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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the Quarterly Period Ended March 31, 2003
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the Transition Period From _________ to _________
Commission File Number 0-23077
______________________
IMAGEMAX, INC.
(Exact name of Registrant as specified in its charter)
Pennsylvania 23-2865585
------------------------------- ------------------
(State or other jurisdiction of (I.R.S. Employer
Incorporation or organization) Identification No.)
455 Pennsylvania Avenue, Suite 200
Fort Washington, Pennsylvania 19034
---------------------------------------- ----------
(Address of principal executive offices) (Zip Code)
(215) 628-3600
----------------------------------------------------
(Registrant's telephone number, including area code)
Indicate by check mark whether the Registrant: (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes [X] No [ ]
Indicate by check mark whether the registrant is an accelerated filer
(as defined in Rule 12b-2 of the Exchange Act).
Yes [ ] No [X]
Indicate the number of shares outstanding of each of the issuer's classes of
common stock as of May 14, 2003:
Common Stock, no par value 7,311,073
-------------------------- ----------------
Class Number of Shares
IMAGEMAX, INC.
INDEX TO FORM 10-Q
PART I - FINANCIAL INFORMATION Page
Item 1 - Condensed Consolidated Financial Statements (Unaudited)
Consolidated Statements of Operations...................................... 1
Consolidated Balance Sheets................................................ 2
Consolidated Statements of Cash Flows...................................... 3
Notes to Consolidated Financial Statements................................. 4
Item 2 - Management's Discussion and Analysis of Financial
Condition and Results of Operations........................................ 8
Item 3 - Quantitative and Qualitative Disclosures
about Market Risk.......................................................... 11
Item 4 - Controls and Procedures.................................................... 12
PART II - OTHER INFORMATION
Item 1 - Legal Proceedings.......................................................... 12
Item 5 - Other Information.......................................................... 12
Item 6 - Exhibits and Reports on Form 8-K........................................... 12
SIGNATURES................................................................................... 13
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited, in thousands except per share amounts)
Three Months
Ended March 31,
---------------
2003 2002
---- ----
Revenues:
Services.......................................................................... $9,776 $8,871
Products.......................................................................... 1,358 1,467
------ --------
11,134 10,338
------ --------
Cost of revenues:
Services.......................................................................... 6,288 5,106
Products.......................................................................... 927 924
Depreciation...................................................................... 254 322
------ --------
7,469 6,352
------ --------
Gross profit................................................................... 3,665 3,986
Selling and administrative expenses.................................................... 3,590 3,558
Amortization of intangibles............................................................ 143 95
------ --------
Operating income (loss) ....................................................... (68) 333
Interest expense ..................................................................... 316 295
------ --------
Income (loss) before cumulative effect of accounting change........................ (384) 38
Cumulative effect of accounting change................................................. -- (15,084)
------ --------
Net loss............................................................................... $ (384) $(15,046)
====== ========
Basic and diluted net loss per share................................................... $ (.06) $ (2.22)
====== ========
Shares used in computing basic and diluted loss per share.............................. 6,859 6,793
====== ========
See accompanying notes.
1
CONSOLIDATED BALANCE SHEETS
(Unaudited, in thousands except share amounts)
March 31, December 31,
2003 2002
---- ----
ASSETS
Current assets:
Cash and cash equivalents....................................................... $ 62 $ 878
Accounts receivable, net of allowance for doubtful
accounts of $275 as of March 31, 2003 and
December 31, 2002........................................................... 9,297 8,983
Inventories..................................................................... 1,241 1,165
Prepaid expenses and other...................................................... 1,191 1,086
------- -------
Total current assets........................................................ 11,791 12,112
Property, plant and equipment, net................................................. 3,120 3,143
Intangibles, primarily goodwill, net............................................... 19,945 19,974
Other assets....................................................................... 610 625
------- -------
Total assets................................................................ $35,466 $35,854
======= =======
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Short-term debt and current portion of long-term debt........................... $6,423 $802
Subordinated convertible debt, net of discount of $121.......................... 6,866 --
Accounts payable................................................................ 5,110 4,867
Accrued expenses................................................................ 2,180 2,623
Deferred revenue................................................................ 1,413 1,279
------- -------
Total current liabilities................................................... 21,992 9,571
Long-term debt..................................................................... 1,028 6,784
Subordinated convertible debt, net of discount of $156............................. -- 6,678
Shareholders' equity:
Preferred stock, no par value, 10,000,000 shares
authorized, none issued..................................................... -- --
Common stock, no par value, 40,000,000 shares authorized,
7,311,073 shares issued and outstanding
at March 31, 2003 and December 31, 2002..................................... 53,567 53,567
Restricted common stock............................................................ (59) (68)
Accumulated deficit................................................................ (41,062) (40,678)
------- -------
Total shareholders' equity.................................................. 12,446 12,821
------- -------
Total liabilities and shareholders' equity.................................. $35,466 $35,854
======= =======
See accompanying notes.
