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 December 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 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. 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 January 25, 1999 - -------------------------- ------------------------------- Common Stock, no par value 1,116,367 2 SCOPE INDUSTRIES AND SUBSIDIARIES INDEX PAGE ---- Part I. Financial Information: Consolidated Balance Sheets - December 31, 1998 and June 30, 1998 3 Consolidated Statements of Operations - Three Months Ended December 31, 1998 and 1997 4 Consolidated Statements of Operations - Six Months Ended December 31, 1998 and 1997 5 Consolidated Statements of Cash Flows - Six Months Ended December 31, 1998 and 1997 6 Notes to Consolidated Financial Statements 7 Management's Discussion and Analysis of Results of Operations and Financial Condition 9 Part II. Other Information: Item 2. Increases and Decreases in Outstanding Securities and Indebtedness 11 Item 5. Other Information 12 Item 6. Exhibits and Reports on Form 8-K 12 Signatures 12 -2- 3 PART I. FINANCIAL INFORMATION SCOPE INDUSTRIES AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS DECEMBER 31 JUNE 30 1998 1998 ----------- ----------- (UNAUDITED) ASSETS CURRENT ASSETS: Cash and cash equivalents $ 1,040,345 $ 755,904 Treasury bills available for sale-at fair value 41,013,273 43,024,640 Accounts and notes receivable, less allowance for doubtful accounts of $194,814 at December 31, 1998 and $205,318 at June 30, 1998 1,445,400 1,618,150 Inventories 569,994 662,399 Deferred income taxes 710,000 700,000 Prepaid expenses and other current assets 1,145,358 459,465 ----------- ----------- TOTAL CURRENT ASSETS 45,924,370 47,220,558 ----------- ----------- NOTES RECEIVABLE 1,046,518 897,829 ----------- ----------- PROPERTY AND EQUIPMENT: Machinery and equipment 24,148,047 23,407,396 Land, buildings and improvements 10,580,292 10,581,881 ----------- ----------- 34,728,339 33,989,277 Less accumulated depreciation and amortization 24,109,850 23,304,941 ----------- ----------- 10,618,489 10,684,336 ----------- ----------- OTHER ASSETS: Deferred charges and other assets 471,122 244,590 Investments available for sale-at fair value 13,523,332 17,326,799 Other equity investments-at cost 2,006,002 2,006,002 ----------- ----------- 16,000,456 19,577,391 ----------- ----------- $73,589,833 $78,380,114 =========== =========== LIABILITIES AND SHAREOWNERS' EQUITY CURRENT LIABILITIES: Accounts payable $ 956,525 $ 1,050,796 Other accrued liabilities 2,482,718 1,359,136 Accrued payroll and related employee benefits 523,861 705,604 Income taxes payable 187,431 475,506 ----------- ----------- TOTAL CURRENT LIABILITIES 4,150,535 3,591,042 ----------- ----------- DEFERRED INCOME TAXES 2,285,000 3,635,000 ----------- ----------- 6,435,535 7,226,042 ----------- ----------- SHAREOWNERS' EQUITY: Common stock, no par value, 5,000,000 shares authorized; shares issued and outstanding December 31, 1998 1,116,367 June 30, 1998 1,122,842 4,161,300 4,138,462 Retained earnings 55,777,650 57,635,588 Net unrealized gain on investments 7,215,348 9,380,022 ----------- ----------- 67,154,298 71,154,072 ----------- ----------- $73,589,833 $78,380,114 =========== =========== The accompanying notes are an integral part of these statements. -3- 4 SCOPE INDUSTRIES AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED) THREE MONTHS ENDED DECEMBER 31 ---------------------------- 1998 1997 ----------- ----------- REVENUES: Sales $ 3,964,808 $ 5,708,983 Vocational school revenues 1,178,696 1,155,933 ----------- ----------- 5,143,504 6,864,916 ----------- ----------- OPERATING COSTS AND EXPENSES: Cost of sales 3,693,832 3,976,905 Vocational school expenses 899,990 884,509 Depreciation and amortization 520,522 516,119 General and administrative 960,053 979,808 ----------- ----------- 6,074,397 6,357,341 ----------- ----------- (930,893) 507,575 Investment and other income 607,809 4,584,245 ----------- ----------- Income (loss) before income taxes (323,084) 5,091,820 Provision (benefit) for income taxes (85,000) 1,890,000 ----------- ----------- NET INCOME (LOSS) $ (238,084) $ 3,201,820 =========== =========== NET INCOME (LOSS) PER SHARE - BASIC $ (0.21) $ 2.82 NET INCOME (LOSS) PER SHARE - DILUTED $ (0.21) $ 2.80 Average shares outstanding - Basic 1,117,242 1,134,102 Dilutive effect of stock options 9,391 9,508 ----------- ----------- Average shares outstanding - Diluted 1,126,633 1,143,610 Cash dividends declared per share $ 1.00 $ 