Back to GetFilings.com
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
( X ) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2005
--------------------------------------------------
OR
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from to
----------------- -----------------
Commission File No. 0-5265
--------------------------------------------------------
SCAN-OPTICS, INC.
- --------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
Delaware 06-0851857
- ------------------------------------ ----------------------------------------
(State or other jurisdiction of (I.R.S. Employer Identification Number)
incorporation or organization)
169 Progress Drive, Manchester, CT 06040
- --------------------------------------------------------------------------------
(Address of principal executive offices) Zip Code
(860) 645-7878
- --------------------------------------------------------------------------------
(Registrant's telephone number, including area code)
Indicate by check mark whether the Registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. ( X ) YES ( ) NO
Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). ( ) YES ( X ) NO
The number of shares of common stock, $.02 par value, outstanding as of May 12,
2005 was 41,451,577.
1
SCAN-OPTICS, INC.
FORM 10-Q
I N D E X
PAGE
NO.
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements............................................................ 3
Item 2. Management's Discussion and Analysis of Consolidated Financial Condition
and Results of Operations................................................... 13
Item 3. Quantitative and Qualitative Disclosures About Market Risk....................... 19
Item 4. Controls and Procedures.......................................................... 19
PART II - OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K................................................ 21
2
PART I - FINANCIAL INFORMATION
1. Financial Statements.
SCAN-OPTICS, INC., AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS (UNAUDITED)
(thousands, except share data) March 31, 2005 December 31, 2004
- ------------------------------------------------------------------------------------------------------------------------------------
Assets
Current Assets:
Cash and cash equivalents $ 326 $ 477
Accounts receivable less allowance of $239 at
March 31, 2005 and $238 at December 31, 2004 3,705 4,314
Unbilled receivables - contracts in progress 83 298
Inventories 7,320 7,461
Prepaid expenses and other 362 389
-------------------------------------------------------------
Total current assets 11,796 12,939
Equipment and Leasehold Improvements:
Equipment 3,391 3,386
Leasehold improvements 4,089 4,089
Office furniture and fixtures 558 557
-------------------------------------------------------------
8,038 8,032
Less allowances for depreciation and amortization 7,206 7,095
-------------------------------------------------------------
832 937
Goodwill 9,040 9,040
Other assets 1,326 1,422
-------------------------------------------------------------
Total Assets $ 22,994 $ 24,338
=============================================================
3
(thousands, except share data) March 31, 2005 December 31, 2004
- ------------------------------------------------------------------------------------------------------------------------------------
Liabilities and Stockholders' Equity
Current liabilities:
Note payable to related party $ 1,000 $ 1,000
Accounts payable 2,255 2,822
Salaries and wages 661 702
Taxes other than income taxes 510 641
Income taxes 69 68
Customer deposits 227 143
Deferred revenues 3,531 3,408
Other 1,152 1,243
-----------------------------------------------------------------
Total current liabilities 9,405 10,027
Notes payable to related party 10,647 10,605
Other liabilities 527 537
Mandatory redeemable preferred stock, at redemption
value:
Series I, 420,857 shares issued and outstanding 864 855
-----------------------------------------------------------------
Total Liabilities 21,443 22,024
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; issued - 41,865,077
shares including treasury shares 837 837
Capital in excess of par value 41,651 41,651
Accumulated retained-earnings deficit (37,109) (36,339)
Accumulated other comprehensive loss-currency
translation (1,182) (1,189)
-----------------------------------------------------------------
4,197 4,960
Cost of common stock in treasury,
413,500 shares (2,646) (2,646)
-----------------------------------------------------------------
Total stockholders' equity 1,551 2,314
-----------------------------------------------------------------
Total Liabilities and Stockholders' Equity $ 22,994 $ 24,338
=================================================================
See accompanying notes.
