FORM 10-Q
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
QUARTERLY REPORT UNDER SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended: June 30, 2001 Commission file No. 0-15338
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PHOTOWORKS, INC.
-----------------
(Exact name of registrant as specified in its charter.)
Washington 91-0964899
------------------------------- ------------------------------------
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
1260 16th Avenue West, Seattle, WA 98119
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (206) 281-1390
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to the
filing requirements for the past 90 days.
Yes X No
--- ---
As of August 1, 2001, there were issued and outstanding 16,612,105 shares
of common stock, par value $.01 per share.
Index to Exhibits at Page 16
Page 1 of 16
PHOTOWORKS, INC.
INDEX
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Page No.
--------
PART I -- FINANCIAL INFORMATION
Page No.
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Item 1 - Financial Statements 3-9
Consolidated Balance Sheets as of June 30, 2001
and September 30, 2000 3-4
Consolidated Statements of Operations for the third quarter
and nine months ended June 30, 2001 and June 24, 2000 5
Consolidated Statements of Cash Flows for the nine months
ended June 30, 2001 and June 24, 2000 6
Notes to Consolidated Financial Statements 7-9
Item 2 - Management's Discussion and Analysis of
Financial Condition and Results of Operations 10-14
PART II -- OTHER INFORMATION
Item 1 - Legal Proceedings 14
Item 6 - Exhibits and Reports on Form 8-K 14
SIGNATURES 15
INDEX TO EXHIBITS 16
EXHIBITS
Page 2 of 16
PART I -- FINANCIAL INFORMATION
-------------------------------
ITEM 1 - FINANCIAL STATEMENTS
PHOTOWORKS, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands)
(UNAUDITED) (NOTE)
June 30, September 30,
ASSETS 2001 2000
=========== =============
CURRENT ASSETS
Cash and cash equivalents $ 1,605 $ 1,629
Securities available-for-sale - 1,022
Accounts receivable, net of allowance for doubtful accounts 1,026 1,300
Inventories 2,350 5,562
Prepaid income taxes - 970
Prepaid promotional expenditures 151 1,412
Prepaid expenses and other 134 377
------- -------
TOTAL CURRENT ASSETS 5,266 12,272
FURNITURE, FIXTURES, AND EQUIPMENT,
at cost, less accumulated depreciation 8,292 12,390
TOTAL ASSETS $13,558 $24,662
======= =======
Note: The September 30, 2000 consolidated balance sheet has been derived from
audited consolidated financial statements.
See notes to consolidated financial statements.
Page 3 of 16
PHOTOWORKS, INC.
CONSOLIDATED BALANCE SHEETS (continued)
(in thousands, except per share and share data)
(UNAUDITED) (NOTE)
June 30, September 30,
LIABILITIES AND SHAREHOLDERS' EQUITY 2001 2000
=========== =============
CURRENT LIABILITIES
Current portion of note payable $ 2,387 $ 821
Accounts payable 3,761 5,478
Accrued compensation 1,728 1,854
Accrued expenses 2,674 1,732
Current portion of capital lease obligations 215 250
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TOTAL CURRENT LIABILITIES 10,765 10,135
Note payable, net of current portion - 1,231
Capital lease obligation, net of current portion 141 292
Subordinated convertible debentures 2,500 -
SHAREHOLDERS' EQUITY
Preferred Stock, $.01 par value, authorized 2,000,000 shares,
issued and outstanding 15,000 - -
Common Stock, $.01 par value, authorized 101,250,000
shares, issued and outstanding 16,612,105 166 165
Additional paid-in capital 15,752 15,629
Retained earnings (15,766) (2,790)
-------- -------
TOTAL SHAREHOLDERS' EQUITY 152 13,004
-------- -------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 13,558 $24,662
======== =======
Note: The September 30, 2000 consolidated balance sheet has been derived from
audited consolidated financial statements.
See notes to consolidated financial statements.
