** **

**UNITEDSTATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington, DC 20549**

 

**FORM 10-K**

 

ý                            Annual Report Pursuant to Section 13 or 15(d) ofthe Securities Exchange Act of 1934 for the fiscal year ended December 28, 2001

or

o                                  Transition Report Under Section 13 or 15(d) of theSecurities Exchange Act of 1934 for the transition period from                  to               .

 

CommissionFile Number:  0-28426

 

 

**ZOMAX INCORPORATED**

(Exactname of registrant as specified in its charter)

 

| **Minnesota**                             |   | **No. 41-1833089**  |
|-------------------------------------------|--------|---------------------|
| (State or Other Jurisdiction of           |   | (IRS Employer       |
| Incorporation or Organization)            |   | Identification No.) |
| **5353 Nathan  Lane, Plymouth, MN 55442** |
| (Address of Principal Executive  Offices) |

 

Registrant’stelephone number (763) 553-9300

 

Securitiesregistered under Section 12(b) of the Exchange Act:  None

 

Securitiesregistered under Section 12(g) of the Exchange Act:

CommonStock, no par value

 

Check whether the registrant (1)filed all reports required to be filed by Section 13 or 15(d) of the ExchangeAct during the past 12 months (or for such shorter period that the registrantwas required to file such reports), and (2) has been subject to such filingrequirements for the past 90 days.  YESý  NOo

 

Check if there is no disclosureof delinquent filers in response to Item 405 of Regulation S-K contained inthis form, and no disclosure will be contained, to the best of registrant’sknowledge, in definitive proxy or information statements incorporated byreference in Part III of this Form 10-K or any amendment to this Form10-K.   ý

 

The aggregate market value of thevoting stock held by non-affiliates was $203.7 million based on the closingsale price of the Company’s Common Stock as reported on the Nasdaq Stock Marketon March 6, 2002.

 

The number of shares outstanding ofthe registrant’s common stock as of March 6, 2002: 32,998,865 shares.

 

**DOCUMENTS INCORPORATED BY REFERENCE**

 

Portions of the Proxy Statementfor the Annual Meeting of Shareholders to be held April 24, 2002, areincorporated by reference into Part III of this report.

 

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**PART I**

**ITEM 1.  BUSINESS**

 

**General**

 

Zomax Incorporated (Zomax or theCompany) is a leading international outsource provider of process managementservices.  The Company’s fullyintegrated services include “front-end” e-commerce support; contact center andcustomer support solutions; DVD authoring services; CD and DVD mastering; CDand DVD replication; supply chain and inventory management; graphic design;print management; assembly; packaging; warehousing; distribution andfulfillment; and RMA processing.  Byproviding a full range of process management services, Zomax differentiatesitself from its competitors who offer only a subset of these services.  Zomax believes its expertise and capitalinvestment allow its customers to focus on their core competencies, reducecosts, accelerate time to market, access advanced replication and designcapabilities, reduce capital investment, improve inventory management andpurchasing power, and access manufacturing, warehousing and distributioncapabilities in a variety of geographic regions.

 

The Company services a broadcustomer base, including Microsoft®, Logitech®, Apple®,Novell®, Hewlett Packard® and Gateway®.  The Company has demonstrated an ability toprovide consistently high quality products and services in a short turnaroundtime.  Zomax believes its high level ofcustomer service and responsiveness to customers’ needs provides it with acompetitive advantage which differentiates the Company from its competitors.  The Company was established in 1996 andcurrently has eight offices and facilities with approximately 1,300 employeeslocated in the United States, Canada and Ireland.

 

To enhance its position as aleading outsource service provider, Zomax has expanded its geographic presenceand outsource services by acquiring production capacity as well as customercontact centers, distribution and RMA capabilities.  The Company believes that its acquisitions have enabled it toprovide additional integrated services, create an opportunity to attract newcustomers and cross-market its services to existing customers.

 

**Industry**

 

The process management servicesindustry consists of companies that provide a wide variety of services tosoftware publishers, computer manufacturers, Internet companies, book publishers,independent record labels and other producers of multimedia products rangingfrom replication to fulfillment to complete process management services.Consumer demand for multimedia products such as CD-ROM and DVD-ROM and acorresponding increase in the installed base of CD and DVD drives as well asthe increased business conducted over the Internet have been significantfactors driving the demand for process management services.

 

During the 1990s, CD-ROM becamethe dominant medium for software distribution nearly replacing diskettes.  Industry analysts expect DVD-ROM tosupplement and eventually replace CD-ROM. The increased storage capacity allows DVD-ROM to be the naturalreplacement for CD-ROM as programs expand and require more storage capacity.  DVD-ROM growth has been slow in the industryto date with CD-ROM dominating the medium.

 

 

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The fulfillment segment ofprocess management services had been experiencing growth due to the Internetbut has slowed due to the recent economic recession.  Analysts are projecting worldwide commerce on the Internet willresume growth when the economy improves although growth rates previouslyexperienced may not be repeated.

 

        Somesoftware publishers and computer hardware OEMs still dedicate in-houseresources to manufacturing and fulfillment. However, demand exists for outsource services from providers who canreliably manufacture and process multimedia products within short turnaroundtimes.  The same factors that have ledto the trend of more outsourcing are driving consolidation in the industry asmany small local and regional service providers find it increasingly difficultto access the capital required to invest in new capital equipment andadditional value-added services. Industry analysts predict the consolidation of the industry willaccelerate as marginal companies struggle to compete during the economicdownturn.

 

**Services**

 

      The Company offers a comprehensive range of processmanagement services. These value-added services cover each aspect of a softwareproduct’s life cycle.  Customers canengage Zomax on a service-by-service basis, depending on their needs.  In all cases, Zomax’s project managementmaintains regular contact with customers and coordinates all servicesprovided.  With the breadth of servicesoffered by the Company, customers can bring their end products to marketwithout ever handling the product themselves.

 

        *CustomerContact Centers.*  The Companyoffers complete front-end e-commerce and customer contact centers which includeprogram management, call center operations, financial services, fulfillment andinformation systems.  The customercontact centers provide various levels of customer support, first leveltechnical support and outbound telemarketing services covering sixteenlanguages.  The Company is in directcontact with its customers’ customers.

 

*        Graphic Design*.  The Company works directly with itscustomers in developing product and packaging designs.

 

        *PrintManagement*.  The Companyreceives print specifications from its customers, facilitates printingpurchases and implements quality controls to ensure on-time delivery of the endproduct.  Additionally, Zomax providesprint inventory management services.

 

        *Mastering.*  During the mastering process, a laser beamrecorder transfers the digital information onto a glass masteringsubstrate.  This substrate thenundergoes an electroforming process that creates a metal stamper from which CDsand DVDs are molded.  The masteringprocess is critical to product quality and is conducted in a clean-roomenvironment free of microscopic contaminants which can obscure large amounts ofdata.

 

        *Replication.*  CDs and DVDs are replicated using anintegrated robotic line process which incorporates plastic injection molding,metalizing, lacquering and inspection equipment.  The replication process begins with the injection of highquality, CD-grade polycarbonate into the mold cavity where the metal stamperhas been mounted. The top surface of the molded clear polycarbonate disccontaining all of the digitized data is then covered with a metallic coating toprovide for reflection of the reading laser beam in the player.  A thin layer of lacquer is then applied 

 

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over the metal to protect it andto serve as a base for printing on the disc. Unacceptable CDs and DVDs are detected and discarded through anautomated, in-line inspection process. The Company currently has a combination of CD and DVD production linesat its facilities.

 

        *CD and DVDPrinting.*  Printing isperformed in batches off-line in order to take advantage of the high speednature of the printing process while avoiding the production delays typicallyrequired for printer setup.  The Company’sprinting equipment includes screen printing presses with capabilities of up tosix-color printing.  Automated label andprint quality inspection equipment is integrated with the screen printers toensure high quality control and reduce the need for manual quality inspection.

 

        *Packaging*.  The Company has automated equipment toprovide for commonly requested packaging configurations.  Currently, standard CD packagingconfigurations include the plastic “jewel box” with customer or Zomax suppliedprint material in the bottom and top of the box and paper or chipboardsleeves.  For non-automated assemblyrequirements, the Company provides a full range of hand assembly options.  As part of its dedication to be afull-service provider, the Company works with its customers to developsophisticated retail packaging configurations.

 

        *Warehousingand Inventory Management.*  Toassist customers in minimizing costs and reducing time to market, Zomax offerscomprehensive warehousing and inventory management services.  Increasingly, the Company is warehousingproducts for customers and shipping those products directly into the customers’distribution channels.   The Companybelieves this service provides customers with a more comprehensive solution andenables them to be more responsive to market demands.

 

        *Distributionand Fulfillments.*  TheCompany offers its customers flexible, just-in-time delivery programs allowingproduct shipments to be closely coordinated with customers’ inventoryrequirements.  Zomax can accommodatelarge shipments to distribution centers and receive and fulfill same-day ordersto individual locations.

 

        *RMAProcessing*.  Zomax employeesreceive, sort, count, recycle, reprice, repackage and redistribute returned,obsolete or excess software merchandise. The Company also receives, tests and redistributes hardwareproducts.  A customer can maximize itsoperating efficiencies by using Zomax to coordinate RMA processing withinventory management and replication orders.

 

**Customers and Markets**

 

        The Companymarkets and sells multimedia services to a variety of customers, includingsoftware publishers, computer manufacturers, Internet companies, bookpublishers, independent record labels, marketing groups and data basesuppliers.  Zomax currently services abroad customer base in these industry segments including Microsoft.

 

The Company is an authorizedreplicator of Microsoft, which allows the Company to replicate Microsoftproducts for any authorized distributor. The Company is also authorized to perform fulfillment services forMicrosoft licensed OEMs.  Thesearrangements are pursuant to annual agreements with Microsoft.  The Company expects, but cannot guarantee,that these agreements will be renewed. The Company also provides certain telemarketing and fulfillment servicesto Microsoft under a one-year Master Services Agreement, which expires in June30, 2002.  

 

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The Company expects, but cannot guarantee, that thisagreement will be renewed. During 2001, 2000 and 1999, revenues derived fromall of Microsoft activities accounted for 35%, 40% and 39%, respectively, ofthe Company’s consolidated sales.

 

**Marketing and Sales**

 

        Zomax focuses its marketing efforts oncustomers that require personal service, flexibility, fast turnaround time anda complete outsource solution to their process management service needs.  The Company has successfully marketed itselfto these customers by managing all of the steps in the process from design toreplication to packaging to delivery. As part of its strategy, the Company also intends to continuecross-marketing its services to customers who may currently rely on the Companyfor only a portion of their process management service needs.

 

        The Company employs a direct sales staffthat is responsible for maintaining relationships with existing customers anddeveloping new business relationships. The Company has a direct sales staff, supported by a project managementstaff that are responsible for ensuring that each order is processed on atimely basis, all required support materials are in place and desired qualitylevels are achieved.  Each customeraccount is assigned one or more project managers to provide daily contact withthe customer, coordinate the purchase and manufacture of all necessarymaterials, adapt to order changes and generally act as liaison with thecustomer.

 

**Competition**

 

        Themultimedia service industry is highly competitive and is experiencingconsolidation.  The Company competesprimarily with independent service providers and, to a lesser extent, withaffiliates of major international music companies and small localized serviceproviders.  Each of these producersgenerally services a defined set of customer needs.

 

•                  *Independent service providers*.  Participants in this segment includecompanies such as Zomax, Disctronics, Inc., Bertlesman, CinramInternational Inc., Startek Corporation, Modus Media International and MetatecCorporation.  Independent service providersgenerally have the ability to handle large volume requirements and have varyingdegrees of service capability.  However,most independent manufacturers do not typically offer as comprehensive a rangeof outsource services as Zomax.

 

•                  *Affiliates of major international musiccompanies.*  This categoryconsists of large manufacturers who are affiliated with major internationalmusic companies such as Sony Music Entertainment, Inc., PolyGramHoldings, Inc., Warner Music, BMG Music and EMI Music.  These service providers dedicate a majorityof their manufacturing capacity to the production of CD-Audio for affiliatedrecord labels and typically offer a limited range of services.

 

•                  *Small localized service providers*.  These service providers generally havelimited production capacity and offer a limited range of related services.  The complexity of the manufacturing processand the large capital investment required to maintain and upgrade capacitygenerally constrain these small service providers.

 

 

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        Other existing technologies also competewith the Company’s products that deliver digital information.  Portable media, such as digital audio tape,digital compact cassette and mini-disc have already been introduced commerciallybut have not yet achieved widespread consumer acceptance.  In addition, one-time recordable CDs(“CD-R”) are available and are often used to replicate short run products thatare more expensive to manufacture in the traditional manner.  The Company does not expect any of thesetechnologies to expand beyond their current markets in the near future.

 

        Electronicon-line delivery of digital information, such as through the Internet, is apotential future competitor of CD and DVD technology.  The Company believes that current and projected transmissionspeeds and infrastructure limitations of on-line delivery systems will preventthem from replacing CD and DVD technology in the foreseeable future.  In addition, future advances in CD and DVDtechnology, such as higher speed drives and greater data compression, couldincrease the advantages of these technologies over electronic on-line deliveryand other potential competitive technologies.

 

        Competitionin the hardware and software RMA processing industry segment is extremelyfragmented.  Generally, participants inthis industry segment include a number of independent companies as well aspublishers and OEMs that dedicate in-house resources to RMA processing.

 

        Manyof the Company’s national and regional competitors are, and future potential competitorsmay be, larger and more established with greater financial and other resourcesthan the Company, particularly as consolidation in the industry continues.  As a result, such competitors may be able torespond more quickly to market changes or to devote greater resources to themanufacture, promotion and sale of their products and services than theCompany.

 

        TheCompany believes that it competes favorably with its competitors with respectto quality, service, reliability, price, manufacturing capacity and timelydelivery of product, the principal competitive factors in this industry.  The Company also believes that customers arewilling to incur additional costs for extra services.  As such, to enhance its competitive position, the Company offersa full range of value-added services to customers including design, preparationand printing of artwork and packaging, warehousing and shipping and RMAprocessing.

