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UNITED STATES
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 June 30, 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 No. 0-9220
METATEC, INC.
(Exact name of Registrant as specified in its charter)
OHIO 31-1647405
(State of Incorporation) (IRS Employer Identification No.)
7001 Metatec Boulevard
Dublin, Ohio 43017
(Address of principal executive offices) (Zip code)
Registrant's telephone number, including area code: (614) 761-2000
METATEC INTERNATIONAL, INC.
---------------------------
(Former name, former address, and former fiscal year,
if changed since last report)
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, 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 Act).
Yes No X
--- ---
Number of Common Shares outstanding as of July 16, 2003: 6,536,113
Page 1 of 19
METATEC, INC.
-------------
FORM 10-Q
IMPORTANT INFORMATION REGARDING FORWARD-LOOKING STATEMENTS
All statements, other than statements of historical facts, included in this
Form 10-Q of Metatec, Inc. (the "Company") or incorporated herein by reference,
including, without limitation, statements regarding the Company's future
financial position, business strategy, budgets, projected costs, goals and plans
and objectives of management for future operations, are forward-looking
statements within the meaning of the Private Securities Litigation Reform Act of
1995. Forward-looking statements generally can be identified by the use of
forward-looking terminology such as "may," "will," "expect," "intend,"
"estimate," "anticipate," "project," "believe" or "continue" or the negative
thereof or variations thereon or similar terminology. Forward-looking statements
speak only as the date the statements were made. Although the Company believes
that the expectations reflected in forward-looking statements have a reasonable
basis, it can give no assurance that these expectations will prove to be
correct. Forward-looking statements are subject to risks and uncertainties that
could cause actual events or results to differ materially from those expressed
in or implied by the statements. For a discussion of the most significant risks
and uncertainties that could cause the Company's actual results to differ
materially from those projected, see the Company's Form 10-K for its fiscal year
ending December 31, 2002, Item 7--Forward-Looking Statements; Risk Factors
Affecting Future Results. Except to the limited extent required by applicable
law, the Company undertakes no obligation to update or revise any
forward-looking statements, whether as a result of new information, future
events, or otherwise.
Page 2 of 19
INDEX PAGE
----- ----
Part I: Financial Information
Item 1 - Financial Statements
Consolidated Balance Sheets as of June 30,
2003 (unaudited) and December 31, 2002 4
Consolidated Statements of Operations
for the three months ended June 30, 2003
and 2002 (unaudited) 5
Consolidated Statements of Operations
for the six months ended June 30, 2003
and 2002 (unaudited) 6
Consolidated Statements of Shareholders'
Deficiency for the six months ended
June 30, 2003 (unaudited) 7
Consolidated Statements of Cash Flows
for the six months ended June 30,
2003 and 2002 (unaudited) 8
Notes to Consolidated Financial
Statements (unaudited) 9-11
Item 2 - Management's Discussion and Analysis of
Financial Condition and Results of Operations 11-16
Item 3 - Quantitative and Qualitative Disclosures about
Market Risk 17
Item 4 - Controls and Procedures 17
Part II: Other Information
Items 1-6 18
Signatures 19
Page 3 of 19
PART I - FINANCIAL INFORMATION
Item I. Financial Statements
METATEC, INC.
- --------------------------------------------------------------------------------
CONSOLIDATED BALANCE SHEETS At June 30, At December 31,
-------------------- ------------------
2003 2002
(Unaudited)
-------------------- ------------------
ASSETS
Current assets:
Cash and cash equivalents $ 377,006 $ 336,597
Restricted cash 120,000 146,000
Accounts receivable, net of allowance for doubtful accounts of $200,000 5,750,427 7,251,086
Inventory 1,213,704 1,096,912
Prepaid expenses 568,989 920,514
-------------------- ------------------
Total current assets 8,030,126 9,751,109
Property, plant and equipment - net 22,213,292 24,094,376
Other assets 136,068 147,101
-------------------- ------------------
TOTAL ASSETS $ 30,379,486 $ 33,992,586
==================== ==================
LIABILITIES & SHAREHOLDERS' DEFICIENCY
Current liabilities:
Accounts payable $ 2,434,404 $ 2,556,727
Accrued expenses:
Royalties 346,082 452,152
Personal property taxes and real estate taxes 1,175,892 1,362,188
Payroll and benefits 1,056,280 1,059,480
Restructuring 354,575 901,721
Other 487,184 615,120
Unearned income 82,131 58,767
Current maturities of long-term real estate debt 173,944 170,995
Current maturities of other long-term debt and capital lease obligations 10,854,490 793,850
-------------------- ------------------
Total current liabilities 16,964,982 7,971,000
Long-term real estate debt 18,268,113 18,356,891
Other long-term debt and capital lease obligations, less current maturities 4,284,903 17,018,611
Other long-term liabilities 1,118,194 1,148,638
-------------------- ------------------
Total liabilities 40,636,192 44,495,140
-------------------- ------------------
Shareholders' deficiency:
Common stock - no par value; authorized 10,000,000 shares;
issued 7,217,855 shares 33,008,138 33,008,138
Accumulated deficit (39,582,932) (39,819,030)
Treasury stock, at cost; 681,742 shares (3,670,537) (3,670,537)
Unamortized restricted stock (11,375) (21,125)
-------------------- ------------------
Total shareholders' deficiency (10,256,706) (10,502,554)
-------------------- ------------------
TOTAL LIABILITIES & SHAREHOLDERS' DEFICIENCY $ 30,379,486 $ 33,992,586
==================== ==================
See notes to consolidated financial statements.