Page 4 of 16
PHOTOWORKS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
(in thousands, except per share and share data)
Third Quarter Ended Nine Months Ended
-------------------------- -------------------------
June 30, June 24, June 30, June 24,
2001 2000 2001 2000
=========== =========== =========== ===========
Net revenues $ 14,365 $ 19,862 $ 42,040 $ 59,149
Cost of goods and services 10,926 15,543 34,171 42,501
----------- ----------- ----------- -----------
Gross Profit 3,439 4,319 7,869 16,648
Operating expenses:
Marketing 2,570 23,606 10,335 37,429
Research and development 895 779 3,420 1,862
General and administrative 2,165 1,976 6,102 5,007
Lawsuit settlement 759 - 1,094 -
----------- ----------- ----------- -----------
Total operating expenses 6,389 26,361 20,951 44,298
----------- ----------- ----------- -----------
Loss from Operations (2,950) (22,042) (13,082) (27,650)
Other income (expense):
Interest expense (100) (10) (388) (33)
Interest income - 317 45 952
Non-operating income (expense), net 4 16 450 (6)
----------- ----------- ----------- -----------
Total other income (expense) (96) 323 107 913
----------- ----------- ----------- -----------
Loss before income taxes (3,046) (21,719) (12,975) (26,737)
Provision for income taxes - (183) - (428)
----------- ----------- ----------- -----------
Net loss (3,046) (21,902) (12,975) (27,165)
Preferred stock accretion - (1,511) - (2,546)
----------- ----------- ----------- -----------
Loss attributable to common shareholders $ (3,046) $ (23,413) $ (12,975) $ (29,711)
=========== =========== =========== ===========
Net loss per share $(.18) $(1.33) $(.78) $(1.66)
=========== =========== =========== ===========
Net loss per common share $(.18) $(1.43) $(.78) $(1.81)
=========== =========== =========== ===========
Weighted average shares outstanding 16,612,000 16,415,000 16,547,000 16,370,000
=========== =========== =========== ===========
See notes to consolidated financial statements.
Page 5 of 16
PHOTOWORKS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(in thousands)
Nine Months Ended
-------------------
June 30, June 24,
2001 2000
======== ========
OPERATING ACTIVITIES:
- ---------------------
Net loss $(12,975) $(27,165)
Charges to income not affecting cash:
Depreciation and amortization 5,764 3,675
Loss on disposal of assets 236 -
Deferred income taxes - 1,334
Net change in receivables, inventories, payables and other 1,782 7,613
Capitalized promotional expenditures, net (464) (2,777)
-------- --------
NET CASH USED IN OPERATING ACTIVITIES (5,657) (17,320)
INVESTING ACTIVITIES:
- ---------------------
Purchase of furniture, fixtures, and equipment (177) (6,496)
Purchases of securities available-for-sale - (13,740)
Sales of securities available-for-sale 1,022 10,217
-------- --------
NET CASH FROM (USED IN) INVESTING ACTIVITIES 845 (10,019)
FINANCING ACTIVITIES:
- ---------------------
Proceeds from issuance of Convertible Debentures 2,500 -
Drawing on bank line 2,350 -
Proceeds from issuance of Preferred Stock - 14,936
Proceeds from issuance of Common Stock 124 373
Payment on capital lease obligation (186) (104)
-------- --------
NET CASH FROM FINANCING ACTIVITIES 4,788 15,205
-------- --------
DECREASE IN CASH AND CASH EQUIVALENTS (24) (12,134)
Cash and cash equivalents at beginning of period 1,629 15,001
-------- --------
CASH AND CASH EQUIVALENTS
AT END OF PERIOD $ 1,605 $ 2,867
======== ========
See notes to consolidated financial statements.
Page 6 of 16
PHOTOWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE A -- BASIS OF PRESENTATION
PhotoWorks, Inc. ("PhotoWorks" or the "Company") is a leading photo
services company dedicated to providing its customers with innovative ways to
enjoy and use their photos. The Company, formerly Seattle FilmWorks, Inc.,
changed its corporate name to PhotoWorks, Inc. on February 1, 2000. The
PhotoWorks service provides film and image processing and online image storage
and management services to both traditional and digital camera users, providing
customers with the easiest way to store and organize photos online, share them
with friends and family, and order reprints, photo albums, and photo related
products. The Company also offers an array of complementary products and
services, primarily under the brand names PhotoWorks(R) and Seattle
FilmWorks(R). To a lesser extent, the Company provides photo-related products on
a wholesale basis.
The accompanying unaudited consolidated financial statements have been
prepared in accordance with generally accepted accounting principles for interim
financial information and with the instructions to Form 10-Q and Rule 10-01 of
Regulation S-X. Accordingly, they do not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, all adjustments (consisting
of normal recurring adjustments) considered necessary for fair presentation of
interim results have been included. The Company follows a policy of recording
its interim periods and year-end on a 5 week, 4 week and 4 week basis for
comparability of results and to be consistent with its internal weekly
reporting. Fiscal year 2001 will include 52 weeks compared to fiscal 2000 that
included 53 reporting weeks, with the additional week reported in the fourth
quarter of fiscal 2000. Operating results for the third quarter ended June 30,
2001 are not necessarily indicative of the results that may be expected for the
fiscal year ending September 29, 2001. For further information, refer to the
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" under Item 2 below and under Item 7 of Part II of the Company's
Annual Report on Form 10-K for the year ended September 30, 2000 and the
Company's consolidated financial statements and footnotes thereto also included
in the Company's Annual Report.
