Goons ><> ‘SCOPE INDUSTRIES. CONDENSED CONSOLIDATED INCOME STATEMENT For the quarier and six months ended December 31,2016 and December 31, 2015, (Unaudited) SECOND QUARTER ENDED SIXMONTHS ENDED December 31, December31, December 31, December 31, 2016 2015, pita s Sales and revenues $47,086,737 $51,885,136 $96,328,500. 103,583,089 Operating ests and expenses @7851677) (1,106,581) (98,074461) (101,047,322) Investment ad other incomefexpense)-ne Los7.282 (1.715796) 35533 _(S.u3'900 Incomei(loss) before income taxes 232342 (1.397241) 1.310428) @,808,197) Provisionl(benefit) for income taxes 37.000 __ (550.000 (00,000), _L'384.000) Netincometoss) SCisssez “Egan Soowes Sass Net income(oss) per share-basi So sas Som s_u9 Average shares outstanding basic son 397,02 397.02 397.02 April 19, 2017 ‘TO OUR SHAREOWNERS: Sales for our secad fiscal quarter ended Devember 31, 2016 wore $47,046,737 and net income was $195,342, oF 2 cents per share. The comparable quarter for last year had sales of $51,485,136 and anet loss of $747,241, ora loss per share of &3 cents For the six months ended December 31, 2016 sales were 96,328,500 with a net loss of $710,428, or loss of 9 cents per share. ‘Whereas, the prior six months reported sales of $103,883,049 and amet loss of $1,424,197 0 aS1.89 loss per share “The results of our cureet second garter reflected small increas in volume, lower selling pices, but a marked improvement in ‘operations. The third quarter has shown a small increase in volume ad selling prices. Respectfully submit, Upper order Meyer Luskin President£0b06 VO “OUOW PUES Olp ang ‘pacaaynog amyspiAy 1187 samsnpuy adoog 910e ‘Le 1aquia9eq papus porsod ays 40 AOA AALAVAD GNOIAS FET SSSSCOPE INDUSTRIES CONDENSED CONSOLIDATED INCOME STATEMENT. For the quarter and nine months ended Mach 31,2017 and March 31,2016 (Wnausited) _THIRD_ QUARTER ENDED. NINE_ MONTHS ENDED. ‘March 37, March31, March 31, March 1, 2017 26 2016, Sales and evenves 48,309,408 $47,362,921 'S_14997,908 150,945,970 Operating costs and expenses (47937.273) (48'569,535) (146,011,734) (149,716,857) Investment and other income (expense)-net 1.3501433), _@.060.324) 23900) _ (7 348 Incomelloss) before income taxes (0,127,301) 367038) (437,729) 6.175.235) Provisio(benefi) for income axes (3081000), _0:368'000 1.108000) 0.752.000) Net incomel(oss) sTyo1s.a0n" “Zd.999.038 SU229) $G.425.285) Swe) $2) $_uu §_G.8) Net incomel(loss} per share-basc 59702 597.02 597.021 _897,021 Average shares outstanding ~basi = June 28,2017 ‘TO OUR SHAREOWNERS: Sales fr our third fiscal quarter ended March 31,2017 were § 48,369,408 and the net los was $619,301, oF a net oss of 69 cents er share, Last year’ third quarter reported sales of 47,362,921 and anet loss of $1,999,038, o loss oF S2.23 per share. The eutent nine month fsa! period ended March 31,2017 recorded sles of $144,697,905 and ant los of| 1,329,729, ora loss S148 per share; the prior years’ results were sales of $130,945, 970 with a net loss of $3,423,235, oranet loss pet share of $3.82. ‘Aso this writing, the forecasts ofthe coming com crop ae that it willbe another excellent year in output ae quality “Thus, com prices have start to Weaken, ad so the cucent cash rice is less than the prices inthe las five months. Therefore, the present expectation i that com prices Wil be in low range forthe next 9 ~ 12 months. Once again, we caution you regarding eying on com price forecasts, svaly, ad annually. We shall not be Fellow sharcowner, please nae that inthe foture we shall report to you semi issuing fist and third quarter reports. ur next report to you shal be Our annual report and thereafter a semi-annual report Respectfully submited, Migr Juados Meyer Luskin President£0F06 Vo ‘voruopy mues OlF auIng ‘preadmnog aNYSHLA L187 sounsnpuy adoog L102 ‘TS Yo4npy papua porrad ay) 40.p LYOdTY WALYVNO CUIHL GSI r Organization Scope Industries was organized and incorporated in the State of California on February 8, 1938. Scope Industries (Scope, and together with its subsidiaries, the “Company”) operates plants for the collection and processing of bakery ‘waste materials into a feed ingredient for animals. The Company currently operates a total of 17 manufacturing facilities throughout the United States under the name of Reconserve. Principal customers are poultry farms, dairies and feedlots. The ‘Company also owns and operates a plant in Vernon, California under the name Topnotch Foods, Inc., where certain bakery ‘material is processed and converted into edible breadcrumbs for human consumption. Its prineipal customers are pre= packaged and restaurant supply food processors. The waste material recycling segment is dependent upon the Company's ability to secure surplus and waste material, which it does under both short and long-term contracts with bakeries and snack food manufacturers. ‘The market value of bakery waste material recycled into animal food ingredient products is directly tied 10 commodity prices, primarily corn and some animal grade fat items that are alternatives to the Company's finished product ‘As such, the selling price of the Company's product is directly correlated to the selling prices of the related commodity items. During the year ended June 30, 2016, the Company experienced a fire at one of its manufacturing facilites. The Company received insurance proceeds of $8,000,000 for damage to the buildings and equipment and recognized a loss on the disposal of the damaged buildings and equipment of $12,370 during the year ended June 30, 2016. The manufacturing facility continues to operate on a limited capacity, in fiscal years 2016 and 2017, Note 2; Summary of Significant Aecounting