AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON NOVEMBER 14, 2001
REGISTRATION NO. 333-50576
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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
AMENDMENT NO. 4 TO
FORM S-1
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
------------------------
ARTISTDIRECT, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 7389 95-4760230
(STATE OR OTHER JURISDICTION OF (PRIMARY STANDARD INDUSTRIAL (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) CLASSIFICATION NUMBER) IDENTIFICATION NO.)
------------------------
5670 WILSHIRE BOULEVARD, SUITE 200
LOS ANGELES, CALIFORNIA 90036
(323) 634-4000
(ADDRESS, INCLUDING ZIP CODE AND TELEPHONE NUMBER, INCLUDING AREA CODE, OF
REGISTRANT'S PRINCIPAL EXECUTIVE OFFICES)
------------------------
JAMES B. CARROLL
CHIEF FINANCIAL OFFICER
5670 WILSHIRE BOULEVARD, SUITE 200
LOS ANGELES, CALIFORNIA 90036
(323) 634-4000
(NAME, ADDRESS, INCLUDING ZIP CODE AND TELEPHONE NUMBER, INCLUDING AREA CODE, OF
AGENT FOR SERVICE)
------------------------
COPIES TO:
GREG T. WILLIAMS, ESQ.
JOSEPH H. CHI, ESQ.
PARKER A. SCHWEICH, ESQ.
BROBECK, PHLEGER & HARRISON LLP
38 TECHNOLOGY DRIVE
IRVINE, CALIFORNIA 92618
(949) 790-6300
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APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC:
As soon as practicable after this Registration Statement becomes effective.
------------------------
If any of the securities being registered on this form are to be offered on
a delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933, check the following box. [X]
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, please check the following box
and list the Securities Act registration statement number of the earlier
effective registration statement for the same offering. [ ]
If this Form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [ ]
If this Form is a post-effective amendment filed pursuant to Rule 462(d)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [ ]
If delivery of the prospectus is expected to be made pursuant to Rule 434
under the Securities Act, please check the following box. [ ]
------------------------
CALCULATION OF REGISTRATION FEE
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PROPOSED PROPOSED
MAXIMUM MAXIMUM AMOUNT OF
TITLE OF EACH CLASS OF AMOUNT TO BE OFFERING PRICE AGGREGATE REGISTRATION
SECURITIES TO BE REGISTERED REGISTERED(1) PER SHARE OFFERING PRICE FEE
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Common stock, $0.01 par value............... 58,572 $40.00(2) $2,223,971(3) $556.00(4)
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Common stock, $0.01 par value, issuable upon
exercise of options pursuant to the
Registrant's 1999 Employee Stock Option
Plan...................................... 395,649 $140.00(5) $16,999,832(6) $4,250.00(7)
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Options to purchase common stock, $0.01 par
value, issued pursuant to the Registrant's
1999 Employee Stock Option Plan........... 395,649(8) $28.00(9) $3,399,966(10) $850.00(11)
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Common stock, $0.01 par value, issuable upon
exercise of options pursuant to the
Registrant's 1999 Artist Stock Option
Plan...................................... 222,375 $139.28(12) $13,311,203(6) $3,328.00(13)
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Options to purchase common stock, $0.01 par
value, issued pursuant to the Registrant's
1999 Artist Stock Option Plan............. 222,375(8) $27.86(14) $2,662,241(15) $665.60(11)
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Common Stock, $0.01 par value, issuable upon
exercise of options pursuant to the
Registrant's 1999 Artist and Artist
Adviser Stock Option Plan................. 119,336 $139.28(16) $8,001,216(6) $2,000.00(13)
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Options to purchase common stock, $0.01 par
value, issued pursuant to the Registrant's
1999 Artist and Artist Advisor Stock
Option Plan............................... 119,336(8) $27.86(17) $1,600,243(18) $400.00(11)
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Total....................................... $12,049.60(19)
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(1) All share numbers have been adjusted to reflect a 1-for-10 reverse split of
the Registrant's Common Stock in July 2001.
(2) Highest price, excluding interest, to be payable per share in connection
with the rescission offer covered by this registration statement. The price
per share will range from $12.40 to $40.00, depending on the price
originally paid by the offeree and excluding interest.
(3) Aggregate purchase price, excluding interest, estimated to be payable if the
rescission offer covered by this registration statement is accepted in full
with respect to the shares of common stock.
(4) Calculated pursuant to Rule 457(j) on the basis of the amount at which such
securities were sold.
(5) Highest exercise price of the options issued under the Registrant's 1999
Employee Stock Option Plan which are subject to the rescission offer covered
by this registration statement. The price per share ranges from $12.40 to
$140.00.
(6) Aggregate purchase price estimated to be payable if the rescission offer
covered by this registration statement is rejected in full as to the options
issued under the Registrant's 1999 Employee Stock Option Plan and all shares
of common stock underlying such options are exercised.
(7) Calculated pursuant to Rule 457(h)(1) on the basis of the exercise price at
which such securities may be purchased.
(8) Reflects the number of underlying shares for which the options are
exercisable for. The options are subject to the rescission offer.
(9) Highest price, excluding interest, to be payable per share underlying the
unexercised options issued pursuant to the Registrant's 1999 Employee Stock
Option Plan which are subject to the rescission offer. The price per share
will range from $2.48 to $28.00, depending on the exercise price of the
related option and excluding interest.
(10)Aggregate purchase price, excluding interest, estimated to be payable if the
rescission offer covered by this registration statement is accepted in full
as to the options issued under the Registrant's 1999 Employee Stock Option
Plan.
(11)Calculated pursuant to Rule 457(j) on the basis of the aggregate proposed
re-purchase price, excluding interest.
(12)Highest exercise price of the options issued under the Registrant's 1999
Artist Stock Option Plan which are subject to the rescission offer covered
by this registration statement. The price per share ranges from $40.00 to
$139.28.
(13)Calculated pursuant to Rule 457(i) on the basis of the exercise price at
which such securities may be purchased.
(14)Highest price, excluding interest, to be payable per share underlying the
unexercised options issued pursuant to the Registrant's 1999 Artist Stock
Option Plan which are subject to the rescission offer. The price per share
will range from $8.00 to $27.856, depending on the exercise price of the
related option and excluding interest.
(15)Aggregate purchase price, excluding interest, estimated to be payable if the
rescission offer covered by this registration statement is accepted in full
as to the options issued under the Registrant's 1999 Artist Stock Option
Plan.
(16)Highest exercise price of the options issued pursuant to the Registrant's
1999 Artist and Artist Advisor Stock Option Plan which are subject to the
rescission offer covered by this registration statement. The price per share
ranges from $36.00 to $139.28.
(17)Highest price, excluding interest, to be payable per share underlying the
unexercised options issued pursuant to the Registrant's 1999 Artist and
Artist Advisor Stock Option Plan which are subject to the rescission offer.
The price per share will range from $7.20 to $27.856, depending on the
exercise price of the related option and excluding interest.
(18)Aggregate purchase price, excluding interest, estimated to be payable if the
rescission offer covered by this registration statement is accepted in full
as to the options issued under the Registrant's 1999 Artist and Artist
Advisor Stock Option Plan.
(19)$10,134.06 was previously paid. The Registrant is paying the remaining
balance of $1,915.54 with the filing of this registration statement.
THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL
FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION
STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(a) OF
THE SECURITIES ACT OF 1933 OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME
EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID SECTION 8(a),
MAY DETERMINE.
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PROSPECTUS NOVEMBER 14, 2001
[ARTISTDIRECT LOGO]
RESCISSION OFFER
795,932 SHARES OF COMMON STOCK
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SYMBOL & MARKET:
- ARTD/The Nasdaq National Market
- On November 13, 2001, the last reported sale price for our common stock
on The Nasdaq National Market was $6.07 per share.
THE RESCISSION OFFER:
- We are offering to repurchase 58,572 shares of our common stock from
employees and artists and their managers and advisors who purchased those
shares upon exercise of options granted to them (regardless of whether
the shares have been subsequently sold by such persons).
- We are also offering to repurchase vested and unvested unexercised
options to purchase up to 737,360 shares of our common stock from
employees and artists and their managers and advisors who have not
exercised options granted to them (regardless of whether the options have
expired). We are also registering these shares so that if you decide to
reject the rescission offer and later exercise your options, the shares
issued will be registered under the 1933 Securities Act, as amended.
- The repurchase price for the shares subject to our rescission offer
ranges from $12.40 to $40.00 per share, depending on the price paid by
those offerees who exercised options before the expiration of the
rescission offer, plus interest, from the date of purchase of the shares
until the rescission offer expires, at the interest rate set forth below
(less any amounts received if an offeree has already sold the shares).
- The repurchase price for the vested and unvested unexercised options
subject to our rescission offer will be at 20% of the option exercise
price multiplied by the number of shares subject to such options, plus
interest, from the date of the option grant until the rescission offer
expires, at the interest rate set forth below. The options subject to the
rescission offer have exercise prices ranging from $12.40 to $140.00 per
share. Accordingly, the repurchase price for the vested and unvested
unexercised options ranges from $2.48 to $28.00 per share, which is 20%
of the option exercise price, plus interest.
- Depending on the state in which the shares were purchased by you or the
options were granted to you, you will be entitled to receive the interest
at the following annual rate: 10% in Arizona or Maryland; 9% in Oregon;
8% in Washington; 7% in California, Florida, Illinois, Nevada, New
Jersey, New York, Tennessee, Texas or any foreign countries; and 6% in
Georgia, Massachusetts or Michigan.
- The rescission offer will expire on , 2001, thirty days
after the effective date of the registration statement filed with this
prospectus.
- See "Risk Factors" beginning on page 12 to read about certain factors you
should consider before accepting or rejecting the rescission offer.
Neither the Securities and Exchange Commission nor any state securities
commission has approved or disapproved of these securities or determined whether
this prospectus is truthful or complete. Any representation to the contrary is a
criminal offense.
TABLE OF CONTENTS
PAGE
----
Prospectus Summary.................. 7
Risk Factors........................ 12
Our Rescission Offer................ 29
Special Note Regarding
Forward-Looking Statements........ 38
Dividend Policy..................... 38
Price Range of Common Stock......... 38
Capitalization...................... 39
Selected Consolidated Financial
Data.............................. 40
Management's Discussion and Analysis
of Financial Condition and Results
of Operations..................... 42
PAGE
----
Business............................ 60
Management.......................... 75
Related Party Transactions.......... 109
Principal Stockholders.............. 120
Description of Capital Stock........ 122
Shares Eligible for Future Sale..... 125
Plan of Distribution................ 126
Legal Matters....................... 126
Experts............................. 127
Where You Can Find Information...... 127
Index to Consolidated Financial
Statements........................ F-1
You should rely only on the information contained in this prospectus. We
have not authorized anyone to provide you with information different from that
contained in this prospectus. We are offering to sell, and seeking offers to
buy, shares of common stock only in jurisdictions where offers and sales are
permitted. The information contained in this prospectus is accurate only as of
the date of this prospectus, regardless of the time of delivery of this
prospectus or of any sale of the common stock.
2
QUESTIONS AND ANSWERS ABOUT OUR RESCISSION OFFER
Q:Why are you making the rescission offer?
A:Prior to our initial public offering in March 2000, we issued shares or
options to purchase shares of our common stock to our employees pursuant
to our 1999 Employee Stock Option Plan and to artists and their managers
and advisors pursuant to our 1999 Artist Stock Option Plan and our 1999
Artist and Artist Advisor Stock Option Plan. Due to the total number of
shares and options issued to our employees pursuant to our 1999 Employee
Stock Option Plan, and our belief that our artists and their managers and
advisors may not have qualified as consultants pursuant to Rule 701
promulgated under the Securities Act of 1933, as amended, we believe the
issuance of some of these shares and options did not comply with the
requirements of Rule 701 or any other available exemptions from the
registration requirements of Section 5 of the Securities Act, and also
may not have qualified for any exemption from qualification or
registration under the securities laws of Arizona, California, Georgia,
Maryland, Massachusetts, Michigan, Oregon or Washington. The rescission
offer is intended to address these federal and state compliance issues by
allowing holders of shares or options covered by the rescission offer to
sell those securities back to us and to reduce our contingent liability
with respect to options and shares which may not have been issued in
compliance with applicable federal and state securities laws.
Q:What will I receive if I accept the rescission offer?
A:If you accept our rescission offer, we will repurchase those shares
purchased by you pursuant to option exercises you made before the
expiration of this rescission offer (regardless of whether you have
subsequently sold the shares), at the purchase or exercise price paid for
these shares, plus interest, from the date of purchase of the shares
until the rescission offer expires, at the current statutory rate per
year mandated by the state in which the shares were purchased by you, or
at 7% per year if a "private placement" exemption was available in a
particular state or if the shares were otherwise issued in compliance
with state law (less any amounts received if you have already sold the
shares). If you accept our rescission offer, we will also repurchase all
unexercised options granted to you (regardless of whether the options
have expired) at 20% of the option exercise price multiplied by the
number of shares subject to such options, plus interest, from the date of
grant until the rescission offer expires, at the current statutory rate
per year mandated by the state in which the options were granted to you,
or at 7% per year if a "private placement" exemption was available in a
particular state or if the options were otherwise issued in compliance
with state law. Depending on the state in which the shares were purchased
by you or the options were granted to you, you will be entitled to
receive interest at the following annual rate: 10% in Arizona or
Maryland; 9% in Oregon; 8% in Washington; 7% in California, Florida,
Illinois, Nevada, New Jersey, New York, Tennessee, Texas or any foreign
countries; and 6% in Georgia, Massachusetts or Michigan. In addition,
although we believe that the shares purchased and options granted in
Florida, Illinois, Nevada, New Jersey, Tennessee and Texas complied with
applicable "private placement" exemptions in those states, and that the
shares purchased and options granted in New York and any foreign
countries are not subject to rescission rights under state law, we will
nonetheless offer to repurchase those shares purchased by you pursuant to
option exercises you made before the expiration of this rescission offer
(even if you subsequently sold those shares), at the purchase or exercise
price paid for those shares (less any amounts received if you have
already sold the shares), and to repurchase all unexercised options
granted to you (even if the options have expired) at 20% of the option
exercise price multiplied by the number of shares subject to such
options, all together with interest at an annual rate of 7% on amounts
paid to you for shares purchased and options granted in those states and
foreign countries. We believe that your acceptance of the rescission
offer will,
3
under general theories of estoppel, preclude you from later seeking
similar relief, and we are unaware of any federal or state case law to
the contrary. However, we urge you to consult with an attorney regarding
all of your legal rights and remedies before deciding whether or not to
accept the rescission offer.
Q:What if I have already exercised my options, or hold options that have
expired?
A:If you have already exercised your options, you will only be entitled to
exercise your rescission rights with respect to the shares of stock that
were issued upon the exercise of those options. If you hold options that
have expired, they will be treated in the same manner as any other
options subject to the rescission offer that have not expired.
Q:What if I already sold some or all of my shares subject to the rescission
offer?
A:If you already sold some or all of your shares subject to the rescission
offer, you will still be entitled to receive the full amount that you
paid for those shares plus interest on such amount at the applicable
annual state interest rate, but less any amounts you previously received
when you sold those shares at a loss; provided, if you have already
received more for those shares than you would otherwise be entitled to
under the rescission offer, you will not receive anything under the
rescission offer.
Q:What will happen if I affirmatively reject or fail to accept the
rescission offer before the expiration date?
A:If you affirmatively reject or fail to accept the rescission offer, you
will retain ownership of the options and/or shares you received and will
not receive any cash for those securities. In addition, any shares
issuable upon the exercise of your currently unexercised options, will be
registered under the Securities Act, and will be fully tradeable under
the Securities Act (unless you are an "affiliate" of ARTISTdirect within
the meaning of Rule 144 of the Securities Act) but will remain subject to
any applicable terms and conditions of the original agreement under which
they were issued. You should note that if you already exercised your
options, we are not registering the shares that were issued when you
exercised your options and accordingly, you would only be able to resell
those shares pursuant to an exemption from registration; however we
believe that all such shares are currently eligible to be sold pursuant
to the exemption provided by Rule 144 of the Securities Act, as amended.
If you affirmatively reject or fail to accept the rescission offer, it is
unclear whether or not your federal right of rescission will remain
preserved. The staff of the Securities and Exchange Commission takes the
position that a person's federal right of rescission may survive the
rescission offer. However, federal courts in the past have ruled that a
person who rejects or fails to accept a rescission offer is precluded
from later seeking similar relief. Generally, the federal statute of
limitation for non-compliance with the requirement to register securities
under the Securities Act of 1933 is one year. The state remedies and
statutes of limitation vary and depend upon the state in which the
options were granted to you and/or the shares were purchased by you:
- ARIZONA. Generally, the Arizona statute of limitation for
non-compliance with the requirement to register or qualify securities
under the Arizona Securities Act is one year after the non-compliance
occurred. If the shares or options were issued to you in Arizona, and
you do not accept the rescission offer, you will still retain your
right of rescission under Arizona law. However, if the applicable
statute of limitation has expired, you will not have any right of
rescission. The Arizona Corporation Commission also has the
administrative power to order a rescission offer. It is unclear whether
such an administrative action would be precluded by our rescission
offer or any statute of limitation.
4
- CALIFORNIA. Generally, the California statute of limitation for
non-compliance with the requirement to register or qualify securities
under the California Corporate Securities Law of 1968 is the earlier of
two years after the non-compliance occurred, or one year after
discovery of the facts constituting such non-compliance. However, if
the shares or options were issued to you in California, and you do not
accept the rescission offer, you will no longer have any right of
rescission under California law.
- GEORGIA. Generally, the Georgia statute of limitation for
non-compliance with the requirement to register or qualify securities
under the Georgia Securities Act of 1973 is two years after the date of
the contract for sale of such securities. However, if the shares or
options were issued to you in Georgia, and you do not accept the
rescission offer, you will no longer have any right of rescission under
Georgia law.
- MARYLAND. Generally, the Maryland statute of limitation for
non-compliance with the requirement to register or qualify securities
under the Maryland Securities Act is the earlier of three years after
the contract for sale of such securities, or one year after the
non-compliance occurred. However, if the shares or options were issued
to you in Maryland, and you do not accept the rescission offer, you
will no longer have any right of rescission under Maryland law.
- MASSACHUSETTS. Generally, the Massachusetts statute of limitation for
non-compliance with the requirement to register or qualify securities
under the Massachusetts Uniform Securities Act is four years after the
discovery of such non-compliance. However, if the shares or options
were issued to you in Massachusetts, and you do not accept the
rescission offer, you will no longer have any right of rescission under
Massachusetts law.
- MICHIGAN. Generally, the Michigan statute of limitation for
non-compliance with the requirement to register or qualify securities
under the Michigan Uniform Securities Act is two years after the date
of the contract for sale of such securities. However, if the shares or
options were issued to you in Michigan, and you do not accept the
rescission offer, you will no longer have any right of rescission under
Michigan law.
- NEW YORK. If the shares or options were issued to you in New York, you
do not have a right of rescission under New York law. Accordingly, your
acceptance or non-acceptance of the rescission offer pursuant to your
federal right of rescission will have no effect under New York law.
- OREGON. Generally, the Oregon statute of limitation for non-compliance
with the requirement to register or qualify securities under the Oregon
Securities Law is three years after the sale of such securities.
However, if the shares or options were issued to you in Oregon, and you
do not accept the rescission offer, you will no longer have any right
of rescission under Oregon law.
- WASHINGTON. Generally, the Washington statute of limitation for
non-compliance with the requirement to register or qualify securities
under the Securities Act of Washington is three years after the
contract for sale of such securities. However, if the shares or options
were issued to you in Washington, and you do not accept the rescission
offer, you will no longer have any right of rescission under Washington
law.
- FLORIDA, ILLINOIS, NEVADA, NEW JERSEY, TENNESSEE AND TEXAS. If the
shares or options were issued to you in Florida, Illinois, Nevada, New
Jersey, Tennessee or Texas, we believe those issuances complied with
applicable "private placement" exemptions in those states. Accordingly,
your acceptance or non-acceptance of the rescission offer pursuant to
your
5
federal right of rescission will have no effect under the laws of
Florida, Illinois, Nevada, New Jersey, Tennessee or Texas.
- FOREIGN COUNTRIES. If the shares or options were issued to you in a
foreign country, we believe that the only applicable rescission rights
you have under applicable U.S. law are those under federal securities
laws. As previously stated, the staff of the Securities and Exchange
Commission takes the position that a person's federal right of
rescission may survive the rescission offer. However, federal courts in
the past have ruled that a person who rejects or fails to accept a
rescission offer is precluded from later seeking similar relief.
Generally, the federal statute of limitation for non-compliance with
the requirement to register securities under the Securities Act of 1933
is one year.
The above discussions do not relate to the antifraud provisions of
applicable federal and state securities laws or rights under common law or
equity. We urge you to consult with an attorney regarding all of your legal
rights and remedies before deciding whether or not to accept the rescission
offer.
Q:When does the rescission offer expire?
A:Our rescission offer expires , 2001, thirty days after the
effective date of the registration statement filed with this prospectus.
Q:What do I need to do now to accept the rescission offer?
A:You should complete, sign and date the accompanying election form and return
it to us, together with your stock certificates and/or option agreement for
the shares and/or options you want us to repurchase, in the enclosed return
envelope prior to the expiration date.
Q:What happens if I do not return my election form?
A:If you do not return your election form before the expiration date of our
rescission offer, you will be deemed to have rejected our offer and the shares
of common stock that you purchased and the shares of common stock issuable
upon exercise of the options subject to the rescission offer will be
registered under the Securities Act.
Q:Can I change my mind after I have mailed my signed election form?
A:Yes. You can change your decision about accepting or rejecting our rescission
offer at any time before the expiration date. You can do this by completing
and submitting a new election form.
Q:If I accept the rescission offer, will ARTISTdirect withhold any taxes?
A:If the options or shares subject to the rescission offer were issued to you in
connection with your employment as an ARTISTdirect employee, we will withhold
a portion of your payment at the applicable tax withholding rate. If the
options or shares subject to the rescission offer were not issued to you in
connection with your employment as an ARTISTdirect employee, no taxes will be
withheld on your payment. Regardless of whether you were employed by
ARTISTdirect, however, we strongly urge you to consult with your tax advisor
as to the tax consequences of accepting or rejecting the rescission offer.
Q:Who can help answer my questions?
A:We suggest that you consult your legal counsel prior to making your decision
about accepting or rejecting our rescission offer. In addition, you can call
James B. Carroll of ARTISTdirect at (323) 634-4000 with any questions about
the rescission offer.
6
PROSPECTUS SUMMARY
You should read the following summary together with the more detailed
information regarding our company and the common stock being sold in this
offering and our financial statements and the notes to those financial
statements appearing elsewhere in this prospectus. In addition, except as
expressly stated, all share numbers herein assume that no stockholders receiving
the Rescission Offer exercise their right to rescind.
ARTISTdirect
We are a music entertainment company that combines an online music network
with offline assets, including a record label and talent agency, to provide an
integrated music solution for music fans, artists and marketing partners. The
ARTISTdirect Network is a network of Web sites offering multi-media content,
music news and information, community around shared music interests, music
related commerce and digital music services.
Our ARTISTdirect Network is an integrated network of Web sites consisting
of:
- The Ultimate Band List or the UBL -- a comprehensive online music search
engine with information on more than 100,000 artists across numerous
musical genres and links to thousands of music Web sites. The UBL
features news, concert information, biographies, album reviews, contests,
promotions, music samples and downloads;
- iMusic -- an online music community with chats, message boards and fan
clubs. Through hosted chats and fan conferences on iMusic, fans can
interact directly with their favorite artists;
- The ARTISTdirect Superstore -- a retail site offering a wide selection of
music titles and artist merchandise;
- Digital Music -- a feature which enables users to download music from the
ARTISTdirect Network and listen to streaming Internet radio stations; and
- ARTISTtv -- a site for broadband programming including a variety of
current music videos and other programs.
We also operate a music talent agency, the ARTISTdirect Agency, that
procures live performance and concert touring appearance engagements and seeks
advertising and sponsorship opportunities for a roster of high-profile artists.
In connection with our agency activities, we have developed, managed and
promoted integrated series of live concert tours and festivals, including Fan
Nation and Sno-Core. These services enhance the relationships we have with many
of our artists and enable us to identify potential sponsorship opportunities for
advertisers with whom we have relationships.
7
We recently formed a new record label company, ARTISTdirect Records, LLC,
as a co-venture between our wholly-owned subsidiary, ARTISTdirect Recordings,
Inc., and Radar Records Holdings, LLC, an entity wholly owned by our Chief
Executive Officer, Mr. Field. Mr. Field serves as the Chief Executive Officer of
ARTISTdirect Records. ARTISTdirect Records will seek to develop new music
artists, and to produce and distribute their recordings as an independent label
utilizing both traditional channels and emerging Internet distribution channels,
including our own Internet music distribution network and artist services. We
believe ARTISTdirect Records will allow us to strengthen our position as a music
entertainment company with both traditional and new media capabilities based on
the Internet.
We have generated substantially all of our revenue from online sales of
compact discs and other artist-related merchandise, online advertising and
sponsorships, royalties on record sales and talent agency commissions. Our
revenue was $21.7 million for the year ended December 31, 2000 and $8.6 million
for the nine months ended September 30, 2001. We incurred a net loss of
approximately $59.3 million for the year ended December 31, 2000 and
approximately $47.4 million for the nine months ended September 30, 2001. Our
accumulated losses of ARTISTdirect, Inc. and its predecessors as of September
30, 2001 were approximately $171.3 million, of which approximately $58.0 million
represented stock-based compensation. While we believe that we can increase our
revenue and diversify our revenue opportunities, we expect to continue to incur
net losses and negative cash flows for the foreseeable future. We also expect to
continue to face strong competition in our industry from the online music
companies, traditional music retailers, "portals" and record labels. Such
competition could adversely affect our future operating results.
ARTISTdirect, Inc. was incorporated in Delaware in July 1999. ARTISTdirect,
LLC, our predecessor, was organized as a California limited liability company in
August 1996. Our principal executive offices are located at 5670 Wilshire
Boulevard, Suite 200, Los Angeles, California 90036, and our telephone number is
(323) 634-4000. Our World Wide Web address is www.artistdirect.com. The
information on our Web site is not a part of this prospectus.
We use the following registered service marks and domain names of
ARTISTdirect in this prospectus: ARTISTdirect(SM), UBL(SM), iMusic(SM),
www.artistdirect.com, www.ubl.com, www.imusic.com and www.downloadsdirect.com.
All other trade names and trademarks appearing in this prospectus are the
property of their respective holders.
8
RESCISSION OFFER
Common stock and options to purchase
common stock subject to rescission
offer............................. 795,932 shares and options
Common stock outstanding............ 3,554,708 shares (as of September 30,
2001)
Nasdaq National Market symbol....... ARTD
-------------------------
Unless otherwise indicated, all information in this prospectus:
- reflects the one-for-four reverse split of our common stock effected on
March 21, 2000 and the one-for-ten reverse split of our common stock
effected on July 5, 2001;
- excludes 200,000 shares of our common stock that we repurchased in April
2001 in connection with a partial self-tender offer;
- excludes 27,528 shares of our common stock that we repurchased in the
open market;
- reflects outstanding shares as of September 30, 2001;
- excludes shares of our common stock issuable pursuant to options and
warrants outstanding as of September 30, 2001;
- excludes unexercised options and warrants assumed by us in connection
with our acquisition of Mjuice.com, Inc.; and
- assumes that, except as expressly stated herein, no stockholder accepts
the rescission offer.
We have issued shares or options to purchase shares of our common stock to
our employees pursuant to our 1999 Employee Stock Option Plan and to artists and
their managers and advisors pursuant to our 1999 Artist Stock Option Plan and
our 1999 Artist and Artist Advisor Stock Option Plan. Due to the total number of
shares and options issued to our employees pursuant to our 1999 Employee Stock
Option Plan, and our belief that our artists and their managers and advisors may
not have qualified as consultants pursuant to Rule 701 promulgated under the
Securities Act of 1933, as amended, we believe the issuance of some of these
shares and options did not comply with the requirements of Rule 701 or any other
available exemptions from the registration requirements of Section 5 of the
Securities Act, and may not have qualified for any exemption from qualification
or registration under applicable state securities laws either. We are thus
making this rescission offer to all these persons pursuant to a registration
statement filed under the Securities Act and pursuant to applicable state
securities laws.
In this rescission offer, we are offering to repurchase from these persons
all shares issued directly to these persons or pursuant to option exercises by
these persons before the expiration of this rescission offer (regardless of
whether these persons have subsequently sold their shares), at the purchase or
exercise price paid for these shares, plus interest from the date of purchase
until this rescission offer expires, at the current statutory rate per year
mandated by the state in which the shares were purchased by each person, or at
7% per year if a "private placement" exemption was available in a particular
state or if the shares were otherwise issued in compliance with state law (less
any amounts received if these persons have already sold their shares). We are
also offering to repurchase all vested and unvested unexercised options granted
to such persons (regardless of whether the options have expired) at 20% of the
option exercise price multiplied by the number of shares subject to such
options, plus interest from the date of grant until this rescission offer
expires, at the current statutory rate per year mandated by the state in which
the options were granted to each person, or at 7% per year if a "private
placement" exemption was available in a particular state or if the options were
otherwise issued in compliance with state law. Depending on the state in which
the shares were purchased by or the options were granted to these persons, each
will be entitled to receive interest at the following annual rate: 10% in
Arizona or Maryland; 9% in Oregon; 8% in
9
Washington; 7% in California, Florida, Illinois, Nevada, New Jersey, New York,
Tennessee, Texas or any foreign countries; and 6% in Georgia, Massachusetts or
Michigan. In addition, although we believe that the shares and options issued in
Florida, Illinois, Nevada, New Jersey, Tennessee and Texas complied with
applicable "private placement" exemptions in those states, and that the shares
and options issued in New York and any foreign countries are subject to
rescission rights only under federal law, we are nonetheless offering to
repurchase those shares issued pursuant to option exercises made before the
expiration of this rescission offer (even if those shares were subsequently
sold), at the purchase or exercise price paid for those shares (less any amounts
received if the shares have already been sold), and to repurchase all
unexercised options issued (even if the options have expired), at 20% of the
option exercise price multiplied by the number of shares subject to such
options, all together with interest at an annual rate of 7% on amounts paid for
shares and options issued in those states and foreign countries. The options
subject to the rescission offer have exercise prices ranging from $12.40 to
$140.00 per share. Accordingly, the repurchase price for the vested and unvested
unexercised options ranges from $2.48 to $28.00 per share, which is 20% of the
option exercise price, plus interest.
We are also registering the shares of common stock issuable upon the
exercise of currently unexercised options subject to the rescission offer. In
the event an offeree rejects the rescission offer with respect to unexercised
options and subsequently exercises these options, the shares issued upon the
exercise of such options will be registered under the Securities Act and will be
freely tradeable (unless you are an "affiliate" of ARTISTdirect within the
meaning of Rule 144 of the Securities Act), subject to the terms and conditions
of the option agreement itself. You should note that if you already exercised
your options, we are not registering the shares that were issued when you
exercised your options and accordingly, you would only be able to resell those
shares pursuant to an exemption from registration; however we believe that all
such shares are currently eligible to be sold pursuant to the exemption provided
by Rule 144 of the Securities Act, as amended.
This rescission offer will expire 30 days after the effective date of the
registration statement filed with this prospectus. We believe that a person's
acceptance of the rescission offer will, under general theories of estoppel,
preclude that person from later seeking similar relief, and we are unaware of
any federal or state case law to the contrary. However, we urge these persons to
consult with an attorney regarding all of their legal rights and remedies before
deciding whether or not to accept the rescission offer.
10
SUMMARY CONSOLIDATED FINANCIAL DATA
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
PERIOD FROM
AUGUST 8,
1996 NINE MONTHS ENDED
(INCEPTION) TO YEAR ENDED DECEMBER 31, SEPTEMBER 30,
DECEMBER 31, --------------------------------------- ---------------------
1996 1997 1998 1999 2000 2000 2001
-------------- ------ ------ --------- --------- --------- ---------
(UNAUDITED)
CONSOLIDATED STATEMENT OF OPERATIONS DATA:
Net revenue................................... $ -- $1,888 $4,582 $ 10,274 $ 21,676 $ 15,657 $ 8,594
Gross profit (loss)........................... -- 1,280 2,067 34 (4,866) (3,711) (5,465)
Operating expenses............................ 28 1,737 8,416 58,169 60,176 42,562 40,931
Loss from operations.......................... 28 457 6,349 58,135 (65,042) (46,273) (46,396)
Net loss...................................... 28 460 6,318 57,804 (59,308) (42,265) (47,393)
Basic and diluted net loss per share(1)....... (17.14) (26.83) (22.90) (13.11)
Weighted average shares outstanding used in
computing basic and diluted net loss per
share for periods from October 6, 1999 to
December 31, 1999 and for the year ended
December 31, 2000 and for the nine months
ended September 30, 2000 and 2001........... 1,417,746 3,175,126 2,966,541 3,656,333
------------------------
(1) We were organized as an LLC for tax purposes prior to October 6, 1999.
Consequently, the basic and diluted loss per share for 1999 represents the
period from October 6, 1999 to December 31, 1999.
The "pro forma" column below reflects our capitalization as of September
30, 2001 with adjustments to give effect to:
- the acceptance of the rescission offer by all holders of common stock and
unexercised options subject to the rescission offer; and
- stock based compensation of approximately $11.2 million assuming the
acceptance of the rescission offer as of September 30, 2001, of which
$6.2 million would be recorded as expense upon the expiration of the
rescission offer and $4.9 million of which would be recorded as expense
over the remaining term of the underlying service agreements for
non-employees (assuming there are no terminations or revisions to the
existing service agreements underlying the shares and options subject to
the rescission offer). The compensation amount would be recorded as
expense of $1.3 million in the final three months of 2001, $3.3 million
in 2002 and $252,000 in 2003.
AS OF
SEPTEMBER 30, 2001
--------------------
ACTUAL PRO FORMA
------- ---------
(UNAUDITED)
CONSOLIDATED BALANCE SHEET DATA:
Cash, cash equivalents and short term investments........... $60,600 $49,411
Working capital............................................. 60,690 49,501
Goodwill and intangibles, net............................... 936 936
Total assets................................................ 73,748 62,559
Total redeemable securities................................. 11,189 --
Total stockholders' equity.................................. 56,850 56,850
See page 39 for a further discussion of our pro forma capitalization, which
assumes that the rescission offer is accepted in its entirety by all eligible
option holders and eligible stockholders.
11
RISK FACTORS
You should carefully consider the risks described below, together with all
of the other information included in this prospectus, before making a decision
to accept or reject our rescission offer. If any of the following risks actually
occurs, our business, financial condition or operating results could be
materially and adversely affected. In such case, the trading price of our common
stock could decline, and you may lose part or all of your investment.
RISKS RELATED TO OUR BUSINESS
IT IS DIFFICULT TO EVALUATE OUR BUSINESS AND PROSPECTS BECAUSE WE HAVE A
LIMITED OPERATING HISTORY AND RAPIDLY EVOLVING BUSINESS.
Our limited operating history and rapidly evolving business make it
difficult to evaluate our prospects or to accurately predict our future revenue
or results of operations. Our revenue and income potential are unproven, and our
business model is constantly and rapidly evolving. In particular, the Internet
is constantly changing and we may need to modify our business model to adapt to
these changes, including our recent decision to focus a significant amount of
resources on off-line businesses such as ARTISTdirect Recordings, our record
label co-venture with Frederick Field.
OUR BUSINESS MODEL IS NEW AND UNPROVEN, AND WE MAY NOT BE ABLE TO GENERATE
SUFFICIENT REVENUE TO OPERATE OUR BUSINESS SUCCESSFULLY
Our model for conducting business and generating revenue is new and
unproven. Our success will depend primarily on our ability to generate revenue
from our offline assets and from multiple sources through the ARTISTdirect
Network, including:
- online sales of music and related merchandise;
- sales of advertising and sponsorships;
- marketing our database of consumer information and preferences;
- sales of, or subscription fees for, digitally distributed music; and
- royalties and related revenue from record label operations.
It is uncertain whether a music-related Web site that relies on attracting
people to learn about, listen to and purchase music and related merchandise can
generate sufficient revenue from electronic commerce, advertising, sales of
database information and sales of, or fees for, digital downloads of music, to
become a viable business. We provide many of our products and services without
charge, and we may not be able to generate sufficient revenue to pay for these
products and services. In addition, it may take a significant amount of time for
us to develop and operate our record label co-venture with Frederick Field.
Accordingly, we are not certain that our business model will be successful or
that we can sustain revenue growth or be profitable. If our markets develop more
slowly than expected or become saturated with competitors, our products and
services do not achieve or sustain market acceptance, we may not be able to
successfully operate our business.
WE HAVE A HISTORY OF OPERATING LOSSES AND ANTICIPATE LOSSES AND NEGATIVE
CASH FLOW FOR THE FORESEEABLE FUTURE
To date, we have not been profitable on an annual or quarterly basis and
have incurred accumulated losses of approximately $171.3 million as of September
30, 2001. For the nine months ended September 30, 2001 and the year ended
December 31, 2000, we incurred net losses of approximately $47.4 million and
$59.3 million, respectively, which represented approximately 552% and 274%,
respectively, of our revenue for those periods. We expect our operating losses
and negative
12
cash flow to continue for at least the near future. We will need to generate
significant additional revenue to achieve profitability. Consequently, it is
possible that we may never achieve profitability, and even if we do achieve
profitability, we may not sustain or increase profitability on a quarterly or
annual basis in the future. If we do not achieve or sustain profitability in the
future, then we will likely be unable to continue our operations.
OUR OPERATING RESULTS WILL LIKELY BE UNPREDICTABLE
Our operating results are likely to fluctuate significantly in the future
due to a variety of factors, many of which are outside of our control. Because
our operating results are volatile and difficult to predict, our operating
results have in the past, and in the future may, fall below the expectations of
securities analysts and investors. In this event, the trading price of our
common stock may fall significantly.
IF WE ARE NOT SUCCESSFUL IN GENERATING REVENUE FROM A CO-VENTURE RECORD
LABEL WITH FREDERICK FIELD, WE MAY NOT BE ABLE TO INCREASE OUR NET
REVENUES.
We recently decided to invest a significant amount of our resources in
offline activities such as a record label. Accordingly, in May 2001, we entered
into an agreement with music and entertainment veteran, Frederick Field, to
develop and operate a co-venture record label and to hire Mr. Field as our
Chairman of the Board and Chief Executive Officer. The co-venture record label
is a new enterprise and will face significant challenges in developing and
operating its planned business, including but not limited to the following:
- identifying and entering into recording agreements with artists for the
record label;
- hiring new personnel for the record label;
- producing and promoting new music recordings for artists signed to the
record label;
- developing a recognized brand name in the music industry;
- developing distribution channels for the record label;
- integrating the record label's operations with our existing operations;
and
- generating record label revenue and achieving profitability.
The record label has no operating history upon which to assess whether it
will be able to meet all of the challenges required to successfully develop and
operate its business. Accordingly, there can be no assurance that Mr. Field will
be able to successfully operate the label. If the record label is not able to
develop a successful business with revenue and profits, we will not receive the
anticipated benefits of our investment in the record label and our business,
financial condition and results of operations would be materially and adversely
affected.
WE HAVE COMMITTED A SUBSTANTIAL AMOUNT OF OUR AVAILABLE CASH TO THE RECORD
LABEL CO-VENTURE WITH FREDERICK FIELD AND, AS A RESULT, THE AMOUNT OF CASH
THAT WE WILL HAVE AVAILABLE TO OPERATE OUR OTHER BUSINESSES HAS BEEN
SUBSTANTIALLY REDUCED.
The record label co-venture with Mr. Field represents a potentially
significant shift in the planned use of our cash resources. We will be required
to commit as much as $50 million to the record label over the next five years.
Subject to this overall limit, we may be required to advance as much as $15
million per year to the record label, including an initial commitment of $12
million that has been partially funded. As of September 30, 2001, we had
approximately $60.6 million in cash (including short-term investments in
marketable securities). While we currently believe this amount of cash is
adequate to fund our obligations to the record label and our existing businesses
for the
13
foreseeable future, including obligations to our joint venture with the Cisneros
Television Group, if the record label is not successful, if there is a material
delay in anticipated cash flow from the record label or if we are required to
contribute a significant amount of funds to the joint venture with Cisneros
Television Group, there can be no assurance that our existing cash resources
will be adequate to enable us to successfully operate our other businesses or to
become cash flow positive at any time in the foreseeable future. If this occurs,
we will need to raise additional capital to continue operating our businesses.
There can be no assurance that we will be able to raise this additional funding
at all or on reasonably acceptable terms if it is needed in the future. If we
are unable to successfully raise any necessary funding, our ability to
successfully operate our business would be materially adversely affected. See
"Liquidity and Capital Resources" on pages 56-57 for more information on our
liquidity and capital resources.
WE DO NOT CURRENTLY EXPECT ONLINE ADVERTISING TO GROW SIGNIFICANTLY IN THE
NEAR FUTURE AND AS A RESULT, OUR BUSINESS MAY BE ADVERSELY AFFECTED
If we do not increase advertising revenue, our business will be adversely
affected. Increasing our advertising revenue depends upon many factors,
including our ability to:
- respond to and anticipate fluctuations in the demand for, and pricing of,
online advertising;
- conduct successful selling and marketing efforts aimed at advertisers;
- increase the size of our audience and the amount of time that our
audience spends on our Web sites;
- increase our direct advertising sales force and build up our
international marketing team;
- increase the amount of revenue per advertisement;
- aggregate our target demographic group of 13 to 34 year-old active music
consumers;
- offer advertisers the means to effectively target their advertisements to
our audience;
- accurately measure the size and demographic characteristics of our
audience; and
- maintain key advertising relationships; and compete for advertisers with
Internet and traditional media companies.
Our failure to achieve one or more of these objectives could impair our
ability to increase advertising revenue, which could adversely affect our
business. In addition to the above factors, general economic conditions, as well
as economic conditions specific to online advertising, electronic commerce and
the music industry, could affect our ability to increase our advertising
revenue. In particular, the growth of online advertising has recently declined,
which has had, and in the future may continue to have, a significant adverse
effect on our revenue from online advertising. We do not currently expect online
advertising to grow significantly in the near future. In the past, we have
traditionally relied on a limited number of customers for our advertising
revenue. For instance, for the nine months ended September 30, 2001, Universal
Music Group and Pringles, a division of Procter & Gamble, accounted for 23% and
14%, respectively, of our media revenue for that period. Accordingly, the loss
of any of our large advertising customers could materially adversely impact our
advertising revenue and our business, financial condition and results of
operations.
IF WE DO NOT GENERATE INCREASED REVENUE FROM ONLINE PRODUCT SALES, OUR
GROWTH WILL BE LIMITED AND OUR BUSINESS WILL BE ADVERSELY AFFECTED
If we do not generate increased revenue from sales of online products, our
growth will be limited and our business will be adversely affected. To generate
significant online product revenue, we will have to offer music and related
merchandise that appeal to a large number of online consumers. We
14
also will have to continue to create online communities that are conducive to
electronic commerce, maintain a sufficiently robust and scalable electronic
commerce platform and increase our order fulfillment capability. Since our
target market includes Internet users below the age of 18, and these users have
limited access to credit cards, our ability to capture online product revenue
from this group may be limited. If we are not successful in meeting these
challenges, our growth will be limited and our business will be adversely
affected.
THE EFFECTIVENESS OF THE INTERNET FOR ADVERTISING IS UNPROVEN, WHICH MAY
DISCOURAGE SOME ADVERTISERS FROM ADVERTISING ON OUR SITES
Our future depends in part on an increase in the use of the Internet and
other forms of digital media for advertising. The Internet advertising market is
relatively new and rapidly evolving, and we cannot yet gauge the effectiveness
of advertising on the Internet as compared to traditional media. As a result,
demand for Internet advertising is uncertain. Many advertisers have little or no
experience using the Internet for advertising purposes. The adoption of Internet
advertising, particularly by companies that have historically relied upon
traditional media for advertising, requires the acceptance of a new way of
conducting business, exchanging information and advertising products and
services. Such customers may find advertising on the Internet to be undesirable
or less effective than traditional advertising media for promoting their
products and services. In particular, online advertising revenue has
significantly decreased. If the Internet advertising market fails to grow, our
business could be adversely affected. In addition, the market for advertising on
other forms of digital media, such as broadband distribution, is even less
developed than Internet advertising, and if that market does not develop, our
growth may be limited.
WE DEPEND UPON ARTISTS TO ATTRACT ADVERTISERS AND GENERATE ELECTRONIC
COMMERCE REVENUE
We believe that our future success depends in part on our ability to
maintain our existing artist relationships and to establish additional
relationships with artists. We recently began a process of negotiating new
commerce agreements that generally simplify the relationship between the artists
and us. Our business would be adversely affected by any of the following:
- our inability to establish relationships with new artists and offer their
music and merchandise for sale to our customers;
- the loss of popularity of artists for whom we sell music and merchandise;
- increased competition to maintain existing relationships with artists;
- non-renewals or non-conversions of certain of our current agreements with
artists; and
- poor performance or negative publicity of our artists.
If we are not able to provide valuable services or incentives to artists,
or if we otherwise fail to maintain good relations with our artists, they may
lose interest in providing content and merchandise and otherwise promoting the
ARTISTdirect Network. The artists own the domain names for their Web sites and
some of the intellectual property rights with respect to content developed for
the Web sites. As a result, we may lose the rights to operate artists' sites if
our agreements with these artists terminate and are not renewed or converted.
Most of our current artist contracts have a term of three years. Upon
expiration, artists may decide not to renew these contracts on reasonable terms,
if at all. If artists decide to remove their online stores from the ARTISTdirect
Network when their agreements terminate, we may be unable to recoup our costs to
develop, operate and promote the sites. We are negotiating new agreements with
some of our existing artists and terminating existing agreements with some of
our other artists.
15
Our inability to negotiate new agreements or to terminate existing agreements
may have an adverse impact on our business.
In the past, we have offered our artists options to purchase our common
stock. Options were intended to provide artists with an additional incentive to
actively promote their Web sites and the ARTISTdirect Network. We may not be
able to offer artists options or other equity incentives on terms as attractive
to artists as what we have offered previously. If we cannot provide adequate
incentives, our efforts to sign new artists may be impaired. If we cannot
maintain our current relationships with artists or sign agreements with new
artists, our user base would likely diminish and our ability to generate
revenues from electronic commerce and advertising would be seriously harmed.
WE MAY NOT BE ABLE TO DEVELOP OR OBTAIN SUFFICIENTLY COMPELLING CONTENT TO
ATTRACT AND RETAIN OUR TARGET AUDIENCE
For our business to be successful, we must provide content and services
that attract consumers who will purchase music and related merchandise online.
We may not be able to provide consumers with an acceptable mix of products,
services, information and community to attract them to our Web sites or to
encourage them to remain on our Web sites for an extended period of time. If our
audience determines that our content does not reflect its tastes, then our
audience size could decrease or the demographic characteristics of our audience
could change and we may be unable to react to those changes effectively or in a
timely manner. Any of these results would adversely affect our ability to
attract advertisers and sell music and other related merchandise. Our ability to
provide compelling content could be impaired by any of the following:
- reduced access to content controlled by record labels, music publishers
and artists;
- diminished technical expertise and creativity of our production staff;
and
- inability to anticipate and capitalize on trends in music.
IF WE DO NOT BUILD AND MAINTAIN STRONG BRANDS, WE MAY NOT BE ABLE TO
ATTRACT A SUFFICIENT NUMBER OF USERS TO OUR WEB SITES
To attract users we must develop a brand identity for ARTISTdirect and
increase public awareness of the ARTISTdirect Network; however to conserve cash,
we have significantly decreased the amounts we plan to spend on our offline and
online advertising and promotional efforts to increase brand awareness, traffic
and revenue. Accordingly, our marketing activities may not result in increased
revenue and, even if they do, any increased revenue may not offset the expenses
we incur in building our brands. Moreover, despite these efforts we may be
unable to increase public awareness of our brands, which would have an adverse
effect on our results of operations.
OUR ONLINE STORE AGREEMENTS WITH ARTISTS DO NOT PRECLUDE OUR ARTISTS FROM
SELLING MUSIC AND RELATED MERCHANDISE ON OTHER WEB SITES
Our online store agreements with artists do not preclude them from selling
merchandise and compact discs or offering music downloads on other Web sites. If
we are unable to attract sufficient traffic to the ARTISTdirect Network,
consumers may purchase the products that we offer on other Web sites. If we are
unable to generate revenue from the sale of music and related merchandise, our
results of operations will be adversely affected.
OUR MARKET IS HIGHLY COMPETITIVE AND WE MAY NOT BE ABLE TO COMPETE
SUCCESSFULLY AGAINST OUR CURRENT AND FUTURE COMPETITORS
The market for the online promotion and distribution of music and related
merchandise is highly competitive and rapidly changing. There are a significant
number of Web sites promoting and
16
distributing music and related merchandise that compete for the attention and
spending of consumers, advertisers and users.
We face competitive pressures from numerous actual and potential
competitors. Our competitors include MP3.com, Launch Media, Amazon.com, CDnow,
MTVi, major Internet portals and traditional music companies. Competition is
likely to increase significantly as new companies enter the market and current
competitors expand their services. Some of our competitors have announced
agreements to work together to offer music over the Internet, and we may face
increased competitive pressures as a result. Many of our current and potential
competitors in the Internet and music entertainment businesses may have
substantial competitive advantages relative to us, including:
- longer operating histories;
- significantly greater financial, technical and marketing resources;
- greater brand name recognition;
- larger existing customer bases; and
- more popular content or artists.
These competitors may be able to respond more quickly to new or emerging
technologies and changes in customer requirements and devote greater resources
to develop, promote and sell their products or services than we can. Consumers,
artists, talent management companies and other music-related vendors or
advertisers may perceive Web sites maintained by our existing and potential
competitors as being superior to ours. In addition, increased competition could
result in reduced advertising rates and margins and loss of market share, any of
which could harm our business.
WE DEPEND ON A LIMITED NUMBER OF SUPPLIERS FOR MUSIC MERCHANDISE,
FULFILLMENT AND DISTRIBUTION; IF WE CANNOT SECURE ALTERNATE SUPPLIERS, OUR
BUSINESS MAY BE HARMED
We rely to a large extent on timely distribution by third parties. We
currently rely substantially on one vendor, Alliance Entertainment, to fulfill
and distribute our orders for music and related merchandise. During the nine
months ended September 30, 2001 and the year ended December 31, 2000, virtually
all of our orders for music and related merchandise were fulfilled by Alliance.
Our agreement with Alliance covers fulfillment services for sales under the
ARTISTdirect Superstore, but does not cover fulfillment services for our
artist-specific Web sites. Although Alliance has been fulfilling orders for
music and related merchandise from the artist-specific Web sites on the same
terms as orders from the ARTISTdirect Superstore, Alliance may terminate the
artist-specific Web sites arrangement at any time.
We purchase almost all of our compact discs from Alliance and a substantial
portion of our other music-related merchandise from Giant Merchandising, SMI
Promotional Apparel and several other vendors. Our business could be
significantly disrupted if Alliance, Giant or SMI Promotional Apparel were to
terminate or breach their agreements or suffer adverse developments that affect
their ability to supply products to us. If, for any reason, Alliance, Giant or
SMI Promotional Apparel are unable or unwilling to supply products to us in
sufficient quantities and in a timely manner, we may not be able to secure
alternative suppliers, on acceptable terms in a timely manner, or at all.
WE DEPEND ON THIRD PARTY INVENTORY AND FINANCIAL SYSTEMS AND CARRIER
SERVICES
Because we rely on third parties to fulfill orders, we depend on their
systems for tracking inventory and financial data. If our distributors' systems
fail or are unable to scale or adapt to changing needs, or if we cannot
integrate our information systems with the systems of any new distributors, we
may not have adequate, accurate or timely inventory or financial information. We
also rely on third-party carriers for shipments to and from distribution
facilities. We are therefore subject
17
to the risks, including employee strikes and inclement weather, associated with
our carriers' ability to provide delivery services to meet our distribution and
shipping needs. In the past, both we and Alliance have occasionally experienced
an unusually high volume of orders, which resulted in shipping delays to our
customers. These delays did not have a material adverse effect, however, our
failure to deliver products to our customers in a timely and accurate manner in
the future could harm our reputation, our relationship with customers, the
ARTISTdirect brand and our results of operations.
OUR BUSINESS IS SUBJECT TO SEASONALITY, WHICH COULD ADVERSELY AFFECT OUR
OPERATING RESULTS
We have experienced and expect to continue to experience seasonal
fluctuations in our online sales. These seasonal patterns will cause quarterly
fluctuations in our operating results. In particular, a disproportionate amount
of our online sales have been realized during the fourth calendar quarter and
during the summer months, traditionally when artists go on tour. Due to our
limited operating history, it is difficult to predict the seasonal pattern of
our online sales and the impact of such seasonality on our business and
operating results. Our seasonal online sales patterns may become more
pronounced, strain our personnel, warehousing, and order shipment activities and
cause our operating results to be significantly less than expected for any given
period. This would likely cause our stock price to fall.
WE MAY BE SUBJECT TO SYSTEM DISRUPTIONS, WHICH COULD REDUCE OUR REVENUE
Our ability to attract and retain artists, users, advertisers and merchants
for our online network depends on the performance, reliability and availability
of our Web sites and network infrastructure. The maintenance and operation of
substantially all of our Internet communications hardware and servers have been
outsourced to CNP, Inc. (formerly Amplified Holdings, Inc.) and its providers.
We have periodic maintenance windows, and we experience outages from to time
caused by temporary problems in our own systems or software or in the systems or
software of these third parties. While we are implementing procedures to improve
the reliability of our systems, these interruptions may continue to occur from
time to time.
Our users also depend on third party Internet service providers and Web
site operators for access to our Web sites. These entities have experienced
significant outages in the past, and could experience outages, delays and other
difficulties due to system failures in the future which are unrelated to our
systems, but which could nonetheless adversely affect our business.
COMPUTER VIRUSES, ELECTRONIC BREAK-INS OR SIMILAR DISRUPTIVE EVENTS COULD
DISRUPT OUR ONLINE SERVICES
Computer viruses, electronic break-ins or similar disruptive events could
disrupt our online services. System disruptions could result in the
unavailability or slower response times of our Web sites, which would reduce the
number of advertisements delivered or commerce conducted on our Web sites and
lower the quality of our users' experience. Service disruptions could adversely
affect our revenue and, if they were prolonged, would seriously harm our
business and reputation. Our business interruption insurance may not be
sufficient to compensate us for losses that may occur as a result of these
interruptions.
IF WE DO NOT MANAGE OUR OPERATIONS, WE MAY NOT BE ABLE TO OPERATE OUR
BUSINESS EFFECTIVELY
Since our inception in August 1996, we have rapidly and significantly
expanded and changed our operations. We expect further significant changes,
particularly as a result of the record label co-venture and other potential
opportunities. This process has strained, and we expect that it will continue to
strain, our management, operations, systems and financial resources. In
addition, we recently reduced our headcount to conserve cash and may further
reduce headcount. At the same
18
time, we expect to expand staff associated with the record label co-venture.
Accordingly, to manage our operations and personnel, we must improve and
effectively utilize our existing operational, management, marketing and
financial systems and maintain close coordination among our technical, finance,
marketing, sales and production staffs. In addition, we may also need to
increase the capacity of our software, hardware and telecommunications systems
on short notice. We also will need to manage an increasing number of complex
relationships with users, strategic partners, advertisers and other third
parties, especially in light of certain functions being outsourced. Our failure
to manage growth could disrupt our operations and ultimately prevent us from
generating the revenue we expect.
THE LOSS OF KEY PERSONNEL, INCLUDING FREDERICK FIELD, MARC GEIGER, DONALD
MULLER OR KEITH YOKOMOTO, COULD ADVERSELY AFFECT OUR BUSINESS BECAUSE THESE
INDIVIDUALS ARE IMPORTANT TO OUR CONTINUED GROWTH
Our future success depends to a significant extent on the continued
services of our senior management, particularly Frederick Field, Marc Geiger,
Donald Muller and Keith Yokomoto. The loss of any of these individuals would
likely have an adverse effect on our business. Competition for personnel
throughout our industry is intense and we may be unable to retain these key
employees or attract, integrate or retain other highly qualified employees in
the future. We have in the past experienced, and we expect to continue to
experience, difficulty in hiring and retaining highly skilled employees with
appropriate qualifications. If we do not succeed in attracting new personnel or
retaining and motivating our current personnel, our business could be adversely
affected.
IF WE DO NOT REALIZE THE ANTICIPATED BENEFITS OF POTENTIAL FUTURE
ACQUISITIONS, OUR BUSINESS COULD BE SERIOUSLY HARMED AND OUR STOCK PRICE
COULD FALL
We regularly evaluate, in the ordinary course of business, potential
acquisitions of, or investments in, complementary businesses, products and
technologies. If we are presented with appropriate opportunities, we intend to
actively pursue these acquisitions and/or investments. We may not, however,
realize the anticipated benefits of any acquisition or investment. If we buy a
company, we could have difficulty in assimilating that company's personnel,
technology, operations or products into our operations. In addition, the key
personnel of the acquired company may decide not to work for us. These
difficulties could disrupt our ongoing business, distract our management and
employees and increase our expenses. Acquisitions or business combinations could
also cause us to issue equity securities that would dilute your percentage
ownership in us, incur debt or assume contingent liabilities and take large
immediate or future write-offs or charges, including amortization of goodwill or
compensation expense. Each of these results could materially and adversely
affect our business and adversely affect the price of our common stock.
IF WE ARE UNABLE TO PROTECT OUR INTELLECTUAL PROPERTY RIGHTS, OUR
COMPETITIVE POSITION COULD BE HARMED OR WE COULD BE REQUIRED TO INCUR
EXPENSES TO ENFORCE OUR RIGHTS
We rely upon registered trademark rights in the United States for our
commercial use of the ARTISTdirect, UBL, Ultimate Band List, and iMusic brand
names and their respective associated domain names, and common-law trademark
rights that arise from our commercial use of the ARTISTdirect Agency brand name,
and its associated domain name, and the ARTISTdirect logo. We seek to protect
our trademarks, copyrights and other proprietary rights by registration and
other means, but these actions may be inadequate. We have trademark applications
pending in several jurisdictions, but our registrations may not be accepted or
may be preempted by third parties and/or we may not be able to register our
trademarks in all jurisdictions in which we intend to do business. We generally
enter into confidentiality or license agreements with our employees, consultants
and corporate partners, and generally control access to and distribution of our
proprietary information.
19
The steps we have taken may not prevent misappropriation of our proprietary
rights, particularly in foreign countries where laws or law enforcement
practices may not protect our proprietary rights as fully as in the United
States. If third parties were to use or otherwise misappropriate our copyrighted
materials, trademarks or other proprietary rights without our consent or
approval, our competitive position could be harmed, or we could become involved
in litigation to enforce our rights. In addition, policing unauthorized use of
our content, trademarks and other proprietary rights could be very expensive,
difficult or impossible, particularly given the global nature of the Internet.
OUR ACCESS TO COPYRIGHTED CONTENT DEPENDS UPON THE WILLINGNESS OF CONTENT
OWNERS TO MAKE THEIR CONTENT AVAILABLE
The music content available on the ARTISTdirect Network is typically
comprised of copyrighted works owned or controlled by multiple third parties.
Most of the content on our artist-specific Web sites is either owned or licensed
by the artist. On other parts of the ARTISTdirect Network, depending on the
nature of the content and how we use the music content, we typically license
such rights from publishers, record labels, performing rights societies or
artists. We frequently either do not have written contracts or have short-term
contracts with copyright owners, and, accordingly, our access to copyrighted
content depends upon the willingness of such parties to continue to make their
content available. If the fees for music content increase substantially or if
significant music content becomes unavailable, our ability to offer music
content could be materially limited.
We have not obtained a license for some of the content offered on the
ARTISTdirect Network, including links to other music-related sites and
thirty-second streamed song samples, because we believe that a license is not
required under existing law. However, this area of law remains uncertain and may
not be resolved for a number of years. When this area of law is resolved, we may
be required to obtain licenses for such content, alter or remove the content
from our Web sites and be forced to pay potentially significant financial
damages for past conduct.
INTELLECTUAL PROPERTY CLAIMS AGAINST US COULD BE COSTLY AND COULD RESULT IN
THE LOSS OF SIGNIFICANT RIGHTS
Third parties may assert trademark, copyright, patent and other types of
infringement or unfair competition claims against us. If we are forced to defend
against any such claims, whether they are with or without merit or are
determined in our favor, we may face costly litigation, loss of access to, and
use of, content, diversion of technical and management personnel, or product
shipment delays. As a result of such a dispute, we may have to develop
non-infringing technology or enter into royalty or licensing agreements. Such
royalty or licensing agreements, if required, may be unavailable on terms
acceptable to us, or at all. While we have resolved all such disputes in the
past, we may not be able to do so in the future. If there is a successful claim
of infringement against us and we are unable to develop non-infringing
technology or license the infringed or similar technology or content on a timely
basis, it could harm our business.
In addition, we rely on third parties to provide services enabling our
online product sales transactions, including credit card processing, order
fulfillment and shipping. We could become subject to infringement actions by
third parties based upon our use of intellectual property provided by our
third-party providers. It is also possible that we could become subject to
infringement actions based upon the content licensed from third parties. Any
such claims or disputes could subject us to costly litigation and the diversion
of our financial resources and technical and management personnel. Further, if
our efforts to enforce our intellectual property rights are unsuccessful or if
claims by third parties against ARTISTdirect, the UBL and iMusic are successful,
we may be required to change our trademarks, alter or remove content, pay
financial damages, or alter our business practices. These
20
changes of trademarks, alteration of content, payment of financial damages or
alteration of practices may adversely affect our business.
WE MAY BE UNABLE TO ACQUIRE NECESSARY WEB DOMAIN NAMES
We may be unable to acquire or maintain Web domain names relating to our
brand or to artist-specific Web sites in the United States and other countries
in which we may conduct business. We currently hold various relevant domain
names, including the "artistdirect.com," "ubl.com," "imusic.com" and
"downloadsdirect.com" domain names. The acquisition and maintenance of domain
names generally is regulated by governmental agencies and their designees and is
subject to change. The relationship between regulations governing domain names
and laws protecting trademarks and similar proprietary rights is unclear.
Therefore, we could be unable to prevent third parties from acquiring or using
domain names that infringe or otherwise decrease the value of our brand name,
trademarks and other proprietary rights.
IF OUR ONLINE SECURITY MEASURES FAIL, WE COULD LOSE VISITORS TO OUR SITES
AND COULD BE SUBJECT TO CLAIMS FOR DAMAGE FROM OUR USERS, CONTENT
PROVIDERS, ADVERTISERS AND MERCHANTS
Our relationships with consumers would be adversely affected and we may be
subject to claims for damage if the security measures that we use to protect
their personal information, especially credit card numbers, are ineffective. We
rely on security and authentication technology that we license from third
parties to perform real-time credit card authorization and verification with our
bank. We cannot predict whether events or developments will result in a
compromise or breach of the technology we use to protect a customer's personal
information.
Our infrastructure is vulnerable to unauthorized access, physical or
electronic computer break-ins, computer viruses and other disruptive problems.
Internet service providers have experienced, and may continue to experience,
interruptions in service as a result of the accidental or intentional actions of
Internet users, current and former employees and others. Anyone who is able to
circumvent our security measures could misappropriate proprietary information or
cause interruptions in our operations. Security breaches relating to our
activities or the activities of third-party contractors that involve the storage
and transmission of proprietary information could damage our reputation and our
relationships with our content providers, advertisers and merchants. We also
could be liable to our content providers, advertisers and merchants for the
damages caused by such breaches or we could incur substantial costs as a result
of defending claims for those damages. We may need to expend significant capital
and other resources to protect against such security breaches or to address
problems caused by such breaches. Our security measures may not prevent
disruptions or security breaches.
WE MAY BE SUBJECT TO LIABILITY IF PRIVATE INFORMATION PROVIDED BY OUR USERS
WERE MISUSED
Our privacy policy discloses how we use individually identifiable
information that we collect. This policy is displayed and accessible throughout
the ARTISTdirect Network. Despite this policy, however, if third persons were
able to penetrate our network security or otherwise misappropriate our users'
personal information or credit card information, we could be subject to
liability. We could also be subject to liability for claims for unauthorized
purchases with credit card information, impersonation or other similar fraud
claims, or other misuses of personal information, such as for unauthorized
marketing purposes. These claims could result in costly and time-consuming
litigation.
21
CHANGES IN LAWS OR REGULATIONS MAY ADVERSELY AFFECT OUR ABILITY TO COLLECT
DEMOGRAPHIC AND PERSONAL INFORMATION FROM USERS, OR TO DISPLAY CERTAIN
CONTENT ON OUR SITES, AND COULD AFFECT OUR ABILITY TO ATTRACT ADVERTISERS
Legislatures and government agencies have adopted and are considering
adopting additional laws and regulations regarding the collection, use and
disclosure of personal information obtained from individuals when accessing Web
sites. For example, the Children's Online Privacy Protection Act restricts the
ability of Internet companies to collect information from children under the age
of 13 without their parents' consent. In addition, the Federal Trade Commission
and state and local authorities have been investigating Internet companies
regarding their use of personal information. Our privacy programs may not
conform with laws or regulations that are adopted. In addition, these
legislative and regulatory initiatives may adversely affect our ability to
collect demographic and personal information from users, which could have an
adverse effect on our ability to provide advertisers with demographic
information. These initiatives may also affect our ability to conduct electronic
commerce.
