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, 2004
( ) Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the transition period from __________________________
Commission File No. 0-5265
SCAN-OPTICS, INC.
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(Exact name of registrant as specified in its charter)
Delaware 06-0851857
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
169 Progress Drive, Manchester, CT 06040
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(Address of principal executive offices) Zip Code
(860) 645-7878
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(Registrant's telephone number, including area code)
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:
$2,810,493 as of June 30, 2004.
The number of shares of common stock, $.02 par value, outstanding as of March
22, 2005 was 41,451,577.
1
DOCUMENTS INCORPORATED BY REFERENCE
- -----------------------------------
Portions of the definitive Proxy Statement, relating to the 2005 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
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 designs, develops and implements transaction and information
management work processes. Adept with sophisticated recognition, image,
workflow, network and data base technologies, the Company provides cost
effective, high quality solutions that match the unique information processing
requirements of its sophisticated client base.
The Company is a leader in developing, applying and supporting technology for
the conversion of analog information into digital. Historically the Company's
research and development activity has focused on improving accuracy and
performance of the high speed image and "OCR" (optical character recognition)
scanning platforms. Microsoft development environments on Intel platforms have
enhanced the Company's strength in developing and supporting complex system
integration projects. With clarity of experience, Scan-Optics has consistently
demonstrated the ability to maximize system performance while limiting
investment requirements for its clients. By extending this capability to the
Application Service Provider (ASP) environment we now provide our clients with
the option to receive cost reduction and service benefits through an ASP model
as well as through our traditional in-house solution.
The Company's strategy is to expand into the larger market opportunities in
Business Process Outsourcing (BPO) while utilizing the primary core competencies
of the Company in vertical solution applications.
The Company is applying its resources to provide customer solutions in four main
areas: SO series image scanner platform and solution applications, the Test and
Assessment Market, Business Process Outsourcing and Access Services. The Company
has established these divisions to focus the Company's resources in a
cost-effective manner on the clients that it serves. Although each activity 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 SO series scanner platform and solutions continues the Company's
36 year commitment to the very high end of the image capture market. Like its
predecessor, the 9000 series scanner, this SO series scanner family integrates
technology based on years of 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.
Unlike its predecessor the SO series scanner opens significant new market
opportunities in the "image only" world. 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.
In the Assessment market, the Company follows an ISO9001:2000 documented quality
process to define the customer requirements prior to proposing a value-based
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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. The company has continually invested in the skills and
expertise within its development organization. Therefore, Scan-Optics is
positioned to deliver quality solutions to this market in a timely manner.
The Business Process Outsourcing (BPO) service is focused in four areas (1)
document conversion services, (2) data capture, (3) business continuation
services and (4) knowledge applications. These services provide a low-risk,
cost-effective solution for customers with document imaging needs and will
follow the disciplined ISO9001:2000 processes for quality control that have
served the division in the past.
The Access Services Division of the Company provides third party and proprietary
product maintenance services nationwide, as well as in the UK and Canada. Access
Services has been selected by over 28 companies to provide maintenance services
for their products at customer sites or through the Access Services depot
maintenance facility. In support of its many third-party contracts, the Company
has adapted its logistics and dispatch center to support these high volume, low
cost products. This business model demonstrates the flexibility of the Company
to provide customized services to meet specific customer needs. Like the rest of
the Company, this division depends on its ISO9001:2000 quality processes to
assure high levels of customer satisfaction.
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 2005 include its existing customer base and the
vertical markets they represent, the Federal Government and the value-added
Reseller/Channel market.
Scan-Optics Technology
The Company has been a leader of technological developments in the Optical
Character Recognition (OCR), Intelligent Character Recognition (ICR), Optical
Mark Read (OMR) and Imaging arena. Our most recent developments yielded patent
applications for gray scale OMR recognition for assessment applications,
software based endorsement of images, a patent for "detecting double documents"
using acoustic sensors and a high performance image scanner based on a software
design residing on Intel platforms in a Microsoft environment.
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
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o Industry standard image scanners
o Flexible, easy-to-use forms definition tool
o Extremely high accuracy rates
o Greater flexibility in forms design
Scan-Optics' DocWise, provides a secure digital information archive utilizing
sophisticated workflow processes. DocWise can store virtually any type of
electronic file: E-mail, computer documents (Microsoft Excel and Word), digital
photos, faxes, XML files and ERM reports. DocWise provides security under
Windows NT, 2000 and XP security architecture with seven levels of access rights
built in. DocWise 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' VistaCapture is a software solution suite for rapid development of
data capture applications requiring character recognition, business rule
oriented workflow and systems integration.
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.
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:
High performance production level document scanning
Image enhancement algorithms to create high levels of 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
Test and Assessment domain knowledge
Professional Services (design, development, installation and support)
Value Added Engineering services and solutions
ISO9001:2000 documented process controls in all business disciplines
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Professional Services
In order to provide a solution that meets the processing requirement of the
client the Company provides 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 as well as third-party products, the
professional services group provides 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 designed and developed by professional services and
implemented on the customer's site or in the Scan-Optics BPO facility. The
Company also provides ongoing change control with individual, custom software
services as requested by the client. In this way, the Company can provide the
entire solution of hardware and software with support for the length of the
contract.
Customer Satisfaction
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 ISO9001:2000 certification program.
ACCESS SERVICES DIVISION
The Company has offered service and maintenance support to its customer base
since 1968. This support, offered through our Access Services Division, 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 28 different domestic and foreign
manufacturers.
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
Access Services has developed comprehensive depot maintenance capability with
logistics and call center support. The Company focuses on comprehensive
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diagnostic routines, modular designs, preventive maintenance procedures and
customer surveys to provide its users high system availability to perform
mission critical applications.
BUSINESS PROCESS OUTSOURCING
Beginning with the customer's needs, the Company can implement each outsourcing
engagement/project from concept through production. The capabilities provided
include:
Project Management
Networks/System Integration
Systems Testing
Professional Services and Training
Scan-Optics has successfully utilized its manufacturing process disciplines in
structuring an outsourcing service capability for image capture, data entry and
knowledge management. The Company has gained significant experience, validating
management's belief that significant customer value is achieved in terms of
quality and efficiency when managing the BPO workflow under documented process
and workflow controls.
SIGNIFICANT CUSTOMERS
In 2004 the Company derived 11% of its total revenue from one customer Mitsui &
Co Ltd., one of the Company's distributors in Japan. In 2003, the Company
derived 23% of its total revenue from one customer, Northrop Grumman, IT Inc. In
2002 no customers accounted for more than 10% of total revenue.
CHANNELS OF DISTRIBUTION
The Company sells to end-users, system integrators, value added resellers and
independent distributors in both the domestic and international markets.
QUALITY
All aspects of the Company's business fall under the ISO9001:2000 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, 2004 was
approximately $13.1 million. As of December 31, 2003, the backlog was
approximately $15.2 million. Backlog as of March 11, 2005 was approximately
$14.8 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.
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COMPETITION
The SO series scanner competes with the high end of the Kodak product line as
well as other companies that serve niche markets. Our strategy is to compete in
this $140M market based on price and performance.
In the assessment market we compete with a "solution" focus that includes the
integration of technologies that yield a product uniquely designed for the
testing environment defined by the client. Our competition is typically in-house
development, which would cause us to modify our approach to enter the
opportunity with a technological component as a sub-contractor. Due to the No
Child Left Behind Law this is currently a very active market where we are well
positioned.
Business Process Outsourcing is a $13 billion market and the competition is well
established, however the expertise and experience at Scan-Optics allows us to
provide a defined lower cost benefit for the client. Our client base has
required improved efficiencies over the years that we have supplied. Our clients
have generally received long term benefits based on short "payback" periods of
18 months to 2 years, which we can make our advantage as we market the solutions
based on transaction based pricing versus integrated systems pricing.
Over 50% of the revenue generated by the Access Services Division is derived
from post installation hardware and software services on Scan-Optics integrated
systems. Due to the proprietary nature of these integrated systems, this
division faces little competition for this business. The majority of 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 there 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 ISO9001:2000 quality process manual and its 35 years of experience in
providing scanner repair.
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;
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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 2003. 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 continued 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 April
2005.
PATENTS
The Company currently has nine United States patents in force, which expire
between 2005 and 2022, and two patents 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.
EMPLOYEES
As of December 31, 2004 the Company employed 183 people, including 16 with
administrative responsibilities, 12 in marketing and sales, 98 in software and
service activities, 9 in engineering and 48 in manufacturing capacities. The
Company considers its employee relations to be good. The Company has not
experienced any work stoppages.
FUNDED DEVELOPMENT AGREEMENTS
During 2004, 2003 and 2002, the Company completed a number of small custom
development contracts for specific customers resulting in revenue of
approximately $79,000, $200,000 and $43,000, respectively. These revenues offset
the related costs incurred for this development. The Company owns the technology
developed under these contracts. No royalties or other consideration is required
as part of these agreements.
