PHOTOCHANNEL NETWORKS INC. FORM 20-F
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 20-F
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED SEPTEMBER 30, 2003
Commission file number 0-30148
PHOTOCHANNEL NETWORKS INC.
(Exact name of Registrant as specified in its charter)
BRITISH COLUMBIA, CANADA
(Jurisdiction of incorporation or organization)
506 - 425 CARRALL STREET, VANCOUVER, BRITISH COLUMBIA V6B 6E3, CANADA
(Address of principal executive offices)
Securities registered or to be registered pursuant to Section 12(b) of the Act: None
Securities registered or to be registered pursuant to SECTION 12(G) of the Act:
COMMON SHARES, WITHOUT PAR VALUE
(Title of Class)
Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act: None
Number of shares of each of the Registrant's classes of capital stock
outstanding as of the close of the period covered by the annual report.
COMMON SHARES 127,313,538 SHARES
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 |_| NO |X|
Indicate by check mark which financial statement item the registrant has
elected to follow.
ITEM 17 |X| ITEM 18 |_|
PHOTOCHANNEL NETWORKS INC. FORM 20-F
TABLE OF CONTENTS
PAGE
PART I
ITEM 1. IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS 2
ITEM 2. OFFER STATISTICS AND EXPECTED TIMETABLE 2
ITEM 3. KEY INFORMATION 2
ITEM 4. INFORMATION ON THE COMPANY 12
ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS 19
ITEM 6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES 26
ITEM 7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS 31
ITEM 8. FINANCIAL INFORMATION 33
ITEM 9. THE OFFER AND LISTING 34
ITEM 10. ADDITIONAL INFORMATION 36
ITEM 11. QUANTITATIVE AND QUALITATIVE DISCLOSURES
ABOUT MARKET RISK 40
ITEM 12. DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES 40
PART II
ITEM 13. DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES 41
ITEM 14. MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY
HOLDERS AND USE OF PROCEEDS 41
ITEM 15. INTERNAL CONTROLS 41
ITEM 16. [RESERVED] 41
PART III
ITEM 17. FINANCIAL STATEMENTS 42
ITEM 18. FINANCIAL STATEMENTS 42
ITEM 19. EXHIBITS 42
SIGNATURE PAGE 44
CERTIFICATIONS
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PHOTOCHANNEL NETWORKS INC. FORM 20-F
PART I
ITEM 1. IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS
Not Applicable.
ITEM 2. OFFER STATISTICS AND EXPECTED TIMETABLE
Not Applicable.
ITEM 3. KEY INFORMATION
A. SELECTED FINANCIAL DATA
The following table summarizes certain selected consolidated financial data for
each of the five financial years ended September 30, 2003. The data for the
fiscal years ended September 30, 2003, 2002, 2001, 2000 and 1999 are derived
from audited consolidated financial statements. The selected financial data set
forth below with respect to our consolidated statements of operations for each
of the three financial years in the period ended September 30, 2003 and with
respect to the consolidated balance sheets as at September 30, 2003 and 2002,
are derived from our audited consolidated financial statements included
elsewhere in this annual report. Consolidated statements of operations data for
the years ended September 30, 2000 and 1999, and consolidated balance sheet data
as at September 30, 2001, 2000 and 1999, have been derived from our audited
consolidated financial statements that have not been included in this annual
report.
Readers should read the following selected financial data in conjunction with
our consolidated financial statements and the notes thereto appearing in this
annual report. The consolidated financial statements were prepared in accordance
with accounting principles generally accepted in Canada ("Canadian GAAP").
Readers are referred to Note 19 in the accompanying September 30, 2003
consolidated financial statements for a quantitative reconciliation of the
measurement differences between Canadian GAAP and generally accepted accounting
principles in the United States ("US GAAP"), as it relates to us.
The data is expressed in Canadian dollars ("CDN$"), unless otherwise described.
We refer readers to "Currency and Exchange Rates" below for a history of
exchange rates between the Canadian dollar and the U.S. dollar.
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PHOTOCHANNEL NETWORKS INC. FORM 20-F
SELECTED FINANCIAL DATA:
- ------------------------------------------------------------------------------------------------------------------------------------
UNDER CANADIAN GAAP For the years ended September 30th
- ------------------------------------------------------------------------------------------------------------------------------------
ITEM 2003 2002 2001 2000 1999
- ------------------------------------------------------------------------------------------------------------------------------------
Revenue $255,573 $173,801 $97,112 $126,313 $160,560
- ------------------------------------------------------------------------------------------------------------------------------------
Loss from operations ($3,282,445) ($5,334,672) ($20,259,747) ($7,155,793) ($2,206,260)
- ------------------------------------------------------------------------------------------------------------------------------------
Net loss for the year restated ($2,822,394) ($1,851,661) ($19,871,231) ($6,940,356) ($2,196,785)
- ------------------------------------------------------------------------------------------------------------------------------------
Loss attributed to Limited Partnership $372,410 $1,237,590 N/A N/A N/A
restated
- ------------------------------------------------------------------------------------------------------------------------------------
Net loss for the year attributed to common shareholders ($2,449,984) ($614,071) ($19,871,231) ($6,940,356) ($2,196,785)
restated
- ------------------------------------------------------------------------------------------------------------------------------------
Basic and diluted net loss per common share ($0.03) ($0.01) ($0.60) ($0.32) ($0.18)
restated
- ------------------------------------------------------------------------------------------------------------------------------------
Total assets $1,851,097 $709,237 $1,488,276 $15,715,937 $536,720
- ------------------------------------------------------------------------------------------------------------------------------------
Net assets (liabilities) $673,850 ($2,145,836) ($5,127,511) $13,664,132 ($300,345)
- ------------------------------------------------------------------------------------------------------------------------------------
Share Capital $31,826,678 $26,390,849 $24,168,231 $16,315,246 $10,000,072
- ------------------------------------------------------------------------------------------------------------------------------------
Weighted average number of Common Shares 89,448,942 59,479,315 33,187,579 21,873,716 12,112,461
- ------------------------------------------------------------------------------------------------------------------------------------
Long term obligations and redeemable preferred stock Nil Nil Nil Nil Nil
- ------------------------------------------------------------------------------------------------------------------------------------
Cash dividends declared per common share Nil Nil Nil Nil Nil
- ------------------------------------------------------------------------------------------------------------------------------------
The above selected financial data in accordance with U.S. GAAP is indicated below:
- ------------------------------------------------------------------------------------------------------------------------------------
For the years ended September 30th
- ------------------------------------------------------------------------------------------------------------------------------------
ITEM 2003 2002 2001 2000 1999
- ------------------------------------------------------------------------------------------------------------------------------------
Revenue $255,573 $173,801 $97,112 $126,313 $160,560
- ------------------------------------------------------------------------------------------------------------------------------------
Net loss for the year ($2,586,400) ($615,024) ($19,692,225) ($8,957,412) ($2,549,635)
restated
- ------------------------------------------------------------------------------------------------------------------------------------
Basic and diluted net loss per common share ($0.03) ($0.01) ($0.59) ($0.36) ($0.21)
restated
- ------------------------------------------------------------------------------------------------------------------------------------
Total assets $1,851,097 $709,237 $1,488,276 $15,715,937 $536,720
- ------------------------------------------------------------------------------------------------------------------------------------
Net assets (liabilities) $673,850 ($2,145,836) ($5,127,511) $13,664,132 $($300,345)
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PHOTOCHANNEL NETWORKS INC. FORM 20-F
- ------------------------------------------------------------------------------------------------------------------------------------
For the years ended September 30th
- ------------------------------------------------------------------------------------------------------------------------------------
2003 2002 2001 2000 1999
- ------------------------------------------------------------------------------------------------------------------------------------
Share Capital $31,718,518 $26,282,689 $24,060,071 $16,207,086 $9,925,892
- ------------------------------------------------------------------------------------------------------------------------------------
Weighted average number of common shares 89,448,942 59,479,315 33,187,579 21,873,716 12,112,461
outstanding
- ------------------------------------------------------------------------------------------------------------------------------------
Long term obligations and redeemable preferred Nil Nil Nil Nil Nil
stock
- ------------------------------------------------------------------------------------------------------------------------------------
Cash dividends declared per common share Nil Nil Nil Nil Nil
- ------------------------------------------------------------------------------------------------------------------------------------
CURRENCY AND EXCHANGE RATES
All dollar amounts set forth in this annual report are in Canadian dollars,
unless we indicate otherwise. In the following table we set forth:
o the rates of exchange for the U.S. dollar, expressed in Canadian
dollars, in effect at the end of each of the periods indicated;
o the average of the exchange rates in effect on the last day of each
month during such periods; and
o the high and low exchange rate during such periods, in each case
based on the noon buying rate in New York City for cable transfers
in Canadian dollars as certified for customs purposes by the Federal
Reserve Bank of New York.
PREVIOUS SIX MONTHS
- ---------------------------------------------------------------------------------------------------------------------
SEPTEMBER OCTOBER NOVEMBER DECEMBER JANUARY FEBRUARY
2003 2003 2003 2003 2004 2004
- ---------------------------------------------------------------------------------------------------------------------
High Rate 1.3976 1.3556 1.3433 1.3420 1.3360 1.3512
- ---------------------------------------------------------------------------------------------------------------------
Low Rate 1.3363 1.3010 1.2928 1.2905 1.2679 1.3065
- ---------------------------------------------------------------------------------------------------------------------
YEARS ENDING SEPTEMBER 30
- ---------------------------------------------------------------------------------------------------------------------
2003 2002 2001 2000 1999
- ---------------------------------------------------------------------------------------------------------------------
Rate at end of Period 1.3536 1.5785 1.5775 1.5009 1.4682
- ---------------------------------------------------------------------------------------------------------------------
Average Rate During Period 1.4648 1.5730 1.5351 1.4719 1.5035
- ---------------------------------------------------------------------------------------------------------------------
High Rate 1.5991 1.6195 1.5832 1.5150 1.5648
- ---------------------------------------------------------------------------------------------------------------------
Low Rate 1.3305 1.5024 1.4895 1.4310 1.4447
- ---------------------------------------------------------------------------------------------------------------------
On September 30, 2003 and February 29, 2004, the noon buying rate in New York
City for cable transfers in US dollars as certified for customs purposes by the
Federal Reserve Bank of New York was Canadian $1.3536 and $1.3360, respectively,
equals US $1.00.
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PHOTOCHANNEL NETWORKS INC. FORM 20-F
B. CAPITALIZATION AND INDEBTEDNESS
Not applicable.
C. REASONS FOR THE OFFER AND USE OF PROCEEDS
Not applicable.
D. RISK FACTORS
Our business operations and our securities are subject to a number of
substantial risks, including those described below. If any of these or other
risks actually occur, our business, financial condition and operating results,
as well as the trading price or value of our securities could be materially and
adversely affected. Any person who is not in a position to lose the entire
amount of any investment should not invest in our securities.
THE FOLLOWING RISKS RELATE TO OUR CURRENT AND PLANNED BUSINESS OPERATIONS
IN THE PAST WE HAVE RELIED ON THE PROCEEDS OF FINANCINGS TO FUND OUR OPERATIONS.
IF WE ARE UNABLE TO GENERATE POSITIVE CASH FLOW FROM OPERATIONS OR CONTINUE TO
RAISE FUNDS, WE MAY BE REQUIRED TO LIMIT OR CURTAIL OPERATIONS.
Since inception we have operated at a loss and, at September 30, 2003, had an
accumulated deficit of $40,176,059 and a working capital position of $388,277.
Historically, we have funded our operating, administrative and development costs
through the sale of equity capital or debt financing. We have had and will
continue to have capital requirements in excess of our currently available
resources. Currently, we are able to meet our financial commitments as they come
due. We are dependent upon the proceeds of future financings to further finance
the development and implementation of our business objectives. In the event that
our plans and/or assumptions change or prove inaccurate, or we are unable to
obtain further financing, or such financing and other capital resources, in
addition to projected cash flow, if any, prove to be insufficient to fund
operations, our continued viability could be at risk. To the extent that any
such financing involves the sale of our equity securities, the interests of our
then existing shareholders could be substantially diluted. There is no assurance
that we will be successful in achieving any or all of these objectives over the
coming year and, accordingly, there exists substantial doubt that we will be
able to continue as a going concern.
We are implementing a plan to address these issues and to enable us to continue
as a going concern through the end of fiscal year 2004 and beyond. This plan
includes obtaining debt or equity financing in amounts sufficient to sustain
operations, expanding our customer base, and the subsequent realization of
sufficient revenues produced by this network. However, there is only a limited
operating history with the existing business model, and there is no assurance
that the necessary financing can be obtained or on what terms it may be
obtained. The accompanying financial statements do not include any adjustments,
which may be material, to reflect the possible future effects on the
recoverability and classification of assets or the amount and classification of
liabilities that may result from the outcome of this uncertainty.
As a result of equity financing activities, as of September 30, 2003, we had
cash, cash equivalents and short-term investments of approximately $1,449,410
and as of February 29, 2004, we had cash, cash equivalents and short-term
investments of $419,449.
In addition, we currently are generating monthly revenues of approximately
$80,000, of which $40,000 relates to recurring revenues from the use of our
Network. Accordingly, based on our planned operations during fiscal 2004, we
believe that we have sufficient funds for the next four months without need to
access the equity markets. Although we do not believe that there is an immediate
need for additional capital, we anticipate accessing the equity markets for
additional funding depending on actual sales and resulting cash flow during this
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PHOTOCHANNEL NETWORKS INC. FORM 20-F
period. Should our revenue not grow during the next 12 months we would be
required to raise approximately $1,800,000 to sustain our current level of
operations for this period.
Although we do not believe that we have an immediate need for capital, we have
yet to generate sufficient revenues to cover our operating expenses.
Accordingly, if we are unable to generate positive cash flow from operations or
continue to raise funds, we may be required to either limit, curtail, cease or
stop operations. In the event that we cease or stop operations, shareholders
could lose their entire investment.
IF WE NEED ADDITIONAL FINANCING AND SUCH FINANCING IS NOT AVAILABLE, WE MAY BE
FORCED TO LIMIT OR CURTAIL OPERATIONS.
We may need additional capital if:
o we are unable to generate sufficient revenues to cover operations;
o our creditors demand payment;
o we determine necessary to expand our business; or
o we encounter unanticipated expenses.
To date we have been able to raise funding, however, we have not been successful
at generating revenues sufficient to fund our operating expenses. If market
conditions are conducive, we may be able to raise capital through:
o the exercise of common share purchase warrants already in the
market; or
o the sale of equity or debt securities in private or public
offerings.
If additional funding is required, this will further dilute our existing
shareholder's ownership. See "The Following Risks Relate To The Market For Our
Common Shares", below.
If requisite funding on acceptable terms cannot be attracted in a timely
fashion, we may be forced to delay activities and, possibly, lose market
opportunities to competitors. Similarly, delayed financing could force
reductions in planned marketing and product deployment and development
expenditures, resulting in delays in meeting our business objectives or could
also force us into receivership or bankruptcy.
OUR BUSINESS IS PRIMARILY FOCUSED ON THE CANADIAN MARKETPLACE, HOWEVER, SHOULD
WE ENTER THE UNITED STATES AND OUR PRODUCT SET BE ACCEPTED, WE COULD HAVE
SIGNIFICANT EXPOSURE TO FOREIGN EXCHANGE RATES, WHICH MAY ADVERSELY IMPACT OUR
BUSINESS MODEL.
We have been focused on the Canadian marketplace. Although we have a limited
number of customers in the United States, it is now our intent to focus more on
the United States marketplace. The United States marketplace for photofinishing
is approximately twenty times the size of the Canadian marketplace and should we
be successful in the United States market, we would expect a substantial portion
of our operations to be based on sales and services rendered to customers in the
United States. As a result, our financial performance will be affected by
fluctuations in the value of the US dollar to the Canadian dollar. At the
present time, we have no plan or policy to utilize forward contracts or currency
options to minimize this exposure, and even if these measures are implemented
there can be no assurance that such arrangements will be available, be cost
effective or be able to fully offset such future currency risks.
OUR AUDITED FINANCIAL STATEMENTS CONTAIN A FOOTNOTE ABOUT OUR ABILITY TO
CONTINUE AS A GOING CONCERN. THE AUDITOR'S REPORT ON OUR SEPTEMBER 30, 2003
FINANCIAL STATEMENTS CONTAINS ADDITIONAL COMMENTS THAT INDICATE THAT SUBSTANTIAL
DOUBT EXISTS ABOUT OUR ABILITY TO CONTINUE AS A GOING CONCERN. IF WE ARE UNABLE
TO CONTINUE AS A GOING CONCERN, WE WOULD BE REQUIRED TO RESTATE OUR FINANCIAL
STATEMENTS ON A LIQUIDATION BASIS.
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PHOTOCHANNEL NETWORKS INC. FORM 20-F
Our financial statements have been prepared on the basis of accounting
principles applicable to a going concern. As of September 30, 2003, we had an
accumulated deficit of $40,176,059, which, if prepared under US GAAP, would have
been an accumulated deficit of $42,504,328. We continue to incur operating
losses, including losses of $3,282,445 during fiscal 2003 (2002 - $5,334,672,
2001 - $20,259,747). Our ability to continue as a going concern and the
recoverability of the amounts expended on research and development are dependent
on our ability to achieve profitable operations or sufficient proceeds from the
sale of our software related projects. Failure to continue as a going concern
would require a restatement of assets and liabilities on a liquidation basis,
which would differ materially from the going concern basis on which our
financial statements were prepared.
Under generally accepted auditing standards in the United States of America
("U.S. GAAS"), the auditor's report on the consolidated financial statements
contains an explanatory paragraph when the financial statements are affected by
conditions and events that cast substantial doubt on a company's ability to
continue as a going concern, such as those described in Note 1 to the financial
statements.
We believe, but cannot assure, that we will be able to continue to raise equity
financing. In addition, our operating revenues from our Network solution have
continued to increase during the year ended September 30, 2003.
OUR PRODUCTS ARE RELATIVELY NEW. IF THEY ARE NOT ACCEPTED IN THE MARKETPLACE,
OUR BUSINESS COULD BE MATERIALLY AND ADVERSELY AFFECTED.
Our Network has only been marketed since May 2001. There can be no assurance
that our services will receive the widespread market acceptance necessary to
attain profitable operations. Even if our services attain widespread acceptance,
there can be no assurance we will be able to meet the demands of our customers
on an ongoing basis. Our operations may be delayed or halted as a result of the
failure to perform as described. Such delays or failure would seriously harm our
reputation and future operations. We cannot assure that the Network will be
accepted in the marketplace to yield material and sustained revenues. If our
product is not accepted in the market place, our business could be materially
and adversely affected.
Our business is focused on a market niche that has never been fully addressed,
and hence our operations are subject to a high level of uncertainty and risk. As
the market for our service is new and evolving, it is difficult to predict the
size of the market, the future growth rate, if any, or the level of premiums the
market will pay for our services. There can be no assurance that the market for
our services will emerge to a profitable level or be sustainable. There can be
no assurance that any increase in marketing and sales efforts will result in a
larger market or increase in market acceptance for our services. If the market
fails to develop, develops more slowly than expected or becomes saturated with
competitors, or if our proposed services do not achieve or sustain market
acceptance, our proposed business, results of operations and financial condition
will continue to be materially and adversely affected.
IF WE ARE UNABLE TO RESPOND TO RAPID TECHNOLOGICAL CHANGE AND IMPROVE OUR
PRODUCTS, OUR BUSINESS COULD BE MATERIALLY AND ADVERSELY AFFECTED.
The market for our products is characterized by:
o rapidly changing technology;
o evolving industry standards; and
o frequent new introductions which may be comparable or superior to
our products.
Our success will depend upon market acceptance of our existing solution and our
ability to enhance these solutions and introduce new solutions and features to
meet changing customer requirements. We cannot assure that we will be successful
7
PHOTOCHANNEL NETWORKS INC. FORM 20-F
in identifying, manufacturing and marketing new solutions or enhancing our
existing solutions. We may introduce unsatisfactory solutions to the market,
negatively impacting our ability to generate sales. In addition, we cannot
assure that solutions or technologies developed by others will not render our
solutions or technologies non-competitive or obsolete.
To remain competitive, we must continue to enhance and improve the
responsiveness, functionality and features of our solutions and our networking
services. The Internet and the e-commerce industry are characterized by rapid
technological change, changes in user and customer requirements and preferences,
frequent new product and service introductions embodying new technologies and
the emergence of new industry standards and practices that could render our
existing online operations, network services and proprietary technology and
systems obsolete. Our success will depend, in part, on our ability to license
leading technologies useful in our business, enhance our existing services,
develop new services and technology that address the varied needs of our
existing and prospective customers and respond to technological advances and
emerging industry standards and practices on a cost-effective and timely basis.
The development of our solutions, the network services and other proprietary
technology entails significant technical, financial and business risks. There
can be no assurance that we will successfully implement new technologies or
adapt our solutions, network services, proprietary technology and
transaction-processing systems to customer requirements or emerging industry
standards. If we are unable to adapt in a timely manner in response to changing
market conditions or customer requirements for technical, legal, financial or
other reasons, our business could be materially adversely affected.
Expected rapid growth in all areas of our Network may place a significant strain
on our operational and technical resources. We expect operating expenses and
staffing levels to increase in the future. To manage our growth, we must expand
our operational and technical capabilities and manage our employee base, while
effectively administering multiple relationships with various third parties,
including affiliates.
WE COMPETE WITH OTHERS WHO PROVIDE PRODUCTS COMPARABLE TO OUR NETWORK. IF WE ARE
UNABLE TO COMPETE WITH CURRENT AND FUTURE COMPETITORS, OUR BUSINESS COULD BE
MATERIALLY AND ADVERSELY AFFECTED.
We operate in a competitive market place. Our success is dependent upon our
ability to maintain our current customers and obtain additional customers. Many
of our potential competitors have:
o longer operating histories;
o significantly greater financial, technical and marketing resources;
o greater name and product recognition; and
o larger existing customer bases.
As potential competitors introduce competing solutions we may encounter
additional and more intense competition. We may experience delays or
difficulties in introducing new functionalities into our products, allowing
competitors to exploit opportunities in the market. We cannot be sure that we
will be able to compete successfully against current and future competitors. If
we are unable to do so it will have a material adverse effect on our business,
results of operations and financial condition.
WE RELY ON OUR ABILITY TO ATTRACT AND RETAIN CUSTOMERS. IF WE ARE UNABLE TO
MAINTAIN RELIABILITY OF OUR NETWORK WE MAY LOSE BOTH PRESENT AND POTENTIAL
CUSTOMERS.
Our ability to attract and retain customers depends on the performance,
reliability and availability of our services and network infrastructure. We may
experience periodic service interruptions caused by temporary problems in our
own systems or software or in the systems or software of third parties upon whom
we rely to provide such service. Fire, floods, earthquakes, power loss,
telecommunications failures, break-ins and similar events could damage these
systems and interrupt our services. Computer viruses, electronic break-ins or
other similar disruptive events also could disrupt our services. System
disruptions could result in the unavailability or slower response times of the
website(s) we host for our customers, which would lower the quality of the
8
consumers' experiences. Service disruptions could adversely affect our revenues
and if they were prolonged, would seriously harm our business and reputation. We
do not carry business interruption insurance to compensate for losses that may
occur as a result of these interruptions. Our customers depend on Internet
service providers and other website operators for access to our Network. These
entities have experienced significant outages in the past, and could experience
outages, delays and other difficulties due to system failures unrelated to our
systems. Moreover, the Internet network infrastructure may not be able to
support continued growth. Any of these problems could adversely affect our
business.
The infrastructure relating to our services are vulnerable to unauthorized
access, physical or electronic computer break-ins, computer viruses and other
disruptive problems. Internet service providers have experienced, and may
continue to experience, interruptions in service as a result of the accidental
or intentional actions of Internet users, current and former employees and
others. Anyone who is able to circumvent our security measures could
misappropriate proprietary information or cause interruptions in our operations.
Security breaches relating to our activities or the activities of third-party
contractors that involve the storage and transmission of proprietary information
could damage our reputation and relationships with our customers and strategic
partners. We could be liable to our customers for the damages caused by such
breaches or we could incur substantial costs as a result of defending claims for
those damages. We may need to expend significant capital and other resources to
protect against such security breaches or to address problems caused by such
breaches. Security measures taken by us may not prevent disruptions or security
breaches.
WE RELY ON THIRD PARTIES FOR THE DEVELOPMENT AND MAINTENANCE OF THE INTERNET AND
THE AVAILABILITY OF INCREASED BANDWIDTH TO USERS
The success of our business will rely on the continued improvement of the
Internet as a convenient means of consumer interaction and commerce. Our
business will depend on the ability of our customers' consumers to use the
Network without significant delays or aggravation that may be associated with
decreased availability of Internet bandwidth and access to our Network. This
will depend upon the maintenance of a reliable network with the necessary speed,
data capacity and security, as well as timely development of complementary
products such as high speed modems for providing reliable Internet access and
services. The failure of the Internet to achieve these goals may reduce our
ability to generate significant revenue.
Our penetration of a broader consumer market will depend, in part, on continued
proliferation of high speed Internet access. The Internet has experienced, and
is likely to continue to experience, significant growth in the number of users
and amount of traffic. As the Internet continues to experience increased numbers
of users, increased frequency of use and increased bandwidth requirements, the
Internet infrastructure may be unable to support the demands placed on it. In
addition, increased users or bandwidth requirements may harm the performance of
the Internet. The Internet has experienced a variety of outages and other delays
and it could face outages and delays in the future. These outages and delays
could reduce the level of Internet usage as well as the level of traffic, and
could result in the Internet becoming an inconvenient or uneconomical source of
products and services, which would cause our revenue to decrease. The
infrastructure and complementary products or services necessary to make the
Internet a viable commercial marketplace for the long term may not be developed
successfully or in a timely manner.
