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 June 25, 2004
Commission File Number: 0-28426
ZOMAX INCORPORATED
(Exact name of registrant as specified in its charter)
Minnesota |
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No. 41-1833089 |
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(State or Other Jurisdiction
of |
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(IRS Employer |
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5353 Nathan
Lane |
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55442 |
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(Address of Principal Executive Offices) |
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(Zip Code) |
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(763) 553-9300 |
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(Registrant’s telephone number, including area code) |
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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 July 30, 2004 was 32,455,490 shares.
ZOMAX INCORPORATED
INDEX
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DESCRIPTION |
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Management’s Discussion and Analysis of Financial Condition and Results of Operations |
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Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities |
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2
ZOMAX INCORPORATED
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
(In thousands, except per share data)
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Three
Months Ended |
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Six Months
Ended |
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2004 |
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2003 |
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2004 |
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2003 |
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Revenue |
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$ |
45,082 |
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$ |
43,997 |
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$ |
95,117 |
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$ |
91,225 |
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Cost of revenue |
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36,289 |
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37,666 |
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78,985 |
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78,196 |
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Gross profit |
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8,793 |
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6,331 |
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16,132 |
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13,029 |
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Selling, general and administrative expenses |
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9,597 |
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8,880 |
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18,763 |
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18,213 |
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Operating loss |
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(804 |
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(2,549 |
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(2,631 |
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(5,184 |
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Interest expense |
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— |
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(18 |
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— |
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(46 |
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Interest income |
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127 |
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208 |
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305 |
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493 |
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Gain on sale of available-for-sale securities |
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2,770 |
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— |
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2,770 |
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— |
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Other income (expense), net |
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34 |
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(363 |
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15 |
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(681 |
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Income (loss) before income taxes |
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2,127 |
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(2,722 |
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459 |
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(5,418 |
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Income tax expense (benefit) |
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875 |
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(1,212 |
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188 |
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(2,183 |
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Net earnings (loss) |
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$ |
1,252 |
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$ |
(1,510 |
) |
$ |
271 |
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$ |
(3,235 |
) |
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Earnings (loss) per share: |
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Basic |
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$ |
0.04 |
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$ |
(0.05 |
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$ |
0.01 |
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$ |
(0.10 |
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Diluted |
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$ |
0.04 |
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$ |
(0.05 |
) |
$ |
0.01 |
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$ |
(0.10 |
) |
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Weighted average common shares outstanding: |
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Basic |
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32,790 |
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32,459 |
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32,753 |
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32,674 |
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Dilutive effect of stock options |
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283 |
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— |
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362 |
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— |
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Diluted |
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33,073 |
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32,459 |
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33,115 |
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32,674 |
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See notes to consolidated financial statements.
3
ZOMAX INCORPORATED
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June |
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December |
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ASSETS |
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Current assets: |
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Cash and cash equivalents |
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$ |
69,854 |
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$ |
68,899 |
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Accounts receivable, net of allowance of $1,035 in 2004 and $1,362 in 2003 |
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27,765 |
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39,403 |
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Inventories |
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11,238 |
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12,757 |
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Deferred income taxes |
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2,670 |
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2,685 |
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Other current assets |
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7,882 |
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7,384 |
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Total current assets |
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119,409 |
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131,128 |
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Property and equipment, net |
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35,016 |
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38,859 |
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Available-for-sale securities |
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5,390 |
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11,646 |
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Deferred income taxes |
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33 |
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— |
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$ |
159,848 |
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$ |
181,633 |
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LIABILITIES AND SHAREHOLDERS’ EQUITY |
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Current liabilities: |
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Accounts payable |
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$ |
12,514 |
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$ |
20,524 |
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Accrued expenses and other current liabilities |
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12,408 |
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22,028 |
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Total current liabilities |
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24,922 |
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42,552 |
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Deferred income taxes |
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— |
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1,315 |
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Total liabilities |
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24,922 |
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43,867 |
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Shareholders’ equity: |
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Common stock, no par value, 100,000 shares authorized; 32,790 and 32,589 shares issued and outstanding in 2004 and 2003, respectively |
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62,960 |
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62,469 |
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Retained earnings |
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66,163 |
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65,892 |
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Accumulated other comprehensive income |
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5,803 |
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9,405 |
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Total shareholders’ equity |
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134,926 |
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137,766 |
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$ |
159,848 |
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$ |
181,633 |
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See notes to consolidated financial statements.
