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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
[ X ] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended SEPTEMBER 28, 1996
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ______ to ______
Commission file No. 0-15338
SEATTLE FILMWORKS, INC.
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(Exact name of registrant as specified in its charter)
WASHINGTON 91-0964899
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(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)
1260 16TH AVENUE WEST, SEATTLE, WA 98119
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (206) 281-1390
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Securities registered pursuant to Section 12(b) of the Act: NONE
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Securities registered pursuant to Section 12(g) of the Act: COMMON STOCK, PAR
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VALUE $.01 PER SHARE.
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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: [_]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K (Section 229.405 of this chapter) is not contained herein,
and will not be contained, to the best of registrant's knowledge, in definitive
proxy or information statements incorporated by reference in Part III of this
Form 10-K or any amendment to this Form 10-K. [X]
As of November 29, 1996, there were issued and outstanding 10,833,680
shares of Common Stock, par value $.01 per share. As of November 29, 1996, the
aggregate market value of the Registrant's Common Stock held by nonaffiliates of
the Registrant was $194,011,514, based on the last sale price of the
Registrant's Common Stock as reported by the NASDAQ National Market.
Documents incorporated by reference:
Portions of the registrant's proxy statement relating to its 1996 annual
meeting of shareholders, to be held on February 12, 1997, are incorporated by
reference into Part III of this Annual Report on Form 10-K.
Page 1 of 100
Exhibit Index at Page 43
PART I
ITEM 1 - BUSINESS
DESCRIPTION OF BUSINESS
Seattle FilmWorks, Inc. ("Seattle FilmWorks" or the "Company") is a leading
direct-to-consumer marketer and provider of high-quality amateur photofinishing
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).
Since 1978, the Company has been an industry leader in the introduction of
value-added photo-related services and products. The Company offers prints,
slides and digital images, all from the same roll of 35mm film. Seattle
FilmWorks was among the first to provide express-mail delivery, cross-referenced
data on prints and negatives, a composite photo index and a convenient reorder
system. To a lesser extent, the Company provides photofinishing services,
products and supplies on a wholesale basis.
Since 1994, the Company has been a pioneer in providing digital-imaging
technologies which enable photofinishing customers to creatively enhance and
share personal photographs with friends, family and business associates.
Products incorporating these technologies include (i) Pictures On Disk(TM) a
single floppy disk containing digital images from a roll of film; (ii)
PhotoWorks(R) software, which can be used to create digital photograph albums
and screen savers; (iii) PhotoMail(TM), a service which reduces turnaround time
by privately delivering digital images to customers over the Internet; and (iv)
most recently, FilmWorksNet(TM), a free service which provides customers the
ability to share pictures through the creation of a private photographic home
page uploaded to the Seattle FilmWorks Web site (www.filmworks.com). The Company
is currently developing additional digital-imaging and Internet-related services
and products.
The Company attributes its growth in photofinishing revenues in large part
to its direct-marketing programs, which are primarily based on the customer
acquisition technique of offering two rolls of film for $2.00 or less. Direct-
marketing techniques enable the Company to target selected consumers, measure
customer response and obtain direct customer feedback to changes in marketing
strategies. Recently, the Company has targeted the growing population of
personal computer users in connection with the introduction of digital-imaging
services and products. The Company has developed comprehensive statistical
models for the design and analysis of its direct-response marketing programs
using proprietary customer data compiled over 15 years.
The Company was incorporated in Washington State in June 1976. The
executive offices of the Company are located at 1260 Sixteenth Avenue West,
Seattle, Washington 98119, and the Company's telephone number is (206) 281-1390.
References to Seattle FilmWorks and the Company in this Report include Seattle
FilmWorks, Inc., and its subsidiaries. Seattle FilmWorks, Inc., reorganized its
business on September 30, 1996 by forming two wholly-owned subsidiaries, Seattle
FilmWorks Manufacturing Company and OptiColor, Inc., and transferring a portion
of its assets to each of these subsidiaries.
FORWARD-LOOKING INFORMATION
Statements in this report concerning expectations for the future constitute
forward-looking statements which are subject to a number of known and unknown
risks, uncertainties and other factors which may cause actual results,
performance or achievements of the Company or industry trends to differ
materially from those expressed or implied by such forward-looking statements.
Relevant risks and uncertainties include, among others, those discussed in Item
1 of Part 1 under the heading "Risk Factors" and elsewhere in this Report and
those described from time to time in the Company's other filings with the
Securities and Exchange Commission, press releases and other communications.
2
PHOTOFINISHING INDUSTRY AND DIRECT-MARKETING OVERVIEW
According to information published by the Photo Marketing Association
International ("PMAI"), domestic amateur photofinishing sales totaled
approximately $5.5 billion in 1994, having exhibited little or no growth since
1990. In 1994, the dominant method of distributing photofinishing services and
products was through retail stores, including discount and mass merchants,
drugstores, supermarkets and camera/specialty stores. Management believes the
vast majority of rolls of film are sent to wholesale photofinishing laboratories
for processing, although a growing percentage are processed in-store using on-
site equipment.
Outside the photofinishing industry, direct-to-consumer marketing, with
distribution through the mail, has grown significantly in recent years. Leading
users of direct marketing include mail-order houses and catalog mailers,
magazine publishers, insurance companies, book and record clubs, financial
institutions and credit card companies. Management believes growth in the use of
direct-marketing is generally attributable to social, economic and technological
changes and to the relative cost-effectiveness of direct-marketing techniques.
Management also believes several factors have enhanced consumer responsiveness
to direct marketing as a purchasing medium, including growth in the number of
people in the most active segment of the purchasing population, growth in the
number of two-career families that have more disposable income and less time to
shop, and increased availability and use of credit cards. In the future, on-line
services and increased use of personal computers may provide additional channels
for direct-to-consumer marketing. See "Risk Factors--Dependence on Direct-
Marketing Programs; Accounting for Customer Acquisition" and "--Dependence on
the Internet and Potential Liability for Content."
OPERATING STRATEGY
Over the past five years, Seattle FilmWorks has consistently achieved
annual and corresponding-quarter growth in net revenues and net income through
the execution of its operating strategy, the principal elements of which are the
introduction of innovative, value-added services and products, application of
direct-to-consumer marketing techniques and a commitment to customer
satisfaction.
Innovative, Value-Added Services and Products. Management believes that
Seattle FilmWorks has distinguished itself from its competitors through service
and product differentiation. The Company strives to develop and introduce
value-added photofinishing services and products based on focused research and
development efforts as well as anticipation of consumer demand by monitoring
customer feedback. Management believes that the continuous expansion of its
array of complementary services and products promotes (i) increased acquisition
of new customers, (ii) retention of existing customers and (iii) higher average-
order sizes. Management believes that this operating strategy has contributed
to the Company's growth in an industry characterized by little or no growth.
In the late 1970s, the Company introduced Seattle FilmWorks(R) branded film
and shortly thereafter offered its customers the option of prints and/or
individually color-corrected slides from the same roll of film. More recently,
the Company has been a leader in introducing numerous other value-added
features, including express-mail delivery, cross-referencing data on prints and
negatives, Pictures Plus(TM) Index, a convenient Easy-Order System and Professor
FilmWorks(TM) (free telephone pre-recorded mini-lessons on photography).
In addition, the Company has been a leader in marketing photofinishing
services which employ digital technology. These include (i) Pictures On
Disk(TM), a single floppy disk containing digital images from a roll of film
(ii) PhotoWorks(R) software, which can be used to create digital photograph
albums and screen savers; (iii) PhotoMail(TM), a service which reduces
turnaround time by privately delivering digital images to customers over the
Internet; and (iv) most recently, FilmWorksNet(TM), a free service which
provides customers the ability to share pictures through the creation of a
private photographic home page uploaded to the Seattle FilmWorks Web site
(www.filmworks.com). The Company is currently developing additional digital-
imaging and Internet-related services and products. See "Business Services and
Products."
3
Direct-to-Consumer Marketing. The Company's business model is founded on
direct-response marketing. Management believes an important advantage of its
direct-marketing strategy is the opportunity to contact a large number of
consumers who may appreciate the convenience of mail order and the Company's
array of complementary services and products. Direct access to consumers
permits the Company to target and monitor selected potential and existing
customers, measure customer response and obtain direct customer feedback to
changes in marketing strategies. Generally, the Company attempts to identify
prospective customers by targeting specific groups of individuals with common
characteristics. For example, recently the Company has targeted the growing
population of personal computer users in connection with the introduction of its
digital-imaging services and products. Information derived from the Company's
extensive database compiled over 15 years has been used to create statistical
models to develop targeted marketing programs and estimate future demand. In
addition, the Company's proprietary database is used to plan, personalize,
implement and evaluate marketing programs for existing customers. Historically,
the Company has been able to identify targeted consumer groups that, when
extended the Introductory Offer, yield economically attractive response rates.
See "Business Marketing and Customer Acquisition."
Commitment to Customer Satisfaction. The Company seeks to develop and
provide high-quality, user-friendly and reliable photofinishing services and
products to enhance brand recognition for "Seattle FilmWorks" and to engender
customer loyalty. Management believes that a significant portion of its
business comes from repeat customers. As part of its dedication to customer
service, Seattle FilmWorks offers a 100% money-back satisfaction guarantee,
provides an Easy-Order System whereby a customer sets up a standing order, thus
avoiding the need to fill out an order form with each order, and offers
Professor FilmWorks(TM). In addition, to achieve its customer service goals,
the Company conducts customer surveys and holds management meetings to identify
areas for service enhancement. Moreover, through investments in automation and
state-of-the-art photofinishing equipment, as well as through the commitment of
its employees to quality control, the Company delivers greater than 99.8% of its
orders without loss or damage. See "Business Customer Service and Support."
GROWTH STRATEGY
The Company's strategy for growth is to continue to leverage the strength
of its services, products and marketing programs to acquire additional customers
and increase the level of business with prospective and existing customers.
New Customers. Historically, the Company has grown primarily through the
acquisition of new customers. In a mail-order photofinishing environment that
has recently exhibited little or no growth, the Company has increased net
revenues at an 18% compound annual growth rate during the past five years and
has increased the total number of its customers. The Company continuously
refines existing, and develops, tests and implements new, marketing programs to
additional groups of consumers with different demographic characteristics to
offset the potential impact of market saturation in any given target customer
group. In addition, the Company continues to explore alternative direct-
marketing platforms in order to acquire additional customers. To this end, the
Company has established a Web site on the Internet (www.filmworks.com) from
which customers can access answers to frequently asked questions, download
versions of Company software, create and view personal home pages and send
electronic messages to customer service.
Increasing Sales to New and Existing Customers. Management believes its
complementary value-added services and products promote customer loyalty and
increase customer demand. The Company strives to increase both average order
size and order frequency by informing both targeted consumers and its large
existing customer base of its integrated array of services and products. The
Company's commitment to expanding its service and product offerings, including
enhancements to its Internet-related offerings, supports this strategy. In
addition, the Company employs a variety of other direct-marketing techniques to
increase business from existing customers and generate business from inactive
customers.
4
MARKETING AND CUSTOMER ACQUISITION
One of the key elements of the Company's operating strategy is to generate
demand for its services and products by using its proprietary direct-marketing
techniques and extensive database to efficiently target existing and prospective
customers. The Company has used mail, print media, television, radio, telephone
and, more recently, the Internet and on-line services to target groups of
consumers and businesses, bypassing the traditional distribution channel of
retail outlets.
The Company makes extensive use of marketing tests in order to evaluate
which of a variety of marketing programs offers the best probable return on
investment. The Company's direct-marketing programs use coded advertisements to
monitor consumer response and to provide measurable results for each specific
marketing program. Measuring the effectiveness of marketing tests takes into
account both the response rate to advertised offers and estimates of customer
lifetime value to the Company, measured in terms of profit generated from the
estimated future stream of orders, thereby allowing for the targeting of a
marketing effort to specific market segments through selected media. The Company
uses computers to maintain and analyze extensive data and segment markets using
geographic, demographic and psychographic information about potential customers.
Since the early 1980s, the primary method the Company has used to acquire
new film processing customers has been its introductory offer of two rolls of
film for $2.00 or less (the "Introductory Offer"). The Company regularly refines
the Introductory Offer to improve its effectiveness, but the basic concept of
sending two rolls of Seattle FilmWorks(R) branded film to targeted potential
customers has remained fairly constant. The Introductory Offer has been
nationally advertised through direct-response media, including package inserts,
newspaper supplements and magazines. The Company also has a customer referral
program in which existing customers suggest family and friends to whom the
Company mails an introductory package. Beginning in early 1995, the Company
further refined its Introductory Offer program by targeting the growing
population of personal computer users. Favorable rates of return from this group
led to an expansion of the Company's customer acquisition investment. See "Risk
Factors-Dependence on Direct-Marketing Programs; Accounting for Customer
Acquisition."
SERVICES AND PRODUCTS
Seattle FilmWorks is a leader in the development and introduction of
innovative photofinishing services and products. Beginning in 1978 with the
introduction of its privately branded film and continuing with the option of
receiving both photographic prints and individually color-corrected slides from
the same roll of film, the Company established an early tradition of service and
product differentiation. The following table illustrates the Company's service
and product introductions during the past six years:
SERVICE OR PRODUCT YEAR OF INTRODUCTION
PhotoWorks(R) Plus - How to Use Every Feature(C) 1996
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FilmWorksNet(TM)............................ 1996
PhotoMail(TM)............................... 1995
PhotoWorks(R) for Macintosh................. 1995
PhotoWorks(R) Plus for Windows.............. 1994
PhotoWorks(R) for Windows................... 1994
PhotoWorks(R) for MS-DOS.................... 1994
Pictures On Disk(TM)........................ 1994
Pictures Plus(TM) Index..................... 1993
Professor FilmWorks(TM)..................... 1992
Backprinting & Referenced Negatives......... 1992
Easy-Order System........................... 1991
Express-Mail Delivery....................... 1991
5
In 1991, the Company began to offer mail-order photofinishing customers the
options of express-mail pickup and delivery service and the Easy-Order System,
whereby a customer sets up a standing order, thus avoiding the need to fill out
an order form with each order. This pattern of service and product innovation
continued with the introduction in early 1992 of the Company's system for
printing the date, roll identification and print number on the back of each
print and the corresponding information on each strip of negatives (known as
backprinting) and free telephone pre-recorded mini-lessons on photography from
Professor FilmWorks(TM). In 1993, the Company introduced the Pictures Plus(TM)
Index, which offers thumbnail-size copies of images from a roll of film on a
single 4" by 6" print as a handy reference for the customer.
