FORM 10-Q
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
QUARTERLY REPORT UNDER SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended: March 30, 2002 Commission file No. 0-15338
-------------- -------
PHOTOWORKS, INC.
----------------
(Exact name of registrant as specified in its charter.)
Washington 91-0964899
------------------------------- ------------------------------------
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
1260 16th Avenue West, Seattle, WA 98119
----------------------------------- -----
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, (206) 281-1390
including area code: --------------
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to the
filing requirements for the past 90 days.
Yes X No
--- ---
As of April 30, 2002, there were issued and outstanding 16,655,285
shares of common stock, par value $.01 per share.
Index to Exhibits at Page 16
Page 1 of 16
PHOTOWORKS, INC.
INDEX
-----
Page No.
--------
PART I -- FINANCIAL INFORMATION
Item 1 - Financial Statements 3-10
Consolidated Balance Sheets as of March 30, 2002
and September 29, 2001 3-4
Consolidated Statements of Operations for the second quarter
and six months ended March 30, 2002 and March 31, 2001 5
Consolidated Statements of Cash Flows for the six months
ended March 30, 2002 and March 31, 2001 6
Notes to Consolidated Financial Statements 7-10
Item 2 - Management's Discussion and Analysis of
Financial Condition and Results of Operations 11-13
PART II -- OTHER INFORMATION
Item 1 - Legal Proceedings 14
Item 4 - Submission of Matters to a Vote of Security Holders 14
Item 6 - Exhibits and Reports on Form 8-K 14
SIGNATURES 15
INDEX TO EXHIBITS 16
Page 2 of 16
PART I -- FINANCIAL INFORMATION
-------------------------------
ITEM 1 - FINANCIAL STATEMENTS
PHOTOWORKS, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands)
(UNAUDITED) (NOTE)
March 30, September 29,
ASSETS 2002 2001
===============================================================================================================
CURRENT ASSETS
Cash and cash equivalents $ 1,788 $ 2,861
Income tax receivable (Note D) 3,758 -
Accounts receivable, net of allowance for doubtful accounts 616 406
Inventories 1,031 2,203
Prepaid expenses and other 458 382
------- -------
TOTAL CURRENT ASSETS 7,651 5,852
FURNITURE, FIXTURES, AND EQUIPMENT,
at cost, less accumulated depreciation 4,329 6,529
TOTAL ASSETS $11,980 $12,381
======= =======
Note: The September 29, 2001 consolidated balance sheet has been derived from
audited consolidated financial statements.
See notes to consolidated financial statements.
Page 3 of 16
PHOTOWORKS, INC.
CONSOLIDATED BALANCE SHEETS (continued)
(in thousands, except per share and share data)
(UNAUDITED) (NOTE)
March 30, September 29,
LIABILITIES AND SHAREHOLDERS' EQUITY 2002 2001
===============================================================================================================
CURRENT LIABILITIES
Bank note payable $ 1,200 $ 2,350
Accounts payable 1,876 2,872
Accrued compensation 961 1,141
Accrued lawsuit settlement 203 705
Other accrued expenses 1,309 1,438
Note payable - other - 38
Current portion of capital lease obligation 186 198
------- -------
TOTAL CURRENT LIABILITIES 5,735 8,742
Subordinated convertible debentures 2,500 2,500
Capital lease obligation, net of current portion - 94
------- -------
TOTAL LONG TERM LIABILITIES 2,500 2,594
------- -------
TOTAL LIABILITIES 8,235 11,336
SHAREHOLDERS' EQUITY
Preferred Stock, $.01 par value, authorized 2,000,000 shares,
issued and outstanding 15,000 shares - -
Common Stock, $.01 par value, authorized 101,250,000
shares, issued and outstanding 16,655,285 167 167
Additional paid-in capital 15,816 15,790
Retained deficit (12,238) (14,912)
------- -------
TOTAL SHAREHOLDERS' EQUITY 3,745 1,045
------- -------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $11,980 $12,381
======= =======
Note: The September 29, 2001 consolidated balance sheet has been derived from
audited consolidated financial statements.
See notes to consolidated financial statements.
