Company and the Executive an opinion that the Executive will not be liable for any excise tax under Section 4999 of the Code. The Company and the Executive will each provide the Accounting Firm access to and copies of any books, records, and documents in the possession of the Company or the Executive, as the case may be, reasonably requested by the Accounting Firm, and otherwise cooperate with the Accounting Firm in connection with the preparation and issuance of the determinations and calculations contemplated by this Section 4. The fees and expenses of the Accounting Firm for its services in connection with the determinations and calculations contemplated by this Section 4 will be borne by the Company. 5. No Mitigation Obligation: The Company hereby acknowledges that it will be difficult, and may be impossible, for the Executive to find reasonably comparable -6- employment following the Date of Termination. The payment of the severance compensation by the Company to the Executive in accordance with the terms of this Agreement will be liquidated damages, and the Executive will not be required to mitigate the amount of any payment provided for in this Agreement by seeking other employment or otherwise, nor will any profits, income, earnings, or other benefits from any source whatsoever create any mitigation, offset, reduction, or any other obligation on the part of the Executive hereunder or otherwise. 6. Legal Fees and Expenses: If the Company has failed to comply with any of its obligations under this Agreement or in the event that the Company or any other person takes or threatens to take any action to declare this Agreement void or unenforceable, or institutes any litigation or other action or proceeding designed to deny, or to recover from, the Executive the benefits provided or intended to be provided to the Executive hereunder, the Company irrevocably authorizes the Executive from time to time to retain counsel of the Executive's choice, at the expense of the Company to the extent hereafter provided, to advise and represent the Executive in connection with any such interpretation, enforcement, or defense, including, without limitation, the initiation or defense of any litigation or other legal action, whether by or against the Company or any member of the Board, officer, stockholder, or other person or entity affiliated with the Company, in any jurisdiction. If the Executive prevails, in whole or in part, in connection with any such litigation, the Company will pay and be solely financially responsible for any and all attorneys' and related fees' and expenses incurred by the Executive in connection with such litigation. 7. Employment Rights: Nothing expressed or implied in this Agreement will create any right or duty on the part of the Company or the Executive to have the Executive remain in the employment of the Company prior to or following any Change of Control. 8. Withholding of Taxes: Except as otherwise provided in this Agreement, the Company may withhold from any amounts payable under this Agreement all federal, state, city, or other taxes as the Company is required to withhold pursuant to any law or government regulation or ruling. 9. Successors and Binding Agreement: (a) The Company will require any successor (whether direct or indirect, by purchase, merger, consolidation, reorganization, or otherwise) to all or substantially all of the business and/or assets of the Company, by agreement in form and substance satisfactory to the Executive, expressly to assume and agree to perform this agreement in the same manner and to the same extent the Company would be required to perform if no such succession had taken place. This Agreement will be binding upon and inure to the benefit of the Company and any successor to the Company, including, without limitation, any persons acquiring directly or indirectly all or substantially all of the business and/or assets of the Company whether by purchase, merger, consolidation, reorganization, or otherwise (and such successor will thereafter be deemed the "Company" for the purposes of this Agreement), but will not otherwise be assignable, transferable, or delegable by the Company. (b) This Agreement will inure to the benefit of and be enforceable by the Executive's personal or legal representatives, executors, administrators, successors, heirs, distributees, and/or legatees. -7- (c) This Agreement is personal in nature and neither of the parties hereto will, without the consent of the other, assign, transfer, or delegate this Agreement or any rights or obligations hereunder except as expressly provided in Sections 9(a) and 9(b). Without limiting the generality or effect of the foregoing, the Executive's right to receive payments hereunder will not be assignable, transferable, or delegable, whether by pledge, creation of a security interest, or otherwise, other than by a transfer by will or by the laws of descent and distribution and, in the event of any attempted assignment or transfer contrary to this Section 9(c), the Company will have no liability to pay any amount so attempted to be assigned, transferred, or delegated. 10. Notices: For all purposes of this Agreement, all communications, including, without limitation, notices, consents, requests, or approvals, required or permitted to be given hereunder will be in writing and will be deemed to have been duly given when hand delivered or dispatched by electronic facsimile transmission (with receipt thereof orally confirmed), or two business days after having been mailed by United States registered or certified mail, return receipt requested, postage prepaid, or one business day after having been sent by a nationally recognized overnight courier service, addressed to the Company (to the attention of the Chairman of the Board) at its principal executive office and to the Executive at the Executive's principal residence, or to such other address as any party may have furnished to the other in writing and in accordance herewith, except that notices of changes of address will be effective only upon receipt. 