4
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Six Months
Ended |
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2004 |
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2003 |
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Operating activities: |
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Net earnings (loss) |
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$ |
271 |
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$ |
(3,235 |
) |
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Adjustments to reconcile net earnings (loss) to net cash (used) provided by operating activities: |
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Depreciation |
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4,662 |
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4,006 |
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Gain on sale of available-for-sale securities, net of tax |
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(1,629 |
) |
— |
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Other, net |
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125 |
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387 |
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Changes in operating assets and liabilities: |
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Accounts receivable |
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11,388 |
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7,614 |
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Inventories |
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1,431 |
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2,320 |
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Other current assets |
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(896 |
) |
(1,455 |
) |
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Accounts payable and accrued expenses |
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(17,805 |
) |
71 |
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Income taxes |
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(328 |
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(2,810 |
) |
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Net cash (used) provided by operating activities |
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(2,781 |
) |
6,898 |
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Investing activities: |
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Purchases of property and equipment |
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(1,463 |
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(3,582 |
) |
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Sale of available-for-sale securities |
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5,230 |
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— |
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Escrow deposit returned on terminated acquisition |
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— |
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3,902 |
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Net cash provided by investing activities |
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3,767 |
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320 |
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Financing activities: |
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Repayments of notes payable |
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— |
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(3,782 |
) |
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Repurchases of common stock |
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— |
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(2,587 |
) |
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Issuance of common stock, net |
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491 |
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525 |
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Net cash provided (used) by financing activities |
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491 |
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(5,844 |
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Effect of exchange rate changes on cash and cash equivalents |
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(522 |
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1,532 |
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Net increase in cash and cash equivalents |
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955 |
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2,906 |
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Cash and cash equivalents, beginning of period |
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68,899 |
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72,146 |
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Cash and cash equivalents, end of period |
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$ |
69,854 |
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$ |
75,052 |
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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 June 2004, December 2003 and June 2003 refer to the fiscal periods ended June 25, 2004, December 26, 2003 and June 27, 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 the 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 the implementation of EITF 03-1 will have a material effect on our consolidated financial statements.
Reclassifications. Certain prior year amounts in Note 6 to the Consolidated Financial Statements have been reclassified for comparative purposes. These reclassifications had no effect on our consolidated financial statements as previously reported.
NOTE 2. OTHER FINANCIAL STATEMENT INFORMATION
Inventories (in thousands):
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June |
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December |
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Raw materials |
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$ |
5,325 |
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$ |
7,011 |
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Work in process |
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2,162 |
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2,425 |
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Finished goods |
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3,751 |
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3,321 |
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$ |
11,238 |
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$ |
12,757 |
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Supplemental Cash Flow Information (in thousands):
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Six Months Ended June |
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2004 |
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2003 |
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Cash paid for: |
