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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
(X) Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934
For the fiscal year ended December 31, 2003
( ) Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the transition period from
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Commission File No. 0-5265
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SCAN-OPTICS, INC.
(Exact name of registrant as specified in its charter)
Delaware 06-0851857
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(State or other jurisdiction (I.R.S. Employer Identification Number)
of incorporation or organization)
169 Progress Drive, Manchester, CT 06040
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(Address of principal executive offices) Zip Code
(860) 645-7878
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(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act: None
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Securities registered pursuant to Section 12(g) of the Act:
Common stock, $.02 par value
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(Title of Class)
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. ( X ) YES ( ) NO
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-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, 2003.
The number of shares of common stock, $.02 par value, outstanding as of March
24, 2004 was 7,439,732.
1
DOCUMENTS INCORPORATED BY REFERENCE
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Portions of the definitive Proxy Statement, relating to the 2004 Annual Meeting
of Stockholders, which will be filed pursuant to Regulation 14A with the
Securities and Exchange Commission not later than 120 days after the end of the
fiscal year, are incorporated by reference and included in the following:
Part III-Item 10 - Directors and Executive Officers of the Registrant
Part III-Item 11 - Executive Compensation
Part III-Item 12 - Security Ownership of Certain Beneficial Owners and
Management
Part III-Item 13 - Certain Relationships and Related Transactions
Part III-Item 14 - Principal Accountant Fees and Services
2
PART I
ITEM 1 - BUSINESS
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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.
3
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 20 companies to provide maintenance services
for their products at customer sites or through the Company's depot 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 34
years of experience serving specific target markets.
Target Markets
Scan-Optics' key values to the markets it serves are its customer relationships
and commitment to customer satisfaction, expertise in data entry, forms
processing, OCR/ICR/OMR and archive, storage and retrieval solutions and its
experience in systems integration. Scan-Optics' focus on communicating these key
values - Customer Satisfaction, Relationships, Quality, Experience and Expertise
is an integral factor in all of its marketing activities.
The Company's target markets for 2004 include its customer base of data and
image capture and processing customers, the Federal Government market and the
Value-Added Reseller/Channel market.
4
Scan-Optics' corporate message consists of a "Services-Led Strategy" - which is
a focused services approach vs. a product approach, and which communicates a
Services-Led message that emphasizes Scan-Optics' key values in implementing
successful information capture solutions in high-volume paper processing
environments.
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.
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
AccuScore is currently being used by three of the top Large Scale Assessment
processors and is well positioned to facilitate the increased demand for test
scoring created by the "No Child Left Behind" Act.
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 is designed to work with the Microsoft suite of database
products and Oracle's 8i Database product. DocWise has both an Internet client
and a desktop client for optimum flexibility. 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' VistaCapture is a software solution suite for rapid development of
data capture applications.
5
Scan-Optics' KeyEntry III is the ideal development tool for creating
applications that work in conjunction with mainframe computers and personal
computers. Typical applications range from "heads down" data entry to highly
sophisticated multi-user "front-ends" for large corporate databases.
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.
Hardware Products
Scan-Optics' SO Series Scanner provides a single platform to address high speed
image capture and high throughput intelligent document processing with the
lowest cost/highest performance ratio of any scanner in its class.
Using the latest advancements in technology, Scan-Optics has re-engineered this
scanner to create a single platform that provides a solution for commercial
businesses and government agencies that need high-speed image data capture, and
high-throughput intelligent document processing. There are two transport options
with the SO Series Scanner; the SO Series Image-Only and the SO Series OCR.
In 2004, 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
6
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
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. 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 internally 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:
7
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.
ACCESS SERVICES DIVISION
The Company has offered 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. In addition to supporting Company
products, the Access Services Division provides service and maintenance support
on a variety of electro-mechanical products for more than 20 different domestic
and foreign manufactures.
Maintenance service is provided through a network of over 120 highly skilled
service technicians including employees and contractors. 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 the Pacific Rim.
The Company maintains high standards of teamwork and customer satisfaction.
BUSINESS PROCESS OUTSOURCING
Manufacturing 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.
8
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 this division, provides
electro-mechanical assembly and test services under contracts with customers who
develop and sell a variety of equipment.
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 utilizes 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 2003, the Company derived 23% of its total revenue from one customer,
Northrop Grumman, IT Inc. In 2002 and 2001, no customers accounted for more than
10% of total revenue.
CHANNELS OF DISTRIBUTION
The Company sells directly to end-users and integrators in the USA and
independent distributors internationally.
9
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.
BACKLOG
The backlog for the Company's products and services as of December 31, 2003 was
approximately $15.2 million. As of December 31, 2002, the backlog was
approximately $18.7 million. Backlog as of March 19, 2004 was approximately $17
million. The backlog consists of firm orders for equipment, software and
services, the majority of which are expected to be delivered within the next 12
months, and maintenance due on existing contracts expected to be provided during
the next 12 months. 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 Solutions and Products 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 34 years of
experience in providing scanner repair.
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 completed our transition to ISO9001:2000 and obtained certification
in May. We initially targeted October 2003 to complete our 2000 certification,
but through teamwork and corporate commitment enterprise-wide, Scan-Optics
achieved certification five months earlier than the target date.
In 2004, we will continue to monitor and maintain our Quality System through
internal audits, corrective and preventive actions and continuous improvement
initiatives. Our next third party surveillance audit is scheduled for May 2004.
PATENTS
The Company currently has nine United States patents in force, which expire
between 2004 and 2022, and one patent pending. 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, 2003 the Company employed 187 people, including 19 with
administrative responsibilities, 16 in marketing and sales, 94 in software and
service activities, 17 in engineering and 41 in manufacturing capacities. The
Company considers its employee relations to be good. The Company has not
experienced any work stoppages.
FUNDED DEVELOPMENT AGREEMENTS
During 2003, 2002 and 2001, the Company completed a number of small custom
development contracts for specific customers resulting in revenue of
approximately $200,000, $43,000 and $110,000, 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) 2003 2002 2001
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Restated
Revenues
Solutions and products $ 21,108 $ 16,376 $ 16,667
Access services 10,563 11,499 13,193
Contract manufacturing services 410 1,466 880
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Total revenues 32,081 29,341 30,740
Cost of solutions and products 13,407 10,715 13,298
Service expenses 8,813 8,539 11,200
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Gross profit margin 9,861 10,087 6,242
Operating expenses, net 9,017 9,064 12,522
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Income (loss) before income taxes $ 844 $ 1,023 $ (6,280)
==================================
Total assets $ 26,073 $ 26,406 $ 27,380
Total expenditures for additions to long-lived assets
$ 173 $ 79 $ 121
The Company restated the 2002 consolidated financial statements to reflect a
change in the application of generally accepted accounting principles relating
to certain liabilities. The net impact of this change increased 2002 net income
before taxes by $111,000, from the amount previously reported. Refer to Note B
of the consolidated financial statements for more details.
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.
In 2003, the Company derived 23% of its total revenue from one customer,
Northrop Grumman, IT Inc. In 2002 and 2001, no customers accounted for more than
10% of total revenue.
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.
13
Export sales by geographic area (based on the location of the customer) were as
follows:
(thousands) 2003 2002 2001
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Latin America $ 124 12% $ 72 24% $ 152 3%
Europe 0% 149 49% 3,706 73%
Pacific Rim 944 88% 81 27% 1,225 24%
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$1,068 $ 302 $5,083
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Export sales represented 5%, 2%, and 30% of the Solutions and Products Segment
revenues for the three years ended December 31, 2003, 2002, and 2001,
respectively. There are no exports sales derived from the Company's Access
Services Segment or Contract Manufacturing Services Segment.
ITEM 2 - PROPERTIES
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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
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Since 2001, an action has been pending against Scan-Optics alleging, among other
things, breach of contract in connection with a contract for the delivery of
hardware, software and professional services. Scan-Optics has denied the
material allegations of the complaint and counterclaimed for breach of contract
and seeks recovery of unpaid receivables, totaling $1.4 million. Although the
ultimate outcome is uncertain, based on currently known facts, the Company
believes that it has strong defenses against the lawsuit and valid claims for
recovery for the net amount of unpaid receivables recorded in the financial
statements, and that the resolution of this matter 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
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The Company did not submit any matters during the fourth quarter of 2003 to a
vote of the stockholders.
