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: December 31, 1999

OR

[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR (15d) OF THE

SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED]

For the transition period from ______ to ______

Commission File No.: 0-11927

MOTO PHOTO, INC.

(Exact name of registrant as specified in its charter)

Delaware 31-1080650

(State of Incorporation) (Employer Identification No.)

4444 Lake Center Dr. Dayton, OH 45426

(Address of principal executive offices) (Zip Code)

(937) 854-6686

(Registrant's telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act: None

Securities registered pursuant to Section 12(g) of the Act:

Voting Common Stock, $.01 per share value

Moto Photo, Inc., together with its subsidiaries, ("the Company") is engaged in the franchising and ownership of stores offering one-hour photo processing services, portrait, and related imaging services and merchandise under the trade names and service marks of "MOTOPHOTO", "ONE HOUR MOTOPHOTO", and "ONE HOUR MOTOPHOTO & PORTRAIT STUDIO."

The Company was incorporated as an Oklahoma corporation on July 29, 1981 and was reincorporated under Delaware law in 1983.

The operating segments of the Company's business are Development, Royalty and Advertising, Wholesale, and Company Stores. Development markets the Company's franchise and recruits franchisees. Royalty and Advertising provides services to current franchisees. Wholesale sells to franchisees products and related services not covered under the franchise agreement which the franchisees need to operate their businesses. Company Stores operates retail photo processing and portrait stores owne

The Company offers franchises for stores which provide one-hour photo processing, portraiture, and sales of related imaging services and merchandise under the trade names and service marks of "MOTOPHOTO", "ONE HOUR MOTOPHOTO", and "ONE HOUR MOTOPHOTO & PORTRAIT STUDIO." See "Business - Trade Names, Service Marks, and Logo Types." The Company, as franchisor, licenses to the franchisee such trade names, service marks, and other proprietary names and marks. The franchisee has the righ

The Company offers franchises in the United States through area developers and Company personnel, who generate leads through advertising, brokers, referrals, franchise shows, and the internet. At December 31, 1999, the Company had a total of eleven area developers covering twenty-four states and the District of Columbia. An area developer receives a portion of the initial franchise fee as compensation for the recruitment of a franchisee in its area and for providing assistance in openin

During 1999, the Company continued to use its new store design in all new stores opening in the system. The new design, Project Aspire, is intended to appeal to the target customers of MOTOPHOTO stores and the Company believes it will complement the services the stores offer. Project Aspire will be also be used to retrofit existing stores over time.

In addition, the Company continued to use and refine its new real estate model, developed with a national real estate modeling and consulting firm, for selecting store sites and evaluating their potential for both sales and risk of failure. The Company believes that this real estate model, the MotoWizardÔ program, will help choose better store sites and is also useful as a sales tool in attracting new franchisees.

The Company receives initial franchise fees for new franchises of up to $35,000; it offers a discounted franchise fee for each additional store opened by an existing franchisee.

During fourth quarter 1999, the Company began to offer two new programs to attract franchisees. Under its Limited Time Offer, it has lowered its initial franchise fee from $35,000 to $15,000 for first-time franchisees and to $7,500 for existing franchisees and agreed to contribute $4,000 to grand opening advertising expenses, provided the franchisee signs a franchise agreement by June 30, 2000 and opens its store by December 31, 2000. The franchisee must also agree to purchase all of it

The Company also began to offer the MotoPhoto QuickStart II^SM financing program, replacing the MotoPhoto QuickStart I^SM program which the Company first offered in 1998. Under the MotoPhoto QuickStart II^SM program, a third party lender offers financing which enables franchisees to open a MOTOPHOTO store for a much smaller initial cash investment (currently approximately $58,900) than a franchisee who used traditional financing methods would have (currently

The Company targets for conversion into the Company's franchise system independently operated stores offering one-hour photo processing services which meet the Company's criteria for location and have an acceptable operating history. The Company has developed certain programs and incentives described below that are intended to encourage such "conversion franchises." These programs provide to the Company additional means to penetrate new market areas and to broaden the Company's base of

The Company has a program to increase the number of conversion franchises, which is used primarily by franchisees already in the System who acquire non-affiliated stores and convert them to MOTOPHOTO franchise stores. The Company has lowered its initial franchise fee for conversion franchises to $10,000. If the conversion franchisee's sales in the preceding twelve months were over $167,000, the Company will give the conversion franchisee a credit equal to 6% of the previous year's sale s

In addition to the MotoPhoto QuickStart^SM program, the Company has arranged in the past and may in the future arrange for financing of portions of the initial investment for franchisees through third parties, which the Company may be required to guarantee in whole or in part.

