**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, DC 20549**

 

**FORM 10-K**

 

**ý****   Annual Report Pursuant to Section 13 or 15(d)of the Securities Exchange Act of 1934**

 

**for thefiscal year ended December 27, 2002**

 

**or**

 

**o****     Transition Report Under Section 13 or 15(d)of the Securities Exchange Act of 1934**

 

**for thetransition period from           to          .**

 

**Commission FileNumber:  0-28426**

 

**ZOMAX INCORPORATED**

(Exact name of registrant asspecified in its charter)

 

| **Minnesota**                                                   |   | **No. 41-1833089**                 |
|-----------------------------------------------------------------|--------|------------------------------------|
| (State or Other Jurisdiction of  Incorporation or Organization) |   | (IRS Employer  Identification No.) |
|                                                            |   |                               |
| **5353 Nathan Lane, Plymouth, MN 55442**                        |
| (Address of Principal Executive Offices)                        |
|                                                            |
| Registrant’s telephone number **(763)  553-9300**          |
|                                                            |
| Securities registered under Section 12(b) of the Exchange Act:  |
| **None**                                                        |
|                                                            |
| Securities registered under Section 12(g) of the Exchange Act:  |
| **Common Stock, no par value**                                  |

 

Indicate by check mark whether the registrant (1) filed all reportsrequired to be filed by Section 13 or 15(d) of the Exchange Act during the past12 months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements for thepast 90 days.  YES ý  NO o

 

Indicate by check mark if there is no disclosure of delinquent filers inresponse to Item 405 of Regulation S-K contained in this form, and nodisclosure will be contained, to the best of registrant’s knowledge, indefinitive proxy or information statements incorporated by reference in PartIII of this Form 10-K or any amendment to this Form 10-K. o

 

Indicate by checkmark whether the registrant is an accelerated filer (as defined in Exchange ActRule 12b-2). YES ý  NO o

 

The aggregate market value of the voting stock held by non-affiliateswas $116,821,240 based on the closing sale price of the Company’s Common Stockas reported on the NASDAQ Stock Market on June 28, 2002.

 

The number of shares outstanding of the registrant’s common stock as ofMarch 10, 2003 was 32,426,657 shares.

 

**DOCUMENTSINCORPORATED BY REFERENCE**

 

Portions of the Proxy Statement for the Annual Meeting of Shareholdersto be held April 30, 2003 are incorporated by reference into Part III of thisreport.

 

 

**PART I**

 

**ITEM 1.  BUSINESS**

 

**General**

 

ZomaxIncorporated (Zomax or the Company) helps companies more efficiently bringtheir products and content to market worldwide.  The Company’s outsourcing solutions enhance the process ofsourcing, production, and fulfillment through a modular suite of supply chainservices.  Through operational excellenceand consistent execution, the Company’s goal is to provide superior and lastingvalue for its customers.

 

        Established in 1993, theCompany has approximately 1,150 full -time employees and operates twelvefacilities worldwide in the United States, Canada, Mexico, and Ireland.  The Company has demonstrated an ability toprovide consistently high quality products and services in a just-in-time (JIT)model.  Zomax continues to expand itsgeographic presence and supply chain services offering by building andacquiring additional manufacturing, customer contact, distribution, and returnsmanagement capabilities.

 

Zomaxmarkets and sells outsourced supply chain services to industry leadingcustomers in a variety of markets. Zomax believes its expertise in integrating and managing critical supplychain functions allows its customers to focus on their core competencies,reduce costs, accelerate time to market, decrease inventory obsolescence, andimprove response to customer demand in a variety of geographic regions.

 

Whether Zomax isfulfilling orders directly to its customer’s end-users or channel partners, or JIT to the customer’s productionfacilities, the Company’s goal is to help customers deliver “The Perfect Order”— that means the right product, the right place, the right time, at the rightvalue.

 

**Industry**

 

Thesupply chain outsourcing services industry manages a vast array of products andcontent for a wide range of markets.  Whether it is IT hardware, IT software, consumer electronics, automotiveparts, pharmaceuticals or other products, organizations are increasinglyturning to experienced outsourcing partners to help deliver their products tomarket more efficiently.  The need forfaster time to market, quicker inventory turns, greater focus on corecompetencies and lower costs have driven the growth of supply chainoutsourcing.

 

Thesame factors that have led to the trend of more outsourcing are drivingconsolidation in the industry, as many small local and regional serviceproviders find it increasingly difficult to access the capital required toinvest in new equipment and additional value-added services.  Consolidation of the industry continues asmarginal companies struggle to compete during the economic downturn.

 

Zomax’ strong balancesheet, end-to-end solutions, consistent execution and solid reputation in theindustry continue to be a competitive advantage and have positioned Zomax tocontinue to capture market share as the economy improves.

 

**Services**

 

        The Company’s outsourcingsolutions enhance the process of sourcing, production, and fulfillment througha modular suite of supply chain services that enable customers to select thecombination of services that best meet their unique needs.        Zomax’ services are delivered fromtwelve multifunctional facilities across North America, Mexico, Canada, andIreland and include the following:

 

•   CustomerContact Services – Integrated order management, e-commerce, and teleservicesfor Zomax clients and their customers to support revenue growth.

 

•   SourcingServices – Global procurement and material management services to decreasecosts and ensure quality.  Examplesinclude a range of technology, packaging, print, displays, manuals, and otherproduct related items.

 

•   ProductionServices – Media replication, manufacturing, and print services for consistentproducts and scalable supply.  IncludesCD/DVD manufacturing with ISO standard processes for high quality and efficientproduction.

 

•   Assembly/KittingServices – JIT services optimize inventory levels, product mix, and volume tomeet customer demand.  Zomax manages theentire process and supports various assembly models, inventory managementprocesses and near site or remote site locations.

 

•   FulfillmentServices – Physical or electronic distribution to ensure timely delivery to thechannel, retailer or end-customer. Includes a range of warehousing services, EDI capabilities to majorretailers, and logistics management services.

 

•   ReturnsManagement Services – Reverse logistics services ranging from damaged productto finished goods returns.

 

In 2002, Zomaxalso completed a strategic partnership with Intraware to incorporate ElectronicSoftware Delivery (ESD) as part of the solutions offered in 2003 andbeyond.  The need for faster productdelivery and lower costs are driving the demand for these types of serviceswhich augment Zomax’ traditional service offering.

 

With the breadthand modularity of Zomax’ services, customers can choose to outsource some orall of their supply chain functions in bringing their products and content tomarket.  In all cases, Zomax’ accountand project management organizations maintain regular contact with customersand coordinate all services provided.

 

**Customers,  Markets and Sales**

 

Zomaxmarkets and sells outsourced supply chain services to a variety ofcustomers.  Historically, the Companyhas derived the majority of its revenue from customers in the computer hardwaremanufacturing and software publishing industries.  The Company currently services a broad customer base in theseindustry segments including Microsoft®, Dell®, AOL®, Logitech®, Apple® andHewlett Packard®.

 

In late 2002, Zomaxincreased the size of its sales and marketing staff to continue to expand inthe industries it serves and penetrate into new markets.  In 2003,the company will focus on additional expansion in industries that have thecommon and growing need to bring large volumes of products and/or content tomarket more efficiently.  These includeindustries where Zomax has experience and proven customer examples includingconsumer electronics, marketing services, and corporate information services.

 

Zomax employs a directsales staff that is responsible for maintaining relationships with existingcustomers and developing new business relationships.  The Company also employs a project management staff that isresponsible for ensuring that each order is processed on a timely basis, allrequired support materials are in place, and desired quality levels areachieved.  Each customer account isassigned one or more project managers to provide daily contact with thecustomer, coordinate the purchase and manufacture of all necessary materials,adapt to order changes, and generally act as liaison with the customer.

 

Zomaxis also an authorized replicator of Microsoft, which allows the Company toreplicate Microsoft products for any authorized distributor.  The Company is also authorized to performfulfillment services for Microsoft licensed OEMs.  These arrangements are pursuant to annual agreements withMicrosoft.  The Company expects, butcannot guarantee, that these agreements will be renewed.  The Company also provides replication,telemarketing and fulfillment services for certain Microsoft programs under atwo-year Master Services Agreement, which expires in June 2003.  The Company expects, but cannot guarantee,that this agreement will be renewed. During 2002, 2001, and 2000, revenues derived from all of Microsoftactivities accounted for 20%, 35%, and 40%, respectively, of the Company’sconsolidated revenue.  This downwardtrend is primarily due to the maturing nature of these programs.

 

Financialinformation about the Company’s geographic segments is presented in Note 12 tothe Consolidated Financial Statements included in Item 8 of this Form 10-K.

 

**Competition**

 

Thesupply chain service industry is highly competitive and is experiencingconsolidation.  Zomax competes primarilywith supply chain service providers and, to a lesser extent, with mediareplicators and Third Party Logistics companies.  Each of these producers generally services a defined set ofcustomer needs.

 

•   *Supply ChainOutsourced Service Providers*. Participants in this segment include companies such as Zomax, Arvato (adivision of Bertlesman AG), Cinram International Inc., Startek Corporation,SalesLink, Modus Media International, and Metatec Corporation.  Independent service providers generally havethe ability to handle large volume requirements and have varying degrees ofservice capability.

 

•   *MediaReplicators*.  Several mediareplicators have expanded their solutions to include additional supply chainservices such as distribution or returns management.  Many companies in this segment do not have complete solutions incomparison to Zomax.  This includesCustomer Contact Services and ESD.

 

•   *Third PartyLogistics Organizations*. Zomax competes with some participants in this market.  Core services for these companies aredistribution and logistics but they have recently expanded their services toprovide a broader set of supply chain capabilities.

 

•   *Printing andPackaging Firms*. Organizations such as Banta, IPC and Q-Media started in the printing orpackaging market and expanded their services to include other aspects of thesupply chain.  These organizations lackkey capabilities such as media replication and Contact Center Services.  Some of these companies are also partners ofZomax and provide printing and packaging services for customers.

 

Many of the Company’s national and regional competitors are larger andmore established with greater financial and other resources than the Company,particularly as consolidation in the industry continues.  As a result, such competitors may be able torespond more quickly to market changes or to devote greater resources to themanufacture, promotion, and sale of their products and services than theCompany.  Alternatively, othercompetitors have weak financial status in comparison to Zomax.  As financial strength becomes a key decisionmaking component for customers, Zomax’ financial position becomes an advantageover these competitors.

 

The Company believes that it competes favorably with its competitorswith respect to quality, service, reliability, price, manufacturing capacity,and timely delivery of product, the principal competitive factors in thisindustry.  The Company also believesthat customers are willing to incur additional costs for extra services.  As such, to enhance its competitiveposition, the Company offers a full range of value-added services to customersincluding sourcing, production, fulfillment, returns management, and a range ofcontact center services.

 

**Fiscal Year End**

 

TheCompany’s fiscal year ends on the last Friday of the calendar year.  Unless otherwise indicated, the fiscal yearsended December 27, 2002, December 28, 2001, and December 29, 2000 are referredto herein as 2002, 2001, and 2000, respectively.

 

**Backlog**

 

The Company’s business is characterized by short leadtimes for customer orders.  For thisreason and because of the timing of orders, delivery intervals, and thepossibility of customer changes in quantities and delivery schedules, theCompany’s backlog as of any particular date is not a meaningful indicator offuture financial results.

 

**Proprietary Rights**

 

Zomax, like most other CD and DVD manufacturers, uses patentedtechnology primarily under nonexclusive licenses.  These licenses generally provide for the payment of royaltiesbased upon the number, size and use of CDs and DVDs sold and terminate eitherupon the expiration of the patents being licensed or on a certain date.  If the Company is unable to maintain theselicenses, it could have a material adverse effect on the Company’s results ofoperations.

 

**Seasonality**

 

The demand for CDs and related services is seasonal, with demandincreasing in the fall due to the new school year and holiday seasonpurchases.  This seasonality couldresult in significant quarterly variations in financial results, with fourthquarter generally being the strongest in terms of revenue.

 

**Employees**

 

The Company has approximately 1,150 full-time employees and hiresadditional employees on a temporary basis to perform manufacturing-relatedservices as the need arises.  TheCompany believes that its relations with its employees are good.  None of the Company’s employees is coveredby a collective bargaining agreement.

 

**Available Information**

 

See the Company’sweb site at www.zomax.com for additional information regarding the Company andits products and services.  All reportsfiled electronically by Zomax with the Securities and Exchange Commission(“SEC”), including its annual reports on Form 10-K, quarterly reports on Form10-Q, current reports on Form 8-K, proxy and information statements, otherinformation and amendments to those reports filed (if applicable), areavailable by contacting the Company’s Investor Relations atinvestorrelations@zomax.com or (763) 553-9300. These filings are also accessible on the SEC’s web site atwww.sec.gov.  The public may read andcopy any materials filed by the Company with the SEC at the SEC’s PublicReference Room at 450 Fifth Street, NW, Washington, DC 20549.  The public may obtain information for thePublic Reference Room by calling the SEC at 1-800-SEC-0330.

 

**Cautionary Statement for Purposes ofthe “Safe Harbor” Provisions of the Private Securities Litigation Reform Act of1995**

 

The foregoing discussion and the discussion containedin Item 7 of this Form 10-K contain various “forward-looking statements” withinthe meaning of Section 27A of the Securities Act of 1933, as amended, andSection 21E of the Securities Exchange Act of 1934, as amended.  Forward-looking statements are based oncurrent expectations or beliefs concerning future events.  Such statements can be identified by the useof terminology such as “anticipate,” “believe,” “estimate,” “expect,” “intend,”“may,” “could,” “possible,” “plan,” “project,” “will,” “forecast” and similarwords or expressions.  The Company’sforward-looking statements generally relate to its growth strategy, financialresults, sales efforts, acquisition plans and cash requirements.  There are certain important factors thatcould cause results to differ materially from those anticipated by some of thestatements made herein.  Investors arecautioned that all forward-looking statements involve risks and uncertainties.

 

Although it is not possible to foresee all of thefactors that may cause actual results to differ from the Company’sforward-looking statements, such factors include, among others:

 

•      the ability of the Company toeffectively compete in an intensely competitive environment;

•      the Company’s dependence on asmall number of key customers in the personal computer hardware and softwareindustries;

•      the ability of the Company tomaintain its status as a Microsoft Authorized Replicator;

•      the ability of the Company torespond to declining market demand and unit prices resulting from the economicslowdown in the personal computer hardware and software industries;

•      the ability of the Company tomeet its customers’ increasing security requirements regarding theirintellectual property, inventory and other assets;

•      the Company’s ability toattract and retain a skilled and qualified workforce in diverse locations atacceptable costs;

•      risks associated withestablishing and maintaining international operations;

•      the Company’s dependence onits ability to maintain licenses to use patented technology in itsmanufacturing operations; and

•      the development and rate ofmarket acceptance of new electronic media products or technologies, includingDVD and electronic software downloading services, and other media storagetechniques.

 

The Company undertakes noobligation to update any forward-looking statements, but investors are advisedto consult any further disclosures by the Company on this subject in itsfilings with the Securities and Exchange Commission, especially on Forms 10-K,10-Q and 8-K (if any), in which the Company discusses in more detail variousimportant factors that could cause actual results to differ from expected orhistorical results.  It is not possibleto foresee or identify all such factors. As such, investors should not consider any list of such factors to be anexhaustive statement of all risks, uncertainties or potentially inaccurateassumptions.

