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, 2002
-----------------------------------------
( )Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934 For the transition period from
--------------------------------------
Commission File No. 0-5265
--------------------------------------------------------------
SCAN-OPTICS, INC.
(Exact name of registrant as specified in its charter)
Delaware 06-0851857
- -------------------------------- ----------------------------------
(State or other jurisdiction (I.R.S. Employer Identification Number)
of 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)
Securities registered pursuant to Section 12(b) of the Act: None
----------------------
Securities registered pursuant to
Section 12(g) of the Act: Common stock, $.02 par value
----------------------------
(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]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 126-2) (_) YES (X) NO
The aggregate market value of the voting and non-voting common equity held by
non-affiliates computed by reference to the price at which common equity was
last sold, or the average bid and asked price of such common equity, as of the
last day of the registrant's most recently completed second fiscal quarter:
$2,083,125 as of June 30, 2002.
The number of shares of common stock, $.02 par value, outstanding as of March
24, 2003 was 7,439,732.
1
DOCUMENTS INCORPORATED BY REFERENCE
- -----------------------------------
Portions of the definitive Proxy Statement, relating to the 2003 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
2
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 provides information capture hardware and software products combined
with lifecycle support and maintenance services, which constitute the platform
for its systems integration and professional services organization to create
information management solutions in response to a customer's business needs.
The Company is a leader in developing, applying and supporting technology to
solve information capture and customer service problems for government agencies
and commercial businesses. Historically the Company's research and development
activity has focused on improving accuracy and performance of the image and
"OCR" (optical character recognition) scanning platforms yielding the premier
scanner in the industry. More recently this effort has grown to encompass the
expansion and enhancement of the software suites that surround these versatile
scanner platforms. Acquired and developed expertise in database, storage,
network and Microsoft development environments have enhanced the Company's
strength in developing and supporting complex system integration projects. Still
focused on the information capture portion of system architecture, the Company
has built a comprehensive development and support infrastructure. The range of
these solutions has expanded to include data capture, data perfection and
archival solutions, adding value to the information available for our customers
to better serve their customers and manage their business.
The Company's strategy is to provide information capture solutions to select
vertical markets. With demonstrated success in, government, insurance,
assessment, transportation, order fulfillment and financial markets, the Company
has chosen to focus on and serve these industries.
The Company has three distinct divisions: Solutions and Products, Access
Services and Manufacturing Services. These divisions are established to focus
the Company's resources and assets in a cost-effective manner on the clients
that it serves. Although each division is autonomous in pursuit of new business
and revenue sources, they possess tremendous synergy for the end-user community
that is searching for a "single-source" supplier.
The Company's Solutions and Products Division combines technology with its
experience and expertise in the development of cost-effective, high quality
solutions for applications in the government, insurance, assessment,
transportation, order fulfillment and financial markets. 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.
The Access Services Division of the Company provides third party and proprietary
product maintenance services nationwide, as well as in the UK and Canada. The
Company has been selected by over 18 companies to provide maintenance services
for their products at the customer site or through the Company's depot
3
maintenance facility. In support of its many third-party contracts, the Company
has implemented a logistics and dispatch center that is being utilized in
support of several high volume, low cost products. This business model
demonstrates the flexibility of the Company to provide customized services to
meet customer needs, versus having the customer adapt to Company's business
model. Like the rest of the Company this division depends on its ISO9001 quality
processes to assure high levels of customer satisfaction.
The Manufacturing Services Division manufactures the Company's high performance
proprietary scanning platforms. Due to its ability to deliver high quality
products, this division is able to attract several contract manufacturing
customers. Recently it supplemented its ISO9001 certification with initial FDA
registration that authorizes the Company to manufacture medical diagnostic
imaging equipment. This division is also establishing an outsourcing capability,
Business Process Outsourcing ("BPO"), which is a service to image-enable
documents for subsequent document management, storage and retrieval. These
services provide a low-risk, cost-effective solution for customers with document
imaging needs and will follow the disciplined process for quality control that
have served the division in the past.
SOLUTIONS AND PRODUCTS DIVISION
Solutions
Focused on the needs of the client, the Company follows an ISO9001 documented
process to define the customer requirements prior to proposing a value-based
information capture solution. The solution may be rich in Scan-Optics product
and technology content or may integrate third-party technology to meet specific
customer objectives. Because of its investment in the skills and expertise of
its development organization, the Company is well positioned to deliver quality
solutions in a timely manner. This capability is further enhanced by over 33
years of experience serving specific target markets.
Target Markets
The Company has six defined target markets that are a focus for its go-to-market
strategy. The following describe these markets:
o Government - federal, state and local tax processing, licensing and labor
reporting
o Insurance - medical claims and enrollments
o Assessment - test scoring
o Transportation - proof of delivery and 3rd party billing accounting
o Order Fulfillment - subscription and order processing
o Financial - proxy balloting and real estate taxes
Scan-Optics Technology
The Company has continually been on the leading edge of technological
developments in the OCR, "ICR" (intelligent character recognition), "OMR"
(optical mark read) and Imaging arena. Our most recent developments have yielded
a patent application for gray scale OMR recognition for assessment applications
and software based endorsement of images and a patent for "detecting double
documents" using acoustic sensors.
4
Software Products
Scan-Optics' AccuScore, for the automatic scoring of "bubble" forms, uses
electronic image-capture technology in conjunction with patent pending gray
scale OMR recognition software for performing the scoring with:
o Inexpensive paper or printing
o Industry standard image scanners
o Flexible, easy-to-use forms definition tool
o Extremely high accuracy rates
o Greater flexibility in forms design
Scan-Optics' DocWise, provides a secure digital information archive utilizing
sophisticated workflow processes. DocWise can store virtually any type of
electronic file: E-mail, computer documents (Microsoft Excel and Word), digital
photos, faxes, XML files and ERM reports. DocWise provides security under
Windows NT, 2000 and XP security architecture with seven levels of access rights
built in. DocWise has the capacity to import and index thousands of documents
per hour in industry standard TIFF format.
Scan-Optics' ImageEMC++, developed as a result of the Company's experience with
many of the nation's leading health insurance and other claims payment
companies, is a comprehensive business solution designed to efficiently process
the paper forms and other documents these organizations receive. It equips the
organization with the technology to minimize the time and labor involved with
processing single and multi-part health claims, enrollments, and other forms, as
well as correspondence, re-pricing sheets and other general documents.
Scan-Optics' PayWise, is a turnkey solution designed to increase the efficiency
of an Accounts Payable department by integrating image processing of the
supplier invoice to a company's' Accounts Payable system. The Company has
implemented this product in its own SAP accounts payable function with
significant cost and efficiency savings.
TIS eFLOW, comes to the Company through a cooperative marketing agreement with
Top Image Systems, Ltd. and provides forms processing in both structured and
unstructured environments.
TIS eMobilis, comes to the Company through a marketing agreement with Top Image
Systems, Ltd. and provides electronic data entry via electronic devices such as
personal digital assistants (PDA's).
Mitek, is a character recognition engine that has been integrated into many
Scan-Optics solutions.
SONAR (Scan-Optics Neural Auxiliary Recognition) is a software product released
in 2001. SONAR incorporates the Company's patented Context Edit product and ICR
recognition technology for lower volume forms/data capture applications.
Applications such as enrollments with address changes are ideally suited for
SONAR.
5
Hardware Products
Scan-Optics' Series 9000M and the Series 9000mm image scanners feature modular
design, advanced digital camera technology, with black and white, color or
grayscale output. Both scanners are based on Windows 2000 operating environment,
and can process intermixed forms of varying sizes and weights, and both are
available as simplex or duplex, with an integrated image quality monitor,
acoustic double-detect feeder, and character recognition rates up to 10,000
characters per second.
Scan-Optics' Series 8000 image only scanner is targeted at the mid-range market
for production scanning. Rated at 200 pages per minute, the Series 8000 scanner
family converts large volumes of documents into compressed industry standard
electronic images.
In 2003, the Company intends to continue its aggressive program of research and
development enhancements of additional options and capabilities for its existing
products as well as the development of new products that utilize the advantage
of the Company's core competencies. The Company will continue to develop
relationships with other technology companies to provide technology outside its
product suite to be implemented through the Company's integration services
organization to meet customer requirements.
Core Competencies
Key product disciplines utilize integration expertise and experience that
leverage the core competencies of the Company to provide specific solution
alternatives. These core competencies include:
Document Scanning
Image Enhancement Algorithms and Image Quality
Character Recognition (OCR, ICR, Barcode, Mark Sense, OMR, etc.)
Key-From-Image and Key-From-Paper Data Entry
Document Management, Workflow and Availability
Line of Business Domain Knowledge
Professional Services (Design, Development, Installation and Support)
Value Added Engineering Services and Solutions
Professional Services
In order to provide a total solution to the customer, the Company has provided a
consultative approach to integrate solutions with proven professional services
core competencies in the following areas:
Application Expertise Industry Standards Open Systems
Archival / Retrieval Installation Paper Handling
Custom Engineering Microfilming Project Management
Development Tools Networking Systems Engineering
Forms Design Neural Technology System Integration
Imaging OCR Technology Training
Microsoft 2000 Database Performance Tuning
6
The Company has provided software solutions to its customers since 1968.
Utilizing Company developed products and third-party products, the professional
services group provides turn-key solutions to address the customer's mission
critical applications. The Company's image scanners provide the hardware
platforms for delivering advanced high-volume forms processing, imaging, and
document management system solutions, especially in its target markets.
These targeted solutions are provided through the 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 solution of hardware and software with support or simply provide those
specific services that the customer desires.
Customer Satisfaction
Expansion of this business has been possible with the excellent customer
relationships that we enjoy. Customer satisfaction continues to be a key area of
focus for the Company. Our quality processes focus on the delivery of quality
products and services and we monitor, measure and report customer satisfaction
levels in various surveys conducted throughout the year. The surveys also follow
a documented quality process within our ISO9001 certification program.
Management meets weekly to assure the proper attention is focused on the needs
of our customers.
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,
archival storage and retrieval, and communications. The following are three
examples of the capabilities of the Company's engineering services organization:
o 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.
o The Company has developed 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. Similar techniques have
been used to provide quality and fraud control application for the indicia
from postal meters.
o The Company has also developed recognition analysis for educational test
scoring. This process is accomplished in full duplex mode at a transport
speed of 50 inches per second.
7
ACCESS SERVICES DIVISION
The Company has been offering service and maintenance support to its customer
base since 1968. This support is available with either leased or purchased
systems in both domestic and international markets.
