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, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ________________ to __________________
Commission File Number 000-21657
SKYMALL, INC.
(Exact name of Registrant as specified in its charter)
NEVADA 86-0651100
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1520 EAST PIMA STREET, PHOENIX, ARIZONA 85034
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (602) 254-9777
Securities registered pursuant to Section 12(b) of the Act: NONE.
Securities registered pursuant to Section 12(g) of the Act:
COMMON STOCK, .001 PAR VALUE
(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. [X]
On March 22, 1999, the aggregate market value of Common Stock held by
non-affiliates of the Registrant was approximately $50,658,796. 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 22, 1999, the number of shares of Common Stock outstanding was
8,868,798 and there were no shares of Preferred Stock outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
The Registrant's Definitive Proxy Statement for its Annual Meeting of
Shareholders, to be held on June 4, 1999, which will be filed pursuant to
Regulation 14A 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
PART I
Item 1. Business..................................................... 4
Item 2. Properties................................................... 13
Item 3. Legal Proceedings............................................ 14
Item 4. Submission of Matters to a Vote of Security Holders.......... 14
PART II
Item 5. Market for the Registrant's Common Stock and Related
Stockholder Matters...................................... 15
Item 6. Selected Financial Data..................................... 16
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................ 18
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.. 28
Item 8. Financial Statements and Supplementary Data................. 28
Item 9. Changes in and Disagreements With Accountants on
Accounting and Financial Disclosure..................... 29
PART III
Item 10. Directors and Executive Officers of the Registrant.......... 30
Item 11. Executive Compensation...................................... 30
Item 12. Security Ownership of Certain Beneficial Owners and
Management.............................................. 30
Item 13. Certain Relationships and Related Transactions.............. 30
PART IV
Item 14. Exhibits, Financial Statement Schedules and
Reports on Form 8-K..................................... 31
SIGNATURES................................................................ S-1
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PART I
FORWARD-LOOKING STATEMENTS
Certain statements made herein, in documents incorporated herein by
reference, 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.
These statements discuss, among other items, the Company's growth strategy and
anticipated trends in our business. Words and phrases such as "should be," "will
be," "believes," "expects," "anticipates," "plans," "intends", "may" and similar
expressions identify forward-looking statements. Forward-looking statements are
made based upon our belief as of the date that such statements are made. These
forward-looking statements are based largely on our current expectations and are
subject to a number of risks and uncertainties, many of which are beyond our
control. Actual results could differ materially from these forward-looking
statements as a result of the factors described herein, including, among others,
regulatory or economic influences. Examples of such uncertainties include, but
are not limited to, the Company's dependence on its relationships with its
airline, merchant, and other partners, the ability of the Company to attract and
retain key personnel, especially highly skilled technology personnel, the
ability of the Company to secure additional capital to finance its business
strategy, fluctuations in paper prices and airline fuel costs, customer credit
risks, competition from other catalog companies, retailers and e-commerce
companies, and the Company's reliance on technology and information and
telecommunications systems, all of which are discussed more fully below and 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. See "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS -- ADDITIONAL FACTORS THAT MAY AFFECT FUTURE
RESULTS."
ITEM 1. BUSINESS
GENERAL
Founded in 1989, SkyMall, Inc. capitalizes on exclusive agreements to
create both print and e-commerce solutions for consumers and merchants. We offer
products and services to consumers through print and on-line media. Our products
and services are provided by more than 100 of the country's leading retailers,
including Balducci's, Brookstone(R), Frontgate(R), Hammacher Schlemmer(R),
Improvements(R), Lillian Vernon(R), Orvis(R), Successories(R), The Sharper
Image(R) and The Wine Enthusiast(TM). The Company offers a diverse variety of
products from numerous product categories, including clothing, fashion
accessories, health and beauty aids, children's toys, executive gifts,
educational products, gourmet cooking aids, exercise equipment, jewelry,
luggage, travel aids, and home accessories. Because most of our merchants ship
merchandise directly to our customers, the Company has little inventory risk.
Our total revenues have increased from approximately $30.3 million in 1994 to
approximately $66.3 million in 1998, for a compound annual growth rate of 21.6%.
Our revenue per passenger enplanement for all of our programs on flights
carrying SkyMall catalogs increased from approximately $0.06 in 1994 to
approximately $0.12 in 1998, for a compound annual growth rate of 18.9%.
Currently, our largest distribution channel is the airline seat pocket
through which our in-flight catalogs were available to more than 1.1 million
airline passengers each day in 1998, or approximately 68% of all domestic
airline passengers. We also sell products through a number of other print media
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including catalogs distributed through our international airline partnerships
and catalogs offering high quality logo merchandise distributed in the corporate
workplace. Through our on-line media subsidiary, SKYMALL.COM, we offer an
expanded selection of products and services to on-line shoppers at our Web site,
WWW.SKYMALL.COM and through our affiliate program.
We plan to significantly increase our content offering to consumers by
attracting new merchants to the SkyMall program and offering appealing
non-merchandise travel-related content to consumers through our on-line media.
We also plan to further broaden our distribution channels and our customer base
through, among other things, electronic commerce initiatives, international
expansion of our in-flight catalog program and implementation of additional
workplace marketing programs. From time to time, we may also consider further
expanding our media capabilities and distribution channels, either through joint
venture relationships, acquisitions or other arrangements.
Unless the context indicates otherwise, the terms "SkyMall", the "Company,"
"we", "us" or "ours" refer to SkyMall, Inc. and its subsidiaries.
CUSTOMER RELATIONSHIPS
SkyMall's mission is to make shopping more convenient for consumers and we
have more than eight years of experience in ensuring that shopping from SkyMall
is convenient and easy. SkyMall has adopted the following strategies for
satisfying the needs of time-pressed consumers, particularly those who have
adopted the Internet as a preferred method of shopping and have grown to expect
higher standards of customer service and convenience.
PROVIDE CUSTOMERS WITH ONLY THE BEST-SELLING, HIGH-QUALITY MERCHANDISE FROM
WELL-KNOWN BRANDS. SkyMall offers its customers more than 3,500 products from
over 100 well-known merchants. Our print media, which typically includes
approximately 2,000 items per catalog, provides consumers with a selection of
only the best-selling products from our most well-known merchant partners. This
ensures that consumers quickly see the most popular items, without having to
review hundreds of items that may be of little interest. Through our on-line
database, we offer on-line consumers a greater product selection and currently
offer more than 3,500 products for sale. For the convenience of our customers,
our on-line database is searchable by a number of parameters that allow the
customer to quickly locate products that are of interest to that consumer. We
plan to further expand the selection and variety of our product offering and
implement additional on-line technologies that will allow us to use customer
recommendation software to offer SkyMall customers personalized recommendations
based on individual tastes and preferences. See "TECHNOLOGY -- CUSTOMER
RECOMMENDATION TECHNOLOGY".
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 from many different well-known merchants in a single transaction.
Although most of the merchandise offered in the SkyMall catalogs is available
from other catalog and retail companies, each of these companies typically has
its own policies for shipping and handling charges, merchandise returns, sales
taxes and price guarantees, as well as its own Web site. In addition, each
company typically has different customer service hours and credit and payment
policies. By aggregating the merchandise of our various participating merchants
into a single location in our print catalogs and on the Web, we afford our
customers access to thousands of products offered by more than 100 participating
merchants and the convenience of one-stop shopping.
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PROVIDE SUPERIOR CUSTOMER SERVICE, ORDER PROCESSING AND FULFILLMENT. The
Company maintains a well-trained, in-house staff of customer service
representatives located in Phoenix, Arizona, for its domestic business and uses
outsource call centers with expertise in as many as 16 languages for its
international orders. Our global customers enjoy the convenience of being able
to shop twenty-four hours a day, seven days a week. The Company's customer
service representatives encourage customers to purchase additional products with
each order to increase the Company's average revenue per order. Consumers can
shop while traveling by ordering from free in-flight phones or by phones
anywhere using our toll-free number. Consumers can also shop on-line wherever an
Internet connection is available. Unlike many Internet retailers, the Company
offers telephone support to its on-line consumers twenty-four hours a day, seven
days a week, providing the Company's on-line consumer the benefit of live
customer service assistance. On-line consumers can also make customer service
inquiries via e-mail. To facilitate prompt delivery of products, all orders
taken by the Company are forwarded to the Company's merchant partners who ship
merchandise directly to consumers. Although we currently offer a two-to-four day
expedited shipping option for most products, we plan to implement an overnight
delivery option in the future in order to further improve our customer service
capabilities.
PROVIDE CUSTOMER GUARANTEES AND EASY RETURNS. We offer a no mark-up, low
price guarantee under which we will refund the price difference if the customer
finds the same item advertised elsewhere at a lower price. We also offer a total
satisfaction guarantee that lets a customer return merchandise for any reason
within 60 days of purchase. SkyMall distinguishes itself from other catalog
companies and on-line retailers by providing its customers a simplified return
process. With each order, SkyMall automatically includes a pre-printed return
form, allowing customers to return the merchandise without first notifying
SkyMall to solicit a return authorization. Providing this pre-printed form in
advance also allows our customers to contact UPS or Federal Express to pick up
the item directly from the delivery address, eliminating the need to travel,
stand in line, or request approval to return items.
PRINT MEDIA
We market our merchandise through a number of print media, including our
in-flight catalogs, international catalogs and workplace catalogs. We continue
to seek additional ways to expand our print media distribution and are currently
testing a number of new channels, including hotels, consumer loyalty programs
and alliances with credit card companies who have access to significant customer
databases. The merchandise of each participating merchant in our catalogs is
presented in a separate section of each catalog to allow browsing from "store to
store," providing the convenience and variety of an upscale shopping mall
environment.
SKYMALL DOMESTIC IN-FLIGHT CATALOGS. Our in-flight catalogs, which are
placed in airline seat pockets, are our largest distribution channel. Over the
past eight years, we have experienced substantial growth in our domestic
in-flight catalog business, which accounted for approximately 93% of our net
merchandise sales and substantially all of our placement fees and other revenue
in 1998. During 1998, we had exclusive agreements to place our catalogs on 16
airlines, making our catalog available to more than 410 million airline
passengers in 1998. These 16 airlines, which carried approximately 68% of all
domestic passengers in 1998, include America West, Continental, Delta,
Southwest, TWA, United and US Airways. The Company's catalogs carry the SkyMall
name on all participating airlines, except United and US Airways, which offer
SkyMall catalogs under the names "High Street Emporium" and "Selections,"
respectively. In order to enhance the appeal of our product offerings, we
produce four new domestic in-flight catalogs per year. To gain efficiency in
production and printing, the catalog content is substantially the same for all
of our airline partners. During the first three quarters of the year, our
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catalogs typically average 170 pages. During our peak selling season in the
fourth quarter of the year, we generally expand our catalog offering to over 225
pages.
In February 1999, SkyMall entered into a three and one-half year exclusive
agreement with Northwest Airlines, the world's fourth-largest airline, which
will bring our in-flight catalogs to all domestic Northwest passengers by July
1, 1999, increasing the Company's market share to approximately 453 million
passengers per year, or approximately 75% of all domestic airline passengers.
SkyMall and Northwest have also agreed to develop additional marketing programs
to specifically target frequent fliers and to explore international
opportunities for the in-flight catalogs.
The SkyMall program offers airlines a low-risk means of incrementally
increasing their earnings. In exchange for placement of our catalogs in
seat-back pockets, we pay 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 1998, total commissions paid or
payable to SkyMall's airline partners amounted to approximately $3.4 million
which included minimum monthly commissions and boarding costs of approximately
$2.5 million. In addition to increasing airline earnings, our airline partners
also benefit from enhancing the in-flight experience of their passengers by
providing our catalogs 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 with 60 to
180 days' advance notice by either SkyMall or the airline. We believe our
relations with each of our airline partners are good.
The following airline partners each accounted for in excess of 10% of the
Company's net merchandise sales for the year ended 1998:
PERCENT OF NET MERCHANDISE SALES
NAME OF AIRLINE THROUGH DECEMBER 31, 1998
Delta 23%
United 21%
Continental 11%
Southwest Airlines 10%
---
Total 65%
===
We continue to develop marketing and promotional programs focused on
increasing revenue per passenger enplanement, some of which are facilitated
through the unique relationships between the Company and our airline partners.
Among the plans in various stages of implementation are (i) enhancing promotion
of our shopping services through in-flight announcements, including video and
audio programming, (ii) encouraging repeat customer purchases through discounts
and other special offers, (iii) offering airlines and key airline employees
incentives for promoting the use of our catalogs among airline passengers, (iv)
conducting in-flight promotions, such as gift certificates, discount
certificates, and special offers to passengers who order while in-flight, and
(v) expanding the number of merchants in our program as well as the selection
and variety of products. The Company has tested a number of the foregoing
initiatives with some of its airline partners and, where successful, plans to
expand the programs to other airline partners.
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SKYMALL INTERNATIONAL IN-FLIGHT CATALOGS. We believe that the demographic
and technological trends that are driving the domestic consumer to shift from
traditional retail shopping are also present in many international markets,
which we believe are substantially under-served. In early 1998, we launched a
new international initiative with United Airlines under which we began providing
specialized catalogs to the more than five million international passengers who
travel each year on United Airlines' flights originating from Tokyo and Osaka,
Japan and serving the Pacific Rim. These catalogs feature merchandise tailored
to this audience and are offered in three languages: English, Japanese and
Chinese. Although revenue from this program has been immaterial to date, we
attribute this result primarily to the poor economic conditions in Asia and we
plan to continue this program for the foreseeable future.