In marketing its franchise, the Company faces general competition from franchisors of other types of businesses. The opportunities available and costs associated with other franchise operations may affect the Company's ability to market MOTOPHOTO franchises. Furthermore, with the strong economy, fewer individuals are leaving the corporate workplace to seek to operate their own businesses; the number of franchise sales leads is down throughout the franchising industry. In addition, ees face competition from other providers of photo processing services. See "The Business as a Whole - Competition" below. Accordingly, as market conditions change, it may be necessary to change some or all of the strategies discussed above.

The Company owns no patents. The Company's principal service marks "MOTO-PHOTO," "ONE HOUR MOTOPHOTO," "ONE HOUR MOTOPHOTO & PORTRAIT STUDIO," and "CLUBMOTO" are registered on the principal register of the United States Patent and Trademark Office. In addition, the Company has registered other secondary principal service marks. The initial period of registration is for twenty years and registration is renewable so long as the Company is using the marks. The marks "MOTO-PHOTO", "M

The Company has devoted substantial time, effort and expense toward developing name recognition and goodwill for stores operated under the trade names of "MOTOPHOTO," "ONE HOUR MOTOPHOTO," and "ONE HOUR MOTOPHOTO & PORTRAIT STUDIO." The Company intends to maintain the integrity of its trade names, service marks and other proprietary names and marks against unauthorized use and to protect the franchisees' use against claims of infringement and unfair competition where circumstances wa

The Company is subject to Federal Trade Commission ("FTC") regulation and certain state laws that regulate the offer and sale of franchises. The Company is also subject to a number of state laws that regulate substantive aspects of the franchisor-franchisee relationship.

Several additional states have enacted or proposed legislation concerning certain "key" aspects of the franchisor-franchisee relationship, including termination and renewal of the franchise, franchise transfers, and encroachment. Similar legislation has been proposed at the federal level. If such legislation were enacted, it could ultimately weaken the cohesiveness of franchise systems and could affect the way the Company does business in the future. The Company believes that its opera

The Company provides to franchisees operation, management, and marketing programs and systems and other services designed to promote the business of the franchisee. The Company develops advertising materials for its franchisees which promote the franchisee's business and build goodwill and name recognition for the "MOTOPHOTO", "ONE HOUR MOTOPHOTO", and "ONE HOUR MOTOPHOTO & PORTRAIT STUDIO" trade names and service marks and other proprietary names and marks of the Company. I

The Company also has devoted substantial efforts to the development of a series of manuals which provide operation and management guidelines for stores. These manuals deal with, among other things, technical operations, store design, marketing, portraiture, and merchandising. All of these manuals are the sole property of the Company but are available for use by a franchisee of the Company so long as the franchisee operates its store pursuant to the terms of the franchise agreement. Th e

The Company enforces a strict quality control program to ensure the high quality of products, services, and the maintenance of appearance and image of both franchised and company stores. The quality control program requires the franchisee to conduct daily testing of equipment and chemicals used in processing and printing. Store management is encouraged to stress personal service to build customer loyalty.

Generally, the franchise agreements are for a period of ten years and are renewable at the option of the franchisee if certain conditions are met. Franchise agreements for most franchises do not give franchisees a unilateral right to terminate. However, fifteen stores are operated under older agreements that allow the franchisee to terminate the agreement on three months' prior notice. Franchises are transferable only with the prior approval of the Company. Except in limited circumst a

Under the form of franchise agreement for new franchises, the Company receives a royalty of 6% of the franchisee's net retail sales and 3% of net wholesale sales. The franchise agreement requires franchisees to expend or contribute to their local advertising cooperative for advertising an amount of at least 5.5% of net retail sales. In addition, franchisees are required to pay to the Company 0.5% of net retail sales for advertising development.