WE MAY NOT BE ABLE TO PROTECT AND ENFORCE OUR INTELLECTUAL PROPERTY RIGHTS,
WHICH COULD RESULT IN THE LOSS OF OUR RIGHTS, LOSS OF BUSINESS OR INCREASED
COSTS.
Our success and ability to compete depends, to a large degree, on our current
technology and, in the future, technology that we might develop or license from
third parties. To protect our technology, we have used the following:
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PHOTOCHANNEL NETWORKS INC. FORM 20-F
o confidentiality agreements;
o retention and safekeeping of source codes; and
o duplication of such for backup.
We are in the process of inquiring into and applying for patents in Canada and
the United States.
Despite these precautions, it may be possible for unauthorized third parties to
copy or otherwise obtain and use our technology or proprietary information. In
addition, effective proprietary information protection may be unavailable or
limited in certain foreign countries. Litigation may be necessary in the future
to:
o enforce our intellectual property rights;
o protect our trade secrets; or
o determine the validity and scope of the proprietary rights of
others.
Such misappropriation or litigation could result in substantial costs and
diversion of resources and the potential loss of intellectual property rights,
which could impair our financial and business condition. Although currently we
are not engaged in any form of litigation proceedings in respect to the
foregoing, in the future, we may receive notice of claims of infringement of
other parties' proprietary rights. Such claims may involve internally developed
technology or technology and enhancements that we may license from third
parties. Moreover, although we sometimes may be indemnified by third parties
against such claims related to technology that we have licensed, such
infringements against the proprietary rights of others and indemnity there from
may be limited, unavailable, or, where the third party lacks sufficient assets
or insurance, ineffectual. Any such claims could require us to spend time and
money defending against them, and, if they were decided adversely to us, could
cause us to:
o pay damages;
o be subject to injunctions; or
o halt deployment of our Network and products while we re-engineer
them or seek licenses to the necessary technology, which necessary
technology may increase our costs and might not be available on
reasonable terms.
Any of these factors could have a material and adverse effect on our financial
condition and business.
THE LOSS OF ANY OF OUR EXECUTIVE OFFICERS, KEY PERSONNEL OR CONTRACTORS WOULD
LIKELY HAVE AN ADVERSE EFFECT ON OUR BUSINESS.
We are dependent upon our management, employees and contractors for meeting our
business objectives. In particular, members of the senior management team play
key roles in our executive management and technical development. We do not carry
key man insurance coverage to mitigate the financial effect of losing the
services of any of these key individuals. Our loss of any of these key
individuals most likely would have an adverse effect on our business.
In addition, we may require additional capabilities, especially in our
representation on the board of directors. We cannot assure that we will be
successful in attracting personnel of the appropriate caliber.
THE FOLLOWING RISKS RELATE TO THE MARKET FOR OUR COMMON SHARES
AT PRESENT, THERE IS A LIMITED MARKET FOR OUR COMMON SHARES IN THE UNITED
STATES. IF A SUBSTANTIAL AND SUSTAINED MARKET FOR OUR COMMON SHARES DOES NOT
DEVELOP IN THE UNITED STATES, OUR US SHAREHOLDERS' ABILITY TO SELL THEIR SHARES
MAY BE MATERIALLY AND ADVERSELY AFFECTED.
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PHOTOCHANNEL NETWORKS INC. FORM 20-F
Our common shares trade in Canada on the TSX Venture Exchange. Trading of these
shares is presently concentrated in the Canadian marketplace. At present there
is a limited trading market in the United States for our common shares and such
is unlikely to develop further under the present circumstances. We have no
agreement with any broker-dealer to act as a market-maker for our common shares.
If one or more broker-dealers become a market maker in our shares, the shares
may be quoted on the OTC Bulletin Board. Any trading will be limited to the
non-NASDAQ over-the-counter market. We presently do not qualify for trading on
either NASDAQ or on any US stock exchange because we do not meet any of those
organizations' financial listing requirements. Further, there can be no
assurance that our securities will ever qualify for such listing. Accordingly,
there can be no assurance that any US market for our securities will develop or,
that if developed, it will continue. The absence of such a US market would
materially and adversely affect the ability of US shareholders to sell their
shares.
At the present time, all of our revenues are retained by us and used to fund our
growth. The payment of dividends on the common shares is within the discretion
of our Board of Directors and will depend upon our future earnings, our capital
requirements, our financial condition, and other relevant factors. We do not
currently anticipate declaring any dividends on our common shares in the
foreseeable future.
OUR COMMON SHARES MAY BE DEEMED TO BE A "PENNY STOCK" IN THE UNITED STATES. AS A
RESULT, TRADING OF OUR SHARES MAY BE SUBJECT TO SPECIAL REQUIREMENTS THAT COULD
IMPEDE OUR SHAREHOLDERS' ABILITY TO RESELL THEIR SHARES IN THE UNITED STATES.
At present our common shares are deemed to be a "penny stock" as that term is
defined in Rule 3a51-1 of the Securities and Exchange Commission. Penny stocks
are stocks:
o with a price of less than five US dollars per share;
o that are not traded on a recognized national exchange;
o whose prices are not quoted on the NASDAQ automated quotation
system;
o of issuers with net tangible assets less than
o $2,000,000 if the issuer has been in continuous operation for
at least three years; or
o $5,000,000 if in continuous operation for less than three
years; or
o of issuers with average revenues of less than $6,000,000 for the
last three years.
Section 15(g) of the Exchange Act, and Rule 15g-2 of the Securities and Exchange
Commission, require broker-dealers dealing in penny stocks to provide potential
investors with a document disclosing the risks of penny stocks and to obtain a
manually signed and dated written receipt of the document before effecting any
transaction in a penny stock for the investor's account. Moreover, Rule 15g-9 of
the Securities and Exchange Commission requires broker-dealers in penny stocks
to approve the account of any investor for transactions in such stocks before
selling any penny stock to that investor. This procedure requires the
broker-dealer:
o to obtain from the investor information concerning his or her
financial situation, investment experience and investment
objectives;
o to determine reasonably, based on that information, that
transactions in penny stocks are suitable for the investor and that
the investor has sufficient knowledge and experience so as to be
reasonably capable of evaluating the risks of penny stock
transactions;
o to provide the investor with a written statement setting forth the
basis on which the broker-dealer made the determination above; and
o to receive a signed and dated copy of such statement from the
investor, confirming that it accurately reflects the investor's
financial situation, investment experience and investment
objectives.
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PHOTOCHANNEL NETWORKS INC. FORM 20-F
Compliance with these requirements may make it more difficult for holders of our
common shares to resell their shares to third parties or to otherwise dispose of
them in the United States.
ITEM 4. INFORMATION ON THE COMPANY
SUMMARY
We develop and market digital imaging technology, which connects the
photofinishing retailer to its customer through a wide variety of businesses
including professional and commercial photo processing labs, image content
owners and targeted portal services. We have created and manage a digital
Network environment whose focus is on delivering digital image orders from
capture to fulfillment under the control of our originating Network partner.
This Network is described in greater detail in "Our Products" in Item 4.B
Business Overview below.
A. HISTORY AND DEVELOPMENT OF THE COMPANY
We were incorporated on December 1, 1995 pursuant to the laws of British
Columbia, Canada under the name InMedia Presentations Inc. We obtained receipts
in April 1997 for a Prospectus filed with the British Columbia Securities
Commission and the Ontario Securities Commission. Our shares were subsequently
listed for trading on the Montreal Exchange on April 21, 1997 under the trading
symbol "IMD". We changed our name on July 14, 1999 to PhotoChannel Networks Inc.
and concurrently changed our symbol on the Montreal Exchange to "PNI". In
September 2001 the Montreal Exchange ("ME") merged with the Canadian Venture
Exchange ("CDNX") and effective October 1, 2001 we began trading on the CDNX.
Subsequently the CDNX was acquired by the TSX Venture Exchange in 2002 and on
April 1, 2002 we were listed for trading on the TSX Venture Exchange.
Our principal executive office is located at 506-425 Carrall Street, Vancouver,
British Columbia, Canada V6B 6E3, our telephone number is 604-893-8955 and our
website is www.photochannel.com.
IMPORTANT EVENTS IN THE DEVELOPMENT OF OUR BUSINESS
Important events in the development of our business are provided under Item 4.
B., below, and in other sections of this filing.
PRINCIPAL CAPITAL EXPENDITURES AND DIVESTITURES SINCE OCTOBER 1, 1997
We continue to develop, change and enhance our software and product offerings.
Since October 1, 1999, the only capital divestiture has been the filing by our
US operating subsidiary, PhotoChannel, Inc., under Chapter 7 of the United
States Bankruptcy Code with the United States Bankruptcy Court, District of
Connecticut, on November 1, 2001. The only capital expenditures have been for
computer equipment and software, development and furniture and leaseholds, which
occurred in the normal course of our operations. Our total capital expenditures
were approximately $264,123 for the year ended September 30, 2003 compared with
$1,882 in 2002, $1,186,256 in 2001, $4,710,973 in 2000 and $54,359 in 1999. We
have financed these expenditures primarily by issuing debt and common shares.
Further details applicable to our anticipated capital expenditures and funding
sources are detailed in Liquidity and Capital Resources in Item 5.B.
PRINCIPAL CAPITAL EXPENDITURES AND DIVESTITURES CURRENTLY IN PROCESS
As of February 29, 2004 there were no capital expenditures or divestitures in
process outside of the normal course of business.
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PHOTOCHANNEL NETWORKS INC. FORM 20-F
PUBLIC TAKEOVER OFFERS SINCE OCTOBER 1, 2000
There have been no public takeover offers by third parties in respect of our
shares or by us in respect of other companies' shares since October 1, 2000.
B. BUSINESS OVERVIEW
Historically, we have been in the business of developing and marketing digital
imaging software products for use by consumers and businesses. We originally
formed to develop and market a suite of "easy to use" multimedia presentation
products for use by consumers wishing to present and display images captured on
digital cameras and photo scanners. We marketed these products under the trade
name Slides & Sound PlusTM. We discontinued development of these products during
1999 in order to focus on the development of our e-Processing and network
strategy. During the fiscal year ending September 30, 2000, all of our revenue
was generated from the sale of our multimedia presentation products. However, as
of January 31, 2001, we no longer actively marketed or supported these products.
In February 1999, we established our website at www.photochannel.com as an
online photo community for both digital camera and conventional film
photographers. Our online photo community consisted of an Internet portal
through which users could participate in photography focused chat groups,
discussion forums, e-mail and have access to articles relating to photography
hints, tips and techniques. Users could also upload, store and manipulate
digital images online and create photo websites, albums and slide shows.
On October 2, 2000, we launched an e-Processing service with the introduction of
a photofinishing, e-Processing service as a business - to - consumer strategy
providing film processing, scanning, storage and printing of digital images
directly to US consumers via our wholly owned US subsidiary, PhotoChannel, Inc.
This was to be a joint strategy between our future Network members and the "mail
order" model of our US subsidiary. With this launch, we were able to beta test
the technology and the marketing of this concept. Our US subsidiary was
attempting to target digital camera users who required a photofinishing solution
and eventually it was our goal to also provide photofinishing fulfillment
through our future Network of professional photofinishing retailers. Regardless
of whether our US subsidiary's customers or our future retailer's customers were
digital camera or conventional film photographers, our Network member's
customers would be able to preview and edit their digital/digitized pictures
online before ordering any prints.
In March 2001, we went through a major reorganization, which resulted in a
change of management, a complete corporate restructuring and a change in
business focus. We determined that we could not offer both solutions, as the
e-processing "mail order" model provided by our US subsidiary was, in fact,
competing with our Network model. In April of 2001, we ceased to provide the
e-processing mail order option. On November 1, 2001, after attempting to debt
settle with creditors of our US subsidiary, our US operating subsidiary,
PhotoChannel, Inc. filed under Chapter 7 of the United States Bankruptcy Code
with the United States Bankruptcy Court, District of Connecticut.
Subsequent to March 2001, our focus has been one of a digital imaging technology
provider for a wide variety of businesses including photofinishing retailers,
professional and commercial photo processing labs, image content owners and
targeted portal services. We have created and manage a digital network
environment whose focus is on delivering digital image orders from capture to
fulfillment under the control of our originating Network member.
On May 10, 2001 the first retail Network members outfitted with their own
branded Internet sites were activated onto the Network. These retailers accept
the upload of images that originate within digital cameras or have been scanned
within the store environment to sites we create and host. Our Network is a
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PHOTOCHANNEL NETWORKS INC. FORM 20-F
transparent component to the consumer, existing solely as the technology
backbone of the retailer's digital imaging strategy.
With the establishment and launch of our Network, we distanced ourselves from
our immediate past of being an Internet photofinishing "mail order" service into
an Internet infrastructure company that manages a Network environment that today
is focused on delivering digital imaging from order origination to fulfillment
through our retail relationships and connectivity to the retail locations.
THE DIGITAL PHOTOGRAPHY MARKET
Digital camera and scanner manufacturers fabricate devices for digitizing
pictures. Their products capture an image and output it as a digitized picture.
Alternatively, conventional film images can be digitized through a scanning
mechanism, and either uploaded to the Internet for storage or transferred to a
floppy disk or CD. Digitized pictures can then be printed on colour inkjet or
dye sublimination photo printers. Alternatively, they can be processed through
an online service, which provides print photographs at a quality consistent with
that offered by conventional film processors. Digital pictures may be stored on
desktop or laptop computers, on floppy disks or picture CDs or as negatives at a
website of an online digital photography service provider.
The primary target market for our Network services are print origination members
such as communities, portals and retailers, and print fulfillment members such
as photofinishing retailers.
The use of digital cameras is increasing and management believes that the
popularity of the digital camera will continue to grow as the cost of such
cameras continue to decrease and the availability of photographic quality
digitized print services increases. InfoTrends predicts that 20% of US
households own a digital camera already, and that was expected to grow to 30% by
the end of 2003. InfoTrends further predicts that 45% of consumers with Internet
connectivity owned a digital camera in 2002 and that 24% planned to purchase
their first digital camera by the end of 2003. The worldwide install-base of
digital cameras has risen quickly since their introduction in the mid 1990's.
There is no demographic in which digital cameras are exclusive to, nor is there
a prohibitive degree of technological sophistication required to operate these
cameras.
Photofinishing retailers have viewed digital camera penetration as threatening
their future. According to PMA's "Photo Industry 2004 Review and Forecast" film
processing volume fell by an estimated 6% in 2003 to 686 million rolls in the
United States and processing revenue fell by nearly 8%, to $5.4 billion. As
consumers shift their picture-taking activity from film to digital, one of the
greatest challenges has been making them aware of the options for printing their
digital pictures. The effect of digital imaging today and the future forecasting
indicates that digital will have an additive effect on the growth of picture
taking. Photofinishing News estimates that total worldwide photo exposures were
92 billion in 2001 with 81% derived from film and 19% from digital. Worldwide
exposures are projected to grow at a Compound Annual Growth Rate of 8% with film
representing 59% and digital representing the remaining 41%. Translated into
photofinishing revenue, it is anticipated that digital photofinishing will be a
$7,694,000,000 worldwide industry by 2005, up from $713,000,000 in 2001.
The most important point in all of these forecasts is the belief of our
management that the consumer will not change their habits - they will continue
to look to the photofinishing retailer as their destination for convenient,
quality driven printing. The photofinishing retailers are making changes to
ensure they remain at the center of the photofinishing universe. As picture
taking becomes digital, the retailers want to ensure they retain the foot
traffic in their stores and the relationship with their customers. The first
step for them is ensuring they have equipment that can print digital images and
can create digital images from film. The piece of equipment the retailers are
utilizing is known as the "digital minilab".
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PHOTOCHANNEL NETWORKS INC. FORM 20-F
According to PMA, 53% of specialty retailers operated digital minilabs in 2002,
compared to only 19% in 2001. Twenty-nine percents planned to add a digital
minilab during 2003. The growing availability of digital minilab equipment is
reflected in the share of prints produced by digital minilabs. Specialty
retailers produced 62% of the prints they made during 2002 using digital
equipment. Of significant interest is that over 75% of the world's
photofinishing is done by less than 20% of its retailers. With large volume
retailers being the most advanced retailers, it is projected that over 75% of
the world's photofinishing volume will be processed by retailers who are 100%
digitally capable by the end of 2004.
PRODUCTS
Multimedia Presentation Products
During fiscal 1998, 1999 and 2000, 100% of our revenue was generated through the
distribution of our multimedia presentation products. As a result of declining
interest in our multimedia presentation products, effective January 31, 2001, we
no longer actively market or support these products.
The PhotoChannel Network
On May 10, 2001 the first retail Network members outfitted with their own
branded Internet sites were activated onto our Network. These retailers accept
the upload of images that originate within digital cameras or have been scanned
within the store environment to sites we create and host. Our Network is a
transparent component to the consumer, existing solely as the technology
backbone of the retailer's digital imaging strategy.
With the establishment and launch of our Network, we distanced ourselves from
our immediate past of being an Internet photofinishing "mail order" service into
an Internet infrastructure company that owns retail relationships, the
connectivity to the retail locations and manages a Network environment that
today is focused on delivering digital imaging from order origination to
fulfillment.
In October 2002, we launched our Network with our first large retail chain,
Black Photo Corporation ("Black's"). Black's is a wholly owned subsidiary of
Fuji Film Canada. Black's owns and operates 168 photo retail stores across
Canada under the Black's and Astral banners. As part of our Network, we
developed a fully syndicated white branded site at www.blackphotocenter.com,
which prints back to a large Canadian wholesaler and is then delivered back to a
Black's location of the customer's choice for pickup, or is mailed or couriered
back to the customer, at the customer's option. Black's has advised us that in
2004, it intends to use our Network's capability to print directly to their
retail locations, thus creating a one hour digital printing service.
During fiscal 2003, we increased our retail photofinishing base to include such
companies as Wal-Mart Canada, Loblaw Group of Companies and Sobeys Inc. in
Canada and Giant Eagle, Inc. in the United States.
SUMMARY OF GROSS REVENUES
September 30,
------------------------------------------------------------------------
2003 2002 2001
Multimedia Products $ - $ - $ 26,046
Online Photofinishing - - 41,758
Network 255,573 173,801 29,308
----------------------- ---------------------- ---------------------
Total Revenue $ 255,573 $ 173,801 $ 97,112
======================= ====================== =====================
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PHOTOCHANNEL NETWORKS INC. FORM 20-F
COMPETITION
Online photo print service
Internet photography service providers offer different services, some associated
with photofinishing, others with archiving and sharing, and some provide a
comprehensive photo-community service such as we launched. The following are the
common services provided:
o Content - the ability to offer uploading through photofinishing or other
devices, as well as photo enhancing options. Internet portals can charge
for the uploading service or provide it free of charge. Some companies
offer the content for online photography community sites, promoting
photographic education via articles and photo-magazine subscriptions or
via chats and lectures with professional photographers.
o Sharing/Albums - via the creation of albums and archives, many of the
sites offer the ability to view and share photos.
o Photofinishing - is generated through prints, reprints, enlargements, gift
items and sales of photo hardware and supplies.
o Community - communities offer an interactive location where the user can
find a one-stop-shop catering to photography.
We offered all of these services through our syndicated websites.
The online photo print service market is a fairly new market. The first
generation of online photo print services arose with the 1996 introduction of
online photo print services by PictureVision, Inc. under the trade name
"PhotoNet". Shortly thereafter, in August 1997, Eastman Kodak Inc. ("Kodak")
entered the online photo print business with the introduction of the Kodak
Picture Network service, which provided conventional film scanning and uploading
of digitized pictures to the Internet. In February 1998, Kodak acquired a 51%
interest in PictureVision, Inc. Through this acquisition, Kodak then represented
almost 100% of the online digital photography service market. Shortly after
Kodak acquired a controlling interest in PictureVision, Inc., Sony introduced an
online photo print service featuring free uploading of digital images to a Sony
image station for online ordering of prints. The other first generation online
photo print service provider is Foto Wire Development S.A. of Geneva,
Switzerland, which has been providing Internet photo print services designed
specifically for digital camera photographers in Europe since 1998. In 1999,
Foto Wire Development S.A. entered the U.S. market in partnership with two mail
order photography developing labs, Mystic Color Lab in Connecticut and Signature
Color in Texas.
The second generation of online photo print services began in November 1999 with
the entry into the market by Ofoto, Shutterfly, PhotoAccess and Snapfish. This
generation was a business to consumer model focused on the "mail order" concept
of delivering digital/digitized photos through the Internet to a wholesaler with
delivery back to the consumer through the postal service or by way of courier.
The provision of online photo print services through a distributed network, as
we have contemplated, represents, what we believe to be, the third generation of
this type of service.
Network
The market for our solutions and technologies are new, evolving and growing
rapidly. Our business model of being an open, scalable and secure network
provider for the photofinishing industry is currently unique. The most notable
names in the online photofinishing business, names such as Kodak's Ofoto,
Shutterfly and Snapfish, are not our direct competitors. These companies have
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PHOTOCHANNEL NETWORKS INC. FORM 20-F
focused on a pure business to consumer model of online photofinishing. These
players are competing with the established "mail order" players such as Mystic
Color and District Photo (the world's largest mail order photofinishing
operator). It's worth noting that mail order has vanished as a market force over
the last decade as the one-hour onsite operations of retailers have come to
dominate the photofinishing landscape.
The photofinishing retailers are our true customers. Organizations such as
Kodak, Fuji, Pixel Magic, Lifepics and Fotowire all work with retailers in terms
of providing equipment to scan silver halide images to digital and some provide
online storage and web site hosting. We believe that we can co-exist in many
retail environments with these other industry players without directly competing
with them, as our services are independent of the type of digital imaging
hardware the retailer prefers to use. We also believe that we can deliver the
secure network component and lab broker system of delivering print orders from
outside parties without having to compete on the equipment, hosting and storage
business.
Kodak, through PhotoNet, was developing a similar network, however it was
restricted to Kodak affiliates. Prior to Kodak's decision to completely shut
down its operations in October 2001 it was in fact being rejected by most
retailers as Kodak had publicly announced it was working on a direct to consumer
strategy based on a new service called Print@Kodak, which superseded PhotoNet.
Some larger retailers have created internal networks, however, such networks are
restricted to that retailer's stores. These companies mentioned above are all in
various stages of competitive stance and we believe that we will be able to work
with most of them without having to directly compete, as our relationships with
the retailer is centered on building the actual physical network in a way that
leaves the retailer in complete possession of their customers. We do not get
between a retailer and their customers.
We are the only company offering a complete solution that creates a secure and
open network, which is agnostic to the brand of hardware being utilized by the
photofinishing retailer. This allows different retailers and web properties to
do business together if they so desire. Up until now, the climate has been
fairly one-dimensional with closed, non-integrated networks. Our business model
is allowing us to create the first true open and multi-dimensional digital image
network.
Our current customers, when given the alternative of "white branding", have
gravitated quickly toward our solutions of technology coupled with our private
label branding, service and flexibility. Photofinishing retailers need
innovative digital imaging goods and services. In many cases the big hardware,
paper and chemistry companies, such as Kodak and Fuji, are not servicing these
accounts properly.
We believe that one of our advantages is that we are a small enough organization
to make speedy and informed decisions. This flexibility means the retailer or
their customer does not have to go through a bureaucracy to get a decision. We
believe that the principal factors enabling us to compete, include: a complete
solution service; strategic market positioning; channel distribution; and the
functionality and architecture of our technologies. The relative importance of
each of these factors depends upon the specific customer involved.
C. ORGANIZATIONAL STRUCTURE
We have two wholly owned subsidiaries, PhotoChannel Capital Inc. and
PhotoChannel Management Inc. Both subsidiaries are inactive. PhotoChannel
Capital Inc. was incorporated on January 25, 2000 to undertake the sale and
distribution of units of PhotoChannel.Com Limited Partnership and is the sole
shareholder of PhotoChannel Management Inc. PhotoChannel Management Inc. was
incorporated on January 25, 2000 and is the general partner of the
PhotoChannel.Com Limited Partnership. The PhotoChannel.Com Limited Partnership
is inactive and does not carry on any business.
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PHOTOCHANNEL NETWORKS INC. FORM 20-F
On February 14, 2002, the PhotoChannel LP was formed under a Limited Partnership
Agreement to carry on the sales, marketing and deployment of the PhotoChannel
Network in Canada. The partnership initially sold 1,250 Limited Partnership
units in June 2002, at a price of $1,000 per unit, raising $1,250,000. In
December 2002 and September 2003, the partnership sold an additional 115 units
and 245 units, respectively, at a price of $1,000 per unit, raising $360,000. We
have granted to the PhotoChannel LP a software license to commercially exploit
the PhotoChannel Network in Canada. Pursuant to an operating agreement, we will
receive payments for services provided to the PhotoChannel LP from a software
license agreement and management and operating services agreements (representing
software rights, management, personnel and facilities and equipment that we have
agreed to provide to the PhotoChannel LP), which will enable us to continue its
development, deployment and exploitation of its digital imaging network software
in other market segments.