In March 1999, the Company began a five-month test program with British
Airways, which began offering SkyMall catalogs on most of its transatlantic
flights originating from New York and Boston. Pending the results of this test,
the Company and British Airways may consider expanding the program to additional
flights. In addition, in January 1999, the Company began testing a Spanish
language order form on several Continental flights to Latin America.
Although international sales were immaterial to our total net merchandise
sales in 1998, we plan to continue exploring opportunities in these markets.
SkyMall continues to gain experience in international markets, including in
merchandising, customer service and fulfillment. The Company plans to enter into
other controlled and carefully planned expansions into large international
markets through cooperative ventures with its current domestic airline partners,
as well as new international partners. The Company believes that its experience
in the domestic in-flight business, as well as its Web-based infrastructure that
allows it to quickly set-up call center operations in foreign countries, will
enable it to expand into selected international markets, particularly those with
a strong interest in U.S. products or where remote shopping already has some
level of acceptance by consumers.
WORKPLACE MERCHANDISE CATALOGS. In October 1998, SkyMall acquired Durham &
Company, a 15-year-old company with annual revenues of approximately $4 million
that supplies logo merchandise and recognition products to more than one million
employees of a number of blue-chip organizations, primarily through print
catalogs. Durham & Company accounted for approximately 2% of the Company's net
merchandise sales in 1998. Competing in the highly fragmented $23 billion
incentive industry, Durham distinguishes itself by providing high-quality
products and excellent customer service and focuses its marketing efforts on
large organizations. SkyMall plans to provide Durham's clients unique,
high-quality merchandise offered through other SkyMall channels as well as logo
merchandise and recognition products for corporate gift giving, employee
recognition, sales promotions and incentives, and similar programs.
Through the Durham acquisition, SkyMall began to further leverage its
existing airline relationships by offering them the expanded logo merchandise
and recognition product lines. In February 1999, SkyMall and Durham entered into
an agreement with a third party pursuant to which Durham's logo merchandise and
SkyMall's products are offered at United's corporate store at the airline's
headquarters outside Chicago, which serves United's employees and visitors. In
addition, commencing in February 1999, Durham began providing a logo merchandise
catalog to United's 85,000 domestic employees.
The Company believes the number of women in the workplace and the gaining
popularity of non-traditional methods of shopping presents an ideal opportunity
to market its products to busy consumers in the workplace. We plan to continue
to increase our presence in the corporate marketplace by leveraging Durham's
quality logo merchandise with the unique products typically offered by SkyMall
and attempting to secure additional corporate clients. With the increasing
acceptance of the Internet in the workplace, we also plan to explore electronic
commerce-based workplace programs.
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OTHER PRINT CHANNELS
GOLD POINTS. In November 1998, Gold Points Corporation selected SkyMall as
a primary merchandise redemption source for its Gold Points customer loyalty
program. Gold Points Corporation is a subsidiary of Carlson Companies Inc.,
which owns such well-known brands as Regent International Hotels, Radisson
Hotels Worldwide, Radisson Seven Seas Cruises, Country Inns & Suites By Carlson,
Carlson Wagonlit Travel, T.G.I. Friday's and Italianni's, and operates Carlson
Marketing Group, the largest relationship marketing company in the United
States. Through a network of well-known brands in different industries, the Gold
Points program offers participants the opportunity to earn and redeem points
with a variety of network merchants. Participants in the Gold Points program
include Carlson-owned hospitality and service companies, as well as MCI
Worldcom, the American Bar & Grill and others. The SkyMall redemption catalog
will be available from participating Gold Points merchants in April 1999 and
will be the primary general merchandise catalog promoted to consumers for point
redemption. SkyMall will also participate in the Gold Points merchant network
and will award consumers Gold Points at their request.
OTHER PRINT MEDIA PROGRAMS. We provide unique, upscale catalogs to the
membership-oriented airport lounges of one of our major airline partners. The
SkyMall catalogs are also available on certain Northeastern routes of Amtrak. We
also continue to test distribution of our print catalogs in a number of other
venues, including hotels and in connection with other loyalty and marketing
programs. We are also testing other alliances, including with major credit card
companies. To the extent the test results of these programs prove successful, we
may expand our presence in these channels.
ELECTRONIC MEDIA
GENERAL. We launched our first Internet Web site in January of 1996 and
since then have continued to further refine and develop our e-commerce
strategies. Our e-commerce channels showcase products offered in our print
catalogs and provide customers an additional means of customer service and
support. In addition, because the Internet does not pose the same size and
weight constraints as our paper catalogs, we offer products and services from a
greater number of merchants and a full complement of products from merchants who
offer only their best-selling items in our catalogs. Through our wholly-owned
subsidiary, SKYMALL.COM, INC., we plan to increase our revenues from this media
by developing SkyMall's Web site as a premier Internet shopping and travel
destination and increase the number of partners in our affiliate program. We
also plan to increase our database of products.
During 1998, we experienced a significant increase in our e-commerce
activity. Net merchandise sales from our e-commerce initiatives for fiscal 1998
were $2.5 million compared with net merchandise sales in 1997 of approximately
$235,000; an increase of over 900%. Our e-commerce sales accounted for
approximately 5% of our net merchandise sales in 1998. We believe this trend
demonstrates that the Internet is increasingly becoming a more popular way to
shop and we plan to continue to leverage our merchandise content, customer
service expertise, off-line channels and back-end infrastructure to capitalize
on the opportunities of the Internet. During 1999, we plan to make significant
additional investments in our e-commerce initiatives. For further discussion,
see "ELECTRONIC MEDIA - GROWTH STRATEGY" and "MANAGEMENT'S DISCUSSION AND
ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS."
SKYMALL.COM'S marketing strategy is designed to strengthen the SkyMall
brand name on-line, increase customer traffic to the SKYMALL.COM Web site, build
strong customer loyalty, maximize repeat purchases and develop revenue
opportunities. SKYMALL.COM seeks to build customer loyalty by creatively
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applying technology to deliver personalized programs and services, as well as
creative and flexible merchandising. The Company employs a variety of media,
marketing and promotional methods to achieve these goals.
We believe our in-flight readership is a valuable asset as we expand our
business, particularly our electronic commerce initiatives. SkyMall is uniquely
positioned among Internet retailers because it promotes its Internet site at
virtually no cost to more than 1.1 million airline passengers each day through
the SkyMall in-flight print catalogs. As we grow our in-flight presence, the
brand awareness and visibility we gain with our high-profile consumer audience
strengthens the visibility of our Web initiative and can be used as a tool to
promote traffic to our Web site. While other companies expend tremendous
resources on off-line advertising to reach a portion of our audience, SkyMall
has the advantage of promoting its site in another proven distribution channel.
AFFILIATE PROGRAM. In addition to developing our own site, we have an
affiliate program through which we provide a turn-key merchant solution to
businesses that are interested in providing SkyMall's merchandise to visitors to
their own Web sites. Our unique proprietary technology and other systems allow
us to quickly and cost-effectively implement affiliate site programs, in many
cases with lead times of less than three weeks. Visitors to SkyMall's affiliate
sites go directly to a SkyMall site, which is typically co-branded with the
affiliate partner, for shopping services. After shopping, the customer is
directed back exclusively to the site from which they began so that the
affiliate partner does not lose the benefit of the traffic to its site. Although
we can private label an on-line store for our affiliate partners, most of our
affiliate sites are co-branded to increase SkyMall's brand awareness as well as
generate affinity for our on-line partners.
Under our agreements with our affiliate partners, we typically pay them a
commission based on net merchandise sales. Our affiliate program offers
advantages to both consumers and our partners. Consumers enjoy the convenience
of SkyMall's on-line shopping and our partner sites enjoy the benefit of
increased revenue, while ensuring their customers return to their site.
Early participants in our affiliate program include some of our airline
partners, such as Delta Air Lines, Delta Crown Room and Continental Air Lines.
We also have arrangements with a number of other high-traffic sites, including
the site offered by the best-selling book series, Chicken Soup for the Soul,
Microsoft's on-line shopping mall called MSN Shopping and The Trip.com. The
Company continues to evaluate the success of its individual affiliates and, in
some cases, has terminated relationships. Gaining additional knowledge from
these experiences, the Company plans to continue to expand its affiliate
program.
ELECTRONIC COMMERCE GROWTH STRATEGY. In 1999, we plan to devote substantial
financial, marketing, technical and personnel resources to further develop our
electronic commerce initiatives. Our strategies in this area include, among
other things, (i) significantly improving the look and feel, as well as the
speed, performance and search functionality of our Web site, (ii) further
developing our technology and other business infrastructures used to convey
orders and provide order status information to our customers, (iii) undertaking
marketing and other promotional campaigns through both on-line and off-line
media to enhance brand awareness of the SkyMall name and drive traffic to our
Web site, (iv) significantly increasing the selection and variety of products
for our programs, and (v) developing non-product travel-related content for our
Web site that will encourage consumers to visit our site for information as well
as shopping. We also plan to further our marketing initiatives in order to
secure more affiliate relationships. Implementation of our growth strategy will
require the addition of new personnel as well as significant financial
resources. For further discussion, please see "MANAGEMENT'S DISCUSSION AND
ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- ADDITIONAL FACTORS
THAT MAY AFFECT FUTURE RESULTS."
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COMPETITION
PRINT MEDIA. All aspects of the Company's print media business are highly
competitive. The Company competes for customers to some degree with all
retailers and catalog companies, including airport retailers, duty-free
retailers, specialty stores, incentive and logo merchandise companies,
department stores, specialty catalog companies, and general merchandise catalog
companies. Although the Company believes that its long-standing relationships
with its business partners and participating merchants create substantial
barriers to competition, many of its competitors and potential competitors have
greater financial, marketing, and other resources, and may seek to enter or
expand penetration into the Company's markets. In its in-flight business, the
Company competes with other advertisers, including those who advertise in
in-flight magazines and other periodicals. Several companies have announced they
may develop seatback interactive video shopping services, some of which have
greater resources than the Company. As seatback interactive video shopping
services become more available to airline passengers, competition in the
in-flight marketing business is likely to increase.
ELECTRONIC MEDIA. The Internet on-line commerce market is relatively new,
rapidly evolving and intensely competitive. The Company expects that competition
in the on-line commerce market will intensify in the future. Barriers to entry
are minimal and current and new competitors can launch new Web sites at a
relatively low cost. Many competitors in this area have greater financial,
technical and marketing resources than the Company. In addition, new
technologies and the expansion of existing technologies may increase the
competitive pressures on on-line retailers, including the Company. See
"MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS -- ADDITIONAL FACTORS THAT MAY AFFECT FUTURE RESULTS."
TECHNOLOGY
We have implemented order entry, transaction-processing and fulfillment
services and systems using a combination of our own proprietary technologies and
commercially available licensed technologies. The Company's current strategy is
to focus its development efforts on creating and enhancing the specialized,
proprietary software that is unique to its business and to license commercially
developed technology for other applications where available and appropriate.
ORDER ENTRY AND CUSTOMER SERVICE SYSTEM. In July 1998, we began the
implementation of our Microsoft Site Server 3.0 Internet-based order entry and
customer service system. The system became fully operational in November 1998
and provides a fully integrated order management and customer service system.
Like other well-known companies, including Dell Computers, Barnes and Noble and
1-800-Flowers, we selected Microsoft Site Server 3.0 to decrease time-to-market
and reduce development costs. Although many companies are using Microsoft
products for their e-commerce business, we believe we are the only company of
significant size to use these products as the infrastructure for both our print
and on-line media. Our Internet-based system has already provided the Company
with many first-to-market advantages, including giving us significant
flexibility in implementing marketing programs and other promotions, allowing
quick implementation of affiliate programs, permitting us to establish call
center operations in foreign countries to support our international expansion
and enabling us to reduce costs in our print media business.
CUSTOMER RECOMMENDATION TECHNOLOGY. In December 1998, SkyMall entered into
a licensing agreement with Net Perceptions(TM) Inc., a leading Internet database
technology provider and developer of real-time customer relationship
technologies, to add advanced customer recommendation technology software to
both its Web site and call center. Using the software, effective in the Spring
of 1999, SkyMall will begin offering customers personalized recommendations
11
<PAGE>
based on individual purchasing behavior. Because of our Web-based business
infrastructure, we can offer this technology to all of our customers whether
they order over the Internet or through our call center.
BUSINESS OPERATIONS
MERCHANT AGREEMENTS. We enter into agreements with merchants who supply the
products and services offered in our print and on-line media. Under these
contracts, we earn percentages of revenues generated by sales or placement fees
for inclusion of the merchants' products in SkyMall programs, or a combination
thereof. 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 prices for products be honored by merchants
as long as the Company receives orders for them. The agreements typically have
an initial term of a single quarterly catalog and automatically renew thereafter
for successive catalog editions. During 1997, the Company renegotiated many of
its merchant partner agreements to establish more favorable cost structures. The
Company experienced the benefits of those negotiations in 1998, with gross
margins increasing from 42.3% in 1997 to 49.4% in 1998; however, there is no
assurance that these gross margin levels can be increased or sustained in the
future. The merchants typically agree to indemnify the Company for any losses
associated with injuries caused to customers from the use of such merchant's
products, 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. See
"MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS -- ADDITIONAL FACTORS THAT MAY AFFECT FUTURE RESULTS."
