**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington,DC 20549**

 

**FORM 10-K**

 

| **ý**                                 |   | **Annual Report Pursuant to Section 13 or 15(d) of the  Securities Exchange Act of 1934 for the fiscal year ended December 26, 2003**                                                                                                                                                     |
|--------------------------------------------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                                       |   |                                                                                                                                                                                                                                                                                      |
| **or**                                     |
|                                       |
| **o**                                      |   | **Transition Report Under Section 13 or 15(d) of the  Securities Exchange Act of 1934 for the transition period from               to               .** |
|                                       |   |                                                                                                                                                                                                                                                                                      |
| **Commission  File Number:  0-28426** |

 

**ZOMAX INCORPORATED**

(Exact name of registrantas specified in its charter)

 

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

 

Indicate by check mark 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

 

Indicate by check mark if there is no disclosure ofdelinquent filers in response to Item 405 of Regulation S-K contained in thisform, 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 Form 10-K. o

 

Indicate by check mark whether the registrant is anaccelerated filer (as defined in Exchange Act Rule 12b-2). YESý  NOo

 

The aggregate market value of the voting stock held bynon-affiliates was $110,224,309 based on the closing sale price of theCompany’s Common Stock as reported on the NASDAQ Stock Market on June 27, 2003.

 

The number of shares outstanding of the registrant’scommon stock as of March 3, 2004 was 32,787,947 shares.

 

**DOCUMENTSINCORPORATED BY REFERENCE**

 

Portions of the Proxy Statement for the 2004 AnnualMeeting of Shareholders are incorporated by reference into Part III of thisreport.

 

 

----

 

**PART I**

** **

**ITEM1.  BUSINESS**

 

**General**

 

At Zomax, we help companies more efficiently bring theirproducts and content to market worldwide. We enhance the process of sourcing, production, and fulfillment througha modular suite of supply chain outsourcing services.  We believe our commitment to operational excellence results inconsistent execution and superior value for our customers.  We have demonstrated the ability to provideconsistently high quality products and services in a just-in-time (JIT) model.

 

Established in 1993, we have approximately 1,300full-time employees and operate twelve facilities in the United States, Canada,Mexico, and Ireland.  In January 1999,we acquired the businesses and certain assets of KAO Corporation in the U.S.,Canada and Ireland.  This acquisitionsignificantly expanded our media replication capacity, scope of services andgeographical footprint and we continue to expand our geographic presence andsupply chain services by building and acquiring new capabilities.

 

We market and sell outsourced supply chain services toindustry leading customers in a variety of markets.  We believe our expertise in integrating and managing criticalsupply chain functions allows our customers to focus on their corecompetencies, reduce costs, accelerate time to market, decrease inventory obsolescence,and improve response to customer demand in a variety of geographic regions.

 

Whether we fulfill orders directly to our customer’send-users or channel partners, or JIT to the customer’s production facilities,our goal is to help companies deliver “The Perfect Order” - that means the rightproduct, the right place, the right time, at the right value.

 

**Industry**

 

The supply chain outsourcing services industry managesa vast array of products and content for a wide range of markets.   Whether it is IT hardware, software,consumer electronics, automotive parts, pharmaceuticals or other products,organizations are increasingly turning to experienced outsourcing partners tobring their products to market more efficiently.  The need for faster time-to-market, quicker inventory turns,greater focus on core competencies and lower costs have driven the growth ofsupply chain outsourcing.

 

The same factors that have led to more outsourcing aredriving consolidation in the industry, as many small local and regional serviceproviders find it increasingly difficult to access the capital required toinvest in new equipment and additional value-added services.  Consolidation of the industry continues asmarginal companies struggle to compete.

 

We believe our strong balance sheet, end-to-endsolutions, customer list, consistent execution and solid reputation in theindustry continue to be a competitive advantage and position us to continue tocapture market share as the economy improves.

 

**Services**

 

Our outsourcing solutions enhance the process ofsourcing, production, and fulfillment through a modular suite of supply chainservices that enable customers to select the combination of services that bestmeet their unique needs.   Our servicesare delivered from a network of twelve facilities across the United States,Mexico, Canada, and Ireland and include the following:

 

•                  **CustomerContact Services** – To help build sustainable, interactiverelationships between our customers and their end-users, we provide a broadrange of end-customer services.  Ourend-to-end approach covers inbound/outbound teleservices, order processing,financial management and e-commerce to support the entire customer life-cycle.

 

•                  **Sourcing –**Constant change in the availability and quality of materials is a majorchallenge for many of our customers. To address this challenge, we offer a fullrange of print, packaging, and hardware procurement services to support theirgrowing businesses.

 

2

----

 

•                  **Production**– High-capacity CD ROM and DVD manufacturing is critical to meeting the mediarequirements for our customers.  Inaddition, our in-house Print-on-Demand offerings enable personalized,quick-turn print materials for product or information kits.

 

•                  **Assembly andKitting** – Our customers require a highly flexible set of assemblyand kitting services to handle a broad range of products. We provide scalableassembly services that include automated assembly, a flexible workforce, andJIT capabilities to meet unique customer requirements.

 

•                  **Fulfillment–** We support a full range of retail and end-customer distributionmodels and provides integrated returns management services.  Our capabilities include physicalfulfillment and electronic software delivery to meet the unique needs of ourcustomers.

 

In 2002, we completed a strategic partnership withIntraware (ticker symbol “ITRA” ) to incorporate Electronic Software Delivery(ESD) into our solutions offered in 2003 and beyond.  The need for faster product delivery and lower costs are drivingthe demand for these types of services which augment our traditional serviceoffering.

 

In 2003, we also added Print-On-Demand services to ourFremont, California facility.  Thissolution enables companies to customize documentation, manuals and promotionalmaterials and bundle them just-in-time with their products as they bring themto market.

 

With the breadth and modularity of our services,customers can choose to outsource some or all of their supply chainfunctions.  In all cases, our accountand project management organizations maintain daily contact with our customersto ensure the highest level of quality and responsiveness.

 

**Customers,Markets and Sales**

 

We market and sell outsourced supply chain services toa variety of customers.  Historically,the majority of our revenue is derived from customers in the computer hardwaremanufacturing and software publishing industries.  We currently service a broad base of customers in these industrysegments including Microsoft®, Dell®, AOL®, Logitech®, Apple® and HewlettPackard®.  During 2003, 2002, and 2001,Microsoft revenues accounted for 22%, 20%, and 35%, respectively, of our totalrevenues.  In addition, in 2003, Dellaccounted for approximately 10% of our total revenues.

 

In late 2002, we expanded our sales and marketingefforts to continue to penetrate the industries we serve and expand into newmarkets.  We are focusing on additionalexpansion in industries that have a common and growing need to bring largevolumes of products and/or content to market more efficiently.  These include industries where we haveexperience and proven customer references, including consumer electronics,marketing services, corporate information services and more.

 

We employ a direct sales staff that is responsible formaintaining relationships with existing customers and developing new businessrelationships.  We also employ a projectmanagement staff that is responsible for ensuring that each order is processedon a timely basis, all required support materials are in place, and desiredquality levels are achieved.  Eachcustomer account is assigned one or more project managers to provide regularcontact with the customer, coordinate the purchase and manufacture of allnecessary materials, adapt to order changes, and generally act as liaison withthe customer.

 

We are also an authorized replicator of Microsoft,which allows us to replicate Microsoft products for any authorized distributoror OEM.  We are also authorized toperform fulfillment services for Microsoft licensed OEMs.  These arrangements are pursuant to annualagreements with Microsoft.  We expect,but cannot guarantee, that these agreements will be renewed.  We also provide replication, telemarketingand fulfillment services for certain Microsoft programs under a Master ServicesAgreement, which expires in May 2004. We expect, but cannot guarantee, that this agreement will also berenewed.

 

**Competition**

 

The supply chain service industry is highlycompetitive and is undergoing consolidation. We compete primarily with supply chain service providers and, to alesser extent, with media replicators and third party logistics companies.  Each of these producers generally services adefined set of customer needs.

 

•          *Supply Chain Service Providers*.  Companies in this segment provide servicesthat help companies manage the flow of their products to their consumers fromsourcing to manufacturing to distribution. Examples include companies

 

3

----

 

such as Zomax, Arvato (adivision of Bertlesman AG), Startek Corporation, SalesLink, Modus MediaInternational, Digital River, and Inoveris. We believe our in-house media replication and contact centers, whichenable us to provide better synchronized programs for customers. provides us anadvantage over these competitors.

 

•          *Media Replicators*.  Companies in this segment manufacture anddistribute CD and DVD media.  Examplesinclude Sonopress, Cinram International Inc., Duplium, Technicolor and Crest.  Several media replicators have expandedtheir solutions to include additional supply chain services such asdistribution or returns management.  Webelieve that our complete range of services, including customer contactservices and ESD, provide a competitive advantage for Zomax.

 

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

 

•          *Printing and Packaging Firms*.  Organizations such as Banta, IPC and Q-Mediastarted in the printing or packaging market and expanded their services toinclude other aspects of the supply chain. Our in-house media replication and contact center services help positionus as a more complete solution provider than these companies.  Some of these companies partner with us toprovide printing and packaging services for our customers.

 

Many of our national and regional competitors arelarger and more established with greater financial and other resources than us,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 wecan.  Alternatively, other competitorshave weak financial status in comparison to us.  As financial strength continues to be a key decision makingcomponent for customers, our financial position is an advantage over thesecompetitors.

 

We believe that we compete favorably with respect toquality, service, reliability, price, manufacturing capacity, and timelydelivery of product, the principal competitive factors in this industry.  We also believe that customers are willingto incur additional costs for extra services. As such, to enhance our competitive position, we offer a full range ofvalue-added services to customers including sourcing, production, fulfillment,returns management, and a range of contact center services.

 

**FinancialInformation About Geographical Areas:**

 

Financial information about our geographic segments ispresented in Note 12 to the Consolidated Financial Statements included in Item8 of this Form 10-K.

 

**FiscalYear End**

 

Our fiscal year ends on the last Friday of thecalendar year.  Unless otherwiseindicated, our fiscal years ended December 26, 2003, December 27, 2002, andDecember 28, 2001 are referred to herein as 2003, 2002, and 2001, respectively.

 

**Backlog**

 

Our business is characterized by short lead times forcustomer orders.  For this reason andbecause of the timing of orders, delivery intervals, and customer changes inquantities and delivery schedules, our backlog as of any particular date is nota meaningful indicator of future financial results.

 

**ProprietaryRights**

 

Like most other CD and DVD manufacturers, we usepatented technology primarily under nonexclusive licenses.  These licenses generally provide for thepayment of royalties based upon the number, type and use of CDs and DVDs soldand terminate either upon the expiration of the patents being licensed or on acertain date.  If we are unable tomaintain these licenses, it could have a material adverse effect on our resultsof operations.

 

4

----

 

**Seasonality**

 

The demand for CDs, DVDs and related services isseasonal, with demand increasing in the fall due to the new school year andholiday season purchases.  Thisseasonality can result in significant quarterly variations in financialresults, with our fourth quarter generally being our strongest in terms ofrevenue.

 

**Employees**

 

We have approximately 1,300 full-time employees and wecontract to hire additional employees on a temporary basis to performmanufacturing-and fulfillment related services as the need arises.  We believe that our relations with ouremployees are good and that we provide competitive salary and benefits programs.  None of our employees are covered by acollective bargaining agreement.

 

**Risk and Uncertainties**

 

The foregoing discussion and the discussion containedin Item 7 of this Form 10-K contain various “forward-looking statements” withinthe meaning of Section 27A of the Securities Act of 1933, as amended, andSection 21E of the Securities Exchange Act of 1934, as amended.  Such statements can be identified by the useof terminology such as “anticipate,” “believe,” “estimate,” “expect,” “intend,”“may,” “could,” “possible,” “plan,” “project,” “will,” “forecast” and similarwords or expressions.  Ourforward-looking statements generally relate to our growth strategy, theexpansion of our geographic presence and supply chain services, our ability tocapture market share, decrease costs, improve customer satisfaction, improveefficiency, or develop new product features and functionality, our financialresults, sales efforts, our continued ability to provide competitiveadvantages, acquisition plans and cash requirements.  Investors are cautioned that all forward-looking statementsinvolve risks and uncertainties that could cause results to differsignificantly from our expectations.

 

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

 

Our business faces manyrisks and uncertainties.  The risks anduncertainties described below may not be the only ones we face.  Additional risks and uncertainties that wedo not yet know of or that we currently think are immaterial may also impairour business operations.  If any of theevents or circumstances described in the following listing of risks anduncertainties actually occur, our business, financial condition or results ofoperations could suffer.  The risks anduncertainties described below may be amended, supplemented or superceded fromtime to time by other reports we file with the SEC in the future.  These risks and uncertainties include,without limitation:

 

*We are dependent on a small number of key customers in thepersonal computer(PC) hardware and software industries.*

 

Our business continues to bedependent on a small number of key customers in the PC hardware and softwareindustries.  Our top five customers in2003, 2002, and 2001 were all members of these industries and represented50.1%, 47.6%, and 54.8% respectively, of our total revenue.  In general, our contractual agreements withthese and other customers allow them to terminate service with very littlenotice and without cause.  Further, thework we perform for our customers is periodically put out for competitivebid.  While we believe we arecompetitive, the risk exists that we may not be the successful bidder and loseexisting business with current customers. Also, some of these customers rely on unique information technologysystems that we possess, which provides us a competitive advantage.  However, there can be no assurances thatthis advantage will not be reduced or eliminated by alternative solutionsdeveloped internally by our customers or by our competitors.  If we were to lose all or a significantportion of our business with one of these key customers, our revenues andprofit margins would be materially and negatively impacted.  In addition, competition in theseindustries, particularly the PC hardware industry, has resulted in the need forthese companies to put continued pressure on their vendors, including Zomax,for price reductions and increased service levels.

 

While we continue to makeefforts to expand our base of customers to those outside these industries,these customers tend to be smaller, making it very unlikely that we couldquickly recover from the loss of one of our key customers through theacquisition of several new customers outside these industries.

 

*We may not be able to effectively compete in an increasinglycompetitive environment.*

 

Competition in the supplychain outsourcing services industry is intense.  Our industry is currently characterized by many vendors pursuingrelatively few and very large customers, which provides these customers withthe ability to exert significant pressures on their suppliers.  We have experienced and anticipateexperiencing continued pricing pressures from current and future competitors aswell as general pricing pressure from our customers as part of their costreduction efforts.  These pricingpressures have, and may continue to limit our ability to achieve acceptablelevels of profitability.

 

5

----

 

In addition, some of ourcompetitors are larger and have substantially greater resources andcapabilities in information technology, global facilities, staff expertise andother areas that can limit our ability to make the investments required toremain competitive and be profitable. We have identified the need to make additional investments ininformation technology, expansion into other geographical markets and thedevelopment and capabilities of our staff. However, we can not be assured that these investments will generate orsustain a particular competitive advantage.

 

While we believe ourcapabilities are unique, they do not involve significant proprietaryproperties.  Therefore, we are dependentprimarily on our ability to provide exceptional service to our customers andmaintain strong relationships with them. These relationships may be positively or negatively impacted by changesin personnel or shifts in strategies within Zomax, our customers or ourcompetitors.

 

*We may not be able to maintain our status as a MicrosoftAuthorized Replicator.*

 

We have been designated byMicrosoft as an Authorized Replicator (AR) of their software and are one of alimited number of Microsoft AR’s in the United States.  Retaining our status as a Microsoft ARrequires that we continue to meet a number of stringent criteria established byMicrosoft.  Our status as a Microsoft ARis not only a requirement to replicate CD and DVD media directly for Microsoft,but also to replicate Microsoft software for our customers in the PC hardwareindustry that sell or use Microsoft software with their products.  While we have no reason to believe it islikely that we could lose our status as a Microsoft AR, if this were to happen,we would lose a significant portion of our business with these customers andour revenues and profitability would be severely and negatively impacted.

 

*We may not be able to meet our customers’ requirementsregarding the security of their intellectual property, inventory and otherassets.*

 

We manage or take possessionof many of our customers’ physical and intellectual properties.  Much of this property consists of consignedinventory or intellectual property in our possession, the value of which is notreflected in our financial statements. If we fail to protect their property or meet their securityrequirements, we may be liable to these customers for penalties orreimbursement up to full retail value of the property and may lose theirbusiness, which could have a significant negative impact on our financialcondition or results of operations.