It is a condition of the PhotoChannel LP agreement that each limited partner
enter into an agreement with us, pursuant to which we have the option to acquire
all the Limited Partnership units from the limited partners, at any time on or
before June 30, 2004. Each of the Limited Partnership units sold in June and
December 2002 may be exchanged for 10,000 of our units, each unit being
comprised of one common share and one common share purchase warrant. Each common
share purchase warrant entitles the holder to purchase one additional common
share of us, at a price of $0.10 per share, at any time on or before the earlier
of two years from the date of issue of the Limited Partnership units and June
30, 2004. Each Limited Partnership unit sold in September 2003 may be exchanged
for 10,000 of our common shares.
In view of the existence of our option to acquire the Limited Partnership units
from the limited partners, certain common ownership and management of us and the
Limited Partnership and that we control the PhotoChannel LP, the partnership
equity is presented within our shareholders' equity and the accounts of the
partnership have been consolidated with ours.
D. PROPERTY, PLANT AND EQUIPMENT
Our executive offices are located at 425 - 506 Carrall Street, Vancouver,
British Columbia, Canada, V6B 6E3. The premises comprise approximately 4,337
square feet in an office building. The premises are leased from an unaffiliated
party for a period of forty-nine months expiring on July 31, 2007. The base
monthly rent is approximately $3,994.50 for the period July 1, 2003 to May 31,
2004 and $6,505.50 for the period June 1, 2004 to July 31, 2007.
ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS
GENERAL
In this section, we explain our consolidated financial condition and results of
operations for each of the years ended September 30, 2003, 2002 and 2001. As
readers read this section, they may find it helpful to refer to our consolidated
financial statements at the end of this annual report and the information
contained in the section entitled "Selected Financial Data" in Item 3 of Part I
of this annual report.
Our consolidated financial statements were prepared in accordance with Canadian
GAAP. See Note 19 to the September 30, 2003 consolidated financial statements
for a discussion of material measurement differences between Canadian and US
GAAP, as it relates to us.
CRITICAL ACCOUNTING POLICIES
The preparation of our financial statements requires management to make
judgments, 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 amount of revenues and
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PHOTOCHANNEL NETWORKS INC. FORM 20-F
expenses during the reporting period. Our estimates are based upon historical
experience and on various other assumptions that are believed to be reasonable
under the circumstances. The result of our ongoing evaluation of these estimates
forms the basis for making judgments about the carrying values of assets and
liabilities and the reported amount of expenses, which are not readily apparent
from other sources. Actual results may differ from these estimates under
different assumptions.
Our critical accounting policies are those that affect our consolidated
financial statements' materially and involve a significant level of judgment by
management. A summary of our significant accounting policies, including the
critical accounting policies discussed below, is set forth in note 2 to our
consolidated financial statements.
Revenue recognition: During fiscal year 2003, we earned installation, commission
and membership revenue from the provision of the PhotoChannel Network to
electronically connect photofinishing retailers to their customers, through the
Internet. Revenue received in advance from installation services for the set-up
of a customer website is recorded as deferred revenue and is recognized into
income over the estimated term of the customer relationship period. Revenue from
monthly membership fees from photofinishing retailers for the connection to the
PhotoChannel Network is earned and recognized monthly as the connection is
provided. Revenue from commissions earned on transactions processed by the
photofinishing retailers, utilizing the PhotoChannel Network, is recognized at
the time the digital image processing services are provided to the end customer.
Bad Debt Allowance: We estimate the amount of uncollectible receivables each
period and establish an allowance for uncollectible amounts. The amount of the
allowance is based on the age of unpaid amounts, information about the ongoing
creditworthiness of the customer(s), and other relevant information. Estimates
of uncollectible amounts are revised each period and changes are recorded in the
period as they become known.
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
We have made forward-looking statements in this annual report that are subject
to risks and uncertainties. Forward-looking statements include information
concerning our possible or assumed future results of operations. Also, when we
use such words as "believe," "expect," "anticipate," "plan," "could," "intend"
or similar expressions, we are making forward-looking statements. Readers should
note that an investment in our securities involves certain risks and
uncertainties that could affect our future financial results. Although we
believe that the assumptions that we have used in making forward-looking
statements are reasonable, our actual results could and most likely will differ
materially from those anticipated in these forward-looking statements as a
result of certain factors, including those set forth in this annual report:
o elsewhere in this Item 5.; and
o in the "Risk Factors" subsection of Part I, Item 3 "Key
Information."
Given these uncertainties, we caution readers not to place undue reliance on
such forward-looking statements.
A. OPERATING RESULTS
From October 2000 until December 2000 we focused on our subsidiary,
PhotoChannel, Inc. Through funding our subsidiary, PhotoChannel, Inc., we were
able to assemble a team and develop the infrastructure believed necessary to
capture market share in the online ("mail order") photofinishing industry.
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PHOTOCHANNEL NETWORKS INC. FORM 20-F
In January 2001, it became very apparent that this business was not sustainable.
On March 19, 2001 a new management team took over our operations. The new
management team quickly changed focus from being an online photo portal and
worked on our restructuring. This restructuring included drastic cuts in
staffing and consultants, travel and marketing and focused operations on the
deployment of a retailer based network of digital photofinishing.
Our main business focus became being a technology producer and integrated
provider of services for the photofinishing retailer. We no longer attempted to
compete with the retailer through the online "mail order" concept, but began to
support and help the retailer grow and meet the increasing needs of their
customers. The new business model focused strictly on a business to business
model and ceased all further development of the business to consumer model that
our US subsidiary had been developing. Our focus was to complete the "Network",
which would enable the delivery of digital photo image orders under the control
of the originating photofinishing retailer.
We installed our first retail member to the Network in May 2001. Our new
technology, at this point, was completed and stable. Significant feature
additions were added over the next few months and today our technology allows us
to build completely customized retailer branded web sites within hours and
connect them to our lab server environment in the retail store. The photo
retailer now has full administrative control over their customer's orders and
accounts. Our lab server software now connects to any retailer using any one of
twelve of the most popular digital printing and/or scanning devices on the
market today. These include such established brands as the Fuji Frontier digital
minilab(s), Noritsu digital minilab(s), Agfa D-lab digital minilab and the
Konica digital minilab(s). Our technology is open and scalable, providing a vast
market within which to sell our products and services.
During the remainder of 2001 and during 2002, we worked on automating all of our
processes and procedures in order to reduce future costs. We built an online
knowledge database, which significantly reduces the costs of service and
support, along with automating sign-up and installation processes connecting
retail stores to our Network.
Today, although we have solved many of our past problems, we continue to be
beset with the challenge of raising additional capital to rapidly deploy our
solution and achieve profitability. We believe that we are well positioned to
profit from the large, ever increasing, digital imaging market.
YEAR ENDED SEPTEMBER 30, 2003 AND SEPTEMBER 30, 2002
Revenue
Revenue for the year ended September 30, 2003 was $255,573 versus $173,801 for
the year ended September 30, 2002. Revenue increased by 47% due to an increase
in installation fees and a 2,410% increase in transaction fees as an increased
number of retailers and consumers began to adopt our services. We defer revenue
from installation fees earned for the set-up of a customer website and
recognizes it as income over the estimated term of the customer relationship
period. At September 30, 2003, we had deferred revenue of $60,000. Membership
fees during fiscal 2003 were reduced, as we changed our strategy of providing
ADSL (high speed) Internet connections to the photofinishing retailer.
Photofinishing retailers now contract directly with the ADSL providers. This
also resulted in a significant decrease in our cost of sales. During fiscal 2003
and 2002, 100% of the Company's revenue was derived from the provision of
Network services, compared to only 30% or $29,308 for the year ended September
30, 2001.
Management's strategy is to focus on being a digital imaging technology provider
for a wide variety of businesses including: photofinishing retailers;
professional and commercial photo processing labs; image content owners; and
targeted portal services. Our digital Network is focused on delivering digital
image orders from capture to fulfillment under the control of the originating
photofinishing retailer. We charge our photofinishing retailers an upfront fee
20
PHOTOCHANNEL NETWORKS INC. FORM 20-F
for the development of its website, a monthly fee for their connection to the
Network and take a percentage of all gross print revenues derived through the
Network. In addition, we charge the customers of the photofinishing retailers a
storage fee for hosting their digital images.
Operating Expenses and Net Loss
Losses incurred by the Limited Partnership in 2002 and 2003 are allocated first
to the Limited Partnership units to the extent of their equity investment and
thereafter to us. In 2002, we previously attributed all losses to our common
shareholders. Accordingly, the loss for 2002 has been restated for comparative
purposes to allocate losses to the Limited Partnership units to the extent of
its equity. This restatement has had the effect of reducing the deficit
attributable to our common shareholders at September 30, 2002 from $38,963,665
to $37,726,075, the net loss attributed to common shareholders from $1,851,661
to $614,071 and the basic and fully diluted net loss per share from $0.03 to
$0.01.
We recorded a loss for the year ended September 30, 2003 of $2,449,984 ($0.03
per share). This represents an increase of 1,835,913 or 299% as compared to the
restated loss of $614,071 ($0.01 per share) for the year ended September 30,
2002. The significant increase in loss was a result of the change in treatment
of the loss attributable to Limited Partnership units (2003 - $372,410 versus
2002 - $1,237,590); the gain on the bankruptcy of our US subsidiary in fiscal
2002 of $2,746,944; and the reduction on gain on the settlement of obligations
(2003 - $457,599 versus 2002 - $808,774). The extent of the current period's
increase in loss was partially offset by a large reduction in operating expenses
during fiscal 2003. A comparison of operating results and non-operating events
for the two years ended September 30 are set out in the table below.
DESCRIPTION 2003 2002
Loss from operations ($ 3,282,445) ($ 5,334,672)
Gain on bankruptcy of subsidiary - 2,746,944
Gain on settlement of obligations 457,599 808,774
Loss attributed to limited partnership 372,410 1,237,590
Other items 2,452 (72,707)
----------------- ------------------
Net loss for the year attributed to common shareholders ($ 2,449,984) ($ 614,071)
----------------- ------------------
In fiscal 2003, general and administration expenses decreased $1,580,039 to
$1,528,449 (2002 - $3,108,488), a 50.8% decline over the comparable period of
2002. The largest contributors to this reduction during fiscal 2003 were as
follow: salaries and consulting decreased by $1,097,854 due to both temporary
and permanent layoffs; accounting and legal decreased by $231,071 due to a
reduction of legal costs; and office and miscellaneous decreased by $299,284
primarily due to a reduction in travel.
In fiscal 2003, sales and marketing expenses increased $80,536 to $734,792 (2002
- - $654,256), a 12.3% increase over the previous fiscal year. This increase was
primarily attributable to distributor services provided by NBJ Enterprises Ltd.,
dba Skana Photo-Lab Products, who were issued common share purchase warrants for
services provided. The common share purchase warrants were attributed a value of
$93,000, which was determined using the Black-Scholes option-pricing model.
In fiscal 2003, research and development costs increased $174,705 to $789,189
(2002 -$614,484), a 28.4% increase over fiscal 2002. This increase is primarily
due to the addition of staffing and consultants required to meet the demands of
new customers and maintain our competitive edge in the marketplace by being the
first to market with new value added solutions.
In fiscal 2003, amortization expense decreased $609,609 to $280,778 (2002 -
$890,387), a 68.5% decrease over fiscal 2002. This reduction is primarily the
result of certain of our equipment being fully amortized, along with replacing
21
PHOTOCHANNEL NETWORKS INC. FORM 20-F
old expensive equipment with new, less expensive and more cost effective,
equipment. The purchase of this new equipment provides us with future growth
potential and the ability scale much more efficiently, based upon its
anticipated growth.
We recorded a gain on settlement of obligations of $457,599 during the year
ended September 30, 2003 (2002 - $808,774; 2001 - $66,382). These amounts were
the result of negotiating settlements with our creditors at less than the face
value of the original obligations.
YEAR ENDED SEPTEMBER 30, 2002 AND SEPTEMBER 30, 2001
Revenue
Revenue for the year ended September 30, 2002 was $173,801 versus $97,112 for
the year ended September 30, 2001. Revenue increased by 79% due to the
implementation and usage of our Network within photofinishing retailers. During
fiscal 2002, 100% of our revenue was derived from the Network, compared to only
30% or $29,308 for the year ended September 30, 2001. During fiscal 2001, our
discontinued business model, which had focused on the "mail order" printing
service to US customers, accounted for $41,758 or 43% of our revenue and the
sale of Multimedia Presentation Products contributed the remaining 27% or
$26,046. In January 2001, we discontinued any further development and support of
or Multimedia Presentation Products, although we continued to earn revenue from
these products up to June 30, 2001.
Management's strategy going forward is to focus on that of being a digital
imaging technology provider for a wide variety of businesses including,
photofinishing retailers, professional and commercial photo processing labs,
image content owners and targeted portal services. We have created and manage a
digital network environment whose focus is delivering digital image orders from
capture to fulfillment under the control of our originating Network member. We
charge our photo retailers a monthly fee for their connection to our Network and
take a percentage of all gross print revenue that is derived through the
Network. In addition, we charge customers of our photo retailers a storage fee
for hosting their digital images.
Operating Expenses and Net Loss
Losses incurred by the Limited Partnership in 2002 have been restated to first
allocate to the Limited Partnership units to the extent of their equity
investment and thereafter to us. In 2002, we previously attributed all losses to
our common shareholders. Accordingly, the loss for 2002 has been restated for
comparative purposes to allocate losses to the Limited Partnership units to the
extent of its equity. This restatement has had the effect of reducing the
deficit attributable to our common shareholders at September 30, 2002 from
$38,963,665 to $37,726,075, the net loss attributed to common shareholders from
$1,851,661 to $614,071 and the basic and fully diluted net loss per share from
$0.03 to $0.01.
As a result, we recorded a restated net loss for the year ended September 30,
2002 of $614,071 ($0.01 per share) a decrease of $19,257,160 or 96.9%, as
compared to the net loss of $19,871,231 ($0.60 per share) for the year ended
September 30, 2001. The significant reduction of our net loss was a result of
certain non-recurring items. During fiscal 2002, we recognized a gain of
$3,555,718, represented by an expense recovery from the bankruptcy by our US
subsidiary and the settlement of obligations at amounts which were less than
previously expensed. In addition, we made significant reductions on expenditures
for research and development, sales and marketing and general and
administration. During fiscal 2001, our net losses increased due to a one time
charge related to an amortization and impairment write down, as the result of us
refocusing our business model. Excluding the impairment write down in the amount
of $4,806,390 recognized at year end 2001 and described below, 82% of the fiscal
2001's losses occurred during the first six months of operations, or prior to
the restructuring. A comparison of operating results and non-operating events
for the two years ended September 30 are set out in the table below.
22
PHOTOCHANNEL NETWORKS INC. FORM 20-F
DESCRIPTION 2002 2001
Loss from operations ($ 5,334,672) ($20,259,747)
Gain on bankruptcy of subsidiary 2,746,944 -
Gain on settlement of obligations 808,774 66,382
Loss attributed to limited partnership 1,237,590 -
Other items (72,707) 322,134
----------------- -----------------
Net loss for the year attributed to common shareholders ($ 614,071) ($19,871,231)
----------------- -----------------
General and Administration expenses decreased $6,222,679 to $3,108,488, a 66.7%
decline over the comparable period of 2001. This reduction was due to further
significant reductions in the cost of salaries and consulting, accounting and
legal, travel, rent and general corporate administration throughout fiscal 2002.
Sales and marketing expenses decreased $1,488,384 to $654,256, a 69.5% reduction
over the previous fiscal year, as a result of the elimination of salaries,
printing, advertising and promotion.
Research and development costs decreased $797,144 to $614,484, a 56.5% decline
over fiscal 2001. This reduction is due to the elimination of staffing and
consultants, as the core of our Network solution was completed.
We recorded an impairment write down of $4,806,390 during the year ended
September 30, 2001, as a result of discontinuing the e-Processing Service of
providing film processing, scanning, storage and printing of digital images
directly to US consumers. This change in focus resulted in our US subsidiary,
PhotoChannel, Inc., filing under Chapter 7 of the United States Bankruptcy Code
with the United States Bankruptcy Court, District of Connecticut on November 1,
2001, which resulted in us realizing a gain of $2,746,944 during fiscal 2002.
We recorded a gain on settlement of obligations of $808,774 during the year
ended September 30, 2002, in addition to a gain of $66,382 during the previous
fiscal year. This gain was the result of negotiating debt settlement agreements
with our creditors.
YEAR ENDED SEPTEMBER 30, 2001 AND SEPTEMBER 30, 2000
Revenue
Revenue for the year ended September 30, 2001 was $97,112 versus $126,313 for
the year ended September 30, 2000. Revenue decreased by 23% due to the
discontinuation of the Multi-Media Presentation Products, which attributed to
100% of our revenue during the year ended September 30, 2000, but only 27% of
our revenue for the year ended September 30, 2001. In October 2000, we focused
our business on the "mail order" printing service, which accounted for $41,758
or 43% of the current year's revenues and in March 2001, subsequent to our
restructuring and business refocus, we focused on our Network, which began to
generate revenues in July 2001 and contributed $29,308 or 30% to the revenue for
the year ended September 30, 2001.
We continued to earn negligible revenue from the sale of Slides & Sound Plus via
orders downloaded from the web site during the period ended June 30, 2001.
However, we no longer view Slides & Sound PlusTM as our core business and as
such, it has not been further developed, sold nor supported since January 31,
2001.
23
PHOTOCHANNEL NETWORKS INC. FORM 20-F
Management's strategy going forward is to focus on that of being a digital
imaging technology provider for a wide variety of businesses including,
photofinishing retailers, professional and commercial photo processing labs,
image content owners and targeted portal services. We have created and manage a
digital network environment whose focus is delivering digital image orders from
capture to fulfillment under the control of our originating Network member. We
charge our photo retailers a monthly fee for their connection to our Network and
take a percentage of all gross print revenue that is derived through the
Network. In addition, we charge customers of our photo retailers a storage fee
for hosting their digital images.
Operating Expenses and Net Loss
We recorded a net loss for the year ended September 30, 2001 of $19,871,231
($0.60 per share) an increase of 186% as compared to the net loss of $6,940,356
($0.32 per share) for the year ended September 30, 2000. The significant
increase in net loss was a result of increased expenditures on research &
development, sales and marketing and general and administration required to
commercially launch and operate Version 2.0 of our Web Site, along with
amortization and an impairment write down as the result of refocusing our
business model. Excluding the impairment recognized at year end, 82% of the
fiscal year's loss occurred in the first six months of operations, or prior to
the restructuring.
General and Administration expenses increased $4,017,475 to $9,331,167, a 76%
increase over the comparable period in 2000 as a result of increases in the
costs of salaries and consulting, accounting and legal, travel, rent and general
corporate administration associated with commercially launching and operating
our online photo print services.
Sales and marketing expenses increased $1,460,910 to $2,142,640, a 214% increase
over the previous fiscal year, as a result of printing, advertising and
promotion of our online photo print services.
Research and development costs increased $539,597 to $1,411,628, a 62% increase
over fiscal 2000. This increase is associated with additional staffing and
consultants.
We recorded an impairment write down of $4,806,390 for the year ended September
30, 2001, as a result of discontinuing the e-Processing Service offered by our
US subsidiary as a business - to - consumer strategy, which provided film
processing, scanning, storage and printing of digital images directly to US
consumers. This change in focus resulted in us filing our US subsidiary,
PhotoChannel, Inc., under Chapter 7 of the United States Bankruptcy Code with
the United States Bankruptcy Court, District of Connecticut on November 1, 2001,
subsequent to our 2001 fiscal yearend.
B. LIQUIDITY AND CAPITAL RESOURCES
As at September 30, 2003, for the first time since fiscal 2000, we had a
positive working capital position of $388,277 compared to a working capital
deficiency of $2,601,835 at September 30, 2002 (working capital deficiency of
$6,484,812 at September 30, 2001). As a start-up company, which continues to
strive for profitability, our main source of funds has been, and will continue
to be, the sale of equity capital until we manage to reach a cash flow positive
position.
For the year ended September 30, 2003 we raised a total of $5,691,899 of which
$3,371,725 was from the issuance of our common shares and common share purchase
warrants, $1,854,910 was on exercise of common share purchase warrants, $360,000
was through the issuance of limited partnership units and $105,264 on the
repayment of demand loans.
We began generating revenues in July 2001 through our Network solution. In
September 2002, we, through our limited partnership signed our first large
Canadian national photofinishing retailer. Throughout fiscal 2003, we continued
to sign on large Canadian retailers through our limited partnership and signed
24
PHOTOCHANNEL NETWORKS INC. FORM 20-F
our first large photofinishing retailer in the United States in December 2003.
Currently, our operating expenses exceed revenues, and there continues to be
significant risk that sufficient revenues will not be generated through the
Network solution to sustain operations. As a result, we will need to raise funds
from private and public equity or debt offerings in order to remain in business.
On February 14, 2002, the PhotoChannel LP was formed under a Limited Partnership
Agreement to carry on the sales, marketing and deployment of the PhotoChannel
Network in specified market segments. The partnership initially sold 1,250
Limited Partnership units in June 2002, at a price of $1,000 per unit, raising
$1,250,000. In December 2002 and September 2003, the partnership sold an
additional 115 units and 245 units, respectively, at a price of $1,000 per unit,
raising $360,000. We have granted to the PhotoChannel LP a software license to
commercially exploit the PhotoChannel Network in Canada. Pursuant to an
operating agreement, we will receive payments for services provided to the
PhotoChannel LP from a software license agreement and management and operating
services agreements (representing software rights, management, personnel and
facilities and equipment that we have agreed to provide to the PhotoChannel LP),
which will enable us to continue its development, deployment and exploitation of
its digital imaging network software in other market segments.
It is a condition of the PhotoChannel LP agreement that each limited partner
enter into an agreement with us, pursuant to which we have the option to acquire
all the Limited Partnership units from the limited partners, at any time on or
before June 30, 2004. Each of the Limited Partnership units sold in June and
December 2002 may be exchanged for 10,000 of our units, each unit being
comprised of one common share and one common share purchase warrant. Each common
share purchase warrant entitles the holder to purchase one additional common
share of us, at a price of $0.10 per share, at any time on or before the earlier
of two years from the date of issue of the Limited Partnership units and June
30, 2004. Each Limited Partnership unit sold in September 2003 may be exchanged
for 10,000 of our common shares.
We currently generate monthly revenues of approximately $80,000, of which
$40,000 relates to recurring revenues from the use of our Network. We believe
that cash on hand and recurring revenues will be sufficient to support our
operating expenditures for a period of approximately four months, without any
revenue growth. We anticipate accessing the equity markets for additional
funding depending on actual sales and resulting cash flow during this period.
Should our revenue not grow during the next 12 months we would be required to
raise approximately $1,800,000 to sustain our current level of operations for
this period.
We have yet to generate sufficient revenues to cover our operating expenses.
Accordingly, if we are unable to generate positive cash flow from operations or
continue to raise funds, we may be required to either limit, curtail, cease or
stop operations. In the event that we cease or stop operations, shareholders
could lose their entire investment.
C. RESEARCH AND DEVELOPMENT, PATENTS AND LICENSES, ETC.
During the fiscal year ended September 30, 2003, we expended $789,189 on
research and development related to our new Network. This included simplifying
workflow and enhancing features, which are offered to our customers.
Proprietary Protection - Trademarks, Copyrights, Etc.
We rely on a combination of contractual rights, trade secrets, copyrights,
non-disclosure agreements and technical measures to establish and protect our
proprietary rights. There can be no assurance, however, that the steps taken by
us will be adequate to prevent misappropriation of the technology or independent
development by others of software products with features based upon, or
otherwise similar to, those provided by us. In addition, although we believe
that our technology has been independently developed, there can be no assurance
that our technology does not, and will not, infringe proprietary rights of
25
PHOTOCHANNEL NETWORKS INC. FORM 20-F
others or that third parties will not assert infringement claims against us in
the future. In the case of infringement, we would, under certain circumstances,
be required to modify our products or obtain a license and any failure to do so
could have a material adverse effect on us. In addition, there can be no
assurance that we will have the necessary resources to defend or pursue any
infringement actions.
D. TREND INFORMATION
The photo industry is undergoing a massive revolution caused by technology. Two
major trends are reshaping the landscape. One is the emergence of the digital
camera as an increasingly viable replacement for film. The other is the
deployment by retailers of digital printing equipment to enable them to make
digital images from traditional images captured on film and to make prints from
digital images. As the industry adapts to the technological advancements forcing
new ways of business to be conducted, the opportunity exists for the emergence
of new players to provide the products and services to make retailers with
photofinishing operations successful.
The use of digital cameras is increasing and management believes that the
popularity of the digital camera will continue to grow as the cost of such
cameras continues to decrease and the availability of photographic quality
digitized print services increases. The worldwide install-base of digital
cameras has risen quickly since their introduction in the mid 1990's. Gartner
Dataquest predicts that digital camera penetration will reach 17% of all U.S.
households by the end of 2002 and about 50 percent by 2006, while Infotrends
Research Group reported that 33% of all Internet connected households owned a
digital camera and this number would approach 60% by the end of 2002. They
further predict that in 2000 6% of U.S. households owned a digital camera, 20%
by the end of 2002 and that 42% will own a digital camera by the end of 2004.
There is no demographic in which digital cameras are exclusive to, nor is there
a prohibitive degree of technological sophistication required to operate these
cameras.
..
