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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-K
[X] Annual Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 for the fiscal year ended December 25, 1998 or
[ ] Transition Report Under Section 13 or 15(d) of the Securities
Exchange Act of 1934 for the transition period from
_________to__________ .
Commission File Number: 0-28426
ZOMAX OPTICAL MEDIA, INC.
(Exact name of registrant as specified in its charter)
Minnesota No. 41-1833089
(State or Other Jurisdiction of (IRS Employer
Incorporation or Organization) Identification No.)
5353 Nathan Lane, Plymouth, MN 55442
(Address of Principal Executive Offices)
Registrant's telephone number (612) 553-9300
Securities registered under Section 12(b) of the Exchange Act: None
Securities registered under Section 12(g) of
the Exchange Act:
Common Stock, no par value
Check whether the registrant (1) filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such
shorter period that the registrant was required to file such reports), and (2)
has been subject to such filing requirements for the past 90 days. YES[ ] NO[x]
Check if there is no disclosure of delinquent filers in response to Item 405 of
Regulation S-K contained in this form, and no disclosure will be contained, to
the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]
The aggregate market value of the voting stock held by non-affiliates was $
99,611,964 based on the closing sale price of the Company's Common Stock as
reported on the Nasdaq National Market on March 11, 1999.
The number of shares outstanding of the registrant's common stock as of March
11, 1999: 7,268,577 shares.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Proxy Statement for the Annual Meeting of Shareholders to be
held May 3, 1999, are incorporated by reference into Part III of this report.
PART I
ITEM 1. BUSINESS
General
Zomax Optical Media, Inc. is a leading outsource service provider to
software publishers, computer manufacturers and other producers of multimedia
products. These outsource services include front-end marketing programs (call
centers), graphic design, print management, compact disc ("CD") and digital
versatile disc ("DVD") mastering, CD, DVD, diskette and cassette replication,
printing, packaging, warehousing and inventory management, fulfillment and
distribution, and returned merchandise authorization ("RMA") processing
services. By providing a full range of multimedia services, Zomax differentiates
itself from its competitors who offer only a subset of these services. Zomax
believes its expertise and capital investment allow its customers to focus on
their core competencies, reduce costs, accelerate time to market, access
advanced replication and design capabilities, reduce capital investment, improve
inventory management and purchasing power, and access manufacturing, warehousing
and distribution capabilities in a variety of geographic regions.
The Company services a broad customer base, including Microsoft,
Novell, Hewlett Packard and Gateway. The Company has demonstrated an ability to
provide consistently high quality products and services in a short turnaround
time. Zomax believes its high level of customer service and responsiveness to
customers' needs provides it with a competitive advantage which differentiates
the Company from its competitors.
Recent Acquisitions
To enhance its position as a leading outsource service provider, Zomax
has expanded its geographic presence and outsource services by acquiring
production capacity as well as call centers, distribution and RMA capabilities.
The Company believes that its recent acquisitions enable it to provide
additional integrated services, create an opportunity to attract new customers
and cross-market its services to existing customers.
Within the last two years, the Company has made the following
acquisitions:
o Benchmark Media Services, Inc., (Benchmark) a software media
replicator with operations in Plymouth, Minnesota and
Indianapolis, Indiana; acquired in March 1997;
o Trotter Technologies, Inc., (TTI) an RMA processing,
warehousing and distribution company based in San Jose,
California; acquired in May 1997;
o Primary Marketing Group, (PMG) a manufacturers' representative
group, based in San Jose, California servicing the needs of
computer hardware and software publishers; primary sales group
for Kao Corporation in California; acquired in February 1998;
o Next Generation Services, LLC, (NGS) an RMA processing company
with facilities in Hayward, California and Boston,
Massachusetts; acquired in February 1998;
o Primary Marketing Group Ltd., (PMG Ireland) an RMA processor
and provider of manufacturers' representative services in
Ireland; acquired in February 1998.
o Certain assets and contractual rights of Kao Corporation,
including an agreement regarding the manufacture and
distribution of products for Novell, Inc.; acquired in
February 1998.
o Kao Corporation, an industry leading software replicator with
operations in Fremont and San Ramon, California; Arnprior,
Canada; Dublin, Ireland and Langen, Germany; acquired in
January 1999.
Industry
The multimedia services industry is comprised of companies that provide
a wide variety of services to software publishers, computer manufacturers, book
publishers, independent record labels and other producers of multimedia products
ranging from replication only to complete multimedia services. Growing consumer
demand for multimedia products such as CD-ROM, DVD-ROM and CD-Audio and a
corresponding increase in the installed base of CD and DVD drives and CD-Audio
players have been significant factors driving the demand for multimedia
services.
According to the Optical Publishing Industry Assessment (9th ed. 1998)
prepared by InfoTech, Incorporated, an independent market research and
consulting firm headquartered in Woodstock, Vermont, the worldwide installed
base of CD-ROM drives more than doubled each year from 1992 to 1995, to 68
million and is estimated to increase from 195 million in 1997 to 338 million in
2000. Furthermore, InfoTech reports that the number of CD-ROMs replicated
worldwide increased from 500 million in 1995 to 1.4 billion in 1997 and is
estimated to increase to 2.2 billion in 2000. The worldwide installed base of
DVD-ROM drives is estimated by InfoTech to increase from 330,000 in 1997 to 6.5
million in 1998 and 78 million in 2000. The number of DVD-ROMs replicated
worldwide is estimated to increase from 1.5 million in 1997 to 57 million in
1998 and 580 million in 2000.
While CD-ROM technology has become the preferred medium in the computer
software industry, some software developers continue to utilize diskettes.
Similarly, although CD-Audio is the preferred medium for audio products, audio
cassettes continue to be a significant format. According to InfoTech, the
worldwide installed base of CD-Audio players was estimated at 420 million in
1997 and is expected to reach 500 million in 1998. InfoTech estimates that the
number of replicated CD-Audio products worldwide will reach 3.3 billion units in
1998, up from 3.1 billion units in 1997. The Recording Industry Association of
America estimated that 173 million audio cassettes were distributed in the U.S.
in 1997.
Some software publishers and computer hardware OEMs still dedicate
in-house resources to manufacturing and fulfillment. However, significant and
increasing demand exists for outsource services from providers who can reliably
manufacture and process multimedia products within short turnaround times. The
Company estimates that, based on discussions with software publishers, 15
percent of all shipments to software retailers ultimately require RMA
processing. The same factors that have led to the trend toward more outsourcing
are driving consolidation in the industry as many small local and regional
service providers find it increasingly difficult to access the capital required
to invest in new capital equipment and additional value-added services.
Services
The Company believes that it offers the most comprehensive range of
multimedia manufacturing services. These value-added services cover each aspect
of a software product's life cycle. Customers can engage Zomax on a
service-by-service basis, depending on their needs. In all cases, Zomax project
management maintains regular contact with customers and coordinates all services
provided. With the breadth of services offered by the Company, customers can
bring their end products to market without ever handling the product themselves.
Marketing Programs. The Company offers a complete marketing program
services which includes program management, call center operations, financial
services, fulfillment and information systems. The call centers provide various
levels of customer support, first level technical support and outbound for
revenue generation opportunities covering sixteen languages. The Company is in
direct contact with its customers' customers.
Graphic Design. The Company works directly with its customers in
developing product and packaging designs.
Print Management. The Company receives print specifications from its
customers, facilitates printing purchases and implements quality controls to
ensure on-time delivery of the end product. Additionally, Zomax provides print
inventory management services.
Mastering. During the mastering process, a laser beam recorder
transfers the digital information onto a glass mastering substrate. This
substrate then undergoes an electroforming process that creates a metal stamper
from which CDs and DVDs are molded. The mastering process is critical to product
quality and is conducted in a clean-room environment free of microscopic
contaminants which can obscure large amounts of data.
Replication. CDs and DVDs are replicated using an integrated robotic
line process which incorporates plastic injection molding, metalizing,
lacquering and inspection equipment. The replication process begins with the
injection of high quality, CD-grade polycarbonate into the mold cavity where the
metal stamper has been mounted. The extruded clear polycarbonate into the mold
cavity where the metal stamper has been mounted. The extruded clear
polycarbonate disc containing all of the digitized data is then covered with a
metallic coating to provide for reflection of the reading laser beam in the
player. A thin layer of lacquer is then applied over the metal to protect it and
to serve as a base for printing on the disc. Unacceptable CDs and DVDs are
detected and discarded through the inline inspection process. The Company
currently has a combination of 52 CD and DVD production lines at its facilities.
Audio cassettes are mass-duplicated from a master tape which is run on
an endless loop on a high speed duplicating system comprised of a master unit
which feeds audio programming to "slave" units. The slave units make copies as
the master unit runs and reruns the tape, creating large reels or "pancakes" of
tape recorded with information. The tape is then fed into cassette loaders which
remove the duplicated tape off the reel and place it into cassette housings.
These housings are then labeled or imprinted and combined with graphics.
Computer diskettes are duplicated on multiple duplicating drives which
are connected to a PC-based controller. The master diskette is read into the
system and the controller sends the image of the master to each duplicating
drive, writing the information to the blank diskettes. Each diskette is verified
after being duplicated. After duplication, the diskettes are labeled, collated,
if necessary, and packaged for distribution.
CD and DVD Printing. Printing is performed in batches off-line in order
to take advantage of the high speed nature of the printing process while
avoiding the production delays typically required for printer setup. The
Company's printing equipment includes screen printing presses with capabilities
of up to six-color printing. The Company produces its own screens and custom
mixes all ink in-house. Automated label and print quality inspection equipment
is integrated with the screen printers to ensure high quality control and reduce
the need for manual quality inspection.
Packaging. The Company has automated equipment to provide for commonly
requested packaging configurations. Currently, the standard CD packaging
configuration is the plastic "jewel box" with customer or Zomax supplied print
material in the bottom and top of the box. The standard audio cassette packaging
is the "Norelco box." For non-automated assembly requirements, the Company
provides a full range of hand assembly options. As part of its dedication to be
full-service provider, the Company works with its customers to develop
sophisticated retail packaging configurations.
Warehousing and Inventory Management. To assist customers in minimizing
costs and reducing time to market, Zomax offers comprehensive warehousing and
inventory management services. Increasingly, the Company is warehousing products
for customers and shipping those products directly into the customers'
distribution channels. The Company believes this service provides customers with
a more comprehensive solution and enables them to be more responsive to market
demands.
Distribution and Fulfillments. The Company offers its customers
flexible, just-in-time delivery programs allowing product shipments to be
closely coordinated with customers' inventory requirements. Zomax can
accommodate large shipments to distribution centers and receive and fulfill
same-day orders to individual locations.
RMA Processing. Zomax employees receive, sort, count, recycle,
re-price, repackage and redistribute returned, obsolete or excess software
merchandise. The Company also receives, tests and redistributes hardware at one
of its California facilities. A customer can maximize its operating efficiencies
by using Zomax to coordinate RMA processing with inventory management and
replication orders.
Customers and Markets
The Company markets and sells multimedia services to a variety of
customers, including software publishers, computer manufacturers, book
publishers, independent record labels, marketing groups and data base suppliers.