Some of the major catalog and retail companies currently featured by
SkyMall and those who have participated in Company programs recently include:
<TABLE>
<CAPTION>
NAME BRAND STORES IN THE SKYMALL CATALOGS
<S> <C> <C>
1-800-Flowers(R) Igia(R) Solutions(R)
Balducci's Improvements(R) Spilsbury Puzzle Co.
Brainstorms Intelihealth Healthy Home(R) Sturbridge Yankee Workshop
Brookstone(R) Lillian Vernon(R) Successories(R)
Calyx & Corolla Magellan's(R) Sundance Catalog Company
Competitive Edge Golf(R) Mattel(R) The American Historic Society
Design Toscano(R) Mrs. Beasley's(R) The Cigar Enthusiast
Ethel M Chocolates Mrs. Field's The Golf Company by Golf Digest
Field Trips Nightingale Conant The Safety Zone(R)
Fitness Quest, Inc.(R) Orvis(R) The Sharper Image(R)
Frontgate(R) Personal Creations(R) The Wine Enthusiast(TM)
Gumps(R) Plow and Hearth Timex(R)
Hale Groves(R) Pro Tour Memorabilla Travel Tools(TM)
Hammacher Schlemmer(R) Reliable Home Office United States Postal Service(R)
Hello Direct(R) Seiko Verbal Advantage(R)
Huntington Clothiers(R) Silvo Home(TM) Welbilt(R)
</TABLE>
ORDER PROCESSING, CUSTOMER SERVICE AND FULFILLMENT. At March 22, 1999, we
employed approximately 150 customer service representatives. We outsource part
of our call volume during peak order times. Our telephone equipment distributes
calls to sales representatives and provides detailed call reporting and
analysis, assisting us with order processing and marketing efforts. Over 86% of
the Company's daily orders are received on "toll-free" numbers, including 10%
from toll-free air phones, with the remaining orders arriving by U.S. mail,
12
<PAGE>
facsimile, and the Internet. We typically receive approximately 3,000 calls per
day in off-peak seasons and approximately 7,400 calls per day during the peak of
the Holiday season. We maintain no significant inventory. Therefore, once we
receive a customer's order, it is transmitted to the appropriate merchant who
ships the merchandise directly to the customer. Although expedited service is
available, most orders are delivered to customers within seven-to-ten days. The
Company's average order size is approximately $98. Our customer service
representatives are given incentives for increasing order size.
REGULATION
Our 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 Federal Trade
Commission regulations applicable to our operations impose various requirements
on the processing of customer orders, including shipping deadlines, delay
notices, order cancellations, and refunds. Our subsidiary, Durham & Company,
operates a small manufacturing facility where it manufacturers recognition
jewelry and related products. These operations involve certain hazardous
chemicals that are used in the manufacturing process and are subject to various
federal, state and local environmental laws and regulations.
EMPLOYEES
At March 22, 1999, the Company had 323 employees, including 26 employees of
SKYMALL.COM and 44 employees of Durham & Company. 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.
The Company believes that its future success will depend in part on its
continued ability to attract, hire and retain qualified personnel. See
"MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS -- ADDITIONAL FACTORS THAT MAY AFFECT FUTURE RESULTS."
TRADEMARKS AND TRADE NAMES
SkyMall(R) 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
Our executive offices are located in Phoenix, Arizona, where we lease
approximately seven acres of land under long-term leases expiring in 2012, with
an option to extend to 2062. We own the improvements to this land which include
offices, storage facilities, and a small retail shopping center, consisting of
an aggregate of approximately 50,000 square feet. Our subsidiary, SKYMALL.COM,
also leases approximately 7,500 square feet of office space in New York City
under a month-to-month lease. Our logo merchandise subsidiary, Durham & Company,
leases approximately 18,000 square feet of space in an industrial park in Tempe,
Arizona, under a lease expiring in 2002, where it houses a small warehouse and
manufacturing facility as well as administrative offices.
13
<PAGE>
ITEM 3. LEGAL PROCEEDINGS
The Company is involved in legal actions in the ordinary course of its
business. Although the outcomes of any such legal actions cannot be predicted,
in the opinion of management, there is no legal proceeding pending or asserted
against or involving the Company for which the outcome is likely to have a
material adverse effect upon the consolidated financial position or results of
operations of the Company.
On May 13, 1998, Kathy Jordan, a purchaser of products through a SkyMall
catalog in March 1998, filed an action in the District Court of Cherokee County,
Oklahoma, styled as Kathy Jordan, Plaintiff v. SkyMall, Inc. a corporation, and
John Doe(s), et al., Defendants, which is designated as Case No. CJ-98-208.
Plaintiff alleges that SkyMall improperly collected from her certain state and
local taxes relating to her purchase. Plaintiff brought the action on behalf of
herself and a class of persons in the United States similarly situated. She
alleges causes of action for unjust enrichment, fraud, breach of contract, and
declaratory judgement, and seeks return of allegedly unlawful revenue collected
with interest, an injunction against collecting taxes improperly, compensatory
and punitive damages, and attorneys' fees and costs. The Company believes Ms.
Jordan's claims are without merit and intends to vigorously defend this action.
On January 29, 1999, a securities class action complaint was filed against
SkyMall and Robert Worsley, the Company's Chief Executive Officer, Chairman and
principal shareholder, in connection with certain disclosures made by the
Company in December 1998 relating to its Internet sales. The complaint was filed
in the United States District Court, District of Arizona, Case No.
CIV-99-0166-PHX-ROS. The complaint alleges unlawful manipulation of the price of
the Company's stock and insider selling during the period from December 28, 1998
through December 30, 1998. The complaint seeks unspecified damages for alleged
violations of federal securities laws. SkyMall believes that the allegations
against it and Mr. Worsley are without merit and intends to vigorously defend
the lawsuit.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the fourth
quarter of 1998.
14
<PAGE>
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED
STOCKHOLDER MATTERS
SkyMall's Common Stock is traded on the Nasdaq Stock Market's National
Market under the symbol "SKYM". The following table sets forth, for the periods
indicated, the high and low sales prices per share of the Common Stock for the
two most recent fiscal years as reported on Nasdaq. As of March 22, 1999, the
closing sale price for SkyMall's Common Stock was $12.125 per share. On that
date, there were 193 holders of record of SkyMall's Common Stock. This figure
does not reflect beneficial stockholders whose shares are held in nominee names.
YEAR ENDED 1998 HIGH LOW
1st Quarter $ 5.375 $4.000
2nd Quarter $ 7.500 $4.000
3rd Quarter $ 5.625 $2.250
4th Quarter $48.000 $1.875
YEAR ENDED 1997 HIGH LOW
1st Quarter $10.500 $8.000
2nd Quarter $ 8.500 $5.500
3rd Quarter $ 7.750 $4.125
4th Quarter $ 6.875 $4.125
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.
15
<PAGE>
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 each of the five years ended
December 31, 1998 are derived from the Consolidated Financial Statements of the
Company and its subsidiaries, which have been audited by Arthur Andersen LLP,
independent public accountants, and should be read in conjunction with the
Consolidated 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,
-----------------------------------------------------------------
1998 1997 1996 1995 1994
----------- ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Merchandise sales, net $ 49,320 $ 42,844 $ 30,978 $ 26,883 $ 22,062
Placement fees and other 16,937 17,974 12,707 16,198 8,241
----------- ----------- ----------- ---------- ----------
Total revenues 66,257 60,818 43,685 43,081 30,303
Cost of goods sold 33,507 35,099 24,257 24,564 16,266
----------- ----------- ----------- ---------- ----------
Gross Margin 32,750 25,719 19,428 18,517 14,037
----------- ----------- ----------- ---------- ----------
Catalog expenses 11,155 9,082 7,670 9,532 9,644
Selling expenses 3,474 3,450 2,476 2,229 2,754
Customer service and fulfillment expenses 5,567 4,438 2,823 2,136 2,919
General and administrative expenses 8,700 6,340 3,340 3,112 5,886
Restructure charges 0 0 0 0 4,332
----------- ----------- ----------- ---------- ----------
Total operating expenses 28,896 23,310 16,309 17,009 25,535
----------- ----------- ----------- ---------- ----------
Income (loss) from operations 3,854 2,409 3,119 1,508 (11,498)
Interest and other income (expense), net 404 462 (651) (750) (688)
----------- ----------- ----------- ---------- ----------
Income (loss) before income taxes 4,258 2,871 2,468 758 (12,186)
Income taxes 1,707 300 280 0 0
----------- ----------- ----------- ---------- ----------
Net income (loss) 2,551 2,571 2,188 758 (12,186)
Preferred stock dividends 0 0 77 0 0
----------- ----------- ----------- ---------- ----------
Net income (loss) available for
Common shares $ 2,551 $ 2,571 $ 2,111 $ 758 $ (12,186)
=========== =========== =========== ========== ==========
Diluted net income (loss) per common share $ .30 $ .30 $ .38 $ .14 $ (3.43)
Diluted weighted average shares outstanding 8,540,592 8,675,803 5,599,443 5,431,337 3,557,787
</TABLE>
16
<PAGE>
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------------------------------------------
1998 1997 1996 1995 1994
----------- ----------- ----------- ----------- ----------
<S> <C> <C> <C> <C> <C>
SELECTED OPERATING DATA (UNAUDITED):
Number of domestic enplanements
(in 000's)(1) 604,169 579,822 530,661 498,611 481,755
Domestic enplanement percentage (2) 68% 70% 63% 64% 72%
Revenue per passenger enplanement (3) $ 0.12 $ 0.11 $ 0.09 $ 0.08 $ 0.06
Number of airlines at end of period (4) 16 16 15 20 21
Number of catalogs produced (in 000's) (5) 17,973 16,933 15,729 17,162 15,747
Average number of pages per catalog (6) 192 168 148 137 133
Revenue per catalog produced (7) $ 2.74 $ 2.53 $ 1.97 $ 1.57 $ 1.40
Revenue per page printed (8) $ 0.014 $ 0.015 $ 0.013 $ 0.011 $ 0.011
BALANCE SHEET DATA:
Cash and cash equivalents $ 7,785 $ 9,412 $ 11,491 $ 775 $ 896
Working capital (deficit) 4,838 6,050 6,692 (4,734) (7,540)
Total assets 32,666 26,634 19,721 4,726 5,913
Long-term debt 44 66 139 10,818 8,082
Shareholders' equity (deficit) $ 14,263 $ 10,307 $ 8,601 $ (15,033) $ (15,791)
</TABLE>
- -------------
(1) Approximate number of revenue passengers flown on scheduled domestic
airlines in the given period.
(2) Approximate number of passenger enplanements on domestic airlines that
carried the SkyMall catalogs 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 from all Company
programs for the period divided by the approximate number of domestic
enplanements during the period on all scheduled domestic airlines that
carried the SkyMall catalogs.
(4) Represents the number of airlines at end of period with which the Company
had an agreement to carry the SkyMall catalogs. During the year ended
December 31, 1996, the Company eliminated unprofitable circulation of the
SkyMall catalogs by eliminating routes on certain airlines and terminating
agreements with certain smaller regional airlines.
(5) Represents the number of SkyMall catalogs produced by the Company during
the period for distribution to airlines.
(6) Represents the average number of pages in the SkyMall catalogs during the
period.
(7) Represents net merchandise sales from all Company programs for the period
divided by the number of SkyMall catalogs produced by the Company during
the period.
(8) Represents net merchandise sales from all Company programs for the period
divided by the number of SkyMall catalogs produced multiplied by the
average number of pages per catalog during the period.
17
<PAGE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion and analysis provides information which management
believes is relevant to an assessment and understanding of the Company's results
of operations and financial condition. The discussion should be read in
conjunction with the Consolidated Financial Statements and the related notes
thereto, and the Selected Financial and Operating Data contained elsewhere
herein.
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,
-------------------------------
1998 1997 1996
------ ------ ------
Net merchandise sales 74% 70% 71%
Placement fees and other 26% 30% 29%
---- ---- ----
Total revenues 100% 100% 100%
---- ---- ----
Gross margin 49% 42% 44%
---- ---- ----
Catalog expenses 17% 15% 17%
Selling expenses 5% 6% 6%
Customer service and fulfillment expenses 8% 7% 6%
General and administrative expenses 13% 10% 8%
---- ---- ----
Total operating expenses 43% 38% 37%
---- ---- ----
Income from operations 6% 4% 7%
==== ==== ====
1998 COMPARED TO 1997
CONSOLIDATED REVENUE AND GROSS MARGIN. Net merchandise sales increased
15.2% to $49.3 million in 1998 from $42.8 million in 1997. The increase is due
to revenue generated from an increase in catalog distribution of 6.1%, a 14.3%
increase in average pages per catalog and the acquisition of Durham & Company in
the fourth quarter of 1998, which contributed 1.7% of the Company's total
revenue. Placement fees and other revenues decreased 6.1% to $16.9 million in
1998 from $18.0 million in 1997. Gross margin increased 27.6% to $32.8 million
in 1998 from $25.7 million in 1997. The decrease in placement fees and increase
in gross margin was primarily due to a change in the mix of agreements with
merchants, emphasizing more variable compensation associated with merchandise
sales versus fixed placement fees.
