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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
( X ) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2003
-----------------------------------------
OR
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from to
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Commission File No. 0-5265
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SCAN-OPTICS, INC.
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(Exact name of registrant as specified in its charter)
Delaware 06-0851857
-------------------------------- ---------------------------------------
(State or other jurisdiction of (I.R.S. Employer Identification Number)
incorporation or organization)
169 Progress Drive, Manchester, CT 06040
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(Address of principal executive offices) Zip Code
(860) 645-7878
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(Registrant's telephone number, including area code)
Indicate by check mark whether the Registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. ( X ) YES ( ) NO
Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). ( ) YES ( X ) NO
1
Indicate by check mark whether the Registrant has filed all documents and
reports required to be filed by Section 12, 13 or 15(d) of the Securities
Exchange Act of 1934 subsequent to the distribution of securities under a plan
confirmed by a court.
( X ) YES ( ) NO
The number of shares of common stock, $.02 par value, outstanding as of July 31,
2003 was 7,439,732.
2
SCAN-OPTICS, INC.
FORM 10-Q
I N D E X
PAGE
NO.
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements............................................................... 4
Item 2. Management's Discussion and Analysis of Consolidated Financial
Condition and Results of Operations................................................ 14
Item 3. Quantitative and Qualitative Disclosures About Market Risk ........................ 18
Item 4. Controls and Procedures............................................................ 18
PART II - OTHER INFORMATION
Item 4. Submission of Matters to a Vote of Security Holders................................ 20
Item 6. Exhibits and Reports on Form 8-K................................................... 21
3
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements.
SCAN-OPTICS, INC., AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(thousands, except share data) June 30, 2003 December 31, 2002
- ---------------------------------------------------------------------------------------------
(UNAUDITED)
Assets
Current Assets:
Cash and cash equivalents $ 734 $ 274
Accounts receivable less allowance of $1,080 at
June 30, 2003 and $1,574 at December 31, 2002 7,828 5,554
Unbilled receivables - contracts in progress 313 377
Inventories 8,686 9,139
Prepaid expenses and other 479 591
-------------------------
Total current assets 18,040 15,935
Plant and equipment:
Equipment 8,911 8,836
Leasehold improvements 5,209 5,209
Office furniture and fixtures 733 725
-------------------------
14,853 14,770
Less allowances for depreciation and amortization 13,670 13,456
-------------------------
1,183 1,314
Goodwill 9,040 9,040
Other assets 117 117
-------------------------
Total Assets $28,380 $26,406
=========================
4
(thousands, except share data) June 30, 2003 December 31, 2002
- --------------------------------------------------------------------------------------------------
(UNAUDITED)
Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable $ 2,767 $ 2,454
Notes payable to bank 1,500 1,500
Salaries and wages 1,256 958
Taxes other than income taxes 356 501
Income taxes 42 45
Customer deposits 1,485 1,308
Deferred revenues 2,518 2,217
Other 1,617 1,669
-----------------------------
Total current liabilities 11,541 10,652
Note payable 9,100 9,042
Other liabilities 2,154 1,640
Mandatory redeemable preferred stock, par value $.02
per share, authorized 3,800,000 shares;
3,800,000 issued and outstanding 3,800 3,800
Stockholders' Equity
Preferred stock, par value $.02 per share,
authorized 1,200,000 shares; none
issued or outstanding
Common stock, par value $.02 per share,
authorized 15,000,000 shares;
issued, 7,439,732 shares at June 30, 2003
and December 31, 2002 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 (33,257) (33,667)
Accumulated other comprehensive loss (815) (918)
-----------------------------
4,431 3,918
Less cost of common stock in treasury,
413,500 shares 2,646 2,646
-----------------------------
Total stockholders' equity 1,785 1,272
-----------------------------
Total Liabilities and Stockholders' Equity $ 28,380 $ 26,406
=============================
See accompanying notes.