Zomax currently services a broad customer base in these industry segments
including Gateway, Microsoft, Novell, GT Interactive and Expert Software.
In 1999, the Company obtained authorized replicator status with
Microsoft that allows the Company to replicate Microsoft(R) products for any
authorized distributor. This status is pursuant to an agreement with Microsoft
that expires in October 1999. Previously, the Company had been a select
authorized replicator of Microsoft(R) products for Gateway only. The Company
expects, but cannot guarantee, that the authorized replicator status will
continue. In addition, the Company has an agreement with Microsoft to provide
RMA processing, which agreement may be terminated by Microsoft upon 30 days'
notice.
One of the Company's primary customers is Gateway, which accounted for
16.7%, 38.3% and 18.0% of the Company's consolidated sales in 1998, 1997 and
1996, respectively. Zomax is a primary supplier of CDs to Gateway and in August
1997 was named its North American Supplier of the Year. The Company has an
agreement with Gateway that governs the procedures for making and receiving
orders. This agreement expires July 31, 1999, but may be renewed for additional
one-year terms upon agreement of the parties, subject to earlier termination by
Gateway upon 30 days notice.
In 1998, the Company began providing replication, packaging,
distribution and fulfillment services to Novell from its San Jose, California
facilities under an Agreement for Manufacturing Turnkey Products. This agreement
expires in 2000 but may be renewed annually, subject to earlier termination by
Novell upon 90 days' notice. Sales to Novell accounted for 13% of the Company's
consolidated sales in 1998.
Marketing and Sales
Zomax focuses its marketing efforts on customers that require personal
service, flexibility, fast turnaround time and a complete outsource solution to
their multimedia service needs. The Company has successfully marketed itself to
these customers by managing all of the steps in the process from design to
replication to packaging to delivery. As part of its strategy, the Company also
intends to continue cross-marketing its services to customers who may currently
rely on the Company for only a portion of their multimedia service needs.
The Company employs a direct sales staff that is responsible for
maintaining relationships with existing customers and developing new business
relationships. With the Kao acquisition in January 1999, the Company expanded
its direct sales staff to 22 people. The Company's direct sales staff is
supported by a project management staff of 118 people that is responsible for
ensuring that each order is processed on a timely basis, all required support
materials are in place and desired quality levels are achieved. Each customer
account is assigned one or more project managers to provide daily contact with
the customer, coordinate the purchase and manufacture of all necessary
materials, adapt to order changes and generally act as liaison with the
customer.
Competition
The multimedia service industry is highly competitive and is
experiencing consolidation. The Company competes primarily with independent
service providers and, to a lesser extent, with affiliates of major
international music companies and small localized service providers. Each of
these producers generally services a defined set of customer needs.
o Affiliates of major international music companies. This
category consists of large manufacturers who are affiliated
with major international music companies such as Sony Music
Entertainment, Inc., PolyGram Holdings, Inc., Warner Music,
BMG Music and EMI Music. These service providers dedicate a
majority of their manufacturing capacity to the production of
CD-Audio for affiliated record labels and typically offer a
very limited range of services.
o Independent service providers. Participants in this segment
include companies such as Zomax, Disctronics, Inc., Denon
Electronics, Inc., Cinram International Inc., Startek
Corporation and Metatec Corporation. Independent service
providers generally have the ability to handle large volume
requirements and have varying degrees of service capability.
However, most independent manufacturers do not typically offer
as comprehensive a range of outsource services as Zomax.
o Small localized service providers. These service providers
generally have limited production capacity and offer a limited
range of related services. The complexity of the manufacturing
process and the large capital investment required to maintain
and upgrade capacity generally constrain these small service
providers.
Other existing technologies also compete with the Company's products
that deliver digital information. Portable media, such as digital audio tape,
digital compact cassette and mini-disc have already been introduced commercially
but have not yet achieved widespread consumer acceptance. In addition, one-time
recordable CDs ("CD-R") are available and are often used to replicate short run
products that are more expensive to manufacture in the traditional manner. The
Company does not expect any of these technologies to expand beyond their current
market niches in the near future.
Electronic on-line delivery of digital information, such as through the
Internet, is a potential future competitor of CD and DVD technology. The Company
believes that current and projected transmission speeds and infrastructure
limitations of on-line delivery systems will prevent them from replacing CD and
DVD technology in the foreseeable future. In addition, future advances in CD and
DVD technology, such as higher speed drives and greater data compression, could
increase the advantages of these technologies over electronic on-line delivery
and other potential competitive technologies.
Competition in the hardware and software RMA processing industry
segment is extremely fragmented. Generally, participants in this industry
segment include a number of independent companies as well as publishers and OEMs
that dedicate in-house resources to RMA processing.
Many of the Company's national and regional competitors are, and future
potential competitors may be, larger and more established with greater financial
and other resources than the Company, particularly as consolidation in the
industry continues. As a result, such competitors may be able to respond more
quickly to market changes or to devote greater resources to the manufacture,
promotion and sale of their products and services than can the Company.
The Company believes that it competes favorably with its competitors
with respect to quality, service, reliability, price, manufacturing capacity and
timely delivery of product, the principal competitive factors in this industry.
The Company also believes that customers are willing to incur additional costs
for extra services. As such, to enhance its competitive position, the Company
offers a full range of value-added services to customers including design,
preparation and printing of artwork and packaging, warehousing and shipping and
RMA processing.
Proprietary Rights
Zomax, like most other CD manufacturers, uses patented technology
primarily under nonexclusive licenses. These licenses generally provide for the
payment of royalties based upon the number, size and use of CDs sold and
terminate either upon the expiration of the patent being licensed or on a date
certain.
Zomax currently has license agreements with U.S. Philips Corporation
("Philips") and Discovision Associates ("DVA"). These agreements grant to Zomax
non-exclusive, royalty-bearing, non-transferable licenses to make, use and sell
CDs. The royalty payments due under the licenses generally depend of the number
of CDs manufactured, their size and their use. The Company's license from
Philips expires in 2006. The term of the DVA license continues until the
expiration of the last DVA patent covered by the license which is currently in
2010. This date may change in the event of a patent invalidity ruling, premature
expiration of a currently licensed patent or the subsequent issuance of a
related patent.
The Company is currently negotiating licenses from the owners of DVD
technology to manufacture DVDs. Although the Company expects to obtain such
licenses, no assurances can be made that such licenses will be obtained and the
Company cannot predict the amount of the royalty that will be payable under any
such license.
Employees
The Company has approximately 1,200 full-time employees and hires
additional employees on a temporary, full-time basis to perform
manufacturing-related services as the need arises. The Company currently
operates its Minneapolis, Arnprior, Fremont and Dublin facilities 24 hours a
day, seven days a week. The Company believes that its relations with its
employees are good. None of the Company's employees is covered by a collective
bargaining agreement.
Cautionary Factors That May Affect Future Results
Certain statements contained in this Annual Report on Form 10-K are
forward-looking, based on current expectations. Such statements can be
identified by the use of terminology such as "anticipate," "believe,"
"estimate," "expect," "intend," "may," "could," "possible," "plan," "project,"
"will," "forecast" and similar words or expressions. The Company's
forward-looking statements generally relate to its growth strategy, financial
results and sales efforts. Investors are cautioned that all forward-looking
statements involve risks and uncertainties, including among others those
identified below. The Company undertakes no obligation to update any
forward-looking statement, but investors are advised to consult any further
disclosures by the Company on this subject in its filings with the Securities
and Exchange Commission. In this regard, please also see the Outlook section of
Item 7 below.
Although it is not possible to create a comprehensive list of all
factors that may cause actual results to differ from the Company's
forward-looking statements, such factors include, among others, (i) the
Company's ability to sustain and manage its growth and implement its business
strategy, including the integration of newly acquired and geographically
dispersed operations; (ii) the Company's ability to adapt quickly to changes in
information storage and retrieval technology; (iii) the Company's reliance on a
few key customer and strategic relationships, including those with Microsoft,
Gateway and Novell; (iv) the trend of consolidation in the industry and the
ability of the Company to effectively compete in an intensely competitive
environment; (v) the development of new products or technologies by competitors,
technological obsolescence and other changes in competitive factors; (vi) risks
associated with establishing and maintaining international operations; (viii)
the Company's dependence on its ability to obtain and maintain licenses to use
patented technology in its manufacturing operations; and (viii) economic factors
over which the Company has no control.
ITEM 2. PROPERTIES
The Company leases facilities throughout the U.S. and Europe and owns
property in Canada. The following table sets forth information about the
Company's facilities. Management believes its facilities are adequate for the
Company for the foreseeable future.
- ---------------------------- --------------------- --------------------- -------------------------------------------
Approximate Square Lease Expiration
Location Feet Services
- ---------------------------- --------------------- --------------------- -------------------------------------------
Dublin, Ireland (1) 110,000 1999 - 2016 (2) Call center, print management, mastering,
replication, printing, packaging,
warehousing, fulfillment, distribution
and RMA processing
- ---------------------------- --------------------- --------------------- -------------------------------------------
Hayward, California 64,000 2002 RMA processing and hardware return
testing and processing
- ---------------------------- --------------------- --------------------- -------------------------------------------
Indianapolis, Indiana 107,000 2002 (3) Diskette replication, packaging,
fulfillment and distribution
- ---------------------------- --------------------- --------------------- -------------------------------------------
Minneapolis, Minnesota 96,000 2000 (4) Graphic design, print management,
mastering, replication, printing,
packaging, warehousing, fulfillment,
distribution and RMA processing
- ---------------------------- --------------------- --------------------- -------------------------------------------
San Jose, California 275,000 2002 (5) Includes new facility completed in 1998
to provide graphic design, print
management, mastering, replication,
printing, packaging, warehousing,
fulfillment, distribution and RMA
processing
- ---------------------------- --------------------- --------------------- -------------------------------------------
Fremont, California (1) 150,000 2006 Print management, mastering, replication,
printing, packaging, warehousing,
fulfillment and distribution.
- ---------------------------- --------------------- --------------------- -------------------------------------------
San Ramon, California (1) 58,000 2001 Call center
- ---------------------------- --------------------- --------------------- -------------------------------------------
Arnprior, Canada (1) 158,000 Owned Print management, mastering, replication,
printing, packaging, warehousing and
distribution.
- ---------------------------- --------------------- --------------------- -------------------------------------------
Langen, Germany (1) 25,000 2000 Diskette duplication, packaging,
warehousing and distribution.
- ---------------------------- --------------------- --------------------- -------------------------------------------
- ------------------
(1) These facilities were acquired as part of the Kao acquisition in
January 1999.
(2) Includes leases for four different sites.
(3) Includes bases for two sites, in addition, the Company also leases
105,000 square feet on a monthly basis for a customer specific
project (this amount not included above).
(4) Included leases for two sites, one of which is 68,000 sq. ft, with
Nathan Lane Partnership, LLP (described below) expires in 2000 but
has an option to extend two additional terms of three years each. Lease
for additional facility expires in 2000 but has an option to extend for
an additional three years.
(5) Includes leases for three different sites, two of which expire in 2002 but
have options to extend for an additional five years. The third lease,
covering the Berryessa facility (described below), expires in 1999.