 

**ITEM 2.  PROPERTIES**

 

The Company leasesfacilities in the U.S. and Europe andowns property in Canada.  The followingtable sets forth information about the Company’s facilities.  Management believes its facilities areadequate for the Company for the foreseeable future.

 
| **Location**            |   | **Approximate Square Feet** |   | **Lease****Expiration** |   | **Activities**                                                                                                                                                 |
|-------------------------|--------|-----------------------------|--------|-------------------------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------|
| Arnprior,  Canada       |   | 158,000                     |   | Owned                   |   | Print  management, mastering, replication, printing, packaging, warehousing and  distribution.                                                                 |
|                    |   |                        |   |                    |   |                                                                                                                                                           |
| Concord,  California    |   | 30,000                      |   | 2008                    |   | Customer  contact center                                                                                                                                       |
|                    |   |                        |   |                    |   |                                                                                                                                                           |
| Dublin,  Ireland        |   | 139,000                     |   | 2016 - 2028             | (1)    | Customer  contact center, print management, mastering, replication, printing,  packaging, warehousing, fulfillment, distribution and RMA processing            |
|                    |   |                        |   |                    |   |                                                                                                                                                           |
| Fremont,  California    |   | 153,000                     |   | 2006                    |   | Print  management, mastering, replication, printing, packaging, warehousing,  fulfillment and distribution.                                                    |
|                    |   |                        |   |                    |   |                                                                                                                                                           |
| Indianapolis,  Indiana  |   | 91,000                      |   | 2003                    |   | Packaging,  fulfillment, distribution and RMA processing                                                                                                       |
|                    |   |                        |   |                    |   |                                                                                                                                                           |
| Minneapolis,  Minnesota |   | 155,000                     |   | 2003 - 2004             | (2)    | Graphic  design, print management, mastering, replication, printing, packaging,  warehousing, fulfillment, distribution, RMA processing and Corporate offices. |

 

----

(1)   Includes leases for two different sites.

(2)   Includes leases for three sites, one of which is a lease for82,000 square feet, with Nathan Lane Partnership LLP (described below), whichexpires in 2003 with an option to extend for an additional term of three years.

 

TheCompany leases a facility comprised of manufacturing, office and warehousespace in Minneapolis, Minnesota from Nathan Lane Limited Partnership, aMinnesota limited liability partnership of which Mr. Phillip T. Levin, adirector of Zomax, owns a one-third interest. Pursuant to this lease, as amended, the Company leases approximately82,000 square feet at a base rent of $7.93 per net rentable square foot perannum.  The Company is also obligated topay all taxes and operating expenses of this facility.

 

**ITEM 3.  LEGAL PROCEEDINGS**

 

On February 21,2002, the Company signed an Asset Purchase Agreement (“APA”) to purchase thebusiness and substantially all the assets of Software Logistics Corporation(“iLogistix”).  iLogistix providessupply chain services to technology companies and has operating facilities inthe United States, Netherlands, Singapore, Taiwan, Mexico, Ireland and Brazil.

 

The closing of thetransaction was scheduled for February 28, 2002, subject to significant closingconditions.  As of March 19, 2002,certain significant conditions to closing were not satisfied by iLogistix;therefore, the Company terminated the APA. The Company incurred and expensed transaction costs of $1.3 million, netof tax, or approximately $.04 cents per share. The Company also deposited $3.9 million in an escrow account, which theCompany believes iLogistix is required to refund with interest.  This escrow is recorded in other currentassets in the Company’s consolidated balance sheet.

 

On March 19, 2002,iLogistix filed a lawsuit in a United States Bankruptcy Court for specificperformance under the APA and for unspecifieddamages and declaratory relief. Subsequently, iLogistix dismissed its claim for specificperformance.  The Company has submittedan answer to iLogistix’ legal action averring that the APA had been properlyterminated and that the legal action by iLogistix is without merit.

 

On July 11, 2002,iLogistix sold substantially all of its assets to CMGI for consideration inexcess of the amount under the Zomax contract. Zomax has demanded a return of the $3.9 million deposit, accruedinterest, payment of certain legal fees and payment of the break-up fee.

 

On or about October 28, 2002the Bankruptcy Court granted Zomax authority to file a counterclaim in theadversary proceeding, including, in particular, claims for a break-up fee andattorney’s fees.  On December 26, 2002,Zomax filed a motion for summary judgment in the case with the Court.

 

On March 13, 2003, Zomax and iLogistix reached a settlement whereby the$3.9 million deposit, plus all accrued interest thereon, will be paid to Zomax,and both parties will drop all other claims and actions arising out of theAPA.  This settlement agreement will bepresented to the Court at a hearing scheduled for April 3, 2003.  If, as expected, the settlement agreement isapproved by the Court, the deposit plus accrued interest would be returned soonthereafter.

 

The Companypreviously announced that the Securities and Exchange Commission is conductinga preliminary investigation into the trading of Zomax securities byinsiders.  The Company is cooperatingwith the SEC in its investigation.  TheSEC has not indicated when it expects the investigation to be concluded.

 

The Company isinvolved in certain other claims arising in the normal course of business.  In management’s opinion, the finalresolution of these claims should not have a material adverse effect on theCompany’s financial position or results from operations.

 

**ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS**

 

No matters were submitted to a vote of security holders during thefourth quarter of  2002.

 

**PART II**

 

**ITEM 5.  MARKET FOR REGISTRANT’S COMMON EQUITY AND RELATED STOCKHOLDERMATTERS**

 

**Market Information**

 

The Company’s Common Stock isquoted on the NASDAQ Stock Market under the symbol “ZOMX.”  The following table sets forth, for theperiods indicated, the high and low closing bid prices of the Company’s CommonStock.  These bid quotations representinter-dealer prices and do not include retail mark-ups, mark-downs orcommissions and may not necessarily represent actual transactions.

 
|           |   | **2002** |   | **2001** |   |
|----------------|--------|----------|--------|----------|--------|
|           |   | **High** |   | **Low**  |   | **High** |   | **Low** |   |
| First Quarter  |   | $        | 8.22   |     | $      | 6.10 |   | $ | 7.44 |   | $ | 4.16 |   |
| Second Quarter |   | 7.46     |   | 3.90     |   | 8.91 |   | 3.44 |   |
| Third Quarter  |   | 4.30     |   | 3.10     |   | 9.22 |   | 4.25 |   |
| Fourth Quarter |   | 4.50     |   | 3.22     |   | 8.90 |   | 5.01 |   |
|                |        |          |        |          |        |  |  |  |  |  |  |  |  |

 

**Holders**

 

As of March 10, 2003, there wereapproximately 400 record holders of the Company’s Common Stock, excludingstockholders whose stock is held either in nominee name and/or street namebrokerage accounts.  Based oninformation which the Company has obtained from its transfer agent, there areapproximately 14,000 stockholders of the Company’s Common Stock whose stock isheld either in nominee name and/or street name brokerage accounts.

 

**Dividends**

 

The Company has never declaredor paid cash dividends on its capital stock and does not anticipate declaringor paying any cash dividends in the foreseeable future.  The Company intends to retain futureearnings for the development of its business.

 

**ITEM6.  SELECTEDFINANCIAL DATA**

 

The following summaryinformation should be read in conjunction with the Consolidated FinancialStatements and related notes thereto set forth in Item 8 of this Form 10-K.

 

**FIVE-YEAR FINANCIAL SUMMARY**

**(Inthousands, except per share data)**

 
|                                                   |   | **2002** |    | **2001(1)** |   | **2000** |   | **1999(2)** |    | **1998** |   |
|--------------------------------------------------------|--------|----------|---------|-------------|--------|----------|--------|-------------|---------|----------|--------|
| **STATEMENT OF  OPERATIONS DATA:**                     |   |     |    |        |   |     |   |        |    |     |   |
| Sales                                                  |   | $        | 185,500 |        | $      | 216,797  |   | $           | 239,090 |     | $      | 238,698 |   | $ | 61,485 |   |
| Gross profit                                           |   | 32,812   |    | 50,109      |   | 71,526   |   | 73,916      |    | 16,804   |   |
| Selling, general and administrative expenses           |   | 35,264   |    | 31,964      |   | 33,532   |   | 37,724      |    | 10,595   |   |
| Operating income (loss)                                |   | (2,452   | )       | 17,222      |   | 37,994   |   | 36,192      |    | 6,209    |   |
| Income (loss) before income taxes                      |   | (1,252   | )       | 14,254      |   | 38,451   |   | 37,804      |    | 6,141    |   |
| Income tax expense (benefit)                           |   | (573     | )       | 5,221       |   | 13,592   |   | 11,977      |    | 2,475    |   |
| Net income (loss)                                      |   | (679     | )       | 9,033       |   | 24,859   |   | 25,827      |    | 3,666    |   |
| Earnings (loss) per share:                             |   |     |    |        |   |     |   |        |    |     |   |
| Basic                                                  |   | (0.02    | )       | 0.28        |   | 0.78     |   | 0.87        |    | 0.14     |   |
| Diluted                                                |   | (0.02    | )       | 0.27        |   | 0.74     |   | 0.79        |    | 0.13     |   |
| Weighted average number of common shares outstanding : |   |     |    |        |   |     |   |        |    |     |   |
| Basic                                                  |   | 33,050   |    | 32,364      |   | 31,915   |   | 29,662      |    | 25,470   |   |
| Diluted                                                |   | 33,050   |    | 33,152      |   | 33,529   |   | 32,692      |    | 26,926   |   |
| **BALANCE SHEET  DATA:**                               |   |     |    |        |   |     |   |        |    |     |   |
| Cash and cash equivalents                              |   | $        | 72,146  |        | $      | 74,999   |   | $           | 63,577  |     | $      | 51,128 |   | $ | 25,621 |   |
| Working capital                                        |   | 89,960   |    | 89,889      |   | 69,872   |   | 47,466      |    | 26,969   |   |
| Total assets                                           |   | 167,183  |    | 163,506     |   | 167,935  |   | 142,304     |    | 65,423   |   |
| Long-term notes payable, net of current portion        |   | 747      |    | 3,720       |   | 6,757    |   | 10,603      |    | 1,746    |   |
| Total shareholders’ equity                        |   | 130,549  |    | 124,424     |   | 112,095  |   | 82,430      |    | 50,087   |   |

 

----

(1)   Results of operations for the year endedDecember 28, 2001, include one-time charges of $2.9 million net of tax, or$0.09 per share, for the write-off of the Company’s investment in Microgistix,and $0.6 million net of tax, or $0.02 per share, for the write-off of goodwillrelated to the acquisition of Trotter Technologies, Inc.

 

(2)   In January 1999, the Company acquired thebusinesses and certain net assets of Kao Corporation in the United States,Canada, Ireland and Germany.  Kao’sresults of operations have been included with the Company’s results of operationssince the date of acquisition.

 

**ITEM 7.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION ANDRESULTS OF OPERATIONS**

 

**FiscalYear-End**

 

The Company’s fiscal year ends on the last Friday ofthe calendar year.  Unless indicatedotherwise, the  fiscal years endedDecember 27, 2002, December 28, 2001, and December 29, 2000  are referred to as 2002, 2001, and 2000,respectively.

 

**Applicationof Critical Accounting Policies**

 

*Revenue Recognition*  The Company records sales revenue at thetime product is shipped or as services are rendered.  For certain customers, product is invoiced upon completion, withshipment occurring based on written customer instructions.  In these cases, the customer accepts titleto the goods as of the date of the invoice and sales revenue is recognized bythe Company.  In each case of bill andhold sales, the Company ensures that the transaction complies with theconditions and considerations contained in Accounting and Auditing EnforcementRelease No. 108 of the Securities and Exchange Commission.

 

*Royalties.*  The Company has license agreements withcertain companies for the use of certain CD and DVD manufacturing technology.The cost of these royalties is accrued based on units sold and charged to costof sales.

 

**RecentlyIssued Accounting Pronouncements**

 

In April, 2002, the Financial Accounting StandardsBoard (“FASB”) issued Statement No. 145, “Rescission of FASB StatementsNo. 4, 44 and 64, Amendment of FASB Statement No. 13, and TechnicalCorrections”.  This statement eliminatesextraordinary accounting treatment for a gain or loss reported on theextinguishment of debt and amends other existing authoritative pronouncementsto make technical corrections, clarify meanings, or describe theirapplicability under changed conditions. The provisions of this statement becomeeffective for the Company in 2003.  Theadoption of this statement is not expected to have a material impact on theCompany’s financial position or results of operations.

 

In June, 2002, the FASB issued Statement No. 146,“Accounting for Costs Associated with Exit or Disposal Activities” (“SFASNo. 146”).  This statement requiresthat the fair value of a liability associated with an exit or disposal activitybe recognized when the liability is incurred. Prior to the adoption of SFAS No. 146, certain exit costs wererecognized when a commitment was made to a restructuring plan, which may havebeen before the liability was incurred. The Company adopted the provisions ofthis statement in 2002. The adoption of SFAS No. 146 had no impact on theCompany’s financial position or results of operations.

 

In November 2002, the FASB issued FASB InterpretationNo. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees,Including Indirect Guarantees of Indebtedness of Others” (FIN 45).  FIN 45 clarifies the requirements for aguarantor’s accounting for and disclosure of certain guarantees issued andoutstanding.  The initial recognitionand initial measurement provisions of FIN 45 are applicable to guaranteesissued or modified after December 31, 2002. The disclosure requirements of FIN 45 are effective for financialstatements of interim or annual periods ending after December 15, 2002.  The adoption of FIN 45 did not impact theCompany’s financial position or results of operations.

 

In December, 2002, the FASB issued StatementNo. 148, “Accounting for Stock-Based Compensation—Transition andDisclosure” (“SFAS No. 148”).  SFASNo. 148 presents additional alternatives for transitioning to the fairvalue method of accounting for stock-based compensation, prescribes the formatto be used for pro forma disclosures and requires the inclusion of similar proforma disclosures in interim financial statements.  The provisions of SFAS No. 148 became effective for theCompany in fiscal 2002.  The adoption ofSFAS 148 did not impact the Company’s financial position or results ofoperations.

 

**Resultsof Operations**

 

The following table sets forth certain operating datato aid in the understanding of the discussion and analysis of the results ofoperations.  Amounts are shown as apercentage of sales, except for income taxes, which is presented as apercentage of income or loss before taxes.

 
|                                          |   | **2002** |   | **2001** |   | **2000** |   |
|-----------------------------------------------|--------|----------|--------|----------|--------|----------|--------|
| Sales                                         |   | 100.0    | %      | 100.0    | %      | 100.0    | %      |
| Gross profit                                  |   | 17.7     |   | 23.1     |   | 29.9     |   |
| Selling, general  and administrative expenses |   | 19.0     |   | 14.7     |   | 14.0     |   |
| Operating income  (loss)                      |   | (1.3     | )      | 7.9      |   | 15.9     |   |
| Other income  (expense)                       |   | 0.6      |   | (1.4     | )      | 0.2      |   |
| Income tax  expense (benefit)                 |   | (45.8    | )      | 36.6     |   | 35.3     |   |
| Net income  (loss)                            |   | (0.4     | )      | 4.2      |   | 10.4     |   |

 

**2002 Compared to 2001**

 

*Net Income (Loss)*.  TheCompany’s net income decreased from $9.0 million in 2001 to a net loss of $0.7million in 2002.  Diluted earnings pershare declined from $0.27 in 2001 to a net loss per share of $0.02 in2002.  The decline in earnings reflectsthe cumulative effect of decreased revenues and gross profit margins andincreased selling, general and administrative expenses as discussed in moredetail below.

