1 FORM 10-Q SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 QUARTERLY REPORT UNDER SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Quarter Ended Commission File March 31, 1998 Number 1-3552 - --------------------- --------------- SCOPE INDUSTRIES ------------------------------------------------------ (Exact name of Registrant as specified in its charter) California 95-1240976 - ------------------------------- ---------------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 233 Wilshire Blvd., Ste.310, Santa Monica, CA 90401 - --------------------------------------------- ----- (Address of principal executive office) (ZIP Code) Registrant's telephone number, including area code (310) 458-1574 -------------- 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 preceeding 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. Yes [X] No[ ] Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. Class Outstanding at April 21, 1998 - -------------------------- ----------------------------- Common Stock, no par value 1,125,342 2 SCOPE INDUSTRIES AND SUBSIDIARIES INDEX PAGE ---- Part I. Financial Information: Consolidated Balance Sheets - March 31, 1998 and June 30, 1997 3 Consolidated Statements of Income - Three Months Ended March 31, 1998 and 1997 4 Consolidated Statements of Income - Nine Months Ended March 31, 1998 and 1997 5 Consolidated Statements of Cash Flows - Nine Months Ended March 31, 1998 and 1997 6 Notes to Consolidated Financial Statements 7 Management's Discussion and Analysis of Results of Operations and Financial Condition 10 Part II. Other Information: Item 2. Increases and Decreases in Outstanding Securities and Indebtedness 13 Item 6. Exhibits and Reports on Form 8-K 13 Signatures 13 -2- 3 PART I. FINANCIAL INFORMATION SCOPE INDUSTRIES AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS MARCH 31 JUNE 30 1998 1997 ----------- ----------- (UNAUDITED) (AUDITED) ASSETS CURRENT ASSETS: Cash and cash equivalents $ 4,484,798 $ 5,946,050 Treasury bills (par value $33,500,000 at March 31, 1998 and $24,000,000 at June 30, 1997) 32,597,798 23,540,939 Accounts and notes receivable, less allowance for doubtful accounts of $176,769 at March 31, 1998 and $159,167 at June 30, 1997 2,857,836 1,637,066 Inventories 467,127 584,401 Deferred income taxes 705,000 675,000 Prepaid expenses and other current assets 390,939 379,654 ----------- ----------- TOTAL CURRENT ASSETS 41,503,498 32,763,110 ----------- ----------- NOTES RECEIVABLE 1,059,165 232,276 ----------- ----------- PROPERTY AND EQUIPMENT: Machinery and equipment 23,272,211 22,551,992 Land, buildings and improvements 10,226,285 9,652,554 ----------- ----------- 33,498,496 32,204,546 Less accumulated depreciation and amortization 23,065,230 22,016,611 ----------- ----------- 10,433,266 10,187,935 ----------- ----------- OTHER ASSETS: Deferred charges and other assets 4,256 256,006 Investments available for sale-at fair value 31,800,319 15,539,706 Other equity investments-at cost 1,006,000 2,505,000 ----------- ----------- 32,810,575 18,300,712 ----------- ----------- $85,806,504 $61,484,033 =========== =========== LIABILITIES AND SHAREOWNERS' EQUITY CURRENT LIABILITIES: Accounts payable $ 814,752 $ 1,104,205 Other accrued liabilities 1,288,143 1,255,321 Accrued payroll and related employee benefits 869,118 940,631 Income taxes payable 3,205,510 534,231 ----------- ----------- TOTAL CURRENT LIABILITIES 6,177,523 3,834,388 ----------- ----------- DEFERRED INCOME TAXES 6,250,000 ----------- ----------- 12,427,523 3,834,388 ----------- ----------- SHAREOWNERS' EQUITY: Common stock, no par value, 5,000,000 shares authorized; shares issued and outstanding March 31, 1998 1,130,352 June 30, 1997 1,168,665 4,138,462 4,138,462 Retained earnings 51,306,659 45,513,699 Net unrealized gain on investments 17,933,860 7,997,484 ----------- ----------- 73,378,981 57,649,645 ----------- ----------- $85,806,504 $61,484,033 =========== =========== The accompanying notes are an integral part of these statements. -3- 4 SCOPE INDUSTRIES AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED) THREE MONTHS ENDED MARCH 31 ---------------------------- 1998 1997 ----------- ----------- REVENUES: Sales $ 4,709,027 $ 5,473,282 Vocational school revenues 1,136,429 1,129,391 ----------- ----------- 5,845,456 6,602,673 ----------- ----------- OPERATING COSTS AND EXPENSES: Cost of sales 3,433,989 3,740,035 Vocational school expenses 868,334 882,964 Depreciation and amortization 498,676 533,618 General and administrative 1,023,830 879,965 ----------- ----------- 5,824,829 6,036,582 ----------- ----------- 20,627 566,091 Investment and other income 8,791,385 2,562,004 ----------- ----------- Income before income taxes 8,812,012 3,128,095 Provision (benefit) for income taxes 3,460,000 (640,000) ----------- ----------- NET INCOME $ 5,352,012 $ 3,768,095 =========== =========== NET INCOME PER SHARE - BASIC $ 4.73 $ 3.18 NET INCOME PER SHARE - DILUTED $ 4.69 $ 3.15 Average shares outstanding - Basic 1,132,002 1,186,690 Dilutive effect of stock options 9,324 7,963 ----------- ----------- Average shares outstanding - Diluted 1,141,326 1,194,653 The accompanying notes are an integral part of these statements. -4- 5 SCOPE INDUSTRIES AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED) NINE MONTHS ENDED MARCH 31 ---------------------------- 1998 1997 ----------- ----------- REVENUES: Sales $15,775,574 $20,020,116 Vocational school revenues 3,429,603 3,410,966 ----------- ----------- 19,205,177 23,431,082 ----------- ----------- OPERATING COSTS AND EXPENSES: Cost of sales 11,098,539 12,005,375 Vocational school expenses 2,654,003 2,594,839 Depreciation and amortization 1,534,372 1,582,453 General and administrative 3,090,113 2,877,687 ----------- ----------- 18,377,027 19,060,354 ----------- ----------- 828,150 4,370,728 Investment and other income 13,805,497 19,033,221 ----------- ----------- Income before income taxes 14,633,647 23,403,949 Provision for income taxes 5,665,000 5,450,000 ----------- ----------- NET INCOME $ 8,968,647 $17,953,949 =========== =========== NET INCOME PER SHARE - BASIC $ 7.84 $ 15.08 NET INCOME PER SHARE - DILUTED $ 7.78 $ 15.00 Average shares outstanding - Basic 1,143,706 1,190,325 Dilutive effect of stock options 9,093 6,874 ----------- ----------- Average shares outstanding - Diluted 1,152,799 1,197,199 Cash dividends declared per share $ 1.00 $ 1.25 The accompanying notes are an integral part of these statements. -5- 6 SCOPE INDUSTRIES AND SUBSDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) NINE MONTHS ENDED MARCH 31 ------------------------------- 1998 1997 ------------ ------------ CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 8,968,647 $ 17,953,949 Adjustments to reconcile net income to net cash flows from operating activities: Depreciation and amortization 1,534,372 1,582,453 Gains on investments available for sale (12,432,382) (17,309,726) Gains on sale of equipment (4,055) (3,952) Deferred income taxes 30,000 (2,115,000) Changes in operating assets and liabilities: Accounts and notes receivable (1,388,859) 1,172,610 Inventories 117,274 (29,364) Prepaid expenses and other current assets (11,285) 110,561 Accounts payable and accrued liabilities (328,144) (929,528) Income taxes payable 2,671,279 1,243,589 Other assets 16,750 39,552 ------------ ------------ Net cash flows from (used in) operating activities (826,403) 1,715,144 ------------ ------------ CASH FLOWS FROM INVESTING ACTIVITIES: Purchase of U.S. Treasury bills (32,056,859) (29,323,899) Maturities of U.S. Treasury bills 23,000,000 8,035,000 Purchase of property and equipment (1,891,716) (1,099,496) Disposition of property and equipment 116,068 22,846 Purchase of long-term notes receivable (658,800) Purchase of investments available for sale (334,702) (3,181,872) Purchase of other equity investments (1,001,000) Disposition of investments available for sale 15,367,847 27,497,783 ------------ ------------ Net cash flows from investing activities 2,540,838 1,950,362 ------------ ------------ CASH FLOWS FROM FINANCING ACTIVITIES: Dividends to shareowners (1,133,352) (1,491,132) Repurchases of common stock (2,042,335) (1,777,543) Proceeds from stock options exercised 119,000 Change in bank overdraft (159,864) ------------ ------------ Net cash used in financing activities (3,175,687) (3,309,539) ------------ ------------ Net change in cash and cash equivalents (1,461,252) 355,967 Cash and cash equivalents at beginning of period 5,946,050 1,721,939 ------------ ------------ Cash and cash equivalents at end of period $ 4,484,798 $ 2,077,906 ============ ============ Noncash investing transaction: Acquired stock of OSI Systems, Inc. in exchange for cancellation of a loan by the exercise of warrants issued as a condition of the loan $ 2,500,000 ============ The accompanying notes are an integral part of these statements. -6- 7 SCOPE INDUSTRIES AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) MARCH 31, 1998 1. In the opinion of the Registrant, the accompanying unaudited consolidated financial statements contain all adjustments (consisting of only normal recurring accruals) necessary to present fairly