Page 4 of 16
PHOTOWORKS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
(in thousands, except per share and share data)
Second Quarter Ended Six Months Ended
-------------------- ----------------
March 30, March 31, March 30, March 31,
2002 2001 2002 2001
=====================================================================================================================
Net revenues $ 9,269 $12,690 $20,332 $27,675
Cost of goods and services 7,435 10,947 15,925 23,245
------- ------- -------- -------
Gross Profit 1,834 1,743 4,407 4,430
Operating expenses:
Marketing expenses 946 5,199 1,880 7,765
Research and development 412 1,350 828 2,525
General and administrative 1,370 2,088 2,686 3,937
------- ------- -------- -------
Total operating expenses 2,728 8,637 5,394 14,227
------- ------- -------- -------
Loss from Operations (894) (6,894) (987) (9,797)
Other income (expense):
Interest income 2 17 18 44
Interest expense (75) (118) (168) (287)
Non-operating income, net 50 99 53 111
------- ------- -------- -------
Total other expense (23) (2) (97) (132)
------- ------- -------- -------
Loss before income taxes (917) (6,896) (1,084) (9,929)
Benefit from income taxes (Note D) 3,758 - 3,758 -
------- ------- -------- -------
Net Income (Loss) $ 2,841 $(6,896) $ 2,674 $(9,929)
======= ======= ======== =======
Earnings (loss) per share - diluted $.17 $(.42) $.16 $(.60)
==== ===== ==== =====
Basic earnings (loss) per share $.17 $(.42) $.16 $(.60)
==== ===== ==== =====
Weighted average shares and dilutive
equivalents outstanding 17,124,000 16,522,000 16,867,000 16,514,000
========== ========== ========== ==========
Weighted average shares - basic 16,655,000 16,522,000 16,656,000 16,514,000
========== ========== ========== ==========
See notes to consolidated financial statements.
Page 5 of 16
PHOTOWORKS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(in thousands)
Six Months Ended
--------------------------
March 30, March 31,
2002 2001
===============================================================================================================
OPERATING ACTIVITIES:
- ---------------------
Net income (loss) $2,674 $(9,929)
Charges to income not affecting cash:
Depreciation and amortization 2,205 3,738
Accrued lawsuit settlement (502) -
Loss on disposal of assets - 236
Income tax receivable (3,758) -
Net change in receivables, inventories, payables and other (393) 1,655
------ -------
NET CASH FROM (USED) IN OPERATING ACTIVITIES 226 (4,300)
INVESTING ACTIVITIES:
- ---------------------
Purchase of furniture, fixtures, and equipment (17) (172)
Sales of furniture, fixtures and equipment 12 -
Sales of securities available-for-sale - 1,022
------ -------
NET CASH FROM (USED IN) INVESTING ACTIVITIES (5) 850
FINANCING ACTIVITIES:
- ---------------------
Payment on bank note payable (1,150) -
Payment on capital lease obligation (106) (122)
Payment on note payable-other (38) -
Drawing on bank note payable - 2,350
Proceeds from issuance of Common Stock - 124
------ -------
NET CASH FROM (USED IN) FINANCING ACTIVITIES (1,294) 2,352
------ -------
DECREASE IN CASH AND CASH EQUIVALENTS (1,073) (1,098)
Cash and cash equivalents at beginning of period 2,861 1,629
------ -------
CASH AND CASH EQUIVALENTS
AT END OF PERIOD $1,788 $ 531
====== =======
See notes to consolidated financial statements.