 

**Proprietary Rights**

 

        Zomax,like most other CD and DVD manufacturers, uses patented technology primarilyunder nonexclusive licenses.  Theselicenses generally provide for the payment of royalties based upon the number,size and use of CDs and DVDs sold and terminate either upon the expiration ofthe patents being licensed or on a certain date.

 

        Zomax currently has CD licenseagreements with U.S. Philips Corporation (“Philips”) and Discovision Associates(“DVA”).  These agreements grant toZomax non-exclusive, royalty-bearing and non-transferable licenses to make, useand sell CDs.  The royalty payments dueunder the licenses generally depend on the number of CDs sold, their size andtheir use.  The Company’s license fromPhilips expires in 2006.  The term ofthe DVA license continues until the expiration of the last DVA patent coveredby the license.  If the Company isunable to maintain these licenses, it could have a material adverse effect onthe Company’s results of operations.

 

 

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        TheCompany currently has DVD license agreements with Philips and DVA.  The Philips’ agreement expires in 2009 withroyalty payments due based on the number of DVDs sold.  The DVA agreement expires upon theexpiration of the last DVA patent covered by the license.  The Company is currently negotiatinglicenses from other owners of DVD technology to manufacture DVDsworldwide.  If the Company is unable toobtain these licenses, it could have a material adverse effect on the Company’sfuture results of operations.  Althoughthe Company expects to obtain such licenses, no assurances can be made thatsuch licenses will be obtained and the Company cannot predict the amount of theroyalty that will be payable under any such license.

 

**Employees**

 

        TheCompany has approximately 1,300 full-time employees and hires additional employeeson a temporary basis to perform manufacturing-related services as the needarises.  The Company currently operatesits Minneapolis, Minnesota, Arnprior, Canada, Fremont, California, and Dublin,Ireland facilities 24 hours a day, seven days a week.  The Company believes that its relations with its employees aregood.  None of the Company’s employeesis covered by a collective bargaining agreement.

 

**CautionaryFactors That May Affect Future Results**

 

        Certainstatements contained in this Annual Report on Form 10-K are forward-looking,based on current expectations.  Suchstatements can be identified by the use of terminology such as “anticipate,”“believe,” “estimate,” “expect,” “intend,” “may,” “could,” “possible,” “plan,”“project,” “will,” “forecast” and similar words or expressions.  The Company’s forward-looking statementsgenerally relate to its growth strategy, financial results and salesefforts.  Investors are cautioned thatall forward-looking statements involve certain risks and uncertainties, includingamong others those identified below. The Company undertakes no obligation to update any forward-lookingstatement, but investors are advised to consult any further disclosures by theCompany on this subject in its filings with the Securities and ExchangeCommission. In this regard, please also see the Outlook section of Item 7 below.

 

        Although it is not possible to create acomprehensive list of all factors that may cause actual results to differ fromthe Company’s forward-looking statements, such factors include, among others,(i) the Company’s ability to sustain and manage its growth and implement itsbusiness strategy, including the integration of newly acquired andgeographically dispersed operations; (ii) the Company’s ability to adapt quicklyto changes in information storage and retrieval technology; (iii) the Company’sreliance on a few key customer and strategic relationships, including thosewith Microsoft; (iv) the trend of consolidation in the industry and the abilityof the Company to effectively compete in an intensely competitive environment;(v) the development of new products or technologies by competitors,technological obsolescence and other changes in competitive factors; (vi) risksassociated with establishing and maintaining international operations; (vii)the risks associated with price declines; (viii) the Company’s dependence onits ability to obtain and maintain licenses to use patented technology in itsmanufacturing operations; and (ix) general economic factors over which theCompany has no control.

 

 

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**ITEM 2.  PROPERTIES**

 

        TheCompany leases facilities throughout the U.S. and Europe and owns property inCanada.  The following table sets forthinformation about the Company’s facilities. Management believes its facilities are adequate for the Company for theforeseeable future.

 
| **Location**            |   | **Approximate Square Feet** |   | **Lease****Expiration** |   | **Services**                                                                                                                                        |
|-------------------------|--------|-----------------------------|--------|-------------------------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------|
| Arnprior,  Canada       |   | 158,000                     |   | Owned                   |   | Print  management, mastering, replication, printing, packaging, warehousing and  distribution.                                                      |
| Concord,  California    |   | 30,000                      |   | 2008                    |   | Customer  contact center                                                                                                                            |
| Dublin,  Ireland        |   | 138,000                     |   | 2016 - 2028 (1)         |   | Customer  contact center, print management, mastering, replication, printing,  packaging, warehousing, fulfillment, distribution and RMA processing |
| Fremont,  California    |   | 150,000                     |   | 2006                    |   | Print  management, mastering, replication, printing, packaging, warehousing,  fulfillment and distribution.                                         |
| Indianapolis,  Indiana  |   | 91,000                      |   | 2002                    |   | Packaging,  fulfillment, distribution and RMA processing                                                                                            |
| Minneapolis,  Minnesota |   | 134,000                     |   | 2003 (2)                |   | Graphic  design, print management, mastering, replication, printing, packaging,  warehousing, fulfillment, distribution and RMA processing          |
| San  Jose, California   |   | 325,000                     |   | 2002 (3)                |   | Graphic  design, print management, packaging, warehousing, fulfillment, distribution  and RMA processing                                            |

 

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(1)          Includes leases for two differentsites,

(2)          Includes leases for two sites,one of which is a lease for 82,000 square feet, with Nathan Lane Partnership,LLP (described below), which expires in 2003 with an option to extend for anadditional term of three years.

(3)          Includes leases for threedifferent sites, two of which expire in 2002 and are currently not beingutilized by the Company.  The Company issubleasing these two sites to third parties. The third lease also expires in 2002.

 

        The Companyleases its manufacturing, office and warehouse space in Minneapolis, Minnesotafrom Nathan Lane Limited Partnership, a Minnesota limited liability partnershipof which Mr. Phillip T. Levin, a director of Zomax, owns a one-thirdinterest.  Pursuant to this lease, asamended, the Company leases approximately 82,000 square feet at an average baserent of $5.59 per net rentable square foot per annum.  The Company is also obligated to pay its proportionate share oftaxes and operating expenses.

 

 

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**ITEM 3.  LEGALPROCEEDINGS**

 

        TheCompany is involved in certain claims arising in the normal course ofbusiness.  In management’s opinion, thefinal resolution of these claims should not have a material adverse effect onthe Company’s financial position or results from operations.

 

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

 

       No matters weresubmitted to a vote of security holders during the fourth quarter of 2001.

 

**PART II**

 

**ITEM 5.****                                                    ****MARKET FOR REGISTRANT’S COMMON EQUITYAND RELATED STOCKHOLDER MATTERS**

 

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

 

| **Fiscal Year Ended December 29, 2000:** |   | **High** |   | **Low** |   |
|------------------------------------------|--------|----------|--------|---------|--------|
| First Quarter                            |   | $        | 33.13  |    | $      | 20.44 |    |
| Second Quarter                           |   | 28.59    |   | 12.63   |   |
| Third Quarter                            |   | 19.88    |   | 6.63    |   |
| Fourth Quarter                           |   | 7.44     |   | 4.00    |   |
|                                          |        |          |        |         |        |  |  |

 

 

| **Fiscal Year Ended December 28, 2001:** |   | **High** |   | **Low** |   |
|------------------------------------------|--------|----------|--------|---------|--------|
| First Quarter                            |   | $        | 7.44   |    | $      | 4.16 |   |
| Second Quarter                           |   | 8.91     |   | 3.44    |   |
| Third Quarter                            |   | 9.22     |   | 4.25    |   |
| Fourth Quarter                           |   | 8.90     |   | 5.01    |   |
|                                          |        |          |        |         |        |  |  |

 

        The Company has neverdeclared or paid cash dividends on its capital stock and does not anticipatedeclaring or paying any cash dividends in the foreseeable future.  The Company intends to retain futureearnings for the development of its business.

 

        As of March 6, 2002, therewere approximately 423 record holders of the Company’s Common Stock, excludingstockholders whose stock is held either in nominee name and/or street namebrokerage accounts.  Based oninformation which the Company has obtained from its transfer agent, there areapproximately 18,000 stockholders of the Company’s Common Stock whose stock isheld either in nominee name and/or street name brokerage accounts.

 

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**ITEM 6.    SELECTED FINANCIAL DATA**

 

|                                                    |   | **For the years ended**                        |
|---------------------------------------------------------|--------|------------------------------------------------|
|                                                    |   | **(in thousands, except for per share  data)** |
|                                                    |   |    2001(1)                           |   | 2000 |   |    1999(2) |   | 1998 |   |    1997(3) |   |
| Statement  of operations data:                          |   |                                           |   |   |   |   |   |   |   |   |   |
|                                                    |   |                                           |   |   |   |   |   |   |   |   |   |
| Sales                                                   |   | $                                              | 216,797 |   | $ | 239,090 |   | $ | 238,698 |   | $ | 61,485 |   | $ | 47,877 |   |
|                                                    |   |                                           |   |   |   |   |   |   |   |   |   |
| Gross  profit                                           |   | 50,109                                         |   | 71,526 |   | 73,916 |   | 16,804 |   | 15,104 |   |
|                                                    |   |                                           |   |   |   |   |   |   |   |   |   |
| Selling,  general and administrative  expenses          |   | 31,964                                         |   | 33,532 |   | 37,724 |   | 10,595 |   | 9,860 |   |
|                                                    |   |                                           |   |   |   |   |   |   |   |   |   |
| Operating  income                                       |   | 17,222                                         |   | 37,994 |   | 36,192 |   | 6,209 |   | 5,244 |   |
|                                                    |   |                                           |   |   |   |   |   |   |   |   |   |
| Income  before income taxes                             |   | 14,254                                         |   | 38,451 |   | 37,804 |   | 6,141 |   | 5,218 |   |
|                                                    |   |                                           |   |   |   |   |   |   |   |   |   |
| Provision  for income taxes                             |   | 5,221                                          |   | 13,592 |   | 11,977 |   | 2,475 |   | 2,090 |   |
|                                                    |   |                                           |   |   |   |   |   |   |   |   |   |
| Net  income                                             |   | 9,033                                          |   | 24,859 |   | 25,827 |   | 3,666 |   | 3,128 |   |
|                                                    |   |                                           |   |   |   |   |   |   |   |   |   |
| Earnings  per share:                                    |   |                                           |   |   |   |   |   |   |   |   |   |
|                                                    |   |                                           |   |   |   |   |   |   |   |   |   |
| Basic                                                   |   | 0.28                                           |   | 0.78 |   | 0.87 |   | 0.14 |   | 0.15 |   |
|                                                    |   |                                           |   |   |   |   |   |   |   |   |   |
| Diluted                                                 |   | 0.27                                           |   | 0.74 |   | 0.79 |   | 0.13 |   | 0.15 |   |
|                                                    |   |                                           |   |   |   |   |   |   |   |   |   |
| Weighted  average number of common shares outstanding : |   |                                           |   |   |   |   |   |   |   |   |   |
|                                                    |   |                                           |   |   |   |   |   |   |   |   |   |
| Basic                                                   |   | 32,364                                         |   | 31,915 |   | 29,662 |   | 25,470 |   | 20,896 |   |
|                                                    |   |                                           |   |   |   |   |   |   |   |   |   |
| Diluted                                                 |   | 33,152                                         |   | 33,529 |   | 32,692 |   | 26,926 |   | 21,430 |   |
|                                                    |   |                                           |   |   |   |   |   |   |   |   |   |
|                                                    |   | 2001                                           |   | 2000 |   | 1999 |   | 1998 |   | 1997 |   |
| Balance  sheet data (at year’s end):               |   |                                           |   |   |   |   |   |   |   |   |   |
|                                                    |   |                                           |   |   |   |   |   |   |   |   |   |
| Cash  and cash equivalents                              |   | $                                              | 74,999 |   | $ | 63,577 |   | $ | 51,128 |   | $ | 25,621 |   | $ | 5,213 |   |
|                                                    |   |                                           |   |   |   |   |   |   |   |   |   |
| Working  capital                                        |   | 89,889                                         |   | 69,872 |   | 47,466 |   | 26,969 |   | 5,049 |   |
|                                                    |   |                                           |   |   |   |   |   |   |   |   |   |
| Total  assets                                           |   | 163,506                                        |   | 167,935 |   | 142,304 |   | 65,423 |   | 31,026 |   |
|                                                    |   |                                           |   |   |   |   |   |   |   |   |   |
| Long-term  notes payable,  net of current portion       |   | 3,720                                          |   | 6,757 |   | 10,603 |   | 1,746 |   | 3,104 |   |
|                                                    |   |                                           |   |   |   |   |   |   |   |   |   |
| Total  shareholders’ equity                        |   | 124,424                                        |   | 112,095 |   | 82,430 |   | 50,087 |   | 16,463 |   |

 

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(1)  Results of operations for the year endedDecember 28, 2001, include one-time charges of $2.9 million, net of tax, or$.09 per share and $0.6 million, net of tax, or $.02 per share for thewrite-off of the Company’s investment in Microgistix and the write-off ofgoodwill related to the acquisition of Trotter Technologies, Inc.,respectively.

 

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

 

(3)  A pro forma provision for income taxes hasbeen established as if all consolidated companies were taxable entities for allperiods presented.  Prior to 1998,certain acquired companies operated as nontaxable entities.

 

** **

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** **

**ITEM 7.****                                                    ****MANAGEMENT’S DISCUSSIONAND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

**General**

 

        The Company is a leading internationaloutsource service provider of process management services.  The Company’s fully integrated servicesinclude: “front end” E-commerce support; customer contact centers and customersupport solutions; DVD authoring services; CD and DVD mastering; CD and DVDreplication; supply chain and inventory management; graphic design; printmanagement; CD and DVD printing; assembly; packaging; warehousing; distributionand fulfillment; and RMA processing services. The Company has facilities in the United States, Canada and Ireland.

 

TheCompany’s business has been characterized by short lead times for customerorders.  For this reason and because ofthe timing of orders, delivery intervals and the possibility of customerchanges in delivery schedules, the Company’s backlog as of any particular dateis not a meaningful indicator of future financial results.

