10-Q 1 tenq.txt TEN1.TXT ================================================================================ SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q [ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Quarterly Period Ended September 30, 2003 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Transition Period From _________ to _________ Commission File Number 0-23077 ---------------------- IMAGEMAX, INC. (Exact name of Registrant as specified in its charter) Pennsylvania 23-2865585 ------------------------------------- ------------------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 455 Pennsylvania Avenue, Suite 200 Fort Washington, Pennsylvania 19034 ---------------------------------------- ---------- (Address of principal executive offices) (Zip Code) (215) 628-3600 --------------------------------- (Registrant's telephone number, including area code) Indicate by check mark whether the Registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No Indicate the number of shares outstanding of each of the issuer's classes of common stock as of November 14, 2003: Common Stock, no par value 7,505,087 -------------------------------- ----------------- Class Number of Shares ================================================================================ IMAGEMAX, INC. INDEX TO FORM 10-Q PART I - FINANCIAL INFORMATION Page Item 1 - Condensed Consolidated Financial Statements (Unaudited) Consolidated Statements of Operations.................. 1 Consolidated Balance Sheets............................ 2 Consolidated Statements of Cash Flows.................. 3 Notes to Consolidated Financial Statements............. 4 Item 2 - Management's Discussion and Analysis of Financial Condition and Results of Operations.................... 9 Item 3 - Quantitative and Qualitative Disclosures about Market Risk...................................... 14 Item 4 - Controls and Procedures................................ 14 PART II - OTHER INFORMATION Item 1 - Legal Proceedings...................................... 15 Item 5 - Other Information .................................... 15 Item 6 - Exhibits and Reports on Form 8-K....................... 15 SIGNATURES............................................................... 16 IMAGEMAX, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited, in thousands except per share amounts)

See accompanying notes. 1 CONSOLIDATED BALANCE SHEETS (Unaudited, in thousands except share amounts)

See accompanying notes. 2 CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited, in thousands)

See accompanying notes. 3 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) 1. BACKGROUND AND BASIS OF PRESENTATION: ImageMax, Inc. ("ImageMax") is a single-source provider of outsourced document management solutions to companies located throughout the United States and concentrated primarily in the health care, financial services, engineering and legal services industries. The Company's services include electronic (digital) and micrographic media conversion, data entry and indexing, Internet retrieval and hosting services, document storage (including Internet "web-enabled" document storage and retrieval) and system integration. The Company also sells and supports document management equipment and proprietary as well as third party open architecture imaging and indexing software. The Company has one reportable segment. The accompanying unaudited condensed consolidated financial statements include the accounts of ImageMax and its subsidiary (the "Company"). All material intercompany balances and transactions have been eliminated in consolidation. The consolidated balance sheet as of December 31, 2002 has been derived from the Company's consolidated financial statements that have been audited by the Company's independent auditors. The unaudited financial statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial reporting pursuant to rules and regulations of the Securities and Exchange Commission ("SEC") in accordance with the requirements of Form 10-Q. Accordingly, unaudited interim financial statements such as those in this report allow certain information and footnotes required by accounting principles generally accepted in the United States for year end financial statements to be excluded. The Company believes all adjustments necessary for a fair presentation of these interim financial statements have been included and are of a normal and recurring nature except for the goodwill impairment charge taken under SFAS 142. Interim results are not necessarily indicative of results for a full year. These interim financial statements should be read in conjunction with the Company's pro forma and historical financial statements and notes thereto included in its Annual Report on Form 10-K for the year ended December 31, 2002. The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICES: Other than Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangibles" ("SFAS 142"), there were no changes in the accounting policies of the Company during the periods presented. For a description of these policies, refer to Note 2 to Consolidated Financial Statements of ImageMax, Inc. and Subsidiary included in the Company's Annual Report on Form 10-K for the year ended December 31, 2002. For a description of SFAS 142 and its impact on the Company, refer to Note 4 hereof. The accompanying consolidated financial statements of the Company have been prepared on a going-concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. The consolidated financial statements do not include any adjustments that might be necessary should the Company be unable to continue in its existence. In the first, second and third quarters of 2003, the Company incurred net losses and failed to meet a required financial covenant under the Revolving Credit Line (the "Revolver," which matures on January 15, 2004) and was therefore in default with respect to the Revolver and its subordinated debt agreements, which mature on February 15, 2004. The Company entered into the First Amendment of the Forbearance Agreement effective September 30, 2003 with the senior lenders, which extended the forbearance period until October 31, 2003. The Company is in discussions with the senior lenders to extend the forbearance period for the balance of 2003. The rights and remedies available to the senior lenders include acceleration of the Revolver balance to be due and payable. Further, at September 30, 2003, the Company had resolved the over-advance position that existed at June 30, 2003 of $886,000, resulting from a reduction in its eligible accounts receivable, as defined in the credit agreement, as amended. There was no over-advance position at September 30, 2003. The Company will require additional working capital in order to continue to meet its current operating obligations beyond December 31, 2003. The combination of these factors indicates significant uncertainty about the Company's ability to continue as a going concern. Management continues to monitor its sales activity and implement certain short-term cost-deferral and cost reduction measures where possible. In addition, the Company has retained an investment-banking firm to act as its exclusive financial advisor to assist the Board of Directors and management in the exploration of strategic alternatives available to the Company. The Company is in