UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
SCHEDULE 14A INFORMATION
Proxy Statement Pursuant to Section 14(a) of the Securities Exchange Act of 1934
Filed by the Registrant [x]
Filed by a Party other than the Registrant [ ]
Check the appropriate box:
[x] Preliminary Proxy Statement
[ ] Confidential, for use of the Commission Only (as permitted by
Rule 14a-6(e)(2))
[ ] Definitive Proxy Statement
[ ] Definitive Additional Materials
[ ] Soliciting Materials Pursuant to sec. 240.14a-11(c) or sec. 240.14a-12
SCAN-OPTICS, INC
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(Exact Name of Registrant as Specified in its Charter)
Payment of Filing Fee (Check the appropriate box)
[x] No fee required.
[ ] Fee computed on table below per Exchange Act Rules 14a-6(i)(l) and 0-11.1
(1) Title of each class of securities to which transaction applies:
N/A
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(2) Aggregate number of securities to which transaction applies:
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(3) Per unit or other underlying value of transaction computed pursuant to
Exchange Act Rule 0-11 (set forth the amount on which the filing fee is
calculated and state how it was determined):
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(4) Proposed maximum aggregate value of transaction:
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(5) Total fee paid:
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[ ] Fee paid previously with preliminary materials.
[ ] Check box if any part of the fee is offset as provided by Exchange Act Rule
0-11(a)(2) and identify the filing for which the offsetting fee was paid
previously. Identify the previous filing by registration statement number, or
the Form or Schedule and the date of its filing.
(1) Amount Previously Paid
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(2) Form, Schedule or Registration Statement No.:
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(4) Date Filed:
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[GRAPHIC OMITTED]
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[____________ __, 2005]
Dear Stockholders:
You are cordially invited to the Special Meeting of Stockholders of
Scan-Optics, Inc. ("Scan-Optics"), scheduled to be held [____________ __, 2005],
at the offices of Day, Berry & Howard, LLP, CityPlace I, 25th Floor, Hartford,
Connecticut, commencing at [__:__ o'clock] local time. This meeting is
particularly significant as we are seeking stockholder approval of the Plan of
Dissolution of Scan-Optics.
Accompanying this letter you will find the formal Notice of the Special
Meeting, which lists the matters to be considered and acted upon, as well as our
Proxy Statement, which describes those matters in detail and provides certain
other information about Scan-Optics. We have also enclosed a Proxy Card.
Regardless of the number of shares you own, it is important that they
are represented and voted at the meeting, whether or not you plan to attend.
Accordingly, you are requested to mark, sign, date and return the enclosed proxy
in the envelope provided at your earliest convenience.
Sincerely,
Scott Schooley
Chairman of the Board and President
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PRELIMINARY COPY
SCAN-OPTICS, INC.
179 Allyn Street--Suite 508
Hartford, Connecticut 06103
Notice of Special Meeting of Stockholders
A Special Meeting of Stockholders of Scan-Optics, Inc. ("Scan-Optics") will be
held at the offices of Day, Berry & Howard, LLP, Cityplace I, 25th Floor,
Hartford, Connecticut, on [__________ __, 2005] at [__:__] local time to
consider and take action on the following items:
1. To approve the voluntary liquidation and dissolution of the Company
pursuant to the Plan of Dissolution attached as Annex A to the proxy
statement;
2. To approve an amendment to the Company's Amended and Restated
Certificate of Incorporation to decrease the minimum number of
directors to no fewer than one director in the form attached as Annex
B to the proxy statement; and
3. To transact such other business as may properly come before the
meeting or any adjournment thereof.
Only holders of our common stock at the close of business on [___________ __,
2005] are entitled to notice of and to vote at the meeting or any adjournment
thereof. A list of stockholders entitled to vote at the meeting will be
available for examination by any stockholder for any purpose germane to the
meeting during ordinary business hours for ten days prior to the meeting at the
offices of Scan-Optics, 179 Allyn Street--Suite 508, Hartford, Connecticut.
By Order of the Board of Directors,
- ------------------------------
Scott Schooley
Secretary
Hartford, Connecticut
[___________ __, 2005]
Directions to Scan-Optics' special meeting of stockholders at the offices of
Day, Berry & Howard, LLP in Hartford, Connecticut:
From I-84 Eastbound:
Take 84 East to Asylum Street/Capital Avenue (Exit 48); take the left-hand fork
in the exit; at the end of exit, take a right; go under the railroad bridge;
straight at the light; bear to the right at
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second light, but get into far left-hand lane; take first left onto Pearl
Street; go straight at light; the CityPlace garage entrance is on the left just
before Trumbull Street intersection.
From I-84 Westbound:
Take 84 West to downtown Hartford (Exit 54); follow signs for downtown Hartford;
go straight at light up a short hill; after road curves to the left around the
Old State House, bear right onto Central Row; go straight at light, crossing
Main Street onto Pearl Street; go straight at next light, crossing Trumbull
Street; the CityPlace garage entrance is immediately on the right.
From I-91 Northbound:
Take 91 North to exit for Capitol Area (Exit 29A); follow traffic circle
(Pulaski Circle) and take first right off the circle; at second light, turn
right onto Trumbull Street; at next light, turn left onto Pearl Street; the
CityPlace garage entrance is immediately on the right.
From I-91 Southbound:
Take 91 South to Trumbull Street exit (Exit 32); at the end of exit, go straight
to light at the top of the hill; go straight at light, crossing Main Street onto
Trumbull Street; follow Trumbull Street for five lights, passing the Hartford
Civic Center on the right; at fifth light, turn right onto Pearl Street; the
CityPlace garage entrance is immediately on the right.
YOUR VOTE IS IMPORTANT. EVEN IF YOU PLAN TO ATTEND THE MEETING IN PERSON, PLEASE
MARK, SIGN, DATE AND RETURN YOUR PROXY IN THE ENCLOSED ENVELOPE AS PROMPTLY AS
POSSIBLE.
NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY STATE SECURITIES
COMMISSION HAS APPROVED OR DISAPPROVED OF THE TRANSACTIONS DISCUSSED HEREIN;
PASSED UPON THE MERITS OR FAIRNESS OF SUCH TRANSACTIONS; OR PASSED UPON THE
ADEQUACY OR ACCURACY OF THE DISCLOSURE IN THIS PROXY STATEMENT. ANY
REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
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PRELIMINARY COPY
SCAN-OPTICS, INC.
179 Allyn Street--Suite 508
Manchester, Connecticut 06103
PROXY STATEMENT
This proxy statement is furnished in connection with the solicitation of proxies
to be used at the Special Meeting of Stockholders of Scan-Optics, Inc., a
Delaware corporation ("Scan-Optics" or the "Company"), to be held at the offices
of Day, Berry & Howard, LLP, Cityplace I, 25th Floor, Hartford, Connecticut, on
[__________ __, 2005] at [__:__ o'clock] local time and any adjournments
thereof.
The solicitation of proxies on the accompanying form is made on behalf of the
Board of Directors of Scan-Optics.
The cost of soliciting proxies on the accompanying form has been or will be
borne by Scan-Optics. In addition to solicitation by mail, Scan-Optics will
request banks, brokers and other custodians, nominees, and fiduciaries to send
proxy material to the beneficial owners and to secure their voting instructions,
if necessary. Scan-Optics will reimburse them for their expenses in so doing.
Directors of Scan-Optics, who will receive no compensation for their services
other than their regular salaries, may solicit proxies personally, by telephone
or otherwise from stockholders. This proxy statement and the accompanying form
of proxy are being mailed to stockholders on or about [__________ __, 2005].
A stockholder signing and returning a proxy on the accompanying form has the
power to revoke it at any time before the shares subject to it are voted by
notifying the Secretary of Scan-Optics in writing of such revocation, or by
filing a duly executed proxy bearing a later date, or by attending the meeting
and voting in person. Properly executed proxies, not revoked, will be voted in
accordance with the instructions contained thereon at the meeting or any
adjournment thereof. If this meeting is adjourned, you will be permitted to
change or revoke your proxy until such time as it is voted. Unless a contrary
specification is made thereon, it is the intention of the persons named in the
enclosed proxy to vote FOR the liquidation and dissolution of the Company in
accordance with the Plan of Dissolution, and FOR the amendment to the Company's
Amended and Restated Certificate of Incorporation.
OUTSTANDING VOTING SECURITIES
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Only holders of our common stock, $.02 par value, at the close of business on
[___________ __, 2005] are entitled to notice of and to vote at the meeting. On
[___________ __, 2005], the record date, there were [41,451,577] shares of
common stock outstanding. Each share of common stock is entitled to one vote per
share.
See "Share Ownership of Certain Beneficial Owners and Management" below for
information on beneficial ownership of common stock by current directors and
officers of Scan-Optics and holders of more than 5% of our outstanding voting
stock as of our record date and information on beneficial ownership of common
stock by past directors and officers of Scan-Optics as of the dates indicated.
QUORUM REQUIRED TO TRANSACT BUSINESS
At the close of business on [___________ __, 2005], [41,451,577] shares of
common stock were outstanding. Our by-laws require that a majority of the
outstanding shares on that date be present in person or by proxy at the meeting
in order to constitute a quorum to transact business. Shares as to which holders
abstain from voting as to a particular matter, and shares held in "street name"
by brokers or nominees who indicate on their proxies that they do not have
discretionary authority to vote those shares as to a particular matter (that is,
broker non-votes), will be counted in determining whether there is a quorum of
stockholders present at the meeting.
STOCKHOLDER APPROVAL REQUIRED TO DECIDE MATTERS
Proposal 1, Liquidation and Dissolution of the Company, will be decided by the
affirmative vote of a majority of shares of stock outstanding and entitled to
vote on the matter. Abstentions and broker non-votes with respect to this matter
will accordingly have the same effect as negative votes.
Proposal 2, Amendment to the Certificate of Incorporation to decrease to one the
number of directors that may constitute the Board of Directors, must be approved
by the affirmative vote of the holders of at least 80 percent of the voting
power of the shares of stock of the Company entitled to vote thereon, voting
without regard to class. Abstentions and broker non-votes with respect to this
matter will accordingly have the same effect as negative votes.
ARK CLO 2000-1 Limited "(ARK CLO"), holder of approximately 83% of the
outstanding common stock of Scan-Optics, Inc. has indicated its intent to vote
in favor of all proposals presented at the special meeting. ARK CLO is an
affiliate of the Company's lender as described in "Recent Events" below.
Scan-Optics' principal offices are located at 179 Allyn Street--Suite 508,
Hartford, Connecticut 06103 and its telephone number is (860) 547-1761.
This proxy statement includes forward-looking statements regarding
expectations and statements that include words such as "believes," "expects,"
"anticipates," "projects,"
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"estimates," or words of similar effect. While these statements reflect
management's reasonable judgment, numerous factors may cause actual results to
vary materially from those expressed in such statements, including the factors
set forth under the caption "Factors to Consider in Deciding Whether to Approve
the Plan of Dissolution" below and elsewhere in this proxy statement.
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SUMMARY TERM SHEET
1. What am I being asked to approve?
You are being asked to approve the dissolution and complete liquidation
of the Company pursuant to the Plan of Dissolution and an amendment to the
Company's Amended and Restated Certificate of Incorporation to decrease the
minimum number of directors that may constitute the Board of Directors to one.
2. Why is the Company planning to dissolve?
On August 5, 2005, the Company entered in a Foreclosure Agreement with
SO Acquisition, LLC, the Company's lender and an affiliate of Zohar CDO 2003-1,
Limited and Zohar II 2005-1, Limited, the lenders under the Company's third
amended and restated credit agreement (the "Credit Agreement") who transferred
their rights as lenders to SO Acquisition LLC, after SO Acquisition accelerated
approximately $14,310,000 in outstanding principal amount owed by the Company
under the Credit Agreement pursuant to a notice of default delivered to the
Company on August 2, 2005. Pursuant to the Foreclosure Agreement, substantially
all of the Company's assets were transferred to SO Acquisition, LLC in exchange
for the Company's release from its outstanding debt under the Credit Agreement
and the lender's agreement to assume the Company's obligations to the majority
of its unsecured trade creditors and certain other unsecured creditors. Because
the Company will conduct no actual business and has no means to generate revenue
after the transfer of assets pursuant to the Foreclosure Agreement, the Board of
Directors of the Company has determined that it is advisable and in the best
interests of the Company for its affairs to be wound up and for it to be
dissolved.
3. What are the material terms of the plan of dissolution?
The Plan of Dissolution provides that the Board of Directors will
liquidate the Company's assets in accordance with applicable provisions of the
Delaware General Corporation Law. Without limiting the flexibility of the Board
of Directors, the Board of Directors may, at its option, follow or instruct its
agent to follow the procedures set forth in the Delaware General Corporation Law
to:
o collect the Company's assets;
o dispose of the Company's assets;
o discharge or make provision for discharging our liabilities; and
o take every other act necessary to wind up and liquidate our business
and affairs.
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The Board of Directors is granted broad powers under the Plan of
Dissolution and is granted a great amount of discretion in exercising those
powers. See "Proposal No. 1--Liquidation and Dissolution--General."
4. What will happen if the Plan of Dissolution is approved?
If the Plan of Dissolution is approved, we will file a Certificate of
Dissolution with the Delaware Secretary of State promptly after this meeting,
complete the liquidation of our remaining assets, and satisfy (or make
provisions to satisfy) our remaining obligations to the extent of available
cash. Under the Foreclosure Agreement, the lender has assumed the majority of
the Company's trade payables and certain other ordinary course liabilities due
on or after the closing. The lender has further agreed to fund a wind-down
budget for the Company of up to $827,794 to permit the Company to effect an
orderly wind-down. See "Recent Events -Description of the Foreclosure Agreement
- - Assumed Liabilities and Other Obligations" and "--Post-Closing Transactions,"
and "Proposal No. 1--Liquidation and Dissolution--Principal Provisions of the
Plan of Dissolution."
5. Will the Company make any distribution to the shareholders upon
liquidation?
There will not be any cash or other property distributed to the holders
of our common stock. The Company's remaining assets consist largely of certain
balance sheet items not capable of generating cash income, including deferred
income tax assets, prepaid commissions and prepaid premiums on directors' and
officers' insurance (including "tail" insurance coverage), deferred costs
in acceptance, debt related fees and costs incurred in the development of the
Company's SO series scanners. The carrying value of these assets subsequent to
the closing of the Foreclosure Agreement was approximately $50,000, of which
$31,008 representing prepaid insurance premiums on the Company's directors' and
officers' insurance was applied to the retention of a "tail" policy, and the
remainder of which (representing prepaid commissions) is an asset that cannot be
reduced to cash. The Company also retained its directors and officers insurance
policy and a software license that does not generate income. Further, the
Company may not make any distribution to the common stockholders until it has
first satisfied any additional claims of creditors or other claimants not
assumed by the lender as well as an approximately $872,000 liquidation
preference payable to ARK-CLO as the holder of the Company's 4% Series I
Cumulative Redeemable Preferred Stock. Although the preferred stock has a
liquidation preference senior to the common stock, based on the wind-down budget
provided in the Foreclosure Agreement there will not be any cash or other
property distributed to the holder of our preferred stock either. See "Proposal
No.1--Liquidation and Dissolution--Factors to Consider in Deciding Whether to
Approve the Plan of Dissolution."
6. What are the interests of the officers and directors in the
dissolution?
Following the filing of the Certificate of Dissolution with the
Delaware Secretary of State, we will continue to indemnify each of our current
and former directors and officers to the extent required by Delaware law and our
Amended and Restated Certificate of Incorporation and
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By-laws as in effect immediately prior to the filing of the Certificate of
Dissolution. In addition, we obtained "tail" insurance coverage for our
directors and officers, which extends the coverage of the existing policy for a
period of three years following the closing of the Foreclosure Agreement with
respect to events that occurred prior to the closing. Of the total $298,775
premium for this coverage, $267,767 was paid by the Company's lender pursuant to
the terms of the Foreclosure Agreement, and the balance of $31,008 was paid by
applying the Company's existing prepayment credit to the "tail" policy.
Additionally, the wind-down budget that the lender has agreed to fund under the
Foreclosure Agreement provides for payments of up to $50,000 to Woodside Capital
Management, LLC with respect to services related to the winding up of the
Company's business. Scott Schooley, the Company's President and Chairman of the
Board, is a manager of Woodside Capital Management, LLC.
7. Why did the Company agree to the Foreclosure Agreement?
Despite the Company's completion of a recapitalization in 2004 in
which significant amounts of debt owed to the Company's lenders were exchanged
for common stock in the Company, the Company became unable to meet its on-going
obligations to third parties and its employees. During the first quarter of
2005, the Company encountered increasing technology challenges relating to its
new SO Series scanners that resulted in slower than expected development of
sales through its direct and indirect channels and a more gradual ramp-up of
business process outsourcing sales than was anticipated. The Company's projected
liquidity problems were reported in its Quarterly Report on Form 10-Q for the
fiscal quarter ended March 31, 2005, and in subsequent disclosures in Form 8-K
filings made on June 29, 2005 and July 14, 2005. After meeting its payroll
obligations in late July 2005, the Company was rapidly running out of money and
would have been unable to meet its next due payroll obligations in mid-August.
Further, the lender notified the Company on August 2, 2005, that it was in
default under the Credit Agreement and that the lender was therefore
accelerating all amounts due thereunder and was further reserving all other
rights available to it as a secured creditor. The Board of Directors concluded
that its options were limited, that entering into the Foreclosure Agreement had
a greater probability of satisfying the Company's obligations to its secured and
unsecured creditors, and that there were no alternatives that would provide any
residual value to the Company's equity holders, either preferred or common.
8. What are the interests of ARK-CLO in the Foreclosure Agreement
ARK-CLO is the holder of approximately 83% of the Company's voting
stock. ARK-CLO is a former lender of the Company and an affiliate of SO
Acquisition, LLC, the Company's lender at the time of the Foreclosure Agreement
closing.
9. What will happen if the stockholders do not approve the Plan of
Dissolution?
Because ARK-CLO, the holder of approximately 83% of the Company's
outstanding common stock, has indicated that it will vote in favor of the
adoption of the Plan of Dissolution and liquidation pursuant to the Plan of
Dissolution, approval of the Plan of Dissolution is
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therefore assured. If the stockholders do not approve the dissolution the
Company will explore its options, but does not presently believe that there are
any.
10. Why does the Company wish to reduce the number of directors?
The Company is operating in a wind-down phase. Upon the filing of a
Certificate of Dissolution with the Delaware Secretary of State, the Company
will continue to operate in a wind-down phase in order to dissolve and liquidate
in an orderly fashion. For these purposes, only one director is required for the
remainder of the Company's existence.
11. Why is a charter amendment necessary to decrease the minimum number of
directors?
A charter amendment, approved by the holders of at least 80% of the
capital stock entitled to vote thereon, is necessary to decrease the minimum
number of directors to one because the Company's Amended and Restated
Certificate of Incorporation currently provides for a minimum of three
directors. The Amended and Restated Certificate of Incorporation further
provides that any amendments to this section of the Amended and Restated
Certificate of Incorporation must be approved by the holders of at least 80% of
the capital stock entitled to vote thereon.
12. What will happen if the charter amendment is not approved?
If the charter amendment is not approved and Messrs. Takala, Clarke and
Flannery resign from the Board of Directors, as they have indicated they intend
to do, leaving Mr. Schooley as the sole director, the Company will not have a
properly constituted Board of Directors and the Board of Directors will be
unable to take any required action. Although the Company does not anticipate
that its Board will need to take any further action upon the filing of the
Certificate of Dissolution, it is possible that Board action could be required
in the future.
13. What is the Board of Directors' recommendation with respect to the
proposals?
The Board of Directors has determined that each of the proposals
described in this proxy statement is advisable and in the best interests of the
Company and recommends that you vote "FOR" each proposal.
14. What are the material federal income tax consequences of the
dissolution and liquidation?
As discussed below, there will be no assets available for distribution
to our stockholders in connection with the liquidation and dissolution of the
Company. See "Proposal No.1--Liquidation and Dissolution--No Liquidating
Distribution to Stockholders." As a result of filing the Certificate of
Dissolution, a stockholder will recognize loss equal to such stockholder's tax
basis in their shares of common stock. A stockholder's tax basis in the shares
will depend upon various factors, including the stockholder's cost and the
amount and nature of any distributions
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received with respect thereto. A stockholder's loss will be computed on a "per
share" basis, so that loss is calculated separately for blocks of stock acquired
at different dates and for different prices. The loss recognized by a
stockholder will be capital loss, provided the stock is held as a capital asset,
and will be long-term capital loss if the share has been held for more than one
year.
15. Has anyone considered the fairness of the foreclosure and the
liquidation and dissolution?
At the closing of the Foreclosure Agreement, the Company received an
opinion of Parker Benjamin, Inc. that the Foreclosure Agreement was fair, from a
financial point of view, to the Company and the holders of its common stock. See
"Recent Event--Scan-Optics' Reasons for Agreeing to the Foreclosure Agreement."
The Company has not sought and does not plan to seek an evaluation by any third
party of the fairness of the dissolution and liquidation.
16. Do I have appraisal rights in connection with the dissolution?
No. The Company's stockholders do not have appraisal rights in
connection with the dissolution.
17. Can I still sell my shares of Scan-Optics common stock?
Shares of the Company's common stock are currently traded on the OTC
BB, the over-the-counter bulletin board maintained by the National Association
of Securities Dealers, Inc. The Company's stock transfer books will be closed
and we expect to prohibit transfers of the common stock, other than transfers by
will, intestate succession or by operation of law immediately after the filing
of the Certificate of Dissolution with the Delaware Secretary of State, which we
expect will occur promptly following approval of the Plan of Dissolution by the
stockholders at the special meeting.
RECENT EVENTS
The Company has been operating at a loss, including losses of
$3,769,000, for the fiscal year, ended December 31, 2004 and $12,024,000 for the
six months ended June 30, 2005.
As of June 30, 2005, we had an accumulated deficit of $48,363,000. As
of June 30, 2005, the Company had cash and cash equivalents of $1,698,000, of
which approximately $637,308 was held by the Company's United Kingdom subsidiary
and approximately $20,023 was held by the Company's Canadian subsidiary. At the
closing of the Foreclosure Agreement described below, the Company was required
to transfer all of its remaining cash at the time, approximately $404,000, to
the Company's lender.
As discussed in more detail in Proposal No. 1 "Liquidation and
Dissolution - Background and Reasons for Dissolution" below, the Board of
Directors had previously explored various alternatives for raising funds or
refinancing the Company in order to meet its obligations. After
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numerous attempts at obtaining alternative financing, the Board of Directors
determined that these alternatives could not be achieved and in any case would
not result in full payment of its obligations under the Credit Agreement. On
August 2, 2005, the lender delivered a notice of default under the Credit
Agreement to the Company in which the lender accelerated all the obligations of
the Company, aggregating approximately $14,310,000, and reserved all of its
rights as a secured creditor thereunder. The lender proposed that the Company
enter into the Foreclosure Agreement in lieu of a strict foreclosure or exercise
of other remedies available to the lender. As a result, management and the Board
of Directors determined that a transfer of substantially all assets as a going
concern to the lender in accordance with the Uniform Commercial Code under the
Foreclosure Agreement offered the best available means to meet its obligations,
enabling the Company to repay a significant portion of amounts outstanding to
its unsecured creditors and to provide the opportunity for continued employment
to a majority of its employees.
Prior to the Foreclosure Agreement, the Company designed, developed
and implemented transaction and information management work processes, including
developing, applying and supporting technology for the conversion of analog
information into digital. The Company's resources had been applied toward
providing customer solutions in four main areas: SO series image scanner
platform and solution applications, the test and assessment market, business
process outsourcing and access services.
