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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-Q
<TABLE>
<S> <C>
[ 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 _______________
</TABLE>
COMMISSION FILE NUMBER 0-23077
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IMAGEMAX, INC.
(Exact name of Registrant as specified in its charter)
<TABLE>
<S> <C>
PENNSYLVANIA 23-2865585
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
1100 E. HECTOR STREET, SUITE 396
CONSHOHOCKEN, PENNSYLVANIA 19428
(Address of principal executive offices) (Zip Code)
</TABLE>
(610) 832-2111
(Registrant's telephone number including area code)
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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___
Indicate the number of shares outstanding of each of the issuer's classes
of common stock as of November 6, 1998:
<TABLE>
<CAPTION>
CLASS NUMBER OF SHARES
----- ----------------
<S> <C>
Common Stock, no par value 6,352,084
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<PAGE>
IMAGEMAX, INC. AND SUBSIDIARIES
INDEX TO FORM 10-Q
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PAGE
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PART I -- FINANCIAL INFORMATION
Item 1 -- Financial Statements (Unaudited)
Consolidated Statements of Operations.................. 1
Consolidated Balance Sheets............................ 2
Consolidated Statements of Cash Flows.................. 3
Notes to Consolidated Financial Statements............. 4
Item 2 -- Management's Discussion and Analysis of
Financial Condition and Results of Operations... 7
PART II -- OTHER INFORMATION
Item 2 -- Changes in Securities and Use of Proceeds....... 14
Item 6 -- Exhibits and Reports on Form 8-K................ 14
SIGNATURES.................................................. 15
</TABLE>
<PAGE>
IMAGEMAX, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED, IN THOUSANDS EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
THREE MONTHS NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
-------------------- --------------------
1998 1997 1998 1997
------- ------- ------- -------
<S> <C> <C> <C> <C>
Revenues:
Services................................... $13,765 $ -- $36,015 $ --
Products................................... 4,149 -- 11,443 --
------- ------- ------- -------
17,914 -- 47,458 --
------- ------- ------- -------
Cost of revenues:
Services................................... 9,299 -- 24,039 --
Products................................... 2,702 -- 7,457 --
Depreciation............................... 415 -- 1,039 --
------- ------- ------- -------
12,416 -- 32,535 --
------- ------- ------- -------
Gross profit............................... 5,498 -- 14,923 --
Selling and administrative expenses.......... 5,358 163 12,686 331
Restructuring costs.......................... 925 -- 925 --
Special compensation charge.................. -- 931 -- 2,235
Amortization of intangibles.................. 484 -- 1,125 --
------- ------- ------- -------
Operating income (loss).................... (1,269) (1,094) 187 (2,566)
Interest expense (income), net............... 432 (3) 744 (4)
------- ------- ------- -------
Income (loss) before income taxes.......... (1,701) (1,091) (557) (2,562)
Income tax provision (benefit)............... (468) -- -- --
------- ------- ------- -------
Net income (loss)............................ $(1,233) $(1,091) $ (557) $(2,562)
======= ======= ======= =======
Basic and diluted net income (loss) per
share...................................... $ (0.20) $ (1.18) $ (0.09) $ (3.26)
======= ======= ======= =======
Shares used in computing basic and diluted
net income (loss) per share................ 6,321 923 5,922 787
======= ======= ======= =======
</TABLE>
The accompanying notes are an integral part of these financial statements.
1
<PAGE>
IMAGEMAX, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(UNAUDITED, IN THOUSANDS EXCEPT SHARE AMOUNTS)
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<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1998 1997
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<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents................................ $ 563 $ 1,310
Accounts receivable, net of allowance for doubtful
accounts of $575 and $375 as of September 30, 1998 and
December 31, 1997, respectively....................... 12,609 6,922
Inventories.............................................. 2,391 1,997
Prepaid expenses and other............................... 432 367
Deferred income taxes.................................... 164 160
------- -------
Total current assets.................................. 16,159 10,756
Property, plant and equipment, net......................... 7,759 4,381
Intangibles, primarily goodwill, net....................... 51,505 32,996
Other assets............................................... 99 95
------- -------
$75,522 $48,228
======= =======
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Short-term debt and current portion of long-term debt.... $19,486 $ 251
Accounts payable......................................... 4,353 2,846
Accrued expenses......................................... 5,068 3,248
Deferred revenue......................................... 1,923 1,333
Income taxes payable..................................... -- 84
------- -------
Total current liabilities............................. 30,830 7,762
------- -------
Deferred income taxes...................................... 55 59
------- -------
Long-term debt............................................. 243 342
------- -------
Other long-term liabilities................................ 50 47
------- -------
Shareholders' equity:
Preferred stock, no par value, 10,000,000 shares
authorized, none issued............................... -- --
Common stock, no par value, 40,000,000 shares authorized,
6,352,084 and 5,537,436 shares issued and outstanding
as of September 30, 1998 and December 31, 1997,
respectively.......................................... 52,463 47,580
Accumulated deficit...................................... (8,119) (7,562)
------- -------
Total shareholders' equity............................ 44,344 40,018
------- -------
$75,522 $48,228
======= =======
</TABLE>
The accompanying notes are an integral part of these financial statements.