NOTE B -- ADVERTISING AND PROMOTIONAL EXPENDITURES
Prepaid promotional expenditures consist of deposits made for direct
advertising to be mailed in future periods and prepaid amounts for Internet
advertising. Direct mail promotional costs are recorded as expenses during the
period in which the promotional materials are mailed. Internet advertising is
expensed on a straight-line basis over the periods in which the advertising
takes place.
NOTE C -- INVENTORIES
Inventories are stated at the lower of cost (using the first-in, first-out
method) or market. Inventories consist primarily of preloaded cameras, film and
photofinishing supplies.
NOTE D -- RECLASSIFICATIONS
Certain prior year balances have been reclassified to conform to the
current year's presentation.
NOTE E -- SEGMENT REPORTING
The Company currently operates in one principal business segment.
NOTE F -- INCOME TAXES
The Company accounts for its income taxes in accordance with the asset and
liability method. Under this method, deferred tax assets and liabilities are
determined based on the difference between the financial statement and tax bases
of assets and liabilities using enacted tax rates in effect for the year in
which the differences are expected to affect taxable income. The Company has
determined it is appropriate to provide a valuation allowance equal to the
amount of deferred tax assets not recoverable through operating loss carrybacks.
For the nine months ended June 30, 2001 the income tax benefit was $0, as
opposed to a benefit of approximately $4,504,000 (assuming a normal statutory
rate of 34%). Utilization of the remaining deferred tax assets of approximately
$17,834,000 is dependent on future profits that are not assured.
Page 7 of 16
PHOTOWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE G -- EARNINGS PER SHARE
The Company calculates earnings per share in accordance with the Financial
Accounting Standards Board Statement of Financial Accounting Standards No. 128,
"Earnings per Share". Net loss per share is based on the weighted average number
of common shares outstanding. Convertible preferred shares, outstanding warrants
and stock options to purchase shares of common stock were excluded from the
computation of earnings per share because their effect was antidilutive.
The following table sets forth the computation of loss per share:
Third Quarter Ended Nine Months Ended
------------------------------ ------------------------------
June 30, 2001 June 24, 2000 June 30, 2001 June 24, 2000
============== ============== ============== ==============
Numerator for basic and diluted earnings per share:
Net loss $(3,046,000) $(21,902,000) $(12,975,000) $(27,165,000)
Preferred stock accretion - (1,511,000) - (2,546,000)
----------- ------------ ------------ ------------
Loss attributable to common shareholders (3,046,000) (23,413,000) (12,975,000) (29,711,000)
=========== ============ ============ ============
Denominator:
Weighted-average number of common shares 16,612,000 16,415,000 16,547,000 16,370,000
=========== ============ ============ ============
Net loss per share $ (.18) $ (1.33) $ (.78) $ (1.66)
=========== ============ ============ ============
Net loss per common share $ (.18) $ (1.43) $ (.78) $ (1.81)
=========== ============ ============ ============
NOTE H -- CONTINGENCIES
The Company is a defendant in a legal proceeding that was filed by Fuji
Photo Film Co., Ltd. with the International Trade Commission in February 1998.
The action was filed against a number of importers, including the Company's
OptiColor, Inc. subsidiary, alleging patent infringement of U.S. patents held by
Fuji on single use cameras through the importation and resale of recycled
cameras. Fuji was seeking an order prohibiting importation of infringing cameras
into the U.S. and prohibiting further sales of such products which had been
imported. Sales of recycled cameras accounted for 4.3% and 4.1% of the Company's
net revenues during fiscal 2000 and 1999, respectively. After an evidentiary
hearing before an ITC Administrative Law Judge in November 1998, the ITC
Commissioners issued a final order in June 1999 prohibiting the Company and its
subsidiaries from importing and selling imported recycled single use cameras.
The Company has appealed the ITC Commissioners' order to the Federal Circuit
Court of Appeals. In the appeal, as in the ITC proceeding, the issues have been
and are vigorously contested. On June 27, 2001, Fuji Photo Film filed a
Complaint with the ITC for Enforcement Proceedings alleging 22 claims contained
in nine utility patents and named certain entities as "enforcement respondents."
