-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, HOMpr7KYGRsAEpXN2DZJvaXYAHRPrlQ4TztMy33uxC3yh8ERSlX41DBlJ+ZwACoD A7JSxw7+D4N8T3Q6TwddHQ== 0001032210-99-000719.txt : 19990510 0001032210-99-000719.hdr.sgml : 19990510 ACCESSION NUMBER: 0001032210-99-000719 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 19990327 FILED AS OF DATE: 19990507 FILER: COMPANY DATA: COMPANY CONFORMED NAME: SEATTLE FILMWORKS INC CENTRAL INDEX KEY: 0000791050 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-PHOTOFINISHING LABORATORIES [7384] IRS NUMBER: 910964899 STATE OF INCORPORATION: WA FISCAL YEAR END: 0928 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 000-15338 FILM NUMBER: 99614339 BUSINESS ADDRESS: STREET 1: 1260 16TH AVE WEST CITY: SEATTLE STATE: WA ZIP: 98119 BUSINESS PHONE: 2062811390 MAIL ADDRESS: STREET 1: 1260 16TH AVENUE WEST CITY: SEATTLE STATE: WA ZIP: 98119 FORMER COMPANY: FORMER CONFORMED NAME: AMERICAN PASSAGE MARKETING CORP DATE OF NAME CHANGE: 19890320 10-Q 1 FORM 10-Q FORM 10-Q UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 QUARTERLY REPORT UNDER SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended: March 27, 1999 Commission file No. 0-15338 -------------- ------- SEATTLE FILMWORKS, INC. ----------------------- (Exact name of registrant as specified in its charter.) Washington 91-0964899 --------------------------- -------------------- (State or other jurisdiction of (I.R.S. Employer Identification No.) incorporation or organization) 1260 16th Avenue West, Seattle, WA 98119 ---------------------------------- ------- (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (206) 281-1390 -------------- 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 the filing requirements for the past 90 days. Yes X No --- --- As of April 30, 1999, there were issued and outstanding 16,301,435 shares of common stock, par value $.01 per share. Index to Exhibits at Page 17 Page 1 of 18 SEATTLE FILMWORKS, INC. INDEX ----- Page No. -------- PART I -- FINANCIAL INFORMATION
Item 1 - Financial Statements 3-8 Consolidated Balance Sheets as of March 27, 1999 and September 26, 1998 3-4 Consolidated Statements of Operations for the second quarter and six months ended March 27, 1999 and March 28, 1998 5 Consolidated Statements of Cash Flows for the six months ended March 27, 1999 and March 28, 1998 6 Notes to Consolidated Financial Statements 7-8 Item 2 - Management's Discussion and Analysis of Financial Condition and Results of Operations 9-14 PART II -- OTHER INFORMATION Item 1 - Legal Proceedings 15 Item 4 - Submission of Matters to a Vote of Security Holders 15 Item 6 - Exhibits and Reports on Form 8-K 15 SIGNATURES 16 INDEX TO EXHIBITS 17 EXHIBITS 18
Page 2 of 18 PART I -- FINANCIAL INFORMATION ------------------------------- ITEM 1 - FINANCIAL STATEMENTS SEATTLE FILMWORKS, INC. CONSOLIDATED BALANCE SHEETS (in thousands)
(UNAUDITED) (NOTE) March 27, September 26, ASSETS 1999 1998 ================================================================================================= CURRENT ASSETS Cash and cash equivalents $12,188 $11,780 Securities available-for-sale 3,848 4,555 Accounts receivable, net of allowance for doubtful accounts 1,037 1,914 Inventories 9,995 7,561 Capitalized promotional expenditures 165 121 Prepaid expenses and other 1,596 831 Deferred income taxes 358 387 ------- ------- TOTAL CURRENT ASSETS 29,187 27,149 FURNITURE, FIXTURES, AND EQUIPMENT, at cost, less accumulated depreciation 11,087 10,954 CAPITALIZED CUSTOMER ACQUISITION EXPENDITURES 8,400 16,800 DEPOSITS AND OTHER ASSETS 590 213 ------- ------- TOTAL ASSETS $49,264 $55,116 ======= =======
Note: The September 26, 1998 consolidated balance sheet has been derived from audited consolidated financial statements. See notes to consolidated financial statements. Page 3 of 18 SEATTLE FILMWORKS, INC. CONSOLIDATED BALANCE SHEETS (continued) (in thousands, except per share and share data)
(UNAUDITED) (NOTE) March 27, September 26, LIABILITIES AND SHAREHOLDERS' EQUITY 1999 1998 =============================================================================================== CURRENT LIABILITIES Accounts payable $ 4,918 $ 2,359 Current portion of capital lease obligations 179 174 Accrued expenses 1,187 1,376 Accrued compensation 1,514 1,570 Income taxes payable 7 7 ------- ------- TOTAL CURRENT LIABILITIES 7,805 5,486 LONG-TERM CAPITAL LEASE OBLIGATIONS, net of current portion 631 706 DEFERRED INCOME TAXES 2,096 5,223 ------- ------- TOTAL LIABILITIES 10,532 11,415 SHAREHOLDERS' EQUITY Preferred Stock, $.01 par value, authorized 2,000,000 shares, none issued Common Stock, $.01 par value, authorized 101,250,000 shares, issued and outstanding 16,266,986 163 167 Additional paid-in capital 23 981 Retained earnings 38,546 42,553 ------- ------- TOTAL SHAREHOLDERS' EQUITY 38,732 43,701 ------- ------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $49,264 $55,116 ======= =======
Note: The September 26, 1998 consolidated balance sheet has been derived from audited consolidated financial statements. See notes to consolidated financial statements. Page 4 of 18 SEATTLE FILMWORKS, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED) (in thousands, except per share and share data)
Second Quarter Ended Six Months Ended ----------------------- ----------------------- March 27, March 28, March 27, March 28, 1999 1998 1999 1998 ========== ========== ========== ========== Net revenues $19,302 $21,439 $40,814 $43,910 Cost of goods and services 12,750 12,408 26,557 25,380 ------- ------- ------- ------- GROSS PROFIT 6,552 9,031 14,257 18,530 Operating expenses: Amortized customer acquisition costs 4,200 3,944 8,400 7,772 Marketing expenses 5,208 2,263 9,386 4,578 Research and development 287 153 455 296 General and administrative 1,216 1,043 2,360 2,099 ------- ------- ------- ------- Total operating expenses 10,911 7,403 20,601 14,745 ------- ------- ------- ------- INCOME (LOSS) FROM OPERATIONS (4,359) 1,628 (6,344) 3,785 Other income (expense): Interest income 188 175 420 389 Non-operating expense, net (54) (12) (54) (12) ------- ------- ------- ------- Total other income 134 163 366 377 ------- ------- ------- ------- INCOME (LOSS) BEFORE INCOME TAXES (4,225) 1,791 (5,978) 4,162 Benefit (Provision) for income taxes 1,692 (614) 2,393 (1,427) ------- ------- ------- ------- NET INCOME (LOSS) $(2,533) $ 1,177 $(3,585) $ 2,735 ======= ======= ======= ======= Diluted Earnings (Loss) per Share $ (.16) $ .07 $ (.22) $ .16 ======= ======= ======= ======= Basic Earnings (Loss) per Share $ (.16) $ .07 $ (.22) $ .17 ======= ======= ======= ======= Weighted Average Shares and Dilutive Equivalents Outstanding 16,257,000 17,479,000 16,297,000 17,561,000 ========== ========== ========== ========== Weighted Average Shares - Basic 16,257,000 16,564,000 16,297,000 16,552,000 ========== ========== ========== ==========