5
SCAN-OPTICS, INC., AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
Three Months Ended Six Months Ended
June 30 June 30
(thousands, except share data) 2003 2002 2003 2002
- --------------------------------------------------------------------------------------------------
Revenues
Hardware and software $ 4,079 $ 2,889 $ 8,301 $ 6,296
Professional services 1,239 1,708 2,623 3,334
Access services 2,789 3,245 5,293 6,036
--------------------------- ---------------------------
Total revenues 8,107 7,842 16,217 15,666
Costs of Revenue
Hardware and software 2,310 2,130 4,938 4,214
Professional services 684 742 1,452 1,428
Access services 2,380 2,271 4,511 4,566
--------------------------- ---------------------------
Total costs of revenue 5,374 5,143 10,901 10,208
Gross Margin 2,733 2,699 5,316 5,458
Operating Expenses
Sales and marketing 919 815 1,847 1,665
Research and development 440 507 779 1,066
General and administrative 901 923 1,829 1,875
Interest 283 221 482 439
--------------------------- ---------------------------
Total operating expenses 2,543 2,466 4,937 5,045
--------------------------- ---------------------------
Operating income 190 233 379 413
Other income, net 44 6 61 12
--------------------------- ---------------------------
Income before income taxes 234 239 440 425
Income tax expense 20 21 30 41
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Net Income $ 214 $ 218 $ 410 $ 384
=========================== ===========================
Basic earnings per share $ 0.03 $ 0.03 $ 0.06 $ 0.05
=========================== ===========================
Basic weighted-average shares 7,026,232 7,026,232 7,026,232 7,026,232
Diluted earnings per share $ 0.03 $ 0.03 $ 0.05 $ 0.05
=========================== ===========================
Diluted weighted-average shares 7,812,441 7,308,118 7,487,598 7,357,627
See accompanying notes.
6
SCAN-OPTICS, INC., AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
Six Months Ended
June 30
(thousands) 2003 2002
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Operating Activities
Net Income $ 410 $ 384
Adjustments to reconcile net income
to net cash provided by operating activities:
Depreciation 194 209
Amortization of customer service inventory and
software license 1,023 1,374
Changes in operating assets and liabilities:
Accounts receivable and unbilled receivables (2,210) (254)
Inventories (570) (1,118)
Prepaid expenses and other 112 (65)
Accounts payable 313 (484)
Accrued salaries and wages 298 5
Taxes other than income taxes (145) (67)
Income taxes (3) 10
Deferred revenues 301 797
Customer deposits 177 77
Other 565 26
------------------------------
Net cash provided by operating activities 465 894
Investing Activities
Purchases of plant and equipment, net (63) (13)
------------------------------
Net cash used by investing activities (63) (13)
Financing Activities
Proceeds from borrowings 2,850 2,401
Principal payments on borrowings (2,792) (3,426)
------------------------------
Net cash provided (used) by financing activities 58 (1,025)
Increase (decrease) in cash and cash equivalents 460 (144)
Cash and Cash Equivalents at Beginning of Year 274 1,662
------------------------------
Cash and Cash Equivalents at End of Period $ 734 $ 1,518
==============================
See accompanying notes.
7
NOTE 1 - Basis of Presentation and Significant Accounting Policies
- ------
The accompanying unaudited consolidated financial statements have been prepared
in accordance with generally accepted accounting principles for interim
financial information and with the instructions to Form 10-Q and Article 10 of
Regulation S-X. Accordingly, they do not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, all adjustments (consisting
of normal recurring accruals) considered necessary for a fair presentation have
been included. Operating results for the six month period ended June 30, 2003
are not necessarily indicative of the results that may be expected for the year
ending December 31, 2003. For further information, refer to the consolidated
financial statements and footnotes thereto included in the Company's Annual
Report on Form 10-K for the year ended December 31, 2002.
Certain 2002 amounts have been reclassified to conform to current year
presentation.
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.
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.