negotiations with its subordinated debt holders to obtain necessary working capital and the Company is also in discussions to obtain forbearance from the senior lenders. There can be no assurance that these negotiations or discussions will be successful and any agreement with the subordinated debt holders would be subject to approval by the Company's senior lenders. In the event the Company is unable to secure additional working capital, negotiate any necessary forbearance agreements and/or obtain waivers of any covenant violations from its senior lenders or subordinated debt 4 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) holders currently or in the future, or to be successful in its efforts to locate and consummate strategic alternatives that result in either the sale of the Company or a refinancing of the senior and subordinated debt, the Company may not have the ability to continue as a going concern, may not be able to pay its obligations as they come due, its operations may be significantly curtailed and the Company may have to consider additional alternatives, which may include bankruptcy or liquidation. Accounting for stock-based compensation Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" ("SFAS 123"), encourages entities to record compensation expense for stock-based employee compensation plans at fair value but provides the option of measuring compensation expense using the intrinsic value method prescribed in Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB 25"). The Company accounts for stock-based compensation in accordance with APB 25. The following presents pro forma results of operations as if SFAS 123 had been used to account for stock-based compensation plans. Options were not granted in the nine months ending September 30, 2003 and the quarter ended December 31, 2002. The following pro forma results would have been reported had compensation cost been recorded for the fair value of the options granted:

3. RECLASSIFICATIONS: Prior year amounts have been reclassified to conform to the current year presentation. 4. GOODWILL AND INTANGIBLE ASSETS: The Company performs its annual impairment test in the fourth quarter of each year. The Company, which has one operating segment, has determined that its reporting units should be aggregated under SFAS 142 and deemed a single reporting unit because they have similar economic characteristics. SFAS 142 requires companies to perform an impairment test between the normal required annual tests when an event occurs or circumstances change that would reduce the fair value of a reporting unit below its carrying amount. Management reviewed SFAS 142 and believed that in accordance with SFAS 142 there were impairment indicators, such as incurring operating losses through the first nine months of 2003, the inability to meet a required quarterly financial covenant under the Revolver and the termination of the forbearance agreement with the bank on October 31, 2002, that required the Company to perform the impairment test as of September 30, 2003. The Company completed its calculation of the implied fair value of goodwill during the quarter ended September 30, 2003 and recorded a non-cash charge to the carrying value of goodwill in the amount of $11.4 million. Upon adoption of SFAS 142 during the six months ended June 30, 2002, the Company completed its calculation of the implied fair value of goodwill and recorded a non-cash charge of approximately $15.1 million to reduce the carrying value of its goodwill. Such charge is non-operational in nature and is reflected as a cumulative effect of an accounting change in the accompanying consolidated statements of operations as of January 1, 2002. 5. LONG-TERM DEBT: The Company entered into the First Amendment of the Forbearance Agreement ("First Amendment") effective September 30, 2003 in which the senior lenders agreed to forbear from exercising the rights and remedies available to them as a result of the financial covenant default through October 31, 2003. The original forbearance agreement expired on September 30, 2003. The rights and remedies available to the senior lenders include acceleration of the Revolver balance to be due and payable. In the first, second and third quarters, the Company incurred net losses and failed to meet a required financial covenant under the Revolving Credit Line (the "Revolver," which matures on January 15, 2004) and was therefore in default with respect to the Revolver and its subordinated debt agreements, which mature on February 15, 2004. The Company incurred $30,000 in bank fees associated with the original 5 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) forbearance agreement dated August 21, 2003 and paid $15,000 in September 2003 with the remaining balance of $15,000 due in November 2003. In addition, the Company incurred $25,000 in fees related to the First Amendment. Further, at September 30, 2003, the Company had resolved the over-advance position that existed at June 30, 2003 of $886,000, resulting from a reduction in its eligible accounts receivable, as defined in the credit agreement, as amended. There was no over-advance position at September 30, 2003. As of September 30, 2003, approximately $5.4 million was outstanding on the Revolver. As of June 30, 2003, the Company made the final payment of $365,000 on its Term Loan. On April 11, 2003 the Company completed the Second Amendment to the Amended and Restated Credit Agreement with the Lenders that extended the maturity date of the Revolver to January 15, 2004. Borrowing availability is based on the level of the Company's eligible accounts receivable, as defined in the Credit Agreement. The Credit Facility restricts the payment of dividends and is secured by substantially all assets of the Company and requires maintenance of various financial and restrictive covenants, including a minimum level of quarterly EBITDA of $746,000 (commencing with the first quarter of 2003), total liabilities not exceeding fifty percent (50%) of net worth (as defined in the Credit Agreement), and no interest payment on the subordinated convertible notes issued to the Investors (as defined below) until February 15, 2004. The Company incurred $40,000 in loan fees associated with the Second Amendment payable over the second and third quarters of 2003, which are being amortized over the remaining loan term. The Company paid the first installment of $20,000 in April 2003 and the second installment of $20,000 in September 2003. The Company paid $5,000 for the First Amendment on January 2003. The Company paid $112,000 in bank fees in 2002 (payment was made over the second and third quarters) related to the Credit Agreement dated June 13, 2002, which are being amortized over the loan term. In April 1999, the Company executed a $900,000 mortgage loan with a lender relating to a Company-owned property that houses a production facility. The Company received $869,000 in proceeds, net of closing costs, from the transaction. In July 1999, the $869,000 was applied to the balance of the Credit Facility. Interest on the mortgage is at the greater of 8.50% or the U.S. Treasury rate plus 375 basis points (9.01% at September 30, 2003). The loan carries a ten-year term (maturing May 2009), is secured by the mortgaged property, and requires equal monthly repayments of principal and interest of $7,600. 