FORM 10-Q
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended: December 25, 1999 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
SEATTLE FILMWORKS, INC
(Former name, former address, and former year, if changed since last report)
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 January 28, 2000, there were issued and outstanding 16,347,890 shares
of common stock, par value $.01 per share.
Index to Exhibits at Page 16
Page 1 of 16
<PAGE>
PHOTOWORKS, INC.
INDEX
Page No.
PART I -- FINANCIAL INFORMATION
Item 1 - Financial Statements 3-9
Consolidated Balance Sheets as of December 25, 1999
and September 25, 1999 3-4
Consolidated Statements of Operations for the first quarter
ended December 25, 1999 and December 26, 1998 5
Consolidated Statements of Cash Flows for the first quarter
ended December 25, 1999 and December 26, 1998 6
Notes to Consolidated Financial Statements 7-9
Item 2 - Management's Discussion and Analysis of
Financial Condition and Results of Operations 10-14
PART II -- OTHER INFORMATION
Item 5 - Other Information 14
Item 6 - Exhibits and Reports on Form 8-K 14
SIGNATURES 15
INDEX TO EXHIBITS 16
Page 2 of 16
<PAGE>
PART I -- FINANCIAL INFORMATION
ITEM 1 - FINANCIAL STATEMENTS
PHOTOWORKS, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands)
<TABLE>
<CAPTION>
(UNAUDITED) (NOTE)
December 25, September 25,
ASSETS 1999 1999
================================================================================================================
<S> <C> <C>
CURRENT ASSETS
Cash and cash equivalents $16,408 $15,001
Securities available-for-sale 3,957 4,513
Accounts receivable, net of allowance for doubtful accounts 923 1,460
Inventories 8,536 6,475
Prepaid income taxes 272 1,439
Deferred income taxes 634 645
Prepaid expenses and other 437 431
------- -------
TOTAL CURRENT ASSETS 31,167 29,964
FURNITURE, FIXTURES, AND EQUIPMENT,
at cost, less accumulated depreciation 9,628 10,424
DEFERRED INCOME TAXES 767 689
DEPOSITS AND OTHER ASSETS 143 23
TOTAL ASSETS $41,705 $41,100
======= =======
</TABLE>
Note: The September 25, 1999 consolidated balance sheet has been derived from
audited consolidated financial statements.
See notes to consolidated financial statements.
Page 3 of 16
<PAGE>
PHOTOWORKS, INC.
CONSOLIDATED BALANCE SHEETS (continued)
(in thousands, except per share and share data)
<TABLE>
<CAPTION>
(UNAUDITED) (NOTE)
December 25, September 25,
LIABILITIES AND SHAREHOLDERS' EQUITY 1999 1999
================================================================================================================
<S> <C> <C>
CURRENT LIABILITIES
Accounts payable $ 6,414 $ 4,599
Accrued compensation 1,375 1,928
Accrued expenses 1,334 1,538
Current portion of capital lease obligations 189 186
Income taxes payable 7 7
------- -------
TOTAL CURRENT LIABILITIES 9,319 8,258
LONG-TERM CAPITAL LEASE OBLIGATIONS, net of current portion 472 521
TOTAL LIABILITIES 9,791 8,779
SHAREHOLDERS' EQUITY
Preferred Stock, $.01 par value,
authorized 2,000,000 shares, none issued
Common Stock, $.01 par value, authorized 101,250,000
shares, issued and outstanding 16,327,640 163 163
Additional paid-in capital 219 154
Retained earnings 31,532 32,004
------- -------
TOTAL SHAREHOLDERS' EQUITY 31,914 32,321
------- -------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $41,705 $41,100
======= =======
</TABLE>
Note: The September 25, 1999 consolidated balance sheet has been derived from
audited consolidated financial statements.
See notes to consolidated financial statements.
Page 4 of 16
<PAGE>
PHOTOWORKS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
(in thousands, except per share and share data)
<TABLE>
<CAPTION>
First Quarter Ended
December 25, December 26,
1999 1998
===============================================================================================================
<S> <C> <C>
Net revenues $20,491 $21,512
Cost of goods and services 13,335 13,666
------- --------
GROSS PROFIT 7,156 7,846
Operating expenses:
Amortized customer acquisition costs - 4,200
Marketing expenses 6,307 4,178
Research and development 465 168
General and administrative 1,352 1,285
------- --------
Total operating expenses 8,124 9,831
------- --------
LOSS FROM OPERATIONS (968) (1,985)
Other income (expense):
Interest income 271 232
Non-operating income (expense), net (25) -
-------- --------
Total other income 246 232
------- --------
LOSS BEFORE INCOME TAXES (722) (1,753)
Benefit for income taxes 250 701
------- --------
NET LOSS $ (472) $ (1,052)
======== =========
Net Loss per Share-Basic $(.03) $(.06)
====== ======
Weighted Average Shares - Basic 16,327,000 16,338,000
========== ==========
</TABLE>
See notes to consolidated financial statements.
