10-Q 1 tenq.txt 10-Q ================================================================================ 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, 2002 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 13, 2002: Common Stock, no par value 6,793,323 -------------------------- ---------------- Class Number of Shares ================================================================================ IMAGEMAX, INC. INDEX TO FORM 10-Q

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, 2001 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 information pursuant to rules and regulations of the Securities and Exchange Commission ("SEC"). 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, 2001. 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, 2001. For a description of SFAS 142 and its impact on the Company, refer to Note 5 hereof. 3. NEW ACCOUNTING STANDARDS: Effective January 1, 2002, Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets" ("SFAS No. 142"), was adopted. SFAS No. 142 requires the testing of goodwill and indefinite-lived intangible assets for impairment rather than amortizing them. ImageMax ceased amortizing goodwill effective January 1, 2002 and determined during the second quarter of 2002 that its goodwill was impaired. The Company's amortization of goodwill and indefinite-lived intangible assets was $1.8 million during the year 2001. In August 2001, the FASB issued Statement of Financial Accounting Standards No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets" ("SFAS No. 144"). Among other things, SFAS No. 144 significantly changes the criteria that would have to be met to classify an asset as held-for-sale. This statement supersedes Statement of Financial Accounting Standards No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of", and the provisions of Accounting Principles Board Opinion 30, "Reporting the Results of Operations - Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions" that relate to reporting the effects of a disposal of a segment of a business. The Company adopted SFAS 144 effective January 1, 2002, when adoption was mandatory. This new accounting standard had no impact on the Company's consolidated results. In August 2001, Statement of Financial Accounting Standards No. 143, "Accounting for Asset Retirement Obligations" ("SFAS No. 143"), was issued. This statement significantly changes the method of accruing for costs that an entity is legally obligated to incur associated with the retirement of fixed assets. The Company will evaluate the impact and timing of implementing SFAS No. 143, which is required no later than January 1, 2003. 4 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) 4. RECLASSIFICATIONS: Certain prior year amounts have been reclassified to conform to the current year presentation. 5. GOODWILL AND INTANGIBLE ASSETS: Cumulative Effect of Accounting Policy Change In July 2001, the Financial Accounting Standards Board ("FASB") issued SFAS Nos. 141 and 142, "Business Combinations" and "Goodwill and Other Intangibles." SFAS 141 requires all business combinations initiated after July 1, 2001, to be accounted for using the purchase method. SFAS 142 concluded that purchased goodwill would not be amortized but would be reviewed for impairment when certain events indicate that the goodwill of a reporting unit is impaired. 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. The impairment test uses a fair value based approach, whereby if the implied fair value of a reporting unit's goodwill is less than its carrying amount, goodwill would be considered impaired. SFAS 142 requires that goodwill be tested for impairment upon adoption if an indicator of impairment exists at that date and that any transition adjustment be recorded at the beginning of the year in which SFAS 142 is adopted. All goodwill and indefinite-lived intangible assets must be tested for impairment at least annually. The new goodwill model applies not only to goodwill arising from acquisitions completed after the effective date, but also to goodwill previously recorded. Effective January 1, 2002, the Company adopted SFAS 142. Upon adoption of SFAS 142, the Company ceased amortization of its goodwill and determined that the fair value of the reporting units exceeded the reporting units' carrying value. During the six months ended June 30, 2002, the Company completed its calculation of the implied fair value of goodwill under SFAS 142 and recorded a one time, 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 statement of operations as of January 1, 2002. In calculating the impairment charge, the fair value of the reporting units of the Company was estimated using both discounted cash flow methodology and recent comparable transactions. The Company will perform its required annual impairment review during the fourth quarter of each year, commencing in the fourth quarter of 2002 using the same methodology. The following table presents the impact of SFAS 142 on income prior to cumulative effect of accounting change per share had the standard been in effect for the three months and nine months ended September 30, 2001.

