**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington,DC 20549**

 

**FORM 10-K**

 

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

**for thefiscal year ended December 31, 2004**

 

**Or**

 

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

**for thetransition period from            to            .**

 

**CommissionFile Number: 0-28426**

 

**ZOMAX INCORPORATED**

(Exact name ofregistrant as specified 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 markwhether the registrant (1) filed all reports required to be filed by Section 13or 15(d) of the Exchange Act during the past 12 months (or for such shorterperiod that the registrant was required to file such reports), and (2) has beensubject to such filing requirements for the past 90 days.  YESý  NOo

 

Indicate by check mark ifthere is no disclosure of delinquent filers in response to Item 405 ofRegulation S-K contained in this form, and no disclosure will be contained, tothe best of registrant’s knowledge, in definitive proxy or informationstatements incorporated by reference in Part III of this Form 10-K or anyamendment to this Form 10-K. o

 

Indicate by check markwhether the registrant is an accelerated filer (as defined in Exchange Act Rule12b-2). YESý  NOo

 

The aggregatemarket value of the voting stock held by non-affiliates was $113,406,267 basedon the closing sale price of the Company’s Common Stock as reported on theNASDAQ Stock Market on June 25, 2004.

 

The number ofshares outstanding of the registrant’s common stock as of March 15, 2005 was32,632,061 shares.

 

**DOCUMENTS INCORPORATED BY REFERENCE**

 

Portions of theProxy Statement for the 2005 Annual Meeting of Stockholders are incorporated byreference into Part III of this report.

 

 

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**PART I**

** **

**ITEM1.  BUSINESS**

 

**General**

 

At Zomax, we helpcompanies more efficiently bring their products and content to marketworldwide.  We enhance the process ofsourcing, production, and fulfillment through a modular suite of supply chainoutsourcing services.  We believe ourcommitment to operational excellence results in consistent execution andsuperior value for our customers.  Wehave demonstrated the ability to provide consistently high quality products andservices in a just-in-time (JIT) model.

 

Established in 1993, wehave approximately 1,300 full-time employees and operate eleven facilities inthe United States (“U.S.”), Canada, Mexico, and Ireland.  In January 1999, we acquired the businessesand certain assets of KAO Corporation in the U.S., Canada and Ireland.  This acquisition significantly expanded ourmedia replication capacity, scope of services and geographical footprint and wecontinue to expand our geographic presence and supply chain services bybuilding and acquiring new capabilities.

 

We market and selloutsourced supply chain services to industry leading customers in a variety ofmarkets.  We believe our expertise inintegrating and managing critical supply chain functions allows our customersto focus on their core competencies, reduce costs, accelerate time to market,decrease inventory obsolescence, and improve response to customer demand in avariety of geographic regions.

 

Whether we fulfill ordersdirectly to our customer’s end-users or channel partners, or JIT to thecustomer’s production facilities, our goal is to help companies deliver “ThePerfect Order” - that means the right product, the right place, the right time,at the right value.

 

**Industry**

 

The supply chainoutsourcing services industry manages a vast array of products and content fora wide range of markets.   Whether it isIT hardware, software, consumer electronics, automotive parts, pharmaceuticalsor other products, organizations are increasingly turning to experiencedoutsourcing partners to bring their products to market more efficiently.  The need for faster time-to-market, quickerinventory turns, greater focus on core competencies and lower costs have driventhe growth of supply chain outsourcing.

 

The same factors thathave led to more outsourcing are driving consolidation in the industry, as manysmall local and regional service providers find it increasingly difficult toaccess the capital required to invest in new equipment and additionalvalue-added services.  Consolidation ofthe industry continues as marginal companies struggle to compete.

 

We believe our strongbalance sheet, end-to-end solutions, customer list, consistent execution andsolid reputation in the industry continue to be a competitive advantage andposition us to continue to capture market share as the economy improves.

 

**Services**

 

Our outsourcing solutionsenhance the process of sourcing, production, and fulfillment through a modularsuite of supply chain services that enable customers to select the combinationof services that best meet their unique needs.  Our services are delivered from a network of eleven facilities acrossthe United States, Mexico, Canada, and Ireland and include the following:

 

•                  **Customer Contact Services** – To help build sustainable,interactive relationships between our customers and their end-users, we providea broad range of end-customer services. Our end-to-end approach covers inbound/outbound teleservices, orderprocessing, financial management and e-commerce to support the entire customerlife-cycle.

 

•                  **Sourcing –** Constant change in the availability and qualityof materials is a major challenge for many of our customers. To address thischallenge, we offer a full range of print, packaging, and hardware procurementservices to support their growing businesses.

 

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•                  **Production** – High-capacity CD and DVD manufacturing is criticalto meeting the media requirements for our customers.  In addition, our in-house Print-on-Demandofferings enable personalized, quick-turn print materials for product orinformation kits.

 

•                  **Assembly and Kitting** – Our customers require a highly flexibleset of assembly and kitting services to handle a broad range of products. Weprovide scalable assembly services that include automated assembly, a flexibleworkforce, and JIT capabilities to meet unique customer requirements.

 

•                  **Fulfillment –** We support a full range of retail andend-customer distribution models and provide integrated returns managementservices.  Our capabilities includephysical fulfillment and electronic software delivery to meet the unique needsof our customers.

 

In 2002, we completed astrategic partnership with Intraware (Nasdaq “ITRA”) to incorporate ElectronicSoftware Delivery (ESD) into our solutions offered.  In May 2004, Zomax announced a change to thisagreement which allows Zomax to offer customized services that are specificallytailored to the requirements of our large technology customers. The revisedagreement also allows both Zomax and Intraware to partner with other providersand sell to a broader universe of customers.

 

In 2003, we also addedPrint-On-Demand services to our Fremont, California facility.  This solution enables companies to customizedocumentation, manuals and promotional materials and bundle them just-in-timewith their products as they bring them to market.

 

In 2004, Zomax opened anew assembly and distribution center in Memphis, Tennessee. The Memphisfacility will leverage its central U.S. location and proximity to leadinglogistics carriers to support increasing market requirements for just-in-timeassembly and distribution services.  Thenew center, the largest in Zomax’ network of facilities, will provide customerswith automated and manual assembly, direct-to-store and distribution centerfulfillment, and reverse logistics services.

 

With the breadth andmodularity of our services, customers can choose to outsource some or all oftheir supply chain functions.  In allcases, our account and project management organizations maintain daily contactwith our customers to ensure the highest level of quality and responsiveness.

 

**Customers,Markets and Sales**

 

We market and selloutsourced supply chain services to a variety of customers.  Historically, the majority of our revenue isderived from customers in the computer hardware manufacturing and softwarepublishing industries.  We currentlyservice a broad base of customers in these industry segments includingMicrosoft®, Dell®, Logitech®, Apple® and Hewlett Packard®.  During 2004, 2003, and 2002, Microsoftrevenues accounted for 22%, 22%, and 20%, respectively, of our totalrevenues.  In addition, Dell accountedfor approximately 19% of our total revenues in 2004 and 10% of our total revenues in 2003.

 

Zomax is organized withcross-functional customer-focused teams to support our customers.  We employ Business Unit Managers for ourlargest customers who lead a team of Zomax employees to deliver the servicesand support the customer requires. Within each customer team are project managers responsible for ensuringthat each order is processed on a timely basis, all required support materialsare in place, and desired quality levels are achieved.  We also employ a direct sales staff in the USand Ireland that is responsible for developing new business relationships.  The sales team focuses on markets where wehave experience and proven customer references including software publishing,marketing services, customer information services and more.

 

We are also an authorizedreplicator of Microsoft, which allows us to replicate Microsoft products forany authorized distributor or OEM in the North and South American regions.  We are also authorized to perform fulfillmentservices for Microsoft licensed OEMs. These arrangements are pursuant to annual agreements with Microsoft.  We also provide replication, telemarketingand fulfillment services for certain Microsoft programs under a Master ServicesAgreement.  Each of our primary contractswith Microsoft expires in June 2005.  Weexpect, but cannot guarantee, that these agreements will be renewed.

 

**Competition**

 

The supply chain serviceindustry is highly competitive and is undergoing consolidation.  We compete primarily with supply chainservice providers and, to a lesser extent, with media replicators and thirdparty logistics companies.  Each of theseproducers generally services a defined set of customer needs.

 

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•          *Supply Chain Service Providers*.  Companies in this segment provide servicesthat help companies manage the flow of their products to their consumers fromsourcing to manufacturing to distribution. Examples include companies such as Zomax, Arvato (a division ofBertlesman AG), Startek Corporation, ModusLink, Digital River, andInoveris.  We believe our in-house mediareplication and contact centers enable us to provide better synchronizedprograms for customers and provide us an advantage over these competitors.

 

•          *Media Replicators*. Companies in this segment manufacture and distribute CD and DVDmedia.  Examples include Sonopress (adivision of Bertlesman, AG), Cinram International Inc., Duplium, Technicolorand Crest.  Several media replicatorshave expanded their solutions to include additional supply chain services suchas distribution or returns management. We believe that our complete range of services, including customercontact services and ESD, provide a competitive advantage for Zomax.

 

•          *Third Party Logistics Organizations*.  Core services for these companies aredistribution and logistics and include organizations such as Ingram-MicroLogistics and UPS.  Our in-houselogistics capabilities coupled with our media replication and assembly serviceshelp position us well against these companies, and in some situations, enablepartnership opportunities with these competitors for large customers.

 

•          *Printing and Packaging Firms*.  Organizations such as Banta, IPC and Q-Mediastarted in the printing or packaging market and expanded their services toinclude other aspects of the supply chain. We believe that our in-house mediareplication and contact center services help position us as a more completesolution provider than these companies. Some of these companies partner with us to provide printing andpackaging services for our customers.

 

A number of our nationaland regional competitors are larger and more established with greater financialand other resources than us, particularly as consolidation in the industrycontinues.  As a result, such competitorsmay be able to respond more quickly to market changes or to devote greaterresources to the manufacture, promotion, and sale of their products and servicesthan we can.  Alternatively, othercompetitors have weak financial status in comparison to us. We believe thatfinancial strength continues to be a key decision making component forcustomers, and that our financial position is an advantage over these othercompetitors.

 

We believe that wecompete favorably with respect to quality, service, reliability, price,manufacturing capacity, and timely delivery of product, the principalcompetitive factors in this industry.  Wealso believe that customers are willing to incur additional costs for extraservices.  As such, to enhance ourcompetitive position, we offer a full range of value-added services tocustomers including sourcing, production, fulfillment, returns management, anda range of contact center services.

 

**Financial Information AboutGeographical Areas:**

 

Financial informationabout our geographic segments is presented in Note 13 to the ConsolidatedFinancial Statements included in Item 8 of this Form 10-K.

 

**Fiscal Year End**

 

Our fiscal year ends on thelast Friday of the calendar year.  Unlessotherwise indicated, our fiscal years ended December 31, 2004, December 26,2003, and December 27, 2002, are referred to herein as 2004, 2003, and 2002,respectively.

 

**Backlog**

 

Our business ischaracterized by short lead times for customer orders.  For this reason and because of the timing oforders, delivery intervals, and customer changes in quantities and deliveryschedules, our backlog as of any particular date is not a meaningful indicatorof future financial results.

 

**Proprietary Rights**

 

Like most other CD andDVD manufacturers, we use patented technology primarily under nonexclusivelicenses.  These licenses generallyprovide for the payment of royalties based upon the number, type and use of CDsand DVDs sold and terminate either upon the expiration of the patents beinglicensed or on a certain date.  If we areunable to maintain these licenses, it could have a material adverse effect onour results of operations.

 

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**Seasonality**

 

The demand for CDs, DVDsand related services is seasonal, with demand increasing in the fall due to thenew school year and holiday season purchases. This seasonality can result in significant quarterly variations infinancial results, with our fourth quarter generally being our strongest interms of revenue.

 

**Employees**

 

We have approximately1,300 full-time employees and we contract to hire additional labor resources ona temporary basis to perform manufacturing and fulfillment related services asthe need arises.  We believe that ourrelations with our employees are good and that we provide competitive salaryand benefits programs.  None of ouremployees are covered by a collective bargaining agreement.

 

**Risk and Uncertainties**

 

## The discussion inthis Item 1 and in Management’s Discussion and Analysis of Financial Conditionand Results of Operations, 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.  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.  Ourforward-looking statements represent our expectations or beliefs concerningfuture events, including but not limited to the following:

## •                  ourcompetitive position relative to other companies providing similar services;

## •                  ourrelationships with our employees;

## •                  theeffect on our business of communication from certain customers regarding theirintentions to eliminate certain recovery CDs and print materials from some oftheir PC shipments or award certain business currently provided by us to one ofour competitors, the possible lack of permanency of those decisions and/orchanges in their implementation timelines;

## •                  thestrength of our customer relationships and related impact on our ability toretain such customers in the future;

## •                  thepotential negative impact on profitability due to the growing pricing pressurefrom competitors;

## •                  theimpact of polycarbonate price increases on our gross profit margins and ourability to pass these price increases on to our customers;

## •                  ourability to successfully resolve issues related to our notice from Microsoftregarding non-compliance with certain Authorized Replicator (AR) policies andour belief that we are not at significant risk of losing our AR status as aresult of these issues;

## •                  thepotential threat caused by the development and rate of market acceptance of newmedia storage techniques or other electronic technologies on the need for CDmedia in the PC hardware and software industries;

## •                  theeffectiveness of actions taken to remediate the material weakness we haveidentified in our internal control over financial reporting;

## •                  ourexpectations about our ability to meet the challenges of our business;

## •                  thegrowth prospects of supply-chain outsourcing services;

## •                  thegrowth opportunities associated with our efforts to broaden our customer baseoutside our traditional markets;

## •                  achievementof long-term benefits associated with necessary investments in our business;

## •                  thesufficiency of our cash balances and cash generated from operating and financingactivities for our future liquidity and capital resource needs;

## •                  ourability to manage near-term exposure to continuing upward polycarbonate pricingpressures through our supply agreement with our polycarbonate supplier.

 

## We caution thatany forward-looking statements made by us in this report or in otherannouncements made by us are qualified by important risks and uncertaintiesthat could cause actual results to differ materially from those in theforward-looking statements. The risks and uncertainties described below may notbe the only ones we face. Additional risks and uncertainties that we do not yetknow of or that we currently think are immaterial may also impair our businessoperations. If any of the events or circumstances described in the followinglisting of risks and uncertainties actually occur, our business, financialcondition or results of operations could suffer. The risks and uncertaintiesdescribed below may be amended, supplemented or superseded from time to time byother reports we file with the SEC in the future. These risks and uncertaintiesinclude, without limitation:

 

*We aredependent on a small number of key customers in the personal computer (PC)hardware and software industries.*

 

Ourbusiness continues to be dependent on a small number of key customers in the PChardware and software industries.  Ourtop five customers in 2004, 2003, and 2002, were all members of theseindustries and in the aggregate represented 58%, 50%, and

 

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48%, respectively, of our total revenue.Accordingly, our operating results are influenced by the changes and volatility in theseindustries and the macroeconomic factors that influence the demand for personalcomputer hardware and software. In general, our contractual agreements withthese and other customers allow them to terminate service with very littlenotice and without cause.  Furthermore,significant portions of our revenue from these customers are derived fromindividually large product programs within these customers.  As a result, our revenues can be materiallysensitive to decisions customers make with respect to these individualprograms. Included in our top five customers are Microsoft and Dell,from which we received, in the aggregate, approximately 41% of our revenues in2004 and 32% in 2003. The loss of either of these customers, in particular,would have a material adverse effect on our operations.

 

Wehave been informed of changes to certain programs we support for several of ourlarger customers that may result in noticeable declines in the level ofbusiness we currently have with these customers. The first of thesecustomer-driven changes involves the elimination of certain recovery CDs andprinted materials from some of the new PC’s shipped to their customers. Thischange was originally expected to go into full effect during the third quarterof 2004, and while we began to see some effects of this change in 2004, themajority of the planned change has been delayed to 2005.  We have also been informed by one of ourlarger customers that, possibly starting in 2005, a certain portion of theircustomer base supported by us will be migrated to a new service delivery systemoperated by one of our competitors. Although these customers have indicatedtheir intent to implement these changes, the permanency and timing of thesedecisions is not certain, and to date, these changes have not had a materialnegative impact on our business. Due to these uncertainties, we are unable toaccurately quantify their future affect on our business. However, these changescould have a significant impact on our future revenues and profitability shouldthey be fully and permanently implemented.

 

Inaddition to the risk of program changes, the work we perform for our customersis periodically put out for competitive bid. We believe we have strong relationships with our currentcustomers and that our knowledge of their business, our flexibility to meettheir changing needs, our broad range of service capabilities and our strongbalance sheet are important decision factors for them.  However,the risks exist that we may not be the successful bidder, that ourprofit margins will be negatively impacted by pricing changes necessary toretain their business, or that consolidationamong our customers or competitors could cause disruption in our existingcustomer relationships. Some of ourlarger customers rely on unique information technology systems that we possess,which provides us a competitive advantage. However, there can be no assurances that this advantage will not bereduced or eliminated by alternative solutions developed internally by thesecustomers or by our competitors.  If wewere to lose all or a significant portion of our business with one of these keycustomers, our revenues and profit margins would be materially and negativelyimpacted.  In addition, competition inthese industries, particularly the PC hardware industry, has resulted in theneed for these companies to put continued pressure on their vendors, includingZomax, for price reductions and increased service levels.

 

Whilewe continue to make efforts to expand our base of customers to those outsidethese industries, these customers tend to be smaller, making it very unlikelythat we could quickly recover from the loss of one of our key customers throughthe acquisition of several new customers outside these industries.

 

*We maynot be able to effectively compete in an increasingly competitive environment.*

 

Competitionin the supply chain outsourcing services industry is intense. Our industry iscurrently characterized by many vendors pursuing relatively few and very largecustomers, which provides these customers with the ability to exert significantpressures on their suppliers.  We haveexperienced and anticipate experiencing continued pricing pressures fromcurrent and future competitors as well as general pricing pressure from ourcustomers as part of their cost reduction efforts.  These pricing pressures have, and maycontinue to limit our ability to achieve acceptable levels of profitability.

 

Inaddition, some of our competitors are larger and have substantially greaterresources and capabilities in information technology, global facilities, staffexpertise and other areas that can limit our ability to make the investmentsrequired to remain competitive and be profitable.  We have identified the need to continue tomake additional investments in information technology, expansion into othergeographical markets and the development and capabilities of our staff.  However, we can not be assured that theseinvestments will generate or sustain a particular competitive advantage.

 

Whilewe believe our capabilities are unique, they do not involve significantproprietary properties.  Therefore, weare dependent primarily on our ability to provide exceptional service to ourcustomers and maintain strong relationships with them.  These relationships may be positively ornegatively impacted by changes in personnel or shifts in strategies withinZomax, our customers or our competitors.

 

*We haveexperienced increasing costs of polycarbonate, a petroleum-based raw materialused in the manufacture of optical media.*

 

Startingin the middle of 2004, the cost of polycarbonate began to increase andindications are that these increases will continue throughout most of2005.   While we were able tosuccessfully implement a one cent surcharge to customers in the fourth quarterof 

 

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2004, we cannot be assured we will be able tocontinually pass these increasing costs on to our customers.  If we are unable to do so, our gross marginsand profitability will be significantly and negatively impacted.

 

*We maynot be able to maintain our status as a Microsoft Authorized Replicator.*

 

Wehave been designated by Microsoft as an Authorized Replicator (AR) of theirsoftware and are one of a limited number of Microsoft AR’s in the UnitedStates.  Retaining our status as aMicrosoft AR requires that we continue to meet a number of stringent criteriaestablished by Microsoft.  Our status asa Microsoft AR is not only a requirement to replicate CD and DVD media directlyfor Microsoft, but also to replicate Microsoft software for our customers inthe PC hardware industry that sell or use Microsoft software with theirproducts.

 

Microsoft has informed usof instances of non-compliance with certain AR policies largely related to ourintegration of a business partner’s work that involved some non-standardbusiness practices.  We are working with Microsoft and the businesspartner to satisfactorily resolve these matters and believe that we willsuccessfully do so.

 

We do not believe that weare at significant risk of losing our status as a Microsoft AR because of thesematters and are unaware of any other matters that may jeopardize our ARstatus.  If, however, we were to lose our Microsoft AR status, we wouldlose a significant portion of our business with our customers that sellMicrosoft software and our revenues and profitability would be materially andnegatively impacted.

 

*We maynot be able to meet our customers’ requirements regarding the security of theirintellectual property, inventory and other assets.*

 

Wemanage or take possession of many of our customers’ physical and intellectualproperties.  Much of this propertyconsists of consigned inventory or intellectual property in our possession, thevalue of which is not reflected in our financial statements.  If we fail to protect their property or meettheir security requirements, we may be liable to these customers for penaltiesor reimbursement up to full retail value of the property and may lose theirbusiness, which could have a material negative impact on our financialcondition or results of operations.