4
SCAN-OPTICS, INC., AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
Three Months Ended
March 31
(thousands, except share data) 2005 2004
- -----------------------------------------------------------------------------------------------------------------------------------
Revenues
Hardware and software $ 2,741 $ 3,427
Professional services 1,335 1,510
Access services 2,700 2,396
------------------------------------------------------------
Total revenues 6,776 7,333
Costs of Revenue
Hardware and software 2,326 2,605
Professional services 794 879
Access services 2,251 2,332
------------------------------------------------------------
Total costs of revenue 5,371 5,816
------------------------------------------------------------
Gross Profit 1,405 1,517
Operating Expenses
Sales and marketing 705 690
Research and development 397 551
General and administrative 817 833
Interest
Related party 256
Other 167
------------------------------------------------------------
Total operating expenses 2,175 2,241
------------------------------------------------------------
Operating loss (770) (724)
Other income, net 6 32
------------------------------------------------------------
Loss before income taxes (764) (692)
Income taxes 6 20
------------------------------------------------------------
Net Loss $ (770) $ (712)
============================================================
Basic and diluted loss per share $ (.02) $ (.10)
============================================================
Basic and diluted weighted-average common shares 41,451,577 7,026,232
============================================================
See accompanying notes.
5
SCAN-OPTICS, INC., AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
Three Months Ended
March 31
(thousands) 2005 2004
- -----------------------------------------------------------------------------------------------------------------------------------
Operating Activities
Net loss $ (770) $ (712)
Adjustments to reconcile net loss to net cash (used)
provided by operating activities:
Depreciation and amortization of equipment and leasehold
improvements 112 90
Amortization of customer service inventory and
development costs 418 429
Amortization of deferred debt costs 40
Accretion of interest on debt 42
Accretion of interest on preferred stock 9 57
Changes in operating assets and liabilities:
Accounts receivable 824 2,436
Inventories (221) 62
Prepaid expenses and other 27 (234)
Accounts payable (567) 409
Accrued salaries and wages (41) (680)
Taxes other than income taxes (131) (144)
Income taxes 1 37
Deferred revenues 123 20
Customer deposits 84 (486)
Other (94) (394)
-------------------------------------------------------
Net cash (used) provided by operating activities (144) 890
Investing Activities
Purchases of equipment (7) (66)
-------------------------------------------------------
Net cash used by investing activities (7) (66)
Financing Activities
Proceeds from borrowings 750 3,211
Principal payments on borrowings (750) (2,200)
-------------------------------------------------------
Net cash provided by financing activities 0 1,011
------------------------------------------------------
Change in cash and cash equivalents (151) 1,835
Cash and Cash Equivalents at Beginning of Period 477 585
------------------------------------------------------
Cash and Cash Equivalents at End of Period $ 326 $ 2,420
======================================================
See accompanying notes.
6
SCAN-OPTICS, INC., AND SUBSIDIARIES
Notes to the Financial Statements
NOTE 1 - Basis of Presentation
- ------
The accompanying unaudited interim condensed consolidated financial statements
have been prepared in accordance with U.S. generally accepted accounting
principles for interim financial information and with the instructions to Form
10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of
the information and footnotes required by U.S. generally accepted accounting
principles for complete financial statements. In the opinion of management, all
adjustments (consisting of normal recurring accruals) considered necessary for a
fair presentation have been included. Operating results for interim periods are
not necessarily indicative of the results that may be expected for the year. For
further information, refer to the consolidated financial statements and
footnotes thereto included in the Company's Annual Report on Form 10-K for the
year ended December 31, 2004. The condensed consolidated balance sheet as of
December 31, 2004 was derived from the audited financial statements for the year
then ended.
NOTE 2 - Stock Based Compensation
- ------
The Company 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".
For the purpose of pro forma disclosures, the estimated fair value of the stock
options is expensed ratably over the vesting period, which is generally 36
months for key employees and 6 months for the Board of Directors.
In December 2002, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") 148, "Accounting for
Stock-Based Compensation--Transition and Disclosure". SFAS 148 amends the
disclosure requirements of SFAS 123 to require prominent disclosures in both
annual and interim financial statements about the method of accounting for
stock-based employee compensation and the effect of the method used on reported
results.