2
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited, in thousands)
Three Months
Ended March 31,
---------------
2003 2002
---- ----
Cash flows from operating activities:
Net loss........................................................................... $(384) $(15,046)
Adjustments to reconcile net loss to net cash
provided by (used in) operating activities-
Cumulative effect of accounting change......................................... -- 15,084
Compensation expense - restricted common stock................................. 9 --
Depreciation and amortization.................................................. 283 352
Amortization of deferred financing costs....................................... 113 63
Accrued interest on subordinated debt.......................................... 153 135
Imputed interest on subordinated debt.......................................... 35 35
Changes in operating assets and liabilities-
Accounts receivable, net................................................... (314) 407
Inventories................................................................ (76) 59
Prepaid expenses and other................................................. (105) (100)
Other assets............................................................... (98) (81)
Accounts payable........................................................... 243 (339)
Accrued expenses........................................................... (443) (142)
Deferred revenue........................................................... 134 140
---- ----
Net cash provided by (used in) operating activities.................... (450) 567
---- ----
Cash flows from investing activities:
Purchases of property and equipment................................................ (231) (73)
---- ----
Net cash used in investing activities.......................................... (231) (73)
---- ----
Cash flows from financing activities:
Principal payments on debt and capital lease obligations........................... (381) (509)
Net borrowings under line of credit................................................ 246 --
---- ----
Net cash used in financing activities.................................. (135) (509)
---- ----
Net decrease in cash and cash equivalents.............................................. (816) (15)
Cash and cash equivalents, beginning of period......................................... 878 84
---- ----
Cash and cash equivalents, end of period............................................... $ 62 $ 69
==== ====
Supplemental disclosures of cash flow information:
Cash paid for:
Interest....................................................................... $128 $153
==== ====
See accompanying notes.
3
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. BACKGROUND AND BASIS OF PRESENTATION:
ImageMax, Inc. ("ImageMax") is a single-source provider of outsourced document
management solutions to companies located throughout the United States and
concentrated primarily in the health care, financial services, engineering and
legal services industries. The Company's services include electronic (digital)
and micrographic media conversion, data entry and indexing, Internet retrieval
and hosting services, document storage (including Internet "web-enabled"
document storage and retrieval) and system integration. The Company also sells
and supports document management equipment and proprietary as well as third
party open architecture imaging and indexing software. The Company has one
reportable segment.
The accompanying unaudited condensed consolidated financial statements include
the accounts of ImageMax and its subsidiary (the "Company"). All material
intercompany balances and transactions have been eliminated in consolidation.
The consolidated balance sheet at December 31, 2002 has been derived from the
Company's consolidated financial statements that have been audited by the
Company's independent auditors.
The unaudited financial statements have been prepared in accordance with
accounting principles generally accepted in the United States for interim
financial information pursuant to rules and regulations of the Securities and
Exchange Commission ("SEC"). Accordingly, unaudited interim financial statements
such as those in this report allow certain information and footnotes required by
accounting principles generally accepted in the United States for year end
financial statements to be excluded. The Company believes all adjustments
necessary for a fair presentation of these interim financial statements have
been included and are of a normal and recurring nature except for the goodwill
impairment charge taken under SFAS 142. Interim results are not necessarily
indicative of results for a full year. These interim financial statements should
be read in conjunction with the Company's pro forma and historical financial
statements and notes thereto included in its Annual Report on Form 10-K for the
year ended December 31, 2002.
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICES:
Other than Statement of Financial Accounting Standards No. 142, "Goodwill and
Other Intangibles" ("SFAS 142"), there were no changes in the accounting
policies of the Company during the periods presented. For a description of these
policies, refer to Note 2 to Consolidated Financial Statements of ImageMax, Inc.
and Subsidiary included in the Company's Annual Report on Form 10-K for the year
ended December 31, 2002. For a description of SFAS 142 and its impact on the
Company, refer to Note 4 hereof.
The accompanying consolidated financial statements of the Company have been
prepared on a going-concern basis, which contemplates the realization of assets
and the satisfaction of liabilities in the normal course of business. The
consolidated financial statements do not include any adjustments that might be
necessary should the Company be unable to continue in existence. The amended
credit facility requires the Company on a quarterly basis beginning in June 2003
to meet a specified level of EBITDA and to not exceed a maximum leverage ratio,
as defined. Management has implemented a sales and operating plan in 2003, which
they believe will allow the Company to meet these quarterly covenants. Further,
management is implementing certain short-term cost-deferral and cost-cutting
measures to ensure the EBITDA covenants are attained. Management believes that
these current actions will enable the Company to meet its quarterly financial
covenants throughout 2003, and therefore, have the necessary financing to
continue as a going concern.
Accounting for stock-based compensation
Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation" ("SFAS 123"), encourages entities to record compensation expense
for stock-based employee compensation plans at fair value but provides the
option of measuring compensation expense using the intrinsic value method
prescribed in Accounting Principles Board Opinion No. 25, "Accounting for Stock
Issued to Employees" ("APB 25"). The Company accounts for stock-based
compensation in accordance with APB 25. The following presents pro forma results
of operations as if SFAS 123 had been used to account for stock-based
compensation plans.
Options were not granted in the quarters ending March 31, 2003 and 2002. The
following pro forma results would have been reported had compensation cost been
recorded for the fair value of the options granted:
Quarter Ended March 31
---------------------------
2003 2002
---- ----
Net income (loss), as reported $ (384,000) $ (15,046,000)
Pro forma net income (loss) (399,000) (15,077,000)
Basic and diluted income (loss) per share, as reported (.06) (2.22)
Pro forma basic and diluted income (loss) per share (.06) (2.22)
4
3. RECLASSIFCATIONS:
Certain prior year amounts have been reclassified to conform to the current year
presentation.
4. GOODWILL AND INTANGIBLE ASSETS:
Cumulative Effect of Accounting Policy Change
In July 2001, the Financial Accounting Standards Board ("FASB") issued SFAS Nos.
141 and 142, "Business Combinations" and "Goodwill and Other Intangibles." SFAS
141 requires all business combinations initiated after July 1, 2001, to be
accounted for using the purchase method. SFAS 142 concluded that purchased
goodwill would not be amortized but would be reviewed for impairment annually
and when certain events indicate that the goodwill of a reporting unit may be
impaired. The Company, which has one operating segment, has determined that its
reporting units should be aggregated under SFAS 142 and deemed a single
reporting unit because they have similar economic characteristics. The
impairment test uses a fair value based approach, whereby if the implied fair
value of a reporting unit's goodwill is less than its carrying amount, goodwill
would be considered impaired. SFAS 142 requires that goodwill be tested for
impairment and that any transition adjustment be recorded at the beginning of
the year in which SFAS 142 is adopted. All goodwill and indefinite-lived
intangible assets must be tested for impairment at least annually. The new
goodwill model applies not only to goodwill arising from acquisitions completed
after the effective date, but also to goodwill previously recorded.
