UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
( X ) Quarterly Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the quarterly period ended June 30, 2002
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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
incorporation or organization) Identification Number)
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)
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
The number of shares of common stock, $.02 par value, outstanding as of July 29,
2002 was 7,439,732.
1
SCAN-OPTICS, INC., AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(thousands, except share data) June 30, 2002 December 31, 2001
- -------------------------------------------------------------------------------------------
(UNAUDITED)
Assets
Current Assets:
Cash and cash equivalents $ 1,518 $ 1,662
Accounts receivable less allowance of $1,772 at
June 30, 2002 and $1,936 at December 31, 2001 1,801 2,252
Unbilled receivables - contracts in progress 853 945
Inventories 8,705 8,543
Deferred costs, net of revenues 179 179
Prepaid expenses and other 390 325
-------------------------
Total current assets 13,446 13,906
Plant and equipment:
Equipment 13,378 13,340
Leasehold improvements 5,232 5,232
Office furniture and fixtures 1,348 1,338
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19,958 19,910
Less allowances for depreciation and amortization 18,774 18,530
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1,184 1,380
Software license, net 209 627
Goodwill, net 9,249 9,249
Other assets 117 117
-------------------------
Total Assets $24,205 $25,279
=========================
2
(thousands, except share data) June 30, 2002 December 31, 2001
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(UNAUDITED)
Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable $ 2,978 $ 3,462
Notes payable to bank 1,500 1,500
Salaries and wages 1,385 1,380
Taxes other than income taxes 457 524
Income taxes 15 5
Customer deposits 584 507
Other 2,454 2,642
------------------------------
Total current liabilities 9,373 10,020
Note payable to bank 9,367 10,392
Other liabilities 862 707
Mandatory redeemable preferred stock, par value $.02
per share, authorized 3,800,000 shares;
3,800,000 issued and outstanding 3,800 3,800
Stockholders' Equity
Preferred stock, par value $.02 per share,
authorized 5,000,000 shares; none
issued or outstanding
Common stock, par value $.02 per share,
authorized 15,000,000 shares;
issued, 7,439,732 shares at June 30, 2002
and December 31, 2001 149 149
Common stock Class A Convertible, par
value $.02 per share, authorized 3,000,000
shares; available for issuance 2,145,536
shares; none issued or outstanding
Capital in excess of par value 38,354 38,354
Retained earnings deficit (34,114) (34,498)
Foreign currency translation adjustments (940) (999)
------------------------------
3,449 3,006
Less cost of common stock in treasury,
413,500 shares 2,646 2,646
------------------------------
Total stockholders' equity 803 360
------------------------------
Total Liabilities and Stockholders' Equity $ 24,205 $ 25,279
==============================
See accompanying notes.
3
SCAN-OPTICS, INC., AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
Three Months Ended Six Months Ended
June 30 June 30
(thousands, except share data) 2002 2001 2002 2001
- --------------------------------------------------------------------------------------------------------------
Revenues
Hardware and Software $ 2,889 $ 1,722 $ 6,296 $ 7,886
Professional Services 1,708 1,943 3,334 3,386
Access Services 3,245 3,326 6,036 6,627
------------------------------ ------------------------------
Total revenues 7,842 6,991 15,666 17,899
Costs of Revenue
Hardware and software 2,130 1,545 4,214 5,944
Professional services 742 1,104 1,428 2,300
Access services 2,271 2,689 4,566 5,430
------------------------------ ------------------------------
Total costs of revenue 5,143 5,338 10,208 13,674
Gross Margin 2,699 1,653 5,458 4,225
Operating Expenses
Sales and marketing 815 913 1,665 1,895
Research and development 507 686 1,066 1,431
General and administrative 923 545 1,875 1,530
Interest 221 439 439 951
------------------------------ ------------------------------
Total operating expenses 2,466 2,583 5,045 5,807
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Operating income (loss) 233 (930) 413 (1,582)
Other income (expense), net 6 (2) 12 8
------------------------------ ------------------------------
Income (loss) before income taxes 239 (932) 425 (1,574)
Income tax expense 21 8 41 30
------------------------------ ------------------------------
Net Income (Loss) $ 218 $ (940) $ 384 $ (1,604)
============================== ==============================
Basic earnings (loss) per share $ .03 $ (.13) $ .05 $ (.23)
============================== ==============================
Basic weighted-average shares 7,026,232 7,027,712 7,026,232 7,026,972
Diluted earnings (loss) per share $ .03 $ (.13) $ .05 $ (.23)