11. Governing Law: The validity, interpretation, construction, and performance of this Agreement will be governed by and construed in accordance with the substantive laws of the State of Connecticut, without giving effect to the principles of conflict of laws of such State, to the extent not preempted by applicable federal law. 12. Validity: If any provision of this Agreement or the application of any provision hereof to any person or circumstances is held invalid, unenforceable, or otherwise illegal, the remainder of this Agreement and the application of such provision to any other person or circumstances will not be affected, and the provision so held to be invalid, unenforceable, or otherwise illegal will be reformed to the extent (and only to the extent) necessary to make it enforceable, valid, or legal. 13. Non-Exclusivity of Rights: Nothing in this Agreement will prevent or limit the Executive's present or future participation in any benefit, bonus, incentive, or other plan or program provided by the Company for which the Executive may qualify, nor will this Agreement in any manner limit or otherwise affect such rights as the Executive may have under any stock option or other agreements with the Company. Amounts or benefits which are vested or which the Executive is otherwise entitled to receive under any plan or program of the Company at or subsequent to the Date of Termination will be payable in accordance with such plan or program, except as otherwise expressly provided in this Agreement; provided, however, that any amounts received by the Executive pursuant to this Agreement shall be in lieu of (but, if necessary to give effect to this provision, shall be reduced by) any benefits which the Executive is entitled to receive or may become entitled to receive under any reduction-in-force or severance pay plan or practice which the Company now has in effect or may hereafter put into effect, any other benefits to which the Executive may be entitled under any previous individual agreement -8- of employment or severance agreement with the Company which would provide a benefit to the Executive upon the occurrence of, or the termination of employment following, a Change of Control (whether or not so defined in said individual agreement), and any severance benefits required under federal or state law to be paid to the Executive. 14. Miscellaneous: No provision of this Agreement may be modified, waived, or discharged unless such waiver, modification, or discharge is agreed to in writing signed by the Executive and the Company. No waiver by either party hereto at any time of any breach by the other party hereto or compliance with any condition or provision of this Agreement to be performed by such other party will be deemed a waiver of similar or dissimilar provisions or conditions at the same or at any prior or subsequent time. No agreements or representations, oral or otherwise, expressed or implied with respect to the subject matter hereof have been made by either party which are not set forth expressly in this Agreement. References to Sections are to references to Sections of this Agreement. IN WITNESS WHEREOF, the parties have caused this Agreement to be duly executed and delivered as of the date first above written. SCAN-OPTICS, INC. By /s/ James C. Mavel ------------------ Name: James C. Mavel Title: Chairman, President and Chief Executive Officer /s/ Peter H. Stelling --------------------- Peter H. Stelling -9- EX-10 3 ex10-2.txt EXHIBIT 10..2 SCAN-OPTICS,INC. 2004 INCENTIVE AND NON-QUALIFIED STOCK OPTION PLAN 1. Purposes. The purpose of the Scan-Optics, Inc. 2004 Incentive and Non-Qualified Stock Option Plan (the "Plan") is to (a) secure for Scan-Optics, Inc. (the "Company") and its stockholders the benefits arising from stock ownership by officers and other key employees of the Company, and any parent or subsidiary of the Company, who will be responsible for its future growth and continued success, and (b) enable the Company to attract and retain the services of key employees by providing them with an opportunity to become owners of Scan-Optics, Inc. Common Stock under the terms and conditions and in the manner contemplated by this Plan. 2. Administration. The Plan shall be administered by the Stock Options and Executive Compensation Committee of the Board of Directors (the "Committee"), consisting of not less than two Directors appointed by the Board of Directors. Members of the Board of Directors may only serve on the Committee if they are non-employee directors for purposes of Rule 16b-3 under the Securities Exchange Act of 1934, as amended, and "outside directors" as defined in Treasury Regulations ss.1.162m-27(e)(3). Any action of the Committee with respect to the administration of the Plan shall be taken by majority vote. Subject to the express provisions of the Plan, the Committee shall have authority to (i) construe and interpret the Plan, (ii) prescribe, amend and rescind rules and regulations relating to the Plan, (iii) determine the individuals to whom and the time or times at which options shall be granted, the number of shares to be subject to each option, the option price, and the duration of each option, and (iv) make all other determinations necessary or advisable for the administration of the Plan. All determinations and interpretations made by the Committee shall be binding and conclusive on all participants in the Plan and on their legal representatives and beneficiaries. 