Policies Principles of Consolidation: “The consolidated financial statements include the accounts of Scope Industries and its wholly owned subsidiaries. {All inter-company accounts and transactions have been eliminated in consolidation. Use of Estimates: ‘The preparation of the consolidated financial statements in conformity with U.S. generally accepted accounting principles ("GAAP") as set forth in the Financial Accounting Standard (“FASB”) Accounting Standards Codification (“ASC”) requites management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reported periods in the consolidated financial statements and accompanying notes. Actual results may differ from those estimates. Cash Equivalens ‘The Company considers all liquid debt instruments to be cash equivalents if the securities mature within 90 days of acquisition. Carrying amounts approximate fair value. Accounts Receivable: ‘Accounts receivable are stated at the amount management expects to collect from outstanding balances. Management performs an assessment of the current status of individual accounts to determine the appropriate level of allowance for doubtful accounts, Balances that are still outstanding after management has used reasonable collection efforts are writen off against the allowance. Accounts are considered past due or delinquent based on contractual terms and how recently payments have been received. Fair Value of Financial Instruments; ‘The carrying amount of accounts receivable, accounts payable and accrued expenses approximates fair value due to the short maturity of these instruments. The carrying amounts of the Company's note payable and notes receivable approximate fair value considering the terms of the notes.Notes to Consolidated Financial Statements ‘Note 2: Summary of Significant Accounting Policies (continued) Inventories: Tnventories consist of raw materials and manufactured finished goods. Inventories are stated at the lower of cost or smatket, determined by using the average cost basis, which approximates the first, first-out method. Inventories consist of the following: June 3 2017 2016 Raw materials $ 1,852,911 $ 2,324,990 Finished goods 1,829,881 1,742,161 Other 169,187, 185,230 33851979 “S_4252.,381 Property and Equipment Property and equipment are recorded at cost less accumulated depreciation and amortization, Depreciation and ‘amortization are provided generally on the straight-line method over the estimated useful lives of the assets. Service lives are 30 years for buildings, 10 years, but not exceeding the lease terms, for leasehold improvements and 3 to 7 years for ‘machinery and equipment. Maintenance and repairs are charged to expense as incurred. Depreciation expense was $12,916,868 for the year ended June 30, 2017 and $12,577,453 for the year ended June 30, 2016. Intangible Assets: Intangible assets are subject to amortization and consist of: 1) collection routes which represent the value assigned upon purchase for @ group of suppliers of raw materials in similar geographic areas from which the Company will derive a dependable source of raw materials; 2) customer relationships that represent the value assigned to customers that the Company has had established and ongoing relations with and will continue to be a source for finished feed sales; 3) permits that represent licensing of operating plants that have been acquired, giving those plants the ability to operate; 4) non-compete fagreements that represent contractual arrangements with former competitors. whose businesses were acquired: 5) trade yhames; and 6) software. Amortization expense is calculated using the straight-line method over the estimated useful lives of the assets ranging from: 5 years for collection routes; 16 years for customer relationships; 3 years for permits; 5 to 7 years for ‘non-compete agreements; 5 years for trade names; and 3 years for software. ‘The gross carrying amount of intangible assets are as follows: June 30, 2017 2016 Collection routes S$ 48,710,000 $ 48,710,000 Customer relationships 47,570,000 47,570,000 Permits 1,440,000 1,440,000 ‘Non-compete agreements 33,290,000 33,290,000 ‘Trade names 5,300,000 5,300,000 Software 320,000 320,000 5 156,630,000_ “5 _ 136,630,000, Accumulated amortization: June 3 2017 16, Collection routes S 44243453 $34,502,925 Customer relationships 13,802,943 10,529,818, Permits 1,440,000 1,440,000 ‘Non-compete agreements 30,247,583 23,609,583, ‘Trade names 4,814,167 3,754,167 Software 320,000 320,000 394,568,146 S 74,156.493Notes to Consolidated Financial Statements Note 2: Summary of Significant Accounting Policies (eontinued) Total amortization expense was $20,411,653 and $20,689,157 for the years ended June 30, 2017 and 2016, respectively. Amortization expense for the next five years is estimated to be $10,967,930, $2,973,125, $2.973,125, $2,973,125 and $2,973,125. Goodwill: ‘Goodwill is tested for impairment annually or more frequently if events or changes in circumstances indicate that the asset might be impaired. The Company follows a two-step process for testing impairment. First, the fair value of each reporting unit is compared to its carrying value to determine whether an indication of impairment exists. If impairment is indicated, then the fair value of the reporting unit’s goodwill is determined by allocating the unit's fair value ofits assets and liabilities (including any unrecognized intangible assets) as if the reporting unit had been acquired in a business combination. The amount of impairment for goodwill is measured as the excess of its carrying value over its implied fair value. As of June 30, 2017 and 2016, the fair value of the Company's reporting