ZOMAX INCORPORATED
INDEX
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
ZOMAX INCORPORATED
Consolidated Balance Sheets
(In Thousands)
| | Sept. 28, 2001 (Unaudited) | | Dec. 29, 2000 | |
ASSETS | | | | | |
Current Assets: | | | | | |
Cash and cash equivalents | | $ | 70,447 | | $ | 63,577 | |
Accounts receivable, net | | 28,108 | | 32,182 | |
Inventories | | 9,385 | | 13,992 | |
Deferred income taxes | | 2,364 | | 2,374 | |
Prepaid and other assets | | 3,111 | | 3,543 | |
Total current assets | | 113,415 | | 115,668 | |
| | | | | |
Property and equipment, net | | 42,385 | | 46,159 | |
Investments in unconsolidated entity | | 4,500 | | 5,031 | |
Other assets | | 1,080 | | 1,077 | |
| | $ | 161,380 | | $ | 167,935 | |
| | | | | |
LIABILITIES AND SHAREHOLDERS' EQUITY | | | | | |
| | | | | |
Current Liabilities: | | | | | |
Current portion of notes payable | | $ | 2,981 | | $ | 3,788 | |
Accounts payable | | 13,335 | | 21,968 | |
Accrued expenses: | | | | | |
Accrued royalties | | 5,278 | | 7,217 | |
Accrued compensation | | 4,102 | | 6,349 | |
Other liabilities | | 1,731 | | 3,212 | |
Income taxes payable | | 2,892 | | 3,262 | |
Total current liabilities | | 30,319 | | 45,796 | |
| | | | | |
Notes payable, net of current portion | | 4,472 | | 6,757 | |
Deferred income taxes | | 3,276 | | 3,287 | |
Shareholders' Equity: | | | | | |
Common stock, no par value, 100,000 authorized shares, 32,399 and 31,737 shares issued and outstanding | | 60,446 | | 58,456 | |
Retained earnings | | 67,655 | | 58,093 | |
Accumulated other comprehensive loss | | (4,788 | ) | (4,454 | ) |
Total shareholders' equity | | 123,313 | | 112,095 | |
| | $ | 161,380 | | $ | 167,935 | |
The accompanying notes are an integral part of these consolidated financial statements.
ZOMAX INCORPORATED
Consolidated Statements of Operations
(Unaudited)
(In Thousands, except for Per Share Data)
| | Three Months Ended | | Nine Months Ended | |
| | Sept. 28, 2001 | | Sept. 29, 2000 | | Sept. 28, 2001 | | Sept. 29, 2000 | |
| | | | | | | | | |
Sales | | $ | 45,829 | | $ | 59,348 | | $ | 160,440 | | $ | 180,470 | |
Cost of sales | | 36,077 | | 42,473 | | 122,888 | | 124,629 | |
Gross profit | | 9,752 | | 16,875 | | 37,552 | | 55,841 | |
Selling, general and administrative expenses | | 7,435 | | 7,948 | | 23,730 | | 25,169 | |
Operating income | | 2,317 | | 8,927 | | 13,822 | | 30,672 | |
Equity in losses of unconsolidated entity | | (174 | ) | (529 | ) | (531 | ) | (1,343 | ) |
Interest expense | | (126 | ) | (273 | ) | (491 | ) | (850 | ) |
Interest income | | 645 | | 845 | | 2,162 | | 2,270 | |
Other income (expense), net | | 266 | | (158 | ) | 41 | | (73 | ) |
Income before income taxes | | 2,928 | | 8,812 | | 15,003 | | 30,676 | |
| | | | | | | | | |
Provision for income taxes | | 1,063 | | 3,355 | | 5,441 | | 11,027 | |
| | | | | | | | | |
Net income | | $ | 1,865 | | $ | 5,457 | | $ | 9,562 | | $ | 19,649 | |
| | | | | | | | | |
Earnings per share | | | | | | | | | |
Basic | | $ | 0.06 | | $ | 0.17 | | $ | 0.30 | | $ | 0.62 | |
Diluted | | $ | 0.06 | | $ | 0.16 | | $ | 0.29 | | $ | 0.58 | |
| | | | | | | | | |
Weighted average common shares outstanding | | 32,379 | | 32,312 | | 32,221 | | 31,920 | |
Dilutive effect of stock options and warrants | | 832 | | 1,493 | | 776 | | 1,896 | |
Weighted average common and diluted shares outstanding | | 33,211 | | 33,805 | | 32,997 | | 33,816 | |
The accompanying notes are an integral part of these consolidated financial statements.