Page 4 of 19
METATEC, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
Three Months Ended June 30,
-------------------------------------
2003 2002
- --------------------------------------------------------------- ----------------- ---------------
NET SALES $ 10,132,457 $ 11,956,331
Cost of sales 6,884,121 7,897,983
----------------- ---------------
Gross margin 3,248,336 4,058,348
Selling, general and administrative expenses (2,910,207) (4,065,761)
Gain on sale of assets 280,557 0
----------------- ---------------
OPERATING EARNINGS (LOSS) FROM CONTINUING OPERATIONS 618,686 (7,413)
Other income and (expense):
Investment income 3,013 3,216
Interest expense (655,281) (719,362)
----------------- ---------------
LOSS FROM CONTINUING OPERATIONS BEFORE INCOME TAXES (33,582) (723,559)
Income tax benefit 0 0
----------------- ---------------
LOSS FROM CONTINUING OPERATIONS (33,582) (723,559)
Income from discontinued operations 0 680,565
----------------- ---------------
NET LOSS $ (33,582) $ (42,994)
================= ===============
WEIGHTED AVERAGE NUMBER OF SHARES OUTSTANDING
Basic and diluted 6,536,113 6,536,113
================= ===============
LOSS FROM CONTINUING OPERATIONS PER COMMON SHARE
Basic and diluted $ (0.01) $ (0.11)
================= ===============
NET LOSS COMMON SHARE
Basic and diluted $ (0.01) $ (0.01)
================= ===============
See notes to consolidated financial statements.
Page 5 of 19
METATEC, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
Six Months Ended June 30,
-------------------------------------
2003 2002
- ---------------------------------------------------------------- ----------------- ----------------
NET SALES $ 20,581,512 $ 25,082,028
Cost of sales 13,469,153 16,924,216
----------------- ----------------
Gross margin 7,112,359 8,157,812
Selling, general and administrative expenses (6,301,894) (8,185,150)
Gain on sale of assets 737,066 0
----------------- ----------------
OPERATING EARNINGS (LOSS) FROM CONTINUING OPERATIONS 1,547,531 (27,338)
Other income and (expense):
Investment income 3,076 3,573
Interest expense (1,314,509) (1,471,326)
----------------- ----------------
INCOME (LOSS) FROM CONTINUING OPERATIONS BEFORE INCOME TAXES 236,098 (1,495,091)
Income tax benefit 0 875,000
----------------- ----------------
INCOME (LOSS) FROM CONTINUING OPERATIONS 236,098 (620,091)
Income from discontinued operations 0 783,660
----------------- ----------------
NET INCOME $ 236,098 $ 163,569
================= ================
WEIGHTED AVERAGE NUMBER OF SHARES OUTSTANDING
Basic and diluted 6,536,113 6,536,113
================= ================
INCOME (LOSS) FROM CONTINUING OPERATIONS PER COMMON SHARE
Basic and diluted $ 0.04 $ (0.09)
================= ================
NET INCOME COMMON SHARE
Basic and diluted $ 0.04 $ 0.03
================= ================
See notes to consolidated financial statements.
Page 6 of 19
METATEC, INC.
- ----------------------------------------------------------
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' DEFICIENCY (UNAUDITED)
Unamortized
Common Accumulated Treasury Restricted
Stock Deficit Stock Stock Total
- ----------------------------------- -------------- --------------- ----------------- --------------- -------------
BALANCE AT DECEMBER 31, 2002 $ 33,008,138 $ (39,819,030) $ (3,670,537) $ (21,125) $ (10,502,554)
Net income 236,098 236,098
Amortization of restricted stock 9,750 9,750
-------------- --------------- ----------------- --------------- -------------
BALANCE AT JUNE 30, 2003 $ 33,008,138 $ (39,582,932) $ (3,670,537) $ (11,375) $ (10,256,706)
============== =============== ================= =============== =============
See notes to consolidated financial statements.
Page 7 of 19
METATEC, INC.