The European Union has adopted a directive that imposes restrictions on the
collection and use of personal data. The directive imposes restrictions that are
more stringent than current Internet privacy standards in the United States. If
this directive were enforced against us, it could prevent us from collecting
data from users in European Union member countries or subject us to liability
for use of information in contravention of the directive. Other countries have
adopted or may adopt similar legislation. We could incur additional expenses if
new regulations regarding the use of personal information are introduced or if
government authorities choose to investigate our privacy practices.
In addition, legislatures and government agencies have adopted and are
considering adopting additional laws and regulations governing the content of
material transmitted over the Internet. These include laws relating to
obscenity, indecency, libel and defamation. For example, the Child Online
Protection Act, or COPA, prohibits and imposes criminal penalties and civil
liability on anyone communicating material harmful to minors through the
Internet for commercial purposes, unless access to such material is blocked to
minors under age 17. The Third U.S. Circuit Court of Appeals has upheld a
preliminary injunction precluding enforcement of COPA. We could be liable if the
injunction against COPA is lifted and if content delivered by us or placed on
our Web sites violates COPA. Such a result may adversely affect our ability to
attract users under age 17 and, consequently, may adversely affect our ability
to attract advertisers.
WE MAY CONTINUE TO HAVE CONTINGENT LIABILITY EVEN AFTER THIS RESCISSION
OFFER IS MADE DUE TO OUR ISSUANCES OF SECURITIES IN VIOLATION OF SECURITIES
LAWS
We have issued shares and options to purchase shares of our common stock to
our employees and to artists and their managers and advisors. Due to the nature
of the persons who received these shares and options in addition to our
employees and the total number of shares and options issued to them and our
employees, the issuance of some of these shares and options did not comply with
the requirements of Rule 701 under the Securities Act of 1933, as amended, or
any other available exemptions from the registration requirements of Section 5
of the Securities Act, and may not have qualified for any exemption from
qualification or registration under applicable state securities laws either.
As a result, we are making this rescission offer to all these persons
pursuant to a registration statement filed under the Securities Act and pursuant
to applicable state securities law. In this rescission offer, we are offering to
repurchase from these persons all shares purchased by these persons pursuant to
option exercises by these persons before the expiration of the rescission offer
(regardless of whether these persons have subsequently sold their shares) for an
amount equal to the purchase or exercise price paid for these purchased shares,
plus interest from the date of purchase
22
until the rescission offer expires, at the current statutory rate per year
mandated by the state in which the shares were purchased, or at 7% per year if a
"private placement" exemption was available in a particular state or if the
shares were otherwise issued in compliance with state law (less any amounts
received if these persons have already sold their shares). The rescission offer
will expire approximately 30 days after the effective date of the registration
statement filed with this prospectus. Based upon the number of options exercised
through September 30, 2001, and assuming that all such issued shares are
tendered in the rescission offer, the out-of-pocket cost to us would be
approximately $2.2 million, plus interest of $280,000. See "Capitalization" on
page 39 for more information regarding the financial effect of the rescission
offer, assuming that it is accepted in its entirety.
In addition, we are also offering to repurchase all unexercised options
granted to these persons (regardless of whether the options have expired) at 20%
of the option exercise price times the number of option shares, plus interest
from the date the options were granted until the rescission offer expires, at
the current statutory rate per year mandated by the state in which the options
were granted, or at 7% per year if a "private placement" exemption was available
in a particular state or if the options were otherwise granted in compliance
with state law. In addition, although we believe that the shares purchased and
options granted in Florida, Illinois, Nevada, New Jersey, Tennessee and Texas
complied with applicable "private placement" exemptions in those states, and
that the shares purchased and options granted in New York and any foreign
countries are subject to rescission rights only under federal law, we will
nonetheless offer to repurchase those shares issued pursuant to option exercises
made before the expiration of this rescission offer (even if those shares were
subsequently sold), at the purchase or exercise price paid for those shares
(less any amounts received if the shares have already been sold), and to
repurchase all unexercised options granted (even if the options have expired) at
20% of the option exercise price multiplied by the number of shares subject to
such options, all together with interest at an annual rate of 7% on amounts paid
for shares purchased and options granted in those states and foreign countries.
Based on the number of options outstanding as of September 30, 2001, and
assuming that none of these options are exercised prior to the end of the
rescission offer, and, further, that all such options are tendered in the
rescission offer, the cost to us in repurchasing such options would be
approximately $7.7 million, plus interest of $1.0 million. Accordingly, should
all of these persons accept our rescission offer, our maximum out-of-pocket cost
will be approximately $11.2 million. See "Capitalization" on page 39 for more
information regarding the financial effect of the rescission offer, assuming
that it is accepted in its entirety.
The Securities Act does not expressly provide that a rescission offer will
terminate a purchaser's right to rescind a sale of stock which was not
registered under the Securities Act as required. Accordingly, should any
offerees reject the rescission offer, we may continue to be contingently liable
under the Securities Act for the purchase price of their shares and options
which were not issued in compliance with the Securities Act or applicable state
securities laws. In addition, it is possible that offerors may claim that the
consideration offered to them in this rescission offer is insufficient, in which
case we may have additional liability. If we are required to repurchase all of
the shares subject to the rescission offer or if we incur any other liability
with respect to rescission claims, our operating results and liquidity during
the period in which such repurchase or liability occurs could be adversely
affected.
RISKS RELATED TO OUR INDUSTRY
WE MAY BE SUED FOR CONTENT AVAILABLE OR POSTED ON OUR WEB SITES OR PRODUCTS
SOLD THROUGH OUR WEB SITES OR FOR LINKING AND FRAMING OF THIRD-PARTY WEB
SITES
We may be liable to third parties for content published on our Web sites
and other Web sites where our syndicated content appears if the music, artwork,
text or other content available violates their copyright, trademark or other
intellectual property rights or if the available content is defamatory, obscene
or pornographic. Similar claims have been brought, sometimes successfully,
23
against Web site operators in the past. We also may be liable for content
uploaded or posted by our users on our Web sites, such as digitally distributed
music files, postings on our message boards, chat room discussions and
copyrightable works. In addition, we could have liability to some of our content
licensors for claims made against them for content available on our Web sites.
We also could be exposed to these types of claims for content that may be
accessed from our Web sites or via links to other Web sites or for products sold
through our Web site. While we have resolved all of these types of claims made
against us in the past, we may not be able to do so in the future. We intend to
implement measures to reduce exposure to these types of claims, but such
measures may not be successful and may require us to expend significant
resources. Any litigation as a result of defending these types of claims could
result in substantial costs and damages. Our insurance may not adequately
protect us against these types of claims or the costs of their defense or
payment of damages.
We link to and "frame" third-party Web sites of our artists without express
written permission to do so. In addition, in the past we have provided a search
feature to allow users to find music residing elsewhere on the Internet. Those
practices are controversial, and have, in instances not involving us, resulted
in litigation. Various claims, including trademark and copyright infringement,
unfair competition, and commercial misappropriation, as well as infringement of
the right of publicity may be asserted against us as a result. The law regarding
linking and framing remains unsettled; it is uncertain as to how existing laws,
especially trademark and copyright law, will be applied by the judiciary to the
Internet. Also, Congress is increasingly active in passing new laws related to
the Internet, and there is uncertainty as to the impact of future potential
laws, especially those involving domain names, databases and privacy.
SOFTWARE PROGRAMS THAT PREVENT OR LIMIT THE DELIVERY OF ADVERTISING MAY
SERIOUSLY DAMAGE OUR ABILITY TO ATTRACT AND RETAIN ADVERTISERS
A number of "filter" software programs have been developed which limit or
prevent advertising from being delivered to an Internet user's computer. This
software could adversely affect the commercial viability of Internet
advertising. These programs attempt to blank out, or block, banner and other
advertisements. To date, such programs have not had a material adverse impact on
our ability to attract and retain advertisers or caused us to fail to meet the
terms of our advertising agreements. These programs may, however, have these
effects on us in the future. Widespread adoption of this type of software would
seriously damage our ability to attract and retain advertisers.
WE MAY NEED TO CHANGE THE MANNER IN WHICH WE CONDUCT OUR BUSINESS IF
GOVERNMENT REGULATION INCREASES
There are currently few laws or regulations that specifically regulate
communications or commerce on the Internet. Laws and regulations may be adopted
in the future, however, that address issues such as user privacy, pricing,
taxation, content, copyrights, distribution, security, and the quality of
products and services. Several telecommunications companies have petitioned the
Federal Communications Commission to regulate Internet service providers and
online services providers in a manner similar to long distance telephone
carriers and to impose access fees on these companies. Any imposition of access
fees could increase the cost of transmitting data over the Internet. In
addition, the growth and development of the market for online commerce may lead
to more stringent consumer protection laws, both in the United States and
abroad, that may impose additional burdens on us. The United States Congress has
enacted Internet laws regarding children's privacy, copyrights, taxation and the
transmission of sexually explicit material. The law of the Internet, however,
remains largely unsettled, even in areas where there has been some legislative
action. Moreover, it may take years to determine the extent to which existing
laws relating to issues such as property ownership, libel and
24
personal privacy are applicable to the Web. Any new, or modifications to
existing, laws or regulations relating to the Web could adversely affect our
business.
Prohibition and restriction of Internet content and commerce could reduce
or slow Internet use, decrease the acceptance of the Internet as a
communications and commercial medium and expose us to liability. Any of these
outcomes could have a material adverse effect on our business, results of
operations and financial condition. The growth and development of the market for
Internet commerce may prompt calls for more stringent consumer protection laws,
both in the United States and abroad, that may impose additional burdens on
companies conducting business over the Internet.
THE INTERNET IS SUBJECT TO RAPID CHANGES, WHICH COULD RESULT IN SIGNIFICANT
ADDITIONAL COSTS
The market for Internet products and services is characterized by rapid
change, evolving industry standards and frequent introductions of new
technological developments. These new standards and developments could make our
existing or future products or services obsolete. Keeping pace with the
introduction of new standards and technological developments could result in
significant additional costs or prove difficult or impossible for us. The
failure to keep pace with these changes and to continue to enhance and improve
the responsiveness, functionality and features of our Web sites could harm our
ability to attract and retain users. Among other things, we will need to license
or develop leading technologies, enhance our existing services and develop new
services and technologies that address the varied needs of our users.
OUR NET SALES COULD BE ADVERSELY AFFECTED IF WE BECOME SUBJECT TO SALES AND
OTHER TAXES
If one or more states or any foreign country successfully asserts that we
should collect sales or other taxes on the sale of our products, our net sales
and results of operations could be harmed. We do not currently collect sales or
other similar taxes for physical shipments of goods into states other than
California and Florida. However, one or more states may seek to impose sales tax
collection obligations on companies, such as ARTISTdirect, which engage in or
facilitate online commerce. A number of proposals have been made at the state
and local level that would impose additional taxes on the sale of goods and
services through the Internet. Such proposals, if adopted, could substantially
impair the growth of electronic commerce and could adversely affect our
opportunity to derive financial benefit from electronic commerce. Moreover, if
any state or foreign country were to successfully assert that we should collect
sales or other taxes on the exchange of merchandise on its system, our results
of operations could be adversely affected. In addition, any operations in states
outside California and Florida could subject our shipments in such states to
state sales taxes under current or future laws.
Congress has enacted legislation limiting the ability of the states to
impose taxes on Internet-based transactions. This legislation, known as the
Internet Tax Freedom Act, imposed a moratorium on state and local taxes on
electronic commerce where such taxes are discriminatory and on Internet access
unless such taxes were generally imposed and actually enforced before October 1,
1998. This moratorium ended on October 21, 2001 and has not been renewed.
Failure to renew this legislation would allow various states to impose taxes on
Internet-based commerce.
OUR SUCCESS DEPENDS ON THE CONTINUED DEVELOPMENT AND MAINTENANCE OF THE
INTERNET AND THE AVAILABILITY OF INCREASED BANDWIDTH TO CONSUMERS
The success of our business will rely on the continued improvement of the
Internet as a convenient means of consumer interaction and commerce, as well as
an efficient medium for the delivery and distribution of music. Our business
will depend on the ability of our artists and consumers to conduct commercial
transactions with us, as well as to continue to upload and download music files,
without significant delays or aggravation that may be associated with decreased
25
availability of Internet bandwidth and access to our Web site. This will depend
upon the maintenance of a reliable network with the necessary speed, data
capacity and security, as well as timely development of complementary products,
such as high-speed modems, for providing reliable Internet access and services.
The failure of the Internet to achieve these goals will reduce our ability to
generate significant revenue.
Our penetration of a broader consumer market will likely depend, in part,
on continued proliferation of high speed Internet access. The Internet has
experienced, and is likely to continue to experience, significant growth in the
numbers of users and amount of traffic. As the Internet continues to experience
increased numbers of users, increased frequency of use and increased bandwidth
requirements, the Internet infrastructure may be unable to support the demands
placed on it. In addition, increased users or bandwidth requirements may harm
the performance of the Internet.
The Internet has experienced a variety of outages and other delays and it
could face outages and delays in the future. These outages and delays could
reduce the level of Internet usage as well as the level of traffic, and could
result in the Internet becoming an inconvenient or uneconomical source of music
and related products and merchandise which would cause our revenue to decrease.
The infrastructure and complementary products or services necessary to make the
Internet a viable commercial marketplace for the long term may not be developed
successfully or in a timely manner. Even if these products or services are
developed, the Internet may not become a viable commercial marketplace for the
products or services that we offer.
RISKS RELATED TO THE OFFER
OUR EXECUTIVE OFFICERS, DIRECTORS AND MAJOR STOCKHOLDERS BENEFICIALLY OWN
APPROXIMATELY 61.0% OF OUR OUTSTANDING COMMON STOCK AND CONSEQUENTLY ARE
ABLE TO EXERCISE SIGNIFICANT CONTROL OVER ARTISTdirect.
As of September 30, 2001, our executive officers, directors and holders of
5% or more of the outstanding ARTISTdirect common stock together beneficially
owned approximately 61.0% of our outstanding common stock. These stockholders
are able to significantly influence all matters requiring approval by our
stockholders, including the election of directors and the approval of
significant corporate transactions. This concentration of ownership may also
have the effect of delaying, deterring or preventing a change in control of
ARTISTdirect and may make some transactions more difficult or impossible to
complete without the support of these stockholders.
IT MAY BE DIFFICULT FOR A THIRD PARTY TO ACQUIRE OUR COMPANY, AND THIS COULD
PREVENT CHANGES IN OUR MANAGEMENT.
We are subject to the Delaware anti-takeover laws regulating corporate
takeovers. These anti-takeover laws prevent a Delaware corporation from engaging
in a business combination involving a merger or sale of more than 10% of its
assets with any stockholder, including all affiliates and associates of the
stockholder, who owns 15% or more of the corporation's outstanding voting stock,
for three years following the date that the stockholder acquired 15% or more of
the corporation's stock unless:
- prior to such date, the board of directors approved either the business
combination or the transaction where the stockholder acquired 15% or more
of the corporation's stock;
- after the transaction where the stockholder acquired 15% or more of the
corporation's stock, the stockholder owned at least 85% of the
corporation's outstanding voting stock, excluding shares owned by
directors, officers and employee stock plans in which employee
participants do not have the right to determine confidentially whether
shares held under the plan will be tendered in a tender or exchange
offer; or
- on or after such date, the business combination is approved by the board
of directors and authorized at an annual or special meeting of
stockholders by the affirmative vote of the
26
holders of at least two-thirds of the outstanding voting stock that is
not owned by the stockholder who owns 15% or more of the corporation's
stock.
A Delaware corporation may opt out of the Delaware anti-takeover laws if
its certificate of incorporation or bylaws so provide. We have not opted out of
the provisions of the anti-takeover laws. As such, these laws prohibit or delay
mergers or other takeovers or changes of control of ARTISTdirect and may
discourage attempts by other companies to acquire us.
Our certificate of incorporation and our bylaws include a number of
provisions that may delay, deter or impede hostile takeovers or changes of
control or management. These provisions include:
- our board is classified into three classes of directors as nearly equal
in size as possible with staggered three year-terms;
- the authority of our board to issue up to five million shares of
preferred stock and to determine the price, rights, preferences and
privileges of these shares, without stockholder approval;
- all stockholder actions must be effected at a duly called meeting of
stockholders and not by written consent;
- special meetings of the stockholders may be called only by the Chairman
of the Board, the Chief Executive Officer or the Board; and
- the elimination of cumulative voting.
Our certificate of incorporation and bylaws provide that we will indemnify
officers and directors against losses that may incur in investigations and legal
proceedings resulting from their services to us, which may include services in
connection with takeover defense measures. These provisions may have the effect
of preventing changes in our management.
OUR COMMON STOCK PRICE HAS BEEN VOLATILE, WHICH COULD RESULT IN SUBSTANTIAL
LOSSES FOR INDIVIDUAL STOCKHOLDERS.
The market prices of Internet-related stocks, including our common stock,
have been volatile and we expect that they will continue to be volatile. In
particular, our common stock may be subject to significant fluctuations in
response to a variety of factors, including but not limited to:
- general economic conditions;
- actual or anticipated variations in quarterly operating results;
- changes in financial estimates by securities analysts;
- failure to meet analyst predictions and projections;
- changes in market valuations of media and online e-commerce companies;
- new products or services offered by us or our competitors;
- announcements of significant acquisitions, strategic partnerships, joint
ventures or capital commitments by us or our competitors;
- additions or departures of key personnel;
- our sales of common stock or other securities in the future; and
- other events or factors, many of which are beyond our control.
In addition, the average trading volume of our common stock has been
extremely low for the past several months. As a result, our stock price may be
susceptible to significant volatility on a day-
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to-day basis, depending on the number of shares traded on any given day. Due to
these factors, you may not be able to sell your stock at or above the price you
paid for it, which could result in substantial losses.
WE MAY NOT BE ABLE TO SECURE ADDITIONAL FINANCING TO MEET OUR FUTURE
CAPITAL NEEDS
We currently anticipate that our available cash resources will be
sufficient to meet our anticipated needs for working capital and capital
expenditures for at least the next eighteen months, including our significant
financial commitment to the record label co-venture with Frederick Field. There
can be no assurance, however, that the underlying assumed levels of revenue and
expenses will prove to be accurate. If our available cash and cash flows from
operations are insufficient to meet our anticipated needs for working capital
and capital expenditures, we will need to raise additional funds to continue our
operations, promote our brands, develop new or enhanced services, respond to
competitive pressures or make acquisitions. In light of the decline in our stock
price and the recent extreme volatility in the capital markets, we may be unable
to obtain any required additional financing on terms favorable to us, if at all.
If adequate funds are not available on acceptable terms, we may be unable to
fund our expansion, successfully promote our brands, develop or enhance
services, respond to competitive pressures or take advantage of acquisition
opportunities, any of which could have a material adverse effect on our
business. If we raise additional funds through the issuance of equity
securities, our stockholders may experience dilution of their ownership
interest, and the newly-issued securities may have rights superior to those of
the common stock. If we raise additional funds by issuing debt, we may be
subject to limitations on our operations, including limitations on the payment
of dividends.
SUBSTANTIAL SALES OF OUR COMMON STOCK COULD CAUSE OUR STOCK PRICE TO FALL
If our stockholders sell substantial amounts of our common stock, including
shares issued upon the exercise of outstanding options and warrants, in the
public market following this offering, the market price of our common stock
could fall. Such sales also might make it more difficult for us to sell equity
or equity-related securities in the future at a time and price that we deem
appropriate. We had outstanding 3,554,708 shares of common stock as of September
30, 2001. All of these shares, other than shares held by affiliates, are freely
tradable.
SALES OF STOCK TO EMPLOYEES, ARTISTS AND KEY INDIVIDUALS WILL REDUCE YOUR
OWNERSHIP PERCENTAGE
We seek to attract and retain officers, directors, employees, artists and
other key individuals, in part by offering them stock options and other rights
to purchase shares of common stock. As of September 30, 2001, we had outstanding
options to purchase 1,194,688 shares of our common stock, including the options
granted to Frederick Field and excluding the options we assumed in our
acquisition of Mjuice.com, Inc., and had reserved a total of an additional
614,906 shares for future grants under our three option plans. The exercise of
stock options will reduce your percentage ownership in ARTISTdirect.
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OUR RESCISSION OFFER
BACKGROUND
From August 1, 1998 through March 21, 2000:
- we issued options to purchase an aggregate of 795,932 shares of our
common stock under our 1999 Employee Stock Option Plan, 1999 Artist Stock
Option Plan and 1999 Artist and Artist Advisor Stock Option Plan at
exercise prices ranging from $12.40 to $140.00 per share;
- we issued 58,572 shares of our common stock upon the exercise of some of
these options at exercise prices ranging from $12.40 to $40.00 per share;
and
Some of these stock and option issuances may not have been exempt from
registration or qualification under federal and applicable state securities
laws. As a result, we may have failed to comply with the registration or
qualification requirements of federal and applicable state securities laws
because we did not register or qualify these stock and option issuances under
either federal or applicable state securities laws.
Because of the frequency and number of sales, including the number of
persons who received offers and purchased shares, pursuant to our 1999 Employee
Stock Option Plan, 1999 Artist Stock Option Plan and 1999 Artist and Artist
Advisor Stock Option Plan, we do not believe that a valid exemption under the
Securities Act of 1933, as amended, was available for these stock and option
issuances. We also do not believe that the federal exemption provided by Rule
701 of the Securities Act was available for these stock and option issuances
pursuant to our 1999 Employee Stock Option Plan, 1999 Artist Stock Option Plan
and our 1999 Artist and Artist Advisor Stock Option Plan because the amount of
securities sold exceeded the limits set forth in Rule 701 and because our
artists and their managers and advisors may not have qualified as consultants
pursuant to Rule 701.
The stock and option issuances under our 1999 Employee Stock Option Plan,
1999 Artist Stock Option Plan and our 1999 Artist and Artist Advisor Stock
Option Plan also may have failed to meet the qualification or registration
requirements of applicable state securities laws.
We are offering to repurchase all shares purchased directly or pursuant to
option exercises (regardless of whether the shares have been subsequently sold),
at the purchase or exercise price paid for those shares, plus interest from the
date the shares were purchased (less any amounts received if the shares have
already been sold). Based upon the number of issued shares through September 30,
2001, and assuming that all such issued shares are tendered in this rescission
offer, the out-of-pocket cost to us of repurchasing those issued shares would be
approximately $2.2 million, plus interest of $280,000. In addition, we are
offering to repurchase all vested and unvested unexercised options granted
(regardless of whether the options have expired) at 20% of the option exercise
price times the number of option shares, plus interest from the date the options
were granted. Based on the number of options outstanding as of September 30,
2001, and assuming that none of these options are exercised prior to the end of
this rescission offer, and further, that all such options are tendered in the
rescission offer, the cost to us in repurchasing such options would be
approximately $7.7 million, plus interest of $1.0 million. Accordingly, should
all of the offerees accept our rescission offer, our maximum out-of-pocket cost
will be approximately $11.2 million. While these amounts are significant, we do
not believe that payment of such amounts will create a material hardship on our
ability to operate our business.
The Securities Act does not expressly provide that a rescission offer will
terminate a purchaser's right to rescind a sale of stock, which was not
registered under the Securities Act as required. Accordingly, should any
offerees reject this rescission offer, we may continue to be contingently liable
under the Securities Act for the purchase price of their shares and options
which were not issued in compliance with the Securities Act or applicable state
securities laws. In addition, it is possible that
29
offerees may claim that the consideration offered to them in this rescission
offer is insufficient, in which case we may have additional liability.
If we are required to repurchase all of the shares subject to this
rescission offer, our operating results and liquidity during the period in which
such repurchase occurs could be adversely affected.
RESCISSION OFFER AND PRICE
Because the stock and option issuances discussed above failed to comply
with federal and in some cases, state securities laws, we may have incurred a
contingent liability with respect to these shares and options because persons
who received such options and/or purchased such shares by exercising these
options may have a claim against us for the issuance of these options and
shares. Accordingly, we are offering to rescind the issuance of options and
shares under our 1999 Employee Stock Option Plan, 1999 Artist Stock Option Plan
and 1999 Artist and Artist Advisor Stock Option Plan prior to the effectiveness
of our registration statement on Form S-1 filed on March 27, 2000. Our
rescission offer is not a waiver by us of any applicable statutes of
limitations.
If you accept our rescission offer, we will repurchase any shares that you
purchased pursuant to an option exercise and that is subject to the rescission
offer (regardless of whether you subsequently sold the shares) at the price per
share you paid to us plus interest from the date of purchase by you to the
expiration date of the rescission offer, at the current statutory rate per year
mandated by the state in which the shares were purchased by you, or at 7% per
year if a "private placement" exemption was available in a particular state or
if the shares were otherwise issued in compliance with state law (less any
amounts received if you have sold the shares). In addition, if you accept our
rescission offer, we will repurchase all vested and unvested unexercised options
to purchase stock that you hold (regardless of whether the options have expired)
at 20% of the option exercise price multiplied by the number of shares subject
to such options plus interest from the date of grant to you to the expiration
date of the rescission offer, at the current statutory rate per year mandated by
the state in which the options were granted to you, or at 7% per year if a
"private placement" exemption was available in a particular state or if the
options were otherwise issued in compliance with state law.
Depending on the state in which the shares were purchased by you or the
options were granted to you, you will be entitled to receive interest at the
following annual rate: 10% in Arizona or Maryland; 9% in Oregon; 8% in
Washington; 7% in California, Florida, Illinois, Nevada, New Jersey, New York,
Tennessee, Texas or any foreign countries; and 6% in Georgia, Massachusetts or
Michigan.
In addition, although we believe that the shares purchased by you and the
options granted to you in Florida, Illinois, Nevada, New Jersey, Tennessee and
Texas complied with applicable "private placement" exemptions in those states,
and that the shares purchased by you and the options granted to you in New York
and any foreign countries are subject to rescission rights only under federal
law, we will nonetheless offer to repurchase those shares purchased by you
pursuant to option exercises you made before the expiration of this rescission
offer (even if you subsequently sold those shares), at the purchase or exercise
price paid for those shares (less any amounts received if you have sold the
shares), and to repurchase all unexercised options granted to you (even if the
options have expired) at 20% of the option exercise price multiplied by the
number of shares subject to such options, all together with interest at an
annual rate of 7% on amounts paid to you for shares purchased by you and options
granted to you in those states and foreign countries.
The options subject to the rescission offer have exercise prices ranging
from $12.40 to $140.00 per share. Accordingly, the repurchase price for the
vested and unvested unexercised options ranges from $2.48 to $28.00 per share,
which is 20% of the option exercise price, plus interest.
30
On November 13, 2001, the last reported sale price of our common stock on
The Nasdaq National Market was $6.07 per share. The range of closing prices, as
quoted on The Nasdaq National Market, from March 27, 2000 to November 13, 2001
has been $127.50 to $3.30. However, these prices are not necessarily indicative
of future performance, and no assurance can be given as to the level at which
the common stock will trade in the future.
ACCEPTANCE
You may accept our rescission offer in whole or in part by:
- completing and signing the election form accompanying this prospectus, a
form of which is attached hereto as Exhibit A; and
- delivering the certificates representing the shares being repurchased
and/or the option agreement representing the options being repurchased to
us on or before the expiration date of the rescission offer.
Unless otherwise indicated in the registration statement filed with this
prospectus, all acceptances of the rescission offer will be deemed to be
effective on the expiration date of the rescission offer. Unless you accept the
rescission offer before the expiration date, your right to accept the rescission
offer will terminate. You can revoke your acceptance or rejection of our
rescission offer prior to the expiration date. You can do this by completing and
submitting a new election form that is received by us prior to the expiration
date.
Payment for securities as to which the rescission offer has been accepted
will be made within fifteen business days after the expiration date.
OTHER TERMS AND CONDITIONS
We have not retained nor do we intend to retain any person to make
solicitations or recommendations to you in connection with our rescission offer.
Unless extended by us, our rescission offer will expire at 5:00 p.m.,
Pacific standard time, , 2001, thirty days after the effective date
of the registration statement filed with this prospectus.
Unless a fully completed and executed election form is received by the
expiration date from those persons receiving notice of the rescission offer
through this prospectus, the rescission offer will be deemed to have been
rejected by such offerees.
Neither we nor our officers or directors may make any recommendations to
you with respect to our rescission offer. We urge you to read this prospectus
carefully and to make an independent evaluation with respect to the rescission
offer.
If you decide to accept our rescission offer and intend to use the mail to
return your stock certificates to us, we recommend that you use insured
registered mail, return receipt requested.
EFFECT OF RESCISSION OFFER
We believe that your acceptance of the rescission offer will, under general
theories of estoppel, preclude you from later seeking similar relief, and we are
unaware of any federal or state case law to the contrary. However, we urge you
to consult with an attorney regarding all of your legal rights and remedies
before deciding whether or not to accept the rescission offer.
If you affirmatively reject or fail to accept our rescission offer, you
will retain ownership of the options and/or shares you received and will not
receive any cash for those securities. In addition, any shares issuable upon the
exercise of your currently unexercised options, will be registered under the
31
Securities Act and will be fully tradeable under the Securities Act (unless you
are an "affiliate" of ARTISTdirect within the meaning of Rule 144 of the
Securities Act) but will remain subject to any applicable terms and conditions
of the original agreement under which they were issued. You should note that if
you already exercised your options, we are not registering the shares that were
issued when you exercised your options and accordingly, you would only be able
to resell those shares pursuant to an exemption from registration; however we
believe that all such shares are currently eligible to be sold pursuant to the
exemption provided by Rule 144 of the Securities Act, as amended.
Our securities counsel, Brobeck, Phleger & Harrison LLP, has advised us
that the rescission offer will have the following effects. It is unclear whether
the rescission offer will terminate our liability, if any, for failure to
register the issuance of the shares and options that are subject to the
rescission offer with the Securities and Exchange Commission under the
Securities Act. The staff of the Securities and Exchange Commission takes the
position that a person's federal right of rescission may survive the rescission
offer. However, federal courts in the past have ruled that a person who rejects
or fails to accept a rescission offer is precluded from later seeking similar
relief. Generally, the statute of limitation for non-compliance with the
requirement to register securities under the Securities Act of 1933 is one year.
The state remedies and statutes of limitation vary and depend upon the state in
which the options were granted to you and/or the shares were purchased by you.
ARIZONA
Arizona law does not provide for voluntary rescission offers initiated by
an issuer as a means of curing non-compliance with the requirement to register
securities under the Arizona Securities Act. A purchaser may elect to void a
sale or contract for sale of any securities in violation of the registration
requirements of Arizona law, and may bring an action in a court of competent
jurisdiction to recover the consideration paid for the securities, with interest
(at 10% per year), taxable court costs and reasonable attorney fees, less the
amount of any income received by dividend or otherwise from ownership of the
securities, on tender of the securities purchased or the contract made, at any
time prior to the one year anniversary of the non-compliance with the
registration requirements.
In addition, the Arizona Corporation Commission has the administrative
authority to order a rescission offer. In that instance, the issuer must file
the following materials with and receive prior approval from the Director of the
Arizona Corporation Commission before distribution to the purchasers: (1) a
written offer to repurchase stating in reasonable detail the facts out of which
liability arose, including an offer of (a) cash (or other property as determined
by the Arizona Corporation Commission) equal to the fair market value of the
consideration paid (determined as of the date such purchase payment) or such
lesser amount as shall be ordered by the Arizona Corporation Commission,
together with (b) such amount or rate of interest as shall be ordered by the
Arizona Corporation Commission for the period from the date of purchase payment
to the date of repayment, less (c) the amount of any principal, interest, or
other distributions received on the security for the period from the date of
purchase payment to the date of repayment; (2) a prospectus and other documents
making full written disclosure about the financial and business condition of the
issuer and the financial and business risks associated with the retention of the
securities and any such further information as the Arizona Corporation
Commission may require; and (3) a statement that such offer may be accepted by
the purchaser at any time within a specified period of not less than 30 days
after the date of receipt thereof unless a shorter period of time is ordered by
the Arizona Corporation Commission. The issuer must also provide financial
statements prepared in accordance with applicable Arizona law, or other
appropriate documentation, to the Director of the Arizona Corporation Commission
demonstrating that the issuer has adequate funds to pay the rescission amount
ordered to all eligible purchasers.
32
It is unclear whether such an administrative action by the Arizona
Corporation Commission would be precluded by our rescission offer or any statute
of limitation. However, even if such an action were instituted, we believe that
our rescission offer complies in all material respects with the administrative
requirements of the Arizona Corporation Commission.
CALIFORNIA
Under California law, an issuer is civilly liable to a purchaser of its
securities sold in violation of the registration or qualification requirements
of the California Corporate Securities Law of 1968. The purchaser may sue to
recover the consideration paid for such securities with interest (at 7% per
year), less the amount of any income received from ownership of the securities,
upon the tender of such securities, at any time prior to the earlier of the two
year anniversary of the non-compliance with the registration or qualification
requirements or the one year anniversary of the discovery by the purchaser of
the facts constituting such non-compliance.
However, an issuer may cure its non-compliance with the requirement to
register or qualify securities under the California Corporate Securities Law of
1968 by making a written rescission offer before suit is commenced by the
purchaser, approved as to form by the California Commissioner of Corporations
(1) stating the respect in which liability under the registration or
qualification requirements may have arisen; (2) offering to repurchase the
securities for a cash price payable upon delivery of the securities or offering
to pay the purchaser an amount in cash equal in either case to the amount
recoverable by the purchaser, or offering to rescind the transaction by putting
the parties back in the same position as before the transaction; (3) providing
that such offer may be accepted by the purchaser at any time within a specified
period of not less than 30 days after the date of receipt of the offer unless
rejected earlier during such period by the purchaser; (4) setting forth the
provisions of the rescission offer requirements under the California Corporate
Securities Law of 1968; and (5) containing such other information as the
California Commissioner of Corporations may require by rule or order. If the
purchaser fails to accept such offer in writing within the specified period of
not less than 30 days after the date of receipt of the offer, that purchaser
will no longer have any right of rescission under California law. The issuer
must also file with the Commissioner of Corporations, in such form as the
Commissioner of Corporations by rule prescribes, an irrevocable consent
appointing the Commissioner of Corporations or its successor in office to be
such issuer's attorney to receive service of any lawful process in any
noncriminal suit, action or proceeding against such issuer or its successor,
which arises under California law after the consent has been filed, with the
same force and validity as if served personally on the issuer filing the
consent.
We believe that our rescission offer complies in all material respects with
the rescission offer requirements of the California Commissioner of Corporations
and have received a permit from the California Commissioner of Corporations to
proceed with the rescission offer.
GEORGIA
Under Georgia law, an issuer is civilly liable to a purchaser of its
securities sold in violation of the registration or qualification requirements
of the Georgia Securities Act of 1973. The purchaser may sue in any court of
competent jurisdiction to recover the consideration paid in cash (or the fair
value of the consideration at the time it was paid if such consideration was not
paid in cash) for such securities with interest (at 6% per year) from the date
of payment to the date of repayment, less the amount of any income received on
such securities, together with all taxable court costs and reasonable attorney's
fees, upon the tender of the securities at any time before the entry of
judgment, at any time prior to the two year anniversary of the contract for sale
or sale, if there is no contract for sale.
33
However, an issuer may cure its non-compliance with the requirement to
register or qualify securities under the Georgia Securities Act of 1973 by
making a written rescission offer pursuant to an effective registration
statement under the Georgia Securities Act of 1973, before suit is commenced by
the purchaser, to repay in cash or by certified or official bank check, within
30 days from the date of acceptance of such offer in exchange for the
securities, the fair value of the consideration paid (determined as of the date
such payment was originally paid by the purchaser), together with interest (at
6% per year) on such amount for the period from the date of payment to the date
of repayment, less the amount of any income received on the securities. If the
purchaser fails to accept such offer within 30 days of its receipt, or if such
offer was accepted and its terms were complied with by the issuer, that
purchaser will no longer have any right of rescission under Georgia.
We believe that our rescission offer complies in all material respects with
the rescission offer requirements of the Georgia Securities Act of 1973 and that
the registration statement filed with this prospectus satisfies the registration
statement requirements of the Georgia Securities Act of 1973.
MARYLAND
Under Maryland law, an issuer is civilly liable to a purchaser of its
securities sold in violation of the registration or qualification requirements
of the Maryland Securities Act. The purchaser may sue either at law or in equity
to recover the consideration paid for such securities, together with interest
(at 10% per year) from the date of payment, costs, and reasonable attorneys'
fees, less the amount of any income received on the securities, upon the tender
of the securities before entry of judgment, at any time prior to the earlier of
the three year anniversary of the contract for sale of such securities, or the
one year anniversary of the non-compliance with the registration or
qualification requirements.
However, an issuer may cure its non-compliance with the requirement to
register or qualify securities under the Maryland Securities Act by making a
written rescission offer, before suit, to refund the consideration paid together
with interest (at 10% per year) from the date of payment, less the amount of any
income received on the securities. If the purchaser fails to accept such offer
within 30 days of its receipt, that purchaser will no longer have any right of
rescission under Maryland law.
We believe that our rescission offer complies in all material respects with
the rescission offer requirements of the Maryland Securities Act.
MASSACHUSETTS
Under Massachusetts law, an issuer is civilly liable to a purchaser of its
securities sold in violation of the registration or qualification requirements
of the Massachusetts Uniform Securities Act. The purchaser may sue either at law
or in equity to recover the consideration paid for such securities, together
with interest (at 6% per year) from the date of payment, costs, and reasonable
attorneys' fees, less the amount of any income received on the securities, upon
the tender of the securities before entry of judgment, at any time prior to the
four year anniversary of the discovery of the non-compliance with the
registration or qualification requirements.
However, an issuer may cure its non-compliance with the requirement to
register or qualify securities under the Massachusetts Uniform Securities Act by
making a written rescission offer, before suit, to refund the consideration paid
together with interest (at 6% per year) from the date of payment, less the
amount of any income received on the securities. If the purchaser fails to
accept such offer within 30 days of its receipt, that purchaser will no longer
have any right of rescission under Massachusetts law.
We believe that our rescission offer complies in all material respects with
the rescission offer requirements of the Massachusetts Uniform Securities Act.
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MICHIGAN
Under Michigan law, an issuer is civilly liable to a purchaser of its
securities sold in violation of the registration or qualification requirements
of the Michigan Uniform Securities Act. The purchaser may sue either at law or
in equity to recover the consideration paid for such securities, together with
interest (at 6% per year) from the date of payment, costs, and reasonable
attorney fees, less the amount of income received on the securities, upon the
tender of the securities before entry of judgment, at any time prior to the two
year anniversary of the contract for sale of such securities.
However, an issuer may cure its non-compliance with the requirement to
register or qualify securities under the Michigan Uniform Securities Act by
making a written rescission offer, before suit, to refund the consideration paid
together with interest (at 6% per year) from the date of payment, less the
amount of any income received on the securities. The issuer must provide the
purchaser with documents making full written disclosure about the financial and
business condition of the issuer and the financial and business risks associated
with the retention of the securities, concurrently with the written rescission
offer. The rescission offer must recite the applicable provisions of the
Michigan Uniform Securities Act, and will not be valid unless the issuer
substantiates in the disclosure documents that it has the ability to fund the
offering. If the purchaser fails to accept such offer within 30 days of its
receipt, that purchaser will no longer have any right of rescission under
Michigan law. Acceptance or rejection of the offer will not be binding until 48
hours after receipt by the issuer.
We believe that our rescission offer complies in all material respects with
the rescission offer requirements of the Michigan Uniform Securities Act.
NEW YORK
Under New York law, there is no requirement to register or qualify
securities, and there is no provision for rescission offers. Accordingly, the
rescission offer is being made with respect to individuals who purchased shares
of our common stock and/or were granted options in New York, pursuant only to
federal rights of rescission. The acceptance or non-acceptance of the rescission
offer by these individuals will have no effect under New York law and,
accordingly, interest will be paid at the same rate as if such shares had been
purchased and/or options had been granted in California.
OREGON
Under Oregon law, an issuer is civilly liable to a purchaser of its
securities sold in violation of the registration requirements of the Oregon
Securities Law. The purchaser may sue to recover the consideration paid for such
securities, with interest (at 9% per year) from the date of payment, and
reasonable attorney fees, less any amount received on the securities, upon
tender of the securities before entry of judgment, at any time prior to the
three year anniversary of the sale of such securities.
However, an issuer may cure its non-compliance with the requirement to
register securities under the Oregon Securities Law by making a written
rescission offer pursuant to an effective registration statement under the
Oregon Securities Law (unless an exemption from registration is available),
before suit, that contains (1) an offer to pay the consideration paid for such
securities, and interest (at 9% per year) from the date of payment, and
reasonable attorney fees, less any amount received on the securities, upon
tender of the security; and (2) a statement of the effect on the purchaser's
rights of failure to respond to the offer. If the purchaser fails to accept such
offer within 30 days of its receipt, that purchaser will no longer have any
right of rescission under Oregon law.
We believe that our rescission offer complies in all material respects with
the rescission offer requirements of the Oregon Securities Law and that we are
exempt from the requirement to register this rescission offer under the Oregon
Securities Law.
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WASHINGTON
Under Washington law, an issuer is civilly liable to a purchaser of its
securities sold in violation of the registration or qualification requirements
of the Securities Act of Washington. The purchaser may sue either at law or in
equity to recover the consideration paid for such securities, together with
interest (at 8% per year) from the date of payment, costs, and reasonable
attorneys' fees, less the amount of any income received on the securities, upon
the tender of the securities before entry of judgment, at any time prior to the
three year anniversary of the contract for sale of such securities.
However, an issuer may cure its non-compliance with the requirement to
register or qualify securities under the Securities Act of Washington by making
a written rescission offer, which has been passed upon by the director of
financial institutions of Washington before suit, to refund the consideration
paid together with interest (at 8% per year) from the date of payment, less the
amount of any income received on the securities. If the purchaser receives such
offer before suit, that purchaser will no longer have any right of rescission
under Washington law.
We believe that our rescission offer complies in all material respects with
the rescission offer requirements of the Securities Act of Washington.
FLORIDA, ILLINOIS, NEVADA, NEW JERSEY, TENNESSEE AND TEXAS
Under the laws of Florida, Illinois, Nevada, New Jersey, Tennessee and
Texas, we believe that our issuance of shares and/or options complied with
applicable "private placement" exemptions in those states. Accordingly, the
rescission offer is being made with respect to individuals who purchased shares
of our common stock and/or were granted options in Florida, Illinois, Nevada,
New Jersey, Tennessee and Texas, pursuant only to federal rights of rescission.
The acceptance or non-acceptance of the rescission offer by these individuals
will have no effect under the laws of Florida, Illinois, Nevada, New Jersey,
Tennessee or Texas and, accordingly, interest will be paid at the same rate as
if such shares had been purchased and/or options had been granted in California.
FOREIGN COUNTRIES
If the shares were purchased and/or options were granted in a foreign
country, we believe that the only applicable rescission rights a purchaser has
under applicable U.S. law are those under federal securities laws. Accordingly,
the rescission offer is being made with respect to individuals who purchased
shares of our common stock and/or were granted options in foreign countries,
pursuant only to federal rights of rescission. The acceptance or non-acceptance
of the rescission offer by these individuals will have no effect under foreign
law and, accordingly, interest will be paid at the same rate as if such shares
had been purchased and/or options had been granted in California.
The above discussions do not relate to the antifraud provisions of
applicable securities laws or rights under common law or equity. We urge you to
consult with an attorney regarding all of your legal rights and remedies before
deciding whether or not to accept the rescission offer.
The shares subject to the rescission offer held by persons who choose not
to accept the rescission offer will, for purposes of applicable federal and
state securities law, be registered securities as of the expiration date of the
rescission offer and, unless held by persons who may be deemed to be
"affiliates" of us, will be freely tradable in the public market at such time
subject to the vesting rights under any stock restriction agreement with us.
Those shares held by our affiliates will be subject to restrictions on resale
provided in Rule 144 under the Securities Act of 1933.
36
FUNDING OF THE RESCISSION OFFER
We will fund any payments required under our rescission offer from a
portion of our existing cash balances. As of September 30, 2001, we had $60.6
million of cash and cash equivalents and short-term investments.
MATERIAL FEDERAL INCOME TAX CONSIDERATIONS
The following discussion summarizes the material federal income tax
considerations relevant to ARTISTdirect stockholders and/or optionholders who
hold shares or options that are subject to the rescission offer. We do not
discuss or analyze all income tax considerations that may be relevant to
particular ARTISTdirect stockholders and/or optionholders in light of their
individual circumstances, such as stockholders and/or optionholders who are
foreign persons, stockholders and/or optionholders who are not individuals, or
stockholders and/or optionholders subject to the alternative minimum tax
provisions of the Internal Revenue Code of 1986, as amended. In addition, we do
not address the tax consequences of the rescission offer to persons holding
shares and/or options that are subject to hedging, conversion, or constructive
sale transactions, or whose tax year is other than a calendar year. Finally, we
do not address any foregoing, state or local tax considerations. ACCORDINGLY,
ARTISTDIRECT STOCKHOLDERS AND/OR OPTIONHOLDERS ARE URGED TO CONSULT THEIR OWN
TAX ADVISORS AS TO THE SPECIFIC TAX CONSEQUENCES OF THE RESCISSION OFFER,
INCLUDING THE APPLICABLE FEDERAL, STATE, LOCAL AND FOREIGN TAX CONSEQUENCES TO
THEM OF THE RESCISSION OFFER.
HOLDERS OF SHARES
The law applicable to the federal income tax consequences of the rescission
offer is unclear and we have not received an opinion of counsel or a ruling from
the Internal Revenue Service regarding such tax consequences. The IRS is not
precluded from successfully asserting a contrary position or otherwise
recharacterizing the transaction in whole or in part.
We intend to take the tax reporting position that, with respect to the
share purchases rescinded pursuant to our rescission offer, the rescission
constitutes a return of the original purchase price for the shares, plus the
payment of interest which would be taxable as ordinary income. Any such interest
payments to employees or former employees will be subject to withholding at the
applicable tax rate.
OPTION HOLDERS
Individuals who accept the rescission offer with respect to their
outstanding vested and unvested unexercised stock options will recognize
immediate taxable income on the payment they receive for their rescinded
options, whether those options are incentive stock options or non-statutory
stock options under the federal tax laws. Such income will be taxable at
ordinary income rates and, in the case of payments to employees or former
employees, will be subject to withholding at the applicable tax rate.
The law applicable to the rescission offer is unclear and we have not
received an opinion of counsel or a ruling from the Internal Revenue Service to
that effect. Thus, the IRS is not precluded from successfully asserting a
contrary position or otherwise recharacterizing the transaction in whole or in
part.
37
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
Some of the statements under "Prospectus Summary," "Risk Factors,"
"Management's Discussion and Analysis of Financial Condition and Results of
Operations," "Business" and elsewhere in this prospectus constitute
forward-looking statements. These statements involve known and unknown risks,
uncertainties and other factors that may cause our actual results, levels of
activity, performance or achievements to be materially different from any future
results, levels of activity, performance, or achievements expressed or implied
by such forward-looking statements. Such factors include, among other things,
those listed under "Risk Factors" and elsewhere in this prospectus.
In some cases, you can identify forward-looking statements by terminology
such as "may," "will," "should," "could," "expects," "plans," "intends,"
"anticipates," "believes," "estimates," "predicts," "potential" or "continue" or
the negative of such terms or other comparable terminology.
Although we believe that the expectations reflected in the forward-looking
statements are reasonable, we cannot guarantee future results, levels of
activity, performance, or achievements. You should not place undue reliance on
these forward-looking statements.
DIVIDEND POLICY
We have never declared or paid any cash dividends on our capital stock. Our
predecessor, ARTISTdirect, LLC, made cash distributions to its members,
principally to pay taxes. We currently intend to retain all available funds and
any future earnings for use in the operation and expansion of our business, and
we do not expect to pay any cash dividends in the foreseeable future.
PRICE RANGE OF COMMON STOCK
Our common stock commenced trading on The Nasdaq National Market under the
symbol ARTD on March 27, 2000. The following table sets forth, for the periods
indicated, the intra-day high and low bid prices per share of common stock on
The Nasdaq National Market:
HIGH LOW
------ -------
2001
Third Quarter............................................... $ 7.00 $ 4.90
Second Quarter.............................................. 7.80 3.30
First Quarter............................................... 10.00 4.06
2000
Fourth Quarter.............................................. $15.00 $ 3.44
Third Quarter............................................... 38.75 11.25
Second Quarter.............................................. 82.50 27.50
On November 13, 2001 the last reported sale price for our common stock was
$6.07 per share. There were approximately 107 holders of record of our common
stock as of September 30, 2001.
38
CAPITALIZATION
The following table sets forth our actual capitalization as of September
30, 2001 and does not reflect:
- the 130,689 shares of common stock issuable upon exercise of warrants, of
which 59,180 were exercisable as of September 30, 2001 with a weighted
average exercise price of $78.90 per share;
- the 1,194,688 shares subject to outstanding options under our stock
option plans and the options granted to Mr. Field as of September 30,
2001. These outstanding option shares have a weighted average exercise
price of $40.07 per share;
- the 1,306 shares of common stock issuable upon exercise of warrants
assumed as part of the Mjuice.com, Inc. acquisition, all of which are
exercisable as of September 30, 2001 with a weighted average exercise
price of $45.00 per share and the 472 shares subject to outstanding
options under the stock option plans assumed as part of the Mjuice.com,
Inc. acquisition, with a weighted average exercise price of $30.14; and
- any exercise by stockholders and optionholders receiving the Rescission
Offer of their right to rescind, unless otherwise indicated.
The table below should be read in conjunction with our financial statements
and the notes to those financial statements, which are included elsewhere in
this prospectus:
(UNAUDITED)
AS OF SEPTEMBER 30, 2001
------------------------
ACTUAL PRO FORMA(1)
--------- ------------
(IN THOUSANDS)
Cash, cash equivalents and short term investments........... $ 60,600 $ 49,411
========= =========
Loans and notes payable..................................... 198 198
Redeemable securities:
Redeemable common securities -- issued and
outstanding:(2)........................................ 11,189 --
--------- ---------
Total redeemable securities............................ 11,189 --
--------- ---------
Stockholders' equity:
Common stock, $.01 par value, 150 million shares
authorized; 3,782,274 shares issued and 3,554,708
shares outstanding in 2001............................. 379 379
Treasury stock, 227,566 shares in 2001.................... (2,663) (3,004)
Additional paid in capital(1)............................. 198,861 208,249
Unearned compensation(1).................................. (9,428) (12,231)
Accumulated deficit(1).................................... (130,299) (136,543)
--------- ---------
Total stockholders' equity............................. 56,850 56,850
--------- ---------
Total capitalization.............................. $ 68,039 $ 56,850
========= =========
------------------------
(1) The pro forma amounts reflect the acceptance of the rescission offer by all
holders of common stock and unexercised options subject to the rescission
offer. The amounts also reflect stock based compensation expense of
approximately $6.2 million recognized immediately as a result of the
acceptance of the rescission offer by our employees holding unexercised
options and shares issued pursuant to exercised options that are subject to
the rescission offer as of September 30, 2001, as well as $4.9 million in
compensation charges that will be recognized as expense over future periods
related to non-employee option grants for services. See further discussion
of the pro forma compensation charges on pages 46 - 47.
(2) The redeemable common securities include 58,572 shares of common stock
issued pursuant to the exercise of stock options as of September 30, 2001,
which are subject to this rescission offer. In addition, redeemable common
securities includes unexercised options subject to this rescission offer.
39
SELECTED CONSOLIDATED FINANCIAL DATA
The selected consolidated financial data presented below for the period
from August 8, 1996 (inception) to December 31, 1996, for the years ended
December 31, 1997, 1998, 1999 and 2000 and as of December 31, 1996, 1997, 1998,
1999 and 2000 are derived from our audited financial statements. The selected
consolidated financial data below for the nine months ended September 30, 2000
and 2001 and as of September 30, 2001 are derived from our unaudited financial
statements.
You should read the financial data presented below together with
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and our financial statements and the related notes included in this
prospectus.
PERIOD FROM
AUGUST 8, 1996 NINE MONTHS ENDED
(INCEPTION) TO YEAR ENDED DECEMBER 31, SEPTEMBER 30,
DECEMBER 31, ---------------------------------------- ---------------------
1996 1997 1998 1999 2000 2000 2001
-------------- ------ ------- --------- --------- --------- ---------
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
CONSOLIDATED STATEMENT OF
OPERATIONS DATA:
Net revenue:
E-commerce...................... $ -- $ 269 $ 1,548 $ 5,282 $ 12,160 $ 7,874 $ 5,651
Media........................... -- 95 552 2,910 6,326 5,016 2,205
Agency.......................... -- 974 1,917 1,304 2,946 2,523 738
Record label.................... -- 550 565 778 244 244 --
---- ------ ------- --------- --------- --------- ---------
Total net revenue............. -- 1,888 4,582 10,274 21,676 15,657 8,594
Cost of revenue................... -- 608 2,515 10,240 26,542 19,368 14,059
---- ------ ------- --------- --------- --------- ---------
Gross profit (loss)........... -- 1,280 2,067 34 (4,866) (3,711) (5,465)
Operating expense:
Website development............. -- 78 589 1,815 5,364 2,757 3,269
Sales and marketing............. 10 196 1,395 13,222 25,623 19,542 5,053
General and administrative...... 13 1,442 2,545 10,319 17,874 12,832 10,877
Stock-based compensation(1)..... -- -- 3,828 30,304 5,067 3,116 4,859
Depreciation and amortization... 5 21 59 2,509 6,248 4,315 5,429
Loss from impairment of
goodwill...................... -- -- -- -- -- -- 11,444
---- ------ ------- --------- --------- --------- ---------
Loss from operations.......... (28) (457) (6,349) (58,135) (65,042) (46,273) (46,396)
Income/(loss) from equity
investments..................... -- -- 2 50 (235) 15 (4,054)
Interest income (expense), net.... -- (3) 29 281 5,969 3,993 3,057
---- ------ ------- --------- --------- --------- ---------
Net loss...................... $(28) $ (460) $(6,318) $ (57,804) $ (59,308) (42,265) (47,393)
==== ====== =======
Interest on rescission offer...... -- -- -- 237 532 339 533
Dividends on redeemable preferred
securities...................... 1,414 963 963 --
Beneficial conversion feature on
redeemable preferred stock...... -- 24,375 24,375 --
--------- --------- --------- ---------
Net loss attributable to common
shareholders.................... $ (59,455) $ (85,178) $ (67,942) $ (47,926)
========= ========= ========= =========
Basic and diluted net loss per
share(2)........................ $ (17.14) $ (26.83) $ (22.90) $ (13.11)
========= ========= ========= =========
Weighted average shares used in
computing basic and diluted net
loss per share(2)(3)............ 1,417,746 3,175,126 2,966,541 3,656,333
========= ========= ========= =========
40
AS OF DECEMBER 31,
------------------------------------------------ SEPTEMBER 30,
1996 1997 1998 1999 2000 2001
---- ----- ------- -------- -------- -------------
CONSOLIDATED BALANCE SHEET
DATA:
Cash, cash equivalents and
short term investments...... $ 80 $ 167 $ 1,940 $ 69,119 $ 87,825 $60,600
Working capital............... (20) (526) 1,079 67,730 84,336 60,690
Goodwill and intangibles,
net......................... -- 16 45 13,415 15,018 936
Total assets.................. 173 314 3,412 98,600 118,505 73,748
Total redeemable securities... -- -- 5,135 111,707 10,778 11,189
Total members' and
stockholders' equity
(deficit)................... 72 (412) (3,436) (23,745) 97,799 56,850
-------------------------
(1) Stock-based compensation is comprised of sales and marketing expense of $0,
$8,551, $2,209, $3,853 and $1,527 for the years ended December 31, 1998,
1999 and 2000 and for the nine months ended September 30, 2000 and 2001,
respectively, and general and administrative expense of $3,828, $21,753,
$2,858, $(737) and $3,332 for the years ended December 31, 1998, 1999 and
2000 and for the nine months ended September 30, 2000 and 2001,
respectively.
(2) The basic and diluted loss per share and the weighted average shares used in
computing the basic and diluted net loss per share for 1999 represents the
share and per share data for the period from October 6, 1999 to December 31,
1999, as we were organized as an LLC for tax purposes prior to October 6,
1999.
(3) See Note 3 to notes to consolidated financial statements for an explanation
of the determination of the number of shares and share equivalents used in
computing basic and diluted loss per share and pro forma loss per share.
41
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion should be read in conjunction with our
consolidated financial statements and the notes to those financial statements
included elsewhere in this prospectus. The following discussion contains
forward-looking statements based on our current expectations, estimates and
projections about our industry, management's beliefs and certain assumptions
made by us. Words such as "anticipates," "expects," "intends," "plans,"
"believes," "may," "will" or similar expressions are intended to identify
forward-looking statements. In addition, any statements that refer to
expectations, projections or other characterizations of future events or
circumstances, including any underlying assumptions, are forward-looking
statements. Such statements include, but are not limited to, statements
concerning our unproven business model, increased competition in its industry,
our ability to increase revenues from its record label, online product sales,
advertising and other revenue streams, ability to increase visits to our site,
ability to attract and retain artists, ability to offer compelling content,
ability to fulfill on-line music and merchandise orders in a timely manner,
ability to build brand recognition, ability to integrate acquisitions of
technology and other businesses, ability to protect and/or obtain intellectual
property rights, and ability to manage growth. Such statements are not
guarantees of future performance and are subject to risks, uncertainties and
assumptions that are difficult to predict. Therefore, our actual results could
differ materially and adversely from those expressed in any forward-looking
statements as a result of various factors. Factors that could cause or
contribute to the differences are discussed in "Risk Factors" and elsewhere in
this prospectus. You should carefully consider those risks, in addition to the
other information in this prospectus and in our other filings with the SEC,
before deciding whether or not to accept this rescission offer. We undertake no
obligation to revise or update publicly any forward-looking statements for any
reason. The information contained in this prospectus is not a complete
description of our business or the risks associated with an investment in our
common stock. We urge you to carefully review and consider the various
disclosures made by us in this prospectus and in our other filings with the SEC
that discuss our business in greater detail.
OVERVIEW
We are a music entertainment company that combines an online music network
with offline assets, including a record label and talent agency, to provide an
integrated music solution for music fans, artists and marketing partners. The
ARTISTdirect Network is a network of Web sites offering multi-media content,
music news and information, community around shared music interests, music-
related commerce and digital music. Prior to June 30, 2000, we also managed a
traditional record label, Kneeling Elephant Records, which we no longer operate.
On June 29, 2001, our stockholders approved the formation of a new record label,
ARTISTdirect Records, LLC, as a co-venture between ARTISTdirect and Frederick
Field, our Chairman of the Board and Chief Executive Officer.
In May 2001, we entered into an agreement with veteran entertainment
executive Frederick Field to become our Chairman and Chief Executive Officer and
form a new record label in partnership with us. On June 29, 2001, our
stockholders approved the employment of Mr. Field and the formation of the
record label. The record label is a 50/50 co-venture between us and Mr. Field,
where we will provide a significant financial commitment. Due to our commitment
to fully fund the operations of the joint venture, we will record 100% of the
losses of the co-venture. In addition to the formation of the record label and
our financial commitment, we entered into a five-year employment agreement with
Mr. Field and he joined our Board of Directors. Mr. Field also serves as the
Chief Executive Officer of the record label.
In January 2001, ARTISTdirect reorganized the company into five distinct
business groups: ARTISTdirect Media Group, or "Media", E-Commerce Operations
Group, or "E-Commerce",
42
Digital Music Distribution Group, or "Digital Music", Talent Agency and Live
Event Group, or "Agency" and Record Label, or "Record Label". As part of the
reorganization and cost-cutting measures implemented in 2001, we also
significantly reduced our number of employees. In particular, during the three
months ended December 31, 2000 and nine months ended September 30, 2001, we laid
off 58 and 116 employees, respectively. We expect this to help us reduce our net
loss and conserve our cash resources given prevailing market conditions.
On November 30, 2000, Nasdaq notified us that, because the closing bid
price of our common stock had been below $1.00 for over 30 consecutive trading
days, we would be subject to delisting. At our request, the Nasdaq Listing
Qualifications Panel conducted a hearing on April 12, 2001 to give us an
opportunity to appeal Nasdaq's decision to delist our common stock. On May 23,
2001, the Nasdaq Listing Qualifications Panel decided to allow the continued
listing of our common stock on The Nasdaq National Market provided that (i) the
closing bid price of our common stock on Nasdaq reached a minimum of $1.00 per
share on or before July 9, 2001 and remained at or above that level for a
minimum of 10 consecutive trading days (or longer, if required by the Nasdaq
Listing Qualifications Panel), and (ii) we demonstrated compliance with all
requirements for continued listing on The Nasdaq National Market. On July 25,
2001, we received notification from Nasdaq that we were in compliance with the
provisions of the exchange and would, therefore, remain listed on The Nasdaq
National Market.
We have incurred cumulative net losses of $171.3 million from inception to
September 30, 2001, of which approximately $58.0 million represented stock-based
compensation expense. While we have significantly reduced our operating
expenses, especially those related to our online operations, technology
infrastructure and marketing, we expect our net losses to continue and continue
to be significant for the foreseeable future. We plan to spend up to $50 million
over five years developing the new record label with Frederick Field. We have a
limited operating history on which to base an evaluation of our business and
prospects. Our prospects must be considered in light of the risks, expenses, and
difficulties encountered by companies in their early stage of development,
particularly companies in new and rapidly evolving markets. See "Risk Factors"
for a more complete description of the many risks we face. Our business is
evolving rapidly, and therefore we believe that period-to-period comparisons of
our operating results may not be meaningful and may not be accurate indicators
of future performance.
RESCISSION OFFER
As stated in more detail elsewhere in this prospectus, we are undertaking a
rescission offer with respect to 58,572 shares of our common stock purchased
upon the exercise of options and vested and unvested unexercised options to
purchase up to 737,360 shares of our common stock. The shares of stock were
purchased at prices ranging from $12.40 to $40.00 per share and the unexercised
options have exercise prices ranging from $12.40 to $140.00 per share. In the
rescission offer, we will offer to repurchase the shares of common stock at the
price per share paid, plus interest, and we will offer to repurchase the options
at 20% of their exercise price (which ranges from $2.48 to $28.00 per option),
plus interest. Since the current trading price of our common stock is
significantly below the lowest price per share paid by offerees in the
rescission offer and the options are significantly underwater, we expect that
the rescission offer will be accepted by a significant number of the offerees,
if not by all offerees. In this event, we believe our maximum out-of-pocket
expense will be approximately $11.2 million. We have enough available cash to
fund the rescission offer and do not believe that payment of this amount will
cause a material hardship to our ability to operate our business. However, if
the rescission offer is accepted, the number of our fully-diluted shares will be
reduced. Accordingly, our loss or earnings per share, as applicable, will be
larger on a pro-forma basis.
43
REVENUE
We currently generate revenue from three sources: E-Commerce, Media and
Agency. Currently we offer Digital Music free of charge; accordingly there is no
revenue from this source. Prior to June 30, 2000, we generated revenue from our
Record Label. Substantially all of our revenue is generated in cash. For the
nine months ended September 30, 2001 there was no barter revenue and
approximately 1% of our revenue for the year ended December 31, 2000 was barter
revenue.
E-Commerce Revenue. E-Commerce revenue includes the sale of music and
related merchandise, such as apparel, collectibles and accessories, through the
ARTISTdirect shopping mall of our network. We recognize the gross amount of
product sales and shipping revenue upon shipment of the item and record
appropriate reserves for product returns. We have experienced seasonality with
respect to our online product sales. In particular, our e-commerce sales in the
fourth quarter have, on average, been higher than in other quarters. We believe
that this trend may continue for the foreseeable future. For the nine months
ended September 30, 2001 and the year ended December 31, 2000, e-commerce
revenue was $5.7 million and $12.2 million, respectively, which constituted
approximately 66% and 56%, respectively, of our total net revenue for those
periods.
Media Revenue. Media revenue consists primarily of sales of banner
advertisements and sponsorships. In sales of banner advertisements, we
principally earn revenue based on the number of impressions or times an
advertisement appears on pages viewed within our Web sites. Our banner
advertising commitments generally range from one to six months. Banner
advertising revenue is generally recognized as the impressions are served during
the period in which the advertisement is displayed, provided that no significant
obligations of ARTISTdirect remain and collection of the resulting receivable is
probable. We typically guarantee a minimum number of impressions to the
advertiser. To the extent that minimum guaranteed page deliveries are not met,
we defer recognition of the corresponding revenue until the guaranteed
impressions are delivered. We also sell to advertisers sponsorship of a Web page
or event for a specified period of time. We recognize sponsorship revenue over
the period in which the sponsored page or event is displayed. To the extent that
committed obligations under sponsorship agreements are not met, revenue
recognition is deferred until the obligations are met. For the nine months ended
September 30, 2001 and the year ended December 31, 2000, media revenue was $2.2
million and $6.3 million, respectively, which constituted approximately 26% and
29%, respectively, of our total net revenue for those periods. Since most of our
sponsorship and advertising contracts are short-term in nature, our advertising
revenue is susceptible to significant fluctuation. In particular, our net
revenue from advertising revenue has significantly decreased since the third
quarter of 2000. This decrease is primarily due to advertisers spending less
money on banner advertising. In addition, we have been focusing our sales
efforts on integrated marketing solution packages that offer advertisers a
combination of off-line concert and tour sponsorships that are supported by
online banner advertising and custom content areas. These deals can take
anywhere from six to twelve months to put together due to their complex nature.