unit containing goodwill exceeded the related carrying values. Goodwill was $8,044,194 at June 30, 2017 and 2016, Long-lived Assets ‘The Company accounts for the impairment and disposition of long-lived assets in accordance with FASB ASC ‘Topic 360, Impairment or Disposal of Long-lived Assets. In accordance with this guidance, long-lived assets to be held are reviewed for events or changes in circumstances that indicate that their carrying value may not be recoverable. Recoverability of assets to be held and used is measured by comparing the carrying amount of the assets to the undiscounted future cash flows expected to be generated by the assets. When this comparison indicates that impairment must be recorded, the impairment recognized is the amount by which the carrying amount of the assets exceeds the fair value of these assets, No impairment write-downs were recorded during the years ended June 30, 2017 and 2016, Self-Insurance Reserves: The Company was self-insured up to November 2010 in various states for its workers’ compensation insurance, ‘The ‘Company accrued costs for actual reported claims related to self-insured workers’ compensation and for claims incurred but not reported during this period to reflect the total estimated costs. Such accrual is included in other accrued and current liabilities inthe accompanying consolidated balance sheets. Debr Issuance Costs; Debt issuance costs, net of accumulated amortization, are reported as a direct deduction from the face amount of the debt to which such costs relate. Amortization of debt issuance costs is reported as a component of interest expense and is computed using an imputed interest rate on the related loan. Revenue Recognition: Sales are recorded at contract prices as deliveries are made; shipping charges billed to customers are included within revenues and totaled $14,291,881 and $13,683,165 for the years ended June 30, 2017 and 2016, respectively. Related shipping costs are included within cost of sales and totaled $14,319,360 and $13,650,844 for the years ended June 30, 2017 and 2016, respectively. Income Taxes: ‘The Company files a consolidated Federal income tax return and separate or combined state income tax returns with its subsidiaries. The Company provides for income taxes using the asset and liability method under which deferred income taxes are recognized for the estimated future tax effects attributable to temporary differences and carry-forwards that result fiom events that have been recognized ether in the consolidated financial statements or the income tax returns, but not both. ‘The measurement of current and deferred income tax liabilities and assets is based on provisions of enacted tax laws. Valuation allowances are recognized if, based on the weight of available evidence, itis more likely than not that some portion of the deferred tax assets will nat be realized.Notes to Consolidated Financial Statements ote 2: Summary of Significant Accounting Policies (continued) ‘The Company follows the guidance under ASC Topic 740, Income Taxes, to account for uncertain tax positions. The ‘Company has no unrecognized tax benefits as of June 30, 2017 and 2016, ‘The Company's U.S. Federal tax retums prior to the 2014 fiscal year and state income tax returns prior to the 2013 fiseal year are closed. Management continually evaluates ‘expiring statutes of limitations, audits, proposed settlements, changes in tax law and new authoritative rulings. If necessary, the Company recognizes interest and penalties associated with tax matters as part of the income tax provision and includes accrued interest and penalties with the related tax liability in the consolidated balance sheets. Derivatives: FASB Accounting Standards establish accounting and reporting requirements for derivative instruments, including certain derivative instruments embedded in other contracts, and hedging activites. These standards require recognition of all erivative instruments as assets or liabilities on the Company's balance sheet and measurement of those instruments at fair value. The accounting treatment of changes in fair value is dependent upon whether or not a derivative instrument is designated as a hedge for Financial accounting purposes and ifso, the type of hedge. The Company does not designate any of its derivatives as hedges for financial accounting purposes. Gains and losses on derivative instruments not designated as hedges are currently ineluded in earnings, The resulting cash flows are reported as eash ftom operating activities. See Note 4 for detail on the Company's derivative instruments, Stock-Based Compensation: The Company measures and recognizes compensation expense for all stock-based awards based on fair value of the awards on the grant date, The fair value of stock option awards to employees with service based vesting conditions is estimated using an option pricing model, The value of an award is recognized as expense over the requisite service period in the consolidated statement of operations, The option pricing model requires management to make assumptions and to apply judgement in determining fair value of the awards. The most significant assumptions include the expected volatility, risk-free rate, expected dividend rate and expected term of the award, The expected volatility of the awards is based on historical volatility of selected public ‘companies within the Company’s industry. The risk-free interest rate is based on the implied yield currently available on U.S ‘Treasury notes with term approximately equal to the expected term of the awards. The expected dividend rate is based upon the Company's historical