6. SUBORDINATED CONVERTIBLE DEBT: In order for the Company to enter into the June 14, 2002 Credit Facility, the Company's subordinated debt holders, TDH III, L.P., LVIR Investors Group, LP (formerly known as Dime Capital Partners, Inc.) and Robert E. Drury (the "Investors"), agreed to forego payments of interest until February 15, 2004. In consideration for such forbearance of interest, the Company and the Investors amended the terms of the $6 million convertible subordinated loan and warrant purchase agreement (the "Amendment") on June 14, 2002. Under the terms of the Amendment, the Investors received new convertible subordinated notes (the "New Notes") that replaced the existing notes purchased by the Investors on February 15, 2000 and capitalized $0.27 million of the currently outstanding interest. The New Notes and accrued interest are due and payable on February 15, 2004. Interest accrues at a rate of nine percent (9%), compounded semi-annually on June 30 and December 31. The Company cannot voluntarily prepay the New Notes. However, the Company can elect to extend the due date of the New Notes to February 15, 2005 (the "Extension Right"), if the Company pays seventy-five percent (75%) of the currently outstanding principal balance of the New Notes and interest accrued thereon by February 15, 2004. Up to an aggregate of approximately $2.0 million of the principal amount of the New Notes is voluntarily convertible by the Investors into the Company's common stock, no par value, (the "Common Stock") at a price of $0.40 per share (subject to downward adjustment under certain circumstances), for approximately 4.9 million shares of Common Stock. The Company also issued new warrants (the "New Warrants") that replaced the existing warrants issued to the Investors on February 15, 2000. The New Warrants provide that the Investors may purchase an aggregate of 1.8 million shares of Common Stock at $3.50 per share (subject to downward adjustment under certain circumstances). The New Warrants are only exercisable once the Company has repaid the New Notes in full. If the holder of a New Warrant converts its New Note, in whole or in part, into shares of Common Stock, their New Warrant will be cancelled. Furthermore, the New Warrants will be cancelled if the Additional Warrant (defined below) becomes exercisable. 6 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) The Company also issued additional warrants (the "Additional Warrants") to purchase an aggregate of 8.4 million shares of Common Stock at a price per share equal to the lesser of (i) $0.25 or (ii) eighty percent (80%) of the market price of the Common Stock at the time of exercise. The Additional Warrants are only exercisable upon (i) the date the Company defaults in the payment of any amount due and payable under the New Notes, regardless of whether or not the Company has exercised its Extension Right, or (ii) if the Company has exercised its Extension Right, the date the Company pays the New Notes in full. Once the Additional Warrant is exercisable, the New Warrants will be cancelled. The Additional Warrant is exercisable for a period equal to (i) two (2) years in the event of a default in the payment of amounts due and payable by the Company or (ii) two (2) years from the date the Company exercised the Extension Right in the event the Company pays the New Notes in full. If the Company defaults in the payment of amounts due and payable under the New Notes, when the Company either (i) does not exercise its Extension Right or (ii) exercises its Extension Right after the New Notes have been converted, in whole or in part, into shares of Common Stock, then the Investors can exercise the Additional Warrant by delivery of two-year, interest free, non-recourse notes secured by the pledge of the Additional Warrant shares or by cashless exercise, and the Investors shall be entitled to vote the 8.4 million shares of Common Stock. In the event that the Company exercises its Extension Right and pays the remainder due by February 15, 2005, and the New Notes have not been converted, in whole or in part, into shares of Common Stock, then the number of shares of Common Stock purchasable under the Additional Warrant shall be reduced to an aggregate of 2.2 million shares of Common Stock. 7. INCOME TAXES: At September 30, 2003, the Company had net operating loss carryforwards for federal income tax purposes of approximately $13.4 million expiring in 2016 through 2022. The net operating loss carryforward differs from the accumulated deficit principally due to differences in the recognition of certain expenses for financial and income tax reporting purposes, as well as, the nondeductibility of the loss on the sale of business units and goodwill amortization. The timing and manner in which the company will utilize the net operating loss carryforwards in any year, or in total, may be limited by the provision of the Internal Revenue Service Code. Such limitation may have an impact on the ultimate realization and timing of these net operating loss carryforwards. At September 30, 2003, a valuation allowance offset the Company's tax benefit based upon the uncertainty of the realizability of the associated deferred tax asset given the Company's losses to date under the guidelines set forth in the Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes". 8. EARNINGS PER SHARE: The Company has presented net loss per share pursuant to SFAS No. 128, "Earning Per Share", which requires dual presentation of basic and diluted earnings per share. Basic earnings per share ("Basic EPS") is computed by dividing the net loss for the period by the weighted average number of shares of common stock outstanding for the period. Diluted earnings per share ("Diluted EPS") is computed by dividing net loss for the period by the weighted average number of shares of common stock and common stock equivalents outstanding during the period. For the nine months and three months ended September 30, 2003 and 2002, common stock equivalents are considered anti-dilutive and are not included because of the Company's net loss position, option exercise prices and debt conversion prices exceed the average market price for the period and as such, Basic EPS and Diluted EPS are the same. 9. RESTRICTED COMMON STOCK: Under the Company's 1997 Incentive Plan, in an effort to retain qualified management, Directors and employees, the Company has cancelled 606,000 stock options that far exceed prevailing market values and issued 925,750 shares of restricted common stock. The following common stock issues were made in the fourth quarter of 2002 and second quarter of 2003: Date Shares Value Issued: Issued: per Share: October 22, 2002 463,500 $ 0.14 December 30, 2002 54,250 $ 0.21 April 17, 2003 408,000 $ 0.28 ------- 925,750 ======= The Common stock issued is restricted from sale on the open market for a period of two years. Compensation expense in the amount of $ 191,000 will be recognized over the two-year vesting period. 