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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
(X) Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934
For the fiscal year ended DECEMBER 31, 1998
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( ) Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the transition period from to
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Commission File No. 0-5265
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SCAN-OPTICS, INC.
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(Exact name of registrant as specified in its charter)
DELAWARE 06-0851857
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(State or other jurisdiction of (I.R.S. Employer Identification Number)
incorporation or organization)
169 PROGRESS DRIVE, MANCHESTER, CT 06040
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(Address of principal executive offices) Zip Code
(860) 645-7878
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(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act: NONE
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Securities registered pursuant to Section 12(g) of the Act: COMMON STOCK,
$.02 PAR VALUE
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(Title of Class)
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. ( X ) YES ( ) NO
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to
this Form 10-K. [X]
The aggregate market value of the voting stock (common) held by non-affiliates
of the registrant: $26,489,512 as of March 22, 1999.
The number of shares of common stock, $.02 par value, outstanding as of March
22, 1999 was 7,370,482.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the definitive Proxy Statement, relating to the 1999 Annual Meeting
of Stockholders, which will be filed pursuant to Regulation 14A with the
Securities and Exchange Commission not later than 120 days after the end of the
fiscal year, are incorporated by reference and included in the following:
Part III-Item 10 - Directors and Executive Officers of the Registrant
Part III-Item 11 - Executive Compensation
Part III-Item 12 - Security Ownership of Certain Beneficial Owners and
Management
Part III-Item 13 - Certain Relationships and Related Transactions
PART I
ITEM 1 - BUSINESS
Scan-Optics, Inc. (the "Company") was incorporated in Delaware in 1968 and has
its principal office at 169 Progress Drive, Manchester, Connecticut 06040.
The Company has been a leader in applying technology to high-speed recognition,
data entry and imaging solutions for the past 31 years. The Company was among
the first to develop Optical Character Recognition (OCR) technology for data
capture and is a leading provider of image scanning systems worldwide.
Leveraging the core competencies of character recognition, image processing,
paper handling and data entry, the Company has transitioned to become a
provider of solutions that focus on the needs of its customers.
The Company has transformed into three distinct business segments, product and
solution sales, maintenance revenue and contract manufacturing.
The Company combines technology, experience and expertise to develop cost-
effective solutions for applications in the government, healthcare,
transportation, financial and order entry industries. The Company's ability to
offer customized and integrated system solutions has helped customers all over
the world to meet their productivity and profitability objectives.
Access Services is a hardware maintenance division of the Company that provides
third party and proprietary maintenance services. The division provides
hardware maintenance support for equipment related to imaging, automated
data capture, document processing and information management as well as other
forms of electro-mechanical equipment.
During 1998, Scan-Optics formed its Contract Manufacturing division to provide
electro-mechanical assembly and test services for equipment such as mail
processing systems, advanced security systems, large-format scanners, plotters
and printers, and other large-scale electro-mechanical devices.
A key component of the Company's business strategy is based upon accretive
acquisitions of businesses or assets that add value either from a strategic or
tactical perspective. The Company completed two such strategic acquisitions
during the second quarter of 1998 as discussed on pages 35 and 36.
PRODUCTS
The Company designs, manufactures, markets and services information processing
systems which use "state of art" technology for imaging, automated data
capture, document processing and the management of information. These systems
employ high speed paper movement, OCR/ICR (Intelligent Character Recognition),
high speed image capture, image storage and retrieval systems, image information
processing, key-entry, microfilming, ink jet printing, multi-pocket page and/or
document sorting, local area networking, client/server PC processing,
communications software, software/hardware integration, application software
development, and professional services.
These key product disciplines utilize integration skills that leverage the core
competencies of the Company to provide broader solution alternatives. These
core competencies include:
Line of Business Domain Knowledge
Professional Services
Network Services
High Speed Paper Handling
Document Scanning
Image Enhancement Algorithms and Image Quality
Character Recognition (OCR, ICR, Barcode, Mark Sense, etc.)
Key-From-Image and Key-From-Paper Data Entry
Image Storage and Retrieval
Customer Relations - Hardware Maintenance
Contract Manufacturing
Value Added Engineering Services and Solutions
CORE COMPETENCIES
Line of Business Domain Knowledge
The Company provides solutions that are proven and are in production. The
Company has the domain knowledge to provide total solutions in the following
industries: government, healthcare, transportation, financial and order entry.
That domain knowledge is utilized in the product suite of applications:
ImageEMC++, TAXexpress, ORDERexpress and PROOFexpress.
Professional Services
In order to provide a total solution to the customer, the Company has provided
a consultative approach to integrate solutions with proven core competencies in
the following areas:
Paper Handling Application Expertise Project Management
Installation Training Archival / Retrieval
Custom Engineering Development Tools Forms Design
Open Systems Neural Technology System Integration
Microfilming OCR Technology Industry Standards
Imaging Networking
The Company has provided customized software support to its customers since
1968. The Company's scanners and assorted network system products provide the
hardware platforms for delivering advanced high-volume forms processing,
imaging, and document management system solutions, especially in government,
healthcare, transportation, financial and order entry. This customized
software support enables the Company to provide full production-ready
application systems tailored to the customer's specific needs.
This support is provided through professional services offered by the Company.
The Company also provides individual, custom software services as requested by
the customer. In this way, the Company can either provide the entire package
of software support or simply provide those services that the customer desires.
Network Services
Network Services specializes in providing professional network integration
services to customers of all sizes, from small companies with simple local area
networks to large organizations with enterprise-wide wide area networks. The
Company offers solutions for every networking requirement including data,
voice, and video. The Network Services staff is comprised of qualified
professionals that have earned hardware and software vendor certifications such
as the Novell CNE, Microsoft MCSE, Compaq ASE, IBM PSE and others. The
Company's employees are experienced with Ethernet, Fast Ethernet, Token-Ring,
and FDDI networks utilizing the IPX/SPX, TCP/IP, and NetBIOS/NetBEUI protocols.
The operating systems supported include Novell NetWare, Microsoft Windows NT,
Windows 95, Windows 98, DOS/Windows, and OS/2.
High Speed Paper Handling
The Company is a leader in patented high-speed paper handling systems. The
Series 9000 scanner has over 250 systems installed worldwide. The Company has
over 445 scanning systems installed worldwide processing over 23 million pieces
of paper on a daily basis.
Document Scanning
The Company has been addressing the high-speed, high-volume, page/document
processing marketplace since its inception in 1968. During 1992, the Company
introduced the Series 9000 generation of scanners. This system launched the
Company into the full page image and recognition market. Full page
document processing includes front and back imaging, OCR reading, serialization
and microfilming of a document in a single pass. During 1994, the Company
introduced the Model 7800 scanner which captures images that can be utilized to
improve Customer Service, Order Processing, and Data Capture. In 1998 the
Company introduced the Model 7400 scanner, targeted at the mid-volume
production market.
Image Enhancement Algorithms and Image Quality
Image enhancement algorithms and image quality are priority enhancement
activities for the Company. The program to continually enhance their data
processing attributes is driven by the Company's large customer base. The need
for continuous improvement helps customers reduce their bottom line expenses for
processing a growing amount of data. Image enhancement starts at the scanner
capture system. The Company provides the fastest page capture and image system
on the market today. This processing is carried forward into the Company's OCR,
Key-From-Image and Image Storage and Retrieval Systems. Management believes
that the Company's image quality is among the best in the industry. Electronic
image processing and storage are rapidly overtaking the use of microfilm and the
Company is on the leading edge of this technology with its hardware and
application software solutions.
Character Recognition
The Company has been developing and providing its own character recognition
since 1968. This recognition has always included the basic in-line recognition
of machine printed, handprinted, and mark sense forms. With the introduction
of the Series 9000 system, the Company has expanded this recognition to include
barcode, patch code, special educational score testing analysis, and special
stamp recognition. In addition to these recognition processes, the Company has
integrated and developed neural recognition technologies that support both in-
line and post capture recognition. The Company's character recognition
technology was enhanced in 1999 with its patented Context Edit capability that
brings a new level of data purification to the integrated solutions.
Key-From-Image and Key-From-Paper
The Company has been providing complete hardware and software solutions using
Key-From-Image (KFI) and Key-From-Paper (KFP) since 1976. This KFI and KFP
solution remains important today, using the latest open network and platform
designs with Windows, UNIX, Novell, TCP/IP, NT, and other industry standard
components. By combining the high-speed scanning systems with the flexibility
of KFI and KFP, customers are able to lower their overall data capture and
document processing costs while improving the level of data accuracy and
availability.
Image Storage and Retrieval
The Company's Image Storage and Retrieval solution is based on industry
standards and powerful "best in class" components backed by 31 years of
experience in high-volume, mission-critical production systems. The solution
is an imaging application development environment that is modular and scaleable
in design. Due to an open architecture environment, all data, rules, indexes
and workflow processes are maintained in an ODBC-compliant or SQL database
product. This allows future migration to more powerful and cost-effective
operating systems and hardware platforms as dictated by changing organizational
and operational requirements.
Customer Relations - Hardware Maintenance
The Company has been offering service and maintenance support to its broad
customer base since 1968. This support is available with either leased or
purchased systems in both domestic and international markets.
In June of 1998, the Company acquired the hardware maintenance division of
Access Corporation of Cincinnati, Ohio. This business was combined with Scan-
Optics' existing hardware maintenance division to form Access Services, a
separate division, dedicated to serving the Scan-Optics customer base and the
third party maintenance marketplace.
Service is provided through a network of over 140 service centers worldwide.
The Company provides on-site and on-call service with response times of two
hours or less. The Company focuses on comprehensive diagnostic routines,
modular designs, preventive maintenance procedures and customer surveys to
provide its users high system availability to perform mission critical
applications.
The Company's customers include government, healthcare organizations,
transportation, subscription and catalog fulfillment companies, financial
institutions and manufacturers in the U.S., Canada, Latin America, Europe and
Asia. The Company maintains high standards of teamwork and customer
satisfaction.
Contract Manufacturing
Beginning with the customer's plans, Scan-Optics manages each project from
concept to completion. The capabilities provided include:
Project Management
Engineering and Prototyping
Procurement and Materials Management
Precision Machining, Sheetmetal Fabrication and Welding
Networks/System Integration
Systems Testing
Just-in-Time/Kanban Delivery Systems
Professional Services and Training
Worldwide Field Service
Strong Supplier Partnerships with:
Agency Standards Certification (FCC, UL, LE, CSA)
Commercial Painting and Metal Finishing
Printed Circuit Board Assemblies and Testing
Wire Harness and Cable Assembly and Testing
Specialty Packaging
Worldwide Shipping
Value Added Engineering Services and Solutions
The Company has been supplying engineering services and solutions to meet
customer needs since introducing its first fully integrated solution in 1976.
The solutions include scanning, recognition, Key-From-Image, data entry, and
communications. During 1993, the Company was selected to develop a prototype
system to process medical claims for a healthcare agency in Japan. This system
was designed with 36 stacker pockets for sorting forms; expanded paper handling
capabilities for light-weight, flimsy forms; high resolution image cameras to
permit recognition of complex Japanese kanji characters; and software forms
recognition for up to 20,000 different document formats.
The Company has been involved in special recognition techniques to process
order forms that contain stamps. These stamps are used as an entry into a
sweepstakes contest or to select ordered items for a record or book club. The
stamps are of a multitude of colors and are successfully processed through the
Company's special recognition features. In addition to stamp processing, the
Company has been engaged in recognition analysis for educational test scoring.
This process is accomplished in full duplex mode at a transport speed of 50
inches per second.