Page 6 of 16
PHOTOWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE A -- BASIS OF PRESENTATION
PhotoWorks, Inc. ("PhotoWorks" or the "Company") is a leading photo
services company dedictated to providing its customers with innovative ways to
enjoy and use their photos. The PhotoWorks service provides film and image
processing and online image storage and management services to both traditional
and digital camera users, providing customers with the easiest way to store and
organize photos online, share them with friends and family, and order reprints,
photo albums, and photo related products. The Company also offers an array of
complementary products and services, primarily under the brand names
PhotoWorks(R) and Seattle FilmWorks(R). To a lesser extent, the Company provides
photo-related products on a wholesale basis. The Company currently operates in
one principal business segment
The accompanying unaudited consolidated financial statements have been
prepared in accordance with generally accepted accounting principles for interim
financial information and with the instructions to Form 10-Q and Rule 10-01 of
Regulation S-X. Accordingly, they do not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, all adjustments (consisting
of normal recurring adjustments) considered necessary for a fair presentation of
interim results have been included. The Company follows a policy of recording
its interim periods and year-end on a 13 week basis for comparability of results
and to be consistent with its internal weekly reporting. Operating results for
the second quarter ended March 30, 2002 are not necessarily indicative of the
results that may be expected for the fiscal year ending September 28, 2002. For
further information, refer to the "Management's Discussion and Analysis of
Financial Condition and Results of Operations" under Item 2 below and under Item
7 of Part II of the Company's Annual Report on Form 10-K for the year ended
September 29, 2001 and the Company's consolidated financial statements and
footnotes thereto also included in the Company's Annual Report
Certain prior year balances have been reclassified to conform to the
current year's presentation.
NOTE B -- EARNINGS PER SHARE
The Company calculates earnings per share in accordance with the
Financial Accounting Standards Board Statement of Financial Accounting Standards
No. 128, "Earnings per Share". Earnings per share is based on the weighted
average number of shares and dilutive Common Stock equivalents outstanding
during the period. Net loss per share is based on the weighted average number of
common shares outstanding. Convertible preferred shares, outstanding warrants
and stock options to purchase shares of common stock were excluded from the
computation of loss per share because their effect was antidilutive.
The following table sets forth the computation of basic and diluted
earnings (loss) per share:
Second Quarter Ended Six Months Ended
------------------------------- --------------------------------
March 30, 2002 March 31, 2001 March 30, 2002 March 31, 2001
===========================================================================================================================
Numerator for basic and diluted earnings per share:
Net income (loss) $2,841,000 $(6,896,000) $2,674,000 $(9,929,000)
========== =========== ========== ===========
Denominator:
Denominator for basic earnings
per share - weighted-average shares 16,655,000 16,522,000 16,656,000 16,514,000
Net effect of dilutive stock options 469,000 - 211,000 -
---------- ---------- ---------- ----------
Denominator for diluted earnings per share 17,124,000 16,522,000 16,867,000 16,514,000
========== ========== ========== ==========
Basic earnings (loss) per share $.17 $(.42) $.16 $(.60)
==== ===== ==== =====
Diluted earnings (loss) per share $.17 $(.42) $.16 $(.60)
==== ===== ==== =====
Page 7 of 16
PHOTOWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE C -- LIQUIDITY
For the most recent quarter ended March 30, 2002, the Company incurred
a pre-tax loss of $917,000 and an overall decline in cash of $54,000. In fiscal
2001, the Company incurred a net loss of $12,122,000 and had negative cash flows
from operating activities of $4,596,000. For the past three years, the Company
has incurred significant losses on declining revenues.
As more fully described in Note D, Congress recently enacted changes in
federal income tax laws that will allow the Company to carryback its 2001 and
2002 tax losses, resulting in the recognition of tax benefits, most of which
were previously reserved, of approximately $3,758,000. Additionally, management
has taken various other actions, including workforce reductions, store and
facility closures, and reduced marketing, administrative, and research and
development expenditures, to more closely align its cost structure with its
reduced revenue levels, which have resulted in positive operating cash flow
during each of the first two quarters of fiscal 2002.
Management believes that under its current operational and financing
plans and current cash balances, combined with projected cash flows from
operations, including the fiscal 2001 tax refund of $3,592,000, will be
sufficient to fund the Company's operations through the next twelve months.
NOTE D -- INCOME TAXES
In fiscal 2000, it was determined that it was appropriate to provide a
valuation allowance equal to the amount of deferred tax assets not recoverable
through operating loss carrybacks. However, the Job Creation and Worker
Assistance Act enacted by Congress on March 8, 2002, extended the carryback
period for certain net tax operating losses. This will allow the Company to
carryback all of its 2001 tax loss of approximately $10,560,000 and any tax
losses it incurs in fiscal 2002 up to approximately $6,580,000.
The Company will receive a tax refund of approximately $3,592,000 for
its 2001 tax loss. Through the first six months of fiscal 2002, the Company has
a net tax operating loss of approximately $489,000, for which the company has
recorded a tax benefit of $166,000.