Effective January 1, 2002, the Company adopted SFAS 142. Upon adoption of SFAS
142, the Company ceased amortization of its goodwill and completed its
calculation of the implied fair value of goodwill. As a result of the
calculation, the Company recorded a non-cash charge of approximately $15.1
million or $2.22 per share to reduce the carrying value of its goodwill. Such
charge is non-operational in nature and is reflected as a cumulative effect of
an accounting change in the accompanying consolidated statement of operations as
of January 1, 2002. In calculating the impairment charge, the fair value of the
reporting units of the Company was estimated using both discounted cash flow
methodology and recent comparable transactions.
For the period from December 31, 2002 through May 14, 2003, no further
impairment indicators were noted. There can be no assurance that future goodwill
impairment tests will not result in an additional charge to earnings.
5. LONG-TERM DEBT:
On April 11, 2003, the Company completed the Second Amendment to the Amended and
Restated Credit Agreement with Commerce Bank, NA and FirsTrust Bank (the
"lenders"), which extends the maturity date of the Company's Revolving Credit
Line to January 15, 2004 and expands the borrowing availability under the
Revolving Credit Line from $6.0 to $7.0 million. The expansion of the Revolving
Credit Line is based upon the Company's Eligible Accounts Receivable and the
Company intends to use the proceeds of the Revolving Credit Line primarily for
working capital purposes.
Under the Revolving Credit Line, the Company is required to pay interest monthly
at the prime rate plus 2.0% (effective rate of 6.25% as of March 31, 2003). The
outstanding principal of the Revolving Credit Line is due and payable at the end
of term on January 15, 2004. Borrowing availability is based on the level of the
Company's eligible accounts receivable, as defined in the Credit Agreement. At
March 31, 2003, approximately $6.0 million was outstanding under the Revolving
Credit Line, and there was nominal borrowing availability under the Revolving
Credit Line. On April 11, 2003, borrowing availability under the expanded
Revolving Credit Line was approximately $500,000.
Under the Term Loan, interest is payable monthly at the prime rate plus 2.0%
(effective rate of 6.25% as of March 31, 2003). The outstanding principal amount
of the Term Loan was $365,000. The outstanding balance on the Term Loan of
$365,000 is due June 30, 2003.
The Credit Facility restricts the payment of dividends and is secured by
substantially all assets of the Company and requires maintenance of various
financial and restrictive covenants, including a minimum level of quarterly
EBITDA of $746,000 (commencing with the first quarter of 2003), total
liabilities not exceeding fifty percent (50%) of net worth (as defined in the
Credit Agreement), and no interest payment on the subordinated convertible notes
issued to the Investors (as defined below) until February 15, 2004. The Company
obtained a waiver from the lenders for violation of the first quarter 2003
EBITDA covenant.
On December 23, 2002, the Company completed the First Amendment to the Amended
and Restated Credit Agreement that expanded the Company's Revolving Credit Line
from $5.25 million to $6.0 million.
On June 14, 2002, the Company completed the closing (the "Closing") of a new
$7.48 million senior credit facility (the "Credit Facility") pursuant to the
Credit Agreement dated June 13, 2002 (the "Credit Agreement") with the Lenders.
The Credit Facility consisted of a $5.25 million revolving credit line (the
"Revolving Credit Line") and a $2.23 million term loan (the "Term Loan"). The
Company used the proceeds of the Credit Facility to repay existing senior debt
and for working capital purposes.
The Company incurred $40,000 in loan fees associated with the Second Amendment
payable over the second and third quarters of 2003, which are being amortized
over the remaining loan term. The Company paid $5,000 for the First Amendment on
January 2003. The Company paid $112,000 in bank fees in 2002 (payment was made
over the second and third quarters) related to the Credit Agreement dated June
13, 2002, which are being amortized over the loan term.
5
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
5. LONG-TERM DEBT - (continued):
In connection with the Credit Facility, the Company entered into an interest
rate cap agreement maturing on June 13, 2003, with a total notional amount of
$2,000,000. The Company paid the counterparty a premium of $7,500 on June 12,
2002, and will receive monthly an amount equal to the product of the amount by
which the Prime Rate (4.25% at March 31, 2003) exceeds the Cap Rate (6.5%)
multiplied by the notional amount. The premium is being amortized over a
one-year period. Since entering the interest rate cap agreement, the Prime Rate
has not exceeded the Cap Rate. Accordingly, the Company has not received any
payments under this agreement.
In April 1999, the Company executed a $900,000 mortgage loan with a lender
relating to a Company-owned property that houses a production facility. The
Company received $869,000 in proceeds, net of closing costs, from the
transaction. In July 1999, the $869,000 was applied to the balance of the Credit
Facility. Interest on the mortgage is at the greater of 8.50% or the U.S.
Treasury rate plus 375 basis points (9.01% at March 31, 2003). The loan carries
a ten-year term (maturing May 2009), is secured by the mortgaged property, and
requires equal monthly repayments of principal and interest of $7,600.
6. SUBORDINATED CONVERTIBLE DEBT:
In order for the Company to enter into the June 14, 2002 Credit Facility, the
Company's subordinated debt holders, TDH III, L.P., LVIR Investors Group, LP
(formerly known as Dime Capital Partners, Inc.) and Robert E. Drury (the
"Investors"), agreed to forego payments of interest until February 15, 2004. In
consideration for such forbearance of interest, the Company and the Investors
amended the terms of the $6 million convertible subordinated loan and warrant
purchase agreement (the "Amendment") on June 14, 2002.
