SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
(MARK ONE)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended DECEMBER 31, 1996
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES
AND EXCHANGE ACT OF 1934
For the transition period from ________________ to __________________
Commission File Number 000-21657
SKYMALL, INC.
(Exact name of Registrant as specified in its charter)
Nevada 86-0651100
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1520 East Pima Street, Phoenix, Arizona 85034
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (602) 254-9777
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Securities registered pursuant to Section 12(b) of the Act:
Name of each exchange on which
Title of each class registered
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None
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Securities registered pursuant to Section 12(g) of the Act:
Common Stock, .001 par value
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(Title of class)
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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 such
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 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. [ ]
On March 17, 1997, the aggregate market value of Common Stock held by
non-affiliates of the Registrant was approximately $26,238,098. The aggregate
market value was based on the closing price of Common Stock as reported by the
Nasdaq National Market.
APPLICABLE ONLY TO REGISTRANTS INVOLVED IN BANKRUPTCY
PROCEEDINGS DURING THE PRECEDING FIVE YEARS:
Indicate by check mark whether the registrant has filed all documents
and reports required to be filed by Section 12, 13 or 15(d) of the Securities
Exchange Act of 1934 subsequent to the distribution of securities under a plan
confirmed by a court. Yes [ ] No [ ]
APPLICABLE ONLY TO CORPORATE REGISTRANTS
Indicate the number of shares outstanding of each of the Registrant's
classes of common stock, as of the latest practicable date.
At March 17, 1997, the number of shares of Common Stock outstanding
was 8,654,000.
DOCUMENTS INCORPORATED BY REFERENCE
The Registrant's Information Statement for its Annual Meeting of
Shareholders, to be held on May 15, 1997, which will be filed pursuant to
regulation 14C within 120 days of the close of the Registrant's fiscal year, is
incorporated by reference in answer to Part III of this report, but only to the
extent indicated therein.
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TABLE OF CONTENTS
Page
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PART I
Item 1. Business................................................ 1
Item 2. Properties.............................................. 10
Item 3. Legal Proceedings....................................... 11
Item 4. Submission of Matters to a Vote of Security Holders..... 11
PART II
Item 5. Market for the Registrant's Common Stock and Related
Stockholder Matters................................ 11
Item 6. Selected Financial Data................................. 11
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations................ 12
Item 8. Financial Statements and Supplementary Data............. F-1
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure..................... 37
PART III
Item 10. Directors and Executive Officers of the Registrant...... 37
Item 11. Executive Compensation.................................. 37
Item 12. Security Ownership of Certain Beneficial Owners
and Management..................................... 37
Item 13. Certain Relationships and Related Transactions.......... 37
PART IV
Item 14. Exhibits, Financial Statement
Schedules and Reports on Form 8-K....................... 37
SIGNATURES................................................................ S-1
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ITEM 1. BUSINESS
GENERAL
SkyMall is the largest in-flight catalog company in the United States
that makes high-quality products and services available to more than 375.0
million airline passengers per year. The Company markets and sells a broad
selection of premium merchandise provided by participating merchants, including
major catalog companies and specialty retailers, such as Disney, Hammacher
Schlemmer and The Sharper Image. The merchandise of each participating merchant
is presented in a separate section of the SkyMall catalog to allow browsing from
"store to store," providing the convenience and variety of an upscale shopping
mall environment. Substantially all of the merchandise sold by the Company is
shipped directly to customers by participating merchants, thus avoiding
significant inventory risk. The Company has exclusive agreements to place its
catalogs in aircraft seat pockets on 15 airlines, which carried approximately
70% of all domestic passengers in 1996, including America West, Continental,
Delta, Southwest, TWA, United and US Airways. As a result, the Company believes
that the SkyMall catalog is available to over 1.0 million domestic airline
passengers each day. SkyMall has experienced substantial growth since the
Company began operations in 1990. Total revenues have increased from
approximately $5.4 million in fiscal 1991 to approximately $43.7 million in
fiscal 1996, for a compound annual growth rate of 52%. The Company's revenue per
passenger enplanement on flights carrying the SkyMall catalog has increased from
approximately $0.038 in 1991 to approximately $0.093 for the year ended December
31, 1996, for a compound annual growth rate of 20%.
BUSINESS STRATEGY. The Company's foundation is built on its
relationships with its customers, airline partners and participating merchants.
The Company's customers enjoy the convenience of being able to shop for a wide
variety of innovative products while traveling. The Company offers a fair price
guarantee under which the Company will refund the price difference if the
customer finds the same item advertised elsewhere at a lower price. In order to
enhance the ongoing appeal of its product offerings, the Company produces four
new catalogs per year. The Company maintains a toll free 24-hour telephone
ordering service (from air and ground phones) and an in-house staff of customer
service representatives who are trained to provide exemplary service in order to
build strong customer loyalty and increase revenue from repeat and referral
business.
In exchange for placement of its catalogs in aircraft seat pockets, the
Company pays each airline partner a monthly commission based on net merchandise
revenues generated by the Company from sales to that airline's passengers. Some
of the Company's airline agreements also require payment of minimum monthly
fees. The Company's airline partners benefit from additional revenue and from
being able to enhance the in-flight experience of their passengers by providing
the Company's catalog as an additional amenity.
Participating merchants obtain exposure for their products and services
to a demographically diverse group of potential customers with strong economic
profiles, generate additional revenues and acquire new customers to add to their
own proprietary mailing lists. Under contracts with participating merchants, the
Company earns percentages of revenues generated by the Company's sales,
placement fees for inclusion of the merchants' products in the SkyMall catalog,
or a combination thereof. The SkyMall catalog typically features 40 to 60
participating merchants. Participating merchants recently featured in the
SkyMall catalog are: Brookstone(R), Compaq Computer, The Disney Catalog,
Frontgate(R), Hammacher Schlemmer, Hello Direct(R), Johnston & Murphy,
Mattel(R), The Metropolitan Museum of Art, Norm Thompson Solutions(R),
Pepperidge Farm(R), The Safety Zone, SelfCare(R), The Sharper Image(R),
Successories(R), SyberVision(R), Thomas Cook and The Wine Enthusiast(R).
GROWTH STRATEGY. The Company's growth strategies are to increase its
revenue per passenger enplanement and to increase circulation of the SkyMall
catalog. The Company plans to increase its revenue per passenger enplanement
through innovative marketing programs, some of which are modeled after
successful "duty-free" in-flight sales programs offered on international
flights. The Company also plans to expand its distribution to travelers and
other potential customers by securing agreements from additional airlines to
carry the Company's catalogs, including both domestic and foreign airlines.
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The Company also plans to implement additional distribution channels
outside of its airline franchise, including direct marketing "mail-to-home"
programs, magazine inserts and catalog placement in hotels, railways, rental
cars and other locations where travelers may be reached. SkyMall recently began
test marketing the SkyMall concept with its first foreign airline, Japan-based
JAL. In addition, in 1994, Amtrak began carrying the Company's catalog on
selected routes. The Company is currently employing advanced database management
techniques to utilize its rapidly growing customer database of over one million
names for the development of direct targeted marketing programs and to generate
additional revenues from database list rentals.
MARKET OVERVIEW
A broad spectrum of companies market their goods and services to airline
passengers. Fifty five percent (55%) of people with household incomes in excess
of $40,000 per year fly at least once each year, while only 23% of people with
household incomes of $40,000 or less travel on airlines. A significant portion
of in-flight marketing consists of "direct-response" marketing, where the
merchant seeks to entice the passenger to take immediate action in response to
viewing the advertisement or marketing materials, such as placing a telephone
call to obtain the goods or services offered. By contrast, "image" marketing,
which is also conducted in-flight, seeks to build brand awareness and foster a
favorable image of products or services and the company offering them. Although
the primary goal of the SkyMall catalog is to elicit a direct-response from
passengers, merchants that offer goods and services in the SkyMall catalog also
build their brand awareness and image.
Although many products and services are offered to passengers while
in-flight through a number of media, the SkyMall catalog is unique in the
airline marketing industry because it is the only publication available to
passengers on major domestic airlines that is exclusively devoted to catalog
shopping. Most airlines provide their passengers with airline-sponsored
"in-flight" magazines, which are placed in airline seat pockets along with the
SkyMall catalog, as well as other magazines and periodicals. Many of the
in-flight magazines contain pages devoted exclusively to marketing products and
services. None of these in-flight magazines, however, is devoted solely to
shopping.
Video marketing is also conducted while passengers are in-flight in the
form of video promotions played on monitors located at the front of or
interspersed throughout passenger cabins and on seatback video displays. Video
marketing on the monitors frequently consists of various in-flight programming
that is prepared by the airline and sponsored by companies that are targeting
the favorable economic profiles of airline passengers. Much of the video
advertising included in this programming consists of image marketing; however,
some airlines, particularly on longer flights, make video shopping services
available to their passengers while in-flight. Seatback video screens that are
available to passengers on certain airlines offer movies, information,
entertainment and in-flight shopping. The Company believes that the current
quality of most seatback video screens does not make them the most effective
method of marketing products and services; however, as the quality of seatback
video screens improves, more shopping services will likely become available.
During 1996, pursuant to various nonexclusive agreements with certain of its
airline partners, the Company offered video shopping services on both video
monitors and seatback video displays on selected flights. Although video
shopping has not historically been a significant source of revenue for the
Company, the Company plans to take advantage of new opportunities in this market
when appropriate, including opportunities resulting from enhancements in the
quality of video monitors and systems. See "-- Growth Strategy."
On many international flights, airlines offer passengers duty-free
products while in-flight through their flight attendants who deliver the
merchandise to passengers at the time of purchase. Because airlines carry the
merchandise on the plane, the product selections are somewhat limited,
consisting principally of spirits, tobacco, perfume and gift items.
Of the various media employed by merchants to market goods and services
to airline passengers, the Company believes that the SkyMall catalog is among
the most effective, due in part to the increasing popularity of catalog shopping
in general. Over the past 15 years, consumers have increasingly relied on
catalogs and direct mail to purchase goods and services. According to the Direct
Marketing Association, 43.8% of the adult population in the United States
ordered merchandise from catalogs in 1996 generating approximately $46.0 billion
in consumer catalog sales. If current trends continue, the Company believes
in-flight catalog shopping will gain increasing acceptance by airline
passengers, particularly those who appreciate the time-saving convenience of
catalog shopping.
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CUSTOMER RELATIONSHIPS
The Company's primary target customers are frequent business travelers
with medium-to-high incomes. The Company's targeted customer spends
approximately $1,200 annually for merchandise while traveling. According to the
Company's market research, passengers who shop from the SkyMall catalog while
traveling do so because they have limited time to shop and the SkyMall catalog
offers a convenient alternative to shopping in retail stores. In addition, the
Company's research indicates that many customer purchases are "impulse"
purchases, as well as purchases for gifts. The key elements of the Company's
strategy to cater to the needs of its targeted customers are:
OFFER PREMIUM MERCHANDISE. The Company offers high-quality merchandise
from leading catalog and retail suppliers at competitive prices. The
Company maintains close working relationships with participating
merchants and carefully studies the buying patterns of its customers
to ensure that catalog space is devoted to products and services that
have proven appeal to the Company's customers. In order to enhance the
ongoing appeal of its product offerings, the Company produces four new
catalogs per year.
OFFER COMPETITIVE PRICING AND A FAIR PRICE GUARANTEE. SkyMall offers
its customers the convenience of in-flight shopping at prices that are
competitive with those of merchants offering the same or similar
products. To emphasize its competitive pricing strategy, SkyMall
offers its customers a fair price guarantee under which the Company
will refund the price difference to the customer if the customer finds
the same item advertised elsewhere at a lower price.
APPEAL TO A BROAD CONSUMER BASE. Airline travelers represent a diverse
cross-section of the public. Accordingly, the Company's catalogs are
designed to have a much broader appeal than most catalogs. The Company
offers a wide variety of products, including health and beauty aids,
children's toys, executive gifts, educational foreign language tapes,
gourmet cooking aids, exercise equipment, luggage, travel aids and
stylish home accessories. Many of the Company's products are luxury
items, which are particularly well-suited to the diverse demographics
of airline passengers who have higher than average disposable incomes.
PROVIDE CUSTOMERS WITH A CONVENIENT ONE-STOP SHOPPING SERVICE. SkyMall
is a "one-stop" shopping source for customers who may purchase a
variety of merchandise offered by many participating merchants with a
single phone call. Although most of the merchandise offered in the
SkyMall catalog is available from other catalog and retail companies,
each of these companies typically has its own policies with respect to
shipping and handling charges, merchandise returns, sales taxes and
price guarantees, and each company generally also has different
customer service hours and credit and payment policies. In addition,
few of these companies offer frequent flier credit for purchases. By
compiling the merchandise of its various participating merchants into
a single catalog, the Company affords its customers access to more
than 1,000 products offered by approximately 40 to 60 participating
merchants and the convenience of uniform customer service policies.
PROVIDE OUTSTANDING CUSTOMER SERVICE AND TOLL-FREE ORDERING. The
Company maintains an in-house staff of customer service
representatives who are trained to solve customer problems and who are
friendly and helpful with customers and knowledgeable about the
products sold by the Company. The Company's customer service
representatives encourage customers to purchase additional products
with each order to increase the Company's average revenue per order.
The Company believes that the customer goodwill developed by its
customer service representatives builds strong customer loyalty and
increases revenue from repeat and referral business. The Company also
offers services designed to maximize convenience to the traveler,
including 24-hour telephone and facsimile ordering, toll-free ordering
from airline seat phones and a 60-day "no questions asked" return or
exchange policy.