See notes to consolidated financial statements. Page 5 of 18 SEATTLE FILMWORKS, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) (in thousands)
Six Months Ended ----------------------- March 27, March 28, 1999 1998 ========== ========== OPERATING ACTIVITIES: - -------------------- Net income (loss) $(3,585) $ 2,735 Charges to income not affecting cash: Depreciation and amortization 2,317 1,885 Amortization of capitalized customer acquisition expenditures 8,400 7,772 Deferred income taxes (3,098) 772 Net change in receivables, inventories, payables and other (9) (1,818) Capitalized promotional expenditures, net (44) 95 Additions to capitalized customer acquisition expenditures - (10,294) ------- -------- NET CASH FROM OPERATING ACTIVITIES 3,981 1,147 INVESTING ACTIVITIES: - -------------------- Purchase of furniture, fixtures, and equipment (2,826) (2,808) Purchases of securities available-for-sale (1,236) (3,620) Sales of securities available-for-sale 1,943 3,437 ------- -------- NET CASH USED IN INVESTING ACTIVITIES (2,119) (2,991) FINANCING ACTIVITIES: - -------------------- Proceeds from issuance of Common Stock 109 706 Payment on purchase of Common Stock (1,493) (2,637) Payment on capital lease obligation (70) - ------- -------- NET CASH USED IN FINANCING ACTIVITIES (1,454) (1,931) ------- -------- INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 408 (3,775) Cash and cash equivalents at beginning of period 11,780 10,252 ------- -------- CASH AND CASH EQUIVALENTS AT END OF PERIOD $12,188 $ 6,477 ======= ========
See notes to consolidated financial statements. Page 6 of 18 SEATTLE FILMWORKS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) NOTE A -- BASIS OF PRESENTATION Seattle FilmWorks, Inc. and its subsidiaries (the "Company") is a leading direct-to-consumer marketer and provider of high-quality amateur traditional photofinishing and digital and Internet related imaging services and products. The Company offers an array of complementary services and products, primarily on a mail-order basis, under the brand name Seattle FilmWorks(R). To a lesser extent, the Company provides services, products and photofinishing supplies on a wholesale basis to a variety of commercial customers. The accompanying unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for fair presentation of interim results have been included. The Company follows a policy of recording its interim periods and year-end on a 5 week, 4 week and 4 week basis for comparability of results and to be consistent with its internal weekly reporting. Operating results for the second quarter and six months ended March 27, 1999 are not necessarily indicative of the results that may be expected for the fiscal year ending September 25, 1999. For further information, refer to the "Management's Discussion and Analysis of Financial Condition and Results of Operations" and consolidated financial statements and footnotes thereto included in the Company's Annual Report on Form 10-K for the year ended September 26, 1998. NOTE B -- CUSTOMER ACQUISITION EXPENDITURES The Company's principal technique for acquiring new customers is its Introductory Offer of two rolls of 35mm film for $2.00 or less. Customer acquisition costs are comprised of the costs of generating a lead and the amortization of direct costs associated with the Company's promotional offers sent to prospective and existing customers. The costs of generating a lead, which are expensed when the promotion is run, include all direct-response media, advertising and other costs associated with developing target customer lists. The direct costs of customer acquisition include film, postage and printed material costs associated with mailings to prospective and existing customers. Prior to fiscal 1999, the direct costs of customer acquisition were capitalized as an asset on the Company's consolidated balance sheet under "capitalized customer acquisition expenditures" and those related to prospective customers were amortized over three years on an accelerated basis. During the fourth quarter of fiscal 1998 the overall performance of the customer acquisition programs showed a decline. Upon completing the quarterly review of the recoverability of the capitalized costs as of September 26, 1998, management concluded that the lower response rates to customer acquisition programs required an adjustment to the amount of capitalized costs associated with those programs. Accordingly, the Company reduced the capitalized customer acquisition cost asset by $613,000 to its net realizable value. In accounting for customer acquisition costs, the Company follows the American Institute of Certified Public Accountants Statement of Position 93-7, Reporting on Advertising Costs (SOP 93-7). Previously, the Company capitalized and then amortized customer acquisition costs so that the expenses resulting from the amortization of these costs would match the period in which associated estimated revenue would be received with respect to those marketing efforts. However, as a result of recent trends in customer responses, the Company's marketing plans and Internet and retail distribution strategies, management believes that the net profit margin on identifiable responses will be insufficient to justify deferral of such costs in the future. Effective in the first quarter of fiscal 1999, the Company began expensing all customer acquisition costs as incurred. In addition, the Company began amortizing $16,800,000 of previously deferred