SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
|X| Annual Report Under Section 13 or 15(d) of the Securities Exchange Act of
1934. For the fiscal year ended December 31, 2005
OR
[ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934. For the transition period from ___________ to ____________
Commission File Number 001-13469
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MEDIABAY, INC.
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(Exact Name of Registrant as Specified in Its Charter)
Florida 65-0429858
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(State or other jurisdiction of (IRS employer identification no.)
incorporation or organization)
2 Ridgedale Avenue
Cedar Knolls, NJ 07927
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(Address of principal executive offices) (Zip Code)
973-539-9528
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(Registrant's Telephone Number, Including Area Code)
Securities registered pursuant to Section 12(b) of the Act: None
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Securities registered pursuant to Section 12(g) of the Act:
Common Stock
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(Title of Class)
Indicate by check mark if the registrant is a well-know seasoned issuer, as
defined in Rule 405 of the Securities Act.
[ ] Yes |X| No
Indicate by check mark if the registrant is not required to file reports
pursuant to Section 13 or Section 15(d) of the Act.
[ ] Yes |X| No
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports) and (2) has been subject to such filing
requirements for the past 90 days. |X| Yes [ ] No Indicate by check mark if
disclosure of delinquent filers pursuant to Item 405 of Regulation
S-K(ss.229.405 of this chapter) is not contained herein, and will not be
contained, to the best of registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-K
or any amendment of this Form 10-K. |X| Indicate by check mark whether the
registrant is a large accelerated filer, an accelerated filer, or a
non-accelerated filer. See definition of "accelerated filer and large
accelerated filer" in Rule 12b2 of the Exchange Act. (Check one):
Large accelerated filer [ ] Accelerated Filer [ ] Non-accelerated filer |X|
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Act). |_| Yes |X| No
The aggregate market value of the voting and non-voting common equity held
by non-affiliates of the Registrant, computed by reference to the last reported
sale price at which the common stock was sold on June 30, 2005 (the last
business day of the Registrant's most recently completed second fiscal quarter)
was approximately $19,900,000. As of March 29, 2006, there were 10,516,444
shares of the Registrant's Common Stock outstanding.
Documents Incorporated by Reference:
None
MEDIABAY, INC.
Form 10-K
Table of Contents
ITEM I 3
Item 1. Business 3
Item 1A. Risk Factors 10
Item 2. Properties 18
Item 3. Legal Proceedings 18
Item 4. Submission of Matters to a Vote of Security Holders 18
PART II 19
Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and
Issuer Purchases of Equity Securities 19
Item 6. Selected Financial Data 19
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations 21
Item 7A. Quantitative and Qualitative Disclosures About Market Risk 46
Item 8. Financial Statements and Supplementary Data 46
Item 9. Changes in and Disagreements With Accountants on Accounting and
Financial Disclosure 46
Item 9A. Controls and Procedures 46
Item 9B. Other Information 46
PART III 47
Item 10. Directors and Executive Officers of the Registrant 47
Item 11. Executive Compensation 50
Item 12. Security Ownership of Certain Beneficial Owners and Management and
Related Stockholder Matters 55
Item 13. Certain Relationships and Related Transactions 57
Item 14. Principal Accountant Fees and Services 60
PART IV 61
Item 15. Exhibits, Financial Statements Schedules, and Reports on Form 8-K 61
PART I
Item 1. Business
Forward-looking Statements
Certain statements in this Form 10-K and in the documents incorporated by
reference in this Form 10-K constitute "forward-looking" statements within the
meaning of the Private Securities Litigation Reform Act of 1995. All statements
other than statements of historical facts included in this report, including,
without limitation, statements regarding our future financial position, business
strategy, budgets, projected costs and plans and objectives of our management
for future operations are forward-looking statements. In addition,
forward-looking statements generally can be identified by the use of
forward-looking terminology such as "may," "will," "expect," "intend,"
"estimate," "anticipate," "believe," or "continue" or the negative thereof or
variations thereon or similar terminology. Although we believe that the
expectations reflected in such forward-looking statements are reasonable, we
cannot assure you that such expectations will prove to be correct. These forward
looking statements involve certain known and unknown risks, uncertainties and
other factors which may cause our actual results, performance or achievements to
be materially different from any results, performances or achievements expressed
or implied by such forward-looking statements. Important factors that could
cause actual results to differ materially from our expectations, include,
without limitation our ability to implement our new strategy and transition our
business and the risks related thereto: our history of losses and declining
revenues; our ability to license and sell new spoken word content, obtain
additional financing, anticipate and respond to changing customer preferences,
license and produce desirable content, protect our databases and other
intellectual property from unauthorized access, and collect receivables;
dependence on third-party providers, suppliers and distribution channels;
competition; the costs and success of our marketing strategies, product returns,
member attrition; and risks relating to our capital structure. Undue reference
should not be placed on these forward-looking statements, which speak only as of
the date hereof. We undertake no obligation to update any forward-looking
statements.
Introduction
We are a digital media and publishing company specializing in spoken audio
entertainment, such as audio readings of books, newspapers, magazines, original
productions and radio broadcast transcripts, each of which audio readings is
referred to as a title. We offer thousands of audio titles, comprising over
75,000 hours of aggregate audio content, which we distribute via mail order, our
websites and some of the nation's largest retailers. Our titles can be purchased
in digital format via Internet downloads through subscription services at a flat
monthly fee for a specified number of titles per month, and/or on a per title,
or a la carte, basis. Our titles can also be obtained in hard copy format, such
as CDs and cassettes.
We have two principal content libraries; (1) audiobooks which we sell via
digital download and on compact disc and cassette, through Soundsgood.com, the
Audio Book Club and third-party websites; and (2) an archive of the history of
American radio which we produce and sell on compact disc and cassettes through
our catalog, a mail order based continuity program, retail outlets, and our
on-line download subscription service and third-party websites. We broadcast our
radio programs through a syndicated radio show on approximately 200 commercial
stations across the United States, as well as its 24-hour Radio Classics
channels on Sirius and XM Satellite Radio.
3
We are transitioning our business from selling hard goods primarily via
mail order to digital distribution via wireless and Internet downloads. Our
distribution strategy is two pronged: (1) to wholesale our audio content to the
leading music services, broadband portals, cell phone and satellite radio
companies, both domestically and internationally; and (2) to operate our own
downloadable content stores and subscription services which are co-branded via
partnerships with celebrities and corporate affiliates, each chosen specifically
to reach the targeted demographics known to be interested in its content. In
addition to our growing list of marketing partners, we intend to use various
means to market our downloadable content stores, including marketing to our
existing customer list of approximately 2.5 million audiobook buyers that
participated in the Audio Book Club or have purchased from Radio Spirits, as
well as working with manufacturers of digital music players, smart phones, and
PDAs to include samples of our audio content for consumers to preview when they
purchase these new devices, with the hope that these samples will attract
consumers to our content stores.
In October 2005, we launched our new digital storefront and technology
platform, www.Soundsgood.com. Soundsgood.com is a fully enabled digital download
service that offers thousands of digital audiobooks, classic radio shows and
other spoken word audio content on a per title basis or as part of a monthly
subscription. The service offers users audio content that can be downloaded
directly to the users' personal computers, burned to CD or transferred to any
Window's Media compatible device that plays secured WMA (Windows Media Audio)
files. There are over 70 digital devices on the market today that are compliant
with Microsoft Corporation's PlaysforSure"(TM) digital rights management and
device platform, which means they can play WMA formatted digital files, and we
are working closely with Microsoft Corporation to ensure that our content works
seamlessly on these devices and the many new smart cellular phones that will run
the new Windows Mobile 5.0 operating system.
To expand the digital distribution of our audio content, we executed an
exclusive distribution agreement with Microsoft's MSN Music to provide our
spoken word content to the MSN audience, which has 350 million unique monthly
visitors, a content distribution agreement with Real Networks, which operates
Rhapsody, the largest music subscription service in the United States, and a
distribution agreement with Music Net, a business-to-business digital music
service provider, to serve as its exclusive spoken word content aggregator. We
have also executed distribution agreements for our growing library of classic
radio ring tones with Infospace, MobileStreams, Jamster and DotPhoto. These
distributors place the ringtones with the following service providers: Nextel,
Verizon, Alltell, T-Mobile Alltel, nTelos, Midwest Wireless, Verizon Wireless
and Verizon Wireless Puerto Rico services.
We have acquired the rights to distribute digital audiobooks from
substantially all of the major publishing houses in the United States and have a
growing number of titles with various international rights of distribution. Our
content library consists of all genres of audiobooks, classic American radio
shows, educational courses, university lectures, theatre plays, self improvement
courses, television soundtracks, stand-up comedy, children's storytelling,
parenting advice and study guides.
Our digital content partners include BBC, Blackstone, Brilliance Audio,
CBS Radio, Harper Collins, Hay House, Oasis, Penguin Group USA Audio, Random
House, Simon & Schuster, Sound Room Publishers, Time Warner Audio and Zondervan.
In addition to Audio Book Club, we distribute our content through proprietary
web sites soundsgood.com and radiospirits.com, as well as through partner
channels including MSN Music, Sirius Satellite Radio and XM Satellite Radio.
We have also begun to produce a series of exclusive audio works in
partnership with large publishing companies such as John Wiley to produce a
series of Audio Cliffs Notes, and the Hindustan Times to produce and distribute
a daily audio newspaper. We anticipate that this production effort will grow if
these initial projects are successful.
4
Strategy
In response to the music industry's recent success in creating a market
for legal digital downloads using digital rights management solutions that are
intended to prevent piracy of copyrighted content, we intend to become a leading
distributor of downloadable or streaming, spoken word audio entertainment for
the mobile marketplace. We intend to build this new distribution channel by
utilizing our nearly twelve years of experience operating the Audio Book Club
and our old-time radio business. During those twelve years, we have serviced
approximately 2.9 million customer accounts and plan to leverage this list of
audio buyers to attract new digital shoppers.
We intend to use the Windows Media Digital Rights Management (DRM) system,
and other easy to use, rights management technologies that may evolve over time
for the cellular marketplace. Beginning this past Christmas season, 70 new
digital devices that support the Microsoft "PlaysforSure(TM)" digital rights
management platform became available for sale by many of the leading device
manufacturers. Examples of companies offering a "PlaysforSure(TM)" device
include Hewlett Packard, Dell, Creative, Rio, i-River and Samsung. Many of these
devices have large file storage capacities and support the playback of our
content. Typically our content is one half hour in length for our classic radio
shows, to an average of 6 to 10 hours for an audiobook.
In addition, the rapid evolution of cell and smart phones with hard drives
and media players presents a large potential user base of digital devices for
our content, as more than 800 million new handsets are sold each year in the
market place. These portable devices, coupled with the ubiquitous installed base
of personal computers with CD burners and USB port memory discs are making
digital audio content portable and more accessible to users.
We believe the proliferation of broadband Internet service, the Microsoft
digital rights management solution, and an expanding user base of portable
devices have created an inflection point where digital downloads are a better
way to distribute audio than traditional Compact Discs and audio cassette tape
distribution by mail order. Broadband Internet and ubiquitous wireless networks
means companies like MediaBay can deliver audio files quickly and affordably.
Downloading provides consumers a more convenient way to purchase audio in real
time and an incredible opportunity for broad choice since there are no inventory
requirements. We believe that download distribution is better for the
environment because it eliminates the need for the physical storage format of
the content, such as the CD or cassette. Digital delivery also enables us to
pass through the savings we realize from no media manufacturing costs to the
consumer, as two audiobooks can be downloaded for $19.95 whereas we typically
charge $25.00 for one audiobook on CD or cassette.
We changed our strategy because we determined that future investment in
our mail order, hard goods based, Audio Book Club would not provide the returns
adequate to justify future expenditures. Accordingly, in 2004, we discontinued
marketing to attract new Audio Book Club members and we have begun transitioning
current members to new programs including encouraging existing members to begin
downloading spoken word.
5
Digital Distribution Agreements with Microsoft, Real Networks and MusicNet
The first step in executing our new strategy was the completion of two
agreements with Microsoft. These agreements provide for us to distribute spoken
word audio content, including audiobooks from the largest publishers and our
old-time radio programs, through an exclusive distribution relationship with the
new MSN Music Service. Today, MSN has an audience of 350 million unique monthly
visitors. Microsoft's new music service has one of the largest selections of
songs and audio content of any service and is compatible with a large number of
digital devices, leveraging its industry leading windows media player and
windows digital rights management platform.
Additionally we signed a distribution agreement with Real Networks to
provide spoken work and audio entertainment content to Real's subscriber base.
We will provide our content library on an "a la carte" basis through Real's
Music Store or to the approximately 1.0 million subscribers of the Rhapsody
music service. In addition, we expect users to be able to transfer their spoken
word libraries onto hundreds of portable devices supported by Real. At the
current time, these devices include the Apple iPod, and most models from
Creative, i-River, Rio, and many other MP3 players listed at
http://music.guide.real.com/rhapsodydevices.
We also signed an agreement with MusicNet, a business-to-business digital
music service provider, to serve as its exclusive spoken word content
aggregator. Through the new deal, consumers visiting MusicNet-enabled digital
music services will have access to our library of audiobooks and other spoken
word content available on Windows Media. MusicNet's distribution partners
include a wide array of subscription-based digital music services such as
Yahoo!, HMV, Virgin Digital, Synacor and Cdigix. MusicNet offers these companies
and others a suite of fully customized digital music experiences, enabling
consumers to buy digital music subscriptions, portable subscriptions and a la
carte downloads. MusicNet has licensed two million tracks and offers the largest
catalog available in the industry today for subscription and purchase.
Open standard platform technology
We have chosen to leverage the proliferation of the Windows Media DRM
platform as the de facto rights management standard for content owners to
protect their intellectual property on the Internet. According to a report from
the International Federation of the Phonographic Industry (IFPI) trade group,
the number of online music stores quadrupled to more than 230 in 2004. This
trend is certain to improve consumer choice as it allows consumers to shop in a
broad range of stores, but maintain the flexibility to switch devices over time
as functionality improves without having to worry about media format conversion
issues that closed proprietary systems, such as Apple i-Tunes, create. On-line
music stores in the United States that use the Window's DRM system include such
companies as RealNetworks, MSN Music, Wal-Mart, Napster, AOL Music Now, Yahoo's
Music Match, Buy.com, Music Now, and VirginDigital. The competing storefronts,
which use proprietary DRM technologies or closed systems, are Apple and Audible.
Industry background
A major trend over the thirty years in the United States is to work longer
hours, spend more time in the automobile commuting to and from work, and thus
have less time for leisure activities. According to Harris Interactive, from
1973 to 2003, the median number of hours that people say they work has jumped
from 41 hours a week to 49. Over the same period, Harris reports that people's
leisure time has dropped from 26 to 19 hours per week. Listening is a way for
individuals to consume content at times when they are unable to read, such as
when they are driving. The 2003 edition of the Veronis Suhler Stevenson
Communications Industry Forecast estimates that on average Americans spent 1,013
hours listening to the radio in 2003, compared to 911 hours in 1998, which
averages out to an additional approximately 2 hours a week spent listening to
the radio in 2003. In comparison, Veronis Suhler Stevenson estimates that book
reading declined among Americans from an average of 118 hours in 1998 to 110
hours in 2003. According to the 2000 United States Census, 97 million people
drove to and from work alone that year, an increase of 15% from 1990. The
average travel time to work increased to 25.5 minutes each way, an increase of
14% from 1990. In addition, more than 42 million individual drivers have a
commute of at least 30 minutes or more each way.
6
As individuals look to use their commuting time more efficiently and
manage an increasing amount of available content, audiobooks have emerged as a
personalized "pay-to-listen" alternative to radio, because radio does not allow
listeners to control when they listen to a particular program.
According to the Audio Publishers Association 2004 Sales Survey, the U.S.
market for audiobooks has reached an estimated $800 million. The APA also
estimated that one in five, or 23 million, American households listened to
audiobooks in 2001.
This increasing usage of audiobooks exists despite limited types of
content, high prices and the limitations of cassette tapes and CDs. For
instance, the audiobook market based on retail sales does not include the many
audiobooks and other spoken word products sold to consumers directly or in
vertical markets such as personal improvement, training, and educational
markets, nor does it address the emerging market in personalized "time-shifted"
radio programming or timely print content such as newspapers, newsletters,
magazines, and journals.
The Internet has emerged as a powerful global communications and
entertainment medium, giving millions of people the ability to access large
amounts of valuable, pay-for-access media. Jupiter Research reported that as of
the end of 2003, 21.5 million households, or about one-fifth of U.S. households,
were connected to the Internet via broadband. Based on historic growth rates and
current trends around broadband availability, interest, and pricing, Jupiter
Research forecasts that by 2008, 46 million households, representing half of
online households and 40% of all U.S. households will connect via high-speed,
always-on technologies. Through the Internet, people can buy various forms of
information and entertainment, from books to music and video for usage both at
and away from the computer.
According to a 2001 report by market analyst International Data Corp.
(IDC), worldwide sales of smart handheld devices were expected to grow at a rate
of 48% per year over the next four years, reaching approximately $26 billion by
2004.
In December 2003, Jupiter Research published a report that predicted the
demand for MP3 players in the U.S. would grow at a rate of 50% per year through
2006. According to Jupiter, shipments of MP3 players in the U.S. for 2003 were
forecasted at over 3.5 million. Jupiter also predicted that there would be an
installed based of more than 26 million MP3 players by 2006 and that, starting
in 2004, the demand for players with hard drives would surpass that of players
with flash memory. According to a Consumer Electronics Market Association study
from June 2005, nearly 20 million DVD players were shipped in 2004 and household
penetration of DVD players rose from 60% at the beginning of 2004 to 75%, or
over 86 million households, at the beginning of 2005.
The market for personal digital assistants that have digital audio
capabilities had been led by Pocket PCs -- devices running on Microsoft
operating systems which are manufactured by Hewlett-Packard, Toshiba, and Dell
among others. Research firm IDC published a report in February 2004 in which it
noted that smartphones showed significant growth and future promise and that, in
2003, the worldwide smartphone market grew 181% year-over-year to 9.6 million
units.
The key characteristic of smartphones that enable the download of spoken
word content is the inclusion of enough internal memory to store our audio
content. Since most smartphones "dock" to computers, allowing for data exchange
of contact and schedule information, spoken word can also be transferred to
smartphones via a personal computer.
We are seeking to develop relationships with cell phone companies and
other high technology providers. Wireless handheld technology is the ideal match
for the download spoken word business. The combination of wireless freedom and
digital transmission will in the future allow a consumer to download from a
library of audio recordings and bypass the anchored desktop PC. This freedom to
download wirelessly will allow unprecedented convenience for consumers.
7
Businesses
Soundsgood.com
SoundsGood.com which was launched in October 2005, provides consumers with
an easy way to access thousands of best selling audio books, classic radio shows
and theatre performances, as well as a growing collection of audio newspapers,
magazines, lectures, self help and wellness courses, modern day radio shows and
other spoken word entertainment.
SoundsGood.com provides customers with both digital downloads for
immediate listening as well as the ability to purchase CDs and audiocassettes
for those more comfortable with traditional media. SoundsGood supports digital
downloads that are compatible with MP3 players, CD players, PCs and a growing
number of smart cellular phones that support the Windows Media audio format.
SoundsGood offers a wide range of audiobook titles ranging from New York
Times best sellers to the obscure. There is a monthly subscription for two
downloads, and individual purchases of CDs, cassettes and digital downloads are
available at an additional cost.
Audio Book Club
Audio Book Club was originally modeled after the traditional
"book-of-the-month club" format and had a negative option requirement. This
meant that, unless a member affirmatively declined the featured selection in our
mailing on or prior to the designated reply date, the selection was
automatically shipped to the member and the member was billed. We recently
transitioned this business to one that has a positive option drop ship format,
meaning that products are shipped only if the customer affirmatively orders the
product, and that sells audiobooks via download, CD and cassette format.
We mail one catalog approximately every month, which offers between 50 and
75 audio book titles. Audiobook Club customers are encouraged to make their
purchases on Soundsgood.com by downloading their selections. Alternatively,
customers can purchase their selections in traditional CD or cassette format. We
purchase audiobooks on a wholesale basis and utilize the services of a
third-party fulfillment provider, which allows us to ship the titles from its
inventory. We also utilize the services of a third-party that provides order
processing and data processing services. These services include accepting
customer orders, implementing our credit policies, billing and invoicing. We
intend to migrate our customer base over to Internet ordering and credit card
purchases only.
Radio Spirits
Radio Spirits sells old-time radio programs on audiocassettes and compact
discs through retail, direct mail and online channels. Radio Spirits has a
database of names of more than 400,000 catalog customers and prospects and sells
its products in such well-known national chains as Barnes & Noble and Borders
and online retailers such as Amazon.com. Radio Spirits' products can also be
purchased online at www.radiospirits.com. The Radio Spirits content library
consists of more than 65,000 hours of classic radio shows licensed on a
primarily exclusive basis. Radio Spirits' library of classic radio shows
includes episodes from the following notable series: The Shadow, The Jack Benny
Program, The Bob Hope Show, Superman, Suspense and many others including famous
stars such as Clark Gable, Cary Grant, Humphrey Bogart, Jimmy Stewart, Lucille
Ball, Frank Sinatra, Judy Garland, Orson Welles and Bing Crosby. Radio Spirits
also offers its old-time radio programs in a continuity format, a marketing
program that automatically sends selections to a customer once an initial order
is placed. Radio Spirits accounted for approximately 46.2% of our revenue in
2005.
8
We have acquired exclusive licensing rights to a substantial majority of
our old time radio library. These rights have been principally acquired from the
original rights holders (actors, directors, writers, producers or others) or
their estates. Our engineers use digital sound equipment to improve the sound
quality of our old time radio programs and then we contract with third-party
manufacturers to duplicate and manufacture our old time radio program cassettes
and CDs.
We utilize the services of a third-party fulfillment provider to warehouse
and track our inventory, ship the ordered product, implement our credit
policies, and provide data processing services, including billing and invoicing
services.
MediaBay.com
MediaBay.com provides the infrastructure and support for all of our web
sites including www.audiobookclub.com, www.radiospirits.com,
www.RadioClassics.com, www.soundsgood.com, and www.msn.soundsgood.com.
RadioClassics division
RadioClassics was created to distribute our proprietary old-time radio
content across multiple distribution platforms including traditional radio,
cable television, satellite television (DBS), satellite radio and the Internet.
RadioClassics currently distributes a national "classic" radio program, "When
Radio Was" and can also be heard 24 hours a day on dedicated channels on both
the Sirius Satellite Radio and XM Satellite Radio services.
Competition
We compete for discretionary consumer spending with other mail order
clubs, catalogs, direct marketers and traditional and on-line retailers that
offer products with similar entertainment value as audiobooks and old-time radio
programs, such as music on cassettes and compact discs, printed books, videos,
and laser and digital video discs. Many of these competitors are
well-established companies, which have much greater financial resources.
We compete for consumers of spoken word content with other Internet-based
audio distributors, as well as with our existing competitors, such as
distributors of audio on cassette tape or compact disc. The business of
providing content over the Internet is experiencing rapid growth and is
characterized by rapid technological changes, changes in consumer habits and
preferences, and the emergence of new and established companies. Inherent with
this rapid increase in growth of digital media are new market entrants due to
limited barriers to entry. We also continue to compete with (i) book store
chains deep-discount and general merchandise retailers, mass merchandisers, mail
order catalogs, content clubs, and libraries that sell, rent, or loan audiobooks
on cassette tape or compact discs. Examples in these categories are Borders,
Barnes & Noble, Amazon.com, Books-a-Million, and Wal-Mart (ii) websites that
offer downloadable access to spoken audio content using tools such as the
RealPlayer or Windows Media Player, (iii) websites that offer downloadable
access to spoken audio using their own technologies and audio players, such as
Audible and Apple i-Tunes, and (iv) large Internet portals such as America
Online, Inc. and Yahoo! Inc. which are either offering or have the potential to
offer audio content. Moreover Audible, Inc., has begun to establish itself as a
leader in downloadable spoken word content distribution.
Warranties and return policies
Our policy is to accept returns of damaged audiobooks and old time radio
programs. In order to maintain favorable customer relations, we generally accept
returns of unopened audiobooks and old time radio products sold through our
catalogs within 30 days of purchase. We also accept returns of unsold products
sold on a wholesale basis.
9
Intellectual property
We have several United States registered trademarks and service marks for
slogans and designs used in our advertisements, member mailings and member
solicitation packages, including the Audio Book Club logo, "MediaBay," "Radio
Spirits", "MediaBay.com," "audiobookclub.com" and the MediaBay logos. We believe
that our trademarks and service marks have significant value and are important
to our marketing. We also own or license the rights to substantially all of our
radio programs in our content library.
We rely on trade secrets and proprietary know-how and employ various
methods to protect our ideas, concepts and membership database. In addition, we
typically obtain confidentiality agreements with our executive officers,
employees, list managers and appropriate consultants and service suppliers.
Employees
As of March 29, 2006 we had 27 full-time employees. Of these employees, 2
served in corporate management; 19 served in operational positions at our Audio
Book Club operations and 6 served in operational positions at our old-time radio
operations. We believe our employee relations to be good. None of our employees
are covered by a collective bargaining agreement.
Item 1. Risk Factors
Risks related to our business
We have received a going concern opinion from our independent registered
public accounting firm, which could adversely affect our stock price and
our ability to raise capital.
Amper, Politziner and Mattia, P.C, our independent registered public
accounting firm, has included an explanatory paragraph in their report on our
financial statements for the year ended December 31, 2005, which highlights that
current cash balances are insufficient to support operations for the next twelve
months, thereby raising substantial doubt about our ability to continue as a
going concern. The inclusion of a going concern explanatory paragraph in Amper,
Politziner and Mattia, P.C's report on our financial statements could have an
adverse effect on our stock price and ability to raise additional capital.
Our financial statements have been prepared on the basis of a going
concern, which contemplates the realization of assets and satisfaction of
liabilities in the normal course of business. We have not made any adjustments
to the financial statements as a result of the outcome of the uncertainty
described above.
We have a history of losses, are not currently profitable, and expect to
incur losses in the future.
Since our inception, we have incurred significant losses. As of December
31, 2005, we had incurred an accumulated deficit of approximately $163 million.
Losses are continuing and are expected to continue. We may not be able to
achieve and sustain profitable operations.
Our revenues have declined significantly and will continue to decline. We
do not intend to devote sufficient funds to market to attract new Audio
Book Club members and our revenue bases will continue to erode.
10
Because we significantly reduced our marketing expenditures for new
members, our club membership and revenues declined significantly. Sales for the
year ended December 31, 2005 decreased 52.4% as compared to the year ended
December 31, 2004. Audio Book Club sales for the year ended December 31, 2005
decreased 62.2% compared to the year ended December 31, 2004 as a result of a
reduction in our advertising expenditures for new members. We do not anticipate
conducting any significant new member acquisition marketing of Audio Book Club
as we have moved to a new strategy to grow our business. As a result, our
revenues will continue to decline until such time, if ever, as we successfully
implement our new strategies.
We may be unable to anticipate changes in consumer preference for our
products and may lose sales opportunities.
Our success depends largely on our ability to anticipate and respond to a
variety of changes in the audiobook and old-time radio industries. These changes
include economic factors affecting discretionary consumer spending,
modifications in consumer demographics and the availability of other forms of
entertainment. The audiobook and old-time radio markets are characterized by
changing consumer preferences, which could affect our ability to:
o plan for product offerings;
o introduce new titles;
o anticipate order lead time;
o accurately assess inventory requirements; and
o develop new product delivery methods.
We may not be able to license or produce desirable spoken word content,
which could reduce or limit our ability to grow revenues.
We could lose sales opportunities if we are unable to continue to obtain
the rights to additional premium spoken word content or maintain our existing
rights. We rely on third-party content providers to license premium spoken word
content for digital download. These third party providers include publishers. In
some cases, we may be required to pay substantial advances to obtain this third
party content. In order to provide a compelling service, we must license a wide
variety of spoken word content to our customers with attractive usage rules such
as recording, output to digital audio devices, portable subscription rights and
other rights. In addition, if we do not have sufficient breadth and depth or
access to the current best sellers of the titles necessary to satisfy increased
demand arising from growth in our customer base, our customer satisfaction may
be affected adversely. We cannot guarantee that we will be able to secure
licenses to spoken word content or that such licenses will be available on
commercially reasonable terms. Some of our license agreements expire over the
several months unless they are renewed.
If our third-party providers fail to perform their services properly, we
may not be able to service our customers properly and our operations may
not function effectively.
Third-party providers conduct all of our Audio Book Club and a majority of
our Radio Spirits customer service operations and process orders and collect
payments for us. If these providers fail to perform their services properly, we,
in turn, may not be able to service our customers properly, and, as a result,
our Audio Book Club and Radio Spirits' customers could develop negative
perceptions of our business, our operations might not function efficiently,
collections of receivables could be delayed, our revenue could decline and our
expenses could increase.
11
If our marketing strategies to acquire new customers are not successful
our sales growth will decline and our costs could increase.
Many factors beyond our control, such as the public's receptiveness to
direct mail or email solicitations, may affect the success of our marketing
strategies. If our direct mail, internet and other marketing strategies are not
successful, our per customer acquisition costs may increase and we may acquire
fewer new customers than anticipated or the customers we do acquire may not
purchase as many products as we anticipate, return products at a higher rate
than we expect or fail to pay for their purchases. As a result, our sales growth
would be inhibited and our costs would increase.
New laws addressing the sending of e-mails may limit our ability to market
or subject us to penalties.
New laws recently enacted to limit "spam" e-mails may impact our ability
to conduct e-mail campaigns. While we attempt to only use "opt-in" e-mail
addresses (those belonging to customers that have affirmatively elected to
receive emails from us) and to work with third parties whose lists consist of
"opt-in" e-mails, the law may limit the number of third parties whose lists we
can use or significantly reduce the number of e-mails within these lists.
Limitations on our ability to continue the use of e-mail marketing campaigns
could adversely affect our ability to attract new customers and increase our
cost to acquire new customers.
We face significant competition from a wide variety of sources for the
sale of our products, which could prevent us from significantly increasing
our revenues.
We may not be able to compete effectively because of the significant
competition in our markets from many competitors, many of whom are better
financed and have greater resources than us, and from other products providing
similar entertainment value, such as music on cassettes and CDs, printed books,
videos and DVDs. We compete for discretionary consumer spending with other mail
order clubs, catalogs, direct marketers and traditional and on-line retailers
that offer products with similar entertainment value as audiobooks and old-time
radio programs, such as music on cassettes and compact discs, printed books,
videos, and laser and digital video discs. Many of these competitors are
well-established companies, which have much greater financial resources.
We compete for consumers of spoken word content with other Internet-based
audio distributors, as well as with our existing competitors, such as
distributors of audio on cassette tape or compact disc. The business of
providing content over the Internet is experiencing rapid growth and is
characterized by rapid technological changes, changes in consumer habits and
preferences, and the emergence of new and established companies. Inherent with
this rapid increase in growth of digital media are new market entrants due to
limited barriers to entry. We also continue to compete with (i) book store
chains deep-discount and general merchandise retailers, mass merchandisers, mail
order catalogs, content clubs, and libraries that sell, rent, or loan audiobooks
on cassette tape or compact discs. Examples in these categories are Borders,
Barnes & Noble, Amazon.com, Books-a-Million, and Wal-Mart (ii) websites that
offer downloadable access to spoken audio content using tools such as the
RealPlayer or Windows Media Player, (iii) websites that offer downloadable
access to spoken audio using their own technologies and audio players, such as
Audible and Apple i-Tunes, and (iv) large Internet portals such as America
Online, Inc. and Yahoo! Inc. which are either offering or have the potential to
offer audio content. Moreover Audible, Inc., has begun to establish itself as a
leader in downloadable spoken word content distribution.
We have not fully complied with the terms of all of our license agreements
and failure to do so may impair our ability to license products from some
rightsholders.
As of December 31, 2005, we had past due royalty payments under our
licensing agreements aggregating $1,397,000. The publishers and other
rightsholders to whom these payments would be payable have not requested royalty
statements or payments. These amounts are accrued for and reflected in our
financial statements.
12
Additional risks relating to our change in strategy and our downloadable
spoken word content offerings and online initiatives
We are pursuing a new strategy of selling downloadable spoken word content
and selling hard good format content online. We have limited experience in the
emerging and competitive downloadable content distribution business and cannot
assure you that we will be successful in transitioning, operating and growing
our business. In the event that we are unable to successfully implement our new
strategy, we will be required to pursue alternative business strategies, such as
seeking to enter new markets or finding strategic partners with greater
financial, marketing and other resources, and if we are unable to do so,
discontinue operations.
Our new strategy to focus on downloadable spoken word content and our
online initiatives is subject to many uncertainties and could result in
continuing losses and declining revenues until such time, if ever, it is
successfully implemented.
Historically, we have sold audiobooks through a membership club format and
other spoken word content, substantially all in hard goods format (audio
cassettes and compact discs). Over the past two years, we significantly reduced
our new member and customer marketing activities.
