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 September 30, 2002
( ) Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the transition period from __________ to __________________
Commission File No. 0-5265
SCAN-OPTICS, INC.
(Exact name of registrant as specified in its charter)
Delaware 06-0851857
(State or other jurisdiction of (I.R.S. Employer Identification Number)
incorporation or organization)
169 Progress Drive, Manchester, CT 06040
(Address of principal executive offices) Zip Code
(860) 645-7878
(Registrant's telephone number, including area code)
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. ( X ) Yes ( ) No
Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). ( )
Yes (X) No
The number of shares of common stock, $.02 par value, outstanding as of November
1, 2002 was 7,439,732.
1
SCAN-OPTICS, INC., AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(thousands, except share data) September 30, 2002 December 31, 2001
- -----------------------------------------------------------------------------------------------------------------------------------
(UNAUDITED)
Assets
Current Assets:
Cash and cash equivalents $ 753 $ 1,662
Accounts receivable less allowance of $1,712 at
September 30, 2002 and $1,936 at December 31, 2001 2,515 2,252
Unbilled receivables - contracts in progress 390 945
Inventories 8,868 8,543
Deferred costs, net of revenues 174 179
Prepaid expenses and other 364 325
----------------------------------------------------------
Total current assets 13,064 13,906
Plant and equipment:
Equipment 13,398 13,340
Leasehold improvements 5,232 5,232
Office furniture and fixtures 1,352 1,338
----------------------------------------------------------
19,982 19,910
Less allowances for depreciation and amortization 18,893 18,530
----------------------------------------------------------
1,089 1,380
Software license, net 627
Goodwill, net 9,249 9,249
Other assets 117 117
----------------------------------------------------------
Total Assets $ 23,519 $ 25,279
==========================================================
2
(thousands, except share data) September 30, 2002 December 31, 2001
- ------------------------------------------------------------------------------------------------------------------------------------
(UNAUDITED)
Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable $ 2,931 $ 3,462
Notes payable 1,500 1,500
Salaries and wages 1,290 1,380
Taxes other than income taxes 387 524
Customer deposits 1,208 507
Other 2,101 2,647
-----------------------------------------------------------------
Total current liabilities 9,417 10,020
Notes payable 8,142 10,392
Other liabilities 1,119 707
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 1,200,000 shares; none
issued or outstanding
Common stock, par value $.02 per share,
authorized 15,000,000 shares;
issued, 7,439,732 shares at September 30, 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 (33,894) (34,498)
Foreign currency translation adjustments (922) (999)
-----------------------------------------------------------------
3,687 3,006
Less cost of common stock in treasury,
413,500 shares 2,646 2,646
-----------------------------------------------------------------
Total stockholders' equity 1,041 360
-----------------------------------------------------------------
Total Liabilities and Stockholders' Equity $ 23,519 $ 25,279
=================================================================
See accompanying notes.