 

*Sales.* Sales decreased 14.4% to $185.5 million in 2002 from $216.8 million in2001.  The decrease is attributable to adecline in sales to Microsoft, the Company’s largest customer, which decreasedfrom 35% of sales in 2001 to 20% of sales in 2002.  The Company’s sales to Microsoft consist of replication,fulfillment and call center services in support of certain Microsoftprograms.  These programs have beenmaturing over the past several years, resulting in lower levels of servicerequirements from the Company.  Whilethe Company anticipates that support requirements and related revenuesassociated with these Microsoft programs will continue to decline in 2003, itbelieves it maintains a strong relationship with Microsoft and continues topursue opportunities to provide additional services to this key customer.

 

Excluding the decline insales to Microsoft, the Company’s revenues increased 4% from 2001 to 2002.  During 2002, the Company added several newaccounts to its customer base as well as increased the volume and types ofservices performed for a number of existing customers.  In 2002, the Company significantly increasedthe number of low-priced, raw CD units sold to one major customer.  This customer accounted for 30% of totalunits sold in 2002.  However, the effecton revenues of these increases in business activity were offset by continueddeclines in CD and DVD unit prices attributable to industry over-capacity anddeclining demand for CD media.  TheCompany expects these factors will continue to exert downward pressures on pricingin 2003.

 

*Gross Profit*.  Gross profit decreased to 17.7% of sales in 2002 from 23.1% ofsales in 2001.  This decrease reflects adecline in total sales relative to the fixed nature of certain costs includedin cost of sales, continued unit price deterioration of CD and DVD media and acontinued shift in the Company’s product mix to products that contain a highercontent of low margin packaging materials. Pricing pressures and product mix changes are expected to continue toexert downward pressure on the Company’s gross profit margins in 2003.

 

In the Company’s Form 10-Q for the quarter endedSeptember 27, 2002, the Company reported that it was in the final stages ofnegotiations with Philips Corporation for a reduction in the royalty rateavailable under Philips’ Compliance Reward Program.  The Company expectedthese negotiations to be completed by December 27, 2002 and that the reducedrates would be retroactive to July 1, 2002. These expectations were based on the Company’s assessment of the statusof the negotiations as well assurances to this effect from Philips.  The Company did not complete thesenegotiations as of year-end and adjusted its Philips royalty rates for all of2002 to those in effect under the existing agreement.  As a result, fourth quarter cost of sales includes approximately$700,000 of royalty expenses related to the third quarter.  While these negotiations are ongoing, theCompany can not guarantee that it will reach agreement for a reduction in thePhilips royalty rate.  The Company’sinability to successfully complete these negotiations could result in furtherdownward pressure on the Company’s gross profit margins as CD and DVD unitprices have begun to reflect the anticipated reduction in costs associated withthis change in the royalty rates.

 

*Selling, General and Administrative (SG&A) Expenses*.SG&A expenses increased 10.3% to $35.3 million in 2002 from $32.0 millionin 2001.  The increase is the result ofapproximately $2.2 million in legal and other costs associated with potentialacquisition opportunities pursued in the first half of 2002 and a $1.3 millionwrite-down of the Company’s existing call center software systems as a resultof the replacement of those systems that began in the fourth quarter of2002.  Excluding these unusual items,SG&A expenses declined slightly in 2002 from 2001.

 

*Other Income and Expense*. Interest income decreased to $1.4 million in 2002 from $2.7 million in2001.  This decrease reflects thedecline in interest rates earned on the Company’s investments.  Interest expense declined to $0.2 million in2002 from $0.6 million in 2001 as a result of lower outstanding borrowings andlower interest rates.

 

In the fourth quarter of 2001, the Company wrote-offits remaining $4.4 million investment in an unconsolidated entity, Microgistix,on the basis that Microgistix’ historical operating results and cash flowrequirements could not justify the Company’s carrying value of thisinvestment.  As a result of thiswrite-down, the Company did not recognize any portion of Microgistix 2002losses in the current year

 

*IncomeTaxes*.  The effective income tax rate for 2002 was45.8%, compared to 36.6% in 2001.  Dueto the decline in earnings before income taxes, income and deductions that arepermanently treated differently for book and tax purposes have a largerrelative effect in 2002 than in 2001 when measured as a percentage of the lower2002 pretax results.

 

**2001 Compared to 2000**

 

*Net Income.*  Net income for 2001 decreased 63.7% to $9.0 million compared to$24.9 million in 2000.  Diluted earningsper share declined to $0.27 per share in 2001 from $0.74 per share in2000.  As discussed in more detailbelow, the decline in earnings reflects the decreased revenues and gross profitmargins partially offset by a decrease in selling, general and administrative expenses.

 

*Sales*. Sales decreased 9.3% to $216.8 million in 2001 from to $239.1 million in2000.  The decrease resulted from a 9.6%decrease in CD and DVD related sales. This decrease primarily relates to unitvolume decreasing by 18.0% during 2001 offset by the average unit priceincreasing 9.9% due to the Company performing more value added services forcustomers. Revenues in 2001 were negatively affected by the slowdown inpersonal computer and software spending and worldwide economic uncertainty.

 

*GrossProfit*.  Gross profitas a percentage of sales was 23.1% in 2001 and 29.9% in 2000.  The gross profit percentage decrease wasprimarily due to the Company’s sales mix and pricing pressures.  The Company’s sales mix for 2001 included anincrease in lower margin materials and freight billings, while fixed costsincreased as a percentage of sales due to CD/DVD manufacturing capacitycompleted in 2000 and manufacturing operating at lower utilizations.  These increases were partially offset by adecrease in the amount of outsourced production, which is more costly than CDsproduced internally.  The Companyoutsources its CD production when customer orders exceed its productioncapabilities.  The Company outsourced 2%of its CD production in 2001 and 7% in 2000.

 

*Selling, General and Administrative (SG&A) Expenses.*  SG&A expenses as a percentage of saleswere 14.7% in 2001 and 14.0% in 2000. SG&A expenses decreased $1.5 millionto $32.0 million in 2001 from $33.5 million in 2000.  The decrease in dollars was achieved through operationalefficiencies and cost containment measures implemented in 2001.

 

*Impairment of Goodwill.*The Companyanalyzed projected undiscounted cash flows and determined that goodwillassociated with the 1997 purchase of Trotter Technologies, Inc. wasimpaired.  Accordingly, the Companycharged to earnings the entire amount of unamortized goodwill of approximately$0.9 million in 2001.  The write-down ofthe goodwill was based on an analysis of projected discounted cash flows, whichwere no longer deemed adequate to support the value of goodwill associated withthe business.

 

*Equity in Losses of Unconsolidated Entity*.  During 2001, the Company recognized a lossof $0.6 million from its equity investment in Microgistix, compared to a $1.4million loss in 2000.  The lossesrepresent the Company’s share of Microgistix losses and the amortization of theCompany’s excess purchase price of the Microgistix common stock acquired overthe fair value of the underlying net assets acquired.

 

*Impairment of Investment****in Unconsolidated Entity.*  In December 2001, the Company wrote off itsremaining investment in Microgistix, which amounted to $4.4 million.  Based on Microgistix’ historical operatingresults and cash flow requirements, the Company could not foresee that it wouldbe able to recover the carrying amount of its investment in Microgistix or thatMicrogistix has the ability to sustain an earnings capacity which would justifythe carrying amount of the investment.

 

*Interest Income and Expense*.  Interest income was $2.7 million and $3.2million for 2001 and 2000, respectively. Interest expense was $0.6 million and $1.1 million for 2001 and 2000,respectively.  Interest income decreaseddue to lower interest rates.  Interestexpense decreased as a result of lower outstanding loan balances and lowerinterest rates.

 

*Income Tax Expense (Benefit).*  The effective income tax rate for 2001 was36.6% compared to 35.3% in 2000.  Theincrease in the effective tax rate is due primarily to a lower amount of incomefrom Ireland, which has a lower effective tax rate.

 

**Liquidityand Capital Resources**

 

*Cash and Cash Equivalents.*  Atthe end of  2002, cash and cashequivalents totaled $72.1 million, a decrease of $2.9 million from 2001.  Despite the Company’s net loss in 2002, theCompany generated $8.9 million of cash from operations, a decrease of $8.2million from the $17.1 million generated in 2001.  This  decrease wasprimarily due to the decrease in net earnings as discussed above.

 

Cash used in investing activities in 2002 was $11.9million, including a $5.0 million minority investment in Intraware, a leadingprovider of electronic software delivery services, and a $3.9 million escrowdeposit related to the iLogistix acquisition that was subsequently terminated.  (See Item 3 of this Form 10-K.)  The Company expects return of this depositin the first half of 2003.  Capitalexpenditures in 2002 totaled $3.0 million, a decrease of $1.9 million from2001.  In the fourth quarter of 2002,the Company’s Board of Directors approved a $4.5 million capital expenditureplan related to upgrades to the Company’s call center systems and an increasein DVD replication capacity.  These upgrades represented a significantportion of the Company’s capital expenditures in 2002 and are expected tocontinue into the third quarter of 2003.

 

Net cash used in financing activities in 2002 was $2.2million, a decrease from the $0.3 million of cash provided by these activitiesin 2001.  This change is attributable toa decline in proceeds from employee exercises of stock option grants.  In the fourth quarter of 2002, the Board ofDirectors approved a Stock Buy-back Program to expend up to $10.0 million torepurchase the Company’s stock in the open market.  The Companyrepurchased 118,300 shares for a total cost of $0.5 million under this programin 2002.  In the first quarter of 2003,the Company repurchased a total of 761,900 shares for a total cost of $2.6million.  The timing and extent offuture repurchases under this program will vary based on market conditions aswell as regulatory limitations imposed on such programs.

 

Changes in foreign currency exchange rates had a $2.4million positive impact on reported cash balances in 2002 due to the declineduring the year in the value of the U.S. dollar relative to the Euro, thefunctional currency of the Company’s Ireland operations.

 

*WorkingCapital and Liquidity*. Working capital totaled $90.0 million, $89.9 million and $69.9 millionat the end of 2002, 2001 and 2000, respectively.  The Company’s primary source of working capital continues to becash and cash equivalent balances as described above.  In addition, the Company has a revolving line of credit facilitywith available borrowings up to $25.0 million. Borrowings under this facility are limited to an amount based on aformula using eligible accounts receivable and inventories. There were noborrowings outstanding under the revolving line of credit facility at the endof 2002, 2001 or 2000.

 

At the end of 2002, 2001 and 2000, the Company had totaloutstanding debt of $3.7 million, $6.7 million and $10.5 million,respectively.  The Company’s futurepayments of long-term debt and operating leases as of the end of 2002 are asfollows (in millions):

 
|             |   | **Less than**1  Year |   | **2 to 3  Years** |   | **4 to 5  Years** |   | **After**5 Years |   | **Total** |   |
|------------------|--------|----------------------|--------|-------------------|--------|-------------------|--------|------------------|--------|-----------|--------|
| Long-term debt   |   | $                    | 3.0    |              | $      | .7                |   | $                | — |      | $      | — |   | $ | 3.7 |   |
| Operating leases |   | 4.7                  |   | 6.9               |   | 5.0               |   | 26.2             |   | 42.8      |   |
| Total            |   | $                    | 7.7    |              | $      | 7.6               |   | $                | 5.0    |      | $      | 26.2 |   | $ | 46.5 |   |

 

Future liquidity needs will depend on, among otherfactors, the timing of capital expenditures, expenditures in connection withpossible acquisitions, changes in customer order volume and the timing andcollection of receivables. The Company believes that existing cash balances,anticipated cash flow from operations and amounts available under existingcredit facilities will be sufficient to fund its operations for the foreseeablefuture.

 

**MarketRisk**

 

*Foreign Currency.*  A portion of the Company’s operations arelocated in Ireland and Canada.  Amajority of the Company’s sales from its Canadian operations, and a portion ofthe related costs, are denominated in US dollars.  As a result, the Company has limited exposure to the Canadiancurrency.  The majority of salesrevenues and related costs in its Ireland operations are denominated in Euros.  Foreigncurrency transaction gains and losses are reflected in the Company’s financialstatements and have historically not been material to the company’s results ofoperations or financial condition. However, the Company anticipates it will continue to incur exchangegains and losses from foreign operations in the future which may besignificant depending on factors such as changes in foreign currency or weakeconomic conditions in foreign markets. In addition, sales of products and services are directly impacted by thevalue of the U.S. dollar relative to other currencies.

 

*Interest. *As of December 27, 2002, the Company hadtotal outstanding debt of $3.7 million, with interest rates that are tied tothe prime rate or LIBOR.  Therefore, theCompany is exposed to interest rate risk for these borrowings based onfluctuations in the interest rates. Based upon the outstanding indebtedness as of December 27, 2002, anincrease in the interest rates of 1.0% would cause a corresponding increase inannual interest expense of less than $0.1 million.

 

**Inflation**

 

Historically, inflation has not had a material impacton the Company.  The cost of theCompany’s products is influenced by the cost of raw materials and labor.  There can be no assurance that the Companywill be able to pass on any increased material and labor costs to its customersin the future.

 

**Outlook**

 

This section should be read in conjunction with thesection titled “Cautionary Statement for Purposes of the “Safe Harbor”Provisions of the Private Securities Litigation Reform Act of 1995” included inPart I of this Form 10-K

 

The Company believes thatworldwide demand for CDs and its other services has declined due to theeconomic slowdown in the personal computer hardware and software markets andthe continuing uncertainty in the worldwide economy.  Pricing strategies of competitors and general economic factorsaffecting demand in the personal computer hardware and software industrydirectly impact the Company.  Inaddition, a substantial part of the Company’s revenue and unit volume isderived from a small number of key customers in these industries, includingMicrosoft and AOL, and revenues and operating income will be significantlylower than expected if the Company cannot retain these customers.

 

Unit prices will likelycontinue to decline due to the overcapacity in the industry.  If market demand and unit prices continue todecline, the Company’s revenues will be directly and adversely impacted andcapacities will be further underutilized. In addition, if the Company does not respond rapidly to technologicalchanges, it is subject to the loss of some of its customer base, which willmaterially and adversely effect revenue.

 

**ITEM 7A.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**

 

See “Market Risk” and “Outlook” under Item 7 above.

 

**ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA**

 

**Report of Independent Auditors**

 

**To the Board of Directors andShareholders ofZomax Incorporated**

 

We have audited the accompanyingconsolidated balance sheet of Zomax Incorporated and Subsidiaries (the Company)as of December 27, 2002, and the related consolidated statements of operations,shareholders’ equity, and cash flows for the year then ended. These financialstatements are the responsibility of the Company’s management. Ourresponsibility is to express an opinion on these financial statements based onour audit. The financial statements of the Company as of and for the year endedDecember 28, 2001 and for the year ended December 29, 2000, were audited byother auditors who have ceased operations. Those auditors expressed anunqualified opinion on those financial statements in their report dated January25, 2002.

 

We conducted our audit in accordance with auditingstandards generally accepted in the United States of America. Those standardsrequire that we plan and perform the audit to obtain reasonable assurance aboutwhether the financial statements are free of material misstatement. An auditincludes examining, on a test basis, evidence supporting the amounts anddisclosures in the financial statements. An audit also includes assessing theaccounting principles used and significant estimates made by management, aswell as evaluating the overall financial statement presentation. We believethat our audit provides a reasonable basis for our opinion.

