UNITED STATES 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, 2004 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 0-18450 SECURITIES AND EXCHANGE COMMISSION COLOR IMAGING, INC. (Exact name of registrant as specified in its charter) Delaware 13-3453420 ----------------------------------------- ----------------------------------- (State or other jurisdiction of (IRS Employer Identification No.) incorporation or organization) 4350 Peachtree Industrial Blvd, Suite 100 Norcross, GA 30071 ----------------------------------------- ------------- (Address of principal executive offices) (Zip Code) (770) 840-1090 Registrant's telephone number, including area code Not Applicable Former name, former address and former fiscal year, if changed since last report 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 by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2). Yes ___ No x Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practical date. As of October 26 2004, there were 12,699,005 shares outstanding of Common Stock. COLOR IMAGING, INC. QUARTERLY REPORT ON FORM 10-Q FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2004 INDEX PART I: FINANCIAL INFORMATION Item 1. Financial Statements Condensed Balance Sheets at September 30, 2004 (Unaudited) and December 31, 2003(Audited)...........................3 Condensed Statements of Operations (Unaudited) for the Three and Nine Months ended September 30, 2004 and 2003..........................................4 Condensed Statements of Cash Flows (Unaudited) for the Nine Months ended September 30, 2004 and 2003..........................................5 Notes to Interim Unaudited Condensed Financial Statements ..........................................................6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.................................10 Item 3. Quantitative and Qualitative Disclosures about Market Risks.........25 Item 4. Controls and Procedures.............................................25 PART II: OTHER INFORMATION Item 1. Legal Proceedings ..................................................27 Item 2. Changes in Securities and Use of Proceeds...........................27 Item 3. Defaults Upon Senior Securities.....................................29 Item 4. Submission of Matters to a Vote of Security Holders.................29 Item 5. Other information ..................................................29 Item 6. Exhibits and Reports on Form 8-K....................................29 Signatures....................................................................31 Exhibits 2 PART I: FINANCIAL INFORMATION ITEM 1 -FINANCIAL STATEMENTS COLOR IMAGING, INC. CONDENSED BALANCE SHEETS 30-Sep-04 31-Dec-03 - ASSETS - (Unaudited) (Audited) --------------- --------------- CURRENT ASSETS: Cash $ 1,929,272 $ 2,213,830 Accounts receivable - net of allowance for doubtful accounts of $100,361 and $67,839 for 2004 and 2003, respectively 2,794,657 1,941,404 Inventories 5,242,745 5,624,328 Related party portion of IDR bond - current 92,664 87,912 Other current assets 190,990 114,721 --------------- --------------- TOTAL CURRENT ASSETS 10,250,328 9,982,195 --------------- --------------- PROPERTY, PLANT AND EQUIPMENT - NET 6,696,597 6,973,834 --------------- --------------- OTHER ASSETS: Related party portion of IDR bond 554,764 647,428 Other assets 31,858 291,978 --------------- --------------- 586,622 939,406 --------------- --------------- $ 17,533,547 $ 17,895,435 =============== =============== - LIABILITIES & STOCKHOLDERS' EQUITY - CURRENT LIABILITIES: Revolving credit line $ -- $ -- Accounts payable 2,231,082 2,413,695 Current portion of notes payable 5,953 5,612 Current portion of notes payable - related parties 168,538 343,736 Current portion of bonds payable 390,000 370,000 Other current liabilities 231,527 393,579 --------------- --------------- TOTAL CURRENT LIABILITIES 3,027,100 3,526,622 --------------- --------------- LONG TERM LIABILITIES: Notes payable 7,000 11,509 Notes payable - related parties -- 120,102 Bonds payable 2,335,000 2,725,000 Deferred tax liability 563,450 292,700 --------------- --------------- LONG TERM LIABILITIES 2,905,450 3,149,311 --------------- --------------- TOTAL LIABILITIES 5,932,550 6,675,933 --------------- --------------- COMMITMENTS & CONTINGENCIES STOCKHOLDERS' EQUITY: Common stock, $.01 par value, authorized 20,000,000 shares; 12,699,005 and 12,730,505 shares issued and outstanding on September 30, 2004 and December 31, 2003, respectively. 126,990 127,305 Additional paid-in capital 12,685,288 12,708,368 Treasury stock, at cost, 5,800 shares ( 2,656) -- Accumulated deficit (1,208,625) (1,616,171) --------------- --------------- 11,600,997 11,219,502 --------------- --------------- $ 17,533,547 $ 17,895,435 =============== =============== See accompanying notes. 3 COLOR IMAGING, INC. CONDENSED STATEMENTS OF OPERATIONS (UNAUDITED) THREE MONTH PERIODS ENDED NINE MONTH PERIODS ENDED ------------------------- -------------------------- 30-SEP-04 30-SEP-03 30-SEP-04 30-SEP-03 ------------ ------------ ------------ ------------ SALES $ 5,678,893 $ 5,360,703 $16,949,248 $16,048,697 C0ST OF SALES 4,356,515 3,993,199 12,694,680 11,822,528 ------------ ------------ ------------ ------------ GROSS PROFIT 1,322,378 1,367,504 4,254,568 4,226,169 ------------ ------------ ------------ ------------ OPERATING EXPENSES Administrative 300,363 418,924 1,039,396 1,311,715 Research & development 287,258 286,407 888,360 883,888 Sales & marketing 583,487 439,441 1,787,589 1,195,061 ------------ ------------ ------------ ------------ 1,171,108 1,144,772 3,715,345 3,390,664 ------------ ------------ ------------ ------------ INCOME FROM OPERATIONS 151,270 222,732 539,223 835,505 ------------ ------------ ------------ ------------ OTHER INCOME (EXPENSE) Other income 49,215 57,216 208,645 165,740 Financing expenses (21,235) (28,146) (68,322) (138,409) ------------ ------------ ------------ ------------ 27,980 29,070 140,323 27,331 ------------ ------------ ------------ ------------ INCOME BEFORE TAXES 179,250 251,802 679,546 862,836 PROVISION FOR INCOME TAXES 71,900 100,000 272,000 345,000 ------------ ------------ ------------ ------------ NET INCOME $ 107,350 $ 151,802 $ 407,546 $ 517,836 ============ ============ ============ ============ INCOME PER COMMON SHARE - BASIC Basic $ .01 $ .01 $ .03 $ .04 Diluted $ .01 $ .01 $ .03 $ .04 ------------ ------------ ------------ ------------ $ .01 $ .01 $ .03 $ .04 ============ ============ ============ ============ WEIGHTED AVERAGE SHARES OUTSTANDING Basic 12,700,308 12,838,170 12,707,484 11,710,487 Assumed conversion -- 9,091 -- 5,515 ------------ ------------ ------------ ------------ 12,700,308 12,847,261 12,707,484 11,716,002 ============ ============ ============ ============ See accompanying notes 4 COLOR IMAGING, INC. CONDENSED STATEMENTS OF CASH FLOWS FOR THE NINE MONTH PERIODS ENDED SEPTEMBER 30 (UNAUDITED) 2004 2003 ------------- ------------ Cash flows from operating activities: Net income from continuing operations $ 407,546 $ 517,836 Adjustments to reconcile net income to net cash provided (used) by operating activities: Depreciation and amortization 443,892 433,778 Deferred income taxes 270,750 349,000 Allowance for doubtful accounts 32,522 1,334 (Increase) decrease in: Accounts receivable and other receivables (885,775) (857) Inventories 381,583 (1,249,194) Prepaid expenses and other assets 183,851 267,968 Due from related party - IDR bond 87,912 83,160 (Decrease) in: Accounts payable and accrued liabilities (344,665) (588,333) ------------- ------------ Net cash provided by (used in) operations 577,616 (185,308) ------------- ------------ Cash flows (used in) investing activities: Capital expenditures (166,655) (387,606) ------------- ------------ Net cash (used in) investing activities (166,655) (387,606) ------------- ------------ Cash flows from financing activities: Net (payments) under line of credit -- (1,022,470) Net proceeds from sale of common stock -- 5,900,140 Repurchase of common shares and warrants (26,051) (279,202) Principal payments on related party borrowings (295,300) (440,022) Principal payments of long-term debt (374,168) (1,685,000) ------------- ------------ Net cash (used in) provided by financing activities (695,519) 2,473,446 ------------- ------------ Net (decrease) increase in cash (284,558) 1,900,532 Cash at beginning of year 2,213,830 128,501 ------------- ------------ Cash at end of period $ 1,929,272 $ 2,029,033 ============= ============ See accompanying notes 5 COLOR IMAGING, INC. NOTES TO INTERIM CONDENSED FINANCIAL STATEMENTS September 30, 2004 (Unaudited) NOTE 1. BASIS OF PRESENTATION The accompanying unaudited interim condensed financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals and adjustments) considered necessary for a fair presentation have been included. Operating results for the three and nine months ended September 30, 2004 are not necessarily indicative of the results that may be expected for the year ended December 31, 2004. NOTE 2. COMMON STOCK AND EQUIVALENTS During the third quarter ended September 30, 2004, the Company repurchased in the open market 5,800 shares of the Company's common stock at an average price of $0.46 per share. For the nine months ended September 30, 2004, the Company repurchased in the open market 37,300 shares of the Company's common stock at an average price of $0.70 per share. As of October 17, 2004, all of the shares repurchased by the Company through June 30, 2004, were cancelled and retired by the Company's transfer agent, while the 5,800 shares repurchased by the Company during the third quarter have not yet been cancelled and retired by the Company's transfer agent. On April 1, 2004 the Company granted options to an officer to purchase 100,000 shares of the Company's common stock at an exercise price of $.73 per share. Options to purchase 20,000 shares of the Company's common stock vested immediately and the remainder vest at the rate of 20,000 per year beginning on the first anniversary date of the grant and continuing annually thereafter and expire five years from their respective date of vesting. On May 18, 2004, the Company granted 335,000 options to officers, 50,000 options to non-employee directors and 80,000 options to employees at an exercise price of $0.54. One-half of the options granted vested immediately and the remainder vest equally upon the next two anniversary dates of the grant and expire five years from their respective date of vesting. In accordance with the provisions of SFAS No. 148, the Company has elected to continue applying the intrinsic value approach under APB No. 25 in accounting for its stock-based compensation plans. Accordingly, the Company does not recognize compensation expense for stock options when the exercise price at the grant date is equal to or greater than the fair market value of the stock at that date. The Company generally recognizes compensation expense only when it grants options with a discounted exercise price, at which time any resulting compensation expense is recognized ratably over the associated service period, which is generally the option vesting term. The following table illustrates the effect on net income and net income per share as if the fair value based method had been applied to all outstanding and vested awards in each period: NINE MONTHS SEPTEMBER 30, 2004 2003 ------------ ------------- Net income, as reported $ 407,546 $ 517,836 Less: Pro forma stock based compensation expense - net of tax 80,758 56,635 ------------ ------------- Pro forma net income $ 326,788 $ 461,201 ============ ============= Basic Earnings per share: As reported $ 0.03 $ 0.04 Pro forma $ 0.03 $ 0.04 Diluted Earnings per share: As reported $ 0.03 $ 0.04 Pro forma $ 0.03 $ 0.04 The fair value of each option was estimated on the date of the grant using the Black-Scholes option-pricing model with the following weighted average assumptions for the periods ended September 30, 2004 and 2003, respectively: expected volatility of 2.4 and .9, respectively; risk free interest rate of 2.5% and 2.7%, respectively; and expected lives of 2 to 7 years. For purposes of pro forma disclosures, the estimated fair value of the options is amortized over the average vesting period of the options. 6 NOTE 2. COMMON STOCK AND EQUIVALENTS (CONTINUED) In computing the number of options exercisable, shares of common stock subject to options or warrants that are currently exercisable or will become exercisable within 60 days of the date of this report are deemed outstanding. The following is a summary of total outstanding and exercisable options and stock warrants at September 30, 2004: Options and Warrants Outstanding Options and Warrants Exercisable Weighted-Average Range of Exercise Weighted-Average Remaining Weighted-Average Prices Number Exercise Price Contractual Life Number Exercise Price ------------------- ----------- ------------------ ------------------ ----------- ------------------ Options $0.45-$2.75 1,420,000 $1.58 3.08 years 1,042,500 $1.88 Warrants $2.00 100,000 $2.00 0.78 years 100,000 $2.00 ------------------ ------------------ ----------- ------------------ Options and warrants 1,520,000 $1.61 3.60 years 1,142,500 $1.89 ================== ================== NOTE 3. INVENTORIES Inventories consisted of the following components as of September 30, 2004 and December 31, 2003: September 30, 2004 December 31, 2003 ------------------ ----------------- Raw materials $ 1,255,898 $ 631,960 Work-in-process 1,739,290 1,715,684 Finished goods 2,323,801 3,374,773 Obsolescence allowance (76,244) (98,089) ------------------ ----------------- Total $ 5,242,745 $ 5,624,328 ================== ================= NOTE 4. CHANGES TO BORROWING ARRANGEMENTS The Company has a $1.5 million revolving line of credit, as amended, with an outstanding balance as of September 30, 2004 of $0, bearing interest at the one-month Libor interest rate in effect two business days before the first day of the month plus 2.50%. As of September 30, 2004, the interest rate was the one-month Libor rate of 1.84% plus 2.50% (4.34%). This revolving line of credit has a June 30, 2005 expiration date. Under the line of credit, the Company is permitted to borrow up to 75% of eligible accounts receivable and 50% of eligible inventories (up to a maximum of $750,000 and not to exceed 50% of the total outstanding). On February 6, 2004, the Bank issued an irrevocable standby letter of credit in the amount of $1.5 million for the benefit of a non-affiliated foreign supplier. The letter of credit has an expiration date of June 30, 2005. The Company has granted the Bank a security interest in all of the Company's assets as security for the repayment of the line of credit and the obligations under the letter of credit. The Bank agreement also contains various covenants that the Company is required to maintain, and as of September 30, 2004, the Company was in compliance with these covenants. NOTE 5. EMPLOYMENT AGREEMENTS: On April 1, 2004, the Company hired and entered into a two year employment agreement with the Senior Vice President of Marketing and Sales, providing the employee with an annual salary of $150,000, the lesser of three months severance or the remainder of the term of the agreement if terminated by the Company without cause and granting the employee options to purchase 100,000 shares of the Company's common stock. On April 19, 2004, upon the hiring of the Senior Vice President of Marketing and Sales, the Executive Vice President and Chief Financial Officer's responsibilities and duties were changed and the employment agreement between the Company and the Executive Vice President and Chief Financial Officer was amended, reducing annual salary from $151,190 to $120,000 and providing for a one-half of one percent (0.5%) commission on only the net sales of 100% new all-in-one products of the Company. On May 28, 2004, the duties and responsibilities of the Vice President of Technology were changed to encompass certain research and development projects and technical sales, and his title was changed to Vice President of Technical Sales and his $100,000 annual salary is to be reduced in equal amounts over four months until reaching $80,000 per annum. NOTE 6. SIGNIFICANT CUSTOMERS In the three and nine month periods ended September 30, 2004, one customer accounted for 23% and 27% of net sales. The Company does not have a written or oral contract with this customer. All sales are made through purchase orders. Accounts receivable from this customer at September 30, 2004, was $302,649. 