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AIRLINE RELATIONSHIPS
SkyMall has exclusive relationships with its airline partners, which
are a vital component of the Company's business strategy. The SkyMall program
offers airlines a low-risk means of incrementally increasing their earnings.
Since commencing operations in 1991, the Company has grown from a single airline
partner to 15 airline partners, including most of the major domestic airlines.
In exchange for placement of its catalogs in aircraft seat pockets, the Company
pays each airline partner a monthly commission based on net merchandise revenues
generated by the Company from sales to that airline's passengers. Some
agreements also require payment of a minimum monthly commission or a boarding
cost that reimburses the airline for the increased fuel costs attributable to
the weight of the catalogs. For fiscal 1996, minimum monthly commissions and
boarding costs paid by the Company to its airline partners totalled $2.5
million. In addition to increasing airline earnings, the Company's airline
partners also benefit from being able to enhance the in-flight experience of
their passengers by providing the Company's catalog as an additional amenity.
SkyMall's agreements with its airline partners generally have a term of at least
one year and thereafter are automatically renewable on an annual basis subject
to termination on 60 to 180 days' advance notice by either SkyMall or the
airline. SkyMall believes its relations with each of its airline partners are
good.
The SkyMall catalog is currently available or will soon become
available on all domestic and selected international flights of the following
air carriers:
1996 DOMESTIC
ENPLANEMENTS INITIAL
CARRIERS(1) (IN MILLIONS)(2) CATALOG(3)
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Delta 91.2 July 1991
United 71.1 June 1992
US Airways 55.4 July 1991
Southwest 55.4 July 1996
Continental 32.3 April 1991
TWA 21.5 Feb 1991
America West 17.8 Feb 1994
Alaska 11.8 July 1991
Reno Air 4.9 April 1997
Horizon 3.8 July 1991
Atlantic Southeast 3.6 July 1991
SkyWest 2.7 July 1991
Sun Country 2.3 Jan 1995
Midway 1.8 June 1994
Frontier 1.3 Sept 1995
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Total 376.9
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(1) The Company's catalog carries the SkyMall name on all participating airlines
except (a) United, where the Company's catalog carries the name "High Street
Emporium" and (b) US Airways, where the Company's catalog begins carrying the
name "Selections" effective April 1, 1997.
(2) Source: United States Department of Transportation.
(3) The Company's catalog has been available on these airlines continuously from
the date that the initial catalog was placed on the airline, except for US
Airways which suspended carrying the SkyMall catalog on July 1, 1996 but resumed
carrying the SkyMall catalog effective November 1, 1996.
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The following airline partners each accounted for in excess of 10% of
the Company's net merchandise sales for fiscal 1996:
% OF NET MERCHANDISE SALES
NAME OF AIRLINE THROUGH DECEMBER 31, 1996
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United 28%
Delta 25%
Continental 16%
US Airways 10%
---
Total 79%
===
MERCHANT RELATIONSHIPS
MERCHANT AGREEMENTS. The Company enters into agreements with merchants
who supply the products and services offered in the Company's catalog. Under its
contracts with participating merchants, the Company earns percentages of
revenues generated by the Company's sales or placement fees for inclusion of the
merchants' products in the SkyMall catalog or a combination thereof. In
addition, most participating merchants are required to reimburse the Company for
certain paper, printing and distribution costs to the extent they exceed certain
budgeted amounts. Participating merchants agree to maintain sufficient levels of
inventory to satisfy customer demand and to ship all orders within 72 hours
unless the merchandise is out of stock. Generally, the Company's agreements with
participating merchants provide that the prices of products included in the
SkyMall catalog will be honored by the merchant for as long as SkyMall receives
orders from that edition of the catalog. The agreements typically have an
initial term consisting of a single quarterly catalog and thereafter
automatically renew for successive catalog editions unless either the Company or
the merchant gives 60 days' advance notice of termination. The merchants
typically agree to indemnify the Company for any losses associated with injuries
caused to customers from the use of such merchant's product, to carry product
liability insurance that names SkyMall as an additional insured, and to
indemnify the Company against claims that their products infringe on the
intellectual property rights of third parties.
NAME BRAND STORES IN THE SKYMALL CATALOG. SkyMall's catalogs assemble
premium, name brand merchandise and are formatted to allow the traveling
customer to browse from "store-to-store," providing the convenience and variety
of an upscale shopping mall environment. Its largest "stores" are generally
well-known catalog and retail companies that have chosen to participate in the
SkyMall program in order to generate additional revenue, build name recognition
and brand awareness and acquire new customers to add to their own proprietary
mailing lists. The major catalog and retail companies currently featured in the
SkyMall catalog or those who have participated in recent editions of the catalog
include:
NAME BRAND STORES IN THE SKYMALL CATALOG
British Links Norm Thompson Solutions(R)
Brookstone(R) Orvis(R)
Calyx & Corrolla Official Airline Guide
Chef's Catalog(R) Paul Frederick MenStyle(TM)
Compaq Computer Pepperidge Farm(R)
Competitive Edge Golf(R) SelfCare(R)
Frontgate(R) Successories(R)
Hammacher Schlemmer Syber Vision(R)
Health Rider(R) The Cigar Enthusiast
Hello Direct(R) The Disney Catalog
Huntington Clothiers(R) The Metropolitan Museum of Art
Johnston & Murphy The Safety Zone
Mattel(R) The Sharper Image(R)
Neiman Marcus' Trifles The Wine Enthusiast(R)
Nightingale Conant Thomas Cook
MERCHANDISE SELECTION. The Company responds to inquiries from
approximately 50 merchants each week who inquire about showcasing their products
or services in the SkyMall catalog. As a result, the Company has been able to
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identify and offer to its customers the unique products they desire at
competitive prices. Products are selected for each catalog by the Company's
merchandising staff with the help of each of the major participating merchants.
Approximately one-third of the products in each new edition of the SkyMall
catalog have not been previously featured in the SkyMall catalog.
PRODUCTS OFFERED. The Company typically offers more than 1,000 products
in each of its catalogs, which consist of approximately 150 pages. In order to
enhance the ongoing appeal of its product offerings, the Company produces four
new catalogs per year and regularly replaces the products in its catalogs. The
Company seeks out new and unique items that may not be available in ordinary
retail stores, with an emphasis on upscale merchandise selling for $29.95 or
more. During fiscal 1996, the Company's more popular product categories included
household items, electronics, personal care items, clothing, multimedia items
and telephones.
GROWTH STRATEGY
INCREASE REVENUE PER PASSENGER. One of the Company's primary growth
strategies is to increase its revenue per passenger enplanement. The Company's
revenue per passenger enplanement on flights carrying the SkyMall catalog has
increased from $0.038 in 1991 to approximately $0.093 for the year ended
December 31, 1996, for a compound annual growth rate of 20%.To increase revenue
per passenger enplanement, the Company recently has implemented or plans to
implement the following programs:
MARKETING AND PROMOTIONAL PROGRAMS. The Company has developed several
innovative marketing and promotional programs, some of which will be
facilitated through the unique relationships between the Company and
its airline partners. Some of these programs are modeled after
successful "duty-free" in-flight sales programs offered on
international flights. Although the Company does not plan to offer
duty-free merchandise to airline passengers, it believes it can
emulate several of the marketing aspects of duty-free shopping to
increase sales of merchandise offered in the SkyMall catalog. The
Company believes that duty-free merchandising is successful for many
reasons, including: (i) there is a high level of awareness of
duty-free shopping among airline passengers, (ii) customers who
purchase duty-free merchandise perceive they are purchasing such
merchandise at a discount, (iii) the duty-free merchandise is offered
to passengers only while the plane is in flight and passengers must
therefore purchase merchandise while in flight to take advantage of
the perceived discount, (iv) flight attendants are paid commissions on
sales of merchandise and (v) duty-free shopping markets an optimal mix
of products, some of which encourage "impulse purchases" by
passengers.
Among the plans under consideration or recently implemented by the
Company to increase the use of SkyMall catalogs are: (i) enhancing
promotion of the Company's shopping services through on-board flight
attendant announcements supported by videotape and audio programming;
(ii) awarding airline passengers frequent flier miles for purchases
and permitting customers to redeem frequent flier miles as payment for
product purchases; (iii) mailing inserts in frequent flyer statements
in order to promote awareness of the Company's products and services;
(iv) offering airlines and flight attendants incentives for promoting
the use of the Company's catalogs among airline passengers; (v)
establishing an in-flight "video shopping channel" and advertisements
for the Company's products and services on in-flight videos; (vi)
conducting in-flight, gate and jetway promotions, such as gift
certificates, discount certificates and special offers to passengers
who order while in-flight; (vii) making the Company's catalogs
available in airport gate areas and lounges; and (viii) continually
upgrading and analyzing the appropriate mix of products for inclusion
in the SkyMall catalog to encourage passengers to make purchases. The
Company believes the foregoing programs will increase revenue per
passenger enplanement and will also increase the awareness of the
SkyMall catalog generally so that airline passengers will be more
likely to make purchases from the SkyMall catalog. However, there can
be no assurance that the Company will be able to successfully
implement the foregoing marketing programs, including those modeled
after successful duty-free programs and there can be no assurance that
the successful implementation of the foregoing programs will result in
an increase in the Company's revenue per passenger enplanement.
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VIDEO SHOPPING AND OTHER NEW TECHNOLOGIES. Several companies have
recently begun making interactive video systems available to the
airline industry that have greater capabilities than those currently
available. As more sophisticated interactive video systems become
available, the Company plans to explore opportunities to provide
shopping services on these systems and has developed a prototype,
multi-media catalog offering SkyMall products on interactive video. In
order to become proficient in this new medium, in January of 1996, the
Company began offering its products and services on the Internet at
http://www.skymall.com.
INCREASE CATALOG CIRCULATION. To expand its catalog circulation and
thereby increase its customer base, the Company has implemented or plans to
implement a number of programs designed to increase the circulation of the
SkyMall catalog and reach new customers, including the following:
EXPANDING DOMESTIC AIRLINE PARTNERSHIPS. The Company will seek to
expand its catalog circulation by securing agreements from additional
domestic airlines to carry the SkyMall catalog. In furtherance of this
strategy, the Company recently entered into an agreement with Reno
Airlines, which has annual passenger enplanements of approximately 5.0
million, pursuant to which Reno Airlines will begin carrying the
SkyMall catalog in April of 1997. In addition, the Company plans to
pursue opportunities to include a small selection of its products and
services in in-flight magazine inserts to give new airlines the
opportunity to test the Company's services and to make the Company's
products and services available on smaller airlines where a
full-length catalog is not cost effective. The Company recently
completed a test program in the in-flight magazine of Northwest
Airlines, which is not presently an airline partner of the Company.
DEVELOPING INTERNATIONAL AIRLINE PARTNERSHIPS. According to the Air
Transport Association, in 1995, the most recent period for which
information is available, there were over 780 million international
airline passenger enplanements (excluding the U.S.), including 373.9
million in Europe, 306.4 million in Asia and 71.5 million airline
passenger enplanements in North and South America. Although some
duty-free merchandise is available on international flights, the
Company believes that this market is substantially underserved. The
Company believes that controlled and carefully planned expansion into
the larger international markets through cooperative ventures with
potential foreign partners offers a significant growth opportunity.
The Company is in the process of evaluating potential foreign markets
and developing catalogs in foreign languages with products and
services designed to appeal to targeted international travelers.
Consistent with its growth strategy, SkyMall entered into an agreement
in August 1996 with its first foreign airline, Japan-based JAL, to
test certain merchandise from the SkyMall catalog on a trial basis.
The testing program on JAL is continuing and results of various
aspects of the program are currently under evaluation.
DIRECT MARKETING PROGRAM. Through its data management system, the
Company maintains a database of customer information, including
customer names, addresses and product purchases. From this database,
the Company obtains information about customer buying patterns and
preferences. The Company strives to develop customer loyalty, and
repeat customer purchases have been an increasing source of revenue
for the Company. In 1996, 29% of the Company's customers had placed at
least one additional order with the Company within the preceding 24
months. To increase the number of repeat customer purchases, the
Company is in the process of implementing a direct marketing
"mail-to-home" program to its customers, particularly those who make
several purchases during the year. Using information from its customer
database, the Company initiated its first direct marketing
"mail-to-home" program in August 1996. The Company plans to expand its
direct marketing efforts to selected customer groups and to tailor the
marketing materials to the preferences of those groups as demonstrated
by their prior purchasing history.
EXPANDING INTO OTHER TRAVEL RELATED MARKETS. The Company believes that
its shopping services will appeal to travelers in locations other than
airlines, such as in hotels and rental cars and while traveling by
rail. There are over three million hotel rooms in the United States,
providing a market that the Company believes could be larger than its
current airline market. In addition, rail passengers in both in the
United States and abroad may present a significant market for the
Company's services. In furtherance of this strategy, the Company
entered into an agreement with Amtrak in 1994 under which Amtrak began
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carrying the Company's catalogs under the TravelMall name on selected
routes, which serve approximately two million passengers annually. The
Company is considering a program to make its catalogs available to
travel agents to distribute to their customers when delivering travel
documents. The Company is evaluating other opportunities to reach
travelers, and plans to implement additional non-airline based travel
programs when appropriate.
BUSINESS OPERATIONS
CUSTOMER SERVICE CENTER; ORDER PROCESSING AND FULFILLMENT. The Company
maintains a well-trained, in-house staff of customer service representatives and
outsources "overflow" calls to an independent call center. The Company recently
entered into an agreement with a major hotel chain under which the hotel chain's
call processing center accepts the Company's overflow calls during the peak
holiday ordering season, which is typically a slower season for the hotel
industry. The Company believes this arrangement resulted in more cost-effective
processing of its overflow calls during the 1996 holiday peak. The Company
monitors the quality of its customer service operations closely and regularly
implements improvements in its customer service operations.
