FORM 10-Q
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
QUARTERLY REPORT UNDER SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended: June 29, 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, including area code: (206) 281-1390
--------------
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to the
filing requirements for the past 90 days.
Yes |X| No |_|
As of August 9, 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 June 29, 2002
and September 29, 2001 3-4
Consolidated Statements of Operations for the third quarter
and nine months ended June 29, 2002 and June 30, 2001 5
Consolidated Statements of Cash Flows for the nine months
ended June 29, 2002 and June 30, 2001 6
Notes to Consolidated Financial Statements 7-10
Item 2 - Management's Discussion and Analysis of
Financial Condition and Results of Operations 11-14
PART II -- OTHER INFORMATION
Item 1 - Legal Proceedings 14
Item 6 - Exhibits and Reports on Form 8-K 14
SIGNATURES 15
INDEX TO EXHIBITS 16
Page 2 of 16
PART I -- FINANCIAL INFORMATION
ITEM 1 - FINANCIAL STATEMENTS
PHOTOWORKS, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands)
(UNAUDITED) (NOTE)
June 29, September 29,
ASSETS 2002 2001
===============================================================================================
CURRENT ASSETS
Cash and cash equivalents $ 1,775 $ 2,861
Income tax receivable (Note D) 4,242 --
Accounts receivable, net of allowance for doubtful accounts 630 406
Inventories 1,389 2,203
Prepaid promotional expenditures 121 79
Prepaid expenses and other 222 303
------- -------
TOTAL CURRENT ASSETS 8,379 5,852
FURNITURE, FIXTURES, AND EQUIPMENT,
at cost, less accumulated depreciation 3,481 6,529
TOTAL ASSETS $11,860 $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)
June 29, September 29,
LIABILITIES AND SHAREHOLDERS' EQUITY 2002 2001
===========================================================================================
CURRENT LIABILITIES
Bank note payable $ 825 $ 2,350
Accounts payable 2,222 2,872
Accrued compensation 1,205 1,141
Accrued lawsuit settlement 30 705
Other accrued expenses 1,634 1,438
Note payable - other -- 38
Current portion of capital lease obligations 141 198
-------- --------
TOTAL CURRENT LIABILITIES 6,057 8,742
Capital lease obligation, net of current portion -- 94
Subordinated convertible debentures 2,500 2,500
-------- --------
TOTAL LIABILITIES 8,557 11,336
SHAREHOLDERS' EQUITY
Preferred Stock, $.01 par value, authorized 2,000,000 shares,
issued and outstanding 15,000 -- --
Common Stock, $.01 par value, authorized 101,250,000
shares, issued and outstanding 16,655,285 166 167
Additional paid-in capital 15,816 15,790
Retained earnings (12,679) (14,912)
-------- --------
TOTAL SHAREHOLDERS' EQUITY 3,303 1,045
-------- --------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 11,860 $ 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)
Third Quarter Ended Nine Months Ended
------------------- -----------------
June 29, June 30, June 29, June 30,
2002 2001 2002 2001
==========================================================================================================
Net revenues $ 10,514 $ 14,365 $ 30,846 $ 42,040
Cost of goods and services 7,657 10,926 23,582 34,171
------------ ------------ ------------ ------------
Gross Profit 2,857 3,439 7,264 7,869
Operating expenses:
Marketing 1,779 2,570 3,659 10,335
Research and development 400 895 1,228 3,420
General and administrative 1,571 2,165 4,257 6,102
Lawsuit settlement -- 759 -- 1,094
------------ ------------ ------------ ------------
Total operating expenses 3,750 6,389 9,144 20,951
------------ ------------ ------------ ------------
Loss from Operations (893) (2,950) (1,880) (13,082)
Other income (expense):
Interest expense (67) (100) (235) (388)
Interest income 9 -- 27 45
Non-operating income, net 26 4 79 450
------------ ------------ ------------ ------------
Total other income (expense) (32) (96) (129) 107
------------ ------------ ------------ ------------
Loss before income taxes (925) (3,046) (2,009) (12,975)
Benefit from income taxes (Note D) 484 -- 4,242 --
------------ ------------ ------------ ------------
Net income (loss) $ (441) $ (3,046) $ 2,233 $ (12,975)
============ ============ ============ ============
Basic earnings (loss) per share $ (.03) $ (.18) $ .13 $ (.78)
============ ============ ============ ============
Earnings (loss) per share - diluted $ (.03) $ (.18) $ .13 $ (.78)
============ ============ ============ ============
Weighted average shares basic 16,655,000 16,612,000 16,655,000 16,547,000
============ ============ ============ ============
Weight average shares and diluted
equivalents outstanding 16,655,000 16,612,000 17,060,000 16,547,000
============ ============ ============ ============
See notes to consolidated financial statements.