 

*We are dependent on revenues from the replication of CD andDVD media which may be threatened by the development and rate of marketacceptance of new media storage techniques or other electronic mediatechnologies.*

 

Our business continues to beheavily dependent on the use of CD, and to a lesser degree, DVD media in the PChardware and software industries.  Theincreasing availability of broadband communications services, changes in fixedstorage techniques used in the PC industry, and the development of alternativeelectronic storage technologies at lower costs, are examples of technologiesthat may threaten to reduce or eliminate the need for CD media in the PC hardwareand software industries.  A significantdecline in the use of CD media in these industries would have a significantnegative impact on our revenues and profitability.

 

While we have establishedelectronic software download (ESD) capabilities through our strategic alliancewith Intraware, our success in this market has been limited.  If we are unable to develop significantmarket penetration in the ESD market through this relationship or others, ourability to participate in the increasing shift to electronic delivery ofsoftware may be impacted.

 

*We have been issued a “Wells Notice” from the Securities andExchange Commission (SEC) and have been named as a defendant in a lawsuitalleging certain securities laws violations.*

 

In December 2003, we receiveda “Wells Notice” from the Chicago Regional Office of the SEC indicating theirintention to recommend that a civil enforcement action be commenced against theCompany for alleged violations of securities rules and regulations regardingfalse and misleading forward looking statements made to the public and in aquarterly report in the year 2000. While we have made a Wells Submission to the SEC setting forth the basisfor our belief that we have complied with all applicable rules and regulations,there is no assurance that an enforcement action will not be brought againstthe Company or that the Company will be successful if an enforcement action iscommenced.

 

In March 2004, we were namedas a defendant in a purported shareholder class action lawsuit.  The lawsuit alleges securities lawviolations regarding false and misleading statements made to the public and thefailure to disclose material events between June 6, 2000 and September 21,2000.  While we strongly deny theseallegations and intend to vigorously defend this case, there can be noassurance of a favorable outcome.

 

These events may result inmanagement attention being diverted from our business, significant legal costsand possible fines, penalties or judgments assessed against the Company.  In addition, these actions could threatenour ability to retain existing customers and employees or attract new customersand employees.

 

**Available Information**

 

See our web site at www.zomax.com for additionalinformation regarding our products and services.  All reports we file electronically with the SEC are available bycontacting our Investor Relations at investorrelations@zomax.com or (763)553-9300.  These filings are also accessibleon the SEC’s web site at www.sec.gov. The public may read and copy any materials we file with the SEC at theSEC’s Public Reference Room at 450 Fifth Street, NW, Washington, DC 20549.  The public may obtain information for thePublic Reference Room by calling the SEC at 1-800-SEC-0330.

 

6

 

**ITEM 2.   PROPERTIES**

 

Our principal facilities consist of the following:

 

•                  We lease threefacilities in Minneapolis, Minnesota, totaling approximately 183,000 squarefeet in which we perform mastering, replication, printing, print management,packaging, warehousing, fulfillment, distribution, and RMA processingactivities.  Our corporate offices arealso located in one of these facilities. These leases expire in 2004 through 2006.  The largest of these facilities is an 82,000 square foot facilitythat we lease from a partnership of which Mr. Phillip T. Levin, a member of ourBoard of Directors, owns a one-third interest. We lease this space at a base rent of $8.03 per net rentable square footper year.  We are also obligated to payall taxes and operating expenses of this facility.  This lease expires in 2006.

 

•                  We own a 158,000square foot facility in Arnprior, Canada, in which we perform mastering,replication, print management, printing, packaging, warehousing anddistribution activities.

 

•                  We lease a153,000 square foot facility in Fremont, California, in which we performmastering, replication, print management, printing, packaging, warehousing,fulfillment, distribution and RMA processing activities.  This lease expires in 2006.

 

•                  We lease twofacilities in Dublin, Ireland, totaling approximately 139,000 square feet inwhich we perform customer contact center activities as well as replication,print management, printing, packaging, warehousing, fulfillment, distributionand RMA processing activities.  Theseleases expire from 2016 to 2028.

 

•                  We lease a92,000 square foot facility in Juarez, Mexico, in which we perform warehousingand distribution activities.  This leaseexpires in 2005.

 

•                  We lease a91,000 square foot facility in Indianapolis, Indiana, in which we performpackaging, fulfillment, distribution and RMA processing activities.  This lease expires in 2004.

 

•                  We lease a30,000 square foot facility in Concord, California, in which we performcustomer contact center activities. This lease expires in 2008.

 

We believe that the facilities used in our operations are adequate tomeet our current needs.

 

**ITEM3.  LEGAL PROCEEDINGS**

 

*Customer claim of unauthorized production of software*. During the second quarter of 2003, one of our major customersalleged that Zomax Ireland, a subsidiary we acquired from Kao Corporation inJanuary 1999, was responsible for unauthorized production of the customer’ssoftware.  Our customer claimed thatbecause of these alleged unauthorized activities it had suffered significantdamages representing lost profits on displaced product sales.  In the fourth quarter of 2003, we and our customer reached a finalaccommodation related to these claims. While we continue to deny these claims, in order to avoid potentiallylengthy and expensive litigation, we agreed to make a one-time payment to ourcustomer of $3,000,000.  As a part ofthe settlement agreement, neither party admitted any liability and both partiesobtained mutual releases related to the claims.

 

*“Wells Notice” and Shareholder Lawsuit.*  In October 2002, we announcedthat the Securities and Exchange Commission (SEC) was conducting a preliminaryinvestigation into the trading of Zomax securities by insiders.  In December 2003 , we received a “Wells Notice”from the staff of the Chicago Regional office of the SEC indicating theirintention to recommend that a civil enforcement action be commenced against usand certain of our current and former officers.  The notice alleges violations regarding false and misleadingforward-looking statements made to the public and in a quarterly report in theyear 2000.  The staff also indicated itsintention to recommend a civil enforcement action be commenced against certaincurrent and former officers regarding alleged insider trading violations duringthe same period.  The Company and thecurrent and former officers believe they have complied with all applicablerules and regulations.

 

On March 9, 2004 a lawsuit was filed against the Company and certain ofits former officers.  The complaintalleges securities law violations regarding false and misleading statementsmade to the public and the failure to disclose material events between June 6,2000 and September 21, 2000.  Thecomplaint was filed in the United States District Court, District of Minnesotaby an individual purporting to represent a class of purchasers of Zomaxstock.  The lawsuit seeks unspecifieddamages.  We believe this lawsuit iswithout merit and intend to defend this action vigorously.

 

We do not believe the amount of any potential liability associated withthese matters can be estimated at this time, but an unfavorable resolution ofthese matters is possible and could have a material adverse effect on ourresults of operations, financial condition or cash flows.

 

We are involved in certain other claims arising in thenormal course of business.  In ouropinion, the final outcome of these matters will not have a material adverseeffect on the Company’s financial position, cash flow or results of operations.

 

7

----

 

**ITEM4.  SUBMISSION OF MATTERS TO A VOTE OFSECURITY HOLDERS**

 

No matters were submitted to a vote of securityholders during the fourth quarter of 2003.

 

8

----

 

**PART II**

 

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

 

**MarketInformation**

 

Our Common Stock is quoted on the NASDAQ Stock Marketunder the symbol “ZOMX.”  The followingtable shows the high and low closing bid prices of our Common Stock.  These bid quotations represent inter-dealerprices and do not include retail mark-ups, mark-downs or commissions and maynot necessarily represent actual transactions.

 
|           |   | **2003** |   | **2002** |   |
|----------------|--------|----------|--------|----------|--------|
|           |   | **High** |   | **Low**  |   | **High** |   | **Low** |   |
| First Quarter  |   | $        | 4.55   |     | $      | 2.87 |   | $ | 8.22 |   | $ | 6.10 |   |
| Second Quarter |   | 4.00     |   | 2.90     |   | 7.46 |   | 3.90 |   |
| Third Quarter  |   | 5.59     |   | 3.34     |   | 4.30 |   | 3.10 |   |
| Fourth Quarter |   | 6.50     |   | 4.77     |   | 4.50 |   | 3.22 |   |
|                |        |          |        |          |        |  |  |  |  |  |  |  |  |

 

**Holders**

 

As of March 3, 2004, there were approximately 410record holders of our Common Stock, excluding stockholders whose stock is heldeither in nominee name and/or street name brokerage accounts.  Based on information which we have obtainedfrom our transfer agent, there are approximately 12,500 holders of our CommonStock whose stock is held either in nominee name and/or street name brokerageaccounts.

 

**Dividends**

 

We have never declared or paid cash dividends on ourcapital stock and do not anticipate declaring or paying any cash dividends inthe foreseeable future and intend to retain future earnings for the developmentof our business.

 

9

----

 

**ITEM6.  SELECTEDFINANCIAL DATA**

 

The following five-year financial summary informationshould be read in conjunction with the Consolidated Financial Statements andrelated notes thereto set forth in Item 8 of this Form 10-K.

 
|                                              |   | **2003(1)**                               |    | **2002** |   | **2001(2)** |   | **2000** |    | **1999** |   |
|---------------------------------------------------|--------|-------------------------------------------|---------|----------|--------|-------------|--------|----------|---------|----------|--------|
|                                              |   | **(In thousands, except per share data)** |    |
| **STATEMENT OF OPERATIONS DATA:**                 |   |                                      |    |     |   |        |   |     |    |     |   |
| Revenue                                           |   | $                                         | 197,670 |     | $      | 185,500     |   | $        | 216,797 |     | $      | 239,090 |   | $ | 238,698 |   |
| Gross profit                                      |   | 37,407                                    |    | 32,812   |   | 50,109      |   | 71,526   |    | 73,916   |   |
| Selling, general and administrative  expenses     |   | 41,172                                    |    | 35,264   |   | 31,964      |   | 33,532   |    | 37,724   |   |
| Operating income (loss)                           |   | (3,765                                    | )       | (2,452   | )      | 17,222      |   | 37,994   |    | 36,192   |   |
| Income (loss) before income taxes                 |   | (3,508                                    | )       | (1,252   | )      | 14,254      |   | 38,451   |    | 37,804   |   |
| Income tax expense (benefit)                      |   | (2,953                                    | )       | (573     | )      | 5,221       |   | 13,592   |    | 11,977   |   |
| Net earnings (loss)                               |   | (555                                      | )       | (679     | )      | 9,033       |   | 24,859   |    | 25,827   |   |
| Earnings (loss) per share:                        |   |                                      |    |     |   |        |   |     |    |     |   |
| Basic                                             |   | (0.02                                     | )       | (0.02    | )      | 0.28        |   | 0.78     |    | 0.87     |   |
| Diluted                                           |   | (0.02                                     | )       | (0.02    | )      | 0.27        |   | 0.74     |    | 0.79     |   |
| Weighted average common shares outstanding:       |   |                                      |    |     |   |        |   |     |    |     |   |
| Basic                                             |   | 32,621                                    |    | 33,050   |   | 32,364      |   | 31,915   |    | 29,662   |   |
| Diluted                                           |   | 32,621                                    |    | 33,050   |   | 33,152      |   | 33,529   |    | 32,692   |   |
|                                              |   |                                      |    |     |   |        |   |     |    |     |   |
| **BALANCE SHEET DATA:**                           |   |                                      |    |     |   |        |   |     |    |     |   |
| Cash and cash equivalents                         |   | $                                         | 68,899  |     | $      | 72,146      |   | $        | 74,999  |     | $      | 63,577 |   | $ | 51,128 |   |
| Working capital                                   |   | 88,576                                    |    | 89,960   |   | 89,889      |   | 69,872   |    | 47,466   |   |
| Total assets                                      |   | 181,633                                   |    | 167,183  |   | 163,506     |   | 167,935  |    | 142,304  |   |
| Long-term notes payable,  net  of current portion |   | —                                    |    | 747      |   | 3,720       |   | 6,757    |    | 10,603   |   |
| Total shareholders’ equity                   |   | 137,766                                   |    | 130,549  |   | 124,424     |   | 112,095  |    | 82,430   |   |

 

----

(1)         Results of operations in 2003 include a pretaxcharge of $3.0 million, or $0.05 per share, for the settlement of a customerclaim, a pretax charge of $2.0 million, or $0.04 per share, for accruedpayments under a separation agreement with our former CEO, a pre-tax benefit of$2.7 million, or $0.05 per share, for a royalty adjustment relating to amountsaccrued in 2002, and a $1.0 million benefit, or $0.03 per share, related to areduction in our tax accruals following the completion of a Canadian tax audit.

 

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

 

10

----

 

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

 

**FiscalYear-End**

 

Our fiscal year ends on the last Friday of thecalendar year.  To simplify ournarrative discussion, we refer to the fiscal years ended December 26, 2003,December 27, 2002, and December 28, 2001, as 2003, 2002, and 2001,respectively.

 

## **Introductionand Overview**

##  

## While fiscal 2003 wasanother financially challenging year overall, we ended the year with our bestquarter in terms of revenues and earnings since the first quarter of 2001,posting strong seasonal fourth quarter revenues of $61.9 million and earningsof $0.16 per share before adjusting for certain significant items as discussedin “Results of Operations” below.  Inaddition, revenues in 2003 were $197.7 million, an increase of 6.6% over 2002,marking the first year of annual revenue growth since fiscal year 2000.  While we are encouraged by these results, itis not yet clear whether these results represent the beginning of a positive trendor were simply an unusually strong seasonal increase in demand.

##  

## Over the past threeyears, the conditions in the markets we serve have changed significantly, and areturn to moderate revenue growth may not ensure a return to acceptable levelsof profitability.  The majority of ourrevenues have historically been, and continue to be, driven by a relativelysmall number of technology-focused customers in the personal computer hardwareand software industries such as Microsoft and Dell.  The latter part of the year 2000 marked the start of an abruptdownturn in technology spending by the companies and consumers served by ourcustomers, and our business was affected accordingly.  Demand for our services decreased, capacity in our industrybecame under utilized, competition grew more fierce and prices declinedsignificantly.  These factors have beenthe primary determinants of our financial results over this time period inwhich we have generally experienced declining revenues, gross margins andprofitability.

##  

## The effects of thesemarket changes have not only had an impact on our financial performance, buthave defined our challenges and opportunities going forward.  In general, media production capacity in ourindustry continues to be under utilized, particularly during seasonally slowperiods.  Until this capacity eitherbecomes more consistently fully utilized through an increase or diversificationin demand, or is in some way removed from the market, the ability of Zomax orother companies in our industry to maintain or regain pricing power andacceptable levels of profitability, will be limited.  We are privileged to have long-standing relationships with largecustomers who are market leaders in their industries, but these customersdemand continuous improvements in service, quality and price from theirvendors, and our ability to retain these customers is dependent on our abilityto consistently deliver on these demands better and more efficiently than ourcompetitors.  Because a large portion ofour business is dependent on a relatively few number of these customers, ourability to retain and grow our business with these customers in the face ofintense competition is critical to our financial performance into theforeseeable future.

##  

## While we recognize thedifficult challenges to growing our business and returning it to acceptablelevels of profitability, we believe we are well-positioned to address suchchallenges.  Our core market –supply-chain outsourcing services – continues to show promising growth asindustry leading companies continue to focus on their core competencies andoutsource their non-critical business functions.  The challenges mentioned above associated with our customer andindustry dependencies also provide us opportunities.  We believe our relationships with these customers are strong andthat our knowledge of their businesses, our broad range of service capabilitiesand our financially strong balance sheet are important decision factors forthese customers.  We also believe thatour efforts over the past two years in broadening our customer base in bothtraditional and new markets should provide opportunities for growth.  While we believe we have many of theingredients necessary to return growth and profitability to our business, doingso will require that we continue to increase our investments in the people,processes and technologies that are critical to delivering services to ourcustomers and positioning our business for growth, and that we continue toaddress and manage the many risks and uncertainties we face in ourbusiness.  A more detailed discussion ofthese risks and uncertainties can be found in the section captioned “RiskFactors” at Item 1 of the Form 10-K.