7 NOTE 7. SIGNIFICANT SUPPLIERS In the three and nine month periods ended September 30, 2004 the Company purchased 22% and 37% of its raw materials, components and supplies from one supplier in connection with sales to its largest customers. At September 30, 2004, the accounts payable to this supplier was $614,846. On February 6, 2004, the Company caused its Bank to issue an irrevocable standby letter of credit in the amount of $1.5 million for the benefit of this non-affiliated foreign supplier. The letter of credit has an expiration date of June 30, 2005. NOTE 8. FINANCIAL REPORTING FOR BUSINESS SEGMENTS: The Company believes that its operations are in a single industry segment involving the development and manufacture of products used in electronic printing. All of the Company's assets are domestic. The sales to unaffiliated customers by geographic region from continuing operations for the nine-month periods ended September 30 are as follows: 2004 2003 ------------- ------------- Sales to Unaffiliated Customers: United States $ 9,162,553 $ 9,534,055 Europe/Eastern Europe 4,226,258 3,436,261 Mexico 2,186,368 1,896,999 Asia/Southeast Asia 879,303 618,688 South America 165,305 346,022 Others 329,461 216,672 ------------- ------------- Total $16,949,248 $16,048,697 ============= ============= NOTE 9. RELATED PARTY TRANSACTIONS: (A) LEASE: Directors, Jui-Hung Wang, Jui-Kung Wang, Sueling Wang and Jui-Chi Wang, own Kings Brothers, LLC, the landlord from which the Company leases its Norcross, Georgia, plant. The real property lease agreement between the Company and Kings Brothers, LLC, was entered into on April 1, 1999, and was amended on February 5, 2003, extending the expiration date from March 31, 2009 to March 31, 2013. The rental payments for the nine months ended September 30, 2004 and 2003 were $408,546 and $398,583, respectively. (B) INDUSTRIAL DEVELOPMENT REVENUE BOND On June 1, 1999, the Development Authority of Gwinnett County (the Authority), issued $4,100,000 of industrial development revenue bonds on behalf of the Company and Kings Brothers, LLC. The 1.76% revenue bonds, 2.76% inclusive of the 1% letter of credit fee, as of September 30, 2004, are payable in varying annual principal and monthly interest payments through July 2019. The bond is secured, as amended on April 7, 2003, by specific equipment assets of the Company and by real property owned by Kings Brothers, LLC. Two related financial institutions hold the bonds, along with the line of credit and term loan. A loan agreement between the Authority and the Company and Kings Brothers, LLC allows funds to effectively pass through the Authority to the Company. The majority of the proceeds, $3,125,872, were used by the Company to relocate, purchase and install certain manufacturing equipment, while $974,128 was used by Kings Brothers, LLC to pay down the mortgage on the real property leased to the Company. The Company and the Related Party are jointly obligated to repay any outstanding debt. Under the Joint Debtor Agreement of June 28, 2000, between the Company and the Kings Brothers, LLC, each has agreed to be responsible to the other for their share of the bond obligations and that any party causing an act of default shall be responsible for 100% of the bond obligations. The amount for which Kings Brothers, LLC is responsible to the Company is reflected in current and other assets of the Company. Kings Brothers, LLC amounts owed to the Authority are secured by a lien on the real property leased by the Company and by a personal guarantee, as amended, executed by Director and President of the Company, Sueling Wang. At this time, the Company believes that the Kings Brothers, LLC portion of the bond is fully collectible. As of September 30, 2004, the bond principal outstanding was $2,725,000 and the portion due from Kings Brothers, LLC was $647,428. 8 (C) PURCHASES: The Company purchased from an affiliate for the three and nine months ended September 30, 2004, $1,302,457 and $2,896,248 of all in one cartridges and empty injection molded cartridges for use in copiers and laser printers. Accounts payable to the affiliate at September 30, 2004, was $1,310,229. NOTE 9. RELATED PARTY TRANSACTIONS (C0NTINUED): (D) MARKETING AND LICENSE AGREEMENT: On June 1, 2003, the Company entered into a Marketing and Licensing Agreement with its foreign affiliate. Per the Marketing and Licensing Agreement the affiliate agrees to indemnify and hold harmless the Company for any costs and expenses arising from any defective licensed product, and/or any recalled licensed product including litigation arising therefrom. Further the affiliate agrees to credit the Company for product cost, shipping and related expenses arising from any defective licensed product, and/or any recalled licensed product. Effective April 1, 2004, the parties agreed to amend the Marketing and Licensing Agreement to reduce the costs of the product to the Company and to include a royalty payment by the Company to the affiliate based on the net profit realized upon the sale of the products, after certain marketing expenses of the Company. (E) NOTES PAYABLE: On March 14, 2002, the Company borrowed $500,000 from director, Sueling Wang, on an unsecured basis. The interest rate on the loan was 12% per annum, matured on March 14, 2003 and was evidenced in writing. On September 2, 2002, the note was modified to extend the term to March 1, 2005, provide for a $100,000 principal payment, decrease the interest rate to 6% per annum, provide for interest only payments through February 28, 2003, and 24 monthly payments of principal with interest extra beginning on April 1, 2003, in the amount of $7,500. The Company borrowed the $500,000 to meet a supplier commitment for product. Principal and interest paid Sueling Wang on the note from January 1 through September 30, 2004, was $67,500 and $906, respectively. As of September 30, 2004 the principal outstanding was $37,500. On August 21, 2002, the Company borrowed $100,000 from director, Jui-Chi Wang, on an unsecured basis. The loan bears interest at the rate of 6% per annum, matures on March 1, 2005 and is evidenced in writing. The Company borrowed this amount in order to repay $100,000 borrowed from director Sueling Wang on March 14, 2002. The note is interest only through February 28, 2003, and then is fully amortizing over 24 months with principal and interest payments payable monthly beginning April 1, 2003 in the amount of $4,434. Principal and interest paid Jui-Chi Wang on the note from January 1 through September 30, 2004 was $37,967 and $1,939, respectively. As of September 30, 2004 the principal outstanding was $21,840. On August 21 and September 2, 2002, the Company borrowed $200,000 and $300,000, respectively, from director, Jui-Hung Wang, on an unsecured basis. The loan bears interest at the rate of 6% per annum, matures on March 1, 2005 and is evidenced in writing. The Company borrowed this amount in order to make a principal payment due on its industrial development bond in the approximate amount of $255,000, for the acquisition of capital equipment in the approximate amount of $125,000 and for general corporate purposes. The note is interest only through February 28, 2003, and then is fully amortizing over 24 months with principal and interest payments payable monthly beginning April 1, 2003 in the amount of $22,170. Principal and interest paid Jui-Hung Wang on the note from January 1 through September 30, 2004 was $189,834 and $9,693, respectively. As of September 30, 2004 the principal outstanding was $109,198. (F) COMMON STOCK On March 6, 2003, the Company received from Chi Fu Investment Co Ltd $6,075,000 of subscription proceeds for the public sale of 4,500,000 of its common shares at a price of $1.35 per share in its offering on Form SB-2 filed with the Securities and Exchange Commission. Chi Fu Investment Co Ltd is a wholly owned subsidiary of the Company's affiliate, General Plastic Industrial Co., Ltd, and as of September 30, 2004, Company directors Jui-Hung Wang, Jui-Chi Wang, Jui-Kung Wang, Sueling Wang and Yi Jen Wang each owned 8.0%, 8.4%, 1.8%, 0.4% and 2.4%, respectively, of General Plastic Industrial Co., Ltd. 9 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussions should be read in conjunction with our condensed financial statements and the related notes thereto. BACKGROUND On June 28, 2000, Color Imaging, formerly known as Advatex Associates, Inc. merged with Logical Imaging Solutions, Inc. and Color Image, Inc. and Logical Imaging Solutions and Color Image became wholly-owned subsidiaries of Advatex. On December 31, 2000, Color Image was merged with and into Color Imaging. On September 30, 2002, we divested Logical Imaging Solutions in exchange for 1.7 million shares of our common stock and warrants to purchase up to 15% of the common stock of Digital Color Print or Logical Imaging Solutions. As the result of our disposing of Logical Imaging Solutions, Inc. we no longer offer printing systems to commercial printers nor the support services and consumables related thereto. As a further result of Color Imaging's divestiture of Logical Imaging Solutions, our investments in the furthering of Logical Imaging Solutions' technologies and carrying its operations have ceased. Significantly, since the merger on June 28, 2000, Color Imaging had invested approximately $2.35 million in the operations of Logical Imaging Solutions and the development of its technologies. COLOR IMAGING, INC. Since 1989, Color Imaging has developed, manufactured and marketed products used in electronic printing. Color Imaging formulates and manufactures black text and specialty toners, including color and magnetic character recognition toners for numerous laser printers, facsimile machines and analog and digital photocopiers. Color Imaging's toners permit the printing of a wide range of user-selected colors and also the full process color printing of cyan, yellow, magenta and black. Magnetic character recognition toners enable the printing of magnetic characters that are required for the high-speed processing of checks and other financial documents. Color Imaging also supplies other consumable products used in electronic printing and photocopying, including toner cartridges, cartridge components, photoreceptors and imaging drums. Color Imaging has continually expanded its product line and manufacturing capabilities. This expansion, including expansion through sourcing from strategic partners, has led to the creation over the years of hundreds of different black text, color, magnetic character recognition and specialty toner formulations, including aftermarket toners and imaging products for printers and facsimile machines manufactured by Brother(TM), Canon(TM), Delphax(TM), Hewlett Packard(TM), IBM(TM), Lexmark(TM), Sharp(TM), Xerox(TM), Minolta(TM), Mita(TM), Panafax(TM), Pentax(TM), Pitney Bowes(TM), Epson(TM), Fuji-Xerox(TM), Toshiba(TM), Kyocera(TM), Okidata(TM), and Panasonic(TM). Color Imaging also manufactures and/or markets toners for use in Ricoh(TM), Lanier(TM), Gestetner(TM), Savin(TM), Sharp(TM), Xerox(TM), Canon(TM), Minolta(TM), Konica(TM), and Toshiba(TM) copiers. Color Imaging markets branded products directly to OEMs and its aftermarket products worldwide to distributors and re-manufacturers of laser printer toner cartridges and to OEM, distributors and dealers of copier products. STRATEGY Our strategy for growing revenue and operating profit is to expand, including through strategic acquisition(s), our printer and copier products business. The key elements of our strategy are (1) increasing vertical integration by supplying complete toner and cartridge devices, (2) capitalizing on our research and development expertise of producing specialty, color and digital copier and or multifunctional device toners, (3) exploiting the efficiencies associated with the investment made in manufacturing facilities, (4) expanding our sources for products from strategic suppliers that we can add value to or resell and that complement our product lines, (5) adding offices/warehouses to improve distribution to customers in the United States and Europe and (6) broadening our sales channels. GOALS AND FOCUS FOR THE NEXT FIVE YEARS We are of the belief that to remain a public company and offer our stockholders both attractive value and liquidity we should have sales of at least $100 million to $150 million per year, earnings before interest, income taxes, depreciation and amortization of $15 million to $20 million and move our stock to a major exchange. We are prepared to grow our Company both internally through the introduction of uniquely competitive products as well as through mergers and or acquisitions, even though such an event could mean a change in our management or control. We have met with a specialist of the American Stock Exchange and explored the possibility of listing with American Stock Exchange when our sales, profitability and outlook are such that we would benefit from a major exchange listing. In the alternative, we have not ruled out the possibility of going private or being taken private in a merger or acquisition, should that eventuality be deemed to be in the best interest of our stakeholders. 