Management of the Company believes that relations with franchisees are generally satisfactory.

The franchisee is required to purchase MOTOPHOTO private label film and single-use cameras and certain start-up advertising materials from the Company. The franchisee generally is not required to purchase other supplies or equipment from the Company but is required to purchase or lease supplies and equipment in accordance with certain specifications in order to maintain the quality and integrity of the franchise. The Company is a distributor to franchisees of photo processing paper,

The Company has negotiated arrangements with a number of suppliers which provide favorable pricing to the Company's franchisees on supplies and equipment. In return for providing services for certain suppliers, the Company may receive as compensation a rebate or commission on certain products and equipment sold directly to its franchisees by those suppliers. See also "The Business as a Whole - Supply Contract" below.

At December 31, 1999, the Company had 44 company stores in operation compared to 37 at year-end 1998. This increase in the number of Company stores was part of its plan to open stores to fill out existing markets. Although it plans to continue the majority of its growth of the system through franchises, the Company plans to open approximately five additional stores during 2000. The Company will continue to offer for sale some of its older stores that are in outlying areas. The Company

Seasonal demand in the photo processing industry is at its greatest during the Christmas season and in the summer and at its lowest during the winter following the Christmas season. Demand for photo processing services during spring and fall is fairly equal.

As of February 25, 2000, the Company had 478 employees, 225 of whom are employed part-time. None of the Company's employees belongs to any labor unions, and the Company believes its relationship with its employees is good.

The Company has a supply contract with Fuji in which the Company has agreed to use best efforts to have all system stores purchase Fuji products to meet the stores' requirements for photographic paper, equipment, chemistry, certain film, and other items. The supply contract has a term ending on December 31, 2001, and automatically renews every three years, absent notice from either party that it does not wish to renew. The supply contract was executed in 1992 in connection with a series

In December 1999, the Company exchanged its Series G Stock, all of which was held by Fuji, for an Amended Series G Preferred Stock issue. The Amended Series G Stock extended the mandatory redemption date from January 1, 2000 to January 1, 2003. The Amended Series G Stock is redeemable by the Company at any time in aggregate amounts of at least $1 million. No dividends will be paid. Scheduled payments of $800,000 in 2000 under the Series G Stock would have increased to $900,000 in 2001

In connection with the Amended Series G Stock transactions, the supply agreement was amended to reduce the associated revolving credit agreement by $2.7 million to $4 million. The Company executed a note to pay Fuji the $2.7 million over three years.

Fuji may terminate the supply contract and may require the Company to redeem the Amended Series G Stock under certain other circumstances ("Redemption Event") which include, after appropriate cure periods, failure by the Company to make payments when due under the supply contract, failure by the Company to renegotiate prices for the Fuji products as required by the supply contract, bankruptcy or insolvency of the Company, failure by the Company to meet its obligation under other indebtedn

The terms of the Amended Series G Stock permit the holder to require redemption in cash from the proceeds of an equity offering rather in Common Stock of the Company. If the Company defaulted under the supply contract so that Fuji could require redemption of the Amended Series G Stock, the Company would have to make an offering of equity securities to obtain the funds to redeem the Amended Series G Stock if the Company chose not to redeem it in Common Stock. There is no certainty that t

Competition

The Company is the largest franchisor of one-hour photo processing franchises in the United States, based on number of franchises. However, competition in the photo processing industry in general, and the one-hour photo processing industry in particular, is intense. Photo processing services are provided through various channels of distribution, including one-hour stores, specialty stores and photographic chains, large retail stores, drug stores, and mail order. The Company's competito

Principal competitive factors in the industry are convenience, quality of service, quality of product, price, and timeliness. Centralized photo processors can offer their services at significantly lower prices than those of the Company and its franchisees, although the customer may wait several days for photo processing. The Company's one-hour concept provides the market with more timely service. In addition, personnel at MOTOPHOTO stores are trained to be able to advise customers on p

The operating history of the Company and its franchisees indicates that substantial demand exists for the one-hour photo service offered by the Company and its franchisees; however, significantly lower prices offered by already established centralized photo processing outlets and other one-hour outlets may adversely affect the business of the Company and its franchisees. Factors allowing the Company and its franchisees to realize higher prices are quality and speed of service, the variet

The photo processing industry in which the Company operates is continuing to introduce new products and services, such as digital imaging products and the 24 mm Advanced Photo System, introduced in 1997. The Company has introduced, and will continue to introduce, these products and services into its franchised and company stores as the markets for these products demonstrate commercial viability.