9
EFFECTS OF ENVIRONMENTAL LAWS
The effect of federal and state environmental regulations on the Company's
operations is insignificant.
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) 2004 2003 2002
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Revenues
Solutions and products $ 15,886 $ 21,108 $ 16,376
Access services 10,933 10,563 11,499
Contract manufacturing services 1,922 410 1,466
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Total revenues 28,741 32,081 29,341
Cost of solutions and products 12,528 13,407 10,715
Service expenses 8,980 8,813 8,539
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Gross profit margin 7,233 9,861 10,087
Operating expenses, net 10,931 9,017 9,064
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Income (loss) before income taxes $ (3,698) $ 844 $ 1,023
===============================================================
Total assets $ 24,338 $ 26,073 $ 26,406
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Total expenditures for additions
to long-lived assets $ 329 $ 173 $ 79
===============================================================
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.
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.
10
Export sales by geographic area (based on the location of the customer) were as
follows:
(thousands) 2004 2003 2002
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Latin America $ 82 2 % $ 124 12 % $ 72 24 %
Europe 161 5 0 149 49
Pacific Rim 3,302 93 944 88 81 27
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$ 3,545 100 % $ 1,068 100 % $ 302 100 %
===============================================================================
Export sales represented 22%, 5%, and 2% of the Solutions and Products Segment
revenues for the three years ended December 31, 2004, 2003, and 2002,
respectively. There are no exports sales derived from the Company's Access
Services Segment or Contract Manufacturing Services Segment.
ITEM 2 - PROPERTIES
The Company's world headquarters and manufacturing facility is located in an
84,000 square foot, one-story building in Manchester, Connecticut, leased for a
term expiring in December 2006. The Company also leases 1,238 square feet of
office space, under a lease expiring in July 2005, in Dallas, Texas for
professional services and sales.
Scan-Optics, Ltd., a wholly owned subsidiary in the United Kingdom, also leases
office space for sales, service, and equipment demonstration.
ITEM 3 - LEGAL PROCEEDINGS
As of December 31, 2004, the Company had settled all outstanding claims and
contingencies pending during 2004 with no significant effect on cash flows or
operating results.
ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Company did not submit any matters during the fourth quarter of 2004 to a
vote of the stockholders.
11
PART II
ITEM 5 - MARKET PRICE OF AND DIVIDENDS ON THE REGISTRANT'S COMMON
EQUITY AND RELATED STOCKHOLDER MATTERS
COMMON STOCK MARKET PRICES AND DIVIDENDS
The following is a two-year history of Common Stock prices for each quarter. The
table sets forth the high and low closing quotations per share for the periods
indicated of the Common Stock on the Over-the-Counter Bulletin Board based upon
information provided by the National Association of Securities Dealers, Inc. The
closing quotations represent prices between dealers and do not include retail
markups, markdowns or commissions and may not represent actual transactions.
There were 901 stockholders of record at December 31, 2004.
Quarter Ended March 31 June 30 September 30 December 31
High Low High Low High Low High Low
- -----------------------------------------------------------------------------------------------------------------
2004 $ .80 $ .46 $ .70 $ .28 $ .43 $ .22 $ .30 $ .18
2003 $ .35 $ .25 $ .65 $ .27 $ .74 $ .50 $ .70 $ .45
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.
On August 6, 2004, the Company issued an aggregate of 34,425,345 shares of its
common stock, $.02 par value (the "Shares") to lenders affiliated with Patriarch
Partners, LLC (the Lenders), in a recapitalization pursuant to a Second Amended
and Restated Subscription and Repurchase Agreement dated as of August 6, 2004
between the Company and the Lenders. The issuance of Shares to the Lenders is a
key component of a comprehensive financial restructuring arrangement with the
Lenders commenced as of March 30, 2004 pursuant to the terms of a Third Amended
and Restated Credit Agreement between the Company and the Lenders. The terms of
the purchase and sale are discussed under "Management's Discussion and Analysis
of Consolidated Financial Condition and Results of Operation - Liquidity and
Capital Resources." The transaction was made pursuant to the exemption from
registration in Section 4(2) of the Securities Act of 1933, as amended.
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ITEM 6 - SELECTED FINANCIAL DATA
SCAN-OPTICS, INC. AND SUBSIDIARIES
FIVE YEAR SUMMARY OF OPERATIONS
SELECTED FINANCIAL DATA
(thousands, except share data) 2004 2003 2002 2001 2000
- ---------------------------------------------------------- --------------- --------------- ---------------- ---------------
Total Revenues $ 28,741 $ 32,081 $ 29,341 $ 30,740 $ 38,302
================ =============== =============== ================ ===============
Income (loss) before income taxes (3,698) 844 1,023 (6,280) (17,709)
Income taxes (benefit) 71 (142) 81 33 61
---------------- --------------- --------------- ---------------- ---------------
Net Income (Loss) $ (3,769) $ 986 $ 942 $ (6,313) $ (17,770)
================ =============== =============== ================ ===============
Basic earnings (loss) per share $ (.18) $ .14 $ .13 $ (.90) $ (2.53)
================ =============== =============== ================ ===============
Basic weighted-average shares 20,890,686 7,026,232 7,026,232 7,026,232 7,025,064
================ =============== =============== ================ ===============
Diluted earnings (loss) per share $ (.18) $ .13 $ .13 $ (.90) $ (2.53)
================ =============== =============== ================ ===============
Diluted weighted-average shares 20,890,686 7,806,491 7,317,437 7,026,232 7,025,064
================ =============== =============== ================ ===============
SELECTED BALANCE SHEET DATA
Total assets $ 24,338 $ 26,073 $ 26,406 $ 27,380 $ 36,513
Working capital (deficit) 2,912 4,957 5,394 4,184 (9,833)
Long term obligations 11,142 9,379 10,428 11,397
Mandatory redeemable preferred stock 855 4,286 4,054 3,800
Total stockholder's equity 2,314 2,443 1,383 360 4,307
The Company has not paid any dividends for the five-year period ended December
31, 2004.
The above financial data should be read in conjunction with the related
consolidated financial statements and notes thereto.
Certain amounts have been reclassified to conform to the current year
presentation.
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ITEM 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF CONSOLIDATED FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Forward Looking Information
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, 2004 of approximately $11.6 million by
$.1 million. The Company completed a recapitalization on August 6, 2004 (see
"-Liquidity and Capital Resources" and Note F to the Company's Consolidated
Financial Statements for further details), and as a result the Company's lenders
have acquired a significant voting control and accordingly have the right and
the ability to influence the way in which the Company does business, including
its strategy and tactics. 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. Further, the Company's
business could be adversely affected by technological changes.
Overview
The Company reported net loss for the year of $3.8 million or $.18 per share,
compared to a net income of $1 million, or $.13 per diluted share, for 2003. The
Company's ability to effectively address these issues will have a direct impact
on its operating results, its ability to generate sufficient cash to fund
operations and its ability to comply with existing debt covenants. The Company's
operating results for 2004 were significantly adversely affected compared to
2003 by certain non-recurring and transitional events, including the settlement
of outstanding litigation, the phasing out of the sale of the Company's mature
line of 9000 Series scanners, the phased market introduction of varied models of
the Company's new generation of SO Series scanners, and the development of new
channels of distribution for the Company's hardware and software. During 2004
the Company executed a financial restructuring and recapitalization that was
approved at the annual meeting on July 15, 2004. See "Liquidity and Capital
Resources" and Note F to the Company's Consolidated financial statements under
14
Item 8 of this Form 10-K. The Company continued its investment in research and
development for a new image scanning platform in 2004 and introduced the first
product in the SO series family during the AIIM trade show in March 2004. The SO
product earned "Best in Show Award" for high-end image scanners. This success
was followed by the installation of the in-line OCR version in the fourth
quarter of 2004. This image scanner family was designed to satisfy the
requirement of our very sophisticated customer base but is also scalable to
provide excellent price performance in the competitive market space.
The Company has three major initiatives currently underway to develop sources of
revenue growth and profitability. The first is to capitalize on the SO series
investment and generate significant sales revenues in the high-end image scanner
market both domestically and internationally. In 2004 the Company introduced its
entry into the Business Process Outsourcing marketplace with initial contracts
in state tax processing, warranty registration forms processing, knowledge
management and business continuation services. The Company is also focused on
the assessment market with "solution" content. Currently on hold is activity to
add long term value through the acquisition of key strategic services or
enterprises. The inability of the Company to carry out these initiatives could
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 its high-speed image transports. The Company has
expanded its target market approach to include value-added resellers and
distributors. It has also expanded its market coverage to include International
distributors in Japan and other countries.
The second initiative is Business Process Outsourcing ("BPO") Services that
offer the market access to the Company's technology and systems on a transaction
basis. The Company's' BPO Services provide a low-risk, cost-effective solution
for customers with requirements for document conversion services, business
continuation services, knowledge management or business process outsourcing. The
BPO services offer customers a high quality, ISO9001 2000 certified, turnkey
outsourcing solution utilizing the Company's proprietary hardware technology,
and further leveraging software skills, resources and process controls.