10 LAST FIVE YEARS We expanded manufacturing capacity four-fold and improved production efficiency, raised capital in a private placement and public offering, divested ourselves of an unprofitable subsidiary in which we had invested $2.3 million and have substantially moved away from low margin (commodity-like) bulk laser toner and parts products to finished copier and laser printing products, increasing sales and margins. While margins may decrease in the near terms from the introduction and success of lower margin all in one products, we expect margins overall to continue to improve as more of our color copier products are sold. For the year ended December 31, 2001, our sales reached $30 million, with our three largest customers accounting for 70% (some $21 million) of those sales, and by the end of 2004 we expect these customers to account for only about $6.5 million of our net sales, down some $14.5 million or 70% from 2001. The products sold to these customers were primarily analog copier toners and developers, and our sales to these customers of these products have rapidly declined for several reasons, including as the products are discontinued in the market. As a result of the decreasing sales to our largest customers, our total sales declined during 2002 and 2003, and our sales to these customers for the nine months ended September 30, 2004 have declined to approximately 32% of our $17 million of sales. Challenged to replace the sales lost from our largest customers, we introduced new products and expanded our sales channels. In 2003 we were the first to introduce aftermarket, full-color, Segment 3-4, networked copier/printer/MFP toner products and will expand it from one product (4 toners) in 2003 to as many as 10-12 (40 or more toners) during 2004. To our knowledge we are still the only source for these full-color toner products worldwide, other than the OEMs. During 2003 we also introduced 100% new complicated toner cartridges, generally referred to as all-in-one ("AIO") imaging, toner or drum cartridges with their becoming 10% of sales so far in 2004, and will be introducing other such products and selected color AIO products during 2004. As a result, we stemmed the pattern of declining sales in 2004. PRODUCTS Our primary product focus is full-color, 100% new, finished products for multifunctional printers/devices ("MFPs"), copiers and printers. In particular, we are concentrating on work group/networked solutions segments, complicated all in one cartridges and selected specialty toner products for certain industrial applications and for the printing of magnetic characters on checks and or financial documents. In 1999 approximately 10% of the Company's sales were derived from finished products, while, at this time, nearly 80% of the Company's sales are derived from finished products. Both the 100% new AIO and full-color products are important for increasing sales, while the largest contribution to improved profitability will come from our full-color ("business color") finished toner products, without competition from others except the OEMs, for the "sweet-spot" of digital multi-functional copiers/printers. In addition, we continue to develop and offer other niche specialty products like MICR and toners for industrial applications. WHY 100% NEW PRODUCTS AND PRODUCT TRENDS While remanufactured or refurbished ("remanufactured") toner cartridges for use in printers generally have 30% of the market in units and 25% in dollar value and are just now being introduced for use in copiers, remanufactured cartridges have a perception with the users from past experience of being of inferior quality even though they offer a cost savings. The quality of the some 2,500 remanufacturers in the U.S. is, by its nature, inconsistent and certain cartridges cannot be readily remanufactured due to the technology utilized by the OEMs. Contributing to the perception of poorer quality for these products is the fact that remanufacturers will not always replace all of the worn parts in a particular cartridge. The dilemma is that if too few parts are changed the cartridge could fail prematurely or not deliver the required print quality, while changing all of the parts subject to wear not only increases the cost of the product but also can result in more variation in print performance to that of the OEM. While users may save 25% or more by using a remanufactured cartridge, as a result of past and existing quality issues remanufactured product have consistently enjoyed only a 30% share of the market, leaving 70% of the users buying 100% new product from the OEM. Other factors contributing the users opting for the OEM, or new product, over remanufactured includes the inconsistent availability of remanufactured cartridges and market confusion from the marketing of remanufactured cartridges as compatible, remanufactured, refurbished, new drum, 100% new parts, other descriptions, and a wide range of prices, all of which leave the user wondering what is being purchased. Increasingly, the OEMs have moved to prevent aftermarket companies from supplying alternatives to their product. The OEMs accomplish this by increasing the technological barriers with patents, chemical toners and computer chips, and a few have used licensing arrangements (prebate programs) for their product (Lexmark and recently Dell Computers) to make the remanufacture of their cartridges illegal. In addition, recycle programs designed to get the OEM's cartridge back from the user, effectively keeping it away from remanufacturers, are growing worldwide. While recycle programs are touted as being protective of the environment, their effect is to reduce competition from remanufacturers by taking cartridges off the market. On the other hand, a 100% new product priced lower than the OEM and competitively with remanufactured cartridges, redesigned so as not to infringe on the OEM's intellectual property, is not subject to many of the above mentioned problems. Further, with our improved financial strength, significant trade support from our affiliated foreign supplier and expected profitability of our color products, we believe we will not need additional financial resources to realize our goals, excepting, perhaps, the needs that may arise should we be successful in identifying and completing a merger or acquisition. 11 MARKETING AND SALES While we have changed our product mix from almost entirely bulk toners and parts to now primarily finished products, we have also expanded our sales channels over the last five years from almost solely unfinished printer products sold to domestic remanufacturers, and a few distributors serving them, to distributors and dealers worldwide of finished copier and printer products, including acquiring large private label arrangements (OEM and distributor). As a result our international sales have increased from approximately 10% to more than 50% of our total sales. We accomplished this by not only acquiring significant corporate account relationships, but by also implementing a worldwide manufacturer's representative program, recruiting industry experienced and successful executives for technical sales and marketing. To improve distribution in the western United States, we opened a sales office/warehouse in Los Angeles, California late in 2003. Now that our California office has surpassed its breakeven point in sales, we are actively recruiting experienced sales managers with whom we can open additional sales offices with warehouses in the northeast and Texas, and we have begun exploring arrangements to have distribution in Europe to better support our customers there. Also during 2003 we obtained our first retail customers who are reselling our products in not only retail store locations but also on the internet. During 2005 we plan to substantially increase sales by adding as customers one or more large national office product retailers. STOCKHOLDER VALUE, LIQUIDITY AND MERGERS OR ACQUISITIONS Many of our stockholders invested in our private placement that closed in 2001 at prices up to $2.00 per share and in 2003 our public offering of 4,500,000 shares of our common stock at $1.35 per share. We believe that these and our other stockholders are expecting a return on their investment and a more liquid market for our stock. In 2002 we divested ourselves of a subsidiary that was losing money and had required investments by us of some $2.35 million. Its new owner acquired several hundred thousand shares of our common stock in an exchange thereafter and it and its management sold these shares in the market during 2003 and 2004, contributing to the decline in our stock price of from over $2.00 per share to the low of $0.35. Though the divestiture of the subsidiary, the completion of our public offering and our improved operations significantly improved the financial condition of the Company, and with cash on hand at September 30, 2004 of $1.9 million ($0.15 per common share), our stock price languishes and on October 14 closed at $0.48. With the belief that our common shares were undervalued and represented a good use of some of the Company's working capital, in 2002 our Board of Directors approved through September 30, 2004, the repurchase of up to the lesser of $1 million or 1 million shares of our common stock. This year our Board of Directors approved the extension of our stock repurchase program to September 30, 2005, and from inception through September 30, 2004, the Company has repurchased 81,800 of the Company's common shares at a cost of approximately $55,000 and at an average price of $0.67. We continue to be interested in making our Company more successful, more quickly, through a successful acquisition or merger. In that regard our criteria generally acceptable merger/acquisition candidates include: - An experienced and capable management team that would remain. - A sound and improving financial condition with sales of from $25 million to $75 million and earnings before interest, income taxes, depreciation and amortization of from $4 million to $15 million. - Products that would complement ours and offer unique competitive advantages. - Sales channels to include office product superstores, contract stationers, corporate accounts, copy product distributers or dealers. - Distribution not only in the United States but preferably in Europe as well. - A core value and excellent reputation for high quality. Our management realizes that an acquisition or merger with a company like that described above could mean changes to both the existing management of our Company, control over the Company's operations and, among other things, whether or not the Company is the surviving entity or remains a public company. With approximately 75% of our common shares controlled by directors, officers, affiliates and or their family members, management believes that these stockholders and others could be persuaded to vote for the completion of a merger or acquisition that was expected to increase in the future both stockholder value and liquidity. At this time there are no definitive proposals for a transaction, though we continue to seek out and engage in discussions with prospective merger or acquisition candidates. There can be no assurance that any transaction will be completed. RECENT DEVELOPMENTS Last year the Company successfully introduced 100% new color toner cartridges for use in Ricoh's AP3800c copier, a 28 page per minute networked full-color copier. During the quarter ended September 30, 2004, the Company introduced color toner cartridges for Ricoh's CL5000 and CL7000 printers as well as its 1224/1232 and 2232/2238 color copiers. These Ricoh cartridges are also used by Lanier, Gestetner, Savin and by InfoTech in Europe. During the fourth quarter 2004 the Company plans to introduce 100% new color toner cartridges for the Ricoh CL3000 printer and the Minolta 2002/3102 copiers. The same Minolta cartridges are also used by Konica, Kyocera Mita and Imagistics. Additionally during the fourth quarter 2004 the Company plans to introduce color toner cartridges for the Okidata C5100/C5300 and toners for use by remanufacturers for use in the Okidata C5000, C7000 and C9000 series of printers and Canon's C3200 copier and HP's 9500 color printer. 12 Through September 30, 2004, the Company's net sales for 100% new all-in-one products were: Year 1st Quarter 2nd Quarter 3rd Quarter 4th Quarter ----------- ----------- ----------- ----------- ----------- 2004 $ 158,311 $ 657,771 $ 919,197 N/A 2003 $ -- $ -- $ 64,414 $ 64,457 As of September 30, 2004, the backlog of the Company for these products was $227,854. OVERVIEW The following discussion and analysis should be read in conjunction with our financial data and our Financial Statements and notes appearing elsewhere in this report. Net sales for the three months ended September 30, 2004, increased by approximately $318,000, or 6%, to $5.7 million compared to 2003. Net sales for nine months ended September 30, 2004 increased by approximately $901,000, or 6%, to $17.0 million compared to 2003. Net sales in 2004 increased primarily due to increased sales from the Company's copier and all-in-one products, more than offsetting the decline in sales from the sales of our two largest customers to approximately $5,392,000 for the nine months ended September 30, 2004, compared to approximately $7,431,000 for the same periods in 2003, a decrease of approximately 27%. Sales to these customers consist primarily of analog copier products, and as a result are expected to decline over time. In the three and nine month periods ended September 30, 2004, our net sales were primarily generated from the sale of finished consumable products for photocopying machines and electronic printers and comprised approximately 80% and 79% of net sales, respectively. For the three and nine month periods ended September 30, 2003, our net sales from the sale of finished products comprised approximately 78% and 73% of net sales, respectively. Net sales made outside of the United States for the three and nine month periods ended September 30, 2004, were approximately $2.5 and $7.8 million, respectively, or 44% and 46% of total sales, and increased by approximately $0.3 million, or 14%, and $1.3 million, or 19%, over the same periods in 2003. This increase in international sales resulted primarily from the increase in sales of our color copier and all in one products to customers other than our two largest customers. The following table reflects the consolidated new orders, net of cancellations, revenues and backlog as of the beginning and end of the three and nine months ended September 30, 2004, as well as for Color Imaging's two general product lines. Backlog Backlog at start at end of New Net of Period Orders Revenue Period -------- -------- -------- -------- (IN THOUSANDS OF DOLLARS) Three Months September 30, 2004: Copier Products $ 1,813 $ 4,673 $ 5,285 $ 1,201 Printer Products 377 485 394 468 -------- -------- -------- -------- Total $ 2,190 $ 5,158 $ 5,679 $ 1,669 ======== ======== ======== ======== (IN THOUSANDS OF DOLLARS) Nine Months September 30, 2004: Copier Products $ 1,896 $ 12,945 $ 13,640 $ 1,201 Printer Products 575 3,202 3,309 468 -------- -------- -------- -------- Total $ 2,471 $ 16,147 $ 16,949 $ 1,669 ======== ======== ======== ======== 13 CRITICAL ACCOUNTING ESTIMATES "Management's Discussion and Analysis of Financial Condition and Results of Operations" discusses our financial statements that have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires us to make estimates and assumptions that affect the reported amount of assets and liabilities at the date of the financial statements, the 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. On an on-going basis, we evaluate our estimates and judgments, including those related to revenue recognition, valuation allowances for inventory and accounts receivable, warranty and impairment of long-lived assets. We base our estimates and judgments on historical experience and on various other factors that we believe to be reasonable under the circumstances. The result of these estimates and judgments form the basis for making conclusions about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. Our significant estimates and assumptions are reviewed and any required adjustments are recorded on a quarterly basis. A critical accounting policy is one that is both important to the portrayal of Color Imaging's financial condition and results and requires management's most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain. Management believes the following critical accounting policies affect its more