Page 5 of 16
<PAGE>
PHOTOWORKS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(in thousands)
<TABLE>
<CAPTION>
First Quarter Ended
December 25, December 26,
1999 1998
===============================================================================================================
<S> <C> <C>
OPERATING ACTIVITIES:
Net loss $ (472) $ (1,052)
Charges to income not affecting cash:
Depreciation and amortization 1,033 1,140
Amortization of capitalized customer
acquisition expenditures - 4,200
Deferred income taxes (67) (1,542)
Net change in receivables, inventories, payables and other 695 (368)
Capitalized promotion expenditures, net - 16
------- -------
NET CASH FROM OPERATING ACTIVITIES 1,189 2,394
INVESTING ACTIVITIES:
Purchase of furniture, fixtures, and equipment (357) (1,405)
Purchases of securities available-for-sale (1,965) (422)
Sales of securities available-for-sale 2,521 1,043
------ -------
NET CASH FROM (USED IN) INVESTING ACTIVITIES 199 (784)
FINANCING ACTIVITIES:
Proceeds from issuance of Common Stock 65 100
Payment on purchase of Common Stock - (1,493)
Payment on capital lease obligations (46) (42)
------ -------
NET CASH FROM (USED IN) FINANCING ACTIVITIES 19 (1,435)
------ -------
INCREASE IN CASH AND CASH EQUIVALENTS 1,407 175
Cash and cash equivalents at beginning of period 15,001 11,780
------ -------
CASH AND CASH EQUIVALENTS
AT END OF PERIOD $16,408 $11,955
======= =======
</TABLE>
See notes to consolidated financial statements.
Page 6 of 16
<PAGE>
PHOTOWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE A -- BASIS OF PRESENTATION
PhotoWorks, Inc. ("PhotoWorks" or the "Company") is a leading
direct-to-consumer Internet and mail order provider of film and image processing
and online image storage and management services. The Company offers an array of
complementary services and products primarily under the brand names Seattle
FilmWorks(R) and PhotoWorks(R). To a lesser extent, the Company provides
services, products, and photofinishing supplies on a wholesale basis to a
variety of commercial customers.
The accompanying unaudited consolidated financial statements have been
prepared in accordance with generally accepted accounting principles for interim
financial information and with the instructions to Form 10-Q and Rule 10-01 of
Regulation S-X. Accordingly, they do not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, all adjustments (consisting
of normal recurring adjustments) considered necessary for fair presentation of
interim results have been included. The Company follows a policy of recording
its interim periods and year-end on a 5 week, 4 week and 4 week basis for
comparability of results and to be consistent with its internal weekly
reporting. Fiscal year 2000 will include 53 weeks and the fourth quarter will
include one extra week as compared to fiscal 1999. Operating results for the
first quarter ended December 25, 1999 are not necessarily indicative of the
results that may be expected for the fiscal year ending September 30, 2000. 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 25, 1999 and the Company's consolidated financial statements and
footnotes thereto also included in the Company's Annual Report
NOTE B -- CUSTOMER ACQUISITION EXPENDITURES
Historically, the Company's principal technique for acquiring new customers
was its Introductory Offer of two rolls of 35mm film for $2.00 or less. Prior to
the first quarter of fiscal 1999, the direct costs of customer acquisition were
deferred as "capitalized customer acquisition expenditures."
During the fourth quarter of fiscal 1998, the overall performance of the
customer acquisition programs showed a decline and management concluded the
lower response rates to customer acquisition programs required an adjustment to
the amount of capitalized costs associated with those programs. Accordingly, the
Company reduced the capitalized customer acquisition cost asset by $613,000 to
its net realizable value in the fourth quarter of fiscal 1998. Effective in the
first quarter of fiscal 1999, the Company began expensing customer acquisition
costs as incurred. The September 26, 1998 deferred capitalized customer
acquisition balance of $16,800,000 was fully amortized during fiscal 1999.
NOTE C -- INVENTORIES
Inventories are stated at the lower of cost (using the first-in, first-out
method) or market. Inventories consist primarily of film and photofinishing
supplies.
NOTE D -- RECLASSIFICATIONS
Certain prior year balances have been reclassified to conform to the
current year's presentation.