7 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) 10. NEW ACCOUNTING STANDARDS Effective January 1, 2003, the Company adopted the provisions of Statement of Financial Accounting Standards No. 146, "Accounting for Costs Associated with Exit or Disposal Activities" ("SFAS No. 146"). This statement superseded Emerging Issues Task Force ("EITF") Issue No. 94-3, "Liability Recognition for Certain Employee Terminal Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)." SFAS No. 146 requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred. Under SFAS No. 146, an entity's commitment to a plan, by itself, does not create an obligation that meets the definition of a liability. SFAS No. 146 also establishes fair value as the objective for initial measurement of the liability. Severance pay would be recognized over time rather than at the plan commitment date if the benefit arrangement requires employees to render future service beyond a "minimum retention period." The provisions of SFAS No. 146 are effective for exit or disposal activities that are initiated after December 31, 2002. SFAS No. 146 only applies to prospective activities, and it had no impact on the Company's financial position or results of operations for the three and nine months ended Septmeber 30, 2003. In January 2003, Financial Accounting Standards Board Interpretation No. 46, "Consolidation of Variable Interest Entities" ("FASB Interpretation No. 46"), was issued. Among other things, FASB Interpretation No. 46 defines a variable interest entity ("VIE") as an entity that either has investor voting rights that are not proportional to their economic interests or has equity investors that do not provide sufficient financial resources for the entity to support its activities. FASB Interpretation No. 46 requires a VIE to be consolidated by a company if that company is subject to a majority of the risk of loss from the VIE's activities. If no company is subject to a majority of such risk, consolidation would be required by a company that is entitled to receive a majority of the VIE's residual returns. The Company currently intends to adopt FASB Interpretation No. 46 in the fourth quarter of 2003, when adoption is mandatory, retroactive to January 1, 2003. While management has not completed its evaluation of FASB Interpretation No. 46 at this time, it does not expect that the adoption of FASB Interpretation No. 46 will have a significant impact on the Company's financial statements. 8 PART I - ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS This Report on Form 10-Q contains certain forward-looking statements that involve substantial risks and uncertainties. When used in this Report, the words "anticipate," "believe," "estimate," "expect," "intend," and similar expressions, as they relate to the Company or its management, are intended to identify such forward-looking statements. The Company's actual results, performance, or achievements could differ materially from the results expressed in, or implied by, these forward-looking statements. Factors that could cause or contribute to such differences include those set forth in "Business--Risk Factors" as disclosed in the Company's Annual Report on Form 10-K for the year ended December 31, 2002 and other ImageMax filings with the Securities and Exchange Commission, and risks associated with the results of the continuing operations of ImageMax. Accordingly, there is no assurance that the results in the forward-looking statements will be achieved. The Company is a national single-source provider of integrated document management solutions. The Company's revenues are derived from a broad range of media conversion, storage and retrieval services, the sale of third party document management software products which support digital imaging and indexing services and the sale and service of a variety of document management equipment. The Company's revenues consist of service revenues, which are generally recognized as the related services are rendered, and product revenues, which are recognized when the products are shipped to clients. Service revenues are primarily derived from media conversion, storage and retrieval, imaging and indexing of documents, and the service of imaging and micrographic equipment sold. Product revenues are derived from equipment sales and software sales and support. Cost of revenues consists principally of the costs of products sold and wages and related benefits, supplies, facilities and equipment expenses associated with providing the Company's services. Selling and administrative ("S&A") expenses include salaries and related benefits associated with the Company's executive and senior management, marketing and selling activities (principally salaries and related costs), and financial and other administrative expenses. Critical Accounting Policies The following discussion and disclosures included elsewhere in this Report are based upon the unaudited condensed consolidated financial statements, which have been prepared in accordance with the requirements of Form 10-Q and accounting principles generally accepted in the United States for interim financial reporting. The preparation of these financial statements requires the Company to make estimates, judgments and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities at the date of the financial statements and for the period then ended. The Company continually evaluates the estimates used, including those related to the allowance for doubtful accounts, impairments of tangible and intangible assets, income taxes, and contingencies. The Company has based its estimates on historical experience, current conditions and various other assumptions that the Company believes to be reasonable under the circumstances. These estimates form the basis for making judgments about the carrying values of assets and liabilities and are not readily apparent from other sources. The Company uses these estimates to assist in the identification and assessment of the accounting treatment necessary with respect to commitments and contingencies. Actual results may differ from these estimates under different assumptions or conditions. The Company believes the following critical accounting policies involve more significant judgments and estimates used in the preparation of the consolidated financial statements. Basis of Presentation The accompanying consolidated financial statements of the Company have been prepared on a going-concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. The consolidated financial statements do not include any adjustments that might be necessary should the Company be unable to continue in its existence. Revenue Recognition The Company recognizes media conversion services revenue on services in process, such as scanning projects, as units are completed under the proportional performance method, subject to consideration of guidance in SAB No. 101. Revenue generated from software sales fall under the guidance of SOP 97-2. Hardware and other equipment revenue is recognized FOB shipping point. Accounting for Acquisitions The Company was founded in November 1996 and on December 4, 1997 completed its initial public offering the "Offering". Concurrent with the Offering, the Company began material operations with the acquisition of 14 document management service companies and in the first eight months of 1998 acquired an additional 13 document management service companies. The Company performs its annual impairment test in the fourth quarter of each year. The Company, which has one operating segment, has determined that its reporting units should be aggregated under SFAS 142 and deemed a single reporting unit because they have similar economic characteristics. SFAS 142 