Page 5 of 16
PHOTOWORKS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(in thousands)
Nine Months Ended
----------------------
June 29, June 30,
2002 2001
========================================================================================
OPERATING ACTIVITIES:
Net income (loss) $ 2,233 $(12,975)
Adjustments to income not affecting cash:
Depreciation and amortization 2,999 5,764
Deferred sales 416 4
Loss on disposal of assets -- 236
Accrued lawsuit settlement (675) --
Income tax receivable (4,242) --
Capitalized promotional expenditures, net (42) (464)
Net change in receivables, inventories, payables and other (110) 1,778
-------- --------
NET CASH FROM (USED IN) OPERATING ACTIVITIES 579 (5,657)
INVESTING ACTIVITIES:
Purchase of furniture, fixtures, and equipment (17) (177)
Proceeds from sales of furniture, fixtures and equipment 66 --
Sales of securities available-for-sale -- 1,022
-------- --------
NET CASH FROM INVESTING ACTIVITIES 49 845
FINANCING ACTIVITIES:
Payment on bank note payable (1,525) --
Payment on capital lease obligation (151) (186)
Payment on note payable - other (38) --
Proceeds from issuance of Convertible Debentures -- 2,500
Drawing on note payable -- 2,350
Proceeds from issuance of Common Stock -- 124
-------- --------
NET CASH FROM (USED IN) FINANCING ACTIVITIES (1,714) 4,788
-------- --------
DECREASE IN CASH AND CASH EQUIVALENTS (1,086) (24)
Cash and cash equivalents at beginning of period 2,861 1,629
-------- --------
CASH AND CASH EQUIVALENTS
AT END OF PERIOD $ 1,775 $ 1,605
======== ========
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). 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 third quarter ended June 29, 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
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:
Third Quarter Ended Nine Months Ended
-------------------------------- ------------------------------
June 29, 2002 June 30, 2001 June 29, 2002 June 30, 2001
================================================================================================================================
Numerator for basic and diluted earnings per share:
Net income (loss) $(441,000) $(3,046,000) $2,233,000 $(12,975,000)
========= =========== ========== ============
Denominator:
Denominator for basic earnings
per share - weighted-average shares 16,655,000 16,612,000 16,655,000 16,547,000
Net effect of dilutive stock options -- -- 405,000 --
---------- ---------- ---------- ----------
Denominator for diluted earnings per share 16,655,000 16,612,000 17,060,000 16,547,000
========== =========== ========== ==========
Basic earnings (loss) per share $(.03) $(.18) $.13 $(.78)
===== ===== ==== =====
Diluted earnings (loss) per share $(.03) $(.18) $.13 $(.78)
===== ===== ==== =====
Page 7 of 16
PHOTOWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE C -- LIQUIDITY
For the most recent quarter ended June 29, 2002, the Company incurred a
net loss of $441,000. Fiscal year to date net income was $2,233,000 and overall
cash declined by $1,086,000. As more fully described in Note D, Congress
recently enacted changes in federal income tax laws that allows 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 $4,200,000.
In July 2002, the Company received a tax refund of $3,864,000 for its 2001 tax
loss.
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.
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 three quarters of fiscal 2002.
Management believes that under its current operational and financing
plans, current cash balances, combined with projected cash flows from
operations, including the tax benefits, 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 allowed the Company to
carryback all of its 2001 tax loss and also allows the carryback of any tax
losses it incurs in fiscal 2002 up to approximately $5,700,000.
In July, the Company received a refund of $3,864,000 for its 2001 tax
loss. Through the first nine months of fiscal 2002, the Company has a net tax
operating loss of approximately $1,111,000, for which the company has recorded
an additional $378,000 as income tax receivable.
Utilization of the remaining deferred tax assets of is dependent on future
profits that are not assured. As a result, deferred tax assets of $12,926,000
are 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.
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.
Page 8 of 16
PHOTOWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE F -- CONTINGENCIES (Continued)
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 which is expected on or about August 14, 2002. 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 and has
begun 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.
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. The Company believes
its accrual of approximately $325,000 is adequate for possible assessments
related to the outstanding issue.
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.
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 June
29, 2002, the Company has distributed approximately $675,000 of film under the
settlement terms. Settlement costs of $30,000 are accrued at June 29, 2002 for
estimated amounts outstanding.
The Company is also involved in various routine legal proceedings in the
ordinary course of its business.
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.