Utilization of the remaining deferred tax assets of approximately
$13,049,000 is dependent on future profits that are not assured and are still
offset fully by a valuation allowance.
NOTE E - SUBORDINATED DEBENTURES
On April 25, 2001, the Company closed a $2,500,000 Subordinated
Debenture financing with investment advisory clients of Zesiger Capital Group,
LLC. The subordinated debentures have a 7% interest rate (payable semi-annually)
and are convertible at the discretion of the holders, into Series B Preferred
Stock at a conversion price of $75.00 per share, one year after closing. Each
share of Series B Preferred Stock is convertible, at the option of the holder,
at any time into 100 shares of Common Stock (Series B conversion to common stock
results in a price of $.75 per common share). If not previously converted, the
debentures are repayable five years from closing.
Page 8 of 16
PHOTOWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE F -- CONTINGENCIES
Fuji Photo Film Co. Ltd. - The Company is a defendant in a legal
proceeding that was filed by Fuji Photo Film Co., Ltd. with the International
Trade Commission in February 1998. The action was filed against a number of
importers, including the Company's OptiColor, Inc. subsidiary, alleging patent
infringement of U.S. patents held by Fuji on single use cameras through the
importation and resale of recycled cameras. Fuji was seeking an order
prohibiting importation of infringing cameras into the U.S. and prohibiting
further sales of such products which had been imported. After an evidentiary
hearing before an ITC Administrative Law Judge in November 1998, the ITC
Commissioners issued a final order in June 1999 prohibiting the Company and its
subsidiaries from importing and selling imported recycled single use cameras.
The Company appealed the ITC Commissioners' order to the Federal Circuit Court
of Appeals and that Court issued a decision in November 2001, upholding the
order against the Company.
In July 2001, the ITC commenced enforcement and advisory opinion
proceedings against the Company and several other respondents, based on a new
Complaint filed by Fuji with the ITC on June 27, 2001. This Complaint alleges
that the Company is infringing certain claims of six of Fuji's patents on single
use cameras, through the importation and sale of certain newly manufactured and
preloaded cameras. The Complaint requests that the ITC determine that through
these imports and sales the Company is violating the ITC's previous order. On
May 2, 2002, an Administrative Law Judge of the International Trade Commission
issued an initial determination that the Company's preloaded camera infringes
three patents owned by Fuji Photo Film Co., Ltd. for single-use cameras, and
also recommended that the Commission assess a penalty of $1.6 million for such
infringement. The infringement determination is subject to review by the full
Commission. If that determination is upheld, the Commission would then decide
what, if any, penalty to assess. The Company believes it has strong grounds for
challenging both the initial infringement determination and the penalty
recommendation, and intends to pursue such challenges to the extent necessary.
As such, no accrual has been made in the Company's financial statements for this
matter. Any action by the Commission is subject to further appeal to the Federal
Circuit Court of Appeals.
There is risk that Fuji might bring a civil action against OptiColor
and the Company for damages for patent infringement by reason of sales of
cameras which have been found in the ITC proceedings to infringe Fuji patents.
In June 1999, Fuji brought civil action for patent infringement against three
other companies and stated in a press release that it is reviewing its options
with respect to other companies involved in the sale of products that infringe
Fuji patents. If such an action were brought against the Company, the ITC
decision would not be binding in the civil proceeding and would not prevent
OptiColor and the Company from raising and litigating all available defenses,
but the federal circuit's decision affirming the ITC order could have some
persuasive effect.
Massachusetts Institute of Technology, et al vs. Abacus Software, Inc.,
et al; United States District Court for the Eastern District of Texas; No.
501CV344 - On April 25, 2002, a Complaint was filed against the Company and 213
other defendants by The Massachusetts Institute of Technology and Electronics
for Imaging, Inc. claiming infringement on a patent issued in 1985 for a Color
Reproduction System. The Complaint requests injunctive relief, damages adequate
to compensate them for Defendants' infringement of the 4,500,919 patent, their
costs and prejudgment interest on their damages and reasonable attorney fees.