 

**CriticalAccounting Policies**

Zomaxprepares the consolidated financial statements in conformity with accountingprinciples generally accepted in the United States.  As such, the Company is required to make certain estimates,judgments and assumptions that the Company believes are reasonable based uponthe information available.  Theseestimates and assumptions affect the reported amounts of assets and liabilitiesat the date of the financial statements and the reported amounts of revenuesand expenses during the periods presented. The critical accounting policies, which Zomax believes are the mostcritical to aid in fully understanding and evaluating its reported financialresults, include the following:

 

*Revenue recognition*.  The Companyrecords sales revenue at the time merchandise is shipped or as services arerendered.  For certain customers,merchandise is invoiced upon completion of orders, with shipment occurringbased on written customer instructions. In these cases, the customer accepts title to the goods as of the dateof the Company’s invoice.  In each caseof bill and hold sales, the Company ensures that the transaction complies withthe conditions and considerations contained in Accounting and AuditingEnforcement Release No. 108 of the Securities and Exchange Commission (SEC).

 

TheCompany records amounts being charged to customers for shipping and handling asrevenue in accordance with Emerging Issues Task Force (EITF) Issue 00-10,“Accounting for Shipping and Handling Fees and Costs.”  Historically, the Company had netted theshipping and handling revenue with the costs of shipping and handling in costof sales.

 

*Accounts Receivable. *Zomaxperforms ongoing credit evaluations of its customers and adjust credit limitsbased upon payment history and the customer’s current credit worthiness, asdetermined by review of their current credit information.  The Company continuously monitor collectionsand payments from customers and maintain a provision for estimated creditlosses based upon historical experience and any specific customer collectionissues that have been identified.  Whilesuch credit losses have historically been within expectations and theprovisions 

# *** ***

 

11

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established, theCompany cannot guarantee that it will continue to experience the same creditloss rates as in the past.  Since theCompany’s accounts receivable are concentrated in a relatively few number ofcustomers, a significant change in the liquidity or financial position of anyone of these customers could have a material adverse impact on the collectabilityof  the Company’s accounts receivablesand future operating results.

 

*Inventories.* Inventoriesare valued at the lower rate of cost or market value and have been reduced byan allowance for excess and obsolete inventories.  The estimated allowance is based on management’s review ofinventories on hand compared to estimated future usage and sales.

 

*Related party transactions. *As ofDecember 28, 2001, the Company owned 25.2% of Microgistix which was accountedfor under the equity method of accounting. Microgistix conducts its operations through two wholly ownedsubsidiaries, Microgistix.com, Inc. and Point Group Corporation.  Microgistix.com, Inc. has developedproprietary software for Internet commerce and operates a web site sellingcomputer software over the Internet. Point Group Corporation is a licensee and reseller of computer software.

 

Salesby the Company to the Point Group Corporation totaled $4.9 million, $6.1million, and $1.2 million in 2001, 2000 and 1999, respectively.  Point Group Corporation’s accountsreceivable balances totaled $1.1 million, $2.2 million and $0.1 million in2001, 2000 and 1999, respectively.  TheCompany has eliminated unrealized profit associated with the sales to PointGroup Corporation to the extent of its equity interest.

 

InDecember 2001, the Company wrote off its remaining investment in Microgistix,which amounted to $4.4 million pretax. Based on Microgistix’ historical operating results and cash flowrequirements, the Company could not foresee that it would be able to recoverthe carrying amount of its investment in Microgistix or that Microgistix hasthe ability to sustain an earnings capacity which would justify the carryingamount of the investment.

 

*Recently issued accounting pronouncements.* In July 2001, the Financial Accounting Standards Board issued Statementof Financial Accounting Standards (SFAS) No. 141, “Business Combinations,” andSFAS No. 142, “Goodwill and Other Intangible Assets”.  SFAS 141 requires all business combinations initiated after June30, 2001 to be accounted for using the purchase method.  Under SFAS 142, goodwill and intangibleassets with indefinite lives are no longer amortized, but are reviewed annually(or more frequently if impairment indicators arise) for impairment.  Separable intangible assets that are notdeemed to have indefinite lives will continue to be amortized over their usefullives (but with no maximum life).  Theamortization provisions of SFAS No. 142 apply to goodwill and intangible assetsacquired after June 30, 2001.  Withrespect to goodwill and intangible assets acquired prior to July 1, 2001, theCompany is required to adopt SFAS No. 142 effectively the first day of fiscal2002.  The adoption of SFAS No. 142 willhave no effect on the Company’s financial position or results of operations asthe Company has no remaining goodwill or other intangibles as of December 28,2001.

 

12

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**Results of Operations**

 

        Thefollowing table sets forth certain operating data as a percentage of sales forthe periods indicated.

 
|                                               |   | **For the Years Ended** |
|----------------------------------------------------|--------|-------------------------|
|                                               |   | **December 28, 2001**   |   | **December 29, 2000** |   | **December 31, 1999** |   |
| Sales                                              |   | 100.0                   | % | 100.0 | % | 100.0 | % |
| Cost of sales                                      |   | 76.9                    |   | 70.1 |   | 69.0 |   |
| Gross profit                                       |   | 23.1                    |   | 29.9 |   | 31.0 |   |
| Selling, general and  administrative expenses      |   | 14.7                    |   | 14.0 |   | 15.8 |   |
| Impairment of goodwill                             |   | 0.4                     |   | — |   | — |   |
| Operating income                                   |   | 8.0                     |   | 15.9 |   | 15.2 |   |
| Equity in losses of  unconsolidated entity         |   | 0.3                     |   | 0.6 |   | 0.8 |   |
| Impairment of  investment in unconsolidated entity |   | 2.0                     |   | — |   | — |   |
| Gain on unconsolidated  entity stock sale          |   | —                  |   | — |   | (1.5) |   |
| Interest expense                                   |   | 0.3                     |   | 0.5 |   | 0.5 |   |
| Interest income                                    |   | (1.2)                   |   | (1.4) |   | (0.4) |   |
| Other expense, net                                 |   | —                  |   | 0.1 |   | — |   |
| Income before income  taxes                        |   | 6.6                     |   | 16.1 |   | 15.8 |   |
| Provision for income  taxes                        |   | 2.4                     |   | 5.7 |   | 5.0 |   |
| Net income                                         |   | 4.2                     | % | 10.4 | % | 10.8 | % |

 

# **For Years Ended December 28, 2001 and December 29,2000**

 

*Sales*.  TheCompany’s total sales decreased 9.3% to $216.8 million in 2001 as compared to$239.1 million in 2000.  The decrease insales for the year resulted from a 9.6% decrease in CD and DVD related sales.The decrease primarily relates to unit volume decreasing by 18.0% during 2001offset by the average unit price increasing 9.9% due to the Company performingmore value added services for customers. Sales in 2001 were negatively affectedby the slowdown in personal computer and software spending and worldwideeconomic uncertainty.

 

*Cost of sales*. Cost of sales as a percentage of sales were 76.9% in 2001 and 70.1% in2000.  Cost of sales decreased $0.9million to $166.7 million from $167.6 million in 2000.  The cost of sales percentage increase isprimarily due to the Company’s sales mix and pricing pressures.  The Company’s sales mix for 2001 included anincrease in lower margin materials and freight billings, while fixed costsincreased as a percentage of sales due to CD/DVD manufacturing capacitycompleted last year and manufacturing operating at lower utilizations.  These increases were partially offset with adecrease in the amount of outsourced production, which is more costly than CDsproduced internally.  The Companyoutsources its CD production when customer orders exceed its productioncapabilities.  The Company outsourced 2%of its CD 

 

 

13

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production in 2001and 7% in 2000.

 

*Selling, general and administrativeexpenses.*  Selling, general and administrative expensesas a percentage of sales were 14.7% in 2001 and 14.0% in 2000. Selling, generaland administrative expenses decreased $1.5 million to $32.0 million in 2001from $33.5 million in 2000.  Thedecrease in dollars was achieved with operational efficiencies and costcontainment measures implemented in 2001.

 

*Impairment of goodwill.*The Company analyzed projectedundiscounted cash flows and determined that goodwill associated with the 1997purchase of Trotter Technologies, Inc. was impaired.  Accordingly, the Company charged to earnings the entire amount ofunamortized goodwill of approximately $0.9 million in 2001.  The write-down of the goodwill was based onan analysis of projected discounted cash flows, which were no longer deemedadequate to support the value of goodwill associated with the business.

 

*Equity in losses of unconsolidatedentity*.  During 2001, the Company recognized a lossof $0.6 million from its equity investment in Microgistix compared to a $1.4million loss in 2000.  The lossesrepresents the Company’s share of Microgistix losses and the amortization ofthe Company’s excess purchase price of the Microgistix common stock acquiredover the fair value of the underlying net assets.

 

*Impairment of investment****inunconsolidated entity.*  In December 2001, the Companywrote off its remaining investment in Microgistix, which amounted to $4.4million.  Based on Microgistix’historical operating results and cash flow requirements, the Company could notforesee that it would be able to recover the carrying amount of its investmentin Microgistix or that Microgistix has the ability to sustain an earningscapacity which would justify the carrying amount of the investment.

 

*Interest income and expense*. Interest income was $2.7 million and $3.2 million for 2001 and 2000,respectively.  Interest expense was $0.6million and $1.1 million for 2001 and 2000, respectively.  Interest income decreased due to lowerinterest rates.  Interest expensedecreased as a result of lower outstanding loan balances and lower interestrates.

 

*Other expense, net.* Other expense consists of foreign currency losses.

 

*Provision for income taxes.* The effective income tax rate for 2001 was 36.6% compared to 35.3% in2000.  The increase in the effective taxrate is due primarily to a lower amount of income from Ireland, which has alower effective tax rate.

 

*Net income.* Net income for 2001 decreased 63.7% to $9.0 million compared to $24.9million in 2000.

 

 

**ForYears Ended December 29, 2000 and December 31, 1999**

 

*Sales*.  TheCompany’s total sales increased 0.2% to $239.1 million in 2000 as compared to$238.7 million in 1999.  The increase insales for the year resulted from a 7.2% increase in CD and DVD related salesand a 4.1% increase from the customer contact centers.  These increases were partially offset by a58.7% decrease in diskette, audiocassette and RMA sales, which 

 

 

14

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represented 4.1%of total sales in 2000. Sales in the second half of 2000 were negativelyaffected by the slowdown in personal computer and software spending andworldwide economic uncertainty. Although CD and DVD unit volumes increased 11.7% in 2000, the averageunit price declined as customers reduced their product costs in this uncertaineconomic environment and CD prices declined due to excess capacity within ourindustry.

 

*Cost of sales*. Cost of sales as a percentage of sales was 70.1% in 2000 and 69.0% in1999.  In dollars, cost of salesincreased $2.8 million to $167.6 million from $164.8 million in 1999.  The cost of sales percentage increase isprimarily due to increases in polycarbonate prices, increase in depreciationexpense for additional property and equipment acquired during the year,customer efforts to reduce their product costs and changes in product mix.  In addition, the manufacturing facilitiesoperated at lower utilization rates in 2000 with the softness of the industry anda 20% increase in capacity created in 2000. These increases were partially offset with a decrease in the amount ofoutsourced production, which is more costly than CDs produced internally.  The Company outsources its CD productionwhen customer orders exceed its production capabilities.  The Company outsourced 7% of its CDproduction in 2000 and 9% in 1999.

 

*Selling, general and administrativeexpenses.*  Selling, general and administrative expensesas a percentage of sales were 14.0% in 2000 and 15.8% in 1999.  In dollars, selling, general andadministrative expenses decreased $4.2 million to $33.5 million in 2000 from$37.7 million in 1999.  The decrease indollars and as a percentage of sales was achieved with operationalefficiencies, lower compensation incentives in 2000 and consolidation ofcertain facilities.

 

*Equity in losses of unconsolidatedentity*.  During 2000, the Company recognized a lossof $1.4 million from its equity investment in Microgistix (formerly ChumboHoldings Corporation (Chumbo)) compared to a $1.9 million loss in 1999.  The losses represents the Company’s share ofChumbo losses and the amortization of the Company’s excess purchase price ofthe Chumbo common stock acquired over the fair value of the underlying netassets.  In December 1999, Chumbo soldadditional equity in a private round of financing.  The Company recognized a gain of $3.7 million on Chumbo’sissuance of additional equity, representing the increase in the Company’s shareof Chumbo’s net assets after the funding.

 

*Interest income and expense*. Interest income was $3.2 million and $1.0 million for 2000 and 1999,respectively.  Interest expense was $1.1million and $1.2 million for 2000 and 1999, respectively.  Interest income increased due to higher cashbalances and higher interest rates on amounts invested.

 

*Other expense, net.* Other expense consists of foreign currency losses.

 

*Provision for income taxes.* The effective income tax rate for 2000 was 35.3% compared to 31.7% in1999.  The increase in the effective taxrate is due primarily to a lower amount of income from Ireland, which has alower effective tax rate.

 

*Net income.* Net income for 2000 decreased 3.7% to $24.9 million compared to $25.8million in 1999.

 

 

15

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#### **Liquidity andCapital Resources**

 

        As of December 28, 2001, theCompany had working capital of $89.9 million, compared to working capital of$69.9 million as of December 29, 2000 and $47.5 million as of December 31,1999. The increase in working capital in 2001 was primarily due to the increasein cash and a decrease in payables and accrued expenses during the year.  The increase in working capital in 2000 wasprimarily due to the increase in cash provided by operating activities.  The increase in working capital in 1999 wasprimarily due to the increase in cash provided by operating activities whichwere significantly impacted by the Kao acquisition.

 

        As of December 28, 2001, the Company hadcash totaling $75.0 million.  Cashgenerated from operating activities was $17.1 million, $32.9 million and $64.7million during 2001, 2000 and 1999, respectively.  The decrease in cash generated from operating activities in 2001as compared to 2000 was primarily related to lower net income in 2001.  The decrease in cash generated fromoperating activities in 2000 as compared to 1999 was due primarily to 1999being a fifty-three week year, which allowed for additional collections onaccounts receivable and shipping of inventory. The remainder of the decrease related to normal fluctuations in workingcapital components.  The increase in1999 operating cash flow resulted primarily from the increase in net income andimprovements in accounts receivable collections from the Kao acquiredbusinesses.