SIGNIFICANT CUSTOMERS
In 1998, the Company derived 12% of its total revenue from one customer, Toyo
Officemation, Inc., one of the Company's distributors in Japan. In 1997 and
1996, this same customer accounted for 39% and 38% of consolidated revenues.
For more information about this customer, see the Outlook section of
Management's Discussion and Analysis of Consolidated Financial Condition and
Results of Operations.
CHANNELS OF DISTRIBUTION
The Company is augmenting its practice of selling directly to end-users and
distributors to respond to new opportunities in the marketplace. The focus on
providing more complete solutions to customers has stimulated the pooling of
resources with selected system integration firms and specialized niche
suppliers. The cooperative effort with system integrators and other vendors
has introduced the Scan-Optics logo to new markets both domestically and
internationally.
BACKLOG
The backlog for the Company's products and services as of December 31, 1998 was
approximately $26,445,460. There were no orders outstanding for health claims
processing systems to the Japanese government. As of December 31, 1997, the
backlog was approximately $23,139,000, of which $17,399,000 was for core
business. Core business includes all domestic and international orders except
those for health claims processing systems to the Japanese government, which
amounted to approximately $6 million as of December 31, 1997. The backlog
consists of equipment, software and services to be sold and noncancelable
rentals and maintenance due on existing rental and maintenance contracts over
the next year. The Company normally delivers a system within 30 to 180 days
after receiving an order, depending upon the degree of software customization
required.
MANUFACTURING
Manufacture of the Company's products requires the fabrication of sheet metal
and mechanical parts, the subassembly of electronic and mechanical parts and
components, and operational and quality control testing of components,
assemblies and completed systems. The Company's products consist of both
standard and Company-specified mechanical and electronic parts, sub-assemblies
and major components, including microcomputers. Most parts are purchased,
including many complex electronic and mechanical sub-assemblies. The Company
also purchases major standard components, including low speed scanners,
jukeboxes, PCs, printers and servers. An important aspect of the Company's
manufacturing activities is its quality control program which uses
computer-controlled testing equipment.
The Company has not experienced significant shortages of any components or
subassemblies; however, alternate sources for such components and subassemblies
have been developed.
COMPETITION
The Company competes with service providers utilizing multiple vendor
architectures. The Company differentiates its solutions by offering a total
system, including post installation support of hardware and software services.
The Company focuses on industry specific "application" areas with solutions
utilizing image and data entry/data capture systems provided by the Company.
PATENTS
The Company currently has nine United States patents in force which expire
between 2003 and 2018. The patents are on mechanical systems, electronic
circuits, electronic systems and software algorithms which are used throughout
the product lines. The Company expects to continue to apply for patents on its
new technological developments when it believes they are significant. In
November 1997, the Company licensed a patent to IBML for their use in an image
transport designed for processing airline tickets.
EMPLOYEES
As of December 31, 1998 the Company employed 339 persons, including 28 with
administrative and support responsibilities, 34 in marketing and sales, 173 in
software and service activities, 49 in engineering and 55 in manufacturing
capacities. The Company considers its employee relations to be good. The
Company has not experienced any work stoppages.
PRODUCT DEVELOPMENT
In June 1992, the Company introduced the Series 9000 scanner. The Series 9000
integrates the latest in character recognition, image capture, and paper
handling technology into a high speed scanner. During 1993, the Company
introduced several options for this scanner. These options permit character
recognition and image processing on the "reverse side" of documents; a special
small document stacker module; and the ability to recognize several industry
standard bar-codes.
The Series 9000 interfaces with other company products to provide multi-media
data entry and image storage and retrieval. During 1994, the Company developed
and delivered a network-based scanning, recognition and data entry product -
the Series 7000 - which addresses requirements for a distributed solution.
In April 1995, the Company introduced the Model 7800 scanner. The Model 7800
is the world's fastest full-page image scanner, capable of capturing up to 200
full size pages per minute. It is based on Scan-Optics' high-end, industry
proven Series 9000. In April 1996, the Model 7800 was recognized at an
industry trade show with the "Showstopper Award" for outstanding product.
In August 1995, the Company signed a license agreement to sell and support the
ImageEMC product. As part of the agreement, the Company took over support
requirements of the currently installed customer base and hired development and
support personnel from TCSI Corporation. The product was enhanced to accept
images and data from Scan-Optics' scanners. Any enhancements made to the
product are owned by the Company. This product provides a total solution for
processing healthcare claim forms (HCFA 1500s). The product is a client/server
architecture and operates on industry standard hardware and software platforms.
In July 1996, the Company introduced a high-speed neural network based
handprint recognition system for use in the Series 9000 scanner. The In-Line
Neural Classifier operates at speeds of up to 7500 characters per second while
achieving a 50% reject rate reduction and 10% substitution rate reduction over
the current handprint recognition engine. The classifier is based on a special
neural network algorithm which is resistant to overtraining making it an ideal
candidate for character recognition systems.
The Company is focusing its research and development on total solutions. In
1997, ImageEMC++ was released. Developed as a result of the Company's
experience with many of the nation's leading health insurance and other claim
payment companies, ImageEMC++ is a comprehensive business solution designed to
efficiently process all the paper forms and other documents these organizations
receive. It minimizes the time and labor involved with processing single and
multi-part paper health claims, enrollments and other forms as well as
correspondence, re-pricing sheets and other general documents.
The Company has been involved in leveraging the power of neural recognition
engines to assure success with each operation. Context Edit analyzes
incorrectly-recognized data, conducts a database library search, compares
fields, character by character, to locate a correct match, and then
automatically updates the data batch with the correct information. With an
extensive electronic postal/name library, virtually every combination is
considered but only the correct value is accepted.
The Company released VistaCapture in 1998. VistaCapture represents a new
paradigm for creating data entry applications. The VistaCapture product suite,
an open-system solution based on Visual basic that utilizes Microsoft ActiveX
(OCX) technology, includes the VistaImage, VistaEdit, VistaStat, VistaICR and
VistaForm modules. VistaCapture is designed for high-speed key-entry, key-
from-image, and state-of-the-art character recognition (OCR/ICR) applications.
The Company continues to support its traditional data entry products of Key
Entry III and ImageKey. Typical applications range from "heads down" data
entry to highly sophisticated multi-user "front-ends" for large corporate
databases.
In 1998, releases of solutions in the government, order entry and
transportation markets were made:
Scan-Optics' TAXexpress, an automated image-based tax
processing and data capture solution, consists of processing modules to
handle income tax, sales tax and other tax returns. It applies the
technologies of character recognition, data and image capture, data
correction, verification and transfer to a host system, including image
workflow and archive capabilities. As a result, TAXexpress can
achieve the principal goal of most tax and revenue departments in
implementing an image-based tax processing system.
Scan-Optics' ORDERexpress is an automated image-based data
capture solution for "club" style order solicitation and order processing.
ORDERexpress provides mark sense, machineprint and handprint
recognition, which are integral parts of most reply cards. It also offers
processing modules to handle order reply cards, return non-orders, and
process payments. This solution eliminates the need to manually sort and
separately process orders from non-orders, and name and address changes.
Also available are hardware and application software to process mail-out
announcements and return order documents and payments.
Scan-Optics' PROOFexpress is an automated image-based solution
for delivery, data capture and storage and retrieval. It provides
processing modules to handle waybills, delivery tickets and other billing
documents. It applies the technologies of character recognition, data and
image capture, data correction and verification and transfer to a host
system. As a result, PROOFexpress can achieve the principal
goal of most billing departments in implementing an image-based storage
and retrieval system.
The Company considers product development to be a significant element in
maintaining market share. During the years ended December 31, 1998, 1997, and
1996, the Company's research and development expenses were $5,560,000,
$4,552,000, and $4,142,000, respectively. Some portion of these amounts were
funded under the development agreements described below.
The Company intends to continue its program of development of additional
options and capabilities for its existing products as well as the development
of new products which exploit the Company's core competencies.
FUNDED DEVELOPMENT AGREEMENTS
During 1990, the Company entered into two separate agreements for the
development of new product technology, which provided a total funding of
$3,645,000 over an eighteen month period. Revenues related to these
development projects were recorded through 1992, which offset related costs
incurred to successfully develop the products. The agreements provide the
respective third party with exclusive rights to market the developed product in
its geographic market area while the Company will manufacture the product and
retain ownership and all other distribution rights. Royalties and other
considerations, up to a maximum of 130% of the amount advanced to the Company,
were required to be paid based on sales of the new product technology through
the termination dates of the agreements, June 30, 1995 and December 31, 1996.
As of December 31, 1996, the Company had repaid $4,738,500, or 100% of the
maximum potential obligation.
During 1995, the Company entered into $700,000 of product development
agreements with a specific customer, which required various modifications and
enhancements to the Company's Series 9000 product. The Company recorded
revenue related to these development agreements of $336,000 in 1995, and
$364,000 in 1996. These revenues offset related costs incurred to develop the
modifications and enhancements. The ownership of the technologies created as a
result of this development agreement remains with the Company. No royalties or
other considerations are required as a part of this agreement.
In August 1995, the Company signed a license agreement to sell and support the
Image EMC product. The agreement requires payment of royalties based upon the
net sales price of the software. Royalties are expensed as a part of cost of
sales at a rate of 10%, decreasing to 5% after a minimum royalty payment is met.
During 1997, the Company entered into a $636,000 product development agreement
with a specific customer, which required various modifications and enhancements
to the Company's Series 9000 product. The Company recorded all revenue related
to this development agreement in 1997. These revenues offset related costs
incurred to develop the modifications and enhancements. The ownership of the
technologies created as a result of this development agreement remains with the
Company. No royalties or other considerations are required as a part of this
agreement.
During 1998, the Company completed a $200,000 custom development project
with a specific customer. The project involved adding fluorescent bar code
printing and reading to the Series 9000 product and adding additional stacker
modules to accommodate the document sorting requirements. The Company recorded
all revenue related to this development agreement in 1998. These revenues
offset related costs incurred to develop the modifications and enhancements.
The ownership of the technologies created as a result of this development
agreement remains with the Company. No royalties or other considerations are
required as a part of this agreement.
EFFECTS OF ENVIRONMENTAL LAWS
The effect of federal and state environmental regulations on the Company's
operations is insignificant.
BUSINESS SEGMENTS
The Company views its business in three distinct revenue categories: Product
and solution sales, Maintenance revenue and Contract manufacturing. Revenues
are used by management as a guide to determine the effectiveness of the
individual segment. The Company manages its operating expenses through a
traditional functional perspective and accordingly does not report operating
expenses on a segment basis.
Year Ended December 31
(thousands) 1998 1997 1996
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Revenues
Product and solution sales $ 40,174 $ 45,002 $ 34,293
Maintenance revenue 13,222 11,606 11,741
Contract manufacturing 575
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Total revenues 53,971 56,608 46,034
Cost of product sales 19,335 25,066 19,622
Service expenses 14,693 10,400 9,544
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Gross profit margin 19,943 21,142 16,868
Operating expenses, net 16,709 15,451 13,603
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Income before income taxes $ 3,234 $ 5,691 $ 3,265
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Total assets $ 52,992 $ 38,707 $ 31,121
Total expenditures for additions to $ 560 $ 1,139 $ 2,581
long-lived assets
Note: The Japanese Health Organization accounted for $5.7 million, $20.2
million and $14.1 million in product and solution sales in 1998, 1997 and 1996,
respectively.
Sales of equipment to customers in the international market represent an
important source of the Company's revenues. The Company has international
distributors located in 46 countries and covering six continents. Changes in
the economic climates of foreign markets could have an unfavorable impact on
future international sales.
