UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-Q
QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF
THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year quarter ended March 26, 2004
Commission File Number: 0-28426
ZOMAX INCORPORATED
(Exact name of registrant as specified in its charter)
Minnesota |
|
No. 41-1833089 |
|
(State or Other Jurisdiction of |
|
(IRS Employer |
|
|
|
|
|
5353 Nathan Lane Plymouth, MN |
|
55442 |
|
(Address of Principal Executive Offices) |
|
(Zip Code) |
|
|
|
|
|
(763) 553-9300 |
||
|
(Registrant’s telephone number, including area code) |
||
Indicate by check mark whether the registrant (1) filed all reports required to be filed by Section 13 or 15(d) of the 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.
YESý NOo
Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2).
YESý NOo
The number of shares outstanding of the registrant’s common stock as of April 30, 2004 was 32,789,895 shares.
ZOMAX INCORPORATED
INDEX
|
DESCRIPTION |
|
|
||
|
|
|
|||
|
|
||||
|
|
|
|||
|
|
|
|||
|
|
|
|
|
|
|
|
|
|
||
|
|
|
|
|
|
|
|
|
|
||
|
|
|
|
|
|
|
|
|
|
||
|
|
|
|
|
|
|
|
|
|
||
|
|
|
|
|
|
|
|
Management’s Discussion and Analysis of Financial Condition and Results of Operations |
|
||
|
|
|
|
|
|
|
|
|
|||
|
|
|
|
|
|
|
|
|
|||
|
|
|
|
|
|
|
|
||||
|
|
|
|||
|
|
|
|||
|
|
|
|
|
|
|
|
Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities |
|
||
|
|
|
|
|
|
|
|
|
|||
|
|
|
|
|
|
|
|
||||
|
|
|
|||
|
|
||||
2
ITEM 1. FINANCIAL STATEMENTS
ZOMAX INCORPORATED
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
|
|
|
Three
Months Ended |
|
||||
|
|
|
2004 |
|
2003 |
|
||
|
|
|
|
|
|
|
||
|
Revenue |
|
$ |
50,035 |
|
$ |
47,228 |
|
|
|
|
|
|
|
|
||
|
Cost of revenue |
|
42,696 |
|
40,530 |
|
||
|
|
|
|
|
|
|
||
|
Gross profit |
|
7,339 |
|
6,698 |
|
||
|
|
|
|
|
|
|
||
|
Selling, general and administrative expenses |
|
9,166 |
|
9,333 |
|
||
|
|
|
|
|
|
|
||
|
Operating loss |
|
(1,827 |
) |
(2,635 |
) |
||
|
|
|
|
|
|
|
||
|
Other income (expense): |
|
|
|
|
|
||
|
Interest expense |
|
— |
|
(28 |
) |
||
|
Interest income |
|
178 |
|
285 |
|
||
|
Other, net |
|
(19 |
) |
(318 |
) |
||
|
|
|
|
|
|
|
||
|
Loss before income taxes |
|
(1,668 |
) |
(2,696 |
) |
||
|
|
|
|
|
|
|
||
|
Income tax benefit |
|
(687 |
) |
(971 |
) |
||
|
|
|
|
|
|
|
||
|
Net loss |
|
$ |
(981 |
) |
$ |
(1,725 |
) |
|
|
|
|
|
|
|
||
|
Loss per share: |
|
|
|
|
|
||
|
Basic |
|
$ |
(0.03 |
) |
$ |
(0.05 |
) |
|
|
|
|
|
|
|
|
|
|
Diluted |
|
$ |
(0.03 |
) |
$ |
(0.05 |
) |
|
|
|
|
|
|
|
||
|
Weighted average common shares outstanding: |
|
|
|
|
|
||
|
Basic |
|
32,716 |
|
32,898 |
|
||
|
Dilutive effect of stock options |
|
— |
|
— |
|
||
|
Diluted |
|
32,716 |
|
32,898 |
|
||
See notes to consolidated financial statements.