significant judgments and estimates in the preparation of its financial statements. VALUATION ALLOWANCE FOR ACCOUNTS RECEIVABLE. We maintain allowances for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. These allowances are based on historical experience, credit evaluations and specific customer collection issues we have identified. Since our accounts receivable are often concentrated in a relatively few number of customers, a significant change in the liquidity or financial position of any one of these customers could have a material adverse impact on the collectibility of our accounts receivable and our future operating results. INVENTORY VALUATION. Our inventories are recorded at the lower of standard cost or the current estimated market value. As with any manufacturer or wholesaler, economic conditions, cyclical customer demand, product introductions or pricing changes of our competitors and changes in purchasing or distribution can affect the carrying value of inventory. Demand for our products has fluctuated significantly and may do so in the future, which could result in an increase in the cost of inventory or an increase in excess inventory quantities on hand. As circumstances warrant, we record lower of cost or market inventory adjustments. In some instances these adjustments can have a material effect on the financial results of an annual or interim period. In order to determine such adjustments, we evaluate the age, inventory turns, estimated fair value and, in the case of toner products, whether or not they can be reformulated and manufactured into other products, and record any adjustment if estimated fair value is below cost. Through periodic review of each of our inventory categories and by offering markdown or closeout pricing, we regularly take steps to sell off slower moving inventory to eliminate or lessen the effect of any lower of cost or market adjustment. If assumptions about future demand or actual market conditions are less favorable than those projected by management, write-downs of inventory could be required, and there can be no assurance that future developments will not necessitate further write-downs. VALUATION OF LONG-LIVED ASSETS. We periodically evaluate whether events and circumstances have occurred which may affect the estimated useful life or the recoverability of the remaining balance of our long-lived assets, such as our investment in our toner manufacturing equipment. We have approximately $8.1 million invested in such equipment and plant improvements, with a carrying value of $6.2 million, that have estimated lives of up to twenty years. Should competing technologies or offshore competitors cause our manufacturing technology to be non-competitive, or should other events or circumstances indicate that the carrying amount of these assets would not be recoverable, the estimated life of these assets may need to be shortened and their carrying value could be materially affected. If the sum of the undiscounted expected cash flows from an asset to be held and used in operations is less than the carrying value of the asset, an impairment loss is recognized. WARRANTY. We provide a limited warranty, generally ninety (90) days, to all purchasers of our products. Accordingly, we do not make a provision for the estimated cost of providing warranty coverage, and instead we expense these costs as they are incurred. On occasion, we have been required and may be required in the future to provide additional warranty coverage to ensure that our products are ultimately accepted or to maintain customer goodwill. While our warranty costs have historically not been significant, we cannot guarantee that we will continue to experience a similar level of predictability with regard to warranty costs as we have in the past. In addition, the introduction of more expensive finished products, technological changes or previously unknown defects in raw materials or components may result in more extensive and frequent warranty claims than anticipated, which could have a material adverse impact on our operating results for the periods in which such additional costs materialize. 14 RESULTS OF OPERATIONS Color Imaging's net sales were $5.7 million and $16.9 million for the three and nine months ended September 30, 2004, an increase of approximately 6% from both the three and nine months ended September 30, 2003. The net sales by product category were as follows: % Increase (Dollars in thousands) 2004 % (Decrease) 2003 % ------------ ------------ ------------ ------------ ------------ Three Months ------------ Product Category: Cartridges and bottles Copier finished products $ 4,146 73% 31% $ 3,166 59% Printer finished products 394 7% (49) 773 14% ------------ ------------ ------------ 4,540 80% 15 3,939 73% Bulk toner and parts 1,139 20% (20) 1,422 27% ------------ ------------ ------------ Total net revenue $ 5,679 100% 5 $ 5,361 100% ============ ============ ============ Nine Months ---------- Product Category: Cartridges and bottles Copier finished products $ 11,913 70% 31 $ 9,059 56% Printer finished products 1,486 9 (43) 2,596 16% ------------ ------------ ------------ 13,399 79 15 11,655 73% Bulk toner and parts 3,550 21 (19) 4,394 27% ------------ ------------ ------------ Total net revenue $ 16,949 100% 6 $ 16,049 100% ============ ============ ============ The following table sets forth certain information derived from the Company's unaudited interim statements of operations: THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, 2004 2003 2004 2003 ------ ------ ------ ------ (PERCENTAGE OF NET SALES) Net sales 100 100 100 100 Cost of sales 77 74 75 74 Gross profit 23 26 25 26 Administrative expenses 5 8 6 8 Research and development 5 5 5 6 Sales and marketing 10 8 11 7 Operating income 3 4 3 5 Interest expense - 1 - 1 Depreciation and amortization 3 8 3 5 Income before taxes 3 5 4 5 Provision for income taxes 1 2 2 2 Net income 2 3 2 3 15 THREE MONTHS ENDED SEPTEMBER 30, 2004 COMPARED TO THREE MONTHS ENDED SEPTEMBER 30, 2003 NET SALES. Our net sales increased by $0.3 million, or 6%, to $5.7 million for the three months ended September 30, 2004, from $5.4 million for the three months ended September 30, 2003. Net sales made in the United States were $3.2 million for the three months ended September 30, 2004 and for the comparable period in 2003. Net sales made outside of the United States increased by $0.3 million, or 14%, for the quarter compared to the same quarter of 2003. While net sales for the quarter compared to that of a year ago made inside of the United States was approximately the same, sales of copier and all in one products increased while sales from laser and MICR products to customers other than our two largest customers decreased. The increase in net sales for the quarter compared to that of year ago made outside of the United States was primarily the result of increased sales from copier and all in one products to customers other than our two largest customers. Of the $5.6 million in net sales, $4.5 million, or 80%, were attributable to our copier, all in one and printer finished products, compared to 71% for the comparable period in 2003, while the net sales of bulk toner and parts declined from 27% of net sales for the three months ended September 30, 2003 compared to 20% for the comparable period in 2004. Net sales to our two largest customers decreased as a percentage of our total sales to 32% for the three months ended September 30, 2004, from 41% for the comparable period in 2003. COST OF GOODS SOLD. Cost of goods sold increased by $0.4 million, or 9%, to $4.4 million from $4.0 million for the three months ended September 30, 2004 for the comparable period in 2003, primarily as the result of the increase in net sales and secondarily from selling all in one products at lower margins. Cost of goods sold as a percentage of net sales increased by 3 percentage points from 74% for the three months ended September 30, 2003 to 77% for the three months ended September 30, 2004, primarily as the result more of our net sales being derived from lower margin all-in-one and analog copier products. GROSS PROFIT. As a result of the above factors, gross profit was $1.3 million in both the three months ended September 30, 2004 and 2003, while net sales for the same period increased by $0.3 million, or 6%. Gross profit as a percentage of net sales decreased by 3 percentage points from 26% to 23% for the three months ended September 30, 2004, as compared to the corresponding period of the prior year. The decrease in the percentage of gross profit resulted primarily from more of our sales being derived from lower margin all-in-one and analog copier products. OPERATING EXPENSES. Operating expenses increased $26,000, or 2%, to $1,171,000 in the three months ended September 30, 2004 from $1,145,000 in the three months ended September 30, 2003. General and administrative, selling and R&D expenses decreased, as a percentage of net sales, to 20% in the three months ended September 30, 2004 from 21% in the three months ended September 30, 2003 as a result of the increase in net sales for the quarter and lower expenditures in general and administrative expenses. General and administrative expenses decreased approximately 28%, or $119,000 to $300,000 for the three months ended September 30, 2004 from the comparable period in 2003, largely resulting from decreased professional fees in connection with complying with the change in SEC reporting requirements from Regulation SB to S-K and bonus and salary related expenses. Selling expenses increased by $144,000, or 33%, in the three months ended September 30, 2004 compared to the three months ended September 30, 2003. Selling expenses increased primarily as a result of increased sales costs in connection with the opening of our California office, the hiring of a senior vice president for marketing and sales earlier this year, appointing a vice president for technical sales and increased manufacturer's representative expenses. Research and development expenses decreased by $1,000, or less than 1%, to $287,000 in the three months ended September 30, 2004, from the comparable period in 2003. OPERATING INCOME. As a result of the above factors, primarily the 3% decrease in gross profit and the 2% increase in operating expenses, operating income decreased by $72,000, or 32%, to income of $151,000 in the three months ended September 30, 2004 from $223,000 in the three months ended September 30, 2003. INTEREST AND FINANCE EXPENSE. Interest expense decreased by $7,000 in the three months ended September 30, 2004 from the three months ended September 30, 2003. The decrease was primarily the result of reduced interest bearing debt levels. OTHER INCOME. Other income decreased by $8,000, or 14%, from income of $57,000 to income of $49,000 in the three months ended September 30, 2004 from the three months ended September 30, 2003, primarily as the result of decreased Euro exchange gains. INCOME TAXES. As the result of our income from continuing operations in the three months ended September 30, 2004, we recorded an income tax provision of $71,900 for the period, while the income tax provisions were $100,000 for the three months ended September 30, 2003. 16 NINE MONTHS ENDED SEPTEMBER 30, 2004 COMPARED TO NINE MONTHS ENDED SEPTEMBER 30, 2003 NET SALES. Our net sales increased by $0.9 million, or 6%, to $17 million for the nine months ended September 30, 2004, from $16 million for the nine months ended September 30, 2003. Net sales made in the United States were $9.2 million, a decrease of $0.4 million, or 4%, from $9.5 million made in the comparable period in 2003. Net sales made outside of the United States increased by $1.3 million, or 20%, to $7.8 million for the nine months ended September 30, 2004 compared to the same nine months of 2003. The increase in net sales for the nine months ended September 30, 2004, compared to that of a year ago resulted primarily from the sale of our color copier and all-in-one products. Of the $17 million in net sales for the nine months ended September 30, 2004, $13.4 million, or 79%, were attributable to our finished products for use in copiers and printers, while $3.6 million, or 21%, were derived from the sale of bulk toners and parts. Of the $16 million in net sales for the nine months ended September 30, 2003, $11.7 million, or 73%, were attributable to our finished products for use in copiers and printers, while $4.3 million, or 27%, were derived from the sale of bulk toners and parts. COST OF GOODS SOLD. Cost of goods sold increased by $0.9 million, or 7%, to $12.7 million from $11.8 million for the nine months ended September 30, 2004 from the comparable period in 2003. Cost of goods sold as a percentage of net sales increased by 1 percentage point from 74% for the nine months ended September 30, 2003 to 75% for the nine months ended September 30, 2004, primarily as the result of the sales derived from lower margin all-in-one products. GROSS PROFIT. As a result of the above factors, gross profit increased by $29,000, or 1%, to $4,255,000 in the nine months ended September 30, 2004 from $4,226,000 for the comparable period in 2003. Gross profit as a percentage of net sales decreased by 1 percentage point from 26% to 25% for the nine months ended September 30, 2004, as compared to the corresponding period of the prior year. The decrease in the percentage of gross profit resulted primarily from increased sales derived from lower margin all-in-one products. OPERATING EXPENSES. Operating expenses increased $324,000 or 10% to $3.7 million in the nine months ended September 30, 2004 from $3.4 million in the nine months ended September 30, 2003. As a percentage of net sales general and administrative, selling and R&D expenses, was 22% and 21%, respectively, for the nine months ended September 30, 2004 and 2003. The increase in operating expenses as a percentage of net sales was largely the result of the increased selling and marketing expenses for the nine months ended September 30, 2004. General and administrative expenses decreased approximately 21%, or $273,000 to $1,039,000 for the nine months ended September 30, 2004 from the comparable period in 2003, largely resulting from decreased professional expenses for compliance with changing from SEC regulation SB to S-K reporting and the repurchase of securities issued in our private placement completed in 2001 and having made no provision for a bonus program in 2004. Selling expenses increased by $593,000, or 50%, in the nine months ended September 30, 2004 compared to the nine months ended September 30, 2003. Selling expenses increased primarily as the result of expenses in connection with the California sales office opened at the end of 2003 and the increased salary related expenses for newly appointed sales executives and increased manufacturer's representative expenses. Research and development expenses increased by $4,000, or 1%, in the nine months ended September 30, 2004. OPERATING INCOME. As a result of the above factors, primarily the 1% decrease in gross profit and the 50% increase in sales and marketing expenses, operating income decreased by $297,000, to income of $539,000 in the nine months ended September 30, 2004 from $836,000 in the nine months ended September 30, 2003. INTEREST AND FINANCE EXPENSE. Interest expense decreased by $70,000 in the nine months ended September 30, 2004 from the nine months ended September 30, 2003, or 51%. The decrease was primarily the result of reduced interest bearing debt levels. OTHER INCOME. Other income increased by $43,000 from income of $166,000 to income of $209,000 in the nine months ended September 30, 2004 from the nine months ended September 30, 2003, primarily as the result of Euro exchange gains. INCOME TAXES. As the result of our decreased profit from operations for the nine months ended September 30, 2004, our provision for taxes decreased from $345,000 in the nine months ended September 30, 2003 to $272,000 for the period ended September 30, 2004. LIQUIDITY AND CAPITAL RESOURCES At September 30, 2004, and December 31, 2003, our working capital and current ratio was approximately $7.2 million and $6.5 million and 3.39 to 1 and 2.83 to 1, respectively. Our working capital and current ratio have increased primarily from the net proceeds we received from the public sale of our common stock during March 2003 and our continuing profitability. Cash provided by operating activities was $578,000 in the nine months ended September 30, 2004 compared to $185,000 used by operations in the nine months ended September 30, 2003. The cash provided by operating activities in the nine months ended September 30, 2004 increased primarily due to the decrease in inventories. Cash used in investing activities was $167,000 in the nine months ended September 30, 2004, compared to $388,000 in the nine months ended September 30, 2003. The decrease in cash used in investing activities in the nine months ended September 30, 2004, was entirely attributable to decreased capital expenditures in connection with the acquisition and installation of new factory equipment. 