The third initiative is the solution focus in the assessment market. Fueled by
the No Child Left Behind law, Scan-Optics has experienced significant success in
this market adding significant value with our proprietary software solutions and
high performance image and optical mark read (OMR) scanners.
The Access Services Division continues to provide critical support capability to
customers as well as other third parties where they provide services. 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 maintenance to its existing customer
base as well as new accounts.
While the Company is principally focused on achieving consistent profitability
with 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.
15
RESULTS OF OPERATIONS - 2004 VS. 2003
Total revenues decreased $3.3 million or 10% from 2003 to 2004.
Hardware and software revenue decreased $4.2 million or 26% from the prior year.
North American sales decreased $3.2 million or 28%. Total international sales
increased to $3.5 million in 2004 compared to $1.1 million in 2003.
International sales in the Pacific Rim increased to $3.3 million due to
significant scanner systems orders and spare parts sold to the Company's
distributor in Japan. Sales to Europe and Latin American increased to $.2
million in 2004 compared to $.1 million in the prior year. The Company has
phased out the sale and production of its mature line of 9000 Series scanners,
while introducing to the market, in phases, varied models of the Company's new
generation of SO Series scanners and developing new channels of distribution for
the Company's hardware and software, which concurrent activities accounted for a
majority of the decreased hardware and software revenue.
Professional services revenue increased to $5.9 million ($.5 million or 8% from
2003 to 2004) mainly due increased solution sales to the Company's target
customer base.
Access services revenue increased to $10.9 million ($.4 million or 4% from 2003
to 2004). Commencing in the fourth quarter of 2004, revenues on contracts that
are not expected to be activated are recognized over the estimated final term
for which the Company may possibly be required to perform. Under this change in
accounting estimate, the Company recognized $.4 million revenues on contracts
for which its obligation to perform is remote. Other increases in revenue from
the Company's third party maintenance business were offset by a decline in
proprietary maintenance contracts.
Cost of hardware and software revenue gross margin for 2004 was 19% compared to
33% for 2003 and reflects the start up phase of the new SO Series scanners. The
gross margin in 2004 included a provision of $.5 million for slow-moving
inventory.
Cost of professional services revenue gross margin in 2004 was 52%, as compared
to 50% in 2003. The change was mainly due to increased sales volume which
results in higher utilization rates for available resources.
Cost of Access services revenue gross margin was 18% in 2004 compared to 17% in
2003 reflecting higher sales volume and a relatively fixed cost structure. Gross
margin in 2004 was effected by a $.3 million provision for slow-moving inventory
related to the United Kingdom.
Sales and marketing expenses decreased $.1 million or 4% from 2003, principally
due to lower salary and commission expenses partially offset by increased
advertising expense.
Research and development expenses increased $.7 million or 54% from 2003 mainly
due to higher salary and external consulting costs in 2004. These costs were
lower in 2003 due to the capitalization of certain software development costs.
General and administrative expense increased $1.2 million or 34% from 2003. The
increase reflects a $.5 million provision for accounts receivable as a result of
the settlement of a legal action. The remaining portion of the increase is
16
mainly due to increased legal fees of $.2 million, stock option expense of $.2
million, health insurance claims expense of $.2 million and other expenses.
Interest expense of $.9 million remained consistent with 2003. The weighted
average interest rate was 7.3% in 2004 compared to 4.8% in 2003. The increase in
the weighted average interest rate is due to accretion on the $1.5 million term
loan working capital facility for which the Company is obligated to repay $2
million at maturity.
Other income decreased $.1 million from 2003. In 2003, the Company recognized as
other income on $.1 million for previously recorded liabilities that were no
longer due or had been settled for amounts less than that previously recorded.
Income tax expense increased $.2 million from 2003 mainly for state income and
foreign taxes.
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.
17
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 an effort to expand into
the federal government 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.
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.
18
LIQUIDITY AND CAPITAL RESOURCES
Cash and cash equivalents at December 31, 2004 of $.5 million decreased $0.1
million from December 31, 2003.
Outstanding borrowings increased $3.6 million to $11.6 million at December 31,
2004 from $8.0 million at the end of 2003. The available balance on the line of
credit was $1.5 million at December 31, 2004. As of December 31, 2004, the
Company is in compliance with all financial covenants. The Company anticipates
meeting its current obligations and other resource needs in 2005 with funds
generated through operations and its available line of credit. However,
Underachieved operating results could adversely effect the Company's ability to
remain in compliance.
On August 6, 2004, the Company completed a recapitalization with its lenders,
Patriarch Partners LLC, (the Lenders) after obtaining stockholder approval at
the Company's July 15, 2004 annual meeting. The recapitalization included, among
other terms, the cancellation of $3.8 million of mandatorily redeemable Series B
preferred stock, including accrued dividends, and warrants for 33.2% of the
Company's outstanding common stock on a fully-diluted basis, both held by the
Lenders, in exchange for the issuance of 34,425,345 shares of common stock of
the Company (or 79.8% of the Company's outstanding common stock on a
fully-diluted basis, subject to dilution for certain compensatory stock options
granted by the Company) to the Lenders. In addition:
* The Company's secured term and revolving debt was exchanged for a
$9.0 million term loan and a $2.5 million revolving loan. The new term loan is
payable in annual amounts of $90,000 beginning April 1, 2005 with the balance
due at maturity. Borrowings accrue interest at a rate of prime plus 2%.
* An additional $1.5 million term loan working capital facility was
made available to the Company, with the Company obligated to repay $2 million at
maturity. (Interest is being accreted such that the carrying amount of this loan
at maturity will be $2 million.) This loan accrues interest at the prime rate.
* The Company's financial covenants with respect to backlog, capital
expenditure and EBITDA were modified.
* Effective upon the closing of the recapitalization on August 6,
2004, the maturity date for all of the Company's secured indebtedness to the
Lenders was extended through 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 short-term 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 loan maturities
through March 2007.
19
The Company's significant contractual obligations and commitments that impact
its liquidity as of December 31, 2004 follow:
Contractual Obligations Payments Due by Period
- -----------------------------------------------------------------------------------------------------
Less
than 1 1 - 3 4 - 5 After 5
(thousands) Total year years years years
- ------------------------------------------------ ------------ ------------- ------------ ------------
Notes payable $ 11,605 $ 1,000 $ 10,605
Redeemable preferred stock 855 855
Executive insurance agreement 359 50 100 $ 100 $ 109
Capital leases 225 84 141
Operating leases 1,262 450 552 104 156
-------------- ------------ ------------- ------------ ------------
Total contractual
cash obligations $ 14,306 $ 1,584 $ 12,253 $ 204 $ 265
============== ============ ============= ============ ============
Operating activities used $2.2 million of cash in 2004 compared to providing
$3.0 million in 2003. Non-cash expenses in 2004 were $4.2 million compared to
$2.6 million in 2003. The non-cash items relate to depreciation, amortization of
customer service inventory and software license, and provisions for losses on
accounts receivable and slow-moving inventory. These and other components of
operating activities are discussed below.
Net accounts receivable and unbilled receivables decreased $1.8 million from
December 31, 2003 due principally to lower sales in the second half of 2004,
$14.5 million, as compared to the second half of 2003, $15.8 million and
provision for losses on accounts receivable of $.6 million.
Total inventories increased $.2 million from 2003 levels. Manufacturing
inventories increased $.8 million during the year due to an increase in
materials and component parts of $1.2 million and a decrease in work-in-process
inventory of $.4 million. Finished goods inventory remained consistent with
prior year levels. The increase in materials and component parts is mainly due
to the ongoing production schedule for the SO Series scanner in first quarter of
2005 as compared to the initial product launch schedule of the SO Series scanner
in early 2004. Customer service inventory decreased for the year by $.6 million,
which was mainly attributable to the amortization of spare parts.
Net plant and equipment decreased $.1 million in 2004. This net decrease is due
to depreciation of $.4 million, partially offset by additions of $.3 million. No
significant additions are planned for 2005.
Accounts payable increased $.5 million over December 31, 2003 relating to the
timing of payments.
Notes payable to bank increased $3.6 million as a result of borrowing against
the Company's available line of credit to fund increased production schedules
for the SO Series scanner and general corporate needs. Salaries and wages
decreased $.8 million from 2003 mainly due to the absence of a bonus accrual at
December 31, 2004.
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.
20
Customer deposits decreased $.8 million due mainly to large orders in 2003 that
contained deposit requirements as part of the contract which were not replicated
in the fourth quarter of 2004.
Other current liabilities decreased $.3 million due mainly to a $.3 million
decrease in various accrued expenses.
Other long term liabilities decreased $.9 million mainly due to the conversion
of operating leases totaling $.8 million into preferred stock as part of the
debt restructuring effective August 6, 2004.
