CONFORMED
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED
SEPTEMBER 30, 1998; OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM ______ TO ______.
COMMISSION FILE NUMBER: 0-20728
RIMAGE CORPORATION
(Exact name of Registrant as specified in its charter)
Minnesota 41-1577970
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
7725 Washington Avenue South, Edina, MN 55439
(Address of principal executive offices)
612-944-8144
( Registrant's telephone number, including area code)
NA
(Former name, former address, and former fiscal year,
if changed since last report.)
Common Stock outstanding at November 4, 1998
-- 3,236,999 shares of $.01 par value
Common Stock.
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the Registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes _X_ No ___
RIMAGE CORPORATION
FORM 10-Q
TABLE OF CONTENTS
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 1998
Description Page
----------- ----
PART I FINANCIAL INFORMATION
- - ------
Item 1. Financial Statements
Consolidated Balance Sheets as of
September 30, 1998 (unaudited) and
December 31, 1997 ..................................................... 3
Consolidated Statements of Operations
(unaudited) for the Three and Nine Months
Ended September 30, 1998 and 1997 ..................................... 4
Consolidated Statements of Cash Flows
(unaudited) for the nine Months
Ended September 30, 1998 and 1997 ..................................... 5-6
Condensed Notes to Consolidated
Financial Statements (unaudited) ...................................... 7-11
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations ....................... 12-18
PART II OTHER INFORMATION ......................................................... 19
- - -------
Items 1-3. None
Item 4. Submission of Matters to Vote of Security Holders
Item 5. None
Item 6. Exhibits
SIGNATURES ................................................................................. 20
2
RIMAGE CORPORATION AND SUBSIDIARIES
Consolidated Balance Sheets
September 30, 1998 and December 31, 1997
September 30, December 31,
Assets 1998 1997
- - ------------------------------------------------------------------------------------------------------------------
(unaudited)
Current assets:
Cash and cash equivalents $ 4,147,534 $ 656,127
Trade accounts receivable, net of allowance for doubtful accounts
and sales returns of $314,810 and $505,458 respectively 5,974,486 4,778,055
Inventories (Note 2) 2,002,116 2,265,867
Income tax receivable 452,621 23,350
Deferred income taxes (Note 6) 750,000 -
Prepaid expenses and other current assets 166,781 472,728
- - ------------------------------------------------------------------------------------------------------------------
Total current assets 13,493,538 8,196,127
- - ------------------------------------------------------------------------------------------------------------------
Property and equipment, net 943,798 5,846,953
Goodwill, net 788,156 848,692
Other noncurrent assets 64,496 271,740
- - ------------------------------------------------------------------------------------------------------------------
Total assets $ 15,289,988 $ 15,163,512
===================================================================================================================
Liabilities and Stockholders' Equity
- - ------------------------------------------------------------------------------------------------------------------
Current liabilities:
Current portion of notes payable $ - $ 900,000
Current installments of capital lease obligations (note 4) - 356,053
Trade accounts payable 2,477,914 2,789,973
Accrued expenses 1,471,506 1,069,315
Deferred income and customer deposits 610,973 640,725
- - ------------------------------------------------------------------------------------------------------------------
Total current liabilities 4,560,393 5,756,066
Notes payable, less current portion - 750,000
Capital lease obligations, less current installments (note 4) - 2,661,334
- - ------------------------------------------------------------------------------------------------------------------
Total liabilities 4,560,393 9,167,400
- - ------------------------------------------------------------------------------------------------------------------
Minority interest in inactive subsidiary - 57,907
Stockholders' equity:
Common stock, $.01 par value, authorized 10,000,000 shares,
issued and outstanding 3,236,999 and 3,091,302, respectively 32,370 30,913
Additional paid-in capital 11,404,770 10,468,136
Accumulated deficit (681,484) (4,405,218)
Foreign currency translation adjustment (26,061) (155,626)
- - ------------------------------------------------------------------------------------------------------------------
Total stockholders' equity 10,729,595 5,938,205
- - ------------------------------------------------------------------------------------------------------------------
Total liabilities and stockholders' equity $ 15,289,988 $ 15,163,512
===================================================================================================================