Because we are pursuing a new strategy, which focuses on downloadable
spoken word content, we have transitioned the Audio Book Club to a positive
option drop ship business and will not devote the funds necessary to acquire new
Audio Book Club members to offset member attrition. As a result, our revenue
will continue to decline, which will continue to negatively impact our
performance. We expect this trend to continue until such time, if ever, as we
generate significant revenue from the sale of downloadable spoken word content
and attract and establish a meaningful customer base for our online websites or
other websites we may develop. There can be no assurance that we will meet these
launch dates, or be able to successfully implement our new strategies or that
implementation will result in increased revenues or profitable operations.
The download spoken word distribution business is new and rapidly evolving
and may not prove to be a profitable or even viable business model.
Download spoken word distribution services are a relatively new business
model for delivering digital media over the Internet. It is too early to predict
whether consumers will accept, in significant numbers, online spoken word
content services and accordingly whether the services will be financially
viable. If download spoken word distribution services do not prove to be popular
with consumers, or if these services cannot sustain any such popularity, our
business and prospects would be harmed.
The market for our service is uncertain and if consumers are not willing
to use the Internet to purchase spoken audio content, our revenues will be
limited.
Downloading audio content from the Internet is a relatively new method of
distribution and its growth and market acceptance is highly uncertain. Our
success will depend in large part on more widespread consumer willingness to
purchase and download spoken audio content over the Internet. Purchasing this
content over the Internet involves changing purchasing habits, and if consumers
are not willing to purchase and download this content over the Internet, our
revenue will be limited. We believe that acceptance of this method of
distribution may be subject to network capacity constraints, hardware
limitations, company computer security policies, the ability to change user
habits, and the quality of the audio content delivered.
13
Manufacturers of electronic devices may not manufacture, make available,
or sell a sufficient number of products suitable for our service, which
would limit our revenue growth.
If manufacturers of electronic devices do not manufacture, make available,
or sell a sufficient number of electronic devices enabled with the Windows Media
Platform for downloadable spoken word content or if these players do not achieve
sufficient market acceptance our sales could be adversely affected and our
business will be materially and adversely affected. Microsoft competes with
others for relationships with manufacturers of electronic devices with audio
playback capabilities. Manufacturers of electronic devices have experienced
delays in their delivery schedule of their digital players due to parts
shortages and other factors. Although the content we intend to provide can be
played on personal computers and burned to CDs for later listening, we believe
that a key to our future success is the ability to playback this content on
hand-held electronic devices that have digital audio capabilities.
If we do not provide digital rights management solutions in our download
distribution services, content providers may refuse to license content to
us and consumers may not purchase our content.
We must provide digital rights management solutions and other security
mechanisms in our download spoken word distribution services in order to address
concerns of content providers and authors, and we cannot be certain that content
licensors or consumers will accept them. Content providers may be unwilling to
continue to support portable subscription services. Consumers may be unwilling
to accept the use of digital rights management technologies that limit their use
of content, especially with large amounts of free content readily available.
Third-party providers of digital rights management software, such as
Microsoft, may be unwilling to continue to provide such software to us upon
reasonable or any terms. If we are unable to acquire these solutions on
reasonable or any terms, or if customers are unwilling to accept these
solutions, our business and prospects could be harmed.
Capacity constraints and failures, delays, or overloads could interrupt
our service and reduce the attractiveness of downloading spoken word to
potential customers.
Any capacity constraints or sustained failure or delay in downloading
spoken word could reduce the attractiveness of downloading spoken word products
which could materially and adversely affect our ability to implement our new
strategy. The success of our new strategy depends on our ability to
electronically, efficiently, and with few interruptions or delays distribute
spoken audio content to potential customers. Accordingly, the performance,
reliability, and availability of our Website, our transaction processing systems
and our network infrastructure are critical to our operating results. We believe
the potential instability of the Internet could mean that periodic interruptions
to our new service could occur. These interruptions might make it difficult to
download audio content from our Website in a timely manner and jeopardize
prospective customer relationships.
Because we do not have a comprehensive disaster recovery plan and have
only limited back-up systems, a disaster could severely damage our
operations and could result in loss of customers.
If our computer systems are damaged or interrupted by a disaster,
including fire or major computer virus, for an extended period of time, we will
not be able to service our customers until such time as we are able to repair
our systems. This will result in a loss of revenue. We might also be unable to
utilize customer data for direct marketing initiatives, which would also reduce
revenue. We do not have a comprehensive disaster recovery plan in effect. Our
operations depend upon our ability to maintain and protect our computer systems;
all of which are located in our headquarters and at a third-party offsite
hosting facility. Although we maintain insurance against general business
interruptions, we cannot assure you that the amount of coverage will be adequate
to compensate us for our losses.
14
Problems associated with the Internet could discourage use of
Internet-based services and adversely affect our business.
If the Internet fails to develop or develops more slowly than we expect as
a commercial medium, our business may also grow more slowly than we anticipate
or fail to grow. Our success will depend in large part on increasing use of the
Internet. There are critical issues concerning the commercial use of the
Internet which we expect to affect the development of the market for
downloadable spoken word, including:
o secure transmission of customer credit card numbers and other
confidential information;
o reliability and availability of Internet service providers;
o cost of access to the Internet;
o availability of sufficient network capacity; and
o ability to download audio content consistent with computer security
measures employed by businesses.
If we are unable to offer downloads of our content on non-PC devices, we
may fail to capture a significant share of the market for digital media
services and our revenues may be limited.
In the coming years, the number of individuals who access digital content
through devices other than a personal computer, such as personal digital
assistants, cellular telephones, television set-top devices, game consoles and
Internet appliances, is expected to increase dramatically. Manufacturers of
these types of products are increasingly investing in media-related
applications, but development of these devices is still in an experimental stage
and business models are new and unproven. If we are unable to offer downloads of
spoken word content on these alternative non-PC devices, we may fail to capture
a sufficient share of an increasingly important portion of the market for
digital media services and our revenues may be limited.
We could be sued for content that we distribute over the Internet, which
could subject us to substantial damages.
A lawsuit based on the spoken word content we intend to distribute could
be expensive and damaging to our business. As a distributor and publisher of
content over the Internet, we may be liable for copyright, trademark
infringement, unlawful duplication, negligence, defamation, indecency, and other
claims based on the nature and content of the materials that we publish or
distribute to customers. Our liability insurance may not cover claims of these
types or may not be adequate to protect us from the full amount of the
liability. If we are found liable in excess of the amount of our insurance
coverage, we could be liable for substantial damages. Our reputation and
business may suffer even if we are not liable for significant financial damages.
We could face liability and other costs relating to our storage and use of
personal information about our users.
Users provide us with personal information, including credit card
information, which we do not share without the user's consent. Despite this
policy of obtaining consent, however, if third persons were able to penetrate
our network security or otherwise misappropriate our users' personal or credit
card information, we could be subject to liability, including claims for
unauthorized purchases with credit card information, impersonation or other
similar fraud claims, and misuses of personal information, such as for
unauthorized marketing purposes. New privacy legislation may further increase
this type of liability. California, for example, passed a privacy law that would
apply to a security breach that affects unencrypted, computerized personal
information of a California resident. Furthermore, we could incur additional
expenses if additional regulations regarding the use of personal information
were introduced or if federal or state agencies were to investigate our privacy
practices.
15
We may not be able to protect our licenses or our intellectual property,
which could jeopardize our competitive position. Unauthorized duplication
of the content we sell could result in our liability for substantial
damages and discourage other content providers from entering into
agreements with us.
If we fail to protect our customer lists, licenses or our intellectual
property, we may be exposed to expensive litigation or risk jeopardizing our
competitive position. The steps we have taken may be inadequate to protect our
licenses or other intellectual property. We rely on a combination of licenses,
confidentiality agreements, and other contracts to establish and protect our
intellectual property rights.
We believe that we are able to license spoken word audio content in part
because our service has been designed to reduce the risk of unauthorized
duplication and playback of audio files. If these security measures fail, our
content may be vulnerable to unauthorized duplication playback. If others
duplicate the content we provide without authorization, content providers may
terminate their agreements with us and hold us liable for substantial damages.
Although we maintain general liability insurance, including insurance for errors
or omissions, we cannot assure you that the amount of coverage will be adequate
to compensate us for these losses. Security breaches might also discourage other
content providers from entering into agreements with us. We may be required to
expend substantial money and other resources to protect against the threat of
security breaches or to alleviate problems caused by these breaches.
We may have to litigate to enforce our licenses or other intellectual
property rights or to determine the validity and scope of the proprietary rights
of others. Litigation could result in substantial costs and the diversion of our
management and other resources, which would harm our business.
Other companies may claim that we infringe their copyrights or patents,
which could subject us to substantial damages.
Any claims of infringement could cause us to incur substantial costs
defending against the claim, even if the claim is invalid, and could distract
our management from our business. A party making a claim could secure a judgment
that requires us to pay substantial damages. A judgment could also include an
injunction or other court order that could prevent us from offering downloads of
spoken word content.
Risks Relating to Our Capital Structure
Our stock price has been and could continue to extreme volatility, which
could result in delisting from Nasdaq if we fail to satisfy the $1.00
minimum bid request for our common stock.
In September 2005, we received notification from Nasdaq indicating that we
were not in compliance with the $1.00 minimum bid request for continued listing
of our common stock and, therefore were subject to delisting from the Nasdaq
National Market. In October 2005, following shareholder and board approval, we
effected a 6- for -1 share reverse split of our common stock and in November
2005, Nasdaq advised us that our common stock remained eligible for listing on
the Nasdaq National Market. The market price of our common stock has remained
subject to significant fluctuations, including trading at a closing sale price
below $1.00 for consecutive trading days since regaining compliance with
Nasdaq's $1.00 minimum bid price requirement. If our common stock again falls
below $1.00 for a significant period of time, we will be required to seek to
effect another reverse stock split or may be delisted from Nasdaq. If we are
delisted from Nasdaq, the market for our securities may be more limited.
Additionally, if we are delisted from Nasdaq and, at any time we have net
tangible assets of $5,000,000 or less and our common stock has a market price
per share of less than $5.00, transactions in our securities may be subject to
the "penny stock" rules promulgated under the Securities Exchange Act. If our
common stock becomes subject to these rules, broker-dealers may find it
difficult to effectuate customer transactions and trading activity in our
securities may be adversely affected. As a result, the market price of our
securities may be depressed and securityholders may find it more difficult to
sell their securities.
16
Our ability to use our net operating losses will be limited in future
periods, which could increase our tax liability.
Under Section 382 of the Internal Revenue Code of 1986, utilization of
prior net operating losses is limited after an ownership change, as defined in
Section 382, to an annual amount equal to the value of the corporation's
outstanding stock immediately before the date of the ownership change multiplied
by the long-term tax exempt rate. In the event we achieve profitable operations,
any significant limitation on the utilization of net operating losses would have
the effect of increasing our tax liability and reducing after tax net income and
available cash reserves. We are unable to determine the availability of net
operating losses since this availability is dependent upon profitable
operations, which we have not achieved in prior periods.
The number of shares of common stock which are available for sale upon
exercise of convertible preferred stock and exercise of warrants and
options is substantial in relation to our currently outstanding common
stock and the public float of our common stock, and could cause downward
pressure on the market price for our common stock.
The number of shares of common stock registered for resale upon exercise
of convertible preferred stock and exercise of warrants and options is
significantly greater than the number of shares currently outstanding and in the
public float. If those securityholders determine to sell a significant number of
shares into the market at any given time, there likely will not be sufficient
demand in the market to purchase the shares without a decline in the market
price for our common stock. Moreover, continuous sales into the market of a
number of shares in excess of the typical trading market for our common stock,
or even the availability of such a large number of shares, could continue to
depress the trading market for our common stock over an extended period of time.
A large number of shares of our common stock could be sold in the market
in the near future, which could depress our stock price.
As of March 29, 2006, we had outstanding approximately 10,516,444 shares
of common stock. In addition, a substantial portion of our shares are currently
freely trading without restriction under the Securities Act of 1933, having been
registered for resale or held by their holders for over two years and are
eligible for sale under Rule 144(k). There are currently outstanding options and
warrants to purchase and convertible preferred stock convertible into an
aggregate of approximately 18.4 million shares of our common stock and
substantially all of the underlying shares are available for sale under
effective registration statements. To the extent any of our warrants or options
are exercised or convertible preferred stock is converted, your percentage
ownership will be diluted and our stock price could be further adversely
affected. Moreover, as the underlying shares are sold, the market price could
drop significantly if the holders of these restricted shares sell them or if the
market perceives that the holders intend to sell these shares.
Because our board of directors consists of three classes, it may be more
difficult for a third party to acquire our company.
Our by-laws divide our board of directors into three classes, serving
staggered three-year terms. As a result, a shareholder acquiring a majority of
the voting stock may not be able to appoint a majority of the members of our
board of directors upon acquiring majority ownership because at least two annual
meetings, instead of one, will be required to effect a change of control of a
majority of the members of the board of directors. The staggered board of
directors may make it more difficult for a third party to acquire, or may
discourage acquisition bids for our company.
17
Our outstanding preferred stock and our ability to designate additional
preferred stock could adversely affect the rights of our common
stockholders.
Our articles of incorporation authorize our board of directors to issue up
to 5,000,000 shares of "blank check" preferred stock without shareholder
approval, in one or more series and to fix the dividend rights, terms,
conversion rights, voting rights, redemption rights and terms, liquidation
preferences, and any other rights, preferences, privileges, and restrictions
applicable to each new series of preferred stock. We currently have two series
of preferred stock outstanding all of which have liquidation preferences senior
to our common stock. One of these series have approval rights with respect to
amendments to our articles of incorporation which adversely affect the preferred
stock, incurrence of indebtedness, payment of dividends and distributions,
redemption of capital stock, the creation of other series of capital stock
convertible into our common stock. Moreover, one of the series of preferred
stock has voting rights, including an approval right with respect to certain
corporate events, such as, mergers and other business combinations and certain
sales and transfer of assets. The existence of our outstanding preferred stock
and designation of additional series of preferred stock in the future could,
among other results, adversely affect the voting power of the holders of common
stock and, under certain circumstances, could make it difficult for third
parties to gain control of our company, prevent or substantially delay a change
in control, discourage bids for our common stock at a premium, or otherwise
adversely affect the market price of our common stock.
Item 2. Properties
Our executive office is currently located at 2 Ridgedale Avenue, Cedar
Knolls, New Jersey, where we lease approximately 12,000 square feet of office
space. The lease expires in October 2008 and provides for minimum annual
payments of $189,000 in 2006 and $198,000 in each of 2007 and 2008.
We also subleased two offices in New York, New York from a company
partially owned by our Chairman. The lease commenced on August 1, 2005 and ends
on July 31, 2006. The lease amount is $3,000 per month. The annual lease
payments in 2006 are $21,000.
Item 3. Legal Proceedings
We are not a party to any lawsuit or proceeding, which we believe is likely to
have a material adverse effect on us.
Item 4. Submission of Matters to a Vote of Security Holders
An Annual Meeting of Shareholders was held on October 6, 2005 at which
time Mr. Jeffrey Dittus and Mr. Robert B. Montgomery were reappointed to serve
as Class II directors until the Annual Meeting of Shareholders of the Company to
be held in 2008. Shareholder voting for these directors was as follows:
Director Votes For Votes Withheld
-------- --------- --------------
Jeffrey Dittus 6,689,640 58,898
Robert Montgomery 6,690,882 57,656
The shareholders also approved the adoption of a resolution to amend the
Company's Articles of Incorporation to effect a combination (a "Reverse Split")
of the Company's issued and outstanding Common Stock. The motion received
6,604,490 votes for and 120,420 votes against. The Board of Directors approved a
1 for 6 Reverse Split which became effective on October 25, 2005.
18
PART II
Item 5. Market for Registrant's Common Equity Related Stockholder Matters and
Issuer Purchases of Equity Securities
Our common stock has been quoted on the Nasdaq National Market since
November 15, 1999. From November 15, 1999 to October 24, 2005 it was quoted
under the symbol "MBAY." In September 2005, we received a letter from Nasdaq
indicating that we were not in compliance with the $1.00 minimum bid price
requirement for continued listing of our common stock. From October 25, 2005 to
November 25, 2005 our common stock temporarily traded under the symbol "MBAYD"
and beginning November 25, 2005 it resumed trading under the symbol "MBAY",
following receipt of a letter dated November 9, 2005, from Nasdaq indicating
that our common stock remained eligible for listing on the Nasdaq National
Market. The following table shows the high and low sales prices of our common
stock as reported by the Nasdaq National Market for the fiscal quarters
indicated, after giving retroactive effect to our October 2005 1-for-6 share
reverse stock split.
High Low
------ ------
Fiscal Year Ended December 31, 2004
First Quarter $ 9.54 $ 3.12
Second Quarter $ 4.32 $ 2.16
Third Quarter $ 2.94 $ 1.50
Fourth Quarter $11.46 $ 1.98
Fiscal Year Ended December 31, 2005
First Quarter $ 9.54 $ 3.06
Second Quarter $ 4.14 $ 2.34
Third Quarter $ 4.20 $ 1.44
Fourth Quarter $ 2.31 $ 1.20
On March 29, 2006 the last reported sale price of our common stock on the
Nasdaq National Market was $0.95 per share. As of such date, there were
approximately 149 record owners of our common stock; however, a number of our
shares are held in street name and as such we believe that the actual number of
beneficial owners is higher.
Dividend Policy
We have never declared or paid and do not anticipate declaring or paying any
dividends on our common stock in the near future. The terms of our Series D
preferred Stock prohibit us from declaring or paying any dividends or
distributions on our common stock. Any future determination as to the
declaration and payment of dividends will be at the discretion of our Board of
Directors and will depend on then existing conditions, including our financial
condition, results of operations, capital requirements, business factors and
other factors as our Board of Directors deems relevant.
19
Item 6. Selected Financial Data
We have derived the selected statement of operations data for the years
ended December 31, 2003, 2004 and 2005 and selected balance sheet data as of
December 31, 2005 and 2004 from our audited consolidated financial statements
that are included in this Report on Form 10-K. We have derived the selected
statement of operations data for the years ended December 31, 2001 and 2002 and
the selected balance sheet data as of December 31, 2001, 2002 and 2003 from our
audited consolidated financial statements that are not included in this Report
of Form 10-K.
As a result of such factors as the capitalization and write-off of direct
response advertising costs, recording of goodwill write-offs, severance and
other termination costs and income tax benefit and subsequent expense, as well
as fluctuations in operating results depending on the timing, magnitude and
success of Audio Book Club new member advertising campaigns, and the changes in
our strategy made in 2004, all as discussed elsewhere herein, comparisons of our
historical operating results from year to year may not be meaningful.
You should read the following selected consolidated financial data
together with the "Management's Discussion and Analysis of Financial Condition
and Results of Operations" section appearing elsewhere herein and with our
consolidated financial statements and accompanying notes appearing at the end of
this Report on Form 10-K:
Years Ended December 31,
------------------------------------------------------------
2001 2002 2003 2004 2005
-------- -------- -------- -------- --------
(thousands, except per share data)
Statement of Operations Data:
Net sales $ 41,805 $ 45,744 $ 36,617 $ 18,831 $ 8,955
Cost of sales 22,044 20,651 17,764 12,547 5,920
Advertising and promotion 15,893 10,156 10,452 5,546 2,091
Bad debt expense 2,833 2,821 3,940 829 51
General and administrative 15,694 8,347 6,816 6,043 6,895
Severance and other termination costs -- -- 544 -- 697
Depreciation and amortization 5,156 1,314 328 144 154
Non-cash write-down of intangibles -- 1,224 -- -- --
Non-cash write-down of goodwill -- -- -- -- 3,502
-------- -------- -------- -------- --------
Operating (loss) income (19,815) 1,231 (3,227) (6,278) (10,355)
Interest income (expense), net (2,790) (2,974) (1,925) (9,082) (510)
Loss on early extinguishment of debt (579)
-------- -------- -------- -------- --------
Loss before income tax benefit (expense) (22,605) (1,743) (5,152) (15,360) (11,444)
Income tax benefit (expense) 17,200 (550) (1,471) (14,753) --
-------- -------- -------- -------- --------
Net loss (5,405) (2,293) (6,623) (30,113) (11,444)
Dividends on preferred stock -- 217 246 574 1,446
Deemed dividend on beneficial conversion of Series D
Preferred Stock -- -- -- -- 17,423
-------- -------- -------- -------- --------
Net loss applicable to common shares $ (5,405) $ (2,510) $ (6,869) $(30,687) (30,313)
======== ======== ======== ======== ========
Basic and diluted loss applicable to common shares $ (2.34) $ (1.08) $ (2.92) $ (10.24) $ (4.08)
======== ======== ======== ======== ========
Basic and diluted weighted average number of shares
outstanding 2,310 2,348 2,350 2,996 7,430
======== ======== ======== ======== ========
20
As of December 31,
2001 2002 2003 2004 2005
-------- -------- -------- -------- --------
(thousands, except per share data)
Balance Sheet Data:
Working capital (deficit) $ (4,167) $ (4,336) $(20,165) $ 720 $ 5,364
Total assets 44,452 48,619 36,893 16,576 18,667
Current liabilities 15,491 18,984 29,194 5,905 5,320
Long-term debt (less current portion) 15,849 14,680 -- 16,852 608
Common stock subject to contingent put rights 758 758 125 -- --
Total Common Stockholders' equity (deficit) $ 8,562 $ 10,405 $ 6,949 $ (6,181) $ 12,739
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations Introduction
We are a seller of spoken audio and nostalgia products, including
audiobooks and old-time radio shows, through direct response, retail and
Internet channels. Our content and products are sold in multiple formats,
including physical (cassette and compact disc) and secure digital download
formats.
Amper, Politziner and Mattia, P.C, our independent registered public
accounting firm, has included an explanatory paragraph in their report on our
financial statements for the year ended December 31, 2005, which highlights that
current cash balances are insufficient to support operations for the next twelve
months, thereby raising substantial doubt about our ability to continue as a
going concern. The inclusion of a going concern explanatory paragraph in Amper,
Politziner and Mattia, P.C's report on our financial statements could have an
adverse effect on our stock price and ability to raise additional financing.
Our financial statements have been prepared on the basis of a going
concern, which contemplates the realization of assets and satisfaction of
liabilities in the normal course of business. We have not made any adjustments
to the financial statements as a result of the outcome of the uncertainty
described above.
We report financial results on the basis of four business segments;
Corporate, Audio Book Club, Radio Spirits and MediaBay.com. A fifth division,
RadioClassics, is aggregated with Radio Spirits for financial reporting
purposes. Except for corporate, each segment serves a unique market segment
within the spoken word audio industry. In 2005, our Audio Book Club segment had
net sales of approximately $4.6 million, our Radio Spirits segment had net sales
of approximately $4.1 million, and our MediaBay.com segment had sales of
approximately $0.2 million.
We derive our principal revenue through sales of audiobooks, classic radio
shows and other spoken word audio products directly to consumers principally
through direct mail. We also sell classic radio shows to retailers either
directly or through distributors. We derive additional revenue through rental of
our proprietary database of names and addresses to non-competing third parties
through list rental brokers. We also derive a small amount of revenue from
advertisers who advertise on our nationally syndicated classic radio shows.
21
New sources of entertainment media continue to grow as the quantity and
variety of content and its sources proliferate. The Internet has emerged as a
powerful global communications and entertainment media, giving millions of
people the ability to access large amounts of valuable pay-for-access media.
Additionally, recent advances in technologies have made it possible to deliver
digital downloads of music and spoken word content, such as audiobooks,
newspapers and magazines. A key driving force in consumer acceptance of digital
downloads has been the emerging market for handheld devices that play digital or
compressed audio. Over the past few years, the music industry has been
successful in creating a market for digital downloads. According to a report
published January 19, 2006 by the International Federation of the Phonographic
Industry, global sales of music via the Internet and mobile phones proliferated
in 2005, generating sales of $1.1 billion for record companies a threefold
increase on 2004. Accordingly, our strategy is to provide digital audio books to
this rapidly growing audience of music buyers and mobile phone users who are
using different broadband and wireless technologies to access their audio
content.
As a provider of secure WMA audio content, we hope to take advantage of
the large worldwide installed base of windows media players on consumers
desktops worldwide, and the growing number of smart phones that are being
shipped with the new Windows Mobile 5.0 platform which includes a mobile windows
media player that enables playback of the companies content on these mobile
devices. While we cannot predict the adoption rate for our content on this
technology platform, we have chosen to leverage the Microsoft technologies
rather than build our own proprietary digital rights management and compression
system due to the large market opportunity presented by this installed base and
the difficulty and expense in creating a new unproven system and the complexity
of intellectual property laws.
In October 2005, we launched our digital distribution strategy through the
launch of Soundsgood.com, our fully enabled digital storefront and technology
platform. We also continue to enter into strategic agreements to license content
and to distribute downloads to consumers. In December 2005, we launched our
co-branded digital storefront with Microsoft at msn.soundsgood.com. We have also
entered into distribution agreements with Real Network's Rhapsody and with
MusicNet. We have gradually begun increasing our marketing efforts to drive
customers to our storefronts, and expect to continue to do so at these modest
levels until such time as we believe it will be cost effective to aggressively
market to new customers, including our database of 2.5 million customers that
have purchased audiobooks from us in the past.
To date, our sales of digital downloads have been minimal. Our sales will
continue to decline until such time as we generate significant sales from the
implementation of our digital strategy.
Critical accounting policies
Our discussion and analysis of our financial condition and results of
operations are based on our consolidated financial statements, which have been
prepared in accordance with accounting principles generally accepted in the
United States of America. The preparation of financial statements requires us to
make estimates and judgments that affect the reported amounts of assets,
liabilities, revenues and expenses, and related disclosures of contingent assets
and liabilities. On an on-going basis we evaluate our estimates including those
related to product returns, bad debts, the carrying value and net realizable
value of inventories, the recoverability of advances to publishers and other
rightsholders, the future revenue associated with deferred advertising and
promotion costs, investments, fixed assets, the valuation allowance provided to
reduce our deferred tax assets and valuation of goodwill and other intangibles.
The Securities and Exchange Commission ("SEC") defines "critical
accounting policies" as those that require application of management's most
difficult, subjective or complex judgments, often as a result of the need to
make estimates about the effect of matters that are inherently uncertain and may
change in subsequent periods.
22
Our significant accounting policies are described in Note 3 to the Notes
to Consolidated Financial Statements. Not all of these significant accounting
policies require management to make difficult, subjective or complex judgments
or estimates. However the following policies are considered to be critical
within the SEC definition:
Revenue recognition
We derive our principal revenue through sales of audiobooks, classic radio
shows and other spoken word audio products directly to consumers principally
through direct mail. We also sell classic radio shows to retailers either
directly or through distributors. We derive additional revenue through rental of
our proprietary database of names and addresses to non-competing third parties
through list rental brokers. We also derive a small amount of revenue from
advertisers included in our nationally syndicated classic radio shows. We
recognize sales to consumers, retailers and distributors upon shipment of
merchandise. List rental revenue is recognized on notification by the list
brokers of rental by a third party when the lists are rented. We recognize
advertising revenue upon notification of the airing of the advertisement by the
media buying company representing us. Allowances for future returns are based
upon historical experience and evaluation of current trends. The historical
return rates for ABC members have been consistent for the past year and our
estimate is based on a detailed historical examination of trends. Based on the
current performance and historical trends, we do not expect significant changes
in the estimate of returns for ABC members. The estimate of returns for
wholesale sales of our old-time radio products is based on a detailed review of
each significant customer, depending on the amount of products sold to a
particular customer in a specific periods, the overall return rate for wholesale
sales could vary.
We record reductions to our revenue for future returns and record an
estimate of future bad debts arising from current sales in general and
administrative expenses. These allowances are based upon historical experience
and evaluation of current trends. If members and customers return products to us
in the future at higher rates than in the past or than we currently anticipate,
our net sales would be reduced and our operating results would be adversely
affected. In November 2001, the Emerging Issues Task Force ("EITF") issued EITF
No. 01-9, "Accounting for Consideration Given by a Vendor to a Customer
(Including a Reseller of the Vendor's Products)", which addresses the income
statement classification of certain credits, allowances, adjustments, and
payments given to customers for the services or benefits provided. We adopted
EITF No. 01-9 effective January 1, 2002, and, as such, have classified the cost
of these sales incentives as a reduction of sales. The effect on sales of
applying EITF No. 01-9 in 2003, 2004 and 2005 was $60,000, $48,000 and $62,000
respectively.
Downloadable content revenue from the sale of individual content titles is
recognized in the period when the content is downloaded and the customer's
credit card is processed. Content revenue from the sale of content subscriptions
is recognized pro rata over the term of the subscription period. Rebates and
refunds are recorded as a reduction of revenue in the period in which the rebate
or refund is paid in accordance with Emerging Issues Task Force Issue No. 01-9,
Accounting for Consideration Given by a Vendor to a Customer (Including a
Reseller of the Vendor's Products).
Accounts receivable valuation
We record an estimate of our anticipated bad debt expense and return rates
based on our historical experience. If the financial condition of our customers,
including either individual consumers or retail chains, were to deteriorate, or
if the payment or buying behavior were to change, resulting in either their
inability or refusal to make payment to us, additional allowances would be
required. For example, a one percent increase in returns as a percentage of
gross sales for the year ended 2005, assuming a constant gross profit percentage
and all other expenses unchanged, would have resulted in a decrease in net sales
of $108,000 and an increase in net loss available to common shares of $37,000. A
one percent increase in bad debt expense as a percentage of net sales, assuming
all other expenses were unchanged, would have resulted in an increase in bad
debt expenses and corresponding increase in net loss available to common shares
of $90,000.
23
Income Taxes
The ultimate realization of deferred tax assets is dependent on the
generation of future taxable income during the periods in which temporary timing
differences become deductible. We determine the utilization of deferred tax
assets in the future based on current year projections by management.
Based on a change in our strategy, which we believe will result in lower
sales and losses in the near term, but ultimately will be more profitable, we
have determined that it is more likely than not that we will, in the foreseeable
future, be unable to realize all or part of our net deferred tax asset. We have
accordingly made an adjustment to the deferred tax asset recording an increase
to the valuation allowance, resulting in a deferred tax expense charged against
income in the fourth quarter of 2004, the period when such determination was
made.
Goodwill
Goodwill represents the excess of the purchase price over the fair value
of net assets acquired in business combinations accounted for using the purchase
method of accounting. In July 2001, the Financial Accounting Standards Board
issued SFAS No. 142, "Goodwill and Other Intangible Assets". SFAS No. 142
requires that an intangible asset that is acquired shall be initially recognized
and measured based on its fair value. The statement also provides that goodwill
should not be amortized, but shall be tested for impairment annually, or more
frequently if circumstances indicate potential impairment, through a comparison
of fair value to its carrying amount. We conducted our annual impairment test
for 2005 in February 2006 and for 2004 in January 2005, utilizing the services
of an independent appraiser, and our annual impairment tests for 2003 in October
2003. We recorded an impairment charge of $3,502,000 at December 31, 2005 as a
result of the impairment test conducted in February 2006.
24
Results of Operations
The following tables set forth, for the periods indicated, historical
operating data as a percentage of net sales:
Year Ended December 31,
---------------------------
2003 2004 2005
---- ---- ----
Net sales 100% 100% 100%
Cost of sales 49 67 66
Advertising and promotion 29 29 23
Bad debt expense 11 4 1
General and administrative expense 18 32 77
Severance and other termination costs 1 -- 8
Depreciation and amortization expense 1 1 2
Charge for impairment of goodwill -- -- 39
Interest expense, net 5 48 6
Loss on early extinguishment of debt -- -- 6
Income tax expense (benefit) 4 78 --
---- ---- ----
Net (loss) (18) (160) (128)
---- ---- ----
Dividends on preferred stock 1 3 16
Deemed dividends on beneficial conversion of -- -- 195
Series D Preferred Stock ==== ==== ====
Net (loss) applicable to common shares (19)% (163)% (339)%
==== ==== ====
Year ended December 31, 2005 compared to year ended December 31, 2004
Net Sales
$(000's)
2004 2005 Change %
------- ------- ------- -----
Sales
Audio Book Club $12,304 $ 4,648 $(7,656) (62.2%)
------------------------------------------
Radio Spirits
Catalog 3,248 2,591 (657) (20.2%)
Wholesale 1,671 1,009 (662) (39.6%)
Continuity 1,403 534 (869) (61.9%)
------------------------------------------
6,322 4,134 (2,188) (34.6%)
------------------------------------------
MediaBay.com 205 173 (32) (15.6%)
Total $18,831 $ 8,955 $(9,876) (52.4%)
==========================================
Audio Book Club sales decreased principally due to a decrease in club
membership as a result of discontinuing our advertising expenditures for new
members.