The Company does not have exclusive right to the use of the photo processing equipment, which is available from several manufacturers. To the Company's knowledge, no manufacturers currently offer exclusive rights to the use of their equipment or are anticipated to offer such rights in the future.

The Company is planning to expand its offerings of imaging services as quickly as reasonably practicable in order to assure its market position in the rapidly changing retail photo processing industry. During 1999, the directors, officers, and senior managers of the Company, together with outside consultants, engaged in strategic planning processes and rethinking of the Company's business concept. As one result of this process, the Company has allocated funds and formed a separate manag

The Company continues to add digital imaging to the services which may be offered by MOTOPHOTO stores. The Company believes that its base of two million customers represents both an opportunity and advantage to it in the rapidly-expanding world of e-commerce and digital services. The Company is working to develop marketing strategies and services to meet those customers' digital imaging needs. During fourth quarter 1999, new equipment expanding the range of digital imaging capabilities

During 2000, the Company plans to effect system expansion through the establishment of new franchises, the conversion of profitable existing stores to MOTOPHOTO stores, and through the planned opening of Company stores. The Company is also devoting increased efforts to developing and implementing operations and training programs to improve the profitability of existing Company stores and franchised stores.

During 1999, the Company granted fourteen new franchises and sold one company store as a franchise, while twenty-two franchises were canceled or terminated, for a net decrease of eight franchises in the United States.

During 1999, the number of stores in foreign countries declined overall. The Company's master franchisor for Canada, Canadian Industrial Systems, Inc., granted four new franchises in Ontario, while fourteen franchises were canceled or terminated, for a net decrease of ten international franchises. The Company also has an affiliate store program in Norway. Affiliate stores are not franchises but independent stores that have the right to advertise themselves as affiliate stores of the Mot

During 1999, the Company opened or acquired thirteen new company stores. Although the Company will continue during 1999 to emphasize development of the system through franchised stores, the Company plans to open approximately five new stores in 2000. The Company will continue to offer for sale as franchises some of its stores that are in outlying areas.

Set forth below is a summary of the store development of the Company in the United States and abroad during 1998 and 1999:

As indicated in the chart above, a number of franchises were terminated or failed to renew in 1998 and 1999. Reasons for terminated franchises relate to franchise management, failure to follow system requirements, market conditions, location, sales of stores, and other factors typically affecting franchisee operations. In addition, 26 Norway franchises converted to affiliate stores during 1998.

The Company's corporate offices are located at 4444 Lake Center Drive, Dayton, Ohio 45426. Such offices, which have approximately 33,000 square feet on approximately 2.4 acres of land, have been leased by the Company, pursuant to a lease providing for rent of $20,327 per month through June 2004 and $22,374 from July 2004 through June 2009. There are two five-year renewal options on the lease. These offices are leased from a partnership controlled by certain officers and/or directors o

Management of the Company believes these facilities are generally adequate for its current operations. In addition, management of the Company believes it will be able to secure additional facilities as it expands its operations.

In connection with the resale of stores acquired by it, the Company assigns or subleases to the franchisee the lease for the store premises. In addition, in certain instances, the Company has secured a lease for rental space and then assigned the lease to a franchisee. The Company is currently the lessee or assignee of the leases for approximately six MOTOPHOTO stores, which have in turn been assigned to franchisees. In addition, at December 31, 1999, the Company was the lessee or ass i

The Company is involved in legal proceedings that it believes are routine and incidental to its business. These actions are being contested and defended. Management of the Company is of the opinion that such actions are not likely to result in any liability that would have a material adverse effect on the consolidated financial position of the Company.

No matters were submitted by the Company to a vote of its security holders during the quarter ended December 31, 1999.