Maintenance service is provided through a network of over 120 service
technicians worldwide. The Company provides on-site service with response times
of 2 to 24 hours based on the service plan selected by the customer. In support
of its third-party maintenance contracts Scan-Optics has developed comprehensive
depot maintenance capability with logistics and call center support. 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, insurance, assessment,
transportation, and order 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.
MANUFACTURING SERVICES DIVISION
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 standard and
Company-specified mechanical and electronic parts, sub-assemblies and major
components, including microcomputers. A majority of parts are purchased,
including many complex electronic and mechanical subassemblies. 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 documented in the ISO9001 quality
system. One of the many methods to assure quality is the use of
computer-controlled testing equipment.
The Company has not experienced significant shortages of any components or
subassemblies. Alternate sources for such components and subassemblies have been
developed. Certain sole source items have been evaluated and the Company has
determined that a minor engineering effort would be required to qualify a
replacement.
The contract manufacturing services function, within the Manufacturing Services
Division, provides electro-mechanical assembly and test services under contracts
with customers who develop and sell a variety of equipment.
8
Beginning with the customer's plans, the Company can manage each project from
concept to completion. The capabilities provided include:
Project Management
Engineering and Prototyping
Procurement and Materials Management
Precision Machining, Sheet metal Fabrication and Welding
Networks/System Integration
Systems Testing
Just-in-Time/Kanban Delivery Systems
Professional Services and Training
Worldwide Field Service - through Access Services
Agency Standards Certification (FCC, UL, CE, CSA, ISO9001)
Strong Supplier Relationships with:
Commercial Painting and Metal Finishing
Printed Circuit Board Assemblies and Testing
Wire Harness and Cable Assembly and Testing
Specialty Packaging
Worldwide Shipping
This division is also utilizing its manufacturing process disciplines in
structuring an outsourcing service capability for image capture and data entry.
Although it is in the early stages of development the Company believes the
disciplines that are practiced everyday in the manufacturing process will add
significant customer value in terms of quality and efficiency to an outsourcing
function.
SIGNIFICANT CUSTOMERS
In 2002 and 2001, no customers accounted for more than 10% of total revenue. In
2000, the Company derived 13% of its total revenue from one customer, Toyo
Officemation, Inc., one of the Company's distributors in Japan.
CHANNELS OF DISTRIBUTION
The Company sells directly to end-users and integrators in the USA and
distributors internationally.
QUALITY
All aspects of the Company's business fall under the ISO9001 certification
requirements. Customer satisfaction is a driving priority and the chosen method
of producing the measurable results is through the documented procedures defined
in the Company's quality manual.
9
BACKLOG
The backlog for the Company's products and services as of December 31, 2002 was
approximately $18.7 million. As of December 31, 2001, the backlog was
approximately $22.5 million. Backlog as of March 19, 2003 was approximately
$24.9 million. The backlog consists of equipment, software and services to be
sold and non-cancelable 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
professional services and software customization required.
COMPETITION
The Company's Solutions and Products Division competes with software service
providers who integrate systems with products from multiple vendors. The Company
differentiates its solutions by offering a total system, including post
installation support of hardware and software services along with image scanning
and document handling transports under the defined processes in the ISO9001
quality manual. The Division focuses on industry specific "application" areas
with solutions utilizing image and data entry/data capture systems provided by
the Company and implemented under strictly defined quality processes.
A large portion of the revenue generated by the Access Services Division is from
post installation hardware and software services on integrated systems installed
by the Company's Solutions and Products Division. Due to the proprietary nature
of these integrated systems, this division faces little competition for this
business. The remaining revenue is generated by the field repair of
electro-mechanical devices manufactured by third-party equipment manufacturers,
primarily of scanner products, that do not have their own field maintenance
staff. The division competes with other third party maintenance providers for
this revenue by using its reputation for quality, which has been generated from
the strict adherence to its ISO9001 quality process manual and its 33 years of
experience in providing scanner repair in this market.
Contract manufacturing, a function of the Manufacturing Services Division,
provides electro-mechanical assembly and test services under contracts with
customers who develop and sell a variety of equipment. The primary competition
for this business is the customers themselves who can decide to manufacture the
products instead of outsourcing them. Competition from other contract
manufacturers is minimal due to the Company's expertise in the electo-mechanical
field as well as the flexibility to handle various order requirements.
10
ISO9001 CERTIFICATION
In 2000, the Company took the first step in expanding its quality program by
bringing the Access Service Division into compliance with the already certified
product development organization and manufacturing division. The Company also
performed internal audits to test for compliance in the sales, design,
manufacturing and service areas to continue to improve the quality management
system. The registering body performed four surveillance audits on the Company's
product development and manufacturing divisions, all of which were successful.
In 2001, the Company maintained its quality systems and began to prepare for the
transition to ISO9001:2000.
During November 2002, the Company introduced the new quality scope, which
encompasses all areas of the Company. The scope of the certification is for the
design, manufacture, installation and service of scanning equipment; the
contract manufacturing, installation and service of electro-mechanical devices;
the provision of related products and software services including the design,
development, installation and support; and project management of integrated
solutions for targeted lines of business.
In 2003, we continue our transition to ISO9001:2000. The Company expects to
complete the transition process and obtain ISO9001:2000 certification by October
2003.
PATENTS
The Company currently has nine United States patents in force and one pending
which expire between 2003 and 2022. The patents are on mechanical systems,
electronic circuits, electronic systems and software algorithms, which are used
throughout the product lines. The Company values the investments made in new
technology and attempts to protect its intellectual property. 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 Imaging Business Machines, LLC. for use in an image transport designed
for processing airline tickets. In 1999, this same patent was licensed to Nale
Corporation for use on its paper handling transports. In 2000, the Company filed
for a patent for gray scale OMR used in test scoring applications. In 2001, the
Company received the patent for the ultrasonic overlapping document detection
system for our scanners.
11
EMPLOYEES
As of December 31, 2002 the Company employed 192 people, including 17 with
administrative responsibilities, 22 in marketing and sales, 101 in software and
service activities, 14 in engineering and 38 in manufacturing capacities. The
Company considers its employee relations to be good. The Company has not
experienced any work stoppages.
FUNDED DEVELOPMENT AGREEMENTS
During 2002, 2001 and 2000, the Company completed a number of small custom
development contracts for specific customers resulting in revenue of
approximately $43,000, $110,000 and $200,000, respectively. These revenues
offset the related costs incurred for this development. The ownership of these
technologies remains with the Company. No royalties or other considerations are
required as part of these agreements.
EFFECTS OF ENVIRONMENTAL LAWS
The effect of federal and state environmental regulations on the Company's
operations is insignificant.
12
BUSINESS SEGMENTS
The Company views its business in three distinct operating segments: Solutions
and Products, 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.
Year Ended December 31
(thousands) 2002 2001 2000
- -------------------------------------------------------------------------------------------------------
Revenues
Solutions and products $ 16,376 $ 16,667 $ 23,295
Access services 11,499 13,193 12,669
Contract manufacturing services 1,466 880 2,338
-------------------------------------------------
Total revenues 29,341 30,740 38,302
Cost of solutions and products 10,715 13,298 22,806
Service expenses 8,539 11,200 11,287
-------------------------------------------------
Gross profit margin 10,087 6,242 4,209
Operating expenses, net 9,175 12,522 21,918
-------------------------------------------------
Income (loss) before income taxes $ 912 $ (6,280) $ (17,709)
=================================================
Total assets $ 26,406 $ 27,380 $ 36,513
Total expenditures for additions to
long-lived assets $ 79 $ 121 $ 109
Certain 2001 and 2000 amounts have been reclassified to conform to the current
year presentation.
The Solutions and Products Division includes the sale of hardware and software
products as well as professional services. Contract Manufacturing Services
provides assembly and test services under contracts with customers who develop
and sell a variety of equipment.
Note: In 2002 and 2001, no customers accounted for more than 10% of total
revenue. In 2000, the Company derived 13% of its total revenue from one
customer, Toyo Officemation, Inc., one of the Company's distributors in Japan.
13
The Company has international distributors located in 13 countries and covering
six continents. All international sales other than sales originating from the UK
and Canadian subsidiaries are denominated in United States dollars. 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) 2002 2001 2000
- ---------------------------------------------------------------------
Latin America $ 72 24% $ 152 3% $ 152 2%
Europe 149 49% 3,706 73% 1,667 22%
Pacific Rim 81 27% 1,220 24% 5,881 76%
---------------------------------------------------
$ 302 $ 5,078 $ 7,700
===================================================
Export sales represented 3%, 45%, and 43% of hardware and software revenues for
the three years ended December 31, 2002, 2001, and 2000, respectively.
ITEM 2 - PROPERTIES
- --------------------
The Company's world headquarters and manufacturing facility is located in an
84,000 square foot, one-story building in Manchester, Connecticut, leased for a
term expiring in December 2006. The Company also leases 1,238 square feet of
office space, under a lease expiring in July 2005, in Dallas, Texas for
professional services and sales.
Scan-Optics, Ltd., a wholly owned subsidiary in the United Kingdom, also leases
office space for sales, service, and equipment demonstration.
ITEM 3 - LEGAL PROCEEDINGS
- --------------------------
There are two lawsuits currently pending against the Company. Although the
ultimate outcome is uncertain, based on currently known facts, the Company
believes that it has strong defenses against both lawsuits and the resolution of
these matters will not have a material adverse effect on the Company's financial
position or annual operating results.
ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
- ------------------------------------------------------------
The Company did not submit any matters during the fourth quarter of 2002 to a
vote of the stockholders.
14
EXECUTIVE AND OTHER OFFICERS OF THE REGISTRANT
Officers of the Company are set forth in the schedule below.
Officer
Name Age Principal Occupation: Since
- -----------------------------------------------------------------------------
James C. Mavel 57 Chairman, Chief Executive Officer
and President 1996
Joseph P. Crouch 40 Vice President -
Manufacturing Services Division 1999
Richard C. Goyette 51 Vice President -
Sales and Marketing 1996
Richard D. Harris 42 Corporate Secretary 2001
Joel K. Howser 55 Vice President -
Software Development 1998
Clarence W. Rife 63 Vice President -
Access Services Division and
Hardware Engineering 1975
Michael J. Villano 43 Chief Financial Officer, Vice
President and Treasurer 1992
Alan W. Ware 64 Vice President -
Project and System Integration 2000
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.
15
Mr. Crouch joined the Company in March 1999 and was appointed to the position of
Vice President - Manufacturing Services Division in November 1999. Prior to
joining the Company, Mr. Crouch was Director of Manufacturing Operations for
CalComp's Input Technologies Division. Mr. Crouch had over ten years of contract
manufacturing experience before joining the Company.
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.
He is currently Vice President - Sales and Marketing.