ZOMAX INCORPORATED
Consolidated Statements of Cash Flows
(Unaudited)
(In Thousands)
| | Nine Months Ended | |
| | Sept. 28, 2001 | | Sept. 29, 2000 | |
Operating Activities: | | | | | |
Net income | | $ | 9,562 | | $ | 19,649 | |
Adjustments to reconcile net income to net cash provided by operating activities- | | | | | |
Depreciation and amortization | | 8,058 | | 7,087 | |
Equity in losses of unconsolidated entity | | 531 | | 1,343 | |
Tax benefits from employee stock option plan | | - | | 5,900 | |
Changes in operating assets and liabilities: | | | | | |
Accounts receivable | | 3,774 | | (8,580 | ) |
Inventories | | 4,538 | | 615 | |
Prepaid and other assets | | 397 | | (2,206 | ) |
Accounts payable | | (8,404 | ) | 1,405 | |
Accrued expenses | | (5,151 | ) | (3,603 | ) |
Income taxes payable | | (349 | ) | 2,216 | |
| | | | | |
Net cash provided by operating activities | | 12,956 | | 23,826 | |
| | | | | |
Investing Activities: | | | | | |
Purchase of property and equipment | | (4,647 | ) | (14,010 | ) |
Change in other assets | | (62 | ) | (5 | ) |
| | | | | |
Net cash used in investing activities | | (4,709 | ) | (14,015 | ) |
| | | | | |
Financing Activities: | | | | | |
Issuance of common stock | | 1,990 | | 4,081 | |
Repayment of notes payable | | (3,032 | ) | (2,961 | ) |
Net cash provided by (used in) financing activities | | (1,042 | ) | 1,120 | |
| | | | | |
Effect of exchange rate changes on cash and cash equivalents | | (335 | ) | (2,094 | ) |
| | | | | |
Net increase in cash | | 6,870 | | 8,837 | |
| | | | | |
Cash and Cash Equivalents: | | | | | |
Beginning of period | | 63,577 | | 51,128 | |
End of period | | $ | 70,447 | | $ | 59,965 | |
| | | | | |
Supplemental Cash Flow Disclosures: | | | | | |
Cash paid for interest | | $ | 496 | | $ | 886 | |
Cash paid for income taxes | | $ | 4,899 | | $ | 2,970 | |
The accompanying notes are an integral part of these consolidated financial statements.
Zomax Incorporated
Notes to Consolidated Financial Statements
(Unaudited)
1. Business Description
Zomax Incorporated (Zomax or the Company) is a leading international outsource provider of process management services. The Company’s fully integrated services include “front-end” e-commerce support; customer contact center and customer support solutions; DVD authoring services; CD and DVD mastering; CD and DVD replication; supply chain and inventory management; graphic design; print management; assembly; packaging; warehousing; distribution and fulfillment; and returned merchandise authorization (RMA) processing.
2. Basis of Presentation
The accompanying interim consolidated financial statements of the Company are unaudited; however, in the opinion of 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 the Company’s business, results may not be indicative of results for a full year. The accompanying consolidated financial statements should be read in conjunction with the Company’s Form 10-K for the year ended December 29, 2000.
3. Recently Issued Accounting Pronouncements
Statement of Financial Accounting Standards (SFAS) No. 133, “Accounting for Derivative Instruments and Hedging Activities” (SFAS 133), as amended, is effective for years beginning after June 15, 2000 (fiscal 2001 for the Company). SFAS 133 establishes accounting and reporting standards requiring that every derivative instrument, including certain derivative instruments embedded in other contracts, be recorded in the balance sheet as either an asset or liability measured at its fair value. SFAS 133 requires that changes in the derivative’s fair value be recognized currently in earnings unless specific hedge criteria are met. Special accounting for qualifying hedges allows a derivative’s gains or losses to offset related results on the hedged item in the statement of operations and requires that a company must formally document, designate and assess the effectiveness of transactions that receive hedge accounting treatment. The adoption of SFAS 133 did not have a material effect on the Company’s financial position or results of operations.