The suit is in its beginning stage and management of the Company
intends to contest the suit vigorously as to the complaint's substantive
allegations. Although the Company believes the claim to be without merit, it is
not possible to predict an outcome at this time or the potential affect on its
business or financial condition. The Company's defense of this claim will cause
it to incur additional legal expenses. The Company does not expect the
litigation to have a significantly harmful impact on its financial condition,
results of operations or liquidity.
Page 9 of 16
PHOTOWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE F -- CONTINGENCIES (Continued)
Sharon Drinkard, et al vs. PhotoWorks, Inc. - A complaint was filed in
March 2000, alleging that the Company had engaged in unfair and deceptive
practices by allegedly misrepresenting that film received from the Company, must
be processed only by the Company and that replacement film is "free". Without
admitting wrongdoing or liability, and for the sole purpose of compromising
disputed claims and avoiding costs and risks of further litigation, PhotoWorks
and the plaintiffs, who represented the Class, agreed to a proposed settlement.
The settlement was approved by the Court on July 16, 2001.
The Company accrued a total of $675,000 related to the future
distribution of 900,000 rolls of film pursuant to terms of the final settlement.
As of March 30, 2002, the Company has distributed approximately $502,000 of film
under the settlement terms. The remainder of the estimated settlement cost of
$203,000 is accrued at March 30, 2002.
Washington Department of Revenue - The Company has an outstanding tax
issue with the Washington State Department of Revenue related to use taxes owed
as a result of advertising materials (including order forms) mailed to
out-of-state customers. The Company is seeking resolution of the issues
involved, primarily related to future periods, as this is an ongoing issue for
the Company for tax reporting periods after January 1, 1997. That is, it is
reasonable that a future routine audit by the Department of Revenue will result
in a further use tax assessment unless the issue can be resolved in a manner
favorable to the Company prior to such audit assessment. In December 2001, the
Company resolved certain amounts related to the outstanding tax issue which
resulted in a reduction of taxes payable which had been previously accrued. The
Company believes its accrual of approximately $325,000 is adequate for possible
assessments related to the outstanding issue.
Although the Company believes it has a reasonable position relative to
the claims listed above, it is not possible to predict an outcome at this time
or the potential affect on its business or financial condition. The Company's
defense of these claims will cause it to incur additional legal expenses. The
Company does not expect the litigation to have a significant impact on its
financial condition, results of operations or liquidity.
The Company is also involved in various routine legal proceedings in
the ordinary course of its business.
Page 10 of 16
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Safe Harbor Statement under the Private Securities Litigation Reform Act of
1995:
- ---------------------------------------------------------------------------
This report contains forward-looking statements that relate to future
events, product or service offerings or the future financial performance of the
Company. In some cases, you can identify forward-looking statements by
terminology such as "may," "will," "should," "expects," "plans," "anticipates,"
"believes," "estimates," "predicts," "potential," or "continue" or the negative
of such terms and other comparable terminology. These statements only reflect
the Company's management's expectations and estimates. Actual events or results
may differ materially from those expressed or implied by such forward-looking
statements due to a number of known and unknown risks and uncertainties. These
risks and uncertainties include the ability to generate cash to fund operating
activities or obtain additional funding; legal matters; system performance
problems due to technical difficulties, system malfunctions, Internet
interruptions or other factors; marketing activities, pricing and other
activities by competitors; economic and industry factors, and other risks
including those described in the Company's Annual Report on Form 10-K and those
described from time to time in the Company's other filings with the Securities
and Exchange Commission, press releases and other communications. Any
forward-looking statements in this report reflect the Company's expectations at
the time of this report only, and the Company disclaims any responsibility to
revise or update any such forward-looking statements except as may be required
by law.
General
- -------
PhotoWorks, Inc. ("PhotoWorks" or the "Company") is a leading online
photo services company dedicated to providing customers with innovative ways to
create and tell the stories of their lives through photos. The Company is a
direct-to-consumer Internet and mail order provider of film and image processing
and online image storage and management services and offers an array of
complementary services and products primarily under the brand names
PhotoWorks(R) and Seattle FilmWorks(R).
