UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
QUARTERLY REPORT UNDER SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarter ended March 26, 1999
Commission File Number 0-28429
ZOMAX INCORPORATED
(Name of registrant as specified in its charter)
Minnesota 41-1833089
(state or other juris- (I.R.S. Employer
diction of incorporation) Identification No.)
5353 Nathan Lane, Plymouth, MN 55442
(Address of principal executive offices) (zip code)
Registrant's telephone number, including area code:
(612) 553-9300
ZOMAX OPTICAL MEDIA, INC.
(Former Name)
Check whether the registrant (1) 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 ( )
As of April 30, 1999, the issuer had 7,271,177 shares of Common Stock, no par
value, outstanding.
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
ZOMAX INCORPORATED
Consolidated Balance Sheets
(In Thousands)
ASSETS Mar. 26, 1999 Dec. 25, 1998
(Unaudited)
------------------ -----------------
Current Assets:
Cash and cash equivalents $ 13,214 $ 25,621
Accounts receivable, net of allowance for doubtful
accounts of $3,485 and $2,035 38,660 9,872
Inventories 7,763 2,088
Deferred income taxes 3,175 1,425
Prepaid expenses and deposits 1,288 543
------------------ -----------------
Total current assets 64,100 39,549
Property and equipment, net of accumulated depreciation 37,046 18,925
of $9,114 and $5,908
Investments in unconsolidated entity 4,256 4,662
Goodwill, net 1,140 1,158
Other assets, net 31 1,130
------------------ -----------------
$ 106,573 $ 65,424
================== =================
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities:
Current portion of notes payable $ 3,921 $ 1,380
Accounts payable 22,006 5,469
Accrued expenses:
Accrued royalties 2,629 2,446
Accrued compensation 3,166 1,786
Other 6,958 566
Income taxes payable 1,143 934
------------------ -----------------
Total current liabilities 39,823 12,581
Notes payable, net of current portion 13,748 1,746
Deferred income taxes 995 1,010
Shareholders' Equity:
Common stock, no par value, 15,000 authorized 42,808 42,680
shares, 7,269 and 7,189 shares issued
and outstanding
Retained earnings 9,375 7,407
Other cumulative comprehensive income (176) -
------------------ -----------------
Total shareholders' equity 52,007 50,087
------------------ -----------------
$ 106,573 $ 65,424
================== =================
The accompanying notes are an integral part of these consolidated
balance sheets.
-2-
ZOMAX INCORPORATED
Consolidated Statements Of Operations
(Unaudited)
(In thousands, except Per Share Data)
Three Months Ended
Mar. 26, Mar. 27,
1999 1998
------- -------
Sales $ 48,235 $ 14,233
Cost of Sales 36,200 9,939
-------- --------
Gross Profit 12,035 4,294
Selling, General and
Administrative Expenses 8,554 2,712
-------- --------
Operating Income 3,481 1,582
Loss from unconsolidated entity 406 -
Interest Expense 363 117
Interest Income (72) (59)
Other expense, net 3 278
-------- --------
Income Before Income Taxes 2,781 1,246
Provision for Income Taxes 813 393
-------- --------
Net Income $ 1,968 $ 853
======== ========
PRO FORMA:
Net income before income taxes $ 1,246
Provision for income taxes 498
--------
Net income $ 748
========
Earnings Per Share
Basic $0.27 $0.14
======== ========
Diluted $0.25 $0.13
======== ========
Weighted Average Number of
Shares Outstanding
Basic 7,256 5,259
======== ========
Diluted 7,894 5,655
======== ========
The accompanying notes are an integral part of these consolidated
balance sheets.