21
OTHER MATTERS
New Accounting Standards
Refer to Note B of the Notes to Consolidated Financial Statements in Item 8 for
a discussion of new accounting pronouncements and the potential impact on the
Company's consolidated financial statements.
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 estimations 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 for
excess and obsolete manufacturing inventories to determine if the inventory
valuation allowances are 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 carrying
amounts are reviewed periodically for appropriateness.
22
Long-lived assets: The Company records impairment losses on long-lived assets
(including goodwill) 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 long-lived assets, to determine whether
events or circumstances warrant revised estimates of useful lives. If the
business plan's operating results, the Company used to calculate the
undiscounted cash flows are not achieved, a potential impairment could result
with a write-down of the carrying value of long-lived assets required.
23
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, 2004 of approximately $11.6 million by $.1 million.
The Company has minimal foreign currency translation risk. All international
sales other than sales originating from the UK and Canadian subsidiaries are
denominated in United States dollars.
Refer to the 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.
24
ITEM 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
25
REPORT of UHY LLP, INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Stockholders and Board of Directors
Scan-Optics, Inc.
We have audited the accompanying consolidated balance sheet of Scan-Optics, Inc.
and subsidiaries as of December 31, 2004 and the related consolidated statements
of operations, stockholders' equity, and cash flows for the year then ended. Our
audit also included the financial statement schedule for 2004 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 audit.
We conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (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 audit provides 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, 2004 and the consolidated
results of their operations and their cash flows for the year then ended in
conformity with accounting principles generally accepted in the United States of
America. Also, in our opinion, the related financial statement schedule for
2004, when considered in relation to the basic financial statements taken as a
whole, presents fairly in all material respects the information set forth
therein.
/s/ UHY LLP
Hartford, Connecticut
March 18, 2005
26
REPORT of ERNST & YOUNG LLP, INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
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 the related consolidated
statements of operations, stockholders' equity, and cash flows for each of the
two years in the period ended December 31, 2003. Our audits also included the
financial statement schedule for 2003 and 2002 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 the standards of the Public Company
Accounting Oversight Board (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 the consolidated
results of their operations and their cash flows for each of the two 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 for the years ended December 31, 2003 and 2002,
when considered in relation to the basic financial statements taken as a whole,
presents fairly in all material respects the information set forth therein.
/s/ Ernst & Young LLP
Hartford, Connecticut
March 26, 2004
27
SCAN-OPTICS, INC., AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
December 31
(thousands, except share data) 2004 2003
- -------------------------------------------------------------------------------------------------
Assets
Current Assets:
Cash and cash equivalents $ 477 $ 585
Accounts receivable less allowance of $238 in 2004
and $1,134 in 2003 4,314 6,043
Unbilled receivables - contracts in progress 298 415
Inventories 7,461 7,282
Prepaid expenses and other 389 597
--------------------------------------
Total current assets 12,939 14,922
Equipment and Leasehold Improvements:
Equipment 3,386 3,682
Leasehold improvements 4,089 4,010
Office furniture and fixtures 557 745
--------------------------------------
8,032 8,437
Less accumulated depreciation and amortization 7,095 7,422
--------------------------------------
937 1,015
Goodwill 9,040 9,040
Other assets 1,422 1,096
--------------------------------------
Total Assets $ 24,338 $ 26,073
======================================
28
December 31
(thousands, except share data) 2004 2003
- -----------------------------------------------------------------------------------------------------------------
Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable $ 2,822 $ 2,323
Note payable 1,000
Salaries and wages 702 1,484
Taxes other than income taxes 641 758
Income taxes 68 189
Deferred revenue 3,408 2,787
Customer deposits 143 929
Other 1,243 1,495
------------------------------------
Total current liabilities 10,027 9,965
Notes payable 10,605 7,989
Other liabilities 537 1,390
Mandatory redeemable preferred stock, at redemption value:
Series B, 3,800,000 shares issued and outstanding 4,286
Series I, 420,857 shares issued and outstanding 855
------------ ------------
Total Liabilities 22,024 23,630
Stockholders' Equity
Preferred stock, par value $.02 per share, authorized
5,000,000 shares
Common stock, par value $.02 per share:
authorized 65,000,000 shares; 41,865,077 issued
at December 31, 2004 and 7,439,732 issued
at December 31, 2003, including treasury shares 837 149
Capital in excess of par value 41,651 38,354
Accumulated retained-earnings deficit (36,339) (32,570)
Accumulated other comprehensive loss - currency
translation adjustment (1,189) (844)
------------------------------------
4,960 5,089
Cost of common stock in treasury, 413,500 shares (2,646) (2,646)
------------------------------------
Total stockholders' equity 2,314 2,443
------------------------------------
Total Liabilities and Stockholders' Equity $ 24,338 $ 26,073
====================================
See accompanying notes.
29
SCAN-OPTICS, INC., AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
Year Ended December 31
(thousands, except share data) 2004 2003 2002
- ------------------------------------------------------------------------------------------------------
Revenues
Hardware and software $ 11,883 $ 16,044 $ 11,292
Professional services 5,925 5,474 6,550
Access services 10,933 10,563 11,499
--------------- ------------- -----------------
Total revenues 28,741 32,081 29,341
Costs of Revenue
Hardware and software 9,655 10,690 7,816
Professional services 2,873 2,717 2,899
Access services 8,980 8,813 8,539
--------------- ------------- -----------------
Total costs of revenues 21,508 22,220 19,254
Gross Profit 7,233 9,861 10,087
Operating Expenses
Sales and marketing 3,327 3,455 3,273
Research and development 1,955 1,267 1,798
General and administrative 4,787 3,572 3,566
Interest 867 856 846
--------------- ------------- -----------------
Total costs and expenses 10,936 9,150 9,483
--------------- ------------- -----------------
Operating income (loss) (3,703) 711 604
Other income, net 5 133 419
--------------- ------------- -----------------
Income (loss) before income taxes (3,698) 844 1,023
Income taxes (benefit) 71 (142) 81
--------------- ------------- -----------------
Net Income (Loss) $ (3,769) $ 986 $ 942
=============== ============= =================
Basic earnings (loss) per share $ (.18) $ .14 $ .13
=============== ============= =================
Basic weighted-average shares 20,890,686 7,026,232 7,026,232
=============== ============= =================
Diluted earnings (loss) per share $ (.18) $ .13 $ .13
=============== ============= =================
Diluted weighted-average shares 20,890,686 7,806,491 7,317,437
=============== ============= =================
See accompanying notes.
30
SCAN-OPTICS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF
STOCKHOLDERS' EQUITY
Accumulated Accumulated
Common Stock Capital in Retained- Other
(thousands, except share data) ----------------- Excess of Earnings Comprehensive Treasury
Shares Amount Par Value Deficit Loss Stock Total
- ------------------------------------------------------------------------------------- -------------- ------------- -------------
Balance January 1, 2002 7,439,732 $ 149 $ 38,354 $ (34,498) $ (999) $ (2,646) $ 360
Net income 942 942
Currency
translation 81 81
adjustments
-------------
Comprehensive income 1,023
- --------------------------------------------------------------------------------------------------------------------------------
Balance December 31, 2002 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
Net loss (3,769) (3,769)
Currency translation
adjustments (345) (345)
-------------
Comprehensive loss (4,114)
Exchange of common stock for
debt 34,425,345 688 3,712 4,400
Common stock issuance costs (606) (606)
Fair value of stock options
issued to non-employees 191 191
- --------------------------------------------------------------------------------------------------------------------------------
Balance December 31, 2004 41,865,077 $ 837 $ 41,651 $ (36,339) $(1,189) $ (2,646) $ 2,314
================================================================================================================================
See accompanying notes.
31
SCAN-OPTICS, INC., AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year Ended December 31
(thousands) 2004 2003 2002
- ------------------------------------------------------------------------------------- --------------------- --------------------
Operating Activities
Net income (loss) $ (3,769) $ 986 $ 942
Adjustments to reconcile net income (loss) to net
cash provided (used) by operating activities:
Depreciation 404 426 425
Amortization of customer service inventory and
development costs 2,134 1,885 2,355
Amortization of deferred debt costs 119
Accretion of interest on debt 105
Accretion of interest on preferred stock 128 486 254
Fair value of common stock options granted to
non-employees 191
Provision for losses on accounts receivable 567 22 35
Provision for slow-moving inventory 527 50
Reversal of previously recorded liabilities (183) (369)
Changes in operating assets and liabilities:
Accounts receivable 1,279 (549) (668)
Inventories (2,648) (28) (2,634)
Prepaid expenses and other 208 (6) (87)
Accounts payable 499 232 (819)
Accrued salaries and wages (782) 457 (353)
Taxes other than income taxes (117) 257 (23)
Income taxes (121) 144 40
Deferred revenue 621 570 116
Customer deposits (786) (379) 801
Other (767) (1,283) (233)
------------------- --------------------- --------------------
Net cash provided (used) by operating activities (2,208) 3,037 (168)
Investing Activities
Acquisition related settlement 209
Purchases of plant and equipment, net (329) (173) (79)
------------------- --------------------- --------------------
Net cash provided (used) by investing activities (329) (173) 130
Financing Activities
Debt and equity transaction costs (1,082)
Proceeds from borrowings 5,711 7,650 4,376
Principal payments on borrowings (2,200) (10,203) (5,726)
-------------------- -------------------- --------------------
Net cash provided (used) by financing activities 2,429 (2,553) (1,350)
Increase (decrease) in cash and cash equivalents (108) 311 (1,388)
Cash and cash equivalents at beginning of year 585 274 1,662
-------------------- -------------------- --------------------
Cash and Cash Equivalents at End of Year $ 477 $ 585 $ 274
==================== ==================== ====================
Supplemental Cash Flow Information
Interest paid $ 626 $ 732 $ 667
==================== ==================== ====================
Income taxes paid $ 126 $ 24 $ 44
==================== ==================== ====================
See accompanying notes.