The Commission, having examined the request for a formal enforcement proceeding
determined to institute formal enforcement proceedings to determine whether
twelve named respondents are in violation of the Commission's general exclusion
order and/or cease and desist order issued in the investigation, and what if any
enforcement measures are appropriate.
A complaint was filed in March 2000, since twice amended, against the
Company, by six individual plaintiffs suing on their own behalf and purportedly
on behalf of a class of all private citizens and non-governmental entities who
had received from the Company, and had the Company process, "C-41" 35mm color
film from the Company or who had received replacement rolls of film from the
Company after film processing. This complaint alleged that the Company had
engaged in unfair and deceptive practices by allegedly misrepresenting that film
received from the Company must be processed only by the Company and that
replacement film is "free". On April 24, 2001, without admitting wrongdoing or
liability, and for the sole purpose of compromising disputed claims and avoiding
costs and risks of further litigation, PhotoWorks and the plaintiffs who
represent the Class agreed to a proposed settlement. PhotoWorks agreed with
class representatives to settle the lawsuit for agreements regarding future
business conduct, distribution of film and discount coupons to the public, and
disclosure of film processing information. Pursuant to the agreement and Court
order, a summary
Page 8 of 16
PHOTOWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE H -- CONTINGENCIES (Continued)
of the terms of settlement was published in the USA Today on May 7, 2001 and was
posted on a website referred to in that publication. The settlement was approved
by the Court on July 16, 2001.
As part of the settlement, PhotoWorks will provide these benefits to Class
Members: (1) Within one year PhotoWorks will make the following distributions of
free rolls of 24-exposure standard C-41 film: (a) It will distribute an
aggregate of 900,000 rolls to persons who are active PhotoWorks customers, with
the identity of recipients and number of rolls per recipient (not to exceed
three) determined by PhotoWorks in a way that reasonably takes into account past
and/or anticipated quantity or frequency of their transactions; (b) It will also
distribute one roll to each of the first 300,000 Class Members who request the
roll within six months of the notice, and who do not receive any of the 900,000
rolls above. Materials accompanying these distributions will inform recipients
that the C-41 process identified on the film is an industry standard chemical
process that most photo-processing labs use to develop film. (2) Each member of
the Class who does not receive free film under (1) above may submit to
PhotoWorks a Coupon appended or attached to the Notices (prior to the Coupon's
expiration) to receive a $1 discount on a film processing order. The Company
accrued a total of $675,000 in the quarter ended June 30, 2001 related to the
future distribution of 900,000 rolls of film pursuant to terms of the final
settlement.
In addition, PhotoWorks will pay $15,000 in total to the named
plaintiffs/class representatives as compensation for their time and involvement
in the Class Suit, and approximately $260,000 to the attorneys for the Class for
their services and costs in the Class Suit.
The Company is also involved in various routine legal proceedings in the
ordinary course of its business.
The Company has a revolving line of credit of $2,356,250 that matured on
July 31, 2001. Under terms of the amended agreement dated July 23, 2001, the
Company is required to maintain a certificate of deposit with the bank equal to
or greater than $356,250. The certificate of deposit shall remain in effect for
so long as any obligations under the agreement are outstanding. Management
believes this bank line of credit can be converted to a term loan or revolving
line of credit and is currently negotiating the terms of this agreement with the
bank.
NOTE I -- SUBORDINATED DEBENTURES
On April 25, 2001, the Company closed a $2,500,000 Subordinated Debenture
financing with investment advisory clients of Zesiger Capital Group, LLC. The
subordinated debentures have a 7% interest rate and are convertible at the
discretion of the holders, into Series B Preferred Stock at a conversion price
of $75.00 per share, one year after closing. Each share of Series B Preferred
Stock is convertible, at the option of the holder, at any time into 100 shares
of Common Stock (Series B conversion to common stock results in $.75 per common
share). If not previously converted, the debentures will be repaid five years
from closing.
NOTE J -- ADOPTION OF ACCOUNTING STANDARDS
The Company adopted Statement of Financial Accounting Standards No. 133
("SFAS 133"), "Accounting for Derivative Instruments and Hedging Activities," in
the first quarter of fiscal year 2001. The Standard requires the Company to
recognize all derivatives on the balance sheet at fair value. The adoption of
SFAS 133 is not expected to have a material effect on the Company's financial
position or overall trends in the results of operations.