 

*We aredependent on revenues from the replication of CD and DVD media which may bethreatened by the development and rate of market acceptance of new mediastorage techniques or other electronic media technologies.*

 

Ourbusiness continues to be heavily dependent on the use of CD, and to a lesserdegree, DVD media in the PC hardware and software industries.  The increasing availability of broadbandcommunications services, changes in fixed storage techniques used in the PCindustry, and the development of alternative electronic storage and back-uptechnologies at lower costs, are examples of technologies that may threaten toreduce or eliminate the need for CD media in the PC hardware and softwareindustries.  A significant decline in theuse of CD media in these industries would have a significant negative impact onour revenues and profitability.

 

Whilewe have established electronic software download (ESD) capabilities through ourstrategic alliance with Intraware, our success in this market has beenlimited.  If we are unable to developsignificant market penetration in the ESD market through this relationship orothers, our ability to participate in the increasing shift to electronicdelivery of software may be impacted.

 

*We havebeen issued a “Wells Notice” from the Securities and Exchange Commission (SEC)and have been named as a defendant in a lawsuit alleging certain securitieslaws violations.*

 

As previously disclosedin our filings with the SEC, we have been the subject of a SEC investigationand a consolidated class action lawsuit involving allegations of securities lawviolations. The allegations relate to Company disclosures and certain stocksales by two former officers during the third quarter of the year 2000.  Under FASB Statement No. 5, *“Accounting for Contingencies”*, and FASB Interpretation No.14, *“Reasonable Estimation of the Amount of a Loss, aninterpretation of FASB Statement No. 5”*, we have established areserve as of December 31, 2004, of $8.5 million which represents our estimateof the related minimum expected probable losses that would result fromsettlement offers we have made. There is no assurance that these offers willresult in settlements, and eventual losses in these matters may exceed thesereserves and could have a material adverse effect on our results of operations,financial condition or cash flows.

 

*We concluded that our internal controls overfinancial reporting were not operating effectively as of December 31, 2004.*

 

As furtherdiscussed in Part II, Item 9A of this Form 10-K, we identified a materialweakness in our internal control over financial reporting and thereforeconcluded that our internal controls over financial reporting were ineffectiveas of December 31, 2004.  While webelieve that we either have implemented, or expect to implement, actions toremediate this weakness, there can be no assurances that these remediationswill be effective at preventing such weakness from continuing. Failure tocorrect this weakness may lead to a further negative impact on our financialresults, including the possible loss of business from certain customers as aresult of uncertainties caused by the weakness, a qualified report from ourindependent auditors, a loss in 

 

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confidence in thereliability of our financial reports or a decline in our stock price due to anadverse reaction from the financial markets.

 

We undertake no obligationto update or revise any forward-looking statements we make in this report dueto new information or future events. Investors are advised to consult any further disclosures we make on thissubject in our filings with the Securities and Exchange Commission, especiallyon Forms 10-K, 10-Q and 8-K, in which we discuss in more detail variousimportant factors that could cause actual results to differ from expected orhistorical results.

 

**Available Information**

 

See our web site atwww.zomax.com for additional information regarding our products andservices.  All reports we fileelectronically with the SEC are available by contacting 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 we file with the SEC at the SEC’s Public Reference Room at450 Fifth Street, NW, Washington, DC 20549. The public may obtain information for the Public Reference Room bycalling the SEC at 1-800-SEC-0330.

 

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**ITEM2.   PROPERTIES**

 

Our principal facilitiesconsist of the following:

 

•                  Welease two facilities in Minneapolis, Minnesota, totaling approximately 183,000square feet in which we perform mastering, replication, printing, printmanagement, packaging, warehousing, fulfillment, distribution, and RMAprocessing activities.  Our corporateoffices are also located in one of these facilities.  These leases expire in 2005 through2006.  The largest of these facilities isan 82,000 square foot facility that we lease, with terms equivalent to those inan arms-length transaction, from a partnership in which a significantshareholder and former member of our Board of Directors, owns a one-thirdinterest.  We lease this space at a baserent of $8.03 per net rentable square foot per year.  We are also obligated to pay all taxes andoperating expenses of this facility. This lease expires in December 2006.

 

•                  Weown a 158,000 square foot facility in Arnprior, Canada, in which we performmastering, replication, print management, printing, packaging, warehousing anddistribution activities.

 

•                  Welease a 153,000 square foot facility in Fremont, California, in which weperform mastering, replication, print management, printing, packaging,warehousing, fulfillment, distribution and RMA processing activities.  This lease expires in March 2006.

 

•                  Welease two facilities in Dublin, Ireland, totaling approximately 139,000 squarefeet in which we perform customer contact center activities as well asreplication, print management, printing, packaging, warehousing, fulfillment,and distribution.  These leases expirefrom 2016 to 2026.  We have the option in2007 and 2011 to cancel these leases upon providing appropriate notice andpenalty payment.

 

•                  Welease a 46,000 square foot facility in Juarez, Mexico, in which we performwarehousing and distribution activities. This lease expires in December 2005.

 

•                  Welease a 227,500 square foot facility in Memphis, Tennessee. in which we performpackaging, fulfillment, distribution and RMA processing activities.  This lease expires in April 2008. Under theagreement we have the option to extend the lease for an additional 36 months.

 

•                  Welease a 30,000 square foot facility in Concord, California, in which we performcustomer contact center activities.  Thislease expires in March 2008.

 

We believe that the facilitiesused in our operations are adequate to meet our current needs.

 

**ITEM3.  LEGAL PROCEEDINGS**

 

*Legal Matters. *Aspreviously disclosed in our filings with the SEC, we have been the subject of aSEC investigation and a consolidated class action lawsuit involving allegationsof securities law violations. The allegations relate to Company disclosures andcertain stock sales by two former officers during the third quarter of the year2000.  Under FASB Statement No. 5, *“Accounting for Contingencies”*, and FASB Interpretation No.14, *“Reasonable Estimation of the Amount of a Loss, aninterpretation of FASB Statement No. 5”*, we have established areserve as of December 31, 2004 of $8.5 million which represents our estimateof the related minimum expected probable losses that would result fromsettlement offers made by us in these matters. A portion of the settlement offer related to the consolidated classaction lawsuit includes the proposed issuance of 1,500,000 shares of thecompany’s common stock and has been valued at $6.2 million based on the closingmarket price of $4.11 on December 31, 2004. There is no assurance that these offers will result in settlements, andeventual losses in these matters may exceed these reserves and could have amaterial adverse effect on our results of operations, financial condition orcash flows.

 

We are involved incertain other claims arising in the normal course of business.  In our opinion, the final outcome of thesematters will not have a material adverse effect on the Company’s financialposition, cash flow or results of operations.

 

**ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITYHOLDERS**

 

No matters were submittedto a vote of security holders during the fourth quarter of 2004.

 

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**PART II**

 

**ITEM5.  MARKET FOR REGISTRANT’S COMMON EQUITYAND RELATED STOCKHOLDER MATTERS**

 

**Market Information**

 

Our Common Stock isquoted on the Nasdaq National Market under the symbol “ZOMX.”  The following table shows the high and lowclosing bid prices of our Common Stock. These bid quotations represent inter-dealer prices and do not includeretail mark-ups, mark-downs or commissions and may not necessarily representactual transactions.

 
| ** **     | ** ** | **2004** | ** ** | **2003** | ** ** |
|----------------|------------|----------|------------|----------|------------|
| ** **     | ** ** | **High** | ** ** | **Low**  | ** ** | **High** | ** ** | **Low** | ** ** |
| First Quarter  |       | $        | 5.32       |     | $          | 3.93 |   | $ | 4.55 |   | $ | 2.87 |   |
| Second Quarter |       | 4.30     |       | 3.59     |       | 4.00 |   | 2.90 |   |
| Third Quarter  |       | 3.78     |       | 2.93     |       | 5.59 |   | 3.34 |   |
| Fourth Quarter |       | 4.11     |       | 3.10     |       | 6.50 |   | 4.77 |   |
|                |            |          |            |          |            |  |  |  |  |  |  |  |  |

 

**Holders**

 

As of March 15, 2005,there were approximately 418 recordholders of our Common Stock, excludingstockholders whose stock is held either in nominee name and/or street namebrokerage accounts.  Based on informationwhich we have obtained from our transfer agent, there are approximately 10,372holders of our Common Stock whose stock is held either in nominee name and/orstreet name brokerage accounts.

 

**Dividends**

 

We have never declared orpaid cash dividends on our capital stock and do not anticipate declaring orpaying any cash dividends in the foreseeable future and intend to retain futureearnings for the development of our business.

 

10

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**ITEM 6.  SELECTEDCONSOLIDATED FINANCIAL DATA**

 

The following five-yearfinancial summary information should be read in conjunction with the ConsolidatedFinancial Statements and related notes thereto set forth in Part II, Item 8 ofthis Form 10-K.

 
| ** **                                             | ** ** | **2004(1)**                                | ** ** | **2003(2)(4)** | ** ** | **2002**   | ** ** | **2001(3)** | ** ** | **2000**   | ** ** |
|--------------------------------------------------------|------------|--------------------------------------------|------------|----------------|------------|------------|------------|-------------|------------|------------|------------|
| ** **                                             | ** ** | **(In thousands, except per share data )** | ** ** |
| ** **                                             | ** ** | ** **                                 | ** ** | ** **     | ** ** | ** ** | ** ** | ** **  | ** ** | ** ** | ** ** |
| **STATEMENT OF OPERATIONS DATA:**                      |       |                                       |       |           |       |       |       |        |       |       |       |
| Revenue                                                |       | $                                          | 199,428    |           | $          | 197,816    |       | $           | 185,500    |       | $          | 216,797 |   | $ | 239,090 |   |
| Gross profit                                           |       | 30,397                                     |       | 36,529         |       | 32,812     |       | 50,109      |       | 71,526     |       |
| Selling, general and administrative expenses           |       | 45,704                                     |       | 40,982         |       | 35,264     |       | 31,964      |       | 33,532     |       |
| Operating income (loss)                                |       | (15,307                                    | )          | (4,453         | )          | (2,452     | )          | 17,222      |       | 37,994     |       |
| Income (loss) before income taxes                      |       | (12,034                                    | )          | (4,196         | )          | (1,252     | )          | 14,254      |       | 38,451     |       |
| Income tax expense (benefit)                           |       | (3,623                                     | )          | (3,021         | )          | (573       | )          | 5,221       |       | 13,592     |       |
| Net earnings (loss)                                    |       | (8,411                                     | )          | (1,175         | )          | (679       | )          | 9,033       |       | 24,859     |       |
| Earnings (loss) per share:                             |       |                                       |       |           |       |       |       |        |       |       |       |
| Basic                                                  |       | (0.26                                      | )          | (0.04          | )          | (0.02      | )          | 0.28        |       | 0.78       |       |
| Diluted                                                |       | (0.26                                      | )          | (0.04          | )          | (0.02      | )          | 0.27        |       | 0.74       |       |
| Weighted average common shares outstanding:            |       |                                       |       |           |       |       |       |        |       |       |       |
| Basic                                                  |       | 32,628                                     |       | 32,621         |       | 33,050     |       | 32,364      |       | 31,915     |       |
| Diluted                                                |       | 32,628                                     |       | 32,621         |       | 33,050     |       | 33,152      |       | 33,529     |       |
|                                                   |       |                                       |       |           |       |       |       |        |       |       |       |
| **BALANCE SHEET DATA:**                                |       |                                       |       |           |       |       |       |        |       |       |       |
| Cash and cash equivalents                              |       | $                                          | 41,092     |           | $          | 51,899     |       | $           | 66,146     |       | $          | 74,999 |   | $ | 63,577 |   |
| Short-term available-for-sale securities               |       | 19,200                                     |       | 17,000         |       | 6,000      |       | —      |       | —     |       |
| Working capital                                        |       | 83,332                                     |       | 88,140         |       | 89,960     |       | 89,889      |       | 69,872     |       |
| Total assets                                           |       | 168,154                                    |       | 181,039        |       | 167,183    |       | 163,506     |       | 167,935    |       |
| Long-term notes payable,  net  of current portion |       | —                                     |       | —         |       | 747        |       | 3,720       |       | 6,757      |       |
| Total shareholders’ equity                        |       | 128,112                                    |       | 137,053        |       | 130,549    |       | 124,424     |       | 112,095    |       |

 

----

(1)       Results of operations in 2004 include a pretax charge of $8.5 million, or$0.18 per share, for litigation reserves related to minimum expectedprobable losses that would result from our settlement offers to the SEC andclass action shareholders, and a pretaxgain of $2.8 million, or $0.05 per share, on sales of a portion of ourIntraware shareholdings.

 

(2)         Results of operations in 2003 include a pretaxcharge of $2.0 million, or $0.04 per share, for accrued payments under aseparation agreement with our former CEO, a pretax benefit of $2.7 million, or$0.05 per share, for a royalty adjustment relating to amounts accrued in 2002,and a $1.0 million benefit, or $0.03 per share, related to a reduction in our taxaccruals following the completion of a Canadian tax audit.

 

(3)         Results of operations in 2001 include a pretaxcharge of $4.4 million, or $0.09 per share, for the write-off of our investmentin Microgistix, and a pretax charge of $0.9 million, or $0.02 per share, forthe write-off of goodwill related to our acquisition of Trotter Technologies,Inc.

 

(4)         We have restated our 2003 consolidated financialstatements for misstatements discovered in our Ireland subsidiary.  These restatements primarily affected cost ofrevenue and resulted in an increase of our loss per share from ($0.02) to($0.04).  See Note 14 to the ConsolidatedFinancial Statements for further discussion of these restatements.  The table in this Item 6 reflects theserestatements.

 

11

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**ITEM7.  MANAGEMENT’S DISCUSSION AND ANALYSISOF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

**Fiscal Year-End**

 

Our fiscal year ends onthe last Friday of the calendar year.  Tosimplify our narrative discussion, we refer to the fiscal years ended December31, 2004, December 26, 2003, and December 27, 2002, as 2004, 2003, and 2002,respectively.

 

## **Restatement of FinancialStatements**

##  

As fully discussed inmore detail in Note 14 to the Consolidated Financial Statements included inPart II, Item 8 of this Form 10-K, our 2003 consolidated financial statementshave been restated to reflect the results of our internal investigation intofinancial reporting and accounting irregularities at our Ireland Subsidiary,Zomax Limited.  Our discussion andanalysis of financial condition and results of operations in this Item 7reflect the effect of the restatement.

 

## **Introduction and Overview**

##  

## Overall, fiscal2004 represented a financially challenging year.  From a revenue perspective, we posted strongseasonal fourth quarter revenues of $58.6 million and ended the year with$199.4 million in revenues.  Theseresults exceeded fiscal year 2003 by $1.6 million.  However this slight growth did not result inimproved gross profit margins or improved operating income.  Costs related to the pending SECinvestigation and consolidated class action lawsuit, significant losses in ourIrish operations, continued upward pressure on polycarbonate costs and ongoingchanges in our customers’ product mix combined to negatively impact ourprofitability.  For 2004, we posted aloss of $0.26 per share compared to a loss of $0.04 per share in fiscal 2003.

 

## The majority ofour revenue has historically been, and continues to be, driven by a relativelysmall number of large technology-focused customers in the personal computerhardware and software industries.  We areprivileged to have long-standing relationships with our customers who aremarket leaders in their industries, but these customers demand continuousimprovements in service, quality and price from their vendors.  Furthermore, media production over-capacityin our industry, particularly during seasonally slow periods, continues toresult in fierce competition between vendors. This combination of customer demands for continuous improvement andintense competition continues to limit the ability of Zomax and other companiesin our industry to maintain or regain pricing power.  Accordingly, while we have grown our revenuesover 2003, we continue to experience pressure on our ability to improve ourlevels of profitability at comparable growth rates.

##  

## In addition to thechallenges discussed above, our business faces a number of other risks anduncertainties, a more detailed discussion of which can be found in Part I, Item1 of our Form 10-K.

##  

## While we recognizethe many risks and challenges to growing our business and returning it toconsistent profitability, we believe we are well-positioned to address suchchallenges.  Our core market –supply-chain outsourcing services – continues to show promising growth.  We believe we have strong relationships withour customers and that our knowledge of their businesses, our flexibility tomeet their changing needs, our broad range of service capabilities and our financiallystrong balance sheet are important decision factors for these customers.  We also believe that our efforts over thepast two years in broadening our customer base in both traditional and newmarkets should provide opportunities for growth.  While we believe we have many of theingredients necessary to return growth and profitability to our business, doingso will require that we continue to increase our investments in the people,processes and technologies that are critical to delivering services to ourcustomers and positioning our business for growth.  Some of these investments will provide addedpressure on our profitability in the short term, but we believe they willdeliver the benefits necessary to our long-term success.

 

**General Factors Affecting OurFinancial Results**

 

*Fiscal Calendar.*  The comparability of our 2004 and 2003operating results is affected by our 2004 fiscal calendar, which included 53weeks of business operations as compared to 52 weeks in 2003.  This factor affected both revenue andoperating costs.

 

*Revenue. *We derive our revenues from a wide variety ofsupply chain services provided to our customers.  The number of CD and DVD media units that wereplicate for our customers, changes in pricing, changes in the composition ofthe products and services we provide, consumer demand for our customers’products, seasonal consumer buying patterns, and changes in the mix ofcustomers we serve, are all factors that contribute to changes in our revenuesfrom period to period.  In addition, asignificant portion of revenue from our larger customers is derived fromindividually large product programs within these customers.  As a result, our revenues can be materiallysensitive to decisions customers make with respect to these individual programs.  Revenues are generally more favorablyimpacted when our mix of customers is weighted toward those who are using abroad range of our services.  Bundledpricing, changes 

 

12

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in the content of the products we make forour customers, and other dynamics make it difficult to precisely determine theimpact each of these factors has on changes in our total revenue.

 

*Gross Profit Percentage.*  Our gross profitpercentage during a period is dependent on a number of factors.  Changes in raw material prices, particularlypolycarbonate, a petroleum-based plastic used in the manufacturing of CD andDVD media, can impact margins. While polycarbonate pricing had been relativelystable over the past few years, recent increases in petroleum prices and supplyshortages are continuing to put upward pressure on polycarbonate pricing andare negatively impacting our gross profit margins. Although we implemented aone cent surcharge on CD and DVD media in the fourth quarter of 2004, we cannot be assured we will be able to continue to pass the increasing costs ofpolycarbonate on to our customers. See further discussion below under thecaption titled “*Gross Profit”*forthe impact of polycarbonate price increases on our 2004 gross profitpercentage. In addition to changes in pricing and raw material costs, thevolume of business we experience in a given period also impacts ourmargins.  A large portion of the costsrequired to deliver our products and services are fixed in nature.  Increases in volume allow us to leveragethese costs resulting in higher gross profit margins, while decreases in volumehave the opposite effect.  Our relativemix of customers, as well as the related content of products or services weprovide them, can also have a significant impact on gross profit margins.  For example, the relative mix of CD/DVDmedia, labor, print and other material in the products we produce for ourcustomers can affect our overall gross profit percentage.  Although gross profit measured as apercentage of revenue may be lower, we believe providing incremental,value-added services to our customers, has an overall positive effect on grossmargin as measured in dollars. Additionally, our ability to utilize automated packaging equipmentversus manual labor can have a favorable effect on gross profit.

 

*Selling, General and Administrative (SG&A) Expenses.*  Asubstantial portion of our SG&A expenses are fixed in nature.  However, certain components such as incentivecompensation, professional services, travel and other expenses can vary basedon business results, individual events, or initiatives we may be pursuing atvarious times throughout the year.  Inaddition to these factors, some of our SG&A expenses are incurred inIreland and Canada and changes in the respective foreign currency rates cancause our expenses reported in U.S. dollars to fluctuate.

 

**Results of Operations**

 

The followingtable summarizes certain key information to aid in the understanding of ourdiscussion and analysis of results of operations.

 
| ** **                                               | ** ** | **2004** | ** ** | **2003  Restated** | ** ** | **2002** | ** ** |
|----------------------------------------------------------|------------|----------|------------|--------------------|------------|----------|------------|
| **Percent  of Revenue:**                                 |       |     |       |               |       |     |       |
| Revenue                                                  |       | 100.0    | %          | 100.0              | %          | 100.0    | %          |
| Gross profit                                             |       | 15.2     |       | 18.5               |       | 17.7     |       |
| Selling, general  and administrative (SG&A) expenses |       | 22.9     |       | 20.7               |       | 19.0     |       |
| Operating loss                                           |       | (7.7     | )          | (2.3               | )          | (1.3     | )          |
| Income tax  benefit                                      |       | (1.8     | )          | (1.5               | )          | (0.3     | )          |
| Net loss                                                 |       | (4.2     | )          | (0.6               | )          | (0.4     | )          |
| **Other  Operating Statistics:**                         |       |     |       |               |       |     |       |
| Media units sold  -% change from prior year              |       | (0.9     | )%         | 4.1                | %          | 2.6      | %          |
| Revenue -%  change from prior year                       |       | 0.8      |       | 6.6                |       | (14.4    | )          |
| SG&A  expenses -% change from prior year             |       | 11.5     |       | 16.2               |       | 10.3     |       |
| Effective tax  rate                                      |       | 30.1     |       | 72.0               |       | 45.8     |       |

 

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Note:                   We have restated our 2003 consolidated financialstatements for misstatements discovered in our Ireland subsidiary.  These restatements primarily affected cost ofrevenue and resulted in an increase of our loss per share from ($0.02) to($0.04).  See Note 14 to the ConsolidatedFinancial Statements for further discussion of these restatements.