Photofinishing retailers have viewed digital camera penetration as threatening
their future. According to PMA's "Photo Industry 2004 Review and Forecast" film
processing volume fell by an estimated 6% in 2003 to 686 million rolls in the
United States and processing revenue fell by nearly 8%, to $5.4 billion. As
consumers shift their picture-taking activity from film to digital, one of the
greatest challenges has been making them aware of the options for printing their
digital pictures. The effect of digital imaging today and the future forecasting
indicates that digital will have an additive effect on the growth of picture
taking. Photofinishing News estimates that total worldwide photo exposures were
92 billion in 2001 with 81% derived from film and 19% from digital. Worldwide
exposures are projected to grow at a Compound Annual Growth Rate of 8% with film
representing 59% and digital representing the remaining 41%. Translated into
photofinishing revenue, it is anticipated that digital photofinishing will be a
$7,694,000,000 worldwide industry by 2005, up from $713,000,000 in 2001.
The most important point in all of these forecasts is the belief of our
management that the consumer will not change their habits - they will continue
to look to the photofinishing retailer as their destination for convenient,
quality driven printing. The photofinishing retailers are making changes to
ensure they remain at the center of the photofinishing universe. As picture
taking becomes digital, the retailers want to ensure they retain the foot
traffic in their stores and the relationship with their customers. The first
step for them is ensuring they have equipment that can print digital images and
can create digital images from film. The piece of equipment the retailers are
utilizing is known as the "digital minilab".
According to PMA, 53% of specialty retailers operated digital minilabs in 2002,
compared to only 19% in 2001. Twenty-nine percents planned to add a digital
minilab during 2003. The growing availability of digital minilab equipment is
reflected in the share of prints produced by digital minilabs. Specialty
retailers produced 62% of the prints they made during 2002 using digital
equipment. Of significant interest is that over 75% of the world's
photofinishing is done by less than 20% of its retailers. With large volume
retailers being the most advanced retailers, it is projected that over 75% of
the world's photofinishing volume will be processed by retailers who are 100%
digitally capable by the end of 2004.
26
PHOTOCHANNEL NETWORKS INC. FORM 20-F
E. OFF-BALANCE SHEET ARRANGEMENTS
Not Applicable
F. TABULAR DISCLOSURE OF CONTRACTUAL OBLIGATIONS
- ----------------------------------------------------------------------------------------------------------------------
PAYMENTS DUE BY PERIOD
- ----------------------------------------------------------------------------------------------------------------------
MORE THAN 5
CONTRACTUAL OBLIGATIONS TOTAL LESS THAN 1 YEAR 1 - 3 YEARS 3 - 5 YEARS YEARS
- ----------------------------------------------------------------------------------------------------------------------
Long-Term Debt Nil N/A N/A N/A N/A
- ----------------------------------------------------------------------------------------------------------------------
Capital (Finance) Lease Nil N/A N/A N/A N/A
- ----------------------------------------------------------------------------------------------------------------------
Operating Lease 286,084 64,897 156,132 65,055 Nil
- ----------------------------------------------------------------------------------------------------------------------
Purchase 1,792,060 287,800 802,272 701,988 Nil
- ----------------------------------------------------------------------------------------------------------------------
Other Long-Term Liabilities Nil N/A N/A N/A N/A
- ----------------------------------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------------------------------------
Total 2,078,144 352,697 958,404 767,043 Nil
- ----------------------------------------------------------------------------------------------------------------------
ITEM 6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES
The names, residences, ages, positions with us, principal occupations within the
last five years and beneficial ownership of our securities of each of our
directors and executive officers as at February 29, 2004 are as follows. All
Directors serve until the next Annual General Meeting of our Shareholders.
- --------------------------------------------------------------------------------------------------------------------
NAME AND RESIDENCE POSITIONS WITH COMPANY AND SECURITIES BENEFICIALLY
(IF A DIRECTOR, PERIOD SUCH POSITION PRINCIPAL OCCUPATIONS OWNED, DIRECTLY OR
HELD) AGE DURING THE LAST 5 YEARS INDIRECTLY(3)
- --------------------------------------------------------------------------------------------------------------------
Peter Fitzgerald (1)(2) 56 February 3, 2003 - Present: Chairman 11,645,200
of the Company Common Shares
Herts, United Kingdom August 1998 - October 2000: Chief
Executive Officer of Gretag Inc.; Stock Options
Director (July 31, 2001 - present)
July 1991 - July 1998: Chief 1,000,000
Executive Officer of Qualex Inc.
- ---------------------------------------------------------------------------------------------------------------------
Peter Scarth (2)(4) 59 August 1, 2002 - Present: President & 8,462,735
CEO of the Company
West Vancouver, BC, Canada
March 2001- February 3, 2004: 1,050,000
Director (Oct 10, 2000 to present) Chairman of the Company; Stock Options
March 2001 - June 10, 2002: Chief
Executive Officer of the Company;
1997-1999: Executive Vice President,
Telepix Imaging;
1993-1996: Vice President, Consumer
Imaging, Kodak Canada.
- ---------------------------------------------------------------------------------------------------------------------
27
PHOTOCHANNEL NETWORKS INC. FORM 20-F
- --------------------------------------------------------------------------------------------------------------------
NAME AND RESIDENCE POSITIONS WITH COMPANY AND SECURITIES BENEFICIALLY
(IF A DIRECTOR, PERIOD SUCH POSITION PRINCIPAL OCCUPATIONS OWNED, DIRECTLY OR
HELD) AGE DURING THE LAST 5 YEARS INDIRECTLY(3)
- --------------------------------------------------------------------------------------------------------------------
Cory Kent (1)(2) 34 February 2003 to Present: Lawyer at 60,000
Lang Michener LLP Common Shares
Vancouver, BC, Canada July 26, 2002 - March 13, 2003 600,000
Corporate Secretary of the Company; Stock Options
Director (March 10, 1999 - Present) 1996 to February 2003: Lawyer at
Anfield Sujir Kennedy & Durno
- --------------------------------------------------------------------------------------------------------------------
Kent Thexton(1)(2) 40 President, Chief Data and Marketing 160,000
Officer of O2 Online since June 1998; Common Shares
West Vancouver, B.C. Canada
Director (February 4, 2004 - present) President of Genie (now O2 Online)
from February 2000 to July 2001;
Sales & Marketing Director of BT
Celnet from June 1998 to February 2000
- --------------------------------------------------------------------------------------------------------------------
Robert Chisholm 42 Nov. 2001 - Present: Chief Financial 100,000
Officer of the Company; Common Shares
Vancouver, BC, Canadav 1999 - 2001: COO & CFO SCS Solars 750,000
Computing Systems Inc.; Stock Options
1988 - 1999: VP Finance &
Administration TIM Dealer Services
Inc.;
1991 - 1997: Purchasing Mgr. City of
Whitehorse, Yukon.
- --------------------------------------------------------------------------------------------------------------------
Kyle Hall(5) 38 March 13, 2003 - Present: Corporate 142,500
Secretary of the Company Common Shares
Vancouver, BC, Canada June 5, 2002 to Present: Executive
Vice President, Business Development 1,050,000
Stock Options
Director of the Company from March
9, 2001 - July 5, 2002)
March 9, 2001 - June 5, 2002
President & C00 of the Company;
September 15, 2000 - March 9, 2001:
Vice-President, Sales & Business
Development of the Company's US
subsidiary;
1998 - September 2000: Vice
President, Sales, Marketing, and
Business Development for Telepix
Imaging Inc;
1996 -1998: Senior Director, Americas
Sales & Marketing for MGI Software;
28
PHOTOCHANNEL NETWORKS INC. FORM 20-F
- --------------------------------------------------------------------------------------------------------------------
NAME AND RESIDENCE POSITIONS WITH COMPANY AND SECURITIES BENEFICIALLY
(IF A DIRECTOR, PERIOD SUCH POSITION PRINCIPAL OCCUPATIONS OWNED, DIRECTLY OR
HELD) AGE DURING THE LAST 5 YEARS INDIRECTLY(3)
- --------------------------------------------------------------------------------------------------------------------
Timothy J. Kerbs 32 March 9, 2001-Present: Executive 575,500
Stamford, CT, USA Vice President, Network Services of Common Shares
the Company;
Director of the Company from March 1,050,000
29, 2001 - July 5, 2002. Stock Options
July 2000 - March 2001: Vice
President Operations of the Company's
US subsidiary;
March 2000 - July 2000: Vice
President Operations and Strategic
Analysis for Juno Online, Inc.;
August 1998 - February 2000: Vice
President Operations and Planning for
American Softworks Corp.;
October 1997 - August 1998: Assistant
Vice President of Operations for
Computer Associates, Inc.;
October 1996 - October 1997: Senior
Manager of Production for Computer
Associates, Inc.;
(1) Member of the Compensation and Audit Committees. (2) Member of the
Corporate Governance Committee.
(3) Information regarding shares beneficially owned or controlled is at the
period ended February 29, 2004 and has been furnished by the respective
individuals. As such, we assume no responsibility for its accuracy or
completeness.
(4) Participant in the PhotoChannel LP and upon our exercise of the call option
would be issued 100 of our units, which would result in an additional
1,540,000 common shares and 1,340,000 common share purchase warrants.
(5) Participant in the PhotoChannel LP and upon our exercise of the call option
would be issued 200 of our units, which would result in an additional
2,000,000 common shares.
B. COMPENSATION
During the fiscal year ended September 30, 2003, the aggregate amount of
compensation paid by us and our subsidiaries to all directors and officers as a
group for services in all capacities was $641,906. Of such amount, nil was paid
or accrued under a described bonus and profit sharing plans.
During the fiscal year ended September 30, 2003, neither us nor our subsidiaries
set aside or accrued any amount to provide pension, retirement or similar
benefits for directors and officers pursuant to any existing plan provided or
contributed to by us or our subsidiaries. The term "plan" includes all plans,
contracts, authorizations or arrangements, whether or not set forth in any
formal document.
The following table sets out all compensation paid to our Chief Executive
Officer and our four most highly compensated executive officers other than the
Chief Executive Officer during the fiscal periods indicated.
29
PHOTOCHANNEL NETWORKS INC. FORM 20-F
- -------------------------------------------------------------------------------------------------------------------------
ANNUAL COMPENSATION LONG TERM COMPENSATION
NAME AND OTHER ANNUAL COMMON SHARES UNDER-
PRINCIPAL FISCAL SALARY BONUS COMPENSATION LYING OPTIONS GRANTED
POSITION YEAR ($) ($) ($) (NUMBER)
- -------------------------------------------------------------------------------------------------------------------------
Peter Scarth (1) 2003 142,670 Nil Nil Nil
President & CEO 2002 180,833
2001 111,042
- -------------------------------------------------------------------------------------------------------------------------
Kyle Hall (2) 2003 142,570 Nil Nil Nil
EVP Business Development 2002 205,000
2001 205,000 13,750
- -------------------------------------------------------------------------------------------------------------------------
Timothy Kerbs (3) 2003 150,027 Nil Nil Nil
EVP Operations 2002 153,822
2001 203,000 6,250
- -------------------------------------------------------------------------------------------------------------------------
Robert Chisholm 2003 135,833 Nil Nil Nil
CFO 2002 180,000
2001 7,500
- -------------------------------------------------------------------------------------------------------------------------
Mo Asgari 2003 70,806(4) Nil Nil Nil
Former VP Technology 2002 162,195
2001 180,000
- -------------------------------------------------------------------------------------------------------------------------
(1) On March 16, 2001, Peter Scarth, formerly one of our directors, assumed the
role of Chairman of the Board of Directors and Chief Executive Officer. On
June 5, 2002, Mr. Scarth assumed the role of President. On February 3,
2004, Mr. Scarth relinquished the role of Chairman, but remains a director.
The new chairman, Peter Fitzgerald, is not employed by us.
(2) On March 9, 2001, Kyle Hall, formerly VP Sales and Business Development for
our US subsidiary, PhotoChannel, Inc., became our President and Chief
Operating Officer. On June 5, 2002, Mr. Hall resigned as President and
Chief Operating Officer and assumed the role of Executive Vice President of
Business Development. On March 13, 2003, Mr. Hall assumed the role of
Corporate Secretary.
(3) On March 29, Timothy J. Kerbs, formerly VP Operations for our US
subsidiary, PhotoChannel, Inc., became our Executive Vice President of
Network Services.
(4) Mr. Asgari was laid-off on July 22, 2003, at which time he continued to act
as a consultant to the Company and received an additional $34,375 after
being laid off.
C. BOARD PRACTICES
Our articles provide that our Board of Directors shall consist of a minimum of
three directors. Directors can be either elected annually by the shareholders at
the annual meeting of the shareholders or, subject to our articles and
applicable law, be appointed by the Board of Directors between annual meetings.
Each director shall hold office until the close of the next annual meeting of
shareholders or until he or she ceases to be a director by operation of law or
until his or her resignation becomes effective. None of the directors have a
30
PHOTOCHANNEL NETWORKS INC. FORM 20-F
service contract with us to provide for benefits upon termination of his or her
directorship.
COMMITTEES OF THE BOARD
Our Board of Directors has formed three committees.
The Audit Committee consists of three directors. This committee is responsible
for all relationships between our independent external auditor and for actively
engaging in a dialog with that auditor with respect to any disclosed
relationships or services that may impact the objectivity and independence of
the auditor. This Committee also oversees and establishes procedures concerning
our systems of internal accounting and auditing controls. This committee
consists of Peter Fitzgerald (Chairman), Cory Kent and Kent Thexton.
The Compensation Committee consists of three directors. This committee is
responsible for recommending of the salary levels and granting of options. This
committee consists of Kent Thexton (Chairman), Cory Kent and Peter Fitzgerald.
The Corporate Governance Committee consists of all four directors. This
committee is responsible for corporate goverance.
D. EMPLOYEES
We currently have twenty-one (21) permanent full-time employees, one (1)
permanent part-time employee and seven (7) consultants we retain for regular
engagements. None of our staff are unionized.
Executive Officers 5
Operations 5, includes 1 executive officer.
Finance/Administration 4, includes 1 executive officer.
Technology and Applications 14
Sales, and Business Development 5, includes 2 executive officer.
E. SHARE OWNERSHIP
As of February 29, 2004, each of our current directors and executive officers
reported to us the shares he or she owned. The directors and executive officers
own a total of 21,145,935 common shares being the number of our common shares
designated beside his or her name in Item 6. A.
As of February 29, 2004, options to purchase an aggregate of 12,109,667 common
shares were outstanding as follows:
31
PHOTOCHANNEL NETWORKS INC. FORM 20-F
Number of Purchase Price Expiration
Common Shares Per Common Share Date
------------- ---------------- -------------
125,000 $ 0.15 April 20, 2004
275,000 $0.15 March 16, 2005
100,000 $0.15 May 1, 2005
330,736 $0.15 June 28, 2005
50,000 $.015 June 29, 2005
200,000 $1.00 US July 25, 2005
49,660 $0.15 July 25, 2005
100,000 $0.15 August 10, 2005
100,000 $0.15 October 2, 2005
100,000 $0.15 October 27, 2005
15,000 $0.15 November 17, 2005
4,125,000 $0.15 July 26, 2006
5,489,271 $0.15 May 27, 2007
300,000 $0.15 September 2, 2008
750,000 $0.17 September 18, 2008
As of February 29, 2004, a total of 5,500,000 common shares were subject to
options held by our directors and officers as a group, as listed in Item 6. A.,
as follows:
Number of Purchase Price Expiration
Common Shares Per Common Share Date
------------- ---------------- -------------
330,736 $0.15 June 28, 2005
100,000 $0.15 August 10, 2005
100,000 $0.15 October 2, 2005
100,000 $0.15 October 27, 2005
3,525,000 $0.15 July 26, 2006
1,344,264 $0.15 May 27, 2007
ITEM 7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS
A. MAJOR SHAREHOLDERS
To the knowledge of our directors and senior officers, as of February 29, 2004,
no person or corporation beneficially owns, directly or indirectly, or exercises
control or direction over 5% or more of our outstanding common shares, except as
noted below. Our directors and officers, as a group, control us by reason of
32
PHOTOCHANNEL NETWORKS INC. FORM 20-F
their positions with us and their ownership of common shares and common share
options. As a group, they beneficially own, directly or indirectly, 21,145,935
common shares, representing about 15.5% of our presently issued and outstanding
common shares. As a group, they beneficially own common share options to
purchase an aggregate of 5,500,000 common shares.
Discovery Capital Corporation and its affiliated entities (collectively,
"Discovery") is a significant shareholder and investor in us. Currently,
Discovery owns 3,570,000 of our common shares or 2.6% of our outstanding common
shares.
In addition to the foregoing, in June of 2002, Discovery acquired 800 units (the
"LP Units") of the PhotoChannel Networks Limited Partnership. Pursuant to a call
option, we can acquire all, but not less than all, of the then outstanding LP
Units, including the LP Units held by Discovery, subject to certain conditions,
at any time after March 1, 2003 and on or before June 30, 2004. In order to
exercise the call option, we must issue 10,000 common shares and common share
purchase warrants to acquire a further 10,000 common shares, at an exercise
price of $0.10, in exchange for each LP Unit owned by Discovery. To exercise the
call options and acquire all of the currently outstanding LP Units, we would
issue a total of 16,100,000 common shares and common share purchase warrants
entitling the holders to acquire a further 13,650,000 common shares.
Accordingly, assuming the exercise of the call options, the exercise by
Discovery of all of the common share purchase warrants then owned by it, and
assuming no other common shares of us are issued prior to such exercise,
Discovery could own 19,570,000 of our common shares, representing 12.2% of our
then outstanding securities.
Pursuant to the policies of the TSX Venture Exchange, where an issuance of
securities may result in the creation of a new control person of an issuer
(which is a person holding greater than 20% of the outstanding securities of an
issuer is deemed to be), the issuance must be approved by the disinterested
shareholders of the company. In this instance, the disinterested shareholders
means our shareholders, other than Discovery. Accordingly, before we can
exercise the call option, we must obtain the approval of the disinterested
shareholders, if the exercise will result in Discovery becoming a new control
person.
In addition to the foregoing, Discovery has participated in several of our
financings in the past and may, in the future invest in our securities. Such
investments may have the potential to increase Discovery's ownership interest in
us to greater than 20%. Accordingly, at our Annual General Meeting of our
shareholders, held on March 10, 2004, we sought and received approval from our
disinterested shareholders authorizing the potential increase in the ownership
interest of Discovery to greater than 20%.
Peter Fitzgerald is our Chairman and is a significant shareholder and investor
in us. Currently, Mr. Fitzgerald owns 11,645,200 of our common shares or 8.5% of
our outstanding common shares. Mr. Fitzgerald also holds 1,000,000 common share
options and if he were to exercise all of these options and assuming no other
common shares of us are issued prior to such exercise, Mr. Fitzgerald could own
12,645,200 of our common shares, representing 9.2% of our then outstanding
securities.
Peter Scarth is a director and our President and Chief Executive Officer and is
a significant shareholder and investor in us. Currently, Mr. Scarth owns
8,462,735 of our common shares or 6.2% of our outstanding common shares. Mr.
Scarth also holds 1,050,000 common share options and 154 LP Units of the
PhotoChannel Networks Limited Partnership. Pursuant to a call option, we can
acquire all, but not less than all, of the then outstanding LP Units, including
the LP Units held by Mr. Scarth, subject to certain conditions, at any time
after March 1, 2003 and on or before June 30, 2004. Upon exercise of the call
option Mr. Scarth would own an additional 1,540,000 common shares and 1,340,000
common share purchase warrants, entitling him to purchase an additional
1,340,000 of our common shares, at an exercise price of $0.10. Accordingly,
assuming the exercise of the common share options, the call options and the
exercise by Mr. Scarth of all of the common share purchase warrants then owned
by him, and assuming no other common shares of us are issued prior to such
exercise, Mr. Scarth could own 12,392,735 of our common shares, representing 8%
of our then outstanding securities
33
PHOTOCHANNEL NETWORKS INC. FORM 20-F
As of February 29, 2004, our shareholders' register listed approximately 230
registered shareholders holding an aggregate of 136,613,341 common shares. A
total of 181 of these registered shareholders were shown to be residents of
Canada, owning 109,708,743 shares representing 80% of our issued and outstanding
common shares. A total of 32 of these registered shareholders were shown to be
residents of the United States, owning 1,540,692 shares representing 1.13% of
our issued and outstanding common shares.
B. RELATED PARTY TRANSACTIONS
None of our directors or senior officers, or any associate or affiliate of any
such person, has or had any material interest, direct or indirect, in any
transaction during the past year or any proposed transaction which has
materially affected or will materially affect us, other than as disclosed
herein.
For the fiscal year ended September 30, 2003, wages and consulting fees of
$641,906 were paid to our directors and officers. The fees were as part of the
annual compensation as disclosed in Item 6. B.
All transactions entered into with Management as disclosed in this section were
based on terms and conditions that are similar to those of transactions with
disinterested third parties.
C. INTERESTS OF EXPERTS AND COUNSEL
Not Applicable.
ITEM 8. FINANCIAL INFORMATION
A. CONSOLIDATED STATEMENTS AND OTHER FINANCIAL INFORMATION
Please see the Consolidated Financial Statements listed in Item 17 hereof and
included at the end of this annual report.
LEGAL PROCEEDINGS.
Except as set forth below, as of February 29, 2004, in the opinion of our
management, we are not currently a party to any litigation or legal proceedings
which are material, either individually or in the aggregate, and, to our
knowledge, no legal proceedings of a material nature involving us currently are
contemplated by any individuals, entities or governmental authorities.
1. On February 24, 1999, Thomas Jackson, our former President and Chief
Executive Officer, commenced proceedings against us in the Supreme
Court of British Columbia. Mr. Jackson has claimed damages for
unpaid services not exceeding $150,000. Management is of the view
that the claim is without merit and is vigorously defending these
proceedings. There have been no further proceedings in this matter
since we filed our statement of defense on August 3, 1999.
2. On March 3, 1999, we received a letter from DATT Japan indicating
that they had proceeded with legal action in the Japanese courts and
for an order for payment. On September 10, 2001, our legal
representative received a telephone call from an individual claiming
that he represented DATT Japan. He indicated that his client had
received a judgment from a Japanese court against us for
approximately $99,000. We intend to defend ourselves against the
enforcement of this judgment, however, there have been no further
proceedings or correspondence since the September 10, 2001 telephone
call.
34
PHOTOCHANNEL NETWORKS INC.
Consolidated Financial Statements
SEPTEMBER 30, 2003, 2002 AND 2001
(expressed in Canadian dollars)
AUDITORS' REPORT
TO THE SHAREHOLDERS OF
PHOTOCHANNEL NETWORKS INC.
We have audited the consolidated balance sheets of PHOTOCHANNEL NETWORKS INC. as
at September 30, 2003 and 2002 and the consolidated statements of loss and
deficit, shareholders' equity (deficiency) and cash flows for each of the three
years ended September 30, 2003, 2002 and 2001. 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
in Canada and the United States of America. Those standards require that we plan
and perform an audit to obtain reasonable assurance 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.
In our opinion, these consolidated financial statements present fairly, in all
material respects, the financial position of the company as at September 30,
2003 and 2002 and the results of its operations and its cash flows for each of
the three years ended September 30, 2003, 2002 and 2001 in accordance with
generally accepted accounting principles in Canada. As required by the British
Columbia Company Act, we report that, in our opinion, these principles have been
applied on a basis consistent with that of the preceding year.
As described in note 9 to the consolidated financial statements, the net loss
attributed to common shareholders and earnings per share for the year ended
September 30, 2002 have been restated.
(signed) PricewaterhouseCoopers LLP
CHARTERED ACCOUNTANTS
Vancouver, B.C., Canada
January 9, 2004
COMMENTS BY AUDITORS FOR U.S. READERS ON CANADA-U.S. REPORTING DIFFERENCE
In the United States of America, reporting standards for auditors require the
addition of an explanatory paragraph (following the opinion paragraph) when the
financial statements are affected by conditions and events that cast substantial
doubt on the company's ability to continue as a going concern, such as those
described in Note 1 to the financial statements. Our report to the shareholders
dated January 9, 2004 is expressed in accordance with reporting standards in
Canada, which do not permit a reference to such events and conditions in the
auditor's report when these are adequately disclosed in the financial
statements.
(signed) "PricewaterhouseCoopers LLP"
CHARTERED ACCOUNTANTS
Vancouver, B.C., Canada
January 9, 2004
PHOTOCHANNEL NETWORKS INC.
Consolidated Balance Sheets
AS AT SEPTEMBER 30, 2003 AND 2002
- --------------------------------------------------------------------------------
(expressed in Canadian dollars)
2003 2002
$ $
ASSETS
CURRENT ASSETS
Cash and cash equivalents 1,104,410 85,586
Cash held in trust (note 20) 345,000 --
Short-term deposits (note 3) -- 15,000
Accounts receivable (note 4) 96,750 117,685
Prepaid expenses (note 5) 19,364 34,967
----------- -----------
1,565,524 253,238
PROPERTY, PLANT AND EQUIPMENT (note 6) 285,573 455,999
----------- -----------
1,851,097 709,237
=========== ===========
LIABILITIES
CURRENT LIABILITIES
Accounts payable and accrued liabilities (note 7) 1,117,247 2,581,461
Deferred revenue 60,000 --
Due to related parties -- 273,612
----------- -----------
1,177,247 2,855,073
----------- -----------
SHAREHOLDERS' EQUITY (DEFICIENCY)
CAPITAL STOCK (note 8(a)) 31,826,678 26,390,849
CONTRIBUTED SURPLUS 6,976,915 6,189,605
LOANS RECEIVABLE (note 8(e)) (122,206) (227,470)
WARRANTS (note 8(d)) 2,168,522 3,214,845
LIMITED PARTNERSHIP EQUITY (note 9) -- 12,410
DEFICIT (40,176,059) (37,726,075)
----------- -----------
673,850 (2,145,836)
----------- -----------
1,851,097 709,237
=========== ===========
NATURE OF OPERATIONS AND GOING CONCERN (note 1)
COMMITMENTS AND CONTINGENCIES (note 17)
SUBSEQUENT EVENTS (note 20)
APPROVED BY THE BOARD OF DIRECTORS
(signed) Peter Scarth Director (signed) Cory Kent Director
- ------------------------------- ----------------------
The accompanying notes are an integral part of
these consolidated financial statements.