See accompanying condensed notes to consolidated financial statements
3
RIMAGE CORPORATION AND SUBSIDIARIES
Consolidated Statements of Operations
(unaudited)
Three Months Ended Nine Months Ended
September 30, September 30,
1998 1997 1998 1997
- - ---------------------------------------------------------------------------------------------------------------------
Revenues $ 9,225,576 $ 8,443,604 $ 27,715,465 $ 29,608,308
Cost of revenues 5,477,044 5,758,059 16,439,886 21,460,335
- - ---------------------------------------------------------------------------------------------------------------------
Gross profit 3,748,532 2,685,545 11,275,579 8,147,973
- - ---------------------------------------------------------------------------------------------------------------------
Operating expenses:
Engineering and development 550,764 425,862 1,467,641 1,510,529
Selling, general and administrative 1,687,095 1,606,179 5,635,026 5,044,491
- - ---------------------------------------------------------------------------------------------------------------------
Total operating expenses 2,237,859 2,032,041 7,102,667 6,555,020
======================================================================================================================
Operating earnings 1,510,673 653,504 4,172,912 1,592,953
- - ---------------------------------------------------------------------------------------------------------------------
Other (expense) income:
Interest, net 22,585 (183,863) (135,293) (695,928)
Gain (loss) on currency exchange 50,728 (10,562) 77,498 28,178
Gain on capital leases (Note 4) 512,192 - 512,192 -
Other, net (Note 5) (1,017,817) 97,213 (977,738) 112,312
- - ---------------------------------------------------------------------------------------------------------------------
Total other expense, net (432,312) (97,212) (523,341) (555,438)
- - ---------------------------------------------------------------------------------------------------------------------
Earnings before income taxes 1,078,361 556,292 3,649,571 1,037,515
Income tax (benefit) expense (Note 6) (594,363) 29,857 (74,163) 90,000
- - ---------------------------------------------------------------------------------------------------------------------
Net earnings $ 1,672,724 $ 526,435 $ 3,723,734 $ 947,515
======================================================================================================================
Basic net earnings per common share $ 0.52 $ 0.17 $ 1.18 $ 0.31
- - ---------------------------------------------------------------------------------------------------------------------
Diluted net earnings per common share
and common share equivalents $ 0.45 $ 0.16 $ 1.03 $ 0.29
- - ---------------------------------------------------------------------------------------------------------------------
Basic weighted average shares 3,218,632 3,085,701 3,151,921 3,084,905
======================================================================================================================
Diluted weighted average shares and
common share equivalents outstanding 3,731,275 3,283,725 3,614,141 3,224,127
======================================================================================================================
See accompanying condensed notes to consolidated financial statements
4
RIMAGE CORPORATION AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(unaudited)
Nine months ended
September 30,
1998 1997
- - -------------------------------------------------------------------------------------------------------------------
Cash flows from operating activities:
Net earnings $ 3,723,734 $ 947,515
Adjustments to reconcile net earnings to net cash
provided by operating activities:
Minority interest in net earnings of dissolved subsidiary 57,907 -
Depreciation and amortization 1,484,040 1,835,988
Change in reserve for excess and obsolete inventories 166,423 21,787
Change in reserve for allowance for doubtful accounts (190,648) (513,050)
Loss on sale of property and equipment 979,583 74,783
Write off of other assets (15,000) -
Deferred income tax benefit (750,000) -
Gain on capital leases (512,192) -
Changes in operating assets and liabilities:
Trade accounts receivable (1,005,783) 1,061,478
Inventories 97,328 1,274,825
Income tax receivable (429,271) 794,079
Prepaid expenses and other current assets 228,178 (100,638)
Trade accounts payable (312,059) (1,728,965)
Accrued expenses 326,092 (565,388)
Deferred income and customer deposits (29,752) 120,420
- - -------------------------------------------------------------------------------------------------------------------
Net cash provided by operating activities 3,818,580 3,222,834
- - -------------------------------------------------------------------------------------------------------------------
Cash flows from investing activities:
Purchase of property and equipment (504,617) (287,129)
Proceeds from the sale of property and equipment 2,120,884 16,000
Other noncurrent assets 157,018 183,403
Receipts from sales-type leases 89,782 253,272