requires companies to perform an impairment test between the normal required annual tests when an event occurs or circumstances change that would reduce the fair value of a reporting unit below its carrying 9 amount. Management reviewed SFAS 142 and believed that in accordance with SFAS 142 there were impairment indicators, such as incurring operating losses through the first nine months of 2003, the inability to meet a required quarterly financial covenant under the Revolver and the termination of the forbearance agreement with the bank on October 31, 2002, that required the Company to perform the impairment test as of September 30, 2003. The Company completed its calculation of the implied fair value of goodwill during the quarter ended September 30, 2003 and recorded a non-cash charge to the carrying value of goodwill in the amount of $11.4 million. Upon adoption of SFAS 142 during the six months ended June 30, 2002, the Company completed its calculation of the implied fair value of goodwill and recorded a non-cash charge of approximately $15 million to reduce the carrying value of its goodwill. Such charge is non-operational in nature and is reflected as a cumulative effect of an accounting change in the accompanying consolidated statements of operations as of January 1, 2002. Results of Operations Three Months Ended September 30, 2003 Compared to Three Months Ended September 30, 2002 Overview: For the three months ended September 30, 2003, net loss amounted to $11.9 million or $1.72 per basic and diluted share compared to net income of $16,000 or $0.00 per basic and diluted share for the three months ended September 30, 2002. The Company recorded a goodwill impairment charge of $11.4 million in the quarter due to impairment indicators as defined under SFAS 142 "Goodwill and Other Intangibles". Revenues: For the three months ended September 30, 2003, total revenues decreased $1.1 million, or 10.6% as compared to the corresponding period in 2002. For the three months ended September 30, 2003, services revenue and products revenue, respectively, comprised 89.8% and 10.2% of total revenues, as compared to 84.8% and 15.2% in the corresponding period in 2002. Services revenue decreased 5.3% or $0.5 million primarily due to declines in data entry and litigation coding ($0.4 million) and electronic data discovery ($0.4 million), partially offset by an increase in conversion services ($0.3 million). The decrease in data entry and litigation coding revenue is primarily attributed to the loss of former customers that were part of the Digiscribe litigation disclosed in the Company's Form 10-Q filing dated May 15, 2003. The decrease in electronic data discovery services revenue is attributed to a change in business terms, effective July 2003, in which the outsourced component of these services were directly billed by the provider to certain customers. The impact of this change was to reduce services revenue and cost of services revenue by $0.4 million. Products revenue decreased 40.0% or $0.7 million as a result of lower analog equipment and related supplies sales and lower third party software revenues. These declines were primarily attributable to volume and the Company believes that results related to software, coupled with delayed buying decisions, were indicative of the prolonged effects of the national economy. Results related to equipment and supplies revenues are consistent with recent trends as the Company continues to focus its efforts on services based revenues. Gross Profit: For the three months ended September 30, 2003, gross profit decreased by $0.5 million, or 11.9%. Gross profit percentage decreased from 36.4% to 35.8% in 2003 versus the same corresponding quarter in 2002. The impact of the change in business terms regarding electronic data discovery services discussed above was to increase gross profit percentage from 34.3% to 35.8%. Gross profit declined $0.2 million on services revenue primarily due to the decrease in data entry and litigation coding noted above, partially offset by higher conversion services volume that improved production capacity utilization in several locations. Gross profit declined $0.3 million on products revenue due primarily to volume declines noted above. Selling and Administrative Expenses: For the three months ended September 30, 2003, selling and administrative expenses increased by $93,000, or by 2.7% as compared to the corresponding period in 2002, due primarily to a $53,000 charge incurred for telecommunications utilization and higher business insurance costs. Interest Expense: Interest expense remained constant as the company maintained relatively consistent debt levels at September 30, 2003 versus September 30, 2002. 10 Results of Operations Nine Months Ended September 30, 2003 Compared to Nine Months Ended September 30, 2002 Overview: For the nine months ended September 30, 2003, net loss amounted to $12.8 million or $1.85 per basic and diluted share compared to a net loss of $14.9 million or $2.19 per basic and diluted share for the nine months ended September 30, 2002. The Company recorded a goodwill impairment charge of $11.4 million in the third quarter of 2003 due to impairment indicators defined under SFAS 142 "Goodwill and Intangibles". As previously disclosed, in the first nine months of 2002 the Company recorded a non-cash goodwill charge of $15.1 million or $2.22 per share as a result of implementing SFAS 142. Revenues: For the nine months ended September 30, 2003, total revenues decreased $1.5 million or 4.6% as compared to the corresponding period in 2002. For the nine months ended September 30, 2003, services revenue and products revenue, respectively, comprised 88.5% and 11.5% of total revenues, as compared to 85.1% and 14.9% in the corresponding period in 2002. Service revenue decreased 0.8% or $0.2 million due primarily to a decrease in data entry and litigation coding service ($1.6 million) related to the loss of former customers that were part of the Digiscribe litigation disclosed in the Company's Form 10-Q filing dated May 15, 2003. This decrease was offset by increases in digital conversion services revenue as a result of higher volume, notably in southern California, a facility opened in the fourth quarter of 2002 ($1.0 million) and in litigation projects utilizing electronic data discovery services ($0.6 million). Conversion services revenue increased 6% as digitally based services increased over the prior period. As noted above, there was a change in business terms, effective July 2003, in which the outsourced component of certain electronic data discovery services were directly billed by the provider to certain customers. The impact of this change was to reduce services revenue and cost of services revenue by $0.4 million. Products revenue decreased 25.9% or $1.2 million as a result of lower analog equipment and related supplies sales and lower third party software revenues. These declines were primarily attributable to volume and the Company believes that results related to software, coupled with delayed buying decisions, were indicative of the prolonged effects of the national economy and war in Iraq. Results related to equipment and supplies revenues are consistent with recent trends as the Company continues to focus its efforts on services based revenues. Gross Profit: For the nine months ended