In December 2002, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") 148, "Accounting for
Stock-Based Compensation--Transition and Disclosure". SFAS 148 amends the
disclosure requirements of SFAS 123 to require prominent disclosures in both
annual and interim financial statements about the method of accounting for
stock-based employee compensation and the effect of the method used on reported
results. The following table illustrates the effect on net income and income per
share if the Company had applied the fair value recognition provisions of SFAS
No. 123:
8
For the three months ended For the six months ended
June 30 June 30
(thousands, except per share amounts) 2003 2002 2003 2002
- ----------------------------------------------------------------------------------------------------------
Net income, as reported $ 214 $ 218 $ 410 $ 384
Stock option expense (25) (88) (38) (251)
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Pro forma net income $ 189 $ 130 $ 372 $ 133
============================================================
Basic earnings per share, as reported $ .03 $ .03 $ .06 $ .05
Stock option expense .00 (.01) (.01) (.04)
------------------------------------------------------------
Pro forma basic earnings per share $ .03 $ .02 $ .05 $ .01
============================================================
Diluted earnings per share, as reported $ .03 $ .03 $ .05 $ .05
Stock option expense .00 (.01) (.01) (.03)
------------------------------------------------------------
Pro forma diluted earnings per share $ .03 $ .02 $ .04 $ .02
============================================================
NOTE 2 - Inventories
- ------
The components of inventories were as follows:
June 30 December 31
(thousands) 2003 2002
- ---------------------------------------------------------------
Finished goods $ 58 $ 56
Work-in-process 1,911 1,325
Service parts 3,432 3,715
Materials and component parts 3,285 4,043
------------------------
$8,686 $9,139
========================
9
NOTE 3 - 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.
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.
The outstanding borrowings at June 30, 2003 and December 31, 2002 were $10.6
million and $10.5 million, respectively. The revolving line of credit has been
classified as long term, with the exception of $1.5 million classified as
current, since management has the ability to maintain the June 30, 2003
outstanding balance through the next fiscal year. The available balance on the
outstanding borrowings was $1.4 million and $1.5 million at June 30, 2003 and
December 31, 2002, respectively. The weighted average interest rate for the
second quarter of 2003 was 5.4% compared to 5.7% in 2002.
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. The recapture of excess cash flow for 2002
was $.4 million. Payment was made in the third quarter of 2003, which reduced
the term loan balance.
The carrying value of the notes payable to bank approximates its fair value and
is secured by all of the Company's assets.
NOTE 4 - Income Taxes
- ------
At June 30, 2003, the Company had U.S. federal and state net operating loss
carryforwards of approximately $27,700,000 and $26,450,000, respectively. The
U.S. federal and state net operating loss carryforwards expire through 2015. At
June 30, 2003, the Company had approximately $3,400,000 and $800,000 of net
operating loss carryforwards for the United Kingdom and Germany, respectively,
which expire through 2007. At December 31, 2002, the Company had U.S. federal
and state net operating loss carryforwards of approximately $27,200,000 and
$26,000,000, respectively. At December 31, 2002, the Company had approximately
$226,000, $3,400,000 and $800,000 of net operating loss carryforwards for
Canada, the United Kingdom and Germany, respectively. For financial reporting
purposes, a valuation allowance has been recorded to fully offset deferred tax
assets relating to U.S. federal, state, and foreign net operating loss
carryforwards and other temporary differences.