17 The Company has a $1.5 million revolving line of credit, as amended, with an outstanding balance as of September 30, 2004 of $0, bearing interest at the one-month Libor interest rate in effect two business days before the first day of the month plus 2.50%. As of September 30, 2004, the interest rate was the one-month Libor rate of 1.84% plus 2.50% (4.34%). This revolving line of credit has a June 30, 2005 expiration date. Under the line of credit, the Company is permitted to borrow up to 75% of eligible accounts receivable and 50% of eligible inventories (up to a maximum of $750,000 and not to exceed 50% of the total outstanding). The Bank agreement also contains various covenants that the Company is required to maintain, and as of September 30, 2004, the Company was in compliance with these covenants. If the Company fails to meet these covenants in future periods, the line of credit and letter of credit facilities may become unavailable to the Company, and the Bank may have the right to accelerate the payment of any outstanding amounts. Cash used in financing activities were $696,000, primarily for the repayment of related party debt and the July 1st principal reduction to the IDR bond, for the nine months ended September 30, 2004 compared to cash provided by financing activities of $2,473,000 for the same period in 2003, resulting largely from the $5,900,000 in net proceeds received for the public sale of our common stock to an affiliate. On April 18, 2003, the Company established a stock repurchase program under which Color Imaging's common stock, with an aggregate market value up to the lesser of $1 million or 1 million shares, may be acquired in the open market or through private or other transactions. Through October 18, 2004, the Company has repurchased 81,800 shares of our common stock for approximately $55,000, or for an average price of $0.67 per share. We believe that existing cash balances, cash expected to be generated by operating activities, and funds available under our credit facility will be, in the aggregate, sufficient to finance our operating and investing activities for at least the next 12 months, which will include expenditures not to exceed approximately $500,000 for manufacturing, $150,000 for research and development equipment, $175,000 potentially for computer software upgrades to accommodate electronic data interchange, the repurchase of our stock under the stock repurchase program of up to the lesser of $1,000,000 or 1,000,000 shares of our common stock and any advances made by our bank on our behalf under our off-balance sheet arrangement of $1.5 million for a standby letter of credit issued to a non-affiliated foreign supplier. OFF BALANCE SHEET ARRANGEMENTS On February 6, 2004, our Bank issued on our behalf an irrevocable standby letter of credit in the amount of $1.5 million for the benefit of a non-affiliated foreign supplier. The letter of credit has an expiration date of June 30, 2005, and guarantees the payment of moneys owed the supplier for materials purchased from them by the Company on terms from N30 to N120. At September 30, 2004, the Company's accounts payable to this supplier was $614,846. The Company has granted the Bank a security interest in all of the Company's assets as security for the repayment of the line of credit and the obligations under the letter of credit. FACTORS THAT MAY AFFECT FUTURE RESULTS AND INFORMATION CONCERNING FORWARD-LOOKING STATEMENTS RISK FACTORS RISKS RELATED TO OUR BUSINESS: OUR BUSINESS DEPENDS ON A LIMITED NUMBER OF CUSTOMERS. For the nine months ended September 30, 2004, two customers accounted for approximately 32% of our net sales. We do not have contracts with these customers and all of the sales to them are made through purchase orders. While our products typically go through the customer's required qualification process, which we believe gives us an advantage over other suppliers, this does not guarantee that the customer will continue to purchase from us. The loss of either of these customers, including through an acquisition, other business combination or the loss by them of business from their customers could have a substantial and adverse effect on our business. We have in the past, and may in the future, lose one or more major customers or substantial portions of our business with one or more of our major customers. If we do not sell products or services to customers in the quantities anticipated, or if a major customer reduces or terminates its relationship with us, market perception of our products and technology, growth prospects, and financial condition and results of operation could be harmed. OUR RELIANCE ON SALES TO A FEW MAJOR CUSTOMERS AND GRANTING CREDIT TO THOSE CUSTOMERS PLACES US AT FINANCIAL RISK. As of September 30, 2004, receivables from two customers comprised 16% of accounts receivable. A concentration of our receivables from a small number of customers places us at risk should these receivables become uncollectible. If any one or more of our major customers is unable to pay us it could adversely affect our results of operations and financial condition. Color Imaging attempts to manage this credit risk by performing credit checks, requiring significant partial payments prior to shipment where appropriate, and actively monitoring collections. 18 APPROXIMATELY 32% OF OUR BUSINESS DEPENDS ON A FOREIGN SUPPLIER APPROVED BY TWO OF OUR CUSTOMERS TO WHOM WE HAVE ISSUED A LETTER OF CREDIT. Some of our products incorporate technologies that are available from a particular foreign supplier that has been approved by one of our customers. Approximately 32% of our sales for the nine months ended September 30, 2004 were derived from products limited to a specific foreign supplier. For the nine months ended September 30, 2004, we purchased 37% of our supplies from that same foreign supplier. We do not have a written agreement with this or any other supplier. We rely on purchase orders. To secure the payment of moneys due this same foreign supplier we have caused our bank to issue a standby letter of credit in the amount of $1.5 million, expiring June 30, 2005. Should we be unable to obtain the necessary materials from this foreign supplier, including as a result of our not being able to modify, extend or renew the letter of credit upon expiry, product shipments could be prevented or delayed, which could result in a loss of sales. If we are unable to fulfill existing orders or accept new orders because of a shortage of materials, we may lose revenues and risk losing customers. IF OUR CRITICAL SUPPLIERS FAIL TO DELIVER SUFFICIENT QUANTITIES OF MATERIALS OR PRODUCTS IN A TIMELY AND COST-EFFECTIVE MANNER IT COULD NEGATIVELY AFFECT OUR BUSINESS. We use a wide range of materials in the manufacture of our products, and we use numerous suppliers to supply materials and certain finished products. We generally do not have guaranteed supply arrangements with our suppliers. Because of the variability and uniqueness of customers' orders, we do not maintain an extensive inventory of materials for manufacturing or resale. Key suppliers include providers of special resins, toners and toner related products, including those from our largest supplier who is also foreign, and our injection molder affiliate that provides plastic bottles, cartridges and related components designed to avoid the intellectual property rights of others. Although we make reasonable efforts to ensure that raw materials, toners and certain finished products are available from multiple suppliers, this is not always possible; accordingly, some of these materials are being procured from a single supplier or a limited group of suppliers. Many of these suppliers are outside the United States, including our largest supplier, resulting in longer lead-times for many important materials, which could cause delays in meeting shipments to our customers. We have sought, and will continue to seek, to minimize the risk of production interruptions and shortages of key materials and products by: o selecting and qualifying alternative suppliers for key materials and products; o monitoring the financial stability of key suppliers; and o maintaining appropriate inventories of key materials and products. There can be no assurance that results of operations will not be materially and adversely affected if, in the future, we do not receive in a timely and cost-effective manner a sufficient quantity of raw materials, toners or finished products to meet our production or customer delivery requirements. OUR SUCCESS IS DEPENDENT ON OUR ABILITY TO UTILIZE AVAILABLE MANUFACTURING CAPACITY. From 1999 through 2000, we expanded our manufacturing capacity by acquiring new manufacturing equipment and moving to a larger location. Thereafter we further expanded our capacity by placing in service additional manufacturing equipment during 2002 and 2003, and we continue to make investments in and acquire and install new factory equipment. To fully utilize these new additions to the factory, new formulations for toner have to be developed specifically for manufacture on this new equipment or orders for larger quantities of existing toners must be obtained. While we have been successful in developing formulas for new equipment in the past and increasing sales of many of our existing toner products, our continued success will be dependent on our ability to develop additional formulations or increase our sales from existing formulations and manufacture the toners with the new equipment to achieve a reduction in production costs. We cannot assure you that we will be successful in developing all of the formulations needed in the future or that we will be able to manufacture toner at a lower production cost on a regular basis or that such products will achieve market acceptance. If we are not successful in increasing the sales of our manufactured products, or if our existing sales from manufactured products declines, our business will be materially and adversely affected. OUR SUCCESS IS DEPENDENT ON OUR ABILITY TO SUCCESSFULLY DEVELOP, OR USE OR HAVE ACCESS TO THIRD PARTIES', INTELLECTUAL PROPERTY OR PRODUCTS THAT WE CAN COMMERCIALIZE AND THAT ACHIEVE MARKET ACCEPTANCE. Our success depends in part on our ability to develop proprietary toner formulas and manufacturing processes, maintain trade secret protection and operate without infringing the proprietary rights of others. Future claims of intellectual property infringement could prevent us from obtaining products incorporating the technology of others and could otherwise adversely affect our operating results, cash flows, financial position or business, as could expenses incurred enforcing intellectual property rights against others or defending against claims that our products or those acquired from others infringe the intellectual property rights of another. Success in the aftermarket imaging industry depends, in part, on developing consumable products that are compatible with the printers, photocopiers and facsimile machines made by the OEMs, and that have a selling price less than that of like consumable supplies offered by 19 the OEM. For example, if the OEMs introduce chemical toners with better imaging characteristics and higher yields, microprocessor chips that communicate between the toner cartridge and the device, or introduce products using patented or other proprietary technologies, then the aftermarket industry has to respond with ongoing development programs to offer compatible products that emulate the OEMs' without infringing upon the OEM's intellectual property. Technical innovations are inherently complex and require long development cycles and appropriate professional staffing. Our future business success depends on our ability, and that of critical suppliers, to develop and introduce new products that successfully address the changing technologies of the OEMs, meet the customer's needs and win market acceptance in a timely and cost-effective manner. If we do not develop and introduce products compatible with the OEM's technologies in a timely manner in response to changing market conditions or customer requirements, our business could be seriously harmed. The challenges we face in implementing our business model include establishing market acceptance of existing products and successfully developing or acquiring new products for resale that achieve market acceptance, as well as obtaining additional channels through which to sell various products. We must successfully commercialize the products that are currently being developed, such as our color and magnetic character recognition toner for printers and black text and color toners for new digital copiers and continue to acquire from third parties all-in-one cartridges, parts, materials and finished product that can be integrated into finished products or sold as our products. While we have successfully developed toners in the past and are in the late stages of developing and testing several new toners, we have not commercialized many of the toners that are under development. While we have in the past acquired from third parties materials and products that we have been successful in selling, there can be no assurance that parts, materials or products for new products will be available or will achieve market acceptance, or that we will be successful in increasing our sales to large regional, national or international retailers. If we fail to successfully commercialize products we develop or acquire for resale from third parties, or if these products fail to achieve market acceptance, our financial condition and results of operation would be seriously harmed. OUR BUSINESS MIGHT BE ADVERSELY AFFECTED BY OUR DEPENDENCE ON FOREIGN BUSINESS. We sell a significant amount of product to customers outside of the United States. International