Accordingly, we do not expect our advertising revenue to increase significantly
in the near future.
During the nine months ended September 30, 2001, Universal Music Group
accounted for 23% and Pringles, a division of Procter & Gamble, accounted for
14% of our total media revenue. No other advertisers accounted for more than 10%
of our media revenue for that period.
Agency Revenue. Revenue from the ARTISTdirect Agency consists primarily of
commissions generated on tour and event bookings of artists represented by the
agency. Agency revenue is recognized at the time the artist gets paid. Agency
revenue fluctuates depending on touring schedules of major artists represented
by the agency. Touring schedules are subject to seasonality, with summer
typically being a more active period. For the nine months ended September 30,
2001 and the year
44
ended December 31, 2000, agency revenue was $738,000 and $2.9 million,
respectively, which constituted approximately 9% and 14%, respectively, of our
total net revenue for those periods.
Record Label. Prior to June 30, 2000, revenue from Kneeling Elephant
Records was generated from overhead advances and from royalties earned on albums
sold by artists signed to the label. We recognized royalties at the time the
releases were shipped to the retailer. Reserves were established for possible
returns. We discontinued our Kneeling Elephant Records operation after June 30,
2000.
ARTISTdirect Records. We expect that ARTISTdirect Records will generate
revenue primarily from the sale of compact discs by artists signed to the record
label. Since ARTISTdirect Records is a co-venture between our wholly-owned
subsidiary, ARTISTdirect Recordings, Inc., and Radar Records Holdings, LLC, any
income or loss generated by ARTISTdirect Records will be accounted for under the
equity method of accounting as income or loss from equity investments in the
statement of operations.
COST OF REVENUE
Cost of revenue consists primarily of amounts payable to artists, which
includes the cost of merchandise sold and share of net proceeds, online
transaction costs, including credit card fees, fulfillment charges and shipping
costs, Web site hosting and maintenance costs, online content and programming
costs, online advertising serving costs, payroll and related expenses for staff
involved in Web site maintenance, content programming and the ARTISTdirect
Agency, and amortization of non-cash compensation expense related to vendor
warrants and stock options granted to artists and their advisors in connection
with entering into contractual commitments to exclusively operate their online
commerce activities. Artist royalties are based primarily on electronic commerce
revenue generated from the sale of their licensed merchandise. Web site
maintenance costs include personnel-related costs, software consulting costs,
Internet hosting charges, and networking costs.
In connection with the amortization of vendor warrants and artist stock
options granted through September 30, 2001, we recorded non-cash compensation
expense of approximately $4.6 million for the nine months ended September 30,
2001 and approximately $7.5 million for the year ended December 31, 2000. We may
grant additional equity instruments in the future related to signing additional
artists. These equity grants may cause us to record substantial non-cash
compensation expense in the foreseeable future. Since the quarter ended December
31, 1999, our cost of revenue has exceeded our net revenue primarily as a result
of expansion and changes in our operations along with the increase in
amortization of vendor warrants and artist stock options. We expect this trend
to continue, for at least the near future as we continue to refocus our business
and operations.
OPERATING EXPENSE
Web Site Development. Web site development expense consists primarily of
expenses incurred to update the content and design of our Web sites and
underlying technology infrastructure. These expenses primarily include payments
to third-party service vendors and personnel costs. The implementation of
Emerging Issues Task Force No. 00-02, "Accounting for Website Development
Costs," effective July 1, 2000, did not have a material impact on our
consolidated financial statements.
Sales and Marketing. Sales and marketing expense consists primarily of
advertising, marketing and promotion expenses incurred to promote our Web sites
and our brands, plus payroll and related expenses for personnel engaged in
marketing and advertising sales activities.
45
General and Administrative. General and administrative expense consists of
payroll and related expenses for executive and administrative personnel,
professional services expenses, facilities expenses, travel and other general
corporate expenses.
Amortization of Stock-based Compensation. We recorded a total of $44.1
million of stock-based compensation expense for the period from inception
through September 30, 2001 in connection with equity granted to employees,
directors, professional firms, artists and artist advisors during this period.
We recorded amortization of stock-based compensation expense of approximately
$4.9 million during the nine months ended September 30, 2001 and approximately
$5.1 million during the year ended December 31, 2000. We anticipate granting
additional equity securities in the future to employees, directors, artists and
artist advisors.
We are making a rescission offer to certain holders of stock options and
shares purchased pursuant to stock options. To the extent that the holders of
options and shares subject to rescission accept the offer, we shall record stock
based compensation expense which could be significant. The amount of the
expense, assuming the closing date of the rescission offer was September 30,
2001, would be as follows:
The compensation expense recorded for the repurchase of unexercised
stock options (vested and unvested) from employees would be the sum of the
intrinsic value at the original measurement date (less any expense related
to the intrinsic value recorded up to the acceptance of the rescission
offer) and the amount of cash paid to the holder that exceeds the lesser of
the intrinsic value at the original measurement date or immediately prior
to settlement (the settlement date being the closing date of the 30-day
period for the rescission offer). This amount would be $6.0 million, which
we would record as stock based compensation expense immediately upon the
closing date of the rescission offer.
The compensation that shall be recorded for the repurchase of
unexercised non-employee options (vested and unvested) is calculated as the
difference between the amount of cash paid for the repurchase of the
options and the fair value of the options on the closing date of the
rescission offer. This compensation amount, which would be $3.0 million,
shall be amortized over the remaining period over which services will be
provided. The compensation amount would be recognized as follows: $830,000
in the final three months of 2001, $1.9 million in 2002 and $252,000 in
2003. The fair value of the options shall be determined using the
Black-Scholes option-pricing model over the remaining life of the options.
Any unamortized expense at the time of repurchase related to the initial
grant of the options to the non-employees shall continue to be amortized
over the remaining service period related to the original option grants.
The key assumptions used in the Black Scholes model for the purpose of the
calculation were: a risk free rate of 6%; a volatility factor of 180% in
September 2001; no expected dividends; and an expected life which is equal
to the remaining contractual life of the options as of September 30, 2001.
The compensation charge for the repurchase of shares issued pursuant
to the exercise of options (by employees and non-employees) is calculated
as the difference between the amount of cash paid for the repurchase of the
shares (which includes the exercise proceeds and accrued interest) and the
fair value of the shares on the date the repurchase is accepted (in this
case we are assuming the stock price as of September 30, 2001). The
compensation charge related to the employee option exercises would be
$230,000 and would be recorded as stock based compensation immediately, and
the compensation charge related to the non-employee option exercises of
$1.9 million would be recorded over the remaining service period related to
the original option grants. The non-employee compensation amount would be
recorded as expense as follows: $500,000 in the final three months of 2001
and $1.4 million in 2002.
46
In the event holders of shares and options subject to the rescission
offer do not accept the rescission offer, we will not record any
compensation expense related to those shares and options for which the
rescission offer was not accepted. The staff of the Securities and Exchange
Commission has taken the position that a person's federal right of
rescission may survive the rescission offer. However, federal courts in the
past have ruled that a person who rejects or fails to accept a rescission
offer is precluded from later seeking similar relief. We believe that
subsequent to the rescission offer, any rights to rescind will be
contingent upon legal rulings, the outcome of which are not currently
determinable. Accordingly, we will account for shares and options which
were not rescinded within the 30 day period as if there is no right of
rescission. In the event any rescissions occur subsequent to the 30 day
period, we will account for those rescissions, if any, in the manner
described above at the time those rescissions are completed.
Depreciation and Amortization. Depreciation and amortization expense
consists of the depreciation of fixed assets and the amortization of acquired
intangible assets. The acquisitions of iMusic, Mjuice and the minority interest
of the UBL were accounted for using the purchase method of accounting and,
accordingly, the purchase prices have been allocated to the tangible and
intangible assets acquired and liabilities assumed on the basis of their fair
value on the acquisition dates. Substantially all of the purchase price of these
transactions is attributable to the acquired intangible assets. As a result, the
aggregate excess purchase price over the net tangible assets allocated to
goodwill was $20.6 million and is being amortized over five years, the expected
estimated average useful life of these assets. We have recorded write-downs of
$11.4 million of goodwill during the nine months ended September 30, 2001. The
remaining net goodwill balance at September 30, 2001 is approximately $900,000.
These non-cash charges will affect our reported operating results over the
remainder of 2001, and in the future periods for the portion of goodwill
allocated to identifiable intangible assets, which will continue to be amortized
after December 31, 2001.
INTEREST INCOME AND EXPENSE
Interest income consists of earnings on our cash and cash equivalents, and
interest expense consists of interest associated with short-term borrowings.
RESULTS OF OPERATIONS
NINE MONTHS ENDED SEPTEMBER 30, 2001 AND 2000
NET REVENUE
Net revenue decreased to $8.6 million for the nine months ended September
30, 2001 from $15.7 million for the nine months ended September 30, 2000, which
represented a decrease of 45%. The decrease was due to decreases in e-commerce,
media and agency revenue. E-commerce revenue decreased 28% to $5.7 million for
the nine months ended September 30, 2001 from $7.9 million for the nine months
ended September 30, 2000, primarily as a result of a decrease in sales from our
top selling artists. For the nine months ended September 30, 2001, media revenue
decreased $2.8 million, or 56% to $2.2 million from $5.0 million for the nine
months ended September 30, 2000, primarily as a result of an overall soft
advertising market. Commission revenue from the agency decreased 71% from $2.5
million for the nine months ended September 30, 2000 to $738,000 for the nine
months ended September 30, 2001, due primarily to decreased touring activity of
the agency's artists.
COST OF REVENUE
Direct cost of product revenue. Direct cost of product revenue decreased
to $4.7 million for the nine months ended September 30, 2001 from $7.1 million
for the nine months ended September 30,
47
2000, which represented a decrease of 33%. This $2.4 million decrease
corresponded with the decrease in online product sales revenue and was primarily
attributable to a related decrease in product and royalty costs payable to our
vendors and artists and a decrease in transaction costs.
Other cost of revenue. Other cost of revenue decreased to $4.7 million for
the nine months ended September 30, 2001 from $6.2 million for the nine months
ended September 30, 2000, which represented a decrease of 24%. This $1.5 million
decrease was primarily due to decreases in Web site hosting and maintenance
costs.
Stock-based compensation. For the nine months ended September 30, 2001 we
recorded non-cash stock-based compensation charges of $4.7 million compared to
$6.2 million for the nine months ended September 30, 2000. The stock-based
compensation expense relates primarily to the amortization of the estimated
value of the options, using the Black-Scholes method, given to artists in
connection with the operation of their stores and is amortized over the life of
the associated contract periods. We expect to record amortization of stock based
compensation of $1.5 million in the remaining three months of 2001, $4.1 million
in 2002 and $196,000 in 2003 (not including any compensation amount recorded as
a result of the rescission offer). See pages 46-47 of the Registration Statement
for potential future compensation charges that may result from the rescission
offer.
Gross loss. For the nine months ended September 30, 2001 and 2000, our
overall gross profit margin decreased to -64% from -24%, respectively, primarily
due to the significant decrease in media and e-commerce revenue. Gross profit
excluding stock-based compensation and amortization of vendor prepaid was -8%
and 17% for the nine months ended September 30, 2001 and 2000, respectively.
OPERATING EXPENSE
Web Site Development. Web site development expense increased 19% to $3.3
million for the nine months ended September 30, 2001 from $2.8 million for the
nine months ended September 30, 2000. This increase was primarily attributable
to maintenance costs associated with our Pandesic e-commerce system, as well as
fees paid to third party service vendors relating to maintenance on the
procurement system interface, and development costs of digital music products.
Sales and Marketing. Sales and marketing expense decreased 74% to $5.1
million for the nine months ended September 30, 2001 from $19.5 million for the
nine months ended September 30, 2000. The decrease was primarily attributable to
reduced spending on advertising to promote the ARTISTdirect Network as a result
of termination of certain marketing commitments and planned cost control
measures.
General and Administrative. General and administrative expense decreased
15% to $10.9 million for the nine months ended September 30, 2001 from $12.8
million for the nine months ended September 30, 2000. This decrease was
primarily attributable to salary and benefits savings associated with the
reduction in staff in 2001 and overall cost savings in travel and entertainment,
communications and facilities, and other general and administrative costs.
Amortization of Stock-based Compensation. We recorded stock-based
compensation expense of $4.9 million for the nine months ended September 30,
2001 in connection with stock issuances to employees, directors, professional
firms, artists and artist advisors for promotional services. Stock-based
compensation for the comparable period in 2000 was $3.1 million, primarily in
connection with stock issuances to employees, directors and professional firms,
which represented an increase of 56% compared to the corresponding period in
2000. The expense for the nine months ended September 30, 2000 reflected a $6.6
million credit to stock-based compensation granted to certain executives of
48
ARTISTdirect as a result of a reduction in the valuation of ARTISTdirect's
underlying common stock as compared with December 31, 1999. The credit resulted
from variable equity instruments that were settled upon the completion of the
IPO, and these instruments will not have a continuing impact on the future
results of operations. This credit was offset by $9.7 million of expense which
was comprised primarily of the following: amortization of stock based
compensation for equity grants to employees and artists and advisors of $5.6
million, stock based compensation expense of approximately $1.0 million in
connection with stock options granted to an officer of ARTISTdirect and $3.1
million for equity instruments granted to non-employees. We expect to record
amortization of stock based compensation of $1.1 million in the remaining three
months of 2001, $2.1 million in 2002 and $57,000 in 2003 and $350,000 from 2004
through 2010 (not including any compensation amounts recorded as a result of the
rescission offer).
Depreciation and Amortization. Depreciation and amortization expense
increased to $5.4 million for the nine months ended September 30, 2001 from $4.3
million for the nine months ended September 30, 2000. This increase was
primarily attributable to fixed asset and leasehold improvement additions.
Impairment of Goodwill. During the three months ended September 30, 2001,
we determined that there was insufficient basis to support the entire carrying
amount of goodwill associated with the 1999 acquisitions of iMusic and UBL based
upon the projected undiscounted future cash flows related to the underlying
assets of these goodwill amounts. Online advertising and promotions have been
the primary source of revenue derived from these assets, and that revenue has
declined for the three and nine months ended September 30, 2001, significantly
affecting the value of these assets, and we cannot reasonably estimate if or
when these revenue sources will recover. As a result, during the three months
ended September 30, 2001, we recorded a loss from impairment of the goodwill
from these transactions of $7.0 million based on revised estimates of discounted
cash flows. For the nine months ended September 30, 2001, we recorded an
aggregate $11.4 million loss from impairment to goodwill, which also included a
$4.5 million write-off of goodwill related to our acquisition of Mjuice,
recorded in March 2001.
INTEREST INCOME AND EXPENSE
For the nine months ended September 30, 2001, interest income decreased to
$3.1 million from $4.0 million for the nine months ended September 30, 2000. The
decrease is due to less interest earned on lower available cash balances for the
relevant periods, as well as declining interest rates.
NET LOSS
EBITDA loss decreased $12.6 million or 39% to $19.9 million for the nine
months ended September 30, 2001, compared to $32.4 million for the nine months
ended September 30, 2000. This decrease is attributable to a $652,000 decrease
in e-commerce EBITDA loss, a $5.2 million decrease in media EBITDA loss, a $9.0
million decrease in corporate expenditures, partially offset by a $1.8 million
decrease in agency EBITDA income and a $683,000 million increase in digital
music EBITDA loss.
Net loss increased to $47.4 million for the nine months ended September 30,
2001, compared to $42.3 million for the nine months ended September 30, 2000,
which represented an increase of 12%. The increase in the net loss is
attributable to a $1.8 million increase in gross loss, a $512,000 increase in
web site development, a $1.7 million increase in the amortization of stock-based
compensation, a $1.1 million increase in depreciation and amortization expense,
an $11.4 million loss from impairment of goodwill, a $4.1 million increase in
loss from equity investments and a $936,000 decrease in interest income,
partially offset by a $14.5 million decrease in sales and marketing expense and
a $2.0 million decrease in general and administrative expense.
49
YEARS ENDED DECEMBER 31, 2000 AND 1999
NET REVENUE
Net revenue for the year ended December 31, 2000 increased to $21.7 million
from $10.3 million for the year ended December 31, 1999, which represented an
increase of 111%. The increase was primarily due to increases in E-commerce
revenues, media revenue and agency revenue.
E-commerce product sales revenue for the year ended December 31, 2000,
increased 130% to $12.2 million from $5.3 million for the year ended December
31, 1999, primarily as a result of an increase in the number of ARTISTchannels
that were operated.
Media revenue increased $3.4 million, or 117%, to $6.3 million for the year
ended December 31, 2000, from $2.9 million for the year ended December 31, 1999,
primarily as a result of increased page views generated by our Web sites plus a
significant increase in the number of advertisers, primarily in sales of
non-impression based sponsorships.
Agency revenue increased from $1.3 million for the year ended December 31,
1999 to $2.9 million for the year ended December 31, 2000, which represented an
increase of 126%, due primarily to increased touring activity of the agency's
artists.
COST OF REVENUE
Direct cost of product revenue. Direct cost of product revenue increased to
$10.4 million for the year ended December 31, 2000 from $5.1 for the year ended
December 31, 1999, which represented an increase of 104%. This $5.3 million
increase corresponded with the increase in online product sales revenue and was
primarily attributable to a $3.7 million increase in product and royalty costs
payable to our vendors and artists and a $1.6 million increase in transaction
costs.
Other cost of revenue. Other cost of revenue increased to $8.6 million for
the year ended December 31, 2000, from $3.4 million for the year ended December
31, 1999, which represented an increase of 155%. This $5.2 million increase was
primarily due to increases in Web site hosting and maintenance costs.
Stock-based compensation. For the year ended December 31, 2000 we recorded
non-cash stock-based compensation charges of $7.5 million compared to $1.8
million for the year ended December 31, 1999. The stock-based compensation
expense relates primarily to the amortization of the estimated value of the
options, using the Black-Scholes method, given to artists in connection with the
operation of their stores and is amortized over the life of the associated
contract periods. As of December 31, 2000, $11.1 million of unearned
compensation remains to be amortized.
OPERATING EXPENSE
Website Development. Product development expense increased to $5.4 million
for the year ended December 31, 2000, from $1.8 million for the year ended
December 31, 1999, which represented an increase of 196%. This increase was
primarily attributable to increased fees paid to third party service vendors
relating to the continued development of our Web site, as well as an increase in
the development costs of programming.
Sales and Marketing. Sales and marketing expense increased to $25.6 million
for the year ended December 31, 2000 from $13.2 million for the year ended
December 31, 1999, which represented an increase of 94%. The increase was
primarily attributable to a significant increase in our online advertising
expenditures, as well as increased offline advertising. We expect the growth
rate of sales and marketing expenses to decrease in future periods.
50
General and Administrative. General and administrative expense increased to
$17.9 million for the year ended December 31, 2000 from $10.3 million for the
year ended December 31, 1999, which represented an increase of 73%. This
increase was primarily attributable to increases in personnel and related
expenses, facilities and outside professional services expenses. We expect the
growth rate of general and administrative expense to decrease as we seek to
operate more efficiently.
Amortization of Stock-based Compensation. We recorded stock-based
compensation expense of $5.1 million for the year ended December 31, 2000 in
connection with stock issuances to employees, directors, professional firms,
artists and advisors for promotional services, which represented a decrease of
83% for the comparable period in 1999. Stock-based compensation for the
comparable period in 1999 was $30.3 million, primarily in connection with stock
issuances to employees, directors and professional firms. The expense during the
year ended December 31, 2000 reflected a credit to stock-based compensation of
$6.6 million related to stock appreciation rights granted to certain of our
executives as a result of a reduction in the valuation of our underlying common
stock as compared with December 31, 1999. This credit was offset by $11.7
million of amortization of stock-based compensation expense related to options
granted to employees, artists and advisors.
Depreciation and Amortization. Depreciation and amortization expense
increased to $6.2 million for the year ended December 31, 2000 from
approximately $2.5 million for the year ended December 31, 1999, which
represented an increase of 149%. This increase was primarily attributable to the
amortization of the goodwill associated with the acquisition of iMusic, Mjuice
and the minority interest in the UBL, as well as an increase in depreciation of
fixed assets and amortization of leasehold improvements.
INTEREST INCOME AND EXPENSE
Interest income increased to $6.0 million for the year ended December 31,
2000 from $281,000 for the year ended December 31, 1999, which represented an
increase of 2,024%. The increase is due to interest earned on higher cash
balances resulting from the proceeds we received from our initial public
offering in March 2000 and the Series C redeemable preferred shares issued in
December 1999 and January 2000.
NET LOSS
Net loss increased to $59.3 million for the year ended December 31, 2000,
compared to $57.8 million for the year ended December 31, 1999, which
represented an increase of 3%. The increase in the net loss is primarily
attributable to a $4.9 million decrease in gross profit due to stock-based
compensation related to artist store agreements, a $12.4 million increase in
sales and marketing expense, a $7.6 million increase in general and
administrative expense and a $3.7 million increase in depreciation and
amortization expense, partially offset by a $25.2 million decrease in the
amortization of stock-based compensation and a $5.7 million increase in interest
income.
FISCAL YEARS ENDED DECEMBER 31, 1999 AND 1998
NET REVENUE
Net revenue increased to $10.3 million in the year ended December 31, 1999
from $4.6 million in the same period of 1998, which represented an increase of
approximately 124%. The increase was primarily due to an increase in online
E-commerce revenue to $5.3 million from $1.5 million, reflecting additional
ARTISTchannels plus contributions from the ARTISTdirect Superstore. Media
revenue also increased to $2.9 million from $552,000, which represented an
increase of approximately 425%, reflecting an increase in the page views
generated by our Web sites plus a significant increase in sales of sponsorships.
Agency revenue from the ARTISTdirect Agency decreased from $1.9 million
51
to $1.3 million, which represented a decrease of approximately 32%, due
primarily to a decrease in the touring activity of the agency's artists.
COST OF REVENUE
Direct cost of product revenue increased to $5.1 million in the year ended
December 31, 1999 from $1.5 million for the same period of 1998, which
represented an increase of 240%. This $3.6 million increase corresponded with
the increase in online product sales revenue and was primarily attributable to a
related $2.4 million increase in royalties payable to artists and $1.1 million
increase in transaction costs. Other cost of revenue increased to $5.1 million
in 1999 from $1.0 million in 1998, which represented an increase of 410%. This
$4.1 million increase was primarily due to a $2.0 million increase in Web site
hosting and maintenance costs and $1.8 million of non-cash expense for the
amortization of warrants issued to vendors and options issued to artists and
their advisors related to our rights to operate ARTISTchannels. In total, in
1999 we recorded non-cash compensation charges of $15.5 million and such amount
will be amortized to cost of revenue over the life of the contract periods
associated with the warrants and options. Our overall gross profit margin
decreased to 0.3% of net revenue for the year ended December 31, 1999 from 45%
of net revenue for the year ended December 31, 1998, due to a higher proportion
of online product sales revenue, which has lower gross margin than our other
sources of revenue, and the increased costs detailed above.
OPERATING EXPENSE
Website Development. Product development expense increased to $1.8 million
for the year ended December 31, 1999 from $589,000 for the same period in 1998,
which represented an increase of approximately 206%. This increase was primarily
attributable to fees paid to third party service vendors relating to the
development of the new ARTISTdirect Network Web site, which launched in July
1999.
Sales and Marketing. Sales and marketing expense increased to $13.2 million
for the year ended December 31, 1999 from $1.4 million for the same period in
1998, which represented an increase of approximately 843%. The increase was
primarily attributable to a significant increase in online and offline
advertising, promotion and sponsorship. In addition, personnel and related
expenses increased as we added to our advertising sales and marketing staffs.
General and Administrative. General and administrative expense increased to
$10.3 million for the year ended December 31, 1999 from $2.5 million for the
year ended December 31, 1998, which represented an increase of 312%. This
increase was primarily attributable to a $3.0 million increase in personnel and
related expenses and a $2.0 million increase in outside professional services
expenses.
Amortization of Stock-based Compensation. We recorded a total of $30.3
million of stock-based compensation expense for the year ended December 31, 1999
in connection with stock issuances to employees, directors, professional firms
and artists for promotional services which are being treated as variable stock
compensation, which represented an increase of approximately 697% for the
comparable period in 1998. Stock-based compensation for the comparable period in
1998 was $3.8 million, primarily in connection with stock issuances to
employees, directors and professional firms.
Depreciation and Amortization. Depreciation and amortization expense
increased to $2.5 million for the year ended December 31, 1999 from
approximately $59,000 in the same period of 1998, which represented an increase
of approximately 4,137%. This increase was primarily attributable to the
amortization of the goodwill associated with the acquisition of iMusic and the
minority interest in the UBL.
52
NET LOSS
Net loss increased to $57.8 million in the year ended December 31, 1999
compared to $6.3 million in the year ended December 31, 1998, which represented
an increase of approximately 817%. The increase in the net loss can be primarily
attributed to a $26.5 million increase in the amortization of stock-based
compensation, $11.8 million increase in sales and marketing expense, $7.8
million increase in general and administrative expense, $2.5 million increase in
depreciation and amortization expense and $2.0 million decrease in gross profit
due to increased expenditures for Web site hosting, maintenance and content
compared with the prior year.
SEGMENT OPERATIONS
We provide music entertainment products and services through the following
five reportable segments:
- E-Commerce Operations Group, or "E-Commerce" -- music related merchandise
- ARTISTdirect Media Group, or "Media" -- advertising and sponsorship of
both the ARTISTdirect network and offline events
- Talent Agency and Live Event Group, or "Agency" -- artist booking
operations
- Digital Music Distribution Group, or "Digital Music" -- digital music
product development
- Record Label, or "Record Label" -- record label operations
The factors for determining reportable segments were based on the
distinctive services and products. Each segment is responsible for executing a
unique marketing and business strategy. The accounting policies of the new
classifications of segments are the same as those described in the summary of
significant accounting policies. We evaluate performance based on EBITDA
earnings/loss, or earnings or loss before interest, taxes, depreciation and
amortization, stock-based compensation, loss from impairment of goodwill,
amortization of vendor prepaid, interest income and income (loss) from equity
investments. The following table summarizes the net revenue, cost of
53
revenue, gross profit/(loss), operating expenses and EBITDA by segment for the
years ended December 31, 1998, 1999 and 2000 and for the nine months ended
September 30, 2000 and 2001.
(UNAUDITED)
NINE MONTHS ENDED
YEAR ENDED DECEMBER 31, SEPTEMBER 30,
----------------------------- -------------------
1998 1999 2000 2000 2001
------- -------- -------- -------- --------
(IN THOUSANDS)
E-COMMERCE
Net Revenue........................................ $ 1,548 $ 5,282 $ 12,160 $ 7,874 $ 5,651
Cost of revenue.................................... 1,505 5,091 10,381 7,051 4,698
------- -------- -------- -------- --------
Gross profit....................................... 43 191 1,779 823 953
Operating expense(1)............................... 299 2,947 5,882 4,104 3,582
------- -------- -------- -------- --------
EBITDA......................................... $ (256) $ (2,756) $ (4,103) $ (3,281) $ (2,629)
------- -------- -------- -------- --------
MEDIA
Net Revenue........................................ $ 552 $ 2,910 $ 6,326 $ 5,016 $ 2,205
Cost of revenue.................................... 735 2,608 7,751 5,466 3,436
------- -------- -------- -------- --------
Gross profit (loss)................................ (183) 302 (1,425) (450) (1,231)
Operating expense(1)............................... 355 12,632 14,590 9,488 3,467
------- -------- -------- -------- --------
EBITDA......................................... $ (538) $(12,330) $(16,015) $ (9,938) $ (4,698)
------- -------- -------- -------- --------
TALENT AGENCY
Net revenue........................................ $ 1,917 $ 1,304 $ 2,946 $ 2,523 $ 738
Cost of revenue.................................... 259 432 513 432 574
------- -------- -------- -------- --------
Gross profit....................................... 1,658 872 2,433 2,091 164
Operating expense(1)............................... 2,287 850 242 116 21
------- -------- -------- -------- --------
EBITDA......................................... $ (629) $ 22 $ 2,191 $ 1,975 $ 143
------- -------- -------- -------- --------
DIGITAL MUSIC
Net revenue........................................ $ -- $ -- $ -- $ -- $ --
Cost of revenue.................................... -- -- -- -- 564
------- -------- -------- -------- --------
Gross profit....................................... -- -- -- -- --
Operating expense(1)............................... -- -- 794 -- 119
------- -------- -------- -------- --------
EBITDA......................................... $ -- $ -- $ (794) $ -- $ (683)
------- -------- -------- -------- --------
RECORD LABEL
Net revenue........................................ $ 565 $ 778 $ 244 $ 244 $ --
Cost of revenue.................................... 16 229 19 19 --
------- -------- -------- -------- --------
Gross profit....................................... 549 549 225 225 --
Operating expense(1)............................... 1,013 806 487 428 --
------- -------- -------- -------- --------
EBITDA......................................... $ (464) $ (257) $ (262) $ (203) $ --
------- -------- -------- -------- --------
CORPORATE
Operating expense(2)............................... $ 575 $ 8,121 $ 26,866 $ 20,995 $ 12,010
------- -------- -------- -------- --------
EBITDA......................................... $ (575) $ (8,121) $(26,866) $(20,995) $(12,010)
------- -------- -------- -------- --------
Total EBITDA................................... $(2,462) $(23,442) $(45,849) $(32,442) $(19,877)
======= ======== ======== ======== ========
Reconciliation of EBITDA to Net Loss:
Total EBITDA Per Segments.......................... $(2,462) $(23,442) $(45,849) $(32,442) $(19,877)
Amortization of vendor prepaid..................... -- (111) (333) (250) (139)
Amortization of stock-based compensation........... (3,828) (32,073) (12,612) (9,266) (9,507)
Depreciation and amortization...................... (59) (2,509) (6,248) (4,315) (5,429)
Loss from impairment of goodwill................... -- -- -- -- (11,444)
Interest income (expense), net..................... 29 281 (235) 3,993 3,057
Income/(loss) from equity investments.............. 2 50 5,969 15 (4,054)
------- -------- -------- -------- --------
Net Loss....................................... $(6,318) $(57,804) $(59,308) $(42,265) $(47,393)
======= ======== ======== ======== ========
54
-------------------------
(1) Operating expense in the above table for the purpose of calculating EBITDA
include direct operating expenses for the business segment and exclude stock
based compensation, depreciation and amortization and loss from impairment
of goodwill for the respective periods.
(2)Corporate operating expense includes general and administrative expenses not
associated with a business segment.
QUARTERLY RESULTS OF OPERATIONS
The following table sets forth unaudited quarterly results of operations
for the ten most recent quarters ended September 30, 2001. This unaudited
quarterly information has been derived from our unaudited financial statements
and, in our opinion, includes all adjustments, consisting only of normal
recurring adjustments, necessary for a fair presentation of the information for
the periods covered. The quarterly data should be read in conjunction with our
financial statements and related notes. The operating results for any quarter
are not necessarily indicative of the operating results for any future period.
QUARTER ENDED
---------------------------------------------------------------------------------------------
JUNE 30, SEPTEMBER 30, DECEMBER 31, MARCH 31, JUNE 30, SEPTEMBER 30, DECEMBER 31,
1999 1999 1999 2000 2000 2000 2000
-------- ------------- ------------ --------- -------- ------------- ------------
(IN THOUSANDS EXCEPT SHARE DATA)
Net revenue:
E-commerce.................. $ 1,154 $ 1,331 $ 1,781 $ 2,029 $ 2,580 $ 3,265 $ 4,286
Media....................... 508 777 1,244 1,797 1,973 1,246 1,310
Agency...................... 161 371 642 545 927 1,051 423
Record label................ 161 273 173 126 118 -- --
------- -------- -------- -------- -------- -------- --------
Total net revenue..... 1,984 2,752 3,840 4,497 5,598 5,562 6,019
Cost of revenue............... 1,653 2,707 4,584 6,347 6,125 6,896 7,174
------- -------- -------- -------- -------- -------- --------
Gross profit (loss)... 331 45 (744) (1,850) (527) (1,334) (1,155)
Operating expense:
Website development......... 440 397 787 807 679 1,271 2,607
Sales and marketing......... 1,760 2,901 7,784 5,117 6,676 7,749 6,081
General and
administrative............ 1,929 2,385 4,697 3,660 4,398 4,774 5,042
Amortization of stock-based
compensation.............. 1,115 19,625 8,762 (366) 1,757 1,725 1,951
Depreciation and
amortization.............. 625 841 955 1,174 1,457 1,684 1,933
Loss from impairment of
goodwill.................. -- -- -- -- -- -- --
------- -------- -------- -------- -------- -------- --------
Loss from
operations.......... (5,538) (26,104) (23,729) (12,242) (15,494) (18,537) (18,769)
Income/(loss) from equity
investments................. -- -- 17 -- 15 -- (250)
Interest income (expense),
net......................... 65 90 114 1,055 1,476 1,462 1,976
------- -------- -------- -------- -------- -------- --------
Net loss.............. $(5,473) $(26,014) $(23,598) $(11,187) $(14,003) $(17,075) $(17,043)
======= ======== ======== ======== ======== ======== ========
Basic and diluted net loss per
share....................... -- -- (17.14) (24.66) (3.87) (4.45) (4.56)
Weighted average shares
outstanding................. -- -- 1,417,746 1,490,151 3,685,255 3,735,556 3,777,331
QUARTER ENDED
------------------------------------
MARCH 31, JUNE 30, SEPTEMBER 30,
2001 2001 2001
--------- -------- -------------
(IN THOUSANDS EXCEPT SHARE DATA)
Net revenue:
E-commerce.................. $ 2,394 $ 1,688 $ 1,569
Media....................... 734 1,051 420
Agency...................... 225 154 359
Record label................ -- -- --
-------- -------- --------
Total net revenue..... 3,353 2,893 2,348
Cost of revenue............... 5,403 4,405 4,251
-------- -------- --------
Gross profit (loss)... (2,050) (1,512) (1,903)
Operating expense:
Website development......... 1,647 1,166 456
Sales and marketing......... 2,426 1,482 1,145
General and
administrative............ 4,220 3,617 3,040
Amortization of stock-based
compensation.............. 1,683 1,607 1,569
Depreciation and
amortization.............. 1,996 1,644 1,789
Loss from impairment of
goodwill.................. 4,458 -- 6,986
-------- -------- --------
Loss from
operations.......... (18,480) (11,028) (16,888)
Income/(loss) from equity
investments................. 55 (778) (3,331)
Interest income (expense),
net......................... 1,343 856 858
-------- -------- --------
Net loss.............. $(17,082) $(10,950) $(19,361)
======== ======== ========
Basic and diluted net loss per
share....................... (4.56) (3.07) (5.48)
Weighted average shares
outstanding................. 3,779,608 3,623,154 3,568,577
Our quarterly operating results have fluctuated in the past and may
fluctuate significantly in the future due to a variety of factors, many of which
are outside of our control. We believe that quarter-to-quarter comparisons of
our operating results are not a good indication of our future performance.
55
LIQUIDITY AND CAPITAL RESOURCES
On March 31, 2000, we completed our IPO and raised net proceeds of
approximately $52.4 million through the sale of 5,000,000 common shares (500,000
with the effect of the 1 for 10 reverse stock split in July 2001). In addition,
we raised an aggregate of $97.5 million of gross proceeds through the sale of
Series C preferred stock in December 1999 and January 2000. In May 1999, we
issued shares of Series B preferred securities in exchange for an aggregate
purchase price of $15.0 million. Between July 1998 and December 1998, we issued
shares of Series A preferred securities in exchange for an aggregate purchase
price of $4.9 million. Prior to July 1998, we financed our operations and growth
entirely from internally generated cash flow and capital contributions from
founders. As of September 30, 2001, we had $60.6 million of cash and cash
equivalents and short term investments, excluding cash held for clients.
Net cash used in operating activities was $2.3 million, $26.0 million,
$35.1 million, $26.8 million and $19.4 million for the years ended December 31,
1998, 1999 and 2000 and for the nine months ended September 30, 2000 and 2001,
respectively. Net cash used in operating activities for each of these periods
primarily consisted of net losses partially offset by non-cash items such as
stock-based compensation and depreciation and amortization.
Net cash used in investing activities was $514,000, $4.4 million, $46.3
million and $52.5 million for the years ended December 31, 1998, 1999 and 2000
and for the nine months ended September 30, 2000, respectively. The net cash
used in 1998 consisted of the purchase of fixed assets and investments in
affiliated companies. The net cash used in 1999 consisted primarily of the
purchase of fixed assets. The net cash used in 2000 consisted of purchases of
fixed assets of $7.5 million, primarily computer equipment to support the
ARTISTdirect Network, leasehold improvements to our corporate offices, the
purchase of short-term investments of $36.4 million, and $2.0 million relating
to the purchase of Mjuice.com, Inc. Net cash used during the nine months ended
September 30, 2000 consisted of the purchase of fixed assets of $6.4 million,
the purchase of short term investments of $43.8 million and $2.0 million
relating to the purchase of Mjuice.com, Inc.
Net cash provided by investing activities was $11.3 million for the nine
months ended September 30, 2001, which resulted from proceeds from the maturity
of short term investments of $16.4 million, partially offset by the purchase of
fixed assets and an investment in an affiliated company.
Net cash provided by financing activities was $4.6 million, $97.6 million,
$63.7 million and $63.7 million for the years ended December 31, 1998, 1999 and
2000 and for the nine months ended September 30, 2000. Net cash provided by
financing activities during each of these periods consisted of cash proceeds
from the following issuances of preferred securities:
- Between July 1998 and December 1998, we issued Series A preferred
securities in exchange for an aggregate purchase price of $4.9 million.
- In May 1999, we issued Series B preferred securities in exchange for an
aggregate purchase price of $15.0 million.
- In December 1999, we issued Series C preferred shares for a total
purchase price of approximately $82.3 million.
- In January 2000, we issued Series C preferred shares for total proceeds
approximately $10.4 million, net of offering costs.
- In March 2000, we completed an IPO in which we obtained total proceeds of
$52.4 million, net of offering costs.
56
Net cash used in financing activities was $2.7 million for the nine months
ended September 30, 2001 as a result of our repurchase of 227,566 shares of
common stock (after the effect of the 1 for 10 reverse stock split in July
2001).
As of September 30, 2001 our principal commitments consisted of obligations
outstanding under operating leases, employment contracts and the rescission
offer. In November 1999, we entered into an agreement with Cisneros Television
Group that obligated both us and Cisneros each to contribute up to $20 million
to develop a Latin American joint venture. To date we have provided
approximately $600,000 of funding to the joint venture and we do not currently
believe that we will be required to provide any significant additional funding.
In May 2001, we entered into an agreement with Frederick Field for a co-venture
record label. We are required to provide up to $50 million of funding over the
next five years to the record label. As of September 30, 2001, we had funded
$4.0 million to the record label.
We currently anticipate that our available cash resources will be
sufficient to meet our anticipated cash needs for working capital and capital
expenditures for at least the next 18 months, including the rescission offer and
the significant financial commitment to the co-venture record label with
Frederick Field. There can be no assurance, however, that the underlying assumed
levels of revenues and expenses will prove to be accurate. Although we do not
currently have any specific material capital commitments other than the record
label and the rescission offer beyond such 18-month period, if we are
unsuccessful in generating sufficient cash flow from operations, we may need to
raise additional funds in future periods through public or private financings,
or other arrangements to fund our operations and potential acquisitions. In
light of the decline in our stock price and the recent extreme volatility in the
capital markets, if any additional financing is needed, we might not be able to
raise capital on reasonable terms or at all. Failure to raise capital when
needed could seriously harm our business and operating results. If additional
funds were raised through the issuance of equity securities, the percentage of
ownership of our stockholders would be reduced. Furthermore, these equity
securities might have rights, preferences or privileges senior to our common
stock. We currently do not have any plans for future equity offerings.
57
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
The Financial Accounting Standards Board recently issued SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities," which is
effective for all fiscal quarters of all fiscal years beginning after June 15,
2000 (as amended by SFAS No. 137, "Accounting for Derivative Instruments and
Hedging Activities -- Deferral of the Effective date of FASB Statement No. 133")
and SFAS 138, "Accounting for Certain Derivative Instruments and Certain Hedging
Activities," which become effective January 1, 2001. These pronouncements
establish accounting and reporting standards for derivative instruments and
hedging activities by requiring that all derivative instruments be reported as
assets or liabilities and measured at their fair values. Under SFAS 133, changes
in the fair values of derivative instruments are recognized immediately in
earnings unless those instruments qualify as hedges of the (1) fair values of
existing assets, liabilities, or firm commitments, (2) variability of cash flows
of forecasted transactions, or (3) foreign currency exposures on net investments
in foreign operations. The adoption of these pronouncements did not have a
material impact on our consolidated financial statements.
In December 1999, the Securities and Exchange Commission issued SAB 101,
Revenue Recognition in Financial Statements. SAB 101 provides guidance on the
recognition, presentation, and disclosure of revenue in financial statements of
all public registrants. The adoption of SAB 101 in the fourth quarter of fiscal
2000 did not have an impact on our consolidated financial statements.
In July 2001, FASB issued Statement No. 141, "Business Combinations", and
Statement No. 142, "Goodwill and Other Intangible Assets." Statement 141
requires that the purchase method of accounting be used for all business
combinations initiated after June 30, 2001 as well as all purchase method
business combinations completed after June 30, 2001. Statement 141 also
specifies criteria intangible assets acquired in a purchase method business
combination must meet to be recognized and reported apart from goodwill.
Statement 142 will require that goodwill and intangible assets with indefinite
useful lives no longer be amortized, but instead tested for impairment at least
annually in accordance with the provisions of Statement 142. Statement 142 will
also require that intangible assets with definite useful lives be amortized over
their respective estimated useful lives to their estimated residual values, and
reviewed for impairment in accordance with SFAS No. 121.
We are required to adopt the provisions of Statement 141 immediately and
Statement 142 effective January 1, 2002. Furthermore, any goodwill and any
intangible asset determined to have an indefinite useful life that are acquired
in a purchase business combination completed after June 30, 2001 will not be
amortized, but will continue to be evaluated for impairment in accordance with
the appropriate pre-Statement 142 accounting literature. Goodwill and intangible
assets acquired in business combinations completed before July 1, 2001 will
continue to be amortized prior to the adoption of Statement 142.
Statement 141 will require upon adoption of Statement 142, that we evaluate
our existing intangible assets and goodwill that were acquired in a prior
purchase business combination, and to make any necessary reclassifications in
order to conform with the new criteria in Statement 141 for recognition apart
from goodwill. Upon adoption of Statement 142, we will be required to reassess
the useful lives and residual values of all intangible assets acquired in
purchase business combinations, and make any necessary amortization period
adjustments by the end of the first interim period after adoption. In addition,
to the extent an intangible asset is identified as having an indefinite useful
life, we will be required to test the intangible asset for impairment in
accordance with the provisions of Statement 142 within the first interim period.
Any impairment loss will be measured as of the date of adoption and recognized
as the cumulative effect of a change in accounting principle in the first
interim period.
In connection with the transitional goodwill impairment evaluation,
Statement 142 will require that we perform an assessment of whether there is an
indication that goodwill (and equity-method
58
goodwill) is impaired as of the date of adoption. To accomplish this we must
identify its reporting units and determine the carrying value of each reporting
unit by assigning the assets and liabilities, including the existing goodwill
and intangible assets, to those reporting units as of the date of adoption. We
will then have up to six months from the date of adoption to determine the fair
value of each reporting unit and compare it to the reporting unit's carrying
amount. To the extent a reporting unit's carrying amount exceeds its fair value,
an indication exists that the reporting unit's goodwill may be impaired and we
must perform the second step of the transitional impairment test. In the second
step, we must compare the implied fair value of the reporting unit's goodwill,
determined by allocating the reporting unit's fair value to all of it assets
(recognized and unrecognized) and liabilities in a manner similar to a purchase
price allocation in accordance with Statement 141, to its carrying amount, both
of which would be measured as of the date of adoption. This second step is
required to be completed as soon as possible, but no later than the end of the
year of adoption. Any transitional impairment loss will be recognized as the
cumulative effect of a change in accounting principle in our statement of
operations.
As of the date of adoption, we expect to have unamortized goodwill in the
amount of $788,000, which will be subject to the transition provisions of
Statements 141 and 142. Amortization expense related to goodwill was $2.2
million, $3.5 million, $2.5 million and $2.6 million for the years ended
December 31, 1999 and 2000 and for the nine months ended September 30, 2000 and
2001, respectively. Because of the extensive effort needed to comply with
adopting Statements 141 and 142, it is not practicable to reasonably estimate
the impact of adopting these Statements on our financial statements at the date
of this report, including whether any transitional impairment losses will be
required to be recognized as the cumulative effect of a change in accounting
principle.
In May 2000, the Emerging Issues Task Force (EITF) issued EITF 00-14,
"Accounting for Certain Sales Incentives," which provides guidance in the
recognition of sales incentives. This pronouncement, which is effective January
1, 2002, will not have a material impact on our consolidated financial
statements.
In September 2000, EITF 00-22, "Accounting for "Points" and Certain Other
Time-Based or Volume-Based Sales Incentive Offers, and Offers for Free Products
or Services to Be Delivered in the Future," was issued, which provides guidance
on the accounting for membership-based loyalty programs. Certain provisions of
the pronouncement were effective for the quarter ended March 31, 2001. The
implementation of this pronouncement has not, and is not expected to, have a
material impact on our consolidated financial statements.
In September 2000, EITF 00-25, "Vendor Income Statement Characterization of
Consideration from a Vendor to a Retailer," was issued, which provides guidance
on the recognition, presentation and disclosure for arrangements between vendors
and retailers involving consideration. The implementation of this pronouncement
is effective January 1, 2002, and is not expected to have a material impact on
our consolidated financial statements.
In October 2001, the FASB issued Statement No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets," which addresses financial
accounting and reporting for the impairment or disposal of long-lived assets.
Statement No. 144 supersedes Statement No. 121, however, it retains many of the
fundamental provisions of that Statement. Statement No. 144 also supersedes the
accounting and reporting provisions of Accounting Principles Board No. 30
(Opinion 30), "Reporting the Results of Operations -- Reporting the Effects of
Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently
Occurring Events and Transactions," for the disposal of a segment of a business.
Statement No. 144 is effective January 1, 2002. We have not yet evaluated the
impact that the adoption of Statement No. 144 will have on our financial
statements.
59
BUSINESS
OVERVIEW
We are a music entertainment company that combines an online music network
with offline assets, including a record label and talent agency, to provide an
integrated music solution for music fans, artists and marketing partners. The
ARTISTdirect Network (www.artistdirect.com) is a network of Web sites offering
multi-media content, music news and information, community around shared music
interests, music-related commerce and digital music services. Through the
ARTISTdirect Agency, we provide live performance booking services to artists and
develop live event marketing programs. Through our co-venture record label,
ARTISTdirect Records, we develop new musical artists and produce and distribute
their recordings as an independent label utilizing both traditional channels and
emerging Internet distribution channels.
The ARTISTdirect Network features the UBL, a music search engine, iMusic, a
popular music-oriented online community, the Superstore, a retail commerce site
that includes official artist stores, Digital Music, a site that allows users to
listen to and download music, and ARTISTtv, a source for music videos and other
broadband programming.
- The Ultimate Band List -- a comprehensive online music search engine and
resource for music information. The UBL provides information on more than
100,000 artists across numerous musical genres, featuring news, concert
information, artist biographies, album reviews, contests, promotions,
music samples and downloads. The UBL also offers links to numerous other
Web sites in the online music community;
- iMusic -- a music-oriented online community providing chats, message
boards and fan clubs relating to specific artists and general music
topics. iMusic allows fans to communicate with others around the world to
share interests and commentary about their favorite music and artists.
iMusic also serves as a platform for fans to interact directly with their
favorite artists through hosted chats and fan conferences that we
organize periodically;
- The ARTISTdirect Superstore -- a retail site offering a wide selection of
music titles and artist merchandise. The ARTISTdirect Superstore includes
official stores for a number of artists, including *NSYNC, Blink-182 and
Metallica;
- Digital Music -- a free feature that enables users to download music and
listen to Internet radio programs. Downloads are available from a variety
of artists. The radio feature includes pre-programmed stations in a
variety of genre formats as well as a guide to other Internet radio
stations; and
- ARTISTtv -- a site for broadband programming including a variety of
current music videos and other programs produced exclusively by
ARTISTdirect and featuring popular artists.
We also operate a music talent agency, the ARTISTdirect Agency, that
procures live performance and concert touring appearance engagements and seeks
advertising and sponsorship opportunities for a roster of high-profile artists.
In connection with our agency activities, we have developed, managed and
promoted integrated series of live concert tours and festivals, including Fan
Nation and Sno-Core. These services enhance the relationships we have with many
of our artists and enable us to identify potential sponsorship opportunities for
advertisers with whom we have relationships.
We recently formed a new record label company, ARTISTdirect Records, LLC,
as a co-venture between our wholly-owned subsidiary, ARTISTdirect Recordings,
Inc., and Radar Records Holdings, LLC, an entity wholly owned by our Chief
Executive Officer, Mr. Field. Mr. Field serves as the Chief Executive Officer of
ARTISTdirect Records. ARTISTdirect Records will seek to develop new
60
music artists, and to produce and distribute their recordings as an independent
label utilizing both traditional channels and emerging Internet distribution
channels, including our own Internet music distribution network and artist
services. ARTISTdirect Records will generate revenue primarily from the sale of
compact discs by artists signed to the label. We believe ARTISTdirect Records
will allow us to strengthen our position as a music entertainment company with
both traditional and new media capabilities based on the Internet.
INDUSTRY BACKGROUND
THE MUSIC INDUSTRY
Music is one of the most popular forms of entertainment worldwide and a
multi-billion dollar consumer industry. Concert tours also generate significant
revenue for the music industry. In addition, the music industry generates
substantial advertising, sponsorship, promotional and merchandise revenue
related to music events and individual artists.
The music industry identifies artists and develops, promotes and
distributes their content. The high cost associated with development, promotion
and distribution has led artists to rely on third parties such as record labels,
merchandisers and tour promoters. Consequently, artists have had limited ability
to control how they are marketed to consumers, to identify and communicate
directly with their fans and to maximize their economic participation in all
available revenue streams.
The experience of the typical music consumer has been fragmented and
inefficient. Music consumers have had to search a variety of media to find music
news and information and have had to purchase compact discs, tickets and
merchandise through different retail channels. Goods, such as apparel and other
artist merchandise, have been difficult to find and frequently available only at
concerts or selected retail outlets. For music fans, opportunities to interact
with their favorite artists and fellow enthusiasts have been limited.
THE INTERNET OPPORTUNITY
The Internet has emerged as a platform that allows millions of people
worldwide to deliver and receive information rapidly, create virtual communities
around shared interests and engage in electronic commerce. This has made the
Internet an important new medium for music, dramatically altering the way
consumers search for, discover, listen to and purchase music. The Internet
offers:
- efficient reach to a worldwide audience;
- convenient access to a vast offering of musical content and services;
- ongoing flexibility to tailor products and services to consumer interests
and market dynamics;
- digital distribution of music;
- consumer personalization of the music experience; and
- timely collection of customer preferences and demographics for targeted
advertising and promotion.
61
Artists have begun to view the Internet as a platform to gain greater
control over the programming, promotion and distribution of their music and
related merchandise and to communicate directly with their fans. Consumers have
adopted the Internet to locate music information, share interests and discover
and buy music. We believe that the features of the Internet and the common
demographics of music consumers and Internet users present an opportunity to
reshape the music industry. Artists now have the opportunity to exert greater
control over the programming, promotion and distribution of their music and
consumers can now search for, discover and purchase music and related
merchandise and content at a single destination.
OUR SOLUTION
BENEFITS TO ARTISTS
By providing artists with a platform to develop their presence on the Web,
we enable artists to assume more creative control over their image, promote
their music in innovative ways, interact with their fans, extend their reach and
participate in incremental revenue streams. Our benefits to artists include:
Online Media Network. We offer artists access to an online media platform
to create, present, promote and distribute their content. Features include
auto-publishing tools, content management, and capabilities for advertising and
direct marketing and electronic commerce. Our technology enables us to quickly
launch artist-specific Web sites. Artists actively collaborate on the design,
content and other features. With continuing advances in broadband technology and
standards for digital music distribution, we believe these artist sites will
emerge as the artists' preferred platform for the full range of their content,
commerce, digital distribution and community activities on the Internet.
Closer Relationships with Fans. Artist-specific Web sites promote greater
fan affinity and loyalty by directly linking artists and fans. Artists can use
these Web sites to provide content and products to fans, including artist news,
concert information, music and video programming, exclusive chats, ticket
giveaways and fan club activities. Artists can also solicit the views of fans on
new music, live performances and music videos. A better understanding of their
fans enables artists to develop relevant content, promote their music more
effectively and create new revenue opportunities.
Access to Traffic from the ARTISTdirect Network. We attract, aggregate and
retain consumers within the ARTISTdirect Network through our content and
commerce offerings, thereby providing our artists the opportunity to tap into an
active community of millions of music fans. Artist sites can be accessed
directly or through the ARTISTdirect Network, allowing artists the opportunity
not only to reach their existing audience, but to broaden their fan base as
well. We aggregate global consumer traffic, collect targeted fan information and
generate incremental revenue from electronic commerce and advertising for the
shared benefit of the artist and ARTISTdirect.
New Revenue Opportunities. We provide artists with a number of incremental
revenue opportunities, including from music and related merchandise sales,
advertising and direct marketing. Our sites increase consumers' access to artist
merchandise that was previously generally available only at concert venues or
selected retail locations. We also assist artists in developing original
merchandise items for sale through their sites. We believe that our
revenue-sharing with artists provides incentives for them to promote the
ARTISTdirect Network. In addition, through our Marketing Solutions business, we
are able to present artists with revenue from advertising and sponsorship in
connection with their music recordings, live performances and Internet
activities.
Direct Marketing Opportunities. We encourage fans to provide identifying
information that allows the artists to develop consumer databases. Artists use
this database information to communicate news, upcoming music releases, live
appearances or online events that are targeted to a
62
particular fan base. Data may be also used to develop artist-approved targeted
advertising and marketing opportunities. Artists have access to detailed
information about how many people visited their sites, listened to or downloaded
their music and purchased compact discs. We maintain artist databases and share
revenue generated through their use with the artist.
New Platform for Digital Distribution. The Internet represents an important
new platform for digital music distribution. As the music industry develops
standards for secure digital distribution, we are implementing the
infrastructure and systems for digital distribution through the ARTISTdirect
Network. We currently provide free and paid digital downloads of music and a
variety of streaming audio services through the Digital Music area of the
ARTISTdirect Network. We intend to provide artists with a broad array of
opportunities to generate revenue from digital music distribution, including
pay-per-download, subscription services and advertising or sponsor-supported
services.
BENEFITS TO CONSUMERS
Our ARTISTdirect Network offers a comprehensive one-stop destination for
the music consumer. Our benefits to consumers include:
Direct Connection to Artists. Consumers have access to content specifically
created or endorsed by their favorite artists, as well as official artist news
and concert information, music, merchandise, special promotions and other
benefits. Special promotions have included opportunities to meet artists,
concert ticket giveaways, trips to live concerts, online fan conferences with
artists, exclusive music downloads and exclusive videos. Consumers can interact
with artists and offer direct feedback on new releases, concert performances and
videos.
Comprehensive Music Resource. The ARTISTdirect Network includes the UBL, a
comprehensive destination for searching, discovering and enjoying music content.
The UBL is an online search engine and database of more than 100,000 artists
covering a wide variety of musical genres, organized links to other Internet
music resources, news, concert information, artist biographies, album reviews,
contests and promotions, music samples and downloads. The UBL is designed to
encourage user participation by allowing users to create entries in the artist
database and links from the UBL to music sites elsewhere on the Internet. The
UBL also includes tools to allow artists to upload content, including
biographies, pictures and music for the benefit of their fans.
Rich Community Features. Our iMusic community site provides chats, message
boards, fan clubs and personalization tools relating to both specific artists
and more general music topics. Our site enables fans around the world to share
interests and commentary about their favorite music and artists and facilitates
their discovery of new music. iMusic also serves as a platform for fans to
interact directly with their favorite artists through hosted chats and fan
conferences.
Comprehensive Shopping Destination. The ARTISTdirect Network brings
together many of the disparate elements of the music shopping experience. Music
consumers can purchase and pre-order a full range of recorded music and shop for
artist-related merchandise, including some items available only through
ARTISTdirect. In addition, our content, downloadable music, special promotions
and auctions enhance the consumer experience. The UBL and iMusic provide
relevant information to help consumers make purchasing decisions.
Access to Online Digital Distribution. We currently provide digital
downloads of music and provide users with a variety of streaming audio services
through the Digital Music area of the ARTISTdirect Network, including some
content that is available only through ARTISTdirect. As digital distribution
becomes commercially viable, we plan to offer consumers a variety of ways to
acquire and experience music, including subscription services, pay-per-download
and advertising or sponsor-supported services.
63
ONLINE-OFFLINE INTEGRATION
Our original business vision was to integrate the capabilities of the
emerging Internet platform with the traditional music businesses of a talent
agency and record label to provide artists with a unique service offering that
also reached out to a global consumer audience. During 1999 and 2000, our
primary focus was on the development of our online activities. One of our
objectives with the formation of ARTISTdirect Records is to reemphasize the
offline aspects of our business to create more balance between online and
offline activities. In addition, our advertising sales and marketing solutions
activities are designed to integrate our online and offline assets to provide
greater value to our advertisers and marketing partners. We believe that this
integration of online and offline assets is essential to satisfying the needs of
our major constituencies: music fans, artists and marketing partners.
BUSINESS STRATEGY
Our objective is to be a leading music entertainment company, producing and
distributing new music, providing artist services and reaching music fans
through a comprehensive online music network. Our strategy is to:
Build Our Record Labels. We believe that there is a significant opportunity
to establish ARTISTdirect Records and ARTISTdirect Digital as independent record
labels. We intend to sign high potential artists capable of delivering new music
releases in the near term. We also intend to enter into an agreement with a
major record label for the distribution of our releases in both domestic and
international markets, as we believe that outsourcing distribution is more
effective and cost-efficient than self-distribution at this time.
Expand Our Talent Agency Business. We intend to expand our talent agency
business, ARTISTdirect Agency, both through the direct signing of new artists
and, potentially, through acquisitions, joint ventures or strategic alliances
with other agencies. We believe that the agency business is attractive both on a
stand-alone basis and as an element of our integrated artist service offering
and our marketing solutions business.
Build Brand Awareness. We intend to establish ARTISTdirect as a leading
brand for music entertainment. We intend to use both online and offline
marketing channels to reach consumers and promote the ARTISTdirect brand name.
We believe that the establishment of ARTISTdirect Records will provide a
significant new platform for branding as we begin to issue new releases under
the ARTISTdirect Records name. Through the ARTISTdirect Agency, we intend to
create ARTISTdirect-branded concerts and concert tours that will include both
media and venue promotion.
Enhance Our Users' Experience. We intend to add features and content to the
ARTISTdirect Network to enhance our users' experience. We plan to help our users
discover new music by providing personalization tools, targeted recommendations,
digital downloads and streaming audio and video. In addition, we plan to offer
one or more digital music subscription services either directly or under
agreements with third-party providers of such services.
Exploit Our Unique Assets. We intend to exploit our uniquely integrated
assets, broad reach and experienced, artist-oriented management team to
differentiate ourselves from companies with less comprehensive offerings. For
example, we aim to:
- offer selected artists a range of services, including live performance
booking through our talent agency; development, marketing and promotion
through our record label; and online programming, promotion and
distribution through the ARTISTdirect Network;
- develop branded live events and tours sponsored by advertisers and
merchants; and
64
- enable advertisers and merchants to deliver their messages to the
audience of the entire ARTISTdirect Network or to targeted audiences
within the ARTISTdirect Network.
Pursue Additional Revenue Streams. We intend to increase revenue from
existing sources and add new revenue streams. New revenue opportunities include:
- digital distribution of music: As the music industry develops standards
for secure digital distribution, we plan to provide consumers with a
variety of products and services that will generate revenue from sales of
digital music and subscription fees;
- database marketing: We plan to derive revenue from our databases of
consumer information and preferences. Our databases enable us to create
affinity groups and frequent buyer programs, promote existing artists
more effectively, and assist advertisers and merchants in targeting
specific audiences; and
- ancillary network opportunities: Our network will allow us to pursue a
variety of incremental revenue, for example, by offering a tiered menu of
subscription services and syndicated content for use both online and
offline.
ARTISTdirect BUSINESS UNITS
ARTISTdirect NETWORK
The ARTISTdirect Network is comprised of the UBL, iMusic, the ARTISTdirect
Superstore, Digital Music and ARTISTtv.
The UBL. The UBL is a music-specific Internet search engine. The UBL serves
as a comprehensive resource for music information relating to specific artists,
various genres and a wide range of events. The UBL combines content that we
generate with third-party content either licensed for use on our Web site or
accessible using edited links to other Web sites. Users have ready access to
artist profiles, music downloads, tour information, contests, Internet radio,
Webcasts and other content. The UBL allows users to add or update their own
information about their favorite artists. We believe that this process, together
with links to other music content sites, has made the UBL one of the most
comprehensive databases of bands available on the Web. The UBL currently
contains information regarding more than 100,000 artists and contains links to
numerous of other music-related sites.
iMusic. iMusic offers message boards, text chats, video chats, fan
conferences and other opportunities for fans to interact with each other and
with artists. We also host artist chats and conferences, providing users with
the opportunity to interact and communicate with their favorite artists.
Digital Music. In October 1999, we added an area within the ARTISTdirect
Network devoted to music downloads. We provide users with a selection of free
downloads chosen by the editorial staff of the UBL. Some of these downloads are
made available to us on an exclusive basis from artists. In addition, we provide
pre-programmed streaming Internet radio stations that users can access free of
charge. We also provide a guide to third party Internet radio stations as a
service to our users.
ARTISTdirect Superstore. The ARTISTdirect Superstore is a retail center for
leading brands and artists, offering recorded music and related merchandise. The
ARTISTdirect Superstore offers a wide selection of music titles and merchandise
for a broad range of artists, including official stores for a number of artists,
including *NSYNC, Blink-182 and Metallica.
ARTISTtv. In September 1999, we added ARTISTtv to the ARTISTdirect Network.
ARTISTtv is a site for broadband programming on the ARTISTdirect Network,
offering a variety of
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current music videos and other programs produced exclusively by ARTISTdirect
featuring popular artists.
ARTISTdirect AGENCY
The ARTISTdirect Agency is a music talent agency that procures live
performance and concert touring appearance engagements, and seeks advertising
and sponsorship opportunities, for a roster of high-profile artists. In
connection with our agency activities, we have developed, managed and promoted
integrated series of live concert tours and festivals, including Fan Nation and
Sno-Core. We believe that our agency services enhance the relationships we have
with many of our artists for whom we also host artist-specific Web sites. These
services also enable us to identify potential sponsorship opportunities for the
advertisers with whom we have relationships. We typically receive 10% of the net
revenue generated from agency-provided services. For the nine months ended
September 30, 2001 and the years ended December 31, 1999 and 2000, we derived
9%, 13% and 14% of our revenue from commissions generated by the ARTISTdirect
Agency, respectively. Currently, the ARTISTdirect Agency roster includes over 70
acts.
RECORD LABELS
ARTISTdirect Records: We recently formed a new record label company,
ARTISTdirect Records, LLC, as a co-venture between our wholly-owned subsidiary,
ARTISTdirect Recordings, Inc., and Radar Records Holdings, LLC, an entity wholly
owned by our Chief Executive Officer, Mr. Field. Mr. Field serves as the Chief
Executive Officer of ARTISTdirect Records. ARTISTdirect Records will seek to
develop new music artists, and to produce and distribute their recordings as an
independent label utilizing both traditional channels and emerging Internet
distribution channels, including our own Internet music distribution network and
artist services. We believe ARTISTdirect Records will allow us to strengthen our
position as a music entertainment company with both traditional and new media
capabilities based on the Internet.
ARTISTdirect Digital: We recently formed a new record label entity,
ARTISTdirect Digital, Inc., as a wholly-owned subsidiary of ARTISTdirect. We
plan to conduct record label operations through ARTISTdirect Digital that will
be separate from ARTISTdirect Records. The focus of ARTISTdirect Digital will be
on signing established artists who are no longer under major label contract and
leveraging targeted marketing methods to efficiently reach their existing base
of fans and expose them to people who like similar music. Use of online
marketing through our ARTISTdirect Network is an important element of this
strategy. By focusing on artists who have name recognition and a base of fans,
ARTISTdirect Digital also creates opportunities for these artists to take part
in our marketing solutions activities through, for example, tour sponsorships
and endorsements.
INFRASTRUCTURE AND OPERATIONS
TECHNOLOGY
Our infrastructure is designed to be integrated, scalable, reliable and
secure. The software that we use supports the acquisition, management and
publication of content on our Web sites.
Our Web sites and servers for content, applications, database and
electronic commerce are currently hosted by CNP, Inc. at CNP's Internet service
provider, IX2 Networks, LLC, in Los Angeles, California, under either
co-location or managed server agreements. Our operations depend on these
companies' ability to protect their systems against fire, power loss,
telecommunications failure, break-ins and other events. These companies provide
comprehensive facilities management services, including human and technical
monitoring of all production servers 24 hours per day, seven
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days per week. All Web sites, servers, and systems are monitored continuously.
Weekly backups are stored at a remote location.