2
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IMAGEMAX, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED, IN THOUSANDS)
<TABLE>
<CAPTION>
NINE MONTHS
ENDED SEPTEMBER 30,
--------------------
1998 1997
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<S> <C> <C>
Cash flows from operating activities:
Net income (loss)......................................... $ (557) $(2,562)
Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities
Depreciation and amortization of intangibles........... 2,164 --
Amortization of deferred financing costs............... 66 --
Special compensation charge............................ -- 2,235
Deferred income tax benefit............................ (11) --
Changes in operating assets and liabilities, excluding
effect of businesses acquired --
Accounts receivable, net............................ (2,208) --
Inventories......................................... (223) --
Prepaid expenses and other.......................... (146) --
Other assets........................................ 39 (1,987)
Accounts payable.................................... 437 --
Accrued expenses.................................... 596 1,092
Income taxes payable................................ (84) --
Deferred revenue.................................... 200 --
------- -------
Net cash provided by (used in) operating
activities..................................... 273 (1,222)
------- -------
Cash flows from investing activities:
Payments for businesses acquired, net of cash acquired.... (16,445) --
Purchases of property and equipment....................... (2,683) (5)
Increase in deferred acquisition costs.................... -- (25)
------- -------
Net cash used in investing activities............ (19,128) (30)
------- -------
Cash flows from financing activities:
Net borrowings under line of credit....................... 19,325 --
Payment of deferred financing costs....................... (693) --
Principal payments on debt and capital lease
obligations............................................ (524) --
Proceeds from issuances of preferred stock................ -- 2,552
------- -------
Net cash provided by financing activities........ 18,108 2,552
------- -------
Net increase (decrease) in cash and cash equivalents........ (747) 1,300
Cash and cash equivalents, beginning of period.............. 1,310 62
------- -------
Cash and cash equivalents, end of period.................... $ 563 $ 1,362
======= =======
Supplemental disclosures of cash flow information:
Cash paid for:
Interest............................................... $ 505 $ --
======= =======
Income taxes........................................... $ 204 $ --
======= =======
</TABLE>
The accompanying notes are an integral part of these financial statements.
3
<PAGE>
IMAGEMAX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. BACKGROUND AND BASIS OF PRESENTATION
ImageMax, Inc. ("ImageMax") was founded in November 1996 to become a
leading, national single source provider of integrated document management
solutions. On December 4, 1997, ImageMax sold 3,100,000 shares of its common
stock in an initial public offering (the "Offering") at $12 per share which
raised net proceeds to ImageMax of $30.5 million, net of offering costs of $6.7
million. Concurrent with the Offering, ImageMax began material operations with
the acquisition of 14 document management services companies (the "Founding
Companies"). ImageMax was identified as the accounting acquirer for financial
statement presentation purposes. These acquisitions were accounted for using the
purchase method of accounting.
The accompanying unaudited historical consolidated financial statements
include the accounts of ImageMax and its subsidiaries (the "Company"). All
material intercompany balances and transactions have been eliminated in
consolidation. The consolidated balance sheet as of December 31, 1997 has been
derived from the Company's consolidated financial statements that have been
audited by the Company's independent public accountants. The unaudited financial
statements have been prepared in accordance with generally accepted accounting
principles for interim financial information pursuant to rules and regulations
of the Securities and Exchange Commission. Accordingly, unaudited interim
financial statements such as those in this report allow certain information and
footnotes required by generally accepted accounting principles for year end
financial statements to be excluded. The Company believes all adjustments
necessary for a fair presentation of these interim financial statements have
been included and are of a normal and recurring nature. Interim results are not
necessarily indicative of results for a full year. These interim financial
statements should be read in conjunction with the Company's pro forma and
historical financial statements and notes thereto included in its Annual Report
on Form 10-K.
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 and
disclosure of contingent 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. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
For a description of the Company's accounting policies, refer to Note 2 of
the Notes to Consolidated Financial Statements of ImageMax, Inc. and
Subsidiaries included in the Company's Annual Report on Form 10-K.
3. RESTRUCTURING COSTS
For the three months ended September 30, 1998, the Company recorded a
restructuring charge of $925,000, primarily for severance payments related to
headcount reductions at the corporate office and facility costs associated with
business unit consolidations.
4. ACQUISITIONS
Since the Offering and prior to September 30, 1998, the Company acquired 13
additional document management services companies (the "Acquired Businesses").
The aggregate purchase price approximated $21 million plus transaction costs.