 

Cashused in investing activities was $4.9 million, $14.3 million, and $53.4 millionin 2001, 2000 and 1999, respectively. The purchase of property and equipment was $4.9 million, $14.3 millionand $12.0 million in 2001, 2000 and 1999, respectively.  In 1999, the Company used $42.5 million topurchase the businesses and net assets of Kao.

 

Cashprovided by financing activities in 2001 related to the Company receiving $4.1million from the issuance of common stock offset by $3.8 million used to reducenotes payable.  The Company used $4.7million for financing activities in 2000, which was comprised of $5.0 millionused to repurchase Company common stock under its current stock buy-backprogram and $4.1 million used to reduce notes payable.  These were offset by $4.4 million receivedfrom the issuance of common stock.  In1999, the Company financed a portion of the Kao acquisition with the proceedsof a $15.0 million term loan facility. The Company also reduced notes payable by $3.6 million.

 

        As of December 28, 2001, December 29,2000 and December 31, 1999, the Company had a revolving line of credit facilityfor up to $25.0 million of borrowings. Such borrowings are limited to an amount based on a formula usingeligible accounts receivable and inventories. There were no borrowings outstanding under the revolving line of creditfacility at December 28, 2001, December 29, 2000 and December 31, 1999.

 

 

16

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As of December 28, 2001,December 29, 2000 and December 31, 1999, the Company had total outstanding debtof $6.7 million, $10.5 million and $14.6 million, respectively.  The Company’s future payments of long-termdebt and operating leases as of December 28, 2001 are as follows (in millions):

 
|             |   | **Total** |   | **Less than 1 Year** |   | **2 - 3 Years** |   | **4 - 5 Years** |   | **After 5 Years** |   |
|------------------|--------|-----------|--------|----------------------|--------|-----------------|--------|-----------------|--------|-------------------|--------|
| Long-term debt   |   | $         | 6.7    |                 | $      | 3.0             |   | $               | 3.7    |              | $      | — |   | $ | — |   |
| Operating leases |   | 40.5      |   | 5.5                  |   | 7.0             |   | 5.0             |   | 23.0              |   |
| Total            |   | $         | 47.2   |                 | $      | 8.5             |   | $               | 10.7   |              | $      | 5.0 |   | $ | 23.0 |   |

 

        Future liquidity needs will depend on,among other factors, the timing of capital expenditures and expenditures inconnection with any acquisitions, changes in customer order volume and thetiming and collection of receivables. The Company believes existing cash balances, anticipated cash flow fromoperations and amounts available under existing credit facilities will besufficient to fund its operations for the foreseeable future.

 

## **Market Risk**

# ** **

*Foreign currency.*  A portion of the Company’s operations are located in foreignjurisdictions including Ireland and Canada. The Company’s financial results could be significantly affected byfactors such as changes in foreign currency or weak economic conditions inforeign markets.  In addition, sales ofproducts and services are directly impacted by the value of the U.S. dollar relativeto other currencies.

 

Foreign currency gains and losses are reflected inthe Company’s financial statements.  Thenet exchange loss was nil in 2001.  TheCompany anticipates it will incur exchange gains and losses from foreignoperations in the future.

# ** **

*Interest. * As ofDecember 28, 2001, the Company had total outstanding debt of $6.7 million, withinterest rates that are tied to the prime rate or LIBOR.  Therefore, the Company is subject toexposure to interest rate risk for these borrowings based on fluctuations inthe interest rates.  Based upon theoutstanding indebtedness as of December 28, 2001, an increase in the interestrates of 1.0% would cause a corresponding increase in our annual interestexpense of approximately $0.1 million.

 

## ** **

**EuroCurrency Conversion**

 

OnJanuary 1, 1999, 11 of the 15 member countries of the European Union, includingIreland, adopted the “Euro” as their common legal currency.  The Euro trades on currency exchanges and isavailable for non-cash transactions. From January 1, 2000 through January 1, 2002, each of the participatingcountries is scheduled to maintain its national (“legacy”) currency as legaltender for goods and services. Beginning January 1, 2002, new euro-denominated bills and coins wereissued, and legacy currencies will be withdrawn from circulation no later thanJuly 1, 2002.  The Company’s foreignoperating subsidiaries affected by the Euro conversion 

 

 

17

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have evaluated thebusiness issues raised, including the competitive impact of cross-border pricetransparency.  The Euro currencyconversion did not have a material effect on its results of operations orfinancial position.

 

**Inflation**

 

        Historically, inflation has not had amaterial impact on the Company.  Thecost of the Company’s products is influenced by the cost of raw materials andlabor.  There can be no assurance thatthe Company will be able to pass on any increased material and labor costs toits customers in the future.

 

##### **Seasonality**

 

Thedemand for CDs and other multimedia consumer products is generally seasonal,with increases during the fall reflecting increased demand relative to the newschool year and holiday season purchases. This seasonality could result in significant quarterly variations infinancial results, with the third and fourth quarters generally being thestrongest.

 

**Outlook**

 

        The statements contained in this Outlooksection and elsewhere in this Annual Report are based on currentexpectations.  These statements areforward-looking and are made pursuant to the safe harbor provisions of thePrivate Securities Reform Act of 1995. Such statements can be identified by the use of terminology such as“anticipate,” “believe,” “estimate,” “expect,” “intend,” “may,” “could,”“possible,” “plan,” “project,” “will,” “forecast” and similar words orexpressions.  The Company’sforward-looking statements generally relate to its growth strategy, financialresults, sales efforts and cash requirements. There are certain important factors that could cause actual results todiffer materially from those anticipated by some of the statements madeherein.  Investors are cautioned thatall forward-looking statements involve risks and uncertainties, including,among others, those identified below.

 

TheCompany believes the worldwide demand for CD/DVDs has declined due to theeconomic slowdown in the PC and software markets.  Unit prices may continue to decline given the overcapacity stateof the industry.

 

If CDmarket demand continues to decline, the Company’s revenues will be directly andadversely impacted and the manufacturing capacity installed will be furtherunderutilized.  Pricing strategies ofcompetitors and general economic factors, such as consumer confidence andinflation, directly impact the Company. A substantial part of the Company’s revenue is derived from a smallnumber of key customers, and revenues will be significantly lower than expectedif the Company cannot retain these customers. In addition, if the Company does not respond rapidly to technologicalchanges, it is subject to the loss of some of its customer base, which willmaterially and adversely effect revenue.

 

TheCompany undertakes no obligation to update any forward-looking statements, butinvestors are advised to consult any further disclosures by the Company on thissubject in its filings with the Securities and Exchange Commission, especiallyon Forms 10-K, 10-Q and 8-K (if any), in which the Company discusses in moredetail various important factors that could 

 

 

18

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cause actualresults to differ from expected or historic results.  It is not possible to foresee or identify all such factors.  As such, investors should not consider anylist of such factors to be an exhaustive statement of all risks, uncertaintiesor potentially inaccurate assumptions.

 

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

 

        See “Market Risk” and “Euro CurrencyConversion” under Item 7 above.

 

**ITEM 8.  FINANCIALSTATEMENTS AND SUPPLEMENTARY DATA**

 

**       **The followingfinancial statements and schedules are included immediately following thesignature page of this report on the pages indicated:

 
|                                                                                                                              |   |
|-----------------------------------------------------------------------------------------------------------------------------------|--------|
| Report of  Independent Public Accountants dated January 25, 2002                                                                  |   |
| Consolidated Balance Sheets  as of December 28, 2001 and December 29, 2000                                                        |   |
| Consolidated  Statements of Operations for Years Ended December 28, 2001, December 29,  2000, and December 31, 1999               |   |
| Consolidated  Statements of Shareholders’ Equity for Years Ended December 28, 2001,  December 29, 2000 and December 31, 1999 |   |
| Consolidated  Statements of Cash Flows for Years Ended December 28, 2001, December 29, 2000  and December 31, 1999                |   |
| Notes to  Consolidated Financial Statements                                                                                       |   |
| Schedule II —  Valuation and Qualifying Accounts With Report of Independent Public Accountants                               |   |

All other schedules are omitted since they are not applicable, notrequired or the information is presented in the consolidated financialstatements or related notes.

 

**ITEM 9.****                                                    ****CHANGES IN AND DISAGREEMENTS WITHACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE**

 

Not applicable.

 

**PART III**

 

**ITEM 10.****                                             ****DIRECTORS AND EXECUTIVE OFFICERS OF THEREGISTRANT**

 

The information concerning theCompany’s directors and executive officers and compliance with Section 16(a)required by this item is contained in the sections entitled “Election ofDirectors,” “Executive Officers of the Company” and “Compliance with Section16(a) of the Exchange Act,” appearing in the Company’s Proxy Statement to bedelivered to stockholders in connection with the Annual Meeting of Stockholdersto be held on April 24, 2002.  Suchinformation is incorporated herein by reference.

 

 

19

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**ITEM 11.       EXECUTIVECOMPENSATION**

 

The information required by thisitem is contained in the section entitled  “Executive Compensation” appearing in the Company’s ProxyStatement to be delivered to stockholders in connection with the Annual Meetingof Stockholders to be held on April 24, 2002. Such information is incorporated herein by reference.

 

**ITEM 12.****                                             ****SECURITY OWNERSHIP OF CERTAIN BENEFICIALOWNERS AND MANAGEMENT**

 

The information required by thisitem is contained in the sections entitled “Principal Shareholders andManagement Shareholdings” appearing in the Company’s Proxy Statement to bedelivered to stockholders in connection with the Annual Meeting of Stockholdersto be held on April 24, 2002.  Suchinformation is incorporated herein by reference.

 

**ITEM 13.       CERTAIN RELATIONSHIPS AND RELATEDTRANSACTIONS**

 

The information required by thisitem is contained in the section entitled “Certain Transactions” appearing inthe Company’s Proxy Statement to be delivered to stockholders in connectionwith the Annual Meeting of Stockholders to be held on April 24, 2002.  Such information is incorporated herein byreference.

 

**PART IV**

** **

**ITEM 14.**                                              EXHIBITS, FINANCIAL STATEMENT SCHEDULESAND REPORTS ON FORM 8-K

 
| (a)  Exhibits.                                                                                                                                                                            |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                                                                                                                                                                                      |   |   |
| The following exhibits  are included in this report:  See  “Exhibit Index” immediately following the financial statements following the  signature page of this Form 10-K. |
|                                                                                                                                                                                      |   |   |
| (b) Financial Statements and Schedules.                                                                                                                                                   |
| The following financial statements and schedules are  included in Part II, Item 8 of this Form 10-K.                                                                                      |
|                                                                                                                                                                                      |   |   |
| Report of Independent Public Accountants dated January  25, 2002                                                                                                                          |   |   |
|                                                                                                                                                                                      |   |   |
| Consolidated Balance Sheets as of December 28, 2001  and December 29, 2000                                                                                                                |   |   |
|                                                                                                                                                                                      |   |   |
| Consolidated Statements  of Operations for Years Ended December 28,  2001, December 29, 2000 and December 31, 1999                                                                        |
|                                                                                                                                                                                      |
| Consolidated Statements of Shareholders’ Equity for Years  Ended December 28, 2001, December 29, 2000 and December 31, 1999                                                          |
|                                                                                                                                                                                      |   |   |
| Consolidated  Statements of Cash Flows for Years Ended December 28, 2001, December 29, 2000  and December 31, 1999                                                                        |
|                                                                                                                                                                                      |
| Notes  to Consolidated Financial Statements                                                                                                                                               |   |   |
|                                                                                                                                                                                      |   |   |
| Schedule  II - Valuation and Qualifying Accounts with Report of Independent Public  Accountants                                                                                           |
|                                                                                                                                                                                      |   |   |
| All other schedules are  omitted since they are not applicable, not required or the information is  presented in the consolidated financial statements or related notes.                  |
|                                                                                                                                                                                      |   |   |
| (c)  Reports on Form 8-K.                                                                                                                                                            |   |   |
|                                                                                                                                                                                      |   |   |
| None                                                                                                                                                                                      |   |   |

 

 

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**SIGNATURES**

 

In accordance withSection 13 or 15(d) of the Exchange Act, the registrant caused this report tobe signed on its behalf by the undersigned, thereunto duly authorized.

 

                                                    ZOMAXINCORPORATED

 

Date:  March 27, 2002

 
| By     | /s/ James T.  Anderson                |
|--------|---------------------------------------|
|   | James T.  Anderson                    |
|   | Chairman and  Chief Executive Officer |

 

In accordance with theExchange Act, this report has been signed below by the following persons onbehalf of the registrant and in the capacities and on the dates indicatedbelow.

 

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

 
| **Name**                  |   | **Title**                                                                                                                         |   | **Date**       |
|---------------------------|--------|-----------------------------------------------------------------------------------------------------------------------------------|--------|----------------|
|                      |   |                                                                                                                              |   |           |
| /s/James T.  Anderson     |   | Chairman of the  Board and Chief Executive Officer  (principal executive officer)                                                 |   | March 27, 2002 |
| James T.  Anderson        |   |
|                      |   |                                                                                                                              |   |           |
| /s/Anthony  Angelini      |   | President, Chief  Operating Officer and Director                                                                                  |   | March 27, 2002 |
| Anthony Angelini          |   |
|                      |   |                                                                                                                              |   |           |
| /s/John Gelp              |   | Executive Vice  President, Chief Financial Officer and Secretary   (principal financial officer and principal accounting officer) |   | March 27, 2002 |
| John Gelp                 |   |
|                      |   |                                                                                                                              |   |           |
| /s/Phillip T.  Levin      |   | Director                                                                                                                          |   | March 27, 2002 |
| Phillip T. Levin          |   |                                                                                                                              |   |           |
|                      |   |                                                                                                                              |   |           |
| /s/Robert  Ezrilov        |   | Director                                                                                                                          |   | March 27, 2002 |
| Robert Ezrilov            |   |                                                                                                                              |   |           |
|                      |   |                                                                                                                              |   |           |
| /s/Howard P.  Liszt       |   | Director                                                                                                                          |   | March 27, 2002 |
| Howard P. Liszt           |   |                                                                                                                              |   |           |
|                      |   |                                                                                                                              |   |           |
| /s/Janice  Ozzello Wilcox |   | Director                                                                                                                          |   | March 27, 2002 |
| Janice Ozzello  Wilcox    |   |                                                                                                                              |   |           |

 

** **

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**Reportof independent public accountants**

 

To Zomax Incorporated:

 

We have audited the accompanying consolidated balance sheets of ZomaxIncorporated (a Minnesota corporation) and Subsidiaries as of December 28,2001 and December 29, 2000, and the related consolidated statements ofoperations, shareholders’ equity and cash flows for each of the three years inthe period ended December 28, 2001. These financial statements are theresponsibility of the Company’s management. Our responsibility is to express anopinion on these financial statements based on our audits.