Description of Foreclosure Agreement
The following is a brief summary of the material provisions of the
Foreclosure Agreement that was executed on August 5, 2005, a copy of which was
included with the Company's Periodic Report on Form 8-K filed on August 5, 2005.
Parties
The primary parties to the foreclosure agreement are Scan-Optics, Inc.,
SO Acquisition, LLC, and Patriarch Partners Agency Services, LLC ("Patriarch").
SO Acquisition, LLC is the assignee of Scan-Optic's secured lenders, Zohar CDO
2003-1, Limited ("Zohar CDO") and Zohar II 2005-1, Limited ("Zohar II"), and
consequently, SO Acquisition, LLC is the Company's secured lender under the
agreement. Zohar CDO and Zohar II are also parties to the agreement for the
limited purposes described below. ARK CLO 2000-1, Limited ("ARK CLO"), the
majority holder of the Company's common stock and sole holder of its preferred
stock and an affiliate of Zohar CDO and Zohar II, is also a party for purposes
of the release described below.
Following the closing of the Foreclosure Agreement, SO Acquisition, LLC
changed its name to Scan-Optics, LLC and is located at 169 Progress Drive,
Manchester, Connecticut 06040.
Recitals
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The recitals to the foreclosure agreement are incorporated into the
agreement and include the following:
o that pursuant to the Credit Agreement, dated March 30, 2004, SO
Acquisition made loans to the Company secured by substantially all
of the Company's assets;
o that SO Acquisition purchased the rights, title and interest in
the documents and obligations under the Credit Agreement from
Zohar CDO and Zohar II to become the lender;
o that the Company acknowledged as of August 5, 2005, that the
aggregate principal outstanding under the Credit Agreement was
$14,310,000, and that the Company had failed to repay certain
amounts when due under the Credit Agreement, and had defaulted on
its obligation under the Credit Agreement to maintain a certain
threshold of consolidated earnings before interest taxes and
depreciation and amortization;
o that the Company and the lender determined independently that the
principal amount of the outstanding loans under the Credit
Agreement exceeded the fair market value of the Company's business
as a going concern;
o the Company acknowledged that under Sec. 9-620 of the Delaware
Uniform Commercial Code or equivalent provisions of other such
codes ("UCC"), the lender had the right, with the Company's
written consent, to accept the secured assets of the Company in
partial satisfaction of the Company's loan obligations under the
Credit Agreement;
o the Company acknowledged that all of its loan obligations under
the Credit Agreement have been accelerated and are immediately due
and payable;
o the lender has asked the Company, and the Company has agreed, to
surrender possession of the secured assets in partial satisfaction
of the loan obligations under the Credit Agreement, and surrender
other remaining assets of the Company as payment in kind for the
remaining balance of the Company's loan obligations; and
o the lender agreed to assume certain liabilities of the Company.
Transferred and Excluded Assets
The Company agreed to transfer substantially all of its assets to the
lender free and clear of liens and other encumbrances pursuant to Sec. 9-620 of
the UCC, except for certain assets retained by the Company, which include our
directors' and officers' "tail" insurance policy, a retained software license
agreement that does not provide a stream of income, and certain balance sheet
items such as deferred tax accounts, fees related to our debt, amounts related
to the development of our SO series scanners, and prepaid commissions and
prepaid insurance
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premiums (which were applied to the premium for our directors'
and officers' "tail" insurance policy). None of these will yield cash for the
benefit of the Company, its creditors or its stockholders.
Assumed Liabilities and Other Obligations
The lender assumed certain liabilities of the Company, which
liabilities relate primarily to accrued employee obligations and the majority of
the Company's unsecured trade payables outstanding at the closing or that relate
to products or services provided to the Company on or prior to the closing. The
lender also agreed to satisfy checks and other debit advices of the Company
dated on or before August 5, 2005, and subsequently presented against the
Company's bank accounts. The Company retained approximately $192,170 in trade
payables as continuing liabilities of the Company.
Employees and Benefit Plans
The lender agreed to offer employment to the Company's employees
employed as of August 5, 2005 on terms substantially equivalent to those such
employees had with the Company. In addition, the lender agreed to credit such
employees for their service with the Company when determining eligibility,
participation and vesting in the lender's employee benefits plans.
The lender also assumed sponsorship of each employee benefit plan
sponsored by the Company, and agreed to be substituted for the previous plan
sponsor and plan administrator under such plans. The lender also assumed all
responsibilities and liabilities for making contributions and paying benefits
under each employee benefit plan of the Company, whether accrued before or after
the closing date.
The lender did not assume any liabilities or obligations with respect
to any employment or severance agreements of the Company, and the lender did not
assume any liability or obligations with respect to the accrued retirement
benefits owed by the Company to Clarence Rife.
Compliance with the UCC
The Company acknowledged and agreed that the foreclosure agreement
shall be deemed its acceptance of and consent to the lender's proposal under
Sec. 9-620 of the UCC for the acceptance of the Company's secured assets in
partial satisfaction of the Company's loan obligations under the Credit
Agreement.
Directors and Officers Insurance
The agreement provides for the Company obtaining a directors' and
officers' "tail" insurance policy covering the Company and its officers and
directors for a period of three years
-16-
following the closing with respect to liability incurred on or prior to the
closing date. The lender agreed to either reimburse the Company for the cost of
such policy or pay the premium directly to the insurer. The policy coverage is
limited to $10 million, and the premium paid by the lender may not exceed
$268,000. Each of Zohar CDO and Zohar II have agreed to pay for such policy in
the event that the lender fails to pay for it. The directors' and officers'
insurance policy was retained as an asset by the Company.
Closing Transactions
The parties agreed that the following actions would be taken or the
following documents obtained or delivered at the closing:
o the Company obtained a fairness opinion from Parker Benjamin, Inc.
regarding the transactions contemplated in the foreclosure agreement;
o the Company received a written waiver of ARK CLO as the holder of all
of the Company's preferred stock and a majority of its common stock
waiving any objections to consummation of the foreclosure transaction
and ARK CLO agreed to vote in favor of the dissolution and amendment
to the Company's Amended and Restated Certificate of Incorporation;
and
o the Company delivered a wind-down budget to the lender.
Representations, Warranties and Covenants of the Company
In the foreclosure agreement the Company made a number of
representations, warranties and covenants regarding the following matters:
o its due organization, valid existence and good standing;
o its power and authority to carry out the transactions contemplated in
the foreclosure agreement (except that certain assigned contracts may
require counterparty consents);
o no violations of laws or government regulations by executing and
delivering the foreclosure agreement;
o its certificate of incorporation and bylaws;
o due execution and delivery of the foreclosure agreement and its
enforceability against the Company subject to certain limitations;
o the location of the Company's assets;
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o receipt of notice of default under the Credit Agreement and
acknowledgement that the Company is in material default;
o existence of other liens;
o indebtedness to the lender and Patriarch of not less than $14,310,000
in outstanding principal;
o permitting lender access to the Company's books and records;
o the Company's agreement to change its name at lender's request;
o assignment of the Company's bank accounts to the lender; and
o notification of the lender in the event that judicial process is
commenced or about to be commenced against the Company or its officers
or directors.
Representations, Warranties and Covenants of the Lender
In the foreclosure agreement the lender made a number of
representations, warranties and covenants regarding the following matters:
o its power and authority to carry out the transactions contemplated in
the foreclosure agreement;
o due execution and delivery of the foreclosure agreement and its
enforceability against the lender subject to certain limitations;
o that the lender is the sole lender under the Credit Agreement and
related documents and entitled to all rights and benefits under them;
and
o acknowledgement that the Company would not comply with any bulk
transfer laws in connection with the foreclosure agreement.
Post-Closing Transactions
The Company agreed to turn over to the lender payments received after
the closing in respect of assets transferred to the lender. The Company also
appointed the lender as its attorney-in-fact to take further action necessary or
desirable to accomplish the purposes of the foreclosure agreement.
The lender agreed to fund the Company's winding-down of its business in
accordance with a mutually agreed upon wind-down budget that cannot exceed
$827,794. The $827,794 available under the wind down budget is allocated as
follows: $274,000 for the payment of unpaid sales and use taxes; $105,000 for
legal services to be incurred on behalf of the Company following the
foreclosure; $179,244 for payment of
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legal expenses incurred during June and July 2005; $65,700 for severance
payments to non-executive employees; $121,850 for accounting services; $12,000
for services related to the Company's compliance with securities law filings and
the printing and distribution of this Proxy Statement; $20,000 for the payment
of state income and franchise taxes; and $50,000 for Woodside Capital LLC for
general services associated with winding down the Company's business. Payments
from the wind down budget may be made to the Company directly or to parties
designated by the Company, provided that the funds requested are used only for
specific items for which the payment is requested. If the wind-down costs are
below $827,794, the Company is not entitled to obtain cash in the amount of such
differential.
The lender agreed to either fund the defense of, or assume the defense
of, any action brought against the Company or its officers or directors after
the closing that is disclosed to the lender under the foreclosure agreement.
The lender agreed that until the earlier of September 30, 2005 or the
date that it secures all required consents with respect to contracts of the
Company's Access Services division, the lender shall name the Company as an
additional insured under the lender's errors and omissions policy.
Further Assurances and Releases
The parties agreed to execute and deliver additional instruments and
take additional actions as a party may request and in good faith determine is
necessary or desirable to accomplish the purposes of the foreclosure agreement.
In the event of a bankruptcy filing under Chapter 11 of the bankruptcy code,
whether by or against the Company, the Company agreed to assist in effectuating
the transfer and assignment of its assets to the lender in the bankruptcy court,
subject to the lender providing funds to the Company for such an action.
The parties agreed to waive and release one another from claims and
other actions, whether arising on or before the date of closing, that relate
indirectly or directly to the Company and the Credit Agreement and related
documents. The parties provided that releases with respect to certain individual
former officers of Scan-Optics would be contingent on receiving releases from
such persons. On August 8, 2005, one such individual, Joseph Crouch, provided
the Company with such a release. The Company also gave ARK CLO a waiver and
release with respect to claims and other actions that relate indirectly or
directly to the Company, the Credit Agreement and related documents or the
transactions contemplated by the foreclosure agreement.
Scan-Optics' Reasons for Agreeing to Foreclosure Agreement
The Board of Directors concluded that entering into the Foreclosure
Agreement had a greater probability of satisfying the Company's obligations to
its secured and unsecured creditors
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and that there were no available alternatives that would provide any residual
value to the Company's equity holders. Since the Company was operating in the
zone of insolvency, the directors were advised by counsel that their duties had
expanded to encompass constituencies like creditors in addition to the Company's
stockholders. Although the Company had engaged an investment banker to identify
potential acquirers for a portion of its business, the investment banker was
advised that the Company would also consider offers to acquire all of the assets
of the Company. The Company did not receive any viable acquisition offers.
Ultimately, the Board of Directors determined that there were no viable
alternatives superior to the terms offered by the Foreclosure Agreement and
found that the following factors weighed in favor of approving the Foreclosure
Agreement:
o the Company's precarious financial situation as reported in its public
disclosures was having a deleterious effect on the Company's
relationships with its vendors, customers and others in the
marketplace, and the uncertainty as to a resolution of its financial
problems was eroding the value of the Company's business;
o the Company's secured lender, who held a lien on substantially all of
the Company's assets, was unwilling to extend additional credit to the
Company after it temporarily raised the Company's credit facility by
$900,000 pursuant to the June 27, 2005 amendment to the operative
credit agreement;
o the Independent Directors Committee of the Board of Directors had been
advised at its July 5, 2005 meeting by a representative of Parker
Benjamin, Inc., an investment banker engaged by the Company to advise
the Board of Directors on the Company's value, that any sale of the
Company would take at least four to six months and the committee
believed that there was a low probability of the Company obtaining a
viable offer to be acquired at a reasonable price;
o a preliminary valuation of the Company presented by the Parker
Benjamin, Inc. representative to the committee at the same meeting
indicated that there was no value left in the Company for its equity
holders;
o the Company's secured lenders had informed the Company that they would
not provide additional funding in a bankruptcy reorganization of the
Company, and without such funding, the Board of Directors concluded,
after consulting with counsel, that there would be little if any value
left in the Company to pay unsecured creditors in a bankruptcy
liquidation proceeding;
o the lender's proposed foreclosure transaction included the lender's
assumption of the Company's obligations with respect to the majority of
its unsecured trade creditors and certain other unsecured creditors;
o the lender had agreed to employ the Company's employees as well as
assume accrued liabilities of the Company with respect to those
employees;
-20-
o the lender notified the Company on August 2, 2005, that it was in
default under the Credit Agreement and that the lender was therefore
accelerating all amounts due thereunder and was further reserving all
other rights available to it as a secured creditor; and
o the Company was running out of money and as of August 5, 2005, the date
the foreclosure transaction was approved and consummated, it appeared
highly unlikely that the Company would have sufficient cash to meet its
next bi-weekly payroll obligation.
In addition, as a condition to its approval of the Foreclosure
Agreement the Board of Directors received a fairness opinion from Parker
Benjamin, Inc. The opinion concludes that on August 5, 2005, the date of the
foreclosure, the fair market value of the Company's business as an ongoing
concern was less than the Company's indebtedness under its Credit
Agreement, and that although appraisals of the Company's major assets did not
exist, the facts and data strongly suggested that the value to be obtained
through a liquidation was less than the Company's value as a going concern.
Consequently, Parker Benjamin determined that the Foreclosure Agreement was
fair, from a financial point of view, to the Company and the holders of its
common stock.
Although in connection with the closing of the Foreclosure Agreement
the Company obtained the waiver of ARK CLO, the Company's majority common stock
holder and sole preferred stock holder, with respect to any objections it might
raise regarding the Foreclosure Agreement, the Company's rapidly declining
financial circumstances did not permit it time to seek stockholder approval in
advance of the closing of the Foreclosure Agreement and the Company acted
pursuant to a Delaware common law doctrine that provides if a company's assets
are rapidly losing value and an emergency situation exists, stockholder approval
may be foregone for the good of preserving maximum value of the Company's
assets. ARK CLO would have approved the Foreclosure Agreement if there had been
sufficient time to obtain approval by calling a stockholders meeting in advance
of the closing.
PROPOSAL ONE - LIQUIDATION AND DISSOLUTION
General
The Board of Directors is proposing the Plan of Dissolution and
dissolution of the Company for approval by the stockholders at the Special
Meeting. The Board of Directors approved a plan of dissolution, subject to
stockholder approval, on August 5, 2005, and further modified the plan on
November 8, 2005, which is the Plan of Dissolution being submitted to the
stockholders in this proxy statement. A copy of the Plan of Dissolution is
attached as Annex A to this proxy statement. Certain material features of the
plan are summarized below. We encourage you to read the Plan of Dissolution in
its entirety.
As a result of the Foreclosure Agreement described above, the Company's
lender, SO Acquisition LLC is in possession of substantially all of the
Company's assets. The Company only retained certain minimal assets, which
include a "tail" insurance policy for directors and officers, a software license
agreement between the Company and a service provider that
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generates no income to the Company and certain balance sheet items not capable
of generating cash income, including deferred income tax assets, prepaid
commissions and prepaid premiums on directors' and officers' insurance
(including "tail" insurance coverage), deferred costs in acceptance, debt
related fees and costs incurred in the development of the Company's SO series
scanners. The carrying value of these assets subsequent to the closing of the
Foreclosure Agreement was approximately $50,000, of which $31,008 representing
prepaid insurance premiums on the Company's directors' and officers' insurance
was applied to the retention of a "tail" policy, and the remainder of which
(representing prepaid commissions) is an asset that cannot be reduced to cash.
None of these retained assets is capable of generating cash for the Company for
purposes of the liquidation and dissolution described below. In addition, the
Company retained certain liabilities, including obligations to some trade
creditors, and any contingent liabilities. The Foreclosure Agreement also
provided for a wind down budget to be funded by the Company's lender to provide
for the winding down of the Company's business (see "Recent Events--Description
of Foreclosure Agreement--Post Closing Transactions" above). However, the
Company cannot convert unused portions of the wind down budget into cash.
After adoption of the Plan of Dissolution, the Company's activities
will be limited to actions we deem necessary or appropriate to accomplish, inter
alia, the following:
o filing a Certificate of Dissolution with the Delaware Secretary of
State and, thereafter, remaining in existence as a non-operating
entity for three years;
o selling our limited remaining assets (if any), if possible;
o collecting, or providing for the collection of, accounts receivable,
debts and other claims owing to the Company, of which the Company
believes there are few, if any, to which the lender is not entitled
under the Foreclosure Agreement;
o paying, or providing for the payment of, our debts and liabilities,
including both known liabilities and those that are contingent,
conditional, unmatured or unknown, in accordance with Delaware law, to
the extent of available cash;
o winding up our remaining business activities and withdrawing from any
jurisdictions in which we remain qualified to do business;
o complying with Securities and Exchange Commission filing requirements
for so long as we are required to do so; and
o making ongoing tax and other regulatory filings.
Background and Reasons for Plan of Dissolution
On March 30, 2004, the Company entered into a Third Amended and
Restated Credit Agreement (the "Credit Agreement") with ARK CLO 2000-1, Limited
("ARK CLO"), ZOHAR CDO 2003-1, Limited and Patriarch Partners Agency Services,
LLC, as agent, to restructure existing secured obligations of Scan-Optics to ARK
CLO which had a maturity date of December 31, 2004. Pursuant to the Credit
Agreement the Company's then existing secured term debt of $2 million and
revolving debt of $10 million, were exchanged for a $9 million term loan and a
$2.5 million revolving loan. In addition, on August 6, 2004, the Company issued
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and sold an aggregate of 34,425,345 shares of its common stock to ARK CLO as
described below under the heading "Changes in Control of the Registrant." The
issuance of the shares to ARK CLO was a key component of the comprehensive
financial restructuring arrangement with ARK CLO commenced as of March 30, 2004
pursuant to the terms of the Credit Agreement.
During 2005, the Company focused on a strategy that included 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, the development of new channels of distribution for the
Company's hardware and software, and the development of a business process
outsourcing business for image capture applications. During the first quarter of
2005, the Company encountered increasing technology challenges relating to the
new SO Series scanners that resulted in slower than expected development of
sales through its direct and indirect channels and a more gradual ramp up of
business process outsourcing sales than was anticipated.
At the same time, the Company was experiencing changes in its
management. The Company appointed Paul M. Yantus as chief operating officer
effective March 7, 2005. On March 9, 2005, the Company received the resignation
of its president and chief executive officer, James C. Mavel. Also on March 9,
the Company appointed Logan Clarke, Jr. as the Company's acting president and
chief executive officer. On March 17, 2005, the Company received Mr. Mavel's
resignation as a director and chairman of the Board of Directors. On May 16,
2005, acting president and chief executive officer Logan Clarke, Jr. resigned
and the Company appointed Paul M. Yantus as president and chief executive
officer. Mr. Clarke remained as a director of the Company.
In its Form 10-Q filed on May 16, 2005, the Company's management
described its belief that the Company's operating cash flow would be
insufficient to allow the Company to meet all of its contractual obligations as
they came due beginning in the second quarter of 2005, and that the Company
would most likely be unable to comply with certain financial covenants under its
existing Credit Agreements. Management also stated its belief that the Company's
liquidity position would improve by year-end and described steps that it was
taking and cautioned that any means of resolving the Company's short-term
liquidity problems might have an adverse effect on the Company's stockholders.
At a meeting of the Board of Directors on May 16, 2005, the board
was informed of proposals to acquire its manufacturing and Access Services
divisions, although the offer for the manufacturing division was still
preliminary and the offer for the Access Services division undervalued its
assets.
On May 23, the Company's management sent its secured lenders an
updated financial forecast highlighting the Company's need for $1.9 million in
additional incremental capital to get the Company through to the end of the
year. On May 26, 2005, Mr. Schooley and Mr. Yantus met with attorneys from Day,
Berry & Howard LLP, the Company's outside counsel, to discuss
-23-
the Company's situation and explore potential options, including obtaining
additional financing, a sale of all or part of the Company, and foreclosure and
bankruptcy scenarios.
On May 26, 2005, the Company drew down on the remaining $500,000 on
its revolving line of credit available to it under the Credit Agreement.
On May 27, 2005, the Board of Directors met and, in light of
conflicts that certain directors might have in dealing with the Company's
lenders, established an independent directors' committee comprised of Logan
Clarke, Jr., John J. Holton, Scott Schooley, Ralph Takala and Kevin Flannery to
negotiate with the Company's secured lenders regarding issues arising from any
possible default under the Credit Agreement. Immediately following the Board of
Directors meeting, the independent directors committee met and, following
discussion, decided to approach the Company's secured lender regarding an
increase in the Company's credit facility. On May 31, 2005 the Company sent a
letter to Patriarch Partners Agency Services, LLC as the agent for the secured
lenders describing the Company's liquidity problems requesting an increase of $4
million in available credit.
On or about June 6, 2005, Mr. Schooley and Mr. Takala (who
participated by telephone) met with Mr. Michael Scinto, then a director of the
Company designated by the lender who was acting in his capacity as a
representative of the lenders, to discuss the Company's financial situation.
On June 7, 2005, the independent directors' committee met to discuss
developments in the Company's status and decided to engage Parker Benjamin, Inc.
to provide a valuation for the Company. At that meeting, the committee discussed
the Company's options, including cooperating in a foreclosure by the lenders if
the lenders agreed to assume all or most of the Company's outstanding
liabilities and filing for bankruptcy. It was noted that a bankruptcy proceeding
would reduce any final distribution to the Company's creditors while a
foreclosure might have a more favorable outcome for creditors. Throughout the
remainder of June, the Company's management met and corresponded with a
representative of Parker Benjamin, Inc. to provide the information needed for
the valuation. The Company also provided additional financial information
regarding the Company as requested by the lender's agent.
On June 9, 2005, the Company sent another letter to Patriarch
Partners requesting an $876,000 increase in available credit to pay for certain
obligations of the Company including payroll, trade payables and health
insurance costs. Also on June 9, the Company received the written resignation of
Lynn Tilton from the Board of Directors of the Company.
On June 14, 2005 the independent directors' committee met again to
discuss developments in the Company's situation. At that time the Company had
not received a response from the lenders with respect to its June 9 letter.
-24-
On June 15, 2005, the Company had to adjourn the Company's annual
meeting of stockholders because there was an insufficient quorum to conduct
business at the meeting. The meeting was adjourned until July 15, 2005.
Also on June 15, 2005, the attorneys for the lenders, Richards
Spears Kibbe & Orbe, sent the Company's outside counsel, Day, Berry & Howard
LLP, a draft amendment agreement to the Credit Agreement, which offered to
increase the Company's credit facility by $900,000 until July 1, 2005, at which
point the amount of the facility would again decrease to its prior level.
Through the following week the parties negotiated the terms of the credit
agreement amendment.
On June 21, 2005, the independent directors committee met and
discussed the offer of additional credit from the lenders as well as other
options available to the Company, including filing for bankruptcy. The committee
considered the lenders' proposal, which would mean having to repay the amount
borrowed by July 1, 2005. It was noted that if the amount borrowed was not
repaid, the lenders might foreclose on the Company's assets. However, it was
also observed at that meeting that certain of the Company's trade creditors
needed to be paid in order to avoid damaging the Company's ability to continue
as a going concern and that it was clear the Company would soon run out of money
if it did not obtain additional financing from the lenders. The committee also
considered the possibility of using the additional credit facility to fund a
bankruptcy filing, but that this was an expensive process and might lead to a
liquidation of the Company in which the unsecured creditors as well as the
stockholders would likely receive nothing. The committee discussed trying to
reach an arrangement with the lenders that would satisfy the Company's secured
and unsecured creditors and possibly provide some value to stockholders.
Ultimately, the committee decided to review a final draft of the proposed
amendment to the Credit Agreement, and that it would act by written consent on
the proposed agreement.