- - -------------------------------------------------------------------------------------------------------------------
Net cash provided by investing
activities 1,863,067 165,546
- - -------------------------------------------------------------------------------------------------------------------
(Continued)
5
RIMAGE CORPORATION AND SUBSIDIARIES
Consolidated Statements of Cash Flows, Continued
Nine months ended
September 30,
1998 1997
- - --------------------------------------------------------------------------------------------------------------------
Cash flows from financing activities:
Proceeds from stock option exercise 938,091 16,005
Principal payments on capital lease obligation (1,504,878) (246,028)
Proceeds from other notes payable - 26,001,642
Repayment of other notes payable (1,650,000) (29,189,238)
- - --------------------------------------------------------------------------------------------------------------------
Net cash used in financing activities (2,216,787) (3,417,619)
- - --------------------------------------------------------------------------------------------------------------------
Effect of exchange rate changes on cash 26,547 (75,233)
- - --------------------------------------------------------------------------------------------------------------------
Net increase (decrease) in cash 3,491,407 (104,472)
Cash and cash equivalents, beginning of period 656,127 117,322
- - --------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents, end of period $ 4,147,534 $ 12,850
- - --------------------------------------------------------------------------------------------------------------------
Supplemental disclosures of net cash received (paid) during the period for:
Interest $ 135,293 $ (513,388)
Income taxes $ (1,061,900) $ (18,186)
Supplemental disclosures of non-cash investing and financing activities:
Reduction of obligations under capital leases as a result of
conversions to operating leases $ 1,512,509
===================
Reduction of net book value of facilities under capital leases as
a result of conversions to operating leases $ 1,000,317
===================
See accompanying condensed notes to the consolidated financial statements
6
RIMAGE CORPORATION AND SUBSIDIARIES
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(1) BASIS OF PRESENTATION AND NATURE OF BUSINESS
The consolidated financial statements include the accounts of Rimage
Corporation, Rimage Europe GmbH, A/G Systems Inc., d/b/a
Duplication Technology Inc. (Rimage Boulder), Knowledge Access
International (Knowledge Access) and Rimage Services, collectively
hereinafter referred to as Rimage or the Company. All material
intercompany accounts and transactions have been eliminated upon
consolidation.
The Company operates in two divisions, Rimage Systems Division and
Rimage Services Division. The Rimage Systems Division consists of
substantially all of the former Rimage Companies. The Rimage
Services Division consists of Rimage Services in addition to the
existing service business at Rimage Boulder. During the third
quarter of 1998, the Company ceased operations of its Bloomington
Service division (Rimage Services) and sold the equipment and
inventory associated with it.
The Systems Division develops, manufactures and distributes high
performance CD-Recordable (CD-R) publishing and duplication
systems, and continues to support its long-term involvement in
diskette duplication and publishing equipment. The Services
Division provides computer media duplication and production
services to software developers and manufacturers and information
publishers.
The accompanying unaudited consolidated financial statements of the
Company have been prepared pursuant to the rules of the Securities
and Exchange Commission. These financial statements should be read
in conjunction with the more detailed financial statements and
notes thereto included in the Company's most recent annual report
on Form 10-K.
The Company extends unsecured credit to its customers as well as
credit to a limited number of authorized distributor wholesalers,
who in turn provide warehousing, distribution, and credit to a
network of authorized value added resellers. These distributors
and value added resellers sell and service a variety of hardware
and software products.
In the opinion of management, the accompanying consolidated financial
statements reflect all adjustments, consisting of only normal
recurring adjustments, necessary for a fair presentation of the
financial position and results of operations and cash flows of the
Company for the periods presented. Certain previously reported
amounts have been reclassified to conform with the current
presentation.
(Continued)
7
RIMAGE CORPORATION AND SUBSIDIARIES
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(1) BASIS OF PRESENTATION AND NATURE OF BUSINESS (CONTINUED)
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make
estimates and assumptions that affect the reported amounts of
assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting
period. Actual results could differ from those estimates.