Export sales by geographic area (based on the location of the customer) were as
follows:
(thousands) 1998 1997 1996
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Latin America $ 88 1% $ 2,207 8% $ 113 1%
Europe 328 3% 37 433 2%
Pacific Rim 9,649 96% 24,894 92% 18,281 97%
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$10,065 $ 27,138 $ 18,827
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Export sales represented 31%, 66% and 62% of net sales for the three years ended
December 31, 1998, 1997 and 1996, respectively.
ITEM 2 - PROPERTIES
The Company's world headquarters and manufacturing facility is located in a
newly renovated 84,000 square foot, one-story building in Manchester,
Connecticut, leased for a term expiring in December 2006. Southern Computer
Systems, Inc., leases 24,000 square feet of office space, expiring in December
1999, in Birmingham, Alabama, for professional services, software engineering
and support, administration and equipment demonstration. The Company also
leases a 3,000 square foot sales, support, and research and development
facility in Berkeley, California that expires in December 2000.
The Company leases office space throughout the United States for sales, service
and administrative functions. Office space for administration and equipment
demonstration is also leased by Scan-Optics, Ltd., in the United Kingdom and
Scan-Optics (Canada), Ltd., both wholly owned subsidiaries.
ITEM 3 - LEGAL PROCEEDINGS
There are no lawsuits currently pending against the Company.
ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Company did not submit any matters during the fourth quarter of 1998 to a
vote of the stockholders.
EXECUTIVE AND OTHER OFFICERS OF THE REGISTRANT
Officers of the Company are set forth in the schedule below.
Name Age Principal Occupation: Officer Since
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James C. Mavel 53 Chairman, Chief Executive Officer,
President and Director 1996
William H. Cuddy 63 Corporate Secretary 1984
Marianna C. Emanuelson 37 Vice President -
Human Resources 1997
Richard C. Goyette 47 Vice President -
Sales, Marketing and Professional
Services 1996
Joel K. Howser 51 Vice President -
Product Development 1998
Clarence W. Rife 59 Vice President -
Customer Relations 1975
Michael J. Villano 39 Chief Financial Officer, Vice
President and Treasurer 1992
Mr. Mavel joined the Company in January 1996 as President and Chief Operating
Officer. In June 1996, Mr. Mavel became a Director of the Company. On
December 31, 1996, Mr. Mavel was promoted to Chief Executive Officer. In May
1997, Mr. Mavel was elected Chairman of the Board of Directors. Prior to
joining the Company, from 1992 through 1995, Mr. Mavel was Vice President and
General Manager of the Imaging Systems Division of Unisys. From 1991 to 1992,
he was Group Vice President of the Financial Information Systems Division of
National Data Corporation.
Mr. Cuddy has been a partner in the law firm of Day, Berry and Howard since
1968. He was elected to the position of Corporate Secretary in September 1984.
Ms. Emanuelson joined the Company in August 1994, and was elected to the
position of Vice President in 1997. She is currently Vice President - Human
Resources.
Mr. Goyette joined the Company in March 1996 as Vice President - Sales and
Marketing. Prior to joining the Company, from 1993 through 1995, Mr. Goyette
was Vice President of the Imaging Systems Division of Unisys. From 1992 to
1993, he was Vice President of the Software Products Group of Unisys. From 1990
to 1992 he was Vice President of Corporate Information Productivity Systems of
Unisys.
Mr. Howser joined the Company in February 1997 as Vice President - Marketing.
In December of 1997, Mr. Howser assumed the responsibility of Vice President -
Product Development. Prior to joining the Company, from 1989 through 1996, he
was director of development for Unisys in its image program. Mr. Howser had
twenty years in transaction processing and OCR/image development prior to
joining Unisys.
Mr. Rife has been employed by the Company since 1969 and was elected to the
position of Vice President in 1975. He is currently Vice President - Customer
Relations.
Mr. Villano joined the Company in 1986 and in 1988 was named Assistant
Controller. In 1989 he was promoted to the position of Controller, in February
1992 was named Vice President and Controller and in March 1994 was named Chief
Financial Officer and Vice President. Mr. Villano was appointed Treasurer in
May 1997.
The executive officers are elected for a one year term effective at the
conclusion of the Annual Meeting of Stockholders each year. There are no
family relationships between any of the listed officers.
PART II
ITEM 5 - MARKET PRICE OF AND DIVIDENDS ON THE REGISTRANT'S COMMON
EQUITY AND RELATED STOCKHOLDER MATTERS
COMMON STOCK MARKET PRICES AND DIVIDENDS
The following is a two year history of Common Stock prices for each quarter.
The table sets forth the high and low closing quotations per share for the
periods indicated of the Common Stock in the over-the-counter market based upon
information provided by the National Association of Securities Dealers, Inc.
The closing quotations represent prices between dealers and do not include
retail markups, markdowns or commissions and may not represent actual
transactions. There were 1,163 stockholders of record at December 31, 1998.
Quarter Ended March 31 June 30 September 30 December 31
High Low High Low High Low High Low
- ---------------------------------------------------------------------------------------------------------------------------
1998 9 13/16 5 15/16 6 1/2 4 13/16 6 13/16 3 15/16 4 7/8 3 3/16
1997 8 3 1/4 7 3/8 4 11/16 12 3/8 5 1/8 13 1/4 7 1/16
The Company has not paid dividends on its Common Stock and the Board of
Directors of the Company has no intention of declaring dividends in the
foreseeable future. The declaration and payment of dividends in the future will
be determined by the Board of Directors in light of conditions then existing,
including the Company's earnings, financial condition, capital requirements and
other factors.
ITEM 6 - SELECTED FINANCIAL DATA
SCAN-OPTICS, INC. AND SUBSIDIARIES
FIVE YEAR SUMMARY OF OPERATIONS
SELECTED FINANCIAL DATA
(thousands, except share data) 1998 1997 1996 1995 1994
- ----------------------------------------------------------------------------------------------------------------------------------
Total Revenues $ 53,971 $ 56,608 $ 46,034 $ 42,084 $ 43,889
=======================================================================================
Income (loss) before income taxes 3,234 5,691 3,265 (1,327) 1,244
Income taxes (benefit) 1,105 (99) (9) (72) (40)
---------------------------------------------------------------------------------------
Net Income (Loss) 2,129 5,790 3,274 (1,255) 1,284
=======================================================================================
Basic earnings (loss) per share $ .31 $ .87 $ .50 $ (.19) $ .20
=======================================================================================
Basic weighted-average shares 6,921,331 6,632,248 6,530,244 6,512,475 6,457,701
Diluted earnings (loss) per share $ .30 $ .82 $ .49 $ (.19) $ .19
=======================================================================================
Diluted weighted-average shares 7,102,658 7,070,013 6,715,942 6,512,475 6,872,417
SELECTED BALANCE SHEET DATA
Total assets $ 52,992 $ 38,707 $ 31,121 $ 29,514 $ 29,619
Working capital $ 15,107 $ 24,643 $ 17,318 $ 14,239 $ 14,015
Total stockholders' equity $ 30,246 $ 27,733 $ 21,207 $ 17,751 $ 18,731
The Company has not paid any dividends for the five year period ended
December 31, 1998.
The above financial data should be read in conjunction with the related
consolidated financial statements and notes thereto.
The earnings per share amounts prior to 1997 have been restated as required to
comply with Statement of Financial Accounting Standards No. 128, EARNINGS PER
SHARE. For further discussion of earnings per share, see Notes to the
Consolidated Financial Statements.
ITEM 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF CONSOLIDATED FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Outlook
The forward-looking statements contained in this Outlook and elsewhere in this
document are based on current expectations. As such, actual results may differ
materially. The ability for Scan-Optics, Inc. (the "Company") to achieve the
following expectations could be impacted by increased competition or a slowdown
in growth within the scanning and imaging market, alternate forms of
processing, inability to consummate accretive acquisitions and changes in the
economic climates of foreign markets as well as that of the United States. See
also Year 2000 Compliance below. The foregoing factors should not be construed
as exhaustive.
In 1997, the Company derived 39% of its total revenue from one customer, Toyo
Officemation, Inc., one of the Company's distributors in Japan. Health claims
processing systems represented 90% of this revenue. The Company received
orders from this customer for ten image scanning and OCR transports, valued at
approximately $6 million, that were delivered in the first quarter of 1998. The
Company has been notified by its Japanese distributor that the end user of the
health claim processing systems has chosen to reallocate 12 systems from
existing locations rather than purchase new systems to meet the remainder of
their current requirement. The Company believes that success in achieving the
initiatives described below will help offset the continued foreseen reduction
in sales from this customer. The inability of the Company to meet these
initiatives may have a materially adverse effect on earnings.
Four major initiatives currently underway are expected to compensate for the
decline in revenues. The first initiative consists of the Company's
development of target market data capture applications that, combined with its
other high speed transports and archival systems, will provide cost effective
solutions. The current focus is on the government, healthcare, transportation,
financial and order entry markets. The Company expects to continue to
emphasize its "Solutions at Work" 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
at Work" in these new markets. The Company was successful with this initiative
and achieved growth of 40% primarily in the government and healthcare markets
in 1998.
The second initiative is further expansion into the international marketplace.
The Company has successfully supplied product to the Japanese market and has
experienced strong sales activity through relationships with highly qualified
and productive distributors. During the last three years, sales to Japanese
distributors have averaged 30% of total revenues. The Company will continue to
focus on developing comparably strong relationships in Europe, Latin America
and other Pacific Rim countries. During 1998, the Company had minimal
achievements with this initiative. The Asian marketplace, due to its economic
challenge, most notably Japan, was a significant disappointment to the Company
during 1998. The economic environment in Latin America has also been an
impediment to growth in these markets. The Company has been strengthening its
relationships in Europe, demonstrated by three sales to a distributor in
England and the active pursuit of sales of the Series 7400 with four Value
Added Resellers in Europe. Also, the Vice President of Marketing has taken
over the responsibility of the sales channel which includes the international
marketplace.
The third initiative relates to leveraging the Company's core competencies in
an effort to add revenues and profits. The Company believes that the hardware
service and manufacturing organizations have potential to sell their individual
expertise, experience and cost effectiveness to other entities. The Company
was successful in attaining in 1998 a $2 million contract manufacturing order
from Rapor, Inc., a security door provider, for delivery in 1999. During 1998,
the Company added agreements with five new hardware manufacturers for third
party maintenance. These agreements comprise approximately fifty end user
customers.
The last initiative is growth through an accretive acquisition or acquisitions.
In the fourth quarter of 1997, the Company engaged the services of an
investment banking firm to assist in a corporate growth strategy that is
focused on the consolidation occurring in the imaging and data capture market.
The imaging industry is made up of many smaller companies and management
believes achieving greater critical mass will increase the likelihood of growth
in the adoption of this technology. With that in mind, the Company is pursuing
acquisitions that will utilize its core competencies and will provide
immediately accretive earnings. During 1998, the Company completed two
acquisitions, Southern Computer Systems (SCS), a software and solutions
provider, and the hardware maintenance division of Access Corporation. It is
the Company's policy not to discuss or comment on negotiations regarding such
transactions until a definitive agreement is signed or after circumstances
indicate a high degree of probability that a transaction will be consummated,
unless the law otherwise requires.
RESULTS OF OPERATIONS - 1998 VS. 1997
Total revenues decreased $2.6 million or 5% from 1997 to 1998.
Product sales decreased $8.9 million or 22% from the prior year. The Company's
core business sales increased $5.5 million or 26% from 1997 to 1998. The core
business includes all domestic and international sales except those for health
claims processing to the Japanese government. North American sales increased
$8.1 million or 57%. SCS provided $4.8 million of this increase.