On June 23, 2005, the independent directors' committee, acting by
written consent, approved the first amendment to the Credit Agreement. The
agreement was executed and delivered by all of the parties on June 27, 2005. The
Company drew-down the entire $900,000 shortly thereafter. The additional funds
were used in part to cover the Company's payroll obligations and to pay several
critical vendors.
On June 29, 2005, the independent directors' committee met and
discussed the obligation to repay the additional $900,000 borrowed under the
amendment to the credit agreement. The committee elected to retain the entire
amount borrowed in order to be able to meet its payroll obligations through July
15. The committee again considered the effects of a bankruptcy filing and
details related to the possible disposition of its manufacturing division. Also
on June 29, the Company filed a Form 8-K disclosing the first amendment to the
Credit Agreement and disclosing that in the absence of further extensions of
credit and the forbearance of the Company's creditors there was substantial
doubt as to the Company's ability to continue as a going concern and that any
means of resolving the Company's liquidity problems may have an adverse affect
on the Company's stockholders.
-25-
On July 5, 2005, the independent directors' committee met to
discuss, among other things, the valuation being prepared by Parker Benjamin,
Inc. A representative of Parker Benjamin, Inc. informed the committee at that
meeting that, based on the valuation model used by them and after taking into
account the amount owed to the Company's secured lenders, there was no value
left for the Company's equity holders. The representative also informed the
committee that the process of selling the Company was likely to take four to six
months. The committee also heard from management that the Company's accounts
receivable were being rapidly reduced and that product sales were not
materializing as rapidly as expected. The committee decided to again ask the
lenders for additional credit and to negotiate a possible long-term solution.
On July 7, 2005, the Company sent a letter to Patriarch Partners
describing its continuing financial difficulties and renewed its request for an
increase of $4 million in its available working capital under the Credit
Agreement in order to execute the Company's business plan.
On July 8, 2005, the lenders' representative, Mr. Scinto, tendered
his resignation from the Board of Directors and delivered to the Company a draft
foreclosure agreement and letter stating that the lenders proposed to foreclose
on all of the Company's assets, but that they would be willing to accept the
assets and certain of the Company's liabilities in full satisfaction of the
Company's debt under the Credit Agreement.
On July 12, 2005, Mr. Schooley and Mr. Takala along with the
Company's outside counsel from Day, Berry & Howard met telephonically with Mr.
Scinto. At this meeting the lenders told the Company's representatives that they
would not continue to extend additional credit to the Company nor participate in
a pre-packaged bankruptcy and that they required a response to the foreclosure
proposal. The Board of Directors met later in the day on July 12 and were
informed of the discussions with the lenders and their counsel. Following
discussion of the few options available, the board directed the Company's
outside counsel, Day, Berry & Howard to send comments on the proposed
foreclosure agreement to the lenders' counsel. From July 12 through the August
5, the parties exchanged several drafts of the proposed foreclosure agreement
and attached schedules, and the Company's management and directors had numerous
contacts with Mr. Scinto in an effort to negotiate the terms of the foreclosure
proposal. The Company also filed a current report on Form 8-K on July 14, 2005
disclosing the negotiations of the foreclosure agreement and advising that
following any surrender of the Company's assets to the lenders there was
unlikely to be any value remaining in the Company for the Company's stockholders
and remaining unsecured creditors.
On July 15, 2005, the Company held its adjourned annual meeting at
which Mr. Flannery was re-elected as a director, and Mr. Holton, who was not
nominated for re-election, ceased being a director following the meeting.
-26-
The Board of Directors subsequently met on July 18, 22 and 27 and
August 2, 2005, to review the status of the Company, receive updates on
negotiations with respect to the proposed foreclosure agreement and to consider
the Company's other options. The Company was informed in this time period that
the rights and obligations of the existing secured lenders under the Credit
Agreement were to be assigned to SO Acquisition, LLC, an entity formed for the
purpose of acquiring the Company's assets and assuming certain liabilities in
the event that the proposed foreclosure transaction proceeded, and that SO
Acquisition, LLC would be the Company's sole secured lender under the Credit
Agreement thereafter.
On August 3, 2005, Scan-Optics, Inc. received a notice of default from
its secured lender, SO Acquisition, LLC under the Credit Agreement. The notice
of default stated that Scan-Optics, Inc. failed to repay when due certain
amounts due under the Credit Agreement, and that it had failed at the end of the
Company's second fiscal quarter ending June 30, 2005 to meet certain financial
covenants in the Credit Agreement. The notice of default accelerated all of the
Company's indebtedness under the Credit Agreement, and all of the approximately
$14,310,000 plus accrued interest outstanding and other charges under the Credit
Agreement became immediately due and owing. Later that afternoon and again on
August 4, the Board of Directors met to discuss the status of the Company and
the proposed foreclosure transaction.
Finally, on August 5, 2005, the Board of Directors met in the afternoon
to consider adoption of the Foreclosure Agreement. A representative of Parker
Benjamin, Inc. informed the Board of Directors that in his firm's opinion the
fair market value of the Company as an on-going concern was less than its
indebtedness to the Company's secured lender and that the proposed foreclosure
transaction was fair to the Company and its common stockholders. The directors
reviewed the possible alternatives that they had considered, including
bankruptcy, which it was believed would leave little for the Company's unsecured
creditors, and a sale of the Company, although the Company had been unable to
obtain any serious offers. The Board of Directors then considered adoption of
the proposed Foreclosure Agreement, and in particular the lender's agreement to
assume the majority of the Company's trade debt and to offer employment to the
Company's employees as of the closing date. The Board of Directors approved the
proposed foreclosure transaction. The Board of Directors also approved
dissolution of the Company and an amendment to the Company's certificate of
incorporation to provide for a board consisting of one director, both contingent
on stockholder approval. Later that same afternoon, the parties executed and
delivered the Foreclosure Agreement and other ancillary documents and agreements
and the foreclosure transaction was closed.
Following the foreclosure of the Company's assets, the Company no
longer has any assets with which to operate an ongoing business and no means to
generate revenue. A dissolution is the means to wind up the affairs of the
Company and terminate the Company's public company reporting obligations.
Factors to Consider in Deciding Whether to Approve the Plan of Dissolution
-27-
There are many factors that stockholders should consider when deciding whether
to vote to approve the Plan of Dissolution.
Following the dissolution of the Company there will not be any remaining assets
available for distribution to the Company's stockholders.
The Company has retained no material assets that may be converted into cash, and
unused amounts available under the wind-down budget provided for in the
Foreclosure Agreement cannot be reduced to cash that can be used by the Company
for distribution to the stockholders or for any other uses. The Company also has
retained certain liabilities which would have to be settled before any
distributions could be made to the Company's preferred and common stockholders.
Consequently, no distributions will be made to stockholders in connection with
the Company's dissolution.
We intend to close our stock transfer books and discontinue recording transfers
of our common stock on the date of filing the Certificate of Dissolution with
the Secretary of State of the State of Delaware (the "Final Record Date"). This
is expected to occur shortly after approval of the Plan of Dissolution by the
stockholders, if approved. Thereafter, certificates representing shares of our
common stock will not be assignable or transferable on our books except by will,
intestate succession or operation of law. After the Final Record Date, we will
not issue any new stock certificates, other than replacement certificates. It is
anticipated that no further trading of our shares will occur on or after the
Final Record Date.
Members of our Board of Directors may have a potential conflict of interest in
recommending approval of the Plan of Dissolution.
Because directors' and officers' "tail" insurance was obtained for the Company
in connection with the Foreclosure Agreement, members of the Board of Directors
may be deemed to have a potential conflict of interest in adopting and approving
the Plan of Dissolution that the Company is asking stockholders to ratify. See
"--Interests of Directors and Executive Officers in Plan of Dissolution" below.
Stockholders will generally be able to recognize a loss for federal income tax
purposes, depending on various factors.
As discussed above, there will be no assets available for distribution to our
stockholders in connection with the liquidation and dissolution of the Company.
As a result of our filing the Certificate of Dissolution of the Company, a
stockholder will recognize loss equal to such stockholder's tax basis in their
shares of common stock. A stockholder's tax basis in the shares will depend upon
various factors, including the stockholder's cost and the amount and nature of
-28-
any distributions received with respect thereto. A stockholder's loss will be
computed on a "per share" basis, so that loss is calculated separately for
blocks of stock acquired at different dates and for different prices. The loss
recognized by a stockholder will be capital loss, provided the stock is held as
a capital asset, and will be long-term capital loss if the share has been held
for more than one year. Each stockholder is urged to consult with their own tax
advisors as to the specific tax consequences to them in connection with the Plan
of Dissolution and our dissolution, including tax return reporting requirements,
the applicability and effect of foreign, federal, state, local and other
applicable tax laws and the effect of any proposed changes in the tax laws.
Our Board of Directors may abandon or delay implementation of the Plan of
Dissolution, even if approved by our stockholders.
Even if the Plan of Dissolution is approved by our stockholders, the Board of
Directors has reserved the right, in its discretion, to abandon or delay
implementation of the Plan of Dissolution and the Company's dissolution, if it
determines that doing so is in the best interests of the Company's stockholders
and creditors.
The majority holder of our common stock controls a sufficient portion of our
common stock to determine the outcome of the stockholder vote on approval of the
Plan of Dissolution.
ARK CLO, which owns approximately 83% of our outstanding common stock,
has sufficient voting power to approve the Plan of Dissolution on its own. ARK
CLO has indicated that it intends to cause its shares of common stock to be
voted "FOR" approval of the Plan of Dissolution.
Interest of Directors and Executive Officers in Plan of Dissolution
Directors' and Officers' "tail" insurance was obtained for the Company
in connection with the Foreclosure Agreement. The "tail" policy extends the
coverage of the existing policy for a period of three years following the
closing of the Foreclosure Agreement, but only with respect to claims made with
respect to events that occurred prior to the closing. In accordance with the
Foreclosure Agreement, SO Acquisition paid approximately $267,767 toward the
premium of the "tail" coverage and the balance of the $298,775 premium was paid
by the application of $31,008 in prepayments retained by the Company and
previously made with respect to the policy in effect prior to the "tail"
coverage. The Foreclosure Agreement also provides that the Company will promptly
notify SO Acquisition of any lawsuit or judicial process commenced or to be
commenced against the Company or its officers and directors, and that SO
Acquisition will, in its sole discretion, either fund the Company's defense of
such an action or assume the defense of such an action.
Paul M. Yantus, the Company's former President and Chief Executive
Officer, and Peter K. Stelling, the Company's former Vice President and Chief
Financial Officer, are employed by SO Acquisition, LLC along with other
employees of the Company. Mr. Stelling and directors Logan Clarke, Jr. and Ralph
Takala also hold options exercisable for shares of common stock as
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set forth under the heading "Share Ownership of Certain Beneficial Owners and
Management" below, although none of such options will have value upon the
dissolution and liquidation of the Company. Two of the Company's former
directors, Michael Scinto and Lynn Tilton are affiliates of Patriarch Partners
Agency Services, LLC, the agent and representative of the Company's secured
lender under the Credit Agreement. Mr. Scinto resigned from the board of
directors at the same time the initial draft of the Foreclosure Agreement was
transmitted to the Company on July 11, 2005, and Ms. Tilton had resigned from
the board of directors effective on June 9, 2005. Consequently, neither Mr.
Scinto nor Ms. Tilton were directors of the Company at the time the Company
began negotiating the terms of the draft Foreclosure Agreement.
Dissolution under Delaware Law
Section 275 of the Delaware General Corporation Law provides that a
corporation may dissolve upon either (a) a majority vote of the Board of
Directors of the corporation followed by a favorable majority vote of its
stockholders or (b) a unanimous stockholder consent. Following such approval,
the dissolution is effected by filing a Certificate of Dissolution with the
Delaware Secretary of State. Once a corporation is dissolved, its existence is
automatically continued for a term of three years (or for such longer period as
the Delaware Court of Chancery directs), but solely for the purpose of winding
up its business. The process of winding up includes:
o prosecution and defense of any lawsuits;
o settling and closing of any business;
o disposition and conveyance of any property;
o discharge of any liabilities; and
o distribution of any remaining assets to the stockholders of the
corporation.
If any action, suit or proceeding is commenced by or against a
corporation before or within the winding up period, the corporation will, solely
for the purpose of such action, suit or proceeding, automatically continue to
exist beyond the three-year period until any judgments, orders or decrees are
fully executed.
Principal Provisions of the Plan of Dissolution
General
The Plan of Dissolution provides that our Board of Directors, as well
as Scott Schooley, our Liquidating Agent (as appointed by the Board of Directors
on August 5, 2005) may liquidate our assets in accordance with Section 281 of
the Delaware General Corporation Law. As noted below under the heading "No
Liquidating Distributions to Stockholders," the assets retained by the Company
after the foreclosure include the Company's directors' and officers' insurance
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policy, a non-income generating software license agreement, a deferred tax
account, various prepaid items and other items that are balance sheet assets but
could not be sold to yield cash on behalf of the Company. Without limiting its
flexibility, the Board of Directors may, at its option, instruct our officers to
follow the procedures set forth in Sections 281(b). If the Board of Directors
should so instruct our officers, they would, in accordance with Section 281(b):
o pay or make reasonable provision to pay all claims and obligations,
including all contingent, conditional or unmatured contractual claims
known to the Company or such successor entity;
o make such provision as will be reasonably likely to be sufficient to
provide compensation for any claim against the Company which is the
subject of a pending action, suit or proceeding to which the Company
is a party;
o make such provision as will be reasonably likely to be sufficient to
provide compensation for claims that have not been made known to the
Company or that have not arisen but that, based on facts known to the
Company or successor entity, are likely to arise or to become known to
the Company or successor entity within 10 years after the date of
dissolution; and
o pay such claims in full or make provision for payment in full if there
are sufficient assets and, if there are insufficient assets, pay or
provide for such claims and obligations according to their priority
and, among claims of equal priority, ratably to the extent of assets
legally available therefor.
Although we do not currently contemplate use of a liquidating trust to complete
the liquidation, we have the discretion to transfer remaining assets, if any, to
one or more liquidating trusts in a final distribution. In the highly unlikely
event of any transfer of assets to a liquidating trust, we would distribute, pro
rata to the holders of our common stock and preferred stock, beneficial
interests in such liquidating trust. We anticipate that the interests in any
liquidating trust will not be transferable. Therefore, although the recipients
of the interests would be treated for tax purposes as having received their pro
rata share of property transferred to the liquidating trust and will thereafter
take into account for tax purposes their allocable portion of any income, gain
or loss realized by such liquidating trust, the recipients of the interests will
not realize the value thereof unless and until the liquidating trust distributes
cash or other assets to them.
Following approval by our stockholders of the Plan of Dissolution, we
expect to file a Certificate of Dissolution with the Delaware Secretary of
State. The dissolution will become effective, in accordance with the Delaware
General Corporation Law, upon proper filing of the Certificate of Dissolution
with the Delaware Secretary of State or on such later date as may be specified
in the Certificate of Dissolution. We currently intend to file the Certificate
of Dissolution promptly following stockholder approval of the Plan of
Dissolution at the Special Meeting and do not intend to specify an effective
date after the date of filing. Pursuant to the Delaware General Corporation Law,
the Company will continue to exist for three years after
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effectiveness of the dissolution, or for such longer period as the Delaware
Court of Chancery directs, for the purpose of prosecuting and defending suits,
whether civil, criminal or administrative, by or against our Company, and
enabling us gradually to settle and close our business, to dispose of and convey
our property and to discharge our liabilities, but not for the purpose of
continuing the business for which we were organized or any other business. Any
legal action commenced by or against us during the three-year dissolution period
will not terminate by reason of the expiration of such period.
Abandonment
Under the Plan of Dissolution, our Board of Directors may abandon the
Plan of Dissolution, notwithstanding stockholder approval, to the extent
permitted by the Delaware General Corporation Law.
No Liquidating Distributions to Stockholders
The Company has no liquid assets. Our retained assets are minimal and
include a "tail" insurance policy for directors and officers, a software license
agreement between the Company and a service provider that generates no income to
the Company and certain balance sheet items not capable of generating cash
income, including deferred income tax assets, prepaid commissions and prepaid
premiums on directors' and officers' insurance (including "tail" insurance
coverage), deferred costs in acceptance, debt related fees and costs incurred in
the development of the Company's SO series scanners. The carrying value of these
assets subsequent to the closing of the Foreclosure Agreement was approximately
$50,000, of which $31,008 representing prepaid insurance premiums on the
Company's directors' and officers' insurance was applied to the retention of a
"tail" policy, and the remainder of which (representing prepaid commissions) is
an asset that cannot be reduced to cash. None of the retained assets are capable
of generating cash for the benefit of the Company, its creditors or its
stockholders. Pursuant to the Foreclosure Agreement, the lender assumed certain
liabilities of the Company, relating primarily to employee obligations and the
majority of the Company's trade payables. The lender also agreed to satisfy
checks and other debit advices of the Company dated on or before August 5, 2005
and subsequently presented against the Company's bank accounts. The lender
agreed to satisfy in full the assumed liabilities due on or after the closing
date in the ordinary cause of business.
In addition to satisfying any liabilities not assumed by the lenders,
we anticipate using cash in connection with a number of items, including, but
not limited to, the following:
o Expenses incurred in connection with the dissolution and our
liquidation;
o Professional, legal, accounting and consulting fees and expenses.
The lender agreed to fund the Company's winding-down of its business in
accordance with a mutually agreed upon wind-down budget that cannot exceed
$827,794. Payments may be made to the Company directly or to parties designated
by the Company, provided that the funds
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requested are used only for specific items for which the payment is requested,
primarily including then outstanding legal fees, legal, accounting and other
service provider fees (including Woodside Capital, LLC--see "--Our Conduct
following Adoption of the Plan of Dissolution" below) to assist the Company in
effecting the dissolution, fees of service providers in connection with this
proxy statement, payment of outstanding sales and use and franchise taxes and
employee severance. See "Recent Events--Description of Foreclosure
Agreement--Post Closing Transactions" above. If the wind-down costs are less
than $827,794, the Company is not entitled to obtain cash in the amount of such
differential.
Even if there were any cash available for distribution to our
stockholders, the holder of our 4% Series I Cumulative Redeemable Preferred
Stock is entitled to an aggregate liquidation preference of approximately
$872,000 prior to any payment to our common stockholders.
For these reasons, there will be no cash available for distribution to
any of our common stockholders.
Sales of our Remaining Assets
The Plan of Dissolution gives our Board of Directors the authority to
sell all of our remaining assets. Approval of the Plan of Dissolution and our
dissolution will constitute approval of any and all such agreements and sales.
We will sell our remaining assets, if any, on such terms as are approved by our
Board of Directors or the Liquidating Agent. We may conduct sales by any means,
including by competitive bidding or private negotiations. We will not solicit
any stockholder votes with respect to the approval of the specific terms of any
particular sale of assets approved by our Board of Directors. It is our
expectation that the Company will have few, if any, assets available for sale
because as noted above, the few remaining assets of the Company are not capable
of being sold to realize cash.
Our Conduct following Adoption of the Plan of Dissolution
The only officer or director of the Company who will receive
compensation for duties relating to winding up our affairs is Scott Schooley,
our President and Chairman and the Liquidating Agent, who will be indirectly
paid $50,000 pursuant to the wind-up budget. The wind-up budget provides up to
$50,000 for payments to Woodside Capital Management, LLC in connection with
services to be provided in the Company's winding-up, and Mr. Schooley is a
member of Woodside Capital Management, LLC.
Following dissolution (assuming that it is approved by our
stockholders), we will continue to indemnify our officers, directors, employees
and agents in accordance with our Amended and Restated Certificate of
Incorporation and by-laws for actions taken in connection with the Plan and the
winding up of our affairs. One of the assets that is retained is a "tail"
policy, for which the lender, SO Acquisition, LLC, has prepaid in part the
premium to continue to maintain our directors' and officers' liability insurance
for claims made following the
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expiration of the then current policy and that relate to events arising on or
before the closing under the Foreclosure Agreement for a period of three (3)
years.
Contingency Reserve
Under the Delaware General Corporation Law, we generally are required,
in connection with our dissolution, to pay or make reasonable provision for
payment of our liabilities and obligations. Following stockholder approval of
the Plan of Dissolution and our dissolution at the Special Meeting, to the
extent possible we will pay all expenses and fixed and other known liabilities,
or set aside a contingency reserve, consisting of cash or other assets that we
believe to be adequate for payment of those known liabilities, as well as claims
that are unknown or have not yet arisen but that, based on facts known to us,
are likely to arise or become known to us within ten years after the date of our
dissolution. We are currently unable to provide a precise estimate of the amount
of a contingency reserve, if any, that may be required, but any such contingency
reserve will be entirely subject to our ability to obtain payments from the
lender pursuant to the wind-down budget provided for in the Foreclosure
Agreement.
The actual amount of any contingency reserve will be based upon
estimates and opinions of our Board of Directors, derived from consultations
with management and outside experts, if the Board determines that it is
advisable to retain such experts, and a review of, among other things, our
estimated contingent liabilities and our estimated ongoing expenses, including,
without limitation, estimated investment banking, legal and accounting fees,
taxes, miscellaneous office expenses and expenses accrued in our financial
statements. Even if established, a contingency reserve is unlikely to be
sufficient to satisfy all of our obligations, expenses and liabilities.
Potential Liability of Stockholders
Under the Delaware General Corporation Law, in the event we fail to
create an adequate contingency reserve, or should such contingency reserve and
the assets held by any liquidating trusts be insufficient to satisfy the
aggregate amount ultimately found payable in respect of our expenses and
liabilities, each stockholder could be held liable for amounts due creditors of
the Company to the extent of amounts that such stockholder received from us and
from any liquidating trust as distributions under the Plan of Dissolution.
However, since the Company will not be making any distributions to stockholders
under the Plan of Dissolution, there will be no exposure to stockholders from
creditor claims arising from distributions on the Plan of Dissolution.
Regulatory Approvals
We do not believe that any material United States federal or state
regulatory requirements must be met or approvals obtained in connection with the
Plan of Dissolution or our dissolution.
Reporting Requirements
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Whether or not the Plan of Dissolution is approved, we have an
obligation to continue to comply with the applicable reporting requirements of
the Exchange Act, even though compliance is economically burdensome. If the Plan
of Dissolution is approved, in order to curtail expenses, we will, after filing
our Certificate of Dissolution, seek relief from the Securities and Exchange
Commission from the reporting requirements under the Exchange Act. We anticipate
that, if such relief is granted, we would continue to file current reports on
Form 8-K to disclose material events relating to our liquidation and dissolution
along with any other reports that the Securities and Exchange Commission might
require. However, there can be no assurance that the Securities and Exchange
Commission will grant any such relief.
Final Record Date; No Further Trading in the Common Stock
We intend to close our stock transfer books and discontinue recording
transfers of our common stock on the date of filing the Certificate of
Dissolution with Delaware (the "Final Record Date"). This is expected to occur
shortly after approval of the Plan of Dissolution by the stockholders, if
approved. Thereafter, certificates representing shares of our common stock will
not be assignable or transferable on our books except by will, intestate
succession or operation of law. After the Final Record Date, we will not issue
any new stock certificates, other than replacement certificates. It is
anticipated that no further trading of our shares will occur on or after the
Final Record Date.
Absence of Appraisal Rights
Under Delaware law, our stockholders are not entitled to appraisal
rights for their shares of common stock in connection with the transactions
contemplated by the Plan of Dissolution.
Material United States Federal Income Tax Consequences
The following discussion is a general summary of the material U.S. federal
income tax consequences of the Plan of Dissolution to Scan-Optics and our
stockholders and holders of options to purchase our stock, but does not purport
to be a complete analysis of all the potential tax effects. Tax considerations
applicable to particular stockholders will depend on the stockholder's
individual circumstances. The discussion addresses neither the tax consequences
that may be relevant to particular categories of stockholders subject to special
treatment under certain federal income tax laws (such as dealers in securities,
banks, insurance companies, tax-exempt organizations, mutual funds, and foreign
individuals and entities) nor any tax consequences arising under the laws of any
state, local or foreign jurisdiction.