In early 1994, the Company introduced Pictures On Disk(TM), which delivers
on a single floppy disk a digital version of each photograph on a roll of film.
This product was coupled with the introduction of the Company's internally
developed PhotoWorks(R) software, which enables users to create digital albums
of their photographs and to incorporate the digital images into text, slide
shows and screen savers. PhotoWorks(R) software is available in Microsoft
Windows, MS-DOS and Apple Macintosh versions and is provided at no charge with a
customer's first order of Pictures On Disk(TM). PhotoWorks(R) is also available
for free download over the Internet from the Company's Web site. A more fully
featured version, PhotoWorks(R) Plus, is sold directly to customers as an
upgrade and is available through selected retail software stores.
In October 1995, the Company introduced the private delivery of digital
photographs from its laboratory directly to customers over the Internet through
its PhotoMail(TM) delivery service. Customers requesting PhotoMail(TM) delivery
are sent an e-mail notifying them that their photographs are ready for
downloading at the Company's Web site (www.filmworks.com). Such customers can
then share their photographs with friends, family and business associates who
may view and download the photographs using a download password. Management
believes that communication with digital versions of personal photographs is a
natural extension of the rapid proliferation of e-mail and other forms of
Internet communication.
In February 1996, the Company announced FilmWorksNet(TM), a free service
through which its customers can create and upload a private personalized
photographic home page to the Seattle FilmWorks Web site using the most recent
version of the PhotoWorks(R) software (which is available for download at no
charge). By providing the guest password to their home page, Seattle FilmWorks
customers can share their photographs with friends, family and business
associates worldwide. Both PhotoMail(TM) and FilmWorksNet(TM) provide
flexibility and creativity in this new way of sharing photographs.
In August 1996, the Company published PhotoWorks(R) Plus - How to Use Every
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Feature(C). This 260-page reference book provides customers with detailed
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information on using the Company's PhotoWorks(R) Plus software.
Although mail-order photofinishing is viewed as a convenience by many
consumers, mail-order turnaround time (generally seven to ten days) is longer
than many alternative sources for photofinishing services (in some cases within
one hour). The Company has addressed this issue by offering the option of
express-mail pickup and delivery service by means of the U.S. Postal Service for
an extra charge and, more recently, with an immediate delivery-after-processing
option through its PhotoMail(TM) Internet delivery service. However, turnaround
time remains a competitive disadvantage for the Company.
Management believes that the prices for its services and products are
competitive. The Company, however, has chosen not to compete primarily on the
basis of price, but rather by offering a variety of value-added, innovative and
high-quality services and products, thereby seeking to differentiate itself from
other photofinishers.
The Company also provides a variety of reprint and enlargement services for
its mail-order customers, as well as selling 35mm rolled film, single-use
cameras and photofinishing supplies on a wholesale basis to photofinishing
minilabs, retail stores and commercial users of photographic film. These
products are packaged by the Company and marketed under the brand OptiColor(TM)
Film & Photo. Rolled film and single-use cameras are also marketed on a private
label basis with the customer specifying its own brand name. Although it
represents a small percentage of
6
revenues, the Company also provides photofinishing services on private label,
retail and wholesale bases. The Company also licenses certain digital
technology, including Pictures On Disk(TM) and PhotoWorks(R), to other
photofinishers outside of the U.S.
Net revenues generated by sales outside the United States accounted for
8.5% of the Company's total net revenues in fiscal 1996, as compared to 8.5% and
9.5% in fiscal 1995 and fiscal 1994, respectively.
RESEARCH AND DEVELOPMENT
Through internal and external research and development efforts, the Company
has established the capability to develop innovative digital media and
photofinishing services and products. The Company seeks to identify customer
needs and shifts in consumer preferences in order to design or refine the
Company's services and products. In fiscal 1996, fiscal 1995 and fiscal 1994,
the Company incurred research and development expenses of $732,000, $458,000 and
$459,000, respectively, primarily in connection with development and enhancement
of its FilmWorksNet(TM), PhotoMail(TM), PhotoWorks(R) and Pictures On Disk(TM)
services and products. See Item 7 of Part II--"Management's Discussion and
Analysis of Financial Condition and Results of Operations."
CUSTOMER SERVICE AND SUPPORT
Management believes that customer satisfaction is critical to the Company's
ongoing success. The Company has a 100% money-back satisfaction-guarantee
policy under which it will provide a full refund if a customer's complaint
cannot otherwise be resolved.
The direct-to-consumer photofinishing business involves contacts with a
large number of customers. For customer convenience, the Company provides toll-
free telephone access at 1-800-FILMWORKS. As of November 23, 1996, the Company
had a customer service staff of 53, which is equipped with direct access to the
Company's extensive proprietary database and is trained to promote certain of
the Company's services and products, as well as to answer questions regarding
order status, basic photography and photofinishing and use of PhotoWorks(R)
software. On average, in a week the Company's customer support personnel respond
to approximately 30,000 telephone calls from customers, 3,000 written inquiries
and 4,000 e-mail messages. The majority of these inquiries are general
information requests and order status inquiries. In addition, the Company offers
free pre-recorded mini-lessons on photography over the telephone from Professor
FilmWorks(TM).
The Company also maintains a Web site on the Internet (www.filmworks.com).
While on-line, customers may download Pictures On Disk(TM) orders and versions
of Company software, view personal home pages, access answers to frequently
asked questions, send electronic messages to customer service and check the
status of their photofinishing orders.
OPERATIONS
The Company operates a laboratory in a single facility in Seattle,
Washington, which is designed to produce consistent, high-quality
photofinishing. The system is designed for 24-hour in-house turnaround
processing of photofinishing orders. The photofinishing process begins with the
entry of each order into the Company's customer database, primarily using
information provided by the customer on the order form. Each roll received for
processing is bar-coded with an identification number which enables the tracking
of each order throughout the production process. Following order entry,
individual rolls of film are spliced together into a reel of film which is then
developed as a batch. Once the film is developed, each negative is computer
analyzed, and the color-corrected image is printed on photographic paper using
state-of-the-art equipment. Order information is then printed on the back of
each print and the corresponding information is printed on a paper tab which is
attached to each sleeved negative. After a visual quality inspection, the orders
are packaged for delivery to the customer. If a customer requests, photographs
are digitized and delivered through the mail on 3 1/2" diskettes or via download
over the Internet. Although much of the
7
photofinishing and order handling process has been automated, trained personnel
operate machinery and regularly monitor product quality with the assistance of
computerized control and measurement systems.
The Company has the ability to process various types of 35mm color film,
including those manufactured by Eastman Kodak Company, Fuji Photo Film U.S.A.,
Inc., Konica U.S.A., Inc., Imation Enterprises Corp., Agfa and other major
producers of conventional 35mm color negative film. The Company also has the
ability to process 35mm color negative film manufactured by Eastman Kodak
Company for professional motion picture studios which has been packaged by the
Company or others for use in 35mm still cameras.
Currently, the Company estimates that it is capable of processing up to
approximately 160,000 rolls of film per week with its existing facilities and
equipment. The Company has initiated steps to expand its processing capacity.
SUPPLIERS
The Company obtains its conventional 35mm film from a few large
manufacturers of photographic film, including Agfa and Imation Enterprises
Corp., its supply of Eastman motion picture film as surplus from motion picture
studios and television production companies and its photographic paper and
chemicals from a single supplier, Agfa. In addition, the individual cassettes
into which the Company spools 35mm film for still cameras are manufactured for
the Company by foreign sources, principally in China and South Korea. Currently,
substantially all of the Company's purchases from foreign suppliers are paid for
in U.S. dollars. The Company's mail-order services and products are handled
largely through the U.S. Postal Service. See "Risk Factors--Reliance on Key
Vendor and Supplier Relationships; Foreign Sourcing."
MANAGEMENT INFORMATION SYSTEMS
Management information systems ("MIS") are an essential component of the
Company's strategy to provide superior service to its customers, as well as to
effectively support internal operations. The systems support all major aspects
of the Company's business, including mail-order operations, order entry,
production, warehousing, distribution, purchasing, inventory control and
customer service, as well as various financial systems and electronic
communication systems. All shared data, including the Company's customer
database files, are backed up on a regular basis, with tapes stored in an off-
site secure facility. The Company uses MIS to automate much of its
photofinishing operations.
The Company is in the process of replacing and upgrading a portion of its
systems software and most recently completed a replacement and upgrade it its
systems hardware. It is not uncommon for system defects, shutdowns, slowdowns
or other problems to occur in connection with a conversion to new data-
processing equipment or software. While the Company has taken a number of
precautions against certain events that could disrupt the operation of its
management information systems, including events associated with the software
and hardware upgrade, there can be no assurance that the Company will not
experience systems failures or interruptions, which could have a material
adverse effect on its business, financial condition and operating results. See
"Risk Factors--Dependence on Production Capabilities, Statistical Models and
Management Information Systems."
COMPETITION
The market for consumer photofinishing services is characterized by intense
competition among a number of firms competing in a segment in which average
revenue per roll processed declined during the 1990s, according to
photofinishing industry data. Many of the Company's competitors have
substantially greater financial, technical and other resources than the Company.
The Company faces competition in the consumer photofinishing market from other
direct marketers and from competitors in other distribution channels, including
much larger companies which provide photofinishing services on a wholesale basis
to independent retail outlets and, in some cases, through multiple retail
outlets owned by the photofinisher, many of which provide photofinishing service
within hours. The largest of the wholesale photofinishers are Qualex Inc., and
Fuji TruColor, Inc. In addition, management believes that the largest
8
mail-order photofinishers include Nashua Corp. (dba York Labs), District Photo
Inc. (dba Clark) and Mystic Color Lab Inc.
Management believes that the principal competitive factors in the consumer
photofinishing industry are price, convenience, range of available services,
quality of processing, speed of service and product differentiation. There are
no significant proprietary or other barriers to entry into the photofinishing
industry. The Company has sought to differentiate its photofinishing services by
offering a number of value-added services and products and emphasizing quality
and convenience rather than seeking to be a low-price or rapid turnaround
provider. Although management believes the Company is a leader in developing
and marketing innovative photo-related services and products, competitors can
and do provide similar services and products. Some of these competitors have
introduced products which compete with the Company's Pictures On Disk(TM) and
PhotoWorks(R) products. Also, sales of consumer photofinishing services have
experienced little or no growth since 1990. See "Business--Photofinishing
Industry and Direct-Marketing Overview." Accordingly, the Company's growth has
been the result of market-share gain.
In addition, the wholesale distribution market for rolled film and
photofinishing supplies is highly competitive and is dominated by suppliers
which manufacture what they sell and may, therefore, potentially have lower
costs of goods for these items than the Company. Relatively few firms, however,
have the capability to produce small-production quantities of private label
rolled film. Management believes the principal competitive factors in this
segment of the wholesale distribution market are price, ability to provide
private label products and capability to deliver small-production quantities on
short notice.
The photography industry is characterized by evolving technology and
changing services and products. The introduction of photographic services and
products embodying new technologies could render existing services and products
obsolete. The Company's future success will depend on its ability to adapt to
new technologies and develop new or modify existing services and products to
satisfy evolving consumer needs. For example, the commercialization of filmless
digital imaging technologies may have a negative impact on the photofinishing
industry generally. Moreover, Advanced Photo System ("APS"), which includes a
new film format, has been introduced and the processing of which requires
special equipment the Company does not presently possess. Management believes
that APS currently constitutes an insignificant percentage of the film the
Company is asked to process, and the Company has therefore decided not to
establish this capability. However, there can be no assurance that the
development of these or other new technologies or any failure by the Company to
anticipate or successfully respond to such developments will not have a material
adverse effect on the Company's business, financial condition and operating
results. See "Risk Factors--Competition" and "--Rapid Technological Change."
PROPRIETARY TECHNOLOGY
The Company markets its services and products under registered and common-
law trademarks and service marks, including Seattle FilmWorks(R), OptiColor(TM)
Film & Photo, Pictures On Disk(TM), PhotoMail(TM), PhotoWorks(R), Pictures
Plus(TM) Index, Professor FilmWorks(TM), and FilmWorksNet(TM). See "Risk
Factors--Intellectual Property."
The Company considers a large portion of its PhotoWorks(R) software, its
process for production of Pictures On Disk(TM) and certain other processes to be
proprietary. The Company has not filed any patents or patent applications, in
part to avoid disclosure of its competitive strengths. The Company, however,
does attempt to protect its proprietary rights to software through a combination
of copyright, trademark and trade secret laws and employee and third-party
nondisclosure agreements, by restricting access to certain portions of its
premises and by including contractual restrictions on use and disclosure in its
end-user licenses. Moreover, the Company's PhotoWorks(R) Plus product is shipped
in sealed packages on which notices are prominently displayed informing the end-
user that, by breaking the package seal, the end-user agrees to be bound by the
license agreement contained in the package. The legal and practical
enforceability and extent of liability for violations of license agreements that
purport to become effective upon opening a sealed package are unclear.
This Report contains trademarks other than those of the Company.