International sales decreased $2.6 million or 37% from 1997. International
sales in the Pacific Rim that relate to the core business declined 17% or $.8
million and sales to Europe and Latin America decreased 81% or $1.8 million
mainly due to the decline in economic conditions in the Latin American
countries. Sales to the Japanese government decreased $14.4 million or 72% as
discussed in the Outlook section above.
Service revenues increased $6.5 million from 1997 to 1998. Hardware maintenance
and support revenue increased $1.8 million or 16% due to the June 30, 1998
acquisition of the hardware maintenance division of Access Corporation.
Professional service revenue increased $4.7 million or 193% due to an increase
in the focus on "Solutions at Work", the marketing campaign to provide greater
customer value in the target markets, as well as the acquisition of SCS, which
came with a professional services organization of a similar size to that of
Scan-Optics.
Engineering revenues decreased $.6 million from 1997 to 1998 due to a decline
in customer funded development contracts from 1997 levels. (See Note H of
the Notes to Consolidated Financial Statements.)
Cost of product sales decreased $5.7 million or 23% from 1997 to 1998. Cost of
product sales as a percentage of product sales decreased 1% from 61% in 1997 to
60% in 1998. The decrease is mainly due to a change in sales mix from 1997 to
1998 relating to the significant reduction in sales to the Japanese distributor.
Service expenses increased by $4.3 million in 1998. Customer service expenses
increased $1.5 million due to the acquisition of the hardware maintenance
division of Access Corporation on June 30, 1998. Professional service expenses
increased $2.8 million from 1997 to 1998 due to the acquisition of SCS on June
16, 1998.
Sales and marketing expenses decreased by $.3 million in 1998 principally due
to a reduction in salaries and related expenses of $.5 million related to a
reorganization of the sales department, a specific accounts receivable
provision of $.4 million recorded in 1997, offset by an increase in commission
expense of $.3 million related to the increase in North American sales, and an
increase related to SCS of $.3 million.
Research and development expenses increased $1 million from 1997 due in part to
increases in salary and benefit expenses of $.3 million and travel of $.2
million offset by a reduction in outside services of $.2 million. In addition,
SCS added $.7 million to engineering expense in the second half of 1998. During
1998 the Company invested in its core technologies of imaging, recognition,
paper handling and data entry, as well as its continued investment in
application software to meet the requirements of its target markets.
General and administrative expenses increased $.2 million in 1998 compared to
the prior year. The increase is mainly due to SCS.
Interest expense increased $.4 million due to the funding requirements related
to the acquisitions completed during the second quarter of 1998.
Income taxes increased $1.2 million from 1997 due to the full utilization of
U.S. net operating loss carryforwards in 1997. The Company's effective tax
rate for 1998 was 34%.
RESULTS OF OPERATIONS - 1997 VS. 1996
Total revenues increased $10.6 million or 23% from 1996 to 1997.
Product sales increased $11.1 million or 37% from the prior year. The
Company's core business sales increased $4.4 million or 26% from 1996 to 1997.
The core business includes all domestic and international sales except those
for health claims processing to the Japanese government. North American sales
increased $2.8 million or 24% and international sales increased $8.3 million or
44% from 1996. International sales in the Pacific Rim showed another year of
growth with a sales volume increase of 36% or $6.6 million mainly due to the
increase in orders with the Japanese government. Sales to Europe decreased $.4
million as new channels were being established and sales to Latin America
increased $2.1 million from 1996 to 1997.
Service revenues decreased $.4 million from 1996 to 1997. Hardware maintenance
and support revenue decreased $.3 million due to the replacement of older
product lines with current products which require less maintenance than earlier
product lines. Professional service revenue decreased $.1 million due to an
increase in distributor sales which do not carry a professional service
component and also due to the process of transitioning to become a solution
provider in the marketplace.
Engineering revenues decreased $.3 million from 1996 to 1997 due to a decline
in the funded development contracts from 1996 levels. (See Note H of the
Consolidated Financial Statements.)
Cost of product sales increased $5.4 million from 1996 to 1997. The cost of
product sales as a percentage of product sales decreased 4% from 65% in 1996 to
61% in 1997. The decrease is mainly due to continued manufacturing
efficiencies achieved from increased production volume, favorable material
pricing due to purchasing volumes and quality improvement processes.
Service expenses increased by $.9 million in 1997. Customer service expenses
increased $.4 million principally due to an increase in outside services
expense and an increase in amortization of customer service parts inventory.
Professional service expenses increased $.5 million in 1997 from 1996 mainly
due to increases in staffing levels and related fringe benefits and travel
expenses.
Sales and marketing expenses increased by $1.8 million in 1997 principally due
to an increase in sales staffing levels and associated fringe benefits and
travel expenses. Commission expense also increased which is reflective of the
increase in North American sales. The Company has expanded its sales and
marketing organization to increase the coverage in the worldwide marketplace
and focus on North American selling efforts in the target markets.
Research and development expenses increased $.4 million from 1996 due to
increases in outside services and consulting expenses. During 1997, the
Company invested in its core technologies of imaging, recognition and paper
handling, as well as new "Total Solution" application software.
General and administrative expenses decreased $.2 million in 1997 compared to
the prior year. The decrease is mainly due to one time 1996 expenses for
legal fees, offset by an increase in expenses due to the Company's focus on
investor relations and the establishment of a relationship with an investment
banking firm to meet the Company's strategic planning requirements.
Interest expense decreased $.1 million due to the continued decrease in the
average outstanding loan balance for 1997, which was $.2 million compared to
$1.1 million in 1996.
LIQUIDITY AND CAPITAL RESOURCES
Cash and cash equivalents decreased by $4.2 million from 1997 to 1998 for the
reasons discussed below.
At December 31, 1998, the Company had $11.5 million in outstanding borrowings
against its $13 million line of credit. The average borrowing level for 1998
was $4.9 million compared to $.2 million for 1997. The increase in borrowing
level is directly related to the two acquisitions completed in the second
quarter of 1998 as well as the continued shift to solutions sales which
typically brings extended implementation and payment cycles. The Company
expects to receive a commitment letter from the bank extending the maturity
date of the bank line of credit to May 27, 2000. Management believes that the
line of credit provides the Company with sufficient financial resources to meet
its working capital requirements. (See Note D of the Notes to Consolidated
Financial Statements.) Additional acquisition activity may cause the Company to
review other financing alternatives.
Operating activities used $3.6 million of cash in 1998 compared to cash
provided of $3.4 million in 1997. Non-cash expenses in 1998 were $3.5 million
vs. $3.2 million in 1997. These expenses relate to depreciation of fixed
assets which is discussed in net plant and equipment below, amortization of
customer service spare parts inventory, amortization of goodwill, provisions
for losses on accounts receivable, provisions for inventory obsolescence and
deferred taxes.
Net accounts receivable increased $7.0 million or 45% from 1997, reflective of
the increase in fourth quarter revenue of $4.3 million or 28%, as well as a
change in the sales mix. In 1997, $20 million of sales were from the Japanese
health organization which carried 30 day payment terms. Substantially all of
this revenue was replaced by solution sales customers which have longer
implementation and payment cycles. As the Company continues to grow its
solutions business, contract payment structures will be modified to better
match the cash flow requirements of each transaction.
Total inventories decreased $1.1 million from 1997 levels. Manufacturing
inventories decreased $1.1 million during the year mainly due to decreases in
work-in-process inventories of $1.7 million and finished goods inventory of $.7
million due to the Company's focused effort to reduce inventory levels. These
decreases were offset by an increase in stockroom inventory of $1.3 million due
to the timing of the manufacturing production cycle. Customer service inventory
was flat on a year to year comparison, due to the continued focused effort to
manage inventory levels while expanding the revenue base of the business.
Net plant and equipment decreased $.5 million in 1998. This decrease is mainly
due to recorded depreciation of $1.4 million. Offsetting the depreciation were
additions of $.9 million compared to 1997 additions of $1.2 million. A major
component of the additions includes $.3 million due to the acquisition of SCS.
Other additions include $.2 million of capitalized leasehold improvements to
the facilities in Manchester, Connecticut and $.4 million of computer equipment
for internal use. During 1997, additions of $.6 million include the
capitalization of engineering and manufacturing test equipment and upgrades of
internal network computers, and $.6 million of additions related to capitalized
leasehold improvements for the renovation of facilities in Manchester,
Connecticut. Capital commitments were $.1 million at December 31, 1997 and
December 31, 1998.
Accounts payable and accrued expenses increased $3.4 million from 1997 levels.
The increase is reflective of a change in the business to a solution provider.
The amount of third party hardware purchased to fulfill the solution
requirements of customers has increased significantly from the prior year. The
Company also experienced a significant increase in payables associated with
third party contractors due to the creation of the Access Services division.
Salaries and wages accrual increased $.3 million from 1997 due to the increased
headcount related to the acquisitions.
Income taxes accrual decreased $.5 million from 1997 due to the timing of
quarterly estimated payments.
Customer deposits decreased $2.5 million from 1997 reflective of the completion
of the Japanese health organization order in the first quarter of 1998 which
contained a deposit of $1.9 million. The remaining change in the account
balance from 1997 is based upon timing of orders requiring deposits and revenue
recognition of those orders.
Deferred revenues, net of costs, decreased $.7 million from 1997 levels.
There were no systems undergoing acceptance testing at year end.
OTHER DISCLOSURES
Year 2000 Compliance
The Company is continuing to devote significant resources to minimize the risk
of potential disruption from the Year 2000 problem. In general terms, the
problem arises from the fact that many existing computer systems and other
equipment containing date-sensitive embedded technology (including non-
information technology equipment and systems) use only two digits to identify a
year in the date field, with the assumption that the first two digits of the
year are always "19". As a result of this and other common date-related
programming errors (collectively, the "Year 2000 problem"), such systems may
misinterpret dates after December 31, 1999, which may result in
miscalculations, other malfunctions or the total failure of such systems.
Because the Company is dependent upon the proper functioning of computer
systems and other equipment containing date-sensitive technology, a failure of
such systems and equipment to be Year 2000 compliant could have a material
adverse effect on the Company. If not remedied, potential risks include
business interruption or shutdown, financial loss, regulatory actions and legal
liability.
The Company has established a Year 2000 task force comprised of senior
management and operating personnel to coordinate its Year 2000 efforts. This
task force has been evaluating the Company's exposure to the Year 2000 problem
and has prepared a preliminary written plan for managing the risks and costs
associated with the Year 2000 problem.
The Company's process of addressing the Year 2000 problem consists of the
following steps: (a) inventorying products and services, systems, equipment and
other items (including those of third parties) that potentially present a Year
2000 problem, (b) determining the materiality of such items to the Company, (c)
assessing the Year 2000 compliance of the material items through internal
testing and outside certification, (d) repairing, replacing or preparing for
the failure of material items that are determined to be non-compliant, (e)
testing repaired or replaced items, and (f) to the extent advisable, designing
and implementing contingency plans.
The Company is aware and has informed each of its customers for whom it has
current information that certain of its products, systems and applications
developed, produced or sold, to the extent they are date sensitive at all, may
not be Year 2000 compliant. Since the Company sells systems that are designed
and integrated to order, the Company also reminded its customers that it is the
customers responsibility to test the products, systems and applications
purchased by them to determine whether such items are Year 2000 compliant. The
Company has offered to its customers, where applicable, upgrades or consulting
assistance at the customer's cost. The Company has also posted information
regarding the Year 2000 compliance of its products, systems and applications on
its web site at www.scanoptics.com.