September 30, 2003, gross profit decreased by $1.4 million, or 11.7%. Gross profit percentage decreased from 37.7% to 34.9% in 2003 versus the same corresponding period in 2002. Gross profit declined $0.7 million on services revenue primarily due to: lower margins on projects utilizing electronic data discovery services resulting from lower prices accorded to large volume customers; the decline in data entry and litigation coding services noted above; and the impact of severe weather in the Mid-Atlantic and Northeast during the first quarter of 2003. These effects were partially offset by an increase in gross profit related to conversion services in the second and third quarters of 2003 as a result of higher volume and production capacity utilization. The impact of the change in business terms regarding electronic data discovery services discussed above was to increase gross profit percentage from 34.4% to 34.9%. Gross profit declined $0.7 million on products revenue due primarily to volume declines noted above. Selling and Administrative Expenses: For the nine months ended September 30, 2003, selling and administrative expenses increased $89,000 as compared to the corresponding period in 2002. The increase was related to a $53,000 charge incurred for telecom utilization and higher business insurance costs. In addition, administrative expenses included a benefit of $0.1 million related to the settlement of the Digiscribe litigation in the second quarter of 2003, which was more than offset by expenses incurred in the first quarter of 2003 related to the move of operations to more cost effective facilities within the Boston, Detroit and Philadelphia markets. Interest Expense: Interest expense remained constant as the company maintained relatively consistent debt levels at September 30, 2003 versus September 30, 2002. Liquidity and Capital Resources In the first, second and third quarters of 2003, the Company incurred net losses and failed to meet a required financial covenant under the Revolving Credit Line (the "Revolver," which matures on January 15, 2004) and was therefore in default with respect to the Revolver and its subordinated debt agreements, which mature on February 15, 2004. The First Amendment of the Forbearance Agreement, in which the Company's senior lenders agreed to forbear certain of their rights in default, expired on October 31, 2003. The rights and remedies available to the senior lenders include acceleration of the Revolver balance to be due and payable. Further, at September 30, 2003, the Company resolved the over-advance position that existed at June 30, 2003 of $886,000, resulting from a reduction in its eligible accounts receivable, as defined in the credit agreement, as amended. There was no over-advance position at September 30, 2003. The Company will require additional working capital in order to continue to meet its current operating obligations. The combination of these factors indicates significant uncertainty about the Company's ability to continue as a going concern. 11 Management continues to monitor its sales activity and implement certain short-term cost-deferral and cost reduction measures where possible. In addition, the Company has retained an investment-banking firm to act as its exclusive financial advisor to assist the Board of Directors and management in the exploration of strategic alternatives available to the Company. The Company is in negotiations with its subordinated debt holders to obtain necessary working capital and the Company is also in discussions to obtain forbearance from the senior lenders. There can be no assurance that these negotiations or discussions will be successful and any agreement with the subordinated debt holders would be subject to approval by the Company's senior lenders. In the event the Company is unable to secure additional working capital, negotiate any necessary forbearance agreements and/or obtain waivers of any covenant violations from its senior lenders or subordinated debt holders currently or in the future, or to be successful in its efforts to locate and consummate strategic alternatives that result in either the sale of the Company or a refinancing of the senior and subordinated debt, the Company may not have the ability to continue as a going concern, may not be able to pay its debts as they come due, its operations may be significantly curtailed and the Company may have to consider additional alternatives, which may include bankruptcy or liquidation. As of September 30, 2003, the Company had nominal cash and cash equivalents, and a working capital deficit of $11.2 million. The working capital deficit includes the outstanding balance of the Revolver of $5.4 million and subordinated convertible debt of $7.3 million, which are due January 15, 2004 and February 15, 2004, respectively. Working capital net of the senior and subordinated debt balances was approximately $1.6 million as of September 30, 2003. As of December 31, 2002 the Company had cash and cash equivalents of $0.9 million and working capital of $2.5 million. In addition, the Company made $0.8 million in principal payments on the Term Loan for the six months ended June 30, 2003 and reduced its Revolver balance by $0.3 million for the nine months ended September 30, 2003. For the nine months ended September 30, 2003 net cash provided by operating activities amounted to $0.8 million; net cash used in investing activities amounted to $0.5 million; and net cash used in financing activities amounted to $1.2 million. The Company will require additional working capital in order to continue to meet its current operating obligations. Net cash provided by operating activities primarily represents net loss before depreciation and amortization. For the nine months ended September 30, 2003, increases in deferred revenue for advance customer deposits, increased cash collections on accounts receivable and decreases in inventories to meet future production needs were offset by increases in prepaid assets and deposits for upcoming projects, decreases in accrued expenses due to payment of 2002 sales commissions and other operating expenses, and decreases in accounts payable arising from the Company's ongoing efforts to manage its working capital position. Net cash used in investing activities represents the Company's investments in equipment and information technology for new and existing production facilities. For the nine months ended September 30, 2003, the Company made capital expenditures of $0.5 million. Net cash used in financing activities primarily represents the $0.8 million of payments under the Term Loan, $0.3 of net payments on the Revolver, and $0.1 payment of deferred financing costs. The Company continues to selectively invest in equipment and technology to meet the needs of its operations and to improve its operating efficiency. Credit Facility (The following disclosure is consistent with Note 5 to the Consolidated Financial Statements) The Company entered into the First Amendment of the Forbearance Agreement ("First Amendment") effective September 30, 2003 in which the senior lenders agreed to forbear from exercising the rights and remedies available to them as a result of the financial covenant default through October 31, 2003. The original forbearance agreement expired on September 30, 2003. The rights and remedies available to the