 

We conducted our audits in accordance with auditing standards generallyaccepted in the United States. Those standards require that we plan and performthe audit to obtain reasonable assurance about whether the financial statementsare free of material misstatement. An audit includes examining, on a testbasis, evidence supporting the amounts and disclosures in the financialstatements. An audit also includes assessing the accounting principles used andsignificant estimates made by management, as well as evaluating the overallfinancial statement presentation. We believe that our audits provide areasonable basis for our opinion.

 

In our opinion, the consolidated financial statements referred to abovepresent fairly, in all material respects, the financial position of ZomaxIncorporated and Subsidiaries as of December 28, 2001 andDecember 29, 2000, and the results of their operations and their cashflows for each of the three years in the period ended December 28, 2001,in conformity with accounting principles generally accepted in the UnitedStates.

 

Arthur AndersenLLP

 

Minneapolis, Minnesota,

January 25, 2002

 

F-1

----

 

# **ZOMAX INCORPORATED ANDSUBSIDIARIES**

##  

## Consolidated balance sheets

## (In thousands)

|                                                                                                         |   | **December 28,   2001** |    | **December 29,   2000** |   |
|--------------------------------------------------------------------------------------------------------------|--------|------------------------------|---------|------------------------------|--------|
| **ASSETS**                                                                                                   |   |                         |    |
|                                                                                                         |   |                         |    |                         |   |
| CURRENT ASSETS:                                                                                              |   |                         |    |                         |   |
| Cash and cash equivalents                                                                                    |   | $                            | 74,999  |                         | $      | 63,577 |   |
| Accounts receivable, net of allowance of $2,234  and $2,408                                             |   | 30,328                       |    | 32,182                       |   |
| Inventories                                                                                                  |   | 11,142                       |    | 13,992                       |   |
| Deferred income taxes                                                                                        |   | 3,183                        |    | 2,374                        |   |
| Prepaid expenses and other                                                                                   |   | 3,855                        |    | 3,543                        |   |
|                                                                                                         |   |                         |    |                         |   |
| Total current assets                                                                                         |   | 123,507                      |    | 115,668                      |   |
|                                                                                                         |   |                         |    |                         |   |
| PROPERTY AND EQUIPMENT, net                                                                                  |   | 39,913                       |    | 46,159                       |   |
|                                                                                                         |   |                         |    |                         |   |
| INVESTMENT IN UNCONSOLIDATED ENTITY                                                                          |   | —                       |    | 5,031                        |   |
|                                                                                                         |   |                         |    |                         |   |
| OTHER ASSETS                                                                                                 |   | 86                           |    | 1,077                        |   |
|                                                                                                         |   | $                            | 163,506 |                         | $      | 167,935 |   |
|                                                                                                         |   |                         |    |                         |   |
| **LIABILITIES  AND SHAREHOLDERS’ EQUITY**                                                               |   |                         |    |                         |   |
|                                                                                                         |   |                         |    |                         |   |
| CURRENT LIABILITIES:                                                                                         |   |                         |    |                         |   |
| Current portion of notes payable                                                                             |   | $                            | 2,976   |                         | $      | 3,788 |   |
| Accounts payable                                                                                             |   | 12,964                       |    | 21,968                       |   |
| Accrued expenses-                                                                                            |   |                         |    |                         |   |
| Accrued royalties                                                                                            |   | 6,424                        |    | 7,217                        |   |
| Accrued compensation                                                                                         |   | 5,743                        |    | 6,349                        |   |
| Other                                                                                                        |   | 1,794                        |    | 3,212                        |   |
| Income taxes payable                                                                                         |   | 3,717                        |    | 3,262                        |   |
| Total current liabilities                                                                                    |   | 33,618                       |    | 45,796                       |   |
|                                                                                                         |   |                         |    |                         |   |
| LONG-TERM NOTES PAYABLE, net of current portion                                                              |   | 3,720                        |    | 6,757                        |   |
|                                                                                                         |   |                         |    |                         |   |
| DEFERRED INCOME TAXES                                                                                        |   | 1,744                        |    | 3,287                        |   |
| Total liabilities                                                                                            |   | 39,082                       |    | 55,840                       |   |
|                                                                                                         |   |                         |    |                         |   |
| COMMITMENTS AND CONTINGENCIES (Notes 8 and 9)                                                                |   |                         |    |                         |   |
|                                                                                                         |   |                         |    |                         |   |
| SHAREHOLDERS’ EQUITY:                                                                                   |   |                         |    |                         |   |
| Common stock, no par value, 100,000 shares  authorized; 32,833 and 31,737 shares issued and outstanding |   | 63,214                       |    | 58,456                       |   |
| Retained earnings                                                                                            |   | 67,126                       |    | 58,093                       |   |
| Accumulated other comprehensive loss                                                                         |   | (5,916                       | )       | (4,454                       | )      |
| Total shareholders’ equity                                                                              |   | 124,424                      |    | 112,095                      |   |
|                                                                                                         |   | $                            | 163,506 |                         | $      | 167,935 |   |

 

The accompanying notes are an integral part of theseconsolidated balance sheets.

# ** **

## F-2

----

 

 

**ZOMAX INCORPORATED AND SUBSIDIARIES**

 

## Consolidated statements of operations

## (In thousands,except per share data)

|                                                         |   | **For the years ended**      |    |
|--------------------------------------------------------------|--------|------------------------------|---------|
|                                                         |   | **December 28,   2001** |    | **December 29, 2000** |   | **December 31, 1999** |   |
| SALES                                                        |   | $                            | 216,797 |   | $ | 239,090 |   | $ | 238,698 |   |
|                                                         |   |                         |    |   |   |   |   |
| COST OF SALES                                                |   | 166,688                      |    | 167,564 |   | 164,782 |   |
| Gross profit                                                 |   | 50,109                       |    | 71,526 |   | 73,916 |   |
|                                                         |   |                         |    |   |   |   |   |
| SELLING, GENERAL AND ADMINISTRATIVE EXPENSES            |   | 31,964                       |    | 33,532 |   | 37,724 |   |
|                                                         |   |                         |    |   |   |   |   |
| IMPAIRMENT OF GOODWILL                                       |   | 923                          |    | — |   | — |   |
| Operating income                                             |   | 17,222                       |    | 37,994 |   | 36,192 |   |
|                                                         |   |                         |    |   |   |   |   |
| EQUITY IN LOSSES OF UNCONSOLIDATED ENTITY               |   | (631                         | )       | (1,416 | ) | (1,890 | ) |
|                                                         |   |                         |    |   |   |   |   |
| IMPAIRMENT OF INVESTMENT IN  UNCONSOLIDATED ENTITY      |   | (4,400                       | )       | — |   | — |   |
| GAIN ON UNCONSOLIDATED ENTITY STOCK SALE                     |   | —                       |    | — |   | 3,685 |   |
| INTEREST EXPENSE                                             |   | (577                         | )       | (1,103 | ) | (1,179 | ) |
| INTEREST INCOME                                              |   | 2,651                        |    | 3,225 |   | 1,036 |   |
| OTHER EXPENSE, net                                           |   | (11                          | )       | (249 | ) | (40 | ) |
| Income before income taxes                                   |   | 14,254                       |    | 38,451 |   | 37,804 |   |
| PROVISION FOR INCOME TAXES                                   |   | 5,221                        |    | 13,592 |   | 11,977 |   |
| NET INCOME                                                   |   | $                            | 9,033   |   | $ | 24,859 |   | $ | 25,827 |   |
| EARNINGS PER SHARE:                                          |   |                         |    |   |   |   |   |
| Basic                                                        |   | $                            | 0.28    |   | $ | 0.78 |   | $ | 0.87 |   |
| Diluted                                                      |   | $                            | 0.27    |   | $ | 0.74 |   | $ | 0.79 |   |
|                                                         |   |                         |    |   |   |   |   |
| WEIGHTED AVERAGE COMMON SHARES OUTSTANDING              |   | 32,364                       |    | 31,915 |   | 29,662 |   |
| DILUTIVE EFFECT OF STOCK OPTIONS AND WARRANTS           |   | 788                          |    | 1,614 |   | 3,030 |   |
| WEIGHTED AVERAGE COMMON AND DILUTED  SHARES OUTSTANDING |   | 33,152                       |    | 33,529 |   | 32,692 |   |

 

The accompanying notes are an integral part of theseconsolidated financial statements.

# ** **

## F-3

----

 

# **ZOMAX INCORPORATED ANDSUBSIDIARIES**

##  

## Consolidated statements of shareholders’ equity

(In thousands)
|                                                                  |              |       |     | **Retained  earnings** |      | **Accumulated** |      |   |   |
|-----------------------------------------------------------------------|-------------------|------------|----------|------------------------|-----------|-----------------|-----------|--------|--------|
|                                                                  |              |       |     |                   | **other** |            | **Total** |   |
| **Common stock**                                                      | **comprehensive** |
| **Shares**                                                            |              | **Amount** | **loss** |
| BALANCE, December 25, 1998                                       |              | 28,756     |     | $                      | 42,680    |            | $         | 7,407  |   | $ | — |   | $ | 50,087 |   |
| Comprehensive income:                                                 |              |       |     |                   |      |            |      |   |   |   |   |
| Net income                                                            |              | —     |     | —                 |      | 25,827          |      | — |   |   |   |
| Translation adjustments                                               |              | —     |     | —                 |      | —          |      | (2,757 | )      |   |   |
| Total comprehensive income                                            |              | —     |     | —                 |      | —          |      | — |   | 23,070 |   |
| Common stock issued under employee stock  purchase plan          |              | 186        |     | 622                    |      | —          |      | — |   | 622 |   |
| Common stock issued upon exercise of stock options  and warrants |              | 2,024      |     | 2,740                  |      | —          |      | — |   | 2,740 |   |
| Tax benefit realized from exercise of  stock options             |              | —     |     | 5,911                  |      | —          |      | — |   | 5,911 |   |
| BALANCE, December 31, 1999                                       |              | 30,966     |     | 51,953                 |      | 33,234          |      | (2,757 | )      | 82,430 |   |
| Comprehensive income:                                                 |              |       |     |                   |      |            |      |   |   |   |   |
| Net income                                                            |              | —     |     | —                 |      | 24,859          |      | — |   |   |   |
| Translation adjustments                                               |              | —     |     | —                 |      | —          |      | (1,697 | )      |   |   |
| Total comprehensive income                                            |              | —     |     | —                 |      | —          |      | — |   | 23,162 |   |
| Common stock issued under employee stock  purchase plan          |              | 143        |     | 1,412                  |      | —          |      | — |   | 1,412 |   |
| Common stock issued upon exercise of stock options  and warrants |              | 1,428      |     | 3,031                  |      | —          |      | — |   | 3,031 |   |
| Tax benefit realized from exercise of  stock options             |              | —     |     | 7,100                  |      | —          |      | — |   | 7,100 |   |
| Common stock repurchased (Note 5)                                |              | (800       | )        | (5,040                 | )         | —          |      | — |   | (5,040 | ) |
| BALANCE, December 29, 2000                                       |              | 31,737     |     | 58,456                 |      | 58,093          |      | (4,454 | )      | 112,095 |   |
| Comprehensive income:                                                 |              |       |     |                   |      |            |      |   |   |   |   |
| Net income                                                            |              | —     |     | —                 |      | 9,033           |      | — |   |   |   |
| Translation adjustments                                               |              | —     |     | —                 |      | —          |      | (1,462 | )      |   |   |
| Total comprehensive income                                            |              | —     |     | —                 |      | —          |      | — |   | 7,571 |   |
| Common stock issued under employee stock  purchase plan          |              | 339        |     | 1,311                  |      | —          |      | — |   | 1,311 |   |
| Common stock issued upon exercise of stock options  and warrants |              | 757        |     | 2,756                  |      | —          |      | — |   | 2,756 |   |
| Tax benefit realized from exercise of  stock options             |              | —     |     | 430                    |      | —          |      | — |   | 430 |   |
| Stock compensation expense                                            |              | —     |     | 261                    |      | —          |      | — |   | 261 |   |
| BALANCE, December 28, 2001                                       |              | 32,833     |     | $                      | 63,214    |            | $         | 67,126 |   | $ | (5,916 | ) | $ | 124,424 |   |
|                                                                       |                   |            |          |                        |           |                 |           |        |        |  |  |  |  |  |  |  |  |

 

The accompanying notes are an integral part of theseconsolidated financial statements.