The Company is required to perform goodwill impairment tests on an annual basis and between tests in certain circumstances. For the period from June 30, 2002 through November 13, 2002, no further impairment indicators were noted. No additional impairment charge of goodwill has been recognized. There can be no assurance that future goodwill impairment tests will not result in an additional charge to earnings. 5 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) 6. LONG-TERM DEBT: On June 14, 2002, ImageMax, Inc. (the "Company") completed the closing (the "Closing") of a new $7.48 million senior credit facility (the "Credit Facility") pursuant to the Credit Agreement dated June 13, 2002 (the "Credit Agreement") with Commerce Bank, NA and FirsTrust Bank (the "Lenders"). The Credit Facility consists of a $5.25 million revolving credit line (the "Revolving Credit Line") and a $2.23 million term loan (the "Term Loan"). The Company used the proceeds of the Credit Facility to repay existing senior debt and for working capital. Under the Revolving Credit Line, the Company is required to pay interest monthly at the prime rate plus 2.0% (effective rate of 6.75% as of September 30, 2002). The outstanding principal of the Revolving Credit Line is due and payable at the end of term on June 30, 2003. Borrowing availability is based on the level of the Company's eligible accounts receivable, as defined in the Credit Agreement. As of September 30, 2002, approximately $4.7 million was outstanding under the Revolving Credit Line, and approximately $539,000 was available under the credit line. The Company borrowed $300,000 on the Revolving Credit Line in October 2002. Under the Term Loan, interest is payable monthly at the prime rate plus 2.0% (effective rate of 6.75% as of September 30, 2002). The outstanding principal amount of the Term Loan is due and payable in three consecutive quarterly payments of $500,000 commencing June 30, 2002, with two additional quarterly installments of $365,000 due on March 31, 2003 and June 30, 2003. At September 30, 2002, the Company paid its quarterly installment of $500,000 which resulted in a balance on the Term loan of $1.23 million. 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 $750,000 (commencing with the second quarter of 2002), 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 paid $56,115 in bank fees at the Closing, and an additional $56,115 on September 12, 2002, which are being amortized over the loan term. In connection with the Credit Facility, the Company entered into an interest rate cap agreement maturing 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 will receive monthly an amount equal to the product of the amount by which the Prime Rate (4.75% at September 30, 2002) exceeds the Cap Rate (6.5%) multiplied by the notional amount. The premium is being amortized over a one year period. Since entering the interest rate cap agreement, the Prime Rate has not exceeded the Cap Rate. Accordingly, the Company has not received 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 (9.00% at September 30, 2002). 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 $10,000. 6 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) 7. SUBORDINATED CONVERTIBLE DEBT: In order for the Company to enter into the Credit Facility, the Company's subordinated debt holders, TDH III, L.P., Dime Capital Partners, Inc. and Robert E. Drury (the "Investors"), were required 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 (subject to downward adjustment under certain circumstances) 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) becomes 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 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. 8. INCOME TAXES: At September 30, 2002, the Company had net operating loss carryforwards for federal income tax purposes of approximately $11.9 million expiring in 2016 through 2021. 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. 7 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) 8. INCOME TAXES (continued): At September 30, 2002, a valuation allowance was established for 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". 9. EARNINGS PER SHARE: The Company has presented net income (loss) per share pursuant to SFAS No. 128, "Earnings 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 income (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 income (loss) for the period by the weighted average number of shares of common stock and common stock equivalents outstanding during the period. For the three months and nine months ended September 30, 2002, common stock equivalents are not included because 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. For the three months and nine months ended September 30, 2001, common stock equivalents are not included, as their effect is antidilutive and, as such, Basic EPS and Diluted EPS are the same. 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, 2001 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. ImageMax was founded in November 1996 to become a leading, 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 proprietary, as well as third party open-architecture 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 consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. 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. On an on-going basis, the Company 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. Revenue Recognition The Company recognizes media conversion services revenue on services in process, such as scanning projects, based on the percentage-of-completion method in accordance with SOP 81-1. 