Under the terms of the Amendment, the Investors received new convertible
subordinated notes (the "New Notes") that replaced the existing notes purchased
by the Investors on February 15, 2000 and capitalized $0.27 million of the
currently outstanding interest. The New Notes and accrued interest are due and
payable on February 15, 2004. Interest accrues at a rate of nine percent (9%),
compounded semi-annually on June 30 and December 31. The Company cannot
voluntarily prepay the New Notes. However, the Company can elect to extend the
due date of the New Notes to February 15, 2005 (the "Extension Right"), if the
Company pays seventy-five percent (75%) of the currently outstanding principal
balance of the New Notes and interest accrued thereon by February 15, 2004. Up
to an aggregate of approximately $2.0 million of the principal amount of the New
Notes is voluntarily convertible by the Investors into the Company's common
stock, no par value, (the "Common Stock") at a price of $0.40 per share (subject
to downward adjustment under certain circumstances), for approximately 4.9
million shares of Common Stock.
The Company also issued new warrants (the "New Warrants") that replaced the
existing warrants issued to the Investors on February 15, 2000. The New Warrants
provide that the Investors may purchase an aggregate of 1.8 million shares of
Common Stock at $3.50 per share (subject to downward adjustment under certain
circumstances). The New Warrants are only exercisable once the Company has
repaid the New Notes in full. If the holder of a New Warrant converts its New
Note, in whole or in part, into shares of Common Stock, their New Warrant will
be cancelled. Furthermore, the New Warrants will be cancelled if the Additional
Warrants (defined below) become exercisable.
The Company also issued additional warrants (the "Additional Warrants") to
purchase an aggregate of 8.4 million shares of Common Stock at a price per share
equal to the lesser of (i) $0.25 or (ii) eighty percent (80%) of the market
price of the Common Stock at the time of exercise. The Additional Warrants are
only exercisable upon (i) the date the Company defaults in the payment of any
amount due and payable under the New Notes, regardless of whether or not the
Company has exercised its Extension Right, or (ii) if the Company has exercised
its Extension Right, the date the Company pays the New Notes in full. Once the
Additional Warrant is exercisable, the New Warrants will be cancelled. The
Additional Warrant is exercisable for a period equal to (i) two (2) years in the
event of a default in the payment of amounts due and payable by the Company or
(ii) two (2) years from the date the Company exercised the Extension Right in
the event the Company pays the New Notes in full. If the Company defaults in the
payment of amounts due and payable under the New Notes, when the Company either
(i) does not exercise its Extension Right or (ii) exercises its Extension Right
after the New Notes have been converted, in whole or in part, into shares of
Common Stock, then the Investors can exercise the Additional Warrant by delivery
of two-year, interest free, non-recourse notes secured by the pledge of the
Additional Warrant shares or by cashless exercise, and the Investors shall be
entitled to vote the 8.4 million shares of Common Stock. In the event that the
Company exercises its Extension Right and pays the remainder due by February 15,
2005, and the New Notes have not been converted, in whole or in part, into
shares of Common Stock, then the number of shares of Common Stock purchasable
under the Additional Warrants shall be reduced to an aggregate of 2.2 million
shares of Common Stock.
6
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
7. INCOME TAXES:
At March 31, 2003, the Company had net operating loss carryforwards for federal
income tax purposes of approximately $13.6 million expiring in 2016 through
2022. The net operating loss carryforward differs from the accumulated deficit
principally due to differences in the recognition of certain expenses for
financial and income tax reporting purposes, as well as, the nondeductibility of
the loss on the sale of business units and goodwill amortization. The timing and
manner, in which the company will utilize the net operating loss carryforwards
in any year, or in total, may be limited by the provision of the Internal
Revenue Service Code. Such limitation may have an impact on the ultimate
realization and timing of these net operating loss carryforwards.
At March 31, 2003, a valuation allowance offset the Company's tax benefit based
upon the uncertainty of the realizability of the associated deferred tax asset
given the Company's losses to date under the guidelines set forth in the
Statement of Financial Accounting Standards No. 109, "Accounting for Income
Taxes".
8. EARNINGS PER SHARE:
The Company has presented net loss per share pursuant to SFAS No. 128, "Earnings
Per Share", which requires dual presentation of basic and diluted earnings per
share. Basic earnings per share ("Basic EPS") is computed by dividing the net
loss for the period by the weighted average number of shares of common stock
outstanding for the period. Diluted earnings per share ("Diluted EPS") is
computed by dividing net loss for the period by the weighted average number of
shares of common stock and common stock equivalents outstanding during the
period. For the three months ended March 31, 2003 and 2002, common stock
equivalents are considered anti-dilutive and are not included because of the
Company's net loss position and option exercise prices and debt conversion
prices exceed the average market price for the period and as such, Basic EPS and
Diluted EPS are the same.
7
PART I - ITEM 2
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
This Report on Form 10-Q contains certain forward-looking statements that
involve substantial risks and uncertainties. When used in this Report, the words
"anticipate," "believe," "estimate," "expect," "intend," and similar
expressions, as they relate to the Company or its management, are intended to
identify such forward-looking statements. The Company's actual results,
performance, or achievements could differ materially from the results expressed
in, or implied by, these forward-looking statements. Factors that could cause or
contribute to such differences include those set forth in "Business--Risk
Factors" as disclosed in the Company's Annual Report on Form 10-K for the year
ended December 31, 2002 and other ImageMax filings with the Securities and
Exchange Commission, and risks associated with the results of the continuing
operations of ImageMax. Accordingly, there is no assurance that the results in
the forward-looking statements will be achieved.