32
SCAN-OPTICS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE A - DESCRIPTION OF BUSINESS
Scan-Optics, Inc. and its subsidiaries (collectively, the Company) combine
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 - 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 have been eliminated in the consolidated
financial statements. Certain amounts have been reclassified to conform to the
current year presentation.
Use of Estimates: The preparation of financial statements in conformity with
accounting principles generally accepted in the United States of America
requires management to make estimates and assumptions that affect the amounts
reported in them, including the 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. Significant estimates included in the financial statements relate to
asset valuation allowances for potentially uncollectible accounts receivable;
slow-moving and obsolete inventories; and deferred income tax assets. Further,
other significant estimates relate to revenue recognition
Foreign Currency Translation: All balance sheet accounts have been translated
using the exchange rates in effect at the balance sheet date. Statement of
operations accounts 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 accumulated other comprehensive loss, a
component of Stockholders' Equity.
Cash Equivalents: Highly liquid investments purchased with maturities of three
months or less when purchased 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
33
installation depending on the contract terms and conditions. When customers,
under the terms of specific orders or contracts, request the Company to
manufacture and invoice the equipment on a bill and hold basis, the Company
recognizes revenue based on 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.
Returns were not significant for any period presented. At December 31, 2004 two
customers represented 30% and 17%, respectively, of accounts receivable. At
December 31, 2003 one customer represented 33% of accounts receivable.
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, as 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. No
significant losses were required to be provided for any period presented.
The Company provides maintenance services under contracts with terms ranging
from nine to 36 months. Revenues on activated contracts are recognized over the
term of the contract as the Company fulfills its obligation for performance.
Commencing in the fourth quarter of 2004, revenues on contracts that are not
expected to be activated are recognized over the estimated final term for which
the Company may possibly be required to perform. Under this change in accounting
estimate, the Company recognized $405,000 of revenues on contracts for which its
obligation to perform is remote.
Accounts receivable are recognized when billed under the contract terms. Based
on certain pre-negotiated contract terms billings may not coincide with revenue
recognition. Revenues earned but not yet billable are shown as 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 each customer's current financial condition,
general economic and industry conditions and past experience. Accounts
receivable are charged to the allowance when deemed uncollectible.
Inventories: Inventories of materials and component parts, and in-process and
finished goods are stated at the lower of cost (first-in, first-out method) or
market. The Company periodically provides for obsolete and slow-moving
inventories based on historical usage, future requirements and anticipated
demand. The fourth quarter of 2004 includes a provision of $527,000 for
slow-moving inventory. As of December 31, 2004 allowances for obsolete and
slow-moving inventories were $1,764,000 ($1,268,000 as of December 31, 2003).
Service parts held and restricted primarily for customer use under maintenance
contracts are amortized over four years. As such, service parts are stated at
amortized cost which is reviewed periodically for reasonableness.
Equipment and Leasehold Improvements: Equipment and leasehold improvements are
stated on the basis of cost. Depreciation is computed principally using the
straight-line method over the estimated
34
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.
Other Assets: Other assets consist primarily of capitalized software development
costs and deferred debt costs. Certain internal and external software
development costs are capitalized in accordance with FASB Statement No. 86,
Accounting for the Costs of Software to be Sold, Leased, or Otherwise Marketed.
These costs are amortized on a straight-line basis over the estimated economic
life of the software. Related amortization is greater than that computed on a
units sold basis. Deferred debt costs are being amortized over the term of the
debt.
Asset Impairment: Goodwill and other long-lived assets are reviewed at least
annually for impairment or whenever facts and circumstances suggest they may be
impaired. There were no impairments for any of the years presented.
Goodwill: Goodwill consists of the excess of cost over the fair value of
identifiable net assets of businesses acquired. Goodwill is carried at cost,
less amortization thereon to January 1, 2002; the carrying amount of goodwill is
not in excess of its estimated recoverable amount.
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, 2004 and 2003 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 ($171,000 in 2004,
$10,000 2003, and $12,000 in 2002) 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.
35
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. Options granted to non-employees are recorded at fair value.
The Company recognized compensation expense of $191,000 in 2004 associated with
options granted to non-employees.
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:
Year Ended December 31
(thousands, except per share amounts) 2004 2003 2002
-------------------------------------------------------------- ---------------- --------------- ----------------
Net income (loss), as reported $ (3,769) $ 986 $ 942
Stock option expense (815) (93) (199)
---------------- --------------- ----------------
Pro forma net income (loss) $ (4,584) $ 893 $ 743
================ =============== ================
Basic earnings (loss) per share, as reported $ (.18) $ .14 $ .13
Stock option expense (.04) (.01) (.03)
---------------- --------------- ----------------
Pro forma basic earnings (loss) per share $ (.22) $ .13 $ .10
================ =============== ================
Diluted earnings (loss) per share, as reported $ (.18) $ .13 $ .13
Stock option expense (.04) (.01) (.03)
---------------- --------------- ----------------
Pro forma diluted earnings (loss) per share $ (.22) $ .12 $ .10
================ =============== ================
The weighted-average fair value price of options granted was $.21, $.27 and $.34
for 2004, 2003, and 2002, respectively.
Option valuation models require the input of highly subjective assumptions
including the expected stock price volatility. The assumptions used in the
valuation model were: expected life-10 years; risk free interest rate of 4%, 3%,
and 7% for 2004, 2003, and 2002, respectively and expected volatility of .786,
1.102, and 1.39 for 2004, 2003, and 2002, respectively.
36
Earnings (Loss) Per Share: The following table sets forth the computation of
basic and diluted earnings (loss) per share:
Year Ended December 31
(thousands, except share data) 2004 2003 2002
----------------------- ---------------------- ----------------------
Numerator:
Net earnings (loss) $ (3,769) $ 986 $ 942
======================= ====================== ======================
Denominator:
Denominator for basic earnings (loss)
per share (weighted-average shares) 20,890,686 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) 20,890,686 7,806,491 7,317,437
======================= ====================== ======================
Basic earnings (loss) per share $ (.18) $ .14 $ .13
======================= ====================== ======================
Diluted earnings (loss) per share $ (.18) $ .13 $ .13
======================= ====================== ======================
New Accounting Pronouncements:
Statement of Financial Accounting Standards (FAS) No. 151, Inventory Costs, an
amendment of ARB No. 43, Chapter 4 requires that abnormal amounts of idle
capacity and spoilage costs should be excluded from the cost of inventories and
expensed when incurred. FAS No. 151 is effective for fiscal periods beginning
after June 15, 2005. The Company does not expect this standard to have a
material effect on its financial statements upon adoption.
FAS No. 123R, Share-Based Payment requires that a public entity measure the cost
of equity based service awards based on the grant-date fair value of the award.
That cost will be recognized over the period during which an employee is
required to provide service in exchange for the award or the vesting period. No
compensation cost is recognized for equity instruments for which employees do
not render the requisite service. A public entity will initially measure the
cost of liability based service awards based on current fair value. The fair
value of those awards will be re-measured subsequently at each reporting date
through the settlement date. Changes in fair value during the requisite period
be recognized as compensation cost over that period. FAS 123R is required for
fiscal periods beginning after June 15, 2005. The Company has not yet attempted
to evaluate the likely effects on its financial statements.
37
NOTE C - UNBILLED RECEIVABLES - CONTRACTS IN PROGRESS
Unbilled amounts in accounts receivable under contracts in progress were $.3
million and $.4 million at December 31, 2004 and 2003, 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
2005.