-3-
ZOMAX INCORPORATED
Consolidated Statements of Cash Flows
(Unaudited)
(In Thousands)
For the three months ended
-----------------------------
March 26, March 27,
1999 1998
-------- --------
Operating Activities:
Net income $1,968 $853
Adjustments to reconcile net income to net
cash provided by operating activities-
Depreciation and amortization 1,854 836
Equity in losses of unconsolidated entity 406 -
Deferred income taxes - (159)
Changes in operating assets and liabilities:
Accounts receivable 4,227 (713)
Inventories 417 (876)
Prepaid expenses and deposits (609) 82
Accounts payable 9,724 1,289
Accrued expenses (5,473) 691
Income taxes payable 193 204
-------- -------
Net cash provided by operating activities 12,707 2,207
-------- -------
Investing Activities:
Purchase of property and equipment (1,207) (4,423)
Acquisitions, net of cash acquired (39,500) -
Change in other assets 1,099 38
-------- -------
Net cash used in investing activities (39,608) (4,385)
-------- -------
Financing Activities:
Issuance of common stock 128 139
Proceeds from notes payable 15,000 1,124
Repayment of notes payable (458) (702)
Bank borrowings, net - 3,000
-------- -------
Net cash provided by financing activities 14,670 3,561
-------- -------
Effect of exchange rate changes on cash and cash equivalents (176) -
Net increase (decrease) in cash (12,407) 1,383
Cash and Cash Equivalents:
Beginning of period 25,621 5,213
-------- -------
End of period $13,214 $6,596
======== =======
Supplemental Cash Flow Disclosures:
Cash paid for interest $363 $117
======== =======
Cash paid for income taxes $604 $490
======== =======
The accompanying notes are an integral part of these statements.
-4-
Zomax Incorporated
Notes to Consolidated Financial Statements
(Unaudited)
1. Basis of Presentation
The accompanying interim 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 some of the Company's business, results may not be indicative of
results for a full year. The accompanying financial statements should be read in
conjunction with the Company's Form 10-K for the year ended December 25, 1998.
Zomax Incorporated (Zomax or the Company) is a leading outsource
service provider to software publishers, computer manufacturers and other
producers of multimedia products. These outsource services include compact disc
(CD) and digital versatile disc (DVD) mastering; CD, DVD, diskette and cassette
replication; graphic design; print management; CD and DVD printing; packaging;
warehousing; inventory management; distribution and fulfillment; and returned
merchandise authorization processing services.
The Company was incorporated on February 22, 1996 and completed its
initial public common stock offering on May 10, 1996. Concurrent with the
initial public offering of common stock, the Company received all of the
operating assets and liabilities of Zomax Optical Media Limited Partnership in
exchange for 2,800,000 shares of its common stock.
On February 4, 1998, the Company acquired all of the outstanding shares
of Primary Marketing Group, Inc. (PMG), Next Generation Services (NSG), LLC and
Primary Marketing Group Limited (PMG Ireland) (collectively, the Companies) in
exchange for 800,002 shares of the Company's common stock. Prior to these
acquisitions, the Companies' business consisted of providing manufacturers'
representative services and returned merchandise processing services for the
computer industry. The Companies have provided substantially the same products
and services they provided prior to these transactions. In connection with the
transactions described above, Zomax acquired certain assets and assumed certain
liabilities, including a lease obligation from an unrelated third party for $1.1
million. The acquisitions of the Companies have been accounted for as a pooling
of interests and, accordingly, the consolidated financial statements for all
periods presented have been restated to reflect the effects of the transactions.
5
On January 7, 1999, the Company acquired the businesses and certain
net assets of Kao Corporation in the United States, Canada, Ireland and Germany.
The purchase price for the business, net assets and net working capital acquired
was $37.5 million plus transaction costs, subject to certain post closing
adjustments. The assets and businesses acquired by the Company were used in the
manufacturing and sale of CDs and related businesses, and the Company intends to
continue to use the assets and businesses in a similar manner. The acquisition
has been accounted for using the purchase method of accounting and, accordingly
the purchase price has been allocated to net assets acquired based on their
preliminary estimated fair values.