 

 

13

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**Revenue**

 

*2004 vs. 2003.* Our revenues increased on anannual basis for the second consecutive year, growing 0.8%, from $197.8 in 2003to $199.4 million in 2004.  Our volumewith Microsoft, which remains our largest customer, has continued atapproximately the same percentage of total revenue, 22%, as in 2003.  As discussed in our 2003 Form 10-K, Dellbecame a greater than 10% customer for the first time in 2003, and our volumewith this key customer has continued to grow in 2004, comprising approximately 19%of our total revenue.  Offsetting ourincreased business with Dell in 2004, were decreases in revenue from a customerto which we provided large volumes of low-priced, bulk CDs in 2003, a decreasein revenue from a large customer which moved a portion of the kitting andassembly work previously performed in the U.S. to Asia, and a general businessdecline experienced by one of our other customers in the PC OEM industry. Our2004 fiscal calendar, which included 53 weeks, as compared to 52 weeks in 2003,also had a favorable impact on our 2004 revenues.

 

*2003 vs. 2002.*  For the first time since fiscal year 2000,our revenue increased on an annual basis, growing 6.6%, from $185.5 million in2002, to $197.8 million in 2003.  In2003, we experienced a 4.1% increase in media unit volume, accounting for themajority of our 6.6% increase in revenue. This volume increase was driven mostly by increases in demand from ourcurrent customer base, but also by demand from new customers.  The balance of the revenue increase was aresult of a favorable change in our customer mix, partially offset by continuedpricing pressures. The increase in demand in 2003 was relatively broad acrossour major customer base.  Microsoft, ourlargest customer, represented approximately 22% of our revenue in 2003, up fromapproximately 20% in 2002.  In additionto Microsoft, sales to Dell Computer were 10% of our total revenue in 2003,representing a significant increase over 2002. The improvement in customer mixin 2003 was primarily related to a reduction in sales to a customer whichpurchased large volumes of lower priced, bulk CDs from us in 2002.  Bulk CDs represent CDs that we replicate andsell without providing additional services such as packaging orfulfillment.  The price declines were aresult of the general industry conditions discussed in the “Introduction andOverview” above.

 

**Gross Profit**

** **

*2004vs. 2003*. Our gross profit percentage fell 3.3% from 18.5% in2003 to 15.2% in 2004. Our 2003 gross profit margin was favorably impacted by a$4.8 million benefit related to the signing of a revised royalty agreementwhich resulted in a retroactive reduction in unpaid royalties accrued in 2002and 2003.  Of this benefit, $2.7 millionrelates to royalties accrued and charged to cost of revenue in 2002, andaccounts for 1.4% of the total 3.3% decline in gross profit margin from 2003 to2004.  In addition, our 2004 margins weresignificantly impacted by increases in the price of polycarbonate, a petroleum-basedplastic that is the primary raw material used in the manufacturing of CD andDVD media. Over the last three quarters of 2004, petroleum price increases andsupply shortages have placed significant upward pressures on the price ofpolycarbonate. While we have entered into a purchase agreement with ourpolycarbonate supplier that limits future price increases and ensures adequatesupply for our anticipated first half 2005 production, the increases allowedunder the agreement have had a negative impact on our gross profit.Polycarbonate cost increases accounted for an estimated decline of $1.9million, or 1.0%, in our gross profit margins as compared to 2003. This declineincludes the offsetting effect of a one cent surcharge on CD and DVD mediapassed on to our customers in the fourth quarter of 2004. Also, significantoperational deficiencies in our Ireland manufacturing facility contributed tothe decline in our gross profit margin from 2004 to 2003. 

 

*2003vs. 2002.*Our gross profit percentage improved from 17.7% in2002, to 18.5% in 2003. Our 2003 gross profit margin was favorably impacted bya $4.8 million benefit related to the signing of a revised royalty agreementwhich resulted in a retroactive reduction in unpaid royalties accrued in 2002and 2003.  Of this benefit, $2.7 millionrelates to royalties accrued and charged to cost of revenue in 2002.  If 2003 and 2002 gross profit margins wereadjusted for this benefit, our gross profit percentage would have declined from19.1% in 2002 to 17.1% in 2003. This decrease is primarily attributable to theeffect of declining unit prices, partially offset by an increase in unitvolumes as discussed under “Revenue” above, particularly in the fourth quarter.This increase in unit volume resulted in improved leverage of our fixed costsand had a favorable effect of approximately 0.5% on our gross profit marginpercentage. 

 

 

 

14

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**Selling,General and Administrative (SG&A) Expenses**

** **

*2004 vs. 2003.*Our2004 SG&A expenses increased $4.7 million, or 11.5%, over 2003.  SG&A expenses in 2004 include a $8.5million charge for litigation reserves related to minimum expected probablelosses that would result from the settlement offers made in relation to ourpending SEC investigation and consolidated class action lawsuit as discussed inItem 3 of this Form 10-K. SG&A expenses in 2003 include a $3.0 millioncharge related to a settlement of a customer claim that alleged unauthorizedreproduction of this customer’s software and a $2.0 million charge related to aseparation agreement with our former CEO. Net of the effects of theaforementioned items, SG&A expenses increased $1.2M, or 3.3%. Approximately$0.8 million of this increase is attributable to professional fees related tothe implementation of our Sarbanes-Oxley compliance procedures and $0.4 millionis attributable to the translation effect of currency exchange rate changes onexpenses incurred in our Ireland and Canadian operations.

 

*2003vs. 2002.*Our SG&A expenses increased $5.7 million, or16.2%, from 2002 to 2003. SG&A expenses in 2002 included approximately $2.2million of costs associated with unsuccessful acquisition opportunities pursuedearlier in that year, and a $1.3 million write-down of customer contact centersoftware systems as a result of the replacement of those systems beginning latein 2002. SG&A expenses in 2003 include a $3.0 million charge related to asettlement of a customer claim that alleged unauthorized reproduction of thiscustomer’s software and a $2.0 million charge related to a separation agreementwith our former CEO. Net of the effects of the aforementioned items, SG&Aexpenses increased $4.2 million, or 13.3% from 2002 to 2003. A significantportion of this increase is related to investments we started making in the latterpart of 2002, in capabilities aimed at increasing the number of customers andmarkets we serve, the suite of services we offer, including electronic softwaredownloading, our capabilities to support new and existing markets and services,and new locations in the U.S. and Mexico. In addition to the effects of theseinvestments on our SG&A expenses, approximately $0.7 million of theincrease is attributable to the translation effect of currency exchange ratechanges on expenses incurred in our Ireland and Canadian operations. Increasesin employee medical and general business insurance costs and incentivecompensation also contributed to the increase in SG&A expense in 2003. 

** **

**Other Income and Expense**

 

In 2004 we sold a portionof our Intraware shareholdings in two separate private placements whichresulted in a pre-tax gain of approximately $2.8 million. See Note 4 to theconsolidated financial statements in Item 8 of this Form 10-K for furtherdiscussion.

 

**IncomeTaxes**

 

*2004vs. 2003*.  Our reported 2004 income tax benefitrepresents 30.1% of our pretax loss, compared to 72.0 % of our pretax loss in2003.  While our tax rate in 2003included several one-time benefits as discussed below, our 2004 tax rateincludes the effect of  $0.7 million innon-deductible expenses in 2004 and a $0.4 million benefit related toreductions in our tax accruals (see “Income Taxes” under Application ofCritical Accounting Policies below).  Also, our significant losses in Irelandadversely impacted our tax benefit as those losses are subject to relativelylow tax rates as compared to our U.S. operations.  See Note 9 to the consolidated financialstatements in Item 8 of this Form 10-K for a reconciliation of the statutoryU.S. federal income tax rate to our effective income tax rate.

 

*2003vs. 2002*.  On an as reported basis, our income taxbenefit in 2003 represents 72.0% of our pretax loss, compared to 45.8% of ourpretax loss in 2002.  Our income taxbenefit in 2003 includes a $1.0 million benefit related to a reduction in ourtax accruals following the completion of a Canadian tax audit (see “IncomeTaxes” under Application of Critical Accounting Policies below).  Excluding this benefit, our 2003 effectivetax rate would have been 55.4%, reflecting the favorable tax position of havingcurrent year operating profits in our Ireland operations, which are subject torelatively low tax rates, and current year operating losses in our U.S.operations, which are subject to relatively higher tax rates.  Had our consolidated operating losses beenspread evenly across all tax jurisdictions in which we operate, our 2003effective tax rate, excluding the $1.0 million benefit previously discussed,would have been more comparable to 2002.

 

**Supplemental Information**

 

Our financialresults as reported in our Consolidated Statement of Operations were preparedin accordance with accounting principles generally accepted in the UnitedStates (GAAP) and are the basis for the information presented in the tableabove.  In 2004, 2003, and 2002 theseresults include certain significant items which we believe are not indicativeof our results of continuing operations. For purposes of our internal understanding of business operations, aswell as for planning and forecasting future periods, we exclude from our GAAP resultsthose items that meet the definition of non-recurring, as defined by theSecurities and Exchange Commission. Accordingly, to aid in the understanding of our financial results, ourdiscussion and analysis of results of operations is supplemented with the followingreconciliation of our reported results on both a GAAP basis (“as reported”),and on the basis of the exclusion of these non-recurring items (“asadjusted”).  However, the presentation ofas adjusted results is not meant to be a substitute for financial resultsprepared in accordance with GAAP.

 

 

15

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The followingTable A presents a reconciliation of our results of operations as reported, toour results of operations adjusted for those significant non-recurring itemswhich we believe are not representative of our continuing operations:

 

**Table A – Reconciliation of As Reported Results toAs Adjusted Results**

**(Dollars in thousands except per share data)**

 
| ** **                   | ** ** | **Gross  Profit** | ** ** | **SG&A  Expenses** | ** ** | **Earnings  (Loss)  Before  Income  Taxes** | ** ** | **Income  Tax  Expense  (Benefit)** | ** ** | **Net  Earnings  (Loss)** | ** ** | **Diluted  Earnings  (Loss) Per  Share****(5)** | ** ** |
|------------------------------|------------|-------------------|------------|------------------------|------------|---------------------------------------------|------------|-------------------------------------|------------|---------------------------|------------|-------------------------------------------------|------------|
| **2004:**                    | ** ** | ** **        | ** ** | ** **             | ** ** | ** **                                  | ** ** | ** **                          | ** ** | ** **                | ** ** | ** **                                      | ** ** |
| As reported                  |       | $                 | 30,397     |                   | $          | 45,704                                      |       | $                                   | (12,034    | )                         | $          | (3,623                                          | )          | $ | (8,411 | ) | $ | (0.26 | ) |
| Litigation reserves(1)       |       | —            |       | (8,520                 | )          | 8,520                                       |       | 2,686                               |       | 5,834                     |       | 0.18                                            |       |
| As adjusted                  |       | $                 | 30,397     |                   | $          | 37,184                                      |       | $                                   | (3,514     | )                         | $          | (937                                            | )          | $ | (2,577 | ) | $ | (0.08 | ) |
| Percent of revenue           |       | 15.2              | %          | 18.7                   | %          | (1.8                                        | )%         | (0.5                                | )%         | (1.3                      | )%         |                                            |       |
|                         |       |              |       |                   |       |                                        |       |                                |       |                      |       |                                            |       |
| **2003 Restated:**           |       |              |       |                   |       |                                        |       |                                |       |                      |       |                                            |       |
| As reported                  |       | $                 | 36,529     |                   | $          | 40,982                                      |       | $                                   | (4,196     | )                         | $          | (3,021                                          | )          | $ | (1,175 | ) | $ | (0.04 | ) |
| Royalty adjustment(2)        |       | (2,660            | )          | —                 |       | (2,660                                      | )          | (1,064                              | )          | (1,596                    | )          | (0.05                                           | )          |
| Customer claim settlement(3) |       | —            |       | (3,000                 | )          | 3,000                                       |       | 1,200                               |       | 1,800                     |       | 0.06                                            |       |
| Severance costs(4)           |       | —            |       | (2,000                 | )          | 2,000                                       |       | 800                                 |       | 1,200                     |       | 0.04                                            |       |
| As adjusted                  |       | $                 | 33,869     |                   | $          | 35,982                                      |       | $                                   | (1,856     | )                         | $          | (2,085                                          | )          | $ | 229 |   | $ | 0.01 |   |
| Percent of revenue           |       | 17.1              | %          | 18.2                   | %          | (0.9                                        | )%         | (1.1                                | )%         | 0.1                       | %          |                                            |       |
| ** **                   | ** ** | ** **        | ** ** | ** **             | ** ** | ** **                                  | ** ** | ** **                          | ** ** | ** **                | ** ** | ** **                                      | ** ** |
| **2002:**                    | ** ** | ** **        | ** ** | ** **             | ** ** | ** **                                  | ** ** | ** **                          | ** ** | ** **                | ** ** | ** **                                      | ** ** |
| As reported                  |       | $                 | 32,812     |                   | $          | 35,264                                      |       | $                                   | (1,252     | )                         | $          | (573                                            | )          | $ | (679 | ) | $ | (0.02 | ) |
| Royalty adjustment(2)        |       | 2,660             |       | —                 |       | 2,660                                       |       | 1,064                               |       | 1,596                     |       | 0.05                                            |       |
| As adjusted                  |       | $                 | 35,472     |                   | $          | 35,264                                      |       | $                                   | 1,408      |                      | $          | 491                                             |       | $ | 917 |   | $ | 0.03 |   |
| Percent of revenue           |       | 19.1              | %          | 19.0                   | %          | 0.8                                         | %          | 0.3                                 | %          | 0.5                       | %          |                                            |       |

 

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**Notes toTable A:**

 

(1) Adjustment represents charges for litigation reservesrelated to minimum expected probable losses that would result from thesettlement offers made in relation to ourpending SEC investigation and consolidated class action lawsuit asdiscussed in Item 3 of this Form 10-K.

 

(2) In the fourth quarterof 2003, we signed a revised royalty agreement which resulted in a retroactivereduction in unpaid royalties accrued in 2002 and 2003 (See “Application ofCritical Accounting Policies” in this Item 7 below).  This adjustment represents the portion ofthis retroactive reduction that related to royalties accrued and charged tocost of revenue in 2002.

 

(3) Adjustment representsa payment made in the settlement of a customer claim that alleged unauthorizedreproduction of this customer’s software (See Note 11 to the consolidatedfinancial statements in Item 8 of this Form 10-K).

 

(4) Adjustment representspayments accrued in 2003 in accordance with the terms of a separation agreementwith our former CEO who resigned in December 2003, effective in January 2004.

 

(5) Both as reported andas adjusted results in 2004 and 2003 include an income tax benefit of $0.4million, or $0.01 per share, and $1.0 million, or $0.03 per share,respectively, related to a reduction in our tax accruals.   See “Application of Critical AccountingPolicies” below for further discussion.  Bothas reported and as adjusted results in 2004 include a pretax gain of $2.8million, or $0.05 per share, on sales of a portion of our IntrawareShareholdings.  These items are notreflected as an adjustment in the table as they do not meet the definition of anon-recurring item as defined by the Securities and Exchange Commission.

 

**Application of CriticalAccounting Policies**

 

*Revenue Recognition.* We recordrevenue at the time product is shipped or as services are rendered.  For certain customers, product is invoicedupon completion of production and assembly services, with final shipmentoccurring based on written customer instructions.  In these cases, the customer accepts title tothe goods as of the date of the invoice and sales revenue is recognized at thattime.  In each case of these “bill andhold” sales, we ensure that the transaction complies with the conditions andconsiderations contained in Staff Accounting Bulletin No. 101 and Accountingand Auditing Enforcement Release No. 108 of the Securities and ExchangeCommission.

 

*Royalties.*  We have license agreements with severalcompanies for the use of certain CD and DVD manufacturing technology we use inour business.  We do not necessarily haveagreements with every patent holder that may assert or has asserted a claim toroyalties.  The cost of these royaltiesis accrued based on units sold and charged to cost of revenue.  Our royalty costs are based upon the terms ofour royalty agreements as well as our assessment of the applicability of anyother known or potential royalties.  Inthe fourth quarter of 2003, we completed negotiations with one of the majorpatent holders resulting in the signing of a revised royalty agreement thatretroactively reduced the royalties payable to this patent holder.  These negotiations, which had been previouslydisclosed in our 2002 and 2003 Form 10-Ks, began in 2002.  While we were hopeful from the start of ournegotiations that we would achieve a retroactive application of the reducedroyalty rates, this was not guaranteed and, in our judgment, it was notappropriate to recognize the benefit of the potentially reduced rates until thecompletion of a final agreement.  Uponsigning the new agreement in the fourth quarter of 2003, we recorded a benefitto cost of revenue totaling $4.8 million related to these reduced rates as wellas 

 

16

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smaller adjustments to the rates at which we accrue other known orpotential royalties.  This total benefitreflected a reduction of unpaid royalties of $2.1 million accrued in the firstthree quarters of 2003 and $2.7 million accrued in 2002.

 

*IncomeTaxes*.  We file aconsolidated federal income tax return and separate state and foreign returns.  Deferred income taxes are provided fordifferences between the tax basis of assets and liabilities and their carryingamounts for financial reporting purposes, based on the expected income taxrates for the year in which these temporary differences are expected toreverse. Foreign net operating loss carryforwards may be carried forwardindefinitely.

 

The preparation of ourincome tax returns requires the interpretation of the associated tax laws.  Many tax laws are complex, and at timesambiguous, and our interpretations of these laws may differ from theinterpretations of the taxing authorities who have the right to audit ourreturns within statutory time periods. Where we believe there is a quantifiable risk that our interpretationsof these laws could reasonably differ from those of the taxing authorities, wemake appropriate provisions in our tax liabilities.  In 2004, we assessed the probabilities ofthose provisions and recognized a $0.4million benefit related to reductions in our tax accruals from 2003.  In 2003, Canadian tax authoritiescompleted an audit of our Canadian tax returns for the years 1999, 2000 and2001.  Accordingly in 2003, we removed$1.0 million of provisions we had made in our tax liabilities related to therisk that tax authorities would reject certain positions we had taken in thepreparation of these returns.

 

*AccountsReceivable.*  We reviewour accounts receivable balances on a regular basis to determine theircollectibility.  An allowance fordoubtful accounts is recorded based on management’s estimate of those accountswhich may become uncollectible.

 

*Inventory.*  We review our inventory on a regular basiswith the objective of assessing its net realizable value.  We adjust the carrying value of inventoryaccording to our estimates of the net realizable value of individual inventorycomponents relative to their purchase or carrying value.

 

**New Accounting Standards**

 

See Note 1 of “Notes to Consolidated FinancialStatements” included in Item 8 herein for a discussion of new accountingstandards.

 

**Liquidity and Capital Resources**

 

*Cash and Cash Equivalents and Short-TermAvailable-for-Sale Securities.*  At December 2004, cash andcash equivalents and short-term available-for-sale securities totaled $60.3million, a decrease of $8.6 million from December 2003.  Cash flow from operating activities forfiscal 2004 was a negative $9.6 million, reflecting the following significantitems:

•                  Firstquarter payments of approximately $8.5 million of royalties accrued at the endof 2003. The majority of these royalty payments related to the fourth quarter2003 signing of a revised royalty agreement with one of our major patentholders.  Negotiation of this agreementbegan in 2002.  Royalties under theprevious agreement continued to be accrued, with payment suspended pending thecompletion of a revised agreement; and

•                  Apreviously disclosed severance payment of $2.0 million made pursuant to anemployment agreement with our former CEO.

 

Also impacting our changein cash and cash equivalents in 2004 were the following:

•                  Repurchaseof $1.4 million of common stock from a former director (see Note 6 to theConsolidated Financial Statements included in Item 8 herein);

•                  Purchasesof property and equipment totaling $4.7 million related primarily to investmentsin the Company’s information systems infrastructure;

•                  Netincrease in short term available-for-sale securities of $2.2 million;

•                  Proceedsof $5.2 million from the sale of a portion of our Intraware shareholdings inthe second quarter of 2004 (see Note 4 to the Consolidated Financial Statementsincluded in Item 8 herein); and

•                  Proceedsof $0.9 million from the issuance of common stock primarily related to employeepurchases of stock under the Company’s stock option and employee purchaseplans.

 

*WorkingCapital and Liquidity*. Working capital totaled $83.3 million and $88.1 million at December 2004and December 2003, respectively. This decrease primarily reflects the decreasein our cash balances discussed above. Our principal source of working capitalcontinues to be cash and cash equivalents and short-term available-for-salesecurities.  In addition to our workingcapital balances, we also hold long term available-for-sale securities whichrepresent our investment in Intraware (see Note 4 to the Consolidated FinancialStatements included in Item 8 herein). These securities are fully registered and had a market value at December31, 2004 of $3.6 million.