##  

F-4

----

# **ZOMAX INCORPORATED ANDSUBSIDIARIES**

 

## Consolidated statements of cash flows

## (In thousands)

|                                                                                    |   | **For the years ended**     |   |
|-----------------------------------------------------------------------------------------|--------|-----------------------------|--------|
|                                                                                    |   | **December 28,  2001** |   | **December 29,  2000** |   | **December 31,  1999** |   |
| OPERATING ACTIVITIES:                                                                   |   |                        |   |   |   |   |   |
| Net income                                                                              |   | $                           | 9,033  |   | $ | 24,859 |   | $ | 25,827 |   |
| Adjustments to reconcile net income to net cash  provided by operating activities- |   |                        |   |   |   |   |   |
| Depreciation and amortization                                                           |   | 10,443                      |   | 9,758 |   | 7,970 |   |
| Compensation expenses                                                                   |   | 261                         |   | — |   | — |   |
| Impairment of goodwill                                                                  |   | 923                         |   | — |   | — |   |
| Equity in losses of unconsolidated entity                                               |   | 631                         |   | 1,416 |   | 1,890 |   |
| Impairment of investment in unconsolidated entity                                       |   | 4,400                       |   | — |   | — |   |
| Foreign currency exchange                                                               |   | 11                          |   | 249 |   | 40 |   |
| Tax benefits from employee stock option plan                                            |   | 430                         |   | 7,100 |   | 5,911 |   |
| Gain on unconsolidated entity stock sale                                                |   | —                      |   | — |   | (3,685 | ) |
| Deferred income taxes                                                                   |   | (2,352                      | )      | 1,179 |   | 149 |   |
| Changes in operating assets and liabilities:                                            |   |                        |   |   |   |   |   |
| Accounts receivable                                                                     |   | 1,265                       |   | (4,504 | ) | 11,987 |   |
| Inventories                                                                             |   | 2,739                       |   | (4,493 | ) | (1,515 | ) |
| Prepaid expenses and other                                                              |   | (290                        | )      | (1,021 | ) | (1,816 | ) |
| Accounts payable                                                                        |   | (8,642                      | )      | 2,615 |   | 7,285 |   |
| Accrued expenses                                                                        |   | (2,261                      | )      | (5,832 | ) | 7,538 |   |
| Income taxes payable                                                                    |   | 475                         |   | 1,533 |   | 3,081 |   |
| Net cash provided by operating activities                                          |   | 17,066                      |   | 32,859 |   | 64,662 |   |
|                                                                                    |   |                        |   |   |   |   |   |
| INVESTING ACTIVITIES:                                                                   |   |                        |   |   |   |   |   |
| Purchase of property and equipment                                                      |   | (4,934                      | )      | (14,283 | ) | (11,963 | ) |
| Acquisitions, net of cash acquired                                                      |   | —                      |   | — |   | (42,500 | ) |
| Change in other assets                                                                  |   | (15                         | )      | (44 | ) | 1,088 |   |
| Net cash used in investing activities                                                   |   | (4,949                      | )      | (14,327 | ) | (53,375 | ) |
|                                                                                    |   |                        |   |   |   |   |   |
| FINANCING ACTIVITIES:                                                                   |   |                        |   |   |   |   |   |
| Proceeds from notes payable                                                             |   | —                      |   | — |   | 15,000 |   |
| Repayment of notes payable                                                              |   | (3,778                      | )      | (4,123 | ) | (3,560 | ) |
| Repurchase of common stock                                                              |   | —                      |   | (5,040 | ) | — |   |
| Issuance of common stock, net                                                           |   | 4,067                       |   | 4,443 |   | 3,362 |   |
| Net cash provided by (used in)  financing activities                               |   | 289                         |   | (4,720 | ) | 14,802 |   |
|                                                                                    |   |                        |   |   |   |   |   |
| EFFECT OF EXCHANGE RATE CHANGES ON CASH AND  CASH EQUIVALENTS                      |   | (984                        | )      | (1,363 | ) | (582 | ) |
| Net increase in cash                                                                    |   | 11,422                      |   | 12,449 |   | 25,507 |   |
|                                                                                    |   |                        |   |   |   |   |   |
| CASH AND CASH EQUIVALENTS:                                                              |   |                        |   |   |   |   |   |
| Beginning of year                                                                       |   | 63,577                      |   | 51,128 |   | 25,621 |   |
| End of year                                                                             |   | $                           | 74,999 |   | $ | 63,577 |   | $ | 51,128 |   |
| SUPPLEMENTAL CASH FLOW DISCLOSURE:                                                      |   |                        |   |   |   |   |   |
| Cash paid for interest                                                                  |   | $                           | 585    |   | $ | 1,125 |   | $ | 1,125 |   |
| Cash paid for income taxes                                                              |   | $                           | 6,205  |   | $ | 1,625 |   | $ | 2,682 |   |

 

The accompanying notes are an integral part of theseconsolidated financial statements.

# ** **

F-5

----

 

# **ZOMAX INCORPORATED ANDSUBSIDIARIES**

##  

## Notes to consolidated financial statements

 

December 28, 2001,December 29, 2000 and December 31, 1999

 

**1      Business description**

 

Zomax Incorporatedand subsidiaries (Zomax or the Company) is a leading international outsourceprovider of process management services. The Company’s fully integratedservices include front-end e-commerce support, call center and customer supportsolutions; DVD authorizing services; CD and DVD mastering; CD and DVDreplication; supply chain and inventory management; graphic design; printmanagement; assembly; packaging; warehousing; distribution and fulfillment; andRMA processing. The Company has facilities in the United States, Canada andIreland.

 

**2      Summary of significant accountingpolicies**

 

**Principles of consolidation**

 

The consolidatedfinancial statements include the accounts of the Company and its wholly ownedsubsidiaries. All material intercompany accounts and transactions have beeneliminated in consolidation.

 

**Fiscal year-end**

 

The Company’sfiscal year ends on the last Friday of the calendar year. For the purposes ofthese notes to the consolidated financial statements, the fiscal years endedDecember 28, 2001, December 29, 2000 and December 31, 1999 arereferred to as 2001, 2000 and 1999, respectively. The fiscal year ended in 1999included 53 weeks, as compared to 52 weeks in 2001 and 2000.

 

**Use of estimates**

 

The preparation offinancial 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. Actual results could differ from thoseestimates.

 

**Revenue recognition**

 

The Companyrecords sales revenue at the time merchandise is shipped or as services arerendered. For certain customers, merchandise is invoiced upon completion oforders, with shipment occurring based on written customer instructions. Inthese cases, the customer accepts title to the goods as of the date of theCompany’s invoice. In each case of bill and hold sales, the Company ensuresthat the transaction complies with the conditions and considerations containedin Accounting and Auditing Enforcement Release No. 108 of the Securities andExchange Commission. In 2001, 2000 and 1999, one customer represented35 percent, 40 percent and 39 percent, respectively, of theCompany’s sales.

 

EffectiveJanuary 1, 2000, the Company began recording amounts being charged tocustomers for shipping and handling as revenue in accordance with recentlyreleased Emerging Issues Task Force Issue 00-10, “Accounting for Shipping andHandling Fees and Costs.” Historically, the Company had netted the shipping andhandling revenue with the cost of shipping and handling in cost of sales. TheCompany has reclassified $9,437,000 in 1999 from cost of sales to sales in theaccompanying consolidated statements of operations.

** **

**Cost of sales**

 

The Companyincludes direct labor, direct materials and production overhead, which includesshipping costs, in cost of sales on the consolidated statements of operations.

** **

**Cash and cash equivalents**

 

Cash and cashequivalents primarily consist of highly liquid short-term investments withoriginal maturities of 90 days or less and are recorded at cost, whichapproximates market value.

** **

F-6

----

 

**Inventories**

 

Inventories,consisting of material, labor and overhead, are stated at the lower offirst-in, first-out cost or market. Inventories were as follows (in thousands):

 
|            |   | **December 28,  2001** |   | **December 29,  2000** |   |
|-----------------|--------|-----------------------------|--------|-----------------------------|--------|
|            |   |                        |   |
| Raw materials   |   | $                           | 8,575  |                        | $      | 8,709 |   |
| Work in process |   | 896                         |   | 3,855                       |   |
| Finished goods  |   | 1,671                       |   | 1,428                       |   |
|            |   | $                           | 11,142 |                        | $      | 13,992 |   |

 

**Property and equipment**

 

Property andequipment are stated at cost less accumulated depreciation. Repairs andmaintenance are charged to expense as incurred, while significant improvementsare capitalized. Depreciation is calculated using the straight-line method forfinancial reporting purposes over the estimated useful lives. Depreciationexpense totaled approximately $10,363,000 in 2001, $9,678,000 in 2000 and$7,895,000 in 1999.

 

Property andequipment consisted of the following (dollars in thousands):

 
|                                            |   | **December 28,   2001** |   | **December 29,  2000** |   | **Lives**  |   |
|-------------------------------------------------|--------|------------------------------|--------|-----------------------------|--------|------------|--------|
|                                            |   |                         |   |
| Manufacturing equipment                         |   | $                            | 60,160 |                        | $      | 57,101     |   | 7 years |   |
| Office equipment                                |   | 5,683                        |   | 6,417                       |   | 5-7 years  |   |
| Land, building and leasehold improvements       |   | 7,194                        |   | 6,780                       |   | 4-35 years |   |
|                                            |   | 73,037                       |   | 70,298                      |   |       |   |
| Less- Accumulated depreciation and amortization |   | (33,124                      | )      | (24,139                     | )      |       |   |
| Property and equipment, net                     |   | $                            | 39,913 |                        | $      | 46,159     |   |   |   |

 

**Income taxes**

 

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

 

**Fair value of financial instruments**

 

The financialinstruments with which the Company is involved are primarily of a traditionalnature. For most instruments, including cash, receivables, accounts payable,accrued expenses and short-term debt, the Company believes that the carryingamounts approximate fair value because of their short-term nature. The carryingvalue of long-term debt approximated fair value as of December 28, 2001 andDecember 29, 2000. The fair values are based on current rates available to theCompany.

 

**Long-lived assets**

 

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

 

As a result of theslowdown in the RMA processing business in the second half of 2001, the Companyanalyzed projected undiscounted cash flows and determined that goodwillassociated with the 1997 purchase of Trotter Technologies, Inc. was impaired.Accordingly, the Company charged to earnings the entire amount of unamortizedgoodwill of approximately $923,000 in 2001. The write-off of the goodwill wasbased on an analysis of projected 

 

F-7

----

 

discounted cashflows, which were no longer deemed adequate to support the value of goodwillassociated with the business. Excluding the write-off in 2001, amortizationexpense totaled $80,000 in 2001, $80,000 in 2000 and $75,000 in 1999.

 

**Royalty payments**

 

The Company haslicense agreements with certain companies for the use of certain CD and DVDmanufacturing technology. The Company accrues for royalties based on unitssold.

 

**Earnings per share**

 

Basic earnings pershare (EPS) is computed by dividing net income by the weighted average numberof common shares outstanding during the year. Diluted EPS is computed bydividing net income by the sum of the weighted average number of common sharesoutstanding plus all additional common shares that would have been outstandingif potentially dilutive common shares related to stock options and warrants hadbeen issued. Potential common shares of 671,000, 654,000 and 199,000 related tothe Company’s outstanding stock options were excluded from the computation ofdiluted earnings per share for 2001, 2000 and 1999, respectively, as inclusionof these shares would have been antidilutive.

 

**Foreign currency translation**

 

Zomax convertsassets and liabilities of foreign operations to their U.S. dollar equivalentsat exchange rates in effect at the balance sheet date and records translationadjustments as a component of shareholders’ equity in the consolidated balancesheets. Income statements of foreign operations are translated from theoperations’ functional currency to U.S. dollar equivalents at average exchangerates prevailing during the period. Foreign exchange transaction gains andlosses are reported in other expense, net on the consolidated statements ofoperations.

 

**Recently issued accounting pronouncements**

 

In July 2001, theFinancial Accounting Standards Board issued Statement of Financial AccountingStandards (SFAS) No. 141, “Business Combinations,” and SFAS No. 142,“Goodwill and Other Intangible Assets.” SFAS No. 141 requires allbusiness combinations initiated after June 30, 2001 to be accounted forusing the purchase method. Under SFAS No. 142, goodwill and intangibleassets with indefinite lives are no longer amortized, but are reviewed annually(or more frequently if impairment indicators arise) for impairment. Separableintangible assets that are not deemed to have indefinite lives will continue tobe amortized over their useful lives (but with no maximum life). Theamortization provisions of SFAS No. 142 apply to goodwill andintangible assets acquired after June 30, 2001. With respect to goodwilland intangible assets acquired prior to July 1, 2001, the Company isrequired to adopt SFAS No. 142 effective the first day of fiscal year2002. The adoption of SFAS No. 142 will have no effect on theCompany’s financial position or results of operations as the Company has noremaining goodwill or other intangibles as of December 28, 2001.

 

**3      Acquisitions**

 

In January 1999,the Company acquired the businesses and certain net assets of Kao Corporation(Kao) in the United States, Canada, Ireland and Germany. The purchase price forthe businesses, net assets and net working capital acquired was $37,500,000 incash, plus transaction costs. The assets and businesses acquired by the Companywere used in the manufacturing and sale of CDs and related businesses, and theCompany intends to continue to use the assets and businesses in a similarmanner. The acquisition was accounted for using the purchase method ofaccounting, and accordingly, the purchase price has been allocated to netassets acquired based on their estimated fair values. Kao’s results ofoperations have been included in the accompanying consolidated statements ofoperations since the date of acquisition.

 

**Investment in unconsolidated entity**

 

On October 2,1998, the Company acquired 4,310,345 shares of the common stock of Microgistix(formerly Chumbo Holdings Corporation), a private company, in exchange for cashand warrants for total consideration of $5,000,000. The warrants were grantedto certain shareholders of Microgistix to purchase 400,000 shares of theCompany’s common stock at a price of $5.00 per share. The warrants wereimmediately exercisable for a period of three years. At the time of theinvestment, the Company owned approximately one-third of the outstanding equityof Microgistix, which is accounted for using the equity method of accounting.As part of the agreement, Zomax has access to Microgistix’s proprietaryInternet software to service customers of the Company. The Company’s chiefexecutive officer (CEO) served as Microgistix’s CEO until August 27, 1999,and in recognition of his additional duties and responsibilities, receivedwarrants to purchase Microgistix’s common stock.

 

F-8

----

 

In December 1999,Microgistix sold additional equity in a private round of financing. The Companyrecognized a gain on Microgistix’s issuance of additional equity in the amountof $3,685,000, representing the increase in the Company’s share ofMicrogistix’s net assets after the transaction. As of December 28, 2001,the Company owns 25.2 percent of Microgistix. The Company recognized aloss of $631,000, $1,416,000 and $1,890,000 in 2001, 2000, and 1999,respectively, representing its share of Microgistix’s net loss and amortizationof the purchase price in excess of the underlying fair value of net assetsacquired.

 

In December 2001,the Company wrote off its remaining investment in Microgistix, which amountedto $4,400,000. Based on Microgistix’s historical operating results and cashflow requirements, the Company could not foresee that it would be able torecover the carrying amount of its investment in Microgistix or thatMicrogistix has the ability to sustain an earnings capacity which would justifythe carrying amount of the investment.