The only shares of common stock that the Company has issued are Voting Common. At March 1, 2000, there were approximately 799 record holders and approximately 1,291 beneficial holders of the Company's Voting Common. The Company's Voting Common trades on The NASDAQ Small-Cap Market^SM under the symbol "MOTO."

The following table sets forth for the periods indicated the range of high and low last actual transaction prices for the Company's Voting Common, as reported by The NASDAQ Small-Cap Market^SM. The stock prices shown do not include mark-ups, markdowns, and commissions.

The Company has never declared a cash dividend on any class of its common stock. It is the present policy of the Company not to pay cash dividends on common stock and to retain earnings for use in its business and to pay debt. The Company may not pay any dividends on common stock so long as any Amended Series G Stock is outstanding. Should the Amended Series G Stock be redeemed, any payment of cash dividends on common stock in the future will depend upon the amount of funds legally avai

(1) Weighted-Average Common Shares Outstanding - Basic

The Company has never paid a cash dividend on its common shares.

Through the granting of franchises, conversion of independent stores, and acquisitions, Moto Photo, Inc. and its subsidiaries ("the Company") have developed a system of 419 operational stores, including 47 affiliate stores in Norway, at December 31, 1999 compared to 427 operational stores, including 44 affiliate stores, at December 31, 1998.

Systemwide sales, which include sales by franchisees, were approximately $140,000,000 in 1999 compared to $143,000,000 in 1998. The Company goal is to expand its basic store concept to increase the average sale per store from approximately $400,000 per year to over $600,000 by 2005. To facilitate this concept expansion, the Company has established a separate management team that is responsible for identifying, testing, and presenting implementation plans for new services, products and i

To fund this initiative, the Company has re-examined programs and functions and has eliminated or is eliminating those that have been determined to be marginal or modest contributors. However, contributions from these changes will likely not be sufficient to fully fund these initiatives and accordingly, there is a likelihood of lower profit in the next two years. The Company is budgeting $500,000 per year for the next two years for these expansion efforts.

Furthermore, to facilitate growth, management is examining "new economy" opportunities. The term "new economy" is used to categorize the rapid expansion of the Internet and its implication for businesses and the relatively high market capitalization achieved by "dot.com" companies. Management believes that the transformation to the new economy will be shaped by emerging technologies and the Internet. To enhance shareholder value, the Company is examining ways to participate in this gro

The Company believes that successful implementation of the above strategies will make its franchise investment opportunity more attractive to prospects and will make its Company stores more profitable. This will lead to system growth through granting of new franchises, conversion of independent stores to franchise stores, and opening and or acquiring new Company stores.

The Company's experience suggests the more system stores in a local market, the better individual stores in that market perform. Therefore, growth in existing markets and opening new markets with multiple stores are important for the Company's long-range growth.

The Company operates primarily in the specialty retail channel of the photo processing industry (see "Item 1. Business Competition" on page 3). There is a consolidation of photographic specialty retail outlets occurring and the Company estimates that the three largest chains, of which the Company is one, have approximately 35-40% of the U.S. specialty retail photo processing market. The Company estimates its share at approximately 8% of the U.S. stand-alone one-hour processing market.

The Company believes it operates a "recession resistant" business; however, a growing economy is beneficial for demand for the Company's products and services. Favorable weather, particularly on weekends, is important to store results and, therefore, Company results. The Company's business as a whole is subject to seasonal fluctuations. The demand for photo processing services is lowest in the first quarter and highest in the fourth quarter of the year.

The Company has market risk exposure to interest rates. At December 31, 1999, the Company has interest bearing debt obligations that are subject to market risk exposure relating to changes in interest rates. At December 31, 1999, $4,227,981 of outstanding debt is at fixed rates with a weighted-average interest rate of 8.8% and $3,472,088 is at variable rates with a weighted-average rate of 9.4%. The estimated fair value of the Company's debt at December 31, 1999 is equal to its carryin

The aggregate annual maturities of the Company's variable interest debt obligations for the five years subsequent to December 31, 1999 are as follows: $905,053, $961,064, $586,064, $586,064 and $433,843.