3
ZOMAX INCORPORATED
|
|
|
March |
|
December |
|
||
|
ASSETS |
|
|
|
|
|
||
|
|
|
|
|
|
|
||
|
Current assets: |
|
|
|
|
|
||
|
Cash and cash equivalents |
|
$ |
59,386 |
|
$ |
68,899 |
|
|
Accounts receivable, net of allowance of $1,027 in 2004 and $1,362 in 2003 |
|
31,902 |
|
39,403 |
|
||
|
Inventories |
|
11,287 |
|
12,757 |
|
||
|
Deferred income taxes |
|
2,680 |
|
2,685 |
|
||
|
Other current assets |
|
9,298 |
|
7,384 |
|
||
|
|
|
|
|
|
|
||
|
Total current assets |
|
114,553 |
|
131,128 |
|
||
|
|
|
|
|
|
|
||
|
Property and equipment, net |
|
36,690 |
|
38,859 |
|
||
|
|
|
|
|
|
|
||
|
Available-for-sale securities |
|
10,915 |
|
11,646 |
|
||
|
|
|
|
|
|
|
||
|
|
|
$ |
162,158 |
|
$ |
181,633 |
|
|
|
|
|
|
|
|
||
|
LIABILITIES AND SHAREHOLDERS’ EQUITY |
|
|
|
|
|
||
|
|
|
|
|
|
|
||
|
Current liabilities: |
|
|
|
|
|
||
|
Accounts payable |
|
$ |
12,527 |
|
$ |
20,524 |
|
|
Accrued expenses and other current liabilities |
|
12,666 |
|
22,028 |
|
||
|
|
|
|
|
|
|
||
|
Total current liabilities |
|
25,193 |
|
42,552 |
|
||
|
|
|
|
|
|
|
||
|
Deferred income taxes |
|
1,049 |
|
1,315 |
|
||
|
|
|
|
|
|
|
||
|
Total liabilities |
|
26,242 |
|
43,867 |
|
||
|
|
|
|
|
|
|
||
|
Shareholders’ equity: |
|
|
|
|
|
||
|
Common stock, no par value, 100,000 shares authorized; 32,790 and 32,589 shares issued and outstanding in 2004 and 2003, respectively |
|
62,917 |
|
62,469 |
|
||
|
Retained earnings |
|
64,911 |
|
65,892 |
|
||
|
Accumulated other comprehensive income |
|
8,088 |
|
9,405 |
|
||
|
|
|
|
|
|
|
||
|
Total shareholders’ equity |
|
135,916 |
|
137,766 |
|
||
|
|
|
|
|
|
|
||
|
|
|
$ |
162,158 |
|
$ |
181,633 |
|
See notes to consolidated financial statements.
4
|
|
|
Three
Months Ended |
|
||||
|
|
|
2004 |
|
2003 |
|
||
|
Operating activities: |
|
|
|
|
|
||
|
Net loss |
|
$ |
(981 |
) |
$ |
(1,725 |
) |
|
Adjustments to reconcile net loss to net cash provided by operating activities: |
|
|
|
|
|
||
|
Depreciation |
|
2,357 |
|
2,110 |
|
||
|
Other, net |
|
262 |
|
95 |
|
||
|
Changes in operating assets and liabilities: |
|
|
|
|
|
||
|
Accounts receivable |
|
7,283 |
|
4,794 |
|
||
|
Inventories |
|
1,413 |
|
1,190 |
|
||
|
Other current assets |
|
(1,110 |
) |
(527 |
) |
||
|
Accounts payable |
|
(7,903 |
) |
(2,544 |
) |
||
|
Accrued expenses and other current liabilities |
|
(10,161 |
) |
(797 |
) |
||
|
|
|
|
|
|
|
||
|
Net cash provided (used) by operating activities |
|
(8,840 |
) |
2,596 |
|
||
|
|
|
|
|
|
|
||
|
Investing activities: |
|
|
|
|
|
||
|
Purchases of property and equipment |
|
(615 |
) |
(1,917 |
) |
||
|
|
|
|
|
|
|
||
|
Net cash used by investing activities |
|
(615 |
) |
(1,917 |
) |
||
|
|
|
|
|
|
|
||
|
Financing activities: |
|
|
|
|
|
||
|
Repayments of notes payable |
|
— |
|
(750 |
) |
||
|
Repurchases of common stock |
|
— |
|
(2,587 |
) |
||
|
Issuance of common stock, net |
|
448 |
|
471 |
|
||
|
|
|
|
|
|
|
||
|
Net cash provided (used) by financing activities |
|
448 |
|
(2,866 |
) |
||
|
|
|
|
|
|
|
||
|
Effect of exchange rate changes on cash and cash equivalents |
|
(506 |
) |
633 |
|
||
|
|
|
|
|
|
|
||
|
Net decrease in cash and cash equivalents |
|
(9,513 |
) |
(1,554 |
) |
||
|
|
|
|
|
|
|
||
|
Cash and cash equivalents, beginning of period |
|
68,899 |
|
72,146 |
|
||
|
|
|
|
|
|
|
||
|
Cash and cash equivalents, end of period |
|
$ |
59,386 |
|
$ |
70,592 |
|
See notes to consolidated financial statements
5
ZOMAX INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE 1. GENERAL
Basis of Presentation. The accompanying interim consolidated financial statements are unaudited; however, in the opinion of our management, all adjustments necessary for a fair presentation (consisting of only normal recurring adjustments) have been reflected in the interim periods presented. Due principally to the seasonal nature of our business, results may not be indicative of results for a full year. The accompanying consolidated financial statements should be read in conjunction with our 2003 Annual Report on Form 10-K.