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 purchase price of these acquisitions was determined after due diligence of the acquired business, market research, strategic planning, and the forecasting of expected future results and synergies. Estimated future results and expected synergies are subject to revisions as the Company integrates each acquisition and attempts to leverage resources. Each acquisition was accounted for using the purchase method of accounting in accordance with Accounting Principles Board Opinion No. 16, "Accounting for Business Combinations" resulting in the capitalization of the cost in excess of fair value of the net assets acquired in each of these acquisitions as goodwill. 9 PART I - ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The Company's acquisitions have resulted in a significant accumulation of goodwill and for acquisitions prior to July 1, 2001, the Company amortized the related goodwill over an estimated benefit period of 30 years. There have been no acquisitions completed after July 1, 2001 and the Company is no longer amortizing goodwill beginning on January 1, 2002, in accordance with SFAS 142, "Goodwill and Other Intangible Assets". 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 under SFAS 142 and recorded a one time, 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 statement of operations as of January 1, 2002. In calculating the impairment change, the fair value of the reporting units of the Company was estimated using both discounted cash flow methodology and recent comparable transactions. The Company will perform its required annual impairment review during the fourth quarter of each year, commencing in the fourth quarter of 2002 using the same methodology. Historical Results of Operations Three Months Ended September 30, 2002 Compared to Three Months Ended September 30, 2001 Overview. For the three months ended September 30, 2002, net income amounted to $16,000 or $0.00 per Basic and Diluted share compared to a net loss of $580,000 or $0.09 per Basic and Diluted share for the three months ended September 30, 2001. Revenues. For the three months ended September 30, 2002, total revenues increased $0.1 million, or 1.2%, as compared to the corresponding period in 2001. This was primarily due to a services revenue increase of 1.9%. For the three months ended September 30, 2002, services revenue and products revenue, respectively, comprised 84.8% and 15.2% of total revenues, as compared to 84.3% and 15.7% in the corresponding period in 2001. In services revenue, legal conversion services, litigation coding and electronic data discovery were the primary drivers of the third quarter increase. In addition, ImageMaxOnline, the Company's internet document repository, reported a modest increase in the quarter. Products revenue was flat versus 2001; however, the mix was favorable as higher margin software products were the larger component of revenue in the quarter. Gross profit. For the three months ended September 30, 2002, gross profit increased by $0.1 million, or 2.6%, as a result of higher revenues and improved gross profit percentage due to favorable mix gains. Gross profit percentage improved from 35.9% to 36.4% in the current quarter 2002 versus the same corresponding quarter in 2001. Selling and administrative expenses. For the three months ended September 30, 2002, S&A expenses decreased by $0.1 million, or 2.0%, as compared to the corresponding period in 2001. The decrease resulted from the Company's ongoing efforts to centralize its accounting and administrative functions net of investments aimed at expanding its sales presence in major metropolitan markets such as Chicago, Los Angeles and Minneapolis. Interest expense. For the three months ended September 30, 2002, interest expense amounted to $0.3 million, as compared to interest expense of $0.4 million in the corresponding period in 2001. The decrease is due to lower senior debt levels and lower interest rates in 2002 versus 2001. Nine Months Ended September 30, 2002 Compared to Nine Months Ended September 30, 2001 Overview. For the nine months ended September 30, 2002, net loss amounted to $14.9 million or $2.22 per Basic and Diluted share compared to a net loss of $1.1 million or $0.17 per Basic and Diluted share for the nine months ended September 30, 2001. In addition, for the nine months ended September 30, 2002, income before cumulative effect of accounting change amounted to $171,000 or $0.03 per Basic and Diluted share before the Company recorded an impairment charge of $15.1 million due to the implementation of SFAS 142 during the nine months ended September 30, 2002. Revenues. For the nine months ended September 30, 2002, total revenues decreased $4.1 million, or 11.3%, as compared to the corresponding period in 2001. This was due to a product revenue decrease of 22.4% and a service revenue decrease of 9.0%. For the nine months ended September 30, 2002, service revenue and product revenue, respectively, comprised 85.1% and 14.9% of total revenues, as compared to 83.0% and 17.0% in the corresponding period in 2001. 