- -----------------------------------------------------------------
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
For the six months ended June 30, 2003 2002
- ----------------------------------------------------------------- -----------------------------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 236,098 $ 163,569
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation and amortization 1,969,437 2,744,447
Gain on sale of assets (623,872) 0
Changes in assets and liabilities:
Accounts receivable 1,590,659 3,386,157
Inventory (116,596) (31,631)
Prepaid expenses and other assets 303,380 (22,053)
Accounts payable and accrued expenses (1,003,646) (3,258,632)
Unearned income 23,364 34,988
Net assets of discontinued operations 0 (247,278)
-----------------------------------
Net cash provided by operating activities 2,378,824 2,769,567
-----------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property, plant and equipment (311,503) (166,542)
Proceeds from the sales of property, plant and equipment 849,672 1,209,134
--------------- ---------------
Net cash provided by investing activities 538,169 1,042,592
--------------- ---------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Decrease in restricted cash 26,000 0
Payment of long-term debt and capital lease obligations (1,587,670) (1,030,043)
Net payments on revolving line of credit (1,314,914) (3,917,252)
--------------- ---------------
Net cash used in financing activities (2,876,584) (4,947,295)
--------------- ---------------
Increase (decrease) in cash and cash equivalents 40,409 (1,135,136)
Cash and cash equivalents at beginning of period 336,597 1,291,778
--------------- ---------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 377,006 $ 156,642
=============== ===============
SUPPLEMENTAL CASH FLOW DISCLOSURES:
Interest paid $ 1,183,354 $ 1,412,861
=============== ===============
Income tax refunds received $ 15,587 $ 891,482
=============== ===============
Assets purchased by the assumption of a liability $ 29,119 $ 12,015
=============== ===============
Issuance of restricted stock $ 0 $ 39,000
=============== ===============
Payment of accrued restrucuturing expense by the issuance
of treasury stock $ 0 $ 90,000
=============== ===============
Assets sold for the assumption of a receivable $ 90,000 $ 0
=============== ===============
See notes to condensed consolidated financial statements.
Page 8 of 19
METATEC, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
1. BASIS OF PRESENTATION The consolidated balance sheet as of June 30, 2003, the
consolidated statements of operations for the three and six months ended June
30, 2003 and 2002, the consolidated statement of shareholders' deficiency for
the six months ended June 30, 2003, and the consolidated statements of cash
flows for the six month periods then ended have been prepared by the Company,
without audit. In the opinion of management, all adjustments, which consist
solely of normal recurring adjustments, necessary to present fairly, in
accordance with accounting principles generally accepted in the United States of
America, the financial position, results of operations and changes in cash flows
for all periods presented have been made. At the May 15, 2003 Shareholders
Meeting, shareholders voted to change the Company's name to Metatec, Inc.
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with accounting principles generally accepted
in the United States of America have been condensed or omitted. These
consolidated financial statements should be read in conjunction with the
consolidated financial statements and notes thereto included in the Company's
December 31, 2002 annual report on Form 10-K. The results of operations for the
period ended June 30, 2003 are not necessarily indicative of the results for the
full year.
In January 2003, the Company sold its Internet-based electronic software
distribution ("ESD") business to Digital River, Inc. ("Digital River"), a global
e-commerce outsource solutions provider based in Minneapolis, Minnesota. Under
the terms of the agreement, Digital River acquired certain assets and assumed
certain liabilities associated with the Company's ESD business, and the Company
received approximately $1,100,000 in cash and notes, subject to adjustment based
on an earn out computation. The Company recognized a gain on the sale of
approximately $167,000 during the second quarter of 2003 and $635,000 for the
six months ended June 30, 2003.
In February 2003, the Company entered into a licensing agreement with one of its
DVD patent licensors which, among other things, provides for a deferred payment
schedule for accrued royalties owed by the Company under prior licensing
agreements, and, as a result, $137,000 of accrued royalties were reclassified to
other long-term liabilities as of December 31, 2002.
In March 2002, the President signed the Job Creation and Worker Assistance Act
of 2002 into law. This law extended the carry back period from two to five years
for net operating losses arising in the 2001 and 2002 taxable years. The Company
recorded an income tax benefit of $875,000 in the quarter ended March 31, 2002
related to this law.
SFAS No. 145, "Rescission of FASB Statements No. 4, 44, and 64, Amendment of
FASB Statement No. 13, and Technical Corrections," is effective for fiscal years
beginning after May 15, 2002 (December 31, 2003 for the Company). This Statement
rescinds FASB Statements No. 4 and 64 that dealt with issues relating to the
extinguishment of debt. This Statement also rescinds FASB Statement No. 44 that
dealt with intangible assets of motor carriers. This Statement modifies SFAS No.
13, "Accounting for Leases," so that certain capital lease modifications must be
accounted for by lessees as sale-leaseback transactions. Additionally, this
Statement identifies amendments that should have been made to previously
existing pronouncements and formally amends the appropriate pronouncements. The
adoption of SFAS No. 145 does not have a significant effect on the Company's
results of operations or its financial position.
SFAS No. 146, "Accounting for Costs Associated With Exit or Disposal Activities"
is effective for exit or disposal activities that are initiated after December
31, 2002. This Statement addresses financial accounting and reporting for costs
associated with exit or disposal activities and nullifies Emerging Issues Task
Force
Page 9 of 19
(EITF) Issue No. 94-3, "Liability Recognition for Certain Employee Termination
Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred
in a Restructuring)." The principal difference between this Statement and Issue
94-3 is that this Statement requires that a liability for a cost associated with
an exit or disposal activity be recognized when the liability is incurred. Under
Issue 94-3, a liability for an exit cost was recognized at the date of an
entity's commitment to an exit plan. The adoption of SFAS No. 146 did not have a
material impact on the Company's consolidated financial statements.