Fiscal Quarters. Our fiscal quarters end on the last Friday of the calendar quarter. References herein to the periods ended March 2004, December 2003 and March 2003 refer to the fiscal periods ended March 26, 2004, December 26, 2003 and March 28, 2003, respectively.
Recently Issued Accounting Pronouncements. In March 2004, the EITF reached consensus on Issue No. 03-1, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments” regarding disclosures about unrealized losses on available-for-sale debt and equity securities accounted for under FASB Statements No. 115, “Accounting for Certain Investments in Debt and Equity Securities”, and No. 124, “Accounting for Certain Investments Held by Not-for-Profit Organizations”. The guidance for evaluating whether an investment is other-than-temporarily impaired should be applied in such evaluations made in reporting periods beginning after June 15, 2004. The disclosures are effective in annual financial statements for fiscal years ending after December 15, 2003, for investments accounted for under Statements 115 and 124. For all other investments within the scope of this Issue, the disclosures are effective in annual financial statements for fiscal years ending after June 15, 2004. The additional disclosures for cost method investments are effective for fiscal years ending after June 15, 2004. We do not expect that the implementation of EITF 03-1 will have a material effect on our financial statements.
NOTE 2. OTHER FINANCIAL STATEMENT INFORMATION
Inventories (in thousands):
|
|
|
March |
|
December |
|
||
|
Inventories: |
|
|
|
|
|
||
|
Raw materials |
|
$ |
5,299 |
|
$ |
7,011 |
|
|
Work in process |
|
2,406 |
|
2,425 |
|
||
|
Finished goods |
|
3,582 |
|
3,321 |
|
||
|
|
|
$ |
11,287 |
|
$ |
12,757 |
|
Supplemental Cash Flow Information (in thousands):
|
|
|
Three
Months Ended |
|
||||
|
|
|
2004 |
|
2003 |
|
||
|
Cash paid for: |
|
|
|
|
|
||
|
Interest |
|
$ |
88 |
|
$ |
71 |
|
|
Income taxes |
|
297 |
|
289 |
|
||
|
Non-cash transactions: |
|
|
|
|
|
||
|
Unrealized loss on available-for-sale securities, net of deferred taxes of $285 in 2004 and $109 in 2003 |
|
(446 |
) |
(194 |
) |
||
6
Comprehensive Income (Loss). The table below presents comprehensive loss, defined as changes in shareholders’ equity excluding changes resulting from investments by and distributions to shareholders (in thousands):
|
|
|
Three
Months Ended |
|
||||
|
|
|
2004 |
|
2003 |
|
||
|
|
|
|
|
|
|
||
|
Net loss |
|
$ |
(981 |
) |
$ |
(1,725 |
) |
|
Unrealized holding loss on available-for-sale securities, net of tax |
|
(446 |
) |
(194 |
) |
||
|
Translation adjustments |
|
(871 |
) |
1,417 |
|
||
|
|
|
|
|
|
|
||
|
Comprehensive loss |
|
$ |
(2,298 |
) |
$ |
(502 |
) |
NOTE 3. STOCK BASED COMPENSATION
We have a 1996 Stock Option Plan (the 1996 Plan) and an Employee Stock Purchase Plan. Options granted under the 1996 Plan are accounted for under Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees.” Because our stock options are granted at the market value on the date of grant, no related compensation expense is recognized. However, had the compensation expense of option grants been determined by applying the fair value recognition provisions as described in SFAS No. 123, “Accounting for Stock-Based Compensation,” as amended by SFAS No. 148, “Accounting for Stock-Based Compensation—Transition and Disclosure”, our net loss and loss per share, on a pro forma basis, would have been reported as follows (in thousands, except per share data):
|
|
|
Three
Months Ended |
|
||||
|
|
|
2004 |
|
2003 |
|
||
|
Net loss: |
|
|
|
|
|
||
|
As reported |
|
$ |
(981 |
) |
$ |
(1,725 |
) |
|
|
|
|
|
|
|
||
|
Pro forma |
|
$ |
(1,212 |
) |
$ |
(2,223 |
) |
|
|
|
|
|
|
|
||
|
Basic Loss per Share: |
|
|
|
|
|
||
|
As reported |
|
$ |
(0.03 |
) |
$ |
(0.05 |
) |
|
|
|
|
|
|
|
||
|
Pro forma |
|
$ |
(0.04 |
) |
$ |
(0.07 |
) |
|
|
|
|
|
|
|
||
|
Diluted Loss per Share:: |
|
|
|
|
|
||
|
As reported |
|
$ |
(0.03 |
) |
$ |
(0.05 |
) |
|
|
|
|
|
|
|
||
|
Pro forma |
|
$ |
(0.04 |
) |
$ |
(0.07 |
) |
NOTE 4. STRATEGIC ALLIANCE AND AVAILABLE-FOR-SALE SECURITIES
On August 12, 2002, we announced the signing of a Strategic Alliance Agreement with Intraware, Inc., a leading provider of global electronic software delivery (ESD) services. Under this agreement, as amended, we have an exclusive right to market and resell Intraware’s ESD services in the supply chain outsourcing market. Revenues earned to date under this agreement have not been significant. The agreement has an initial term of ten years and may be cancelled earlier at our option upon 30 days notice. Minimum fees payable under the agreement, assuming the full ten-year term and certain other conditions, are $14,600,000. We expensed $225,000 and $125,000 under this agreement in 2004 and 2003, respectively. See Note 7 to consolidated financial statements for a discussion of a subsequent event related to this agreement.