Scope Industries' financial position as of March 31, 1998 and June 30, 1997, and the results of its operations for the three and nine months ended March 31, 1998 and 1997. The accounting policies followed by the Company are set forth in Note 1 of its financial statements in its 1997 Annual Report which is incorporated by reference on Form 10-K. 2. The Financial Accounting Standards Board has issued Statement of Financial Accounting Standards (SFAS) No. 128, "Earnings Per Share." SFAS 128 requires the disclosure of basic earnings per share which replaces primary earnings per share, and diluted earnings per share, which replaces fully diluted earnings per share. Primary earnings per share is based on the weighted average number of shares of common stock outstanding and the dilutive effect of options and other common stock equivalents. Basic earnings per share does not consider any dilution. Diluted earnings per share is similar to fully diluted earnings per share, which considers all potentially dilutive securities. SFAS 128 became effective for the Registrant with its December 31, 1997 financial statements. All earnings per share data presented for prior periods has been restated to conform to the new standard. Diluted earnings per share is less than basic earnings per share because the assumed increase in the average number of common shares outstanding resulting from the assumed exercise of outstanding options in periods in which the average market price of the Registrant's common shares exceeded the related option exercise prices. 3. Quarterly results of operations are not necessarily indicative of the results to be expected for the full year. 4. Treasury bills consisted of the following: (at adjusted cost which approximates fair value) March 31 June 30 1998 1997 ----------- ------------ Held to maturity $ $ 22,591,800 Available for sale 32,597,798 949,139 ----------- ------------ $32,597,798 $23,540,939 =========== ============ 5. Inventories consisted of the following: March 31 June 30 1998 1997 ----------- ---------- Finished products $ 196,597 $ 255,850 Raw materials 83,654 134,968 Operating supplies 186,876 193,583 ----------- ---------- $ 467,127 $ 584,401 =========== ========== -7- 8 SCOPE INDUSTRIES AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) MARCH 31, 1998 (CONTINUED) 6. Investments consisted of the following: Net Unrealized Gains Before Provision For Cost Income Taxes Fair Value ---- ------------ ---------- At March 31, 1998: Investments available for sale $5,316,459 $26,483,860 $31,800,319 (a) Other equity investments 1,006,000 1,006,000 (b) At June 30, 1997: Investments available for sale $5,417,222 $10,122,484 $15,539,706 Other equity investments 2,505,000 2,505,000(a)(b) (a) At June 30, 1997 the Registrant held 1,875,000 shares of OSI Systems, Inc. (OSI) common stock. At June 30, 1997 the shares of OSI were not publicly traded. The Registrant's June 30, 1997 holdings of OSI were classified as "other equity investments" and valued at their cost of $2,500,000. In October 1997, an initial public offering of OSI common stock occurred. Included in the public offering were 227,097 shares sold by the Registrant. Proceeds of $2,821,173 were received from the sale of those shares and a pre-tax gain of $2,518,378 resulted from the October 1997 transaction. The Registrant, as a condition of participating in the initial public offering, has agreed to refrain from disposing of any of its remaining 1,647,903 shares for a six month period following the public offering. In accordance with Financial Accounting Standards Board (FASB) guidelines, the Registrant's March 31, 1998 financial statements classify the OSI holdings as "available for sale" investments whose fair value of $18,950,885 was determined by the March 31, 1998 closing bid price for OSI as reported by NASDAQ. (b) No quoted prices are available for these securities. -8- 9 SCOPE INDUSTRIES AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) MARCH 31, 1998 (CONTINUED) 7. During the nine month period ended March 31, 1998, investment gains of $12,432,382 were recognized in the determination of income. Unrealized investment holding gains (excluded from income but reported, net of income taxes, as a separate component of shareowners' equity) increased by $9,936,376 to $17,933,860 at March 31, 1998 from $7,997,484 at June 30, 1997. During the nine months ended March 31, 1997, investment gains of $17,309,726 were recognized and included as income. Unrealized investment holding gains, (excluded from income but reported, net of income taxes, as a separate component of shareowners' equity) decreased by $9,326,194 to $5,041,813 at March 31, 1997 from $14,368,007 at June 30, 1996. 