The purchases were funded through borrowings under the Company's line of credit
facility (see Note 5) and the issuance of 814,648 shares of the Company's common
stock. The excess of purchase price over net assets acquired of approximately
$19 million was allocated to goodwill.
4
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IMAGEMAX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(UNAUDITED)
4. ACQUISITIONS -- (CONTINUED)
The following unaudited pro forma information shows the results of the
Company's operations in accordance with APB No. 16, "Business Combinations," for
the nine months ended September 30, 1998 and 1997 as though the acquisitions of
the Acquired Businesses had occurred as of January 1, 1997 (in thousands, except
share data):
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<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30,
---------------------
1998 1997
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Total revenues.......................................... $54,905 $52,472
Operating income........................................ $ 775 $ 784
Net income (loss)....................................... $ (591) $ (948)
Basic and diluted net income (loss) per share........... $ (0.11) $ (0.18)
</TABLE>
The pro forma results have been prepared for comparative purposes only and
are not necessarily indicative of the actual results of operations had the
acquisitions of the Acquired Businesses taken place as of January 1, 1997, or
the results that may occur in the future. The pro forma results do not give
effect to the Offering and exclude any reductions in historical interest
expense. Furthermore, the pro forma results do not give effect to all cost
savings or incremental costs which may occur as a result of the integration and
consolidation of the Acquired Businesses.
The following table displays supplemental cash flow information for the
nine months ended September 30, 1998 of the net non-cash assets acquired
relating to Acquired Businesses (in thousands):
<TABLE>
<S> <C>
Fair value of assets acquired.............................. $24,481
Liabilities assumed........................................ (3,024)
Fair value of common stock issued.......................... (4,883)
Cash acquired.............................................. (129)
-------
Total consideration................................... $16,445
=======
</TABLE>
5. LINE OF CREDIT AND LONG-TERM OBLIGATIONS
On March 30, 1998, the Company entered into a credit facility with a bank
(the "Credit Facility"), providing a revolving line of credit of $30 million in
borrowings. Under the terms of the Credit Facility, the Company may borrow up to
$25 million to finance future acquisitions and up to $5 million for working
capital purposes. Outstanding working capital advances of up to $2 million may
be made in the form of standby letters of credit for an applicable fee. The
Credit Facility is secured by substantially all of the assets of the Company.
Borrowings under the facility bear interest at LIBOR or prime plus an applicable
margin at the option of the Company. In addition to interest and other customary
fees, the Company is obligated to remit a fee ranging from 0.2% to 0.375% per
year on unused commitments. The Credit Facility matures on December 31, 2002,
and is subject to certain financial covenants which pertain to criteria such as
minimum levels of cash flow, ratio of debt to cash flow, and ratio of fixed
charges to cash flow. The Company's available borrowing capacity under the
Credit Facility is contingent upon the Company meeting certain financial ratios
and other criteria.
As of September 30, 1998, the Company was not in compliance with certain
existing financial and other covenants under the Credit Facility. An amendment
to the Credit Facility dated November 16, 1998 cured such non-compliance,
amended certain financial covenants for future periods, reduced the amount
available under the Credit Facility to the amount ($20.1 million) outstanding on
November 6, 1998, changed the maturity date to December 1, 1999, required a $5.0
million principal repayment or commitments therefor by December 31, 1998 and
changed the interest rate and other provisions. The Company believes that it
will be able to obtain the funding needed for the $5.0 million repayment,
5
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IMAGEMAX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(UNAUDITED)
5. LINE OF CREDIT AND LONG-TERM OBLIGATIONS -- (CONTINUED)
either by additional financings or the sales of certain assets. The
Company's belief in the foregoing statement is a forward-looking statement that
involves substantial risks and uncertainties, including those set forth in
"Business-Risk Factors" in the Company's Annual Report on Form 10-K for the year
ended December 31, 1997 and risks associated with the results of the Company's
future operations and with the availability and terms of additional financing
and potential asset transactions. As a result, the Company's long-term
indebtedness under the Credit Facility has been reclassified for accounting
purposes as short-term debt.
Upon entering into the Credit Facility, the Company incurred $693,000 of
lending and other customary fees. The Company has capitalized these amounts and
included them within intangible assets at September 30, 1998. These costs will
be amortized to interest expense over the term of the Credit facility.
As of September 30, 1998, the Company had borrowed $19.3 million under the
Credit Facility. As of November 6, 1998, $20.1 million was outstanding under the
facility. The increase was attributable to working capital uses.
In connection with its acquisitions, the Company assumed debt of
approximately $928,000 representing notes payable, capital lease obligations and
other indebtedness. As of September 30, 1998, $403,000 was outstanding under
this indebtedness.