In the second quarter of 2005, we changed our business model from that of
a traditional "book-of-the-month club" with a negative option format to a
business selling audiobooks and other audio entertainment under a positive
option drop ship format. Under the negative option format, unless the member
affirmatively declined the audiobook selection featured in our mailing on or
prior to the designated reply date, the featured item was automatically shipped
to the member and the member was billed for the product. Under our current
positive option drop ship format, products are shipped only if and when the
customer affirmatively orders them. As a result of this change, we anticipate
lower returns from our customers in future periods.
25
The decrease in Radio Spirits catalog sales is principally attributable to
fewer customers, as we have not incurred marketing expenditures to attract new
members, and greater discounting in our catalogs. Wholesale sales of old-time
radio products decreased principally due to reduced sales to our major
customers. Sales of our World's Greatest Old-Time Radio continuity program
decreased principally due to the lack of advertising expenditures for new
customers. Cost of sales
Cost of sales
$(000's)
As a % As a %
2004 of NetSales 2005 of Net Sales Change %
----------------------------------------------------------------------
Audio Book Club $ 8,469 68.8% $ 3,488 75.0% $ 4,981 58.8%
----------------------------------------------------------------------
Radio Spirits
Catalog 1,476 45.5% 1,261 48.7% 215 14.6%
Wholesale 1,346 80.6% 934 92.6% 412 30.6%
Continuity 495 35.3% 237 44.4% 258 52.1%
Other 760 12.0% -- -- 760 100.0%
----------------------------------------------------------------------
4,077 64.5% 2,432 58.8% 1,645 40.3%
----------------------------------------------------------------------
MediaBay.com 1 0.3% -- 0.0% 1 100.0%
----------------------------------------------------------------------
Total $12,547 66.6% $ 5,920 66.1% $ 6,627 52.8%
----------------------------------------------------------------------
The principal reason f or the de cline in cost of sales at Audio Book Club
was a reduction in sales of 62.2% as described above. Cost of sales as a
percentage of sales at Audio Book Club for the year ended December 31, 2005 was
75.0% compared to 68.8% for 2004. The increase in cost of sales as a percentage
of sales is principally due to an increase in product and related royalty costs
as a percentage of sales (accounting for 42% of the increase) since a smaller
active membership requires us to purchase finished goods from publishers rather
than the licensing and manufacturing of product due to lower sales and our
inability to meet manufacturing minimums and recoup advances to publishers,
higher sales of unabridged and CD titles with higher costs and higher
manufacturing costs due to lower volumes until in the second quarter of 2005 we
moved our warehouse and fulfillment operations to a facility which allows us to
drop ship from its inventory and accordingly we have changed from licensing and
manufacturing our audiobook titles to buying on a wholesale basis. Under our new
buying arrangement we are buying products at a fixed percentage off of
manufacturer's suggested retail price. The cost of the new arrangement will be
dependent on future sales volume. Additionally, an increase in fulfillment costs
as a percentage of sales (accounting for 58% of the increase) due to the fixed
cost of fulfillment being allocated over lower sales as well as one time
programming and transition costs associated with the change in our fulfillment
operations and the move from a negative option book club to a business selling
audiobooks and other audio entertainment without a negative option requirement
contributed to the increase in cost of sales as a percentage of sales at Audio
Book Club.
Cost of Radio Spirits catalog sales increased as a percentage of sales to
48.7% for year ended December 31, 2005 as compared to 45.5% for 2004,
principally due to higher royalty and fulfillment costs as a percentage of the
lower sales volume due to the fixed portion of royalty advances and warehousing
and fulfillment costs. The cost of wholesale sales as percentage of sales
increased to 92.6% for the year ended December 31, 2005 as compared to 80.6% for
2004, principally due to a greater portion of fixed costs, the fixed cost of
warehousing and fulfillment (accounting for 54% of the increase) and royalty
advances (accounting for 46% of the increase) in relation to the lower sales
volume. The cost of World's Greatest Old-Time Radio continuity sales as a
percentage of sales increased to 44.4% for the year ended December 31, 2005 as
compared to 35.3% for 2004, principally due to the fixed cost associated with
warehousing and fulfillment in relation to the lower sales volume as we have not
marketed for new customers.
26
In the second quarter of 2005, due to the change in strategy for our
audiobook club we recorded a $305,000 write-down of royalty advances to what we
believe is net realizable value at December 31, 2005. In 2004 we recorded $3.0
million of charges relating to Audio Book Club representing $1.9 million in
inventory write-downs and $1.1 million for the write-down of royalty advances.
Additionally, we recorded $760,000 in charges relating to Radio Spirits
representing the write-down of inventory of $560,000 and royalty advances of
$200,000 included in the other category on the chart above as they are not able
to be allocated to any one business line within Radio Spirits.
Advertising and promotion
$(000's) 2004 2005 Change %
------- ------- ------- ------
Audio Book Club
New member $ 414 $ -- $ 414 100.0%
Current Member 994 448 546 54.9%
---------------------------------------
Total Audio Book Club 1,408 448 960 68.2%
---------------------------------------
Radio Spirits
Catalog 787 760 27 3.4%
Wholesale 57 43 14 24.6%
Continuity 6 0 6 100.0%
---------------------------------------
Total Radio Spirits 850 803 47 5.5%
---------------------------------------
New Projects 164 824 (660) (402.4)%
---------------------------------------
Total Spending 2,422 2,075 347 14.3%
---------------------------------------
Amount Capitalized (354) -- (354) 100.0%
Amount Amortized 3,478 16 3,462 99.5%
---------------------------------------
Advertising and Promotion Expense $ 5,546 $ 2,091 $ 3,455 62.3%
=======================================
Advertising and promotion expenses decreased to $2.1 million for the year
ended December 31, 2005 as compared to $5.5 million in 2004, principally due to
lower amortization of deferred customer acquisition costs. In the fourth quarter
of 2004, based on the change in our strategy, described above, we determined
that the future net revenue from our Audio Book Club would not support the
carrying amount of the direct-response advertising reported as assets relating
to the Audio Book Club. Accordingly, we wrote-off $846 the carrying amount of
the asset in the fourth quarter for 2004 resulting in an increase in advertising
expense in 2004 and lower expense in 2005. The decrease in spending was due to
the lack of new customer marketing for Audio Book Club new customers due to our
change in strategy as described above and decreased advertising to existing
customers due to the reduction in Audio Book Club customers because of customer
attrition with no marketing to replace leaving members.
27
In 2005, we spent $824,000 related to new projects, principally direct
marketing related to the promotion of digital downloads of spoken word
entertainment.
Bad debt expense
As a % As a %
$(000's) 2004 of Net Sales 2005 of Net Sales Change %
---- --- ---- --- ---- ----
Audio Book Club $744 6.0% $ 8 0.2% $736 98.9%
---- --- ---- --- ---- ----
Radio Spirits
Catalog -- 0.0% -- 0.0% -- *
Wholesale 15 0.9% 15 1.5% -- 0.0%
Continuity 70 5.0% 28 5.3% 42 59.8%
---- --- ---- --- ---- ----
85 1.3% 43 1.0% 42 49.3%
---- --- ---- --- ---- ----
MediaBay.com -- -- -- -- -- --
---- --- ---- --- ---- ----
Total $829 4.4% $ 51 0.6% $778 93.9%
==== === ==== === ==== ====
The principal reason for the decline in bad debt expense at Audio Book
Club was a reduction in net sales of 62.2% as described above. Bad debt expense
as a percentage of sales at Audio Book Club for the year ended December 31, 2005
was 0.2 %, compared to 6.0% for the year ended December 31, 2004. The decrease
in bad debt expense as a percentage of net sales at Audio Book Club was
principally due to better than anticipated payments from remaining core members
who historically have been good paying customers.
General and administrative
As a % As a %
$(000's) 2004 of Net Sales 2005 of Net Sales Change %
---- ------------ ---- ------------ ------ -
Audio Book Club $ 2,379 19.3% $ 1,452 31.2% $ 927 39.0%
Radio Spirits 959 15.2% 858 20.8% 101 10.5%
MediaBay.com 621 302.7% 561 325.1% 60 9.6%
Corporate 2,084 4,024 0.0% (1,940) (93.1%)
--------------------------------------------------------------------------
Total $ 6,043 32.1% $ 6,895 77.0% $ (851) (14.1%)
==========================================================================
The increase in general and administrative expenses of $851,000 for the
year ended December 31, 2005 as compared to the year ended December 31, 2004 is
principally due to increases in payroll and related costs of $347,000, travel
and entertainment expenses of $72,000, and professional fees of $440,000. The
increase in payroll was mainly attributable to various bonuses paid in the
second quarter of 2005 and the hiring, retention and promotion of key employees.
The increase in travel and entertainment expenses relates mainly to business
development travel incurred to build the new digital download business. The
increase in professional fees was mainly attributable to legal and consulting
fees associated with the transition to the new download business strategy, as
well as an increase in accounting fees related to Sarbanes-Oxley compliance.
28
Termination costs
Year ended December 31,
-------------------------
$(000's) 2004 2005
---------- -----------
Termination costs................... $ -- $ 697
========== ===========
In the second quarter of 2005, the employment of one senior executive who
had an employment agreement was terminated and the employment of several
employees, one of which had an employment agreement, was also terminated. We
agreed to make aggregate settlement payments totaling $697,000 payable through
March 2006.
Depreciation and amortization
Year ended
December 31,
-------------------------
$(000's) 2004 2005
---------- -----------
Depreciation:
Audio Book Club............................. $ 83 $ 126
Radio Spirits............................... 37 20
---------- -----------
Total depreciation....................... 120 146
Amortization:
Corporate................................... 24 8
---------- -----------
Total depreciation and amortization.. $ 144 $ 154
========== ===========
The increase in depreciation and amortization expenses for the year ended
December 31, 2005 as compared to the year ended December 31, 2004 is principally
attributable to depreciation on fixed asset additions in 2005, partially offset
by reductions in the amortization of intangibles, which had been fully amortized
or written off during the year ended December 31, 2004.
Charge on impairment of goodwill
Year ended December 31,
--------------------------
$(000's) 2004 2005
----------- ----------
Charge on impairment of goodwill.... -- $ 3,502
=========== ==========
Goodwill represents the excess of the purchase price over the fair value
of net assets acquired in business combinations accounted for using the purchase
method of accounting. In accordance with Statement of Financial Accounting
Standards ("SFAS") No. 142, "Goodwill and Other Intangible Assets", we ceased
amortization of goodwill as of January 1, 2002. We performed annual impairment
tests as of December 31, 2005, 2004 and 2003 in February 2006, January 2005 and
October 2003, respectively. We recorded an impairment charge of $3,502 at
December 31, 2005 as a result of the impairment test conducted in February 2006.
29
Interest expense
2004 2005 Change %
-------- ------- --------- ---------
$ (000's)
Total interest paid $ 1,045 $ 677 $ (368) (35.2%)
Interest accrued 25 - (25) (100.0%)
Interest included in principle amount of debt (1) 521 - (521) (100.0%)
Amortization of deferred financing costs
and original issue discount 1,341 90 (1,251) (93.3%)
Loss from early extinguishment of debt 1,532 579 (953) (62.2%)
Beneficial Conversion of Debt 3,991 - (3,991) (100.0%)
Inducement to Convert 391 - (391) (100.0%)
Interest converted to preferred stock 254 - (254) (100.0%)
-------- ------- --------- ---------
Total interest expense 9,100 1,346 (7,754) (85.2%)
Interest Income (18) (257) 239 (1,327.8%)
-------- ------- --------- ---------
Net interest expense $ 9,082 $ 1,089 $ (7,993) (88.0%)
======== ======== ========= =========
(1) For the year ended December 31, 2004 we had outstanding loan
agreements that provided for accrued interest on the loans to be added to the
principal amount of the debt.
The decrease in interest expenses is principally due to the conversion of
debt into preferred stock and common stock in 2004 and the payment of the senior
debt facility and related party debt in connection with our March 2005 Series D
preferred stock financing described below under "Liquidity and capital resources
- Financing activities."
Income tax expense
Year ended December 31,
------------------------------
$ (000's) 2004 2005
------------- ------------
Income tax expense........... $ 14,753 $ --
========= =====
The ultimate realization of deferred tax assets is dependent on the
generation of future taxable income during the periods in which temporary timing
differences become deductible. We determine the utilization of deferred tax
assets in the future based on current year projections by management.
Based on the change in our distribution strategy, described above, we have
determined that it is more likely than not (a likelihood of more than 50%) that
we will be unable to realize all or part of our net deferred tax asset.
Accordingly, we have made an adjustment to the deferred tax asset recording an
increase to the valuation allowance, resulting in a deferred tax expense charged
against income of $14.8 million in the fourth quarter of 2004, the period when
such determination was made.
We have provided a full valuation allowance against the increase in
deferred tax assets relating to our loss in 2005.
30
Preferred stock dividends
2004 2005
---- ----
$ (000's)
Dividends accrued on Series A Preferred Stock $ 228 $ 50
Dividends accrued on Series B Preferred Stock 28 2
Dividends accrued on Series C Preferred Stock 318 100
Dividends accrued on Series D Preferred Stock -- 1,294
--------------------
Total dividends accrued on preferred stock 574 1,446
Deemed dividend on beneficial conversion of
Series D Preferred Stock -- 17,423
--------------------
Total $ 574 $ 18,869
====================
The shares of our Series D Preferred Stock are convertible at any time at
the option of the holder into shares of our common stock at the rate of $3.30
per share, and each warrant issued in connection with our March 2005 Series D
Preferred Stock financing is exercisable to purchase one share of our common
stock at an exercise price of $3.36 per share. The market price for our common
stock at March 21, 2005 was $4.14. We recorded a non-cash deemed dividend in the
amount of $17,423,000 to reflect the value of the beneficial conversion feature
of the Series D Preferred Stock and increased contributed capital by
$17,423,000. The recording of the dividend had no effect on our cash or net
equity.
The increase in preferred stock dividends for the year ended December 31,
2005 as compared to the year ended December 31, 2004 is due to the accrual of
dividends for the Series D Preferred Stock issued in March 2005, as described
below in "Liquidity and capital resources - Recent financing transaction."
During the second quarter of 2005, 1,180 shares of Series D Preferred
Stock were converted into 361,700 shares of common stock and between July 1,
2005 and during the third quarter an additional 13,657 shares of Series D
Preferred Stock and related dividends were converted into 4,159,822 shares of
common stock. These conversions and future conversions, if any, will reduce the
preferred stock dividend in future periods.
Loss applicable to common stockholders
$(000's) Year ended December 31, From 2004 to 2005
----------------------------- -------------------------
2004 2005 $ change % change
------------ ------------ -------- --------
Loss applicable to common stockholders..... $ (30,687) $ (30,313) $ 374 1.2%
============ ============= ======== ====
Principally due to the deemed dividend for beneficial conversion of Series
D Preferred Stock of $17,423,000 charge on impairment of goodwill of $3,502,000
and lower sales, our net loss applicable to common shares for the year ended
December 31, 2005 was $30.3 million or $4.08 per diluted share.
Principally due to reduced sales and interest expense, including
beneficial conversion charges, and recognition of deferred tax expenses, our net
loss applicable to common shares for the year ended December 31, 2004 was $30.7
million, or $10.24 per diluted share.
31
Year ended December 31, 2004 compared to year ended December 31, 2003
Net sales
Year ended December 31,
------------------------------------------------------------ Change from
$(000's) 2003 2004 2003 to 2004
------------- -------------- ------------- ------------- ----------------------------
$ As a % of $ As a % of
amount net sales amount net sales $ change % change
------------- -------------- ------------- ------------- -------------- ------------
Audio Book Club............... $ 26,380 72.0% $ 12,303 65.3% $ (14,076) (53.4)%
------------- -------------- ------------- ------------- --------------
Radio Spirits:
Catalog.................... 4,210 11.5% 3,248 17.2% (962) (22.8)%
Wholesale.................. 3,048 8.3% 1,671 8.9% (1,377) (45.2)%
Continuity................. 2,841 7.8% 1,403 7.5% (1,438) (50.6)%
------------- -------------- ------------- ------------- --------------
Total Radio Spirits...... 10,099 27.6% 6,322 33.6% (3,777) (37.4)%
------------- -------------- ------------- ------------- --------------
MediaBay.com.................. 138 0.4% 205 1.1% 67 48.7%
------------- -------------- ------------- ------------- --------------
$ 36,617 100.0% $ 18,831 100.0% $ (17,786) (48.6)%
============= ============== ============= ============= ==============
Audio Book Club sales decreased principally due to a decrease in club
membership as a result of a reduction in our advertising expenditures for new
members. For the year ended December 31, 2004, the Audio Book Club spent
$414,000 to attract new members, a reduction of $1.7 million, or 80.2%, from the
amount spent to attract new members of $2.1 million during the year ended
December 31, 2003. Audio Book Club attracted approximately 19,000 new members in
the year ended December 31, 2004 as compared to approximately 134,000 new
members in the year ended December 31, 2003.
The decrease in Radio Spirits catalog sales is principally attributable to
lower sales from catalogs mailed due to less new product introductions into the
catalogs and fewer new customers. Wholesale sales of old-time radio products
decreased principally due to lower orders from mass merchants and other
retailers. Sales of our The World's Greatest Old-Time Radio continuity program
decreased for the year ended December 31, 2004, as compared to the year ended
December 31, 2003, principally due to the reduction in our advertising
expenditures for new members. For the year ended December 31, 2004, we spent
$6,000 to attract new continuity customers, compared to $775,000 spent to
attract new customers during the year ended December 31, 2003.
Cost of sales
Year ended December 31,
------------------------------------------------------------ Change from
$(000's) 2003 2004 2003 to 2004
------------- -------------- ------------- ------------- ----------------------------
$ As a % of $ As a % of
amount net sales amount net sales $ change % change
------------- -------------- ------------- ------------- -------------- ------------
Audio Book Club.......... $ 12,392 47.0% $ 8,469 68.8% $(3,923) (31.7)%
------------- -------------- ------------- ------------- -------------- ------------
Radio Spirits:
Catalog............... 2,015 47.9% 1,476 45.5 (539) (26.7)
Wholesale............. 2,057 67.5% 1,346 80.6 (711) (34.6)
Continuity............ 1,295 45.6% 495 35.3 (800) (61.8)
Other -- -- 760 12.0 760 100.0
------------- -------------- ------------- ------------- -------------- ------------
Total Radio Spirits. 5,367 53.1% 4,077 64.5 (1,290) (24.0)
MediaBay.com............. 5 -- 1 0.3 (4) (80.0)
------------- -------------- ------------- ------------- -------------- ------------
$ 17,764 48.5% $ 12,547 66.7% $(5,217) (29.4)%
============= ============== ============= ============= ============== ============
32
The principal reason for the decline in cost of sales at Audio Book Club
was a reduction in net sales of 53.4% as described above. Cost of sales as a
percentage of net sales at Audio Book Club for the year ended December 31, 2004
was 68.8%, compared to 47.0% for 2003.
We are committed to digitizing and encoding our library of spoken word
content and making our content available to the digital customer as described in
the introduction to this section and are transitioning our business from a
predominately mail order business to an Internet based business. The increase in
cost of sales as a percentage of sales was mainly attributable to $1.87 million
of inventory written down to net realizable value due to a reduction in Audio
Book Club members and our new focus on delivering our audiobooks and other
spoken word products via downloads and $1.1 million of write-downs to royalty
advances paid to audiobook publishers and other license holders, which will not
be recoverable due to our new focus on delivering spoken word products via
downloads.
As a percentage of net sales, cost of sales at Radio Spirits increased to
64.5% for the year ended December 31, 2004 from 53.1% for the year ended
December 31, 2003. Cost of catalog sales decreased as a percentage of net dales
to 45.5% as compared to 47.9% for the year ended December 31, 2003 principally
due to less discounting in the catalogs. The cost of wholesale sales as a
percentage of net revenue increased to 80.6% as compared to 67.5% for the year
ended December 31, 2003 principally due to sales to discounters of discontinued
items. The cost of World's Greatest Old-time Radio continuity sales as a
percentage of sales decrease to 35.3% from 45.6% principally due to the smaller
number of new customers in 2004 whose initial purchase has as very high cost of
goods sold. In the fourth quarter of 2004, we reviewed our product mix of
offerings to both our mail order and wholesale Radio Spirits customers. We have
experienced a significant shift in the mix between compact discs and cassettes
and will substantially reduce the number of cassette offerings in the future.
Accordingly, we wrote off $560,000 of cassette inventory as well as a portion of
our CD inventory relating to older products and $200,000 of royalty advances
which we do not expect to recoup. The write off amounts are included in the
other category on the chart above as they are not able to be allocated to any
one business line within Radio Spirits.
In the fourth quarter of 2003, we evaluated the performance of Audio
Passages, an Audio Book Club marketing program tailored to listeners with an
interest in Christian product, and determined based on past performance and
expected future performance that we should terminate the Audio Passages
marketing program. In connection with the termination of the Audio Passages
marketing program, we took a strategic charge for the establishment of a reserve
for obsolescence of Audio Passages inventory of $0.3 million.
33
Advertising and promotion
Year ended December 31, From 2003 to 2004
------------------------------ -----------------------------
$(000's) 2003 2004 $ change % change
-------------- -------------- ----------- ---------------
Audio Book Club:
New member............................ $ 2,092 $ 414 $ (1,678) (80.2)%
Current member......................... 1,993 994 (999) (50.1)%
-------------- -------------- -----------
Total Audio Book Club............... 4,085 1,408 (2,677) (65.5)%
Radio Spirits:
Catalog................................ 964 787 (177) (18.4)%
Wholesale.............................. 74 57 (17) (22.3)%
Continuity............................. 775 6 (769) (99.2)%
-------------- -------------- -----------
Total Radio Spirits................. 1,813 850 (963) (53.1)%
-------------- -------------- -----------
New projects.............................. 339 164 (175) (51.6)%
-------------- -------------- -----------
Total spending............................ 6,237 2,422 3,815 61.2%
Amount capitalized........................ (2,410) (354) (2,056) (85.3)%
Amount amortized.......................... 6,625 3,478 3,147 47.5%
-------------- -------------- -----------
Advertising and promotion expense......... $ 10,452 $ 5,546 $ (4,906) (46.9)%
============== ============== ===========
Advertising and promotion decreased $4.9 million to $5.5 million or 46.9%
for the year ended December 31, 2004 from the year ended December 31, 2003 of
$10.4 million. Actual advertising expenditures for the year ended December 31,
2004 decreased $3.8 million to $2.4 million from $6.2 million during the year
ended December 31, 2003. The decrease was due to a minimal amount of new member
marketing for Audio Book Club new members due to cash constraints and our change
in strategy as described above and decreased advertising to existing members due
to the reduction in Audio Book Club membership because of normal member
attrition with no marketing to replace leaving members. Radio Spirits continuity
advertising was reduced due to cash constraints. We spent $164,000 on new
projects in 2004 principally marketing tests for the digital business.
Included in Audio Book amortization in 2004 is an adjustment to write-off
the carrying amount of the capitalized advertising in the amount of $846,000 due
to the change in strategy described above. In 2003 we wrote off $0.5 million in
capitalized advertising in connection with the termination of the Audio Passages
marketing program.
Bad debt expense
Year ended December 31,
------------------------------------------------------------ Change from
$(000's) 2003 2004 2003 to 2004
------------- -------------- ------------- ------------- ----------------------------
$ As a % of $ As a % of
amount net sales amount net sales $ change % change
------------- -------------- ------------- ------------- -------------- ------------
Audio Book Club.......... $ 3,404 12.9% $ 744 6.0% $ (2,660) (78.1)%
------------- -------------- ------------- ------------- --------------
Radio Spirits:
Catalog............... -- -- -- -- -- --%
Wholesale............. 15 0.5 15 0.8 -- --%
Continuity............ 521 18.3 70 5.2 (451) (86.5)%
------------- -------------- ------------- ------------- --------------
Total Radio Spirits. 536 5.3 85 1.3 (451) (84.1)%
MediaBay.com............. -- -- -- -- -- --%
------------- -------------- ------------- ------------- --------------
$ 3,940 10.8% $ 829 4.4% $ 3,111 (79.0)%
============= ============= ==============
34
The principal reason for the decline in bad debt expense at Audio Book
Club was a reduction in net sales of 53.4% as described above. Bad debt expense
as a percentage of net sales at Audio Book Club for the year ended December 31,
2004 was 6.0 %, compared to 12.9% for the year ended December 31, 2003. The
decrease in bad debt expense as a percentage of net sales is principally due to
a reduced number of new members, who typically have higher bad debt expense,
since a lower number of new members were added in the year ended December 31,
2004 as compared to the year ended December 31, 2003.
The bad debt expense of World's Greatest Old-Time Radio continuity for the
year ended December 31, 2004 decreased by $451,000 to $70,000 from $521,000 for
the year ended December 31, 2003. As a percentage of net sales, bad debt expense
for the World's Greatest Old-Time Radio continuity for the year ended December
31, 2004 was 5.2% as compared to 18.3% for the year ended December 31, 2003. The
decrease in bad debt expense as a percentage of net sales is principally due to
a reduced number of new customers, who typically have higher bad debt expense,
since a lower number of new customers were added in the year ended December 31,
2004 as compared to the year ended December 31, 2003.
Because of the reasons stated above, our bad debt expense decreased $3.1
million, or 79.0% to $829,000 for the year ended December 31, 2004 as compared
to $3.9 million for the year ended December 31, 2003. As a percentage of net
sales, bad debt expense was 4.4 % for the year ended December 31, 2004 as
compared to 10.8% for the year ended December 31, 2003.
General and administrative
Year ended December 31,
------------------------------------------------------------ Change from
$(000's) 2003 2004 2003 to 2004
---------------------------- ---------------------------- ----------------------------
$ As a % of $ As a % of
amount net sales amount net sales $ change % change
------------- -------------- ------------- ------------- -------------- ------------
Audio Book Club....... $ 2,626 10.0% $ 2,379 19.3% $ (247) (9.4)%
Radio Spirits......... 1,163 11.5% 959 15.2% (204) (17.5)%
MediaBay.com.......... 614 621 7 1.1%
Corporate............. 2,413 2,084 (329) (13.6)%
------------- ------------- --------------
$ 6,816 18.6% $ 6,043 32.1% $ (773) (11.3)%
============= ============= ==============
General and administrative expenses at Audio Book Club declined
principally due to reductions in payroll and related costs due to reduced staff.
General and administrative expenses at Radio Spirits for the year ended December
31, 2004 declined principally due to reductions in payroll of $136,000 due to
reduced staff and reduced commissions to outside sales personnel of $127,000 due
to lower wholesale sales. Our corporate general and administrative expenses for
the year ended December 31, 2004 declined principally due to lower payroll of
$257,000 costs due to fewer employees.
Termination costs
Year ended December 31,
-------------------------------
$(000's) 2003 2004
------------- -------------
Termination costs...................... $ 544 $ --
============= =============
In 2003, the employment of two senior executives who had employment
agreements was terminated and the decision was made to terminate the employment
agreement of another senior executive. A consulting agreement was also
terminated. We agreed to make aggregate settlement payments under the employment
agreements and consulting agreement for total consideration of $.5 million
payable through May 2005.
35
Depreciation and amortization
Year ended December 31,
------------------------------------------------------------ Change from
$(000's) 2003 2004 2003 to 2004
---------------------------- ---------------------------- ----------------------------
$ As a % of $ As a % of
amount net sales amount net sales $ change % change
------------- -------------- ------------- ------------- -------------- ------------
Depreciation:
Audio Book Club..... $ 104 0.4% $ 83 0.7% $ (21) (19.9)%
Radio Spirits....... 42 0.4% 37 0.6% (5) (11.9)%
------------- ------------- --------------
Total depreciation. 146 120 (26)
------------- ------------- --------------
Amortization:
Corporate.......... 182 -- 24 -- (158) (87.0)%
------------- ------------- --------------
Total depreciation and
amortization........ $ 328 0.9% $ 144 0.8% $ (184) (75.0)%
============= ============= ==============
The decrease in amortization expenses is principally attributable to the
reduction of the carrying amounts of our intangible assets made in the fourth
quarter of 2003. Specifically, we made a strategic decision to no longer compete
in the DVD market and accordingly wrote off the value of certain video and DVD
rights we had acquired in the amount of $90,000. We also made the strategic
decision in the fourth quarter of 2003 to discontinue future mailings to the
Columbia House lists of members of other clubs. Accordingly, in the fourth
quarter of 2003, we wrote off the unamortized value of the Columbia House
mailing agreement of $986,000.
Interest expense
Year ended December 31, From 2003 to 2004
-------------------------------- ------------------------------
$(000's) 2003 2004 $ Change % Change
--------------- --------------- ------------ -------------
Interest paid.............................. $ 384 $ 1,045 $ 661 159.1%
Interest accrued........................... 74 25 (49) (66.2)%
Accrued interest included in principle amount
of debt outstanding..................... 907 521 (386) (42.6)%
Amortization of deferred financing costs and
original issue discount................. 560 1,341 (781) (139.5)%
Loss on early extinguishment of debt....... -- 1,532 1,532 --
Beneficial conversion expense.............. -- 3,991 3,991 --
Inducement to convert...................... -- 391 391 --
Interest converted to preferred stock...... -- 254 254 --
Less: Interest income...................... -- (18) (18) --
--------------- --------------- ------------
Total interest expense..................... $1,925 $ 9,082 $ 7,157 371.8%
=============== =============== ============
The increase in interest expenses is principally due to increased debt and
higher interest costs and amortization of debt discount relating to the 2004
financing transactions as described below in "Liquidity and capital resources -
Recent financing transactions."
Net loss before income taxes for the year ended December 31, 2004 was
$15.4 million as compared to a net loss before income taxes for the year ended
December 31, 2003 of $5.2 million.
Income tax expense
Year ended December 31, From 2003 to 2004
------------------------------ -------------------------------
$ (000's) 2003 2004 $ change % change
------------- ------------ ------------- -------------
Income tax expense........... $ 1,471 $ 14,753 $ (13,282) 902.9%
============= ============ ============= =============
36
The ultimate realization of deferred tax assets is dependent on the
generation of future taxable income during the periods in which temporary timing
differences become deductible. We determine the utilization of deferred tax
assets in the future based on current year projections by management.
Based on the change in our distribution strategy, described above, we have
determined that it is more likely than not (a likelihood of more than 50%) that
we will be unable to realize all or part of our net deferred tax asset.
Accordingly, we have made an adjustment to the deferred tax asset recording an
increase to the valuation allowance, resulting in a deferred tax expense charged
against income of $14.8 million in the fourth quarter of 2004, the period when
such determination was made.
During the years ended December 31, 2003, we utilized $1,471,000, of the
$17.2 million deferred tax asset recorded in 2001. Accordingly, we recorded
income tax expense of $1,471,000 for the year ended December 31, 2003.
Preferred stock dividends
Year ended December 31, From 2003 to 2004
------------------------------- ------------------------------
$ (000's) 2003 2004 $ Change % Change
-------------- -------------- -------------- -------------
Series A Preferred Stock dividends............ $ 228 $ 228 $ -- --%
Series B Preferred Stock dividends............ 18 28 10 55.6%
Series C Preferred Stock dividends............ -- 318 318 --%
-------------- -------------- --------------
Total dividends accrued on preferred stock.... $ 246 $ 574 328 133.3%
============== ============== ==============
The increase in preferred stock dividends for the year ended December 31,
2004 as compared to the year ended December 31, 2003, is due to an increase in
dividends for Series B Preferred Stock which was issued May 2003 and outstanding
for only part of 2003 and dividends on the Series C Preferred Stock issued in
May 2004. Our Principal Shareholder agreed to exchange the principal of certain
notes, plus accrued and unpaid interest owed to the Principal Shareholder
aggregating $3.8 million and accrued and unpaid dividends owed to the Principal
Shareholder aggregating $519,000 into an aggregate of 43,527 shares of Series C
Preferred Stock convertible into (i) an aggregate of 930,064 shares of Common
Stock at an effective conversion price of $4.68, and (ii) warrants to purchase
an aggregate of 1,860,128 shares of Common Stock. The Series C Preferred Stock
accrues dividends at the rate of 9% per annum.
Loss applicable to common stockholders
Year ended December 31,
---------------------------------- --------------
$(000's) 2003 2004 $ change
----------------- ---------------- --------------
Loss applicable to common stockholders..... $ 6,869 $ 30,687 $ 23,818
======= ========= ========
Principally due to reduced sales and higher interest costs, partially
offset by lower advertising, bad debt expense, certain write-offs and strategic
charges described above general and administrative expenses, increased interest
expenses, including beneficial conversion charges and recognition of deferred
tax expenses, our net loss applicable to common shares for the year ended
December 31, 2004 increased $23.8 million to $30.7 million, or $10.26 per
diluted share as compared to a net loss applicable to common shares for the year
ended December 31, 2003 of 6.9 million, or $2.94 per diluted share of common
stock.
37
Liquidity and capital resources
Historically, we have funded our cash requirements through sales of equity
and debt securities and borrowings from financial institutions and our principal
shareholders.