NOTE E -- SEGMENT REPORTING
The Company currently operates in one principal business segment.
Page 7 of 16
<PAGE>
PHOTOWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE F -- 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.
Common Stock equivalents consist of stock options. The dilutive effect of stock
options, if any, is excluded from the calculation of basic earnings per share,
but included in the computation of diluted earnings per share.
The following table sets forth the computation of basic and diluted
earnings per share:
<TABLE>
<CAPTION>
First Quarter Ended
December 25, 1999 December 26, 1998
<S> <C> <C>
Numerator for basic and diluted earnings per share:
Net loss $(472,000) $(1,052,000)
========== ============
Denominator:
Denominator for basic earnings per share - weighted-average shares 16,327,000 16,338,000
Effect of dilutive securities:
Stock options - * - *
---------- -----------
Denominator for diluted earnings per share 16,327,000 16,338,000
========== ==========
BASIC LOSS PER SHARE $(.03) $(.06)
===== ======
</TABLE>
* The exercise of stock options is not assured as the result would be
anti-dilutive.
NOTE G -- CONTINGENCIES
The Company was a defendant in a legal proceeding that was filed by Fuji
Photo Film Co., Ltd. with the International Trade Commission on February 13,
1998. The action was filed against a number of importers, including the
Company's OptiColor, Inc. subsidiary, alleging patent infringement of U.S.
patents held by Fuji on single-use cameras through the importation and resale of
recycled cameras. Fuji was seeking an order prohibiting importation of
infringing cameras into the U.S. and prohibiting further sales of such products
which had been imported. Sales of recycled cameras accounted for 4.1% of the
Company's net revenues during fiscal 1999 and 3.8% for fiscal 1998. After an
evidentiary hearing before an ITC Administrative Law Judge in November 1998, the
ITC Commissioners issued a final order in June 1999 prohibiting the Company and
its subsidiaries from importing and selling imported recycled single-use
cameras. The Company has appealed the ITC Commissioners' order to the Federal
Circuit Court of Appeals. A decision on the appeal is not expected until
sometime in the spring of 2000. There is a risk that Fuji might bring a civil
action against OptiColor and the Company for damages caused by the sales of
cameras which have been found in the ITC proceeding to infringe Fuji patents.
Fuji has brought civil action for patent infringement against three other
companies and has stated in a press release that it is reviewing its options
with respect to other companies involved in the sale of products that infringe
its 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 defense, but
may be persuasive against the Company. At this time, the likelihood that such an
action would be brought, and, if brought, its ultimate outcome and impact on the
Company, are not determinable. 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 8 of 16
<PAGE>
PHOTOWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE H -- ADOPTION OF ACCOUNTING STANDARDS
In March 1998, the Accounting Standards Executive Committee issued
Statement of Position 98-1, "Accounting for the Costs of Computer Software
Developed or Obtained for Internal Use" ("SOP 98-1"). SOP 98-1 requires all
costs related to the development of internal use software other than those
incurred during the application development state to be expensed as incurred.
Costs incurred during the application development stage are required to be
capitalized and amortized over the estimated useful life of the software. The
Company adopted SOP 98-1 in the first quarter of fiscal 2000 and does not
believe the adoption of this standard will have a significant impact on the
Company's financial position or operating results.
In April 1998, the American Institute of Certified Public Accountants
issued Statement of Position 98-5, "Reporting on the Costs of Start-Up
Activities" ("SOP 98-5"). SOP 98-5 requires costs of start-up activities and
organization costs be expensed as incurred. The Company adopted SOP 98-5 in the
first quarter of fiscal 2000 and does not believe the adoption of this standard
will have a significant impact on the Company's financial position or operating
results.
NOTE I -- SUBSEQUENT EVENT
On February 1, 2000, the Company changed its corporate name to PhotoWorks,
Inc. In addition, the Company announced that Orca Bay Partners, a private equity
investment firm affiliated with John McCaw (a co-founder of McCaw Cellular) had
agreed to lead a $15 million round of financing which will include a $5 million
investment from Madrona Venture Group. The investment, which is subject to
customary closing conditions and is expected to close by February 14, 2000, will
consist of shares of Series A Preferred Stock with a conversion price of $4.75
and warrants to purchase common stock at an exercise price of $6.00 per share.
The shares of Series A Preferred Stock are convertible into a total of 3,157,895
shares of common stock and the warrants are exercisable to purchase a total of
789,474 shares of common stock. The shares are convertible at any time six
months after the closing date. The investment objective is to take advantage of
PhotoWorks' leading technology, photo processing capabilities and customer base
to capitalize on the expected explosive growth in the digital image management
and Internet photo processing market.* The Company intends to use the proceeds
to expand the Company's marketing presence, enhance its branding campaign,
leverage its Internet presence through additional strategic alliances and add
senior management resources.*
It is expected that a representative from both Orca Bay Partners and
Madrona Venture Group will join the Board of Directors following the closing of
the investment, increasing the number of Board members from five to seven.