PHOTOCHANNEL NETWORKS INC.
Consolidated Statements of Shareholders' Equity (Deficiency) FOR THE YEARS ENDED
SEPTEMBER 30, 2003, 2002 AND 2001
- --------------------------------------------------------------------------------
(expressed in Canadian dollars)
COMMON STOCK
- -----------------------------------------------------------------------------------------------------------------
NUMBER OF CONTRIBUTED LOANS SPECIAL
SHARES AMOUNT SURPLUS RECEIVABLE WARRANTS AMOUNT
$ $ $ $
BALANCE - SEPTEMBER 30, 2000 29,865,766 16,315,246 59,857 -- 11,000,000 9,105,302
Shares issued on exercise of
warrants 836,154 836,154 926,720 -- -- --
Issuance of shares for cash from
exercised options 74,667 37,434 -- -- -- --
Issuance of options in exchange
for services provided -- -- 44,000 -- -- --
Vesting of warrants -- -- -- -- -- --
Shares and warrants issued on
conversion of special warrants 11,000,000 6,979,397 -- -- (10,000,000) (9,028,802)
Expiry of warrants -- -- 2,770,780 -- -- --
Expiry of warrants -- -- 2,049,405 -- -- --
Expiry of agent's warrants -- -- 76,500 -- (1,000,000) (76,500)
Net loss for the year -- -- -- -- -- --
----------- ----------- ----------- ----------- ------------ -----------
BALANCE - SEPTEMBER 30, 2001 41,776,587 24,168,231 5,927,262 -- -- --
Issuance of options in exchange
for services provided -- -- 73,343 -- -- --
Issuance of warrants in exchange
for services provided -- -- -- -- -- --
Expiry of warrants -- -- 189,000 -- -- --
Private placement of 26,576,381
special warrants -- -- -- -- 26,576,381 2,657,638
Employee loan -- -- -- (227,470) -- --
Shares and warrants issued on
conversion of special warrants 26,576,381 1,575,176 -- -- (26,576,381) (2,657,638)
Private placement of 8,542,000
units 8,542,000 503,953 -- -- -- --
Shares issued on exercise of
warrants 1,000,000 143,489 -- -- -- --
Issuance of Limited Partnership
units -- -- -- -- -- --
Loss for the year -- -- -- -- -- --
Loss for the year attributable to
the Limited Partnership -- -- -- -- -- --
----------- ----------- ----------- ----------- ------------ -----------
BALANCE - SEPTEMBER 30, 2002 77,894,968 26,390,849 6,189,605 (227,470) -- --
Issuance of options in exchange
for services provided -- -- 97,181 -- -- --
Issuance of warrants in exchange
for services provided -- -- -- -- -- --
Expiry of warrants -- -- 690,129 -- -- --
Private placement of 5,669,470
units 5,669,470 406,414 -- -- -- --
Private placement of 25,200,000
units 25,200,000 2,425,414 -- -- -- --
Shares issued on exercise of
warrants 18,549,100 2,604,001 -- -- -- --
Issuance of Limited Partnership
units -- -- -- -- -- --
Employee loan -- -- -- 105,264 -- --
Loss for the year -- -- -- -- -- --
Loss for the year attributable to
the Limited Partnership -- -- -- -- -- --
----------- ----------- ----------- ----------- ------------ -----------
BALANCE - SEPTEMBER 30, 2003 127,313,538 31,826,678 6,976,915 (122,206) -- --
=========== =========== =========== =========== =========== ===========
OTHER CAPITAL ACCOUNTS
- -----------------------------------------------------------------------------------------------------------------------------------
TOTAL
SHAREHOLDERS'
LIMITED DEFERRED EQUITY
WARRANTS AMOUNT PARTNERSHIP AMOUNT COMPENSATION DEFICIT (DEFICIENCY)
$ UNITS $ $ $ $
BALANCE - SEPTEMBER 30, 2000 4,336,155 5,847,500 -- -- (423,000) (17,240,773) 13,664,132
Shares issued on exercise of
warrants (836,154) (926,720) -- -- -- -- 836,154
Issuance of shares for cash from
exercised options -- -- -- -- -- -- 37,434
Issuance of options in exchange
for services provided -- -- -- -- -- -- 44,000
Vesting of warrants -- -- -- -- 162,000 -- 162,000
Shares and warrants issued on
conversion of special warrants 5,500,000 2,049,405 -- -- -- -- --
Expiry of warrants (2,500,000) (2,770,780) -- -- -- -- --
Expiry of warrants (5,500,000) (2,049,405) -- -- -- -- --
Expiry of agent's warrants -- -- -- -- -- -- --
Net loss for the year -- -- -- -- -- (19,871,231) (19,871,231)
----------- ----------- ----------- ----------- ----------- ----------- -----------
BALANCE - SEPTEMBER 30, 2001 1,000,001 2,150,000 -- -- (261,000) (37,112,004) (5,127,511)
Issuance of options in exchange
for services provided -- -- -- -- -- -- 73,343
Issuance of warrants in exchange
for services provided 5,025,000 125,625 -- -- -- -- 125,625
Expiry of warrants (1,000,000) (450,000) -- -- 261,000 -- --
Private placement of 26,576,381
special warrants -- -- -- -- -- -- 2,657,638
Employee loan -- -- -- -- -- -- (227,470)
Shares and warrants issued on
conversion of special warrants 24,890,381 1,082,462 -- -- -- -- --
Private placement of 8,542,000
units 8,542,000 350,247 -- -- -- -- 854,200
Shares issued on exercise of
warrants (1,000,000) (43,489) -- -- -- -- 100,000
Issuance of Limited Partnership
units -- -- 1,250 1,250,000 -- -- 1,250,000
Loss for the year -- -- -- -- -- (1,851,661) (1,851,661)
Loss for the year attributable to
the Limited Partnership -- -- -- (1,237,590) -- 1,237,590 --
----------- ----------- ----------- ----------- ----------- ----------- -----------
BALANCE - SEPTEMBER 30, 2002 37,457,382 3,214,845 1,250 12,410 -- (37,726,075) (2,145,836)
Issuance of options in exchange
for services provided -- -- -- -- -- -- 97,181
Issuance of warrants in exchange
for services provided 4,100,000 198,000 -- -- -- -- 198,000
Expiry of warrants (15,883,281) (690,129) -- -- -- -- --
Private placement of 5,669,470
units 5,669,470 160,533 -- -- -- -- 566,947
Private placement of 25,200,000
units 500,000 34,364 -- -- -- -- 2,459,778
Shares issued on exercise of
warrants (18,549,100) (749,091) -- -- -- -- 1,854,910
Issuance of Limited Partnership
units -- -- 360 360,000 -- -- 360,000
Employee loan -- -- -- -- -- -- 105,264
Loss for the year -- -- -- -- -- (2,822,394) (2,822,394)
Loss for the year attributable to
the Limited Partnership -- -- -- (372,410) -- 372,410 --
----------- ----------- ----------- ----------- ----------- ----------- -----------
BALANCE - SEPTEMBER 30, 2003 13,294,471 2,168,522 1,610 -- -- (40,176,059) 673,850
=========== =========== =========== =========== =========== =========== ===========
PHOTOCHANNEL NETWORKS INC.
Consolidated Statements of Loss and Deficit
FOR THE YEARS ENDED SEPTEMBER 30, 2003, 2002 AND 2001
- --------------------------------------------------------------------------------
(expressed in Canadian dollars)
2003 2002 2001
$ $ $
REVENUE 255,573 173,801 97,112
COST OF SALES 91,091 111,670 126,036
----------- ----------- -----------
GROSS PROFIT (LOSS) 164,482 62,131 (28,924)
----------- ----------- -----------
EXPENSES
Amortization 280,778 890,387 2,428,873
Impairment writedown -- -- 4,806,390
General and administration (note 12) 1,528,449 3,108,488 9,331,167
Sales and marketing (note 12) 734,792 654,256 2,142,640
Research and development (note 12) 789,189 614,484 1,411,628
Interest expense 113,719 129,188 110,125
----------- ----------- -----------
3,446,927 5,396,803 20,230,823
----------- ----------- -----------
(3,282,445) (5,334,672) (20,259,747)
INTEREST AND OTHER INCOME 263 2,193 52,210
GAIN ON BANKRUPTCY OF SUBSIDIARY (note 12) -- 2,746,944 --
GAIN ON SETTLEMENT OF OBLIGATIONS (note 12) 457,599 808,774 66,382
FOREIGN EXCHANGE GAIN (LOSS) 2,189 (74,900) 269,924
----------- ----------- -----------
NET LOSS FOR THE YEAR (2,822,394) (1,851,661) (19,871,231)
LOSS ATTRIBUTED TO LIMITED PARTNERSHIP (note 9) 372,410 1,237,590 --
----------- ----------- -----------
NET LOSS FOR THE YEAR ATTRIBUTED TO COMMON SHAREHOLDERS (2,449,984) (614,071) (19,871,231)
DEFICIT - BEGINNING OF YEAR (37,726,075) (37,112,004) (17,240,773)
----------- ----------- -----------
DEFICIT - END OF YEAR (40,176,059) (37,726,075) (37,112,004)
----------- ----------- -----------
BASIC AND FULLY DILUTED NET LOSS PER SHARE 0.03 0.01 0.60
=========== =========== ===========
WEIGHTED AVERAGE NUMBER OF COMMON SHARES 89,448,942 59,479,315 33,187,579
=========== =========== ===========
The accompanying notes are an integral part of
these consolidated financial statements.
PHOTOCHANNEL NETWORKS INC.
Consolidated Statements of Cash Flows
FOR THE YEARS ENDED SEPTEMBER 30, 2003, 2002 AND 2001
- --------------------------------------------------------------------------------
(expressed in Canadian dollars)
2003 2002 2001
$ $ $
----------- ----------- -----------
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss for the year (2,449,984) (614,071) (19,871,231)
Items not affecting cash
Amortization 280,778 890,387 2,428,873
Loss attributed to Limited Partnership (372,410) (1,237,590) --
Impairment writedown -- -- 4,806,390
Loss on sale of property, plant and equipment 44,209 386 53,144
Issuance of options and warrants for goods and
services received 295,181 198,968 206,000
----------- ----------- -----------
(2,202,226) (761,920) (12,376,824)
Net change in non-cash working capital items (note 10) (1,641,288) (2,368,078) 5,270,733
----------- ----------- -----------
(3,843,514) (3,129,998) (7,106,091)
----------- ----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchase of property, plant and equipment (264,123) (1,882) (1,186,256)
Sale (purchase) of short-term deposits 15,000 (4,813) 743,986
Proceeds from sale of property, plant and equipment 109,562 12,411 631,750
----------- ----------- -----------
(139,561) 5,716 189,480
----------- ----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES
Repayment on capital lease -- (453,658) (156,876)
Issuance of common shares and warrants 3,026,725 854,200 --
Increase in cash held in trust (345,000) -- --
Issuance of common shares on exercise of warrants and
options 1,854,910 100,000 873,588
(Repayment) issue of demand loan -- (467,986) 467,986
Repayment of loans receivable 105,264 -- --
Issuance of limited partnership units 360,000 1,250,000 --
Issuance of special warrants -- 1,921,295 508,873
----------- ----------- -----------
5,001,899 3,203,851 1,693,571
----------- ----------- -----------
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 1,018,824 79,569 (5,223,040)
CASH AND CASH EQUIVALENTS - BEGINNING OF YEAR 85,586 6,017 5,229,057
----------- ----------- -----------
CASH AND CASH EQUIVALENTS - END OF YEAR 1,104,410 85,586 6,017
=========== =========== ===========
SUPPLEMENTARY INFORMATION
Interest paid 113,719 129,188 110,125
Interest received 263 2,193 52,210
NON-CASH ACTIVITIES CONSIST OF
Shares issued on conversion of special warrants -- 1,575,176 6,979,397
Warrants issued on conversion of special warrants -- 1,082,462 2,049,405
Settlement of debt -- 227,470 --
Expiry of warrants 690,129 189,000 2,770,780
Issuance of common shares on exercise of warrants 749,091 43,489 --
The accompanying notes are an integral part of
these consolidated financial statements.
PHOTOCHANNEL NETWORKS INC.
Notes to Consolidated Financial Statements
FOR THE YEARS ENDED SEPTEMBER 30, 2003, 2002 AND 2001
- --------------------------------------------------------------------------------
(expressed in Canadian dollars)
1 NATURE OF OPERATIONS AND GOING CONCERN
PhotoChannel Networks Inc. (the company) was incorporated on
December 1, 1995 and commenced active business operations on
January 1, 1996. During the year ended September 30, 1999, the
company changed its name from InMedia Presentations Inc. to
PhotoChannel Networks Inc.
Historically, the company was engaged in the business of developing and
marketing packaged multimedia presentation software products. In July
1999, the company launched its website. On October 2, 2000, the company
launched a second version of the website which included an e-Processing
service in the United States. This e-Processing service, operated by the
company's U.S. operating subsidiary, PhotoChannel, Inc., provided film
processing, scanning, storage and printing of digital images directly to
U.S. consumers. This service did not prove viable, and PhotoChannel, Inc.
was unable to continue as an operating entity. On November 1, 2001,
PhotoChannel, Inc., filed under Chapter 7 of the United States Bankruptcy
Code with the United States Bankruptcy Court, District of Connecticut (the
accounting impact of this filing is set out in note 12).
On March 16, 2001, the company was restructured under new management.
Under the restructuring plan, new management refocused and repositioned
the company to be a business to business solution rather than a business
to consumer model, which had been offered by PhotoChannel, Inc. The
company implemented significant cost reduction measures such as:
elimination of staff, relocation of premises, significant reductions in
travel and marketing expenses, and the elimination of an investor
relations program. The company's technology was refocused and further
developed to provide e-commerce and Internet infrastructure solutions to
photo-finishing retailers. The PhotoChannel Network now electronically
connects the photo-finishing retailer and its customers through the
Internet and provides digital image delivery, hosting, storage and
financial reporting for the photo-finishing retailer.
At September 30, 2003, the company has an accumulated deficit of
$40,176,059 (2002 - $37,726,075) and has incurred significant losses in
each of its last six fiscal years. During the year ended September 30,
2003, the company used cash of approximately $3,844,000 (2002 -
$3,130,000) to fund operations while obtaining approximately $5,002,000
(2002 - $3,204,000) from financing activities. The company has and will
continue to have capital requirements in excess of its currently available
resources. The company is dependent upon the proceeds of future financings
to further finance the development and implementation of its business
objectives. These consolidated financial statements have been prepared on
a going concern basis. The company's ability to continue its operations is
dependent upon the continued support of its shareholders, obtaining
additional financing and generating revenues sufficient to cover its
operating costs in an industry characterized by rapid technological
change. There is no assurance that the company will be successful in
achieving any or all of these objectives over the coming year and,
accordingly, there exists substantial doubt that the company will be able
to continue as a going concern.
(1)
PHOTOCHANNEL NETWORKS INC.
Notes to Consolidated Financial Statements
FOR THE YEARS ENDED SEPTEMBER 30, 2003, 2002 AND 2001
- --------------------------------------------------------------------------------
(expressed in Canadian dollars)
Management is implementing a plan to address these issues and to enable
the company to continue as a going concern through the end of fiscal year
2004 and beyond. This plan includes obtaining debt or equity financing in
amounts sufficient to sustain operations, expanding the company's customer
base, and the subsequent realization of sufficient revenues produced by
this network. However, there is only a limited operating history with the
existing business model, and there is no assurance that the necessary
financing can be obtained or on what terms it may be obtained. The
accompanying financial statements do not include any adjustments, which
may be material, to reflect the possible future effects on the
recoverability and classification of assets or the amount and
classification of liabilities that may result from the outcome of this
uncertainty.
2 SIGNIFICANT ACCOUNTING POLICIES
BASIS OF CONSOLIDATION
These consolidated financial statements are prepared in accordance with
generally accepted accounting principles (GAAP) in Canada and, except as
explained and quantified in note 19, comply in all material measurement
respects with GAAP in the United States of America. These consolidated
financial statements include the accounts of the company and each of its
wholly owned or controlled subsidiaries, PhotoChannel Capital Inc. and
PhotoChannel Management Inc. Management has determined that the company
controls the PhotoChannel LP. Therefore the accounts of PhotoChannel
Networks Limited Partnership (the PhotoChannel LP) are being consolidated
in view of the existence of the company's option to acquire the
PhotoChannel LP units from the limited partners and certain common
ownership and management of the company and the PhotoChannel LP (note 9).
All material intercompany balances and transactions are eliminated upon
consolidation.
RESEARCH AND DEVELOPMENT
Research costs are expensed in the period incurred. Where, in the opinion
of management, the deferral criteria established under GAAP are satisfied
in all material respects, development costs are capitalized and amortized
over the estimated life of the related products. Otherwise, development
costs are charged as an expense in the period incurred. To date, no
development costs have been deferred.
PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment are recorded at cost less accumulated
amortization. Amortization of property, plant and equipment and assets
capitalized under capital leases is charged over the estimated useful
lives of the assets at the following annual rates:
Computer equipment 30% straight line
Furniture and office equipment 20% straight line
Software 33% - 100% straight line
Leasehold improvements life of the lease
(2)
PHOTOCHANNEL NETWORKS INC.
Notes to Consolidated Financial Statements
FOR THE YEARS ENDED SEPTEMBER 30, 2003, 2002 AND 2001
- --------------------------------------------------------------------------------
(expressed in Canadian dollars)
The company tests the carrying value of long-lived assets for
recoverability whenever events or changes in circumstances indicate that
the carrying value may not be recoverable from future undiscounted cash
flows. An impairment loss equal to the difference is recognized in the
period in which the determination is made.
REVENUE RECOGNITION
Revenue is recognized when all of the following criteria have been met:
persuasive evidence of an arrangement exists; the services have been
provided; the price is fixed or determinable; customer acceptance has been
received or implied; and the collection of sales proceeds is reasonably
assured.
During fiscal years 2003 and 2002, the company earned commission and
membership revenue from the provision of the PhotoChannel Network to
electronically connect photo-finishing retailers to their customers,
through the Internet. Revenue received in advance from installation
services for the set-up of a customer website is recorded as deferred
revenue and is recognized into income over the estimated term of the
customer relationship period. Revenue from monthly membership fees from
photo-finishing retailers for the connection to the PhotoChannel Network
is earned and recognized monthly as the connection is provided. Revenue
from commissions earned on transactions processed by the photo-finishing
retailers, utilizing the PhotoChannel Network, is recognized at the time
the digital image processing services are provided to the end customer.
During the fiscal year ended September 30, 2001, the company through its
U.S. subsidiary, PhotoChannel, Inc., earned revenue from the direct
provision of e-processing services providing film processing, scanning,
storage and printing of digital images directly to U.S. consumers. These
revenues were recognized upon the collection of proceeds, at the time the
digital image was made available to the customer.
COST OF SALES
Cost of sales consists of charges which are directly related to the
company's generation of revenue. Amortization of equipment and salary
costs, which would have to be arbitrarily applied have not been included.
During fiscal 2003 and 2002, the company's cost of sales consisted of the
telecommunication costs incurred to deliver digital images to the
photo-finishing retailer for processing and the installation cost of the
lab server connecting to the photofinishing retailer's on-site digital
minilab. Fiscal 2002, also included discounts and rebates given to the
photo-finishing retailer as an incentive to join the network.
During fiscal 2001, such costs included telecommunications costs, along
with the costs of processing the digital images, as the company's U.S.
subsidiary, PhotoChannel, Inc. provided film processing for U.S. end
customers.
SHARE ISSUE COSTS
Direct costs associated with an issue of capital stock or special warrants
are deducted from the related proceeds at the time of the issue.
(3)
PHOTOCHANNEL NETWORKS INC.
Notes to Consolidated Financial Statements
FOR THE YEARS ENDED SEPTEMBER 30, 2003, 2002 AND 2001
- --------------------------------------------------------------------------------
(expressed in Canadian dollars)
STOCK-BASED COMPENSATION PLAN
Effective October 1, 2002, the company adopted Canadian Institute of
Chartered Accountants (CICA) Handbook Section 3870, "Stock-Based
Compensation and Other Stock-Based Payments". The new recommendations are
to be applied prospectively to all stock-based payments to employees and
non-employees granted on or after October 1, 2002.
No compensation expense is recorded for the company's employee stock-based
compensation. Consideration paid by employees on the exercise of stock
options is recorded as capital stock. A description of the company's
stock-based compensation plan and the pro forma effect on the accounting
for stock options granted to employees under the fair value method are
disclosed in note 8(b).
Stock-based compensation to third parties is recognized and recorded in
the accounts of the company at its fair market value determined by the
Black-Scholes option-pricing model.
FINANCIAL INSTRUMENTS
Financial instruments are classified in accordance with the substance of
the contractual arrangement. Financial liabilities, which are defined as
any contractual obligation to deliver cash or another financial asset to
another party, are classified as liabilities. Where a financial instrument
contains both a debt and equity component, the instruments are presented
at their component fair values at the time they were originally issued.
NET LOSS PER SHARE
Basic net earnings (loss) per share is computed using the weighted average
number of common shares outstanding during the year. The treasury stock
method is used for the calculation of diluted net earnings (loss) per
share. Under the treasury stock method, the weighted average number of
common shares outstanding for the calculation of diluted net earnings
(loss) per share assumes that the proceeds to be received on the exercise
of dilutive stock options and warrants are applied to repurchase common
shares at the average market price for the period. Stock options and
warrants are dilutive when the average market price of the common shares
during the period exceeds the exercise price of the options and warrants.
FOREIGN CURRENCY TRANSLATION
Monetary assets and liabilities denominated in foreign currencies are
translated into Canadian dollars at the exchange rate prevailing at the
balance sheet date. Revenue and expenses denominated in foreign currencies
are translated at the exchange rate prevailing at the transaction date.
Exchange differences are included in income as they arise.
(4)
PHOTOCHANNEL NETWORKS INC.
Notes to Consolidated Financial Statements
FOR THE YEARS ENDED SEPTEMBER 30, 2003, 2002 AND 2001
- --------------------------------------------------------------------------------
(expressed in Canadian dollars)
USE OF ESTIMATES AND MEASUREMENT UNCERTAINTY
The preparation of financial statements in conformity with GAAP requires
management to make estimates and assumptions that affect the reported
amount of assets and liabilities and other reported amounts in the
consolidated financial statements and the related notes. Significant
estimates and assumptions are necessary in the determination of the
recoverable amounts for property, plant and equipment and in the
determination of the value ascribed to the components of stock-based
transactions. Actual results may differ from those estimates.
CASH AND CASH EQUIVALENTS
Cash and cash equivalents consist of cash on deposit and highly liquid
short-term interest bearing securities with maturities at the date of
purchase of three months or less.
INCOME TAXES
The company uses the liability method of accounting for income taxes.
Under the liability method, future tax assets and liabilities are
recognized for the future tax consequences attributable to differences
between the financial statement carrying amounts of existing assets and
liabilities and their respective tax balances. Future tax assets and
liabilities are measured using enacted or substantially enacted tax rates
expected to apply to the taxable income in the years in which those
temporary differences are expected to be recovered or settled. The effect
on future tax assets and liabilities of a change in tax rates is
recognized in income in the period that includes the date of enactment or
substantive enactment. A valuation allowance is recognized to the extent
the recoverability of future income tax assets is not considered more
likely than not.
3 SHORT-TERM DEPOSITS
Short-term deposits consisted of term deposits with Canadian chartered
banks with maturities, at the date of initial deposit, of one year. These
term deposits were redeemed, at maturity, for their face value plus
accrued interest and, therefore, the carrying value approximated their
fair value.
4 ACCOUNTS RECEIVABLE
2003 2002
$ $
Trade receivables 96,750 40,012
GST receivable -- 77,653
Other -- 20
------- -------
96,750 117,685
======= =======
(5)
PHOTOCHANNEL NETWORKS INC.
Notes to Consolidated Financial Statements
FOR THE YEARS ENDED SEPTEMBER 30, 2003, 2002 AND 2001
- --------------------------------------------------------------------------------
(expressed in Canadian dollars)
5 PREPAID EXPENSES
2003 2002
$ $
Prepaid consulting -- 17,900
Prepaid rent, insurance and miscellaneous expenses 19,364 17,067
------ ------
19,364 34,967
====== ======
6 PROPERTY, PLANT AND EQUIPMENT
2003
-------------------------------------
ACCUMULATED
COST AMORTIZATION NET
$ $ $
Computer equipment 2,506,915 2,224,685 282,230
Furniture and office equipment 152,428 152,428 --
Software 208,398 208,398 --
Leasehold improvements 59,910 56,567 3,343
--------- --------- ---------
2,927,651 2,642,078 285,573
========= ========= =======
2002
-------------------------------------
ACCUMULATED
COST AMORTIZATION NET
$ $ $
Computer equipment 2,852,597 2,411,443 441,154
Furniture and office equipment 152,428 138,774 13,654
Software 204,101 204,101 --
Leasehold improvements 56,459 55,268 1,191
--------- --------- ---------
3,265,585 2,809,586 455,999
========= ========= =========
Amortization of property, plant and equipment for 2003 was $280,778
(2002 - $890,387; 2001 - $2,428,873).