10
NOTE 5 - Earnings Per Share
- ------
The following table sets forth the computation of basic and diluted earnings per
share:
Three Months Ended Six Months Ended
June 30 June 30
2003 2002 2003 2002
-------------------------------------------------------------------
Numerator:
Net earnings $ 214 $ 218 $ 410 384
===================================================================
Denominator:
Denominator for basic earnings
per share (weighted-average shares) 7,026,232 7,026,232 7,026,232 7,026,232
Effect of dilutive securities:
Employee stock options 786,209 281,886 461,366 331,395
-------------------------------------------------------------------
Denominator for diluted earnings
per share (adjusted weighted-average
shares and assumed conversions) 7,812,441 7,308,118 7,487,598 7,357,627
===================================================================
Basic earnings per share $ .03 $ .03 $ .06 $ .05
===================================================================
Diluted earnings per share $ .03 $ .03 $ .05 $ .05
===================================================================
NOTE 6 - Comprehensive Income
- ------
The components of comprehensive income, net of related tax, for the three and
six months ended June 30, 2003 and 2002 are as follows:
Three Months Ended Six Months Ended
June 30 June 30
(thousands) 2003 2002 2003 2002
- --------------------------------------------------------------------------------------------
Net Income $214 $218 $410 $384
Foreign currency translation adjustments 98 73 94 54
------------------------------------------
Comprehensive income $312 $291 $504 $438
==========================================
11
The components of accumulated comprehensive loss, net of related tax, at June
30, 2003 and December 31, 2002 are as follows:
June 30 December 31
(thousands) 2003 2002
- -----------------------------------------------------------------------------------------
Foreign currency translation adjustments $ (801) $ (895)
-----------------------------------
Accumulated comprehensive loss $ (801) $ (895)
===================================
NOTE 7 - Segment Information
The Company views its business in three distinct revenue categories: Solutions
and products sales, Access services, and Contract manufacturing services.
Revenues are used by management as a guide to determine the effectiveness of the
individual segment. The Company manages its operating expenses through a
traditional functional perspective and accordingly does not report operating
expenses on a segment basis.
Three Months Ended Six Months Ended
June 30 June 30
(thousands) 2003 2002 2003 2002
- ------------------------------------------------------------------------------------------------
Revenues
Solutions and products $ 5,246 $ 4,332 $10,844 $ 8,859
Access services 2,789 3,245 5,293 6,036
Contract manufacturing services 72 265 80 771
-------------------------------------------------------
Total revenues 8,107 7,842 16,217 15,666
Cost of solutions and products 2,994 2,872 6,390 5,642
Service expenses 2,380 2,271 4,511 4,566
-------------------------------------------------------
Gross profit margin 2,733 2,699 5,316 5,458
Operating expenses
and other income, net 2,499 2,460 4,876 5,033
-------------------------------------------------------
Income before income taxes $ 234 $ 239 $ 440 $ 425
=======================================================
Total expenditures for additions
to long-lived assets $ 7 $ 7 $ 60 $ 48
Certain 2002 amounts have been reclassified to conform to the current year
presentation.
12
The Solutions and Products Division includes the sale of hardware and software
products as well as professional services. Contract Manufacturing Services
provides assembly and test services under contracts with customers who develop
and sell a variety of equipment.
NOTE 8 - Bill and Hold Transactions
- ------
Revenues relating to sales of certain equipment (principally optical character
recognition equipment) are recognized upon acceptance, shipment, or installation
depending on the contract specifications. When customers, under the terms of
specific orders or contracts, request that the Company manufacture and invoice
the equipment on a bill and hold basis, the Company recognizes revenue based
upon an acceptance received from the customer. The Company recorded $.6 million
of bill and hold revenue during the second quarter of 2003 and $2.3 million in
the first six months of 2003. At June 30, 2003, accounts receivable included
bill and hold receivables of $1.9 million. There were no bill and hold
transactions in the first six months of 2002.
13
Item 2. Management's Discussion and Analysis of Consolidated Financial
Condition and Results of Operations.
Outlook
The forward-looking statements contained in this section 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 3 to the
consolidated financial statements for further information), the Company remains
highly leveraged and could be adversely affected by a significant increase in
interest rates or an inability to comply with financial covenants in its debt
agreements. A one percent increase in the prime rate would increase the annual
interest cost on the outstanding loan balance at June 30, 2003 of approximately
$10.6 million by $.1 million. The Company's business could be adversely affected
by downturns in the domestic and international economy. The Company's
international sales and operations are subject to various international business
risks. The Company's revenues depend in part on contracts with various state or
federal governmental agencies, and could be adversely affected by patterns in
government spending. The Company faces competition from many sources, and its
products may be replaced with products relying on alternative technologies. The
Company's business could be adversely affected by technological changes.