3. Maximum Number of Shares Subject to Plan. Subject to adjustment as provided in Section 15 hereof, the shares of stock to be offered under the Plan may be authorized but unissued shares of the Company's Common Stock, par value $.02 per share (the "Common Stock"), or issued shares which have been reacquired. The aggregate amount of Common Stock to be delivered upon exercise of all options granted under the Plan shall not exceed 2,391,268 shares. If any option granted hereunder shall expire or terminate for any reason without having been exercised in full, the unpurchased shares subject thereto shall again be available for the purpose of this Plan. 4. Incentive and Non-Qualified Options. Options granted under the Plan may be either incentive stock options ("Incentive Options") intended to meet the requirement of Section 422 of the Internal Revenue Code of 1986, as amended (the "Code"), or non-qualified stock options ("Non-Qualified Options"). The Committee shall have the right, with the consent of the optionee, to convert an Incentive Option granted under the Plan to a Non-Qualified Option pursuant to Section 13 hereof. 5. Eligibility and Participation. Officers and other key employees of the Company or of any parent or subsidiary of the Company, whether or not directors of the Company, shall be eligible to participate in the Plan. Directors who are not also employees are not eligible to participate in the Plan. An individual who has been granted an option may, if he is otherwise eligible, be granted additional options. Nothing in the Plan shall be deemed to give any employee any right to participate in this Plan or to receive an options hereunder. An optionee may be granted and hold more than one option, but the aggregate fair market value (determined at the time the option is granted pursuant to Section 6 below) of the Common Stock for which any optionee may be granted Incentive Options which are exercisable for the first time in any one calendar year (under all incentive stock option plans of the Company and any parent or subsidiary of the Company) shall not exceed $100,000. There shall be no limit on the aggregate fair market value (as so determined) of the Common Stock for which any optionee may be granted Non-Qualified Options. Notwithstanding the foregoing, the aggregate amount of Common Stock subject to options granted to a single employee in any calendar year shall not exceed 100,000 shares. 6. Purchase Price. The purchase price of Common Stock covered by each option shall be determined by the Committee, but the purchase price of Incentive Options shall not be less than 100% of the fair market value of the Common Stock at the time such Incentive Option is granted and the purchase price of Non-Qualified Options shall not be less than 100% of the fair market value of the Common Stock at the time such Non-Qualified Option is granted; provided, however, that the Committee may set the purchase price of Non-Qualified Options granted to employees who are not "covered employees" (as defined in Section 162(m) of the Code) at an amount less than 100% of such market value, but not less than 85% of such market value if the Committee expressly determines to grant the discount from 100% of such fair market value in lieu of a reasonable amount of salary or cash bonus which would otherwise be paid to the employee granted such Non-Qualified Options. The fair market value of the Common Stock shall be determined pursuant to procedures adopted by the Committee. Anything herein to the contrary notwithstanding, no Incentive Option shall be granted to an employee if, at the time the Incentive Option is granted, such employee owns stock possessing more than 10% of the total combined voting power of all classes of stock of the Company, or a parent or subsidiary of the Company, unless the Incentive Option price is at least 110% of the fair market value of the Common Stock subject to the Incentive Option at the time the Incentive Option is granted and the Incentive Option is not exercisable after the expiration of five (5) years from the date the Incentive Option is granted. 7. Duration and Time of Exercise of Options. Each option and all rights thereunder shall expire on such date as the Committee may determine, but in no event later than ten (10) years from the date on which the option is granted, and shall be subject to earlier termination as provided herein. Each option shall be exercisable in such installments during the period prior to its expiration date as the Committee shall determine, or may, if so determined by the Committee, be exercisable either in whole or in part at any time prior to its expiration date. If the option is made exercisable in installments and the optionee shall not in any given installment period purchase -2- all of the shares which the optionee is entitled to purchase in such installment period, then the optionee shall have the right cumulatively thereafter to purchase any shares not so purchased and such right shall continue until the expiration date or sooner termination of such option. In the event of (a) a reorganization, merger or consolidation of the Company in which the Company is not the surviving corporation, (b) the dissolution or liquidation of the Company, or (c) a sale or lease of fifty percent (50%) or