senior lenders include acceleration of the Revolver balance to be due and payable. In the first, second and third quarters of 2003, the Company incurred net losses and failed to meet a required financial covenant under the Revolving Credit Line (the "Revolver," which matures on January 15, 2004) and was therefore in default with respect to the Revolver and its subordinated debt agreements, which mature on February 15, 2004. The Company incurred $30,000 in bank fees associated with the forbearance agreement dated August 21, 2003 and paid $15,000 in September 2003 with the remaining balance of $15,000 due in November 2003. In addition, the Company incurred $25,000 in fees related to the First Amendment. Further, at September 30, 2003, the Company resolved the over-advance position that existed at June 30, 2003 of $886,000, resulting from a reduction in its eligible accounts receivable, as defined in the credit agreement, as amended. There was no over-advance position at September 30, 2003. As of June 30, 2003, the Company made the final payment of $365,000 on its Term Loan. On April 11, 2003 the Company completed the Second Amendment to the Amended and Restated Credit Agreement with the Lenders that extended the maturity date of the Revolver to January 15, 2004. Borrowing availability is based on the level of the Company's eligible accounts receivable, as defined in the Credit Agreement. As of September 30, 2003, approximately $5.4 million was outstanding on the Revolver. 12 The Credit Facility restricts the payment of dividends and is secured by substantially all assets of the Company and requires maintenance of various financial and restrictive covenants, including a minimum level of quarterly EBITDA of $746,000 (commencing with the first quarter of 2003), total liabilities not exceeding fifty percent (50%) of net worth (as defined in the Credit Agreement), and no interest payment on the subordinated convertible notes issued to the Investors (as defined below) until February 15,2004 The Company incurred $40,000 in loan fees associated with the Second Amendment payable over the second and third quarters of 2003, which are being amortized over the remaining loan term. The Company paid $20,000 in April 2003 for and $20,000 in November 2003 the Second Amendment in 2002. The Company paid $5,000 for the First Amendment on January 2003. The Company paid $112,000 in bank fees in 2002 (payment was made over the second and third quarters) related to the Credit Agreement dated June 13, 2002, which are being amortized over the loan term. In connection with the Credit Facility, the Company entered into an interest rate cap agreement that matured on June 13, 2003, with a total notional amount of $2,000,000. The Company paid the counterparty a premium of $7,500 on June 12, 2002, and was to receive monthly an amount equal to the product of the amount by which the Prime Rate (4.0% at September 30, 2003) exceeded the Cap Rate (6.5%) multiplied by the notional amount. The premium was amortized over a one-year period. The Prime Rate did not exceed the Cap Rate and the Company did not receive any payments under this agreement. In April 1999, the Company executed a $900,000 mortgage loan with a lender relating to a Company-owned property that houses a production facility. The Company received $869,000 in proceeds, net of closing costs, from the transaction. In July 1999, the $869,000 was applied to the balance of the Credit Facility. Interest on the mortgage is at the greater of 8.50% or the U.S. Treasury rate plus 375 basis points (9.01% at September 30, 2003). The loan carries a ten-year term (maturing May 2009), is secured by the mortgaged property, and requires equal monthly repayments of principal and interest of $7,600. Convertible Subordinated Debt (The following disclosure is consistent with Note 6 to the Consolidated Financial Statements) In order for the Company to enter into the June 14, 2003 Credit Facility, the Company's subordinated debt holders, TDH III, L.P., LVIR Investors Group, LP (formerly known as Dime Capital Partners, Inc.) and Robert E. Drury (the "Investors"), agreed to forego payments of interest until February 15, 2004. In consideration for such forbearance of interest, the Company and the Investors amended the terms of the $6 million convertible subordinated loan and warrant purchase agreement (the "Amendment") on June 14, 2002. Under the terms of the Amendment, the Investors received new convertible subordinated notes (the "New Notes") that replaced the existing notes purchased by the Investors on February 15, 2000 and capitalized $0.27 million of the currently outstanding interest. The New Notes and accrued interest are due and payable on February 15, 2004. Interest accrues at a rate of nine percent (9%), compounded semi-annually on June 30 and December 31. The Company cannot voluntarily prepay the New Notes. However, the Company can elect to extend the due date of the New Notes to February 15, 2005 (the "Extension Right"), if the Company pays seventy-five percent (75%) of the currently outstanding principal balance of the New Notes and interest accrued thereon by February 15, 2004. Up to an aggregate of approximately $2.0 million of the principal amount of the New Notes is voluntarily convertible by the Investors into the Company's common stock, no par value, (the "Common Stock") at a price of $0.40 per share (subject to downward adjustment under certain circumstances), for approximately 4.9 million shares of Common Stock. The Company also issued new warrants (the "New Warrants") that replaced the existing warrants issued to the Investors on February 15, 2000. The New Warrants provide that the Investors may purchase an aggregate of 1.8 million shares of Common Stock at $3.50 per share (subject to downward adjustment under certain circumstances). The New Warrants are only exercisable once the Company has repaid the New Notes in full. If the holder of a New Warrant converts its New Note, in whole or in part, into shares of Common Stock, their New Warrant will be cancelled. Furthermore, the New Warrants will be cancelled if the Additional Warrants (defined below) become exercisable. The Company also issued additional warrants (the "Additional Warrants") to purchase an aggregate of 8.4 million shares of Common Stock at a price per share equal to the lesser of (i) $0.25 or (ii) eighty percent (80%) of the market price of the Common Stock at the time of exercise. The Additional Warrants are only exercisable upon (i) the date the Company defaults in the payment of any amount due and payable under the New Notes, regardless of whether or not the Company has exercised its Extension Right, or (ii) if the Company has exercised its Extension Right, the date the Company pays the New Notes in full. Once the Additional Warrant is exercisable, the New Warrants will be cancelled. The Additional Warrant is exercisable for a period equal to (i) two (2) years in the event of a default in the payment of amounts due and payable by the Company or (ii) two (2) years from the date the Company exercised the Extension Right in the event the Company pays the New Notes in full. If the Company defaults in the payment of amounts due and payable under the New Notes, when the Company either (i) does not exercise its Extension Right or (ii) exercises its Extension Right after the New Notes have