1.00 The accompanying notes are an integral part of these statements. -4- 5 SCOPE INDUSTRIES AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED) SIX MONTHS ENDED DECEMBER 31 ------------------------------ 1998 1997 ------------ ------------ REVENUES: Sales $ 7,991,983 $ 11,066,547 Vocational school revenues 2,302,901 2,293,174 ------------ ------------ 10,294,884 13,359,721 ------------ ------------ OPERATING COSTS AND EXPENSES: Cost of sales 7,131,422 7,664,550 Vocational school expenses 1,797,463 1,785,669 Depreciation and amortization 1,030,589 1,035,696 General and administrative 1,901,013 2,066,283 ------------ ------------ 11,860,487 12,552,198 ------------ ------------ (1,565,603) 807,523 Investment and other income 1,292,171 5,014,112 ------------ ------------ Income (loss) before income taxes (273,432) 5,821,635 Provision (benefit) for income taxes (40,000) 2,205,000 ------------ ------------ NET INCOME (LOSS) $ (233,432) $ 3,616,635 ============ ============ NET INCOME (LOSS) PER SHARE - BASIC $ (0.21) $ 3.15 NET INCOME (LOSS) PER SHARE - DILUTED $ (0.21) $ 3.12 Average shares outstanding - Basic 1,118,763 1,148,915 Dilutive effect of stock options 9,610 8,973 ------------ ------------ Average shares outstanding - Diluted 1,128,373 1,157,888 Cash dividends declared per share $ 1.00 $ 1.00 The accompanying notes are an integral part of these statements. -5- 6 SCOPE INDUSTRIES AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) SIX MONTHS ENDED DECEMBER 31 ------------------------------ 1998 1997 ------------ ------------ CASH FLOWS FROM OPERATING ACTIVITIES: Net income (loss) $ (233,432) $ 3,616,635 Adjustments to reconcile net income (loss) to net cash flows from operating activities: Depreciation and amortization 1,030,589 1,035,696 Gains on investments available for sale (10,258) (4,128,161) (Gains) losses on sale of equipment (45,534) 18,435 Deferred income taxes (145,000) (120,000) Changes in operating assets and liabilities: Accounts and notes receivable 179,061 (272,493) Inventories 92,405 166,412 Prepaid expenses and other current assets (685,893) (218,942) Accounts payable and accrued liabilities 847,568 758,166 Income taxes payable (288,075) (35,963) Other assets (6,532) 4,423 ------------ ------------ Net cash flows from operating activities 734,899 824,208 ------------ ------------ CASH FLOWS FROM INVESTING ACTIVITIES: Purchase of U.S. Treasury bills (16,988,633) (22,872,420) Maturities of U.S. Treasury bills 19,000,000 18,750,000 Purchase of property and equipment (1,112,700) (632,038) Disposition of property and equipment 193,492 53,409 Purchase of long-term notes receivable (340,000) (658,800) Purchase of investments available for sale (319,049) (335,703) Purchase of other equity investments (1,001,000) Proceeds from sale of investments available for sale 718,100 4,979,967 ------------ ------------ Net cash flows from (used in) investing activities 1,151,210 (1,716,585) ------------ ------------ CASH FLOWS FROM FINANCING ACTIVITIES: Dividends to shareowners (1,117,967) (1,133,352) Repurchases of common stock (506,539) (1,857,602) Proceeds from stock options exercised 22,838 Change in bank overdraft 66,896 ------------ ------------ Net cash used in financing activities (1,601,668) (2,924,058) ------------ ------------ Net change in cash and cash equivalents 284,441 (3,816,435) Cash and cash equivalents at beginning of period 755,904 5,946,050 ------------ ------------ Cash and cash equivalents at end of period $ 1,040,345 $ 2,129,615 ============ ============ The accompanying notes are an integral part of these statements. -6- 7 SCOPE INDUSTRIES AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) DECEMBER 31, 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 December 31, 1998 and June 30, 1998, and the results of its operations and cash flows for the six months ended December 31, 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: December 31 June 30 1998 1998 ----------- ----------- At adjusted cost which approximates fair value $41,013,273 $43,024,640 At par value 41,750,000 44,250,000 4. Inventories consisted of the following: December 31 June 30 1998 1998 ----------- -------- Finished products $196,122 $276,320 Raw materials 198,357 207,862 Operating supplies 175,515 178,217 -------- -------- $569,994 $662,399 ======== ======== -7- 8 SCOPE INDUSTRIES AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) DECEMBER 31, 1998 (CONTINUED) 5. Investments consisted of the following: Net Unrealized Gains Before Provision For Cost Income Taxes Fair Value ---- ------------ ---------- At December 31, 1998: - --------------------- Investments available for sale $ 2,682,984 $10,840,348 $13,523,332 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. Gains of $10,258 and $4,128,161 from sales of investments were included in the determination of the respective loss and net income for the six month period ended December 31, 1998 and 1997. 