SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
SCHEDULE 14A
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PHOTOWORKS, INC.
(Name of Registrant as Specified in Its Charter)
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Dear Shareholders,
As announced on December 22, 2004, PhotoWorks has successfully negotiated a
financing and recapitalization plan that, if approved by the shareholders, will
result in a cash infusion to strengthen the Company's balance sheet and a
simplified capital structure for the Company. The Company will use the funds
from the financing to expand its digital marketing activities to aggressively
compete in a very vigorous market.
I am writing to you today to further explain the rationale for developing this
plan. As the President and CEO of PhotoWorks and after having invested my heart
and soul in turning around the company for the past 12 months, I believe this is
the best outcome for all constituencies involved. Below, I will explain the
rationale underlying the proposed deal.
First, let me briefly recap the key elements of the plan (for a complete
description, please refer to the attached press release):
o Cash infusion of $4 million from new and current groups of investors
o Series A preferred shares with liquidation preference and accrued
interest totaling approximately $19 million to convert to common stock
o Subordinated debt of $2.5 million due April 2006 to convert to common
stock
While very attractive, the proposed plan may be viewed, however, as having a
dilutive effect on the common stock and, as such, one might question why this
proposed plan is in the best interest of all shareholders.
Allow me to explain...
PhotoWorks' current capital structure and market valuation present a grid-lock
that deprives the Company and its shareholders of a bright future.Specifically:
1. Despite recently improved performance, PhotoWorks' finances remain
fragile. In fiscal year 2004, the Company incurred a loss of $1.7M.
Total liabilities are greater than total assets including a cash
balance of $2.5M at the end of fiscal year 2004. The Company either
needs to raise financing or further reduce its expenditures to be able
to continue operations through September 2005. At this point, reduced
expenditures would seriously undermine our competitive position.
2. Holders of Series A preferred stock have a liquidation preference of
approximately $19 million including accrued dividends. Management
believes that in the event of a sale of the Company today, the proceeds
from the sale would not be sufficient to repay the outstanding debt and
the Series A preference, so that the common shareholders would receive
nothing. In addition, Series A holders also have the right to prevent
the Company from raising any capital with a liquidation preference
superior or equal to them. Although we talked to many potential
investors, none were willing to invest new capital and be subordinated
to the preference of the Series A. And without new capital, the
Company's prospects are bleak.
3. PhotoWorks has a long-term subordinated debt of $2.5 million due April
2006. Servicing this debt puts pressure on the Company's cash flow and
profitability.
This debt is due and payable in 16 months and without additional
financing or a renegotiation with the debt holders, it is unlikely that
the Company would be able to repay the debt. If this resulted in
bankruptcy, the debt holder would come first, leaving common
shareholders and holders of Series A Preferred Stock with little if any
proceeds. Consequently, no new investor would be willing to invest in
PhotoWorks knowing that a significant amount of the investment would
need to be used to repay the subordinated debt.
To recap, our objective was to get new cash and to eliminate the debt. Two
issues loomed large: the outstanding Series A with its liquidation preference
and right to prevent other financing and the upcoming maturity of the
subordinated notes. We believed that the only possible outcome was to structure
a deal where both would agree to convert their assets to common stock, so that
new investors would be willing to come forward.
After lengthy and difficult negotiations, that is exactly what we achieved: if
the plan is approved, both Series A holders and debt holders will convert to
common stock, leaving the company debt free and with a simple capital structure
consisting of one class of stock. The negotiation was long and, at times,
painful. Everyone had to give so that all would ultimately gain. In the final
analysis, this is a clear vote of confidence in the future of PhotoWorks on the
part of the Series A holders as well as the debt holders.
Let me assure you that I and the entire PhotoWorks management team share that
confidence and are very optimistic for the future of the Company and unanimously
support this proposal. Online revenue for digital photography service is
projected to grow at a fast pace fuelled by the rapid adoption of digital
cameras and broadband access. Over the past 12 months, several important steps
have been achieved in the turnaround path PhotoWorks has followed to garner its
share in this growth. The company has:
o Attracted a new leadership team
o Built a new state-of-the-art website and digital infrastructure
o Launched a new line of industry defining, high quality digital products
including Custom Photo Books bound in leather and linen and Signature
Greeting Cards, and
o Improved financial performance
o Digital revenues for the 4th quarter of FY2004 were 24.3% higher
than the prior year's 4th quarter;
o Overall gross margin for FY2004 improved to 27.6% from 24.8% the
year before;
o Operating expenses for FY2004 were reduced to $7.2M from $11.3M
the year before (the reduction includes $738k from a vendor
settlement which won't carry over to FY2005).
And significantly, for the first time since Q4 FY2001, PhotoWorks' reported net
income of $250,000 in Q4 FY2004 was attributable entirely to improved operating
results; i.e. through increased digital sales, improved gross margin and lower
operating costs.
This is an important decision and I want you to be fully informed. More
information will be posted on the web site prior to the March shareholder
meeting. Look for it at www.photoworks.com under the heading "About Us."
The future is bright... but only if we all face the current challenges together.
I am, therefore, asking for your vote of approval of the proposed
recapitalization plan. I believe it is our best opportunity for the reasons
outlined above. Thank you.
Sincerely,
Philippe Sanchez
President and CEO
PhotoWorks, Inc.
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The soliciting material presented herein is prepared and on behalf of management
and the Board of Directors of PhotoWorks, Inc. in connection with proposals to
be presented to shareholders at the upcoming annual meeting of shareholders of
PhotoWorks, Inc. Information regarding the shareholdings of management and the
Board of Directors of PhotoWorks, Inc. can be found in the company's filings
with the Securities and Exchange Commission. In addition, additional information
will be contained in the definitive proxy statement to be filed by the company
with the Securities and Exchange Commission prior to the annual meeting.
Shareholders should read the proxy statement when it becomes available because
it will contain important information concerning management's proposals. A copy
of the definitive proxy statement will be mailed to each shareholder of record
prior to the annual meeting, and will be available for free at the SEC's
website, www.sec.gov, and may also be obtained free (when available) from the
company.