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure," ("SFAS 148"). SFAS 148 amends FASB
Statement No. 123, "Accounting for Stock-Based Compensation" ("SFAS 123") to
provide alternative methods for an entity that voluntarily changes to the fair
value based method of accounting for stock-based compensation, amends the
disclosure provisions of SFAS 123 and amends APB Opinion No. 28, "Interim
Financial Reporting," to require disclosure about those effects in interim
financial information. The transition guidance and annual disclosure provisions
of SFAS 148 are effective for fiscal years ending after December 15, 2002. In
addition, this Statement amends the disclosure requirements of Statement No. 123
to require prominent disclosures in both annual and interim financial
statements. Certain of the disclosure modifications are required for fiscal
years ending after December 15, 2002 and are included in the notes to these
consolidated financial statements.
In November 2002, the FASB issued FASB Interpretation No. 45 ("FIN 45"),
Guarantor's Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others, an interpretation of FASB
Statements No. 5, 57 and 107 and Rescission of FASB Interpretation No. 34. FIN
45 clarifies the requirements of SFAS No. 5, "Accounting for Contingencies,"
relating to the guarantor's accounting for, and disclosure of, the issuance of
certain types of guarantees. The disclosure provisions of FIN 45 are effective
for the current fiscal year and were not material in relation to the Company's
2002 consolidated financial statements. However, the provisions for initial
recognition and measurement are effective on a prospective basis for guarantees
that are issued or modified after December 31, 2002, irrespective of a
guarantor's year-end. The adoption of FIN 45 did not have a material impact on
the Company's financial condition or results of operations.
In January 2003, the FASB issued FIN 46, Consolidation of Variable Interest
Entities. FIN 46 clarifies the application of Accounting Research Bulletin No.
51, Consolidated Financial Statements, to certain entities in which equity
investors do not have the characteristics of a controlling financial interest or
do not have sufficient equity at risk for the entity to finance its activities
without additional subordinated financial support from other parties. FIN 46
requires a variable interest entity to be consolidated by a company, if that
company is subject to a majority of the risk of loss from the variable interest
entity's activities or entitled to receive a majority of the entity's residual
returns or both. FIN 46 also requires disclosures about variable interest
entities that a company is not required to consolidate but in which it has a
significant variable interest. The consolidation requirements of FIN 46 apply
immediately to variable interest entities created after January 31, 2003 and to
existing entities in the first fiscal year or interim period beginning after
June 15, 2003. Certain of the disclosure requirements apply to all financial
statements issued after January 31, 2003, regardless of when the variable
interest entity was established. The initial adoption of this accounting
pronouncement did not have a material impact on the Company's consolidated
financial statements.
In May 2003, the FASB issued FAS 150, Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity. FAS 150
requires that an issuer classify a financial instrument that is within its scope
as a liability (or an asset in some circumstances), many of which were
previously classified as equity. This statement is effective for financial
instruments entered into or modified after May 31, 2003 and otherwise shall be
effective for the Company's 2004 financial statements. Management does not
expect the initial adoption of this accounting pronouncement will have a
material impact on the Company's financial statements.
Page 10 of 19
2. DISCONTINUED OPERATIONS Pursuant to an agreement dated as of September 30,
2002, the Company sold its European CD-ROM manufacturing operations in Breda,
The Netherlands, to Nimbus, a Netherlands-based private investment group. The
transaction was structured as a sale of all of the shares of Metatec's European
subsidiary to Nimbus. The shares were sold in exchange for the assumption of the
European subsidiary's liabilities as of August 31, 2002.
European operations had revenues for the three months ended June 30, 2002 of
$2,870,000 and $4,990,000 for the six months ended June 30, 2002.
Pre-tax income for the Company's European operations for the three months ended
June 30, 2002 was $681,000 and $784,000 for the six months ended June 30, 2002.
The Company accounted for these operations as discontinued operations in the
2002 consolidated financial statements.
3. STOCK OPTIONS The Company accounts for employee and director stock options
using the intrinsic value method. Under this method, no compensation expense is
recognized in all years presented because all stock options are granted at an
exercise price equal to the fair market value of the Company's stock on the date
of the grant. If compensation expense for the Company's stock option grants had
been determined based on their estimated fair value at the grant dates, the
Company's net income and earnings per share for the six months ending June 30,
2003 would have been as follows:
Net income, as reported $236,098
Deduct: total stock-based compensation expense determined
under the fair value method for all awards, net of
related tax benefits (41,585)
---------
Pro forma net income $194,513
========
Earnings per common share, basic and diluted:
As reported $.04
Pro forma $.03
The fair value of options granted was estimated on the date of the grant using
the Black-Scholes option-pricing model.
4. LONG-TERM DEBT Included in the Company's long-term debt balance at December
31, 2002 is a term loan facility and a revolving loan facility (collectively,
the "Loans"). As of June 30, 2003, $7,680,000 and $2,295,000 were outstanding
under the term loan facility and revolving loan facility, respectively, which
are included in current maturities of long-term debt, as they are scheduled to
mature on April 1, 2004. As further discussed in Part II- Other Information,
Item. 5 Other Information, on August 8, 2003, the Company received notice that
the Loans had been sold and assigned to ComVest Investment Partners II LLC, an
affiliate of Commonwealth Associates Group Holdings, LLC ("Commonwealth"), and
the Board of Directors of the Company has received a non-binding proposal from
Commonwealth regarding a potential restructuring of the Loans.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS FOR THE THREE MONTHS ENDED JUNE 30, 2003 COMPARED TO THREE MONTHS
ENDED JUNE 30, 2002 AND THE SIX MONTHS ENDED JUNE 30, 2003 COMPARED TO THE SIX
MONTHS ENDED JUNE 30, 2002
RECENT EVENTS
The information set forth in Item 5 of Part II of this Form 10-Q is incorporated
by reference into this Item 2 of Part I.