6. Comprehensive income consisted of the following: Six Months Ended December 31 ------------------------------ 1998 1997 ------------ ------------ Net (loss) income $ (233,432) $ 3,616,635 Unrealized holding (losses) gains arising during the period, net of income taxes (2,159,416) 15,218,985 Reclassify gains realized and included in net income, net of income taxes (5,258) (2,563,161) ------------ ------------ Other comprehensive (loss) income (2,164,674) 12,655,824 ------------ ------------ Comprehensive (loss) income $ (2,398,106) $ 16,272,459 ============ ============ 7. The benefit for income taxes for the six months ended December 31, 1998 is 14.6% of the loss before taxes. The determination of the benefit or provision for income taxes considers certain permanent differences between taxable income or loss and income or loss as reported using generally accepted accounting methods. Those differences sometimes cause distortions in the relationships between income or loss before income taxes and the benefit or provision for income taxes. For the six month period ended December 31, 1997 the effective rate for income taxes was 37.9%. -8- 9 SCOPE INDUSTRIES AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION RESULTS OF OPERATIONS The Company's second fiscal quarter ended December 31, 1998 resulted in a net loss of $238,084 which is a $0.21 loss per share-diluted. For the second quarter last year, net income was $3,201,820, which was $2.80 per share-diluted. Total operating revenues for this year's second quarter were 25% below the revenues for the same quarter last year. Waste Material Recycling segment revenues in the current quarter dropped 27% from last year's second quarter revenues. The segment's reduced revenues were a result of unit selling prices falling 27% from the year earlier average price level. Selling prices of Dried Bakery Product closely track corn prices as they are competitive feed commodities. Cash corn prices during the quarter ending December 1998 averaged 76% of year earlier prices. Vocational School Group revenues for the quarter were 2% above revenues for the same quarter last year. Operating costs for the Waste Material Recycling segment dropped 7% compared to the same quarter last year. Vocational School Group operating costs were 2% higher in the current quarter than in the comparable quarter last year. The dramatic selling price drop for the Waste Material Recycling segment production, accompanied by costs that were reduced but not to the same extent as the drop in sales prices, resulted in an operating loss for the segment. Vocational School operations for the quarter were profitable. For the comparable quarter last year, operations in both the Waste Material Recycling segment and the Vocational School Group segment were profitable. Investment and other income for the quarter ended December 31, 1998 is $607,809 compared to $4,584,245 for the same three months last year. Investment income for the current quarter is comprised primarily of interest income. The year earlier quarter included gains of $4,128,161 from sales of investments. For the six months ended December 31, 1998, the Company incurred a net loss of $233,432 or $0.21 loss per share-diluted. For the comparable six months in the prior year, net income was $3,616,635 or $3.12 per share-diluted. Revenues for the six months ended December 31, 1998 were 23% less than revenues for the comparable six months last year. The reduced revenue in the current six month period is a result of lower product prices realized in the Waste Material Recycling segment in this year's six month period compared to prices that prevailed for the six month period last year. Corn prices have been lower during the current six month period than the prices during the comparable period last year. As a consequence, the Company's Dried Bakery Product has sold at lower prices in the current period compared to the comparable six months last year. The Waste Material Recycling segment incurred an operating loss in the six month period ended December 31, 1998 compared to achieving profits in the prior