7
The following table illustrates the effect on net loss and loss per share as if
the Company had applied the fair value recognition provisions of SFAS No. 123:
For the Three Months Ended
March 31
(thousands, except per share amounts) 2005 2004
- ---------------------------------------------------------------------------------------------------------
Net loss, as reported $ (770) $ (712)
Stock option expense (2) (14)
------------------------------------------
Pro forma net loss $ (772) $ (726)
==========================================
Basic and diluted loss per share, as reported $ (.02) $ (.10)
Stock option expense .00 .00
-----------------------------------------
Pro forma basic and diluted loss per share $ (.02) $ (.10)
==========================================
In December 2004, the FASB issued a revised standard, SFAS No. 123R,
"Share-Based Payment". SFAS No. 123R 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
will be recognized as compensation cost over that period. Under a rule adopted
by the SEC on April 14, 2005, the Company is allowed to implement SFAS No. 123R
for its fiscal year beginning January 1, 2006. The Company has not yet attempted
to evaluate the likely effects on its financial statements.
NOTE 3 - Inventories
- ------
The components of inventories were as follows:
March 31 December 31
(thousands) 2005 2004
- --------------------------------------------------------------------------------
Finished goods $ 58 $ 57
Work-in-process 713 644
Service parts 2,617 2,713
Materials and component parts 3,932 4,047
----- -----
$ 7,320 $ 7,461
========== ==========
8
NOTE 4 - 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 March 31, 2005, $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 owned 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.
9
NOTE 5 - Income Taxes
- ------
Income tax expense relates to minimum tax requirements in certain states and
Canadian income taxes. A valuation allowance has been provided for U.S. income
tax benefits applicable to the operating losses since it is not more likely than
not that the Company will benefit from their future utilization.
The Company's future ability to utilize the available net operating loss
carryforwards may be restricted due to limitations effected by the change in
control related to the credit agreements described in Note 4.
NOTE 6 - Comprehensive Income
- ------
The components of comprehensive loss follow:
Three months ended March 31
(thousands) 2005 2004
- --------------------------------------------------------------------------------
Net loss $ (770) $ (712)
Foreign currency translation adjustments 7 13
-----------------------------------
Comprehensive loss $ (763) $ (699)
===================================
10
NOTE 7 - Segment Information
- ------
The Company views its business in three distinct revenue categories: Solution
and products sales, Access services, and Contract manufacturing services.
Additional segment information follows:
Three Months Ended
March 31
(thousands) 2005 2004
- --------------------------------------------------------------------------------
Revenues
Solutions and products $ 3,215 $ 4,827
Access services 2,700 2,396
Contract manufacturing services 861 110
----------------------------------
Total revenues 6,776 7,333
Cost of solutions and products 3,120 3,484
Service expenses 2,251 2,332
----------------------------------
Gross margin 1,405 1,517
Operating and other expenses, net 2,169 2,209
----------------------------------
Loss before income taxes $ (764) $ (692)
==================================
NOTE 8 - Bill and Hold Transactions
- ------
Revenues relating to sales of certain equipment (principally optical character
recognition equipment) are recognized upon acceptance, shipment, or installation
depending on the contract specifications. When customers, under the terms of
specific orders or contracts, request that the Company manufacture and invoice
the equipment on a bill and hold basis, the Company recognizes revenue based
upon an acceptance received from the customer. Revenues recorded during the
first quarter of 2005 included bill and hold transactions of $0.1 million. The
Company recorded no bill and hold revenue during the first quarter of 2004.
Accounts receivable included $0.1 million related to bill and hold transactions
at both March 31, 2005 and December 31, 2004.
11
NOTE 9 - Contingencies
- ------
On March 9, 2005, the Company received from attorneys representing James C.
Mavel, the Company's 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 payment of severance
compensation to Mr. Mavel could have a material adverse affect on the financial
condition of the Company. The Company believes that severance compensation would
not exceed $1.3 million.
NOTE 10 - Liquidity
- -------
The Company's working capital has declined to $2.4 million as of March 31, 2005
compared to $2.9 million as of December 31, 2004 reflecting unfavorable
operating results. Continued unfavorable operating results will not allow the
Company to meet all of its contractual obligations as they become due beginning
in the second quarter of 2005. Further, management believes that the Company may
not comply with certain financial covenants under its existing credit
agreements. In response to the Company's anticipated short-term liquidity
problems, management is reviewing the Company's ability to further reduce
operating costs. Management has also initiated discussions with the primary
lenders and majority stockholder to increase availability under the line of
credit and make other modifications to the Company's credit arrangements.