8. The provision for income taxes for the nine months ended March 31, 1998 represents an effective rate of 38.7% for federal and state income taxes. For the nine month period ended March 31, 1997 the effective rate for income taxes was 23.3%. In the 1997 period, deferred tax benefits were recognized, which reduced the provision for income taxes to an effective rate that was lower than statutory federal income tax rate. -9- 10 SCOPE INDUSTRIES AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION RESULTS OF OPERATIONS Net income for the third quarter ended March 31, 1998 increased 42.0% from the third quarter last year to $5,352,012 or $4.69 per share-diluted, compared to $3,768,095 or $3.15 per share. Total operating revenues for this year's third quarter were 11.5% less than the revenues for the same quarter last year. Waste Material Recycling segment sales for the current quarter fell 12.2% from last year's third quarter revenues. Tonnage volume in this year's third quarter was 6.5% less than tonnage for the same quarter last year. Unit selling prices were 6.3% below prices in last year's third quarter. Commodity prices for corn and other grains in the quarter just ended were below the prices that prevailed last year. Waste Material Recycling segment unit pricing closely follows these commodity prices. Operating costs for the Waste Material Recycling segment decreased 8.5% from the costs of the same quarter last year. The segment's sales revenues decline being greater than the reduction of costs, caused lower current quarter profit margins compared to the margins of the comparable quarter last year. Vocational School Group revenues this quarter were 0.6% above the revenues for the comparable quarter last year. The Group's operating costs for the quarter were 1.6% lower in the current quarter than in the comparable quarter last year. Investment and other income for the quarter ended March 31, 1998 was $8,791,385 compared to $2,562,004 for the same three months last year. The investment income included gains of $8,304,221 from sales of investments during the current period and $1,891,071 in gains from investment sales in the prior year's third quarter. The major source of the gains in the current quarter was from dispositions of equity securities of Lone Star Industries, Inc. that had been held for several years. For the nine months ended March 31, 1998, net income was $8,968,647 or $7.78 per share-diluted. Last year's comparable nine months' net income was $17,953,949 or $15.00 per share. Revenues for the nine months ended March 31, 1998 were 18.0% below the revenues for the comparable nine months last year. Lower corn prices prevailing for the current year have caused unit selling prices of Dried Bakery Product to be 21.6% below last year's average selling price for the comparable nine months. Although volume of Dried Bakery Product has been comparable for the nine month periods, the lower unit prices have caused revenues to decline. The Waste Material Recycling segment continues to operate profitably but at lower margins. The Vocational Schools Group segment operated with a small net loss for the current nine month period compared to profitable operations for the comparable nine month period last year. Investment and other income for the nine months ended March 31, 1998 was $13,805,497. This includes gains of $12,432,382 from sales of investments. Investment and other income was $19,033,221 including $17,309,726 of investment gains for the comparable nine months last year. -10- 11 SCOPE INDUSTRIES AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION (CONTINUED) EARNINGS PER SHARE The Financial Accounting Standards Board has issued Statement of Financial Accounting Standards (SFAS) No. 128, "Earnings Per Share." SFAS 128 requires the disclosure of basic earnings per share which replaces primary earnings per share, and diluted earnings per share, which replaces fully diluted earnings per share. Primary earnings per share is based on the weighted average number of shares of common stock outstanding and the dilutive effect of options and other common stock equivalents. Basic earnings per share does not consider any dilution. Diluted earnings per share is similar to fully diluted earnings per share, which considers all potentially dilutive securities. SFAS 128 became effective for the Company with the December 31, 1997 financial statements. All earnings per share data presented for prior periods