The Company has three major initiatives currently underway to improve revenue
growth and profitability. They are designed to emphasize the "Business of
Solutions" focus in targeted markets, introduce the Business Process Outsourcing
Service and expand the Access Services Division to include enterprise-wide
maintenance services. The inability of the Company to carry out these
initiatives may have a material adverse effect on revenue growth and earnings.
The first initiative is to provide cost-effective solutions through the
Company's development of target market data capture applications combined with
its high speed transports and archival systems. The Company has refined its
target market approach and has chosen to focus primarily on the government and
insurance markets, while continuing to address the transportation, assessment,
financial and order fulfillment markets. The Company expects to continue to
emphasize its "Business of Solutions" focus on these targeted markets for the
foreseeable future. As other market opportunities emerge, the Company will
evaluate the potential of using its products and services to provide solutions
in these new markets. The Company's revenue in the solutions initiative
increased $2.5 million or 52% from the first six months of 2002 to 2003 and $1
million or 30% in a comparison of the second quarter of 2003 vs. 2002, mainly
due to an increase in the government market.
The second initiative, introduced in early 2003, is a Business Process
Outsourcing ("BPO") Service to capture images of documents for subsequent
document management, storage and retrieval. The Company's new BPO Services
provide a low-risk, cost-effective solution for
14
customers with document imaging needs. As increasing numbers of both government
and commercial clients migrate from paper-based filing systems to image-based
storage and retrieval systems, they are faced with the need to convert their
existing paper files or to outsource the activity. The BPO Services offer
customers a high quality, turnkey outsourcing solution utilizing the Company's
proprietary hardware technology, as well as its software skills, resources and
process controls.
The third initiative, by our Access Services Division, is an expansion to
include enterprise-wide maintenance services for network and network-related
equipment. Leveraging off the experience it has gained through its many third
party agreements, Access Services is well positioned to expand maintenance
coverage and provide customers with "one number to call" for maintenance
services regardless of the equipment manufacturer. Through the division's 120
technical service representatives strategically located throughout the U.S., the
Company believes that it can provide high quality, cost-effective enterprise
maintenance to its existing customer base as well as new accounts.
While the Company is principally focused on improving the profitability of its
existing operations, the Company may consider acquiring key strategic products
or enterprises. Acquisitions will be considered based upon their individual
merit and benefit to the Company.
Results of Operations for the Three and Six Months Ended June 30, 2003 vs. 2002
Total revenues increased $.6 million or 4% from the first six months of 2002 to
the first six months of 2003 and increased $.3 million or 3% from the second
quarter of 2002 to the second quarter of 2003.
Hardware and software revenues increased $2 million or 32% in the first six
months of 2003 compared with the same period in 2002 and increased $1.2 million
from the second quarter of 2002 compared to 2003. Compared to the first six
months of 2002, North American sales increased $2.1 million or 34% and increased
$1.2 million or 41% during the second quarter of 2003 compared to the second
quarter of 2002 mainly due to the increase in hardware sales to replace or
upgrade existing equipment at current customer sites. International sales
remained consistent with the first six months of 2002 and the second quarter of
2002.
Professional services revenues decreased $.7 million or 21% in the first six
months of 2003 compared with the first six months of 2002 and decreased $.5
million or 27% during the second quarter of 2003 compared to the second quarter
of 2002. These decreases relate to the difficulties selling large solution sales
in the current United States economy.
Access services revenues decreased $.7 million or 12% in the first six months of
2003 compared with the first six months of 2002 and decreased $.5 million or 14%
during the second quarter of 2003 compared to the second quarter of 2002. The
decrease in revenue is mainly due to decreases in 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
15
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 increased $.7 million or 17% in the first six
months of 2003 compared to the first six months of 2002 and increased $.2
million or 8% in the second quarter of 2003 compared to the second quarter of
2002. The gross margin was 41% for the first six months of 2003, compared to 33%
in the first six months of the prior year. The gross margin was 44% during the
second quarter of 2003, compared to 26% in the second quarter of the prior year.