9
GOVERNMENTAL REGULATION
The Company's direct-mail operations, including its transmission of digital
images over the Internet, are subject to regulation by the U.S. Postal Service,
the Federal Trade Commission and various state, local and private consumer
protection and other regulatory authorities. In general, these regulations
govern the manner in which orders may be solicited, the form and content of
advertisements, information which must be provided to prospective customers, the
time within which orders must be filled, obligations to customers if orders are
not shipped within a specified period of time and the time within which refunds
must be paid if the ordered merchandise is unavailable or returned. The law
relating to the liability of on-line services companies, Internet access and/or
content providers, Web hosts and electronic publishers for information carried
on or disseminated through their systems for, among other things, infringement
of copyrighted material or trademarks, violations of personal rights of privacy
and publicity and dissemination of material legally judged to be obscene,
indecent or defamatory, is currently unclear. Such claims have been brought,
and sometimes successfully asserted, against on-line services, including cases
against Prodigy and NETCOM. In addition, the recently passed Telecommunications
Act of 1996 (the "Telecommunication Act") imposes, in some circumstances,
liability for or prohibits the transmission over the Internet of certain types
of information and content. Although a federal district court recently blocked
enforcement of that portion of the Telecommunications Act intended to regulate
obscene content, this or other legislation could result in significant potential
liability to the Company, as well as additional costs and technological
challenges in complying with mandatory requirements. See "Risk Factors--
Dependence on the Internet and Potential Liability for Content" and "--
Governmental Regulation."
ENVIRONMENTAL COMPLIANCE
The Company's photofinishing operations involve the use of several
chemicals which are subject to federal, state and local governmental regulations
relating to the storage, use, handling and disposal of such chemicals. The
Company actively monitors its compliance with applicable regulations and works
with regulatory authorities to ensure compliance. To the best of management's
knowledge, the Company has never received a significant citation or fine for
failure to comply with applicable environmental requirements. However, there can
be no assurance that changes in environmental regulations or in the kinds of
chemicals used by the Company will not impose the need for additional capital
equipment or other requirements. See "Risk Factors--Potential Adverse Impact of
Environmental Regulations."
EMPLOYEES
As of November 23, 1996, the Company had 608 employees, of whom
approximately 450 were engaged in production operations, 70 in administration,
23 in marketing, 53 in customer service and 12 in research and development. None
of the Company's employees are covered by a collective bargaining agreement, and
the Company believes its relations with its employees are good.
DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The executive officers and directors of the Company, as of November 30, 1996
were:
Name Age Position
- --------------------------------------------------------------------------------------
Gary R. Christophersen 50 President, Chief Executive Officer and Director
Michael F. Lass 42 Vice President-Operations
Case H. Kuehn 44 Vice President-Finance, Chief Financial Officer
and Treasurer
Bruce A. Ericson 47 Vice President-Marketing
Annette F. Mack 39 Vice President-Human Resources
Sam Rubinstein 79 Director
Douglas A. Swerland 51 Director
Craig E. Tall 50 Director
Peter van Oppen 44 Director
10
Currently all directors are elected annually and hold office until the next
annual meeting of the shareholders of the Company and until their successors are
elected and qualified. Pursuant to a proposed amendment (the "Proposed
Amendment") to the Company's Amended and Restated Articles of Incorporation (the
"Articles") approved by the Board of Directors on November 13, 1996 and to be
presented for a vote at the annual meeting of shareholders to be held on
February 12, 1997 (the "1996 Annual Meeting"), the Board of Directors will be
classified into three classes, each of which shall be as nearly equal in number
as possible. If the Proposed Amendment is approved, then at the 1996 Annual
Meeting, one class will be elected for a one-year term, one class will be
elected for a two-year term and one class will be elected for a three-year term.
All directors will hold office until the annual meeting of shareholders at which
their terms expire and the election and qualification of their successors. Upon
expiration of these initial terms all classes will be elected to three-year
terms. In addition, if the Proposed Amendment is approved, directors may be
removed only for cause and only by a vote of a majority of shares of the
Company's common stock entitled to vote on an election of directors. Officers
serve at the discretion of the Board of Directors.
GARY R. CHRISTOPHERSEN, the Company's President and Chief Executive Officer
since August 1988, joined the Company in January 1982 as Vice President-
Operations and has served as a Director of the Company since 1982. From May
1983 to August 1988, Mr. Christophersen was a Senior Vice President of the
Company and its General Manager.
MICHAEL F. LASS, the Company's Vice President-Operations since September
1988, joined the Company in 1984 as Manager of Operations. From 1982 to 1984,
Mr. Lass was Vice President and General Manager of Breezin' Sportswear, a
manufacturer and marketer of sportswear, and, from 1980 to 1982, General Manager
and a DIrector of Mountain Safety Research, Inc., a manufacturer of outdoor
recreational products.
CASE H. KUEHN, has been the Company's Vice President-Finance, Chief
Financial Officer and Treasurer since February 1995. From April 1994 to February
1995, Mr. Kuehn was Chief Financial Officer of Shoe Inn, Inc., doing business as
Shoe Pavilion. From January 1992 to March 1994, Mr. Kuehn was General Manager of
Pro Mark Technologies, Inc., a manufacturer of computer/video-based inspection
equipment, and, from March 1990 to January 1992, Vice President, Commercial
Lending, at First National Bank of Chicago. From November 1985 to February 1990,
Mr. Kuehn performed business valuation consulting with Price Waterhouse.
BRUCE A. ERICSON, the Company's Vice President-Marketing since November
1989, joined the Company in March 1985 as Director of Publishing and, from
January 1988 to October 1989, was its Director of Marketing.
ANNETTE F. MACK, the Company's Vice President-Human Resources since January
1996, joined the Company in March 1986 as Human Resources Manager and, from
August 1988 to December 1995, was its Director of Human Resources.
SAM RUBINSTEIN became a Director of the Company in March 1986. From June
1985 to May 1988, he was the Chairman of the Board and Chief Executive Officer
of Farwest Fisheries, Inc., a seafood processing and marketing firm. From 1974
to December 1987, Mr. Rubinstein was the Chairman of the Board and Chief
Executive Officer of Bonanza Stores, Inc., an operator of variety stores and
drugstores, and, from February 1984 to January 1986, the Chairman of the Board
and Chief Executive Officer of Whitney-Fidalgo Seafoods, Inc., a seafood
processor.
DOUGLAS A. SWERLAND became a Director of the Company in October 1988. In
December 1993, Mr. Swerland founded and became the President of Savi, Inc., a
clothing superstore retailer specializing in designer clothing. Mr. Swerland
had been employed by Jay Jacobs, Inc., the operator of a chain of specialty
retail apparel stores, in various capacities beginning in 1969, most recently as
President and a Director from 1978 to November 1995. Jay Jacobs, Inc., filed a
voluntary petition for Chapter 11 bankruptcy protection in May 1994 and emerged
therefrom in November 1995.
11
CRAIG E. TALL became a Director of the Company in October 1988. Since
September 1990, Mr. Tall has been an Executive Vice President of Washington
Mutual, Inc., a bank holding company. In addition, since April 1987, Mr. Tall
has been an Executive Vice President of Washington Mutual Bank.
PETER H. VAN OPPEN became a Director of the Company in October 1988. Since
February 1994, Mr. van Oppen has been Chairman and Chief Executive Officer of
Advanced Digital Information Corporation ("ADIC"), a manufacturer of automated
tape data libraries for network and workstation markets. ADIC was a wholly-
owned subsidiary of Interpoint Corporation, a diversified publicly-traded
manufacturer, until it was spun-off as a separate public company in October
1996. Mr. van Oppen served as a Director of Interpoint since 1984, President
and Chief Executive Officer since 1989 and Chairman and Chief Executive Officer
from 1995 through October 1996. Mr. van Oppen is also a Director of ADIC.
RISK FACTORS
In addition to the other information in this Report, the following risk
factors should be carefully considered in evaluating the Company and its
business.
ABILITY TO SUSTAIN AND MANAGE GROWTH
The Company has experienced significant growth in revenues and
profitability in recent periods. This growth has occurred despite little or no
growth in the U.S. photofinishing industry in the 1990s and an actual decline in
the number of rolls processed by the mail-order film processing portion of the
domestic photofinishing market during the same period. See "Business-
Photofinishing Industry and Direct-Marketing Overview." The continued growth of
the Company's revenues and profitability is dependent in large part on its
ability to acquire new customers at a reasonable cost. There can be no assurance
that the Company will continue to grow or to effectively manage its growth. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and "Business." The Company may, when and if the opportunity arises,
acquire other businesses involved in activities or having service and product
lines that are compatible with the Company's business, but the Company has no
current understanding, agreement or arrangement to make any acquisitions.
Acquisitions involve numerous risks, which could have a material adverse effect
on the Company's business, financial condition and operating results.
DEPENDENCE ON DIRECT-MARKETING PROGRAMS; ACCOUNTING FOR CUSTOMER ACQUISITION
Management believes that a large part of the Company's growth in
photofinishing revenues is attributable to its direct-marketing programs, which
are primarily based on its customer acquisition technique of offering two rolls
of film for $2.00 or less. The Company devotes substantial resources to and
regularly tests new and modified direct-marketing programs in an effort to
improve the efficiency of its customer acquisition and retention efforts. There
can be no assurance that the Company's customer acquisition and retention
efforts will continue to be effective. A decline in the effectiveness of these
efforts or a failure to compete effectively against new or existing competitors
which use direct-marketing techniques could have a material adverse effect on
the Company's business, financial condition and operating results. See
"Business-Marketing and Customer Acquisition" and "-Competition."
The direct costs of the customer acquisition program, primarily the cost of
film, postage and printed materials for the Company's free or low-cost film
offers sent to prospective and existing customers, but excluding advertising
costs, are deferred and amortized over a period of up to three years as part of
customer acquisition costs. The Company establishes amortization rates for
these capitalized assets based on estimates of the timing of future roll
processing volumes per customer. Rates of amortization are compared from time
to time with the actual timing of roll processing volumes in order to assess
whether the amortization rates appropriately match the direct costs of customer
acquisition with the related revenues. If the Company were to experience a
material change in the timing of roll processing volumes, it could be required
to accelerate the rate of amortization of capitalized customer acquisition
expenditures, which could have a material adverse effect on the Company's
business, financial condition and operating results. Moreover, if the Company
were to experience a significant decline in the amount of revenues from its
customers
12
without an offsetting decrease in direct customer acquisition costs, the Company
may not be allowed to capitalize customer acquisition costs under generally
accepted accounting principles, which could have a material adverse effect on
the Company's business, financial condition and operating results. See Item 7 of
Part II-"Management's Discussion and Analysis of Financial Condition and Results
of Operations."
RAPID TECHNOLOGICAL CHANGE
The photography industry is characterized by evolving technology and
changing services and products. The introduction of photographic services and
products embodying new technologies could render existing services and products
obsolete. The Company's future success will depend in part on its ability to
adapt to new technologies and develop new or modify existing services and
products to satisfy evolving consumer needs. For example, the commercialization
of filmless digital imaging technologies, including mass-market filmless digital
cameras, may have a negative impact on companies such as Seattle FilmWorks,
which process traditional film-based images and slides. The development of these
or other new technologies, or any failure by the Company to anticipate or
successfully respond to such developments, could have a material adverse effect
on the Company's business, financial condition and operating results. See
"Business-Competition."
FLUCTUATIONS IN QUARTERLY RESULTS AND SEASONALITY
The Company's quarterly operating results have fluctuated in the past and
are expected to fluctuate in the future as a result of a variety of factors,
including 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 or effectiveness
of customer acquisition programs, and other factors. As a result, the Company's
operating results for any period are not necessarily indicative of results for
any future period. Due to the foregoing factors, the Company's operating results
in a future period may be below the expectations of public market analysts and
investors. In such event, the price of the Common Stock may be materially
adversely affected. See Item 7 of Part II-"Management's Discussion and Analysis
of Financial Condition and Results of Operations."
COMPETITION
The market for consumer photofinishing services is characterized by intense
competition among a number of firms competing in a segment in which average
revenue per roll processed declined during the 1990s, according to
photofinishing industry data. Many of the Company's competitors have
substantially greater financial, technical and other resources than the Company.
The Company faces competition in the consumer photofinishing market from other
direct marketers and from competitors in other distribution channels, including
much larger companies which provide photofinishing services on a wholesale basis
to independent retail outlets and, in some cases, through multiple retail
outlets owned by the photofinisher, many of which provide photofinishing service
within hours. There are no significant proprietary or other barriers to entry
into the photofinishing industry. Many of the Company's competitors offer
similar photofinishing services and products at lower prices and with a more
rapid turnaround time than those offered by the Company. However, the Company
has sought to differentiate its photofinishing services by offering a number of
value-added services and products and emphasizing quality and convenience rather
than seeking to be a low-price or rapid turnaround provider. Although
management believes the Company is a leader in developing and marketing
innovative photo-related services and products, competitors can and do provide
similar services and products. There can be no assurance the Company will
continue to compete effectively through development of innovative services and
products or to respond appropriately to industry trends or to activities of
competitors. In addition, the wholesale distribution market for rolled film and
photofinishing supplies is highly competitive and is dominated by suppliers that
manufacture what they sell and may, therefore, potentially have lower costs of
goods for
13
these items than the Company. There can be no assurance that the Company will be
able to compete effectively with current or future competitors or that the
competitive pressures faced by the Company will not have a material adverse
effect on the Company's business, financial condition and operating results. See
"Business-Competition."
DEPENDENCE ON KEY PERSONNEL
The Company's success depends in large part on the abilities and continued
service of its executive officers and other key employees, in particular Gary R.
Christophersen, the Company's President and Chief Executive Officer. These
individuals, including Mr. Christophersen, are not subject to employment
agreements that would prevent them from leaving the Company. There can be no
assurance that the Company will be able to retain the services of such executive
officers and other key employees. The loss of key personnel could have a
material adverse effect on the Company's business, financial condition and
operating results. See "Management."