 

11

----

 

**Resultsof Operations**

 

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

 
|                                                     |   | **2003** |   | **2002** |   | **2001** |   |
|----------------------------------------------------------|--------|----------|--------|----------|--------|----------|--------|
| **Percent  of Revenue:**                                 |   |     |   |     |   |     |   |
| Revenue                                                  |   | 100.0    | %      | 100.0    | %      | 100.0    | %      |
| Gross profit                                             |   | 18.9     |   | 17.7     |   | 23.1     |   |
| Selling, general  and administrative (SG&A) expenses |   | 20.8     |   | 19.0     |   | 14.7     |   |
| Operating income  (loss)                                 |   | (1.9     | )      | (1.3     | )      | 7.9      |   |
| Income tax  expense (benefit)                            |   | (1.5     | )      | (0.3     | )      | 2.4      |   |
| Net earnings  (loss)                                     |   | (0.3     | )      | (0.4     | )      | 4.2      |   |
| **Other  Operating Statistics:**                         |   |     |   |     |   |     |   |
| CD/DVD media  units sold -% change                       |   | 4.1      | %      | 2.6      | %      | (15.4    | )%     |
| Revenue -%  change                                       |   | 6.6      |   | (14.4    | )      | (9.3     | )      |
| SG&A  expenses -% change                             |   | 16.8     |   | 10.3     |   | (4.7     | )      |
| Effective tax  rate                                      |   | 84.2     |   | 45.8     |   | 36.6     |   |

 

Our financial results asreported in our Consolidated Statement of Operations were prepared inaccordance with Generally Accepted Accounting Principles (GAAP) and are thebasis for the information presented in the table above.  In 2003, these results include certainsignificant items which we believe are not indicative of our continuing resultsof operations.  For purposes of ourinternal understanding of business operations, as well as for planning andforecasting future periods, we exclude from our GAAP results those items thatmeet the definition of non-recurring, as defined by the Securities and ExchangeCommission.  Accordingly, to aid in theunderstanding of our financial results, our discussion and analysis of resultsof operations is presented on both a GAAP basis (“as reported”), and on thebasis of the exclusion of these non-recurring items (“as adjusted”).  However, the presentation of as adjustedresults is not meant to be a substitute for financial results prepared inaccordance with GAAP.

 

The following Table Apresents a reconciliation of our results of operations as reported, to ourresults of operations adjusted for those significant non-recurring items whichwe believe are not representative of our continuing operations:

 

**Table A – Reconciliation of AsReported Results to As Adjusted Results**

 
|                         |   | **Gross****Profit** |   | **SG&A  Expenses** |   | **Earnings  (Loss)  Before  Income  Taxes** |   | **Income  Tax  Expense  (Benefit)** |   | **Net  Earnings  (Loss)** |   | **Diluted  Earnings  (Loss) Per  Share(4)** |   |
|------------------------------|--------|---------------------|--------|------------------------|--------|---------------------------------------------|--------|-------------------------------------|--------|---------------------------|--------|---------------------------------------------|--------|
| **2003:**                    |   |                |   |                   |   |                                        |   |                                |   |                      |   |                                        |   |
| As reported                  |   | $                   | 37,407 |                   | $      | 41,172                                      |   | $                                   | (3,508 | )                         | $      | (2,953                                      | )      | $ | (555 | ) | $ | (0.02 | ) |
| Royalty adjustment(1)        |   | (2,660              | )      | —                 |   | (2,660                                      | )      | (1,064                              | )      | (1,596                    | )      | (0.05                                       | )      |
| Customer claim settlement(2) |   | —              |   | (3,000                 | )      | 3,000                                       |   | 1,200                               |   | 1,800                     |   | 0.06                                        |   |
| Severance costs(3)           |   | —              |   | (2,000                 | )      | 2,000                                       |   | 800                                 |   | 1,200                     |   | 0.04                                        |   |
| As adjusted                  |   | $                   | 34,747 |                   | $      | 36,172                                      |   | $                                   | (1,168 | )                         | $      | (2,017                                      | )      | $ | 849 |   | $ | 0.03 |   |
| Percent of revenue           |   | 17.6                | %      | 18.3                   | %      | (0.6                                        | )%     | (1.0                                | )%     | 0.4                       | %      |                                        |   |
| **2002:**                    |   |                |   |                   |   |                                        |   |                                |   |                      |   |                                        |   |
| As reported                  |   | $                   | 32,812 |                   | $      | 35,264                                      |   | $                                   | (1,252 | )                         | $      | (573                                        | )      | $ | (679 | ) | $ | (0.02 | ) |
| Royalty adjustment(1)        |   | 2,660               |   | —                 |   | 2,660                                       |   | 1,064                               |   | 1,596                     |   | 0.05                                        |   |
| As adjusted                  |   | $                   | 35,472 |                   | $      | 35,264                                      |   | $                                   | 1,408  |                      | $      | 491                                         |   | $ | 917 |   | $ | 0.03 |   |
| Percent of revenue           |   | 19.1                | %      | 19.0                   | %      | 0.8                                         | %      | 0.3                                 | %      | 0.5                       | %      |                                        |   |

 

12

----

 

----

**Notes to Table A:**

(1)In the fourth quarter of 2003, we signed a revised royalty agreement whichresulted in a retroactive reduction in unpaid royalties accrued in 2002 and2003 (See “Application of Critical Accounting Policies” in this Item 7below).  This adjustment represents theportion of this retroactive reduction that related to royalties accrued andcharged to cost of revenue in 2002.  Thetax effect of this adjustment was determined using a 40% marginal rate.

 

(2)Adjustment represents a payment made in the settlement of a customer claim thatalleged unauthorized reproduction of this customer’s software (See “Item 3.Legal Proceedings” of this Form 10-K). The tax effect of this adjustment was determined using a 40% marginalrate.

 

(3)Adjustment represents payments accrued in 2003 in accordance with the terms of aseparation agreement with our former CEO who resigned in December 2003,effective in January 2004.  The taxeffect of this adjustment was determined using a 40% marginal rate.

 

(4)Both as reported and as adjusted results in 2003 include an income tax benefitof $1.0 million, or $0.03 per share, related to a reduction in our tax accrualsfollowing the completion of a Canadian tax audit in 2003 (See “Application ofCritical Accounting Policies” in this Item 7 below).  This item is not reflected as an adjustment in the table as itdoes not meet the definition of a non-recurring item as defined by theSecurities and Exchange Commission.

 

**Revenue**

 

*General Factors AffectingRevenue. *We derive our revenues from a wide variety ofsupply chain services provided to our customers.  Changes in our revenues from period to period are directlyrelated to changes in the number of CD and DVD media units that we replicatefor our customers, changes in pricing, changes in the composition of theproducts and services we provide, and changes in the mix of customers weserve.  Revenues are generally morefavorably impacted when our mix of customers is weighted toward those who areusing a broad range of our services. Bundled pricing, changes in the content of the products we make for ourcustomers and other factors make it difficult to precisely determine the impacteach of these factors has on changes in our total revenue.

 

*2003 vs. 2002.*  Forthe first time since fiscal year 2000, our revenue increased on an annualbasis, growing 6.6%, from $185.5 million in 2002, to $197.7 million in2003.  In 2003, we experienced a 4.1%increase in media unit volume, accounting for the majority of our 6.6% increasein revenue.  This volume increase wasdriven mostly by increases in demand from our current customer base, but alsoby demand from new customers.  Thebalance of the revenue increase was a result of a favorable change in ourcustomer mix, partially offset by continued pricing pressures.

 

The increase in demand in2003 was relatively broad across our major customer base.  Microsoft, our largest customer, representedapproximately 22% of our revenue in 2003, up from approximately 20% in2002.  While our sales to Microsoftincreased in 2003, the programs we support for Microsoft continue to evolve andwe anticipate that related support requirements and revenues associated withthese programs will continue to decline going forward.  However, we believe we maintain a positiverelationship with Microsoft and continue to pursue opportunities to provideadditional services to this key customer. In addition to Microsoft, sales to Dell Computer exceeded 10% of ourtotal revenue in 2003, representing a significant increase over 2002.

 

The improvement in customermix in 2003 was primarily related to a reduction in sales to a customer whichpurchased large volumes of lower priced, bulk CDs from us in 2002.  Bulk CDs represent CDs that we replicate andsell without providing additional services such as packaging orfulfillment.  The price declines were aresult of the general industry conditions discussed in the “Introduction andOverview” above.

 

*2002 vs. 2001.* Total revenues in 2002 declined 14.4% despite an increase ofapproximately 2.6% in the number of media units sold.  The volume increase was more than offset by changes in ourcustomer mix and pricing declines.  In2002, our customer mix was unfavorably impacted by an increase in the number oflower priced, bulk CDs sold to one major customer, and a significant decreasein our sales to Microsoft, our largest customer.  Sales to Microsoft, which consist of replication, fulfillment andcall center services in support of certain Microsoft programs, decreased from35% of revenue in 2001, to 20% in 2002. This decrease was attributable to the composition and pricing of theMicrosoft programs we support, resulting in a decrease in the cost to Microsoftof providing those services.

 

**Gross Profit**

 

*General Factors Affecting GrossProfit.*  Our gross profit percentage during aperiod is dependent on a number of factors. The pricing declines discussed under “Revenue” above have been theprimary contributor to the gross profit 

 

13

----

 

erosion we experienced from 2001 to 2003.  In addition to changes in pricing, the volume of business weexperience in a given period also impacts our margins.  A large portion of the costs required todeliver our products and services are fixed in nature.  Increases in volume allow us to leveragethese costs resulting in higher gross profit margins, while decreases in volumehave the opposite effect.  Our relativemix of customers, as well as the related content of products or services weprovide them, can also have a significant impact on gross profit margins.  For example, the relative mix of CD/DVDmedia, labor and print material in the products we produce for our customerscan affect our overall gross profit percentage.  Although gross profit measured as a percentage of revenue may belower, we believe providing incremental value-added services to our customershas an overall positive effect on gross margin as measured in dollars.  Additionally, our ability to utilizeautomated packaging equipment versus manual labor can have a favorable effecton gross profit.

 

*2003 vs. 2002.*  On an as reported basis, our gross profit percentage improvedfrom 17.7% in 2002, to 18.9% in 2003. This increase reflects a $4.8 million benefit related to the signing ofa revised royalty agreement as discussed in footnote (1) to Table A above.  However,had the reduced royalty rates been in effect since 2002, as reflected in TableA above, our gross profitpercentage would have declined from 19.1% in 2002 to 17.6% in 2003.  This decrease is primarily attributable tothe effect of declining unit prices, partially offset by an increase in unitvolumes as discussed under “Revenue” above, particularly in the fourthquarter.  This increase in unit volumeresulted in improved leverage of our fixed costs and had a favorable effect ofapproximately 0.5% on our gross profit margin percentage.

 

*2002 vs. 2001.*  Onan as reported basis, our gross profit percentage decreased 5.4%, from 23.1% in2001, to 17.7% in 2002.  However, hadthe reduced royalty rates been in effect since 2002, as reflected in Table Aabove, our gross profit percentage would have decreased only 4.0%, from 23.1%in 2001 to 19.1% in 2002.  Thisdecrease reflected continued unit price deterioration of CD and DVD media, adecline in total revenue relative to our fixed costs and the shift in ourproduct mix to products that contain a higher content of lower margin packagingmaterials.  While unit volumes increased 2% from 2001 to 2002,this increase provided only minimal fixed cost leverage as the volume increasewas attributable to sales of low-priced, bulk CDs to a single customer.

 

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

 

*General Factors Affecting SG&AExpenses.*  A substantial portion of our SG&Aexpenses are fixed in nature.  However,certain components such as incentive compensation, professional services,travel and other expenses can vary based on business results, individualevents, or initiatives we may be pursuing at various times throughout theyear.  In addition to these factors,some of our SG&A expenses are incurred in countries outside the U.S. andchanges in foreign currency rates can cause our SG&A expenses reported inU.S. dollars to fluctuate.

 

*2003 vs. 2002.*  On an as reported basis, our SG&A expenses increased $5.9million, or 16.8%.  On an as adjustedbasis, which excludes the effect of a charge related to the settlement of acustomer claim and a severance charge related to the resignation of our CEO asdescribed in Table A above, SG&A expenses increased $0.9 million, or2.6%.  SG&A expenses in 2002included approximately $2.2 million of costs associated with potentialacquisition opportunities pursued earlier in that year, and a $1.3 millionwrite-down of customer contact center software systems as a result of thereplacement of those systems beginning late in 2002.  Excluding these expenses from 2002, SG&A expenses increased$4.4 million, or 13.8% from 2002 to 2003. A significant portion of this increase is related to investments westarted making in the latter part of 2002, in capabilities aimed at increasingthe number of customers and markets we serve, the suite of services we offer,including electronic software downloading, our capabilities to support new andexisting markets and services, and new locations in the U.S. and Mexico.  In addition to the effects of these investmentson our SG&A expenses, approximately $0.7 million of the increase isattributable to the translation effect of currency exchange rate changes onexpenses incurred in our Ireland and Canadian operations.  Increases in employee medical and general businessinsurance costs and incentive compensation also contributed to the increase inSG&A expense in 2003.

 

*2002 vs. 2001.*  On an as reported basis, SG&A expenses increased 10.3% to$35.3 million in 2002 from $32.0 million in 2001.  The increase is the result of approximately $2.2 million in legaland other costs associated with potential acquisition opportunities pursued inthe first half of 2002 and a $1.3 million write-down of the Company’s existingcall center software systems as a result of the replacement of those systemsthat began in the fourth quarter of 2002.

 

**Income Taxes**

 

*2003vs. 2002*.  On an as reported basis, our income taxbenefit in 2003 represents 84.2% of our pretax loss, compared to 45.8% of ourpretax loss in 2002.  Our income taxbenefit in 2003 includes a $1.0 million benefit related to a reduction in ourtax accruals following the completion of a Canadian tax audit (see “IncomeTaxes” under Application of Critical Accounting Policies below).  Excluding this benefit, our 2003 effectivetax rate would have been 55.4%, reflecting the favorable tax position of havingcurrent year operating profits in our Ireland operations, which are subject torelatively low tax rates, and current year operating losses in our U.S.operations, which are subject to relatively higher tax rates.  Had 

 

14

----

 

our consolidated operating losses been spread evenly across all taxjurisdictions in which we operate, our 2003 effective tax rate, excluding the$1.0 million benefit previously discussed, would have been more comparable to2002.

 

*2002vs. 2001*.  On an as reported basis, the effectiveincome tax rate for 2002 was 45.8% compared to 36.6% in 2001.  Due to the decline in earnings before incometaxes, income and deductions that are permanently treated differently for bookand tax purposes had a larger relative effect in 2002 than in 2001 whenmeasured as a percentage of the lower 2002 pretax results.

 

**Applicationof Critical Accounting Policies**

 

*Revenue Recognition* We record revenue atthe time product is shipped or as services are rendered.  For certain customers, product is invoicedupon completion, with shipment occurring based on written customerinstructions.  In these cases, thecustomer accepts title to the goods as of the date of the invoice and salesrevenue is recognized at that time.  Ineach case of these “bill and hold” sales, we ensure that the transactioncomplies with the conditions and considerations contained in Accounting andAuditing Enforcement Release No. 108 of the Securities and Exchange Commission.

 

*Royalties.*  We have license agreements with severalcompanies for the use of certain CD and DVD manufacturing technology we use inour business.  We do not necessarilyhave agreements with every patent holder that may assert or has asserted aclaim to royalties.  The cost of theseroyalties is accrued based on units sold and charged to cost of revenue.  Our royalty costs are based upon the termsof our royalty agreements as well as our assessment of the applicability of anyother known or potential royalties.  Inthe fourth quarter of 2003, we completed negotiations with one of the majorpatent holders resulting in the signing of a revised royalty agreement thatretroactively reduced the royalties payable to this patent holder.  These negotiations, which had beenpreviously disclosed in our 2002 Form 10-K, began in 2002.  While we were hopeful from the start of ournegotiations that we would achieve a retroactive application of the reducedroyalty rates, this was not guaranteed and, in our judgment, it was notappropriate to recognize the benefit of the potentially reduced rates until thecompletion of a final agreement.  Uponsigning the new agreement in the fourth quarter of 2003, we recorded a benefitto cost of revenue totaling $4.8 million related to these reduced rates as wellas smaller adjustments to the rates at which we accrue other known or potentialroyalties.  This total benefit reflecteda reduction of unpaid royalties of $2.1 million accrued in the first threequarters of 2003 and $2.7 million accrued in 2002.

 

*IncomeTaxes*.  We file aconsolidated federal income tax return and separate state and foreignreturns.  Deferred income taxes areprovided for differences between the tax basis of assets and liabilities andtheir carrying amounts for financial reporting purposes, based on the expectedincome tax rates for the year in which these temporary differences are expectedto reverse. Foreign net operating loss carryforwards may be carried forwardindefinitely.