The Company leases a majority of its manufacturing, office and
warehouse space in Minneapolis, Minnesota from Nathan Lane Limited Partnership,
a Minnesota limited liability partnership of which Mr. Phillip T. Levin,
Chairman of the Board of Zomax, owns a one-third interest. Pursuant to this
lease, as amended, the Company leases approximately 68,000 square feet at an
average base rent of $6.57 per net rentable square foot per annum. The Company
is also obligated to pay its proportionate share of taxes and operating
expenses.
The Company leases its Berryessa Road facility in San Jose under a
sublease from Novell, Inc. At this facility, the Company provides services
primarily to Novell under the terms of an Agreement for Manufacturing Turnkey
Products.
ITEM 3. LEGAL PROCEEDINGS
The Company is involved in claims arising in the normal course of
business. In management's opinion, the final resolution of these claims should
not have a material adverse effect on the Company's financial position or
results from operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the
fourth quarter of 1998.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's Common Stock is quoted on the Nasdaq National Market
under the symbol "ZOMX." The following table sets forth, for the periods
indicated, the high and low bid prices of the Company's Common Stock. These bid
quotations represent inter-dealer prices and do not include retail mark-ups,
mark-downs or commissions and may not necessarily represent actual transactions.
Fiscal Year Ended December 26, 1997: High Low
First Quarter.................................. $7.38 $4.75
Second Quarter................................. 7.63 4.13
Third Quarter.................................. 10.38 7.75
Fourth Quarter................................. 15.00 10.50
Fiscal Year Ended December 25, 1998:
First Quarter.................................. $18.19 $9.13
Second Quarter................................. 20.00 14.13
Third Quarter.................................. 16.25 8.50
Fourth Quarter................................. 16.50 3.88
The Company has never declared or paid cash dividends on its capital
stock and does not anticipate declaring or paying any cash dividends in the
foreseeable future. The Company intends to retain future earnings for the
development of its business.
As of March 11, 1999, there were approximately 160 record holders of
the Company's Common Stock, excluding stockholders whose stock is held either in
nominee name and/or street name brokerage accounts. Based on information which
the Company has obtained from its transfer agent, there are approximately 6,200
stockholders of the Company's Common Stock whose stock is held either in nominee
name and/or street name brokerage accounts.
ITEM 6. SELECTED FINANCIAL DATA
(000's except per share data) For the years ended
----------------------------------------------------------------------------------
1998 1997 1996 1995 1994
---------------- -------------- -------------- -------------- -------------
Statement of Operations Data:
Sales $61,074 $47,877 $26,867 $16,858 $10,085
Gross Profit 16,804 15,104 8,776 5,632 2,541
Selling, general and 10,595 9,860 5,366 3,853 1,435
administrative expenses
Operating Income 6,208 5,244 3,410 1,779 1,106
Income before taxes 6,141 5,218 3,613 3,575 938
Pro Forma(1):
Income before income taxes 6,141 5,218 3,613 3,575 938
Provision for income taxes (2,580) (2,090) (1,461) (1,434) (362)
Net Income 3,561 3,128 2,152 2,141 576
Earnings per share -
Basic 0.56 0.60 0.47 0.59 0.16
Diluted 0.53 0.58 0.47 0.59 0.16
Weighted average number of
shares outstanding:
Basic 6,367 5,224 4,599 3,600 3,600
Diluted 6,731 5,358 4,601 3,600 3,600
1998 1997 1996 1995 1994
---------------- -------------- -------------- -------------- -------------
Balance Sheet Data:
Cash $25,621 $ 5,213 $ 7,945 $ 937 $ 1,636
Working capital 26,969 5,049 9,029 2,631 618
Total assets 65,424 31,026 24,322 12,485 6,682
Long-term notes payable, less 1,746 3,104 1,834 2,979 2,188
current portion
Total shareholders' equity 50,087 16,463 14,643 5,166 2,106
================ ============== ============== ============== =============
(1) A pro forma provision has been established as if all consolidated companies
were taxable entities for all periods presented.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
General
The Company is a leading outsource service provider to software
publishers, computer manufacturers and other producers of multimedia products.
These services include CD and DVD mastering; CD, DVD, diskette and cassette
replication; graphic design; print management; CD printing; packaging;
warehousing; inventory management; distribution and fulfillment; and RMA
processing services. The Company records sales to its customers at the time
merchandise is shipped or as services are rendered. For certain customers,
merchandise is invoiced upon completion of orders with shipment occurring based
on written customer instructions.
The multimedia services industry has been characterized by short lead
times for customer orders. For this reason and because of the timing of orders,
delivery intervals and the possibility of customer changes in delivery
schedules, the Company's backlog as of any particular date is not a meaningful
indicator of future financial results.
On January 7, 1999, the Company acquired the businesses and certain net
assets of Kao Corporation in United States, Canada, Ireland and Germany. The
purchase price for the business, net assets and net working capital acquired was
$37.5 million, subject to certain post closing adjustments. The assets and
businesses acquired by the Company were used in the manufacturing and sale of
CDs and related businesses, and the Company intends to continue to use the
assets and businesses in a similar manner. The acquisition will be accounted for
using the purchase method of accounting and, accordingly the purchase price will
be allocated to net assets acquired based on their estimated fair values. Since
this acquisition occurred after year-end, no financial results have been
included in the accompanying audited financial statements.
On February 4, 1998, PMG, NGS and PMG Ireland were merged with and into
the Company. As a result of these transactions, all ownership interests in the
acquired companies were exchanged for 800,002 shares of the Company's Common
Stock. Prior to these transactions, the businesses of PMG, NGS, and PMG Ireland
consisted of providing manufacturer's representative services and RMA processing
services to the computer industry. PMG, NGS and PMG Ireland operated their
respective businesses from facilities located in and around San Jose,
California; Boston, Massachusetts; and Dublin, Ireland. In connection with the
transactions described above, the Company acquired certain assets and assumed
certain liabilities from an unrelated third party for $1.1 million. The
acquisition of PMG, NGS and PMG Ireland were accounted for using the
pooling-of-interests method of accounting, and accordingly, all periods
presented have been restated to reflect the effects of these transactions.
On May 1, 1997, the Company acquired the outstanding shares of Trotter
Technologies, Inc. (TTI), an RMA processing, warehouse and distribution company
based in San Jose, CA, servicing the software publishing market. The purchase
price of TTI was $712,000 cash and 59,268 shares of the Company's Common Stock.
The acquisition of TTI was accounted for using the purchase method of
accounting. As a result of this treatment, the TTI purchase price was allocated
to net assets acquired based on estimated fair values and approximately $1.2
million of cost in excess of net assets acquired was recorded as goodwill.
On March 31, 1997, the Company acquired the outstanding shares of
Benchmark Media Services, Inc., a software media replicator with operations in
Minneapolis, Minnesota and Indianapolis, Indiana. The Company agreed to pay
consideration based on revenues of Benchmark in 1997. Revenue levels were not
met; therefore, no consideration was paid. The Benchmark acquisition was
accounted for using the purchase method of accounting.
Prior to the Company's initial public offering, the Company operated as
a partnership and, prior to the acquisitions described above, certain of the
companies operated as non-taxable entities. A pro forma tax provision has been
established as if all consolidated companies were taxable entities for all
periods presented.
Results of Operations
The following table sets forth certain operating data as a percentage
of sales for the periods indicated.
For the Years Ended
-----------------------------------------------------------
December 25, December 26, December 27,
1998 1997 1996
-------------------- -------------------- ---------------
Sales........................................... 100.0% 100.0% 100.0%
Cost of sales................................... 72.5 68.5 67.3
-------------------- -------------------- ---------------
Gross profit.................................... 27.5 31.5 32.7
Selling, general and administrative
expenses........................................ 17.3 20.6 20.0
-------------------- -------------------- ---------------
Operating income................................ 10.2 10.9 12.7
Equity in losses of unconsolidated
entity.......................................... 0.6 - -
Interest expense................................ 0.6 0.8 1.3
Interest income................................. (1.6) (0.5) (1.2)
Other (income) expense, net..................... 0.5 (0.3) (0.8)
-------------------- -------------------- ----------------
Income before income taxes...................... 10.1 10.9 13.4
Pro forma provision for income
taxes(1)........................................ 4.2 4.4 5.4
-------------------- -------------------- ---------------
Pro forma net income............................ 5.9% 6.5% 8.0%
==================== ==================== ================
(1) A pro forma tax provision has been established as if all consolidated
companies were taxable entities for all periods presented.
For the Years Ended December 25, 1998 and December 26, 1997
Sales. The Company's sales were $61.1 million for 1998, an increase of
27.6% from $47.9 million in 1997. CD related sales increased 68% in 1998 from
1997. The increase in 1998 CD related sales resulted from the increased CD
capacity in the Minneapolis, Minnesota facility and the opening of new CD and
assembly/distribution facilities in San Jose, California. The Company believes
the growth in CD related sales was due to its strategy of being a full-service
provider of multimedia products and related services. Diskette related sales
decreased 41% from the prior year as customers moved their software from
diskettes to CDs. RMA processing revenue is comprised of processing fees
associated with handling customer returns from the retail channels, as well as
sales of recycled diskettes which are received in returns and processed for
resale. RMA processing revenue decreased 34.0% in 1998 compared to 1997 as fewer
recycled diskettes were processed and sold in 1998 compared to 1997 and the 1997
RMA processing revenue included a significant one-time project.
Cost of sales. Cost of sales as a percentage of sales was 72.5% and
68.5% for 1998 and 1997, respectively. The cost of sales percentage increase
resulted from a change in product mix discussed above and start up expenses
incurred in connection with opening the new CD facility. The Company outsources
its CD production when customer orders exceed its production capabilities. The
Company outsourced 7% of its CD manufacturing in 1998 and 9% in 1997.
Selling, general and administrative expenses. Selling, general and
administrative expenses as a percentage of sales were 17.3% in 1998 and 20.6% in
1997. In dollars, general and administrative expenses increased $736,000 from
1997. Selling, general and administrative expenses have decreased as a
percentage of sales in 1998 as the Company has achieved operational efficiencies
from integrating its acquisitions.
Equity in losses of unconsolidated entity. In the fourth quarter of
1998, the Company purchased a one-third equity interest in Chumbo Holdings
Corporation, an Internet based reseller of software. The Company accounts for
this investment using the equity method of accounting and accordingly,
recognized a loss of $370,000 representing its share of the Chumbo net loss and
the amortization of excess purchase price over the fair value of the underlying
net assets acquired.
Interest income and expense. Interest income was $949,000 and $228,000
for 1998 and 1997, respectively. The increase in interest income in 1998
resulted from investment income on proceeds from the Company's public stock
offering. Interest expense was $369,000 and $409,000 for 1998 and 1997,
respectively.
Other (income) expense, net. In 1998, the Company incurred expenses
totaling $278,000 relating to the acquisition of PMG, NGS and PMG Ireland. These
costs were expensed as incurred according to the pooling-of-interest accounting
rules. In 1997, PMG generated other income as a result of representing certain
manufacturers' products.
Pro forma provision for income taxes. The pro forma effective income
tax rate for 1998 was 42.0% compared to 40.1% for 1997. Such rates principally
reflect the federal statutory tax rate plus the effect of state income taxes.