 

17

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Our future liquidityneeds will depend on, among other factors, the timing of capital expenditures,expenditures in connection with possible acquisitions, changes in customerorder volume and the timing and collection of receivables. We believe thatexisting cash and investment balances and anticipated cash flow from operationswill be sufficient to fund our operations for the foreseeable future.

 

*ContractualObligations: *Paymentsdue under known contractual obligations as of the end of 2004 are as follows(in millions):

 
| ** **                      | ** ** | **Less than  1 Year** | ** ** | **2 to 3  Years** | ** ** | **4 to 5  Years** | ** ** | **After  5 Years** | ** ** | **Total** | ** ** |
|---------------------------------|------------|-----------------------|------------|-------------------|------------|-------------------|------------|--------------------|------------|-----------|------------|
| Operating lease  obligations    |       | $                     | 5.8        |              | $          | 8.6               |       | $                  | 2.2        |      | $          | 2.0 |   | $ | 18.6 |   |
| Polycarbonate  supply agreement |       | 7.5                   |       | —            |       | —            |       | —             |       | 7.5       |       |
| Total                           |       | $                     | 13.3       |              | $          | 8.6               |       | $                  | 2.2        |      | $          | 2.0 |   | $ | 26.1 |   |

 

During the second quarterof 2004, we entered into an agreement with our supplier of polycarbonate, apetroleum-based commodity which is the primary raw material used in theproduction of CD and DVD media.  Over thepast three quarters, supply shortages and increases in petroleum prices haveplaced significant upward pressure on polycarbonate pricing.  Under the agreement, which runs through June2005, we have agreed to purchase a total of 9.4 million pounds of polycarbonateat set price terms.  These price termsrestrict monthly price increases and help us to limit our exposure to potentialfuture price increases while also allowing us to reduce our purchase volumeshould the price terms increase above an agreed-upon level over the initialbase price. Minimum remaining commitments under this agreement, subject topurchase volume reductions, are approximately $7.5 million based on the currentadjusted base price and minimum remaining quantity. We believe that thisagreement will allow us to manage our near-term exposure to continuing upwardprice pressures on this key raw material.

 

**Off-Balance sheet Arrangements**

 

At December 2004 we had no off-balance sheet financing arrangements.

 

 

**Market Risk**

 

*ForeignCurrency.*  A portion ofour operations are located in Ireland and Canada.  A majority of the revenue from our Canadianoperations, and a portion of the related costs, are denominated in U.S.dollars.  As a result, we have limitedexposure to the Canadian currency.  Themajority of revenues and related costs in our Ireland operations are denominatedin Euros.  Foreign currency transaction gains and losses are reflected in ourfinancial statements and historically have not been material to our results ofoperations or financial condition. However, we anticipate we will continue to incur exchange gains andlosses from foreign operations in the future which may be significantdepending on factors such as changes in foreign currency or weak economicconditions in foreign markets.  Inaddition, sales of our products and services may be directly impacted by thevalue of the U.S. dollar relative to other currencies.

 

**Inflation**

 

Historically, inflationhas not had a material impact on our operations.  The cost of labor and raw material,particularly the cost of petroleum, which affects the cost of polycarbonateused in the manufacture of optical discs, can influence the cost of ourproducts and services.  There can be noassurance that we will be able to pass on any increased material or labor coststo our customers in the future.

 

**ITEM 7A.  QUANTITATIVE AND QUALITATIVE DISCLOSURESABOUT MARKET RISK**

 

See “Market Risk” underItem 7 above.

 

18

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

 

**REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTINGFIRM**

 

To the Board of Directorsand Shareholders of

Zomax Incorporated:

 

 

We have audited theaccompanying consolidated balance sheets of Zomax Incorporated and Subsidiaries(the “Company”) as of December 31, 2004 and December 26, 2003, and the relatedconsolidated statements of operations, shareholders’ equity, and cash flows foreach of the three years in the period ended December 31, 2004.  Ouraudits also included the financial statement schedule listed in the Index atItem 15(a).** **Thesefinancial statements and financial statement schedule are the responsibility ofthe Company’s management.  Ourresponsibility is to express an opinion on these financial statements andfinancial statement schedule based on our audits.

 

We conducted our auditsin accordance with the standards of the Public Company Accounting OversightBoard (United States).  Those standardsrequire that we plan and perform the audit to obtain reasonable assurance aboutwhether the financial statements are free of material misstatement.  An audit includes examining, on a test basis,evidence supporting the amounts and disclosures in the financialstatements.  An audit also includesassessing the accounting principles used and significant estimates made by management,as well as evaluating the overall financial statement presentation.  We believe that our audits provide areasonable basis for our opinion.

 

In our opinion, suchconsolidated financial statements present fairly, in all material respects, thefinancial position of Zomax Incorporated and Subsidiaries as of December 31,2004 and December 26, 2003, and the results of their operations and their cashflows for each of the three years in the period ended December 31, 2004, inconformity with accounting principles generally accepted in the United Statesof America.  Also, in our opinion, such financial statement schedule, when consideredin relation to the basic consolidated financial statements taken as a whole,present fairly, in all material respects, the information set forth therein.

 

As discussed in Note 14to the accompanying financial statements, the Company has restated itsconsolidated financial statements as of and for the year ended December 26,2003.

 

We have also audited, inaccordance with the standards of the Public Company Accounting Oversight Board(United States), the effectiveness of the Company’s internal control overfinancial reporting as of December 31, 2004, based on the criteria establishedin *Internal Control – Integrated Framework*issued by the Committee of Sponsoring Organizations of the Treadway Commissionand our report dated March 30, 2005 expressed an unqualified opinion onmanagement’s assessment of the effectiveness of the Company’s internal controlover financial reporting and an adverse opinion on the effectiveness of theCompany’s internal control over financial reporting.

 

 
| /s/ Deloitte &  Touche LLP |   |
|--------------------------------|--------|
| Minneapolis, Minnesota         |
| March 30, 2005                 |

 

19

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**ZOMAX INCORPORATED**

**CONSOLIDATEDSTATEMENTS OF OPERATIONS**

## **(In thousands, except per share data)**

 
| ** **                                      | ** ** | **Year Ended**        | ** ** |
|-------------------------------------------------|------------|-----------------------|------------|
| ** **                                      | ** ** | **December 31, 2004** | ** ** | **December 26,  2003 (Restated –  See Note 14)** | ** ** | **December 27,  2002** | ** ** |
|                                            |       |                  |       |   |   |   |   |
| **Revenue**                                     |       | $                     | 199,428    |   | $ | 197,816 |   | $ | 185,500 |   |
|                                            |       |                  |       |   |   |   |   |
| Cost  of revenue                                |       | 169,031               |       | 161,287 |   | 152,688 |   |
|                                            |       |                  |       |   |   |   |   |
| **Gross profit**                                |       | 30,397                |       | 36,529 |   | 32,812 |   |
|                                            |       |                  |       |   |   |   |   |
| Selling,  general and administrative expenses   |       | 45,704                |       | 40,982 |   | 35,264 |   |
|                                            |       |                  |       |   |   |   |   |
| **Operating loss**                              |       | (15,307               | )          | (4,453 | ) | (2,452 | ) |
|                                            |       |                  |       |   |   |   |   |
| **Other income (expense):**                     |       |                  |       |   |   |   |   |
| Interest  expense                               |       | (11                   | )          | (145 | ) | (228 | ) |
| Interest  income                                |       | 879                   |       | 864 |   | 1,423 |   |
| Gain  on sale of available-for-sale securities  |       | 2,770                 |       | — |   | — |   |
| Other,  net                                     |       | (365                  | )          | (462 | ) | 5 |   |
| **Loss before income taxes**                    |       | (12,034               | )          | (4,196 | ) | (1,252 | ) |
|                                            |       |                  |       |   |   |   |   |
| Income  tax benefit                             |       | (3,623                | )          | (3,021 | ) | (573 | ) |
| **Net loss**                                    |       | $                     | (8,411     | ) | $ | (1,175 | ) | $ | (679 | ) |
|                                            |       |                  |       |   |   |   |   |
| **Loss per share:**                             |       |                  |       |   |   |   |   |
| Basic                                           |       | $                     | (0.26      | ) | $ | (0.04 | ) | $ | (0.02 | ) |
| Diluted                                         |       | $                     | (0.26      | ) | $ | (0.04 | ) | $ | (0.02 | ) |
|                                            |       |                  |       |   |   |   |   |
| **Weighted average common shares outstanding:** |       |                  |       |   |   |   |   |
| Basic                                           |       | 32,628                |       | 32,621 |   | 33,050 |   |
| Dilutive  effect of stock options and warrants  |       | —                |       | — |   | — |   |
| Diluted                                         |       | 32,628                |       | 32,621 |   | 33,050 |   |

 

*See notesto consolidated financial statements.*

 

20

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**ZOMAXINCORPORATED**

## **CONSOLIDATEDBALANCE SHEETS**

## **(In thousands)**

 
| ** **                                                                                                                                   | ** ** | **December 31,  2004** | ** ** | **December 26,  2003 (Restated –  See Note 14)** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|-------------------------------------------------------|------------|
| **ASSETS**                                                                                                                                   |       |                   |       |                                                  |       |
| **Current  assets:**                                                                                                                         |       |                   |       |                                                  |       |
| Cash and cash  equivalents                                                                                                                   |       | $                      | 41,092     |                                                  | $          | 51,899 |   |
| Available-for-sale  securities                                                                                                               |       | 19,200                 |       | 17,000                                                |       |
| Accounts  receivable, net of allowances of $868 in 2004 and $1,362 in 2003                                                              |       | 36,180                 |       | 39,577                                                |       |
| Inventories, net                                                                                                                             |       | 14,633                 |       | 12,346                                                |       |
| Deferred income  taxes                                                                                                                       |       | 1,704                  |       | 2,685                                                 |       |
| Other current  assets                                                                                                                        |       | 10,410                 |       | 7,304                                                 |       |
|                                                                                                                                         |       |                   |       |                                                  |       |
| Total current  assets                                                                                                                        |       | 123,219                |       | 130,811                                               |       |
|                                                                                                                                         |       |                   |       |                                                  |       |
| **Property  and equipment, net**                                                                                                             |       | 35,408                 |       | 38,582                                                |       |
|                                                                                                                                         |       |                   |       |                                                  |       |
| **Available-for-sale  securities**                                                                                                           |       | 3,624                  |       | 11,646                                                |       |
|                                                                                                                                         |       |                   |       |                                                  |       |
| **Deferred  income taxes**                                                                                                                   |       | 5,903                  |       | —                                                |       |
|                                                                                                                                         |       |                   |       |                                                  |       |
|                                                                                                                                         |       | $                      | 168,154    |                                                  | $          | 181,039 |   |
|                                                                                                                                         |       |                   |       |                                                  |       |
| **LIABILITIES  AND SHAREHOLDERS’ EQUITY**                                                                                               |       |                   |       |                                                  |       |
| **Current  liabilities:**                                                                                                                    |       |                   |       |                                                  |       |
| Accounts payable                                                                                                                             |       | $                      | 20,710     |                                                  | $          | 20,635 |   |
| Accrued expenses  and other current liabilities                                                                                              |       | 19,177                 |       | 22,036                                                |       |
|                                                                                                                                         |       |                   |       |                                                  |       |
| Total current  liabilities                                                                                                                   |       | 39,887                 |       | 42,671                                                |       |
|                                                                                                                                         |       |                   |       |                                                  |       |
| **Deferred  rent**                                                                                                                           |       | 155                    |       | —                                                |       |
|                                                                                                                                         |       |                   |       |                                                  |       |
| **Deferred  income taxes**                                                                                                                   |       | —                 |       | 1,315                                                 |       |
|                                                                                                                                         |       |                   |       |                                                  |       |
| Total  liabilities                                                                                                                           |       | 40,042                 |       | 43,986                                                |       |
|                                                                                                                                         |       |                   |       |                                                  |       |
| **Commitments  and contingencies (Note 11)**                                                                                                 |       |                   |       |                                                  |       |
|                                                                                                                                         |       |                   |       |                                                  |       |
| **Shareholders’  equity:**                                                                                                              |       |                   |       |                                                  |       |
| Common stock, no  par value, 100,000 shares authorized; 32,536 and 32,589 shares issued  and outstanding in 2004 and 2003, respectively |       | 62,134                 |       | 62,469                                                |       |
| Retained  earnings                                                                                                                           |       | 56,861                 |       | 65,272                                                |       |
| Accumulated  other comprehensive income                                                                                                      |       | 9,117                  |       | 9,312                                                 |       |
|                                                                                                                                         |       |                   |       |                                                  |       |
| Total  shareholders’ equity                                                                                                             |       | 128,112                |       | 137,053                                               |       |
|                                                                                                                                         |       | $                      | 168,154    |                                                  | $          | 181,039 |   |

 

*Seenotes to consolidated financial statements*.

 

21

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**ZOMAX INCORPORATED**

**CONSOLIDATEDSTATEMENTS OF SHAREHOLDERS’ EQUITY**

**(Inthousands)**

 
| ** **                                                                                              | ** ** | **Common stock** | ** ** | **Retained** | ** ** | **Accumulated  other  comprehensive** | ** ** | **Total  shareholders’** | ** ** |
|---------------------------------------------------------------------------------------------------------|------------|------------------|------------|--------------|------------|---------------------------------------|------------|-------------------------------|------------|
| ** **                                                                                              | ** ** | **Shares**       | ** ** | **Amount**   | ** ** | **earnings**                          | ** ** | **income (loss)**             | ** ** | **equity** | ** ** |
|                                                                                                    |       |             |       |         |       | ** **                            |       |                          |       |   |   |
| **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 |   |
| Comprehensive  Income                                                                                   |       | —           |       | —       |       | —                                |       | —                        |       | 5,268 |   |
| 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 |   |
|                                                                                                    |       |             |       |         |       |                                  |       |                          |       |   |   |
| Net loss  (Restated – see Note 14)                                                                 |       | —           |       | —       |       | (1,175                                | )          | —                        |       | (1,175 | ) |
| Unrealized  holding gain on available-for-sale securities, net of tax                                   |       | —           |       | —       |       | —                                |       | 2,819                         |       | 2,819 |   |
| Translation  adjustments (Restated – see Note 14)                                                  |       | —           |       | —       |       | —                                |       | 6,462                         |       | 6,462 |   |
| Comprehensive  Income                                                                                   |       | —           |       | —       |       | —                                |       | —                        |       | 8,106 |   |
| Common stock  issued under employee stock purchase plan                                                 |       | 184              |       | 533          |       | —                                |       | —                        |       | 533 |   |
| Common stock  issued upon exercise of stock options                                                     |       | 139              |       | 348          |       | —                                |       | —                        |       | 348 |   |
| Tax benefit  realized from exercise of stock options                                               |       | —           |       | 104          |       | —                                |       | —                        |       | 104 |   |
| Common stock  repurchases                                                                               |       | (762             | )          | (2,587       | )          | —                                |       | —                        |       | (2,587 | ) |
|                                                                                                    |       |             |       |         |       |                                  |       |                          |       |   |   |
| **Balance,  December 26, 2003 (Restated - See Note 14)**                                           |       | 32,589           |       | 62,469       |       | 65,272                                |       | 9,312                         |       | 137,053 |   |
|                                                                                                    |       |             |       |         |       |                                  |       |                          |       |   |   |
| Net loss                                                                                                |       | —           |       | —       |       | (8,411                                | )          | —                        |       | (8,411 | ) |
| Unrealized  holding loss on available-for-sale securities, net of tax                                   |       | —           |       | —       |       | —                                |       | (1,785                        | )          | (1,785 | ) |
| Reclassification  to net loss of previously deferred gain on available-for-sale securities, net  of tax |       | —           |       | —       |       | —                                |       | (1,629                        | )          | (1,629 | ) |
| Translation  adjustments                                                                                |       | —           |       | —       |       | —                                |       | 3,219                         |       | 3,219 |   |
| Comprehensive  loss                                                                                     |       | —           |       | —       |       | —                                |       | —                        |       | (8,606 | ) |
| Common stock  issued under employee stock purchase plan                                                 |       | 174              |       | 496          |       | —                                |       | —                        |       | 496 |   |
| Common stock  issued upon exercise of stock options                                                     |       | 188              |       | 403          |       | —                                |       | —                        |       | 403 |   |
| Tax benefit  realized from exercise of stock options                                               |       | —           |       | 185          |       | —                                |       | —                        |       | 185 |   |
| Common stock  repurchases                                                                               |       | (415             | )          | (1,419       | )          | —                                |       | —                        |       | (1,419 | ) |
|                                                                                                    |       |             |       |         |       |                                  |       |                          |       |   |   |
| **Balance,  December 31, 2004**                                                                    |       | 32,536           |       | $            | 62,134     |                                  | $          | 56,861                        |       | $ | 9,117 |   | $ | 128,112 |   |

 

*Seenotes to consolidated financial statements.*

 

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# **ZOMAXINCORPORATED**

# **CONSOLIDATED STATEMENTS OF CASHFLOWS**

# **(Inthousands)**

##  

| ** **                                                                                   | ** ** | **Year Ended**         | ** ** |
|----------------------------------------------------------------------------------------------|------------|------------------------|------------|
| ** **                                                                                   | ** ** | **December 31,  2004** | ** ** | **December 26,  2003  (Restated –  See Note 14)** | ** ** | **December 27,  2002** | ** ** |
| **Operating  activities:**                                                                   |       |                   |       |   |   |   |   |
| Net loss                                                                                     |       | $                      | (8,411     | ) | $ | (1,175 | ) | $ | (679 | ) |
| Adjustments to  reconcile net loss to net cash (used) provided by operating activities: |       |                   |       |   |   |   |   |
| Depreciation and  amortization                                                               |       | 9,829                  |       | 8,668 |   | 8,349 |   |
| Stock  compensation benefit                                                                  |       | —                 |       | — |   | (32 | ) |
| Loss on disposal  or writedown of property and equipment                                     |       | —                 |       | 347 |   | 1,352 |   |
| Gain on sale of  available-for-sale securities, net of tax                                   |       | (1,629                 | )          | — |   | — |   |
| Provision for  litigation reserves, net of tax                                               |       | 5,834                  |       | — |   | — |   |
| Deferred income  taxes                                                                       |       | (3,806                 | )          | 1,338 |   | (473 | ) |
| Other, net                                                                                   |       | —                 |       | (32 | ) | — |   |
| Changes in  operating assets and liabilities:                                                |       |                   |       |   |   |   |   |
| Accounts  receivable                                                                         |       | 4,200                  |       | (5,014 | ) | (1,423 | ) |
| Inventories, net                                                                             |       | (2,009                 | )          | (2,156 | ) | 1,651 |   |
| Other current  assets                                                                        |       | (2,717                 | )          | 1,450 |   | (96 | ) |
| Accounts payable                                                                             |       | (421                   | )          | 5,439 |   | 869 |   |
| Accrued expenses  and other current liabilities                                              |       | (12,622                | )          | 2,015 |   | 3,120 |   |
| Income taxes                                                                                 |       | 2,187                  |       | (5,595 | ) | (3,758 | ) |
| Net cash (used)  provided by operating activities                                       |       | (9,565                 | )          | 5,285 |   | 8,880 |   |
|                                                                                         |       |                   |       |   |   |   |   |
| **Investing  activities:**                                                                   |       |                   |       |   |   |   |   |
| Purchases of  property and equipment                                                         |       | (4,695                 | )          | (9,589 | ) | (2,950 | ) |
| Purchases of  available-for-sale securities                                                  |       | (28,950                | )          | (11,000 | ) | (11,019 | ) |
| Escrow deposit  on terminated acquisition                                                    |       | —                 |       | 3,902 |   | (3,902 | ) |
| Sale of  available-for-sale securities                                                       |       | 31,980                 |       | — |   | — |   |
| Net cash  provided (used) by investing activities                                            |       | (1,665                 | )          | (16,687 | ) | (17,871 | ) |
|                                                                                         |       |                   |       |   |   |   |   |
| **Financing  activities:**                                                                   |       |                   |       |   |   |   |   |
| Repayment of  notes payable                                                                  |       | —                 |       | (3,781 | ) | (2,973 | ) |
| Repurchase of  common stock                                                                  |       | (1,419                 | )          | (2,587 | ) | (464 | ) |
| Issuance of  common stock                                                                    |       | 899                    |       | 881 |   | 1,195 |   |
| Net cash used by  financing activities                                                  |       | (520                   | )          | (5,487 | ) | (2,242 | ) |
|                                                                                         |       |                   |       |   |   |   |   |
| **Effect  of exchange rate changes on cash and cash equivalents**                            |       | 943                    |       | 2,642 |   | 2,380 |   |
|                                                                                         |       |                   |       |   |   |   |   |
| Net decrease in  cash and cash equivalents                                                   |       | (10,807                | )          | (14,247 | ) | (8,853 | ) |
|                                                                                         |       |                   |       |   |   |   |   |
| Cash and cash  equivalents, beginning of year                                                |       | 51,899                 |       | 66,146 |   | 74,999 |   |
| **Cash  and cash equivalents, end of year**                                                  |       | $                      | 41,092     |   | $ | 51,899 |   | $ | 66,146 |   |

 

*See notes to consolidated financial statements.*

 

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**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS**

 

**NOTE 1.  SUMMARY OFSIGNIFICANT ACCOUNTING POLICIES**

 

***Nature of Business.***Zomax Incorporated (“the Company,”“we”, “us”, or “our”), is a globalprovider of supply chain outsourcing services. These services, which includesourcing, production, and fulfillment, are delivered through a network of 11facilities in the United States, Canada, Mexico, and Ireland.