Mr. Harris joined the law firm of Day, Berry and Howard LLP in 1990 and became
partner in 1998. He was appointed to the position of Corporate Secretary in
January 2001.
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 of experience in transaction processing and OCR/image development
prior to joining Unisys. He is currently Vice President - Software Development.
Mr. Rife has been employed by the Company since 1969 and was appointed to the
position of Vice President in 1975. He is currently Vice President - Access
Services Division and Hardware Engineering.
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.
Mr. Ware joined the Company in October 2000 as Vice President - Project and
System Integration. Prior to joining the Company he was Chief Executive Officer
and Chairman of American OBGYN, Inc. (formally Spectrascan Imaging Services,
Inc.) from 1984 to 2000. He was Vice President of Sales and Marketing for
Scan-Optics from 1974 to 1984 and Director of Engineering and Customer Service
at Recognition Equipment, Inc. from 1968 to 1974.
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.
16
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.
Effective November 10, 2000 the Company was notified by The NASDAQ Stock Market,
Inc. that its common stock would begin listing on the Over the Counter Bulletin
Board. This action was taken because of the inability to maintain the $1 per
share bid price requirement for continued listing on the NASDAQ Stock Market.
The closing quotations represent prices between dealers and do not include
retail markups, markdowns or commissions and may not represent actual
transactions. There were 912 stockholders of record at December 31, 2002.
Quarter Ended March 31 June 30 September 30 December 31
High Low High Low High Low High Low
- ----------------------------------------------------------------------------------------------------------------
2002 $ .41 $ .22 $ .38 $ .26 $ .39 $ .25 $ .40 $ .25
2001 $ .33 $ .14 $ .35 $ .21 $ .93 $ .27 $ .35 $ .20
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 Company's loan agreement does not allow dividend
payments on common stock.
17
ITEM 6 - SELECTED FINANCIAL DATA
- --------------------------------
SCAN-OPTICS, INC. AND SUBSIDIARIES
FIVE YEAR SUMMARY OF OPERATIONS
SELECTED FINANCIAL DATA
(thousands, except share data) 2002 2001 2000 1999 1998
- ------------------------------------------------------------------------------------------------------------------------------------
Total Revenues $ 29,341 $ 30,740 $ 38,302 $ 51,992 $ 53,971
=======================================================================================
Income (loss) before income taxes 912 (6,280) (17,709) (8,415) 3,234
Income taxes (benefit) 81 33 61 (240) 1,105
---------------------------------------------------------------------------------------
Net Income (Loss) $831 $ (6,313) $ (17,770) $(8,175) $ 2,129
=======================================================================================
Basic earnings (loss) per share .12 (.90) (2.53) (1.17) 0. 31
Basic weighted-average shares 7,026,232 7,026,232 7,025,064 6,979,651 6,921,331
Diluted earnings (loss) per share .11 (.90) (2.53) (1.17) 0.30
Diluted weighted-average shares 7,317,437 7,026,232 7,025,064 6,979,651 7,102,658
SELECTED BALANCE SHEET DATA
Total assets 26,406 27,380 36,513 56,792 54,301
Working capital (deficit) 5,283 4,184 (9,833) 4,727 15,107
Long Term Obigations 10,682 11,397
Mandatory redeemable preferred stock 3,800 3,800
Total stockholders' equity 1,272 360 4,307 22,081 30,246
The Company has not paid any dividends for the five-year period ended December
31, 2002.
The above financial data should be read in conjunction with the related
consolidated financial statements and notes thereto.
Certain amounts have been reclassified to conform to the current year
presentation.
18
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. Scan-Optics, Inc. (the "Company")
and its future operations are subject to a number of risks, including those
discussed below. The following list is not intended to be an exhaustive list of
all the risks to which the Company's business is subject, but only to highlight
certain substantial risks faced by the Company. Although the Company completed a
total debt restructuring effective December 31, 2001 (see Note F 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. A one percent increase in the prime rate would increase the
annual interest cost on the outstanding loan balance at December 31, 2002 of
approximately $10.5 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. The Company's revenues depend in part on contracts
with various state or federal governmental agencies, and could be adversely
affected by patterns in government spending. The Company faces competition from
many sources, and its products and services may be replaced by alternative
technologies. The Company's business could be adversely affected by
technological changes. The foregoing factors should not be construed as
exhaustive.
The Company reported net income for the year of $.8 million or $.11 per diluted
share, compared to a net loss of $6.3 million, or $.90 per diluted share, for
2001. During the fourth quarter of 2002, the Company determined that certain
amounts previously recorded as liabilities were no longer due or have been
settled for amounts less than previously recorded. This resulted in other income
of $.4 million in the fourth quarter of 2002. During the third quarter of 2002,
the Company negotiated a reduction in the final payment due BlueBird Systems,
Inc. for the 1999 purchase of the DocWise source code license which resulted in
a reduction of previously recorded amortization expense of $.3 million. The
Company has delivered excellent operational results even though the industry has
been burdened with a difficult economic environment. Our efforts to improve
efficiencies through quality control have paid significant benefits to our
customers and our bottom line. We are fully committed to delivering successful
solutions by using the quality standards we have established under our ISO9001
certification.
The Company has three major initiatives currently underway to develop sources of
revenue growth and increase profitability. They are to emphasize the "Business
of Solutions" focus in targeted markets, introduction of a Business Process
Outsourcing Service, and expansion of the Access Services Division to include
enterprise wide maintenance services. 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 material adverse effect on revenue growth and earnings.
The first initiative is to provide cost effective solutions through the
Company's development of target market data capture applications combined with
its high speed transports and archival systems. The Company has refined its
19
target market approach and has chosen to place its primary focus on the
government and insurance markets, while continuing to address the
transportation, assessment, financial and order fulfillment markets. The Company
expects to continue to emphasize its "Business of Solutions" focus on these
targeted markets for the foreseeable future. As other market opportunities
emerge, the Company will evaluate the potential of using its products and
services to provide solutions in these new markets. The Company's revenue in the
solutions initiative increased $1.8 million from 2001 to 2002 mainly in the
assessment market.
The second initiative, introduced in early 2003, is a Business Process
Outsourcing ("BPO") Service to image-enable documents for subsequent document
management, storage and retrieval. The Company's' new BPO Services provide a
low-risk, cost-effective solution for customers with document imaging needs. As
increasing numbers of both government and commercial clients migrate from
paper-based filing systems to state-of-the-art image-based storage and retrieval
systems, they are faced with the need to convert their existing paper files or
opt to outsource the activity to a proven solution provider. The BPO services
offer customers a high quality, ISO9001 certified, turnkey outsourcing solution
utilizing the Company's proprietary hardware technology, and further leveraging
software skills, resources and process controls.
The third initiative, recently announced by our Access Services Division, is an
expansion to include enterprise wide maintenance services. Leveraging off the
experience it has gained through its many third party agreements, Access
Services is well positioned to expand maintenance coverage and provide customers
with "one number to call" for maintenance services regardless of the equipment
manufacturer. Through the division's 120 technical service representatives
strategically located throughout the US, the Company believes that it can
provide high quality, cost effective enterprise maintenance to its existing
customer base as well as new accounts.
While the Company is principally focused on improving the profitability of its
existing operations, the Company may consider acquiring key strategic products
or enterprises. Acquisitions will be considered based upon their individual
merit and benefit to the Company.
20
RESULTS OF OPERATIONS - 2002 VS. 2001
Total revenues decreased $1.4 million or 5% from 2001 to 2002.
Hardware and software revenue increased $.1 million or 1% from the prior year.
North American sales increased $4.9 million or 80% due mainly to the replacement
of obsolete Series 9000 systems that were at least seven years old and were not
capable of being maintained due to the lack of parts availability. Total
international sales decreased $4.8 million or 94% from 2001. International sales
in the Pacific Rim decreased 93% or $1.1 million due to the significant
reduction of spare parts orders and scanner systems sold to the Company's
distributor in Japan. Sales to Europe decreased $3.6 million or 96% due to a
large integrated solution sale to the British government that was recorded in
2001. Latin American sales remained consistent with the prior year mainly due to
the continued decline in economic conditions in the Latin American countries.
Professional services revenue increased $.2 million or 3% from 2001 to 2002
mainly due to the increase in hardware and software revenue.
Access services revenue decreased $1.7 million or 13% from 2001 to 2002 due
mainly to a decrease in revenue from the Company's proprietary maintenance
contracts as a result of lower maintenance rates for the latest generation of
the Series 9000 scanner, the 9000M, as compared to the earlier Series 9000
scanner. The Company was also impacted by a few customers discontinuing
maintenance due to changes in their business or the use of other technologies.
Cost of hardware and software revenue decreased $1.5 million or 16% from 2001.
Cost of hardware and software revenue as a percentage of revenue was 69% in
2002, as compared to 83% in 2001. The decrease is mainly due to the improvement
in gross margins related to the sales mix. In 2002, the Company recorded
approximately three times the number of Series 9000 scanners as compared to
2001, which accounted for more revenue and increased margins. In 2001, a
significant portion of the revenue was made up of third-party products and
distributor sales of Series 8000 scanners, which yield lower margins than Series
9000 scanners.
Cost of professional services revenue decreased $1.1 million or 27% in 2002
compared to the prior year mainly due to decreases in salaries and related
expenses of $.3 million, contractor expenses of $.5 million, travel expenses of
$.1 million and other expenses of $.2 million. Cost of professional services
revenue as a percentage of revenue was 44% in 2002, as compared to 62% in 2001.
Cost of Access services revenue decreased $2.7 million or 24% from 2001 to 2002.
The decrease is mainly due to a decrease in goodwill amortization expense of $.8
million, a decrease in UK operating expense of $.7 million and a decrease in
salaries and related expenses of $.6 million. Cost of Access services revenue as
a percentage of revenue was 74% in 2002, as compared to 85% in 2001.
21
Sales and marketing expenses decreased $.6 million or 16% from 2001 mainly due
to a decrease in UK operations.
Research and development expenses decreased $1.1 million or 39% from 2001 mainly
due to a decrease in salaries and related expenses of $.6 million and
amortization of the software license agreement of $.5 million in 2001.
General and administrative expenses decreased $.2 million or 6% from 2001 mainly
due to decrease in goodwill amortization expense of $.5 million, and a $.2
million decrease in legal and accounting fees, offset by the recording of the
settlement of the Southern Computer Systems stock purchase agreement which
forgave $.5 million due under the consulting and non-compete retainer in 2001.
Interest expense decreased $.9 million from 2001 due to the $6.5 million
reduction in the Company's outstanding debt as a result of the debt
restructuring that was effective December 31, 2001, as well as the reduction in
the prime rate that occurred in 2002. The weighted average interest rate was
5.5% in 2002 compared to 9.8% in 2001.