Foreign currency transactions are not material to the Company because transactions with the Company's suppliers are in U.S. dollars and the majority of the key supplier's manufacturing is currently done domestically. However, costs of certain photoprocessing equipment could be influenced by exchange rates.

In 1999 the Company recorded net income of $1,653,543, or $.18 per common share basic and $.12 per common share diluted. This compared to net income of $1,690,253, or $.18 per common share basic and $.18 per common share diluted in 1998.

Development segment revenue decreased $135,000, or 24.2% in 1999 compared to 1998, primarily due to $100,000 of revenue in 1998 from the sale of development rights in Canada. The decreased revenue led to a decrease of $66,000 in operating segment contribution.

During 1999 the Company modified its MotoPhoto QuickStart^SM financing program and introduced the QuickStart II^SM financing program. Along with this new financing program, the Company restructured its franchise offering and has a lower cost franchise fee program for stores that open by December 31, 2000. The Company believes that these modifications are making its franchise business opportunity more attractive to potential prospects and will lead to an increase in t

Company store revenue declined $150,000, or 1% in 1999 compared to 1998. One Company store was sold to a franchisee in 1999 and three others were closed. Additionally, the Company opened seven new Company stores during the year and acquired six stores including two from a franchisee. However, these openings and acquisitions occurred over the last six months of 1999 and, hence, only contributed low start-up level revenue for a partial year.

The change in mix in stores along with a 1.7% comparable store sales decrease accounted for the 1% decrease in revenue. Operating segment contribution declined $430,000 as a result of the opening of the new stores, which were responsible for $309,000 of the decline with increased allocations of overhead expenses primarily accountable for the balance. The Company plans to open approximately five Company stores in 2000. Company store revenue as a result of the openings in 1999 and 2000 s

Royalty and advertising revenue decreased $186,000, or, 3.5% in 1999 compared to 1998 due to a decrease in eight stores during the year offset by a 1.3 % comparable store sales increase and a decrease in revenue earned from rebates on franchisee's equipment purchases. This decrease in revenue led to a $186,000 decrease in operating segment contribution. The Company anticipates modest growth in royalty and advertising revenue as a result of increases in comparable franchise store sales a

Wholesale revenue increased $146,000, or 0.8% in 1999 compared to 1998. The increases in revenue are due to a reversal of the sales declines the Company suffered during the first half of 1998 due to uncompetitive pricing on certain products, primarily photographic paper and film, offset by lost revenue of $426,000 contributed in 1998 by telemarketing which was closed in 1998. The increased revenue, lower costs of certain products for resale, the absence of the telemarketing operation co

In 1999, the Company disposed of certain fixed assets from its stores at a loss aggregating $99,000 compared to a $137,000 loss in 1998 from the same activity. Also, in 1998 the Company closed its telemarketing operation creating a loss on disposal of furniture and fixtures, and leasehold write-offs totaling $75,000. The Company disposes of various fixed assets in the course of its business and will likely continue to do so in 2000 and future years. It is not possible to predict the ti

Selling general and administrative expenses decreased by $796,000, or 12% in 1999 compared to 1998 primarily as a result of $840,000 reduced expenses from closing the telemarketing operation.

Depreciation and amortization expenses increased $254,000, or 25% for 1999 as compared to 1998. Additions to property and equipment in Company stores led to increased depreciation of $267,000. Depreciation in the wholesale segment decreased $75,000 due to the absence of telemarketing. In 2000, depreciation and amortization expenses will continue to increase to approximately $1.6 million due to investments made in new company stores in late 1999 and during 2000.

Interest expense in 1999 increased $68,000 from 1998, primarily because of the Company's short-term bond transaction. Interest income, which is primarily from notes receivable and temporary investments of cash, decreased $155,000 in 1999 compared to 1998, due to greater collections in 1998 of interest on notes classified as non-performing. The Company anticipates interest income in 2000 to approximate the 1999 amount.

Income tax benefit in 1999 was $403,000, with an effective tax benefit rate of 32% compared to a tax benefit of $360,000 and an effective tax benefit rate of 27% in 1998. The tax benefits are due to the closing of certain Company stores which created a deductible tax expense for assets previously written off for book purposes, generating a realization of tax deductions for which no deferred tax asset recognition was available as of December 31, 1998. Additionally, the Company decreased deferred tax assets because it developed strategies which will make it more likely than not that the Company will be able to realize tax benefits from deferred tax assets related to capital loss carryforwards. The Company believes that it will show "fully taxed" book earnings in 2000.