14
PART II
ITEM 5 - MARKET PRICE OF AND DIVIDENDS ON THE REGISTRANT'S COMMON EQUITY AND
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RELATED STOCKHOLDER MATTERS
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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 Company's 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 916 stockholders of record at December 31, 2003.
Quarter Ended March 31 June 30 September 30 December 31
High Low High Low High Low High Low
- ----------------------------------------------------------------------------------------------------------------------------------
2003 $ .35 $ .25 $ .65 $ .27 $ .74 $ .50 $ .70 $ .45
2002 $ .41 $ .22 $ .38 $ .26 $ .39 $ .25 $ .40 $ .25
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.
See "Item 12 - Security Ownership of Certain Beneficial Owners and Management
and Related Stockholder Matters" for information about the Company's equity
compensation plans.
15
ITEM 6 - SELECTED FINANCIAL DATA
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SCAN-OPTICS, INC. AND SUBSIDIARIES
FIVE YEAR SUMMARY OF OPERATIONS
SELECTED FINANCIAL DATA
(thousands, except share data) 2003 2002 2001 2000 1999
- -----------------------------------------------------------------------------------------------------------------------
Restated
Total Revenues $ 32,081 $ 29,341 $ 30,740 $ 38,302 $ 51,992
==============================================================================
Income (loss) before income taxes 844 1,023 (6,280) (17,709) (8,415)
Income taxes (benefit) (142) 81 33 61 (240)
------------------------------------------------------------------------------
Net Income (Loss) $ 986 $ 942 $ (6,313) $ (17,770) $ (8,175)
==============================================================================
Basic earnings (loss) per share $ .14 $ .13 $ (.90) $ (2.53) $ (1.17)
Basic weighted-average shares 7,026,232 7,026,232 7,026,232 7,025,064 6,979,651
Diluted earnings (loss) per share $ .13 $ .13 $ (.90) $ (2.53) $ (1.17)
Diluted weighted-average shares 7,806,491 7,317,437 7,026,232 7,025,064 6,979,651
SELECTED BALANCE SHEET DATA
Total assets $ 26,073 $ 26,406 $ 27,380 $ 36,513 $ 56,792
Working capital (deficit) $ 4,957 $ 5,394 $ 4,184 $ (9,833) $ 4,727
Long term obligations $ 9,865 $ 10,682 $ 11,397
Mandatory redeemable preferred stock $ 3,800 $ 3,800 $ 3,800
Total stockholder's equity $ 2,443 $ 1,383 $ 360 $ 4,307 $ 22,081
The Company restated the 2002 consolidated financial statements to reflect a
change in the application of generally accepted accounting principles relating
to certain liabilities. The net impact of this change increased 2002 net income
and earnings per share by $111,000 and $.02, respectively, from amounts
previously reported. Refer to Note B of the consolidated financial statments for
more details.
The Company has not paid any dividends for the five-year period ended December
31, 2003.
The above financial data should be read in conjunction with the related
consolidated financial statements and notes thereto.
16
ITEM 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF CONSOLIDATED FINANCIAL
- -----------------------------------------------------------------------
CONDITION AND RESULTS OF OPERATIONS
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Overview
Certain statements contained in this Annual Report on Form 10-K may contain
forward-looking statements within the meaning of Section 27A of the Securities
Act of 1933 and Section 21E of the Securities and Exchange Act of 1934 and as
such may involve known or unknown risks, uncertainties and other factors which
may cause the Company's actual results, performance or achievements to be
materially different from future results, performance or achievements expressed
or implied by such forward-looking statements. Forward-looking statements, which
are based on certain assumptions and describe the Company's future plans,
strategies and expectations are generally identifiable by use of the words
"may," "will," "should," "expect," "anticipate," "estimate," "believe," "intend"
or "project" or the negative thereof or other variations thereon or comparable
terminology. Factors which could have a material adverse effect on the
operations and future prospects of the Company include, but are not limited to
those set forth below. These risks and uncertainties should be considered in
evaluating any forward-looking statements contained or incorporated by reference
herein.
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 debt
restructuring effective March 30, 2004 (see "Liquidity and Capital Resources"
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, 2003 of approximately $8 million by $.1
million. Further, if the recapitalization described under "Liquidity and Capital
Resources" occurs, as contemplated by the 2004 debt restructuring described
under such heading, the Company's lenders will acquire significant voting
control and will accordingly have the right and the ability to influence the way
in which the Company does business, including its strategy and tactics. If the
recapitalization fails to occur, the Company's secured obligations (including
the Company's mandatorily redeemable preferred stock), which exceeds in the
aggregate $13.6 million as of March 30, 2004, will be due and payable June 1,
2005. 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 $1 million or $.13 per diluted
share, compared to a net income of $.9 million, or $.13 per diluted share, for
2002. There was an 18% improvement in operating income, along with 9% revenue
growth for the year compared to 2002. In 2003 we received certification for
ISO9001:2000 for our entire Company, which extends the focus on customer
satisfaction to all areas of the enterprise. The Company invested in research
and development to develop a new image scanning platform in 2003, which it
introduced during the AIIM trade show in March 2004. In fact, this product
earned "Best in Show Award" for high-end image scanners. This image scanner was
designed to satisfy the requirement of our very sophisticated customer base but
also scalable to provide an excellent price performance in the competitive
market space.
17
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
target market approach and has chosen to place its primary focus on the
government and assessment markets, while continuing to address the
transportation, insurance, 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 $5.1 million from 2002 to 2003 mainly in the
government 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' 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, in 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, including
employees and contractors, 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.
18
RESULTS OF OPERATIONS - 2003 VS. 2002
The 2002 consolidated financial statements have been restated to reflect a
change in the application of generally accepted accounting principles relating
to the adjustment of certain liabilities. The Company identified certain
liabilities relating to services and transactions dating back to 2002 and 2001.
In 2003, the Company determined the amounts were no longer valid obligations of
the Company. Further, it was determined that payment of the obligation or
resolution of the circumstances originally creating the liability occurred in
2002. As a result, the liabilities should have been removed from the Company's
books in 2002. The net impact of this change increased 2002 net income and
earnings per share by $111,000 and $.02, respectively, representing a reduction
of payables offset by required additional bonuses. The effect of income taxes
was determined immaterial.
Total revenues increased $2.7 million or 9% from 2002 to 2003.
Hardware and software revenue increased $4.8 million or 42% from the prior year.
North American sales increased $4.2 million or 38% due mainly to the replacement
or upgrade of existing Series 9000 systems at current customer sites. The
Company does not expect the replacement revenue to continue at the same level as
2003. Total international sales increased $.6 million or 189% from 2002.
International sales in the Pacific Rim increased 849% or $.7 million due to
spare parts orders and a scanner system sold to the Company's distributor in
Japan. Sales to Europe and Latin American decreased $.1 million from the prior
year.
Professional services revenue decreased $1.1 million or 16% from 2002 to 2003
mainly due to the decrease in the service revenue component of certain hardware
systems installations and difficulties in the current U.S. economy.
Access services revenue decreased $.9 million or 8% from 2002 to 2003 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 increased $2.9 million or 37% from 2002.
The increase in cost is mainly due to an increase in hardware and software sales
volume. In 2003, the Company recorded approximately twice the number of Series
9000 scanners sales as compared to 2002, which accounted for more revenue and
therefore increased manufacturing costs. Cost of hardware and software revenue
as a percentage of revenue was 67% in 2003, as compared to 69% in 2002.
Cost of professional services revenue decreased $.2 million or 6% in 2003
compared to the prior year mainly due to decreases in salaries and travel
expenses. Cost of professional services revenue as a percentage of revenue was
50% in 2003, as compared to 44% in 2002, due mainly to a decline in new
solutions sales, as well as fixed costs that exist to support a higher volume of
business.
Cost of Access services revenue increased $.3 million or 3% from 2002 to 2003.
The increase is principally due to an increase in UK operating expenses. Cost of
Access services revenue as a percentage of revenue was 83% in 2003, as compared
to 74% in 2002, traceable to lower revenues in 2003 and a relatively fixed cost
structure.
Sales and marketing expenses increased $.2 million or 6% from 2002, principally
due to an increased use of outside services related to the Company's new website
as well as increases in consulting services related to a reseller in the
Washington, D.C. area to expand into the federal goverment market, and increased
trade show activity.