sales accounted for 46% and 41% of net sales in the nine months ended September 30, 2004 and 2003, respectively. We expect that shipments to international customers will continue to account for a material portion of net sales. During the nine month period ended September 30, 2004, our sales were made to customers outside the United States as follows: o Europe (including Eastern Europe) - 25% o Mexico - 13% o Asia/Southeast Asia - 5% o Other - 3% Most of our products sold internationally, including those sold to our larger international customers, are on open account, giving rise to the added costs of collection in the event of non-payment. On foreign customer accounts other than those we feel are credit worthy and justify open credit terms with us, we mitigate the risk of non-payment and collection of foreign accounts receivable by obtaining foreign credit insurance on those customers who qualify. Further, should a product shipped overseas be defective, the Company would experience higher costs in connection with a product recall or return and replacement. Most of our sales are priced in U.S. dollars, but because we began selling products in Europe denominated in Euros during 2001, fluctuations in the Euro could also cause our products there to become less affordable or less competitive or we may sell some products at a loss to otherwise maintain profitable business from a customer. We recorded gains of approximately $143,000 and $124,000 during the nine month periods ended September 30, 2004 and 2003, respectively, as a result of foreign currency transactions. While our business has not been materially affected in the past by foreign business or currency fluctuations, because of our increasing dependence on international revenues, our operating results could be negatively affected by a continued or additional decline in the economies of any of the countries or regions in which we do business. Periodic local or international economic downturns, trade balance issues, changes to duties, tariffs or environmental regulations, political instability and fluctuations in interest and currency exchange rates could negatively affect our business and results of operations. We cannot assure you that these factors will not have a material adverse effect on our international sales and would, as a result, adversely impact our results of operation and financial condition. OUR RESULTS OF OPERATIONS MAY BE MATERIALLY HARMED IF WE ARE UNABLE TO RECOUP OUR INVESTMENT IN RESEARCH AND DEVELOPMENT. The rapid change in technology in our industry requires that we continue to make investments in research and development in order to not only develop technologies that function like the OEMs' and do not infringe on the OEMs' intellectual property rights, but we must also enhance the performance and functionality of our products and keep pace with competitive products and satisfy customer demands for 20 improved performance, features, functionality and costs. There can be no assurance that revenues from future products or product enhancements will be sufficient to recover the development costs associated with such products or enhancements or that we will be able to secure the financial resources necessary to fund future development. Research and development costs typically are incurred before we confirm the technical feasibility and commercial viability of a product, and not all development activities result in commercially viable products. In addition, we cannot ensure that these products or enhancements will receive market acceptance or that we will be able to sell these products at prices that are favorable to us. Our business could be seriously harmed if we are unable to sell our products at favorable prices or if the market in which we operate does not accept our products. OUR INTELLECTUAL PROPERTY PROTECTION IS LIMITED. We do not rely on patents to protect our proprietary rights. We do rely on a combination of laws such as trade secrets and contractual restrictions such as confidentiality agreements to protect proprietary rights. Despite any precautions we have taken: o laws and contractual restrictions might not be sufficient to prevent misappropriation of our technology or deter others from developing similar technologies; and o policing unauthorized use of our products is difficult, expensive and time-consuming and we might not be able to determine the extent of this unauthorized use. Therefore, there can be no assurance that we can meaningfully protect our rights in such unpatented proprietary technology or that others will not independently develop substantially equivalent proprietary products or processes or otherwise gain access to the proprietary technology. Reverse engineering, unauthorized copying or other misappropriation of our proprietary technology could enable third parties to benefit from our technology without paying us, which could significantly harm our business. WE DEPEND ON THE EFFORTS AND ABILITIES OF CERTAIN SENIOR MANAGEMENT AND OTHER KEY PERSONNEL TO CONTINUE OUR OPERATIONS AND GENERATE REVENUES. Our success depends to a significant extent on the continued services of senior management and other key personnel. While we do have confidentiality agreements with executive officers and certain other key individuals, we have few employment agreements and they may be terminated by either party upon giving the required notice. The loss of the services of any of our executive officers or other key employees could harm our business. Our success also depends on our ability to attract, retain and motivate highly skilled employees. Competition for qualified employees in the industries in which we operate is intense. If we fail to hire and retain a sufficient number of qualified employees, our business will be adversely affected. WE HAVE A SINGLE MANUFACTURING FACILITY AND WE MAY LOSE REVENUE AND BE UNABLE TO MAINTAIN OUR CLIENT RELATIONSHIPS IF WE LOSE OUR PRODUCTION CAPACITY. We manufacture all of the products we sell in our existing facility in Norcross, Georgia. If our existing production facility becomes incapable of manufacturing products for any reason, we may be unable to meet production requirements, we may lose revenue and we may not be able to maintain our relationships with our customers. Without our existing production facility, we would have no other means of manufacturing products until we were able to restore the manufacturing capability at our facility or develop an alternative manufacturing facility. Although we carry business interruption insurance to cover lost revenue and profits in an amount we consider adequate, this insurance does not cover all possible situations. In addition, our business interruption insurance would not compensate us for the loss of opportunity and potential adverse impact on relations with our existing customers resulting from our inability to produce products for them. OUR ACQUISITION STRATEGY MAY PROVE UNSUCCESSFUL. We intend to pursue acquisitions of businesses or technologies that management believes complement or expand the existing business. Acquisitions of this type involve a number of risks, including the possibility that the operations of any businesses that are acquired will be unprofitable or that management attention will be diverted from the day-to-day operation of the existing business. An unsuccessful acquisition could reduce profit margins or otherwise harm our financial condition, by, for example, impairing liquidity and causing non-compliance with lending institution's financial covenants. In addition, any acquisition could result in a dilutive issuance of equity securities, our going private, the incurrence of debt or the loss of key employees. Certain benefits of any acquisition may depend on the taking of one-time or recurring accounting charges that may be material. We cannot predict whether any acquisition undertaken by us will be successfully completed or, if one or more acquisitions are completed, whether the acquired assets will generate sufficient revenue to offset the associated costs or other adverse effects. We are exploring the possibility of a strategic merger. Any such merger could result in a change in control of the Company. There can be no assurance that any merger or acquisition could be successfully completed. In addition, the Company could incur expenses in exploring a merger or acquisition transactions which are not completed. 21 COMPLIANCE WITH GOVERNMENT REGULATIONS MAY CAUSE US TO INCUR UNFORESEEN EXPENSES. Our black text, color and magnetic character toner supplies and manufacturing operations are subject to domestic and international laws and regulations, particularly relating to environmental matters that impose limitations on the discharge of pollutants into the air, water and soil and establish standards for treatment, storage and disposal of solid and hazardous wastes. In addition, we are subject to regulations for storm water discharge, and as a requirement of the State of Georgia have developed and implemented a Storm Water Pollution Prevention Plan. We are also required to have a permit issued by the State of Georgia in order to conduct various aspects of our business. Compliance with these laws and regulations has not in the past had a material adverse affect on our capital expenditures, earnings or competitive position. There can be no assurance, however, that future changes in environmental laws or regulations, or in the criteria required to obtain or maintain necessary permits, will not have a material adverse affect on our operations. OUR QUARTERLY OPERATING RESULTS FLUCTUATE AS A RESULT OF MANY FACTORS. Our quarterly operating results fluctuate due to various factors. Some of these factors include the mix of products sold during the quarter, the availability and costs of raw materials or components, the costs and benefits of new product introductions, and customer order and shipment timing. Because of these factors, our quarterly operating results are difficult to predict and are likely to vary in the future. DUE TO INHERENT LIMITATIONS, THERE CAN BE NO ASSURANCE THAT OUR SYSTEM OF DISCLOSURE AND INTERNAL CONTROLS AND PROCEDURES WILL BE SUCCESSFUL IN PREVENTING ALL ERRORS OR FRAUD, OR IN MAKING ALL MATERIAL INFORMATION KNOWN IN A TIMELY MANNER TO THE APPROPRIATE MANAGEMENT. Though we have concluded with reasonable assurance that our books, records and accounts are kept in reasonable detail, accurately and fairly reflect the transactions and dispositions of assets, transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, receipts and expenditures and access to assets is permitted in accordance with authorizations of management and directors of the Company, we do not have internal auditors and we depend on a small staff with which it is sometimes difficult to segregate certain duties or to document our practices in policies and procedures. Further, notwithstanding management's conclusions, the effectiveness of a system of disclosure and internal controls and procedures is subject to certain inherent limitations, including cost and staffing limitations, judgments used in decision making, assumptions regarding the likelihood of future events, soundness of internal controls and fraud. Due to such inherent limitations, there can be no assurance that any system of disclosure or internal controls and procedures will be successful in preventing all errors or fraud, or in making all material information known in a timely manner to the appropriate management. RISKS RELATING TO OUR INDUSTRY: WE OPERATE IN A COMPETITIVE AND RAPIDLY CHANGING MARKETPLACE. There is significant competition in the toner and consumable imaging products industry in which we operate. In addition, the market for digital color printers and copiers and related consumable products is subject to rapid change and the OEM technologies are becoming increasingly difficult barriers to market entry. Many competitors, both OEMs and other after market firms, have longer operating histories, larger customer bases, greater brand recognition and significantly greater financial, marketing and other resources than we do. These competitors may be able to devote substantially more resources to developing their business than we can. Our ability to compete depends upon a number of factors, including the success and timing of product introductions, marketing and distribution capabilities and the quality of our customer support. Some of these factors are beyond our control. In addition, competitive pressure to develop new products and technologies could cause our operating expenses to increase substantially. THE IMAGING SUPPLIES INDUSTRY IS COMPETITIVE AND WE ARE RELATIVELY SMALL IN SIZE AND HAVE FEWER RESOURCES IN COMPARISON WITH MANY OF OUR COMPETITORS. Our industry includes large original equipment manufacturers of printing and photocopying equipment and the related imaging supplies, as well as other manufacturers and resellers of aftermarket imaging supplies, with substantial resources to support customers worldwide. Our future performance depends, in part, upon our ability to continue to compete successfully worldwide. All of the original equipment manufacturers and many of our other competitors are diversified companies with greater financial resources and more extensive research, engineering, manufacturing, marketing and customer service and support capabilities than we can provide. We face competition from companies whose strategy is to provide a broad array of products, some of which compete with the products that we offer. These competitors may bundle their products in a manner that may discourage customers from purchasing our products. In addition, we face competition from smaller emerging imaging supply companies whose strategy is to provide a portion of the products and services that we offer. Loss of competitive position could impair our prices, customer orders, revenues, gross margins, and market share, any of which would negatively affect our operating results and financial condition. Our failure to compete successfully with these other companies would seriously harm our business. There is risk that larger, better-financed competitors will develop and market more advanced products than those that we currently offer or may be able to offer, or that competitors with greater financial resources may decrease prices thereby putting us under financial pressure. The occurrence of any of these events could have a negative impact on our revenues. 