 

In our opinion, such financial statements presentfairly, in all material respects, the financial position of the Company as ofDecember 27, 2002, and the results of its operations and its cash flows for theyear then ended in conformity with accounting principles generally accepted inthe United States of America.

 
| **/s/ Deloitte & Touche LLP** |   |
|-----------------------------------|--------|
|                              |
| Minneapolis, Minnesota            |
| February 18, 2003                 |

 

----

*Notice:  The following report is a copy of a report previously issued byArthur Andersen LLP (“Andersen”).  Thisreport relates to prior years’ financial statements and has not been reissuedby Andersen.*

 

**Report of Independent PublicAccountants**

 

**To Zomax Incorporated:**

 

We have audited the accompanying consolidated balancesheets of Zomax Incorporated (a Minnesota corporation) and Subsidiaries as ofDecember 28, 2001 and December 29, 2000, and the related consolidatedstatements of operations, shareholders’ equity and cash flows for each of thethree years in the period ended December 28, 2001. These financialstatements are the responsibility of the Company’s management. Ourresponsibility is to express an opinion on these financial statements based onour audits.

 

We conducted our audits in accordance with auditingstandards generally accepted in the United States. Those standards require thatwe plan and perform the audit to obtain reasonable assurance about whether thefinancial statements are free of material misstatement. An audit includesexamining, on a test basis, evidence supporting the amounts and disclosures inthe financial statements. An audit also includes assessing the accountingprinciples used and significant estimates made by management, as well asevaluating the overall financial statement presentation. We believe that ouraudits provide a reasonable basis for our opinion.

 

In our opinion, the consolidated financial statementsreferred to above present fairly, in all material respects, the financialposition of Zomax Incorporated and Subsidiaries as of December 28, 2001and December 29, 2000, and the results of their operations and their cashflows for each of the three years in the period ended December 28, 2001,in conformity with accounting principles generally accepted in the United States.

 
| **/s/ Arthur Andersen LLP** |   |
|-----------------------------|--------|
|                        |
| Minneapolis, Minnesota,     |
| January 25, 2002       |

 

**ZOMAXINCORPORATED**

**CONSOLIDATEDSTATEMENTS OF OPERATIONS**

**(Inthousands, except per share data)**

 
|                                              |   | **Year Ended** |       |
|---------------------------------------------------|--------|----------------|------------|
|                                              |   | **2002**       |       | **2001** |   | **2000** |   |
|                                              |   |           | ** ** |   | ** ** |   | ** ** |
| **Sales**                                         |   | $              | 185,500    |   | $ | 216,797 |   | $ | 239,090 |   |
|                                              |   |           |       |   |   |   |   |
| Cost of sales                                     |   | 152,688        |       | 166,688 |   | 167,564 |   |
| **Gross profit**                                  |   | 32,812         |       | 50,109 |   | 71,526 |   |
|                                              |   |           |       |   |   |   |   |
| Selling, general and administrative expenses      |   | 35,264         |       | 31,964 |   | 33,532 |   |
|                                              |   |           |       |   |   |   |   |
| Impairment of goodwill                            |   | —         |       | 923 |   | — |   |
| **Operating income (loss)**                       |   | (2,452         | )          | 17,222 |   | 37,994 |   |
|                                              |   |           |       |   |   |   |   |
| **Other income (expense):**                       |   |           |       |   |   |   |   |
| Equity in losses of unconsolidated entity         |   | —         |       | (631 | ) | (1,416 | ) |
| Impairment of investment in unconsolidated entity |   | —         |       | (4,400 | ) | — |   |
| Interest expense                                  |   | (228           | )          | (577 | ) | (1,103 | ) |
| Interest income                                   |   | 1,423          |       | 2,651 |   | 3,225 |   |
| Other, net                                        |   | 5              |       | (11 | ) | (249 | ) |
| **Income (loss) before income taxes**             |   | (1,252         | )          | 14,254 |   | 38,451 |   |
|                                              |   |           |       |   |   |   |   |
| Income tax expense (benefit)                      |   | (573           | )          | 5,221 |   | 13,592 |   |
| **Net income (loss)**                             |   | $              | (679       | ) | $ | 9,033 |   | $ | 24,859 |   |
|                                              |   |           |       |   |   |   |   |
| **Earnings (loss) per share:**                    |   |           |       |   |   |   |   |
| Basic                                             |   | $              | (0.02      | ) | $ | 0.28 |   | $ | 0.78 |   |
| Diluted                                           |   | $              | (0.02      | ) | $ | 0.27 |   | $ | 0.74 |   |
|                                              |   |           |       |   |   |   |   |
| **Weighted average common shares  outstanding:**  |   |           |       |   |   |   |   |
| Basic                                             |   | 33,050         |       | 32,364 |   | 31,915 |   |
| Dilutive effect of stock options and warrants     |   | —         |       | 788 |   | 1,614 |   |
| Diluted                                           |   | 33,050         |       | 33,152 |   | 33,529 |   |

 

*See notes to consolidated financialstatements.*

 

**ZOMAXINCORPORATED**

**CONSOLIDATED BALANCE SHEETS**

**(Inthousands)**

 
|                                                                                                                                         |   | **2002** |    | **2001** |   |
|----------------------------------------------------------------------------------------------------------------------------------------------|--------|----------|---------|----------|--------|
| **ASSETS**                                                                                                                                   |   |     |    |     |   |
| **Current Assets:**                                                                                                                          |   |     |    |     |   |
| Cash and cash equivalents                                                                                                                    |   | $        | 72,146  |     | $      | 74,999 |   |
| Accounts receivable, net of allowance of $1,937 in  2002 and $2,234 in 2001                                                             |   | 32,785   |    | 30,328   |   |
| Inventories                                                                                                                                  |   | 9,712    |    | 11,142   |   |
| Deferred income taxes                                                                                                                        |   | 2,555    |    | 3,183    |   |
| Other current assets                                                                                                                         |   | 8,025    |    | 3,855    |   |
| Total current assets                                                                                                                         |   | 125,223  |    | 123,507  |   |
|                                                                                                                                         |   |     |    |     |   |
| **Property and Equipment, net**                                                                                                              |   | 34,947   |    | 39,913   |   |
|                                                                                                                                         |   |     |    |     |   |
| **Investment in Available-For-Sale  Securities**                                                                                             |   | 7,013    |    | —   |   |
|                                                                                                                                         |   |     |    |     |   |
| **Other Assets**                                                                                                                             |   | —   |    | 86       |   |
|                                                                                                                                         |   | $        | 167,183 |     | $      | 163,506 |   |
|                                                                                                                                         |   |     |    |     |   |
| **LIABILITIES AND SHAREHOLDERS’  EQUITY**                                                                                               |   |     |    |     |   |
| **Current Liabilities:**                                                                                                                     |   |     |    |     |   |
| Current portion of notes payable                                                                                                             |   | $        | 2,989   |     | $      | 2,976 |   |
| Accounts payable                                                                                                                             |   | 14,333   |    | 12,964   |   |
| Accrued expenses                                                                                                                             |   | 17,422   |    | 13,961   |   |
| Income taxes payable                                                                                                                         |   | 519      |    | 3,717    |   |
| Total current liabilities                                                                                                                    |   | 35,263   |    | 33,618   |   |
|                                                                                                                                         |   |     |    |     |   |
| **Long-Term Notes Payable,**net  of current portion                                                                                          |   | 747      |    | 3,720    |   |
|                                                                                                                                         |   |     |    |     |   |
| **Deferred Income Taxes**                                                                                                                    |   | 624      |    | 1,744    |   |
| Total liabilities                                                                                                                            |   | 36,634   |    | 39,082   |   |
|                                                                                                                                         |   |     |    |     |   |
| **Commitments and Contingencies**                                                                                                            |   |     |    |     |   |
|                                                                                                                                         |   |     |    |     |   |
| **Shareholders’ Equity:**                                                                                                               |   |     |    |     |   |
| Common stock, no par value, 100,000 shares  authorized; 33,028 and 32,833 shares issued and outstanding in 2002 and  2001, respectively |   | 64,071   |    | 63,214   |   |
| Retained earnings                                                                                                                            |   | 66,447   |    | 67,126   |   |
| Accumulated other comprehensive income (loss)                                                                                                |   | 31       |    | (5,916   | )      |
| Total shareholders’ equity                                                                                                              |   | 130,549  |    | 124,424  |   |
|                                                                                                                                         |   | $        | 167,183 |     | $      | 163,506 |   |

 

*See notes to consolidated financialstatements.*

 

**ZOMAXINCORPORATED**

**CONSOLIDATEDSTATEMENTS OF SHAREHOLDERS’ EQUITY**

**(Inthousands)**

 
|                                                                  |   | **Common Stock** |   | **Retained****Earnings** |   | **Accumulated  Other  Comprehensive  Income (Loss)** |   | **Total  Shareholders’  Equity** |   |
|-----------------------------------------------------------------------|--------|------------------|--------|--------------------------|--------|------------------------------------------------------|--------|---------------------------------------|--------|
| **Shares**                                                            |   | **Amount**       |
|                                                                  |   |             |   |                     |   |                                                 |   |                                  |   |   |   |
| **Balance, December 31, 1999**                                   |   | 30,966           |   | $                        | 51,953 |                                                 | $      | 33,234                                |   | $ | (2,757 | ) | $ | 82,430 |   |
|                                                                  |   |             |   |                     |   |                                                 |   |                                  |   |   |   |
| Net income                                                            |   | —           |   | —                   |   | 24,859                                               |   | —                                |   | 24,859 |   |
| Translation adjustments                                               |   | —           |   | —                   |   | —                                               |   | (1,697                                | )      | (1,697 | ) |
| Common stock issued under employee stock  purchase plan          |   | 143              |   | 1,412                    |   | —                                               |   | —                                |   | 1,412 |   |
| Common stock issued upon exercise of stock options                    |   | 1,428            |   | 3,031                    |   | —                                               |   | —                                |   | 3,031 |   |
| Tax benefit realized from exercise of  stock options             |   | —           |   | 7,100                    |   | —                                               |   | —                                |   | 7,100 |   |
| Common stock repurchases                                              |   | (800             | )      | (5,040                   | )      | —                                               |   | —                                |   | (5,040 | ) |
|                                                                  |   |             |   |                     |   |                                                 |   |                                  |   |   |   |
| **Balance, December 29, 2000**                                   |   | 31,737           |   | 58,456                   |   | 58,093                                               |   | (4,454                                | )      | 112,095 |   |
|                                                                  |   |             |   |                     |   |                                                 |   |                                  |   |   |   |
| Net income                                                            |   | —           |   | —                   |   | 9,033                                                |   | —                                |   | 9,033 |   |
| Translation adjustments                                               |   | —           |   | —                   |   | —                                               |   | (1,462                                | )      | (1,462 | ) |
| Common stock issued under employee stock  purchase plan          |   | 339              |   | 1,311                    |   | —                                               |   | —                                |   | 1,311 |   |
| Common stock issued upon exercise of stock options  and warrants      |   | 757              |   | 2,756                    |   | —                                               |   | —                                |   | 2,756 |   |
| Tax benefit realized from exercise of stock options              |   | —           |   | 430                      |   | —                                               |   | —                                |   | 430 |   |
| Stock compensation expense                                            |   | —           |   | 261                      |   | —                                               |   | —                                |   | 261 |   |
|                                                                  |   |             |   |                     |   |                                                 |   |                                  |   |   |   |
| **Balance, December 28, 2001**                                   |   | 32,833           |   | 63,214                   |   | 67,126                                               |   | (5,916                                | )      | 124,424 |   |
|                                                                  |   |             |   |                     |   |                                                 |   |                                  |   |   |   |
| Net loss                                                              |   | —           |   | —                   |   | (679                                                 | )      | —                                |   | (679 | ) |
| Unrealized holding gain on available-for-sale  securities, net of tax |   | —           |   | —                   |   | —                                               |   | 1,275                                 |   | 1,275 |   |
| Translation adjustments                                               |   | —           |   | —                   |   | —                                               |   | 4,672                                 |   | 4,672 |   |
| Common stock issued under employee stock  purchase plan          |   | 188              |   | 873                      |   | —                                               |   | —                                |   | 873 |   |
| Common stock issued upon exercise of stock options                    |   | 125              |   | 322                      |   | —                                               |   | —                                |   | 322 |   |
| Tax benefit realized from exercise of  stock options             |   | —           |   | 158                      |   | —                                               |   | —                                |   | 158 |   |
| Common stock repurchases                                              |   | (118             | )      | (464                     | )      | —                                               |   | —                                |   | (464 | ) |
| Stock compensation expense                                            |   | —           |   | (32                      | )      | —                                               |   | —                                |   | (32 | ) |
|                                                                  |   |             |   |                     |   |                                                 |   |                                  |   |   |   |
| **Balance, December 27, 2002**                                   |   | 33,028           |   | $                        | 64,071 |                                                 | $      | 66,447                                |   | $ | 31 |   | $ | 130,549 |   |

 

*See notes to consolidated financialstatements.*

 

**ZOMAXINCORPORATED**

**CONSOLIDATEDSTATEMENTS OF CASH FLOW**

**(Inthousands)**

 
|                                                                                       |   | **Year Ended** |   |
|--------------------------------------------------------------------------------------------|--------|----------------|--------|
|                                                                                       |   | **2002**       |   | **2001** |   | **2000** |   |
| **Operating Activities**:                                                                  |   |           |   |   |   |   |   |
| Net income (loss)                                                                          |   | $              | (679   | ) | $ | 9,033 |   | $ | 24,859 |   |
| Adjustments to reconcile net income or loss to net  cash provided by operating activities: |   |           |   |   |   |   |   |
| Depreciation and amortization                                                              |   | 8,349          |   | 10,443 |   | 9,758 |   |
| Stock compensation expenses                                                                |   | (32            | )      | 261 |   | — |   |
| Write-down of property and equipment andgoodwill                                           |   | 1,352          |   | 923 |   | — |   |
| Equity in losses of unconsolidated entity                                                  |   | —         |   | 631 |   | 1,416 |   |
| Impairment of investment in unconsolidated entity                                          |   | —         |   | 4,400 |   | — |   |
| Foreign currency exchange                                                                  |   | —         |   | 11 |   | 249 |   |
| Tax benefits from employee stock option plan                                               |   | 158            |   | 430 |   | 7,100 |   |
| Deferred income taxes                                                                      |   | (473           | )      | (2,352 | ) | 1,179 |   |
| Changes in operating assets and liabilities:                                               |   |           |   |   |   |   |   |
| Accounts receivable                                                                        |   | (1,423         | )      | 1,265 |   | (4,504 | ) |
| Inventories                                                                                |   | 1,651          |   | 2,739 |   | (4,493 | ) |
| Other current assets                                                                       |   | (96            | )      | (290 | ) | (1,021 | ) |
| Accounts payable                                                                           |   | 869            |   | (8,642 | ) | 2,615 |   |
| Accrued expenses                                                                           |   | 3,120          |   | (2,261 | ) | (5,832 | ) |
| Income taxes payable                                                                       |   | (3,916         | )      | 475 |   | 1,533 |   |
| Net cash provided by operating activities                                             |   | 8,880          |   | 17,066 |   | 32,859 |   |
|                                                                                       |   |           |   |   |   |   |   |
| **Investing Activities:**                                                                  |   |           |   |   |   |   |   |
| Purchase of property and equipment                                                         |   | (2,950         | )      | (4,934 | ) | (14,283 | ) |
| Investment in Intraware                                                                    |   | (5,019         | )      | — |   | — |   |
| Escrow deposit on terminated acquisition                                                   |   | (3,902         | )      | — |   | — |   |
| Change in other assets                                                                     |   | —         |   | (15 | ) | (44 | ) |
| Net cash used in investing activities                                                      |   | (11,871        | )      | (4,949 | ) | (14,327 | ) |
|                                                                                       |   |           |   |   |   |   |   |
| **Financing Activities:**                                                                  |   |           |   |   |   |   |   |
| Repayment of notes payable                                                                 |   | (2,973         | )      | (3,778 | ) | (4,123 | ) |
| Repurchase of common stock                                                                 |   | (464           | )      | — |   | (5,040 | ) |
| Issuance of common stock, net                                                              |   | 1,195          |   | 4,067 |   | 4,443 |   |
| Net cash provided by (used in)  financing activities                                  |   | (2,242         | )      | 289 |   | (4,720 | ) |
|                                                                                       |   |           |   |   |   |   |   |
| **Effect of exchange rate changes on  cash and cash equivalents**                          |   | 2,380          |   | (984 | ) | (1,363 | ) |
|                                                                                       |   |           |   |   |   |   |   |
| Net increase (decrease) in cash and cash equivalents                                       |   | (2,853         | )      | 11,422 |   | 12,449 |   |
|                                                                                       |   |           |   |   |   |   |   |
| Cash and cash equivalents, beginning of year                                               |   | 74,999         |   | 63,577 |   | 51,128 |   |
|                                                                                       |   |           |   |   |   |   |   |
| **Cash and Cash Equivalents, End of  Year**                                                |   | $              | 72,146 |   | $ | 74,999 |   | $ | 63,577 |   |

 

*See notes to consolidated financialstatements.*

 

**NOTES TOCONSOLIDATED FINANCIAL STATEMENTS**

 

**NOTE 1.  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES**

 

***Principles of Consolidation***.  The consolidated financial statementsinclude the accounts of the Company and its wholly-owned subsidiaries. Allmaterial intercompany accounts and transactions have been eliminated inconsolidation.