Research and development expenses decreased $.5 million or 30% from 2002 mainly
due to the capitalization of certain software development costs.
General and administrative expenses remained consistent with the prior year. A
reduction in legal expenses of $.2 million and $.1 million of bad debt recovery
was offset by increased salary expense of $.2 million and increased group
insurance expense of $.1 million.
19
Interest expense of $.8 million remained consistent with 2002. The weighted
average interest rate was 4.8% in 2003 compared to 5.5% in 2002.
Other Income decreased $.3 million from 2002 mainly due to a reduction in 2002
of $.4 million for certain amounts previously recorded as liabilities that were
no longer due or have been settled for amounts less than previously recorded.
Income tax benefit increased $.2 million from 2002 mainly due to the reduction
of potential tax exposures associated with certain state and foreign exposure
items.
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.
20
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.
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 $.3 million or 9% 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.
Expenses have been restated from amounts previously recorded for a reduction in
liabilities of $.2 million offset by $.1 million for additional bonus
compensation.
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.
LIQUIDITY AND CAPITAL RESOURCES
The Company expects to utilize available liquid resources to fund additional
investments in its marketing and research and development organizations, provide
for professional fees arising from the debt restructuring process and general
working capital and corporate needs.
Cash and cash equivalents increased $.3 million from 2002 to 2003 mainly due to
increased cash from operations offset by the paydown of the revolving line of
credit.
At December 31, 2003, the Company had $8 million in outstanding borrowings,
classified as long term, against its $12 million available borrowings. The
Company anticipates meeting its current obligations and resource needs through
the funds generated from operations and available borrowings. The average
borrowing level for 2003 was $9.8 million compared to $10.7 million for 2002.
The decrease is due to payments of portions of the outstanding debt from cash
flow generated in 2003.
21
Effective March 30, 2004, the Company entered into a new credit agreement with
lenders affiliated with Patriarch Partners, LLC. (the "Lenders") that, among
other things, extends from December 31, 2004 through June 1, 2005 the repayment
date for all of the Company's secured debt and provides additional working
capital in the amount of $1.5 million. Subject to approval by the shareholders
at the Company's Annual Meeting scheduled to be held on or before July 1, 2004,
the Company will issue to the Lenders 79.8% of the fully-diluted Common Stock of
the Company in consideration for, among other things, the Lenders' agreement to
extend the repayment date for outstanding secured debt through March 30, 2007.
More specifically, the financing arrangement includes the following items:
o The Company's secured term and revolving debt is exchanged for a $9
million term loan. The new term loan is payable in annual amounts of
$90,000 beginning March 2005 with the balance due at maturity. A new $2.5
million revolving credit facility is also provided, which can be used for
working capital and other general business purposes. Borrowings against
both such loans will continue to accrue interest at a rate of prime plus
2%. The maturity date for these loans is extended from December 31, 2004 to
June 1, 2005.
o An additional $1.5 million working capital term loan is available to
the Company, with the Company obligated to repay $2 million at maturity on
June 1, 2005. The working capital term loan will accrue interest on $2
million at the prime rate.
o The Company's financial covenants with respect to backlog, capital
expenditure and EBITDA have been modified to enhance the financial
flexibility of the Company.
o The Company has exchanged the $3.8 million mandatorily redeemable
Series A preferred stock held by the Lenders for $3.8 million of
mandatorily redeemable Series B preferred stock, which Series B preferred
stock has substantially the same terms as the Series A, except that the
redemption date is extended from December 31, 2004 to June 1, 2005.
o The Company has agreed to use its best efforts, subject to the
fiduciary duties of the Board of Directors, to complete a recapitalization
of the Company by July 1, 2004. The Lenders currently hold both the Series
B preferred stock noted above and a warrant to purchase common stock issued
to the Lenders in December 2001. The Lenders are entitled to exercise the
warrant, upon the earlier of January 1, 2005 or a triggering event, for
33.2% of the fully-diluted common stock of the Company at $0.02 per share.
In addition, upon the Lender's exercise of the warrant, the Series B
preferred would be entitled to vote with the common stock and would have
46.67% of the voting power of the Company, on a fully-diluted basis. The
recapitalization will include, among other terms, the cancellation of the
$3.8 million mandatorily redeemable Series B preferred stock and the
existing warrant, and the issuance of common stock of the Company to the
Lenders so that following such issuance the Lenders will own 79.8% of the
fully-diluted common stock of the Company, subject to dilution for certain
current and future compensatory stock options issued by the Company. The
recapitalization is subject to the approval by the stockholders of the
Company of an amendment to the certificate of incorporation of the Company
to increase the authorized common stock of the Company and related matters,
which approval will be sought at the Company's planned annual meeting to be
held on or before July 1, 2004.
22
o Upon approval by the Company's shareholders of the recapitalization
described above, the maturity date for all of the Company's secured
indebtedness to the Lenders will be further extended from June 1, 2005 to
March 30, 2007.
The Company believes that the 2004 loan restructuring will allow execution
of the Company's business plan through the term of the credit agreement by
reducing required payments under the borrowing arrangements with the Lenders and
increasing available funds through the working capital term loan facility,
thereby enhancing the Company's ability to invest in its business, by lowering
the thresholds of the financial covenants and by extending the loan maturities
through June 2005, and through March 2007 if the shareholders approve the
recapitalization transaction. In the event that shareholders fail to approve the
recapitalization transaction or the recapitalization transaction fails to occur
for any other reason, the Company's secured obligations (including the Company's
mandatorily redeemable preferred stock), which exceeds $13.6 million as of March
30, 2004, will be due and payable on June 1, 2005.
The following summarizes the Company's significant contractual obligations and
commitments that impact its liquidity as of December 31, 2003 after giving
effect to March 30, 2004 financing agreement.
Contractual Obligations Payments Due by Period
- -------------------------------------------------------------------------------------------------------------
Less than 1 - 3 4 - 5 After
(thousands) Total 1 year years years 5 years
- -------------------------------------------------------------------------------------------------------------
Notes payable $ 7,989 $ 7,989
Redeemable preferred stock 3,800 3,800
Interest payable 486 486
Executive insurance agreement 408 50 $ 100 $ 258
Capital leases 319 $ 94 225
Operating leases 2,476 442 1,723 104 207
-------------------------------------------------------------------
Total contractual cash obligations $15,478 $ 536 $14,273 $ 204 $ 465
===================================================================
Operating activities provided $3 million of cash in 2003 compared to using $.2
million in 2002. The non-cash expenses in 2003 were $2.2 million compared to
$2.5 million in 2002. 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 $.5 million from
December 31, 2002. The increase is due to the increase in revenue from the
fourth quarter of 2002 of $6.4 million to revenue of $8.5 million in the fourth
quarter of 2003.
23
Total inventories decreased $1.9 million from 2002 levels. Manufacturing
inventories decreased $1.5 million during the year due to a decrease in
materials and component parts of $1.2 million and a decrease in work-in-process
inventory of $.3 million. Finished goods inventory remained consistent with
prior year levels. The decrease in materials and component parts is mainly due
to a decrease in the production schedule for the first quarter of 2004 and lower
production costs of the new SO series scanner. Customer service inventory
decreased for the year by $.4 million, which was mainly attributable to the
amortization of spare parts inventory.
Net plant and equipment decreased $.3 million in 2003. This net decrease is
mainly due to depreciation of $.4 million which was offset by additions of $.2
million. During the year the Company conducted a physical inventory of fixed
assets and as a result $6.5 million in asset value and accumulated depreciation
of $6.4 million were written off resulting in a loss on disposals of $.1
million.
Goodwill remained consistent with prior year. 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 remained consistent with the prior year.
Notes payable to bank decreased $2.6 million due to pay down of the notes
payable during the year. (See Note G.)
Salaries and wages increased $.5 million from 2002 mainly due to a $.5 million
increase in bonus accrual.
Deferred revenue increased $.6 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 decreased $.4 million due mainly to two large orders in 2002
that contained deposit requirements as part of the contract.
Other current liabilities decreased $.2 million due mainly to a decrease in a
tax contingency reserve of $.3 million, decrease of $.1 million in accrued legal
fees partially offset by a $.2 million increase in VAT reserves and
miscellaneous accruals in the UK operations.