3
SCAN-OPTICS, INC., AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
Three Months Ended Nine Months Ended
September 30 September 30
(thousands, except share data) 2002 2001 2002 2001
- ---------------------------------------------------------------------------------------------------------------------------
Revenues
Hardware and Software $ 2,799 $ 901 $ 9,095 $ 8,787
Professional Services 1,628 1,579 4,962 4,965
Access Services 2,741 3,106 8,777 9,733
-------------------------------------- ----------------------------------
Total revenues 7,168 5,586 22,834 23,485
Costs of Revenue
Hardware and software 1,785 1,121 5,999 7,065
Professional services 754 805 2,182 3,105
Access services 2,105 2,621 6,671 8,051
-------------------------------------- ----------------------------------
Total costs of revenue 4,644 4,547 14,852 18,221
Gross Margin 2,524 1,039 7,982 5,264
Operating Expenses
Sales and marketing 874 935 2,539 2,830
Research and development 323 642 1,389 2,073
General and administrative 879 873 2,754 2,403
Interest 203 401 642 1,352
-------------------------------------- ----------------------------------
Total operating expenses 2,279 2,851 7,324 8,658
-------------------------------------- ----------------------------------
Operating income (loss) 245 (1,812) 658 (3,394)
Other income (expense), net (5) 4 7 12
-------------------------------------- ----------------------------------
Income (loss) before income taxes 240 (1,808) 665 (3,382)
Income tax expense 20 1 61 31
-------------------------------------- ----------------------------------
Net Income (Loss) $ 220 $ (1,809) $ 604 $ (3,413)
======================================= ===================================
Basic earnings (loss) per share $ .03 $ (.26) $ .09 $ (.49)
======================================= ===================================
Basic weighted-average shares 7,026,232 7,026,232 7,026,232 7,026,232
Diluted earnings (loss) per share $ .03 $ (.26) $ .08 $ (.49)
======================================= ===================================
Diluted weighted-average shares 7,229,109 7,026,232 7,314,788 7,026,232
4
SCAN-OPTICS, INC., AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
Nine Months Ended
September 30
(thousands) 2002 2001
- ----------------------------------------------------------------------------------------------------------------------------------
Operating Activities
Net Income (Loss) $ 604 $ (3,413)
Adjustments to reconcile net income (loss)
to net cash provided by operating activities:
Depreciation 314 522
Amortization of customer service inventory and
software license 1,800 1,897
Amortization of goodwill 993
Changes in operating assets and liabilities:
Accounts receivable 292 6,619
Refundable income taxes 124
Inventories (1,758) (1,893)
Prepaid expenses and other (33) 555
Accounts payable (531) (2,379)
Accrued salaries and wages (90) 11
Taxes other than income taxes (137) 6
Deferred costs, net of revenues 5 11
Customer deposits 701 (491)
Other 197 (1,642)
------------------------------------------------------
Net cash provided by operating activities 1,364 920
Investing Activities
Acquisition related settlement 400
Purchases of plant and equipment, net (23) (79)
------------------------------------------------------
Net cash provided (used) by investing activities (23) 321
Financing Activities
Proceeds from borrowings 2,626 3,485
Principal payments on borrowings (4,876) (3,098)
------------------------------------------------------
Net cash provided (used) by financing activities (2,250) 387
Increase (decrease) in cash and cash equivalents (909) 1,628
Cash and Cash Equivalents at Beginning of Year 1,662 36
-----------------------------------------------------
Cash and Cash Equivalents at End of Period $ 753 $ 1,664
=====================================================
See accompanying notes.
5
SCAN-OPTICS, INC., AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
For the Quarter Ended September 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 nine month period ended September 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 nine month period ended September 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 third quarter of 2001 and $1
million or $.14 per share for the nine month period ended September 30, 2001.
Certain 2001 amounts have been reclassified to conform to current year
presentation.
NOTE 2 - Inventories
The components of inventories were as follows:
September 30 December 31
(thousands) 2002 2001
Finished goods $ 200 $ 199
Work-in-process 1,303 1,604
Service parts 3,749 3,941
Materials and component parts 3,616 2,799
--------- -------
$ 8,868 $ 8,543
========= =======
6
NOTE 3 - Credit Arrangements
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 returned to $10 million. All
revolving loans continue to accrue interest at a rate of prime plus 2%.
o The Company's existing term loan was reduced from $8.5 million to $2
million 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
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 September 30, 2002 and December 31, 2001 were $9.6
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 September 30, 2002
outstanding balance through the next fiscal year. The available balance on the
outstanding borrowings was $2.4 million and $.9 million at September 30, 2002
and December 31, 2001, respectively. The weighted average interest rate for the
third quarter of 2002 was 5.6% compared to 9.9% in 2001.
The carrying value of the notes payable to lender approximates its fair value
and is secured by all of the Company's assets.