6. EARNINGS PER SHARE
The Company has presented net income (loss) per share pursuant to Statement
of Financial Accounting Standards ("SFAS") No. 128, "Earnings Per Share", which
requires dual presentation of basic and diluted earnings per share. Basic
earnings per share ("Basic EPS") is computed by dividing the net income (loss)
for the period by the weighted average number of shares of common stock
outstanding for the period. Diluted earnings per share ("Diluted EPS") is
computed by dividing net income (loss) for the period by the weighted average
number of shares of common stock and common stock equivalents outstanding during
the period. For both periods presented, common stock equivalents are not
included, as their effect is antidilutive and, as such, Basic EPS and Diluted
EPS are the same.
7. INTANGIBLE ASSETS
The Company continually evaluates whether events or circumstances have
occurred that indicate that the remaining useful lives of intangible assets
should be revised or that the remaining balance of such assets may not be
recoverable. When the Company concludes it is necessary to evaluate its long-
lived assets, including intangibles, for impairment, the Company will use an
estimate of the related undiscounted cash flow as the basis to determine whether
impairment has occurred. If such a determination indicates an impairment loss
has occurred, the Company will utilize the valuation method which measures fair
value based on the best information available under the circumstances. As of
September 30, 1998, the Company believes that no revisions of the remaining
useful lives or write-downs of intangible assets are required, however, the
Company's continuing review of underperforming business units may lead to
write-downs in the future.
8. COMPREHENSIVE INCOME
The Company has reviewed SFAS No. 130, "Reporting Comprehensive Income",
and has determined that for the nine months ended September 30, 1998 and 1997,
no items meeting the definition of comprehensive income as specified in SFAS No.
130 existed in the consolidated financial statements. As such, no disclosure is
necessary to comply with SFAS No. 130.
6
<PAGE>
PART I -- ITEM 2
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Except for the historical information contained herein, this Report on Form
10-Q contains certain forward-looking statements that involve substantial risks
and uncertainties. When used in this Report, the words "anticipate," "believe,"
"estimate," "expect", and similar expressions, as they relate to the Company or
its management, are intended to identify such forward-looking statements. The
Company's actual results, performance, or achievements could differ materially
from the results expressed in, or implied by, these forward-looking statements.
Factors that could cause or contribute to such differences include those set
forth in "Business -- Risk Factors" as disclosed in the Company's Annual Report
on Form 10-K for the year ended December 31, 1997.
The Company's revenues consist of service revenues, which are recognized as
the related services are rendered, and product revenues, which are recognized
when the products are shipped to clients. Service revenues are primarily derived
from media conversion, storage and retrieval, imaging and indexing of documents,
and the service of imaging and micrographic equipment sold. Product revenues are
derived from equipment sales and software sales and support. Cost of revenues
consists principally of the costs of products sold and wages and related
benefits, supplies, facilities and equipment expenses associated with providing
the Company's services. Selling and administrative ("S&A") expenses include
salaries and related benefits associated with the Company's executive and senior
management, marketing and selling activities (principally salaries and related
costs), and financial and other administrative expenses.
HISTORICAL RESULTS OF OPERATIONS
Three Months Ended September 30, 1998 Compared to Three Months Ended September
30, 1997, and Nine Months Ended September 30, 1998 Compared to Nine Months Ended
September 30, 1997
The results of operations for the three months ended and nine months ended
September 30, 1998, respectively, include the revenues, cost of revenues and S&A
expenses of the Founding Companies for the entire period, and for Acquired
Businesses from the date of their acquisition. ImageMax did not conduct material
operations prior to the Offering. The results of operations for the three months
ended and nine months ended September 30, 1997, respectively, include only S&A
expenses of ImageMax, principally legal and travel costs, and a special
compensation charge.
UNAUDITED PRO FORMA COMBINED, AS ADJUSTED, RESULTS OF OPERATIONS
The unaudited pro forma, as adjusted, combined Founding Companies' results
of operations for the three months ended September 30, 1997 include pro forma
combined revenues, cost of revenues and S&A expenses for the Founding Companies
as if their acquisition occurred on January 1, 1997. Such results are not
necessarily indicative of the results the Company would have obtained had these
events actually then occurred or of the Company's future results. These results
exclude the operating results of the Acquired Businesses. Management believes
the pro forma presentation is informative in analyzing the business.
Prior to their acquisition, the Founding Companies were managed as
independent private companies, and the results of their operations reflect
different tax structures (S corporations and C corporations) which have
influenced, among other things, their historical levels of owners' compensation.
Certain former owners and key employees of the Founding Companies agreed to
certain reductions in their historical compensation subsequent to their
acquisition, and these adjustments are reflected in the pro forma results of
operations.
The Company has begun and will continue to integrate the operations and
administrative functions of the Founding Companies over a period time. This
integration process may present opportunities to reduce costs through the
elimination of duplicative functions and through economies
7
<PAGE>
of scale, but will also necessitate additional costs and expenditures for
corporate management and administration, systems integration and facilities
expansion. These costs and possible cost-savings may make the comparison to past
pro forma operating results incompatible with, or not indicative of, future
performance.