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Interest |
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$ |
88 |
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$ |
15 |
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Income taxes |
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843 |
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655 |
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Non-cash transactions: |
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Unrealized (loss) gain on available-for-sale securities, net of deferred taxes of $236 in 2004 and $(241) in 2003 |
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(790 |
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430 |
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6
Comprehensive Income. The table below presents comprehensive income, defined as changes in shareholders’ equity excluding changes resulting from investments by and distributions to shareholders (in thousands):
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Three
Months Ended |
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Six Months
Ended |
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2004 |
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2003 |
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2004 |
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2003 |
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Net earnings (loss) |
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$ |
1,252 |
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$ |
(1,510 |
) |
$ |
271 |
|
$ |
(3,235 |
) |
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Reclassification to net earnings of gain on available-for-sale securities previously deferred, net of tax |
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(1,629 |
) |
— |
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(1,629 |
) |
— |
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Unrealized holding (loss) gain on available-for-sale securities, net of tax |
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(344 |
) |
624 |
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(790 |
) |
430 |
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Translation adjustments |
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(312 |
) |
2,122 |
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(1,183 |
) |
3,540 |
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Comprehensive (loss) income |
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$ |
(1,033 |
) |
$ |
1,236 |
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$ |
(3,331 |
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$ |
735 |
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NOTE 3. STOCK BASED COMPENSATION
We have a 1996 Stock Option Plan (the 1996 Plan), a 2004 Equity Incentive Plan (the 2004 Plan) and an Employee Stock Purchase Plan. No options or restricted stock have been issued under the 2004 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 in accordance with SFAS No. 123, “Accounting for Stock-Based Compensation,” as amended by SFAS No. 148, “Accounting for Stock-Based Compensation—Transition and Disclosure”, our net earnings (loss) and earnings (loss) per share, on a pro forma basis, would have been reported as follows (in thousands, except per share data):
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Three
Months Ended |
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Six Months
Ended |
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2004 |
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2003 |
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2004 |
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2003 |
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Net Earnings (Loss): |
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As reported |
|
$ |
1,252 |
|
$ |
(1,510 |
) |
$ |
271 |
|
$ |
(3,235 |
) |
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Pro forma |
|
$ |
948 |
|
$ |
(1,906 |
) |
$ |
(265 |
) |
$ |
(4,126 |
) |
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Basic Earnings (Loss) per Share: |
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As reported |
|
$ |
0.04 |
|
$ |
(0.05 |
) |
$ |
0.01 |
|
$ |
(0.10 |
) |
|
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Pro forma |
|
$ |
0.03 |
|
$ |
(0.06 |
) |
$ |
(0.01 |
) |
$ |
(0.13 |
) |
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Diluted Earnings (Loss) per Share: |
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||||
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As reported |
|
$ |
0.04 |
|
$ |
(0.05 |
) |
$ |
0.01 |
|
$ |
(0.10 |
) |
|
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|
|
|
|
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Pro forma |
|
$ |
0.03 |
|
$ |
(0.06 |
) |
$ |
(0.01 |
) |
$ |
(0.13 |
) |
NOTE 4. STRATEGIC ALLIANCE AND AVAILABLE-FOR-SALE SECURITIES
On April 30, 2004, we announced the restructuring of our agreement with Intraware, Inc. (Intraware), whereby our
Strategic Alliance Agreement (SAA), originally signed in August 2002, was terminated and replaced with a Reseller Agreement under which we will continue to offer Intraware global electronic software delivery (ESD) services to our customers. Under the original SAA, as amended, we had an exclusive right to market and resell Intraware’s ESD services in the supply chain outsourcing market. Revenues earned under the SAA prior to the restructuring had not been significant. Additionally, the SAA required us to pay annual license fees for which we expensed $435,000 and $250,000 under this agreement in six month period ending June 2004 and 2003, respectively.
In addition to restructuring the agreement, we sold 3,000,000 shares of our Intraware shareholdings in two separate private placements which resulted in proceeds of approximately $5,230,000 and a pre-tax gain of approximately $2,770,000. These shares were originally obtained in August 2002 when we purchased approximately 6,098,000 shares of Intraware common stock (NASDAQ Symbol: ITRA) in a private placement at $0.82 per share, representing approximately 12% of the outstanding shares of Intraware at that time. 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
7
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 our investment in Intraware was $5,390,000 as of June 2004, and $11,646,000 as of December 2003.
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 in the United States District Court, District of Minnesota against the Company and certain of its former officers by an individual purporting to represent a class of purchasers of Zomax stock. 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 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 and therefore have not recorded a liability for them, 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.
Lease Commitment. On July 12, 2004, we entered into a lease commitment for a facility in Memphis, Tennessee. See “Lease Commitment” under Note 7 to the Consolidated Financial Statements for a more detailed discussion.
