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 September 30, 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 October 27, 1998 Common Stock, no par value 1,117,567 2 SCOPE INDUSTRIES AND SUBSIDIARIES INDEX PAGE ---- Part I. Financial Information: Consolidated Balance Sheets - September 30, 1998 and June 30, 1998 3 Consolidated Statements of Income - Three Months Ended September 30, 1998 and 1997 4 Consolidated Statements of Cash Flows - Three Months Ended September 30, 1998 and 1997 5 Notes to Consolidated Financial Statements 6 Management's Discussion and Analysis of Results of Operations and Financial Condition 8 Part II. Other Information: Item 2. Increases and Decreases in Outstanding Securities and Indebtedness 10 Item 4. Submission of Matters to a Vote of Security Holders 10 Item 5. Other Information 10 Item 6. Exhibits and Reports on Form 8-K 10 Signatures 11 -2- 3 PART I. FINANCIAL INFORMATION SCOPE INDUSTRIES AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS SEPTEMBER 30 JUNE 30 1998 1998 ------------ -------- (UNAUDITED) ASSETS CURRENT ASSETS: Cash and cash equivalents $ 440,660 $ 755,904 Treasury bills available for sale-at fair value 41,921,037 43,024,640 Accounts and notes receivable, less allowance for doubtful accounts of $207,318 at September 30, 1998 and $205,318 at June 30, 1998 1,571,379 1,618,150 Inventories 752,986 662,399 Deferred income taxes 700,000 700,000 Prepaid expenses and other current assets 1,164,727 459,465 ----------- ----------- TOTAL CURRENT ASSETS 46,550,789 47,220,558 ----------- ----------- NOTES RECEIVABLE 1,060,365 897,829 ----------- ----------- PROPERTY AND EQUIPMENT: Machinery and equipment 23,782,656 23,407,396 Land, buildings and improvements 10,670,526 10,581,881 ----------- ----------- 34,453,182 33,989,277 Less accumulated depreciation and amortization 23,790,931 23,304,941 ----------- ----------- 10,662,251 10,684,336 ----------- ----------- OTHER ASSETS: Deferred charges and other assets 407,435 244,590 Investments available for sale-at fair value 13,364,262 17,326,799 Other equity investments-at cost 2,006,002 2,006,002 ----------- ----------- 15,777,699 19,577,391 ----------- ----------- $74,051,104 $78,380,114 =========== =========== LIABILITIES AND SHAREOWNERS' EQUITY CURRENT LIABILITIES: Bank Overdraft $ 276,195 $ Accounts payable 1,012,605 1,050,796 Other accrued liabilities 1,412,875 1,359,136 Accrued payroll and related employee benefits 530,785 705,604 Income taxes payable 440,181 475,506 ----------- ----------- TOTAL CURRENT LIABILITIES 3,672,641 3,591,042 ----------- ----------- DEFERRED INCOME TAXES 2,110,000 3,635,000 ----------- ----------- 5,782,641 7,226,042 ----------- ----------- SHAREOWNERS' EQUITY: Common stock, no par value, 5,000,000 shares authorized; shares issued and outstanding September 30, 1998 1,118,067 June 30, 1998 1,122,842 4,138,462 4,138,462 Retained earnings 57,305,399 57,635,588 Net unrealized gain on investments 6,824,602 9,380,022 ----------- ----------- 68,268,463 71,154,072 ----------- ----------- $74,051,104 $78,380,114 =========== =========== The accompanying notes are an integral part of these statements. -3- 4 SCOPE INDUSTRIES AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED) THREE MONTHS ENDED SEPTEMBER 30 ----------------------------- 1998 1997 ---- ---- REVENUES: Sales $ 4,027,175 $ 5,357,564 Vocational school revenues 1,124,205 1,137,241 ----------- ----------- 5,151,380 6,494,805 ----------- ----------- OPERATING COSTS AND EXPENSES: Cost of sales 3,437,590 3,687,645 Vocational school expenses 897,473 901,160 Depreciation and amortization 510,067 519,577 General and administrative 940,960 1,086,475 ----------- ----------- 5,786,090 6,194,857 ----------- ----------- (634,710) 299,948 Investment and other income 684,362 429,867 ----------- ----------- Income before income taxes 49,652 729,815 Provision for income taxes 45,000 315,000 ----------- ----------- NET INCOME $ 4,652 $ 414,815 =========== =========== NET INCOME PER SHARE - BASIC $ 0.00 $ 0.36 NET INCOME PER SHARE - DILUTED $ 0.00 $ 0.35 Average shares outstanding - Basic 1,120,111 1,160,587 Dilutive effect of stock options 10,391 8,368 ----------- ----------- Average shares outstanding - Diluted 1,130,502 1,168,954 The accompanying notes are an integral part of these