<TABLE>
<CAPTION>
UNAUDITED UNAUDITED
PRO FORMA, PRO FORMA,
AS ADJUSTED AS ADJUSTED
COMBINED COMBINED
FOUNDING FOUNDING
HISTORICAL COMPANIES, HISTORICAL COMPANIES,
THREE MONTHS THREE MONTHS NINE MONTHS NINE MONTHS
ENDED ENDED ENDED ENDED
SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30,
1998 1997 1998 1997
------------- ------------- ------------- -------------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C>
Revenues:
Services............................. $13,765 $ 9,212 $36,015 $27,172
Products............................. 4,149 2,671 11,443 9,301
------- ------- ------- -------
17,914 11,883 47,458 36,473
------- ------- ------- -------
Cost of revenues:
Services............................. 9,299 5,861 24,039 17,090
Products............................. 2,702 1,668 7,457 6,160
Depreciation......................... 415 334 1,039 1,029
------- ------- ------- -------
12,416 7,863 32,535 24,279
------- ------- ------- -------
Gross profit................... 5,498 4,020 14,923 12,194
Selling and administrative expenses.... 5,358 3,316 12,686 9,008
Restructuring costs.................... 925 -- 925 --
Special compensation charge............ -- 931 -- 2,235
Amortization of intangibles............ 484 270 1,125 868
------- ------- ------- -------
Operating income (loss)........ (1,269) (497) 187 83
Interest expense (income), net......... 432 15 744 5
------- ------- ------- -------
Income (loss) before income taxes.... (1,701) (512) (557) 78
Income tax provision (benefit)......... (468) 243 -- 1,140
------- ------- ------- -------
Net income (loss)...................... $(1,233) $ (755) $ (557) $(1,062)
======= ======= ======= =======
Basic and dilutive net income (loss)
per share............................ $ (0.20) $ (0.14) $ (0.09) $ (0.20)
======= ======= ======= =======
Shares used in computing basic and
dilutive net income (loss) per
share................................ 6,321 5,457 5,922 5,457
======= ======= ======= =======
</TABLE>
RESULTS OF HISTORICAL THREE MONTHS ENDED SEPTEMBER 30, 1998 COMPARED TO PRO
FORMA COMBINED, AS ADJUSTED, THREE MONTHS ENDED SEPTEMBER 30, 1997
Total revenues. For the three months ended September 30, 1998, total
revenues increased $6.0 million, or 50.8%, as compared to the corresponding
period in 1997. This increase was derived from a service revenue increase of
49.4% and a product revenue increase of 55.3%. For the three months ended
September 30, 1998, service revenue and product revenue, respectively, comprised
76.8% and 23.2% of total revenues, as compared to 77.5% and 22.5% in the
corresponding period in 1997.
The increase in total revenues, as well as the change in mix between
service and product revenues, was primarily attributable to the Acquired
Businesses which are not included in the three months ended September 30, 1997.
When comparing the three months ended September 30, 1998 to the corresponding
period in 1997, the Founding Companies' experienced an increase in total
revenues of 2.3% and a slight change in mix (76% service revenues and 24%
product revenues).
8
<PAGE>
Gross profit. For the three months ended September 30, 1998, gross profit
increased by $1.5 million, or 36.8%, as compared to the corresponding period in
1997, while as a percentage of total revenues, gross profit declined from 33.8%
to 30.7%. The Founding Companies' experienced a decrease of $0.3 million and a
decline in gross profit percentage of 3.5%. Acquired Businesses contributed $1.8
million of gross profit at a gross profit percentage of 32.1% for the three
months ended September 30, 1998.
The Founding Companies' gross profit percentage decline was primarily due
to: (1) a shift toward lower margin equipment and supplies sales and away from
higher margin service and software sales; (2) higher service costs in the South
Carolina, Virginia, and Massachusetts business units, primarily due to
production inefficiencies; and (3) an offsetting decrease in service costs at
most other locations, particularly in the Indiana and New York business units,
due to a combination of improved media conversion efficiency and larger
off-shore data entry sales volumes.
Selling and administrative expenses. For the three months ended September
30, 1998, S&A expenses increased $2.0 million, or 61.6%, as compared to the
corresponding period in 1997. This increase is comprised of $1.0 million in
corporate expenses; $1.3 million attributable to the Acquired Businesses; and an
offsetting decrease of $0.3 million related to non-recurring transaction costs
incurred by the Founding Companies in the three months ended September 30, 1997
in connection with their acquisitions.
The increase in corporate expenses relates primarily to the staffing of the
Company's headquarters function; the integration of technology; sales
development costs; increased travel and marketing expenses; and the costs
associated with being a public company. Because the corporate office was formed
toward the end of 1997, pro forma results for 1997 exclude the bulk of corporate
overhead costs.