(2) INVENTORIES
Inventories consist of the following as of:
September 30, December 31,
1998 1997
(unaudited)
- - --------------------------------------------------------------------------------
Finished goods and demonstration equipment $1,053,623 $ 578,689
Work-in-proces 199,491 234,177
Purchased parts and subassemblies 1,363,425 1,901,001
- - --------------------------------------------------------------------------------
2,616,539 2,713,867
Less reserve for excess inventories 614,423 448,000
- - --------------------------------------------------------------------------------
$2,002,116 $2,265,867
- - --------------------------------------------------------------------------------
(Continued)
8
RIMAGE CORPORATION AND SUBSIDIARIES
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(3) SEGMENT REPORTING
The following table summarizes certain financial information for the
Systems and Services segments:
Nine Months Ended September 30,
(unaudited)
(in thousands)
- - --------------------------------------------------------------------------------
1998 1997
- - --------------------------------------------------------------------------------
Revenues from unaffiliated customers:
Systems $20,023 $ 15,428
Services 7,693 14,180
----- ------
27,716 29,608
Operating earnings (loss):
Systems 4,308 2,125
Services (135) (532)
---- ----
$ 4,173 $ 1,593
September 30, December 31,
1998 1997
(unaudited)
- - --------------------------------------------------------------------------------
Net identifiable assets:
Systems $14,785 $ 7,881
Services 1,115 7,283
----- -----
$15,900 $15,164
(4) CAPITAL LEASES
During September 1998, the Company renegotiated its existing capital
leases for both the Edina and Bloomington Minnesota facilities,
resulting in operating leases and a gain of $512,192.
(Continued)
9
RIMAGE CORPORATION AND SUBSIDIARIES
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(5) SHUT DOWN OF BLOOMINGTON SERVICES OPERATION
In connection with the August 31, 1998 sale of a portion of the
Company's services division, the Company sold the fixed assets and
inventory used in its Bloomington, Minnesota services operation
during the third quarter. From the July 23, 1998 measurement date
to September 30, 1998, the Bloomington, Minnesota services
operation had income from operations of $20,155 and generated
proceeds of approximately $2.1 million from the sale of assets
used in its operation. The Company has recognized a loss on the
sale of these assets during the third quarter totaling
approximately $859,000. The Company filed a Form 8-K dated July
31, 1998 which contained unaudited pro forma condensed
consolidated statements of operations for the year ended December
31, 1997 and for the six months ended June 30, 1998 excluding the
operations related to the assets of its Bloomington, Minnesota
services business, as if the assets had been sold at the beginning
of the respective periods. Pro forma consolidated revenues were
$35.7 million and $17.9 million for the year ended December 31,
1997 and for the six months ended June 30, 1998, respectively. Pro
forma consolidated net earnings were $1.2 million and $2.1 million
for the year ended December 31, 1997 and for the six months ended
June 30, 1998, respectively. As of June 30, 1998, pro forma
consolidated total assets and total liabilities were $15.8 and
$7.9 million, respectively.
(6) INCOME TAXES
In accordance with SFAS No. 109, in prior years the Company
established a valuation allowance against its net deferred tax
asset. A valuation allowance is necessary when, based upon a
review of all applicable facts and circumstances, it is more
likely than not that the deferred tax asset will not be realized.
The Company periodically evaluates the continued need for this
valuation allowance. As a result of a review of the Company's
current and projected earnings and other positive business
factors, the Company believes it is now more likely than not that
the deferred tax asset will be realized; therefore, the valuation
allowance of $750,000 was reduced to zero during the third quarter
of 1998. The resulting tax benefit of $750,000 reduced the
Company's income tax expense recognized for the three and nine
months ended September 30, 1998. (Continued)
10
RIMAGE CORPORATION AND SUBSIDIARIES
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(7) COMPREHENSIVE INCOME
In June 1997, the Financial Accounting Standards Board (FASB) issued
SFAS No. 130, REPORTING COMPREHENSIVE INCOME. This statement
requires companies to classify items of other comprehensive income
by their nature in a financial statement and display the
accumulated balance of other comprehensive income separately from
retained earnings and additional paid-in capital in the equity
section of the balance sheet, and is effective for the Company's
year ending December 31, 1998. The Company's only item of other
comprehensive income relates to foreign currency translation
adjustments, and is presented separately on the balance sheet as
required. If presented on the statement of operations for the
three and nine months ended September 30, 1998, comprehensive
income would be $1.8 million and $3.9 million or $103,968 and
$129,565 more than reported net income, respectively, due to
foreign currency translation adjustments.
11
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, selected
items from the Company's consolidated statements of operations, shown in
thousands.