10 PART I - ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The decline in total revenue was due primarily to lower micrographics conversion services and equipment and supplies sales as the Company continues its transition to higher margin services and products. Overall, the Company's revenue mix continues to improve with digital conversion services, legal services, ImageMaxOnline, and software and systems sales increasing as a percentage of total revenue. Gross profit. For the nine months ended September 30, 2002, gross profit decreased by $0.9 million, or 7.2%, as compared to the corresponding period in 2001 as a result of lower revenues. However, during the same corresponding periods, gross profit percentage increased from 36.0% to 37.8% due to favorable revenue mix gains due to the Company's migration to digital conversion services, and software products along with lower operating costs. Selling and administrative expenses. For the nine months ended September 30, 2002, S&A expenses decreased by $0.8 million, or 6.6%, as compared to the corresponding period in 2001. The decrease resulted from the Company's ongoing efforts to centralize its accounting and administrative functions net of investments aimed at expanding its sales presence in major metropolitan markets. Interest expense. For the nine months ended September 30, 2002, interest expense amounted to $0.9 million, as compared to interest expense of $1.3 million in the corresponding period in 2001. The decrease is due to lower senior debt levels and lower interest rates in 2002 versus 2001. Liquidity and Capital Resources As of September 30, 2002, the Company had cash and cash equivalents of $0.2 million and a working capital deficit of $3.5 million. The working capital deficit includes the outstanding balance of the Revolving Credit Line of $4.7 million which is due June 30, 2003. As of December 31, 2001 the Company had cash and cash equivalents of $0.1 million and working capital of $0.6 million. In addition, the Company made $1.5 million in principal payments on the Term Loan for the nine months ended September 30, 2002. For the nine months ended September 30, 2002 net cash provided by operating activities amounted to $1.8 million; net cash used in investing activities amounted to $0.4 million; and net cash used in financing activities amounted to $1.3 million. Net cash provided by operating activities primarily represents net income before depreciation and amortization and cumulative effect of accounting change. For the nine months ended September 30, 2002, liquidation of supplies inventory to meet maintenance and conversion services demands, increases in deferred revenue for advance cash deposits on software and systems installations, and increases in accounts payable to accommodate working capital needs were offset by increased billings to customers, increases in prepaid assets and deposits for upcoming projects, and decreases in accrued expenses due to payments of restructuring charges incurred during 2001. Net cash used in investing activities represents the Company's investments in production facilities equipment and information technology for ImageMaxOnline, the sales force and corporate headquarters. For the nine months ended September 30, 2002, the Company made capital expenditures of $0.4 million. Net cash used in financing activities primarily represents the $1.5 million of payments under the Term Loan and $0.3 million in payments of deferred financing costs offset by $0.5 borrowings on the Revolver loan. The Company borrowed $300,000 on the Revolving Credit Line in October 2002. The Company continues to selectively invest in equipment and technology to meet the needs of its operations and to improve its operating efficiency. The Company may also consider selective synergistic in-market acquisitions in the future. The Company believes that its operating cash flow together with the unused portion of the new Revolving Credit Line will be sufficient to finance current operating requirements through the first half of 2003. Credit Facility (The following disclosure is consistent with Note 6 to the Consolidated Financial Statements) On June 14, 2002, ImageMax, Inc. (the "Company") completed the closing (the "Closing") of a new $7.48 million senior credit facility (the "Credit Facility") pursuant to the Credit Agreement dated June 13, 2002 (the "Credit Agreement") with Commerce Bank, NA and FirsTrust Bank (the "Lenders"). The Credit Facility consists of a $5.25 million revolving credit line (the "Revolving Credit Line") and a $2.23 million term loan (the "Term Loan"). The Company used the proceeds of the Credit Facility to repay existing senior debt and for working capital. 11 PART I - ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Under the Revolving Credit Line, the Company is required to pay interest monthly at the prime rate plus 2.0% (effective rate of 6.75% as of September 30, 2002). The outstanding principal of the Revolving Credit Line is due and payable at the end of term on June 30, 2003. Borrowing availability is based on the level of the Company's eligible accounts receivable, as defined in the Credit Agreement. As of September 30, 2002, approximately $4.7 million was outstanding under the Revolving Credit Line and approximately $539,000 was available under the credit line. The Company borrowed $300,000 on the Revolving Credit Line in October 2002. Under the Term Loan, interest is payable monthly at the prime rate plus 2.0% (effective rate of 6.75% as of September 30, 2002). The outstanding principal amount of the Term Loan is due and payable in three consecutive quarterly payments of $500,000 commencing June 30, 2002, with two additional quarterly installments of $365,000 due on March 31, 2003 and June 30, 2003. At September 30, 2002, the company paid $500,000 which resulted in a balance on the Term loan of $1.23 million. 