Restructuring costs. For the three months ended September 30, 1998, a
restructuring charge of $0.9 million was recorded, primarily for severance
payments related to headcount reductions at the corporate office and facility
costs associated with business unit consolidations. Management estimates that
the corporate office reductions will provide an annual reduction in corporate
expenses of approximately $0.8 million. The Company's review of overhead
spending and underperforming business units is ongoing and may result in another
restructure charge in the fourth quarter of 1998.
Special compensation charge. For the three months ended September 30,
1997, the Company sold a total of 72,981 shares of common stock to officers and
directors of ImageMax at prices of $1.18, $2.36, and $4.73 per share. As a
result, the Company recorded a non-recurring, non-cash compensation charge of
$0.9 million, representing the difference between the amount paid for the shares
and the deemed value for accounting purposes (based on the Offering price of
$12.00 per share).
Operating income. For the three months ended September 30, 1998, the
Company's operating loss increased $0.8 million to $1.3 million, as compared to
an operating loss of $0.5 million in the corresponding period in 1997. Excluding
the impact of corporate expenses, restructuring costs, and the special
compensation charge, operating income increased by $0.2 million for the three
months ended September 30, 1998, as compared to the corresponding period in
1997.
Interest expense, net. For the three months ended September 30, 1998, net
interest expense increased $0.4 million as compared to the corresponding period
in 1997. The increase is attributable to borrowings under the Credit Facility
and the amortization of related financing costs.
Income tax provision. For the three months ended September 30, 1998, due
to the Company's cumulative loss position, an income tax benefit of $0.5 million
was recognized, as compared to an income tax provision of $0.2 million on a loss
before taxes of $0.5 million in the corresponding period in 1997.
9
<PAGE>
RESULTS OF HISTORICAL NINE MONTHS ENDED SEPTEMBER 30, 1998 COMPARED TO PRO FORMA
COMBINED, AS ADJUSTED, NINE MONTHS ENDED SEPTEMBER 30, 1997
Total revenues. For the nine months ended September 30, 1998, total
revenues increased $11.0 million, or 30.1%, as compared to the corresponding
period in 1997. This increase was derived from a service revenue increase of
32.5% and a product revenue increase of 23.0%. For the nine months ended
September 30, 1998, service revenue and product revenue, respectively, comprised
75.9% and 24.1% of total revenues, as compared to 74.5% and 25.5% in the
corresponding period in 1997.
The increase in total revenues was comprised of $0.8 million attributable
to the Founding Companies and $10.2 million attributable to the Acquired
Businesses, which are not included in the nine months ended September 30, 1997.
The Founding Companies' increase was primarily due to: (1) increased utilization
of media conversion capacity; and (2) an increase in off-shore data entry sales
volume.
Gross profit. For the nine months ended September 30, 1998, gross profit
increased by $2.7 million, or 22.4%, as compared to the corresponding period in
1997, while as a percentage of total revenues, gross profit declined from 33.4%
to 31.4%. The Founding Companies' experienced a decrease of $0.3 million and a
decline in gross profit percentage of 1.6%. Acquired Businesses contributed $3.0
million of gross profit at a gross profit percentage of 29.7% for the nine
months ended September 30, 1998.
The Founding Companies' gross profit percentage decline was primarily due
to: (1) higher service costs in the South Carolina, Virginia, and Massachusetts
business units, primarily due to production inefficiencies; (2) an offsetting
decrease in service costs at most other locations, particularly in the
California, Indiana, and New York business units, due to a combination of
improved media conversion efficiency and larger off-shore data entry sales
volumes; and (3) an offsetting increase attributable to the increase in high
margin digital imaging software sales.
Selling and administrative expenses. For the nine months ended September
30, 1998, S&A expenses increased by $3.7 million, or 40.7%, as compared to the
corresponding period in 1997. This increase is comprised of $2.0 million in
corporate expenses; $2.3 million attributable to the Acquired Businesses; an
offsetting decrease of $0.3 million attributable to the Founding Companies; and
an offsetting decrease of $0.3 million related to non-recurring transaction
costs incurred by the Founding Companies in the nine months ended September 30,
1997 in connection with their acquisitions.
The increase in corporate expenses relates primarily to the staffing of the
Company's headquarters function; the integration of technology; sales
development costs; increased travel and marketing expenses; and the costs
associated with being a public company. The Founding Companies' decrease is
primarily attributable to administrative cost reductions at several business
units, offset by higher sales costs.
Restructuring costs. For the nine months ended September 30, 1998, a
restructuring charge of $0.9 million was recorded, primarily for severance
payments related to headcount reductions at the corporate office and facility
costs associated with business unit consolidations. Management estimates that
the corporate office reductions will provide an annual reduction in corporate
expenses of approximately $0.8 million. The Company's review of overhead
spending and underperforming business units is ongoing and may result in another
restructure charge in the fourth quarter of 1998.