statements. -4- 5 SCOPE INDUSTRIES AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) THREE MONTHS ENDED SEPTEMBER 30 1998 1997 ---- ---- CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 4,652 $ 414,815 Adjustments to reconcile net income to net cash flows from operating activities: Depreciation and amortization 510,067 519,577 Gains on investments available for sale (7,942) (Gains) losses on sale of equipment (41,251) 18,046 Deferred income taxes (50,000) (45,000) Changes in operating assets and liabilities: Accounts and notes receivable 39,235 26,054 Inventories (90,587) (67,931) Prepaid expenses and other current assets (705,262) (77,111) Accounts payable and accrued liabilities (159,271) (615,159) Income taxes payable (35,325) (27,463) Other assets 22,155 10,063 ------------ ------------ Net cash flows (used in) from operating activities (513,529) 155,891 ------------ ------------ CASH FLOWS FROM INVESTING ACTIVITIES: Purchase of U.S. Treasury bills (8,896,397) (8,181,827) Maturities of U.S. Treasury bills 10,000,000 6,750,000 Purchase of property and equipment (635,213) (282,893) Disposition of property and equipment 188,482 53,798 Purchase of investments available for sale (108,924) (60,147) Purchase of other equity investments (1,001,000) Disposition of investments available for sale 48,983 Purchase of long-term note receivable and other investment (340,000) (428,800) ------------ ------------ Net cash flows from (used in) investing activities 256,931 (3,150,869) ------------ ------------ CASH FLOWS FROM FINANCING ACTIVITIES: Repurchases of common stock (334,841) (1,680,276) Change in bank overdraft 276,195 55,489 ------------ ------------ Net cash used in financing activities (58,646) (1,624,787) ------------ ------------ Net decrease in cash and cash equivalents (315,244) (4,619,765) Cash and cash equivalents at beginning of period 755,904 5,946,050 ------------ ------------ Cash and cash equivalents at end of period $ 440,660 $ 1,326,285 ============ ============ The accompanying notes are an integral part of these statements. -5- 6 SCOPE INDUSTRIES AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) SEPTEMBER 30, 1998 1. The accompanying interim consolidated financial statements of Scope Industries are unaudited. The consolidated financial statements reflect all adjustments (consisting of only normal recurring accruals) which are, in the opinion of management, necessary for the fair presentation of the financial position as of September 30, 1998 and June 30, 1998, and the results of its operations and cash flows for the three months ended September 30, 1998 and 1997. The accounting policies followed by the Company are set forth in Note 1 of its financial statements in its 1998 Annual Report which is incorporated by reference on Form 10-K. The results of operations for the interim periods should not be considered indicative of results to be expected for the full year. 2. Effective July 1, 1998, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 130, "Reporting Comprehensive Income". Other comprehensive income for the Company is comprised of changes in unrealized holding gains or losses on investments available for sale, net of taxes and when combined with net income, results in comprehensive net income. Comprehensive income disclosure is presented in Note 6. 3. Treasury bills consisted of the following: September 30 June 30 1998 1998 ---- ---- At adjusted cost which approximates fair value $41,921,037 $43,024,640 At par value 43,000,000 44,250,000 4. Inventories consisted of the following: September 30 June 30 1998 1998 ---- ---- Finished products $ 288,452 $ 276,320 Raw materials 276,010 207,862 Operating supplies 188,524 178,217 ----------- ---------- $ 752,986 $ 662,399 =========== ========== -6- 7 SCOPE INDUSTRIES AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) SEPTEMBER 30, 1998 (CONTINUED) 5. Investments consisted of the following: Net Unrealized Gains Before Provision For Cost Income Taxes Fair Value ---- -------------- ---------- At September 30, 1998: Investments available for sale $ 3,139,659 $10,224,603 $13,364,262 Other equity investments 2,006,002 2,006,002(a) At June 30, 1998: Investments available for sale $ 3,071,776 $14,255,023 $17,326,799 Other equity investments 2,006,002 2,006,002(a) (a) No quoted