 

***Principles ofConsolidation***. The consolidated financial statements include the accounts of theCompany and its wholly-owned subsidiaries. All material intercompany accountsand transactions have been eliminated in consolidation.

** **

*Fiscal Year-End*.** **Ourfiscal year ends on the lastFriday of the calendar year. The fiscal years ended December 31, 2004, December26, 2003, and December 27, 2002 are referred to as 2004, 2003, and 2002,respectively, in the consolidated financial statements and notes thereto.

 

*Restatement.*As fully discussed in Note 14, our 2003 consolidatedfinancial results have been restated to correct the misstatements in ourIreland subsidiary, Zomax Limited.

 

*Use of Estimates. *The preparationof financial statements in conformity with accounting principles generallyaccepted in the United States requires management to make estimates andassumptions that affect the reported amounts of assets and liabilities at thedate of the financial statements and the reported amounts of revenues andexpenses during the reporting period. Estimates are used for such items as theallowance for doubtful accounts, inventory net realizable value, tax provisionsand litigation reserves.  Actual resultscould differ from those estimates.

 

*Revenue Recognition*.  Werecord revenue at the time product is shipped or as services are rendered.  For certain customers, product is invoicedupon completion of production and assembly services, with final shipmentoccurring based on written customer instructions.  In these cases, the customer accepts title tothe goods as of the date of the invoice and revenue is recognized.  In each case of these “bill and hold” sales,we ensure that the transaction complies with the conditions and considerationscontained in Staff Accounting Bulletin No. 101 and Accounting and AuditingEnforcement Release No. 108 of the Securities and Exchange Commission.

 

In2004, 2003 and 2002, one customer accounted for approximately 22%, 22%, and20%, respectively, of our consolidated revenue, and in 2004 and 2003, a secondcustomer accounted for approximately 19% and 10%, respectively of ourconsolidated revenue.

 

*Cost of Revenue*.  Weinclude direct labor, direct materials, royalties and production overhead,which includes shipping costs, in cost of revenue on the consolidatedstatements of operations.

 

*Royalties.*  We have license agreements withseveral companies for the use of certain CD and DVD manufacturing technology weuse in our business.  We do notnecessarily have agreements with every patent holder that may assert or hasasserted a claim to royalties.  The costof these royalties is accrued based on units sold and charged to cost ofrevenue.  Our royalty costs are basedupon the terms of our royalty agreements as well as our assessment of theapplicability of any other known or potential royalties.  In the fourth quarter of 2003, we completednegotiations with one of the major patent holders resulting in the signing of arevised royalty agreement that retroactively reduced the royalties payable tothis patent holder.  These negotiations,which had been previously disclosed in our 2002 Form 10-K, began in 2002.  While we were hopeful from the start of ournegotiations that we would achieve a retroactive application of the reducedroyalty rates, this was not guaranteed and, in our judgment, it was notappropriate to recognize the benefit of the potentially reduced rates until thecompletion of a final agreement.  Uponsigning the new agreement in the fourth quarter of 2003, we recorded a benefitto cost of revenue totaling $4.8 million related to these reduced rates as wellas smaller adjustments to the rates at which we accrue other known or potentialroyalties.  This total benefit reflecteda reduction of unpaid royalties of $2.1 million accrued in the first threequarters of 2003 and $2.7 million accrued in 2002.

 

*Income Taxes*.  We file a consolidated federalincome tax return and separate state and foreign returns. Deferred income taxesare provided for differences between the tax basis of assets and liabilitiesand their carrying amounts for financial reporting purposes, based on theexpected income tax rates for the year in which these temporary differences areexpected to reverse. Foreign net operating loss carryforwards related to ourIrish operations may be carried forward indefinitely.

 

Thepreparation of our income tax returns requires the interpretation of theassociated tax laws.  Many tax laws arecomplex, and at times ambiguous, and our interpretations of these laws maydiffer from the interpretations of the taxing authorities who have the right toaudit our returns within statutory time periods.  Where we believe there is a quantifiable riskthat our interpretations of these laws could reasonably differ from those ofthe taxing authorities, we make appropriate provisions in our taxliabilities.  In 2004, we assessed theprobabilities of those provisions and recognized a $0.4 million benefit related to reductions in our tax accruals from2003.  

 

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In2003, Canadian tax authorities completed an audit of our Canadian tax returnsfor the years 1999, 2000 and 2001. Accordingly, we removed $1.0 million of provisions we had made in ourtax liabilities related to the risk that tax authorities would reject certainpositions we had taken in the preparation of these returns.

 

*Loss Per Share*.  Basicearnings per share (EPS) is computed by dividing net income or loss by theweighted average number of common shares outstanding during the year. DilutedEPS is computed by dividing net income or loss 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 had been issued. In years in which we experience a net loss,basic EPS and diluted EPS will be the same, as the potential shares issuedrelated to stock options are anti-dilutive. Potential common shares of 2,831,000 in 2004, 3,323,000 in 2003, and3,674,000 in 2002, related to outstanding stock options were excluded from thecomputation of diluted earnings per share as inclusion of these shares wouldhave been anti-dilutive.

 

*Cash and Cash Equivalents*.  Cashand cash equivalents consist primarily of highly liquid short-term investmentswith original maturities of 90 days or less and are recorded at cost, whichapproximates market value.

 

*Accounts Receivable.*  We review our accountsreceivable balances on a regular basis to determine their collectibility.  An allowance for doubtful accounts isrecorded based on management’s estimate of those accounts which may becomeuncollectible.  As of the years endedDecember 2004 and 2003, we had three customers with receivable balancesexceeding 10% of the total net receivables. These customers totaled 20%, 18% and 14%, respectively, as of December2004 and 15%, 13% and 11%, respectively, as of December 2003.

 

*Inventories*.  Inventories, consisting ofmaterial, labor and overhead, are stated at the lower of first-in, first-outcost or market.  We review our inventoryon a regular basis with the objective of assessing its net realizable value.  We adjust the carrying value of inventoryaccording to our estimates of the net realizable value of individual inventorycomponents relative to their purchase or carrying value.

 

*Property and 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 methods of depreciation are used for income taxpurposes.  Depreciation expense totaledapproximately $9,829,000 in 2004, $8,668,000 in 2003, and $8,349,000 in 2002.

 

*Sales Returns and Allowances. *We generally warrant to all customers that the products we make for themwill be free from defects in materials and workmanship.  If it is determined that the products soldare defective, we typically repair or replace such products.  The cost of these repairs or replacements hasnot had a material effect on our financial condition, results of operations orcash flows.  The Company records a provisionfor estimated returns and allowances as a reduction to revenues.  This estimate is based upon historicalexperience determined by analysis of credit activity and other known factors.

 

*Fair Value of Financial Instruments*.  Thefinancial instruments with which we are involved are primarily of a traditionalnature.  For these instruments, includingcash, available-for-sale securities, receivables, accounts payable and accruedexpenses, we believe that the carrying amounts approximate fair value becauseof their short-term nature.

 

*Long-Lived Assets*. Long-lived assets, such as property and equipment, are evaluated forimpairment when events or changes in circumstances indicate that the carryingamount of the assets may not be recoverable through the estimated undiscountedfuture cash flows from the use of these assets. If any such impairment exists,the related assets would be written down to fair value.  There were no impairments recorded in any ofthe periods covered under this report.

 

25

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*Stock BasedCompensation.*  Wehavea 1996 Stock Option Plan (the 1996 Plan), a 2004 Equity Incentive Plan (the2004 Plan) and an Employee Stock Purchase Plan. Options granted under these plans are accounted for under Accounting Principles Board OpinionNo. 25, “Accounting for Stock Issued to Employees.”  Because our stock options are granted at themarket value on the date of grant, no related compensation expense isrecognized.  However, had thecompensation expense of option grants been determined in accordance withSFAS No. 123, “Accounting for Stock-Based Compensation,” as amendedby SFAS No. 148, “Accounting for Stock-Based Compensation—Transition andDisclosure”, our net loss and loss per share, on a pro forma basis, would havebeen reported as follows (in thousands, except per share data):

 
| ** **                            | ** ** | **2004** | ** ** | **2003 (Restated   – See Note 14)** | ** ** | **2002** | ** ** |
|---------------------------------------|------------|----------|------------|------------------------------------------|------------|----------|------------|
| Net loss:                             |       |     |       |                                     |       |     |       |
| As reported                           |       | $        | (8,411     | )                                        | $          | (1,175   | )          | $ | (679 | ) |
| Stock-based  compensation, net of tax |       | (1,264   | )          | (1,346                                   | )          | (2,266   | )          |
| Pro forma                             |       | $        | (9,675     | )                                        | $          | (2,251   | )          | $ | (2,945 | ) |
|                                  |       |     |       |                                     |       |     |       |
| Basic EPS:                            |       |     |       |                                     |       |     |       |
| As reported                           |       | $        | (0.26      | )                                        | $          | (0.04    | )          | $ | (0.02 | ) |
| Pro forma                             |       | $        | (0.30      | )                                        | $          | (0.08    | )          | $ | (0.09 | ) |
|                                  |       |     |       |                                     |       |     |       |
| Diluted EPS:                          |       |     |       |                                     |       |     |       |
| As reported                           |       | $        | (0.26      | )                                        | $          | (0.04    | )          | $ | (0.02 | ) |
| Pro forma                             |       | $        | (0.30      | )                                        | $          | (0.08    | )          | $ | (0.09 | ) |
|                                       |            |          |            |                                          |            |          |            |  |  |  |  |

 

Indetermining the compensation cost of the options granted, as specified bySFAS No. 123, the fair value of each option grant has been estimatedon the date of grant using the Black-Scholes option pricing model. The weightedaverage assumptions used in these calculations are summarized below:

 
| ** **                                           | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Risk-free  interest rate                             |       | 3.01     | %          | 3.22     | %          | 2.75     | %          |
| Expected life of  options granted, in years          |       | 5.7      |       | 6.2      |       | 6.6      |       |
| Expected  volatility of options granted         |       | 92.12    | %          | 90.33    | %          | 91.97    | %          |
| Weighted average  fair value of options granted |       | $        | 3.04       |     | $          | 2.78     |       | $ | 3.82 |   |
|                                                      |            |          |            |          |            |          |            |  |  |  |

 

*Foreign Currency Translation.* We translateassets and liabilities of our foreign subsidiaries to their U.S. dollarequivalents at exchange rates in effect at the balance sheet date and recordrelated translation adjustments as a component of shareholders’ equity in theconsolidated balance sheets.  Statementsof operations of our foreign subsidiaries are translated from their functionalcurrencies to U.S. dollar equivalents at average exchange rates during theperiod and we record the related translation adjustment to a component ofshareholders’ equity.  Foreign exchangetransaction gains and losses are reported in other income and expense on theconsolidated statements of operations.

 

*NewAccounting Standards..* In December 2003, the Financial Accounting Standards Board (“FASB”)issued FASB Interpretation No. 46 (revised December 2003), “Consolidation ofVariable Interest Entities” (“FIN 46R”), which addresses how a business shouldevaluate whether it has a controlling financial interest in an entity throughmeans other than voting rights and accordingly should consolidate the entity.FIN 46R replaced FIN 46 which was issued in January 2003. FIN 46 or FIN46R applied immediately to entities created after January 31, 2003 and no laterthan the end of the first reporting period that ended after December 15, 2003to entities considered to be special-purpose entities (“SPEs”). FIN 46R waseffective for all other entities no later than the end of the first interim orannual reporting period ending after March 15, 2004. The adoption of theprovisions of FIN 46 or FIN 46R relative to SPEs and for entities created afterJanuary 31, 2003 did not have an impact on the company’s consolidated financialstatements.

 

In November 2003 andMarch 2004, the Emerging Issues Task Force (EITF) reached consensuses on IssueNo. 03-1, “The Meaning of Other-Than-Temporary Impairment and Its Applicationto Certain investments” (“EITF 03-1”), which addresses how to determine themeaning of other-than temporary impairments and how that concept should beapplied to investments accounted for under SFAS No. 115, “Accounting in CertainInvestments in Debt and Equity Securities”, and SFAS No. 124, “Accounting forCertain Investments Held by Not-for-Profit Organizations.” Disclosures relatedto these investments are effective in annual financial statements for fiscalyears ending after December 15, 2003. The disclosure requirements for all otherinvestments are effective in annual financial statements for fiscal yearsending after June 15, 2004. In September 2004, the EITF delayed the effectivedate to apply EITF 03-1 on debt securities that are impaired because ofinterest rate and/or sector spread increases that are analyzed for 

 

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impairment underparagraph 16. Full adoption of EITF 03-1 is not expected to have a materialeffect on the company’s financial position, results of operations or cashflows.

 

In November 2004 the FASBissued SFAS No. 151, “Inventory Costs, an amendment of ARB No. 43, Chapter 4”(SFAS 151). SFAS 151 amends the guidance in ARB No. 43, Chapter 4, “InventoryPricing”, to clarify the accounting for abnormal amounts of idle facilityexpense, freight, handling costs, and spoilage. This statement requires thatthose items be recognized as current period charges regardless of whether theymeet the criterion of “so abnormal” which was the criterion specified in ARBNo. 43. In addition, this Statement requires that allocation of fixedproduction overheads to the cost of production be based on normal capacity ofthe production facilities. This pronouncement is effective for the companybeginning December 31, 2005. The company is in the process of evaluatingwhether the adoption of SFAS 151 will have a significant impact on the company’soverall results of operations, financial position or cash flows.

 

In December 2004, theFASB issued SFAS No. 153, “Exchanges of Nonmonetary Assets, an amendment of APBOpinion No. 29, Accounting for Nonmonetary Transactions.” The amendments madeby Statement 153 are based on the principle that exchanges of nonmonetaryassets should be measured based on the fair value of the assets exchanged.Further, the amendments eliminate the narrow exception for nonmonetaryexchanges of similar productive assets and replace it with a broader exceptionfor exchanges of nonmonetary assets that do not have commercial substance. TheStatement is effective for the company relative to nonmonetary asset exchangesbeginning December 31, 2005. The provisions of this Statement shall be appliedprospectively. The company is in the process of evaluating whether the adoptionof SFAS 153 will have a significant impact on the company’s overall results ofoperations or financial position, however, it is unlikely the impact will bematerial.

 

In December 2004, theFASB issued SFAS No. 123(R) “Share-Based Payment.” SFAS 123(R) requires therecognition of compensation cost relating to share-based payment transactionsin financial statements. That cost will be measured based on the fair value ofthe equity or liability instruments issued as of the grant date, based on theestimated number of awards that are expected to vest. SFAS 123(R) covers a widerange of share-based compensation arrangements including share options, restrictedshare plans, performance-based awards, share appreciation rights, and employeeshare purchase plans. Statement 123(R) replaces FASB Statement No. 123, “Accountingfor Stock-Based Compensation,” and supersedes APB Opinion No. 25, “Accountingfor Stock Issued to Employees.” Statement 123(R) is effective for the companyduring the third quarter of 2005. The company is in the process of evaluatingthe impact of SFAS 123(R) on the company’s overall results of operations,financial position and cash flows. Refer to pro forma disclosure under “Accountingfor Stock-Based Compensation” in Note 1 above for indication of ongoing expensethat will be included in the income statement beginning in the third quarter of2005.

 

On October 22, 2004, theFASB issued FASB Staff Position (FSP) 109-1, Application of FASB Statement No.109,*Accounting for Income Taxes*,for the Tax Deduction Provided to U.S. Based Manufacturers by the American JobCreation Act of 2004, and FAP 109-2, Accounting and Disclosure Guidance for theForeign Earnings Repatriation Provisions within the American Jobs Creation Actof 2004.  FSP No. 109-1 clarifies how toapply SFAS No. 109 to the new law’s tax deduction for income attributable to “domesticproduction activities.” The fully phased-in deduction is up to nine percent ofthe lesser of taxable income or “qualified production activities income.” Thestaff proposal would require that the deduction be accounted for as a specialdeduction in the period earned, not as a tax-rate reduction.

 

FSP No. 109-2, providesguidance under SFAS No. 109 with respect to recording the potential impact ofthe repatriation provisions of the American Jobs Creation Act of 2004 (the “JobsAct”) on enterprises’ income tax expense and deferred tax liability FSP 109-2states that an enterprise is permitted time beyond the financial reportingperiod of enactment to evaluate the effect of the Jobs Act on its plan forreinvestment or repatriation of foreign earnings for purposes of applying SFASNo. 109.  By electing to apply theprovisions of Section 965 of the Internal Revenue Code, enacted as part of theJobs Act, to repatriate extraordinary dividends we will therefore be eligibleto claim an eighty-five percent dividends received deduction for income taxpurposes on the eligible amounts. We are in the process of determining whetherwe will elect to utilize the provision of the Jobs Act which provides aone-time election to repatriate earnings from foreign subsidiaries at a reducedU.S. tax rate.  As of the end of 2004, wehave not drawn any conclusion regarding this opportunity to our overallstrategy and expect to complete the evaluation of this opportunity by July 1,2005.

 

*Reclassifications.* Certain reclassifications have been made tothe 2003 and 2002 financial statements and footnotes to conform to thepresentation used in 2004.

 

We have begun to classifyinvestments in auction-rate securities and variable rate demand notes asavailable-for-sale securities. These investments were included in cash and cashequivalents in previous years and such amounts have been reclassified in theaccompanying consolidated financial statements to conform to the current periodclassification. This reclassification had no effect on the amounts of totalcurrent assets, total assets, net income or loss or cash flow from operations.

 

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**NOTE 2.  OTHERFINANCIAL STATEMENT INFORMATION**

 

*Consolidated Balance Sheet Information (in thousands):*

* *
| ** **                                                  | ** ** | **2004** | ** ** | **2003 (Restated –  See Note 14)** | ** ** |
|-------------------------------------------------------------|------------|----------|------------|-----------------------------------------|------------|
| *Inventories:*                                              |       |     |       |                                    |       |
| Raw materials                                               |       | $        | 7,531      |                                    | $          | 6,600 |   |
| Work in process                                             |       | 2,821    |       | 2,425                                   |       |
| Finished goods                                              |       | 4,281    |       | 3,321                                   |       |
|                                                        |       | $        | 14,633     |                                    | $          | 12,346 |   |
| *Property  and equipment, net:*                             |       |     |       |                                    |       |
| Manufacturing  equipment                                    |       | $        | 78,269     |                                    | $          | 69,639 |   |
| Office equipment                                            |       | 9,002    |       | 8,141                                   |       |
| Land, building  and leasehold improvements                  |       | 10,338   |       | 9,008                                   |       |
|                                                        |       | 97,609   |       | 86,788                                  |       |
| Less:  Accumulated depreciation and amortization            |       | (62,201  | )          | (48,206                                 | )          |
|                                                        |       | $        | 35,408     |                                    | $          | 38,582 |   |
| *Accrued  expense and other current liabilities:*           |       |     |       |                                    |       |
| Compensation and  benefits                                  |       | $        | 3,914      |                                    | $          | 6,336 |   |
| Royalties                                                   |       | 2,765    |       | 10,255                                  |       |
| Litigation  reserves, excluding expected insurance proceeds |       | 10,720   |       | —                                  |       |
| Other                                                       |       | 1,778    |       | 5,445                                   |       |
|                                                        |       | $        | 19,177     |                                    | $          | 22,036 |   |

 

*Supplemental Cash Flow Information (in thousands):*

 
| ** **                                                                                                                              | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| *Cash  paid for:*                                                                                                                       |       |     |       |     |       |     |       |
| Interest                                                                                                                                |       | $        | 97         |     | $          | 151      |       | $ | 245 |   |
| Income taxes                                                                                                                            |       | 902      |       | 1,045    |       | 1,235    |       |
| *Non-cash  transactions:*                                                                                                               |       |     |       |     |       |     |       |
| Unrealized  (loss) gain on available-for-sale securities, net of deferred taxes of $1,007  in 2004, $(1,815) in 2003 and $(719) in 2002 |       | (1,785   | )          | 2,819    |       | 1,275    |       |
|                                                                                                                                         |            |          |            |          |            |          |            |  |  |  |

 

**NOTE3.  AVAILABLE-FOR-SALE SECURITIES**

 

Our short-terminvestments consist of auction rate preferred securities and municipal auctionrate notes. These investments, which have original maturities beyond one year,may be classified as short-term based on their highly liquid nature and becausethese securities represent the investment of cash that is available for currentoperations. These investments are classified as available-for-sale and recordedat fair value. The carrying value of short term available-for-sale securitiesapproximates fair market value due to their short maturities.  As of December 31, 2004 and December 26,2003, we had $19,200,000 and $17,000,000 in short term available-for-salesecurities, respectively.