Other long term liabilities increased $.2 million mainly due to accruals for
lease payments that were deferred as part of the March 2004 debt restructuring
and will mature on June 1, 2005, and accrued interest on the mandatory
redeemable preferred stock.
24
OTHER MATTERS
New Accounting Standards
Refer to Note C 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 - proportional performance: The Company recognizes revenue
and profit on professional services engagements using the proportional
performance 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.
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. The spare parts are amortized over four years and the
reserves are reviewed periodically for appropriateness.
25
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 going forward it will be tested on at least
an annual basis for impairment, see Note C.
26
ITEM 7A - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
- --------------------------------------------------------------------
On March 30, 2004, the Company completed a total debt restructuring (see
"Liquidity and Capital Resources" 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, 2003 of approximately $8 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 Overview 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.
27
ITEM 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
----------------------------------------------------
REPORT OF INDEPENDENT AUDITORS
------------------------------
Stockholders and Board of Directors
Scan-Optics, Inc.
We have audited the accompanying consolidated balance sheets of Scan-Optics,
Inc. and subsidiaries as of December 31, 2003 and 2002, and the related
consolidated statements of operations, stockholders' equity, and cash flows for
each of the three years in the period ended December 31, 2003. 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, 2003 and 2002, and the
consolidated results of their operations and their cash flows for each of the
three years in the period ended December 31, 2003, 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.
As discussed in Note B, the consolidated financial statements for 2002 have been
restated due to a change in the application of generally accepted accounting
principles relating to the adjustment of certain liabilities.
As discussed in Note C to the consolidated financial statements, in 2002 the
Company changed its method of accounting for goodwill.
/s/ Ernst & Young LLP
Hartford, Connecticut
March 26, 2004, except for Note G,
as to which the date is March 30, 2004
29
SCAN-OPTICS, INC., AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
December 31
(thousands, except share data) 2003 2002
- ------------------------------------------------------------------------------------
Restated
Assets
Current Assets:
Cash and cash equivalents $ 585 $ 274
Accounts receivable less allowance of $1,134 in 2003
and $1,574 in 2002 6,043 5,554
Unbilled receivables - contracts in progress 415 377
Inventories 7,282 9,139
Prepaid expenses and other 597 591
----------------------
Total current assets 14,922 15,935
Plant and Equipment:
Equipment 3,682 8,836
Leasehold improvements 4,010 5,209
Office furniture and fixtures 745 725
----------------------
8,437 14,770
Less allowances for depreciation and amortization 7,422 13,456
----------------------
1,015 1,314
Goodwill 9,040 9,040
Other assets 1,096 117
----------------------
Total Assets $26,073 $26,406
======================
30
December 31
(thousands, except share data) 2003 2002
- ------------------------------------------------------------------------------------------
Restated
Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable $ 2,323 $ 2,274
Note payable 1,500
Salaries and wages 1,484 1,027
Taxes other than income taxes 758 501
Income taxes 189 45
Deferred revenue 2,787 2,217
Customer deposits 929 1,308
Other 1,495 1,669
-------------------------
Total current liabilities 9,965 10,541
Notes payable 7,989 9,042
Other liabilities 1,876 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 in 2003 and 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 (32,570) (33,556)
Accumulated other comprehensive loss (844) (918)
-------------------------
5,089 4,029
Less cost of common stock in treasury,
413,500 shares 2,646 2,646
-------------------------
Total stockholders' equity 2,443 1,383
-------------------------
Total Liabilities and Stockholders' Equity $ 26,073 $ 26,406
=========================
See accompanying notes
31
SCAN-OPTICS, INC., AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
Year Ended December 31
(thousands, except share data) 2003 2002 2001
- ----------------------------------------------------------------------------------------------------
Restated
Revenues
Hardware and software $ 16,044 $ 11,292 $ 11,195
Professional services 5,474 6,550 6,352
Access services 10,563 11,499 13,193
--------------------------------------------------
Total revenues 32,081 29,341 30,740
Costs of Revenue
Hardware and software 10,690 7,816 9,331
Professional services 2,717 2,899 3,967
Access services 8,813 8,539 11,200
--------------------------------------------------
Total costs of revenues 22,220 19,254 24,498
9,861 10,087 6,242
Gross Margin
Operating Expenses
Sales and marketing 3,455 3,273 3,914
Research and development 1,267 1,798 2,936
General and administrative 3,572 3,566 3,899
Interest 856 846 1,788
--------------------------------------------------
Total costs and expenses 9,150 9,483 12,537
--------------------------------------------------
Operating income (loss) 711 604 (6,295)
Other income, net 133 419 15
--------------------------------------------------
Income (loss) before income taxes 844 1,023 (6,280)
Income tax expense (benefit) (142) 81 33
--------------------------------------------------
Net Income (Loss) $ 986 $ 942 $ (6,313)
==================================================
Basic earnings (loss) per share $ .14 $ .13 $ (.90)
==================================================
Basic weighted-average shares 7,026,232 7,026,232 7,026,232
Diluted earnings (loss) per share $ .13 $ .13 $ (.90)
==================================================
Diluted weighted-average shares 7,806,491 7,317,437 7,026,232
See accompanying notes.
32
SCAN-OPTICS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF
STOCKHOLDERS' EQUITY
Accumulated Accumulated
Common Stock Capital in Retained- Other
---------------------- Excess of Earnings Comprehensive Treasury
(thousands, except share data) Shares Amount Par Value Deficit Income (Loss) Stock Total
- -----------------------------------------------------------------------------------------------------------------------------------
Balance January 1, 2001 7,439,732 $ 149 $ 35,654 $ (28,185) $ (665) $ (2,646) $ 4,307
Issuance of common stock
upon exercise of stock
options 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
Issuance of common stock
warrants
Net income (restated) 942 942
Currency translation
adjustments 81 81
--------
Comprehensive income
(restated) 1,023
- ---------------------------------------------------------------------------------------------------------------------------------
Balance December 31, 2002
(restated) 7,439,732 $ 149 38,354 (33,556) (918) (2,646) 1,383
Net income 986 986
Currency translation
adjustments 74 74
--------
Comprehensive income 1,060
- ---------------------------------------------------------------------------------------------------------------------------------
Balance December 31, 2003 7,439,732 $ 149 $ 38,354 $ (32,570) $ (844) $ (2,646) $ 2,443
=================================================================================================================================
See accompanying notes.
33
SCAN-OPTICS, INC., AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year Ended December 31
(thousands) 2003 2002 2001
- -----------------------------------------------------------------------------------------------------------------------
Operating Activities Restated
Net income (loss) $ 986 $ 942 $ (6,313)
Adjustments to reconcile net income (loss) to net
cash provided (used) by operating activities:
Depreciation 426 425 677
Amortization of customer service inventory and
software license 1,885 2,355 2,886
Amortization of goodwill 1,326
Provision for losses on accounts receivable 22 35
Provision for inventory obsolescence 50 178
Reversal of previously recorded liabilities (183) (369)
Changes in operating assets and liabilities:
Accounts receivable (549) (668) 6,507
Refundable income taxes 124
Inventories (28) (2,634) (1,873)
Prepaid expenses and other (6) (87) 465
Software license
Accounts payable 232 (819) (2,604)
Accrued salaries and wages 457 (353) 526
Taxes other than income taxes 257 (23) 131
Income taxes 144 40 (116)
Deferred revenue 570 116 24
Customer deposits (379) 801 (705)
Other (797) 21 (330)
-------------------------------------------
Net cash provided (used) by operating activities 3,037 (168) 903
Investing Activities
Acquisition related settlement 209 400
Proceeds from the sale of plant and equipment 35
Purchases of plant and equipment, net (173) (114) (64)
-------------------------------------------
Net cash provided (used) by investing activities (173) 130 336
Financing Activities
Proceeds from issuance of common stock
Proceeds from borrowings 7,650 4,376 3,485
Principal payments on borrowings (10,203) (5,726) (3,098)
-------------------------------------------
Net cash provided (used) by financing activities (2,553) (1,350) 387
Increase (decrease) in cash and cash equivalents 311 (1,388) 1,626
Cash and Cash Equivalents at Beginning of Year 274 1,662 36
-------------------------------------------
Cash and Cash Equivalents at End of Year $ 585 $ 274 $ 1,662
===========================================
Supplemental Cash Flow Information
Interest paid $ 732 $ 667 $ 1,579
===========================================
Income taxes paid $ 24 $ 44 $ 61
===========================================
See accompanying notes.