(6)
PHOTOCHANNEL NETWORKS INC.
Notes to Consolidated Financial Statements
FOR THE YEARS ENDED SEPTEMBER 30, 2003, 2002 AND 2001
- --------------------------------------------------------------------------------
(expressed in Canadian dollars)
7 ACCOUNTS PAYABLE AND ACCRUED LIABILITIES
2003 2002
$ $
Trade payables 427,972 1,135,459
Trade accruals 245,003 435,109
Accrued payroll taxes 318,980 478,899
Due to employees and consultants 50,844 531,994
Due to former employees (note 17(b)) 74,448 --
--------- ---------
1,117,247 2,581,461
========= =========
In early 2001, the company was significantly in arrears with respect to
remittances to Canadian taxation authorities. At September 30, 2003, there
was an outstanding balance of $161,350 (2002 - $360,489) with respect to
payroll withholdings. Subsequent to September 30, 2003, the company
settled the outstanding balance in full.
8 CAPITAL STOCK, STOCK OPTIONS, SPECIAL WARRANTS, WARRANTS AND LOANS
RECEIVABLE
a) Capital stock
COMMON SHARES
Authorized
500,000,000 (2002 - 500,000,000; 2001 - 500,000,000) common
shares without par value
Issued
127,313,538 (2002 - 77,894,968; 2001 - 41,776,587) common
shares without par value
PREFERRED SHARES
Authorized
10,000,000 (2002 - 10,000,000; 2001 - 10,000,000)
preferred shares without par value
Issued
nil (2002 - nil; 2001 - nil) preferred shares without
par value
The shareholders of the company approved increasing the authorized
capital of the company and creating 10,000,000 preferred shares
without par value by way of a special resolution at an extraordinary
general meeting on January 26, 2001.
(7)
PHOTOCHANNEL NETWORKS INC.
Notes to Consolidated Financial Statements
FOR THE YEARS ENDED SEPTEMBER 30, 2003, 2002 AND 2001
- --------------------------------------------------------------------------------
(expressed in Canadian dollars)
All common stock, stock options and warrant transactions are
reflected on the statement of shareholders' equity (deficiency).
Details of the material transactions are as follows:
i) Pursuant to a non-brokered private placement during the year
ended September 30, 2003, the company issued 5,669,470 units
for net proceeds of $566,947. Each unit consisted of one
common share and one common share purchase warrant. Each
common share purchase warrant entitles the holder to purchase
one additional common share of the company at a price of $0.10
per share for a period of one year from the date of closing.
The net proceeds of $566,947 were allocated: $406,414 to the
common shares issued and $160,533 to the common share purchase
warrants. The value allocated to the common share purchase
warrants was determined using the Black-Scholes option-pricing
model using the following weighted average assumptions:
dividend yield of $nil; expected volatility of 100%; risk-free
interest rate of 4%; and expected life of one year. The common
share purchase warrants expire on January 29, 2004. During the
year ended September 30, 2003, none of the common share
purchase warrants were exercised.
ii) Pursuant to a non-brokered private placement during the year
ended September 30, 2003, the company issued 25,200,000 common
shares at $0.10 per share. Net proceeds of $2,425,414 (net of
cash issuance costs of $60,222 and share purchase warrants
with a value of $34,364 (note 8(d)(i)) were recorded as common
shares. The common shares issued are subject to a hold period
ending February 4, 2004.
iii) Pursuant to a non-brokered private placement during the year
ended September 30, 2002, the company issued 8,542,000 units
for net proceeds of $854,200. Each unit consisted of one
common share and one common share purchase warrant. Each
common share purchase warrant entitled the holder to purchase
one additional common share of the company at a price of $0.10
per share for a period of one year from the date of closing.
During the year ended September 30, 2003, 8,292,000 of these
common share purchase warrants were exercised for net proceeds
of $829,200. The remaining 250,000 common share purchase
warrants expired unexercised on August 6, 2003.
iv) Pursuant to a non-brokered private placement during the year
ended September 30, 2002, the company issued 26,576,381
special warrants for net proceeds of $2,657,638. The special
warrants were subsequently converted to 26,576,381 common
shares and 24,890,381 common share purchase warrants. Each
common share purchase warrant entitled the holder to purchase
one additional common share of the company at a price of $0.10
per share for a period of one year from the date of closing.
During the year ended September 30, 2002, 1,000,000 of these
common share purchase warrants were exercised for net proceeds
of $100,000. During the year ended September 30, 2003,
8,257,100 of these common share purchase warrants were
exercised for net proceeds of $825,710. The remaining
15,633,281 common share purchase warrants expired unexercised
on October 17, 2002.
(8)
PHOTOCHANNEL NETWORKS INC.
Notes to Consolidated Financial Statements
FOR THE YEARS ENDED SEPTEMBER 30, 2003, 2002 AND 2001
- --------------------------------------------------------------------------------
(expressed in Canadian dollars)
v) Pursuant to private offerings and non-brokered portion of a
private placement during the year ended September 30, 2000,
the company issued 6,945,154 common shares for net proceeds of
$5,608,405. As part of these offerings 3,336,154 transferable
common share purchase warrants were issued that entitled the
holder to convert each common share purchase warrant into one
common share at prices between $1.00 and $1.30 per share.
During the year ended September 30, 2001, 836,154 of these
share purchase warrants were exercised for 836,154 common
shares and the remaining 2,500,000 common share purchase
warrants expired unexercised on August 9, 2001.
b) Stock options
During 1997, the company adopted a stock option plan (the Plan). As
at September 30, 2003, the company has reserved 13,600,000 common
shares (2002 - 13,600,000; 2001 - 10,444,146) under the Plan. The
options, which expire five years after the date granted, are subject
to various vesting requirements. Under the original terms of the
Plan, the majority of options vest one third on date of grant and
one third on each of the first and second anniversaries of the date
of grant. However, at an extraordinary general meeting of the
company's shareholders held on December 7, 2001, the Plan was
amended to include a change in the vesting period, permitting
vesting of one-eighteenth of the options granted vesting each month,
with the first eighteenth vesting on date of grant.
(9)
PHOTOCHANNEL NETWORKS INC.
Notes to Consolidated Financial Statements
FOR THE YEARS ENDED SEPTEMBER 30, 2003, 2002 AND 2001
- --------------------------------------------------------------------------------
(expressed in Canadian dollars)
The following table summarizes activity under the company's stock option
plan as of September 30, 2001, 2002 and 2003:
1STOCK OPTIONS
WEIGHTED
AVERAGE WEIGHTED
EXERCISE AVERAGE
PRICE OF EXERCISE
NUMBER OF OUTSTANDING PRICE OF
OPTIONS OPTIONS EXERCISABLE
$ $
Outstanding - September 30, 2000 (4,418,106
shares exercisable) 9,843,520 1.46
Granted 9,303,058 0.70
Exercised (74,667) 0.50
Forfeited (9,551,722) 1.39
----------- ----------- -----------
Outstanding - September 30, 2001 (5,050,397
shares exercisable) 9,520,189 0.66 0.83
Granted 6,299,611 0.15
Expired (15,000) 1.47
Forfeited (2,465,480) 1.20
----------- ----------- -----------
Outstanding - September 30, 2002 (7,023,490
shares exercisable) 13,339,320 0.15 0.19
Granted 1,050,000 0.16
Expired (175,000) 0.15
Forfeited (1,149,320) 0.15
----------- ----------- -----------
Outstanding - September 30, 2003 (11,692,818
shares exercisable) 13,065,000 0.17 0.17
=========== =========== ===========
The following table summarizes information about stock options outstanding
and exercisable at September 30, 2003:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
--------------------------------------------------- -----------------------------------
WEIGHTED
AVERAGE WEIGHTED
REMAINING WEIGHTED AVERAGE
CONTRACTUAL AVERAGE EXERCISE
EXERCISE PRICE NUMBER OF LIFE EXERCISE PRICE NUMBER OF PRICE
$ OPTIONS (YEARS) $ SHARES $
0.15 12,115,000 2.6 0.15 11,492,818 0.15
0.17 750,000 5.0 0.17 -- 0.17
US1.00 200,000 1.8 US1.00 200,000 US1.00
------------- ---------- ---------- ---------- ---------- ----------
0.15 - US1.00 13,065,000 2.8 0.17 11,692,818 0.17
============= ========== ========== ========== ========== ==========
(10)
PHOTOCHANNEL NETWORKS INC.
Notes to Consolidated Financial Statements
FOR THE YEARS ENDED SEPTEMBER 30, 2003, 2002 AND 2001
- --------------------------------------------------------------------------------
(expressed in Canadian dollars)
During the year ended September 30, 2003, the company expensed $97,181
(2002 - $73,343; 2001 - $44,000) in stock-based compensation related to
services provided by consultants who were granted 750,000 stock options
(2002 - 1,033,000; 2001 - 50,340), all with a vesting period of eighteen
months.
Stock-based compensation expense arising from grants of options to
non-employees is estimated using the Black-Scholes option-pricing model
assuming no dividend yield and the following weighted average assumptions
for options granted:
2003 2002 2001
Expected volatility 100% 100% 100%
Risk-free interest rate 4% 4% 4%
Expected life (in years) 5 5 5
During the year ended September 30, 2002, the exercise price of 1,889,709
options originally granted between 1998 and 2000 was reduced from a range of
$1.57 to $0.50 per option to $0.15 per option. During the year ended September
30, 2001, 1,649,000 options originally granted in 1998 and 1999 with an exercise
price of $1.91 per share were cancelled and replaced by options with an exercise
price of US$1.00 per share.
Under the company's current accounting policy, the company has not
recognized any compensation expense for stock options issued to employees during
the year. Had the company determined the expense of granting stock option to
employees during the year, based on the fair value method, the pro forma loss
and pro forma basic and diluted loss per share for the year would not have
changed, as no options granted in the period had vested. The fair value of each
stock option is estimated on the date of grant using the Black-Scholes
option-pricing model with the following assumptions: dividend yield of $nil;
expected volatility of 100%; risk-free interest rate of 4%; and expected life of
five years.
c) Special warrants
i) On October 17, 2001, the company received conditional approval
from the regulatory authorities for an offering of 26,576,381
special warrants at a price of $0.10 per special warrant. Each
special warrant, other than certain special warrants to be
issued to insiders, was exercisable into one unit consisting
of one common share and one common share purchase warrant.
1,686,000 of the special warrants were issued to insiders who
were not entitled to the common share purchase warrant. Each
common share purchase warrant entitled the holder to acquire
one additional common share for $0.10 per share. The common
share purchase warrants expired one year after issuance.
During the year ended September 30, 2002, 26,576,381 special
warrants were exercised, and accordingly, 26,576,381 common
shares and 24,890,391 common share purchase warrants were
issued.
(11)
PHOTOCHANNEL NETWORKS INC.
Notes to Consolidated Financial Statements
FOR THE YEARS ENDED SEPTEMBER 30, 2003, 2002 AND 2001
- --------------------------------------------------------------------------------
(expressed in Canadian dollars)
ii) On May 1, 2000, the company entered into a private placement
for gross proceeds of $15,000,000 on a partly brokered partly
non-brokered basis. During the year ended September 30, 2001,
10,000,000 special warrants related to this transaction were
converted to 11,000,000 common shares and 5,500,000 common
share purchase warrants for no additional compensation. The
common share purchase warrants expired unexercised on August
9, 2001.
The agent for the company in soliciting offers to purchase the
special warrants was paid a cash commission equal to 7.5% of
the gross proceeds raised from the sale of the special
warrants and was provided agent compensation warrants. The
agent compensation warrants expired unexercised during 2001.
The non-brokered portion consisted of 5,000,000 units at a
price of $1.00 per unit for gross proceeds of $5,000,000. Each
unit consisted of one common share and one-half of a common
share purchase warrant. During the year ended September 30,
2001, the 2,500,000 common share purchase warrants related to
the non-brokered portion of this transaction expired
unexercised.
d) Warrants
i) During the year ended September 30, 2003, the company retained
First Associates Investments Inc. (First Associates) to assist
in raising funds for the company. On September 16, 2003 and
pursuant to the private placement of 25,200,000 common shares
of the company, the TSX Venture Exchange, First Associates and
the company agreed to the issuance of 500,000 common share
purchase warrants, with immediate vesting, for services
provided. The common share purchase warrants are exercisable
on or before December 20, 2004, at a price of $0.14. The
common share purchase warrants were assigned a value of
$34,364, which has been included as a share issue cost and
recorded in equity. The value was determined using the
Black-Scholes option-pricing model using the following
weighted average assumptions: dividend yield of $nil; expected
volatility of 100%; risk-free interest rate of 4%; and
expected life of 1.25 years. During the year ended September
30, 2003, none of these common share purchase warrants were
exercised.
ii) During the year ended September 30, 2002, the company retained
TELUS Communications Inc. (TELUS) to provide consulting
services to the company, under an agreement dated June 4,
2002. As consideration under the agreement, the company had
agreed to issue TELUS up to 7,600,000 common share purchase
warrants, which were to be provided as earned during and under
the terms of the agreement. On February 27, 2003, the TSX
Venture Exchange, TELUS and the company agreed to the issuance
of 2,100,000 common share purchase warrants, with immediate
vesting, in lieu of fees of $105,000 for services provided to
January 4, 2003. The common share purchase warrants were
issued on February 27, 2003 and are exercisable on or before
February 27, 2005, at a price of $0.10. These common share
purchase warrants were assigned the value of $105,000, which
has been included as a general and administrative expense and
recorded in equity. As at September 30, 2003, the company has
accrued $75,000 under this agreement, which subject to TSX
Venture Exchange approval, provides for the potential issuance
of 1,500,000 common share purchase warrants, at a price of
$0.10. During the year ended September 30, 2003, none of these
common share purchase warrants were exercised.
(12)
PHOTOCHANNEL NETWORKS INC.
Notes to Consolidated Financial Statements
FOR THE YEARS ENDED SEPTEMBER 30, 2003, 2002 AND 2001
- --------------------------------------------------------------------------------
(expressed in Canadian dollars)
iii) During the year ended September 30, 2002, the company retained
NBJ Enterprises Ltd., dba Skana Photo-Lab Products (Skana), to
act as a distributor for the company's products in Canada,
under an agreement dated February 1, 2002. Amongst other
consideration under the agreement, the company had agreed to
issue Skana up to 2,000,000 common share purchase warrants,
which were to be provided as earned during and under the terms
of the agreement. On January 22, 2003, the TSX Venture
Exchange, Skana and the company agreed to the issuance of
2,000,000 common share purchase warrants, with immediate
vesting, for services provided. The common share purchase
warrants were issued on January 22, 2003 and are exercisable
on or before January 22, 2005, at a price of $0.10. The common
share purchase warrants were assigned a value of $93,000,
which has been included as a sales and marketing expense and
recorded in equity. The value was determined using the
Black-Scholes option-pricing model using the following
weighted average assumptions: dividend yield of $nil; expected
volatility of 100%; risk-free interest rate of 4%; and
expected life of two years. During the year ended September
30, 2003, none of these common share purchase warrants were
exercised.
iv) During the year ended September 30, 2002, the company retained
Discovery Capital Corporation (Discovery) to provide financial
advisory services to the company, under an agreement dated
February 19, 2002. As consideration under the Agreement, the
company issued 5,000,000 common share purchase warrants to
Discovery. On July 26, 2002, the TSX Venture Exchange,
Discovery and the company agreed to the issuance of 4,325,000
common share purchase warrants, with immediate vesting, as
full consideration under the agreement. The common share
purchase warrants were issued on July 26, 2002 and are
exercisable on or before July 26, 2004, at a price of $0.10.
Also during fiscal 2002, the company issued Discovery a
finder's fee of 700,000 common share purchase warrants
(Finder's Warrants), on the private placement of units of the
PhotoChannel Networks Limited Partnership. The Finder's
Warrants are exercisable on or before July 26, 2004, at a
price of $0.10. The common share purchase warrants were
assigned a value of $125,625, which has been included as an
expense and recorded in equity. The value was determined using
the Black-Scholes option-pricing model using the following
weighted average assumptions: dividend yield of $nil; expected
volatility of 100%; risk-free interest rate of 4%; and
expected life of two years. During the year ended September
30, 2003, the company issued 2,000,000 common shares of the
company for proceeds of $200,000 upon exercise of some of the
common share purchase warrants.
v) During the year ended September 30, 2000, as consideration for
financial advisory services provided, the company issued
1,000,000 common share purchase warrants. The value of
warrants was being recognized into income as the services were
provided, resulting in compensation expense of $162,000 in
2001. During September 30, 2002, the 1,000,000 common share
purchase warrants were cancelled, upon the company giving
notice to terminate the contract, and the outstanding value
attributed to the cancelled common share purchase warrants and
deferred compensation expense was transferred to contributed
surplus.
vi) On May 11, 2000, the company granted a common share purchase
warrant, exercisable for a period of five years, to purchase
up to 1,000,000 common shares of the company at a price of
US$1.75 per share.
(13)
PHOTOCHANNEL NETWORKS INC.
Notes to Consolidated Financial Statements
FOR THE YEARS ENDED SEPTEMBER 30, 2003, 2002 AND 2001
- --------------------------------------------------------------------------------
(expressed in Canadian dollars)
The common share purchase warrant was assigned a value of
$1,700,000, which was recorded in equity. The value of the
common share purchase warrant was determined using the
Black-Scholes option-pricing model using the following
assumptions: expected dividend yield of $nil; an expected
volatility of 146%; risk free interest rate of 6.17%; and
expected life of five years. At September 30, 2003, this share
purchase warrant remains outstanding.
e) Loans receivable
During the year ended September 30, 2002, the company made
loans to employees, which were secured by common shares of the
company. As at September 30, 2003, loans totalling $122,206
(2002 - $227,470) were outstanding and have been recorded as a
charge to shareholders' equity. The loans are non-interest
bearing and are repayable on demand. The common shares held as
security have a market value at September 30, 2003 of
$293,294.
9 LIMITED PARTNERSHIP EQUITY
On February 14, 2002, the PhotoChannel LP was formed under a Limited
Partnership Agreement to carry on the sales, marketing and deployment of
the PhotoChannel Network in specified market segments. The partnership
initially sold 1,250 Limited Partnership units in June 2002, at a price of
$1,000 per unit, raising $1,250,000. In December 2002 and September 2003,
the partnership sold an additional 115 units and 245 units, respectively,
at a price of $1,000 per unit, raising $360,000. The company has granted
to the PhotoChannel LP a software license to commercially exploit the
PhotoChannel Network in Canada. Pursuant to an operating agreement, the
company will receive payments for services provided to the PhotoChannel LP
from a software license agreement and management and operating services
agreements (representing software rights, management, personnel and
facilities and equipment that the company has agreed to provide to the
PhotoChannel LP), which will enable the company to continue its
development, deployment and exploitation of its digital imaging network
software in other market segments.
It is a condition of the PhotoChannel LP agreement that each limited
partner enter into an agreement with the company, pursuant to which the
company has the option to acquire all the Limited Partnership units from
the limited partners, at any time on or before June 30, 2004. Each of the
Limited Partnership units sold in June and December 2002 may be exchanged
for 10,000 units of the company, each unit being comprised of one common
share and one common share purchase warrant. Each common share purchase
warrant entitles the holder to purchase one additional common share of the
company, at a price of $0.10 per share, at any time on or before the
earlier of two years from the date of issue of the Limited Partnership
units and June 30, 2004. Each Limited Partnership unit sold in September
2003 may be exchanged for 10,000 common shares of the company.
In view of the existence of the company's option to acquire the Limited
Partnership units from the limited partners, certain common ownership and
management of the company and the Limited Partnership and that the company
controls the PhotoChannel LP, the partnership equity is presented within
shareholders' equity of the company and, the accounts of the partnership
have been consolidated with those of the company.
(14)
PHOTOCHANNEL NETWORKS INC.
Notes to Consolidated Financial Statements
FOR THE YEARS ENDED SEPTEMBER 30, 2003, 2002 AND 2001
- --------------------------------------------------------------------------------
(expressed in Canadian dollars)
The company has also entered into a Support Agreement, pursuant to which
the company has agreed to provide loan financing to the Limited
Partnership, to incur operational and capital costs, once substantially
all equity generated from the Limited Partnership units is utilized.
Losses incurred by the Limited Partnership in 2002 and 2003 are allocated
first to the Limited Partnership units to the extent of their equity
investment and thereafter to the company. In 2002, the company previously
attributed all losses to the company. Accordingly, the loss for 2002 has
been restated for comparative purposes to allocate losses to the Limited
Partnership units to the extent of the equity.
This restatement has the effect of reducing the deficit attributable to
the company's common shareholders from $38,963,665 to $37,726,075, the net
loss attributed to common shareholders from $1,851,661 to $614,071 and the
basic and fully diluted net loss per share from $0.03 to $0.01.
If the company were to exercise its option to acquire the Limited
Partnership units prior to June 30, 2004, the result would be the issuance
of 16,100,000 common shares and 13,650,000 common share purchase warrants
of the company.
10 NET CHANGE IN NON-CASH WORKING CAPITAL ITEMS
2003 2002 2001
$ $ $
Accounts receivable 20,935 (29,681) 507,583
Inventory -- -- 40,822
Prepaid expenses 15,603 (8,200) 978,329
Accounts payable and accrued liabilities (1,464,214) (2,603,809) 3,743,999
Deferred revenue 60,000 -- --
Due to related parties (273,612) 273,612 --
---------- ---------- ---------
(1,641,288) (2,368,078) 5,270,733
========== ========== =========
11 REVENUE
The following is a breakdown of the revenue for the years ended September
30, 2003, 2002 and 2001:
2003 2002 2001
$ $ $
Installation fees 86,914 57,387 --
Membership fees 73,120 104,410 29,308
Commission fees 90,054 3,588 --
Other 5,485 8,415 --
Multi-Media -- -- 20,046
Photofinishing -- -- 41,758
------- ------- ------
255,573 173,800 91,112
======= ======= ======
(15)
PHOTOCHANNEL NETWORKS INC.
Notes to Consolidated Financial Statements
FOR THE YEARS ENDED SEPTEMBER 30, 2003, 2002 AND 2001
- --------------------------------------------------------------------------------
(expressed in Canadian dollars)
12 EXPENSE DETAILS
2003 2002 2001
$ $ $
GENERAL AND ADMINISTRATION
Salaries and consulting 1,051,891 2,145,564 4,992,072
Accounting and legal 106,498 337,569 928,702
Investor relations 29,900 16,000 278,257
Office and miscellaneous 203,024 502,308 2,010,123
Share of previous partnership losses -- -- 347,326
Rent 92,927 106,661 721,543
Loss on sale of property plant and equipment 44,209 386 53,144
--------- --------- ---------
1,528,449 3,108,488 9,331,167
========= ========= =========
SALES AND MARKETING
Salaries and consulting 678,876 602,432 368,911
Printing, advertising and promotion 1,574 1,372 1,729,012
Miscellaneous 54,342 50,452 44,717
--------- ---------
734,792 654,256 2,142,640
========= ========= =========
RESEARCH AND DEVELOPMENT
Salaries and consulting 766,890 611,223 1,176,626
Website planning -- -- 205,986
Miscellaneous 22,299 3,261 29,016
---------
789,189 614,484 1,411,628
========= ========= =========
GAIN ON SETTLEMENT OF OBLIGATIONS
During the year ended September 30, 2003, a gain on settlement of
obligations of $457,599 (2002 - $808,774; 2001 - 66,382) was recognized as
a result of debt settlements with various trade creditors and past
employees of the company.
GAIN ON BANKRUPTCY OF SUBSIDIARY
On November 1, 2001, PhotoChannel, Inc., the company's U.S. operating
subsidiary, filed under Chapter 7 of the United States Bankruptcy
Code with the United States Bankruptcy Court, District of
Connecticut. PhotoChannel, Inc.'s principal operations related to the
provision of film processing, scanning, storage and printing of
digital images directly to U.S. consumers. The provision of this
service did not prove viable, and PhotoChannel, Inc. was unable to
continue as an operating entity. An expense recovery for the year
ended September 30, 2002 of $2,746,944 resulted from the bankruptcy
of PhotoChannel, Inc.
(16)
PHOTOCHANNEL NETWORKS INC.
Notes to Consolidated Financial Statements
FOR THE YEARS ENDED SEPTEMBER 30, 2003, 2002 AND 2001
- --------------------------------------------------------------------------------
(expressed in Canadian dollars)
13 INCOME TAXES
The company is subject to Canadian federal and provincial taxes.
The company has non-capital losses for Canadian income tax purposes of
approximately $18,415,461, which are available for carry forward to reduce
future years' taxable income. These income tax losses expire as follows:
$
Year ending September 30
2004 3,520,400
2005 2,720,600
2006 2,064,600
2007 5,390,900
2008 2,629,755
2009 -
2010 2,119,206
------------------
18,445,461
==================
The tax effect of temporary differences that give rise to significant
portions of future income tax assets and future income tax liabilities are
as follows:
2003 2002 2001
$ $ $
Net operating loss carry-forwards 6,455,911 5,883,656 9,807,144
Property, plant and equipment 1,803,587 1,705,314 2,788,231
Share issue costs 72,840 69,533 92,711
-----------
8,332,338 7,658,503 12,688,086
Valuation allowance (8,332,338) (7,658,503) (12,688,086)
-----------
Net future income tax assets -- -- --
========== =========== ===========
Management believes there is sufficient uncertainty regarding the
realization of future income tax assets such that a full valuation
allowance is appropriate.