Three months ended Nine months ended
September 30, September 30,
------------- -------------
1998 1997 1998 1997
-------- -------- -------- --------
Revenues:
Systems ...................... $ 7,290 $ 4,881 $ 20,023 $ 15,428
Services ..................... 1,936 3,563 7,693 14,180
-------- -------- -------- --------
Total Revenues .......... 9,226 8,444 27,716 29,608
Cost of Revenues:
Systems ...................... 3,647 2,670 9,677 8,931
Services ..................... 1,830 3,088 6,763 12,529
-------- -------- -------- --------
Total Cost of Revenues . 5,477 5,758 16,440 21,460
Operating Expenses:
Systems ...................... 2,003 1,314 6,038 4,372
Services ..................... 235 718 1,065 2,183
-------- -------- -------- --------
Total Operating Expenses 2,238 2,032 7,103 6,555
Operating Earnings:
Systems ...................... 1,640 898 4,308 2,125
Services ..................... (129) (244) (135) (532)
-------- -------- -------- --------
Total Operating Earnings $ 1,511 $ 654 $ 4,173 $ 1,593
======== ======== ======== ========
RESULTS OF OPERATIONS
This report contains forward-looking statements that involve risks and
uncertainties. The Company's actual results could differ significantly from
those discussed in the forward-looking statements. Factors that could cause or
contribute to such differences include, but are not limited to, changes in media
or method used for distribution of software, technological changes in products
offered by the Company or its competitors and changes in general conditions in
the computer market.
12
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS (CONTINUED)
Rimage operates through two primary divisions: (1) the systems division designs,
manufactures and sells high performance, on-demand publishing and duplication
equipment for CD-R's, diskettes and tapes, and (2) the services division
provides media duplication and fulfillment services for most computer media
types, including CD-ROM, diskette, tape and other media such as ZIP and Jazz
disks. Results of operations during the three and nine months ended September
30, 1998 reflected the continued trend of substantial growth and profitability
in the systems division and lower contribution from the services division.
REVENUE. Revenue increased 9.3% from $8.4 million during the third quarter of
1997 to $9.2 million during the third quarter of 1998. The Company's ongoing
intent to focus its sales efforts more heavily towards developing the systems
division current distribution network created increased sales of its CD-R
products. Expanded market penetration caused revenue in the systems division to
increase 49.3% to $7.3 million during the third quarter of 1998 from $4.9 in the
third quarter of 1997. The services division recorded a 45.7% decline in revenue
from $3.6 million in the third quarter of 1997 to $1.9 million in the third
quarter of 1998. Revenue in the services division was affected by the
divestiture of its Bloomington, MN services operation and decreasing demand for
diskette duplication services.
For the nine months ended September 30, 1998, revenues of $27.7 million
represented a 6.4% decrease as compared to revenues of $29.6 million during the
same period in 1997. However, primarily as a result of continued increasing
demand of CD-R related products, systems division revenues increased 29.8% from
$15.4 million during the nine months ended September 30, 1997 to $20.0 million
during the same period in 1998. This increase was offset by services division
revenues which decreased 45.7% from $14.2 million during the nine months ended
September 30, 1997 to $7.7 million during the same period in 1998. Revenue in
the services division was affected by the loss of a customer that provided 8.2%
of services sales during the first quarter of 1997, by the termination of its
Bloomington, MN services operation due to decreasing demand for diskette
duplication services, and as a result of the Company's ongoing intent to focus
its sales efforts more heavily towards developing the systems division's current
distribution network.
As of and for the nine months ended September 30, 1998, foreign revenues from
unaffiliated customers, operating earnings, and net identifiable assets were
$5,731,000, $685,000 and $3,127,000, respectively. As of and for the nine months
ended September 30, 1997, foreign revenues from unaffiliated customers and
operating loss were $3,157,000 and $178,000. Foreign net identifiable assets as
of December 31, 1997 totaled $2,074,000. The growth is due to significant
penetration in the European markets of sales of CD-R products. The Company's
CD-R products have been even more rapidly accepted in Europe than in the United
States and the Company's European operations continue to grow at a significant
rate. The Company sells most of its products in local currencies and is
therefore susceptible to fluctuations of currencies against the dollar.