Our current e-commerce system is based on SAP software with certain
enhancements provided to us by Pandesic, LLC, a joint venture between Intel and
SAP. When Pandesic started to wind down its operations in fall 2001, we migrated
to other SAP-developed solutions. Upon Pandesic's cessation of operations, we
received the source code and executables for the e-commerce system that had been
provided previously by Pandesic, and implemented SAP's software.
CNP, Inc. In August 2001, we entered into a one-year agreement with CNP,
Inc., formerly Amplified Holdings, Inc., whereby we outsourced the majority of
our technology requirements to CNP, including, but not limited to, hosting,
e-commerce, content management, and content publication. The agreement
automatically renews for successive one-year periods unless either party gives
the other party notice of non-renewal before the end of the term in progress.
CNP will provide hosting and professional services, and technology development
during the term of the agreement. As part of the agreement, CNP licensed its
proprietary hosted platform technology to us for our Web sites. Notwithstanding
the foregoing, we maintain an Information Technology department for our internal
administrative needs.
ORDER PROCESSING AND FULFILLMENT
Our Web sites include an ordering system that is designed to facilitate
convenient online purchasing of pre-recorded music and merchandise. Customers
can add items to their "shopping cart" while surfing our Web sites. At any time
they can securely "checkout", at which time they need to register (if they are
new customers), or enter a username and password to retrieve previously saved
billing, shipping and credit card information. We verify orders submitted for
credit card payment for fraud detection and sufficient funds before we release
them for fulfillment. We also accept alternative modes of payment, such as
checks and money orders. Credit card numbers are encrypted, and all customer,
commerce and transactional data are stored in secure databases protected by
firewalls. The transmission of information over the Internet uses Secure Socket
Layer security technology verified by VeriSign.
Alliance Entertainment. In August 1998, we entered into a five-year
agreement with Alliance Entertainment Corp. to be our primary supplier of music
and music-related information for our ARTISTdirect Superstore. Alliance owns the
All Music Guide, a comprehensive source of artist and album information that is
supplied to our users primarily through its integration into the UBL. Alliance
fulfills compact discs ordered by our customers and we pay Alliance the
wholesale cost plus a fulfillment fee. In addition, Alliance provides warehouse
space for our music-related merchandise that allows the consolidated shipping of
customer orders for both music and merchandise. We have integrated our order
processing system with Alliance's information systems to assist in fulfillment
tracking, inventory management and customer service.
We maintain very low levels of inventory. Almost all of the music titles
available for sale on our Web sites are purchased by us from inventory held by
Alliance. Similarly, almost all of the music-related merchandise available for
sale is the inventory of the artist. We take physical title to the product at
the time of shipment and have ultimate credit and collection risk.
Giant and Winterland. We entered into a four-year agreement with Giant
Merchandising in April 1999 and a three-year agreement with Winterland
Concessions Company in June 1999 to supply merchandise on a wholesale basis for
both our ARTISTchannels and the ARTISTdirect Superstore. We believe that our
inventory management and distribution strategy allows us to offer extensive
selection while avoiding the high fixed costs and capital requirements
associated with
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owning and warehousing product inventory as well as the operational effort
integral to shipping and delivery.
We depend on Alliance, Giant and Winterland for timely shipment of products
purchased through our Web sites. Alliance currently provides fulfillment
services for our ARTISTchannels pursuant to an oral agreement that Alliance may
terminate at any time. If we are unable to renew our agreements with these
suppliers when they expire, on favorable terms or at all, or if Alliance ceases
to provide fulfillment services for our ARTISTchannels, our business could be
adversely affected.
CUSTOMER SERVICE
AEC One-Stop Group, Inc. provides customer support services for our Web
sites' consumers and responds to customer inquiries, orders and other requests
made by phone, fax, e-mail and regular mail.
SALES AND MARKETING
ADVERTISING SALES
We sell marketing solutions, including advertising and sponsorships, to a
variety of advertisers seeking to reach one or more of the distinct demographic
audiences viewing content in the ARTISTdirect Network or attending a live event
that we organize. Components of a marketing solution may include, among other
things, title sponsorship of an event or concert tour, promotion in marketing
materials for an event or tour, signage and presence at live events, contests to
promote consumer registration for sponsor services, and banner ads or content
sponsorship on the ARTISTdirect Network. In addition, advertisers may choose
single elements such as targeted or run-of-network banners on our Web sites.
Pricing is negotiated based upon the size of the target audience, the duration
and intensity of the campaign, the number of elements involved, and payments to
third parties, such as artists, to secure their services. Our strategy is to
expand the number of advertisers using our marketing solutions and specifically
increase our penetration of national, consumer-oriented brand advertisers.
We derive a significant portion of our revenue from the sale of
advertising. For the nine months ended September 30, 2001 and the year ended
December 31, 2000, advertising represented 26% and 29%, respectively, of
revenue. Pringles, a division of Procter & Gamble, accounted for 14% and 11% of
our advertising revenue for the nine months ended September 30, 2001 and the
year ended December 31, 2000, respectively. During the same periods, Universal
Music Group accounted for 23% and 16% of our advertising revenue.
MARKETING AND PROMOTION
We use a number of methods to create awareness of the ARTISTdirect Network
and drive traffic to our Web sites. We have focused much of our online
advertising on specific artists, contests, promotions and other events designed
to attract interest to our sites. We have also used print and radio advertising
to create brand awareness for ARTISTdirect and to promote special events taking
place on the ARTISTdirect Network. In addition, we participate in the
sponsorship of live music and other industry events that provide prominent
visibility for either ARTISTdirect or the UBL and maintain an aggressive public
relations program generating press coverage and speaking engagements for our
senior executives.
We also use e-mail direct marketing to communicate with registered users of
the ARTISTdirect Network. Campaigns have included direct notification of special
merchandise offers, live artist chats, music downloads and non-scheduled live
performances. As we continue to build our user databases,
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we expect to expand the use of e-mail direct marketing to facilitate user
retention and create loyalty and affinity programs.
COMPETITION
The market for the online promotion and distribution of music and
music-related products and services is new, highly competitive and rapidly
changing. The number of Web sites competing for the attention and spending of
consumers and advertisers has increased, and we expect it to continue to
increase, because there are few barriers to entry to Internet commerce. In
addition, the competition for advertising revenue, both on Web sites and in more
traditional media, is intense. We compete as follows:
- for music consumers, advertisers and, to a lesser extent, artist
relationships, with providers of music information, community and content
such as MTVi, Launch Media, mp3.com, EMusic, Listen.com and various other
companies;
- with major online music retailers such as Amazon.com and CDnow in selling
music and merchandise;
- for music consumers and advertisers with online "portals" which have
music-oriented sites, including America Online, MSN and Yahoo!;
- for music consumers and artist relationships with traditional music
industry companies, including BMG Entertainment, a unit of Bertelsmann
AG, EMI Music, a unit of EMI Group, Sony Music Entertainment, a unit of
Sony Corporation, Warner Music Group, a unit of AOL Time Warner, and
Universal Music Group, a unit of Vivendi Universal. Some of these
companies have recently established online presences to promote and
distribute the music and tours of their respective artists;
- for music consumers and advertisers with publishers and distributors of
traditional media, such as television, radio and print, including MTV,
CMT, Rolling Stone and Spin and their Internet affiliates; and
- with traditional retailers targeting music consumers, including Tower
Records and Virgin Megastore and their Internet affiliates, in selling
music and merchandise.
Some of our competitors have agreed to work together to offer music over
the Internet, and we may face increased competitive pressures as a result. For
example, Universal Music Group and Sony Music have formed a joint venture to
operate pressplay, a subscription music service that will offer consumers both
downloads and on-demand streaming. In addition, RealNetworks, AOL Time Warner,
Bertelsmann AG and EMI Group formed MusicNet, a digital music subscription
platform featuring on-demand downloads and streaming.
We believe that we compete primarily on the bases of:
- our integrated offering of both online and offline assets, including the
ARTISTdirect Network, the ARTISTdirect Agency and ARTISTdirect Records;
- the breadth and quality of the UBL database and the community features of
iMusic;
- the variety, availability and price of music-related merchandise on our
sites;
- the ease of use and consumer acceptance of the ARTISTdirect Network; and
- the ability to effectively promote our brands.
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Competition is likely to increase significantly as new companies enter the
market and current competitors expand their services. Many of our current and
potential competitors in the Internet and music entertainment businesses may
have substantial competitive advantages to us, including:
- longer operating histories;
- significantly greater financial, technical and marketing resources;
- greater brand name recognition;
- larger existing customer bases; and
- more popular content or artists.
These competitors may be able to respond more quickly to new or emerging
technologies and changes in customer requirements and to devote greater
resources to the development, promotion and sale of their products or services
than we can. Web sites maintained by our existing and potential competitors may
be perceived by consumers, artists, talent management companies and other music-
related vendors or advertisers as being superior to ours. In addition, we may
not be able to maintain or increase our Web site traffic levels, purchase
inquiries and number of click-throughs on our online advertisements. Further,
our competitors may experience greater growth in these areas than we do.
Increased competition could result in advertising price reduction, reduced
margins or loss of market share, any of which could harm our business.
GOVERNMENTAL REGULATION
The laws and regulations that govern our business change rapidly. Although
our operations are currently based in California, the United States government
and the governments of other states and foreign countries have attempted to
regulate activities on the Internet. The following are some of the evolving
areas of law that are relevant to our business:
CONTENT REGULATION
Federal, state and foreign governments have adopted and proposed laws
governing the content of material transmitted over the Internet. These include
laws relating to obscenity, indecency, libel and defamation. For example, the
Child Online Protection Act, or COPA, prohibits and imposes criminal penalties
and civil liability on anyone communicating material harmful to minors through
the Internet for commercial purposes, unless access to such material is blocked
to minors under age 17. The Third U.S. Circuit Court of Appeals has upheld a
preliminary injunction precluding enforcement of COPA. We could be liable if the
injunction against COPA is lifted and if content delivered by us or placed on
our Web sites violates COPA.
PRIVACY LAW
The state of privacy law is unsettled, and rapidly changing. Current and
proposed federal, state and foreign privacy regulations and other laws
restricting the collection, use and disclosure of personal information could
limit our ability to use the information in our databases to generate revenues.
In late 1998, the Children's Online Privacy Protection Act, or COPPA, was
enacted, mandating that measures be taken to safeguard minors under the age of
13. The FTC promulgated regulations implementing COPPA on October 21, 1999 which
became effective on April 21, 2000. The principal COPPA requirement is that
individually identifiable information about minors under the age of 13 not be
collected, used or displayed without first obtaining informed parental consent
that is verifiable in light of present technology. The FTC final regulations
create a "sliding scale" of permissible methods for obtaining such consent.
Consent for internal use of the individually identifiable information of
children under the age of 13 can be obtained through e-mail plus an additional
safeguard, such as confirming consent with a delayed e-mail, telephone call, or
letter. Obtaining verifiable consent from a child's parent to share that child's
information with a third party or enable
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the child to publicly distribute the information by, for example, allowing
unrestricted access to a chat room or message board is significantly more
burdensome.
The FTC has required that parental consent for such higher risk activities
be verified by more secure methods than e-mail, such as a credit card in
connection with a transaction, print-and-sign forms, toll-free numbers staffed
by trained operators, or digital signatures. Complying with the new requirements
is costly and will likely dissuade some percentage of our customers. While we
are attempting to be fully compliant with the FTC requirements, our efforts may
not be entirely successful. In addition, at times we rely upon outside vendors
to maintain data-collection software, and there can be no assurance that they
will at all times comply with our instructions to comply with COPPA. If our
methods of complying with COPPA are inadequate, we may face litigation with the
FTC or individuals, which would adversely affect our business.
Moreover, we have posted a Private Policy pertaining to all users and
visitors to our Web site. By doing so, we have subjected ourselves to the
jurisdiction of the FTC. Should any of our business practices be found to differ
from our Private Policy, we could be subject to sanctions and penalties from the
FTC. It is also possible that users or visitors could try to recover damages in
a civil action as well.
SALES TAX
The tax treatment of goods sold over the Internet is currently unsettled.
We collect sales taxes for goods shipped to California and Florida, where we
have a physical presence. A number of proposals have been made at the state and
local level that would impose additional taxes on the sale of goods through the
Internet. Such proposals, if adopted, could substantially impair the growth of
electronic commerce and could adversely affect our opportunity to derive
financial benefit from electronic commerce. While the Internet Freedom Act
placed a three-year moratorium on new state and local taxes on Internet
commerce, the tax moratorium expired on October 21, 2001 and has not been
renewed. Failure to renew this legislation would allow various states to impose
taxes on Internet-based commerce, which could adversely affect our business.
ONLINE CONTESTS AND SWEEPSTAKES
We conduct online promotional contests and sweepstakes. No purchase is
necessary to participate. Our official rules, with all material terms,
conditions of eligibility, dates of participation, methods of entry and
limitations, if any, along with the odds and prize offerings, are posted on our
Web sites. In order to comply with New York and Florida state law, our prizes
are limited in value to less than $5,000, or we comply with those states'
registration and bonding requirements. While we attempt to comply with the law
of all fifty state jurisdictions, we may not be uniformly successful, and
foreign jurisdictions may attempt to regulate or ban our promotional contests.
In that event, we could lose an effective tool for increasing and keeping
visitors to our Web site, and our business could be adversely affected.
INTELLECTUAL PROPERTY
OUR PROPRIETARY RIGHTS
Copyrighted material that we develop, as well as our service marks and
domain names relating to the ARTISTdirect, UBL or iMusic brands and other
proprietary rights are important to our business prospects. We seek to protect
our common-law trademarks through federal registration, but these actions may be
inadequate. Where consultants develop copyrighted content for us, our general
policy is to use written agreements prior to content creation to obtain
ownership of that content. In addition, we principally rely upon trademark,
copyright, trade secret and contract law to protect our proprietary rights. We
generally enter into confidentiality agreements, "work-made-for-hire" contracts
and intellectual property licenses with our employees, consultants and corporate
partners, respectively, as
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part of our efforts to control access to and distribution of our technologies,
content and other proprietary information.
Despite our efforts to protect our proprietary rights from unauthorized use
or disclosure, parties may attempt to disclose or use our customer lists, Web
site content, service marks, domain names or confidential commercial data. The
steps that we have taken may not prevent misappropriation of our proprietary
rights, particularly in foreign countries where laws or law enforcement
practices may not protect our proprietary rights at all, or as fully as in the
United States. If third parties were to use or otherwise misappropriate our
copyrighted materials, trademarks or other proprietary rights without our
consent or approval, our competitive position could be harmed, or we could
become involved in costly and distracting litigation to enforce our rights.
OUR WEB SITES FEATURE CONTENT THAT IS COPYRIGHTED BY MULTIPLE THIRD-PARTIES
A copyright gives the owner divisible rights, including those of
performance, reproduction and distribution. The music featured by us is
typically comprised of copyrighted works owned, controlled or administered by
multiple third parties, including record labels, artists, songwriters, music
publishers and performance rights and licensing organizations such as The Harry
Fox Agency, Broadcast Music Inc. and the American Society of Composers, Authors
and Publishers. Each song often has multiple copyright owners, who control
rights which may include performance, reproduction and distribution rights in
the "musical composition" comprised of the lyrics and music, as well as with the
"sound recording" of the artist's interpretation of the "musical composition."
In the case of music videos, there are separate copyrights to the visual
content, as well as "synchronization rights" for integrating the music and
video. We, or our artists, may have different licensing arrangements with some
or all of these parties to perform, reproduce and distribute works depending
upon how the song or music video is used by us.
Our Web sites, depending upon the specific musical work, may offer audio
streaming of part or all of an entire song or "Web casting," or the downloading
of an entire song in MP3 or other compressed audio formats. Full-length
streaming only occurs in special instances after obtaining an oral license from
the record label or band manager for the "sound recording." In that case, an
ASCAP or BMI blanket music license is also obtained by us or by our artists for
rights to perform the associated underlying "musical composition." Where we
offer full-length downloads of songs in MP3 or other compressed audio formats,
we seek to obtain the rights to transmit, reproduce and perform the "sound
recording" in writing from the person or entity owning or controlling copyrights
in such "sound recording." With respect to rights in the "musical compositions"
embodied in such "sound recordings" offered for download, we seek to clear
rights in musical composition in one of the following three ways:
- a license agreement with the publisher, writer or other owner of such
copyright in the "musical composition";
- a waiver of any fees or royalties that would otherwise be required for
such use; or
- a representation and warranty from the owner of the copyrights in the
"sound recording" that no mechanical royalties are owed to any third
parties.
In the event that the foregoing steps are insufficient to clear rights, or
we otherwise fail to obtain rights, we could be exposed to claims of copyright
infringement, with attendant disruption to our operations and liability
including potential statutory or actual damages and loss of profits attributable
to infringement, plus payment of attorneys' fees and entry of an injunction.
There are other situations, such as a limited 30-second sample of a song
that is "streamed," where we use content relying upon a sub-license from an
artist's record label. However, the laws in this area are uncertain, and we may
be forced to obtain such licenses or may be prevented from third party content
use, and may further be liable to pay actual or statutory damages, profits
attributable to
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any alleged infringement, as well as attorneys' fees. Our licensing arrangements
for third-party content vary from formal contracts to informal agreements based
on the promotional nature of the content. In some cases we pay a fee to the
licensor for use of the "sound recording," "musical composition" or music video
and in other cases the use is free. We also use other third-party content,
including photographs, artist names, likenesses and concert reviews. While it is
our general policy to obtain a written release or license for such use, in many
instances we rely only upon an oral license for such use. We rely upon our
positive working relationships with copyright owners to obtain licenses on
favorable terms. Any changes in the nature or terms of these arrangements,
including any requirement that we pay significant fees for the use of the
content, could have a negative impact on the availability of content or our
business.
For example, the Copyright Office recently opined that additional
royalties, besides those collected for musical compositions by ASCAP or BMI, are
due for Web casted music that is selected by or on behalf of the recipient
pursuant to 17 U.S.C. sec. 114(j)(7). If upheld, that ruling would prevent us
from expanding our service to permit users to play a requested song via our Web
site without paying additional royalties.
LINKING AND FRAMING OF THIRD-PARTY WEB SITES
We link to and "frame" third-party Web sites of our artists without express
written permission to do so. In addition, in the past we have provided a search
feature to allow users to find music residing elsewhere on the Internet. Those
practices are controversial, and have, in instances not involving us, resulted
in litigation. Various claims, including trademark and copyright infringement,
unfair competition, and commercial misappropriation, as well as infringement of
the right of publicity may be asserted against us as a result. The law regarding
linking and framing remains unsettled; it is uncertain as to how existing laws,
especially trademark and copyright law, will be applied by the judiciary to the
Internet. Also, Congress is increasingly active in passing new laws related to
the Internet, and there is uncertainty as to the impact of future potential
laws, especially those involving domain names, databases and privacy.
DEFAMATION OR CONTRIBUTORY INFRINGEMENT
Our Web sites feature live "chat," or interactive on-line discussion groups
made up of our customers. We do not censor such comments in advance and it is
possible that a customer could use our Web sites as a forum to make false,
misleading or disparaging remarks about others. Such on-line comments could lead
to claims for defamation or infringement. As to libel claims brought in the
United States, we believe that we qualify for safe harbor protection for
third-party postings under 47 U.S.C. sec. 230(c)(1). However, other countries,
notably the United Kingdom, may impose such liability, and it is possible we
could be sued there for third-party postings. Separately, our Web sites allow
consumers to use our personal Web publishing tools to post samples of their
works. Such postings could be misused to post unlicensed copyrighted content of
others. We have obtained limited safe-harbor protection under the
recently-enacted Digital Millennium Copyright Act against liability for
infringing material of which we do not have control and knowledge.
EMPLOYEES
As of September 30, 2001, we had 79 full-time employees. None of our
employees is represented by a labor union. We have not experienced any work
stoppages and consider our employee relations to be good.
FACILITIES
Our principal corporate offices are located in Los Angeles, California
where we lease approximately 64,000 square feet under a lease that expires in
2010. In addition, we currently lease
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approximately 1,400 square feet for our New York sales office under a lease that
expires in November 2002 and lease approximately 3,500 square feet for our San
Francisco office under a lease that expires in May 2002. We expect that our
current space will accommodate our needs for the foreseeable future.
LEGAL PROCEEDINGS
From time to time, we may be involved in litigation relating to claims
arising out of our ordinary course of business. We are not presently involved in
any material legal proceedings.
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MANAGEMENT
EXECUTIVE OFFICERS, DIRECTORS AND KEY EMPLOYEES
The following table sets forth specific information regarding our
directors, executive officers and other key employees as of September 30, 2001:
NAME AGE POSITION(S)
---- --- -----------
Frederick W. Field....................... 49 Chairman of the Board and Chief Executive
Officer
Marc P. Geiger........................... 38 Vice-Chairman of the Board and President,
Artist Services
Keith K. Yokomoto........................ 38 President, Chief Operating Officer and
Director
James B. Carroll......................... 46 Executive Vice President, Chief Financial
Officer and Secretary
Clifford H. Friedman..................... 42 Director
Dara Khosrowshahi........................ 32 Director
Stephen M. Krupa......................... 36 Director
Allen D. Lenard.......................... 59 Director
Benjamin Moody........................... 41 Director
Richard B. Colbert....................... 44 Senior Vice President, Sales and
Marketing Solutions
Pascal O. Desmarets...................... 39 Vice President, Information Technology
and Operations
Thomas F. Fuelling....................... 39 Executive Vice President, Finance and
Operations
Donald P. Muller......................... 40 Senior Agent
Nicholas J. Turner....................... 42 Senior Vice President, Artist Services
EXECUTIVE OFFICERS AND DIRECTORS
Frederick W. Field has served as our Chairman of the Board and Chief
Executive Officer, and as Chief Executive Officer of ARTISTdirect Records, since
June 29, 2001. He also serves as Chairman of the Board and Chief Executive
Officer of Radar Pictures, Inc., a film production company. From 1990 to 2001,
Mr. Field served as Co-Chairman of Interscope Records, a music production
company. From 1979 to 1997, Mr. Field served as Chairman of the Board and Chief
Executive Officer of Interscope Communications, Inc. Additionally, Mr. Field
serves on the board of directors of Interland, Inc. and several privately-held
companies.
Marc P. Geiger co-founded ARTISTdirect and has served as our Vice-Chairman
of the Board and President, Artist Services, since June 29, 2001. He served as
Chief Executive Officer from our inception to June 2001 and as our Chairman of
the Board from July 1998 to June 2001. From January 1992 to December 1996, Mr.
Geiger was the Senior Vice President of Marketing, A&R and New Media at American
Recordings, Inc. From 1984 to 1991, Mr. Geiger worked as a talent agent for
Regency Artists, that was later acquired by the William Morris Agency. In 1990,
Mr. Geiger co-founded the Lollapalooza concert tour.
Keith K. Yokomoto co-founded ARTISTdirect and has served as our President
since July 1999, as our Chief Operating Officer since January 1997 and as a
director since July 1998. From September 1985 to January 1997, Mr. Yokomoto was
a manager of new ventures and business development and a project engineer at
Hughes Electronics. Mr. Yokomoto received his B.S. in
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Mechanical Engineering from the University of California at San Diego and his
M.B.A. from the University of Southern California.
James B. Carroll has served as our Executive Vice President and Chief
Financial Officer since May 1999. Mr. Carroll has served as our Secretary since
July 1999. From November 1994 to May 1999, Mr. Carroll was a Managing Director
in the Media & Entertainment Group at Bear, Stearns & Co. Inc., where he served
as an investment banker to companies primarily in broadcasting and new media.
From January 1989 to August 1994, Mr. Carroll was a Managing Director at Smith
Barney Inc., where he co-founded the Media & Communications Group and served on
the Investment Banking Management Committee. Mr. Carroll received his B.A. in
Psychology from Claremont McKenna College and his M.B.A. from Harvard Business
School.
Clifford H. Friedman has served as a director since July 1998. Mr. Friedman
is a Senior Managing Director at Bear, Stearns & Co. Inc. where he manages
venture capital funds, including Constellation Venture Capital, L.P. From
January 1996 to August 1997, Mr. Friedman served as a Senior Vice President of
Universal Studios. From January 1995 to January 1996, Mr. Friedman was a Vice
President of Corporate Development at NBC. Mr. Friedman received his B.S. in
Electrical Engineering and Computer Science and his M.S. in Electrophysics from
Polytechnic University. Mr. Friedman received his M.B.A. from Adelphi
University.
Dara Khosrowshahi has served as a director since March 2000. Since July
2000, Mr. Khosrowshahi has been Executive Vice President, Operations and
Strategic Planning of USA Networks Incorporated. From October 1999 to July 2000,
Mr. Khosrowshahi was President of USANetworks Interactive, a division of USAi.
From February 1998 to October 1999, Mr. Khosrowshahi was the Vice President of
Strategic Planning for USAi and USANi LLC. From 1991 to 1998, he was at Allen &
Company Incorporated, an investment bank, where he was a Vice President from
1995 to 1996 and a Director from 1996 to 1998. Mr. Khosrowshahi also serves as a
director of Hotel Reservation Network and several private companies. Mr.
Khosrowshahi received his B.S. in Bioelectrical Engineering from Brown
University.
Stephen M. Krupa has served as a director since May 1999. Mr. Krupa is a
founding member and Managing Director of Psilos Group Managers, LLC, a private
venture capital fund focused on the digital media, information technology and
health care sectors. Mr. Krupa is currently a director of several private
technology and healthcare companies. From February 1995 to July 1998, Mr. Krupa
held various positions at Wasserstein Perella & Co., most recently as a Vice
President where he specialized in mergers and acquisitions advisory work. Mr.
Krupa received his B.S. in Mechanical Engineering from the University of South
Florida and his M.B.A. from the Wharton School of the University of
Pennsylvania.
Allen D. Lenard has served as a director since July 1998. Mr. Lenard is
Managing Partner of Lenard, Brisbin & Klotz LLP, a transactional entertainment
law firm. Mr. Lenard received his B.A. in Business Administration from the
University of Wisconsin, Madison and his J.D. from the University of California
at Los Angeles School of Law.
Benjamin Moody has served as a director since March 2001. Mr. Moody
presently is Vice Chairman and Chief Financial Officer of Cisneros TV Group, a
media entertainment company, as well as Managing Director and Chief Financial
Officer of Ibero-American Partners II, Ltd. Moody also currently serves as a
director of several media companies, including Playboy TV International, LLC and
The Locomotion Channel. From June 1996 to June 1998, Mr. Moody was a Managing
Director of Violy, Byorum and Partners, LLC. From June 1992 to June 1996, Mr.
Moody was a Vice President of Citicorp Securities, Inc. Mr. Moody received his
B.A. in English Language and Literature from Saint Benet's Hall, Oxford
University.
76
Our executive officers are elected by the Board of Directors on an annual
basis and serve until their successors have been duly elected and qualified.
There are no family relationships among any of our directors or executive
officers.
OTHER KEY EMPLOYEES
Richard B. Colbert has served as our Senior Vice President of Sales and
Marketing Solutions since September 1999. From October 1998 to September 1999,
Mr. Colbert served as President of Northern NOMA Corp., providing consulting
services to internet and broadcasting companies. From 1983 to 1998, Mr. Colbert
was President of IntelliVentures, Inc., a producer and distributor of special
interest video programming. From 1989 to 1993, Mr. Colbert was Senior Executive
Vice President of ITC Domestic Television, a distributor of first-run television
programming.
Pascal O. Desmarets has served as our Senior Vice President, Information
Technology since February 1999. From February 1997 to February 1999, Mr.
Desmarets held various management positions in the engineering group at Optum
Software. Mr. Desmarets received his B.S. in Industrial Engineering and
Management from the Catholic University of Louvain, Belgium and his M.B.A. from
the University of Southern California.
Thomas F. Fuelling has served as our Executive Vice President, Finance and
Operations since October 1999. From April 1998 to September 1999, Mr. Fuelling
was Vice President, Finance and CFO of Sega GameWorks, LLC. From December 1995
to March 1998, Mr. Fuelling was Executive Vice President, Finance and CFO of
Village Roadshow Pictures. From March 1994 to November 1995, Mr. Fuelling was
Vice President and Controller of The Samuel Goldwyn Company. From 1984 to 1994,
Mr. Fuelling was a certified public accountant with Price Waterhouse LLP in its
Entertainment practice unit. Mr. Fuelling received his B.S. in Business
Administration from the University of Southern California and his Master of
Management from Northwestern University.
Donald P. Muller co-founded ARTISTdirect and has served as our Senior Agent
since September 2001. He served as the President of ARTISTdirect Agency from
July 1999 to September 2001 and as a director from July 1998 to September 2001.
From January 1997 to June 1999, Mr. Muller was a co-Chief Executive Officer of
ARTISTdirect, LLC. From October 1992 to December 1996, Mr. Muller was a talent
agent overseeing William Morris Agency's Contemporary Music Worldwide division.
From 1986 to September 1992, Mr. Muller was an agent at Triad Artists Agency,
which was sold to William Morris Agency in 1992. Mr. Muller received his B.A. in
Communications from the University of Iowa. In 1990, Mr. Muller co-founded the
Lollapalooza concert tour.
Nicholas J. Turner has served as our Senior Vice President, Artist
Services, since March 1999. From June 1996 to February 1999, Mr. Turner was Vice
President, West Coast for N2K's Music Boulevard, and from June 1994 to June
1996, Mr. Turner founded and operated Rocktropolis. Music Boulevard and
Rocktropolis are online music entertainment companies. Before founding
Rocktropolis, Mr. Turner was an associate of artist manager Miles Copeland,
working in various capacities with recording artists.
BOARD COMPOSITION
Our Board of Directors is divided into three classes designated as Class I,
Class II and Class III, and our directors are assigned to each class by the
Board of Directors. The Class I directors are Frederick Field, Keith Yokomoto
and Benjamin Moody; the Class II directors are Allen Lenard and Stephen Krupa;
and the Class III directors are Marc Geiger, Clifford Friedman and Dara
Khosrowshahi. Donald Muller resigned from our Board of Directors in September
2001. At our 2004
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annual meeting of stockholders, the term of office of the Class I directors will
expire, and Class I directors will be elected for a full term of three years. At
our 2002 annual meeting of stockholders, the term of office of the Class II
directors will expire, and Class II directors will be elected for a full term of
three years. At our 2003 annual meeting of stockholders, the term of office of
the Class III directors will expire, and Class III directors will be elected for
a full term of three years. At each succeeding annual meeting of stockholders,
directors will be elected for a full term of three years to succeed the
directors of the class whose terms expire at such annual meeting.
Messrs. Yokomoto and Moody, and each of our Class II and Class III
directors, were appointed to the Board of Directors pursuant to the stockholders
agreement described on pages 116-117. Although the provisions of the
stockholders agreement regarding appointment of directors terminated upon the
closing of our initial public offering, our existing directors, officers and 5%
stockholders beneficially owned approximately 61.0% of our common stock as of
September 30, 2001. As a result, they will be able to re-elect these directors.
Messrs. Yokomoto and Moody were re-elected at our last annual meeting and Mr.
Field was elected for the first time at that same meeting. Clifford Friedman is
affiliated with Constellation Venture Capital, L.P., which beneficially owned
approximately 7.7% of our common stock as of September 30, 2001.
BOARD COMMITTEES
The Board of Directors has established a Compensation Committee and an
Audit Committee. The Compensation Committee is primarily responsible for
reviewing and approving our general compensation policies and setting
compensation levels for our executive officers. The Compensation Committee also
reviews and makes recommendations to the Board of Directors on matters relating
to employee compensation and benefit plans. The Compensation Committee currently
consists of three directors, Messrs. Friedman, Krupa and Lenard. The Audit
Committee is primarily responsible for approving the services performed by our
independent accountants and reviewing their reports regarding our accounting
practices and systems of internal accounting controls. The Audit Committee also
reviews our accounting and financial policies in general and our management's
procedures and policies with respect to our internal accounting controls. The
Audit Committee currently consists of three directors, Messrs. Friedman,
Khosrowshahi and Krupa.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
The members of our Compensation Committee of the Board of Directors are
currently Messrs. Friedman, Krupa and Lenard, none of whom has ever been an
officer or employee of ARTISTdirect. Before establishing the Compensation
Committee in September 1999, the Board of Directors as a whole performed the
functions delegated to the Compensation Committee. None of our executive
officers serves as a member of the board of directors or compensation committee
of any entity that has one or more executive officers who serve on our Board of
Directors or Compensation Committee.
DIRECTOR COMPENSATION
Directors who are not our employees or employees of one of our subsidiaries
do not currently receive any cash compensation from us for their service as
members of the Board of Directors or any Board committee. However, Directors are
reimbursed for all reasonable travel and lodging expenses incurred by them in
attending Board and committee meetings. All directors are eligible to
participate in the 1999 Employee Stock Option Plan.
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In December 2000, we granted Dara Khosrowshahi, one of our outside
directors, options to purchase 5,000 shares of our common stock at a price per
share of $7.50. In May 2001, we granted Frederick Field, our Chairman of the
Board, non-plan options to purchase an aggregate of 444,480 shares of our common
stock at a price per share of $7.50. See "Related Party Transactions -- Options
Issued to Frederick Field" on page 113 for more information on the options
granted to Mr. Field. In September 2001, we granted Allen Lenard, one of our
directors, an option to purchase 24,535 shares of our common stock at a price
per share of $7.50.
SUMMARY OF CASH AND CERTAIN OTHER COMPENSATION
The following table provides summary information concerning the
compensation earned by Marc Geiger, our former Chief Executive Officer and each
of our four other most highly compensated executive officers whose salary and
bonus for the 2000 Fiscal Year was in excess of $100,000, for services rendered
to us and our subsidiaries in all capacities for the fiscal years ended December
31, 1998, 1999 and 2000. None of these executive officers received any long-term
compensation during the fiscal years ended December 31, 1998, 1999 and 2000. No
other executive officers who would have otherwise been includable in such table
on the basis of salary and bonus earned for the 2000 Fiscal Year have been
excluded by reason of their termination of employment or change in executive
status during that year. The listed individuals shall be hereinafter referred to
as the named executive officers.
SUMMARY COMPENSATION TABLE
ANNUAL COMPENSATION
------------------------------------
OTHER
ANNUAL
NAME AND PRINCIPAL POSITIONS YEAR SALARY BONUS COMPENSATION
---------------------------- ---- -------- -------- ------------
Marc P. Geiger(3)........................... 2000 $156,250 $120,833 $1,300
Chairman and Chief Executive Officer 1999 150,000 100,000 4,715
1998 175,192 50,000 --
Donald P. Muller(4)......................... 2000 156,250 104,167 1,300
President, ARTISTdirect Agency and 1999 150,000 100,000 4,508
Kneeling Elephant Records 1998 176,431 50,000 --
Keith K. Yokomoto........................... 2000 156,250 104,167 1,300
President, Chief Operating Officer and 1999 150,000 50,000 6,011
Director 1998 130,769(2) 25,000 --
Stephen P. Rennie(1)........................ 2000 156,250 91,667 --
President, UBL 1999 137,500 37,500 --
1998 75,000 -- --
James B. Carroll............................ 2000 156,250 79,167 --
Executive Vice President and 1999 81,250 29,167 --
Chief Financial Officer 1998 -- -- --
-------------------------
(1) Mr. Rennie resigned in March 2001.
(2) Does not include deferred compensation in 1998 of $200,000.
(3) In June 2001, in connection with Frederick Field's appointment as our
Chairman and Chief Executive Officer, Mr. Geiger resigned his position as
Chairman and Chief Executive Officer and took the position of Vice-Chairman
and President, Artist Services. See "Related Party
79
Transactions -- Transactions with Frederick Field" on page 112 for more
information on Mr. Field's Compensation.
(4) In September 2001, Mr. Muller resigned his position as President,
ARTISTdirect Agency and Kneeling Elephant Records and took the position of
Senior Agent.
STOCK OPTIONS AND STOCK APPRECIATION RIGHTS
The following table contains information concerning the stock options
granted to the named executive officers during the 2000 Fiscal Year. All the
grants were made under our 1999 Employee Stock Option Plan. No stock
appreciation rights were granted to the named executive officers during the 2000
Fiscal Year.
OPTION GRANTS IN LAST FISCAL YEAR
INDIVIDUAL GRANTS POTENTIAL REALIZABLE
--------------------------------------------------------------- VALUE AT ASSUMED
NUMBER OF % OF TOTAL ANNUAL RATES OF STOCK
SECURITIES OPTIONS MARKET PRICE APPRECIATION
UNDERLYING GRANTED TO EXERCISE PRICE FOR OPTION TERM(1)
OPTIONS EMPLOYEES PRICE ON DATE EXPIRATION ----------------------
NAME GRANTED IN FISCAL YEAR PER SHARE OF GRANT DATE 5% 10%
---- ---------- -------------- --------- -------- ---------- ---------- ----------
James B. Carroll......... 22,608 7.1% $120.00 $120.00 3/26/07 $1,104,447 $2,573,832
Keith K. Yokomoto........ 69,683 21.8 139.28 69.38 3/30/07 -- --
Stephen P. Rennie(2)..... 23,891 7.5 139.28 69.38 3/30/07 -- --
-------------------------
(1) The 5% and 10% assumed annual rates of compounded stock price appreciation
are mandated by rules of the Securities and Exchange Commission and do not
represent our estimate or projection of our future common stock prices.
Amounts represent hypothetical gains that could be achieved for the
respective options if exercised at the end of the option term. These amounts
represent assumed rates of appreciation in the value of the common stock
from the fair market value on the date of grant. Actual gains, if any, on
stock option exercises are dependent on the future performance of our common
stock and overall stock market conditions. The amounts reflected in the
table may not necessarily be achieved. Potential realizable values are net
of exercise price, but before the payment of taxes associated with exercise.
(2) Mr. Rennie resigned in March 2001.
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AGGREGATED OPTION FISCAL YEAR-END VALUE
The following table provides information, with respect to the named
executive officers, concerning unexercised options held by them at the end of
the 2000 Year. None of named executive officers exercised any stock appreciation
rights during the 2000 Fiscal Year and no stock appreciation rights were held by
the named executive officers at the end of such year.
AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR-END OPTION
VALUES
NUMBER OF VALUE OF UNEXERCISED
UNEXERCISED OPTIONS IN-THE-MONEY OPTIONS
AT FISCAL YEAR END(#) AT FISCAL YEAR END($)
---------------------------- ----------------------------
NAME EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
---- ----------- ------------- ----------- -------------
James B. Carroll.................... 33,721 34,805 0 0
Keith K. Yokomoto................... 0 69,683 0 0
Stephen P. Rennie(1)................ 0 23,891 0 0
======= ======= == ==
-------------------------
(1) Mr. Rennie resigned in March 2001.
BENEFIT PLANS
STOCK OPTION PLANS.
Introduction. We maintain the following three separate stock option plans,
in addition to the Audio Explosion 1998 Stock Option Plan and the Mjuice.com,
Inc. 1999 Stock Option Plan that we assumed in connection with our August 2000
acquisition of Mjuice.com, Inc.:
1999 EMPLOYEE STOCK OPTION PLAN
Introduction. Our 1999 Employee Stock Option Plan became effective on
October 6, 1999 in connection with our conversion from ARTISTdirect, LLC, a
California limited liability company, into ARTISTdirect, Inc., a Delaware
corporation. All options to purchase membership units in the limited liability
company which were outstanding at the time of such conversion were assumed by
the Delaware corporation and converted into options for shares of our common
stock. The number of shares subject to each assumed and converted option was
equal to the number of membership units in the limited liability company which
were subject to that option immediately prior to the conversion, and the
exercise price per share remained the same as the per unit exercise price in
effect under the option at the time of conversion. Except for the conversion of
the securities subject to the option into shares of our common stock, each
option will continue to be governed by the terms of the agreement evidencing
that option at the time of our conversion into a Delaware corporation.
Administration. The employee option plan will be administered by our
compensation committee. This committee is comprised of two (2) or more
non-employee members of our board of directors. The members will be appointed by
the board, and each member will serve for so long as the board deems appropriate
and may be removed by the board at any time.
The compensation committee will have full authority to determine the
persons who are to be granted options under the employee option plan, the time
or times when such option grants are to be made, the number of shares to be
subject to each such grant, the time or times when each option is to become
exercisable, the vesting schedule applicable to the option shares and the
maximum period for which the option is to remain outstanding.
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Eligibility. Employees, non-employee members of the board, and consultants
and other independent advisors in our employ or service will be eligible to
receive option grants under the employee option plan.
Share Reserve. The number of shares of common stock issuable over the term
of the employee option plan was initially 650,000 shares and increased by 75,593
shares to 725,593 shares on January 1, 2001 (subject to adjustment for certain
changes in our capital structure). The share reserve will automatically increase
on the first trading day in January each calendar year, beginning with calendar
year 2001, by an amount equal to 2% of the total number of shares of our common
stock outstanding on the last trading day in December in the immediately
preceding calendar year, but in no event will any such annual increase exceed
87,500 shares. As of September 30, 2001, 308,040 shares remained available for
issuance under the employee option plan.
Except for restrictions in connection with incentive stock option grants
discussed below, there are no limitations on the number of shares of common
stock for which an eligible individual may be granted options under the employee
option plan.
Should one or more outstanding options under the employee option plan
expire or terminate for any reason prior to exercise in full, the shares subject
to the portion of each such option not so exercised will be available for
subsequent option grant. Should the exercise price of an option grant under the
employee option plan be paid with shares of common stock or should we withhold
shares of common stock otherwise issuable under the employee option plan in
satisfaction of the withholding taxes incurred in connection with the exercise
of an outstanding option, then the number of shares available for issuance under
the employee option plan will be reduced by the gross number of shares for which
the option is exercised or which vest under the stock issuance, and not by the
net number of shares issued to the holder of such option.
The common stock will be made available either from authorized but unissued
shares of our common stock or from shares of common stock we reacquire,
including shares repurchased on the open market.
Changes in Capital Structure. In the event of any change in our outstanding
common stock resulting from a stock dividend, stock split, recapitalization,
combination of shares, exchange of shares or other change affecting the
outstanding common stock as a class without our receipt of consideration,
appropriate adjustments will automatically be made to (i) the maximum number
and/or class of securities issuable under the employee option plan, (ii) the
maximum number and/or class of securities by which the share reserve is to
increase automatically each calendar year pursuant to the automatic share
increase provisions of the employee option plan, (iii) the maximum number and/or
class of securities for which any one person may be granted stock options and
direct stock issuances per calendar year and (iv) the number and/or class of
securities and the exercise price per share in effect under each outstanding
option. The adjustments to such outstanding options will preclude the dilution
or enlargement of the rights and benefits available under those options.
Amendments. Our board has exclusive authority to amend or modify the
employee option plan in any and all respects. However, no amendment or
modification may, without the holder's consent, adversely affect such
individual's rights and obligations under his or her outstanding options. In
addition, certain amendments may require the approval of our stockholders.
Termination. The employee option plan will terminate upon the earliest to
occur of (i) October 13, 2009, (ii) the date on which all shares available for
issuance under the employee option plan are issued as fully-vested shares or
(iii) the termination of all outstanding options in connection with certain
changes in control as discussed on page 86. Should the employee option plan
82
terminate on October 13, 2009, then any option grants outstanding at that time
will continue to have force and effect in accordance with the provisions of the
agreements evidencing those grants.
Option Grants. Our compensation committee will have complete discretion
(subject to the express limitations of the employee option plan) to determine
when and to whom options will be granted and the terms of each such grant. Each
option grant will be evidenced by a written option agreement with the optionee.
No option may have a term in excess of 10 years. The actual expiration date
of the option will be set forth in the option agreement. The option may,
however, terminate prior to its designated expiration date in the event of the
termination of the optionee's service or upon the occurrence of certain other
events, as discussed on page 85.
Options under the employee option plan may be incentive stock options
designed to meet the requirements of Section 422 of the Internal Revenue Code,
or non-statutory options which do not satisfy such requirements. For a
discussion of the difference in tax treatment under the Internal Revenue Code
between these two types of options, see the section on page 87 entitled "Federal
Tax Consequences."
Exercise Price. The exercise price of an option will be determined by the
compensation committee at the time of grant. However, the exercise price may not
be less than 85% of the fair market value per share of our common stock on the
grant date.
The fair market value per share of our common stock on any relevant date
under the employee option plan will be the closing selling price per share on
that date, as reported on the Nasdaq National Market and published in The Wall
Street Journal. If the common stock is not traded on that day, the fair market
value will be the closing selling price per share on the last preceding date for
which such quotation exists.
Transferability. Options generally are not assignable or transferable,
except by the provisions of the optionee's will or the laws of inheritance
following the optionee's death or pursuant to any beneficiary designation the
optionee has in effect for the option at the time of his or her death. However,
one or more non-statutory options may be structured so that those options will
be assignable in whole or in part during the optionee's lifetime to one or more
members of the optionee's immediate family or to a trust established exclusively
for one or more such family members or to the optionee's former spouse in
connection with divorce or other marital separation proceedings.
Stockholder Rights. The optionee will not have any stockholder rights with
respect to the option shares until the optionee exercises the option, pays the
exercise price and becomes a holder of record of the purchased shares.
Vesting. The option will generally vest and become exercisable for the
option shares in a series of installments over the period of the optionee's
service. The specific vesting schedule applicable to each option will be
determined by the compensation committee at the time of grant and will be set
forth in the option agreement for that grant. The optionee may exercise the
option at any time for the shares for which that option is vested and
exercisable, provided such exercise occurs before the option terminates.
Option Exercise. To exercise the option, the optionee must provide us with
written notice of the exercise in which the number of shares to be purchased
under the option is indicated. The notice must be accompanied by payment of the
exercise price for the purchased shares, together with appropriate proof that
the person exercising the option (if other than the optionee) has the right to
effect such exercise. The optionee must satisfy all applicable income and
employment tax withholding requirements at that time.
83
The exercise price may be paid in cash or in shares of our common stock.
Any shares delivered in payment of the exercise price will be valued at fair
market value on the exercise date and must have been held for the requisite
period necessary to avoid a charge to our earnings for financial reporting
purposes (generally a six (6)-month period).
Cashless exercises are also permitted. To use this procedure, the optionee
must provide irrevocable instructions to a designated brokerage firm to effect
the immediate sale of the shares of common stock purchased under the option and
to pay over to us, out of the sale proceeds available on the settlement date,
sufficient funds to cover the aggregate exercise price payable for the purchased
shares plus all applicable withholding taxes. Concurrently with such
instructions, the optionee must also direct us to deliver the certificates for
the purchased shares to the brokerage firm in order to complete the sale.
Incentive Options. Options which are intended to qualify as incentive stock
options under the Internal Revenue Code must meet certain requirements. Those
requirements may be summarized as follows:
- Incentive stock options may only be granted to individuals who are our
employees.
- The aggregate fair market value of the shares of common stock (determined
at the date of grant) for which an option may for the first time become
exercisable in any calendar year as an incentive stock option may not
exceed $100,000. Options which do not qualify for incentive stock option
treatment by reason of this dollar limitation may nevertheless be
exercised as non-statutory options in the calendar year in which they
become exercisable for the excess number of shares.
EXAMPLE: On March 1, 2000, Sam Smith is granted an incentive stock
option to purchase 20,000 shares of our common stock at an exercise price
of $15.00 per share, the fair market value of the common stock on that
date. The option will become exercisable for the option shares in a series
of four successive equal annual installments, beginning March 1, 2001. When
the option becomes exercisable for the second annual installment on March
1, 2002, the fair market value of the common stock is assumed to be $25.00
per share. On April 25, 2001, Sam is granted a second incentive stock
option to purchase 10,000 shares of our common stock at an exercise price
of $20.00 per share, the fair market value of the common stock on that
date. This option will also become exercisable for the option shares in a
series of four successive equal annual installments beginning on April 25,
2002. When the option becomes exercisable for the first annual installment
on that date, the fair market value of the common stock is assumed to be
$25.00 per share.
The aggregate fair market value of the 5,000 shares (measured as of
the grant date) which become exercisable under the first option in calendar
year 2002 is $75,000. The aggregate fair market value of the 2,500 shares
(measured as of the grant date) which become exercisable under the second
option in calendar year 2002 is $50,000. Accordingly, 1,250 of the shares
which first become purchasable in calendar year 2002 under the calendar
year 2001 option will not qualify for favorable tax treatment as incentive
stock options because the aggregate value (as measured as of the grant
date) of the shares for which the two options first become exercisable in
calendar year 2002 exceeds $100,000 ($75,000 + $50,000 = $125,000). The
1,250 shares which do not qualify for incentive stock option treatment
under the calendar year 2001 option may be exercised as non-statutory
options.
An option granted as an incentive stock option will lose such status and be
taxed as a non-statutory option if exercised more than three (3) months after
the optionee terminates employee status with us. Certain amendments or
modifications to the option may also cause the loss of
84
incentive stock option status, but no such amendment or modification may be made
without the optionee's consent.
Early Termination of Options. After the optionee's termination of service
for any reason other than death, disability or cause, the optionee will have a
limited period of time in which to exercise his or her outstanding options for
any shares of common stock for which those options are exercisable on the date
the optionee's service terminates. The length of this period will be set forth
in the option agreement and will generally not be in excess of three (3) months.
However, the option will in all events terminate on the specified expiration
date of the option term. To the extent the option is not vested and exercisable
for one or more shares at the time of the optionee's termination of service,
that option will immediately terminate and cease to be outstanding with respect
to those unvested shares.
Unless the option agreement specifically provides otherwise, the optionee
will be deemed to continue in service for so long as he or she renders services
on a periodic basis to us or one of our majority-owned subsidiaries, whether as
(i) an employee, subject to the control and direction of the employer entity as
to both the work to be performed and the manner and method of performance, (ii)
a non-employee Board member or (iii) a consultant or other independent advisor.
The compensation committee has the discretion to extend the period during
which the option may be exercised following the optionee's termination of
service and/or to permit the option to be exercised not only with respect to the
number of shares of common stock for which the option is vested and exercisable
at that time but also with respect to one or more additional installments for
which the option would have vested and become exercisable had the optionee
continued in service. The optionee will be notified in writing in the event the
compensation committee decides to provide him or her with any of those
additional benefits.
Should the optionee be discharged from service for cause while his or her
options are outstanding, then all of those outstanding options will immediately
terminate. For purposes of the employee option plan, "cause" will have the
meaning given that term in any written agreement governing the terms of the
optionee's employment or service with us. In the absence of such a written
employment or service agreement, Cause will include any of the following actions
on the part of the optionee: (i) any act of fraud, embezzlement or dishonesty,
(ii) any unauthorized use or disclosure of our confidential information or trade
secrets, (iii) gross negligence, willful misconduct or other failure to perform
any of his or her material duties, and (iv) conviction of, or plea of nolo
contendere to any felony. However, the foregoing list is not inclusive of all
the acts or omissions which may be considered as grounds for dismissal or
discharge of any individual in our service.
Death or Disability. Should the optionee die while any of his or her
options are outstanding, then the personal representative of the optionee's
estate or the person or persons to whom the options are transferred by the
provisions of his or her will or the laws of inheritance or pursuant to the
beneficiary designation the optionee has in effect for those options, may
exercise each of those options for any or all of the shares of common stock for
which the option was exercisable on the date the optionee's service terminated,
less any shares he or she may have subsequently purchased prior to death. The
right to exercise each such option will lapse upon the earlier to occur of (i)
the expiration of the option term or (ii) the expiration of the 6-month period
measured from the date of the optionee's death.
If the optionee's service terminates by reason of disability, he or she
will normally have a period of 6-months from the date of such termination of
service during which to exercise his or her options for any or all of the shares
for which those options were exercisable at the time of such termination. In no
event, however, may the option be exercised after the specified expiration of
the option term.
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For purposes of the employee option plan, the optionee will be deemed to be
disabled if he or she is unable to perform any substantial gainful activity by
reason of any medically-determinable physical or mental impairment expected to
result in death or to be of continuous duration of 12 consecutive months or
more.
Change in Control. In the event of any change in control events listed
below, all options outstanding under the employee option plan will automatically
accelerate so that each such option will, immediately prior to the effective
date of the change in control, become exercisable for all the shares of common
stock at the time subject to that option and may be exercised for any or all of
those shares as fully vested shares. However, an outstanding option will not
become exercisable on such an accelerated basis if and to the extent: (i) the
option is assumed by the successor corporation or otherwise continued in full
force and effect pursuant to the terms of the change in control transaction or
(ii) such option is replaced with a cash incentive program which preserves the
option spread existing at the time of the change in control on any shares for
which the option is not otherwise at that time vested and exercisable and
provides for subsequent payout in accordance with the same vesting schedule
applicable to those option shares.
A change in control will be deemed to occur in the event (i) we are
acquired by a merger or consolidation in which securities possessing more than
fifty percent (50%) of the total combined voting power of our outstanding
securities are transferred to a person or persons different from the persons
holding those securities immediately prior to such transaction, (ii) there is a
sale, transfer or other disposition of all or substantially all our assets or
(iii) securities possessing more than fifty percent (50%) of the total combined
voting power of our outstanding securities are acquired by any person or group
of related persons through a direct tender or exchange offer with our
shareholders.
All outstanding options under the employee option plan will, to the extent
not assumed by the successor corporation or otherwise continued in full force
and effect pursuant to the terms of the change in control transaction, terminate
and cease to be outstanding immediately following the completion of the change
in control transaction.
Each option which is assumed by the successor corporation in the change in
control transaction or otherwise continued in effect will be appropriately
adjusted to apply to the number and class of securities which would have been
issued to the optionee in consummation of the change in control transaction had
the option been exercised immediately prior to that transaction. Appropriate
adjustments will also be made to the exercise price payable per share, provided
the aggregate exercise price for the option shares will remain the same. To the
extent the actual holders of our common stock receive cash consideration for
their common stock in the change in control transaction, the successor
corporation may, in connection with the assumption of the option, substitute one
or more shares of its own common stock with a fair market value equivalent to
the cash consideration paid per share of our common stock in such change in
control transaction.
Our compensation committee may structure one or more options under the
employee option plan so that those options will immediately vest and become
exercisable for all the option shares upon an involuntary termination of the
optionee's service (other than for Cause) within a designated period following
the effective date of a change in control in which the options are assumed and
do not otherwise vest.
NOTE: OPTIONS WHICH WERE GRANTED WHILE WE WERE A LIMITED LIABILITY COMPANY
CONTAIN DIFFERENT CHANGE IN CONTROL PROVISIONS. SHOULD A CHANGE IN CONTROL OCCUR
WHILE THOSE OPTIONS ARE OUTSTANDING, THE OPTIONS WILL TERMINATE UNLESS ASSUMED
BY THE SUCCESSOR ENTITY. HOWEVER, OUR COMPENSATION COMMITTEE WILL HAVE THE
DISCRETION TO ACCELERATE THE VESTING OF ANY OPTIONS WHICH WOULD SO TERMINATE.
FOR PURPOSES OF THESE PARTICULAR OPTIONS, A CHANGE IN CONTROL WILL BE DEEMED TO
OCCUR UPON: (i) THE
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SALE OF ALL OR SUBSTANTIALLY ALL OF OUR ASSETS, (ii) ANY REORGANIZATION, MERGER,
CONSOLIDATION, SALE OR EXCHANGE OF SECURITIES IN WHICH WE DO NOT SURVIVE AS A
SEPARATE ENTITY, (iii) ANY REORGANIZATION, MERGER, CONSOLIDATION, SALE OR
EXCHANGE OF SECURITIES IN WHICH WE DO SURVIVE AND ANY OF OUR STOCKHOLDERS ARE
PROVIDED WITH THE OPPORTUNITY TO RECEIVE CASH, SECURITIES OF ANOTHER ENTITY
AND/OR OTHER PROPERTY IN EXCHANGE FOR THEIR SHARES OF COMMON STOCK, OR (iv) ANY
ACQUISITION OF MORE THAN FIFTY PERCENT (50%) OF OUR OUTSTANDING SHARES OF COMMON
STOCK BY ANY PERSON OR GROUP OF RELATED PERSONS.
Miscellaneous. The following features should be noted concerning the
employee option plan.
- Nothing in the employee option plan or in any option grant under the
employee option plan is intended to provide any person with the right to
remain in our service for any specific period, and both we and the
optionee will each have the right to terminate the optionee's service at
any time and for any reason, with or without cause.
- The grant of options under the employee option plan and the issuance of
common stock under those options are subject to our procurement of all
approvals and permits required by regulatory authorities having
jurisdiction over the employee option plan and the securities issuable
thereunder. It is possible that we could be prevented from granting
options or from issuing shares of our common stock under the employee
option plan in the event one or more required approvals or permits were
not obtained.
- The employee option plan does not limit our authority to grant options
outside of the employee option plan or to grant options to, or assume the
options of, any person in connection with the acquisition of the business
and assets of any firm, corporation or other business entity.
- Option grants under the employee option plan do not in any way affect,
limit or restrict the optionee's eligibility to participate in any other
stock plan or other compensation or benefit plan or program which we
maintain for our employees.
- The employee option plan is not a qualified retirement plan subject to
the provisions of the Employee Retirement Income Security Act of 1974
(ERISA) or Section 401(a) of the Internal Revenue Code.
FEDERAL TAX CONSEQUENCES
The following is a general description of the material federal income tax
consequences of option grants made under our employee option plan. State and
local tax treatment, which is not discussed below, may vary from such federal
income tax treatment. Each option holder should consult with his or her own tax
advisor as to the tax consequences of his or her particular option transactions.
The tax consequences of incentive stock options and non-statutory stock
options differ under the Internal Revenue Code as described below.
INCENTIVE STOCK OPTIONS
Grant. Incentive stock options can only be granted to our employees. The
grant of the incentive stock option will not result in any federal income tax
liability to the optionee.
Exercise. The optionee will not recognize any taxable income at the time
the incentive stock option is exercised. However, the amount by which the fair
market value (at the time of exercise) of the purchased shares exceeds the
exercise price paid for those shares will constitute an adjustment to
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the optionee's income for purposes of the alternative minimum tax (see the
"Alternative Minimum Tax" section on page 90). However, this adjustment will not
apply if the optionee disposes of the purchased shares in a "disqualifying
disposition" (as discussed below) before the end of the calendar year in which
the optionee exercises the incentive stock option.
Disposition. Generally, the optionee will recognize income in the year in
which he or she makes a disposition of the shares purchased under the incentive
stock option.
A disposition of shares will be deemed to occur in the event the optionee
transfers legal title to those shares, whether by sale, exchange or gift, or the
optionee delivers such shares in payment of the exercise price of any other
incentive stock option he or she may hold. However, a disposition will not occur
if the optionee engages in any of the following transactions: a transfer of the
shares to the optionee's spouse, a transfer into joint ownership with right of
survivorship provided the optionee remains one of the joint owners, a pledge of
the shares as collateral for a loan, a transfer by bequest or inheritance upon
the optionee's death or certain tax-free exchanges of the shares permitted under
the Internal Revenue Code.
The federal income tax liability will depend upon whether the optionee
makes a qualifying or disqualifying disposition of the shares purchased under
the incentive stock option. A qualifying disposition will occur if the sale or
other disposition of the shares takes place more than two years after the date
the incentive stock option was granted for those shares and more than one year
after the date that option was exercised for the particular shares involved in
the disposition. A disqualifying disposition is any sale or other disposition
made before both of these minimum holding periods are satisfied.
Upon a qualifying disposition, the optionee will recognize a long-term
capital gain equal to the excess of (i) the amount realized upon the sale or
other disposition over (ii) the exercise price paid for the shares. The optionee
will recognize a long-term capital loss if the amount realized is lower than the
exercise price paid for the shares.
Normally, if the optionee makes a disqualifying disposition of shares
purchased under his or her incentive stock option, then he or she will recognize
ordinary income at the time of the disposition in an amount equal to the excess
of (i) the fair market value of the shares on the option exercise date over (ii)
the exercise price paid for those shares. If the disqualifying disposition is
effected by means of an arm's length sale or exchange with an unrelated party,
the ordinary income will be limited to the amount by which (i) the amount
realized upon the disposition of the shares or (ii) their fair market value on
the exercise date, whichever is less, exceeds the exercise price paid for the
shares. The amount of the disqualifying disposition income will be reported by
us on the optionee's Form W-2 for the year of disposition, and any applicable
withholding taxes which arise in connection with the disqualifying disposition
will be deducted from the optionee's wages or otherwise collected from such
individual.
Any additional gain recognized upon the disqualifying disposition will be
capital gain, which will be long-term if the shares have been held for more than
one year following the exercise date of the option.
In the event the shares purchased under an incentive stock option are sold
in a disqualifying disposition for less than the exercise price paid for those
shares, the optionee will not recognize any income but will recognize a capital
loss equal to the excess of (i) the exercise price paid for the shares over (ii)
the amount realized upon the disposition of those shares.
Company Deduction. If the optionee makes a qualifying disposition of shares
acquired upon the exercise of an incentive stock option, then we will not be
entitled to any income tax deduction with
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respect to such shares. Should the optionee make a disqualifying disposition of
such shares, then we will be entitled to an income tax deduction equal to the
amount of ordinary income the optionee recognizes in connection with the
disposition. The deduction will, in general, be allowed to us in the taxable
year in which the disposition occurs.
NON-STATUTORY STOCK OPTIONS
Grant. The grant of a non-statutory stock option will not result in any
federal income tax liability to the optionee.
Exercise. The optionee will recognize ordinary income in the year in which
the non-statutory stock option is exercised in an amount equal to the excess of
(i) the fair market value of the purchased shares on the exercise date over (ii)
the exercise price paid for those shares. This income will be reported by us on
the optionee's Form W-2 for the year of exercise (or on a Form 1099 if the
optionee is not an employee), and the optionee will be required to satisfy the
tax withholding requirements applicable to this income.
Disposition. The optionee will recognize a capital gain to the extent the
amount realized upon the sale of such shares exceeds their fair market value at
the time he or she recognized the ordinary income with respect to their
acquisition. A capital loss will result to the extent the amount realized upon
the sale is less than such fair market value. The gain or loss will be long-term
if the shares are held for more than one year prior to the disposition.
Company Deduction. We will be entitled to an income tax deduction equal to
the amount of ordinary income the optionee recognizes in connection with the
exercise of the non-statutory stock option. The deduction will, in general, be
allowed for the taxable year in which the optionee recognizes such ordinary
income.
REGULAR TAX RATES
As a result of the Economic Growth and Tax Relief Reconciliation Act of
2001, the maximum federal tax rate on ordinary income in excess of $297,350
($148,675 for a married taxpayer filing a separate return) is 39.1% for the 2001
calendar year. The applicable $297,350 or $148,675 threshold is subject to
cost-of-living adjustments in taxable years beginning after December 31, 2001.
Certain limitations are imposed upon a taxpayer's itemized deductions, and the
personal exemptions claimed by the taxpayer are subject to phase-out. These
limitations may result in the taxation of ordinary income at an effective top
marginal rate in excess of 39.1%.
The 2001 tax relief act has lowered the federal tax rates which were in
effect for the 2000 taxable year as follows:
THE CORRESPONDING PERCENTAGES
SHALL BE SUBSTITUTED FOR THE
FOLLOWING PERCENTAGES:
--------------------------------
IN THE CASE OF TAXABLE YEARS BEGINNING DURING CALENDAR YEAR: 28.0% 31.0% 36.0% 39.6%
------------------------------------------------------------ ----- ----- ----- -----
2001..................................................... 27.5% 30.5% 35.5% 39.1%
2002 and 2003............................................ 27.0% 30.0% 35.0% 38.6%
2004 and 2005............................................ 26.0% 29.0% 34.0% 37.6%
2006 and thereafter...................................... 25.0% 28.0% 33.0% 35.0%
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CAPITAL GAIN TAX RATES
Short-term capital gains are subject to the same tax rates as ordinary
income. Long-term capital gain is subject to a maximum federal income tax rate
of 20%, provided the capital asset is held for more than one year prior to sale
or other taxable disposition.
Beginning with the 2001 calendar year, capital gain recognized on the sale
or disposition of capital assets held for more than five years by individuals
whose tax rate on ordinary income for the year of such sale or disposition is
below 28% will be subject to tax at a rate of 8%.
Beginning in 2006, capital gain recognized on the sale or disposition of
capital assets held for more than five years by individuals whose tax rate on
ordinary income for the year of such sale or disposition is 28% or more will be
taxed at a rate of 18%, provided the holding period for such property begins
after December 31, 2000.
ITEMIZED DEDUCTIONS
For the tax year ending December 31, 2001, itemized deductions are reduced
by 3% of the amount by which the taxpayer's adjusted gross income for the year
exceeds $132,950 ($66,475 for a married taxpayer filing a separate return).
However, the reduction may not exceed 80% of the total itemized deductions
(excluding medical expenses, casualty and theft losses, and certain investment
interest expense) claimed by the taxpayer. The applicable $132,950 or $66,475
threshold is subject to cost-of-living adjustments in taxable years beginning
after December 31, 2001.
PERSONAL EXEMPTIONS
In addition, the deduction for personal exemptions claimed by the taxpayer
is reduced by 2% for each $2,500 ($1,250 for a married taxpayer filing a
separate return) or fraction thereof by which the taxpayer's adjusted gross
income for the year exceeds a specified threshold amount. The applicable
thresholds for 2001 are $199,450 for married taxpayers filing joint returns (and
in certain instances, surviving spouses), $166,200 for heads of households,
$132,950 for single taxpayers and $99,725 for married taxpayers filing separate
returns. Accordingly, the deduction is completely eliminated for any taxpayer
whose adjusted gross income for the year exceeds the applicable threshold amount
by more than $122,500 (or $61,250 for a married taxpayer filing a separate
return). The threshold amounts will be subject to cost-of-living adjustments in
taxable years beginning after December 31, 2001.