NOTE D - INVENTORIES
The components of inventories were as follows:
December 31
(thousands) 2004 2003
- --------------------------------------------------------------------------------
Finished goods $ 57 $ 57
Work-in-process 644 1,066
Service parts 2,713 3,291
Materials and component parts 4,047 2,868
--------------------------
$ 7,461 $ 7,282
==========================
NOTE E - OTHER ASSETS
The following table summarizes other assets:
December 31,
2004 2003
-------------------------
Software development cost $ 1,120 $ 960
Deferred debt costs 476 -
Cash surrender value of life insurance policy 137 136
-------------------------
1,733 1,096
Accumulated amortization (311) -
-------------------------
$ 1,422 $ 1,096
=========================
The Company capitalized software development costs of $160,000 and $960,000 in
2004 and 2003, respectively. The Company commenced amortizing these costs in
2004 over a five year period. Total amortization of software development costs
was $192,000 in 2004. In connection with the new credit agreement disclosed in
Note F, the Company incurred $1,082,000 of transaction costs of which $476,000
were allocated to debt. These costs were deferred and are being recognized in
expense over the three year term of the credit agreement. Total amortization of
deferred debt costs was $119,000 in 2004.
The estimated aggregate amortization expense for each of the next five
succeeding years follows: 2005 - $384,000, 2006 - $384,000, 2007 - $264,000,
2008 - $225,000, and 2009 - $28,000.
38
NOTE F - CREDIT ARRANGEMENTS
Effective March 30, 2004, the Company entered into a new credit agreement (the
Credit Agreement) with lenders affiliated with Patriarch Partners, LLC. (the
Lenders). Among other things, under the Credit Agreement the Company's existing
revolving and term loans with outstanding amounts of $9.0 million were exchanged
for a $9.0 million term loan, a $2.5 million revolving credit facility and a
$1.5 million term loan working capital facility. The $9.0 million term loan
bears interest at prime plus 2% and is payable in two annual installments of
$90,000 on April 1, 2005 and 2006 with the balance of $8,820,000 due on March
30, 2007.
In the second quarter of 2004, the Company borrowed $1.5 million under the term
loan working capital facility of the Credit Agreement. Such borrowings bear
interest at prime. The Credit Agreement requires the Company to repay the
borrowed amount plus $500,000 at March 30, 2007. The additional $500,000 is
being expensed as interest and accreted to debt over the term of the loan.
As of December 31, 2004, $1 million was outstanding under the $2.5 million
revolving credit facility portion of the Credit Agreement. Outstanding
borrowings bear interest at prime plus 2% and are due March 30, 2007.
As part of the Credit Agreement the Company is required to meet financial
covenants with respect to backlog, capital expenditures and EBITDA. The Company
is in compliance with the modified covenants.
On August 6, 2004, the Company completed a recapitalization with its Lenders,
which had been approved by the Company's shareholders on July 15, 2004. The
recapitalization included, among other terms, the cancellation of the $3.8
million of Mandatorily Redeemable Series B Preferred Stock, including dividends
of $0.6 million and outstanding warrants held by the Lenders, in exchange for
34,425,345 shares of Common Stock. As such, the Lenders own 79.8% of the
fully-diluted Common Stock of the Company at the date of issuance, subject to
dilution for certain current and future compensatory stock options granted by
the Company. Due to the compensatory stock options, 6,470,929 shares are
redeemable if the 2001 executive options are exercised. The Company also issued
an aggregate of 420,857 shares of 4% Series I Preferred Stock with a mandatory
redemption on March 30, 2007 for $841,714 plus unpaid dividends at 4%.
Effective upon the closing of the recapitalization on August 6, 2004, the
maturity date for all of the Company's secured indebtedness to the Lenders was
extended through March 30, 2007.
Borrowings under the Credit Agreement are secured by all of the Company's
assets.
NOTE G - CAPITAL STOCK
An amended and restated certificate of incorporation was approved by the
shareholders at the Company's annual meeting held July 15, 2004. As such, the
total authorized capital stock of the Corporation is 70,000,000 shares
consisting of 65,000,000 shares of Common Stock, par value $.02 per
39
share and 5,000,000 shares of Preferred Stock, par value $.02 per share. As of
December 31, 2004 420,857 shares of Preferred Stock have been designated as
Series I, with dividends at 4%, and are outstanding.
On August 6, 2004, the Company issued 420,857 shares of Series I Preferred Stock
in exchange for cancellation of lease obligations aggregating $842,000 that the
Lenders acquired from the lessor. The Series I Preferred Stock and accrued 4%
annual dividends are redeemable March 30, 2007. As of December 31, 2004 the
carrying value of Preferred Stock is $855,000. Accumulated deferred dividends
were $13,000 as of December 31, 2004.
The recapitalization which was effective August 6, 2004 included, among other
terms, the cancellation of the 380,000 shares of $3.8 million mandatorily
redeemable Series B Redeemable Preferred Stock, par value $.02, the cancellation
of existing warrants exercisable for Common Stock held by the Lenders, and the
issuance of 34,425,345 shares of Common Stock of the Company to the Lenders.
There are 41,451,577 shares issued and outstanding as of December 31, 2004.
There are also 413,500 shares of treasury stock.
At December 31, 2004, the Company had reserved 1,292,983 shares of common stock
for the issuance or exercise of stock options.
40
NOTE H - 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 and certain other options granted in 2004 under the senior
executive stock option plan were exercisable in full upon grant of such option.
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, 2004:
Number of Weighted Option Price
Shares Average Price Per Share
- ----------------------------------------------------------- ---------------------- ----------------- ------------------------------
Outstanding January 1, 2002 (782,261 exercisable) 2,198,083 $ 1.41 $ .24 to $9.19
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
2004 Activity
- -------------
Granted 5,485,929 .25 .25 to .66
Canceled (1,153,608) .90 .24 to 7.50
---------------------- ----------------- ------------------------------
Outstanding December 31, 2004 (6,579,984 exercisable) 6,985,004 $ .45 $ .24 to $9.19
====================== ================= ==============================
The weighted-average price of options exercisable was $.46, $1.31 and $1.43 at
December 31, 2004, 2003, and 2002, respectively. The weighted-average remaining
contractual life of the options outstanding at December 31, 2004 was 9 years.
41
Options Outstanding Options Exercisable
- ------------------------------------------------------------------------- ------------------------------------------------------
Weighted
Average
Remaining Weighted Weighted
Number Contractual Average Number Average
Range of Exercise Prices Outstanding Life (Years) Exercise Price Exercisable Exercise Price
- ---------------------------- ------------------- ------------------- ------------------ ------------------- ----------------------
$ .24 to $ .60 6,540,671 9 $ .25 6,135,651 $ .25
$ .61 to $1.50 122,500 7 .88 122,500 .88
$1.51 to $3.75 246,333 3 3.39 246,333 3.39
$3.76 to $9.19 75,500 2 6.98 75,500 6.98
- ---------------------------- ------------------- ------------------- ------------------ ------------------- ----------------------
6,985,004 6,579,984
=================== ===================
At December 31, 2004 there were 3,470,511 options available for grant of which
261,500 were reserved for the Directors.
NOTE I - RESEARCH AND DEVELOPMENT AGREEMENTS
During 2004, 2003 and 2002, the Company completed a number of small custom
development contracts for specific customers resulting in revenue of
approximately $79,000, $200,000 and $43,000, respectively. These revenues offset
the related costs incurred for this development. The ownership of these
technologies remains with the Company. No royalties or other considerations are
required as part of these agreements.
NOTE J - EMPLOYEE BENEFITS
The Company maintains a Retirement Savings Plan for United States employees.
Under this plan, all employees may contribute up to 15% of their salary to a
retirement account up to the maximum amount allowed by law. Starting in 1997,
the Company contributed an amount equal to 50% of the first 6% contributed by
the participant; in 2001, the employer match was increased to 67% of the first
6%. The Company's contributions to this plan were $378,000, $346,000 and
$346,000, in 2004, 2003 and 2002, respectively. Effective January 15, 2005 the
Company suspended its matching contribution.
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. At December
31, 1998, all shares had been allocated. The Company did
42
not allocate any additional shares to the Plan in 2004, 2003 or 2002. The
Company, at its discretion, may make annual allocations to the Plan in the
future. There were no expenses related to the Plan in 2004, 2003 and 2002.
The Company terminated the Plan effective December 31, 2003; its assets are
expected to be distributed in 2005. There will be no significant financial
impact to the Company.
NOTE K - INCOME TAXES
At December 31, 2004, the Company has U.S. federal and state operating loss
carry forwards of approximately $32,400,000 and $29,900,000 respectively. The
U.S. federal and state net operating loss carry forwards expire from 2005
through 2024. In 2004 the Company's ability for utilization of net operating
loss carry forwards was significantly restricted due to the change in control as
a result of the recapitalization (see Note F for further details). At December
31, 2004, the Company has approximately $3,500,000 and $800,000 of net operating
loss carry forwards for the United Kingdom and Germany, respectively. These loss
carry forwards expire from 2005 through 2014. There are no net operating loss
carry forwards for Canada.