13
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS (CONTINUED)
On August 31, 1998, the Company terminated its Bloomington, Minnesota services
operation. The Company recognized a $859,000 loss on the sale of equipment
associated with its Bloomington services operation, which is reflected in other
expense during the third quarter 1998. The Bloomington operation, which
contributed $3.9 million to revenue during the nine month period, generated an
operating loss of $84,711. Although the Company anticipates generating
increasing revenue in its systems division over the next few quarters, it is
unlikely that such revenues will offset the decrease in revenue from termination
of the Bloomington services operation.
GROSS PROFIT. Gross profit as a percent of sales was 40.6% during the third
quarter of 1998 compared to 31.8% during the same period of 1997 and was 40.7%
during the first nine months of 1998 compared to 27.5% during the same period of
1997. Systems division gross profit as a percent of sales was 50.0% during the
third quarter of 1998 compared to 45.3% during the same period of 1997 and was
51.7% during the nine month period ended September 30, 1998 compared to 42.1%
during the same period of 1997. The increase in total and systems sales during
both the three and nine month periods was due to the greater proportion of high
margin systems sales in the 1998 periods, primarily sales of CD-R equipment,
and. to manufacturing efficiencies instituted during the latter half of 1997.
Services division gross profit as a percent of sales was 5.5% during the third
quarter of 1998 compared to 13.3% during the same period of 1997 and was 12.1%
during the first nine months of 1998 compared to 11.6% during the same period in
1997. The decrease during the third quarter is due to the reduced margins
experienced in connection with the termination of its Bloomington, Minnesota
services operation on August 31, 1998. With the termination of the Bloomington
services operation and the resulting increase in the proportion of revenue from
the Company's systems division, margins should continue to improve over the next
several quarters.
OPERATING EXPENSES. Operating expenses were $2.2 million or 24.3% of revenues
during the third quarter of 1998 compared to $2.0 million or 24.1% of revenues
for the same period of 1997. Operating expenses increased from $6.6 million, or
22.1% of revenue, during the nine month period ended September 30, 1997 to $7.1
million, or 25.6% of revenue, during the same period of 1998. Most of the
increase in operating expenses related to increased sales and marketing
expenses. During 1998, the Company continued to expand its distribution network,
both domestically and internationally, for its systems products and has focused
efforts on the promotion of joint marketing campaigns with distributors and
value added resellers. These steps, combined with the increasing percentage of
overall sales from the systems division (where products are sold through
distribution) as opposed to services (where services are generated primarily
through contacts and advertisement) were primary causes of sales and marketing
expense to increase from $702,000 or 8.3% of revenue in the third quarter of
1997 to $1,273,000 or 13.8% of revenue in the third quarter of 1998 and from
$2.7 million or 9.0% of revenue during the nine months ended September 30, 1997
to $3.8 million or 13.9% of revenue during the same period of 1998. Partially
offsetting the increased sales and marketing expense was a decrease in general
and administrative expense due to the consolidation of certain administrative
duties. Research and development expense remained relatively constant during
both the three and nine month comparative periods, but decreased slightly as a
percentage of revenue because of higher sales. One of the Company's principal
objectives is to continue to reduce
14
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS (CONTINUED)
expenditures in administration as a percentage of revenue and direct more
resources to research and development activities and towards revenue producing
activities through selling and marketing expense. Accordingly, the Company
intends to continue spending in research and development and sales and
marketing. With the termination of the Bloomington services operation, the
Company anticipates that both general and administrative expenses and sales and
marketing expenses will increase as a percent of revenues.
INTEREST. The Company repaid all outstanding borrowings under its line of credit
during the fourth quarter of 1997. Furthermore, the Company's cash position at
June 30 enabled it to extinguish the outstanding balance of its Term Note with
the bank in the amount of $1.2 million and to eliminate debt associated with a
capital lease on certain CD-ROM equipment in the amount of $1.4 million. These
transactions contributed to the Company recognizing net interest income of
$23,000 during the third quarter of 1998. Net interest expense during the third
quarter of 1997 totaled $184,000. Also, in September 1998, the Company
renegotiated its existing capital leases for both the Edina and Bloomington
Minnesota facilities, resulting in operating leases and the elimination of
future interest expense. As a result of these transactions, the Company
anticipates recognizing interest income for the balance of the year.