 

The preparation of our income tax returns requires theinterpretation of the associated tax laws. Many tax laws are complex, and at times ambiguous, and ourinterpretations of these laws may differ from the interpretations of the taxingauthorities who have the right to audit our returns within statutory timeperiods.  Where we believe there is aquantifiable risk that our interpretations of these laws could reasonablydiffer from those of the taxing authorities, we make appropriate provisions inour tax liabilities.  In 2003, Canadiantax authorities completed an audit of our Canadian tax returns for the years1999, 2000 and 2001.  Accordingly, weremoved $1.0 million of provisions we had made in our tax liabilities relatedto the risk that tax authorities would reject certain positions we had taken inthe preparation of these returns.

 

*Accounts Receivable.*  We review our accounts receivable balanceson a regular basis to determine their collectability.  An allowance for doubtful accounts is recorded based onmanagement’s estimate of those accounts which may become uncollectible.

 

*Inventory.*  We review our inventory on a regular basis with the objective ofassessing its net realizable value.  Weadjust the carrying value of inventory according to our estimates of the netrealizable value of individual inventory components relative to their purchaseor carrying value.

 

**RecentlyIssued Accounting Pronouncements**

 

In January 2003, the FASB issued FinancialInterpretation No. 46, “Consolidation of Variable Interest Entities” revisedDecember 2003 (“FIN 46(R)”).  FIN 46(R)requires that companies consolidate a variable interest entity if it is subjectto a majority of the risk of loss from the variable interest entity’sactivities, or is entitled to receive a majority of the entities residualreturns, or both.  The provisions of FIN46(R) currently are required to be applied no later than the first reportingperiod ending after March 15, 2004 for variable interest entities acquired onor before January 31, 2003.  Forvariable interest entities acquired after January 31, 2003, Companies maycontinue to apply the provisions of FIN 46 or apply FIN 46(R) beginningDecember 31, 2003.  Companies that holda variable interest in a special purpose entity, as 

 

15

----

 

defined, are required to apply either FIN 46 or FIN 46(R) no later thanthe end of the first reporting period that ends after December 15, 2003.  The adoption of FIN 46(R) is not expected tohave an impact on our financial position or results of operations.

 

In April 2003, the FASB issued Statement on FinancialAccounting Standards No. 149, “Amendment of Statement 133 on DerivativeInstruments and Hedging Activities,” which amends and clarifies financialaccounting and reporting for derivative instruments, including certainderivative instruments embedded in other contracts and for hedging activitiesunder FAS 133.  FAS 149 is effective forcontracts entered into or modified after June 30, 2003 except for theprovisions that were cleared by the FASB in prior pronouncements.  The adoption of FAS 149 did not have amaterial impact on our consolidated balance sheet or results of operations.

 

In May 2003, the FASB issued Statement on FinancialAccounting Standards No. 150, “Accounting for Certain Financial Instrumentswith Characteristics of both Liabilities and Equity”.  This statement establishes standards for how an issuer classifiesand measures in its statement of financial position certain financial instrumentswith characteristics of both liabilities and equity.  In accordance with the standard, financial instruments thatembody obligations for the issuer are required to be classified as liabilities.  FAS No. 150 is effective for financialinstruments entered into or modified after May 31, 2003, and was otherwiseeffective for us during the second quarter of 2003.  The adoption of FAS 150 did not have a material impact on ourconsolidated balance sheet or results of operations.

 

In December 2003, the FASB issued SFAS No. 132(R), arevision to SFAS No. 132, “Employers’ Disclosure about Pensions and OtherPostretirement Benefits.  SFAS No.132(R) requires additional disclosures about the assets, obligations, cash flowsand net periodic benefit cost of defined benefit pension plans and otherdefined benefit postretirement plans. SFAS No. 132(R) is effective for financial statements with fiscal yearsending after December 15, 2003, with the exception of disclosure requirementsrelated to foreign plans and estimated future benefit payments which areeffective for fiscal years ending after June 15, 2004.  The adoption of SFAS No. 132(R) did notimpact our financial position or results of operations.

 

**Liquidityand Capital Resources**

 

*Cash and Cash Equivalents.*  Atthe end of 2003, cash and cash equivalents totaled $68.9 million, a decrease of$3.2 million from 2002.  Despite our netloss in 2003, we generated $5.3 million of cash from operations.  This represents a decrease of $3.6 millionfrom the $8.9 million generated in 2002. This decrease is primarily due to increases in working capitalrequirements in the fourth quarter of 2003 resulting from the strong increasein revenues during that quarter.

 

Cash used in investing activities in 2003 was $5.7million, net of the return of a $3.9 million escrow deposit related to theiLogistix acquisition that was subsequently terminated.  (See Item 3 of this Form 10-K.)  Capital expenditures in 2003 totaled $9.6million, an increase of $6.6 million from 2002, and consisted primarily ofupgrades to our customer contact center systems and an increase in DVDreplication capacity.

 

Net cash used in financing activities in 2003 was $5.5million, an increase from the $2.2 million of cash used by these activities in2002.  In the fourth quarter of 2002,our Board of Directors approved a Stock Buy-back Program to expend up to $10.0million to repurchase Zomax’ common stock in the open market.  We repurchased 761,900 shares in 2003 for atotal cost of $2.6 million, bringing our total repurchases under this programto 880,200 shares for a total cost of $3.1 million.  The timing and extent of future repurchases will vary based onmarket conditions as well as regulatory limitations imposed on suchprograms.  In 2003, we also retired allof our long-term debt obligations for a total of $3.8 million.

 

Changes in foreign currency exchange rates had a $2.7million positive impact on reported cash balances in 2003 due to the increaseduring the year in the value of the Euro and Canadian dollar, the functionalcurrencies of our Ireland and Canadian operations, relative to the U.S. dollar.

 

*WorkingCapital and Liquidity*. Working capital totaled $88.6 million and $90.0 million at the end of2003 and 2002, respectively.  Ourprimary source of working capital continues to be cash and cash equivalentbalances as described above.  Inaddition to our working capital balances, we also have available-for-salesecurities which had a value at the end of 2003 of $11.6 million, up from $7.0million at the end of 2002, representing our investment in Intraware (see Note3 to the consolidated financial statements). As of the end of 2003, these securities were fully registered.

 

At the end of 2003, we had no outstanding debt.  At the end of 2002 and 2001, our totaloutstanding debt was $3.7 million and $6.7 million, respectively.  In 2003 we cancelled our revolving line ofcredit facility which had available

 

16

----

 

borrowings up to $25.0 million. There were no borrowings outstanding under this credit facility during2003, 2002 or 2001.

 

Our future liquidity needs will depend on, among otherfactors, the timing of capital expenditures, expenditures in connection withpossible acquisitions, changes in customer order volume and the timing andcollection of receivables. We believe that existing cash and investmentbalances and anticipated cash flow from operations will be sufficient to fundour operations for the foreseeable future.

 

*Contractual Obligations: *Payments due under known contractual obligations as ofthe end of 2003 are as follows (in millions):

 
|                          |   | **Less than  1 Year** |   | **2 to 3   Years** |   | **4 to 5  Years** |   | **After   5 Years** |   | **Total** |   |
|-------------------------------|--------|-----------------------|--------|--------------------|--------|-------------------|--------|---------------------|--------|-----------|--------|
| Operating lease  obligations  |   | $                     | 4.9    |               | $      | 7.6               |   | $                   | 4.3    |      | $      | 20.1 |   | $ | 36.9 |   |
| Strategic  Alliance agreement |   | 1.0                   |   | 2.8                |   | 3.6               |   | 6.3                 |   | 13.7      |   |
| Total                         |   | $                     | 5.9    |               | $      | 10.4              |   | $                   | 7.9    |      | $      | 26.4 |   | $ | 50.6 |   |

 

As described in Note 3 to the consolidated financialstatements, we have entered into a strategic alliance agreement with Intraware,a provider of electronic software download services.  This agreement has a ten year term that may be cancelled earlierat our option upon 30 days notice.  Wealso incur other contractual obligations in the ordinary course of businessrelated primarily to the purchase of goods and services such as inventory,supplies and capital equipment.  Theseobligations are generally cancelable up until the time we receive the relatedgoods or services.

 

**Market Risk**

 

*Foreign Currency.*  A portion of our operations are located inIreland and Canada.  A majority of therevenue from our Canadian operations, and a portion of the related costs, aredenominated in US dollars.  As a result,we have limited exposure to the Canadian currency.  The majority of revenues and related costs in our Irelandoperations are denominated in Euros.  Foreign currency transaction gains andlosses are reflected in our financial statements and historically have not beenmaterial to our results of operations or financial condition.  However, we anticipate we will continue toincur exchange gains and losses from foreign operations in the future which maybe significant depending on factors such as changes in foreign currencyor weak economic conditions in foreign markets.  In addition, sales of our products and services may be directly impactedby the value of the U.S. dollar relative to other currencies.

# ** **

**Inflation**

 

Historically, inflation has not had a material impacton our operations.  The cost of laborand raw material, particularly the cost of petroleum, which affects the cost ofpolycarbonate used in the manufacture of optical discs, can influence the costof our products and services.  There canbe no assurance that we will be able to pass on any increased material or laborcosts to our customers in the future.

 

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

 

See “Market Risk” under Item 7 above.

 

17

----

 

**ITEM8.  FINANCIAL STATEMENTS ANDSUPPLEMENTARY DATA**

 

**Independent Auditors’ Report**

 

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

 

We have audited theaccompanying consolidated balance sheets of Zomax Incorporated and Subsidiaries(the Company) as of December 26, 2003 and December 27, 2002, and the relatedconsolidated statements of operations, shareholders’ equity, and cash flows forthe years then ended. These financial statements are the responsibility of theCompany’s management. Our responsibility is to express an opinion on thesefinancial statements based on our audit. The financial statements of theCompany for the year ended December 28, 2001, were audited by other auditorswho have ceased operations. Those auditors expressed an unqualified opinion onthose financial statements in their report dated January 25, 2002.

 

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

 

In our opinion, the 2003 and 2002 consolidatedfinancial statements present fairly, in all material respects, the financialposition of Zomax Incorporated and Subsidiaries as of December 26, 2003 andDecember 27, 2002, and the results of their operations and their cash flows forthe years then ended, in conformity with accounting principles generallyaccepted in the United States of America.

 
| **/s/ Deloitte & Touche LLP** |   |
|-----------------------------------|--------|
| Minneapolis, Minnesota            |
| March 11, 2004                    |

 

 

*Notice:The following report is a copy of a report previously issued by Arthur AndersenLLP (“Andersen”). This report relates to prior years’ financial statements andhas not been reissued by Andersen.*

 

**Reportof Independent Public Accountants**

 

**Tothe Board of Directors and Shareholders of Zomax Incorporated:**

 

We have auditedthe accompanying consolidated balance sheets of Zomax Incorporated (a Minnesotacorporation) and

Subsidiaries as ofDecember 28, 2001 and December 29, 2000, and the related consolidatedstatements of operations, shareholders’ equity and cash flows for each of thethree years in the period ended December 28, 2001. These financial statementsare the responsibility of the Company’s management. Our responsibility is toexpress an opinion on these financial statements based on our audits.

 

We conducted ouraudits in accordance with auditing standards generally accepted in the UnitedStates. Those standards require that we plan and perform the audit to obtainreasonable assurance about whether the financial statements are free ofmaterial misstatement. An audit includes examining, on a test basis, evidencesupporting the amounts and disclosures in the financial statements. An auditalso includes assessing the accounting principles used and significantestimates made by management, as well as evaluating the overall financialstatement presentation. We believe that our audits provide a reasonable basisfor our opinion.

 

In our opinion,the consolidated financial statements referred to above present fairly, in allmaterial respects, the financial position of Zomax Incorporated andSubsidiaries as of December 28, 2001 and December 29, 2000, and the results oftheir operations and their cash flows for each of the three years in the periodended December 28, 2001, in conformity with accounting principles generallyaccepted in the United States.

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

 

18

 

**ZOMAX INCORPORATED**

**CONSOLIDATEDSTATEMENTS OF OPERATIONS**

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

 
|                                               |   | **Year Ended** |    |
|----------------------------------------------------|--------|----------------|---------|
|                                               |   | **2003**       |    | **2002** |   | **2001** |   |
|                                               |   |           |    |   |   |   |   |
| **Revenue**                                        |   | $              | 197,670 |   | $ | 185,500 |   | $ | 216,797 |   |
|                                               |   |           |    |   |   |   |   |
| Cost of revenue                                    |   | 160,263        |    | 152,688 |   | 166,688 |   |
|                                               |   |           |    |   |   |   |   |
| **Gross profit**                                   |   | 37,407         |    | 32,812 |   | 50,109 |   |
|                                               |   |           |    |   |   |   |   |
| Selling, general  and administrative expenses      |   | 41,172         |    | 35,264 |   | 31,964 |   |
|                                               |   |           |    |   |   |   |   |
| Impairment of  goodwill                            |   | —         |    | — |   | 923 |   |
|                                               |   |           |    |   |   |   |   |
| **Operating income (loss)**                        |   | (3,765         | )       | (2,452 | ) | 17,222 |   |
|                                               |   |           |    |   |   |   |   |
| **Other income (expense):**                        |   |           |    |   |   |   |   |
| Interest expense                                   |   | (145           | )       | (228 | ) | (577 | ) |
| Interest income                                    |   | 864            |    | 1,423 |   | 2,651 |   |
| Equity in losses  of unconsolidated entity         |   | —         |    | — |   | (631 | ) |
| Impairment of  investment in unconsolidated entity |   | —         |    | — |   | (4,400 | ) |
| Other, net                                         |   | (462           | )       | 5 |   | (11 | ) |
| **Income (loss) before income taxes**              |   | (3,508         | )       | (1,252 | ) | 14,254 |   |
|                                               |   |           |    |   |   |   |   |
| Income tax  expense (benefit)                      |   | (2,953         | )       | (573 | ) | 5,221 |   |
|                                               |   |           |    |   |   |   |   |
| **Net earnings (loss)**                            |   | $              | (555    | ) | $ | (679 | ) | $ | 9,033 |   |
|                                               |   |           |    |   |   |   |   |
| **Earnings (loss) per share:**                     |   |           |    |   |   |   |   |
| Basic                                              |   | $              | (0.02   | ) | $ | (0.02 | ) | $ | 0.28 |   |
| Diluted                                            |   | $              | (0.02   | ) | $ | (0.02 | ) | $ | 0.27 |   |
|                                               |   |           |    |   |   |   |   |
| **Weighted average common shares  outstanding:**   |   |           |    |   |   |   |   |
| Basic                                              |   | 32,621         |    | 33,050 |   | 32,364 |   |
| Dilutive effect  of stock options and warrants     |   | —         |    | — |   | 788 |   |
| Diluted                                            |   | 32,621         |    | 33,050 |   | 33,152 |   |

 

*See notes to consolidated financialstatements.*

 

19

----

 

**ZOMAXINCORPORATED**

## **CONSOLIDATEDBALANCE SHEETS**

## **(Inthousands)**

 
|                                                                                                                                         |   | **2003** |    | **2002** |   |
|----------------------------------------------------------------------------------------------------------------------------------------------|--------|----------|---------|----------|--------|
| **ASSETS**                                                                                                                                   |   |     |    |     |   |
| **Current assets:**                                                                                                                          |   |     |    |     |   |
| Cash and cash  equivalents                                                                                                                   |   | $        | 68,899  |     | $      | 72,146 |   |
| Accounts  receivable, net of allowance of $1,362 in 2003 and $1,937 in 2002                                                             |   | 39,403   |    | 32,785   |   |
| Inventories                                                                                                                                  |   | 12,757   |    | 9,712    |   |
| Deferred income  taxes                                                                                                                       |   | 2,685    |    | 2,555    |   |
| Other current  assets                                                                                                                        |   | 7,384    |    | 8,025    |   |
|                                                                                                                                         |   |     |    |     |   |
| Total current  assets                                                                                                                        |   | 131,128  |    | 125,223  |   |
|                                                                                                                                         |   |     |    |     |   |
| **Property and equipment, net**                                                                                                              |   | 38,859   |    | 34,947   |   |
|                                                                                                                                         |   |     |    |     |   |
| **Available-for-sale securities**                                                                                                            |   | 11,646   |    | 7,013    |   |
|                                                                                                                                         |   |     |    |     |   |
|                                                                                                                                         |   | $        | 181,633 |     | $      | 167,183 |   |
|                                                                                                                                         |   |     |    |     |   |
| **LIABILITIES AND SHAREHOLDERS’  EQUITY**                                                                                               |   |     |    |     |   |
| **Current liabilities:**                                                                                                                     |   |     |    |     |   |
| Accounts payable                                                                                                                             |   | $        | 20,524  |     | $      | 14,333 |   |
| Accrued expenses  and other current liabilities                                                                                              |   | 22,028   |    | 17,422   |   |
| Current portion  of notes payable                                                                                                            |   | —   |    | 2,989    |   |
| Income taxes  payable                                                                                                                        |   | —   |    | 519      |   |
|                                                                                                                                         |   |     |    |     |   |
| Total current liabilities                                                                                                                    |   | 42,552   |    | 35,263   |   |
|                                                                                                                                         |   |     |    |     |   |
| **Long-term notes payable,** net of current portion                                                                                          |   | —   |    | 747      |   |
|                                                                                                                                         |   |     |    |     |   |
| **Deferred income taxes**                                                                                                                    |   | 1,315    |    | 624      |   |
|                                                                                                                                         |   |     |    |     |   |
| Total  liabilities                                                                                                                           |   | 43,867   |    | 36,634   |   |
|                                                                                                                                         |   |     |    |     |   |
| **Commitments and contingencies (Note  10)**                                                                                                 |   |     |    |     |   |
|                                                                                                                                         |   |     |    |     |   |
| **Shareholders’ equity:**                                                                                                               |   |     |    |     |   |
| Common stock, no  par value, 100,000 shares authorized; 32,589 and 33,028 shares issued  and outstanding in 2003 and 2002, respectively |   | 62,469   |    | 64,071   |   |
| Retained  earnings                                                                                                                           |   | 65,892   |    | 66,447   |   |
| Accumulated  other comprehensive income                                                                                                      |   | 9,405    |    | 31       |   |
|                                                                                                                                         |   |     |    |     |   |
| Total  shareholders’ equity                                                                                                             |   | 137,766  |    | 130,549  |   |
|                                                                                                                                         |   | $        | 181,633 |     | $      | 167,183 |   |

 

*Seenotes to consolidated financial statements*.