Page 9 of 16
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Safe Harbor Statement under the Private Securities Litigation Reform Act of
- ---------------------------------------------------------------------------
1995:
- -----
This report contains forward-looking statements that relate to future
events, product or service offerings or the future financial performance of the
Company. In some cases, you can identify forward-looking statements by
terminology such as "may," "will," "should," "expects," "plans," "anticipates,"
"believes," "estimates," "predicts," "potential," or "continue" or the negative
of such terms and other comparable terminology. These statements only reflect
the Company's management's expectations and estimates. Actual events or results
may differ materially from those expressed or implied by such forward-looking
statements due to a number of known and unknown risks and uncertainties. These
risks and uncertainties include the Company's inability to generate cash to fund
its operations, inability to convert the bank line of credit to a term loan or
revolving line of credit, inability to successfully achieve operational plans
and marketing initiatives, system performance problems due to technical
difficulties, system malfunctions, Internet interruptions or other factors;
pricing and other activities by competitors; and other risks including those
described in the Company's Annual Report on Form 10-K and those described from
time to time in the Company's other filings with the Securities and Exchange
Commission, press releases and other communications. Any forward-looking
statements in this report reflect the Company's expectations at the time of this
report only, and the Company disclaims any responsibility to revise or update
any such forward-looking statements except as may be required by law.
General
- -------
PhotoWorks, Inc. ("PhotoWorks" or the "Company") is a leading online,
direct mail and retail photo services company dedicated to providing customers
with innovative ways to create and tell the stories of their lives through
photos. PhotoWorks is a direct-to-consumer provider of film and image processing
and online image storage and management services. The Company offers an array of
complementary services and products primarily under the brand names
PhotoWorks(R) and Seattle FilmWorks(R).
To promote its services and products, the Company relies primarily on
direct-marketing and online e-mail programs. The Company continually tests and
refines its offers in an effort to improve its effectiveness and reach a broader
market. Offers designed to showcase the PhotoWorks(R) services may include
introductory pricing, film or other offers. In past years, the Company primarily
relied on an introductory film offer and free processing to first time customers
to introduce potential customers to PhotoWorks products and services. The
Company's introductory offers have been advertised through direct-response
media, print media, and national advertising campaigns. The Company also
promotes its introductory offers on its Web site (www.photoworks.com). In
addition, the Company has a customer referral program for online and mail order
customers which encourages existing customers to suggest family and friends that
may be interested in the Company's services and products.
Since 1978, the Company has been an industry leader in the introduction of
value-added photo-related services and products and has continued this tradition
by launching its online image management service, PhotoWorks(R) in April 1999.
The Company offers prints, slides, digital images and online archiving, all from
the same roll of 35mm film. PhotoWorks can process any brand of 35mm film,
Advanced Photo Systems (24mm) film or 35mm single-use camera. PhotoWorks was
among the first to provide express-mail delivery, cross-referenced data on
prints and negatives, a composite photo index and a convenient reorder system.
To a lesser extent, the Company provides products and supplies on a wholesale
basis.
Page 10 of 16
Since 1994, the Company has been a pioneer in providing digital-imaging
technologies which enable photofinishing customers to share personal photographs
with friends and family. Products incorporating these technologies include (i)
Pictures On Disk a floppy disk(TM) containing digital images from a roll of
film; (ii) PhotoWorks(R) software, which can be used to create digital
photograph albums and screen savers and; (iii) Pictures On Disk(TM) on CD, a CD
containing digital images from a roll of film. In April 1999, the Company
introduced PhotoWorks(R), an online image management system which enables
customers to view, share, archive and order reprints and organize their photos
online. Other recent products include PhotoWorks(R) Albums, an online tool to
easily create and share photo albums, PhotoWorks(R) Cards, an online service
which allows customers to create personalized greeting cards using their
favorite photos, and an assortment of personalized photo gifts. In April 2001,
the Company launched PhotoDVD(TM), a new product that puts customers' photos on
media format DVD. PhotoDVD allows customers to enjoy their favorite photos on
television. The Company expects to continue to offer products that will provide
traditional and digital camera users with a simple and convenient way to store,
print and use their online digital images.
The net loss for the first nine months of fiscal 2001 was $12,975,000 or a
loss of $.78 per share, compared to a net loss of $27,165,000 or a loss of $1.66
per share for the first nine months of fiscal 2000. Operating results will
fluctuate in the future due to changes in the mix of sales, promotional
activities, price increases by suppliers, introductions of new products,
research and development requirements, actions by competitors, foreign currency
exchange rates, conditions in the direct-to-consumer market and the
photofinishing industry in general, national and global economic conditions and
other factors.