A summary of income (loss) before income taxes follows:
Year Ended December 31
(thousands) 2004 2003 2002
- --------------------------------------------------------------------------------
Domestic $ (3,739) $ 708 $ 811
Foreign 41 136 212
--------------------------------------------
Income (loss) before income taxes $ (3,698) $ 844 $ 1,023
============================================
Income taxes (benefit) follow:
Year Ended December 31
(thousands) 2004 2003 2002
- --------------------------------------------------------------------------------
Current :
State $ 30 $ 40 $ 80
Federal benefit (321)
Foreign 41 139 1
------------------------------------------
Total current 71 (142) 81
Deferred - - -
------------------------------------------
Total $ 71 $ (142) $ 81
==========================================
43
Significant components of deferred income tax assets and (liabilities) follow:
December 31
(thousands) 2004 2003
- -----------------------------------------------------------------------------------------------------------
Deferred income tax assets:
Net operating loss carry forward $ 13,890 $ 12,109
Alternative minimum tax credit carry forward 168 168
Foreign equipment 92 92
Inventories 807 584
Bonus accrual 26
Accounts receivable allowance 81 354
Vacation accrual 202 183
Other 110 109
---------------------------
Total deferred income tax assets 15,350 13,625
Deferred income tax liabilities:
Goodwill (511) (175)
Plant and equipment (215) (151)
---------------------------
Total deferred income tax liabilities (726) (326)
Valuation allowance (14,624) (13,299)
---------------------------
Net deferred income tax $ - $ -
===========================
A reconciliation of income taxes computed using the U.S. statutory rate to the
provision (benefit) for income taxes follows:
Year Ended December 31
2004 2003 2002
- ------------------------------------------------------------- ---------------------- --------------------- ----------------------
Federal income taxes at statutory rate $ (1,271) $ 287 $ 348
State income taxes, net of federal benefit 30 66 80
Foreign income taxes 41 93
Valuation allowance, net of deferred income
tax adjustments 1,271 (382) (348)
Adjustment of tax reserves (206)
Other 1
---------------------- --------------------- ----------------------
Provision (benefit) for income taxes $ 71 $ (142) $ 81
====================== ===================== ======================
The tax reserve decrease in 2003 of $206,000 or $.03 per diluted share is
directly related to the reduction of potential tax exposures associated with
certain state and foreign items.
44
NOTE L - LEASE COMMITMENTS
The Company's principal lease commitment is for its corporate office and
manufacturing facility in Manchester, Connecticut. This lease expires on
December 31, 2006. The Company also has capital leases for office equipment.
Minimum rental payments for these noncancelable leases, with terms of one year
or more as of December 31, 2004, follow:
(thousands) Operating Leases Capital Lease
2005 $ 450 $ 84
2006 448 74
2007 52 67
2008 52
2009 52
Thereafter 208
--------------------------------
Total minimum lease payments $ 1,262 225
Amounts representing interest ======= (35)
---------
Present value of net minimum lease payments $ 190
=========
Rental expense for 2004, 2003, and 2002 was $445,000, $470,000, and $681,000,
respectively.
The cost of assets recorded under capital leases and accumulated depreciation
thereon was $322,000 and $125,000 as of December 31, 2004 ($322,000 and $43,000,
at December 31, 2003). All assets under capital leases are classified as
equipment. Amortization of assets recorded under capital leases is included in
depreciation expense.
Long term capital leases are included in other long term liabilities on the
balance sheet.
NOTE M - CONTINGENCIES
As of December 31, 2004, the Company had settled all outstanding claims and
contingencies pending during 2004 with no significant effect on cash flows or
operating results.
45
NOTE N - SEGMENT INFORMATION
The Company views its business in three distinct operating segments: Solutions
and Products, Access Services and Contract Manufacturing Services. Revenues are
used by management as a guide to determine the effectiveness of the individual
segment. The Company manages its operating expenses through a traditional
functional perspective and accordingly does not report operating expenses on a
segment basis.
Year Ended December 31
(thousands) 2004 2003 2002
- ----------------------------------------------------------------------------------------------------------------------
Revenues
Solutions and products $ 15,886 $ 21,108 $ 16,376
Access services 10,933 10,563 11,499
Contract manufacturing services 1,922 410 1,466
-------------- ----------------- ---------------
Total revenues 28,741 32,081 29,341
Cost of solutions and products 12,528 13,407 10,715
Service expenses 8,980 8,813 8,539
-------------- ----------------- ---------------
Gross profit margin 7,233 9,861 10,087
Operating expenses, net 10,931 9,017 9,064
-------------- ----------------- ---------------
Income (loss) before income taxes $ (3,698) $ 844 $ 1,023
============== ================= ===============
Total assets $ 24,338 $ 26,073 $ 26,406
============== ================= ===============
Total expenditures for additions to long-lived
assets $ 329 $ 173 $ 79
============== ================= ===============
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 2004 the Company derived 11% of its total revenue from Mitsui & Co Ltd., one
of the Company's distributors in Japan. In 2003, the Company derived 23% of its
total revenue from Northrop Grumman, IT Inc. No other customer accounted for
more than 10% of total revenue for any year presented.
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.
46
Export sales by geographic area (based on the location of the customer) were as
follows:
Year Ended December 31
(thousands) 2004 2003 2002
- ----------------------------------------------------------------------------------------------------------------------
Latin America $ 82 2% $ 124 12% $ 72 24%
Europe 161 5 0 149 49
Pacific Rim 3,302 93 944 88 81 27
-------------------------------------------------------------------------
$ 3,545 100% $ 1,068 100% $ 302 100%
=========================================================================
Export sales represented 22%, 5%, and 2% of the Solutions and Products Segment
revenues for 2004, 2003, and 2002, respectively. There are no exports sales
derived from the Company's Access Services Segment or Contract Manufacturing
Services Segment.
NOTE O - BILL AND HOLD TRANSACTIONS
Revenues relating to sales of certain equipment (principally optical character
recognition equipment) are recognized upon acceptance, shipment, or installation
depending on the contract specifications. When customers, under the terms of
specific orders or contracts, request that the Company manufacture and invoice
the equipment on a bill and hold basis, the Company recognizes revenue based
upon an acceptance test that is certified by the customer. Revenues recorded
during 2004, 2003, and 2002 included bill and hold transactions of $.1 million,
$2.3 million and $1.3 million, respectively. Accounts receivable included bill
and hold receivables of $.1 million at December 31, 2004. There were no accounts
receivable associated with bill and hold transactions at December 31, 2003.
47
NOTE P - QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
Following is a summary of quarterly results of operations.
(thousands, except per share amounts) March June September December
- -------------------------------------------------------------------------------------------------------------------
2004
- ----
Revenues $ 7,333 $ 6,878 $ 6,187 $ 8,343
Cost of product sales and service expenses 5,816 5,178 4,327 6,187
Net loss (712) (1,619) (663) (775)
Basic earnings (loss) per share (.10) (.23) (.02) (.02)
Diluted earnings (loss) per share (.10) (.23) (.02) (.02)
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
Fourth quarter 2004 net loss of $775,000 includes a provision for slow moving
inventory adjustment of $527,000 or $.01 per share. In addition, the Company
recognized $405,000 or $.01 per share of revenue applicable to a change in
accounting estimate for revenues on maintenance service contracts for which the
Company's obligation to perform is remote.
The second quarter 2004 net loss of $1,619,000 includes a $543,000 provision or
$.07 per share for an account receivable as a result of the settlement of a
legal action.
Fourth quarter 2003 net income of $564,000 includes a tax benefit of $206,000 or
$.03 per share due to a reduction in the tax reserves.
NOTE Q - SUBSEQUENT EVENTS
On March 9, 2005, the Company received from attorneys representing James C.
Mavel, the former Chief Executive Officer and President, a "notice of
termination" pursuant to his Employment Agreement and asserting entitlement to
severance compensation under the agreement. The Company intends to investigate
the assertions promptly and raise all available defenses. While, based on
currently available information, the Company does not believe that Mr. Mavel's
claim to severance compensation is supported by the Employment Agreement or the
facts, should Mr. Mavel's claim be supported, the Company believes that
severance compensation would not exceed $1.3 million.
48
ITEM 9 - CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
- --------------------------------------------------------------------------------
FINANCIAL DISCLOSURE
- --------------------
Previously reported on Form 8-K filed October 13, 2004.
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 during any fiscal
quarter in 2004 to the Company's internal controls or other factors that has
materially affected, or is reasonably likely to materially affect, the Company's
internal controls and financial reporting.
49
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 2005 Annual Meeting of Stockholders and is incorporated herein by reference
and made a part hereof.
EXECUTIVE AND OTHER OFFICERS OF THE REGISTRANT
Officers of the Company as of March 22, 2005 are set forth in the schedule
below.