In July 2001, the Financial Accounting Standards Board issued SFAS No. 141, “Business Combinations” (SFAS 141) and No. 142, “Goodwill and Other Intangible Assets” (SFAS 142). SFAS 141 requires all business combinations initiated after June 30, 2001 to be accounted for using the purchase method. Under SFAS 142, goodwill and intangible assets with indefinite lives are no longer amortized but are reviewed annually (or more frequently if impairment indicators arise) for impairment. Separable intangible assets that are not deemed to have indefinite lives will continue to be amortized over their useful lives (but with no maximum life). The amortization provisions of SFAS 142 apply to goodwill and intangible assets acquired after June 30, 2001. With respect to goodwill and intangible assets acquired prior to July 1, 2001, the Company is required to adopt SFAS 142 effective the first day of fiscal 2002. The Company is currently evaluating the effect that adoption of the provisions of SFAS 142 that are effective the first day of fiscal 2002 will have on its results of operations and financial position.
4. Shareholders’ Equity
On May 8, 2000, the Company’s board of directors approved a second 2-for-1 stock split effected as a stock dividend to shareholders. All per share and share outstanding data in the consolidated financial statements and notes to consolidated financial statements have been retroactively restated to reflect the stock split.
The Company’s board of directors authorized a stock repurchase plan in October 2000, which allows the Company to repurchase up to 2,000,000 common shares. No shares have been repurchased during 2001.
5. Comprehensive Income
The table below presents comprehensive income, defined as changes in the equity of the Company excluding changes resulting from investments by and distributions to shareholders (in thousands).
| | Three Months Ended | | Nine Months Ended | |
| | Sept. 28, 2001 | | Sept. 29, 2000 | | Sept. 28, 2001 | | Sept. 29, 2000 | |
| | | | | | | | | |
Net income | | $ | 1,865 | | $ | 5,457 | | $ | 9,562 | | $ | 19,649 | |
Change in cumulative translation Adjustment | | 1,867 | | (2,057 | ) | (334 | ) | (3,050 | ) |
Comprehensive income | | $ | 3,732 | | $ | 3,400 | | $ | 9,228 | | $ | 16,599 | |
6. Industry Segment and Operations by Geographic Areas
The Company operates in one industry segment. The geographic distributions of the Company's identifiable assets, operating income and sales for the periods ended September 28, 2001 and September 29, 2000 are summarized as follows (in thousands):
| | Three Months Ended | | Nine Months Ended | |
| | Sept. 28, 2001 | | Sept. 29, 2000 | | Sept. 28, 2001 | | Sept. 29, 2000 | |
Total sales: | | | | | | | | | |
United States | | $ | 37,366 | | $ | 42,431 | | $ | 125,758 | | $ | 129,292 | |
Europe | | 9,554 | | 15,045 | | 35,443 | | 46,954 | |
Canada | | 4,511 | | 5,257 | | 14,100 | | 16,183 | |
Less - Intergeographic sales | | (5,602 | ) | (3,385 | ) | (14,861 | ) | (11,959 | ) |
| | $ | 45,829 | | $ | 59,348 | | $ | 160,440 | | $ | 180,470 | |
| | | | | | | | | |
Operating income: | | | | | | | | | |
United States | | $ | 3,603 | | $ | 7,893 | | $ | 15,279 | | $ | 25,944 | |
Europe | | (14 | ) | 1,132 | | 1,245 | | 5,854 | |
Canada | | 724 | | 1,648 | | 2,415 | | 4,369 | |
Corporate and eliminations | | (1,996 | ) | (1,746 | ) | (5,117 | ) | (5,495 | ) |
| | $ | 2,317 | | $ | 8,927 | | $ | 13,822 | | $ | 30,672 | |
| | | | | | | | | |
Captial expenditures: | | | | | | | | | |
United States | | $ | 335 | | $ | 6,312 | | $ | 1,053 | | $ | 8,317 | |
Europe | | $ | 671 | | 2,299 | | 3,342 | | 2,697 | |
Canada | | 75 | | 2,718 | | 252 | | 2,996 | |
| | $ | 1,081 | | $ | 11,329 | | $ | 4,647 | | $ | 14,010 | |
| | | | | | | | | |
Depreciation and amortization | | | | | | | | | |
United States | | $ | 1,871 | | $ | 1,823 | | $ | 5,790 | | $ | 5,153 | |
Europe | | 466 | | 446 | | 1,343 | | 1,270 | |
Canada | | 309 | | 210 | | 925 | | 664 | |
| | $ | 2,646 | | $ | 2,479 | | $ | 8,058 | | $ | 7,087 | |
| | | | | | | | | |