In addition to the Strategic Alliance Agreement, we invested $5,000,000 in a private placement of Intraware common stock (NASDAQ Symbol: ITRA) at $0.82 per share, representing approximately 12% of the outstanding shares of Intraware. The common stock was issued in a private placement without registration under the Securities Act of 1933. In 2003, Intraware filed a registration statement with the Securities Exchange Commission to register the resale of the common stock issued to us. We have classified this investment as an available-for-sale security, and accordingly, unrealized holding gains and losses are excluded from earnings and reported as a component of other comprehensive income. The market value of this investment was $10,915,000 as of March 2004, and $11,646,000 as of December 2003. See Note 7 to consolidated financial statements for a discussion of a subsequent event related to this investment.
7
NOTE 5. COMMITMENTS AND CONTINGENCIES
“Wells Notice” and Shareholder Lawsuit. In October 2002, we announced that the Securities and Exchange Commission (SEC) was conducting a preliminary investigation into the trading of Zomax securities by insiders. In December 2003, we received a “Wells Notice” from the staff of the Chicago Regional office of the SEC indicating their intention to recommend that a civil enforcement action be commenced against the Company and certain of its current and former officers. The notice alleges violations regarding false and misleading forward-looking statements made to the public and in a quarterly report in the year 2000. The staff also indicated its intention to recommend a civil enforcement action be commenced against certain former officers regarding alleged insider trading violations during the same period. The Company and the current and former officers believe they have complied with all applicable rules and regulations.
On March 9, 2004 a lawsuit was filed against the Company and certain of its former officers. The complaint alleges securities law violations regarding false and misleading statements made to the public and the failure to disclose material events between June 6, 2000 and September 21, 2000. The complaint was filed in the United States District Court, District of Minnesota by an individual purporting to represent a class of purchasers of Zomax stock. The lawsuit seeks unspecified damages. We believe this lawsuit is barred by the statute of limitations and is without merit. We intend to defend this action vigorously.
We do not believe that the amount of any potential liability associated with these matters can be estimated at this time, but an unfavorable resolution of these matters is possible and could have a material adverse effect on our results of operations, financial condition or cash flows.
We are involved in certain other claims arising in the normal course of business. In our opinion, the final resolution of these claims should not have a material adverse effect on our financial position, cash flow or results from operations.