The discussion is based upon the Internal Revenue Code of 1986, as amended
(the "Code"), U.S. Department of the Treasury regulations, rulings of the
Internal Revenue Service ("IRS"), and judicial decisions now in effect, all of
which are subject to change or to varying interpretation at any time. Any such
changes or varying interpretations may also be applied
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retroactively. The following discussion has no binding effect on the IRS or the
courts and assumes that we will liquidate substantially in accordance with the
Plan.
There will be no assets available for distribution to our stockholders
following our dissolution. No ruling has been requested from the IRS with
respect to the anticipated tax treatment of the Plan of Dissolution, and we will
not seek either such a ruling or an opinion of counsel with respect to the
anticipated tax treatment. If any tax consequences prove not to be as
anticipated and described herein, the result could be increased taxation at the
corporate or stockholder level.
Stockholders are urged to consult their own tax advisors as to the
specific tax consequences to them in connection with the Plan of Dissolution and
our dissolution, including tax return reporting requirements, the applicability
and effect of foreign, federal, state, local and other applicable tax laws and
the effect of any proposed changes in the tax laws.
Consequences to the Company
Commencing with stockholder approval of the Plan of Dissolution and our
dissolution and until the liquidation is completed, Scan Optics will continue to
be subject to U.S. federal income tax on any taxable income or loss associated
with the sale of our assets and income from operations. We believe that the
Company has sufficient available net operating losses to offset any income or
gain that might be recognized. Accordingly, the dissolution should not produce a
corporate tax liability for federal income tax purposes.
Consequences to Stockholders
As noted above, there will be no assets available for distribution to our
stockholders in connection with the liquidation and dissolution of the Company.
As a result of our filing a Certificate of Dissolution, a stockholder will
recognize loss equal to such stockholder's tax basis in the shares of Common
Stock. A stockholder's tax basis in the shares will depend upon various factors,
including the stockholder's cost and the amount and nature of any distributions
received with respect thereto.
A stockholder's loss will be computed on a "per share" basis, so that loss
is calculated separately for blocks of stock acquired at different dates and for
different prices. The loss recognized by a stockholder will be capital loss,
provided the stock is held as a capital asset, and will be long-term capital
loss if the share has been held for more than one year.
Consequences to Option Holders
To the extent that they have not already terminated with the passage of
time following the termination of service of the particular option holder, all
currently outstanding compensatory options under our stock option plans will
terminate upon our dissolution.
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Taxation of Non-United States Stockholders
Foreign corporations or persons who are not citizens or residents of the
United States should consult their own tax advisors with respect to the U.S. and
non-U.S. tax consequences of the Plan of Dissolution.
State and Local Taxes
Stockholders may also be subject to state or local taxes and should
consult their own tax advisors with respect to the state and local tax
consequences of the Plan of Dissolution.
Vote Required and Board Recommendation
The approval of the Plan of Dissolution requires the affirmative vote
of the holders of a majority of the outstanding shares of our common stock. ARK
CLO 2000-1, Limited which holds, as of the record date, approximately 83% of the
outstanding shares of common stock, has indicated that it will vote in favor of
the proposal.
The Board of Directors believes that the Plan of Dissolution and
dissolution of the Company is advisable and in the best interests of the Company
and recommends a vote "FOR" this proposal. It is intended that the shares
represented by the enclosed form of proxy will be voted in favor of this
proposal unless otherwise specified in such proxy.
PROPOSAL TWO - AMENDMENT TO CERTIFICATE OF INCORPORATION TO
DECREASE NUMBER OF DIRECTORS
Amended and Restated Certificate of Incorporation
The Amended and Restated Certificate of Incorporation of Scan-Optics
provides for a Board of Directors of no fewer than three nor more than nine
directors. The exact number of directors constituting the Board of Directors and
each respective class thereof is fixed from time to time by the Board of
Directors within these limits. The Amended and Restated Certificate of
Incorporation further provides that notwithstanding any other provision of the
Amended and Restated Certificate of Incorporation, the by-laws of the Company or
otherwise, the affirmative vote of the holders of at least 80 percent of the
voting power of the shares of stock of the Company entitled to vote thereon,
voting without regard to class, shall be required to amend, repeal, or adopt any
provision inconsistent with this section of the Amended and Restated Certificate
of Incorporation.
Because the Company will be operating only in order to wind-down the
Company, the Board of Directors has determined that it is in the best interests
of the Company to streamline the Board of Directors by decreasing the minimum
number of directors from three to one effective immediately following the
Special Meeting of Stockholders. In connection with the decrease in
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directors, only Class II will have a director. The term of the Class II director
expires with the 2007 Annual Meeting of Stockholders. Mr. Schooley will remain
the Class II director.
Pursuant to our Amended and Restated Certificate of Incorporation, any
vacancy on the Board of Directors may be filled by the vote of a majority of the
directors then in office and any director elected to fill such a vacancy will
hold office for the unexpired term of his or her predecessor. There will be no
vacancies on the Board of Directors following the resignation of the Company's
other directors and effectiveness of the decrease in the number of directors.
The Board of Directors approved an amendment to the Amended and
Restated Certificate of Incorporation, subject to stockholder approval, on
August 5, 2005, and further modified the amendment on November 8, 2005, which
is the amendment being submitted to the stockholders in this proxy statement. A
copy of the proposed amendment to the Amended and Restated Certificate of
Incorporation is attached as Annex B to this proxy statement.
Reasons for Amendment to Amended and Restated Certificate of Incorporation;
Board Recommendation
Messrs. Takala, Clarke and Flannery have notified the Company of their
intention to resign from the Board of Directors immediately upon filing of the
Certificate of Dissolution by the Company. Thereafter, only one director, Mr.
Schooley, will remain as a director of the Company. Under the Company's Amended
and Restated Certificate of Incorporation as it now exists, the Board of
Directors must have a minimum of three members in order to act. The Board has
determined that it is in the best interests of the Company to amend the Amended
and Restated Certificate of Incorporation to provide that Mr. Schooley as the
sole director can take any action required by the Board of Directors after the
filing of the Certificate of Dissolution.
The Board of Directors believes that the amendment to the Amended and
Restated Certificate of Incorporation is in the best interests of our
stockholders and recommends a vote "FOR" this proposal. It is intended that the
shares represented by the accompanying proxy will be voted for the amendment to
Article SEVENTH of the Amended and Restated Certificate of Incorporation to
decrease the minimum number of directors required to one unless the proxy
indicates that authority to vote for such action is withheld.
Under the Amended and Restated Certificate of Incorporation, the
affirmative vote of the holders of at least 80 percent of the voting power of
the shares of stock of the Company entitled to vote thereon, voting without
regard to class, is required to amend, repeal or adopt any provision
inconsistent with, Paragraph 1 of Article SEVENTH of the Amended and Restated
Certificate of Incorporation. ARK CLO 2000-1, Limited which holds, as of the
record date, approximately 83% of the outstanding shares of common stock, has
indicated that it will vote in favor of the proposal.
Absence of Appraisal Rights
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Under Delaware law, our stockholders are not entitled to appraisal
rights for their shares of common stock in connection with the amendment to the
Amended and Restated Certificate of Incorporation.
PROPOSAL THREE - OTHER BUSINESS
The Board of Directors does not know of any matters to be presented at
the Special Meeting other than those set forth in the Notice of Special Meeting
of Stockholders. However, if any other matters properly come before such
meeting, the persons named in the enclosed proxy will have discretionary
authority to vote all proxies on such matters in accordance with their judgment.
Share Ownership of Certain Beneficial Owners and Management
The following table sets forth certain information regarding the
beneficial ownership of shares of common stock as of [___________ __, 2005], the
record date for this meeting of each director, each executive officer named in
the Summary Compensation Table contained elsewhere in this proxy statement and
the directors and executive officers of the Company as a group, except that the
information with respect to Messrs. Mavel, Rife, Crouch, Goyette, Howser and
Stelling is as of April 22, 2005, as it may be modified only by subsequent
terminations of options granted to each such individual of which the Company is
aware. The Company is not aware of any other changes to such ownership. We know
of no persons with beneficial ownership of more than 5% of our voting stock as
of August 5, 2005, other than ARK CLO 2000-1, Limited or its related entities
and individuals listed in Note 9 below. Except as noted, each stockholder listed
has sole voting and investment power with respect to the shares shown as being
beneficially owned by such stockholder. The address for the individuals listed
below is c/o Scan-Optics, Inc., 179 Allyn Street-Suite 508, Hartford, CT 06103,
except that the address for Mr. Scinto and Ms. Tilton is c/o Patriarch Partners,
LLC, 227 West Trade Street, Suite 700, Charlotte, NC 28202, Mr. Flannery is c/o
Whelan Financial Corp, 255 Farmington Drive, Charlottesville, VA 22901, and Mr.
Schooley is c/o Woodside Capital LLC, 179 Allyn Street- Suite 508, Hartford, CT
06103.
Number Percentage
of Shares (1) of Common Stock
Name Outstanding
- ---------------------- -------------- ----------------
Logan Clarke, Jr. (2) 50,600 *
Joseph P. Crouch (3) 666,671 1.6%
Kevin S. Flannery 0 N/A
Richard C. Goyette (3) 987,347 2.3%
John J. Holton 30,000 *
Joel K. Howser (4) 1,082 *
James C. Mavel (5) 60,485 *
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Clarence W. Rife (6) 3,287 *
Scott Schooley 0 N/A
Michael Scinto (7) 0 N/A
Peter H. Stelling 29,958 *
Ralph J. Takala 5,000 *
Lynn Tilton (8) (9) 34,425,345 83%
Paul M. Yantus 0 N/A
ARK CLO 2000-1 (9) 34,425,345 83%
Directors and executive officers
as a
group (14 persons) 36,259,775 83.9 %
(*) Ownership is less than 1%.
(1) Includes the following number of shares subject to options exercisable
within 60 days of [___________ __, 2005] based on acceleration of such
options in connection with the Foreclosure Agreement and/or filing of
Certificate of Dissolution: Logan Clarke, Jr., 50,000 shares; Joseph P.
Crouch, 647,490 shares; Richard C. Goyette, 962,694 shares; John J.
Holton, 30,000 shares; Peter H. Stelling, 29,958 shares; Ralph J. Takala,
10,000 shares; and all directors and executive officers as a group,
1,730,142 shares.
(2) Mr. Clarke was appointed Acting CEO and President following the
resignation of James Mavel on March 9, 2005 and resigned as acting CEO
and President on May 16, 2005.
(3) Mr. Crouch and Mr. Goyette ceased being officers and employees on August
5, 2005, in connection with the closing of the Foreclosure Agreement.
(4) Mr. Howser ceased being an officer and employee of the Company on June 2,
2005. Any unexercised options held by him terminated pursuant to their
terms on or about September 2, 2005.
(5) Mr. Mavel resigned as CEO and President on March 9, 2005. Any unexercised
options held by him terminated pursuant to their terms on or about June
17, 2005.
(6) Mr. Rife retired on December 16, 2004. Any unexercised options held by
him terminated pursuant to their terms on March 16, 2005.
(7) Mr. Scinto resigned from the Board of Directors on July 8, 2005.
(8) Ms. Tilton resigned from the Board of Directors effective June 9, 2005.
(9) Upon the recapitalization of the Company's equity in August 2004, ARK CLO
became the beneficial owner of 34,425,345 shares of common stock of
Scan-Optics, of which 6,470,929 shares are subject to repurchase by
Scan-Optics upon exercise of outstanding
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options under the Senior Executive Stock Option Plan. Pursuant to the
rules of the Securities and Exchange Commission relating to beneficial
ownership, (i) Patriarch Partners, LLC ("Patriarch"), as sole owner of
ARK CLO, (ii) LD Investments, LLC ("LDI"), as the sole member of
Patriarch, and (iii) Lynn Tilton, a former director of the Company, as
the sole director of ARK CLO and the manager and sole holder of the
voting power in respect of LDI, can each be deemed to beneficially own
the 34,425,345 shares of common stock of Scan-Optics owned by ARK CLO. As
of August 5, 2005, each of Patriarch, LDI and Lynn Tilton disclaimed any
beneficial ownership of such securities.
Changes in Control of Registrant
On August 6, 2004, the Company issued and sold an aggregate of
34,425,345 shares of its common stock to the Company's then principal lender,
ARK CLO 2000-1, Limited, in a recapitalization pursuant to a Second Amended and
Restated Subscription and Repurchase Agreement dated as of August 6, 2004
between the Company and ARK CLO, as described in a Form 8-K filing made with the
Securities and Exchange Commission on August 6, 2004. The issuance of the shares
to ARK was a key component of a comprehensive financial restructuring
arrangement with ARK CLO commenced as of March 30, 2004 pursuant to the terms of
a Third Amended and Restated Credit Agreement among the Company, ARK CLO and the
other lenders identified therein, the Guarantors identified therein and
Patriarch Partners Agency Services LLC.
The shares were issued in exchange for:
o cancellation of $3.8 million of mandatorily redeemable preferred
stock held by ARK CLO with a redemption date of June 1, 2005 and
contingent voting power representing 46.67% of the voting power of
the Company on a fully diluted basis;
o cancellation of a warrant held by ARK CLO exercisable after
December 31, 2004 for 33.2% of the fully diluted common stock of
the Company as of the issuance date of the warrant at $.02 per
share; and
o the extension of the maturity of all of the Company's secured
indebtedness under the Credit Agreement from June 30, 2005 to
March 20, 2007.
At the Company's 2004 annual meeting of stockholders, the Company's
stockholders approved an Amended and Restated Certificate of Incorporation of
the Company increasing the number of authorized shares of common stock of the
Company from 15,000,000 shares to 65,000,000 shares in order to permit the
Company to complete the recapitalization.
At the annual meeting and as a condition to the recapitalization,
stockholders elected three designees of ARK CLO, Messrs. Schooley and Scinto and
Ms. Tilton, as Class II directors to the Board of Directors. As a further
condition to the recapitalization, three directors of the Company - Messrs. E.
Bulkeley Griswold, Robert H. Steele and Lyman C. Hamilton, Jr. - tendered their
resignations from the Board of Directors.
-41-
The shares issued to ARK CLO represented 79.8% of the fully diluted
common stock of the Company at the time of issuance. The shares are subject to
reduction or dilution in two circumstances, however: first, 6,470,929 of the
shares are subject to redemption by the Company at $.02 per share to the extent
that one or more current or former senior executives or the heirs holding
options under the Company's Amended and Restated Senior Executive Stock Option
Plan exercises his options, which plan reserves approximately 15% of the fully
diluted common stock of the Company; and second, the shares are subject to
dilution for options that may be granted under the 2004 Incentive and
Non-Qualified Stock Option Plan, which plan reserve represents approximately 5%
of the fully diluted common stock of the Company. Accordingly, ARK CLO's
beneficial ownership may be reduced to no less than approximately 61% of the
fully diluted common stock of the Company should all of the shares subject to
redemption upon exercise of options under the Senior Executive Plan be redeemed.
FINANCIAL INFORMATION
Appendix 1 to the Proxy Statement which is a part of this Proxy
Statement contains the Company's financial statements, selected financial data
and Management's Discussion and Analysis for the year ended December 31, 2004.
Appendix 2 to this Proxy Statement which is a part of this Proxy Statement
contains the Company's financial statements and Management's Discussion and
Analysis for the quarter and six months ended June 30, 2005. Appendix Three to
this Proxy Statement which is a part of this Proxy Statement contains the
Company's Selected Financial Data.
STOCKHOLDER PROPOSALS TO BE PRESENTED
AT NEXT ANNUAL MEETING
If the stockholders of the Company approve Proposal No. 1 set forth in
this Proxy Statement, it is anticipated that the Company will be dissolved prior
to the date of the Company's Annual Meeting of Stockholders in 2006. Should this
occur, the Company will not hold an Annual Meeting of Stockholders in 2006. If,
however, Proposal No. 1 is not approved by the stockholders, the Company may
hold an Annual Meeting of Stockholders in 2006.
Stockholder proposals intended to be presented at the Annual Meeting of
Stockholders in 2006, must be received by Scan-Optics at its principal executive
offices no later than December 29, 2005 in order to be considered for inclusion
in Scan-Optics' proxy statement and form of proxy relating to the Annual Meeting
of Stockholders in 2006. Any such proposal must comply with Rule 14a-8
promulgated by the Securities and Exchange Commission and the notice provisions
of our By-Laws.
In addition, with respect to the Annual Meeting of Stockholders in 2006, if
a stockholder does not provide notice to Scan-Optics of a stockholder proposal
by March 14, 2006, the attorneys named in the form of proxy mailed with our
proxy statement for that meeting will have discretionary authority to vote as
they determine on the proposal. If we change the date of the
-42-
2006 Annual Meeting by more than 30 days from the date of the 2005 Annual
Meeting, notice of the stockholder proposal must be submitted a reasonable time
before we begin to print and mail our proxy materials for the meeting.
ADDITIONAL INFORMATION
We are subject to the reporting requirements of the Securities Exchange
Act of 1934, as amended, and we file reports, proxy statements and other
information with the SEC. You may read and copy any materials we file with the
SEC at the SEC's Public Reference Room at Room 1550, 100 F. Street, N.E.,
Washington, DC 20549. Please call the SEC at 1-800-SEC-0330 for further
information on the Public Reference Room. Our public filings are also available
to the public on the website maintained by the SEC at http://www.sec.gov. If you
have any questions about the Special Meeting or the proposals to be voted on at
the Special Meeting, or if you need additional copies of the proxy statement or
copies of any of Scan-Optics public filings referred to in this proxy statement,
you should contact Scott Schooley at 179 Allyn Street--Suite 508, Hartford,
Connecticut 06103 .
By Order of the Board of Directors,
- ------------------------------
Scott Schooley
Chairman of the Board of Directors and President
Hartford, Connecticut
[__________ __, 2005]
-43-
Annex A
PLAN OF DISSOLUTION
OF
SCAN-OPTICS, INC.
This Plan of Dissolution (the "Plan") is intended to accomplish the
dissolution and winding-up of Scan-Optics, Inc., a Delaware corporation
("Scan-Optics"), in accordance with the Delaware General Corporation Law, as
follows:
1. The Board of Directors of Scan-Optics (the "Board of Directors") has
adopted this Plan and will solicit the holders of the requisite percentage of
Scan-Optics' outstanding common stock to approve the dissolution of Scan-Optics
pursuant to this plan of dissolution (the "Stockholder Vote"). If stockholders
holding a majority of Scan-Optics' outstanding common stock, par value $0.02 per
share (the "Common Stock") approve the Plan pursuant to the Stockholder Vote,
the Plan shall constitute the adopted Plan of Dissolution of Scan-Optics as of
the date of the Stockholder Vote (such date, the "Adoption Date").
2. Pursuant to the terms of that certain Foreclosure Agreement dated as
of August 5, 2005, among Scan-Optics, PATRIARCH PARTNERS AGENCY SERVICES, LLC
and SO Acquisition, LLC (the "Foreclosure Agreement"), Scan-Optics will be
retaining certain rights, assets and liabilities pursuant to the Foreclosure
Agreement as set forth in the schedules to the Foreclosure Agreement. If,
notwithstanding the approval of the dissolution pursuant to this Plan by the
requisite stockholders of Scan-Optics, the Board of Directors determines that it
would be in the best interests of Scan-Optics' stockholders or creditors for
Scan-Optics not to dissolve, the dissolution of Scan-Optics pursuant to this
Plan may be abandoned or delayed until a future date to be determined by the
Board of Directors.
3. From and after the Adoption Date, contingent upon the consummation
of the transactions contemplated by the Foreclosure Agreement, and subject to
the discretionary right of the Board of Directors to abandon or delay
implementation of this Plan as described in Section 2 above, Scan-Optics shall
complete the following corporate actions, all of which may be accomplished by a
liquidating agent duly appointed by the Board of Directors (the "Liquidating
Agent"), except to the extent that any such action may be taken only by the
Board of Directors in accordance with the General Corporation Law of the State
of Delaware:
(a) Scan-Optics shall determine whether and when to (i) transfer
Scan-Optics' remaining property and assets to a liquidating trust
(established pursuant to Section 5 hereof), or (ii) collect, sell,
exchange or otherwise dispose of all of its property and assets in one
or more transactions upon such terms and conditions as the Board of
Directors (which may, pursuant to the resolutions of the Board of
Directors at a meeting held on August 5, 2005, consist of a sole
director for all purposes hereof) or the Liquidating Agent in his or
its absolute discretion, deems expedient and in the best interests of
Scan-Optics and the stockholders and
-44-
creditors of Scan-Optics, without any further vote or action by
Scan-Optics stockholders. Scan-Optics' assets and properties may be
sold by the Board of Directors (or Liquidating Agent or Trustees) in
bulk to one buyer or a small number of buyers or on a piecemeal basis
to numerous buyers. The Board of Directors (or Liquidating Agent or
Trustees) will not be required to obtain appraisals or other third
party opinions as to the value of its properties and assets in
connection with the liquidation. In connection with sale, exchange and
other disposition, the Board of Directors (or Liquidating Agent or
Trustees) shall use commercially reasonable means to collect or make
provision for the collection of all accounts receivable, debts and
claims owing to Scan-Optics which constitute Excluded Assets under the
Foreclosure Agreement.
(b) To the extent of all available assets, Scan-Optics shall pay or, as
determined by the Board of Directors (or Liquidating Agent or
Trustees), make reasonable provision to pay, all claims, liabilities
and obligations of Scan-Optics, including all unascertained,
contingent, conditional or unmatured claims known to Scan-Optics and
all claims which are known to Scan-Optics but for which the identity
of the claimant is unknown, all in accordance with Section 281(b) of
the Delaware General Corporation Law. If and to the extent deemed
necessary, appropriate or desirable by the Board of Directors (or
Liquidating Agent or Trustees), in their absolute discretion,
Scan-Optics may establish and set aside a reasonable amount of cash
and/or property (the "Contingency Reserve") to satisfy claims against
and unmatured or contingent liabilities and obligations of
Scan-Optics, including, without limitation, tax obligations, and all
expenses of the sale of Scan-Optics' property and assets, of the
collection and defense of Scan-Optics' property and assets, and the
liquidation and dissolution provided for in this Plan.
(c) Such claims shall be paid in full and any such provision for payment
made shall be made in full if there are sufficient assets. If there
are insufficient assets, such claims and obligations shall be paid or
provided for according to their priority and, among claims of equal
priority, ratably to the extent of assets legally available therefor.
(d) Subject to the approval of any such distribution by the Board of
Directors (or Liquidating Agent or Trustees), and only after
satisfaction of claims and liabilities pursuant to Section 3(b) above,
Scan-Optics shall distribute first to its Preferred Stockholders and,
upon payment in full of the Preferred Stock, pursuant to the
Certificate of Designation of the Preferred Stock of Scan-Optics,
second, pro rata to its holders of Common Stock all available cash,
including the cash proceeds of any sale, exchange or disposition,
except such cash, property or assets as are required for paying or
making reasonable provision for the liabilities and obligations of
Scan-Optics. Such distribution may occur all at once or in a series of
distributions and shall be in cash or assets, in such amounts, and at
such time or
-45-
times, as the Board of Directors (or Liquidating Agent or Trustees), in
their absolute discretion, may determine.