Pro forma consolidated results of operations as if the acquisitions had taken
place at the beginning of 1998 are shown below (in thousands, except per share
data). The pro forma results for 1999 were not materially different as the
acquisition closed effective January 1, 1999.
Three Months Ended
March 27, 1998
--------------
Net Sales $67,733
Net Income $1,418
Earnings per Share:
Basic $.27
Diluted $.25
2. Credit Facilities
On January 7, 1999, the Company entered into a $15 million term loan
facility which was used to finance the purchase of the businesses and assets of
the Kao Corporation. A $25 million revolving line of credit facility was also
established. The term loan facility requires quarterly principal payments on a
straight-line amortization schedule. Interest rate is at the lower of prime plus
.75% or LIBOR rate plus 2.25%. The revolving line-of-credit facility provides
for borrowings based on a formula using eligible accounts receivable and
inventories with interest rates of prime plus .5% or LIBOR plus 2.0%. Both
facilities have five-year terms and contain certain financial covenants.
3. Recently Issued Accounting Standards
The Company adopted SFAS No. 130, "Reporting Comprehensive Income."
SFAS No. 130 establishes standards for reporting in the financial statements all
changes in equity during a period, except those resulting from investments by
and distributions to owners. For the Company, comprehensive income represents
net income adjusted for cumulative foreign currency translation adjustments.
Comprehensive loss as defined by SFAS No. 130, was $176,000 for the three month
period ended March 26, 1999.
6
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
General
The Company is a leading outsource service provider to software
publishers, computer manufacturers and other producers of multimedia products.
These services include CD and DVD mastering; CD, diskette and cassette
replication; graphic design; print management; CD and DVD printing; packaging;
warehousing; inventory management; distribution and fulfillment; and RMA
processing services. The Company records sales to 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 written customer instructions.
The multimedia services industry 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 has not been
significant and is not a meaningful indicator of future financial results.
On February 4, 1998, PMG, NGS and PMG Ireland were merged with and into
ZSI. As a result of these transactions, all ownership interests in the acquired
companies were exchanged for 800,002 shares of the Company's Common Stock. Prior
to these transactions, the businesses of PMG, NGS and PMG Ireland consisted of
providing manufacturer's representative services and RMA processing services to
the computer industry. PMG, NGS and PMG Ireland operated their respective
businesses from facilities located in and around San Jose, California; Boston,
Massachusetts; and Dublin, Ireland. In connection with the transactions
described above, the Company acquired certain assets and assumed certain
liabilities from an unrelated third party for $1.1 million. The acquisitions of
PMG, NGS and PMG Ireland were accounted for using the pooling-of-interests
method of accounting, and, accordingly, all periods presented have been restated
to reflect the effects of these transactions.
On January 7, 1999, the Company acquired certain businesses and assets
of Kao Corporation located in the United States, Canada, Ireland and Germany.
The purchase price for the businesses and assets acquired was $37.5 million plus
transaction costs, subject to certain post-closing adjustments. The assets and
businesses acquired by the Company were used in the manufacturing and sale of
CDs and related businesses, and the Company intends to continue to use the
assets and businesses in a similar manner. The Company financed the acquisition
through $22.5 million of its own funds and a $15.0 million term loan facility.
The acquisition has been accounted for using the purchase method of accounting
and accordingly, the purchase price has been allocated to net assets acquired
based on their preliminary estimated fair values.
7
Results of Operations
For the Thirteen Weeks Ended March 26, 1999 and March 27, 1998
Sales. The Company's sales were $ 48.2 million for the first quarter of
1999, an increase of 239%, from $14.2 million in the first quarter of 1998. The
increase in sales is primarily related to the Kao acquisition. The increase in
total sales resulted from a 393% increase in CD related sales and a 264%
increase in diskette sales. These increases were partially offset by a 55%
decrease in audio cassette sales and a 69% decrease in RMA sales.