INCOME TAXES. The provision for income taxes represents federal, state, and
foreign income taxes on earnings before income taxes. Income tax (benefit)
expense for the third quarter of 1998 amounted to $(594,000) as compared to
$30,000 for the third quarter of 1997. In accordance with FAS 109, the Company
periodically evaluates the need for a valuation allowance against its deferred
tax asset. As a result of expected continued earnings, the Company has
determined the valuation allowance is no longer necessary. The tax benefit
reduced the Company's income tax expense recognized for the three and nine
months ended September 30, 1998 by $750,000. Hereafter, the Company's operating
results will be reported on a fully taxed basis.
NET EARNINGS. The significant change in mix of revenue to higher margin product
sales in the systems division, combined with only marginal increases in
operating expense to support those sales, the gain on the capital lease
restructurings coupled with the benefit from the elimination of the valuation
allowance against its deferred tax asset netted with the loss incurred with the
termination of the Company's Bloomington services operation caused net earnings
to increase dramatically to $1.7 million in the third quarter of 1998 and $3.7
million for the nine month period ended September 30, 1998. The Company expects
to continue to emphasize and devote much of its resources to its systems
business in coming quarters.
15
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS (CONTINUED)
LIQUIDITY AND CAPITAL RESOURCES
The Company's balance sheet changed significantly during the third quarter of
1998 through (i) the sale of substantially all of the assets associated with the
Company's Bloomington, Minnesota services operation, generating proceeds of
approximately $2.1 million, of which approximately $1.3 million was used to
repay debt associated with certain equipment under a capital lease and
generating a loss on the sale of property totaling $859,000; (ii) the
renegotiations of leases previously accounted for as capital leases and the
classification of the new leases as operating leases resulting in the
elimination of debt totaling $1.5 million and generating a gain of $512,000; and
(iii) the elimination of a valuation allowance against the Company's deferred
tax asset that generated a deferred tax benefit of $750,000 during the third
quarter of 1998.
Operating activities generated $3.8 million of cash during the nine months ended
September 30, 1998. This amount consisted of $4.9 million of cash generated from
net earnings after adjustment for non-cash items. These non-cash items consisted
of depreciation and amortization, the loss on the sale of equipment (majority of
which was used in the Bloomington services operation), and the deferred income
tax benefit recognized as a result of the Company's elimination of its valuation
allowance against its deferred tax asset.
Investing activities generated $1.9 million of cash during the nine months ended
September 30, 1998, as the Company received cash proceeds from the sale of fixed
assets totaling approximately $2.1 million. A majority of these proceeds were a
result of the sale of equipment used in the Company's Bloomington services
operation. The Company invested approximately $505,000 in additional equipment
primarily for manufacturing purposes.
Financing activities consumed $2.2 million of cash primarily as a result of
monthly payments under a term note agreement with its bank and payment of
approximately $1.3 million to extinguish the debt associated with equipment held
under a capital lease. The remaining balance of the term note was paid off in
July of 1998.
The Company also maintains a revolving credit agreement with the same bank that
provides for borrowings of up to $5,000,000 based on qualifying balances of
varying assets. The Company estimates that it had available borrowing authority
of approximately $3.2 million under such line at September 30, 1998 but had no
outstanding advances under the line at that date.
The Company believes that the $4.1 million cash balance at September 30, 1998
and available borrowings under its credit line will be more than adequate to
finance operations through 1999.