The Company's customer service representatives are located in its
customer service center in Phoenix, Arizona, where the Company accepts orders 24
hours per day. The Company's telephone equipment distributes calls to the sales
representatives and provides detailed call reporting and analysis, which assists
the Company with its order processing and marketing efforts. The Company
maintains no significant inventory. Therefore, once the Company receives a
customer order, it is transmitted to the appropriate merchant who ships the
merchandise directly to the Company's customers. Most orders are delivered to
customers within seven to ten days. The Company's average order size was $90,
$96 and $93, respectively, per customer in fiscal 1994, 1995 and 1996. The
Company's customer service representatives are given incentives for outstanding
service. At March 1, 1997, the Company employed approximately 140 customer
service representatives.
Over 85% of the Company's daily orders are received on "toll-free"
numbers, including 5% from toll-free seat phones. Airline seat phones offer
customers a convenient way to order goods and services from the Company while
in-flight. Some airline passengers who have access to seat phones may place
orders with the Company while in-flight by using a "speed dial" number
programmed into the seat phone. When SkyMall began operations in 1990, seat
phones were available to less than 5% of all domestic airline passengers. Today,
the Company estimates that seat phones are available to approximately 86% of all
domestic airline passengers. The Company believes that airlines will continue to
equip their planes with seat phones and that passengers will be more accustomed
to using them as they are made more available and the quality of service
continues to improve.
CREDIT SALES. Of the more than 438,000 customer orders received by the
Company during fiscal 1996, approximately 91% of them were billed to customer
credit cards. The remaining customers generally paid for their purchases by
personal check. To minimize credit losses, the Company obtains approval from the
customer's credit card company prior to processing each order. In addition, when
the customer requests that his or her merchandise be shipped to an address that
is different than the customer's billing address, the Company typically verifies
the charge authorization directly with the credit card holder at his or her
billing address. The Company verifies personal bank checks received from
customers with an independent service bureau prior to processing the customer's
order. Although the Company's credit losses are generally immaterial, under its
agreements with participating merchants, the Company has the right to obtain
reimbursement from the merchants for any reasonable credit losses it incurs.
INFORMATION SYSTEMS. The Company maintains an information system that is
used primarily to capture and process customer orders. The Company typically
receives approximately 2,000 calls per day in off-peak seasons and approximately
6,000 calls per day during the peak of the holiday season. The Company's
information system is designed to process approximately 10,000 calls per day,
and at times during the holiday season of 1996 the call center received more
than 10,000 calls per day, which strained the Company's call center. The Company
plans to expand the capacity of its call center during 1997, including to the
extent feasible expanding its outsourced call processing program, to satisfy
increasing customer demand during the year and at the peak of the holiday
season.
8
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Once the Company processes an order in its information system, the order
is forwarded to a merchant to be filled. Until recently, the Company transmitted
approximately half of all orders to merchants electronically through various
electronic data transmission systems maintained by the merchants, and the
remaining orders were sent by facsimile or overnight delivery. In late 1996, the
Company began implementation of a uniform electronic transmission system that
allows the Company to transmit customer orders to merchants electronically,
which the Company believes will reduce delivery times to the Company's
customers. Under the recently implemented system, orders received through the
Company's information system are forwarded to a third party, the LitleNet Direct
Commerce Network(SM) (the "Network"), for further processing. The Network is in
the process of developing a system that will electronically deliver order
information to the merchants in a form that is compatible with each such
merchant's information systems. In addition, the Network will manage order
information relationships and enable shipment confirmation according to
individual merchant capabilities. The Company contracts for access to the
Network on a per transaction basis, permitting the Company to expand its
information systems without additional infrastructure development, maintenance
and upgrade expense. Currently, approximately 30% of the Company's participating
merchants receive orders via the Network, with plans to have most merchants
on-line through the Network by mid-1997.
CATALOG PRODUCTION AND DISTRIBUTION. Catalog design and layout for each
section of SkyMall's catalog is generally provided directly by the participating
merchant but must be within SkyMall's design guidelines. After the catalog is
designed, the Company submits its catalog to each of its airline partners for
approval. The cover and some of the pages of the airline catalogs are customized
to achieve a look and feel unique to that airline, although the products
featured and the balance of the basic content are common to all of the Company's
catalogs. After the catalogs are printed, the Company ships the catalogs to its
airline partners who distribute the catalogs to the cities in which they operate
and place the catalogs on their aircraft. Each catalog has a source code that
permits the Company to track catalog distribution and sales attributable to
catalogs carried by its airline's partners.
HOUSE FILE
The Company maintains a customer database or "house file" that contains
a variety of information about the more than one million customers who have
purchased merchandise or services from the Company. In addition to the
customer's name and address, the Company's house file also contains a detailed
history of all purchases made by SkyMall's customers with SkyMall. This
information serves as a useful tool for the Company in evaluating the
effectiveness of its marketing efforts and in identifying its best customers.
Like other catalog companies, the Company "rents" its house file to other
catalog, retail and direct marketing companies for a fee. By renting its house
file, the Company is able to generate additional incremental revenues without
incurring significant costs. The Company updates its house file on a daily basis
as orders are received, which increases the value of the house file. In
addition, in connection with its growth strategy, the Company plans to implement
a direct marketing "mail-to-home" program to certain targeted customers and will
use its house file as the primary source of information for implementing the
mail-to-home program.
Direct marketing, credit card and other companies that have large
databases containing customer information have begun sharing database
information in order to obtain more detailed information about customers.
Enhancements in computer technology have made storing large amounts of data more
feasible and cost effective, and have permitted such companies to accumulate
more information about customer buying patterns and preferences. This
information has become increasingly important to companies that seek to
cost-effectively target customers and improve customer response rates. The
Company plans to explore opportunities to combine its house files with the files
of other companies when appropriate to improve its direct marketing efforts and
increase the value of its customer database.
9
<PAGE>
COMPETITION
IN-FLIGHT SHOPPING. SkyMall believes that its long standing
relationships with its airline partners and participating merchants and its
customer service standards create substantial barriers to entry into the
in-flight catalog shopping business. Although several companies have attempted
to enter the in-flight catalog shopping market, none has been successful in
providing a shopping catalog to a major domestic airline. Nevertheless,
competitors, some of which may have greater financial, marketing and other
resources than the Company, may seek to enter the in-flight catalog shopping
market in competition with the Company.
IN-FLIGHT MARKETING. The Company competes with other companies who
market products and services to passengers while in-flight, including those who
advertise in in-flight magazines and other periodicals, sponsor airline video
and audio programming and offer in-flight video shopping services. Several
companies have announced plans to develop seatback interactive video shopping
services, each of which has greater resources than the Company. As seatback
interactive video shopping services become more available to airline passengers,
competition in the in-flight marketing business may increase.
GENERAL CATALOG AND RETAIL SALES. The catalog sales and retail markets
are both highly fragmented and highly competitive. The Company competes for
customers to some degree with all retailers and catalog companies, including
airport retailers, duty-free retailers, specialty stores, department stores,
specialty catalog companies and general merchandise catalog companies, many of
which have significantly greater financial, marketing and other resources than
the Company. However, because many of the Company's competitors target people
with strong economic profiles, a number of the Company's competitors are also
participants in the SkyMall catalog program.
REGULATION
The Company's operations are subject to various federal, state and local
laws and regulations, including state sales tax laws and various Federal Trade
Commission regulations governing the sale of merchandise by mail. The Company
collects applicable sales taxes from its customers on all merchandise sales and
remits the sales taxes to state taxing authorities. The Federal Trade Commission
regulations applicable to the Company's operations impose various requirements
on the processing of customer orders, including shipping deadlines, delay
notices, order cancellations and refunds. The Company believes that these
regulations do not have a material impact on its business operations.
EMPLOYEES
At March 1, 1996, the Company had 180 employees, including 6 employed in
management positions, 17 in sales and marketing, 17 in accounting,
administrative and information management positions and 140 in customer service
capacities. Approximately 90% of the Company's employees are full-time
employees. The Company makes significant use of temporary and part-time
employees to process orders during the holiday season. The Company believes it
has good relations with its employees.
TRADEMARKS AND TRADE NAMES
SkyMall is a registered trademark of the Company. The loss of the
SkyMall trademark could have a material adverse effect on the Company. In
addition, the Company uses a number of other trademarks and trade names in its
business, none of which the Company believes are material to its overall
operations.
ITEM 2. PROPERTIES
The Company's executive offices are located in Phoenix, Arizona, where
the Company leases approximately seven acres of land under long-term leases
expiring in 2012, with an option to extend to 2062. Aggregate annual rental
expense on this land is approximately $37,000 per year. The improvements to this
land include offices, warehouses, storage facilities and a small retail shopping
center aggregating approximately 50,000 square feet, which are owned by the
Company. In December of 1996, the Company entered into an agreement to sell
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the small retail shopping center, which consists of approximately 12,000 square
feet. The sale of the shopping center is subject to customary closing
conditions. In January of 1997, the Company refinanced certain debt and, in
connection with such refinancing, granted to its lender a security interest in
substantially all of the foregoing property, except the small retail shopping
center. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations - Liquidity."
ITEM 3. LEGAL PROCEEDINGS
The Company is not a party to any pending or threatened legal
proceedings that it believes will have a material impact on the Company's
business.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On October 11, 1996, prior to the Company's initial public offering, the
shareholders of the Company approved the reincorporation of the Company from
Arizona to Nevada by unanimous written consent.
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS
The Company's Common Stock is traded on the Nasdaq National Market under
the symbol "SKYM". The high and low sales prices of the Company's Common Stock
from December 11, 1996 (the date of the Company's initial public offering)
through December 31, 1996 were $9.25 and $8.00, respectively. As of March 19,
1997, the Company had 76 record holders of its Common Stock.
The Company has never paid a dividend on its Common Stock and does not
anticipate paying dividends on its Common Stock in the foreseeable future. It is
the current policy of the Company's Board of Directors to retain any earnings to
finance operations and expand the Company's business. The payment of future
dividends is within the discretion of the Board of Directors and will depend
upon the Company's future earnings, if any, its capital requirements, financial
condition and other relevant factors.
ITEM 6. SELECTED FINANCIAL DATA
SELECTED FINANCIAL AND OPERATING DATA
(IN THOUSANDS, EXCEPT SHARE, PER SHARE AND OPERATING DATA)
The selected financial data as of and for the years ended December 31,
1992, 1993, 1994, 1995 and 1996 are derived from the Financial Statements of the
Company, which have been audited by Arthur Andersen LLP, independent public
accountants, and should be read in conjunction with the Financial Statements
included elsewhere in this Form 10-K and the related notes thereto and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------------------------------------------------
1992 1993 1994 1995 1996
----------- ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Merchandise sales, net $ 15,875 $ 24,507 $ 22,062 $ 26,883 $ 30,978
Placement fees and other 178 2,560 8,241 16,198 12,707
----------- ----------- ----------- ---------- -----------
Total revenues 16,053 27,067 30,303 43,081 43,685
Cost of goods sold 10,364 13,691 16,266 24,564 24,257
----------- ----------- ----------- ---------- -----------
Gross margin 5,689 13,376 14,037 18,517 19,428
Catalog expenses 4,071 6,890 9,644 9,532 7,670
Selling expenses 2,116 2,921 2,754 2,229 2,476
Customer service and fulfillment expenses 3,618 4,514 2,919 2,136 2,823
General and administrative expenses 4,784 4,530 5,886 3,112 3,340
Restructure charges -- -- 4,332 -- --
----------- ----------- ----------- ---------- -----------
Total operating expenses 14,589 18,855 25,535 17,009 16,309
</TABLE>
11
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<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------------------------------------------------
1992 1993 1994 1995 1996
------------ ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C>
Interest expense and other income
(expense), net (740) (287) (688) (750) (651)
------------ ------------ ------------ ------------ ------------
Income (loss) before income taxes (9,640) (5,766) (12,186) 758 2,468
Income taxes -- -- -- -- 280
------------ ------------ ------------ ------------ ------------
Net income (loss) (9,640) (5,766) (12,186) 758 2,188
Preferred stock dividends -- -- -- -- 77
------------ ------------ ------------ ------------ ------------
Net income (loss) available for common
shares $ (9,640) $ (5,766) $ (12,186) $ 758 $ 2,111
============ ============ ============ ============ ============
Net income (loss) per common share $ (2.04) $ (1.69) $ (3.43) $ .14 $ .38
Weighted average shares outstanding 4,729,380 3,413,073 3,557,787 5,431,337 5,611,913
SELECTED OPERATING DATA:
Number of domestic enplanements(1) 436,310,000 448,647,000 481,755,000 498,611,000 530,661,000
Domestic enplanement percentage(2) 74% 76% 72% 64% 63%
Revenue per passenger enplanement(3) $ 0.049 $ 0.072 $ 0.064 $ 0.084 $ 0.093
Number of airlines at end of period(4) 11 15 21 20 15
Number of catalogs produced(5) 11,915,000 15,661,000 15,747,000 17,162,000 15,729,000
Average number of pages per catalog(6) 80 102 133 137 148
Revenue per catalog produced(7) $ 1.33 $ 1.56 $ 1.40 $ 1.57 $ 1.97
DECEMBER 31,
--------------------------------------------------------------------------
1992 1993 1994 1995 1996
------------ ------------ ------------- ------------ ------------
BALANCE SHEET DATA:
Cash and cash equivalents, including
escrow accounts $ 1,797 $ 171 $ 896 $ 775 $ 11,491
Working capital (deficit) (1,506) (3,580) (7,540) (4,734) 6,692
Total assets 8,757 10,394 5,913 4,726 19,721
Long-term debt 40 2,978 8,082 10,818 139
Shareholders' equity (deficit) $ 1,941 $ (3,603) $ (15,791) $ (15,033) $ 8,601
</TABLE>
- ----------
(1) Represents the number of revenue passengers flown on scheduled domestic
airlines in the given period.