Special compensation charge. For the nine months ended September 30, 1997,
the Company sold a total of 259,135 shares of Common stock to officers and
directors of ImageMax at prices of $1.18, $2.36, and $4.73 per share. As a
result, the Company recorded a non-recurring, non-cash compensation charge of
$2.2 million, representing the difference between the amount paid for the shares
and the deemed value for accounting purposes (based on the Offering price of
$12.00 per share).
Operating income. For the nine months ended September 30, 1998, operating
income increased by $0.1 million, or 125.3%, as compared to the corresponding
period in 1997. Excluding the impact of corporate expenses, restructuring costs,
and the special compensation charge, operating income
10
<PAGE>
increased by $0.8 million for the nine months ended September 30, 1998, as
compared to the corresponding period in 1997.
Interest expense, net. For the nine months ended September 30, 1998, net
interest expense increased $0.7 million as compared to the corresponding period
in 1997. The increase is attributable to borrowings under the Credit Facility
and the amortization of related financing costs.
Income tax provision. For the nine months ended September 30, 1998, due to
the Company's loss position, no income tax provision was recognized, as compared
to a tax provision of $0.9 million on income before taxes of $0.6 million in the
corresponding period in 1997.
LIQUIDITY AND CAPITAL RESOURCES
The Company's primary capital requirements relate to its working capital,
capital expenditures and historically to its acquisition program.
As of September 30, 1998, the Company had cash and cash equivalents of $0.6
million and a working capital deficiency of $14.7 million, as compared to cash
and cash equivalents of $1.3 million and working capital of $3.0 million as of
December 31, 1997. The decrease in working capital was primarily attributed to
the classification of bank debt as current as of September 30, 1998.
For the nine months ended September 30, 1998, net cash provided by
operating activities amounted to $0.3 million; net cash used in investing
activities amounted to $19.1 million; and net cash provided by financing
activities amounted to $18.1 million.
Net cash provided by operating activities represents an increase in working
capital offset by the payment of accrued expenses related to the Offering.
Net cash used in investing activities represents the Company's investments
in the Acquired Businesses and capital equipment and technology. For the nine
months ended September 30, 1998, the Company made $2.7 million of capital
expenditures, principally production equipment and computer hardware.
Net cash provided by financing activities represents borrowings of $19.3
million under the Credit Facility and payment of $0.7 million in related
financing costs, net of repayments of other indebtedness. Of the amount borrowed
under the facility, $14.8 million was used to finance the purchase of the
Acquired Businesses and $4.5 million was used for working capital purposes and
capital expenditures. As of September 30, 1998 and November 6, 1998,
respectively, $10.7 million and $9.9 million was available under the facility.
The decrease in availability from September 30 is due to borrowings for working
capital purposes.
The Company has temporarily put its acquisition program on hold, but
continues to invest in equipment and technology to meet the needs of its
operations and to improve its operating efficiency. As of September 30, 1998,
the Company was not in compliance with certain existing financial and other
covenants under the Credit Facility. An amendment to the Credit Facility dated
November 16, 1998 cured such non-compliance, amended certain financial covenants
for future periods, reduced the amount available under the Credit Facility to
the amount ($20.1 million) outstanding on November 6, 1998, changed the maturity
date to December 1, 1999, required a $5.0 million principal repayment or
commitments therefor by December 31, 1998 and changed the interest rate and
other provisions. The Company believes that it will be able to obtain the
funding needed for the $5.0 million repayment, either by additional financings
or the sales of certain assets. The Company's belief in the foregoing statement
is a forward-looking statement that involves substantial risks and
uncertainties, including those set forth in "Business-Risk Factors" in the
Company's Annual Report on Form 10-K for the year ended December 31, 1997 and
risks associated with the results of the Company's future operations and with
the availability and terms of additional financing and potential asset
transactions. As a result, the Company's long-term indebtedness under the Credit
Facility has been reclassified for accounting purposes as short-term debt.
11
<PAGE>
The Company has been notified by the Nasdaq Stock Market, Inc. that it no
longer meets the minimum net tangible asset requirements for continued listing
on the Nasdaq National Market. The Company has been granted a hearing before a
Nasdaq panel to be held on November 19, 1998 which could result in delisting,
continued listing or listing on the Nasdaq Small Cap Market. Nasdaq has informed
the Company that any potential action on the listing of its stock will be
postponed until a decision of the panel has been reached, which decision will be
issued at an indeterminate date following the date of the hearing. An
unfavorable decision could adversely effect the liquidity of the Company's
common stock.