Pro forma net income. Pro forma net income for 1998 was $3.6 million,
an increase of 14.0% from $3.1 million in 1997.
For the Years Ended December 26, 1997 and December 27, 1996
Sales. The Company's sales were $47.9 million for 1997, an increase of
78.2% from $26.9 million in 1996. The 1997 sales increase was attributable to a
69% increase in sales to new and existing customers with the remaining increase
attributable to additional sales resulting from acquisition of Benchmark and TTI
during the year. CD related sales increased 70% in 1997, due primarily to an
increase in the number of units sold, and diskette sales increased 1200% to $7.4
million. These increases were partially offset by a 12% decline in audiocassette
sales. The Company believes the growth in CD related sales was due to its
strategy of being a full-service provider of multimedia products and related
services, along with increased production capacity. Sales from PMG, NGS, and PMG
Ireland represented $10.0 million of total sales in 1997, an increase of 19.9%
from $8.3 million in 1996. The increase in sales generated by PMG, NGS and PMG
Ireland was the result of an increase in the number of RMA processing customers
and the volume of returns processed. RMA processing revenue is comprised of
processing fees associated with handling customer returns from retail channels,
as well as sales of recycled diskettes, which are received with returns and
processed for resale. In 1997, fewer recycled diskettes were processed and sold
than in 1996. As a result, revenue from RMA processing fees became a larger
component of the Company's total revenues.
Cost of sales. Cost of sales as a percentage of sales was 68.5% and
67.3% for 1997 and 1996, respectively. This cost of sales percentage increase is
primarily due to an increase in outsourced CD unit production, partially offset
by a change in the RMA processing sales mix from lower-margin recycled diskette
sales to higher-margin RMA processing fees. The Company outsources its CD
production when customer orders exceed its production capabilities. The Company
outsourced 9% of its CD manufacturing in 1997 and 3% in 1996. The cost for such
outsourced production is higher than the cost of CDs produced internally by the
Company.
Selling, general and administrative expenses. Selling, general and
administrative expenses as a percentage of sales were 20.6% in 1997 and 20.0%
1996. In dollars, selling, general and administrative expenses increased $4.5
million from 1996. The dollar increase in 1997 resulted primarily from the added
infrastructure necessary to support the significant increase in sales volume and
growth of the Company.
Interest income and expense. Interest income was $228,000 and $329,000
for 1997 and 1996, respectively. Interest expense was $409,000 and $357,000 for
1997 and 1996, respectively. Interest expense increased with borrowings used to
finance the purchase of additional CD manufacturing equipment in 1997.
Other (income) expense, net. Other income, net was $155,000 in 1997
compared to $231,000 in 1996. The Company generated other income resulting from
PMG representing certain manufacturers' products.
Pro forma provision for income taxes. The pro forma effective income
tax rate for 1997 was 40.1% compared to 40.4% for 1996. Such rates principally
reflect the federal statutory tax rate plus the effect of state income taxes.
Pro forma net income. Pro forma net income for 1997 was $3.1 million,
an increase of 45.4% from $2.2 million in 1996.
Liquidity and Capital Resources
As of December 25, 1998, the Company had working capital of $27.0
million, compared to working capital of $5.0 million as of December 26, 1997 and
$9.0 million as of December 27, 1996. The increase in working capital in 1998
was primarily due to the proceeds received from the Company's secondary stock
offering. In May 1998, the Company sold 1.9 million shares of common stock
netting $29.7 million, net of offering costs.
As of December 25, 1998, the Company had cash totaling $25.6 million.
Cash generated from operating activities was $7.7 million, $6.9 million and $4.9
million during 1998, 1997 and 1996, respectively. The increase in operating cash
flow is consistent with the Company's sales and net income growth.
Cash used in investing activities was $15.0 million, $6.6 million and
$3.8 million in 1998, 1997 and 1996, respectively. In 1998, cash used in
investing activities included $5.0 million for the purchase of a one-third
equity interest in Chumbo Holdings Corporation and $1.1 million of expenses
incurred relating to the Kao acquisition (see Note 11 to the consolidated
financial statements). The balance of 1998 and prior years investing activities
primarily relates to the purchase of property and equipment to support the
Company's growth in business.
In 1998, the Company acquired certain assets and assumed certain
liabilities from an unrelated third party in exchange for a short-term note in
the principal amount of $1.1 million. The Company financed equipment purchases
with long-term debt totaling $3.8 million in 1997 and $791,000 in 1996. The
Company reduced the amount of notes payable in the amount of $3.4 million, $3.9
million and $1.5 million in 1998, 1997 and 1996, respectively. PMG and NGS made
distributions to its owners of $2.2 million in 1997 and $2.7 million in 1996.
These distributions were made in accordance with the dividend policies of these
companies. Zomax Optical Media, Inc. has never declared or paid dividends on its
Common Stock.
As of December 25, 1998, the Company had a revolving line of credit
facility for up to $5.0 million of borrowings. Such borrowings are limited to an
amount based on a formula using eligible accounts receivable and inventories.
There were no borrowings outstanding under the revolving line of credit facility
at December 25, 1998. In addition, the Company had $4.35 million available under
a capital term loan facility at December 25, 1998.
Subsequent to year-end, the Company acquired the business and certain
net assets of Kao Corporation in the United Stated, Canada, Ireland and Germany.
The purchase price for the business and net assets acquired was $37.5 million,
subject to certain post-closing adjustments. The Company used $22.5 million of
its existing cash and obtained a $15.0 million five-year term loan to finance
the transaction. In addition, the Company also entered into a $25.0 million
revolving line of credit facility with borrowings based on a formula using
eligible accounts receivable and inventories.
Future liquidity needs will depend on, among other factors, the timing
of capital expenditures and expenditures in connection with any acquisitions,
changes in customer order volume and the timing and collection of receivables.
The Company believes existing cash balances, anticipated cash flow from
operations and amounts available under existing credit facilities, will be
sufficient to fund its operations for the foreseeable future.
Year 2000 Compliance
The Company continues to work on and resolve the potential impact of
the Year 2000 issue on both the information technology ("IT") and non-IT systems
throughout its U.S., Canada and Ireland operations. The Year 2000 issue is the
result of computer programs being written using two digits (rather than four) to
define the applicable year. Any systems that have date sensitive software may
recognize a date using "00" as the year 1900 rather than the year 2000, which
could result in system problems or failures.
Zomax has developed a Year 2000 plan, the objective of which is to
determine and assess the risks of the Year 2000 issue, and plan and institute
corrective actions to minimize those risks. The Company's goal is to ensure
current business operations will continue to function accurately with no
material disruption into and beyond year 2000. The Company has formed internal
review teams and has engaged an independent Year 2000 consulting firm to assist
and advise it regarding Year 2000 compliance. The Year 2000 plan addresses (a)
information technology such as software and hardware, (b) non-information system
or embedded technology contained in manufacturing equipment and facilities, and
(c) readiness of key third party suppliers.
Zomax implemented a new enterprise wide financial and information
system in 1997 to meet its growing business needs. The Company also implemented
this financial and information system in new businesses acquired in 1997 and
1998. The new business systems are represented to be Year 2000 compliant by the
respective vendors and the Company has performed initial tests confirming this
compliance. The Company has identified embedded technology in its manufacturing
equipment and facilities and is currently testing such technology and/or
contacting vendors regarding the Year 2000 readiness of such technology. The
Company estimates that it is substantially complete in its testing of its
manufacturing equipment and facilities. The Company has also contacted material
suppliers and customers to address their exposure to Year 2000 related risks.
The Company expects to substantially complete its assessment of Year
2000 compliance with regard to embedded technology and material suppliers and
customers by the end of the first quarter of 1999. During the balance of 1999,
the Company will work to remedy any Year 2000 problems identified and formulate
contingency plans, if appropriate, to reduce risks and exposure to Year 2000
related issues.
Through December 25, 1998, costs associated with the Company's Year
2000 plan have been less than $50,000. The costs of addressing Year 2000
potential problems are not currently expected to have a material adverse impact
on the financial position, results of operations or cash flows of the business
in the future. However, the costs relating to the resolution of Year 2000
compliance issues cannot be fully estimated at this time. The Company has not
yet formed expectations regarding a most likely worst case scenario for the Year
2000 but expects to do so upon completing its assessment of embedded technology
and the readiness of material vendors and customers. If significant customers or
vendors identify Year 2000 issues in the future and fail to resolve such issues
in a timely manner, such failure could result in a material adverse impact on
the company's business or results of operations.
Inflation
Historically, inflation has not had a material impact on the Company.
The cost of the Company's products is influenced by the cost of raw materials
and labor. There can be no assurance that the Company will be able to pass on
increased costs to its customers in the future.
Seasonality
The demand for CDs and other multimedia consumer products is seasonal,
with increases during the fall reflecting increased demand relative to the new
school year and holiday season purchases. This seasonality could result in
significant quarterly variations in financial results, with the third and fourth
quarters generally being the strongest.
Outlook
The statements contained in this Outlook section and elsewhere in this
Annual Report are based on current expectations. These statements are
forward-looking and are made pursuant to the safe harbor provisions of the
Private Securities Reform Act of 1995. Such statements can be identified by the
use of terminology such as "anticipate," "believe," "estimate," "expect,"
"intend," "may," "could," "possible," "plan," "project," "will," "forecast" and
similar words or expressions. The Company's forward-looking statements generally
relate to its growth strategy, financial results and sales efforts. There are
certain important factors that could cause results to differ materially from
those anticipated by some of the statements made herein. Investors are cautioned
that all forward-looking statements involve risks and uncertainties, including
among others those identified below.
The Company believes the total number of CDs sold worldwide will
continue to grow in 1999. 1999 unit prices are expected to remain somewhat
consistent as the number of CD manufacturers and production capacity for
existing manufacturers has not grown significantly. Further, the Company
believes that its recent acquisitions will make significant contributions to its
sales in 1999 including a tripling of revenues from the Kao acquisition. The
Company believes it has the personnel, strategies and financial strength in
place to support the expected increase in sales growth with a minimum increase
in salaried personnel. However, increases in the Company's sales and its ability
to be a leader in the industry depends on its ability to manage industry changes
as well as its own growth and organizational changes, particularly with respect
to the integration of recent acquisitions.
If CD market demand does not continue to grow as expected, revenue
growth would be adversely impacted and the manufacturing capacity installed may
be underutilized. Pricing strategies of competitors and general economic
factors, such as consumer confidence and inflation, all impact the Company.