dividend rates and expectations of future cash dividends on its common stock. The expected term is based upon the Company's estimate of the average time from the date of grant to exercise. During the year ended June 30, 2017, the Company elected to early adopt the forfeiture guidance under FASB ‘Accounting Standards Update (“ASU”) 2016-09, Compensation — Stock Compensation (Topic 718): Improvements to Employee Share- Based Payment Accounting. Accordingly, the Company accounts for forfeitures as they occur; therefore, they are not included in the option-pricing model. ‘The Company has elected to apply a straight-line recognition method to account for awards that contain graded ‘vesting with time-based service conditions. Per Share Information: Basie net income or loss per common share is computed using the weighted average number of common shares outstanding during the period. Diluted net income or loss per share is computed using the weighted average number of ‘common and dilutive common equivalent shares outstanding during the period except for periods of net loss for which no common share equivalents are included because their effect would be anti-dilutive. Dilutive common equivalent shares consist of common stock issuable upon exercise of stock options. For the year ended June 30, 2017, 50,000 potential ‘common shares from outstanding stock options were excluded from diluted loss per share as the Company had a net loss for the year. There were no potentially dilutive common equivalent shares outstanding during the year ended June 30, 2016.Notes to Consolidated Financial Statements Note 2: Summary of Significant Accounting Polieles (continued) (Change in accounting principle: During the year ended June 30, 2017, the Company adapted the provisions of FASB ASU 2015-03, Simplifving the Presentation of Debi Issuance Costs (“ASU 2015-03"), which modifies the presentation of debt issuance costs and the related amortization, The change in accounting under ASU 2015-03 improves the reporting of debt issuance costs by no longer reporting them as assets. It also improves the reporting of the related amortization by including it as a component of interest expense, ASU 2015-03 has been adopted by the Company on a retrospective basis. As a result, total assets as well as loans payable for the year ended June 30, 2016 have been reduced by the effect of the reclassification of debt issuance costs, net of accumulated amortization of $307,173. Subsequent Events: ‘The Company has evaluated events and transactions for potential recognition or disclosure through September 22, 2017, which is the date the consolidated financial statements were available to be issued. Note 3: Fair Value Measurements ‘The Company performs fair value measurements in accordance with the guidance provided by ASC Topie $20, Fair Value Measurements and Disclosures. ASC 820 defines fair value as the price that would be received from selling an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The Company did not elec the fair value option for any ofits eligible financial assets or liabilities. ‘The guidance for fir value measurements accounting established a three-tier hierarchy for fair value measurements, Which prioritizes the inputs used in measuring fair value as follows: pr ra ig Level 1 — observable inputs such as quoted prices for identical instruments in active markets, Level 2 ~ inputs other than quoted prices in active markets that are observable either directly or indirectly through corroboration with observable market data. Level 3 — unobservable inputs in which there is little or no market data, which would require the Company to develop its own assumptions, ‘The asset or liability’s fair value measurement level within the fair value hierarchy is based on the lowest level of any input that is significant to the fair value measurement. Valuation techniques used need to maximize the use of observable inputs and minimize the use of unobservable inputs. Following is a description of the valuation methodology used for liabilities measured at fair value. There have been ‘no changes in the methodologies used at June 30, 2017 and 2016. Investments in money market funds and equity securities are valued using observable inputs that are readily available in public markets or can be derived from information available in publicly quoted market prices. The fair value of interest rate swaps is determined using observable market inputs such as current published interest rate, and considers nonperformance risk of the Company and that of its counterparties. The fair value of natural gas and diesel fuel swaps is determined using observable market inputs such as current published commodity prices, and considers nonperformance risk of the Company and that of its counterpa ‘The preceding methods described may produce fair value calculations that may not be indicative of net realizable value or reflective of future fair values. Furthermore, although the Company believes its valuation methods are appropriate and consistent with other market participants, the use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in different fair value measurements at the reporting dateNotes to Consolidated Financial Statements Noe 3: Fair Value Measurements (continued) At June 30, 2017, the Company's assets and ilities at fair value within the fair value hierarchy were as follows’ Level Level 2 Level 3 Total Cash equivalents Money market funds S$ 1554151 8 Ss = 8 1,854,151 Derivative financial instruments (see Note 4) Interest rate swaps - (400,117) - (400,117) ‘Natural gas swaps : (444,158) - (444,158) Diesel fuel swaps A (1,545,306) = (1,545,306) Employee