(2) Represents the passenger enplanements on domestic airlines that carried the
SkyMall catalog during the period as a percentage of total domestic
passenger enplanements in the period by all scheduled domestic airlines.
(3) Revenue per passenger enplanement is net merchandise sales for the period
divided by the number of domestic enplanements during the period on all
scheduled domestic airlines that carried the SkyMall catalog.
(4) Represents the number of airlines at end of period with which the Company
had an agreement to carry the SkyMall catalog. During the year ended
December 31, 1996, the Company eliminated unprofitable circulation of the
SkyMall catalog by eliminating routes on certain airlines and terminating
agreements with certain smaller regional airlines. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations."
(5) Represents the number of catalogs produced by the Company during the period
for distribution to airlines.
(6) Represents the average number of pages in the SkyMall catalog during the
period.
(7) Represents net merchandise sales for the period divided by the number of
catalogs produced by the Company during the period.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The Company commenced operations in late 1990 with an initial business
strategy of establishing exclusive relationships with major United States
airlines, delivering merchandise ordered by passengers at the airport upon
landing and offering concierge services. In 1991, the Company acquired its only
major competitor, which resulted in the addition of five new airline partners
for the Company. Since its first full year of operations in 1991, the Company
has experienced rapid growth. From 1991 to 1994, the Company devoted its
resources to increasing revenue per passenger enplanement and expanding
circulation of the SkyMall catalog. During this period, the Company gained
market share by acquiring exclusive contracts with airline partners, developing
12
<PAGE>
relationships with participating merchants and gaining knowledge about its
consumer market. Total revenue increased from $5.4 million in 1991 to $30.3
million in 1994 and revenue per passenger enplanement grew from $0.038 to $0.064
in the same period.
In late 1994, management focused its emphasis on translating the
Company's growth into profitability. Beginning in late 1994, the Company
implemented increases in placement fees charged to participating merchants for
inclusion of their merchandise in the SkyMall catalog. As a result of these
increases, placement fees and other revenues increased from $2.6 million in
fiscal 1993 to $16.2 million in fiscal 1995. During late 1994, the Company also
simplified its business strategy by outsourcing its merchandise fulfillment
operations to participating merchants. Through its market research and
experience, the Company determined that while customers valued the convenience
of in-flight shopping, most passengers preferred delivery at home rather than at
the airport. Although airport delivery and concierge services were essential in
attracting new airline partners to the program, they were no longer necessary to
maintain the Company's airline relationships. Accordingly, the Company
discontinued its airport delivery service and began its current practice of
forwarding merchandise orders to participating merchants for fulfillment. Thus,
the Company no longer maintains any significant inventory and has eliminated
from its business operations the costs and risks associated with managing
inventory and a complex airport delivery system. The Company also began
significantly reducing its operating expenses in late 1994, including
outsourcing its concierge operation, reducing its work force, requiring
merchants to provide their own creative catalog materials and eliminating
unprofitable circulation. These actions substantially reduced the Company's
operating costs, from $25.5 million in fiscal 1994 (including a $4.3 million
restructure charge) to $17.0 million in fiscal 1995 and $16.3 million in fiscal
1996. As a result of these changes in placement fees and operating expenses, the
Company's results of operations improved from a net loss of $12.2 million in
fiscal 1994 to $0.8 million net income in fiscal 1995 and $2.2 million net
income in fiscal 1996.
In fiscal 1996, the Company's principal sources of revenues were
merchandise sales (71% of total revenues) and placement fees from participating
merchants (28% of total revenues). The Company also rented its customer database
to direct marketing companies (1% of total revenues), which was included in
placement fees and other revenues in the Company's statement of operations.
Merchandise sales represent the Company's total fulfilled sales at retail sales
prices, net of returns and allowances, from products displayed in the Company's
catalog. Placement fees are charged to participating merchants for inclusion of
their merchandise in the SkyMall catalog. These fees are designed to cover
catalog expenses and to stabilize the Company's revenues by reducing the impact
of fluctuations in merchandise sales. In exchange for placement fees, the
Company offers the participating merchants' products in the Company's catalogs
and performs order taking and processing services. The placement fees are
recognized ratably over the life of the catalog (currently quarterly). Order
taking and processing service expenses are recognized in the period incurred.
Customers place their orders by telephone, mail, e-mail or facsimile
to the Company's call center. The Company forwards customers' order information
to participating merchants who then ship products directly to the Company's
customers. Upon notification from a participating merchant of the shipment of
goods, the Company recognizes the merchandise sale and the related cost of goods
sold, and establishes a reserve for anticipated returns. The cost of goods sold
represents the amount paid by the Company to participating merchants in
connection with the sale of merchandise included in the SkyMall catalog. The
percentage of sales that the Company pays to participating merchants varies from
agreement to agreement; generally, the higher the placement fee paid by a
participating merchant, the higher percentage of sales paid by the Company to
the merchant, and vice versa. The Company believes that a combination of
placement fees with a variable percentage of sales component, together with the
payment of sales commissions to its airline partners, creates a situation in
which SkyMall, participating merchants and the airlines all benefit from and
have incentives to promote growth in merchandise sales.
The Company's major costs include costs of goods sold; catalog
expenses, which include paper, printing and catalog production costs; selling
expenses, which are primarily sales commissions to airlines and airline fuel
reimbursement costs; customer service and fulfillment costs, which include a
full-service call center and a drop-ship and order-processing coordination
center; and general and administrative expenses, which include corporate
salaries, employee benefits, facilities, legal and accounting expenses.
13
<PAGE>
RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, the
percentage relationships that certain items bear in relation to total revenues
of the Company.
YEAR ENDED DECEMBER 31,
------------------------
1994 1995 1996
---- ---- ----
Net merchandise sales 73% 62% 71%
Placement fees and other 27% 38% 29%
--- --- ---
Total revenues 100% 100% 100%
--- --- ---
Gross margin 46% 43% 44%
--- --- ---
Catalog expenses 32% 22% 18%
Selling expenses 9% 5% 6%
Customer service and fulfillment expense 10% 5% 6%
General and administrative expenses 19% 7% 8%
FISCAL YEAR ENDED DECEMBER 31, 1996 COMPARED TO THE FISCAL YEAR ENDED
DECEMBER 31, 1995
REVENUE AND GROSS MARGIN. Net merchandise sales increased from $26.9
million in fiscal 1995 to $31.0 million in fiscal 1996, or 15%. Placement fees
and other revenues decreased from $16.2 million in fiscal 1995 to $12.7 million
in fiscal 1996, or 22%. Beginning in the first quarter of fiscal 1996, the
Company began changing the mix of agreements with participating merchants to
reduce placement fees and to increase the percentages of sales revenues retained
by the Company in order to position the Company to benefit from anticipated
sales increases in the fourth quarter. In addition, a significant participating
merchant, which had previously paid only placement fees to the Company,
decreased its number of pages in the SkyMall catalog. SkyMall replaced the
merchant on these pages with new participating merchants, most of which had
arrangements with lower placement fees and a significantly higher percentage of
sales retained by the Company. As a result, due to the change in sales mix,
gross margin as a percentage of total revenues increased from 43% in fiscal 1995
to 44% in fiscal 1996.
OPERATING EXPENSES. Total operating expenses decreased from $17.0
million in fiscal 1995 to $16.3 million in fiscal 1996, or 4%, due primarily to
a $1.9 million reduction in catalog expenses. This reduction resulted from
elimination of unprofitable circulation of the SkyMall catalog by eliminating
routes on certain airlines and terminating agreements with certain regional
airlines and lower pricing on the Company's printing contract. As a result of
the elimination of unprofitable circulation and increased net merchandise sales,
revenue per catalog increased from $1.57 in fiscal 1995 to $1.97 in fiscal 1996,
or 25%. The reduction in catalog expenses was offset by increases of $0.3
million, $0.7 million and $0.2 million in selling expenses, customer service and
fulfillment expenses, and general and administrative expenses, respectively.
INCOME FROM OPERATIONS. Income from operations increased from $1.5
million in fiscal 1995 to $3.1 million in fiscal 1996, primarily due to the $0.7
million reduction in the Company's total operating expenses, and the $0.9
million increase in gross margin.
INCOME TAXES. Prior to October 21, 1996, the Company had elected to be
taxed under Subchapter S of the Internal Revenue Code and corresponding
provisions of Arizona tax laws. As a result of the election, federal and state
income taxes on the net income of the Company were payable personally by the
shareholders. Accordingly, the statements of income for all prior years do not
include a provision for federal and state income taxes. Had the Company been a C
corporation for these periods, no federal or state income taxes would have been
due as a result of net operating loss carry-forwards from the earlier years. In
the fourth quarter of fiscal 1996 and thereafter, the Company became subject to
14
<PAGE>
federal and state income taxes as a result of its conversion from an S
corporation to a C corporation and no net operating losses incurred while the
Company was an S corporation are available to the Company to offset future
earnings. As a result of the change from an S corporation to a C corporation,
the Company recorded a provision for income taxes of $280,000 in fiscal 1996.
FISCAL YEAR ENDED DECEMBER 31, 1995 COMPARED TO FISCAL YEAR ENDED DECEMBER 31,
1994
REVENUE AND GROSS MARGIN. Net merchandise sales increased from $22.1
million in 1994 to $26.9 million in fiscal 1995, or 22%, due primarily to better
fulfillment of orders in 1995. Due to a lack of working capital in 1994 and
certain order fulfillment problems due to a computer conversion, the Company was
unable to purchase adequate inventory to fulfill many orders. With restructured
operations in place in 1995, order fulfillment percentages returned to normal
levels, which are approximately 90% of all orders received by the Company.
Placement fees and other revenues also increased from $8.2 million in fiscal
1994 to $16.2 million in fiscal 1995, or 98%, due primarily to the Company's
decision in late 1994, effective for the fourth quarter 1994 catalog, to change
its revenue mix to emphasize placement fees, which provide a more stable revenue
base. Gross margin as a percentage of total revenues decreased from 46% to 43%
due to higher total revenues which were the result of the shift to higher
placement fees and a higher cost of sales under its agreements with
participating merchants.
OPERATING EXPENSES. Total operating expenses, exclusive of the Company's
one-time restructure charge, decreased from $21.2 million in fiscal 1994 to
$17.0 million in fiscal 1995, or 20%. This decrease was due principally to the
Company's implementation of cost containment initiatives beginning in the fourth
quarter of fiscal 1994. Catalog costs decreased 1% from $9.6 million in fiscal
1994 to $9.5 million in fiscal 1995. Despite a 48% increase in average paper
prices and a 12% increase in pages printed, the Company realized offsetting cost
reductions from requiring participating merchants to provide their own creative
materials, lower printing prices and the elimination of fees that had been paid
by the Company to some merchants to participate in the program. Although net
merchandise sales increased substantially, selling expenses decreased by 21%
from $2.8 million in fiscal 1994 to $2.2 million in fiscal 1995 because SkyMall
began to require merchants to reimburse SkyMall for credit card processing
expenses. Likewise, customer service and fulfillment expenses decreased by 28%
from $2.9 million in fiscal 1994 to $2.1 million in fiscal 1995 due to the
Company's decision in the fourth quarter of 1994 to require participating
merchants to drop ship merchandise to the Company's customers rather than
maintain its own inventory. General and administrative expenses decreased by 47%
from $5.9 million in fiscal 1994 to $3.1 million in fiscal 1995. In connection
with the Company's 1994 restructuring, personnel in merchandise fulfillment
operations, merchandising, purchasing and concierge services were eliminated,
saving the Company nearly $1.0 million in payroll expenses. The Company closed
its fulfillment operations in seven cities which resulted in savings of $0.4
million in facilities expenses. Administrative expenses decreased by $0.8
million from fiscal 1994 to fiscal 1995 due to simplification of the business
and a reduction in professional fees.
RESTRUCTURE CHARGE. In 1994, the Company incurred a one-time charge of
$4.3 million relating to the restructure of the business. The costs associated
with the restructure included:
(i) Losses on a long-term major vendor contract ($3.6 million).
In September 1994, the Company entered into a series of contracts with
a participating merchant. The contractual arrangements provided the
working capital which allowed the Company to continue operations, but
is estimated to cost the Company approximately $3.6 million between
September 1994 and mid-1997 when this contract is expected to expire.
(ii) Abandoned facilities and equipment ($1.0 million). The
Company abandoned leasehold improvements and equipment in its
merchandise fulfillment operations requiring the Company to write-off
assets that would no longer be used in the business. The Company also
had long-term lease commitments for two warehouse facilities which the
Company continued to pay in fiscal 1995 and fiscal 1996 for which the
associated loss was recorded in fiscal 1994.
(iii) Uncollectible accounts receivable ($0.8 million). Many
receivables from pre-restructure placement fees, which would have been
offset against inventory purchases, became uncollectible after the
restructure.
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(iv) Severance and outsourcing expenses ($0.2 million). The
Company incurred severance costs as part of the reductions in its
workforce. The Company also paid a one-time fee to outsource its
concierge services.
The foregoing costs were partially offset by a benefit of $1.3 million
in debt forgiveness from participating merchants and vendors.