The Company is a national single-source provider of integrated document
management solutions. The Company's revenues are derived from a broad range of
media conversion, storage and retrieval services, the sale of third party
document management software products which support digital imaging and indexing
services and the sale and service of a variety of document management equipment.
The Company's revenues consist of service revenues, which are generally
recognized as the related services are rendered, and product revenues, which are
recognized when the products are shipped to clients. Service revenues are
primarily derived from media conversion, storage and retrieval, imaging and
indexing of documents, and the service of imaging and micrographic equipment
sold. Product revenues are derived from equipment sales and software sales and
support. Cost of revenues consists principally of the costs of products sold and
wages and related benefits, supplies, facilities and equipment expenses
associated with providing the Company's services. Selling and administrative
("S&A") expenses include salaries and related benefits associated with the
Company's executive and senior management, marketing and selling activities
(principally salaries and related costs), and financial and other administrative
expenses.
Critical Accounting Policies
The following discussion and disclosures included elsewhere in this Report are
based upon the unaudited consolidated condensed financial statements, which have
been prepared in accordance with accounting principles generally accepted in the
United States for interim financial information. The preparation of these
financial statements requires the Company to make estimates, judgments and
assumptions that affect the reported amounts of assets, liabilities, revenues
and expenses, and related disclosure of contingent assets and liabilities at the
date of the financial statements and for the period then ended. The Company
continually evaluates the estimates used, including those related to the
allowance for doubtful accounts, impairments of tangible and intangible assets,
income taxes, and contingencies. The Company has based its estimates on
historical experience, current conditions and various other assumptions that the
Company believes to be reasonable under the circumstances. These estimates form
the basis for making judgments about the carrying values of assets and
liabilities and are not readily apparent from other sources. The Company uses
these estimates to assist in the identification and assessment of the accounting
treatment necessary with respect to commitments and contingencies. Actual
results may differ from these estimates under different assumptions or
conditions. The Company believes the following critical accounting policies
involve more significant judgments and estimates used in the preparation of the
consolidated financial statements.
Revenue Recognition
The Company recognizes media conversion services revenue on services in process,
such as scanning projects, as units are completed under the proportional
performance method, subject to consideration of guidance in SAB#101. Revenue
generated from software sales fall under the guidance of SOP 97-2. Hardware and
other equipment revenue is recognized FOB shipping point.
Accounting for Acquisitions
The Company was founded in November 1996 and on December 4, 1997 completed its
initial public offering the "Offering". Concurrent with the Offering, the
Company began material operations with the acquisition of 14 document management
service companies and in the first eight months of 1998 acquired an additional
13 document management service companies.
The Company's acquisitions have resulted in a significant accumulation of
goodwill and for acquisitions prior to July 1, 2001; the Company amortized the
related goodwill over an estimated benefit period of 30 years. There have been
no acquisitions completed after July 1, 2001 and the Company is no longer
amortizing goodwill beginning on January 1, 2002, in accordance with SFAS 142,
"Goodwill and Other Intangible Assets". Upon adoption of SFAS 142 during the six
months ended June 30, 2002, the Company completed its calculation of the implied
fair value of goodwill and recorded a non-cash charge of approximately $15.1
million or $2.22 per share to reduce the carrying value of its goodwill. Such
charge is non-operational in nature and is reflected as a cumulative effect of
an accounting change in the accompanying consolidated statements of operations
as of January 1, 2002. In calculating the impairment charge, the fair value of
the reporting units of the Company was estimated using both discounted cash flow
methodology and recent comparable transactions.
For the period from December 31, 2002 through May 14, 2003, no further
impairment indicators were noted. The Company will perform its required annual
impairment review during the fourth quarter each year using the same
methodology.
8
Results of Operations
Three Months Ended March 31, 2003 Compared to Three Months Ended March 31, 2002
Overview. For the three months ended March 31, 2003, net loss amounted to $0.4
million or $0.06 per basic and diluted share compared to a net loss of $15.0
million or $2.22 per basic and diluted share for the three months ended March
31, 2002.
Revenues. For the three months ended March 31, 2003, total revenues increased
$0.8 million, or 7.7% as compared to the corresponding period in 2002. For the
three months ended March 31, 2003 services revenue and products revenue,
respectively, comprised 87.8% and 12.2% of total revenues, as compared to 85.8%
and 14.2% in the corresponding period in 2002.
The overall increase in revenue is a result of the Company's strategic focus
towards digitally based conversion services and sales of third party software in
response to declining demand and opportunities in analog based conversion
services and equipment product sales.
Service revenue increased 10.2% or $0.9 million as the Company experienced
increases primarily in litigation projects utilizing electronic data discovery
services ($1.5 million) and digital conversion services as a result of higher
volume, notably in southern California, a facility opened in the fourth quarter
of 2002 ($0.3 million). These increases were partially offset by a $0.9 million
decrease in data entry and litigation coding services related to the loss of
former customers that were part of the litigation described in Part II - Item 1
- - Legal Proceedings on page 12.
Product revenue decreased 7.4% or $0.1 million as a result of lower software
volume.
In the second quarter of 2003, we expect lower revenues than the first quarter,
primarily attributable to the timing of several litigation projects.
Gross profit. For the three months ended March 31, 2003, gross profit decreased
by $0.3 million, or 8.1%. Gross profit percentage decreased from 38.6% to 32.9%
in the current quarter 2003 versus the same corresponding quarter in 2002.
Gross profit declined $0.2 million on service revenue primarily due to lower
margins on projects utilizing electronic data discovery services, which have
margins of 27% to 30% versus the Company's historical service margins of 36% to
40%. In addition, gross profit derived from service revenues was adversely
impacted by the decline in data entry and litigation coding services noted
above, and the impact of severe weather on operations in the Mid-Atlantic and
Northeast during the first quarter of 2003.