8
NOTE 6. SEGMENT AND GEOGRAPHICAL INFORMATION
We operate in one industry segment. The geographic distributions of our revenue, operating income (loss), capital expenditures, depreciation and identifiable assets for 2004 and 2003 are summarized as follows (in thousands):
|
|
|
Three
Months Ended |
|
Six Months
Ended |
|
||||||||
|
|
|
2004 |
|
2003 |
|
2004 |
|
2003 |
|
||||
|
Revenue: |
|
|
|
|
|
|
|
|
|
||||
|
United States |
|
$ |
33,811 |
|
$ |
32,125 |
|
$ |
71,303 |
|
$ |
66,721 |
|
|
Ireland |
|
8,330 |
|
8,629 |
|
17,625 |
|
16,868 |
|
||||
|
Canada |
|
6,791 |
|
5,858 |
|
14,343 |
|
14,650 |
|
||||
|
Intergeographic sales |
|
(3,850 |
) |
(2,615 |
) |
(8,154 |
) |
(7,014 |
) |
||||
|
|
|
|
|
|
|
|
|
|
|
||||
|
|
|
$ |
45,082 |
|
$ |
43,997 |
|
$ |
95,117 |
|
$ |
91,225 |
|
|
|
|
|
|
|
|
|
|
|
|
||||
|
Operating income (loss): |
|
|
|
|
|
|
|
|
|
||||
|
United States |
|
$ |
1,811 |
|
$ |
313 |
|
$ |
2,019 |
|
$ |
334 |
|
|
Ireland |
|
267 |
|
446 |
|
639 |
|
686 |
|
||||
|
Canada |
|
715 |
|
20 |
|
1,266 |
|
929 |
|
||||
|
Corporate and eliminations |
|
(3,597 |
) |
(3,328 |
) |
(6,555 |
) |
(7,133 |
) |
||||
|
|
|
|
|
|
|
|
|
|
|
||||
|
|
|
$ |
(804 |
) |
$ |
(2,549 |
) |
$ |
(2,631 |
) |
$ |
(5,184 |
) |
|
|
|
|
|
|
|
|
|
|
|
||||
|
Capital expenditures: |
|
|
|
|
|
|
|
|
|
||||
|
United States |
|
$ |
422 |
|
$ |
858 |
|
$ |
758 |
|
$ |
2,370 |
|
|
Ireland |
|
289 |
|
494 |
|
570 |
|
869 |
|
||||
|
Canada |
|
137 |
|
313 |
|
135 |
|
343 |
|
||||
|
|
|
|
|
|
|
|
|
|
|
||||
|
|
|
$ |
848 |
|
$ |
1,665 |
|
$ |
1,463 |
|
$ |
3,582 |
|
|
|
|
|
|
|
|
|
|
|
|
||||
|
Depreciation: |
|
|
|
|
|
|
|
|
|
||||
|
United States |
|
$ |
1,483 |
|
$ |
1,472 |
|
$ |
2,967 |
|
$ |
2,926 |
|
|
Ireland |
|
275 |
|
77 |
|
581 |
|
408 |
|
||||
|
Canada |
|
547 |
|
347 |
|
1,114 |
|
672 |
|
||||
|
|
|
|
|
|
|
|
|
|
|
||||
|
|
|
$ |
2,305 |
|
$ |
1,896 |
|
$ |
4,662 |
|
$ |
4,006 |
|
|
|
|
|
|
|
|
|
|
|
|
||||
|
|
|
June |
|
December |
|
|
|
|
|
||||
|
Assets: |
|
|
|
|
|
|
|
|
|
||||
|
United States |
|
$ |
38,794 |
|
$ |
52,506 |
|
|
|
|
|
||
|
Ireland |
|
28,476 |
|
31,858 |
|
|
|
|
|
||||
|
Canada |
|
16,241 |
|
25,257 |
|
|
|
|
|
||||
|
|
|
|
|
|
|
|
|
|
|
||||
|
Total identifiable assets |
|
83,511 |
|
109,621 |
|
|
|
|
|
||||
|
|
|
|
|
|
|
|
|
|
|
||||
|
Corporate assets |
|
76,337 |
|
72,012 |
|
|
|
|
|
||||
|
|
|
|
|
|
|
|
|
|
|
||||
|
|
|
$ |
159,848 |
|
$ |
181,633 |
|
|
|
|
|
||
9
NOTE 7. SUBSEQUENT EVENTS
Lease Commitment. On July 12, 2004, we entered into a 45 month lease for a 227,500 square foot multi-purpose facility in Memphis, Tennessee. Minimum rental payments due under the lease are approximately $2,986,000. Under the agreement we have the option to extend the lease for an additional 36 months. We will be consolidating existing smaller facilities in Memphis and Indianapolis into the new Memphis center to improve the efficiency and flexibility needed to meet changing market demands. These activities are not expected to have a material impact on our financial results for the balance of 2004.