Demand for the Company's photo-related services and products is seasonal,
with the highest volume of photofinishing activity occurring during the summer
months. However, seasonality of demand may be offset by the introduction of new
services and products, changes in the level of effectiveness of customer
acquisition, retention or reactivation programs, activities by competitors,
production difficulties and other factors. This seasonality has generally
produced greater photofinishing net revenues during the last half of the
Company's fiscal year (April through September), with a peak occurring in the
fourth fiscal quarter. Net income or loss is affected by the seasonality of the
Company's net revenues due to the fixed nature of a portion of the Company's
operating expenses, seasonal variation in sales mix and the Company's practice
of incurring relatively higher marketing program expenditures prior to the
summer months.
Results of Operations
- ---------------------
The following table presents information from the Company's consolidated
statements of operations, expressed as a percentage of net revenues for the
periods indicated.
Third Quarter Ended Nine Months Ended
--------------------- --------------------
June 30, June 24, June 30, June 24,
2001 2000 2001 2000
======== ======== ======== ========
Net revenues 100.0% 100.0% 100.0% 100.0%
Cost of goods and services 76.1 78.3 81.3 71.9
------ ------- ----- ------
Gross profit 23.9 21.7 18.7 28.1
Operating expenses:
Marketing 17.9 118.9 24.6 63.3
Research and development 6.2 3.9 8.1 3.1
General and administrative 15.0 9.9 14.5 8.4
Lawsuit settlement 5.3 - 2.6 -
------ ------- ----- ------
Total operating expenses 44.4 132.7 49.8 74.8
------ ------- ----- ------
Loss from Operations (20.5) (111.0) (31.1) (46.7)
Total other income (expense) (.7) 1.6 .2 1.5
------ ------- ----- ------
Loss before income taxes (21.2) (109.4) (30.9) (45.2)
Provision for income taxes - (.9) - (.7)
------ ------- ----- ------
Net loss (21.2)% (110.3)% (30.9) (45.9)%
====== ======= ===== ======
Page 11 of 16
Net revenues for the third quarter of fiscal 2001 were $14,365,000 as
compared to net revenues of $19,862,000 in the third quarter of fiscal 2000. For
the nine months ended June 30, 2001, net revenues were $42,040,000 compared to
$59,149,000 for the same period of fiscal 2000. The decline in net revenues is
primarily due to significantly lower processing volumes. Management believes
processing volumes decreased primarily due to lower marketing expenditures
combined with an overall softness in the photofinishing industry. In addition,
net revenues in the first half of fiscal 2001 were affected by an overall
decrease in net revenue per roll as compared to the prior year periods primarily
as a result of aggressive pricing and competition in the online photo space.
During the third quarter of fiscal 2001, net revenue per roll increased as
compared to the prior year period due to changes in marketing promotions and
pricing, combined with fewer competitors in the online photo space.
Cost of goods and services consist of labor, postage, supplies and fixed
operating costs related to the Company's services and products. Gross profit in
the third quarter of fiscal 2001 increased to 23.9% of net revenues compared to
21.7% in the third quarter of fiscal 2000. Gross profit increased primarily due
to an increase in net revenue per roll for the quarter. For the first nine
months of fiscal 2001, gross profit decreased to 18.7% compared to 28.1% for the
same period of fiscal 2000. The year to date decline in gross margin is
primarily due to declines in net revenue per roll, as discussed above, as well
as fixed operating costs related to equipment, facilities, and overhead costs,
including increased depreciation and lease costs for scanning and archiving
equipment. Fluctuations in gross profit will occur in future periods due to the
seasonal nature of revenues, mix of product sales, level and nature of marketing
activities and other factors.
Total operating expenses in the third quarter of fiscal 2001 decreased to
$6,389,000 compared to $26,361,000 in the third quarter of fiscal 2000. For the
first nine months of fiscal 2001, total operating expenses decreased to
$20,951,000 compared to $44,298,000 for the same period of fiscal 2000. The
decrease in operating expenses was primarily due to a reduction in marketing
expenses, partially offset by increased costs related to research and
development, information technology, general and administrative and costs
associated with settlement of a class action lawsuit. Future periods may reflect
increased or decreased operating costs due the timing and magnitude of marketing
activities and research and development activities.
Marketing expenses include current period expenses associated with customer
acquisition and reactivation, building brand awareness, testing of new marketing
strategies and marketing to existing customers. Marketing expenses in the third
quarter of fiscal 2001 decreased to $2,570,000 compared to $23,606,000 in the
third quarter of fiscal 2000. For the first nine months of fiscal 2001,
marketing expenses decreased to $10,335,000 compared to $37,429,000 for the same
period in fiscal 2000. The fiscal 2000 marketing expenses included costs
associated with a major marketing campaign to promote the Company's PhotoWorks
brand and introduce its online services and products. The campaign included
national print and media advertising combined with direct marketing mailings.