Year 2000 Compliance
At midnight on December 31, 1999, computer systems that use two digits to
represent the year are at risk of malfunction or failure. Many systems will
continue to run, but may interpret any date in the year '00 to be prior to any
date in the year '99, posing potential date comparison problems, or may fail to
recognize that the Year 2000, unlike 1900, is a leap year. Businesses and
systems that use a four-digit format to report and process dates later than
December 31, 1999 are often denoted as "Year 2000 compliant". While many systems
have no date comparison functions and operate in a date-independent mode they
may have a date function. If full system operation and correct display of dates
subsequent to January 1, 2000 are possible, these systems may be denoted as
"Year 2000 operationally ready". Many systems and subsystems using two-digit
dates will operate smoothly until the end of their technological or economic
life without regard to the actual date. These systems are unaffected by whether
it is 2000 or 1900, make no "real-time" date comparisons and have no date
display features. At the other extreme are systems which will cease functioning
or malfunction when an unacceptable date is perceived (which in some cases could
be during 1999). The categories in which the Company faces potential exposure
are as follows:
o Business Applications -- Includes proprietary software, all client/server
and desktop hardware and software used in routine business operations
including order processing, system design and documentation, procurement,
and production.
o Infrastructure/Embedded Systems -- Includes building facilities,
production equipment and systems, control systems and instrumentation.
o Telecommunications -- Includes voice, video and data switching systems
and network components.
o Business Relationships -- Includes the supply chain for the Company's
products and service providers including banks, insurance companies,
payroll and pension plan administrators, legal, accounting and consulting
firms as well as public utilities, telecommunications providers,
transportation and overnight delivery companies and local government
services.
To date, the Company has completed Year 2000 compliance testing on certain
of its proprietary software products in accordance with standards promulgated by
the British Standards Institute ("BSI"). These standards address that: (i) no
value for current date will cause any interruption in operation; (ii) date-based
functionality must behave consistently for dates prior to, during, and after
year 2000; (iii) in all interfaces and data storage, the century in any date
must be specified either explicitly or by unambiguous algorithms or inferencing
rules; and (iv) year 2000 must be recognized as a leap year. Based on these
standards, all software tested to date is Year 2000 compliant. The Company will
continue to apply the BSI rules to other software and hardware testing.
The Company plans to modify or replace its affected systems in a manner
that will minimize any detrimental effects on operations. Toward that end, the
Company has formed a management team with active participation by
representatives of functions throughout the Company. In addition to the
Company's Year 2000 team, additional personnel within each business unit are
working to complete the assessment and remediation process. An inventory of
exposures is currently in process and operational steps necessary to deal with
each exposure will be established by year end. The Company believes it is on
schedule to complete its remediation efforts by June 30, 1999. Accordingly, the
12
<PAGE>
Company has not undertaken any contingency planning at this time. In addition to
making its own systems Year 2000 ready, the Company has and will continue to
survey its key suppliers and customers to determine the extent to which the
systems of such suppliers and customers are Year 2000 compliant and the extent
to which the Company could be affected by the failure of such third parties to
be Year 2000 compliant. The Company cannot presently estimate the impact of the
failure of such third parties to be Year 2000 compliant.
The Company recognizes that the Year 2000 problem is a serious,
enterprise-wide issue. Management believes that appropriate personnel and
resources have been assigned to this effort. Continued diligence by the members
of the Company's Year 2000 team and appropriate monitoring by and support from
senior management are intended to further enhance the Company's efforts to
ensure that its business will not be negatively impacted by any Year 2000 issues
in any material adverse respect.
The Company believes that the cost of developing an inventory of potential
Year 2000 issues within the Company, the analysis of that inventory, and
remediation of any issues found to cause potential operational problems will not
exceed $100,000. While the Company presently believes that the ultimate outcome
of any such modifications or replacements will not have a material effect on the
Company's current financial position, liquidity or results of operations,
information developed as a result of the Company's continuing inventory and
analysis of issues may result in increased cost estimates and such costs could
have a material effect on results of operations.
13
<PAGE>
PART II -- OTHER INFORMATION
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
On August 18, 1998, the Company issued a total of 58,425 shares of common
stock as partial consideration in connection with the acquisition of Varallo
Technologies, Inc. of Philadelphia, PA.
The issuance of common stock did not involve underwriters and was exempt
from registration under the Securities Act by virtue of the exemption provided
by Section 4(2) thereof for transactions not involving any public offering.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
a) Exhibits:
27 Financial Data Schedule (filed in electronic format only.)
b) Reports on Form 8-K:
None.
14
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this Report to be signed on its behalf by the
undersigned, thereunto duly authorized.
<TABLE>
<S> <C> <C>
By: /s/ ANDREW R. BACAS Chief Executive Officer November 17, 1998
----------------------
Andrew R. Bacas
By: /s/ JAMES D. BROWN Chief Financial Officer and Principal November 17, 1998
---------------------- Accounting Officer
James D. Brown
</TABLE>
15
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