To promote its service and products, the Company relies primarily on
direct-marketing and online e-mail programs. The Company uses e-mail to
communicate with its existing online customer base to increase retention,
customer satisfaction and communication with inactive customers and employs a
variety of other direct-marketing techniques to increase business from existing
customers and generate business from inactive customers. In recent years, the
Company has seen a decline in the effectiveness of its customer acquisition
programs and is currently evaluating and testing various marketing programs that
may generate new customers cost effectively.
Management believes its complementary value-added services and
products promote customer loyalty and increase customer demand. The Company
strives to increase both average order size and order frequency by informing its
existing customer base of its integrated array of services and products. The
Company also believes that the online archive is a viable and economic
opportunity to monetize its customer's "personal equity" through film processing
for film-based cameras, and through photo output, in the form of prints,
reprints, and gifts for digital and traditional camera users. The Company's
commitment to expanding its service and product offerings, including
enhancements to its digital and online offerings, is intended to support this
strategy.
Demand for the Company's services and products is generally seasonal,
with the highest volume of activity occurring during the summer months. This
seasonality has generally produced greater net revenues during the last half of
the Company's fiscal year (April through September), with a peak occurring in
the fourth fiscal quarter. However, seasonality of demand may be offset by
changes in the effectiveness of marketing programs, the introduction of new
services and products, actions by competitors, production difficulties and other
factors. Net income is affected by the seasonality of the Company's net revenues
due to the fixed nature of a portion of the Company's operating expenses and the
Company's practice of relatively higher marketing program expenditures prior to
the summer months.
Page 11 of 16
Operating results may fluctuate in the future due to changes in the mix
of sales, marketing and promotional activities, price increases by suppliers,
introductions of new products, research and development requirements, actions by
competitors, conditions in the direct-to-consumer market and the photofinishing
industry in general, national and global economic conditions and other factors.
Results of Operations
- ---------------------
The following table presents information from the Company's
consolidated statements of operations, expressed as a percentage of net revenues
for the periods indicated.
Second Quarter Ended Six Months Ended
--------------------------- ---------------------------
March 30, March 31, March 30, March 31,
2002 2001 2002 2001
============================================================================================================================
Net revenues 100.0% 100.0% 100.0% 100.0%
Cost of goods and services 80.2 86.3 78.3 84.0
----- ----- ----- -----
Gross profit 19.8 13.7 21.7 16.0
Operating expenses:
Marketing expenses 10.2 41.0 9.2 28.1
Research and development 4.4 10.6 4.1 9.1
General and administrative 14.8 16.4 13.2 14.2
----- ----- ----- -----
Total operating expenses 29.4 68.0 26.5 51.4
----- ----- ----- -----
Loss from Operations (9.6) (54.3) (4.8) (35.4)
Total other expense (.3) - (.5) (.5)
----- ----- ----- -----
Loss before income taxes (9.9) (54.3) (5.3) (35.9)
Benefit from income taxes 40.6 - 18.5 -
----- ----- ----- -----
Net income (loss) 30.7% (54.3)% 13.2% (35.9)%
===== ===== ===== =====
Net revenues for the second quarter of fiscal 2002 were $9,269,000 as
compared to net revenues of $12,690,000 in the second quarter of fiscal 2001.
For the six months ended March 30, 2002, net revenues were $20,332,000 compared
to $27,675,000 for the same period of fiscal 2001. The decline in net revenues
was primarily due to lower processing volumes and general market conditions. The
decline in processing volumes was partially offset by an increase in revenue per
roll of approximately 14% in the second quarter of fiscal 2002, and 19% for the
first six months of 2002, as compared to the fiscal 2001 periods. This increase
in revenue per roll is primarily due to changes in marketing promotions, product
offerings and pricing. Management believes processing volumes decreased
primarily due to lower marketing expenditures combined with an overall decline
in the photofinishing industry. Net revenues for the remainder of fiscal 2002
are expected to continue to be lower than fiscal 2001.
Cost of goods and services consist of labor, postage, supplies and
fixed operating costs related to the Company's services and products. Gross
profit in the second quarter of fiscal 2002 increased to 19.8% of net revenues
compared to 13.7% in the second quarter of fiscal 2001. For the first six months
of fiscal 2002, gross profit increased to 21.7% compared to 16.0% for the same
period of fiscal 2001. The increase in gross margin was primarily due to an
overall increase in net revenue per roll, as discussed above, combined with
expense reductions in overhead areas. Gross profit fluctuates due to
seasonality, processing volumes and revenue per roll against certain fixed
operating costs associated with equipment, facilities and other overhead costs
related to services and products.