Marketing expenditures in fiscal 2001 were lower primarily due to the Company's
testing of programs to target its customer databases through retention and
reactivation marketing programs. The Company has been evaluating marketing
programs that focus on more immediate returns on investment through targeted and
cost effective promotions. In addition, the Company renegotiated with certain of
its Internet partners to reduce the cash and promotional obligations related to
the agreements that resulted in non-cash charges of approximately $513,000 in
the second quarter of fiscal 2001.
Research and development expenses increased to $895,000 for the third
quarter of fiscal 2001 compared to $779,000 in the third quarter of fiscal 2000.
For the first nine months of fiscal 2001, research and development costs
increased to $3,420,000 as compared to $1,862,000 for the same period of fiscal
2000. The increase was due primarily to additional personnel hired to support
research and development for PhotoWorks(R) online archiving, photo sharing
services and development of new products and services. Research and development
expenses consist primarily of costs incurred in the development and enhancement
of its PhotoWorks(R) service, Internet and other online digital services and
products.
General and administrative expenses increased to $2,165,000 for the third
quarter of fiscal 2001 compared to $1,976,000 for the third quarter of fiscal
2000. For the nine months ended June 30, 2001, general and administrative
expenses increased to $6,102,000 compared to $5,007,000 for the same period of
fiscal 2000. The increase is primarily a result of increased expenditures
related to information systems to support the Company's computer-based and
Internet-related operations and general and administrative costs associated with
legal fees, wages, recruiting, and shareholder relations. General and
administrative expenses consist of costs related to computer operations, human
resource functions, finance, legal, accounting, investor relations and general
corporate activities.
Page 12 of 16
Lawsuit settlement expenses relate to the settlement of a class action
lawsuit (See Note H - Contingencies). The settlement agreement was approved by
the Court on July 16, 2001.
Other income for the nine months ended June 30, 2001 was $107,000 compared
to $913,000 for the same period of fiscal 2000. Interest income for fiscal 2001
was significantly lower due to decreased cash and investments while interest
expense increased in fiscal year 2001 due to bank line of credit and
subordinated debentures. In addition, the Company wrote off $236,000 of fixed
assets that were no longer in use due to lower processing volumes and production
changes. In the second quarter of fiscal 2001, the Company recorded other income
of approximately $675,000 for a reduction in an amount due under notes payable.
The reduction of the note was the result of renegotiation of amounts charged for
certain advertising services in fiscal year 2000.
The Company's common stock trades on the Nasdaq Stock Market under the
symbol FOTO. On July 13, 2001 the Company announced that it received a Nasdaq
Staff Determination indicating that the Company fails to comply with the net
tangible assets requirement for continued listing under Marketplace Rule
4450(a)(3), and that its securities are, therefore, subject to delisting from
the Nasdaq National Market. The Company requested a hearing before a Nasdaq
Listing Qualifications Panel to review the Staff's Determination. The Company is
reviewing options to meet all Nasdaq listing qualifications but believes there
is a strong possibility that it will be delisted from the Nasdaq. If delisting
occurs, the Company believes that its stock is eligible to trade on the OTC
Bulletin Board.
Liquidity and Capital Resources
As of August 8, 2001, the Company's principal sources of liquidity included
$1,801,000 in cash, which included a $356,250 certificate of deposit that is
required for the Company's bank line of credit. The Company has a revolving line
of credit of $2,356,250 that matured on July 31, 2001. Under terms of the
amended agreement dated July 23, 2001, the Company is required to maintain a
certificate of deposit with the bank equal to or greater than $356,250. The
certificate of deposit shall remain in effect for so long as any obligations
under the agreement are outstanding. Management believes this bank line of
credit can be converted to a term loan or revolving line of credit and is
currently negotiating the terms of this agreement with the bank. The Company
does not currently have any fixed material commitments with regard to capital
expenditures and does not anticipate spending a material amount during the
remainder of fiscal 2001.
During the first nine months of fiscal 2001, the Company had negative cash
flow from operations of approximately $5.7 million. Cash and securities
available-for-sale as of June 30, 2001 decreased to $1,605,000 compared to
$2,651,000 as of September 30, 2000. The Company's current ratio as of June 30,
2001 declined to .5 compared to the September 30, 2000 current ratio of 1.2. The
Company believes that it will generate positive operating cash flow in the
fourth quarter (July-September) of fiscal 2001, which is typically the Company's
strongest quarter primarily due to the seasonality of its business.