more, computed on the basis of book value, of the Company's consolidated assets, the time at which all options then outstanding may be exercised shall be accelerated and all such options shall become exercisable in full on or before a date fixed by the Committee prior to the effective time of such reorganization, merger, consolidation, dissolution, liquidation, sale or lease, and upon such effective time any unexercised options shall expire. The Committee may, at any time, in its absolute discretion, accelerate the time at which an outstanding option can be exercised, in whole or in part, provided, however, that no such acceleration of the time for exercise shall be made if such acceleration would result in a modification of an Incentive Option (within the meaning of Section 424 of the Code), or cause such Incentive Option to fail to continue to qualify as an incentive stock option under Section 422 of the Code. Notwithstanding the provisions of this Section 7, the time at which an outstanding option may be exercised may not be accelerated to a date which is less than six (6) months after the date of grant of such option, except in the case of death or disability. 8. Replacement and Substitute Options. The Committee may, in its absolute discretion, grant to optionees, in exchange for the surrender and cancellation of their outstanding options, new options having option prices lower than the option price of the options so surrendered and canceled (the "Replacement Options") and containing such other terms and conditions as the Committee may deem appropriate, but only if (i) the Committee determines that it needs to grant Replacement Options to retain key employees, to provide necessary incentives to key employees or to further some other important corporate purpose; (ii) Replacement Options are rarely granted and only where extreme circumstances beyond management's control have substantially diminished the value of the outstanding options to be exchanged for Replacement Options; and (iii) the number of shares of Common Stock to be delivered upon exercise of the Replacement Options does not exceed ten percent (10%) of the number of shares of Common Stock to be delivered upon exercise of all options authorized to be granted under the Plan. Notwithstanding the preceding sentence, if, at a time when no additional shares of Common Stock are authorized to be delivered upon exercise of options granted under the Plan, the Committee determines that it needs to grant Replacement Options to employees who are not executive officers before the next stockholders' meeting, it may grant additional Replacement Options for a number of shares of Common Stock not exceeding ten percent (10%) of the number of shares of Common Stock to be delivered upon exercise of all options authorized to be granted under the Plan if such grant of additional Replacement Options is made continent upon the stockholder's authorization for such additional Replacement Options being obtained at the next stockholders' meeting. Options may be granted under the Plan and in substitution for stock options held by person who become or are to become salaried employees of the Company or any parent or subsidiary of the Company in any transaction to which Section 424(a) of the Code applies. -3- 9. Exercise of Options. Options shall be exercised by the delivery of written notice to the officer of the Company designated by the Committee setting forth the number of shares with respect to which the option is to be exercised, and specifying the address to which the certificates for such shares are to be mailed. The option price shall be paid in full at the time of exercise in cash by United States currency, certified check or money order or by tendering to the Company (i) shares of Common Stock having a fair market value on the date of exercise equal to the option price (including shares that would otherwise be issued pursuant to such exercise), or (ii) a combination of cash and shares of Common Stock valued at such fair market value. As promptly as practicable after receipt of such written notification of the exercise of an option and payment, the Company shall deliver to the optionee certificates for the number of shares with respect to which such option has been so exercised, issued in the optionee's name. 10. Non-Transferability of Options. An Incentive Option and, unless otherwise determined by the Committee, a Non-Qualified Option granted under the Plan shall, by its terms, be non-transferable by the optionee, either voluntarily or by operation of law, otherwise than by will or the laws of descent and distribution, and shall be exercisable during the optionee's lifetime only by the optionee, regardless of any community property interest therein of the spouse of the optionee, or such spouse's successors in interest. 11. Continuance of Employment. Nothing contained in the Plan or in any option granted under the Plan shall confer upon any optionee any right with respect to the continuation of employment by the Company or any parent or subsidiary of the Company, or interfere in any way with the right of the Company or any parent or subsidiary of the Company (subject to the terms of any separate employment agreement to the contrary) at any time to terminate such employment or to increase or decrease the compensation of the optionee from the rate in existence at the time of granting of an option. 