NOTE 4 - Income Taxes
At September 30, 2002, the Company had U.S. federal and state net operating loss
carryforwards of approximately $24,800,000 and $25,600,000, respectively. The
U.S. federal and state net operating loss carryforwards expire through 2015. At
September 30, 2002, the Company had approximately $315,000, $3,500,000 and
$800,000 of net operating loss carryforwards for Canada, the United Kingdom and
Germany, respectively, which expire through 2008. At September 30, 2001, the
Company had U.S. federal and state net operating loss carryforwards of
approximately $19,500,000 and $21,200,000, respectively. At September 30, 2001,
the Company had approximately $450,000, $3,100,000 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
third 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
Significant components of the Company's deferred tax liabilities and assets were
as follows:
September 30 December 31
(thousands) 2002 2001
Deferred tax assets:
Net operating losses $ 11,190 $ 8,557
Alternative minimum tax credit carryforward 168 168
Depreciation 92 92
Charitable contribution carryforward 37
Inventory valuation 541 586
Inventory 305 328
Accounts receivable reserves 596 669
Goodwill 142 604
Vacation accrual 182 209
Other 156 157
------------- -------------
Total gross deferred tax assets 13,372 11,407
Deferred tax liabilities:
Depreciation and other (28) (359)
------------- -------------
Total gross deferred tax liabilities (28) (359)
Valuation allowance (13,344) (11,048)
------------- -------------
Net deferred tax asset $ - $ -
============= =============
9
NOTE 5 - Earnings Per Share
The following table sets forth the computation of basic and diluted earnings
(loss) per share:
Three Months Ended Nine Months Ended
September 30 September 30
(thousands, except share data) 2002 2001 2002 2001
Numerator:
Net earnings (loss) $ 220 $ (1,809) $ 604 $ (3,413)
=================================================================
Denominator:
Denominator for basic earnings (loss)
per share (weighted-average shares) 7,026,232 7,026,232 7,026,232 7,026,232
Effect of dilutive securities:
Employee stock options 202,877 288,556
Denominator for diluted earnings (loss)
per share (adjusted weighted-average
shares and assumed conversions) 7,229,109 7,026,232 7,314,788 7,026,232
=================================================================
Basic earnings (loss) per share $ .03 $ (.26) $ .09 $ (.49)
=================================================================
Diluted earnings (loss) per share $ .03 $ (.26) $ .08 $ (.49)
=================================================================
NOTE 6 - Comprehensive Income
The components of comprehensive income (loss), net of related tax, for the three
and nine months ended September 30, 2002 and 2001 are as follows:
Three Months Ended Nine Months Ended
September 30 September 30
(thousands) 2002 2001 2002 2001
Net Income (loss) $ 220 $ (1,809) $ 604 $ (3,413)
Foreign currency translation adjustments 17 38 71 (320)
-----------------------------------------------------------------
Comprehensive income (loss) $ 237 $ (1,771) $ 675 $ (3,733)
=================================================================
10
The components of accumulated comprehensive loss, net of related tax, at
September 30, 2002 and December 31, 2001 are as follows:
September 30 December 31
(thousands) 2002 2001
Foreign currency translation adjustments $ (899) $ (970)
--------------------------------------------
Accumulated comprehensive loss $ (899) $ (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 Nine Months Ended
September 30 September 30
(thousands) 2002 2001 2002 2001
Revenues
Solutions and products $ 4,129 $ 2,372 $ 12,988 $ 12,973
Access services 2,741 3,106 8,777 9,733
Contract manufacturing services 298 108 1,069 779
-------------------------------------------------------------------
Total revenues 7,168 5,586 22,834 23,485
Cost of solutions and products 2,539 1,926 8,181 10,170
Service expenses 2,105 2,621 6,671 8,051
-------------------------------------------------------------------
Gross profit margin 2,524 1,039 7,982 5,264
Operating expenses
and other income, net 2,284 2,847 7,317 8,646
-------------------------------------------------------------------
Income (Loss) before income taxes $ 240 $ (1,808) $ 665 $ (3,382)
===================================================================
Total expenditures for additions
to long-lived assets $ 24 $ 6 $ 72 $ 79
11
NOTE 8 - Bill and Hold Transactions
Revenues relating to sales of certain equipment (principally optical character
recognition equipment) are recognized upon acceptance, shipment, or installation
depending on the contract specifications. When customers, under the terms of
specific orders or contracts, request that the Company manufacture and invoice
the equipment on a bill and hold basis, the Company recognizes revenue based
upon a certification received from the customer. Revenues recorded during the
third quarter of 2002 included bill and hold transactions of $.9 million.