DEPENDENCE ON THE INTERNET AND POTENTIAL LIABILITY FOR CONTENT
In October 1995, the Company introduced the private delivery of digital
photographs from its laboratory directly to customers over the Internet through
its PhotoMail(TM) delivery service. More recently, the Company announced
FilmWorksNet(TM), a free service to its customers through which the customer can
create and upload a private personal photographic home page to the Seattle
FilmWorks Web site for viewing by friends, family and business associates to
whom the customer gives a guest password. Although the Company provides its
services and products through multiple distribution channels, the Company's
success may depend in part on the continued expansion of the Internet and its
network infrastructure. Rapid growth in interest in and use of the Internet is
a recent phenomenon, and there can be no assurance that the Company's Internet-
related services will prove to be a competitive advantage. Moreover, critical
issues concerning the commercial use of the Internet (including security,
reliability, cost, ease of use and access and quality of service) remain
unresolved and may affect both the growth of Internet use and the Company's
financial results. The law relating to the liability of on-line services
companies, Internet access and/or content providers, Web hosts and electronic
publishers for information carried on or disseminated through their systems for,
among other things, infringement of copyrighted material or trademarks,
violations of personal rights of privacy and publicity and dissemination of
material legally judged to be obscene, indecent or defamatory, is currently
unclear. Such claims have been brought, and sometimes successfully asserted,
against on-line services, including cases against Prodigy and NETCOM. In
addition, the recently passed Telecommunications Act imposes, in some
circumstances, liability for or prohibition against the transmission over the
Internet of certain types of information and content. Although a federal
district court recently blocked enforcement of that portion of the
Telecommunications Act intended to regulate obscene content, this or other
legislation could result in significant potential liability to the Company, as
well as additional costs and technological challenges in complying with
mandatory requirements. From time to time, the Company has assisted authorities
in the discovery and prosecution of child pornography. However, the Company
does not assume responsibility to edit the content of its customers'
photographs, slides, digital images or personal home pages unless responding to
a specific complaint. The potential liability for content made available over
the Internet through its Web site could require the Company to implement
additional measures to reduce its exposure to such liability, which may require
it to incur significant expense or to discontinue certain service or product
offerings. While the Company carries general liability insurance, such insurance
may not cover potential claims of this type or may not be adequate to compensate
the Company for any liability that may be imposed for information carried on or
disseminated through its systems. Any costs not covered by insurance incurred
as a result of such liability or asserted liability could have a material
adverse effect on the Company's business, financial condition and operating
results. See "Business-Governmental Regulation."
RELIANCE ON KEY VENDOR AND SUPPLIER RELATIONSHIPS; FOREIGN SOURCING
The Company obtains its conventional 35mm film from a few large
manufacturers of photographic film, including Agfa Photo Imaging Systems, a
division of Bayer ("Agfa") and Imation Enterprises, Corp., its supply of Eastman
motion picture film as surplus from motion picture studios and television
production companies and its photographic paper and chemicals from a single
supplier, Agfa. In addition, the individual cassettes into which the
14
Company spools 35mm film for still cameras are manufactured for the Company by
foreign sources, principally in China and South Korea. As there are relatively
few suppliers of film, photographic paper and chemicals, the elimination of any
one supplier could cause a material disruption within the industry and could
have a material adverse effect on the Company's business, financial condition
and operating results. Other than an agreement with Agfa which is subject to
possible termination beginning in September 1998, the Company has no long-term
purchase contracts or other contractual assurance of continued supply, pricing
or access to film, paper, chemicals or cassettes. Although the Company has
experienced limited delays in the delivery of certain supplies in the past, such
delays have not had a significant impact on the Company's operations. While
management believes that alternate sources of film, paper, chemicals and
cassettes are available, there can be no assurance that the Company will be able
to continue to acquire its requirements for these supplies in sufficient
quantities or on terms as favorable to the Company as those currently available
to it. Also, conversion to an alternate supplier may cause delays, reduced
quality or other problems. The Company's operations may be adversely affected by
political instability resulting in the disruption of trade with foreign
countries in which the Company's contractors and suppliers are located and
existing or potential duties, tariffs or quotas that may limit the quantity of
certain types of goods that may be imported into the United States. Moreover,
sales of the Company's services and products on a direct-to-consumer mail-order
basis are largely dependent on the U.S. Postal Service for receipt of orders and
delivery of processed film or other products. Any significant changes in the
operations of or prices charged by the U.S. Postal Service or extended
interruptions in postal deliveries could have a material adverse effect on the
Company's business, financial condition and operating results. See "Business-
Operations" and "-Suppliers."
DEPENDENCE ON PRODUCTION CAPABILITIES, STATISTICAL MODELS AND MANAGEMENT
INFORMATION SYSTEMS
The Company depends on its management information systems to process
orders, provide rapid response to customer inquiries, manage inventory and
accounts receivable collections, purchase, sell and ship products efficiently
and on a timely basis and maintain cost-efficient operations. The Company is in
the process of replacing and upgrading a portion of its systems software and
most recently completed a replacement and upgrade of its systems hardware. It is
not uncommon for system defects, shutdowns, slowdowns or other problems to occur
in connection with a conversion to new data-processing equipment or software.
While the Company has taken a number of precautions against certain events that
could disrupt the operation of its management information systems, including
events associated with the software and hardware upgrade, there can be no
assurance that the Company will not experience systems failures or
interruptions, which could have a material adverse effect on its business,
financial condition and operating results. See "Business-Management Information
Systems." The Company also depends on statistical models developed to measure
the effectiveness of its marketing programs and on its employees who are
knowledgeable about such models. In addition, the Company continually faces
risks regarding the availability and cost of labor, the potential need for
additional capital equipment, plant and equipment obsolescence, quality control,
excess or insufficient capacity and disruption in the Company's operations. The
loss of employees knowledgeable about the Company's statistical models or a
disruption in the Company's photofinishing or direct-marketing operations could
have a material adverse effect on the Company's business, financial condition
and operating results. See "Business-Operations" and "-Suppliers."
GOVERNMENTAL REGULATION
The Company's direct-mail operations are subject to regulation by the U.S.
Postal Service, the Federal Trade Commission and various state, local and
private consumer protection and other regulatory authorities. In general, these
regulations govern the manner in which orders may be solicited, the form and
content of advertisements, information which must be provided to prospective
customers, the time within which orders must be filled, obligations to customers
if orders are not shipped within a specified period of time and the time within
which refunds must be paid if the ordered merchandise is unavailable or
returned. From time to time the Company has modified its methods of doing
business and its marketing operations in response to inquiries and requests from
regulatory authorities. To date, such changes have not had an adverse effect on
the Company's business. There can be no assurance, however, that future
regulatory requirements or actions will not have a material adverse effect on
the Company's business, financial condition and operating results. See
"Business-Governmental Regulation."
15
POTENTIAL ADVERSE IMPACT OF ENVIRONMENTAL REGULATIONS
The Company's photofinishing operations involve the use of several
chemicals which are subject to federal, state and local governmental regulations
relating to the storage, use, handling and disposal of such chemicals. The
Company actively monitors its compliance with applicable regulations and works
with regulatory authorities to ensure compliance. However, there can be no
assurance that changes in environmental regulations or in the kinds of chemicals
used by the Company will not impose the need for additional capital equipment or
other requirements. Any failure by the Company to control the use of, or
adequately restrict the discharge of, hazardous substances under present or
future regulations could subject it to substantial liability or could cause its
operations to be suspended. Such liability or suspension of operations could
have a material adverse effect on the Company's business, financial condition
and operating results. See "Business-Environmental Compliance."
STATE SALES TAX
Many states impose taxes on the sale or use of products and the sale of
certain services within the taxing state's borders. To the extent a seller of
taxable products or services is subject to the jurisdiction of a taxing state,
the state may impose a sales tax directly on the seller or may impose a duty on
the seller to collect a sales or use tax from the seller's customers. A seller
is generally considered subject to the jurisdiction of a taxing state for sales
or use tax purposes when the seller has an in-state presence that is beyond de
minimis. An in-state presence can include solicitation of orders for sales in
the taxing state either in-person or through an employee or other agent. The
Company currently collects and pays sales tax only with respect to shipments to
the state of Washington. The Company has structured its operations in a manner
designed to minimize the likelihood that it has more than a de minimis physical
presence in any state other than Washington. However, if a state taxing
authority determines that the Company has established more than a de minimis
physical presence in that particular state, the Company could be obligated to
collect a sales or use tax (or pay a sales tax in states that impose a tax on
the seller) on some sales of its services and products. Should the Company be
found liable by a state taxing authority for unpaid historic sales and use
taxes, such liabilities could have a material adverse effect on the Company's
business, financial condition and operating results. From time to time,
legislation has been introduced in the U.S. Congress that, if enacted into law,
would impose a state sales or use tax collection obligation on out-of-state
mail-order companies such as the Company. Enactment of any such legislation
could have a material adverse effect on the Company's business, financial
condition and operating results.
INTELLECTUAL PROPERTY
The Company considers a large portion of its PhotoWorks(R) software, its
process for production of Pictures On Disk(TM) and certain other processes to be
proprietary. The Company has not filed any patents or patent applications, in
part to avoid disclosure of its competitive strengths. Moreover, the Company's
PhotoWorks(R) Plus product is shipped in sealed packages on which notices are
prominently displayed informing the end-user that, by breaking the package seal,
the end-user agrees to be bound by the license agreement contained in the
package. The legal and practical enforceability and extent of liability for
violations of license agreements that purport to become effective upon opening a
sealed package are unclear. See "Business-Proprietary Technology."
POSSIBLE VOLATILITY OF STOCK PRICE
The market price of the Common Stock has been, and is likely to continue to
be, volatile. There can be no assurance that the market price of the Common
Stock will not fluctuate significantly from its current level. The market price
of the Common Stock could be subject to significant fluctuations in response to
a number of factors, such as actual or anticipated variations in the Company's
quarterly operating results, the introduction of new services or products by the
Company or its competitors, changes in other conditions or trends in the
Company's industry, changes in governmental regulations, changes in securities
analysts' estimates of the Company's, or its competitors' or industry's, future
performance or general market conditions. See Item 7 of Part II-"Management's
Discussion and Analysis of Financial Condition and Results of Operations." In
addition, stock markets have experienced extreme price and volume volatility in
recent years, and this volatility has had a substantial effect on the market
prices of securities of many
16
smaller public companies for reasons frequently unrelated to the operating
performance of such companies. These broad market fluctuations may adversely
affect the market price of the Common Stock. See "Price Range of Common Stock."
ANTITAKEOVER CONSIDERATIONS
The Company's Board of Directors has the authority, without shareholder
approval, to issue up to 2,000,000 shares of Preferred Stock and to fix the
rights and preferences thereof. This authority, together with certain
provisions of the Articles, including proposed amendments to the Articles
providing for a classified board and removal of directors only for cause, and
the Washington Business Corporation Act, may discourage takeover attempts or
tender offers that could result in shareholders receiving a premium over the
market price for the Common Stock or that shareholders may otherwise consider to
be in their best interests.
ITEM 2 - PROPERTIES
The Company's headquarters are located in Seattle, Washington. This
building also houses the Company's photofinishing and mail-order operations.
The building's square footage has recently been expanded to approximately 60,000
square feet to accommodate increased levels of production. The building is
occupied under a lease which expires in September 2000.
The Company also occupies 80,000 square feet in a building that is used as
a warehouse storage and limited production facility. This building, located in
Seattle, Washington, is occupied under a three-year lease expiring January 31,
1999, with options to extend the lease for two additional one-year periods to
January 31, 2001.
ITEM 3 - LEGAL PROCEEDINGS
The Company is involved in various routine legal proceedings incident to
the ordinary course of its business. Management believes that the outcome of
all pending legal proceedings in the aggregate will not have a material adverse
effect on the Company's business, financial condition or operating results.
ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of shareholders during the fourth
quarter of the Company's fiscal year.
17
PART II
ITEM 5 - MARKET PRICES AND DIVIDENDS ON COMMON STOCK
The Company's Common Stock trades on the NASDAQ National Market tier of The
NASDAQ Stock Market under the symbol "FOTO." The following table sets forth,
for the periods indicated, the high and low sale prices of the Common Stock as
reported on NASDAQ, as adjusted for stock splits.
HIGH LOW
---- ---
Fiscal Year Ended September 30, 1995
First Quarter........................ $ 8.56 $ 6.56
Second Quarter....................... 10.22 7.28
Third Quarter........................ 11.83 8.33
Fourth Quarter....................... 15.83 11.17
Fiscal Year Ended September 28, 1996
First Quarter........................ $15.83 $12.00
Second Quarter....................... 20.50 13.33
Third Quarter........................ 21.75 16.00
Fourth Quarter....................... 22.00 14.50
On November 29, 1996, the last sale price reported on NASDAQ for the Common
Stock was $19.625 per share and was held by an estimated 8,400 shareholders
with approximately 387 holders of record.
The Company has never declared or paid cash dividends on the Common Stock
and does not anticipate paying any dividends in the foreseeable future. The
Company currently intends to retain its earnings, if any, for the development of
its business. In addition, the Company is restricted under the covenants of a
bank loan agreement from declaring any dividends on shares of its capital stock
in excess of $4 million in any fiscal year, noncumulative from year to year,
without the bank's prior consent.
ITEM 6 - SELECTED FINANCIAL DATA
The selected financial data set forth below with respect to the Company's
statements of income for the years ended September 28, 1996, September 30, 1995
and September 24, 1994 and the Company's balance sheets at September 28, 1996
and September 30, 1995 are derived from the audited financial statements
included elsewhere in this report and should be read in conjunction with those
financial statements and their related footnotes. The selected income statement
data for the years ended September 25, 1993 and September 26, 1992 and selected
balance sheet data at September 24, 1994, September 25, 1993 and September 26,
1992 are derived from audited financial statements which are not included in
this report.