(17)
PHOTOCHANNEL NETWORKS INC.
Notes to Consolidated Financial Statements
FOR THE YEARS ENDED SEPTEMBER 30, 2003, 2002 AND 2001
- --------------------------------------------------------------------------------
(expressed in Canadian dollars)
The income tax recovery for the year ended September 30, 2003 differs from
the amount obtained by applying the applicable statutory income tax rates
to loss before income taxes as follows:
2003 2002 2001
Combined statutory income tax rate 38% 42% 45%
======== ========== ==========
$ $ $
Income tax recovery based on combined
statutory rate 930,994 257,910 8,942,054
Effect of U.S. subsidiary Chapter 7
bankruptcy (note 12) -- (5,229,535) --
Expiration of tax losses (169,467) -- --
Effect of change in expected tax rates (73,500) (42,985) (3,635,168)
Non-deductible expenses and other differences (14,193) (14,972) (64,800)
Change in valuation allowance (673,834) 5,029,582 (5,242,086)
-------- ---------- ----------
-- -- --
======== ========== ==========
14 RELATED PARTY TRANSACTIONS
During the year ended September 30, 2003, the company incurred consulting
fees of approximately $nil (2002 - $180,833; 2001 - $111,042) to a company
owned by a director and officer. The fees are recorded in general and
administration expense.
As at September 30, 2003, there is $nil (2002 - $273,612) due for
consulting fees owed to officers and employees of the company.
15 SEGMENTED INFORMATION
During the years ended September 30, 2003 and 2002, the company obtained
all of its revenue from the provision of the PhotoChannel Network to
photo-finishing retailers. During the year ended September 30, 2001, the
company obtained revenues from its e-processing operations, through the
provision of film processing, scanning, storage and printing of digital
images directly to U.S. consumers, and the sale of its packaged multimedia
presentation software. During all of the above periods, losses were
attributable to the related segments. At September 30, 2003, the company
recorded sales of $145,559 and $110,014 from the Canadian and United
States marketplaces, respectively, and its property, plant and equipment
were located in Canada. At September 30, 2002 and 2001, all of the
company's sales were from the U.S. market and its property, plant and
equipment were located in Canada.
(18)
PHOTOCHANNEL NETWORKS INC.
Notes to Consolidated Financial Statements
FOR THE YEARS ENDED SEPTEMBER 30, 2003, 2002 AND 2001
- --------------------------------------------------------------------------------
(expressed in Canadian dollars)
Major customers, representing 10% or more of sales in the year ended
September 30, 2003, include: Customer A - $39,682; Customer B - $36,444;
Customer C - $28,905; Customer D - $27,400. During the years ended
September 30, 2002 and 2001, no individual customers made up more than 10%
of sales.
16 FINANCIAL INSTRUMENTS
a) Fair values
The fair values of cash and cash equivalents, cash held in trust,
short-term deposits, accounts receivable, accounts payable and
accrued liabilities, due to related parties and loans receivable
approximate their carrying amounts due to the near-term maturity of
these instruments.
b) Credit risk
Financial instruments that potentially subject the company to
significant concentrations of credit risk consist primarily of cash
and cash equivalents and accounts receivable. The company limits its
exposure to credit risk by placing its cash and cash equivalents and
short-term investments with high credit quality financial
institutions and corporations. The company does not have a
significant exposure to any individual customer or counter party.
The company provides its services on credit in the normal course of
conducting its business.
c) Foreign exchange risk
The company is subject to foreign exchange risk for sales and
purchases denominated in foreign currencies. Foreign currency risk
arises from the fluctuation of foreign exchange rates and the degree
of volatility of these rates relative to the Canadian dollar. The
company does not actively manage this risk.
(19)
PHOTOCHANNEL NETWORKS INC.
Notes to Consolidated Financial Statements
FOR THE YEARS ENDED SEPTEMBER 30, 2003, 2002 AND 2001
- --------------------------------------------------------------------------------
(expressed in Canadian dollars)
17 COMMITMENTS AND CONTINGENCIES
COMMITMENTS
The company has entered into agreements to lease premises and services for
periods to 2008. The annual rent for premises includes minimum rent plus
realty taxes and operating expenses. Minimum payments for each of the next
five years are as follows:
$
2004 352,697
2005 479,202
2006 479,202
2007 466,191
2008 300,852
---------
2,078,144
=========
CONTINGENCIES
Other than as set out below, as of January 9, 2004, there were no legal
proceedings material to the company to which the company or its
subsidiaries are a party or to which their property is subject, nor to the
best of the knowledge of management, are any such legal proceedings
contemplated. Other than the amounts described in note 17(b), no accrual
has been made in relation to any of the matters described.
a) On February 24, 1999, Thomas Jackson, a former President and Chief
Executive Officer of the company, commenced proceedings against the
company in the Supreme Court of British Columbia. Mr. Jackson has
claimed damages for unpaid services not exceeding $150,000.
Management is of the view that the claim is without merit and is
vigorously defending these proceedings. There have been no further
proceedings in this matter since the company filed its statement of
defence on August 3, 1999.
b) On January 13, 2000, Arthur Tesser, the former Chief Operating
Officer of PhotoChannel, Inc., commenced arbitration proceedings
against PhotoChannel, Inc. for US$317,000. Mr. Tesser claimed being
owed a severance under an employment contract dated July 26, 2000.
Under the terms of the settlement agreement on August 15, 2003
between the company and Mr. Tesser, the company was to pay Mr.
Tesser US$105,000 by way of instalments. At September 30, 2003, the
company had five instalments remaining as follows: US$15,000 on or
before October 15, 2003; and US$10,000 each, payable on or before
each of November 15, 2003, December 15, 2003, January 15, 2004 and
February 15, 2004 (note 20).
(20)
PHOTOCHANNEL NETWORKS INC.
Notes to Consolidated Financial Statements
FOR THE YEARS ENDED SEPTEMBER 30, 2003, 2002 AND 2001
- --------------------------------------------------------------------------------
(expressed in Canadian dollars)
c) On March 3, 1999, the company received a letter from DATT Japan
indicating that they had proceeded with legal action in the Japanese
courts and asking for an order for payment. On September 10, 2001,
the company's legal representative received a telephone call from an
individual claiming that he represented DATT Japan and indicating
that his client had received a judgment from a Japanese court
against the company for approximately $99,000. The company intends
to defend itself against the enforcement of this judgment; however,
there have been no further proceedings or correspondence since the
September 10, 2001 telephone call.
d) On November 5, 2001, Donald Sutherland of P.O. Box 345, Staten
Island, New York, New York, commenced an action in the Supreme Court
of British Columbia, claiming $132,771 plus interest, for the
provision of text, photographs and services. The company is
disputing the claim.
18 RECENT CANADIAN ACCOUNTING PRONOUNCEMENTS
a) Impairment of long-lived assets
In 2002, the CICA issued Handbook Section 3063, "Impairment of
Long-Lived Assets", which is effective for the company's fiscal year
commencing October 1, 2003. Under this section, an impairment loss
is measured as the difference between the carrying value of an asset
and its fair value. The company does not expect the adoption of this
section to have significant impact on its financial results.
b) Hedging relationships
In June 2003, the CICA revised Accounting Guideline 13, "Hedging
Relationships", which is effective for fiscal years beginning on and
after July 1, 2003. The guideline addresses the identification,
designation, documentation and effectiveness of hedging
relationships, for the purpose of applying hedge accounting. The
guideline establishes certain conditions for applying hedge
accounting and also deals with the discontinuance of hedge
accounting. The company does not expect the adoption of this
guideline to have a significant impact on its consolidated financial
statements.
c) Consolidation of variable interest entities
In June 2003, the CICA issued Accounting Guideline 15,
"Consolidation of Variable Interest Entities", which will be
effective for annual and interim periods beginning on or after
November 1, 2004. This guideline addresses the application of
consolidation principles to entities that are subject to control on
a basis other than ownership of voting interests. The company does
not expect the adoption of this section to have a significant impact
on its consolidated financial statements.
(21)
PHOTOCHANNEL NETWORKS INC.
Notes to Consolidated Financial Statements
FOR THE YEARS ENDED SEPTEMBER 30, 2003, 2002 AND 2001
- --------------------------------------------------------------------------------
(expressed in Canadian dollars)
d) Generally accepted accounting principles
In July 2003, the CICA issued Handbook Section 1100, "Generally
Accepted Accounting Principles." The section establishes standards
for financial reporting in accordance with GAAP, and provides
guidance on sources to consult when selecting accounting policies
and determining appropriate disclosures when a matter is not dealt
with explicitly in the primary sources of GAAP. The company will
implement the new section prospectively beginning on October 1,
2003. The company does not expect the adoption of this section to
have a significant impact on its consolidated financial statements.
19 RECONCILIATION TO ACCOUNTING PRINCIPLES GENERALLY ACCEPTED IN THE
UNITED STATES OF AMERICA
The financial statements have been prepared in accordance with Canadian
generally accepted accounting principles (Canadian GAAP), which differ in
certain respects from those principles and practices that the company
would have followed had its financial statements been prepared in
accordance with accounting principles and practices generally accepted in
the United States (U.S. GAAP).
The reconciliation of the loss for the year based on Canadian GAAP to U.S.
GAAP is as follows:
2003 2002 2001
$ $ $
Net loss for the year under Canadian GAAP 2,822,394 1,851,661 19,871,231
Compensation cost (recovery) (i) 136,416 953 (179,006)
Minority interest (372,410) (1,237,590) --
-----------
Net loss and comprehensive loss for the year
under U.S. GAAP (iii) 2,586,400 615,024 19,692,225
========== ========== ===========
Basic and fully diluted loss per share under
U.S. GAAP (iv) 0.03 0.01 0.59
========== ========== ===========
The reconciliation of the balance sheet between Canadian GAAP and U.S.
GAAP is as follows:
2003 2002 2001
$ $ $
Minority interest
Canadian GAAP -- -- --
U.S. GAAP -- 12,410 --
(22)
PHOTOCHANNEL NETWORKS INC.
Notes to Consolidated Financial Statements
FOR THE YEARS ENDED SEPTEMBER 30, 2003, 2002 AND 2001
- --------------------------------------------------------------------------------
(expressed in Canadian dollars)
The reconciliation of the statement of shareholders' equity (deficiency)
between Canadian GAAP and U.S. GAAP is as follows:
TOTAL
DEFERRED SHAREHOLDERS
CAPITAL CONTRIBUTED LOAN LP UNITS COMPEN- DEFICIT EQUITY
STOCK (I) SURPLUS RECEIVABLE WARRANTS (II) SATION (i) AND (ii) (DEFICIENCY)
$ $ $ $ $ $ $ $
Balance -
September 30, 2001
Canadian GAAP 24,168,231 5,927,262 - 2,150,000 - (261,000) (37,112,004) (5,127,511)
U.S. GAAP 24,060,071 8,226,322 - 2,150,000 - (261,000) (39,302,904) (5,127,511)
Balance -
September 30, 2002
Canadian GAAP 26,390,849 6,189,605 (227,470) 3,214,845 12,410 - (37,726,075) (2,145,836)
U.S. GAAP 26,282,689 8,489,618 (227,470) 3,214,845 - - (39,917,928) (2,158,246)
Balance -
September 30, 2003
Canadian GAAP 31,826,678 6,976,915 (122,206) 2,168,522 - - (40,176,059) 673,850
U.S. GAAP 31,718,518 9,413,344 (122,206) 2,168,522 - - (42,504,328) 673,850
i) Stock-based compensation
Under Canadian GAAP, the company does not measure compensation
expense in connection with the granting of options to employees.
Under U.S. GAAP, the company applies APB Opinion 25, "Accounting for
Stock Issued to Employees," and related interpretations in
accounting for stock compensation to employees and directors. Under
APB 25, because the exercise price of the company's employee stock
options equals the market price of the underlying stock on the date
of the grant, no compensation expense is recognized at the time of
the initial grant. If the exercise price of a fixed stock option
award is subsequently reduced, Financial Accounting Standards Board
(FASB) Interpretation No. 44 (FIN 44) requires that the option award
be accounted for as variable from the date of the modification to
the date the award is exercised, forfeited or expires unexercised.
Accordingly, the company records compensation expense or recovery
for such modified options calculated as the amount of the change in
the intrinsic value of the options from the time of the modification
to the date the modified option is exercised, forfeited or expires.
(23)
PHOTOCHANNEL NETWORKS INC.
Notes to Consolidated Financial Statements
FOR THE YEARS ENDED SEPTEMBER 30, 2003, 2002 AND 2001
- --------------------------------------------------------------------------------
(expressed in Canadian dollars)
Statement of Financial Accounting Standards (SFAS) No. 123,
"Accounting for Stock-Based Compensation" requires the company to
provide pro forma information regarding net income and earnings per
share as if compensation for the company's stock option plans had
been determined in accordance with the fair value based method
prescribed in SFAS 123. The company estimates the fair value of each
stock option at the grant date or measures compensation for options
modified and requiring variable accounting from the date of
modification by using the Black-Scholes option-pricing model with
the following weighted average assumptions used for grants in the
year ended September 30, 2003:
2003 2002 2001
Dividend yield nil nil nil
Expected volatility (private
company) 100% 100% 100%
Risk-free interest rate 4% 4% 4%
Expected life (in years) 5 5 5
The weighted average fair value of options granted during 2003 was
$0.12 (2002 - $0.07; 2001 - $0.37). The effect of pro forma
compensation expense on the company's loss and loss per share is as
follows:
2003 2002 2001
$ $ $
Loss per U.S. GAAP 2,586,400 615,024 19,692,225
Additional compensation expense 203,299 302,165 2,243,708
----------
Pro forma loss 2,789,699 917,189 21,935,933
========= ======= ==========
Pro forma basic and diluted loss
per share 0.03 0.02 0.66
========= ======= ==========
ii) Minority interest
Under Canadian GAAP, the company presents the partnership equity
within shareholders' equity and separates the net loss attributed to
limited partnership from the net loss attributed to the common
shareholders (note 9). Under U.S. GAAP the company applies
Accounting Research Bulletin No. 51, "Consolidated Financial
Statements" (ARB 51) and related interpretations in accounting for
the consolidation of the limited partnership. Under ARB 51, the
partnership equity is presented as minority interest to the extent
of the limited partners' equity investment, net of losses attributed
to the limited partners. The loss attributed to the limited partners
is shown as minority interest on the statement of loss and deficit.
(24)
PHOTOCHANNEL NETWORKS INC.
Notes to Consolidated Financial Statements
FOR THE YEARS ENDED SEPTEMBER 30, 2003, 2002 AND 2001
- --------------------------------------------------------------------------------
(expressed in Canadian dollars)
In 2002, the company previously attributed all losses to the
company. Accordingly, the loss for 2002 has been restated to
allocate losses attributed to the Limited Partnership units to
minority interest. Also, the residual limited partnership equity has
been restated as minority interest.
The restatement has the effect of increasing minority interest to
$12,410, reducing the deficit from $41,155,518 to $39,917,928, and
reducing the net loss from $1,852,614 to $615,024 and the basic and
fully diluted loss per share from $0.03 to $0.01.
iii) Comprehensive loss
U.S. GAAP requires disclosure of comprehensive income (loss), which
is intended to reflect all changes in equity except those resulting
from contributions from owners. There are no material adjustments
required to present comprehensive income for the purposes of these
consolidated financial statements
iv) Net loss per share
Outstanding options and warrants as described in note 8, with the
exception of contingently issuable shares, have not been included in
the calculation of diluted earnings per share as their effect would
be anti-dilutive. As such, the basic and diluted earnings per share
calculations do not differ.
v) Cash flow statement
The Canadian accounting standard for the preparation of cash flow
statements is consistent with the guidance provided by IAS 7, and
accordingly, the cash flow statements presented herein have not been
reconciled to U.S. GAAP under the accommodation provided by the
Securities and Exchange Commission of the United States (SEC).
vi) Recent U.S. GAAP announcements
In July 2002, the FASB issued SFAS No. 146, Accounting for Exit or
Disposal Activities. SFAS No. 146 addresses the recognition,
measurement, and reporting of costs that are associated with exit
and disposal activities, including costs related to terminating a
contract that is not a capital lease and termination benefits that
employees who are involuntarily terminated receive under the terms
of a one-time benefit arrangement that is not an ongoing benefit
arrangement or an individual deferred-compensation contract. SFAS
No. 146 supersedes Emerging Issues Task Force Issue No. 94-3,
"Liability Recognition for Certain Employee Termination Benefits and
Other Costs to Exit an Activity (including Certain Costs Incurred in
a Restructuring)." SFAS 146 has had no significant impact on the
consolidated financial statements.
(25)
PHOTOCHANNEL NETWORKS INC.
Notes to Consolidated Financial Statements
FOR THE YEARS ENDED SEPTEMBER 30, 2003, 2002 AND 2001
- --------------------------------------------------------------------------------
(expressed in Canadian dollars)
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain
Financial Instruments with Characteristics of Both Liabilities and
Equity" (SFAS 150). This statement establishes standards for issuers
on how to classify and measure certain financial instruments with
characteristics of both liabilities and equity. An issuer must
classify a financial instrument that is within its scope as a
liability (or an asset in some circumstances). Included in the scope
of this standard is: (a) a financial instrument issued in the form
of shares that is mandatorily redeemable; (b) a financial instrument
other than an outstanding share that, at inception, embodies an
obligation to repurchase the issuer's equity shares, or is indexed
to such an obligation, and that requires or may require the issuer
to settle the obligation by transferring assets; and (c) a financial
instrument that embodies an unconditional obligation, or a financial
instrument other than an outstanding share that embodies a
conditional obligation, that the issuer must or may settle by
issuing a variable number of its equity shares. SFAS 150 has had no
significant impact on the consolidated financial statements.
In January 2003, the FASB issued FIN 46, "Consolidation of Variable
Interest Entities", an interpretation of Accounting Research
Bulletin (ARB) 51. FIN 46 addresses the consolidation of entities
for which control is achieved through means other than through
voting rights (variable interest entities or VIE) by clarifying the
application of ARB 51, "Consolidated Financial Statements," to
certain entities in which equity investors do not have the
characteristics of a controlling financial interest or do not have
sufficient equity investment at risk to permit the entity to finance
its activities without additional subordinated financial support
from other parties.
FIN 46 requires the primary beneficiary to consolidate a VIE if it
has a variable interest that will absorb a majority of the entity's
expected losses if they occur, receive a majority of the entity's
expected residual returns if they occur, or both.
Effective December 2003, the FASB issued additional guidance
clarifying FIN 46. The modification also provides a deferral of FIN
46 for certain entities. Application of FIN 46 is required in
financial statements of public entities that have interests in
structures that are commonly referred to as special purpose entities
for periods ending after December 15, 2003. Application for all
other types of VIEs is required in financial statements for periods
ending after March 15, 2004. Management has not yet determined the
effect that the adoption will have on its financial statement.
In December 2002, the FASB issued SFAS 148, "Accounting for
Stock-Based Compensation - Transition and Disclosure - An amendment
of FASB Statement No. 123". SFAS 148 amends Statement of Financial
Accounting Standards No. 123 (SFAS 123), "Accounting for Stock-Based
Compensation," to provide alternative methods of transition for a
voluntary change to the fair value based method of accounting for
stock-based employee compensation. SFAS 148 amends the disclosure
requirements of SFAS 123 to require prominent disclosures both in
annual and interim financial statements about the method of
accounting for stock-based employee compensation and effect of the
method used on reported results. The company has included the
disclosures required by SFAS 148 in this reconciliation to U.S.
GAAP.
The company has determined that other recently issued Canadian and
U.S. accounting pronouncements will have no impact on adoption.
(26)
PHOTOCHANNEL NETWORKS INC.
Notes to Consolidated Financial Statements
FOR THE YEARS ENDED SEPTEMBER 30, 2003, 2002 AND 2001
- --------------------------------------------------------------------------------
(expressed in Canadian dollars)
20 SUBSEQUENT EVENTS
COMMON SHARE PURCHASE WARRANTS
Between September 30, 2003 and October 21, 2003, the company issued
2,675,000 common shares of the company for proceeds of $267,500 upon
exercise of common share purchase warrants granted to Discovery Capital
Corporation.
ARTHUR TESSER
Between September 30, 2003 and January 9, 2004, the company paid
instalment payments of US$35,000 under the terms of the August 15, 2003
settlement agreement. As at January 9, 2004, the company has two
instalment payments remaining totalling US$20,000.
LOANS RECEIVABLE
Between September 30, 2003 and December 29, 2003, the company was repaid
$33,600 of the loans to employees, which were secured by common shares of
the company.
CASH HELD IN TRUST
Between September 30, 2003 and December 29, 2003, the company received the
$345,000 which had been held in trust at September 30, 2003 as a result of
the non-brokered private placement in September 2003.
(27)
PHOTOCHANNEL NETWORKS INC. FORM 20-F
3. On November 5, 2001 Donald Sutherland of P.O. Box 345, Staten
Island, New York, New York, commenced an action in the Supreme Court
of British Columbia, claiming $132,770.63 plus interest, for the
provision of text, photographs and other services. We are disputing
the claim.
B. SIGNIFICANT CHANGES
Since the date of the audited consolidated financial statements, there have been
significant changes as detailed in Liquidity and Capital Resources in Item 5.B
and in Business Overview in Item 4.B.
ITEM 9. THE OFFER AND LISTING
Not applicable except for Item 9A(4) and Item 9C.
A. (4). PRICE HISTORY
MARKET AND TRADING PRICES
Our common shares are listed and posted for trading on the TSX Venture Exchange,
commonly called the TSX-V, under the trading symbol "PNI". Our shares were first
listing for trading on the Montreal Exchange ("ME"), in Montreal, Quebec,
Canada, which merged with the Canadian Venture Exchange ("CDNX") in September
2001 and effective October 1, 2001 we began trading on the CDNX. Subsequently
the CDNX was acquired by the TSX in 2002 and on April 1, 2002 we were listed for
trading on the TSX-V. The following table sets forth the reported high and low
sale prices of our common shares as reported by the TSX-V and CDNX for each full
quarterly period within our two most recent fiscal years:
Sales Prices (CAN$)
-------------------------
High Low
Common Shares ------- -------
-------------
Annual Data 2003 $0.32 $0.07
2002 0.12 0.05
Quarterly data 2003
December 31, 2003 $0.39 $0.24
September 30, 2003 0.32 0.09
June 30, 2003 0.12 0.08
March 31, 2003 0.11 0.07
2002
December 31, 2002 $0.11 $0.05
September 30, 2002 0.11 0.05
June 30, 2002 0.12 0.06
March 31, 2002 0.11 0.05
December 31, 2001 0.10 0.05
Monthly Data February 2004 $0.33 $0.24
January 2004 0.34 0.23
December 2003 0.39 0.29
November 2003 0.32 0.29
October 2003 0.36 0.24
September 2003 0.32 0.12
35
PHOTOCHANNEL NETWORKS INC. FORM 20-F
Our common shares are also listed on the NASD Over the Counter Bulletin Board
("NASD OTC BB") in the United States, however, we do not presently have an
active market maker in the United States. The following table sets forth the
high and low sales prices for the common shares on the NASD OTC BB for each full
quarterly period within our two most recent fiscal years.
Sales Prices (US$)
-------------------------
High Low
Common Shares ------- -------
-------------
Annual Data 2003 $0.25 $0.01
2002 0.095 0.01
Quarterly data 2003
December 31, 2003 $0.28 0.18
September 30, 2003 0.25 0.04
June 30, 2003 0.10 0.05
March 31, 2003 0.08 0.01
2002
December 31, 2002 $0.095 0.01
September 30, 2002 0.08 0.02
June 30, 2002 0.09 0.02
March 31, 2002 0.075 0.02
December 31, 2001 0.10 0.01
Monthly Data February 2004 $0.25 $0.17
January 2004 0.25 0.17
December 2003 0.28 0.21
November 2003 0.26 0.20
October 2003 0.28 0.18
September 2003 0.25 0.07
Our common share register indicates that 32 persons holding approximately 1.13%
of our outstanding common stock are persons with United States addresses. We
have no information and express no opinion regarding the identities, addresses
or holdings of the beneficial owners of these securities.
B. PLAN OF DISTRIBUTION
Not Applicable.
C. MARKETS
See Item 9A(4) above.
D. SELLING SHAREHOLDERS
Not Applicable.
E. DILUTION
Not Applicable.
36
PHOTOCHANNEL NETWORKS INC. FORM 20-F
F. EXPENSES OF THE ISSUE
Not Applicable.
ITEM 10. ADDITIONAL INFORMATION
A. SHARE CAPITAL
Not Applicable.
B. MEMORANDUM AND ARTICLES OF ASSOCIATION
Our corporation number as assigned by the British Columbia Ministry of Consumer
and Commercial Relations is 509287. Our charter documents consist of our
Memorandum and our Articles. Neither our Memorandum nor our Articles contain our
purpose or our objectives, as neither is required under the laws of British
Columbia.
None of our directors is permitted to vote on any resolution to approve a
material contract or transaction in which such director has a material interest.