4. Any distributions to the stockholders of Scan-Optics pursuant to
Section 3 hereof shall be in complete redemption and cancellation of all of the
outstanding Preferred Stock or Common Stock, as applicable, of Scan-Optics. As a
condition to receipt of any distribution to Scan-Optics' stockholders, the Board
of Directors (or Liquidating Agent or Trustees), in their absolute discretion,
may require the stockholders to (i) surrender their certificates evidencing the
Preferred Stock or Common Stock, as applicable, to Scan-Optics or its agents for
recording of such distributions thereon or (ii) furnish Scan-Optics with
evidence satisfactory to the Board of Directors (or Liquidating Agent or
Trustees) of the loss, theft or destruction of their certificates evidencing the
Preferred Stock or Common Stock, as applicable, together with such surety bond
or other security or indemnity as may be required by and satisfactory to the
Board of Directors (or Liquidating Agent or Trustees). As a condition to receipt
of any final distribution to Scan-Optics' stockholders, the Board of Directors
(or Liquidating Agent or Trustees), in their absolute discretion, may require
the stockholders to (i) surrender their certificates evidencing the Preferred
Stock or Common Stock, as applicable, to Scan-Optics or its agent for
cancellation or (ii) furnish Scan-Optics with such security or indemnity. The
Company will finally close its stock transfer books and discontinue recording
transfers of Preferred Stock and Common Stock (other than with respect to
transfers by will, intestate succession or operation of law) on the date on
which the Certificate of Dissolution is filed with the Secretary of State of
Delaware, which certificate will not be filed until the Adoption Date.
5. If the Board of Directors deems it necessary, appropriate and
desirable, in furtherance of the liquidation and distribution of Scan-Optics'
assets to the stockholders, Scan-Optics shall transfer to one or more
liquidating trustees (the "Trustees"), for the benefit of its stockholders
and/or creditors, under a liquidating trust (the "Trust"), the assets and
liabilities of the Company not transferred to, or assumed by, the other parties
to the Foreclosure Agreement. The Board of Directors is hereby authorized to
appoint one or more individuals, corporations, partnerships or other persons, or
any combination thereof, including, without limitation, any one or more
officers, directors, employees, agents or representatives of Scan-Optics, to act
as the initial Trustee or Trustees for the benefit of the stockholders and to
receive any assets of Scan-Optics. Any Trustees appointed as provided in the
preceding sentence shall succeed to all right, title and interest of Scan-Optics
of any kind and character with respect to such transferred assets and, to the
extent of the assets so transferred and solely in their capacity as Trustees,
shall assume all of the liabilities and obligations of Scan-Optics, including,
without limitation, any unsatisfied claims and unascertained or contingent
liabilities. Further, any conveyance of assets to the Trustees shall be deemed
to be a distribution of property and assets by Scan-Optics to the stockholders
for the purposes of Section 3 of this Plan. Any such conveyance to the Trustees
shall be in trust for the creditors and the stockholders of Scan-Optics.
Approval of the dissolution of Scan-Optics pursuant to this Plan by the holders
of a majority of the outstanding Common Stock shall constitute the approval of
the stockholders of any such appointment, any such liquidating trust agreement
and any transfer of assets by Scan-Optics to the Trust, as their act and as a
part hereof as if herein written.
-46-
6. The officers or agents of Scan-Optics shall, at such time as the
Board of Directors or the Liquidating Agent, in his or its absolute discretion,
deems necessary, appropriate or desirable, obtain any certificates required from
the Delaware tax authorities and, upon obtaining such certificates but in no
event prior to the Adoption Date, Scan-Optics shall file with the Secretary of
State of the State of Delaware a certificate of dissolution in accordance with
the Delaware General Corporation Law. After the filing of the Certificate of
Dissolution, Scan-Optics shall not engage in any business activities except to
the extent necessary to preserve the value of its assets, wind-up its business
affairs and distribute its assets in accordance with this Plan.
7. In connection with and for the purpose of implementing and assuring
completion of this Plan, Scan-Optics may, in the absolute discretion of the
Board of Directors (or the Liquidating Agent or the Trustees), pay Scan-Optics'
officers, directors, employees, agents and representatives, or any of them,
compensation, in money or other property, as severance, bonus, or stock options,
or in any other form, in recognition of the extraordinary efforts they, or any
of them, will be required to undertake, or actually undertake, in connection
with the implementation of this Plan. Approval of the dissolution of Scan-Optics
pursuant to this Plan by holders of a majority of the outstanding Common Stock
shall constitute the approval of Scan-Optics' stockholders of the payment of any
such compensation.
8. Scan-Optics shall continue to indemnify its officers, directors,
employees, agents and representatives in accordance with its certificate of
incorporation, as amended, and by-laws and any contractual arrangements, for the
actions taken in connection with this Plan and the winding-up of the affairs of
Scan-Optics. Scan-Optics' obligation to indemnify such persons may also be
satisfied out of the assets of the Trust, if a Trust is established pursuant to
Section 5 of this Plan. The Board of Directors (or the Liquidating Agent or the
Trustees), in their absolute discretion, are authorized to obtain and maintain
insurance as may be necessary or appropriate to cover Scan-Optics' obligation
hereunder, including seeking an extension in time and coverage of Scan-Optics'
insurance policies currently in effect.
9. The Board of Directors of Scan-Optics is hereby authorized, and the
Liquidating Agent and the Trustees are hereby authorized, all without further
action by Scan-Optics' stockholders, to do and perform or cause the officers and
agents of Scan-Optics, subject to approval of the Board of Directors (or
Liquidating Agent or Trustees), to do and perform, any and all acts, and to
make, execute, deliver or adopt any and all agreements, resolutions,
conveyances, certificates and other documents of every kind which are deemed
necessary, appropriate or desirable, in the absolute discretion of the Board of
Directors (or Liquidating Agent or Trustees), to implement this Plan and the
transaction contemplated hereby, including, without limiting the foregoing, all
filings or acts required by any state or federal law or regulation to wind-up
its affairs.
-47-
Annex B
CERTIFICATE OF AMENDMENT
TO
AMENDED AND RESTATED
CERTIFICATE OF INCORPORATION
OF
SCAN-OPTICS, INC.
Pursuant to Section 242 of the General Corporation Law of the State of
Delaware (the "DGCL"), Scan-Optics, Inc., a Delaware corporation (the
"Corporation"), does hereby certify as follows:
FIRST: The name of the Corporation is Scan-Optics, Inc.
SECOND: The Amended and Restated Certificate of Incorporation of the Corporation
(the "Certificate of Incorporation") was originally filed with the Secretary of
State of the State of Delaware on July 16, 2004.
THIRD: On [___________ __, 2005] the board of directors of the Corporation duly
adopted a resolution setting for the following amendment to the Certificate of
Incorporation (the "Amendment"):
That the first and second sentences of Article Seventh, Section 1 of
the Certificate of Incorporation be amended to read in its entirety as follows:
"The management of the business and the conduct of the affairs of the
Corporation, including the election of the Chairman of the Board of
Directors, if any, the President, the Treasurer, the Secretary, and
other principal officers of the Corporation, shall be vested in a Board
of Directors of no fewer than one nor more than nine directors. The
directors of the Corporation shall be divided into three classes,
namely, Classes I, II and III, as nearly equal in number as possible."
FOURTH: On [___________ __, 2005], at a special meeting of the stockholders of
the Corporation, duly held and called upon notice in accordance with Section 222
of the DGCL, the requisite number of shares as required by statute and the
Certificate of Incorporation were voted for the Amendment.
FIFTH: This Amendment was duly adopted in accordance with the provisions of
Section 242 of the DGCL.
[Signature Page Follows]
IN WITNESS WHEREOF, the Corporation has caused this Amendment to be
signed pursuant to Section 103(a)(2) of the DGCL by the undersigned duly
authorized officer of the Corporation, as of the ___ day of _______, [2005].
SCAN-OPTICS, INC.
By:___________________________
Name: Scott Schooley
Title: President and Secretary
Appendix 1
*********
Scan-Optics, Inc. financial statements, selected financial data and
Management's Discussion and Analysis from the Scan-Optics Form 10-K for the year
ended December 31, 2004
Appendix 1
Scan-Optics, Inc. financial statements, selected financial data and Management's
Discussion and Analysis from the Scan-Optics Form 10-K for the year ended
December 31, 2004.
SCAN-OPTICS, INC., AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
December 31
(thousands, except share data) 2004 2003
- -------------------------------------------------------------------------------------------------
Assets
Current Assets:
Cash and cash equivalents $ 477 $ 585
Accounts receivable less allowance of $238 in 2004
and $1,134 in 2003 4,314 6,043
Unbilled receivables - contracts in progress 298 415
Inventories 7,461 7,282
Prepaid expenses and other 389 597
--------------------------------------
Total current assets 12,939 14,922
Equipment and Leasehold Improvements:
Equipment 3,386 3,682
Leasehold improvements 4,089 4,010
Office furniture and fixtures 557 745
--------------------------------------
8,032 8,437
Less accumulated depreciation and amortization 7,095 7,422
--------------------------------------
937 1,015
Goodwill 9,040 9,040
Other assets 1,422 1,096
--------------------------------------
Total Assets $ 24,338 $ 26,073
======================================
28
December 31
(thousands, except share data) 2004 2003
- -----------------------------------------------------------------------------------------------------------------
Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable $ 2,822 $ 2,323
Note payable 1,000
Salaries and wages 702 1,484
Taxes other than income taxes 641 758
Income taxes 68 189
Deferred revenue 3,408 2,787
Customer deposits 143 929
Other 1,243 1,495
------------------------------------
Total current liabilities 10,027 9,965
Notes payable 10,605 7,989
Other liabilities 537 1,390
Mandatory redeemable preferred stock, at redemption value:
Series B, 3,800,000 shares issued and outstanding 4,286
Series I, 420,857 shares issued and outstanding 855
------------ ------------
Total Liabilities 22,024 23,630
Stockholders' Equity
Preferred stock, par value $.02 per share, authorized
5,000,000 shares
Common stock, par value $.02 per share:
authorized 65,000,000 shares; 41,865,077 issued
at December 31, 2004 and 7,439,732 issued
at December 31, 2003, including treasury shares 837 149
Capital in excess of par value 41,651 38,354
Accumulated retained-earnings deficit (36,339) (32,570)
Accumulated other comprehensive loss - currency
translation adjustment (1,189) (844)
------------------------------------
4,960 5,089
Cost of common stock in treasury, 413,500 shares (2,646) (2,646)
------------------------------------
Total stockholders' equity 2,314 2,443
------------------------------------
Total Liabilities and Stockholders' Equity $ 24,338 $ 26,073
====================================
See accompanying notes.
29
SCAN-OPTICS, INC., AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
Year Ended December 31
(thousands, except share data) 2004 2003 2002
- ------------------------------------------------------------------------------------------------------
Revenues
Hardware and software $ 11,883 $ 16,044 $ 11,292
Professional services 5,925 5,474 6,550
Access services 10,933 10,563 11,499
--------------- ------------- -----------------
Total revenues 28,741 32,081 29,341
Costs of Revenue
Hardware and software 9,655 10,690 7,816
Professional services 2,873 2,717 2,899
Access services 8,980 8,813 8,539
--------------- ------------- -----------------
Total costs of revenues 21,508 22,220 19,254
Gross Profit 7,233 9,861 10,087
Operating Expenses
Sales and marketing 3,327 3,455 3,273
Research and development 1,955 1,267 1,798
General and administrative 4,787 3,572 3,566
Interest 867 856 846
--------------- ------------- -----------------
Total costs and expenses 10,936 9,150 9,483
--------------- ------------- -----------------
Operating income (loss) (3,703) 711 604
Other income, net 5 133 419
--------------- ------------- -----------------
Income (loss) before income taxes (3,698) 844 1,023
Income taxes (benefit) 71 (142) 81
--------------- ------------- -----------------
Net Income (Loss) $ (3,769) $ 986 $ 942
=============== ============= =================
Basic earnings (loss) per share $ (.18) $ .14 $ .13
=============== ============= =================
Basic weighted-average shares 20,890,686 7,026,232 7,026,232
=============== ============= =================
Diluted earnings (loss) per share $ (.18) $ .13 $ .13
=============== ============= =================
Diluted weighted-average shares 20,890,686 7,806,491 7,317,437
=============== ============= =================
See accompanying notes.
30
SCAN-OPTICS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF
STOCKHOLDERS' EQUITY
Accumulated Accumulated
Common Stock Capital in Retained- Other
(thousands, except share data) ----------------- Excess of Earnings Comprehensive Treasury
Shares Amount Par Value Deficit Loss Stock Total
- ------------------------------------------------------------------------------------- -------------- ------------- -------------
Balance January 1, 2002 7,439,732 $ 149 $ 38,354 $ (34,498) $ (999) $ (2,646) $ 360
Net income 942 942
Currency
translation 81 81
adjustments
-------------
Comprehensive income 1,023
- --------------------------------------------------------------------------------------------------------------------------------
Balance December 31, 2002 7,439,732 149 38,354 (33,556) (918) (2,646) 1,383
Net income 986 986
Currency translation
adjustments 74 74
-------------
Comprehensive income 1,060
- --------------------------------------------------------------------------------------------------------------------------------
Balance December 31, 2003 7,439,732 149 38,354 (32,570) (844) (2,646) 2,443
Net loss (3,769) (3,769)
Currency translation
adjustments (345) (345)
-------------
Comprehensive loss (4,114)
Exchange of common stock for
debt 34,425,345 688 3,712 4,400
Common stock issuance costs (606) (606)
Fair value of stock options
issued to non-employees 191 191
- --------------------------------------------------------------------------------------------------------------------------------
Balance December 31, 2004 41,865,077 $ 837 $ 41,651 $ (36,339) $(1,189) $ (2,646) $ 2,314
================================================================================================================================
See accompanying notes.
31
SCAN-OPTICS, INC., AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year Ended December 31
(thousands) 2004 2003 2002
- ------------------------------------------------------------------------------------- --------------------- --------------------
Operating Activities
Net income (loss) $ (3,769) $ 986 $ 942
Adjustments to reconcile net income (loss) to net
cash provided (used) by operating activities:
Depreciation 404 426 425
Amortization of customer service inventory and
development costs 2,134 1,885 2,355
Amortization of deferred debt costs 119
Accretion of interest on debt 105
Accretion of interest on preferred stock 128 486 254
Fair value of common stock options granted to
non-employees 191
Provision for losses on accounts receivable 567 22 35
Provision for slow-moving inventory 527 50
Reversal of previously recorded liabilities (183) (369)
Changes in operating assets and liabilities:
Accounts receivable 1,279 (549) (668)
Inventories (2,648) (28) (2,634)
Prepaid expenses and other 208 (6) (87)
Accounts payable 499 232 (819)
Accrued salaries and wages (782) 457 (353)
Taxes other than income taxes (117) 257 (23)
Income taxes (121) 144 40
Deferred revenue 621 570 116
Customer deposits (786) (379) 801
Other (767) (1,283) (233)
------------------- --------------------- --------------------
Net cash provided (used) by operating activities (2,208) 3,037 (168)
Investing Activities
Acquisition related settlement 209
Purchases of plant and equipment, net (329) (173) (79)
------------------- --------------------- --------------------
Net cash provided (used) by investing activities (329) (173) 130
Financing Activities
Debt and equity transaction costs (1,082)
Proceeds from borrowings 5,711 7,650 4,376
Principal payments on borrowings (2,200) (10,203) (5,726)
-------------------- -------------------- --------------------
Net cash provided (used) by financing activities 2,429 (2,553) (1,350)
Increase (decrease) in cash and cash equivalents (108) 311 (1,388)
Cash and cash equivalents at beginning of year 585 274 1,662
-------------------- -------------------- --------------------
Cash and Cash Equivalents at End of Year $ 477 $ 585 $ 274
==================== ==================== ====================
Supplemental Cash Flow Information
Interest paid $ 626 $ 732 $ 667
==================== ==================== ====================
Income taxes paid $ 126 $ 24 $ 44
==================== ==================== ====================
See accompanying notes.
32
SCAN-OPTICS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE A - DESCRIPTION OF BUSINESS
Scan-Optics, Inc. and its subsidiaries (collectively, the Company) combine
technology, experience and expertise to develop cost-effective solutions for
applications that include government, insurance, assessment, transportation,
financial and order entry. The Company's systems, software and services are
marketed worldwide to commercial and government organizations either directly by
the Company's sales organization or through distributors. The Company also
markets with system integrators and specialized niche suppliers. The Company's
business is vulnerable to a number of factors beyond its control. These factors
include (1) the effect of a continued weakening in the domestic and
international economies, which potentially impacts capital investments by
customers, (2) the cyclical nature of funding within federal and state
government agencies, (3) competition from similar products, (4) the
implementation of other technologies, which may provide alternative solutions to
customers, and (5) the stability of sole source suppliers.
NOTE B - ACCOUNTING POLICIES
Basis of Presentation: The consolidated financial statements include the
accounts of Scan-Optics, Inc. and its subsidiaries, all wholly-owned. All
intercompany accounts and transactions have been eliminated in the consolidated
financial statements. Certain amounts have been reclassified to conform to the
current year presentation.
Use of Estimates: The preparation of financial statements in conformity with
accounting principles generally accepted in the United States of America
requires management to make estimates and assumptions that affect the amounts
reported in them, including the accompanying notes. While management believes
that the estimates and related assumptions used in the preparation of these
financial statements are appropriate, actual results could differ from those
estimates. Significant estimates included in the financial statements relate to
asset valuation allowances for potentially uncollectible accounts receivable;
slow-moving and obsolete inventories; and deferred income tax assets. Further,
other significant estimates relate to revenue recognition
Foreign Currency Translation: All balance sheet accounts have been translated
using the exchange rates in effect at the balance sheet date. Statement of
operations accounts have been translated using the average exchange rate for the
year. The gains and losses resulting from the changes in exchange rates from
year to year have been reported in accumulated other comprehensive loss, a
component of Stockholders' Equity.
Cash Equivalents: Highly liquid investments purchased with maturities of three
months or less when purchased are considered cash equivalents.
Accounts Receivable and Revenue Recognition: Revenues relating to sales of
certain equipment (principally optical character recognition equipment) are
recognized upon acceptance, shipment, or
33
installation depending on the contract terms and conditions. When customers,
under the terms of specific orders or contracts, request the Company to
manufacture and invoice the equipment on a bill and hold basis, the Company
recognizes revenue based on an acceptance test that is certified by the customer
(Note O). When right of return exists, the Company recognizes revenue in
accordance with SFAS 48, Revenue Recognition When Right of Return Exists.
Returns were not significant for any period presented. At December 31, 2004 two
customers represented 30% and 17%, respectively, of accounts receivable. At
December 31, 2003 one customer represented 33% of accounts receivable.
Revenues under systems integration and professional services contracts are
recognized on a proportionate performance basis, based on the ratio of earned
revenue to total contract price, after considering accumulated costs and
estimated costs to complete each contract or when services have been performed
and accepted, depending on the nature of the individual project. Under fixed
price contracts, the Company may encounter, as has been the case with certain
contracts in prior years, cost overruns caused by project management problems
and the expense of hiring outside contractors to assist in project completions,
as well as changes to previously agreed upon project designs. Adjustments to
contract cost estimates are made in the periods in which the facts requiring
such revisions become known. When the estimates indicate a loss on a particular
contract, such a loss is provided for in the period it is identified. No
significant losses were required to be provided for any period presented.
The Company provides maintenance services under contracts with terms ranging
from nine to 36 months. Revenues on activated contracts are recognized over the
term of the contract as the Company fulfills its obligation for performance.
Commencing in the fourth quarter of 2004, revenues on contracts that are not
expected to be activated are recognized over the estimated final term for which
the Company may possibly be required to perform. Under this change in accounting
estimate, the Company recognized $405,000 of revenues on contracts for which its
obligation to perform is remote.
Accounts receivable are recognized when billed under the contract terms. Based
on certain pre-negotiated contract terms billings may not coincide with revenue
recognition. Revenues earned but not yet billable are shown as unbilled
receivables until the customer is actually invoiced in accordance with the
contract terms.
An allowance for potentially uncollectible accounts receivable is provided based
on management's assessment of each customer's current financial condition,
general economic and industry conditions and past experience. Accounts
receivable are charged to the allowance when deemed uncollectible.
Inventories: Inventories of materials and component parts, and in-process and
finished goods are stated at the lower of cost (first-in, first-out method) or
market. The Company periodically provides for obsolete and slow-moving
inventories based on historical usage, future requirements and anticipated
demand. The fourth quarter of 2004 includes a provision of $527,000 for
slow-moving inventory. As of December 31, 2004 allowances for obsolete and
slow-moving inventories were $1,764,000 ($1,268,000 as of December 31, 2003).
Service parts held and restricted primarily for customer use under maintenance
contracts are amortized over four years. As such, service parts are stated at
amortized cost which is reviewed periodically for reasonableness.
Equipment and Leasehold Improvements: Equipment and leasehold improvements are
stated on the basis of cost. Depreciation is computed principally using the
straight-line method over the estimated
34
useful lives of the assets, which range from 3 to 10 years. Leasehold
improvements are amortized over the useful life of the improvements or the life
of the lease, whichever is shorter.
Other Assets: Other assets consist primarily of capitalized software development
costs and deferred debt costs. Certain internal and external software
development costs are capitalized in accordance with FASB Statement No. 86,
Accounting for the Costs of Software to be Sold, Leased, or Otherwise Marketed.
These costs are amortized on a straight-line basis over the estimated economic
life of the software. Related amortization is greater than that computed on a
units sold basis. Deferred debt costs are being amortized over the term of the
debt.
Asset Impairment: Goodwill and other long-lived assets are reviewed at least
annually for impairment or whenever facts and circumstances suggest they may be
impaired. There were no impairments for any of the years presented.
Goodwill: Goodwill consists of the excess of cost over the fair value of
identifiable net assets of businesses acquired. Goodwill is carried at cost,
less amortization thereon to January 1, 2002; the carrying amount of goodwill is
not in excess of its estimated recoverable amount.
Fair Value of Financial Instruments: The carrying amounts reported in the
balance sheets for accounts receivable, accounts payable, and accrued expenses
and other liabilities approximate fair value due to the immediate to short-term
maturity of these financial instruments. The fair values of the revolving credit
facility and term loan are determined using current interest rates for similar
instruments, as of December 31, 2004 and 2003 and approximate the carrying value
of these financial instruments.
Shipping Costs: Shipping costs are included in costs of revenue.
Advertising Costs: The Company expenses the production costs of advertising the
first time the advertising takes place. Advertising costs ($171,000 in 2004,
$10,000 2003, and $12,000 in 2002) are included in selling, general and
administrative expenses.
Income Taxes: Deferred income taxes are provided for on differences between the
income tax and the financial reporting bases of assets and liabilities at the
statutory tax rates that will be in effect when the differences are expected to
reverse. A valuation allowance for deferred tax assets is recorded to the extent
the Company cannot determine that the ultimate realization of net deferred tax
assets is more likely than not. In making such determination, the Company may
consider estimated future reversals of existing temporary differences, estimated
future earnings and available tax planning strategies. To the extent that the
estimates of these items are reduced or not realized, the amount of the deferred
tax assets considered realizable could be adversely affected.
35
Stock Based Compensation: The Company generally grants stock options to key
employees and members of the Board of Directors with an exercise price equal to
the fair value of the shares on the date of grant. The Company accounts for
stock option grants in accordance with APB Opinion No. 25, Accounting for Stock
Issued to Employees and, accordingly, recognizes no compensation expense for the
stock option grants. Therefore, the Company has elected the disclosure
provisions only of FASB Statement No. 123, Accounting for Stock-Based
Compensation. Options granted to non-employees are recorded at fair value.
The Company recognized compensation expense of $191,000 in 2004 associated with
options granted to non-employees.
Pro forma information regarding net income (loss) and earnings (loss) per share
determined as if the Company granted stock options under the fair value method
is required by FASB Statement No. 123. The fair value of these options was
estimated at the date of grant using a Black-Scholes option pricing model.