CONSOLIDATED OPERATING EXPENSES. Total operating expenses increased to
$28.9 million, or 43.6% of total revenues in 1998 from $23.3 million or 38.3% of
total revenues in 1997. Catalog expenses increased to $11.2 million, or 16.8% of
total revenues in 1998 from $9.1 million, or 14.9% of total revenues in 1997.
The increase is due primarily to increases in (i) average pages per catalog of
14.3% and (ii) average equivalent paper cost per hundred weight to $47 in 1998
from $41 in 1997, or 14.6%. The total number of catalogs distributed increased
6.1% in 1998 from 1997 levels. Selling expenses, which represent commissions
18
<PAGE>
paid to airline and marketing partners and are generally variable in nature,
decreased as a percentage of revenue to 5.2% in 1998 from 5.7% in 1997. Customer
service and fulfillment expenses, which include a full-service customer contact
and order fulfillment center, increased to $5.6 million, or 8.4% of total
revenues in 1998 compared to $4.4 million, or 7.3% of total revenues in 1997.
The increase in customer service and fulfillment expense is primarily due to the
addition of management and call center personnel along with outsourcing
solutions and other expenditures designed to improve the Company's customer
service levels. General and administrative expenses increased to $8.7 million,
or 13.1% of total revenues in 1998 from $6.3 million, or 10.4% of total revenues
in 1997. The increase is primarily due to the addition of key management
personnel, marketing promotions, information technology personnel, depreciation
and other infrastructure investments relating to the Company's new business
initiatives.
CONSOLIDATED INCOME FROM OPERATIONS. Income from operations was $3.9
million, or 5.8% of total revenues in 1998, an increase from $2.4 million, or
4.0% of total revenues in 1997, as a result of the items discussed above.
CONSOLIDATED INCOME TAXES. Income tax expense totaled $1.7 million in 1998
compared to $300,000 in 1997. Income tax expense for 1998 approximated the
statutory rate. Income tax expense for 1997 was lower than the statutory rate
due to a reduction in certain timing differences, as well as the elimination of
the valuation allowance for deferred tax asset items.
1997 COMPARED TO 1996
REVENUE AND GROSS MARGIN. Net merchandise sales increased to $42.8 million
in 1997 from $31.0 million in 1996, or 38%. The increase is primarily due to
increases over the prior year in catalog distribution of 8% and in net
merchandise revenue per page printed of 13%. Placement fees and other revenues
increased to $18.0 million in 1997 from $12.7 million in 1996, or 41%. Gross
margin increased to $25.7 million in 1997 from $19.4 million in 1996, or 32%;
however, gross margin declined to 42% of total revenues in 1997 from 44% in
1996. The decrease in gross margin percentage was primarily due to a change in
the mix of agreements with merchants which resulted in higher placement fees,
but retention of a lower percentage of net merchandise sales in 1997.
OPERATING EXPENSES. Total operating expenses increased to $23.3 million or
38% of total revenues in 1997 from $16.3 million or 37% of total revenues in
1996. Catalog expenses, consisting of catalog production, paper, and printing
costs, increased to $9.1 million in 1997 from $7.7 million in 1996, or 17%. The
increase is due to increases in catalog distribution of 8% and in average pages
per catalog of 14% in 1997 compared to 1996, offset in part by a decrease in
average paper cost per hundred weight to $41 in 1997 from $55 in 1996. Selling
expenses, which represent commissions paid to airlines and marketing partners,
remained constant at 6% of total revenues. Customer service and fulfillment
expenses, which include a full-service customer contact and order fulfillment
center, increased to $4.4 million, or 7% of total revenues, in 1997 compared to
$2.8 million, or 6% of total revenues, in 1996. The increase in customer service
and fulfillment expense in 1997 is due primarily to the addition of call center
personnel. General and administrative expenses increased to $6.3 million in 1997
from $3.3 million in 1996. The increase is due primarily to the addition of key
management personnel and other infrastructure investments to support anticipated
future business growth. During fourth quarter of 1997, the Company launched
several new business initiatives including an international catalog, an expanded
electronic commerce initiative, and a specialty catalog distributed in
membership-oriented airport lounges.
INCOME FROM OPERATIONS. Income from operations was $2.4 million or 4% of
total revenues in 1997, a decrease from $3.1 million or 7% of total revenues in
1996, as a result of the items discussed above.
19
<PAGE>
INCOME TAXES. Income tax expense amounted to $300,000 in 1997 compared to
$280,000 in 1996. Income tax expense in 1997 was lower than the statutory rate
due to a reduction in certain temporary differences, as well as the elimination
of the valuation allowance for deferred tax asset items. Income tax expense in
1996 was lower than the statutory rate due to the conversion from an S
corporation to a C corporation in October, 1996.
LIQUIDITY AND CAPITAL RESOURCES
Cash provided by operating activities was $4.3 million, $2.6 million and
$2.2 million in 1998, 1997, and 1996, respectively. The increase in 1998 cash
provided by operating activities compared to 1997 resulted primarily from a
change in the billing methods of the Company, timing of cash receipts and
disbursements and the positive tax effects of certain transactions. The increase
in 1997 over 1996 cash provided by operating activities resulted primarily from
an increase in net income and timing of cash receipts and cash disbursements.
Cash used in investing activities was $6.1 million, $2.8 million and
$448,000 in 1998, 1997 and 1996, respectively. During 1998, the Company paid
$2.9 million in connection with the purchase of Durham & Company. Building
improvements and purchases of computer hardware and software totaled $3.2
million in 1998. During 1997, cash used in investing activities consisted
primarily of building improvements, furniture and fixtures, and computer
hardware and software relating to the Company's customer service center and
corporate offices. During 1996, cash used in investing activities consisted
primarily of telecommunications and computer hardware, and furniture and
fixtures.
Cash provided by financing activities totaled $123,000 in 1998. During
1998, the Company received $310,000 from the issuance of the Company's common
stock. The Company used cash to repurchase shares of the Company's common stock
for $127,000 and to make payments on capital leases of $60,000 in 1998. Cash
used in financing activities totaled $1.9 million in 1997. During 1997, the
Company made payments on notes payable of $1.0 million and repurchased shares of
the Company's common stock for $900,000. Cash provided by financing activities
totaled $9.0 million in 1996. The Company received cash from (i) its initial
public offering resulting in net proceeds of $14.0 million and (ii) issuance of
preferred stock for $2.5 million. The Company used $7.5 million for payment of
debt obligations in 1996.
WORKING CAPITAL AND NEGATIVE PROFITABILITY TRENDS
The Company plans to spend substantial additional resources in 1999 in
connection with its electronic commerce and other growth initiatives. The
Company anticipates that such expenditures will approximate $20 million,
including approximately $8.0 million in capital expenditures, and plans to spend
such funds on a number of activities, including improving the Company's Web user
interface, improving the speed, stability and functionality of the Company's Web
site, implementing marketing and public relations initiatives to raise awareness
of the SkyMall brand name, securing additional content for the Company's Web
site, improving the selection and variety of products offered by the Company,
and recruiting and hiring additional personnel, particularly technology managers
and developers. Although the Company has been profitable in recent years, the
Company expects that the significant investment spending it plans to undertake
in 1999 will cause it to incur losses in 1999 in the range of approximately
$1.00 to $1.20 per share.
At December 31, 1998, the Company had net working capital of $4.8 million,
which included cash and cash equivalents of $7.8 million. Additionally, the
Company maintains a reducing revolving line of credit at a bank with a maximum
available line of $3.0 million. As of March 22, 1999, the entire balance of the
revolving line of credit was unused. Existing working capital is insufficient to
permit the Company to fully implement its business plan and growth strategy.
20
<PAGE>
Management plans to finance its working capital needs and capital expenditures
through a combination of funds from operations, the existing bank line of
credit, and by securing additional capital resources through the issuance of
debt or equity securities. There can be no assurance that the Company will be
able to secure additional capital to meet its working capital needs or to secure
such capital on terms favorable to the Company. A failure to secure such capital
may be detrimental to the Company and cause it to reduce or eliminate its growth
initiatives. See also, "ADDITIONAL FACTORS THAT MAY AFFECT FUTURE RESULTS."
CHANGES IN SECURITIES AND USE OF PROCEEDS
The Company conducted its initial public offering (the "Offering") in
December 1996, pursuant to a Form S-1 Registration Statement (File No.
333-17609), declared effective on December 11, 1996. The Company sold 2,000,000
shares of Common Stock to the public at a price of $8.00 per share, or $16.0
million in the aggregate.
The Company's actual expenses incurred in connection with the Offering were
approximately $2.0 million in the aggregate, resulting in approximately $14.0
million in net proceeds to the Company. For the period from December 16, 1996
through December 31, 1998, the Company used the net proceeds as follows:
approximately (i) $1.2 million for building improvements to the corporate
offices and the customer contact center, (ii) $3.3 million for the purchase and
installation of telephone and computer software and equipment, (iii) $4.0
million for the reduction of the Company's revolving line of credit, (iv)
$700,000 for marketing and promotional expenses, (v) $1.6 million for
development of additional circulation media, (vi) $1.0 million for the
repurchase of 164,400 of the Company's common shares, and (vii) $2.2 million for
the acquisition of Durham & Company in October 1998. None of the above mentioned
amounts consist of direct or indirect payments to affiliates. The preceding
discussion of the Company's use of net proceeds is based upon reasonable
estimates by management. Except for capital expenditures, the reduction of the
line of credit, the repurchase of the Company's common shares and the
acquisition of Durham & Company discussed in items (i), (ii), (iii), (vi) and
(vii) above, the Company's use of proceeds, as described herein, does not
represent a material change from that described in the Prospectus for the
Offering.
In October 1996, the Company issued 180,000 warrants to purchase Common
Stock of the Company to preferred shareholders in a private placement, at an
exercise price of $8.00 per share (the "Pre-IPO Warrants"). As of December 31,
1998, 20,400 of the Pre-IPO Warrants had been exercised, resulting in net
proceeds to the Company for fiscal 1998 of $163,200. In addition, during the
first quarter of the 1999 fiscal year, 129,900 of the Pre-IPO Warrants were
exercised, resulting in net proceeds to the Company of $1,039,200. Total net
proceeds from the exercise of the Pre-IPO Warrants as of March 22, 1999 was
$1,202,400. All of such proceeds are designated for general corporate purposes.
The shares issued upon exercise of the Pre-IPO Warrants were issued in reliance
upon the exemption provided under Section 4(2) of the Securities Act of 1933 and
Regulation D thereunder.
In December 1996, the Company issued 200,000 Warrants to purchase Common
Stock of the Company to the underwriters in the Company's Offering, at an
exercise price of $9.60 per share (the "Underwriter Warrants"). As of December
31, 1998, 160,000 of the Underwriter Warrants were exercised by cashless
exercise. In addition, in January 1999, the remaining 40,000 of the Underwriter
Warrants were exercised by cashless exercise. The Company did not receive any
proceeds as a result of these warrant exercises. The shares were issued upon
exercise of the Underwriter Warrants in reliance on the exemption provided under
Section 4(2) of the Securities Act of 1933 and Regulation D thereunder.
21
<PAGE>
During the 1998 fiscal year, 105,536 Options were exercised under the
Company's 1994 Stock Option Plan at exercise prices ranging from $4.38 to $8.00
per share, resulting in net proceeds from the exercise of the Options of
$549,375 including a receivable from an employee of approximately $401,000 that
was collected subsequent to December 31, 1998. Such proceeds are designated for
general corporate purposes.
FLUCTUATION 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 typically
recognizes its highest sales levels during the fourth quarter, and during 1998
the fourth quarter accounted for approximately 41% of the Company's annual net
merchandise sales.
The following table sets forth certain unaudited information about the
Company's revenue and results of operations on a quarterly basis for 1998 and
1997.