 

Microgistixconducts its operations through two wholly owned subsidiaries, Microgistix.com,Inc. and Point Group Corporation. Microgistix.com, Inc. has developedproprietary software for Internet commerce and operates a web site(http/www.microgistix.com) selling computer software over the Internet. PointGroup Corporation is a licensee and reseller of computer software.

 

Sales by theCompany to Point Group Corporation totaled $4,877,000, $6,097,000 and$1,156,000 in 2001, 2000 and 1999, respectively. Point Group Corporation’saccounts receivable balances totaled $1,140,000, $2,222,000 and $125,000 in2001, 2000 and 1999, respectively. The Company has eliminated unrealized profitassociated with the sales to Point Group Corporation to the extent of itsequity interest.

 

**4      Credit facilities and long-term notespayable**

 

The Company has a$15,000,000 term loan facility which was used to finance the purchase of thebusinesses and net assets of Kao. The Company also has a $25,000,000 revolvingline-of-credit facility. The term loan facility requires quarterly principalpayments of $750,000 on a straight-line amortization schedule. The interestrate is at the lower of prime plus .75 percent or LIBOR plus2.25 percent (4.39 percent at December 28, 2001). The revolvingline-of-credit facility provides for borrowings based on a formula usingeligible accounts receivable and inventories with interest rates of prime plus..5 percent or LIBOR plus 2.0 percent (4.14 percent atDecember 28, 2001). Both facilities have five-year terms and containcertain financial covenants. The Company was in compliance with such covenantsas of December 28, 2001.

 

The amountoutstanding on the term loan facility at December 28, 2001 andDecember 29, 2000 was $6,696,000 and was $9,760,000, respectively. TheCompany had no borrowings outstanding under the revolving line-of-creditfacility at December 28, 2001 and December 29, 2000.

 

The Company alsohad an installment note, payable in monthly installments, at an interest rateof 8.1 percent. The note was collateralized by certain equipment. Theamount outstanding under this installment note as of December 29, 2000 was$785,000. The note was paid in full during 2001.

 

Future scheduledmaturities of long-term debt are as follows as of December 28, 2001 (inthousands):

 

|                                                 |   |   |   |
|------------------------------------------------------|--------|--------|--------|
| 2002                                                 |   | $      | 2,976  |   |
| 2003                                                 |   | 2,976  |   |
| 2004                                                 |   | 744    |   |
| Total                                                |   | 6,696  |   |
| Less- Current portion                                |   | 2,976  |   |
| Long-term notes payable, net of current portion |   | $      | 3,720  |   |

 

**5      Shareholders’ equity**

 

EffectiveAugust 11, 1999, the Company’s board of directors approved a 2-for-1 stocksplit effected as a stock dividend to shareholders. On May 8, 2000, theCompany’s board of directors approved a second 2-for-1 stock split effected asa stock dividend to shareholders. All per share and share outstanding data inthe consolidated financial statements and notes to consolidated financial statementshave been retroactively restated to reflect both stock splits.

 

The Company’sboard of directors authorized a stock repurchase plan in October 2000 thatallows the Company to repurchase up to 2,000,000 common shares. The Companyrepurchased a total of 800,200 shares at a cost of $5,040,000 during 2000. Noshares were repurchased during 2001.

 

F-9

----

 

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

 

**6      Stock plans**

 

**Employee stock purchase plan**

 

The Company has anemployee stock purchase plan, which enables employees to contribute up to10 percent of their compensation toward the purchase of the Company’scommon stock at a price equal to 85 percent of fair market value. A totalof 1,000,000 shares have been reserved for issuance under this plan. Sharesissued under the plan totaled approximately 339,000 in 2001, 143,000 in 2000and 186,000 in 1999.

 

**Stock option plan**

 

The Company has a1996 Stock Option Plan (the Plan) to provide for the granting of stock optionsto employees, officers, directors and independent consultants of the Company atexercise prices not less than 100 percent of the fair market value of theCompany’s common stock on the date of grant. The authorized number of sharesreserved for issuance totaled 6,400,000, of which 125,220 remained availablefor grant at December 28, 2001. These options, which can be eitherincentive stock options or nonqualified options, vest over a three- tofive-year schedule and expire 10 years after the grant date. The Company alsoissued nonqualified stock options outside of the Plan for the purchase of1,268,000 shares of common stock. 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.

 

During 2001, theCompany granted 693,000 nonqualified stock options to certain officers of theCompany. Since these options were not granted pursuant to an approved plan,such options are subject to variable plan accounting pursuant to FinancialAccounting Standards Board Interpretation No. 44, “Accounting for CertainTransactions Involving Stock Compensation (an Interpretation of APB OpinionNo. 25).” The Company is required to recognize compensation expense equal tothe amount by which the quoted market value of the Company stock exceeds theexercise price of the option, prorated for the length of time the grants havebeen outstanding. The variable plan accounting will cease when the shareholdersapprove the granting of the options or the options are exercised or cancelled.The Company recognized compensation expense related to these options of$261,000 in 2001, which is reflected in selling, general and administrativeexpenses in the accompanying consolidated statement of operations.

 

Informationregarding the options is summarized below (shares in thousands):

 
|                                        |   | **2001**   |   | **2000**                              |   | **1999**   |   |
|---------------------------------------------|--------|------------|--------|---------------------------------------|--------|------------|--------|
|                                        |   | **Shares** |   | **Weighted  average  exercise price** |   | **Shares** |   | **Weighted  average   exercise price** |   | **Shares** |   | **Weighted  average   exercise price** |   |
|                                        |   |       |   |                                  |
| Options outstanding, beginning of year |   | 2,268      |   | $                                     | 7.40   |       | 3,210  |   | $ | 2.63 |   | 4,624 |   | $ | 1.98 |   |
| Granted                                     |   | 2,312      |   | 6.20                                  |   | 1,160      |   | 20.63 |   | 742 |   | 4.96 |   |
| Exercised                                   |   | (357       | )      | 2.12                                  |   | (1,410     | )      | 2.04 |   | (1,772 | ) | 1.92 |   |
| Canceled                                    |   | (374       | )      | 13.59                                 |   | (692       | )      | 22.60 |   | (384 | ) | 2.57 |   |
|                                        |   |       |   |                                  |   |       |   |   |   |   |   |   |   |
| Options outstanding,  end of year |   | 3,849      |   | $                                     | 7.07   |       | 2,268  |   | $ | 7.40 |   | 3,210 |   | $ | 2.63 |   |
|                                        |   |       |   |                                  |   |       |   |   |   |   |   |   |   |
| Options exercisable,  end of year |   | 926        |   | $                                     | 3.40   |       | 690    |   | $ | 3.30 |   | 259 |   | $ | 2.49 |   |

 

F-10

----

 

Optionsoutstanding at December 28, 2001 have exercise prices ranging from $1.13to $24.13 and a weighted average remaining contractual life of 8.0 years(shares in thousands).

 
|                         |      |                                           |                       | **Options outstanding**                            |   |                                  |                  |
|------------------------------|-----------|------------------------------------------------|----------------------------|----------------------------------------------------|--------|---------------------------------------|-----------------------|
|                         |      | **Outstanding  as of  December 28, 2001** |                       | **Weighted  average  remaining life   (in years)** |   | **Weighted   average exercise price** |                  | **Options exercisable** |   |
|                         |      |                                           |                       |                                               |   |                                  | **Exercisable ** |   | **Weighted** |   |
| **Range of exercise prices** | **as of** | **average exercise**                           |
| **Low**                      |      | **High**                                       | **December 28, 2001** | **price**                                          |
|                         |
| $                            | 1.13      |                                           | $                          | 2.86                                               |   | 878                                   |                  | 6.2 |   | $ | 2.18 |   | 709 |   | $ | 2.12 |   |
| 2.87                         |      | 5.71                                           |                       | 502                                                |   | 7.3                                   |                  | 4.28 |   | 104 |   | 4.15 |   |
| 5.72                         |      | 8.57                                           |                       | 2,039                                              |   | 9.2                                   |                  | 6.17 |   | 75 |   | 5.97 |   |
| 14.28                        |      | 17.14                                          |                       | 5                                                  |   | 7.9                                   |                  | 16.53 |   | 2 |   | 16.53 |   |
| 17.15                        |      | 19.99                                          |                       | 11                                                 |   | 8.5                                   |                  | 17.59 |   | 2 |   | 17.22 |   |
| 20.00                        |      | 22.85                                          |                       | 400                                                |   | 8.3                                   |                  | 20.94 |   | 32 |   | 20.94 |   |
| 22.86                        |      | 24.13                                          |                       | 14                                                 |   | 8.1                                   |                  | 24.13 |   | 2 |   | 24.13 |   |
|                         |      |                                           |                       | 3,849                                              |   | 8.0                                   |                  | $ | 7.07 |   | 926 |   | $ | 3.40 |   |
|                              |           |                                                |                            |                                                    |        |                                       |                       |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

The Companyaccounts for its stock option grants under Accounting Principles Board OpinionNo. 25, “Accounting for Stock Issued to Employees.” Since options havebeen granted at not less than the market value on the date of grant, nocompensation expense has been recognized for the stock options granted. Had thecompensation cost of option grants been determined consistent withSFAS No. 123, “Accounting for Stock-Based Compensation,” theCompany’s income and EPS, on a pro forma basis, would have been reported asfollows (in thousands, except per share data):

 
|             |   | **2001** |   | **2000** |   | **1999** |   |
|------------------|--------|----------|--------|----------|--------|----------|--------|
|             |   |     |   |
| Net income:      |   |     |   |     |   |     |   |
| As reported      |   | $        | 9,033  |     | $      | 24,859   |   | $ | 25,827 |   |
| Pro forma        |   | $        | 6,193  |     | $      | 24,122   |   | $ | 23,030 |   |
|             |   |     |   |     |   |     |   |
| EPS as reported: |   |     |   |     |   |     |   |
| Basic            |   | $        | 0.28   |     | $      | 0.78     |   | $ | 0.87 |   |
| Diluted          |   | $        | 0.27   |     | $      | 0.74     |   | $ | 0.79 |   |
|             |   |     |   |     |   |     |   |
| Pro forma EPS:   |   |     |   |     |   |     |   |
| Basic            |   | $        | 0.19   |     | $      | 0.76     |   | $ | 0.78 |   |
| Diluted          |   | $        | 0.19   |     | $      | 0.72     |   | $ | 0.71 |   |

 

In determining thecompensation 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:

 
|                                                |   | **2001** |   | **2000** |   | **1999** |   |
|-----------------------------------------------------|--------|----------|--------|----------|--------|----------|--------|
| Risk-free interest rate                             |   | 5.05     | %      | 6.40     | %      | 5.48     | %      |
| Expected life of options granted                    |   | 7 years  |   | 10 years |   | 10 years |   |
| Expected volatility of options granted         |   | 94.56    | %      | 127.79%  |   | 82.67    | %      |
| Weighted average fair value of options granted |   | $        | 5.44   |     | $      | 19.55    |   | $ | 8.71 |   |
|                                                     |        |          |        |          |        |          |        |  |  |  |

 

F-11

----

 

**7      Income taxes**

 

The provision forincome taxes for the Company was as follows (in thousands):

 
|                   |   | **2001** |   | **2000** |   | **1999** |   |
|------------------------|--------|----------|--------|----------|--------|----------|--------|
|                   |   |     |   |
| Current taxes payable: |   |     |   |     |   |     |   |
| Federal                |   | $        | 5,776  |     | $      | 8,607    |   | $ | 7,661 |   |
| State                  |   | 738      |   | 1,284    |   | 834      |   |
| Foreign                |   | 1,059    |   | 2,522    |   | 3,333    |   |
|                   |   | 7,573    |   | 12,413   |   | 11,828   |   |
| Deferred               |   | (2,352   | )      | 1,179    |   | 149      |   |
| Total provision        |   | $        | 5,221  |     | $      | 13,592   |   | $ | 11,977 |   |

 

The provision forforeign income taxes is based upon foreign pretax-income of approximately$4,500,000, $12,300,000 and $16,000,000 in 2001, 2000 and 1999, respectively.

 

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

 
|                                                        |   | **2001** |   | **2000** |   | **1999** |   |
|-------------------------------------------------------------|--------|----------|--------|----------|--------|----------|--------|
| Statutory federal income tax rate                           |   | 34.0     | %      | 34.0     | %      | 34.0     | %      |
| State income taxes, net of federal income  tax benefit |   | 3.2      |   | 0.5      |   | 1.6      |   |
| Effects of unconsolidated entity                            |   | (8.8     | )      | 1.3      |   | 1.7      |   |
| Foreign tax effect                                          |   | (1.8     | )      | (3.4     | )      | (8.3     | )      |
| Valuation allowance                                         |   | 11.3     |   | —   |   | —   |   |
| Other                                                       |   | (1.3     | )      | 2.9      |   | 2.7      |   |
| Effective income tax rate                                   |   | 36.6     | %      | 35.3     | %      | 31.7     | %      |

 

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

 
|                                          |   | **December 28,  2001** |   | **December 29,  2000** |   |
|-----------------------------------------------|--------|-----------------------------|--------|-----------------------------|--------|
|                                          |   |                        |   |
| Current:                                      |   |                        |   |                        |   |
| Accounts receivable reserves                  |   | $                           | 749    |                        | $      | 793 |   |
| Inventory reserves                            |   | 582                         |   | 581                         |   |
| Accrued liabilities                           |   | 1,302                       |   | 571                         |   |
| Other                                         |   | 550                         |   | 429                         |   |
| Total current deferred tax asset         |   | $                           | 3,183  |                        | $      | 2,374 |   |
| Long-term:                                    |   |                        |   |                        |   |
| Depreciation and amortization                 |   | $                           | (1,744 | )                           | $      | (1,813 | ) |
| Gain on unconsolidated entity stock sale |   | —                      |   | (1,474                      | )      |
| Capital loss carryforward                     |   | 1,610                       |   | —                      |   |
| Valuation allowance                           |   | (1,610                      | )      | —                      |   |
| Total long-term deferred tax liability   |   | $                           | (1,744 | )                           | $      | (3,287 | ) |

 

The Company hasnot recorded deferred income taxes applicable to undistributed earnings of itsnon-U.S. subsidiaries as all such earnings are deemed to be indefinitelyreinvested in those operations. If earnings of these non-U.S. subsidiaries werenot indefinitely reinvested, a deferred liability would have been required inthe amount of $0.6 million and $1.7 million as of December 28,2001 and December 29, 2000, respectively.