12. Termination of Employment, Disability or Death of Optionee. (a) Expect as may be otherwise expressly provided herein, options shall terminate, unless exercised, three (3) months after the date of the severance of the employment relationship between the optionee and the Company, or a parent or subsidiary of the Company; provided, however, that all options held by an optionee shall terminate immediately upon receipt by an optionee of the notice of termination if the optionee is terminated for deliberate, willful or gross misconduct as determined by the Company. Absence on leave approved by the Committee shall not be considered a severance of employment. (b) If, before the date of expiration of the option, the optionee shall retire from the employ of the Company, or a parent or subsidiary of the Company, for reasons of age pursuant to a pension or retirement plan of the Company, or a parent or subsidiary of the Company, or for reasons of disability as defined in Section 22(e)(3) of the Code, the option shall terminate on the earlier of such date of expiration or one year after the date of such retirement. In the event of such retirement, the optionee shall have the right prior to the termination of such option to exercise the option to the extent to which the optionee was entitled to exercise such option immediately prior to such retirement. If the retired optionee shall die before the termination of the -4- option, the optionee's executors, administrators or any person or persons to whom the option may be transferred by will or by the laws of descent and distribution shall have the right, at any time within the earlier of the date of expiration of the option or the one-year period beginning on the date of the optionee's death, to exercise the option to the same extent as said retired optionee. (c) In the event of the death of the holder of an option while in the employ of the Company, or a parent or subsidiary of the Company, and before the date of expiration of such option, such option shall terminate on the earlier of such date of expiration or one year following the date of such death. After the death of the optionee, the optionee's executors, administrators or any person or persons to whom the option may be transferred by will or by the laws of descent and distribution shall have the right, at any time prior to such termination, to exercise the option to the same extent to which the deceased optionee was entitled to exercise such option immediately prior to the deceased optionee's death. (d) In the case of a Non-Qualified Option, the Committee may, in its discretion, vary the terms set forth in Sections 12(a), 12(b) and 12(c) by providing for different provisions in the applicable option agreement granting such Non-Qualified Options. 13. Conversion of Incentive Options into Non-Qualified Options; Termination of Incentive Options. The Committee may, at the written request of the optionee, take such actions as may be necessary to convert such optionee's Incentive Options (or any installments or portions of installments thereof) that have not been exercised on the date of conversion into Non-Qualified Options at any time prior to the expiration of such Incentive Options, regardless of whether the optionee is an employee of the Company, or a parent or subsidiary of the Company, at the time of such conversion. Such actions may include, but not be limited to, extending the exercise period or reducing the exercise price of the appropriate installments of such options. At the time of such conversion, the Committee (with the consent of the optionee) may impose such conditions on the exercise of the resulting Non-Qualified Options as the Committee in its discretion may determine, provided that such conditions shall not be inconsistent with the Plan. Nothing in the Plan shall be deemed to give any optionee the right to have such optionee's Incentive Options converted into Non-Qualified Options, and no such conversion shall occur until and unless the Committee takes appropriate action. The Committee, with the consent of the optionee, may also terminate any portion of any Incentive Options that has not been exercised at the time of such termination. 14. Privilege of Stock Ownership. No person entitled to exercise any option granted under the Plan shall have any of the rights or privileges of a stockholder of the Company in respect of any shares of stock issuable upon exercise of such option until certificates representing such shares shall have been issued and delivered. No share shall be issued and delivered upon exercise of any option unless and until, in the opinion of counsel for the Company, any applicable registration requirements of the Securities Act of 1993, any applicable listing requirements of any national securities exchange on which stock of the same class is then listed, and any other requirements of law or of any regulatory bodies having jurisdiction over such issuance and delivery, shall have been fully complied with. -5- 15. Adjustments. If the outstanding shares of Common Stock of the Company are increased, changed into or exchanged for a different number or kind of shares or securities of the Company as a result of a merger, reorganization, recapitalization, reclassification, stock dividend, stock split or reverse stock split, an appropriate and proportionate adjustment shall be made in the maximum number and kind of shares as to which options may be granted under this Plan. A corresponding adjustment changing the number or kind of shares allocated to unexercised options or portion thereof, which shall have been granted prior to any such change, shall likewise be made. Any such adjustment in the outstanding options shall be made without change in the aggregate purchase price applicable to the unexercised portion of the option but with a corresponding adjustment in the price for each share covered by the option. Adjustments under this Section shall be made by the Committee, whose determination as to what adjustments shall be made, and the extent thereof, shall be final, binding and conclusive. No fractional shares of stock shall be issued under the Plan for any such adjustment. 