<TABLE>
<CAPTION>
Year Ended Year Ended
December 31, 1998 December 31, 1997
---------------------------------- ----------------------------------
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 $ 9,234 $ 10,131 $ 9,657 $20,298 $ 8,084 $ 8,596 $ 9,175 $16,989
Placement fees and other 3,930 3,639 3,935 5,433 3,507 3,703 3,793 6,971
------- ------- ------- ------- ------- ------- ------- -------
Total revenues 13,164 13,770 13,592 25,731 11,591 12,299 12,968 23,960
------- ------- ------- ------- ------- ------- ------- -------
Gross margin 6,355 6,639 7,225 12,531 4,981 5,346 5,261 10,131
------- ------- ------- ------- ------- ------- ------- -------
Catalog expenses 2,663 2,717 2,723 3,052 1,889 2,033 2,004 3,156
Selling expenses 864 821 816 973 670 702 736 1,342
Customer service and fulfillment expenses 1,099 912 940 2,616 987 987 912 1,552
General and administrative expenses 1,761 1,939 2,224 2,776 1,092 1,443 1,394 2,411
------- ------- ------- ------- ------- ------- ------- -------
Total operating expenses 6,387 6,389 6,703 9,417 4,638 5,165 5,046 8,461
------- ------- ------- ------- ------- ------- ------- -------
Income from operations $ (32) $ 250 $ 522 $ 3,114 $ 343 $ 181 $ 215 $ 1,670
======= ======= ======= ======= ======= ======= ======= =======
</TABLE>
RECENTLY ISSUED ACCOUNTING STANDARDS
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, Accounting for Derivative Instruments
and Hedging Activities. The Statement establishes accounting and reporting
standards requiring that every derivative instrument (including certain
derivative instruments embedded in other contracts) be recorded in the balance
sheet as either an asset or liability measured at its fair value. The Statement
requires that changes in the derivative's fair value be recognized currently in
earnings unless specific hedge accounting criteria are met. Special accounting
for qualifying hedges allows a derivative's gains and losses to offset related
results on the hedged item in the income statement, and requires that a company
must formally document, designate, and assess the effectiveness of transactions
that receive hedge accounting.
Statement 133 is effective for fiscal years beginning after June 15, 1999.
A company may also implement the Statement as of the beginning of any fiscal
quarter after issuance (that is, fiscal quarters beginning June 16, 1998 and
thereafter). Statement 133 cannot be applied retroactively. Statement 133 must
be applied to (a) derivative instruments and (b) certain derivative instruments
22
<PAGE>
embedded in hybrid contracts that were issued, acquired, or substantively
modified after December 31, 1997 (and, at the company's election, before January
1, 1998). Application of the Statement's requirements is not expected to have a
material impact on the Company's financial position, results of operations, or
earnings per share data as currently reported.
SEGMENT DISCLOSURE
During the fourth quarter of 1998, the Company acquired Durham & Company.
This acquisition created two reportable segments as required under Financial
Accounting Standards Board SFAS No. 131 "DISCLOSURES ABOUT SEGMENTS OF AN
ENTERPRISE AND RELATED INFORMATION." Operating segment information pertaining to
revenues, gross margins, operating income and assets is provided in the Notes to
Consolidated Financial Statements filed herewith.
ADDITIONAL FACTORS THAT MAY AFFECT FUTURE RESULTS
In addition to other information in this Annual Report on Form 10-K, the
following important factors should be carefully considered in evaluating the
Company and its business because such factors currently have a significant
impact or may have a significant impact on the Company's business, prospects,
financial condition and results of operations.
WE MAY NOT BE PROFITABLE IN THE FUTURE. Although we have been profitable in
recent years, we plan to significantly increase spending on our growth
initiatives from historical levels and we expect to incur losses in the
foreseeable future. We estimate that we will incur losses of approximately $1.00
- - $1.20 per share in 1999. In addition, although we plan to spend significant
additional resources in connection with the execution of our growth strategy,
including for marketing, technological development and personnel costs, there
can be no assurance that we can successfully deploy such resources to accomplish
the objectives of our growth strategies and increase the revenues of the
Company.
WE MAY NOT BE ABLE TO RAISE SUFFICIENT CAPITAL. Our current working
capital, along with our existing line of credit, is not sufficient to permit the
Company to fully implement its business plan. In order to fully implement our
growth strategy, we will need to raise additional capital from third parties or
otherwise secure additional financing for the Company. There can be no assurance
that the Company will be able to successfully raise additional capital or secure
other financing, or that such funding will be available on terms that are
favorable to the Company. To the extent we are unable to raise sufficient
additional capital or secure other financing, we may be unable to fully
implement our planned growth strategy.
OUR BUSINESS MAY NOT GROW IN THE FUTURE. Since our inception, we have
rapidly expanded our operations, growing from total revenues of $200,000 in 1990
to total revenues of $66.3 million in 1998. Our continued future growth will
depend to a significant degree on our ability to increase revenues from our
existing businesses, maintain existing channel partner relationships and develop
new channel partner relationships, expand our product and content offering to
consumers, while maintaining adequate gross margins, and implement other
programs that increase the circulation of the SkyMall print catalogs and
generate traffic for our e-commerce programs. Our ability to implement our
growth strategy will also depend on a number of other factors, many of which are
or may be beyond our control, including (i) our ability to select products that
appeal to our customer base and effectively market them to our target audience,
(ii) sustained or increased levels of airline travel, particularly in domestic
airline markets, (iii) increasing adoption by consumers of the Internet for
shopping, (iv) the continued perception by participating merchants that we offer
an effective marketing channel for their products and services, and (v) our
ability to attract, train and retain qualified employees and management. There
can be no assurance that we will be able to successfully implement our growth
strategy.
23
<PAGE>
OUR FUTURE GROWTH IS IN PART DEPENDENT UPON THE CONTINUED GROWTH OF THE
ELECTRONIC COMMERCE MARKET. The market for the sale of products and services
over the Internet is a new and rapidly evolving market. Our future growth
strategy is partially dependent upon the widespread acceptance and use of
on-line services as an avenue for retail purchases. Consumers have only recently
begun to make purchases over the Internet and there is no assurance that they
will continue to do so in the future. In order for us to grow our on-line
customer base, we will need to attract purchasers who have historically relied
upon traditional venues for making their retail purchases. If use of on-line
services does not continue to grow as expected, or if the technological
infrastructure for the Internet is unable to effectively support its growing
use, our growth strategy may be materially adversely affected.
WE MAY BE UNABLE TO MANAGE THE POTENTIAL GROWTH OF OUR BUSINESS. Our
potential growth may place significant demands upon our personnel, management
and financial resources. In order to manage this growth, we may have to hire
additional personnel and develop additional management infrastructure. There is
no assurance that people with the necessary skills and experience will be
available as needed or on terms favorable to us. There is no assurance that our
current and planned personnel, systems, procedures and controls will be adequate
to support our future operations, that we will be able to attract, hire, train,
retain, motivate and manage necessary personnel, or that our management will be
able to identify, manage and exploit existing and potential strategic
relationships and market opportunities. If we are unable to effectively manage
any potential growth, our business and financial condition could be adversely
affected.
OUR PLANS FOR INTERNATIONAL EXPANSION POSE ADDITIONAL RISKS. A significant
aspect of our growth strategy is to expand our business internationally, through
our in-flight catalog program as well as the Internet. We have limited
experience in selling our products and services internationally. Such expansion
will place additional burdens upon our management, personnel and financial
resources and may cause the Company to incur losses. We will also face different
and additional competition in these international markets. In addition,
international expansion has certain unique risks, such as regulatory
requirements, legal uncertainty regarding liability, tariffs and other trade
barriers, difficulties in staffing and managing foreign operations, longer
payment cycles, political instability and potentially adverse tax implications.
To the extent we expand our business internationally, we will also become
subject to risks associated with international monetary exchange fluctuations.
Any one of these risks could impair our ability to expand internationally as
well as have a material adverse impact upon our overall business operations,
growth and financial condition.
WE FACE INTENSE COMPETITION. The distribution channels for our products are
highly competitive. From time to time in our airline catalog business,
competitors, typically other catalog retailers, have attempted to secure
contracts with various airlines to offer merchandise to their customers.
American Airlines currently offers merchandise catalogs to their customers
through a competitor. Various international airlines also offer merchandise
catalogs to their passengers through our competitors. We also face competition
for customers from airport-based retailers, duty-free retailers, specialty
stores, department stores and specialty and general merchandise catalogs, many
of which have greater financial and marketing resources than we have. In
addition, we compete for customers with other in-flight marketing media, such as
airline-sponsored in-flight magazines and airline video programming. In our
electronic commerce sales, we face intense competition from other content
providers and retailers who seek to offer their products and/or services at
their own Web sites or those of other third parties. The success of on-line
marketing cannot be currently determined, and further penetration in this market
will require substantial additional financial resources, acquisition of
technology, investments in marketing and contractual relationships with third
parties. Results will also be affected by existing competition, which the
Company anticipates will intensify, and by additional entrants to the market who
may already have the necessary technology and expertise, many of whom may have
substantially greater resources than the Company.
24
<PAGE>
DEPENDENCE ON CHANNEL RELATIONSHIPS. Our business depends significantly on
our relationships with the airlines, affiliate Web sites, hotels and other
channel partners. Our agreements with our channel partners are typically
short-term allowing the partner to terminate the relationship on 60 to 180 days'
advance notice. There is no assurance that our channel partners will continue
their relationships with us and the loss of one or more of our significant
channel partners could have a material adverse effect on our financial condition
and results of operations.
WE MAY BE UNABLE TO MAINTAIN HISTORICAL MARGIN LEVELS. Although our gross
margin levels on sales of our products have increased in recent years, we may be
unable to further increase or maintain our gross margins at historical levels,
particularly for our electronic commerce initiatives. As competition in on-line
shopping intensifies, our merchant participants may be unable or unwilling to
participate in our programs when more favorable economic arrangements may be
available from other third parties. Although many of our merchants have
participated with us for several years, most of our relationships are short-term
and may be re-negotiated by the merchant every 90 days. To the extent our gross
margins decline from historical levels, our financial condition and results of
operations may be adversely affected.
WE FACE CREDIT RISKS. Some participating merchants agree to pay a placement
fee to us for including their merchandise in our programs. We record an account
receivable from the merchant for the placement fee. In some cases, we collect
the placement fee either from the merchant or by withholding it from amounts due
to the merchant for merchandise sold. To the extent that the placement fee
receivable exceeds the sales of the merchant's products and the merchant is
unable or unwilling to pay the difference to us, we may experience credit losses
which could have a material adverse effect on our financial condition and
results of operations.
WE ARE VULNERABLE TO INCREASES IN PAPER COSTS AND AIRLINE FUEL PRICES. The
cost of paper used to print our catalogs and the fees paid to airlines to
reimburse them for the increased fuel costs associated with carrying our
catalogs are significant expenses of our operations. Historically, paper and
airline fuel prices have fluctuated significantly from time to time. Prices in
the paper market can and often do change dramatically over a short period of
time. Any significant increases in paper or airline fuel costs that we must pay
could have a material adverse effect on our financial condition and results of
operations.
OUR INFORMATION AND TELECOMMUNICATIONS SYSTEMS MAY FAIL OR BE INADEQUATE.
We process a large volume of relatively small orders. Consequently, our success
depends to a significant degree on the effective operation of our information
and telecommunications systems. These systems could fail for unanticipated
reasons or they may be inadequate to process any increase in our sales volume
that may occur. Any extended failure of our information and telecommunications
systems could have a material adverse effect on our financial condition and
results of operations.
WE FACE RISKS ASSOCIATED WITH ON-LINE SECURITY BREACHES OR FAILURES. In
order to successfully make sales over the Internet, it is necessary that we be
able to ensure the secure transmission of confidential customer information over
public telecommunications networks. We employ certain technology in order to
protect such information, including customer credit card information. However,
there is no assurance that such information will not be intercepted illegally.
Advances in cryptography or other developments that could compromise the
security of confidential customer information could have a direct negative
impact upon our electronic commerce business. In addition, the perception by
consumers that making purchases over the Internet is not secure, even if
unfounded, will mean that fewer consumers are likely to make purchases through
that medium. Finally, any breach in security, whether or not a result of our
acts or omissions, may cause us to be the subject of litigation, which could be
very time-consuming and expensive to defend.
25
<PAGE>
OUR BUSINESS IS SEASONAL. Our business is seasonal in nature, with the
greatest volume of sales typically occurring during the Holiday selling season
of the fourth calendar quarter. During 1998, approximately 41% of our net
merchandise sales were generated in the fourth quarter. Any substantial decrease
in sales for the fourth quarter could have a material adverse effect on our
results of operations.
WE FACE RISKS OF INCREASED GOVERNMENTAL REGULATION AND OTHER LEGAL
UNCERTAINTIES. Our electronic commerce activities are not currently subject to
significant regulation, other than those applicable to businesses generally.
However, electronic commerce is a new market and it is likely that regulations
and laws may be enacted in the future which would apply to our electronic
commerce activities. Any such laws or regulations could result in additional
costs associated with such activities, reduce or inhibit the growth of Internet
use, thereby reducing the growth of our electronic commerce business, or have
other adverse effects. Additionally, certain states or international
jurisdictions could enact laws that would require us to register in such
jurisdictions, pay fees or otherwise increase our costs of doing business.
WE FACE A RISK OF PRODUCT LIABILITY CLAIMS. Our catalogs and electronic
commerce sites typically feature over 3,500 products and services from more than
100 participating merchants. Generally, our agreements with these participating
merchants require the merchants to indemnify us and thereby be solely
responsible for any losses arising from product liability claims made by
customers, including the costs of defending any such claims, and to carry
product liability insurance that names SkyMall as an additional insured. In
addition, we maintain product liability insurance in the aggregate amount of
$2.0 million and $1.0 million per occurrence. If a merchant was unable or
unwilling to indemnify us as required, and any such losses exceeded our
insurance coverage or were not covered by our insurer, our financial condition
and results of operations could be materially adversely affected.
WE RELY UPON OUR PRESIDENT AND OTHER KEY PERSONNEL. We depend on the
continued services of Robert M. Worsley, our chairman, president and chief
executive officer, and on the services of certain other executive officers. The
loss of Mr. Worsley's services or of the services of certain other executive
officers could have a material adverse effect on our business.