Repurchase of Common Stock. On July 8, 2004, in connection with the resignation of Mr. Phillip Levin, one of our non-employee directors, we entered into an agreement to purchase 415,000 shares of the Company’s Common Stock in a private transaction with Mr. Levin at a price of $3.42 per share, the closing market price on that day, subject to a “Post Closing Price Adjustment” as defined in the agreement should the market price of the stock fall below pre-defined levels within a defined period of time.
10
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 June 25, 2004 and June 27, 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
11
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. Changes in raw material prices, particularly polycarbonate, a petroleum-based plastic used in the manufacturing of CD and DVD media, can also impact margins. While polycarbonate pricing has been relatively stable over the past few years, recent increases in petroleum prices are putting upward pressure on polycarbonate pricing. In addition to changes in pricing and raw material costs, 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 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 Ireland and Canada and changes in the respective foreign currency rates can cause our 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 |
|
Six Months
Ended |
|
||||
|
|
|
2004 |
|
2003 |
|
2004 |
|
2003 |
|
|
Percent of Revenue: |
|
|
|
|
|
|
|
|
|
|
Revenue |
|
100.0 |
% |
100.0 |
% |
100.0 |
% |
100.0 |
% |
|
Gross profit |
|
19.5 |
|
14.4 |
|
17.0 |
|
14.3 |
|
|
Selling, general and administrative expenses |
|
21.3 |
|
20.2 |
|
19.7 |
|
20.0 |
|
|
Operating loss |
|
(1.8 |
) |
(5.8 |
) |
(2.8 |
) |
(5.7 |
) |
|
Income tax expense (benefit) |
|
1.9 |
|
(2.8 |
) |
0.2 |
|
(2.4 |
) |
|
Net earnings (loss) |
|
2.8 |
|
(3.4 |
) |
0.3 |
|
(3.5 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
Other Operating Statistics: |
|
|
|
|
|
|
|
|
|
|
Media units sold - % change from prior year |
|
8.7 |
% |
(16.1 |
)% |
0.5 |
% |
(3.2 |
)% |
|
Revenue - % change from prior year |
|
2.5 |
|
(3.0 |
) |
4.3 |
|
(0.1 |
) |
|
SG&A expenses - % change from prior year |
|
8.1 |
|
15.8 |
|
3.0 |
|
13.7 |
|
|
Effective tax rate |
|
41.1 |
% |
44.5 |
% |
41.1 |
% |
40.3 |
% |
Revenue
Our second quarter 2004 revenue increased to $45.1 million, representing a 2.5% increase over revenue of $44.0 million in the second quarter of 2003. Media unit volume increased 8.7% over the same comparable periods. As discussed in our 2003 Form 10-K, Dell became a greater than 10% customer for the first time in 2003. Our increased volume with this key customer has continued into 2004. Partially offsetting this increase was a decrease in revenue earned from the production of low-priced, bulk CDs for one customer, as well as a decrease in revenue earned during the quarter on the programs we support for Microsoft, our largest customer.
On a year-to-date basis, our 2004 revenue also increased over the same period in 2003, from $91.2 million to $95.1 million, while our media unit volume was flat. The factors discussed above related to our increased business with Dell and the decrease in the volume of bulk CD production had similar impacts on our year-to-date results. However, on a year-to-date basis, our Microsoft business remained comparable between periods. Also negatively impacting our year-to-date results was a reduction in revenue from a large customer which has moved a portion of the kitting and assembly work previously performed in the U.S. to Asia.