Moreover, management has begun consideration of other alternatives, including,
but not limited to, the sale of certain assets to raise funds. However, there
can be no assurances that the Company will be able to negotiate any such
proposed modifications to the credit arrangements, increase availability under
the line of credit or sell specific assets.
12
Item 2. 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 March 31, 2005 of approximately $11.7 million by $.1
million. The Company completed a recapitalization on August 6, 2004 (see
"-Liquidity and Capital Resources" and Note 4 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. As a result of the Company's minimal liquidity (see
"-Liquidity and Capital Resources" below for further details), it is possible
that delivery of critical parts and supplies could be delayed or suspended and
that the Company may not always be able to make shipments of its products on
time. 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. In addition, delayed
market acceptance and slower than anticipated establishment of new distribution
channels for its new SO series scanners, difficulties in resolving technology
challenges relating to the SO Series scanners or developing its BPO business
could further adversely affect the Company's business (see "-Liquidity and
Capital Resources" below for further details).
13
Overview
The Company reported net loss for the quarter of $0.8 million or $.02 per share,
compared to a net loss of $0.7 million, or $.10 per diluted share, for 2004. The
net loss for the quarter was mainly attributable to the sales volume of the SO
Series scanner and related software products. The per share loss numbers reflect
the increase in outstanding common shares from 7,026,232 for the quarter ended
March 31, 2004, to 41,451,577 for the quarter ended March 31, 2005, due to our
recapitalization described in Note 4 to the Company's Consolidated Financial
Statements.
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 ("BPO") 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. 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 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.
14
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.
Results of Operations for the Three Months Ended March 31, 2005 vs. 2004
Total revenues decreased $0.6 million or 8% from the first quarter of 2004 to
the first quarter of 2005.
Hardware and software revenues decreased $0.7 million or 20% in the first
quarter of 2005 compared with the first quarter of 2004. North American sales
increased $0.7 million or 61% due principally to increased contract
manufacturing revenue. Scanner related revenue was flat for the first quarter of
2005 compared to the first quarter of 2004. International sales decreased $1.4
million in the first quarter of 2005 as compared to the same period in 2004 due
to reduced order flow from the Japanese market.
Professional services revenues decreased $0.2 million or 12% in the first
quarter of 2005 compared with the first quarter of 2004, due mainly to decreased
solution sales to the Company's target customer base.
Access Services revenues increased $0.3 million or 13% from the first quarter of
2004, due mainly to increased third party contracts, parts and time and
materials revenue which offset a slight decrease in revenue from the Company's
proprietary maintenance contracts.
Cost of hardware and software revenue gross margin for the first quarter of 2005
was 15% compared to 24% for the first quarter of 2004 due to the composition of
the sales mix and increased production costs.
Cost of professional services revenue gross margin for the first quarter of 2005
was 41%, which remained consistent with the margin of 42% for the first quarter
of 2004. The professional services organization includes software product
support, professional services implementation and business process outsourcing.
Software product support gross margin was partially offset by lower margins in
professional services implementation activity due to reduced revenue and
business process outsourcing as the Company drives toward critical mass in this
market.
Cost of Access Services revenue gross margin was 17% for the first quarter of
2005 compared to 3% for the first quarter of 2004, reflecting higher third party
sales volume and a relatively fixed cost structure.
Sales and marketing expenses remained consistent with the prior year quarter as
reductions in travel and consulting were offset by higher spending on trade
shows.
15
Research and development expenses decreased $0.2 million or 28% from the first
quarter of 2005 from the first quarter of 2004, mainly due to lower salary and
benefit costs and reduced external consulting costs.
General and administrative expenses remained consistent with the prior year
quarter.
Interest expense increased $0.1 million for the quarter as compared to the first
quarter of 2004. The weighted average interest rate for the first three months
of 2005 was 9.2% compared to 4.5% for the same period in 2004.