THE WORSLEYS CAN CONTROL MANY IMPORTANT COMPANY DECISIONS. As of March 22,
1999, Mr. Worsley and his wife (the "Worsleys") beneficially own 4,577,416
shares, or approximately 52% of our outstanding Common Stock. As a result, the
Worsleys have the ability to significantly influence the affairs of the Company
and matters requiring a shareholder vote, including the election of the
Company's directors, the amendment of the Company's charter documents, the
merger or dissolution of the Company, and the sale of all or substantially all
of the Company's assets. The voting power of the Worsleys may also discourage or
prevent any proposed takeover of the Company pursuant to a tender offer.
THE PRICE OF OUR COMMON STOCK IS EXTREMELY VOLATILE. The market price of
our Common Stock has been highly volatile. Occurrences that could cause the
trading price of our Common Stock to fluctuate dramatically in the future
include:
o new merchant agreements
o the acquisition or loss of one or more airline, electronic commerce
or other channel partners
o fluctuations in our operating results
o analyst reports, media stories, Internet chat room discussions,
news broadcasts and interviews
o market conditions for retailers in general
o changes in airline fuel, paper or our other significant expenses
o decreases in the commissions we are able to negotiate with our
merchants
26
<PAGE>
The stock market has from time to time experienced extreme price and volume
fluctuations that have particularly affected the market price for companies that
do some or all of their business on the Internet. Although Internet sales
represent only a small portion of our business, the price of our Common Stock
may nonetheless be impacted by these or other trends.
WE FACE RISKS ASSOCIATED WITH THE YEAR 2000
BACKGROUND. Many software programs use only two digits to identify the year
in the date field. If such programs are not corrected, data that includes a date
in the Year 2000 or later could cause many computer applications to fail,
lock-up or generate erroneous results. Further, certain computer programs may
not properly process the dates of September 9, 1999 or February 29, 2000. This
potential problem is generally referred to as the "Year 2000 Issue." We have
initiated a program to evaluate and address our exposure to the Year 2000 Issue.
If not corrected, many computer applications could fail or create erroneous
results.
OUR STATE OF READINESS. We have a program in process to identify our
exposure to the Year 2000 Issue and we have begun to implement measures to
mitigate any problems. We believe we have identified all significant internal
systems and applications that require attention of some form in order to address
Year 2000 Issue risks.
Our information or production systems which consist of order entry, order
conveyance and customer service are primarily based on the Microsoft suite of
products and the hardware is principally late model Compaq servers, both of
which are designed and represented to meet Year 2000 Issue functional
requirements. We are in the process of testing these systems to confirm that
they are Year 2000 compliant.
We have other non-production systems such as internal security systems,
telephone systems, and network computer equipment, which we are also currently
reviewing for Year 2000 compliance. In addition, we are surveying certain third
parties, such as our vendor partners, banks and telephone service providers, to
attempt to determine the Year 2000 Issue capability of their critical systems
upon which our essential business operations are dependent.
COSTS. The financial and resource demands of our Year 2000 Issue project
are estimated to total less than $100,000. Much of this amount represents
existing resources which will be used to survey third parties, review internal
and external systems environments, analyze potential impacts and document our
efforts.
RISKS. We believe that our most significant worst case Year 2000 Issue
scenarios involve the inability of our vendors to process orders and conduct
business such as arranging deliveries to customers and replenishing inventories.
We do not currently have enough data to make an accurate assessment of the
potential impact of a material failure of our vendors to be adequately prepared
for the Year 2000 Issue.
CONTINGENCY PLANS. We have not yet developed formal contingency plans to
address the possibility that our critical systems, as well as those of our key
business partners on which we rely, will experience significant interruption as
a result of the Year 2000 Issue. We will develop contingency plans in the coming
months if such plans are deemed necessary after a more thorough evaluation of
all of our mission critical systems and the results of our review of the systems
of our third-party providers.
UNCERTAINTY. To the extent we are unable to adequately identify, evaluate
and address all of the Year 2000 Issues relating to our business, or are unable
to develop and implement effective contingency plans, we could experience a
significant disruption of our ability to receive and process customer orders, in
which case our financial condition and results of operations would be likely to
be materially adversely affected.
27
<PAGE>
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK.
Not Applicable.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEX TO FINANCIAL STATEMENTS
PAGE
Report of Independent Public Accountants....................................F-1
Consolidated Balance Sheets as of December 31, 1998 and 1997................F-2
Consolidated Statements of Income for the Years Ended
December 31, 1998, 1997 and 1996.........................................F-3
Consolidated Statements of Shareholders' Equity (Deficit) for the
Years Ended December 31, 1998, 1997 and 1996.............................F-4
Consolidated Statements of Cash Flows for the Years Ended December 31,
1998, 1997 and 1996......................................................F-5
Notes to Consolidated Financial Statements..................................F-6
28
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Shareholders of SkyMall, Inc.:
We have audited the accompanying consolidated balance sheets of SkyMall, Inc. (a
Nevada corporation) and subsidiaries, as of December 31, 1998 and 1997, and the
related consolidated statements of income, shareholders' equity (deficit) and
cash flows for the three years in the period ended December 31, 1998. 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 consolidated financial statements referred to above present
fairly, in all material respects, the financial position of SkyMall, Inc. and
subsidiaries as of December 31, 1998 and 1997, and the results of their
operations and their cash flows for the three years in the period ended December
31, 1998, in conformity with generally accepted accounting principles.
Phoenix, Arizona,
March 1, 1999.
F-1
<PAGE>
SKYMALL, INC.
CONSOLIDATED BALANCE SHEETS
(Amounts in thousands, except shares and par value)
<TABLE>
<CAPTION>
December 31,
-------------------
1998 1997
--------- --------
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 7,785 $ 9,412
Accounts receivable, net 12,351 10,427
Inventories 630 -
Prepaid catalog costs and other 1,513 1,863
Deferred income taxes 709 500
--------- --------
Total current assets 22,988 22,202
PROPERTY AND EQUIPMENT, net 6,474 4,133
GOODWILL, net 3,022 -
OTHER ASSETS, net 182 299
--------- --------
Total assets $32,666 $26,634
========= ========
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $11,665 $13,669
Accrued liabilities 1,217 1,863
Unearned revenue 4,281 -
Income taxes 761 556
Current portion of notes payable and capital leases 226 64
--------- --------
Total current liabilities 18,150 16,152
DEFERRED INCOME TAXES 209 109
NOTES PAYABLE AND CAPITAL LEASES, net of current portion 44 66
--------- --------
Total liabilities 18,403 16,327
--------- --------
COMMITMENTS AND CONTINGENCIES (Note 7)
SHAREHOLDERS' EQUITY:
Common stock, $0.001 par value; 50,000,000
shares authorized; issued and outstanding
shares - 8,725,415 in 1998 and 8,516,600
in 1997 9 9
Additional paid-in capital 8,128 6,723
Retained earnings 6,126 3,575
--------- --------
Total shareholders' equity 14,263 10,307
--------- --------
Total liabilities and shareholders' equity $ 32,666 $ 26,634
========= ========
</TABLE>
The accompanying notes are an integral part of these
consolidated balance sheets.
F-2
<PAGE>
SKYMALL, INC.
CONSOLIDATED STATEMENTS OF INCOME
(Amounts in thousands, except shares and per share)
<TABLE>
<CAPTION>
For the Year Ended December 31,
-------------------------------------
1998 1997 1996
----------- ----------- -----------
<S> <C> <C> <C>
REVENUES:
Merchandise sales, net $ 49,320 $ 42,844 $ 30,978
Placement fees and other 16,937 17,974 12,707
----------- ----------- -----------
Total revenues 66,257 60,818 43,685
COST OF GOODS SOLD 33,507 35,099 24,257
----------- ----------- -----------
Gross margin 32,750 25,719 19,428
----------- ----------- -----------
OPERATING EXPENSES:
Catalog expenses 11,155 9,082 7,670
Selling expenses 3,474 3,450 2,476
Customer service and fulfillment expenses 5,567 4,438 2,823
General and administrative expenses 8,700 6,340 3,340
----------- ----------- -----------
Total operating expenses 28,896 23,310 16,309
----------- ----------- -----------
INCOME FROM OPERATIONS 3,854 2,409 3,119
Interest expense (32) (71) (60)
Interest expense to shareholders - (28) (669)
Interest and other income 436 561 78
----------- ----------- -----------
INCOME BEFORE INCOME TAXES 4,258 2,871 2,468
Income taxes 1,707 300 280
----------- ----------- -----------
NET INCOME 2,551 2,571 2,188
PREFERRED STOCK DIVIDENDS - - 77
----------- ----------- -----------
NET INCOME AVAILABLE TO COMMON SHAREHOLDERS $ 2,551 $ 2,571 $ 2,111
=========== =========== ===========
BASIC NET INCOME PER COMMON SHARE $ .30 $ .30 $ .40
=========== =========== ===========
BASIC WEIGHTED AVERAGE SHARES OUTSTANDING 8,512,623 8,620,482 5,303,181
=========== =========== ===========
DILUTED NET INCOME PER COMMON SHARE $ .30 $ .30 $ .38
=========== =========== ===========
DILUTED WEIGHTED AVERAGE SHARES OUTSTANDING 8,540,592 8,675,803 5,599,443
=========== =========== ===========
</TABLE>
The accompanying notes are an integral part of these
consolidated financial statements.
F-3
<PAGE>
SKYMALL, INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (DEFICIT)
(Amounts in thousands, except shares)
<TABLE>
<CAPTION>
Convertible Retained
Preferred Stock Common Stock Additional Earnings/
-------------------- -------------------- Paid-in (Accumulated)
Shares Amount Shares Amount Capital Deficit) Total
--------- --------- --------- --------- ---------- ------------- ----------
<S> <C> <C> <C> <C> <C> <C> <C>
BALANCE, December 31, 1995 - $ - 5,150,000 $ 5 $ 18,438 $ (33,476) $ (15,033)
Issuance of preferred shares, net of
issuance costs 3,000 2,555 - - - - 2,555
Conversion of shareholder debt to
preferred shares 5,000 5,000 - - - - 5,000
Payment of dividend on preferred shares - (77) - - - - (77)
Issuance of common shares upon
conversion of preferred shares (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 - 13,968
Elimination of accumulated deficit upon
conversion from S corporation to
C corporation - - - - (32,292) 32,292 -
Net income - - - - - 2,188 2,188
--------- --------- --------- --------- ---------- ------------- ----------
BALANCE, December 31, 1996 - - 8,654,000 9 7,588 1,004 8,601
Repurchase of common shares - - (137,400) - (865) - (865)
Net income - - - - - 2,571 2,571
--------- --------- --------- --------- ---------- ------------- ----------
BALANCE, December 31, 1997 - - 8,516,600 9 6,723 3,575 10,307
Repurchase of common shares - - (27,000) - (127) - (127)
Stock option plans and other, net
of mature shares exchanged - - 235,815 - 1,432 - 1,432
Net income - - - - - 2,551 2,551
Warrants issued in connection
with asset purchase - - - - 100 - 100
--------- --------- --------- --------- ---------- ------------- ----------
BALANCE, December 31, 1998 - $ - 8,725,415 $ 9 $ 8,128 $ 6,126 $ 14,263
========= ========= ========= ========= ========== ============= ==========
</TABLE>
The accompanying notes are an integral part of these
consolidated financial statements.
F-4
<PAGE>
SKYMALL, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Amounts in thousands)
<TABLE>
<CAPTION>
For the Year Ended December 31,
---------------------------------------
1998 1997 1996
----------- ----------- -----------
<S> <C> <C> <C>
CASH FLOWS PROVIDED BY OPERATING ACTIVITIES:
Net income $ 2,551 $ 2,571 $ 2,188
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization 1,118 609 344
Provision for doubtful accounts 281 343 -
Deferred income taxes and other tax effects, net 878 (391) -
Change in assets and liabilities, net of effects of acquisition:
(Increase) decrease in:
Accounts receivable (1,329) (6,620) (3,258)
Inventory 22 - -
Prepaid catalog costs and other 351 51 (652)
Other assets 117 (174) (2)
(Decrease) increase in:
Accounts payable (2,256) 5,046 3,928
Accrued liabilities (1,413) 1,071 463
Unearned revenue 3,818 - -
Income taxes 205 276 280
Reserve for restructure charges - (165) (1,111)
----------- ----------- -----------
Net cash provided by operating activities 4,343 2,617 2,180
----------- ----------- -----------
CASH FLOWS USED IN INVESTING ACTIVITIES:
Purchase of property and equipment (3,193) (2,760) (448)
Payments for acquisition, net of cash acquired (2,900) - -
----------- ----------- -----------
Net cash used in investing activities (6,093) (2,760) (448)
----------- ----------- -----------
CASH FLOWS PROVIDED BY (USED IN) FINANCING ACTIVITIES:
Payments on notes payable and capital leases (60) (951) (4,090)
Payments on notes payable to shareholders - (120) (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 310 - 13,968
Repurchase of common shares (127) (865) -
----------- ----------- -----------
Net cash provided by (used in) financing activities 123 (1,936) 8,984
----------- ----------- -----------
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (1,627) (2,079) 10,716
CASH AND CASH EQUIVALENTS, beginning of year 9,412 11,491 775
----------- ----------- -----------
CASH AND CASH EQUIVALENTS, end of year $ 7,785 $ 9,412 $ 11,491
=========== =========== ===========
INCOME TAXES PAID $ 623 $ 415 $ -
=========== =========== ===========
TOTAL INTEREST PAID $ 32 $ 99 $ 1,217
=========== =========== ===========
INTEREST PAID TO SHAREHOLDERS $ - $ 28 $ 1,157
=========== =========== ===========
SUPPLEMENTAL DISCLOSURE OF NONCASH ACTIVITY:
Notes payable incurred with business acquisition $ 200 $ - $ -
=========== =========== ===========
Capital leases incurred $ - $ - $ 204
=========== =========== ===========
Notes payable to shareholders converted to preferred stock $ - $ - $ 5,000
=========== =========== ===========
Employee receivable for stock options exercised $ 401 $ - $ -
=========== =========== ===========
Mature shares received for stock options exercised $ 208 $ - $ -
=========== =========== ===========
</TABLE>
The accompanying notes are an integral part of these
consolidated financial statements.