Total operating expenses in the second quarter of fiscal 2002 decreased
to $2,728,000 compared to $8,637,000 in the second quarter of fiscal 2001. For
the first six months of fiscal 2002, total operating expenses decreased to
$5,394,000 compared to $14,227,000 for the same period of fiscal 2001. The
decrease in operating expenses was primarily due to a significant reduction in
marketing expenses, and lower costs for research and development and general and
administrative expenses. Future periods may reflect increased or decreased
operating costs due the timing and magnitude of marketing and other activities.
Page 12 of 16
Marketing expenses in the second quarter of fiscal 2002 decreased to
$946,000 compared to $5,199,000 in the second quarter of fiscal 2001. For the
first six months of fiscal 2002, marketing expenses decreased to $1,880,000
compared to $7,765,000 for the same period in fiscal 2001. Marketing
expenditures in fiscal 2002 were lower primarily due to the Company's focus on
its existing customers through targeted retention and reactivation programs.
Marketing expenses include expenses associated with customer retention,
reactivation and acquisition, promotion of the Company's products and services,
and testing of new marketing programs to both new and existing customers. The
Company continues to test and evaluate new marketing programs designed to
effectively acquire new customers. Marketing expenditures for fiscal 2002 are
expected to be lower as compared to fiscal 2001.
Research and development expenses decreased to $412,000 for the second
quarter of fiscal 2002 compared to $1,350,000 in the second quarter of fiscal
2001. For the first six months of fiscal 2002, research and development costs
decreased to $828,000 as compared to $2,525,000 for the same period of fiscal
2001. The decrease was due primarily to reductions in staff and overhead costs.
Research and development expenses consist primarily of costs incurred in
developing online photo archiving and photo sharing services, computerized
online image management concepts, other online services, and creating equipment
necessary to provide customers with new digital photographic services and
products. Expenditures for fiscal 2002 are expected to continue to be lower as
compared to fiscal 2001 as the Company concentrates on a more focused approach
to its research and development projects.
General and administrative expenses decreased to $1,370,000 for the
second quarter of fiscal 2002 compared to $2,088,000 for the second quarter of
fiscal 2001. For the six months ended March 30, 2002, general and administrative
expenses decreased to $2,686,000 compared to $3,937,000 for the same period of
fiscal 2001. The decrease was primarily due to reductions in staff and overhead
costs and is consistent with lower sales activity for the Company. General and
administrative expenses consist of costs related to computer operations, human
resource functions, finance, legal, accounting, investor relations and general
corporate activities.
Net loss before income taxes for the second quarter of fiscal 2002 was
$917,000, compared to a net loss before income taxes of $6,896,000 in the second
quarter of fiscal 2001. For the first six months of fiscal 2002, net loss before
income taxes was $1,084,000, compared to a net loss before income taxes of
$9,929,000 for the same period of fiscal 2001.
On March 8, 2002, Congress enacted the "Job Creation and Worker
Assistance Act". This bill provided for an economic stimulus package of
temporary business tax incentives. The Company benefited from a business tax
incentive contained in the bill, which allows a business to extend the net
operating loss carryback period to five years (from two years) for net operating
losses arising in taxable years ending in 2001 and 2002. As a result, the
Company booked a tax benefit of $3,758,000 in the second quarter of fiscal 2002,
which includes tax benefits related to fiscal 2001 and estimated year-to-date
tax benefits for fiscal 2002. The Company expects to receive a tax refund for
its 2001 tax year of approximately $3,592,000 in due course.
Net income for the second quarter of fiscal 2002 was $2,841,000, or
$.17 diluted earnings per share, compared to a net loss of $6,896,000, or loss
of $.42 per share for the second quarter of fiscal 2001. For the first six
months of fiscal 2002, net income was $2,674,000, or diluted earnings per share
of $.16, compared to a net loss of $9,929,000, or loss of $.60 per share for the
first six months of fiscal 2001. Net income for fiscal 2002 periods included
$3,758,000 of tax benefit as discussed above.