During fiscal 2000, a substantial portion of marketing expenses were
incurred for brand advertising and customer acquisition that was undertaken
pursuant to the Company's corporate name change. Marketing expenditures in
fiscal 2000 were heavily focused on establishing a leadership position in the
online photo space combined with rebranding and renaming the Company from
Seattle FilmWorks to PhotoWorks. The Company does not anticipate this level of
marketing and advertising expenditures in future periods. Additionally, the
Company has been reducing direct marketing expenditures by utilizing more
efficient communications with customers. In November 2000 and March 2001, the
Company realigned its organizational structure and has reduced its workforce by
a total of approximately 25%.
The Company negotiated a reduction of approximately $675,000 in the amount
due under a note payable. The reduction related to amounts charged for certain
advertising services in fiscal year 2000. As part of the renegotiation of the
note, payments of approximately $1.3 million were made during the third quarter
of fiscal 2001.
On April 25, 2001, the Company closed a $2,500,000 Subordinated Debenture
financing with investment advisory clients of Zesiger Capital Group, LLC. The
subordinated debentures have a 7% interest rate and are convertible at the
discretion of the holders, into Series B Preferred Stock at a conversion price
of $75.00 per share, one year after closing. Each share of Series B Preferred
Stock is convertible, at the option of the holder, at any time into 100 shares
of Common Stock (Series B conversion to common stock results in $.75 per common
share). If not previously converted, the debentures will be repaid five years
from closing.
Page 13 of 16
Management believes that, under its current operational and financing plans
outlined above, current cash balance, recent financing, and estimated future
cash flows, the Company will have sufficient funds for operations through at
least the next twelve months. However, the Company's inability to convert the
$2.35 million bank line of credit to a term loan or revolving line of credit, or
generate cash flow from operations would have a material adverse impact on the
Company's financial position and liquidity which may require the Company to
further reduce its expenditures, seek additional capital or refinance its
obligations to enable it to continue operations. There can be no assurance that
the Company will be able to obtain adequate financing in the future.
PART II -- OTHER INFORMATION
----------------------------
ITEM 1 - LEGAL PROCEEDINGS
For an update concerning the legal proceeding filed by Fuji Photo Film Co.,
Ltd., and the class action filed on March 29, 2000, see Note H of notes to
Consolidated Financial Statements in Part I above.
ITEM 6 - EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits.
---------
(b) Reports on Form 8-K.
--------------------
Form 8-K dated April 25, 2001 - Item 5 - Other Events related to the
Company's closing of a $2,500,000 Subordinated Debenture financing.
Page 14 of 16
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
PHOTOWORKS, INC.
DATED: August 13, 2001 /s/ Gary R. Christophersen
-----------------------------------------
Gary R. Christophersen
President/Chief Executive Officer
(Principal Executive Officer)
/s/ Loran Cashmore Bond
-----------------------------------------
Loran Cashmore Bond
Treasurer/Chief Accounting Officer
Page 15 of 16
INDEX TO EXHIBITS
PHOTOWORKS, INC.
Quarterly Report on Form 10-Q
For The Quarter Ended June 30, 2001
Exhibit Description Page No.
- --------- ----------- --------
3.1 Bylaws of the Company, as amended and restated on November 13, 1996
(Incorporated by reference to Exhibit 3.2 filed with the Company's Annual Report
on Form 10-K for the year ended September 28, 1996)
3.2 Articles of Amendment to Articles of Incorporation of PhotoWorks, Inc. dated
February 9, 2000 (Incorporated by reference to Exhibit 3.1 filed with the
Company's 8-K filed February 16, 2000)
3.3 Articles of Amendment to Articles of Incorporation of PhotoWorks, Inc. dated
April 24, 2001 (Incorporated by reference to Exhibit 3.1 filed with the
Company's 8-K filed April 27, 2001)
3.4 Articles of Correction to Articles of Incorporation of PhotoWorks, Inc. dated
April 25, 2001 (Incorporated by reference to Exhibit 3.2 filed with the
Company's 8-K filed April 27, 2001)
3.5 Form of Certificate of Designation Preferences and Rights of Series RP
Preferred Stock (Incorporated by reference to Exhibit 3.4 to the Company's
Annual Report on 10-K for the year ended September 25, 1999)
4.1 Rights Agreement dated December 16, 1999 between the Registrant and Chase
Mellon Shareholder Services L.L.C., as Rights Agent (Incorporated by
reference to Exhibit 4.1 to the current report on Form 8-K filed with the
Commission on December 17, 1999)
Page 16 of 16