Page 9 of 16
<PAGE>
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 including, without
limitation, statements identified by an asterisk (*). These statements 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 possibility of delays in the expansion of
image storage capacity due to delays in deliveries from suppliers or technical
problems; system performance problems due to technical difficulties, system
malfunctions, Internet interruptions or other factors; pricing and other
activities by competitors; and other risks including those described in the
Company's Annual Report on Form 10-K and those described from time to time in
the Company's other filings with the Securities and Exchange Commission, press
releases and other communications. Any forward-looking statements in this report
reflect the Company's expectations at the time of this report only, and the
Company disclaims any responsibility to revise or update any such
forward-looking statements except as may be required by law.
General
PhotoWorks, Inc. ("PhotoWorks" or the "Company") is a leading
direct-to-consumer Internet and mail order provider of film and image processing
and online image storage and management services.* The Company offers an array
of complementary services and products primarily under the brand names Seattle
FilmWorks(R) and PhotoWorks(R). The Company, formerly Seattle FilmWorks, Inc.,
changed its corporate name to PhotoWorks, Inc. on February 1, 2000.
Since 1978, the Company has been an industry leader in the introduction of
value-added photo-related services and products and has continued this tradition
by launching its online image management service, PhotoWorks(R) in April 1999.*
The Company offers prints, slides, digital images and online archiving, all from
the same roll of 35mm film. PhotoWorks can process any brand of 35mm film,
Advanced Photo Systems (24mm) film or 35mm single-use camera. PhotoWorks was
among the first to provide express-mail delivery, cross-referenced data on
prints and negatives, a composite photo index and a convenient reorder system.
To a lesser extent, the Company provides photofinishing services, products and
supplies on a wholesale basis.
Since 1994, the Company has been a pioneer in providing digital-imaging
technologies which enable photofinishing customers to share personal photographs
with friends, family and business associates. Products incorporating these
technologies include (i) Pictures On Disk(TM) a floppy disk containing digital
images from a roll of film; (ii) PhotoWorks(R) software, which can be used to
create digital photograph albums and screen savers; (iii) Pictures On Disk(TM)
on CD, a CD containing digital images from a roll of film; and (iv)
PhotoWorks(R), an online image management system which enables customers to
view, share, order reprints and organize their photos online. Recently, the
Company introduced PhotoWorks(R) Cards, an online service which allows customers
to create personalized greeting cards using their favorite photos. In February
2000, the Company also announced the initial launch of its PhotoWorks(R)
Uploader service for digital cameras, signifying its commitment to the online
business model.* PhotoWorks(R) Uploader provides free downloadable software that
customers can use to extract images from their cameras and upload them to their
password-protected PhotoWorks(R) online archive quickly and easily. Customers
may upload as many images as they wish and archive them at the PhotoWorks(R)
site for free as long as they remain an active customer of PhotoWorks.
PhotoWorks provides Internet image storage and management services for all
photographers regardless of what type of camera they use to take their photos.
In addition, PhotoWorks has targeted for development additional products and
services to enable customers to view and share their photos over the Internet
simply and conveniently.*
Page 10 of 16
<PAGE>
In addition, the Company has partnered with other Internet-related
companies to broaden the marketing of its PhotoWorks(R) services and provide
customers with new and interesting ways to share their photos. The Company has
entered into agreements with Amazon.com Auctions, RealNetworks, VStream, and
most recently, AT&T WorldNet(R) Services. These partnering alliances enable
customers to integrate their digital images into the partnering companies'
services and products.
The Company primarily uses direct-marketing techniques to target selected
consumers, measure customer response and obtain direct customer feedback to
changes in marketing strategies. Over the past several years, the Company has
targeted the growing population of personal computer users in connection with
the introduction of digital-imaging services and products. The Company has
developed comprehensive statistical models for the design and analysis of its
direct-response marketing programs using proprietary customer data compiled over
18 years. The Company also uses other traditional advertising such as radio,
television and print advertising, to promote its new PhotoWorks(R) services and
products.