has been restated to conform to the new standard. Diluted earnings per share is less than basic earnings per share because the assumed increase in the average number of common shares outstanding resulting from the assumed exercise of outstanding options in periods in which the average market price of the Company's common shares exceeded the related option exercise prices. FINANCIAL POSITION Working Capital was $35,325,975 at March 31, 1998. It was $28,928,722 at June 30, 1997. The working capital ratio at March 31, 1998 was 6.7 and at June 30, 1997 was 8.5. During the nine months ended March 31, 1998, the Company sold investment securities whose aggregate proceeds totaled $15,367,847. A portion of the long term investment position in Lone Star Industries, Inc. has been liquidated. At March 31, 1998, investments held included $26,483,860 in unrealized gains based on fair values that exceed adjusted costs for investment securities. Shareowners' equity at March 31, 1998 reflects $17,933,860 for net unrealized gains on investments after a provision for deferred taxes. The unrealized holding gains are excluded from earnings. The Company, as a result of its investment in OSI Systems, Inc. in 1990, was in October 1997, OSI's largest single shareholder although not a controlling shareholder. In October 1997, OSI Systems, Inc. completed an initial public offering of its common stock. The Company sold 227,097 shares of OSI as a participant in the public offering. A pre-tax gain of $2,518,378 was recognized on the transaction. The Company still holds 1,647,903 OSI Shares. As a condition of participating in the public offering, the Company agreed to refrain from disposing of any of its remaining shares for a period that expired on April 1, 1998. Upon the establishment of public stock trading of OSI in October 1997, the Company changed the classification of the investment holdings in OSI in accordance with Financial Accounting Standards Board (FASB) guidelines. The holding is now classified as an "available-for-sale" investment and is valued at fair value. Fair value of the OSI holdings at March 31, 1998 was $18,950,885 which was determined by the March 31, 1998 closing bid price for OSI as reported by NASDAQ. -11- 12 SCOPE INDUSTRIES AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION (CONTINUED) TAXES The provision for income taxes for the nine month period ended March 31, 1998 is $5,665,000 and represents an effective rate of 38.7% for federal and state income taxes. For the first nine months of the prior fiscal year, the income tax provision was $5,450,000 and the effective tax rate was 23.3%. Deferred tax benefits were recognized during the prior fiscal year, which reduced the provision for income taxes to an effective rate that was lower than the statuary federal income tax rate. FORWARD LOOKING STATEMENTS Forward looking statements included in the Management's Discussion and Analysis of Results of Operations and Financial Condition and elsewhere in this quarterly report are subject to risks and uncertainties that could affect actual future results. Potential risks and uncertainties include, but are not limited to, general business conditions, unusual volatility in equity and interest rate markets, disruptions in the availability or pricing of raw materials, transportation difficulties, changing government educational aid policies, or disruption of operations from acts of God. -12- 13 SCOPE INDUSTRIES AND SUBSIDIARIES PART II. OTHER INFORMATION Item 2. Increases and Decreases in Outstanding Securities and Indebtedness. Increases and decreases in outstanding equity securities in the nine months ending March 31, 1998 were as follows: Common Stock No Par Value --------- Shares outstanding June 30, 1997 1,168,665 Shares purchased and retired during the nine months (38,313) --------- Shares outstanding March 31, 1998 1,130,352 ========= A corporate resolution requires the retirement of all reacquisitions of common stock. During the nine months ended March 31, 1998, the Registrant purchased and retired 38,313 shares of common stock at a cost of $2,042,335. Item 6. Exhibits and Reports on Form 8-K. (A) Exhibits - None (B) No Form 8-K was filed for the quarter ended March 31, 1998. SIGNATURES Pursuant to the requirements of the Securities and Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized and accepting responsibility as the signatory. SCOPE INDUSTRIES (Registrant) DATE: May 6, 1998 /s/ John J. Crowley --------------------- ------------------------------------- John J. Crowley, Vice President and Chief Financial Officer -13-