customer acquisition costs over a twelve month period on a straight-line basis. In the first six months of fiscal 1999, the change in estimate from a three year accelerated amortization to a twelve month straight-line amortization resulted in incremental amortization of previously deferred customer acquisition costs of $1,815,000 or a loss of $.07 per share. NOTE C -- RECLASSIFICATIONS Certain prior year balances have been reclassified to conform to the current year's presentation. Page 7 of 18 SEATTLE FILMWORKS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) NOTE D -- CONTINGENCIES The Company is a defendant in a legal proceeding that was filed by Fuji Photo Film Co., Ltd. ("Fuji") with the International Trade Commission ("ITC") on February 13, 1998. The action was filed against a number of importers, including the Company's OptiColor, Inc. subsidiary, alleging patent infringement of U.S. patents on single use cameras through the importation and resale of recycled cameras. Fuji is seeking an order prohibiting importation of infringing cameras into the U.S. and prohibiting further sales of such products which have been imported. Sales of recycled cameras accounted for 3.8% of the Company's net revenues during fiscal 1998 and 4.4% during the first six months of fiscal 1999. An evidentiary hearing before an ITC Administrative Law Judge ("ALJ") was held in November, 1998 and the ALJ has issued an initial decision in favor of Fuji which the ITC Commissioners have decided to let stand. The ITC Commissioners are expected to issue a final order in late May or early June, 1999; it is likely that the order will prohibit the Company and its subsidiaries from importing and selling imported recycled single use cameras. The ITC Commissioners' order will be subject to appeal to the Federal Circuit Court of Appeals. The Company is currently considering whether to appeal the ITC order. There is risk that Fuji might bring a civil action against OptiColor and the Company for damages for patent infringement by reason of sales of cameras which have been found in the ITC proceeding to infringe Fuji patents. If such an action were brought, the ITC decision would not be binding in the civil proceeding and would not prevent OptiColor and the Company from raising and litigating all available defenses. At this time, the likelihood that such an action would be brought, and, if brought, its ultimate outcome and impact on the Company, are not determinable. The Company does not expect the pending litigation to have a significant impact on its financial condition, results of operations or liquidity. The Company is also involved in various routine legal proceedings in the ordinary course of its business. NOTE E -- EARNINGS PER SHARE The Company calculates earnings per share in accordance with the SFAS No. 128, "Earnings per Share". Earnings per share is based on the weighted average number of shares and dilutive Common Stock equivalents outstanding during the period. Common Stock equivalents consist of stock options. The dilutive effect of stock options, if any, is excluded from the calculation of basic earnings per share, but included in the computation of diluted earnings per share. The following table sets forth the computation of basic and diluted earnings per share:
Second Quarter Ended Six Months Ended -------------------------------- ---------------- March 27, 1999 March 28, 1998 March 27, 1999 March 28, 1998 =============== ============== ================= ============== Numerator for basic and diluted earnings per share: Net income (loss) $(2,533,000) $ 1,177,000 $(3,585,000) $ 2,735,000 =========== =========== =========== =========== Denominator: Denominator for basic earnings per share - weighted-average shares 16,257,000 16,564,000 16,297,000 16,552,000 Net effect of dilutive stock options - 915,000 - 1,009,000 ----------- ----------- ----------- ----------- Denominator for diluted earnings per share 16,257,000 17,479,000 16,297,000 17,561,000 =========== =========== =========== =========== Basic Earnings (Loss) per Share $ (.16) $ .07 $ (.22) $ .17 =========== =========== =========== =========== Diluted Earnings (Loss) per Share $ (.16) $ .07 $ (.22) $ .16 =========== =========== =========== ===========
NOTE F -- SEGMENT REPORTING In June 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards (SFAS) No. 131, "Disclosure about Segments of an Enterprise and Related Information." SFAS No. 131, which is effective for years beginning after December 15, 1997, establishes standards for the way that public business enterprises report information about operating segments in published financial reports. The Company will adopt the new requirements in fiscal 1999. Management has not yet determined the manner in which it will present the information required by SFAS No. 131. Page 8 of 18 ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Forward-Looking Information - --------------------------- Statements in this report concerning future results, trends, new product or service development or introduction plans, digital image storage capacity and durability, Year 2000 or any other statement which may be construed as a prediction of future capabilities, performance or events are forward-looking statements, the occurrence of which are subject to a number of known and unknown risks and uncertainties which might cause actual capabilities, performance, or occurrences to differ materially from those expressed or implied by such statements. These risks and uncertainties include the Company's ability to create and implement effective customer acquisition techniques; timely development, delivery and market acceptance of products and services which differentiate the Company from other photofinishers; technological changes; product development or production difficulties or delays due to technical difficulties, supply constraints or other factors; changing economic conditions; the impact of competitive products and pricing; the possibility of delays in the expansion of image storage capacity due to delays in deliveries from suppliers or technical problems; system performance problems due to malfunctions, Internet interruptions