INCOME (LOSS) FROM OPERATIONS. The Company earned income from
operations of $1.5 million in fiscal 1995 compared to a loss from operations of
$11.5 million in fiscal 1994. This improvement was due primarily to the positive
impact in 1995 of the 1994 restructure, the effect of implementation of cost
containment measures in late 1994 and the recognition of the restructure charge
in fiscal 1994.
LIQUIDITY AND CAPITAL RESOURCES
While the Company was developing and executing its original
inventory-based business plan from start-up to late 1994, the Company had a
significant need for capital to fund investment in facilities and equipment,
inventory, working capital and start-up operating losses. At December 31, 1994,
the Company had an accumulated deficit of $34.2 million and a working capital
deficit of $7.5 million. During this period, the Company's primary sources of
cash included debt and equity financing from shareholders, a bank loan
guaranteed by a shareholder, credit from suppliers and cash flow from
operations. The Company also financed its operations through the restructure and
deferral of accounts payable in connection with the Company's 1994 restructure.
In fiscal 1995 and fiscal 1996, the Company's principal requirements
for cash were to fund working capital needs and to pay debt obligations to
vendors. The Company no longer needed significant capital to fund inventory and
warehouse facilities. The Company's primary sources of cash during this period
were cash flow from operations, vendor credit supported by shareholder
guarantees, and loans from shareholders. Cash flow from operations was
sufficient to fund operating expenses, but was not adequate to also fund debt
service to vendors relating to the 1994 restructure. The Company made its debt
payments to vendors in 1995 but became delinquent in 1996. In order to finance
its working capital shortfalls, management and certain shareholders took steps
to strengthen the Company's financial condition and improve the Company's
liquidity. These steps included (i) issuing approximately $2.6 million of
Convertible Preferred Stock, net of offering costs, the proceeds of which were
used to pay past due debts and notes payable to vendors, (ii) converting notes
and other obligations to shareholders of $5.0 million to 5,000 shares of
Convertible Preferred Stock and (iii) issuing approximately $14.0 million of
common stock in an initial public offering, net of offering costs. The
Convertible Preferred Stock automatically converted into Common Stock of the
Company upon completion of its initial public offering.
In October 1996, the Company obtained a line of credit from a bank in
the amount of $4.0 million. The proceeds of this line were used to repay notes
payable to shareholders. In January of 1997, the Company terminated the
foregoing line of credit and obtained a $5.0 million five year, reducing
revolving line of credit from a bank. Available borrowings reduce by $1 million
annually, until February 2002, when the line expires. Advances made on the line
bear interest at either Prime or LIBOR, at the option of the Company, and at
rates ranging from Prime to Prime plus 1.5 percent, or LIBOR plus 2.25 percent
to LIBOR plus 3.25 percent, depending on certain financial ratios at the time of
advance. The line is collateralized by substantially all assets of the Company,
and contains convenants that require maintenance of certain financial ratios.
The Company believes it will generate sufficient cash flow from
operations to adequately fund its operations over the next twelve months and
liquidate its remaining notes payable to vendors and other liabilities as they
come due. Additionally, management believes that the working capital provided by
the offering of Common Stock will allow the Company to further reduce its
operating costs by taking advantage of trade discounts.
Cash provided by (used for) operating activities was ($2.2) million,
$1.1 million and $2.2 million in fiscal 1994, 1995 and 1996, respectively. The
improvement in fiscal 1995 compared to fiscal 1994 was due primarily to higher
placement fees and lower operating costs resulting from the 1994 restructure and
continuing cost reduction activities thereafter. The improvement in fiscal 1996
compared to fiscal 1995 was due primarily to cost reduction activities.
16
<PAGE>
Cash used for investing activities was $0.4 million, $0.2 million, and
$0.4 million in fiscal 1994, 1995 and 1996, respectively. These investments were
primarily for computer and telecommunications equipment and furniture and
fixtures.
Cash provided by (used for) financing activities was $3.3 million,
$(1.0) million and $9.0 million in fiscal years 1994, 1995 and 1996,
respectively. Cash provided of $3.3 million in 1994 was primarily from $3.0
million in loans from shareholders. Cash used for financing activities of $1.0
million for fiscal 1995 resulted from approximately $2.2 million in payments on
notes payable to vendors which was partially offset by loans and accrued
interest of $1.2 million provided by shareholders. Cash provided of $9.0 million
in 1996 was from $14.0 million in proceeds from the issuance of Common Stock and
$2.5 million in proceeds from the issuance of Convertible Preferred Stock, which
was offset by payments on notes payable of $7.5 million.
FLUCTUATIONS IN QUARTERLY RESULTS
The Company's operating results may fluctuate from period to period as
a result of the seasonal nature of the retail industry. The Company recognizes
its highest sales levels during the fourth quarter holiday season, and the
fourth quarter typically accounts for approximately 33% of the Company's annual
merchandise sales.
The following table sets forth certain unaudited information about the
Company's revenue and results of operations on a quarterly basis for 1995 and
1996.
<TABLE>
<CAPTION>
YEAR ENDED YEAR ENDED
DECEMBER 31, 1995 DECEMBER 31, 1996
------------------------------------- -------------------------------------
1ST QTR 2ND QTR 3RD QTR 4TH QTR 1ST QTR 2ND QTR 3RD QTR 4TH QTR
------- ------- ------- ------- ------- ------- ------- -------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Merchandise sales, net $6,299 $5,956 $6,123 $8,504 $5,882 $6,550 $6,474 $12,072
Placement fees and other 4,466 3,829 3,609 4,294 3,073 2,720 2,838 4,076
------ ------ ------ ------ ------ ------ ------ -------
Total revenues 10,765 9,785 9,732 12,798 8,955 9,270 9,312 16,148
------ ------ ------ ------ ------ ------ ------ -------
Gross Margin 4,958 3,982 4,242 5,334 4,259 4,414 4,139 6,616
------ ------ ------ ------ ------ ------ ------ -------
Catalog expense 2,336 2,397 2,310 2,489 2,151 1,828 1,726 1,965
Selling expenses 514 534 546 635 514 620 531 811
Customer service and
fulfillment 526 495 513 602 457 515 539 1,312
General and administrative 887 702 718 804 753 695 842 1,050
------ ------ ------ ------ ------ ------ ------ -------
Total operating expenses $4,263 $4,128 $4,087 $4,530 $3,875 $3,658 $3,638 $ 5,138
====== ====== ====== ====== ====== ====== ====== =======
</TABLE>
NET OPERATING LOSSES IN SUB S CORPORATION - CONVERSION TO C CORPORATION FOR TAX
PURPOSES
Prior to October 21, 1996, the Company had elected to be taxed under
Subchapter S of the Internal Revenue Code and corresponding provisions of
Arizona tax laws. As a result of the election, federal and state income taxes on
the net income of the Company were payable personally by the shareholders.
Accordingly, the statements of income for all prior years do not include a
provision for federal and state income taxes. Had the Company been a C
corporation for these periods, no federal or state income taxes would have been
due as a result of net operating loss carry-forwards from the earlier years. In
the fourth quarter of fiscal 1996 and thereafter, the Company became subject to
federal and state income taxes as a result of its conversion from an S
corporation to a C corporation and no net operating losses incurred while the
Company was an S corporation are available to the Company to offset future
earnings.
17
<PAGE>
RECENTLY ISSUED ACCOUNTING STANDARDS
The Company accounts for its stock-based compensation plans under
Accounting Principles Board Opinion No. 25, (APB No. 25), under which no
compensation cost has been recognized. In October 1995, the Financial Accounting
Standards Board issued Statement of Financial Accounting Standards No. 123,
"Accounting for Stock-based Compensation" (SFAS No. 123). SFAS No. 123 requires
that companies that account for stock-based compensation as prescribed by APB
No. 25 and disclose the pro forma effects on earnings and earnings per share as
if SFAS No. 123 had been adopted, in addition to certain other disclosures with
respect to stock compensation and the assumptions used to determine the pro
forma effects of SFAS No. 123. As the Company has adopted the "disclosure only"
provisions of SFAS No. 123, there is no impact on results of operations as a
result of the adoption of this standard.
INFLATION
Management does not believe that inflation has had a material effect on
the Company's operations during the past several years with the exception of
unusually significant increases in paper prices in 1995 and the first six months
of 1996 and a subsequent significant decrease in the third and fourth quarters
of 1996. The Company's average paper price increased 48% from fiscal 1994 to
fiscal 1995 from $38.91 cwt to $57.61 cwt, costing the Company an additional
$1.7 million in 1995 compared to costs at 1994 prices. The average paper price
decreased from $57.61 cwt in fiscal 1995 to $55.40 in fiscal 1996 as a result of
a decrease in the cost of paper purchased for the fourth quarter of 1996 to
$42.13 cwt, which is only 8% higher than the 1994 level. The Company's paper
costs are expected to be approximately $40.00 cwt in the first quarter of 1997.
Increases in labor, aircraft fuel, paper, printing, shipping, or merchandise
costs could adversely affect the Company's operations. In the past, except for
paper price increases, the Company has been able to modify its operating
procedures or increase its prices to substantially offset increases in its
costs.
FORWARD-LOOKING STATEMENTS AND ASSOCIATED RISK
Certain statements herein, in future filings by the Company with the
Securities and Exchange Commission and in the Company's written and oral
statements made by or with the approval of an authorized executive officer
constitute "forward-looking statements" within the meaning of Section 27A of the
Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934,
and the Company intends that such forward-looking statements be subject to the
safe harbors created thereby. The words and phrases "should be," "will be,"
"believes," "expects," "anticipates," "plans," "intends" and similar expressions
identify forward-looking statements. These forward looking statements reflect
the Company's current views with respect to future events and financial
performance, but are subject to many uncertainties and factors relating to the
Company's operations and business environment which may cause the actual results
of the Company to be materially different from any future results expressed or
implied by such forward-looking statements. Examples of such uncertainties
include, but are not limited to, the Company's dependence on its relationships
with its airline partners, fluctuations in paper prices and airline fuel costs,
customer credit risks, competition from other catalog companies and retailers
and the Company's reliance on information and telecommunications systems, all of
which are discussed more fully in the Company's other filings with the
Securities and Exchange Commission. The Company undertakes no obligation to
publicly update or revise any forward-looking statements whether as a result of
new information, future events or otherwise.
18
<PAGE>
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEX TO FINANCIAL STATEMENTS
Report of Independent Public Accountants................................. F-2
Balance Sheets as of December 31, 1995 and 1996.......................... F-3
Statements of Operations for the Years Ended December 31, 1994,
1995 and 1996.......................................................... F-4
Statements of Shareholders' Equity (Deficit) for the Years Ended
December 31, 1994, 1995 and 1996....................................... F-5
Statements of Cash Flows for the Years Ended December 31, 1994,
1995 and 1996.......................................................... F-6
Notes of Financial Statements............................................ F-7
F-1
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Shareholders of SkyMall, Inc.:
We have audited the accompanying balance sheets of SkyMall, Inc. (a
Nevada corporation), as of December 31, 1995 and 1996, and the related
statements of operations, shareholders' equity (deficit) and cash flows for each
of the three years in the period ended December 31, 1996. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements 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 SkyMall, Inc. as of
December 31, 1995 and 1996, and the results of its operations and its cash flows
for each of the three years in the period ended December 31, 1996, in conformity
with generally accepted accounting principles.
ARTHUR ANDERSEN LLP
Phoenix, Arizona,
February 17, 1997.
F-2
<PAGE>
SKYMALL, INC.
BALANCE SHEETS
(AMOUNTS IN THOUSANDS, EXCEPT SHARES AND PAR VALUE)
DECEMBER 31,
1995 1996
-------- -------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents, including escrow accounts $ 775 $11,491
Accounts receivable, net 892 4,150
Merchandise inventory, net 22 14
Prepaid catalog costs 1,242 1,900
Deferred income taxes -- 59
-------- -------
Total current assets 2,931 17,614
PROPERTY AND EQUIPMENT, net 1,581 1,949
OTHER ASSETS, net 214 158
-------- -------
TOTAL ASSETS $ 4,726 $19,721
======== =======
LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT)
CURRENT LIABILITIES:
Accounts payable $ 4,695 $ 8,623
Accrued liabilities 329 792
Income taxes -- 280
Reserve for restructure charges -- 165
Current portion of notes payable and capital leases 77 72
Current portion of notes payable to vendors 2,564 870
Current portion of notes payable to shareholders -- 120
-------- -------
Total current liabilities 7,665 10,922
DEFERRED INCOME TAXES -- 59
RESERVE FOR RESTRUCTURE CHARGES 1,276 --
NOTES PAYABLE AND CAPITAL LEASES, net of
current portion -- 128
NOTES PAYABLE TO VENDORS, net of
current portion 2,326 11
NOTES PAYABLE TO SHAREHOLDERS,
net of current portion 8,492 --
-------- -------
Total liabilities 19,759 11,120
-------- -------
COMMITMENTS AND CONTINGENCIES
(Note 9)
SHAREHOLDERS' EQUITY (DEFICIT):
Convertible preferred stock -- --
Common stock, $0.001 par value; 50,000,000 shares authorized;
Issued and outstanding shares - 5,150,000 in 1995
and 8,654,000 in 1996 5 9
Additional paid-in capital 18,438 7,588
Retained earnings (accumulated deficit) (33,476) 1,004
-------- -------
Total shareholders' equity (deficit) (15,033) 8,601
-------- -------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT) $ 4,726 $19,721
======== =======
The accompanying notes are an integral part of these balance sheets.
F-3
<PAGE>
SKYMALL, INC.