 

Our long-term investmentin available-for-sale securities consist of shares of Intraware common stockand is discussed further in Note 4.

 

**NOTE 4.  ACQUISITIONSAND STRATEGIC ALLIANCES**

 

*Strategic Alliance Agreement.*** **On April 30, 2004, we announcedthe restructuring of our agreement with Intraware, Inc. (Intraware), wherebyour Strategic Alliance Agreement (SAA), originally signed in August 2002, wasterminated and replaced with a Reseller Agreement under which we will continueto offer Intraware global electronic software delivery (ESD) services to ourcustomers.  Under the original SAA, asamended, we had an exclusive right to market and resell Intraware’s ESDservices in the supply chain outsourcing market.  Revenues earned under the SAA prior to therestructuring had not been significant. Additionally, the SAA required us to pay annual license fees for whichwe expensed $435,000 and $656,000 in 2004 and 2003, respectively.

 

In addition torestructuring the agreement, we sold 3,000,000 shares of our Intraware shareholdingsin two separate private placements which resulted in proceeds of approximately$5,230,000 and a pre-tax gain of approximately $2,770,000.  These shares 

 

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were originally obtainedin August 2002 when we purchased approximately 6,098,000 shares of Intrawarecommon stock (Nasdaq Symbol: ITRA) in a private placement at $0.82 per share,representing approximately 12% of the outstanding shares of Intraware at thattime.  The common stock was issued in aprivate placement without registration under the Securities Act of 1933.  In 2003, Intraware filed a registrationstatement with the Securities and Exchange Commission to register the resale ofthe common stock issued to us.  We haveclassified 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 our investment in Intraware was $3,624,000 and$11,646,000 as of the end of 2004 and 2003, respectively.

 

*Investmentin Unconsolidated Entity. *OnOctober 2, 1998, we 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, based on Microgistix’historical operating results and cash flow requirements, we determined that wecould not justify any carrying amount of this investment, and accordingly,wrote off the remaining value.

 

Oursales to Microgistix were $1,430,000 in 2004, $2,305,000 in 2003, and$3,863,000 in 2002.  Microgistix accountsreceivable balances as of the end of the year were $345,000 in 2004, $345,000in 2003, and $773,000 in 2002.

 

**NOTE 5.  CREDITFACILITIES AND LONG-TERM NOTES PAYABLE**

 

Atthe end of 2002, we had a $15,000,000 term loan facility and a $25,000,000revolving line-of-credit facility.  Theamount outstanding on the term loan facility as of the end of 2002 was$3,736,000 and there were no amounts outstanding under the revolving line ofcredit facility.  In 2003, we paid allamounts due under the term loan facility and cancelled the revolving line ofcredit facility.

 

**NOTE 6.  SHAREHOLDERS’EQUITY**

 

*Stock Repurchases*.  InOctober 2002, our Board of Directors authorized a stock repurchase plan thatallows us to repurchase up to $10,000,000 of our common stock.  In 2003, we repurchased a total of 761,900shares at a cost of $2,587,000.  OnJuly 8, 2004, in connection with the resignation of one of our non-employeedirectors, we entered into an agreement to purchase 415,000 shares of theCompany’s common stock held by the former director in a private transaction ata price of $3.42 per share, the closing market price on that day.  The repurchase price was subject to a “PostClosing Price Adjustment” as defined in the agreement should the market priceof the stock fall below pre-defined levels within a defined period oftime.  This defined period of timeexpired on September 30, 2004 with no resulting price adjustments.

 

*LitigationSettlement Offer.*  Asdiscussed in more detail in Note 11 to the consolidated financial statements,we have made a settlement offer in relation to a consolidated class actionlawsuit.  A portion of this settlement offerincludes the proposed issuance of 1,500,000 shares of our common stock.  There are no assurances that this or anyother portion of the settlement offer will be accepted.

 

**NOTE 7.  COMPREHENSIVEINCOME (LOSS)**

 

Thetable below presents comprehensive income, defined as changes in the equity ofthe Company excluding changes resulting from investments by and distributionsto shareholders (in thousands):

 
| ** **                                                                                              | ** ** | **2004** | ** ** | **2003 (Restated –  See Note 14)** | ** ** | **2002** | ** ** |
|---------------------------------------------------------------------------------------------------------|------------|----------|------------|-----------------------------------------|------------|----------|------------|
| Net loss                                                                                                |       | $        | (8,411     | )                                       | $          | (1,175   | )          | $ | (679 | ) |
| Reclassification  to net loss of gain on available-for-sale securities previously deferred, net  of tax |       | (1,629   | )          | —                                  |       | —   |       |
| Unrealized  holding (loss) gain on available-for-sale securities, net of tax                            |       | (1,785   | )          | 2,819                                   |       | 1,275    |       |
| Translation  adjustments                                                                                |       | 3,219    |       | 6,462                                   |       | 4,672    |       |
| Comprehensive  (loss) income                                                                            |       | $        | (8,606     | )                                       | $          | 8,106    |       | $ | 5,268 |   |

 

**NOTE 8.  STOCK PLANS**

 

***Employee StockPurchase Plan***. We have an employee stock purchase plan which enables our employees tocontribute up to 10 percent of their compensation toward the purchase ofthe Company’s common stock at a price equal to the lower of 85 percent of fairmarket value as of the beginning or end of each plan period.  A total of approximately 2,395,189 shareshave been reserved for issuance under this plan.  This amount is increased on January 1stof each year in accordance with the plan. We reserved shares totaling approximately 176,000, 219,000, and1,000,000 in 2004, 2003, and 2002, respectively.  Shares issued under the plan totaledapproximately 174,000 in 2004, 184,000 in 2003, and 188,000 in 2002.

 

29

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*Stock Option Plans*.  Wehave a 1996 Stock Option Plan (the “1996 Plan”) that provides for the grantingof stock options to employees, officers, directors and independent consultantsat exercise prices not less than 100 percent of the fair market value ofthe Company’s common stock on the date of grant.  These options, which can be either incentivestock options or nonqualified options, vest over a three- to five-year scheduleand expire 10 years after the grant date. The authorized number of shares reserved for issuance under the 1996Plan total 6,400,000, of which 352,799 remained available for grant at the endof 2004.

 

We also have a 2004Equity Incentive Plan (the “2004 Plan”) that provides for the granting of stock awards to employees, officers,directors and independent consultants. These awards, which can be either incentive stock options, restrictedstock or nonqualified options, vest over a one to five-year schedule and expire10 years after the grant date.  Exerciseprices for stock options granted under the 2004 Plan will not be less than100 percent of the fair market value of the Company’s common stock on thedate of grant.  The authorized number ofshares reserved for issuance under the 2004 Plan total 2,000,000, of which1,892,000 remained available for grant at the end of 2004.

 

Wehave also issued nonqualified stock options to our employees outside of thesePlans for the purchase of 1,659,350 shares of common stock, of which options topurchase 611,589 shares were outstanding as of December 31, 2004.  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 were options granted in 2001 priorto shareholder approval and therefore were subject to variable plan accountingpursuant to FASB Interpretation No. 44, “Accounting for Certain Transactions InvolvingStock Compensation (an Interpretation of APB Opinion No. 25).”  The variable plan accounting ceased when theshareholders approved the granting of the options on April 24, 2002.  We recognized a compensation benefit relatedto these options of $32,000 in 2002.

 

Informationregarding all stock option activity during the year is summarized as follows(shares in thousands):

 
| ** **                              | ** ** | **2004**   | ** ** | **2003**                              | ** ** | **2002**   | ** ** |
|-----------------------------------------|------------|------------|------------|---------------------------------------|------------|------------|------------|
| ** **                              | ** ** | **Shares** | ** ** | **Weighted  Average  Exercise Price** | ** ** | **Shares** | ** ** | **Weighted  Average  Exercise Price** | ** ** | **Shares** | ** ** | **Weighted  Average  Exercise Price** | ** ** |
|                                    |       |       |       |                                  |       |       |       |   |   |   |   |   |   |
| Options  outstanding, beginning of year |       | 3,323      |       | $                                     | 5.03       |       | 3,674      |   | $ | 5.07 |   | 3,849 |   | $ | 7.07 |   |
| Granted                                 |       | 849        |       | 3.91                                  |       | 273        |       | 3.65 |   | 545 |   | 4.86 |   |
| Exercised                               |       | (188       | )          | 2.06                                  |       | (138       | )          | 2.52 |   | (126 | ) | 2.56 |   |
| Canceled                                |       | (1,153     | )          | 5.71                                  |       | (486       | )          | 5.30 |   | (594 | ) | 15.72 |   |
| Options  outstanding, end of year       |       | 2,831      |       | $                                     | 4.61       |       | 3,323      |   | $ | 5.03 |   | 3,674 |   | $ | 5.07 |   |
|                                    |       |       |       |                                  |       |       |       |   |   |   |   |   |   |
| Options  exercisable, end of year       |       | 1,298      |       | $                                     | 4.69       |       | 1,463      |   | $ | 4.53 |   | 1,337 |   | $ | 4.14 |   |

 

Informationregarding all outstanding stock options as of December 31, 2004 is summarizedas follows (shares in thousands):

 
| ** **                    | ** ** | ** ** | ** ** | **Options Outstanding**          | ** ** | **Options Exercisable** | ** ** |
|-------------------------------|------------|------------|------------|----------------------------------|------------|-------------------------|------------|
| **Range of  Exercise Prices** | ** ** | ** ** | ** ** | **Weighted  Average  Remaining** | ** ** | **Weighted  Average**   | ** ** | ** ** | ** ** | **Weighted  Average** | ** ** |
| **Low**                       | ** ** | **High**   | ** ** | **Shares**                       | ** ** | **Life (in years)**     | ** ** | **Exercise Price** | ** ** | **Shares** | ** ** | **Exercise Price** | ** ** |
|                          |       |       |       |                             |       |                    |       |   |   |   |   |   |   |
| $                             | 1.13       |       | $          | 2.86                             |       | 458                     |       | 3.4 |   | $ | 2.17 |   | 458 |   | $ | 2.17 |   |
| 2.87                          |       | 5.71       |       | 1,429                            |       | 8.3                     |       | 3.91 |   | 329 |   | 3.96 |   |
| 5.72                          |       | 8.57       |       | 898                              |       | 6.3                     |       | 6.15 |   | 468 |   | 6.19 |   |
| 8.58                          |       | 24.13      |       | 46                               |       | 5.3                     |       | 21.10 |   | 43 |   | 20.77 |   |
|                          |       |       |       | 2,831                            |       | 6.8                     |       | $ | 4.61 |   | 1,298 |   | $ | 4.69 |   |
|                               |            |            |            |                                  |            |                         |            |  |  |  |  |  |  |  |  |  |  |

 

30

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**NOTE 9.  INCOME TAXES**

 

Detailsregarding the income tax benefit included in the consolidated statement ofoperations are as follows (in thousands):

 
| ** **                | ** ** | **2004** | ** ** | **2003 (Restated –  See Note 14)** | ** ** | **2002** | ** ** |
|---------------------------|------------|----------|------------|-----------------------------------------|------------|----------|------------|
| Current:                  |       |     |       |                                    |       |     |       |
| U.S. Federal              |       | $        | (868       | )                                       | $          | (3,628   | )          | $ | (815 | ) |
| State                     |       | 626      |       | (578                                    | )          | (142     | )          |
| Foreign                   |       | 425      |       | (153                                    | )          | 876      |       |
|                      |       | 183      |       | (4,359                                  | )          | (81      | )          |
|                      |       |     |       |                                    |       |     |       |
| Deferred                  |       |     |       |                                    |       |     |       |
| U.S. Federal              |       | (2,438   | )          | 1,190                                   |       | (429     | )          |
| State                     |       | (1,069   | )          | —                                  |       | —   |       |
| Foreign                   |       | (299     | )          | 148                                     |       | (63      | )          |
|                      |       | (3,806   | )          | 1,338                                   |       | (492     | )          |
| Total income tax  benefit |       | $        | (3,623     | )                                       | $          | (3,021   | )          | $ | (573 | ) |

 

Excludedfrom our provision for income taxes are tax benefits we realize from employeesales of stock issued under our stock option and employee stock purchase plansof $185,000 in 2004, $104,000 in 2003, and $158,000 in 2002.  These tax benefits are recorded directly tostockholders’ equity.  The provision forforeign income taxes is based upon foreign pretax (loss) income ofapproximately $(1,487,000) in 2004, $3,812,000 in 2003, and $2,104,000 in 2002.

 

The determination ofannual income tax expense takes into consideration amounts which may be neededto cover exposures for open tax years.  In 2004, we assessed the probabilities ofthose exposures and recognized a $385,000benefit related to reductions in our tax accruals from 2003.  In 2003, Canadian tax authoritiescompleted an audit of our Canadian tax returns for the years 1999, 2000 and2001 and, accordingly, we removed $1,010,000 of provisions we had made in ourtax liabilities related to the risk that tax authorities would reject certainpositions we had taken in the preparation of these returns.  We do not expect any material impacton earnings to result from the resolution of matters related to open tax years;however, actual settlements may differ from amounts accrued.

 

Areconciliation of the statutory U.S. federal income tax rate to our effectiveincome tax rate is as follows:

 
| ** **                                                  | ** ** | **2004** | ** ** | **2003 (Restated –  See Note 14)** | ** ** | **2002** | ** ** |
|-------------------------------------------------------------|------------|----------|------------|-----------------------------------------|------------|----------|------------|
| Statutory U.S.  federal income tax rate                     |       | 34.0     | %          | 34.0                                    | %          | 34.0     | %          |
| State income  taxes, net of federal income tax benefit |       | 2.4      |       | 6.3                                     |       | 4.1      |       |
| Reduction in tax  accruals                                  |       | 3.2      |       | 24.4                                    |       | —   |       |
| Non-deductible  expenses                                    |       | (5.7     | )          | —                                  |       | —   |       |
| Foreign tax  effect                                         |       | (5.3     | )          | 4.0                                     |       | (7.8     | )          |
| Tax deductible  goodwill                                    |       | 1.3      |       | 3.8                                     |       | 12.8     |       |
| Other                                                       |       | 0.2      |       | (0.5                                    | )          | 2.7      |       |
| Effective income  tax rate                                  |       | 30.1     | %          | 72.0                                    | %          | 45.8     | %          |

 

31

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Thecomponents of our deferred tax assets and liabilities are as follows (inthousands):

 
| ** **                                      | ** ** | **2004** | ** ** | **2003 (Restated –  See Note 14)** | ** ** |
|-------------------------------------------------|------------|----------|------------|-----------------------------------------|------------|
| Deferred tax  assets:                           |       |     |       |                                    |       |
| Accounts  receivable reserves                   |       | $        | 301        |                                    | $          | 412 |   |
| Inventory  valuation                            |       | 1,320    |       | 1,424                                   |       |
| Accrued  liabilities                            |       | 693      |       | 849                                     |       |
| Foreign tax  credit                             |       | 850      |       | 1,294                                   |       |
| Capital loss  carryforward                      |       | 1,556    |       | 1,538                                   |       |
| Ireland  operating loss carry forward           |       | 2,241    |       | 1,784                                   |       |
| Domestic  operating loss carry forward          |       | 4,609    |       | —                                  |       |
| Other                                           |       | 224      |       | —                                  |       |
| Gross deferred  tax assets                      |       | 11,794   |       | 7,301                                   |       |
| Valuation  Allowance                            |       | (2,333   | )          | (2,315                                  | )          |
|                                            |       | $        | 9,461      |                                    | $          | 4,986 |   |
| Deferred tax  liabilities:                      |       |     |       |                                    |       |
| Depreciation and  amortization                  |       | $        | (1,317     | )                                       | $          | (1,137 | ) |
| Unrealized gain  on available-for-sale security |       | (410     | )          | (2,479                                  | )          |
| Other                                           |       | (127     | )          | —                                  |       |
|                                            |       | $        | (1,854     | )                                       | $          | (3,616 | ) |
| Net deferred tax  asset (liability)             |       | $        | 7,607      |                                    | $          | 1,370 |   |

 

A valuation allowance of$2,333,000 and $2,315,000 exists for deferred income tax benefits related tocertain loss carryforwards available that may not be realized as of December31, 2004 and 2003, respectively.  Webelieve that sufficient taxable income will be generated in the respectivecountries to allow us to fully recover the remainder of the tax losses.

 

We have not recordeddeferred income taxes applicable to undistributed earnings of our 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 the amount of such liability. Weare in the process of determining whether we will elect to utilize provisionsof the American Jobs Creation Act of 2004, which provides a one-time electionto repatriate earnings from foreign subsidiaries at a reduced U.S. tax rate. Asa result of this Act, we have the opportunity to repatriate cash in 2005 thathas been generated over time by our foreign operations, which would result inan increase in our tax provision in 2005. As of the end of 2004, we have not drawn any conclusion regarding thisopportunity to our overall strategy and expect to complete the evaluation ofthis opportunity by July 1, 2005.

 

32

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**NOTE 10.  RELATED-PARTYTRANSACTIONS**

 

*Operating Lease. *We lease one of ourmanufacturing and office facilities from a partnership that is one-third ownedby a significant shareholder and former member of our Board of Directors.  We believe the terms of this lease areequivalent to those that would be paid in an arm’s-length transaction. Paymentsunder this lease totaled $656,000 in 2004, $642,000 in 2003, and $649,000 in2002.

 

*Sales to Related Party.*  One ofour customers is owned by a significant shareholder and a former member of ourBoard of Directors.  We believe our termsof sale with this customer are equivalent to those offered to all our customersfor similar services and volume of business. Sales to this customer were $17,000 in 2004, $234,000 in 2003, and$241,000 in 2002.  Amounts owed to us asof the end of the year were $0 in 2004, $109,000 in 2003, and $48,000 in 2002.

 

*Stock Repurchase.*  As discussed in moredetail in Note 6 to the consolidated financial statements, we repurchased415,000 shares of the Company’s common stock from a significant shareholder andformer member of our Board of Directors in a private transaction.  The repurchase price was the $3.42 per share,the closing market price on that day.

 

**NOTE 11.  COMMITMENTSAND CONTINGENCIES**

 

*Operating Leases*.  Weare committed under operating leases with related and unrelated parties for therental of manufacturing, warehouse and office facilities.  Future minimum lease obligations as ofDecember 31, 2004 are as follows (in thousands):

 
| 2005       |   | $     | 5,761  |   |
|------------|--------|-------|--------|--------|
| 2006       |   | 4,617 |   |
| 2007       |   | 4,048 |   |
| 2008       |   | 1,289 |   |
| 2009       |   | 923   |   |
| Thereafter |   | 2,004 |   |
|       |   | $     | 18,642 |   |

 

Rentexpense under all operating leases, exclusive of real estate taxes, insuranceand maintenance expense, was $7,081,000 in 2004, $6,104,000 in 2003, and$5,649,000 in 2002.

 

*Ireland Employment Grants*.  Our Ireland businesses have receivedemployment grants from the Ireland Development Authority (IDA) totaling$3,454,000 during the period from 1995 through 2000.  We recognized these grants as income inprevious years on an straight-line basis in selling, general and administrativeexpenses 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, at the election ofthe IDA, result in the pro rata return of the grants based on the number ofpositions terminated compared to the number of new positions originallycreated.  At December 31, 2004, ouremployment levels in Ireland were below the levels for which we had receivedgrants.  However, historically the IDAhas informed us that it does not intend to seek repayment of any grant moniesat this time or in the foreseeable future, and accordingly, we have notprovided for such repayment in our financial statements.  Under FASB Statement No. 5, *“Accounting for Contingencies”*, and FASB Interpretation No. 14,*“Reasonable Estimation of the Amount of a Loss, aninterpretation of FASB Statement No. 5”*, we have determined thatrepayment is not probable and have not accrued a liability in the consolidatedfinancials statements as of December 31, 2004.

 

*Polycarbonate SupplyAgreement. *During thesecond quarter of 2004, we entered into an agreement with our supplier ofpolycarbonate, a petroleum-based commodity which is the primary raw materialused in the production of CD and DVD media. Over the past three quarters, supply shortages and increases inpetroleum prices have placed significant upward pressure on polycarbonatepricing.  Under the agreement, which runsthrough June 2005, we have agreed to purchase a total of 9.4 million pounds ofpolycarbonate at set price terms.  Theseprice terms restrict monthly price increases and help us to limit our exposureto potential future price increases while also allowing us to reduce ourpurchase volume should the price terms increase above an agreed-upon level overthe initial base price. Minimum remaining commitments under this agreement,subject to purchase volume reductions, are approximately $7,500,000 based onthe current adjusted base price and minimum remaining quantity. We believe thatthis agreement will allow us to minimize our near-term exposure to continuingupward price pressures on this key raw material.