or other factors; and other risks including those described in the Company's Annual Report on Form 10-K and those described from time to time in the Company's other filings with the Securities and Exchange Commission, press releases and other communications. Any forward-looking statements in this report reflect the Company's expectations at the time of this report only, and the Company disclaims any responsibility to revise or update any such forward- looking statements except as may be required by law. General - ------- Seattle FilmWorks, Inc. including its subsidiaries is a leading direct-to- consumer marketer and provider of high-quality amateur traditional photofinishing and digital and Internet imaging services and products. The Company offers an array of complementary services and products primarily on a mail-order basis under the brand name Seattle FilmWorks(R). To promote its service and products, the Company relies primarily on direct-marketing programs, including the customer acquisition technique of offering two rolls of film for $2.00 or less (the "Introductory Offer"). The Introductory Offer has been nationally advertised in package inserts, newspaper supplements and magazines and through various other direct-response media. Beginning in fiscal 1995, the Company shifted the focus of, and substantially expanded, its customer acquisition programs. This shift in focus included mailing of two rolls of film to users of personal computers, together with materials promoting the Company's digital imaging services and products, such as Pictures On Disk(TM) and PhotoMail(TM) Internet image delivery. Customer acquisition costs are comprised of the costs of generating a lead and the amortization of direct costs associated with the Company's promotional offers sent to prospective and existing customers. The costs of generating a lead include all direct-response media, advertising and other costs associated with developing target customer lists. The direct costs of customer acquisition include film, postage and printed material costs associated with mailings to prospective and existing customers. Until the end of fiscal 1998, the direct costs of customer acquisition were capitalized as an asset on the Company's consolidated balance sheet as "capitalized customer acquisition expenditures." Historically, capitalized customer acquisition expenditures relating to prospective customers were amortized over three years, and, beginning in fiscal 1996, capitalized customer acquisition expenditures relating to certain marketing activities to groups of existing customers were amortized over six months. These amortization rates were based on estimates of the timing of future roll processing volumes per customer. The proportion of capitalized customer acquisition expenditures amortized over three years relative to those to be amortized over six months varied from period to period based on the timing and mix of promotional activities. Based on developments in fiscal 1998 as discussed below, the Company has changed its accounting estimate for customer acquisition costs in future periods. For approximately 75% of rolls received from customers, the Company has the ability to determine the specific mailing to which a customer is responding. These "identifiable responses" serve as the basis for estimates of future response rates for the purpose of determining the appropriate amortization period and for the purpose of assessing recoverability of the investment in customer acquisition expenditures. Net recoverability estimates of the capitalized costs are assessed each quarter based on identifiable responses to the programs for which costs are recorded as an asset. Specifically, the Company compared amortized expense of customer acquisition programs with the actual profitability of such programs to assess whether the costs are fully recoverable. Quarterly analyses prior to fiscal 1998 indicated that the marketing programs for Page 9 of 18 which costs were capitalized were consistently yielding net profits from identifiable responses in excess of the program costs. During the first three quarters of fiscal 1998, the quarterly analyses showed a decline in net profitability, but capitalized costs appeared to be fully recoverable. As discussed in the 10-Q filing for the third fiscal quarter ended June 27, 1998, management's statistical analysis of marketing programs indicated that photofinishing volumes continued to be adversely affected by extended delivery times experienced by customers during the summer of 1997. Based on this analysis completed in the third quarter of fiscal 1998, management believed that these extended delivery times had a negative impact on customer responses. Nevertheless, the amount of net capitalized costs at the end of the third quarter of fiscal 1998 were not in excess of the estimated net profit from identifiable responses expected to be received under the programs in the future. During the fourth quarter of fiscal 1998 the overall performance of customer acquisition programs continued to decline. Upon completing the quarterly review of the recoverability of capitalized costs as of September 26, 1998, management concluded that the lower response rates to customer acquisition programs required an adjustment to the amount of capitalized costs associated with those programs. Accordingly, the Company reduced the capitalized customer acquisition cost asset by $613,000, or 3.5% of the total asset of $17,400,000, recognizing the $613,000 as a pre-tax expense in the fourth quarter of fiscal 1998 and reducing the capitalized customer acquisition cost asset to $16,800,000 as of September 26, 1998. Management attributes the need for this action to a gradual decline in profitability of the average customer, primarily related to response rates. Through fiscal 1998, capitalized customer acquisition costs were amortized over 36 months on an accelerated basis. Historical statistical data supported this amortization schedule as a good approximation of identifiable responses to specific customer acquisition marketing programs. As a result, this amortization estimate provided a good matching of the amortization