12
Gross Profit
Our reported second quarter gross profit percentage improved from 14.4% in 2003 to 19.5% in 2004. There are several factors impacting the comparability of reported gross profit percentages between periods. Our 2004 margins were favorably impacted by a gain on a settlement with one of our vendors. Excluding the impact of this gain, our 2004 margins would have been 18.2%. In addition, 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 second 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 16.2%. Taking both of these factors into account, our gross profit margins would have increased 2.0%. This increase is attributable to a favorable shift in product mix away from bulk CD production as described under “Revenue” above, as well as benefits achieved from efficiency initiatives put in place earlier this year.
On a year-to-date basis, our reported gross profit margins improved from 14.3% in 2003 to 17.0% in 2004. Had these margins been adjusted for the royalty expense and settlement gains in a manner similar to that described above, year-to-date margins would have been 16.3% in 2004, and 16.0% in 2003. This increase is also attributable, but to a lesser degree, to similar factors affecting second quarter margins as described above.
Selling, General and Administrative (SG&A) Expenses
SG&A expenses in 2004 increased approximately 8.1% on a quarterly basis and 3.0% on a year-to-date basis, as compared to the same periods in 2003. These increases are primarily attributable to increases in professional fees related primarily to the implementation of Sarbanes-Oxley compliance procedures, Intraware license fee amortization and the cost of employee health insurance.
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 carry-forwards may be carried forward indefinitely.
13
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 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 consolidated financial statements.
Liquidity and Capital Resources
Cash and Cash Equivalents. At June 2004, cash and cash equivalents totaled $69.9 million, an increase of $1.0 million from December 2003. Cash flow from operating activities in 2004 was a negative $2.8 million, reflecting the payment of approximately $8.5 million of royalties accrued at the end of 2003 related to the fourth quarter 2003 signing of a revised royalty agreement with one of our major patent holders. 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. Also negatively affecting our operating cash flow were previously disclosed payments made pursuant to an employment agreement with our former CEO. Offsetting our negative operating cash flow were proceeds of $5.2 million from the sale of a portion of our Intraware shareholdings in the second quarter (see Note 4 to the consolidated financial statements). Also providing favorable impact to our cash flow were initiatives we implemented during the year to ensure we are diligently managing our accounts receivable and accounts payable balances, ensuring that we receive timely payments from our customers while taking advantage of our payment terms, including discounts where appropriate, with our vendors.
Working Capital and Liquidity. Working capital totaled $94.5 million and $88.6 million at June 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 June 2004 of $5.4 million.
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.
Contractual Obligations. Subsequent to the end of the second quarter, we entered into a lease for a 227,500 square feet multi-purpose facility in Memphis, TN (See “Lease Commitment” under Note 5 to the Consolidated Financial Statements). The initial lease term runs through April 2008 and will require minimum rental payments totaling approximately $2,986,000. Under the agreement we have the option to extend the lease for an additional 36 months.
14
During the second quarter of 2004, we entered into an agreement with our primary supplier of polycarbonate, a petroleum-based commodity which is the primary raw material used in the production of CD and DVD media. Over the past several months, supply shortages and increases in petroleum prices have placed significant upward pressure on polycarbonate pricing. Under the agreement, which runs through June 2005, we have agreed to purchase 9.4 million pounds of polycarbonate at set price terms. These price terms restrict monthly price increases and help us to limit our exposure to potential future price increases while also allowing us to reduce our purchase volume should the price terms increase above an agreed-upon level over the initial base price. Minimum commitments due under this agreement are approximately $10.3 million based on the initial base price and minimum quantity. We believe that this agreement will allow us to minimize our near-term exposure to continuing upward price pressures on this key raw material and help us to maximize cash provided from our operations.
Outlook
During the second quarter of 2004, we were informed of changes to certain programs we support for several of our larger customers that may result in noticeable declines in the level of business we currently have with these customers. The first of these customer-driven changes involves the elimination of certain recovery CDs from some of the new PC’s shipped to their customers. This change is expected to go into effect during the third quarter of 2004. We have also been informed by one of our larger customers that, starting in 2005, a certain portion of their customer base supported by us will be migrated to a new service delivery system operated by one of our competitors. In addition to these changes, we have also experienced an increased emphasis on the part of several of our customers to move portions of the services we currently provide to them to lower cost geographies, particularly Asia. Although these customers have indicated their intent to implement these changes, the permanency and timing of these decisions is not certain, and to date, these changes have not had a material negative impact on our business. Due to these uncertainties, we are unable at this time to accurately quantify their effect on our business in 2004 or beyond. However, these changes could have a significant impact on our future revenues and profitability should they be fully and permanently implemented.