Accounts receivable included bill and hold receivables of $.6 million at
September 30, 2002. There were no bill and hold transactions in the first nine
months of 2001.
NOTE 9 - Recent Developments
During the third quarter of 2002 the Company negotiated a $.3 million reduction
in the final payment due Bluebird Systems for the 1999 purchase of the Docwise
source code license. This reduction was recorded as decrease in the accrual and
a decrease in research and development amortization expense during the third
quarter of 2002.
12
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 September 30, 2002 of approximately $9.6 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 achieved net income of $.2 million in the third quarter of 2002 as
compared with a loss of $1.8 million in the third quarter of 2001. The Company
earned net income in the first nine months of 2002 of $.6 million, which is an
improvement over the prior year loss of $3.4 million. In the third quarter of
2002, the professional services organization experienced another quarter of
profitability improving over the prior year. The gross margin for professional
services for the first nine months of 2002 was 56% compared to a margin of 37%
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 (earnings 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 million in the third quarter of
13
2002, as compared to an EBITDA loss of $.3 million in the third quarter of 2001.
EBITDA was $3.4 million in the first nine months of 2002, as compared to EBITDA
of $1.4 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,
insurance and assessment 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 increased $.5 million in the first nine months of 2002 as compared to
2001 and increased $2 million during the third quarter of 2002 compared to the
third quarter of 2001.
The second initiative is further expansion into the international marketplace.
The Company has focused on improving partner relationships with distributors,
resellers and others. International sales represented approximately 5% of the
Company's revenues in the nine months ended September 30, 2002, down from 22% of
the Company's revenues in the corresponding period of 2001. The Company's
international sales depend on relationships with distributors, resellers and
others, and vary considerably from period to period.
The third initiative relates to leveraging the Company's core competencies in an
effort to offset fixed expenses 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 nine months of 2002 compared to 2001, Access
Services revenue decreased by $1 million or 10% and decreased $.4 million or 12%
for the quarter. Contract manufacturing revenue increased by $.3 million or 37%
during the first nine months of 2002 compared to 2001 and increased $.2 million
or 176% in the third quarter comparison.
14
While the Company is principally focused on improving the profitability of its
existing operations, the Company may consider acquiring key strategic products
or enterprises. Acquisitions will be considered based upon their individual
merit and benefit to the Company.
Results of Operations for the Three and Nine Months Ended September 30, 2002 vs.
2001
Total revenues for the first nine months of 2002 decreased $.7 million or 3% as
compared to the first nine months of 2001. Total revenues for the third quarter
of 2002 increased $1.6 million or 28% as compared to the third quarter of 2001.
Hardware and software revenues increased $.3 million or 4% in the first nine
months of 2002 compared with the first nine months of 2001. Hardware and
software revenues increased $1.9 million or 211% in the third quarter of 2002
compared with the third quarter of 2001. Compared to the first nine months of
2001, North American sales increased $4.8 million or 118% and increased $2.5
million or 805% during the third quarter of 2002 compared to the third quarter
of 2001 mainly due to the focus on solutions for vertical lines of business.
International sales during the first nine months of 2002 decreased $4.5 million
or 96% and decreased $.6 million or 96% during the third 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 remained flat for the first nine months of 2002
compared with the first nine months of 2001 and for the third quarter of 2002
compared to the third quarter of 2001.