 

*401(k) Plan.*  We have a discretionary 401(k)plan for all employees who are at least 21 years of age and have completed 60days of service with the Company.  Ourdiscretionary contributions totaled $283,000 in 2004, $245,000 in 2003, and$245,000 in 2002.

 

33

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* “Wells Notice”and Shareholder Lawsuit. *Aspreviously disclosed in our Forms 10-Q and 2003 10-K, we have been the subjectof a Securities and Exchange Commission investigation and a consolidated classaction lawsuit involving allegations of securities law violations. Theallegations relate to Company disclosures and certain stock sales by two formerofficers during the third quarter of the year 2000.  Under FASB Statement No. 5, *“Accounting for Contingencies”*, and FASB Interpretation No.14, *“Reasonable Estimation of the Amount of a Loss, aninterpretation of FASB Statement No. 5”*, we have established areserve as of December 31, 2004 of $8,520,000 which represents our estimate ofthe related minimum expected probable losses that would result from settlementoffers made by us in these matters.  Aportion of the settlement offer related to the consolidated class actionlawsuit includes the proposed issuance of 1,500,000 shares of the company’scommon stock and has been valued at $6,165,000 based on the closing marketprice of $4.11 on December 31, 2004. There is no assurance that these offers will result in settlements, andeventual losses in these matters may exceed these reserves and could have amaterial adverse effect on our results of operations, financial condition orcash flows.

 

*Customer claim ofunauthorized production of software*. During the second quarter of 2003, one of our major customers alleged that Zomax Ireland, asubsidiary we acquired from Kao Corporation in January 1999, was responsiblefor unauthorized production of the customer’s software.  Our customer claimed that because of thesealleged unauthorized activities it had suffered significant damagesrepresenting lost profits on displaced product sales.  In the fourth quarter of 2003, we and our customer reached a finalaccommodation related to these claims. While we continue to deny these claims, in order to avoid potentiallylengthy and expensive litigation, we agreed to make a one-time payment to ourcustomer of $3,000,000.  As a part of thesettlement agreement, neither party admitted any liability and both partiesobtained mutual releases related to the claims.

 

We are involved in certain other claims arising inthe normal course of business.  In ouropinion, the final resolution of these claims should not have a materialadverse effect on our financial position, cash flow or results from operations.

 

**NOTE12.  QUARTERLY FINANCIAL DATA (UNAUDITED)**

 

Theoperating results for each of the quarters in the nine month period endedSeptember 24, 2004 and the year ended December 26, 2003 have been restated to correctthe misstatements in our Ireland subsidiary, Zomax Limited, as discussed inNote 14 below.

 

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

 
| ** **                         | ** ** | **Quarter Ended** | ** ** |
|------------------------------------|------------|-------------------|------------|
| ** **                         | ** ** | **March**         | ** ** | **June** | ** ** | **September** | ** ** | **December** | ** ** |
| **2003 As  Reported:**             | ** ** | ** **        | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Revenue                            |       | $                 | 47,228     |   | $ | 43,997 |   | $ | 44,535 |   | $ | 61,910 |   |
| Gross profit                       |       | 6,698             |       | 6,331 |   | 6,390 |   | 17,988 |   |
| Operating income  (loss)           |       | (2,635            | )          | (2,549 | ) | (4,645 | ) | 6,064 |   |
| Net earnings  (loss)               |       | (1,725            | )          | (1,510 | ) | (2,534 | ) | 5,214 |   |
| Basic earnings  (loss) per share   |       | $                 | (0.05      | ) | $ | (0.05 | ) | $ | (0.08 | ) | $ | 0.16 |   |
| Diluted earnings  (loss) per share |       | $                 | (0.05      | ) | $ | (0.05 | ) | $ | (0.08 | ) | $ | 0.16 |   |

 
| ** **                                | ** ** | **Quarter Ended** | ** ** |
|-------------------------------------------|------------|-------------------|------------|
| ** **                                | ** ** | **March**         | ** ** | **June** | ** ** | **September** | ** ** | **December** | ** ** |
| **2003 As  Restated – See Note 14:** |       |              |       |   |   |   |   |   |   |
| Revenue                                   |       | $                 | 47,228     |   | $ | 43,997 |   | $ | 44,535 |   | $ | 62,056 |   |
| Gross profit                              |       | 6,123             |       | 6,371 |   | 6,123 |   | 17,912 |   |
| Operating income  (loss)                  |       | (3,059            | )          | (2,496 | ) | (4,900 | ) | 6,001 |   |
| Net earnings  (loss)                      |       | (2,106            | )          | (1,463 | ) | (2,764 | ) | 5,158 |   |
| Basic earnings  (loss) per share          |       | $                 | (0.06      | ) | $ | (0.05 | ) | $ | (0.09 | ) | $ | 0.16 |   |
| Diluted earnings  (loss) per share        |       | $                 | (0.06      | ) | $ | (0.05 | ) | $ | (0.09 | ) | $ | 0.16 |   |

 

34

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| ** **                         | ** ** | **Quarter Ended** | ** ** |
|------------------------------------|------------|-------------------|------------|
| ** **                         | ** ** | **March**         | ** ** | **June** | ** ** | **September** | ** ** | **December** | ** ** |
| **2004 As  Reported:**             | ** ** | ** **        | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Revenue                            |       | $                 | 50,035     |   | $ | 45,082 |   | $ | 45,718 |   | $ | 58,593 |   |
| Gross profit                       |       | 7,339             |       | 8,793 |   | 7,796 |   | 8,205 |   |
| Operating loss                     |       | (1,827            | )          | (804 | ) | (8,885 | ) | (1,765 | ) |
| Net earnings  (loss)               |       | (981              | )          | 1,252 |   | (5,497 | ) | (1,362 | ) |
| Basic earnings  (loss) per share   |       | $                 | (0.03      | ) | $ | 0.04 |   | $ | (0.17 | ) | $ | (0.04 | ) |
| Diluted earnings  (loss) per share |       | $                 | (0.03      | ) | $ | 0.04 |   | $ | (0.17 | ) | $ | (0.04 | ) |

 
| ** **                                | ** ** | **Quarter Ended** | ** ** |
|-------------------------------------------|------------|-------------------|------------|
| ** **                                | ** ** | **March**         | ** ** | **June** | ** ** | **September** | ** ** |
| **2004 As  Restated – See Note 14:** |       |              |       |   |   |   |   |
| Revenue                                   |       | $                 | 50,035     |   | $ | 45,082 |   | $ | 45,718 |   |
| Gross profit                              |       | 6,950             |       | 8,020 |   | 7,222 |   |
| Operating loss                            |       | (2,455            | )          | (1,602 | ) | (9,485 | ) |
| Net earnings  (loss)                      |       | (1,546            | )          | 534 |   | (6,037 | ) |
| Basic earnings  (loss) per share          |       | $                 | (0.05      | ) | $ | 0.02 |   | $ | (0.19 | ) |
| Diluted earnings  (loss) per share        |       | $                 | (0.05      | ) | $ | 0.02 |   | $ | (0.19 | ) |

 

In the second quarterof 2004, we sold a portion of our investment in Intraware and recorded apre-tax gain of $2,770,000.  See “StrategicAlliance Agreement” in Note 4 to the consolidated financial statements.  Additionally, in the third quarter and fourthquarter of 2004 we recognized pre-tax charges of $7,500,000 and $1,020,000,respectively, to establish reserves for liabilities that represent the Company’sestimate of the minimum expected probable losses resulting from settlementoffers made by the Company in connection with the pending Securities andExchange Commission investigation and consolidated class action lawsuit. See “‘WellsNotice” and Shareholder Lawsuit” in Note 11 to the consolidated financialstatements.

 

Inthe fourth quarter of 2003, we signed a revised royalty agreement whichretroactively reduced the rates at which royalties are payable under theagreement.  The signing of this contractresulted in a $4,776,000 non-cash benefit related to unpaid royalties accruedand charged to cost of revenue in 2002 and the first three quarters of2003.  See “Royalties” in Note 1 toconsolidated financial statements.

 

35

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**NOTE 13.  SEGMENT ANDGEOGRAPHICAL INFORMATION**

 

Weoperate in one industry segment. The geographic distributions of ouridentifiable assets, operating income (loss) and revenues for 2003, 2002 and2001 are summarized as follows (in thousands):

 
| ** **                          | ** ** | **2004** | ** ** | **2003 (Restated – See  Note 14)** | ** ** | **2002** | ** ** |
|-------------------------------------|------------|----------|------------|-----------------------------------------|------------|----------|------------|
| **Revenue:**                        |       |     |       |                                    |       |     |       |
| United States                       |       | $        | 152,763    |                                    | $          | 145,259  |       | $ | 141,306 |   |
| Ireland                             |       | 34,978   |       | 36,084                                  |       | 29,926   |       |
| Canada                              |       | 32,321   |       | 31,203                                  |       | 26,813   |       |
| Intergeographic  revenue            |       | (20,634  | )          | (14,730                                 | )          | (12,545  | )          |
|                                |       | $        | 199,428    |                                    | $          | 197,816  |       | $ | 185,500 |   |
| **Operating  income (loss):**       |       |     |       |                                    |       |     |       |
| United States                       |       | $        | 4,609      |                                    | $          | 9,669    |       | $ | 8,931 |   |
| Ireland                             |       | (3,287   | )          | 994                                     |       | (381     | )          |
| Canada                              |       | 3,963    |       | 2,888                                   |       | 3,427    |       |
| Corporate  and eliminations    |       | (20,592  | )          | (18,004                                 | )          | (14,429  | )          |
|                                |       | $        | (15,307    | )                                       | $          | (4,453   | )          | $ | (2,452 | ) |
| **Assets:**                         |       |     |       |                                    |       |     |       |
| United States                       |       | $        | 42,946     |                                    | $          | 52,506   |       | $ | 49,390 |   |
| Ireland                             |       | 27,646   |       | 31,264                                  |       | 25,174   |       |
| Canada                              |       | 17,384   |       | 25,257                                  |       | 17,519   |       |
| Total  identifiable assets          |       | 87,976   |       | 109,027                                 |       | 92,083   |       |
| Corporate assets  and eliminations  |       | 80,178   |       | 72,012                                  |       | 75,100   |       |
|                                |       | $        | 168,154    |                                    | $          | 181,039  |       | $ | 167,183 |   |
| **Capital  expenditures:**          |       |     |       |                                    |       |     |       |
| United States                       |       | $        | 3,035      |                                    | $          | 3,716    |       | $ | 2,611 |   |
| Ireland                             |       | 1,160    |       | 1,409                                   |       | 79       |       |
| Canada                              |       | 500      |       | 4,464                                   |       | 260      |       |
|                                |       | $        | 4,695      |                                    | $          | 9,589    |       | $ | 2,950 |   |
| **Depreciation  and amortization:** |       |     |       |                                    |       |     |       |
| United States                       |       | $        | 5,928      |                                    | $          | 5,897    |       | $ | 5,936 |   |
| Ireland                             |       | 1,388    |       | 1,132                                   |       | 1,168    |       |
| Canada                              |       | 2,513    |       | 1,639                                   |       | 1,245    |       |
|                                |       | $        | 9,829      |                                    | $          | 8,668    |       | $ | 8,349 |   |

 

**NOTE 14.  RESTATEMENTOF FINANCIAL STATEMENTS**

 

On February 24, 2005, ourmanagement and the Audit Committee of the Board of Directors concluded that, asa result of our internal investigation into financial reporting and accountingirregularities at our Ireland Subsidiary, Zomax Limited (“Zomax Ireland”), theCompany’s financial statements for the full year 2003 and for the first, secondand third quarters of 2004, should be restated.

 

Our internalinvestigation indicated that the actions of certain accounting personnel in theZomax Ireland operation caused the operation to overstate its operatingresults.  These actions include theimproper accounting for certain expenses and the failure to follow Companypolicy and properly reconcile certain balance sheet accounts.  These irregularities resulted in theunderstatement of our previously reported 2003 and 2004 consolidated net lossby $620,000 and $1,823,000, respectively. The restatement did not impact the Company’s reported 2003 cash flows.  However, the restatement did impact the cashprovided by operating activities and the effect of exchange rate changes oncash and cash equivalents.

 

36

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The effects of therestatement on the Company’s consolidated statement of operations and balancesheet reported in the 2003 Form 10-K are as follows:

 

**CONSOLIDATEDSTATEMENT OF OPERATIONS**

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

 
| ** **                                    | ** ** | **For the Year ended December 26,  2003** | ** ** |
|-----------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                    | ** ** | **As Reported**                           | ** ** | **As Restated** | ** ** |
|                                          |       |                                      |       |   |   |
| **Revenue**                                   |       | $                                         | 197,670    |   | $ | 197,816 |   |
|                                          |       |                                      |       |   |   |
| Cost of revenue                               |       | 160,263                                   |       | 161,287 |   |
|                                          |       |                                      |       |   |   |
| **Gross  profit**                             |       | 37,407                                    |       | 36,529 |   |
|                                          |       |                                      |       |   |   |
| Selling, general  and administrative expenses |       | 41,172                                    |       | 40,982 |   |
|                                          |       |                                      |       |   |   |
| **Operating  loss**                           |       | (3,765                                    | )          | (4,453 | ) |
|                                          |       |                                      |       |   |   |
| Other income  (expense)                       |       | 257                                       |       | 257 |   |
|                                          |       |                                      |       |   |   |
| **Loss  before income taxes**                 |       | (3,508                                    | )          | (4,196 | ) |
|                                          |       |                                      |       |   |   |
| Income tax  benefit                           |       | (2,953                                    | )          | (3,021 | ) |
| **Net  loss**                                 |       | $                                         | (555       | ) | $ | (1,175 | ) |
|                                          |       |                                      |       |   |   |
| **Loss  per share:**                          |       |                                      |       |   |   |
| Basic                                         |       | $                                         | (0.02      | ) | $ | (0.04 | ) |
| Diluted                                       |       | $                                         | (0.02      | ) | $ | (0.04 | ) |

 

37

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**CONSOLIDATEDBALANCE SHEET**

***(Inthousands*)**

 
| ** **                                      | ** ** | **As of December 26, 2003** | ** ** |
|-------------------------------------------------|------------|-----------------------------|------------|
| ** **                                      | ** ** | **As Reported**             | ** ** | **As Restated** | ** ** |
| **ASSETS**                                      |       |                        |       |   |   |
| **Current  assets:**                            |       |                        |       |   |   |
| Cash and cash  equivalents                      |       | $                           | 51,899     |   | $ | 51,899 |   |
| Available-for-sale  securities                  |       | 17,000                      |       | 17,000 |   |
| Accounts  receivable                            |       | 39,403                      |       | 39,577 |   |
| Inventories                                     |       | 12,757                      |       | 12,346 |   |
| Deferred income  taxes                          |       | 2,685                       |       | 2,685 |   |
| Other current  assets                           |       | 7,384                       |       | 7,304 |   |
|                                            |       |                        |       |   |   |
| Total current  assets                           |       | 131,128                     |       | 130,811 |   |
|                                            |       |                        |       |   |   |
| **Property  and equipment, net**                |       | 38,859                      |       | 38,582 |   |
|                                            |       |                        |       |   |   |
| **Available-for-sale  securities**              |       | 11,646                      |       | 11,646 |   |
|                                            |       |                        |       |   |   |
|                                            |       | $                           | 181,633    |   | $ | 181,039 |   |
|                                            |       |                        |       |   |   |
| **LIABILITIES  AND SHAREHOLDERS’ EQUITY**  |       |                        |       |   |   |
| **Current  liabilities:**                       |       |                        |       |   |   |
| Accounts payable                                |       | $                           | 20,524     |   | $ | 20,635 |   |
| Accrued expenses  and other current liabilities |       | 22,028                      |       | 22,036 |   |
|                                            |       |                        |       |   |   |
| Total current  liabilities                      |       | 42,552                      |       | 42,671 |   |
|                                            |       |                        |       |   |   |
| **Deferred  income taxes**                      |       | 1,315                       |       | 1,315 |   |
|                                            |       |                        |       |   |   |
| Total  liabilities                              |       | 43,867                      |       | 43,986 |   |
|                                            |       |                        |       |   |   |
| **Shareholders’  equity:**                 |       |                        |       |   |   |
| Common stock                                    |       | 62,469                      |       | 62,469 |   |
| Retained  earnings                              |       | 65,892                      |       | 65,272 |   |
| Accumulated  other comprehensive income         |       | 9,405                       |       | 9,312 |   |
|                                            |       |                        |       |   |   |
| Total  shareholders’ equity                |       | 137,766                     |       | 137,053 |   |
|                                            |       |                        |       |   |   |
|                                            |       | $                           | 181,633    |   | $ | 181,039 |   |

 

38

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

 

None.

 

**ITEM 9A. CONTROLS AND PROCEDURES**

 

**Evaluationof Disclosure Controls and Procedures**

 

As of the end of theperiod covered by this report, we conducted an evaluation, under thesupervision and with the participation of our chief executive officer and chieffinancial officer, of our disclosure controls and procedures (as defined inRules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934). Basedon this evaluation, and due to the material weakness as described below inManagement’s Report on Internal Control over Financial Reporting, the chiefexecutive officer and chief financial officer concluded that, as of December31, 2004, the disclosure controls and procedures for Zomax Incorporated werenot effective to ensure that information required to be disclosed in reportsthat it files or submits under the Securities Exchange Act is recorded,processed, summarized and reported within the time periods specified in SECrules and forms.

 

**Management’sReport on Internal Control over Financial Reporting**

 

The management of ZomaxIncorporated is responsible for establishing and maintaining adequate internalcontrol over financial reporting. Our internal control system was designed toensure that material information regarding our consolidated operations is madeavailable to management and the board of directors to provide them reasonableassurance that the published financial statements are fairly presented. There are limitations inherent in any internal control, such as the possibilityof human error and the circumvention or overriding of controls.  As a result, even effective internal controlscan provide only reasonable assurance with respect to financial statementpreparation.  As conditions change overtime so too may the effectiveness of internal controls.

 

An internal controlsignificant deficiency is a control deficiency, or combination of controldeficiencies, that adversely affects a company’s ability to initiate,authorize, record, process, or report external financial data reliably inaccordance with generally accepted accounting principles such that there ismore than a remote likelihood that a misstatement of the company’s annual orinterim financial statements that is more than inconsequential will not beprevented or detected. An internal control material weakness is a significantdeficiency, or combination of significant deficiencies, that results in morethan a remote likelihood that a material misstatement of the annual or interimfinancial statements will not be prevented or detected.

 

Our management evaluatedour internal control over financial reporting as of December 31, 2004, based onthe framework in Internal Control – Integrated Framework issued by theCommittee of Sponsoring Organizations (“COSO”) of the Treadway Commission.  This evaluation identified the followingmaterial weakness in our internal control over financial reporting:

 

*Insufficientsupervision and oversight of accounting personnel at the Company’s Irelandsubsidiary, Zomax, Ltd.(“Zomax Ireland”).*  Our assessment has determined that oversightand supervision procedures established at Zomax Ireland were not sufficientlyperformed.  Specifically, there wasinsufficient review of journal entries and account reconciliations prepared byZomax Ireland accounting personnel, and Company accounting policiescommunicated to Zomax Ireland were not followed. The Zomax Ireland operationrepresents approximately 17% of both consolidated total assets and consolidatedtotal revenues of the Company as of and for the year ended December 31, 2004.

 

The aforementionedmaterial weakness in internal control permitted (i) the intentional recordingof incorrect accounting entries by local accounting personnel, (ii) theinadequate preparation and review of certain balance sheet accountreconciliations, and (iii) failure of Zomax Ireland to follow certain companyaccounting policies.  These activitiesresulted in an understatement of the Company’s 2003 consolidated net loss by$620,000, or $0.02 per share, and the understatement of the previously reportednet loss for the nine months ended September 24, 2004 by $1,823,000, or $0.06per share. These material understatements required the restatement of theCompany’s previously issued consolidated financial statements for 2003, and theinterim quarterly periods for 2004.  Therestatements primarily resulted in increases to cost of sales in both periodsand slightly increased revenues in 2003. Previously reported revenues in 2004 were not affected by therestatements.

 

Because of the materialweakness described above, management concluded that, as of December 31, 2004,our internal control over financial reporting was not effective based on thecriteria set forth by the COSO of the Treadway Commission in Internal Control –Integrated Framework.

 

Zomax Incorporated’sindependent registered public accounting firm, Deloitte & Touche LLP, haveissued an audit report on our assessment of our internal control over financialreporting. Their report appears below.

 

39

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**RemediationSteps to Address Material Weakness**

 

To remediate the materialweakness in our internal control over financial reporting in our Irelandoperations, subsequent to year end we have implemented, or are in the processof implementing, the following actions:

 

•                  TheIreland financial controller is no longer employed by the company.  We have engaged an external resource withappropriate experience and qualifications as the acting financial controller inIreland.  In addition, our corporateoperations controller has been assigned to directly oversee and implementchanges to the monthly financial close process in Zomax Ireland.  These changes include the implementation ofappropriate journal entry reviews, balance sheet reconciliation processes andprocedures to ensure company policies are followed.