For the purpose of pro-forma disclosures, the estimated fair value of the stock
options at the date of grant was determined using a Black-Scholes option pricing
mode and is expensed ratably over the vesting period of the grant, which is 36
months for key employees and 6 months for nonemployee members of the Board of
Directors. Options for senior management that were granted on December 31, 2001
as part of the previous debt restructuring vested over six months. The Company's
pro-forma information is as follows:
Year Ended December 31
(thousands, except per share amounts) 2004 2003 2002
-------------------------------------------------------------- ---------------- --------------- ----------------
Net income (loss), as reported $ (3,769) $ 986 $ 942
Stock option expense (815) (93) (199)
---------------- --------------- ----------------
Pro forma net income (loss) $ (4,584) $ 893 $ 743
================ =============== ================
Basic earnings (loss) per share, as reported $ (.18) $ .14 $ .13
Stock option expense (.04) (.01) (.03)
---------------- --------------- ----------------
Pro forma basic earnings (loss) per share $ (.22) $ .13 $ .10
================ =============== ================
Diluted earnings (loss) per share, as reported $ (.18) $ .13 $ .13
Stock option expense (.04) (.01) (.03)
---------------- --------------- ----------------
Pro forma diluted earnings (loss) per share $ (.22) $ .12 $ .10
================ =============== ================
The weighted-average fair value price of options granted was $.21, $.27 and $.34
for 2004, 2003, and 2002, respectively.
Option valuation models require the input of highly subjective assumptions
including the expected stock price volatility. The assumptions used in the
valuation model were: expected life-10 years; risk free interest rate of 4%, 3%,
and 7% for 2004, 2003, and 2002, respectively and expected volatility of .786,
1.102, and 1.39 for 2004, 2003, and 2002, respectively.
36
Earnings (Loss) Per Share: The following table sets forth the computation of
basic and diluted earnings (loss) per share:
Year Ended December 31
(thousands, except share data) 2004 2003 2002
----------------------- ---------------------- ----------------------
Numerator:
Net earnings (loss) $ (3,769) $ 986 $ 942
======================= ====================== ======================
Denominator:
Denominator for basic earnings (loss)
per share (weighted-average shares) 20,890,686 7,026,232 7,026,232
Effect of dilutive securities:
Employee stock options 780,259 291,205
----------------------- ---------------------- ----------------------
Denominator for diluted earnings (loss)
per share (adjusted weighted-average
shares and assumed conversions) 20,890,686 7,806,491 7,317,437
======================= ====================== ======================
Basic earnings (loss) per share $ (.18) $ .14 $ .13
======================= ====================== ======================
Diluted earnings (loss) per share $ (.18) $ .13 $ .13
======================= ====================== ======================
New Accounting Pronouncements:
Statement of Financial Accounting Standards (FAS) No. 151, Inventory Costs, an
amendment of ARB No. 43, Chapter 4 requires that abnormal amounts of idle
capacity and spoilage costs should be excluded from the cost of inventories and
expensed when incurred. FAS No. 151 is effective for fiscal periods beginning
after June 15, 2005. The Company does not expect this standard to have a
material effect on its financial statements upon adoption.
FAS No. 123R, Share-Based Payment requires that a public entity measure the cost
of equity based service awards based on the grant-date fair value of the award.
That cost will be recognized over the period during which an employee is
required to provide service in exchange for the award or the vesting period. No
compensation cost is recognized for equity instruments for which employees do
not render the requisite service. A public entity will initially measure the
cost of liability based service awards based on current fair value. The fair
value of those awards will be re-measured subsequently at each reporting date
through the settlement date. Changes in fair value during the requisite period
be recognized as compensation cost over that period. FAS 123R is required for
fiscal periods beginning after June 15, 2005. The Company has not yet attempted
to evaluate the likely effects on its financial statements.
37
NOTE C - UNBILLED RECEIVABLES - CONTRACTS IN PROGRESS
Unbilled amounts in accounts receivable under contracts in progress were $.3
million and $.4 million at December 31, 2004 and 2003, respectively, and are
recoverable from the customer upon completion of the phase or milestone. The
Company estimates that substantially all unbilled amounts will be collected in
2005.
NOTE D - INVENTORIES
The components of inventories were as follows:
December 31
(thousands) 2004 2003
- --------------------------------------------------------------------------------
Finished goods $ 57 $ 57
Work-in-process 644 1,066
Service parts 2,713 3,291
Materials and component parts 4,047 2,868
--------------------------
$ 7,461 $ 7,282
==========================
NOTE E - OTHER ASSETS
The following table summarizes other assets:
December 31,
2004 2003
-------------------------
Software development cost $ 1,120 $ 960
Deferred debt costs 476 -
Cash surrender value of life insurance policy 137 136
-------------------------
1,733 1,096
Accumulated amortization (311) -
-------------------------
$ 1,422 $ 1,096
=========================
The Company capitalized software development costs of $160,000 and $960,000 in
2004 and 2003, respectively. The Company commenced amortizing these costs in
2004 over a five year period. Total amortization of software development costs
was $192,000 in 2004. In connection with the new credit agreement disclosed in
Note F, the Company incurred $1,082,000 of transaction costs of which $476,000
were allocated to debt. These costs were deferred and are being recognized in
expense over the three year term of the credit agreement. Total amortization of
deferred debt costs was $119,000 in 2004.
The estimated aggregate amortization expense for each of the next five
succeeding years follows: 2005 - $384,000, 2006 - $384,000, 2007 - $264,000,
2008 - $225,000, and 2009 - $28,000.
38
NOTE F - CREDIT ARRANGEMENTS
Effective March 30, 2004, the Company entered into a new credit agreement (the
Credit Agreement) with lenders affiliated with Patriarch Partners, LLC. (the
Lenders). Among other things, under the Credit Agreement the Company's existing
revolving and term loans with outstanding amounts of $9.0 million were exchanged
for a $9.0 million term loan, a $2.5 million revolving credit facility and a
$1.5 million term loan working capital facility. The $9.0 million term loan
bears interest at prime plus 2% and is payable in two annual installments of
$90,000 on April 1, 2005 and 2006 with the balance of $8,820,000 due on March
30, 2007.
In the second quarter of 2004, the Company borrowed $1.5 million under the term
loan working capital facility of the Credit Agreement. Such borrowings bear
interest at prime. The Credit Agreement requires the Company to repay the
borrowed amount plus $500,000 at March 30, 2007. The additional $500,000 is
being expensed as interest and accreted to debt over the term of the loan.
As of December 31, 2004, $1 million was outstanding under the $2.5 million
revolving credit facility portion of the Credit Agreement. Outstanding
borrowings bear interest at prime plus 2% and are due March 30, 2007.
As part of the Credit Agreement the Company is required to meet financial
covenants with respect to backlog, capital expenditures and EBITDA. The Company
is in compliance with the modified covenants.
On August 6, 2004, the Company completed a recapitalization with its Lenders,
which had been approved by the Company's shareholders on July 15, 2004. The
recapitalization included, among other terms, the cancellation of the $3.8
million of Mandatorily Redeemable Series B Preferred Stock, including dividends
of $0.6 million and outstanding warrants held by the Lenders, in exchange for
34,425,345 shares of Common Stock. As such, the Lenders own 79.8% of the
fully-diluted Common Stock of the Company at the date of issuance, subject to
dilution for certain current and future compensatory stock options granted by
the Company. Due to the compensatory stock options, 6,470,929 shares are
redeemable if the 2001 executive options are exercised. The Company also issued
an aggregate of 420,857 shares of 4% Series I Preferred Stock with a mandatory
redemption on March 30, 2007 for $841,714 plus unpaid dividends at 4%.
Effective upon the closing of the recapitalization on August 6, 2004, the
maturity date for all of the Company's secured indebtedness to the Lenders was
extended through March 30, 2007.
Borrowings under the Credit Agreement are secured by all of the Company's
assets.
NOTE G - CAPITAL STOCK
An amended and restated certificate of incorporation was approved by the
shareholders at the Company's annual meeting held July 15, 2004. As such, the
total authorized capital stock of the Corporation is 70,000,000 shares
consisting of 65,000,000 shares of Common Stock, par value $.02 per
39
share and 5,000,000 shares of Preferred Stock, par value $.02 per share. As of
December 31, 2004 420,857 shares of Preferred Stock have been designated as
Series I, with dividends at 4%, and are outstanding.
On August 6, 2004, the Company issued 420,857 shares of Series I Preferred Stock
in exchange for cancellation of lease obligations aggregating $842,000 that the
Lenders acquired from the lessor. The Series I Preferred Stock and accrued 4%
annual dividends are redeemable March 30, 2007. As of December 31, 2004 the
carrying value of Preferred Stock is $855,000. Accumulated deferred dividends
were $13,000 as of December 31, 2004.
The recapitalization which was effective August 6, 2004 included, among other
terms, the cancellation of the 380,000 shares of $3.8 million mandatorily
redeemable Series B Redeemable Preferred Stock, par value $.02, the cancellation
of existing warrants exercisable for Common Stock held by the Lenders, and the
issuance of 34,425,345 shares of Common Stock of the Company to the Lenders.
There are 41,451,577 shares issued and outstanding as of December 31, 2004.
There are also 413,500 shares of treasury stock.
At December 31, 2004, the Company had reserved 1,292,983 shares of common stock
for the issuance or exercise of stock options.
40
NOTE H - STOCK OPTION PLANS
The Company has six stock option plans for key employees and board members.
Options granted under the plans are for a period of ten years and at prices not
less than 85% of the fair market value of the shares at date of grant. Options
for employees are not exercisable for one year following the date of grant and
then are exercisable in such installments during the period prior to expiration,
as the Stock Option and Executive Compensation Committee shall determine.
Options for senior management that were granted on December 31, 2001 as part of
the total debt restructuring are not exercisable until six months after the
grant thereof and certain other options granted in 2004 under the senior
executive stock option plan were exercisable in full upon grant of such option.
Options for Directors are also not exercisable until six months after the grant
thereof. Options may be exercised from time to time, in part or as a whole, on a
cumulative basis as determined by the Stock Option and Executive Compensation
Committee under all stock option plans.
The following schedule summarizes the changes in stock options for each of the
three years in the period ended December 31, 2004:
Number of Weighted Option Price
Shares Average Price Per Share
- ----------------------------------------------------------- ---------------------- ----------------- ------------------------------
Outstanding January 1, 2002 (782,261 exercisable) 2,198,083 $ 1.41 $ .24 to $9.19
Granted 30,000 .34 .34 to .34
Canceled (236,800) 1.65 .24 to 9.19
---------------------- ----------------- ------------------------------
Outstanding December 31, 2002 (1,869,142 exercisable) 1,991,283 1.37 .24 to 9.19
2003 Activity
- -------------
Granted 717,500 .29 .28 to .55
Canceled (56,100) 2.67 .31 to 3.88
---------------------- ----------------- ------------------------------
Outstanding December 31, 2003 (1,970,183 exercisable) 2,652,683 1.05 .24 to 9.19
2004 Activity
- -------------
Granted 5,485,929 .25 .25 to .66
Canceled (1,153,608) .90 .24 to 7.50
---------------------- ----------------- ------------------------------
Outstanding December 31, 2004 (6,579,984 exercisable) 6,985,004 $ .45 $ .24 to $9.19
====================== ================= ==============================
The weighted-average price of options exercisable was $.46, $1.31 and $1.43 at
December 31, 2004, 2003, and 2002, respectively. The weighted-average remaining
contractual life of the options outstanding at December 31, 2004 was 9 years.
41
Options Outstanding Options Exercisable
- ------------------------------------------------------------------------- ------------------------------------------------------
Weighted
Average
Remaining Weighted Weighted
Number Contractual Average Number Average
Range of Exercise Prices Outstanding Life (Years) Exercise Price Exercisable Exercise Price
- ---------------------------- ------------------- ------------------- ------------------ ------------------- ----------------------
$ .24 to $ .60 6,540,671 9 $ .25 6,135,651 $ .25
$ .61 to $1.50 122,500 7 .88 122,500 .88
$1.51 to $3.75 246,333 3 3.39 246,333 3.39
$3.76 to $9.19 75,500 2 6.98 75,500 6.98
- ---------------------------- ------------------- ------------------- ------------------ ------------------- ----------------------
6,985,004 6,579,984
=================== ===================
At December 31, 2004 there were 3,470,511 options available for grant of which
261,500 were reserved for the Directors.
NOTE I - RESEARCH AND DEVELOPMENT AGREEMENTS
During 2004, 2003 and 2002, the Company completed a number of small custom
development contracts for specific customers resulting in revenue of
approximately $79,000, $200,000 and $43,000, respectively. These revenues offset
the related costs incurred for this development. The ownership of these
technologies remains with the Company. No royalties or other considerations are
required as part of these agreements.
NOTE J - EMPLOYEE BENEFITS
The Company maintains a Retirement Savings Plan for United States employees.
Under this plan, all employees may contribute up to 15% of their salary to a
retirement account up to the maximum amount allowed by law. Starting in 1997,
the Company contributed an amount equal to 50% of the first 6% contributed by
the participant; in 2001, the employer match was increased to 67% of the first
6%. The Company's contributions to this plan were $378,000, $346,000 and
$346,000, in 2004, 2003 and 2002, respectively. Effective January 15, 2005 the
Company suspended its matching contribution.
The Company sponsors an Employee Stock Ownership Plan (the "Plan") covering
substantially all full-time employees. The Plan, which is a tax qualified
employee benefit plan, was adopted by the Board of Directors of the Company in
1988 to provide retirement benefits for employees. The Plan borrowed $1,325,000
to purchase 260,000 shares of the Company's stock to be allocated to
participants ratably over a ten year period. The ESOP loan was guaranteed by the
Company and the outstanding balance of the loan was repaid in 1991. At December
31, 1998, all shares had been allocated. The Company did
42
not allocate any additional shares to the Plan in 2004, 2003 or 2002. The
Company, at its discretion, may make annual allocations to the Plan in the
future. There were no expenses related to the Plan in 2004, 2003 and 2002.
The Company terminated the Plan effective December 31, 2003; its assets are
expected to be distributed in 2005. There will be no significant financial
impact to the Company.
NOTE K - INCOME TAXES
At December 31, 2004, the Company has U.S. federal and state operating loss
carry forwards of approximately $32,400,000 and $29,900,000 respectively. The
U.S. federal and state net operating loss carry forwards expire from 2005
through 2024. In 2004 the Company's ability for utilization of net operating
loss carry forwards was significantly restricted due to the change in control as
a result of the recapitalization (see Note F for further details). At December
31, 2004, the Company has approximately $3,500,000 and $800,000 of net operating
loss carry forwards for the United Kingdom and Germany, respectively. These loss
carry forwards expire from 2005 through 2014. There are no net operating loss
carry forwards for Canada.
A summary of income (loss) before income taxes follows:
Year Ended December 31
(thousands) 2004 2003 2002
- --------------------------------------------------------------------------------
Domestic $ (3,739) $ 708 $ 811
Foreign 41 136 212
--------------------------------------------
Income (loss) before income taxes $ (3,698) $ 844 $ 1,023
============================================
Income taxes (benefit) follow:
Year Ended December 31
(thousands) 2004 2003 2002
- --------------------------------------------------------------------------------
Current :
State $ 30 $ 40 $ 80
Federal benefit (321)
Foreign 41 139 1
------------------------------------------
Total current 71 (142) 81
Deferred - - -
------------------------------------------
Total $ 71 $ (142) $ 81
==========================================
43
Significant components of deferred income tax assets and (liabilities) follow:
December 31
(thousands) 2004 2003
- -----------------------------------------------------------------------------------------------------------
Deferred income tax assets:
Net operating loss carry forward $ 13,890 $ 12,109
Alternative minimum tax credit carry forward 168 168
Foreign equipment 92 92
Inventories 807 584
Bonus accrual 26
Accounts receivable allowance 81 354
Vacation accrual 202 183
Other 110 109
---------------------------
Total deferred income tax assets 15,350 13,625
Deferred income tax liabilities:
Goodwill (511) (175)
Plant and equipment (215) (151)
---------------------------
Total deferred income tax liabilities (726) (326)
Valuation allowance (14,624) (13,299)
---------------------------
Net deferred income tax $ - $ -
===========================
A reconciliation of income taxes computed using the U.S. statutory rate to the
provision (benefit) for income taxes follows:
Year Ended December 31
2004 2003 2002
- ------------------------------------------------------------- ---------------------- --------------------- ----------------------
Federal income taxes at statutory rate $ (1,271) $ 287 $ 348
State income taxes, net of federal benefit 30 66 80
Foreign income taxes 41 93
Valuation allowance, net of deferred income
tax adjustments 1,271 (382) (348)
Adjustment of tax reserves (206)
Other 1
---------------------- --------------------- ----------------------
Provision (benefit) for income taxes $ 71 $ (142) $ 81
====================== ===================== ======================
The tax reserve decrease in 2003 of $206,000 or $.03 per diluted share is
directly related to the reduction of potential tax exposures associated with
certain state and foreign items.
44
NOTE L - LEASE COMMITMENTS
The Company's principal lease commitment is for its corporate office and
manufacturing facility in Manchester, Connecticut. This lease expires on
December 31, 2006. The Company also has capital leases for office equipment.
Minimum rental payments for these noncancelable leases, with terms of one year
or more as of December 31, 2004, follow:
(thousands) Operating Leases Capital Lease
2005 $ 450 $ 84
2006 448 74
2007 52 67
2008 52
2009 52
Thereafter 208
--------------------------------
Total minimum lease payments $ 1,262 225
Amounts representing interest ======= (35)
---------
Present value of net minimum lease payments $ 190
=========
Rental expense for 2004, 2003, and 2002 was $445,000, $470,000, and $681,000,
respectively.
The cost of assets recorded under capital leases and accumulated depreciation
thereon was $322,000 and $125,000 as of December 31, 2004 ($322,000 and $43,000,
at December 31, 2003). All assets under capital leases are classified as
equipment. Amortization of assets recorded under capital leases is included in
depreciation expense.
Long term capital leases are included in other long term liabilities on the
balance sheet.
NOTE M - CONTINGENCIES
As of December 31, 2004, the Company had settled all outstanding claims and
contingencies pending during 2004 with no significant effect on cash flows or
operating results.
45
NOTE N - SEGMENT INFORMATION
The Company views its business in three distinct operating segments: Solutions
and Products, Access Services and Contract Manufacturing Services. Revenues are
used by management as a guide to determine the effectiveness of the individual
segment. The Company manages its operating expenses through a traditional
functional perspective and accordingly does not report operating expenses on a
segment basis.
Year Ended December 31
(thousands) 2004 2003 2002
- ----------------------------------------------------------------------------------------------------------------------
Revenues
Solutions and products $ 15,886 $ 21,108 $ 16,376
Access services 10,933 10,563 11,499
Contract manufacturing services 1,922 410 1,466
-------------- ----------------- ---------------
Total revenues 28,741 32,081 29,341
Cost of solutions and products 12,528 13,407 10,715
Service expenses 8,980 8,813 8,539
-------------- ----------------- ---------------
Gross profit margin 7,233 9,861 10,087
Operating expenses, net 10,931 9,017 9,064
-------------- ----------------- ---------------
Income (loss) before income taxes $ (3,698) $ 844 $ 1,023
============== ================= ===============
Total assets $ 24,338 $ 26,073 $ 26,406
============== ================= ===============
Total expenditures for additions to long-lived
assets $ 329 $ 173 $ 79
============== ================= ===============
The Solutions and Products Division includes the sale of hardware and software
products as well as professional services. Contract Manufacturing Services
provides assembly and test services under contracts with customers who develop
and sell a variety of equipment.
In 2004 the Company derived 11% of its total revenue from Mitsui & Co Ltd., one
of the Company's distributors in Japan. In 2003, the Company derived 23% of its
total revenue from Northrop Grumman, IT Inc. No other customer accounted for
more than 10% of total revenue for any year presented.
The Company has international distributors located in 13 countries and covering
six continents. All international sales other than sales originating from the UK
and Canadian subsidiaries are denominated in United States dollars. Changes in
the economic climates of foreign markets could have an unfavorable impact on
future international sales.
46
Export sales by geographic area (based on the location of the customer) were as
follows:
Year Ended December 31
(thousands) 2004 2003 2002
- ----------------------------------------------------------------------------------------------------------------------
Latin America $ 82 2% $ 124 12% $ 72 24%
Europe 161 5 0 149 49
Pacific Rim 3,302 93 944 88 81 27
-------------------------------------------------------------------------
$ 3,545 100% $ 1,068 100% $ 302 100%
=========================================================================
Export sales represented 22%, 5%, and 2% of the Solutions and Products Segment
revenues for 2004, 2003, and 2002, respectively. There are no exports sales
derived from the Company's Access Services Segment or Contract Manufacturing
Services Segment.
NOTE O - BILL AND HOLD TRANSACTIONS
Revenues relating to sales of certain equipment (principally optical character
recognition equipment) are recognized upon acceptance, shipment, or installation
depending on the contract specifications. When customers, under the terms of
specific orders or contracts, request that the Company manufacture and invoice
the equipment on a bill and hold basis, the Company recognizes revenue based
upon an acceptance test that is certified by the customer. Revenues recorded
during 2004, 2003, and 2002 included bill and hold transactions of $.1 million,
$2.3 million and $1.3 million, respectively. Accounts receivable included bill
and hold receivables of $.1 million at December 31, 2004. There were no accounts
receivable associated with bill and hold transactions at December 31, 2003.
47
NOTE P - QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
Following is a summary of quarterly results of operations.
(thousands, except per share amounts) March June September December
- -------------------------------------------------------------------------------------------------------------------
2004
- ----
Revenues $ 7,333 $ 6,878 $ 6,187 $ 8,343
Cost of product sales and service expenses 5,816 5,178 4,327 6,187
Net loss (712) (1,619) (663) (775)
Basic earnings (loss) per share (.10) (.23) (.02) (.02)
Diluted earnings (loss) per share (.10) (.23) (.02) (.02)
2003
- ----
Revenues 8,110 8,107 7,365 8,499
Cost of product sales and service expenses 5,527 5,374 5,227 6,092
Net income 196 214 12 564
Basic earnings per share .03 .03 .00 .08
Diluted earnings per share .03 .03 .00 .07
Fourth quarter 2004 net loss of $775,000 includes a provision for slow moving
inventory adjustment of $527,000 or $.01 per share. In addition, the Company
recognized $405,000 or $.01 per share of revenue applicable to a change in
accounting estimate for revenues on maintenance service contracts for which the
Company's obligation to perform is remote.
The second quarter 2004 net loss of $1,619,000 includes a $543,000 provision or
$.07 per share for an account receivable as a result of the settlement of a
legal action.
Fourth quarter 2003 net income of $564,000 includes a tax benefit of $206,000 or
$.03 per share due to a reduction in the tax reserves.
NOTE Q - SUBSEQUENT EVENTS
On March 9, 2005, the Company received from attorneys representing James C.
Mavel, the former Chief Executive Officer and President, a "notice of
termination" pursuant to his Employment Agreement and asserting entitlement to
severance compensation under the agreement. The Company intends to investigate
the assertions promptly and raise all available defenses. While, based on
currently available information, the Company does not believe that Mr. Mavel's
claim to severance compensation is supported by the Employment Agreement or the
facts, should Mr. Mavel's claim be supported, the Company believes that
severance compensation would not exceed $1.3 million.