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; sales or other taxes;
governmental and other state regulations; 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). The Company believes that the online
archive is a viable and economic opportunity to monetize its customers'
"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.
The Company has retail operations in the Pacific Northwest to provide a
"drop off" alternative to mail order delivery. During the fiscal year, the
Company has closed 8 of its under performing retail stores and has plans to
close certain other retail locations during the remainder of fiscal year 2002.
To a lesser extent, the Company provides photo related products and
services on a wholesale basis. The Company anticipates phasing out its wholesale
business during the fourth quarter of fiscal year 2002. Net revenues
attributable to wholesale products and services in the first nine month of
fiscal 2002 were approximately 6% of the Company's total net revenues.
To promote its services 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 and
customer satisfaction and employs a variety of other direct-marketing techniques
to increase business from existing customers and generate business from inactive
customers. 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 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.
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
Page 11 of 16
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.
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.
Third Quarter Ended Nine Months Ended
------------------- -----------------
June 29, June 30, June 29, June 30,
2002 2001 2002 2001
===============================================================================
Net revenues 100.0% 100.0% 100.0% 100.0%
Cost of goods and services 72.8 76.1 76.5 81.3
------ ------ ------ ------
Gross profit 27.2 23.9 23.5 18.7
Operating expenses:
Marketing 16.9 17.9 11.8 24.6
Research and development 3.8 6.2 4.0 8.1
General and administrative 15.0 15.0 13.8 14.5
Lawsuit settlement -- 5.3 -- 2.6
------ ------ ------ ------
Total operating expenses 35.7 44.4 29.6 49.8
------ ------ ------ ------
Loss from Operations (8.5) (20.5) (6.1) (31.1)
Total other income (expense) (.3) (.7) (.4) .2
------ ------ ------ ------
Loss before income taxes (8.8) (21.2) (6.5) (30.9)
Benefit from income taxes 4.6 -- 13.7 --
------ ------ ------ ------
Net income (loss) (4.2)% (21.2)% 7.2 (30.9)%
====== ====== ====== ======
Net revenues for the third quarter of fiscal 2002 were $10,514,000 as
compared to net revenues of $14,365,000 in the third quarter of fiscal 2001. For
the nine months ended June 29, 2002, net revenues were $30,846,000 compared to
$42,040,000 for the same period of fiscal 2001. The decline in net revenues is
primarily due to lower processing volumes. The decline in net revenues was
partially offset by an increase in revenue per roll of approximately 8% in the
third quarter of fiscal 2002, and 14% for the first nine months of fiscal 2002,
as compared to the fiscal 2001 periods. 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 consists of labor, materials, shipping costs,
and fixed operating costs related to the Company's services and products. Gross
profit in the third quarter of fiscal 2002 increased to 27.2% of net revenues
compared to 23.9% in the third quarter of fiscal 2001. For the first nine months
of fiscal 2002, gross profit increased to 23.5% compared to 18.7% for the same
period of fiscal 2001. The increase in gross margin was primarily due to an
overall increase in the revenue per roll, as discussed above, combined with
reductions in overhead costs. Gross profit fluctuates due to the seasonality of
revenues, (i.e. fluctuation in 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 third quarter of fiscal 2002 decreased to
$3,750,000 compared to $6,389,000 in the third quarter of fiscal 2001. For the
first nine months of fiscal 2002, total operating expenses decreased to
$9,144,000 compared to $20,951,000 for the same period of fiscal 2001. The
decrease in operating expenses was primarily due to reductions in marketing,
research and development, information technology, general and administrative
costs, as well as costs associated with settlement of a class action lawsuit.
Future periods may reflect increased or decreased operating costs due the timing
and magnitude of marketing activities and research and development activities.
Page 12 of 16
Marketing expenses in the third quarter of fiscal 2002 decreased to
$1,779,000 compared to $2,570,000 in the third quarter of fiscal 2001. For the
first nine months of fiscal 2002, marketing expenses decreased to $3,659,000
compared to $10,335,000 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 design 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 $400,000 for the third
quarter of fiscal 2002 compared to $895,000 in the third quarter of fiscal 2001.
For the first nine months of fiscal 2002, research and development costs
decreased to $1,228,000 as compared to $3,420,000 for the same period of fiscal
2001. The decrease was primarily due to reductions in staff and related 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 $1,571,000 for the third
quarter of fiscal 2002 compared to $2,165,000 for the third quarter of fiscal
2001. For the nine months ended June 29, 2002, general and administrative
expenses decreased to $4,257,000 compared to $6,102,000 for the same period of
fiscal 2001. The decrease is due primarily to staff reductions and an overall
decrease in legal fees. General and administrative expenses consist of costs
related to computer operations, human resource functions, finance, legal,
accounting, investor relations and general corporate activities.