In order to improve access to business information through common, integrated
computing systems worldwide, the Company is in the process of replacing its
internal corporate information system and several other systems with systems
that use programs primarily from SAP America, Inc. The implementation of the
new systems, which are expected to make substantially all of the Company's
internal corporate computer systems Year 2000 compliant, was completed March 1,
1999. The vendors of all new systems have certified them as being Year 2000
compliant. The Company intends to perform independent Year 2000 testing of
these systems, and the testing is expected to be completed during the second
quarter of 1999.
The Company has completed its inventory of other systems, equipment and items
that potentially present a Year 2000 problem. The Company in the process of
performing internal testing, and seeking outside certification, of material
inventoried items, and expects to complete such assessment by the end of the
second quarter of 1999. While the Company will not know the nature and extent
of required repairs and replacements of non-compliant systems and equipment
until such assessment is completed, it currently anticipates completing and
testing such repairs and replacements by June 1999.
In addition to its own systems and equipment, the Company depends upon the
proper function of computer systems and other date-sensitive equipment of
outside parties. These parties include banks, telecommunications service
providers, electric and other utilities and significant suppliers. The
Company has contacted most of such parties to determine the extent to which
they are vulnerable to the Year 2000 problem, and expects to complete this
process during the second quarter of 1999. The Company does not currently
have sufficient information about the Year 2000 exposure or remediation plans
of such parties to predict the risk they pose to the Company. If the third
parties with which the Company interacts have Year 2000 problems that are not
remedied, resulting problems could include the loss of telecommunications and
electrical service, the receipt of inaccurate financial and billing-related
information, and the disruption of capital flow potentially resulting in
liquidity stress.
Due to the uncertainties presented by such third party Year 2000 problems, and
the possibility that, despite its efforts, the Company may be unsuccessful in
preparing its internal systems and equipment for the Year 2000, the Company is
developing contingency plans for dealing with the most reasonably likely worst
case scenarios. The exact nature and scope of the Company's contingency plans
will be based upon an analysis of information gathered during the inventory,
assessment and remediation phases of its Year 2000 program. The Company expects
to complete its contingency planning during the second quarter of 1999, and to
have all contingency systems in place and fully tested by the fourth quarter of
1999.
The Company estimates that, as of December 31, 1998, its costs of addressing
the Year 2000 problem have been less than $100,000. The Company's best estimate
at this time of the future costs of addressing the Year 2000 problem is that
the costs will not exceed an additional $200,000. The Company has funded, and
expects to continue to fund, the costs of its Year 2000 efforts through
operating cash flow, and to expense such costs as incurred.
This description of matters relating to the Year 2000 problem contains a number
of forward-looking statements. (See the Outlook section above.) The Company's
assessment of the costs of its Year 2000 program and the timetable for
completing its Year 2000 preparations are based on current estimates, which
reflect numerous assumptions about future events, including the continued
availability of certain resources, the timing and effectiveness of third-party
remediation plans and other factors. The Company can give no assurance that
these estimates will be achieved, and actual results could differ materially
from those currently anticipated. In addition, there can be no assurance that
the Company's Year 2000 program will be effective or that its contingency plans
will be sufficient. Specific factors that might cause material differences
include, but are not limited to, the availability and cost of personnel trained
in this area, the ability to locate and correct relevant computer software codes
and embedded technology, the results of internal and external testing and the
timeliness and effectiveness of remediation efforts of third parties.
Impact of Recently Issued Accounting Standards
In June 1998, the Financial Accounting Standards Board issued Statement No.
133, ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES, which is
required to be adopted in years beginning after June 15, 1999. The Statement
permits early adoption as of the beginning of any fiscal quarter after its
issuance. The Company expects to adopt the new Statement effective January 1,
2000. The Statement will require the Company to recognize all derivatives on
the balance sheet at fair value. Derivatives that are not hedges must be
adjusted to fair value through income. If a derivative is a hedge, depending
on the nature of the hedge, changes in the fair value of the derivative will
either be offset against the change in fair value of the hedged asset,
liability, or firm commitment through earnings, or recognized in other
comprehensive income until the hedged item is recognized in earnings. The
ineffective portion of a derivative's change in fair value will be immediately
recognized in earnings. The Company does not anticipate that the adoption of
this Statement will have a significant effect on its results of operations or
financial position.
ITEM 7A - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Refer to the Outlook section of Management's Discussion and Analysis of
Consolidated Financial Condition and Results of Operations, and to Note A of
the Notes to Consolidated Financial Statements.
ITEM 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Report of Independent Auditors
Stockholders and Board of Directors
Scan-Optics, Inc.
We have audited the accompanying consolidated balance sheets of Scan-Optics,
Inc. and subsidiaries as of December 31, 1998 and 1997, and the related
consolidated statements of income, stockholders' equity, and cash flows for
each of the three years in the period ended December 31, 1998. Our audits also
included the financial statement schedule listed in the Index at Item 14(a).
These financial statements and schedule are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements and schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of Scan-
Optics, Inc. and subsidiaries at December 31, 1998 and 1997, and the
consolidated results of its operations and its cash flows for each of the three
years in the period ended December 31, 1998, in conformity with generally
accepted accounting principles. Also, in our opinion, the related financial
statement schedule, when considered in relation to the basic financial
statements taken as a whole, presents fairly in all material respects the
information set forth therein.
Ernst & Young LLP
Hartford, Connecticut
February 16, 1999
SCAN-OPTICS, INC., AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
December 31
(thousands, except share data) 1998 1997
- -------------------------------------------------------------------------------------------------------------------
Assets
Current Assets:
Cash and cash equivalents $ 216 $ 4,386
Accounts receivable less allowance of $206 in
1998 and $104 in 1997 22,682 15,695
Inventories 11,478 12,547
Deferred taxes 960 1,038
Deferred costs, net of revenues 502
Prepaid expenses and other 1,055 969
----------------------------------------
Total current assets 36,893 34,635
Plant and equipment:
Equipment 13,601 13,355
Leasehold improvements 4,815 4,585
Office furniture and fixtures 1,307 1,275
----------------------------------------
19,723 19,215
Less allowances for depreciation and amortization 16,367 15,355
----------------------------------------
3,356 3,860
Goodwill, net of accumulated amortization of $577 12,110
Other assets 633 212
----------------------------------------
Total Assets $ 52,992 $38,707
========================================
December 31
(thousands, except share data) 1998 1997
- -------------------------------------------------------------------------------------------------------------------
Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable $ 5,487 $ 2,071
Notes payable to bank 11,524
Salaries and wages 2,263 1,984
Taxes other than income taxes 691 744
Income taxes 35 533
Customer deposits 99 2,565
Deferred revenues, net of costs 734
Other 1,687 1,361
---------------------------------------------
Total current liabilities 21,786 9,992
Deferred taxes 263 486
Other liabilities 697 496
Stockholders' Equity
Preferred stock, par value $.02 per share,
authorized 5,000,000 shares; none
issued or outstanding
Common stock, par value $.02 per share,
authorized 15,000,000 shares;
issued, 7,370,482 shares in 1998
and 7,218,455 shares in 1997 147 144
Common stock Class A Convertible, par
value $.02 per share, authorized 3,000,000
shares; available for issuance 2,145,536 shares;
none issued or outstanding
Capital in excess of par value 35,501 35,025
Retained-earnings deficit (2,240) (4,369)
Accumulated other comprehensive loss (516) (421)
---------------------------------------------
32,892 30,379
Less cost of common stock in treasury,
413,500 shares 2,646 2,646
---------------------------------------------
Total stockholders' equity 30,246 27,733
---------------------------------------------
Total Liabilities and Stockholders' Equity $ 52,992 $ 38,707
=============================================
See accompanying notes.
SCAN-OPTICS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
December 31
(thousands, except share data) 1998 1997 1996
- ----------------------------------------------------------------------------------------------------------------------------------
Revenues
Product sales $ 32,413 $ 41,361 $ 30,275
Service revenues 20,577 14,124 14,515
Engineering revenues 284 876 1,156
Other operating revenues 697 247 88
----------------------------------------------------------------
Total revenues 53,971 56,608 46,034
Costs and Expenses
Cost of product sales 19,335 25,066 19,622
Service expenses 14,693 10,400 9,544
Sales and marketing expenses 7,011 7,297 5,502
Research and development expenses 5,560 4,552 4,142
General and administrative expenses 3,903 3,737 3,939
Interest expense 397 14 102
----------------------------------------------------------------
Total costs and expenses 50,899 51,066 42,851
----------------------------------------------------------------
Operating income 3,072 5,542 3,183
Other income, net 162 149 82
----------------------------------------------------------------
Income before income taxes 3,234 5,691 3,265
Income tax expense (benefit) 1,105 (99) (9)
----------------------------------------------------------------
Net Income $ 2,129 $ 5,790 $ 3,274
================================================================
Basic earnings per share $ .31 $ .87 $ .50
================================================================
Basic weighted-average shares 6,921,331 6,632,248 6,530,244
Diluted earnings per share $ .30 $ .82 $ .49
================================================================
Diluted weighted-average shares 7,102,658 7,070,013 6,715,942
See accompanying notes.
SCAN-OPTICS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF
STOCKHOLDERS' EQUITY
Accumulated
Capital in Retained Other Unearned
Common Stock Excess of Earnings Comprehensive ESOP Treasury
(thousands, except share data) Shares Amount Par Value Deficit Income(loss) Compensation Stock Total
- ----------------------------------------------------------------------------------------------------------------------------------
Balance January 1, 1996 6,934,584 $ 139 $ 34,271 $ (13,433) $ (315) $ (265) $ (2,646) $ 17,751
Issuance of common stock
upon exercise of stock
options 10,517 26 26
Unearned ESOP compensation
amortization 133 133
Net income 3,274 3,274
Currency translation
adjustments 23 23
--------
Comprehensive income 3,297
- ---------------------------------------------------------------------------------------------------------------------------------
Balance December 31, 1996 6,945,101 139 34,297 (10,159) (292) (132) (2,646) 21,207
Issuance of common stock
upon exercise of stock
options 273,354 5 728 733
Unearned ESOP compensation
amortization 132 132
Net income 5,790 5,790
Currency translation
adjustments (129) (129)
--------
Comprehensive income 5,661
- ----------------------------------------------------------------------------------------------------------------------------------
Balance December 31, 1997 7,218,455 144 35,025 (4,369) (421) (2,646) 27,733
Issuance of common stock upon
exercise of stock options
and warrants 152,027 3 476 479
Unearned ESOP compensation
amortization
Net income 2,129 2,129
Currency translation
adjustments (95) (95)
--------
Comprehensive income 2,034
- ----------------------------------------------------------------------------------------------------------------------------------
Balance December 31, 1998 7,370,482 $ 147 $ 35,501 $ (2,240) $ (516) $ $ (2,646) $ 30,246
==================================================================================================================================
See accompanying notes.