As of December 31, 2005, we had cash on hand of $8.2 million, which is
substantially greater than the $3.1 million cash on hand at December 31, 2004.
However, our cash balance has declined during 2006 and will continue to decline
for the foreseeable future unless we obtain financing, as we continue to use
cash in our operations.
We are currently pursuing a new strategy of selling downloadable spoken
word and hard good format content online. To date, our sales of digital
downloads have been minimal.
Because we are pursuing a new strategy, which focuses on downloadable
spoken word content, we have not, and will not, devote the funds necessary to
acquire new Audio Book Club members to offset member attrition. As a result,
revenue will continue to decline, which will continue to negatively impact our
performance and result in negative cash flow from operations. We expect this
trend to continue until such time, if ever, we can generate significant revenue
from the sale of downloadable spoken word content and attract and establish a
meaningful customer base for our online websites or other websites we may
develop.
We believe that our existing cash plus anticipated revenues will not be
sufficient to fund our capital commitments described below and operate our
business for the next twelve months without raising additional financing. We
have engaged investment bankers to help seek strategic alternatives for us
including raising additional financing. There can be no assurance that we will
be successful in raising additional financing. The failure to do so in a timely
manner will limit our ability to execute our business plan and could ultimately
impair our ability to continue as a going concern.
Cash flows
For the year ended December 31, 2005, cash increased by $5.1 million, as
we had net cash used in operating activities of $6.2 million, used net cash of
$1.7 million in investing activities and had cash provided by financing
activities of $13.0 million.
Operating Activities
We used approximately $6.2 million in operating activities during 2005.
Net cash used in operating activities principally consisted of the net loss of
$11.4 million, increases of $319,000 and $34,000 in prepaid expenses and royalty
advances, respectively and a decrease in accounts payable and accrued expense of
$643,000 which were partially offset by the non-cash charges consisting of the
charge for impairment of goodwill of $3,502,000 the loss on early extinguishment
of debt of $579,000, depreciation and amortization expenses of $154,000,
amortization of deferred financing costs and original issue discount of
$240,000, non-current accrued interest and dividends payable of $155,000 and
amortization of deferred member acquisition costs of $17,000; as well as
decreases in accounts receivable and inventory of $816,000 and $767,000,
respectively. The decreases in accounts receivable and inventory are primarily
attributable to the reduction in sales as described above and the remaindering
of manufactured audio book inventory under license due to the change in strategy
discussed above. The increase in prepaid expenses is principally due to the
timing of payments of marketing costs and other costs related to the download
business and certain Radio Spirit's catalog costs. The decrease in accounts
payable and accrued expenses is principally due to the payment of back royalties
to publishers.
38
Investing Activities
During the year ended December 31, 2005, net cash used in investing
activities consists of acquisition of fixed assets and website development costs
of $1.7 million, principally computer equipment and the cost of the development
of the new websites offering downloadable audio.
Financing Activities.
During the year ended December 31, 2005, we received net cash proceeds
from the sale of Series D Preferred Stock of $31.4 million, as described below,
repaid debt in the amount of $11.8 million, repaid accrued interest, dividends
and fees relating to the debt of $891,000 and redeemed Series A and Series C
Preferred Stock in the amount of $5.8 million, received $40,000 from the
exercise of stock options and had an increase in deferred financing costs of
$107,000. Recent financing transactions
The following is a summary of our financing activities since January 1, 2004:
January 2004 convertible debt
On January 29, 2004, we issued $4.0 million aggregate principal amount of
promissory notes and warrants to purchase 392,158 shares of common stock,
referred to as the January 2004 warrants, to institutional and accredited
investors.
The notes were due on the earlier of (i) April 30, 2005, (ii) such date on
or after July 1, 2004 when all of our indebtedness under our existing credit
facility was either repaid or refinanced or (iii) our consummation of a merger,
combination or sale of all or substantially all of our assets or the purchase by
a single entity, person or group of affiliated entities or persons of 50% of our
voting stock. The notes bore interest at the rate of 6%, increasing to 9% on
April 28, 2004 and 18% on July 27, 2004. In accordance with the terms of the
notes, upon our receipt of shareholder approval, which occurred on April 12,
2004, the principal amount of the notes automatically converted into shares of
our common stock at the rate of $4.50 per share, or approximately 888,888
shares. In addition, accrued interest in the amount of $49,000 also converted
into common stock at $4.50 per share, or 10,813 shares.
The January 2004 warrants are exercisable until January 28, 2009 at an
exercise price of $7.68 per share.
In connection with our January 2004 note financing, we issued to the
placement agent and a broker warrants to purchase an aggregate of 40,833 shares
of common stock and also issued to the placement agent warrants to purchase an
additional 83,481 shares of our common stock on April 12, 2004 as partial
consideration for the placement agent's services. All of these warrants are
identical to the January 2004 warrants.
We used a portion of the proceeds of the January 2004 financing to repay
$1,250,000 of principal due on our prior credit agreement with ING (U.S.)
Capital, L.L.C. and Patriarch Partners, L.L.C. and to reduce our accounts
payable.
2004 Credit Agreement and related financing transactions
On April 28, 2004, we entered into a credit agreement, referred to as the
2004 Credit Agreement, by and among MediaBay and certain of its subsidiaries,
the guarantors signatory thereto, Zohar CDO 2003-1, Limited, referred to as
Zohar, as lender, and Zohar, as agent, pursuant to which we and certain of our
subsidiaries initially borrowed $9.5 million. The initial term of the 2004
Credit Agreement was one year and it was extendable, at our sole option, for two
additional one-year terms upon issuance of additional notes of $600,000 for the
first additional year and $300,000 for the second additional year,
39
provided there was no event of default. The loan bears interest at the rate of
LIBOR plus 10%. In the first year of the loan, a fee of $900,000 has been added
to the principal balance, which will be reflected as debt discount and will be
accreted to interest expense over the next twelve months. We used a portion of
the $8.6 million of funds received under the 2004 Credit Agreement to satisfy
all of our outstanding obligations under (i) promissory notes that we issued in
October 2003 in the aggregate principal amount of $1.0 million plus accrued
interest of $200,000 and (ii) our outstanding credit agreement, which had an
outstanding principal balance of approximately $1.4 million and a partial
payment of $1.6 million on the convertible note issued to ABC Investment, L.L.C.
as described below. In connection with the March 2005 financing described below,
we repaid all amounts due under the 2004 Credit Agreement.
Norton Herrick, a principal shareholder of ours at that time, referred to
as Herrick, Huntingdon Corporation, a company wholly-owned by Herrick, referred
to as Huntingdon, and N. Herrick Irrevocable ABC Trust, of which Herrick is the
beneficiary, and Howard Herrick, a principal shareholder of ours at the time,
was the trustee, referred to as the Herrick Trust, consented to the 2004 Credit
Agreement and the other transactions described above and entered into a
subordination agreement with Zohar. The 2004 Credit Agreement required the
aggregate amount of principal and interest owed by us to Herrick, Huntingdon and
the Herrick Trust be reduced to $6,800,000 ("Permissible Debt") by June 1, 2004.
Pursuant to an agreement dated April 28, 2004, on May 25, 2004, Herrick
exchanged accrued and unpaid interest and dividends (including accrued and
unpaid interest distributed by the Herrick Trust to Herrick) owed by us to
Herrick aggregating $1,181,419 into (i) 11,814 shares of our Series C Preferred
Stock with a liquidation preference of $100 per share convertible into an
aggregate of 252,436 shares of common stock at an effective conversion price of
$4.68, and (ii) warrants to purchase 504,872 shares of common stock. The
warrants are exercisable until April 28, 2014 at an exercise price of $3.18.
Pursuant to an agreement dated April 28, 2004, on May 25, 2004 Huntingdon
exchanged the principal of the $500,000 principal amount note, $1,000,000
principal amount note, $150,000 principal amount note and $350,000 principal
amount note held by Huntingdon, plus accrued and unpaid interest owed by us to
Huntingdon aggregating $1,171,278 into (i) 31,713 shares of our Series C
Preferred Stock convertible into an aggregate of 677,628 shares of common stock
at an effective conversion price of $4.68, and (ii) warrants to purchase an
aggregate of 1,355,256 shares of our common stock. The warrants are exercisable
until April 28, 2014 at an exercise price of $3.18. If the amount of the
Permissible Debt is required to be reduced due to our failure to raise the
requisite additional equity, such reduction will automatically occur by the
exchange of Permissible Debt held by Huntingdon for additional shares of Series
C Preferred Stock in an aggregate liquidation preference equal to the amount of
debt exchanged and warrants to purchase a number of shares of common stock equal
to two times the number of shares of preferred stock issuable upon conversion of
the Series C Preferred Stock.
Herrick and Huntingdon agreed not to demand repayment of their debt
until the earlier of (i) the repayment of the 2004 Credit Agreement or (ii) June
28, 2007. In connection with our March 2005 financing described below, Herrick
and Huntingdon converted all their notes into common stock at their stated
terms.
New ABC note
On April 28, 2004, we repaid $1.6 million principal amount of the $3.2
million principal amount convertible note issued to ABC Investment, L.L.C. We
issued a new $1.6 million note for the remaining principal amount. The new ABC
note extended the maturity date from December 31, 2004 to July 29, 2007. In
exchange for extending the maturity date, the conversion price of the new ABC
note was reduced to $3.00. The closing sale price of our common stock on the
closing date was $2.88. In the fourth quarter of 2004, the new ABC note was
converted into shares of our common stock.
40
Settlement of put obligations
Premier Electronic Laboratories, Inc. ("Premier") exercised its right to
put its shares of common stock to us pursuant to a Put Agreement dated December
11, 1990. We entered into a settlement agreement with Premier dated April 1,
2004, pursuant to which, among other things, we agreed to pay Premier $950,000
as payment of the amount due to Premier. Our obligation under the put agreement
was reduced by $150,000 in exchange for relinquishing certain leases for real
property. We paid $14,000 on closing and are paying the remaining balance over
six years in monthly payments starting at $7,000 in July 2004 and increasing to
$19,000 from May 2007 through April 2010.
October 2004 sale of equity
On October 11, 2004, we entered into a Securities Purchase Agreement
pursuant to which we issued to Forest Hill Capital LLC, referred to as Forest
Hill, for the account of certain of its affiliates, referred to as the Forest
Hill entities, an aggregate of 300,000 shares of our common stock and warrants
to purchase 66,667 shares of common stock, referred to as the October 2004
warrants. The Forest Hill entities paid an aggregate purchase price of $900,000
for these shares and October 2004 warrants. Each October 2004 warrant is
exercisable to purchase one share of our common stock at an exercise price of
$4.98 per share until October 11, 2009. In connection with the March 2005
financing described below, the Forest Hill entities exchanged the shares of
common stock and October 2004 warrants issued to them in October 2004 for
securities issued in the March 2005 financing.
March 2005 equity financing
On March 23, 2005, we issued to accredited investors for an aggregate
purchase price of $35.9 million an aggregate of (a) 35,900 shares of our Series
D Convertible Preferred Stock, convertible into 10,878,788 shares of our common
stock, (b) 5,439,394 five-year common stock purchase warrants, referred to as
the March 2005 warrants, and (c) preferred warrants, referred to as
Over-Allotment Warrants, to purchase for additional proceeds to us of $8.975
million, up to 8,975 additional shares of Series D Preferred Stock and 1,359,849
additional March 2005 warrants in a private financing, referred to as the March
2005 financing.
Immediately prior to the March 2005 financing, holders of a majority of
our voting securities approved by written consent (the "Shareholder Consent")
(a) an amendment to our articles of incorporation, increasing the number of our
authorized shares of common stock from 150,000,000 to 300,000,000, (b) a change
of control which could occur as a result of the financing, and (c) our issuance,
in connection with the transactions contemplated by the financing, of common
stock in excess of 19.99% of the number of shares of common stock outstanding
immediately prior to the financing. However, while such actions were approved by
a majority of our shareholders prior to the financing, we were not permitted to
effect them until we satisfied certain information requirements to our
shareholders not party to the Shareholder Consent. As a result, the Shareholder
Consent did not become effective until May 3, 2005.
The shares of Series D Preferred Stock have a face or stated value of
$1,000 per share and are convertible at any time at the option of the holder
into shares of common stock at the rate of $3.30 per each share of common stock,
subject to certain anti-dilution adjustments, including for issuances of common
stock for consideration below the conversion price. The Series D Preferred
shares are also mandatorily convertible at our option, subject to satisfaction
of certain conditions and subject to certain
41
limitations. Under certain limited circumstances within our control, the holders
will also have the right to require us to redeem their shares of Series D
Preferred Stock at their stated value. Cumulative dividends accrue on the Series
D Preferred shares on an annualized basis in an amount equal to 6% of their
stated value until they are converted or redeemed and are payable quarterly in
arrears, on each of January 1, April 1, July 1 and October 1, in cash or, at our
option, subject to satisfaction of certain conditions, in shares of our common
stock valued at 93% of the average of the daily volume weighted average
per-share price of the common stock for the five trading days prior to the
applicable payment date. The Series D Preferred Stock is non-voting. Subject to
certain exceptions for accounts receivable and equipment and capital lease
financings, we may not incur additional indebtedness for borrowed money or issue
additional securities that are senior to or pari passu to the Series D Preferred
Stock without the prior written consent of holders of at least two-thirds of the
then outstanding shares of the Series D Preferred Stock.
Each of the March 2005 warrants is exercisable to purchase one share of
our common stock, at an exercise price of $3.36 per share, until September 23,
2010, subject to certain anti-dilution adjustments, including for issuances of
common stock for consideration below the exercise price of the warrants. In
addition, once exercisable, the March 2005 warrants permit cashless exercises
during any period when the underlying shares are not covered by an effective
resale registration statement.
The Over-Allotment warrants expired unexercised pursuant to their terms.
As part of the March 2005 financing, the Forest Hill entities exchanged
the 300,000 million shares of common stock and 66,667 October 2004 Warrants
previously purchased by them in October 2004, for $900,000 of the securities
issued in the March 2005 financing.
In connection with the March 2005 financing, we also entered into an
agreement, referred to as the Herrick Agreement, with Herrick and Huntingdon,
collectively referred to as the "Herrick Entities, pursuant to which,
concurrently with the financing:
o all $5.784 million principal amount of our convertible notes owned
by the Herrick Entities, referred to as the Herrick Notes, and
10,684 of their shares of our Series A Preferred Stock were
converted into an aggregate of approximately 2.03 million shares of
our common stock, referred to as the Herrick Shares, at their stated
conversion rate of $3.36 per share;
o we also agreed to redeem the remaining 14,316 shares of Series A
Preferred Stock held by the Herrick Entities and all 43,527 of their
shares of our Series C Convertible Preferred Stock for $5.8 million,
the aggregate stated capital of such shares, on the earlier of the
effective date of the Shareholder Consent and September 1, 2005, and
both the shares to be redeemed and the redemption price were placed
into escrow pending such date;
o the Herrick Entities waived certain of their registration rights and
we agreed to include the Herrick Shares for resale in a registration
statement as long as they were owned by the Herrick Entities and not
otherwise transferred, except as contemplated in the Herrick
Agreement;
o the Herrick Entities consented to the terms of the March 2005
financing and the agreements entered into in connection with such
financing, as we were required to obtain such consents pursuant to
the terms of the Herrick Notes, the Series A Preferred Stock and the
Series C Preferred Stock; and
o Herrick and Huntingdon also entered into a voting agreement and
proxy with us pursuant to which they agreed not to take any action
to contradict or negate the Shareholder Consent.
42
We received $35 million of gross proceeds (not including the securities
exchanged by the Forest entities for $900,000 of the purchase price) in the
March 2005 financing. Merriman Curhan Ford & Co. acted as a financial advisor
with respect to certain of the investors in the financing for which it received
compensation from us of $2,625,000 plus a five-year warrant to purchase
1,193,182 shares of common stock at an exercise price of $4.14 per share
commencing upon the effectiveness of the Shareholder Consent. Merriman also
received a $175,000 structuring fee from us with respect to the financing. In
addition, we issued to Satellite Strategic Finance Associates, LLC, an investor
in the financing, a warrant to purchase 41,667 shares of common stock (identical
to the March 2005 warrants), and reimbursed it $55,000 for expenses, for
consulting services rendered by it in connection with the financing.
Concurrently with the March 2005 financing, we repaid from the net
financing proceeds all of the principal and accrued and unpaid interest due on
our outstanding senior notes issued on April 28, 2004, in the aggregate amount
of approximately $9.4 million, and reported an additional charge in the first
quarter of 2005 to reflect the write-off of unamortized financing charges
related to the repayment of this debt.
We used approximately $2.3 million of the proceeds from the March 2005
financing to pay all accrued and unpaid interest to the Herrick Entities on
their convertible notes and the Series A Preferred Stock and Series C Preferred
Stock.
As of March 29, 2006, 14,837 shares of Series D Preferred Stock plus
accrued dividends thereon had been converted into 4,521,592 shares of common
stock and 21,063 shares of Series D Preferred Stock are outstanding.
Commitments
The following table sets forth our contractual obligations as of December
31, 2005:
Commitments as of 12/31/05
$(000,s)
Payments Due by Period
Contractual Obligations More
Less than 1-3 3-5 Than
Total 1 Year Years Years 5 Years
----- ------ ----- ----- -------
Debt Obligations $803 $77 $416 $310 $--
Capital Lease Obligations 5 5 -- -- --
Operating Lease Obligations 606 210 396 -- --
Purchase Obligations 943 453 490 -- --
Interest payments on Debt -- -- -- -- --
Dividend payments on Preferred Stock 6,330 1,266 2,532 2,532 *
----------------------------------------
Total $8,687 $2,011 $3,834 $2,842
========================================
* Dividend payments will continue at $1,266 per year assuming that the
preferred stock that they relate to is not redeemed or converted.
================================================================================
We lease approximately 12,000 square feet of office space in Cedar Knolls,
New Jersey pursuant to a sixty-six month lease agreement dated April 18, 2003.
43
We subleased two offices in New York, New York from a company partially
owned our Chairman. The lease commenced on August 1, 2005 and ends on July 31,
2006.
Minimum annual lease commitments including capital improvement payments
under all non-cancelable operating leases are as follows (in thousands):
Year ending December 31,
2006 ................................. 210
2007 ................................. 198
2008 ................................. 198
Thereafter ........................... --
----
Total lease commitments .............. $606
====
Capitalized leases.
During the year ended December 31, 2005, we had one capital leases. Lease
payments under these agreements were $6,000, $59,000 and $53,000 in 2005, 2004
and 2003, respectively. The amount of equipment capitalized under the leases and
included in fixed assets is $159,000, and net of depreciation the fixed asset
balance is $4,000 and $24,000 at December 31, 2005 and 2004, respectively. The
obligations under the leases included in accounts payable and accrued expenses
on the consolidated balance sheets at December 31, 2005 and 2004 were $5,000 and
$9,000, respectively.
Minimum annual lease commitments under capital leases are as follows (in
thousands):
Year ending December 31,
2006............................... 5
----------
Total capital lease commitments.... $ 5
==========
Employment agreements
We have commitments pursuant to employment agreements with certain of our
officers. Our minimum aggregate commitments under such employment agreements are
approximately $365,000, $280,000 and $117,000 during 2006, 2007, and 2008,
respectively.
Licensing agreements
We have numerous licensing agreements for both audiobooks and old-time
radio shows with terms generally ranging from one to five years, which require
us to pay, in some instances, non-refundable advances upon signing agreements,
against future royalties. We are required to pay royalties based on net sales.
Royalty expenses were $913,000 $1,473,000 and $2,524,000 for 2005, 2004 and
2003, respectively.
As of December 31, 2005, we had past due royalty payments under our
licensing agreements aggregating $1,397,000. The publishers and other
rightsholders to whom these payments would be payable have not requested royalty
statements or payments. These amounts are accrued for and reflected in our
financial statements.
Minimum advances required to be paid under existing agreements are as
follows (in thousands):
Year ended December 31,
2006........................ 453
2007........................ 235
2008........................ 148
------------------
Total....................... $836
==================
44
Recent accounting pronouncements
Consolidation of variable interest entities
In March 2005, the FASB issued Staff Position (FSP) No. FIN 46(R)-5,
Implicit Variable Interests under FASB Interpretation No. 46 (revised December
2003), Consolidation of Variable Interest Entities. This FSP clarifies that when
applying the variable interest consolidation model, a reporting enterprise
should consider whether it holds an implicit variable interest in a variable
interest entity (VIE) or potential VIE when specific conditions exist. FSP No.
FIN 46(R)-5 is effective as of April 1, 2005. We do not anticipate an impact
from the adoption of this statement.
Accounting changes and error corrections
In May 2005, the FASB issued SFAS No. 154 "Accounting Changes and Error
Corrections--A Replacement of APB Opinion No. 20 and FASB Statement No. 3". This
Statement requires retrospective application to prior periods' financial
statements of changes in accounting principle, unless it is impracticable to
determine either the period-specific effects or the cumulative effect of the
change. This Statement does not change the guidance for reporting the correction
of an error in previously issued financial statements or a change in accounting
estimate. The provisions of this Statement shall be effective for accounting
changes and correction of errors made in fiscal years beginning after December
15, 2005. The impact of FASB 154 will depend on the accounting change, if any,
in future periods.
Share-based payment
In December 2004, the FASB issued SFAS No. 123(R), "Share-Based Payment,"
which is a revision of SFAS No. 123, "Accounting for Stock-Based Compensation".
SFAS 123(R) requires that the compensation cost relating to share-based payment
transactions be recognized in financial statements. The compensation cost will
be measured based on the fair value of the equity or liability instruments
issued. The Statement is effective as of the beginning of the first annual
period beginning after June 15, 2005. We are required to adopt Statement 123(R)
in 2006. This statement applies to all awards granted after the date of adoption
and to awards modified, repurchased or cancelled after that date. The cumulative
effect of initially applying Statement 123(R), if any, will be recognized as of
the date of adoption. We have evaluated the impact of Statement SFAS 123(R) on
our financial position and results of operations and do not expected the impact
to be material as all options outstanding at December 31, 2005 were fully
vested.
Exchanges of Nonmonetary Assets
In December 2004, the FASB issued Statement No. 153, Exchanges of
Nonmonetary Assets, an Amendment of APB Opinion No. 29 ("Statement No. 153").
Statement No.153 is effective for nonmonetary asset exchanges occurring in our
fiscal year beginning January 1, 2006. Statement No. 153 requires that exchanges
of productive assets be accounted for at fair value unless fair value cannot be
reasonably determined or the transaction lacks commercial substance. Statement
No. 153 is not expected to have a material impact on our financial statements.
Inventory costs
In November 2004, the FASB issued SFAS No. 151, "Inventory Costs." SFAS
151 amends ARB No. 43, "Inventory Pricing", to clarify the accounting for
certain costs as period expense. The Statement is effective for fiscal years
beginning after June 15, 2005; however, early adoption of this Statement is
permitted. We do not anticipate an impact from the adoption of this statement.
45
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
We have no exposure to market risk for changes in interest rates. We had
total debt outstanding as of December 31, 2005 of $639,000 all of which is at
fixed rates. Changes in the prime rate or LIBOR would not have an impact on our
fair values, cash flows, or earnings for the year ended December 31, 2005.
Item 8. Financial Statements and Supplementary Data
The financial statements appear in a separate section of this report following
Part IV.
Item 9. Changes in and Disagreements With Accountants on Accounting and
Financial Disclosure.
Not applicable.
Item 9A. Controls and Procedures
Conclusion Regarding the Effectiveness of Disclosure Controls and Procedures
Our management, with the participation of our Chief Executive Officer and
Chief Financial Officer, evaluated the effectiveness of our disclosure controls
and procedures as of December 31, 2005. The term "disclosure controls and
procedures," as defined in Rules 13a-15(e) and 15d-15(e) under the Securities
Exchange Act of 1934 (the "Exchange Act"), means controls and other procedures
of a company that are designed to ensure that information required to be
disclosed by a company in the reports that it files or submits under the
Exchange Act is recorded, processed, summarized and reported, within the time
periods specified in the SEC's rules and forms. Disclosure controls and
procedures include, without limitation, controls and procedures designed to
ensure that information required to be disclosed by a company in the reports
that it files or submits under the Exchange Act is accumulated and communicated
to the company's management, including its principal executive and principal
financial officers, as appropriate to allow timely decisions regarding required
disclosure. Management recognizes that any controls and procedures, no matter
how well designed and operated, can provide only reasonable assurance of
achieving their objectives and management necessarily applies its judgment in
evaluating the cost-benefit relationship of possible controls and procedures.
Changes in Internal Control over Financial Reporting
During the quarter ended December 31, 2005 there were no changes in our
internal controls over financial reporting that have materially affected, or are
reasonably likely to materially affect, our internal controls over financial
reporting.
Item 9B. Other Information
Not applicable.
46
PART III
Item 10. Directors and Executive Officers of the Registrant
Our executive officers and directors are as follows:
Name Age Position
---- --- --------
Joseph R. Rosetti.......... 71 Chairman and Director
Jeffrey Dittus............. 39 Chief Executive Officer and Director
Robert Toro................ 41 Chief Financial Officer and
Senior Vice President of Finance
Daniel J. Altobello........ 65 Director
Richard J. Berman.......... 63 Director
Robert B. Montgomery....... 44 Director
Marshall C. Phelps......... 61 Director
Carl U.J. Rossetti......... 57 Director
Joseph R. Rosetti was appointed Chairman of our Board of Directors in
August 2004 and has been a member of our board of directors since December 2002.
Since December 1, 2001, Mr. Rosetti has been President of SafirRosetti, an
investigative and security firm owned by Omnicom Group, Inc. From 1987 to 1991,
Mr. Rosetti was the Vice Chairman of Kroll Associates. As Vice Chairman, he had
responsibility for Corporate Security/Crisis Management, which provides industry
and professional organizations with preventive measures to combat corporate and
financial crimes. From 1971 to 1987 he had worldwide responsibility at IBM for
security programs in physical security, investigations, personnel security,
trade secret protection, information asset security, real and movable and
financial asset security and Department of Defense Security. Mr. Rosetti was a
member of the U.S. National Chamber of Commerce Crime Reduction Panel and was
Staff Director for the Conference of the National Commission on Criminal Justice
Standards and Goals, a member of the private Security Task Force to the National
Advisory Committee on Criminal Justice Standards and Goals and Chairman of the
American Management Association's Council on Crimes against Business. Prior to
joining IBM, Mr. Rosetti was the Northeast Director for the Law Enforcement
Assistance Administration of the U.S. Department of Justice and a Special Agent,
Group Supervisor, and Special Assistant to the Assistant Commissioner for
Compliance in the Intelligence Division, U.S. Treasury Department. Prior to
joining the Treasury Department, Mr. Rosetti held the position of Chief
Accountant at Marriott Corporation. Mr. Rosetti is a director of GVI Security
Solutions, Inc., a publicly traded company.
Jeffrey Dittus has been our Chief Executive Officer and has been a member
of our board of directors since January 2004. From 1995 through 1998, Mr. Dittus
was a senior executive with one of the world's largest direct response
marketers, National Media Corporation. While at National Media, Mr. Dittus had
direct responsibility for over 300 staff in two different countries, and built a
process that streamlined the marketing process in concert with building direct
marketing systems that quickly evaluated the profitability of new product
launches. After leaving National Media, Mr. Dittus founded IT Capital Limited, a
publicly traded investment company focused on early stage, new media and
software investments based in New Zealand, serving as its Chief Executive
Officer until November 2001. Mr. Dittus returned to the United States and, in
November 2001 founded a merchant banking firm Kauri Capital, serving as its
managing director until January 2004. Mr. Dittus is a member of the board of
directors of the Audio Publishers Association, the audiobook publishers'
industry trade association and is a member of the Board of Directors of the
Leukemia and Lymphoma Society. He is also the founder of Divine 9 Open, a golf
tournament that raises money for Leukemia and Lymphoma research. Mr. Dittus
earned a Bachelor of Science degree from Pennsylvania State University in
Finance and began his career with Philadelphia Bank.
47
Robert Toro has been our Chief Financial Officer since May 2005 and our
Senior Vice President of Finance since July 1999, Chief Financial Officer of our
Audio Book Club division since November 2001 and an employee since April 1999.
Prior to joining us, Mr. Toro was Senior Vice President of AM Cosmetics Co. and
had previously served in senior financial positions in both public and private
entertainment and publishing companies. From 1992 through early 1997, Mr. Toro
served in various senior financial positions with Marvel Entertainment Group,
Inc., a publicly traded youth entertainment company. Mr. Toro is a Certified
Public Accountant with six years of progressive experience with Arthur Andersen
where he was employed immediately prior to joining Marvel Entertainment Group.
Daniel J. Altobello has been a member of our board of directors since
April 2005. Mr. Altobello has been retired since serving as Director and
Chairman of Onex Food Services, the parent corporation of Caterair
International, Inc., and LSG/SKY Chefs from September 1995 to June 2001. From
1989 to 1995, Mr. Altobello served as Chairman, President and Chief Executive
Officer of Caterair International Corporation. From 1979 to 1989, he held
various managerial positions with the food service management and in-flight
catering divisions of Marriott Corporation, including Executive Vice President
of Marriott Corporation and President of Marriott Airport Operations Group. Mr.
Altobello began his management career at Georgetown University as Vice President
of Administration Services. He is a member of the board of directors of Mesa Air
Group, Inc., World Air Holdings, Inc. and Friedman, Billings and Ramsey Group,
Inc. (public reporting companies). Mr. Altobello is also a director of several
public companies: Diamond Rock Hospitality Trust, Inc., JER Real Estate
Investment Trust, and a private company, Mercury Air Centers; and is also a
trustee of Loyola Foundation, Inc. Mr. Altobello obtained a Bachelor of Arts in
English from Georgetown University and a Master of Business Administration from
Loyola College.
Richard J. Berman became a director in June 2003. Since January 2006, Mr.
Berman has been Chief Executive Officer of Nexmed, Inc., a publicly traded
biotechnology company. From 2000 to March 2004, Mr. Berman was Chairman of the
Board of KnowledgeCube Group, Inc., an Internet commerce firm. From September,
1998 to June, 2000, Mr. Berman was Chairman of the Board and C.E.O. of Internet
Commerce Corporation (Nasdsaq: ICCA), a leading e-commerce business-to-business
service provider. From 1982 to 1998, Mr. Berman was President of the American
Acquisitions Company, a privately held merchant banking firm, and from 1983 to
1993, Chairman of the Board of Prestolite Battery Company of Canada, the largest
battery producer in Canada. From 1975 to 1982, Mr. Berman served in various
executive positions at Banker's Trust Company, including Senior Vice President
responsible for managing the M&A and Equity Buyout Departments. Mr. Berman
currently serves on the board of directors of Internet Commerce Corporation
(Nasdaq: ICCA), Nexmed, Inc. (Nasdaq: NexM), Advaxis (OTCBB: ADVS), GVI Security
Solutions Inc. (OTCBB: GVIS), Dyadic International, Inc. (OTCBB: DYAD)
International Microcomputer Software (OTCBB: IMSI) Nayna networks, Inc.
(OTCBB:NAYN) and National Investment Managers (OTLBB:NIVM). Mr. Berman holds a
J.D. from Boston College Law School and an M.B.A. in Finance from New York
University.
Robert B. Montgomery has been a member of our board of directors since
June 6, 2005. Since August 2001, Mr. Montgomery has been a Partner at Achilles
Partners, LLC, an advisory firm specializing in the media, communications and
technology industries. Mr. Montgomery is also currently Chief Executive Officer
of Achilles Media Ltd., a Toronto-based event management firm for television and
new media industry events. In addition, since August 2000, Mr. Montgomery has
served as a director of First Maximilian Associates Ltd. He holds a Bachelor of
Arts degree from the University of Manitoba in Canada.
48
Marshall C. Phelps has been a member of our board of directors since June
6, 2005. In June 2003, Mr. Phelps joined Microsoft Corporation serving as Deputy
General Counsel and Corporate Vice President for intellectual property and
licensing, where his responsibilities include supervising Microsoft's
intellectual property groups, including those responsible for trademarks, trade
secrets, patents, licensing, business development, standards and copyrights.
From September 2000 to December 2002, Mr. Phelps worked for Spencer Trask
Intellectual Capital Company LLC, where for two years he served as Chairman and
Chief Executive Officer. Mr. Phelps holds a Bachelor of Arts degree from
Muskingum College, a Master of Science degree from Stanford Graduate School of
Business and a Doctorate from Cornell Law School.
Carl U.J. Rossetti has been a member of our board of directors since June
6, 2005. Since January 2000, Mr. Rossetti has been employed at Time Warner
Cable, most recently as Executive Vice President of Corporate Development and
President of Time Warner Cable Voice Services. In this position, Mr. Rossetti
oversees the digital phone business and is responsible for developing and
launching new products, new businesses and new services for Time Warner Cable.
He earned his BA in Accounting (1970) and his MBA (1975), both at Chamindale
University in Honolulu, Hawaii.