ALTERNATIVE MINIMUM TAX
Tax Rates. The alternative minimum tax is an alternative method of
calculating the income tax an individual must pay each year in order to assure
that a minimum amount of tax is paid for the year. The first $175,000 ($87,500
for a married taxpayer filing a separate return) of alternative minimum taxable
income for the year over the allowable exemption amount is subject to
alternative minimum taxation at the rate of 26%. The balance of the alternative
minimum taxable income for the year is subject to alternative minimum taxation
at the rate of 28%. However, the portion of the individual's alternative minimum
taxable income attributable to capital gain recognized upon the sale or
disposition of capital assets held for more than one year will be subject to a
reduced alternative minimum tax rate of 20% (10% for individuals whose ordinary
income is taxable below 28%). Beginning with the 2001 calendar year, the
alternative minimum tax rate applicable to capital gain recognized upon the sale
or disposition of capital assets held for more than five years will be equal to
the capital gain tax rate in effect for such gain for regular tax purposes. The
alternative minimum tax will, however, be payable only to the extent that it
exceeds the individual's regular federal income tax for the year (computed
without regard to certain credits and special taxes).
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Exemption. The allowable exemption amount for each of the 2001, 2002, 2003
and 2004 taxable years is $49,000 for a married taxpayer filing a joint return,
$35,750 for an unmarried taxpayer and $24,500 for a married taxpayer filing a
separate return. The allowable exemption amount is, however, to be reduced by
$0.25 for each $1.00 by which the individual's alternative minimum taxable
income for the year exceeds $150,000 for a married taxpayer filing a joint
return, $112,500 for an unmarried taxpayer, and $75,000 for a married taxpayer
filing a separate return.
Calculation. The individual's alternative minimum taxable income is based
upon his or her own regular taxable income for the year, adjusted to (i) include
certain additional items of income and tax preference and (ii) disallow or limit
certain deductions otherwise allowable for regular tax purposes.
The spread on the shares purchased under an incentive stock option (the
excess of the fair market value of the purchased shares at the time of exercise
over the aggregate exercise price paid for those shares) is normally included in
the optionee's alternative minimum taxable income at the time of exercise,
unless the shares are subject to a disqualifying disposition in the same year in
which you exercise the incentive stock option.
Tax Credit. If alternative minimum taxes are paid for one or more taxable
years, a portion of those taxes (subject to certain adjustments and reductions)
will be applied as a partial credit against the individual's regular tax
liability (but not alternative minimum tax liability) for subsequent taxable
years. In addition, upon the sale or other disposition of the purchased shares,
whether in the year of exercise or in any subsequent taxable year, the basis for
computing the gain for purposes of alternative minimum taxable income (but not
regular taxable income) will include the amount of the incentive stock option
spread previously included in the individual's alternative minimum taxable
income.
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1999 ARTIST STOCK OPTION PLAN
Introduction. Our 1999 Artist Stock Option Plan became effective on October
6, 1999 in connection with our conversion from ARTISTdirect, LLC, a California
limited liability company, into ARTISTdirect, Inc., a Delaware corporation. All
options to purchase membership units in the limited liability company which were
outstanding at the time of such conversion were assumed by the Delaware
corporation and converted into options for shares of our common stock. The
number of shares subject to each assumed and converted option was equal to the
number of membership units in the limited liability company which were subject
to that option immediately prior to the conversion, and the exercise price per
share remained the same as the per unit exercise price in effect under the
option at the time of conversion. Except for the conversion of the securities
subject to the option into shares of our common stock, each option will continue
to be governed by the terms of the agreement evidencing that option at the time
of our conversion into a Delaware corporation.
Administration. The artist option plan will be administered by our
compensation committee. In its capacity as artist option plan administrator, the
compensation committee will have full authority to determine the persons who are
to be granted options under the artist option plan, the time or times when such
option grants are to be made, the number of shares to be subject to each such
grant, the time or times when each option is to become exercisable and the
maximum period for which the option is to remain outstanding.
Eligibility. Performing artists who provide products and services through
the ARTISTchannel Web sites we operate and maintain for them pursuant to
ARTISTchannel agreements will be eligible to receive option grants under the
artist option plan.
Share Reserve. The number of shares of common stock issuable over the term
of the artist option plan was initially 400,000 shares and increased by 75,593
shares to 475,593 shares on January 1, 2001 (subject to adjustment for certain
changes in our capital structure). The share reserve will automatically increase
on the first trading day in January each calendar year, beginning with calendar
year 2001, by an amount equal to 2% of the total number of shares of our common
stock outstanding on the last trading day in December in the immediately
preceding calendar year, but in no event will any such annual increase exceed
87,500 shares. As of September 30, 2001, 217,249 shares remained available for
issuance under the artist option plan.
There are no limitations on the number of shares of common stock for which
an eligible individual may be granted options under the artist option plan.
Should one or more outstanding options under the artist option plan expire
or terminate for any reason prior to exercise in full, the shares subject to the
portion of each such option not so exercised will be available for subsequent
option grant. Should the exercise price of an option grant under the artist
option plan be paid with shares of common stock, then the number of shares
available for issuance under the artist option plan will be reduced by the gross
number of shares for which the option is exercised or which vest under the stock
issuance, and not by the net number of shares issued to the holder of such
option.
The common stock will be made available either from authorized but unissued
shares of our common stock or from shares of common stock we reacquire,
including shares repurchased on the open market.
Changes in Capital Structure. In the event of any change in our outstanding
common stock resulting from a stock dividend, stock split, recapitalization,
combination of shares, exchange of shares or other change affecting the
outstanding common stock as a class without our receipt of consideration,
appropriate adjustments will automatically be made to (i) the maximum number
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and/or class of securities issuable under the artist option plan, (ii) the
maximum number and/or class of securities by which the share reserve is to
increase automatically each calendar year pursuant to the automatic share
increase provisions of the artist option plan, (iii) the maximum number and/or
class of securities for which any one person may be granted stock options and
direct stock issuances per calendar year and (iv) the number and/or class of
securities and the exercise price per share in effect under each outstanding
option. The adjustments to such outstanding options will preclude the dilution
or enlargement of the rights and benefits available under those options.
Amendments. Our board has exclusive authority to amend or modify the artist
option plan in any and all respects. However, no amendment or modification may,
without the holder's consent, adversely affect such individual's rights and
obligations under his or her outstanding options. In addition, certain
amendments may require the approval of our stockholders.
Termination. The artist option plan will terminate upon the earliest to
occur of (i) October 13, 2009, (ii) the date on which all shares available for
issuance under the artist option plan are issued as fully-vested shares or (iii)
the termination of all outstanding options in connection with certain changes in
control as discussed on pages 94-95. Should the artist option plan terminate on
October 13, 2009, then any option grants outstanding at that time will continue
to have force and effect in accordance with the provisions of the agreements
evidencing those grants.
Option Grants. Our board will have complete discretion (subject to the
express imitations of the artist option plan) to determine when and to whom
options will be granted and the terms of each such grant. Each option grant will
be evidenced by a written option agreement with the optionee.
No option may have a term in excess of 10 years. The actual expiration date
of the option will be set forth in the option agreement and will in most
instances not exceed 7 years. The option may, however, terminate prior to its
designated expiration date in the event of the termination of the optionee's
ARTISTchannel agreement with us or upon the occurrence of certain other events,
as discussed on pages 94-95.
All options granted under the artist option plan will be non-statutory
options and will not qualify as incentive stock options under Section 422 of the
Internal Revenue Code. The tax treatment of non-statutory options is discussed
in the section on page 96 entitled "Federal Tax Consequences."
Exercise Price. The exercise price of an option will be determined by the
board at the time of grant. However, the exercise price may not be less than 85%
of the fair market value per share of our common stock on the grant date.
The fair market value per share of our common stock on any relevant date
under the artist option plan will be the closing selling price per share on that
date, as reported on the Nasdaq National Market and published in The Wall Street
Journal. If the common stock is not traded on that day, the fair market value
will be the closing selling price per share on the last preceding date for which
such quotation exists.
Transferability. Options generally are not assignable or transferable,
except by the provisions of the optionee's will or the laws of inheritance
following the optionee's death or pursuant to any beneficiary designation the
optionee has in effect for the option at the time of his or her death. However,
one or more options under the artist option may be structured so that those
options will be assignable in whole or in part during the optionee's lifetime to
one or more members of the optionee's immediate family or to a trust established
exclusively for one or more such family members or to the optionee's former
spouse in connection with divorce or other marital separation proceedings.
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Stockholder Rights. The optionee will not have any stockholder rights with
respect to the option shares until the optionee exercises the option, pays the
exercise price and becomes a holder of record of the purchased shares.
Exercisabililty. The option will generally vest and become exercisable for
the option shares in a series of installments over the period the optionee's
ARTISTchannel agreement with us remains in effect. The specific exercise
schedule applicable to each option will be determined by the board at the time
of grant and will be set forth in the option agreement for that grant. The
optionee may exercise the option at any time for the shares for which that
option is exercisable, provided such exercise occurs before the option
terminates.
Option Exercise. To exercise the option, the optionee must provide us with
written notice of the exercise in which the number of shares to be purchased
under the option is indicated. The notice must be accompanied by payment of the
exercise price for the purchased shares, together with appropriate proof that
the person exercising the option (if other than the optionee) has the right to
effect such exercise.
The exercise price may be paid in cash or in shares of our common stock.
Any shares delivered in payment of the exercise price will be valued at fair
market value on the exercise date and must have been held for the requisite
period necessary to avoid a charge to our earnings for financial reporting
purposes (generally a six (6)-month period).
Cashless exercises are also permitted. To use this procedure, the optionee
must provide irrevocable instructions to a designated brokerage firm to effect
the immediate sale of the shares of common stock purchased under the option and
to pay over to us, out of the sale proceeds available on the settlement date,
sufficient funds to cover the aggregate exercise price payable for the purchased
shares plus all applicable withholding taxes. Concurrently with such
instructions, the optionee must also direct us to deliver the certificates for
the purchased shares to the brokerage firm in order to complete the sale.
Early Termination of Options. The option will immediately terminate, prior
to the specific expiration date of the option term, in the event: (i) the
optionee's ARTISTchannel agreement is terminated by us by reason of the
optionee's breach of a material provision of that agreement and the optionee's
failure to cure such breach during the applicable cure period (ii) the
ARTISTchannel agreement is terminated by the optionee other than by reason of a
material breach by us of that agreement.
Change in Control. In the event of any change in control events listed
below, all options outstanding under the artist option plan will automatically
accelerate so that each such option will, immediately prior to the effective
date of the change in control, become exercisable for all the shares of common
stock at the time subject to that option and may be exercised for any or all of
those shares as fully vested shares. However, an outstanding option will NOT
become exercisable on such an accelerated basis if and to the extent: (i) the
option is assumed by the successor corporation or otherwise continued in full
force and effect pursuant to the terms of the change in control transaction or
(ii) such option is replaced with a cash incentive program which preserves the
option spread existing at the time of the change in control on any shares for
which the option is not otherwise at that time exercisable and provides for
subsequent payout in accordance with the same exercisable schedule applicable to
those option shares.
A change in control will be deemed to occur in the event (i) we are
acquired by a merger or consolidation in which securities possessing more than
fifty percent (50%) of the total combined voting power of our outstanding
securities are transferred to a person or persons different from the persons
holding those securities immediately prior to such transaction, (ii) there is a
sale, transfer or
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other disposition of all or substantially all our assets or (iii) securities
possessing more than fifty percent (50%) of the total combined voting power of
our outstanding securities are acquired by any person or group of related
persons through a direct tender or exchange offer with our shareholders.
All outstanding options under the artist option plan will, to the extent
not assumed by the successor corporation or otherwise continued in full force
and effect pursuant to the terms of the change in control transaction, terminate
and cease to be outstanding immediately following the completion of the change
in control transaction.
Each option which is assumed by the successor corporation in the change in
control transaction or otherwise continued in effect will be appropriately
adjusted to apply to the number and class of securities which would have been
issued to the optionee in consummation of the change in control transaction had
the option been exercised immediately prior to that transaction. Appropriate
adjustments will also be made to the exercise price payable per share, provided
the aggregate exercise price for the option shares will remain the same. To the
extent the actual holders of our common stock receive cash consideration for
their common stock in the change in control transaction, the successor
corporation may, in connection with the assumption of the option, substitute one
or more shares of its own common stock with a fair market value equivalent to
the cash consideration paid per share of our common stock in such change in
control transaction.
Our compensation committee may structure one or more options under the
artist option plan so that those options will immediately vest and become
exercisable for all the option shares upon a change in control transaction,
whether or not those options are to be assumed or otherwise continued in effect
following that transaction.
NOTE: OPTIONS WHICH WERE GRANTED WHILE WE WERE A LIMITED LIABILITY COMPANY
CONTAIN DIFFERENT CHANGE IN CONTROL PROVISIONS. SHOULD A CHANGE IN CONTROL OCCUR
WHILE THOSE OPTIONS ARE OUTSTANDING, THE OPTIONS WILL TERMINATE UNLESS ASSUMED
BY THE SUCCESSOR ENTITY. HOWEVER, ANY OPTIONS WHICH ARE NOT SO ASSUMED WILL
ACCELERATE AND BECOME EXERCISABLE FOR ALL THE OPTION SHARES IMMEDIATELY PRIOR TO
THE CHANGE IN CONTROL. FOR THESE PARTICULAR OPTIONS, A CHANGE IN CONTROL WILL BE
DEEMED TO OCCUR UPON: (i) THE SALE OF ALL OR SUBSTANTIALLY ALL OF OUR ASSETS,
(ii) ANY REORGANIZATION, MERGER, CONSOLIDATION, SALE OR EXCHANGE OF SECURITIES
IN WHICH WE DO NOT SURVIVE AS A SEPARATE ENTITY, (iii) ANY REORGANIZATION,
MERGER, CONSOLIDATION, SALE OR EXCHANGE OF SECURITIES IN WHICH WE DO SURVIVE AND
ANY OF OUR STOCKHOLDERS ARE PROVIDED WITH THE OPPORTUNITY TO RECEIVE CASH,
SECURITIES OF ANOTHER ENTITY AND/OR OTHER PROPERTY IN EXCHANGE FOR THEIR SHARES
OF COMMON STOCK, OR (iv) ANY ACQUISITION OF MORE THAN FIFTY PERCENT (50%) OF OUR
OUTSTANDING SHARES OF COMMON STOCK BY ANY PERSON OR GROUP OF RELATED PERSONS.
Miscellaneous. The following features should be noted concerning the artist
option plan.
- The grant of options under the artist option plan and the issuance of
common stock under those options are subject to our procurement of all
approvals and permits required by regulatory authorities having
jurisdiction over the artist option plan and the securities issuable
thereunder. It is possible that we could be prevented from granting
options or from issuing shares of our common stock under the artist
option plan in the event one or more required approvals or permits were
not obtained.
- The artist option plan does not limit our authority to grant options
outside of the artist option plan or to grant options to, or assume the
options of, any person in connection with the acquisition of the business
and assets of any firm, corporation or other business entity.
- The artist option plan is not a qualified retirement plan subject to the
provisions of the Employee Retirement Income Security Act of 1974 (ERISA)
or Section 401(a) of the Internal Revenue Code.
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FEDERAL TAX CONSEQUENCES
The following is a general description of the material federal income tax
consequences of option grants made under the artist stock option plan. State and
local tax treatment, which is not discussed below, may vary from such federal
income tax treatment. Each option holder should consult with his or her own tax
advisor as to the tax consequences of his or her particular option transactions.
Grant. The grant of a non-statutory stock option will not result in any
federal income tax liability to the optionee.
Exercise. The optionee will recognize ordinary income in the year in which
the non-statutory stock option is exercised in an amount equal to the excess of
(i) the fair market value of the purchased shares on the exercise date over (ii)
the exercise price paid for those shares. This income will be reported by us on
a Form W-2 for the year of exercise (or on a Form 1099 if the optionee is not an
employee), and the optionee will be required to satisfy the tax withholding
requirements applicable to this income.
Disposition. The optionee will recognize a capital gain to the extent the
amount realized upon the sale of such shares exceeds their fair market value at
the time he or she recognized the ordinary income with respect to their
acquisition. A capital loss will result to the extent the amount realized upon
the sale is less than such fair market value. The gain or loss will be long-term
if the shares are held for more than one year prior to the disposition.
Company Deduction. We will be entitled to an income tax deduction equal to
the amount of ordinary income the optionee recognizes in connection with the
exercise of the non-statutory stock option. The deduction will, in general, be
allowed for the taxable year in which the optionee recognizes such ordinary
income.
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1999 ARTIST AND ARTIST ADVISORS STOCK OPTION PLAN
Introduction. Our 1999 Artist and Artist Advisor Stock Option Plan became
effective on October 6, 1999 in connection with our conversion from
ARTISTdirect, LLC, a California limited liability company, into ARTISTdirect,
Inc., a Delaware corporation. All options to purchase membership units in the
limited liability company which were outstanding at the time of such conversion
were assumed by the Delaware corporation and converted into options for shares
of our common stock. The number of shares subject to each assumed and converted
option was equal to the number of membership units in the limited liability
company which were subject to that option immediately prior to the conversion,
and the exercise price per share remained the same as the per unit exercise
price in effect under the option at the time of conversion. Except for the
conversion of the securities subject to the option into shares of our common
stock, each option will continue to be governed by the terms of the agreement
evidencing that option at the time of our conversion into a Delaware
corporation.
Administration. The artist and artist advisor option plan will be
administered by our compensation committee. In its capacity as artist and artist
advisor plan administrator, the compensation committee will have full authority
to determine the persons who are to be granted options under the artist and
artist advisor plan, the time or times when such option grants are to be made,
the number of shares to be subject to each such grant, the time or times when
each option is to become exercisable and the maximum period for which the option
is to remain outstanding.
Eligibility. Performing artists and their attorneys, business managers,
agents and other advisors who provide services to us will be eligible to receive
option grants under the artist and artist advisor plan.
Share Reserve. The number of shares of common stock issuable over the term
of the artist and artist advisor plan was initially 185,000 shares and increased
by 37,500 shares to 222,500 shares on January 1, 2001 (subject to adjustment for
certain changes in our capital structure). The share reserve will automatically
increase on the first trading day in January each calendar year, beginning with
calendar year 2001, by an amount equal to 1% of the total number of shares of
our common stock outstanding on the last trading day in December in the
immediately preceding calendar year, but in no event will any such annual
increase exceed 37,500 shares. As of September 30, 2001, 89,617 shares remained
available for issuance under the artist and artist advisor option plan.
There are no limitations on the number of shares of common stock for which
an eligible individual may be granted options under the artist and artist
advisor plan.
Should one or more outstanding options under the artist and artist advisor
plan expire or terminate for any reason prior to exercise in full, the shares
subject to the portion of each such option not so exercised will be available
for subsequent option grant. Should the exercise price of an option grant under
the artist and artist advisor plan be paid with shares of common stock, then the
number of shares available for issuance under the artist and artist advisor plan
will be reduced by the gross number of shares for which the option is exercised
or which vest under the stock issuance, and not by the net number of shares
issued to the holder of such option.
The common stock will be made available either from authorized but unissued
shares of our common stock or from shares of common stock we reacquire,
including shares repurchased on the open market.
Changes in Capital Structure. In the event of any change in our outstanding
common stock resulting from a stock dividend, stock split, recapitalization,
combination of shares, exchange of shares or other change affecting the
outstanding common stock as a class without our receipt of
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consideration, appropriate adjustments will automatically be made to (i) the
maximum number and/or class of securities issuable under the artist and artist
advisor plan, (ii) the maximum number and/or class of securities by which the
share reserve is to increase automatically each calendar year pursuant to the
automatic share increase provisions of the artist and artist advisor plan, (iii)
the maximum number and/or class of securities for which any one person may be
granted stock options and direct stock issuances per calendar year and (iv) the
number and/or class of securities and the exercise price per share in effect
under each outstanding option. The adjustments to such outstanding options will
preclude the dilution or enlargement of the rights and benefits available under
those options.
Amendments. Our board has exclusive authority to amend or modify the artist
and artist advisor plan in any and all respects. However, no amendment or
modification may, without the holder's consent, adversely affect such
individual's rights and obligations under his or her outstanding options. In
addition, certain amendments may require the approval of our stockholders.
Termination. The artist and artist advisor plan will terminate upon the
earliest to occur of (i) October 13, 2009, (ii) the date on which all shares
available for issuance under the artist and artist advisor plan are issued as
fully-vested shares or (iii) the termination of all outstanding options in
connection with certain changes in control as discussed on pages 99-100. Should
the artist and artist advisor plan terminate on October 13, 2009, then any
option grants outstanding at that time will continue to have force and effect in
accordance with the provisions of the agreements evidencing those grants.
Option Grants. Our board will have complete discretion (subject to the
express imitations of the artist and artist advisor plan) to determine when and
to whom options will be granted and the terms of each such grant. Each option
grant will be evidenced by a written option agreement with the optionee.
No option may have a term in excess of 10 years. The actual expiration date
of the option will be set forth in the option agreement and will in most
instances not exceed 7 years. The option may, however, terminate prior to its
designated expiration date in the event of the termination of the optionee's
service for cause or upon the occurrence of certain other events, as discussed
on pages 99-100.
All options granted under the artist and artist advisor plan will be
non-statutory options and will not qualify as incentive stock options under
Section 422 of the Internal Revenue Code. The tax treatment of non-statutory
options is discussed in the section on page 101 entitled "Federal Tax
Consequences."
Exercise Price. The exercise price of an option will be determined by the
board at the time of grant. However, the exercise price may not be less than 85%
of the fair market value per share of our common stock on the grant date.
The fair market value per share of our common stock on any relevant date
under the artist and artist advisor plan will be the closing selling price per
share on that date, as reported on the Nasdaq National Market and published in
The Wall Street Journal. If the common stock is not traded on that day, the fair
market value will be the closing selling price per share on the last preceding
date for which such quotation exists.
Transferability. Options generally are not assignable or transferable,
except by the provisions of the optionee's will or the laws of inheritance
following the optionee's death or pursuant to any beneficiary designation the
optionee has in effect for the option at the time of his or her death. However,
one or more options under the artist and artist advisor plan may be structured
so that those
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options will be assignable in whole or in part during the optionee's lifetime to
one or more members of the optionee's immediate family or to a trust established
exclusively for one or more such family members or to the optionee's former
spouse in connection with divorce or other marital separation proceedings.
Stockholder Rights. The optionee will not have any stockholder rights with
respect to the option shares until the optionee exercises the option, pays the
exercise price and becomes a holder of record of the purchased shares.
Vesting. The option will generally vest and become exercisable for the
option shares in a series of installments over the period of the optionee's
service. The specific vesting schedule applicable to each option will be
determined by the board at the time of grant and will be set forth in the option
agreement for that grant. The optionee may exercise the option at any time for
the shares for which that option is vested and exercisable, provided such
exercise occurs before the option terminates.
Option Exercise. To exercise the option, the optionee must provide us with
written notice of the exercise in which the number of shares to be purchased
under the option is indicated. The notice must be accompanied by payment of the
exercise price for the purchased shares, together with appropriate proof that
the person exercising the option (if other than the optionee) has the right to
effect such exercise.
The exercise price may be paid in cash or in shares of our common stock.
Any shares delivered in payment of the exercise price will be valued at fair
market value on the exercise date and must have been held for the requisite
period necessary to avoid a charge to our earnings for financial reporting
purposes (generally a six (6)-month period).
Cashless exercises are also permitted. To use this procedure, the optionee
must provide irrevocable instructions to a designated brokerage firm to effect
the immediate sale of the shares of common stock purchased under the option and
to pay over to us, out of the sale proceeds available on the settlement date,
sufficient funds to cover the aggregate exercise price payable for the purchased
shares plus all applicable withholding taxes. Concurrently with such
instructions, the optionee must also direct us to deliver the certificates for
the purchased shares to the brokerage firm in order to complete the sale.
Early Termination of Options. The option will immediately terminate, prior
to the specific expiration date of the option term, upon the in the event the
optionee's service is terminated by us for cause. Cause will mean (i) the
termination of any other written agreement the optionee has with us prior to
expiration of the full term of that agreement, either by us by reason of
optionee's breach of a material provision of that agreement and his or her
failure to cure such breach within the applicable cure period or by the optionee
for any reason other than a material breach by us of that agreement and our
failure to cure that breach within the applicable cure period and (ii) any other
events designated as for "cause" events in any other written agreements
governing the optionee's contractual relationship with us or our subsidiaries.
Change in Control. In the event of any change in control events listed
below, all options outstanding under the artist and artist advisor plan will
automatically accelerate so that each such option will, immediately prior to the
effective date of the change in control, become exercisable for all the shares
of common stock at the time subject to that option and may be exercised for any
or all of those shares as fully vested shares. However, an outstanding option
will not become exercisable on such an accelerated basis if and to the extent:
(i) the option is assumed by the successor corporation or otherwise continued in
full force and effect pursuant to the terms of the change in control transaction
or (ii) such option is replaced with a cash incentive program which preserves
the option spread existing at the time of the change in control on any shares
for which the option is not
99
otherwise at that time exercisable and provides for subsequent payout in
accordance with the same exercisable schedule applicable to those option shares.
A change in control will be deemed to occur in the event (i) we are
acquired by a merger or consolidation in which securities possessing more than
fifty percent (50%) of the total combined voting power of our outstanding
securities are transferred to a person or persons different from the persons
holding those securities immediately prior to such transaction, (ii) there is a
sale, transfer or other disposition of all or substantially all our assets or
(iii) securities possessing more than fifty percent (50%) of the total combined
voting power of our outstanding securities are acquired by any person or group
of related persons through a direct tender or exchange offer with our
shareholders.
All outstanding options under the artist and artist advisor plan will, to
the extent not assumed by the successor corporation or otherwise continued in
full force and effect pursuant to the terms of the change in control
transaction, terminate and cease to be outstanding immediately following the
completion of the change in control transaction.
Each option which is assumed by the successor corporation in the change in
control transaction or otherwise continued in effect will be appropriately
adjusted to apply to the number and class of securities which would have been
issued to the optionee in consummation of the change in control transaction had
the option been exercised immediately prior to that transaction. Appropriate
adjustments will also be made to the exercise price payable per share, provided
the aggregate exercise price for the option shares will remain the same. To the
extent the actual holders of our common stock receive cash consideration for
their common stock in the change in control transaction, the successor
corporation may, in connection with the assumption of the option, substitute one
or more shares of its own common stock with a fair market value equivalent to
the cash consideration paid per share of our common stock in such change in
control transaction.
Our board may structure one or more options under the artist and artist
advisor plan so that those options will immediately vest and become exercisable
for all the option shares upon a change in control transaction, whether or not
those options are to be assumed or otherwise continued in effect following that
transaction.
NOTE: OPTIONS WHICH WERE GRANTED WHILE WE WERE A LIMITED LIABILITY COMPANY
CONTAIN DIFFERENT CHANGE IN CONTROL PROVISIONS. SHOULD A CHANGE IN CONTROL OCCUR
WHILE THOSE OPTIONS ARE OUTSTANDING, THE OPTIONS WILL TERMINATE UNLESS ASSUMED
BY THE SUCCESSOR ENTITY. HOWEVER, ANY OPTIONS WHICH ARE NOT SO ASSUMED WILL
ACCELERATE AND BECOME EXERCISABLE FOR ALL THE OPTION SHARES IMMEDIATELY PRIOR TO
THE CHANGE IN CONTROL. FOR THESE PARTICULAR OPTIONS, A CHANGE IN CONTROL WILL BE
DEEMED TO OCCUR UPON: (i) THE SALE OF ALL OR SUBSTANTIALLY ALL OF OUR ASSETS,
(ii) ANY REORGANIZATION, MERGER, CONSOLIDATION, SALE OR EXCHANGE OF SECURITIES
IN WHICH WE DO NOT SURVIVE AS A SEPARATE ENTITY, (iii) ANY REORGANIZATION,
MERGER, CONSOLIDATION, SALE OR EXCHANGE OF SECURITIES IN WHICH WE DO SURVIVE AND
ANY OF OUR STOCKHOLDERS ARE PROVIDED WITH THE OPPORTUNITY TO RECEIVE CASH,
SECURITIES OF ANOTHER ENTITY AND/OR OTHER PROPERTY IN EXCHANGE FOR THEIR SHARES
OF COMMON STOCK, OR (iv) ANY ACQUISITION OF MORE THAN FIFTY PERCENT (50%) OF OUR
OUTSTANDING SHARES OF COMMON STOCK BY ANY PERSON OR GROUP OF RELATED PERSONS.
Miscellaneous. The following features should be noted concerning the artist
and artist advisor plan.
- Nothing in the artist and artist advisor plan or in any option grant
under the artist and artist advisor plan is intended to provide any
person with the right to remain in our service for any specific period,
and both we and the optionee will each have the right to terminate the
optionee's service at any time and for any reason, with or without cause.
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- The grant of options under the artist and artist advisor plan and the
issuance of common stock under those options are subject to our
procurement of all approvals and permits required by regulatory
authorities having jurisdiction over the artist and artist advisor plan
and the securities issuable thereunder. It is possible that we could be
prevented from granting options or from issuing shares of our common
stock under the artist and artist advisor plan in the event one or more
required approvals or permits were not obtained.
- The artist and artist advisor plan does not limit our authority to grant
options outside of the artist and artist advisor plan or to grant options
to, or assume the options of, any person in connection with the
acquisition of the business and assets of any firm, corporation or other
business entity.
- The artist and artist advisor plan is not a qualified retirement plan
subject to the provisions of the Employee Retirement Income Security Act
of 1974 (ERISA) or Section 401(a) of the Internal Revenue Code.
FEDERAL TAX CONSEQUENCES
The following is a general description of the material federal income tax
consequences of option grants made under the artist and artist advisor stock
option plan. State and local tax treatment, which is not discussed below, may
vary from such federal income tax treatment. Each option holder should consult
with his or her own tax advisor as to the tax consequences of his or her
particular option transactions.
Grant. The grant of a non-statutory stock option will not result in any
federal income tax liability to the optionee.
Exercise. The optionee will recognize ordinary income in the year in which
the non-statutory stock option is exercised in an amount equal to the excess of
(i) the fair market value of the purchased shares on the exercise date over (ii)
the exercise price paid for those shares. This income will be reported by us on
a Form 1099 issued to the optionee for the year of exercise.
Disposition. The optionee will recognize a capital gain to the extent the
amount realized upon the sale of such shares exceeds their fair market value at
the time he or she recognized the ordinary income with respect to their
acquisition. A capital loss will result to the extent the amount realized upon
the sale is less than such fair market value. The gain or loss will be long-term
if the shares are held for more than one year prior to the disposition.
Company Deduction. We will be entitled to an income tax deduction equal to
the amount of ordinary income the optionee recognizes in connection with the
exercise of the non-statutory stock option. The deduction will, in general, be
allowed for the taxable year in which the optionee recognizes such ordinary
income.
1999 EMPLOYEE STOCK PURCHASE PLAN.
Introduction. Our 1999 Employee Stock Purchase Plan was adopted by the
board on October 13, 1999 and approved by the stockholders in October 1999. The
plan became effective immediately upon the signing of the underwriting agreement
for our initial public offering on March 27, 2000. The plan is designed to allow
our eligible employees and the eligible employees of our participating
subsidiaries to purchase shares of common stock at semi-annual intervals with
accumulated payroll deductions.
101
Share Reserve. 50,000 shares of our common stock was reserved for issuance
and increased by 25,000 shares to 75,000 shares on January 1, 2001. The reserve
automatically increases on the first trading day in January each calendar year
by an amount equal to one percent (1%) of the total number of outstanding shares
of our common stock on the last trading day in December in the prior calendar
year. In no event will any such annual increase exceed 25,000 shares. As of
September 30, 2001, there were 65,575 shares of common stock reserved for
purchase under this plan.
Offering Periods. The plan will have a series of successive offering
periods, each with a maximum duration of 24 months. The initial offering period
started on March 27, 2000 and will end on the last business day in April 2002.
The next offering period will start on the first business day in May 2002, and
subsequent offering periods will be set by our compensation committee.
Eligible Employees. Individuals scheduled to work more than 20 hours per
week for more than 5 calendar months per year may join an offering period on the
start date or any semi-annual entry date within that period. Semi-annual entry
dates will occur on the first business day of May and November each year.
Individuals who become eligible employees after the start date of an offering
period may join the plan on any subsequent semi-annual entry date within that
offering period.
Payroll Deductions. A participant may contribute up to 15% of his or her
total cash earnings through payroll deductions, and the accumulated deductions
will be applied to the purchase of shares on each semi-annual purchase date. The
purchase price per share will be equal to 85% of the fair market value per share
on the participant's entry date into the offering period or, if lower, 85% of
the fair market value per share on the semi-annual purchase date. Semi-annual
purchase dates will occur on the last business day of April and October each
year. However, a participant may not purchase more than 75 shares on any
purchase date, and not more than 25,000 shares may be purchased in total by all
participants on any purchase date. Our compensation committee will have the
authority to change these limitations for any subsequent offering period.
Change in Control. Should we be acquired by merger or sale of substantially
all of our assets or more than fifty percent of our voting securities, then all
outstanding purchase rights will automatically be exercised immediately before
the effective date of the acquisition. The purchase price will be equal to 85%
of the market value per share on the participant's entry date into the offering
period in which an acquisition occurs or, if lower, 85% of the fair market value
per share immediately before the acquisition.
Plan Provisions. The following provisions will also be in effect under the
plans:
- The plan will terminate no later than the last business day of October
2009.
- The board may at any time amend, suspend or discontinue the plan.
However, amendments may require stockholder approval.
102
EMPLOYMENT CONTRACTS, TERMINATION OF EMPLOYMENT AND CHANGE IN CONTROL
ARRANGEMENTS
We have entered into employment agreements with our named executive
officers. The compensation and dates of employment under the employment
agreements are as follows:
Marc Geiger
Previously, in July 1998, we had entered into an employment agreement with
Marc Geiger, our Vice-Chairman and President, Artist Services, which provided
for the following:
- Mr. Geiger was paid an annual salary of $150,000 and a guaranteed annual
bonus of $100,000.
- The agreement provided for the payment of salary and a guaranteed bonus
for twelve months after the date of termination if the termination was:
(1) other than due to a disability,
(2) other than for "cause," such as the commission of a felony, material
dishonesty against us, or gross negligence in the performance of
duties,
(3) other than due to Mr. Geiger's death, or
(4) for "good reason," such as an adverse change of duties, a
reassignment of location, or a material breach of our obligations to
Mr. Geiger.
- The agreement also provided that if Mr. Geiger's employment was
terminated for cause or disability, or he resigned for other than good
reason, he would be prohibited, for a period of the later of one year
after the early termination of his employment, or the expiration of the
term of his employment agreement, from competing with us or attempting to
hire any of our employees.
In June 2001, Mr. Geiger resigned his position as our Chairman of the Board
and Chief Executive Officer and took the position of Vice Chairman of the Board
and President, Artist Services. In June 2001, Mr. Geiger also executed an
agreement with us, effective as of April 27, 2001, agreeing that such changes in
his title and duties would not constitute "good reason" that would entitle him
to the severance pay described above if he chooses to terminate his employment.
In July 2001, we amended Mr. Geiger's original employment agreement to
provide for the following:
- Mr. Geiger is paid an annual salary of $500,000 (to be reviewed annually
for any increases by our Compensation Committee in consultation with our
Chief Executive Officer), is entitled to four weeks' vacation each year,
and is eligible to participate in our executive performance bonus pool
and in the Artists & Repertoire Bonus Plan of ARTISTdirect Records, LLC.
- The initial term of the amended agreement expires June 30, 2006.
Beginning July 1, 2006, and on each anniversary, the term of the amended
agreement will automatically be extended for an additional one-year
period unless written notice is provided otherwise.
- Mr. Geiger is entitled to receive a one-time lump sum advance of
$300,000, representing a pre-payment of $60,000 against any monies
otherwise becoming payable to Mr. Geiger under our executive performance
bonus pool for each year of the initial five-year term of the amended
agreement.
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- The amended agreement provides for the payment of $1,000,000 plus one
years' salary (or whatever shorter period remains in the term of the
amended agreement) upon the termination of Mr. Geiger's employment if the
termination was:
(1) other than due to a disability,
(2) other than for "cause," such as the commission of a felony, fraud or
embezzlement, gross negligence or willful misconduct in the
performance of duties, material breach of the amended agreement, or
misappropriation of a corporate opportunity,
(3) other than due to Mr. Geiger's death, or
(4) for "good reason," such as a material and substantial reduction in
title, responsibilities or duties, a reassignment of location, or a
material breach of our obligations to Mr. Geiger.
- If Mr. Geiger's employment is terminated for cause or he resigns for
other than good reason, he must repay us within 30 days the amount, if
any, by which the $300,000 advance exceeds the lesser of (1) the amount
earned by him under our executive performance bonus pool or (2) the
product of $5,000 and the number of full months that have elapsed between
July 1, 2001 and the employment termination date.
- The amended agreement provides that prior to the termination of his
employment, Mr. Geiger is prohibited from competing with us. In addition,
for a period of one year after the expiration of the amended agreement,
Mr. Geiger is prohibited from hiring any of our employees.
Donald Muller
In July 1998, we entered into an employment agreement with Donald Muller,
our Senior Agent, which provided for the following:
- Mr. Muller was paid an annual salary of $150,000 and a guaranteed annual
bonus of $100,000.
- The initial term of the employment agreement expired September 30, 2001,
but is automatically extended for an additional one-year period on each
anniversary of October 1 unless written notice is provided otherwise.
Neither we nor Mr. Muller received written notice from the other prior to
the expiration of the initial term of an intention not to extend the
term.
- The agreement provided for the payment of salary and a guaranteed bonus
for twelve months after the date of termination if the termination was:
(1) other than due to a disability,
(2) other than for "cause," such as the commission of a felony, material
dishonesty against us, or gross negligence in the performance of
duties,
(3) other than due to Mr. Muller's death, or
(4) for "good reason," such as an adverse change of duties, a
reassignment of location, or a material breach of our obligations to
Mr. Muller.
- If Mr. Muller's employment was terminated for cause or disability or he
resigned for other than good reason, he would be prohibited, for a period
of the later of one year after the early termination of his employment,
or the expiration of the term of his employment agreement, from competing
with us or attempting to hire any of our employees.
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In September 2001, Mr. Muller resigned his position as President,
ARTISTdirect Agency and director and took the position of Senior Agent.
Keith Yokomoto
Previously, in January 1998, we had entered into an employment agreement
with Keith Yokomoto, our President and Chief Operating Officer, which provided
for the following:
- Mr. Yokomoto was paid an annual salary of $100,000 for the first five
months of the agreement and $150,000 thereafter, with a guaranteed bonus
of $50,000 the second year and $100,000 for each year thereafter.
- The initial term of the agreement expired December 31, 2000.
- The agreement provided for the payment of his salary and a guaranteed
bonus for the lesser of:
(1) twelve months after the date of termination, or
(2) until the end of the agreement, if he was terminated other than due
to a disability, death or for "cause," such as the commission of a
felony, material dishonesty against us, or gross negligence in the
performance of duties.
Mr. Yokomoto also signed a separate agreement concurrently with his
employment agreement which prohibits him from competing with us or attempting to
hire any of our employees for the later of one year after termination of
employment, or the expiration of the then-current period of the term of the
agreement.
In July 2001, we entered into a new employment agreement with Mr. Yokomoto,
which provides for the following:
- Mr. Yokomoto is paid an annual salary of $500,000 (to be reviewed
annually for any increases by our Compensation Committee in consultation
with our Chief Executive Officer), is entitled to four weeks' vacation
each year, and is eligible to participate in our executive performance
bonus pool and in the Artists & Repertoire Bonus Plan of ARTISTdirect
Records, LLC.
- The initial term of the agreement expires June 30, 2006. Beginning July
1, 2006, and on each anniversary, the term of the agreement will
automatically be extended for an additional one-year period unless
written notice is provided otherwise.
- Mr. Yokomoto is entitled to receive a one-time lump sum advance of
$300,000, representing a pre-payment of $60,000 against any monies
otherwise becoming payable to Mr. Yokomoto under our executive
performance bonus pool for each year of the initial five-year term of the
agreement.
- Mr. Yokomoto also is entitled to receive a performance-based stock option
to purchase shares of our common stock at a per share exercise price
equal to the fair market value of our common stock on the date of the
option grant. The exact number of shares and terms of the stock option
will be determined by our Compensation Committee in consultation with our
Chief Executive Officer.
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- The agreement provides for the payment of $350,000 plus one years' salary
(or whatever shorter period remains in the term of the agreement) upon
the termination of Mr. Yokomoto's employment if the termination was:
(1) other than due to a disability,
(2) other than for "cause," such as the commission of a felony, fraud or
embezzlement, gross negligence or willful misconduct in the
performance of duties, material breach of the agreement, or
misappropriation of a corporate opportunity,
(3) other than due to Mr. Yokomoto's death, or
(4) for "good reason," such as a material and substantial reduction in
title, responsibilities or duties, a reassignment of location, or a
material breach of our obligations to Mr. Yokomoto.
- If Mr. Yokomoto's employment is terminated for cause or he resigns for
other than good reason, he must repay us within 30 days the amount, if
any, by which the $300,000 advance exceeds the lesser of (1) the amount
earned by him under our executive performance bonus pool or (2) the
product of $5,000 and the number of full months that have elapsed between
July 1, 2001 and the employment termination date.
- The agreement provides that prior to the termination of his employment,
Mr. Yokomoto is prohibited from competing with us. In addition, for a
period of one year after the expiration of the agreement, Mr. Yokomoto is
prohibited from hiring any of our employees.
James Carroll
In May 1999, we entered into an employment agreement with James Carroll,
our Chief Financial Officer, which provides for the following:
- Mr. Carroll is paid an annual salary of $150,000 and a guaranteed annual
bonus of $50,000.
- The initial term of the agreement expired May 23, 2001. In March 2001, we
extended the initial term of Mr. Carroll's employment to May 23, 2002.
- The employment agreement provides that if Mr. Carroll's employment is
terminated other than due to a disability, death or for "cause," such as
the commission of a felony, material dishonesty against us, or gross
negligence in the performance of duties, he will be paid his base salary
for the lesser of:
(1) six months after the date of termination, or
(2) the remainder of the agreement.
- If Mr. Carroll is terminated for cause, he is prohibited from competing
with us until the date the agreement would otherwise have expired. Mr.
Carroll is also prohibited from attempting to hire any of our employees
for one year following the later of:
(1) the date the agreement expires, or
(2) the actual date of termination.
Frederick Field
We also entered into an employment agreement and stock option agreements in
May 2001 with Frederick Field, our current Chairman of the Board and Chief
Executive Officer. In general, the employment agreement has a five-year term and
provides that Mr. Field is paid an annual base salary of $500,000, plus bonus
pool participation. If we terminate Mr. Field's employment other than for cause,
disability or death, or Mr. Field terminates his employment for good reason, he
will receive a
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lump sum payment equal to the amount of his annual base salary for (i) 50% of
the remaining term of the employment agreement if the termination occurs within
the first 3 years of his employment, (ii) 12 months if the termination occurs in
the fourth year of his employment or (iii) the full remaining term of the
employment agreement if the termination occurs in the fifth year of his
employment. These payments also will be made if (i) Mr. Field terminates his
employment upon written notice upon the commencement of any arbitration
proceeding to determine whether or not his employment with our subsidiary,
ARTISTdirect Records, may be terminated for good reason and (ii) Mr. Field's
employment with ARTISTdirect Records is terminated for good reason. If (i) Mr.
Field terminates his employment upon written notice upon the commencement of any
arbitration proceeding to determine whether or not his employment with
ARTISTdirect Records may be terminated for cause and (ii) Mr. Field remains
employed at ARTISTdirect Records because the arbitrator determined that
ARTISTdirect Records is not entitled to terminate Mr. Field's employment for
cause, then the payments will be made, but the applicable pay period will be
reduced by 50%.
We granted Mr. Field three non-plan, non-qualified stock options to
purchase 444,480 shares of common stock at an exercise price of $7.50 per share.
One of the stock option agreements generally provides that Mr. Field's right to
purchase 302,370 shares is immediately exercisable subject to a right of
repurchase, and vests in a series of 60 successive equal monthly installments
from June 29, 2001. The vesting fully accelerates upon (i) a change of control
or (ii) upon Mr. Field's cessation of service with us pursuant to an involuntary
termination. In addition, if (i) Mr. Field terminates his employment upon
written notice in connection with the commencement of any arbitration proceeding
to determine whether or not his employment with ARTISTdirect Records may be
terminated for cause and (ii) Mr. Field remains employed at ARTISTdirect Records
because the arbitrator determined that ARTISTdirect Records was not entitled to
terminate Mr. Field's employment for cause, then the vesting accelerates 50%.
Another stock option agreement generally provides that Mr. Field's right to
purchase 75,588 shares vests and becomes exercisable upon the occurrence prior
to June 29, 2004 of any one of the following events: (i) the 30-day average
closing sale price of our common stock or the consideration paid per share in an
acquisition of us reaches a minimum of $35.00 per share; (ii) our common stock
is re-listed on The Nasdaq National Market following a delisting; (iii) a change
of control occurs; or (iv) Mr. Field's service with us ceases pursuant to an
involuntary termination.
The third stock option agreement generally provides that Mr. Field's right
to purchase 66,522 shares vests and becomes exercisable upon the occurrence
prior to June 29, 2004 of any one of the following events: (i) the 30-day
average closing sale price of our common stock or the consideration paid per
share in an acquisition of us reaches a minimum of $70.00 per share; (ii) our
common stock is re-listed on The Nasdaq National Market following a delisting;
(iii) a change of control occurs; or (iv) Mr. Field's service with us ceases
pursuant to an involuntary termination.
For additional information regarding the terms of Mr. Field's employment
agreement and stock option agreements, see "Related Party
Transactions -- Transactions with Frederick Field" and "-- Options Issued to
Frederick Field" on pages 112 and 113.
The Compensation Committee of the Board of Directors has the authority to
provide for accelerated vesting of the shares of Common Stock subject to any
outstanding options held by the Chief Executive Officer or any other executive
officer or any unvested share issuances actually held by such individual, in
connection with certain changes in our control or the subsequent termination of
the officer's employment following the change in control event.
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INDEMNIFICATION OF DIRECTORS AND EXECUTIVE OFFICERS AND LIMITATION OF LIABILITY
Section 145 of the Delaware General Corporation Law authorizes a court to
award, or a corporation's board of directors to grant, indemnity to directors
and officers in terms sufficiently broad to permit indemnification for
liabilities, including reimbursement for expenses incurred, arising under the
Securities Act. This indemnification may, however, be unenforceable as against
public policy.
As permitted by Delaware law, our amended and restated certificate of
incorporation, which became effective upon the closing of our initial public
offering, includes a provision that eliminates the personal liability of its
directors for monetary damages for breach of fiduciary duty as a director,
except for liability:
- for any breach of the director's duty of loyalty to us or our
stockholders;
- for acts or omissions not in good faith or that involve intentional
misconduct or a knowing violation of law;
- under Section 174 of the Delaware law regarding unlawful dividends and
stock purchases; or
- for any transaction from which the director derived an improper personal
benefit.
As permitted by Delaware law, our amended and restated certificate of
incorporation and our amended and restated bylaws, which became effective upon
the closing of our initial public offering, provide that:
- we are required to indemnify our directors and officers to the fullest
extent permitted by Delaware law, so long as such person acted in good
faith and in a manner the person reasonably believed to be in or not
opposed to the best interests of ARTISTdirect, and with respect to any
criminal action or proceeding, had no reasonable cause to believe the
person's conduct was unlawful;
- we are permitted to indemnify our other employees to the extent that we
indemnify our officers and directors, unless otherwise required by law,
our amended and restated certificate of incorporation, our amended and
restated bylaws or other agreements;
- we are required to advance expenses to our directors and officers
incurred in connection with a legal proceeding to the fullest extent
permitted by Delaware law, subject to very limited exceptions; and
- the rights conferred in our amended and restated bylaws are not
exclusive.
We have entered into indemnity agreements with each of our current
directors and officers to give such directors and officers additional
contractual assurances regarding the scope of the indemnification set forth in
our amended and restated certificate of incorporation and our amended and
restated bylaws and to provide additional procedural protections. At present,
there is no pending litigation or proceeding involving any of our directors,
officers or employees regarding which indemnification is sought, nor are we
aware of any threatened litigation that may result in claims for
indemnification.
We have obtained directors' and officers' liability insurance.
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RELATED PARTY TRANSACTIONS
ISSUANCES OF INTERESTS IN PREDECESSOR
INITIAL ISSUANCES
In September 1996, Marc Geiger and Don Muller formed ARTISTdirect, LLC, our
predecessor, and each acquired 17,461,365 common units of its membership
interest. All information with respect to units of ARTISTdirect, LLC in this
section gives effect to a 35-for-1 forward unit split that occurred in May 1999
and does not give effect to the one-for-four reverse stock split effected on
March 21, 2000 or the one-for-ten reverse stock split effected on July 5, 2001.
The information in this section with respect to the Series C preferred stock of
ARTISTdirect, Inc. does not give effect to the one-for-four reverse stock split
effected on March 21, 2000 or the one-for-ten reverse stock split effected on
July 5, 2001.
In 1998, as partial compensation for services rendered and to be rendered,
ARTISTdirect, LLC issued common units to Keith Yokomoto, our President and Chief
Operating Officer, Steve Rennie, our former President of the UBL, Robert Morse,
our former Vice President and Treasurer and L&G Associates One. These common
units entitled the holders to share in the profits and losses of ARTISTdirect,
LLC but limited the holders' share of the capital of ARTISTdirect, LLC to
increases in its fair value after the issuance of the units. The value of the
capital at the time of these issuances remained the property of Messrs. Geiger
and Muller. In January 1998, Mr. Yokomoto and L&G Associates One received
4,014,107 and 1,204,232 common units, respectively. Allen Lenard, one of our
directors, is General Partner of Lenard Holdings, L.P., which is Managing
Partner of L&G Associates One and is also Managing Partner of Lenard, Brisbin &
Klotz LLP, one of our outside law firms. In June 1998, Messrs. Rennie and Morse
received 1,605,643 and 401,411 common units, respectively. In connection with
these issuances, Messrs. Geiger and Muller agreed that the percentages
represented by these common units would not be diluted for the first $5 million
in capital contributions made to ARTISTdirect, LLC by outside investors. To
effect this anti-dilution protection, Messrs. Geiger and Muller periodically
contributed common units to ARTISTdirect, LLC and ARTISTdirect, LLC issued the
same total number of common units to Messrs. Yokomoto, Rennie, Morse and L&G
Associates One for no additional consideration.
In July 1998, Messrs. Geiger and Muller contributed their interests in MGE,
LLC, another company they wholly-owned, to ARTISTdirect Holdings, L.L.C., a
newly-formed Delaware limited liability company, and then contributed their
interests in ARTISTdirect Holdings, L.L.C. to ARTISTdirect, LLC in exchange for
additional common units. As a result, ARTISTdirect Holdings, L.L.C. became a
wholly-owned subsidiary of ARTISTdirect, LLC.
In July 1997, ARTISTdirect New Media, LLC, one of our subsidiaries or ADNM,
and American Recordings, Inc., or ARI, which was wholly-owned by Rick Rubin, one
of our former directors, formed UBL, LLC. ARI contributed all of the assets used
in connection with the operation of the UBL Web site to UBL, LLC in exchange for
a membership interest in UBL, LLC. Since its inception, ADNM has been 99% owned
by ARTISTdirect LLC and 1% owned by an entity owned by the members of
ARTISTdirect, LLC. From UBL, LLC's inception in June 1997 until May 1999, when
ADNM exchanged its interest in UBL, LLC for interests in ARTISTdirect LLC, ADNM
owned approximately 49% of the membership interests in UBL, LLC, and controlled
and funded the operations of the UBL Web site.
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ISSUANCES OF ARTISTDIRECT, LLC SERIES A PREFERRED UNITS
Between July 1998 and December 1998, ARTISTdirect, LLC sold a total of
9,458,340 of its Series A preferred units at a purchase price of approximately
$0.31 per unit to the following purchasers:
AGGREGATE
SERIES A PURCHASE
PURCHASER PREFERRED UNITS PRICE
--------- --------------- ----------
Constellation Venture Capital, L.P. ........................ 5,850,520 $1,800,000
Psilos Group Partners, L.P. ................................ 1,950,172 600,000
DreamMedia Internet Ventures, LLC........................... 1,462,632 450,000
Carl Kawabe................................................. 195,016 60,000
In January 1999, ARTISTdirect, LLC redeemed 780,068 of its Series A
preferred units from Psilos Group Partners, L.P. for a purchase price of
$240,080 and re-issued those units to CCP/Psilos ARTISTdirect, LLC for the same
price. Mr. Friedman, one of our directors, is a member of Constellation Ventures
Management, LLC, which is the General Partner of Constellation Venture Capital,
L.P. and Mr. Krupa, one of our directors, is a member of Psilos Group Investors,
LLC, which is the General Partner of Psilos Group Partners, L.P.
ISSUANCES OF UBL, LLC UNITS
Between July 1998 and December 1998, UBL, LLC, sold an aggregate of
1,940,000 of its Series A preferred units, and 1,940,000 of its Series B
preferred units, at a purchase price of $1.00 per unit to the following
purchasers:
AGGREGATE
SERIES A SERIES B PURCHASE
PURCHASER PREFERRED UNITS PREFERRED UNITS PRICE
--------- --------------- --------------- ----------
Constellation Venture Capital, L.P. .............. 1,200,000 -- $1,200,000
Psilos Group Partners, L.P........................ 400,000 -- 400,000
DreamMedia Internet Ventures, LLC................. 300,000 -- 300,000
Carl Kawabe....................................... 40,000 -- 40,000
ADNM.............................................. -- 1,940,000 1,940,000
In January 1999, UBL, LLC redeemed 160,000 of its Series A preferred units
from Psilos Group Partners, L.P. for a purchase price of $160,000 and re-issued
those units to CCP/Psilos UBL, LLC for the same price.
In February 1999, UBL, LLC issued 392,134 of its common units to Scott
Blum, our Senior Vice President of Digital Music Services, in consideration of
his contribution of 540,000 shares of common stock of iMusic, Inc. All
information with respect to units of UBL, LLC in this section gives effect to a
1,000-for-1 unit split that occurred in April 1999.
EXCHANGE TRANSACTION AND ISSUANCE OF ARTISTDIRECT, LLC SERIES B PREFERRED
UNITS
In May 1999, we completed an exchange transaction in which the holders of
common and/or Series A preferred units of UBL, LLC, other than ADNM exchanged a
total of 8,042,134 UBL, LLC common units and 1,940,000 UBL, LLC preferred units
for a total of 13,982,207 common units and 3,372,920 Series A preferred units of
ARTISTdirect, LLC. At the same time, ADNM distributed units in UBL, LLC to
ARTISTdirect, LLC and to ARTISTdirect Holdings LLC, so that
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after giving effect to the exchange and distribution transactions, UBL, LLC was
99% owned by ARTISTdirect, LLC and 1% owned by ARTISTdirect Holdings LLC. In
connection with this transaction, Messrs. Geiger and Muller contributed 491,467
and 995,819 common units, respectively, to the capital of ARTISTdirect, LLC.
These units were then reissued to Mr. Rubin.
In May 1999, ARTISTdirect, LLC also sold an aggregate of 15,000,000 of its
Series B preferred units at a purchase price of $1.00 per unit to the following
purchasers:
SERIES B AGGREGATE
PREFERRED PURCHASE
PURCHASER UNITS PRICE
--------- --------- ----------
Chase Capital Partners...................................... 4,800,000 $4,800,000
CCP/Psilos ARTISTdirect, LLC................................ 922,509 922,509
Flatiron Fund............................................... 200,000 200,000
Bowman Capital Management LLC............................... 4,000,000 4,000,000
Constellation Venture Capital, L.P.......................... 2,500,000 2,500,000
Psilos Group Partners, L.P.................................. 1,383,764 1,383,764
Cassandra/ARTISTdirect Partners, LLC........................ 1,000,000 1,000,000
Toronto Dominion Investments, Inc........................... 193,727 193,727
In connection with this financing, the holders of Series A preferred units
in ARTISTdirect, LLC received 354,526 common units in ARTISTdirect, LLC and
$85,000 in exchange for accrued and unpaid preferred returns.
The preferred and common units of ARTISTdirect, LLC were exchanged for
preferred and common stock in connection with the merger of ARTISTdirect, LLC
into ARTISTdirect, Inc. on October 6, 1999. All shares of preferred stock
converted into shares of common stock on a one-for-one basis upon the closing of
our initial public offering (not taking into account our one-for-four reverse
stock split effected in March 2000 or our one-for-ten reverse stock split
effected in July 2001). In addition, approximately 80,216 shares of common stock
were issued as accrued but unpaid dividends on the preferred stock. See the
notes to the beneficial ownership table in "Principal Stockholders" on page 120
for information relating to the beneficial ownership of such shares.
ISSUANCES OF ARTISTDIRECT, INC. SERIES C PREFERRED STOCK
Between December 1999 and January 2000, ARTISTdirect, Inc. sold an
aggregate of 7,000,291 (taking into account our one-for-four reverse stock split
effected in March 2000, but not taking into account our one-for-ten reverse
stock split effected in July 2001) of its Series C preferred stock at a purchase
price of $13.928 per share to the following purchasers:
SHARES OF
SERIES C AGGREGATE
PREFERRED PURCHASE
PURCHASER STOCK PRICE
--------- --------- -----------
Universal Music Group, Inc.................................. 2,153,935 $30,000,000
Cisneros Television Group(1)................................ 1,435,957 20,000,000
Sony Music, a Group of Sony Music Entertainment Inc......... 1,076,968 15,000,000
BMG Music d/b/a BMG Entertainment........................... 1,076,968 15,000,000
Time Warner Inc.(2)......................................... 1,005,170 14,000,000
Yahoo! Inc.................................................. 179,495 2,500,000
Maverick Recording Company.................................. 71,798 1,000,000
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---------------
(1) Shares were actually acquired by Meadowlane Enterprises Ltd., an affiliate
of Cisneros Television Group. Pursuant to a Transfer and Assignment
Agreement dated as of December 28, 2000, Meadowlane transferred the shares
to Victoria Springs Investments Ltd., an affiliate of the Cisneros
Television Group. Subsequently, Victoria Springs Investments Ltd.
distributed all of its assets, including the shares of ARTISTdirect, Inc.,
on an equal basis, to (i) Carlton Investments LLC, a holding company
indirectly beneficially owned by a trust established by Gustavo A. Cisneros
for the benefit of himself and members of his family, and (ii) Carlyle
Investments LLC, a holding company indirectly beneficially owned by a trust
established by Ricardo J. Cisneros for the benefit of himself and members of
his family.
(2) Shares are actually held by Art-Dir Holdings Inc., an affiliate of Time
Warner Inc.
Mr. Khosrowshahi, one of our other directors, serves as a designee of
Universal Music Group, Inc. Each share of Series C preferred stock converted
into approximately 1.4508 shares of our common stock upon the closing of our
initial public offering in March 2000.
STRATEGIC AGREEMENTS WITH SERIES C PREFERRED STOCK INVESTORS
Each of our Series C preferred stock investors entered into strategic
agreements with us in connection with its purchase of Series C preferred stock.
Of these investors, Universal Music Group, Inc. beneficially owned more than 5%
of our common stock as of September 30, 2001.
TRANSACTIONS WITH FREDERICK FIELD
In May 2001, our wholly-owned subsidiary, ARTISTdirect Recordings, Inc.,
entered into an operating agreement and a loan and security agreement with Radar
Records Holdings, LLC for the joint formation, ownership and operation of a
traditional record label, ARTISTdirect Records, LLC. We will own a 50% equity
interest in ARTISTdirect Records. Radar Records Holdings is wholly owned by our
Chairman of the Board and Chief Executive Officer, Frederick Field.
Consequently, Mr. Field indirectly owns 50% of ARTISTdirect Records.
Through our wholly-owned subsidiary, ARTISTdirect Recordings, we are
providing a significant financial commitment to the co-venture under a five-year
$50 million revolving credit facility pursuant to the loan and security
agreement. Mr. Field will be responsible for running the day-to-day operations
of the co-venture.
ARTISTdirect Records entered into a five-year employment contract with Mr.
Field to serve as its Chief Executive Officer. Mr. Field receives an annual base
salary of $1,000,000 plus certain benefits. If Mr. Field terminates his
employment with ARTISTdirect Records for good reason, he will receive a lump sum
payment equal to the amount of his annual base salary for (i) 50% of the
remaining term of the employment agreement if the termination occurs within the
first 3 years of his employment, (ii) 12 months if the termination occurs in the
fourth year of his employment or (iii) the full remaining term of the employment
agreement if the termination occurs in the fifth year of his employment.
ARTISTdirect Records may not terminate Mr. Field's employment other than for
cause or due to his disability or death.
In connection with the formation of ARTISTdirect Records, we also entered
into a five-year employment contract with Mr. Field to serve as our Chief
Executive Officer, entered into non-qualified stock option agreements with Mr.
Field and nominated Mr. Field to our Board of Directors. Mr. Field receives an
annual base salary of $500,000, plus bonus pool participation and certain other
benefits, to serve as our Chief Executive Officer and Chairman of the Board. If
we terminate Mr. Field's employment other than for cause, disability or death,
or Mr. Field terminates his
112
employment for good reason, he will receive a lump sum payment equal to the
amount of his annual base salary for (i) 50% of the remaining term of the
employment agreement if the termination occurs within the first 3 years of his
employment, (ii) 12 months if the termination occurs in the fourth year of his
employment or (iii) the full remaining term of the employment agreement if the
termination occurs in the fifth year of his employment. These payments also will
be made if (i) Mr. Field terminates his employment upon written notice upon the
commencement of any arbitration proceeding to determine whether or not his
employment with ARTISTdirect Records may be terminated for good reason and (ii)
Mr. Field's employment with ARTISTdirect Records is terminated for good reason.
If (i) Mr. Field terminates his employment upon written notice upon the
commencement of any arbitration proceeding to determine whether or not his
employment with ARTISTdirect Records may be terminated for cause and (ii) Mr.
Field remains employed at ARTISTdirect Records because the arbitrator determined
that ARTISTdirect Records is not entitled to terminate Mr. Field's employment
for cause, then the payments will be made, but the applicable pay period will be
reduced by 50%.
Mr. Field is entitled to devote up to 20% of his total business time on a
yearly basis to Radar Pictures, LLC and to his service on the board of directors
of Huge Click, Interland, Load Media, Omnipod, Strategic Data Corporation and
E-Vox. In all decisions or determinations regarding ARTISTdirect Records to be
made by ARTISTdirect Recordings, Mr. Field must defer to the decision of our
Board and he must abstain from voting in any such decision by our Board (unless
it is by unanimous written consent).
Through our wholly-owned subsidiary, ARTISTdirect Recordings, we paid legal
fees of $130,000 to Lenard, Brisbin & Klotz LLP in connection with its
representation of ARTISTdirect Recordings in negotiating the agreements with Mr.
Field. Allen Lenard, one of our directors, is the managing partner of Lenard,
Brisbin & Klotz LLP. In addition, ARTISTdirect Recordings paid legal fees of
$227,000 incurred in the transactions by Radar Records. These payments to
Lenard, Brisbin & Klotz LLP and on behalf of Radar Records are being treated as
advances to ARTISTdirect Records under the operating agreement. Subsequently, in
September 2001, we granted Mr. Lenard a stock option to purchase 24,535 shares
of our common stock at an exercise price of $7.50 per share as additional
consideration for work performed in connection with forming ARTISTdirect Records
and negotiations with Mr. Field. This stock option is immediately exercisable
for all the option shares and expires September 28, 2008.
OPTIONS ISSUED TO FREDERICK FIELD
On May 31, 2001, we granted Frederick Field, our Chairman of the Board and
Chief Executive Officer, three non-plan, non-qualified stock options to purchase
444,480 shares of common stock at an exercise price of $7.50 per share, as an
inducement to serve as our Chairman of the Board and Chief Executive Officer
pursuant to an Employment Agreement dated May 31, 2001.
The right to purchase 302,370 shares of common stock (the "Base Option") is
immediately exercisable for all the option shares, but any shares purchased
under the Base Option will be subject to repurchase by us, at the exercise price
paid per share, to the extent those shares are unvested when Mr. Field ceases to
remain in our service. Mr. Field will acquire a vested interest in and our
repurchase right will lapse with respect to the option shares in a series of 60
successive equal monthly installments upon Mr. Field's completion of each month
of service measured from June 29, 2001. The option shares will automatically
accelerate in full so that they are immediately fully vested and exercisable
upon (i) a change of control that occurs prior to Mr. Field's cessation of
service with us or (ii) upon Mr. Field's cessation of service with us pursuant
to an involuntary termination. A change of control includes a merger,
consolidation, sale of all or substantially all of our assets and a sale of
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our voting control. An involuntary termination includes (i) our termination of
Mr. Field's employment for reasons other than for cause, (ii) a cessation of
services pursuant to Mr. Field's permanent disability or death and (iii) Mr.