Net loss for the first quarter of fiscal 2000 was $472,000, or a loss of
$.03 per share, compared to net loss of $1,052,000 or a loss of $.06 per share
for the first quarter of fiscal 1999. However, net loss for the first quarter of
fiscal 1999 included a $4,200,000 charge related to accelerated amortization of
previously deferred customer acquisition costs and therefore, is not directly
comparable to net loss for the first quarter of fiscal 2000. Operating results
will fluctuate in the future due to changes in the mix of sales, intensity and
effectiveness of promotional activities, price increases by suppliers,
introductions of new products, research and development requirements, actions by
competitors, foreign currency exchange rates, conditions in the
direct-to-consumer market and the photofinishing industry in general, national
and global economic conditions and other factors.*
Demand for the Company's photo-related services and products is seasonal,
with the highest volume of photofinishing activity occurring during the summer
months. However, seasonality of demand may be offset by the introduction of new
services and products, changes in the level of effectiveness of customer
acquisition programs, activities by competitors, production difficulties and
other factors. This seasonality, when combined with the general growth of the
Company's photofinishing business, has produced greater photofinishing net
revenues during the last half of the Company's fiscal year (April through
September), with a peak occurring in the fourth fiscal quarter. Net income is
affected by the seasonality of the Company's net revenues due to the fixed
nature of a portion of the Company's operating expenses, seasonal variation in
sales mix and the Company's practice of incurring relatively higher marketing
program expenditures prior to the summer months.
Page 11 of 16
<PAGE>
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.
<TABLE>
<CAPTION>
First Quarter Ended
------------------------------
December 25, December 26,
1999 1998
================================================================================================================
<S> <C> <C>
Net revenues 100.0% 100.0%
Cost of goods and services 65.1 63.5
------ ------
GROSS PROFIT 34.9 36.5
Operating expenses:
Amortized customer acquisition costs - 19.5
Marketing expenses 30.8 19.4
Research and development 2.3 .8
General and administrative 6.5 6.0
------- -------
Total operating expenses 39.6 45.7
------ ------
LOSS FROM OPERATIONS (4.7) (9.2)
Total other income 1.2 1.0
------- --------
LOSS BEFORE INCOME TAXES (3.5) (8.2)
Provision for income taxes 1.2 3.3
------- -------
NET LOSS (2.3)% (4.9)%
======= ========
</TABLE>
Net revenues for the first quarter of fiscal 2000 were $20,491,000 as
compared to net revenues of $21,512,000 in the first quarter of fiscal 1999.
Although net revenues declined in the first quarter of fiscal 2000 compared to
the first quarter of fiscal 1999, the Company's net revenues from its core
Seattle FilmWorks(R) branded photofinishing business increased .6% over net
revenues for the same business in the first quarter of fiscal 1999. The decline
in net revenues was primarily due to a reduction in sales of the Company's
wholesale film primarily attributable to lower retail pricing of major competing
film brands and the Company's curtailment of recycled single-use camera sales
following the June 1999 ruling by the International Trade Commission prohibiting
the importation and sales of recycled single-use cameras.
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 first quarter of fiscal 2000 decreased to 34.9% of net revenues compared to
36.5% in the first quarter of fiscal 1999. The decrease in gross profit was
primarily due to higher production labor, equipment and material costs relating
to enhancements in digital services and products. Fluctuations in gross profit
will occur in future periods due to the seasonal nature of revenues, mix of
product sales, level and nature of marketing activities and other factors.*
Total operating expenses in the first quarter of fiscal 2000 decreased to
39.6% of net revenues compared to 45.7% in the first quarter of fiscal 1999.
First quarter operating expenses in fiscal 1999 included $4,200,000 relating to
the amortization of previously deferred capitalized customer acquisition costs
which were fully amortized during fiscal 1999. Excluding these accelerated
amortization costs, total operating expenses in the first quarter of fiscal 1999
would have been $5,631,000 or 26.2% of net revenues. Comparable fiscal 2000
operating expenses increased over the first quarter of the previous year due to
increased marketing expenses and research and development costs relating to the
Company's online services and products. Each year the Company prepares detailed
plans for its various marketing activities, including the mix between customer
acquisition and other marketing expenses. However, the Company occasionally
changes both the mix and total marketing expenditures between periods to take
advantage of marketing opportunities as they become available. 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
<PAGE>
Marketing expenses include current period expenses associated with customer
acquisition, building brand awareness, testing of new marketing strategies and
marketing to existing customers. Marketing expenses in the first quarter of
fiscal 2000 increased to 30.8% of net revenues compared to 19.4% of net revenues
for the first quarter of fiscal 1999. The increase was primarily due to
increased expenditures made to promote the Company's online services and
products.
Research and development expenses increased to $465,000 for the first
quarter of fiscal 2000 compared to $168,000 in the first quarter of fiscal 1999.