============================== ==============================
Diluted weighted-average shares 7,308,118 7,027,712 7,357,627 7,026,972
4
SCAN-OPTICS, INC., AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
Six Months Ended
June 31
(thousands) 2002 2001
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Operating Activities
Net Income (Loss) $ 384 $(1,604)
Adjustments to reconcile net income (loss)
to net cash provided by operating activities:
Depreciation 209 346
Amortization of customer service inventory and
software license 1,374 1,265
Amortization of goodwill 674
Changes in operating assets and liabilities:
Accounts receivable 543 4,947
Refundable income taxes 120
Inventories (1,118) (1,064)
Prepaid expenses and other (65) 512
Accounts payable (484) (2,098)
Accrued salaries and wages 5 (49)
Taxes other than income taxes (67) 35
Income taxes 10 (121)
Deferred costs, net of revenues (1)
Customer deposits 77 (477)
Other 26 (1,620)
-----------------------
Net cash provided by operating activities 894 865
Investing Activities
Acquisition related settlement 400
Purchases of plant and equipment, net (13) (73)
-----------------------
Net cash provided (used) by investing activities (13) 327
Financing Activities
Proceeds from borrowings 2,401 3,484
Principal payments on borrowings (3,426) (3,098)
-----------------------
Net cash provided (used) by financing activities (1,025) 386
Increase (decrease) in cash and cash equivalents (144) 1,578
Cash and Cash Equivalents at Beginning of Year 1,662 36
-----------------------
Cash and Cash Equivalents at End of Period $ 1,518 $ 1,614
=======================
See accompanying notes.
5
SCAN-OPTICS, INC., AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
For the Quarter Ended June 30, 2002
NOTE 1 - Basis of Presentation
- ------
The accompanying unaudited consolidated financial statements have been prepared
in accordance with generally accepted accounting principles for interim
financial information and with the instructions to Form 10-Q and Article 10 of
Regulation S-X. Accordingly, they do not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, all adjustments (consisting
of normal recurring accruals) considered necessary for a fair presentation have
been included. Operating results for the six month period ended June 30, 2002,
are not necessarily indicative of the results that may be expected for the year
ending December 31, 2002. For further information, refer to the consolidated
financial statements and footnotes thereto included in the Company's annual
report on Form 10-K for the year ended December 31, 2001.
On January 1, 2002, the Company adopted Financial Accounting Standards Board
Statement No. 142 "Goodwill and Other Intangibles". Statement No. 142 eliminates
amortization of goodwill and requires at least an annual assessment for
impairment applying a fair value based test. As a result, there was no
amortization of goodwill recorded for the six month period ended June 30, 2002
and no impairment of goodwill was required upon adoption based upon the
performance of the fair value test. The Company recorded goodwill amortization
expense of $.3 million or $.05 per share for the second quarter of 2001 and $.7
million or $.10 per share for the six month period ended June 30, 2001.
Certain 2001 amounts have been reclassified to conform to current year
presentation.
NOTE 2 - Inventories
- ------
The components of inventories were as follows:
June 30 December 31
(thousands) 2002 2001
- -------------------------------------------------------------
Finished goods $ 200 $ 199
Work-in-process 511 1,604
Service parts 3,868 3,941
Materials and component parts 4,126 2,799
--------------------
$8,705 $8,543
====================
6
SCAN-OPTICS, INC., AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
For the Quarter Ended June 30, 2002
NOTE 3 - Credit Arrangements
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Effective December 31, 2001, the Company restructured its loan agreements with
Patriarch Partners, LLC. ("Patriarch"). The restructuring includes the following
terms:
o The maturity date of the Company's Loan Agreement with Patriarch is
extended through December 31, 2004.
o Patriarch's commitment under the Company's existing revolving line of
credit was increased from $10 million to $10.75 million until June 30,
2002, at which point the commitment amount will return to $10 million. All
revolving loans continue to accrue interest at a rate of prime plus 2%.
o The Company's existing term loan was reduced from $8.5 million to $2
million and continues to accrue interest at a rate of prime plus 2%. No
principal payments are required on the term loan until maturity on
December 31, 2004. The agreement contains a provision that requires the
quarterly recapture of fifty percent of the excess cash flow to be applied
to the term loan, based upon the calculation of consolidated cash flow
minus the aggregate amount of consolidated financial obligations.