Field's voluntary resignation for good reason, as set forth in the Employment
Agreement. Permanent disability exists if Mr. Field becomes unable to engage in
any substantial gainful activity by reason of any medically determinable
physical or mental impairment which is expected to result in death or has lasted
or can be expected to last for a continuous period of at least 12 months. In
addition, if (i) Mr. Field terminates his employment upon written notice in
connection with the commencement of any arbitration proceeding to determine
whether or not his employment with ARTISTdirect Records may be terminated for
cause and (ii) Mr. Field remains employed at ARTISTdirect Records because the
arbitrator determined that ARTISTdirect Records was not entitled to terminate
Mr. Field's employment for cause (together, such events will constitute a
"Termination With Justification"), then 50% of the then unvested option shares
will automatically accelerate so they are immediately fully vested and
exercisable.
The right to purchase 75,588 shares of common stock (the "Level One
Option") will not be exercisable by Mr. Field unless one of the following events
occurs prior to June 29, 2004, in which event Mr. Field will acquire a vested
interest in and the option will become fully exercisable with respect to all of
the option shares: (i) the 30-day average closing sale price of our common stock
or the consideration paid per share in an acquisition of us reaches a minimum of
$35.00 per share; (ii) our common stock is re-listed on The Nasdaq National
Market following a delisting; (iii) a change of control occurs; or (iv) Mr.
Field's service with us ceases pursuant to an involuntary termination (each a
"Level One Triggering Event"). If no Level One Triggering Event has occurred by
June 29, 2004, then the option will terminate and no option shares will vest or
become exercisable by Mr. Field.
The right to purchase 66,522 shares of common stock (the "Level Two
Option") will not be exercisable by Mr. Field unless one of the following events
occurs prior to June 29, 2004, in which event Mr. Field will acquire a vested
interest in and the option will become fully exercisable with respect to all of
the option shares: (i) the 30-day average closing sale price of our common stock
or the consideration paid per share in an acquisition of us reaches a minimum of
$70.00 per share; (ii) our common stock is re-listed on The Nasdaq National
Market following a delisting; (iii) a change of control occurs; or (iv) Mr.
Field's service with us ceases pursuant to an involuntary termination (each a
"Level Two Triggering Event"). If no Level Two Triggering Event has occurred by
June 29, 2004, then the option will terminate and no option shares will vest or
become exercisable by Mr. Field.
All three stock options expire no later than May 30, 2008. All three stock
options may also terminate prior to the expiration date as follows: (i) upon the
later of the 12 month anniversary of Mr. Field's cessation of service or the
expiration of Mr. Field's initial five-year employment term with us if Mr.
Field's employment with us ceases pursuant to an involuntary termination; (ii)
upon the earlier of the 12 month anniversary of Mr. Field's cessation of service
or the expiration of Mr. Field's initial five-year employment term with us if
Mr. Field terminates his employment pursuant to a Termination With
Justification; (iii) upon the earlier of the 90-day anniversary of Mr. Field's
cessation of service or the expiration date of the stock option if Mr. Field
ceases to remain in our service for any reason other than an involuntary
termination or a Termination With Justification; (iv) immediately if we
terminate Mr. Field's employment for cause; (v) upon the earlier of the 12 month
anniversary of Mr. Field's death or the expiration date of the stock option if
Mr. Field ceases to remain in our service due to his death; and (vi) upon the
latter of the 12 month anniversary of Mr. Field's cessation of service with us
or the expiration of Mr. Field's initial five-year employment term with us if
Mr. Field ceases to remain in our service due to his permanent disability,
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Additionally, the Level One Option and the Level Two Option will also terminate
if a Level One Triggering Event or a Level Two Triggering Event, as applicable,
has not occurred by June 29, 2004.
OPTIONS AND STOCK ISSUED TO JAMES CARROLL
In May 1999, we granted James Carroll, our Chief Financial Officer, two
options to purchase a total of 45,919 shares of common stock at an exercise
price of $36.00 per share. One-fourth of the 34,439 shares subject to the first
option became exercisable immediately, and the remaining option shares become
exercisable in three equal annual installments from the date of the grant. All
of these remaining option shares become immediately exercisable if a change of
control occurs.
At the time Mr. Carroll's second option was granted, the option was
initially not exercisable and became exercisable as follows:
- One-half of the 11,480 shares underlying Mr. Carroll's second option
would become exercisable upon the completion of an offering.
- The remaining shares underlying this option would become exercisable if
the closing price of our common stock on any two or more trading days
exceeds 150% of the initial offering price during the one month period
following the closing of our initial public offering. The remaining
shares would also become exercisable immediately upon a change of control
which occurs before May 24, 2002, provided that the valuation of
ARTISTdirect at the change of control equaled or exceeded $300 million.
In February 2000, we accelerated the exercisability of this option so
that it immediately became exercisable for all 11,480 of the shares
subject to the option.
On September 23, 1999, James Carroll purchased 8,387 shares of common stock
from Don Muller and 2,795 shares of common stock from Keith Yokomoto for
$300,000 and $100,000, respectively.
On March 6, 2000, the Board approved an option grant to Mr. Carroll which
became effective on March 27, 2000, the time the initial public offering price
for our initial public offering was determined. The option grant is exercisable
for 22,608 shares, has an exercise price equal to the initial public offering
price of $120.00 per share and will become exercisable with respect to one-third
of the option shares on each anniversary of the effectiveness of the option
grant.
DEBT TO EXECUTIVE OFFICERS AND DIRECTOR
In satisfaction of our obligations to make distributions triggered by the
merger of ARTISTdirect, LLC into ARTISTdirect, Inc., we issued a note in the
principal amount of $275,000 to each of Messrs. Geiger and Muller and a note in
the principal amount of $190,714 to Mr. Rubin. Each of these notes bore interest
at a rate of 5.98% per annum and was repaid in April 2000.
DEFERRED COMPENSATION AGREEMENT
In April 1998, we entered into a deferred compensation agreement with Keith
Yokomoto, our President and Chief Operating Officer. The agreement grants Mr.
Yokomoto deferred compensation of up to $200,000, depending on the value of our
company as of the payment date. The compensation is due on the earlier to occur
of:
- Mr. Yokomoto's sale of all of his shares of our common stock;
- the occurrence of specific capital events, including the sale of
substantially all of our assets and receipt of insurance proceeds from
the occurrence of an extraordinary event; or
- April 1, 2005.
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Messrs. Geiger and Muller are obligated to contribute to ARTISTdirect the
amounts necessary to fund this obligation. We have recorded the $200,000
obligation as an expense for 1998.
TRANSACTIONS WITH SCOTT BLUM
In connection with UBL, LLC's acquisition of iMusic, we granted Scott Blum,
our Senior Vice President of Digital Music Services, an option to have all of
his shares of our common stock redeemed for a redemption price of up to $2.8
million. The redemption option was triggered by the occurrence of specified
events, including our initial public offering in March 2000. Mr. Blum elected
not to exercise his option. Accordingly, it terminated on the closing of our
initial public offering in March 2000. If Mr. Blum had exercised his option we
would have been required to pay a total of $200,000 in bonuses to employees of
iMusic designated by Mr. Blum.
In addition, UBL, LLC entered into a contingent loan agreement with Mr.
Blum to make loans to pay federal and state tax liabilities that he may incur as
a result of (a) the liquidation of iMusic or a taxable disposition or other
transfer of iMusic common stock or (b) a distribution of property by UBL, LLC to
Mr. Blum not involving sufficient cash or marketable securities for him to pay
the resulting tax liability, in either case. Any advances to Mr. Blum under the
contingent loan agreement will bear interest at the then lowest permissible rate
under the Internal Revenue Code and be secured by a pledge of a portion of Mr.
Blum's shares of our common stock.
Between 1996 and 1998, Mr. Blum periodically advanced iMusic funds for
various expenses. The largest amount outstanding at any one time during this
period was $66,000. During this period, iMusic leased its principal executive
office from Mr. Blum, for which Mr. Blum received annual rental payments of
$13,500.
REGISTRATION RIGHTS AGREEMENT
We have entered into a registration rights agreement with Rick Rubin, one
of our former directors, Marc Geiger, our Vice-Chairman of the Board and
President, Artist Services, Donald Muller, our Senior Agent, and the holders of
our Series A, Series B and Series C preferred stock. The registration rights
agreement provides these stockholders with rights to require us to register
their stock with the Securities and Exchange Commission. These registration
rights will terminate no later than ten years after the closing date of our
initial public offering in March 2000.
We entered into a registration rights agreement with Frederick Field, our
Chairman of the Board and Chief Executive Officer, requiring us to register the
shares of common stock, issuable to Mr. Field upon exercise of his options, with
the Securities and Exchange Commission, and to keep such registration effective
until all of his options have been exercised in full or have expired. In August
2001, we registered the shares of common stock issuable to Mr. Field upon
exercise of his options on a registration statement on Form S-8 under the
Securities Act. However, Mr. Field has agreed not to sell or transfer his option
shares (other than to immediate family members, family trusts or by will or the
laws of descent) prior to the first anniversary of the commencement of his
employment, without the prior written consent of our Board of Directors.
STOCKHOLDERS AGREEMENT
We have entered into a stockholders agreement with a number of our
stockholders with respect to their rights, restrictions and obligations as
stockholders. These stockholders include several of our current and former
officers and directors and their affiliates, including Marc Geiger, Donald
Muller, Keith Yokomoto, L&G Associates One, Steve Rennie, James Carroll, Robert
Morse, Constellation
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Venture Capital, L.P., Psilos Group Partners, L.P., Rick Rubin, Scott Blum,
Chase Venture Capital Associates, L.P., Universal Music Group, Inc., Meadowlane
Enterprises, Ltd., Sony Music, Art-Dir Holdings Inc., Maverick Recording
Company, BMG Music and Yahoo!. Although most of the provisions of this agreement
terminated upon the consummation of our initial public offering, the following
provisions remain in effect:
- Private Transfer. If Messrs. Geiger or Muller, or any of their
transferees, proposes to transfer five percent or more of our outstanding
capital stock in a single private transaction or series of private transactions,
each of the parties to the stockholders agreement will be allowed to participate
in the transaction;
- Mandatory redemption of Mr. Elson's Common Stock. In connection with our
initial public offering in March 2000, William Elson exercised the option he
received in connection with the settlement agreement described in "-- Settlement
Agreement" on page 119. In connection with this exercise, we redeemed 5,000
shares of common stock from each of Messrs. Geiger and Muller. The price per
share paid to Messrs. Geiger and Muller was $17.50, which was equal to the price
per share paid to us by Mr. Elson; and
- Errors and omissions insurance. We are required to obtain and maintain an
errors and omissions insurance policy covering our officers and directors with a
stated policy limit of no less than $5,000,000. Constellation Ventures (BVI),
Inc., CCP/Psilos ARTISTdirect, LLC, Chase Venture Capital Associates, L.P.
Flatiron Fund 1998/99, LLC, Universal Music Group, Inc., Meadowlane Enterprises,
Ltd., Sony Music, Art-Dir Holdings Inc., Maverick Recording Company and BMG
Music shall be additional named insureds on the policy as long as such coverage
is reasonably available.
PERSONAL GUARANTEES BY EXECUTIVE OFFICERS AND DIRECTORS
In February 1999, Marc Geiger, our Vice-Chairman of the Board and
President, Artist Services, and Donald Muller, our Senior Agent, personally
guaranteed obligations by us under a $750,000 credit facility with Republic Bank
California, N.A., and obligations by UBL under a $1,250,000 credit facility with
Republic Bank. In November 1999, the $1,250,000 credit facility was increased to
$4,250,000 and James Carroll, our Chief Financial Officer, was added as one of
the personal guarantors on both this facility and the $750,000 facility. Rick
Rubin, one of our former directors, also personally guaranteed the obligations
by UBL under the $4,250,000 credit facility. In March 2000, the credit
facilities expired and we repaid all outstanding amounts on the credit
facilities.
In connection with the personal guarantees by Messrs. Geiger and Muller for
the $750,000 line of credit, ARTISTdirect, LLC, ARTISTdirect Holdings, L.L.C.,
ARTISTdirect Agency, LLC, ARTISTdirect New Media, LLC, Kneeling Elephant
Records, Keith Yokomoto, our President, Chief Operating Officer and one of our
directors, L&G Associates One, Stephen P. Rennie, former President of The
Ultimate Band List, Robert A. Morse, our former Vice President of Business
Administration and Treasurer, Constellation Venture Capital, L.P., Constellation
Ventures (BVI), Inc., Psilos Group Partners, L.P., DreamMedia Internet Ventures,
LLC, Carl Kawabe and CCP/Psilos ARTISTdirect, LLC, each agreed to reimburse
Messrs. Geiger and Muller on demand for any payment they make pursuant to the
guarantees. Additionally, Messrs. Geiger and Muller each agreed to pay the
other's proportionate share of their obligation if either one of them does not
receive the full amount of reimbursement described above.
In connection with the personal guarantees by Messrs. Geiger, Muller,
Carroll and Rubin for the $4,250,000 line of credit, ARTISTdirect, LLC,
ARTISTdirect Holdings, L.L.C., ARTISTdirect Agency, LLC, ARTISTdirect New Media,
LLC, Kneeling Elephant Records, American Recordings, Inc.,
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Constellation Venture Capital, L.P., Constellation Ventures (BVI), Inc., Psilos
Group Partners, L.P. DreamMedia Internet Ventures, LLC, Carl Kawabe and
CCP/Psilos ARTISTdirect, LLC, each agreed to reimburse Messrs. Geiger, Muller,
Carroll and Rubin on demand for any payment they make pursuant to the
guarantees. Additionally, Messrs. Geiger, Muller, Carroll and Rubin each agreed
to pay each other's proportionate share of their obligation if any one of them
does not receive the full amount of reimbursement described above. Rick Rubin,
one of our former directors, is President of American Recordings, Inc.
EQUITY-RELATED TRANSACTIONS BETWEEN OFFICERS AND DIRECTORS
In March 2000, Marc Geiger, Donald Muller and Rick Rubin agreed to enter
into a series of transactions to transfer to Keith Yokomoto, Steve Rennie and
L&G Associates One the economic benefit of the increase in value over $139.28
per share with respect to an aggregate of 123,439 shares of our common stock,
referred to below as the "Transferred Shares". The purpose of these transactions
was to provide additional equity-based incentives to Messrs. Yokomoto and Rennie
and to provide both equity-based incentives and compensation for past services
to L&G Associates One.
To effect these transactions, Rick Rubin contributed 41,146 shares of his
common stock to ARTISTdirect Investors, LLC in exchange for membership interests
in that entity. ARTISTdirect Investors, LLC is the entity through which Messrs.
Geiger, Muller, Yokomoto, Rennie, and L&G Associates One currently hold their
shares. ARTISTdirect Investors, LLC then granted additional membership interests
to Messrs. Yokomoto and Rennie and L&G Associates One in a transaction that only
diluted the membership interests of Messrs. Geiger, Muller and Rubin. These
additional membership interests, which we refer to as the "Additional
Interests", entitled Messrs. Yokomoto or Rennie or L&G Associates One to share
in any increase in the value of 69,683, 23,891 and 29,864 shares, respectively,
of our common stock held by ARTISTdirect Investors, LLC over $139.28 per share.
Upon the closing of our initial public offering, ARTISTdirect Investors,
LLC distributed the shares of common stock it was holding to its members and
then dissolved. The number of shares distributed to each member was determined
based upon $69.38, the closing price of our common stock on the third day of
trading. Messrs. Yokomoto and Rennie and L&G Associates One did not receive any
additional shares of common stock from ARTISTdirect Investors, LLC as a result
of its issuance of the Additional Interests.
Upon the closing of our initial public offering, we issued Messrs. Yokomoto
and Rennie and L&G Associates One options to purchase 69,683, 23,891 and 29,864
shares, respectively, of our common stock. These options have seven year terms
and have an exercise price of $139.28 per share. The options granted to Messrs.
Yokomoto and Rennie were granted under our 1999 Employee Stock Plan and will be
exercisable at any time following the one year anniversary of their grant,
unless the applicable optionee terminates his employment prior to that date. In
this event, that optionee's option will terminate. The options granted to
Messrs. Yokomoto and Rennie also become immediately exercisable upon a change of
control, or if the optionee dies, becomes disabled or is terminated by us
without cause. The option granted to L&G Associates One was granted under our
1999 Artist and Artist Advisor Plan and is immediately exercisable in full.
Each of Messrs. Rubin, Geiger and Muller have agreed that, upon exercise of
any of these options, they will sell to us, and we will redeem from them, the
same number of aggregate shares that we are required to issue in connection with
the exercise of the option. The price that we will pay Messrs. Rubin, Geiger and
Muller for their shares will be equal to the exercise price that we receive from
the optionee. Each of Messrs. Rubin, Geiger and Muller is obligated to sell us
one third of the number of shares issued by us upon the exercise. To effect this
agreement, Messrs. Rubin, Geiger
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and Muller have irrevocably authorized us to hold in escrow share certificates
representing the maximum number of shares of common stock that may be acquired
upon exercise of these options.
RETURN OF CAPITAL
In August 1997 and August 1998, we paid a total of $100,000 to Marc Geiger,
our Vice-Chairman of the Board and President, Artist Services, as a return of
capital that Mr. Geiger previously contributed to us.
PAYMENTS TO LEGAL COUNSEL
For the nine months ended September 30, 2001 and the years ended December
31, 1998, 1999, and 2000, we paid Lenard, Brisbin & Klotz LLP $254,000,
$350,000, $1,010,000, and $464,000, respectively, for legal services provided to
us. In September 2001, we granted Allen Lenard a stock option to purchase 24,535
shares of our common stock at an exercise price of $7.50 per share for legal
services provided to us. This stock option is immediately exercisable for all
the option shares and expires September 28, 2008. Mr. Lenard, one of our
directors, is Managing Partner of Lenard, Brisbin & Klotz LLP.
SETTLEMENT AGREEMENT
We entered into a settlement agreement with William Elson in connection
with the termination of his employment as our Chief Operating Officer in October
1997. Pursuant to this agreement, Mr. Elson received a severance payment of
$175,000 and an option to purchase the lesser of 10,000 shares of our common
stock, or 2.5% of the common stock issued in our initial public offering at an
exercise price that was determined at the completion of our initial public
offering pursuant to the agreement. Mr. Elson exercised this option by paying an
aggregate of $175,000 to purchase 10,000 shares of our common stock. Messrs.
Geiger and Muller each contributed half the shares of common stock issued to Mr.
Elson upon exercise of his option, in exchange for which we paid Messrs. Geiger
and Muller the consideration we received from Mr. Elson for the exercise of the
option. In addition, Mr. Elson loaned us $100,000 in 1996, which we repaid in
1997.
OPTIONS ISSUED TO DIRECTOR
In December 2000, our Board of Directors granted Dara Khosrowshahi, one of
our directors, an option to purchase 5,000 shares of common stock at an exercise
price of $7.50 per share, subject to the approval of USA Networks, his employer.
We received such approval.
LOAN TO OFFICER
In February 2001, we loaned Marc Geiger, our Chairman and Chief Executive
Officer $150,000. The loan bears an interest rate of 7%. The term of the loan
was initially one year, but was extended, in September 2001, to five years
commensurate with the amendment of the term of Mr. Geiger's employment agreement
in July 2001, with equal principal payments to be made by Mr. Geiger each year
over the course of the loan.
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PRINCIPAL STOCKHOLDERS
The following table sets forth certain information known to us with respect
to the beneficial ownership of our common stock as of September 30, 2001 by (i)
all persons who are beneficial owners of five percent (5%) or more of our common
stock, (ii) each of our directors and nominees for director, (iii) our executive
officers named in the Summary Compensation Table of the Summary of Cash and
Certain Other Compensation section of the registration statement filed with this
prospectus and (iv) all of our current directors and executive officers as a
group.
PERCENTAGE
SHARES OF SHARES
BENEFICIALLY BENEFICIALLY
BENEFICIAL OWNER OWNED OWNED(1)
---------------- ------------ ------------
Entities affiliated with Constellation Venture Capital,
L.P.(2)................................................... 275,113 7.7%
575 Lexington Avenue
New York, New York 10022
Universal Music Group, Inc.................................. 312,500 8.7
10 Universal City Plaza
Universal City, California 91608
Donald P. Muller............................................ 329,177 9.2
Rick Rubin.................................................. 362,022 10.1
c/o Alan S. Halfon & Company
9595 Wilshire Boulevard, Suite 505
Beverly Hills, California 90212
Frederick W. Field(7)....................................... 444,480 11.0
Marc P. Geiger.............................................. 337,740 9.4
Keith K. Yokomoto(3)........................................ 260,422 7.1
James B. Carroll(4)......................................... 63,472 1.8
Clifford H. Friedman(2)..................................... 275,113 7.7
Dara Khosrowshahi........................................... -- --
Stephen Krupa(5)............................................ 78,746 2.2
Allen D. Lenard(6).......................................... 83,394 2.3
1901 Century Park West, Sixth Floor
Los Angeles, California 90067
Benjamin Moody.............................................. 150 *
All directors and executive officers as a group (9
persons)(8)............................................... 1,543,517 37.0
---------------
* Represents less than 1%.
(1) Beneficial ownership is determined in accordance with the rules of the
Securities and Exchange Commission and includes voting or investment power
with respect to the securities. Common stock subject to options or warrants
that are currently exercisable or exercisable within 60 days of September
30, 2001 are deemed to be outstanding and to be beneficially owned by the
person or group holding such options or warrants for the purpose of
computing the percentage ownership of such person or group but are not
treated as outstanding for the purpose of computing the percentage
ownership of any other person or group. Unless otherwise indicated, the
address for each of the individuals listed in the table is care of
ARTISTdirect, Inc., 5670 Wilshire Boulevard, Suite 200, Los Angeles,
California, 90036. Unless otherwise indicated by footnote, the persons
named in the table have sole voting and sole investment power with respect
to all shares of common stock shown as beneficially owned by them, subject
to applicable community property laws. Percentage of beneficial ownership
is based on 3,554,708
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shares of common stock outstanding as of September 30, 2001 and reflects
the effect of our tender offer which was consummated on April 18, 2001,
pursuant to which we purchased approximately 200,000 shares of our common
stock, as well as the effect of our one-for-ten reverse stock split
effected on July 5, 2001.
(2) Includes (a) 226,379 shares held by Constellation Venture Capital, L.P.; and
(b) 48,734 shares held by Constellation Ventures (BVI), Inc. Mr. Friedman is
President and Chief Executive Officer of Constellation Ventures (BVI), Inc.
and a member of Constellation Ventures Management, LLC, the general partner
of Constellation Venture Capital, L.P. As such, Mr. Friedman may be deemed
to exercise voting and investment power over such shares. Mr. Friedman
disclaims beneficial ownership of such shares, except to the extent of his
proportionate interest therein.
(3) Includes (a) 37,102 shares held by Keith Yokomoto as trustee of the Geiger
Children's Trust, (b) 37,102 shares held by Keith Yokomoto as trustee of the
Muller Children's Trust and (c) 69,683 shares issuable upon options
exercisable within 60 days of September 30, 2001. Mr. Yokomoto has sole
voting and dispositive power over these shares. Mr. Yokomoto disclaims
beneficial ownership of these shares. Also includes 200 shares held by Mr.
Yokomoto's spouse.
(4) Includes 52,290 shares subject to options which are exercisable within 60
days of September 30, 2001.
(5) Includes (a) 78,353 shares held by Psilos Group Partners, L.P., and (b) 393
shares held by Psilos Group Investors, LLC. Mr. Krupa is a member of Psilos
Group Investors, LLC, which is the general partner of Psilos Group Partners,
L.P. As such, Mr. Krupa may be deemed to exercise voting and investment
power over such shares. Mr. Krupa disclaims beneficial ownership of such
shares, except to the extent of his proportionate interest therein.
(6) Includes (a) 28,995 shares held by L&G Associates One, and (b) 54,399 shares
issuable upon immediately exercisable options. Mr. Lenard is General Partner
of Lenard Holdings, L.P., which is the Managing Partner of L&G Associates
One, and as such, may be deemed to exercise voting and investment power over
such shares. He disclaims beneficial ownership of the share held by this
entity except to the extent of his proportionate interest therein.
(7) Includes 444,480 shares subject to options of which 302,370 shares are
immediately exercisable.
(8) Includes the information set forth in notes 2-7 above.
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DESCRIPTION OF CAPITAL STOCK
GENERAL
Our authorized capital stock consists of 150 million shares of common
stock, $.01 par value per share, and 5 million shares of preferred stock, $.01
par value per share. Based on the number of shares, options and warrants
outstanding as of September 30, 2001, there are 3,554,708 outstanding shares of
common stock, outstanding options to purchase 1,194,688 shares of common stock
and outstanding warrants to purchase 130,689 shares of common stock (including
options granted to Mr. Field, excluding options and warrants issued pursuant to
the acquisition of Mjuice.com, Inc.).
COMMON STOCK
As of September 30, 2001, there were 3,554,708 shares of common stock
outstanding. Holders of the common stock are entitled to one vote for each share
held on all matters submitted to a vote of the stockholders. Holders of common
stock are entitled to receive ratably any dividends that may be declared by the
Board of Directors out of legally available funds, subject to any preferential
dividend rights of any outstanding preferred stock. Upon our liquidation,
dissolution or winding up, the holders of common stock are entitled to receive
ratably our net assets available after the payment of all debts and other
liabilities and subject to the prior rights of any outstanding preferred stock.
Holders of common stock have no preemptive, subscription, redemption or
conversion rights. The outstanding shares of common stock are, and the shares
offered by us in this offering will be upon receipt of payment for such shares,
fully paid and nonassessable. The rights, preferences and privileges of holders
of common stock are subject to, and may be adversely affected by, the rights of
holders of shares of any series of preferred stock which we may designate and
issue in the future without further stockholder approval. As of September 30,
2001, there were no shares of preferred stock outstanding.
PREFERRED STOCK
Our board of directors is authorized without further stockholder approval
to issue from time to time up to an aggregate of 5 million shares of preferred
stock in one or more series and to fix or alter the designations, preferences,
rights, qualifications, limitations or restrictions of the shares of each
series, including the dividend rights, dividend rates, conversion rights, voting
rights, term of redemption including sinking fund provisions, redemption price
or prices, liquidation preferences and the number of shares constituting any
series or designations of such series without further vote or action by the
stockholders. The issuance of preferred stock may have the effect of delaying,
deferring or preventing a change in control of our management without further
action by the stockholders and may adversely affect the voting and other rights
of the holders of common stock. The issuance of preferred stock with voting and
conversion rights may adversely affect the voting power of the holders of common
stock, including the loss of voting control to others. We have no present plans
to issue any shares of preferred stock.
ANTI-TAKEOVER PROVISIONS
DELAWARE LAW
We are subject to the provisions of Section 203 of the Delaware General
Corporation Law regulating corporate takeovers. Section 203 prevents Delaware
corporations, including those that are listed on the Nasdaq National Market,
from engaging in a "business combination" involving a merger or sale of more
than 10% of the corporation's assets, with any "interested stockholder," that
is, a stockholder who owns 15% or more of the corporation's outstanding voting
stock, as well as affiliates
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and associates of any such person, for three years following the date that such
stockholder became an "interested stockholder" unless:
- the transaction that resulted in the stockholder becoming an "interested
stockholder" was approved by the board of directors prior to the date the
"interested stockholder" attained such status;
- upon consummation of the transaction that resulted in the stockholder
becoming an "interested stockholder," the "interested stockholder" owned
at least 85% of the voting stock of the corporation outstanding at the
time the transaction commenced, excluding those shares owned by (i)
persons who are directors as well as officers and (ii) employee stock
plans in which employee participants do not have the right to determine
confidentially whether shares held subject to the plan will be tendered
in a tender or exchange offer; or
- on or subsequent to such date, the "business combination" is approved by
the board of directors and authorized at an annual or special meeting of
stockholders by the affirmative vote of at least two-thirds of the
outstanding voting stock that is not owned by the "interested
stockholder."
A Delaware corporation may "opt out" of Section 203 with an express
provision in its original certificate of incorporation or an express provision
in its certificate of incorporation or bylaws resulting from a stockholders'
amendment approved by at least a majority of the outstanding voting shares. We
have not "opted out" of the provisions of the Anti-Takeover Law. This statute
could prohibit or delay mergers or other takeover or change-of-control attempts
with respect to ARTISTdirect and, accordingly, may discourage attempts to
acquire us.
CHARTER AND BYLAW PROVISIONS
There are provisions in our amended and restated certificate of
incorporation and our amended and restated bylaws that may make it more
difficult to acquire control of ARTISTdirect by various means. These provisions
could deprive the stockholders of opportunities to realize a premium on the
shares of common stock owned by them. In addition, these provisions may
adversely affect the prevailing market price of the stock. These provisions are
intended to:
- enhance the likelihood of continuity and stability in the composition of
the board and in the policies formulated by the board;
- discourage the types of transactions which may involve an actual or
threatened change in control of ARTISTdirect;
- discourage tactics that may be used in proxy fights;
- encourage persons seeking to acquire control of ARTISTdirect to consult
first with the board of directors to negotiate the terms of any proposed
business combination or offer; and
- reduce our vulnerability to an unsolicited proposal for a takeover that
does not contemplate the acquisition of all outstanding shares of
ARTISTdirect or that is otherwise unfair to our stockholders.
Classified Board of Directors; Removal; Filling Vacancies and
Amendment. The certificate and bylaws provide that the board shall be divided
into three classes of directors serving staggered, three-year terms. The
classification of the board has the effect of requiring at least two annual
stockholder meetings, instead of one, to replace a majority of members of the
board. Subject to the rights of the holders of any outstanding series of
preferred stock, the certificate authorizes only the
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board to fill vacancies, including newly created directorships. Accordingly,
this provision could prevent a stockholder from obtaining majority
representation on the board by enlarging the board of directors and filling the
new directorships with its own nominees. The certificate also provides that
directors may be removed by stockholders only for cause and only by the
affirmative vote of holders of two-thirds of the outstanding shares of voting
stock.
Stockholder Action; Special Meeting of Stockholders. The certificate
provides that stockholders may not take action by written consent, but may only
take action at duly called annual or special meetings of stockholders. The
certificate further provides that special meetings of our stockholders may be
called only by the chairman of the board of directors or a majority of the board
of directors. This limitation on the right of stockholders to call a special
meeting could make it more difficult for stockholders to initiate actions that
are opposed by the board of directors. These actions could include the removal
of an incumbent director or the election of a stockholder nominee as a director.
They could also include the implementation of a rule requiring stockholder
ratification of specific defensive strategies that have been adopted by the
board of directors with respect to unsolicited takeover bids. In addition, the
limited ability of the stockholders to call a special meeting of stockholders
may make it more difficult to change the existing board and management.
Advance Notice Requirements for Stockholder Proposals and Director
Nominations. The bylaws provide that stockholders seeking to bring business
before an annual meeting of stockholders, or to nominate candidates for election
as directors at an annual meeting of stockholders, must provide timely notice
thereof in writing. To be timely, a stockholder's notice must be delivered to or
mailed and received at our principal executive offices not less than 120 days
prior to the date of our annual meeting. The bylaws also specify requirements as
to the form and content of a stockholder's notice. These provisions may preclude
stockholders from bringing matters before an annual meeting of stockholders or
from making nominations for directors at an annual meeting of stockholders.
Authorized but Unissued Shares. The authorized but unissued shares of
common stock and preferred stock are available for future issuance without
stockholder approval. These additional shares may be utilized for a variety of
corporate purposes, including future public offerings to raise additional
capital, corporate acquisitions and employee benefit plans. The existence of
authorized but unissued shares of common stock and preferred stock could render
more difficult or discourage an attempt to obtain control of us by means of a
proxy contest, tender offer, merger or otherwise.
Supermajority Vote to Amend Charter and Bylaws. The Delaware General
Corporation Law provides generally that the affirmative vote of a majority of
the shares entitled to vote on any matter is required to amend a corporation's
certificate of incorporation or bylaws, unless a corporation's certificate of
incorporation or bylaws, as the case may be, requires a greater percentage. Our
amended and restated certificate of incorporation imposes a 66 2/3% vote
requirement in connection with business combination transactions and the
amendment of some provisions of our certificate of incorporation and bylaws,
including those provisions relating to the classified board of directors, action
by written consent, the ability of stockholders to call special meetings and the
ability of stockholders to bring business before an annual meeting or to
nominate directors. Our present directors and executive officers and their
respective affiliates beneficially own approximately 37.0% of our common stock
outstanding (as of September 30, 2001). This gives them veto power with respect
to any stockholder action or approval requiring a two-thirds vote.
REGISTRATION RIGHTS
We have provided purchasers of our Series A, Series B and Series C
preferred stock and Rick Rubin, one of our former directors, with rights to
require us to register their securities under the
124
Securities Act of 1933, as amended. Please see "Related Party
Transactions -- Registration Rights Agreement" on page 116 for more information
on these rights.
WARRANTS
As of September 30, 2001, Warner Music Group and Winterland Concessions
held outstanding warrants to purchase 56,250 and 34,263 shares of our common
stock, respectively, at a price of $40.00 per share, Yahoo! held a warrant to
purchase 16,963 shares of our common stock at a price of $139.28 per share, and
16,963 shares of our common stock at a price of $120.00 per share, 5670
Wilshire, L.P. held a warrant to purchase 6,250 shares of our common stock at
$139.28 per share, and various consultants held outstanding warrants to purchase
1,306 shares of our common stock at prices ranging from $1.90 to $63.50.
TRANSFER AGENT AND REGISTRAR
The Transfer Agent and Registrar for our common stock is Mellon Investor
Services.
LISTING
Our shares are listed on The Nasdaq National Market under the symbol
"ARTD."
SHARES ELIGIBLE FOR FUTURE SALE
Future sales of substantial amounts of common stock, including shares
issued upon exercise of outstanding options and warrants, in the public market
could adversely affect market prices prevailing from time to time and could
impair our ability to raise capital through the sale of our equity securities.
Sales of substantial amounts of our common stock in the public market could
adversely affect the prevailing market price and our ability to raise equity
capital in the future.
We have 3,554,708 shares of common stock outstanding as of September 30,
2001. All of these shares, other than shares held by our affiliates, are freely
tradable without restriction or further registration under the Securities Act.
RULE 144
Under Rule 144 as currently in effect, a person or persons whose shares are
aggregated, who has beneficially owned restricted shares for at least one year,
including the holding period of any prior owner except an affiliate, would be
entitled to sell within any three-month period a number of shares that does not
exceed the greater of:
- 1% of the number of shares of common stock then outstanding, which will
equal approximately 35,547 shares as of the date of this prospectus, or
- the average weekly trading volume of the common stock during the four
calendar weeks preceding the filing of a Form 144 with respect to such
sale. Sales under Rule 144 also are subject to manner of sale provisions
and notice requirements and to the availability of current public
information about us. Under Rule 144(k), a person who is not deemed to
have been an affiliate of ARTISTdirect at any time during the three
months preceding a sale, and who has beneficially owned the shares
proposed to be sold for at least two years, including the holding period
of any prior owner except an affiliate, is entitled to sell such shares
without complying with the manner of sale, public information, volume
limitation or notice provisions of Rule 144.
125
RULE 701
Rule 701 permits resales of shares in reliance upon Rule 144 but without
compliance with some of the restrictions, including the holding period
requirement, of Rule 144. Any of our employees, officers, directors, or
consultants who purchased his or her shares pursuant to a written compensatory
plan or contract may be entitled to rely on the resale provisions of Rule 701.
Rule 701 permits affiliates to sell their Rule 701 shares under Rule 144 without
complying with the holding period requirements of Rule 144. Rule 701 further
provides that non-affiliates may sell such shares in reliance on Rule 144
without having to comply with the holding period, public information, volume
limitation or notice provisions of Rule 144.
We have filed a registration statement on Form S-8 under the Securities Act
covering 760,000 shares of common stock subject to outstanding options under our
1999 Employee Stock Option Plan and nonstatutory stock option agreements which
are outside of these plans. Accordingly, subject to the exercise of such
options, shares registered under such registration statement will be immediately
available for sale in the open market.
REGISTRATION RIGHTS
In addition, some of our stockholders have registration rights with respect
to approximately 2,060,526 shares of common stock. Registration of these
securities under the Securities Act would result in those shares becoming freely
tradeable without restriction under the Securities Act. Pursuant to a
registration rights agreement, we registered, under the Securities Act, 444,480
shares of our common stock issuable to Frederick Field upon exercise of his
stock options. Registration of these securities results in those shares becoming
freely tradeable without restriction other than the restrictions of Rule 144 of
the Securities Act. See "Related Party Transactions -- Registration Rights
Agreement" on page 116 for more information on these rights.
PLAN OF DISTRIBUTION
The shares of common stock being registered have been, or will be issued by
us directly to participants in our 1999 Employee Stock Option Plan, our 1999
Artist Stock Option Plan and our 1999 Artist and Artist Advisor Stock Option
Plan. The shares have been, or will be issued to those participants who exercise
options issued to them pursuant to these stock option plans. We will not receive
any fees, commission, expenses or other compensation in connection with the
issuance of these shares, other than the exercise price for the shares which
will be paid by the participants electing to exercise their options. In
addition, participants under our 1999 Employee Stock Option Plan, our 1999
Artist Stock Option Plan and our 1999 Artist and Artist Advisor Stock Option
Plan are entitled to transfer their options under their will or the laws of
inheritance or to their immediate family or to a trust established exclusively
for one or more of their family members or to their former spouse pursuant to a
domestic relations order, as well as to one or more persons designated as the
beneficiary of the participant's outstanding options. In such event, the
transferees will be entitled to exercise the options by payment of the exercise
price to us and we will issue the shares so purchased directly to the
transferees.
LEGAL MATTERS
The validity of the common stock offered hereby will be passed upon for us
by Brobeck, Phleger & Harrison LLP, Irvine, California.
126
EXPERTS
The consolidated financial statements of ARTISTdirect, Inc. (and its
predecessor company ARTISTdirect, LLC) and subsidiaries as of December 31, 1999
and 2000, and for each of the years in the three year period ended December 31,
2000, and the financial statements of iMusic, Inc., as of December 31, 1997 and
1998 and the years ended December 31, 1997 and 1998, have been included herein
and in the registration statement in reliance upon the reports of KPMG LLP,
independent certified public accountants, appearing elsewhere herein, and upon
the authority of said firm as experts in accounting and auditing.
WHERE YOU CAN FIND INFORMATION
We have filed with the Securities and Exchange Commission a registration
statement on Form S-1 with respect to the shares of common stock offered by this
prospectus. This prospectus, which constitutes a part of the registration
statement, does not contain all of the information set forth in the registration
statement or the exhibits and schedules which are part of the registration
statement. For further information with respect to us and our common stock, see
the registration statement and the exhibits thereto. Statements contained in
this prospectus regarding the contents of any contract or any other document to
which reference is made are not necessarily complete, and, in each instance
where a copy of such contract or other document has been filed as an exhibit to
the registration statement, reference is made to the copy so filed, each such
statement being qualified in all respects by such reference. Any document we
file may be read and copied at the Public Reference Room of the Commission at
Judiciary Plaza, 450 Fifth Street, N.W., Washington, D.C. 20549. The public may
obtain information on the operation of the Public Reference Room by calling the
Commission at 1-800-SEC-0330. Our filings with the Commission are also available
to the public from the Commission's Web site (http://www.sec.gov).
We are subject to the information and periodic reporting requirements of
the Securities Exchange Act and, accordingly, file periodic reports, proxy
statements and other information with the Commission. Such periodic reports,
proxy statements and other information are available for inspection and copying
at the Commission's public reference rooms, and the Web site of the Commission
referred to above.
Our principal executive offices are located at 5670 Wilshire Blvd., Suite
200, Los Angeles, California 90036, and our telephone number is (323) 634-4000.
Our fiscal year ends on December 31. We maintain a worldwide Web site at
http://www.artistdirect.com. The reference to our worldwide Web address does not
constitute incorporation by reference of the information contained at this site.
127
ARTISTDIRECT, INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
PAGE
----
ARTISTdirect, Inc. and Subsidiaries Consolidated Financial
Statements
Independent Auditors' Report.............................. F-2
Consolidated Balance Sheets............................... F-3
Consolidated Statements of Operations..................... F-4
Consolidated Statements of Changes in Members' and
Stockholders' Equity (Deficit)......................... F-5
Consolidated Statements of Cash Flows..................... F-6
Notes to Consolidated Financial Statements................ F-7
iMusic, Inc. Financial Statements
Independent Auditors' Report.............................. F-39
Balance Sheets............................................ F-40
Statements of Operations.................................. F-41
Statements of Shareholders' Equity (Deficit).............. F-42
Statements of Cash Flows.................................. F-43
Notes to Financial Statements............................. F-44
F-1
INDEPENDENT AUDITORS' REPORT
To the Board of Directors
ARTISTdirect, Inc.
We have audited the accompanying consolidated balance sheets of
ARTISTdirect, Inc. (and its predecessor company ARTISTdirect, LLC) and
subsidiaries (the Company) as of December 31, 1999 and 2000 and the related
consolidated statements of operations, changes in members' and stockholders'
equity (deficit) and cash flows for each of the years in the three year period
ended December 31, 2000. These financial statements are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
consolidated financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of ARTISTdirect, Inc. and
subsidiaries as of December 31, 1999 and 2000 and the results of its operations
and its cash flows for each of the years in the three year period ended December
31, 2000, in conformity with accounting principles generally accepted in the
United States of America.
/s/ KPMG LLP
Los Angeles, CA
February 19, 2001
F-2
ARTISTDIRECT, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
DECEMBER 31,
-------------------- SEPTEMBER 30,
1999 2000 2001
-------- -------- -------------
(UNAUDITED)
ASSETS
Current assets:
Cash and cash equivalents................................. $ 69,119 $ 51,457 $ 40,658
Cash held for clients..................................... 770 743 260
Short term investments.................................... -- 36,368 19,942
Accounts receivable, net.................................. 1,001 948 388
Prepaid expenses and other current assets................. 6,795 3,218 4,142
-------- -------- ---------
Total current assets.................................... 77,685 92,734 65,390
Property and equipment, net................................. 3,343 9,057 7,011
Investments in affiliated companies......................... 70 85 406
Goodwill and intangibles, net............................... 13,415 15,018 936
Other assets, net........................................... 4,087 1,611 5
-------- -------- ---------
$ 98,600 $118,505 $ 73,748
======== ======== =========
LIABILITIES, REDEEMABLE SECURITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Cash held for clients..................................... $ 770 $ 743 $ 260
Accounts payable.......................................... 3,709 2,257 642
Accrued expenses.......................................... 4,698 5,186 3,600
Loans and notes payable................................... 741 178 198
Deferred revenue.......................................... 37 34 --
-------- -------- ---------
Total current liabilities............................... 9,955 8,398 4,700
Long term liabilities..................................... 683 1,530 1,009
-------- -------- ---------
Total liabilities....................................... 10,638 9,928 5,709
Redeemable securities:
Series A redeemable preferred stock, $.01 par value.
Authorized, issued and outstanding 3,207,815 shares in
1999. Liquidation preference and redemption value of
$4,963 in 1999.......................................... 4,963 -- --
Series B redeemable preferred stock, $.01 par value.
Authorized 3,750,000 shares, issued and outstanding
3,750,000 shares in 1999. Liquidation preference and
redemption value of $15,350 in 1999..................... 15,350 -- --
Series C redeemable preferred stock, $.01 par value.
Authorized 8,550,000, issued and outstanding 5,905,374
shares in 1999. Liquidation preference and redemption
value of $82,250 in 1999................................ 82,188 -- --
Redeemable common securities, $.01 par value. Authorized
10,800,000 shares. Liquidation preference and redemption
value of $9,206, $10,778 and $11,189 in 1999, 2000 and
2001, respectively...................................... 9,206 10,778 11,189
-------- -------- ---------
Total redeemable securities............................. 111,707 10,778 11,189
-------- -------- ---------
Members' and stockholders' equity (deficit):
Common stock, $.01 par value. Authorized 150 million
shares; issued and outstanding 1,408,867 and 3,779,608
shares in 1999 and 2000; issued 3,782,274 and
outstanding 3,554,708 in 2001........................... 141 379 379
Treasury stock, 227,566 shares in 2001.................... -- -- (2,663)
Additional paid-in-capital................................ 36,688 200,690 198,861
Unearned compensation..................................... (36,976) (20,364) (9,428)
Accumulated deficit....................................... (23,598) (82,906) (130,299)
-------- -------- ---------
Total members' and stockholders' equity (deficit)....... (23,745) 97,799 56,850
-------- -------- ---------
$ 98,600 $118,505 $ 73,748
======== ======== =========
See accompanying notes to consolidated financial statements.
F-3
ARTISTDIRECT, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT FOR SHARE DATA)
NINE MONTHS ENDED
YEAR ENDED DECEMBER 31, SEPTEMBER 30,
------------------------------- ---------------------
1998 1999 2000 2000 2001
------- --------- --------- --------- ---------
(UNAUDITED)
Net revenue:
E-Commerce............................. $ 1,548 $ 5,282 $ 12,160 $ 7,874 $ 5,651
Media.................................. 552 2,910 6,326 5,016 2,205
Agency................................. 1,917 1,304 2,946 2,523 738
Record label........................... 565 778 244 244 --
------- --------- --------- --------- ---------
Total net revenue................... 4,582 10,274 21,676 15,657 8,594
Cost of revenue:
Direct cost of product sales........... 1,505 5,091 10,381 7,051 4,698
Other cost of revenues................. 1,010 3,380 8,616 6,167 4,713
Stock-based compensation............... -- 1,769 7,545 6,150 4,648
------- --------- --------- --------- ---------
Total cost of revenue............... 2,515 10,240 26,542 19,368 14,059
Gross profit (loss)................. 2,067 34 (4,866) (3,711) (5,465)
Operating expense:
Website development costs.............. 589 1,815 5,364 2,757 3,269
Sales and marketing.................... 1,395 13,222 25,623 19,542 5,053
General and administrative............. 2,545 10,319 17,874 12,832 10,877
Stock-based compensation(1)............ 3,828 30,304 5,067 3,116 4,859
Depreciation and amortization.......... 59 2,509 6,248 4,315 5,429
Loss from impairment of goodwill....... -- -- -- -- 11,444
------- --------- --------- --------- ---------
Loss from operations................ (6,349) (58,135) (65,042) (46,273) (46,396)
Income/(loss) from equity
investments......................... 2 50 (235) 15 (4,054)
Interest income, net................... 29 281 5,969 3,993 3,057
------- --------- --------- --------- ---------
Net loss before taxes............... (6,318) (57,804) (59,308) (42,265) (47,393)
Income taxes............................. -- -- -- -- --
------- --------- --------- --------- ---------
Net loss............................ $(6,318) $ (57,804) $ (59,308) $ (42,265) $ (47,393)
=======
Interest on rescission offer............. 237 532 339 533
Dividends on redeemable preferred
securities............................. 1,414 963 963 --
Beneficial conversion feature on
redeemable preferred stock............. -- 24,375 24,375 --
--------- --------- --------- ---------
Net loss attributable to common
shareholders........................... $ (59,455) $ (85,178) $ (67,942) $ (47,926)
========= ========= ========= =========
Basic and diluted net loss per share for
period from October 6, 1999 to December
31, 1999, for the year ended December
31, 2000 and for the nine months ended
September 30, 2000 and 2001............ $ (17.14) $ (26.83) $ (22.90) $ (13.11)
========= ========= ========= =========
Weighted average shares outstanding used
in calculating basic and diluted net
loss per share for period from October
6, 1999 to December 31, 1999, for the
year ended December 31, 2000 and for
the nine months ended September 30,
2000 and 2001.......................... 1,417,746 3,175,126 2,966,541 3,656,333
========= ========= ========= =========
---------------
(1) Stock-based compensation is comprised of sales and marketing expense of $0,
$8,551, $2,209, $3,853 and $1,527 for the years ended December 31, 1998,
1999 and 2000 and for the nine months ended September 30, 2000 and 2001,
respectively, and general and administrative expense of $3,828, $21,753,
$2,858, $(737) and $3,332 for the years ended December 31, 1998, 1999 and
2000 and for the nine months ended September 30, 2000 and 2001,
respectively.
See accompanying notes to consolidated financial statements.
F-4
ARTISTDIRECT, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN MEMBERS' AND STOCKHOLDERS' EQUITY
(DEFICIT)
(IN THOUSANDS)
COMMON STOCK ADDITIONAL
------------------- TREASURY PAID IN MEMBERS' UNEARNED ACCUMULATED TOTAL
SHARES AMOUNT STOCK CAPITAL INTEREST COMPENSATION DEFICIT EQUITY
--------- ------- -------- ---------- -------- ------------ ----------- --------
Balance at December 31, 1997..... -- $ -- $ -- $ -- $ 76 $ -- $ (488) $ (412)
Distribution of members'
interest..................... -- -- -- -- (249) -- -- (249)
Variable equity interests...... -- -- -- -- 4,330 (4,330) -- --
Amortization of unearned
compensation................. -- -- -- -- -- 3,828 -- 3,828
Accrual of dividends to
preferred members............ -- -- -- -- (171) -- -- (171)
Accrual for securities subject
to rescission offer.......... -- -- -- -- (114) -- -- (114)
Net loss....................... -- -- -- -- -- -- (6,318) (6,318)
--------- ---- ------- -------- -------- -------- --------- --------
Balance at December 31, 1998..... -- $ -- $ -- $ -- $ 3,872 $ (502) $ (6,806) $ (3,436)
Issuance of securities......... -- -- -- -- 13,859 -- -- 13,859
Issuance of options/warrants... -- -- -- -- 51,202 (51,202) -- --
Variable equity interests...... -- -- -- -- 16,470 (16,470) -- --
Amortization of unearned
compensation................. -- -- -- -- -- 31,198 -- 31,198
Payment of preferred dividend
by LLC....................... -- -- -- -- (85) -- -- (85)
Conversion of preferred return
to common securities as an
LLC.......................... -- -- -- -- 355 -- -- 355
Accrual of dividends to
preferred members............ -- -- -- -- (1,414) -- -- (1,414)
Accretion of redeemable
stock........................ -- -- -- -- (184) -- -- (184)
Conversion to C corporation.... 1,369,900 137 -- 42,926 (84,075) -- 41,012 --
Payment of preferred dividend
by C corporation............. -- -- -- (191) -- -- -- (191)
Exercise of stock option....... 17,667 2 -- 669 -- -- -- 671
Conversion of preferred return
to common stock as a C
corporation.................. 21,300 2 -- 765 -- -- -- 767
Accrual for securities subject
to rescission offer.......... -- -- -- (6,740) -- -- -- (6,740)
Notes issued to shareholders... -- -- -- (741) -- -- -- (741)
Net loss....................... -- -- -- -- -- -- (57,804) (57,804)
--------- ---- ------- -------- -------- -------- --------- --------
Balance at December 31, 1999..... 1,408,867 $141 $ -- $ 36,688 $ -- $(36,976) $ (23,598) $(23,745)
Issuance of securities upon
initial public offering, net
of offering costs............ 500,000 50 -- 52,385 -- -- -- 52,435
Issuance of securities for
acquisition.................. 86,604 9 -- 2,850 -- -- -- 2,859
Issuance of common stock for
employee stock purchase
plan......................... 6,758 1 -- 39 -- -- -- 40
Series C redeemable preferred
stock offering costs......... -- -- -- (4,800) -- -- -- (4,800)
Issuance/cancellation of
options/warrants............. -- -- -- (1,372) -- 1,372 -- --
Exercise of stock options...... 40,907 4 -- 1,549 -- -- -- 1,553
Amortization of unearned
compensation................. -- -- -- -- -- 15,240 -- 15,240
Variable equity interests...... -- -- -- (6,645) -- -- -- (6,645)
Issuance of stock appreciation
rights/options............... -- -- -- 2,992 -- -- -- 2,992
Issuance of stock for
settlement agreement......... -- -- -- 1,025 -- -- -- 1,025
Accrual of dividends to
preferred shareholders....... -- -- -- (963) -- -- -- (963)
Conversion of redeemable
preferred shares to common
shares....................... 1,719,428 172 -- 118,516 -- -- -- 118,688
Conversion of redeemable common
shares to common shares...... 17,044 2 -- 2,350 -- -- -- 2,352
Accrual for securities subject
to rescission offer.......... -- -- -- (3,924) -- -- -- (3,924)
Net loss....................... -- -- -- -- -- -- (59,308) (59,308)
--------- ---- ------- -------- -------- -------- --------- --------
Balance at December 31, 2000..... 3,779,608 $379 $ -- $200,690 $ -- $(20,364) $ (82,906) $ 97,799
Issuance/cancellation of
options/warrants
(unaudited).................. -- -- -- (1,428) -- 1,428 -- --
Amortization of unearned
compensation (unaudited)..... -- -- -- -- -- 9,508 -- 9,508
Repurchase of common stock
(unaudited).................. (227,566) -- (2,663) -- -- -- -- (2,663)
Issuance of common stock for
employee stock purchase plan
(unaudited).................. 2,666 -- -- 11 -- -- -- 11
Accrual for securities subject
to rescission offer
(unaudited).................. -- -- -- (412) -- -- -- (412)
Net loss (unaudited)........... -- -- -- -- -- -- (47,393) (47,393)
--------- ---- ------- -------- -------- -------- --------- --------
Balance at September 30, 2001
(unaudited).................... 3,554,708 $379 $(2,663) $198,861 $ -- $ (9,428) $(130,299) $ 56,850
========= ==== ======= ======== ======== ======== ========= ========
See accompanying notes to consolidated financial statements.
F-5
ARTISTDIRECT, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
NINE MONTHS ENDED
YEAR ENDED DECEMBER 31, SEPTEMBER 30,
-------------------------------- --------------------
1998 1999 2000 2000 2001
-------- -------- -------- -------- --------
(UNAUDITED)
Cash flows from operating activities:
Net loss............................................. $ (6,318) $(57,804) $(59,308) $(42,265) $(47,393)
Adjustments to reconcile net loss to net cash
provided by (used in) operating activities:
Depreciation and amortization...................... 59 2,509 6,248 4,315 5,429
(Income)/loss from equity investments.............. (2) (50) 235 (15) 4,054
Loss on sale of equipment.......................... -- -- -- -- 34
Loss from impairment of goodwill................... -- -- -- -- 11,444
Allowance for doubtful accounts and sales
returns.......................................... 89 29 341 478 (322)
Write-off of investment............................ -- 250 -- -- --
Stock based compensation........................... 3,828 32,073 12,612 9,266 9,507
Changes in assets and liabilities:
Accounts receivable.............................. (536) (571) (288) (1,932) 882
Prepaid expenses and other current assets........ (391) (6,628) 3,638 958 (923)
Other assets..................................... (49) (2,054) 2,476 1,997 241
Accounts payable, accrued expenses and other
liabilities................................... 1,049 6,384 (1,032) 436 (2,338)
Deferred revenue................................. (43) (120) (19) (35) (34)
-------- -------- -------- -------- --------
Net cash used in operating activities......... (2,314) (25,982) (35,097) (26,797) (19,419)
-------- -------- -------- -------- --------
Cash flows from investing activities:
Purchases of property and equipment.................. (141) (3,513) (7,523) (6,378) (839)
Proceeds from the sale of equipment.................. -- -- -- -- 60
Purchase of short term investments, net of
maturities......................................... -- -- (36,368) (43,765) 16,426
Purchase of programming rights....................... -- (675) -- -- --
Cash paid for acquisitions........................... -- (237) (2,015) (2,015) --
Investments in affiliated companies.................. (373) (30) (250) (250) (4,377)
Investments in trademarks............................ -- -- (120) (120) --
Distribution of earnings from equity investment...... -- 33 -- -- 2
-------- -------- -------- -------- --------
Net cash provided by (used in) investing
activities.................................. (514) (4,422) (46,276) (52,528) 11,272
-------- -------- -------- -------- --------
Cash flows from financing activities:
Repurchase of common stock........................... -- -- -- -- (2,663)
Payment of preferred dividend........................ -- (276) -- -- --
Distribution of members' interest.................... (249) -- -- -- --
Payment of notes to shareholders..................... -- -- (741) (741) --
Proceeds from issuance of securities for employee
stock purchase plan................................ -- -- 40 -- 11
Proceeds from exercise of stock options.............. -- 671 1,553 1,553 --
Proceeds from issuance of preferred securities....... 4,850 97,188 15,224 15,224 --
Payment of Series C redeemable preferred stock
offering costs..................................... -- -- (4,800) (4,800) --
Proceeds from initial public offering, net of
offering costs paid................................ -- -- 52,435 52,435 --
-------- -------- -------- -------- --------
Net cash provided by (used in) financing
activities.................................. 4,601 97,583 63,711 63,671 (2,652)
-------- -------- -------- -------- --------
Net increase (decrease) in cash and cash
equivalents................................. 1,773 67,179 (17,662) (15,654) (10,799)
Cash and cash equivalents at beginning of period....... 167 1,940 69,119 69,119 51,457
-------- -------- -------- -------- --------
Cash and cash equivalents at end of period............. $ 1,940 $ 69,119 $ 51,457 $ 53,465 $ 40,658
======== ======== ======== ======== ========
Supplemental disclosure of cash flow information --cash
paid during the period for interest.................. $ 50 $ 11 $ 43 $ 26 $ 43
======== ======== ======== ======== ========
See accompanying notes to consolidated financial statements.
F-6
ARTISTDIRECT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION
ORGANIZATION
ARTISTdirect, Inc. (the "Company") was formed on October 6, 1999 upon its
merger with ARTISTdirect, LLC (the "Capital Reorganization"). The Capital
Reorganization was only a change in the form of ownership of the Company.
ARTISTdirect, LLC was organized as a California limited liability company and
commenced operations on August 8, 1996. ARTISTdirect, LLC had a 99% ownership
interest in ARTISTdirect Agency LLC, Kneeling Elephant Records, LLC and
ARTISTdirect NewMedia, LLC ("affiliated companies") and has consolidated their
results since inception. In February 1999, Ultimate Band List, LLC ("UBL")
acquired the remaining 80% of iMusic, Inc., a Washington corporation, that it
did not already own. On May 18, 1999, ARTISTdirect, LLC entered into an
agreement with UBL and the affiliated companies whereby units in ARTISTdirect,
LLC were exchanged for the membership interests of UBL and the affiliated
companies (Exchange Transaction). The acquisition of the minority interest in
UBL was accounted for under purchase accounting.
PRINCIPLES OF CONSOLIDATION
The accompanying financial statements include the consolidated accounts of
the Company and its subsidiaries in which it has controlling interests in the
form of voting and operating control. All significant intercompany accounts and
transactions have been eliminated for all periods presented. UBL generated
losses on its operations for all periods prior to the Company's purchase of the
minority interest in UBL. Due to the full funding of those losses by the Company
and its members, none of the losses generated by UBL during the periods
presented have been allocated to the minority holders.
UNAUDITED INTERIM FINANCIAL INFORMATION
The accompanying unaudited financial statements and unaudited footnote
disclosures for the nine months ended September 30, 2000 and 2001 have been
prepared on substantially the same basis as the audited financial statements,
and in the opinion of management of the Company, include all adjustments,
consisting only of normal adjustments, necessary for a fair presentation of the
financial information set forth therein.
LIQUIDITY
The Company has relied on various equity financings to fund its operations
in the past. The Company believes that its available cash resources will be
sufficient to meet its anticipated cash needs for working capital and capital
expenditures for the next 18 months.
2. CAPITAL REORGANIZATION AND REVERSE STOCK SPLITS
The common units and redeemable preferred units outstanding immediately
prior to the Capital Reorganization were converted into common stock and
redeemable preferred stock of the C corporation. Each common and preferred unit
converted into one share of common and preferred stock, respectively.
On March 21, 2000 and July 5, 2001, the Company effected a 1 for 4 reverse
stock split and a 1 for 10 reverse stock split (the "Reverse Stock Splits"),
respectively. The outstanding common securities, options and warrants have been
retroactively adjusted to reflect the Reverse Stock Splits.
F-7
ARTISTDIRECT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
All discussion of equity amounts in the following footnotes reflect the effect
of the Capital Reorganization and Reverse Stock Splits.
3. SIGNIFICANT ACCOUNTING POLICIES
CASH EQUIVALENTS
Cash equivalents consist of investments, which are readily convertible into
cash and have maturities of three months or less at the time of purchase.
CASH HELD FOR CLIENTS
Cash held for clients consists of funds held on behalf of the Company's
clients for musical performances. The cash is restricted for payment to the
clients, and there is a corresponding amount due to clients.
SHORT TERM INVESTMENTS
The Company's investments are classified as held-to-maturity as the Company
has the intent and ability to hold the securities to maturity. The securities
are stated at amortized cost, adjusted for amortization of premiums and
accretion discounts to maturity. The Company invests in fixed income securities
with maturities of one year or less at the time of purchase.
DEPRECIATION
Depreciation is provided using the straight-line method over the following
estimated useful lives:
Computer equipment and software............... 3 years
Furniture and fixtures........................ 7 years
Leasehold improvements........................ Lesser of estimated
useful life or life of
lease (10 years)
REVENUE RECOGNITION
E-commerce revenues, which consist primarily of the gross amount of sales
revenue paid by the customer for recorded music and merchandise sold via the
Internet, include shipping fees and are recognized when the products are
shipped. The Company obtains merchandise from merchandisers and manufacturers,
music from a third party distributor, contracts for warehousing and fulfillment,
processes customer orders and provides customer service. The Company takes title
to all products sold and bears the risk of loss for collections and non-delivery
subject to any recourse against the shipper. E-commerce revenues are subject to
amounts due to the respective artists based on their contracts, and such expense
is recorded as part of direct cost of product sales.
The Company records amounts charged to customers for shipping and handling
in accordance with Emerging Issues Task Force 00-10, "Accounting for Shipping
and Handling Fees and Costs." Pursuant to EITF 00-10, the Company records
amounts charged to customers for shipping and handling as revenue, and records
the related costs incurred for shipping and handling to direct cost of product
sales in the consolidated statements of operations. For the years ended December
31, 1998, 1999 and 2000 and for the nine months ended September 30, 2000 and
2001, the Company recorded $185,000, $832,000, $1.9 million, $1.3 million and
$1.1 million, respectively, as revenue for shipping
F-8
ARTISTDIRECT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
and handling fees charged to customers. For the years ended December 31, 1998,
1999 and 2000 and for the nine months ended September 30, 2000 and 2001, the
Company recorded $189,000, $845,000, $1.6 million, $1.1 million and $803,000,
respectively, as direct cost of product sales in the consolidated statements of
operations.
The Company generates media revenue from the sale of advertisements and
sponsorships, both online and offline, under short-term contracts. To date, the
duration of the Company's advertising and sponsorship commitments has generally
averaged from one to six months. The Company's online obligations typically
include the guarantee of a minimum number of "impressions" or times that an
advertisement appears in pages viewed by the users of the Company's online
properties. Online advertising revenue is generally recognized as the
impressions are served during the period in which the advertisement is
displayed, provided that no significant obligations of the Company remain and
collection of the resulting receivable is probable. The Company records a
reserve for contracts in which the guarantee of a minimum number of impressions
are not expected to be met. There were no such instances as of December 31,
1998, 1999 and 2000 and September 30, 2000 and 2001. Revenue generated from
offline advertising and sponsorships is recognized ratably over the terms of the
sponsorship agreements.
The Company entered into several contracts with advertisers whereby the
parties exchanged online and offline advertising. This revenue was recognized as
trade and barter. Trade and barter is valued based upon similar cash
transactions, which have been entered into within six months of the respective
trade and barter agreement. Trade and barter revenue was $0, $98,000, $309,000,
$234,000 and $0 for years ended December 31, 1998, 1999 and 2000 and for the
nine months ended September 30, 2000 and 2001, respectively.
Agency commission revenue is recognized in accordance with the terms of the
representation agreements between the Company and its clients. Revenue is
generally recorded upon payment for the performance of services or delivery of
materials created by the artists represented.
Overhead advances on the record label are recognized as revenue evenly over
the period covered by the advances. Royalties earned on albums sold by artists
signed to the record label are recognized as revenue at the time the releases
are shipped to the retailer. Reserves are established for possible returns.
COST OF REVENUE
Direct cost of product sales consists of amounts payable to artists, which
includes the cost of merchandise sold and a share of net proceeds, and online
commerce transaction costs, including credit card fees, fulfillment charges and
shipping costs. Other cost of revenue consists primarily of Web site hosting and
maintenance costs, online content programming costs, online advertising serving
costs, record royalties payable to artists and payroll and related expenses for
staff involved in Web site hosting and the agency. Stock-based compensation
expense relates to non-cash charges in connection with warrants issued to
vendors and options issued to artists and their advisors for the right to
operate their stores. Amounts payable to artists and transaction costs are
recognized upon shipment. Web site-related costs are recognized immediately when
incurred. Payroll and related expenses are recognized in the period incurred.
Non-cash stock-based compensation charges are recognized over the period of the
related agreements.
F-9
ARTISTDIRECT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
INVENTORIES
Inventories, included in prepaid expenses and other current assets, consist
of music-related merchandise and amounts advanced for inventory on behalf of
artists and are stated at net realizable value. Cost is determined using the
first-in, first-out method.
INCOME TAXES
Prior to the Capital Reorganization, the Company was treated as a limited
liability company for federal and state income tax reporting purposes whereby
income (or losses) of the Company was reported in the individual income tax
returns of the Company's members. After the Capital Reorganization, the Company
began accounting for income taxes under Statement of Financial Accounting
Standards (SFAS) No. 109, "Accounting for Income Taxes." Under the asset and
liability method of SFAS No. 109, deferred tax assets and liabilities are
recognized for the future tax consequences attributable to differences between
the financial statement carrying amounts of existing assets and liabilities and
their respective tax bases. Deferred tax assets and liabilities are measured
using enacted tax rates expected to apply to taxable income in the years in
which those temporary differences are expected to be recovered or settled. Under
SFAS No. 109, the effect on deferred tax assets and liabilities of a change in
tax rates is recognized in income in the period that includes the enactment
date.