Assets: | | | | | | | | | |
United States | | | | | | $ | 50,918 | | $ | 55,095 | |
Europe | | | | | | 36,465 | | 38,363 | |
Canada | | | | | | 16,466 | | 15,432 | |
Total identifiable assets | | | | | | 103,849 | | 108,890 | |
Corporate assets and eliminations | | | | | | 57,531 | | 54,347 | |
Total assets | | | | | | $ | 161,380 | | $ | 163,237 | |
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
General
The Company is a leading international outsource service provider of process management services. The Company’s fully integrated services include: “front end” e-commerce support; customer contact center and customer support solutions; DVD authoring services; CD and DVD mastering; CD and DVD replication; supply chain and inventory management; graphic design; print management; CD and DVD printing; assembly; packaging; warehousing; distribution and fulfillment; and RMA processing services.
The Company recognizes revenue from its customers at the time merchandise is shipped or as services are rendered. For certain customers, merchandise is invoiced upon completion of orders with shipment occurring based on subsequent written customer instructions. In these cases, the customer accepts title to the goods as of the date of the Company’s invoice.
The Company’s business has been characterized by short lead times for customer orders. For this reason and because of the timing of orders, delivery intervals and the possibility of customer changes in delivery schedules, the Company’s backlog as of any particular date is not a meaningful indicator of future financial results.
Results of Operations
Sales. The Company’s sales were $45.8 million for the third quarter of 2001, a decrease of 22.8% from $59.3 million in the third quarter of 2000. The majority of the 22.8% decrease in third quarter sales relates to a decrease of 25.2% in CD related sales. Customer contact center, assembly and other sales decreased 14.7%. For the nine months ended September 28, 2001, sales were $160.4 million, a decrease of 11.1% from sales of $180.5 million for the same period of 2000. The decrease in sales resulted primarily from an economic slowdown in the PC and software markets.
Cost of sales. Cost of sales as a percentage of sales was 78.7% and 71.6% for the third quarter of 2001 and 2000, respectively. The third quarter increase in the cost of sales as a percentage of sales was primarily due to the change in the mix of sales and pricing pressures. The Company’s sales mix for the third quarter of 2001 included an increase in lower margin materials and freight billings, while fixed costs increased as a percentage of sales due to CD/DVD manufacturing capacity expansion completed last year and manufacturing facilities operating at lower utilizations. For the first nine months of 2001 and 2000, cost of sales as a percentage of sales were 76.6% and 69.1%, respectively.
Selling, general and administrative expenses. Selling, general and administrative expenses as a percentage of sales were 16.2% and 13.4% for the third quarter of 2001 and 2000, respectively. Selling, general and administrative expenses decreased $0.5 million to $7.4 million in the third quarter of 2001, as compared to $7.9 million in the third quarter of 2000. For the first nine months of 2001 and 2000, selling, general and administrative expenses as a percentage of sales were 14.8% and 13.9%, respectively.
Equity in losses of unconsolidated entity. The Company owns an equity interest in Microgistix, Inc. (formerly Chumbo Holdings Corporation), an Internet based reseller of software. The Company accounts for this investment using the equity method of accounting and, accordingly, recognized a loss of $0.2 million in the third quarter of 2001 and a loss of $0.5 million in the third quarter of 2000. This loss represents its share of the Microgistix’s net loss and the amortization of excess purchase price over the fair value of the underlying net assets acquired. For the first nine months of 2001 and 2000, the net loss from Microgistix was $0.5 million and $1.3 million, respectively.