o The Company issued to Patriarch, shares of preferred stock and warrants to
purchase common stock in exchange for forgiveness of the remaining $6.5
million balance of the term loan.
o The warrants represent the right to purchase up to 4,975,000 shares of
common stock of the Company, or approximately 33% of the currently
outstanding shares, plus shares reserved for stock options. The Company
may repurchase the warrants once the term loan and revolving loan are paid
off, if the Company also redeems the preferred stock. The repurchase price
of the warrants is $2.7 million plus accrued interest calculated at prime
plus 2%. In addition, if the warrants are repurchased in 2002, 10% of the
Company's common stock will transfer to Patriarch. This amount increases
to 15% in 2003 and 30% in 2004. The warrants are not exercisable until
after December 31, 2004, except upon certain events of default. The
exercise price of the warrants is $.02 per share. The warrants are
accounted for as an equity instrument through an increase to additional
paid in capital.
o The mandatory redeemable preferred stock ("preferred stock") is subject to
redemption for $3.8 million plus interest at prime plus 2% on December 31,
2004. The preferred stock is non-voting except upon exercise of the
warrants. The preferred stock is accounted as a quasi equity instrument
found on the balance sheet between other liabilities and stockholders'
equity.
7
SCAN-OPTICS, INC., AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
For the Quarter Ended June 30, 2002
o All monthly lease payments due prior to December 31, 2001 and continuing
lease obligations owed to Patriarch have been deferred and become due on
or before December 31, 2004.
o The Agreement contains covenants which, among other things, require the
maintenance of minimum earnings before interest, taxes, depreciation and
amortization, capital expenditure spending limits, accounts receivable
write-offs and backlog levels.
As a result of the debt restructuring, the term loan was reduced by $6.5 million
as of December 31, 2001. No gain resulted from this transaction because of the
issuance of equity in exchange for the indebtedness. The Company recorded the
issuance of preferred stock for $3.8 million, while the warrants to purchase
common stock were recorded as $2.7 million in paid in capital.
The outstanding borrowings at June 30, 2002 and December 31, 2001 were $10.9
million and $11.9 million, respectively. The revolving line of credit has been
classified as long term, with the exception of $1.5 million classified as
current, since management has the ability to maintain the December 31, 2001
outstanding balance through the next fiscal year. The available balance on the
outstanding borrowings was $1.9 million and $.9 million at June 30, 2002 and
December 31, 2001, respectively. The weighted average interest rate for the
second quarter of 2002 was 5.7% compared to 11.4% in 2001.
The carrying value of the notes payable to bank approximates its fair value and
is secured by all of the Company's assets.
NOTE 4 - Income Taxes
At June 30, 2002, the Company had U.S. federal and state net operating loss
carryforwards of approximately $17,300,000 and $23,100,000, respectively. The
U.S. federal and state net operating loss carryforwards expire through 2015. At
June 30, 2002, the Company had approximately $354,000, $3,500,000 and $800,000
of net operating loss carryforwards for Canada, the United Kingdom and Germany,
respectively, which expire through 2007. At June 30, 2001, the Company had U.S.
federal and state net operating loss carryforwards of approximately $18,000,000
and $19,700,000, respectively. At June 30, 2001, the Company had approximately
$480,000, $2,700,000 and $800,000 of net operating loss carryforwards for
Canada, the United Kingdom and Germany, respectively. For financial reporting
purposes, a valuation allowance has been recorded for the second quarter of 2002
and 2001 to fully offset deferred tax assets relating to U.S. federal, state,
and foreign net operating loss carryforwards and other temporary differences.