Cost of sales. Cost of sales as a percentage of sales was 75.0% and
69.8% for 1999 and 1998, respectively. The increase in cost of sales percentage
was due to the acquired Kao sites. Historically, Kao operations have operated at
a higher cost of sales percentage as compared to the Company's prior operating
results.
Selling, general and administrative expense. Selling, general and
administrative expenses as a percentage of sales were 17.7% for the first
quarter of 1999 and 19.1% for the first quarter of 1998. The dollar increase in
the first quarter of 1999 resulted primarily from the Kao acquisition. Selling,
general and administrative expenses have decreased as a percentage of sales in
1999 as the Company has achieved operational efficiencies with the Kao
acquisition.
Equity in losses of unconsolidated entity. In the fourth quarter of
1998, the Company purchased a one-third equity interest in Chumbo Holdings
Corporation an Internet based reseller of software. The Company accounts for
this investment using the equity method accounting and, accordingly, recognized
a loss of $406,000 in the first quarter of 1999, representing its share of the
Chumbo net loss and the amortization of excess purchase price over the fair
value of the underlying net assets acquired.
Interest income and expense. Interest income was $72,000 and $59,000
for the first quarter of 1999 and 1998, respectively. Interest expense was
$363,000 and $117,000 for the first quarter of 1999 and 1998, respectively.
Interest expense increased with the borrowings used to finance the acquisition
of Kao Corporation in January 1999.
Other expenses, net. In the first quarter of 1998, the Company incurred
expenses totaling $278,000 related to the acquisition of PMG, NGS and PMG
Ireland.
Provision for income taxes. The effective income tax rate for the first
quarter of 1999 was 29.2% and the pro forma effective income tax rate for the
first quarter of 1998 was 40.0%. The decrease in the effective income tax rate
in 1999 is due to lower tax rates on income generated in Ireland.
8
Liquidity and Capital Resources
As of March 26, 1999, the Company had working capital of $24.3 million,
compared to working capital of $27.0 million as of December 25, 1998. The
decrease in working capital was primarily due to the financing of the Kao
acquisition.
As of March 26, 1999, the Company had cash totaling $13.2 million. Cash
generated from operating activities for the first three months of 1999 was $12.7
compared to $2.2 million during the first three months of 1998. The increase in
operating cash flow is primarily due to the acquisition of the Kao businesses
and growth of the Company's existing business.
Cash used in investing activities during the first three months of 1999
was $39.6 million compared to $4.4 million in the first three months of 1998. In
1999, the Company used $39.5 million to purchase the businesses and net assets
of Kao Corporation. In 1998, the Company used cash primarily to purchase
property and equipment including the construction of a new CD facility in San
Jose and new DVD equipment.
During the first three months of 1998, the Company acquired certain
liabilities from an unrelated third party in exchange for a short-term note in
the principal amount of $1.1 million. During the first three months of 1999, the
Company repaid notes payable totaling $457,000 as compared to $702,000 in 1998.
In January, 1999, the Company entered into a $15 million term loan
facility and a $25 million revolving line of credit facility. The term loan
facility requires quarterly principal payments on a straight-line amortization
schedule. Interest rate is at the lower of prime plus .75% or LIBOR rate plus
2.25%. The revolving line-of-credit facility provides for borrowings based on a
formula using eligible accounts receivable and inventories with interest rates
of prime plus .5% or LIBOR plus 2.0%. Both facilities have five-year terms and
contain financial covenants. There is no borrowings outstanding under the
revolving line of credit facility as of March 26, 1999.
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.
Year 2000 Compliance
The Company is currently working to fully assess and resolve the
potential impact of the Year 2000 issue on both the information technology
("IT") and non-IT systems throughout its U.S. and European operations. The Year
2000 issue is the result of computer programs being written using two digits
(rather than four) to define the applicable year. Any systems that have date
sensitive software may recognize a date using "00" as the year 1900 rather than
the year 2000, which could result in system problems or failure.