WEBSITE DEVELOPMENT COSTS
Website development costs consist primarily of third-party development
costs and payroll and related expenses for in-house Web site development costs
incurred in the start-up and production of the Company's content and services.
These costs are expensed as incurred. The implementation of Emerging Issues Task
Force No. 00-02, "Accounting for Website Development Costs," effective July 1,
2000, did not have a material impact on the consolidated financial statements.
ADVERTISING COSTS
Advertising costs are expensed as incurred and totaled $461,000, $7.7
million, $14.7 million, $11.2 million and $2.4 million during the years ended
December 31, 1998, 1999 and 2000 and for the nine months ended September 30,
2000 and 2001, respectively.
INTANGIBLE ASSETS
Intangible assets consist of goodwill resulting from the excess of the
purchase price over the net assets acquired from the acquisition of a minority
interest in the UBL, and the acquisitions of iMusic, Inc. and Mjuice.com, Inc.,
which was fully impaired in 2001. Intangible assets are amortized on a
straight-line basis over five years, the estimated period of benefit. The
carrying amount of intangible assets is net of accumulated amortization of $2.1,
$5.7 and $8.3 million as of December 31, 1999 and 2000, and September 30, 2001,
respectively.
IMPAIRMENT OF LONG-LIVED ASSETS AND GOODWILL
The Company periodically reviews the carrying amounts of long-lived assets
to determine whether current events or circumstances warrant adjustments to such
carrying amounts. An impairment adjustment is necessary in the event the net
book value of such long-lived assets exceeds the future undiscounted cash flows
attributable to such assets. In such event, the loss is measured by
F-10
ARTISTDIRECT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
the amount that the carrying value of such assets exceeds their fair value.
Considerable management adjustment is necessary to estimate the fair value of
assets; accordingly, actual results could vary significantly from such
estimates.
The Company determined that the remaining goodwill associated with the
acquisition of Mjuice was impaired due to the Company's decision to wind down
the related operation. As a result, the Company recorded a loss from impairment
of the goodwill from the Mjuice transaction of $4.5 million. In addition, the
Company determined that there was insufficient basis to support the entire
carrying amount of goodwill associated with the 1999 acquisitions of iMusic and
UBL based upon the projected undiscounted future cash flows related to the
underlying assets of these goodwill amounts. Online advertising and promotions
have been the primary source of revenue derived from these assets, and that
revenue has declined for the nine months ended September 30, 2001, significantly
affecting the value of these assets, and the Company cannot reasonably estimate
if or when these revenue sources will recover. As a result, the Company recorded
a loss from impairment of the goodwill from these transactions of $7.0 million
based on current estimates of discounted cash flows. For the nine months ended
September 30, 2001, the Company recorded an aggregate $11.4 million loss from
impairment of goodwill.
CONCENTRATION OF CREDIT RISK AND SUPPLIER RISK
Financial instruments that potentially subject the Company to significant
concentrations of credit risk consist principally of cash, short term
investments and trade accounts receivable. The Company places its cash and short
term investments in high credit quality instruments. Cash balances at certain
financial institutions may exceed the FDIC insurance limits. The Company
purchases high quality debt instruments. The Company performs ongoing credit
evaluations of its customers but does not require collateral. Exposure to losses
on receivables is principally dependent on each customer's financial condition.
The Company monitors its exposure to credit losses and maintains allowances for
anticipated losses.
The Company purchases a large percentage of its music-related merchandise
inventory from five suppliers. The Company is subject to risk in the event that
any of the suppliers is unable to fulfill customer orders.
FAIR VALUES OF FINANCIAL INSTRUMENTS
The carrying amounts of financial instruments, which include cash and cash
equivalents, cash held for clients, short term investments, accounts receivable,
accounts payable and accrued expenses and loans and notes payable, approximate
fair value because of the short maturity of these instruments.
INVESTMENTS
Investments in affiliated companies in which the Company's voting interest
is 20% to 50%, or in which the Company is able to exert significant influence in
instances where the voting interest is less than 20%, are accounted for under
the equity method of accounting. Under this method, the investment, originally
recorded at cost, is adjusted to recognize the Company's share of the net
earnings or losses of the affiliates as they occur rather than as dividends or
other distributions received. The Company's share of losses is generally limited
to the extent of the Company's investment in, advances to and commitments for
the investee.
F-11
ARTISTDIRECT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
LOSS PER COMMON SHARE
The Company computes net loss per share in accordance with SFAS No. 128,
"Earnings per Share" and Securities and Exchange Commission Staff Accounting
Bulletin No. 98 (SAB 98). SFAS No. 128 requires companies with complex capital
structures to present basic and diluted EPS. Basic EPS is measured as the income
or loss available to common shareholders divided by the weighted average
outstanding common shares for the period. Diluted EPS is similar to basic EPS
but presents the dilutive effect on a per share basis of potential common shares
(e.g. convertible securities, options, etc.) as if they had been converted at
the beginning of the periods presented. Potential common shares that have an
anti-dilutive effect (i.e., those that increase income per share or decrease
loss per share) are excluded from diluted EPS. Dividends to preferred
shareholders and interest on the rescission offer balance are added to the net
loss in determining the net loss attributable to common shareholders. Prior to
the Capital Reorganization on October 6, 1999 (see Note 2), the Company was
organized as a limited liability company and had not issued common stock.
Accordingly, no historical loss per share information is included in the
attached financial statements for periods prior to October 6, 1999.
Included in net loss attributable to common shareholders for the year ended
December 31, 2000 is the effect of the beneficial conversion feature of the
Series C redeemable preferred stock which converted into common shares as of
March 31, 2000 in connection with the initial public offering. The value of the
beneficial conversion feature was calculated based on the $24.00 per share
difference between the initial public offering price of $120.00 and the
effective conversion price of $96.00 multiplied by the 1,015,625 shares of
common stock issued to the Series C shareholders.
The diluted loss per share excludes approximately 760,000, 980,000, 1.0
million and 1.3 million securities as of December 31, 1999 and 2000 and
September 30, 2000 and 2001, respectively, since the impact would be
anti-dilutive.
STOCK-BASED COMPENSATION
The Company accounts for stock-based employee compensation in accordance
with the provisions of Accounting Principles Board ("APB") Opinion No. 25 and
FASB Interpretation No. 44 (FIN 44), "Accounting for Certain Transactions
Involving Stock Compensation," and complies with the disclosure requirements of
SFAS No. 123, "Accounting for Stock-Based Compensation." Under APB No. 25,
compensation expense is recorded based on the difference, if any, between the
fair value of the Company's stock and the exercise price on the measurement
date. The Company accounts for stock issued to non-employees in accordance with
SFAS No. 123, which requires entities to recognize as expense over the service
period the fair value of all stock-based awards on the date of grant and EITF
96-18, "Accounting for Equity Investments that are Issued to Other Than
Employees for Acquiring, or in Conjunction with Selling, Goods or Services",
which addresses the measurement date for such transactions.
The Company recognizes compensation expense related to variable awards in
accordance with FIN 28. For fixed awards, the Company recognizes expense over
the vesting period or the period of service as appropriate.
COMPREHENSIVE LOSS
The Company has no significant components of other comprehensive income,
and accordingly, the comprehensive loss is the same as net loss for all periods
presented.
F-12
ARTISTDIRECT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
ESTIMATES
In preparing financial statements in conformity with generally accepted
accounting principles, management is required to make estimates and assumptions
that affect the reported amounts of assets and liabilities and the disclosures
of contingent assets and liabilities at the date of the financial statements and
revenues and expenses during the reporting period. Actual results could differ
from those estimates.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
The Financial Accounting Standards Board (FASB) recently issued SFAS No.
133, "Accounting for Derivative Instruments and Hedging Activities," which is
effective for all fiscal quarters of all fiscal years beginning after June 15,
2000 (as amended by SFAS No. 137, "Accounting for Derivative Instruments and
Hedging Activities -- Deferral of the Effective date of FASB Statement No. 133")
and SFAS 138, "Accounting for Certain Derivative Instruments and Certain Hedging
Activities," which become effective January 1, 2001. These pronouncements
establish accounting and reporting standards for derivative instruments and
hedging activities by requiring that all derivative instruments be reported as
assets or liabilities and measured at their fair values. Under SFAS 133, changes
in the fair values of derivative instruments are recognized immediately in
earnings unless those instruments qualify as hedges of the (1) fair values of
existing assets, liabilities, or firm commitments, (2) variability of cash flows
of forecasted transactions, or (3) foreign currency exposures on net investments
in foreign operations. The adoption of these pronouncements did not have a
material impact on the consolidated financial statements of the Company.
In December 1999, the Securities and Exchange Commission ("SEC") issued
Staff Accounting Bulletin ("SAB") 101, Revenue Recognition in Financial
Statements. SAB 101 provides guidance on the recognition, presentation, and
disclosure of revenue in financial statements of all public registrants. The
adoption of SAB 101 in the fourth quarter of fiscal 2000 did not have an impact
on the Company's consolidated financial statements.
In May 2000, EITF 00-14, "Accounting for Certain Sales Incentives," was
issued, which provides guidance in the recognition of sales incentives. This
pronouncement, which is effective January 1, 2002, will not have a material
impact on the Company's consolidated financial statements.
In September 2000, EITF 00-22, "Accounting for "Points" and Certain Other
Time-Based or Volume-Based Sales Incentive Offers, and Offers for Free Products
or Services to Be Delivered in the Future," was issued, which provides guidance
on the accounting for membership-based loyalty programs. Certain provisions of
the pronouncement were effective for the quarter ended March 31, 2001. The
implementation of this pronouncement has not, and is not expected to, have a
material impact on the Company's consolidated financial statements.
In September 2000, EITF 00-25, "Vendor Income Statement Characterization of
Consideration from a Vendor to a Retailer," was issued, which provides guidance
on the recognition, presentation and disclosure for arrangements between vendors
and retailers involving consideration. The implementation of this pronouncement
is effective January 1, 2002, and is not expected to have a material impact on
the Company's consolidated financial statements.
In July 2001, FASB issued Statement No. 141, "Business Combinations", and
Statement No. 142, "Goodwill and Other Intangible Assets". Statement 141
requires that the purchase method of accounting be used for all business
combinations initiated after June 30, 2001 as well as all
F-13
ARTISTDIRECT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
purchase method business combinations completed after June 30, 2001. Statement
141 also specifies criteria intangible assets acquired in a purchase method
business combination must meet to be recognized and reported apart from
goodwill. Statement 142 will require that goodwill and intangible assets with
indefinite useful lives no longer be amortized, but instead tested for
impairment at least annually in accordance with the provisions of Statement 142.
Statement 142 will also require that intangible assets with definite useful
lives be amortized over their respective estimated useful lives to their
estimated residual values, and reviewed for impairment in accordance with SFAS
No. 121.
The Company is required to adopt the provisions of Statement 141
immediately and Statement 142 effective January 1, 2002. Furthermore, any
goodwill and any intangible asset determined to have an indefinite useful life
that are acquired in a purchase business combination completed after June 30,
2001 will not be amortized, but will continue to be evaluated for impairment in
accordance with the appropriate pre-Statement 142 accounting literature.
Goodwill and intangible assets acquired in business combinations completed
before July 1, 2001 will continue to be amortized prior to the adoption of
Statement 142.
Statement 141 will require upon adoption of Statement 142, that the Company
evaluate its existing intangible assets and goodwill that were acquired in a
prior purchase business combination, and to make any necessary reclassifications
in order to conform with the new criteria in Statement 141 for recognition apart
from goodwill. Upon adoption of Statement 142, the Company will be required to
reassess the useful lives and residual values of all intangible assets acquired
in purchase business combinations, and make any necessary amortization period
adjustments by the end of the first interim period after adoption. In addition,
to the extent an intangible asset is identified as having an indefinite useful
life, the Company will be required to test the intangible asset for impairment
in accordance with the provisions of Statement 142 within the first interim
period. Any impairment loss will be measured as of the date of adoption and
recognized as the cumulative effect of a change in accounting principle in the
first interim period.
In connection with the transitional goodwill impairment evaluation,
Statement 142 will require the Company to perform an assessment of whether there
is an indication that goodwill (and equity-method goodwill) is impaired as of
the date of adoption. To accomplish this the Company must identify its reporting
units and determine the carrying value of each reporting unit by assigning the
assets and liabilities, including the existing goodwill and intangible assets,
to those reporting units as of the date of adoption. The Company will then have
up to six months from the date of adoption to determine the fair value of each
reporting unit and compare it to the reporting unit's carrying amount. To the
extent a reporting unit's carrying amount exceeds its fair value, an indication
exists that the reporting unit's goodwill may be impaired and the Company must
perform the second step of the transitional impairment test. In the second step,
the Company must compare the implied fair value of the reporting unit's
goodwill, determined by allocating the reporting unit's fair value to all of it
assets (recognized and unrecognized) and liabilities in a manner similar to a
purchase price allocation in accordance with Statement 141, to its carrying
amount, both of which would be measured as of the date of adoption. This second
step is required to be completed as soon as possible, but no later than the end
of the year of adoption. Any transitional impairment loss will be recognized as
the cumulative effect of a change in accounting principle in the Company's
statement of operations.
F-14
ARTISTDIRECT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
As of the date of adoption, the Company expects to have unamortized
goodwill in the amount of $788,000, which will be subject to the transition
provisions of Statements 141 and 142. Amortization expense related to goodwill
was $2.2 million, $3.5 million, $2.5 million and $2.6 million for the years
ended December 31, 1999, 2000 and for the nine months ended September 30, 2000
and 2001, respectively. Because of the extensive effort needed to comply with
adopting Statements 141 and 142, it is not practicable to reasonably estimate
the impact of adopting these Statements on the Company's financial statements at
the date of this report, including whether any transitional impairment losses
will be required to be recognized as the cumulative effect of a change in
accounting principle.
In October 2001, the FASB issued Statement No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets," which addresses financial
accounting and reporting of the impairment or disposal of long-lived assets.
Statement No. 144 supersedes Statement No. 121, however, it retains many of the
fundamental provisions of that Statement. Statement No. 144 also supersedes the
accounting and reporting provisions of Accounting Principles Board No. 30
(Opinion 30), "Reporting the Results of Operations -- Reporting the Effects of
Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently
Occurring Events and Transactions," for the disposal of a segment of a business.
Statement No. 144 is effective January 1, 2002. The Company has not yet
evaluated the impact that the adoption of Statement No. 144 will have on its
financial statements.
F-15
ARTISTDIRECT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
4. SUPPLEMENTAL DISCLOSURES TO CONSOLIDATED STATEMENTS OF CASH FLOWS
Significant non-cash investing and financing activities are reflected in
the following table:
(UNAUDITED)
NINE MONTHS ENDED
YEAR ENDED DECEMBER 31, SEPTEMBER 30,
--------------------------- -------------------
1998 1999 2000 2000 2001
---- ------- -------- -------- -------
(IN THOUSANDS)
Cash paid for acquisitions:
Fair value of net assets acquired... $ -- $ 2,463 $ 5,077 $ 5,025 $ --
Net liabilities assumed............. -- (185) (203) (203) --
Common units/stock issued........... -- (2,168) (2,859) (2,807) --
---- ------- -------- -------- -------
Cash paid for acquisitions..... $ -- $ 110 $ 2,015 $ 2,015 $ --
==== ======= ======== ======== =======
Issuance of common securities for
minority interests in affiliated
companies:
Issuance of common securities....... $ -- $13,922 $ -- $ -- $ --
Acquisition costs -- cash paid...... -- 127 -- -- --
Net assets acquired................. -- (938) -- -- --
---- ------- -------- -------- -------
Goodwill....................... $ -- $13,111 $ -- $ -- $ --
==== ======= ======== ======== =======
Accrual of dividends on redeemable
preferred securities................ $171 $ 1,414 $ 963 $ 963 $ --
Securities subject to potential
rescission offer.................... $114 $ 6,740 $ 3,924 $ 3,388 $ 412
Accretion on redeemable stock......... $ -- $ 184 $ -- $ -- $ --
Issuance/(cancellation) of
options/warrants.................... $ -- $51,202 $ (1,372) $ 1,832 $(1,428)
Appreciation (depreciation) of
variable equity interests........... $ -- $16,470 $ (6,645) $ (6,645) $ --
Conversion of preferred return to
common securities................... $ -- $ 1,122 $ -- $ -- $ --
Issuance of shares to officer......... $ -- $ 875 $ -- $ -- $ --
Notes issued to shareholders.......... $ -- $ 741 $ -- $ -- $ --
Conversion of redeemable common stock
to common stock..................... $ -- $ -- $ 2,352 $ 2,352 $ --
Issuance of stock appreciation
rights/options...................... $ -- $ -- $ 2,992 $ 2,992 $ --
Conversion of redeemable preferred
stock and accrued dividends to
common shares....................... $ -- $ -- $118,688 $118,688 $ --
F-16
ARTISTDIRECT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
5. SHORT TERM INVESTMENTS
The Company's short-term investments consist of the following
held-to-maturity securities:
(UNAUDITED)
DECEMBER 31, 2000 SEPTEMBER 30, 2001
------------------- -------------------
FAIR FAIR
MARKET AMORTIZED MARKET AMORTIZED
VALUE COST VALUE COST
------- --------- ------- ---------
(IN THOUSANDS)
U.S. corporate and bank debt................. $30,361 $30,362 $19,440 $19,942
U.S. government and agencies................. 4,001 4,002 -- --
International corporate and bank debt........ 2,003 2,004 -- --
------- ------- ------- -------
Total investments..................... $36,365 $36,368 $19,440 $19,942
======= ======= ======= =======
All held-to-maturity securities mature within one year.
6. PROPERTY AND EQUIPMENT
Property and equipment are recorded at cost and consist of the following:
DECEMBER 31, (UNAUDITED)
------------------- SEPTEMBER 30,
1999 2000 2001
------ ------- -------------
(IN THOUSANDS)
Computer equipment and software............ $3,559 $ 7,845 $ 8,347
Furniture and fixtures..................... 207 1,747 1,728
Leasehold improvements..................... -- 2,542 2,674
------ ------- -------
3,766 12,134 12,749
Less accumulated depreciation.............. (423) (3,077) (5,738)
------ ------- -------
Property and equipment, net................ $3,343 $ 9,057 $ 7,011
====== ======= =======
7. ALLOWANCE FOR DOUBTFUL ACCOUNTS AND SALES RETURN RESERVE
A summary of the activity of the allowance for doubtful accounts for the
periods indicated is reflected in the following table:
(UNAUDITED)
YEAR ENDED NINE MONTHS ENDED
DECEMBER 31, SEPTEMBER 30,
---------------- ------------------
1999 2000 2000 2001
----- ----- ------ ------
(IN THOUSANDS)
Balance, beginning of period........... $ 81 $ 89 $ 89 $ 389
Provision for doubtful accounts........ 385 653 200 117
Amounts charged off.................... (377) (353) (68) (369)
----- ----- ----- -----
Balance, end of period................. $ 89 $ 389 $ 221 $ 137
===== ===== ===== =====
F-17
ARTISTDIRECT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
A summary of the activity of the reserve for sales returns for the periods
indicated is reflected in the following table:
(UNAUDITED)
YEAR ENDED NINE MONTHS ENDED
DECEMBER 31, SEPTEMBER 30,
---------------- ------------------
1999 2000 2000 2001
----- ----- ------ ------
(IN THOUSANDS)
Balance, beginning of period........... $ 13 $ 34 $ 34 $ 75
Provision for sales returns............ 180 244 544 197
Amounts charged off.................... (159) (203) (198) (267)
----- ----- ----- -----
Balance, end of period................. $ 34 $ 75 $ 380 $ 5
===== ===== ===== =====
8. ACCRUED EXPENSES
Accrued expenses are comprised of the following:
DECEMBER 31, (UNAUDITED)
---------------- SEPTEMBER 30,
1999 2000 2001
------ ------ -------------
(IN THOUSANDS)
Accrued payroll and related..................... $1,470 $1,391 $1,184
Accrued cost of sales........................... 865 1,924 902
Accrued advertising costs....................... 873 170 414
Accrued professional fees....................... 333 317 284
Programming rights.............................. 682 682 --
Other accrued expenses.......................... 475 702 816
------ ------ ------
Total accrued expenses..................... $4,698 $5,186 $3,600
====== ====== ======
9. INVESTMENTS IN AFFILIATED COMPANIES
As of December 31, 1999 and 2000 and September 30, 2001, the Company had a
45% ownership in SnoCore, LLC, and accounts for the investment under the equity
method. The Company recorded income of $50,000, $15,000, $15,000 and $48,000 for
this investment for the years ended December 31, 1999 and 2000 and for the nine
months ended September 30, 2000 and 2001, respectively. The Company received a
$33,000 and a $2,000 distribution of income from the investee during the year
ended December 31, 1999 and the nine months ended September 30, 2001,
respectively. The carrying amount of the investment was $70,000, $85,000 and
$131,000 as of December 31, 1999 and 2000 and September 30, 2001, respectively.
During the year ended December 31, 2000, the Company entered into a joint
venture, Latin America Internet Company, LLC in which the Company holds a 50%
ownership interest. The Company accounts for the investment under the equity
method. The Company made an initial investment of $250,000 during the year ended
December 31, 2000. The Company recorded its share of losses of $250,000 and
$327,000 for this investment for the year ended December 31, 2000 and for the
nine months ended September 30, 2001. The Company may be required to fund an
additional $9.5 million for operations.
F-18
ARTISTDIRECT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
In May 2001, the Company entered into an agreement with veteran
entertainment executive Frederick Field to become Chairman and Chief Executive
Officer of ARTISTdirect and form a new record label in partnership with
ARTISTdirect. The record label is a 50/50 co-venture between ARTISTdirect and
Mr. Field, with the Company providing a significant financial commitment. The
Company is required to provide funding of up to $50 million through June 2006.
As of September 30, 2001, the Company had funded $4.0 million to the record
label. Due to the Company's commitment to fund the operations of the joint
venture, the Company records 100% of the losses of the joint venture. For the
nine months ended September 30, 2001, the Company recorded losses of $3.8
million from the joint venture.
As of December 31, 1998, the Company had an approximate 20% ownership in
iMusic, Inc. The majority owner in iMusic, Inc. had a 76% voting interest. As
the Company was not able to exert significant influence in the management of
iMusic, Inc., the investment was accounted for under the cost method. In
February 1999, the Company acquired all of the outstanding capital stock of
iMusic, Inc. that it did not already own.
10. LINE OF CREDIT
In 1997, the Company obtained a $250,000 line of credit with a financial
institution. The line was increased to $500,000 during 1998, to $2.0 million in
February 1999 and to $5.0 million in November 1999. The line of credit was
guaranteed by certain officers and stockholders of the Company and bore
interest, which is payable monthly, at a base rate as defined in the lending
agreement plus 1%. No balance outstanding on the line of credit as of December
31, 1998 and the line of credit was terminated at the Company's option in
September 1999 and reinstated in October 1999. As of December 31, 1999, there
was no balance outstanding on the line of credit. In March 2000, the line of
credit expired.
11. ACQUISITIONS
In February 1999, the Company acquired the remaining 80% of iMusic, Inc.
that it did not own. The consideration paid for the acquisition included
$110,000 in cash, redeemable common units of UBL equal to 2% of its membership
interests and the assumption of approximately $180,000 of liabilities. The value
of the redeemable common units given was approximately $2.2 million. The
acquisition has been accounted for as a purchase and the operations of iMusic,
Inc. have been included from the date of acquisition. The Company recorded
goodwill of approximately $2.4 million as a result of this acquisition, of which
the remaining net balance of $1.2 million was written off in September 2001.
In May 1999 the Company acquired the 40.29% minority interest in the UBL in
exchange for common interests in ARTISTdirect, LLC. The value of the
consideration given was approximately $13.9 million, which was based on the
value of the equity given, using the pricing of third party equity contributed
at or around the time of the purchase transaction; the transaction has been
accounted for as a purchase. Due to the full funding of the losses of UBL by the
Company and its members prior to the purchase of the minority interest, none of
the losses generated by UBL during the periods presented have been allocated to
the minority holders. The Company recorded goodwill of approximately $13.1
million as a result of this acquisition, of which $5.8 million was written off
in September 2001. The remaining balance at September 30, 2001 was $873,000,
which is being amortized over the remainder of the initial five year period.
F-19
ARTISTDIRECT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
In August 2000, ARTISTdirect acquired all of the outstanding capital stock
of Mjuice.com, Inc., a company involved in the development and distribution of
the secure digital distribution of MP3-formatted music. The Company issued
90,000 of its common shares and common share equivalents in exchange for all the
outstanding equity of Mjuice.com, Inc. The total purchase consideration for
Mjuice.com was approximately $5.1 million, which includes cash paid of
approximately $2.0 million. The acquisition was accounted for as a purchase,
with $5.0 million being recorded as goodwill, of which the remaining net balance
of $4.5 million was written off in March 2001.
The pro forma results of operations assuming the above transactions had
occurred at the beginning of the following periods are as follows:
(UNAUDITED)
YEAR ENDED DECEMBER 31,
-----------------------
1999 2000
-------- -----------
(IN THOUSANDS)
Revenues.......................................... $10,337 $ 21,676
------- ----------
Net loss.......................................... $62,470 $ 62,165
------- ----------
Pro forma loss per share.......................... $ 27.30
----------
Pro forma weighted average shares................. 3,227,325
==========
12. INCOME TAXES
Income taxes differ from the amount computed using a tax rate of 35% as a
result of the following (amounts in thousands):
PERIOD FROM (UNAUDITED)
OCTOBER 6, NINE MONTHS ENDED
1999 TO YEAR ENDED SEPTEMBER 30,
DECEMBER 31, DECEMBER 31, --------------------
1999 2000 2000 2001
------------ ------------ -------- --------
Computed expected tax benefit....... $(8,259) $(20,758) $(14,793) $(16,588)
State and local income taxes, net of
federal income tax benefit........ (977) (3,200) (2,280) (2,405)
FAS 109 implementation.............. (9,227) -- -- --
Goodwill amortization............... 271 1,240 878 1,926
Other............................... 27 (303) 27 15
Increase in valuation allowance..... 18,165 23,021 16,168 17,052
------- -------- -------- --------
Total tax benefit......... $ -- $ -- $ -- $ --
======= ======== ======== ========
F-20
ARTISTDIRECT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets and (liabilities) at December 31, 1999 and
2000 and September 30, 2001 are presented below:
(UNAUDITED)
DECEMBER 31, DECEMBER 31, SEPTEMBER 30,
1999 2000 2001
------------ ------------ -------------
Deferred tax assets:
Net operating loss carryforwards........ $ 4,520 $ 23,165 $ 38,538
Amortization of stock based
compensation......................... 14,296 19,817 21,947
Other................................... 576 1,331 2,176
-------- -------- --------
Total deferred tax assets................. 19,392 44,313 62,661
Less -- valuation allowance............... (18,165) (41,186) (58,238)
-------- -------- --------
Net deferred assets....................... 1,227 3,127 4,423
-------- -------- --------
Deferred tax liability -- state income
taxes................................... (1,227) (3,127) (4,423)
-------- -------- --------
Net deferred tax assets......... $ -- $ -- --
======== ======== ========
At September 30, 2001, the Company had net operating loss carryforwards
totaling approximately $87.9 million for Federal income tax purposes expiring
beginning in 2019 and California state net operating loss carryforwards of $87.9
million expiring beginning in 2007. Due to the uncertainty surrounding the
realization of the benefits of its tax attributes, including net operating loss
carryforwards in future tax returns, the Company has recorded a valuation
allowance against its deferred tax assets as of December 31, 1999 and 2000 and
September 30, 2001 of $18.2 million, $41.2 million and $58.2 million,
respectively.
In assessing the potential realization of deferred tax assets, management
considers whether it is more likely than not that some portion or all of the
deferred tax assets will be realized. The ultimate realization of deferred tax
assets is dependent upon the Company attaining future taxable income during the
periods in which those temporary differences become deductible. In addition,
Internal Revenue Code Section 382 substantially restricts the ability of a
Corporation to utilize existing net operating loss in the event of an "ownership
change." Therefore, the Company's net operating losses for Federal income tax
purposes may be limited due to changes in ownership.
13. SIGNIFICANT CONTRACTS
The Company entered into a settlement agreement with an employee in
connection with the termination of his employment in October 1997. Pursuant to
this agreement, the employee received a severance payment of $175,000, to be
paid out in eight quarterly installments. The amount due under this severance
arrangement was $88,000 as of December 31, 1998. The amount was paid in full in
1999. As part of the settlement agreement, the individual received an option to
purchase the lesser of 10,000 securities or 2.5% of the shares offered to the
public upon an initial public offering at an exercise price that will be set at
the completion of the initial public offering pursuant to the provision defined
in the settlement agreement. The employee exercised the purchase option of
10,000 shares. The Company recorded compensation expense of $1,025,000 for the
year ended December 31, 2000, which represented the difference between the fair
value of the common stock and the amount paid.
In 1998 the Company entered into an employment agreement with an officer of
the Company under which deferred compensation of up to $200,000 was granted. The
value of the deferred compensation was determined based on the value of the
Company as of the payment date. The Company has accrued $200,000 in deferred
compensation.
F-21
ARTISTDIRECT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
For the years ended December 31, 1998, 1999 and 2000 and for the nine
months ended September 30, 2000 and 2001, the Company incurred legal expenses of
approximately $450,000, $1,101,000, $464,000, $384,000 and $254,000,
respectively, for legal services provided by Lenard, Brisbin & Klotz LLP. Allen
Lenard, one of the Company's directors, is Managing Partner of Lenard, Brisbin &
Klotz LLP.
Kneeling Elephant Records, LLC, a subsidiary of the Company, entered into
an agreement with RCA in January 1997. Kneeling Elephant was a record label
managed by the Company. Under the agreement, RCA provided all funding to the
Company for the label and owns the rights to all sound recordings made under
artist agreements during the initial three year term of the agreement. RCA had
an option to terminate its agreement with Kneeling Elephant after three years,
at which point, the assets and properties of Kneeling Elephant would be divided
based on the terms of the agreement. Under the agreement, RCA provided funding
of $300,000 in January 1997, which was recognized ratably over the minimum three
year operating term. Additionally, RCA has provided annual funding of $450,000,
paid on a quarterly basis, to the Company for the operation of Kneeling Elephant
under the terms of the agreement. The original agreement with RCA was extended
through June 30, 2000, at which point it was terminated.
In April 1999, the Company entered into an agreement with a merchandiser
for a term of four years. In exchange for merchandise fulfillment services, the
Company granted the merchandiser warrants to purchase 13,125 shares of common
stock upon the signing of the agreement. Additional warrants to purchase common
stock may be earned by the merchandiser based on the achievement of certain
sales levels, none of which have been reached to date.
In June 1999, the Company entered into an agreement with a merchandiser for
a three-year term. In exchange for merchandise fulfillment services over the
term of the agreement, the Company paid a deposit of $1.0 million which is being
amortized over the term of the agreement, and granted the merchandiser warrants
to purchase 22,842 shares of common stock upon the signing of the agreement.
Additional warrants to purchase common stock may be earned by the merchandiser
based on the achievement of certain sales levels, none of which have been
reached to date. In January 2001, the merchandiser filed for bankruptcy
protection under Chapter 11. Due to uncertainty regarding the ability of the
merchandiser to provide future services, the Company has fully expensed the $1
million deposit as of September 30, 2001.
In November 1999, the Company entered into a three year programming license
agreement with CHUMcity International. The Company was amortizing the license
cost over the contractual license period. In July 2001, the Company terminated
this agreement with CHUMcity.
In December 1999, the Company entered into an eighteen month marketing
agreement with ABC News Internet Ventures. The agreement provides for the
exchange and distribution of content by both parties. As the values of the
content and services being provided by both parties is not readily determinable,
the content and services provided and received by the Company are being recorded
at their cost basis to the Company, which is zero.
In connection with the issuance of Series C Preferred shares, the Company
entered into strategic relationships with four record labels. Under the terms of
these agreements, the Company has the right to purchase certain content related
to each of the respective companies' artists on terms generally made available
to other online music companies. The cost associated with the acquisition of
such content will be expensed as it is acquired and broadcast online.
F-22
ARTISTDIRECT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
In December 1999, the Company entered into an advertising and promotion
agreement with Yahoo! pursuant to which the Company purchased media placement on
Yahoo!. The Company recorded the expense related to the amounts paid to Yahoo!
for advertising and promotion services over the term of the agreement as
services or promotions were received. On November 7, 2000, the Company amended
this agreement such that it was terminated as of December 31, 2000. Yahoo!
delivered certain additional page views containing the Company's banners on
various Yahoo! properties through June 30, 2001. In connection with the original
agreement, the Company issued Yahoo! warrants to purchase 33,926 shares of
common stock. The exercise price for 16,963 of the warrants is $139.28, and the
exercise price for the remaining warrants is $120.00. The expense related to the
warrants was amortized through June 30, 2001 (see discussion of fair value under
"Warrants" in note 15).
The Company entered into an agreement with a landlord for office space for
a term of ten years. In connection with the agreement, the Company issued
warrants to purchase 6,250 shares of common stock at $139.28 per share. The
expense related to the warrants is being amortized over the term of the
agreement. (See discussion of fair value under "Warrants" in note 15).
14. REDEEMABLE SECURITIES
From July through December 1998, the Company issued redeemable preferred
units for proceeds of $4.9 million. These preferred units were converted into
12.8 million Series A ARTISTdirect, LLC redeemable preferred securities pursuant
to the Exchange Transaction, and were converted into 320,782 shares of Series A
Redeemable Preferred Stock (Series A Preferred) pursuant to the Capital
Reorganization and Reverse Stock Splits. The Series A Preferred shares carried a
10% cumulative annual dividend. The liquidation preference and redemption value
of the Series A Preferred shares was approximately $5.0 million as of December
31, 1999. The Series A Preferred shares and accrued dividend were converted to
common shares upon the closing of the initial public offering.
On February 17, 1999, the Company issued 17,044 redeemable common shares
(Redeemable Stock) for the purchase of the remaining 80% of iMusic, Inc. The
holder of the Redeemable Stock had the right to redeem the Redeemable Stock upon
the earlier of an initial public offering or February 17, 2002 at a redemption
value of $2.8 million. The holder chose not to redeem the shares. The accreted
value of $2.4 million was included in redeemable common securities in the
balance sheet as of December 31, 1999 and was converted to common shares upon
the completion of the initial public offering in March 2000.
On May 18, 1999, the Company issued 375,000 Series B redeemable preferred
shares (Series B Preferred) for proceeds of $15 million. The Series B Preferred
shares had the same redemption terms as the Series A Preferred shares, and had
an original conversion price of $40.00 per share. The Series B Preferred shares
had liquidation preference over all other classes of shares. The liquidation
preference and redemption value of the Series B Preferred shares was $15.4
million as of December 31, 1999. The Series B Preferred shares and accrued
dividends were converted to common shares upon the closing of the initial public
offering in March 2000.
In December 1999, the Company issued 590,537 Series C redeemable preferred
shares (Series C Preferred) for proceeds of $82.2 million and in January 2000,
the Company issued an additional 109,492 Series C Preferred shares for proceeds
of $15.2 million. The total sum of $97.5 million was raised through the sale of
shares to six music and media companies which included Universal Music Group,
BMG Entertainment, Sony Music Entertainment, Time Warner Inc., an affiliate of
Cisneros Television Group and Yahoo! The Series C Preferred shares had the same
redemption terms as the
F-23
ARTISTDIRECT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Series A and Series B Preferred shares and had an initial conversion price of
$139.28 per share. The liquidation preference and redemption value as of
December 31, 1999 was $82.3 million. The Series C Preferred shares were
converted to 1,015,625 common shares upon the closing of the initial public
offering. The conversion rate was 1.45 common shares for each Series C Preferred
share based on the offering price and pursuant to the Series C shareholder
agreement.
Included in redeemable common securities are amounts related to options and
securities subject to the Company's rescission offer. The Company issued shares
or options to purchase shares to employees, artists and advisors. The issuance
of these shares or options did not fully comply with certain requirements under
the Securities Act or applicable state securities laws, or available exemptions
thereunder, and as a result the Company is making a rescission offer to all
these persons pursuant to the registration statement filed with this prospectus
under the Securities Act and pursuant to applicable state securities laws.
In the rescission offer, the Company is offering to repurchase from these
persons all shares issued directly to these persons or pursuant to option
exercises by these persons before the expiration of the rescission offer
(regardless of whether the shares have been subsequently sold by the person) for
an amount equal to the purchase or exercise price paid for the shares, plus
interest from the date of purchase until the rescission offer expires, at the
annual rate mandated by the state in which such shares were purchased, or at 7%
per year if a "private placement" exemption was available in a particular state
or if the shares were otherwise issued in compliance with state law (less any
amounts received if the shares have already been sold by the purchaser). The
rescission offer will expire approximately 30 days after the effective date of
the registration statement filed with this prospectus. Based upon the number of
options exercised through September 30, 2001, the out-of-pocket cost to the
Company would be approximately $2.2 million, plus interest of $280,000.
In addition, the Company is also offering to repurchase all unexercised
options granted to these persons (regardless of whether the options have
expired), at 20% of the option exercise price times the number of option shares,
plus interest from the date of grant until the rescission offer expires, at the
annual rate mandated by the state in which such options were granted, or at 7%
per year if a "private placement" exemption was available in a particular state
or if the shares were otherwise issued in compliance with state law. Based on
the number of options outstanding as of September 30, 2001, and assuming that
none of these options are exercised prior to the end of the rescission offer,
the out-of-pocket cost to the Company in repurchasing such options would be
approximately $7.7 million, plus interest of $1.0 million.
The Company has accrued $114,000, $6.7 million, $3.9 million, $3.4 million
and $412,000 related to the rescission offer for the years ended December 31,
1998, 1999 and 2000 and for the nine months ended September 30, 2000 and 2001,
respectively. Of the $11.2 million accrued as of September 30, 2001, $7.7
million represents the accrual for options that are subject to the rescission
offer, $2.2 million represents amounts due as a result of the exercise of
options and $1.3 million represents accrued interest at the applicable statutory
rates.
The amount recorded in "Redeemable securities" for the rescission offer has
been recorded as a reduction from "Members' and stockholders' equity" as the
amount that is potentially due to holders of options and shares subject to the
rescission offer represents a redeemable security, as the redemption feature is
not within the control of the Company.
In the event that a holder of options or shares subject to the rescission
offer does not accept the rescission offer, the holder's right to rescission may
survive the rescission offer.
F-24
ARTISTDIRECT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
15. MEMBERS' AND STOCKHOLDERS' EQUITY
COMMON STOCK
In March 2000, the Company completed an initial public offering in which it
sold 500,000 shares for total proceeds, net of offering costs, of $52.4 million.
In April 2001, the Company completed a tender offer in which it repurchased
200,000 shares of common stock for a total cost of $2.5 million. The repurchased
shares are reflected as treasury stock in the balance sheet as of September 30,
2001.
In May 2001, the Company authorized the purchase of up to $2 million worth
of the Company's common stock. The stock repurchase program is being implemented
through purchases in the open market or in privately negotiated transactions
from time to time depending on market conditions and other factors. As of
September 30, 2001, the Company repurchased 27,528 shares of common stock for an
aggregate purchase price of approximately $163,000. This repurchase is separate
from the Company's tender offer described above, and is reflected as treasury
stock in the balance sheet as of September 30, 2001.
MEMBER DISTRIBUTIONS
The Company made distributions to members of $249,000 and $741,000 in 1998
and 1999, respectively.
VARIABLE EQUITY INTERESTS
During 1998, the Company issued common units, which were converted to
common shares upon the conversion of the Company to a C Corporation in October
1999, to certain executive employees and its outside legal counsel in connection
with services rendered and to be rendered. In January 1998, Keith Yokomoto and
L&G Associates One, an affiliate of Lenard, Brisbin & Klotz LLP, one of the
Company's outside legal counsel, received interests of 10.1% and 3.03%
respectively. In June 1998, Steve Rennie and Robert Morse received interests of
4.04% and 1.01% respectively. The units provided for the holder to share in the
capital of the Company to the extent of increases in the fair value of the
Company subsequent to the issuance of the units (Appreciation Rights). The
Appreciation Rights issued to employees have been accounted for as stock
appreciation rights. The Appreciation Rights issued to the outside legal counsel
were valued at the estimated fair value as determined by the Company and
expensed immediately as they related to past services. Accordingly, the value of
the Appreciation Rights has been adjusted based on changes in the fair value of
the Company. The Company has estimated the fair value based on third party
equity transactions and ultimately on the trading price of the Company's common
shares upon the completion of the initial public offering. The Appreciation
Rights were settled upon the closing of the initial public offering on March 31,
2000. The Company has recognized as stock based compensation expense $3.8
million and $16.3 million for the years ended December 31, 1998 and 1999,
respectively. The Company recorded a credit to stock based compensation in the
amount of $6.6 million for the year ended December 31, 2000 as a result of the
decline in the value of the Company's common shares from December 31, 1999 to
March 31, 2000, the date on which the Appreciation Rights were settled.
WARRANTS
In May and June 1999, the Company issued warrants to purchase 35,967 shares
of common stock at $40.00 per share to two vendors from whom it purchases
merchandise ("merchandisers").
F-25
ARTISTDIRECT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The value of the warrants was $864,000, of which $168,000, $262,000, $196,000
and $196,000 has been recognized as expense for the years ended December 31,
1999 and 2000 and for the nine months ended September 30, 2000 and 2001,
respectively. The value of the warrants is being amortized as cost of revenues
over the term of the related merchandising agreements. All of the warrants,
which expire 5 years from the date of issuance, are exercisable as of September
30, 2001 and none have been exercised. Additionally, the merchandisers may earn
up to 54,546 of additional warrants based on certain performance levels as
specified in the merchandising agreements, none of which have been reached as of
September 30, 2001.
In December 1999, the Company issued warrants to purchase 33,926 shares of
common stock in connection with an advertising and promotion agreement. As of
September 30, 2001, 16,963 of the warrants are exercisable and the remaining
warrants vest in December 2001 and have an exercise price of $120.00 per share.
The value of the warrants upon issuance was $2.0 million, of which $19,000 was
recorded as expense for the year ended December 31, 1999. These warrants were
being accounted for as variable instruments under EITF 96-18 up through June 30,
2001, when performance under the agreement was completed and a measurement date
was reached. Due to the decrease in fair value of the Company's common stock,
the value of the warrants was reduced to $66,000 as of June 30, 2001. The
related expense for the year ended December 31, 2000 was $28,000, and $42,000
and $19,000 for the nine months ended September 30, 2000 and 2001, respectively.
The value of the warrants was amortized through June 30, 2001, the period
through which services were performed. The warrants expire in December 2002.
In January 2000, the Company issued warrants to purchase 6,250 shares of
common stock in connection with an office lease. The warrants, which expire in
January 2005, were exercisable upon grant, and none have been exercised as of
September 30, 2001. The warrants were valued at $568,000, of which $47,000,
$33,000 and $43,000 has been recorded as expense for the year ended December 31,
2000 and for the nine months ended September 30, 2000 and 2001, respectively.
The value of the warrants is being amortized over the term of the related lease.
The estimated fair values of the warrants was determined using the
Black-Scholes model. The key assumptions used in the model for the purpose of
the calculation were: a risk free rate of 6% in 1999 and 6.4% in 2000; a
volatility factor of 81% in 1999, 100% in January 2000, 120% in June 2000 and
180% in September 2001; no expected dividends; and an expected life which is
equal to the contractual life of the warrants.
In August 2000, the Company issued warrants to purchase 1,306 shares of
common stock to various consultants in connection with the acquisition of
Mjuice.com, Inc. These warrants were valued at $34,000 and were accounted for as
part of the purchase price. The warrants have exercise prices ranging from $1.90
to $63.50 per share, and all of the warrants were exercisable as of September
30, 2001.
PREFERRED DIVIDENDS
On May 18, 1999, the Company paid to the Series A redeemable preferred
securities holders the accrued dividends to that date of $355,000 in the form of
8,863 common shares, as well as a cash payment of $85,000.
On October 6, 1999, the Company paid to the Series A and B redeemable
preferred stockholders the accrued dividends to that date of $767,000 in the
form of 21,300 shares of common stock, as well as a cash payment of $191,000.
F-26
ARTISTDIRECT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Upon the conversion of the Series A, B and C Preferred shares to common
shares, accrued dividends of $963,000 were converted into 8,021 common shares.
PURCHASE OF SHARES BY OFFICER
In September 1999, the Company's Chief Financial Officer purchased 11,182
shares of common securities from certain officer stockholders for an aggregate
purchase price of $400,000. The difference between the purchase price and the
fair value of the securities as of the date of the transaction has been
reflected as stock-based compensation. The amount of stock-based compensation
aggregated $875,000 for the year ended December 31, 1999. The Company determined
the fair value of the securities based on the continued growth of the Company's
operations and recent equity transactions with third parties.
EQUITY TRANSFER
In March 2000, the founders of the Company entered into a series of
transactions whereby two employees and an outside legal counsel would receive
the appreciation on the Company's common stock above $139.28 per share through
the third day of trading after the initial public offering. Additionally, the
two employees and outside legal counsel received stock options on the third day
of trading after the initial public offering with an exercise price of $139.28.
There was no expense charge for the appreciation rights and stock options
granted to the two employees, as the stock price was below $139.28 per share on
the third day of trading and the exercise price on the stock options was greater
than the fair value of the Company's common stock on the date of grant. The fair
value of the appreciation rights and stock options granted to the outside legal
counsel was $2,029,000 and was recorded as expense for the year ended December
31, 2000, as the grants related to past services. The stock option grants to the
outside legal counsel are reflected as option grants under the Advisor Plan (see
discussion in note 16).
16. OPTIONS
In July 1998, the Company implemented the 1998 Unit Option Plan (which was
subsequently amended and replaced by the 1999 Employee Stock Option Plan), which
has reserved 725,593 shares of the Company's common stock for issuance to
employees, non-employee members of the board of directors and consultants. This
share reserve automatically increases on the first trading day in January each
calendar year, by an amount equal to two percent (2%) of the total number of
shares of our common stock outstanding on the last trading day of December in
the prior calendar year, but in no event will this annual increase exceed 87,500
shares. No option may have a term in excess of 10 years. The options generally
vest within three years. As of September 30, 2001, 308,040 shares remained
available for future option grant.
The Company accounts for its employee stock option plan in accordance with
the provisions of Accounting Principles Board (APB) Opinion No. 25, "Accounting
for Stock Issued to Employees," Interpretation No. 44, and other related
interpretations. As such, compensation expense would be recorded on the date of
grant only if the current market price of the underlying stock exceeded the
exercise price.
F-27
ARTISTDIRECT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Summary stock option activity for 1999 Employee Stock Option Plan during
the years ended December 31, 1998, 1999 and 2000 and the nine months ended
September 30, 2001 is as follows:
OPTIONS OUTSTANDING
---------------------
WEIGHTED
AVERAGE
NUMBER OF EXERCISE
SHARES PRICE
--------- --------
Outstanding options at December 31, 1997.......... -- $ --
Granted......................................... 35,672 15.20
Exercised....................................... -- --
Canceled........................................ -- --
-------- ------
Outstanding options at December 31, 1998.......... 35,672 15.20
Granted......................................... 344,906 36.00
Exercised....................................... (5,875) 34.00
Canceled........................................ (125) 36.00
-------- ------
Outstanding options at December 31, 1999.......... 374,578 34.06
Granted......................................... 319,709 81.64
Exercised....................................... (3,181) 13.72
Canceled........................................ (124,802) 46.18
-------- ------
Outstanding options at December 31, 2000.......... 566,304 58.36
Granted (unaudited)............................. 35,687 7.50
Exercised (unaudited)........................... -- --
Canceled (unaudited)............................ (193,494) 52.16
-------- ------
Outstanding options at September 30, 2001
(unaudited)..................................... 408,497 $56.86
======== ======
During the year ended December 31, 1999 the Company issued 750 options to
consultants, for services previously performed resulting in a weighted average
fair value per option of $102.67, and a total value of $77,000. The Company
recorded this amount as stock based compensation for the year ended December 31,
1999, as the services had been performed.
In February 2000, the Company accelerated the vesting of 11,480 stock
options granted to an executive of the Company. The resulting compensation
expense of $964,000 which represented the difference between the fair value of
the Company's common stock on the date of modification and the exercise price,
was recorded during the year ended December 31, 2000.
In May 2001, the Company granted an officer non-qualified stock options,
which are not part of any stock option plan maintained by the Company, to
purchase 444,480 shares of common stock at an exercise price of $7.50 per share.
Of the 444,480 option shares, 302,370 are exercisable immediately (the
underlying shares pursuant to the exercise of this portion of the options vest
over five years from the date of the option grant), 75,588 are exercisable in
the event the 30-day average closing price of the Company's common stock on
NASDAQ equals or exceeds $35.00 per share within three years from the grant
date, and 66,522 are exercisable in the event the 30-day average closing price
of the Company's common stock on NASDAQ equals or exceeds $70.00 per share
within three years of the grant date. The two options that are not exercisable
upon grant shall also become exercisable in the event of a de-listing of the
Company's common stock from NASDAQ and
F-28
ARTISTDIRECT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
a subsequent re-listing, a change in control of the Company or an involuntary
termination of the officer (within three years of the date of grant).
In September 2001, the Company granted options to purchase 35,687 shares of
its common stock at an exercise price of $7.50 per share to outside legal
counsel. The fair value of the stock options granted to the outside legal
counsel was $205,000 and was recorded as expense for the nine months ended
September 30, 2001, as the grant related to past services.
If the Company had elected to recognize compensation cost based on the fair
value at the date of grant, consistent with the method as prescribed by SFAS No.
123, net loss for the years ended December 31, 1998, 1999 and 2000 would have
changed to the pro forma amounts indicated below:
(UNAUDITED)
NINE MONTHS ENDED
YEAR ENDED DECEMBER 31, SEPTEMBER 30,
---------------------------- ------------------
1998 1999 2000 2000 2001
------ ------- ------- ------- -------
(IN THOUSANDS)
Net loss:
As reported................. $6,318 $57,804 $59,308 $42,265 $47,393
Pro forma................... $6,334 $58,254 $64,678 $46,069 $52,929
====== ======= ======= ======= =======
The fair value of options granted during 1998 and 1999 was determined using
a minimum value pricing model with the following assumptions: risk-free interest
rate of 6.0% and an expected life of five years. The fair value of options
granted during the year ended December 31, 2000 and the nine months ended
September 30, 2000 and 2001 was determined using a Black-Scholes model with the
following assumptions: risk free rate of 6.38%, a volatility factor of 100% in
2000 and 180% in 2001, no expected dividends and an expected life of five years.
The weighted average fair values of the options per share on the date of grant
were $3.20, $55.60, $58.30, $70.90 and $6.05 for the options granted for the
years ended December 31, 1998, 1999 and 2000 and for the nine months ended
September 30, 2000 and 2001, respectively.
F-29
ARTISTDIRECT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The following table summarizes information regarding options outstanding
and options exercisable at September 30, 2001 (unaudited):
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
-------------------------------- --------------------
WEIGHTED
AVERAGE WEIGHTED WEIGHTED
NUMBER REMAINING AVERAGE NUMBER AVERAGE
OF CONTRACTUAL EXERCISE OF EXERCISE
EXERCISE PRICES SHARES LIFE PRICE SHARES PRICE
--------------- ------- ----------- -------- -------- ---------
$ 7.50 43,687 6.84 $ 7.50 35,687 $ 7.50
12.40 13,362 3.83 12.40 13,362 12.40
20.00 300 6.01 20.00 100 20.00
23.20 5,444 3.83 23.20 5,444 23.20
25.00 550 6.01 25.00 199 25.00
30.00 12,567 6.01 30.00 5,145 30.00
36.00 191,729 4.83 36.00 145,466 36.00
40.00 36,891 5.67 40.00 16,844 40.00
120.00 33,659 5.42 120.00 23,124 120.00
139.30 69,683 5.50 139.30 34,842 139.30
140.00 625 5.32 140.00 625 140.00
--------------- ------- ---- ------- ------- -------
$7.50 - $140.00 408,497 5.28 $ 56.86 280,836 $ 57.43
=============== ======= ==== ======= ======= =======
In June 1999 and as amended in October 1999 and March 2000 the Company
adopted the 1999 Artist and Artist Advisor Stock Option Plan (the Advisor Plan).
The Advisor Plan has reserved 222,500 shares of common stock for issuance to
artists for whom the Company maintains ARTISTchannels and their agents, business
managers, attorneys and other advisors. This share reserve automatically
increases on the first trading day in January each calendar year, by an amount
equal to one percent (1%) of the total number of shares of our common stock
outstanding on the last trading day of December in the prior calendar year, but
in no event will this annual increase exceed 37,500 shares. As of September 30,
2001, 89,617 shares remained available for future option grants. The options
expire seven years from the date of grant. Vesting generally varies between one
to three years, as specifically stated in each advisor's option agreement. In
January 2000, the vesting of certain options was accelerated such that these
options grants vested immediately.
F-30
ARTISTDIRECT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Summary stock option activity for the Advisor Plan options during the years
ended December 31, 1999 and 2000 and for the nine months ended September 30,
2001 is as follows:
OPTIONS OUTSTANDING
---------------------
WEIGHTED
AVERAGE
NUMBER OF EXERCISE
SHARES PRICE
--------- --------
Outstanding Options at December 31, 1998.......... -- --
Granted...................................... 99,956 $ 39.24
Exercised.................................... -- --
Canceled..................................... -- --
-------- -------
Outstanding Options at December 31, 1999.......... 99,956 39.24
Granted...................................... 33,302 139.28
Exercised.................................... (13,547) 40.00
Canceled..................................... (375) 40.00
-------- -------
Outstanding Options at December 31, 2000.......... 119,336 67.05
Granted (unaudited).......................... -- --
Exercised (unaudited)........................ -- --
Canceled (unaudited)......................... -- --
-------- -------
Outstanding options at September 30, 2001
(unaudited)..................................... 119,336 $ 67.05
======== =======
The weighted average fair value of options granted under the Advisor Plan
was $93.40 and $66.50 per option, resulting in a total value for options granted
of $9.7 million and $2.1 million for the years ended December 31, 1999 and 2000,
respectively. Of the $2.1 million in option fair value in 2000, $1.8 million was
expensed immediately, as it related to past services. Consequently, $9.7 million
and $300,000 for 1999 and 2000, respectively, of total value for options granted
has been recorded as unearned compensation in the statement of changes in
members' and stockholders' equity and is being amortized over the term of the
advisors' option agreement.
The following table summarizes information regarding options outstanding
and options exercisable at September 30, 2001 (unaudited):
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
------------------------------ --------------------
WEIGHTED
AVERAGE WEIGHTED WEIGHTED
NUMBER REMAINING AVERAGE NUMBER AVERAGE
OF CONTRACT EXERCISE OF EXERCISE
EXERCISE PRICE SHARES LIFE PRICE SHARES PRICE
---------------- ------- --------- -------- -------- ---------
$ 36.00 18,938 5.03 $ 36.00 18,938 $ 36.00
40.00 67,097 4.98 40.00 65,974 40.00
139.28 33,301 5.48 139.28 33,302 139.28
---------------- ------- ---- ------- ------- -------
$36.00 - $139.28 119,336 5.13 $ 67.05 118,214 $ 67.33
================ ======= ==== ======= ======= =======
In June 1999 and as amended in October 1999, the Company adopted the 1999
Artist Stock Plan (the Artist Option Plan), which has reserved 475,593 shares of
common stock for issuance to artists for whom the Company maintains
ARTISTchannels. This share reserve will automatically increases on the first
trading day in January each calendar year, by an amount equal to two percent
F-31
ARTISTDIRECT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(2%) of the total number of shares of our common stock outstanding on the last
trading day of December in the prior calendar year, but in no event will this
annual increase exceed 87,500 shares. As of September 30, 2001, 217,249 shares
remained available for future option grants. The options expire seven years from
the date of grant. Vesting generally varies between one to three years, as
specifically stated in each artist's option agreement. In January 2000, the
vesting of certain options was accelerated such that these options vested
immediately.
Summary stock option activity for the Artist Option Plan during the years
ended December 31, 1999 and 2000, and for the nine months ended September 30,
2001 is as follows:
OPTIONS OUTSTANDING
---------------------
WEIGHTED
AVERAGE
NUMBER OF EXERCISE
SHARES PRICE
--------- --------
Outstanding Options at December 31, 1998.......... -- --
Granted...................................... 226,406 $ 40.00
Exercised.................................... (11,792) 40.00
Canceled..................................... -- --
------- -------
Outstanding Options at December 31, 1999.......... 214,614 40.00
Granted...................................... 46,938 134.09
Exercised.................................... (24,177) 40.00
Canceled..................................... (15,000) 40.00
------- -------
Outstanding Options at December 31, 2000.......... 222,375 59.86
Granted (unaudited).......................... -- --
Exercised (unaudited)........................ -- --
Canceled (unaudited)......................... -- --
------- -------
Outstanding options at September 30, 2001
(unaudited)..................................... 222,375 $ 59.86
======= =======
The weighted average fair value of the options granted under the Artist
Option Plan was $83.30 and $99.70 per option, resulting in a total value for
options granted of $20.6 million and $4.7 million for the years ended December
31, 1999 and 2000, respectively, which has been recorded as unearned
compensation in the statement of changes in members' and stockholders' equity,
and is being amortized over the service period of the related artist agreements.
The following table summarizes information regarding options outstanding
and options exercisable at September 30, 2001 (unaudited):
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
------------------------------ --------------------
WEIGHTED
AVERAGE WEIGHTED WEIGHTED
NUMBER REMAINING AVERAGE NUMBER AVERAGE
OF CONTRACT EXERCISE OF EXERCISE
EXERCISE PRICE SHARES LIFE PRICE SHARES PRICE
---------------- ------- --------- -------- -------- ---------
$ 40.00 175,437 4.93 $ 40.00 157,114 $ 40.00
120.00 12,500 5.47 120.00 12,500 120.00
139.28 34,438 5.43 139.28 21,734 139.28
---------------- ------- ---- ------- ------- -------
$40.00 - $139.28 222,375 5.04 $ 59.86 191,348 $ 56.51
================ ======= ==== ======= ======= =======
F-32
ARTISTDIRECT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Total compensation expense related to the Advisor Plan and the Artist
Option Plan was $12.4 million, $10.2 million, $8.1 million and $6.6 million for
the years ended December 31, 1999 and 2000 and for the nine months ended
September 30, 2000 and 2001, respectively, of which $1.6 million, $7.3 million,
$6.0 million and $4.5 million, respectively, was included in cost of revenue,
and $10.8 million, $2.9 million, $2.1 million and $2.2 million, respectively,
was included in operating expenses.
The estimated fair values of the options granted under the Advisor Plan and
the Artist Option Plan was determined using the Black-Scholes model. The key
assumptions used in the model for the purpose of the calculation were: a risk
free rate of 6.0%, a volatility factor of 80%, no expected dividends and an
expected life of seven years (the contractual term of the options) for options
granted in 1999; and a risk free rate of 6.4%, a volatility factor ranging from
80% to 150%, no expected dividends and an expected life of seven years (the
contractual term of the options) for options granted in 2000.
For the year ended December 31, 1999, the addition to unearned compensation
related to the grant of equity instruments of $67.7 million was comprised of the
issuance of options under the Artist Option Plan and Advisor Plan with a fair
value of $30.3 million; the issuance of compensatory options granted under the
1999 Employee Stock Option Plan with a fair value of $17.9 million; options
granted to non-employees under the 1999 Employee Stock Option Plan with a fair
value of $77,000; warrants granted to vendors with a fair value of $864,000;
warrants granted for advertising services with a fair value of $2.0 million; and
an increase in the value of the variable equity interests of $16.5 million.
For the year ended December 31, 2000, the reduction to unearned
compensation related to the issuance/cancellation of equity instruments of $1.4
million was comprised of additions of $5.7 million, which were offset by
reductions of $7.1 million. The additions were a result of the grant of options
under the Artist Option Plan and Advisor Plan with a fair value of $4.9 million;
warrants granted to the landlord with a fair value of $568,000; and the issuance
of compensatory options under the 1999 Employee Stock Option Plan with a fair
value of $210,000. The reductions were a result of the cancellation of options
under the Artist Option Plan and Advisor Plan with an unamortized balance of
$1.3 million on the cancellation date; a decrease in the value of the
unamortized portion of the variable equity interest of $600,000; a decrease in
the value of warrants accounted for as variable instruments of $1.9 million; and
the cancellation of unvested compensatory employee options with a remaining
unamortized value of $3.3 million as a result of employee terminations in 2000.
For the nine months ended September 30, 2001, the decrease to unearned
compensation related to the issuance/cancellation of equity instruments of $1.4
million was primarily comprised of the cancellation of unvested compensatory
employee options with a remaining unamortized value of $1.6 million as a result
of employee terminations in 2001, as well as a reduction in the value of
variable warrants of $25,000 from December 31, 2000 to September 30, 2001.
In October 1999, the Company adopted the 1999 Employee Stock Purchase Plan
which has reserved 75,000 shares of common stock for issuance under this plan.
This share reserve automatically increases on the first trading day in January
each calendar year by an amount equal to one percent (1%) of the total number of
our common stock outstanding on the last trading day of December in the prior
calendar year, but in no event will this annual increase exceed 25,000 shares.
Terms of the plan permit eligible employees to purchase common stock through
payroll deduction of up to 15% of each employee's compensation. The accumulated
deductions will be applied to the purchase on shares
F-33
ARTISTDIRECT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
on each semi-annual purchase date at a purchase price per share equal to 85% of
the fair market value per share on the participant's entry date into the
offering period or the semi-annual purchase date, whichever is lower. Pursuant
to the provisions of APB No. 25, shares issued to employees under this plan are
considered noncompensatory. During the year ended December 31, 2000 and the nine
months ended September 30, 2001, the Company issued 6,758 and 2,666 shares of
common stock for total proceeds of $40,000 and $11,000 respectively.
In connection with the acquisition of Mjuice.com, Inc. in August 2000, the
Company assumed the Audio Explosion, Inc. 1998 Stock Option Plan and the
Mjuice.com, Inc. 1999 Stock Option Plan. Options granted to employees,
consultants and directors under these plans were converted into options to
purchase shares of the Company's common stock. Options currently outstanding
vest over periods of up to 48 months from their grant date. Each option shall
terminate 10 years after the date of grant. The value of the options issued by
the Company was included as part of the purchase price.
Summary stock option activity for the Audio Explosion and Mjuice.com Stock
Option Plans during the year ended December 31, 2000 and for the nine months
ended September 30, 2001 is as follows:
OPTIONS OUTSTANDING
---------------------
WEIGHTED
AVERAGE
NUMBER OF EXERCISE
SHARES PRICE
--------- --------
Outstanding options at December 31, 1999.......... -- $ --
Granted......................................... 2,091 29.38
Exercised....................................... -- --
Canceled........................................ (107) 52.39
------ ------
Outstanding options at December 31, 2000.......... 1,984 28.13
Granted (unaudited)............................. -- --
Exercised (unaudited)........................... -- --
Canceled (unaudited)............................ (1,512) 27.51
------ ------
Outstanding options at September 30, 2001
(unaudited)..................................... 472 $30.14
====== ======
The following table summarizes information regarding options outstanding
and options exercisable at September 30, 2001 (unaudited):
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
-------------------------------- --------------------
WEIGHTED
AVERAGE WEIGHTED WEIGHTED
REMAINING AVERAGE AVERAGE
NUMBER CONTRACT EXERCISE NUMBER EXERCISE
EXERCISE PRICE OF SHARES LIFE PRICE OF SHARES PRICE
--------------- --------- --------- -------- --------- --------
$18.70 62 7.38 $18.70 62 $18.70
31.80 410 7.91 31.80 410 31.80
--------------- --- ---- ------ --- ------
$18.70 - $31.80 472 7.84 $30.14 472 $30.14
=============== === ==== ====== === ======
F-34
ARTISTDIRECT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
17. 401(k) PLAN
In February 1999 and as amended in January 2000, the Company adopted the
Cash or Deferred Profit Sharing Plan and Trust under Section 401(k) of the
Internal Revenue Code (the 401(k) Plan). Under the 401(k) Plan, participating
employees may defer a percentage (not to exceed 15%) of their eligible pretax
earnings up to the Internal Revenue Service's annual contribution limit. All
employees of the Company age 21 years or older who complete three months of
service are eligible to participate in the 401(k) Plan. The Company does not
match participants' contributions to the 401(k) Plan. Accordingly, there is no
expense for the years ended December 31, 1999 and 2000 and for the nine months
ended September 30, 2000 and 2001.
18. COMMITMENTS AND CONTINGENCIES
LEASE COMMITMENTS
Future minimum lease payments under operating leases for facilities and
certain equipment, including leases entered into subsequent to December 31,
2000, are as follows as of the years ended December 31 (unaudited):
(IN THOUSANDS)
2001.............................................. $ 1,730
2002.............................................. 1,878
2003.............................................. 1,756
2004.............................................. 1,746
Thereafter........................................ 10,251
-------
Total........................................... $17,361
=======
Rent expense under operating leases for the years ended December 31, 1998,
1999 and 2000 and for the nine months ended September 30, 2000 and 2001 for the
Company was $109,000, $341,000, $1,735,000, $1,253,000 and $1,479,000,
respectively.