8
SCAN-OPTICS, INC., AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
For the Quarter Ended June 30, 2002
Significant components of the Company's deferred tax liabilities and assets were
as follows:
June 30 December 31
(thousands) 2002 2001
- --------------------------------------------------------------------------------------
Deferred tax assets:
Net operating losses $ 8,626 $ 8,557
Alternative minimum tax credit carryforward 168 168
Depreciation 92 92
Charitable contribution carryforward 80 37
Inventory valuation 544 586
Inventory 328 328
Accounts receivable reserves 607 669
Goodwill 214 604
Vacation accrual 202 209
Other 155 157
-----------------------------
Total gross deferred tax assets 11,016 11,407
Deferred tax liabilities:
Depreciation and other (75) (359)
-----------------------------
Total gross deferred tax liabilities (75) (359)
Valuation allowance (10,941) (11,048)
-----------------------------
Net deferred tax asset $ - $ -
=============================
9
SCAN-OPTICS, INC., AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
For the Quarter Ended June 30, 2002
NOTE 5 - Earnings Per Share
- ------
The following table sets forth the computation of basic and diluted earnings
(loss) per share:
Three Months Ended Six Months Ended
June 30 June 30
(thousands, except share data) 2002 2001 2002 2001
- ---------------------------------------------------------------------------------------------------------------------------------
Numerator:
Net earnings (loss) $ 218 $ (940) $ 384 $ (1,604)
============================================================================
Denominator:
Denominator for basic earnings (loss)
per share (weighted-average shares) 7,026,232 7,027,712 7,026,232 7,026,972
Effect of dilutive securities:
Employee stock options 281,886 331,395
Denominator for diluted earnings (loss)
per share (adjusted weighted-average ----------------------------------------------------------------------------
shares and assumed conversions) 7,308,118 7,027,712 7,357,627 7,026,972
============================================================================
Basic earnings (loss) per share $ .03 $ (.13) $ .05 $ (.23)
============================================================================
Diluted earnings (loss) per share $ .03 $ (.13) $ .05 $ (.23)
============================================================================
NOTE 6 - Comprehensive Income
- ------
The components of comprehensive income (loss), net of related tax, for the three
and six months ended June 30, 2002 and 2001 are as follows:
Three Months Ended Six Months Ended
June 30 June 30
(thousands) 2002 2001 2002 2001
- ------------------------------------------------------------------------------------------------------------------
Net Income (loss) $ 218 $ (940) $ 384 $(1,604)
Foreign currency translation adjustments 73 16 54 (358)
-----------------------------------------------------------
Comprehensive income (loss) $ 291 $ (924) $ 438 $(1,962)
===========================================================
10
SCAN-OPTICS, INC., AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
For the Quarter Ended June 30, 2002
The components of accumulated comprehensive loss, net of related tax, at June
30, 2002 and December 31, 2001 are as follows:
June 30 December 31
(thousands) 2002 2001
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Foreign currency translation adjustments $(916) $(970)
---------------------
Accumulated comprehensive loss $(916) $(970)
=====================
NOTE 7 - Segment Information
- ------
The Company views its business in three distinct revenue categories: Product and
solution sales, Access services, and Contract manufacturing services. Revenues
are used by management as a guide to determine the effectiveness of the
individual segment. The Company manages its operating expenses through a
traditional functional perspective and accordingly does not report operating
expenses on a segment basis.
Three Months Ended Six Months Ended
June 30 June 30
(thousands) 2002 2001 2002 2001
- ------------------------------------------------------------------------------------------------------------
Revenues
Solutions and products $ 4,332 $ 3,494 $ 8,859 $ 10,601
Access services 3,245 3,326 6,036 6,627
Contract manufacturing services 265 171 771 671
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Total revenues 7,842 6,991 15,666 17,899
Cost of solutions and products 2,872 2,649 5,642 8,244
Service expenses 2,271 2,689 4,566 5,430
---------------------------------------------------------------
Gross profit margin 2,699 1,653 5,458 4,225
Operating expenses
and other income, net 2,460 2,585 5,033 5,799
---------------------------------------------------------------
Income (Loss) before income taxes $ 239 $ (932) $ 425 $ (1,574)
===============================================================
Total expenditures for additions
to long-lived assets $ 7 $ 32 $ 48 $ 73
11
MANAGEMENT'S DISCUSSION AND ANALYSIS OF CONSOLIDATED FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Outlook
The forward-looking statements contained in this Outlook and elsewhere in this
document are based on current expectations. Scan-Optics, Inc. (the "Company")
and its future operations are subject to a number of risks, including those
discussed below. The following list is not intended to be an exhaustive list of
all the risks to which the Company's business is subject, but only to highlight
certain substantial risks faced by the Company. Although the Company completed a
total debt restructuring (see Note 3 to the consolidated financial statements
for further information), the Company remains highly leveraged and could be
adversely affected by a significant increase in interest rates or an inability
to comply with financial covenants in its debt agreements. A one percent
increase in the prime rate would increase the annual interest cost on the
outstanding loan balance at June 30, 2002 of approximately $11 million by $.1
million. The Company's business could be adversely affected by downturns in the
domestic and international economy. The Company's international sales and
operations are subject to various international business risks such as credit
worthiness, currency risk and the local economic environment. The Company's
revenues depend in part on contracts with various state or federal governmental
agencies, and could be adversely affected by patterns in government spending.