 

*Fiscal Year-End***. **The Company’s fiscalyear ends on the last Friday of the calendar year. The fiscal years endedDecember 27, 2002, December 28, 2001, and December 29, 2000 arereferred to as 2002, 2001, and 2000, respectively, in the consolidatedfinancial statements and notes thereto.

 

*Use ofEstimates. *Thepreparation of financial statements in conformity with accounting principlesgenerally accepted in the United States requires management to make estimatesand assumptions that affect the reported amounts of assets and liabilities atthe date of the financial statements and the reported amounts of revenues andexpenses during the reporting period. Actual results could differ from thoseestimates.

 

*RevenueRecognition*.  TheCompany records sales revenue at the time product is shipped or as services arerendered.  For certain customers,product is invoiced upon completion, with shipment occurring based on writtencustomer instructions.  In these cases,the customer accepts title to the goods as of the date of the invoice and salesrevenue is recognized by the Company. In each case of bill and hold sales, the Company ensures that thetransaction complies with the conditions and considerations contained in StaffAccounting Bulletin No. 101 and Accounting and Auditing Enforcement Release No.108 of the Securities and Exchange Commission. In 2002, 2001 and 2000, one customer accounted for 20%, 35% and 40%,respectively, of the Company’s consolidated sales.

 

*Cost ofSales*.  The Companyincludes direct labor, direct materials, royalties and production overhead,which includes shipping costs, in cost of sales on the consolidated statementsof operations.

 

*Royalties*.  The Company has licenseagreements with certain companies for the use of certain CD and DVDmanufacturing technology. The cost of these royalties is accrued based on unitssold and charged to cost of sales.

 

*IncomeTaxes*.  The Companyand its subsidiaries file a consolidated federal income tax return and separatestate and foreign returns. Deferred income taxes are provided for differencesbetween the tax basis of assets and liabilities and their carrying amounts forfinancial reporting purposes, based on the expected income tax rates for theyear in which these temporary differences are expected to reverse. Foreign netoperating loss carryforwards may be carried forward indefinitely.

 

*Earnings(Loss) Per Share*. Basic earnings per share (EPS) is computed by dividing net income orloss by the weighted average number of common shares outstanding during theyear. Diluted EPS is computed by dividing net income by the sum of the weightedaverage number of common shares outstanding plus all additional common sharesthat would have been outstanding if potentially dilutive common shares relatedto stock options and warrants had been issued. In years in which the Companyexperiences a net loss, basic EPS and diluted EPS will be the same as thepotential shares issued related to stock options are anti-dilutive.  Potential common shares of 3,674,000,671,000, and 654,000 related to the Company’s outstanding stock options wereexcluded from the computation of diluted earnings per share for 2002, 2001 and2000, respectively, as inclusion of these shares would have been anti-dilutive.

 

*Cashand Cash Equivalents*. Cash and cash equivalents consist primarily of highly liquid short-terminvestments with original maturities of 90 days or less and are recorded atcost, which approximates market value.

 

*Inventories*.  Inventories, consisting of material, laborand overhead, are stated at the lower of first-in, first-out cost or market.

 

*Propertyand Equipment*. Property and equipment are stated at cost less accumulated depreciation.Repairs and maintenance are charged to expense as incurred, while significantimprovements are capitalized. Depreciation is calculated using thestraight-line method for financial reporting purposes over estimated usefullives of three to thirty years, or in the case of leasehold improvements, theterm of the lease, if shorter.  Bothstraight-line and accelerated depreciation methods of depreciation are used forincome tax purposes.  Depreciationexpense totaled approximately $8,349,000 in 2002, $10,363,000 in 2001, and$9,678,000 in 2000.

 

*Warranty. *The Company generallywarrants to all customers that the goods sold by it will be free from defectsin materials and workmanship.  If it isdetermined that the goods sold are defective, the Company typically repairs orreplaces such goods.  The cost of these repairsor replacements have not had a material effect on the Company’s financialcondition, results of operations or cash flows.

 

*FairValue of Financial Instruments*.  The financial instruments with which the Company is involved areprimarily of a traditional nature.  Formost instruments, including cash, receivables, accounts payable, accruedexpenses and short-term debt, the Company believes that the carrying amountsapproximate fair value because of their short-term nature. The carrying valueof long-term debt approximated fair value as of December 27, 2002 and December28, 2001.  The fair values are based oncurrent rates available to the Company.

 

*Long-LivedAssets*.  Long-livedassets, such as property and equipment, are evaluated for impairment when eventsor changes in circumstances indicate that the carrying amount of the assets maynot be recoverable through the estimated undiscounted future cash flows fromthe use of these assets. If any such impairment exists, the related assetswould be written down to fair value.

 

As a result of a slowdown in the Company’s ReturnsManagement and Authorization (RMA) processing business in the second half of2001, the Company analyzed projected undiscounted cash flows and determinedthat goodwill associated with the 1997 purchase of Trotter Technologies, Inc.was impaired. Accordingly, the Company charged to earnings the entire amount ofunamortized goodwill of approximately $923,000 in 2001.  Excluding the write-off in 2001,amortization expense totaled $80,000 in 2001 and $80,000 in 2000.

 

*StockOptions.*  The Companyaccounts for its stock option grants under Accounting Principles Board OpinionNo. 25, “Accounting for Stock Issued to Employees.” Since options havebeen granted at not less than the market value on the date of grant, nocompensation expense has been recognized for the stock options granted. Asdiscussed in Note 7, the Company has a 1996 Stock Option Plan and an EmployeeStock Purchase Plan.  Had thecompensation cost of option grants been determined consistent withSFAS No. 123, “Accounting for Stock-Based Compensation,” as amendedby SFAS No. 148, Accounting for Stock-Based Compensation–Transition andDisclosure”, the Company’s income and EPS, on a pro forma basis, would havebeen reported as follows (in thousands, except per share data):

 
|               |   | **2002** |   | **2001** |   | **2000** |   |
|--------------------|--------|----------|--------|----------|--------|----------|--------|
| Net income (loss): |   |     |   |     |   |     |   |
| As reported        |   | $        | (679   | )        | $      | 9,033    |   | $ | 24,859 |   |
| Pro forma          |   | $        | (2,945 | )        | $      | 6,193    |   | $ | 24,122 |   |
|               |   |     |   |     |   |     |   |
| Basic EPS:         |   |     |   |     |   |     |   |
| As reported        |   | $        | (0.02  | )        | $      | 0.28     |   | $ | 0.78 |   |
| Pro forma          |   | $        | (0.09  | )        | $      | 0.19     |   | 0.76 |   |
|               |   |     |   |     |   |     |   |
| Diluted EPS:       |   |     |   |     |   |     |   |
| As reported        |   | $        | (0.02  | )        | $      | 0.27     |   | $ | 0.74 |   |
| Pro forma          |   | $        | (0.09  | )        | $      | 0.19     |   | $ | 0.72 |   |

 

In determining the compensation cost of the optionsgranted, as specified by SFAS No. 123, the fair value of each optiongrant has been estimated on the date of grant using the Black-Scholes optionpricing model. The weighted average assumptions used in these calculations aresummarized below:

 
|                                                |   | **2002** |   | **2001** |   | **2000** |   |
|-----------------------------------------------------|--------|----------|--------|----------|--------|----------|--------|
| Risk-free interest rate                             |   | 2.75     | %      | 5.05     | %      | 6.40     | %      |
| Expected life of options granted, in years          |   | 6.6      |   | 7.0      |   | 10.0     |   |
| Expected volatility of options granted         |   | 91.97    | %      | 94.56    | %      | 127.79   | %      |
| Weighted average fair value of options granted |   | $        | 3.82   |     | $      | 5.44     |   | $ | 19.55 |   |
|                                                     |        |          |        |          |        |          |        |  |  |  |

 

*ForeignCurrency Translation.* Zomax converts assets and liabilities of foreign operations to theirU.S. dollar equivalents at exchange rates in effect at the balance sheet dateand records related translation adjustments as a component of shareholders’equity in the consolidated balance sheets. Income statements of foreign operations are translated from theoperations’ functional currencies to U.S. dollar equivalents at averageexchange rates prevailing during the period and records the related translationadjustment to a component of shareholders’ equity.  Foreign exchange transaction gains and losses are reported inother income and expense on the consolidated statements of operations.

 

*RecentlyIssued Accounting Pronouncements.*  In April, 2002, the Financial Accounting Standards Board (“FASB”)issued Statement No. 145, “Rescission of FASB Statements No. 4, 44and 64, Amendment of FASB Statement No. 13, and TechnicalCorrections”.  This statement eliminatesextraordinary accounting treatment for a gain or loss reported on theextinguishment of debt and amends other existing authoritative pronouncementsto make technical corrections, clarify meanings, or describe theirapplicability under changed conditions. The provisions of this statement areeffective for the Company in 2003.  Theadoption of this statement is not expected to have a material impact on theCompany’s financial position or results of operations.

 

In June, 2002, the FASB issued Statement No. 146,“Accounting for Costs Associated with Exit or Disposal Activities” (“SFASNo. 146”).  This statement requiresthat the fair value of a liability associated with an exit or disposal activitybe recognized when the liability is incurred. Prior to the adoption of SFAS No. 146, certain exit costs wererecognized when a commitment was made to a restructuring plan, which may havebeen before the liability was incurred. The Company adopted the provisions ofthis statement in 2002. The adoption of SFAS No. 146 had no impact on theCompany’s financial position or results of operations.

 

In November 2002, the FASB issued FASB InterpretationNo. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees,Including Indirect Guarantees of Indebtedness of Others” (FIN 45).  FIN 45 clarifies the requirements for aguarantor’s accounting for and disclosure of certain guarantees issued andoutstanding.  The initial recognitionand initial measurement provisions of FIN 45 are applicable to guaranteesissued or modified after December 31, 2002. The disclosure requirements of FIN 45 are effective for financialstatements for periods ending after December 15, 2002.  The adoption of FIN 45 did not impact theCompany’s financial position or results of operations.

 

In December, 2002, the FASB issued StatementNo. 148, “Accounting for Stock-Based Compensation—Transition andDisclosure” (“SFAS No. 148”).  SFASNo. 148 presents additional alternatives for transitioning to the fairvalue method of accounting for stock-based compensation, prescribes the formatto be used for pro forma disclosures and requires the inclusion of similar proforma disclosures in interim financial statements.  The provisions of SFAS No. 148 are effective for the Companyin fiscal 2002.  The Company hasincluded the additional disclosures about its stock-based compensationaccounting method in the “Stock Options” section of this Note.

 

**NOTE 2.  OTHER FINANCIAL STATEMENT INFORMATION**

 

*Consolidated Balance SheetInformation (in thousands):*

 
|                                            |   | **2002** |   | **2001** |   |
|-------------------------------------------------|--------|----------|--------|----------|--------|
| *Inventories*:                                  |   |     |   |     |   |
| Raw materials                                   |   | $        | 6,910  |     | $      | 8,575 |   |
| Work in process                                 |   | 1,318    |   | 896      |   |
| Finished goods                                  |   | 1,484    |   | 1,671    |   |
|                                            |   | $        | 9,712  |     | $      | 11,142 |   |
| *Property and equipment, net*:                  |   |     |   |     |   |
| Manufacturing equipment                         |   | $        | 61,494 |     | $      | 60,160 |   |
| Office equipment                                |   | 6,187    |   | 5,683    |   |
| Land, building and leasehold improvements       |   | 7,379    |   | 7,194    |   |
|                                            |   | 75,060   |   | 73,037   |   |
| Less: Accumulated depreciation and amortization |   | (40,113  | )      | (33,124  | )      |
|                                            |   | $        | 34,947 |     | $      | 39,913 |   |
| *Accrued  expenses*:                       |   |     |   |     |   |
| Compensation and benefits                       |   | $        | 6,569  |     | $      | 5,743 |   |
| Royalties                                       |   | 10,508   |   | 6,424    |   |
| Other                                           |   | 345      |   | 1,794    |   |
|                                            |   | $        | 17,422 |     | $      | 13,961 |   |

 

*Supplemental Cash Flow Information(in thousands):*

 
|                                             |   | **2002** |   | **2001** |   | **2000** |   |
|--------------------------------------------------|--------|----------|--------|----------|--------|----------|--------|
| *Cash paid for*:                                 |   |     |   |     |   |     |   |
| Interest                                         |   | $        | 245    |     | $      | 585      |   | $ | 1,125 |   |
| Income taxes                                     |   | 1,235    |   | 6,205    |   | 1,625    |   |
| *Non-cash transactions*:                         |   |     |   |     |   |     |   |
| Unrealized gain on available-for-sale securities |   | 1,994    |   | —   |   | —   |   |
|                                                  |        |          |        |          |        |          |        |  |  |  |

 

**NOTE 3.  ACQUISITIONS AND STRATEGIC ALLIANCES**

 

*StrategicAlliance Agreement.*** **On August 12, 2002, the Companyannounced the signing of a Strategic Alliance Agreement with Intraware, Inc., aleading provider of global electronic software delivery (ESD) services. Under this agreement, the Company has an exclusive right to market and resellIntraware’s ESD services in the supply chain outsourcing market.  Theagreement has an initial term of ten years and may be cancelled earlier at the Company’s option upon one year’s notice.  Minimum fees payable under the agreement,assuming the full ten-year term and certain other conditions, are $15,000,000.