Our Board of Directors is classified into three classes, each with a term
of three years, with only one class of directors standing for election by the
shareholders in any year. Richard Berman and Carl U.J. Rossetti are Class III
directors and stand for re-election at the 2006 annual meeting of shareholders.
Joseph Rosetti, Daniel J. Altobello and Marshall C. Phelps are Class I directors
and will stand for re-election at the 2007 annual meeting of shareholders.
Jeffrey Dittus and Robert Montgomery are Class II directors and stand for
re-election at the 2008 annual meeting of shareholders. Our executive officers
serve at the direction of the Board and until their successors are duly elected
and qualified.
Compliance with Section 16(a) Beneficial Ownership Reporting Companies
Section 16(a) of the Exchange Act requires our officers, directors, and
persons who own more than 10% of a registered class of our equity securities, to
file reports of ownership and changes in ownership with the Securities and
Exchange Commission. Officers, directors, and greater than 10% shareholders are
required by Securities and Exchange Commission regulations to furnish us with
copies of all forms that they file pursuant to Section 16(a).
Based solely upon our review of the copies of such forms that we received,
we believe that, during the year ended December 31, 2005, all filing
requirements applicable to our officers, directors, and greater than 10%
shareholders were complied with.
Director Independence
The Board has determined that Messrs. Altobello, Berman, Montgomery,
Phelps and Carl Rossetti, meet the director independence requirements of the
Marketplace Rules of the National Association of Securities Dealers, Inc.
("NASD") applicable to Nasdaq listed companies.
Board Committees
Audit committee
We have established an Audit Committee of the Board of Directors, which
currently consists of Messrs. Altobello (Chairman), Montgomery and Carl
Rossetti, each of whom is an "independent" director as defined under the rules
of the National Association of Securities Dealers, Inc. The Board has determined
that Mr. Altobello qualifies as a "financial expert" under federal securities
laws.
49
Compensation committee
We have established a Compensation Committee of the Board of Directors,
which currently consists of Messrs. Phelps (Chairman) and Berman, each of whom
is an "independent" director as defined under the rules of the National
Association of Securities Dealers, Inc.
Nominating committee
We have established a Nominating Committee of the Board of Directors,
which currently consists of Messrs. Berman (Chairman) and Montgomery, each of
whom is an "independent" director as defined under the rules of the National
Association of Securities Dealers, Inc. Mr. Berman serves as Chairman.
Code of ethics and business conduct
We have adopted a Code of Ethics and Business Conduct that applies to our
employees, including our senior management, including our Chief Executive
Officer, Chief Financial Officer, Controller and persons performing similar
functions. Copies of the Code of Ethics and Business Conduct can be obtained,
without charge, upon written request, addressed to: Corporate Secretary,
MediaBay, Inc., 2 Ridgedale Avenue, Cedar Knolls, New Jersey 07927.
Communications with the Board
The Board of Directors, through its Nominating Committee, has established
a process for stockholders to send communications to the Board of Directors.
Stockholders may communicate with the Board of Directors individually or as a
group by writing to: The Board of Directors of MediaBay, Inc., c/o Corporate
Secretary, 2 Ridgedale Avenue, Cedar Knolls, New Jersey 07927. Shareholders
should identify their communication as being from one of our shareholders. The
Corporate Secretary may require reasonable evidence that the communication or
other submission is made by one of our shareholders before transmitting the
communication to the Board of Directors.
Item 11. Executive Compensation
The following table discloses for the fiscal years ended December 31,
2003, 2004 and 2005, compensation paid to Jeffrey Dittus, our Chief Executive
Officer during 2005, and our executive officers during 2005 (the "Named
Executives").
50
Summary Compensation Table
The following table discloses for the fiscal years ended December 31,
2002, 2003 and 2004, compensation paid to our current executive officers (the
"Named Executives").
Long-Term
Annual compensation compensation awards
----------------------------------- securities underlying All other
Name and principal position Year Salary Bonus Options/SAR's (#) compensation
----------------------------------- ---- -------- ------- ----------------- ------------
Joseph Rosetti 2005 107,500 -- 50,000 --
Chairman (1) 2004 33,750 -- 95,833 --
Jeffrey Dittus 2005 267,333 175,000 366,667 --
Chief Executive Officer (2) 2004 222,172 -- 375,000 --
Robert Toro 2005 196,567 25,000 158,334
Senior Vice President Finance 2004 185,048 -- --
2003 185,000 5,223 36,024 --
Patricia Campbell 2005 150,991 50,000 301,667 --
Chief Operating Officer (3)
---------------
(1) Joseph Rosetti was appointed Chairman on August 12, 2004.
(2) Jeffrey Dittus became Chief Executive Officer on January 29, 2004.
(3) Patricia Campbell became Chief Operating Officer on April 4, 2005 and
resigned on January 31, 2006.
The following table discloses options granted during the fiscal year ended
December 31, 2005 to the Named Executives:
Option/SAR Grants in Fiscal Year Ending December 31, 2005:
Potential
Realizable Value
Number of % of Total At Assumed Annual Rates of
Shares Options Stock Price
Underlying Granted to Appreciation
Options Employees in Exercise Price for Option Term
Name Granted Fiscal Year ($/share) Expiration Date 5% ($) 10% ($)
--------------------------- ---------- ------------ -------------- --------------- --------- ----------
Joseph Rosetti 50,000 3.6% $3.54 04/04/2015 $ 111,295 $ 282,033
Jeffrey Dittus 200,000 14.5 1.35 12/31/2015 169,772 430,219
166,667 12.1 3.54 04/04/2015 370,984 940,110
Robert Toro 100,000 7.2 1.35 12/31/2015 84,886 215,110
16,667 1.2 3.54 06/06/2015 37,099 94,013
41,667 3.0 3.54 04/04/2015 92,746 235,029
Patricia Campbell (1) 150,000 10.9 1.35 12/31/2015 127,329 322,664
141,667 10.3 3.54 04/04/2015 315,337 799,092
10,000 0.7 2.16 06/06/2015 23,579 35,408
51
(1) Pursuant to a termination agreement dated January 31, 2006, 90,000 options
granted to Ms. Campbell exercisable at $1.35 per share were terminated and
56,667 options exercisable at $3.54 per share were also terminated.
The following table sets forth information concerning the number of
options owned by the Named Executives and the value of any in-the-money
unexercised options as of December 31, 2005. No options were exercised by any of
these executives during fiscal 2005.
Aggregated Option Exercises And Fiscal Year-End Option Values
Number of Securities
Underlying Unexercised Value of Unexercised
Options at In-the-Money Options at
Name December 31, 2005 December 31, 2005
----------------- -----------------
Exercisable Unexercisable Exercisable Unexercisable
Joseph Rosetti 130,834 30,000 -- --
Jeffrey Dittus 329,167 412,502 -- --
Robert Toro 63,524 145,002 -- --
Patricia Campbell (1) 126,666 175,001 -- --
(1) Pursuant to a termination agreement dated January 31, 2006, 90,000 options
granted to Ms. Campbell exercisable at $1.35 per share were terminated and
56,667 options exercisable at $3.54 per share were also terminated.
The year-end values for unexercised in-the-money options represent the
positive difference between the exercise price of such options and the fiscal
year-end market value of the common stock. An option is "in-the-money" if the
fiscal year-end fair market value of the common stock exceeds the option
exercise price. The closing sale price of our common stock on December 30, 2005
was $1.35.
Director compensation
We reimburse directors for reasonable travel expenses incurred in
connection with their activities on our behalf. On April 4, 2005, the Board of
Directors approved payment of $35,000 of director compensation to Mr. Berman,
for previous services as a member of our board of directors. Our independent
directors are compensated for their services as follows:
On April 4, 2005, the Board approved a compensation plan for those persons
who serve as a member of our board of directors and qualify as an "independent
director" under the Nasdaq Marketplace Rules (or the rules of the principal
exchange on which the Common Stock is listed, if the Common Stock is not listed
on Nasdaq). The compensation payable to our independent directors is as follows:
(i) $2,000 per month for serving as a member of the Board of Directors, payable
on the first calendar day of each month, which payments commenced May 1, 2005,
(ii) an additional $1,000 per month for serving as Audit Committee Chairman,
payable on the first calendar of each month, which payments commenced May 1,
2005, and (iii) an additional $2,500 per month for serving as Lead Independent
Director (as designated by the Board of Directors), payable on the first
calendar day of each month, which payments commenced May 1, 2005. Mr. Berman has
been designated by the Board of Directors as Lead Independent Director.
52
Employment agreements
On January 29, 2004, we entered into a 27-month employment agreement with
Jeffrey Dittus. The agreement provided for a base annual salary of $250,000 per
year. Pursuant to the agreement, we granted to Mr. Dittus options to purchase
250,000 shares of our common stock, which have exercise prices and vest as
follows:
Options to purchase: Exercise price Vesting date
-------------------- -------------- ------------
41,667 shares $5.94 04/30/2004
41,667 shares $5.94 07/30/2004
41,667 shares $9.30 01/30/2005
41,667 shares $9.30 07/30/2005
41,667 shares $11.16 01/30/2006
41,667 shares $11.16 04/30/2006
On June 6, 2005, we entered into an another employment agreement with Mr.
Dittus, which agreement became effective on June 6, 2005, for Mr. Dittus to be
employed as its Chief Executive Officer. The employment agreement has a term
ending June 6, 2008 and provides for an annual base salary of $280,000. Upon
termination of Mr. Dittus' employment without Cause (as defined in the
employment agreement) or upon Mr. Dittus' termination of employment for Good
Reason (as defined in the employment agreement), in addition to paying Mr.
Dittus through the date of termination and, otherwise complying with the
employment agreement, we shall pay to Mr. Dittus severance compensation equal to
twelve (12) months of Mr. Dittus' base salary as of the date of termination, a
pro rata portion of any bonus earned through the date of termination, and any
options to purchase our common stock then held by Mr. Dittus shall, as of the
date of such termination, be deemed to be fully vested for all purposes.
On June 6, 2005, we entered into an employment agreement with Joseph R.
Rosetti, which agreement became effective on June 6, 2005, for Mr. Rosetti to be
employed as its Chairman, and ends on June 6, 2006 with automatic successive
one-year extensions. The employment agreement provides for an annual base
compensation of $120,000. Upon termination of Mr. Rosetti's employment without
Cause, we shall pay to Mr. Rosetti, in accordance with the terms of the
employment agreement, a severance payment equal to twelve (12) months of Mr.
Rosetti's base salary as of the date of termination, payable in bi-monthly
installments. If the term or any successive extension is not extended as a
result of Mr. Rosetti providing notice of such non-renewal in accordance with
the agreement, Mr. Rosetti shall receive a severance payment equal to 50% of his
base compensation for the twelve (12) months prior to the date of the
non-renewal, payable in bi-monthly installments.
On April 1, 2005, we entered into an employment agreement with Patricia
Campbell, which agreement became effective on April 4, 2005, the commencement
date of Ms. Campbell's employment (the "Campbell Effective Date"), for Ms.
Campbell to serve as our Chief Operating Officer. The employment agreement had a
term ending March 31, 2008 and provides for an annual base salary of $215,000, a
starting bonus of $50,000, payable upon the first day of employment under the
employment agreement and grant of a stock option to purchase 141,667 shares of
common stock (the "Campbell Option"). The Campbell Option is exercisable at a
price of $3.54 per share, shall be exercisable commencing on the Campbell
Effective Date at the closing sale price of the Common Stock on the Campbell
Effective Date, and shall be exercisable as to 40% of the shares of Common Stock
covered thereby commencing on the Campbell Effective Date and an additional 20%
of the shares covered thereby on each of the first, second and third year
anniversaries of the Campbell Effective Date, and shall expire on the tenth
anniversary of the Campbell Effective Date. On January 31, 2006, Ms. Campbell
resigned her position as Chief Operating Officer. Ms. Campbell has agreed to
continue to
53
provide services for a period of six (6) months (the "Term"), during which she
agreed to devote her full time for the first three (3) months and half of her
time to our business during the second three (3) months. We agreed to pay Ms.
Campbell at the rate equal to her base salary when she was employed by us of
$215,000 (per annum) during the first three (3) months and at the rate of
$107,500 (per annum) during the second three (3) months. Certain stock options
previously granted to Ms. Campbell will remain exercisable for their full term,
and certain other stock options are no longer exercisable and terminated as of
January 31, 2006. Ms. Campbell agreed not to compete or engage in a business
competitive with our business during the Term and for a period of two years
thereafter.
On June 6, 2005, we entered into an employment agreement with Robert Toro,
which agreement became effective on June 6, 2005, for Mr. Toro to be employed as
its Senior Vice President and Chief Financial Officer, and ends on June 6, 2006
with automatic successive one-year extensions, unless Mr. Toro is given 90 days
written notice of non-renewal. The employment agreement provides for an annual
base compensation of $205,000. In addition, Mr. Toro will receive stock options
to acquire an additional 16,667 shares of our Common Stock pursuant to our 2004
Stock Incentive Plan. The options granted to Mr. Toro shall (i) vest
immediately, (ii) be exercisable at a price of $3.54 per share (the closing
price of the Common Stock on the date of the grant), (iii) be immediately
exercisable as to 40% of the shares covered thereby and shall become exercisable
as to an additional 20% of the shares covered thereby on each of the first,
second and third year anniversaries of the date of grant, and (iv) expire ten
(10) years from the grant date. Upon Mr. Toro's termination of his employment
for Good Reason (as defined in the employment agreement) or in the event that we
have terminated Mr. Toro's employment under the agreement (i) "without cause"
(as defined in the employment agreement), (ii) in the event there is a "Change
of Control" (as defined in the employment agreement) and Mr. Toro voluntarily
terminates his employment within three (3) months of such Change of Control, or
(iii) Mr. Toro's employment is terminated by us following the expiration of the
term of the employment agreement (including MediaBay not offering Mr. Toro at
least a one-year employment term at the annual salary then in effect), then Mr.
Toro shall be entitled to receive severance pay equal to 100% of his base salary
for the greater of (i) the balance of the term or (ii) 6 months; such payment,
if any, shall be made to Mr. Toro in equal payments in accordance with our
regular payroll over the remaining unexpired period of Mr. Toro's employment
term or six (6) month period, as the case may be. In addition, upon a Change of
Control, all stock options issued to Mr. Toro as of such date (except for those
which have expired prior thereto), shall immediately be exercisable (in full)
and any unvested options shall immediately vest.
Stock Plans
Our 1997 Stock Option Plan provides for the grant of stock options to
purchase up to 333,333 shares. As of March 29, 2006, options to purchase all of
the shares available under this plan have been granted under the 1997 plan.
Our 1999 Stock Option Plan provides for the grant of stock options to
purchase 416,667 shares. As of March 29, 2006, options to purchase all of the
shares available under this plan have been granted under the 1999 plan.
Our 2000 Stock Incentive Plan provides for the grant of any or all of the
following types of awards: (1) stock options, which may be either incentive
stock options or non-qualified stock options, (2) restricted stock, (3) deferred
stock and (4) other stock-based awards. A total of 583,333 shares of common
stock have been reserved for distribution pursuant to the 2000 plan. As of March
29, 2006, options to purchase all of the shares available under this plan have
been granted under the 2000 plan.
54
Our 2001 Stock Incentive Plan provides for the grant of any or all of the
following types of awards: (1) stock options, which may be either incentive
stock options or non-qualified stock options, (2) restricted stock, (3) deferred
stock and (4) other stock-based awards. A total of 583,333 shares of common
stock have been reserved for distribution pursuant to the 2001 plan. As of March
29, 2006, options to purchase all of the shares available under this plan have
been granted under the 2001 plan.
Our 2004 Stock Incentive Plan provides for the grant of any or all of the
following types of awards: (1) stock options, which may be either incentive
stock options or non-qualified stock options, (2) restricted stock, (3) deferred
stock and (4) other stock-based awards. A total of 1,250,000 shares of common
stock have been reserved for distribution pursuant to the 2004 plan. As of March
29, 2006, options to purchase an aggregate of 1,076,906 shares of our common
stock have been granted under the 2004 plan.
As of March 29, 2006, of the options outstanding under our plans, options
to purchase 1,256,860 shares of our common stock which are outstanding to our
officers and directors as follows: Joseph R. Rosetti - 160,834 shares; Jeffrey
Dittus - 741,667 shares; Robert Toro - 208,524 shares; Daniel J. Altobello -
25,000 shares; Richard J. Berman - 70,834 shares; Robert B. Montgomery - 16,667
shares; Marshall C. Phelps -- 16,667 shares; and Carl U.J. Rossetti - 16,667
shares.
Item 12. Security Ownership of Certain Beneficial Owners and Management and
Related Stockholder Matters
The following table details information regarding our existing equity
compensation plans as of December 31, 2005:
I
Number of securities
(a) remaining available for
Number of securities (b) future issuance under
to be issued upon Weighted-average equity compensation
exercise of outstanding exercise price of plans (excluding
options, warrants and outstanding options, securities reflected
Plan Category rights warrants and rights in column (a)
--------------------------------------------- -------------------------- ------------------- -----------------------
Equity compensation plans approved by 2,901,964 $ 4.90 173,094
security holders..........................
Equity compensation plans not approved by
security holders.......................... 9,242,589 $ 3.76 --
-------------------------- ------------------- -----------------------
Total..................................... 12,144,553 $ 4.03 173,094
========================== =================== =======================
Note 1: See Note 8 and Note 9 to the Consolidated Financial Statements for a
further description of these plans.
The following table sets forth certain information as of March 29, 2005
relating to the beneficial ownership of shares of our common stock by (i) each
person or entity who is known by us to own beneficially 5% or more of our
outstanding common stock according to Schedules 13G and 13D filed with the SEC,
(ii) each of our directors and nominees for director, (iii) each of the Named
Executives, and (iv) all of our directors and executive officers as a group.
55
Number of shares Percentage of shares
Name and address of beneficial owner (1)(2) beneficially owned beneficially owned
------------------------------------------- ------------------ ------------------
Jeffrey Dittus............................................ 528,667(3) 4.8%
Joseph Rosetti............................................ 151,667(4) 1.4
Robert Toro............................................... 111,858(5) 1.1
Richard J. Berman......................................... 66,666(6) *
Daniel J. Altobello....................................... 16,666(7) *
Robert B. Montgomery...................................... 8,333(7) *
Marshall C. Phelps........................................ 8,333(7) *
Carl U. J. Rossetti....................................... 8,333(7) *
Coghill Capital Management L.L.C. (8)..................... 1,036,783 9.9
Radcliffe SPC, Ltd (9).................................... 989,958 9.4
Satellite Strategic Finance, LLC (10)..................... 989,280 9.4
Wood River Partners, L.P (11)............................. 613,100 5.8
All directors and executive officers as a group (8 persons) 900,523 7.9%
* Less than 1%
1. Unless otherwise indicated the address of each beneficial owner is c/o
MediaBay, Inc., 2 Ridgedale Avenue, Cedar Knolls, New Jersey 07927. Unless
otherwise indicated, we believe that all persons named in the following
table have sole voting and investment power with respect to all shares of
common stock that they beneficially own.
2. For purposes of this table, a person is deemed to be the beneficial owner
of the securities if that person has the right to acquire such securities
within 60 days of January 9, 2006 upon the exercise of options, warrants
or other convertible securities. In determining the percentage ownership
of the persons in the table below, we assumed in each case that the person
exercised and converted all options, warrants or convertible securities
which are currently held by that person and which are currently
exercisable, but that options, warrants or other convertible securities
held by all other persons were not exercised or converted. Pursuant to the
Certificate of Designation of the Series D preferred stock and the terms
of the March 2005 warrants, the selling security holder is not permitted
to convert or exercise the foregoing securities to the extent any such
conversion or exercise would result in its beneficial ownership of more
than 4.99% of our outstanding common stock after giving effect to such
conversion or exercise.
3. Represents (i) 2,833 shares of common stock, and (ii) 525,834 shares
issuable upon exercise of options. Does not include 215,834 shares
issuable upon exercise of options.
4. Represents (i) 10,833 shares of common stock, and (ii) 140,834 shares
issuable upon exercise of options. Does not include 20,000 shares issuable
upon exercise of options.
5. Represents shares issuable upon exercise of options. Does not include
96,668 shares issuable upon exercise of options.
6. Represents shares issuable upon exercise of options. Does not include
4,167 shares issuable upon exercise of options.
7. Represents shares issuable upon exercise of options. Does not include
8,334 shares issuable upon exercise of options.
8. The following information is based upon a Schedule 13G/A filed with the
SEC on February 14, 2006. Represent shares of our common stock held by CCM
Master Qualified Fund Ltd. ("CCM"). Clint D. Coghill is the managing
member of Coghill Capital Management, L.L.C. an entity which serves as the
investment manager of CCM.
56
9 The following is based upon a Schedule 13G filed with the SEC on August
16, 2005. Represents shares of our common stock held by Radcliffe SPC,
Ltd., for and on behalf of the Class A Convertible Crossover Segregated
Portfolio. Does not include 212,424 shares of common stock issuable upon
conversion of 701 shares of Series D preferred stock and 606,060 shares of
common stock issuable upon exercise of warrants. Pursuant to an investment
management agreement, RG Capital Management, L.P. ("RG Capital") serves as
the investment manager of Radcliffe SPC, Ltd.'s Class A Convertible
Crossover Segregated Portfolio. RGC Management Company, LLC ("RGC
Management") is the general partner of RG Capital. Steve Katznelson and
Gerald Stahlecker serve as the managing members of RGC Management. Each of
RG Capital, RGC Management and Messrs. Katznelson and Stahlecker disclaims
beneficial ownership of the securities owned by Radcliffe SPC, Ltd. for
and on behalf of the Class A Convertible Crossover Segregated Portfolio.
The address of Radcliffe SPC, Ltd. is c/o SEI Investments Global Fund
Services, Ltd., Styne House, Upper Hatch Street, Dublin 2 Ireland.
10. The following information is based upon a Schedule 13G/A filed on February
15, 2006. Represents 389,257 shares held by Satellite Strategic Finance
Associates, L.L.C. and 600,023 shares of our common stock held by
Satellite Strategic Finance Partners, Ltd. (collectively, the "Satellite
Finance Funds"). Does not include 1,396,667 shares of common stock
issuable upon conversion of 4,609 shares of Series D preferred stock and
893,939 shares of common stock issuable upon exercise of warrants held by
Satellite Strategic Finance Associates, L.L.C. and 2,154,545 shares of
commons stock issuable upon conversion of 7,110 shares of Series D
Preferred Stock and 1,378,787 shares of common stock issuable upon
exercise of warrants held by Satellite Strategic Finance Partners, Ltd.
Satellite Asset Management is the investment manager to each of the
Satellite Finance Funds and exercises investment discretion over each of
the Satellite Finance Funds' portfolios. The general partner of Satellite
Asset Management, L.P. is Satellite Fund Management LLC. Satellite Fund
Management LLC has four members that make investment decisions on behalf
of the Satellite Finance Funds, and investment decisions made by such
members, when necessary, are made through the approval of a majority of
such members. The address of the Satellite Finance Funds is 623 Fifth
Avenue, 20th Floor, New York, New York 10022.
11. The following information is based on a Schedule 13G/A No. 2 filed with
the SEC on February 13, 2006. According to such Schedule 13G/A, Wood River
Associates, L.L.C. and Arthur Steinberg have shared voting power and sole
dispositive power over the shares and Wood River Partners, L.P. has sole
voting power and sole dispositive power over the shares. Mr. Steinberg has
been appointed as the receiver of these entities pursuant to an order of
the United States District Court of the Southern District of New York. The
address for these entities is c/o Kaye Scholer LLP, 425 Park Avenue, New
York, New York 10022.I
Item 13. Certain Relationships and Related Transactions
As of January 1, 2005, we owed to Norton Herrick, referred to as Herrick),
a principal shareholder at the time, and his affiliates approximately $315,000
for reimbursement of certain expenses and services incurred in prior years. On
April 28, 2004, in connection with the agreements described below, we agreed to
repay Herrick based on an agreed upon schedule. From April 28, 2004 through
December 31, 2004, we paid Herrick a total of $324,000. During 2005, we paid
Herrick (i) $40,500 per month on the first of each month through and including
July 2005 and (ii) the remaining $31,410 on August 1, 2005.
On April 28, 2004, we entered into a new credit agreement. Herrick,
Huntingdon and N. Herrick Irrevocable ABC Trust, referred to as the Herrick
Trust, of which Herrick was the beneficiary, consented to the new credit
agreement and the other transactions described above and entered into a
subordination
57
agreement with Zohar CDO 2003-1, Limited. The new credit agreement required the
aggregate amount of principal and interest owed by us to Herrick, Huntingdon and
the Herrick Trust be reduced to $6,800,000 ("Permissible Debt") by June 1, 2004,
and that the Permissible Debt be further reduced by up to an additional
$1,800,000 if we do not raise at least $2,000,000 in additional equity in each
of the two calendar years following the execution of the new credit agreement.
We received a fairness opinion in connection with this transaction.
Pursuant to an agreement dated April 28, 2004, on May 25, 2004, Herrick
exchanged accrued and unpaid interest and dividends (including accrued and
unpaid interest distributed by the Herrick Trust to Herrick) owed to Herrick
aggregating $1,181,419 into (i) 11,814 shares of Series C Convertible Preferred
Stock with a liquidation preference of $100 per share convertible into an
aggregate of 252,436 shares of common stock at an effective conversion price of
$4.68, and (ii) warrants to purchase 504,872 shares of common stock. The
warrants are exercisable until April 28, 2014 at an exercise price of $3.18.
Pursuant to an agreement dated April 28, 2004, on May 25, 2004, Huntingdon
exchanged the principal of the $500,000 principal amount note, $1,000,000
principal amount note, $150,000 principal amount note and $350,000 principal
amount note held by Huntingdon, plus accrued and unpaid interest owed to
Huntingdon aggregating $1,171,278 into (i) 31,713 shares of Series C Preferred
Stock convertible into an aggregate of 677,628 shares of common stock at an
effective conversion price of $4.68, and (ii) warrants to purchase an aggregate
of 1,355,256 shares of common stock. The warrants are exercisable until April
28, 2014 at an exercise price of $3.18. If the amount of the Permissible Debt is
required to be reduced due to our failure to raise the requisite additional
equity, such reduction will automatically occur by the exchange of Permissible
Debt held by Huntingdon for additional shares of Series C Preferred Stock in an
aggregate liquidation preference equal to the amount of debt exchanged and
warrants to purchase a number of shares of common stock equal to two times the
number of shares of common stock issuable upon conversion of the Series C
Preferred Stock.
The Herrick entities and the Herrick Trust agreed not to demand repayment
of their debt until the earlier of (i) the repayment of the New Credit Agreement
or (ii) June 28, 2007. The remaining promissory notes held by Herrick,
Huntingdon and the Herrick Trust are guaranteed by certain of our subsidiaries
and secured by a lien on our assets and certain of our subsidiaries.
On April 28, 2004, we repaid $1.6 million principal amount of the $3.2
million principal amount convertible note issued to ABC Investments, L.L.C., a
former principal shareholder of ours. We issued a new $1.6 million note for the
remaining principal amount. The new ABC note extended the maturity date from
December 31, 2004 to July 29, 2007. In exchange for extending the maturity date,
the conversion price of the new ABC note was reduced to $3.00. The closing sale
price of our common stock on the closing date was $2.88. During October 2004,
ABC Investments, L.L.C. converted $1,000,000 principal amount of the new ABC
note into shares of common stock pursuant to the terms of the note.
On February 8, 2005, we entered into a letter agreement with Forest Hill
Capital, LLC, at that time a principal shareholder, as the manager of Forest
Hill Select Fund, L.P., Forest Hill Select Offshore, Ltd. And Lone Oak Partners
L.P., collectively referred to as the Forest entities, extending the date by
which we were required to file the registration statement covering their
securities to May 1, 2005. As consideration for the extension, we issued an
aggregate of 19,841 shares of common stock, referred to as the extension shares,
based on the last sale price of our common stock on February 8, 2005 of $5.04.
We also agreed that if the last sale price of the common stock on the date the
registration statement covering their securities is declared effective by the
SEC is below $4.50, we would pay an aggregate of $250,000 less the value of the
extension shares on such effective date in cash or in shares of common stock, at
the Forest entities' option. We also granted the Forest entities the right to
require us to purchase an aggregate of 33,333 shares of common stock from them
at a price of $18.00 per share if, at any time prior to the effective date, the
last sale price of the common stock was above $24.00 per share. We timely
complied with our obligations to file the Forest entities' registration
statement.
58
As part of the March 2005 financing, the Forest entities exchanged the
300,000 shares of common stock and 66,667 common stock warrants previously
purchased by them from us in October 2004 for $900,000 of the securities issued
in the March 2005 financing. The Forest entities also purchased an additional
$1.0 million of the securities in the March 2005 financing. We also agreed to
include an additional 19,841 shares of common stock, as well as 8,333 shares of
common stock underlying certain additional warrants, already beneficially owned
and retained by Forest Hill Capital, LLC for resale in the registration
statement filed on behalf of the investors in the March 2005 financing.
In connection with the March 2005 financing, we also entered into an
agreement with the Herrick entities, pursuant to which, concurrently with the
financing:
o all $5.784 million principal amount of our convertible notes owned
by the Herrick entities (the "Herrick Notes") and 10,684 of their
shares of Series A Preferred Stock were converted into an aggregate
of approximately 2,033,333 shares of our common stock, referred to
as the Herrick Shares, at their stated conversion rate of $3.36 per
share;
o we also agreed to redeem the remaining 14,316 shares of Series A
Preferred Stock held by the Herrick entities and all 43,527 of their
shares of Series C Preferred Stock for $5.8 million, the aggregate
stated capital of such shares, on the earlier of the effective date
of the Shareholder Consent and June 1, 2005, and both the securities
to be redeemed, referred to as the redemption securities, and the
redemption price were placed into escrow pending such date;
o the Herrick entities waived certain of their registration rights and
we agreed to include the Herrick Shares for resale in the
registration statement filed on behalf of the investors in the March
2005 financing, so long as such Herrick Shares were owned by the
Herrick entities and not otherwise transferred, including, but not
limited to, in the Herrick Financing described below;
o the Herrick entities consented to the terms of the March 2005
financing and the agreements entered into in connection with such
financing, as we were required to obtain such consents pursuant to
the terms of the Herrick Notes, the Series A Preferred Stock and the
Series C Preferred Stock; and
o the Herrick entities also entered into a voting agreement and proxy
with us pursuant to which they agreed not to take any action to
contradict or negate the Shareholder Consent and gave us a proxy to
vote their shares, at the direction of our Board of Directors, until
the effective date of such consent.
Also on March 23, 2005 in connection with the March 2005 financing, we
entered into a registration rights agreement with the Herrick entities in which
they were granted the same automatic registration rights as the investors in the
March 2005 financing with respect to the shares of common stock issuable to the
Herrick entities upon conversion of the Herrick Notes and Series A Preferred
Stock. We also entered into another registration rights agreement dated March
23, 2005, with the Herrick entities in which we agreed to register the shares of
common stock issuable to the Herrick entities upon exercise of the warrants held
by them in a registration statement to be filed with the SEC within 30 days
following the effective date of the registration statement filed on behalf of
the investors in the March 2005 financing.
59
We also paid to the Herrick entities all accrued and unpaid interest
dividends due to them in the amount of $2,271,000 on March 23, 2005 and redeemed
the redemption securities on May 3, 2005 (the effective date of the Shareholder
Consent) for $5.8 million.
We subleased two offices in New York, New York from a company partially
owned by our Chairman. The lease commenced on August 1, 2005 and ends on July
31, 2006. The lease amount is $3,000 per month. The annual lease payments in
2006 are $21,000.
Item 14. Principal Accountants' Fees and Services
The following table presents fees charged for professional fees charged for
professional audit services for the audit of our financial statements for the
years ended December 31, 2005 and 2004 by Amper Politziner & Mattia, P.C. No
fees were paid for non-audit related services.
2004 2005
Audit Fees (1) $124,000 140,000
Audit-Related Fees (2) $15,750 54,600
Tax Fees (3) -- --
---------- ---------
Total $139,750 194,600
========== =========
(1) The aggregate fees billed for each year for professional services
rendered by our principal accountant for the audit of our financial
statements and review of financial statements included in our Form
10-Q.
(2) Fees billed for assurance and related services by our principal
accountant for the filing of a registration statement on Form S-3
not reported above.
(3) There were no fees billed by our principal accountant for
professional services rendered for compliance, tax advice and tax
planning.
Pre-approval Policies and Procedures
Consistent with the Securities and Exchange Commission requirements regarding
auditor independence, our Audit Committee has adopted a policy to pre-approve
all audit and permissible non-audit services provided by our principal
accountant. Under the policy, the Audit Committee must approve non-audit
services prior to the commencement of the specified service. Our principal
accountants have verified, and will verify annually, to our Audit Committee that
have not performed, and will not perform any prohibited non-audit service.