8
NOTE 6. SEGMENT AND GEOGRAPHICAL INFORMATION
We operate in one industry segment. The geographic distributions of our sales, operating income (loss), capital expenditures and identifiable assets for 2004 and 2003 are summarized as follows (in thousands):
|
|
|
Three
Months Ended |
|
||||
|
|
|
2004 |
|
2003 |
|
||
|
Sales: |
|
|
|
|
|
||
|
United States |
|
$ |
48,511 |
|
$ |
40,820 |
|
|
Ireland |
|
9,295 |
|
8,239 |
|
||
|
Canada |
|
7,552 |
|
8,792 |
|
||
|
Intergeographic sales |
|
(15,323 |
) |
(10,623 |
) |
||
|
|
|
|
|
|
|
||
|
|
|
$ |
50,035 |
|
$ |
47,228 |
|
|
Operating income (loss): |
|
|
|
|
|
||
|
United States |
|
$ |
208 |
|
$ |
21 |
|
|
Ireland |
|
372 |
|
240 |
|
||
|
Canada |
|
551 |
|
909 |
|
||
|
Corporate and eliminations |
|
(2,958 |
) |
(3,805 |
) |
||
|
|
|
|
|
|
|
||
|
|
|
$ |
(1,827 |
) |
$ |
(2,635 |
) |
|
Capital expenditures: |
|
|
|
|
|
||
|
United States |
|
$ |
336 |
|
$ |
1,512 |
|
|
Ireland |
|
281 |
|
375 |
|
||
|
Canada |
|
(2 |
) |
30 |
|
||
|
|
|
|
|
|
|
||
|
|
|
$ |
615 |
|
$ |
1,917 |
|
|
Depreciation: |
|
|
|
|
|
||
|
United States |
|
$ |
1,484 |
|
$ |
1,454 |
|
|
Ireland |
|
306 |
|
331 |
|
||
|
Canada |
|
567 |
|
325 |
|
||
|
|
|
|
|
|
|
||
|
|
|
$ |
2,357 |
|
$ |
2,110 |
|
|
|
|
March |
|
December |
|
||
|
Assets: |
|
|
|
|
|
||
|
United States |
|
$ |
42,493 |
|
$ |
52,506 |
|
|
Ireland |
|
28,834 |
|
31,858 |
|
||
|
Canada |
|
16,284 |
|
25,257 |
|
||
|
|
|
|
|
|
|
||
|
Total identifiable assets |
|
87,611 |
|
109,621 |
|
||
|
|
|
|
|
|
|
||
|
Corporate assets |
|
74,547 |
|
72,012 |
|
||
|
|
|
|
|
|
|
||
|
|
|
$ |
162,158 |
|
$ |
181,633 |
|
NOTE 7. SUBSEQUENT EVENT
On April 30, 2004 we announced the restructuring of our agreement with Intraware (see Note 4 to consolidated financial statements) whereby our Strategic Alliance Agreement was terminated and replaced with a Reseller Agreement under which we will continue to offer Intraware ESD services to our customers. As a result of the restructured agreement, all minimum fees under the Strategic Alliance Agreement have been canceled.
In addition to the restructured agreement, we sold 1,300,000 shares of our Intraware shareholdings in a private placement which resulted in proceeds of approximately $2,340,000 and a pre-tax gain of approximately $1,274,000.
9
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Fiscal Quarter-End
Our fiscal quarters end on the last Friday of the calendar quarter. Unless otherwise indicated, references to 2004 and 2003 refer to the quarters ended March 26, 2004 and March 28, 2003, respectively.
General Factors Affecting Our Financial Results
Revenue. We derive our revenues from a wide variety of supply chain services provided to our customers. The number of CD and DVD media units that we replicate for our customers, changes in pricing, changes in the composition of the products and services we provide, and changes in the mix of customers we serve, are all factors that contribute to changes in our revenues from period to period. Revenues are generally more favorably impacted when our mix of customers is weighted toward those who are using a broad range of our services. Bundled pricing, changes in the content of the products we make for our customers and other dynamics make it difficult to precisely determine the impact each of these factors has on changes in our total revenue.
Gross Profit Percentage. Our gross profit percentage during a period is dependent on a number of factors. In addition to changes in pricing, the volume of business we experience in a given period also impacts our margins. A large portion of the costs required to deliver our products and services are fixed in nature. Increases in volume allow us to leverage these costs resulting in higher gross profit margins, while decreases in volume have the opposite effect. Our relative mix of customers, as well as the related content of products or services we provide them, can also have a significant impact on gross profit margins. For example, the relative mix of CD/DVD media, labor and print material in the products we produce for our customers can affect our overall gross profit percentage. Although gross profit measured as a percentage of revenue may be lower, we believe providing incremental value-added services to our
10
customers has an overall positive effect on gross margin as measured in dollars. Additionally, our ability to utilize automated packaging equipment versus manual labor can have a favorable effect on gross profit.
Selling General and Administrative (SG&A) Expenses. A substantial portion of our SG&A expenses are fixed in nature. However, certain components such as incentive compensation, professional services, travel and other expenses can vary based on business results, individual events, or initiatives we may be pursuing at various times throughout the year. In addition to these factors, some of our SG&A expenses are incurred in countries outside the U.S. and changes in foreign currency rates can cause our SG&A expenses reported in U.S. dollars to fluctuate.