The Company undertakes no obligation to update any forward-looking
statement, but investors are advised to consult any further disclosures by the
Company on this subject in its filings with the Securities and Exchange
Commission, especially on Forms 10-K, 10-Q and 8-K (if any), in which the
Company discusses in more detail various important factors that could cause
actual results to differ from expected or historic results. It is not possible
to foresee or identify all such factors. As such, investors should not consider
any list of such factors to be an exhaustive statement of all risks,
uncertainties or potentially inaccurate assumptions.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not applicable.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The following financial statements and schedules are included
immediately following the signature page of this report on the pages indicated:
Page
Report of Independent Public Accountants dated January 22, 1999 F- 1
Consolidated Balance Sheets as of December 25, 1998 and
December 26, 1997 F- 2
Consolidated Statements of Operations for
Years Ended December 25, 1998, December F- 3
26, 1997 and December 27, 1996
Consolidated Statements of Shareholders' Equity for
Years Ended December 25, 1998, December 26, 1997
and December 27, 1996 F- 4
Consolidated Statements of Cash Flows for Years Ended
December 25, 1998, December 26, 1997 and December 27, 1996 F- 5
Notes to Consolidated Financial Statements F- 6
Schedule II - Valuation and Qualifying Accounts
with Report of Independent Public Accountants F-17
All other schedules are omitted since they are not applicable, not
required or the information is presented in the consolidated financial
statements or related notes.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information concerning the Company's directors and executive
officers and compliance with Section 16(a) required by this item is contained in
the sections entitled "Election of Directors," "Executive Officers of the
Company" and "Compliance with Section 16(a) of the Exchange Act," appearing in
the Company's Proxy Statement to be delivered to stockholders in connection with
the Annual Meeting of Stockholders to be held on May 3, 1999. Such information
is incorporated herein by reference.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this item is contained in the section
entitled "Executive Compensation" appearing in the Company's Proxy Statement to
be delivered to stockholders in connection with the Annual Meeting of
Stockholders to be held on May 3, 1999. Such information is incorporated herein
by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this item is contained in the sections
entitled "Principal Shareholders and Management Shareholdings" appearing in the
Company's Proxy Statement to be delivered to stockholders in connection with the
Annual Meeting of Stockholders to be held on May 3, 1999. Such information is
incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this item is contained in the section
entitled "Certain Transactions" appearing in the Company's Proxy Statement to be
delivered to stockholders in connection with the Annual Meeting of Stockholders
to be held on May 3, 1999. Such information is incorporated herein by reference.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) Exhibits.
The following exhibits are included in this report: See "Exhibit Index"
immediately following the financial statements following the signature page of
this Form 10-K.
(b) Financial Statements and Schedules.
The following financial statements and schedules are included in Part
II, Item 8 of this Form 10-K;
Report of Independent Public Accountants dated January 22, 1999
Consolidated Balance Sheets as of December 25, 1998 and
December 26, 1997
Consolidated Statements of Operations for
Years Ended December 25, 1998, December
26, 1997 and December 27, 1996
Consolidated Statements of Shareholders' Equity for
Years Ended December 25, 1998, December 26, 1997
and December 27, 1996
Consolidated Statements of Cash Flows for Years Ended
December 25, 1998, December 26, 1997 and December 27, 1996
Notes to Consolidated Financial Statements
Schedule II - Valuation and Qualifying Accounts
with Report of Independent Public Accountants
All other schedules are omitted since they are not applicable, not
required or the information is presented in the consolidated financial
statements or related notes.
(c) Reports on Form 8-K.
The Company filed a Form 8-K dated October 2, 1998 to report the
acquisition of 4,310,345 shares of Chumbo Holdings Corporation. The Company also
filed a Form 8-K dated December 2, 1998 to report signing purchase agreements to
acquire certain assets and businesses of Kao Corporation and two of its
subsidiaries (collectively, "Kao"). Subsequently, the Company filed a Form 8-K
dated January 7, 1999 to report the acquisition of certain assets and businesses
of Kao.
SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act, the
registrant caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized.
ZOMAX OPTICAL MEDIA, INC.
Date: March 25, 1999
By /s/ James T. Anderson
James T. Anderson
President and Chief Executive Officer
In accordance with the Exchange Act, this report has been signed below by the
following persons on behalf of the registrant and in the capacities and on the
dates indicated below.
Each person whose signature appears below constitutes and appoints James T.
Anderson and James E. Flaherty as the undersigned's true and lawful attorneys-in
fact and agents, each acting alone, with full power of substitution and
resubstitution, for the undersigned and in the undersigned's name, place and
stead, in any and all amendments to this Annual Report on Form 10-K and to file
the same, with all exhibits thereto, and other documents in connection
therewith, with the Securities and Exchange Commission, granted unto said
attorneys-in-fact and agents, each acting alone, full power and authority to do
and perform each and every act and thing requisite and necessary to be done in
and about the premises, as fully to all intents and purposes as the undersigned
might or could do in person, hereby ratifying and confirming all said
attorneys-in-fact and agents, each acting alone, or his substitute or
substitutes, may lawfully do or cause to be done by virtue thereof.
Name Title Date
/s/ James T. Anderson President, Chief Executive Officer March 25, 1999
James T. Anderson and Director (principal executive
officer)
/s/James E. Flaherty Chief Financial Officer March 25, 1999
James E. Flaherty and Secretary (principal financial
and accounting officer)
/s/Phillip T. Levin Chairman of the Board March 25, 1999
Phillip T. Levin
/s/ Robert Ezrilov Director March 25, 1999
Robert Ezrilov
/s/Howard P. Liszt Director March 25, 1999
Howard P. Liszt
/s/Janice Ozzello Wilcox Director March 25, 1999
Janice Ozzello Wilcox
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Zomax Optical Media, Inc.:
We have audited the accompanying consolidated balance sheets of Zomax Optical
Media, Inc. (a Minnesota corporation) as of December 25, 1998 and December 26,
1997, and the related consolidated statements of operations, shareholders'
equity and cash flows for each of the three years in the period ended December
25, 1998. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Zomax Optical Media,
Inc. as of December 25, 1998 and December 26, 1997, and the results of its
operations and its cash flows for each of the three years in the period ended
December 25, 1998, in conformity with generally accepted accounting principles.
/s/ Arthur Andersen LLP
Minneapolis, Minnesota,
January 22, 1999
ZOMAX OPTICAL MEDIA, INC.
Consolidated Balance Sheets
As of
December 25, December 26,
1998 1997
------------- -----------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $25,621,203 $ 5,213,417
Accounts receivable, net of allowance for doubtful accounts
of $2,035,000 and $881,000 9,871,975 7,160,198
Inventories 2,088,179 1,603,170
Deferred income taxes 1,425,000 897,000
Prepaid expenses and other 543,290 879,714
------------- ------------
Total current assets 39,549,647 15,753,499
PROPERTY AND EQUIPMENT, net 18,925,247 14,002,694
INVESTMENT IN UNCONSOLIDATED ENTITY 4,662,201 -
GOODWILL, net 1,157,223 1,228,023
ACQUISITION COSTS AND OTHER ASSETS, net 1,129,782 42,194
------------- ------------
$65,424,100 $31,026,410
============= ============
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Current portion of notes payable $ 1,380,124 $ 2,293,950
Accounts payable 5,468,364 3,524,892
Accrued expenses-
Accrued royalties 2,445,611 2,994,768
Accrued compensation 1,786,398 1,155,298
Other 565,739 494,882
Income taxes payable 934,382 240,882
------------- ------------
Total current liabilities 12,580,618 10,704,672
LONG-TERM NOTES PAYABLE, net of current portion 1,746,404 3,103,975
DEFERRED INCOME TAX LIABILITY 1,010,000 755,000
COMMITMENTS AND CONTINGENCIES (Notes 8 and 9)
SHAREHOLDERS' EQUITY:
Common stock, no par value, 15,000,000 shares authorized; 7,188,948 and
5,250,817 shares issued and outstanding 42,680,139 12,721,513
Retained earnings 7,406,939 3,741,250
------------- ------------
Total shareholders' equity 50,087,078 16,462,763
------------- ------------
$65,424,100 $31,026,410
============= ============
The accompanying notes are an integral part of
these consolidated balance sheets.
ZOMAX OPTICAL MEDIA, INC.
Consolidated Statements of Operations
For the Years Ended
---------------------------------------------------
December 25, December 26, December 27,
1998 1997 1996
------------ ------------ ------------
SALES $61,074,272 $47,876,953 $26,866,557
COST OF SALES 44,270,635 32,773,368 18,090,158
------------ ----------- -----------
Gross profit 16,803,637 15,103,585 8,776,399
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES 10,595,475 9,859,906 5,366,247
------------ ----------- -----------
Operating income 6,208,162 5,243,679 3,410,152
EQUITY IN LOSSES OF UNCONSOLIDATED ENTITY 369,846 - -
INTEREST EXPENSE 368,758 408,915 357,166
INTEREST INCOME (948,959) (228,348) (329,169)
OTHER (INCOME) EXPENSE, NET 277,828 (155,321) (231,114)
------------ ----------- -----------
Income before income taxes 6,140,689 5,218,433 3,613,269
PROVISION FOR INCOME TAXES 2,475,000 1,520,000 668,000
------------ ----------- -----------
NET INCOME $ 3,665,689 $ 3,698,433 $ 2,945,269
============ =========== ===========
PRO FORMA (Notes 1 and 7):
Income before income taxes $ 6,140,689 $ 5,218,433 $ 3,613,269
Provision for income taxes 2,580,000 2,090,000 1,461,000
------------ ----------- -----------
Net income $ 3,560,689 $ 3,128,433 $ 2,152,269
============ =========== ===========
Earnings per share-
Basic $ 0.56 $ 0.60 $ 0.47
============ =========== ===========
Diluted $ 0.53 $ 0.58 $ 0.47
============ =========== ===========
Weighted average number of shares outstanding-
Basic 6,367,329 5,224,168 4,598,877
Diluted 6,731,302 5,357,511 4,601,446
============ =========== ===========
The accompanying notes are an integral part of
these consolidated statements.
ZOMAX OPTICAL MEDIA, INC.
Consolidated Statements of Shareholders' Equity
Shareholders' Equity
---------------------------------------------
Common Stock
---------------------------- Retained
Shares Amount Earnings Total
--------- ----------- ---------- -----------
BALANCE, December 31, 1995 3,620,515 $ 3,098,266 $2,067,645 $ 5,165,911
Net income - - 2,945,269 2,945,269
Dividends and distributions - - (2,710,152) (2,710,152)
Repurchase of ownership interests (20,513) - (10,000) (10,000)
Sale of common stock at $6.75 per share, net of offering
costs of $1,446,900 1,585,000 9,251,850 - 9,251,850
--------- ----------- ---------- -----------
BALANCE, December 27, 1996 5,185,002 12,350,116 2,292,762 14,642,878
Net income - - 3,698,433 3,698,433
Common stock issued under Employee Stock Purchase Plan 6,547 30,606 - 30,606
Common stock issued in connection with the acquisition
of Trotter Technologies, Inc. on May 1, 1997 59,268 340,791 - 340,791
Dividends and distributions - - (2,249,945) (2,249,945)
--------- ----------- ---------- -----------
BALANCE, December 26, 1997 5,250,817 12,721,513 3,741,250 16,462,763
Net income - - 3,665,689 3,665,689
Common stock issued under Employee Stock Purchase Plan 7,950 57,254 - 57,254
Common stock issued upon exercise of stock options and
warrants 30,181 172,488 - 172,488
Sale of common stock at $17.00 per share, net of offering
costs of $2,571,116 1,900,000 29,728,884 - 29,728,884
--------- ----------- ---------- -----------
BALANCE, December 25, 1998 7,188,948 $42,680,139 $7,406,939 $50,087,078
========= =========== ========== ===========
The accompanying notes are an integral part of
these consolidated statements.
ZOMAX OPTICAL MEDIA, INC.