The Company faces competition from many sources, and its products may be
replaced with products relying on alternative technologies. The Company's
business could be adversely affected by technological changes. The foregoing
factors should not be construed as exhaustive.
The Company experienced net income of $.2 million in the second quarter of 2002
as compared with a loss of $.9 million in the second quarter of 2001. The
Company experienced net income in the first six months of 2002 of $.4 million,
which is an improvement over the prior year loss of $1.6 million. In the second
quarter of 2002, the professional services organization experienced another
quarter of profitability improving over the positive results in the first
quarter. The gross margin for professional services for the first six months of
2002 was 57% compared to a margin of 32% in the same period in 2001.
Because of the existence of significant non-cash expenses, such as depreciation
of fixed assets and amortization of intangible assets and customer service
inventory, the Company believes that EBITDA (earning before interest, taxes,
depreciation and amortization) contributes to a better understanding of the
Company's ability to satisfy its obligations and to utilize cash for other
purposes. EBITDA should not be considered in isolation from or as a substitute
for operating income, cash flow from operating activities, and other
consolidated income or cash flow data prepared in accordance with generally
accepted accounting principles. The operating income before interest, taxes,
depreciation and amortization (EBITDA) was $1.3 million in the second quarter of
2002, as compared to an EBITDA of $.6 million in the second quarter of
12
MANAGEMENT'S DISCUSSION AND ANALYSIS OF CONSOLIDATED FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
2001. EBITDA was $2.4 million in the first six months of 2002, as compared to an
EBITDA of $1.7 million in the same period of 2001.
The Company has three major initiatives currently underway to improve revenue
growth and profitability. They are to emphasize the "Business of Solutions"
focus in targeted markets, to decrease market risk through expansion in the
international marketplace by developing relationships with distributors,
resellers and others, and to capitalize on existing core competencies of the
Company. A fourth initiative that is currently on hold is to add long term value
through the acquisition of key strategic products or enterprises. The inability
of the Company to carry out these initiatives may have a materially adverse
effect on revenue growth and earnings.
The first initiative is to provide cost effective solutions through the
Company's development of target market data capture applications combined with
its high speed transports and archival systems. The Company has refined its
target market approach and has chosen to focus primarily on the government and
insurance markets, while continuing to address the transportation, financial and
order entry markets. The Company expects to continue to emphasize its "Business
of Solutions" focus on these targeted markets for the foreseeable future. As
other market opportunities emerge, the Company will evaluate the potential of
using its products and services to provide solutions in these new markets. The
Company's revenue in the solutions initiative decreased $2.7 million in the
first six months of 2002 as compared to 2001 and increased $1.2 million during
the second quarter of 2002 compared to the second quarter of 2001.
The second initiative is further expansion into the international marketplace.
The Company has focused on developing strong partner relationships with
distributors, resellers and others in Europe, Latin America, Japan and other
Pacific Rim countries. The Company experienced a revenue decrease of $3.4
million or 99% in Europe during the first six months of 2002 from 2001 and
decreased $.3 million or 99% during the second quarter of 2002 compared to the
second quarter of 2001. The Pacific Rim declined in the first six months by $.5
million or 91% and decreased $.3 million or 92% in the second quarter of 2002 as
compared to 2001. The economic environment in Latin America has been an
impediment to growth as the Company has experienced little activity in this
region. The Company plans to continue its international expansion effort through
partners with distributors, resellers and others in the future.
The third initiative relates to leveraging the Company's core competencies in an
effort to offset fixed expense and add revenues and profits. The Company has
demonstrated that Access Services and Contract Manufacturing Services have
potential to sell their individual expertise, experience and cost effectiveness
to other entities. During the first six months of 2002 compared to 2001, Access
Services revenue decreased by $.6 million or 9% and decreased $.1 million or 2%
for the quarter. Contract manufacturing revenue increased by $.1 million or 15%
13
MANAGEMENT'S DISCUSSION AND ANALYSIS OF CONSOLIDATED FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
during the first six months of 2002 compared to 2001 and increased $.1 million
or 55% in the second quarter comparison.