STATEMENTS OF OPERATIONS
(AMOUNTS IN THOUSANDS, EXCEPT SHARES AND PER SHARE)
<TABLE>
<CAPTION>
FOR THE YEAR ENDED
DECEMBER 31,
1994 1995 1996
---------- ---------- ----------
REVENUES:
<S> <C> <C> <C>
Merchandise sales, net $ 22,062 $ 26,883 $ 30,978
Placement fees and other 8,241 16,198 12,707
---------- ---------- ----------
Total revenues 30,303 43,081 43,685
COST OF GOODS SOLD 16,266 24,564 24,257
---------- ---------- ----------
Gross margin 14,037 18,517 19,428
---------- ---------- ----------
OPERATING EXPENSES:
Catalog expenses 9,644 9,532 7,670
Selling expenses 2,754 2,229 2,476
Customer service and fulfillment expenses 2,919 2,136 2,823
General and administrative expenses 5,886 3,112 3,340
Restructure charge 4,332 -- --
---------- ---------- ----------
Total operating expenses 25,535 17,009 16,309
---------- ---------- ----------
INCOME (LOSS) FROM OPERATIONS (11,498) 1,508 3,119
Interest expense (394) (92) (60)
Interest expense to shareholders (206) (663) (669)
Other income (expense) (88) 5 78
---------- ---------- ----------
INCOME (LOSS) BEFORE INCOME TAXES (12,186) 758 2,468
Income taxes -- -- 280
---------- ---------- ----------
NET INCOME (LOSS) (12,186) 758 2,188
PREFERRED STOCK DIVIDENDS -- -- 77
---------- ---------- ----------
NET INCOME (LOSS) AVAILABLE FOR COMMON SHARES $ (12,186) $ 758 $ 2,111
========== ========== ==========
NET INCOME (LOSS) PER
COMMON SHARE $ (3.43) $ .14 $ .38
========== ========== ==========
WEIGHTED AVERAGE
SHARES OUTSTANDING 3,557,787 5,431,337 5,611,913
========== ========== ==========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-4
<PAGE>
SKYMALL, INC.
STATEMENTS OF SHAREHOLDERS' EQUITY (DEFICIT)
(AMOUNTS IN THOUSANDS, EXCEPT SHARES)
<TABLE>
<CAPTION>
CONVERTIBLE PREFERRED STOCK COMMON STOCK ADDITIONAL
--------------------------- -------------------- PAID-IN
SHARES AMOUNT SHARES AMOUNT CAPITAL
----------- -------------- --------- ------ ---------
<S> <C> <C> <C> <C> <C>
BALANCE, January 1, 1994 -- $ -- 2,654,212 $ 3 $ 18,440
Reissuance of shares pursuant
to Stock Redemption and
Royalty Agreement -- -- 2,268,898 2 (2)
Issuance of shares for guarantee
of debt -- -- 226,890 -- --
Net loss -- -- -- -- --
------- ------- --------- ----- --------
BALANCE, December 31, 1994 -- -- 5,150,000 5 18,438
Net income -- -- -- -- --
------- ------- --------- ----- --------
BALANCE, December 31, 1995 -- -- 5,150,000 5 18,438
Issuance of preferred shares,
net of issuance costs 3,000 2,555 -- -- --
Conversion of shareholder debt
to preferred shares 5,000 5,000 -- -- --
Payment of dividend on preferred
shares -- (77) -- -- --
Issuance of common shares pursuant
to preferred shares issued and
converted (8,000) (7,478) 1,504,000 2 7,476
Issuance of shares pursuant to
IPO, net of issuance costs -- -- 2,000,000 2 13,966
Elimination of accumulated
deficit upon conversion from S
to C corporation -- -- -- -- (32,292)
Net income -- -- -- -- --
------- ------- --------- ----- --------
BALANCE, December 31, 1996 -- $ -- 8,654,000 $ 9 $ 7,588
======= ======= ========= ===== ========
RETAINED
EARNINGS/
(ACCUMULATED
DEFICIT) TOTAL
------------ ---------
<C> <C>
BALANCE, January 1, 1994 $ (22,048) $ (3,605)
Reissuance of shares pursuant
to Stock Redemption and
Royalty Agreement -- --
Issuance of shares for guarantee
of debt -- --
Net loss (12,186) (12,186)
-------- --------
BALANCE, December 31, 1994 (34,234) (15,791)
Net income 758 758
-------- --------
BALANCE, December 31, 1995 (33,476) (15,033)
Issuance of preferred shares,
net of issuance costs -- 2,555
Conversion of shareholder debt
to preferred shares -- 5,000
Payment of dividend on preferred
shares -- (77)
Issuance of common shares pursuant
to preferred shares issued and
converted -- --
Issuance of shares pursuant to
IPO, net of issuance costs -- 13,968
Elimination of accumulated
deficit upon conversion from S
to C corporation 32,292 --
Net income 2,188 2,188
-------- -------
BALANCE, December 31, 1996 $ 1,004 $ 8,601
======== =======
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-5
<PAGE>
SKYMALL, INC.
STATEMENTS OF CASH FLOWS
(AMOUNTS IN THOUSANDS)
<TABLE>
<CAPTION>
FOR THE YEAR ENDED
DECEMBER 31,
-----------------------------
1994 1995 1996
-------- ------ --------
CASH FLOWS FROM OPERATING ACTIVITIES:
<S> <C> <C> <C>
Net income (loss) $(12,186) $ 758 $ 2,188
Adjustments to reconcile net income (loss) to net cash
provided by (used for) operating activities-
Depreciation and amortization 197 244 342
Loss on abandonment of equipment and other assets 1,011 -- --
Provision for restructure charge 3,321 -- --
Provision for merchandise inventory 75 -- 2
(Increase) decrease in:
Accounts receivable (28) 174 (3,258)
Merchandise inventory 4,659 182 6
Prepaid catalog costs (380) 430 (658)
Other assets 204 -- (2)
(Decrease) increase in:
Accounts payable 2,902 341 3,928
Accrued liabilities (556) (283) 463
Income taxes -- -- 280
Reserve for restructure (1,386) (768) (1,111)
-------- ------- --------
Net cash provided by (used for) operating activities (2,167) 1,078 2,180
-------- ------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment (400) (164) (448)
-------- ------- --------
Net cash used for investing activities (400) (164) (448)
-------- ------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Payments on notes payable and capital leases -- -- (81)
Payments on notes payable to vendors -- (2,235) (4,009)
Proceeds from (payments on) notes payable to shareholders, net 3,292 1,200 (3,372)
Proceeds from issuance of preferred stock, net of issuance costs -- -- 2,555
Payment of dividends on preferred stock -- -- (77)
Proceeds from issuance of common stock, net of issuance costs -- -- 13,968
-------- ------- --------
Net cash provided by (used for) financing activities 3,292 (1,035) 8,984
-------- ------- --------
INCREASE (DECREASE) IN CASH AND
CASH EQUIVALENTS 725 (121) 10,716
CASH AND CASH EQUIVALENTS,
beginning of year 171 896 775
-------- ------- --------
CASH AND CASH EQUIVALENTS,
end of year $ 896 $ 775 $ 11,491
======== ======= ========
Income taxes paid $ -- $ -- $ --
======== ======= ========
Total interest paid $ 378 $ 356 $ 1,217
======== ======= ========
Interest paid to shareholders $ 25 $ 272 $ 1,157
======== ======= ========
SUPPLEMENTAL DISCLOSURE OF
NONCASH ACTIVITY:
Conversion of accounts payable to notes payable to vendors $ 5,564 $ -- $ --
======== ======= ========
Notes payable converted to notes payable to shareholders $ -- $ 4,000 $ --
======== ======= ========
Capital leases incurred $ -- $ -- $ 204
======== ======= ========
Notes payable to shareholders converted to preferred stock $ -- $ -- $ 5,000
======== ======= ========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-6
<PAGE>
SKYMALL, INC.
NOTES TO FINANCIAL STATEMENTS
(1) THE COMPANY:
Nature of Organization
SkyMall, Inc. ("Company") was incorporated in 1989 as an Arizona
corporation (and reincorporated in Nevada in October 1996). The Company
commenced operations in 1990 after signing an agreement with a major airline to
provide retail merchandise service through inflight catalogs. In 1991, the
Company purchased the assets of GiftMaster, Inc., which included contracts with
three major airlines and two regional airlines. The Company operates on a
calendar year end of December 31. At December 31, 1996, the Company had
agreements with 15 airlines to place its catalogs in the aircraft seat pockets.
Reincorporation and Restatement of Shares
In October, 1996, the Company reincorporated in the State of Nevada. In
connection with the reincorporation, the Company completed a 1,592 to 1 share
exchange, including treasury shares, resulting in 5,150,000 shares of common
stock outstanding. The accompanying financial statements and footnotes have been
restated for the change in the number of shares of common stock outstanding for
all periods presented.
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
Use of Estimates in Preparation of Financial Statements
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities,
disclosure of contingent assets and liabilities at the date of the financial
statements, and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates. In
management's opinion, methodologies used to determine estimates are adequate and
consistent with prior periods.
Revenue Recognition
Merchandise sales represent the Company's total fulfilled sales at
retail sales prices, net of returns and allowances, from products displayed in
the Company's catalog. The Company's agreements with participating vendors
provide that the vendor ship the products directly to the Company's customer
upon notification of the order to the vendor. Upon notification from the
participating vendors of the shipment of the goods, the Company recognizes the
merchandise sale and related cost of goods sold at the agreed-upon product cost,
and establishes a reserve for anticipated returns.
In addition, under contracts with some of its participating vendors, the
Company earns revenues generated by placement fees for inclusion of the
merchants' products in the SkyMall catalog. Placement fees are designed to cover
catalog expenses and to stabilize the Company's revenue by reducing the impact
of fluctuations in merchandise sales. Catalogs are issued four times a year. The
Company offers the participating vendor's products in the Company's catalogs and
performs order taking and processing services. The placement fees are recognized
ratably over the life of the catalog. Order taking and processing service
expenses are recognized in the period incurred.
The cost of goods sold represents the amount payable by the Company to
vendors in connection with sales of merchandise included in the Company's
catalog. The percentage of sales that the Company pays to the vendor varies from
agreement to agreement; generally, the higher the placement fee paid by a
participating merchant, the higher percentage of sales paid by the Company to
the merchant, and vice versa.
F-7
<PAGE>
SKYMALL, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
In addition, the Company generates revenue from the rental of its
customer list. List revenue is included in placement fees and other revenue in
the accompanying statements of operations.
Shipping and Handling Charges
The Company charges its retail customers standard fees for shipping and
handling costs. The fees collected are offset against the amounts charged to the
Company by its vendors for these fulfillment services provided by the vendors.
Any net amount remaining is included in placement fees and other revenue in the
accompanying financial statements and is not significant for any of the periods
presented.
Impairment of Long-Lived Assets
The Company assesses the recoverability of long-lived assets, including
equipment and leasehold improvements and purchased contracts by determining
whether the assets can be recovered from undiscounted future cash flows. The
amount of impairment, if any, is measured based on projected future cash flows
using a discount rate reflecting the Company's average cost of funds.
Recoverability of long-lived assets is dependent upon, among other
things, the Company's ability to continue to achieve profitability, so as to be
able to meet its obligations when they become due. In the opinion of management,
based upon current information and projections, long-lived assets will be
recovered over the period of benefit.
Cash and Cash Equivalents
Cash equivalents include investments purchased with an original maturity
of three months or less. As a result of the Company's restructure in 1994, the
Company is required to pay some vendors through escrow accounts. The escrow
accounts serve as security for these vendors and are funded through cash
receipts of placement fees and sales of merchandise in the ordinary course of
business. Total cash balances in such escrow accounts as of December 31, 1995
and 1996 were approximately $618,000 and $169,000, respectively. These amounts
are included in cash and cash equivalents in the accompanying financial
statements.
Accounts Receivable
Accounts receivable at December 31, 1995 and 1996, include amounts due
from credit card companies, amounts for items shipped but not billed, and
receivables from vendors for placement fees. The allowance for doubtful accounts
is based on balances past due at year end, and as of December 31, 1995 and 1996
was $175,000 for each year.
Inventory
Inventory consists mainly of logo merchandise which cannot be delivered
via drop ship by vendors. Inventory is stated at the lower of cost (first-in,
first-out) or market. The Company typically has arrangements whereby inventory
items may be returned to vendors if not sold. The Company has established a
reserve of approximately $8,000 and $10,000 at December 31, 1995 and 1996,
respectively, for damaged, obsolete or discontinued merchandise that cannot be
returned to vendors.
Prepaid Catalog Costs
Prepaid catalog costs include primarily catalog production costs, which
are deferred and amortized on a straight-line basis over the period each catalog
issue is in use, currently three months.
F-8
<PAGE>
SKYMALL, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
Income Taxes
Through October 21, 1996, the stockholders of the Company elected to
utilize the provisions of subchapter S of the Internal Revenue Code. In lieu of
corporate income taxes, the stockholders of a subchapter S corporation are taxed
on their portion of the Company's taxable income. Therefore, no provision or
liability for Federal income taxes was recorded through October 21, 1996.
Effective October 22, 1996, the Company's S corporation status was
terminated in connection with its issuance of preferred stock, and the Company
became a C corporation. Pursuant to the rules of the Securities and Exchange
Commission, the accumulated deficit at October 22, 1996 of $32,292,000 has been
reclassified to additional paid-in capital.
Concurrently with this change in tax status, the Company adopted the
provisions of Statement of Financial Accounting Standards No. 109, "Accounting
for Income Taxes" (SFAS No. 109).