Access services revenues decreased $1 million or 10% in the first nine months of
2002 compared with the first nine months of 2001 and decreased $.4 million or
12% during the third quarter of 2002 compared to the third quarter of 2001
primarily due to the loss of service contracts on older, obsolete equipment.
Third party service revenue as a percentage of total Access Services revenue has
increased from 25% in the third quarter and first nine months of 2001 to 27% in
the third quarter and 26% in the first nine months of 2002.
Cost of hardware and software decreased $1 million or 15% from the first nine
months of 2001 compared to the first nine months of 2002 and increased $.7
million or 59% from the third quarter of 2001 compared to the third quarter of
2002. The gross margin was 34% for the first nine months of 2002, compared to
20% in the first nine months of the prior year. The gross margin was 36% during
the third quarter of 2002, compared to negative margin of 24% in the third
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 nine months of
2002 vs. 2001 and decreased $.1 million in the third quarter of 2002 compared to
the prior year. The gross margin was 56% for the first nine months of 2002,
compared to 37% in the first nine months of 2001. The gross margin was 54%
during the third quarter of 2002, compared to 49% in the third quarter of the
prior year. The margin improvement was mainly due to process efficiencies and
15
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 $1.4 million in the first nine months of 2002
compared to 2001 and $.5 million from the third quarter of 2001. The gross
margin was 24% for the first nine months of 2002, compared to 17% in the first
nine months of 2001. The gross margin was 23% during the third quarter of 2002,
compared to 16% in the third quarter of the prior year. The increase is mainly
due to the elimination of goodwill amortization expense of $.6 million for the
first nine 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 $.3 million from the first nine months of
2002 compared to 2001 and decreased $.1 million from the third quarter of 2001
mainly due to a decrease in the U.K. operations.
Research and development expenses decreased $.7 million from the first nine
months of 2001 and decreased $.3 million from the third quarter of 2001. The
decrease for the third quarter and the first nine months was due mainly to a
negotiated reduction in the final payment due Bluebird Systems of $.3 million
that resulted in a reversal of previously recorded amortization expense and
further contributing to the year to date decrease was a reduction in salaries
and related benefits.
General and administrative expenses increased $.4 million from the first nine
months of 2001 and remained flat on a third quarter of 2001 to 2002 comparison.
The increase in the nine month comparison is 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 $.7 million from the first nine months of 2001 and
decreased $.2 million from the third 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 nine months of 2002
was 5.6% compared to 9.9% in 2001.
16
Liquidity and Capital Resources
Cash and cash equivalents at September 30, 2002 decreased $.9 million from
December 31, 2001 levels.
Total borrowings decreased $2.3 million to $9.6 million at September 30, 2002
from December 31, 2001. The available balance on the line of credit was $2.4
million at September 30, 2002. The available line of credit decreased by $.75
million on July 1, 2002. As of September 30, 2002, the Company is in compliance
with all of the financial covenants related to its debt. (See Note 3 for further
details.)
Operating activities provided $1.4 million of cash in the first nine months of
2002.
Non-cash expenses recorded during the first nine months of the year were $2.1
million, a decrease of $1.3 million from the same period in 2001. The decrease
is mainly due to the elimination of goodwill amortization expense of $1 million
mandated by the change in rules relating to FASB No. 142. Non-cash 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 September 30, 2002 decreased
$.3 million from December 31, 2001 due to the collection of outstanding
receivables.
Total inventories at September 30, 2002 increased $.3 million from December 31,
2001. Total manufacturing inventories increased $.5 million from the beginning
of the year mainly due to the fourth quarter production plan. Customer service
inventories decreased $.2 million mainly due to amortization of inventory.
Net plant and equipment decreased $.3 million from December 31, 2001 mainly due
to depreciation expense reported during the first nine months of the year.
Software license decreased by $.6 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 $.7 million from December 31, 2001 due to the
addition of various contracts.