 

In addition to the strategic alliance agreement, theCompany has invested $5,000,000 in a private placement of Intraware commonstock at $0.82 per share, representing approximately 12% of the outstandingshares of Intraware.  The common stock was issued in a private placementwithout registration under the Securities Act of 1933 and may not be offered orsold in the United States absent registration or an applicable exemption fromregistration requirements.  Intraware agreed to file with the SecuritiesExchange Commission (SEC) a registration statement to register the resale ofthe common stock issued to Zomax within one year of closing, and to usecommercially reasonable efforts to cause the registration statement to bedeclared effective by the SEC as promptly as practicable.  The Company hasclassified this investment as an available-for-sale security, and accordingly,unrealized holding gains and losses are excluded from earnings and reported asa component of other comprehensive income. The market value of this investment was $7,013,000 as of December 27,2002.

 

*Investmentin Unconsolidated Entity.  *OnOctober 2, 1998, the Company acquired 4,310,345 shares of the common stock ofMicrogistix (formerly Chumbo Holdings Corporation), a private company, inexchange for cash and warrants for total consideration of $5,000,000.  In December 2001, the Company wrote off itsremaining investment in Microgistix, which amounted to $4,400,000.  Based on Microgistix’s historical operatingresults and cash flow requirements, the Company could not foresee that it wouldbe able to recover the carrying amount of its investment in Microgistix or thatMicrogistix had the ability to sustain an earnings capacity which would justifythe carrying amount of the investment.

 

Sales by the Company to Microgistix were $3,863,000,$4,877,000, and $6,097,000 in 2002, 2001, and 2000, respectively.  Microgistix accounts receivable balancestotaled $773,000, $1,140,000, and $2,222,000 in 2002, 2001, and 2000,respectively.  The Company haseliminated unrealized profit associated with sales to Microgistix to the extentof its equity interest.

 

**NOTE 4.  CREDIT FACILITIES AND LONG-TERM NOTES PAYABLE**

 

The Company has a $15,000,000 term loan facility and a$25,000,000 revolving line-of-credit facility. The term loan facility requiresquarterly principal payments of $750,000 on a straight-line amortizationschedule. The interest rate is at the lower of prime plus 0.75 percent orLIBOR plus 2.25 percent (3.63 percent at December 27, 2002). Therevolving line-of-credit facility provides for borrowings based on a formulausing eligible accounts receivable and inventories with interest rates of primeplus 0.5 percent or LIBOR plus 2.00 percent (3.38 percent atDecember 27, 2002). Both facilities have five-year terms and containcertain financial covenants, the most restrictive of which involve limitationson capital expenditures and debt relative to adjusted earnings.  The Company was in compliance with suchcovenants as of December 27, 2002.

 

The amount outstanding on the term loan facility atthe end of 2002 and 2001 was $3,736,000 and $6,696,000, respectively. TheCompany had no borrowings outstanding under the revolving line-of-creditfacility at the end of 2002 or 2001.

 

Future scheduled maturities of long-term debt are asfollows as of December 27, 2002 (in thousands):

 
| 2003                                                 |   | $      | 2,989  |   |
|------------------------------------------------------|--------|--------|--------|--------|
| 2004                                                 |   | 747    |   |
| Total                                                |   | 3,736  |   |
| Less current portion                                 |   | (2,989 | )      |
| Long-term notes payable, net of current portion |   | $      | 747    |   |

 

**NOTE 5.  SHAREHOLDERS’ EQUITY**

 

*StockSplit:*  On May 8,2000, the Company’s Board of Directors approved a 2-for-1 stock split effectedas a stock dividend to shareholders. Accordingly, all per share and share outstanding data in theconsolidated financial statements and related notes have been retroactivelyrestated.

 

*StockRepurchase Plans*.  InOctober 2002, the Company’s Board of Directors authorized a stock repurchaseplan that allows the Company to repurchase up to $10,000,000 of the Company’scommon stock.  The Company repurchased atotal of 118,300 shares at a cost of $464,000 during 2002.  In addition, in the first quarter of 2003,the Company repurchased a total of 761,900 shares for a total cost of$2,579,000.  This plan superceded a planauthorized by the Company’s Board of Directors in October 2000.  Under the plan authorized in 2000, theCompany repurchased a total of 800,200 shares at a cost of $5,040,000.

 

*Warrants. *In October 2001, 400,000outstanding warrants were exercised at $5.00 per share.

 

**NOTE 6.  COMPREHENSIVE INCOME**

 

The table below presents comprehensive income, definedas changes in the equity of the Company excluding changes resulting frominvestments by and distributions to shareholders (in thousands):

 
|                                                                  |   | **2002** |   | **2001** |   | **2000** |   |
|-----------------------------------------------------------------------|--------|----------|--------|----------|--------|----------|--------|
| Net income (loss)                                                     |   | $        | (679   | )        | $      | 9,033    |   | $ | 24,859 |   |
| Unrealized holding gain on available-for-sale  securities, net of tax |   | 1,275    |   | —   |   | —   |   |
| Translation adjustments                                               |   | 4,672    |   | (1,462   | )      | (1,697   | )      |
| Comprehensive income                                                  |   | $        | 5,268  |     | $      | 7,571    |   | $ | 23,162 |   |

 

**NOTE 7.  STOCK PLANS**

 

*EmployeeStock Purchase Plan*. The Company has an employee stock purchase plan, which enables employeesto contribute up to 10 percent of their compensation toward the purchaseof the Company’s common stock at a price equal to the lower of 85 percentof fair market value as of the beginning or end of each plan period.  A total of 2,000,000 shares have beenreserved for issuance under this plan. Shares issued under the plan totaledapproximately 188,000 in 2002, 339,000 in 2001, and 143,000 in 2000.

 

*StockOption Plan*.  TheCompany has a 1996 Stock Option Plan (the “Plan”) to provide for the grantingof stock options to employees, officers, directors and independent consultantsof the Company at exercise prices not less than 100 percent of the fairmarket value of the Company’s common stock on the date of grant.  The authorized number of shares reserved forissuance total 6,400,000, of which 453,830 remained available for grant atDecember 27, 2002.  These options,which can be either incentive stock options or nonqualified options, vest overa three- to five-year schedule and expire 10 years after the grant date.

 

The Company has also issued nonqualified stock optionsoutside of the Plan for the purchase of 1,593,000 shares of common stock, ofwhich 1,338,000 option shares are outstanding as of December 27, 2002.  These options were issued at the fair marketvalue of the Company’s stock on the date of grant and vest over a four- tofive-year schedule.  Included in thesegrants are 693,000 option sharesgranted in 2001 to certain officers of the Company.  These options were granted subject to shareholder approval andtherefore were subject to variable plan accounting pursuant to FASBInterpretation No. 44, “Accounting for Certain Transactions InvolvingStock Compensation (an Interpretation of APB Opinion No. 25).”  The Company is required to recognizecompensation expense equal to the amount by which the quoted market value ofthe Company stock exceeds the exercise price of the option, prorated for thelength of time the grants have been outstanding.  The variable plan accounting ceased when the shareholders approvedthe granting of the options on April 24, 2002. The Company recognized a compensation benefit related to these optionsof $32,000 in 2002 and compensation expense related to these options of  $261,000 in 2001, which is reflected inselling, general and administrative expenses in the consolidated statements ofoperations.

 

Information regarding all stock option activity duringthe year is summarized as follows (shares in thousands):

 
|                                   |   | **2002**   |   | **2001**                              |   | **2000**   |   |
|----------------------------------------|--------|------------|--------|---------------------------------------|--------|------------|--------|
|                                   |   | **Shares** |   | **Weighted  Average  Exercise Price** |   | **Shares** |   | **Weighted  Average  Exercise Price** |   | **Shares** |   | **Weighted  Average  Exercise Price** |   |
|                                   |   |       |   |                                  |   |       |   |   |   |   |   |   |   |
| Options outstanding, beginning of year |   | 3,849      |   | $                                     | 7.07   |       | 2,268  |   | $ | 7.40 |   | 3,210 |   | $ | 2.63 |   |
| Granted                                |   | 545        |   | 4.86                                  |   | 2,312      |   | 6.20 |   | 1,160 |   | 20.63 |   |
| Exercised                              |   | (126       | )      | 2.56                                  |   | (357       | )      | 2.12 |   | (1,410 | ) | 2.04 |   |
| Canceled                               |   | (594       | )      | 15.72                                 |   | (374       | )      | 13.59 |   | (692 | ) | 22.60 |   |
| Options outstanding, end of year       |   | 3,674      |   | $                                     | 5.07   |       | 3,849  |   | $ | 7.07 |   | 2,268 |   | $ | 7.40 |   |
|                                   |   |       |   |                                  |   |       |   |   |   |   |   |   |   |
| Options exercisable, end of year       |   | 1,337      |   | $                                     | 4.14   |       | 926    |   | $ | 3.40 |   | 690 |   | $ | 3.30 |   |

 

Information regarding all outstanding stock options asof December 27, 2002 is summarized as follows (shares in thousands):

 
|                         |   |     |                                              | **Options Outstanding** |   | **Options Exercisable**      |   |
|------------------------------|--------|----------|---------------------------------------------------|-------------------------|--------|------------------------------|--------|
|                         |   |     | **Weighted  Average  Remaining  Life (in years)** |                    |   |                         |   |   |   |   |
|                         |   |     | **Weighted  Average  Exercise Price**             |                    |   |                         |
| **Range of Exercise Prices** |   |     |                                              |                    |   | **Avera4ge  Exercise Price** |   |
| **Low**                      |   | **High** |                                              | **Shares**              |   |                         |   | **Shares** |   |   |
|                         |   |     |                                              |                    |   |                         |   |   |   |   |   |   |   |
| $                            | 1.13   |     | $                                                 | 2.81                    |   | 746                          |   | 4.6 |   | $ | 2.16 |   | 716 |   | $ | 2.14 |   |
| 3.41                         |   | 5.97     |                                              | 2,480                   |   | 8.3                          |   | 5.33 |   | 453 |   | 5.17 |   |
| 6.03                         |   | 8.55     |                                              | 399                     |   | 8.2                          |   | 6.99 |   | 129 |   | 6.55 |   |
| 17.19                        |   | 24.13    |                                              | 49                      |   | 7.1                          |   | 20.89 |   | 39 |   | 20.84 |   |
|                         |   |     |                                              | 3,674                   |   | 7.5                          |   | $ | 5.07 |   | 1,337 |   | $ | 4.14 |   |
|                              |        |          |                                                   |                         |        |                              |        |  |  |  |  |  |  |  |  |  |  |  |  |

 

**NOTE 8.  INCOME TAXES**

 

Details regarding the income tax expense (benefit)included in the statement of operations are as follows (in thousands):

 
|                               |   | **2002** |   | **2001** |   | **2000** |   |
|------------------------------------|--------|----------|--------|----------|--------|----------|--------|
| Current:                           |   |     |   |     |   |     |   |
| Federal                            |   | $        | (815   | )        | $      | 5,776    |   | $ | 8,607 |   |
| State                              |   | (142     | )      | 738      |   | 1,284    |   |
| Foreign                            |   | 876      |   | 1,059    |   | 2,522    |   |
|                               |   | (81      | )      | 7,573    |   | 12,413   |   |
| Deferred                           |   | (492     | )      | (2,352   | )      | 1,179    |   |
| Total income tax expense (benefit) |   | $        | (573   | )        | $      | 5,221    |   | $ | 13,592 |   |

 

The provision for foreign income taxes is based uponforeign pretax income of approximately $2,104,000, $4,500,000, and $12,300,000in 2002, 2001, and 2000, respectively.

 

A reconciliation of the statutory federal income taxrate to the Company’s effective income tax rate is as follows:

 
|                                                        |   | **2002** |   | **2001** |   | **2000** |   |
|-------------------------------------------------------------|--------|----------|--------|----------|--------|----------|--------|
| Statutory federal income tax rate                           |   | 34.0     | %      | 34.0     | %      | 34.0     | %      |
| State income taxes, net of federal income  tax benefit |   | 4.1      |   | 3.2      |   | 0.5      |   |
| Effects of unconsolidated entity                            |   | —   |   | (8.8     | )      | 1.3      |   |
| Foreign tax effect                                          |   | (7.8     | )      | (1.8     | )      | (3.4     | )      |
| Valuation allowance                                         |   | —   |   | 11.3     |   | —   |   |
| Tax deductible goodwill                                     |   | 12.8     |   | —   |   | —   |   |
| Other                                                       |   | 2.7      |   | (1.3     | )      | 2.9      |   |
| Effective income tax rate                                   |   | 45.8     | %      | 36.6     | %      | 35.3     | %      |

 

The components of the deferred tax asset (liability)were as follows (in thousands):

 
|                                           |   | **2002** |   | **2001** |   |
|------------------------------------------------|--------|----------|--------|----------|--------|
| Current:                                       |   |     |   |     |   |
| Accounts receivable reserves                   |   | $        | 565    |     | $      | 749 |   |
| Inventory valuation                            |   | 967      |   | 582      |   |
| Accrued liabilities                            |   | 719      |   | 1,302    |   |
| Other                                          |   | 304      |   | 550      |   |
| Total current deferred tax asset          |   | $        | 2,555  |     | $      | 3,183 |   |
| Long-term:                                     |   |     |   |     |   |
| Depreciation and amortization                  |   | $        | (906   | )        | $      | (1,744 | ) |
| Unrealized gain on available-for-sale security |   | (780     | )      | —   |   |
| Foreign tax credit                             |   | 844      |   | —   |   |
| Capital loss carryforward                      |   | 1,610    |   | 1,610    |   |
| Valuation allowance                            |   | (1,610   | )      | (1,610   | )      |
| Other                                          |   | 218      |   | —   |   |
| Total long-term deferred tax liability    |   | $        | (624   | )        | $      | (1,744 | ) |

 

The Company has not recordeddeferred income taxes applicable to undistributed earnings of its non-U.S.subsidiaries as all such earnings are deemed to be indefinitely reinvested inthose operations. If earnings of these non-U.S. subsidiaries were notindefinitely reinvested, a deferred liability would have been required,however, it is not practicable to determine such amount.

 

**NOTE 9.  RELATED-PARTY TRANSACTIONS**

 

*OperatingLease. *The Company leasesone of its manufacturing and office facilities from a partnership that isone-third owned by a significant shareholder and director of the Company. TheCompany believes the terms are equivalent to those that would be paid in anarm’s-length transaction. Lease payments totaled $649,000 in 2002, $649,000 in2001, and $641,000 in 2000.

 

*Salesto Related Party.*  Oneof the Company’s customers is owned by a significant shareholder and directorof the Company.  The Company believesthe terms of sale are equivalent to those offered to all customers for similarservices and volume of business.  Salesto this customer were $241,000 in 2002, of which $48,000 was owed the Companyat December 27, 2002.

 

**NOTE 10.  COMMITMENTS AND CONTINGENCIES**

 

*OperatingLeases*.  The Companyis committed under operating leases with related and unrelated parties for therental of manufacturing, warehouse and office facilities.  Future minimum lease obligations as ofDecember 27, 2002 are as follows (in thousands):

 
| 2003       |   | $      | 4,655  |   |
|------------|--------|--------|--------|--------|
| 2004       |   | 3,442  |   |
| 2005       |   | 3,453  |   |
| 2006       |   | 2,601  |   |
| Thereafter |   | 28,637 |   |
|       |   | $      | 42,788 |   |

 

The Company has also guaranteed a lease related to itsoperations in Juarez, Mexico.  Totalpayments under this lease are $316,000 through June 2004.  Rent expense under operating leases,exclusive of real estate taxes, insurance and maintenance expense was$6,998,000 in 2002, $5,480,000 in 2001, and $7,849,000 in 2000.