60
PART IV
Item 15. Exhibits, Financial Statements Schedules, and Reports on Form 8-K
(a) Exhibits
3.1 Restated Articles of Incorporation of the Registrant. (1)
3.2 Articles of Amendment to Articles of Incorporation. (3)
3.3 Articles of Amendment to Articles of Incorporation. (4)
3.4 Articles of Amendment to Articles of Incorporation of the
Registrant filed with the Department of State of the State of
Florida on January 18, 2002. (7)
3.5 Articles of Amendment to Articles of Incorporation of the
Registrant filed with the Department of State of the State of
Florida on May 7, 2003. (9)
3.6 Amended and Restated By-Laws of the Registrant. (8)
3.7 Amendment to the Articles of Incorporation of MediaBay, Inc.
regarding the designation of the Series D Preferred Stock.
(14)
3.8 Articles of Amendment to the Articles of Incorporation of
MediaBay, Inc. filed May 3, 2005. (18)
10.1 1997 Stock Option Plan. (1)
10.2 1999 Stock Incentive Plan. (2)
10.3 2000 Stock Incentive Plan. (5)
10.4 2001 Stock Incentive Plan. (6)
10.5 2004 Stock Incentive Plan. (13)
10.6 Form of 2004 Stock Incentive Plan Non-Qualified Stock Option
Agreement for Officers. (16)
10.7 Form of 2004 Stock Incentive Plan Non-Qualified Stock Option
Agreement for Directors. (16)
10.8 Letter Agreement between the Registrant and Norton Herrick
entered into in November 2002. (10)
10.9 Indemnification Agreement dated as of November 15, 2002
between the Registrant, MEH Consulting Services. Inc. and
Michael Herrick. (8)
10.10 Indemnification Agreement dated as of November 15, 2002
between the Registrant and Norton Herrick. (8)
10.11 Termination Agreement dated as of March 8, 2004 among XNH
Consulting Services, Inc., the Registrant and Norton Herrick.
(11)
10.12 Employment Agreement between the Registrant and Jeffrey Dittus
dated June 6, 2005. (14)
10.13 Employment Agreement between the Registrant and Joseph Rosetti
dated June 6, 2005. (14)
10.14 Employment Agreement between the Registrant and John Levy
dated June 6, 2005. (14)
10.15 Employment Agreement between the Registrant and Robert Toro
dated June 6, 2005. (14)
10.16 Amendment No. 1 dated July 5, 2005 to Employment Agreement
between the Registrant and Jeffery Dittus dated June 6, 2005.
(15)
10.17 Employment Agreement between the Registrant and Patricia
Campbell dated April 1, 2005 (effective April 4, 2005. (17)
10.18 Employment Agreement between the Registrant and Howard Herrick
dated October 30, 2002. (21)
10.19 Option Agreement dated as of April 4, 2005 between the
Registrant and Jeffrey Dittus. (19)
10.20 Option Agreement dated as of April 4, 2005 between the
Registrant and Joseph Rosetti. (19)
61
10.21 Option Agreement dated as of April 4, 2005 between the
Registrant and Robert Toro. (19)
10.22 Option Agreement dated as of April 4, 2005 between the
Registrant and Patricia Campbell. (19)
10.23 Option Agreement dated as of April 4, 2005 between the
Registrant and Daniel Altobello. (19)
10.24 Option Agreement dated as of April 4, 2005 between the
Registrant and Richard Berman. (19)
10.25 Option Agreement dated as of April 4, 2005 between the
Registrant and Paul Neuwirth. (19)
10.26 Option Agreement dated as of April 4, 2005 between the
Registrant and Stephen Yarvis. (19)
10.27 Severance and Consulting Agreement between the Registrant and
John Levy. (19)
10.28 Approval of Bonus Payable to Robert Toro. (19)
10.29 Letter Agreement among the Registrant and the Forest Hill
Entities dated February 8, 2005. (20)
10.30 Registration Rights Agreement dated March 21, 2005 by and
among the Registrant and each of the investors whose names
appear on the signature pages thereof. (14)
10.31 Registration Rights Agreement dated March 21, 2005 by and
between the Registrant and Goldman, Sachs & Co. (14)
10.32 Registration Rights Agreement (No. 1) dated March 19, 2005 by
and among the Registrant., Norton Herrick and Huntingdon
Corporation. (14)
10.33 Registration Rights Agreement (No. 2) dated March 19, 2005 by
and among the Registrant, Norton Herrick and Huntingdon
Corporation. (14)
10.34 Securities Purchase Agreement dated March 21, 2005 by and
among the Registrant, Satellite Strategic Finance Associates,
LLC and the other institutional investors whose names appear
on the signature pages thereof, including exhibits and
schedules thereto. (14)
10.35 Form of Warrant issued to each Investor pursuant to the
Securities Purchase Agreement. (14)
10.36 Form of Preferred Warrant issued to each Investor pursuant to
the Securities Purchase Agreement. (14)
10.37 Form of Warrant issued to Satellite Strategic Finance
Associates, LLC. (14)
10.38 Form of Warrant issued to Merriman Curhan Ford & Co. (14)
10.39 Form of Key Employee Agreement dated March 21, 2005 between
the Registrant. and each of Jeffrey A. Dittus and Joseph
Rosetti. (14)
10.40 Form of Voting Agreement and Proxy dated March 21, 2005 by and
among the Registrant, Norton Herrick and Huntingdon
Corporation. (14)
10.41 Agreement dated March 19, 2005 by and among the Registrant,
Norton Herrick and Huntingdon Corporation. (14)
10.42 Letter Agreement dated March 21, 2005 by and among the
Registrant, Forest Hill Select Offshore Ltd., Forest Hill
Select Fund, L.P. and Lone Oak Partners L.P. (14)
10.43 Form of Letter Agreement between the Registrant and each of
Stephen Yarvis, Paul Ehrlich, Paul Neuwirth and Richard
Berman. (14)
10.44 Transition Agreement dated January 31, 2006, by and between
the Registrant and Patricia Campbell. (23)
10.45 Lease on office space at 2 Ridgedale Avenue, Cedar Knolls, New
Jersey.
10.46 Settlement Agreement by and between the Registrant and Premier
Electronics, Inc.
21.1 Subsidiaries of the Company. (11)
23.1 Consent of Amper Politziner & Mattia, P.C.
31.1 Chief Executive Officer Certification Pursuant to Section 302
of the Sarbanes-Oxley Act of 2002.
31.2 Chief Financial Officer Certification Pursuant to Section 302
of the Sarbanes-Oxley Act of 2002.
62
32.1 Certification of Jeffrey Dittus, Chief Executive Officer of
MediaBay, Inc., pursuant to 18 U.S.C Section 1350, as Adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2 Certification of Robert Toro, Chief Financial Officer of
MediaBay, Inc., pursuant to 18 U.S.C Section 1350, as Adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
--------------------------------------------------------------------------------
* Previously filed
(1) Incorporated by reference to the applicable exhibit contained in our
Registration Statement on Form SB-2 (file no. 333-30665) effective
October 22, 1997.
(2) Incorporated by reference to the applicable exhibit contained in our
Definitive Proxy Statement dated February 23, 1999.
(3) Incorporated by reference to the applicable exhibit contained in our
Quarterly Report on Form 10-QSB for the quarterly period ended June
30, 1999.
(4) Incorporated by reference to the applicable exhibit contained in our
Registration Statement on Form SB-2 (file no. 333-95793) effective
March 14, 2000.
(5) Incorporated by reference to the applicable exhibit contained in our
Definitive Proxy Statement dated May 23, 2000.
(6) Incorporated by reference to the applicable exhibit contained in our
proxy statement dated September 21, 2001. (7) Incorporated by
reference to the applicable exhibit contained in our Current Report
on Form 8-K for the reportable event dated January 18, 2002.
(8) Incorporated by reference to the applicable exhibit contained in our
Annual Report on Form 10-K for the year ended December 31, 2002.
(9) Incorporated by reference to the applicable exhibit contained in our
Quarterly Report on Form 10-Q for the quarterly period ended March
31, 2003.
(10) Incorporated by reference to Exhibit 10.32 contained in our Annual
Report on Form 10-K for the year ended December 31, 2002.
(11) Incorporated by reference to the applicable exhibit contained in our
Annual Report on Form 10-K for the year ended December 31, 2003.
(12) Incorporated by reference to the applicable exhibit contained in our
Quarterly Report on Form 10-QSB for the quarterly period ended
September 30, 2004.
(13) Incorporated by reference to the applicable exhibit contained in our
Definitive Proxy Statement dated November 16, 2004.
(14) Incorporated by reference to the applicable exhibit contained in our
Current Report on Form 8-K for the reportable event dated June 10,
2005.
(15) Incorporated by reference to the applicable exhibit contained in our
Current Report on Form 8-K for the reportable event dated July 7,
2005.
(16) Incorporated by reference to the applicable exhibit contained in our
Current Report on Form 10-Q for the quarterly period ended June 30,
2005.
(17) Incorporated by reference to the applicable exhibit contained in our
Current Report on Form 8-K for the reportable event dated April 7,
2005.
(18) Incorporated by reference to the applicable exhibit contained in our
Current Report on Form 8-K for the reportable event dated May 3,
2005.
(19) Incorporated by reference to the applicable exhibit contained in our
Quarterly Report on Form 10-Q for the quarterly period ended March
31, 2005.
(20) Incorporated by reference to the applicable exhibit contained in our
Annual Report on Form 10-K for the fiscal year ended December 31,
2004.
(21) Incorporated by reference to the applicable exhibit contained in our
Quarterly Report on Form 10-Q for the quarterly period ended
September 30, 2002.
63
(22) Incorporated by reference to the applicable exhibit contained in our
Quarterly Report on Form 10-Q for the quarterly period ended
September 30, 2005.
(23) Incorporated by reference to the applicable exhibit contained in our
Current Report on Form 8-K for the reportable event dated January
31, 2006.
(b) Financial Statement Schedule
Schedule -I - Valuation and Qualifying Accounts and Reserve
64
MediaBay, Inc.
Index to Financial Statements
Report of Independent Registered Public Accounting Firm......................F-2
Consolidated Balance Sheets as of December 31, 2005 and 2004.................F-3
Consolidated Statements of Operations for the years ended December 31, 2005,
2004, and 2003...............................................................F-4
Consolidated Statements of Stockholders' Equity for the years ended
December 31, 2005, 2004 and 2003.............................................F-5
Consolidated Statements of Cash Flows for the years ended December 31, 2005,
2004, and 2003...............................................................F-6
Notes to Consolidated Financial Statements...................................F-7
Schedule II Valuation and Qualifying Accounts and Reserves...................S-1
F-1
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors and Stockholders
MediaBay, Inc. and Subsidiaries
We have audited the accompanying consolidated balance sheets of MediaBay,
Inc. and Subsidiaries (the "Company") as of December 31, 2005 and 2004, and the
related consolidated statements of operations, stockholders' equity, and cash
flows for each of the three years in the period ended December 31, 2005. Our
audits also included the financial statement schedule listed in the Index at
page S-1 as of December 31, 2005 and 2004 and for the three years in the period
ended December 31, 2005. These financial statements and schedule are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements and schedule based on our audits.
We conducted our audits in accordance with the standards of the Public
Company Accounting Oversight Board (United States). Those standards require that
we plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. The Company is not
required to have, nor were we engaged to perform, an audit of its internal
control over financial reporting. Our audits included consideration of internal
control over financial reporting as a basis for designing audit procedures that
are appropriate in the circumstances, but not for the purpose of expressing an
opinion on the effectiveness of the Company's internal control over financial
reporting. Accordingly we express no such opinion. An audit also includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements, 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 consolidated financial position of MediaBay, Inc.
and Subsidiaries at December 31, 2005 and 2004, and the consolidated results of
their operations and their cash flows for each of the three years in the period
ended December 31, 2005, in conformity with accounting principles generally
accepted in the United States of America. Also, in our opinion, the related
financial statement schedule as of December 31, 2005 and 2004 and for years then
ended, when considered in relation to the consolidated basic financial
statements taken as a whole, presents fairly in all material respects, the
information set forth therein.
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As discussed in Note 1 to the
financial statements, the Company has suffered recurring losses from operations
which raise substantial doubt about its ability to continue as a going concern.
Management's plans regarding those matters also are described in Note 1. The
financial statements do not include any adjustments that might result from the
outcome of the uncertainty.
/s/ Amper, Politziner & Mattia, P.C.
Edison, New Jersey
March 30, 2006
F-2
MEDIABAY, INC.
Consolidated Balance Sheets
(Dollars in thousands)
December 31,
2005 2004
--------------- ---------------
Assets
Current Assets:
Cash and cash equivalents........................................................... $ 8,243 $ 3,122
Accounts receivable, net of allowances for sales returns and doubtful accounts of
$1,533 and $2,708 at December 31, 2005 and 2004, respectively.................... 691 1,285
Inventory........................................................................... 763 1,530
Prepaid expenses and other current assets........................................... 464 199
Royalty advances.................................................................... 523 489
--------------- ---------------
Total current assets............................................................ 10,684 6,625
Fixed assets, net....................................................................... 1,785 243
Other intangibles, net.................................................................. 42 50
6,156
Goodwill................................................................................ 9,658
--------------- ---------------
$ 18,667 $ 16,576
=============== ===============
Liabilities and Stockholders' Equity (Deficit)
Current liabilities:
Accounts payable and accrued expenses............................................... $ 4,969 $ 5,361
Accounts payable, related party..................................................... -- 315
Current portion of long-term debt....................................................... -- 200
Short-term debt, net of original issue discount of $52 and $54 at December 31, 2005 and
2004, respectively................................................................... 32 29
Preferred dividend payable.............................................................. 319 --
--------------- ---------------
Total current liabilities....................................................... 5,320 5,905
Long-term debt, net of original issue discount of $111 and $908
at December 31, 2005 and 2004, respectively......................................... 608 9,102
Related party long-term debt including accrued interest................................. -- 7,750
--------------- ---------------
Total liabilities............................................................... 5,928 22,757
--------------- ---------------
Commitments and Contingencies -- --
Preferred stock, no par value, authorized 5,000,000 shares; no shares of Series
A outstanding at December 31, 2005 and 25,000 shares of Series A outstanding
at December 31, 2004; 200 shares of Series B issued and outstanding at
December 31, 2005 and December 31, 2004; no shares of Series C issued and
outstanding at December 31, 2005 and 43,527 shares of Series C issued and
outstanding at December 31, 2004; and 21,063 shares of Series D issued and
outstanding at December 31, 2005
and no shares of Series D issued and outstanding at December 31, 2004............... 11,436 6,873
Common stock; no par value, authorized 150,000,000 shares; issued and outstanding
10,516,414 and 4,140,663 at December 31, 2005 and 2004, respectively................ 121,681 101,966
Contributed capital..................................................................... 42,637 17,682
Accumulated deficit..................................................................... (163,015) (132,702)
--------------- ---------------
Total common stockholders' equity (deficit)............................................. 12,739 (6,181)
--------------- ---------------
$ 18,667 $ 16,576
=============== ===============
See accompanying notes to consolidated financial statements.
F-3
MEDIABAY, INC.
Consolidated Statements of Operations
(Dollars in thousands, except per share data)
Years ended December 31,
2005 2004 2003
----------------- --------------- --------------
Sales, net of returns, discounts and allowances of $1,825,
$5,363 and $16,960 for the years ended December 31,
2005, 2004 and 2003, respectively.......................... $ 8,955 $ 18,831 $ 36,617
Cost of sales................................................... 5,920 12,547 17,764
Advertising and promotion expense............................... 2,091 5,546 10,452
Bad debt expense................................................ 51 829 3,940
General and administrative...................................... 6,895 6,043 6,816
Severance and other termination costs........................... 697 -- 544
Depreciation and amortization................................... 154 144 328
Charge for impairment of goodwill 3,502 -- --
----------------- --------------- --------------
Operating (loss) income................................... (10,355) (6,278) (3,227)
Interest (expense).............................................. (767) (9,082) (1,925)
Interest income................................................. 257 -- --
Loss on early extinguishment of debt............................ (579) -- --
----------------- --------------- --------------
Loss before income tax expense............................ (11,444) (15,360) (5,152)
Income tax expense.............................................. -- 14,753 1,471
----------------- --------------- --------------
Net loss.................................................. (11,444) (30,113) (6,623)
Dividends on preferred stock.................................... 1,446 574 246
Deemed dividend on beneficial conversion of
Series D Preferred Stock.................................... 17,423 -- --
----------------- --------------- --------------
Net loss applicable to common shares...................... $ (30,313) $ (30,687) $(6,869)
================= =============== ==============
Basic and diluted loss per share:
Basic and diluted loss per share.......................... $ (4.08) $ (10.24) $ (2.92)
================= =============== ==============
See accompanying notes to consolidated financial statements.
F-4
MEDIABAY, INC.
Consolidated Statements of Stockholders' Equity
Years ended December 31, 2005, 2004 and 2003
(Amounts in thousands)
Series A Series B Series C
Preferred Series A Preferred Series B Preferred Series C
stock - Preferred stock - Preferred stock - Preferred
number of stock no number of stock no number of stock no
shares parvalue shares par value shares parvalue
Balance at January1, 2003 25,000 $ 2,500 - $ - - $ -
Issuance of Series B Preferred Stock - - 3,350 328 - -
Warrants granted in consideration for
non-compete agreements - - - - - -
Exercise of options - - - - - -
Stock issued to consultants - - - - - -
Options issued to consultants - - - - - -
Columbia House settlement - - - - - -
Stock tendered as payment of settlement - - - - - -
Warrants issued in connections
convectionmith financing - - - - - -
Options issued to Directors - - - - - -
Loss applicable to common shares - - - - - -
----------------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 2003 25,000 2,500 3,350 328 - -
Conversion of Series B Preferred Stock,
net of fees - - (3,150) (308) - -
Issuance of Series C Preferred Stock - - - - 43,527 4,353
Conversion of subordinated debt - - - - - -
Sales of common stock - - - - - -
Exercise of options and warrants - - - - - -
Stock issued to consultants - - - - - -
Beneficial conversion feature of debt issued - - - - - -
Warrants issued in connection with financing - - - - - -
Inducement to convert - - - - - -
Settlement of put obligation - - - - - -
Options issued to Directors - - - - - -
Options issued to consultants - - - - - -
Loss applicable to common shares - - - - - -
----------------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 2004 25,000 2,500 200 20 43,527 4,353
Conversion of common stock to preferred - - - - - -
Conversion of debt to common stock - - - - - -
Issuance ot common stock for extension of
registration rights agreement
Exercise of options
Conversion of preferred stock to common (25,000) (2,500) - - (43,527) (4,353)
Warrants issued in connection with sale of
Series D Preferred Stock - - - - - -
Beneficial conversion on Series D
Preferred Stock - - - - - -
Preferred dividends paid in stock - - - - - -
Accretion of original issue discount
and beneficial conversion - - - - - -
Common stock issued to vendor - - - - - -
Sale of Series D Preferred Stock,
net of costs and beneficial conversion - - - - - -
Loss for the year ended December 31, 2005 - - - - - -
----------------------------------------------------------------------------------------------------------------------------------
- $ - 200 $ 20 - $ -
==================================================================================================================================
Series D
Preferred Series D Common
stock - Preferred stock Common
number of stock no number of stock - no Contributed Accumulated
shares parvalue shares par value capital deficit
Balance at January1, 2003 - $ - 2,390 $ 94,800 $ 8,251 $ (95,146)
Issuance of Series B Preferred Stock - - - - - -
Warrants granted in consideration for
non-compete agreements - - - - 23 -
Exercise of options - - 18 - - -
Stock issued to consultants - - 5 14 - -
Options issued to consultants - - - - 26 -
Columbia House settlement - - (54) (247) 3,020 -
Stock tendered as payment of settlement - - (183) - - -
Warrants issued in connections
convectionmith financing - - - - 176 -
Options issued to Directors - - - - 73 -
Loss applicable to common shares - - - - - (6,869)
--------------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 2003 - - 2,176 94,567 11,569 (102,015)
Conversion of Series B Preferred Stock,
net of fees - - 78 365 - -
Issuance of Series C Preferred Stock - - - - - -
Conversion of subordinated debt - - 1,433 5,554 - -
Sales of common stock - - 300 900 - -
Exercise of options and warrants - - 150 562 - -
Stock issued to consultants - - 4 18 - -
Beneficial conversion feature of debt issued - - - - 3,991 -
Warrants issued in connection with financing - - - - 1,164 -
Inducement to convert - - - - 391 -
Settlement of put obligation - - - - 259 -
Options issued to Directors - - - - 219 -
Options issued to consultants - - - - 89 -
Loss applicable to common shares - - - - - (30,687)
--------------------------------------------------------------------------------------------------------------------------------
Balance at lkcember 31, 2004 - - 4,141 101,966 17,682 (132,702)
Conversion of common stock to preferred 909 (300) (909) - -
Conversion of debt to common stock - 2,039 5,784 - -
Issuance ot common stock for extension of
registration rights agreement 19 -
Exercise of options 17 40
Conversion of preferred stock to common (14,837) (9,085) 4,497 15,938 - -
Warrants issued in connection with sale of
Series D Preferred Stock - - - - 12,838 -
Beneficial conversion on Series D
Preferred Stock - - - - 17,423 -
Preferred dividends paid in stock - - 26 47 - -
Accretion of original issue discount
and beneficial conversion - 6,741 - (1,435) (5,306) -
Common stock issued to vendor - - 77 250 - -
Sale of Series D Preferred Stock,
net of costs and beneficial conversion 35,900 12,851 - - - -
Loss for the year ended December 31, 2005 - - - - - (30,313)
--------------------------------------------------------------------------------------------------------------------------------
21,063 $ 11,416 10,516 $121,681 $ 42,637 $ (163,015)
================================================================================================================================
See accompanying notes to consolidated financial statements.
F-5
MEDIABAY, INC.
Consolidated Statements of Cash Flows
(Dollars in thousands)
Years ended December 31,
2005 2004 2003
------------- ------------- -------------
Cash flows from operating activities:
Net loss............................................................. $ (11,444) $ (30,113) $ (6,623)
Adjustments to reconcile net loss to net cash used in
operating activities:
Charge for impairment of goodwill 3,502 -- --
Inventory obsolescence included in cost of goods sold............ -- 2,530 285
Write-off of non-recoupable royalty advances -- 1,215 --
Income tax expense............................................... -- 14,753 1,471
Non-cash beneficial conversion 4,382 --
Amortization of deferred member acquisition costs................ 17 3,509 6,625
Loss on extinguishment of debt 579 1,532 --
Non-current accrued interest..................................... 155 898 909
Amortization of deferred financing costs and original issue
discount......................................................... 240 1,329 561
Depreciation and amortization.................................... 154 144 328
Non-cash compensation expense.................................... 328 118
Changes in asset and liability accounts, net of acquisitions and
asset write-downs:
Decrease in accounts receivable, net........................... 816 1,979 4,195
Decrease in inventory.......................................... 767 103 896
(Increase) decrease in prepaid expenses
and other current assets..................................... (319) (48) 300
(Increase) decrease in royalty advances........................ (34) (1,000) 240
Increase in deferred member acquisition costs.................. -- (356) (2,410)
(Decrease) increase in accounts payable and accrued expenses... (643) (5,406) (5,346)
------------- ------------- -------------
Net cash (used in) provided by operating activities........... (6,210) (4,221) 1,549
------------- ------------- -------------
Cash flows from investing activities:
Purchase of fixed assets........................................... (1,687) (136) (16)
Additions to intangible assets..................................... -- (20) (102)
Cash paid in acquisitions.......................................... -- -- (148)
------------- ------------- -------------
Net cash used in investing activities......................... (1,687) (156) (266)
------------- ------------- -------------
Cash flows from financing activities:
Proceeds from issuance of debt -- 13,500 1,065
Redemption of Series A and C Preferred Stock (5,789)
Proceeds from sale of common stock................................. -- 900 --
Proceeds from exercise of stock options............................ 40 563 --
Proceeds from sale of preferred stock and warrants, net of costs... 31,421 -- 328
Repayment of long-term debt........................................ (11,763) (6,008) (1,615)
Payment of dividends............................................... (891) -- --
Increase in deferred financing costs............................... -- (2,139) (99)
Payments made in connection with litigation
settlement recorded in contributed
capital, net of cash received.................................. -- -- (676)
------------- ------------- -------------
Net cash provided by (used in) financing activities........... 13,018 6,816 (997)
------------- ------------- -------------
Net increase in cash and cash equivalents............................ 5,121 2,439 286
Cash and cash equivalents at beginning of year....................... 3,122 683 397
------------- ------------- -------------
Cash and cash equivalents at end of year............................. $ 8,243 $ 3,122 $ 683
============= ============= =============
See accompanying notes to consolidated financial statements.
F-6
MEDIABAY, INC.
Notes to Consolidated Financial Statements
Years ended December 31, 2005, 2004 and 2003
(Dollars in thousands, except per share data)
(1) Liquidity and Cash Flow
Historically, the Company has funded its cash requirements through sales
of equity and debt securities and borrowings from financial institutions and its
principal shareholders.
As of December 31, 2005, the Company had cash on hand of $8.2 million,
which is substantially greater than the $3.1 million cash on hand at December
31, 2004. However, the Company's cash balance has declined during 2006 and will
continue to decline for the foreseeable future unless we obtain financing, as we
continue to use cash in our operations.
The Company is currently pursuing a new strategy of selling downloadable
spoken word and hard good format content online. To date, its sales of digital
downloads have been minimal.
Because the Company is pursuing a new strategy, which focuses on
downloadable spoken word content, it has not, and will not, devote the funds
necessary to acquire new Audio Book Club members to offset member attrition. As
a result, revenue will continue to decline, which will continue to negatively
impact its performance and result in negative cash flow from operations. The
Company expects this trend to continue until such time, if ever, it can generate
significant revenue from the sale of downloadable spoken word content and
attract and establish a meaningful customer base for our online websites or
other websites it may develop.
The Company believes that its existing cash plus anticipated revenues will not
be sufficient to fund its capital commitments described below and operate its
business for the next twelve months without raising additional financing. The
Company has engaged investment bankers to help seek strategic alternatives for
it including raising additional financing. There can be no assurance that the
Company will be successful in raising additional financing. The failure to do so
in a timely manner will limit its ability to execute its business plan and could
ultimately impair its ability to continue as a going concern.
(2) Organization
MediaBay is a Florida corporation formed on August 16, 1993. The Company
is a digital media, marketing and publishing company specializing in spoken
audio entertainment, such as audio readings of books, newspapers, magazines,
original productions and radio broadcast transcripts. Today, the Company has two
principal content libraries: (1) Audiobooks which it sells via digital download
and on CD and cassette through Soundsgood.com, the Audio Book Club and
third-party websites; and (2) an archive of the history of American radio which
it produces and sells on CD and cassettes through its catalog, a mail
order-based continuity program, retail outlets, its on-line download
subscription service and third-party websites. The Company broadcasts its radio
programs through a syndicated radio show on 200 commercial stations across the
United States, as well as its 24-hour Radio Classics channels on Sirius and XM
Satellite Radio.
F-7
(3) Significant Accounting Policies
Principles of Consolidation
The consolidated financial statements include the accounts of the Company
and its wholly owned subsidiaries. All significant intercompany accounts have
been eliminated.
Cash and Cash Equivalents
Securities with maturities of three months or less when purchased are
considered to be cash equivalents.
Fair Value of Financial Instruments
The carrying amount of cash, accounts receivable, accounts payable and
accrued expenses approximates fair value due to the short maturity of those
instruments.
The fair value of long-term debt is estimated based on the interest rates
currently available for borrowings with similar terms and maturities. The
carrying value of the Company's long-term debt approximates fair value.
Inventory
Inventory, consisting primarily of audiocassettes and compact discs held
for resale, is valued at the lower of cost (weighted average cost method) or
market.
Prepaid Expenses
Prepaid expenses consist principally of deposits and other amounts being
expensed over the period of benefit. All current prepaid expenses will be
expensed over a period no greater than the next twelve months.
Fixed Assets, Net
Fixed assets, consisting primarily of furniture, leasehold improvements,
computer equipment, and third-party web site development costs, are recorded at
cost. Depreciation and amortization, which includes the amortization of
equipment under capital leases, is provided by the straight-line method over the
estimated useful life of three years (the lease term) for computer equipment and
five years (the lease term) for sound equipment under capital leases, five years
for equipment, seven years for furniture and fixtures, five years for leasehold
improvements, and two years for Internet web site development costs. Ongoing
maintenance and other recurring charges are expensed as incurred.
Costs of internal use software are accounted for in accordance with
Statement of Position 98-1 ("SOP 98-1"), "Accounting for the Costs of Computer
Software Developed or Obtained for Internal Use" and Emerging Issue Task Force
Issue No. 00-02 ("EITF 00-02"), "Accounting for Website Development Costs." SOP
98-1 and EITF 00-02 require that the Company expense computer software and
website development costs as they are incurred during the preliminary project
stage. Once the capitalization criteria of SOP 98-1 and EITF 00-02 have been
met, external direct costs of materials and services consumed in developing or
obtaining internal-use software, including website development, the payroll and
payroll-related costs for employees who are directly associated with and who
devote time to the internal use computer software and associated interest costs
are capitalized. Capitalized costs are amortized using the straight-line method
over the software's estimated useful life, estimated at three years. Capitalized
internal use software and website development costs are included in Fixed
Assets, net, in the accompanying balance sheets.
F-8
Other Intangibles, Net
Intangible assets, principally consisting of purchased intellectual
property, which is reviewed for impairment on each reporting date, and
non-compete agreements, which are being amortized over their contractual term.
Goodwill
Goodwill represents the excess of the purchase price over the fair value
of net assets acquired in business combinations accounted for using the purchase
method of accounting. In accordance with Statement of Financial Accounting
Standards ("SFAS") No. 142, "Goodwill and Other Intangible Assets", the Company
ceased amortization of goodwill as of January 1, 2002. The Company performed
annual impairment tests as of December 31, 2005, 2004 and 2003 in February 2006,
January 2005 and October 2003. The Company recorded an impairment charge of
$3,502 at December 31, 2005 as a result of the impairment tested conducted in
February 2006.
Revenue Recognition
During the years ended December 31, 2005, 2004 and 2003, the Company
derived its principal revenue through sales of audiobooks, classic radio shows
and other spoken word audio products directly to consumers principally through
direct mail and the Internet. The Company also sold classic radio shows to
retailers either directly or through distributors. The Company derived
additional revenue through rental of its proprietary database of names and
addresses to non-competing third parties through list rental brokers. The
Company also derived a small amount of revenue from advertisers included in its
nationally syndicated classic radio shows. The Company recognizes sales to
consumers, retailers and distributors upon shipment of merchandise. List rental
revenue is recognized on notification by the list brokers of rental by a third
party when the lists are rented. The Company recognizes advertising revenue upon
notification of the airing of the advertisement by the media buying company
representing the Company or directly from the broadcaster. Allowances for future
returns are based upon historical experience and evaluation of current trends.
Downloadable content revenue from the sale of individual content titles is
recognized in the period when the content is downloaded and the customer's
credit card is processed. Downloadable content revenue from the sale of
downloadable content subscriptions is recognized pro rata over the term of the
subscription period. Rebates and refunds are recorded as a reduction of revenue
in the period in which the rebate or refund is paid in accordance with Emerging
Issues Task Force Issue No. 01-9, Accounting for Consideration Given by a Vendor
to a Customer (Including a Reseller of the Vendor's Products).
Shipping and Handling Revenue and Costs
Amounts paid to the Company for shipping and handling by customers is
included in sales. Amounts the Company incurs for shipping and handling costs
are included in cost of sales. The Company recognizes shipping and handling
revenue upon shipment of merchandise. Shipping and handling expenses are
recognized on a monthly basis from invoices from the third party fulfillment
houses, which provide the services.
Cost of Sales
Cost of sales includes the following:
o Product costs (including free audiobooks in the initial enrollment
offer to prospective customers as well as the cost to digitize
content for download)
o Royalties to publishers and rightsholders
o Fulfillment costs, including shipping and handling
o Customer service
o Direct response billing, collection and accounts receivable
management
F-9
Cooperative Advertising and Related Selling Expenses
In accordance with EITF No. 01-9, "Accounting for Consideration Given by a
Vendor to a Customer (Including a Reseller of the Vendor's Products)", the
Company classifies the cost of sales incentives as a reduction of net sales.
Bad Debt Expense
The Company records an estimate of its anticipated bad debt expense based
on historical experience.