EMPLOYMENT CONTRACTS
Future payments under employment contracts, including agreements entered
into subsequent to December 31, 2000, are as follows for the years ended
December 31 (unaudited):
(IN THOUSANDS)
2001.............................................. $2,737
2002.............................................. 1,602
2003.............................................. 1,500
2004.............................................. 1,500
2005.............................................. 1,500
2006.............................................. 750
------
Total........................................... $9,589
======
LITIGATION
The Company is subject to various pending and threatened legal actions,
which arise in the normal course of business. The Company's management believes
that the impact of such litigation will not have a material adverse impact on
its financial position or results of operations.
F-35
ARTISTDIRECT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
19. REPORTABLE SEGMENTS
The Company provides integrated music entertainment products and services
through five reportable segments. The five reportable segments, based upon
management's new basis for identifying segments in January 2001 are ARTISTdirect
Media Group ("Media"), E-Commerce Operations Group ("E-Commerce"), Digital Music
Distribution Group ("Digital Music"), Talent Agency and Live Event Group
("Agency") and Record Label ("Record Label"). The segment information has been
restated for all periods to reflect the new basis for identifying segments.
E-Commerce revenue is generated from the sale of recorded music and
music-related merchandise. Media revenue is generated primarily from the sale of
advertising and sponsorships, both online and offline. Talent agency revenue is
generated from commissions based on the income received by agency clients for
live performances. The Digital Music and the Record Label segments currently are
not generating revenue. Prior to January 1, 2001, the Company had three
reportable segments: music-related Web site operations ("ARTISTdirect Network"),
musical artist booking operations ("Agency") and record label operations
("Record Label"). ARTISTdirect Network generated revenue primarily from the sale
of recorded music and music-related merchandise and from the sale of advertising
on its Web sites. The Agency generated revenue from commissions based on the
income received by agency clients for live performances. The Record Label
generated revenue from advances under an agreement with RCA, which was
terminated in June 2000, and from royalties on sales of recorded music. The
factors for determining reportable segments were based on the distinctive
services and products. Each segment is responsible for executing a unique
marketing and business strategy. The accounting policies of the segments are the
same as those described in the summary of significant accounting policies. The
Company evaluates performance based on EBITDA earnings/loss (earnings or loss
before interest, taxes, depreciation and amortization, stock-based compensation,
loss from impairment of goodwill, amortization of vendor prepaid, interest
income and income (loss) from equity investments). Included in EBITDA are direct
operating expenses for the segment. The following table summarizes the revenue
and EBITDA by segment for the years ended December 31, 1998, 1999 and 2000 and
for the nine months ended September 30, 2000 and 2001.
(UNAUDITED)
NINE MONTHS ENDED
YEAR ENDED DECEMBER 31, SEPTEMBER 30,
----------------------------- -------------------
1998 1999 2000 2000 2001
------- -------- -------- -------- --------
(IN THOUSANDS)
Net Revenue:
E-Commerce............................. $ 1,548 $ 5,282 $ 12,160 $ 7,874 $ 5,651
Media.................................. 552 2,910 6,326 5,016 2,205
Talent Agency.......................... 1,917 1,304 2,946 2,523 738
Digital Music.......................... -- -- -- -- --
Record Label........................... 565 778 244 244 --
------- -------- -------- -------- --------
F-36
ARTISTDIRECT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
NINE MONTHS ENDED
YEAR ENDED DECEMBER 31, SEPTEMBER 30,
----------------------------- -------------------
1998 1999 2000 2000 2001
------- -------- -------- -------- --------
(IN THOUSANDS)
4,582 10,274 21,676 15,657 8,594
EBITDA:
E-Commerce............................. (256) (2,756) (4,103) (3,281) (2,629)
Media.................................. (538) (12,330) (16,015) (9,938) (4,698)
Talent Agency.......................... (629) 22 2,191 1,975 143
Digital Music.......................... -- -- (794) -- (683)
Record Label........................... (464) (257) (262) (203) --
------- -------- -------- -------- --------
(1,887) (15,321) (18,983) (11,447) (7,867)
Corporate.............................. (575) (8,121) (26,866) (20,995) (12,010)
$(2,462) $(23,442) $(45,849) $(32,442) $(19,877)
======= ======== ======== ======== ========
Reconciliation of EBITDA to Net Loss:
EBITDA Per Segments.................... (2,462) (23,442) (45,849) (32,442) (19,877)
Amortization of vendor prepaid......... -- (111) (333) (250) (139)
Amortization of stock-based
compensation........................ (3,828) (32,073) (12,612) (9,266) (9,507)
Depreciation and amortization.......... (59) (2,509) (6,248) (4,315) (5,429)
Loss from impairment of goodwill....... -- -- -- -- (11,444)
Interest income (expense), net......... 29 281 (235) 3,993 3,057
Income/(loss) from equity
investments......................... 2 50 5,969 15 (4,054)
------- -------- -------- -------- --------
Net Loss............................ $(6,318) $(57,804) $(59,308) $(42,265) $(47,393)
======= ======== ======== ======== ========
The following table summarizes assets as of December 31, 1999 and 2000 and
September 30, 2001.
DECEMBER 31,
------------------- SEPTEMBER
1999 2000 30, 2001
------- -------- -------------
(UNAUDITED)
(IN THOUSANDS)
Assets:
Corporate..................................... $78,406 $ 98,857 $68,908
E-Commerce.................................... 8,434 9,394 1,008
Media......................................... 9,137 9,486 3,450
Talent Agency................................. 2,547 768 382
Digital Music................................. -- -- --
Record Label.................................. 76 -- --
------- -------- -------
$98,600 $118,505 $73,748
======= ======== =======
F-37
ARTISTDIRECT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Assets by segment are those assets used in the Company operations in each
segment. Corporate assets are principally made up of cash and cash equivalents,
short-term investments, prepaid expenses, computer equipment, leasehold
improvements and other assets.
20. QUARTERLY RESULTS OF OPERATIONS
The following table sets forth unaudited quarterly results of operations
for the eight most recent quarters ended September 30, 2001. This unaudited
quarterly information has been derived from the Company's unaudited financial
statements and, in the Company's opinion, includes all adjustments, consisting
only of normal recurring adjustments, necessary for a fair presentation of the
information for the periods covered. The operating results for any quarter are
not necessarily indicative of the operating results for any future period.
QUARTER ENDED
-------------------------------------------------------------------------------
DECEMBER 31, MARCH 31, JUNE 30, SEPTEMBER 30, DECEMBER 31, MARCH 31,
1999 2000 2000 2000 2000 2001
------------ --------- --------- ------------- ------------ ---------
(IN THOUSANDS)
Net revenue................. $ 3,840 $ 4,497 $ 5,598 $ 5,562 $ 6,019 $ 3,353
Gross profit (loss)......... (744) (1,850) (527) (1,334) (1,155) (2,050)
Net loss.................... (23,598) (11,187) (14,003) (17,075) (17,043) (17,082)
Net loss attributed to
common shareholders....... (24,297) (36,747) (14,274) (16,921) (17,236) (17,246)
Basic and diluted loss per
share..................... $ (17.14) $ (24.66) $ (3.87) $ (4.45) $ (4.56) $ (4.56)
Weighted average shares
outstanding -- basic and
diluted................... 1,417,746 1,490,151 3,685,255 3,735,556 3,777,331 3,779,608
QUARTER ENDED
-------------------------
JUNE 30, SEPTEMBER 30,
2001 2001
--------- -------------
(IN THOUSANDS)
Net revenue................. $ 2,893 $ 2,348
Gross profit (loss)......... (1,512) (1,903)
Net loss.................... (10,950) (19,361)
Net loss attributed to
common shareholders....... (11,123) (19,557)
Basic and diluted loss per
share..................... $ (3.07) $ (5.48)
Weighted average shares
outstanding -- basic and
diluted................... 3,623,154 3,568,577
F-38
INDEPENDENT AUDITORS' REPORT
To The Board of Directors
iMusic, Inc.:
We have audited the accompanying balance sheets of iMusic, Inc. (the
"Company") as of December 31, 1997 and 1998 and the related statements of
operations, shareholders' equity (deficit) and cash flows for the years then
ended. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of iMusic, Inc. as of December
31, 1997 and 1998 and the results of its operations and its cash flows for the
years then ended in conformity with generally accepted accounting principles.
/s/ KPMG LLP
Los Angeles, CA
May 26, 1999
F-39
IMUSIC, INC.
BALANCE SHEETS
(IN THOUSANDS, EXCEPT FOR SHARE DATA)
DECEMBER 31,
-------------
1997 1998
----- ----
ASSETS
Current assets:
Cash and cash equivalents................................. $ 2 $116
Accounts receivable....................................... 5 65
----- ----
Total current assets................................... 7 181
----- ----
Property and equipment, at cost:
Computer equipment........................................ -- 7
Less accumulated depreciation............................. -- (1)
----- ----
-- 6
----- ----
Total assets........................................... $ 7 $187
===== ====
LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Accounts payable.......................................... $ 11 $ 15
Accrued payroll taxes..................................... 12 27
Due to related party...................................... 52 66
Note payable.............................................. 5 --
----- ----
Total current liabilities.............................. 80 108
Line of credit.............................................. 7 6
----- ----
Total liabilities...................................... 87 114
----- ----
Shareholders' equity (deficit):
Series A convertible preferred stock, $.01 par value.
Authorized 200,000 shares; issued and outstanding
161,364 as of December 31, 1998. Liquidation value of
$100 as of December 31, 1998........................... -- 2
Common stock, $.01 par value. Authorized 1,000,000 shares;
issued and outstanding 545,455 shares as of December
31, 1997 and 1998...................................... 5 5
Additional paid-in capital................................ 15 113
Accumulated deficit....................................... (100) (47)
----- ----
Total shareholders' equity (deficit)................... (80) 73
----- ----
Total liabilities and shareholders' equity............. $ 7 $187
===== ====
See accompanying notes to financial statements.
F-40
IMUSIC, INC.
STATEMENTS OF OPERATIONS
(IN THOUSANDS)
YEAR ENDED
DECEMBER 31,
------------
1997 1998
---- ----
Revenue, net................................................ $ 51 $260
Cost of revenue............................................. 52 115
---- ----
Gross profit.............................................. (1) 145
Operating expenses:
Sales and marketing....................................... 5 33
General and administrative................................ 39 57
---- ----
(Loss) income from operations............................. (45) 55
Interest expense, net....................................... 1 2
---- ----
Net (loss) income......................................... $(46) $ 53
==== ====
See accompanying notes to financial statements.
F-41
IMUSIC, INC.
STATEMENTS OF SHAREHOLDERS' EQUITY (DEFICIT)
(IN THOUSANDS, EXCEPT FOR SHARE DATA)
SERIES A
PREFERRED STOCK COMMON STOCK TOTAL
---------------- ---------------- ADDITIONAL ACCUMULATED SHAREHOLDERS'
SHARES AMOUNT SHARES AMOUNT PAID-IN-CAPITAL DEFICIT EQUITY (DEFICIT)
------- ------ ------- ------ --------------- ----------- ----------------
Balance at December 31,
1996....................... -- $-- 545,455 $ 5 $ 15 $ (54) $(34)
Net loss..................... -- -- -- -- -- (46) (46)
------- --- ------- --- ---- ----- ----
Balance at December 31,
1997....................... -- -- 545,455 5 15 (100) (80)
Net income................... -- -- -- -- -- 53 53
Issuance of preferred
stock...................... 161,364 2 -- -- 98 -- 100
------- --- ------- --- ---- ----- ----
Balance at December 31,
1998....................... 161,364 $ 2 545,455 $ 5 $113 $ (47) $ 73
======= === ======= === ==== ===== ====
See accompanying notes to financial statements.
F-42
IMUSIC, INC.
STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
YEAR ENDED
DECEMBER 31,
------------
1997 1998
---- ----
Cash flows from operating activities:
Net (loss) income......................................... $(46) $ 53
---- ----
Adjustments to reconcile net (loss) income to net cash
provided by (used in) operating activities:
Depreciation........................................... -- 1
Changes in assets and liabilities:
Accounts receivable.................................. 31 (60)
Accounts payable and accrued expenses................ (2) 19
---- ----
Net cash (used in) provided by operating
activities...................................... (17) 13
---- ----
Cash flows from investing activities -- purchase of
equipment................................................. -- (7)
---- ----
Cash flows from financing activities:
Change in due to related party............................ 13 14
Proceeds from (payment on) note payable................... 5 (5)
Payments on line of credit................................ (1) (1)
Issuance of preferred stock............................... -- 100
---- ----
Net cash provided by financing activities......... 17 108
---- ----
Net increase in cash and cash equivalents......... -- 114
Cash and cash equivalents at beginning of year.............. 2 2
---- ----
Cash and cash equivalents at end of year.................... $ 2 $116
==== ====
Supplemental disclosure of cash flow information -- cash
paid during the year for interest......................... $ 1 $ 2
==== ====
See accompanying notes to financial statements.
F-43
IMUSIC, INC.
NOTES TO FINANCIAL STATEMENTS
1. ORGANIZATION
iMusic, Inc. (the "Company") was incorporated as a Washington corporation
in October 1995. The Company operates an Internet Web site that provides
music-related content such as chats, message boards, news, music information and
live performances.
2. SIGNIFICANT ACCOUNTING POLICIES
CASH AND CASH EQUIVALENTS
Cash equivalents consist of temporary investments in short-term securities
with an original maturity date of three months or less.
PROPERTY AND EQUIPMENT
Property and equipment are recorded at cost. Depreciation is provided using
the straight-line method over a useful life of three years.
REVENUE RECOGNITION
The Company generates revenue from the sale of advertisements under
short-term contracts. To date, the duration of the Company's advertising
commitments has generally averaged from one to three months. Advertising revenue
is generally recognized ratably in the period in which the advertisement is
displayed, provided that no significant obligations of the Company remains and
collection of the resulting receivable is probable. The Company's obligations
typically include the guarantee of a minimum number of "impressions" or times
that an advertisement appears in pages viewed by the users of the Company's
online properties. The Company records a reserve for contracts in which the
guarantee of a minimum number of impressions is not expected to be met. There
were no such instances as of December 31, 1997 and 1998.
The Company also generates revenue from a "link" to the Web site of a third
party. Revenue is based on merchandise purchased on the third-party's Web site
by customers utilizing the "link" on the Company's Web site.
ALLOWANCE FOR DOUBTFUL ACCOUNTS
The allowance for doubtful accounts is based on historical experience and
management's evaluation of outstanding accounts receivable at the balance sheet
date. There was no allowance as of December 31, 1997 and 1998.
PRODUCT DEVELOPMENT EXPENSE
Product development expense consists primarily of third-party Internet
development costs and payroll and related expenses for in-house Web site
development costs incurred in the start-up and production of the Company's
content and services.
INCOME TAXES
The Company accounts for income taxes under Statement of Financial
Accounting Standards (SFAS) No. 109, "Accounting for Income Taxes." Under the
asset and liability method of SFAS No. 109, deferred tax assets and liabilities
are recognized for the future tax consequences attributable to differences
between the financial statement carrying amounts of existing assets and
liabilities and
F-44
IMUSIC, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
their respective tax bases. Deferred tax assets and liabilities are measured
using enacted tax rates expected to apply to taxable income in the years in
which those temporary differences are expected to be recovered or settled. Under
SFAS No. 109, the effect on deferred tax assets and liabilities of a change in
tax rates is recognized in income in the period that includes the enactment
date.
IMPAIRMENT OF LONG-LIVED ASSETS
The Company periodically reviews the carrying amounts of long-lived assets
to determine whether current events or circumstances warrant adjustments to such
carrying amounts. An impairment adjustment is necessary in the event the net
book value of such long-lived assets exceeds the future undiscounted cash flows
attributable to such assets. In such an event, the loss is measured by the
amount that the carrying value of such assets exceeds their fair value.
Considerable management judgment is necessary to estimate the fair value of
assets, accordingly, actual results could vary significantly from such
estimates.
CONCENTRATION OF CREDIT RISK AND REVENUES FROM A SINGLE CUSTOMER
Financial instruments that potentially subject the Company to significant
concentrations of credit risk consist principally of cash investments and trade
accounts receivable. The Company places its cash investments in high-credit
quality instruments and, by policy, limits the amount of credit exposure to any
one financial institution. Certain financial instruments potentially subject the
Company to credit risk. The Company performs ongoing credit evaluations of its
customers but does not require collateral. Exposure to losses on receivables is
principally dependent on each customer's financial condition. The Company
monitors its exposure for credit losses and maintains allowances for anticipated
losses.
During the years ended December 31, 1997 and 1998, the Company derived
revenues from a single customer that comprised 50% and 65% of total revenues,
respectively.
FAIR VALUES OF FINANCIAL INSTRUMENTS
The carrying amounts of financial instruments, which include cash, accounts
receivable, accounts payable and accrued expenses, lines of credit and due to
related party, approximate fair value because of the short maturity of these
instruments.
USE OF ESTIMATES
In preparing financial statements in conformity with generally accepted
accounting principles, management is required to make estimates and assumptions
that affect the reported amounts of assets and liabilities and the disclosures
of contingent assets and liabilities at the date of the financial statements and
revenues and expenses during the reporting period. Actual results could differ
from those estimates.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
The Financial Accounting Standards Board issued SFAS No. 130, "Reporting
Comprehensive Income," in June 1997. SFAS No. 130 establishes standards for
reporting and presentation of comprehensive income and its components in a full
set of financial statements. Comprehensive income includes all changes in
shareholders' equity (except those arising from transactions with
F-45
IMUSIC, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
members) and includes net income and net unrealized gains (losses) on
securities. There is no impact on the Company's financial statements as a result
of the implementation of SFAS No. 130.
In June 1997, the Financial Accounting Standards Board issued SFAS No. 131,
"Disclosures About Segments of an Enterprise and Related Information." SFAS No.
131 requires the use of the "management approach" for segment reporting, which
is based on the way the chief operating decision maker organizes segments within
a company for making operating decisions and assessing performance. The adoption
of this statement did not have a material impact on the Company's financial
statement.
In March 1998, the American Institute of Certified Public Accountants
issued Statement of Position ("SOP") No. 98-1, "Software for Internal Use,"
which provides guidance on accounting for the cost of computer software
developed or obtained for internal use. SOP No. 98-1 is effective for financial
statements for fiscal years beginning after December 15, 1998. The adoption of
SOP 98-1 did not have a material impact on the financial statements.
In April 1998, the AICPA issued SOP 98-5, "Reporting on the Costs of
Start-Up Activities." The statement is effective for fiscal years beginning
after December 15, 1998. The statement requires costs of start-up activities and
organization costs to be expensed as incurred. The Company is required to adopt
SOP 98-5 for the year ended December 31, 1999. The adoption of SOP 98-5 is not
expected to have a material impact on the Company's consolidated financial
statements.
The Financial Accounting Standards Board recently issued SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities," which is
effective for all fiscal years beginning after September 15, 1999. SFAS 133
establishes accounting and reporting standards for derivative instruments and
hedging activities by requiring that all derivative instruments be reported as
assets or liabilities and measured at their fair values. Under SFAS 133, changes
in the fair values of derivative instruments are recognized immediately in
earnings unless those instruments qualify as hedges of the (1) fair values of
existing assets, liabilities, or firm commitments, (2) variability of cash flows
of forecasted transactions, or (3) foreign currency exposures on net investments
in foreign operations. As of December 31, 1997 and 1998, the Company has not
entered into any derivative contracts nor does it hold any derivative financial
instruments. Therefore, SFAS 133 does not have a material impact on the
Company's consolidated results of operations, financial position, or cash flows.
3. LINE OF CREDIT
In 1996, the Company obtained a $10,000 line of credit with a financial
institution which is guaranteed by the majority shareholder of the Company. The
credit line bears interest, which is payable monthly, at an index rate plus 1%
(10.25% and 10% at December 31, 1997 and 1998, respectively). The balance
outstanding on the line of credit as of December 31, 1997 and 1998 was $7,000
and $6,000, respectively. The unused balance under the line of credit as of
December 31, 1997 and 1998 was $3,000 and $4,000, respectively.
4. NOTE PAYABLE
In 1997, the Company issued a note payable in the amount of $5,000 that
bore interest at 10% and was repaid in 1998.
F-46
IMUSIC, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
5. RELATED PARTY TRANSACTIONS
A shareholder of the Company has paid expenses on behalf of the Company
during 1996, 1997 and 1998. Additionally, the Company rents office space from
this shareholder. The facility is on a month-to-month lease, and the monthly
rent approximates a fair market rate. Lease payments for the facility for each
of the years ended 1997 and 1998 were $14,000. The amount due to the shareholder
as of December 31, 1997 and 1998 as a result of these transactions was $52,000
and $66,000, respectively.
6. SHAREHOLDERS' EQUITY
In August 1998, the Company issued 161,364 shares of Series A convertible
preferred stock for proceeds of $100,000. The preferred shareholder may convert
the preferred shares into common shares at a ratio based on the issue price per
share plus any accrued and unpaid dividends. The preferred shares shall be
automatically converted to common shares upon an initial public offering or at
such time when 80% of the shares initially issued have been converted to common
shares. The liquidation value of the preferred shares shall be the initial issue
price plus any accrued and unpaid dividends. The preferred shareholder shall
have voting rights as if the preferred shares had been converted to common
shares.
7. INCOME TAXES
There was no income tax provision for the years ended December 31, 1997 and
1998. Income tax expense (benefit) differs from the amount computed by applying
the federal statutory tax rate of 34% to income before income taxes as shown
below. There is no corporate tax in the state of Washington.
YEAR ENDED
DECEMBER 31,
--------------
1997 1998
---- ----
(IN THOUSANDS)
Computed "expected" income tax expense (benefit)....... $(15) $ 18
Change in valuation allowance.......................... 15 (18)
---- ----
Income taxes......................................... $ -- $ --
==== ====
The tax effects of temporary differences that give rise to significant
portions of deferred tax assets as of December 31, 1997 and 1998 are presented
below:
DECEMBER 31,
--------------
1997 1998
---- ----
(IN THOUSANDS)
Deferred tax assets:
Net operating loss carryforwards..................... $ 29 $ 28
Temporary differences -- accounts receivable and
accounts payable.................................. 1 (17)
Valuation allowance.................................. (30) (11)
---- ----
Net deferred tax assets........................... $ -- $ --
==== ====
F-47
IMUSIC, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
The Company has federal net operating loss carryforwards of $82,000 and
$84,000 as of December 31, 1997 and 1998, respectively, that begin to expire in
2003.
In assessing the realizability of deferred tax assets, management considers
whether it is more likely than not that the deferred tax assets will be
realized. The ultimate realization of deferred tax assets is dependent upon the
generation of future taxable income during the periods in which those temporary
differences become deductible. Management considers historical and projected
future taxable income in making this assessment. Management has provided for a
full valuation allowance.
8. COMMITMENTS AND CONTINGENCIES
In February 1999, the Company entered into a lease agreement for its
facilities. Future minimum lease payments under this operating lease are as
follows for the years ended December 31:
(IN THOUSANDS)
1999.............................................. $24
2000.............................................. 26
2001.............................................. 26
2002.............................................. 2
---
$78
===
9. SUBSEQUENT EVENTS
In February 1999, ARTISTdirect, which previously had a 20% ownership in the
Company, acquired all of the remaining outstanding capital stock of the Company.
The purchase consideration for the Company was approximately $2.5 million,
including $110,000 in cash, a redeemable put option valued at approximately $2.2
million and the assumption of approximately $185,000 in liabilities. The
acquisition was accounted for as a purchase. The purchase price has been largely
allocated to goodwill, which will be amortized over five years.
F-48
[ARTISTDIRECT LOGO]
EXHIBIT A TO PROSPECTUS
ELECTION FORM
To: ARTISTdirect, Inc.
5670 Wilshire Boulevard, Suite 200
Los Angeles, California 90036
Attn: James B. Carroll
[Please check the appropriate response below]
The undersigned acknowledges receipt of a final prospectus ("Prospectus")
from ARTISTdirect, Inc., in which ARTISTdirect has offered certain holders of
Common Stock, or options to purchase Common Stock, the right to rescind or
continue their investment (the "Offer"). This Offer must be accepted or rejected
prior to 30 days after the date of the Prospectus.
ACCEPTANCE OF REPURCHASE OFFER
OPTIONS
[ ] All options: The undersigned hereby accepts the offer of ARTISTdirect,
Inc. (the "Company") to repurchase the options for the Company's Common
Stock described below at the repurchase price(s) described below. The
undersigned acknowledges that the Company will pay interest to the
undersigned from the initial grant date of the securities through the
expiration date of the written repurchase offer. Depending on the state
in which the undersigned was granted the options, the undersigned
acknowledges that the Company will pay interest at the following annual
rate: 10% in Arizona or Maryland; 9% in Oregon; 8% in Washington; 7% in
California, Florida, Illinois, Nevada, New Jersey, New York, Tennessee,
Texas or any foreign countries; and 6% in Georgia, Massachusetts or
Michigan.
PER SHARE PER SHARE AGGREGATE TOTAL
NUMBER OF SHARES EXERCISE REPURCHASE REPURCHASE INTEREST REPURCHASE
GRANT DATE UNDERLYING OPTIONS PRICE PRICE PRICE PAYABLE PAYMENT
---------- ------------------ --------- ---------- ---------- -------- ----------
[ ] Some options: The undersigned hereby accepts the Company's offer to
repurchase the options for the Company's Common Stock described below
at the repurchase price(s) described below with respect to such number
of those options as indicated below by the undersigned. The undersigned
acknowledges that the Company will pay interest to the undersigned from
the initial grant date of the securities through the expiration date of
the written repurchase offer. Depending on the state in which the
undersigned was granted the options, the undersigned acknowledges that
the Company will pay interest at the following annual rate: 10% in
Arizona or Maryland; 9% in Oregon; 8% in Washington; 7% in California,
Florida, Illinois, Nevada, New Jersey, New York, Tennessee, Texas or
any foreign countries; and 6% in Georgia, Massachusetts and Michigan.
PER SHARE PER SHARE
NUMBER OF SHARES EXERCISE REPURCHASE NUMBER OF OPTIONS
GRANT DATE UNDERLYING OPTIONS PRICE PRICE TO BE REPURCHASED
---------- ------------------ --------- ---------- -----------------
(Please fill in)
A-1
PURCHASED SHARES
[ ] All purchased shares: The undersigned hereby accepts the Company's
offer to repurchase shares of the Company's Common Stock acquired by
the undersigned upon exercise of options, as described below, at the
repurchase price(s) described below. The undersigned acknowledges that
the Company will pay interest to the undersigned from the purchase date
of the securities through the expiration date of the written repurchase
offer. Depending on the state in which the undersigned acquired the
shares, the undersigned acknowledges that the Company will pay interest
at the following annual rate: 10% in Arizona or Maryland; 9% in Oregon;
8% in Washington; 7% in California, Florida, Illinois, Nevada, New
Jersey, New York, Tennessee, Texas or any foreign countries; and 6% in
Georgia, Massachusetts or Michigan.
PER SHARE PER SHARE AGGREGATE TOTAL
NUMBER OF EXERCISE REPURCHASE REPURCHASE INTEREST REPURCHASE
DATE OF PURCHASE SHARES PURCHASED PRICE PAID PRICE PRICE PAYABLE PAYMENT
---------------- ---------------- ---------- ---------- ---------- -------- ----------
[ ] Some purchased shares: The undersigned hereby accepts the Company's
offer to repurchase shares of the Company's Common Stock acquired by
the undersigned upon exercise of options, as described below, at the
repurchase price(s) described below with respect to such number of
those shares as indicated below by the undersigned. The undersigned
acknowledges that the Company will pay interest to the undersigned from
the purchase date of the securities through the expiration date of the
written repurchase offer. Depending on the state in which the
undersigned acquired the shares, the undersigned acknowledges that the
Company will pay interest at the following annual rate: 10% in Arizona
or Maryland; 9% in Oregon; 8% in Washington; 7% in California, Florida,
Illinois, Nevada, New Jersey, New York, Tennessee, Texas or any foreign
countries; and 6% in Georgia, Massachusetts and Michigan.
PER SHARE PER SHARE
NUMBER OF EXERCISE REPURCHASE NUMBER OF SHARES
DATE OF PURCHASE SHARES PURCHASED PRICE PAID PRICE TO BE REPURCHASED
---------------- ---------------- ---------- ---------- -----------------
(Please fill in)
A-2
PURCHASED SHARES SUBSEQUENTLY SOLD
[ ] The undersigned hereby accepts the Company's offer to refund the
purchase price of the shares of the Company's Common Stock acquired by
the undersigned upon exercise of options, and subsequently sold by the
undersigned, as described below, at the refund amount described below
(which amount is less the amount received by the undersigned upon the
undersigned's sale of the shares) with respect to such number of those
shares as indicated below by the undersigned. The undersigned
acknowledges that the Company will pay the difference between (a) the
original purchase price paid by the undersigned for the shares plus
interest on the original purchase price from the purchase date of the
securities through the expiration date of the written repurchase offer
and (b) the amount previously received by the undersigned for the
shares. Depending on the state in which the undersigned acquired the
shares, the undersigned acknowledges that the Company will pay interest
at the following annual rate: 10% in Arizona or Maryland; 9% in Oregon;
8% in Washington; 7% in California, Florida, Illinois, Nevada, New
Jersey, New York, Tennessee, Texas or any foreign countries; and 6% in
Georgia, Massachusetts and Michigan. THE UNDERSIGNED HAS ENCLOSED A
COPY OF THE CONFIRMATION OF SALE OF SUCH SHARES AND HAS COMPLETED AND
INITIALED THE AFFIDAVIT OF SOLD STOCK CERTIFICATE BELOW.
PER SHARE
NUMBER OF EXERCISE NUMBER OF PER SHARE NUMBER OF SHARES
DATE OF PURCHASE SHARES PURCHASED PRICE PAID SHARES SOLD SALES PRICE FOR WHICH REFUND SOUGHT
---------------- ---------------- ---------- ---------------- ---------------- -----------------------
(Please fill in) (Please fill in) (Please fill in)
TO THE EXTENT YOU ACCEPT THE REPURCHASE OFFER FOR YOUR OPTIONS OR PURCHASED
SHARES, YOU AGREE YOU WILL CEASE TO HAVE ANY FURTHER RIGHT, TITLE OR INTEREST IN
THOSE OPTIONS OR PURCHASED SHARES AND ANY SUBSEQUENT APPRECIATION IN THE VALUE
OF THE SHARES UNDERLYING SUCH OPTIONS OR SUCH PURCHASED SHARES. DEFINED TERMS
USED HEREIN AND NOT DEFINED SHALL HAVE THE MEANINGS ASCRIBED TO SUCH TERMS IN
THE WRITTEN REPURCHASE OFFER.
REJECTION OF REPURCHASE OFFER
[ ]The undersigned acknowledges receipt of the Company's repurchase offer
but expressly and irrevocably rejects the repurchase offer.
A-3
AFFIDAVIT OF SOLD STOCK CERTIFICATE
By his or her initials below, the undersigned hereby represents, warrants,
and covenants that he or she previously owned shares ("Shares") of the
Company's Common Stock represented by Stock Certificate Number
("Certificate"). On , 200 , the undersigned sold Shares and
surrendered for transfer the Certificate in such transaction. The undersigned
agrees, in consideration of the refund received from the Company's repurchase
offer, to indemnify and hold harmless the Company, its officers, directors,
employees and agents, and the successors and assigns of any such persons or
entities, from and against any and all claims, actions, and suits, whether
groundless or otherwise, and any and all liabilities, loss, damage, costs,
charges, attorney's fees, and other expenses of every nature and character
arising from, or incurred in connection with, said sold Shares and said
transferred Certificate.
Please initial
WITHHOLDING TAXES
If the undersigned is a current or former employee of the Company and
accepts the repurchase offer, the Company is required to withhold tax at the
applicable tax rate on payments of interest to holders of shares and on payments
of principal plus interest to holders of options. If the undersigned is a
current or former employee of the Company, he or she must complete the attached
Form W-4 and return it to the Company along with this Election Form. The
undersigned will not receive any payments until the Company receives his or her
Form W-4.
Dated: --------------------------------------
Signature of Offeree
--------------------------------------
Print Name
Offeree's Tax Identification
or Social Security Number:
--------------------------------------
Address of Offeree:
--------------------------------------
--------------------------------------
--------------------------------------
A-4
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION
The following table sets forth the various expenses and costs expected to
be incurred in connection with the sale and distribution of the securities being
registered. All of the amounts shown are estimated except the registration fee
of the Commission.
ITEM AMOUNT
---- -----------
SEC registration fee....................................... $ 10,134.06
Blue sky fees and expenses................................. $ 25,000.00
Printing and engraving expenses............................ $100,000.00
Legal fees and expenses.................................... $150,000.00
Accounting fees and expenses............................... $ 50,000.00
Miscellaneous.............................................. $ 5,710.34
-----------
Total............................................ $340,844.40
===========
ITEM 14. INDEMNIFICATION OF DIRECTORS AND OFFICERS
ARTISTdirect, Inc. (the "Registrant") is a Delaware corporation. Article VI
of the Registrant's Bylaws provides that the Registrant may indemnify its
officers and Directors to the full extent permitted by law. Section 145 of the
General Corporation Law of the State of Delaware (the "GCL") provides that a
Delaware corporation has the power to indemnify its officers and directors in
certain circumstances.
Subsection (a) of Section 145 of the GCL empowers a corporation to
indemnify any director or officer, or former director or officer, who was or is
a party or is threatened to be made a party to any threatened, pending or
completed action, suit or proceeding, whether civil, criminal, administrative or
investigative (other than an action by or in the right of the corporation),
against expenses (including attorneys' fees), judgments, fines and amounts paid
in settlement actually and reasonably incurred in connection with such action,
suit or proceeding provided that such director or officer acted in good faith
and in a manner reasonably believed to be in or not opposed to the best
interests of the corporation, and, with respect to any criminal action or
proceeding, provided that such director or officer had no cause to believe his
or her conduct was unlawful.
Subsection (b) of Section 145 of the GCL empowers a corporation to
indemnify any director or officer, or former director or officer, who was or is
a party or is threatened to be made a party to any threatened, pending or
completed action or suit by or in the right of the corporation to procure a
judgment in its favor by reason of the fact that such person acted in any of the
capacities set forth above, against expenses actually and reasonably incurred in
connection with the defense or settlement of such action or suit, provided that
such director or officer acted in good faith and in a manner reasonably believed
to be in or not opposed to the best interests of the corporation, except that no
indemnification may be made in respect of any claim, issue or matter as to which
such director or officer shall have been adjudged to be liable to the
corporation unless and only to the extent that the Court of Chancery or the
court in which such action was brought shall have determined that despite the
adjudication of liability such director or officer is fairly and reasonably
entitled to indemnity for such expenses which the court shall deem proper.
Section 145 of the GCL further provides that to the extent a director or
officer of a corporation has been successful in the defense of any action, suit
or proceeding referred to in subsections (a) and (b) or in the defense of any
claim, issue or matter therein, he or she shall be indemnified against
II-1
expenses (including attorneys' fees) actually and reasonably incurred by him or
her in connection therewith; that indemnification provided for by Section 145
shall not be deemed exclusive of any other rights to which the indemnified party
may be entitled; and that the corporation shall have power to purchase and
maintain insurance on behalf of a director or officer of the corporation against
any liability asserted against him or her or incurred by him or her in any such
capacity or arising out of his or her status as such whether or not the
corporation would have the power to indemnify him or her against such
liabilities under Section 145.
The Registrant carries directors' and officers' liability insurance
covering its directors and officers.
Insofar as indemnification for liabilities under the Securities Act may be
permitted to directors, officers or persons controlling the Registrant pursuant
to the foregoing provisions, the Registrant has been informed that, in the
opinion of the Commission, such indemnification is against public policy as
expressed in the Securities Act and is therefore unenforceable.
ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES
The following is a summary of the transactions by the Registrant and
ARTISTdirect LLC, predecessor to the Registrant, within the past three years,
involving sales of the Registrant's securities that were not registered under
the Securities Act. All of the numbers reflect the 35-for-1 forward unit split
that occurred in May 1999 with respect to common and preferred securities of
ARTISTdirect, LLC, but do not reflect the one-for-four reverse stock split of
the Registrant that occurred on March 21, 2000 or the one-for-ten reverse stock
split of the Registrant that occurred on July 5, 2001.
(a) In January 1998, ARTISTdirect, LLC issued 4,014,107 common securities
to one of the founders of the Registrant, Keith Yokomoto, and 1,204,232
common securities to L&G Associates One, in connection with services
rendered and to be rendered. L&G Associates One is affiliated with
Allen Lenard, one of the Registrant's directors.
(b) In June 1998, ARTISTdirect, LLC issued 1,605,643 common securities to
Steve Rennie and 401,411 common securities to Robert Morse in
connection with services rendered and to be rendered.
(c) Throughout 1998, ARTISTdirect, LLC periodically issued additional
common securities, for no additional consideration, to Messrs.
Yokomoto, Rennie and Morse and L&G Associates One. In connection with
each of these issuances, Marc Geiger and Don Muller, the other two
founders of the Registrant, contributed the same number of common
securities to ARTISTdirect, LLC, for no consideration.
(d) In July 1998, the Registrant issued 200,705 shares of common securities
to each of Messrs. Geiger and Muller in exchange for their interests in
ARTISTdirect Holdings, L.L.C.
(e) Between July 1998 and December 1998, ARTISTdirect, LLC issued a total
of 9,458,340 Series A preferred securities for an aggregate purchase
price of $2,910,000 to several outside investors, including affiliates
of Constellation Venture Capital, L.P., Chase Capital Partners, Psilos
Group Partners, DreamMedia Internet Ventures and Carl Kawabe.
(f) In May 1999, ARTISTdirect, LLC issued a total of 13,982,207 common
securities and 3,372,920 Series A preferred securities to the members
of UBL, LLC in exchange for the 8,042,134 common securities and
1,940,000 preferred securities of UBL held by such members.
(g) In May 1999, ARTISTdirect, LLC issued a total of 15,000,000 Series B
preferred securities for an aggregate purchase price of $15,000,000 to
several outside investors, including affiliates of Constellation
Venture Capital, L.P. Psilos Group Partners, L.P., Chase Venture
Capital
II-2
Associates, L.P., Flatiron Fund 1998/99, LLC, Spinnaker Technology
Fund, LP, and Toronto Dominion Investments, Inc. In connection with
this transaction, holders of ARTISTdirect, LLC's Series A preferred
securities received an aggregate of 354,526 common securities of
ARTISTdirect, LLC and $85,000 in exchange for accrued and unpaid
preferred returns on their Series A preferred securities.
(h) In June 1999, ARTISTdirect, LLC issued Winterland Concessions a warrant
to purchase 342,640 shares of our common stock at a price of $4.00 per
share. ARTISTdirect, LLC also issued Giant Merchandising warrants to
purchase a total of 562,500 shares of our common stock at a price of
$4.00 per share.
(i) In December 1999 and January 2000, the Registrant issued a total of
7,000,291 shares of Series C preferred stock for an aggregate purchase
price of $97.5 million to several outside investors, including
affiliates of Universal Music Group, Inc., Cisneros Television Group,
Sony Music, BMG Music, Time Warner Inc., Maverick Recording Company and
Yahoo!.
(j) In December 1999, the Registrant issued Yahoo! a warrant to purchase an
aggregate of 339,254 shares of common stock at an exercise price of
$13.928 per share with respect to half of the shares and an exercise
price of $11.00 per share with respect to the remaining half of the
shares.
(k) In March 2000, the Registrant issued 5670 Wilshire, L.P. a warrant to
purchase 62,500 shares of common stock at an exercise price of $13.92
per share.
(l) In May 2001, the Registrant granted three non-plan, non-qualified stock
options to Frederick Field, its Chairman of the Board and Chief
Executive Officer, to purchase up to an aggregate of 4,444,800 shares
of common stock at an exercise price of $0.75 per share.
None of the foregoing transactions involved any public offering, and the
Registrant believes that at the time of each transaction, the transaction was
exempt from the registration requirements of the Securities Act by virtue of
Section 4(2) thereof. The recipients in each such transaction represented their
intention to acquire the securities for investment only and not with a view to
or for sale in connection with any distribution thereof, and appropriate legends
were affixed to the share certificates and instruments, as applicable, issued in
such transactions. All recipients had adequate access, through their
relationships with the Registrant, to information about the Registrant.
II-3
From August 1, 1998 to September 30, 2001, the Registrant granted options
to purchase an aggregate of 1,587,055 shares of common stock to its directors,
executive officers, employees, artists and consultants at a weighted average
exercise price of $41.78. As of September 30, 2001, the Registrant has
outstanding options to purchase shares of common stock as follows:
NUMBER
EXERCISE PRICE OF SHARES
--------------- -----------
$ 7.50 488,167
$ 12.40 13,362
$ 20.00 300
$ 23.20 5,444
$ 25.00 550
$ 30.00 12,567
$ 36.00 210,667
$ 40.00 279,425
$120.00 46,159
$139.28 137,422
$140.00 625
--------------- ---------
$7.50 - $140.00 1,194,688
=============== =========
At the time these options were issued under the Registrant's various stock
option plans, the Registrant believed that each of the issuances was exempt from
the registration requirements of the Securities Act either by virtue of (i) the
exemption provided by Rule 701 for securities offered under compensatory benefit
plans and contracts or (ii) a "no-sale" theory under Section 5 of the Securities
Act of 1933, since none of the optionees provided any consideration for the
grants (the sale of the underlying option shares occurs only when the option is
exercised and the purchase price for the shares is paid to the Registrant).
Rule 701 was amended in April 1999 to revise, among other things, the
category of persons who will qualify as consultants for purposes of securities
issued pursuant to such rule. As a result, the Registrant believes that a number
of artists and other non-employees who were granted options under the
Registrant's plans may no longer qualify as consultants under amended Rule 701
and that the Rule 701 exemption may no longer be available for the options
granted to those individuals. In addition, the Registrant believes that the
aggregate dollar amount of the offering represented by the options granted under
the Registrant's stock option plans may have exceeded the applicable limits set
forth in Rule 701. Because the Registrant does not wish to rely solely on a
"no-sale" theory for these option grants, the Registrant is making a rescission
offer with respect to the unexercised options and shares of its common stock
issued pursuant to the exercise of options. The details of this rescission offer
are summarized on pages 9-10 of the prospectus contained in this registration
statement.
In August 2000, the Registrant acquired all the outstanding capital stock
of Mjuice.com, Inc. for 900,000 shares of the Registrant's common stock, options
and warrants. The Registrant relied on Section 3(a)(10) of the Securities Act
for an exemption from the registration requirements of the Security Act when
these securities are issued.
II-4
ITEM 16. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a) EXHIBITS
The following Exhibits are attached hereto and incorporated herein by
reference.
EXHIBIT
NUMBER DESCRIPTION
--------- -----------
3.1* Amended and Restated Certificate of Incorporation of the
Registrant.
3.2* Amended and Restated Bylaws of the Registrant.
3.3(1) Certificate of Amendment of the Third Amended and Restated
Certificate of Incorporation.
4.1* See Exhibits 3.1 and 3.2 for provisions of the Registrant's
Certificate of Incorporation and Bylaws determining the
rights of holders of the Registrant's common stock. See
Exhibit 10.8 for the rights of holders of registration
rights.
4.2* Specimen common stock certificate.
4.3(2) Registration Rights Letter Agreement dated May 31, 2001
between the Registrant and Frederick W. Field.
5.1** Opinion of Brobeck, Phleger & Harrison LLP.
10.1+* Agreement dated as of November 15, 1996, between the RCA
Records Label and the Registrant.
10.3+* BMI Music Performance Agreement for the UBL, dated October
9, 1998.
10.5* Settlement Agreement and Mutual General Release, dated as of
October 23, 1997, between William Elson, on the one hand,
and the Registrant, MGE, LLC, Marc Geiger and Donald Muller,
on the other hand.
10.6+* Database, On-Line Internet Retail Store and Consumer Direct
Fulfillment Services Agreement, dated as of August 15, 1998,
between AEC One Stop Group, Inc. and the UBL, as amended.
10.7* Securities Purchase Agreement, dated July 28, 1998, among
the Registrant, the UBL, Constellation Venture Capital, L.P.
and Constellation Ventures (BVI), Inc.
10.8* Third Amended and Restated Registration Rights Agreement,
dated as of November 12, 1999, among the Registrant and the
other parties who are signatories thereto, as amended.
10.9* UBL Exchange, Contribution and Distribution Agreement, dated
May 18, 1999.
10.10* Exchange Agreement, dated February 17, 1999, by and among
the UBL, Scott Blum and Eric Benjamin.
10.11* Contingent Loan Agreement, dated February 17, 1999, by and
between the UBL and Scott Blum.
10.12* Letter Agreement, dated February 17, 1999, between the UBL
and Scott Blum regarding bonuses to cover interest
obligations under the Contingent Loan Agreement.
10.13* Issuance, Noncompetition and Nonsolicitation Agreement,
dated as of January 1, 1996, between the Registrant and
Keith Yokomoto.
10.14* Issuance Agreement, dated as of January 1, 1998, between the
Registrant, Marc Geiger, Donald Muller, and L&G Associates
One.
10.15* Issuance, Noncompetition and Nonsolicitation Agreement,
dated as of June 30, 1998, between the Registrant and Steve
Rennie.
10.16* Deferred Compensation Agreement, dated as of April 1, 1998,
by and between Keith Yokomoto and the Registrant dated July
1, 1998.
10.17* Employment Agreement, dated as of January 1, 1998, between
Keith Yokomoto and the Registrant.
10.19* Employment Agreement, dated as of July 28, 1998, between
Marc Geiger and the Registrant.
10.20* Employment Agreement, dated as of July 28, 1998, between Don
Muller and the Registrant.
10.21* 1999 Employee Stock Purchase Plan.
10.22* 1999 Employee Stock Option Plan.
10.23* 1999 Artist and Artist Advisor Stock Option Plan.
10.24* 1999 Artist Stock Option Plan.
II-5
EXHIBIT
NUMBER DESCRIPTION
--------- -----------
10.25+* Agreement to license Pandesic E-business Solution Service
between Pandesic LLC, AD and UBL.
10.26+* ADNM Merchandiser Agreement, dated as of April 1, 1999,
between Giant Merchandising and ARTISTdirect New Media, LLC.
10.27+* ADNM Merchandiser Agreement, dated as of June 7, 1999,
between Winterland Concessions Company and ARTISTdirect New
Media, LLC.
10.28+* UBL Merchandiser Agreement, dated as of April 1, 1999,
between Giant Merchandising and ARTISTdirect New Media, LLC.
10.29* Form of Directors Indemnification Agreement
10.30* Form of Officers Indemnification Agreement
10.31* Audio Sample License Agreement dated as of December 20, 1999
between the Registrant and Maverick Recording Company.
10.32+* Internet Video License Agreement dated as of December 20,
1999 between the Registrant and Maverick Recording Company.
10.33+* Webcasting Transmission License Agreement dated as of
December 20, 1999 between the Registrant and Maverick
Recording Company.
10.34+* Strategic Marketing Agreement dated as of December 20, 1999
between the Registrant and Maverick Recording Company.
10.35+* Audio Sample License Agreement dated as of December 20, 1999
between the Registrant and Warner Music Group Inc.
10.36+* Internet Video License Agreement dated as of December 20,
1999 between the Registrant and Warner Music Group Inc.
10.37+* Webcasting Transmission License Agreement dated as of
December 20, 1999 between the Registrant and Warner Music
Group Inc.
10.38+* Strategic Marketing Agreement dated as of December 20, 1999
between the Registrant and Warner Music Group Inc.
10.39* Strategic Marketing Agreement dated as of December 6, 1999
between the Registrant and Universal Music Group, Inc.
10.40+* ARTISTdirect -- Cisneros Television Group Memorandum of
Understanding dated as of November 15, 1999 between the
Registrant and Lakeport Overseas Ltd.
10.41+* Strategic Licensing Agreement dated as of December 6, 1999
between the Registrant and Sony Music.
10.42* Strategic Marketing Agreement dated as of December 20, 1999
between the Registrant and BMG Music.
10.43+* Advertising and Promotion Agreement dated as of December 24,
1999 between the Registrant and Yahoo! Inc.
10.45* Form of Series C Preferred Stock Purchase Agreement.
10.46* Warrant dated December 24, 1999, issued to Yahoo!
10.47* 5670 Wilshire Boulevard Office Lease, as amended.
10.48(3) Operating Agreement of ARTISTdirect Records, LLC dated May
31, 2001 by and among ARTISTdirect Records, LLC,
ARTISTdirect Recordings, Inc. and Radar Records Holdings,
LLC.
10.49(4) Loan and Security Agreement dated May 31, 2001 by and
between ARTISTdirect Records, LLC and ARTISTdirect
Recordings, Inc.
10.50(5) Employment Agreement dated May 31, 2001 by and between the
Registrant and Frederick W. Field.
10.51(6) Employment Agreement dated May 31, 2001 by and between
ARTISTdirect Records, LLC and Frederick W. Field.
10.52(7) Letter Agreement dated May 31, 2001 by and among the
Registrant, ARTISTdirect Records, LLC, ARTISTdirect
Recordings, Inc., Frederick W. Field and Radar Records
Holdings, LLC.
10.53** Agreement to Extend Initial Period of Employment, dated as
of April 27, 2001, between Marc Geiger and the Registrant.
10.54** Amendment to Employment Agreement, dated as of July 1, 2001,
between Marc Geiger and the Registrant.
II-6
EXHIBIT
NUMBER DESCRIPTION
--------- -----------
10.55** Employment Agreement, dated as of July 1, 2001, between
Keith Yokomoto and the Registrant.
10.56+ Hosting and Development Agreement, dated August 14, 2001,
between CNP, Inc. (formerly Amplified Holdings, Inc.) and
the Registrant.
10.57+ Agreement dated as of July 19, 2000 between the Registrant
and Ticketmaster Online-City Search, Inc.
21.1 Subsidiaries of the Registrant.
23.1 Consent of Brobeck, Phleger & Harrison LLP (included in
Exhibit 5.1).
23.2 Consent of KPMG LLP with respect to ARTISTdirect, LLC and
subsidiaries.
23.3 Consent of KPMG LLP with respect to iMusic, Inc.
24.1** Powers of Attorney.
99.1(8) 1999 Employee Stock Option Plan (As Amended and Restated
Through March 21, 2000).
99.2(8) 1999 Employee Stock Purchase Plan (As Amended and Restated
Through March 21, 2000).
99.3(9) Mjuice.com, Inc. 1999 Stock Option Plan, as assumed by
Registrant.
99.4(9) Audio Explosion, Inc. 1998 Stock Option Plan, as assumed by
Registrant.
99.5(10) Offer to Purchase, dated February 26, 2001.
-------------------------
* Incorporated by reference to the same exhibit in the Registrant's
Registration Statement on Form S-1 initially filed on September 22, 1999,
as amended by Amendment No.'s 1 - 7 thereto.
** Previously filed.
(1) Incorporated by reference to the same exhibit in the Registrant's Quarterly
Report on Form 10-Q filed on August 14, 2001.
(2) Incorporated by reference to Exhibit 3 filed in connection with the
Registrant's Definitive Proxy Statement on June 11, 2001.)
(3) Incorporated by reference to Appendix B filed in connection with the
Registrant's Definitive Proxy Statement on June 11, 2001.
(4) Incorporated by reference to Appendix C filed in connection with the
Registrant's Definitive Proxy Statement on June 11, 2001
(5) Incorporated by reference to the same exhibit in the Registrant's
Registration Statement on Form S-8 filed on August 27, 2001.
(6) Incorporated by reference to Exhibit 2 filed in connection with the
Registrant's Definitive Proxy Statement on June 11, 2001.
(7) Incorporated by reference to Exhibit 4 filed in connection with the
Registrant's Definitive Proxy Statement on June 11, 2001.
(8) Incorporated by reference to the same exhibits in the Registrant's
Registration Statement on Form S-8 filed on May 31, 2000.
(9) Incorporated by reference to the same exhibits in the Registrant's
Registration Statement on Form S-8 filed on January 4, 2001.
(10) Incorporated by reference to Exhibit (a)(1)(A) filed in connection with the
Registrant's Schedule TO-I on February 26, 2001.
+ Confidential treatment is requested for certain confidential portions of
this exhibit pursuant to Rule 406 under the Securities Act. In accordance
with Rule 406, these confidential portions will be omitted from this
exhibit and filed separately with the Commission.
II-7
ITEM 17. UNDERTAKINGS
1. Insofar as indemnification for liabilities arising under the Securities
Act may be permitted to directors, officers and controlling persons of the
Registrant pursuant to the foregoing provisions, or otherwise, the Registrant
has been advised that in the opinion of the Commission such indemnification is
against public policy as expressed in the Securities Act and is, therefore,
unenforceable. In the event that a claim for indemnification against such
liabilities (other than the payment by the Registrant of expenses incurred or
paid by a director, officer or controlling person of the Registrant in the
successful defense of any action, suit or proceeding) is asserted by such
director, officer or controlling person in connection with the securities being
registered, the Registrant will, unless in the opinion of its counsel the matter
has been settled by controlling precedent, submit to a court of appropriate
jurisdiction the question whether such indemnification by it is against public
policy as expressed in the Securities Act and will be governed by the final
adjudication of such issue.
2. The undersigned Registrant hereby undertakes that:
(a) For purposes of determining any liability under the Securities
Act, the information omitted from the form of prospectus filed as part of
this Registration Statement in reliance upon Rule 430A and contained in the
form of prospectus filed by the Registrant pursuant to Rule 424(b)(1) or
(4) or 497(h) under the Securities Act shall be deemed to be part of this
Registration Statement as of the time it was declared effective.
(b) For the purpose of determining any liability under the Securities
Act, each post-effective amendment that contains a form of prospectus shall
be deemed to be a new registration statement relating to the securities
offered therein, and the offering of such securities at that time shall be
deemed to be the initial bona fide offering thereof.
II-8
SIGNATURES
Pursuant to the requirements of the Securities Act, the Registrant has duly
caused this Amendment No. 4 to the Registration Statement to be signed on its
behalf by the undersigned, thereunto duly authorized, in the City of Los
Angeles, State of California, on the 14th day of November, 2001.
ARTISTDIRECT, INC.
By: /s/ FREDERICK W. FIELD
------------------------------------
Frederick W. Field
Chief Executive Officer and
Chairman of the Board of Directors
Pursuant to the requirements of the Securities Act, this Amendment No. 4 to
the Registration Statement has been signed by the following persons in the
capacities and on the dates indicated.
SIGNATURE TITLE DATE
--------- ----- ----
/s/ FREDERICK W. FIELD Chief Executive Officer November 14, 2001
----------------------------------------------------- and Chairman of the Board
Frederick W. Field of Directors (Principal
Executive Officer)
MARC P. GEIGER* President, ARTISTdirect November 14, 2001
----------------------------------------------------- Artist Services, and Vice-
Marc P. Geiger Chairman of the Board of
Directors
KEITH K. YOKOMOTO* Chief Operating Officer, November 14, 2001
----------------------------------------------------- President and Director
Keith K. Yokomoto
/s/ JAMES B. CARROLL Executive Vice President November 14, 2001
----------------------------------------------------- and Chief Financial
James B. Carroll Officer (Principal
Financial and Accounting
Officer)
ALLEN D. LENARD* Director November 14, 2001
-----------------------------------------------------
Allen D. Lenard
CLIFFORD H. FRIEDMAN* Director November 14, 2001
-----------------------------------------------------
Clifford H. Friedman
STEPHEN M. KRUPA* Director November 14, 2001
-----------------------------------------------------
Stephen M. Krupa
II-9
SIGNATURE TITLE DATE
--------- ----- ----
BENJAMIN MOODY* Director November 14, 2001
-----------------------------------------------------
Benjamin Moody
DARA KHOSROWSHAHI* Director November 14, 2001
-----------------------------------------------------
Dara Khosrowshahi
*Power of attorney
By: /s/ JAMES B. CARROLL
------------------------------------
James B. Carroll
Attorney-in-Fact
II-10
EXHIBIT INDEX
EXHIBIT
NUMBER DESCRIPTION
--------- -----------
3.1* Amended and Restated Certificate of Incorporation of the
Registrant.
3.2* Amended and Restated Bylaws of the Registrant.
3.3(1) Certificate of Amendment of the Third Amended and Restated
Certificate of Incorporation.
4.1* See Exhibits 3.1 and 3.2 for provisions of the Registrant's
Certificate of Incorporation and Bylaws determining the
rights of holders of the Registrant's common stock. See
Exhibit 10.8 for the rights of holders of registration
rights.
4.2* Specimen common stock certificate.
4.3(2) Registration Rights Letter Agreement dated May 31, 2001
between the Registrant and Frederick W. Field.
5.1** Opinion of Brobeck, Phleger & Harrison LLP.
10.1+* Agreement dated as of November 15, 1996, between the RCA
Records Label and the Registrant.
10.3+* BMI Music Performance Agreement for the UBL, dated October
9, 1998.
10.5* Settlement Agreement and Mutual General Release, dated as of
October 23, 1997, between William Elson, on the one hand,
and the Registrant, MGE, LLC, Marc Geiger and Donald Muller,
on the other hand.
10.6+* Database, On-Line Internet Retail Store and Consumer Direct
Fulfillment Services Agreement, dated as of August 15, 1998,
between AEC One Stop Group, Inc. and the UBL, as amended.
10.7* Securities Purchase Agreement, dated July 28, 1998, among
the Registrant, the UBL, Constellation Venture Capital, L.P.
and Constellation Ventures (BVI), Inc.
10.8* Third Amended and Restated Registration Rights Agreement,
dated as of November 12, 1999, among the Registrant and the
other parties who are signatories thereto, as amended.
10.9* UBL Exchange, Contribution and Distribution Agreement, dated
May 18, 1999.
10.10* Exchange Agreement, dated February 17, 1999, by and among
the UBL, Scott Blum and Eric Benjamin.
10.11* Contingent Loan Agreement, dated February 17, 1999, by and
between the UBL and Scott Blum.
10.12* Letter Agreement, dated February 17, 1999, between the UBL
and Scott Blum regarding bonuses to cover interest
obligations under the Contingent Loan Agreement.
10.13* Issuance, Noncompetition and Nonsolicitation Agreement,
dated as of January 1, 1996, between the Registrant and
Keith Yokomoto.
10.14* Issuance Agreement, dated as of January 1, 1998, between the
Registrant, Marc Geiger, Donald Muller, and L&G Associates
One.
10.15* Issuance, Noncompetition and Nonsolicitation Agreement,
dated as of June 30, 1998, between the Registrant and Steve
Rennie.
10.16* Deferred Compensation Agreement, dated as of April 1, 1998,
by and between Keith Yokomoto and the Registrant dated July
1, 1998.
10.17* Employment Agreement, dated as of January 1, 1998, between
Keith Yokomoto and the Registrant.
10.19* Employment Agreement, dated as of July 28, 1998, between
Marc Geiger and the Registrant.
EXHIBIT
NUMBER DESCRIPTION
--------- -----------
10.20* Employment Agreement, dated as of July 28, 1998, between Don
Muller and the Registrant.
10.21* 1999 Employee Stock Purchase Plan.
10.22* 1999 Employee Stock Option Plan.
10.23* 1999 Artist and Artist Advisor Stock Option Plan.
10.24* 1999 Artist Stock Option Plan.
10.25+* Agreement to license Pandesic E-business Solution Service
between Pandesic LLC, AD and UBL.
10.26+* ADNM Merchandiser Agreement, dated as of April 1, 1999,
between Giant Merchandising and ARTISTdirect New Media, LLC.
10.27+* ADNM Merchandiser Agreement, dated as of June 7, 1999,
between Winterland Concessions Company and ARTISTdirect New
Media, LLC.
10.28+* UBL Merchandiser Agreement, dated as of April 1, 1999,
between Giant Merchandising and ARTISTdirect New Media, LLC.
10.29* Form of Directors Indemnification Agreement.
10.30* Form of Officers Indemnification Agreement.
10.31* Audio Sample License Agreement dated as of December 20, 1999
between the Registrant and Maverick Recording Company.
10.32+* Internet Video License Agreement dated as of December 20,
1999 between the Registrant and Maverick Recording Company.
10.33+* Webcasting Transmission License Agreement dated as of
December 20, 1999 between the Registrant and Maverick
Recording Company.
10.34+* Strategic Marketing Agreement dated as of December 20, 1999
between the Registrant and Maverick Recording Company.
10.35+* Audio Sample License Agreement dated as of December 20, 1999
between the Registrant and Warner Music Group Inc.
10.36+* Internet Video License Agreement dated as of December 20,
1999 between the Registrant and Warner Music Group Inc.
10.37+* Webcasting Transmission License Agreement dated as of
December 20, 1999 between the Registrant and Warner Music
Group Inc.
10.38+* Strategic Marketing Agreement dated as of December 20, 1999
between the Registrant and Warner Music Group Inc.
10.39* Strategic Marketing Agreement dated as of December 6, 1999
between the Registrant and Universal Music Group, Inc.
10.40+* ARTISTdirect -- Cisneros Television Group Memorandum of
Understanding dated as of November 15, 1999 between the
Registrant and Lakeport Overseas Ltd.
10.41+* Strategic Licensing Agreement dated as of December 6, 1999
between the Registrant and Sony Music.
10.42* Strategic Marketing Agreement dated as of December 20, 1999
between the Registrant and BMG Music.
10.43+* Advertising and Promotion Agreement dated as of December 24,
1999 between the Registrant and Yahoo! Inc.
10.45* Form of Series C Preferred Stock Purchase Agreement.
10.46* Warrant dated December 24, 1999, issued to Yahoo!
10.47* 5670 Wilshire Boulevard Office Lease, as amended.
10.48(3) Operating Agreement of ARTISTdirect Records, LLC dated May
31, 2001 by and among ARTISTdirect Records, LLC,
ARTISTdirect Recordings, Inc. and Radar Records Holdings,
LLC.
EXHIBIT
NUMBER DESCRIPTION
--------- -----------
10.49(4) Loan and Security Agreement dated May 31, 2001 by and
between ARTISTdirect Records, LLC and ARTISTdirect
Recordings, Inc.
10.50(5) Employment Agreement dated May 31, 2001 by and between the
Registrant and Frederick W. Field.
10.51(6) Employment Agreement dated May 31, 2001 by and between
ARTISTdirect Records, LLC and Frederick W. Field.
10.52(7) Letter Agreement dated May 31, 2001 by and among the
Registrant, ARTISTdirect Records, LLC, ARTISTdirect
Recordings, Inc., Frederick W. Field and Radar Records
Holdings, LLC.
10.53** Agreement to Extend Initial Period of Employment, dated as
of April 27, 2001, between Marc Geiger and the Registrant.
10.54** Amendment to Employment Agreement, dated as of July 1, 2001,
between Marc Geiger and the Registrant.
10.55** Employment Agreement, dated as of July 1, 2001, between
Keith Yokomoto and the Registrant.
10.56+ Hosting and Development Agreement, dated August 14, 2001,
between CNP, Inc. (formerly Amplified Holdings, Inc.) and
the Registrant.
10.57+ Agreement dated as of July 19, 2000 between the Registrant
and Ticketmaster Online -- City Search, Inc.
21.1 Subsidiaries of the Registrant.
23.1 Consent of Brobeck, Phleger & Harrison LLP (included in
Exhibit 5.1).
23.2 Consent of KPMG LLP with respect to ARTISTdirect, LLC and
subsidiaries.
23.3 Consent of KPMG LLP with respect to iMusic, Inc.
24.1** Powers of Attorney.
99.1(8) 1999 Employee Stock Option Plan (As Amended and Restated
Through March 21, 2000).
99.2(8) 1999 Employee Stock Purchase Plan (As Amended and Restated
Through March 21, 2000).
99.3(9) Mjuice.com, Inc. 1999 Stock Option Plan, as assumed by
Registrant.
99.4(9) Audio Explosion, Inc. 1998 Stock Option Plan, as assumed by
Registrant.
99.5(10) Offer to Purchase, dated February 26, 2001.
-------------------------
* Incorporated by reference to the same exhibit in the Registrant's
Registration Statement on Form S-1 initially filed on September 22, 1999,
as amended by Amendment No.'s 1 - 7 thereto.
** Previously filed.
(1) Incorporated by reference to the same exhibit in the Registrant's Quarterly
Report on Form 10-Q filed on August 14, 2001.
(2) Incorporated by reference to Exhibit 3 filed in connection with the
Registrant's Definitive Proxy Statement on June 11, 2001.)
(3) Incorporated by reference to Appendix B filed in connection with the
Registrant's Definitive Proxy Statement on June 11, 2001.
(4) Incorporated by reference to Appendix C filed in connection with the
Registrant's Definitive Proxy Statement on June 11, 2001
(5) Incorporated by reference to the same exhibit in the Registrant's
Registration Statement on Form S-8 filed on August 27, 2001.
(6) Incorporated by reference to Exhibit 2 filed in connection with the
Registrant's Definitive Proxy Statement on June 11, 2001.
(7) Incorporated by reference to Exhibit 4 filed in connection with the
Registrant's Definitive Proxy Statement on June 11, 2001.
(8) Incorporated by reference to the same exhibits in the Registrant's
Registration Statement on Form S-8 filed on May 31, 2000.
(9) Incorporated by reference to the same exhibits in the Registrant's
Registration Statement on Form S-8 filed on January 4, 2001.
(10) Incorporated by reference to Exhibit (a)(1)(A) filed in connection with the
Registrant's Schedule TO-I on February 26, 2001.
+ Confidential treatment is requested for certain confidential portions of
this exhibit pursuant to Rule 406 under the Securities Act. In accordance
with Rule 406, these confidential portions will be omitted from this
exhibit and filed separately with the Commission.