year's six month period. The Vocational School Group segment operated profitably during the current and the previous year's six months periods ending December 31. Investment and other income for the six months ended December 31, 1998 is $1,292,171. It was $5,014,112 for the comparable six months last year. The investment income for the earlier period included gains on investments sold of $4,128,161. -9- 10 SCOPE INDUSTRIES AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION (CONTINUED) 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 six months ended December 31, 1998, unrealized holding gains, net of income taxes, decreased from $9,380,022 to $7,215,348 (loss of $2,164,674). This other comprehensive income (loss), together with the net loss for the period of $233,432 resulted in comprehensive income (loss) for the six months of $2,398,106. Comprehensive income for the six months ended December 31, 1997 was $16,272,459. FINANCIAL CONDITION Working Capital was $41,773,835 at December 31, 1998. It was $43,629,516 at June 30, 1998. The working capital ratio at December 31, 1998 was 11.1 and was 13.1 at June 30, 1998. At December 31, 1998, investments include $10,840,348 in unrealized gains based on fair values that exceed adjusted costs for certain securities. Nearly all of this unrealized gain is represented by the Company's holdings in OSI Systems, Inc. The Company, as a result of its investment in OSI Systems, Inc. in 1990, is OSI's largest single shareholder although not a controlling shareholder. Shareowners' equity reflects $7,215,348 net unrealized gain on investments after a provision for deferred taxes. The unrealized holding gains are excluded from earnings. TAXES The benefit for income tax credits for the six month period ended December 31, 1998 is $40,000. For the first six months of the prior fiscal year, the income tax provision was $2,205,000 and the effective tax rate was 37.9%. 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. -10- 11 SCOPE INDUSTRIES AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION (CONTINUED) 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. 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. 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 six months ending December 31, 1998 were as follows: Common Stock No Par Value ------------ Shares outstanding June 30, 1998 1,122,842 Shares purchased and retired during the six months (7,375) Shares issued for stock options exercised 900 ---------- Shares outstanding December 31, 1998 1,116,367 ========== A corporate resolution requires the retirement of all reacquisitions of common stock. During the six months ended December 31, 1998, the Company purchased and retired 7,375 shares of common stock at a cost of $506,539. -11- 12 PART II. OTHER INFORMATION (CONTINUED) SCOPE INDUSTRIES AND SUBSIDIARIES 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, 1999 to shareowners of record at November 30, 1998. On February 9, 1999, the Company, through its wholly-owned subsidiary, Scope Products, Inc., agreed to purchase the bakery waste recycling business of Darling International Inc. The business, known as International Processing Corporation, consists of manufacturing facilities located in Georgia, Illinois, Indiana, Kansas, New Jersey, North Carolina, Ohio and Texas which process waste bakery materials into animal feed. Darling International Inc., whose stock is traded on the American Stock Exchange, (symbol DAR), is a recycler of animal processing by-products. The acquisition of all the outstanding shares of International Processing Corporation and its affiliate International Transportation Service, Inc., which comprise the bakery waste recycling business to be acquired, if successfully completed, is to be an all cash purchase for $22,000,000. The transaction is expected to be completed and be effective in early April 1999, subject to completing certain conditions including receiving appropriate regulatory approvals. The Company has sufficient cash on hand together with other liquid assets, including US Treasury bills, to complete the purchase without utilizing borrowings or credit lines that may be available to it. Item 6. Exhibits and Reports on Form 8-K. (A) Exhibits - None (B) No Form 8-K was filed for the quarter ended December 31, 1998. 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: February 12, 1999 /s/ John J. Crowley ------------------------------- ------------------------------- John J. Crowley, Vice President and Chief Financial Officer -12-