17
Other current liabilities decreased by $.5 million from December 31, 2001 due
mainly to the final payment and the negotiated reduction in the total amount due
Bluebird Systems, which fulfilled the liability for the purchase of the source
code license. (See Note 9 for further details)
Notes payable to lender decreased $2.3 million due to the pay down of the line
of credit during the first nine months of 2002.
Other liabilities increased $.4 million mainly due to accruals for lease
payments that were deferred as part of the debt restructuring and will mature on
December 31, 2004 and accrued interest on the mandatory redeemable preferred
stock.
Disclosure Controls and Procedures
The Company evaluated the design and operation of its disclosure controls and
procedures to determine whether they are effective in ensuring that the
disclosure of required information is timely made in accordance with the
Exchange Act and the rules and forms of the Securities and Exchange Commission.
This evaluation was made under the supervision and with the participation of
management, including the Company's principal executive officer and principal
financial officer within the 90-day period prior to the filing of this Quarterly
Report on Form 10-Q. The principal executive officer and principal financial
officer have concluded, based on their review, that the Company's disclosure
controls and procedures, as defined at Exchange Act Rules 13a-14(c) and
15d-14(c), are effective to ensure that information required to be disclosed by
the Company in reports that it files under the Exchange Act is recorded,
processed, summarized and reported within the time periods specified in
Securities and Exchange Commission rules and forms. No significant changes were
made to the Company's internal controls or other factors that could
significantly affect these controls subsequent to the date of their evaluation.
18
ITEM 6 (A) EXHIBITS
Listing of Exhibits
Exhibit 99.1 CEO Certification pursuant to Section 906 of the
Sabanes-Oxley Act.
Exhibit 99.2 CFO Certification pursuant to Section 906 of the
Sabanes-Oxley Act.
19
ITEM 6 (B) - REPORTS ON FORM 8-K
For the Quarter Ended September 30, 2002
No reports on Form 8-K were filed during the third quarter of 2002.
20
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
SCAN-OPTICS, INC.
(Registrant)
Date November 14, 2002 / ss/
James C. Mavel
Chairman, Chief Executive Officer and
President
Date November 14, 2002 / ss/
Michael J. Villano
Chief Financial Officer,
Vice President and Treasurer
21
CERTIFICATION OF CHIEF EXECUTIVE OFFICER
I, James C. Mavel, Chairman, Chief Executive Officer and President of
Scan-Optics, Inc., certify that:
1. I have reviewed this quarterly report on Form 10-Q of Scan-Optics,
Inc.;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which such
statement were made, not misleading with respect to the period covered by this
quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) Designed such disclosure controls and procedures to ensure
that material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities, particularly
during the period in which this quarterly report is being prepared;
b) Evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the "Evaluation Date"); and
c) Presented in this quarterly report our conclusions about
the effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed,
based on our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
a) All significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) Any fraud, whether or not material, that involves
management or other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officers and I have indicated in
this quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
22
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: November 14, 2002
________/ ss_/____________________
James C. Mavel
Chairman, Chief Executive Officer
and President
23
CERTIFICATION OF CHIEF FINANCIAL OFFICER
I, Michael J. Villano, Chief Financial Officer, Vice President and
Treasurer of Scan-Optics, Inc., certify that:
1. I have reviewed this quarterly report on Form 10-Q of Scan-Optics,
Inc.;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which such
statement were made, not misleading with respect to the period covered by this
quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) Designed such disclosure controls and procedures to ensure
that material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities, particularly
during the period in which this quarterly report is being prepared;
b) Evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the "Evaluation Date"); and
c) Presented in this quarterly report our conclusions about
the effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed,
based on our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
a) All significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) Any fraud, whether or not material, that involves
management or other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officers and I have indicated in
this quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
24
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: November 14, 2002
_______/ ss_/_____________________
Michael J. Villano
Chief Financial Officer, Vice President
and Treasurer
25