BUSINESS OF THE COMPANY
The Company provides technology driven supply chain solutions that enable its
customers to streamline the process of delivering their products and information
to market, increase efficiencies and reduce costs. The
Page 11 of 19
Company assists its customers with a wide range of services, from preparing
their products for market to delivering their finished products into the
distribution channel or directly to the end-users. The Company's solutions are
built on a solid technology foundation that includes both customized system
integration and a web-based reporting and tracking tool that makes real-time
information easily accessible. Technologies include CD-ROM and DVD manufacturing
services. The Company's core CD-ROM manufacturing, packaging and distribution
capabilities serve as the major component of its supply chain services. The
Company's manufacturing and distribution facilities are located in Dublin, Ohio.
CRITICAL ACCOUNTING POLICIES
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America requires the appropriate
application of accounting policies. Many of these accounting policies require
the Company's management to make estimates and assumptions about future events
and their impact on amounts reported in the Company's financial statements and
related notes. Since future events and their impact cannot be determined with
certainty, actual results will inevitably differ from management's estimates.
Such differences could be material to the Company's financial statements.
Management believes that its application of accounting policies, and the
estimates inherently required therein, are reasonable. Accounting policies and
estimates are periodically reevaluated, and adjustments are made when facts and
circumstances indicate a change is necessary.
The Company's accounting policies are more fully described in Note 1 to the
consolidated financial statements included in the Company's Form 10-K for the
year ended December 31, 2002. Management believes there are certain critical
accounting policies important to a reader of the financial statements which are
described below. These critical accounting policies are not intended to be a
comprehensive list of all the Company's accounting policies. In many cases, the
accounting treatment of a particular transaction is specifically dictated by
accounting principles generally accepted in the United States of America, with
no need for management's judgment in their application. There are also areas in
which management's judgment in selecting other available alternatives would not
produce a materially different result.
Long-lived assets. In evaluating the fair value and future benefits of
long-lived assets, management completes an analysis of the anticipated
undiscounted future net cash flows of the related long-lived assets and reduces
their carrying value by the excess, if any, as a result of such calculation.
Allowance for doubtful accounts. Management provides a reserve for credit losses
based on the Company's past experience with similar accounts receivable, and it
believes that the Company's reserves are adequate. Since the accuracy of
management's estimation process could be materially impacted by the composition
of the accounts receivable over time, management periodically reviews and
modifies the estimation process.
Litigation. The Company and its legal counsel evaluate litigation and review the
likelihood of an outcome and the resulting materiality to the Company. The
Company is involved in various legal claims arising from the normal course of
its business. While the ultimate liability, if any, from these proceedings is
presently indeterminable, in the opinion of management, these matters should not
have a material adverse effect on the consolidated financial statements of the
Company.
Income taxes. The Company has a history of unprofitable operations. These losses
generated a significant federal tax net operating loss, or NOL, carryforward as
of June 30, 2003 and December 31, 2002. Accounting principles generally accepted
in the United States of America require the Company to record a valuation
allowance against the deferred tax asset associated with this NOL if it is "more
likely than not" that the Company will not be able to utilize the NOL to offset
future taxes. Because of the Company's history of unprofitable operations,
management has recorded a valuation allowance to offset the deferred tax asset
associated with the NOL because of the uncertainty surrounding the realizability
of such asset.
Page 12 of 19
In the future the Company could achieve levels of profitability which could
cause management to conclude that it is more likely than not that the Company
will realize all or a portion of the NOL carryforward. Upon reaching such a
conclusion, the Company would reduce the valuation allowance which would
increase the estimated net realizable value of the deferred tax asset at that
time and would then provide for income taxes at a rate equal to the Company's
combined federal and state effective rates.
RESULTS OF OPERATIONS
Net sales for the three months ended June 30, 2003, were $10,132,000, a decrease
of $1,824,000, or 15% over the same period of the prior year. Net sales for the
six months ended June 30, 2003, were $20,582,000, a decrease of $4,501,000, or
18% over the same period of the prior year. These decreases resulted from lower
freight revenue, the sale of the Company's ESD business, which was sold on
January 14, 2003 (see discussion below), and declining prices for the Company's
CD-ROM products and services, a trend the Company anticipates will continue. In
addition, demand for the Company's CD-ROM products and services declined due to
several factors, including the continued poor general economic conditions, the
continued increase in customers using on-line or electronic methods to
distribute information, and the continued maturation of the CD-ROM market.
Gross margin was $3,200,000 or 32% of net sales for the three months ended June
30, 2003, as compared to $4,100,000 or 34% of net sales for the same period of
the prior year. The decrease in the gross margin for the three month
period-to-period comparisons was the result of the price declines noted above
and an increased proportion of lower margin sales of customer procured
materials. In addition, the gross margin in 2002 included higher margin ESD
sales. Gross margin was 35% of net sales for the six months ended June 30, 2003,
as compared to 33% of net sales for the same period of the prior year. The
improvement in gross margin as a percentage of sales in the six month period to
period comparisons reflects a lower volume of freight revenue, as the gross
margin of freight sales is significantly lower than that obtained on the
Company's other sales, coupled with higher first quarter gross margin related to
certain supply chain customers.