The changes in gross margin are mainly due to changes in product mix and a
decline in contract manufacturing volumes.
Cost of professional services remained flat in a comparison of the first six
months of 2003 vs. 2002 and decreased $.1 million in the second quarter of 2003
compared to the prior year. The gross margin was 45% for the first six months
and the second quarter of 2003, compared to 57% in the first six months and
second quarter of 2002. The decrease in gross margin was mainly due to a decline
in new solutions sales, which is directly related to the current poor domestic
economic conditions as well as fixed costs that exist to support a higher volume
of business.
Cost of Access Services decreased $.1 million in the first six months of 2003
vs. 2002 and increased $.1 million in the second quarter of 2003 compared to the
prior year. The gross margin was 15% for the first six months of 2003, compared
to 24% in the first six months of 2002. The gross margin was 14% during the
second quarter of 2003, compared to 30% in the second quarter of the prior year.
The decrease in margin is due to decreased Access Services revenue, which was
partially offset by a decrease in expenses.
Sales and marketing expenses increased $.2 million in the first six months of
2003 compared to the first six months of 2002 and increased $.1 million in the
second quarter of 2003 compared to the second quarter of 2002 mainly due to
increases in outside services related to the Company's new website as well as
increases in consulting services for recoverable monthly payments related to an
additional reseller in the Washington, D.C., area.
Research and development expenses decreased $.3 million from the first six
months of 2002 and decreased $.1 million from the second quarter of 2002 mainly
due to a decrease in software license amortization related to the BlueBird
software agreement, which has been fully amortized.
General and administrative expenses remained consistent in the six month and
second quarter comparison from 2003 vs. 2002.
Interest expense remained consistent with the first six months of 2002 and
increased $.1 million from the second quarter of 2002 due to the recording of
interest on lease commitments
16
to Patriarch. The weighted average interest rate for the first six months of
2003 was 5.4% compared to 5.6% in 2002.
Liquidity and Capital Resources
Cash and cash equivalents at June 30, 2003 increased $.5 million from December
31, 2002 levels.
Total borrowings were consistent with the $10.6 million level at December 31,
2002. The available balance on the line of credit was $1.4 million at June 30,
2003. As of June 30, 2003, the Company is in compliance with all of the
financial covenants. The Company anticipates meeting its current obligations and
resource needs through the funds generated through operations. (See Note 3 for
further details.)
Operating activities provided $.5 million of cash in the first six months of
2003.
Non-cash expenses recorded during the first six months of the year were $1.2
million, a decrease of $.4 million from the same period in 2002. These expenses
relate to depreciation of fixed assets (discussed in net plant and equipment
below) and amortization of customer service inventory and software license.
Net accounts receivable and unbilled receivables at June 30, 2003 increased $2.3
million from December 31, 2002 due mainly to the increase in revenue from the
fourth quarter of 2002 of $6.4 million to revenue of $8.1 million in the second
quarter of 2003. The increase in revenue of $1.7 million along with the timing
of payments created the increase in accounts receivables.
Total inventories at June 30, 2003 decreased $.5 million from December 31, 2002.
Total manufacturing inventories decreased $.2 million from the beginning of the
year mainly due to the timing of the third quarter build plan and second quarter
delivery of equipment. Customer service inventories decreased $.3 million mainly
due to amortization of inventory.
Prepaid expenses and other decreased $.1 million due mainly to the reduction in
prepaid directors and officers insurance for the first six months of 2003.
Net plant and equipment decreased $.1 million from December 31, 2002 mainly due
to depreciation expense reported during the first six months of the year.
Accounts payable increased $.3 million from December 31, 2002 due to the timing
of payments.
Salaries and wages increased $.3 million due mainly to an increase in the
vacation accrual that is expected to be utilized over the remainder of the year
and an increase in accrued commissions.
17
Taxes other than income taxes decreased $.1 million due to payments made for
sales and use taxes in various states and Goods and Services Tax in Canada.
Customer deposits increased $.2 million from December 31, 2002 due to the
addition of various contracts.