Interest income and expense. Interest income was $0.6 million and $0.8 million for the third quarter of 2001 and 2000, respectively. Interest expense was $0.1 million and $0.3 million for the third quarter of 2001 and 2000, respectively. For the first nine months of 2001, interest income was $2.2 million compared to $2.3 million for the same period in 2000. For the first nine months of 2001, interest expense was $0.5 million compared to $0.9 million for the same period in 2000. Interest income decreased due to lower interest rates. There was a decrease in interest expense as a result of lower outstanding loan balances and lower interest rates.
Other income (expenses), net. Other income/expense consists of foreign currency gains/losses.
Provision for income taxes. The effective income tax rate for the third quarter of 2001 was 36.3%, as compared to 38.1% for the third quarter of 2000. The decrease in the effective income tax rate in 2001 is due to a decrease in U.S. based income, which is taxed at a higher rate. For the first nine months of 2001, the effective income tax rate was 36.3% compared to 36.0% for the same period in 2000.
Net income. Net income for the third quarter of 2001 was $1.9 million, a decrease of 65.8% from net income of $5.5 million in 2000. Diluted earnings per share was $.06 for the third quarter of 2001, a decrease of 62.5% from diluted earnings per share of $.16 in third quarter of 2000.
Liquidity and Capital Resources
As of September 28, 2001, the Company had working capital of $83.1 million, compared to working capital of $69.9 million as of December 29, 2000. As of September 28, 2001, the Company had cash and cash equivalents totaling $70.4 million.
Cash provided by operating activities for the first nine months of 2001 was $13.0 million, compared to $23.8 million during the first nine months of 2000. The lower operating cash flow in 2001 was primarily due to the decrease in net income.
Cash used in investing activities during the first nine months of 2001 and 2000 was $4.7 million and $14.0 million, respectively. The cash used in both periods was primarily for the purchase of property and equipment.
Cash used in financing activities during the first nine months of 2001 was $1.0 million, compared to cash provided of $1.1 million during the first nine months of 2000. In 2001, the Company received $2.0 million from the issuance of common stock, compared to $4.1 million in 2000. The Company repaid principal on notes payable totaling $3.0 million in the first nine months of both 2001 and 2000.
As of September 28, 2001, the Company had a revolving line of credit facility with available borrowings up to $25.0 million. Such borrowings are limited to an amount based on a formula using eligible accounts receivable and inventories. There were no borrowings outstanding under the revolving line of credit facility at September 28, 2001.
Future liquidity needs will depend on, among other factors, the timing of capital expenditures and expenditures in connection with any acquisitions, changes in customer order volume and the timing and collection of receivables. The Company believes that existing cash balances, anticipated cash flow from operations and amounts available under existing credit facilities will be sufficient to fund its operations for the foreseeable future.
Euro Currency Conversion
On January 1, 1999, 11 of the 15 member countries of the European Union, including Ireland, adopted the “Euro” as their common legal currency. The Euro trades on currency exchanges and is available for non-cash transactions. From January 1, 2000 through January 1, 2002, each of the participating countries is scheduled to maintain its national (“legacy”) currency as legal tender for goods and services. Beginning January 1, 2002, new Euro-denominated bills and coins will be issued, and legacy currencies will be withdrawn from circulation no later than July 1, 2002. The Company’s foreign operating subsidiaries affected by the Euro conversion are evaluating the business issues raised, including the competitive impact of cross-border price transparency. The Company does not anticipate any significant near-term business ramifications; however, long-term implications such as the Euro currency conversion’s effect on accounting, treasury and computer systems are under review.
Inflation
Historically, inflation has not had a material impact on the Company. The cost of the Company’s products, however, is influenced by the cost of raw materials and labor. There can be no assurance that the Company will be able to pass on any increased costs to its customers in the future.