 

20

----

 

**ZOMAXINCORPORATED**

**CONSOLIDATEDSTATEMENTS OF SHAREHOLDERS’ EQUITY**

**(Inthousands)**

 
|                                                                  |   |       |   | **Retained  earnings** |   | **Accumulated  other  comprehensive  income (loss)** |   | **Total  shareholders’**

**equity** |   |
|-----------------------------------------------------------------------|--------|------------|--------|------------------------|--------|------------------------------------------------------|--------|-------------------------------------------|--------|
|                                                                  |   |
| **Common stock**                                                      |   |
| **Shares**                                                            |   | **Amount** |   |
| **Balance, December 29, 2000**                                   |   | 31,737     |   | $                      | 58,456 |                                                 | $      | 58,093                                    |   | $ | (4,454 | ) | $ | 112,095 |   |
|                                                                  |   |       |   |                   |   |                                                 |   |                                      |   |   |   |
| Net earnings                                                          |   | —     |   | —                 |   | 9,033                                                |   | —                                    |   | 9,033 |   |
| Translation  adjustments                                              |   | —     |   | —                 |   | —                                               |   | (1,462                                    | )      | (1,462 | ) |
| Common stock  issued under employee stock purchase plan          |   | 339        |   | 1,311                  |   | —                                               |   | —                                    |   | 1,311 |   |
| Common stock  issued upon exercise of stock options and warrants      |   | 757        |   | 2,756                  |   | —                                               |   | —                                    |   | 2,756 |   |
| Tax benefit  realized from exercise of stock options             |   | —     |   | 430                    |   | —                                               |   | —                                    |   | 430 |   |
| Stock  compensation expense                                           |   | —     |   | 261                    |   | —                                               |   | —                                    |   | 261 |   |
|                                                                  |   |       |   |                   |   |                                                 |   |                                      |   |   |   |
| **Balance, December 28, 2001**                                   |   | 32,833     |   | 63,214                 |   | 67,126                                               |   | (5,916                                    | )      | 124,424 |   |
|                                                                  |   |       |   |                   |   |                                                 |   |                                      |   |   |   |
| Net loss                                                              |   | —     |   | —                 |   | (679                                                 | )      | —                                    |   | (679 | ) |
| Unrealized  holding gain on available-for-sale securities, net of tax |   | —     |   | —                 |   | —                                               |   | 1,275                                     |   | 1,275 |   |
| Translation  adjustments                                              |   | —     |   | —                 |   | —                                               |   | 4,672                                     |   | 4,672 |   |
| Common stock  issued under employee stock purchase plan               |   | 188        |   | 873                    |   | —                                               |   | —                                    |   | 873 |   |
| Common stock  issued uponexercise of stock options                    |   | 125        |   | 322                    |   | —                                               |   | —                                    |   | 322 |   |
| Tax benefit  realized from exercise of stock options             |   | —     |   | 158                    |   | —                                               |   | —                                    |   | 158 |   |
| Common stock  repurchases                                             |   | (118       | )      | (464                   | )      | —                                               |   | —                                    |   | (464 | ) |
| Stock  compensation expense                                           |   | —     |   | (32                    | )      | —                                               |   | —                                    |   | (32 | ) |
|                                                                  |   |       |   |                   |   |                                                 |   |                                      |   |   |   |
| **Balance, December 27, 2002**                                   |   | 33,028     |   | 64,071                 |   | 66,447                                               |   | 31                                        |   | 130,549 |   |
|                                                                  |   |       |   |                   |   |                                                 |   |                                      |   |   |   |
| Net loss                                                              |   | —     |   | —                 |   | (555                                                 | )      | —                                    |   | (555 | ) |
| Unrealized  holding gain on available-for-sale securities, net of tax |   | —     |   | —                 |   | —                                               |   | 2,819                                     |   | 2,819 |   |
| Translation  adjustments                                              |   | —     |   | —                 |   | —                                               |   | 6,555                                     |   | 6,555 |   |
| Common stock  issued under employee stock purchase plan               |   | 184        |   | 533                    |   | —                                               |   | —                                    |   | 533 |   |
| Common stock  issued upon exercise of stock options                   |   | 139        |   | 348                    |   | —                                               |   | —                                    |   | 348 |   |
| Tax benefit  realized from exercise of stock options             |   | —     |   | 104                    |   | —                                               |   | —                                    |   | 104 |   |
| Common stock  repurchases                                             |   | (762       | )      | (2,587                 | )      | —                                               |   | —                                    |   | (2,587 | ) |
|                                                                  |   |       |   |                   |   |                                                 |   |                                      |   |   |   |
| **Balance, December 26, 2003**                                   |   | 32,589     |   | $                      | 62,469 |                                                 | $      | 65,892                                    |   | $ | 9,405 |   | $ | 137,766 |   |

 

*Seenotes to consolidated financial statements.*

 

21

----

 

# **ZOMAX INCORPORATED**

# **CONSOLIDATED STATEMENTS OF CASHFLOWS**

# **(In thousands)**

##  

|                                                                                              |   | **Year Ended** |   |
|---------------------------------------------------------------------------------------------------|--------|----------------|--------|
|                                                                                              |   | **2003**       |   | **2002** |   | **2001** |   |
| **Operating activities:**                                                                         |   |           |   |   |   |   |   |
| Net earnings  (loss)                                                                              |   | $              | (555   | ) | $ | (679 | ) | $ | 9,033 |   |
| Adjustments to  reconcile net earnings (loss) to net cash provided by  operating activities: |   |           |   |   |   |   |   |
| Depreciation and  amortization                                                                    |   | 8,391          |   | 8,349 |   | 10,443 |   |
| Stock  compensation expense (benefit)                                                             |   | —         |   | (32 | ) | 261 |   |
| Loss on disposal  or writedown of property and equipment                                          |   | 347            |   | 1,352 |   | — |   |
| Writedown of  goodwill                                                                            |   | —         |   | — |   | 923 |   |
| Equity in losses  of unconsolidated entity                                                        |   | —         |   | — |   | 631 |   |
| Impairment of  investment in unconsolidated entity                                                |   | —         |   | — |   | 4,400 |   |
| Deferred income taxes                                                                             |   | 1,409          |   | (473 | ) | (2,352 | ) |
| Unrealized  foreign currency losses (gains)                                                       |   | (32            | )      | — |   | 11 |   |
| Changes in  operating assets and liabilities:                                                     |   |           |   |   |   |   |   |
| Accounts  receivable                                                                              |   | (4,840         | )      | (1,423 | ) | 1,265 |   |
| Inventories                                                                                       |   | (2,568         | )      | 1,651 |   | 2,739 |   |
| Other current  assets                                                                             |   | 1,368          |   | (96 | ) | (290 | ) |
| Accounts payable                                                                                  |   | 5,328          |   | 869 |   | (8,642 | ) |
| Accrued expenses  and other current liabilities                                                   |   | 2,007          |   | 3,120 |   | (2,261 | ) |
| Income taxes                                                                                      |   | (5,595         | )      | (3,758 | ) | 905 |   |
| Net cash  provided by operating activities                                                   |   | 5,260          |   | 8,880 |   | 17,066 |   |
|                                                                                              |   |           |   |   |   |   |   |
| **Investing activities:**                                                                         |   |           |   |   |   |   |   |
| Purchases of  property and equipment                                                              |   | (9,589         | )      | (2,950 | ) | (4,934 | ) |
| Investment in  Intraware                                                                          |   | —         |   | (5,019 | ) | — |   |
| Escrow deposit  on terminated acquisition                                                         |   | 3,902          |   | (3,902 | ) | — |   |
| Change in other  assets                                                                           |   | —         |   | — |   | (15 | ) |
| Net cash used in  investing activities                                                            |   | (5,687         | )      | (11,871 | ) | (4,949 | ) |
|                                                                                              |   |           |   |   |   |   |   |
| **Financing activities:**                                                                         |   |           |   |   |   |   |   |
| Repayment of  notes payable                                                                       |   | (3,781         | )      | (2,973 | ) | (3,778 | ) |
| Repurchase of  common stock                                                                       |   | (2,587         | )      | (464 | ) | — |   |
| Issuance of  common stock, net                                                                    |   | 881            |   | 1,195 |   | 4,067 |   |
| Net cash  provided by (used in) financing activities                                         |   | (5,487         | )      | (2,242 | ) | 289 |   |
|                                                                                              |   |           |   |   |   |   |   |
| **Effect of exchange rate changes on  cash and cash equivalents**                                 |   | 2,667          |   | 2,380 |   | (984 | ) |
|                                                                                              |   |           |   |   |   |   |   |
| Net increase  (decrease) in cash and cash equivalents                                             |   | (3,247         | )      | (2,853 | ) | 11,422 |   |
|                                                                                              |   |           |   |   |   |   |   |
| Cash and cash  equivalents, beginning of year                                                     |   | 72,146         |   | 74,999 |   | 63,577 |   |
| **Cash and cash equivalents, end of  year**                                                       |   | $              | 68,899 |   | $ | 72,146 |   | $ | 74,999 |   |

 

*Seenotes to consolidated financial statements.*

 

22

----

 

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS**

 

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

 

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

 

*Fiscal Year-End*.** **Our fiscal year ends on the last Friday of thecalendar year. The fiscal years ended December 26, 2003, December 27, 2002, andDecember 28, 2001 are referred to as 2003, 2002, and 2001, respectively,in the consolidated financial statements and notes thereto.

 

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

 

*RevenueRecognition*.  Werecord revenue at the time product is shipped or as services are rendered.  For certain customers, product is invoicedupon completion, with shipment occurring based on written customerinstructions.  In these cases, thecustomer accepts title to the goods as of the date of the invoice and revenueis recognized.  In each case of these“bill and hold” sales, we ensure that the transaction complies with theconditions and considerations contained in Staff Accounting Bulletin No. 101and Accounting and Auditing Enforcement Release No. 108 of the Securities andExchange Commission.

 

In 2003, 2002 and 2001, one customer accounted for22%, 20% and 35%, respectively, of our consolidated revenue, and in 2003, a secondcustomer accounted for 10% of our consolidated revenue.

 

*Cost ofRevenue*.  We includedirect labor, direct materials, royalties and production overhead, whichincludes shipping costs, in cost of revenue on the consolidated statements ofoperations.

 

*Royalties.*  We have license agreements with severalcompanies for the use of certain CD and DVD manufacturing technology we use inour business.  We do not necessarilyhave agreements with every patent holder that may assert or has asserted aclaim to royalties.  The cost of theseroyalties is accrued based on units sold and charged to cost of revenue.  Our royalty costs are based upon the termsof our royalty agreements as well as our assessment of the applicability of anyother known or potential royalties.  Inthe fourth quarter of 2003, we completed negotiations with one of the majorpatent holders resulting in the signing of a revised royalty agreement thatretroactively reduced the royalties payable to this patent holder.  These negotiations, which had beenpreviously disclosed in our 2002 Form 10-K, began in 2002.  While we were hopeful from the start of ournegotiations that we would achieve a retroactive application of the reducedroyalty rates, this was not guaranteed and, in our judgment, it was not appropriateto recognize the benefit of the potentially reduced rates until the completionof a final agreement.  Upon signing thenew agreement in the fourth quarter of 2003, we recorded a benefit to cost ofrevenue totaling $4.8 million related to these reduced rates as well as smalleradjustments to the rates at which we accrue other known or potentialroyalties.  This total benefit reflecteda reduction of unpaid royalties of $2.1 million accrued in the first threequarters of 2003 and $2.7 million accrued in 2002.

 

*IncomeTaxes*.  We file aconsolidated federal income tax return and separate state and foreign returns.Deferred income taxes are provided for differences between the tax basis ofassets and liabilities and their carrying amounts for financial reportingpurposes, based on the expected income tax rates for the year in which thesetemporary differences are expected to reverse. Foreign net operating losscarryforwards may be carried forward indefinitely.

 

The preparation of our income tax returns requires theinterpretation of the associated tax laws. Many tax laws are complex, and at times ambiguous, and ourinterpretations of these laws may differ from the interpretations of the taxingauthorities who have the right to audit our returns within statutory timeperiods.  Where we believe there is aquantifiable risk that our interpretations of these laws could reasonablydiffer from those of the taxing authorities, we make appropriate provisions inour tax liabilities.  In 2003, Canadiantax authorities completed an audit of our Canadian tax returns for the years1999, 2000 and 2001.  Accordingly, weremoved $1.0 million of provisions we had made in our tax liabilities relatedto the risk that tax authorities would reject certain positions we had taken inthe preparation of these returns.

 

*Earnings(Loss) Per Share*. Basic earnings per share (EPS) is computed by dividing net income orloss by the weighted average number of common shares outstanding during theyear. Diluted EPS is computed by dividing net income by the sum of the weightedaverage number of common shares outstanding plus all additional common sharesthat would have been outstanding if potentially dilutive common shares relatedto stock options and warrants had been issued. In years in which we experiencea net loss, basic EPS and diluted EPS will be the same, as the potential shares

 

23

----

 

issued related to stock options are anti-dilutive.  Potential common shares of 3,323,000 in2003, 3,674,000 in 2002 and 671,000 in 2001, related to outstanding stockoptions were excluded from the computation of diluted earnings per share asinclusion of these shares would have been anti-dilutive.

 

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

 

*Accounts Receivable.*  We review our accounts receivable balanceson a regular basis to determine their collectability.  An allowance for doubtful accounts is recorded based onmanagement’s estimate of those accounts which may become uncollectible.

 

*Inventories*.  Inventories, consisting of material, laborand overhead, are stated at the lower of first-in, first-out cost ormarket.  We review our inventory on aregular basis with the objective of assessing its net realizable value.  We adjust the carrying value of inventory accordingto our estimates of the net realizable value of individual inventory componentsrelative to their purchase or carrying value.

 

*Propertyand Equipment*. Property and equipment are stated at cost less accumulated depreciation.Repairs and maintenance are charged to expense as incurred, while significantimprovements are capitalized. Depreciation is calculated using thestraight-line method for financial reporting purposes over estimated usefullives of three to thirty years, or in the case of leasehold improvements, theterm of the lease, if shorter.  Bothstraight-line and accelerated depreciation methods of depreciation are used forincome tax purposes.  Depreciationexpense totaled approximately $8,391,000 in 2003, $8,349,000 in 2002, and$10,363,000 in 2001.

 

*Warranty. *We generally warrant toall customers that the products we make for them will be free from defects inmaterials and workmanship.  If it isdetermined that the products sold are defective, we typically repair or replacesuch products.  The cost of theserepairs or replacements has not had a material effect on our financialcondition, results of operations or cash flows.