The increase was due primarily to additional personnel hired to support research
and development for PhotoWorks(R) online archiving and photo sharing services.
Research and development expenses consist primarily of costs incurred in
developing digital services and developing computer software products and
equipment necessary to provide customers with new computer-related photographic
services and products.
General and administrative expenses increased to $1,352,000 for the first
quarter of fiscal 2000 compared to $1,285,000 for the first quarter of fiscal
1999. The increase is primarily a result of increased expenditures related to
information systems to support the Company's expanding computer-based and
Internet-related operations. General and administrative expenses consist of
costs related to computer operations, human resource functions, finance, legal,
accounting, investor relations and general corporate activities.
Total other income for the first quarter of fiscal 2000 increased to
$246,000 as compared to $232,000 for the first quarter of fiscal 1999. The
increase was primarily due to higher interest income resulting from the
Company's higher cash balances in the first quarter of fiscal 2000.
Net loss as a percentage of net revenues decreased to a loss of 2.3% in the
first quarter of fiscal 2000 as compared to 4.9% in the first quarter of fiscal
1999. The net loss for fiscal 1999 included $4,200,000 of previously deferred
customer acquisition costs as discussed in operating expenses above.
Liquidity and Capital Resources
As of January 31, 2000, the Company's principal sources of liquidity
included cash and short-term investments of $18,206,000 and an unused revolving
line of credit of $6,000,000. The ratio of current assets to current liabilities
for the Company was 3.3 to 1 at the end of the first quarter of fiscal 2000,
down from the current ratio of 3.6 to 1 at September 25, 1999. This change in
the Company's current ratio is primarily due to decreases in accounts
receivable, prepaid taxes and accrued compensation, partially offset by
increases in inventory and accounts payable. During the first quarter of fiscal
2000, inventory increased by $2,061,000 due primarily to film and material
purchases. In the same period, accounts payable increased by $1,815,000
primarily due to increased inventory purchases.
Although the Company does not currently have any fixed material commitments
with regard to capital expenditures, it currently expects to spend approximately
$5,000,000 during the remainder of fiscal 2000, principally for data storage and
computer network equipment and photofinishing equipment.
The Company currently anticipates that existing funds together with
anticipated cash flow from operations and the Company's available line of credit
of $6,000,000 will be sufficient to finance its operations and planned capital
expenditures and to service its indebtedness for the foreseeable future. In
addition, on February 1, 2000, the Company received commitments from two
entities for a $15,000,000 equity investment in the Company. This investment is
scheduled to close on February 14, 2000, subject to the satisfaction of
customary closing conditions. See Part 5 of Item II below. However, if the
Company does not generate sufficient cash from operations to satisfy its ongoing
expenses, the Company will be required to seek external sources of financing or
to refinance its obligations. Possible sources of additional 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.
Page 13 of 16
<PAGE>
Year 2000
The Company has not yet experienced any material Year 2000 issues arising
from computer software and hardware ("computer systems") which were designed to
handle only a two-digit year, not a four-digit year (e.g. 1999 is seen by the
computer as "99"). The Company has determined that most products the Company
sells in the ordinary course of business do not have issues relating to Year
2000. Software products previously supplied by the Company, in some cases, may
display an incorrect date but will continue to function. At their option,
customers may upgrade to newer versions of the Company's software to correct the
date display. Any Year 2000 issues in products sold by the Company that are
manufactured by another vendor will be referred to that vendor.
In addition to its own computer systems, it is possible that Year 2000
issues of material third-party providers, including, but not limited to,
suppliers, product sponsors, financial institutions, or service providers could
affect the Company and disrupt its business. The Company has not experienced any
such problems and presently believes that the Year 2000 issue will not pose
significant operational problems for the Company.
PART II -- OTHER INFORMATION
ITEM 5 - OTHER INFORMATION
On February 1, 2000, the Company changed its corporate name to PhotoWorks,
Inc. In addition, the Company announced that Orca Bay Partners, a private equity
investment firm affiliated with John McCaw (a co-founder of McCaw Cellular) had
agreed to lead a $15 million round of financing which will include a $5 million
investment from Madrona Venture Group. The investment, which is subject to
customary closing conditions and is expected to close by February 14, 2000, will
consist of shares of Series A Preferred Stock with a conversion price of $4.75
and warrants to purchase common stock at an exercise price of $6.00 per share.