While the Company is principally focused on improving the profitability of its
existing operations, the Company may consider acquiring key strategic products
or enterprises. Acquisitions will be considered based upon their individual
merit and benefit to the Company.
Results of Operations for the Three and Six Months Ended June 30, 2002 vs. 2001
Total revenues decreased $2.2 million or 12% from the first six months of 2001
to the first six months of 2002 and increased $.9 million or 12% from the second
quarter of 2001 to the second quarter of 2002.
Hardware and software revenues decreased $1.6 million or 20% in the first six
months of 2002 compared with the first six months of 2001. Hardware and software
revenues increased $1.2 million or 68% in the second quarter of 2002 compared
with the second quarter of 2001. Compared to the first six months of 2001, North
American sales increased $2.4 million or 62% and increased $1.8 million or 158%
during the second quarter of 2002 compared to the second quarter of 2001 mainly
due to improvement in market perception of the financial stability of the
Company related to the debt restructuring. International sales during the first
six months of 2002 decreased $4 million or 96% and decreased $.6 million or 95%
during the second quarter of 2002 as compared to 2001 mainly due to a large
integrated solution sale to the British government in the first quarter of 2001.
Professional services revenues decreased $.1 million or 2% in the first six
months of 2002 compared with the first six months of 2001 and decreased $.2
million or 12% during the second quarter of 2002 compared to the second quarter
of 2001.
Access services revenues decreased $.6 million or 9% in the first six months of
2002 compared with the first six months of 2001 and decreased $.1 million or 2%
during the second quarter of 2002 compared to the second quarter of 2001. Third
party service revenue as a percentage of total Access Services revenue has
increased from 23% in the second quarter and first six months of 2001 to 25% in
the second quarter and first six months of 2002.
Cost of hardware and software decreased $1.7 million or 29% from the first six
months of 2001 compared to the first six months of 2002 and increased $.6
million or 38% from the second quarter of 2001 compared to the second quarter of
2002. The gross margin was 33% for the first six months of 2002, compared to 25%
in the first six months of the prior year. The gross margin was 26% during the
second quarter of 2002, compared to 10% in the second quarter of the prior year.
The changes in gross margin are mainly due to changes in product mix and
contract manufacturing volumes.
Cost of professional services decreased $.9 million in the first six months of
2002 vs. 2001 and decreased $.4 million in the second quarter of 2002 compared
to the prior year. The gross
14
MANAGEMENT'S DISCUSSION AND ANALYSIS OF CONSOLIDATED FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
margin was 57% for the first six months of 2002, compared to 32% in the first
six months of 2001. The gross margin was 57% during the second quarter of 2002,
compared to 43% in the second quarter of the prior year. The increase was mainly
due to process efficiencies and improved software capabilities provided through
software development efforts, which resulted in a decrease in contractor
expense, salaries and related benefits and travel expense.
Cost of Access Services decreased $.9 million in the first six months of 2002
compared to 2001 and $.4 million from the second quarter of 2001. The gross
margin was 24% for the first six months of 2002, compared to 18% in the first
six months of 2001. The gross margin was 30% during the second quarter of 2002,
compared to 19% in the second quarter of the prior year. The increase is mainly
due to the elimination of goodwill amortization expense of $.4 million for the
first six months and $.2 million for the quarter as mandated by the change in
rules relating to FASB No. 142 and a decrease in salaries and related benefits.
Sales and marketing expenses decreased $.2 million from the first six months of
2002 compared to 2001 and decreased $.1 million from the second quarter of 2001
mainly due to a decrease in the U.K. operations.
Research and development expenses decreased $.4 million from the first six
months of 2001 and decreased $.2 million from the second quarter of 2001 mainly
due to a decrease in consulting expense, salaries and related benefits because
of reduced headcount.
General and administrative expenses increased $.3 million from the first six
months of 2001 and increased $.4 from the second quarter of 2001. The increases
are mainly due to the recording of the settlement of the Southern Computer
Systems stock purchase agreement during the second quarter of 2001, which
forgave $.5 million due under the consulting and non-compete retainer.
Interest expense decreased $.5 million from the first six months of 2001 and
decreased $.2 million from the first quarter of 2001 due to the total debt
restructuring that was effective December 31, 2001 and the reduction of interest
rates. Both the line of credit and term loan carry an interest rate of prime
plus 2%. The weighted average interest rate for the first six months of 2002 was
5.6% compared to 10.5% in 2001.