been converted, in whole or in part, into shares of Common Stock, then the Investors can exercise the Additional Warrant by delivery of two-year, interest free, non-recourse notes secured by the pledge of the Additional Warrant shares or by cashless exercise, and the Investors shall be entitled to vote the 8.4 million shares of Common Stock. In the 13 event that the Company exercises its Extension Right and pays the remainder due by February 15, 2005, and the New Notes have not been converted, in whole or in part, into shares of Common Stock, then the number of shares of Common Stock purchasable under the Additional Warrants shall be reduced to an aggregate of 2.2 million shares of Common Stock. New Accounting Standards Effective January 1, 2003, the Company adopted the provisions of Statement of Financial Accounting Standards No. 146, "Accounting for Costs Associated with Exit or Disposal Activities" ("SFAS No. 146"). This statement superseded Emerging Issues Task Force ("EITF") Issue No. 94-3, "Liability Recognition for Certain Employee Terminal Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)." SFAS No. 146 requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred. Under SFAS No. 146, an entity's commitment to a plan, by itself, does not create an obligation that meets the definition of a liability. SFAS No. 146 also establishes fair value as the objective for initial measurement of the liability. Severance pay would be recognized over time rather than at the plan commitment date if the benefit arrangement requires employees to render future service beyond a "minimum retention period." The provisions of SFAS No. 146 are effective for exit or disposal activities that are initiated after December 31, 2002. SFAS No. 146 only applies to prospective activities, and it had no impact on the Company's financial position or results of operations for the three and nine months ended September 30, 2003. In January 2003, Financial Accounting Standards Board Interpretation No. 46, "Consolidation of Variable Interest Entities" ("FASB Interpretation No. 46"), was issued. Among other things, FASB Interpretation No. 46 defines a variable interest entity ("VIE") as an entity that either has investor voting rights that are not proportional to their economic interests or has equity investors that do not provide sufficient financial resources for the entity to support its activities. FASB Interpretation No. 46 requires a VIE to be consolidated by a company if that company is subject to a majority of the risk of loss from the VIE's activities. If no company is subject to a majority of such risk, consolidation would be required by a company that is entitled to receive a majority of the VIE's residual returns. The Company currently intends to adopt FASB Interpretation No. 46 in the fourth quarter of 2003, when adoption is mandatory, retroactive to January 1, 2003. While management has not completed its evaluation of FASB Interpretation No. 46 at this time, it does not expect that the adoption of FASB Interpretation No. 46 will have a significant impact on the Company's financial statements. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The Company's major market risk exposure is to changing interest rates. The Company has variable-rate debt representing 39% of its total debt as of September 30, 2003. If interest rates average 25 basis points more in 2003 than they did in 2002, the Company's interest expense would increase approximately $13,600 on an annual basis (interest expense for 2002 was $1.2 million). As of November 13, 2003, the prime rate had not changed, however, the Company's interest rate on its variable-rate Revolver debt increased 50 basis points in accordance with the original forbearance agreement dated August 21, 2003. ITEM 4. CONTROLS AND PROCEDURES (a) An evaluation was performed under the supervision and with the participation of the Company's management, including its Chief Executive Officer, or CEO, and Chief Financial Officer, of CFO, of the effectiveness of the Company's disclosure controls and procedures, (as such term is defined under Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as amended (the "Exchange Act") as of September 30, 2003. Based on that evaluation, the Company's management, including the CEO and CFO, concluded that the Company's disclosure controls and procedures are effective to ensure that information required to be disclosed by the Company in reports that it files or submits under the Exchange Act, is recorded, processed, summarized and reported as specified in Securities and Exchange Commission rules and forms. (b) There were no changes in the Company's internal control over financial reporting identified in connection with the evaluation of such controls that occurred during the Company's most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the Company's internal control over financial reporting. 14 PART II -- OTHER INFORMATION ITEM 1. Legal Proceedings None. ITEM 5. Other Information. None. ITEM 6. Exhibits and Reports on Form 8-K. a. Exhibits. 31.1 Certification pursuant to 18 U.S.C.ss.1350, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 signed by Mark P. Glassman, Chief Executive Officer (filed herewith). 31.2 Certification pursuant to 18 U.S.C.ss.1350, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 signed by David B. Walls, Chief Financial Officer (filed herewith). 32.1 Certification pursuant to 18 U.S.C.ss.1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 signed by Mark P. Glassman, Chief Executive Officer (filed herewith). 32.2 Certification pursuant to 18 U.S.C.ss.1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 signed by David B. Walls, Chief Financial Officer (filed herewith). b. Reports on Form 8-K: The Company filed a Form 8-K on August 1, 2003 reporting the Press Release dated August 1, 2003 which disclosed preliminary financial results of the Company for the fiscal quarter ended June 30, 2003. The Company filed a Form 8-K on August 28, 2003 reporting the Forbearance Agreement dated August 21, 2003 by and among ImageMax, Inc., Commerce Bank, NA, and FirsTrust Bank. The Company filed a Form 8-K on October 8, 2003 reporting the First Amendment to the Forbearance Agreement dated September 30, 2003 by and among ImageMax, Inc., Commerce Bank, NA, and FirsTrust Bank. 15 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized. IMAGEMAX, INC. BY: /S/ MARK P. GLASSMAN November 14, 2003 -------------------- ----------------- Mark P. Glassman Chief Executive Officer BY: /S/ DAVID B. WALLS November 14, 2003 ------------------ ----------------- David B. Walls Chief Financial Officer, Treasurer and Secretary 16 EXHIBIT INDEX 31.1 Certification pursuant to 18 U.S.C.ss.1350, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 signed by Mark P. Glassman, Chief Executive Officer (filed herewith). 31.2 Certification pursuant to 18 U.S.C.ss.1350, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 signed by David B. Walls, Chief Financial Officer (filed herewith). 32.1 Certification pursuant to 18 U.S.C.ss.1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 signed by Mark P. Glassman, Chief Executive Officer (filed herewith). 32.2 Certification pursuant to 18 U.S.C.ss.1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 signed by David B. Walls, Chief Financial Officer (filed herewith).

IMAGEMAX INC 10-Q