18
SEATTLE FILMWORKS, INC.
SELECTED FINANCIAL DATA
(In thousands, except per share and share data)
FISCAL YEARS
1996 1995 1994 1993 1992
==============================================================================================================================
INCOME STATEMENT DATA:
- ----------------------
Net revenues $84,152 $62,185 $49,753 $42,728 $38,442
Gross profit 34,993 24,057 18,907 17,269 15,694
Operating expenses 23,084 15,729 12,709 12,284 11,660
Net income $ 8,017 $ 5,682 $ 4,438 $ 3,570 $ 2,905
======= ======= ======= ======= =======
Income as a percent of revenues 9.5% 9.1% 8.9% 8.4% 7.6%
Earnings per share* $ .68 $ .48 $ .36 $ .29 $ .24
======= ======= ======= ======= =======
Weighted average shares
outstanding* 11,871,898 11,731,761 12,394,677 12,358,157 12,266,046
========== ========== ========== ========== ==========
BALANCE SHEET DATA:
- -------------------
Capitalized customer acquisition
expenditures $11,334 $ 7,356 $ 4,458 $ 3,832 $ 3,349
Total assets 37,826 28,244 18,835 ** 19,632 15,538
Long-term obligations 0 0 0 0 0
Shareholders' equity $26,675 $17,932 $11,347 ** $13,376 $ 9,553
======= ======= ======= == ======= =======
See notes to financial statements.
* All share and per share data are retroactively adjusted to reflect a three for
two stock split distributed February 26, 1993, a two for one stock split
distributed March 16, 1994, a three for two stock split distributed March 15,
1995 and a three for two stock split distributed March 15, 1996.
** Reflects the impact of repurchasing 1,125,000 shares of common stock for
$6,643,000 during the fourth quarter of fiscal 1994.
19
ITEM 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
FORWARD-LOOKING INFORMATION
Statements in this report concerning expectations for the future constitute
forward-looking statements which are subject to a number of known and unknown
risks, uncertainties and other factors which may cause actual results,
performance or achievements of the Company or industry trends to differ
materially from those expressed or implied by such forward-looking statements.
Relevant risks and uncertainties include, among others, those discussed in Item
1 of Part I under the heading "Risk Factors" and elsewhere in this Report and
those described from time to time in the Company's other filings with the
Securities and Exchange Commission, press releases and other communications.
OVERVIEW
Seattle FilmWorks, Inc. (the "Company") is a leading direct-to-consumer
marketer and provider of high-quality amateur photofinishing 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). The
Company has experienced an increase in net revenues in each year since 1990.
Management believes this growth is attributable principally to its 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. Management believes
that these steps are the primary reasons for the acceleration in growth of net
revenues and net income during fiscal 1996 and fiscal 1995. In addition,
management believes its core photofinishing business has benefited from the
introduction of new products, such as the January 1994 introduction of Pictures
On Disk(TM) and PhotoWorks(R).
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. These costs-per-lead have declined during
each of the last three fiscal years. The direct costs of customer acquisition
include film, postage and printed material costs associated with mailings to
prospective and existing customers. These direct costs per recipient of the
Introductory Offer have also declined during each of the last three fiscal
years.
The direct costs of customer acquisition programs are capitalized as an
asset on the Company's balance sheet under "capitalized customer acquisition
expenditures." Capitalized customer acquisition expenditures relating to
prospective customers are amortized over three years, and capitalized customer
acquisition expenditures relating to certain marketing activities to groups of
existing customers are amortized over six months. These amortization rates are
based on estimates of the timing of future roll processing volumes per customer.
The proportion of capitalized customer acquisition expenditures to be amortized
over three years relative to those to be amortized over six months will vary
from period to period based on the timing and mix of promotional activities.
Rates of amortization are compared from time to time with the actual timing of
roll processing volumes in order to assess whether the amortization rates
appropriately match the direct costs of customer acquisition with the related
revenues. If the Company were to experience a material change in the timing of
roll processing volumes, it could be required to accelerate the rate of
amortization of capitalized customer acquisition expenditures, which could have
a material adverse effect on the Company's business, financial condition and
operating results.
Customer acquisition costs as a percentage of net revenues increased to
14.2% in fiscal 1996 as compared to 13.8% in fiscal 1995 and 13.1% in fiscal
1994. Management believes this increase in customer acquisition costs as a
percentage of net revenues is due primarily to expansion of the Company's
customer acquisition programs. Future periods may reflect increased customer
acquisition costs due to timing of the amortization of capitalized expenditures
or
20
the development and initiation of additional marketing programs. For tax
purposes, customer acquisition expenditures are expensed as incurred, thereby
reducing current federal income tax liabilities and increasing deferred federal
income tax liabilities. See Note F of Notes to Financial Statements.
Net income as a percentage of net revenues has improved from 8.9% in fiscal
1994 to 9.5% in fiscal 1996 primarily due to the relationship between changes in
costs of goods sold, customer acquisition costs and other selling expenses which
in turn are primarily driven by changes in sales mix and the Company's customer
acquisition strategy. 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.
Cost of goods and services consist of labor, postage and supplies related
to the Company's services and products. Other selling expenses include marketing
costs associated with building brand awareness, testing new marketing strategies
and marketing to existing customers, as well as certain costs associated with
acquiring new customers. Research and development expenses consist primarily of
costs incurred in researching new computerized digital imaging concepts,
developing computer software products and creating equipment necessary to
provide customers with new computer-related photographic services and products.
General and administrative expenses consist of costs related to computer
operations, human resource functions, finance, accounting, investor relations
and general corporate activities.
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 programs 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 relatively higher marketing program expenditures prior to the summer months.
21
RESULTS OF OPERATIONS
The following table presents information from the Company's statements of
income, expressed as a percentage of net revenues for the periods indicated.
Fiscal Years Ended
September 28, September 30, September 24,
1996 1995 1994
=========================================================================================
Net revenues 100.0% 100.0% 100.0%
Cost of goods and services 58.4 61.3 62.0
----- ----- -----
GROSS PROFIT 41.6 38.7 38.0
Operating expenses:
Customer acquisition costs 14.2 13.8 13.1
Other selling expenses 8.2 6.5 6.9
Research and development 0.9 0.7 0.9
General and administrative 4.2 4.3 4.6
----- ----- -----
Total operating expenses 27.5 25.3 25.5
----- ----- -----
INCOME FROM OPERATIONS 14.1 13.4 12.5
Total other income 0.4 0.4 0.3
----- ----- -----
INCOME BEFORE INCOME TAXES 14.5 13.8 12.8
Provision for income taxes 5.0 4.7 3.9
----- ----- -----
NET INCOME 9.5% 9.1% 8.9%
===== ===== =====
Net revenues increased 35.3% to $84,152,000 in fiscal 1996 from $62,185,000
in fiscal 1995. Net revenues in fiscal 1995 increased 25.0% to $62,185,000 from
$49,753,000 in fiscal 1994. The increases were primarily due to expanded
customer acquisition activities and marketing to existing customers during
fiscal year 1996 and fiscal year 1995 which have resulted in increased net
revenues from photofinishing services and products. Management also believes
that its Seattle FilmWorks(R) branded business has benefited from the Company's
entry into the personal computer market with its PhotoWorks(R) and Pictures On
Disk(TM) products, which were introduced in January 1994. Fiscal 1995 net
revenues were also favorably affected by an additional one-week reporting period
in fiscal 1995 as compared to fiscal 1994.
Gross profit as a percentage of net revenues for fiscal 1996, fiscal 1995
and fiscal 1994 was 41.6%, 38.7% and 38.0%, respectively. The increase in gross
profit percentage in fiscal 1996 and fiscal 1995 as compared to fiscal 1994 was
primarily due to a product mix containing a higher percentage of Seattle
FilmWorks(R) branded products, which carry a higher gross profit margin than the
Company's other services and products. Fluctuations in gross profit will occur
in future periods due to the seasonal nature of revenues, mix of product sales,
intensity and effectiveness of promotional activities and other factors.
Total operating expenses as a percentage of net revenues for fiscal 1996,
fiscal 1995 and fiscal 1994 were 27.5%, 25.3% and 25.5%, respectively. The
increase in total operating expenses in fiscal 1996 as compared to fiscal 1995
and fiscal 1994 was due primarily to an increase in customer acquisition and
other selling activities, which affect
22
revenues in current and future periods. The Company's principal technique for
acquiring new customers is its Introductory Offer of two rolls of 35 mm film for
$2.00 or less. Effective as of the beginning of the second quarter of fiscal
1996 the Company reduced from twelve to six months the amortization period for
certain marketing activities to specific groups of existing customers. This
change in accounting estimate resulted in incremental amortization of $127,000
in fiscal year 1996 of previously deferred customer acquisition costs. The
Company capitalized $14,750,000 of customer acquisition expenditures during
fiscal 1996 compared to $9,187,000 in fiscal 1995 and $5,310,000 in fiscal 1994.
Capitalized customer acquisition expenditures as of September 28, 1996 increased
to $11,334,000 as compared to $7,356,000 as of September 30, 1995. The Company's
increased investment in customer acquisition combined with new service and
product introductions are the primary reasons for the increase in photofinishing
related revenues. Each year the Company prepares detailed plans for its various
marketing activities, including the mix between customer acquisition
expenditures and other selling 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. Future periods
may reflect increased customer acquisition costs due to the timing of the
amortization of capitalized expenditures or the development and initiation of
additional marketing programs.
Other selling expenses in fiscal 1996 increased to 8.2% of net revenues
compared to 6.5% in fiscal 1995 and 6.9% in fiscal 1994. The increase in fiscal
1996 was primarily due to increased marketing activities associated with
expanded promotional activities to new and existing customers compared to fiscal
1995 and fiscal 1994. Fiscal year 1996 selling expenses also included additional
expense as a result of an increase in amortization of a non-compete agreement
due to a change in the estimated life from ten years to five years and expense
related to securing rights to the PhotoWorks(R) mark claimed by a third party.
Research and development expenses during fiscal 1996, fiscal 1995 and
fiscal 1994 were $732,000, $458,000 and $459,000, respectively. The increase in
fiscal 1996 as compared to fiscal 1995 and fiscal 1994 was primarily related to
the Company's continued development of digital services and products.
General and administrative expenses increased to $3,460,000 in fiscal 1996
as compared to $2,657,000 in fiscal 1995 and $2,276,000 in fiscal 1994. The
increases in fiscal 1996 and fiscal 1995 were due primarily to increased
compensation expenditures based on the Company's profitability and increased
legal, accounting and consulting costs. General and administrative expenses as a
percent of net revenues decreased to 4.2% for fiscal 1996 as compared to 4.3% in
fiscal 1995 and 4.6% in fiscal 1994.
Total other income in fiscal 1996 was $328,000 as compared to $252,000 in
fiscal 1995 and $187,000 in fiscal 1994. The increases in total other income in
fiscal 1996 and fiscal 1995 as compared to the prior fiscal year were primarily
due to interest income from short-term investments due to higher levels of cash
generated by operations during fiscal 1996 and fiscal 1995.
The federal income tax rate for fiscal 1996 was 34.5% as compared to 33.8%
for fiscal 1995 and 30.5% for fiscal 1994. The increase in the effective tax
rate for fiscal 1996 as compared to fiscal 1995 was due primarily to an increase
in the marginal federal corporate tax rate due to income levels and the
expiration of the federal research and development tax credit for the first
three quarters of the 1996 fiscal year. The effective tax rate for fiscal 1994
was favorably affected by initial research and development tax credits.
Net income increased to $0.68 per share in fiscal 1996 as compared to $0.48
per share in fiscal 1995 and $0.36 per share in fiscal 1994. The increases in
the fiscal 1996 and fiscal 1995 periods were primarily attributable to the
increases in net revenues and gross profit.
LIQUIDITY AND CAPITAL RESOURCES
Net cash provided by operating activities was $4,554,000, $6,908,000 and
$4,330,000 in fiscal 1996, fiscal 1995 and fiscal 1994, respectively. The
decrease in cash provided by operating activities in fiscal 1996 as compared to
fiscal 1995 was primarily due to a net increase in customer acquisition
expenditures, an increase in inventories and
23
accounts receivable and a decrease in accounts payable, partially offset by
increases in net income, depreciation and amortization and deferred taxes. The
increase in cash provided by operating activities in fiscal 1995 as compared to
fiscal 1994 was primarily due to an increase in net income, deferred taxes and
accounts payable. These increases were partially offset by an increase in net
customer acquisition expenditures.
Net cash used in investing activities was $7,281,000, $1,629,000 and
$809,000 in fiscal 1996, fiscal 1995 and fiscal 1994, respectively. Net cash
used in investing activities during fiscal 1996 increased primarily due to
increases in purchases of furniture, fixtures and equipment and securities
available-for-sale. Net cash used in investing activities during fiscal 1995
increased as compared to fiscal 1994 primarily due to a net decrease in sales of
securities.
Net cash provided by financing activities was $302,000 in fiscal 1996 as
compared to $570,000 in fiscal 1995. The decrease was primarily due to a
decreased level of stock option exercises. Net cash used in financing
activities in fiscal 1994 was $6,517,000. The increase in net cash provided by
financing activities in fiscal 1995 as compared to fiscal 1994 is primarily
attributable to the Company's repurchase of 1,125,000 shares of Common Stock
during fiscal 1994.
As of November 29, 1996, the Company's principal sources of liquidity
included $10,809,000 in cash and short-term investments together with an unused
operating line of credit of $6,000,000. The ratio of current assets to current
liabilities for the Company was 2.7 to 1 at the end of fiscal 1996, which
reflects an increase from the current ratio of 2.0 to 1 at the end of fiscal
1995. During fiscal 1996 the Company increased inventory levels by $1,951,000 to
accommodate expanded marketing plans, achieve faster turnaround of customer
orders and support increased photofinishing volume. In addition, during fiscal
year 1996 the Company decreased its accounts payable by $1,292,000 as compared
to fiscal year 1995. The decrease is due primarily to a change in payment terms
with a major vendor and overall timing of payments at fiscal year end 1996 as
compared to fiscal year end 1995.