of capitalized direct marketing costs with related revenue in accordance with the American Institute of Certified Public Accountants ("AICPA") Statement of Position 93-7, Accounting for Advertising Costs ("SOP 93-7"). Prior to fiscal --------------------------------------------- 1999 the Company had not sent repeat mailings of its introductory free film to households which had received such a mailing within the last 36 months, because to do so would have obscured the response rates to the initial mailing. However, recent marketing tests show that repeat mailings may, in some cases, be more productive than seeking out a marginal new target customer. Under current marketing plans, which commenced in the first quarter of fiscal 1999, a significant number of previously targeted and existing customers will receive additional marketing mailings. Given the negative trend in identifiable response rates to the Company's marketing programs, management believed there was growing uncertainty about the reliability of historical response rates to predict future performance of its marketing programs. Management also believed significant costs remained capitalized on the Company's balance sheet which related to prior marketing activity to a number of individuals likely to receive additional marketing mailings during fiscal 1999. In addition, industry trends suggest that direct marketing with free film may have decreasing marginal returns. Digital technologies are an emerging substitute to film-based systems and growing acceptance of these technologies may cause further deterioration of results from direct marketing programs as consumer behavior changes. The Company is actively pursuing Internet and retail distribution as a complement to its mail order business. It is more difficult to track direct marketing program response rates in a retail environment because customers do not generally submit their orders with coded response forms. As noted above, in accounting for customer acquisition costs, the Company follows SOP 93-7. Previously, the Company was required by SOP 93-7 to capitalize and then amortize customer acquisition costs so that the expenses resulting from the amortization of these costs would match the period in which associated estimated revenue would be received from identifiable responses to those marketing efforts. However, as a result of recent trends in customer responses, the Company's marketing plans and Internet and retail distribution strategies, management believes that the net profit margin on identifiable responses would not be sufficient to justify deferral of such costs due to the trend of lower response rates and to an expected decline in the percentage of identifiable responses to individual programs. As a result of these changes in circumstances, management no longer had persuasive evidence that future direct response advertising would have identifiable results to the degree of reliability that would otherwise require capitalization of such costs pursuant to SOP 93-7. As discussed in the Company's fiscal 1998 Annual Report on Form 10-K, effective in the first quarter of fiscal 1999, the Company began expensing all customer acquisition costs as incurred. In addition, the Company began amortizing $16,800,000 of previously deferred customer acquisition costs over a twelve month period on a straight- line basis. During each of the first and second quarters of fiscal 1999, the Company amortized $4,200,000 of previously capitalized customer acquisition costs in addition to current period marketing costs. The Company expects to amortize Page 10 of 18 $4,200,000 of the remaining capitalized customer acquisition expenditures in each of the two remaining quarters of fiscal 1999. Accordingly, operating expenses will be significantly higher in fiscal 1999 compared to prior periods. Future periods may reflect increased or decreased customer acquisition costs due to the expensing of such costs as incurred, as well as the timing and magnitude of marketing activities. Net loss for the first six months of fiscal 1999 was $3,585,000, or a loss of $.22 per share, compared to net income of $2,735,000 or diluted earnings per share of $.16 for the six months of fiscal 1998. The net loss in fiscal 1999 as compared to net income in fiscal 1998 was primarily attributable to the increase in operating costs as a result of the accelerated amortization of previously deferred customer acquisition costs and expensing of current period marketing costs combined with a decrease in gross profit. Operating results will fluctuate in the future due to changes in the mix of sales, intensity and effectiveness of promotional activities, price increases by suppliers, introductions of new products, research and development requirements, actions by competitors, foreign currency exchange rates, conditions in the direct-to- consumer market and the photofinishing industry in general, national and global economic conditions and other factors. Demand for the Company's photo-related services and products is highly seasonal, with the highest volume of photofinishing activity occurring during the summer months. However, seasonality of demand may be offset by the introduction of new services and products, changes in the level of effectiveness of customer acquisition and marketing programs, activities by competitors, production difficulties and other factors. This seasonality, when combined with the general growth of the Company's photofinishing business, has produced greater photofinishing net revenues during the last half of the Company's fiscal year (April through September), with a peak occurring in the fourth fiscal quarter. Net income is affected by the seasonality of the Company's net revenues due to the fixed nature of a portion of the Company's operating expenses, seasonal variation in sales mix and the Company's practice of incurring relatively higher marketing program expenditures prior to the summer months. Results of Operations - --------------------- The following table presents information from the Company's consolidated statements of operations, expressed as a percentage of net revenues for the periods indicated.