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 $750,000 (commencing with the second quarter of 2002), 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 paid $56,115 in bank fees at the Closing, and an additional $56,115 on September 12, 2002. In connection with the Credit Facility, the Company entered into an interest rate cap agreement maturing 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 will receive monthly an amount equal to the product of the amount by which the Prime Rate (4.75% at September 30, 2002) exceeds the Cap Rate (6.5%) multiplied by the notional amount. Since entering the interest rate cap agreement, the Prime Rate has not exceeded the Cap Rate. Accordingly, the Company has not received any payments under this agreement. Convertible Subordinated Debt (The following disclosure is consistent with Note 7 to the Consolidated Financial Statements) In order for the Company to enter into the Credit Facility, the Company's subordinated debt holders, TDH III, L.P., Dime Capital Partners, Inc. and Robert E. Drury (the "Investors"), were required to commit 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 (subject to downward adjustment under certain circumstances) 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 (as defined below) becomes exercisable. 12 PART I - ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 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. New Accounting Standards See Note 3 in the Notes to Consolidated 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 53% of its total long-term debt at September 30, 2002. If interest rates average 25 basis points more in 2002 than they did during 2001, the Company's interest expense would increase approximately $17,240 on an annual basis. Year-to-date as of November 13, 2002, the prime rate and the Company's interest rates on variable-rate debt have not changed. The Company has limited its interest rate risk by entering into an interest rate cap agreement. The agreement, which matures on June 13, 2003, is for a total notional amount of $2,000,000. In connection with this agreement the Company paid the counterparty a premium of $7,500 on June 13, 2002, and will receive monthly an amount equal to the product of the amount by which the Prime Rate (4.75% at September 30, 2002) exceeds the Cap Rate (6.5%) multiplied by the notional amount. Since entering the interest rate cap agreement, the Prime Rate has not exceeded the Cap Rate. Accordingly, the Company has not received any payments under this agreement. 13 PART II -- OTHER INFORMATION ITEM 4. Controls and Procedures (a) EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES. The Company's Chief Executive Officer and its Chief Financial Officer, after evaluating the effectiveness of the Company's disclosure controls and procedures (as defined in the Securities Exchange Act of 1934 Rules 13a-14(c) and 15d-14(c) as of a date within 90 days of the filing date of this quarterly report of Form 10-Q (the "Evaluation Date")), have concluded that as of the Evaluation Date, the Company's disclosure controls and procedures were adequate and effective to ensure that material information relating to the Company and its consolidated subsidiaries would be made known to them by others within those entities, particularly during the period in which this quarterly report on Form 10-Q was being prepared. ITEM 5. Other Information. On October 22, 2002, the Company announced the appointment of two new directors to the Company's Board, M. Christine Murphy and Dr. Frederick E. Webster, Jr. Ms. Murphy is Chairman and Chief Executive Officer of S. Zitner Company, a Philadelphia based manufacturer of fine confections and also serves on several boards including Sovereign Bank, The Allegheny West Foundation and the Greater Philadelphia Chamber of Commerce. Dr. Webster is the Charles Henry Jones 3rd Century Professor of Management, Emeritus, at the Tuck School of Business at Dartmouth, a Visiting Scholar of Business and Public Administration at the University of Arizona and President of FEW Consulting Services, Inc. Ms. Murphy was appointed a Class II director with a term expiring in 2005. Mr. Webster was appointed a Class III director with a term expiring in 2003. Effective October 22, 2002, the director classification for Mr. Robert E. Drury was changed from Class I to Class III with a term expiring in 2003. ITEM 6. Exhibits and Reports on Form 8-K. A. Exhibits. 99.1 Certification pursuant to 18 U.S.C.ss. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 99.2 Certification pursuant to 18 U.S.C.ss. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 99.3 Certification pursuant to 18 U.S.C.ss. 1350, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 99.4 Certification pursuant to 18 U.S.C.ss. 1350, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. B. Reports on Form 8-K: None. 14 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 13, 2002 -------------------- ----------------- Mark P. Glassman Chief Executive Officer BY: /S/ DAVID B. WALLS November 13, 2002 ------------------ ----------------- David B. Walls Chief Financial Officer, Treasurer and Secretary 15 EXHIBIT INDEX 99.1 Certification pursuant to 18 U.S.C.ss. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 99.2 Certification pursuant to 18 U.S.C.ss. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 99.3 Certification pursuant to 18 U.S.C.ss. 1350, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 99.4 Certification pursuant to 18 U.S.C.ss. 1350, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 16

IMAGEMAX INC 10-Q