 

F-12

----

 

**8      Related-party transactions**

 

**Operating lease**

 

The Company leasesone of its manufacturing and office facilities from a partnership that ismajority-owned by a significant shareholder and director of the Company. TheCompany believes the terms are equivalent to those that would be paid in anarm’s-length transaction. Lease payments totaled $649,000 in 2001, $641,000 in2000 and $719,000 in 1999.

** **

**9      Commitments and contingencies**

** **

**Operating leases**

 

The Company iscommitted under operating leases with related and unrelated parties for therental of manufacturing, warehouse and office facilities. Future minimum leaseobligations are as follows as of December 28, 2001 (in thousands):

 
| 2002       |   | $      | 5,486  |   |
|------------|--------|--------|--------|--------|
| 2003       |   | 4,040  |   |
| 2004       |   | 2,915  |   |
| 2005       |   | 2,919  |   |
| 2006       |   | 2,111  |   |
| Thereafter |   | 23,067 |   |
|       |   | $      | 40,538 |   |

 

**Rentexpense under operating leases, exclusive of real estate taxes, insurance andmaintenance expense was $5,480,000 in 2001, $7,849,000 in 2000 and $7,346,00 in1999.**

 

**Ireland employment grants**

 

The Company andthe Ireland businesses acquired have received employment grants from theIreland Development Authority (IDA) totaling $3,454,000 during the period from1995 through 2000. These grants were awarded by the IDA for creating andmaintaining permanent employment positions in Ireland for a period of at leastfive years. The receipt of future grant installments will extend this period ofcontingent repayment to five years from the date of the last receipt.Termination of any number of these positions within a five-year period mayresult in the pro rata return of the grants based on the number of positionsterminated compared to the number of new positions originally created.

 

The Companyrecognizes income from the grants on a straight-line basis. The income isincluded in selling, general and administrative expenses in the consolidatedstatements of operations.

 

**401(k) plan**

 

The Company has adiscretionary 401(k) plan for all employees who are at least 21 years of ageand have completed 60 days of service with the Company. The Company’sdiscretionary contributions totaled $301,000 in 2001, $665,000 in 2000 and$252,000 in 1999.

 

**Litigation**

 

The Company isinvolved in various claims arising in the normal course of business. Inmanagement’s opinion, the final resolution of these claims should not have amaterial adverse effect on the Company’s financial position or the results ofits operations.

 

F-13

----

 

**10   Quarterly financial data (unaudited)**

 

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

 
|         |   | **Quarters ended** |   |
|--------------|--------|--------------------|--------|
|         |   | **March 30**  |   | **June 29** |   | **September 28** |   | **December 28** |   |
| **2001**     |   |               |   |   |   |   |   |   |   |
| Sales        |   | $                  | 62,796 |   | $ | 51,815 |   | $ | 45,829 |   | $ | 56,358 |   |
| Gross profit |   | 14,873             |   | 12,928 |   | 9,752 |   | 12,558 |   |
| Net income   |   | 4,214              |   | 3,483 |   | 1,865 |   | (528 | ) |
| Basic EPS    |   | .13                |   | .11 |   | .06 |   | (.02 | ) |
| Diluted EPS  |   | .13                |   | .11 |   | .06 |   | (.02 | ) |
|         |   |               |   |   |   |   |   |   |   |
|         |   | **Quarters ended** |   |
|         |   | **March 31**  |   | **June 30** |   | **September 29** |   | **December 29** |   |
| **2000**     |   |               |   |   |   |   |   |   |   |
| Sales        |   | $                  | 57,867 |   | $ | 63,255 |   | $ | 59,348 |   | $ | 58,620 |   |
| Gross profit |   | 18,686             |   | 20,280 |   | 16,875 |   | 15,685 |   |
| Net income   |   | 6,394              |   | 7,798 |   | 5,475 |   | 5,210 |   |
| Basic EPS    |   | .20                |   | .24 |   | .17 |   | .16 |   |
| Diluted EPS  |   | .19                |   | .23 |   | .16 |   | .16 |   |

 

 

Noncash specialcharges recorded in the fourth quarter of 2001 totaled $3,480,000, net of tax,or $.11 per share. $2,926,000 relates to the write-off of the Company’sinvestment in an unconsolidated business; $554,000 relates to the write-off ofgoodwill recorded as part of a 1997 acquisition.

 

F-14

----

 

**11   Industry segment and operations bygeographic areas**

 

The Companyoperates in one industry segment. The geographic distributions of the Company’sidentifiable assets, operating income and revenues for 2001, 2000 and 1999 aresummarized as follows (in thousands):

 
|                                                               |   | **2001** |    | **2000** |   | **1999** |   |
|--------------------------------------------------------------------|--------|----------|---------|----------|--------|----------|--------|
| Total revenues:                                                    |   |     |    |     |   |     |   |
| United States                                                      |   | $        | 176,279 |     | $      | 170,852  |   | $ | 161,488 |   |
| Europe                                                             |   | 44,451   |    | 62,646   |   | 75,543   |   |
| Canada                                                             |   | 20,663   |    | 22,108   |   | 17,789   |   |
| Less- Intergeographic revenues                                     |   | (24,596  | )       | (16,516  | )      | (16,122  | )      |
|                                                               |   | $        | 216,797 |     | $      | 239,090  |   | $ | 238,698 |   |
| Operating income:                                                  |   |     |    |     |   |     |   |
| United States                                                      |   | $        | 20,591  |     | $      | 32,406   |   | $ | 28,202 |   |
| Europe                                                             |   | 1,720    |    | 7,627    |   | 12,670   |   |
| Canada                                                             |   | 3,512    |    | 5,861    |   | 4,440    |   |
| Less- Corporate, interest and other expense  and eliminations |   | (8,601   | )       | (7,900   | )      | (9,120   | )      |
|                                                               |   | $        | 17,222  |     | $      | 37,994   |   | $ | 36,192 |   |
| Assets:                                                            |   |     |    |     |   |     |   |
| United States                                                      |   | $        | 51,008  |     | $      | 58,119   |   | $ | 47,125 |   |
| Europe                                                             |   | 35,732   |    | 39,965   |   | 34,773   |   |
| Canada                                                             |   | 15,713   |    | 17,835   |   | 12,921   |   |
| Total identifiable assets                                          |   | 102,453  |    | 115,919  |   | 94,819   |   |
| Corporate assets and eliminations                                  |   | 61,053   |    | 52,016   |   | 47,485   |   |
|                                                               |   | $        | 163,506 |     | $      | 167,935  |   | $ | 142,304 |   |
| Capital expenditures:                                              |   |     |    |     |   |     |   |
| United States                                                      |   | $        | 1,315   |     | $      | 7,675    |   | $ | 5,885 |   |
| Europe                                                             |   | 3,330    |    | 3,592    |   | 5,660    |   |
| Canada                                                             |   | 289      |    | 3,016    |   | 418      |   |
|                                                               |   | $        | 4,934   |     | $      | 14,283   |   | $ | 11,963 |   |
| Depreciation and amortization:                                     |   |     |    |     |   |     |   |
| United States                                                      |   | $        | 7,407   |     | $      | 7,108    |   | $ | 6,455 |   |
| Europe                                                             |   | 1,806    |    | 1,679    |   | 1,269    |   |
| Canada                                                             |   | 1,230    |    | 971      |   | 246      |   |
|                                                               |   | $        | 10,443  |     | $      | 9,758    |   | $ | 7,970 |   |

 

F-15

----

 

**Report of independent publicaccountants**

 

To ZomaxIncorporated:

 

We have audited,in accordance with auditing standards generally accepted in the United States,the consolidated financial statements included in the Zomax Incorporated andSubsidiaries’ annual report to shareholders incorporated by reference in thisForm 10-K, and have issued our report thereon dated January 25, 2002.  Our audit was made for the purpose offorming an opinion on those statements taken as a whole.  The schedule of valuation and qualifyingaccounts is the responsibility of the company’s management and is presented forpurposes of complying with the Securities and Exchange Commission’s rules andis not part of the basic financial statements. This schedule has been subjected to the auditing procedures applied inthe audit of the basic financial statements and, in our opinion, fairly statesin all material respects the financial data required to be set forth therein inrelation to the basic financial statements taken as a whole.

 

Arthur AndersenLLP

 

Minneapolis,Minnesota,

January 25, 2002

 

F-16

----

 

**ZomaxIncorporated**

Schedule II    Valuation andQualifying Accounts

 
| **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 28, 2001 |   | 2,408,000                            |   | 295,000                             |   | —                         |   | (469,000                            | )      | 2,234,000                      |   |
|                                  |   |                                 |   |                                |   |                           |   |                                |   |                           |   |
| For the year ended  December 29, 2000 |   | 2,645,000                            |   | 98,000                              |   | —                         |   | (335,000                            | )      | 2,408,000                      |   |
|                                  |   |                                 |   |                                |   |                           |   |                                |   |                           |   |
| For the year ended  December 31, 1999 |   | 2,035,000                            |   | 1,953,000                           |   | —                         |   | (1,343,000                          | )      | 2,645,000                      |   |

 

F-17

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**ZOMAXINCORPORATEDEXHIBIT INDEX TO FORM 10-K**

 
| For the Fiscal Year  Ended: | Commission File No.                                                                                                                                                                                                                                                                                                                                   |
|-----------------------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| December 28, 2001           | 0-28426                                                                                                                                                                                                                                                                                                                                               |
|                        |                                                                                                                                                                                                                                                                                                                                                  |
| Exhibit                     |                                                                                                                                                                                                                                                                                                                                                  |
| Number                      |                                                                                                                                                                                                                                                                                                                                                  | Description |
|                        |                                                                                                                                                                                                                                                                                                                                                  |
| 3.1                         | Articles  of Incorporation, as amended (Incorporated by reference to Exhibit 3.1 to  Annual Report on Form 10-K for year ended December 29, 2000)                                                                                                                                                                                                     |
| 3.2                         | Bylaws. (1)                                                                                                                                                                                                                                                                                                                                           |
| **4.1**                     | **Form of Stock Certificate. (1)**                                                                                                                                                                                                                                                                                                                    |
| 4.2                         | Articles of  Incorporation (See Exhibit 3.1).                                                                                                                                                                                                                                                                                                         |
| 4.3                         | Bylaws (See Exhibit  3.2).                                                                                                                                                                                                                                                                                                                            |
| 10.1                        | 1996 Stock Option Plan,  as amended through January 19, 2000, and Forms of Incentive and Nonqualified  Stock Option Agreements (Incorporated by reference to Exhibit 10.1 to Annual  Report on Form 10-K for the year ended December 31, 1999).**                                                                                                     |
| 10.2                        | 1996 Employee  Stock Purchase Plan. (1)**                                                                                                                                                                                                                                                                                                             |
| 10.3                        | Lease between the  Company and Nathan Lane Partnership, LLP dated January 1, 1995, as amended  October 28, 1997 (Incorporated by reference to Exhibit 10.5 to Registration  Statement on Form S-1, SEC File No. 333-2430 and Exhibit 10.15 to Annual  Report on Form 10-KSB for the year ended December 26, 1997).                                    |
| 10.4                        | Employment Agreement  with James T. Anderson dated January 1, 1999 (Incorporated by reference to  Exhibit 10.5 to Annual Report on Form 10-K for the year ended December 31,  1999).**                                                                                                                                                                |
| 10.5                        | License Agreement with  U.S. Phillips Corporation effective January 1, 1996 (Incorporated by  reference to Exhibit 10.7 to Registration Statement on form S-1, SEC File No.  333-2430).                                                                                                                                                               |
| 10.6                        | License Agreement with  Discovision Associates dated January 1, 1994 (Incorporated by reference to  Exhibit 10.8 to Registration Statement on Form S-1, SEC File No. 333-2430).                                                                                                                                                                       |
| 10.7                        | Revolving Credit and  Term Loan Agreement between the Company and Marquette Capital Bank dated  December 31, 1995, as amended April 30, 1997 (Incorporated by reference to  Exhibit 10.16 to Registration Statement on Form S-1, SEC File No. 333-2430,  and Exhibit 10.16 to Quarterly Report on Form 10-QSB for the quarter ended  March 27, 1997). |
| 10.8                        | Lease between the  Company and Chaboya Ranch dated June 5, 1997 (Incorporated by reference to  Exhibit 10.16 to Quarterly Report on Form 10-QSB for the quarter ended March  28, 1997).                                                                                                                                                               |
| 10.9                        | Credit Agreement dated  as of January 6, 1999 among the Company, Certain Lenders and General Electric  Capital Corporation. (2)                                                                                                                                                                                                                       |
| 10.10                       | Credit Agreement dated  as of January 6, 1999 among Zomax Canada Company, Certain Lenders and General  Electric Capital Canada Inc. (2)                                                                                                                                                                                                               |
| 10.11 *                     | Employment Agreement  with Anthony Angelini effective January 1, 2002.**                                                                                                                                                                                                                                                                              |
| 10.12 *                     | Employment Agreement  with John Gelp dated October 10, 2001. **                                                                                                                                                                                                                                                                                       |
| 10.13 *                     | Lease between the  Company and The Scottish Provident Institution effective March 2, 2001.                                                                                                                                                                                                                                                            |
|                             |                                                                                                                                                                                                                                                                                                                                                       |  |  |

 

 

 

E-1

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| 21.1 * | Subsidiaries of the  Company                                   |
|--------|----------------------------------------------------------------|
| 23 *   | Consent of Arthur  Andersen LLP                                |
| 24 *   | Power of Attorney  (included on signature page of this report) |
| 99 *   | Representation from  Arthur Andersen LLP                       |

 

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*      Filed herewith.**   Management agreement or compensatoryplan or arrangement.(1)   Incorporated by reference to thecorresponding exhibit numbers to Form S-1 Registration Statement, SEC File No.333-2430.(2)   Incorporated by reference toexhibits to current report on Form 8-K/A-1 dated January 7, 1999.

 

 

 

 

 

E-2

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