9
Zomax has developed a Year 2000 plan, the objective of which is to
determine and assess the risks of the Year 2000 issue, and plan and institute
corrective actions to minimize those risks. The Company's goal is to ensure
current business operations will continue to function accurately with no
material disruption into and beyond year 2000. The Company has formed an
internal review team, and has engaged with an independent Year 2000 consulting
firm to provide advice regarding the Company's Year 2000 compliance. The Year
2000 plan addresses (a) information technology such as software and hardware,
(b) non-information system or embedded technology contained in manufacturing
equipment and facilities, and (c) readiness of key third party suppliers.
Zomax implemented a new enterprise wide financial and information
system in 1997 to meet its growing business needs. The Company also implemented
this financial and information system in new businesses acquired in 1997 and
1998 and has developed a schedule for implementation of its newly acquired Kao
facilities in 1999. The new business systems are represented to be Year 2000
compliant by the respective vendors and the Company have performed initial tests
confirming the compliance. The Company has identified embedded technology in its
manufacturing equipment and facilities and is testing such technology and
contacting vendors regarding the Year 2000 readiness of such technology. The
Company is also in the process of contacting material suppliers and customers to
address their exposure to Year 2000 related risks.
The Company has substantially completed its assessment of Year 2000
compliance with regard to embedded technology and material suppliers and
customers as of March 26, 1999. During the balance of 1999, the Company will
work to remedy any Year 2000 problems identified and formulate contingency
plans, if appropriate, to reduce risks and exposure to Year 2000 related issues.
Through March 26, 1999, costs associated with the Company's Year 2000
plan have not been material. The costs of addressing Year 2000 potential
problems are not currently expected to have a material adverse impact on the
financial position, results of operations or cash flows of the business in the
future. However, the costs relating to the resolution of Year 2000 compliance
issues cannot be fully estimated at this time. The Company has not yet formed
expectations regarding a most likely worst case scenario for the Year 2000 but
expects to do so upon completing its assessment of embedded technology and the
readiness of material vendors and customers. If significant customers or vendors
identify Year 2000 issues in the future and fail to resolve such issues in a
timely manner, such failure could result in a material adverse impact on the
Company's business or results of operations.
Forward-Looking Statements
This filing contains forward-looking statements related to the adequacy
of the Company's cash reserves and working capital to fund its operations for
the foreseeable future and address the Year 2000 issues. Such forward-looking
statements involve risks and uncertainties which could cause actual results to
10
differ materially from those projected. The factors which could materially
impact the Company's ability to finance its operations are primarily a
substantial reduction in sales and profitability caused by one or more of the
following: unforeseen increase in expenses, significant increase in competition
and reduction in prices, loss of strength in the CD market, introduction of new
technologies and worsening of overall economic conditions. The Company's ability
to address the Year 2000 issue will depend on the ability of the Company and its
vendors and customer to replace, modify and/or upgrade computer technology,
which cannot be assured.
11
PART II - OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits. The following exhibits are included with the Form 10-Q
Exhibit 3.1 Articles of Incorporation, as amended
Exhibit 27 Financial Data Schedule (included in electronic version only)
(b) Reports on Form 8-K.
The Company filed a Form 8-K dated January 7, 1999 to report
the acquisition of businesses and assets of Kao Corporation, which Form
8-K was subsequently amended to file required financial statements.
12
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: May 5, 1999 By /s/ James T. Anderson
James T. Anderson, President and
Chief Executive Officer (principal
executive officer)
By /s/ James E. Flaherty
James E. Flaherty
Chief Financial Officer (principal
financial and accounting officer)
13
Zomax Incorporated
Form 10-Q Quarterly Report
For the Quarter Ended March 26, 1999
EXHIBIT INDEX
Exhibit
Number Item
3.1 Articles of Incorporation, as amended
27 Financial Data Schedule (included in electronic version only)
14