Capital expenditures during fiscal 1996 totaled $4,075,000 including
equipment for new photofinishing services, data processing equipment and for
expanding capacity of existing photofinishing operations. In fiscal 1995, the
Company made capital expenditures of $1,633,000 relating to photofinishing
equipment. The Company has a commitment to purchase equipment related to its
Pictures On Disk(TM) product in the amount of $470,000 by January 1, 1997. In
addition, the Company has plans to expend approximately $4,000,000 in fiscal
1997, principally for additional photofinishing processing equipment and for
leasehold improvements, although at this time it has no binding commitments to
do so.
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, including 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 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. See Item 1 of Part I-"Risk Factors."
INFLATION
The results of the Company's operations have not been significantly
affected by inflation during any of the last three fiscal years. Although the
Company has incurred moderately increased costs for labor, materials, postage
and overhead, it has been able to offset the impact of such increases primarily
through enhanced operating efficiencies.
24
ADOPTION OF ACCOUNTING STANDARDS
In October 1995, the Financial Accounting Standards Board issued Statement
No. 123, "Accounting for Stock-Based Compensation." This pronouncement
establishes accounting and reporting standards for stock-based employee
compensation plans, including stock purchase plans, stock options and stock
appreciation rights. This standard defines a fair value-based method of
accounting for these equity instruments, which method measures compensation cost
based on the value of the award and recognizes that cost over the service
period. Companies may elect to adopt this standard or to continue accounting for
these types of equity instruments under current guidance, Accounting Principles
Board ("APB") Opinion No. 25, "Accounting for Stock Issued to Employees." The
Company has elected to follow APB Opinion No. 25 and related interpretations in
accounting for its employee stock options.
ITEM 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
See pages 26 through 36.
25
REPORT OF ERNST & YOUNG LLP
INDEPENDENT AUDITORS
Shareholders and Board of Directors
SEATTLE FILMWORKS, INC.
We have audited the accompanying balance sheets of SEATTLE FILMWORKS, INC.
as of September 28, 1996 and September 30, 1995, and the related statements of
income, shareholders' equity, and cash flows for each of the three years in the
period ended September 28, 1996. We have also audited the financial statement
schedule listed in the Index at Item 14(a). These financial statements and
schedule are the responsibility of the Company's management. Our responsibility
is to express an opinion on these financial statements and schedule based on our
audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of SEATTLE FILMWORKS, INC. at
September 28, 1996 and September 30, 1995, and the results of its operations and
its cash flows for each of the three years in the period ended September 28,
1996, in conformity with generally accepted accounting principles. Also in our
opinion, the related financial statement schedule, when considered in relation
to the basic financial statements taken as a whole, presents fairly in all
material respects the information set forth therein.
//S// ERNST & YOUNG LLP
Seattle, Washington
November 1, 1996
26
SEATTLE FILMWORKS, INC.
BALANCE SHEETS
(in thousands, except per share and share data)
ASSETS
September 28, September 30,
1996 1995
------------- -------------
CURRENT ASSETS
Cash and cash equivalents $ 6,135 $ 8,560
Securities available-for-sale 4,559 1,345
Accounts receivable, net of allowance for doubtful accounts
of $287 and $546 in 1996 and 1995, respectively 1,980 1,242
Inventories 6,577 4,626
Capitalized promotional expenditures 238 158
Prepaid expenses and other 351 164
Deferred income taxes 311 398
------- -------
TOTAL CURRENT ASSETS 20,151 16,493
FURNITURE, FIXTURES, AND EQUIPMENT,
at cost, less accumulated depreciation (Note C) 5,337 3,200
CAPITALIZED CUSTOMER ACQUISITION EXPENDITURES 11,334 7,356
DEPOSITS AND OTHER ASSETS 253 68
NONCOMPETE AGREEMENT (Note B) 751 1,127
------- -------
TOTAL ASSETS $37,826 $28,244
======= =======
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable $ 3,490 $ 4,782
Accrued expenses 1,086 827
Accrued compensation 2,001 1,537
Income taxes payable 972 856
------- -------
TOTAL CURRENT LIABILITIES 7,549 8,002
DEFERRED INCOME TAXES 3,602 2,310
------- -------
TOTAL LIABILITIES 11,151 10,312
SHAREHOLDERS' EQUITY (Notes G and H)
Preferred Stock, $.01 par value, authorized 2,000,000 shares, none
issued
Common Stock, $.01 par value, authorized 67,500,000 shares, issued
and outstanding 10,821,144 and 10,715,571 in 1996 and 1995,
respectively 108 107
Additional paid-in capital 1,680 955
Retained earnings 24,887 16,870
------- -------
TOTAL SHAREHOLDERS' EQUITY 26,675 17,932
------- -------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $37,826 $28,244
======= =======
See notes to financial statements.
27
SEATTLE FILMWORKS, INC.
STATEMENTS OF INCOME
(in thousands, except per share and share data)
Fiscal Years Ended
------------------------------------------------
September 28, September 30, September 24,
1996 1995 1994
============== ============== ==============
Net revenues $ 84,152 $ 62,185 $ 49,753
Cost of goods and services 49,159 38,128 30,846
----------- ----------- -----------
GROSS PROFIT 34,993 24,057 18,907
Operating expenses:
Customer acquisition costs 11,981 8,579 6,516
Other selling expenses 6,911 4,035 3,458
Research and development 732 458 459
General and administrative 3,460 2,657 2,276
----------- ----------- -----------
Total operating expenses 23,084 15,729 12,709
----------- ----------- -----------
INCOME FROM OPERATIONS 11,909 8,328 6,198
Other income (expense):
Interest expense (1) (4) (25)
Interest income 449 276 222
Nonoperating expense, net (120) (20) (10)
----------- ----------- -----------
Total other income 328 252 187
----------- ----------- -----------
INCOME BEFORE INCOME TAXES 12,237 8,580 6,385
Provision for income taxes (Note F) 4,220 2,898 1,947
----------- ----------- -----------
NET INCOME $ 8,017 $ 5,682 $ 4,438
=========== =========== ===========
EARNINGS PER SHARE $.68 $.48 $.36
=========== =========== ===========
WEIGHTED AVERAGE SHARES AND
EQUIVALENTS OUTSTANDING 11,871,898 11,731,761 12,394,677
=========== =========== ===========
See notes to financial statements.
28
SEATTLE FILMWORKS, INC.
STATEMENTS OF SHAREHOLDERS' EQUITY
(in thousands, except share data)
Common Stock
-------------------------------------------------------
Shares Par Paid-In Retained
Outstanding Value Capital Earnings Total
============ ====== ======== ========= ========
BALANCE AS OF SEPTEMBER 25, 1993 11,551,597 $116 $ 570 $12,690 $13,376
Stock options exercised 57,376 1 32 33
Income tax benefit of stock options 50 50
Employee stock purchase plan 26,586 93 93
Purchase and retirement of Common Stock (1,125,000) (12) (691) (5,940) (6,643)
Net income 4,438 4,438
------- -------
BALANCE AS OF SEPTEMBER 24, 1994 10,510,559 105 54 11,188 11,347
Stock options exercised 115,950 1 274 275
Income tax benefit of stock options 333 333
Employee stock purchase plan 94,612 1 348 349
Purchase and retirement of Common Stock (5,550) (54) (54)
Net income 5,682 5,682
------- -------
BALANCE AS OF SEPTEMBER 30, 1995 10,715,571 107 955 16,870 17,932
Stock options exercised 103,936 1 349 350
Income tax benefit of stock options 424 424
Employee stock purchase plan 13,445 162 162
Purchase and retirement of Common Stock (11,808) (210) (210)
Net income 8,017 8,017
------- -------
BALANCE AS OF SEPTEMBER 28, 1996 10,821,144 $108 $1,680 $24,887 $26,675
========== ==== ====== ======= =======
See notes to financial statements.
29
SEATTLE FILMWORKS, INC.
STATEMENTS OF CASH FLOWS
(in thousands)
Fiscal Years Ended
------------------------------------------------
September 28, September 30, September 24,
1996 1995 1994
============== ============== ==============
OPERATING ACTIVITIES:
- ----------------------------------------------------
Net income $ 8,017 $ 5,682 $ 4,438
Charges to income not affecting cash:
Depreciation and amortization 2,018 1,608 1,320
Amortization of capitalized customer
acquisition expenditures 10,772 6,289 4,684
Deferred income taxes 1,379 830 (89)
Loss on disposal of equipment 102 24 5
Net change in receivables, inventories,
payables, and other (2,904) 1,432 (672)
Capitalized promotional expenditures, net (80) 230 (46)
Additions to capitalized customer
acquisition expenditures (14,750) (9,187) (5,310)
-------- ------- -------
NET CASH FROM OPERATING ACTIVITIES 4,554 6,908 4,330
INVESTING ACTIVITIES:
- ----------------------------------------------------
Purchase of furniture, fixtures, and equipment (4,075) (1,633) (1,414)
Purchases of securities available-for-sale (7,409) (1,356) (3,060)
Sales of securities available-for-sale 4,195 1,341 5,280
Proceeds from sale of equipment 8 19 22
Purchase of assets from Private Label Film, Inc. (1,637)
-------
NET CASH USED IN INVESTING ACTIVITIES (7,281) (1,629) (809)
FINANCING ACTIVITIES:
- ----------------------------------------------------
Proceeds from issuance of Common Stock 512 624 126
Payment on purchase of Common Stock (210) (54) (6,643)
-------- ------- -------
NET CASH FROM (USED IN) FINANCING ACTIVITIES 302 570 (6,517)
-------- ------- -------
INCREASE (DECREASE) IN CASH AND
CASH EQUIVALENTS (2,425) 5,849 (2,996)
Cash and cash equivalents
at beginning of year 8,560 2,711 5,707
-------- ------- -------
CASH AND CASH EQUIVALENTS
AT END OF YEAR $ 6,135 $ 8,560 $ 2,711
======== ======= =======
See notes to financial statements.
30
SEATTLE FILMWORKS, INC.
NOTES TO FINANCIAL STATEMENTS
NOTE A -- OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
SEATTLE FILMWORKS, INC. (the "Company") is a leading direct-to-consumer marketer
and provider of high-quality amateur photofinishing services and products. The
Company offers an array of complementary services and products, primarily on a
mail-order basis, under the brand name SeattleFilmWorks/TM/. To a lesser extent,
the Company provides services, products and photofinishing supplies on a
wholesale basis to a variety of commercial customers.
CASH AND CASH EQUIVALENTS: Cash and cash equivalents include cash on hand and
highly liquid short-term investments with a maturity of three months or less
than at the date of purchase.
SECURITIES AVAILABLE-FOR-SALE: Securities available-for-sale consist primarily
of bankers' acceptances, commercial paper, and government securities issued by
financial institutions with high credit ratings. Company policy limits the
amount of credit exposure with any one financial institution. The fiscal 1996
and fiscal 1995 balance consisted primarily of bankers' acceptances and
government securities. Securities available-for-sale are carried at amortized
cost, which approximates market.
ACCOUNTS RECEIVABLE: Accounts receivable primarily include amounts due from
mail-order customers from the sale of related photographic products and amounts
due from wholesale customers from the sale of film and single-use cameras. An
allowance for doubtful accounts is established for an estimate of bad debts.
INVENTORIES: Inventories are stated at the lower of cost (determined using the
first-in, first-out method) or market. Inventories consist primarily of film
and photofinishing supplies.
CAPITALIZED PROMOTIONAL EXPENDITURES: The Company's promotional programs run
for periods of one to six months. Promotional expenditures primarily consist of
advertising and media costs related to generating consumer interest in the
Company's photofinishing services. The Company capitalizes these costs as
capitalized promotional expenditures and expenses them the first time the
promotion is run. Advertising expense was $2,989,000, $1,882,000, and
$1,944,000 in fiscal years 1996, 1995, and 1994 respectively.
DEPRECIATION AND AMORTIZATION: Furniture, fixtures, and equipment are
depreciated using the straight-line and accelerated methods based on the
estimated useful asset lives ranging from three to five years. Expenditures for
major remodeling and improvements are capitalized as leasehold improvements.
Leasehold improvements are amortized over the shorter of the life of the lease
or the life of the asset.
NONCOMPETE AGREEMENT: Noncompete agreement is amortized as other selling
expenses on a straight-line basis. During fiscal 1996, the Company recorded an
additional $43,000 of amortization related to a change in the estimated life of
the noncompete agreement from ten years to five years. See Note B.
CAPITALIZED 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.
31
SEATTLE FILMWORKS, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
NOTE A -- OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(CONTINUED)
The direct costs of customer acquisition are capitalized as an asset on the
Company's balance sheet under "capitalized customer acquisition expenditures."
Capitalized customer acquisition expenditures relating to prospective customers
are amortized over three years, and capitalized customer acquisition
expenditures relating to certain marketing activities to groups of existing
customers are amortized over six months. These amortization rates are based on
the estimates of timing of future roll processing volumes per customer. Based
on the historical pattern of roll processing volumes and the estimate of orders
to be processed in the future, estimated amortization of capitalized customer
acquisition expenditures as of September 28, 1996 will be $7,237,698, $3,236,523
and $859,827 in fiscal years 1997, 1998, and 1999 respectively.
Effective as of the beginning of the second quarter of fiscal 1996, the
Company reduced from twelve months to six months the amortization period for
certain marketing activities to specific groups of existing customers. This
change in accounting estimate was made to more accurately match revenues and
expenses, and resulted in $127,000 of incremental amortization of deferred
customer acquisition costs.