Stock-based Compensation
The Company accounts for its stock-based compensation plans under
Accounting Principles Board Opinion No. 25, (APB No. 25), under which no
compensation cost has been recognized. In October 1995, the Financial Accounting
Standards Board issued Statement of Financial Accounting Standards No. 123,
"Accounting for Stock-based Compensation" (SFAS No. 123). SFAS No. 123 requires
that companies that account for stock-based compensation as prescribed by APB
No. 25 and disclose the pro forma effects on earnings and earnings per share as
if SFAS No. 123 had been adopted, in addition to certain other disclosures with
respect to stock compensation and the assumptions used to determine the pro
forma effects of SFAS No. 123. See Note 10 for these disclosures.
Concentration of Credit Risk
Financial instruments that potentially subject the Company to
concentrations of credit risk consist of accounts receivable and accounts
payable.
Concentrations of credit risk with respect to accounts receivable and
accounts payable may be limited due to the large number of participating vendors
comprising the balances and the fact that certain receivable and payable
balances may be offset. The Company performs ongoing credit evaluations of its
merchants, but does not require collateral to support receivables. In addition,
the Company has a right of offset using amounts payable to vendors on future
purchases. The Company has established an allowance for doubtful accounts based
on factors surrounding the credit risk of specific customers, historical trends,
and other information.
Net Income (Loss) Per Common Share and Supplemental Net Income Per
Common Share
Net income (loss) per common share is computed using the weighted
average number of shares of common stock and common stock equivalents
outstanding during the year. In accordance with the rules of the Securities and
Exchange Commission, options granted, and other common stock equivalents issued,
by the Company for the twelve month period prior to the Company's initial public
offering have been included in the calculation of common and common equivalent
shares as if they were outstanding for all periods presented. Dilutive common
equivalent shares subsequent to the initial public offering are computed using
the treasury stock method. Fully diluted net income (loss) per share is not
presented since such amounts would not have a material dilutive effect.
F-9
<PAGE>
SKYMALL, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
Supplemental net income per common share - Assuming proceeds from the
issuance of 2,000,000 common shares at the public offering of $8, net of
issuance costs, were used to repay $5.0 million of the Company's indebtedness to
shareholders as of January 1, 1996, net income per common share would have
increased from $.38 to $.44 in 1996.
Financial Instruments
The Company's financial instruments include cash, accounts receivable
and accounts payable. Due to the short-term nature of these instruments, the
fair value of these instruments approximates their recorded value. The Company
does not have material financial instruments with off-balance sheet risk.
(3) PROPERTY AND EQUIPMENT:
Property and equipment are stated at historical cost. Depreciation of
property and equipment is provided over the estimated useful lives of the
respective assets using the straight-line method. Leasehold improvements are
amortized on a straight-line basis over their estimated useful lives or the
terms of the respective leases, whichever is shorter. Assets leased under
capital lease agreements are carried in property and equipment, and related
lease amortization is included in accumulated depreciation. The following is a
summary of property and equipment:
ESTIMATED DECEMBER 31,
USEFUL --------------------
LIFE (YEARS) 1995 1996
------------ ------- -------
(amounts in thousands)
Equipment 3-10 $1,717 $2,342
Buildings and leasehold
improvements 15-31 1,297 1,320
Furniture, fixtures and other 3-7 269 273
------ ------
3,283 3,935
Less -- Accumulated
depreciation (1,702) (1,986)
------ ------
$1,581 $1,949
====== ======
(4) OTHER ASSETS:
Other assets include intangibles acquired in 1991 from the purchase of
GiftMaster, Inc., which are amortized using the straight-line method over their
estimated useful lives. The following is a summary of other assets:
ESTIMATED DECEMBER 31,
USEFUL ------------------
LIFE (YEARS) 1995 1996
------------ ----- ----
(Amounts in thousands)
Purchased airline contracts 10 $326 $326
Other, primarily deposits 19 21
---- ----
345 347
Less - Accumulated amortization (131) (189)
---- ----
$214 $158
==== ====
F-10
<PAGE>
SKYMALL, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
(5) NOTES PAYABLE AND CAPITAL LEASES:
Notes payable consisted of the following:
DECEMBER 31,
-------------
1995 1996
---- ----
(Amounts in thousands)
Note payable, interest at 8%, due in monthly
installments (including interest) of
approximately $4,700 through June 1997,
secured by equipment and rents $ 77 $ 20
Capital leases, interest at varying rates
of 18% to 23%, due in monthly installments
(including interest) of approximately $7,000
through May 2001, secured by equipment -- 180
----- -----
77 200
Less: current portion (77) (72)
----- -----
$ -- $ 128
===== =====
At December 31, 1996, aggregate annual maturities of notes payable and
capital leases were as follows:
(Amounts in thousands)
1997 $ 72
1998 64
1999 26
2000 28
2001 10
-----
$ 200
=====
In October 1996, the Company obtained a line of credit from a bank for
$4 million. The proceeds from this line of credit were used to repay notes
payable to shareholders. The loan was paid in full during 1996, and the line of
credit remained available to the Company through January of 1997.
In January 1997, the Company obtained a $5 million five-year, reducing
revolving line of credit ("line") from a bank. Available borrowings reduce by $1
million annually, until February 2002, when the line expires. Advances made on
the line bear interest at either Prime or LIBOR, at the option of the Company,
and at rates ranging from Prime to Prime plus 1.5 percent, or LIBOR plus 2.25
percent to LIBOR plus 3.25 percent, depending on certain financial ratios at the
time of advance. The line is collateralized by substantially all assets of the
Company, and contains covenants that require maintenance of certain financial
ratios.
F-11
<PAGE>
SKYMALL, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
(6) NOTES PAYABLE TO SHAREHOLDERS:
Notes payable to shareholders consisted of the following:
DECEMBER 31,
----------------------
1995 1996
------- -------
(Amounts in thousands)
Note payable dated March 11, 1995, converted to
preferred stock/paid in full during 1996 $4,000 $ --
Note payable dated March 17, 1994, converted to
preferred stock/paid in full during 1996 2,000 --
Note payable dated March 17, 1994, converted to
preferred stock/paid in full during 1996 1,000 --
Note payable dated June 30, 1995, converted to
preferred stock/paid in full during 1996 850 --
Note payable for royalties (Note 8) 70 38
Accrued interest 572 82
------ -----
8,492 120
Less: current portion -- (120)
------ -----
$8,492 $ --
====== =====
During 1996, the Company converted $5 million of notes payable to
shareholders to preferred stock and obtained a line of credit for $4 million to
pay accrued interest due under shareholders' notes and the remaining principal
balance due on notes payable to shareholders (see Note 5). The line of credit
was repaid with proceeds from the Company's IPO, and the line of credit remained
available to the Company through January 1997 when it was terminated and
replaced by a $5 million line of credit (see Note 5).
Shareholder Guarantees
From April 1993 through March 1995 a shareholder guaranteed the amounts
outstanding under the Company's line of credit with a bank. In 1993, this
shareholder was issued shares in exchange for this guarantee. In 1994, this
shareholder received 226,890 additional shares related to anti-dilution
provisions between the then existing shareholders. The additional shares were
valued at par, which is consistent with the value assigned to the shares giving
rise to this issuance.
A shareholder of the Company had guaranteed the payment of certain
catalog costs incurred through December 31, 1996.
(7) RESTRUCTURE AND RECAPITALIZATION:
Financial and Operational Restructure
In the fourth quarter of 1994, the Company completed a major
restructuring of its business operations and relationships with its
participating vendors. The Company discontinued carrying inventory by
outsourcing order fulfillment to its vendors. Vendors currently drop ship
directly to customers. The Company also outsourced or discontinued its non-core,
nonessential business activities, such as concierge services and airport
delivery of products. The Company focused on its business of providing catalogs
in airline seat pockets, producing a high quality catalog, selecting quality
merchandise for inclusion in its catalog, and conducting customer order taking
F-12
<PAGE>
SKYMALL, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
and processing services. Also, the Company disposed of substantially all of its
remaining inventory, closed its warehouses, received concessions of amounts due
to vendors, deferred the payment of its other vendor payables, and significantly
reduced the size of its workforce. In addition, the Company entered into
agreements with one of its major participating vendors to provide the Company
with working capital, $1.0 million in cash and to provide services for computer
processing, catalog production, database management and other services in
exchange for inventory, trade names, the use of the Company's customer list and
placement fees at rates below cost for a substantial number of pages in its
catalogs.
All of these activities resulted in a restructure charge of
approximately $4.3 million in 1994, which included the following (amounts in
millions):
Loss on long-term major vendor contract discussed above $ 3.6
Losses on fixed asset abandonment and disposal of unneeded
equipment and facilities 1.0
Employee termination, severance costs and other .2
Uncollectible accounts receivable .8
Restructure of and reduction in accounts payable (1.3)
-----
$ 4.3
=====
Notes Payable to Vendors
In connection with the Company's restructuring, the Company negotiated
extended payment terms with its major vendors. In addition to agreeing to the
extended payment terms, certain vendors agreed to settlements of approximately
60% of the original balance owed at the time of the agreement. These amounts
were converted to notes payable, generally with payment terms of 36 months,
beginning January 1, 1995 and include interest at 8%. During 1996, the Company
negotiated an agreement with one of the vendors whereby the Company agreed to
cure its default and issued to the vendor warrants to purchase 58,824 shares of
the Company's common stock at the IPO price. An expense of approximately $4,000
was recorded in 1996 related to these warrants. The proceeds received from the
private placement were used to cure this and other defaults. Remaining amounts
due subsequent to December 31, 1997, are classified as long-term. Other vendors
were paid 50% of the balance owed to them as full settlement by December 31,
1994. As of December 31, 1996, future payments related to these notes are as
follows (amounts in thousands):
1997 $ 870
1998 11
------
$ 881
======
(8) STOCK REDEMPTION AND ROYALTY AGREEMENT:
In April 1993, the Company redeemed 2,268,898 shares of common stock
held by a shareholder in exchange for certain intellectual property, including
the Company's principal trademarks and trade names. The Company secured an
exclusive license to use the intellectual property acquired by the shareholder
in return for a 1% royalty on the Company's sales commencing January 1, 1994.
On October 1, 1994, the shareholder exercised an option to terminate the
Company's obligation to pay the royalty, transferred the intellectual property
back to the Company and was issued 2,268,898 shares of common stock by the
Company. At the time such option was exercised, the Company owed the shareholder
approximately $180,000 pursuant to the license. The shareholder forgave
approximately $72,000 of such amount and agreed to a payment schedule for the
remainder, of which amount $38,000 is outstanding as of December 31, 1996 and is
included as notes payable to shareholders (see Note 6).
F-13
<PAGE>
SKYMALL, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
(9) COMMITMENTS AND CONTINGENCIES:
Litigation
The Company is from time-to-time subject to complaints and claims
arising in the ordinary course of business, including claims concerning
infringement on patent and trademark rights of others. In each instance, the
Company's suppliers had warranted that the products were not infringing and
indemnified the Company against any loss in connection with such claim. The
Company believes that its actions with respect to products offered for sale in
its catalogs are reasonable and in compliance with applicable contractual
provisions. The Company further believes that none of the claims and complaints
of which it is currently aware will materially affect its business, financial
position or future operating results, although no assurance can be given with
respect to the ultimate outcome of any such claims or with respect to the
occurrence of any future claims.
Leases
The Company has entered into several operating leases for equipment and
facilities. As of December 31, 1996, the future minimum payments under these
leases are as follows (amounts in thousands):
1997 $ 96
1998 92
1999 54
2000 43
2001 43
Thereafter 597
----
$925
====
Other equipment and property are leased on a monthly basis. Total lease
expense for the years ended December 31, 1994, 1995 and 1996 was approximately
$264,000, $193,000 and $140,000, respectively.
Lease Revenue
The Company leases certain of its facilities to others under
non-cancelable leases and month-to-month agreements. Lease revenue of $103,000,
$110,000 and $118,000 for the years ended December 31, 1994, 1995 and 1996,
respectively, is included in other income (expense) in the accompanying
financial statements. As of December 31, 1996 future minimum lease payments to
be received under non-cancelable leases are as follows (amounts in thousands):
1997 $118
1998 112
1999 103
2000 68
2001 68
Thereafter 23
----
$492
====
F-14
<PAGE>
SKYMALL, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
401(k) Plan
Under the Company's 401(k) plan (the 401(k) Plan) adopted in 1992,
eligible employees may direct that a portion of their compensation, up to a
legally established maximum, be withheld by the Company and contributed to their
account. All contributions are placed in a trust fund which is invested by the
401(k) Plan's trustee. The 401(k) Plan permits participants to direct the
investment of their account balances among mutual or investment funds and the
Company provides a matching contribution of 25% of a participant's
contributions.
The total contributions made by the Company during the years ended
December 31, 1994, 1995 and 1996 were not significant in any period.
Employment contract
In September 1996, the Company entered into an employment contract
agreement with its president and chief executive officer, which expires
September 30, 1999, at an annual compensation level of $190,000 and bonuses as
the Board of Directors may specify. The contract may be renewed for a two-year
period upon its initial expiration. The contract may be terminated earlier under
terms and circumstances described in the agreement. Under certain circumstances,
the president and chief executive officer may receive up to two years of base
salary upon termination.
(10) STOCK-BASED COMPENSATION:
Stock Option Plans
The Company has an incentive and nonqualified stock option plan, which
allows the Company to grant to officers and key employees, (the Officer and
Employee Plan) options covering up to 650,000 shares of common stock at an
exercise price of not less than fair market value at the date of grant.
In October 1996, the Company adopted a Non-Employee Director Stock
Option Plan (the Director Plan), which allows the Company to grant non-employee
directors options covering up to 100,000 shares of common stock at an exercise
price of not less than fair market value at the date of grant.
Under the Officer and Employee Plan, the option exercise price equals
the stock's fair market value on date of grant. The Plan options generally vest
40% upon grant, and an additional 20% upon completion of each year of
employment; options expire ten years after the date of grant or three months
after grantee's employment termination.