General and Administrative Costs
General and administrative costs include the following:
o Bad debt expense
o Payroll and related items
o Commissions
o Insurance
o Office expenses
o Telephone and postage
o Public and investor relations
o Dues and subscriptions
o Rent and utilities
o Travel and entertainment
o Bank charges
o Professional fees, principally legal and auditing fees
o Consulting
Stock-Based Compensation
The Company accounts for employee stock options in accordance with
Accounting Principles Board Opinion No. 25 ("APB 25"), "Accounting for Stock
Issued to Employees." In October 1995, SFAS No. 123, "Accounting for Stock-Based
Compensation" ("SFAS 123") was issued. SFAS 123, which prescribes the
recognition of compensation expense based on the fair value of options on the
grant date, allows companies to continue applying APB 25 if certain pro forma
disclosures are made assuming a hypothetical fair value method application. In
December 2004, the FASB issued SFAS No. 123(R), "Share-Based Payment," which is
a revision of SFAS No. 123, "Accounting for Stock-Based Compensation". SFAS
123(R) requires that the compensation cost relating to share-based payment
transactions be recognized in financial statements. The compensation cost will
be measured based on the fair value of the equity or liability instruments
issued. The Statement is effective as of the beginning of the first annual
period beginning after June 15, 2005. The cumulative effect of initially
applying Statement 123(R), if any, will be recognized as of the date of
adoption. The Company evaluated the impact of Statement SFAS 123(R) on its
financial position and results of operations and does not expected the impact to
be material as all options outstanding at December 31, 2005 were fully vested.
Had compensation expense for the Company's stock options been recognized on the
fair value on the grant date under SFAS 123, the Company's net loss and net loss
per share for the year ended December 31, 2005 and 2004 would have been as
follows:
F-10
Year Ended December 31,
2005 2004 2003
------------------ ------------------ ------------------
Net loss applicable to common shares, as reported $ (30,313) $ (30,687) $ (6,869)
Add: Stock-based employee compensation expense included in
reported net income applicable to common shares, net
of related tax effects -- -- --
Deduct: Total stock-based employee compensation expense
determined under fair value based method for all
awards, net of related tax effects (2,765) (2,092) (1,486)
------------------ ------------------ ------------------
Pro forma net loss applicable to common shares $ (33,078) $ (32,779) $ (8,355)
================== ================== ==================
Net loss per share:
Basic and diluted-as reported $ (4.08) $ (10.24) $ (2.92)
================== ================== ==================
Basic and diluted-pro forma $ (4.45) $ (10.94) $ (3.56)
================== ================== ==================
Income Taxes
Income taxes are accounted for under the asset and liability method.
Deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial statement
carrying amount of existing assets and liabilities and their respective tax
basis and operating loss and tax credit carryforwards. The ultimate realization
of deferred tax assets is dependent on the generation of future taxable income
during the periods in which temporary timing differences become deductible. The
Company determines the utilization of deferred tax assets in the future based on
current year projections by management. A valuation allowance is provided when
it is more likely than not that some portion or all of the deferred tax assets
will not be realized. 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. The effect
on deferred tax assets and liabilities of a change in tax rates is recognized in
the period that includes the enactment date.
Based on a change in Company strategy, which the Company believes will
result in lower sales and losses in the near term, but ultimately will be more
profitable, the Company has determined that it is more likely than not that it
will, in the foreseeable future, be unable to realize all or part of its net
deferred tax asset. The Company has accordingly made an adjustment to the
deferred tax asset recording an increase to the valuation allowance, resulting
in a deferred tax expense charged against income in the fourth quarter of 2004,
the period when such determination was made. In 2005 the Company continues to
provide a full valuation allowance for its net deferred tax assets.
Deferred Member Acquisition Costs
Promotional costs directed at current members are expensed on the date the
promotional materials are mailed. The cost of any premiums, gifts or the
discounted audiobooks in the promotional offer to new members is expensed as
incurred. The Company accounts for direct response advertising for the
acquisition of new members in accordance with AICPA Statement of Position 93-7,
"Reporting on Advertising Costs" ("SOP 93-7"). SOP 93-7 states that the cost of
direct response advertising (a) whose primary purpose is to elicit sales to
customers who could be shown to have responded specifically to the advertising
and (b) that results in probable future benefits should be reported as assets
net of accumulated amortization Accordingly, the Company has capitalized direct
response advertising costs and amortizes these costs over the period of future
benefit (the average member life), which has been determined to be
F-11
generally 30 months. The costs are being amortized on accelerated basis
consistent with the recognition of related revenue. In the fourth quarter of
2003, the Company adjusted the amortization period for advertising to attract
customers to its World's Greatest Old-Time Radio continuity program and revised
the estimate period for amortization of these advertising costs down to 18
months, which resulted in an increase in advertising expenses for the year ended
December 31, 2003 of $409.
SOP 93-7 requires that the realizability of the mounts of direct-response
advertising reported as assets should be evaluated at each balance sheet date by
comparing the carrying amounts of the assets to their probable remaining future
net revenues. Based on a change in Company strategy, which the Company believes
will result in lower sales and losses in the near term, but ultimately will be
more profitable, the Company determined that the future net revenue from the
Company's Audio Book Club does not support the carrying amount of the
direct-response advertising reported as assets relating to the Audio Book Club.
Accordingly the Company made an adjustment to write-off the entire carrying
amount of the asset in the fourth quarter for 2004 resulting in an increase in
advertising expense of $846. At December 31, 2005, the Company had no
direct-response advertising reported as assets.
Royalties
The Company is liable for royalties to licensors based upon revenue earned
from the respective licensed product. The Company pays certain of its publishers
and other rightsholders advances for rights to products. Royalties earned on the
sale of the products are payable only in excess of the amount of the advance.
Advances, which have not been recovered through earned royalties, are recorded
as an asset. Advances not expected to be recovered through royalties on sales
are charged to royalty expense.
Use of Estimates
The preparation of financial statements in accordance with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities, the disclosure of contingent assets and liabilities at
the date of the financial statements, and the reported amounts of revenue and
expenses during the reporting period. Actual results could differ from these
estimates. On an ongoing basis, management reviews its estimates based on
current available information. Changes in facts and circumstances may result in
revised estimates.
Recent Accounting Pronouncements
Consolidation of variable interest entities
In March 2005, the FASB issued Staff Position (FSP) No. FIN 46(R)-5,
Implicit Variable Interests under FASB Interpretation No. 46 (revised December
2003), Consolidation of Variable Interest Entities. This FSP clarifies that when
applying the variable interest consolidation model, a reporting enterprise
should consider whether it holds an implicit variable interest in a variable
interest entity (VIE) or potential VIE when specific conditions exist. FSP No.
FIN 46(R)-5 is effective as of April 1, 2005. There was no impact to the Company
from the adoption of this statement. Accounting changes and error corrections
In May 2005, the FASB issued SFAS No. 154 "Accounting Changes and Error
Corrections--A Replacement of APB Opinion No. 20 and FASB Statement No. 3". This
Statement requires retrospective application to prior periods' financial
statements of changes in accounting principle, unless it is impracticable to
determine either the period-specific effects or the cumulative effect of the
change. This Statement does not change the guidance for reporting the correction
of an error in previously issued financial statements or a change in accounting
estimate. The provisions of this Statement shall be effective for accounting
changes and correction of errors made in fiscal years beginning after December
15, 2005. The impact of FASB 154 will depend on the accounting change, if any,
in future periods.
F-12
Share-based payment
In December 2004, the FASB issued SFAS No. 123(R), "Share-Based Payment,"
which is a revision of SFAS No. 123, "Accounting for Stock-Based Compensation".
SFAS 123(R) requires that the compensation cost relating to share-based payment
transactions be recognized in financial statements. The compensation cost will
be measured based on the fair value of the equity or liability instruments
issued. The Statement is effective as of the beginning of the first annual
period beginning after June 15, 2005. We are required to adopt Statement 123(R)
in 2006. This statement applies to all awards granted after the date of adoption
and to awards modified, repurchased or cancelled after that date. The cumulative
effect of initially applying Statement 123(R), if any, will be recognized as of
the date of adoption. There was no impact to the Company as a result of adopting
Statement SFAS 123(R) as all options outstanding at December 31, 2005 were fully
vested. Exchanges of Nonmonetary Assets
In December 2004, the FASB issued Statement No. 153, Exchanges of
Nonmonetary Assets, an Amendment of APB Opinion No. 29 ("Statement No. 153").
Statement No.153 is effective for nonmonetary asset exchanges occurring in our
fiscal year beginning January 1, 2006. Statement No. 153 requires that exchanges
of productive assets be accounted for at fair value unless fair value cannot be
reasonably determined or the transaction lacks commercial substance. Statement
No. 153 is not expected to have a material impact on our financial statements.
Inventory costs
In November 2004, the FASB issued SFAS No. 151, "Inventory Costs." SFAS
151 amends ARB No. 43, "Inventory Pricing", to clarify the accounting for
certain costs as period expense. The Statement is effective for fiscal years
beginning after June 15, 2005; however, early adoption of this Statement is
permitted. We do not anticipate an impact from the adoption of this statement.
(4) Fixed Assets
Fixed Assets consist of the following as of December 31,
2005 2004
--------- --------
Capital leases, equipment and related software...$ 1,170 $ 959
Furniture and fixtures........................... 84 84
Leasehold improvements........................... 74 74
Web site development costs....................... 1,532 57
-------- -------
Total............................................ 2,860 1,174
Accumulated depreciation......................... (1,076) (931)
-------- -------
$ 1,784 $ 243
======== =======
Depreciation expense for the years ended December 31, 2005, 2004 and 2003
was $145, $120 and $146, respectively.
(5) Goodwill and Other Intangibles
SFAS No. 142, "Goodwill and Other Intangible Assets" ("SFAS 142") requires
the Company to perform an evaluation of goodwill impairment annually. The
Company conducted its annual impairment test for 2005 in February 2006 and for
2004 in January 2005, utilizing the services of an independent appraiser, and
its annual impairment tests for 2003 in October 2003. The Company recorded an
impairment charge of $3,502 at December 31, 2005 as a result of the impairment
test conducted in February 2006.
F-13
The following is a reconciliation of changes in the carrying amounts of
goodwill for the Radio Spirits reportable segment for each of 2005 and 2004:
2005 2004
Balance at January 1, $ 9,658 $ 9,658
Charge for impairment of Goodwill (3,502) --
----------- -----------
Ending Balance $ 6,156 $ 9,658
=========== ===========
The following table presents details of other intangibles at December 31,
2005 and December 31, 2004:
December 31, 2005 December 31, 2004
--------------------------------------- ---------------------------------------
Accumulated Accumulated
Cost Amortization Net Cost Amortization Net
--------- ------------ -------- -------- -------------- --------
Mailing Agreements $ 592 $ 592 $ -- $ 592 $ 592 $ --
Customer Lists 4,380 4,380 -- 4,380 4,380 --
Non-Compete Agreements 313 296 17 313 288 25
Other 25 -- 25 25 -- 25
--------- ---------- ------- --------- ---------- -------
Total Other Intangibles $ 5,310 $ 5,268 $ 42 $ 5,310 $ 5,260 $ 50
========= ========== ======= ========= ========== =======
Amortization of intangible assets was $8, $24 and $181 for the years ended
December 31, 2005, 2004 and 2003, respectively. The Company estimates intangible
amortization expenses of $8 in 2006 and $9 in 2007.
(6) Debt
As of
December 31, December 31,
2005 2004
------------ ------------
Credit agreement, senior secured debt,
net of original issue discount $ -- $ 8,661
Premier debt, net of original issue discount 640 670
Related party notes and related accrued interest,
net of original issue discount -- 7,750
------------ ------------
Total debt 640 17,081
Less: current portion (32) (229)
------------ ------------
Long-term debt 608 $ 16,852
============ ============
March 2005 Payment and Conversion of Debt
On March 23, 2005, the Company completed the March Financing described
below.
F-14
Concurrently with the March Financing, the Company repaid from the net
proceeds all of the principal and accrued and unpaid interest due on the
Company's outstanding senior notes issued on April 28, 2004, in the aggregate
amount of approximately $9,400. The Company reported a charge in the first
quarter of 2005 of $579 to reflect the write-off of unamortized financing
charges related to the repayment of this debt.
Also in connection with the March Financing, the Company entered into an
agreement (the "Herrick Agreement") with the Herrick Entities, described below
(the "Herrick Agreement"). Pursuant to the Herrick Agreement, concurrently with
the Financing, among other actions, all $5,784 principal amount of the
convertible notes of the Company owned by the Herrick Entities were converted
into an aggregate of approximately 1.7 million shares of Common Stock, at their
stated conversion rate of $3.36 per share.
The Company also paid to Norton Herrick and Huntingdon all accrued and
unpaid interest and dividends due to them in the amount $2,271.
Convertible Debt
On January 29, 2004, the Company issued $4,000 aggregate principal amount
of promissory notes (the "January 2004 Notes") and warrants to purchase 392,158
shares of common stock (the "Investor Warrants") to institutional and accredited
investors (the "Offering"). The notes were due on the earlier of (i) April 30,
2005, (ii) such date on or after July 1, 2004 at such time as all of the
Company's indebtedness under its existing credit facility is either repaid or
refinanced or (iii) the consummation by the Company of a merger, combination or
sale of all or substantially all of the Company's assets or the purchase by a
single entity, person or group of affiliated entities or persons of 50% of the
Company's voting stock. The January 2004 Notes bore interest at the rate of 6%,
increasing to 9% on April 28, 2004 and 18% on July 27, 2004. On receipt of
shareholder approval, which was received on April 12, 2004, in accordance with
the terms of the January 2004 Notes, the principal amount of the notes
automatically converted into MediaBay common stock at the rate of one share of
common stock at $4.50, or approximately 888,888 shares. In addition accrued
interest in the amount $49 also converted into common stock at $4.50 per share,
or 10,813 shares.
In connection with the Offering, the Company issued to the placement agent
and a broker warrants to purchase an aggregate of 40,833 shares of common stock
and also issued to the placement agent warrants to purchase an additional 83,481
shares of Common Stock on April 12, 2004 as partial consideration for its
services as placement agent. All warrants issued are exercisable until January
28, 2009 at an exercise price of $7.68 per share.
The Company accounted for the issuance of the January 2004 debt and its
subsequent conversion in accordance with Emerging Issues task Force No. 00-27,
"Application of Issue No. 98-5 to Certain Convertible Instruments". Accordingly,
the Company recorded an expense of $3,991 as beneficial conversion expenses at
the date of the conversion. The Company also recorded in interest expense a loss
on early extinguishment of debt for the unamortized debt discount relating to
the expenses incurred in the transaction and the relative fair value of the
warrants issued in the transaction totaling $1,343.
In connection with the Offering, the Principal Shareholder and an
affiliate of the Principal Shareholder entered into a letter agreement (the
"Letter Agreement") with the purchasers of January 2004 Notes in the Offering
pursuant to which the Principal Shareholder granted to the holders of the Notes
in the event of an Event of Default (as defined in the Notes) the rights to
receive payment under certain secured indebtedness owed by the Company to the
Principal Shareholder and to exercise their rights under security agreements
securing such secured indebtedness. Pursuant to the Letter Agreement, the
Principal Shareholder also executed Powers of Attorney in favor of a
representative of the January 2004 Note holders pursuant to which such
representative may, following an Event of Default, take actions necessary to
enforce the Note holders rights under the Letter Agreement, including enforcing
the Principal Shareholder's rights under the security agreements.
F-15
Zohar Credit Agreement and Related Transactions
On April 28, 2004, MediaBay entered into a credit agreement ("Zohar Credit
Agreement") by and among MediaBay and certain of its subsidiaries, the
guarantors signatory thereto, Zohar CDO 2003-1, Limited ("Zohar") as lender, and
Zohar, as agent, pursuant to which MediaBay and certain of its subsidiaries
initially borrowed $9,500. The initial term of the New Credit Agreement is one
year and it is extendable, at MediaBay's sole option, for two additional
one-year terms upon issuance of additional notes of $600 for the first
additional year and $300 for the second additional year, provided there is no
event of default. The loan bears interest at the rate of LIBOR plus 10%. In the
first year of the loan, a fee of $900 has been added to the principal balance,
which will be reflected as debt discount and will be accreted to interest
expense over the next twelve months. The New Credit Agreement contains certain
positive and negative covenants, including, beginning with the quarter ending
September 30, 2004, the maintenance of certain minimum levels of EBITDA, as
defined in the New Credit Agreement. Had the New Credit Agreement been in effect
at the date of the filing of this Annual Report on Form 10-K, the Company would
not be in compliance with EBITDA covenant.
MediaBay used a portion of the $8,600 of funds received under the New
Credit Agreement to satisfy all of its outstanding obligations under (i)
promissory notes that it issued in October 2003 in the aggregate principal
amount of $1,065, and (ii) its prior Credit Agreement, which had an outstanding
principal balance of approximately $1,386. The Company has included in interest
expense a loss on early extinguishment of debt of $73 related to unamortized
original issue discount relating to promissory notes that it issued in October
2003 and a loss on early extinguishment of debt of $116 related to unamortized
debt discount relating to the prior Credit Agreement.
The Principal Shareholder and an affiliate of the principal shareholder,
which held a $500 principal amount note and 25,000 shares of Series A
Convertible Preferred Stock, consented to the New Credit Agreement and the other
transactions described above and entered into a subordination agreement with
Zohar. The New Credit Agreement required the aggregate amount of principal and
interest owed by MediaBay to the Principal Shareholder and the affiliate of the
Principal Shareholder be reduced to $6,800 ("Permissible Debt") by June 1, 2004,
and that the Permissible Debt be further reduced by up to an additional $1,800
if MediaBay does not raise at least $2,000 in additional equity in the two years
after the execution of the New Credit Agreement.
On April 28, 2004, to reduce its debt to $6,800, the Principal Shareholder
and his affiliate agreed, subject to, and automatically upon, the receipt of a
fairness opinion from an independent investment banking firm, to exchange the
principal of their $500 Note, $1,000 Note, $150 Note and $350 Note, plus accrued
and unpaid interest owed to the Principal Shareholder aggregating $1,833 and
accrued and unpaid dividends owed to the Principal Shareholder aggregating $519
into an aggregate of 43,527 shares of Series C Preferred Stock convertible into
(i) an aggregate of 930,046 shares of Common Stock at an effective conversion
price of $4.68, and (ii) warrants to purchase an aggregate of 1,860,128 shares
of Common Stock. The Warrants are exercisable until April 28, 2014 at an
exercise price of $3.18. The Series C Preferred Stock has a liquidation
preference of $100 per share. On May 25, 2004, a fairness opinion was received
from an independent investment banking firm, and, pursuant to the agreements
described above, the exchange of debt for units occurred. The transactions
described above resulted in a charge to earnings for debt inducement pursuant to
SFAS 84 of $391.
F-16
The remaining promissory notes held by the Principal Shareholders and its
affiliate were guaranteed by certain subsidiaries of the Company and secured by
a lien on the assets of the Company and certain subsidiaries of the Company. If
the amount of the Permissible Debt was required to be reduced due to MediaBay's
failure to raise the requisite additional equity, such reduction will
automatically occur by the exchange of Permissible Debt for additional shares of
Series C Preferred Stock in an aggregate liquidation preference equal to the
amount of debt exchanged and warrants to purchase a number of shares of common
stock equal to two times the number of shares of preferred stock issuable upon
conversion of the Series C Preferred Stock.
New ABC Note
Also on April 28, 2004, MediaBay repaid $1,600 principal amount of the
$3,200 principal amount convertible note issued to ABC Investment, L.L.C.
MediaBay issued a new $1,600 note (the "New ABC Note") for the remaining
principal amount. The New ABC Note extends the maturity date from December 31,
2004 to July 29, 2007. In exchange for extending the maturity date, the
conversion price of the New ABC Note was reduced to $3.00. The closing sale
price of MediaBay's Common Stock on the closing date was $2.88. The entire
principal amount of the note was converted into common stock during the fourth
quarter of 2004.
Premier Debt
MediaBay entered into a settlement agreement, dated as of April 1, 2004,
with Premier Electronic Laboratories, Inc. ("Premier"). Premier had previously
exercised its right to put its shares of Common Stock to MediaBay for $1,100
pursuant to a Put Agreement dated December 11, 1998. Pursuant to the settlement,
among other things, MediaBay is paying Premier $950 as payment of the amounts
due to Premier. MediaBay's obligation under the Put Agreement was reduced by
$150 in exchange for relinquishing certain leases for real property. MediaBay
paid $14 on closing and is paying the remaining balance over six years in
monthly payments starting at $7 in July 2004 and increasing to $19 from May 2007
through April 2010.
The future minimum loan payments are as follows:
Year Ending December 31,
2006................................................ $ 77
2007................................................ 183
2008................................................ 233
2009................................................ 233
Beyond.............................................. 77
---------------
Total maturities, including debt discount of $164... $ 803
===============
(7) Commitments and Contingencies
Rent expense for the years ended December 31, 2005, 2004 and 2003 amounted
to $189, $179 and $180, respectively.
F-17
Operating Leases
The Company leases approximately 12,000 square feet of office space in
Cedar Knolls, New Jersey pursuant to a sixty-six month lease agreement dated
April 18, 2003.
The Company subleased two offices in New York, New York from a company
partially owned its Chairman. The lease commenced on August 1, 2005 and ends on
July 31, 2006. The lease amount is $3,000 per month. The annual lease payments
in 2006 are $21.
Minimum annual lease commitments including capital improvement payments
under all non-cancelable operating leases are as follows:
Year ending December 31,
2006..................................... $ 210
2007..................................... 198
2008..................................... 198
Thereafter............................... --
------------
Total lease commitments.................. $ 606
============
Capitalized Leases
During the year ended December 31, 2005, the Company had one capital
leases. Lease payments under capitalized lease agreements were $6, $59 and $53
in 2005, 2004 and 2003, respectively. The amount of equipment capitalized under
the leases and included in fixed assets is $159, and net of depreciation the
fixed asset balance is $4 and $24 at December 31, 2005 and 2003, respectively.
The obligations under the leases included in accounts payable and accrued
expenses on the consolidated balance sheets at December 31, 2005 and 2004 were
$5 and $9, respectively.
Minimum annual lease commitments under capital leases are as follows:
2006.....................................$ 5
---------
Total capital lease commitments..........$ 5
=========
Employment Agreements
The Company has commitments pursuant to employment agreements with certain
of its officers. Its minimum aggregate commitments under such employment
agreements are approximately $365,000, $280,000 and 117,000 during 2006, 2007,
and 2008, respectively.
F-18
Licensing Agreements
The Company has numerous licensing agreements for both audiobooks and
old-time radio shows with terms generally ranging from one to five years, which
require the Company to pay, in some instances, non-refundable advances upon
signing agreements, against future royalties. The Company is required to pay
royalties based on net sales. Royalty expenses were $913, $1,473 and $2,524 for
2005, 2004 and 2003, respectively. Minimum advances required to be paid under
existing agreements for the next five years are as follows:
2006 453
2007 235
2008 148
-------
Total $ 836
=======
As of December 31, 2005, we had past due royalty payments under our
licensing agreements aggregating $1,397. The publishers and other rights holders
to whom these payments would be payable have not requested royalty statements or
payments. These amounts are accrued for and reflected in our financial
statements.
Litigation
The Company is not a defendant in any litigation. In the normal course of
business, the Company is subject to threats of litigation. The Company does not
believe that the potential impact of any threatened litigation, if ultimately
litigated, will have a material adverse effect on the Company.
(8) Stock Option and Stock Incentive Plans
In June 1997, the Company adopted the 1997 Stock Option Plan, pursuant to
which the Company's Board of Directors may grant stock options to key employees
of the Company. In June 1998, the Company amended the 1997 Stock Option Plan to
authorize the grant of up to 333,333 shares of authorized but unissued common
stock.
In March 1999, the Company's stockholders approved an amendment to the
Company's Articles of Incorporation adopting the Company's 1999 Stock Incentive
Plan. The 1999 Stock Incentive Plan provides for grants of awards of stock
options, restricted stock, deferred stock or other stock based awards. A total
of 416,667 shares of common stock have been reserved for issuance pursuant to
the plan.
In June 2000, the Company's shareholders adopted the Company's 2000 Stock
Incentive Plan, which provides for grants of awards of stock options, restricted
stock, deferred stock or other stock based awards. A total of 583,333 shares of
common stock have been reserved for issuance pursuant to the plan.
In October 2001, the Company's shareholders adopted the Company's 2001
Stock Incentive Plan, which provides for grants of awards of stock options,
restricted stock, deferred stock or other stock based awards. A total of 583,333
shares of common stock have been reserved for issuance pursuant to the plan.
In December 2004, the Company's shareholders adopted the Company's 2004
Stock Incentive Plan, which provides for grants of awards of stock options,
restricted stock, deferred stock or other stock based awards. A total of
1,250,000 shares of common stock have been reserved for issuance pursuant to the
plan.
F-19
Options under the Company's option plans expire at various times between
2005 and 2014. In accordance with the plans, options generally have terms of 5
to 10 years are exercisable from grant date to three years.
On December 30, 2005, the Board of Directors accelerated the vesting of
all of the Company's unvested stock options awarded to directors, officers and
employees under its various plans all of which had an exercise price greater
than the closing price of the Company's common stock on the NASDAQ National
Market on December 30, 2005.
The Board's decision to accelerate the vesting of these options was in
response to a review of the Company's long-term incentive compensation programs
in light of changes in market practices and recently issued changes in
accounting rules resulting from the issuance of SFAS No. 123R, which the Company
is required to adopt in 2006. The Company believed that accelerating the vesting
of these options prior to the adoption of SFAS No. 123R may have resulted in the
Company not having to recognize compensation expense in the then remaining
vesting periods. Note 3 above discloses the Company's net loss and net loss per
share for the year ended December 31, 2005 and 2004 had compensation expense for
the Company's stock options been recognized on the fair value on the grant date
under SFAS 123 (R).
Stock option activity under the plans is as follows:
Weighted
average
Shares exercise price
----------------- ----------------
Outstanding at January 1, 2003 1,049,100 $ 26.34
Granted 598,964 6.30
Exercised (50,000) 3.00
Canceled and expired (296,250) 28.38
----------------- ----------------
Outstanding at December 31. 2003 1,301,814 17.52
Granted 1,006,250 5.16
Exercised (131,338) 3.72
Canceled and expired (418,548) 16.74
----------------- ----------------
Outstanding at December 31. 2004 1,758,178 11.70
Granted 1,254,164 2.52
Exercised (17,710) 2.08
Canceled and expired (109,335) 26.26
----------------- ----------------
Outstanding at December 31. 2005 2,885,297 $ 7.41
================= ================
F-20
The per share weighted-average fair value of stock options granted during
the years ended December 31, 2005, 2004 and 2003 is as follows using an accepted
option-pricing model with the following assumptions and no dividend yield. The
shares were granted as follows:
Risk-free
No. of Exercise Assumed interest Fair Value
Date Shares Price Volatility rate per Share
------------------------------------------ -------------- -------- ---------- --------- -----------
2003 Grants:
First Quarter 6,667 $ 9.00 165% 4.85% $ 5.40
Second Quarter -- -- -- -- --
Third Quarter 362,309 5.82 165% 4.85% 1.74
Fourth Quarter 229,988 7.02 97% 4.00% 4.02
---------------
Total 598,964
===============
2004 Grants:
First Quarter 275,833 $ 8.52 100% 3.50% $ 3.66
Second Quarter 350,000 3.18 75% 3.45% 1.74
Third Quarter 151,250 2.58 75% 3.44% 1.08
Fourth Quarter 229,167 5.76 200% 3.46% 4.98
---------------
Total 1,006,250
===============
2005 Grants:
First Quarter 16,667 $ 5.22 125% 3.35% $ 2.13
Second Quarter 784,977 3.54 115% 3.35% 3.10
Third Quarter -- -- -- -- --
Fourth Quarter 452,500 $ 1.35 103% 4.38% $1.24
---------------
Total 1,254,164
===============
The following table summarizes information for options outstanding and
exercisable at December 31, 2005:
Options Exercisable
Range of Prices Number Options Outstanding Weighted -------------------------------------------
Weighted Average Average Number Weighted Average
Remaining Life in Years Exercise Price Exercise Price
---------------- ---------------------------------------------- ---------------------------------- -------------------------
$ 1.99-3.00 741,253 4.28 $ 1.65 193,812 $ 2.26
3.18-6.00 1,492,139 5.42 $ 3.94 769,374 $ 4.17
6.12-10.50 375,987 3.72 $ 7.80 293,902 $ 7.94
10.74-42.00 275,018 3.57 $ 22.52 275,018 $ 24.52
---------------------------------------------- ---------------------------------- ------------------------
2,885,297 4.73 $ 7.41 1,515,439 $ 8.30
============================================== ================================== ========================
At December 31, 2005, there were no additional shares available for grant
under the 1997 Plan, no additional shares available for grant under the 1999
Plan, no additional shares available for grant under the 2000 Plan, no
additional shares available for grant under the 2001 Plan and 173,904 additional
shares available for grant under the 2004 Plan.
F-21
(9) Warrants and Non-Plan Options
In connection with the 2005 financings described above the Company issued
warrants to purchase a total of 6,674,318 shares of the Company's common stock,
all of which became exercisable in 2005, to investors and advisors. In
connection with the 2004 financings described above the Company issued warrants
to purchase a total of 2,487,641 shares of the Company's common stock, all of
which became exercisable in 2004, to investors and advisors. During the year
ended December 31, 2004, warrants to purchase 23,323 of the Company's common
stock expired; non-plan options to purchase 33,333 shares of the Company's
common stock expired or were cancelled and non-plan options to purchase 1,333
shares were exercised.
The following table summarizes information for warrants and non-plan
options outstanding and exercisable at December 31, 2005:
Options Exercisable
Range of Prices Number Options Outstanding Weighted ------------------------------------------
Weighted Average Average Number Weighted Average
Remaining Life in Years Exercise Price Exercise Price
---------------- ---------------------------------------------- ---------------------------------- ------------------------
$3.18-$4.14 8,534,446 5.24 $3.43 8,534,446 $3.43
$4.80-$7.50 120,419 3.31 $5.50 120,419 5.50
$7.68-18.00 587,724 3.36 $8.21 587,724 8.21
---------------------------------------------- ---------------------------------- ------------------------
9,242,589 5.10 $3.76 9,242,589 $3.76
============================================== ================================== ========================
(10) Litigation Settlement
In December 1998, the Company acquired certain assets from a third party.
The parties also entered into certain other agreements including a mailing
agreement and a non-compete agreement. As consideration for the assets acquired
and the related transactions, including the mailing agreement and the
non-compete agreement, the third party received cash consideration of $30,750
and an aggregate of 54,167 shares of the Company's common stock"(the "shares")
and warrants to purchase an additional 16,667 shares of the Company's common
stock. The parties also entered into a Registration and Shareholder Rights
Agreement pursuant to which, the Company granted the third party the right under
certain circumstances, commencing December 31, 2004, to require the Company to
purchase from the third party the Shares at a price of $90.00 per Share.
In 2001, the Company commenced litigation alleging, among other things,
that the Company was fraudulently induced to purchase certain of the assets. On
June 16, 2003, Audio Book Club, Inc. ("ABC"), a wholly owned subsidiary of
MediaBay entered into a settlement agreement with respect to the lawsuit.
Pursuant to the settlement agreement, ABC received $350 in cash, the return for
cancellation of 54,167 shares of MediaBay common stock issued in connection with
the acquisition and the termination of put rights granted to the seller in the
acquisition with respect to 38,333 of the shares (put rights with respect to the
remaining 15,833 shares had previously terminated). The termination of the put
rights terminated a $3,450 future contingent obligation of MediaBay and results
in a corresponding increase in stockholders' equity.
F-22
The calculation of the settlement of litigation recorded in Contributed
Capital is as follows:
Termination of contingent put rights $3,450
Return for cancellation of 54,167 shares of common stock 247
Cash received 350
------
Total received in settlement of litigation 4,047
Legal and other costs incurred in connection with the litigation 1,027
------
Settlement of litigation recorded in Contributed Capital $3,020
======
(11) Equity
The following table presents information regarding the Company's
outstanding preferred stock at December 31, 2005 and December 31, 2004:
As of
December 31, December 31,
2005 2004
------------ ------------
Series A Convertible Preferred Stock $ -- $ 2,500
Series B Convertible Preferred Stock 20 20
Series C Convertible Preferred Stock -- 4,353
Series D Convertible Preferred Stock, total outstanding December 31,
2005 $21,063, net of cash fees and expenses of $2,114; value
ascribed to investors' and advisors' warrants of $7,533 11,416 --
------------ ------------
Total Preferred Stock $ 11,436 $ 6,873
============ ============
March 2005 Sale of Series D Convertible Preferred Stock and Warrants
On March 21, 2005, the Company issued an aggregate of (a) 35,900 shares
(the "Offering Shares") of its Series D Convertible Preferred Stock (the "Series
D Preferred") convertible into 10,878,788 shares of the Company's common stock,
(b) 5,439,394 five-year common stock purchase warrants (the "Offering
Warrants"), valued at $10,852 using an accepted valuation method and (c)
preferred warrants (the "Over-Allotment Warrants" and, together with the
Offering Shares and the Offering Warrants, the "Offering Securities")
exercisable for a limited time, for additional proceeds to the Company of
$8,975, to purchase (1) up to 8,975 additional shares of Series D Preferred (the
"Additional Shares" and, together with the Offering Shares, the "Preferred
Shares") and (2) up to 1,359,849 additional warrants identical to the Offering
Warrants (the "Additional Warrants" and, together with the Offering Warrants,
the "Warrants"), to accredited investors (the "Investors") for an aggregate
purchase price of $35,900 (the "Financing").