benefit plans Money market funds 6,668,445 : : 6.668.445 Totals 3 8.222,596 8 OS0958)_S = S_ 5,833,015 ‘At June 30, 2016, the Company's assets and liabilities at fair value within the fair value hierarchy were as follows: Level 1 Level 2 Level 3 Total Cash equivalents ‘Money market funds Ss 52491 S$ oS - 8 S249 Derivative financial instruments (see Note 4) Interest rate swaps 5 (2,082,954) - (2,082,954) "Natural gas swaps - (648,920) (648,920) Diesel fuel swaps e (1,463,825) : (1,463,825) Employee benefit plans ‘Money market funds 2,333,305 = - 2,333,305, Totals 32,385,796 _$ (4 195,009)_$ = 5_ (809,903) Note & Derivative Financial Instruments ‘The Company has the following derivative contracts ‘The Company has interest rate swap agreements with major financial institutions for the purpose of managing its interest rate risks on floating rate long-term debt. At June 30, 2017 and 2016, the Company has interest rate swap agreements having total original notional amounts of $125,000,000 through December 13, 2017. At June 30, 2016, the Company has interest rate swap agreements having total original notional amounts of $50,000,000 from December 13, 2017 through ‘December 31, 2019. During the year ended June 30, 2017, the company settled an interest rate swap agreements having total original notional amount of $25,000,000 for a payment of $506,500, At June 30, 2017, the Company has interest rate swap ‘agreements having total original notional amounts of $25,000,000 from December 13, 2017 through December 31, 2019. ‘Those agreements effectively change the Company’s interest rate exposure on its term loan from LIBOR plus an applicable margin to a fixed 1.03% plus an applicable margin through December 13, 2017 and 3% plus an applicable margin from December 31, 2017 through December 31, 2019. 13Notes to Consolidated Financial Statements Note 4: Derivative Financial Instruments (continued) ‘The Company has commodity price swap agreements with major financial institutions forthe purpose of managing its risks related to the volatility of natural gas and diesel fuel prices. The notional amounts of the agreements cover a portion ‘of commodities that the Company anticipates using in its operations during the periods covered by the agreements. The ‘agreements are settled in eash and not dependent on the actual purchase of the related commodities by the Company. At June 30, 2017, the Company has natural gas price swap agreements with a total notional amount of 2,998,500mmBtu. The ‘agreement effectively changes the Company's natural gas price exposure for the purchase of 2,998,500mmBtu of natural gas fiom market prices to fixed prices ranging from $4.28 to $2.99 per mmBtu through January 31, 2022. At June 30, 2016, the ‘Company had natural gas price swap agreements with a total notional amount of 2,518,500mmBtu, The agreement effectively changes the Company's natural gas price exposure for the purchase of 2,518,500mmBtu of natural gas from market prices to fixed prices ranging from $4.28 to $2.99 per mmBtu through January 31, 2021. At June 30, 2017, the Company has diesel fuel price swap agreements with notional amounts totaling 10,800,000 gallons. The agreements effectively change the Company's diesel fuel price exposure for the purchase of 10,800,000 gallons of diesel fuel from ‘market prices to fixed prices ranging from $2.14 to $1.56 per gallon through January 31, 2022, At June 30, 2016, the Company has diesel fuel price swap agreements with notional amounts totaling 9,180,000 gallons. The agreements effectively change the Company’s diesel fuel price exposure for the purchase of 9,180,000 gallons ‘of diesel fuel from market prices to fixed prices ranging from $2.14 to $1.56 per gallon through January 31, 2021 The Company is exposed to credit loss in the event of nonperformance by other parties to the swap agreements. However, the Company does not anticipate nonperformance by the counterparties. ‘The fair value of derivative instruments not designated as hedging instruments for financial accounting purposes at June 30, 2017 is as follows (see Note 3): Interest Natural Diesel Non- Rate Swaps __ Gas Sway Fuel Swaps Derivatives ___ Total ‘Other non-current liabilities 3 400,117 $ 444,158 § 1,545,306 $109,000 S_2,498,581 Changes in fair value, net of settlements, on derivative instruments not designated as hedging instruments for financial accounting purposes for the year ended June 30, 2017 are as follows: Interest Natural Diesel Rate Swaps __Gas Swaps _Fuel Swaps Total Investments and other income (expense)-net_ $921,787 $ (276,924) $ (987,385) $ (342,522) ‘The fair value of derivative instruments not designated as hedging instruments for financial accounting purposes at June 30, 2016 is as follows (see Note 3) Interest Natural Diesel Rate Swaps __Gas Swaps __Fuel Swaps Total Other non-current liabilities S 2,082,954 $ 648,920 $ 1,463,825 $ 4,195,699 Changes in fair value, net of settlements, on derivative instruments not designated as hedging instruments for financial accounting purposes for the year ended June 30, 2016 are as follows: Interest Natural Diesel Rate Swaps _Gas Swaps _Fuel Swaps oval Investments and other income (expense)-net_ $ (1,783,382) $ (376,126) $ 2,154,267) $ 313.775)Notes to Consolidated Financial Statements Note 5: Investment and Other Income (Expense) - Net For the years ended June 30, 2017 2016, Investment and other income (expense) consist of: Interest and dividend income 8 20364 $ 12,187 Loss on sale of property and equipment (69,780) 634) Interest expense (2,168,764) (2,519,735) ‘Changes in fair value, net of settlements, on derivative instruments (342,522) (4313775) ‘Miscellaneous income - net 535,895 467,403 Investment and other income (expense) - net S_G.024,807) “SG 356.554 Nore 6: Investments Employee benefit plan assets (see Note 10) are invested primarily in money market accounts and are included in deferred charges and other assets in the accompanying consolidated balance sheets. Gross Gross At June 30, 2017, investments were as follows: Unrealized Unrealized Fair Cost Gain Loss Value Employee benefit plans 3 6c68au Ss ons 7S 6668444 Gross Gross ‘At June 30, 2016, investments were as follows: Unrealized Unrealized Fair Cost Gain Loss Value Employee benefit plans 32,333,305 § > Ss 7 S_2,333,305 Note 7= Commitments and Leases ‘The Company occupies certain facilities and operates a portion of its transportation equipment under operating leases. ‘The leases have terms expiring in fiscal years 2018 through 2022. One of the facility leases is renewable for an additional five years. Future minimum rental paymients required under non-cancelable operating leases having lease terms in excess of one year are: For the year ending June 3 2018 3 327,969 2019 258,285 2020 212,237 2021 217,451 2022 184,613 Total minimum lease payments $1,200,555, ‘Total rental expense under operating leases was $660,484 in fiscal 2017 and $994,567 in fiscal 2016. Rent expense also includes payments under cancelable leases which were $223,983 in fiscal 2017 and $267,153 in fiscal 2016. 1sNotes 10 Consolidated Financial Statements Nowe 8 Debr Notes payable cor of the following: Bane 30,2017 ‘Term Joan due in quarteriy payments. through December 13, 2017, with interest at LIBOR plus 2.00% at June 30, 2016, Refinanced on December 21, 2016 s - $84,000,000 Term Joan due in quarterly payments through December 21, 2021, with interest at LIBOR plus 1.25 9% at June 30,2017 34,799,265 34,799,265 84,000,000 Unamortized debt issuance cost 149,033 307,173 Current portion 1,405,147 ‘Note payable, net of current portion 33,245,085 Principal payment requirements due on the note payable in each year subsequent fo June 30, 2017 are as follows: For the year ending June 30, S$ 1,405,147 1,605,882 1,605,882 1,605,882 28576472 $34,799,265 During the fiscal year ended June 30, 2017, Reconserve, Inc. a subsidiary of Scope Industries, amended and restated its Original Credit Agreement with a bank. The Original Credit Agreement provided for a term loan with a principal amount ‘of $160,000,000, a line of credit with a limit of $5,000,000), and standby letters of credit. The Amended Credit Agreement now provides fora term loan of $49,000,000, increases the revolving line of eredit to a limit of $50,000,000, and extends the maturity date to December 21, 2021 from December 13, 2017. Proceeds from the Amended Credit Agreement were used to pay off the loan from the Original Credit Agreement. All borrowings under the credit agreements bear interest at either the Eurodollar Rate (LIBOR plus 1.25% at June 30, 2017 and LIBOR plus 2.00% at June 30, 2016 (2.48% at June 30, 2017 and 2.50% at June 30, 2016) or the Alternative Base Rate, which isthe greatest ofthe 1) Prime Rate, 2) Federal Funds Effective Rate plus 1% of 3) LIBOR plus 1% (4.25% and 4.50% at June 30, 2017 and 2016, respectively) All borrowings are secured by substantially all assets of the Company. Interest on term loans is payable monthly, and principal payments of 10% per annum are payable quarterly (beginning June 30, 2017 for the new term loan). During the fiscal year 2017, the Company rmade an additional $14,000,000 payment on the term loan in addition to the required quarterly payment. During the fiscal year 2016, the Company made an additional $15,720,456 payment on the term loan in addition to the required quarterly payment. Duc to aggregate additional payments in excess of scheduled quarterly principal payments, as of June 30, 2016, no further scheduled quarterly principal payments were required before the maturity date. All outstanding principal and interest are due on December 21, 2021. The line of credit facility expires on December 21, 2021. As of June 30, 2017 and 2016, the amounts outstanding on the line of eredit was $28,171,074 and $0, respectively, net of unamortized debt issuance costs of $152,075 and $0, respectively. The Company has issued standby letters of credit against the line totaling $4,797,000 and $3,952,000 as of June 30, 2017 and 2016, respectively, which are primarily related to surety bonds for selfinsuring workers? compensation in various states and for property insurance. The letters of credit will not be drawn upon unless the Company’ defaults on payments for workers’ compensation claims in those states. The letters of credit have expiration dates maturing through October 15, 2018.Notes to Consolidated Financial Statements Note &: Debt (continued) ‘The Credit Agreement contains certain finaneial and reporting covenants with which the Company is in compliance. During the fiscal year ended June 30, 2017, Reconserve of lowa, Inc. a subsidiary of Reconserve, Inc, entered into a Financing Agreement with a bank and the lowa Finance Authority for the issuance of Revenue Bonds in an aggregate principal amount of $15,000,000 for the construction of @ new manufacturing facility. All borrowings under the Finance ‘Agreement bear interest at 67% of LIBOR plus 838% (1.54%) at June 30, 2017. All borrowings are secured by substantially all assets of the Company. Interest on the Revenue Bonds is payable monthly beginning on January 22, 2017. ‘The bonds are ‘subject to mandatory tender on December 21, 2021. If the bond purchaser and Reconserve of Jowa, Ine. agree to an ‘extension, then no principal payments are due