Consolidated Statements of Cash Flows
For the Years Ended
-------------------------------------------------
December 25, December 26, December 27,
1998 1997 1996
------------ ------------ ------------
OPERATING ACTIVITIES:
Net income $ 3,665,689 $3,698,433 $2,945,269
Adjustments to reconcile net income to net cash provided by
operating activities-
Depreciation and amortization 4,042,616 2,245,734 1,128,213
Write-down of other assets - - 250,000
Equity in losses of unconsolidated entity 369,846 - -
Deferred income taxes (273,000) (133,000) (9,000)
Changes in operating assets and liabilities:
Accounts receivable (2,711,777) 910,259 (1,358,752)
Inventories (485,009) 20,512 (674,587)
Prepaid expenses and other 336,424 (580,951) (24,173)
Accounts payable 1,943,472 (945,712) 1,353,311
Accrued expenses 152,800 1,999,672 761,098
Income taxes payable 693,500 (272,937) 513,819
----------- ---------- ----------
Net cash provided by operating activities 7,734,561 6,942,010 4,885,198
----------- ---------- ----------
INVESTING ACTIVITIES:
Purchase of property and equipment, net (8,894,369) (6,006,728) (4,087,236)
Acquisitions, net of cash acquired - (775,094) -
Investment in unconsolidated entity (5,032,047) - -
Change in acquisition costs and other assets (1,087,588) 192,249 5,850
Sale of financial instruments - - 515,157
Purchase of financial instruments - - (259,000)
----------- ---------- ----------
Net cash used in investing activities (15,014,004) (6,589,573) (3,825,229)
----------- ---------- ----------
FINANCING ACTIVITIES:
Proceeds from notes payable 1,124,346 3,750,000 790,500
Repayment of notes payable (3,395,743) (3,899,134) (1,543,112)
Repayment of short-term borrowings - (715,246) -
Repurchase of ownership interests - - (10,000)
Dividends and distributions - (2,249,945) (2,710,152)
Issuance of common stock, net of offering costs 29,958,626 30,606 9,251,850
----------- ---------- ----------
Net cash provided by (used in) financing activities 27,687,229 (3,083,719) 5,779,086
----------- ---------- ----------
Net increase (decrease) in cash 20,407,786 (2,731,282) 6,839,055
CASH AND CASH EQUIVALENTS:
Beginning of year 5,213,417 7,944,699 1,105,644
----------- ---------- ----------
End of year $25,621,203 $5,213,417 $7,944,699
=========== ========== ==========
SUPPLEMENTAL CASH FLOW DISCLOSURE:
Cash paid for interest $ 369,190 $ 427,224 $ 357,055
=========== ========== ==========
Cash paid for income taxes $ 2,054,500 $1,953,937 $ 162,000
=========== ========== ==========
Common shares issued in connection with the acquisition of Trotter
Technologies, Inc.
$ - $ 340,791 $ -
=========== ========== ==========
The accompanying notes are an integral part of
these consolidated statements.
ZOMAX OPTICAL MEDIA, INC.
Notes to Consolidated Financial Statements
December 25, 1998 and December 26, 1997
1. Business Description:
Zomax Optical Media, Inc. (Zomax or the Company) is a leading outsource service
provider to software publishers, computer manufacturers and other producers of
multimedia products operating primarily in North America. These outsource
services include compact disc (CD) and digital versatile disc (DVD) mastering;
CD, DVD, diskette and cassette replication; graphic design; print management; CD
printing; packaging; warehousing; inventory management; distribution and
fulfillment; and returned merchandise authorization processing services.
The Company was incorporated on February 22, 1996 and completed its initial
public common stock offering on May 10, 1996. Concurrent with the initial public
offering of common stock, the Company received all of the operating assets and
liabilities of Zomax Optical Media Limited Partnership in exchange for 2,800,000
shares of its common stock.
In February 1998, the Company acquired all of the outstanding shares of Primary
Marketing Group, Next Generation Services, LLC and Primary Marketing Group
Limited (collectively, the Acquired Companies) in exchange for 800,002 shares of
the Company's common stock. The acquisitions of the Acquired Companies were
accounted for as a pooling of interests and, accordingly, the consolidated
financial statements have been restated to reflect the effects of the
transactions for all periods presented.
Net sales and pro forma net income (pro forma for the effect of income taxes)
were as follows (in thousands):
The
Acquired
Zomax Companies
-------- ---------
1996:
Net sales $18,548 $8,319
Net income 1,291 861
1997:
Net sales 37,907 9,970
Net income 2,307 821
2. Summary of Significant Accounting Policies:
Principles of Consolidation
The consolidated financial statements include the accounts of the Company and
its wholly owned subsidiaries. All intercompany accounts and transactions have
been eliminated in consolidation.
Fiscal Year-End
The Company's fiscal year ends on the last Friday of the calendar year. For the
purposes of these notes to the consolidated financial statements, the fiscal
years ended December 25, 1998, December 26, 1997 and December 27, 1996 are
referred to as 1998, 1997 and 1996, respectively.
Use of Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities at the date of the
financial statements and the reported amounts of revenues and expenses during
the reporting period. Ultimate results could differ from those estimates.
Revenue Recognition
The Company records sales revenue at the time merchandise is shipped or as
services are rendered. For certain customers, merchandise is invoiced upon
completion of orders with shipment occurring based on written customer
instructions. In 1998, two customers accounted for 16.7% and 13.0% of sales. In
1997 and 1996, one customer accounted for 38.3% and 18.0%, respectively, of the
Company's sales.
Cash and Cash Equivalents
Cash equivalents consist of highly liquid short-term investments with original
maturities of 90 days or less and are recorded at cost, which approximates
market value.
Inventories
Inventories, consisting of material, labor and overhead, are stated at the lower
of first-in, first-out cost or market. Inventories were as follows (in
thousands):
December 25, December 26,
1998 1997
------------ ------------
Raw materials $1,682 $1,070
Finished goods 351 498
Work in process 55 35
------ ------
$2,088 $1,603
====== ======
Property and Equipment
Property and equipment are stated at cost. Repairs and maintenance are charged
to expense as incurred, while significant improvements are capitalized.
Depreciation is calculated using the straight-line method for financial
reporting purposes over the estimated useful lives.
Property and equipment consisted of the following (in thousands):
December 25, December 26,
1998 1997 Lives
------------ ------------ ---------
Manufacturing equipment $23,581 $16,689 7 years
Office equipment 2,100 1,244 5-7 years
Building improvements 1,412 624 Lease term
Vehicles 55 55 5 years
------- -------
27,148 18,612
Less- Accumulated depreciation (8,223) (4,609)
------- -------
Property and equipment, net $18,925 $14,003
======= =======
Goodwill
The Company has classified as goodwill cost in excess of fair value of the net
assets acquired in connection with the acquisitions described in Note 3.
Goodwill is being amortized on a straight-line basis over 15 years. Accumulated
amortization was $121,000 and $50,000 at December 25, 1998 and December 26,
1997, respectively.
Income Taxes
Deferred income taxes are provided for differences between the tax basis of
assets and liabilities and their carrying amounts for financial reporting
purposes, based on income tax rates in effect at the balance sheet date.
Fair Value of Financial Instruments
The financial instruments with which the Company is involved are primarily of a
traditional nature. For most instruments, including cash, receivables, accounts
payable, accrued expenses and short-term debt, the Company has assumed that the
carrying amounts approximate fair value because of their short-term nature.
Long-Lived Assets
Long-lived assets, such as property and equipment and goodwill, are
evaluated for impairment when events or changes in circumstances indicate that
the carrying amount of the assets may not be recoverable through the estimated
undiscounted future cash flows from the use of these assets. When any such
impairment exists, the related assets will be written down to fair value. No
impairment losses have been necessary through December 25, 1998.
Royalty Payments
The Company has license agreements with certain companies for the use of certain
CD manufacturing technology. The Company accrues for royalties based on units
manufactured.
Earnings Per Share
Basic earnings per common share is computed by dividing net income by the
weighted average number of common shares outstanding during the year. Diluted
earnings per share is computed by dividing net income by the sum of the weighted
average number of common shares outstanding plus all additional common shares
that would have been outstanding if potentially dilutive common shares related
to stock options had been issued. The following table reconciles the number of
shares utilized in the pro forma earnings per share calculations (in thousands,
except per share data):
1998 1997 1996
------ ------ ------
Net income $3,561 $3,128 $2,152
Earnings per share--basic $ .56 $ .60 $ .47
Earnings per share--diluted $ .53 $ .58 $ .47
Weighted average common shares outstanding--basic 6,367 5,224 4,599
Effect of dilutive securities--stock options and warrants 364 134 2
Weighted average common shares outstanding--diluted 6,731 5,358 4,601
Recently Issued Accounting Pronouncements
The Company adopted Statement of Financial Accounting Standards (SFAS) No. 130,
"Reporting Comprehensive Income," in 1998, which establishes standards of
disclosure and financial statement display for reporting total comprehensive
income and the individual components thereof. The adoption of SFAS No. 130 did
not have an impact on the Company's disclosures as it has no items of other
comprehensive income.
The Company adopted SFAS No. 131, "Disclosures about Segments of an Enterprise
and Related Information," in 1998, which establishes new standards for segment
reporting. The adoption did not affect the Company's disclosures as it operates
in one segment.
3. Acquisitions:
On March 31, 1997, the Company acquired all of the outstanding shares of
Benchmark, Inc. (Benchmark) for no initial consideration; however, the Company
agreed to pay additional consideration based on revenues of Benchmark during
1997. Such levels were not met, therefore no additional consideration was paid.
The acquisition was accounted for using the purchase method of accounting and,
accordingly, the purchase price was allocated to net assets acquired based on
their estimated fair values. Benchmark's results of operations have been
included in the accompanying consolidated statements of operations since the
date of acquisition. Benchmark was a software replicator located in Plymouth,
Minnesota, with operations in Orlando, Florida, and Indianapolis, Indiana.
On May 1, 1997, the Company acquired all of the outstanding shares of Trotter
Technologies, Inc. (Trotter). The purchase price of Trotter was $712,000,
payable in cash and 59,268 shares of the Company's common stock. The acquisition
was accounted for using the purchase method of accounting and, accordingly, the
purchase price was allocated to net assets acquired based on their estimated
fair values. This treatment resulted in approximately $1.2 million of cost in
excess of net assets acquired (which has been recorded as goodwill in the
accompanying consolidated financial statements). Trotter's results of operations
have been included in the accompanying consolidated statements of operations
since the date of acquisition. Trotter was a return merchandise processing,
warehousing and distribution company based in San Jose, California, servicing
the software publishing market.
Pro forma consolidated results of operations as if the acquisitions had taken
place at the beginning of 1996 are as follows (in thousands, except per share
data):
1997 1996
Net sales $50,062 $34,670
Net income 3,572 2,584
======= =======
Earnings per share:
Basic $ 0.68 $ 0.55
======= =======
Diluted $ 0.66 $ 0.55
======= =======
These pro forma amounts are not necessarily indicative of what the actual
results of operations might have been if the acquisitions had been effective at
the beginning of 1996.