Other Income increased $.4 million due to the reduction of certain amounts
previously recorded as liabilities that were no longer due or have been settled
for amounts less than previously recorded.
RESULTS OF OPERATIONS - 2001 VS. 2000
Total revenues decreased $7.6 million or 20% from 2000 to 2001.
Hardware and software revenue decreased $6.9 million or 38% from the prior year.
North American sales decreased $4.3 million or 41% due mainly to the concern
over the expiration on July 1, 2001 and potential non-renewal of the bank
agreement as well as the general economic environment for goods and services.
Total international sales decreased $2.6 million or 34% from 2000. International
sales in the Pacific Rim decreased 79% or $4.6 million due to the significant
reduction of spare parts orders and scanner systems sold to Japan's National
Ministry of Health. Sales to Europe increased $2 million or 122% due to a large
integrated solution sale to the British government, Latin American sales
remained consistent with the prior year mainly due to the continued decline in
economic conditions in the Latin American countries.
Professional services revenue decreased $1.2 million or 16% from 2000 to 2001
mainly due to the completion of various contracts during 2001 that were not
completed during 2000 and the slowdown in orders as noted above.
Access services revenue increased $.5 million or 4% from 2000 to 2001 due mainly
to an increase in new third party maintenance contracts and the increased
retention of existing customers using Scan-Optics manufactured equipment.
22
Cost of hardware and software revenue decreased $5.4 million or 36% from 2000.
This decrease is mainly due to the decline in hardware and software revenue.
Cost of hardware and software revenue as a percentage of revenue was 83% in
2001, as compared to 81% in 2000.
Cost of professional services revenue decreased $4.2 million or 51% in 2001
compared to the prior year mainly due to a decrease in contractor expense,
salaries and related benefits and travel expense. Cost of professional services
revenue as a percentage of revenue was 62% in 2001, as compared to 108% in 2000.
Cost of Access services revenue remained consistent from 2000 to 2001. Cost of
Access services revenue as a percentage of revenue was 85% in 2001, as compared
to 89% in 2000.
Sales and marketing expenses decreased $2 million or 34% from 2000 mainly due to
a decrease in salaries, commissions and related benefits, travel expense and a
provision for uncollectable accounts receivable.
Research and development expenses decreased $.8 million or 21% from 2000 mainly
due to a decrease in consulting expense and salaries and related benefits.
General and administrative expenses decreased $6 million or 60% from 2000 mainly
due to the accounts receivable allowance recorded during the fourth quarter of
2000 for various accounts that were determined to be uncollectable which was not
required in 2001 and the recording of the settlement of the Southern Computer
Systems stock purchase agreement which forgave $.5 million due under the
consulting and non-compete retainer. (See Note C.)
Interest expense decreased $.6 million from 2000 due mainly to a change in the
interest rate on the Company's indebtedness. Both the line of credit and term
loan carried an interest rate of prime through March 24, 2000 when the rate
increased to prime plus 5%. As of January 30, 2001 the interest rate was reduced
to prime plus 2%. The weighted average interest rate was 9.8% in 2001 compared
to 13.2% in 2000.
LIQUIDITY AND CAPITAL RESOURCES
Cash and cash equivalents decreased $1.4 million from 2001 to 2002 mainly due to
the paydown of the revolving line of credit.
At December 31, 2002, the Company had $10.5 million in outstanding borrowings,
with $1.5 million classified as current, against its $12 million available
borrowings. The Company anticipates meeting its current obligations and resource
needs through the funds generated from operations. The average borrowing level
for 2002 was $10.7 million compared to $18.3 million for 2001. The decrease is
due to the debt restructuring that was effective December 31, 2001 (See Note F)
and payments of portions of the outstanding debt from cash flow generated in
2002.
23
Effective December 31, 2001, the Company restructured its loan agreements with
Patriarch Partners, LLC. ("Patriarch"), which resulted in forgiveness of a
portion of outstanding term debt, additional borrowing capability in the short
term and reduced interest expense due to reduced debt levels. In exchange for
the forgiveness of debt, the Company issued shares of preferred stock and
warrants to purchase common stock. The debt agreement expires on December 31,
2004. The Company believes that the restructuring will allow execution of the
Company's business plan through the term of the debt agreement. The Company
currently anticipates that it will be able to renew or refinance its long term
debt at maturity in December 2004, although there can be no assurance as to the
availability or terms of such financing. The loan agreement with Patriarch
contains covenants which, among other things, require the maintenance of minimum
earnings before interest and taxes, depreciation and amortization, capital
expenditure spending limits, accounts receivable write-offs and backlog levels.
(See Note F.)
The following summarizes the Company's significant contractual obligations and
commitments that impact its liquidity as of December 31, 2002.
Contractual Obligations Payments Due by Period
- -------------------------------------------------------------------------------------------------------------------
(thousands) Less than 1 1- 3 4 - 5 After 5
Total year Years Years years
- -------------------------------------------------------------------------------------------------------------------
Notes payable $ 10,542 $ 1,500 $ 9,042
Interest payable 407 407
Executive insurance agreement 408 50 $ 100 $ 258
Capital leases 361 74 222 65
Operating leases 2,337 646 1,327 104 260
- -------------------------------------------------------------------------------------------------------------------
Total contractual cash obligations $ 14,055 $ 2,220 $ 11,048 $ 269 $ 518
- -------------------------------------------------------------------------------------------------------------------
Operating activities used $.2 million of cash in 2002 compared to providing $.9
million in 2001. The non-cash expenses in 2002 were $2.5 million compared to
$5.1 million in 2001. The non-cash items relate to depreciation of fixed assets
which is discussed in net plant and equipment below, amortization of customer
service inventory and software license, amortization of goodwill, provisions for
losses on accounts receivable, provisions for inventory obsolescence and
non-cash income from a reversal of previously recorded liabilities. These and
other components of operating activities are discussed below.
Net accounts receivable and unbilled receivables increased $.6 million from
December 31, 2001. The increase is mainly related to the slowdown in the
economy, which the Company believes has caused many companies to extend beyond
their traditional payment timeframes.
Total inventories increased $.6 million from 2001 levels. Manufacturing
inventories increased $.8 million during the year due to an increase in
materials and component parts of $1.2 million which was offset by a decrease in
work-in-process and finished goods inventory of $.4 million. The increase in
materials and component parts is mainly due to an increase in the production
schedule for the first quarter of 2003. The manufacturing inventory increase was
offset by a decrease in customer service inventory of $.2 million, which was
mainly attributable to the amortization of spare parts inventory.
24
Net plant and equipment decreased $.1 million in 2002. This decrease is due to
depreciation of $.4 million which was offset by new capital leases of $.3
million.
Software license decreased by $.6 million due to amortization of the source code
license recorded during the year of $.3 million and a negotiated settlement
which reduced the final payment due of $.3 million.
Goodwill decreased by $.2 million in 2002 due to the reduction of certain
amounts previously recorded as liabilities that were no longer due or have been
settled for amounts less than previously recorded. The amortization of goodwill
was eliminated as of January 1, 2002 due to the issuance of Financial Accounting
Standards Board Statements of Financial Accounting Standards No. 142 "Goodwill
and Other Intangibles".
Accounts payable decreased $1 million from December 31, 2001 due to the control
of expenses and the timing of payments along with a $.6 million decrease due to
the reduction of certain amounts recorded as accounts payable that were no
longer due or have been settled for amounts less than previously recorded.
Notes payable to bank decreased $1.4 million due to pay down of the notes
payable during the year. (See Note F.)
Salaries and wages decreased $.4 million from 2001 mainly due to a $.2 million
decrease in accrued commissions, a $.1 million decrease in bonus accrual, and a
$.1 million decrease in accrued vacation.
Deferred revenue increased $.1 million as a result of the increase in annual and
quarterly maintenance billings that are subsequently recognized in revenue over
the maintenance period covered by the billing.
Customer deposits increased $.8 million due mainly to two large orders that
contained deposit requirements as part of the contract.
Other current liabilities decreased $.7 million due mainly to a decrease in
legal and accounting fees of $.2 million, a decrease in accrued health and other
employee related insurance of $.1 million, a decrease of $. 3 million due to a
negotiated reduction in the final payment due BlueBird Systems, Inc. for the
1999 purchase of the DocWise source code license.
Other long term liabilities increased $.6 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 and a new capital lease.
25
OTHER MATTERS
New Accounting Standards
Refer to Note B of the Notes to Consolidated Financial Statements in Item 8 for
a discussion of new accounting pronouncements and the potential impact to the
Company's consolidated results of operations and consolidated financial
position.
Critical Accounting Policies
The policies discussed below are considered by management to be critical to an
understanding of the financial statements because their application places the
most significant demands on management's judgement, with financial reporting
results relying on estimation about the effect of matters that are inherently
uncertain. Specific risks for these critical accounting policies are described
in the following paragraphs.
Revenue recognition - percentage of completion: The Company recognizes revenue
and profit on professional services engagements using the percentage of
completion method of accounting, which relies on estimates of total expected
contract revenues and costs. The Company follows this method since reasonably
dependable estimates of the revenue and costs applicable to various stages of a
contract can be made. Since the financial reporting of these contracts depends
on estimates, which are assessed continually during the term of the contract,
recognized revenues and profit are subject to revisions as the contract
progresses to completion. Revisions in profit estimates are reflected in the
period in which the facts that give rise to the revision become known.
Accordingly, favorable changes in estimates result in additional profit
recognition, and unfavorable changes in estimates result in the reversal of
previously recognized revenue and profits. When estimates indicate a loss under
a contract, the provision for such loss is recorded in that period. As work
progresses under a loss contract, revenue continues to be recognized, and a
portion of the contract costs incurred in each period is charged to the contract
loss reserve. The estimated loss is calculated and adjusted each period. If
estimates change, the professional services revenue, cost of revenue and gross
margins will be impacted.
Allowance for doubtful accounts: The Company evaluates the collectability of
accounts receivable based on a combination of factors. In cases where the
Company has knowledge of a specific customer's inability to meet its financial
obligations (e.g., bankruptcy filings, substantial slow-down in recent payment
history) or contract disputes, a specific reserve for uncollectable amounts will
be recorded. For all other customers, the Company records a reserve for bad
debts based on the age of the receivable balance. If circumstances change (i.e.,
higher than expected defaults, unexpected material adverse change in a
significant customer's ability to meet its financial obligations to the Company
or contract disputes), estimates of the collectability of amounts due could be
reduced by a material amount.