until the maturity date of the bonds on December 1, 2046, at which time the remaining outstanding balance plus all acerued and unpaid interest is due. Through June 30, 2017, borrowings of $10,962,309 have been made under the Finance Agreement. At June 30, 2017, the carrying value of the borrowings under the Finance Agreement is $10,800,798, net of unamortized debt issuance costs of $161,510. ‘The Financing Agreement contains certain financial and reporting covenants with which the Company is in compliance. Interest expense was $2,168,764 and $2,519,735 for the years ended June 30, 2017 and 2016, respectively, ‘Management believes that the carrying value of debt approximated fair value at June 30, 2017 and 2016, as all of the debt bears interest at variable rates based on prevailing market conditions. Note 9: Contingent Liabilities In the normal course of business, the Company and certain of its subsidiaries are defendants in various lawsuits, ‘After consultation with counsel, management is of the opinion that these various lawsuits, individually or in the aggregate, ‘will not have a materially adverse effect on the consolidated financial statements, Note 10; Employee Benefits ‘The Company maintains non-qualified executive savings and profit sharing plans for certain eligible employees. ‘The Company's contributions to the plans are based on matching voluntary employee contributions and on a profit sharing formula after certain minimum earings levels are reached by the Company. During fiscal 2016, the Company paid back $1,250,000 and borrowed an additional $8,250,000. During fiscal 2017, the Company paid back $4,000,000 and borrowed an ‘additional $1, 500,000. At June 30, 2017, the amounts borrowed bear interest at 1.54%, with prineipal and interest to be paid ‘on or before December 21, 2021. At June 30, 2017, participant's account balances that are attributable to the voluntary ‘employee contributions amount to $2,858,411 and to the Company’s contributions amount to $10,335,818. For the years tended June 30, 2017 and 2016, the related contributions to the plan were $1,074,430 and $943,145, respectively. At June 30, 2017 and 2016, plan assets of $6,668,445 and $2,333,308, respectively, and plan liabilities of $14,445,788 and $12,479,678, respectively, are included within deferred charges and other assets with the corresponding liability shown in deferred employee benefits, accounts payable and accrued payroll and related employee benefits in the accompanying consolidated balance sheets. Interest of $167,904 and $100,955 for fiscal years 2017 and 2016, respectively, was charged to the Company on the ‘amounts borrowed and was recorded as a liability at June 30, 2017 and 2016, respectively, within deferred employee benefits in the accompanying consolidated balance sheets with a related charge to compensation expense, Investment income related to plan assets and a corresponding charge to compensation expense of $29,238 and $42,412 has been recorded at June 30, 2017 and 2016, respectively. ‘The Company sponsors a 401(k) plan for al eligible employees of the Company and contributes a certain percentage for every dollar that the employee contributes to their 401(k) account. The Company's contributions to the 401(k) plan for the years ended June 30, 2017 and 2016 were $97,381 and $140,336, respectively.Notes to Consolidated Financial Statements Note IT; Phantom Equity Plan ‘The Company sponsors a Phantom Equity Plan (the “Plan) for officers and key employees of the Company. The Plan may grant awards of economic interest to officers and key employees of the Company. Awards are made at the discretion of the Board of Directors. The total number of awards made under the Plan will be determined by the Board of Directors in its sole discretion. The awards vest immediately upon issuance and expire upon termination of employment with certain conditions. Plan participants will be paid if and when all or substantially all of the Company's assets are sold. Since the sale of the Company's assets cannot be predicted, a value for the phantom equity cannot be determined and thus no Plan expense has been recorded in the consolidated financial statements. Note 12: Sioek-Based Compensation During the year ended June 30, 2017, the Company made a single grant stock option grant to an employee. Under the terms of the award, the Company issued 50,000 stock options to the employee. The stock options award issued has a 10- ‘year term and vest /4th on each anniversary of the date of grant. ‘The assumptions used and calculated fair value of the options issued during the year ended June 30, 2017 are as follows: Expected dividend yield 25% Risk-free interest rate 146% Expected life in years 625 Expected volatility 47 % Fair value of options granted $36.34 ‘The following tables summarize stock option activity for the year ended June 30, 2017: During the year ended June 30, 2017, the Company recognized $308,636 of stock-based compensation for the vesting of outstanding stock options. At June 30, 2017, unrecognized compensation cost related to unvested awards totaled $1,508,359. The weighted-average period over which this remaining compensation cost will be recognized is 3.3 years. Weighted. average Weight- remaining Number of average —comtractual-—_Aggregage options exercise price _ term (ears) Intrinsic Value ustanding at July 1,2016 ~__§ ~ Granted 100 ustanding at June 30, 2017 100 93 Exercisable at June 30, 2017 ee ee Vested or expected to vest at June 30,2017 30,000 $ 100 33S - Weighted Nonvested average fair options value Unvested options, July 1, 2016 : 5 Granted 50,000 36.34 Vested 3 : Forfeited - Unvested options, June 