prices are available for these securities 6. Comprehensive income consisted of the following: Three Months Ended September 30 ------------------- 1998 1997 ---- ---- Net income $ 4,652 $ 414,815 Unrealized holding (losses) gains arising during the period, net of income taxes (2,552,478) 2,597,760 Reclassify gains realized and included in net income, net of income taxes (2,942) ----------- ----------- Other comprehensive (loss) income (2,555,420) 2,597,760 ----------- ----------- Comprehensive (loss) income $(2,550,768) $ 3,012,575 =========== =========== 7. The provision for income taxes for the three months ended September 30, 1998 is 90.6% of the income before taxes. The determination of the provision for income taxes considers certain permanent differences between taxable income and income as reported using generally accepted accounting methods. Those differences sometimes cause distortions in the relationships between income before income taxes and the provision for income taxes. For the three month period ended September 30, 1997 the effective rate for income taxes was 43.2%. -7- 8 SCOPE INDUSTRIES AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION RESULTS OF OPERATIONS For the first quarter ended September 30, 1998, net income was down 98.9% from the first quarter of last year. Net income in the current quarter was $4,652 which, on a per share basis was $0.00. Last year's first quarter net income was $414,815 or $0.35 per share. Total operating revenues for this year's first quarter were 20.7% less than the revenues for the same quarter last year. Waste Material Recycling segment sales for the current quarter fell 24.3% from last year's first quarter revenues. Unit selling prices were for the second year in a row, dramatically below the comparable year earlier prices due to steadily dropping price levels for corn and other animal feed commodities, which recycled bakery waste material prices must compete with. The average price received for materials sold in this year's first quarter was 17.0% below last year's first quarter average price. Tonnage sold in the current quarter was 8.8% below last year's first quarter. Vocational School Group revenues this quarter were 1.1% below the comparable quarter last year. Operating costs for the Waste Material Recycling segment were 7.0% lower in the current quarter than for the same quarter last year. Waste Material Recycling operations were not profitable for the quarter. The Waste Material Recycling segment had completed 23 consecutive profitable quarters prior to experiencing a loss for this year's first quarter, highlighting the impact of lower selling prices. The Vocational School Group operations reported small losses in both the current quarter and the comparable quarter last year. Consolidated operations for the first quarter of the current year resulted in a loss as opposed to earnings for the first quarter of last year. Investment and other income for the three months ended September 30, 1998 was 59.2% higher than for the same three months last year. Interest income from US Treasury bills comprised most of the investment income for both quarterly periods. Effective July 1, 1998, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 130, "Reporting Comprehensive Income". Changes in unrealized gains or losses on investments available for sale are included as other comprehensive income and when combined with net income, results in comprehensive income. During the quarter ended September 30, 1998, unrealized holding gains, net of income taxes, decreased from $9,380,022 to $6,824,602 (loss of $2,555,420). This other comprehensive income (loss), together with the net income for the quarter of $4,652 resulted in comprehensive income (loss) for the quarter of $2,550,768. Comprehensive income for the quarter ended September 30, 1997 was $3,012,575. -8- 9 SCOPE INDUSTRIES AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION (CONTINUED) FINANCIAL CONDITION Working Capital was $42,878,148 at September 30, 1998. It was $43,629,516 at June 30, 1998. The working capital ratio at September 30, 1998 was 12.7 and was 13.1 at June 30, 1998. TAXES The provision for income taxes for the three month period ended September 30, 1998 is $45,000. This provision for income taxes is 90.6% of income before taxes. Certain