Liquidity and Capital Resources
- -------------------------------
Cash and cash equivalents at March 31, 2005 decreased $0.2 million from December
31, 2004 levels.
Outstanding borrowings increased $0.1 million to $11.7 million at March 31, 2005
from $11.6 million at the end of 2004. The available balance on the line of
credit was $1.5 million at March 31, 2005. As of March 31, 2005, the Company is
in compliance with all financial covenants.
As the Company focused on its strategy that includes 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, and the development of a BPO business for image capture
applications, the Company encountered technology challenges relating to the new
SO Series scanners, which have resulted in slower than expected development of
sales through our direct and indirect channels. Further, the ramp up of BPO
sales has occurred more gradually than was anticipated.
Management believes that our operating cash flow will be insufficient to allow
us to meet all of our contractual obligations as they come due beginning in the
second quarter of 2005. Further, management believes that the Company will most
likely be unable to comply with certain financial covenants under its existing
credit agreements. Management believes that the Company's liquidity position
will improve by year-end. In response to these anticipated short-term problems,
we are reviewing our ability to further reduce operating costs. We have also
initiated discussions with our primary lenders and majority stockholder to
increase availability under our line of credit and to make other modifications
to our credit arrangements. Moreover we have begun consideration of other
alternatives, including, but not limited to, the sale of certain assets to raise
funds. However, there can be no assurances that the Company will be able to
negotiate any such proposed modifications to its credit arrangements, increase
availability under the line of credit or sell specific assets. Any means of
resolving the
16
Company's short-term liquidity problems may have an adverse effect on the
Company's stockholders.
On August 6, 2004, the Company completed a recapitalization with lenders
affiliated with 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 at the time of issuance,
subject to dilution for certain compensatory stock options granted by the
Company or 83% of outstanding common stock as of March 31, 2005) 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.
Operating activities used $0.1 million of cash in the first three months of
2005, as compared to the providing $0.9 million in the first three months of
2004. The decrease is mainly due to reduced accounts receivable collections
related to lower revenue in fourth quarter 2004 as compared to the same period
in 2003.
Non-cash expenses were $0.6 million for the first quarter of both 2005 and 2004.
As shown in the statements of cash flows these expenses relate to depreciation,
amortization and accretion.
Net accounts receivable and unbilled receivables at March 31, 2005 decreased
$0.8 million from December 31, 2004 due to the timing of collections and lower
sales in the first quarter of 2005 compared to the fourth quarter of 2004.
17
Total inventories at March 31, 2005 decreased $0.1 million from December 31,
2004. Manufacturing inventory remained consistent with the beginning of the year
amount. Customer service inventory decreased $0.1 million as compared to
December 31, 2004 levels mainly due to amortization.
Net equipment and leasehold improvements at March 31, 2005 decreased $0.1
million due to depreciation and amortization recorded during the quarter.
Other assets decreased $0.1 million from December 31, 2004 due to the
amortization of software development costs and deferred debt costs in the
quarter.
Accounts payable decreased $0.6 million from December 31, 2004 mainly due to the
timing of vendor payments.
Salaries and wages remained consistent with December 31, 2004.
Taxes other than income taxes decreased $0.1 million from December 31, 2004 due
to payments made for state sales and use taxes.
Customer deposits increased $0.1 million from December 31, 2004 due to the
timing of orders which carry deposits in the first quarter of 2005.
Deferred revenues remained consistent with the December 31, 2004 balance.
Other current liabilities increased $0.1 million mainly due to reduced accruals
for consulting fees and other miscellaneous items.
Contractual Obligation
Under the terms of an agreement for goods and services with Columbia Tech, we
issued purchase orders in the aggregate amount of $3.1 million in the second
quarter of 2005. The delivery of these goods and services and subsequent payment
is scheduled over the next nine to twelve months.