Seasonality
The demand for CDs and other multimedia consumer products is seasonal, with demand increase in the fall due to the new school year and holiday season purchases. This seasonality could result in significant quarterly variations in financial results, with the third and fourth quarters generally being the strongest in terms of revenue.
Outlook
The statements contained in this Outlook section and elsewhere in this Form 10-Q are based on current expectations. These statements are forward-looking and are made pursuant to the safe harbor provisions of the Private Securities Reform Act of 1995. Such statements can be identified by the use of terminology such as “anticipate,” “believe,” “estimate,” “expect,” “intend,” “may,” “could,” “possible,” “plan,” “project,” “will,” “forecast” and similar words or expressions. The Company’s forward-looking statements generally relate to its growth strategy, financial results, sales efforts and cash requirements. There are certain important factors that could cause results to differ materially from those anticipated by some of the statements made herein. Investors are cautioned that all forward-looking statements involve risks and uncertainties, including among others those identified below.
The Company believes the worldwide demand for CD/DVDs has declined due to the economic slowdown in the PC and software markets. Unit prices may continue to decline given the overcapacity state of the industry.
If CD market demand continues to decline, the Company’s revenues will be directly and adversely impacted and the manufacturing capacity installed will be further underutilized. Pricing strategies of competitors and general economic factors, such as consumer confidence and inflation, directly impact the Company. A substantial part of the Company’s revenue is derived from a small number of key customers, and revenues will be significantly lower than expected if the Company cannot retain these customers. In addition, if the Company does not respond rapidly to technological changes, it is subject to the loss of some of its customer base, which will materially and adversely effect revenue.
On June 29, 2001, the Company closed its German facility, which primarily duplicated and packaged diskettes for one customer. The customer has transitioned from diskettes to CD’s and the Company does not have CD replication equipment in Germany. The cost of closing the facility is not material to the consolidated financial statements.
The Company undertakes no obligation to update any forward-looking statements, but investors are advised to consult any further disclosures by the Company on this subject in its filings with the Securities and Exchange Commission, especially on Forms 10-K, 10-Q and 8-K (if any), in which the Company discusses in more detail various important factors that could cause actual results to differ from expected or historic results. It is not possible to foresee or identify all such factors. As such, investors should not consider any list of such factors to be an exhaustive statement of all risks, uncertainties or potentially inaccurate assumptions.
ITEM 3. QUANTITIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Foreign Currency. A portion of the Company’s operations are located in foreign jurisdictions, including Ireland and Canada. The Company’s financial results could be significantly affected by factors, including, but not limited to, changes in foreign currency or weak economic conditions in foreign markets. In addition, product sales and services are affected by the value of the U.S. dollar relative to other currencies.
Foreign currency gains and losses are reflected in the Company’s financial statements. The net exchange gain was $0.3 million for the third quarter ended September 28, 2001. The Company believes that it will continue to incur exchange gains and losses from foreign operations in the future.
Interest. As of September 28, 2001, the Company had total outstanding debt of $7.5 million, with interest rates that are tied to the prime rate or LIBOR. Therefore, the Company is subject to exposure to interest rate risk for these borrowings based on fluctuations in the interest rates. Based upon the outstanding indebtedness as of September 28, 2001, an increase in the interest rates of 1.0% would cause a corresponding increase in our annual interest expense of approximately $0.1 million.
PART II - OTHER INFORMATION
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
Effective May 9, 2001, the Company issued to two employees ten year options to purchase 422,561 and 270,439 shares of common stock for $5.86 per share, respectively. Each of the employee’s options will vest and become exercisable over four years. Also, on August 1, 2001, the Company issued to an employee a ten year option to purchase 50,000 shares of common stock for $5.86 per share, which vest and become exercisable over five years. 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.
None
(b) Reports on Form 8-K.
None
SIGNATURES
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.
| | | ZOMAX INCORPORATED |
| | | |
| | | |
Date: November 12, 2001 | By: | | /s/ James T. Anderson |
| | | James T. Anderson, Chairman and Chief Executive Officer (principal executive officer) |
| | | |
| | | |
| By: | | /s/ J. John Gelp |
| | | J. John Gelp, Executive Vice President and Chief Financial Officer (principal financial and accounting officer) |