26
Inventories - slow moving and obsolete: The Company performs regular reviews of
excess and obsolete manufacturing inventories to determine if the inventory
reserve recorded on the balance sheet is adequate to cover the value of parts
deemed excess or obsolete. The review is based upon current inventory levels,
expected product sales over the next twelve to twenty four months and Access
Services requirements for spare parts. Should the Company not achieve expected
product sales or if Access Services parts requirements should change, future
losses may occur through the requirement of additional reserves for excess and
obsolete inventory.
Long-lived assets: The Company records impairment losses 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 longlived assets, to determine whether events or
circumstances warrant revised estimates of useful lives. If the business plans
the Company utilized to calculate the undiscounted cash flows are not achieved,
a potential impairment could exist and a write-down of the net book value of
long-lived assets could be required.
Goodwill: Goodwill consists of the excess of cost over the fair value of
identifiable net assets of businesses acquired and were amortized on a
straight-line basis over five to twenty years. Beginning January 1, 2002,
goodwill is no longer amortized, but is be tested on at least an annual basis
for impairment, see Note C.
27
ITEM 7A - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
- --------------------------------------------------------------------
In 2001, the Company completed a total debt restructuring (see Note F for
further information), however, the Company remains highly leveraged and could be
adversely affected by a significant increase in interest rates. A one percent
increase in the prime rate would increase the annual interest cost on the
outstanding loan balance at December 31, 2002 of approximately $10.5 million by
$.1 million.
The Company has minimal foreign currency translation risk. All international
sales other than sales originating from the UK and Canadian subsidiaries are
denominated in United States dollars.
Refer to the Outlook section of Management's Discussion and Analysis of
Consolidated Financial Condition and Results of Operations, and to Note A of the
Notes to Consolidated Financial Statements.
28
ITEM 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
----------------------------------------------------
29
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, 2002 and 2001, and the related
consolidated statements of operations, stockholders' equity, and cash flows for
each of the three years in the period ended December 31, 2002. Our audits also
included the financial statement schedule listed in the Index at Item 15(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 auditing standards generally accepted
in the United States. 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, 2002 and 2001, and the
consolidated results of their operations and their cash flows for each of the
three years in the period ended December 31, 2002, in conformity with accounting
principles generally accepted in the United States. 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.
/s/ Ernst & Young LLP
Hartford, Connecticut
March 18, 2003
30
SCAN-OPTICS, INC., AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
December 31
(thousands, except share data) 2002 2001
- -------------------------------------------------------------------------------------------------------------------------
Assets
Current Assets:
Cash and cash equivalents $ 274 $ 1,662
Accounts receivable less allowance of $1,574 in 2002
and $1,936 in 2001 5,554 4,353
Unbilled receivables - contracts in progress 377 945
Inventories 9,139 8,543
Prepaid expenses and other 591 504
--------------------------------------------------------
Total current assets 15,935 16,007
Plant and Equipment:
Equipment 8,836 13,340
Leasehold improvements 5,209 5,232
Office furniture and fixtures 725 1,338
--------------------------------------------------------
14,770 19,910
Less allowances for depreciation and amortization 13,456 18,530
--------------------------------------------------------
1,314 1,380
Software license, net of accumulated amortization
of $2,140 in 2002 and $1,773 in 2001 627
Goodwill 9,040 9,249
Other assets 117 117
--------------------------------------------------------
Total Assets $ 26,406 $ 27,380
========================================================
31
December 31
(thousands, except share data) 2002 2001
- ---------------------------------------------------------------------------------------------------------------
Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable $ 2,454 $ 3,462
Note payable 1,500 1,500
Salaries and wages 958 1,380
Taxes other than income taxes 501 524
Income taxes 45 5
Deferred revenue 2,217 2,101
Customer deposits 1,308 507
Other 1,669 2,344
---------------------------------------------
Total current liabilities 10,652 11,823
Notes payable 9,042 10,392
Other liabilities 1,640 1,005
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 in 2002 and 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
Accumulated Retained-earnings deficit (33,667) (34,498)
Accumulated other comprehensive loss (918) (999)
---------------------------------------------
3,918 3,006
Less cost of common stock in treasury,
413,500 shares 2,646 2,646
---------------------------------------------
Total stockholders' equity 1,272 360
---------------------------------------------
Total Liabilities and Stockholders' Equity $ 26,406 $ 27,380
=============================================
See accompanying notes.
32
SCAN-OPTICS, INC., AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
Year Ended December 31
(thousands, except share data) 2002 2001 2000
- ----------------------------------------------------------------------------------------------------------------------------
Revenues
Hardware and software $ 11,292 $ 11,195 $ 18,099
Professional services 6,550 6,352 7,534
Access services 11,499 13,193 12,669
--------------------------------------------------------------
Total revenues 29,341 30,740 38,302
Costs of Revenue
Hardware and software 7,816 9,331 14,685
Professional services 2,899 3,967 8,121
Access services 8,539 11,200 11,287
--------------------------------------------------------------
Total costs of revenues 19,254 24,498 34,093
Gross Margin 10,087 6,242 4,209
Operating Expenses
Sales and marketing 3,273 3,914 5,909
Research and development 1,798 2,936 3,720
General and administrative 3,677 3,899 9,867
Interest 846 1,788 2,393
--------------------------------------------------------------
Total costs and expenses 9,594 12,537 21,889
--------------------------------------------------------------
Operating income (loss) 493 (6,295) (17,680)
Other income (loss), net 419 15 (29)
--------------------------------------------------------------
Income (loss) before income taxes 912 (6,280) (17,709)
Income tax expense 81 33 61
--------------------------------------------------------------
Net Income (Loss) $ 831 $ (6,313) $ (17,770)
==============================================================
Basic earnings (loss) per share $ .12 $ (.90) $ (2.53)
==============================================================
Basic weighted-average shares 7,026,232 7,026,232 7,025,064
Diluted earnings (loss) per share $ .11 $ (.90) $ (2.53)
==============================================================
Diluted weighted-average shares 7,317,437 7,026,232 7,025,064
See accompanying notes.
33
SCAN-OPTICS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF
STOCKHOLDERS' EQUITY
Accumulated Accumulated
Capital in Retained- Other
Common Stock Excess of Earnings Comprehensive Treasury
------------------- Par Value Deficit Income (Loss) Stock Total
(thousands, except share data) Shares Amount
- -------------------------------- ---------------------- --------------- --------------- ------------- --------------- -----------
Balance January 1, 2000 7,396,232$ 148 $ 35,568 $ (10,415) $ (574) $ (2,646) $ 22,081
Issuance of common stock
upon exercise of stock options 43,500 1 86 87
Net loss (17,770) (17,770)
Currency
translation
adjustments (91) (91)
------------
Comprehensive loss (17,861)
- -------------------------------- ---------------------- -------------- ------------------ ------------- --------------- ------------
Balance December 31, 2000 7,439,732$ 149 35,654 (28,185) (665) (2,646) 4,307
Issuance of common stock
warrants 2,700 2,700
Net loss (6,313) (6,313)
Currency translation
adjustments (334) (334)
------------
Comprehensive loss (6,647)
- -------------------------------- ---------------------- -------------- ------------------ ------------- --------------- ------------
Balance December 31, 2001 7,439,732$ 149 38,354 (34,498) (999) (2,646) 360
Net income 831 831
Currency translation
adjustments 81 81
------------
Comprehensive income 912
- -------------------------------- ---------------------- -------------- ------------------ ------------- --------------- ------------
Balance December 31, 2002 7,439,732$ 149 $ 38,354 $ (33,667) $ (918) $ (2,646) $ 1,272
================================ ====================== ============== ================== ============= =============== ============
See accompanying notes.
34
SCAN-OPTICS, INC., AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year Ended December 31
(thousands) 2002 2001 2000
- --------------------------------------------------------------------------------------------------------------
Operating Activities
Net income (loss) $ 831 $ (6,313) $(17,770)
Adjustments to reconcile net income (loss) to net cash
provided (used) by operating activities:
Depreciation 425 677 887
Amortization of customer service inventory and
Software license 2,355 2,886 2,400
Amortization of goodwill 1,326 1,308
Provision for losses on accounts receivable 35 5,505
Provision for inventory obsolescence 50 178 1,064
Reversal of previously recorded liabilities (369)
Changes in operating
assets and liabilities:
Accounts receivable (668) 6,507 8,032
Refundable income taxes 124 1,158
Recoverable income taxes 740
Inventories (2,634) (1,873) (1,578)
Prepaid expenses and other (87) 465 537
Software license (174)
Accounts payable (639) (2,604) (2,013)
Accrued salaries and wages (422) 526 (946)
Taxes other than income taxes (23) 131 (717)
Income taxes 40 (116) 121
Deferred revenue 116 24 471
Customer deposits 801 (705) (141)
Other 21 (330) 371
----------------------------------------------
Net cash provided (used) by operating activities (168) 903 (745)
Investing Activities
Acquisition related settlement 209 400
Proceeds from the sale of plant and equipment 35 215
Purchases of plant and equipment, net (114) (64) (122)
----------------------------------------------
Net cash provided by investing activities 130 336 93
Financing Activities
Proceeds from issuance of common stock 87
Proceeds from borrowings 4,376 3,485 25,686
Principal payments on borrowings (5,726) (3,098) (25,123)
----------------------------------------------
Net cash provided (used) by financing activities (1,350) 387 650
Increase (decrease) in cash and cash equivalents (1,388) 1,626 (2)
Cash and Cash Equivalents at Beginning of Year 1,662 36 38
---------------------------------------------
Cash and Cash Equivalents at End of Year $ 274 $ 1,662 $ 36
=============================================
Supplemental Cash Flow Information
Interest paid $ 667 $ 1,579 $ 2,301
=============================================
Income taxes paid $ 44 $ 61 $ 8
=============================================
See accompanying notes
35
SCAN-OPTICS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE A - DESCRIPTION OF BUSINESS
The Company combines technology, experience and expertise to develop
cost-effective solutions for applications that include government, insurance,
assessment, 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's sales organization or through
distributors. The Company also markets with system integrators and specialized
niche suppliers. 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.
NOTE B - ACCOUNTING POLICIES
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.
Goodwill: Goodwill consists of the excess of cost over the fair value of
identifiable net assets of businesses acquired and were amortized on a
straight-line basis over five to twenty years. Beginning January 1, 2002,
goodwill is no longer amortized, but is tested on at least an annual basis for
impairment, see Note C.
36
Long-Lived Assets: Long-lived assets are recorded at the lower of amortized cost
or fair value. As part of an ongoing review of the valuation of long-lived
assets, the Company assesses the carrying value of such assets if facts and
circumstances suggest they may be impaired. If this review indicates that the
carrying value of these assets may not be recoverable, as determined by
nondiscounted cash flow analysis over the remaining useful life, the carrying
value would be reduced to its estimated fair value. There have been no material
impairments recognized in these financial statements. Software license acquired
in 1999 was amortized on a straight-line basis over 3 years.