Lawsuit settlement expenses in fiscal 2001 relate to the settlement of a
class action lawsuit (See Note F - Contingencies).
Other expense for the first nine months of fiscal 2002 consists primarily
of interest expense. Other income for fiscal 2001 was primarily due to a
reduction in a payable due to a renegotiation of amounts charged for certain
advertising services in fiscal year 2000.
Net loss before income taxes for the third quarter of fiscal 2002 was
$925,000, compared to a net loss before income taxes of $3,046,000 in the third
quarter of fiscal 2001. For the first nine months of fiscal 2002, net loss
before income taxes was $2,009,000, compared to a net loss before income taxes
of $12,975,000 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 recorded a tax
receivable of $3,864,000 for tax benefits related to fiscal 2001 and a further
tax receivable for estimated year-to-date tax benefits of $378,000 for fiscal
2002. The Company received the tax refund of $3,864,000 for its 2001 tax year in
July 2002.
Net loss for the third quarter of fiscal 2002 was $441,000, or a loss of
$.03 per share, compared to a net loss of $3,046,000, or loss of $.18 per share
for the third quarter of fiscal 2001. For the first nine months of fiscal 2002,
net income was $2,233,000, or $.13 per share, compared to a net loss of
$12,975,000, or loss of $.78 per share for the first nine months of fiscal 2001.
Net income for fiscal 2002 periods includes the tax benefits as discussed above.
Liquidity and Capital Resources
During the first nine months of fiscal 2002, the Company had positive cash
flow from operations of approximately $579,000 million. Cash and cash
equivalents as of June 29, 2002 decreased to $1,775,000 compared to $2,861,000
as of September 29, 2001 primarily due to principal payments on the bank note
payable. The Company's current ratio as of June 29, 2002 has improved to 1.4
compared to the September 29, 2001 current ratio of .7.
Page 13 of 16
As of August 9, 2002, the Company's principal source of liquidity is
$4,800,000 in cash. The Company has paid its bank note payable down to $25,000.
The Company anticipates spending approximately $600,000 for capital expenditures
during the remainder of fiscal 2002 primarily for equipment to support its
digital printing services.
Tax benefits available to the Company from the Job Creation and Worker
Assistance Act enacted by Congress in March 2002 allow the Company to carryback
tax year 2002 tax losses for five years. Management anticipates making certain
expenditures in the fourth quarter of fiscal 2002 to maximize tax benefits
available to the Company.
Management believes that, under its current operational plans, current
cash balances, and estimated future cash flows, the Company will have sufficient
funds for operations through at least the next twelve months. However, the
Company's inability to generate cash flow from operations would have a material
adverse impact on the Company's financial position and liquidity which may
require the Company to further reduce its expenditures, or seek additional
financing to enable it to continue operations. There can be no assurance that
the Company will be able to obtain adequate financing in the future.
PART II -- OTHER INFORMATION
ITEM 1 - LEGAL PROCEEDINGS
For an update concerning the legal proceeding filed by Fuji Photo Film
Co., Ltd. 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 6 - EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits.
10.1 Fourth Amendment to Loan & Security Agreement with Comerica
Bank dated April 25, 2002.
99.1 Financial Statement Certification
(b) Reports on Form 8-K.
None
Page 14 of 16
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
PHOTOWORKS, INC.
DATED: August 12, 2002 /s/ Gary R. Christophersen
---------------------------------
Gary R. Christophersen
President/Chief Executive Officer
(Principal Executive Officer)
/s/ Loran Cashmore Bond
---------------------------------
Loran Cashmore Bond
Chief Accounting Officer
Page 15 of 16
INDEX TO EXHIBITS
PHOTOWORKS, INC.
Quarterly Report on Form 10-Q
For The Quarter Ended June 29, 2002
Exhibit Description Page No.
- ------- ----------- --------
3.1 Third Amended and Restated Articles of Incorporation dated
January 27, 1998. (Incorporated by reference to Form
10-K/A for the year ended September 25, 1999, filed
January 14, 2000.)
3.2 Articles of Amendment to Articles of Incorporation dated
January 25, 2000. (Incorporated by reference from Form
10-Q for the quarter ended December 25, 1999.)
3.3 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)
3.4 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)
3.5 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)
3.6 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)
3.7 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)
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)
10.1 Fourth Amendment to Loan & Security Agreement with
Comerica Bank dated April 25, 2002.
99.1 Financial statement certification
Page 16 of 16