Selling, general and administrative ("SG&A") expenses were $2,910,000, or 29% of
net sales, for the three months ended June 30, 2003, as compared to $4,066,000,
or 34% of net sales, for same period of the prior year. During the quarter ended
June 30, 2003, the Company recorded a $200,000 credit related to an adjustment
to personal property taxes and sales and use taxes. SG&A expenses were
$6,302,000, or 31% of net sales for the six months ended June 30, 2003, as
compared $8,185,000 or 33% of net sales for the same period of the prior year.
The reduction in SG&A expenses for the period-to-period comparisons, as well as
the improvement in the SG&A expense percentages for such period-to-period
comparisons, was the result of the Company's cost-cutting initiatives, such as
workforce reductions and facility closures.
On January 14, 2003, the Company sold its Internet-based electronic software
distribution ("ESD") business to Digital River, Inc. ("Digital River"), a global
e-commerce outsource solutions provider based in Minneapolis, Minnesota. Under
the terms of the agreement, Digital River acquired certain assets and assumed
certain liabilities associated with the Company's ESD business, and the Company
received approximately $1,100,000 in cash and notes, subject to adjustment based
on an earn out computation. The Company recognized a gain on the sale of
approximately $635,000 during the six months ended June 30, 2003.
In addition to the gain noted above, the Company recognized a gain of $102,000
during the six months ended June 30, 2003, which was previously considered
contingent and was related to the sale of the Company's Netherlands facility
completed in September 2002.
No restructuring expenses were incurred during the three months or six months
ended June 30, 2003 or the three months or six months of the prior year.
Page 13 of 19
Interest expense for the three months ended June 30, 2003 was $655,000, as
compared to $719,000 for the same period of the prior year. Interest expense for
the six months ended June 30, 2003 was $1,315,000, as compared to $1,471,000 for
the same period of the prior year. Interest expense decreased due to lower debt
balances under the revolving loan and term loan facilities and lower interest
rates.
The Company recognized an income tax benefit of $875,000 for the six months
ended June 30, 2002. In March 2002, the Job Creation and Worker Assistance Act
of 2002 was enacted into law. This law extended the carry back period from two
years to five years for net operating losses arising in the 2001 and 2002
taxable years. For the six months ended June 30, 2003 the Company utilized
approximately $250,000 of its net operating loss carryforward and, therefore,
did not record any income tax expense.
The net income from continuing operations for the six months ended June 30, 2003
was $236,000, or $.04 per basic and diluted common share, as compared to a net
loss from continuing operations in the same period of the prior year of
$620,000, or $.09 per basic and diluted common share. Including discontinued
operations, discussed below, the Company had a net income of $236,000 for the
six months ended June 30, 2003, or $.04 per basic and diluted common share, as
compared to net income in the same period of the prior year of $164,000, or $.03
per basic and diluted common share.
Discontinued Operations
Pursuant to an agreement dated as of September 30, 2002, the Company sold its
European CD-ROM manufacturing operations in Breda, The Netherlands, to Nimbus, a
Netherlands-based private investment group. The transaction was structured as a
sale of all of the shares of Metatec's European subsidiary to Nimbus. The shares
were sold in exchange for the assumption of the European subsidiary's
liabilities as of August 31, 2002.
Revenues for the Company's European operations for the six months ended June 30,
2002, were $4,990,000.
Pre-tax income for the Company's European operations for the six months ended
June 30, 2002, was $784,000.
FINANCIAL CONDITION - LIQUIDITY AND CAPITAL RESOURCES
Sources of Liquidity
The Company financed its business during the six months ended June 30, 2003,
primarily through cash generated from operations and to a lesser extent, net
proceeds from investing activities. Cash flow from operating activities was
$2,379,000 for the three months ended June 30, 2003, as compared to $2,770,000
for the three months ended June 30, 2002. The Company had cash and cash
equivalents of $377,000 as of June 30, 2003, as compared to $157,000 as of June
30, 2002.
Bank Financing Matters
The Company has a term loan facility and a revolving loan facility
(collectively, the "Loans") with The Huntington National Bank and Bank One, N.A.
(the "Banks"). As further described under Item 5 of Part II of this Form 10-Q,
the Company has been notified that, on August 8, 2003, the Loans had been sold
and assigned to ComVest Investment Partners II LLC ("ComVest"), an affiliate of
Commonwealth Associates Group Holdings, LLC ("Commonwealth"). In addition, the
Board of Directors of the Company has received a non-binding proposal (the
"Proposal") from Commonwealth regarding a potential restructuring of the Loans.
See Item 5 of Part II of this Form 10-Q for a further discussion of these
matters.
The borrowing base of the revolving loan facility is limited to the lesser of
(i) $10,000,000, or (ii) the sum of (A) 80% of eligible domestic accounts
receivable, plus (B) 30% of eligible domestic inventory, plus (C) 90% of
domestic machinery and equipment. The borrowing base is further reduced by the
aggregate amount of
Page 14 of 19
the Company's outstanding letters of credit. As of June 30, 2003, $7,680,000 and
$2,295,000 were outstanding under the term loan and revolving loan,
respectively, and the Company had approximately $3,985,000 available to draw on
its revolving loan.