Results of Operations
The following table summarizes certain key information to aid in the understanding of our discussion and analysis of results of operations.
|
|
|
Three
Months Ended |
|
||
|
|
|
2004 |
|
2003 |
|
|
Percent of Revenue: |
|
|
|
|
|
|
Revenue |
|
100.0 |
% |
100.0 |
% |
|
Gross profit |
|
14.7 |
|
14.2 |
|
|
Selling, general and administrative expenses |
|
18.3 |
|
19.8 |
|
|
Operating loss |
|
(3.7 |
) |
(5.6 |
) |
|
Income tax benefit |
|
(1.4 |
) |
(2.1 |
) |
|
Net loss |
|
(2.0 |
) |
(3.7 |
) |
|
|
|
|
|
|
|
|
Other Operating Statistics: |
|
|
|
|
|
|
CD/DVD media units sold - % change 2003 to 2004 |
|
(6.5 |
)% |
— |
|
|
Revenue - % change 2003 to 2004 |
|
5.9 |
|
— |
|
|
SG&A expenses - % change 2003 to 2004 |
|
(1.8 |
) |
— |
|
|
Effective tax rate |
|
41.2 |
|
36.0 |
% |
Revenue
Our revenue increased on a quarterly basis from 2003 to 2004, growing 5.9%, from $47.2 million in the first quarter 2003, to $50.0 million in the first quarter of 2004. We experienced a 6.5% decrease in media unit volume from 2003 to 2004 due to a decrease in the number of low-priced, bulk CDs produced for one customer. Bulk CDs represent media that we replicate and sell without providing additional services such as packaging or fulfillment. This customer accounted for 38% of unit volume in the first quarter of 2003 and approximately 7% of unit volume in 2004, reflecting a focus on customers that require a broader range of our media production and other services. This shift in customer mix resulted in a growth in revenue despite a decline in CD/DVD units sold.
Gross Profit
Our reported gross profit percentage improved from 14.2% in 2003, to 14.7% in 2004. As discussed in detail in our 2003 Form 10-K, we signed a revised royalty agreement in the fourth quarter of 2003 which resulted in a retroactive reduction in the royalty rates payable under the agreement. Had our first quarter 2003 gross profit margins reflected the portion of the retroactive royalty reduction applicable to that period, our 2003 gross profit margin would have been 15.8%. Taking this into account, our gross profit margins would have decreased 1.1%, attributable to the effect of declining unit prices as well as increased fixed costs associated with investments made in 2003 related to increased DVD capacity and our contact center information systems.
Income Taxes
Our income tax benefit in 2004 represents 41.2% of our pretax loss, compared to 36.0% of our pretax loss in 2003. Our 2004 effective tax rate reflects our current estimate of our expected effective tax rate for the full year, taking into consideration the tax laws and expected taxable income in the various tax jurisdictions in which we operate.
11
Application of Critical Accounting Policies
The discussion and analysis of our financial condition and results of operations is based on our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the reported amounts of revenues and expenses during the reporting period and disclosure of contingent assets and liabilities at the date of the consolidated financial statements. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, evaluate them on an ongoing basis and make adjustments as necessary. There can be no assurance that actual results will not differ from those estimates.
We have identified the accounting policies below as the policies most critical to our business operations and the understanding of our results of operations. The impact and any associated risks related to these policies on our business operations is discussed throughout Management’s Discussion and Analysis of Financial Condition and Results of Operations where such policies affect our reported and expected financial results.
Revenue Recognition We record revenue at the time product is shipped or as services are rendered. For certain customers, product is invoiced upon completion, with shipment occurring based on written customer instructions. In these cases, the customer accepts title to the goods as of the date of the invoice and sales revenue is recognized at that time. In each case of these “bill and hold” sales, we ensure that the transaction complies with the conditions and considerations contained in Accounting and Auditing Enforcement Release No. 108 of the Securities and Exchange Commission.
Royalties. We have license agreements with several companies for the use of certain CD and DVD manufacturing technology we use in our business. We do not necessarily have agreements with every patent holder that may assert or has asserted a claim to royalties. The cost of these royalties is accrued based on units sold and charged to cost of revenue. Our royalty costs are based upon the terms of our royalty agreements as well as our assessment of the applicability of any other known or potential royalties.
Income Taxes. We file a consolidated federal income tax return and separate state and foreign returns. Deferred income taxes are provided for differences between the tax basis of assets and liabilities and their carrying amounts for financial reporting purposes, based on the expected income tax rates for the year in which these temporary differences are expected to reverse. Foreign net operating loss carryforwards may be carried forward indefinitely.
Our effective tax rate for interim reporting periods represents our best current estimate of our effective tax rate for the full year, which requires estimates of income or losses across each of the tax jurisdictions in which we operate. These estimates may change throughout the year resulting in potentially significant changes to our overall effective tax rate due to the effect of differences in the tax rates in each jurisdiction. In addition, the preparation of our income tax returns requires the interpretation of the associated tax laws. Many tax laws are complex, and at times ambiguous, and our interpretations of these laws may differ from the interpretations of the taxing authorities who have the right to audit our returns within statutory time periods. Where we believe there is a quantifiable risk that our interpretations of these laws could reasonably differ from those of the taxing authorities, we make appropriate provisions in our tax liabilities.