The shares of Series A Preferred Stock are convertible into a total of 3,157,895
shares of common stock and the warrants are exercisable to purchase a total of
789,474 shares of common stock. The shares are convertible at any time six
months after the closing date. The investment objective is to take advantage of
PhotoWorks' leading technology, photo processing capabilities and customer base
to capitalize on the expected explosive growth in the digital image management
and Internet photo processing market.* The Company intends to use the proceeds
to expand the Company's marketing presence, enhance its branding campaign,
leverage its Internet presence through additional strategic alliances and add
senior management resources.*
It is expected that a representative from both Orca Bay Partners and
Madrona Venture Group will join the Board of Directors following the closing of
the investment, increasing the number of Board members to seven. The full text
of the press release is filed as an exhibit to this report and is incorporated
herein by reference.
ITEM 6 - EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits.
3.1 Articles of Amendment to Articles of Incorporation dated January
28, 2000.
27.1 Financial Data Schedule - 1999
27.2 Financial Data Schedule - 2000
99.1 Press Release issued by the Company dated February 1, 2000.
(b) Reports on Form 8-K.
None
Page 14 of 16
<PAGE>
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: February 7, 2000 /s/ Gary R. Christophersen
--------------------------------
Gary R. Christophersen
President/Chief Executive Officer
(Principal Executive Officer)
/s/ Loran Cashmore Bond
--------------------------------
Loran Cashmore Bond
(Principal Financial and Chief
Accounting Officer)
Page 15 of 16
<PAGE>
INDEX TO EXHIBITS
PHOTOWORKS, INC.
Quarterly Report on Form 10-Q
For The Quarter Ended December 25, 1999
<TABLE>
<CAPTION>
Exhibit Description Page No.
- - ------- ----------- --------
<S> <C> <C>
3.1 Articles of Amendment to Articles of Incorporation dated January 28, 2000. SEC Electronic Filing
27.1 Financial Data Schedule - 1999 SEC Electronic Filing
27.2 Financial Data Schedule - 2000 SEC Electronic Filing
99.1 Press Release issued by the Company dated February 1, 2000. SEC Electronic Filing
</TABLE>
Page 16 of 16
ARTICLES OF AMENDMENT
OF
SEATTLE FILMWORKS, INC.
Pursuant to RCW 23B.10.160, the undersigned officer of Seattle FilmWorks,
Inc., a Washington corporation (hereinafter called the "Corporation"), does
hereby submit for filing these articles of amendment:
1. The name of the Corporation is Seattle FilmWorks, Inc.
2. The articles of incorporation of the Corporation are hereby amended by
striking out Article I thereof and by substituting in lieu of said Article the
following new Article:
ARTICLE I.
The name of the Corporation is PhotoWorks, Inc.
3. The amendment of the articles of incorporation was duly adopted on
January 18, 2000, pursuant to the provisions of RCW 23B.10.020, at a meeting of
the board of directors of the Corporation.
4. The amendment was adopted by the board of directors without shareholder
action, and shareholder action was not required.
5. This amendment shall be effective as of February 1, 2000.
EXECUTED this 25th day of January, 2000.
/s/ Mich Kele Earl
Mich Kele Earl, Secretary
Investor Contact:
Lillian Armstrong/David Barnard
[email protected]/[email protected]
Lippert/Heilshorn & Associates
Investor Relations/San Francisco
(415) 433-3777
Keith Lippert 212/838-3777
SEATTLE FILMWORKS UNVEILS EXPANDED ONLINE DIGITAL PHOTO STRATEGY
Company Receives $15 Million Capital Infusion From Syndicate Led
By Orca Bay Partners
PhotoWorks(R) Uploader Technology Serves Digital Camera Users
Company Changes Name To PhotoWorks, Inc.
SEATTLE February 1, 2000 - Seattle FilmWorks, Inc. (Nasdaq NM: FOTO) today
unveiled its expanded online digital photo strategy.
Orca Bay Partners and Madrona Venture Group Investment
Orca Bay Partners, a private equity investment firm affiliated with John McCaw
(a co-founder of McCaw Cellular) will lead a $15 million round of financing
which will include a $5 million investment from Madrona Venture Group. The
investment, which is subject to customary closing conditions and is expected to
close by February 14, 2000, will consist of shares of Series A Preferred Stock
with a conversion price of $4.75 and warrants to purchase common stock at
$6/share. The investment objective is to take advantage of PhotoWorks' leading
technology, photo processing capabilities and customer base to capitalize on the
expected explosive growth in the digital image management, and Internet photo
processing market. The proceeds will be used to expand the Company's marketing
presence, enhance its branding campaign, leverage its Internet presence through
additional strategic alliances and add senior management resources.
It is expected that Ross Chapin from Orca Bay Partners and Paul Goodrich from
Madrona Venture Group will join the Board of Directors following the closing of
the investment, increasing the number of Board members to seven.