Over the past several months, supply shortages and petroleum price increases have placed significant upward pressures on the price of polycarbonate, a petroleum-based plastic that is the primary raw material used in the manufacturing of CD and DVD media. While we have entered into a purchase agreement with our primary polycarbonate supplier that limits future price increases, the increases allowed under the agreement may have a significant negative impact on our gross profit margins in the event we are not able to pass these price increases on to our customers.
In addition to the market changes and raw material cost pressures described above, our industry continues to experience pricing pressures from our customers. 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 the upward pressure on commodity prices describe above to put offsetting pressure on our gross profit margins. In addition, 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 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 operating results in 2004 will be challenging. In light of this challenge, we will continue to actively pursue investments, internally or through synergistic acquisitions in new geographies, additional service offerings or customer markets that will provide us with opportunities for profitable growth.
Given the dynamic market conditions such as those described above, our ability to accurately predict revenue and earnings for a given time period is difficult. Any predictions made are 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. While we have been able to achieve some level of gross profit margin improvement to date in 2004, there can be no assurances that raw material price increases, additional customer pricing pressures or a decline in overall business volume will not offset these margin improvements. In light of the foregoing, it is our present expectation that our third quarter 2004 operating results will be similar to those achieved in the second quarter of 2004.
15
Cautionary Statement for Purposes of the “Safe Harbor” Provisions of the Private Securities Litigation Reform Act of 1995
• 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.
16
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 impacted by the value primarily 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.
17
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 proceedings 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 suits, 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 second quarter of 2004, we issued options to purchase 19,500 shares of common stock at an average price of $4.04 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 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
(a) Our annual meeting was held on May 26, 2004.
(b) Proxies for the Annual Meeting were solicited pursuant to Regulation 14A under the Securities Exchange Act of 1934. There was no solicitation in opposition to management’s nominees as listed in the proxy statement and all of such nominees were elected.
The shareholders set the number of directors at five (5) by electing five (5) directors. The following persons were elected to serve as directors on our Board until the next annual meeting of shareholders with the following votes:
|
Nominees |
|
Votes For |
|
Votes Withheld |
|
|
|
|
|
|
|
Anthony Angelini |
|
30,827,434 |
|
481,874 |
|
Phillip T. Levin |
|
30,800,229 |
|
509,079 |
|
Janice Ozello Wilcox |
|
29,085,374 |
|
2,223,934 |
|
Robert Ezrilov |
|
29,132,036 |
|
2,177,272 |
|
Howard P. Liszt |
|
29,129,974 |
|
2,179,334 |
The shareholders approved the 2004 Equity Incentive Plan by a vote of 14,067,963 shares in favor, with 3,074,902 shares voted against, 350,994 shares abstaining and 13,815,449 broker non-votes.
The shareholders ratified the appointment of Deloitte & Touche, LLP as our independent public accountants for the fiscal year ending December 31, 2004, by a vote of 30,785,944 shares in favor, with 428,388 shares voted against and 94,976 shares abstaining.
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ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits.
10.1 1996 Employee Stock Purchase Plan, as amended and restated June 8, 2004
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 May 4, 2004, announcing first quarter 2004 financial results.
We filed a Form 8-K dated May 13, 2004, announcing the sale of a portion of the Company’s Intraware shareholdings.
We filed a Form 8-K dated May 26, 2004 announcing that Howard P. Liszt has been named Chairman of the Board of Directors.
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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: August 3, 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 |
|
20
ZOMAX INCORPORATED
FORM 10-Q FOR QUARTER ENDED JUNE 25, 2004
|
Exhibit |
|
Description |
|
|
|
|
|
10.1 |
|
1996 Employee Stock Purchase Plan, as amended and restated June 8, 2004 |
|
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 |
21