Officer
Name Age Principal Occupation: Since
- ----------------------------------------------------------------------------------------------------
Logan Clarke, Jr. 77 Acting Chief Executive Officer
and President 2005
Joseph P. Crouch 42 Vice President -
Manufacturing Services Division 1999
Richard C. Goyette 53 Vice President -
Sales and Marketing 1996
Richard D. Harris 44 Corporate Secretary 2001
Joel K. Howser 57 Vice President -
Software Development 1998
Peter H. Stelling 54 Chief Financial Officer, Vice
President, Treasurer and 2004
Assistant Corporate Secretary
Paul M. Yantus 43 Chief Operating Officer 2005
50
Mr. Clarke has been a Director of Scan-Optics since 1981 and was appointed
Acting Chief Executive Officer and President in March 2005. He had previously
served as Interim Executive Director of Southeast Area Technology Center, a
business incubator and revolving loan fund from 1995 to 1996, independent
management consultant from 1990 to 1995, as Executive Vice President of Society
for Savings, a savings bank, from 1986 to 1990, as Dean of the School of
Management at The Hartford Graduate Center from 1983-1986 and a lecturer in
management from 1979-1983. Prior to 1979, Mr. Clarke served in multiple senior
management positions in the banking industry.
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. 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. Yantus, joined the Company in 2005 as Chief Operating Officer. Prior to
joining the Company, Mr. Yantus was a founder and President of Espire Marketing,
Inc., a web-based solutions provider. Prior to founding Espire, Mr. Yantus
served in various positions at MSX International, a company specializing in
business process outsourcing and staffing, including Senior Vice
President--Business Process Outsourcing and IT (2002-2003), Vice
President--Business and Technology Services (2001-2002), and General
Manager--Integrated Information Solutions (1999-2001). Prior to his employment
with MSX International Mr. Yantus held senior positions at Danka and Lason
Systems.
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.
51
ITEM 11 - EXECUTIVE COMPENSATION
- --------------------------------
This information is included in the Company's definitive proxy statement to be
filed under Regulation 14A for the 2005 Annual Meeting of Stockholders and is
incorporated herein by reference.
52
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 2005 Annual Meeting of
Shareholders, which is incorporated by reference herein. The Company has six
equity compensation plans as of December 31, 2004. 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,
2004.
Number of shares of Common
Stock remaining available
Number of shares of for future issuance under
Common Stock to be Weighted -average equity compensation plans
issued upon exercise of exercise price of (excluding shares
outstanding options, outstanding options, reflected in the first
Plan Category warrants and rights warrants and rights column)
- ------------------------------------------------------------------------------------------------------------------------------
Equity compensation
plans approved by stockholders 1,292,983 $ 1.32 2,654,472
Equity compensation plans not approved
by stockholders:
Senior management options 5,692,021 .25 816,039
--------------------------------------------------------------------------
6,985,004 $ .45 3,470,511
==========================================================================
The Company's equity compensation plan that was not approved by stockholders is
the Senior Executive Stock Option Plan. Under the Plan, individuals who were
senior executive officers of the Company as of December 31, 2001 were eligible
to receive a grant of a non-qualified stock option to purchase one share of
common stock for each dollar of such individual's annual salary as of December
31, 2001; provided, however, that the individual was required to remain employed
until June 30, 2002 before the right to exercise the option accrued. The
exercise price for such options was $0.24, the closing price of the common stock
on December 31, 2001. This plan was amended and restated by our Board of
Directors on April 26, 2004 to permit option grants to executive officers who
were employed by Scan-Optics after December 31, 2001 and to make other certain
changes to the plan and, effective upon the consummation of the
recapitalization, to increase the number of shares available thereunder to
6,815,114 shares. Options were granted on April 26, 2004 to two individuals for
an aggregate of 55,000 shares of common stock at $0.66, the closing price of the
common stock on such date. In connection with the recapitalization, each holder
of options ("Old Options") was granted additional options
53
exercisable for 5.30 shares for each share issuable under the Old Options. When
any options are exercised under the Senior Executive Stock Option Plan, the
Lenders will transfer a like number of shares to the Company for their par value
to cover the option exercise. In this way, only the Lenders, and none of the
stockholders, will suffer dilution upon the exercise of such options. All
options granted under the plan on December 31, 2001 were exercisable on the six
month anniversary of the date of grant and all options granted thereafter were
immediately exercisable in full as of the date of grant.
See Note H to the Notes to Consolidated Financial Statements of the Company
included in this report for additional information.
54
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
2005 Annual Meeting of Stockholders 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 2005 Annual Meeting of Stockholders and is incorporated
by reference.
55
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 UHY LLP, Independent Registered Public Accounting Firm
Report of Ernst & Young LLP, Independent Registered Public Accounting
Firm
Consolidated Balance Sheets at December 31, 2004 and 2003
Consolidated Statements of Operations for the years ended December 31,
2004, 2003 and 2002
Consolidated Statements of Stockholders' Equity for the years ended
December 31, 2004, 2003 and 2002
Consolidated Statements of Cash Flows for the years ended December 31,
2004, 2003 and 2002
Notes to Consolidated Financial Statements - December 31, 2004
(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) Amended and Restated Certificate of Incorporation dated July
16, 2004 filed as Exhibit 10.1 to the Company's quarterly
report on Form 10-Q filed November 12, 2004.
3.1(b) Certificate of Designations, Preferences, Rights and
Restrictions for 4% Series I Redeemable Preferred Stock dated
July 16, 2004.
56
*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.
*+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.
57
*+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 The Scan-Optics, Inc. Amended and Restated Senior Executive
Stock Option Plan is filed as Exhibit 10.3 to the Company's
Quarterly Report on Form 10-Q.
*+10.16 The Scan-Optics, Inc. 2002 Incentive and Non-Qualified Stock
Option Plan.
*10.17 Third Amended and Restated Credit Agreement dated as of March
30, 2004 among Scan-Optics, Inc., the subsidiaries of
Scan-Optics, the lenders parties thereto and Patriarch
Partners Agency Services, LLC, as agent, filed as Exhibit
10.20 to the Company's Annual Report on Form 10-K filed for
the year ended December 31, 2003.
*+10.18 Executive Severance Agreement dated as of April 1, 2004, by
and between the Company and Peter H. Stelling, filed as
Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q
filed August 16, 2004.
*+10.19 Scan-Optics, Inc. 2004 Incentive and Non-Qualified Stock
Option Plan filed as Exhibit 10.2 to the Company's Quarterly
Report on Form 10-Q filed August 16, 2004.
*+10.20 Employment Agreement effective as of March 7, 2005 between the
Company and Paul Yantus, filed as Exhibit 10.1 to a report on
Form 8-K filed by the Company on March 10, 2005.
*10.21 Second Amended and Restated Subscription Agreement and
Repurchase Agreement dated as of August 6, 2004, between the
Company and ARK CLO 2000-1, LIMITED, filed as Exhibit 99.1 to
the Company's report on Form 8-K filed on August 6, 2004.
*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.
23.1 Consent of UHY LLP, Independent Registered Public Accounting
Firm.
23.2 Consent of Ernst & Young LLP, Independent Registered Public
Accounting Firm.
31.1 Certificate of the Acting 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.
58
32.1 Certification of Acting Chief Executive Officer pursuant to
Section 906 of the Sarbanes-Oxley Act.
32.2 Certification of Chief Financial Officer pursuant to Section
906 of the Sarbanes-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 13, 2004 for Changes in
Registrant's Certifying Accountant.
Report on Form 8-K was filed November 10, 2004 regarding third
quarter of 2004 earnings.
Report on Form 8-K was filed November 12, 2004 and November
24, 2004 for the Election of Directors.
(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.
59
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: /s/ Logan Clarke, Jr.
---------------------------------
Logan Clarke, Jr.
Acting Chief Executive Officer and
President
Date: March 25, 2005
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.
/s/ Logan Clarke Jr.
- ---------------------------
Logan Clarke Jr. Acting Chief Executive Officer, President
and a Director (Principal Executive Officer)
Date: March 25, 2005
/s/ Peter H. Stelling
- ---------------------------
Peter H. Stelling Chief Financial Officer, Vice President and
Treasurer
(Principal Financial and Accounting Officer)
Date: March 25, 2005
/s/ John J. Holton
- ---------------------------
John J. Holton Director March 25, 2005
/s/ Kevin Flannery
- ---------------------------
Kevin Flannery Director March 25, 2005
/s/ Scott Schooley
- ---------------------------
Scott Schooley Director March 25, 2005
/s/ Michael Scinto
- ---------------------------
Michael Scinto Director March 25, 2005
/s/ Ralph J. Takala
- ---------------------------
Ralph J. Takala Director March 25, 2005
/s/ Lynn Tilton
- ---------------------------
Lynn Tilton Director March 25, 2005
60
SCHEDULE II
SCAN-OPTICS, INC. AND SUBSIDIARIES
VALUATION AND QUALIFYING ACCOUNTS
THREE YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002
(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, 2004
Allowance for doubtful accounts (billed
and unbilled) $ 1,134 $ 567 $ 1,463(1) $ 238
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
(1) Uncollectible accounts written off, net of recoveries.
The required information regarding the valuation allowance for deferred income
tax assets is included in Note K.
61