Immediately prior to the Financing, holders of a majority of the Company's
voting securities approved by written consent (the "Shareholder Consent") (a) an
amendment to the Articles of Incorporation of the Company, increasing the number
of authorized shares of the common stock of the Company ("Common Stock") from
150,000,000 to 300,000,000, (b) a change of control which may occur as a result
of the Financing, and (c) the Company's issuance, in connection with the
transactions contemplated by the Financing documents, of Common Stock in excess
of 19.99% of the number of shares of Common Stock outstanding immediately prior
to the Financing.
F-23
While such actions were approved by a majority of the shareholders prior
to the Financing, the Company was not permitted to effect them until it
satisfied certain information requirements to the shareholders of the Company
not party to the Shareholder Consent. As a result, the Shareholder Consent did
not become effective until May 3, 2005.
The Preferred Shares have a face value of $1,000 per share ("Stated
Value") and are convertible at any time at the option of the holder into shares
("Conversion Shares") of common stock at the rate of $3.30 per Conversion Share,
subject to certain anti-dilution adjustments, including for issuances of Common
Stock for consideration below the conversion price. The Preferred Shares are
also mandatorily convertible at the option of the Company, subject to its
satisfaction of certain conditions, commencing June 10, 2005, which is 30 days
after May 11, 2005, the effective date of the registration statement registering
the shares underlying the Series D Preferred Stock. Under certain circumstances
under the control of the Company, the holders will also have the right to
require the Company to redeem their Preferred Shares at their Stated Value.
Cumulative dividends will accrue on the Preferred Shares on an annualized basis
in an amount equal to 6% of their Stated Value until they are converted or
redeemed and will be payable quarterly in arrears, beginning April 1, 2005, in
cash or, at the Company's option, subject to its satisfaction of certain
conditions, in shares of Common Stock ("Dividend Shares") valued at 93% of the
average of the daily volume weighted average per-share price of the Common Stock
for the five trading days prior to the applicable payment date. The Preferred
Shares are non-voting. Subject to certain exceptions for accounts receivable and
equipment and capital lease financings, the Company may not incur additional
indebtedness for borrowed money or issue additional securities that are senior
to or pari passu to the Preferred Shares without the prior written consent of
holders of at least two-thirds of the Preferred Shares then outstanding.
Each Warrant is exercisable to purchase one share of Common Stock
(collectively, the "Warrant Shares"), at an exercise price of $3.36 per share
for a period of five years commencing September 23, 2005, subject to certain
anti-dilution adjustments, including for issuances of Common Stock for
consideration below the exercise price. In addition, once exercisable, the
Warrants permit cashless exercises during any period when the Warrant Shares are
not covered by an effective resale registration statement.
The Over-Allotment Warrants were exercisable until February 9, 2006; none
were exercised.
As part of the Financing, the Forest Hill Select Fund L.P. and related
entities (the "Forest Hill Entities") exchanged 300,000 shares of Common Stock
and 66,667 common stock warrants previously purchased by them from the Company
in October 2004 for $900 of the Offering Securities. The Forest Hill Entities
also purchased $1,000 of the Offering Securities. The Company included an
additional 19,841 shares of Common Stock, as well as 8,333 shares of Common
Stock underlying certain additional warrants, already beneficially owned and
retained by Forest Hill Capital, for resale in the registration statement
declared effective May 11, 2005.
In connection with the Financing, the Company also entered into an
agreement with Norton Herrick and certain of his affiliates (the "Herrick
Entities") pursuant to which, concurrently with the Financing:
o all $5,784 principal amount of the convertible notes of the Company
owned by the Herrick Entities (the "Herrick Notes") and 10,684 of
their shares of the Series A Convertible Preferred Stock of the
Company ("Series A Preferred") were converted into an aggregate of
approximately 2.03 million shares of Common Stock (the "Herrick
Shares"), at their stated conversion rate of $3.36 per share;
F-24
o the Company agreed to redeem the remaining 14,316 shares of Series A
Preferred held by the Herrick Entities and all 43,527 of their
shares of the Series C Convertible Preferred Stock of the Company
(collectively, the "Redemption Securities") for $5,784, the
aggregate stated capital of such shares, on the earlier of the
effective date of the Shareholder Consent (May 3, 2005);
o the Herrick Entities waived certain of their registration rights and
the Company agreed to include the Herrick Shares for resale in the
registration statement declared effective May 11, 2005 so long as
such Herrick Shares are owned by the Herrick Entities and not
otherwise transferred, including, but not limited to, in the Herrick
Financing (as defined below); and
o the Herrick Entities consented to the terms of the Financing and the
agreements entered into in connection with the Financing, as the
Company was required to obtain such consents pursuant to the terms
of the Herrick Notes, the Series A Preferred and the Series C
Preferred.
o Herrick and Huntingdon also entered into a voting agreement and
proxy with the Company pursuant to which they agreed not to take any
action to contradict or negate the Shareholder Consent.
o the Company entered into a registration rights agreement dated the
date hereof with Herrick and Huntingdon in which the parties are
granted "piggy-back" registration rights and, with respect to the
shares of Common Stock issuable to Herrick and Huntingdon upon
conversion of the Herrick Notes and Series A Preferred Stock,
Herrick and Huntingdon are granted the same automatic registration
rights as the Investors under the Registration Rights Agreement.
o the Company also entered into another registration rights agreement
dated March 23, 2005, with Herrick and Huntingdon in which the
parties are granted "piggy-back" registration rights and, with
respect to the shares of our common stock issuable to Herrick and
Huntingdon upon exercise of the warrants held by Herrick and
Huntingdon.
The Company received $35,000 of gross proceeds (not including the
securities exchanged by the Forest Hill Entities for $900 of the purchase price)
in the Financing. Merriman Curhan Ford & Co. ("Merriman") acted as a financial
advisor with respect to certain of the investors in the Financing for which it
received compensation from the Company of $2,625 plus a five-year warrant (the
"Merriman Warrant") to purchase 1,193,182 shares of Common Stock at an exercise
price of $4.14 per share commencing upon May 3, 2005, the effective date of the
Shareholder Consent. Merriman also received a structuring fee from the Company
with respect to the Financing in the amount of $175. In addition, the Company
issued to Satellite Strategic Finance Associates, LLC and Satellite Strategic
Finance Partners, Ltd., investors in the Financing, warrants to purchase an
aggregate of 41,667 shares of Common Stock (identical to the Warrants), and
reimbursed them $55 for expenses, for consulting services rendered by it in
connection with the Financing. The Company incurred cash fees and expenses
including fees paid to advisors of $3,579. Warrants issued to advisors were
valued at $1,986 using an accepted valuation method.
The Preferred Shares are convertible at any time at the option of the
holder into shares ("Conversion Shares") of common stock at the rate of $3.30
per Conversion Share and each Warrant is exercisable to purchase one share of
Common Stock (collectively, the "Warrant Shares"), at an exercise price of $3.36
per share. The market price for the Company's common stock at March 21, 2005 was
$4.14. The Company recorded as dividends an amount of $17,423 to reflect the
value of the deemed dividend for beneficial conversion feature of Series D
Preferred Stock.
F-25
As of December 31, 2005, 14,837 shares of Series D Preferred Stock plus
accrued dividends thereon had been converted into 4,521,592 shares of common
stock and 21,063 shares of Series D Preferred Stock are outstanding.
The January Shares were issued to the purchasers without registration
under the Securities Act of 1933, as amended (the "Act"), in reliance upon the
exemptions from registration provided under 4(2) of the Act. The issuances did
not involve any public offering; the Company made no solicitation in connection
with the transactions other than communications with the purchasers; the
Purchasers either received or had access to adequate information about the
Company in order to make informed investment decisions; the Company reasonably
believed that the purchasers were sophisticated within the meaning of Section
4(2) of the Act; and the January Shares were issued with restricted securities
legends. No underwriting discounts or commissions were paid in conjunction with
the issuances.
Concurrently with the Financing, the Company repaid from its net Financing
proceeds, all of the principal and accrued and unpaid interest due on the
Company's outstanding senior notes issued on April 28, 2004, in the aggregate
amount of approximately $9,400. The Company will report an additional charge in
the first quarter of 2005 to reflect the write-off of unamortized financing
charges related to the repayment of this debt.
The Company also paid to Norton Herrick and Huntingdon all accrued and
unpaid interest dividends due to them in the amount $2,271 and placed into
escrow $5,784. This amount was released to redeem the portion of Series A
Preferred Stock not converted and all of the Series C Preferred Stock on May 3,
2005, the 20th day after an information statement was sent to all shareholders
who did not initially vote on the transaction.
October 2004 Stock Sale
On October 11, 2004, MediaBay, Inc. (the "Company") entered into a
Securities Purchase Agreement pursuant to which it issued to the purchasers
thereunder an aggregate of 300,000 shares (the "Shares") of the Company's common
stock, no par value per share (the "Common Stock"), and warrants to purchase
75,000 shares of Common Stock (the "Warrants"). The purchasers paid an aggregate
purchase price of $900 for the Shares and Warrants. Each Warrant is exercisable
to purchase one share of the Company's Common Stock at an exercise price of
$4.98 per share during the five (5)-year period commencing on October 11, 2004.
The Shares and Warrants were issued to the purchasers without registration under
the Securities Act of 1933, as amended (the "Act"), in reliance upon the
exemptions from registration provided under 4(2) of the Act. The issuances did
not involve any public offering; the Company made no solicitation in connection
with the transactions other than communications with the purchasers; the Company
obtained representations from the purchasers regarding their investment intent,
experience and sophistication; the purchasers either received or had access to
adequate information about the Company in order to make informed investment
decisions; the Company reasonably believed that the purchasers were
sophisticated within the meaning of Section 4(2) of the Act; and the Shares and
Warrants were issued with restricted securities legends. No underwriting
discounts or commissions were paid in conjunction with the issuances.
On February 8, 2005, the Company entered into a letter agreement extending
the date by which the Company was required to file the Registration Statement
with respect to the October 11, 2004 sale of common stock and warrants to May 1,
2005 (the "Extension"). As consideration for the Extension, the Company issued
to the Forest Hill Entities an aggregate of 19,841 shares of its Common Stock
(the "January Shares"), based on the last sale price of the Common Stock on
February 8, 2005 of $5.04 and paid to the Forest Hill Entities an aggregate of
19,841 shares of Common Stock, at the Forest Hill Entities' option. The Company
also granted the Forest Hill Entities the right (the "Put Right") to require the
Company to purchase an aggregate of 33,333 shares of the Common Stock issued to
the Forest Hill Entities at a price of $18.00 per share if, at any time prior to
the Effective Date, the last sale price of the Common Stock is above $24.00 per
share, subject to the Company obtaining the Consents. The Company's maximum
potential obligation under the Put Right is $600.
F-26
Series B Convertible Preferred Stock
On May 7, 2003, the Company sold 3,350 shares of a newly created Series B
Convertible Preferred Stock (the "Series B Stock") with a liquidation preference
of $100 per share for $335. Of the total sold, 1,400 shares ($140) were
purchased by Carl Wolf, Chairman and a director of the Company, and 200 shares
($20) were purchased by John Levy, Vice Chairman and Chief Financial Officer of
the Company. The holders of shares of Series B Convertible Preferred Stock will
receive dividends at the rate of $9.00 per share, payable quarterly, in arrears,
in cash on each March 31, June 30, September 30 and December 31; provided that
payment will accrue until the Company is permitted to make such payment in cash
under its Agreement with its senior lender. During the fourth quarter of 2004,
3,150 shares of Series B Preferred Stock were converted into the Company's
common stock.
The Series B Stock is convertible into shares of Common Stock into
MediaBay Common Stock at a conversion rate equal to a fraction, (i) the
numerator of which is equal to the number of Series B Stock times $100 plus
accrued and unpaid dividends though the date of conversion and (ii) the
denominator is $4.62, the average price of the Company's stock on May 6, 2003.
In the event of a liquidation, dissolution or winding up of the Company,
the holders of Series B Stock shall be entitled to receive out of the assets of
the Company, a sum in cash equal to $100.00 per share before any amounts are
paid to the holders of the Company common stock and on a pari passu with the
holders of the Series A Convertible Preferred Stock. The holders of Series B
Stock shall have no voting rights, except as required by law and except that the
vote or consent of the holders of a majority of the outstanding shares of Series
B Stock, voting separately as a class, will be required for any amendment,
alteration or repeal of the terms of the Series B Stock that adversely effects
the rights, preferences or privileges of the Series B Stock.
Options Issued to Directors
During the year ended December 31, 2004, the Company issued options to
purchase 116,666 shares of its common stock to its non-employee directors. The
Company valued the options at $219 using an acceptable valuation method and
recorded an expense for that amount in general and administrative expenses.
Dividends
The terms of the Company's Series D Preferred Stock prohibit the Company
from declaring or paying any dividends or distributions on the Company's common
stock.
(12) Income Taxes
The Company's income tax provision for the years ended December 31, 2005,
2004 and 2003 includes a Federal deferred tax expense of $0 a Federal deferred
tax expense of $14,753 and a Federal deferred tax benefit of $1,471,
respectively.
F-27
Income tax expense for the years ended December 31, 2005, 2004 and 2003
differed from the amount computed by applying the U.S. Federal income tax rate
of 34% and the state income tax rate of 7% to the pre-tax loss as a result of
the following:
2005 2004 2003
----------------- --------------- ---------------
Computed tax benefit $ (5,423) $ (6,360) $ (446)
Increase (decrease) in valuation allowance for
Federal and State deferred tax assets 5,423 21,113 1,917
----------------- --------------- ---------------
Income tax expense $ -- $ 14,753 $ 1,471
================= =============== ===============
As a result of the Company's shift in business strategy, during the second
half of 2004, (i.e. its focus on new distribution channels for its spoken word
product) realization of net deferred tax assets is not assured. Accordingly, the
Company determined, based on its current and projected future results of
operations, that it can no longer satisfy the "more likely than not" criteria of
FASB Statement No. 109 and has established a full valuation allowance against
its deferred tax asset. In 2005 the Company continued to provide a full
valuation allowance for its deferred tax assets. Accordingly, the net deferred
tax asset at December 31, 2005 and 2004 is $0.
The tax effect of temporary differences that give rise to significant
portions of the deferred tax assets are as follows:
Deferred tax assets:
2005 2004
---------------- ---------------
Federal and state net operating loss carry-forwards $ 37,162 $ 31,103
Loss in I-Jam, LLC 85 85
Accounts receivable, principally due to allowance for doubtful accounts
and reserve for returns 214 606
Inventory, principally due to reserve for obsolescence 1,688 1,522
Intangibles 11,101 11,186
Beneficial conversion feature 113 438
---------------- ---------------
Total net deferred tax assets 50,363 44,940
Less valuation allowance (50,363) (44,940)
---------------- ---------------
Net deferred tax assets $ -- $ --
================ ===============
At December 31, 2005, the Company had approximately $90,638 of net
operating loss carry-forwards, which could possibly have been used to offset
possible future earnings, if any, in computing future income tax liabilities.
The Company may have experienced various ownership changes, as defined by the
Act, as a result of past financings, including the March 2005 transactions
discussed in Note 11 and may experience others in connection with future
financings. Accordingly, the Company's ability to utilize the aforementioned
Federal carryforwawrds will be limited.
(13) Net Loss Per Share of Common Stock
Basic net loss per share is computed by dividing net loss by the weighted
average number of common shares outstanding during the applicable reporting
periods. The computation of diluted net loss per share is similar to the
computation of basic loss per share except that the denominator is increased to
include the number of additional common shares that would have been outstanding
if the dilutive potential common shares had been issued.
F-28
Basic and diluted loss per share were computed using the weighted average
number of shares outstanding for the years ended December 31, 2005, 2004 and
2003 of 7,430, 2,996 and 2,350, respectively.
Common equivalent shares of 18,387 including 6,387 relating to convertible
preferred stock were not included in the calculation of fully diluted shares
because they were anti-dilutive. Dividends on the convertible preferred stock
that were not added back to net loss were $1,446 for the year ended December 31,
2005.
Common equivalent shares of 3,759 including 3,400 relating to convertible
subordinated debt and convertible preferred stock were not included in the
calculation of fully diluted shares because they were anti-dilutive. Interest
expense and dividends on the convertible subordinated debt and convertible
preferred stock that were not added back to net loss were $1,322 for the year
ended December 31, 2004.
Common equivalent shares of 2,828 including 2,652 relating to convertible
subordinated debt and convertible preferred stock were not included in the
calculation of fully diluted shares because they were anti-dilutive. Interest
expense and dividends on the convertible subordinated debt and convertible
preferred stock that were not added back to net loss were $1,150 for the year
ended December 31, 2003.
The Company's Board of Directors and shareholders approved a one for six
reverse stock split effective October 25, 2005. All references in the financial
statements and notes thereto to the number of shares outstanding, per share
amounts, and stock option, warrant and convertible security data relating to the
Company's common shares have been restated to reflect the effect of the stock
split for all periods presented.
(14) Supplemental Cash Flow Information
No cash has been expended for income taxes for the years ended December
31, 2005, 2004 and 2003. Cash expended for interest was $677, $1,045 and $384
for the years ended December 31, 2005, 2004 and 2003, respectively. Cash paid
for dividends in 2005 was $1,514.
The Company had the following non-cash activities for the years ended
December 31, 2005, 2004, and 2003:
2005 2004 2003
------ ------ ------
Deemed dividend on beneficial conversion of Series D Preferred
Stock $17,423 -- --
Conversion of notes into preferred shares.............................. $14,837 $4,353 --
Issuance of warrants in connection with the March 2005 Financing $12,838
-- --
Conversions of subordinated notes into common shares................... $ 5,784 $5,649 --
Accrual of dividends on preferred stock................................ $ 555 $ 574 $ 246
Conversion of common shares and warrants into preferred stock and
warrants sold in the March 2005 Financing.......................... $ 900 -- --
Stock tendered as payment for exercise of options...................... -- -- $ 150
Settlement of litigation............................................... -- -- $3,697
F-29
(15) Related Party Transactions
The Company subleased two offices in New York, New York from a company
partially owned by its Chairman. The lease commenced on August 1, 2005 and ends
on July 31, 2006. The lease amount is $3,000 per month. The annual lease
payments in 2006 are $21.
As of December 31, 2004, we owed to Mr. Herrick and his affiliates
approximately $315 for reimbursement of certain expenses and services incurred
in prior years. On April 28, 2004, in connection with the agreements described
below, the Company agreed to repay Mr. Herrick based on an agreed upon schedule.
From April 28, 2004 through December 31, 2004 the Company paid Mr. Herrick a
total of $324. As of December 31, 2004, the Company will pay Mr. Herrick (i)
$40.5 per month on the first of each month through and including July 2005 and
(ii) $31.41 on August 1, 2005.
On May 1, 2003, we entered into a two-year consulting agreement with XNH
Consulting Services, Inc. ("XNH"), a company wholly-owned by Norton Herrick.
Effective December 31, 2003, we agreed with Norton Herrick to terminate the
two-year consulting agreement with XNH, and to pay XNH a fee of $7.5 per month
for 16 months commencing on January 1, 2004 and to provide Mr. Herrick with
health insurance and other benefits applicable to our officers to the extent
such benefits may be provided under our benefit plans. In April 2004, we amended
the termination agreement such that we are no longer required to either pay Mr.
Herrick the $7.5 each month or to provide Mr. Herrick with health insurance and
other benefits applicable to our officers. In connection with the termination
agreement, the non-competition and nondisclosure covenants of the XNH consulting
agreement were extended until December 31, 2006. In accordance with the
agreement, the Company paid or reimbursed certain health insurance premiums for
Mr. Herrick.
In December 2004, the Company entered into a letter agreement with certain
affiliates of Forest Hill Capital, LLC, at that time a principal shareholder
(collectively, the "Forest Hill Entities"), extending the date by which the
Company is required to file a registration statement covering the securities
issued to Forest Hill entities (the "Registration Statement") to January 31,
2005. As consideration for this extension, the Company issued to the Forest Hill
Entities warrants to purchase an aggregate of 8,333 shares of its common stock,
exercisable until December 14, 2008 at a price of $8.52 per share.
On January 29, 2004, the Company issued $4,000 aggregate principal amount
of promissory notes (the "2004 Notes") and warrants to purchase 392,158 shares
of Common Stock to 13 institutional and accredited investors. In connection with
this offering, Norton Herrick and Huntingdon entered into a letter agreement
with the purchasers of the 2004 Notes pursuant to which they granted to the
holders of the 2004 Notes in the event of an Event of Default (as defined in the
2004 Notes) the rights to receive payment under certain secured indebtedness
owed by the Company to Norton Herrick and Huntingdon and to exercise their
rights under security agreements securing such secured indebtedness. Pursuant to
the letter agreement, Norton Herrick and Huntingdon also executed
Powers-of-Attorney in favor of a representative of the 2004 Note holders
pursuant to which such representative may, following an Event of Default, take
actions necessary to enforce the 2004 Note holders rights under the letter
agreement, including enforcing Norton Herrick's and Huntingdon's rights under
the security agreements. On April 12, 2004, the notes were converted into Common
Stock. In consideration for Huntingdon's consent to the Financing and execution
of the letter agreement upon receipt of shareholders' approval, the Company
agreed to reduce the conversion price of $1,150 principal amount of convertible
promissory notes held by Huntingdon from $2.00 to $1.27 and $500 principal
amount of convertible promissory notes held by Huntingdon from $1.82 to $1.27.
F-30
On April 28, 2004, the Company entered into a new credit agreement.
Herrick, Huntingdon and N. Herrick Irrevocable ABC Trust (the "Trust"), of which
Herrick was the beneficiary, consented to the new credit agreement and the other
transactions described above and entered into a subordination agreement with
Zohar. The new credit agreement required the aggregate amount of principal and
interest owed by the Company to Herrick, Huntingdon and the Trust be reduced to
$6,800 ("Permissible Debt") by June 1, 2004, and that the Permissible Debt be
further reduced by up to an additional $1,800 if the Company does not raise at
least $2,000 in additional equity in each of the two calendar years following
the execution of the new credit agreement. MediaBay received a fairness opinion
in connection with this transaction.
Pursuant to an agreement dated April 28, 2004, on May 25, 2004, Herrick
exchanged accrued and unpaid interest and dividends (including accrued and
unpaid interest distributed by the Trust to Herrick) owed to Herrick aggregating
$1,181.4 into (i) 11,814 shares of Series C Convertible Preferred Stock with a
liquidation preference of $100 per share convertible into an aggregate of
252,435 shares of Common Stock at an effective conversion price of $4.68, and
(ii) warrants to purchase 504,872 shares of Common Stock. The warrants are
exercisable until April 28, 2014 at an exercise price of $3.18.
Pursuant to an agreement dated April 28, 2004, on May 25, 2004, Huntingdon
exchanged the principal of the $500 principal amount note, $1,000 principal
amount note, $150 principal amount note and $350 principal amount note held by
Huntingdon, plus accrued and unpaid interest owed to Huntingdon aggregating
$1,171.2 into (i) 31,713 shares of Series C Convertible Preferred Stock
convertible into an aggregate of 677,628 shares of Common Stock at an effective
conversion price of $4.68, and (ii) warrants to purchase an aggregate of
1,355,256 shares of Common Stock. The warrants are exercisable until April 28,
2014 at an exercise price of $3.18. If the amount of the Permissible Debt is
required to be reduced due to the Company's failure to raise the requisite
additional equity, such reduction will automatically occur by the exchange of
Permissible Debt held by Huntingdon for additional shares of Series C
Convertible Preferred Stock in an aggregate liquidation preference equal to the
amount of debt exchanged and warrants to purchase a number of shares of Common
Stock equal to two times the number of shares of Common Stock issuable upon
conversion of the Series C Convertible Preferred Stock.
Herrick and Huntingdon agreed not to demand repayment of their debt until
the earlier of (i) the repayment of the New Credit Agreement or (ii) June 28,
2007. The remaining promissory notes held by Herrick, Huntingdon and the Trust
are guaranteed by certain subsidiaries of the Company and secured by a lien on
the assets of the Company and certain subsidiaries of the Company.
On April 28, 2004, the Company repaid $1,600 principal amount of the
$3,200 principal amount convertible note issued to ABC Investments, L.L.C., a
principal shareholder of the Company. We issued a new $1,600 note (the "New ABC
Note") for the remaining principal amount. The New ABC Note extends the maturity
date from December 31, 2004 to July 29, 2007. In exchange for extending the
maturity date, the conversion price of the New ABC Note was reduced to $3.00.
The closing sale price of our common stock on the closing date was $2.88. During
October 2004, ABC Investments, L.L.C. converted $1,000 principal amount of the
New ABC into shares of Common Stock pursuant to the terms of the note.
(16) Segment Reporting
For 2005, 2004 and 2003, the Company has divided its operations into four
reportable segments: Corporate, Audio Book Club ("ABC") a membership-based club
selling audiobooks in direct mail and on the Internet; Radio Spirits ("RSI")
which produces, sells, licenses and syndicates old-time radio programs and
MediaBay.com a media portal offering spoken word audio content in secure digital
download formats. Segment operating income is total segment revenue reduced by
operating expenses identifiable with that business segment. Corporate includes
general corporate administrative costs, professional fees and interest expenses.
The Company evaluates performance and allocates resources among its three
operating segments based on operating income and opportunities for growth. The
Company evaluates performance and allocates resources among its three operating
segments based on operating income and opportunities for growth. RadioClassics,
which was created to distribute the Company's proprietary old-time radio content
across multiple distribution platforms including traditional radio, cable
television, satellite television (DBS), satellite radio and the Internet, is
aggregated with RSI for segment reporting purposes. Inter-segment sales are
recorded at prevailing sales prices.
F-31
The accounting policies of the reportable segments are the same as those
described in Note 3. Inter-segment sales are recorded at prevailing sales
prices.
Twelve Months Ended December 31, 2005 Inter-
Corporate ABC RSI (1) Mbay.com segment Total
---------- --- --- -------- ------- -----
Sales - 4,648 4,135 173 (1) 8,955
Operating (loss) profit (4,679) (1,698) (3,644) (389) 55 (10,355)
Interest expense, net of interest income 510 - - - - 510
Loss on early retirement of debt 579 - - - - 579
Loss before income taxes (5,768) (1,698) (3,644) (389) 55 (11,444)
Dividends and deemed dividends on Preferred
Stock 18,869 - - - - 18,869
Income tax - -
Net (loss) income applicable to common shares (24,637) (1,698) (3,644) (389) 55 (30,313)
Total assets - 9,154 9,498 15 - 18,667
Acquisition of fixed assets - 1,687 - - - 1,687
(1) Includes a charge for impairment of goodwill of $3,502.
Inter-
Twelve Months Ended December 31, 2004 Corporate ABC RSI Mbay.com segment Total
---------- --- --- -------- ------- -----
Sales - 12,303 6,382 205 (59) 18,831
Operating (loss) profit (2,108) (3,912) 141 (416) 17 (6,278)
Interest expense 9,078 - 4 - - 9,082
Loss on early retirement of debt - - - - - -
Loss before income taxes (11,186) (3,912) 137 (416) 17 (15,360)
Dividends on Preferred Stock 574 - - - - 574
Income Tax 14,753 14,753
Net (loss) income applicable to common shares (26,513) (3,912) 137 (416) 17 (30,687)
Total assets - 3,508 13,122 1 (55) 16,576
Acquisition of fixed assets - 128 8 - - 136
Inter-
Twelve Months Ended December 31, 2003 Corporate ABC RSI Mbay.com segment Total
---------- --- --- -------- ------- -----
Sales $ -- $26,379 $10,247 $ 138 $(147) $36,617
Operating (loss) profit (3,880) 349 804 (481) (19) (3,227)
Interest expense 1,913 -- 12 -- -- 1,925
Income tax expense 1,200 271 -- -- 1,471
Dividends on preferred stock 246 -- -- -- -- 246
Net (loss) income applicable to common
shares (6,039) (851) 521 (481) (19) (6,869)
Total assets 24,312 14,613 38,925
Purchase of fixed assets -- 14 2 -- -- 16
F-32
(17) Quarterly Operating Data (Unaudited)
The following table presents selected unaudited operating data of the
Company for each quarter in the three year period ended December 31, 2005.
Year Ended
December 31, 2005 1st 2nd 3rd 4th
Quarter Quarter Quarter Quarter
----------- ---------- ---------- ----------
Sales $ 3,353 $ 2,272 $ 1,387 $ 1,943
Cost of sales 1,796 1,607 1,002 1,515
Net (loss) income applicable to common shares (19,234) (2,950) (2,240) (5,889)
Basic and diluted loss per share: $ (4.61) $ (0.47) $ (0.25) $ (0.56)
Year Ended
December 31, 2004 1st 2nd 3rd 4th
Quarter Quarter Quarter Quarter
----------- ---------- ---------- ----------
Sales $ 5,684 $ 4,801 $ 3,849 $ 4,496
Cost of sales 2,570 2,228 3,975 3,774
Net (loss) income applicable to common shares (1,168) (7,111) (3,784) (18,624)
Basic and diluted loss per share: $ (0.54) $ (2.40) $ (1.26) $ (4.98)
Year Ended
December 31, 2003 1st 2nd 3rd 4th
Quarter Quarter Quarter Quarter
----------- ---------- ---------- ----------
Sales $ 10,697 $ 9,407 $ 9,572 $ 6,941
Cost of sales 5,234 4,124 4,252 3,869
Net (loss) income applicable to common shares (1,537) (228) 285 (5,389)
Basic and diluted income (loss) per share:
Basic earnings (loss) per common share $ (.66) $ (.12) $ .12 $ (2.28)
Diluted earnings (loss) per common share $ (.66) $ (.12) $ .12 $ (2.28)
(18) Subsequent Events
On January 31, 2006, Patricia G. Campbell resigned her position as Chief
Operating Officer of the Company. Ms. Campbell agreed to continue to provide
services to the Company for a period of six (6) months (the "Term"), during
which she agreed to devote her full time for the first three (3) months and half
of her time to the Company's business during the second three (3) months. The
Company agreed to pay Ms. Campbell at the rate equal to her base salary when she
was employed by the Company of $215,000 (per annum) during the first three (3)
months and at the rate of $107,500 (per annum) during the second three (3)
months. Certain stock options previously granted to Ms. Campbell will remain
exercisable for their full term, and certain other stock options are no longer
exercisable and terminated as of January 31, 2006. Ms. Campbell agreed not to
compete or engage in a business competitive with the Company's business during
the Term and for a period of two years thereafter.
F-33
SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS AND RESERVES
For the years ended December 31, 2005, 2004 and 2003
Balance Amounts Charged Write-Offs
Beginning of to Net Amounts Against Balance End
Period Income Acquired Reserves of Period
---------------- ------------------ ------------ ---------------- --------------
Allowances for sales returns and doubtful accounts:
Year Ended December 31, 2005 $ 2,708 $ 51 $ 1,226 $ 1,533
Year Ended December 31, 2004 $ 4,446 6,192 -- 7,930 2,708
Year Ended December 31, 2003 $ 5,325 20,900 -- 21,779 4,446
Valuation allowance for Federal and State deferred tax assets
Year Ended December 31, 2005 $ 44,940 $ -- $ -- $ 5,423 $ 50,363
Year Ended December 31, 2004 $ 23,826 14,753 6,361 -- 44,940
Year Ended December 31, 2003 $ 21,911 1,471 -- 446 23,826
F-34
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
MEDIABAY, INC.
By: /s/ Robert Toro
-----------------------------------------
Robert Toro
Chief Financial Officer and Senior
Vice President of Finance
Pursuant to the requirements of the requirements of the Securities
Exchange Act of 1934, this report has been signed below by the following persons
on behalf of the registrant in the capacities and on the dates indicated.
Signature Title Date
--------- ----- -------
/s/ Joseph Rosetti Chairman and Director March 30, 2006
-------------------------------
Joseph Rosetti
/s/ Jeffrey Dittus Chief Executive Officer and Director March 30, 2006
------------------------------- (Principal Executive Officer)
Jeffrey Dittus
/s/ Robert Toro Chief Financial Officer and March 30, 2006
------------------------------- Senior Vice President of Finance
Robert Toro (Principal Financial and Accounting Officer)
/s/ Daniel J. Altobello Director March 30, 2006
-------------------------------
Daniel J. Altobello
/s/ Richard Berman Director March 30, 2006
-------------------------------
Richard Berman
/s/ Robert Montgomery Director March 30, 2006
-------------------------------
Robert Montgomery
/s/ Marshall C. Phelps Director March 30, 2006
-------------------------------
Marshall C. Phelps
/s/ Carl U. J. Rossetti Director March 30, 2006
-------------------------------
Carl U.J. Rossetti
F-35