The Loans mature on April 1, 2004. Quarterly principal payments are required for
the term loan if cash flows exceed certain specified targets over designated
periods of time. In March 2003, the Company exceeded these targets and made a
principle payment of $202,592 on May 1, 2003. The Company did not exceed these
targets during the second quarter 2003. The Loans are secured by a first lien on
all non-real estate business assets of the Company and a pledge of the stock of
the Company's subsidiaries. The Company is required to comply with the financial
and other covenants contained in the agreement for the Loans. As of June 30,
2003, the Company was in compliance with these covenants. The Loans accrue
interest at a rate equal to 3.5% in excess of the prime rate of the Banks.
Certain fees are required to be paid by the Company in connection with the
Loans.
Gary W. Qualmann has submitted his resignation as chief financial officer and
treasurer of the Company, effective as of August 19, 2003, to join another
company. Under the terms of the Loans, the Company is prohibited from replacing
or changing its chief financial officer without the prior written consent of the
assignee of the Banks' interest, unless such replacement or change will not
have, or is not likely to have, a "material adverse effect" on the Company, as
defined in the loan agreement. ComVest has waived any default under the Loans
related to Mr. Qualmann's resignation, and the Company is attempting to retain a
replacement chief financial officer. However there can be no assurance that the
Company will be able to retain a replacement chief financial officer acceptable
to ComVest, in which case ComVest may seek to declare the Company in default
under the Loans. If it would be found that the Company was in default of the
Loans for this reason, all principal and accrued interest under the Loans would
be immediately due and payable to ComVest, and such event would have a material
adverse impact on the Company's financial position and continuing operations and
its ability to continue as a going concern.
Real Estate Financing Matters
The Company has a $19,000,000 term loan which was used to permanently finance
the Company's Dublin, Ohio distribution center (completed in 1999) and to pay
down other bank debt. The loan has an outstanding principal balance of
$18,442,057 as of June 30, 2003. This term loan is payable in monthly principal
and interest payments based upon a thirty year amortization schedule, bears
interest at a fixed rate of 8.2%, and matures on September 1, 2009. This loan is
secured by a first lien on all real property of the Company and letters of
credit in favor of the lender, in an aggregate amount of $1,650,000, which are
renewed annually. The current letters of credit were renewed April 2003. A
contingency to the Proposal is the restructuring of this term loan.
Other Liquidity Matters
As of June 30, 2003, the Company had a working capital deficiency of
approximately $8,900,000 primarily due to the $9,975,000 of term loan and
revolving loan (under the Loans described above) maturing April 1, 2004.
Page 15 of 19
The Company had a shareholders' deficiency of $10,257,000 as of June 30, 2003,
as compared to a shareholders' deficiency of $10,503,000 as of December 31,
2002.
In February 2003, the Company entered into a licensing agreement with one of its
DVD patent licensors which, among other things, provides for a deferred payment
schedule for accrued royalties owed by the Company under prior licensing
agreements, and, as a result, $137,000 of accrued royalties were reclassified to
other long-term liabilities.
As previously discussed, the Company sold its EDS business to Digital River on
January 14, 2003.
The Company did not carry any off-balance sheet derivative financial instruments
or have any off-balance sheet financial arrangements at June 30, 2003.
SAFE HARBOR STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
Statements contained in this Form 10-Q or any other reports or documents
prepared by the Company or made by management of the Company may be
"forward-looking" within the meaning of the Private Securities Litigation Reform
Act of 1995. Such forward-looking statements are subject to certain risks and
uncertainties that could cause the Company's actual results to differ materially
from those projected. Such risks and uncertainties that might cause such a
difference include, but are not limited to: changes in general business and
economic conditions; changes in demand for CD-ROM products or supply chain
services; excess capacity levels in the CD-ROM industry; the introduction of new
products or services by competitors;
Page 16 of 19
increased competition (including pricing pressures); changes in manufacturing
efficiencies; changes in supply chain services techniques; changes in
technology; the Company's ability to meet the cash flow thresholds and other
financial covenants in its loan agreement with its banks, the failure of which
could result in the banks' exercising their legal remedies against the Company
or its assets; the Company's shareholders' deficiency, which means that
shareholders may not realize any value upon a sale or liquidation of the Company
or its assets; and other risks discussed in the Company's filings with the
Securities and Exchange Commission, including those risks discussed under the
caption "Forward Looking Statements; Risk Factors Affecting Future Results" and
elsewhere in the Form 10-K for the Company's year ended December 31, 2002.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK.
There is no change in the quantitative and qualitative disclosures about the
Company's market risk from the disclosures contained in the Company's Form 10-K
for its fiscal year ended December 31, 2002.
ITEM 4. CONTROLS AND PROCEDURES
(a) The Company carried out an evaluation, under the supervision and with
the participation of the Company's management, including the Company's Chief
Executive Officer and Chief Financial Officer, of the effectiveness of the
design and operation of the Company's disclosure controls and procedures (as
defined in Exchange Act Rule 13a-15(e)). Based upon that evaluation, the
Company's Chief Executive Officer and Chief Financial Officer concluded that, as
of the end of the period covered by this report, the Company's disclosure
controls and procedures were effective in timely alerting them to material
information relating to the Company (including its consolidated subsidiaries)
required to be included in the Company's periodic filings with the Securities
and Exchange Commission.