34
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 factors include (1) the effect of a continued
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 to customers, and (5) the stability of sole source suppliers.
NOTE B - RESTATEMENT OF 2002 CONSOLIDATED FINANCIAL STATEMENTS
The 2002 consolidated financial statements have been restated to reflect a
change in the application of generally accepted accounting principles relating
to the adjustment of certain liabilities. The Company identified certain
liabilities relating to services and transactions dating back to 2002 and 2001,
and in 2003, the Company determined the amounts were no longer valid obligations
of the Company. Further, it was determined that payment of the obligation or
resolution of the circumstances originally creating the liability occurred in
2002. As a result, the liabilities should have been removed from the Company's
books in 2002. The net impact of this change increased 2002 net income and
earnings per share by $111,000 and $.02, respectively, from amounts previously
reported, representing a reduction of payables as the Company had satisfied its
vendor obligations offset by required additional bonuses. The effect of income
taxes was determined immaterial.
NOTE C - 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.
Use of Estimates: The preparation of financial statements in conformity with
accounting principles generally accepted in the United States 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.
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
35
year to year have been reported in accumulated other comprehensive loss, a
component of Stockholders' Equity.
Cash Equivalents: Highly liquid investments purchased with maturities of three
months or less are considered cash equivalents.
Accounts Receivable and 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 (Note O). When right of return exists,
the Company recognizes revenue in accordance with SFAS 48, Revenue Recognition
When Right of Return Exists.
Revenues under systems integration and professional services contracts are
recognized on a proportionate performance basis, based on 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 individual project. Under fixed
price contracts, the Company may encounter, which has been the case with certain
contracts in prior years, 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 on a particular
contract, such a loss is provided for in the period it is identified.
Revenues from maintenance services are recognized when the related services are
provided.
The Company generally records receivables when the related revenue is
recognized. Based on certain pre-negotiated contract terms billing may not
coincide with revenue recognition, in which case, amounts due from customers are
captured in unbilled receivables until the customer is actually invoiced in
accordance with the contract terms.
An allowance for potentially uncollectible accounts receivable is provided based
on management's assessment of customers' current financial condition, general
economic and industry conditions and past experience. Accounts receivable are
charged to the allowance when deemed uncollectible.
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. The spare parts are amortized over four years and the reserves are
reviewed periodically for appropriateness.
Plant and Equipment: Plant and equipment is stated on the basis of cost.
Depreciation is computed principally using the straight-line method over the
estimated useful lives of the assets, which range from 3 to 10 years. Leasehold
improvements are amortized over the useful life of the improvements or the life
of the lease, whichever is shorter.
Long-Lived Assets: Long-lived assets are recorded at the lower of amortized cost
or fair value. Software license acquired in 1999 was amortized on a
straight-line basis over 3 years.
36
Asset Impairment: 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
non-discounted cash flow analysis over the remaining useful life of the asset,
the carrying value would be reduced to its estimated fair value. There have been
no material impairments recognized in these financial statements.
Goodwill: Goodwill consists of the excess of cost over the fair value of
identifiable net assets of businesses acquired. As of January 1, 2002, the
Company adopted Financial Accounting Standards Board Statement No. 142, Goodwill
and Other Intangible Assets (FAS 142) and as such no longer amortizes goodwill,
but rather tests it annually for impairment. There was no impairment of goodwill
at January 1, 2003 or January 1, 2002. Had Statement No. 142 been in effect as
of the beginning of 2001, amortization expense for the year ended December 31,
2001 would have been reduced by $1,326,000, reducing net loss by the same amount
and reducing net loss per share by $.19 per share.
Capitalized Software Development Costs: The Company capitalizes certain internal
and external costs in accordance with FASB Statement No. 86, Accounting for the
Costs of Software to be Sold, Leased, or Otherwise Marketed associated with the
development of certain software. These costs are amortized on a straight-line
basis over the estimated useful life of the software or on a units sold basis,
whichever results in the shorter amortization period. Capitalized software
totaled $960,000 at December 31, 2003. No costs were capitalized at December 31,
2002.
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, 2003 and 2002 and approximate the carrying value
of these financial instruments.
Shipping Costs: Shipping costs are included in costs of revenue.
Advertising Costs: The Company expenses the production costs of advertising the
first time the advertising takes place. Advertising costs ($10,000 in 2003,
$12,000 2002, and $9,000 in 2001) are included in selling, general and
administrative expenses.
Income Taxes: Deferred income taxes are provided for on 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.
37
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, Accounting for Stock-Based
Compensation.
Pro forma information regarding net income (loss) and earnings (loss) per share
determined as if the Company granted stock options under the fair value method
is required by FASB Statement No. 123. 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 at the date of grant was determined using a Black-Scholes option pricing
mode and is expensed ratably over the vesting period of the grant, which is 36
months for key employees and 6 months for nonemployee members of the Board of
Directors. Options for senior management that were granted on December 31, 2001
as part of the previous debt restructuring vested over six months. The Company's
pro-forma information is as follows:
December 31
(thousands, except per share amounts) 2003 2002 2001
-------------------------------------------------------------------------------------------------
Restated
Net income (loss), as reported $ 986 $ 942 $ (6,313)
Deduct: Stock option expense (93) (199) (134)
-------------------------------------------
Pro forma net income (loss) $ 893 $ 743 $ (6,447)
===========================================
Basic earnings (loss) per share, as reported $ .14 $ .13 $ (.90)
Stock option expense (.01) (.03) (.02)
-------------------------------------------
Pro forma basic earnings (loss) per share $ .13 $ .10 $ (.92)
===========================================
Diluted earnings (loss) per share, as reported $ .13 $ .13 $ (.90)
Stock option expense (.01) (.03) (.02)
-------------------------------------------
Pro forma diluted earnings (loss) per share $ .12 $ .10 $ (.92)
===========================================
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 1.102.
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.
38
Earnings (Loss) Per Share: Basic and diluted earnings (loss) per share is
calculated in accordance with FASB Statement No. 128, Earnings Per Share.
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.
New Accounting Pronouncements:
On January 1, 2003, the Company adopted the Financial Accounting Standards Board
("FASB") Statement of Financial Accounting Standards ("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.
Adoption of this standard did not have an impact on the Company's consolidated
financial position, at December 31, 2003 or results of operations for the year
then ended.
On January 1, 2003, the Company also adopted 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 did not have an impact on the Company's consolidated financial
position, at December 31, 2003 or results of operations for the year then ended.
In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity ("SFAS 150").
This statement establishes standards for classifying and measuring, as
liabilities, certain financial instruments that embody obligations of the issuer
and have characteristics of both liabilities and equity. SFAS 150 generally
requires liability classification for financial instruments, including
mandatorily redeemable equity instruments and other non-equity instruments
requiring, from inception, the repurchase by the issuer of its equity shares.
This statement was applicable to the Company effective September 1, 2003. The
adoption of this Statement did not have a significant effect on the Company's
financial position as of December 31, 2003 or on the results of operations for
the year then ended.
In May 2003, the FASB's Emerging Issues Task Force defined the scope of Issue
00-21, Revenue Arrangements With Multiple Deliverables ("EITF No. 00-21") and
its interaction with other authoritative literature. The statement was adopted
by the Company effective September 1, 2003 and requires revenue arrangements
including multiple deliverables to be divided into separate units of accounting
39
for revenue recognition purposes, if the deliverables in the arrangement meet
certain criteria, including standalone value to the customer, objective and
reliable evidence of the fair value of the undelivered items exists and if the
arrangement includes a general right of return relative to the delivered item,
delivery or performance of the undelivered item is considered probable and
substantially in the control of the vendor. The adoption of this Statement did
not have a significant effect on the Company's financial position as of December
31, 2003 or on the results of operations for the year then ended.
In December 2003, the FASB issued SFAS Interpretation No. 46, Consolidation of
Variable Interest Entities, an Interpretation of ARB No. 51, which effectively
modified and clarified certain provisions of FIN 46, as originally issued. The
Company is required to adopt the provisions of this guidance for the quarter
ending March 31, 2004, as it relates to all variable interests held, except that
adoption is required by December 31, 2004 for all variable interest held in
entities that are considered to be special purpose entities. The adoption of
this Statement did not have a significant effect on the Company's December 31,
2003 financial statements and is not expected to have a significant impact upon
adoption in the first quarter of 2004. The Company has no variable interest
entities.