Critical Accounting Policies
Our critical accounting policies are discussed in Management's Discussion and
Analysis of Consolidated Financial Condition and Results of Operations in our
Annual Report on Form 10-K for the year ended December 31, 2004. There have been
no significant changes in our critical accounting policies since then through
March 31, 2005. The preparation of our financial statements requires us to make
estimates that affect the reported amounts of assets, liabilities, revenue and
expenses and related disclosures of contingent assets and liabilities. We base
our accounting estimates on historical experience and other factors that are
believed to be
18
reasonable under the circumstances. However, actual results may vary from these
estimates under different assumptions or conditions.
New Accounting Pronouncements
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
will be recognized as compensation cost over that period. Under a rule adopted
by the SEC on April 14, 2005, the Company is allowed to implement SFAS No. 123R
for its fiscal year beginning January 1, 2006. The Company has not yet attempted
to evaluate the likely effects on its financial statements.
Item 3. Quantitative and Qualitative Disclosures About Market Risk.
In 2004, the Company completed a total debt restructuring (see Note 4 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 March 31, 2005 of approximately $11.7 million by
$0.1 million. The Company has minimal foreign currency translation risk. All
international sales other than sales originating from the UK and Canadian
subsidiaries are denominated in United States dollars. Refer to the Outlook
section of Management's Discussion and Analysis of Consolidated Financial
Condition and Results of Operations. Our market risks are substantially
unchanged since December 31, 2004.
Item 4. Controls and Procedures.
The Company evaluated the design and operation of its disclosure controls and
procedures to determine whether they are effective in ensuring that the
disclosure of required information is timely made in accordance with the
Securities Exchange Act of 1934 (the "Exchange Act") and the rules and forms of
the Securities and Exchange Commission. This evaluation was made under the
supervision and with the participation of management, including the Company's
principal executive officer and principal financial officer as of the end of the
period covered by this Quarterly Report on Form 10-Q. The principal executive
officer and principal financial officer have concluded, based on their review,
that the Company's disclosure controls and procedures, as defined at Exchange
Act Rules 13a-14(c) and 15d-14(c), are effective to provide reasonable assurance
that information required to be disclosed by the Company in reports that it
files or submits under the Exchange Act is recorded, processed, summarized and
reported within the time periods specified in Securities and Exchange Commission
rules and forms.
19
There were no changes in the Company's internal control over financial reporting
that occurred during the Company's most recent fiscal quarter that materially
affected, or are reasonably likely to materially affect, the Company's internal
control over financial reporting.
20
PART II - OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits.
Exhibit Number Description
Exhibit 10.1 Employment Agreement with Paul M. Yantus
(incorporated by reference to Exhibit 10.1 to
Form 8-K filed on March 10, 2005).
Exhibit 10.2 Consulting Agreement with Kevin S. Flannery
(incorporated by reference to Exhibit 10.1 to
Form 8-K filed on March 29, 2005)
Exhibit 10.3* Agreement with Columbia Tech for goods and
services.
Exhibit 31.1* CEO Certification Pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
Exhibit 31.2* CFO Certification Pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
Exhibit 32.1* CEO Certification Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
Exhibit 32.2* CFO Certification Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
* Filed herewith.
(b) Reports on Form 8-K.
Report on Form 8-K was filed March 10, 2005 for: the entry into a Material
Definitive Agreement for the employment agreement with Paul M. Yantus; for the
Departure of a Principal Officer due to the resignation of James C. Mavel as
Chief Executive Officer and President; and for the Appointment of a Principal
Officer due to the appointment of Logan Clarke, Jr. as Acting Chief Executive
Officer and President.
Report on Form 8-K was filed March 18, 2005 for the Departure of a Director
due to the resignation of James C. Mavel as Director and Chairman of the Board
of Directors.
Report on Form 8-K was filed March 29, 2005 due to the entry into a
Material Definitive Agreement with Kevin S. Flannery, a director, for consulting
services.
21
SIGNATURES
----------
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
SCAN-OPTICS, INC.
Date May 16, 2005 /s/ Logan Clarke. Jr.
------------------- ----------------------------------------
Logan Clarke, Jr.
Acting Chief Executive Officer and President
Date May 16, 2005 /s/ Peter H. Stelling
------------------ ----------------------------------------
Peter H. Stelling
Chief Financial Officer, Vice President
and Treasurer
22