Investment in Unconsolidated Entity
On October 2, 1998, the Company acquired 4,310,345 shares of the common stock of
Chumbo Holdings Corporation (Chumbo) in exchange for $5,000,000 in cash. In
addition, the Company granted warrants to certain shareholders of Chumbo to
purchase 100,000 shares of the Company's common stock at a price of $20.00 per
share. The warrants were immediately exercisable for a period of three years. As
a result of the investment, the Company owns approximately one-third of the
outstanding equity of Chumbo, which is accounted for using the equity method of
accounting. As part of the agreement, Zomax has access to Chumbo's proprietary
Internet software to service customers of the Company. The Company's chief
executive officer (CEO) serves as Chumbo's CEO, and in recognition of his
additional duties and responsibilities, received warrants to purchase Chumbo's
common stock. During the fourth quarter of 1998, the Company recognized a loss
of $369,846, representing its share of Chumbo's net loss and amortization of
purchase price in excess of the underlying fair value of net assets acquired.
Chumbo conducts its operations through two wholly owned subsidiaries,
Chumbo.com, Inc. and Point Group Corporation. Point Group Corporation is a
licensee and reseller of computer software. Chumbo.com, Inc. has developed
proprietary software for Internet commerce and operates a website
(http/www.chumbo.com) selling computer software over the Internet.
Sales by the Company to the Point Group Corporation totaled $1,213,000, $907,000
and $1,435,000 in 1998, 1997 and 1996, respectively.
4. Credit Facilities and Long-Term Notes Payable:
As of December 25, 1998, the Company had a revolving line-of-credit facility
with a lender for up to $5,000,000, which expires on April 30, 1999. The
interest rate was at prime (7.75% at December 25, 1998). Maximum borrowings were
limited to an amount based on a formula using eligible accounts receivable and
inventories ($5,000,000 at December 25, 1998). During 1998 maximum borrowings
outstanding were $3,000,000. There were no borrowings outstanding at December
25, 1998.
In addition, the Company had a capital expenditure term loan facility with the
lender for up to $8,000,000. Borrowings under the capital expenditure term loan
may be for up to 60 months, and interest rates will vary based on the length of
the term loan and the interest rate structure selected. The interest rate
structure that can be selected by the Company varies from a variable rate of
prime plus 1/4% or a fixed rate equal to the three-year U.S. Treasury rate plus
3%. At December 25, 1998, amounts available under the term loan facility totaled
$4,350,000. Amounts outstanding at December 25, 1998 and December 26, 1997 were
$2,637,000 and $3,458,000, respectively.
The line-of-credit agreement and certain of the notes contain covenants related
to levels of net income and net worth. The Company was in compliance with these
covenants as of December 25, 1998.
The Company also has several installment notes, with monthly installments
payable through November 2001, at interest rates ranging from 8.1% to 9.7%. The
notes are collateralized by certain equipment. Amounts outstanding as of
December 25, 1998 and December 26, 1997 were $489,000 and $1,820,000,
respectively.
The Company had a note payable totaling $120,000 at December 26, 1997 in
connection with the redemption of the equity interests of a former owner. This
note was paid off during 1998.
Future scheduled maturities of long-term debt are as follows as of December 25,
1998 (in thousands):
1999 $1,380
2000 967
2001 779
------
Total 3,126
Less- Current portion (1,380)
------
Long-term notes payable, net of current portion $1,746
======
In connection with the acquisition made subsequent to December 25, 1998
(described in Note 10), the above-mentioned revolving line of credit and capital
expenditure term loan facilities were canceled. Those facilities were replaced
by a $15 million term loan facility, which was used entirely to finance the
acquisition, and a $25 million revolving line of credit facility. The term loan
facility requires quarterly principal payments on a straight-line amortization
schedule. Interest rate is at the lower of prime plus .75% or LIBOR rate plus
2.25%. The revolving line-of-credit facility provides for borrowings based on a
formula using eligible accounts receivable and inventories with interest rates
at prime plus .5% or LIBOR plus 2.00%. Both facilities have five-year terms and
contain certain financial covenants.
5. Shareholders' Equity:
On May 10, 1996, the Company completed the sale of 1,400,000 shares of common
stock in an initial public stock offering. On June 17, 1996, the underwriter
exercised an overallotment option and purchased an additional 185,000 shares.
The Company received proceeds from the offering, net of issuance costs, of
$9,252,000. The underwriter also purchased, for a nominal purchase price,
warrants to purchase 140,000 shares of common stock at a price of $8.10 per
share. The warrants are exercisable for a period of four years, commencing one
year from the offering date. During 1998, 4,431 shares were issued in a cashless
exercise of 10,566 warrants.
On May 21, 1998, the Company completed the sale of 1,600,000 shares of
common stock in a secondary public offering. On June 8, 1998, the underwriters
exercised an overallotment option and purchased an additional 300,000 shares.
The Company received proceeds from the offering, net of issuance costs, of
$29,729,000.
6. Stock Plans:
Employee Stock Purchase Plan
The Company has an Employee Stock Purchase Plan (the Employee Plan) effective
July 1, 1996. The Employee Plan enables employees to contribute up to 10% of
their compensation toward the purchase of the Company's common stock at a price
equal to 85% of fair market value. A total of 250,000 shares have been reserved
for issuance under this plan. Shares issued were 7,950 and 6,547 in 1998 and
1997, respectively. No shares were issued in 1996.
Stock Option Plan
The Company has a 1996 Stock Option Plan (the Plan) in order to provide for the
granting of stock options to employees, officers, directors and independent
consultants of the Company at exercise prices not less than 100% of the fair
market value of the Company's common stock on the date of grant. Authorized
number of shares reserved for issuance totaled 1,300,000 of which 118,500
remained available for grant at December 25, 1998. These options, which can be
either incentive stock options or nonqualified options, vest over a three- to
five-year schedule and expire ten years after the grant date.
Information regarding the Plan is summarized below (shares in thousands):
1998 1997 1996
---------------------- ---------------------- ---------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
------ -------- ------ ------- ------ --------
Options outstanding,
beginning of year 655 $ 6.44 360 $6.79 - $ -
Granted 586 10.42 295 5.74 395 6.79
Exercised (26) 6.82 - - - -
Canceled (59) 8.46 - - (35) 6.75
----- ------ ---- ----- ---- -----
Options outstanding, end of year 1,156 $ 7.89 655 $6.44 360 6.79
===== ====== ==== ===== ==== =====
Options exercisable, end of year 269 $ 6.86 151 $6.72 63 $6.75
===== ====== ==== ===== ==== =====
Options outstanding at December 25, 1998 have exercise prices ranging between
$4.50 and $16.75 and a weighted average remaining contractual life of 8.83
years.
The Company accounts for its stock option grants under Accounting Principles
Board Opinion No. 25, "Accounting for Stock Issued to Employees." Since options
have been granted at not less than the market value on the date of grant, no
compensation expense has been recognized for the stock options granted. Had
compensation cost of option grants been determined consistent with SFAS No. 123,
"Accounting for Stock-Based Compensation," the Company's income and earnings per
share (EPS), on a pro forma basis, would have been reported as follows (in
thousands, except per share data):
1998 1997 1996
---- ---- ----
Net income:
As reported $3,561 $3,128 $2,152
====== ====== ======
Pro forma $2,775 $2,615 $1,782
====== ====== ======
EPS:
Basic $ 0.56 $ 0.60 $ 0.47
====== ====== ======
Diluted $ 0.53 $ 0.58 $ 0.47
====== ====== ======
Pro forma:
Basic $ 0.44 $ 0.50 $ 0.39
====== ====== ======
Diluted $ 0.41 $ 0.49 $ 0.39
====== ====== ======
In determining the compensation cost of the options granted, as specified by
SFAS No. 123, the fair value of each option grant has been estimated on the date
of grant using the Black-Scholes option pricing model. The weighted average
assumptions used in these calculations are summarized below:
1998 1997 1996
---- ---- ----
Risk-free interest rate 5.23% 6.72% 6.97%
Expected life of options granted 10 years 10 years 10 years
Expected volatility of options granted 74.58% 50.23% 76.45%
Weighted average fair value of options granted $7.88 $4.47 $5.95
7. Income Taxes:
Prior to the Company's initial public offering, the Company operated as a
partnership, and prior to the acquisitions described in Note 1, the Acquired
Companies operated as nontaxable entities. A pro forma income tax provision has
been established as if they were taxable entities for all periods presented.
Effective with the termination of the Company's nontaxable status, the Company
established deferred tax assets of approximately $160,000 for cumulative
temporary differences between the tax basis and financial reporting basis of the
Company's assets and liabilities at the date of termination.
The pro forma provision for income taxes for the Company was as follows (in
thousands):
1998 1997 1996
------ ------ ------
Current $2,853 $2,381 $1,655
Deferred (273) (291) (194)
------ ------ ------
Total provision $2,580 $2,090 $1,461
====== ====== ======
A reconciliation of the statutory federal income tax rate to the Company's pro
forma effective income tax rate is as follows:
1998 1997 1996
Statutory federal income tax rate 34.0% 34.0% 34.0%
State income taxes, net of federal
income tax benefit 6.0 5.0 4.9
Nondeductible loss in unconsolidated entity 1.9 - -
Other 0.1 1.1 1.5
----- ----- -----
Effective income tax rate 42.0% 40.1% 40.4%
===== ===== =====
The components of the deferred tax asset (liability) were as follows (in
thousands):
December 25, December 26,
1998 1997
------------ ------------
Current:
Accounts receivable reserves $ 760 $ 297
Inventories reserves 126 115
Accrued liabilities 539 485
------- -----
Total current deferred tax asset $ 1,425 $ 897
======= =====
Long-term:
Long-lived assets $(1,010) $(755)
======= =====
8. Related-Party Transactions:
Operating Lease
The Company leases one of its manufacturing and office facilities from Metacom,
Inc. (Metacom), a significant shareholder of the Company. The Company believes
the terms are equivalent to those that would be paid on an arm's-length
transaction. Lease payments totaled $775,000, $600,000 and $460,000 for 1998,
1997 and 1996, respectively.
Manufacturing Agreement
In connection with the acquisition of certain manufacturing operations of
Metacom, Metacom and the Company entered into a manufacturing agreement (the
Agreement) whereby Metacom must purchase minimum quantities of audio cassettes
and CDs from the Company under normal trade terms. In 1997 and 1996 Metacom did
not fulfill its purchase commitments. As a result of the 1996 shortfall, the
Company and Metacom agreed to allow Metacom to make up the shortfall during 1997
in exchange for a contract extension until the year 2000. This contract
extension specifies that Metacom is to purchase all of its supply of CDs and
audio cassettes exclusively from the Company under normal trade terms with no
minimum quantities required.
As a result of the 1997 shortfall, Metacom has agreed to pay the Company
$350,000 under a payment schedule through 1999. Revenue is recognized as
payments are received. As of December 25, 1998, payments totaling $90,000 have
been received.
Metacom purchases totaled $411,000, $1,209,000 and $1,587,000 in 1998, 1997 and
1996, respectively.