SCAN-OPTICS, INC., AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year Ended December 31
(thousands, except share data) 1998 1997 1996
- ----------------------------------------------------------------------------------------------------------------------------------
Operating Activities
Net income $ 2,129 $ 5,790 $ 3,274
Adjustments to reconcile net income
to net cash (used) provided by operating activities:
Depreciation 1,392 1,269 1,524
Amortization 1,687 1,396 1,123
Amortization of goodwill 577
Provision for losses on accounts receivable 424 711
Provision for inventory obsolescence 700 127
Deferred taxes (145) (552)
Changes in operating assets and liabilities:
Accounts receivable (6,176) (6,857) 324
Inventories (618) 277 (2,424)
Prepaid expenses and other (51) 305 (13)
Accounts payable 2,890 (399) (392)
Accrued salaries and wages 49 44 1,031
Taxes other than income taxes (53) 62 344
Income taxes (498) 326 22
Deferred revenues, net of costs (1,849) 734
Customer deposits (2,466) 242 (3,577)
Other (442) (335) 995
------------------------------------------------------------
Net cash (used) provided by operating activities (3,574) 3,426 3,069
Investing Activities
Business acquisitions, net of cash acquired (12,042)
Purchases of plant and equipment, net (557) (954) (1,890)
------------------------------------------------------------
Net cash used by investing activities (12,599) (954) (1,890)
Financing Activities
Proceeds from issuance of common stock 479 733 26
Proceeds from borrowings 22,045 7,741 22,631
Principal payments on borrowings (10,521) (7,839) (22,838)
------------------------------------------------------------
Net cash provided (used) by financing activities 12,003 635 (181)
(Decrease) increase in cash and cash equivalents (4,170) 3,107 998
Cash and Cash Equivalents at Beginning of Year 4,386 1,279 281
------------------------------------------------------------
Cash and Cash Equivalents at End of Year $ 216 $ 4,386 $ 1,279
============================================================
Supplemental Cash Flow Information
Interest paid $ 320 $ 18 $ 129
============================================================
Income taxes paid $ 1,754 $ 159 $ 26
============================================================
See accompanying notes.
SCAN-OPTICS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE A - Accounting Policies
Organization: The Company combines technology, experience and expertise to
develop cost-effective solutions for applications that include, healthcare,
government, transportation, financial and order entry. The Company's systems,
software and services are marketed worldwide to commercial and government
organizations either directly by the Company sales organization or through
distributors. The Company's business is vulnerable to a number of factors
beyond its control. These include (1) the effect of a weakening in the
domestic and international economies which potentially impacts capital
investments by customers, (2) the cyclical nature of funding within federal and
state government agencies, (3) competition from similar products, (4) the
implementation of other technologies which may provide alternative solutions,
and (5) the stability of sole source suppliers.
Basis of Presentation: The consolidated financial statements include the
accounts of Scan-Optics, Inc. and its subsidiaries, all wholly-owned. All
intercompany accounts and transactions are eliminated in the consolidated
financial statements. The preparation of financial statements in conformity
with generally accepted accounting principles requires management to make
estimates and assumptions that affect the amounts reported in the financial
statements and accompanying notes. While management believes that the
estimates and related assumptions used in the preparation of these financial
statements are appropriate, actual results could differ from those estimates.
Cash Equivalents: Highly liquid investments purchased with maturities of three
months or less are considered cash equivalents.
Inventories: Inventories are valued at the lower of cost (first-in, first-out
method) or market. The Company periodically reviews for obsolete and slow-
moving inventory based on historical usage, future requirements and anticipated
spare parts demand.
Plant and Equipment: Plant and equipment is stated on the basis of cost.
Depreciation is computed principally using the straight-line method over
periods of 3 to 10 years. Leasehold improvements are amortized over the useful
life of the improvements or the life of the lease, whichever is shorter.
Intangibles: Goodwill relating to the acquisitions completed in 1998
represents the excess cost over fair value of tangible and identifiable
intangible net assets acquired. It is amortized on a straight-line basis over
5 to 20 years.
Impairment of Long-Lived Assets: The Company records impairment losses on
goodwill and on long-lived assets used in operations when events and
circumstances indicate that the assets might be impaired and the undiscounted
cash flows estimated to be generated by those assets are less than net book
value. The Company also evaluates the amortization periods of assets,
including goodwill and other intangible assets, to determine whether events or
circumstances warrant revised estimates of useful lives.
Revenue Recognition: Revenues from maintenance and certain professional
services are recognized as earned. Revenues relating to sales of certain
equipment (principally optical character recognition equipment) are recognized
upon acceptance of the hardware and related application software.
Income Taxes: Deferred income taxes are provided for differences between the
income tax and the financial reporting bases of assets and liabilities at the
statutory tax rates that will be in effect when the differences are expected to
reverse.
Stock Based Compensation: The Company generally grants stock options to key
employees and members of the board of directors with an exercise price equal to
the fair value of the shares on the date of grant. The Company accounts for
stock option grants in accordance with APB Opinion No. 25, ACCOUNTING FOR STOCK
ISSUED TO EMPLOYEES, and, accordingly, recognizes no compensation expense for
the stock option grants. Therefore, the Company has elected the disclosure
provisions only of FASB Statement No. 123.
Earnings (Loss) Per Share: Basic and diluted earnings per share is calculated
in accordance with FASB Statement No. 128, EARNINGS PER SHARE. All earnings per
share amounts for all periods have been presented, and where appropriate,
restated to conform to the Statement 128 requirements.
Foreign Currency Translation: The financial statements of foreign subsidiaries
have been translated into U.S. dollars in accordance with FASB Statement No.
52, FOREIGN CURRENCY TRANSLATION. All balance sheet accounts have been
translated using the exchange rates in effect at the balance sheet date.
Statement of Income amounts have been translated using the average exchange
rate for the year. The gains and losses resulting from the changes in exchange
rates from year to year have been reported in other comprehensive loss, a
component of Stockholders' Equity.
Reclassifications: Certain 1997 and 1996 amounts have been reclassified to
conform to the current year presentation.
Impact of Recently Issued Accounting Standards: In June 1998, the FASB issued
Statement No. 133, ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING
ACTIVITIES. The Company expects to adopt the new Statement effective January
1, 2000. The Statement will require the Company to recognize all derivatives
on the balance sheet at fair value. The Company does not anticipate that the
adoption of this Statement will have a significant effect on its results of
operations or financial position.
NOTE B - ACQUISITION ACTIVITIES
The Company completed two acquisitions during June 1998. The first was
Southern Computer Systems (SCS), a privately held company, for $7 million in
cash. The Company acquired cash and accounts receivable of $.4 million, fixed
assets of $.3 million and other assets of $.1 million. The Company also
assumed certain liabilities as follows: accounts payable of $.5 million, salary
and benefits accruals of $.2 million, deferred revenue of $.1 million, note
payable to Scan-Optics, Inc. of $.5 million, acquisition related expenses for
investment banker and legal services of $.4 million and bank debt of $1.4
million. Immediately following the closing, the bank debt was repaid. The
operations of SCS are included in the consolidated statement of income from
the date of acquisition. The transaction was accounted for as a purchase and
the excess cost over fair value of the net assets acquired of $9.2 million is
being amortized over a twenty year period. The proforma unaudited results of
operations for the years ended December 31, 1998 and December 31, 1997,
assuming consummation of the purchase as of January 1, 1997, are as follows:
December 31 December 31
(thousands, except per share amounts) 1998 1997
- ---------------------------------------------------------------------------------
Total revenue $ 55,732 $ 63,076
Net income (loss) (1,459) 4,680
Basic earnings (loss) per share (.21) .71
Diluted earnings (loss) per share $ (.21) $ .66
The Company entered into consulting and non-competition agreements with the two
principals of SCS. The agreements call for eight quarterly payments of $50,000
per principal, beginning in the fourth quarter of 1998. The agreements provide
for consulting services to be performed by the principals as well as preventing
the principals from becoming directly involved with a competing business in the
Image Data Capture marketplace. The amount of the quarterly payments is being
amortized over a two-year period.
The second acquisition was the maintenance division of Access Corporation for
$3.3 million in cash. The Company acquired accounts receivable of $.5 million.
The Company also assumed a liability for deferred revenue of $.5 million and
acquisition related expenses for investment banker and legal services of $.2
million. The operations of the maintenance division of Access Corporation are
included in the consolidated statement of income from the date of acquisition.
The transaction was accounted for as a purchase and the excess cost over fair
value of the net assets acquired of $3.5 million is being amortized over a five
year period.
The Company determines the amount of goodwill and the amortization period based
upon a review of the acquired business and its earnings potential.
NOTE C - INVENTORIES
The components of inventories were as follows:
December 31
(thousands) 1998 1997
- ---------------------------------------------------------------------------------
Finished goods $ 1,885 $ 2,586
Work-in-process 2,129 3,823
Service parts 3,808 3,807
Materials and component parts 3,656 2,331
----------------------------------
$ 11,478 $ 12,547
==================================
NOTE D - CREDIT ARRANGEMENTS
On May 28, 1998, the Company amended its credit agreement (the "Agreement")
with a bank to extend the maturity date to May 27, 1999 and to increase the
line from $4 million to $10 million. Subsequently, the line of credit was
increased from $10 million to $13 million through May 27, 1999. The Agreement
contains covenants which, among other things, require the maintenance of
specified working capital, debt to equity ratios, net income levels and
tangible net worth levels. The line bears interest at prime (7 3/4 % at
December 31, 1998) and the unused portion of the line is subject to a
commitment fee of 3/8% per annum. The weighted average interest rate on
borrowings during 1998 and 1997 was 8.1% and 8.8% respectively. The available
balance on the total line of credit was $1.5 million at December 31, 1998.
The Company expects to receive a commitment letter from the bank extending the
maturity date of the line of credit to May 27, 2000 based on similar
limitations and covenants as in the current Agreement.
The carrying value of the notes payable to bank approximates its fair value.
NOTE E - CAPITAL STOCK
The Board of Directors is authorized to issue shares of the Company's preferred
stock in series, to establish from time to time the number of shares to be
included in each series and to fix the designation, powers, preferences and
other terms and conditions with respect to such stock. No shares have been
issued to date.
At December 31, 1998, the Company had reserved 915,055 shares of common stock
for the issuance or exercise of stock options. There are no shares reserved for
the exercise of warrants.
Class A Convertible stock has the same rights as common stock, except that its
holders may not vote for the election of directors, and it is convertible into
common stock on a share for share basis. On September 2, 1994, all outstanding
shares of Class A Convertible stock were converted to common stock. No shares
were outstanding at December 31, 1998 and 1997.
NOTE F - COMMON STOCK WARRANTS
At December 31, 1998, and 1997, there were no warrants outstanding.
PRICE PER SHARE SHARES
- -------------------------------------------------------------------------------------------------
Warrants outstanding December 31, 1995 $ 3.63 - $ 5.38 43,000
=============================================
Expired in 1996 $ 5.38 25,000
---------------------------------------------
Warrants outstanding December 31, 1996 $ 3.63 18,000
=============================================
Exercised in 1997 $ 3.63 18,000
---------------------------------------------
Warrants outstanding December 31, 1998 and 1997 $ 0 0
=============================================
NOTE G -- STOCK OPTION PLANS
The Company has elected to follow Accounting Principles Board Opinion No. 25,
ACCOUNTING FOR STOCK ISSUED TO EMPLOYEES (APB No. 25) and related
interpretations in accounting for its stock options. Under APB No. 25, because
the exercise price of the Company's stock options equals market price of the
underlying stock on the date of grant, no compensation expense is recognized.
The Company has five stock option plans for key employees and board members.
Options granted under the plans are for a period of ten years and at prices not
less than 85% of the fair market value of the shares at date of grant.
Options for employees are not exercisable for one year following the
date of grant and then are exercisable in such installments during the period
prior to expiration as the Stock Option Committee shall determine. Options for
Directors are not exercisable until six months after the grant thereof.
Options may be exercised from time to time, in part or as a whole, on a
cumulative basis as determined by the Stock Option Committee under all stock
option plans.