F-5
<PAGE>
SKYMALL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998
(1) THE COMPANY:
NATURE OF ORGANIZATION
SkyMall, Inc. (the Company) was incorporated in 1989 as an Arizona corporation
(and reincorporated in Nevada in October 1996). The Company provides retail
merchandise service through in-flight catalogs placed in domestic and
international airlines, through the Company's Web site and through employee logo
and incentive merchandise catalogs. The Company maintains substantially no
inventory related to retail merchandise sold through the in-flight catalogs and
Web site. Substantially all products displayed in the Company's in-flight
catalogs and Web site are carried and fulfilled by participating merchants. At
December 31, 1998, the Company had agreements with 16 airlines to place its
catalogs in aircraft seat pockets. The Company operates on a calendar year end
of December 31.
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of the Company and
all wholly-owned subsidiaries. All significant intercompany accounts and
transactions have been eliminated.
USE OF ESTIMATES IN PREPARATION OF FINANCIAL STATEMENTS
The preparation of consolidated 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 consolidated
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 period.
RECLASSIFICATIONS
Certain reclassifications have been made in prior period consolidated financial
statements to conform to the current presentation.
F-6
<PAGE>
REVENUE RECOGNITION
The Company has two primary sources of revenue, net merchandise sales and
placement fees. Net merchandise sales represent product sales at retail prices
and are recognized as revenue upon shipment of product by the Company or
participating merchants, net of estimated returns and allowances. Placement fees
represent fees paid to the Company by participating merchants for inclusion of
their products in the Company's catalogs. Placement fee revenue is recognized on
a straight-line basis over the circulation period of a catalog, generally three
months. Cost of goods sold represents net amounts paid to participating
merchants for products sold and manufacturing costs including materials, labor
and overhead. Usually, the higher the placement fee the higher the percentage of
retail price of product sales remitted to participating merchants. Unearned
revenue represents amounts charged to participating merchants for future
placement fees and consumer credit cards in which all related products for that
charge have not been shipped.
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 the Company by
its participating merchants for provided fulfillment services. Any net amount
remaining is included in placement fees and other revenue in the accompanying
consolidated 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, leasehold improvements, goodwill 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, in order to meet its
obligations when they become due. In the opinion of management, based upon
current information, 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.
ACCOUNTS RECEIVABLE
Accounts receivable at December 31, 1998 and 1997, include amounts due from
credit card companies, items shipped but not billed, and merchant placement
fees. The allowance for doubtful accounts as of December 31, 1998 and 1997,
was approximately $1,205,000 and $222,000, respectively. In addition, at
December 31, 1997, the Company had approximately $400,000 in credits
recorded in accounts receivable and accounts payable related to non-trade
F-7
<PAGE>
receivable allowances. Although these amounts were not included in the accounts
receivable reserve at December 31, 1997, they represent additional reserves
which could be used for accounts receivable write-offs.
INVENTORIES
Inventories are primarily related to Durham & Company and are stated at the
lower of cost or market. Cost is determined using the first-in, first-out
method. Such cost includes raw materials, direct labor and overhead.
PREPAID CATALOG COSTS AND OTHER
Prepaid catalog costs primarily include 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.
GOODWILL
Goodwill represents the excess of the purchase price and related costs over the
value assigned to net tangible assets in connection with the acquisition of
Durham & Company in October 1998. Goodwill is amortized using the straight-line
method over 15 years. Amortization expense for 1998 was $52,192. At December 31,
1998, accumulated amortization of goodwill was $52,192.
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 shareholders of a Subchapter S corporation are taxed on their
portion of the Company's taxable income. Therefore, no provision for 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. 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
is recognized. In October 1995, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 123 requiring companies that
account for stock-based compensation as prescribed by APB No. 25 to disclose the
pro forma effects on earnings and earnings per share as if SFAS No. 123 had been
adopted and certain disclosures with respect to stock compensation and the
assumptions used to determine the pro forma effects of SFAS No. 123 (see Note
8).
F-8
<PAGE>
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 merchants
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 to offset using amounts payable to merchants 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 PER COMMON SHARE
The Company has adopted Statement of Financial Accounting Standards No. 128,
EARNINGS PER SHARE, resulting in the restatement of earnings per share for all
periods presented. Basic net income per common share is based upon the weighted
average shares outstanding. Outstanding stock options and warrants are treated
as common stock equivalents for the purposes of computing diluted net income per
common share and represent the difference between basic and diluted weighted
average shares outstanding. The following is a summary of the computation of
basic and diluted net income per common share (amounts in thousands, except per
share amounts):
For the Years Ended
December 31,
---------------------------------
1998 1997 1996
--------- --------- ---------
Basic net income per common share:
Income available to common shareholders $ 2,551 $ 2,571 $ 2,111
========= ========= =========
Weighted average common shares 8,513 8,621 5,303
========= ========= =========
Basic per share amount $ .30 $ .30 $ .40
========= ========= =========
For the Years Ended
December 31,
---------------------------------
1998 1997 1996
--------- --------- ---------
Diluted net income per common share:
Income available to common shareholders $ 2,551 $ 2,571 $ 2,111
========= ========= =========
Weighted average common shares 8,513 8,621 5,303
Dilutive effect of options and warrants
assumed converted 28 55 296
--------- --------- ---------
Total common shares plus assumed conversions 8,541 8,676 5,599
========= ========= =========
Diluted per share amount $ .30 $ .30 $ .38
========= ========= =========
F-9
<PAGE>
FINANCIAL INSTRUMENTS
The Company's financial instruments include cash, accounts receivable, accounts
payable, notes payable, and capital leases. Due to the short-term nature of
cash, accounts receivable, and accounts payable, the fair value of these
instruments approximates their recorded value. In the opinion of management,
based upon current information, the fair value of notes payable and capital
leases approximates market 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 (amounts in thousands):
Estimated
Useful December 31,
Life ---------------------
(Years) 1998 1997
--------- --------- ---------
Equipment and software 2-10 $ 6,461 $ 4,051
Buildings and leasehold improvements 15-40 2,735 2,022
Furniture, fixtures and other 3-7 668 586
--------- ---------
9,864 6,659
Accumulated depreciation (3,390) (2,526)
--------- ---------
$ 6,474 $ 4,133
========= =========
(4) OTHER ASSETS:
The following is a summary of other assets; purchased airline contracts are
amortized using the straight-line method over their estimated useful lives
(amounts in thousands):
Estimated
Useful December 31,
Life ---------------------
(Years) 1998 1997
--------- --------- ---------
Purchased airline contracts 10 $ 323 $ 323
Other, primarily noncurrent prepaid
expenses 108 195
--------- ---------
431 518
Accumulated amortization (249) (219)
--------- ---------
$ 182 $ 299
========= =========
F-10
<PAGE>
(5) NOTES PAYABLE AND CAPITAL LEASES:
Notes payable and capital leases consisted of the following (amounts in
thousands):
December 31,
-------------------
1998 1997
-------- --------
Capital leases, interest at varying rates
of 18% to 23%, due in monthly installments
(including interest) of approximately $5,000
through May 2001, secured by equipment $ 70 $ 130
Note payable, interest at 9%, due October 12, 1999 200 -
-------- --------
270 130
Less - current portion (226) (64)
-------- --------
$ 44 $ 66
======== ========
At December 31, 1998, aggregate annual maturities of capital leases were as
follows (amounts in thousands):
1999 $ 226
2000 28
2001 16
--------
$ 270
========
In January 1997, the Company obtained a $5 million reducing, revolving line of
credit (the Line) from a bank. Available borrowings are reduced by $1 million
annually, until February 2002, when the Line expires. At the Company's option,
advances made on the Line bear interest at either Prime to Prime plus 1.5%, or
LIBOR plus 2.25 to 3.25%, 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. No
balance was outstanding on the Line at December 31, 1998 or 1997.
(6) SEGMENT AND RELATED INFORMATION:
The Company adopted SFAS No. 131, DISCLOSURES ABOUT SEGMENTS OF AN ENTERPRISE
AND RELATED INFORMATION, in 1998 which changes the way the Company reports
information about its operating segments. The information for 1996 and 1997 has
been restated from the prior year's presentation in order to conform to the 1998
presentation.
During 1998, the Company was engaged principally in two lines of business:
retail merchandise services that provide retail merchandise service through
in-flight catalogs placed in domestic and international airlines and through the
Company's Web site; and workplace merchandise services, since the acquisition of
Durham & Company in October 1998, that provide employee logo and incentive
merchandise service through catalogs.
F-11
<PAGE>
The accounting policies of the reportable segments are the same as those
described in Note 2 of Notes to Consolidated Financial Statements. The Company
evaluates the performance of its operating segments based on income before
taxes. Intersegment transactions are not significant.
Summarized financial information concerning the Company's reportable segments is
shown in the following table (amounts in thousands).
1998 Retail Workplace Total
--------------------- ---------- --------- ---------
Revenues $ 65,135 $ 1,122 $ 66,257
Gross margins 32,300 450 32,750
Income before taxes 4,127 131 4,258
Total assets 28,294 4,372 32,666
1997 Retail Workplace Total
--------------------- ---------- --------- ---------
Revenues $ 60,818 $ - $ 60,818
Gross margins 25,719 - 25,719
Income before taxes 2,871 - 2,871
Total assets 26,634 - 26,634
1996 Retail Workplace Total
--------------------- ---------- --------- ---------
Revenues $ 43,685 $ - $ 43,685
Gross margins 19,428 - 19,428
Income before taxes 2,468 - 2,468
Total assets 19,721 - 19,721
(7) COMMITMENTS AND CONTINGENCIES:
LITIGATION
The Company is from time-to-time subject to complaints and claims arising in the
ordinary course of business. Management 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, 1998, the future minimum payments under these
leases are as follows (amounts in thousands):
1999 $ 221
2000 208
2001 205
2002 47
Thereafter 554
---------
$ 1,235
=========
F-12
<PAGE>
Other equipment and property are leased on a monthly basis. Total lease expense
for the years ended December 31, 1998, 1997 and 1996 was approximately $141,000,
$106,000, 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 approximately $74,000,
$99,000, and $118,000 for the years ended December 31, 1998, 1997 and 1996,
respectively, is included in interest and other income in the accompanying
financial statements. As of December 31, 1998, future minimum lease payments to
be received under non-cancelable leases are as follows (amounts in thousands):
1999 $ 127
2000 118
2001 109
2002 23
-------
$ 377
=======
401(K) PLAN
Under the Company's 401(k) plan (the 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 Plan's
trustee. The Plan permits participants to direct the investment of their account
balances among mutual or investment funds and the Company provides a matching
contribution of 50% of the first 6% a participant's contributions.
The total contributions made by the Company during the years ended December 31,
1998, 1997 and 1996, were approximately $77,000, $33,000, and $13,000,
respectively.
EMPLOYMENT CONTRACTS
The Company entered into employment contracts with its president and certain
officers which expire in September 1999 and January 2002, respectively. The
contracts may be terminated earlier under terms and circumstances described in
the agreements. Under certain circumstances, the president and certain officers
may receive the remaining amounts under the contract upon termination which
total $1,040,000, $850,000 and $850,000 for 1999, 2000 and 2001, respectively.
(8) 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 1,500,000 shares of common stock at an exercise
price of not less than fair market value at the date of grant.
F-13
<PAGE>
Under the Officer and Employee Plan, the option exercise price equals or exceeds
the stock's fair market value on date of grant. The Plan options generally fully
vest on varying schedules upon completion of three years of employment; options
expire ten years after the date of grant or three months after grantee's
employment termination.
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 on the date of grant.
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
fully vested upon grant and expire ten years after the date of issuance.