PhotoWorks(R) Uploader
The Company also announced the initial launch of PhotoWorks(R) Uploader services
for digital cameras, signifying its commitment to the online business model.
PhotoWorks(R) Uploader provides free downloadable software that customers can
use to extract images from their cameras and upload them to their
password-protected PhotoWorks(R) online archive quickly and easily. Customers
may upload as many images as they wish and archive them at the PhotoWorks(R)
site for free as long as they remain an active customer of PhotoWorks.
Company Name Change
The Company further announced it has changed it name to PhotoWorks, Inc. to
better reflect its corporate mission and enhanced digital strategy. The Nasdaq
NM symbol remains the same, FOTO. On February 2, PhotoWorks will host a
reception for all Photo Marketing Association Conference attendees to showcase
the Company's expanded digital services.
In commenting on his firm's capital infusion, Ross K. Chapin, a principal at
Orca Bay Partners, said, "The Internet provides an entirely new way to view,
store and share images. We believe PhotoWorks' integration of its proven, full
service film processing unit with its leading web-based image management and
storage technology creates an Internet company with the largest customer base in
this space as well as significant growth opportunities."
-- MORE --
<PAGE>
In commenting on these current events, Gary Christophersen, PhotoWorks President
and CEO, said, "We anticipate the consumer appetite for online photos is set to
explode later this year. The capital infusion led by Orca Bay Partners provides
a war chest to take advantage of this significant market opportunity. With our
PhotoWorks(R) Uploader digital camera service we believe we offer the finest
value proposition for photographers regardless of their choice of camera. Our
goal is to make PhotoWorks(R) online the premier site for digital and film-based
camera users to store and share their photos. The PhotoWorks name change
signifies our dedication to online image management for everybody, regardless of
their image source."
About Orca Bay Partners
Orca Bay Partners is a private equity investment firm providing equity capital
for transactions ranging from recapitalizations of mature businesses to growth
capital for emerging companies. Founded in 1998, and based in Seattle,
Washington, Orca Bay Partners makes investments in companies that are uniquely
positioned to benefit from growing or changing markets.
About Madrona Venture Group
Madrona Venture Group (http://www.madronagroup.com) is a regional early-stage
investor that focuses on the Internet economy in the Pacific Northwest. The firm
recently closed a $250 million venture fund. Madrona's past investments include
Amazon.com, Homegrocer.com, Nordstrom.com, Improvenet.com and Onvia.com. Paul
Goodrich, one of Madrona's managing partners, also serves on the board of
directors of GreaterGood.com, Senada.com, Giftpoint.com and DailyShopper.com.
About PhotoWorks(R)
PhotoWorks (formerly Seattle FilmWorks) is a photofinishing and online image
management company and a leader in providing digital images over the Internet.
PhotoWorks(R) online is an increasingly popular way for people to share photos
over the Internet. With more than 75 million images archived, PhotoWorks(R)
online is the largest online consumer photo site on the Web. The PhotoWorks(R)
online service includes free scanning of every photograph (with normal film
processing fees), Web posting to a private site and lifetime archiving, as long
as the consumer remains an active customer of PhotoWorks. The online archive is
expanding the way people can enjoy their photos by enabling the growing
popularity of photo e-mails and the ability to order photographic reprints
online without the need for negatives. To get started, customers can request a
free film processing starter kit at www.photoworks.com.
Based in Seattle, Washington, PhotoWorks (Nasdaq NM: FOTO) was founded in 1978.
Safe Harbor Statement under the Private Securities Litigation Reform Act of
1995: Statements in this news release concerning the ability to scan and store a
growing volume of digital images or every photo processed by the Company,
leadership in Internet-based photo services and consumer photo storage, expected
explosive growth in digital image management and Internet photo processing
market, growing popularity of photo e-mails, ease of use and any other statement
which may be construed as a prediction of future capabilities, performance or
events are forward-looking statements, the occurrence of which are subject to a
number of known and unknown risks and uncertainties which might cause actual
performance to differ materially from those expressed or implied by such
statements. These risks and uncertainties include the possibility of delays in
the expansion of image storage capacity due to delays in deliveries from
suppliers or technical problems; system performance problems due to technical
difficulties, system malfunctions, Internet interruptions or other factors;
pricing and other activities by competitors; and other risks including those
described in the Company's Annual Report on Form 10-K and those described from
time to time in the Company's other filings with the Securities and Exchange
Commission, press releases and other communications.
All companies and product names are trademarks of their respective owners. For
more information, e-mail [email protected] or call 800.PHOTOWORKS
(800.746.8696).
Copyright (C) 2000 PhotoWorks, Inc.
########
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