permanent differences between taxable income and the income determined by using generally accepted accounting methods, cause an unusual relationship between income before income taxes and the provision for income taxes. For the first three months of the prior fiscal year, the income tax provision was 43.2% of the reported income before income taxes. YEAR 2000 The Company has undertaken a review of its computer systems and computer applications to identify those which could be affected by "Year 2000" problems. Based on the review and associated testing, the Company believes that its financial data and reporting systems are "Year 2000" ready. The Company also believes its operating systems will not have serious concerns in this regard and are capable of operating in alternative modes that could circumvent "Year 2000" problems. The Company is continuing to review and test its systems and to monitor vendors and service providers to determine what impact may result from the "Year 2000" issue and if action or additional planning is needed. Risks exist that could severely effect the Company's ongoing business should serious failures or interruptions occur in services from utilities, banks, government agencies, government Student Aid funding programs, securities markets or others. Expenses incurred to date to correct "Year 2000" problems have not been material and it is anticipated that no significant additional costs will be incurred with regard to "Year 2000" issues. FORWARD LOOKING STATEMENTS Forward looking statements included in this Management's Discussion and Analysis of Operations and Financial Condition and included elsewhere in this quarterly report, are subject to risks and uncertainties that could affect actual future results. Although the Company believes that the expectations reflected in such forward looking statements are reasonable, it can give no assurance that such expectations will prove to be correct. Potential risk and uncertainties include, but are not limited to, general business conditions, unusual volatility in equity and interest rate markets and in competing commodity markets, disruptions in the availability or pricing or raw materials, transportation difficulties, changing governmental educational aid policies, or disruption of operations due to unavailability of fuels or from acts of God. -9- 10 PART II. OTHER INFORMATION SCOPE INDUSTRIES AND SUBSIDIARIES Item 2. Increases and Decreases in Outstanding Securities and Indebtedness. Increases and decreases in outstanding equity securities in the three months ending September 30, 1998 were as follows: Common Stock No Par Value ------------ Shares outstanding June 30, 1998 1,122,842 Shares purchased and retired during the three months (4,775) ---------- Shares outstanding September 30, 1998 1,118,067 ========== A corporate resolution requires the retirement of all reacquisitions of common stock. During the three months ended September 30, 1998, the Company purchased and retired 4,775 shares of common stock at a cost of $334,841. Item 4. Submission of Matters to a Vote of Security Holders. At the annual meeting of shareowners held on October 27, 1998 with 1,120,967 shares entitled to vote, five directors were elected to serve for the ensuing year and until their successors have been elected and qualified. VOTES VOTES ABSTAINED DIRECTORS FOR WITHHELD FROM VOTING TOTAL --------- ----- -------- ----------- ----- Robert Henigson 1,106,301 15 1,106,316 Meyer Luskin 1,106,301 15 1,106,316 William H. Mannon 1,106,301 15 1,106,316 Franklin Redlich 1,106,301 15 1,106,316 Paul D. Saltman 1,106,251 50 15 1,106,316 Item 5. Other Information. On October 27, 1998 the Company's board of directors declared a regular dividend of $1.00 per share payable on January 5, 1998 to shareowners of record at November 30, 1998. Item 6. Exhibits and Reports on Form 8-K. (A) Exhibits - None (B) No Form 8-K was filed for the quarter ended September 30, 1998. -10- 11 PART II. OTHER INFORMATION (CONTINUED) SCOPE INDUSTRIES AND SUBSIDIARIES SIGNATURES Pursuant to the requirements of the Securities and Exchange Act of 1934, the Company 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: November 12, 1998 /s/ John J. Crowley ------------------------ John J. Crowley, Vice President and Chief Financial Officer -11-