The following schedule summarizes the changes in stock options for each of the
three years in the period ended December 31, 1998:
NUMBER OF SHARES OPTION PRICE PER SHARE
- --------------------------------------------------------------------------------------------------------------
Outstanding January 1, 1996 (587,260 exercisable) 786,715 $1.50 to $9.63
Granted 124,000 3.25 to 4.75
Exercised (10,517) 1.50 to 3.25
Canceled (41,484) 2.13 to 9.63
--------------------------------------------------
Outstanding December 31, 1996 (567,991 exercisable) 858,714 1.50 to 9.63
1997 ACTIVITY
Granted 217,500 4.68 to 9.19
Exercised (255,354) 1.50 to 6.00
Canceled (3,467) 3.38 to 9.63
--------------------------------------------------
Outstanding December 31, 1997 (679,688 exercisable) 817,393 1.50 to 9.19
1998 ACTIVITY
Granted 35,000 5.69 to 9.19
Exercised (152,027) 2.13 to 3.75
Canceled (11,933) 2.13 to 6.38
--------------------------------------------------
Outstanding December 31, 1998 (531,420 exercisable) 688,433 $1.50 to $9.19
==================================================
At December 31, 1998 there were 226,622 options available for grant.
The weighted-average fair value of options granted was $6.21, $7.13 and $3.72
during 1998, 1997, and 1996 respectively. The weighted-average remaining
contractual life of the options outstanding at December 31, 1998 was 6 years.
Pro forma information regarding net income and earnings per share is required
by FASB Statement No. 123, and has been determined as if the Company had
accounted for its stock options under the fair value method of that Statement.
The fair value of these options was estimated at the date of grant using a
Black-Scholes option pricing model.
Option valuation models require the input of highly subjective assumptions
including the expected stock price volatility. The assumptions used in the
valuation model were: risk free interest rate - 7%, expected life - 10 years
and expected volatility of .793.
Because the Company's stock options have characteristics significantly
different from those of traded options, and because changes in the subjective
input assumptions can materially affect the fair value estimate, in
management's opinion, the existing models do not necessarily provide a reliable
single measure of the fair value of its stock options.
For the purpose of pro forma disclosures, the estimated fair value of the stock
options is expensed ratably over the vesting period which is 36 months for key
employees and 6 months for the Board of Directors. The Company's pro forma
information follows:
December 31
(thousands, except per share amounts) 1998 1997 1996
- ------------------------------------------------------------------------------------------------------------------
Net income, as reported $ 2,129 $ 5,790 $ 3,274
Stock option expense 563 351 211
-----------------------------------------------------
Pro forma net income $ 1,566 $ 5,439 $ 3,063
=====================================================
Basic earnings per share, as reported $ .31 $ .87 $ 50
Stock option expense .08 .05 .03
-----------------------------------------------------
Pro forma basic earnings per share $ .23 $ .82 $ .47
=====================================================
Diluted earnings per share, as reported $ .30 $ .82 $ .49
Stock option expense .08 .05 .03
-----------------------------------------------------
Pro forma diluted earnings per share $ .22 $ .77 $ .46
=====================================================
NOTE H - RESEARCH AND DEVELOPMENT AGREEMENTS
During 1990, the Company entered into two separate agreements for the
development of new product technology, which provided a total funding of
$3,645,000 over an eighteen month period. Revenues related to these
development projects were recorded through 1992, which offset related costs
incurred to successfully develop the products. The agreements provide the
respective third party with exclusive rights to market the developed product in
its geographic market area while the Company will manufacture the product and
retain ownership and all other distribution rights. Royalties and sales
discounts, up to a maximum of 130% of the amount advanced to the Company, were
required based on sales of the new product technology through the termination
dates of the agreements, June 30, 1995 and December 31, 1996. As of December
31, 1996, the Company had repaid $4,738,000 or 100% of the maximum potential
obligation.
During 1995, the Company entered into $700,000 of product development
agreements with a specific customer, which required various modifications and
enhancements to the Company's Series 9000 product. The Company recorded
revenue related to this development agreement of $336,000 in 1995 and $364,000
in 1996. These revenues offset related costs incurred to develop the
modifications and enhancements. The ownership of the technologies created as a
result of this development agreement remains with the Company. No royalties or
other considerations are required as a part of this agreement.
In August 1995, the Company signed a license agreement to sell and support the
Image EMC product. The agreement requires payment of royalties based upon the
net sales price of the software. Royalties are expensed as a part of cost of
sales at a rate of 10%, decreasing to 5% after a minimum royalty payment is
met.
During 1997, the Company entered into a $636,000 product development agreement
with a specific customer, which required various modifications and enhancements
to the Company's Series 9000 product. The Company recorded all revenue related
to this development agreement in 1997. These revenues offset related costs
incurred to develop the modifications and enhancements. The ownership of the
technologies created as a result of this development agreement remains with the
Company. No royalties or other considerations are required as a part of this
agreement.
During 1998, the Company entered into a $200,000 custom development project with
a specific customer. The project involved adding fluorescent bar code printing
and reading to the Series 9000 scanner and adding additional stacker modules to
accommodate document sorting requirements. The Company recorded all revenue
related to this development agreement in 1998. These revenues offset related
costs incurred to develop the modifications and enhancements. The ownership of
the technologies created as a result of this development agreement remains with
the Company. No royalties or other considerations are required as a part of
this agreement.
NOTE I - EMPLOYEE BENEFITS
The Company maintains a Retirement Savings Plan for United States employees.
Under this plan, all employees may contribute up to 15% of their salary to a
retirement account up to the maximum amount allowed by law. The Company
contributed an amount equal to 50% of the first 6% contributed by the
participant in 1998 and 50% of the first 4% in 1997 and 1996. The Company's
contributions to this plan were $329,000, $215,000, and $189,000 in 1998, 1997,
and 1996, respectively.
The Company sponsors an Employee Stock Ownership Plan (the "Plan") covering
substantially all full-time employees. The Plan, which is a tax qualified
employee benefit plan, was adopted by the Board of Directors of the Company in
1988 to provide retirement benefits for employees. The Plan borrowed
$1,325,000 to purchase 260,000 shares of the Company's stock to be allocated to
participants ratably over a ten year period. The ESOP loan was guaranteed by
the Company and the outstanding balance of the loan was repaid in 1991. In
1998, the Company did not allocate any additional shares to the Plan and at
December 31, 1998, all shares had been allocated. Expenses related to the Plan
in 1997 and 1996 were $132,481 for each year. The Company, at its discretion,
may make annual allocations to the Plan in the future.
NOTE J - INCOME TAXES
At December 31, 1998, the Company has approximately $450,000, $2,600,000 and
$800,000 of net operating loss carryforwards for Canada, the United Kingdom and
Germany, respectively, which are scheduled to expire periodically between 1999
and 2005. At December 31, 1997, the Company had approximately $600,000,
$2,500,000 and $700,000 of net operating loss carryforwards for Canada, the
United Kingdom and Germany, respectively. For financial reporting purposes a
valuation allowance has been recorded for 1998 and 1997 to offset a significant
portion of the deferred tax assets related to the foreign net operating loss
carryforwards and other temporary differences. In 1997, the valuation
allowance was reduced by $1,722,000 primarily due to the utilization of net
operating loss carry forwards for U.S. tax purposes.
Income before income taxes is set forth in the following tabulation:
Year Ended December 31
(thousands) 1998 1997 1996
- --------------------------------------------------------------------------------------------------------
Domestic $ 3,228 $ 6,649 $ 4,523
Foreign 6 (958) (1,258)
----------------------------------------------------
Income before income taxes $ 3,234 $ 5,691 $ 3,265
====================================================
Income taxes (benefit) are summarized as follows:
Year Ended December 31
(thousands) 1998 1997 1996
- --------------------------------------------------------------------------------------------------------
Current (benefit):
Federal $ 944 $ 418
State 311 68 $ 60
Foreign (5) (33) (69)
---------------------------------------------------
Total current (benefit) $1,250 $ 453 $ (9)
===================================================
Deferred (benefit):
Federal $ (129) $ (491)
State (16) (61)
---------------------------------------------------
Total deferred (benefit) $ (145) $ (552)
===================================================
$1,105 $ (99) $ (9)
===================================================
Significant components of the Company's deferred tax liabilities and assets
were as follows:
December 31
(thousands) 1998 1997
- -------------------------------------------------------------------------------
Deferred tax assets:
Net operating losses $ 1,475 $ 1,479
Depreciation 92 92
Inventory valuation 174 275
Inventory 115
Deferred maintenance revenue 178 130
Accounts receivable reserves 26 36
Goodwill 59
Revenue recognition - systems undergoing
acceptance testing 29 347
Vacation accrual 188 193
Other 162 287
-------------------------
Total deferred tax assets 2,498 2,839
Deferred tax liabilities:
Depreciation and other (84) (486)
Inventory (80)
-------------------------
Total deferred tax liabilities (84) (566)
Valuation allowance (1,717) (1,721)
-------------------------
Net deferred taxes $ 697 $ 552
=========================
A reconciliation of the statutory tax rate to the effective rate is as follows:
Year Ended December 31
1998 1997 1996
- --------------------------------------------------------------------------------------------------------
Statutory federal income tax rate 34% 34% 34%
State income taxes, net of federal benefit 7 2
Foreign sales corporation benefit (9) (5)
Foreign income taxes (benefit) (1) (2)
Net operating loss carryforward
(benefit) (30) (34)
Other 2
--------------------------------------------------
Effective tax rate 34% (2)% 0%
==================================================
NOTE K - LEASE COMMITMENTS
The Company's principal lease commitments are for its corporate office and
manufacturing facility in Manchester, Connecticut, professional services,
software engineering and support, administration and equipment demonstration
facility in Birmingham, Alabama, and its research and development facility in
Berkeley, California. The Manchester lease expires on December 31, 2006, the
Birmingham lease expires on December 31, 1999 and the Berkeley lease expires
on December 31, 2000. Minimum rental payments for all noncancelable leases
which are operating leases with terms equal to or in excess of one year as of
December 31, 1998 are as follows:
Minimum Rental
(thousands) Payments
- ---------------------------------------------------------------
1999 $ 878
2000 654
2001 567
2002 537
2003 492
Thereafter 1,072
------------
Total minimum lease payments $ 4,200
============
Rental expense for the years ended December 31, 1998, 1997, and 1996 was
$795,000, $580,000, and $678,000, respectively.
NOTE L - CONTINGENCIES
There are no lawsuits pending against the Company.
NOTE M - SEGMENT INFORMATION
Business segment data and geographic area data for the years ended 1998, 1997
and 1996 as included on pages 13 and 14 of this report are an integral part of
these financial statements.
NOTE N - BILL AND HOLD TRANSACTIONS
Revenue relating to sales of certain equipment (principally optical character
recognition equipment) is recognized upon acceptance of the related application
software. When customers, under the terms of specific orders or contracts,
request that the Company manufacture and invoice the equipment on a bill and
hold basis, the Company recognizes revenue based upon an in-house acceptance
test that is certified by the customer. Revenues recorded during 1998, 1997
and 1996 included bill and hold transactions of $3.7 million, $12.1 million and
$10.8 million, respectively. Accounts receivable included bill and hold
receivables of $1.7 million, $4.7 million and $4.9 million at December 31,
1998, 1997 and 1996, respectively.