NOTE D - Acquisition Activities
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.
NOTE E - UNBILLED RECEIVABLES - CONTRACTS IN PROGRESS
Unbilled amounts in accounts receivable under contracts in progress were $.4
million at December 31, 2003 and 2002, 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 2004.
40
NOTE F - INVENTORIES
The components of inventories were as follows:
December 31
(thousands) 2003 2002
- ---------------------------------------------------------
Finished goods $ 57 $ 56
Work-in-process 1,066 1,325
Service parts 3,291 3,715
Materials and component parts 2,868 4,043
--------------------
$7,282 $9,139
====================
NOTE G - 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, 2003. At December 31, 2003, the Company had $8
million in outstanding borrowings, all of which are classified as long-term as
the Company has refinanced the notes on a long-term basis. The available balance
on the outstanding borrowings was $3.6 million and $1.5 million at December 31,
2003 and December 31, 2002, respectively. The weighted average interest rate on
borrowings during 2003 and 2002 was 4.8% and 5.5%, respectively.
Effective March 30, 2004, the Company entered into a new credit agreement
with lenders affiliated with Patriarch Partners, LLC. (the "Lenders") that,
among other things, extends from December 31, 2004 through June 1, 2005 the
repayment date for all of the Company's secured debt and provides additional
working capital in the amount of $1.5 million. Subject to approval by the
shareholders at the Company's Annual Meeting scheduled to be held on or before
July 1, 2004, the Company will issue to the Lenders 79.8% of the fully-diluted
Common Stock of the Company in consideration for, among other things, the
Lenders' agreement to extend the repayment date for outstanding secured debt
through March 30, 2007. More specifically, the financing arrangement includes
the following items:
o The Company's secured term and revolving debt is exchanged for a $9
million term loan. The new term loan is payable in annual amounts of $90,000
beginning March 2005 with the balance due at maturity. A new $2.5 million
revolving credit facility is also provided, which can be used for working
capital and other general business purposes. Borrowings against both such loans
will continue to accrue interest at a rate of prime plus 2%. The maturity date
for these loans is extended from December 31, 2004 to June 1, 2005.
o An additional $1.5 million working capital term loan is available to the
Company, with the Company obligated to repay $2 million at maturity on June 1,
2005. The working capital term loan will accrue interest on $2 million at the
prime rate.
o The Company's financial covenants with respect to backlog, capital
expenditure and EBITDA have been modified to enhance the financial flexibility
of the Company.
41
o The Company has exchanged the $3.8 million mandatorily redeemable Series
A preferred stock held by the Lenders for $3.8 million of mandatorily redeemable
Series B preferred stock, which Series B preferred stock has substantially the
same terms as the Series A, except that the redemption date is extended from
December 31, 2004 to June 1, 2005.
o The Company has agreed to use its best efforts, subject to the fiduciary
duties of the Board of Directors, to complete a recapitalization of the Company
by July 1, 2004. The Lenders currently hold both the Series B preferred stock
noted above and a warrant to purchase common stock issued to the Lenders in
December 2001 currently valued at $2.7 million. The Lenders are entitled to
exercise the warrant, upon the earlier of January 1, 2005 or a triggering event,
for 33.2% of the fully-diluted common stock of the Company at $.02 per share. In
addition, upon the Lender's exercise of the warrant, the Series B preferred
would be entitled to vote with the common stock and would have 46.67% of the
voting power of the Company, on a fully-diluted basis. The recapitalization will
include, among other terms, the cancellation of the $3.8 million mandatorily
redeemable Series B preferred stock and the existing warrant, and the issuance
of common stock of the Company to the Lenders so that following such issuance
the Lenders will own 79.8% of the fully-diluted common stock of the Company,
subject to dilution for certain current and future compensatory stock options
issued by the Company. The recapitalization is subject to the approval by the
stockholders of the Company of an amendment to the certificate of incorporation
of the Company to increase the authorized common stock of the Company and
related matters, which approval will be sought at the Company's planned annual
meeting to be held on or before July 1, 2004.
o Upon approval by the Company's shareholders of the recapitalization
described above, the maturity date for all of the Company's secured indebtedness
to the Lenders will be further extended from June 1, 2005 to March 30, 2007.
The carrying value of the notes payable to bank approximates its fair value and
is secured by all of the Company's assets.
NOTE H - 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, 2003
and 2002, 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, 2003, 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 G.)
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, 2003 and 2002.
42
NOTE I - STOCK OPTION PLANS
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.
The following schedule summarizes the changes in stock options for each of the
three years in the period ended December 31, 2003:
Weighted
Number of Average Option Price
Shares Price Per Share
- ------------------------------------------------------------------------------------------------------------------------
Outstanding January 1, 2001 (545,245 exercisable) 1,122,133 $2.56 $ .31 to $9.19
Granted 1,145,000 .24 .24 to .25
Canceled (69,050) .72 .31 to 3.69
-----------------------------------------------------------
Outstanding December 31, 2001 (782,261 exercisable) 2,198,083 1.41 .24 to 9.19
2002 Activity
- -------------
Granted 30,000 .34 .34 to .34
Canceled (236,800) 1.65 .24 to 9.19
-----------------------------------------------------------
Outstanding December 31, 2002 (1,869,142 exercisable) 1,991,283 1.37 .24 to 9.19
2003 Activity
- -------------
Granted 717,500 .29 .28 to .55
Canceled (56,100) 2.67 .31 to 3.88
-----------------------------------------------------------
Outstanding December 31, 2003 (1,970,183 exercisable) 2,652,683 $1.05 $ .24 to $9.19
===========================================================
Options Outstanding Options Exercisable
- ------------------------------------------------------------------------------------------------------------------------------------
Weighted
Average Weighted
Remaining Average Weighted
Number Contractual Exercise Number Average
Range of Exercise Prices Outstanding Life (Years) Price Exercisable Exercise Price
- -----------------------------------------------------------------------------------------------------------------------------------
$ .24 to $ .60 2,095,600 8 $ .27 1,413,100 $ .27
$ .61 to $1.50 87,500 6 1.06 87,500 1.06
$1.51 to $3.75 271,583 4 3.36 271,583 3.36
$3.76 to $9.19 198,000 3 6.10 198,000 6.10
- -----------------------------------------------------------------------------------------------------------------------------------
2,652,683 1,970,183
43
At December 31, 2003 there were 200,272 options available for grant of which
71,500 were reserved for the Directors.
The weighted-average fair value of options exercisable was $1.31, $1.43 and
$3.32 at December 31, 2003, 2002, and 2001, respectively. The weighted-average
remaining contractual life of the options outstanding at December 31, 2003 was 7
years.
NOTE J - RESEARCH AND DEVELOPMENT AGREEMENTS
During 2003, 2002 and 2001, the Company completed a number of small custom
development contracts for specific customers resulting in revenue of
approximately $200,000, $43,000 and $410,000, 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 K - 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, $346,000 and
$254,000, in 2003, 2002 and 2001, respectively.
The Company sponsors an Employee Stock Ownership Plan (the "Plan") covering
substantially all full-time employees. The Plan, which is a tax qualified
employee benefit plan, was adopted by the Board of Directors of the Company in
1988 to provide retirement benefits for employees. The Plan borrowed $1,325,000
to purchase 260,000 shares of the Company's stock to be allocated to
participants ratably over a ten year period. The ESOP loan was guaranteed by the
Company and the outstanding balance of the loan was repaid in 1991. The Company
did not allocate any additional shares to the Plan in 2003, 2002 or 2001. 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 2003, 2002 and 2001.
The Company terminated the ESOP plan effective December 31, 2003. There will be
no significant financial impact to the Company.