48
SCAN-OPTICS, INC. AND SUBSIDIARIES
FIVE YEAR SUMMARY OF OPERATIONS
SELECTED FINANCIAL DATA
(thousands, except share data) 2004 2003 2002 2001 2000
- ---------------------------------------------------------- --------------- --------------- ---------------- ---------------
Total Revenues $ 28,741 $ 32,081 $ 29,341 $ 30,740 $ 38,302
================ =============== =============== ================ ===============
Income (loss) before income taxes (3,698) 844 1,023 (6,280) (17,709)
Income taxes (benefit) 71 (142) 81 33 61
---------------- --------------- --------------- ---------------- ---------------
Net Income (Loss) $ (3,769) $ 986 $ 942 $ (6,313) $ (17,770)
================ =============== =============== ================ ===============
Basic earnings (loss) per share $ (.18) $ .14 $ .13 $ (.90) $ (2.53)
================ =============== =============== ================ ===============
Basic weighted-average shares 20,890,686 7,026,232 7,026,232 7,026,232 7,025,064
================ =============== =============== ================ ===============
Diluted earnings (loss) per share $ (.18) $ .13 $ .13 $ (.90) $ (2.53)
================ =============== =============== ================ ===============
Diluted weighted-average shares 20,890,686 7,806,491 7,317,437 7,026,232 7,025,064
================ =============== =============== ================ ===============
SELECTED BALANCE SHEET DATA
Total assets $ 24,338 $ 26,073 $ 26,406 $ 27,380 $ 36,513
Working capital (deficit) 2,912 4,957 5,394 4,184 (9,833)
Long term obligations 11,142 9,379 10,428 11,397
Mandatory redeemable preferred stock 855 4,286 4,054 3,800
Total stockholder's equity 2,314 2,443 1,383 360 4,307
The Company has not paid any dividends for the five-year period ended December
31, 2004.
The above financial data should be read in conjunction with the related
consolidated financial statements and notes thereto.
Certain amounts have been reclassified to conform to the current year
presentation.
13
MANAGEMENT'S DISCUSSION AND ANALYSIS OF CONSOLIDATED FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Forward Looking Information
Certain statements contained in this Annual Report on Form 10-K may contain
forward-looking statements within the meaning of Section 27A of the Securities
Act of 1933 and Section 21E of the Securities and Exchange Act of 1934 and as
such may involve known or unknown risks, uncertainties and other factors which
may cause the Company's actual results, performance or achievements to be
materially different from future results, performance or achievements expressed
or implied by such forward-looking statements. Forward-looking statements, which
are based on certain assumptions and describe the Company's future plans,
strategies and expectations are generally identifiable by use of the words
"may," "will," "should," "expect," "anticipate," "estimate," "believe," "intend"
or "project" or the negative thereof or other variations thereon or comparable
terminology. Factors which could have a material adverse effect on the
operations and future prospects of the Company include, but are not limited to
those set forth below. These risks and uncertainties should be considered in
evaluating any forward-looking statements contained or incorporated by reference
herein.
The following list is not intended to be an exhaustive list of all the risks to
which the Company's business is subject, but only to highlight certain
substantial risks faced by the Company. Although the Company completed a debt
restructuring effective March 30, 2004 (see "Liquidity and Capital Resources"
for further information), the Company remains highly leveraged and could be
adversely affected by a significant increase in interest rates. A one percent
increase in the prime rate would increase the annual interest cost on the
outstanding loan balance at December 31, 2004 of approximately $11.6 million by
$.1 million. The Company completed a recapitalization on August 6, 2004 (see
"-Liquidity and Capital Resources" and Note F to the Company's Consolidated
Financial Statements for further details), and as a result the Company's lenders
have acquired a significant voting control and accordingly have the right and
the ability to influence the way in which the Company does business, including
its strategy and tactics. The Company's business could be adversely affected by
downturns in the domestic and international economy. The Company's international
sales and operations are subject to various international business risks. The
Company's revenues depend in part on contracts with various state or federal
governmental agencies, and could be adversely affected by patterns in government
spending. The Company faces competition from many sources, and its products and
services may be replaced by alternative technologies. Further, the Company's
business could be adversely affected by technological changes.
Overview
The Company reported net loss for the year of $3.8 million or $.18 per share,
compared to a net income of $1 million, or $.13 per diluted share, for 2003. The
Company's ability to effectively address these issues will have a direct impact
on its operating results, its ability to generate sufficient cash to fund
operations and its ability to comply with existing debt covenants. The Company's
operating results for 2004 were significantly adversely affected compared to
2003 by certain non-recurring and transitional events, including the settlement
of outstanding litigation, the phasing out of the sale of the Company's mature
line of 9000 Series scanners, the phased market introduction of varied models of
the Company's new generation of SO Series scanners, and the development of new
channels of distribution for the Company's hardware and software. During 2004
the Company executed a financial restructuring and recapitalization that was
approved at the annual meeting on July 15, 2004. See "Liquidity and Capital
Resources" and Note F to the Company's Consolidated financial statements under
14
Item 8 of this Form 10-K. The Company continued its investment in research and
development for a new image scanning platform in 2004 and introduced the first
product in the SO series family during the AIIM trade show in March 2004. The SO
product earned "Best in Show Award" for high-end image scanners. This success
was followed by the installation of the in-line OCR version in the fourth
quarter of 2004. This image scanner family was designed to satisfy the
requirement of our very sophisticated customer base but is also scalable to
provide excellent price performance in the competitive market space.
The Company has three major initiatives currently underway to develop sources of
revenue growth and profitability. The first is to capitalize on the SO series
investment and generate significant sales revenues in the high-end image scanner
market both domestically and internationally. In 2004 the Company introduced its
entry into the Business Process Outsourcing marketplace with initial contracts
in state tax processing, warranty registration forms processing, knowledge
management and business continuation services. The Company is also focused on
the assessment market with "solution" content. Currently on hold is activity to
add long term value through the acquisition of key strategic services or
enterprises. The inability of the Company to carry out these initiatives could
have a material adverse effect on revenue growth and earnings.
The first initiative is to provide cost effective solutions through the
Company's development of its high-speed image transports. The Company has
expanded its target market approach to include value-added resellers and
distributors. It has also expanded its market coverage to include International
distributors in Japan and other countries.
The second initiative is Business Process Outsourcing ("BPO") Services that
offer the market access to the Company's technology and systems on a transaction
basis. The Company's' BPO Services provide a low-risk, cost-effective solution
for customers with requirements for document conversion services, business
continuation services, knowledge management or business process outsourcing. The
BPO services offer customers a high quality, ISO9001 2000 certified, turnkey
outsourcing solution utilizing the Company's proprietary hardware technology,
and further leveraging software skills, resources and process controls.
The third initiative is the solution focus in the assessment market. Fueled by
the No Child Left Behind law, Scan-Optics has experienced significant success in
this market adding significant value with our proprietary software solutions and
high performance image and optical mark read (OMR) scanners.
The Access Services Division continues to provide critical support capability to
customers as well as other third parties where they provide services. Through
the division's 120 technical service representatives, including employees and
contractors, strategically located throughout the US, the Company believes that
it can provide high quality, cost effective maintenance to its existing customer
base as well as new accounts.
While the Company is principally focused on achieving consistent profitability
with its existing operations, the Company may consider acquiring key strategic
products or enterprises. Acquisitions will be considered based upon their
individual merit and benefit to the Company.
15
RESULTS OF OPERATIONS - 2004 VS. 2003
Total revenues decreased $3.3 million or 10% from 2003 to 2004.
Hardware and software revenue decreased $4.2 million or 26% from the prior year.
North American sales decreased $3.2 million or 28%. Total international sales
increased to $3.5 million in 2004 compared to $1.1 million in 2003.
International sales in the Pacific Rim increased to $3.3 million due to
significant scanner systems orders and spare parts sold to the Company's
distributor in Japan. Sales to Europe and Latin American increased to $.2
million in 2004 compared to $.1 million in the prior year. The Company has
phased out the sale and production of its mature line of 9000 Series scanners,
while introducing to the market, in phases, varied models of the Company's new
generation of SO Series scanners and developing new channels of distribution for
the Company's hardware and software, which concurrent activities accounted for a
majority of the decreased hardware and software revenue.
Professional services revenue increased to $5.9 million ($.5 million or 8% from
2003 to 2004) mainly due increased solution sales to the Company's target
customer base.
Access services revenue increased to $10.9 million ($.4 million or 4% from 2003
to 2004). Commencing in the fourth quarter of 2004, revenues on contracts that
are not expected to be activated are recognized over the estimated final term
for which the Company may possibly be required to perform. Under this change in
accounting estimate, the Company recognized $.4 million revenues on contracts
for which its obligation to perform is remote. Other increases in revenue from
the Company's third party maintenance business were offset by a decline in
proprietary maintenance contracts.
Cost of hardware and software revenue gross margin for 2004 was 19% compared to
33% for 2003 and reflects the start up phase of the new SO Series scanners. The
gross margin in 2004 included a provision of $.5 million for slow-moving
inventory.
Cost of professional services revenue gross margin in 2004 was 52%, as compared
to 50% in 2003. The change was mainly due to increased sales volume which
results in higher utilization rates for available resources.
Cost of Access services revenue gross margin was 18% in 2004 compared to 17% in
2003 reflecting higher sales volume and a relatively fixed cost structure. Gross
margin in 2004 was effected by a $.3 million provision for slow-moving inventory
related to the United Kingdom.
Sales and marketing expenses decreased $.1 million or 4% from 2003, principally
due to lower salary and commission expenses partially offset by increased
advertising expense.
Research and development expenses increased $.7 million or 54% from 2003 mainly
due to higher salary and external consulting costs in 2004. These costs were
lower in 2003 due to the capitalization of certain software development costs.
General and administrative expense increased $1.2 million or 34% from 2003. The
increase reflects a $.5 million provision for accounts receivable as a result of
the settlement of a legal action. The remaining portion of the increase is
16
mainly due to increased legal fees of $.2 million, stock option expense of $.2
million, health insurance claims expense of $.2 million and other expenses.
Interest expense of $.9 million remained consistent with 2003. The weighted
average interest rate was 7.3% in 2004 compared to 4.8% in 2003. The increase in
the weighted average interest rate is due to accretion on the $1.5 million term
loan working capital facility for which the Company is obligated to repay $2
million at maturity.
Other income decreased $.1 million from 2003. In 2003, the Company recognized as
other income on $.1 million for previously recorded liabilities that were no
longer due or had been settled for amounts less than that previously recorded.
Income tax expense increased $.2 million from 2003 mainly for state income and
foreign taxes.
RESULTS OF OPERATIONS - 2003 VS. 2002
The 2002 consolidated financial statements have been restated to reflect a
change in the application of generally accepted accounting principles relating
to the adjustment of certain liabilities. The Company identified certain
liabilities relating to services and transactions dating back to 2002 and 2001.
In 2003, the Company determined the amounts were no longer valid obligations of
the Company. Further, it was determined that payment of the obligation or
resolution of the circumstances originally creating the liability occurred in
2002. As a result, the liabilities should have been removed from the Company's
books in 2002. The net impact of this change increased 2002 net income and
earnings per share by $111,000 and $.02, respectively, representing a reduction
of payables offset by required additional bonuses. The effect of income taxes
was determined immaterial.
Total revenues increased $2.7 million or 9% from 2002 to 2003.
Hardware and software revenue increased $4.8 million or 42% from the prior year.
North American sales increased $4.2 million or 38% due mainly to the replacement
or upgrade of existing Series 9000 systems at current customer sites. The
Company does not expect the replacement revenue to continue at the same level as
2003. Total international sales increased $.6 million or 189% from 2002.
International sales in the Pacific Rim increased 849% or $.7 million due to
spare parts orders and a scanner system sold to the Company's distributor in
Japan. Sales to Europe and Latin American decreased $.1 million from the prior
year.
Professional services revenue decreased $1.1 million or 16% from 2002 to 2003
mainly due to the decrease in the service revenue component of certain hardware
systems installations and difficulties in the current U.S. economy.
Access services revenue decreased $.9 million or 8% from 2002 to 2003 due mainly
to a decrease in revenue from the Company's proprietary maintenance contracts as
a result of lower maintenance rates for the latest generation of the Series 9000
scanner, the 9000M, as compared to the earlier Series 9000 scanner. The Company
was also impacted by a few customers discontinuing maintenance due to changes in
their business or the use of other technologies.
17
Cost of hardware and software revenue increased $2.9 million or 37% from 2002.
The increase in cost is mainly due to an increase in hardware and software sales
volume. In 2003, the Company recorded approximately twice the number of Series
9000 scanners sales as compared to 2002, which accounted for more revenue and
therefore increased manufacturing costs. Cost of hardware and software revenue
as a percentage of revenue was 67% in 2003, as compared to 69% in 2002.
Cost of professional services revenue decreased $.2 million or 6% in 2003
compared to the prior year mainly due to decreases in salaries and travel
expenses. Cost of professional services revenue as a percentage of revenue was
50% in 2003, as compared to 44% in 2002, due mainly to a decline in new
solutions sales, as well as fixed costs that exist to support a higher volume of
business.
Cost of Access services revenue increased $.3 million or 3% from 2002 to 2003.
The increase is principally due to an increase in UK operating expenses. Cost of
Access services revenue as a percentage of revenue was 83% in 2003, as compared
to 74% in 2002, traceable to lower revenues in 2003 and a relatively fixed cost
structure.
Sales and marketing expenses increased $.2 million or 6% from 2002, principally
due to an increased use of outside services related to the Company's new website
as well as increases in consulting services related to an effort to expand into
the federal government market, and increased trade show activity.
Research and development expenses decreased $.5 million or 30% from 2002 mainly
due to the capitalization of certain software development costs.
General and administrative expenses remained consistent with the prior year. A
reduction in legal expenses of $.2 million and $.1 million of bad debt recovery
was offset by increased salary expense of $.2 million and increased group
insurance expense of $.1 million.
Interest expense of $.8 million remained consistent with 2002. The weighted
average interest rate was 4.8% in 2003 compared to 5.5% in 2002.
Other income decreased $.3 million from 2002 mainly due to a reduction in 2002
of $.4 million for certain amounts previously recorded as liabilities that were
no longer due or have been settled for amounts less than previously recorded.
Income tax benefit increased $.2 million from 2002 mainly due to the reduction
of potential tax exposures associated with certain state and foreign exposure
items.
18
LIQUIDITY AND CAPITAL RESOURCES
Cash and cash equivalents at December 31, 2004 of $.5 million decreased $0.1
million from December 31, 2003.
Outstanding borrowings increased $3.6 million to $11.6 million at December 31,
2004 from $8.0 million at the end of 2003. The available balance on the line of
credit was $1.5 million at December 31, 2004. As of December 31, 2004, the
Company is in compliance with all financial covenants. The Company anticipates
meeting its current obligations and other resource needs in 2005 with funds
generated through operations and its available line of credit. However,
Underachieved operating results could adversely effect the Company's ability to
remain in compliance.
On August 6, 2004, the Company completed a recapitalization with its lenders,
Patriarch Partners LLC, (the Lenders) after obtaining stockholder approval at
the Company's July 15, 2004 annual meeting. The recapitalization included, among
other terms, the cancellation of $3.8 million of mandatorily redeemable Series B
preferred stock, including accrued dividends, and warrants for 33.2% of the
Company's outstanding common stock on a fully-diluted basis, both held by the
Lenders, in exchange for the issuance of 34,425,345 shares of common stock of
the Company (or 79.8% of the Company's outstanding common stock on a
fully-diluted basis, subject to dilution for certain compensatory stock options
granted by the Company) to the Lenders. In addition:
* The Company's secured term and revolving debt was exchanged for a
$9.0 million term loan and a $2.5 million revolving loan. The new term loan is
payable in annual amounts of $90,000 beginning April 1, 2005 with the balance
due at maturity. Borrowings accrue interest at a rate of prime plus 2%.
* An additional $1.5 million term loan working capital facility was
made available to the Company, with the Company obligated to repay $2 million at
maturity. (Interest is being accreted such that the carrying amount of this loan
at maturity will be $2 million.) This loan accrues interest at the prime rate.
* The Company's financial covenants with respect to backlog, capital
expenditure and EBITDA were modified.
* Effective upon the closing of the recapitalization on August 6,
2004, the maturity date for all of the Company's secured indebtedness to the
Lenders was extended through March 30, 2007.
The Company believes that the 2004 loan restructuring will allow execution of
the Company's business plan through the term of the credit agreement by reducing
required short-term payments under the borrowing arrangements with the Lenders
and increasing available funds through the working capital term loan facility,
thereby enhancing the Company's ability to invest in its business, by lowering
the thresholds of the financial covenants and by extending loan maturities
through March 2007.
19
The Company's significant contractual obligations and commitments that impact
its liquidity as of December 31, 2004 follow:
Contractual Obligations Payments Due by Period
- -----------------------------------------------------------------------------------------------------
Less
than 1 1 - 3 4 - 5 After 5
(thousands) Total year years years years
- ------------------------------------------------ ------------ ------------- ------------ ------------
Notes payable $ 11,605 $ 1,000 $ 10,605
Redeemable preferred stock 855 855
Executive insurance agreement 359 50 100 $ 100 $ 109
Capital leases 225 84 141
Operating leases 1,262 450 552 104 156
-------------- ------------ ------------- ------------ ------------
Total contractual
cash obligations $ 14,306 $ 1,584 $ 12,253 $ 204 $ 265
============== ============ ============= ============ ============
Operating activities used $2.2 million of cash in 2004 compared to providing
$3.0 million in 2003. Non-cash expenses in 2004 were $4.2 million compared to
$2.6 million in 2003. The non-cash items relate to depreciation, amortization of
customer service inventory and software license, and provisions for losses on
accounts receivable and slow-moving inventory. These and other components of
operating activities are discussed below.
Net accounts receivable and unbilled receivables decreased $1.8 million from
December 31, 2003 due principally to lower sales in the second half of 2004,
$14.5 million, as compared to the second half of 2003, $15.8 million and
provision for losses on accounts receivable of $.6 million.
Total inventories increased $.2 million from 2003 levels. Manufacturing
inventories increased $.8 million during the year due to an increase in
materials and component parts of $1.2 million and a decrease in work-in-process
inventory of $.4 million. Finished goods inventory remained consistent with
prior year levels. The increase in materials and component parts is mainly due
to the ongoing production schedule for the SO Series scanner in first quarter of
2005 as compared to the initial product launch schedule of the SO Series scanner
in early 2004. Customer service inventory decreased for the year by $.6 million,
which was mainly attributable to the amortization of spare parts.
Net plant and equipment decreased $.1 million in 2004. This net decrease is due
to depreciation of $.4 million, partially offset by additions of $.3 million. No
significant additions are planned for 2005.
Accounts payable increased $.5 million over December 31, 2003 relating to the
timing of payments.
Notes payable to bank increased $3.6 million as a result of borrowing against
the Company's available line of credit to fund increased production schedules
for the SO Series scanner and general corporate needs. Salaries and wages
decreased $.8 million from 2003 mainly due to the absence of a bonus accrual at
December 31, 2004.
Deferred revenue increased $.6 million as a result of the increase in annual and
quarterly maintenance billings that are subsequently recognized in revenue over
the maintenance period covered by the billing.
20
Customer deposits decreased $.8 million due mainly to large orders in 2003 that
contained deposit requirements as part of the contract which were not replicated
in the fourth quarter of 2004.
Other current liabilities decreased $.3 million due mainly to a $.3 million
decrease in various accrued expenses.
Other long term liabilities decreased $.9 million mainly due to the conversion
of operating leases totaling $.8 million into preferred stock as part of the
debt restructuring effective August 6, 2004.
Appendix 2
Scan-Optics, Inc. financial statements and Management's Discussion and Analysis
from the Scan-Optics Form 10-Q for the quarter and six months ended June 30,
2005.
FINANCIAL INFORMATION
1. Consolidated Financial Statements.
SCAN-OPTICS, INC., AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
(thousands, except share data) June 30, December 31, Pro Forma June
2005 2004 30, 2005
- -----------------------------------------------------------------------------------------------
Assets
Current Assets:
Cash and cash equivalents $ 1,698 $ 477 $ 0
Accounts receivable less allowance of $131 at
June 30, 2005 and $238 at December 31, 2004 2,854 4,314 0
Unbilled receivables - contracts in progress 289 298 0
Inventories 7,714 7,461 0
Prepaid expenses and other 880 389 0
--------------------------------------
Total current assets 13,435 12,939 0
Equipment and Leasehold Improvements:
Equipment 3,452 3,386 0
Leasehold improvements 4,090 4,089 0
Office furniture and fixtures 544 557 0
--------------------------------------
8,086 8,032 0
Less allowances for depreciation and amortization 7,319 7,095 0
--------------------------------------
767 937 0
Goodwill 0 9,040 0
Other assets 951 1,422 0
--------------------------------------
Total Assets $15,153 $24,338 $ 0
======================================
Pro Forma June
(thousands, except share data) June 30, 2005 December 31, 2004 30, 2005
- ------------------------------------------------------------------------------------------------------------------------------------
Liabilities and Stockholders' Equity (Deficit)
Current liabilities:
Notes payable to related party including long term
debt in default of $10,910 $ 14,310 $ 1,000 $ 0
Accounts payable 2,819 2,822 192
Salaries and wages 706 702 0
Taxes other than income taxes 498 641 483
Income taxes 44 68 59
Customer deposits 135 143 0
Deferred revenues 3,787 3,408 0
Other 1,119 1,243 689
---------------------------------------------------------------
Total current liabilities 23,418 10,027 1,423
Notes payable to related party 10,605 0
Other liabilities 532 537 358
Mandatory redeemable preferred stock, at redemption value:
Series I, 420,857 shares issued and outstanding 872 855 872
---------------------------------------------------------------
Total Liabilities 24,822 22,024 2,653
Stockholders' Equity (Deficit)
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 837 837 837
Capital in excess of par value 41,651 41,651 44,160
Accumulated retained-earnings deficit (48,363) (36,339) (45,004)
Accumulated other comprehensive
loss-currency
Translation (1,148) (1,189) 0
---------------------------------------------------------------
(7,023) 4,960 (7)
Cost of common stock in treasury,
413,500 shares (2,646) (2,646) (2,646)
---------------------------------------------------------------
Total stockholders' equity (deficit) (9,669) 2,314 (2,653)
---------------------------------------------------------------
Total Liabilities and Stockholders' Equity (Deficit) $ 15,153 $ 24,338 $ 0
===============================================================
See accompanying notes.
SCAN-OPTICS, INC., AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
Three Months Ended Six Months Ended
June 30 June 30
(thousands, except share data) 2005 2004 2005 2004
- -----------------------------------------------------------------------------------------------------------------------------------
Revenues
Hardware and software $ 1,240 $ 2,549 $ 3,981 $ 5,976
Professional services 1,565 1,497 2,900 3,007
Access services 2,999 2,832 5,699 5,228
-------------------------------------- ------------------------------------
Total revenues 5,804 6,878 12,580 14,211
Costs of Revenue
Hardware and software 1,631 1,914 3,957 4,519
Professional services 989 759 1,783 1,638
Access services 2,315 2,505 4,566 4,837
-------------------------------------- ------------------------------------
Total costs of revenue 4,935 5,178 10,306 10,994
-----------------------------------------------------------------------------
Gross Profit 869 1,700 2,274 3,217
Operating Expenses
Sales and marketing 628 802 1,333 1,492
Research and development 489 629 886 1,180
General and administrative 1,355 1,665 2,172 2,498
Goodwill impairment 9,040 0 9,040 0
Interest
Related party 615 0 871 0
Other 191 358
-------------------------------------- ------------------------------------
Total operating expenses 12,127 3,287 14,302 5,528
-------------------------------------- ------------------------------------
Operating loss (11,258) (1,587) (12,028) (2,311)
Other income, net 4 (2) 10 30
-------------------------------------- ------------------------------------
Loss before income taxes (11,254) (1,589) (12,018) (2,281)
Income taxes 0 30 6 50
-------------------------------------- ------------------------------------
Net Loss $ (11,254) $ (1,619) $ (12,024) $ (2,331)
====================================== ====================================
Basic and diluted loss per share $ (0.27) $ (0.23) $ (0.29) $ (0.33)
====================================== ====================================
Basic and diluted weighted-average common shares 41,451,577 7,026,232 41,451,577 7,026,232
====================================== ====================================
See accompanying notes.