Fair Value of Financial Instruments: The carrying amounts reported in the
balance sheets for accounts receivable, accounts payable, and accrued expenses
and other liabilities approximate fair value due to the immediate to short-term
maturity of these financial instruments. The fair values of the revolving credit
facility and term loan, are determined using current interest rates for similar
instruments as of December 31, 2002 and 2001 and approximate the carrying value
of these financial instruments.
Revenue Recognition: Revenues relating to sales of certain equipment
(principally optical character recognition equipment) are recognized upon
acceptance, shipment, or installation depending on the contract terms and
conditions. When customers, under the terms of specific orders or contracts,
request that the Company manufacture and invoice the equipment on a bill and
hold basis, the Company recognizes revenue based upon an acceptance test that is
certified by the customer.
Revenues under systems integration and professional services contracts are
recognized on the basis of the ratio of earned revenue to total contract price,
after considering accumulated costs and estimated costs to complete each
contract or when services have been performed and accepted, depending on the
nature of the project. Under fixed price contracts, the Company may encounter,
and on certain contracts, in prior years, has encountered, cost overruns caused
by project management problems and the expense of hiring outside contractors to
assist in project completions, as well as changes to previously agreed upon
project designs. Adjustments to contract cost estimates are made in the periods
in which the facts requiring such revisions become known. When the estimates
indicate a loss, such loss is provided for when identified.
Revenues from maintenance services are recognized as earned.
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. A valuation allowance for deferred tax assets is recorded to the extent
the Company cannot determine that the ultimate realization of net deferred tax
assets is more likely than not. In making such determination, the Company may
consider estimated future reversals of existing temporary differences, estimated
future earnings and available tax planning strategies. To the extent that the
estimates of these items are reduced or not realized, the amount of the deferred
tax assets considered realizable could be adversely affected.
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.
37
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.
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. Options for senior management
that were granted on December 31, 2001 as part of the total debt restructuring
are exercisable six months after the date of grant. The Company's pro-forma
information follows:
December 31
(thousands, except per share amounts) 2002 2001 2000
- --------------------------------------------------------------------------------------------------
Net income (loss), as reported $ 831 $ (6,313) $ (17,770)
Stock option expense (199) (134) (51)
------------------------------------------
Pro forma net income (loss) $ 632 $ (6,447) $ (17,821)
==========================================
Basic earnings (loss) per share, as reported $ .12 $ (.90) $ (2.53)
Stock option expense (.03) (.02) (.01)
Pro forma basic earnings (loss) per share $ .09 $ (.92) $ (2.54)
==========================================
Diluted earnings (loss) per share, as reported $ .11 $ (.90) $ (2.53)
Stock option expense (.03) (.02) (.01)
Pro forma diluted earnings (loss) per share $ .08 $ (.92) $ (2.54)
==========================================
The weighted-average fair value of options granted was $.34, $.24 and $.46
during 2002, 2001, and 2000, respectively. The weighted-average remaining
contractual life of the options outstanding at December 31, 2002 was 7 years.
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 1.39.
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.
Earnings (Loss) Per Share: Basic and diluted earnings (loss) per share is
calculated in accordance with FASB Statement No. 128, Earnings Per Share. For
2001 and 2000, the effect of stock options was antidilutive, therefore, the
amounts reported for basic and diluted earnings (loss) per share were the same.
38
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
operations 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 2001 and 2000 amounts have been reclassified to
conform to the current year presentation.
New Accounting Pronouncements:
The Company adopted the Financial Accounting Standards Board ("FASB") Statement
of Financial Accounting Standards ("SFAS") No. 142, "Goodwill and Other
Intangible Assets". effective January 1, 2002. This standard addresses financial
accounting and reporting for acquired goodwill and other intangible assets and
supercedes APB Opinion No. 17, "Intangible Assets". Under this standard,
goodwill and other intangible assets deemed to have indefinite lives are no
longer amortized but are subject to annual impairment tests on a reporting unit
level. Other intangible assets are being amortized over their estimated useful
lives.
In August 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets". This standard addresses financial accounting and
reporting for the impairment or disposal of long-lived assets and supercedes
SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to Be Disposed of". The Company adopted this standard on
January 1, 2002 and such adoption did not have an impact on its consolidated
financial position or results of operations.
In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements No.
4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections".
This standard rescinds SFAS No. 4, "Reporting Gains and Losses from
Extinguishment of Debt", and an amendment of that Statement, SFAS No. 64,
"Extinguishments of Debt Made to Satisfy Sinking-Fund Requirements". This
standard amends SFAS No. 13, "Accounting for Leases", to eliminate an
inconsistency related to the required accounting for sale-leaseback transactions
and certain lease modifications. This standard also amends other existing
authoritative pronouncements to make various technical corrections, clarify
meanings, or describe their applicability under changed conditions. The Company
will adopt this standard on January 1, 2003, and such adoption is not expected
to have an impact on its consolidated financial position or results of
operations.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated
with Exit or Disposal Activities". This standard addresses financial accounting
and reporting for costs associated with exit or disposal activities and requires
companies to recognize costs associated with exit or disposal activities when
they are incurred rather than at the date of a commitment to an exit or disposal
plan. This standard nullifies EITF Issue No. 94-3, "Liability Recognition for
Certain Employee Termination Benefits and Other Costs to Exit an Activity
(including Certain Costs Incurred in a Restructuring)". Adoption of this
standard beginning in the first quarter of 2003 is expected to impact the timing
of the recognition of the costs associated with future exit or disposal
activities, if any.
39
In November 2002, the FASB issued Interpretation No. 45, "Guarantor's Accounting
and Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others". This interpretation requires certain guarantees to be
initially recognized and recorded at fair value and also requires new
disclosures related to guarantees even if the likelihood of a guarantor having
to make payments under the guarantees is remote. The Company adopted this
interpretation as of December 31, 2002 and such adoption did not have an impact
on the Company's consolidated financial position, results of operations or on
disclosures in the financial statements.
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation--Transition and Disclosure". This standard provides alternative
methods of transition of the fair value method of accounting for stock-based
employee compensation under SFAS No. 123, "Accounting for Stock-Based
Compensation," but does not require the Company to use the fair value method.
This standard also amends certain disclosure requirements related to stock-based
employee compensation. The Company adopted the additional disclosure required of
this standard as of December 31, 2002.
NOTE C- Acquisition Activities
During June 1999, the Company completed the acquisition of the product rights
and certain assets of the Photomatrix Imaging Corporation's subsidiary of
Photomatrix, Inc. for $2.1 million in cash. The Company acquired accounts
receivable of $1 million, manufacturing and customer service inventory of $1.2
million and other assets of $.1 million. The Company also assumed liabilities
for accounts payable of $.8 million, deferred revenue of $.5 million, salary and
benefits accruals of $.2 million and acquisition related expenses of $.3
million. The acquisition was accounted for as a purchase and the operations are
included in the consolidated statement of operations from the date of
acquisition. The Company recorded goodwill related to the transaction of $1.6
million. Subsequent to the acquisition date, adjustments of $.8 million have
been made to decrease goodwill to $.8 million.
On June 19, 2001 the Company reached a settlement with the former owners of
Southern Computer Systems (SCS) regarding certain disputes that arose under
their original stock purchase agreement executed in June 1998 pursuant to which
Scan-Optics acquired 100% of the equity in SCS. As part of the stock purchase
agreement, Scan-Optics was required to make certain payments to the former
owners of SCS in connection with a consulting and non-compete agreement. The
stock purchase agreement also required the deposit of funds in a representation
and warranty general escrow, which funds were to be released to the former
owners of SCS on the second anniversary following the date of purchase. The
settlement provided for the release of all claims made by Scan-Optics relating
to the former owners' representations and warranties and the release of all
claims made by the former owners against Scan-Optics. In exchange for this
release, the former owners forgave $.5 million due under the consulting and
non-compete agreements and made a cash payment from the general escrow account
of $.4 million to Scan-Optics. The forgiveness of the $.5 million for the
consulting and non-compete retainer was recorded as a reduction in Scan-Optics'
general and administrative expense in the second quarter of 2001. The $.4
million payment from the general escrow account was accounted for as an
adjustment of the original purchase price through a decrease in goodwill.
40
NOTE D - UNBILLED RECEIVABLES - CONTRACTS IN PROGRESS
Unbilled amounts in accounts receivable under contracts in progress were $.4
million and $.9 million at December 31, 2002 and 2001, respectively, and are
recoverable from the customer upon completion of the phase or milestone. The
Company estimates that substantially all unbilled amounts will be collected in
2003.
NOTE E- INVENTORIES
The components of inventories were as follows:
December 31
(thousands) 2002 2001
- -------------------------------------------------------------------------------
Finished goods $ 56 $ 199
Work-in-process 1,325 1,604
Service parts 3,715 3,941
Materials and component parts 4,043 2,799
-------------------------
$ 9,139 $ 8,543
=========================
NOTE F - CREDIT ARRANGEMENTS
Notes payable reflect borrowings under a credit agreement ("Agreement") with
Patriarch Partners, LLC. ("Patriarch"). The Agreement allows for borrowings
under a revolving line of credit facility of $10 million and a term loan of $2
million.
Effective December 31, 2001, the Company restructured its loan agreements with
Patriarch, which included the following terms:
o The maturity date of the Agreement with Patriarch was 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 ($2 million outstanding at December 31, 2002 and 2001) 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 allows for 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.
41
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 2003, the Company must
issue to Patriarch additional shares representing 15% of the Company's
common stock. This amount increases to 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.
o All monthly lease payments owed to Patriarch have been deferred and become
due on December 31, 2004. The lease obligation that accrues on a monthly
basis will be added to the term loan.
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 as of December 31, 2001 was
reduced by $6.5 million and warrants to purchase common stock of $2.7 million
were recorded as paid in capital and preferred stock of $3.8 million was
recorded, accordingly, no gain resulted from the transaction.
As of December 31, 2002, the Company executed an amendment to the loan with
Patriarch to modify the capital expenditure covenant, from a maximum of $50,000
per quarter, to a maximum of $375,000 per year.
At December 31, 2002, the Company had $10.5 million in outstanding borrowings.
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, 2002 outstanding balance through fiscal
year 2003. The available balance on the outstanding borrowings was $1.5 million
and $.9 million at December 31, 2002 and December 31, 2001, respectively. The
weighted average interest rate on borrowings during 2002 and 2001 was 5.5% and
9.8%, respectively.