Gross profit declined $0.1 million on product revenue due to a decline in higher
margin software revenue combined with lower margins on analog equipment and
supplies sales due primarily to price.
For the second quarter of 2003, we expect that the overall mix of revenue,
savings from relocated facilities, and improved productivity in the Mid-Atlantic
and Northeast to increase gross profit percentage.
Selling and administrative expenses. For the three months ended March 31, 2003,
S&A expenses increased by $32,000, or 0.9% as compared to the corresponding
period in 2002. This increase included $0.1 million of expenses incurred for the
move of operations to more cost effective facilities within the Boston, Detroit
and Philadelphia markets.
Interest Expense. Interest expense remained constant as the company maintained
consistent debt levels at March 31, 2003 versus March 31, 2002.
Liquidity and Capital Resources
As of March 31, 2003, the Company had cash and cash equivalents of $ 0.1 million
and a working capital deficit of $10.2 million. The working capital deficit
includes the outstanding balance of the Revolving Credit Line of $6.0 million
and subordinated convertible debt of $6.8 million which are due January 15, 2004
and February 15, 2004, respectively. As of December 31, 2002 the Company had
cash and cash equivalents of $0.9 million and working capital of $2.5 million.
In addition, the Company made $0.4 million in principal payments on the Term
Loan for the three months ended March 31, 2003. For the three months ended March
31, 2003 net cash used in operating activities amounted to $0.5 million; net
cash used in investing activities amounted to $0.2 million; and net cash used in
financing activities amounted to $0.1 million. On April 11, 2003, the Company
completed the Second Amendment to the Amended and Restated Credit Agreement with
Commerce Bank, NA and FirsTrust Bank (the "lenders"), which extends the maturity
date of the Company's Revolving Credit Line to January 15, 2004 and expands the
borrowing availability under the Revolving Credit Line from $6.0 to $7.0
million. Borrowing availability under the expanded Revolving Credit Line was
approximately $500,000.
Net cash provided by operating activities primarily represents net income before
depreciation and amortization and cumulative effect of accounting change. For
the three months ended March 31, 2003 increases in deferred revenue for advance
customer deposits and increases in accounts payable to accommodate working
capital needs were offset by inventory billings to meet future production needs,
increases in prepaid assets and deposits for upcoming projects and decreases in
accrued expenses due to payment of 2002 sales commissions and other operating
expenses.
Net cash used in investing activities represents the Company's investments in
equipment and information technology for new and existing production facilities.
For the three months ended March 31, 2003, the Company made capital expenditures
of $0.2 million.
9
Net cash used in financing activities primarily represents the $0.4 million of
payments under the Term Loan offset by $0.2 borrowings on the revolving credit
line.
The Company continues to selectively invest in equipment and technology to meet
the needs of its operations and to improve its operating efficiency. The Company
may also consider selective synergistic in-market acquisitions in the future.
The Company believes that its operating cash flow together with the unused
portion of the expanded Revolving Credit Line will be sufficient to finance
operating requirements through 2003.
Management Plans
The Company plans to actively pursue financing alternatives in 2003 in response
to the Lender and Investor debt maturities in early 2004.
Credit Facility (The following disclosure is consistent with Note 4 to the
Consolidated Financial Statements)
On April 11, 2003, the Company completed the Second Amendment to the Amended and
Restated Credit Agreement with Commerce Bank, NA and FirsTrust Bank (the
"lenders"), which extends the maturity date of the Company's Revolving Credit
Line to January 15, 2004 and expands the borrowing availability under the
Revolving Credit Line from $6.0 to $7.0 million.
The expansion of the Revolving Credit Line is based upon the Company's Eligible
Accounts Receivable and the Company intends to use the proceeds of the Revolving
Credit Line primarily for working capital purposes.
Under the Revolving Credit Line, the Company is required to pay interest monthly
at the prime rate plus 2.0% (effective rate of 6.25% as of March 31, 2003). The
outstanding principal of the Revolving Credit Line is due on January 15, 2004.
Borrowing availability is based on the level of the Company's eligible accounts
receivable, as defined in the Credit Agreement. As of March 31, 2003,
approximately $6.0 million was outstanding under the Revolving Credit Line, and
there was nominal availability under the credit line. On April 11, 2003
borrowing availability under the expanded Revolving Credit Line was
approximately $500,000.
Under the Term Loan, interest is payable monthly at the prime rate plus 2.0%
(effective rate of 6.25% as of March 31, 2003). The outstanding principal amount
of the Term Loan was $365,000 at March 31, 2003. The outstanding balance on the
Term Loan of $365,000 is due June 30, 2003.
The Credit Facility restricts the payment of dividends and is secured by
substantially all assets of the Company and requires maintenance of various
financial and restrictive covenants, including a minimum level of quarterly
EBITDA of $746,000 (commencing with the first quarter of 2003), total
liabilities not exceeding fifty percent (50%) of net worth (as defined in the
Credit Agreement), and no interest payment on the subordinated convertible notes
issued to the Investors (as defined below) until February 15, 2004. The Company
obtained a waiver from the banks for violation of the first quarter 2003 EBITDA
covenant.
On December 23, 2002, the Company completed the First Amendment to the Amended
and Restated Credit Agreement that expanded the Company's Revolving Credit Line
from $5.25 million to $6.0 million.
On June 14, 2002, the Company completed the closing (the "Closing") of a new
$7.48 million senior credit facility (the "Credit Facility") pursuant to the
Credit Agreement dated June 13, 2002 (the "Credit Agreement") with the Lenders.
The Credit Facility consisted of a $5.25 million revolving credit line (the
"Revolving Credit Line") and a $2.23 million term loan (the "Term Loan"). The
Company used the proceeds of the Credit Facility to repay existing senior debt
and for working capital purposes.