Second Quarter Ended Six Months Ended ----------------------- ----------------------- March 27, March 28, March 27, March 28, 1999 1998 1999 1998 =============================================================================================== Net revenues 100.0% 100.0% 100.0% 100.0% Cost of goods and services 66.1 57.9 65.1 57.8 ------ ----- ----- ----- GROSS PROFIT 33.9 42.1 34.9 42.2 Operating expenses: Amortized customer acquisition costs 21.7 18.4 20.6 17.7 Marketing expenses 27.0 10.6 23.0 10.4 Research and development 1.5 0.7 1.1 0.7 General and administrative 6.3 4.8 5.8 4.8 ------ ----- ----- ----- Total operating expenses 56.5 34.5 50.5 33.6 ------ ----- ----- ----- INCOME (LOSS) FROM OPERATIONS (22.6) 7.6 (15.6) 8.6 Total other income 0.7 0.8 0.9 0.8 ------ ----- ----- ----- INCOME (LOSS) BEFORE INCOME TAXES (21.9) 8.4 (14.7) 9.4 Benefit (provision) for income taxes 8.8 (2.9) 5.9 (3.2) ------ ----- ----- ----- NET INCOME (LOSS) (13.1)% 5.5% (8.8)% 6.2% ====== ===== ===== =====
Page 11 of 18 Net revenues for the second quarter of fiscal 1999 were $19,302,000 compared to net revenues of $21,439,000 in the second quarter of fiscal 1998. For the six months ended March 27, 1999, net revenues were $40,814,000 compared to $43,910,000 for the same period of fiscal 1998. The decreases in net revenues were primarily due to lower-than-expected photofinishing revenues. Management attributes reduced photofinishing revenues to increased competition, primarily relating to lower retail pricing of major film brands. In addition, the Company reduced spending on marketing programs in the first half of fiscal 1999 as compared to the prior year based on a planned shift in concentration of marketing programs to the third and fourth quarters of fiscal 1999. Sales of products and photofinishing supplies to commercial customers also decreased in fiscal 1999 periods primarily due to the lower retail pricing of major film brands which has reduced market share of private-label brands. Net revenues for fiscal 1999 periods were also affected by a planned reduction in ancillary businesses primarily related to wholesale film sales in Asia and the Company's Photo Home Study continuity program. Cost of goods and services consist of labor, postage, supplies and fixed operating costs related to the Company's services and products. Gross profit in the second quarter of fiscal 1999 decreased to 33.9% of net revenues compared to 42.1% in the second quarter of fiscal 1998. For the first six months of fiscal 1999, gross profit decreased to 34.9% compared to 42.2% for the same period of fiscal 1998. The decreases in fiscal 1999 periods were due primarily to lower net revenues combined with higher material and usage costs relating to enhancements in digital and traditional services and products. Gross profit also included higher retail and production labor and equipment costs. Fluctuations in gross profit will occur in future periods due to the seasonal nature of revenues, mix of product sales, level and nature of promotional activities and other factors. Total operating expenses in the second quarter of fiscal 1999 increased to 56.5% of net revenues compared to 34.5% in the second quarter of fiscal 1998. For the first six months of fiscal 1999 total operating expenses increased to 50.5% of net revenues compared to 33.6% for the same period of fiscal 1998. The increases in operating costs were due primarily to the acceleration in amortization of previously deferred customer acquisition costs combined with current customer acquisition and marketing expenditures for the quarter and six month periods. Each year the Company prepares detailed plans for its various marketing activities, including the mix between customer acquisition expenditures and other marketing expenses. However, the Company occasionally changes both the mix and total marketing expenditures between periods to take advantage of marketing opportunities as they become available. Also, the Company expects to amortize $4,200,000 of the remaining capitalized customer acquisition expenditures in each of the two remaining quarters of fiscal 1999. Accordingly, operating expenses will continue to be significantly higher in fiscal 1999 compared to prior periods. Future periods may reflect increased or decreased marketing costs due to the expensing of such costs as incurred, as well as the timing and magnitude of marketing activities. Marketing expenses include current period expenses associated with customer acquisition, building brand awareness, testing of new marketing strategies and marketing to existing customers. Marketing expenses in the second quarter of fiscal 1999 increased to 27.0% of net revenues compared to 10.6% of net revenues for the second quarter of fiscal 1998. For the first six months of fiscal 1999, other marketing expenses were 23.0% of net revenues compared to 10.4% of net revenues for the first six months of fiscal 1998. The increases were primarily due to the expensing of current period acquisition costs as compared to the prior periods. Research and development expenses increased to $287,000 in the second quarter of fiscal 1999 as compared to $153,000 for the second quarter of fiscal 1998. Research and development expenses for the first six months of fiscal 1999 increased to $455,000 as compared to $296,000 for the first six months of fiscal 1998. The increases in fiscal 1999 were due primarily to additional wages and contract services incurred primarily to support the Company's digital imaging development strategy. Research and development expenses consist primarily of costs incurred in researching and developing new computerized digital imaging concepts, developing computer software products and creating equipment necessary to provide customers with new computer-related photographic services and products, including online Internet services and products. General and administrative expenses increased to $1,216,000 for the second quarter of fiscal 1999 as compared to $1,043,000 for the second quarter of fiscal 1998. General and administrative costs increased to $2,360,000 for the first six months of fiscal 1999 as compared to $2,099,000 for the first six months of fiscal 1998. The increases were due primarily to increases in legal and professional fees combined with higher wages and benefits. General and administrative expenses Page 12 of 18 consist of costs related to computer operations, human resource functions, finance, accounting, legal, investor relations and general corporate activities. Total other income for the second quarter of fiscal 1999 decreased to $134,000 as compared to $163,000 for the second quarter of fiscal 1998. For the first six months of fiscal 1999, total other income was $366,000 as compared to $377,000 for the same period of fiscal 1998. The decreases in the fiscal 1999 periods were due primarily to losses related to the disposal of certain obsolete assets. Federal income taxes were recorded at a benefit rate of 40% for the first six months of fiscal 1999 compared to an expense of 34.3% in the first six months of fiscal 1998. The tax rate for the current fiscal year is affected by the reversal of deferred tax liabilities in relation to deferred customer acquisition costs. Other factors affecting the fiscal 1999 tax rate are tax exempt interest and the federal research and development tax credit. Net income as a percentage of net revenues decreased to a loss of 13.1% in the second quarter of fiscal 1999 as compared to net income of 5.5% in the second quarter of fiscal 1998. For the first six months of fiscal 1999 net income as a percentage of net revenues decreased to a loss of 8.8% compared to net income of 6.2% for the same period of fiscal 1998. The fiscal 1999 period decreases were primarily due to increased operating expenses combined with a decrease in net revenues and gross profit. Liquidity and Capital Resources - ------------------------------- As of April 30, 1999, the Company's principal sources of liquidity included cash and short-term investments of $16,060,000 and an unused revolving line of credit of $6,000,000. The ratio of current assets to current liabilities for the Company was 3.7 to 1 at the end of the second quarter of fiscal 1999, compared to 4.9 to 1 at September 26, 1998. During the first six months of fiscal 1999, the Company increased inventory levels by $2,434,000 to accommodate third and fourth quarter marketing plans and support planned for photofinishing volumes. Accounts payable increased by $2,559,000 primarily due to inventory purchases. Accounts receivable decreased by $877,000 primarily due to payments received for wholesale film orders shipped in the fourth quarter