The carrying value of the notes payable to bank approximates its fair value and
is secured by all of the Company's assets.
42
NOTE G- 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. As of December 31, 2002
and 2001, 3,800,000 shares of mandatory redeemable preferred stock are
outstanding. These shares do not contain voting rights until the warrants issued
to Patriarch are exercised.
At December 31, 2002, the Company had reserved 2,852,955 shares of common stock
for the issuance or exercise of stock options. The Company has also reserved
4,975,000 shares of common stock, as part of the total debt restructuring, for
the exercise of warrants. (See Note F.)
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, 2002 and 2001.
NOTE H - 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 six 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 and Executive Compensation Committee shall determine.
Options for senior management that were granted on December 31, 2001 as part of
the total debt restructuring are not exercisable until six months after the
grant thereof. Options for Directors are also 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 and
Executive Compensation Committee under all stock option plans.
43
The following schedule summarizes the changes in stock options for each of the
three years in the period ended December 31, 2002:
Number of Option Price
Shares Per Share
- ------------------------------------------------------------------------------------------------
Outstanding January 1, 2000 (560,457 exercisable) 754,983 $1.50 to $9.19
Granted 561,700 .31 to 1.06
Surrendered (42,500) 6.38 to 9.19
Exercised (43,500) 2.00 to 2.00
Canceled (108,550) 1.06 to 5.75
-----------------------------------
Outstanding December 31, 2000 (545,245 exercisable) 1,122,133 .31 to 9.19
2001 Activity
Granted 1,145,000 .24 to .25
Canceled (69,050) .31 to 3.69
-----------------------------------
Outstanding December 31, 2001 (782,261 exercisable) 2,198,083 .24 to 9.19
2002 Activity
Granted 30,000 .34 to .34
Canceled (236,800) .24 to 9.19
-----------------------------------
Outstanding December 31, 2002 (1,869,142 exercisable) 1,991,283 $.24 to $9.19
===================================
At December 31, 2002 there were 861,672 options available for grant of which
85,000 were reserved for the Directors.
NOTE I - RESEARCH AND DEVELOPMENT AGREEMENTS
During 2002, 2001 and 2000, the Company completed a number of small custom
development contracts for specific customers resulting in revenue of
approximately $43,000, $110,000 and $200,000, respectively. These revenues
offset the related costs incurred for this development. The ownership of these
technologies remains with the Company. No royalties or other considerations are
required as part of these agreements.
NOTE J - 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. Starting in 1997,
the Company contributed an amount equal to 50% of the first 6% contributed by
the participant and in 2001, the employer match was increased to 67% of the
first 6%. The Company's contributions to this plan were $346,000, $254,000 and
$306,000, in 2002, 2001 and 2000, respectively.
44
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. The Company
did not allocate any additional shares to the Plan in 2002, 2001 or 2000. At
December 31, 1998, all shares had been allocated. The Company, at its
discretion, may make annual allocations to the Plan in the future. There were no
expenses related to the Plan in 2002, 2001 and 2000.
NOTE K - INCOME TAXES
At December 31, 2002 the Company has U.S. federal and state operating loss
carryforwards of approximately $ 27,200,000 and $26,000,000, respectively. At
December 31, 2001, the Company has U.S. federal and state operating loss
carryforwards of approximately $25,140,000 and $27,630,000, respectively. The
U.S. federal and state net operating loss carryforwards expire through 2015. At
December 31, 2002, the Company has approximately $226,000, $3,400,000 and
$800,000 of net operating loss carryforwards for Canada, the United Kingdom and
Germany, respectively. At December 31, 2001, the Company has approximately
$400,000, $3,500,000 and $800,000 of net operating loss carryforwards for
Canada, the United Kingdom and Germany, respectively, which begin to expire in
2003 through 2009. For financial reporting purposes, a valuation allowance has
been recorded for 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.
Income (loss) before income taxes is set forth in the following tabulation:
Year Ended December 31
(thousands) 2002 2001 2000
- -----------------------------------------------------------------------------------------
Domestic $ 700 $(6,270) $ (17,436)
Foreign 212 (10) (273)
----------------------------------------------
Income (loss) before income taxes $ 912 $(6,280) $ (17,709)
==============================================
Income taxes are summarized as follows:
Year Ended December 31
(thousands) 2002 2001 2000
- -----------------------------------------------------------------------------------------
Current :
State $ 80 $ 28 $ 49
Foreign 1 5 12
------------------------------------------------
Total current $ 81 $ 33 $ 61
Deferred
- -----------------------------------------------------------------------------------------
Total $ 81 $ 33 $ 61
=========================================================================================
45
Significant components of the Company's deferred tax liabilities and assets were
as follows:
December 31
(thousands) 2002 2001
- -------------------------------------------------------------------------------------
Deferred tax assets:
Net operating loss carryforward $12,005 $ 8,557
Alternative minimum tax credit carryforward 168 168
Depreciation 92 92
Charitable contribution carryforward 37
Inventory 673 914
Accounts receivable allowance 538 669
Goodwill 119 604
Vacation accrual 172 209
Other 155 157
Total gross deferred tax assets 13,922 11,407
Deferred tax liabilities:
Depreciation and other (306) (359)
---------------------------
Total gross deferred tax liabilities (306) (359)
Valuation allowance (13,616) (11,048)
---------------------------
Net deferred tax asset $ - $ -
===========================
A reconciliation of the statutory tax rate to the effective rate is as follows:
Year Ended December 31
2002 2001 2000
- ----------------------------------------------------------------------------------------
Statutory federal income tax rate 34% (34)% (34)%
State income taxes, net of federal benefit 9 .44 .3
Foreign income taxes .1
Valuation allowance (34) 34 34
Other .09
--------------------------
Effective tax rate 9% .53% .4%
==========================
46
NOTE L - LEASE COMMITMENTS
The Company's principal lease commitment is for its corporate office and
manufacturing facility in Manchester, Connecticut. The Manchester lease expires
on December 31, 2006. The capital lease relates to a new phone system and
photocopiers. Minimum rental payments for all noncancelable leases, with terms
equal to or in excess of one year as of December 31, 2002, are as follows:
(thousands) Operating Leases Capital Lease
- -------------------------------------------------------------------------------------------------------
2003 $ 646 $ 74
2004 441 74
2005 443 74
2006 443 74
2007 52 65
Thereafter 312
--------------------------------------
Total minimum lease payments $ 2,337 361
========
Amounts representing interest (81)
--------
Present value of net minimum lease payments $ 280
========
Rental expense for the years ended December 31, 2002, 2001, and 2000 was
$681,000, $718,000 and $1,114,000, respectively.
Long term capital leases are recorded in other long term liabilities on the
balance sheet.
NOTE M - CONTINGENCIES
There are two lawsuits currently pending against the Company. Although the
ultimate outcome is uncertain, based on currently known facts, the Company
believes that it has strong defenses against both lawsuits and the resolution of
these matters will not have a material adverse effect on the Company's financial
position or annual operating results.
47
NOTE N - SEGMENT INFORMATION
The Company views its business in three distinct operating segments: Solutions
and Products, 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.
Year Ended December 31
(thousands) 2002 2001 2000
- ----------------------------------------------------------------------------------------------------------------------
Revenues
Solutions and products $ 16,376 $ 16,667 $ 23,295
Access services 11,499 13,193 12,669
Contract manufacturing services 1,466 880 2,338
----------------------------------------------------------------
Total revenues 29,341 30,740 38,302
Cost of solutions and products 10,715 13,298 22,806
Service expenses 8,539 11,200 11,287
----------------------------------------------------------------
Gross profit margin 10,087 6,242 4,209
Operating expenses, net 9,175 12,522 21,918
-----------------------------------------------------------------
Income (loss) before income taxes $ 912 $ (6,280) $ (17,709)
=================================================================
Total assets $ 26,406 $ 27,380 $ 36,513
Total expenditures for additions to long-lived
assets $ 79 $ 121 $ 109
Certain 2001 and 2000 amounts have been reclassified to conform to the current
year presentation.
The Solutions and Products Division includes the sale of hardware and software
products as well as professional services. Contract Manufacturing Services
provides assembly and test services under contracts with customers who develop
and sell a variety of equipment.
Note: In 2002 and 2001, no customers accounted for more than 10% of total
revenue. In 2000, the Company derived 13% of its total revenue from one
customer, Toyo Officemation, Inc., one of the Company's distributors in Japan.
48
The Company has international distributors located in 13 countries and covering
six continents. All international sales other than sales originating from the UK
and Canadian subsidiaries are denominated in United States dollars. 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) 2002 2001 2000
- --------------------------------------------------------------------------------------------
Latin America $ 72 24% $ 152 3% $ 152 2%
Europe 149 49% 3,706 73% 1,667 22%
Pacific Rim 81 27% 1,220 24% 5,881 76%
------------------------------------------------------------------
$ 302 $ 5,078 $ 7,700
==================================================================
Export sales represented 3%, 45%, and 43% of hardware and software revenues for
the three years ended December 31, 2002, 2001, and 2000, respectively.
NOTE O - BILL AND HOLD TRANSACTIONS
Revenues relating to sales of certain equipment (principally optical character
recognition equipment) are recognized upon acceptance, shipment, or installation
depending on the contract specifications. When customers, under the terms of
specific orders or contracts, request that the Company manufacture and invoice
the equipment on a bill and hold basis, the Company recognizes revenue based
upon an acceptance test that is certified by the customer. Revenues recorded
during 2002, 2001, and 2000 included bill and hold transactions of $1.3 million,
$.1 million and $1.7 million, respectively. Accounts receivable included bill
and hold receivables of $1.1 million, $.1 million and $.4 million at December
31, 2002, 2001 and 2000, respectively.
49
NOTE P - EARNINGS PER SHARE
The following table sets forth the computation of basic and diluted earnings
(loss) per share:
December 31
(thousands, except share data) 2002 2001 2000
- --------------------------------------------------------------------------------------------------
Numerator:
Net earnings (loss) $ 831 $ (6,313) $ (17,770)
================================================
Denominator:
Denominator for basic earnings (loss)
per share (weighted-average shares) 7,026,232 7,026,232 7,025,064
Effect of dilutive securities:
Employee stock options 291,205
Denominator for diluted earnings (loss)
per share (adjusted weighted-average
------------------------------------------------
shares and assumed conversions) 7,317,437 7,026,232 7,025,064
Basic earnings (loss) per share $ .12 $ (.90) $ (2.53)
================================================
Diluted earnings (loss) per share $ .11 $ (.90) $ (2.53)
================================================
For 2001 and 2000, the effect of stock options was antidilutive, therefore, the
amounts reported for basic and diluted earnings (loss) per share were the same.