The Company incurred $40,000 in loan fees associated with the Second Amendment
payable over the second and third quarters of 2003, which are being amortized
over the remaining loan term. The Company paid $5,000 for the First Amendment on
January 2003. The Company paid $112,000 in bank fees in 2002 (payment was made
over the second and third quarters) related to the Credit Agreement dated June
13, 2002, which are being amortized over the loan term.
In connection with the Credit Facility, the Company entered into an interest
rate cap agreement maturing on June 13, 2003, with a total notional amount of
$2,000,000. The Company paid the counterparty a premium of $7,500 on June 12,
2002, and will receive monthly an amount equal to the product of the amount by
which the Prime Rate (4.25% at March 31, 2003) exceeds the Cap Rate (6.5%)
multiplied by the notional amount. The premium is being amortized over a
one-year period. Since entering the interest rate cap agreement, the Prime Rate
has not exceeded the Cap Rate. Accordingly, the Company has not received any
payments under this agreement.
In April 1999, the Company executed a $900,000 mortgage loan with a lender
relating to a Company-owned property that houses a production facility. The
Company received $869,000 in proceeds, net of closing costs, from the
transaction. In July 1999, the $869,000 was applied to the balance of the Credit
Facility. Interest on the mortgage is at the greater of 8.50% or the U.S.
Treasury rate plus 375 basis points (9.01% at March 31, 2003). The loan carries
a ten-year term (maturing May 2009), is secured by the mortgaged property, and
requires equal monthly repayments of principal and interest of $7,600.
10
Convertible Subordinated Debt (The following disclosure is consistent with Note
5 to the Consolidated Financial Statements)
In order for the Company to enter into the June 14, 2003 Credit Facility, the
Company's subordinated debt holders, TDH III, L.P., LVIR Investors Group, LP
(formerly known as Dime Capital Partners, Inc.) and Robert E. Drury (the
"Investors"), agreed to forego payments of interest until February 15, 2004. In
consideration for such forbearance of interest, the Company and the Investors
amended the terms of the $6 million convertible subordinated loan and warrant
purchase agreement (the "Amendment") on June 14, 2002.
Under the terms of the Amendment, the Investors received new convertible
subordinated notes (the "New Notes") that replaced the existing notes purchased
by the Investors on February 15, 2000 and capitalized $0.27 million of the
currently outstanding interest. The New Notes and accrued interest are due and
payable on February 15, 2004. Interest accrues at a rate of nine percent (9%),
compounded semi-annually on June 30 and December 31. The Company cannot
voluntarily prepay the New Notes.
However, the Company can elect to extend the due date of the New Notes to
February 15, 2005 (the "Extension Right"), if the Company pays seventy-five
percent (75%) of the currently outstanding principal balance of the New Notes
and interest accrued thereon by February 15, 2004. Up to an aggregate of
approximately $2.0 million of the principal amount of the New Notes is
voluntarily convertible by the Investors into the Company's common stock, no par
value, (the "Common Stock") at a price of $0.40 per share (subject to downward
adjustment under certain circumstances), for approximately 4.9 million shares of
Common Stock. The Company also issued new warrants (the "New Warrants") that
replaced the existing warrants issued to the Investors on February 15, 2000. The
New Warrants provide that the Investors may purchase an aggregate of 1.8 million
shares of Common Stock at $3.50 per share (subject to downward adjustment under
certain circumstances). The New Warrants are only exercisable once the Company
has repaid the New Notes in full. If the holder of a New Warrant converts its
New Note, in whole or in part, into shares of Common Stock, their New Warrant
will be cancelled. Furthermore, the New Warrants will be cancelled if the
Additional Warrants (defined below) become exercisable.
The Company also issued additional warrants (the "Additional Warrants") to
purchase an aggregate of 8.4 million shares of Common Stock at a price per share
equal to the lesser of (i) $0.25 or (ii) eighty percent (80%) of the market
price of the Common Stock at the time of exercise. The Additional Warrants are
only exercisable upon (i) the date the Company defaults in the payment of any
amount due and payable under the New Notes, regardless of whether or not the
Company has exercised its Extension Right, or (ii) if the Company has exercised
its Extension Right, the date the Company pays the New Notes in full. Once the
Additional Warrant is exercisable, the New Warrants will be cancelled. The
Additional Warrant is exercisable for a period equal to (i) two (2) years in the
event of a default in the payment of amounts due and payable by the Company or
(ii) two (2) years from the date the Company exercised the Extension Right in
the event the Company pays the New Notes in full. If the Company defaults in the
payment of amounts due and payable under the New Notes, when the Company either
(i) does not exercise its Extension Right or (ii) exercises its Extension Right
after the New Notes have been converted, in whole or in part, into shares of
Common Stock, then the Investors can exercise the Additional Warrant by delivery
of two-year, interest free, non-recourse notes secured by the pledge of the
Additional Warrant shares or by cashless exercise, and the Investors shall be
entitled to vote the 8.4 million shares of Common Stock. In the event that the
Company exercises its Extension Right and pays the remainder due by February 15,
2005, and the New Notes have not been converted, in whole or in part, into
shares of Common Stock, then the number of shares of Common Stock purchasable
under the Additional Warrants shall be reduced to an aggregate of 2.2 million
shares of Common Stock.