In 1998 the Company recorded net income of $1,690,253, or $.18 per common share (basic and diluted), compared to net income of $1,703,535 or $.18 per common share (basic and diluted), in 1997.

Development segment revenue increased $78,000, or 16%, in 1998 compared to 1997, due primarily to the sale of development rights to Canada that was partially offset by 11 U.S. franchise openings in 1998 versus 14 in 1997. Costs associated with the introduction of the MotoPhoto QuickStart^SM financing program more than offset the increased revenue.

Company store revenue declined by $3.4 million, or 20%, in 1998 compared to 1997. One Company store was sold to a franchisee in 1998 and five others were closed. The decrease in Company store sales and related expenses was a result of the decrease in the number of Company stores operated and, along with a 3% or $437,000 decrease in Company comparable store sales, led to a decreased contribution from the Company store segment.

Royalty and advertising revenue increased $157,000 or 3% in 1998 compared to 1997 primarily due to a 4% increase in comparable franchise store sales offset by fewer stores. This increase in revenue was approximately equal to the increase in costs and expenses in this segment.

Wholesale revenue decreased $1.5 million, or 8%, in 1998 compared to 1997. During the first half of 1998 the Company suffered sales declines due to uncompetitive pricing on certain products, primarily photographic paper and film. In the third and fourth quarter of 1998, the Company lowered certain prices to remain competitive and also obtained cost concessions from its vendors late in the year. The Company estimates that approximately 6% of its 1997 revenue was lost in 1998 due to fra n

In 1998, the Company closed its telemarketing operation and incurred a loss on the disposal of equipment, furniture, and fixtures and wrote off unamortized leaseholds totaling $75,443. No further losses from telemarketing are anticipated in 1999 and subsequent years. The Company also disposed of certain fixed assets from its stores at a loss aggregating $136,858.

Selling, general and administrative expenses decreased $288,000, or 4%, in 1998 compared to 1997, primarily due to reduced bonuses paid on lower pretax profits.

Advertising expenses decreased by $33,000, or 3%, in 1998 compared to 1997, due to decreases associated with there being fewer Company stores, which more than offset the increases associated with the initiation of the MotoPhoto QuickStart ^SM program.

Depreciation and amortization expenses increased by $168,000, or 20%, in 1998 compared to 1997 primarily as a result of depreciation on additions to property and equipment in Company stores.

Interest expense decreased $34,000, or 8%, in 1998 compared to 1997, due to lower levels of interest bearing debt. Interest and investment income, which is primarily interest income from notes receivable and temporary investments of cash, increased in 1998 due to improved liquidity and collection of interest on certain non-performing notes.

Income tax benefit in 1998 was $360,000, with an effective tax benefit rate of 27% compared to $800,000 of tax expense with an effective rate of 32% in 1997. The reduction is due primarily to the closing of certain Company stores which created a deductible tax expense for assets previously written off for book purposes, generating a realization of tax deductions for which no net deferred tax asset recognition was available to the Company as of December 31, 1997.

In 1999, the Company's operating activities provided $1.1 million more cash than in 1998 due to increased collections on accounts receivable, less cash required for inventory increases in 1999 than in 1998, and an increase in accounts payable due to timing of expenditures offset by the transfer of $1.2 million to a note payable..

In 1998 the Company's operating activities provided $1.6 million more cash than in 1997. The primary reason for the increase was a decrease in payments on accounts payable in 1998 versus unusually high payments on payables otherwise due in 1996. This decrease was offset by an increase in inventory generated by stockpiling certain products at year-end.

In 1999 the combined allowances on notes and accounts receivable decreased $277,000 due to the charge offs exceeding current year provisions. Current year provisions were able to be reduced due to a more stringent credit practice. Allowances of $362,000 were transferred from account receivable allowances to notes receivable allowances when the Company obtained notes from certain franchisees whose accounts were excessively delinquent.