44
NOTE L - INCOME TAXES
At December 31, 2003, the Company has U.S. federal and state operating loss
carryforwards of approximately $ 27,700,000 and $25,500,000, respectively. At
December 31, 2002, the Company has U.S. federal and state operating loss
carryforwards of approximately $27,000,000 and $26,000,000, respectively. The
U.S. federal and state net operating loss carryforwards expire from 2004 through
2014. At December 31, 2003, the Company has approximately $3,600,000 and
$800,000 of net operating loss carryforwards for the United Kingdom and Germany,
respectively. There are no net operating loss carryforwards for Canada. 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, which expire from 2004 through 2009. For financial
reporting purposes, a valuation allowance has been recorded for 2003 and 2002 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) 2003 2002 2001
- -------------------------------------------------------------------------------------
Restated
Domestic $ 708 $ 811 $(6,270)
Foreign 136 212 (10)
-------------------------------------------
Income (loss) before income taxes $ 844 $ 1,023 $(6,280)
===========================================
Income taxes (benefit) are summarized as follows:
Year Ended December 31
(thousands) 2003 2002 2001
- ---------------------------------------------------------------
Current :
State $ 40 $ 80 $ 28
Federal benefit (321)
Foreign 139 1 5
-------------------------------------
Total current $(142) $ 81 $ 33
-------------------------------------
Deferred
-------------------------------------
Total $(142) $ 81 $ 33
=====================================
45
Significant components of the Company's deferred tax liabilities and assets were
as follows:
December 31
(thousands) 2003 2002
- ------------------------------------------------------------------------------------
Deferred tax assets:
Net operating loss carryforward $ 12,109 $ 11,936
Alternative minimum tax credit carryforward 168 168
Depreciation 92 92
Charitable contribution carryforward
Inventory 584 673
Bonus 26 26
Accounts receivable allowance 354 538
Goodwill 119
Vacation accrual 183 172
Other 109 155
-------------------------------
Total gross deferred tax assets 13,625 13,879
Deferred tax liabilities:
Goodwill (175)
Depreciation and other (151) (306)
-------------------------------
Total gross deferred tax liabilities (326) (306)
Valuation allowance (13,299) (13,573)
-------------------------------
Net deferred tax asset $ -- $ --
===============================
A reconciliation of the statutory taxes to the provision (benefit) for income
taxes is as follows:
Year Ended December 31
2003 2002 2001
- ------------------------------------------------------------------------------------------
Federal income taxes at statutory rate $287 $348 $(2,135)
State income taxes, net of federal benefit 66 80 28
Foreign income taxes 93
Valuation allowance, net of deferred
tax adjustments (382) (348) 2,135
Adjustment of tax reserves (206)
Other 1 5
-------------------------------------
Provision (benefit) for income taxes $(142) $81 $33
=====================================
The tax reserve decrease of $206,000 or $.03 per diluted share is directly
related to the reduction of potential tax exposures associated with certain
state and foreign exposure items.
46
NOTE M - 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, 2003, are as follows:
(thousands) Operating Leases Capital Lease
2004 $ 442 $ 94
2005 1,228 84
2006 443 74
2007 52 67
2008 52
Thereafter 259
----------------------------
Total minimum lease payments $ 2,476 319
=======
Amounts representing interest (62)
---------
Present value of net minimum lease payments $ 257
========
Rental expense for the years ended December 31, 2003, 2002, and 2001 was
$470,000, $681,000 and $718,000, respectively.
The amount of gross assets recorded under capital lease arrangements and
accumulated depreciation thereon totaled $322,000 and $43,000, at December 31,
2003 and a gross asset value of $280,000 at December 31, 2002. All leased assets
are classified as equipment. Amortization of assets recorded under capital
leases is included in depreciation expense.
Long term capital leases are recorded in other long term liabilities on the
balance sheet.
NOTE N - CONTINGENCIES
Since 2001, an action has been pending against Scan-Optics alleging, among other
things, breach of contract in connection with a contract for the delivery of
hardware, software and professional services. Scan-Optics has denied the
material allegations of the complaint and counterclaimed for breach of contract
and seeks recovery of unpaid receivables, totaling $1.4 million. Although the
ultimate outcome is uncertain, based on currently known facts, the Company
believes that it has strong defenses against the lawsuit and valid claims for
recovery for the net amount of unpaid receivables recorded in the financial
statements, and that the resolution of this matter will not have a material
adverse effect on the Company's financial position or annual operating results.
47
NOTE O - 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) 2003 2002 2001
- -----------------------------------------------------------------------------------------------------
Restated
Revenues
Solutions and products $ 21,108 $ 16,376 $ 16,667
Access services 10,563 11,499 13,193
Contract manufacturing services 410 1,466 880
------------------------------------------
Total revenues 32,081 29,341 30,740
Cost of solutions and products 13,407 10,715 13,298
Service expenses 8,813 8,539 11,200
------------------------------------------
Gross profit margin 9,861 10,087 6,242
Operating expenses, net 9,017 9,064 12,522
------------------------------------------
Income (loss) before income taxes $ 844 $ 1,023 $ (6,280)
==========================================
Total assets $ 26,073 $ 26,406 $ 27,380
Total expenditures for additions to long-lived assets $ 173 $ 79 $ 121
The Company restated the 2002 consolidated financial statements to reflect a
change in the application of generally accepted accounting principles relating
to certain liabilities. The net impact of this change increased 2002 net income
before taxes by $111,000 from the amount previously reported. Refer to Note B of
the consolidated financial statements for more details.
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.
In 2003, the Company derived 23% of its total revenue from one customer,
Northrop Grumman, IT Inc. In 2002 and 2001, no customers accounted for more than
10% of total revenue.
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) 2003 2002 2001
- ------------------------------------------------------------------------------------------------------
Latin America $ 124 12% $ 72 24% $ 152 3%
Europe 0% 149 49% 3,706 73%
Pacific Rim 944 88% 81 27% 1,225 24%
-----------------------------------------------------------------------------------
$1,068 $ 302 $5,083
===================================================================================
Export sales represented 5%, 2%, and 30% of the Solutions and Products Segment
revenues for the three years ended December 31, 2003, 2002, and 2001,
respectively. There are no exports sales derived from the Company's Access
Services Segment or Contract Manufacturing Services Segment.
NOTE P - 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 2003, 2002, and 2001 included bill and hold transactions of $2.3 million,
$1.3 million and $.1 million, respectively. Accounts receivable included bill
and hold receivables of $1.1 million and $.1 million at December 31, 2002 and
2001, respectively. There were no receivables associated with bill and hold
transactions at December 31, 2003.
49
NOTE Q - EARNINGS PER SHARE
The following table sets forth the computation of basic and diluted earnings
(loss) per share:
December 31
(thousands, except share data) 2003 2002 2001
- -----------------------------------------------------------------------------------------------------------
Restated
Numerator:
Net earnings (loss) $ 986 $ 942 $ (6,313)
=================================================
Denominator:
Denominator for basic earnings (loss)
per share (weighted-average shares) 7,026,232 7,026,232 7,026,232
Effect of dilutive securities:
Employee stock options 780,259 291,205
-------------------------------------------------
Denominator for diluted earnings (loss)
Per share (adjusted weighted-average
Shares and assumed conversions) 7,806,491 7,317,437 7,026,232
Basic earnings (loss) per share $ .14 $ .13 $ (.90)
=================================================
Diluted earnings (loss) per share $ .13 $ .13 $ (.90)
=================================================
For the year ended 2001, the effect of stock options was antidilutive,
therefore, the amounts reported for basic and diluted earnings (loss) per share
were the same.
50
NOTE R - QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
The following is a summary of the quarterly results of operations for the years
ended December 31, 2003 and 2002.
(thousands, except per share amounts) March June September December
- ---------------------------------------------------------------------------------------------------
2003
- ----
Revenues $8,110 $8,107 $7,365 $8,499
Cost of product sales and service expenses 5,527 5,374 5,227 6,092
Net income 196 214 12 564
Basic earnings per share .03 .03 .00 .08
Diluted earnings per share $ .03 $ .03 $ .00 $ .07
2002 Restated Restated
- ----
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 166 218 330 228
Basic earnings per share .02 .03 .02 .03
Diluted earnings per share $ .02 $ .03 $ .02 $ .03
Fourth quarter 2003 net income of $.6 million includes a tax benefit of $.2
million or $.03 per share due to a reduction in the tax reserves.
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. Fourth quarter 2002 net income
includes an adjustment to reduce operating expenses by $.1 million offset by
additional expense of $.1 million for bonus compensation.
Third quarter 2002 net income of $.3 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.
Third quarter 2002 net income has been restated from amounts previously reported
to reflect an increase income for the reduction in a liability of $.1 million or
$.01 per share.