SCAN-OPTICS, INC., AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
Six Months Ended
June 30
(thousands) 2005 2004
- ----------------------------------------------------------------------------------------------------------------------------
Operating Activities
Net loss $ (12,024) $ (2,331)
Adjustments to reconcile net loss
to net cash used by operating activities:
Depreciation and amortization of equipment and leasehold
Improvements 224 150
Amortization of customer service inventory and
development costs 835 1,092
Amortization of deferred debt costs 357 0
Accretion of interest on related party debt 408 0
Accretion of interest on preferred stock 17 0
Goodwill impairment 9,040 0
Provision for losses on accounts receivable 25 0
Provision for inventory obsolescence 50 0
Changes in operating assets and liabilities:
Accounts receivable 1,444 636
Inventories (1,026) (1,096)
Prepaid expenses and other (491) (534)
Accounts payable (3) 520
Accrued salaries and wages 4 (832)
Taxes other than income taxes (143) (81)
Income taxes (24) (88)
Deferred revenues 379 900
Customer deposits (8) (309)
Other (86) (106)
-----------------------------------------------
Net cash used by operating activities (1,022) (2,079)
Investing Activities
Purchases of equipment (54) (101)
------------------------------------------------
Net cash used by investing activities (54) (101)
Financing Activities
Proceeds from borrowings - all from a related party in 2005 3,337 4,711
Principal payments on borrowings - all from a related party in
2005 (1,040) (2,200)
------------------------------------------------
Net cash provided by financing activities 2,297 2,511
Change in cash and cash equivalents 1,221 331
Cash and Cash Equivalents at Beginning of Period 477 585
-----------------------------------------------
Cash and Cash Equivalents at End of Period $ 1,698 $ 916
===============================================
See accompanying notes.
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.
The pro forma balance sheet gives effect to the foreclosure described in Note 2
as if it had occurred as of June 30, 2005.
NOTE 2 - Foreclosure and Cessation of Business
During the quarter ended June 30, 2005, the Company violated certain covenants
of its credit agreement (the Credit Agreement) with lenders affiliated with
Patriarch Partners, LLC (collectively, the Lenders). The Lenders own about 80%
of the Company's capital stock and all of its redeemable preferred stock.
As a result of the covenant violations, on August 5, 2005, the Company entered
into a Foreclosure Agreement with the Lenders. As such, the Company has
classified all amounts due under the Credit Agreement as current as of June 30,
2005. Further, the Company wrote-off remaining unamortized deferred debt costs
and accelerated accretion interest on debt.
Under the Foreclosure Agreement the Company transferred substantially all of its
assets to the Lenders to extinguish its obligations under the Credit Agreement
(The outstanding principal under the Credit Agreement at the time of closing of
the Foreclosure Agreement was $14,310,000). Further, the Company retained
certain limited assets and the Lenders assume certain liabilities of the
Company, including but not limited to, certain accrued obligations with respect
to current employees and certain trade payables and accrued expenses. None of
the assets retained by the Company can be liquidated for cash. The lenders also
assumed certain employee benefit plans of the Company and certain of its
insurance policies. Under the Foreclosure Agreement, the Company was permitted
to obtain extended directors and officers insurance, and the lender agreed to
assume or fund the defense of actions brought against the Company after the
closing. At the closing the Company terminated all of its employees as of that
time.
Under the Foreclosure Agreement the lender agreed to fund certain expenses of
the Company in its winding-down of its business, but the Company has no cash or
other sources of liquidity and if the funds provided for in the wind-down budget
are not used for the purposes specified in the budget, the Company is not
entitled to receive any differential cash. The pro forma balance sheet as of
June 30, 2005 gives effect to the Foreclosure Agreement as if the related
transaction had occurred as of that date.
Following the closing of the Foreclosure Agreement, the Company ceased doing
business and is expected to be dissolved in accordance with the applicable
provisions of the Delaware General Corporation Law. Following the closing of the
Foreclosure Agreement, the Company's sole remaining executive officer is Scott
Schooley who serves as President and Secretary of the Company. Following the
closing of the Foreclosure Agreement, board of directors also voted to dissolve
the Company, subject to requisite stockholder approval and compliance with the
related SEC regulations. Because none of the assets retained by the Company can
be liquidated for cash, there will be no residual value left to the holders of
common stock of the Company following the closing of the Foreclosure Agreement
and any winding-down of the Company's affairs.
As of June 30, 2005, $3.4 million was outstanding under the revolving credit
facility portion and $8.9 million was outstanding on the term loan portion of
the Credit Agreement. Outstanding borrowings for the revolver and term loan bear
interest at prime plus 2%. There is also $2.0 million under the term loan
working capital facility portion of the Credit Agreement, including $500,000 of
accretion. Such borrowings bear interest at prime.
The Company's deteriorating financial condition resulted in the covenant
violations referred to above. As such, the Company evaluated goodwill for
impairment in connection with preparing the accompanying financial statements.
Management considered goodwill impairment and recognized an impairment loss of
$9,040,000 for the quarter ended June 30, 2005.
NOTE 3 - 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.
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 For the six months ended
June 30 June 30
(thousands, except per share amounts) 2005 2004 2005 2004
- ------------------------------------------------------------------------------------------------------------------------
Net loss, as reported $ (11,303) $ (1,619) $(12,073) (2,331)
Stock option expense (8) (17) (17) (32)
Pro forma net loss $ (11,311) $ (1,636) $(12,090) $(2,363)
============================================================
Basic and diluted loss per share, as reported $ (.27) $(.23) $ (.29) $ (.33)
Stock option expense .00 .00 .00 .00
--------------------------------------------------------
Pro forma basic and diluted loss per share $ (.27) $(.23) $(.29) $ (.33)
============================================================
NOTE 4 - Inventories
The components of inventories were as follows:
June 30 December 31
(thousands) 2005 2004
- -------------------------------------------------------------------
Finished goods $ 58 $ 57
Work-in-process 775 644
Service parts 2,701 2,713
Materials and component parts 4,180 4,047
-----------------------------
$7,714 $7,461
=============================
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 a prior change in
control.
NOTE 6 - Comprehensive Income
The components of comprehensive loss follow:
Three Months Ended Six Months Ended
June 30 June 30
(thousands) 2005 2004 2005 2004
- -------------------------------------------------------------------------------------------------------------------
Net loss $ (11,303) $ (1,619) $ (12,073) $ (2,331)
Foreign currency translation adjustments 34 (113) 41 (100)
---------------------------------------------------------------
Comprehensive loss $ (11,269) $ (1,732) $ (12,032) $ (2,431)
===============================================================
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 Six Months Ended
June 30 June 30
(thousands) 2005 2004 2005 2004
- -------------------------------------------------------------------------------------------------------------------
Revenues
Solutions and products $ 1,978 $ 3,703 $ 5,193 $ 8,530
Access services 2,999 2,832 5,699 5,228
Contract manufacturing services 827 343 1,688 453
---------------------------------------------------------------
Total revenues 5,804 6,878 12,580 14,211
Cost of solutions and products 2,620 2,673 5,740 6,157
Service expenses 2,315 2,505 4,566 4,837
---------------------------------------------------------------
Gross margin 869 1,700 2,274 3,217
Operating expenses
and other expenses, net 12,123 3,289 14,292 5,498
---------------------------------------------------------------
Loss before income taxes $ (11,254) $ (1,589) $ (12,018) $ (2,281)
================================================================
NOTE 8 - 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. On or about August 3, 2005 the
Company was notified that Mr. Mavel had filed a demand for arbitration with the
American Arbitration Association, but the Company did not receive a copy of the
demand until on or about August 9, 2005. The demand, among other things claims
that Mr. Mavel is entitled to $2.5 million from the Company. Although the
Company does not believe that Mr. Mavel's claim to severance compensation or the
amount claimed is supported by the Employment Agreement or the facts, should Mr.
Mavel's claim be supported, any material award of severance compensation to Mr.
Mavel would have a material adverse effect on the financial condition of the
Company following the closing of the Foreclosure Agreement with its secured
lender on August 5, 2005.
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.
Foreclosure and Cessation of Business
The Company entered into a foreclosure agreement on August 5, 2005 pursuant to
which it transferred substantially all of its assets to its secured lender and
ceased operations (see "-Liquidity and Capital Resources" below and Note 2 to
the Company's Consolidated Financial Statements for further details).
Results of Operations for the Three and Six Months Ended June 30, 2005 vs. 2004
Total revenues decreased $1.6 million or 11% from the first six months of 2004
to the first six months of 2005 and decreased $1.1 million or 16% from the
second quarter of 2004 to the second quarter of 2005.
Hardware and software revenues decreased $2.0 million or 33% in the first six
months of 2005 compared with the same period in 2004 and decreased $1.3 million
or 51% in the second quarter of 2005 compared to 2004. Compared to the first six
months of 2004, North American sales decreased $1.3 million or 56% and decreased
$.6 million or 16% during the second quarter of 2005 compared to the second
quarter of 2004. International sales decreased $1.4 million during the first six
months of 2005 as compared with the first six months of 2004 and remained
consistent with the second quarter of 2005 compared to 2004. The decrease in
revenue is mainly due to the phased out sale and production of its mature line
of 9000 Series scanners in 2004 and the Company launching the new generation of
SO Series scanners which
has had slower than anticipated establishment of new distribution channels and
delayed market acceptance.
Professional services revenues decreased $0.1 million or 4% in the first six
months of 2005 compared with the first six months of 2004 and increased $0.1
million or 5% during the second quarter of 2005 compared to the second quarter
of 2004.
Access services revenues decreased $0.5 million or 9% in the first six months of
2005 compared with the first six months of 2004 and decreased $0.2 million or 6%
during the second quarter of 2005 compared to the second quarter of 2004. The
Company was impacted by a few customers discontinuing maintenance contracts due
to changes in their businesses or replacement of lower cost SO Series replacing
the 9000 Series.
Cost of hardware and software margin for the first six months of 2005 was 1%
compared to 24% for the first six months of 2004. The gross margin was a
negative 32% during the second quarter of 2005, compared to a positive margin of
25% in the second quarter of the prior year. The decreases in gross margin are
mainly due to the composition of the sales mix and increased production costs.
Cost of professional services gross margin for the first six months of 2005 was
39% compared to 46% for the same period in 2004. The gross margin for the second
quarter of 2005 was 37% as compared to 49% in the second quarter of 2004. The
decrease in gross margin was mainly due to decreased solution sales.
Cost of Access Services gross margin for the first six months of 2005 was 20%
compared to 7% for the same period in 2004. The gross margin for the second
quarter of 2005 was 23% as compared to 12% in the second quarter of 2004. The
increase in gross margin during the first six months of 2005 as compared to 2004
is due to recording a $.3 million inventory provision related to operations in
the United Kingdom in 2004.
Sales and marketing expenses decreased $.2 million or 11% in the first six
months of 2005 compared to the first six months of 2004 and decreased $.2
million or 22% in the second quarter of 2005 compared to the second quarter of
2004 mainly due to lower salary and benefit costs and outside consulting
services.
Research and development expenses decreased $.3 million or 25% in the first six
months of 2005 compared to the first six months of 2004 and decreased $.1
million or 22% in the second quarter of 2005 compared to the second quarter of
2004. The decrease is mainly due to lower external consulting costs related to
the SO series scanner.
General and administrative expenses decreased $.3 million or 13% in the first
six months of 2005 compared to the first six months of 2004 and decreased $.3
million or 19% in the second quarter of 2005 compared to the second quarter of
2004. The decrease is mainly due to the 2004 recording of a $.5 million
provision for accounts receivable as a result of the settlement of
a legal action, offset by the recording of $.3 million of deferred debt costs to
expense as a result of the default on the Credit Agreement.
Goodwill impairment of $9 million was recorded in the second quarter of 2005 as
discussed in Note 2 to the Company's Condensed Consolidated Financial
Statements.
Interest expense increased $.5 million or 143% from the first six months of 2005
and increased $.4 million or 222% from the second quarter of 2004 due to higher
average interest rates and increased borrowings. Additional interest of $0.3
million was also recorded for working capital term loan due to the Company's
default on the loan. The weighted average interest rate for the first six months
of 2005 was 14.8% compared to 5.4% in 2004.
Liquidity and Capital Resources
Please refer to Note 2 Foreclosure and Cessation of Business as part of the
Liquidity and Capital Resources.
Cash and cash equivalents at June 30, 2005 increased 1.2 million from December
31, 2004 levels.
Outstanding borrowings increased $2.7 million to $14.3 million at June 30, 2005
from $11.6 million at the end of 2004.
As a means of attempting to alleviate the Company's liquidity problems
previously disclosed in the company's Form 10-Q for the fiscal quarter ended
March 30, 2005, on June 29, 2005 the Company entered into a First Amendment to
the Credit Agreement (described below) pursuant to which, among other things, an
additional $900,000 was made available to the Company through July 1, 2005 as
part of the Credit Agreement's revolving credit facility. Subsequently, the
Company failed to repay such amounts by July 1, 2005, which was a default under
Section 2.9 of the Credit Agreement. The Company was also in default of certain
financial covenants under Section 6.2(c) of the Credit Agreement regarding
Consolidated Earnings Before Interest, Taxes, Depreciation and Amortization. On
July 8, 2005 Patriarch Partners Agency Services, LLC as agent to the lenders
under the Credit Agreement, submitted to the Company a draft foreclosure
agreement. On August 3, 2005, Patriarch, on behalf of the secured lender,
delivered a notice of default to the company, accelerating all of the
outstanding debt under the Credit Agreement.
As a result of the covenant violations, on August 5, 2005, the Company entered
into a Foreclosure Agreement with the Lenders. As such, the Company has
classified all amounts due under the Credit Agreement as current as of June 30,
2005. Further, the Company wrote-off remaining unamortized deferred debt costs
and accelerated accretion interest on debt.
Under the Foreclosure Agreement the Company transferred substantially all of its
assets to the Lenders to extinguish its obligations under the Credit Agreement.
(The outstanding principal
under the Credit Agreement at the time of closing of the Foreclosure Agreement
was $14,310,000). Further, the Company retained certain limited assets and the
Lenders assume certain liabilities of the Company, including but not limited to,
certain accrued obligations with respect to current employees and certain trade
payables and accrued expenses. None of the assets retained by the Company can be
liquidated for cash. The Lenders also assumed certain employee benefit plans of
the Company and certain of its insurance policies. Under the Foreclosure
Agreement, the Company was permitted to obtain extended directors and officers
insurance, and the Lenders agreed to assume or fund the defense of actions
brought against the Company after the closing. At the closing the Company
terminated all of its employees as of that time. Under the Foreclosure Agreement
the Lenders agreed to fund certain expenses of the Company winding-down its
business. However, the Company has no cash or other sources of liquidity and if
the funds provided for in the wind-down budget are not used for the purposes
specified in the budget, the Company is not entitled to receive any differential
cash. The pro forma balance sheet as of June 30, 2005 gives effect to the
Foreclosure Agreement as if the related transaction had occurred as of that
date.
Following the closing of the Foreclosure Agreement, the Company ceased doing
business and is expected to be dissolved in accordance with the applicable
provisions of the Delaware General Corporation Law. Following the closing of the
Foreclosure Agreement, the Company's sole remaining executive officer is Scott
Schooley who serves as President and Secretary of the Company. Following the
closing of the Foreclosure Agreement, board of directors also voted to dissolve
the Company, subject to requisite stockholder approval and compliance with the
related SEC regulations. Because none of the assets retained by the Company can
be liquidated for cash, there will be no residual value left to the holders of
common stock of the Company following the closing of the Foreclosure Agreement
and any winding-down of the Company's affairs.
As of June 30, 2005, $3.4 million was outstanding under the revolving credit
facility portion and $8.9 million was outstanding on the term loan portion of
the Credit Agreement. Outstanding borrowings for the revolver and term loan bear
interest at prime plus 2%. There is also $2.0 million under the term loan
working capital facility portion of the Credit Agreement, including $500,000 of
accretion. Such borrowings bear interest at prime.
The Company's deteriorating financial condition resulted in the covenant
violations referred to above. As such, the Company evaluated goodwill for
impairment in connection with preparing the accompanying financial statements.
Management considered goodwill impairment and recognized an impairment loss of
$9,040,000 for the quarter ended June 30, 2005.
Operating activities used $1.0 million of cash in the first six months of 2005,
as compared to the using $2.0 million in the first six months of 2004. The
decrease is partly due to the lack of a bonus accrual in 2005 as compared to the
same period in 2004.
Non-cash expenses were $10.7 million for the first six months of 2005 and $1.1
million for the same period in 2004. As shown in the statements of cash flows
these expenses relate to depreciation, amortization and accretion. The non-cash
expenses for the first six months of 2005 include a goodwill impairment of $9.0
million.
Net accounts receivable and unbilled receivables at June 30, 2005 decreased $1.5
million from December 31, 2004 due to the timing of collections and lower sales
in the second quarter of 2005 compared to the fourth quarter of 2004.
Total inventories at June 30, 2005 increased $0.3 million from December 31,
2004. Manufacturing inventory increased $0.2 million from the beginning of the
year. Customer service inventory remained consistent as compared to December 31,
2004.
Net equipment and leasehold improvements at March 31, 2005 decreased $0.2
million due to depreciation and amortization recorded during the quarter.
Other current assets increased $0.5 million from December 31, 2004 mainly due to
a vendor deposit placed in the second quarter for $0.5 million.
Accounts payable remained consistent with December 31, 2004.
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 remained consistent with December 31, 2004.
Deferred revenues increased $0.4 million from December 31, 2004 due to the
timing of invoicing and maintenance contracts.
Other current liabilities decreased $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, the
Company 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. This agreement has
been assigned to SO Acquisition as part of the Foreclosure Agreement.
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
June 30, 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 reasonable under the circumstances. However, actual results may
vary from these estimates under different assumptions or conditions.
Appendix Three
SCAN-OPTICS, INC. AND SUBSIDIARIES
FIVE YEAR SUMMARY OF OPERATIONS
SELECTED FINANCIAL DATA
Six months
ended
(thousands, except share data) June 30, 2005 2004 2003 2002 2001 2000
- ------------------------------------ --------------- -------------- --------------- --------------- --------------- ---------------
Total Revenues $ 12,580 $ 28,741 $ 32,081 $ 29,341 $ 30,740 $ 38,302
============ ============ ============ ============ ============ ============
Income (loss) before income taxes (12,018) (3,698) 844 1,023 (6,280) (17,709)
Income taxes (benefit) 6 71 (142) 81 33 61
------------ ------------ ------------ ------------ ------------ ------------
Net Income (Loss) $ (12,024) $ (3,769) $ 986 $ 942 $ (6,313) $ (17,770)
============ ============ ============ ============ ============ ============
Basic earnings (loss) per share $ (.29) $ (.18) $ .14 $ .13 $ (.90) $ (2.53)
============ ============ ============ ============ ============ ============
Basic weighted-average shares 41,451,577 20,890,686 7,026,232 7,026,232 7,026,232 7,025,064
============ ============ ============ ============ ============ ============
Diluted earnings (loss) per share $ (.29) $ (.18) $ .13 $ 13 $ (.90) $ (2.53)
============ ============ ============ ============ ============ ============
Diluted weighted-average shares 41,451,577 20,890,686 7,806,491 7,317,437 7,026,232 7,025,064
============ ============ ============ ============ ============ ============
SELECTED BALANCE SHEET DATA
Total assets $ 15,153 $ 24,338 $ 26,073 $ 26,406 $ 27,380 $ 36,513
Working capital (deficit) (9,983) 2,912 4,957 5,394 4,184 (9,833)
Long term obligations 532 11,142 9,379 10,428 11,397
Mandatory redeemable preferred stock 872 855 4,286 4,054 3,800
Total stockholder's equity (deficit) (9,669) 2,314 2,443 1,383 360 4,307
The Company has not paid any dividends for the five-year period ended December 31, 2004.
The above financial data should be read in conjunction with the related consolidated financial statements and notes thereto.
Certain amounts have been reclassified to conform to the current year presentation.
SCAN-OPTICS, INC.
Dear Stockholder,
Please take note of the important information enclosed with the Proxy
Ballot. There are a number of issues related to the management and operation of
your Company that require your immediate attention and approval. These are
discussed in detail in the enclosed proxy materials.
Your vote counts, and you are strongly encouraged to exercise your right to vote
your shares.
Please mark the boxes on this proxy card to indicate how your shares will be
voted. Then sign the card, detach it and return your proxy vote in the enclosed
postage paid envelope.
Your vote must be received prior to the Special Meeting of Stockholders,
[_________ __, 2005]. Thank you in advance for your prompt consideration of
these matters.
Sincerely,
Scan-Optics, Inc.
DETACH HERE
- --------------------------------------------------------------------------------
SCAN-OPTICS, INC
179 Allyn Street
Hartford, Connecticut 06103
PROXY SOLICITED ON BEHALF OF THE BOARD OF DIRECTORS
FOR THE SPECIAL MEETING OF STOCKHOLDERS ON [___________ __, 2005]
The undersigned hereby constitutes and appoints Scott Schooley proxy of the
undersigned, with full power of substitution, to vote, as designated on the
reverse side, all shares of capital stock of Scan-Optics, Inc. (the "Company")
held of record by the undersigned on [___________ __, 2005] at the Special
Meeting of Stockholders to be held on [___________ __, 2005] and at any
adjournments thereof (the "Meeting").
APPROVAL OF THE PLAN OF DISSOLUTION AND LIQUIDATION AND
DISSOLUTION OF SCAN-OPTICS
To approve the Plan of Dissolution of Scan-Optics, Inc., substantially in
the form presented to the stockholders of Scan-Optics for their approval at
the Meeting, and the dissolution of Scan-Optics in accordance with the
terms of such Plan of Dissolution.
FOR AGAINST ABSTAIN
[ ] [ ] [ ]
APPROVAL OF THE AMENDMENT TO THE AMENDED AND RESTATED CERTIFICATE OF
INCORPORATION OF SCAN-OPTICS, INC.
To approve the Amendment to the Amended and Restated Certificate of
Incorporation of Scan-Optics, Inc., substantially in the form presented to
the stockholders of Scan-Optics for their approval at the Meeting.
FOR AGAINST ABSTAIN
[ ] [ ] [ ]
DISCRETIONARY AUTHORITY
In his discretion, the Proxy is authorized to vote upon such other
business as may properly come before the Meeting.
THIS PROXY, WHEN PROPERLY EXECUTED, WILL BE VOTED AS DIRECTED BY THE
UNDERSIGNED. IF NO DIRECTION IS GIVEN WITH RESPECT TO A PARTICULAR PROPOSAL,
THIS PROXY WILL BE VOTED FOR SUCH PROPOSAL. THE BOARD OF DIRECTORS RECOMMENDS A
VOTE FOR THE PROPOSALS.
PLEASE MARK, SIGN, AND RETURN THIS PROXY CARD PROMPTLY, USING THE ENCLOSED
ENVELOPE. NO POSTAGE IS REQUIRED IF MAILED IN THE UNITED STATES OF AMERICA.
- --------------------------------------------------------------------------------
Please date and sign exactly as your name appears on the books of the Company.
Joint owners should each sign personally. Trustees and other fiduciaries should
indicate the capacity in which they sign, and where more than one name appears,
a majority must sign. If a corporation, this signature should be that of an
authorized officer who should state his or her title.
- --------------------------------------------------------------------------------
- -------------------- --------------------------------
Date Signature of Owner
--------------------------------
Additional Signature of Joint Owner
(if any)
HAS YOUR ADDRESS CHANGED? DO YOU HAVE ANY COMMENTS?
- ------------------------------- ----------------------------------------
- ------------------------------- ----------------------------------------
________________________________________________________________________________
SCAN-OPTICS, INC.
C/O COMPUTERSHARE
P.O. BOX 8694
EDISON, NJ 08818-8694