It is likely that cash provided by operations will decrease in 2000 due to lower net income and less cash generated from decreases in accounts receivable.

In 1998 the combined allowances on current notes receivable and long-term notes receivable increased $382,000 as a result of the transfer of $432,000 from accounts receivable allowances to notes receivable allowances when the Company obtained notes from certain franchisees whose accounts were excessively delinquent. This also accounts for a corresponding decrease in the allowance from accounts receivable.

In 1999, net cash utilized in investing activities was $350,000 more than in 1998. Purchases of property and equipment plus acquisitions increased by $1,000,000 in 1999 as compared to 1998, primarily as a result of opening seven Company stores, acquiring six stores and continuing to replace equipment and expand services in its older Company stores. In 2000, the Company plans to open approximately five stores and to reduce the level of its equipment replacement and service expansion in e

In 1998 net cash utilized by investing activities was $905,000 as compared to net cash provided by investing activities of $439,000 in 1997. Increased purchases of property and equipment in 1998 accounted for about $900,000 of the change with about $400,000 more accounted for by lower proceeds on sales of assets.

In 1999 the Company borrowed $1,680,000 for capital expenditures, made principal payments of $1,543,000, dividend payments of $700,000, and purchased common shares for treasury stock of $179,000, accounting for the $741,000 net cash utilized in financing activities. The Company has no cash dividend obligations in 2000. It will probably reduce bank borrowing in 2000 but will finance its new Company stores by capitalized leases. The Company is not able to predict whether and when additio

In 1998 the Company borrowed $1.25 million for capital expenditures and made principal payments of $1.9 million that, along with dividend payments, generated a $1.2 million use of cash from financing activities.

The Company's material capital commitments consist primarily of long-term obligations (See Notes E and F). Funds for repaying these commitments are anticipated to be generated primarily from operations and from working capital in 2000 and beyond.

The Company has available a $1.5 million line of credit, none of which was borrowed as of December 31, 1999. This line expires April 30, 2001. The Company believes this is adequate to finance its seasonal working capital needs.

At December 31, 1999, the Company had working capital of $4.35 million. The Company has often operated with a working capital deficit and believes the nature of its business allows it to operate adequately with a working capital deficit. The factors that contribute to this are the substantial percentage of sales from cash, favorable terms with suppliers, non-cash charges to income resulting from depreciation and amortization expenses, and the line of credit to meet seasonal needs. The working capital in 2000 due to the factors discussed above.

On December 31, 1999, the Company had income tax loss carryforwards, tax credits and deductible temporary differences with a tax benefit of approximately $2.1 million. The tax benefit of these carryforwards has a $915,000 valuation allowance for financial reporting purposes (See Note I). These items, if and when used for tax purposes, preserve liquidity and capital resources because tax payments are reduced by realization of these deferred tax assets.

The Company has $10,000,000 of Amended Series G Stock outstanding which is due in 2003 (See Note G and "Item 1. Business - Supply Contract and Amended Series G Preferred Stock" on page 7). These shares can be retired only by an exchange for common shares or from the proceeds of an equity offering. The Company is uncertain at this time as to how the Amended Series G Stock will be retired.

The Company has completed the changes required to ensure that all software, hardware, operating equipment and third-party service providers will function properly with respect to dates in the Year 2000 and thereafter. These changes did not require any material incremental costs. As of the date of this report, the Company's ability to provide services has not been adversely affected by Year 2000 issues. The Company continues to monitor its systems and providers.

All statements, other than statements of historical fact included in this report, which address activities, events or developments which the Company expects or anticipates will or may occur in the future constitute "forward looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. These statements are based on certain assumptions and analyses made by the Company in light of its expe

Quantitative and qualitative disclosures about market risk are included in management's discussion and analysis of financial conditions and result of operations.

The financial statements and supplementary data of the Company are included in this report after the signature page.

None.

1. The following documents are filed as part of this report:
   

1. Financial Statements: See Financial Statements and Schedules immediately following signature page of this report.
2. Exhibits: See Exhibit Index immediately preceding Exhibits

1. Reports on Form 8-K. The Company filed no report on Form 8-K during the
   quarter ended December 31, 1999.

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.