Deferred revenues increased $.3 million due to an increase in annual billings
that were previously billed on a monthly basis.
Other liabilities increased $.5 million mainly due to the recording of deferred
income for a sales type lease in the first and second quarters of 2003.
Critical Accounting Policies
Our critical accounting policies are discussed in Management's Discussion and
Analysis of Consolidated Financial Condition and Results of Operations in our
Annual Report on Form 10-K for the year ended December 31, 2002. The preparation
of our financial statements requires us to make estimates that affect the
reported amounts of assets, liabilities, revenue and expenses and related
disclosures of contingent assets and liabilities. We base our accounting
estimates on historical experience and other factors that are believed to be
reasonable under the circumstances. However, actual results may vary from these
estimates under different assumptions or conditions.
Item 3. Quantitative and Qualitative Disclosures About Market Risk.
In 2001, the Company completed a total debt restructuring (see Note 3 for
further information), however, the Company remains highly leveraged and could be
adversely affected by a significant increase in interest rates. A one percent
increase in the prime rate would increase the annual interest cost on the
outstanding loan balance at June 30, 2003 of approximately $10.6 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.
Item 4. Controls and Procedures.
The Company evaluated the design and operation of its disclosure controls and
procedures to determine whether they are effective in ensuring that the
disclosure of required information is timely made in accordance with the
Securities Exchange Act of 1934 (the "Exchange Act") and the rules and forms of
the Securities and Exchange Commission. This evaluation was made under the
supervision and with the participation of management, including the Company's
principal executive officer and principal financial officer as of the end of the
period covered by this Quarterly Report on Form 10-Q. The principal executive
officer and principal financial officer have concluded, based on their review,
that the Company's disclosure controls and procedures, as defined at Exchange
Act Rules 13a-14(c) and 15d-14(c), are effective to provide reasonable assurance
that information required to be disclosed by the Company in reports that it
files or submits under the Exchange Act is recorded, processed, summarized and
reported within the time periods specified in Securities and Exchange Commission
rules and forms. There were no changes in the Company's internal control over
financial reporting that occurred during the Company's most recent fiscal
quarter that materially affected, or are reasonably likely to materially affect,
the Company's internal control over financial reporting.
18
PART II - OTHER INFORMATION
Item 4. Submission of Matters to a Vote of Security Holders.
The Company held its Annual Meeting of Stockholders on June 12, 2003 to
elect three directors and appoint the Company's independent auditors for the
year ending December 31, 2003.
Lyman C. Hamilton, Jr., James C. Mavel and Ralph J. Takala were elected
directors with terms expiring in 2006 by favorable votes of not less than
6,214,987. There were a total of not more than 146,339 abstentions in the vote
for Messrs. Hamilton, Mavel and Takala and no broker nonvotes. The other members
of the Board of Directors are Logan Clarke, Jr. and Richard J. Coburn, whose
terms expire in 2004, and E. Bulkeley Griswold, John J. Holton and Robert H.
Steele, whose terms expire in 2005.
Ernst & Young LLP was appointed as the Company's independent auditors for
the year ending December 31, 2003 by a vote of 6,264,035 in favor, 79,616
against, 17,675 abstentions and no broker nonvotes.
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Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits.
Exhibit Number Description
Exhibit 31.1* CEO Certification Pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
Exhibit 31.2* CFO Certification Pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
Exhibit 32.1* CEO Certification Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
Exhibit 32.2* CFO Certification Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
* Filed herewith.
(b) Reports on Form 8-K.
Report on Form 8-K filed May 12, 2003 regarding first quarter of 2003
earnings.
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SIGNATURES
------------
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
SCAN-OPTICS, INC.
Date August 14, 2003 / s/ James C. Mavel
- ---------------------- ---------------------------------------
James C. Mavel
Chairman, Chief Executive Officer and
President
Date August 14, 2003 / s/ Michael J. Villano
- ---------------------- ---------------------------------------
Michael J. Villano
Chief Operating Officer, Chief Financial Officer,
Vice President and Treasurer
21