51
ITEM 9 - CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
- ------------------------------------------------------------------------
FINANCIAL DISCLOSURE
--------------------
None.
ITEM 9A - 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, as of the end of the period covered by 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-15(e) and 15d-15(e), 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.
52
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 to be filed under Regulation 14A for
the Annual Meeting of Stockholders presently scheduled to be held on June 16,
2004 and is incorporated herein by reference and made a part hereof.
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 58 Chairman, Chief Executive Officer
and President 1996
Joseph P. Crouch 41 Vice President -
Manufacturing Services Division 1999
Richard C. Goyette 52 Vice President -
Sales and Marketing 1996
Richard D. Harris 43 Corporate Secretary 2001
Joel K. Howser 56 Vice President -
Software Development 1998
Clarence W. Rife 64 Vice President -
Access Services Division and
Hardware Engineering 1975
Peter H. Stelling 53 Chief Financial Officer, Vice
President, Treasurer and 2004
Assistant Corporate Secretary
Alan W. Ware 65 Vice President -
Project and System Integration 2000
53
Mr. Mavel joined the Company in January 1996 as President and Chief Operating
Officer. In June 1996, Mr. Mavel became a Director of the Company. On December
31, 1996, Mr. Mavel was promoted to Chief Executive Officer. In May 1997, Mr.
Mavel was elected Chairman of the Board of Directors. Prior to joining the
Company, from 1992 through 1995, Mr. Mavel was Vice President and General
Manager of the Imaging Systems Division of Unisys. From 1991 to 1992, he was
Group Vice President of the Financial Information Systems Division of National
Data Corporation.
Mr. 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. Stelling joined the Company in 2003 as Vice President of Finance and in 2004
was named Chief Financial Officer, Vice President, Treasurer and Assistant
Corporate Secretary. In his prior assignment, he was Senior Vice president of
Finance and Chief Financial Officer of Gale Group, an operating unit of the
Thomson corporation. Prior to Gale, Mr. Stelling served as Vice President of
Finance at Chambers Engraving Group, a unit of Dyson-Kissner-Moran, Inc, a New
York based investment firm.
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.
54
ITEM 11 - EXECUTIVE COMPENSATION
- --------------------------------
This information is included in the Company's definitive proxy statement to be
filed under Regulation 14A for the Annual Meeting of Stockholders presently
scheduled to be held on June 16, 2004 and is incorporated herein by reference.
ITEM 12 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
- ----------------------------------------------------------------------------
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 to
be filed under Regulation 14A for the Company's 2004 Annual Meeting of
Shareholders presently scheduled to be held on June 16, 2004 which is
incorporated by reference herein. The Company has six equity compensation plans
as of December 31, 2003. 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, 2003.
Number of shares of
Common Stock remaining
available for future
Number of shares of issuance under equity
Common Stock to be issued Weighted -average compensation plans
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 1,627,683 $1.56 200,272
Equity compensation plans not
approved by stockholders:
Senior management options 1,025,000 .24
Debt restructuring warrants 4,975,000 .02
----------------------------------------------------------------------
7,627,683 $1.39 200,272
======================================================================
Equity compensation plans not approved by stockholders include options for
senior management and warrants issued to Patriarch, which were both part of the
Company's 2001 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 G to
the Notes to Consolidated Financial Statements of the Company included in this
report for additional information.
55
ITEM 13 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
- --------------------------------------------------------
This information is included under the caption "Certain Transactions" in the
Company's definitive proxy statement to be filed under Regulation 14A for the
Annual Meeting of Stockholders presently to be held on June 16, 2004 and is
incorporated herein by reference.
ITEM 14 - PRINCIPAL ACCOUNTANT FEES AND SERVICES
- ------------------------------------------------
This information is included under the caption "Principal Accountant Fees and
Services" in the Company's definitive proxy statement to be filed pursuant to
Regulation 14A for the Annual Meeting of Stockholders presently scheduled to be
held on June 16, 2004 and is incorporated by reference.
56
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, 2003 and 2002
Consolidated Statements of Operations for the years ended December 31,
2003, 2002 and 2001
Consolidated Statements of Stockholders' Equity for the years ended
December 31, 2003, 2002 and 2001
Consolidated Statements of Cash Flows for the years ended December 31,
2003, 2002 and 2001
Notes to Consolidated Financial Statements - December 31, 2003
(2) The following consolidated financial statement schedule is included in
Item 14(a):
Schedule II -- Valuation and Qualifying Accounts
All other schedules for which provision is made in the applicable accounting
regulation of the Securities and Exchange Commission are not required under the
related instructions or are inapplicable, and therefore have been omitted.
(3) Listing of Exhibits
*3.1(a) Certificate of Incorporation, including amendments thereto (filed
as Exhibit 3.1 to the Company's Registration Statement on Form
S-1, File No. 2-70277).
*3.1(b) Amendments to Certificate of Incorporation adopted May 17, 1984,
included in Exhibits A, B, C and D in the Company's Proxy
Statement dated April 17, 1984 for the Annual Meeting of
Stockholders held May 17, 1984.
*3.1(c) Amendment to Article Tenth of the Certificate of Incorporation
included as Exhibit A in the Company's Proxy Statement dated
April 16, 1987 for the Annual Meeting of Stockholders held May
19, 1987.
57
3.1(d) 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.
3.1(e) Certificate of Designations, Preferences, Rights and Restrictions
for Series B Redeemable Preferred Stock dated March 30, 2004.
Filed as an exhibit to Exhibit 10.20 to this Form 10-K.
*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 10.9 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.
58
*+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.
*+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 Warrant to Purchase Shares of Common Stock of Scan-Optics, Inc.
dated December 31, 2001, is filed as Exhibit 10.17 in the
Company's Annual Report on Form 10-K filed for the year ended
December 31, 2001.
*+10.18 The Scan-Optics, Inc. Senior Executive Stock Option Plan dated
February 25, 2002 as filed as Exhibit 10.18 to Form S-8 filed on
February 28, 2002.
10.19 The Scan-Optics, Inc. 2002 Incentive and Non-Qualified Stock
Option Plan.
10.20 Third Amended and Restated Credit Agreement dated as of March 30,
2004 among Scan-Optics, Inc., the subsdiaries of Scan-Optics, the
lenders parties thereto and Patriarch Partners Agency Services,
LLC, as agent.
*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.
31.1 Certificate of the Chief Executive Officer pursuant to Section
302 of the Sarbanes-Oxley Act of 2002
31.2 Certificate of the Chief Financial Officer pursuant to Section
302 of the Sarbanes-Oxley Act of 2002
32.1 Certification of Chief Executive Officer pursuant to Section 906
of the Sabanes-Oxley Act.
59
32.2 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.
+ 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
Report on Form 8-K was filed October 30, 2003 regarding third quarter
of 2003 earnings.
(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.
60
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 30, 2004
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 30, 2004
/ss/
Peter H. Stelling
- --------------------------- Chief Financial Officer, Vice President
and Treasurer (Principal Financial and
Accounting Officer)
Date: March 30, 2004
/ss/
- ---------------------------
Logan Clarke, Jr. Director March 30, 2004
/ss/
- ---------------------------
Richard J. Coburn Director March 30, 2004
/ss/
- ---------------------------
E. Bulkeley Griswold Director March 30, 2004
/ss/
- ---------------------------
Lyman C. Hamilton, Jr. Director March 30, 2004
/ss/
- ---------------------------
John J. Holton Director March 30, 2004
/ss/
- ---------------------------
Robert H. Steele Director March 30, 2004
/ss/
- ---------------------------
Ralph J. Takala Director March 30, 2004
A majority of the Directors
61
SCHEDULE II
SCAN-OPTICS, INC. AND SUBSIDIARIES
VALUATION AND QUALIFYING ACCOUNTS
THREE YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001
(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, 2003
Allowance for doubtful
accounts (billed and unbilled) $1,574 $22 $ 462 (1) $1,134
Year ended December 31, 2002:
Allowance for doubtful
accounts (billed and unbilled) $1,936 $35 $ 397 (1) $1,574
Year ended December 31, 2001:
Allowance for doubtful
accounts (billed and unbilled) $5,615 $93 $3,772 (1) $1,936
(1) Uncollectible accounts written off, net of recoveries.
The required information regarding the valuation allowance for deferred tax
assets is included in Note K.
62