of fiscal 1998, sales of which were substantially discontinued in the fourth quarter of fiscal 1998. On January 22, 1997, the Company announced that it may repurchase shares of its Common Stock, either through open market purchases at prevailing market prices, through block purchases or in privately negotiated transactions. Repurchases may be commenced or discontinued by the Company at any time. Although the number of shares to be repurchased is uncertain, any repurchased shares will to some degree offset the dilutive effect on earnings per share of shares of Common Stock issued under the Company's stock option and stock purchase plans. During the first quarter of fiscal 1999 the Company repurchased 466,000 shares of its common stock at a total price of $1,493,000. Although the Company does not currently have any fixed material commitments with regard to capital expenditures, it currently expects to spend approximately $4,500,000 during the remainder of fiscal 1999, principally for photofinishing processing equipment, data storage and computer network equipment and for leasehold improvements. The Company currently anticipates that existing funds together with anticipated cash flow from operations and the Company's available line of credit of $6,000,000 will be sufficient to finance its operations and planned capital expenditures and to service its indebtedness for the foreseeable future. However, if the Company does not generate sufficient cash from operations to satisfy its ongoing expenses, the Company will be required to seek external sources of financing or to refinance its obligations. Possible sources of financing include the sale of equity securities or additional bank borrowings. There can be no assurance that the Company will be able to obtain adequate financing in the future. Year 2000 - --------- The Company recognizes the need to ensure that its operations will not be adversely affected by Year 2000 systems failures. Year 2000 issues arise because some computer software and hardware ("computer systems") were designed to handle only a two-digit year, not a four-digit year (e.g. 1999 is seen by the computer as "99"). When the year 2000 begins, these computer systems may interpret "00" as the year 1900 and not 2000, and could either stop processing date-related computations or process them incorrectly. Page 13 of 18 In order to minimize the impact of the Year 2000 on the Company, a Year 2000 committee has been established for the evaluation and management of risks associated with material Year 2000 issues. The committee's plan includes a review of material computer and imbedded systems that the Company currently has in place, modification or replacement of such systems if required, assessment of Company's software products as relates to Year 2000 issues, inquiry to third- party providers with whom the Company has material business relationships as to their state of readiness for potential Year 2000 issues and the development of contingency plans in the event material Year 2000 issues arise in Company or third-party computer systems. The Company estimates that as of April 30, 1999, it had completed approximately 80% of the initiatives that it believes will be necessary to fully address potential Year 2000 issues relating to its computer equipment and software. The projects are in process and expected to be completed on or about June 30, 1999. The Company anticipates that testing of additional systems and required modifications or replacements will be completed by June 30, 1999. As of March 27, 1999, the Company has not expended any material amount to address potential Year 2000 issues, exclusive of costs associated with previously scheduled modifications, upgrades or replacements unrelated to Year 2000 issues. Other non-Year 2000 information system efforts have not been materially delayed or impacted by Year 2000 initiatives. The Company does not anticipate spending material amounts for additional testing, modification, upgrade and replacement related to Year 2000 during fiscal year 1999. Based on current and anticipated operating needs, many of the Company's critical computer systems do not rely on a two-digit year field as part of the process or are in the process of being replaced with more technologically advanced versions. Each new system being installed has been reviewed for Year 2000 compliance. The computer systems that have been or are in the process of being upgraded or replaced, include, but are not limited to, the Company's accounting system, inventory control system, workstation and network operating systems. The remaining computer and imbedded systems, including but not limited to, plant equipment, alarm systems, phone equipment and general office equipment are currently being reviewed for Year 2000 compliance as part of the overall plan for testing and modification referenced above. The Company has determined that most products the Company sells in the ordinary course of business do not have issues relating to Year 2000. Software products previously supplied by the Company, in some cases, may display an incorrect date but will continue to function. At their option, customers may upgrade to newer versions of the Company's software to correct the date display. Any Year 2000 issues in products sold by the Company that are manufactured by another vendor will be referred to that vendor. In addition to reviewing its own computer systems, the Company has sent letters to material third-party providers, including, but not limited to, suppliers, product sponsors, financial institutions, service providers, and other companies with which the Company has material business relationships in order to assess these companies' state of Year 2000 readiness. These letters request, among other things, disclosure of the companies' plans for minimizing the impact of the Year 2000 on their computer systems and the Company. As of April 30, 1999, the Company had received responses from approximately 50% of such third parties, and 100% of the companies that have responded have provided written assurances that they expect to address all their significant Year 2000 issues on a timely basis. A follow-up mailing to significant vendors and service providers that did not initially respond, or whose responses were deemed unsatisfactory by the Company, has been completed. To date, the Company has not received from any third-party provider with which a material business relationship exists notice of a material Year 2000 issue or inability to address material Year 2000 issues prior to the Year 2000. The Company is not in a position to verify whether third-party service providers are or will become Year 2000 ready apart from such assurances or until a Year 2000 issue arises. The Company presently believes that the Year 2000 issue will not pose significant operational problems for the Company. However, if all Year 2000 issues are not properly identified, or assessment, remediation and testing are not effected timely with respect to Year 2000 problems that are identified, there can be no assurance that the Year 2000 issue will not materially adversely affect the Company's results of operations or adversely affect the Company's relationships with customers, vendors, or others. Additionally, there can be no assurance that the Year 2000 issues of other entities will not have a material adverse impact on the Company's systems or results of operations. If the Company were to experience a material disruption in its computer systems from Year 2000 issues, the Company is prepared to conduct business, particularly the processing of customer orders, utilizing manual processes and third party vendors and back- up data routinely archived by the Company. The Company anticipates that the cost of conducting business utilizing the Company's contingency plans would be higher than conducting business utilizing current and anticipated operational plans. Page 14 of 18 PART II -- OTHER INFORMATION ---------------------------- ITEM 1 - LEGAL PROCEEDINGS For an update concerning the legal proceeding filed by Fuji Photo Film Co., Ltd. on February 13, 1998, see Note D of Notes to Consolidated Financial Statements in Part I above. ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY-HOLDERS On February 9, 1999, the Company held its annual meeting of shareholders. The shareholders acted on the following matter at the annual meeting. The following individuals were elected to the Company's Board of Directors, to hold office for a three-year term and until his respective successor is duly elected and qualified. The number of votes cast, the number of votes withheld, and the number of broker non-votes are listed below.