9. Commitments and Contingencies:
Operating Leases
The Company is committed under operating leases with related and unrelated
parties for the rental of manufacturing, warehouse and office facilities. Future
minimum lease obligations are as follows as of December 25, 1998 (in thousands):
1999 $2,050
2000 2,033
2001 1,430
2002 and thereafter 783
Employment Agreement
The Company had in place an employment agreement with its chief executive
officer which provides for annual compensation and severance under certain
conditions specified in the agreement. The agreement expired on December 31,
1998, and is currently under negotiation for renewal.
401(k) Plan
The Company has a discretionary 401(k) plan for all employees who are at least
21 years of age and have completed one year of service with the Company. During
1998, the Company's discretionary contributions totaled $70,000. The Company
made no contributions during 1997 or 1996.
Litigation
The Company is involved in various claims arising in the normal course of
business. In management's opinion, the final resolution of these claims should
not have a material adverse effect on the Company's financial position or the
results of its operations.
10. Acquisition Subsequent to December 25, 1998 (Unaudited):
On January 7, 1999, the Company acquired certain businesses and assets of Kao
Corporation located in the United States, Canada, Ireland and Germany. The
purchase price for the businesses and assets acquired was $37,500,000, subject
to certain post-closing adjustments. The assets and businesses acquired by the
Company were used in the manufacturing and sale of CDs and related businesses,
and the Company intends to continue to use the assets and businesses in a
similar manner. The Company financed the acquisition through $22,500,000 of its
own funds and a $15,000,000 term loan facility. The acquisition will be
accounted for using the purchase method of accounting and, accordingly, the
purchase price will be allocated to net assets acquired based on their fair
estimated values.
In connection with the acquisition, the Company incurred costs of $1.1 million
as of December 25, 1998 which are included in other assets in the accompanying
consolidated balance sheets.
11. Supplementary Data (Unaudited):
The Company's pro forma results of operations for each of the quarters in the
years ended December 25, 1998 and December 26, 1997 reflect the pro forma effect
of providing a provision for income taxes for all consolidated companies as if
they were taxable entities for all periods presented. The pro forma EPS
information also reflects the effects of the shares issued in connection with
the acquisition of the Acquired Companies. Unaudited quarterly data is as
follows (in thousands, except per share data):
Quarters Ended
---------------------------------------------------------------
March 27 June 26 September 25 December 25
-------- ------- ------------ -----------
1998
Sales $14,233 $14,546 $14,832 $17,463
Gross profit 4,294 3,924 3,523 5,063
Net income 748 931 819 1,062
Basic EPS 0.14 0.16 0.11 0.15
Diluted EPS 0.13 0.15 0.11 0.14
Quarters Ended
---------------------------------------------------------------
March 28 June 27 September 26 December 26
-------- ------- ------------ -----------
1997
Sales $7,952 $11,541 $13,842 $14,542
Gross profit 2,289 3,148 4,925 4,741
Net income 382 343 1,306 1,097
Basic EPS 0.07 0.07 0.25 0.21
Diluted EPS 0.07 0.07 0.24 0.20
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Zomax Optical Media, Inc.
We have audited in accordance with generally accepted auditing standards, the
consolidated financial statements included in this Form 10-K, and have issued
our report thereon dated January 22, 1999. Our audit was made for the purpose of
forming an opinion on those statements taken as a whole. The accompanying
schedule is the responsibility of the Company's management and is presented for
purposes of complying with the Securities and Exchange Commission's rules and
are not part of the basic financial statements. This schedule has been subjected
to the auditing procedures applied in the audit of the basic financial
statements and, in our opinion, fairly states in all material respects the
financial data required to be set forth therein in relation to the basic
financial statements taken as a whole.
/s/ Arthur Andersen LLP
Minneapolis, Minnesota,
January 22, 1999
Zomax Optical Media, Inc.
Schedule II Valuation and Qualifying Accounts
Balance of beg. Charged to costs Charged to other Write-offs, net Balance at end
Description of period and expenses accounts of recoveries of period
- ----------------------------------------------------------------------------------------------------------------------------------
Allowance for doubtful accounts:
For the year ended December 25, 1998 $881,000 $1,149,000 $0 $5,000 $2,035,000
For the year ended December 26, 1997 $531,000 $425,000 $0 ($75,000) $881,000
For the year ended December 27, 1996 $110,000 $381,000 $0 $40,000 $531,000
ZOMAX OPTICAL MEDIA, INC.
EXHIBIT INDEX TO FORM 10-K
For the fiscal year ended: Commission File No.
December 25, 1998 0-28426
Exhibit
Number Description
2.1 Form of Stock Purchase Agreement (1)
2.2 Stock Purchase Agreement dated March 31, 1997 between the Company
and Jesse Arveida (Incorporated by reference to Exhibit 2.1 to
Current Report on Form 8-K dated March 31, 1997)
2.3 Stock Purchase Agreement dated February 3, 1998 by and among the
Company, Zomax Services, Inc., Primary Marketing Group Limited
("PMG Limited") and shareholders of PMG Limited (Incorporated by
reference to Exhibit 2.1 to Current Report on Form 8K dated February
4, 1998)
2.4 Merger Agreement dated February 3, 1998 by and among the Company,
Zomax Services, Inc., Next Generation Services, LLC ("NGS"),
Primary Marketing Group ("PMG") and holders of all membership
interests of NGS and shares of PMG (Incorporated by reference to
Exhibit 2.2 to Current Report on Form 8-K dated February 4, 1998)
2.5 Asset Purchase Agreement dated February 3, 1998 by and among
the Company and Kao Corporation (Incorporated by reference to
Exhibit 2.3 to Current Report on Form 8-K dated February 4, 1998)
2.6 Stock Purchase Agreement dated October 2, 1998 by and among Zomax
Optical Media, Inc., Chumbo Holdings Corporation and the
shareholders of Chumbo Holdings Corporation. Upon the request of the
Commission, the Registrant agrees to furnish a copy of the exhibits
and schedules to the Stock Purchase Agreement, subject to requests
for confidential treatment of certain information contained in such
exhibits and schedules. (4)
2.7 Asset Purchase and Sale Agreement dated November 28, 1998 by and
among Zomax Optical Media, Inc. and Kao Infosystems Company. Upon
the request of the Commission, the Registrant agrees to furnish a
copy of the exhibits and schedules to the Asset Purchase and Sale
Agreement, subject to requests for confidential treatment of
certain information contained in such exhibits and schedules.
2.8 Asset Purchase and Sale Agreement dated November 28, 1998 by and
among Zomax Canada Company and Kao Infosystems Canada, Inc. Upon
the request of the Commission, the Registrant agrees to furnish
a copy of the exhibits and schedules to the Asset Purchase and
Sale Agreement, subject to requests for confidential treatment
of certain information contained in such exhibits and schedules. (3)
2.9 Share Purchase and Sale Agreement dated November 28, 1998 by and
among Primary Marketing Group Limited and Kao Corporation. (3)
3.1 Articles of Incorporation (1)
3.2 Bylaws (1)
4.1 Form of Stock Certificate (1)
4.2 Articles of Incorporation (1)
4.3 Bylaws (1)
4.4 Form of Representative Warrant (1)
10.1 1996 Stock Option Plan, as amended March 7, 1997, and Forms of
Incentive and Non-qualified Stock Option Agreements
(Incorporated by reference to Exhibits 10.1 and 10.17 to
Registration Statement on Form S-1, SEC File No. 333-2430).
10.2 1996 Employee Stock Purchase Plan (1)**
10.3 Manufacturing Agreement between the Company and Metacom, Inc.
dated January 1, 1995, as amended January 31, 1997 (Incorporated by
reference to Exhibit 10.3 to Registration Statement on Form S-1,
SEC File No. 333-2430, and Exhibit 10.15 to Annual Report on
Form 10-KSB for the year ended December 27, 1996).
10.4 Lease between the Company and the Company and Nathan Lane
Partnership, LLP dated January 1, 1995, as amended October 28, 1997
(Incorporated by reference to Exhibit 10.5 to Registration Statement
on Form S-1, SEC File No. 333-2430 and Exhibit 10.15 to Annual Report
on Form 10-KSB for the year ended December 26, 1997). (1)
10.5 Employment Agreement with James T. Anderson dated March 1, 1996
(Incorporated by reference to Exhibit 10.6 to Registration
Statement on Form S-1, SEC File No. 333-2430).
10.6 License Agreement with U.S. Phillips Corporation effective
January 1, 1996 (Incorporated by reference to Exhibit 10.7 to
Registration Statement on form S-1, SEC File No. 333-2430).
10.7 License Agreement with Discovision Associates dated January 1,
1994 (Incorporated by reference to Exhibit 10.8 to Registration
Statement on Form S-1, SEC File No. 333-2430).
10.8 Loan and Security Agreement with Phoenixcor, Inc. dated May 24,
1993 (Incorporated by reference to Exhibit 10.9 to Registration
Statement on Form S-1, SEC File No. 333-2430).
10.9 Loan and Security Agreement with Phoenixcor, Inc. dated July 22,
1993 (Incorporated by reference to Exhibit 10.10 to Registration
Statement on Form S-1, SEC File No. 333-2430).
10.10 Loan and Security Agreement with Phoenixcor, Inc. dated February
10, 1994 (Incorporated by reference to Exhibit 10.11 to Registration
Statement on Form S-1, SEC File No. 333-2430).
10.11 Loan and Security Agreement with Phoenixcor, Inc. dated July 5, 1995
(Incorporated by reference to Exhibit 10.12 to Registration Statement
on Form S-1, SEC File No. 333-2430).
10.12 Promissory Note issued by the Company to Norwest Equipment Finance,
Inc. dated May 22, 1996 and related documents (Incorporated by
reference to Exhibit 10.13 to Registration Statement on Form S-1,
SEC File No. 333-2430).
10.13 Revolving Credit and Term Loan Agreement between the Company and
Marquette Capital Bank dated December 31, 1995, as amended April 30,
1997 (Incorporated by reference to Exhibit 10.16 to Registration
Statement on Form S-1, SEC File No. 333-2430, and Exhibit 10.16 to
Quarterly Report on Form 10-QSB for the quarter ended March 27, 1997).
10.14 Lease between the Company and Chaboya Ranch dated June 5, 1997
(Incorporated by reference to Exhibit 10.16 to Quarterly Report
on Form 10-QSB for the quarter ended March 28, 1997).
10.15 Credit Agreement dated as of January 6, 1999 among the Registrant,
Certain Lenders and General Electric Capital Corporation. (3)
10.16 Credit Agreement dated as of January 6, 1999 among Zomax Canada
Company, Certain Lenders and General Electric Capital Canada Inc. (3)
21.1 * Subsidiaries of the Company
23 * Consent of Arthur Andersen LLP
24 * Power of Attorney (included on signature page of this report)
27 * Financial Data Schedule (included in electronic version only)
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* Filed herewith.
** Management agreement or compensatory plan or arrangement.
(1) Incorporated by reference to the corresponding exhibit numbers to
S-1 Registration Statement, SEC File No. 333-2430.
(2) Incorporated by reference to the corresponding exhibit numbers to
form 10-Q for quarter ended June 26, 1998.
(3) Incorporated by reference to Exhibits to Current Report on Form
8-K/A-1 dated January 7, 1999. (4) Incorporated by reference to
Exhibit 2.1 Current Report on Form 8-K dated October 2, 1998.