50
NOTE Q - QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
The following is a summary of the quarterly results of operations for the years
ended December 31, 2002 and 2001.
(thousands, except per share amounts) March June September December
- --------------------------------------------------------------------------------------------------------------
2002
Revenues $ 7,824 $ 7,842 $ 7,242 $ 6,433
Cost of product sales and service expenses 5,065 5,143 4,718 4,328
Net income 166 218 220 227
Basic earnings per share .02 .03 .03 .03
Diluted earnings per share $ .02 $ .03 $ .03 $ .03
2001
Revenues $ 10,908 $ 6,991 $ 5,586 $ 7,255
Cost of product sales and service expenses 8,336 5,338 4,547 6,277
Net loss (664) (940) (1,809) (2,900)
Basic loss per share (.09) (.13) (.26) (.41)
Diluted loss per share $ (.09) $ (.13) $ (.26) $ (.41)
Fourth quarter 2002 net income of $.2 million includes other income of $.4
million or $.05 per share resulting from a reduction of certain amounts
previously recorded as liabilities that were no longer due or have been settled
for amounts less than previously recorded.
Third quarter 2002 net income of $.2 million includes a negotiated reduction of
$.3 million or $.04 per share. This reduction in the final payment due Bluebird
Systems for the 1999 purchase of the Docwise source code license resulted in the
reduction of previously recorded research and development amortization expense.
Fourth quarter 2001 net loss of $2.9 million includes charges to expense of $1.5
million or $.21 per share. The major components of these charges include $.4
million of inventory reserves related to obsolete parts, $.2 million of
additional amortization of Access Services parts inventory, $.2 million of
accrued severance costs, $.3 million of accrued lease expense and $.4 million of
a management stay bonus.
51
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 June 12, 2003 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 June 12, 2003 and is incorporated
herein by reference.
52
ITEM 12 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
- ------------------------------------------------------------------------
RELATED STOCKHOLDER MATTERS
- ---------------------------
For information with respect to the security ownership of the Directors and
Executive Officers and related stockholders matters, see the Proxy Statement for
the Company's 2003 Annual Meeting of Shareholders filed pursuant to Regulation
14A, which is incorporated by reference herein. The Company has six equity
compensation plans as of December 31, 2002. See Note H to the Notes to
Consolidated Financial Statements of the Company included in this report for
additional information regarding these plans. The following table gives
information about the Company's equity compensation plans as of December 31,
2002.
Number of shares of Common
Stock remaining available
Number of shares of for future issuance under
Common Stock to be Weighted -average equity compensation plans
issued upon exercise of exercise price of (excluding shares
outstanding options, outstanding options, reflected in the first
Plan Category warrants and rights warrants and rights column)
- ------------------------------------------------------------------------------------------------------------------------------
Equity compensation plans approved by
stockholders 966,283 $ 2,472,445 861,672
Equity compensation plans not
approved by stockholders:
Senior management options 1,025,000 246,000
Debt restructuring warrants 4,975,000 2,700,000
--------------------------------------------------------------------------------
6,966,283 $ 5,418,445 861,672
================================================================================
Equity compensation plans not approved by stockholders include options for
senior management and warrants issued to Patriarch, which were both part of the
total debt restructuring. Options for senior management that were granted on
December 31, 2001 were not exercisable until six months after the grant thereof.
See Note H to the Notes to Consolidated Financial Statements of the Company
included in this report for additional information. 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. See Note F to the Notes
to Consolidated Financial Statements of the Company included in this report for
additional information.
53
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 June 12, 2003 and is incorporated herein by reference.
ITEM 14 - 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 Annual
Report on Form 10-K. 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.
54
PART IV
ITEM 15 - 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, 2002 and 2001
Consolidated Statements of Operations for the years ended
December 31, 2002, 2001 and 2000
Consolidated Statements of Stockholders' Equity for the
years ended December 31, 2002, 2001 and 2000
Consolidated Statements of Cash Flows for the years ended
December 31, 2002, 2001 and 2000
Notes to Consolidated Financial Statements -
December 31, 2002
(2) The following consolidated financial statement schedule is
included in Item 15(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.
55
*3.2 Restated By-laws of the Company, as amended is
filed as Exhibit 3.2 in the Company's Annual
Report on Form 10-K filed for the year ended
December 31, 2002.
*+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 The Scan-Optics, Inc. 1990 Incentive and
Non-Qualified Stock Option Plan amendment included
as Item 2 in the Company's Proxy Statement dated
April 14, 1994 for the Annual Meeting of
Stockholders held on May 18, 1994.
*+10.7 The Scan-Optics, Inc. 1990 Stock Option Plan for
Outside Directors amendment included as Item 2 in
the Company's Proxy Statement dated April 15, 1996
for the Annual Meeting of Stockholders held on May
15, 1996.
*+10.8 The Scan-Optics, Inc. 1999 Incentive and
Non-Qualified Stock Option Plan included in
Exhibit A in the Company's Proxy Statement dated
April 8, 1999 for the Annual Meeting of
Stockholders held on May 20, 1999.
*+10.9 Employment agreement, effective as of December 31,
1996, between Scan-Optics, Inc. and James C.
Mavel, included as Exhibit 10.10 in the Company's
Annual Report on Form 10-K filed for the year
ended December 31, 1996.
*+10.10 Executive severance agreement between Joseph P.
Crouch and Scan-Optics, Inc. dated November 15,
1999, is filed as Exhibit 10.10 in the Company's
Annual Report on Form 10-K filed for the year
ended December 31, 1999.
*+10.12 Executive severance agreement between Richard C.
Goyette and Scan-Optics, Inc. dated November 17,
1997, is filed as Exhibit 10.12 in the Company's
Annual Report on Form 10-K filed for the year
ended December 31, 1999.
*+10.13 Executive severance agreement between Joel K.
Howser and Scan-Optics, Inc. dated November 17,
1997, is filed as Exhibit 10.13 in the Company's
Annual Report on Form 10-K filed for the year
ended December 31, 1999.
56
*+10.14 Executive severance agreement between Clarence W.
Rife and Scan-Optics, Inc. dated November 17,
1997, is filed as Exhibit 10.14 in the Company's
Annual Report on Form 10-K filed for the year
ended December 31, 1999.
*+10.15 Executive severance agreement between Michael J.
Villano and Scan-Optics, Inc. dated November 17,
1997, is filed as Exhibit 10.15 in the Company's
Annual Report on Form 10-K filed for the year
ended December 31, 1999.
*+10.16 Executive severance agreement between Alan W. Ware
and Scan-Optics, Inc. dated May 22, 2001, is filed
as Exhibit 10.16 in the Company's Quarterly Report
on Form 10-Q filed for the quarter ended June 30,
2001.
*10.17 Certificate of Designations, Preferences, Rights
and Restrictions for Series A Redeemable Preferred
Stock dated December 31, 2001, is filed as Exhibit
3.3 in the Company's Registration Statement on
Form S-8 (No. 333-83598), filed on March 1, 2002.
*10.18 Warrant to Purchase Shares of Common Stock of
Scan-Optics, Inc. dated December 31, 2001, is
filed as Exhibit 10.18 in the Company's Annual
Report on Form 10-K filed for the year ended
December 31, 2001.
*10.19 Fourth Amendment Agreement dated as of December
31, 2001 between ARK CLO 2000-1, Limited and
Scan-Optics, Inc. and prior loan agreements, is
filed as Exhibit 10.19 in the Company's Annual
Report on Form 10-K filed for the year ended
December 31, 2001.
10.20 Fifth Amendment Agreement dated as of December 31,
2002 between ARK CLO 2000-1, Limited and
Scan-Optics, Inc. and prior loan agreements, is
filed as Exhibit 10.20 in the Company's Annual
Report on Form 10-K filed for the year ended
December 31, 2002.
*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,
1999.
23. Consent of Independent Auditors.
99.1 Certification of Chief Executive Officer pursuant
to Section 906 of the Sabanes-Oxley Act.
99.2 Certification of Chief Financial Officer pursuant
to Section 906 of the Sabanes-Oxley Act.
* Exhibits so marked have heretofore been filed by the Company with the
Securities and Exchange Commission and are incorporated herein by reference.
57
+ 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, 2002.
(c) Exhibits
------------
The exhibits required by this item are included herein.
(d) Financial Statement Schedule
--------------------------------------
The response to this portion of Item 15 is submitted as a
separate section of this report.
58
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 and
President
Date: March 26, 2003
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 and President
(Principal Executive Officer)
Date: March 26, 2003
/ss/
- ----------------------
Michael J. Villano Chief Financial Officer, Vice President and
Treasurer
(Principal Financial and Accounting Officer)
Date: March 26, 2003
/ss/
- ----------------------
Logan Clarke, Jr. Director March 26, 2003
/ss/
- ----------------------
Richard J. Coburn Director March 26, 2003
/ss/
- ----------------------
E. Bulkeley Griswold Director March 26, 2003
/ss/
- ----------------------
Lyman C. Hamilton, J Director March 26, 2003
/ss/
- ----------------------
John J. Holton Director March 26, 2003
/ss/
- ----------------------
Robert H. Steele Director March 26, 2003
A majority of the Directors
59
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 annual report on Form 10-K of Scan-Optics,
Inc.;
2. Based on my knowledge, this annual 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
annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual 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 annual 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 annual 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 annual report (the "Evaluation Date"); and
c) Presented in this annual 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
60
6. The registrant's other certifying officers and I have indicated in
this annual report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: March 26, 2003
________/ ss_/____________________
James C. Mavel
Chairman, Chief Executive Officer
and President
61
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 annual report on Form 10-K of Scan-Optics,
Inc.;
2. Based on my knowledge, this annual 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
annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual 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 annual 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 annual 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 annual report (the "Evaluation Date"); and
c) Presented in this annual 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 annual report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: March 26, 2003
_______/ ss /_____________________
Michael J. Villano
Chief Financial Officer, Vice President
and Treasurer
62
SCHEDULE II
SCAN-OPTICS, INC. AND SUBSIDIARIES
VALUATION AND QUALIFYING ACCOUNTS
THREE YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
(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 Period
- ------------------------------------------------------------------------------------------------------------------------------------
Year ended December 31, 2002 $ 1,936 $ 35 $ 397(1) $ 1,574
Allowance for doubtful
accounts
(billed and unbilled)
Year ended December 31, 2001: $ 5,615 $ 93 $ 3,772(1) $ 1,936
Allowance for doubtful accounts
(billed and unbilled)
Year ended December 31, 2000: $ 308 $ 5,505 $ 13 (2) $ 211 (1) $ 5,615
Allowance for doubtful accounts
(billed and unbilled)
(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 K.
63