New Accounting Standards
None.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company's major market risk exposure is to changing interest rates. The
Company has variable-rate debt representing 50% of its total long-term debt at
March 31, 2003. If interest rates average 25 basis points more in 2003 than they
did during 2002, the Company's interest expense would increase approximately
$18,043 on an annual basis (interest expense for 2002 was $1.2 million). As of
May 14, 2003, the prime rate and the Company's interest rates on variable-rate
debt have not changed. The Company has limited its interest rate risk by
entering into an interest rate cap agreement. The agreement, which matures on
June 13, 2003, is for a total notional amount of $2,000,000. In connection with
this agreement the Company paid the counterparty a premium of $7,500 on June 13,
2002, and will receive monthly an amount equal to the product of the amount by
which the Prime Rate (4.25% at March 31, 2003) exceeds the Cap Rate (6.5%)
multiplied by the notional amount. Since entering the interest rate cap
agreement, the Prime Rate has not exceeded the Cap Rate. Accordingly, the
Company has not received any payments under this agreement.
11
ITEM 4. Controls and Procedures
(a) EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES. The Company's
Chief Executive Officer and its Chief Financial Officer, after evaluating the
effectiveness of the Company's disclosure controls and procedures (as defined in
the Securities Exchange Act of 1934 Rules 13a-14(c) and 15d-14(c) as of a date
within 90 days of the filing date of this quarterly report of Form 10-Q (the
"Evaluation Date")), have concluded that as of the Evaluation Date, the
Company's disclosure controls and procedures were adequate and effective to
ensure that material information relating to the Company and its consolidated
subsidiary would be made known to them by others within those entities,
particularly during the period in which this quarterly report on Form 10-Q was
being prepared. There were no significant changes in the internal controls of
the Company for the three month period ended March 31, 2003.
PART II -- OTHER INFORMATION
ITEM 1. Legal Proceedings
As previously disclosed in the Company's 2002 Annual Report on Form 10-K filed
on April 15, 2003, the Company filed a complaint in the United States District
Court for the Southern District of New York on November 21, 2002 against
Mitchell Taube (former Executive Vice President - Marketing and Sales),
Digiscribe International, Inc., the company Mr. Taube incorporated while
employed at the Company, and two former company employees - Barbara Collins and
Christopher Dutra, who are now employed by Digiscribe (the "Defendants"). In its
complaint, the Company asserted claims to breach of contract, misappropriation
of trade secrets, breach of fiduciary duty, and tortious interference with
contractual relations and prospective contractual relations.
On May 2, 2003, the Company conducted settlement discussions with the Defendants
before the United States District Court for the Southern District of New York.
At these discussions, the Company and the Defendants agreed to settle the
action. While definitive documents memorializing this settlement of the Company
and the Defendants are being drafted, the United States District Court for the
Southern District of New York has issued an Order of Discontinuance on May 7,
2003 regarding this matter.
ITEM 5. Other Information.
None.
ITEM 6. Exhibits and Reports on Form 8-K.
a. Exhibits.
10.3 First Amendment to the Amended and Restated Credit Agreement dated
December 23, 2002 by and among ImageMax, Inc., ImageMax of
Delaware, Inc., Commerce Bank, NA, as agent and lender, and
FirsTrust Bank, as lender (filed as Exhibit 10.1 to Form 8-K filed
by the Company on January 6, 2003).
10.4 First Amended and Restated Revolving Credit Note in favor of
Commerce Bank, NA in the principal amount of $3.6 million dated
December 23, 2002 (filed as Exhibit 10.3 to Form 8-K filed by the
Company on January 6, 2003).
10.5 First Amended and Restated Revolving Credit Note in favor of
FirsTrust Bank, NA in the principal amount of $2.4 million dated
December 23, 2002 (filed as Exhibit 10.4 to Form 8-K filed by the
Company on January 6, 2003).
99.1 Certification pursuant to 18 U.S.C. ss. 1350, as adopted pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002.
99.2 Certification pursuant to 18 U.S.C. ss. 1350, as adopted pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002.
99.3 Certification pursuant to 18 U.S.C. ss. 1350, as adopted pursuant
to Section 302 of the Sarbanes-Oxley Act of 2002.
99.4 Certification pursuant to 18 U.S.C. ss. 1350, as adopted pursuant
to Section 302 of the Sarbanes-Oxley Act of 2002.
b. Reports on Form 8-K:
The Company filed a Form 8-K on January 6, 2003 reporting the First
Amendment to Amended and Restated Credit Agreement dated December 23, 2002.
12
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this Report to be signed on its behalf by the
undersigned, thereunto duly authorized.
IMAGEMAX, INC.
BY: MARK P. GLASSMAN May 15, 2003
- -----------------------
Mark P. Glassman
Chief Executive Officer
BY: DAVID B. WALLS May 15, 2003
- -----------------------
David B. Walls
Chief Financial Officer, Treasurer and Secretary
13
EXHIBIT INDEX
10.3 First Amendment to the Amended and Restated Credit Agreement dated
December 23, 2002 by and among ImageMax, Inc., ImageMax of
Delaware, Inc., Commerce Bank, NA, as agent and lender, and
FirsTrust Bank, as lender (filed as Exhibit 10.1 to Form 8-K filed
by the Company on January 6, 2003).
10.4 First Amended and Restated Revolving Credit Note in favor of
Commerce Bank, NA in the principal amount of $3.6 million dated
December 23, 2002 (filed as Exhibit 10.3 to Form 8-K filed by the
Company on January 6, 2003).
10.5 First Amended and Restated Revolving Credit Note in favor of
FirsTrust Bank, NA in the principal amount of $2.4 million dated
December 23, 2002 (filed as Exhibit 10.4 to Form 8-K filed by the
Company on January 6, 2003).
99.1 Certification pursuant to 18 U.S.C. ss. 1350, as adopted pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002.
99.2 Certification pursuant to 18 U.S.C. ss. 1350, as adopted pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002.
99.3 Certification pursuant to 18 U.S.C. ss. 1350, as adopted pursuant
to Section 302 of the Sarbanes-Oxley Act of 2002.
99.4 Certification pursuant to 18 U.S.C. ss. 1350, as adopted pursuant
to Section 302 of the Sarbanes-Oxley Act of 2002.