Accounts Receivable. We review our accounts receivable balances on a regular basis to determine their collectability. An allowance for doubtful accounts is recorded based on management’s estimate of those accounts which may become uncollectible.
Inventory. We review our inventory on a regular basis with the objective of assessing its net realizable value. We adjust the carrying value of inventory according to our estimates of the net realizable value of individual inventory components relative to their purchase or carrying value.
Recently Issued Accounting Pronouncements
In March 2004, the EITF reached consensus on Issue No. 03-1, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments” regarding disclosures about unrealized losses on available-for-sale debt and equity securities accounted for under FASB Statements No. 115, “Accounting for Certain Investments in Debt and Equity Securities”, and No. 124, “Accounting for Certain Investments Held by Not-for-Profit Organizations”. The guidance for evaluating whether an investment is other-than-temporarily impaired should be applied in such evaluations made in reporting periods beginning after June 15, 2004. The disclosures are effective in annual financial statements for fiscal years ending after December 15, 2003, for investments accounted for under Statements 115 and 124. For all other investments within the scope of this Issue, the disclosures are effective in annual financial statements for
12
fiscal years ending after June 15, 2004. The additional disclosures for cost method investments are effective for fiscal years ending after June 15, 2004. We do not expect that the implementation of EITF 03-1 will have a material effect on our financial statements.
Liquidity and Capital Resources
Cash and Cash Equivalents. At March 2004, cash and cash equivalents totaled $59.4 million, a decrease of $9.5 million from December 2003. The majority of this decrease reflects the payment of accrued royalties related to the signing of a revised royalty agreement with one of our major patent holders in the latter part of the fourth quarter of 2004. Negotiation of this agreement began in 2002. Royalties under the previous agreement continued to be accrued, with payment suspended pending the completion of a revised agreement.
Working Capital and Liquidity. Working capital totaled $90.3 million and $88.6 million at March 2004 and December 2003, respectively. Our primary source of working capital continues to be cash and cash equivalent balances as described above. In addition to our working capital balances, we also hold available-for-sale securities which represent our investment in Intraware (see Note 4 to the consolidated financial statements). These securities are fully registered and had a value at March 2004 of $10.9 million, down from $11.6 million at the end of 2003.
Our future liquidity needs will depend on, among other factors, the timing of capital expenditures, expenditures in connection with possible acquisitions, changes in customer order volume and the timing and collection of receivables. We believe that existing cash and investment balances and anticipated cash flow from operations will be sufficient to fund our operations for the foreseeable future.
Outlook
Our ability to accurately predict revenue and earnings for a given time period is difficult and subject to management interpretation of the data available, and may not directly reflect forecasts produced internally within any individual report. We have very limited visibility to our customer’s near- or long-term demand for our services, and changes by our customer in the content of the products we produce for them can significantly affect our levels of reported revenue and related profit margins. In light of the foregoing, it is our present expectation that our second quarter 2004 results, excluding the effect of any sale of our Intraware shareholdings as discussed in Note 7 to the consolidated financial statements, will be comparable to those achieved in the second quarter of 2003.
Our industry continues to experience pricing pressures. Some of our gains in revenue or market share have resulted in demands from our customers for continued cost savings. While 2004 will benefit from the effect of reduced royalty rates, we expect customer pricing declines and upward pressure on commodity prices, specifically related to polycarbonate used in our media production, to put offsetting pressure on our gross profit margins. We believe we must also make certain investments in our people, processes and technology infrastructure in 2004 to deliver the improvements in the levels of service our customers expect, and to achieve cost savings that may not materialize until later in the year or in 2005. We also expect upward pressure on our 2004 SG&A expenses associated with the implementation costs of the requirements of Section 404 of the Sarbanes-Oxley Act and legal costs that may be required in defense of securities litigation claims. Accordingly, our ability to achieve profitable results in 2004 will be challenging. In light of this challenge, we will continue to pursue investments, internally or through acquisition, in additional service offerings , customer markets or geographies that will provide us with opportunities for profitable growth.
Cautionary Statement for Purposes of the “Safe Harbor” Provisions of the Private Securities Litigation Reform Act of 1995
13
• We are dependent on a small number of key customers in the personal computer hardware and software industries.
• We may not be able to effectively compete in an increasingly competitive environment.
• We may not be able to maintain our status as a Microsoft Authorized Replicator.
• We may not be able to meet our customers’ requirements regarding the security of their intellectual property, inventory and other assets.