30, 2017 3000S 3634Notes to Consolidated Financial Statements Note 13: Income Taxes ‘The components of the income tax benefit are: For the yeors ended June 30 2017 2016 Curren: Federal $260,019 $ 36726 sate eas.843 770541 T287.862 Ts7 80 Deferred Federal 4.196645) 1,518,700) State 530,146 100,398 ‘ota (benefit) provision fr income taxes S__(143899 $1,671.79) Reconciliation of the income tax benefit computed at the U.S. Federal statutory income tax rate to the reported. provision is: For the years ended June 30, 2017, 2016 ULS, Federal statutory income tax $ (1,156,202) $ (1,201,655) State income taxes, net of Federal tax benefit 88,899 (336,078) Domestic production activities deduction (251,621) (93,988) Change in valuation allowance (152,534) 2.155) Other 32,529) 37.918) ‘Total (benefit) provision for income taxes $__.438,929) _$__(1,671,794 ‘The major components of the deferred income tax liabilities and assets are: For the years ended June 30, 2017 2016 Differences in property and equipment S (5457041) $ (5,980,628) Differences in goodwill 1,007,359) 856,618 Total deferred income tax liabilities (6.464.400) (6.837.246) [Expenses not currently deductible 6,123,788 5,488,571 Recognized losses not currently deductible 1,380,986 2,893,154 Differences in intangible assets 20,598,676 16,430,463, ‘Acquisition costs not currently deductible 1,004,795, 1,107,753, Unrealized losses on derivatives 880,022 a Other 258,870 125,785 Valuation allowance (957,059) 4,109,593) ‘Total deferred income tax assets 29.290,078 24,936,135 ‘Net deferred income tax assets $22,825,678 _$__ 18,098,887Notes to Consolidated Financial Statements Note 14: Business and Credit Concentration Financial instruments which potentially subject the Company to concentrations of credit risk consist primarily of ceash and cash equivalents and accounts receivable. ‘The Company maintains its cash and cash equivalents with high-credit quality financial institutions. Concentrations of eredit risk with respect to accounts receivable, for which the Company does not require collateral, are limited due to the large number of customers comprising the Company’s customer base, their persion across different geographic areas and generally short payment terms. In addition, the Company closely monitors the extension of eredit to its customers while maintaining allowances for potential credit losses. ‘The Company's cash and cash equivalent balances in financial institutions at times may exceed Federally insured limits. At June 30, 2017 and 2016, cash in excess of Federal insurance limits totaled $4,316,000 and $1,474,000 respectively. Note 15: Related Party Transactions ‘The Company has three loans outstanding to an officer of Scope Industries totaling $196,000 andS200,000 at June 30, 2017 and 2016, respectively. ‘The notes bear interest at 4% per year and are due December 31, 2018. Interest on these loans for the years ended June 30, 2017 and 2016 totaled $7,862 and $8,044, respectively. At June 30, 2017 and 2016, $15,944 and $20,647, respectively, of interest is outstanding on these loans. 20COHN@REZNICK catemaandt ACCOUNTING # TAX + ADVISORY ccohnreznick.com Independent Auditor's Report To the Board of Directors and Shareowners ‘Scope Industries We have audited the accompanying consolidated financial statements of Scope Industries and Subsidiaries, Which comprise the consolidated balance sheets as of June 30, 2017 and 2016, and the related consolidated ‘statements of operations, shareowners’ equity and cash flows for the years then ended, and the related notes to the consolidated financial statements. Management's Responsibility for the Financial Statements ‘Management is responsible for the preparation and fair presentation of these consolidated financial statements in ‘accordance with accounting principles generally accepted in the United States of America; this includes the Gesign, implementation, and maintenance of intemal control relevant to the preparation and fair presentation of Consolidated financial statements that are free from material misstatement, whether due to fraud or error. Auditor's Responsibility Cur responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free from material misstatement. ‘An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the Consolidated financial statements. The procedures selected depend on the auditors judgment, including the Sesessment of the risks of material misstatement of the consolidated financial statements, whether due to fraud or Grror, In making those tisk assessments, the auditor considers internal control relevant to the entity's preparation Sha fair presentation of the consolidated financial statements in order to design audit procedures that are propriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the entity's internal control Accordingly, we express no such opinion. An audit also includes evaluating the Sppropriateness of accounting policies used and the reasonableness of significant accounting estimates made by management, 28 well as evaluating the overall presentation of the consolidated financial statements, We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our audit opinion, Opinion In our opinion, the consolidated financial statements referred to above present fairy, in all material respects, the financial position of Scope Industries and Subsidiaries as of June 30, 2017 and 2016, and the results of their ‘operations and their cash flows for the years then ended in accordance with accounting principles generally accepted in the United States of America. CokrrRegnch ZI Los Angeles, California September 22, 2017Scope INDUSTRIES 2017 80th ANNUAL REPORT