(b) There has been no change in the Company's internal control over
financial reporting that occurred during the Company's most recent fiscal
quarter that has materially affected, or is reasonably likely to materially
affect, the Company's internal control over financial reporting.
Page 17 of 19
PART II - OTHER INFORMATION
Items 1-4. INAPPLICABLE.
Item 5. OTHER INFORMATION
The Company has received a term loan and a revolving loan (collectively,
the "Loans") under the terms of a loan agreement dated as of February 8,
2002 (the "Loan Agreement"), with The Huntington National Bank and Bank
One, N.A. (the "Banks"). Total principal of $9,975,000 is currently
outstanding under the Loans which are scheduled to mature on April 1, 2004.
On August 8, 2003, the Company received notice that the Loans and all of
the Banks' right, title and interest in and to the Loans, the Loan
Agreement and any other Loan documents had been sold and assigned to
ComVest Investment Partners II LLC ("ComVest"). ComVest is an affiliate of
Commonwealth Associates Group Holdings, LLC ("Commonwealth").
In addition, the Board of Directors of the Company (the "Board") has
received a non-binding proposal (the "Proposal") from Commonwealth
regarding a potential restructuring of the Loans, as well as a potential
equity investment, as a result of which ComVest would acquire control of
the Company and its Board and the interests of the Company's shareholders
would be substantially diluted. The transaction would be subject to various
contingencies, including due diligence, restructuring of the existing
obligations relating to the Company's Dublin, Ohio facility, receipt of
shareholder approval, and the receipt by the Board of a favorable fairness
opinion on the restructuring transaction.
The Board is considering the Proposal and intends to retain an investment
banking firm or other financial advisor to assist it in its evaluation of
the Proposal, as well as any other alternatives that may become available
to the Company. The Company is cooperating with ComVest with respect to its
due diligence reviews and expects that the parties will continue
discussions regarding the Proposal. However, there can be no assurances
that the parties will reach agreement on the Proposal or any alternative
satisfactory to ComVest. Furthermore, ComVest may terminate the discussions
regarding the Proposal at any time. If the parties do not reach agreement
on the Proposal or a satisfactory alternative, or ComVest terminates
discussions regarding the Proposal, and if an event of default occurs
(including ComVest in good faith deeming itself insecure with respect to
payment of the Loans), then ComVest could pursue any or all of its remedies
under the Loan Agreement or related documents, or any other rights that may
be available to it, including seeking to commence an involuntary Chapter 11
proceeding against the Company.
Item 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
Exhibit No. Description of Exhibit
----------- ----------------------
4.1 Form of Share Certificate for Metatec, Inc.
10.1 Second amendment to employment agreement for
Christopher Munro
31.1 Certification of principal executive officer required
by Rule 13a-14(a) of the Securities Exchange Act of 1934.
Page 18 of 19
31.2 Certification of principal financial officer required by
Rule 13a-14(a) of the Securities Exchange Act of 1934.
32.1 Certification of principal executive officer required by
Rule 13a-14(b) of the Securities Exchange Act of 1934 and
Section 1350 of Chapter 63 of Title 18 of the United
States Code.
32.2 Certification of principal financial officer required by
Rule 13a-14(b) of the Securities 32.2 Exchange Act of
1934 and Section 1350 of Chapter 63 of Title 18 of the
United States Cod.
(b) Reports on Form 8-K.
(i) The Company filed a Form 8-K dated May 8, 2003, under Items 7 and
9 furnishing a copy of the Company's earnings release for its
first quarter 2003.
(ii) The Company filed a Form 8-K dated August 8, 2003, to announce
the resignation of its Chief Financial Officer effective August
19, 2003.
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.
Metatec, Inc.
/s/ Gary W. Qualmann
BY: Gary W. Qualmann
Date: August 14, 2003 Chief Financial Officer
(authorized signatory-
principal financial officer)
/s/ Julia A. Fratianne
BY: Julia A. Fratianne
Vice President - Finance
(authorized signatory-
principal accounting officer)
Page 19 of 19
METATEC, INC.
Form 10-Q
For Quarterly Period Ended June 30, 2003
EXHIBIT INDEX
Exhibit Description of Exhibit
- ------- ----------------------
4.1 Form of Share Certificate for Metatec, Inc.
10.1 Second amendment to employment agreement for Christopher Munro
31.1 Certification of principal executive officer required by
Rule 13a-14(a) of the Securities Exchange Act of 1934.
31.2 Certification of principal financial officer required by
Rule 13a-14(a) of the Securities Exchange Act of 1934.
32.1 Certification of principal executive officer required by
Rule 13a-14(b) of the Securities Exchange Act of 1934 and Section
1350 of Chapter 63 of Title 18 of the United States Code.
32.2 Certification of principal financial officer required by
Rule 13a-14(b) of the Securities Exchange Act of 1934 and Section
1350 of Chapter 63 of Title 18 of the United States Code.