INCOME TAXES: The provision for federal income taxes is computed based on
pretax income reported in the financial statements. Research and development
tax credits are recorded as a reduction of the provision for federal income
taxes in the year realized. The provision for income taxes differs from income
taxes currently payable because certain items of income and expense are
recognized in different periods for financial reporting purposes than they are
for federal income tax purposes. Deferred income taxes have been recorded in
recognition of these temporary differences.
The Company adopted Statement of Financial Accounting Standards No. 109,
"Accounting for Income Taxes," in the first quarter of fiscal year 1994. The
adoption of this new Standard did not have a significant impact on operating
results.
EARNINGS PER SHARE: Earnings per share is based on the weighted average number
of shares and dilutive Common Stock equivalents outstanding during the fiscal
year. Common Stock equivalents consist of stock options.
STOCK COMPENSATION: The Company has elected to follow Accounting Principles
Board Opinion No. 25, "Accounting for Stock Issued to Employees", and related
interpretations in accounting for its employee stock options. Generally stock
compensation, if any, is measured as the difference between the exercise price
of a stock option and the fair market value of the Company's stock at the date
of grant, which is then amortized over the related service period.
USE OF ESTIMATES: The preparation of financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ from those estimates.
OTHER FINANCIAL INSTRUMENTS: At September 28, 1996 the carrying value of
financial instruments such as trade receivables and payables approximate their
fair values, based on the short-term maturities of these instruments.
RECLASSIFICATIONS: Certain prior-year amounts have been reclassified to conform
with the fiscal 1996 financial statements.
32
SEATTLE FILMWORKS, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
NOTE B -- ACQUISITION OF PRIVATE LABEL FILM BUSINESS
On December 30, 1993, the Company acquired certain assets of Private Label
Film, Inc. for approximately $1,637,000. The assets relate to the manufacture
and sale of private-label film and related products to retailers and commercial
users. This acquisition has been accounted for using the purchase method.
The purchase price was recorded as follows: equipment $100,000; and other
assets of $1,536,830 related to noncompete agreements which includes capitalized
legal and accounting expenses. See Note A, "Depreciation and Amortization."
NOTE C -- FURNITURE, FIXTURES, AND EQUIPMENT
Furniture, fixtures, and equipment consist of the following:
September 28, September 30,
1996 1995
============== ==============
(in thousands)
Furniture, fixtures, and equipment $12,558 $ 9,673
Leasehold improvements 2,294 1,610
------- -------
14,852 11,283
Less accumulated depreciation and amortization (9,515) (8,083)
------- -------
$ 5,337 $ 3,200
======= =======
NOTE D -- CREDIT AGREEMENT
At September 28, 1996, the Company had a $6,000,000 available line of
credit, with interest at the lending bank's prime rate. There were no
borrowings outstanding at the end of fiscal 1996 or fiscal 1995 under the line
of credit. The Company is restricted under the covenants of a bank loan
agreement from declaring any dividends on shares of its capital stock in excess
of $4,000,000 in any fiscal year, noncumulative from year to year, without the
bank's prior consent.
NOTE E -- PROPERTY AND LEASES
The Company's primary lease relates to its main operating facility. This
lease expires in September 2000. The Company also has a lease agreement for
additional warehouse and limited production space. This lease expires in
January 1999 with an option to extend the lease for two one-year periods. At
September 28, 1996, future minimum payments under noncancelable operating leases
for fiscal years 1997 through 2001 are $518,000, $521,000, $354,000, $265,000,
and $2,000, respectively. Rental expense relating to operating leases for
fiscal years 1996, 1995, and 1994 was $481,000, $353,000, and $335,000,
respectively.
33
SEATTLE FILMWORKS, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
NOTE F -- INCOME TAXES
The provision for income taxes is as follows:
(in thousands)
1996 1995 1994
====== ====== ======
Provision (benefit) for income taxes:
Current $2,863 $2,068 $2,036
Deferred 1,357 830 (89)
------ ------ ------
$4,220 $2,898 $1,947
====== ====== ======
A reconciliation of the federal statutory tax rates to the effective tax rates is as follows:
1996 1995 1994
====== ====== ======
Statutory tax rate 35.0% 34.0% 34.0%
Research and development tax credits (.1) (.4) (.5)
Other, net (.4) .2 (3.0)
------ ------ ------
34.5% 33.8% 30.5%
====== ====== ======
Principal items comprising the cumulative deferred income taxes are as follows:
1996 1995
======================================================================================================
Deferred tax liabilities:
Customer acquisition expenditures $3,899 $2,501
Other liabilities 212 175
------ ------
Total deferred tax liabilities 4,111 2,676
Deferred tax assets:
Accrued expenses 524 573
Depreciation and amortization 296 191
------ ------
Total deferred tax assets 820 764
------ ------
Net deferred tax liabilities $3,291 $1,912
====== ======
Taxes paid in 1996, 1995, and 1994 were $2,300,000, $2,020,000, and $1,520,000,
respectively.
NOTE G -- SHAREHOLDERS' EQUITY
STOCK OPTIONS
Pursuant to the Company's Stock Option Plans adopted in 1982 and 1987,
options may be granted to purchase up to 4,603,125 shares of Common Stock at
prices equal to the fair market value of the shares at the time the options are
granted. Options generally vest over four years and become exercisable
commencing one year after the date of grant and expiring five years after the
date of grant. Shares of Common Stock reserved for issuance under these stock
option plans totaled 1,686,754 at September 28, 1996, of which 369,281 shares
were available for options to be granted in the future.
34
SEATTLE FILMWORKS, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
NOTE G -- SHAREHOLDERS' EQUITY (CONTINUED)
The following schedule summarizes stock option activity for fiscal years
1994, 1995, and 1996.
Option Price
Number of Shares Per Share
================= ===================
Outstanding at September 25, 1993
(861,971 shares exercisable) 1,250,487 $ .12 - $ 3.78
Granted during 1994 108,900 $ 4.00 - $ 8.11
Canceled during 1994 (18,675) $ 1.30 - $ 4.67
Exercised during 1994 (57,376) $ .12 - $ 3.11
---------
Outstanding at September 24, 1994
(959,729 shares exercisable) 1,283,336 $ .26 - $ 8.11
Granted during 1995 152,325 $ 7.17 - $14.17
Canceled during 1995 (21,095) $ 3.11 - $ 7.44
Exercised during 1995 (115,950) $ .26 - $ 6.56
---------
Outstanding at September 30, 1995
(1,004,824 shares exercisable) 1,298,616 $ .28 - $14.17
Granted during 1996 142,050 $12.83 - $20.50
Canceled during 1996 (19,257) $ 3.11 - $14.17
Exercised during 1996 (103,936) $ .28 - $10.17
---------
Outstanding at September 28, 1996
(1,041,751 shares exercisable) 1,317,473 $ .31 - $20.50
=========
EMPLOYEE STOCK PURCHASE PLAN
Effective September 22, 1993, the Company adopted an Employee Stock
Purchase Plan under which employees have the option to purchase 337,500 shares
of Common Stock. Under the Plan, eligible employees may purchase shares of the
Company's Common Stock at six-month intervals at 85% of the fair market value on
the first or last day of the six-month offering period, whichever is lower.
Employees may purchase shares having a value not exceeding 10% of their gross
compensation during the purchase period. During fiscal 1996, shares totaling
13,445 were issued under the Plan at a price of $12.0417 per share. At
September 28, 1996, 202,856 shares were reserved for future issuance.
STOCK SPLITS
All share data, per share data and related accounts in the accompanying
financial statements and these notes reflect a retroactive adjustment for a two-
for-one stock split effective March 16, 1994, a three-for-two stock split
effective March 15, 1995, and a three-for-two stock split effective March 15,
1996.
PURCHASE AND RETIREMENT OF COMMON STOCK
On July 20, 1994, the Company repurchased 1,125,000 shares, or
approximately 10% of its outstanding Common Stock, from Mr. Sam Rubinstein, a
Director and the largest shareholder of the Company, in a private transaction
for $5.78 per share plus legal and brokerage fees.
35
SEATTLE FILMWORKS, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
NOTE H -- RETIREMENT AND PROFIT SHARING PLAN
The Company maintains a 401(k) Plan for substantially all employees. The
Company's contributions are based on matching a percentage of up to 2% of
voluntary employee contributions and discretionary profit sharing contribution
determined by the Board of Directors. The Company's contributions were
$488,000, $366,000, and $285,000 for fiscal years 1996, 1995, and 1994,
respectively.
NOTE I -- CONTINGENCIES
The Company is involved in various routine legal proceedings incident to the
ordinary course of its business. Management believes that the outcome of all
pending legal proceedings in the aggregate will not have a material adverse
effect on the Company's business, financial condition or operating results.
NOTE J -- SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
The following table sets forth summary financial data for the Company by
quarter for fiscal years 1996 and 1995 (in thousands, except per share data).
Quarters
--------
First Second Third Fourth
-------- ------- ------- -------
Fiscal 1996
- -----------
Net revenue $16,689 $17,821 $22,509 $27,133
Gross profit 6,292 7,311 8,927 12,463
Net income 951 503 2,242 4,321
Earnings per share .08 .04 .19 .36
Fiscal 1995
- -----------
Net revenue $12,270 $12,293 $15,791 $21,831
Gross profit 4,590 4,152 6,136 9,179
Net income 655 339 1,513 3,175
Earnings per share .06 .03 .13 .27
The sum of quarterly earnings per share will not necessarily equal the
earnings per share reported for the entire year since the weighted average
shares outstanding used in the earnings per share computation changes throughout
the year. All earnings per share data presented above have been adjusted to
reflect stock splits. See Note G.
ITEM 9 - CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
36
PART III
ITEM 10 -- DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
See "Directors and Executive Officers of the Registrant" under Item 1 -
Part 1 above.
Information concerning compliance with Section 16 of the Securities
Exchange Act is incorporated herein by reference to information appearing in the
Company's Proxy Statement for its annual meeting of shareholders to be held on
February 12, 1997, which information appears under the caption "Compliance with
Section 16(a) of the Exchange Act." Such Proxy Statement will be filed within
120 days of the Company's last fiscal year-end, September 28, 1996.
ITEMS 11, 12, AND 13
The information called for by Part III (Items 11, 12, and 13) is included
in the Company's Proxy Statement relating to the Company's annual meeting of
shareholders to be held on February 12, 1997 and is incorporated herein by
reference. The information appears in the Proxy Statement under the captions
"Remuneration of Executive Officers and Directors," "Voting Securities and
Principal Holders," and "Certain Transactions." Such Proxy Statement will be
filed within 120 days of the Company's last fiscal year-end, September 28, 1996.
PART IV
ITEM 14 -- EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
A. INDEX TO FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES
---------------------------------------------------------------
(1) Financial Statements Page
-------------------- -----
Report of Ernst & Young LLP, Independent Auditors 26
Balance Sheets as of September 28, 1996 and September 30, 1995 27
Statements of Income for the years ended September 28, 1996,
September 30, 1995, and September 24, 1994 28
Statements of Shareholders' Equity for the years ended
September 28, 1996, September 30, 1995, and September 24, 1994 29
Statements of Cash Flows for the years ended September 28, 1996,
September 30, 1995, and September 24, 1994 30
Notes to Financial Statements 31-36
Supplemental Financial Statement Schedule. The following additional
information should be read in conjunction with the Financial Statements of the
Company included in Part II, Item 8.
37
(2) Schedule Page
-------- ----
II - Valuation and Qualifying Accounts 41
All other schedules have been omitted because the required information is
included in the financial statements or the notes thereto, or is not applicable
or required.
B. REPORTS ON FORM 8-K
-------------------
None.
C. EXHIBITS
--------
The following list is a subset of the exhibits set forth below and contains
all compensatory plans, contracts, or arrangements in which any director or
executive officer of the Company is a participant, unless the method of
allocation of benefits thereunder is the same for management and non-management
participants:
(1) The Company's Incentive Stock Option Plan, as amended and restated as
of April 1, 1996. See Exhibit 10.4
(2) The Company's 1987 Stock Option Plan, as amended and restated as of
April 1, 1996. See Exhibit 10.6
Exhibit
Number Exhibit Description
- ------- --------------------
3.1 Articles of Incorporation of the Company, as amended through February
23, 1989.
(Incorporated by reference to Exhibit 3.1 filed with the Company's
Annual Report on Form 10-K for the year ended September 30, 1989.)
3.2 Bylaws of the Company, as amended and restated on November 13, 1996.
3.3 Articles of Amendment to Articles of Incorporation dated July 1, 1993.
(Incorporated by reference to Exhibit 3.3 filed with the Company's
Annual Report on Form 10-K for the year ended September 25, 1993.)
3.4 Articles of Amendment to Articles of Incorporation dated March 2,
1994. (Incorporated by reference to Exhibit 3.4 filed with the
Company's Annual Report on Form 10-K for the year ended September 24,
1994.)
3.5 Articles of Amendment to Articles of Incorporation dated February 16,
1995. (Incorporated by reference to Exhibit 3.0 filed with the
Company's Quarterly Report on Form 10-Q for the quarter ended March
25, 1995.)
3.6 Second Restated Articles of Incorporation of Seattle FilmWorks, Inc.
dated March 5, 1996. (Incorporated by reference to Exhibit 3.0 filed
with the Company's Quarterly Report on Form 10-Q for the quarter ended
March 30, 1996.)
38
10.1 Lease Agreement dated September 10, 1985 between Gilbert Scherer and
Marlyn Friedlander, Lessors, and the Company with respect to certain
office and plant facilities in Seattle, Washington. (Incorporated by
reference to the exhibit with a corresponding number filed with the
Company's registration statement on Form S-1 (file no. 33-4388.)
10.2 First Amendment to Facility Lease Agreement dated April 29, 1989, with
Gilbert Scherer and Marlyn Friedlander, Lessors. (Incorporated by
reference to Exhibit 10.48 filed with the Company's Annual Report on
Form 10-K for the year ended September 30, 1989.)