16. Written Agreement. Each option granted hereunder shall be embodied in a written Option Agreement which shall be subject to the terms and conditions prescribed herein, and shall be signed by the optionee and by an officer of the Company for and on behalf of the Company. Incentive Options and Non-Qualified Options may not be granted in the same Option Agreement. An Option Agreement shall contain such other provisions as the Committee in its discretion shall deem advisable so long as the same are not contrary or inconsistent with the terms and provisions of the Plan. 17. Amendment and Termination of Plan. The Board of Directors of the Company may at any time amend, suspend or terminate the Plan; provided, however, that any material amendment of the Plan and any other amendment of the Plan requiring stockholder approval under Section 422 of the Code shall not be made without the approval of the stockholders of the Company in accordance with the General Corporation Law of the State of Delaware. No amendment, suspension or termination of the Plan shall, without the consent of the optionee, alter or impair any rights or obligation under any outstanding Option Agreement. 18. Withholding. Any person exercising an option shall be required to pay in cash to the Company the amount of any taxes the Company is required by law to withhold with respect to the exercise of such option. Such payment shall be due on the date the Company is required to withhold such taxes. Such payment may also be made at the election of the optionee by the surrender of shares of Common Stock then owned by the optionee, or the withholding of shares of Common Stock otherwise to be issued to the optionee on exercise, in an amount that would satisfy the withholding amount due. The value of such shares withheld or delivered shall be equal to the fair market value of such shares on the date of exercise. In the event that such payment is not made when due, the Company shall have the right to deduct to the extent permitted by law, from any payment of any kind otherwise due to such person from the Company, all or part of the amount required to be withheld. -6- 19. Effective Date of Plan. Subject to stockholder approval of the Plan at the Company's 2004 Annual Meeting of Stockholders, this Plan shall become effective on the date of the filing, if any, of an amended and restated certificate of incorporation for the Company on or before June 30, 2005 increasing the total authorized capital stock of the Corporation to 70,000,000 shares consisting of 65,000,000 shares of Common Stock, and 5,000,000 shares of preferred stock, par value $0.02 per share. No options shall be granted pursuant to the Plan after the date that is ten years from the effective date of the Plan. 20. Construction. The plan and options granted hereunder shall be governed by and construed in accordance with the laws of the State of Delaware and in accordance with such federal laws as may be applicable. -7- EX-10 4 ex10-3.txt EXHIBIT 10.3 SCAN-OPTICS, INC. AMENDED AND RESTATED SENIOR EXECUTIVE STOCK OPTION PLAN (As Amended and Restated Effective April 26, 2004, except as otherwise provided herein) 1. Purposes. The purposes of the Scan-Optics, Inc. Senior Executive Stock Option Plan (the "Plan") are (a) to secure for Scan-Optics, Inc. (the "Company") and its stockholders the benefits arising from stock ownership by senior executive officers of the Company, who will be responsible for its future growth and continued success, (b) to enable the Company to retain the services of the persons who are senior executive officers by providing them with an opportunity to become owners of Scan-Optics, Inc. Common Stock under the terms and conditions and in the manner contemplated by this Plan and (c) to provide such persons with incentives to increase stockholder value. 2. Administration. The Plan shall be administered by the Stock Options and Executive Compensation Committee of the Board of Directors (the "Committee"), consisting of not less than two Directors appointed by the Board of Directors. Members of the Board of Directors may only serve on the Committee if they are non-employee directors for purposes of Rule 16b-3 under the Securities Exchange Act of 1934, as amended, and "outside directors" as defined in Treasury Regulations ss.1.162m-27(e)(3). Any action of the Committee with respect to the administration of the Plan shall be taken by majority vote. Subject to the express provisions of the Plan, the Committee shall have authority to (i) construe and interpret the Plan, (ii) prescribe, amend and rescind rules and regulations relating to the Plan, and (iii) make all other determinations necessary or advisable for the administration of the Plan. All determinations and interpretations made by the Committee shall be binding and conclusive on all participants in the Plan and on their legal representatives and beneficiaries. 