 

*FairValue of Financial Instruments*.  The financial instruments with which we are involved areprimarily of a traditional nature.  Formost instruments, including cash, receivables, accounts payable, accruedexpenses and short-term debt, we believe that the carrying amounts approximatefair value because of their short-term nature. The carrying value of long-termdebt approximated fair value as of December 27, 2002 based on current ratesavailable to us at that time.

 

*Long-LivedAssets*.  Long-livedassets, such as property and equipment, are evaluated for impairment whenevents or changes in circumstances indicate that the carrying amount of theassets may not be recoverable through the estimated undiscounted future cashflows from the use of these assets. If any such impairment exists, the relatedassets would be written down to fair value.

 

As a result of aslowdown in our Returns Management and Authorization (RMA) processing businessin the second half of 2001, we analyzed projected undiscounted cash flows anddetermined that goodwill associated with the 1997 purchase of TrotterTechnologies, Inc. was impaired. Accordingly, we charged to earnings the entireamount of unamortized goodwill of approximately $923,000 in 2001.  Excluding the write-off in 2001,amortization expense totaled $80,000 in 2001.

 

*StockBased Compensation.* We have a 1996 Stock Option Plan (the 1996 Plan), nonqualified optionsissued outside of the 1996 Plan, and an Employee Stock Purchase Plan.  We account for our stock stock-basedcompensation arrangements under Accounting Principles Board OpinionNo. 25, “Accounting for Stock Issued to Employees.”  Because our options are granted at the fairmarket value on the date of grant, no related compensation expense isrecognized.

 

24

----

 

Had the compensation cost of option grants beendetermined by applying the fair value recognition provisions as described inSFAS No. 123, “Accounting for Stock-Based Compensation,” as amendedby SFAS No. 148, “Accounting for Stock-Based Compensation—Transition andDisclosure”, our net earnings (loss) and our earnings (loss) per share (EPS),on a pro forma basis, would have been reported as follows (in thousands, exceptper share data):

 
|                                  |   | **2003** |   | **2002** |   | **2001** |   |
|---------------------------------------|--------|----------|--------|----------|--------|----------|--------|
| Net earnings  (loss):                 |   |     |   |     |   |     |   |
| As reported                           |   | $        | (555   | )        | $      | (679     | )      | $ | 9,033 |   |
| Stock-based  compensation, net of tax |   | (1,151   | )      | (2,266   | )      | (2,840   | )      |
| Pro forma                             |   | $        | (1,706 | )        | $      | (2,945   | )      | $ | 6,193 |   |
|                                  |   |     |   |     |   |     |   |
| Basic EPS:                            |   |     |   |     |   |     |   |
| As reported                           |   | $        | (0.02  | )        | $      | (0.02    | )      | $ | 0.28 |   |
| Pro forma                             |   | $        | (0.05  | )        | $      | (0.09    | )      | $ | 0.19 |   |
|                                  |   |     |   |     |   |     |   |
| Diluted EPS:                          |   |     |   |     |   |     |   |
| As reported                           |   | $        | (0.02  | )        | $      | (0.02    | )      | $ | 0.27 |   |
| Pro forma                             |   | $        | (0.05  | )        | $      | (0.09    | )      | $ | 0.19 |   |

 

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

 
|                                                 |   | **2003** |   | **2002** |   | **2001** |   |
|------------------------------------------------------|--------|----------|--------|----------|--------|----------|--------|
| Risk-free  interest rate                             |   | 3.22     | %      | 2.75     | %      | 5.05     | %      |
| Expected life of  options granted, in years          |   | 6.2      |   | 6.6      |   | 7.0      |   |
| Expected  volatility of options granted         |   | 90.33    | %      | 91.97    | %      | 94.56    | %      |
| Weighted average  fair value of options granted |   | $        | 2.78   |     | $      | 3.82     |   | $ | 5.44 |   |
|                                                      |        |          |        |          |        |          |        |  |  |  |

 

*ForeignCurrency Translation.* We translate assets and liabilities of our foreign subsidiaries to theirU.S. dollar equivalents at exchange rates in effect at the balance sheet dateand record related translation adjustments as a component of shareholders’equity in the consolidated balance sheets. Statements of operations of our foreign subsidiaries are translated fromtheir functional currencies to U.S. dollar equivalents at average exchange ratesduring the period and we record the related translation adjustment to acomponent of shareholders’ equity. Foreign exchange transaction gains and losses are reported in otherincome and expense on the consolidated statements of operations.

 

*Recently Issued Accounting Pronouncements.*  In January 2003, the FASB issued FinancialInterpretation No. 46, “Consolidation of Variable Interest Entities” revisedDecember 2003 (“FIN 46(R)”).  FIN 46(R)requires that companies consolidate a variable interest entity if it is subjectto a majority of the risk of loss from the variable interest entity’sactivities, or is entitled to receive a majority of the entities residualreturns, or both.  The provisions of FIN46(R) currently are required to be applied no later than the first reportingperiod ending after March 15, 2004 for variable interest entities acquired onor before January 31, 2003.  Forvariable interest entities acquired after January 31, 2003, Companies maycontinue to apply the provisions of FIN 46 or apply FIN 46(R) beginningDecember 31, 2003.  Companies that holda variable interest in a special purpose entity, as defined, are required toapply either FIN 46 or FIN 46(R) no later than the end of the first reportingperiod that ends after December 15, 2003. The adoption of FIN 46(R) is not expected to have an impact on ourfinancial position or results of operations.

 

In April 2003, the FASB issued Statement on FinancialAccounting Standards No. 149, “Amendment of Statement 133 on DerivativeInstruments and Hedging Activities,” which amends and clarifies financialaccounting and reporting for derivative instruments, including certainderivative instruments embedded in other contracts and for hedging activitiesunder FAS 133.  FAS 149 is effective forcontracts entered into or modified after June 30, 2003 except for theprovisions that were cleared by the FASB in prior pronouncements.  The adoption of FAS 149 did not have amaterial impact on our consolidated balance sheet or results of operations.

 

In May 2003, the FASB issued Statement on FinancialAccounting Standards No. 150, “Accounting for Certain Financial Instrumentswith Characteristics of both Liabilities and Equity”.  This statement establishes standards for how an issuer classifiesand measures in its statement of financial position certain financialinstruments with characteristics of both liabilities and equity.  In accordance with the standard, financialinstruments that embody obligations for the issuer are required to beclassified as liabilities.  FAS No. 150is effective for financial instruments entered into or modified 

 

25

----

 

after May 31, 2003, and was otherwise effective for us during thesecond quarter of 2003.  The adoption ofFAS 150 did not have a material impact on our consolidated balance sheet orresults of operations.

 

In December 2003, the FASB issued SFAS No. 132(R), arevision to SFAS No. 132, “Employers’ Disclosure about Pensions and OtherPostretirement Benefits.  SFAS No.132(R) requires additional disclosures about the assets, obligations, cashflows and net periodic benefit cost of defined benefit pension plans and otherdefined benefit postretirement plans. SFAS No. 132(R) is effective for financial statements with fiscal yearsending after December 15, 2003, with the exception of disclosure requirementsrelated to foreign plans and estimated future benefit payments which areeffective for fiscal years ending after June 15, 2004.  The adoption of SFAS No. 132(R) did not impactour financial position or results of operations.

 

**NOTE 2.  OTHER FINANCIAL STATEMENT INFORMATION**

 

*Consolidated Balance SheetInformation (in thousands):*

* *
|                                               |   | **2003** |   | **2002** |   |
|----------------------------------------------------|--------|----------|--------|----------|--------|
| *Inventories*:                                     |   |     |   |     |   |
| Raw materials                                      |   | $        | 7,011  |     | $      | 6,910 |   |
| Work in process                                    |   | 2,425    |   | 1,318    |   |
| Finished goods                                     |   | 3,321    |   | 1,484    |   |
|                                               |   | $        | 12,757 |     | $      | 9,712 |   |
| *Property  and equipment, net*:                    |   |     |   |     |   |
| Manufacturing  equipment                           |   | $        | 69,638 |     | $      | 61,494 |   |
| Office equipment                                   |   | 8,141    |   | 6,187    |   |
| Land, building  and leasehold improvements         |   | 9,008    |   | 7,379    |   |
|                                               |   | 86,787   |   | 75,060   |   |
| Less:  Accumulated depreciation and amortization   |   | (47,928  | )      | (40,113  | )      |
|                                               |   | $        | 38,859 |     | $      | 34,947 |   |
| *Accrued  expense and other current liabilitiess*: |   |     |   |     |   |
| Compensation and  benefits                         |   | $        | 6,336  |     | $      | 6,569 |   |
| Royalties                                          |   | 10,255   |   | 10,508   |   |
| Other                                              |   | 5,437    |   | 345      |   |
|                                               |   | $        | 22,028 |     | $      | 17,422 |   |

 

*Supplemental Cash Flow Information(in thousands):*

 
|                                                                                                         |   | **2003** |   | **2002** |   | **2001** |   |
|--------------------------------------------------------------------------------------------------------------|--------|----------|--------|----------|--------|----------|--------|
| *Cash  paid for*:                                                                                            |   |     |   |     |   |     |   |
| Interest                                                                                                     |   | $        | 151    |     | $      | 245      |   | $ | 585 |   |
| Income taxes                                                                                                 |   | 1,045    |   | 1,235    |   | 6,205    |   |
| *Non-cash  transactions*:                                                                                    |   |     |   |     |   |     |   |
| Unrealized gain  on available-for-sale securities, net of deferred taxes of $1,815 in 2003 and  $719 in 2002 |   | 2,819    |   | 1,275    |   | —   |   |
|                                                                                                              |        |          |        |          |        |          |        |  |  |  |

 

**NOTE 3.  ACQUISITIONS AND STRATEGIC ALLIANCES**

 

*StrategicAlliance Agreement.*** **On August 12, 2002, we announcedthe signing of a Strategic Alliance Agreement with Intraware, Inc., a leading providerof global electronic software delivery (ESD) services.  Under thisagreement, as amended, we have an exclusive right to market and resellIntraware’s ESD services in the supply chain outsourcing market.  Revenues earned under this agreement in 2003and 2002 have not been significant.  Theagreement has an initial term of ten years and may be cancelled earlier at our option upon 30 days notice.  Minimum fees payable under the agreement,assuming the full ten-year term and certain other conditions, are$14,600,000.  We expensed $656,000 and$194,000 under this agreement in 2003 and 2002, respectively.

 

Inaddition to the strategic alliance agreement, we invested $5,000,000 in aprivate placement of Intraware common stock at $0.82 per share, representingapproximately 12% of the outstanding shares of Intraware.  The commonstock was issued in a private placement without registration under theSecurities Act of 1933.  In 2003,Intraware filed a registration statement with the Securities Exchange Commission(SEC) to register the resale of the common stock issued to us.  We haveclassified this investment as an available-for-sale security, and accordingly,unrealized holding gains and losses are excluded from earnings and reported asa component of other comprehensive income. The market value of this investment was $11,646,000, and $7,013,000 asof the end of 2003 and 2002, respectively.

 

26

----

 

*Investment in Unconsolidated Entity. *On October 2, 1998, we acquired 4,310,345 shares ofthe common stock of Microgistix (formerly Chumbo Holdings Corporation), aprivate company, in exchange for cash and warrants for total consideration of$5,000,000.  In December 2001, based on Microgistix’ historical operating results and cashflow requirements, we determined that we could not justify any carrying amountof this investment, and accordingly, wrote off the remaining value of$4,400,000.

 

Our sales to Microgistixwere $2,305,000 in 2003, $3,863,000 in 2002, and $4,877,000 in 2001.  Microgistix accounts receivable balances asof the end of the year were $345,000 in 2003, $773,000 in 2002, and $1,140,000in 2001.

 

**NOTE4.  CREDIT FACILITIES AND LONG-TERMNOTES PAYABLE**

 

At the end of 2002, wehad a $15,000,000 term loan facility and a $25,000,000 revolving line-of-creditfacility.  The amount outstanding on theterm loan facility as of this time was $3,736,000 and there were no amountsoutstanding under the revolving line of credit facility.  In 2003, we paid all amounts due under theterm loan facility and cancelled the revolving line of credit facility.

 

**NOTE5.  SHAREHOLDERS’ EQUITY**

 

*StockRepurchase Plans*.  InOctober 2002, our Board of Directors authorized a stock repurchase plan thatallows us to repurchase up to $10,000,000 of our common stock.  In 2003, we repurchased a total of 761,900shares for a total cost of $2,587,000, and in 2002, we repurchased a total of118,300 shares at a cost of $464,000.

 

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

 

**NOTE6.  COMPREHENSIVE INCOME**

 

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

 
|                                                                  |   | **2003** |   | **2002** |   | **2001** |   |
|-----------------------------------------------------------------------|--------|----------|--------|----------|--------|----------|--------|
| Net earnings  (loss)                                                  |   | $        | (555   | )        | $      | (679     | )      | $ | 9,033 |   |
| Unrealized  holding gain on available-for-sale securities, net of tax |   | 2,819    |   | 1,275    |   | —   |   |
| Translation  adjustments                                              |   | 6,555    |   | 4,672    |   | (1,462   | )      |
| Comprehensive  income                                                 |   | $        | 8,819  |     | $      | 5,268    |   | $ | 7,571 |   |

 

**NOTE7.  STOCK PLANS**

 

***Employee Stock Purchase Plan***.  We have an employee stock purchase planwhich enables our employees to contribute up to 10 percent of theircompensation toward the purchase of the Company’s common stock at a price equalto the lower of 85 percent of fair market value as of the beginning or end ofeach plan period.  A total of 2,219,292shares have been reserved for issuance under this plan.  This amount is increased on January 1stof each year in accordance with the plan by an amount equal to the number ofshares issued in the previous two plan periods.  Shares issued under the plan totaled approximately 184,000 in2003, 188,000 in 2002, and 339,000 in 2001.

 

***Stock Option Plan***.  We have a1996 Stock Option Plan (the “Plan”) that provides for the granting of stockoptions to employees, officers, directors and independent consultants 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 shares reserved for issuance under the Plantotal 6,400,000, of which 454,280 remained available for grant at the end of2003.  These options, which can beeither incentive stock options or nonqualified options, vest over a three- tofive-year schedule and expire 10 years after the grant date.

 

We have also issuednonqualified stock options outside of the Plan for the purchase of 1,620,650shares of common stock, of which options to purchase 1,125,650 shares wereoutstanding as of December 26, 2003. These options were issued at the fair market value of the Company’sstock on the date of grant and vest over a four- to five-year schedule.  Included in these grants are 693,000 option shares granted in 2001 to certain of ourofficers.  These options were grantedprior to shareholder approval and therefore were subject to variable planaccounting pursuant to FASB Interpretation No. 44, “Accounting for CertainTransactions Involving Stock Compensation (an Interpretation of APBOpinion No. 25).”  We are requiredto recognize compensation expense equal to the amount by which the quotedmarket value of our stock

 

27

----

 

exceeds the exercise price of the option, prorated for the length oftime the grants have been outstanding.  The variable plan accounting ceased when the shareholders approvedthe granting of the options on April 24, 2002. We recognized a compensation benefit related to these options of $32,000in 2002 and compensation expense related to these options of $261,000 in 2001,which is reflected in selling, general and administrative expenses in theconsolidated statements of operations.