NOTE O -- EARNINGS PER SHARE
The following table sets forth the computation of basic and diluted earnings
per share:
December 31
(thousands, except share data) 1998 1997 1996
- -------------------------------------------------------------------------------------------------------
Numerator:
Net Income $ 2,129 $ 5,790 $ 3,274
=================================================
Denominator:
Denominator for basic earnings
per share (weighted-average shares) 6,921,331 6,632,248 6,530,244
Effect of dilutive securities:
Employee stock options 181,327 437,765 185,698
Denominator for diluted earnings
per share (adjusted weighted-
average shares and assumed
conversions) 7,102,658 7,070,013 6,715,942
=================================================
Basic earnings per share $ .31 $ .87 $ .50
=================================================
Diluted earnings per share $ .30 $ .82 $ .49
=================================================
NOTE P - QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
The following is a summary of the quarterly results of operations for the years
ended December 31, 1998 and 1997.
(thousands, except per share amounts) MAR. 31 JUN. 30 SEP. 30 DEC. 31
- -----------------------------------------------------------------------------------------------------
1998
Revenues $ 12,892 $ 9,704 $ 11,822 $ 19,553
Cost of product sales and service expenses 8,668 5,864(b) 7,319 12,177
Net income 428 140(b) 274 1,287(a)
Basic earnings per share .06 .02(b) .04 .19(a)
Diluted earnings per share $ .06 $ .02(b) $ .04 $ .19(a)
1997
Revenues $ 12,430 $14,061 $ 14,828 $ 15,289
Cost of product sales and service expenses 8,226 8,939 9,463 8,838
Net income 618 1,341 1,436 2,395
Basic earnings per share .09 .20 .22 .35
Diluted earnings per share $ .09 $ .19 $ .20 $ .33
Certain quarterly expenses have been reclassified to conform to the year end
presentation.
(a) In the Company's fourth quarter press release dated February 25, 1999, net
income and diluted earnings per share for the year ended December 31, 1998
were correctly reported as $2,129 and $.30, respectively. However, the
1998 fourth quarter net income and earnings per share were incorrectly
reported as $1,457 and $.21 basic and diluted earnings per share,
respectively. The quarterly data in the above table reflect the correct
amounts.
(b) On September 14, 1998, the Company filed a Form 10-Q/A for the quarterly
period ended June 30, 1998. Amounts previously reported in its quarterly
report on Form 10-Q for the quarterly period ended June 30, 1998 were
amended as follows:
Three months ended Six months ended
June 30, 1998 June 30, 1998
(thousands, except per share amounts) Form 10-Q/A Form 10-Q Form 10-Q/A Form 10-Q
- ---------------------------------------------------------------------------------------------------------------------------
Revenues $9,704 $9,704 $22,596 $22,596
Cost of product sales and service expenses 5,864 5,351 14,533 14,020
Net income 140 453 568 881
Basic earnings per share .02 .07 .08 .13
Diluted earnings per share $ .02 $ .06 $ .08 $ .12
ITEM 9 - CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
PART III
ITEM 10 - DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information pertaining to Directors and additional information pertaining to
Executive Officers is included, under the captions "Governance of the Company"
and "Compliance with Section 16(a) of the Securities Exchange Act of 1934" in
the Company's definitive proxy statement for the Annual Meeting of Stockholders
to be held on May 20, 1999 and is incorporated herein by reference and made a
part hereof.
ITEM 11 - EXECUTIVE COMPENSATION
This information is included in the Company's definitive proxy statement for
the Annual Meeting of Stockholders to be held on May 20, 1999 and is
incorporated herein by reference.
ITEM 12 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
This information is included, under the captions "Security Ownership of Certain
Beneficial Owners" and "Share Ownership of Management", in the Company's
definitive proxy statement for the Annual Meeting of Stockholders to be held
on May 20, 1999 and is incorporated herein by reference.
ITEM 13 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
This information is included, under the caption "Certain Transactions", in the
Company's definitive proxy statement for the Annual Meeting of Stockholders to
be held on May 20, 1999 and is incorporated herein by reference.
PART IV
ITEM 14 - EXHIBITS, FINANCIAL STATEMENT SCHEDULE AND REPORTS ON FORM 8-K
(a) The following consolidated financial statements and report of independent
auditors of the Company and its subsidiaries are included in Item 8:
(1) Report of Independent Auditors
Consolidated Balance Sheets at December 31, 1998 and 1997
Consolidated Statements of Income for the years ended
December 31, 1998, 1997 and 1996
Consolidated Statements of Stockholders' Equity for the
years ended December 31, 1998, 1997 and 1996
Consolidated Statements of Cash Flows for the years ended
December 31, 1998, 1997 and 1996
Notes to Consolidated Financial Statements - December 31, 1998
(2) The following consolidated financial statement schedule is
included in Item 14(a):
Schedule II -- Valuation and Qualifying Accounts
All other schedules for which provision is made in the applicable accounting
regulation of the Securities and Exchange Commission are not required under the
related instructions or are inapplicable, and therefore have been omitted.
(3) LISTING OF EXHIBITS
*3.1(a) Certificate of Incorporation, including amendments thereto
(filed as Exhibit 3.1 to the Company's Registration Statement
on Form S-1, File No. 2-70277).
*3.1(b)Amendments to Certificate of Incorporation adopted May 17,
1984, included in Exhibits A, B, C and D in the Company's
proxy statement dated April 17, 1984 for the Annual Meeting of
Stockholders held May 17, 1984.
*3.1(c)Amendment to Article Tenth of the Certificate of
Incorporation included as Exhibit A in the Company's proxy
statement dated April 16, 1987 for the Annual Meeting of
Stockholders held May 19, 1987
*3.2(a)By-laws of the Company (filed as Exhibit 3.2 to the Company's
Registration Statement on Form S-1, File No. 2-70277).
*3.2(b)Amendments to By-laws of the Company adopted May 17, 1984,
included in Exhibits A and B in the Company's proxy statement
dated April 17, 1984 for the Annual Meeting of Stockholders
held May 17, 1984.
*3.2(c)Amendment to By-laws of the Company adopted at the meeting of
the Board of Directors on January 28, 1991, included as
Exhibit 3.2(c) in the Company's Annual Report on Form 10K
filed for the year ended December 31, 1991.
*+10.1 The Scan-Optics, Inc. 1979 Incentive and Non-Qualified Stock
Option Plan included in Exhibit B in the Company's Proxy
statement dated June 8, 1979 for the Annual Meeting of
Stockholders held on June 27, 1979.
* +10.2 The Scan-Optics, Inc. 1984 Incentive and Non-Qualified Stock
Option Plan included in Exhibit E in the Company's Proxy
statement dated April 19, 1984 for the Annual Meeting of
Stockholders held on May 17, 1984.
* +10.3 The Scan-Optics, Inc. 1987 Incentive and Non-Qualified Stock
Option Plan included in Exhibit B in the Company's Proxy
statement dated April 16, 1987 for the Annual Meeting of
Stockholders held on May 19, 1987.
* +10.4 The Scan-Optics, Inc. 1990 Incentive and Non-Qualified Stock
Option Plan included in Exhibit A in the Company's Proxy
statement dated April 30, 1990 for the Annual Meeting of
Stockholders held on June 12, 1990.
* +10.5 The Scan-Optics, Inc. 1990 Stock Option Plan for Outside
Directors included in Exhibit B in the Company's Proxy
statement dated April 30, 1990 for the Annual Meeting of
Stockholders held on June 12, 1990.
* +10.6 Employment agreement between Richard I. Tanaka and Scan-
Optics, Inc. effective September 5, 1989, included as Exhibit
10.7 in the Company's Annual Report on Form 10-K filed for the
year ended December 31, 1991.
* +10.7 Severance agreement between Clarence W. Rife and Scan-Optics,
Inc. dated December 17, 1986, included as Exhibit 10.8 in the
Company's Annual Report on Form 10-K filed for the year ended
December 31, 1991.
* +10.8 Executive severance agreement between certain officers and
Scan-Optics, Inc. dated July 28, 1992, included as Exhibit
10.8 in the Company's Annual Report on Form 10-K filed for the
year ended December 31, 1992.
+10.9 Amendment No. 1 to Employment Agreement, dated as of December
31, 1996, between Scan-Optics, Inc. and Richard I. Tanaka.
+10.10 Employment agreement, effective as of December 31, 1996,
between Scan-Optics, Inc. and James C. Mavel.
* 22. List of subsidiaries of the Company, included as Exhibit 10.8
in the Company's Annual Report on Form 10-K filed for the year
ended December 31, 1993.
23. Consent of Independent Auditors.
27. Financial Data Schedule.
* Exhibits so marked have heretofore been filed by the Company
with the Securities and Exchange Commission and are incorporated herein by
reference.
+ Management contract for compensatory plan or arrangement
required to be filed as an exhibit to this form pursuant to Item 14(c) of this
report.
(b) REPORTS ON FORM 8-K
No report on Form 8-K was filed for the quarter ended December
31, 1998.
(c) EXHIBITS
The exhibits required by this item are included herein.
(d) FINANCIAL STATEMENT SCHEDULE
The response to this portion of Item 14 is submitted as a
separate section of this report.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Registrant has duly caused this annual report to be signed on
its behalf by the undersigned, thereunto duly authorized.
SCAN-OPTICS, INC.
-----------------
Registrant
By: /ss/
----------------------------------
James C. Mavel
Chairman, Chief Executive Officer,
President and Director
Date: March 23, 1999
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant in the capacities and on the dates indicated.
/SS/
- -------------------------
James C. Mavel Chairman, Chief Executive Officer,
President
and Director
(Principal Executive Officer)
Date: March 23, 1999
/SS/
- -------------------------
Michael J. Villano Chief Financial Officer, Vice President and
Treasurer
(Principal Financial and Accounting Officer)
Date: March 23, 1999
/SS/
- -------------------------
Logan Clarke, Jr. Director March 23, 1999
/SS/
- -------------------------
Richard J. Coburn Director March 23, 1999
- -------------------------
E. Bulkeley Griswold Director March 23, 1999
/SS/
- -------------------------
Lyman C. Hamilton, Jr. Director March 23, 1999
/SS/
- -------------------------
John J. Holton Director March 23, 1999
/SS/
- -------------------------
Robert H. Steele Director March 23, 1999
A majority of the Directors
SCHEDULE II
SCAN-OPTICS, INC. AND SUBSIDIARIES
VALUATION AND QUALIFYING ACCOUNTS
THREE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
(thousands)
COLUMN A COLUMN B COLUMN C COLUMN D COLUMN E
Additions
Balance at Charged to Charged to Balance at
Beginning Costs and Other End of
Description Of Period Expenses Accounts Deductions (1) Period
- ----------------------------------------------------------------------------------------------------------------------------------
Year ended December 31, 1998: $ 104 $ 149(2) $ 47 $ 206
Reserve for doubtful accounts
Year ended December 31, 1997: $ 673 $ 424 $ 993 $ 104
Reserve for doubtful accounts
Year ended December 31, 1996: $ 413 $ 711 $ 451 $ 673
Reserve for doubtful accounts
(1) Uncollectible accounts written off, net of recoveries.
(2) Represents reclassifications from other accounts.
The required information regarding the valuation allowance for deferred tax
assets is included in Note J.
EXHIBIT 23 -- CONSENT OF INDEPENDENT AUDITORS
We consent to the incorporation by reference in the Registration Statements
(Form S-8 No. 33-37253, Form S-8 No. 33-37829, Form S-8 No. 33-16362, Form S-8
No. 2-93268 and Form S-8 No. 2-65503) of Scan-Optics, Inc. of our report dated
February 16, 1999, with respect to the consolidated financial statements and
schedule of Scan-Optics, Inc. and subsidiaries included in this Annual Report
(Form 10-K) for the year ended December 31, 1998.
Ernst & Young LLP
Hartford, Connecticut
March 23, 1999