Liquidity and Capital Resources
Cash and cash equivalents at June 30, 2002 decreased $.1 million from December
31, 2001 levels.
Total borrowings decreased $1 million to $10.9 million at June 30, 2002 from
December 31, 2001. The available balance on the line of credit was $1.9 million
at June 30, 2002. The available line of credit decreased by $.75 million on July
1, 2002. As of June 30, 2002, the
15
MANAGEMENT'S DISCUSSION AND ANALYSIS OF CONSOLIDATED FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Company is in compliance with all of the financial covenants related to its bank
debt. (See Note 3 for further details.)
Operating activities provided $.9 million of cash in the first six months of
2002.
Non-cash expenses recorded during the first six months of the year were $1.6
million, a decrease of $.7 million from the same period in 2001. The decrease is
mainly due to the elimination of goodwill amortization expense of $.7 million
mandated by the change in rules relating to FASB No. 142. These expenses relate
to depreciation of fixed assets (discussed in net plant and equipment below),
amortization of customer service spare parts inventory, amortization of software
license and in 2001, amortization of goodwill.
Net accounts receivable and unbilled receivables at June 30, 2002 decreased $.5
million from December 31, 2001 due to the collection of outstanding receivables.
Total inventories at June 30, 2002 increased $.2 million from December 31, 2001.
Total manufacturing inventories increased $.3 million from the beginning of the
year mainly due to the third quarter production plan. Customer service
inventories decreased $.1 million mainly due to amortization of inventory.
Net plant and equipment decreased $.2 million from December 31, 2001 mainly due
to depreciation expense reported during the first six months of the year.
Software license decreased by $.4 million from December 31, 2001 due to the
amortization of the source code licensing agreement.
Accounts payable decreased $.5 million from December 31, 2001 due to the timing
of payments.
Customer deposits increased $.1 million from December 31, 2001 due to the
addition of various contracts.
Other current liabilities decreased by $.2 million from December 31, 2001 due
mainly to payments applied to accrued expenses.
Notes payable to bank decreased $1 million due to the pay down of the line of
credit during the second quarter of 2002.
Other liabilities increased $.2 million mainly due to the deferred lease
payments that mature as part of the debt restructuring on December 31, 2004 and
accrued interest on the mandatory redeemable preferred stock.
16
SCAN-OPTICS, INC., AND SUBSIDIARIES
PART II - OTHER INFORMATION
Item 4. Submission of Matters to a Vote of Security Holders
The Company held its Annual Meeting of Stockholders on June 6, 2002 to
elect three directors, to approve the Scan-Optics, Inc. 2002 Incentive and
Non-Qualified Stock Option Plan and to appoint the Company's independent
auditors for the year ending December 31, 2002.
E. Bulkeley Griswold, John J. Holton and Robert H. Steele were elected
directors for terms expiring in 2005 by favorable votes of not less than
6,501,736. There were a total of not more than 184,997 abstentions in the vote
for Messrs. Griswold, Holton and Steele and no broker nonvotes. The other
members of the Board of Directors are Lyman C. Hamilton, Jr. and James C. Mavel,
whose terms expire in 2003 and Logan Clarke, Jr. and Richard J. Coburn, whose
terms expire in 2004.
The Scan-Optics, Inc. 2002 Incentive and Non-Qualified Stock Option
Plan was approved by a vote of 1,288,742 in favor, 600,608 against, 73,222
abstentions and 4,724,161 broker nonvotes.
Ernst & Young LLP was appointed as the Company's independent auditors
for the year ending December 31, 2002 by a vote of 6,527,027 in favor, 108,970
against, 50,736 abstentions and no broker nonvotes.
17
ITEM 6 (B) - REPORTS ON FORM 8-K
For the Quarter Ended June 30, 2002
No reports on Form 8-K were filed during the second quarter of 2002.
18
SIGNATURES
----------
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
SCAN-OPTICS, INC.
(Registrant)
Date August 14, 2002 / ss/ James C. Mavel
----------------- -------------------------------------
James C. Mavel
Chairman, Chief Executive Officer and
President
Date August 14, 2002 / ss/ Michael J. Villano
----------------- -------------------------------------
Michael J. Villano
Chief Financial Officer,
Vice President and Treasurer
19