3. Maximum Number of Shares Subject to Plan. Subject to adjustment as provided in Section 12 hereof, the shares of stock to be offered under the Plan may be authorized but unissued shares of the Company's Common Stock, par value $.02 per share (the "Common Stock"), or issued shares which have been reacquired. The aggregate amount of Common Stock to be delivered upon exercise of all options granted under the Plan shall not exceed 1,115,000 shares, subject to adjustment as provided in Section 11 hereof; provided, however, that effective on the date of the filing, if any, of an amended and restated certificate of incorporation for the Company on or before June 30, 2005 increasing the total authorized capital stock of the Corporation to 70,000,000 shares consisting of 65,000,000 shares of Common Stock, and 5,000,000 shares of preferred stock, par value $0.02 per share, the aggregate amount of Common Stock to be delivered upon exercise of all options granted under the Plan shall be increased to 6,815,114 shares, subject to adjustment as provided in Section 12 hereof. 4. Non-Qualified Options. Options granted under the Plan are non-qualified stock options, not intended to qualify for incentive stock option treatment under Section 422 of the Internal Revenue Code. 5. Eligibility and Participation. Options shall be granted hereunder to such individuals as the Committee, in it sole discretion, may determine. The determination by the Committee of the persons who are eligible to participate in the Plan and the number of options to which they are entitled under the Plan shall be final. 6. Purchase Price. The purchase price of Common Stock covered by each option shall be determined by the Committee; provided, however, that the purchase price shall not be less than the par value of the Common Stock ($0.02 per share). 7. Duration and Time of Exercise of Options. Each option and all rights thereunder shall expire on such date as the Committee may determine, but in no event later than ten (10) years from the date on which the option is granted, and shall be subject to earlier termination as provided herein. Each option shall be exercisable in such installments during the period prior to its expiration date as the Committee shall determine, or may, if so determined by the COmmittee, be exercisable either in whole or in part at any time prior to its expiration date. If the option is made exercisable in installments and the optionee shall not in any given installment period purchase all of the shares which the optionee is entitled to purchase in such installment period, then the optionee shall have the right cumulatively thereafter to purchase any shares not so purchased and such right shall continue until the expiration date or sooner termination of such option. In the event of (a) a reorganization, merger or consolidation of the Company in which the Company is not the surviving corporation, (b) the dissolution or liquidation of the Company, or (c) a sale or lease of fifty percent (50%) or more, computed on the basis of book value, of the Company's consolidated assets, the time at which all options then outstanding may be exercised shall be accelerated and all such options shall become exercisable in full on or before a date fixed by the Committee prior to the effective time of such reorganization, merger, consolidation, dissolution, liquidation, sale or lease, and upon such effective time any unexercised options shall expire. The Committee may, at any time, in its absolute discretion, accelerate the time at which an outstanding option can be exercised, in whole or in part, in the case of death or disability. 8. Exercise of Options Options shall be exercised by the delivery of written notice to the officer of the Company designated by the Committee setting forth the number of shares with respect to which the option is to be exercised, and specifying the address to which the certificates for such shares are to be mailed. The option price shall be paid in full at the time of exercise in cash by United States currency, certified check or money order or by tendering to the Company (i) shares of Common -2- Stock having a fair market value on the date of exercise equal to the option price (including shares that would otherwise be issued pursuant to such exercise), or (ii) a combination of cash and shares of Common Stock valued at such fair market value. As promptly as practicable after receipt of such written notification of the exercise of an option and payment, the Company shall deliver to the optionee certificates for the number of shares with respect to which such option has been so exercised issued in the optionee's name. 9. Non-Transferability of Options. Unless otherwise determined by the Committee, Option granted under the Plan shall, by its terms, be non-transferable by the optionee, either voluntarily or by operation of law, otherwise than by will or the laws of descent and distribution, and shall be exercisable during the optionee's lifetime only by the optionee, regardless of any community property interest therein of the spouse of the optionee, or such spouse's successors in interest. 10. Termination of Employment. (a) If an optionee's employment with the Company terminates for any reason other than those set forth in clauses (b) and (c) below, any outstanding option granted under this Plan and held by the optionee shall terminate on the earlier of the date on which such option would otherwise expire or ninety days after such termination. (b) If an optionee's service as an officer is terminated by disability or death, the optionee or the representative of the optionee's estate or beneficiaries thereof to whom the option has been transferred shall have the right during the period commencing on the date of the optionee's disability or death and ending one (1) year after such termination to exercise any then outstanding options granted in whole or in part. (c) If an optionee's service as an officer is terminated for cause, any outstanding option granted under this Plan held by the optionee shall terminate as of the date of such termination for cause. (d) The Committee may, in its sole discretion, vary the terms set forth above in Sections 9(a), (b) and (c) by providing for different provisions in the applicable option agreement granting such options. 