(Articles, Paragraph 15.2). Neither our Memorandum nor our Articles limit the
directors' power, in the absence of an independent quorum, to vote compensation
to themselves or any members of their body. The Articles provide that directors
shall receive such remuneration as the board of directors shall determine from
time to time. (Articles, Paragraph 12.2). The board of directors may, without
the authorization of the shareholders:
o borrow money in such manner and amount, on such security, from such
sources and upon such terms and conditions as they think fit;
o issue bonds, debentures and other debt obligations either outright
or as security for any liability or obligation of us by any other
person; and
o mortgage or charge, whether by way of specific or floating charge,
or give other security on the undertaking and the whole or any part
of the property and assets (both present and future) of us
(Articles, Paragraph 8.1).
Neither our Memorandum nor our Articles discuss the retirement or non-retirement
of directors under an age limit requirement, and there is no number of shares
required for director qualification.
Our authorized capital consists of 500,000,000 common shares without par value
and 10,000,000 preferred shares without par value. The holder of each issued and
outstanding common share is entitled to receive notice of and to attend any of
our general meetings, and to exercise one vote in respect of each common share
held. Dividends are payable on the issued and outstanding common shares in the
discretion of the board of directors. Directors stand for re-election at our
annual general meeting of shareholders and not at staggered intervals. No
cumulative voting is permitted in relation to the common shares. In the event of
our liquidation, the holders of common shares are entitled to participate
ratably in any surplus. Neither our Memorandum nor our Articles contain
provisions, which discriminate against any existing or prospective holders of
securities, as a result of such shareholder owning a substantial number of
shares.
Neither our Memorandum nor our Articles address the process by which the rights
of holders of shares may be changed. The general provisions of the British
Columbia Company Act apply to this process, and require that any change in the
rights, privileges and restrictions attached to shares must be approved by not
less than three quarters of the votes cast at a duly convened general meeting of
shareholders at which the proposed change is put forward for consideration.
37
PHOTOCHANNEL NETWORKS INC. FORM 20-F
Annual general meetings and special general meetings of our shareholders are
held on such day as is determined by resolution of the directors. (Articles,
Paragraph 9.1). The British Columbia Company Act requires that our annual
general meeting be held within 13 months after our last annual general meeting.
Neither our Memorandum nor our Articles contain provisions setting out the
notice period, which must be given to shareholders with respect to general
meetings. The British Columbia Company Act requires that shareholders be given
not less than 21 days' notice of any general meeting. Notices of general
meetings of shareholders must state the nature of the business to be transacted
in detail and must include the text of any special resolution to be submitted to
the meeting. Our board of directors is permitted to fix a record date for any
meeting of the shareholders that is not less than 35 nor more than 49 days prior
to such meeting. Pursuant to the British Columbia Company Act, the only persons
entitled to admission at a meeting of the shareholders are shareholders entitled
to vote, our directors, our auditors, and others entitled by law, by invitation
of the chairman of the meeting, or by consent of the meeting.
Neither our Memorandum nor our Articles discuss limitations on the rights to own
securities or exercise voting rights thereon.
There is no provision of our Memorandum or Articles that would delay, defer or
prevent a change in our control, and that would operate only with respect to a
merger, acquisition, or corporate restructuring involving us or any of our
subsidiaries. Our Articles do not contain a provision indicating the ownership
threshold above which shareholder ownership must be disclosed. With respect to
the matters discussed in this subsection of the annual report, the law
applicable to us is not significantly different from United States law. Neither
the Memorandum nor Articles contain provisions governing changes in capital that
are more stringent than the conditions required by law.
C. MATERIAL CONTRACTS
The following summary of our material agreements, which agreements are filed as
exhibits to this annual report, does not purport to be complete and is subject
to, and is qualified in its entirety by reference to, all the provisions of
those agreements. There are no material contracts, other than those contracts
entered into in the ordinary course of business, currently in place or to which
we or any member of our group is a party, from the two years immediately
preceding the publication of this annual report, except as follows:
1. The rental agreement for our operations in the United States located at 76
Progress Drive, Stamford, Connecticut, USA 06902. The premises comprise
approximately 2,000 square feet in an office building. We lease the
premises from a third party corporation. The lease is for a period of one
year and expired on May 31, 2002. We continue to lease on a month to month
basis under this agreement. The base monthly rent is approximately
US$3,000.00.*
2. The rental agreement for our executive offices located at Suite 506, 425
Carrall Street, Vancouver, British Columbia, Canada. The premises comprise
approximately 2,663 square feet in an office building. We lease the
premises from a third party corporation. The lease is for a period of three
years, expiring on July 31, 2004. The base monthly rent is approximately
$3,994.50.*
3. The Hosting Solutions Contract with TELUS Communications Inc., dated
September 11, 2001. This agreement is for a 60 month period commencing
October 1, 2001.*
4. The Internetworking Services Agreement with TELUS Communications Inc.,
dated September 11, 2001. This agreement is for a 60 month period
commencing October 1, 2001.*
5. The Distribution Agreement, with NBJ Enterprises Ltd., dba Skana Photo-Lab
Products, dated February 1, 2002 and amended July 1, 2002. This agreement
is for a period of 12 months.*
6. The License Agreement with PhotoChannel Networks Limited Partnership, dated
February 14, 2002. This agreement is in perpetuity or until unwound.*
7. The Operating Agreement with PhotoChannel Networks Limited Partnership,
dated February 14, 2002. This agreement is for a period of five years.*
8. The Support Agreement with PhotoChannel Networks Limited Partnership, dated
May 2, 2002. This agreement is in perpetuity or until the License Agreement
is unwound.*
38
PHOTOCHANNEL NETWORKS INC. FORM 20-F
9. The Management Agreement with PhotoChannel Networks Limited Partnership,
dated June 4, 2002. This agreement is for a period of approximately five
years and seven months, terminating on December 31, 2007.*
10. The Amended & Restated Limited Partnership Agreement with 620077 B.C. Ltd.,
Discovery Capital 2001 Technology Limited Partnership, TELUS Corporation,
Ex Fund Technologies Corp. and Peter Scarth, dated June
4, 2002.*
11. The Option Agreement with Discovery Capital 2001 Technology Limited
Partnership, dated June 4, 2002. This agreement is for a period of
approximately 25 months, expiring on June 30, 2004.*
12. The Option Agreement with TELUS Corporation, dated June 4, 2002. This
agreement is for a period of approximately 25 months, expiring on June 30,
2004.*
13. The Option Agreement with Ex Fund Technologies Corp., dated June 4, 2002.
This agreement is for a period of approximately 25 months, expiring on June
30, 2004.*
14. The Option Agreement with Peter Scarth, dated June 4, 2002. This agreement
is for a period of approximately 25 months, expiring on June 30, 2004.*
15. The License and Services Agreement with Black Photo Corporation, dated
September 13, 2002. This Agreement is for a period of two years, expiring
September 12, 2004 (the "Term") and automatically renews for one year
periods unless written notice is provided by one party to the other not
less than ninety (90) days prior to the end of the Term or the then current
renewal term.*
16. The License and Services Agreement with Giant Eagle, Inc., dated December
12, 2002. This Agreement is for a period of two years, expiring December
11, 2004 (the "Term") and automatically renews for one year periods unless
written notice is provided by one party to the other not less than ninety
(90) days prior to the end of the Term or the then current renewal term.
17. The Letter Agreement with Photolab.ca, a division of Loblaw Group of
Companies, dated February 6, 2003. This Agreement is for a period of nine
months, expiring November 5, 2003.
18. The Services Agreement with Wal-Mart Canada Corp., dated April 11, 2003.
This Agreement is for a period of two years, expiring April 10, 2005 (the
"Term") and automatically renews for one year periods unless written notice
is provided by one party to the other not less than thirty (30) days prior
to the end of the Term or the then current renewal term.
19. The rental agreement for our executive offices located at Suite 506, 425
Carrall Street, Vancouver, British Columbia, Canada, as amended on May 16,
2003. The amendment comprises the addition of approximately 1,674 square
feet in the office building. We lease the premises from a third party
corporation. The amendment has extended the term of the lease by three (3)
years to July 31, 2007. The new monthly base rent, effective June 1, 2004,
has been increased to approximately $6,505.50.
- ---------------------
* Previously filed.
D. EXCHANGE CONTROLS
The Investment Canada Act (the "ICA"), as amended, requires that all
acquisitions of control of Canadian businesses by non-Canadians are subject to
formal notification to the Canadian government. These provisions require a
foreign investor to give notice in the required form, which notices are for
information purposes and not for review purposes, unless the acquisition relates
to an acquisition of control of a Canadian business having $150 million or more
of gross assets. As at February 29, 2004, three of our four directors were
Canadian, and 80% of our voting shares were owned by Canadians. We are satisfied
that we complies with ICA at present.
Apart from the ICA, there are no other limitations on the right of non-resident
or foreign owners to hold or vote securities imposed by Canadian law or our
articles of incorporation. There are no other decrees or regulations in Canada
which restrict the export or import of Capital, including foreign exchange
controls, or that affect the remittance of dividends, interest or other payments
to non-resident holders of our securities, except as discussed below in
"Taxation."
39
PHOTOCHANNEL NETWORKS INC. FORM 20-F
E. TAXATION
The following summary is not exhaustive, but is materially complete.
A brief description of certain provisions of the tax treaty between Canada and
the United States is included below, together with a brief outline of certain
taxes, including withholding provisions, to which United States security holders
are subject under existing laws and regulations of Canada. The consequences, if
any, of provincial, state and local taxes are not considered.
The following information is general and security holders should seek the advice
of their own tax advisors, tax counsel or accountants with respect to the
applicability or effect on their own individual circumstances of the matters
referred to herein and of any provincial, state, or local taxes.
CERTAIN CANADIAN FEDERAL INCOME TAX CONSEQUENCES
The discussion under this heading summarizes the principal Canadian federal
income tax consequences of acquiring, holding and disposing of shares of our
common stock for any of our shareholders who is not a resident of Canada but is
a resident of the United States and who will acquire and hold shares of our
common stock as capital property for the purposes of the Income Tax Act (Canada)
(the "Canadian Tax Act"). This summary does not apply to a shareholder who
carries on business in Canada through a "permanent establishment" situated in
Canada or performs independent personal services in Canada through a fixed base
in Canada if the shareholder's holding in our stock is effectively connected
with such permanent establishment or fixed base. This summary is based on the
provisions of the Canadian Tax Act and the regulations thereunder and on an
understanding of the administrative practices of Canada Customs & Revenue
Agency, and takes into account all specific proposals to amend the Canadian Tax
Act or regulations made by the Minister of Finance of Canada as of the date
hereof. It has been assumed that there will be no other relevant amendment of
any governing law although no assurance can be given in this respect. This
discussion is general only and is not a substitute for independent advice from a
shareholder's own Canadian and U.S. tax advisors.
The provisions of the Canadian Tax Act are subject to income tax treaties to
which Canada is a party, including the Canada-United States Income Tax
Convention (1980), as amended (the "Convention").
DIVIDENDS ON COMMON SHARES AND OTHER INCOME
Under the Canadian Tax Act, a non-resident of Canada is generally subject to
Canadian withholding tax at the rate of 25 percent on dividends paid or deemed
to have been paid to him or her by a corporation resident in Canada. The
Convention limits the rate to 15 percent if the shareholder is a resident of the
United States and the dividends are beneficially owned by and paid to such
shareholder, and to 5 percent if the shareholder is also a corporation that
beneficially owns at least 10 percent of the voting stock of the payor
corporation.
The amount of a stock dividend (for tax purposes) would generally be equal to
the amount by which our paid up or stated capital had increased by reason of the
payment of such dividend. We will furnish additional tax information to
shareholders in the event of such a dividend. Interest paid or deemed to be paid
on the Corporation's debt securities held by non-Canadian residents may also be
subject to Canadian withholding tax, depending upon the terms and provisions of
such securities and any applicable tax treaty.
The Convention generally exempts from Canadian income tax dividends paid to a
religious, scientific, literary, educational or charitable organization or to an
organization constituted and operated exclusively to administer a pension,
retirement or employee benefit fund or plan, if the organization is a resident
of the United States and is exempt from income tax under the laws of the United
States.
40
PHOTOCHANNEL NETWORKS INC. FORM 20-F
DISPOSITIONS OF COMMON SHARES
Under the Canadian Tax Act, a taxpayer's capital gain or capital loss from a
disposition of a share of our common stock is the amount, if any, by which his
or her proceeds of disposition exceed (or are exceeded by, respectively) the
aggregate of his or her adjusted cost base of the share and reasonable expenses
of disposition. The capital gain or loss must be computed in Canadian currency
using a weighted average adjusted cost base for identical properties. The
capital gains net of losses included in income are as follows. For gains net of
losses realized before February 28, 2000, as to 75%. For gains net of losses
realized after February 27, 2000 and before October 18, 2000, as to 66 2/3%. For
gains net of losses realized after October 17, 2000, as to 50%. There are
special transitional rules to apply capital losses against capital gains that
arose in different periods. The amount by which a shareholder's capital loss
exceeds the capital gain in a year may be deducted from a capital gain realized
by the shareholder in the three previous years or any subsequent year, subject
to certain restrictions in the case of a corporate shareholder.
Under the Canadian Tax Act, a non-resident of Canada is subject to Canadian tax
on taxable capital gains, and may deduct allowable capital losses, realized on a
disposition of "taxable Canadian property." Shares of our common stock will
constitute taxable Canadian property of a shareholder at a particular time if
the shareholder used the shares in carrying on business in Canada, or if at any
time in the five years immediately preceding the disposition 25% or more of the
issued shares of any class or series in our capital stock belonged to one or
more persons in a group comprising the shareholder and persons with whom the
shareholder and persons with whom the shareholder did not deal at arm's length
and in certain other circumstances.
The Convention relieves United States residents from liability for Canadian tax
on capital gains derived on a disposition of shares unless:
(a) the value of the shares is derived principally from "real property"
in Canada, including the right to explore for or exploit natural
resources and rights to amounts computed by reference to production,
(b) the shareholder was resident in Canada for 120 months during any
period of 20 consecutive years preceding, and at any time during the
10 years immediately preceding, the disposition and the shares were
owned by him when he or she ceased to be resident in Canada, or
(c) the shares formed part of the business property of a "permanent
establishment" that the holder has or had in Canada within the 12
months preceding the disposition.
F. DIVIDENDS AND PAYING AGENTS
Not Applicable.
G. STATEMENTS BY EXPERTS
Not Applicable.
H. DOCUMENTS ON DISPLAY
The documents concerning us which are referred to in this annual report may be
inspected at our offices located at 506 - 425 Carrall Street, Vancouver, British
Columbia V6B 6E3.
41
PHOTOCHANNEL NETWORKS INC. FORM 20-F
I. SUBSIDIARY INFORMATION
For information about our subsidiaries, please see "Item 4. Information On The
Company; Organizational Structure."
We are required to file reports and other information with the securities
commission in British Columbia, Alberta, Ontario and Quebec. Readers are invited
to read and copy any reports, statements or other information, other than
confidential filings, that we file with the provincial securities commission.
These filings are also electronically available for the Canadian System for
Electronic Document Analysis and Retrieval (SEDAR) (www.sedar.com), the Canadian
equivalent of the SEC's electronic document gathering and retrieval system.
ITEM 11. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not Applicable because we are a small business issuer as that term is defined in
regulation S-B.
ITEM 12. DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES
Not Applicable.
42
PHOTOCHANNEL NETWORKS INC. FORM 20-F
PART II
ITEM 13. DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES
There have not been any defaults with respect to dividends, arrearages or
delinquencies since September 30, 2003.
ITEM 14. MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF
PROCEEDS
There have been no material modifications to the rights of our security holders
or use of proceeds since September 30, 2003.
ITEM 15. CONTROLS AND PROCEDURES
Prior to the adoption of the SARBANES-OXLEY ACT OF 2002, we maintained formal
and informal procedures that were designed to ensure that we comply with
disclosure obligations and that there is a flow of important information to the
appropriate collection and disclosure points in a timely manner.
The evaluation of our disclosure controls and procedures, as of June 30, 2003,
was supervised and reviewed by our senior management. In doing so, they
considered the controls and procedures that we have implemented, and evaluated
the existence of any material weaknesses or deficiencies that would
significantly and adversely affect our ability to collect, process or disclose
required information on a timely basis, all in the context of our relatively
small size and the hands-on role that is played by our chief executive officer
and our chief financial officer in our day-to-day operations. As a result, our
chief executive officer and our chief financial officer have concluded that the
procedures and controls that we have implemented ensure timely collection and
evaluation of information potentially subject to disclosure under applicable
securities laws, and that such procedures and controls capture information that
is relevant to an assessment of the need to disclose developments and risks that
pertain to our business.
Finally, we confirm that there were no significant changes in our internal
controls or in other factors that would significantly affect these controls
subsequent to the date of their evaluation.
ITEM 16. [RESERVED]
ITEM 16A. AUDIT COMMITTEE FINANCIAL EXPERT
Our audit committee financial expert is Peter Fitzgerald.
ITEM 16B. CODE OF ETHICS
We have not formally adopted a written code of ethics. We are reviewing the
adoption of a formal code of ethics. We have guided our conduct in accordance
with the rules and policies of the TSX Venture Exchange, the provisions of the
Company Act of British Columbia and our reporting in accordance with the
securities legislation applicable to us. Due to our size we have not deemed it
necessary to adopt a formal written code of ethics at this time.
43
PHOTOCHANNEL NETWORKS INC. FORM 20-F
ITEM 16C. PRINCIPAL ACCOUNTANT FEES AND SERVICES
A. AUDIT FEES
The aggregate fees billed by our auditors were CDN$62,994 and CDN$50,000 for the
fiscal years ended 2003 and 2002, respectively.
B. AUDIT-RELATED FEES
Nil
C. TAX FEES
Nil
D. ALL OTHER FEES
Nil
ITEM 16D. EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT COMMITTEES
Not Applicable
ITEM 16E. PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASERS
Not Applicable
44
PART III
ITEM 17. FINANCIAL STATEMENTS
Our consolidated financial statements are expressed in Canadian dollars and are
prepared in accordance with Canadian Generally Accepted Accounting Principles or
Canadian GAAP. See Note 19 to the consolidated financial statements for a
reconciliation of the measurement differences between Canadian and US GAAP, as
they relate to us.
The financial statements and notes thereto as required under Item 17 are
attached hereto and are found immediately following the text of this annual
report.
ITEM 18. FINANCIAL STATEMENTS
We are providing financial statements pursuant to Item 17.
ITEM 19. EXHIBITS
(a) The following exhibits are filed as part of this annual report:
Exhibit Number Description
- -------------- -----------
1. The rental agreement for our operations in the United States with Progress
Park Corp., dated June 6, 2001.*
2. The rental agreement for our executive offices in Canada with Electric
Avenue Properties Inc., dated July 12, 2001.*
3. The Hosting Solutions Contract with TELUS Communications Inc., dated
September 11, 2001.*
4. The Internetworking Services Agreement with TELUS Communications Inc.,
dated September 11, 2001.*
5. The Distribution Agreement, with NBJ Enterprises Ltd., dba Skana Photo-Lab
Products, dated February 1, 2002 and amended July 1, 2002.*
6. The License Agreement with PhotoChannel Networks Limited Partnership,
dated February 14, 2002.*
7. The Operating Agreement with PhotoChannel Networks Limited Partnership,
dated February 14, 2002.*
8. The Support Agreement with PhotoChannel Networks Limited Partnership,
dated May 2, 2002.*
9. The Management Agreement with PhotoChannel Networks Limited Partnership,
dated June 4, 2002.*
10. The Amended & Restated Limited Partnership Agreement with 620077 B.C.
Ltd., Discovery Capital 2001 Technology Limited Partnership, TELUS
Corporation, Ex Fund Technologies Corp. and Peter Scarth, dated June 4,
2002.*
11. The Option Agreement with Discovery Capital 2001 Technology Limited
Partnership, dated June 4, 2002.*
45
PHOTOCHANNEL NETWORKS INC. FORM 20-F
12. The Option Agreement with TELUS Corporation, dated June 4, 2002.*
13. The Option Agreement with Ex Fund Technologies Corp., dated June 4, 2002.*
14. The Option Agreement with Peter Scarth, dated June 4, 2002.*
15. The License and Services Agreement with Black Photo Corporation, dated
September 13, 2002.*
16. The License and Services Agreement with Giant Eagle, Inc., dated December
12, 2002.
17. The Letter Agreement with Photolab.ca, a division of Loblaw Group of
Companies, dated February 6, 2003.
18. The Services Agreement with Wal-Mart Canada Corp., dated April 11, 2003.
19. The rental agreement for our executive offices located at Suite 506, 425
Carrall Street, Vancouver, British Columbia, Canada, as amended on May 16,
2003.
- ---------------------
* Previously filed.
46
SIGNATURES
Pursuant to the requirements of Section 12 of the Securities Exchange
Act of 1934, the Registrant certifies that it meets all of the requirements for
filing on Form 20-F and has duly caused this annual report to be signed on its
behalf by the undersigned, thereunto duly authorized.
PHOTOCHANNEL NETWORKS INC.
(Registrant)
Date: MARCH 31, 2004 By: "Ian Peter Campbell Scarth"
------------------------------
Ian Peter Campbell Scarth
Chairman
47
PHOTOCHANNEL NETWORKS INC. FORM 20-F
CERTIFICATIONS REQUIRED BY SECTION 302 OF SARBANES-OXLEY ACT OF 2002 AND
SEC RULE 33-8124
CERTIFICATIONS*
I, Ian Peter Campbell Scarth, certify that:
1. I have reviewed this annual report on Form 20-F of PhotoChannel Networks Inc.
(the "registrant");
2. Based on my knowledge, this report does not contain any untrue statement of a
material fact or omit to state a material fact necessary to make the statements
made, in light of the circumstances under which such statements were made, not
misleading with respect to the period covered by this report;
3. Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in all material respects the
financial condition, results of operations and cash flows of the registrant as
of, and for, the periods presented in this report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial
reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the
registrant and have:
a) designed such disclosure controls and procedures, or caused such disclosure
controls and procedures to be designed under our supervision, to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities, particularly
during the period in which this report is being prepared;
b) designed such internal control over financial reporting, or caused such
internal control over financial reporting to be designed under our supervision,
to provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles;
c) evaluated the effectiveness of the registrant's disclosure controls and
procedures and presented in this report our conclusions about the effectiveness
of the disclosure controls and procedures, as of the end of the period covered
by this report based on such evaluation; and
d) disclosed in this report any change in the registrant's internal control over
financial reporting that occurred during the period covered by the annual report
that has materially affected, or is reasonable likely to materially affect, the
registrant's internal control over financial reporting.
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation of internal control over financial reporting, to the
registrant's auditors and the audit committee of registrant's board of directors
(or persons performing the equivalent functions):
a) all significant deficiencies and material weaknesses in the design or
operation of internal control over financial reporting which are reasonably
likely to adversely affect the registrant's ability to record, process,
summarize and report financial information; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal control over
financial reporting.
Date: March 31, 2004
"Ian Peter Campbell Scarth"
Ian Peter Campbell Scarth
Chief Executive Officer
1
PHOTOCHANNEL NETWORKS INC. FORM 20-F
CERTIFICATIONS REQUIRED BY SECTION 302 OF SARBANES-OXLEY ACT OF 2002 AND
SEC RULE 33-8124
CERTIFICATIONS*
I, John Robert Chisholm, certify that:
1. I have reviewed this annual report on Form 20-F of PhotoChannel Networks Inc.
(the "registrant");
2. Based on my knowledge, this report does not contain any untrue statement of a
material fact or omit to state a material fact necessary to make the statements
made, in light of the circumstances under which such statements were made, not
misleading with respect to the period covered by this report;
3. Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in all material respects the
financial condition, results of operations and cash flows of the registrant as
of, and for, the periods presented in this report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial
reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the
registrant and have:
a) designed such disclosure controls and procedures, or caused such disclosure
controls and procedures to be designed under our supervision, to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities, particularly
during the period in which this report is being prepared;
b) designed such internal control over financial reporting, or caused such
internal control over financial reporting to be designed under our supervision,
to provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles;
e) evaluated the effectiveness of the registrant's disclosure controls and
procedures and presented in this report our conclusions about the effectiveness
of the disclosure controls and procedures, as of the end of the period covered
by this report based on such evaluation; and
f) disclosed in this report any change in the registrant's internal control over
financial reporting that occurred during the period covered by the annual report
that has materially affected, or is reasonable likely to materially affect, the
registrant's internal control over financial reporting.
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation of internal control over financial reporting, to the
registrant's auditors and the audit committee of registrant's board of directors
(or persons performing the equivalent functions):
a) all significant deficiencies and material weaknesses in the design or
operation of internal control over financial reporting which are reasonably
likely to adversely affect the registrant's ability to record, process,
summarize and report financial information; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal control over
financial reporting.
Date: March 31, 2004
"John Robert Chisholm"
John Robert Chisholm
Chief Financial Officer
2
PHOTOCHANNEL NETWORKS INC. FORM 20-F
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Annual Report of PhotoChannel Networks Inc. on Form 20-F
for the period ending September 30, 2003, as filed with the Securities and
Exchange Commission on the date hereof (the "Report"), the undersigned hereby
certify that to the best of our knowledge:
1. The Report fully complies with the requirements of Section 13(a) of the
Securities Exchange Act of 1934; and
2. The information contained in the Report fairly presents, in all material
respects, the financial condition and results of operations of PhotoChannel
Networks Inc.
Date: March 31, 2004 "Ian Peter Campbell Scarth"
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Name: Ian Peter Campbell Scarth
Title: Chairman and Chief Executive
Officer
Date: March 31, 2004 "John Robert Chisholm"
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Name: John Robert Chisholm
Title: Chief Financial Officer
3