 

Information regarding allstock option activity during the year is summarized as follows (shares inthousands):

 
|                                    |   | **2003**   |   | **2002**                              |   | **2001**   |   |
|-----------------------------------------|--------|------------|--------|---------------------------------------|--------|------------|--------|
|                                    |   | **Shares** |   | **Weighted  Average  Exercise Price** |   | **Shares** |   | **Weighted  Average  Exercise Price** |   | **Shares** |   | **Weighted  Average  Exercise Price** |   |
|                                    |   |       |   |                                  |   |       |   |   |   |   |   |   |   |
| Options  outstanding, beginning of year |   | 3,674      |   | $                                     | 5.07   |       | 3,849  |   | $ | 7.07 |   | 2,268 |   | $ | 7.40 |   |
| Granted                                 |   | 273        |   | 3.65                                  |   | 545        |   | 4.86 |   | 2,312 |   | 6.20 |   |
| Exercised                               |   | (138       | )      | 2.52                                  |   | (126       | )      | 2.56 |   | (357 | ) | 2.12 |   |
| Canceled                                |   | (486       | )      | 5.30                                  |   | (594       | )      | 15.72 |   | (374 | ) | 13.59 |   |
| Options  outstanding, end of year       |   | 3,323      |   | $                                     | 5.03   |       | 3,674  |   | $ | 5.07 |   | 3,849 |   | $ | 7.07 |   |
|                                    |   |       |   |                                  |   |       |   |   |   |   |   |   |   |
| Options  exercisable, end of year       |   | 1,463      |   | $                                     | 4.53   |       | 1,337  |   | $ | 4.14 |   | 926 |   | $ | 3.40 |   |

 

Information regarding alloutstanding stock options as of December 26, 2003 is summarized as follows(shares in thousands):

 
|                          |   | **Options  Outstanding** |   | **Options  Exercisable**         |   |
|-------------------------------|--------|--------------------------|--------|----------------------------------|--------|
| **Range of  Exercise Prices** |   |                     |   | **Weighted  Average  Remaining** |   | **Weighted  Average** |   |   |   | **Weighted  Average** |   |
| **Low**                       |   | **High**                 |   | **Shares**                       |   | **Life (in years)** |   | **Exercise Price** |   | **Shares** |   | **Exercise Price** |   |
|                          |   |                     |   |                             |   |   |   |   |   |   |   |   |   |
| $                             | 1.13   |                     | $      | 2.86                             |   | 636 |   | 4.1 |   | $ | 2.13 |   | 636 |   | $ | 2.13 |   |
| 2.87                          |   | 5.71                     |   | 780                              |   | 8.2 |   | 4.07 |   | 199 |   | 4.34 |   |
| 5.72                          |   | 8.57                     |   | 1,862                            |   | 7.3 |   | 6.04 |   | 588 |   | 6.08 |   |
| 17.14                         |   | 25.71                    |   | 45                               |   | 6.3 |   | 21.09 |   | 40 |   | 21.04 |   |
|                          |   |                     |   | 3,323                            |   | 6.9 |   | $ | 5.03 |   | 1,463 |   | $ | 4.53 |   |
|                               |        |                          |        |                                  |        |  |  |  |  |  |  |  |  |  |  |  |  |

 

**NOTE8.  INCOME TAXES**

 

Detailsregarding the income tax expense (benefit) included in the consolidatedstatement of operations are as follows (in thousands):

 
|                                |   | **2003** |   | **2002** |   | **2001** |   |
|-------------------------------------|--------|----------|--------|----------|--------|----------|--------|
| Current:                            |   |     |   |     |   |     |   |
| Federal                             |   | $        | (3,628 | )        | $      | (815     | )      | $ | 5,776 |   |
| State                               |   | (578     | )      | (142     | )      | 738      |   |
| Foreign                             |   | (156     | )      | 876      |   | 1,059    |   |
|                                |   | (4,362   | )      | (81      | )      | 7,573    |   |
| Deferred                            |   | 1,409    |   | (492     | )      | (2,352   | )      |
| Total income tax  expense (benefit) |   | $        | (2,953 | )        | $      | (573     | )      | $ | 5,221 |   |

 

Excluded from ourprovision for income taxes are tax benefits we realize from employee sales ofstock issued under our stock option and employee stock purchase plans of$104,000 in 2003, $158,000 in 2002 and $430,000 in 2001.  These tax benefits are recorded directly tostockholders’ equity.  Our income taxbenefit in 2003 includes a benefit of $1,010,000 related to a reduction in ourtax accruals following the completion of a Canadian tax audit.  The provision for foreign income taxes isbased upon foreign pretax income of approximately $3,812,000 in 2003,$2,104,000 in 2002, and $4,500,000 in 2001.

 

28

----

 

A reconciliation of thestatutory federal income tax rate to our effective income tax rate is asfollows:

 
|                                                        |   | **2003** |   | **2002** |   | **2001** |   |
|-------------------------------------------------------------|--------|----------|--------|----------|--------|----------|--------|
| Statutory federal  income tax rate                          |   | 34.0     | %      | 34.0     | %      | 34.0     | %      |
| State income taxes, net  of federal income tax benefit |   | 7.5      |   | 4.1      |   | 3.2      |   |
| Reduction in tax  accruals upon completion of tax audit     |   | 29.2     |   | —   |   | —   |   |
| Effects of  unconsolidated entity                           |   | —   |   | —   |   | (8.8     | )      |
| Foreign tax effect                                          |   | 9.4      |   | (7.8     | )      | (1.8     | )      |
| Valuation allowance                                         |   | —   |   | —   |   | 11.3     |   |
| Tax deductible goodwill                                     |   | 4.6      |   | 12.8     |   | —   |   |
| Other                                                       |   | (.5      | )      | 2.7      |   | (1.3     | )      |
| Effective income tax  rate                                  |   | 84.2     | %      | 45.8     | %      | 36.6     | %      |

 

The components of ourdeferred tax asset (liability) are as follows (in thousands):

 
|                                            |   | **2003** |   | **2002** |   |
|-------------------------------------------------|--------|----------|--------|----------|--------|
| Current:                                        |   |     |   |     |   |
| Accounts receivable  reserves                   |   | $        | 354    |     | $      | 565 |   |
| Inventory valuation                             |   | 1,477    |   | 967      |   |
| Accrued liabilities                             |   | 854      |   | 719      |   |
| Other                                           |   | —   |   | 304      |   |
| Total current deferred  tax asset          |   | $        | 2,685  |     | $      | 2,555 |   |
| Long-term:                                      |   |     |   |     |   |
| Depreciation and  amortization                  |   | $        | (1,137 | )        | $      | (906 | ) |
| Unrealized gain on  available-for-sale security |   | (2,479   | )      | (780     | )      |
| Foreign tax credit                              |   | 1,294    |   | 844      |   |
| Capital loss  carryforward                      |   | 1,538    |   | 1,610    |   |
| Ireland net operating  loss carry forward       |   | 1,784    |   | 1,625    |   |
| Valuation allowance                             |   | (2,315   | )      | (2,654   | )      |
| Other                                           |   | —   |   | (363     | )      |
| Total long-term  deferred tax liability         |   | $        | (1,315 | )        | $      | (624 | ) |

 

Wehave not recorded deferred income taxes applicable to undistributed earnings ofour non-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,however, it is not practicable to determine the amount of such liability.

 

**NOTE9.  RELATED-PARTY TRANSACTIONS**

 

*OperatingLease. *We lease one of our manufacturing andoffice facilities from a partnership that is one-third owned by a significantshareholder and member of our Board of Directors.  We believe the terms of this lease are equivalent to those thatwould be paid in an arm’s-length transaction. Payments under this lease totaled$642,000 in 2003, $649,000 in 2002, and $649,000 in 2001.

 

*Salesto Related Party.*  Oneof our customers is owned by a significant shareholder and a member of ourBoard of Directors.  We believe ourterms of sale with this customer are equivalent to those offered to all ourcustomers for similar services and volume of business.  Sales to this customer were $234,000 in2003, $241,000 in 2002 and $392,000 in 2001. Amounts owed to us as of the end of the year were $109,000 in 2003,$48,000 in 2002 and $144,000 in 2001.

 

29

----

 

**NOTE10.  COMMITMENTS AND CONTINGENCIES**

 

*OperatingLeases*.  We arecommitted under operating leases with related and unrelated parties for therental of manufacturing, warehouse and office facilities.  Future minimum lease obligations as ofDecember 26, 2003 are as follows (in thousands):

 
| 2004       |   | $      | 4,882  |   |
|------------|--------|--------|--------|--------|
| 2005       |   | 4,272  |   |
| 2006       |   | 3,258  |   |
| 2007       |   | 2,368  |   |
| 2008       |   | 1,927  |   |
| Thereafter |   | 20,082 |   |
|       |   | $      | 36,889 |   |

 

Rentexpense under all operating leases, exclusive of real estate taxes, insuranceand maintenance expense was $6,104,000 in 2003, $5,649,000 in 2002, and$5,480,000 in 2001.

 

*Ireland Employment Grants*.  OurIreland businesses have received employment grants from the Ireland DevelopmentAuthority (IDA) totaling $3,454,000 during the period from 1995 through2000.  We recognized these grants asincome in previous years on a straight-line basis in selling, general andadministrative expenses in the consolidated statements of operations.  These grants were awarded by the IDA forcreating and maintaining permanent employment positions in Ireland for a periodof at least five years.  Termination ofany number of these positions within a five-year period may, at the election ofthe IDA, result in the pro rata return of the grants based on the number ofpositions terminated compared to the number of new positions originallycreated.  At December 26, 2003, ouremployment levels in Ireland were below the levels for which we had receivedgrants.  However, the IDA has informedus that it does not intend to seek repayment of any grant monies at this timeor in the foreseeable future, and accordingly, we have not provided for suchrepayment in our financial statements. As of December 26, 2003, our estimate of the amount of grants for whichrepayment could be requested totaled $107,000.

 

*401(k)Plan.*  We have adiscretionary 401(k) plan for all employees who are at least 21 years of ageand have completed 60 days of service with the Company.  Our discretionary contributions totaled$245,000 in 2003, $245,000 in 2002, and $301,000 in 2001.

 

***Terminated Acquisition. ***In February 2002, we signed an Asset PurchaseAgreement (“APA”) to purchase the assets of Software Logistics Corporation(“iLogistix”).  The purchase was subjectto significant closing conditions and required us to deposit $3.9 million in anescrow account.  In March 2002, weterminated the APA because certain of the closing conditions were not satisfiedby the dates required.  In response,iLogistix filed a lawsuit for specific performance under the APA.  In July 2002, iLogistix sold substantiallyall of its assets to another buyer for an amount in excess of the amount weoffered in the APA.  In March 2003, a settlement was reached withiLogistix whereby the $3.9 million deposit, plus accrued interest, was returnedto us and both parties dropped all other claims and actions arising out of theAPA.

 

*Customer Claim of Unauthorized Production ofSoftware. *During the second quarter of 2003, one of ourmajor customers alleged that Zomax Ireland, a subsidiary we acquiredfrom Kao Corporation in January 1999, was responsible for unauthorizedproduction of the customer’s software. Our customer claimed that because of these alleged unauthorized activitiesit had suffered significant damages representing lost profits on displacedproduct sales.  We vigorously denied allclaims.  In the fourth quarter of 2003, we and our customer reached a finalaccommodation related to these claims. While we continue to deny these claims, in order to avoid potentiallylengthy and expensive litigation, we agreed to make a one-time payment to ourcustomer of $3,000,000.  As a part ofthe settlement agreement, neither party admitted any liability and both partiesobtained mutual releases related to the claims.

 

*“WellsNotice” and Shareholder Lawsuit. *In October 2002, we announced that the Securities and Exchange Commission(SEC) was conducting a preliminary investigation into the trading of Zomaxsecurities by insiders.  In December2003, we received a “Wells Notice” from the staff of the Chicago Regionaloffice of the SEC indicating their intention to recommend that a civilenforcement action be commenced against the Company and certain of its currentand former officers.  The notice allegesviolations regarding false and misleading forward-looking statements made tothe public and in a quarterly report in the year 2000.  The staff also indicated its intention torecommend a civil enforcement action be commenced against certain current andformer officers regarding alleged insider trading violations during the sameperiod.  The Company and the current andformer officers believe they have complied with all applicable rules andregulations.

 

On March 9, 2004 a lawsuit was filed against theCompany and certain of its former officers. The complaint alleges securities law violations regarding false andmisleading statements made to the public and the failure to disclose materialevents between June 6, 2000 and September 21, 2000.  The complaint was filed in the United States District Court,District of Minnesota by an individual purporting to represent a class ofpurchasers of Zomax stock.  The lawsuitseeks unspecified damages.  We believe thislawsuit is without merit and intend to defend this action vigorously.

 

We do notbelieve that the amount of any potential liability associated with thesematters can be estimated at this time, but an unfavorable resolution of thesematters is possible and could have a material adverse effect on our results ofoperations, financial condition or cash flows.

 

30

----

 

We areinvolved in certain other claims arising in the normal course of business.  In our opinion, the final resolution ofthese claims should not have a material adverse effect on our financialposition, cash flow or results from operations.

 

**NOTE 11.  QUARTERLYFINANCIAL DATA (UNAUDITED)**

 

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

 
|                               |   | **Quarter  Ended** |       |
|------------------------------------|--------|--------------------|------------|
|                               |   | **March**          |       | **June** |   | **September** |   | **December** |   |
| **2003:**                          |   |               | ** ** |   | ** ** |   | ** ** |   | ** ** |
| Revenue                            |   | $                  | 47,228     |   | $ | 43,997 |   | $ | 44,535 |   | $ | 61,910 |   |
| Gross profit                       |   | 6,698              |       | 6,331 |   | 6,390 |   | 17,988 |   |
| Operating income (loss)            |   | (2,635             | )          | (2,549 | ) | (4,645 | ) | 6,064 |   |
| Net earings (loss)                 |   | (1,725             | )          | (1,510 | ) | (2,534 | ) | 5,214 |   |
| Basic earnings (loss) per  share   |   | (0.05              | )          | (0.05 | ) | (0.08 | ) | 0.16 |   |
| Diluted earnings (loss)  per share |   | (0.05              | )          | (0.05 | ) | (0.08 | ) | 0.16 |   |
|                               |   |               |       |   |   |   |   |   |   |
|                               |   | **Quarter  Ended** |       |
|                               |   | **March**          |       | **June** |   | **September** |   | **December** |   |
| **2002:**                          |   |               |       |   |   |   |   |   |   |
| Revenue                            |   | $                  | 45,985     |   | $ | 45,360 |   | $ | 43,719 |   | $ | 50,436 |   |
| Gross profit                       |   | 8,944              |       | 8,479 |   | 7,930 |   | 7,459 |   |
| Operating income (loss)            |   | (1,507             | )          | 1,109 |   | (1,033 | ) | (1,021 | ) |
| Net income (loss)                  |   | (785               | )          | 855 |   | (474 | ) | (275 | ) |
| Basic earnings (loss)  per share   |   | (0.02              | )          | 0.03 |   | (0.01 | ) | (0.01 | ) |
| Diluted earnings (loss)  per share |   | (0.02              | )          | 0.03 |   | (0.01 | ) | (0.01 | ) |

 

In the fourth quarter of2003, we signed a revised royalty agreement which retroactively reduced therates at which royalties are payable under the agreement.  The signing of this contract resulted in a$4,776,000 non-cash benefit related to unpaid royalties accrued and charged tocost of revenue in 2002 and the first three quarters of 2003.  See “Royalties” in Note 1 to consolidatedfinancial statements.

 

Non-cash charges recordedin the fourth quarter of 2002 include a $1,352,000 pretax write-down of ourexisting call center systems as a result of the replacement of those systemsstarting during that quarter, and $700,000 of royalty costs related to thethird quarter resulting from an adjustment in the fourth quarter, retroactive toJuly 1, 2002, of the rate used to accrue royalties under our license agreementwith Philips Corporation.

 

31

----

 

**NOTE12.  SEGMENT AND GEOGRAPHICALINFORMATION**

 

We operate in oneindustry segment. The geographic distributions of our identifiable assets,operating income (loss) and revenues for 2003, 2002 and 2001 are summarized asfollows (in thousands):

 
|                                |   | **2003** |    | **2002** |   | **2001** |   |
|-------------------------------------|--------|----------|---------|----------|--------|----------|--------|
| **Revenue:**                        |   |     |    |     |   |     |   |
| United States                       |   | $        | 176,510 |     | $      | 165,264  |   | $ | 176,279 |   |
| Ireland                             |   | 35,938   |    | 29,926   |   | 44,451   |   |
| Canada                              |   | 31,203   |    | 26,813   |   | 20,663   |   |
| Intergeographic revenue             |   | (45,981  | )       | (36,503  | )      | (24,596  | )      |
|                                |   | $        | 197,670 |     | $      | 185,500  |   | $ | 216,797 |   |
| **Operating  income (loss):**       |   |     |    |     |   |     |   |
| United States                       |   | $        | 9,669   |     | $      | 8,931    |   | $ | 20,591 |   |
| Ireland                             |   | 1,683    |    | (381     | )      | 1,720    |   |
| Canada                              |   | 2,888    |    | 3,427    |   | 3,512    |   |
| Corporate  and eliminations    |   | (18,005  | )       | (14,429  | )      | (8,601   | )      |
|                                |   | $        | (3,765  | )        | $      | (2,452   | )      | $ | 17,222 |   |
| **Assets:**                         |   |     |    |     |   |     |   |
| United States                       |   | $        | 52,506  |     | $      | 49,390   |   | $ | 51,008 |   |
| Ireland                             |   | 31,858   |    | 25,174   |   | 35,732   |   |
| Canada                              |   | 25,257   |    | 17,519   |   | 15,713   |   |
| Total identifiable  assets          |   | 109,621  |    | 92,083   |   | 102,453  |   |
| Corporate assets and  eliminations  |   | 72,012   |    | 75,100   |   | 61,053   |   |
|                                |   | $        | 181,633 |     | $      | 167,183  |   | $ | 163,506 |   |
| **Capital  expenditures:**          |   |     |    |     |   |     |   |
| United States                       |   | $        | 3,716   |     | $      | 2,611    |   | $ | 1,315 |   |
| Ireland                             |   | 1,409    |    | 79       |   | 3,330    |   |
| Canada                              |   | 4,464    |    | 260      |   | 289      |   |
|                                |   | $        | 9,589   |     | $      | 2,950    |   | $ | 4,934 |   |
| **Depreciation  and amortization:** |   |     |    |     |   |     |   |
| United States                       |   | $        | 5,897   |     | $      | 5,936    |   | $ | 7,407 |   |
| Ireland                             |   | 855      |    | 1,168    |   | 1,806    |   |
| Canada                              |   | 1,639    |    | 1,245    |   | 1,230    |   |
|                                |   | $        | 8,391   |     | $      | 8,349    |   | $ | 10,443 |   |

 

32

----

 

**ITEM 9. CHANGES IN AND DISAGREEMENTSWITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE**

 

On June 24, 2002, theAudit Committee of the Board of Directors of the Company ceased itsclient-auditor relationship with Arthur Andersen LLP (“Andersen”) as theCompany’s independent public accountants, effective immediately on that date.