For Withheld Non-votes ---------- -------- --------- Peter H. van Oppen 15,390,599 235,978 N/A Craig E. Tall 15,399,948 226,629 N/A
ITEM 6 - EXHIBITS AND REPORTS ON FORM 8-K. (a) Exhibits. --------- 10.1 Supplemental lease agreement No. 5 with General Services Administration dated February 10, 1999 27 Financial Data Schedule (b) Reports on Form 8-K. -------------------- None Page 15 of 18 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. SEATTLE FILMWORKS, INC. DATED: May 7, 1999 /s/ Gary R. Christophersen -------------------------------------- Gary R. Christophersen President/Chief Executive Officer (Principal Executive Officer) /s/ Case H. Kuehn --------------------------------------- Case H. Kuehn Vice President-Finance/Treasurer (Principal Financial and Chief Accounting Officer) Page 16 of 18 INDEX TO EXHIBITS SEATTLE FILMWORKS, INC. Quarterly Report on Form 10-Q For The Quarter Ended March 27, 1999
Exhibit Description Page No. - ------- ----------- -------- 10.1 Supplemental lease agreement No 5. with General Service Administration dated February 10, 1999 18 27 Financial Data Schedule Edgar filing
Page 17 of 18 EX-10.1 2 SUPPLEMENTAL LEASE AGREEMENT EXHIBIT 10.1 GENERAL SERVICES ADMINISTRATION SUPPLEMENTAL AGREEMENT DATE PUBLIC BUILDINGS SERVICE NO. 5 FEB 10 1999 SUPPLEMENTAL LEASE AGREEMENT TO LEASE NO. GS-10PES-OL-5-42 ADDRESS OF PREMISES Federal Center South 1202 Warehouse 4735 E. Marginal Way South Seattle, WA 98134 THIS AGREEMENT, made and entered into this date by and between Seattle FilmWorks, Inc. whose address is 1260 16th Avenue West Seattle, WA 98119 hereinafter called the Lessee, and the UNITED STATES OF AMERICA, hereafter called the Government: WHEREAS, the parties hereto desire to amend the above Lease. NOW THEREFORE, these parties for the considerations hereinafter mentioned covenant and agree that the said Lease is amended, effective February 1, 1999, as follows: This SLA #5 (supplemental lease agreement) reflects an extension for one year and a change in rental rate for the warehouse usage, therefore, Paragraphs 3B and 4 are amended as follows: 3B. FIXED TERM: To have and to hold said premises with their appurtenances, beginning February 1, 1999 and ending January 31, 2000. This agreement will revert to a month-to-month occupancy, pending a negotiated agreement of renewal, based on current market rates for like space. Lessee must notify the Contracting Officer, in writing, of intent to renew, no later than thirty (30) days prior to expiration of the initial lease term. 4. The Lessee shall pay the Lessor an annual rental of $288,486.00 (Two hundred eighty eight thousand four hundred eighty six dollars and no/100), payable at the rate of $24,040.50 (Twenty four thousand forty dollars and 50/100), per month in advance. Rent for part of a month shall be prorated. All payments shall be made payable to the General Services Administration and shall contain the outlease number for identification purposes: GS-10PES-OL-5-42. All payments are to be paid by check or money and mailed to the OFFICE OF FINANCE, GENERAL SERVICES ADMINISTRATION, P.O. BOX 70697, CHICAGO, IL 60673, for receipt on or before the first day of each month. All other terms and conditions of the lease shall remain in force and effect. IN WITNESS WHEREOF, the parties subscribed their names as of the above date. ________________________________________________________________________________ LESSEE Seattle FilmWorks, Inc. BY //s// Case H. Kuehn Vice President, Treasurer & CFO (Signature) (Title) IN PRESENCE OF //s// Mich Earl 1260 16th Ave. West, Seattle, WA 98119 (Signature) (Address) UNITED STATES OF AMERICA CONTRACTING OFFICER BY: //s//Lorraine A. Parham GENERAL SERVICES ADMINISTRATION (Signature) (Official Title) Page 18 of 18 EX-27 3 FINANCIAL DATA SCHEDULE
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM SEATTLE FILMWORKS INC SECOND QUARTER 1999 10-Q AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1,000 6-MOS SEP-25-1999 SEP-27-1998 MAR-27-1999 16,036 0 1,037 0 9,995 29,187 11,087 0 49,264 7,805 0 0 0 163 38,569 49,264 0 40,814 26,557 20,601 (366) 0 0 (5,978) (2,393) 0 0 0 0 (3,585) (.22) 0 ASSET VALUES REPRESENT NET AMOUNTS
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