Under the Director Plan, each non-employee Board member is granted an
option to purchase 5,000 common shares upon appointment to the Board and an
option to purchase 3,000 shares annually, subject to certain limitations.
Options are 100% vested upon grant and expire ten years after the date of
issuance.
F-15
<PAGE>
SKYMALL, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
A summary of the status of the Company's Plans at December 31, 1994,
1995 and 1996, and changes during the years ended December 31, 1994, 1995 and
1996, is presented in the table below:
<TABLE>
<CAPTION>
DECEMBER 31,
---------------------------------------------------------
1994 1995 1996
----------------- ---------------- ----------------
Weighted Weighted Weighted
Average Average Average
Shares Exercise Shares Exercise Shares Exercise
(000) Price (000) Price (000) Price
----- --------- ----- -------- ----- --------
<S> <C> <C> <C> <C> <C> <C>
Outstanding at beginning of period 162 $7.39 271 $7.39 271 $7.39
Granted 433 7.39 -- -- 187 5.82
Exercised -- -- -- -- -- --
Cancel shares repriced -- -- -- -- (135) 7.39
Shares repriced -- -- -- -- 135 5.56
Forfeited (324) 7.39 -- -- -- --
Expired -- -- -- -- -- --
---- ----- --- ----- --- -----
Outstanding at end of period 271 $7.39 271 $7.39 458 $6.21
==== ===== === ===== === =====
Exercisable at end of period 119 173 294
==== === ===
</TABLE>
The Company accounts for its stock-based compensation plans under APB
No. 25, under which no compensation expense has been recognized, as all options
have been granted with an exercise price equal to the fair value of the
Company's common stock on the date of grant. The Company estimated the fair
value of each option grant as of the date of grant using the Black-Scholes
option pricing model with the following weighted average assumptions: risk-free
interest rate of 5.5 percent, expected life of 1 to 10 years, dividend rate of
zero, and expected volatility of 50 percent. Using these assumptions, the fair
value of the stock options granted in 1995 and 1996 is approximately zero and
$461,000, respectively, which would be amortized as compensation expense over
the vesting period of the options. Options generally vest over three years. Had
compensation costs been determined consistent with SFAS No. 123, utilizing the
assumptions detailed above, the Company's net income and net income per common
share would have been reduced to the following pro forma amounts (in thousands):
FOR THE YEAR ENDED
DECEMBER 31,
------------------
1995 1996
---- ----
Net income:
As reported $758 $2,188
Pro forma 758 1,943
Net income per common share:
As reported $.14 $ .38
Pro forma .14 .35
Because SFAS No. 123 method of accounting has not been applied to
options granted prior to January 1, 1995, the resulting pro forma compensation
cost may not be representative of that expected in future years.
In February 1997, the Company granted 65,000 options under the Officer
and Employee Plan.
Stock Warrants
In October 1996, the Company issued 200,000 warrants to underwriters,
180,000 warrants to preferred shareholders, and 58,824 warrants to a vendor to
purchase common stock at an exercise price of $9.60, $8.00 and $8.00 per share,
respectively.
F-16
<PAGE>
SKYMALL, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
(11) INCOME TAXES:
Under the asset and liability method of SFAS No. 109, deferred tax
assets and liabilities are recognized for the future tax consequences
attributable to differences between the financial statement carrying amounts of
existing assets and liabilities and their respective tax bases and operating
loss and tax credit carryforwards. Deferred tax assets and liabilities are
measured using enacted tax rates expected to apply to taxable income in the
years in which those temporary differences are expected to be recovered or
settled. The effect on the deferred tax assets and liabilities of a change in
tax rates is recognized in income in the period that includes the enactment
date.
The cumulative effect of the change in the method of accounting for
income taxes is not significant.
Pro forma income taxes have not been provided for 1994 and 1995. As a
result of the losses recognized in the related periods, any income tax benefit
would have been fully offset by the establishment of a valuation allowance for
deferred tax assets had the Company been taxed as a subchapter C corporation.
Significant components of the Company's deferred tax assets and
liabilities are as follows (amounts in thousands):
Deferred tax liabilities:
Tax over book depreciation $ 59
-----
Total deferred tax liabilities 59
-----
Deferred tax assets:
Nondeductible reserves for bad debts and sales returns 787
Restructure reserve 86
Accrued liabilities 94
-----
Total deferred tax assets 967
Valuation reserve (908)
-----
Net deferred tax assets 59
-----
Net deferred taxes $ --
=====
Significant components of the federal and state income tax expense are
(amounts in thousands):
Current:
Federal expense $ 190
State expense 90
-----
Total current 280
-----
Deferred:
Federal --
State --
-----
Total deferred --
-----
Income tax expense $ 280
=====
F-17
<PAGE>
SKYMALL, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
A reconciliation of the Company's effective income tax rate to the
federal statutory rate follows:
Federal statutory rate 34%
State tax, net of federal benefit 7
Income attributable to S corporation (29)
Other (1)
---
11%
===
Income earned prior to the termination of the S status is taxable to the
individual shareholders.
(12) MAJOR VENDORS:
The following table sets forth net merchandise sales, placement fees and
cost of sales as a percentage of the total of each category for the Company's
largest participating vendor:
FOR THE YEAR ENDED
DECEMBER 31,
--------------------------
1994 1995 1996
---- ---- ----
Net merchandise sales 21% 49% 24%
Placement fees 34% 44% 12%
Cost of goods sold 25% 54% 30%
No other vendors accounted for greater than 10% of any category listed
above.
Also, net merchandise sales of the Company's products on the five
largest airlines represent approximately 87%, 80% and 86% of total net
merchandise sales for the years ended December 31, 1994, 1995 and 1996,
respectively.
F-18
<PAGE>
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURES
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information with respect to the directors and executive officers of the
Company is incorporated herein by reference to the Information Statement
relating to the Company's Annual Meeting to be held on May 15, 1997.
ITEM 11. EXECUTIVE COMPENSATION
Information with respect to executive compensation is incorporated
herein by reference to the Information Statement relating to the Company's
Annual Meeting to be held on May 15, 1997.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information with respect to the security ownership of certain beneficial
owners and management is incorporated herein by reference to the Information
Statement relating to the Company's Annual Meeting to be held on May 15, 1997.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information with respect to certain relationships and related
transactions is incorporated herein by reference to the Information Statement
relating to the Company's Annual Meeting to be held May 15, 1997.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.
(a)(1) Financial Statements.
Balance Sheets as of December 31, 1995 and 1996
Statements of Operations for the Years Ended December 31, 1994, 1995
and 1996
Statements of Shareholders' Equity (Deficit) for the Years ended
December 31, 1994, 1995 and 1996
Statements of Cash Flows for the Years Ended December 31, 1994, 1995
and 1996
Notes to Financial Statements
(a)(2) and (d)
None.
(b) Reports on Form 8-K.
None.
(a)(3) and (c) Exhibits.
37
<PAGE>
EXHIBIT
PAGE NUMBER
EXHIBIT OR METHOD
NUMBER DESCRIPTION OF FILING
- ------ ----------- -----------
3.1a Articles of Incorporation of Registrant ........................ **
3.1b Certificate of Amendment to Articles of Incorporation .......... **
3.2 Bylaws of Registrant ........................................... **
4.1 Amended Certificate of Designation for Preferred Stock ......... **
4.2 Form of Common Stock Certificate ............................... **
4.3 Form of Representative's Warrant Agreement ..................... **
10.1 Employment Agreement between Robert M. Worsley and SkyMall, Inc. **
10.2 Form of Airline Customer Services Agreement..................... **
10.2a Schedule of Omitted Material Terms from Material Airline
Customer Services Agreement ............................... **
10.2b Airline Customer Services Agreement between SkyMall, Inc. and
Continental Airlines, Inc., dated January 1, 1992, as amended.. **
10.2c Airline Customer Services Agreement between SkyMall, Inc.
and United Airlines, Inc., dated May 1, 1992 .................. **
10.5 Form of Tax Indemnification Agreement .......................... **
10.6 SkyMall, Inc. 1994 Stock Option Plan, as amended ............... **
10.7 Non-Employee Director Stock Option Plan ........................ **
10.8a Lease Agreement between Pasqualetti Properties, Inc. and
Smitty's Super Valu, Inc. dated June 24, 1960 ................. **
10.8b Agreement between Rose Pasqualetti Perkins, Amos Pasqualetti,
Anthony Pasqualetti, Ben Pasqualetti and Smitty's Super
Valu, Inc. dated March 2, 1961 ................................ **
10.8c Addendum to Lease between Amos Pasqualetti, Ben S. Pasqualetti,
Rose Pasqualetti Jenkins, Estate of Anthony J. Pasqualetti and
Smitty's Super Valu, Inc. dated May 11, 1966 .................. **
10.8d Sublease between Schwan Brothers Properties and Smitty's Super
Valu, Inc. dated August 1, 1984 ............................... **
10.8e Lease Amending Agreement between Smitty's Super Valu, Inc.,
Pasquo Investments, and Amos Pasqualetti and Victoria
McFarland dated October 1, 1984 ............................... **
10.8f Addendum to Sublease between Smitty's Super Valu, Inc. and
Schwan Brothers Properties dated January 1, 1985 .............. **
10.8g Assignment of Sublease from Pima Partners to SkyMall, Inc.
dated July 12, 1990 ........................................... **
11 Statement Re: Computation of per share earnings ................ *
21 Subsidiaries of Registrant. .................................... N/A
23.1 Consent of Accountants.......................................... N/A
25.1 Powers of Attorney ............................................. S-1
- ---------
* Filed herewith.
** Incorporated by reference to Form S-1 Registration Statement (File No.
333-14539).
38
<PAGE>
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 on Form 10-K to
be signed on its behalf by the undersigned, thereunto duly authorized, this 31st
day of March, 1997.
SKYMALL, INC.
By /s/ Robert M. Worsley
-------------------------------------
Robert M. Worsley
President
POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears
below constitutes and appoints ROBERT M. WORSLEY and DAVID A. WIRTHLIN, and each
of them, his true and lawful attorneys-in-fact and agents, with full power of
substitution and resubstitution for him and in his name, place and stead, in any
and all capacities, to sign any and all amendments to this Form 10-K Annual
Report, and to file the same, with all exhibits thereto, and other documents in
connection therewith with the Securities and Exchange Commission, granting unto
said attorneys-in-fact and agents, and each of them, full power and authority to
do and perform each and every act and thing requisite and necessary to be done
in and about the premises, as fully and to all intents and purposes as he might
or could do in person hereby ratifying and confirming all that said
attorneys-in-fact and agents, or his substitute or substitutes, may lawfully do
or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report on Form 10-K has been signed below by the following persons on
behalf of the registrant and in the capacities and on the dates indicated:
SIGNATURE TITLE DATE
--------- ----- ----
/s/ Robert M. Worsley
- -------------------------- Chairman of the Board,
Robert M. Worsley President (Chief Executive Officer) March 31, 1997
/s/ David A. Wirthlin
- -------------------------- Vice President-Finance
David A. Wirthlin (Chief Financial and Principal March 31, 1997
Accounting Officer)
/s/ Alan C. Ashton
- -------------------------- Director March 31, 1997
Alan C. Ashton
/s/ Lyle R. Knight
- -------------------------- Director March 31, 1997
Lyle R. Knight
/s/ Thomas J. Litle IV
- -------------------------- Director March 31, 1997
Thomas J. Litle IV
/s/ Randy Petersen
- --------------------------
Randy Petersen Director March 31, 1997
S-1
EXHIBIT 11
SKYMALL, INC.
STATEMENT RE: COMPUTATION OF INCOME (LOSS) PER SHARE
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------------
For Primary Income (Loss) Per Share(3)(4) 1994 1995 1996
--------- --------- ----------
<S> <C> <C> <C>
Weighted average number of common shares outstanding 3,276,450 5,150,000 5,303,600
Net dilutive impact report of common stock equivalents
issuable upon conversion of Preferred Stock from
private placement in October 1996--based on treasury
stock method (1)(2) 189,000 189,000 180,715
Net dilutive impact of stock options--based on the
treasury stock method (1) 92,337 92,337 92,337
Net dilutive impact of stock options and warrants--based
on the treasury stock method using average market price -- -- 35,261
------------ ---------- ----------
Pro form weighted average number of common and common
equivalent shares outstanding 3,557,787 5,431,337 5,611,913
============ ========== ==========
Net income (loss) $(12,186,000) $ 758,000 $2,188,000
Preferred stock dividends -- -- 77,000
------------ ---------- ----------
Net income (loss) available for common shares $(12,186,000) $ 758,000 $2,111,000
============ ========== ==========
Net income (loss) per common share $ (3.43) $ 0.14 $ 0.38
============ ========== ==========
</TABLE>
- ----------
(1) Pursuant to the rules of the Securities and Exchange Commission, common and
common equivalent shares issued during the 12 months immediately preceding
the filing date of the Company's initial public offering have been included
in the calculation of common and common equivalent shares as if they were
outstanding for all periods presented, including loss years where the
impact of incremental shares is antidilutive; as calculated using the
treasury stock method at the initial public offering price of $8.00 per
share.
(2) Shares of common stock potentially issuable upon conversion of convertible
preferred stock have been included since the convertible preferred stock is
automatically converted upon completion of the initial public offering.
(3) No calculation of fully diluted loss per share has been provided as fully
diluted loss per share is equal to primary loss per share.
(4) Common and common equivalent shares have been adjusted to reflect a
1,592-for-1 stock exchange upon incorporation in Nevada in October 1996.
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
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