•                  Weare evaluating the establishment of an internal audit program in 2005.

•                  Weare further assessing our global financial organization structure for possiblestaffing and structural changes. The assessment is focused toward betterpositioning the organizations’ ability to supervise and oversee the performanceand compliance of all aspects of the financial reporting and controlrequirements necessary for support of the Company.

•                  Wewill establish owners of all primary business processes across our globaloperations who will be responsible for ensuring formalized policies andprocedures are created and that employees are properly trained on thesepolicies.  This training will emphasizeemployee’s general understanding of our control system with particularattention to their responsibility for the integrity of the control procedureswithin their respective operations.

 

**OtherControl Deficiencies**

 

In addition to thematerial weakness in our internal control over financial reporting identifiedabove, our evaluation identified a small number of control deficiency which wehave determined to be significant in accordance with the definition of asignificant deficiency as provided in Auditing Standard No. 2 – An Audit ofInternal Control Over Financial Reporting Performed in Conjunction with AnAudit of Financial Statements.  These deficiencieshave been reported to our audit committee. In addition to the remediation activities discussed above, we are in theprocess of identifying and implementing additional control procedures toaddress these deficiencies.

 

**Change inInternal Control Over Financial Reporting**

 

During the most recentlycompleted fiscal quarter, as a result of our evaluation of internal controlover financial reporting, we initiated and completed a number of remediationsteps to improve our system of internal controls.  However, none of these changes has materiallyaffected or is reasonably likely to materially affect our internal control overfinancial reporting.

 

40

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REPORTOF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

To the Board of Directorsand Shareholders of

Zomax Incorporated:

 

Wehave audited management’s assessment, included in the accompanying Management’sReport on Internal Control over Financial reporting that Zomax Incorporated andSubsidiaries (the “Company”) did not maintain effective internal control overfinancial reporting as of December 31, 2004, because of the effect of thematerial weakness identified in management’s assessment based on criteriaestablished in *Internal Control—IntegratedFramework*issued by the Committee of Sponsoring Organizations of theTreadway Commission.  The Company’s management is responsible formaintaining effective internal control over financial reporting and for itsassessment of the effectiveness of internal control over financialreporting.  Our responsibility is to express an opinion on management’sassessment and an opinion on the effectiveness of the Company’s internalcontrol over financial reporting based on our audit.

 

Weconducted our audit in accordance with the standards of the Public CompanyAccounting Oversight Board (United States).  Those standards require thatwe plan and perform the audit to obtain reasonable assurance about whethereffective internal control over financial reporting was maintained in all materialrespects.  Our audit included obtaining an understanding of internalcontrol over financial reporting, evaluating management’s assessment, testingand evaluating the design and operating effectiveness of internal control, andperforming such other procedures as we considered necessary in thecircumstances.  We believe that our audit provides a reasonable basis forour opinions.

 

Acompany’s internal control over financial reporting is a process designed by,or under the supervision of, the company’s principal executive and principalfinancial officers, or persons performing similar functions, and effected bythe company’s board of directors, management, and other personnel to providereasonable assurance regarding the reliability of financial reporting and thepreparation of financial statements for external purposes in accordance withgenerally accepted accounting principles.  A company’s internal controlover financial reporting includes those policies and procedures that (1)pertain to the maintenance of records that, in reasonable detail, accuratelyand fairly reflect the transactions and dispositions of the assets of thecompany; (2) provide reasonable assurance that transactions are recorded asnecessary to permit preparation of financial statements in accordance withgenerally accepted accounting principles, and that receipts and expenditures ofthe company are being made only in accordance with authorizations of managementand directors of the company; and (3) provide reasonable assurance regardingprevention or timely detection of unauthorized acquisition, use, or dispositionof the company’s assets that could have a material effect on the financialstatements.

 

Becauseof the inherent limitations of internal control over financial reporting, includingthe possibility of collusion or improper management override of controls,material misstatements due to error or fraud may not be prevented or detectedon a timely basis.  Also, projections of any evaluation of theeffectiveness of the internal control over financial reporting to futureperiods are subject to the risk that the controls may become inadequate becauseof changes in conditions, or that the degree of compliance with the policies orprocedures may deteriorate.

 

Amaterial weakness is a significant deficiency, or combination of significantdeficiencies, that results in more than a remote likelihood that a materialmisstatement of the annual or interim financial statements will not beprevented or detected.  The following material weakness has beenidentified and included in management’s assessment:

 

In its assessment as ofDecember 31, 2004, management identified as a material weakness, insufficientsupervision and oversight of accounting personnel at the Company’s Irelandsubsidiary, Zomax Ltd. (“Zomax Ireland”). Specifically, there was insufficient review of journal entries andaccount reconciliations prepared by Zomax Ireland accounting personnel andCompany accounting policies communicated to Zomax Ireland were notfollowed.  As a result of this materialweakness in internal control, Zomax Incorporated’s consolidated financialstatements were misstated due to the recording of incorrect accounting entriesby local accounting personnel beginning in 2003 and continuing through 2004.  These activities resulted in a materialunderstatement of the Company’s 2003 and 2004 consolidated net loss by $620,000and $1,823,000, respectively.

 

The unaudited interimfinancial information for 2003 and 2004 has been restated as described in Note14 to the consolidated financial statements included in Item 8 of this Form10-K.

 

Thismaterial weakness was considered in determining the nature, timing, and extentof audit tests applied in our audit of the consolidated financial statementsand financial statement schedule as of and for the year ended December 31,2004, of the Company and this report does not affect our report on suchfinancial statements and financial statement schedule.

 

In ouropinion, management’s assessment that the Company did not maintain effectiveinternal control over financial reporting as of December 31, 2004, is fairlystated, in all material respects, based on the criteria established in *Internal Control—Integrated Framework*issuedby the Committee of Sponsoring Organizations of the Treadway Commission. Also in our opinion, because of the effect of the material weakness describedabove on the achievement of the objectives of the control criteria, the Companyhas not 

 

41

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maintained effective internal control over financial reporting as ofDecember 31, 2004, based on the criteria established in *Internal Control—Integrated Framework*issuedby the Committee of Sponsoring Organizations of the Treadway Commission.

 

We have also audited, in accordance with the standards of the PublicCompany Accounting Oversight Board (United States), the consolidated financialstatements and financial statement schedule listed in the Index at Item 15(a)as of and for the year ended December 31, 2004, of the Company and our reportdated March 30, 2005 expressed an unqualified opinion on those financialstatements and financial statement schedule.

 

 
| /s/ Deloitte &  Touche LLP |   |
|--------------------------------|--------|
| Minneapolis, Minnesota         |
| March 30, 2005                 |

 

**ITEM 9B.****                    OTHER INFORMATION**

 

On November 17, 2004, the Governance Committee of theBoard of Directors approved the Non-Employee Directors Compensation Plan.  The plan provides for cash payments and thegrant of stock options to non-employee directors for their service on the Boardand its committees.  A copy of the planis filed with this Form 10-K as Exhibit 10.19.

 

42

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**PART III**

 

**ITEM 10.****                      DIRECTORS AND EXECUTIVE OFFICERSOF THE REGISTRANT**

 

Theinformation concerning directors and executive officers and compliance withSection 16(a) required by this item is contained in the sections entitled “CorporateGovernance,” “Election of Directors,” “Executive Officers of the Company” and “Compliancewith Section 16(a) of the Exchange Act,” appearing in our Proxy Statement to bedelivered to stockholders in connection with the 2005 Annual Meeting ofStockholders.  Such information isincorporated herein by reference.

 

Wehave adopted a Code of Ethics and Business Conduct (the “Code”), which isavailable free of charge through our website at www.zomax.com and is availablein print to any stockholder who sends a request for a paper copy to ZomaxIncorporated, Attn. Investor Relations, at the address listed on the frontcover of this report.  The Code appliesto all of our employees including our principal executive officer, principalfinancial officer, principal accounting officer and corporate controller.  Zomax intends to include on its website anyamendment to, or waiver from, a provision of the Code that for any of theseindividuals that relates to any element of the code of ethics definitionenumerated in Item 406(b) of Regulation S-K.

 

**ITEM 11.****                      EXECUTIVECOMPENSATION**

 

Theinformation required by this item is contained in the section entitled “ExecutiveCompensation” appearing in the Company’s Proxy Statement to be delivered tostockholders in connection with the 2005 Annual Meeting of Stockholders.  Such information is incorporated herein byreference.

 

**ITEM 12.****                      SECURITYOWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDERMATTERS**

 

The information required by this item relating to the securityownership of certain holders is contained in the section entitled “PrincipalStockholders and Management Shareholdings” appearing in our Proxy Statement tobe delivered to stockholders in connection with the 2005 Annual Meeting ofStockholders.  Such information isincorporated herein by reference.

 

Thefollowing table summarizes our equity compensation plan information as ofDecember 31, 2004.

 
| **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  (excluding securities reflected in  column (a))** | ** ** |
|----------------------------------------------------------------|------------|------------------------------------------------------------------------------|------------|-------------------------------------------------------------|------------|--------------------------------------------------------------------------------------------------------------------|------------|
| ** **                                                     | ** ** | **(a)**                                                                      | ** ** | **(b)**                                                     | ** ** | **(c)**                                                                                                            | ** ** |
| Equity  compensation plans approved by security holders(1)     |       | 2,218,951                                                                    |       | $                                                           | 4.54       |                                                                                                               | 3,367,781  |   |
| Equity  compensation plans not approved by security holders(2) |       | 611,589                                                                      |       |                                                        | 4.84       |                                                                                                               | N/A        |   |
| Total                                                          |       | 2,830,540                                                                    |       | $                                                           | 4.61       |                                                                                                               | 3,367,781  |   |

 

----

(1)          Plancategory includes the Company’s 2004 Equity Incentive Plan (the “2004 Plan”),1996 Stock Option Plan (the “1996 Plan”), stock options granted outside of the1996 Plan that were subsequently approved by stockholders and the Company’s1996 Employee Stock Purchase Plan.  Thenumber of shares in column (c) includes 1,122,982 shares available for issuanceunder the 1996 Employee Stock Purchase Plan.

(2)          Plancategory includes stock options that were granted to employees outside of our1996 Plan and prior to the approval of the 2004 plan due to an insufficientnumber of shares available under the 1996 Plan. The agreements with respect to these options are substantially the sameas agreements with respect to options under the 1996 Plan and generally providefor a ten-year term with vesting over a period of four to five years.

 

43

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**ITEM 13.****                      CERTAINRELATIONSHIPS AND RELATED TRANSACTIONS**

 

Theinformation required by this item is contained in the section entitled “CertainTransactions” appearing in our Proxy Statement to be delivered to stockholdersin connection with the 2005 Annual Meeting of Stockholders.  Such information is incorporated herein byreference.

 

**ITEM14.****                      PRINCIPALACCOUNTANT FEES AND SERVICES**

 

The information required by this item is containedin the section entitled “Principal Accountant Fees and Services” appearing inour Proxy Statement to be delivered to stockholders in connection with the 2005Annual Meeting of Stockholders.  Suchinformation is incorporated by reference.

 

**PART IV**

** **

**ITEM15.****                      EXHIBITSAND FINANCIAL STATEMENT SCHEDULES**

 

(a)          Listof Financial Statements, 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:

 
| Consolidated  Statements of Operations for Years Ended December 31, 2004, December 26, 2003  (as restated) and December 27, 2002                |   |
|-------------------------------------------------------------------------------------------------------------------------------------------------|--------|
|                                                                                                                                            |   |
| Consolidated Balance Sheets  as of December 31, 2004 and December 26, 2003 (as restated)                                                        |   |
|                                                                                                                                            |   |
| Consolidated  Statements of Shareholders’ Equity for Years Ended December 31, 2004, December  26, 2003 (as restated) and December 27, 2002 |   |
|                                                                                                                                            |   |
| Consolidated  Statements of Cash Flows for Years Ended December 31, 2004, December 26, 2003  (as restated) and December 27, 2002                |   |
|                                                                                                                                            |   |
| Notes to  Consolidated Financial Statements                                                                                                     |   |

 

(2)          *Financial Statement Schedules*.  All schedules for which provision is made inthe applicable accounting regulations of the SEC have been omitted as notrequired or not applicable, or the information required has been includedelsewhere by reference in the financial statements and related notes, exceptfor Schedule II, which is included in this Form 10-K.

 

(3)          *Exhibits*. See “Exhibit Index” on page 47 of this Form 10-K for a description ofthe documents that are filed as Exhibits to this report on Form 10-K orincorporated by reference herein.

 

(b)         SeeItem 15(a)(3) above.

(c)          SeeItem 15(a)(2) above.

 

44

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**SIGNATURES**

 

Inaccordance with Section 13 or 15(d) of the Exchange Act, the registrant causedthis report to be signed on its behalf by the undersigned, thereunto dulyauthorized.

 
| Date: March 30,  2005 | **ZOMAX  INCORPORATED** |
|-----------------------|-------------------------|
|                  | ** **              |
|                  | By                      | /s/ Anthony  Angelini |   |
|                  |                    | Anthony Angelini |
|                  |                    | Chief Executive  Officer |

 

Inaccordance with the Exchange Act, this report has been signed below by thefollowing persons on behalf of the registrant and in the capacities and on thedates indicated below.

 

Eachperson whose signature appears below constitutes and appoints Anthony Angeliniand Robert J. Rueckl as the undersigned’s true and lawful attorneys-in fact andagents, each acting alone, with full power of substitution and resubstitution,for the undersigned and in the undersigned’s name, place and stead, in any andall amendments to this Annual Report on Form 10-K and to file the same, withall exhibits thereto, and other documents in connection therewith, with theSecurities and Exchange Commission, granted unto said attorneys-in-fact andagents, each acting alone, full power and authority to do and perform each andevery act and thing requisite and necessary to be done in and about thepremises, as fully to all intents and purposes as the undersigned might orcould do in person, hereby ratifying and confirming all said attorneys-in-factand agents, each acting alone, or his substitute or substitutes, may lawfullydo or cause to be done by virtue thereof.

 
| **Name**                  | ** ** | **Title**                                     | ** ** | **Date**       |
|---------------------------|------------|-----------------------------------------------|------------|----------------|
|                      |       |                                          |       |           |
| /s/Anthony  Angelini      |       | Chief Executive  Officer and Director         |       | March 30, 2005 |
| Anthony Angelini          |       | (principal  executive officer)                |       |           |
|                      |       |                                          |       |           |
| /s/Robert J.  Rueckl      |       | Chief Financial  Officer and Secretary        |       | March 30, 2005 |
| Robert J. Rueckl          |       | (principal  financial and accounting officer) |       |           |
|                      |       |                                          |       |           |
| /s/Robert  Ezrilov        |       | Director                                      |       | March 30, 2005 |
| Robert Ezrilov            |       |                                          |       |           |
|                      |       |                                          |       |           |
| /s/Howard P.  Liszt       |       | Director                                      |       | March 30, 2005 |
| Howard P. Liszt           |       |                                          |       |           |
|                      |       |                                          |       |           |
| /s/Janice  Ozzello Wilcox |       | Director                                      |       | March 30, 2005 |
| Janice Ozzello  Wilcox    |       |                                          |       |           |
|                      |       |                                          |       |           |
| /s/Joseph J.  Lahti       |       | Director                                      |       | March 30, 2005 |
| Joseph J. Lahti           |       |                                          |       |           |
|                      |       |                                          |       |           |
| /s/Paul F. Foley          |       | Director                                      |       | March 30, 2005 |
| Paul F. Foley             |       |                                          |       |           |

 

45

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**ZOMAX INCORPORATED**

**Schedule II -  Valuation and Qualifying Accounts**

**Year Ended December 31, 2004**

 
| **Description**                       | ** ** | **Balance at  beginning of  period** | ** ** | **Charges to  costs and  expenses** | ** ** | **Charged to  other  accounts** | ** ** | **Write-offs,  net of  recoveries** | ** ** | **Balance at  end of  period** | ** ** |
|---------------------------------------|------------|--------------------------------------|------------|-------------------------------------|------------|---------------------------------|------------|-------------------------------------|------------|--------------------------------|------------|
| **Allowance  for doubtful accounts:** |       |                                 |       |                                |       |                            |       |                                |       |                           |       |
|                                  |       |                                 |       |                                |       |                            |       |                                |       |                           |       |
| For the year  ended December 31, 2004 |       | $                                    | 1,362,000  |                                |       | (250,000                        | )          | —                              |       | (244,000                       | )          | 868,000 |   |
|                                  |       |                                 |       |                                |       |                            |       |                                |       |                           |       |
| For the year  ended December 26, 2003 |       | $                                    | 1,937,000  |                                |       | (420,000                        | )          | —                              |       | (155,000                       | )          | 1,362,000 |   |
|                                  |       |                                 |       |                                |       |                            |       |                                |       |                           |       |
| For the year  ended December 27, 2002 |       | $                                    | 2,234,000  |                                |       | 234,000                         |       | —                              |       | (531,000                       | )          | 1,937,000 |   |

 

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**EXHIBITINDEX TO FORM 10-K**

 
| **For the Fiscal Year Ended:** | ** ** | **Commission File No.** |
|--------------------------------|------------|-------------------------|
| **December 31, 2004**          | ** ** | **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, as amended and restated through June 8, 2004  (Incorporated by reference to Exhibit 10.1 to Quarterly Report on Form 10-Q  for quarter ended June 25, 2004).**                                                                                                                                                    |
| 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                |       | 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).                                                                                                                                                                 |
| 10.5                |       | 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).                                                                                                                                                                       |
| 10.6                |       | 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). |
| 10.7                |       | Credit Agreement dated as of January 6, 1999 among  the Company, Certain Lenders and General Electric Capital Corporation. (2)                                                                                                                                                                                                                        |
| 10.8                |       | Credit Agreement dated as of January 6, 1999 among  Zomax Canada Company, Certain Lenders and General Electric Capital Canada  Inc. (2)                                                                                                                                                                                                               |
| 10.9                |       | 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).**                                                                                                                                                             |
| 10.10               |       | 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).                                                                                                                                           |
| 10.11               |       | Employment  Agreement with Michael Miller effective September 16, 2002 (Incorporated by  reference to Exhibit 10.13 to Annual Report on Form 10-K for the year ended  December 27, 2002).**                                                                                                                                                           |
| 10.12               |       | Form of  Nonqualified Option Agreement for options granted outside of 1996 Stock  Option Plan (Incorporated by reference to Exhibit 10.14 to Annual Report on  Form 10-K for the year ended December 27, 2002).**                                                                                                                                     |
| 10.13               |       | Separation  Agreement dated January 1, 2004 with James T. Anderson (Incorporated by  reference to Exhibit 10.15 to Annual Report on Form 10-K for the year ended  December 26, 2003).**                                                                                                                                                               |
| 10.14               |       | 2003 Equity  Incentive Plan (Incorporated by reference to Appendix to proxy statement for  2004 Annual Stockholders’ Meeting on April 23, 2004).**                                                                                                                                                                                               |
| 10.15*              |       | Stock Purchase  Agreement dated July 8, 2004 between the Company and Phillip T. Levin.                                                                                                                                                                                                                                                                |
| 10.16*              |       | Forms of  Incentive Stock Option Agreement and Nonqualified Stock Option Agreement  currently used under 2004 Equity Incentive Plan.**                                                                                                                                                                                                                |
| 10.17*              |       | Form of  Restricted Stock Agreement currently used under 2004 Equity Incentive Plan.**                                                                                                                                                                                                                                                                |
| 10.18*              |       | 2004 Corporate  Bonus Plan**                                                                                                                                                                                                                                                                                                                          |
| 10.19*              |       | Non-Employee  Director Compensation Plan as of November 17, 2004**                                                                                                                                                                                                                                                                                    |
| 21.1*               |       | Subsidiaries                                                                                                                                                                                                                                                                                                                                          |
| 23.1*               |       | Consent of  Independent Registered Public Accounting Firm – Deloitte & Touche LLP                                                                                                                                                                                                                                                            |
| 24*                 |       | Power of  Attorney (included on signature page of this report)                                                                                                                                                                                                                                                                                        |
| 31.1*               |       | Certification of  Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act.                                                                                                                                                                                                                                                          |
| 31.2*               |       | Certification of  Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act.                                                                                                                                                                                                                                                          |
| 32.1*               |       | Certification of  Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act.                                                                                                                                                                                                                                                          |
| 32.2*               |       | Certification of  Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act.                                                                                                                                                                                                                                                          |
| 99.1*               |       | Report of Governance Committee to the Board of Directors  regarding Disclosure and Trading Procedures                                                                                                                                                                                                                                                 |

 

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*                 Filed herewith.**          Management agreement or compensatory plan or arrangement.(1)          Incorporated by reference to the corresponding exhibitnumbers to Form S-1 Registration Statement, SEC File No. 333-2430.(2)          Incorporated by reference to exhibits to current report onForm 8-K/A-1 dated January 7, 1999.

 

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