Liquidity and Capital Resources
- -------------------------------
As of May 3, 2002, the Company's principal sources of liquidity
included $1,854,000 in cash and cash equivalents. In addition, the Company
expects to receive a tax refund of approximately $3,592,000 (as discussed
above). The Company has a bank note payable with a maturity date of September
30, 2002, subject to certain financial covenants. The Company currently
anticipates that existing funds, bank loan, estimated tax refund and projected
future cash flows from operations will be sufficient to finance its operations,
including capital expenditures and debt service for the foreseeable future.
However, if the Company does not generate sufficient cash from operations to
satisfy its ongoing expenses or does not meet financial covenants related to its
bank loan, the Company may be required to seek other external sources of
financing or refinance its obligations. Possible sources of financing include
the sale of equity securities or additional bank borrowings. There can be no
assurance that the Company will be able to obtain adequate financing in the
future. See Note C of Notes to Consolidated Financial Statements in Part I
above.
Page 13 of 16
PART II -- OTHER INFORMATION
----------------------------
ITEM 1 - LEGAL PROCEEDINGS
For an update concerning the legal proceeding filed by Fuji Photo Film
Co., Ltd. on February 13, 1998, legal proceeding filed by Massachusetts
Institute of Technology on April 25, 2002, and Class Action filed on March 29,
2000, see Note F of Notes to Consolidated Financial Statements in Part I above.
ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY-HOLDERS
On February 5, 2002, the Company held its annual meeting of
shareholders. The shareholders acted on the following matter at the annual
meeting.
The following individual was elected to the Company's Board of
Directors, to hold office for a three-year term and until his respective
successor is duly elected and qualified. The number of votes cast, the number of
votes withheld, and the number of broker non-votes are listed below.
For Withheld Non-votes
---------- -------- ---------
Gary R. Christophersen 18,601,803 357,499 N/A
ITEM 6 - EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits.
---------
(b) Reports on Form 8-K.
--------------------
Form 8-K dated March 15, 2002 - Item 5 - Other Events related
to the Company's tax refund due to the "Job Creation and Work
Assistance Act of 2002".
Page 14 of 16
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
PHOTOWORKS, INC.
DATED: May 13, 2002 s/ Gary R. Christophersen
----------------------------------------------
Gary R. Christophersen
Chief Executive Officer and Chairman
(Principal Executive Officer)
s/ Loran Cashmore Bond
----------------------------------------------
Loran Cashmore Bond
Vice President Administration
Treasurer/Chief Accounting Officer
Page 15 of 16
INDEX TO EXHIBITS
PHOTOWORKS, INC.
Quarterly Report on Form 10-Q
For The Quarter Ended March 30, 2002
Exhibit Description Page No.
- ------- ----------- --------
3.1 Bylaws of the Company, as amended and restated on November 13, 1996
(Incorporated by reference to Exhibit 3.2 filed with the Company's
Annual Report on Form 10-K for the year ended September 28, 1996)
3.2 Articles of Amendment to Articles of Incorporation of PhotoWorks, Inc. dated February 9, 2000
(Incorporated by reference to Exhibit 3.1 filed with the Company's 8-K filed February 16, 2000)
3.3 Articles of Amendment to Articles of Incorporation of PhotoWorks, Inc. dated April 24, 2001
(Incorporated by reference to Exhibit 3.1 filed with the Company's 8-K filed April 27, 2001)
3.4 Articles of Correction to Articles of Incorporation of PhotoWorks, Inc. dated April 25, 2001
(Incorporated by reference to Exhibit 3.2 filed with the Company's 8-K filed April 27, 2001)
3.5 Form of Certificate of Designation Preferences and Rights of Series
RP Preferred Stock (Incorporated by reference to Exhibit 3.4 to the
Company's Annual Report on 10-K
for the year ended September 25, 1999)
4.1 Rights Agreement dated December 16, 1999 between the Registrant and
Chase Mellon Shareholder Services L.L.C., as Rights Agent
(Incorporated by reference to Exhibit 4.1 to the current report on
Form 8-K filed with the Commission on December 17, 1999)
Page 16 of 16