10.3 Consent to Sublease dated September 30, 1996, between Gilbert Scherer
and Marlyn Friedlander and Seattle FilmWorks, Inc.
10.4 Incentive Stock Option Plan, as amended and restated as of April 1
1996. (Incorporated by reference to Exhibit 10.1 filed with the
Company's Quarterly Report on Form 10-Q for the quarter ended June 29,
1996.)
10.5 Form of Incentive Stock Option Agreement. (Incorporated by reference
to Exhibit 10.2 filed with the Company's Registration Statement on
Form S-8, file no. 33-24107.)
10.6 1987 Stock Option Plan, as amended and restated as of April 1, 1996.
(Incorporated by reference to Exhibit 10.2 filed with the Company's
Quarterly Report on Form 10-Q for the quarter ended June 29, 1996.)
10.7 Form of Stock Option Agreement. (Incorporated by reference to Exhibit
10.4 filed with the Company's Registration Statement on Form S-8, file
no. 33-24107.)
10.8 1993 Employee Stock Purchase Plan as amended and restated as of May
31, 1995. (Incorporated by reference to Exhibit 10.58 filed with the
Company's Annual Report on Form 10-K for the year ended September 30,
1995.)
10.9 Purchase and Sale Agreement dated as of December 16, 1993 and related
Amendment to Purchase and Sale Agreement dated December 30, 1993 among
Seattle FilmWorks, Inc., Private Label Film, Inc. and certain
shareholders of Private Label Film, Inc. (Incorporated by reference to
Exhibits 2.1 and 2.2 filed with the Company's Report on Form 10-Q
dated February 7, 1994.)
10.10 Business Loan Agreement with First Interstate Bank of Washington N.A.
as amended and restated on March 31, 1994. (Incorporated by reference
to Exhibit 10.60 filed with the Company's Annual Report on Form 10-K
for the year ended September 24, 1994.)
10.11 Business Loan Agreement with First Interstate Bank of Washington N.A.
as amended and restated on February 28, 1995. (Incorporated by
reference to Exhibit 10.0 filed with the Company's Quarterly Report on
Form 10-Q for the quarter ended March 25, 1995.)
10.12 Business Loan Agreement with First Interstate Bank of Washington N.A.
as amended and restated on January 31, 1996. (Incorporated by
reference to Exhibit 10.1 filed with the Company's Quarterly Report on
Form 10-Q for the quarter ended March 30, 1996.)
10.13 Business Loan Agreement with Wells Fargo Bank, National Association as
amended and restated on December 13, 1996.
39
10.14 Stock Redemption Agreement dated July 20,1994 between the Company and
Sam Rubinstein and related promissory note. (Incorporated by reference
to Exhibits 5.1 and 5.2 filed with the Company's Report on Form 8-K
dated July 22, 1994.)
10.15 Lease Agreement dated September 22, 1995 between the United States of
America, Lessors, and the Company with respect to certain plant and
warehouse facilities in Seattle, Washington. (Incorporated by
reference to Exhibit 10.63 filed with the Company's Annual Report on
Form 10-K for the year ended September 30, 1995.)
10.16 Addendum to Lease Agreement dated January 1, 1996 between the United
States of America, Lessors, and the Company. (Incorporated by
reference to Exhibit 10.3 filed with the Company's Quarterly Report on
Form 10-Q for the quarter ended March 30, 1996.)
10.17 Supplemental Lease Agreement dated October 21, 1996 between the United
States of America, Lessors, and the Company.
10.18* Sales contract dated August 18, 1995 between the Company and Agfa
Division of Miles, Inc. with respect to the purchase of certain
products. (Incorporated by reference to Exhibit 10.64 filed with the
Company's Quarterly Report on Form 10-Q for the quarter ended March
30, 1996.)
10.19* Supplement to sales contract with Agfa Division of Miles, Inc. dated
March 29, 1996. (Incorporated by reference to Exhibit 10.2 filed with
the Company's Quarterly Report on Form 10-Q for the quarter ended
March 30, 1996.)
10.20 Warehouse Sublease between Seattle FilmWorks, Inc. and OptiColor, Inc.
dated September 30, 1996.
10.21 Warehouse Sublease between Seattle FilmWorks, Inc. and Seattle
FilmWorks Manufacturing Company dated September 30, 1996.
10.22 1260 16th Avenue West Sublease between Seattle FilmWorks, Inc. and
OptiColor Inc. dated September 30, 1996.
10.23 1260 16th Avenue West Sublease between Seattle FilmWorks, Inc. and
Seattle FilmWorks Manufacturing Company dated September 30, 1996.
10.24 General Assignment between Seattle FilmWorks, Inc., Seattle FilmWorks
Manufacturing Company and OptiColor, Inc. dated September 30, 1996.
11 Computation of Earnings Per Share
21 Seattle FilmWorks, Inc. Subsidiaries
23 Consent of Independent Auditors
* Exhibit for which confidential treatment has been granted.
40
SEATTLE FILMWORKS, INC.
SCHEDULE II
VALUATION AND QUALIFYING ACCOUNTS
(in thousands)
Additions
----------------------------------
Balance at Charged to Charged to Balance
Beginning Costs and Other at End
Description of Year Expenses Accounts Deductions of Period
================================== ========== ========== ========== ========== =========
FOR THE YEAR ENDED
SEPTEMBER 24, 1994
Allowance for doubtful accounts $327 $481 $0 $347 $461
Allowance for returns $103 $281 $0 $279 $105
FOR THE YEAR ENDED
SEPTEMBER 30, 1995
Allowance for doubtful accounts $461 $639 $0 $554 $546
Allowance for returns $105 $272 $0 $280 $ 97
FOR THE YEAR ENDED
SEPTEMBER 28, 1996
Allowance for doubtful accounts $546 $158 $0 $417 $287
Allowance for returns $ 97 $130 $0 $182 $ 45
____________________________
41
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
(REGISTRANT)
DATED: December 18, 1996 By: //s// Gary R. Christophersen
----------------------------
Gary R. Christophersen
President and Chief Executive
Officer
(Principal Executive Officer)
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the Registrant and
in the capacities and on the dates indicated.
NAME TITLE DATE
By: //s// Gary R. Christophersen President December 18, 1996
----------------------------- Chief Executive Officer
Gary R. Christophersen Director
(Principal Executive Officer)
By: //s// Sam Rubinstein Director December 18, 1996
-----------------------------
Sam Rubinstein
By: //s// Douglas A. Swerland Director December 18, 1996
-----------------------------
Douglas A. Swerland
By: //s// Craig E. Tall Director December 18, 1996
-----------------------------
Craig E. Tall
By: //s// Peter H. van Oppen Director December 18, 1996
-----------------------------
Peter H. van Oppen
By: //s// Case H. Kuehn Vice President-Finance December 18, 1996
----------------------------- Chief Financial Officer
Case H. Kuehn (Principal Financial and
Accounting Officer)
42
EXHIBIT INDEX
-------------
Annual Report on Form 10-K
For The Year Ended September 28, 1996
Exhibit Page
Number Exhibit Description Number
- ------- ------------------- ------
3.1 Articles of Incorporation of the Company, as amended
through February 23, 1989. (Incorporated by reference to
Exhibit 3.1 filed with the Company's Annual Report on
Form 10-K for the year ended September 30, 1989.) 46
3.2 Bylaws of the Company, as amended and restated on
November 13, 1996.
3.3 Articles of Amendment to Articles of Incorporation
dated July 1, 1993. (Incorporated by reference to
Exhibit 3.3 filed with the Company's Annual Report on
Form 10-K for the year ended September 25, 1993.)
3.4 Articles of Amendment to Articles of Incorporation
dated March 2, 1994. (Incorporated by reference to
Exhibit 3.4 filed with the Company's Annual Report on
Form 10-K for the year ended September 24, 1994.)
3.5 Articles of Amendment to Articles of Incorporation
dated February 16, 1995. (Incorporated by reference
to Exhibit 3.0 filed with the Company's Quarterly Report
on Form 10-Q for the quarter ended March 25, 1995.)
3.6 Second Restated Articles of Incorporation of
Seattle FilmWorks, Inc. dated March 5, 1996.
(Incorporated by reference to Exhibit 3.0 filed with
the Company's Quarterly Report on Form 10-Q for the
quarter ended March 30, 1996.)
10.1 Lease Agreement dated September 10, 1985 between
Gilbert Scherer and Marlyn Friedlander, Lessors,
and the Company with respect to certain office
and plant facilities in Seattle, Washington.
(Incorporated by reference to the exhibit with a
corresponding number filed with the Company's
registration statement on Form S-1 (file no.
33-4388.)
10.2 First Amendment to Facility Lease Agreement dated
April 29, 1989, with Gilbert Scherer and
Marlyn Friedlander, Lessors. (Incorporated by
reference to Exhibit 10.48 filed with the Company's
Annual Report on Form 10-K for the year ended
September 30, 1989.)
10.3 Consent to Sublease dated September 30, 1996, between
Gilbert Scherer and Marlyn Friedlander and Seattle
FilmWorks, Inc. 65
10.4 Incentive Stock Option Plan, as amended and restated as
of April 1 1996. (Incorporated by reference to
Exhibit 10.1 filed with the Company's Quarterly Report
on Form 10-Q for the quarter ended June 29, 1996.)
10.5 Form of Incentive Stock Option Agreement. (Incorporated
by reference to Exhibit 10.2 filed with the Company's
Registration Statement on Form S-8, file no. 33-24107.)
43
10.6 1987 Stock Option Plan, as amended and restated as of
April 1, 1996. (Incorporated by reference to Exhibit 10.2
filed with the Company's Quarterly Report on Form 10-Q
for the quarter ended June 29, 1996.)
10.7 Form of Stock Option Agreement. (Incorporated by reference
to Exhibit 10.4 filed with the Company's Registration
Statement on Form S-8, file no. 33-24107.)
10.8 1993 Employee Stock Purchase Plan as amended and restated
as of May 31, 1995. (Incorporated by reference to
Exhibit 10.58 filed with the Company's Annual Report on
Form 10-K for the year ended September 30, 1995.)
10.9 Purchase and Sale Agreement dated as of December 16, 1993
and related Amendment to Purchase and Sale Agreement dated
December 30, 1993 among Seattle FilmWorks, Inc., Private
Label Film, Inc. and certain shareholders of Private Label
Film, Inc. (Incorporated by reference to Exhibits 2.1 and
2.2 filed with the Company's Report on Form 10-Q dated
February 7, 1994.)
10.10 Business Loan Agreement with First Interstate Bank of
Washington N.A. as amended and restated on March 31, 1994.
(Incorporated by reference to Exhibit 10.60 filed with the
Company's Annual Report on Form 10-K for the year ended
September 24, 1994.)
10.11 Business Loan Agreement with First Interstate Bank of
Washington N.A. as amended and restated on February 28, 1995.
(Incorporated by reference to Exhibit 10.0 filed with the
Company's Quarterly Report on Form 10-Q for the quarter ended
March 25, 1995.)
10.12 Business Loan Agreement with First Interstate Bank of
Washington N.A. as amended and restated on January 31, 1996.
(Incorporated by reference to Exhibit 10.1 filed with the
Company's Quarterly Report on Form 10-Q for the quarter
ended March 30, 1996.)
10.13 Business Loan Agreement with Wells Fargo Bank, National
Association as amended and restated on December 13, 1996. 67
10.14 Stock Redemption Agreement dated July 20,1994 between the
Company and Sam Rubinstein and related promissory note.
(Incorporated by reference to Exhibits 5.1 and 5.2 filed
with the Company's Report on Form 8-K dated July 22, 1994.)
10.15 Lease Agreement dated September 22, 1995 between the
United States of America, Lessors, and the Company with
respect to certain plant and warehouse facilities in
Seattle, Washington. (Incorporated by reference to
Exhibit 10.63 filed with the Company's Annual Report on
Form 10-K for the year ended September 30, 1995.)
10.16 Addendum to Lease Agreement dated January 1, 1996 between
the United States of America, Lessors, and the Company.
(Incorporated by reference to Exhibit 10.3 filed with the
Company's Quarterly Report on Form 10-Q for the quarter
ended March 30, 1996.)
10.17 Supplemental Lease Agreement dated October 21, 1996
between the United States of America, Lessors, and
the Company. 74
10.18* Sales contract dated August 18, 1995 between the
Company and Agfa Division of Miles, Inc. with respect
to the purchase of certain products. (Incorporated by
reference to Exhibit 10.64 filed with the Company's
Quarterly Report on Form 10-Q for the quarter ended
March 30, 1996.)
44
10.19* Supplement to sales contract with Agfa Division of
Miles, Inc. dated March 29, 1996. (Incorporated by
reference to Exhibit 10.2 filed with the Company's
Quarterly Report on Form 10-Q for the quarter ended
March 30, 1996.)
10.20 Warehouse Sublease between Seattle FilmWorks, Inc.
and OptiColor, Inc. dated September 30, 1996. 76
10.21 Warehouse Sublease between Seattle FilmWorks, Inc.
and Seattle FilmWorks Manufacturing Company dated
September 30, 1996. 80
10.22 1260 16th Avenue West Sublease between Seattle
FilmWorks, Inc. and OptiColor Inc. dated September
30, 1996. 84
10.23 1260 16th Avenue West Sublease between Seattle
FilmWorks, Inc. and Seattle FilmWorks Manufacturing
Company dated September 30, 1996. 88
10.24 General Assignment between Seattle FilmWorks, Inc.,
Seattle FilmWorks Manufacturing Company and OptiColor,
Inc. dated September 30, 1996. 92
11 Computation of Earnings Per Share 98
21 Seattle FilmWorks, Inc. Subsidiaries 99
23 Consent of Independent Auditors 100
* Exhibit for which confidential treatment has been granted.
45