• We are dependent on revenues from the replication of CD and DVD media which may be threatened by the development and rate of market acceptance of new media storage techniques or other electronic media technologies.
• We have been issued a “Wells Notice” from the Securities and Exchange Commission (SEC) and have been named as a defendant in a lawsuit alleging certain securities laws violations.
We undertake no obligation to update or revise any forward-looking statements we make in this report due to new information or future events. Investors are advised to consult any further disclosures we make on this subject in our filings with the Securities and Exchange Commission, especially on Forms 10-K, 10-Q and 8-K, in which we discuss in more detail various important factors that could cause actual results to differ from expected or historical results.
14
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Foreign Currency. A portion of our operations are located in Ireland and Canada. The financial results of these operations are translated to US dollars at current exchange rates. Changes in exchange rates between periods can affect the comparability of results reported in US dollars.
In addition to these translation gains and losses, we also incur transaction gains and losses which are reflected in our financial statements. A majority of the sales from our Canadian operations, and a large portion of the related costs, are denominated in US dollars. As a result, we have limited exposure to the Canadian currency. The majority of sales revenues and related costs in our Ireland operations are denominated in Euros. Foreign currency transaction gains and losses historically have not been material to our results of operations or our financial condition. However, we anticipate we will continue to incur exchange gains and losses from foreign operations in the future. These gains and losses may be significant depending on factors such as changes in foreign currency or weak economic conditions in foreign markets. In addition, demand for our products and services can be directly impacted by the value of the U.S. dollar relative to other currencies.
ITEM 4. CONTROLS AND PROCEDURES
As of the end of the period covered by this report, we conducted an evaluation under the supervision and with the participation of our principal executive officer and principal financial officer, of our disclosure controls and procedures (as defined in Rules 13(a)-15(e) under the Securities Exchange Act of 1934 (“the Exchange Act”)). Based on this evaluation, the principal executive officer and principal financial officer concluded that our disclosure controls and procedures are effective to ensure that information required to be disclosed by us in the reports we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms. There was no change in our internal control over financial reporting during our most recently completed fiscal quarter that has materially affected, or is reasonably likely to materially affect our internal control over financial reporting.
15
See Note 5 to Consolidated Financial Statements included in Item 1 of Part I of this Quarterly Report on Form 10-Q.
In addition to the proceeding described in Item 1 of Part I of this Quarterly Report, we are a party to various other suits, claims and proceedings arising in the ordinary course of our business and we intend to vigorously defend them. The amount of monetary liability, if any, resulting from an adverse outcome in any of such suits, proceedings and claims in which we are a defendant cannot be determined at this time. However, in the opinion of our management, the aggregate amount of liability under these other su its, proceedings and claims will not have a material adverse effect on our consolidated results of operations, financial condition or cash flows.
ITEM 2. CHANGES IN SECURITIES, USE OF PROCEEDS AND ISSUER PURCHASES OF EQUITY SECURITIES
During the first quarter of 2004, we issued options to purchase 13,650 shares of common stock at an average price of $4.85 per share to certain employees as an inducement for employment. The options expire in ten years and vest annually over a four to five year period. The option grants were exempt from registration under Section 4(2) of the Securities Act of 1933, as amended, which provides an exemption for transactions not involving a public offering.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits.
31.1 Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act
31.2 Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act
32.1 Certification of Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act
32.2 Certification of Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act
(b) Reports on Form 8-K
We filed a Form 8-K dated February 5, 2004, announcing (i) the resignation of James Anderson as Chief Executive Officer and appointment of Anthony Angelini as Chief Executive Officer and Rob Rueckl as Chief Financial Officer (ii) receipt of SEC Wells Notice and (iii) 2003 year-end financial results.
We filed a Form 8-K dated March 10, 2004, announcing that a lawsuit had been filed against the Company and certain of its former officers.
16
In accordance with the requirements of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
|
Date: May 5, 2004 |
|
|
ZOMAX INCORPORATED |
|
|
|
|
|
|
|
|
|
|
|
|
|
By: |
/s/ Anthony Angelini |
|
|
|
|
Anthony Angelini,
President and Chief Executive Officer |
|
|
|
|
|
|
|
|
|
|
|
|
|
By: |
/s/ Robert J. Rueckl |
|
|
|
|
Robert J. Rueckl,
Executive Vice President and Chief |
17
ZOMAX INCORPORATED
FORM 10-Q FOR QUARTER ENDED March 26, 2004
|
Exhibit |
|
Description |
|
|
|
|
|
31.1 |
|
Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act |
|
31.2 |
|
Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act |
|
32.1 |
|
Certification of Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act |
|
32.2 |
|
Certification of Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act |
18