22 OUR PRODUCTS HAVE SHORT LIFE CYCLES AND ARE SUBJECT TO FREQUENT PRICE REDUCTIONS. Rapidly evolving and increasingly difficult technologies, frequent new product introductions and significant price competition characterize the markets in which we operate. Consequently, our products have short life cycles, and we must frequently reduce prices in response to product competition. Our financial condition and results of operations could be adversely affected if we are unable to manufacture new and competitive products in a timely manner. Our success depends on our ability to develop and manufacture technologically advanced products, price them competitively, and achieve cost reductions for existing products. Technological advances require sustained research and development efforts, which may be costly and could cause our operating expenses to increase substantially. OUR FINANCIAL PERFORMANCE DEPENDS ON OUR ABILITY TO SUCCESSFULLY MANAGE INVENTORY LEVELS, WHICH IS AFFECTED BY FACTORS BEYOND OUR CONTROL. Our financial performance depends in part on our ability to manage inventory levels to support the needs of new and existing customers. Our ability to maintain appropriate inventory levels often depends on factors beyond our control, including unforeseen increases or decreases in demand for our products and production and supply difficulties. Demand for our products can be affected by product introductions or price changes by competitors or by us, the life cycle of our products, or delays in the development or manufacturing of our products. Our operating results and ability to increase the market share of our products may be adversely affected if we are unable to address inventory issues on a timely basis. RISKS RELATING TO OWNING OUR COMMON STOCK: OUR OFFICERS AND DIRECTORS BENEFICIALLY OWN APPROXIMATELY 28% OF THE OUTSTANDING SHARES OF COMMON STOCK, AND AN AFFILIATE OWNS 35% OF OUR COMMON STOCK, ALLOWING THESE STOCKHOLDERS TO CONTROL MATTERS REQUIRING APPROVAL OF THE STOCKHOLDERS. As a result of such ownership, and potential increased ownership, by our officers and directors, other investors will have limited control over matters requiring approval by the stockholders, including the election of directors. Such concentrated control may also make it difficult for the stockholders to receive a premium for their shares of our common stock in the event we enter into transactions that require stockholder approval. In addition, certain provisions of Delaware law could have the effect of making it more difficult or more expensive for a third party to acquire, or of discouraging a third party from attempting to acquire control of us. EXERCISE OF WARRANTS AND OPTIONS WILL DILUTE EXISTING STOCKHOLDERS AND COULD DECREASE THE MARKET PRICE OF OUR COMMON STOCK. As of October 20, 2004, we had issued and outstanding 12,699,005 shares of common stock, 100,000 warrants and 1,420,000 options to purchase additional shares of common stock. The existence of the remaining warrants and options may adversely affect the market price of our common stock and the terms under which we obtain additional equity capital. WE MAY FACE POTENTIAL REGULATORY ACTION OR LIABILITY IN CONNECTION WITH OUR 2001 PRIVATE PLACEMENT. Our issuance of common stock and warrants in a private placement which was completed in 2001 could subject us to potential adverse consequences, including securities law liability and the voiding of contracts entered into in connection with the private placement. If our activities or the activities of other parties in the 2001 private placement are deemed to be inconsistent with securities laws under Section 29 of the Securities Exchange Act of 1934 or our activities or the activities or the activities of other parties are deemed to be inconsistent with the broker dealer registration provisions of Section 15(a) of the Exchange Act: o we may be able to void our obligation to pay transaction-related fees in connection with the private placement and we may receive reimbursement for fees already paid; o persons with whom we have entered into securities transactions that are subject to these transaction-related fees may have the right to void these transactions; and o we may be subject to regulatory action. Due to the inherent uncertainties involved with the interpretation of securities laws, we are unable to predict the following: the validity of any potential liability in connection with our private placement, the outcome of any regulatory action or potential liability or the outcome of voiding transactions in connection with the private placement. The defense of any regulatory action or litigation and any adverse outcome could be costly and could have a material adverse effect on our financial position and results of operations and could divert management attention. 23 OUR COMMON STOCK IS LISTED ON THE OVER-THE-COUNTER (OTC) BULLETIN BOARD, WHICH MAY MAKE IT MORE DIFFICULT FOR STOCKHOLDERS TO SELL THEIR SHARES AND MAY CAUSE THE MARKET PRICE OF OUR COMMON STOCK TO DECREASE. Because our common stock is listed on the OTC Bulletin Board, the liquidity of our common stock is impaired, not only in the number of shares that are bought and sold, but also through delays in the timing of transactions, and limited coverage by security analysts and the news media, if any, of us. As a result, prices for shares of our common stock may be lower than might otherwise prevail if our common stock was traded on NASDAQ or a national securities exchange, like the American Stock Exchange. OUR STOCK PRICE MAY BE VOLATILE AND AN INVESTMENT IN OUR COMMON STOCK COULD SUFFER A DECLINE IN VALUE. The market price of our common stock may fluctuate significantly in response to a number of factors, some of which are beyond our control. These factors include: o progress of our products through development and marketing; o announcements of technological innovations or new products by us or our competitors; o government regulatory action affecting our products or competitors' products in both the United States and foreign countries; o developments or disputes concerning patent or proprietary rights; o actual or anticipated fluctuations in our operating results; o the loss of key management or technical personnel; o the loss of major customers or suppliers; o the outcome of any future litigation; o changes in our financial estimates by securities analysts; o fluctuations in currency exchange rates; o general market conditions for emerging growth and technology companies; o broad market fluctuations; o recovery from natural disasters; and o economic conditions in the United States or abroad. OUR CHARTER DOCUMENTS AND DELAWARE LAW MAY HAVE THE EFFECT OF MAKING IT MORE EXPENSIVE OR MORE DIFFICULT FOR A THIRD PARTY TO ACQUIRE, OR TO ACQUIRE CONTROL OF, US. Our certificate of incorporation makes it possible for our board of directors to issue preferred stock with voting or other rights that could impede the success of any attempt to change control of us. Our certificate of incorporation and bylaws eliminate cumulative voting, which may make it more difficult for a minority stockholder to gain a seat on our board of directors and to influence board of directors' decision regarding a takeover. Delaware Law prohibits a publicly held Delaware corporation from engaging in certain business combinations with certain persons, who acquire our securities with the intent of engaging in a business combination, unless the proposed transaction is approved in a prescribed manner. This provision has the effect of discouraging transactions not approved by our board of directors as required by the statute which may discourage third parties from attempting to acquire us or to acquire control of us even if the attempt would result in a premium over market price for the shares of common stock held by our stockholders. The information referred to above should be considered by investors when reviewing any forward-looking statements contained in this report, in any of our public filings or press releases or in any oral statements made by us or any of our officers or other persons acting on our behalf. The important factors that could affect forward-looking statements are subject to change, and we disclaim any obligation or duty to update or modify these forward-looking statements. FORWARD-LOOKING STATEMENTS Statements contained in this report which are not statements of historical fact are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. These forward-looking statements may be identified by the use of forward-looking terms such as "believes," "expects," "may", "will," "should" or "anticipates" or by discussions of strategy that involve risks and uncertainties. From time to time, we have made or may make forward-looking statements, orally or in writing. These forward-looking statements include statements regarding our ability to borrow funds from financial institutions or affiliates, to engage in sales of our securities, our intention to repay certain borrowings from future sales of our securities or cash flow, the ability to expand capacity by placing in service additional manufacturing equipment and making use of that capacity, our expected acquisition of business or technologies, our plans for broadening our sales channels and the outlets for our products, our expectation that shipments to international customers will continue to account for a material portion of net sales, anticipated future revenues, our introduction of new products and our increasing our sales from all in one cartridges, digital copier, color and magnetic character recognition toner products, sales, our expectations for operations, demand, technology, products, business ventures, major customers, major suppliers, retention of key officers, management or 24 employees, competition, capital expenditures, credit arrangements and other statements regarding matters that are not historical facts, involve predictions which are based upon a number of future conditions that ultimately may prove to be inaccurate. Our actual results, performance or achievements could differ materially from the results expressed in, or implied by, these forward-looking statements. Forward-looking statements are made based upon management's current expectations and beliefs concerning future developments and their potential effects upon our business. We cannot predict whether future developments affecting us will be those anticipated by management, and there are a number of factors that could adversely affect our future operating results or cause our actual results to differ materially from the estimates or expectations reflected in such forward-looking statements. These factors include the "Risk Factors" discussed above. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS Market risk is the risk of loss to future earnings, to fair values or to future cash flows that may result from changes in the price of a financial instrument. The value of a financial instrument may change as a result of changes in interest rates, exchange rates, commodity prices, equity prices and other market changes. Market risk is attributed to all market sensitive financial instruments, including long-term debt. We do not hold any investments or assets outside of the United States. However, we are exposed to financial market risks, including changes in foreign currency exchange rates and interest rates. We estimate that about 96% of our transactions are denominated in U.S. dollars, excepting those sales in Euros to a few customers in Europe, including our second largest customer's European operations. Accordingly, beginning in 2001, we are subject to foreign currency risk with respect to future costs or cash flows from our sales in Euros. We have adjusted our prices annually with our customer to reflect the change in the exchange rate and do not expect to be subject to material foreign currency risk, accordingly, with respect to those sales. As a result, to date, we have not entered into any foreign currency forward exchange contracts or other derivative financial instruments to hedge the effects of adverse fluctuations in foreign currency exchange. We recognized a net foreign currency transaction gain of $143,000 in the nine months ended September 30, 2004, and we recognized a net foreign currency transaction gain of $149,000, $2,858 and a loss of $1,877 in the years ended December 31, 2003, 2002 and 2001, respectively. Our contract pricing for our products sold in Euros is currently at the rates of 1.00 and 1.17 Euros relative to the U.S. dollar. A 10% change in the value of the Euro relative to the United States dollar would cause approximately an $8,000 foreign currency translation adjustment in an average month, a type of other comprehensive income (loss), which would be a direct adjustment to stockholders' equity. Our revolving line of credit bears interest based on interest rates tied to the LIBOR rate, which may fluctuate over time based on economic conditions. As a result, we are subject to market risk for changes in interest rates and could be subjected to increased or decreased interest payments if market rates fluctuate and we are in a borrowing mode. At September 30, 2004, there were no amounts outstanding under the line of credit agreement and, accordingly, a sustained increase in the reference rate of 1% would not cause our annual interest expense to change. Our investment policy requires investments with high credit quality issuers and or over night repurchase agreements with our bank. Investments we make will principally consist of U.S. government and government agency obligations and investment-grade, interest-bearing corporate debt securities with varying maturity dates of five years or less, or the overnight purchase of securities held in our bank's investment portfolio. Because of the credit criteria of our investment policies, the primary market risk associated with these investments is interest rate risk. We do not use derivative financial instruments to manage interest rate risk or to speculate on future changes in interest rates. We had approximately $784,000 in overnight repurchase arrangements with our bank and $440,000 invested in short-term securities, which are available for sale, at September 30, 2004. We received dividends of approximately $5,300 and $25,300 for the three and nine months ended September 30, 2004, while recording a net asset value decrease of approximately $500 and $11,200 for the quarter and nine months ended September 30, 2004, respectively. Management believes that a reasonable change in raw material prices could have a material impact on future earnings or cash flows, because we generally are not able to offset increases to our costs with higher prices for our products. ITEM 4. CONTROLS AND PROCEDURES a) On October 22, 2004, our Chief Executive Officer and Chief Financial Officer participated in a meeting during which there was an evaluation of our disclosure controls and procedures as of September 30, 2004. Based on such evaluation, they believe such controls and procedures are effective. The Company's management, including the Chief Executive Officer and Chief Financial Officer, does not expect that its Disclosure Controls will prevent all error and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been 25 detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdown can occur because of simple error or mistake. The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Based upon the Company's Disclosure Controls evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that, subject to the limitations noted above, the Company's Disclosure Controls are effective to give reasonable assurance that the information required to be disclosed by the Company in its periodic reports is accumulated and communicated to management, including the Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding disclosure and is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission's rules and forms. b) Our Chief Executive Officer and Chief Financial Officer are involved in ongoing evaluations of internal controls. On October 22, 2004, in anticipation of the filing of this Form 10-Q, they reviewed our internal controls and have determined, based on such review, that, there have been no significant changes in our internal controls or in other factors that would significantly affect our internal controls during the quarter ended September 30, 2004. 26 PART II ITEM 1. LEGAL PROCEEDINGS None. ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS On January 23, 2003, the Company's registration statement on Form SB-2, registering up to 7 million shares of the Company's common stock, was declared effective (Registration Statement No. 333-76090), and the offering was commenced by the Company's officers and directors. On March 13, 2003, the Company completed the public sale of 4,500,000 shares of the Company's common stock at a price of $1.35 per share, whereby the Company received $6,075,000 in gross proceeds from an affiliate, and the Company terminated the offering before the sale of all 7 million of registered shares. The net proceeds received by the Company, after expenses of $174,416, was $5,900,584. None of the aforementioned expenses were direct or indirect payments to directors, officers, their associates or persons owning ten (10) percent or more of the common stock of the Company. On April 18, 2003, the Company established a stock repurchase program under which the Company may purchase on the open market the lesser of the aggregate value of $1,000,000 or 1,000,000 shares in compliance with Rule 10b-18, and we have reallocated proceeds for this program. Though management is authorized to repurchase the Company's common stock in the aggregate amount of $1,000,000, due to the limitations imposed by Rule 10b-18 and the limited number of shares repurchased to date in accordance therewith, the use of proceeds per Form SB-2 as reflected herein is based upon no more than $500,000 being expended for this purpose. Our intended uses, as reallocated, of the $6,075,000 of proceeds received from the public sale of our common stock, and our uses through September 30, 2004, are listed below in descending order of priority: Purpose: Amount Used Reallocated Remaining ------------------------------------------ ----------- ------------ ------------ ----------- Accounts payable and other corporate and offering expenses . . . . . . . . . . $ 1,000,000 $ (115,042) $ (884,958) $ 0 To retire debt (1) . . . . . . . . . . . . $ 350,000 $ (324,301) $ (25,699) $ 0 To retire debt (2) . . . . . . . . . . . . $ 1,050,000 $ (956,883) $ (93,117) $ 0 To retire debt (3) . . . . . . . . . . . . $ 0 $ (235,000) $ 235,000 $ 0 To reduce IDR Bond debt (4). . . . . . . . $ 0 $ (548,928) $ 846,264 $ 297,336 To acquire capital assets. . . . . . . . . $ 1,500,000 $ (318,774) $ 0 $ 1,181,226 To repurchase our stock (5). . . . . . . . $ 0 $ (54,886) $ 500,000 $ 445,114 For other general corporate purposes including working capital . . . . . . . . $ 2,175,000 $ (986,072) $ (577,490) $ 611,438 ----------- ------------ ----------- Total: $ 6,075,000 $(3,539,886) $ 2,535,114 Pending application: ------------------- Short-term investments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 1,035,114 Pay down of revolving line of credit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 1,500,000 ---------------- (1) On November 30, 2000, we entered into a loan for $500,000 with a 5-year term, secured by specific manufacturing equipment, maturing November 30, 2004, with General Electric Capital Corporation for the purchase of toner manufacturing equipment. The interest rate is 10.214% and the monthly principal and interest payments were $10,676.39. (2) On June 24, 1999, we entered into a loan for $1,752,000 with a 7-year term, secured by our business assets, maturing June 24, 2006, with SouthTrust Bank for the refinancing of obligations owing the bank for the acquisition of equipment and that due under a previous working capital line of credit. The interest rate is 7.90% per annum and the monthly principal and interest payments were $27,205.00. (3) On July 24, 1999, as amended, we entered into a borrowing arrangement under a revolving line of credit in the maximum amount of $2.5 million. During March 2003 we temporarily used $1,735,000 of our proceeds from our public offering on Form SB-2 to pay down the line of credit to $0, which at that time had an interest rate of 3.8375%. On June 16, 2003, we renewed and restructured the line of credit with the bank, reducing the maximum availability to $1.5 million and permanently retiring $235,000. (4) On June 1, 1999, the Development Authority of Gwinnett County (the Authority), issued $4,100,000 of industrial development revenue bonds on behalf of the Company and Kings Brothers, LLC. The 1.09% revenue bonds, 2.09% inclusive of the 1% letter of credit fee, as of June 30, 2004, are payable in varying annual principal and monthly interest payments through July 2019. The bond is secured, as amended on April 7, 2003, by specific equipment assets of the Company and by real property owned by Kings Brothers, LLC. A loan agreement between the Authority and the Company and Kings Brothers, LLC allows funds to effectively pass through the Authority to the Company. The majority of the proceeds, $3,125,872, were used by the Company to relocate, purchase and install certain manufacturing equipment, while $974,128 was used by Kings Brothers, LLC to pay down the mortgage on the real property leased to the Company. The Company and the Related Party are jointly obligated to repay any outstanding debt. As of September 30, 2004, the bond principal outstanding was $2,725,000 and the portion due from Kings Brothers, LLC was $647,428. The $846,264 of principal to 27 be repaid under the IDR bond, as reallocated hereinabove, is the Company's share of the bond principal due and payable on the 1st of July 2003, 2004 and 2005, respectively. (5) From July 2003 through September 30, 2004, under the repurchase program the Company has repurchased 81,800 shares of our common stock on the open market for $54,886, or at an average price of $0.67. There remains $945,114 available for future common stock repurchases under the authorization of the board of directors and $445,114 as allocated by management hereinabove. During March 2003, using proceeds from the offering on Form SB-2, the Company retired debt owed to General Electric Capital Corporation and SouthTrust Bank, and to the extent proceeds were not required in the amounts outlined for those purposes, they have been reallocated to be used for general corporate purposes. During March 2003, pending application of the proceeds from the offering on Form SB-2, the Company paid down its line of credit with the bank by the then outstanding principal balance of $1,735,000. On June 16, 2003, with the renewal of our line of credit with SouthTrust Bank, we permanently reduced our revolving line of credit to $1,500,000; and, as a result, we retired $235,000 of that debt with our bank. The Company's share of the principal payment due under the IDR Bond on July 1, 2003, in the amount of $266,840 has been paid, and as of September 30, 2004, $282,088 was paid on the IDR bond debt due July 1, 2004. The above table reflects the July 1, 2003 and 2004 payments on the IDR bond. The Company's share of the principal payment due under the IDR bond on July 1, 2005, is $297,336. Pending application, we have retained the balance of the net proceeds in a deposit account with the bank and an investment account with a securities firm related to the bank. No direct or indirect payments to directors, officers, their associates or persons owning ten (10) percent or more of the Company's common stock were made with proceeds from the Company's offering on Form SB-2 ISSUER MARKET PURCHASES OF EQUITY SECURITIES On April 18, 2003, the Company established a stock repurchase program under which the Company may purchase on the open market the lesser of the aggregate value of $1,000,000 or 1,000,000 shares in compliance with Rule 10b-18 until September 30, 2005, as extended by the board of directors during the annual meeting held on May 18, 2004, and we have reallocated proceeds for this program. From July 2003 through December 31, 2003, under the repurchase program the Company repurchased 44,500 shares of our common stock on the open market at an average price of $065. From January 1 through September 30, 2004, under the repurchase program the Company has repurchased 37,300 shares of our common stock on the open market at an average price of $0.70. Since the inception of the repurchase program the Company has repurchased 81,800 shares of our common stock for $54,866 and at an average price of $0.67. There remains $945,134 available for future common stock repurchases, as authorized by the board of directors. ----------------------------------------------------------------------------------------------------------- ISSUER (MARKET) PURCHASE OF EQUITY SECURITIES ----------------------------------------------------------------------------------------------------------- Maximum Number Total Number of (or Approximate Shares Purchased Dollar Value) of Total Number Average Price as Part of Publicly Shares that May Be of Shares Paid per Announced Plans Purchased Under the Period Purchased Share ($) or Programs Plans or Programs -------------------- -------------------- -------------------- -------------------- -------------------- During 2003 44,500 0.65 44,500 During 2004 ------------------- January 7,000 0.72 7,000 February 3,500 0.76 3,500 March 7,000 0.77 7,000 April 7,000 0.78 7,000 May 7,000 0.70 7,000 June 0 -- 0 July 0 -- 0 August 2,900 0.45 2,900 September 2,900 0.47 2,900 -------------------- -------------------- -------------------- -------------------- Total 2004 37,300 0.70 37,300 1,000,000 -------------------- -------------------- -------------------- -------------------- Total 81,800 0.67 81,800 1,000,000 28 ITEM 3. DEFAULTS UPON SENIOR SECURITIES None ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None. ITEM 5. OTHER INFORMATION None ITEM 6 -EXHIBITS (a) EXHIBITS Exhibit No. Description --------- -------------- 2.1 Merger Agreement and Plan of Reorganization dated May 16, 2000, by and between Advatex Associates, Inc., Logical Imaging Solutions Acquisition Corp., Color Imaging Acquisition Corp., Logical Imaging Solutions, Inc., and Color Image, Inc., incorporated by reference to the Registrant's Form 8-K filed on July 17, 2000. 2.2 Amendment No. 1 to the Merger Agreement and Plan of Reorganization dated June 15, 2000, incorporated by reference to the Registrant's Form 8-K filed on July 17, 2000. 2.3 Amendment No. 2 to the Merger Agreement and Plan of Reorganization dated June 26, 2000, incorporated by reference to the Registrant's Form 8-K filed on July 17, 2000. 2.4(1) Share Exchange Agreement dated as of September 11, 2002 between Color Imaging, Inc., Logical Imaging Solutions, Inc., Digital Color Print, Inc., and the shareholders of Digital Color Print, Inc., incorporated by reference to Exhibit 2.1 to the Registrant's Form 8-K filed September 26, 2002. 2.5 Amendment No. 1 to Share Exchange Agreement dated as of September 20, 2002 between Color Imaging, Inc., Logical Imaging Solutions, Inc., Digital Color Print, Inc., and the shareholders of Digital Color Print, Inc., incorporated by reference to Exhibit 2.2 to the Registrant's Form 8-K filed September 26, 2002. 3.1 Certificate of Incorporation, incorporated by reference to Exhibit 3.1 to the Registration statement on Form SB-2 filed July 15, 2002. 3.2 Bylaws, incorporated by reference to the Registrant's Form 10-QSB for the quarter ended March 31, 2002. 4.1 Stock Purchase Agreement between the Company and Wall Street Consulting Corp. dated October 30, 2001, incorporated by reference to Exhibit 4.1 to the Registration statement on Form SB-2 filed May 31, 2002. 4.2 Promissory Note of Wall Street Consulting Corp. dated October 30, 2001, incorporated by reference to Exhibit 4.2 to the Registration statement on Form SB-2 filed May 31, 2002. 4.3 Form of Warrant issued to Selling Stockholders, incorporated by reference to Exhibit 4.3 to the Registration statement on Form SB-2 filed November 28, 2001. 29 Exhibit No. Description --------- -------------- 4.4 Development Authority of Gwinnett County, Georgia Industrial Development Trust Indenture dated June 1, 1999, incorporated by reference to Exhibit 4.27 to the Registration statement on Form SB-2 filed May 31, 2002. 4.5 Loan Agreement between the Company, Kings Brothers LLC and the Development Authority of Gwinnett County, Georgia dated June 1, 1999, incorporated by reference to Exhibit 4.28 to the Registration statement on Form SB-2 filed May 31, 2002. 4.6 Joint Debtor Agreement dated June 28, 2000 by and among Color Image, Inc., Kings Brothers, LLC, Dr. Sueling Wang, Jui-Chi Wang, Jui-Kung Wang, and Jui-Hung Wang, incorporated by reference to Exhibit 4.28 to the Registration statement on Form SB-2 filed February 11, 2002. 4.7 First Amendment to Joint Debtor Agreement dated January 1, 2001 by and among Color Imaging, Kings Brothers, LLC, Dr. Sueling Wang, Jui-Chi Wang, Jui-Kung Wang, and Jui-Hung Wang, incorporated by reference to Exhibit 4.29 to the Registration statement on Form SB-2 filed February 11, 2002. 4.8 $500,000 Promissory Note between Color Imaging and Sueling Wang dated March 14, 2002, incorporated by reference to Exhibit 4.34 to the Registration statement on Form SB-2 filed April 11, 2002. 4.9 $500,000 Promissory Note between Color Imaging and Jui Hung Wang dated August 21, 2002, incorporated by reference to Exhibit 4.50 to the Registration statement on Form SB-2 filed October 2, 2002. 4.10 $100,000 Promissory Note between Color Imaging and Jui Chi Wang dated August 21, 2002, incorporated by reference to Exhibit 4.51 to the Registration statement on Form SB-2 filed October 2, 2002. 4.11 First Note Modification Agreement between Sueling Wang and Color Imaging dated August 27, 2002, incorporated by reference to Exhibit 4.52 to the Registration statement on Form SB-2 filed October 2, 2002. 4.12 Amended and restated $1,500,000 revolving note between Color Imaging and SouthTrust Bank dated June 16, 2003, incorporated by reference to Exhibit 4.12 to the Registrant's Form 10-Q for the quarter ended June 30, 2003. 4.13 Amended and restated loan and security agreement between Color Imaging and SouthTrust Bank dated June 16, 2003, incorporated by reference to Exhibit 4.13 to the Registrant's Form 10-Q for the quarter ended June 30, 2003. 4.14 Amendment to Loan Documents between Color Imaging and SouthTrust Bank dated June 29, 2004, incorporated by reference to Exhibit 4.14 to the Registrant's Form 10-Q for the quarter ended June 30, 2004. 31.1+ Chief executive officer's certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 31.2+ Chief financial officer's certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 32.1+ Chief executive officer's certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 32.2+ Chief financial officer's certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. ------------------------ + Filed herewith. * Management contract or compensatory arrangement or plan. (1) Pursuant to Rule 601(b)(2), the schedules and exhibits to this Agreement shall not be filed. A list of the schedules and exhibits is contained on the last page of the Agreement. The Registrant agrees to furnish supplementally a copy of any of the omitted schedules and exhibits to the Securities and Exchange Commission upon request. 30 SIGNATURES In accordance with the requirements of the Exchange Act, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. COLOR IMAGING, INC. /S/ JUI-KUNG WANG -------------------------------------- October 26, 2004 Jui-Kung Wang Chief Executive Officer /S/ MORRIS E. VAN ASPEREN -------------------------------------- Morris E. Van Asperen Executive Vice President and Chief Financial Officer 31