 

Theaudit reports of Andersen on the consolidated financial statements of theCompany for the fiscal years ended December 28, 2001 and December 29, 2000, didnot contain any adverse opinion or disclaimer of opinion, nor were theyqualified or modified as to uncertainty, audit scope or accounting principles.

 

During the Company’sfiscal years ended December 28, 2001 and December 29, 2000, and the subsequentinterim period ended June 24, 2002, (a) there were no disagreements withAndersen on any matter of accounting principles or practices, financialstatement disclosure, or auditing scope or procedure which, if not resolved toAndersen’s satisfaction, would have caused Andersen to make reference to thesubject matter of such disagreement in connection with Andersen’s reports onthe Company’s consolidated financial statements for such years; and (b) therewere no reportable events as listed in Item 304(a)(1)(v) ofRegulation S-K.

 

Also on June 24, 2002,the Audit Committee of the Board of Directors of Zomax, appointed Deloitte& Touche LLP as the Company’s independent public auditors for the Company’sfiscal year ending December 27, 2002, effective immediately.

 

**ITEM 9A. CONTROLS AND PROCEDURES**

 

As of the end of theperiod covered by this report, we conducted an evaluation under the supervisionand with the participation of our principal executive officer and principalfinancial officer, of our disclosure controls and procedures (as defined inRules 13(a)-15(e) under the Securities Exchange Act of 1934 (“the ExchangeAct”)).  Based on this evaluation, theprincipal executive officer and principal financial officer concluded that ourdisclosure controls and procedures are effective to ensure that informationrequired to be disclosed by us in the reports we file or submit under theExchange Act is recorded, processed, summarized and reported within the timeperiods specified in Securities and Exchange Commission rules and forms.  There was no significant change in ourinternal control over financial reporting during our most recently completedfiscal quarter that has materially affected, or is reasonably likely tomaterially affect our internal control over financial reporting.

 

33

----

 

**PART III**

 

**ITEM10.  DIRECTORS AND EXECUTIVE OFFICERS OFTHE REGISTRANT**

 

Theinformation concerning directors and executive officers and compliance withSection 16(a) required by this item is contained in the sections entitled“Corporate Governance,” “Election of Directors,” “Executive Officers of theCompany” and “Compliance with Section 16(a) of the Exchange Act,” appearing inour Proxy Statement to be delivered to shareholders in connection with the 2004Annual Meeting of Shareholders.  Suchinformation is incorporated herein by reference.

 

Wehave adopted a Code of Ethics and Business Conduct (the “Code”), which isavailable free of charge through our website at www.zomax.com and is availablein print to any shareholder who sends a request for a paper copy to ZomaxIncorporated, Attn. Investor Relations, at the address listed on the frontcover of this report.  The Code appliesto our principal executive officer, principal financial officer, principalaccounting officer and corporate controller. Zomax intends to include on its website any amendment to, or waiverfrom, a provision of the Code that for any of these individuals that relates toany element of the code of ethics definition enumerated in Item 406(b) ofRegulation S-K.

 

**ITEM 11.  EXECUTIVE COMPENSATION**

 

Theinformation required by this item is contained in the section entitled“Executive Compensation” appearing in our Proxy Statement to be delivered toshareholders in connection with the 2004 Annual Meeting of Shareholders.  Such information is incorporated herein byreference.

 

**ITEM12.  SECURITY OWNERSHIP OF CERTAINBENEFICIAL OWNERS AND MANAGEMENT AND**

**RELATED SHAREHOLDER MATTERS**

 

The information required by this item relating to the securityownership of certain holders is contained in the section entitled “PrincipalShareholders and Management Shareholdings” appearing in our Proxy Statement tobe delivered to shareholders in connection with the 2004 Annual Meeting ofShareholders.  Such information isincorporated herein by reference.

 

Thefollowing table summarizes our equity compensation plan information as ofDecember 26, 2003.

 
| **Plan Category**                                               |   | **Number of  Securities to be  issued upon exercise of  outstanding options** |   | **Weighted  average exercise  price of outstanding options** |   | **Number of  securities  remaining available for  future issuance** |      |
|-----------------------------------------------------------------|--------|-------------------------------------------------------------------------------|--------|--------------------------------------------------------------|--------|---------------------------------------------------------------------|-----------|
| Equity compensation plans approved by security  holders (1)     |   | 2,890,370                                                                     |   | $                                                            | 5.11   |                                                                | 1,575,384 |   |
| Equity  compensation plans not approved by security holders (2) |   | 432,650                                                                       |   |                                                         | 4.49   |                                                                | N/A       |   |
| Total                                                           |   | 3,323,020                                                                     |   | $                                                            | 5.03   |                                                                | 1,575,384 |   |

 

----

(1)          Plan category includes our 1996 Stock Option Plan (the “1996 Plan”),stock options granted outside of the 1996 Plan that have subsequently beenapproved by shareholders, and our 1996 Employee Stock Purchase Plan.

(2)          Plan category includes stock options that have been granted to employeesoutside of our 1996 Plan due to an insufficient number of shares availableunder the 1996 Plan.  The agreementswith respect to these options are substantially the same as agreements withrespect to options under the 1996 Plan and generally provide for a ten-yearterm with vesting over a period of four to five years.

 

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

 

Theinformation required by this item is contained in the section entitled “CertainTransactions” appearing in our Proxy Statement to be delivered to shareholdersin connection with the 2004 Annual Meeting of Shareholders.  Such information is incorporated herein byreference.

 

34

----

 

**ITEM14.  PRINCIPAL ACCOUNTANT FEES ANDSERVICES**

 

The information required by this item is containedin the section entitled “Principal Accountant Fees and Services” appearing inour Proxy Statement to be delivered to shareholders in connection with the 2004Annual Meeting of Shareholders.  Suchinformation is incorporated by reference.

 

**PART IV**

 

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

 

(a)          Listof Financial Statements, Financial Statement Schedules and Exhibits

 

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

 

Reportof current Independent Auditors dated March 11, 2004

 

Reportof former Independent Public Accountants dated January 25, 2002

 

Consolidated Statementsof Operations for Years Ended December 26, 2003, December 27, 2002, andDecember 28, 2001

 

Consolidated BalanceSheets as of December 26, 2003 and December 27, 2002

 

Consolidated Statementsof Shareholders’ Equity for Years Ended December 26, 2003, December 27, 2002,and December 28, 2001

 

Consolidated Statementsof Cash Flows for Years Ended December 26, 2003, December 27, 2002, andDecember 28, 2001

 

Notes to ConsolidatedFinancial Statements

 

(2)          *Financial Statement Schedules*.  All schedules for which provision is made inthe applicable accounting regulations of the SEC have been omitted as notrequired or not applicable, or the information required has been includedelsewhere by reference in the financial statements and related notes, exceptfor Schedule II, which is included as Exhibit 99.1 to this Form 10-K, as filedwith the SEC.

 

(3)          *Exhibits*. See “Exhibit Index” starting on page 37 of this Form 10-K for adescription of the documents that are filed as Exhibits to this report on Form10-K or incorporated by reference herein.

 

(b)         Reportson Form 8-K filed during the last quarter of the period covered by this report.

 

Wefiled a Form 8-K dated November 28, 2003 announcing the resignation of JohnGelp, our previous Chief Financial Officer.

 

Wefiled a Form 8-K dated November 6, 2003 to announce the settlement of acustomer claim and to furnish our third quarter 2003 financial results.

 

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

 

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

 

35

----

 

**SIGNATURES**

 

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

 

 
| Date:  March 12, 2004 | **ZOMAX  INCORPORATED** |
|----------------------------|-------------------------|
|                       |                    |
|                       | By                      | /s/ Anthony  Angelini |
|                       |                    | Anthony Angelini |
|                       |                    | President, Chief  Executive Officer and Director |

 

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

 

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

 
| **Name**                   |   | **Title**                                        |   | **Date**       |
|----------------------------|--------|--------------------------------------------------|--------|----------------|
|                       |   |                                             |   |           |
| /s/ James T.  Anderson     |   | Chairman of the  Board                           |   | March 12, 2004 |
| James T.  Anderson         |   |                                             |   |           |
|                       |   |                                             |   |           |
| /s/ Anthony  Angelini      |   | President, Chief  Executive Officer and Director |   | March 12, 2004 |
| Anthony Angelini           |   | (principal  executive officer)                   |   |           |
|                       |   |                                             |   |           |
| /s/ Robert J.  Rueckl      |   | Chief Financial  Officer and Secretary           |   | March 12, 2004 |
| Robert J. Rueckl           |   | (principal  financial and accounting officer)    |   |           |
|                       |   |                                             |   |           |
| /s/ Phillip T.  Levin      |   | Director                                         |   | March 12, 2004 |
| Phillip T. Levin           |   |                                             |   |           |
|                       |   |                                             |   |           |
| /s/ Robert  Ezrilov        |   | Director                                         |   | March 12, 2004 |
| Robert Ezrilov             |   |                                             |   |           |
|                       |   |                                             |   |           |
| /s/ Howard P.  Liszt       |   | Director                                         |   | March 12, 2004 |
| Howard P. Liszt            |   |                                             |   |           |
|                       |   |                                             |   |           |
| /s/ Janice  Ozzello Wilcox |   | Director                                         |   | March 12, 2004 |
| Janice Ozzello  Wilcox     |   |                                             |   |           |

 

36

----

 

**EXHIBITINDEX TO FORM 10-K**

 
| **For  the Fiscal Year Ended:** |   | **Commission  File No.** |
|---------------------------------|--------|--------------------------|
| **December  26, 2003**          |   | **0-28426**              |

 
| **Exhibit  Number** |   | **Description**                                                                                                                                                                                                                                                                                                                                       |
|---------------------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 3.1                 |   | Articles of Incorporation, as amended (Incorporated  by reference to Exhibit 3.1 to Annual Report on Form 10-K for year ended  December 29, 2000)                                                                                                                                                                                                     |
| 3.2                 |   | Bylaws. (1)                                                                                                                                                                                                                                                                                                                                           |
| **4.1**             |   | **Form of Stock Certificate. (1)**                                                                                                                                                                                                                                                                                                                    |
| 4.2                 |   | Articles of  Incorporation (See Exhibit 3.1).                                                                                                                                                                                                                                                                                                         |
| 4.3                 |   | Bylaws (See  Exhibit 3.2).                                                                                                                                                                                                                                                                                                                            |
| 10.1                |   | 1996 Stock Option Plan, as amended through January  19, 2000, and Forms of Incentive and Nonqualified Stock Option Agreements  (Incorporated by reference to Exhibit 10.1 to Annual Report on Form 10-K for  the year ended December 31, 1999).**                                                                                                     |
| 10.2*               |   | 1996 Employee  Stock Purchase Plan, as amended February 20, 2002.**                                                                                                                                                                                                                                                                                   |
| 10.3                |   | Lease between  the Company and Nathan Lane Partnership, LLP dated January 1, 1995, as  amended October 28, 1997 (Incorporated by reference to Exhibit 10.5 to  Registration Statement on Form S-1, SEC File No. 333-2430 and Exhibit 10.15  to Annual Report on Form 10-KSB for the year ended December 26, 1997).                                    |
| 10.4                |   | Employment Agreement with James T. Anderson dated  January 1, 1999 (Incorporated by reference to Exhibit 10.5 to Annual Report  on Form 10-K for the year ended December 31, 1999).**                                                                                                                                                                 |
| 10.5                |   | License Agreement with U.S. Philips Corporation  effective January 1, 1996 (Incorporated by reference to Exhibit 10.7 to  Registration Statement on form S-1, SEC File No. 333-2430).                                                                                                                                                                 |
| 10.6                |   | License Agreement with Discovision Associates dated  January 1, 1994 (Incorporated by reference to Exhibit 10.8 to Registration  Statement on Form S-1, SEC File No. 333-2430).                                                                                                                                                                       |
| 10.7                |   | Revolving Credit  and Term Loan Agreement between the Company and Marquette Capital Bank dated  December 31, 1995, as amended April 30, 1997 (Incorporated by reference to  Exhibit 10.16 to Registration Statement on Form S-1, SEC File No. 333-2430,  and Exhibit 10.16 to Quarterly Report on Form 10-QSB for the quarter ended March  27, 1997). |
| 10.8                |   | Credit Agreement dated as of January 6, 1999 among  the Company, Certain Lenders and General Electric Capital Corporation.(2)                                                                                                                                                                                                                         |
| 10.9                |   | Credit Agreement dated as of January 6, 1999 among  Zomax Canada Company, Certain Lenders and General Electric Capital Canada  Inc.(2)                                                                                                                                                                                                                |
| 10.10               |   | Employment Agreement with Anthony Angelini effective  January 1, 2002 (Incorporated by reference to Exhibit 10.11 to Annual Report  on Form 10-K for the year ended December 28, 2001).**                                                                                                                                                             |
| 10.11               |   | Employment Agreement with John Gelp dated October  10, 2001 (Incorporated by reference to Exhibit 10.11 to Annual Report on Form  10-K for the year ended December 28, 2001).**                                                                                                                                                                       |
| 10.12               |   | Lease between the Company and The Scottish Provident  Institution effective March 2, 2001 (Incorporated by reference to Exhibit  10.13 to Annual Report on Form 10-K for the year ended December 28, 2001).                                                                                                                                           |
| 10.13               |   | Employment  Agreement with Michael Miller effective September 16, 2002 (Incorporated by  reference to Exhibit 10.13 to Annual Report on Form 10-K for the year ended  December 27, 2002).**                                                                                                                                                           |
| 10.14               |   | Form of  Nonqualified Option Agreement for options granted outside of 1996 Stock  Option Plan (Incorporated by reference to Exhibit 10.14 to Annual Report on  Form 10-K for the year ended December 27, 2002).**                                                                                                                                     |
| 10.15*              |   | Separation  Agreement dated January 1, 2004 with James T. Anderson.**                                                                                                                                                                                                                                                                                 |

 

37

----

 
| **Exhibit  Number** |   | **Description**                                                                                                                           |   |
|---------------------|--------|-------------------------------------------------------------------------------------------------------------------------------------------|--------|
| 21.1                |   | Listing of  Subsidiaries (Incorporated by reference to Exhibit 21.1 to Annual Report on  Form 10-K for the year ended December 27, 2002). |
| 23.1*               |   | Consent of  Deloitte & Touche LLP                                                                                                     |
| 23.2*               |   | Notice Regarding  Consent of Arthur Andersen LLP                                                                                          |
| 24*                 |   | Power of  Attorney (included on signature page of this report)                                                                            |
| 31.1*               |   | Certification of  Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act.                                              |
| 31.2*               |   | Certification of  Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act.                                              |
| 32.1*               |   | Certification of  Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act.                                              |
| 32.2*               |   | Certification of  Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act.                                              |
| 99.1*               |   | Schedule II –  Valuation and Qualifying Accounts                                                                                     |

 

----

*                 Filed herewith.

**          Management agreementor compensatory plan or arrangement.

(1)          Incorporated byreference to the corresponding exhibit numbers to Form S-1 RegistrationStatement, SEC File No. 333-2430.

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

 

38

----