11. Privilege of Stock Ownership. No person entitled to exercise any option granted under the Plan shall have any of the rights or privileges of a stockholder of the Company in respect of any shares of stock issuable upon exercise of such option until certificates representing such shares shall have been issued and delivered. No share shall be issued and delivered upon exercise of any option unless and until, in the opinion of counsel for the Company, any applicable registration requirements of the Securities Act of 1993, any applicable listing requirements of any national securities exchange on which stock of the same class is then listed, and any other requirements of law or of any regulatory bodies having jurisdiction over such issuance and delivery, shall have been fully complied with. -3- 12. Adjustments. If the outstanding shares of Common Stock of the Company are increased or changed into or exchanged for a different number or kind of shares or securities of the Company as a result of a merger, reorganization, recapitalization, reclassification, stock dividend, stock split or reverse stock split, an appropriate and proportionate adjustment shall be made in the maximum number and kind of shares as to which options may be granted under this Plan. A corresponding adjustment changing the number or kind of shares allocated to unexercised options or portion thereof, which shall have been granted prior to any such change, shall likewise be made. Any such adjustment in the outstanding options shall be made without change in the aggregate purchase price applicable to the unexercised portion of the option but with a corresponding adjustment in the price for each share covered by the option. Adjustments under this Section shall be made by the Committee, whose determination as to what adjustments shall be made, and the extent thereof, shall be final, binding and conclusive. No fractional shares of stock shall be issued under the Plan for any such adjustment. 13. Written Agreement. Each option granted hereunder shall be embodied in a written option agreement, which shall be subject to the terms and conditions prescribed herein, and shall be signed by the optionee and by an officer of the Company for and on behalf of the Company. 14. Amendment and Termination of Plan. The Board of Directors of the Company may at any time amend, suspend or terminate the Plan. No amendment, suspension or termination of the Plan shall, without the consent of the optionee, alter or impair any rights or obligation under any outstanding Option Agreement. 15. Withholding. Any person exercising an option shall be required to pay in cash to the Company the amount of any taxes the Company is required by law to withhold with respect to the exercise of such option. Such payment shall be due on the date the Company is required to withhold such taxes. Such payment may also be made at the election of the optionee by the surrender of shares of Common Stock then owned by the optionee, or the withholding of shares of Common Stock otherwise to be issued to the optionee on exercise, in an amount that would satisfy the withholding amount due. The value of such shares withheld or delivered shall be equal to the fair market value of such shares on the date of exercise. In the event that such payment is not made when due, the Company shall have the right to deduct to the extent permitted by law, from any payment of any kind otherwise due to such person from the Company, all or part of the amount required to be withheld. 16. Effective Date of Plan. The Plan was originally effective on December 31, 2001. This amendment and restatement of the Plan is effective April 26, 2004, except as otherwise provided herein. -4- 17. Construction. The Plan and options granted hereunder shall be governed by and construed in accordance with the laws of the State of Delaware and in accordance with such federal laws as may be applicable. -5- EX-31 5 ex31-1.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 June 30, 2004; 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: August 16, 2004 --------------- /s/ James C. Mavel ------------------------------- James C. Mavel Chairman, Chief Executive Officer and President EX-31 6 ex31-2.txt EXHIBIT 31.2 Exhibit 31.2 CERTIFICATION OF CHIEF FINANCIAL OFFICER I, Peter H. Stelling, 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 June 30, 2004; 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: August 16, 2004 --------------- /s/ Peter H.Stelling ---------------------------------------------- Peter H. Stelling Chief Financial Officer, Vice President and Treasurer EX-32 7 ex32-1.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 June 30, 2004 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 August 16, 2004 By: /s/ James C. Mavel --------------- ------------------------- James C. Mavel Chairman, Chief Executive Officer and President EX-32 8 ex32-2.txt EXHIBIT 32.2 Exhibit 32.2 CERTIFICATION I, Peter H. Stelling, 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 June 30, 2004 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 August 16, 2004 /s/ Peter H. Stelling --------------- ----------------------------------------- Peter H. Stelling Chief Financial Officer, Vice President and Treasurer -----END PRIVACY-ENHANCED MESSAGE-----