 

*Ireland Employment Grants*.  TheCompany and the Ireland businesses it acquired have received employment grantsfrom the Ireland Development Authority (IDA) totaling $3,454,000 during theperiod from 1995 through 2000. The Company recognizes income from the grants ona straight-line basis and includes the income in selling, general andadministrative expenses in the consolidated statements of operations.  These grants were awarded by the IDA forcreating and maintaining permanent employment positions in Ireland for a periodof at least five years.  Termination ofany number of these positions within a five-year period may result in the prorata return of the grants based on the number of positions terminated comparedto the number of new positions originally created, at the election of theIDA.  At December 27, 2002, the Companyhad reduced employment levels in Ireland below the levels for which the Companyhad received grants.  The IDA hasinformed the Company that it does not intend to seek repayment of any grantmonies at this time or in the foreseeable future, and accordingly, the Companyhas not provided for such repayment in its financial statements.  As of December 27, 2002, the Company’sestimate of the amount of grants for which repayment could be requested totaled$145,000.

 

*401(k)Plan.*  The Company hasa discretionary 401(k) plan for all employees who are at least 21 years of ageand have completed 60 days of service with the Company.  The Company’s discretionary contributionstotaled $326,000 in 2002, $301,000 in 2001, and $665,000 in 2000.

 

*Litigation*.  On February 21, 2002, the Company signed anAsset Purchase Agreement (“APA”) to purchase the business and substantially allthe assets of Software Logistics Corporation (“iLogistix”).  iLogistix provides supply chain services totechnology companies and has operating facilities in the United States,Netherlands, Singapore, Taiwan, Mexico, Ireland and Brazil.

 

The closing of the transaction was scheduled forFebruary 28, 2002, subject to significant closing conditions.  As of March 19, 2002, certain significantconditions to closing were not satisfied by iLogistix; therefore, the Companyterminated the APA.  The Companyincurred and expensed transaction costs of $1.3 million, net of tax, orapproximately $.04 cents per share.  TheCompany also deposited $3.9 million in an escrow account, which the Companybelieves iLogistix is required to refund with interest.  This escrow is recorded in other currentassets in the Company’s consolidated balance sheet.

 

On March 19, 2002, iLogistix filed a lawsuit in aUnited States Bankruptcy Court for specific performance under the APA and forunspecified damages and declaratory relief. Subsequently, iLogistix dismissed its claim for specificperformance.  The Company has submittedan answer to iLogistix’ legal action averring that the APA had been properlyterminated and that the legal action by iLogistix is without merit.

 

On July 11, 2002, iLogistix sold substantially all ofits assets to CMGI for consideration in excess of the amount under the Zomaxcontract.  Zomax has demanded a returnof the $3.9 million deposit, accrued interest, payment of certain legal feesand payment of the break-up fee.

 

On or about October 28, 2002the Bankruptcy Court granted Zomax authority to file a counterclaim in theadversary proceeding, including, in particular, claims for a break-up fee andattorney’s fees.  On December 26, 2002,Zomax filed a motion for summary judgment in the case with the Court.

 

On March 13, 2003, Zomax andiLogistix reached a settlement whereby the $3.9 million deposit plus allaccrued interest thereon will be paid to Zomax, and both parties will drop allother claims and actions arising out of the APA.  This settlement agreement will be presented to the Court at ahearing scheduled for April 3, 2003. If, as expected, the settlement agreement is approved by the Court, thedeposit plus accrued interest would be returned soon thereafter.

 

The Company previously announced that the Securitiesand Exchange Commission is conducting a preliminary investigation into thetrading of Zomax securities by insiders. The Company is cooperating with the SEC in its investigation.  The SEC has not indicated when it expectsthe investigation to be concluded.

 

The Company is involved in various other claimsarising in the normal course of business. In management’s opinion, the finalresolution of these claims should not have a material adverse effect on theCompany’s financial position, results of its operations or cash flows.

 

**NOTE11.  QUARTERLY FINANCIAL DATA(UNAUDITED)**

 

Unaudited quarterly data is as follows (in thousands,except per share data):

 
|                              |   | **Quarter Ended** |   |
|-----------------------------------|--------|-------------------|--------|
|                              |   | **March**         |   | **June** |   | **September** |   | **December** |   |
| **2002:**                         |   |              |   |   |   |   |   |   |   |
| Sales                             |   | $                 | 45,985 |   | $ | 45,360 |   | $ | 43,719 |   | $ | 50,436 |   |
| Gross profit                      |   | 8,944             |   | 8,479 |   | 7,930 |   | 7,459 |   |
| Operating income (loss)           |   | (1,507            | )      | 1,109 |   | (1,033 | ) | (1,021 | ) |
| Net income (loss)                 |   | (785              | )      | 855 |   | (474 | ) | (275 | ) |
| Basic earnings (loss) per share   |   | (0.02             | )      | 0.03 |   | (0.01 | ) | (0.01 | ) |
| Diluted earnings (loss) per share |   | (0.02             | )      | 0.03 |   | (0.01 | ) | (0.01 | ) |
|                                   |        |                   |        |  |  |  |  |  |  |  |  |  |  |

 
|                              |   | **Quarter Ended** |   |
|-----------------------------------|--------|-------------------|--------|
|                              |   | **March**         |   | **June** |   | **September** |   | **December** |   |
| **2001:**                         |   |              |   |   |   |   |   |   |   |
| Sales                             |   | $                 | 62,796 |   | $ | 51,815 |   | $ | 45,829 |   | $ | 56,357 |   |
| Gross profit                      |   | 14,873            |   | 12,928 |   | 9,752 |   | 12,556 |   |
| Operating income                  |   | 6,372             |   | 5,133 |   | 2,317 |   | 3,400 |   |
| Net income (loss)                 |   | 4,214             |   | 3,483 |   | 1,865 |   | (529 | ) |
| Basic earnings (loss) per share   |   | 0.13              |   | 0.11 |   | 0.06 |   | (0.02 | ) |
| Diluted earnings (loss) per share |   | 0.13              |   | 0.11 |   | 0.06 |   | (0.02 | ) |
|                                   |        |                   |        |  |  |  |  |  |  |  |  |  |  |

 

Non-cash charges recorded in the fourth quarter of2002 include a $1,352,000 pretax write-down of the Company’s existing callcenter systems as a result of the replacement of those systems starting duringthat quarter, and $700,000 of royalty costs related to the third quarterresulting from an adjustment in the fourth quarter, retroactive to July 1,2002, of the rate used to accrue royalties under the Company’s licenseagreement with Philips Corporation.

 

Non-cash charges recorded in the fourth quarter of2001 totaled $3,480,000, net of tax, or $0.11 per share, of which $2,926,000relates to the write-off of the Company’s investment in an unconsolidatedbusiness and $554,000 relates to the write-off of goodwill recorded as part ofa 1997 acquisition.

 

**NOTE 12.  SEGMENT AND GEOGRAPHICAL INFORMATION**

 

The Company operates in one industry segment. Thegeographic distributions of the Company’s identifiable assets, operating incomeand revenues for 2002, 2001 and 2000 are summarized as follows (in thousands):

 
|                               |   | **2002** |    | **2001** |   | **2000** |   |
|------------------------------------|--------|----------|---------|----------|--------|----------|--------|
| **Sales:**                         |   |     |    |     |   |     |   |
| United States                      |   | $        | 165,264 |     | $      | 176,279  |   | $ | 170,852 |   |
| Europe                             |   | 29,926   |    | 44,451   |   | 62,646   |   |
| Canada                             |   | 26,813   |    | 20,663   |   | 22,108   |   |
| Intergeographic sales              |   | (36,503  | )       | (24,596  | )      | (16,516  | )      |
|                               |   | $        | 185,500 |     | $      | 216,797  |   | $ | 239,090 |   |
| **Operating income (loss):**       |   |     |    |     |   |     |   |
| United States                      |   | $        | 8,931   |     | $      | 20,591   |   | $ | 32,406 |   |
| Europe                             |   | (381     | )       | 1,720    |   | 7,627    |   |
| Canada                             |   | 3,427    |    | 3,512    |   | 5,861    |   |
| Corporate and eliminations    |   | (14,429  | )       | (8,601   | )      | (7,900   | )      |
|                               |   | $        | (2,452  | )        | $      | 17,222   |   | $ | 37,994 |   |
| **Assets:**                        |   |     |    |     |   |     |   |
| United States                      |   | $        | 49,390  |     | $      | 51,008   |   | $ | 58,119 |   |
| Europe                             |   | 25,174   |    | 35,732   |   | 39,965   |   |
| Canada                             |   | 17,519   |    | 15,713   |   | 17,835   |   |
| Total identifiable assets          |   | 92,083   |    | 102,453  |   | 115,919  |   |
| Corporate assets and eliminations  |   | 75,100   |    | 61,053   |   | 52,016   |   |
|                               |   | $        | 167,183 |     | $      | 163,506  |   | $ | 167,935 |   |
| **Capital expenditures:**          |   |     |    |     |   |     |   |
| United States                      |   | $        | 2,611   |     | $      | 1,315    |   | $ | 7,675 |   |
| Europe                             |   | 79       |    | 3,330    |   | 3,592    |   |
| Canada                             |   | 260      |    | 289      |   | 3,016    |   |
|                               |   | $        | 2,950   |     | $      | 4,934    |   | $ | 14,283 |   |
| **Depreciation and amortization:** |   |     |    |     |   |     |   |
| United States                      |   | $        | 5,936   |     | $      | 7,407    |   | $ | 7,108 |   |
| Europe                             |   | 1,168    |    | 1,806    |   | 1,679    |   |
| Canada                             |   | 1,245    |    | 1,230    |   | 971      |   |
|                               |   | $        | 8,349   |     | $      | 10,443   |   | $ | 9,758 |   |

 

**ITEM 9.CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIALDISCLOSURE**

 

On June 24, 2002, the Audit Committee of the Board ofDirectors of the Company ceased its client-auditor relationship with ArthurAndersen LLP (“Andersen”) as the Company’s independent public accountants,effective immediately on that date.

 

The audit reports of Andersen on theconsolidated financial statements of the Company for the fiscal years endedDecember 28, 2001 and December 29, 2000, did not contain any adverse opinion ordisclaimer of opinion, nor were they qualified or modified as to uncertainty,audit scope or accounting principles.

 

During the Company’s fiscal years ended December 28,2001 and December 29, 2000, and the subsequent interim period ended June 24,2002, (a) there were no disagreements with Andersen on any matter ofaccounting principles or practices, financial statement disclosure, or auditingscope or procedure which, if not resolved to Andersen’s satisfaction, wouldhave caused Andersen to make reference to the subject matter of suchdisagreement in connection with Andersen’s reports on the Company’sconsolidated financial statements for such years; and (b) there were noreportable events as listed in Item 304(a)(1)(v) of Regulation S-K.

 

Also on June 24, 2002, the Audit Committee of theBoard of Directors of Zomax, appointed Deloitte & Touche LLP as theCompany’s independent public auditors for the Company’s fiscal year endingDecember 27, 2002, effective immediately.

 

**PART III**

 

**ITEM 10.  DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT**

 

Theinformation concerning the Company’s directors and executive officers andcompliance with Section 16(a) required by this item is contained in thesections entitled “Election of Directors,” “Executive Officers of the Company”and “Compliance with Section 16(a) of the Exchange Act,” appearing in theCompany’s Proxy Statement to be delivered to stockholders in connection withthe Annual Meeting of Stockholders to be held on April 30, 2003.  Such information is incorporated herein byreference.

 

**ITEM 11.  EXECUTIVE COMPENSATION**

 

Theinformation required by this item is contained in the section entitled  “Executive Compensation” appearing in theCompany’s Proxy Statement to be delivered to stockholders in connection withthe Annual Meeting of Stockholders to be held on April 30, 2003.  Such information is incorporated herein byreference.

 

**ITEM 12.  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENTAND RELATED SHAREHOLDER MATTERS**

 

The information required by thisitem relating to the security ownership of certain holders is contained in thesection entitled “Principal Shareholders and Management Shareholdings”appearing in the Company’s Proxy Statement to be delivered to stockholders inconnection with the Annual Meeting of Stockholders to be held on April 30, 2003.  Such information is incorporated herein byreference.

 

The following tablesummarizes the Company’s equity compensation plan information as of December27, 2002.

 
| **Plan Category**                                              |   | **Number of Securities to be  issued upon exercise of  outstanding options** |   | **Weighted average exercise  price of outstanding options** |   | **Number of securities  remaining available for  future issuance** |      |
|----------------------------------------------------------------|--------|------------------------------------------------------------------------------|--------|-------------------------------------------------------------|--------|--------------------------------------------------------------------|-----------|
| Equity compensation plans approved by security holders(1)      |   | 3,029,220                                                                    |   | $                                                           | 5.19   |                                                               | 1,539,830 |   |
| Equity  compensation plans not approved by security holders(2) |   | 645,000                                                                      |   | $                                                           | 4.55   |                                                               | n/a       |   |
| Total                                                          |   | 3,674,220                                                                    |   | $                                                           | 5.07   |                                                               | 1,539,830 |   |

 

----

(1)   Plan category includes the Company’s 1996Stock Option Plan (the “1996 Plan”), stock options granted outside of the 1996Plan that have subsequently been approved by shareholders, and the Company’s1996 Employee Stock Purchase Plan.

(2)   Plan category includes stock options thathave been granted to employees outside of the Company’s 1996 Plan due to aninsufficient number of shares available under the 1996 Plan.  The agreements with respect to these optionsare substantially the same as agreements with respect to options under the 1996Plan and generally provide for a ten-year term with vesting over a period offive years.

 

**ITEM 13.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS**

 

Theinformation required by this item is contained in the section entitled “CertainTransactions” appearing in the Company’s Proxy Statement to be delivered tostockholders in connection with the Annual Meeting of Stockholders to be heldon April 30, 2003.  Such information isincorporated herein by reference.

 

**ITEM14.  CONTROLS AND PROCEDURES**

 

Within the 90-dayperiod prior to the filing of this Annual Report on Form 10-K, anevaluation was carried out under the supervision and with the participation ofthe Company’s management, including the Company’s Chief Executive Officer(“CEO”) and Chief Financial Officer (“CFO”), of the effectiveness of theCompany’s disclosure controls and procedures. Disclosure controls and procedures are procedures that are designed withthe objective of ensuring that information required to be disclosed in theCompany’s reports filed under the Securities Exchange Act of 1934, such as thisForm 10-K, is recorded, processed, summarized and reported within the timeperiods specified in the Securities and Exchange Commission’s rules andforms.  Based on that evaluation, theCompany’s CEO and CFO have concluded that the Company’s disclosure controls andprocedures are effective to satisfy the objectives for which they are intended.  Subsequent to the date of management’sevaluation, there were no significant changes in the Company’s internalcontrols or in other factors that could significantly affect these controls,including any corrective actions with regard to significant deficiencies andmaterial weaknesses.