16
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS (CONTINUED)
The Company believes the approach of the Year 2000 could have a material effect
on the Company's business, results of operations, and financial condition if it
were to avoid the related consequences. To mitigate these potential
consequences, the Company has identified the following areas as requiring
significant analysis: 1) manufactured products, 2) information technology
applications, 3) information technology end user supported applications, 4)
information technology infrastructure, 5) business partners - both vendors and
customers, 6) manufacturing equipment, 7) facility operations (non-information
technology systems). The Company has also identified five phases associated with
each area described above as follows: 1) awareness - educating all levels of the
Company about the importance of Year 2000 readiness; 2) assessment - identify
all electronic systems which are date-sensitive and assess which systems are not
Year 2000 ready; 3) renovation - develop a strategy to repair, replace or retire
the system; 4) validation - testing of changed programs and date files to ensure
they are Year 2000 ready; and 5) implementation - placing the renovated and
validated systems into everyday use. Currently, the Company is in the assessment
phase of its plan to prepare itself for the Year 2000. The Company plans to
complete this assessment phase by December 5, 1998. The following table
describes the Company's estimated completion date for each remaining phase:
Renovation May 1999
Validation July 1999
Implementation August 1999
Through September 30, 1998, the Company has incurred costs of approximately
$75,000 directly attributable to addressing Year 2000 issues. The Company is
unable to, at this time, estimate the remaining costs that will be incurred in
connection with its analysis of Year 2000 issues. The following are some of its
most reasonably likely worst case Year 2000 scenarios the Company has
identified: 1) The Company's manufacturing operations consist primarily of the
assembly of products from components purchased from third parties. While some
parts are stock "off the shelf" components, others are manufactured to the
Company's specifications. Although the Company believes it has identified
alternative assembly contractors for most of its subassemblies, an actual change
in such contractors, as a result of an inability to work with such contractor
due to Year 2000 consequences they face, would likely require a period of
training and testing. Accordingly, an interruption in a supply relationship or
the production capacity of one or more of such contractors could result in the
Company's inability to deliver one or more products for a period of several
months. 2) The Company sells most of its manufactured systems through a limited
number of authorized distributor wholesalers, who in turn provide warehousing,
distribution, and credit to a network of authorized value added resellers. The
interruption of product flow to one or more of these distributors due to their
inability to process date sensitive information could result in lower than
normal sales revenues. To alleviate this decrease, the Company would redirect
these sales to the remaining distributors and/or sell directly to its value
added resellers.
NEW EUROPEAN CURRENCY
On January 1, 1999, eleven of the fifteen member countries of the European
Union are scheduled to establish fixed conversion rates between their existing
currencies and the euro, a new European currency, and to adopt the euro as their
common legal currency (the "Euro Conversion"). Either the euro or a
participating country's present currency will be accepted as legal tender from
January 1, 1999 to January 1, 2002, from which date forward only the euro will
be accepted.
The Company has a fair number of customers located in European Union countries
participating in the Euro Conversion. Such customers will likely have to upgrade
or modify their computer systems and software to comply with the euro
requirements. The amount of money the Company anticipates spending in connection
with product development related to the Euro Conversion is not expected to have
a material adverse effect on the Company's results of operations or financial
condition. The Euro Conversion may also have competitive implications for the
Company's pricing and marketing strategies, which could be material in nature;
however, any such impact is not known at this time.
The Company has also begun to analyze which of its internal systems (such as
payroll, accounting and financial reporting) will need to be modified to deal
with the Euro Conversion. The Company does not currently expect the cost of such
modifications to have a material effect on the Company's results of operations
or financial condition. There is no assurance, however, that all problems
related to the Euro Conversion will be foreseen and corrected, or that no
material disruptions of the Company's business will occur.
17
PART II -- OTHER INFORMATION
Item 1. Legal Proceedings
Not Applicable.
Item 2. Changes in Securities
Not Applicable.
Item 3. Defaults Upon Senior Securities
Not Applicable.
Item 4. Submission of Matters to a Vote of Security Holders
None.
Item 5. Other Information
Not Applicable.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits:
Exhibit No. 10.1 Operating Lease dated September 1,
1998 for Facility at Edina,
Minnesota location
Exhibit No. 10.2 Operating Lease Dated September 1,
1998 for Facility at Bloomington,
Minnesota location
Exhibit No. 11.1 Calculation of Earnings Per Share.
Exhibit No. 27.1 Financial Data Schedule
Exhibit No. 27.2 Financial Data Schedule-Restated
(b) Reports on Form 8-K:
Filed July 31, 1998. Reported the disposition of
equipment associated with the Company's
Bloomington services operation. The financial
information included unaudited pro forma condensed
consolidated balance sheet as of June 30, 1998 and
unaudited pro forma condensed consolidated
statement of operations for the six months ended
June 30, 1998 and the year ended December 31,
1997.
18
SIGNATURES
In accordance with the Exchange Act, this report has been signed below by
following persons on behalf of the registrant and on the dates indicated.
RIMAGE CORPORATION
Registrant
Date: November 11, 1998 By: /s/ Bernard P. Aldrich
--------------------- ----------------------
Bernard P. Aldrich
Director, Chief Executive Officer,
and President
(Principal Executive Officer)
(Principal Financial Officer)
Date: November 11, 1998 By: /s/ Robert M. Wolf
--------------------- ------------------
Robert M. Wolf
Controller
(Principal Accounting Officer)
19