A summary of the status of the Company's Plans at December 31, 1998, 1997 and
1996, and changes during the years ended December 31, 1998, 1997 and 1996, are
presented in the table below (share amounts in thousands):
<TABLE>
<CAPTION>
December 31,
---------------------------------------------------------
1998 1997 1996
----------------- ----------------- -----------------
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
------ -------- ------ -------- ------ --------
<S> <C> <C> <C> <C> <C> <C>
Outstanding at beginning of period 604 $ 6.39 458 $ 6.21 271 $ 7.39
Granted 312 4.66 319 6.52 187 5.82
Exercised (106) 6.89 - - - -
Cancel shares repriced - - - - (135) 7.39
Shares repriced - - - - 135 5.56
Forfeited (266) 6.67 (173) 6.13 - -
Expired - - - - - -
------ -------- ------ -------- ------ --------
Outstanding at end of period 544 $ 5.82 604 $ 6.39 458 $ 6.21
====== ======== ====== ======== ====== ========
</TABLE>
Stock options outstanding and exercisable at December 31, 1998, are as follows
(option amounts in thousands):
Outstanding Exercisable
------------------------------ --------------------
Exercise Average Average
Price Average Exercise Exercise
Range Options Life(a) Price Options Price
------------- ------- ------- -------- ------- -------
$ 2.63-$5.56 358 9.17 $ 4.03 107 $ 5.00
8.00-12.56 186 9.22 9.25 154 8.54
------------- ------- ------- -------- ------- -------
$ 2.63-$12.56 544 9.19 $ 5.82 261 $ 7.09
============= ======= ======= ======== ======= =======
(a) Average contractual life remaining
F-14
<PAGE>
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 or in excess of 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 %, expected life of 1 to 10 years, dividend rate of zero,
and expected volatility of approximately 77%, 45%, and 50% for 1998, 1997, and
1996, respectively. Using these assumptions, the fair value of the stock options
granted in 1998, 1997, and 1996 is approximately $930,000, $709,000, 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 (amounts in
thousands except per common share amounts):
For the Years Ended
December 31,
---------------------------
1998 1997 1996
------- ------- -------
Net income available to common shareholders:
As reported $ 2,551 $ 2,571 $ 2,111
Pro forma 2,433 2,378 1,866
Basic net income per common share:
As reported $ .30 $ .30 $ .40
Pro forma .29 .28 .35
Diluted net income per common share:
As reported $ .30 $ .30 $ .38
Pro forma .28 .27 .33
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 merchant to
purchase common stock at exercise prices of $9.60, $8.00, and $8.00 per share,
respectively. In October 1997, the Company issued 100,000 warrants to outside
consultants to purchase common stock at an exercise price of $8.00 per share. As
of December 31, 1998, 160,000 warrants to underwriters and 20,400 warrants to
preferred shareholders had been exercised.
(9) INCOME TAXES:
Under the asset and liability method of SFAS No. 109, deferred tax assets and
liabilities are recognized for 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 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.
During 1997, the Company's valuation allowance was entirely eliminated in light
of sustained profitability since termination of the S Corporation status.
F-15
<PAGE>
Significant components of the Company's deferred tax assets and liabilities are
as follows (amounts in thousands):
December 31,
----------------
1998 1997
------ ------
Deferred tax liabilities:
Tax depreciation in excess of book depreciation $ 209 $ 109
------ ------
Total deferred tax liabilities 209 109
------ ------
Deferred tax assets:
Nondeductible reserves for bad debts and sales returns 526 252
Accrued liabilities 113 248
Other 70 -
------ ------
Total deferred tax assets 709 500
------ ------
Net deferred taxes $ 500 $ 391
====== ======
Significant components of federal and state income tax expense are as follows
(amounts in thousands):
For the Years Ended
December 31,
--------------------------
1998 1997 1996
------ ------ ------
Current:
Federal $1,374 $ 587 $ 190
State 364 104 90
------ ------ ------
Total current 1,738 691 280
------ ------ ------
Deferred:
Federal (26) (332) -
State (5) (59) -
------ ------ ------
Total deferred (31) (391) -
------ ------ ------
Income tax expense $1,707 $ 300 $ 280
====== ====== ======
A reconciliation of the Company's effective income tax rate to the federal
statutory rate is as follows:
For the Years Ended
December 31,
--------------------------
1998 1997 1996
------ ------ ------
Federal statutory rate 34% 34% 34%
State taxes, net of federal benefit 6 6 7
Income attributable to S corporation - - (29)
Change in deferred tax asset valuation allowance - (32) -
Other - 2 (1)
------ ------ ------
Income tax expense 40% 10% 11%
====== ====== ======
F-16
<PAGE>
(10) BUSINESS ACQUISITION:
In October 1998, the Company acquired all the outstanding shares of Durham &
Company, an employee logo and incentive merchandise company, for $2.9 million in
cash and a note payable of $200,000 totaling $3.1 million. This acquisition has
been accounted for as a purchase, and the results of operations of the acquired
business have been included in the consolidated financial statements since the
date of acquisition. The excess purchase price over the fair value of net assets
acquired was $3,074,206 and has been recorded as goodwill and is being amortized
on a straight-line basis over 15 years. The purchase price was allocated as
follows:
Accounts receivable $ 476,110
Inventory 651,790
Property, equipment and other assets 170,514
Goodwill 3,074,206
Liabilities assumed (1,272,620)
-------------
$ 3,100,000
=============
The following unaudited consolidated pro forma information is presented as if
the Durham & Company acquisition had occurred at the beginning of the periods
presented.
Years Ended December 31,
------------------------
1998 1997
---------- ----------
Net merchandise sales $ 69,189 $ 65,240
Net income $ 2,390 $ 2,453
Basic net income per common share $ .28 $ .29
Diluted net income per common share $ .28 $ .28
The consolidated pro forma information includes adjustments to give effect to
amortization and goodwill. The unaudited consolidated pro forma information is
not necessarily indicative of the combined results that would have occurred had
the acquisition been made at the beginning of the periods presented, nor is it
indicative of the results that may occur in the future.
(11) MAJOR MERCHANTS AND AIRLINES:
Revenue generated through net merchandise sales and fixed placement fees for the
Company's largest participating merchants for the years ended December 31, 1998,
1997 and 1996, is as follows:
1998 1997 1996
------ ------ ------
Number of merchants 2 2 1
Percentage of total merchandise sales and
placement fees 21% 24% 21%
There were no other merchants that exceeded 10% of total revenues.
F-17
<PAGE>
Net merchandise sales originating from the Company's five largest participating
airlines approximated 72%, 79% and 86% for the years ended December 31, 1998,
1997 and 1996, respectively.
(12) TRANSACTIONS WITH RELATED PARTIES:
The Company has an agreement with a company, which is owned by one of the
Company's directors, to provide order conveyance services commencing in January
1997. Expenses related to this agreement totaled $343,000 and $200,000 for the
years ended December 31, 1998 and 1997, respectively.
At December 31, 1998, the Company recorded an employee receivable of
approximately $401,000 for the exercise price of employee stock options. This
receivable was collected subsequent to December 31, 1998.
F-18
<PAGE>
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURES
None.
29
<PAGE>
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 Definitive Proxy Statement
relating to the Company's Annual Meeting to be held on June 4, 1999.
ITEM 11. EXECUTIVE COMPENSATION
Information with respect to executive compensation is incorporated herein
by reference to the Definitive Proxy Statement relating to the Company's Annual
Meeting to be held on June 4, 1999.
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 Definitive
Proxy Statement relating to the Company's Annual Meeting to be held on June 4,
1999.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information with respect to certain relationships and related transactions
is incorporated herein by reference to the Definitive Proxy Statement relating
to the Company's Annual Meeting to be held June 4, 1999.
30
<PAGE>
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.
(a)(1) Consolidated Financial Statements.
Consolidated Balance Sheets as of December 31, 1998
and 1997 Consolidated Statements of Income for the
Years Ended December 31, 1998, 1997 and 1996
Consolidated Statements of Shareholders' Equity for the Years Ended
December 31, 1998, 1997 and 1996
Consolidated Statements of Cash Flows for the Years Ended
December 31, 1998, 1997 and 1996
Notes to Consolidated Financial Statements
(a)(2) and (d) Consolidated Financial Statement Schedules.
None.
(a)(3) and (c) Exhibits.
<TABLE>
<CAPTION>
Exhibit Method
Number Description of Filing
------- ----------- ---------
<S> <C> <C>
3.1a Articles of Incorporation of Registrant (1)
3.1b Certificate of Amendment to Articles of Incorporation (1)
3.2 Bylaws of Registrant (1)
4.1 Amended Certificate of Designation for Preferred Stock (1)
4.2 Form of Common Stock Certificate (1)
4.3 Form of Representative's Warrant Agreement (1)
10.1 Employment Agreement between Robert M. Worsley (1)
and SkyMall, Inc.
10.2 Form of Airline Customer Services Agreement (1)
10.2a Schedule of Omitted Material Terms from Material (1)
Airline Customer Services Agreement
10.2b Airline Customer Services Agreement between SkyMall, Inc. (1)
and Continental Airlines, Inc., dated January 1, 1992,
as amended
10.2c Airline Customer Services Agreement between SkyMall, Inc. (1)
and United Airlines, Inc., dated May 1, 1992
10.3 Form of Tax Indemnification Agreement (1)
10.4 SkyMall, Inc. 1994 Stock Option Plan, as amended (2)
</TABLE>
31
<PAGE>
<TABLE>
<CAPTION>
Exhibit Method
Number Description of Filing
------- ----------- ---------
<S> <C> <C>
10.5 Non-Employee Director Stock Option Plan (3)
10.6a Lease Agreement between Pasqualetti Properties, Inc. and (1)
Smitty's Super Valu, Inc. dated June 24, 1960
10.6b Agreement between Rose Pasqualetti Perkins, Amos (1)
Pasqualetti, Anthony Pasqualetti, Ben Pasqualetti and
Smitty's Super Valu, Inc. dated March 2, 1961
10.6c Addendum to Lease between Amos Pasqualetti, Ben S. (1)
Pasqualetti, Rose Pasqualetti Jenkins, Estate of
Anthony J. Pasqualetti and Smitty's Super Valu, Inc.
dated May 11, 1966
10.6d Sublease between Schwan Brothers Properties and (1)
Smitty's Super Valu, Inc. dated August 1, 1984
10.6e Lease Amending Agreement between Smitty's Super Valu, (1)
Inc., Pasquo Investments, and Amos Pasqualetti and
Victoria McFarland dated October 1, 1984
10.6f Addendum to Sublease between Smitty's Super Valu, Inc. (1)
and Schwan Brothers Properties dated January 1, 1985
10.6g Assignment of Sublease from Pima Partners to SkyMall, Inc. (1)
dated July 12, 1990
21 Subsidiaries of Registrant *
23 Consent of Independent Public Accountants *
24 Powers of Attorney See
Signature Page
27 Financial Data Schedule *
- ---------------
* Filed herewith.
(1) Incorporated by reference to Form S-1 Registration Statement (File No. 333-14539).
(2) Incorporated by reference to Form S-8 Registration Statement (File No. 333-50881).
(3) Incorporated by reference to Form S-8 Registration Statement (File No. 333-14543).
</TABLE>
(b) Reports on Form 8-K
The Company filed one report on Form 8-K during the fourth quarter of
1998.
32
<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 29th
day of March, 1999.
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 STEPHEN R. PETERSON, 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, President March 29, 1999
- -------------------------- and Chief Executive Officer
Robert M. Worsley (Principal Executive Officer)
/s/ Stephen R. Peterson Chief Financial Officer March 29, 1999
- -------------------------- (Principal Financial and
Stephen R. Peterson Accounting Officer)
/s/ Lyle R. Knight Director March 29, 1999
- --------------------------
Lyle R. Knight
/s/ Thomas J. Litle Director March 29, 1999
- --------------------------
Thomas J. Litle
/s/ Randy Petersen Director March 29, 1999
- --------------------------
Randy Petersen
S-1
EXHIBIT 21
SUBSIDIARIES OF THE COMPANY
Jurisdiction of Percent of
Name Incorporation Ownership
- -------------------------- --------------- ----------
Durham & Company Utah 100%
skymall.com Nevada 100%
EXHIBIT 23
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
As independent public accountants, we hereby consent to the incorporation of our
report dated March 1, 1999, included in this Form 10-K, into the Company's
previously filed Registration Statements on Forms S-3 (File No. 333-14539, No.
333-71541), and on Forms S-8 (File No. 333-50881, No. 333-71543).
Phoenix, Arizona,
March 26, 1999.
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> DEC-31-1998
<CASH> 7,785
<SECURITIES> 0
<RECEIVABLES> 12,351
<ALLOWANCES> 1,205
<INVENTORY> 630
<CURRENT-ASSETS> 22,988
<PP&E> 9,864
<DEPRECIATION> 3,390
<TOTAL-ASSETS> 32,666
<CURRENT-LIABILITIES> 18,150
<BONDS> 0
0
0
<COMMON> 9
<OTHER-SE> 14,254
<TOTAL-LIABILITY-AND-EQUITY> 32,666
<SALES> 49,320
<TOTAL-REVENUES> 66,257
<CGS> 33,507
<TOTAL-COSTS> 33,507
<OTHER-EXPENSES> 28,896
<LOSS-PROVISION> 281
<INTEREST-EXPENSE> 32
<INCOME-PRETAX> 4,258
<INCOME-TAX> 1,707
<INCOME-CONTINUING> 2,551
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 2,551
<EPS-PRIMARY> .30
<EPS-DILUTED> .30
</TABLE>