 

**PART IV**

 

**ITEM 15.  EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K**

 

(a)   List of FinancialStatements, Financial Statement Schedules and Exhibits

 

(1)   *Financial Statements*.  The following consolidated financialstatements of the Company are filed with this report and can be found at Item 8of this Form 10-K:

 
| Report of current  Independent Auditors dated February 18, 2003                                                                    |
|------------------------------------------------------------------------------------------------------------------------------------|
|                                                                                                                               |
| Report of  former Independent Public Accountants dated January 25, 2002                                                            |
|                                                                                                                               |
| Consolidated  Statements of Operations for Years Ended  December 27, 2002, December 28, 2001, and December 29, 2000                |
|                                                                                                                               |
| Consolidated Balance Sheets  as of December 27, 2002 and December 28, 2001                                                         |
|                                                                                                                               |
| Consolidated  Statements of Shareholders’ Equity for  Years Ended December 27, 2002, December 28, 2001, and December 29, 2000 |
|                                                                                                                               |
| Consolidated  Statements of Cash Flows for Years Ended December 27, 2002, December 28,  2001, and December 29, 2000                |
|                                                                                                                               |
| Notes to Consolidated  Financial Statements                                                                                        |

 

(2)   *FinancialStatement Schedules*.  Allschedules for which provision is made in the applicable accounting regulationsof the SEC have been omitted as not required or not applicable, or theinformation required has been included elsewhere by reference in the financialstatements and related notes, except for Schedule II, which is included asExhibits 99.3 and 99.4 to this Form 10-K, as filed with the SEC.

 

(3)   *Exhibits*.  See “Exhibit Index” on page 36 of this Form10-K for a description of the documents that are filed as Exhibits to thisreport on Form 10-K or incorporated by reference herein.

 

(b)   Reports onForm 8-K.

 

The Company filed a Form8-K dated October 18, 2002 to report the Securities and Exchange Commission’spreliminary investigation into insider trading of the Company’s stock and theCompany’s third quarter results.

 

The Company filed a Form8-K dated March 26, 2003, to report an adjustment to its 2002 year end resultsthat were previously announced on February 12, 2003.

 

(c)   See Item15(a)(3) above.

 

(d)   See Item 15(a)(2)above.

 

**SIGNATURES**

 

In accordance with Section 13 or 15(d) of the ExchangeAct, the registrant caused this report to be signed on its behalf by theundersigned, thereunto duly authorized.

 
| Date:  March 27, 2003 | **ZOMAX  INCORPORATED** |
|----------------------------|-------------------------|
|                       |                    |
|                       | By                      | /s/ James T.  Anderson |   |
|                       |                    | James T.  Anderson |
|                       |                    | Chairman and  Chief Executive Officer |

 

In accordance with the Exchange Act, this report hasbeen signed below by the following persons on behalf of the registrant and inthe capacities and on the dates indicated below.

 

Each person whose signature appears below constitutesand appoints James T. Anderson and John Gelp as the undersigned’s true andlawful attorneys-in fact and agents, each acting alone, with full power ofsubstitution and resubstitution, for the undersigned and in the undersigned’sname, place and stead, in any and all amendments to this Annual Report on Form10-K and to file the same, with all exhibits thereto, and other documents inconnection therewith, with the Securities and Exchange Commission, granted untosaid attorneys-in-fact and agents, each acting alone, full power and authorityto do and perform each and every act and thing requisite and necessary to bedone in and about the premises, as fully to all intents and purposes as theundersigned might or could do in person, hereby ratifying and confirming allsaid attorneys-in-fact and agents, each acting alone, or his substitute orsubstitutes, may lawfully do or cause to be done by virtue thereof.

 
| **Name**                  |   | **Title**                                                        |   | **Date**       |
|---------------------------|--------|------------------------------------------------------------------|--------|----------------|
|                      |   |                                                             |   |           |
| /s/James T.  Anderson     |   | Chairman of the  Board and Chief Executive Officer               |   | March 27, 2003 |
| James T.  Anderson        |   | (principal  executive officer)                                   |   |           |
|                      |   |                                                             |   |           |
|                      |   |                                                             |   |           |
| /s/Anthony  Angelini      |   | President, Chief  Operating Officer and Director                 |   | March 27, 2003 |
| Anthony Angelini          |   |                                                             |   |           |
|                      |   |                                                             |   |           |
|                      |   |                                                             |   |           |
| /s/John Gelp              |   | Executive Vice  President, Chief Financial Officer and Secretary |   | March 27, 2003 |
| John Gelp                 |   | (principal  financial and accounting officer)                    |   |           |
|                      |   |                                                             |   |           |
|                      |   |                                                             |   |           |
| /s/Phillip T.  Levin      |   | Director                                                         |   | March 27, 2003 |
| Phillip T. Levin          |   |                                                             |   |           |
|                      |   |                                                             |   |           |
|                      |   |                                                             |   |           |
| /s/Robert Ezrilov         |   | Director                                                         |   | March 27, 2003 |
| Robert Ezrilov            |   |                                                             |   |           |
|                      |   |                                                             |   |           |
|                      |   |                                                             |   |           |
| /s/Howard P.  Liszt       |   | Director                                                         |   | March 27, 2003 |
| Howard P. Liszt           |   |                                                             |   |           |
|                      |   |                                                             |   |           |
|                      |   |                                                             |   |           |
| /s/Janice  Ozzello Wilcox |   | Director                                                         |   | March 27, 2003 |
| Janice Ozzello  Wilcox    |   |                                                             |   |           |

 

**SARBANES-OXLEY SECTION302 CERTIFICATION**

 

I,James T. Anderson, certify that:

 

1.      I have reviewed this Annual Report on Form10-K of Zomax Incorporated;

 

2.     Based on my knowledge, this Annual Reportdoes not contain any untrue statement of a material fact or omit to state amaterial fact necessary to make the statements made, in light of thecircumstances under which such statements were made, not misleading withrespect to the period covered by this Annual Report;

 

3.     Based on my knowledge, the financialstatements, and other financial information included in this Annual Report,fairly present in all material respects the financial condition, results ofoperations and cash flows of the registrant as of, and for, the periodspresented in this Annual Report;

 

4.     The registrant’s other certifying officerand I are responsible for establishing and maintaining disclosure controls andprocedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for theregistrant and we have:

 

a)     designedsuch disclosure controls and procedures to ensure that material informationrelating to the registrant, including its consolidated subsidiaries, is madeknown to us by others within those entities, particularly during the period inwhich this Annual Report is being prepared;

 

b)    evaluatedthe effectiveness of the registrant’s disclosure controls and procedures as ofa date within 90 days prior to the filing date of this Annual Report (the“Evaluation Date”); and

 

c)     presentedin this Annual Report our conclusions about the effectiveness of the disclosurecontrols and procedures based on our evaluation as of the Evaluation Date;

 

5.     The registrant’s other certifying officerand I have disclosed, based on our most recent evaluation, to the registrant’sauditors and the audit committee of registrant’s board of directors (or personsperforming the equivalent function):

 

a)     allsignificant deficiencies in the design or operation of internal controls whichcould adversely affect the registrant’s ability to record, process, summarizeand report financial data and have identified for the registrant’s auditors anymaterial weaknesses in internal controls; and

 

b)    anyfraud, whether or not material, that involves management or other employees whohave a significant role in the registrant’s internal controls; and

 

6.     The registrant’s other certifying officerand I have indicated in this Annual Report whether or not there weresignificant changes in internal controls or in other factors that couldsignificantly affect internal controls subsequent to the date of our mostrecent evaluation, including any corrective actions with regard to significantdeficiencies and material weaknesses.

 

 
| Date:  March 27, 2003 | /s/ James T. Anderson                |   |
|----------------------------|--------------------------------------|--------|
|                       | James T. Anderson                    |
|                       | Chairman and Chief Executive Officer |

 

**SARBANES-OXLEY SECTION302 CERTIFICATION**

 

I,John Gelp, certify that:

 

1.     I have reviewed this Annual Report on Form10-K of Zomax Incorporated;

 

2.     Based on my knowledge, this Annual Reportdoes not contain any untrue statement of a material fact or omit to state amaterial fact necessary to make the statements made, in light of thecircumstances under which such statements were made, not misleading withrespect to the period covered by this Annual Report;

 

3.     Based on my knowledge, the financialstatements, and other financial information included in this Annual Report,fairly present in all material respects the financial condition, results ofoperations and cash flows of the registrant as of, and for, the periodspresented in this Annual Report;

 

4.     The registrant’s other certifying officerand I are responsible for establishing and maintaining disclosure controls andprocedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for theregistrant and we have:

 

a)     designedsuch disclosure controls and procedures to ensure that material informationrelating to the registrant, including its consolidated subsidiaries, is madeknown to us by others within those entities, particularly during the period inwhich this Annual Report is being prepared;

 

b)    evaluatedthe effectiveness of the registrant’s disclosure controls and procedures as ofa date within 90 days prior to the filing date of this Annual Report (the“Evaluation Date”); and

 

c)     presentedin this Annual Report our conclusions about the effectiveness of the disclosurecontrols and procedures based on our evaluation as of the Evaluation Date;

 

5.     The registrant’s other certifying officerand I have disclosed, based on our most recent evaluation, to the registrant’sauditors and the audit committee of registrant’s board of directors (or personsperforming the equivalent function):

 

a)     allsignificant deficiencies in the design or operation of internal controls whichcould adversely affect the registrant’s ability to record, process, summarizeand report financial data and have identified for the registrant’s auditors anymaterial weaknesses in internal controls; and

 

b)    anyfraud, whether or not material, that involves management or other employees whohave a significant role in the registrant’s internal controls; and

 

6.     The registrant’s other certifying officerand I have indicated in this Annual Report whether or not there weresignificant changes in internal controls or in other factors that couldsignificantly affect internal controls subsequent to the date of our mostrecent evaluation, including any corrective actions with regard to significantdeficiencies and material weaknesses.

 

 
| Date:  March 27, 2003 | /s/ John Gelp                                         |   |
|----------------------------|-------------------------------------------------------|--------|
|                       | John Gelp                                             |
|                       | Executive Vice President and Chief Financial  Officer |

 

**EXHIBITINDEX TO FORM 10-K**

 
| For the Fiscal Year  Ended: | Commission File No. |
|-----------------------------|---------------------|
| December 27, 2002           | 0-28426             |

 
| **Exhibit  Number** |   | **Description**                                                                                                                                                                                                                                                                                                                                       |
|---------------------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                |   |                                                                                                                                                                                                                                                                                                                                                  |
| 3.1                 |   | Articles of  Incorporation, as amended (Incorporated by reference to Exhibit 3.1 to Annual  Report on Form 10-K for year ended December 29, 2000)                                                                                                                                                                                                     |
| 3.2                 |   | Bylaws.(1)                                                                                                                                                                                                                                                                                                                                            |
| **4.1**             |   | **Form of Stock Certificate.(1)**                                                                                                                                                                                                                                                                                                                     |
| 4.2                 |   | Articles of  Incorporation (See Exhibit 3.1).                                                                                                                                                                                                                                                                                                         |
| 4.3                 |   | Bylaws (See Exhibit  3.2).                                                                                                                                                                                                                                                                                                                            |
| 10.1                |   | 1996 Stock Option Plan,  as amended through January 19, 2000, and Forms of Incentive and Nonqualified  Stock Option Agreements (Incorporated by reference to Exhibit 10.1 to Annual  Report on Form 10-K for the year ended December 31, 1999).**                                                                                                     |
| 10.2                |   | 1996 Employee Stock  Purchase Plan.(1)**                                                                                                                                                                                                                                                                                                              |
| 10.3                |   | Lease between the  Company and Nathan Lane Partnership, LLP dated January 1, 1995, as amended  October 28, 1997 (Incorporated by reference to Exhibit 10.5 to Registration  Statement on Form S-1, SEC File No. 333-2430 and Exhibit 10.15 to Annual  Report on Form 10-KSB for the year ended December 26, 1997).                                    |
| 10.4                |   | Employment Agreement  with James T. Anderson dated January 1, 1999 (Incorporated by reference to  Exhibit 10.5 to Annual Report on Form 10-K for the year ended December 31,  1999).**                                                                                                                                                                |
| 10.5                |   | License Agreement with  U.S. Philips Corporation effective January 1, 1996 (Incorporated by reference  to Exhibit 10.7 to Registration Statement on form S-1, SEC File No.  333-2430).                                                                                                                                                                |
| 10.6                |   | License Agreement with  Discovision Associates dated January 1, 1994 (Incorporated by reference to  Exhibit 10.8 to Registration Statement on Form S-1, SEC File No. 333-2430).                                                                                                                                                                       |
| 10.7                |   | Revolving Credit and  Term Loan Agreement between the Company and Marquette Capital Bank dated  December 31, 1995, as amended April 30, 1997 (Incorporated by reference to  Exhibit 10.16 to Registration Statement on Form S-1, SEC File No. 333-2430,  and Exhibit 10.16 to Quarterly Report on Form 10-QSB for the quarter ended  March 27, 1997). |
| 10.8                |   | Credit Agreement dated  as of January 6, 1999 among the Company, Certain Lenders and General Electric  Capital Corporation.(2)                                                                                                                                                                                                                        |
| 10.9                |   | Credit Agreement dated  as of January 6, 1999 among Zomax Canada Company, Certain Lenders and General  Electric Capital Canada Inc.(2)                                                                                                                                                                                                                |
| 10.10               |   | Employment Agreement  with Anthony Angelini effective January 1, 2002 (Incorporated by reference to  Exhibit 10.11 to Annual Report on Form 10-K for the year ended December 28,  2001).**                                                                                                                                                            |
| 10.11               |   | Employment Agreement  with John Gelp dated October 10, 2001 (Incorporated by reference to Exhibit  10.11 to Annual Report on Form 10-K for the year ended December 28, 2001).**                                                                                                                                                                       |
| 10.12               |   | Lease between the  Company and The Scottish Provident Institution effective March 2, 2001  (Incorporated by reference to Exhibit 10.13 to Annual Report on Form 10-K for  the year ended December 28, 2001).                                                                                                                                          |
| 10.13*              |   | Employment Agreement  with Michael Miller effective September 16, 2002**                                                                                                                                                                                                                                                                              |
| 10.14*              |   | Form of Nonqualified  Option Agreement for options granted outside of 1996 Stock Option Plan**                                                                                                                                                                                                                                                        |
| 21.1*               |   | Listing of Subsidiaries                                                                                                                                                                                                                                                                                                                               |
| 23.1*               |   | Consent of Deloitte  & Touche LLP                                                                                                                                                                                                                                                                                                                 |
| 23.2*               |   | Notice Regarding  Consent of Arthur Andersen LLP                                                                                                                                                                                                                                                                                                      |
| 24*                 |   | Power of Attorney  (included on signature page of this report)                                                                                                                                                                                                                                                                                        |
| 99.1*               |   | Certification of Chief  Executive Officer                                                                                                                                                                                                                                                                                                             |
| 99.2*               |   | Certification of Chief  Financial Officer                                                                                                                                                                                                                                                                                                             |
| 99.3*               |   | Report of Deloitte  & Touche LLP and Schedule II                                                                                                                                                                                                                                                                                                  |
| 99.4*               |   | Report of Arthur  Andersen LLP and Schedule II                                                                                                                                                                                                                                                                                                        |

 

----

*      Filed herewith.

**   Management agreement orcompensatory plan or arrangement.

(1)   Incorporated by reference tothe corresponding exhibit numbers to Form S-1 Registration Statement, SEC FileNo. 333-2430.

(2)   Incorporated by reference toexhibits to current report on Form 8-K/A-1 dated January 7, 1999.